Case U118

Members:
DP Breen DP
P Gerber SM
KL Beddoe SM

Tribunal:
Administrative Appeals Tribunal

Decision date: 21 May 1987.

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D.P. Breen (Deputy President), Dr P. Gerber and K.L. Beddoe (Senior Members)

The question at issue in this application is whether the applicant is exempt from income tax within the terms of para. 23(h) of the Income Tax Assessment Act 1936 ("the Act").

2. Alternatively, the applicant claims, somewhat faintly in the hearing before the Tribunal, that certain interest incurred by the applicant is an allowable deduction within the terms of subsec. 51(1).

3. Paragraph 23(h) of the Act reads as follows:

"23 The following income shall be exempt from income tax: -

• ...
• (h) the income of a society or association not carried on for the purposes of profit or gain to the individual members thereof, established for the purpose of promoting the development of aviation or of the agricultural, pastoral, horticultural, viticultural, manufacturing or industrial resources of Australia;"

4. By direction of the Tribunal the parties proceeded by way of a statement of agreed facts. In essence those facts are as follows.

5. Some time about 1971 the Queensland Government declared its intention to build two

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water storages on a river for the purpose of providing irrigation water for sugar-cane farms in the general vicinity of those water storages. Sugar-cane was and is the main crop in the area.

6. There was, however, a lack of commitment by the Queensland Government to the project, the first water storage not being built until 1977, and there was no real prospect of the second storage being built within a reasonable time after that.

7. In late 1980 a Mill Suppliers Committee acting for the canegrowers in the area made representations to the Government requesting that construction of the second water storage be expedited possibly with financial assistance from a levy raised from the growers.

8. As a result of those representations the Queensland Government put a proposal to the growers by letter dated 4 December 1980 to the effect that if the growers provided a substantial proportion of the finance, the necessary work could commence on the construction of the second water storage in mid-1981. The Government proposal required the growers to contribute $1.55 million to finance the project. The Government expressed the view that as the project was being brought forward for the benefit of the growers the cost of financing the $1.55 million required to be contributed by the growers was to be borne by the growers but the principal would be repaid by the Government over a period of four years. Interest charges, etc., incurred by the growers were to remain an expense of the growers and would not be reimbursed by the Government.

9. That proposal was not accepted by the growers. However by letter dated 18 February 1981 the Government submitted a further proposal to the growers which was accepted. The revised proposal allowed the growers certain concessions in relation to the cost of purchasing water but did not materially alter the arrangements as to the provision of finance by the growers as outlined above.

10. To this point the negotiations had been conducted for the growers by the Mill Suppliers Committee. However that committee did not have power to enter into an arrangement such as that proposed by the Government and agreed to by the growers. It was therefore decided to establish the applicant.

11. The Mill Suppliers Committee was specially empowered by regulation to raise a levy of growers. The levy imposed raised $351,000.

12. The $351,000 became the paid-up capital of the applicant, growers holding shares in the applicant in proportion to their contribution to the levy.

13. The applicant was incorporated in June 1981. Its constituting document (Document T3) provides inter alia:

"(3) The objects of the Association are to contribute to the cost of construction by the Commissioner of Water Resources of a second weir on the... River and for this purpose

• (a) to borrow money;
• (b) to pay to the lenders of any such money interest thereon;
• (c) to enter into agreements or arrangements with the Commissioner of Water Resources whereby the money so borrowed (excluding interest thereon) shall be repaid to the lenders thereof by the Commissioner of Water Resources; and
• (d) to obtain from the Government a Guarantee to the lenders as aforesaid of the repayment of the moneys so borrowed and the repayment of interest thereon."

14. Ancillary objects are set out in cl. 4 but we need not set them out here.

15. Clauses 5-12 have the effect of limiting membership to sugar-cane growers in the defined area who are assigned to the particular mill. If a member ceased to hold or retain specified land as owner or occupier of that land then that member ceased to be a member of the Association. The same result occurred if previously qualifying land ceased to be assigned to the specified sugar mill. Because the levy, which paid for the share capital, was raised by the Mill Suppliers Committee, it was only possible for the growers subject to the levy to contribute to the share capital of the applicant. The committee's power to make the levy on growers assigned to the particular mill thereby restricted membership of the applicant to those sugar-cane growers operating on farms assigned to the mill.

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16. Clause 16 of the constituting document requires that the operations of the applicant shall be managed and controlled by a board of directors. Clause 17 provides for the election of directors from specified areas of the lands assigned to the mill.

Clause 33 provides:

"Notwithstanding anything hereinbefore contained in the event of the winding up of the Association the net proceeds of such winding up shall be distributed amongst the members in the proportion that each member's shareholding having force and effect at the time of such winding up bears to the total issued shares appearing in the Register of Members."

17. At the time the applicant was incorporated it was expected by the applicant's directors that the funds to be borrowed over and above those levied of the members would be borrowed, drawn down and paid away for the construction work during the year of income ended 30 June 1982.

