GA Mowbray

Administrative Appeals Tribunal


Decision date: 5 August 2004

GA Mowbray


1. Mrs Wilma Domjan has had a joint interest in a number of investment properties for some years, for present purposes relevantly the 1997, 1998 and 1999 taxation years. There was a change in the composition of her investments during this period.

2. She has sought review in the Tribunal of taxation assessments on

3. Mrs Domjan has not satisfied me that the assessments for most of her claims were excessive. However, I have accepted the vanity repairs as deductible in 1998 and decided that there should be a reapportionment from January 1999 of the loan borrowings between two of her properties - Downer and Braddon. I have also rejected Mrs Domjan's submission that the 25 percent penalty should not be applied.


4. During the 1997, 1998 and 1999 tax years Mrs Wilma Domjan had an interest in three investment properties

5. During the relevant years Mrs Domjan's interest in these rental properties was financed through a Westpac facility held jointly with her husband

6. At 1 July 1996 Mrs Domjan and her husband jointly owned shares purchased for a total of $39,970.19 and Mrs Domjan's 50 percent interest was $19,985

General principles

7. The relevant legislation for deduction of losses and outgoings is provided in section 51(1) of the Income Tax Assessment Act 1936 (the 1936 Act) for the 1997 tax year and section 8-1 of the Income Tax Assessment Act 1997 (the 1997 Act) for the 1998 and 1999 years. Section 51 of the 1936 Act relevantly provides

``Losses and outgoings

(1AA) Subsection (1) does not apply to the 1997-98 year of income or a later year of income.

Note: Section 8-1 of the Income Tax Assessment Act 1997 sets out rules for working out what losses or outgoings an entity can deduct for the 1997-98 year of income and later years of income.

(1) 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.''

8. Section 8-1 of the 1997 Act provides

``General deductions

(1) You can deduct from your assessable income any loss or outgoing to the extent that:

  • (a) it is incurred in gaining or producing your assessable income; or
  • (b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

Note: Division 35 prevents losses from non- commercial business activities that may contribute to a tax loss being offset against other assessable income.

(2) However, you cannot deduct a loss or outgoing under this section to the extent that:

  • (a) it is a loss or outgoing of capital, or of a capital nature; or
  • (b) it is a loss or outgoing of a private or domestic nature; or
  • (c) it is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income;
  • (d) a provision of this Act prevents you from deducting it.


(3) A loss or outgoing that you can deduct under this section is called a general deduction .''

9. Section 1-3(2) of the 1997 Act provides that if the 1936 Act expressed an idea in a particular form of words and the 1997 Act appears to express the same idea in a different form of words in order to use a clearer or simpler style the ideas are not to be taken to be different just because different forms of words were used.

10. An amount will be deductible where there is some connection between the outgoing and the activities directed at gaining or producing the assessable income. The outgoing must be ``incidental and relevant'' to the gaining or producing the assessable income (
Ronpibon Tin NL & Tongkah Compound NL v FC of T (1949) 8 ATD 431 at 435; (1949) 78 CLR 47 at 56). The occasion of the loss or outgoing should be found in whatever is productive of the assessable income.

11. By virtue of section 14ZZK of the Taxation Administration Act 1953 Mrs Domjan has the burden of proving that the assessments

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which are the subject of the objection decisions under review are excessive.


12. The specific issues in this case are

Are certain interest expenses deductible

Some principles

13. Interest is deductible under section 51(1) of the 1936 Act and section 8-1 of the 1997 Act to the extent to which it is incurred in gaining or producing assessable income or in carrying on a business for that purpose and is not of a capital, private or domestic nature.

14. When looking at whether an outgoing can be a deduction the phrase ``incidental and relevant'' refers to its nature or character (
Charles Moore & Co (WA) Pty Ltd v FC of T (1956) 11 ATD 147 at 149; (1956) 95 CLR 344 at 351). Normally this task of characterisation will involve inquiring what the purpose of the loss or outgoing was (
Colonial Mutual Life Assurance Society Limited v FC of T (1953) 10 ATD 274 at 283; (1953) 89 CLR 428 at 454).

15. In
Kidston Goldmines Ltd v FC of T 91 ATC 4538 at 4545-4546; (1991) 22 ATR 168 at 176-177 Justice Hill said

``In most cases, the purpose of the borrowing will be ascertained from the use to which the borrowed funds were put...


... To be deductible the outgoing, or in a case of apportionment a part of an indivisible outgoing, must be seen to be incidental and relevant to the activity which is directed to the gaining or production of assessable income. In the normal case, the fact that the funds borrowed have been borrowed for the purpose of that activity and can still, in the year of income in which the deduction is claimed, be seen as having that purpose, will lead readily to the conclusion that the interest will be incidental and relevant to the income producing activity. Again, in the usual case the application of funds to an income producing purpose will demonstrate the relevant connection between the outgoing and the income producing activity. Indeed there is much to be said for the view that the tests of purpose and application of funds are but two sides of the one matter.''

16. As Justice Brennan noted in
Ure v FC of T 81 ATC 4100 at 4104; (1981) 11 ATR 484 at 489

``The purposes for which money is laid out is an issue of fact, turning upon the objective circumstances which human experience would judge to be relevant to the issue...''

17. However, as the High Court noted in
Fletcher & Ors v FC of T 91 ATC 4950; (1991) 22 ATR 613 subjective motives may be relevant if the assessable income resulting from the outgoing is less than the amount of the outgoing.

The Westpac loan facility

18. As outlined above Mrs Domjan and her husband financed much of their investment activities particularly in the Downer and Main Beach rental properties through a joint loan facility with Westpac. Until March 1997 this was a Premium Options Home Loan. After that time it became a First Option Home Loan. Both of these loan accounts had a redraw facility but did not have any sub-accounts.

19. From July 1996 to March 1997 regular fortnightly deposits were made to the loan account by direct deposits of salary. During this period monthly deposits of varying amounts were also made directly by real estate agents with the proceeds from the letting of rental properties.

20. From April 1997 to April 1999 regular fortnightly payments of $1,200 or monthly payments of $2,400 were made to the loan account by way of direct deposit from the Westpac cheque/savings account which the Domjans also held. Again from April 1999 to June 1999 regular fortnightly deposits of $500 were made to the loan account by way of direct salary deposit. Very substantial additional deposits were also made to the loan facility. These included gifts from Mrs Domjan's mother and $78,505.97 from Mr Domjan's retrenchment payout.

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21. Over the period in question Mrs Domjan and her husband made the following drawdowns by way of redraw of funds from the loan facility.

   | Withdrawal       | Amount     | Where Deposited         |
   | 16 July 1996     | $8,000.00  | Cheque/savings          |
   | 9 September 1996 | $4,000.00  | Cheque/savings          |
   | 8 October 1996   | $22,793.00 | Repaid loan for car;    |
   |                  |            | cheque/savings; cash    |
   | 2 December 1996  | $3,000.00  | Cheque/savings          |
   | 24 December 1996 | $3,000.00  | Cheque/savings          |
   | 18 March 1997    | $83.13     | Cheque/savings          |
   | 21 October 1997  | $6,000.00  | Cheque/savings          |
   | 5 December 1997  | $7,000.00  | Visa                    |
   | 7 December 1998  | $4,400.00  | Visa                    |
   | 14 May 1999      | $12,500.00 | Shares; cheque/savings; |
   |                  |            | loan to friend          |

22. Mrs Domjan placed great reliance on her modus operandi which she described in her Outline of Submissions as follows

``• Purpose was to minimize exposure to interest charges and to ensure cash flow to meet substantial monthly loan repayments of either $1,137.97 or thereabouts per fortnight or $2,400 per month.

• Property income was insufficient and irregular so other sources were needed to fund repayments. Therefore transfers from salary or cheque account was [sic] as a reliable source of funds to ensure the monthly re payments [sic] were made. If a loan repayment was late despite funds in the redraw facility a penalty was payable.

