Emu Bay Railway Co Ltd v Federal Commissioner of Taxation

71 CLR 596

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(Judgment by: Latham CJ)

Emu Bay Railway Co Ltd v Federal Commissioner of Taxation

Court:

Judges:
Latham CJRich J
Starke J
McTiernan J
Williams J

Subject References:
Taxation and revenue
Income tax
Assessment
Deductions
Outgoings incurred
Income insufficient to pay interest

Legislative References:
Income Tax Assessment Act 1936 No 27 - s 51

Hearing date: 3 October 1944; 6 November 1944;
Judgment date: 6 November 1944

MELBOURNE

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Judgment by:
Latham CJ

The following written judgments were delivered:

LATHAM C.J. Case stated in an appeal by the Emu Bay Railway Company against an assessment to income tax in respect of the financial year 1940-1941. The question asked relates to a sum of PD13,333 13s. 6d. which it is claimed should be allowed as a deduction from the assessable income of the company. The company contends that the said sum was an outgoing incurred in gaining or producing the assessable income of the appellant and was accordingly a proper deduction under the Commonwealth Income Tax Assessment Act 1936-1940, s. 51. That section provides that (a) all losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or (b) are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions, subject to exceptions which are not material for the purpose of this case. The appellant has, in argument, relied only upon the part of the section which I have referred to as (a).

On 7th April 1925, the company entered into a debenture trust deed with certain trustees under which it was provided that two sets of debenture stocks should be issued bearing interest respectively at 4 per cent and 5 per cent. The 4 per cent stock had priority over the 5 per cent stock. Interest on the 4 per cent stock was paid in the income year in question, but the sum of PD13,333, representing 5 per cent interest upon the amount of 5 per cent stock issued, was not paid. The company contends that, though it was not paid, the interest had become payable so that the liability to pay it had accrued, and that therefore it was an "outgoing incurred" within the meaning of s. 51 of the Act. The Commissioner makes three replies to this contention. In the first place, it is argued that no interest had become payable under the terms of the trust deed because, it is said, the obligation to pay interest upon the 5 per cent stock was an obligation to pay interest only out of what is referred to in the deed and a schedule thereto as net income or net annual income of the company, and it is common ground that there has in fact been no net income of the company in any year since the trust deed was executed. Secondly, the Commissioner contends that, even if this contention be wrong and the interest did become payable, it was not in fact paid, and therefore cannot be regarded as an outgoing incurred within the meaning of s. 51. Thirdly, the Commissioner contends that, as the interest was payable only out of the net income of the company, the provision for its payment constituted an agreement to distribute the income of the company when earned, so that it could not be regarded as an outgoing incurred in the production of that income. If the first argument of the Commissioner is right, it will not be necessary to consider the second and third arguments to which I have referred.

The trust deed recites that it was agreed that the 5 per cent stock should bear interest and be secured in manner and have the rights described in the third schedule. Clause 1 (B) of the deed contains an acknowledgment by the company that it is indebted to the trustees on behalf of the holders of the 5 per cent stock in a specified sum carrying interest at the rate of 5 per cent per annum payable half-yearly.

Clause 3 provides that the two stocks are each to rank as a charge on the company's undertaking with the priorities and in manner set out in the second and third schedules to the deed.

Clause 5 provides that until redemption the company shall pay to the stock holders whose stock remains outstanding interest on such respective stocks at the respective rates of 4 per cent and 5 per cent per annum "as mentioned and provided in the Second and Third Schedules hereto."

Clause 6 provides that "the said respective stocks shall be held subject to the conditions relative thereto hereinafter or in the said Second and Third Schedules hereto expressed."