• Sometimes our cash flow did not work out due to unforeseen expenditure both income and private but we knew we could re access our personal funds from the redraw facility. The redraw facility really was our investment savings account.

• When surplus funds were available such were deposited to the redraw facility knowing those funds could be re accessed. Those funds were not paid off the loan but went to the redraw facility.

• Those funds were private funds and nothing to do with our income pursuits apart from having the effect of reducing interest otherwise payable.

• When funds were redrawn we considered our overall position, where cash flow was needed and decided where best to deposit funds to save bank fees and deposit taxes. That is why funds were deposited to the VISA account $7,000 December 1997. There were funds in the cheque account to meet the VISA payment but withdrawals for the loan and another loan repayment was [ sic] needed to be funded and there were income related expenses to be met.''

23. The modus operandi was clearly designed to

The character of the redraws

24. It was Mrs Domjan's contention that when she made deposits of private funds to the loan account into the redraw facility she ``parked additional funds solely from private sources, in the redraw facility of a loan facility that was originally drawn down 100% to fund income producing property, knowing [she] was able and had an enforceable right to re access those funds...''.

25. She summarised her argument as follows

26. Mrs Domjan has a loan account that allows her to make payments over and above the minimum payments required under the agreement. She is then able to redraw those additional funds. This she has done. Her argument is that the loan agreement is a chose in action with a right in Mrs Domjan and her husband to access funds in the redraw facility as if it was a separate sub-account in the loan facility.

27. In making a redraw Mrs Domjan was merely re-accessing her own private funds from the joint bank account which she held with her husband. She had not approached the bank for a further loan, but had merely withdrawn previously deposited personal funds. As she was re-accessing her private funds it followed that the increased interest expense on the loan facility resulting from the redraw was attributable to her investment activities.

28. The Commissioner in his submissions correctly described Mrs Domjan's position as

``29. The extra repayments... create a debt due by the lender to the borrower and are... an asset of the borrower after they have been used to discharge part of the loan debt.. [ T]he reduced loan balance... [comprises] the previous loan balance with a notional offset credit available in respect of extra repayments as if those extra repayments were standing to the credit of the borrower in a separate account in the books of the lender''

29. The Commissioner contends that amounts redrawn from a loan such as this constitute a new borrowing of funds. His views are set out in Taxation Ruling TR 2000/2 - ``Income tax: deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities'' - issued on 1 March 2000

``Further borrowings

39. Where a loan facility allows for redraws of extra repayments, we consider those redraws constitute new borrowings of funds that cannot be traced to the extra repayments. In this regard the term 'redraw' is a misnomer. It is in effect a new borrowing of funds. Similarly, a draw down on a line of credit that has not been fully drawn is a new borrowing of funds.

40.... Those funds used to make extra repayments simply cease to exist as an asset of the borrower after being used to discharge part of the loan debt. In our view, the redraw facility does not involve separate loan and deposit accounts...


42.... under a redraw facility, the loan agreement gives the borrower the right, subject to restrictions in some cases, to borrow a further amount up to the balance of the loan debt that would have been outstanding if the minimum loan repayments required under the loan agreement had been made. The extra repayments do not create a debt payable by the lender to the borrower and are not an asset of the borrower after they have been used to discharge part of the loan debt.

43. We consider... a redraw from a loan account, is a separate borrowing. Therefore, the deductibility of the interest on that separate borrowing depends on whether the interest is incurred in gaining or producing assessable income or is necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. To the extent borrowings are used for income producing purposes, that part of the accrued interest attributable to those borrowings is deductible. Conversely, that part of the accrued interest attributable to borrowings used for non-income producing purposes is not deductible.

ATC 2211

44. The balance outstanding on a mixed purpose line of credit sub-account or a mixed purpose loan account is an undivided single debt owed by the borrower to the lender. When repayments of principal are made, it is not considered possible to direct those payments to only that part of the borrowed funds used for a particular purpose as if it were a separate debt.''

30. The Commissioner pointed to some of the provisions of the loan agreements particularly those contained in the letter of 23 December 1996. These support his view that amounts available to Mrs Domjan to be redrawn did not stand as a credit in the account and that redraws amounted to new advances

31. I reject entirely Mrs Domjan's contention that the amounts available to her in the redraw are her private funds sitting to her credit in that facility. I agree with the Commissioner that the terms of the loan contract and the entries in her loan account directly contradict that assertion. The bank does not pay her interest for amounts which she says are funds standing to her credit. Rather the repayments reduce the loan balance outstanding and redraws increase the outstanding balance. The funds repaid do not remain the property of the debtor once they have been applied to reduce the liability. Instead they become the property of the creditor to whom they are paid.

32. For these reasons I agree with the Commissioner that an amount redrawn from this type of loan facility constitutes a new borrowing of funds. It is therefore necessary to consider the use to which those borrowed funds were put.

Principle in Roberts and Smith

33. There was some discussion at the hearing about whether Mrs Domjan was relying on the principle in
FC of T v JD Roberts; FC of T v Smith 92 ATC 4380; (1992) 23 ATR 494. The Commissioner contended that Mrs Domjan had asserted that each of the amounts drawn down from the loan account was simply a repayment of each partner's (Mrs Domjan and her husband's) capital contributions to the partnership. If that were the case it would be unnecessary to consider what the funds were used for once they were in the hands of the individual partner. The Commissioner argued that the principle in Roberts and Smith could not apply in this case because Mrs Domjan and her husband were not in a partnership at general law.

34. However, in her submissions Mrs Domjan made it clear that she was not seeking to rely on Roberts and Smith but rather she saw herself as only re-accessing private funds from her own bank account. She considered that the amounts which she deposited in the loan facility and redrew were her own private funds. They were not the deemed partnership funds and did not form any part of the outstanding loan.

35. Although I accept the contentions of the Commissioner it is not necessary to consider the Roberts and Smith principle any further given Mrs Domjan's concession. In any event as I have noted above I have rejected the view that the amounts deposited by Mrs Domjan and her husband into the loan facility for later redrawing represent an asset of hers which stands to her credit in the loan facility.

Purpose of the drawdowns

36. In view of my finding above that each new drawdown from Mrs Domjan's loan facility was a new borrowing, it is now necessary to consider the use to which the borrowed funds were put.

37. Mrs Domjan submitted that if I were unable to find that all redraws were merely a

ATC 2212

redraw of her own personal funds or that the loan facility was used constructively to fund her modus operandi then a total of $19,133.59 of outgoings was related to her investment activities.

38. The drawdowns are set out above at paragraph 21. It is clear that in most instances the funds drawn down were deposited in Mrs Domjan's Westpac cheque/savings account number 51-7856. In all but one instance when funds were deposited to the cheque/savings account that account had been in credit balance. Thus the drawn down funds were intermingled with funds already in that account.

39. In two instances the funds were drawn down and deposited to a Visa account (4564 7170 0062 1739) and then applied to the debit balance outstanding on the account.

40. The $8,000 drawn down on 16 July 1996 was deposited into the cheque/savings account when it was overdrawn by $210.77. In this case the Commissioner has accepted that $303.18 was used for an income producing purpose.

41. For the redraw of 14 May 1999 the Commissioner has also accepted that $2,500 was applied for income producing purposes in the acquisition of Capral shares. Of the remaining $10,000, $5,000 was a loan to a friend and $5,000 was deposited in the cheque/ savings account which was in credit balance.

42. On 8 October 1996 $2,000 went to the cheque/savings account which had funds in it. Of the remainder $19,910 was used to repay a loan on a car and details about the expenditure of $883 are unclear.

43. In Case 14/98,
98 ATC 201;
(1998) 39 ATR 1105 the Tribunal considered the circumstance of a taxpayer who had an overdraft account which he operated as a joint account with his wife solely for domestic convenience. The account was used to meet both domestic and income producing expenses. In the year in question the taxpayer claimed one half of the interest as being properly deductible for income tax purposes. The Tribunal found at ATC 205-206; 39 ATR 1110 that it was not possible to attribute any part of the interest incurred on the overdraft to any one item of expenditure during the year, particularly expenditure in relation to an investment property

``... While the decision in
Palvestments Pty Ltd v FC of T (1965) 13 ATD 527; (1965) 112 CLR 661; 9 AITR 691 was concerned with a more limited question of whether any part of overdraft interest related directly to income from dividends (s 50(a)) for the purpose of calculating a rebate under s 46, Menzies J (at ATD 529; CLR 664; AITR 639) questioned `how... can it be said that any particular part of the interest paid upon the overdraft account during the year... directly related to the dividends received in that year'. In the same way I must ask, in the circumstances of an overdraft such as this, how can it be said that any particular part of the interest on the applicant's overdraft can be identified as relating to any particular expenditure made during the year?''

44. The Commissioner relies on this authority to submit that once an amount of money is deposited into an account that already contains funds the account becomes a mixed pool of funds and it is not possible to determine the source of each withdrawal. It is impossible to determine whether the funds used to pay an otherwise deductible expense are sourced from the monies at interest or whether the funds used are sourced from Mrs Domjan's own monies.

45. It is further contended that once the funds that Mrs Domjan has drawn down were commingled with other funds in the cheque/ savings and Visa accounts the essential nexus was lost and it became impossible to say whether any particular part of the interest paid on the loan facility related to income producing expenditure.

46. I accept the Commissioner's submissions. Where the funds have been intermingled it is impossible to determine the use to which they have been put. In other words the purpose of the borrowing cannot be ascertained. It cannot be said that the expenditure - that is the payment of interest - has been incurred in the course of gaining or producing assessable income (
FC of T v Payne 94 ATC 4191; (1994) 28 ATR 58).

47. Furthermore

48. Although the Tribunal was taken in laborious detail through Mrs Domjan's transactions related and unrelated to the drawdowns I do not find it necessary to reproduce that detail here.

49. Apart from where the Commissioner has already accepted or conceded that parts of the drawdowns were used for an income producing purpose, I cannot be satisfied that any of the new borrowing of funds constituted by these drawdowns was used for an income producing purpose, for the reasons that I have given above. Likewise I cannot be satisfied that the interest on these drawdowns was incidental and relevant to the gaining or producing of assessable income (Ronpibon Tin).


50. On 16 July 1996 Mrs Domjan drew down $8,000 from her loan facility and deposited it in her cheque/savings account. In her contentions Mrs Domjan says that two tax refund cheques were received on 23 July 1996 and Mr Domjan's cheque of $7,849.01 was deposited to the loan account together with $151 withdrawn from the cheque account making a total of $8,000.01. She said this replenished the amount redrawn on 16 July 1996.

51. On 5 December 1997 Mrs Domjan drew down $7,000 from her loan facility and deposited it in her Visa account. Initially Mrs Domjan said this amount was repaid in full on 25 March 1998 with funds from a gift from her mother. But in her outline of submissions she says

``107.... The circumstances are slightly different in that between 2 January 1998 and 2 March 1998 there were three amount [sic] of $2,400 paid into the loan facility from the cheque account which were privately sourced and really settled the $7,000 draw down.''

52. It is Mrs Domjan's contention that the repayments replenished the loan account specifically in relation to the redrawn payments on 16 July 1996 and 5 December 1997. She had therefore recouped the two drawdowns and interest should not be disallowed past the dates on which the drawdowns had been replenished.

53. As noted earlier the Commissioner takes the view that the balance outstanding on a mixed purpose loan account is an undivided single debt owed by the borrower to the lender. When repayments of principal are made it is not considered possible to direct those payments to only that part of the borrowed funds which were used for a particular purpose as if it were a separate debt. Rather the payment is applied proportionately to reduce the balance of the outstanding principal attributable to the income producing use and non-income producing use respectively.

54. One exception to this principle is where money borrowed and applied to a particular use is recouped. This happens when an amount of money is borrowed and used for buying a particular asset and some part of it is recovered; for example on the sale of the asset that had been purchased with the borrowed funds.

55. The Commissioner argued that the repayments made on 23 July 1996 and 25 March 1998 respectively did not amount to recoupments as the funds in question were not recovered. Mrs Domjan had not received a refund of the expenses she paid using the redraw funds and then applied that refunded amount to repay the loan. Rather the Commissioner said that Mrs Domjan merely decided to deposit a gift from her mother and her tax refund to the loan account. This was clearly not the same as borrowing money to purchase an asset and then depositing the proceeds from sale of the asset back into the loan account once the asset was sold.

56. I am in complete agreement with the Commissioner for the reasons that he has given which I have outlined above. I do not think that Mrs Domjan is assisted by Case 14/98,
98 ATC 201;
(1998) 39 ATR 1105 on which she sought to rely. In that case the Tribunal discussed the problems where there was commingling of funds and the difficulty of characterising any particular dollar of interest as being incurred in relation to any one item of expenditure. My finding is reinforced by Mrs Domjan's own uncertainty about which repayments replenished the 5 December 1997 drawdown (see paragraph 51 above).

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Beneficial interest after Mr Domjan's loan payment of 7 April 1999

57. Mr Domjan received a retrenchment payout on 7 April 1999 of $98,505.87. He and Mrs Domjan had previously calculated the sum that they determined would settle Mr Domjan's half share of the remaining debt in the loan facility. This was $78,505.07 which was then deposited by Mr Domjan in the joint facility on 7 April 1999. In Mrs Domjan's view the remaining balance was ``to my account''. In Mrs Domjan's view the beneficial interest in the loan facility now rested with her although the legal interest was not hers alone. In her Statement of Facts, Issues and Contentions she said

``450. While the loan may have continued in joint names the remaining outstanding funds in the facility related to my indebtedness financing my equity in the joint and solely owned income producing assets that I was beneficially entitled and required to return in accordance with Section 92(1)(a) of the Act... An objective analysis of the circumstances leads to the conclusion that the use to which the remaining borrowed funds were applied related to my sole beneficial interest and thus the interest accrued on the facility after the payment of the lump sum by my husband was solely to my account.''

58. In the Commissioner's view Mrs Domjan and her husband had jointly borrowed to fund their investment acquisitions and they remained jointly liable for the interest payments even after Mr Domjan had placed these funds in the loan facility. The Commissioner's reasons were that

59. Alternatively the Commissioner asserted that the assumption of liability for the additional interest payments made voluntarily by Mrs Domjan was purely a domestic arrangement in which Mrs Domjan sought to advance her husband's finances. As a consequence the requisite nexus between the outgoing and the gaining of assessable income was not established. It was similar to charity lending. Thus in assuming liability for her husband Mrs Domjan could only claim for 50 percent of the interest. She assumed any amount over that 50 percent voluntarily and thus the added liability was not incurred in earning assessable income.

60. Both parties accepted that Mrs Domjan and her husband were deemed to be in a partnership for income tax purposes under both the 1936 and 1997 Acts. Furthermore Case Q35,
83 ATC 154 provided support for the Commissioner's view that it was the legal interest of the two partners which was of importance here. In circumstances such as that of the Domjans which involved a tax law partnership losses of income were to be shared equally under that partnership (Case 63/96, 34 ATR 1081,
Cripps v FC of T 99 ATC 2428).

61. As the Tribunal noted in Case 63/96 the test for deductibility of interest is the purpose of the borrowing and the use to which the borrowed funds are put. Accordingly in the matter before me I adopt the conclusion reached by the Commissioner

``At the time the Applicant's husband made the payment of $78,505.97 to the loan account, the loan was being used to fund the

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purchase of partnership assets ie assets purchased in the name of the Applicant and her husband as well as assets purchased in the Applicant's name only. The balance of the loan outstanding that relates to the purchase of partnership assets clearly belongs to the deemed partnership and as such the interest incurred on this part of loan should be used to calculate the net income of the Applicant and her husband in accordance with subsection 92(1) of the ITAA 36.''