Clause 7 is in the following terms:"During the period of ten years ending on the 31st of December 1933 the interest on the 5 per cent Stock shall be payable only out of the net income of the Company form time to time available after payment of the interest upon the 4 per cent Stock and after making proper provision for the upkeep of the Company's railways rolling stock workshops buildings plant and tools including the setting aside of reasonable sums for depreciation and after paying the Company's directors fees and the remuneration of the Trustees and discharging all other outgoings and making all other provisions properly chargeable against revenue and necessary to secure the efficient maintenance and working of the said railways and after the expiration of such period the interest on the 5 per cent Stock shall be cumulative." This clause draws a distinction between the period of ten years ending on 31st December 1933 and the subsequent period. During the said ten years, interest on the 5 per cent stock is payable only out of the net income of the company as specified in the clause. After the expiration of that period, the interest becomes cumulative. The meaning of these provisions, in my opinion, is that arrears of interest do not accumulate during the first ten years, so that arrears in respect of one year do not become payable out of income of any subsequent year. During the ten years, the interest is non-cumulative. After the expiry of the ten years, however, the interest is cumulative; that is to say, arrears of interest relating to that period do not disappear, but continue to be payable by the company. It was suggested in argument that the clause might be construed to mean that the total interest for the first ten years became payable out of the total net income for those years, but not out of any subsequent income. This view does not appear to me to be justified by the words of the clause, which I regard as drawing a distinction between an initial period during which interest is non-cumulative and a subsequent period during which it is cumulative. But it is unnecessary actually to decide this point for the purposes of this case. It is at least clear that arrears of interest for the year 1939-1940 (the income year in question) were not non-cumulative.

It may be observed that the reference to the net income of the company in clause 7 is impliedly a reference to the net annual income of the company because the net income can only be ascertained by taking an account relating to a period, and the natural meaning of the provision is that the net income should be ascertained annually by deducting from the income the various annual charges mentioned-the 4 per cent interest and the other outgoings mentioned in the clause.

Clause 10 provides that the company as beneficial owner charges in favour of the trustees for securing the payment of the 4 per cent and the 5 per cent stock respectively "and the interest thereon as aforesaid" all the business and undertaking of the company, its book debts etc The clause also contains a provision that the company shall not create or suffer to be created any other mortgage charge or lien upon the assets in priority to the charge created by the deed.

Clause 11 provides that the company covenants with the trustees to pay to them "(B) the amount of the 5 per cent Stock and Interest thereon in accordance with the terms set out in the Third Schedule."

Thus clauses 3, 5, 6 and 11 all define the obligations of the company in relation to the 5 per cent stock by reference to the third schedule.

Clause 13 provides that the company will perform the covenants with respect to the stock which are expressed in the deed or incorporated by reference to an earlier indenture.

Clause 14 deals with priorities and provides that the 4 per cent stock and the interest thereon shall be a first charge on certain premises and that subject thereto both stocks "and the interest thereon respectively" shall rank pari passu as a first charge on all the other property charged by the trust deed.

Clause 17 deals with the disposition of the proceeds of realization if the trustees exercise the trust for sale referred to in the deed. After payment of certain expenses and subject to the provision as to priority of 4 per cent stock, the proceeds of realization are to be applied "in or towards the payment to the holders of the 4 per cent Stock and 5 per cent Stock equally in proportion to the respective amounts thereof due to them respectively and all arrears of interest thereon."

Clause 21 provides that, upon the trustees being satisfied that "the whole of the 4 per cent Stock and the 5 per cent Stock and all interest there on respectively" has been paid, or satisfied and upon payment of costs etc, the trustees shall reconvey the mortgaged premises to the company.

It will be observed that these provisions relating to the application of the proceeds of realization of the assets charged by the deed cover in terms "all arrears of interest" and "all interest" on the 4 per cent and the 5 per cent stock. It may be that the consequence is that, though no arrears of interest are payable otherwise than out of the net income as available from year to year during the first ten years, yet if the power of sale is exercised these arrears constitute a charge upon the proceeds. But the matters requiring decision in the present case do not necessitate a determination of this question.

It is now necessary to consider the terms of the third schedule by reference to which the deed, in clauses 3, 5, 6 and 11, specifies the obligations of the company and the rights of the stock holders.