62. I therefore find that Mrs Domjan can only claim for 50 percent of the interest accruing after 7 April 1999.

The Downer sale and Braddon acquisition

63. On 29 January 1999 50 percent of the Downer property was sold to one of Mrs Domjan's sons for consideration of $65,000. Mrs Domjan's son paid a deposit of $9,000 and then obtained a bank loan for the balance of $56,000. The $56,000 was paid electronically to the bank settling the acquisition of the Braddon property. This property was purchased on 20 January 1999. Mrs Domjan acquired a third interest in the Braddon property.

64. Mrs Domjan and her husband also sold 500 NAB and 75 BHP shares for $13,060.20 and $861 respectively. Mrs Domjan says that she applied this $13,921.20 to the acquisition of her interest in the Braddon property as well. However, the proceeds from the sale of the shares were banked to the cheque/savings account. Here these funds were intermingled with other funds in that account which was in credit balance at the time the deposits were made.

65. Mrs Domjan asserted that the portion of the loan related to Downer and her share should be reduced based on the percentage of the asset that was sold. That part of the loan apportioned to Braddon should be increased because the proceeds from the sale of those assets - part of Downer and the shares - were applied towards the purchase of Braddon.

66. The Commissioner opposed this

67. In my view the Commissioner's approach to the funds from the Downer sale is unduly technical and does not take sufficient account of commercial reality. In Taxation Ruling TR 2000/2 the Commissioner said

``30. The term `use' in this context does not necessarily require a strict tracing approach to the application of the borrowed money... Rather, the characterisation of interest on borrowed money (and the purpose of the borrowing) is ascertained by reference to the advantages sought from the use of the borrowed funds....

  • ...

31. However, the original purpose of the borrowing and use of the borrowed funds will not always determine the deductibility of interest. Where borrowed money has been used to purchase an income producing asset and that asset subsequently has been sold, the original use of that money will not necessarily determine the character of the interest expense accruing on those borrowed funds....


37. Where the funds borrowed under a line of credit remain outstanding, we believe the deductibility of interest is to be determined by considering the ongoing application of those borrowed funds. Interest is considered to be the cost of retaining the use of the outstanding line of credit funds in the period in which that interest accrues. Where borrowed funds are recouped from the sale

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of an income producing asset purchased with that money, the connection between the interest expense and the income producing use of that asset will be broken when the asset is sold. Interest on those borrowed funds will only be deductible after that time if it can be established that the accrued interest continues to be incurred in the course of deriving assessable income or in carrying on a business.... Deductibility of interest on those borrowed funds will be determined by a consideration of the advantages sought from that new use to which those funds are redirected.''

68. It seems tolerably clear to me that the ``advantages sought from the use of the borrowed funds'' after the half sale of Downer were transferred directly to Braddon. This was not the original purpose but the current use for those funds. After all, the funds were transferred by electronic deposit directly to the bank settling the Braddon acquisition.

69. However, the same result does not follow from the sale of the NAB and BHP shares. The proceeds of these sales were deposited in Mrs Domjan's cheque/savings account and there they were intermingled with other funds at a time when the account was in credit balance. For the reasons given earlier when discussing commingling of funds and repayment redraw drawdowns it is not possible to identify which funds from the cheque/savings account were directed to the Braddon acquisition.

70. Consequently the loan funds attributed to the Braddon property should be reapportioned from January 1999 with half the outstanding portion of the loan attributed to Downer at the time the $56,000 was paid in the purchase of the interest in Braddon.

Conclusions on interest expenses deductibility

71. In summary my conclusions on interest expenses deductibility are

Is the building insurance deductible

Relevant facts

72. In 1996 Mrs Domjan and her husband obtained a loan with Westpac to finance their rental properties

73. The following deductions were claimed

These amounts represented 50 percent of the insurance on the rental property. Mrs Domjan had purchased the property with her husband and she was claiming only her contribution.

Deductibility of building insurance

74. Mrs Domjan contended that the payment was an outgoing incurred in producing assessable income

75. In her Statement of Facts, Issues and Contentions Mrs Domjan stated

``594. In arranging our investment loan to finance our income producing assets it was a condition of the loan that our property be insured. If we were not prepared to insure the property the loan would not have been granted. The loan document solely related to assets acquired for income producing purposes and does not include any loan funds to finance our residence. It should be noted that our residential home... [in] Campbell ACT was owned outright, with the mortgage paid out in 1993 on a separate loan.''

76. The Commissioner submitted that

Therefore the insurance payment does not form a deduction under section 51(1) of the 1936 Act or sections 8-1(2)(a) and (b) of the 1997 Act. Instead it falls within the exceptions to those sections.

77. Mrs Domjan relied on statistics found in a newspaper article to claim that she would not have had to purchase insurance were it not that the bank required it to finance her property purchase. She pointed out that home insurance is not obligatory

``598. Property insurance is not compulsory. In the Melbourne Herald Sun, Page 15, 23 December 2002, in an article written by M/s Susie O'Brien relating to uninsured properties. [sic] M/s O'Brien quoted from figures derived from Australia Bureau of Statistics that show that 22 per cent of Victoria's 1.73 million households do not have insurance to protect their homes and possessions, some 377,000 household [sic]. Similar percentages have been broadcast for properties in the ACT during the recent bushfires.

599. In arranging our loan facility it was a condition of the loan that the property be insured and our home was put forward as the sole security for the loan. Whether the property would have been otherwise insured that is hypothetical and the figures from the Melbourne Sun Herald show a significant number of properties are left uninsured.

600. In light of the insurance being a condition of a loan agreement the funds from which financed solely income producing property it is contended the expense is correctly deductible under s. 8-1 or s. 51(1) as it was necessarily incurred in gaining assessable income.''

78. Mr Booth argued that home insurance might be a personal choice for some people and this would count as a private expenditure. But in Mrs Domjan's case the bank insisted that she have the insurance or else her home could not be used as security. He contended that this meant that the insurance was a necessary part of producing assessable income.

79. Mrs Domjan later contradicted the assumption that she would not normally have had home insurance. At one point she said

``Mrs Domjan: I have had insurance on my property for a very long time because normally the property is the asset put up for the investment properties.

Mr Mowbray:... When was the first investment property that you...

Mrs Domjan: 1979.

Mr Mowbray: And did you have insurance on your house before that?

Mrs Domjan: I had insurance on my house in Melbourne, yes.''

80. She later confirmed this

``Mr Mowbray: On the insurance issue, if you didn't have any investment properties would you insure your house or not?

Mrs Domjan: Yes.

Mr Mowbray: You would insure your house. You're quite clear about that?

Mrs Domjan: On the home loans that you have, you have to have insurance, so it's mandatory for that.


But even if I didn't have that, I would have insured my property. I can't afford to lose that sort of money.''

ATC 2218

81. In oral submissions Mr Quinn, counsel for the Respondent, said

``Mr Quinn: It was the requirement of the Applicant's loan agreement that her residential property would be insured. That would form part of the security for the loan. The Applicant seeks to deduct that amount. We say that that is a private... amount and therefore not deductible....


[W]e say that it is not incurred in the course of earning your assessment income and in those circumstances it is an expense of a private nature which is excluded by the second limb of section 51 and section 8-1... from 1 July 1997.

Mr Mowbray: If I were to say to you that I would not have insured my house if it were not for the loan that I had taken on it for other purposes, or the loan for which surety or security was the house, would that satisfy your test?

Mr Quinn: It may. There is still a difficulty with that because it is an amount to secure a capital sum,... being the advance of the loan amount, and we would say that by reason of that fact, it would fall foul of the second limb of section 51....


So it is either an amount to secure a capital sum or it is of a private nature... still the home is insured. There is a private element to it and... the Applicant gets private use from that insurance premium.... It may be a condition of the loan, but we say that it would generally be either an amount to secure a capital sum or of a private nature.''

82. The Commissioner relied on
FC of T v Faichney 72 ATC 4245; (1972) 129 CLR 38,
Handley v FC of T 81 ATC 4165; (1981) 11 ATR 644 and
Thomas v FC of T 72 ATC 4094; (1972) 3 ATR 165 in support of his contention that the insurance was an outgoing of a private nature for the purposes of the exception in both Acts.

83. In Faichney Justice Mason held that interest on a mortgage over a property in which the taxpayer had a laboratory and study for the purposes of producing income could not be deducted under section 51(1) of the 1936 Act. He said at 72 ATC 4249; 129 CLR 43 ``Expenditure incurred in the erection of the study or in the renovation is as much an outgoing of a capital, private or domestic nature as expenditure on any part of the home.'' In that case the study was part of the family home. In this matter the situation is different. The payment is in relation to insurance over the whole home. And the whole home is security for an income producing purpose; that is a rental property.

84. Justice Walsh in Thomas at ATC 4097; ATR 168 held that

``... the house should not be regarded in the circumstances of this case as being or as including part of the business premises of the appellant and the loan should not be regarded as having been raised for the purpose of providing him with business premises. Payment of the interest, in so far as it was an outgoing connected with the cost of extensions to the house was, in my opinion, an outgoing `of a capital, private or domestic nature' within the meaning of sec 51(1) of the Act. In my opinion it did not lose that character merely because the appellant, like most professional men, did some of his work at home, or because he used one of the added rooms for that purpose.''

85. Thomas was a case in which a barrister acquired land and used it partly for primary production and partly for work. Justice Walsh held that the interest on an overdraft for renovating the taxpayer's home was not deductible because it was not directly related to the purpose of income producing.

86. Handley concerned a barrister's claim for interest and insurance to be deducted for his study at home. Justice Mason held at ATC 4171; 11 ATR 651 that

``... outgoings incurred in gaining or producing assessable income and outgoings of a capital or domestic nature are not mutually exclusive. Whether the same is true of outgoings of a private nature is a question that may be left to some future occasion. The very form of sec 51(1) recognises that there are some outgoings which, though incurred in gaining assessable income, nevertheless fall within the exception. Then, to the extent to which they have the latter character, they are not allowable deductions.''

ATC 2219

87. Justice Wilson in Handley at ATC 4176; 11 ATR 656 said

``... The room used as a study does not cease to be part of the taxpayer's home merely because as a matter of convenience he uses it for professional purposes for 20 hours per week during 45 weeks of the year. It is true that in choosing for purchase in 1969 this particular residence as a home for himself and his family the taxpayer was influenced by the fact that there was in it a room which he considered to be suitable for use by him as a study. But it remained essentially part of his home. The payments for mortgage interest, rates and insurance premiums were of a kind which in the circumstances of this case cannot be apportioned between home and office expenses. They related to the building and/or land as a whole, and are not affected in any way at all by reason of the fact that the taxpayer performs professional work on the premises.''

88. None of these cases is directly on point. They refer to interest and insurance payments for single rooms in a building. The present matter concerns insurance over an entire house. The cases cited deal with taxpayers directly conducting their business on their home premises. In the present matter Mrs Domjan is claiming the deduction for income produced elsewhere. The insurance is needed to secure the loan in order to buy a property which will produce income.

89. Nevertheless I find the reasoning in these cases persuasive. In particular Justice Mason's reasoning in Faichney at ATC 4250; 129 CLR 45 is relevant to the present matter. At this point in his judgment Justice Mason discussed the taxpayer's claim for electricity and heating used in using the study for an income producing purpose. He said

``It may be acknowledged that expense incurred in the provision of light and heating in the taxpayer's home is normally an expense of a private or domestic nature, disassociated from the gaining or production of assessable income. However, to the extent to which the expenditure is incurred in providing light and heating for the taxpayer exclusively whilst he is engaged in work from which he derives income it may be said to be an expense having a business or employment character. By reason of that circumstance it is not an expense of a private or domestic nature. If, however, the light and heating are provided, not exclusively for the taxpayer's benefit whilst he is working, but also for the members of his family, the expenditure continues to have a private or domestic character and to that extent falls within the exception to sec 51(1).''

90. In my opinion this comment of Justice Mason in Facihney is particularly pertinent to the present matter. Justice Mason found that the electricity was used for the purpose of producing income and was therefore deductible. He found that the proportion claimed as deductible was used exclusively for the taxpayer's benefit.

91. In this present matter the home insurance has a benefit not to Mrs Domjan exclusively, but to all members of her immediate family and Mrs Domjan herself as a domestic matter unrelated to the security

92. In any case the nexus between the insurance payments and the production of income seems too wide to be sustained. The insurance is needed to secure a loan. What the loan produces is irrelevant to the security and the insurance.

93. This leads to the Commissioner's alternative argument, that the insurance payment is a capital sum. The insurance was needed to gain capital in order to buy a property that would produce further income. Therefore it is a capital expenditure.

94. In summary I am satisfied that

95. Therefore the insurance over the Campbell property is not deductible because it falls within the exceptions to section 51(1) of the 1936 Act and section 8-1 of the 1997 Act.

Is the vanity deductible

Relevant facts

96. In the 1998 tax year Mrs Domjan replaced the vanity in her Main Beach, Queensland, property

97. In her Statement of Facts, Issues and Contentions Mrs Domjan said

``15. During the 1998 year of income the existing vanity was damaged beyond repair and was replaced with a vanity of the same standard and size in the Main Beach rental property. The cost of the new vanity was $435.00 [sic $465]. The vanity consisted merely of a cupboard and hand basin and cost of labour of removing and installing the replacement vanity. Existing taps and plumbing requirements were used.''

98. The Commissioner of Taxation allowed part of the cost of the vanity amounting to $165 as a deduction on the basis of the second rental statement. The Commissioner concluded that the expense was the cost of a repair to the hot water system. The Commissioner did not accept the claim that the other $300 amounted to costs for repairs to capital works items and only allowed 2.5 percent depreciation on the amount as additional capital works. The Commissioner has since been notified of the mistake in accepting the $165 and not the $300 or in accepting the $165 at all as a repair to capital works, but has decided not to disturb the allowance of the $165. The Commissioner maintains the $300 has been expended on a separate unit of property that is not plant.

99. Mrs Domjan submitted in her Statement of Facts, Issues and Contentions that

``606. There was an existing vanity in the flat that was removed and replaced due to the hot water damage which constitutes a repair as it replaces solely a damaged vanity. This was an isolated repair item not associated with any modernisation program of the bathroom...

607. Both the old vanity and the replacement vanity consisted of solely the cupboard and a hand basin and the cost of $435 [sic $465] included the cost of a plumber replacing and installing the replacement vanity. The quality of the old and the new vanity were similar. The agent explained it was the cheaper alternate to having a carpenter rebuild the cupboard, repainted, etc.

608. Both had 3 drawers and the old had one door while the new had two doors. The size of the unit was exactly the same as it was fitted back exactly to where the old vanity was installed. The old taps were used on the new vanity and it was installed into the existing plumbing fittings being hot and cold water service and to drain waste water, etc. there was no improvement in the quality of the replacement vanity.


612. [T]he unit cannot function as designed as it must be tied into plumbing and drainage. It also needs to be fitted with taps. There is no difference to replacing the spouting on a rented property and that is openly recognised as a repair. In installing the vanity there has been no capital appreciation achieved or an improvement made.''

Legislation and rules

100. Section 25-10 of the 1997 Act provides for deduction for repairs

``(1) You can deduct expenditure you incur for repairs to premises (or part of premises) or a depreciating asset that you held or used solely for the purpose of producing assessable income.