The third schedule consists of two parts, the first containing certain "terms and conditions on which the 5 per cent Stock is to be issued." These terms and conditions are made part of the contract between the company and the trustees by clause 11 of the deed, which contains an express reference to the "terms" set out in the third schedule. These terms provide for half-yearly payment of interest, and contain the following provision: "The interest is to be a charge upon and payable only out of the net annual income of the Company as defined in the Trust Deed subject to the prior charge thereon of the interest upon the 4 per cent Stock. The interest is not to be cumulative until after the 31st day of December 1933." This, in my opinion, is an unambiguous provision that the interest at all times is to be a charge upon and payable only out of the net annual income of the company, becoming cumulative after 31st December 1933. The net annual income of the company is actually defined by the trust deed in the provisions of clause 7, to which reference has been made, though that clause does not use the word "definition." The reference in the third schedule to "net annual income" can refer only to the provisions of that clause. The result is that, as there has never been any annual net income of the company since 31st December 1933 (or at all), the sum of PD13,333 13s. 6d, has not become payable.

The second part of the third schedule contains a form of stock certificate. This stock certificate (to be issued to the holder of stock) contains the following provision: "The interest is non-cumulative until after the 31st of December 1933 and is payable only out of the net income of the Company of each year as provided in the Trust Deed." (This provision, I think, resolves any doubt which might have arisen as to whether arrears accumulated in any sense during the period of ten years. The provision that the interest is non-cumulative until after 31st December 1933 shows plainly that it was intended that interest should be payable during that period only if the net income of the relevant year provided for it. But, as I have said, this is a point which it is not necessary to decide for the purposes of this case.) What is important is the definite provision, applying to all the 5 per cent interest, that the interest is payable "only out of the net income of the Company."

As there has never been any such net income, the interest which the company claims is allowable as a deduction did not become payable, has not become a debt, and may never become a debt. As the cumulative period has now been reached, it might become a debt (if the company should have net income hereafter), and in that case it could certainly, if it were paid, and possibly even if it were not paid, be a proper deduction from the income of the company for income tax purposes. The words "outgoings incurred" should not be limited to expenditure actually made. They include a liability presently incurred and due though not yet discharged-Jolly v Federal Commissioner of Taxation ^[F1] , at p. 137; W. Nevill & Co Ltd v Federal Commissioner of Taxation ^[F2] -cases on a provision not quite identical with s. 51 of the present Act, but which does not differ in any particular which is material for present purposes. It may be argued that the words include a liability which falls within the description debitum in praesenti, solvendum in futuro. But the alleged liability in the present case does not even answer this description. As things stand at present, the interest has not become payable, and all that can be said is that there exists at the present time the possibility of a liability accruing in the future, such possibility depending, not only upon the derivation of net income, but also upon the amount of such income derived. In my opinion, such a possibility cannot be regarded as an outgoing incurred within the meaning of s. 51 of the Income Tax Assessment Act. Not only has no outgoing been made, but no liability to make an outgoing has come into existence.

As against this conclusion, the appellant relies upon clause 7. The argument is that clause 7 is an express provision that during a period of ten years (which is now past) interest shall be payable only out of the net income of the company. It is argued that this provision is plainly intended to confine to the period of the first ten years the limitation of the liability of the company to pay out of net income only, and that it should be held that no such limitation exists during any subsequent period. If this is the true view, then the amount claimed as a deduction has become payable by the company, though it has not been paid.

In my opinion, it is not proper to attribute such an operation to clause 7 in face of the many provisions in the deed which expressly refer to the third schedule for the purpose of determining the obligations of the company and the rights of the stock holder. The provisions in the third schedule are not ambiguous in relation to this matter and the provisions in the deed which refer to the third schedule are not ambiguous. Clause 7 does not contain any provision which is inconsistent with the third schedule. It contains a provision with respect to the first ten years which is consistent with the provisions of the third schedule, though it duplicates those provisions in part-in respect of that period of ten years.

I am, therefore, of opinion that, as the sum of PD13,333 13s. 6d. is payable only out of the net income of the company as defined in the deed, and as there is not and never has been any such income, the sum claimed as a deduction has not become payable; it is not a debt or a liability of any kind, and it cannot be regarded as an outgoing within the meaning of the relevant section of the Income Tax Assessment Act. Accordingly it is unnecessary for me to consider the further arguments submitted on behalf of the Commissioner.

For the reasons which I have given, the question in the case should be answered in the negative.