No deduction for capital expenditure

(3) You cannot deduct capital expenditure under this section''

ATC 2221

101. Taxation Ruling TR 97/23 (TR 97/23) - ``Income Tax: deductions for repairs'' - also provides useful guidance

``13. The word 'repairs' has its ordinary meaning. It ordinarily means the remedying or making good of defects in, damage to, or deterioration of, property to be repaired (being defects, damage or deterioration in a mechanical and physical sense) and contemplates the continued existence of the property.


15.... It involves restoration of the efficiency of function of the property being repaired without changing its character and may include restoration to its former appearance, form, state or condition. A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated.''

102. TR 97/23 clarifies what repairs are in the context of section 25-10

``22.... The work may go beyond `repairs' in terms of the section if it:

  • (a) changes the character of the property; or
  • (b) does more than restore its efficiency of function.


32. Expenditure for repairs to property is capital expenditure if any of the following subparagraphs applies:

  • ...
  • (b) The expenditure, rather than being for work done to restore the property by renewal or replacement of subsidiary parts of a whole, is for work that is a renewal in the sense of reconstruction of the entirety...


35. If work done goes beyond `repair' and the whole cost is capital expenditure, no amount is allowable as a deduction under section 25-10 for `notional' repairs.''

103. TR 97/23 goes on to define ``entirety''

``36. Repair is restoration by renewal or replacement of subsidiary parts of a whole. Renewal or reconstruction, as distinguished from repair, is restoration of the entirety.

37. The term `entirety' is used by the courts in repair cases to refer to something `separately identifiable as a principal item of capital equipment' (Lindsay v. FC of T (1960) 106 CLR 377 at 385...), `a physical thing which satisfies a particular notion' (the Lindsay case 106 CLR at 384...) and `not necessarily the whole, but substantially the whole of the [property] under discussion' (the Lindsay case 106 CLR at 383-384...)...

38. Property is more likely to be an entirety if:

  • • the property is separately identifiable as a principal item of capital equipment; or
  • • the thing or structure is an integral part, but only a part, of entire premises and is capable of providing a useful function without regard to any other part of the premises; or
  • • the thing or item is a separate and distinct item of plant in itself from the thing or structure which it serves...''

Deductibility of the vanity repairs

104. The issues in relation to the vanity concern broadly whether the expenditure on the vanity is deductible

105. Mrs Domjan submitted that fixing the vanity was not a replacement in its entirety in the terms of section 25-10 and TR 97/23, but rather a repair to the existing vanity. Mr Booth, Mrs Domjan's Representative, reiterated the facts in oral submissions

``The hot water unit played up and spilled water down onto the vanity and it is made of chipboard and it expanded and it was fairly useless, and the cost of getting a carpenter in to rebuild a vanity was far, far more than it was to go and buy a replacement vanity and that vanity is not a stand alone item of equipment. That vanity then had to be tied into existing plumbing. It has to have taps put on it. And in essence, what took place was a repair to the existing unit that was there and I see that as no different to

ATC 2222

replacing the spouting on a house and quite clearly that is a repair.''

106. Mr Booth drew an analogy between replacing a concrete driveway and the vanity replacement. He said that once an item is installed anything that is done to it that does not substantially change it is not a capital improvement and thus constitutes a repair. He said that a concrete driveway is dug up and replaced with concrete, but that is a repair rather than a replacement. He said the same thing occurred in this matter. Mrs Domjan's vanity was damaged by a leaking hot water pipe, so she replaced it with a new vanity, but this did not alter the room in anyway. It was the same as a repair.

107. In Mrs Domjan's Final Submissions she stated

``17. As there was an existing vanity in the bathroom and that fell into disrepair it was replaced by a similar item to that previously situated there and did not add to the fabric or existing capital works it simply replaced that which previously existed.

18. The vanity was not a stand alone unit that simply required fixing to the floor for stability to make it functional. It required taps to be fitted and plumbing to be connected to put it in an operational state as it also consisted of a hand basin.

19. The expense was minor in nature and cannot be construed as adding to the value of the capital works or increasing the capital works value but simply reinstated the situation.''

108. She further contended ``[I]t is evident the sole repair to the bathroom by the Applicant was the vanity. That repair merely restored what was previously there and in no manner could be construed as enhancing the value of the overall property.'' In reply to Mr Booth and my questions as to whether an entire vanity has to be installed and whether it came with taps Mrs Domjan said

``Mrs Domjan:... we reused all the fittings that were there previously; they were the same taps when we went up and looked at it.

Mr Booth: Did it enhance the value of the property when you replaced it?

Mrs Domjan: No...


It was a new basin and new cabinet... They replaced it with a new cabinet and a new vanity unit.''

109. She later said in cross-examination

``Mr Quinn: Now the vanity was a complete... replacement, was it not?

Mrs Domjan: Yes.

Mr Quinn: And the vanity?

Mrs Domjan: It was a repair for a replaced - for a damaged

Mr Quinn: It was completely replaced was it not?

Mrs Domjan: Yes.''

110. Mr Booth, for Mrs Domjan, also conceded that the vanity was replaced

``Mr Mowbray: So there was an existing cupboard there, was it, that was actually repaired, or was it completely replaced?

Mr Booth: No... it was replaced because... the water out of the hot water service had come down over the top of the vanity and it had swollen all the... chipboard, and to have somebody come in and rebuild the cupboard, as it was - the replacement unit which was of similar quality and standard - I think the total cost of the - of it was $135 [ sic $165] and $300 which is the 435 [sic $465]''

But he still maintained that the vanity was repaired for the purposes of section 25-10.

111. In
W Thomas & Co Pty Ltd v FC of T (1965) 14 ATD 78 at 87; (1965) 115 CLR 58 at 72, Justice Windeyer said

``... Repair involves a restoration of a thing to a condition it formerly had without changing its character. But in the case of a thing considered from the point of view of its use as distinct from its appearance, it is restoration of efficiency in function rather than exact repetition of form or material that is significant. Whether or not work done upon a thing is aptly described as a repair of that thing is thus a question of fact and degree. But the answer to that question does not of itself decide whether the expenditure on the work is properly to be considered as an outgoing upon capital account or upon revenue account. And that is what must be decided when the question is whether that expenditure is an allowable deduction in the ascertainment of taxable income.''

ATC 2223

112. Justice Windeyer was cited in Case [ 1999] AATA 363 (1999) 42 ATR 1055 relied on by Mrs Domjan. That case concerned whether repairs to a kitchen were repairs or entire replacements which added to the capital value of the house. In that case the Tribunal held that the repairs could not be deducted because they had gone beyond the remedying of defects and had created capital improvements.

113. Mrs Domjan relied on Senior Member Allen's view that if it was practical to replace an entire cupboard, for example, then that might still constitute a repair. He did not have to deal with such an issue and left the question open. However, this is precisely the matter with which I must deal

114. Mr Quinn for the Commissioner summed up his submissions in relation to the vanity as follows

``It certainly was not a repair, it does not constitute a repair....


[A] repair means remedying or making good of defects in damage to or deterioration of property to be repaired. Repair is occasional and partial. It involves restoration of the efficiency of the function of the property being repaired without changing its character. It may include restoration to its former appearance. Repair merely replaces a part of something. The notion of a repair is the item will continue in existence. And here we have a complete replacement in its entirety. And certainly the Applicant is entitled to a building write-off...


a capital write off under section 43(10)... but it is not a situation where we say it is a repair. And it is part of the setting, it is part of a setting, it is part of the fabric of the building and, hence, it attracts the deduction for a capital building write-off.''

115. While the vanity was replaced, I do not think that it was replaced in its entirety for the purposes of section 25-10 and TR 97/23. The vanity was replaced because of damage to the original; the plumbing remained the same and the taps as well. It added no capital gain to the property. In the cases relating to repairs that I have cited above and which are referred to in TR 97/23 the ``repair'' was held to be a replacement in its entirety where it involved stand alone items or large scale projects. Mrs Domjan was merely fixing her vanity, but chose to do it more cheaply by replacing the complete vanity rather than building new parts for the original vanity.

116. On the other hand it is arguable that the vanity could be seen as an integral part of the entire premises and is capable of standing alone as a useful functioning object without reference to any other part of the premises. In his Outline of Submissions Mr Quinn said

``92. The Commission contends that the vanity is an entirety because it is [a] separately identifiable item with its own function. Therefore the Commissioner contends that the expenditure incurred in repairing the vanity is capital in nature.''

117. However, a vanity is not usually a stand alone object. True it has a useful function and can be identified separately, as well as being an integral part of the premises. But it must be attached to plumbing and in this sense it is not replaced in its entirety. Nor is its replacement capital in nature.

118. The Commissioner further contended that these repairs are private in nature and have an insufficient nexus to the production of assessable income. The vanity is a necessary part of the house. While it did not increase the capital value, if it were not there no one would rent the property. The vanity replacement is clearly connected with the production of assessable income.

119. In summary I find

120. Therefore on balance I am satisfied that the vanity repairs constitute repairs for the purposes of section 25-10 of the 1997 Act and the costs of the vanity repairs are deductible.

Did Mrs Domjan take reasonable care with her interest expense claims

Relevant facts

121. In its reviewable decision dated 21 March 2002 the Australian Taxation Office imposed a penalty on Mrs Domjan for recklessness

``§ in claiming a large number of private expenditure,

§ for claiming expenses when no records were kept,

§ for failing to apportion interest when the loan facility was used for both income and private expenses,

§ for claiming petrol separately when you had claimed the car under the 12% method,

§ for claiming home office expenses on an incorrect basis.''

122. In the course of the current proceedings the Commissioner changed this determination of recklessness to a charge of failure to take reasonable care. The Commissioner was not willing to concede that Mrs Domjan was not reckless, but agreed to modify the penalty so that a 25 percent penalty would be imposed rather than a 50 percent penalty.

123. In Mrs Domjan's Statement of Facts, Issues and Contentions she stated

``586. I took reasonable care in determining how I should organize my affairs based on ATO advice and TR 93/D38. I had provided private funding into a loan facility knowing I retained the right to re draw that funding.

587. From that time forward I prepared my tax returns relying on my understanding from enquiries made and the information in Tax Pack and supporting ATO publications on Rental Properties. As there were no apparent changes mentioned in Tax Pack or the ATO Rental Guidelines concerning TR 93/D38 to assist taxpayers with rental income up to the 1999 year I had no reason whatsoever to believe what I was doing was subject to question.''

124. Mrs Domjan argued that she was certainly not reckless, but that she also took reasonable care in lodging her tax returns correctly.

Relevant legislation and rules

125. Section 226G is the relevant section of the 1936 Act. The Commissioner initially relied on section 226H, but later changed this to reflect the determination that in his view Mrs Domjan failed to take reasonable care, rather than that she was reckless. Section 226G provides

``Penalty tax where shortfall caused by lack of reasonable care

Subject to this Part, if:

  • (a) a taxpayer has a tax shortfall for a year; and
  • (b) the shortfall or part of it was caused by the failure of the taxpayer or of a registered tax agent to take reasonable care to comply with this Act or the regulations;

the taxpayer is liable to pay, by way of penalty, additional tax equal to 25% of the amount of the shortfall or part.''

A comparable provision is found in Division 284 of the Taxation Administration Act 1953 where a table sets out the amounts to be deducted as penalties.

126. The Commissioner relied on Taxation Rulings TR 94/4, TR 95/25 and TR 2000/2 to determine whether Mrs Domjan took reasonable care in filling in her tax return. TR 94/4 - ``Income tax: tax shortfall penalties: reasonable care, recklessness and intentional disregard'' - relevantly provides

``13. The reasonable care standard is central to the new penalties. As a minimum, all taxpayers are required to exercise reasonable care in the conduct of their tax affairs. The reasonable care test requires a taxpayer to exercise the care that a reasonable, ordinary person would exercise in the circumstances of the taxpayer to fulfil the taxpayer's tax obligations.

ATC 2225

14.... There are... several key points to note:

  • (a) while the size of a tax shortfall is determined on the basis of statements made by a taxpayer, penalty is attracted for a lack of reasonable care on the part of the taxpayer or a registered tax agent. While a lack of reasonable care may result in making (or failing to make) a statement, it may equally result in an act or omission which lies behind the making of a statement (e.g. a failure to keep adequate records);
  • ...
  • (d) a taxpayer whose only explanation for omitting an amount of assessable income (for example, interest) is that he or she `forgot', would not, in the absence of other relevant factors (e.g. experience, education, age, skill etc.), ordinarily be accepted as having taken reasonable care;
  • (e) a failure to maintain adequate records of income and expenditure will be a major reason for finding that a taxpayer has failed to take reasonable care. But this does not mean that a penalty is attracted every time an error is made in the taxpayer's books that leads to a tax shortfall, provided the taxpayer can show that its procedures are reasonably designed to prevent such errors from occurring. What is reasonable will depend, among other things, on the nature and size of the business, but could include, for example, frequency of internal audits, sample checks of claims made, adequate training of accounting staff and instruction manuals for staff;
  • ...
  • (h) Where a Public Ruling is available on a particular matter, a taxpayer would generally be expected to follow it. However, taking a contrary position to a Public Ruling does not necessarily mean that the taxpayer would fail the reasonable care test for that reason alone. Where a taxpayer has taken a position contrary to a Public Ruling, it would be necessary for the taxpayer to consider the arguments raised in the Public Ruling and be able to demonstrate that the Public Ruling does not apply to his/her particular circumstances in order to satisfy the reasonable care test.

In addition, the reasonable care test will be taken to have been satisfied where a taxpayer did not know and could not reasonably be expected to have known that the Public Ruling existed, for example, where a taxpayer lodged a tax return at about the same time a Public Ruling issued that modified Tax Pack and materially affected the taxpayer's return.''

127. Mrs Domjan stated that she had had access to Draft Taxation Ruling TR 93/D38 when preparing her tax returns and applied it because it related to section 51(1) of the 1936 Act. This Ruling was finalised as TR 95/25 with some changes. TR 95/25.

128. The Commissioner argued that Mrs Domjan did not take reasonable care in applying either TR 93/D38 or TR 95/25. TR 2000/2 applies to borrowed money and redrawn money and is thus relevant to Mrs Domjan's tax assessment. However, the Commissioner conceded that Mrs Domjan would not have had access to TR 2000/2 when doing her tax returns in 1997, 1998 and 1999.

Should the penalty be applied

129. In his reviewable decision dated 21 March 2002 the Commissioner gave examples of how Mrs Domjan had been reckless in her tax claims

``Your actions in making the claims relating to the rental property and your share investments were all made without due care to the application of the relevant legislation. The following comments are made in relation to the various adjustments made as a result of the audit.


Interest - You have mentioned several times that you always follow TaxPack and ATO taxation rulings in trying to comply with income tax legislation. You have stated that you read Taxation Ruling TR 2000/2 which applies retrospectively from the time of its issue. The ruling does not change in any way the previous approach on how apportionment should be calculated to work out deductible interest. It only makes this clearer by giving examples for the different types of accounts where income and non- income related transactions are made within

ATC 2226

the same facility. Therefore it is irrelevant to say that the ruling issued after you had lodged the returns and therefore you cannot be penalised for not following it.

You tried to justify the fact that you had used the facility for private expense by arguing that deposits were only made to cover these expenses and not to repay any of the principle amounts borrowed. However, in doing this you went against the very principles of apportionment clarified in the ruling which you quoted several times.

You claimed 100% of the interest for rental and dividend income when you were fully aware that the loan account was used regularly for private expenses. You made no attempt at trying to apportion the interest, rather you blatantly tried to justify your claim by irrelevant arguments. This approach is seen to be clearly reckless, considering the large number of private transactions.


You repeatedly affirm that you followed stated guidelines and instructions published by the ATO. Yet you ignored these and applied your own interpretations which go against the stated intent of the legislation and rulings. Your income tax affairs are not overly complicated nor are they more wide ranging than any other taxpayers who own rental properties and some share investments. You have stated that you have had this type of investment activity for a number of years and so are experienced at understanding the tax implications of such income and expenses.''

130. The Commissioner contended that Mrs Domjan would have known that the Taxation Ruling that she was relying on (TR 93/D38) was a draft because the ruling cautioned readers as to this fact. It was further contended that Mrs Domjan deliberately ignored Taxation Ruling TR 95/25. The Commissioner said ``a reasonable person with the Applicant's experience would have made further enquiries regarding the deductibility of their interest expenses and that, in the circumstances, the Applicant's failure to do so amounted to `carelessness'.''

131. In his Outline of Submissions Mr Quinn on behalf of the Commissioner stated

``95. The reasonable care test requires a taxpayer to take the care that a reasonable, ordinary person in all the circumstances of the taxpayer [would take] to fulfil the taxpayer's tax obligations. Provided the taxpayer may be judged to have tried his or her best to lodge a correct return, having regard to the taxpayer's experience, education, skill and other relevant circumstances, the tax payer will not be liable to pay penalty.

96. Penalty of 25% has been imposed on the tax shortfall that arose as a result of the disallowance of the Applicant's interest expenses.

97. The Applicant is not considered to have taken reasonable care when claiming the interest expenses in her income tax returns for the 1997, 1998 and 1999 years of income for the following reasons:

  • • The Applicant relied on a Draft Taxation Ruling when making her claim for interest. Although a Draft Taxation Ruling sets out the considered view of the Commissioner at the time it is released a Draft Taxation Ruling (DTR) specifically states on the front page that:
    • ``DTRs may not be relied on by taxation officers, taxpayers or tax practitioners. It is only final Taxation Rulings which represent authoritative statements by the Australian Taxation Office of its stance on the particular matters covered in the Ruling.''
  • • Therefore, the Applicant based what she has referred to as her `modus operandi' entirely on a principle which was set out only in a Draft Taxation Ruling.
  • • The Applicant did not follow up in order to find out when the Draft Taxation Ruling she relied upon was released as a final Ruling. If the Applicant had read the Draft Taxation Ruling, as she has said she did, she would have been aware that the ATO would issue a final version of the Ruling at some time in the future. Given that the Applicant was able to get access to a Draft Taxation Ruling it is reasonable to expect that she would have known how to get access to the final Ruling that issued.

    ATC 2227

  • • The Applicant has stated on numerous occasions that she sought advice from the ATO regarding some of the items she has claimed however there this no evidence that she sought any advice from the ATO in relation to her interest expenses before she made her claims for interest. Given the disclaimer in the Draft Taxation Ruling, it is contended that a reasonable person would have made further enquiries regarding the deductibility of their interest expenses and that, in the circumstances, the Applicant's failure to do so amounted to `carelessness'.''

132. In a letter dated 31 January 2003 Mrs Domjan said at page 51 that

``On assessment the Commissioner imposed a 50% penalty on the grounds that I was reckless. On objection the Commissioner disallowed my objection in full and the penalty remained at 50%. The amended assessments subject to this appeal remain at 50% for being reckless despite what is contained in the Deputy Commissioner's Statement of Contentions lodged with the Administrative Appeals Tribunal that my actions lacked reasonable care in making several claims.

I assume this means that I have made several claims that the Commissioner does not accept.

With my claims for a deduction for interest these fall into 3 categories of issues:

  • • Funds withdrawn from the loan account and deposited to either my cheque or Visa accounts - 9 such transactions over 3 years.
  • • Funds drawn down from the loan account to fund assets solely in my name.
  • • Claiming 100% of the interest on the loan account after the payment of the lump sum by my husband.''

133. Mrs Domjan relied on paragraphs 6 (paragraph 95 of the Commissioner's Submissions - see paragraph 131 above) and 14 (see paragraph 126 above) of the Taxation Ruling TR 94/4 - ``Income tax: tax shortfall penalties: reasonable care, recklessness and intentional disregard'' - to show that she had tried her best to follow Taxation Rulings and to lodge her tax returns. She had contacted the ATO and asked them for advice. She stated that she followed that advice. In her Final Submissions she said

``22. The interest issue is a complex matter for a lay person to comprehend particularly one with the experience the Applicant had at the time.

23. The Applicant made genuine attempts to clarify her tax obligations. The Applicant did not comprehend the Commissioner's Taxation Ruling program and while there was an indication that TR 93/D38 was [a] Draft Ruling the Applicant was not aware of its significance.

24. Rather than the Applicant having identified TR 93/D38 and approaching the ATO for a copy, a Canberra ATO enquiry officer handed the document to the Applicant with a range of other material.

25. The Final Ruling issued as TR 95/25, some 2 years after the draft. While TR 95/25 was mentioned in the Rental Guidelines for taxpayer [sic] it did not indicate it had replaced TR 93/D38. It is a bit presumptuous to suggest a lay person should check the ATO's ruling program regularly.

26. In relation to TR 93/D38 it recognized deemed partnership (receipt of income jointly) as being identical to a legal partnership and that was taking the decision of Smith and Roberts into account. It indicated partners in receipt of income jointly could re access their equity in an investment.

27. TR 95/25 reversed the position taken in TR 93/D38 in not recognizing a deemed partnership as having the same rights as a partnership at law. That Ruling simply addressed the rights of partners in a partnership at law to access partnership funds by involving the use of loan funds.

28. TR 95/25 did not address redraw facilities or multi use loan accounts and the Commissioner has acknowledged that there has not been any published dissemination of the ATO's view prior to the issue of TR 2000/2 issued in the year 2000.

29. It is not supportable to accuse the taxpayer of not following TR 95/25 when it did not address the issues in dispute. Further TR 94/4 states that if a taxpayer does not follow a Public Ruling and the taxpayer's return of income is found inadequate

ATC 2228

providing the position by the taxpayer is reasonable [sic] explainable a penalty should not be imposed, paragraph 14(h) of TR 94/4.''

134. Mrs Domjan made some significant mistakes when preparing her tax returns

135. On the other hand I recognise that

136. Did Mrs Domjan take the care that a reasonable, ordinary person in all her circumstances would have taken? On balance I think not. In my view failure to obtain the final Taxation Ruling and to seek expert advice on redraw facilities amounted to a failure by Mrs Domjan to take reasonable care to comply with the legislation.

137. Accordingly a penalty of tax equal to 25 percent of the shortfall is appropriate.


138. At the hearing I requested the parties to draft a schedule of the amounts that had been agreed between the parties before the hearing and that would therefore not be subject to review by the Tribunal. This schedule is set out in a document dated 14 August 2003 and signed by or on behalf of both parties.

139. In a letter of 17 June 2004 the Commissioner advised the Tribunal that a penalty had been imposed by mistake for the adjustment to the interest calculation related to Mr Domjan's lump sum payment of $78,505.97. The Commissioner advised that the penalty had been wrongly applied to this particular adjustment and would be remitted accordingly.

140. It is appropriate that my decision should reflect both the concessions in the letter of 14 August 2003 and the penalty adjustment in the letter of 17 June 2004. I direct that these matters be attended to on reconsideration by the Commissioner.


141. In summary I conclude that

142. I further find


143. The Tribunal sets aside the decisions under review, being the objection decisions of the Commissioner of 21 March 2002, and remits the matters to the Commissioner with a direction to give effect to the findings of the Tribunal as set out in the reasons for decision as summarised in paragraphs 141 and 142.


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