18. Apparently the funding arrangements took longer than had been expected.

19. By a letter dated 18 December 1981 the applicant's finance manager advised the merchant bank that the bank's offer of a $1.55 million loan facility was accepted subject to satisfactory written documentation and availability of a guarantee from the Queensland Government.

20. As to the guarantee, the applicant was advised by the Queensland Treasury by letter dated 11 February 1982 that the Government would not guarantee the loan of $1.55 million. The Government also objected to the form of the arrangements.

21. The guarantee having been refused, the applicant agreed with the X merchant bank that the guarantee would be forgone by the lender in exchange for an increase in the interest rate payable by the applicant on the loan.

22. By an earlier letter dated 18 February 1981 the Water Resources Commission had agreed to grant the growers in question rebates on water charges and limited rises in water charges in consideration for the growers deciding to advance the $1.55 million for the construction of the water storage.

23. In the meantime the Commissioner for Water Resources had gone ahead with arrangements for the construction of the water storage. Actual construction had been performed by a contractor engaged for the purpose by the Commissioner and the contractor was paid by the Commissioner. The water storage was completed somewhat behind schedule and was opened in June 1983. As will be seen the applicant was not a party to the construction contract.

24. On 2 March 1983, eight deeds were executed by the respective parties. Copies of the deeds form annexures H1 to H8 attached to the statement of agreed facts. These form the main features of the arrangements entered into by the applicant. It is only necessary to give a brief description of each deed (the documents are described in the same order as they were tendered to the Tribunal).

• (H1) A contract dated 2 March 1983 between the construction company and the Commissioner of Water Resources whereby an amount of $1.55 million previously paid to the construction company by the Commissioner was to be repaid to the Commissioner and the time for payment of this amount was deferred on certain terms and conditions.
• (H2) A contract dated 2 March 1983 between the construction company and the Commissioner of Water Resources whereby the Commissioner acknowledged that the $1.55 million was owing to the construction company and the parties agreed on the payment of that amount by instalments.
• (H3) A contract dated 2 March 1983 between the construction company and the applicant whereby the applicant agreed to lend the construction company the amounts agreed to be deferred under H1 in return for an assignment from the construction company of its rights to repayment under H1 and the construction company agreeing to repay the loan in accordance with a schedule which matched the instalment arrangements in H2.
• (H4) A deed of indemnity dated 2 March 1983 whereby the Commissioner for Water Resources indemnified the construction company against breach of contract by the applicant.
• (H5) A deed of assignment dated 2 March 1983 whereby the applicant assigned to the

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  merchant bank the debt of $1.55 million owed by the Commissioner of Water Resources to the applicant because of another assignment of even date H7.
• (H6) A loan agreement dated 2 March 1983, whereby the X merchant bank loaned the applicant $1.55 million at an interest rate of 2.4 percentage points above the Australian Merchant Bankers Association bill rate.
• (H7) A deed of assignment dated 2 March 1983 whereby the contractor assigned the debt owed to it by the Commissioner of Water Supply to the applicant.
• (H8) A deed of mortgage dated 2 March 1983 whereby the applicant executed a fixed charge over all its assets in favour of the merchant bank.

25. The applicant's loan from the merchant bank was drawn down on 2 March 1983 as part of the settlement which occurred on that day.

26. Because of the delays which occurred in both completion of the financial arrangement and the construction of the water storage, the applicant derived interest on the funds raised from the growers' levy which became the paid-up capital of the applicant. Details of the interest derived are set out in Exhibit 1 and are as follows:

      Year ended 30 June 1982
       Interest on investment            $ 1,796
      Year ended 30 June 1983
       Interest on investment            $74,840
      Year ended 30 June 1984
       Interest on investment            $22,107
      

27. No evidence was before the Tribunal as to any other activities carried on by the applicant. The applicant found itself with surplus funds over and above what was necessary to perform its objects. This surplus resulted from the delays, causing the applicant not to incur interest charges to the merchant bank until 2 March 1983, contrary to its expectations. As already noted the applicant earned income from investment of the shareholders' funds which is also attributable to the delays which occurred. The applicant has, since the year of income ended 30 June 1983, completed its objects and will be wound up as soon as its income tax liability is finally determined.

28. It seems to be quite clear to us that the purpose for establishing the applicant was to facilitate early construction of the water storage by financing the project pending Government funds becoming available. This meant that the growers had to bear the interest charges incurred on the project until such time as the Government money became available. Those interest charges were paid for out of the proceeds of the levy and the income derived by the applicant.

29. The motivating force for establishing the applicant was to boost the stored water capacity available to the canegrowers assigned to the particular mill. We have been unable to deduce any other motive for the arrangements entered into. However, the motives of the canegrowers are only relevant to explain the purposes of the applicant.

30. As already noted the purpose or object of the applicant was to finance the construction of the water storage pending the availability of Government funding. Everything it did was directed to that end and it had no other purpose. Therefore it facilitated the construction of the water storage by the Queensland Government at a time earlier than would otherwise have been the case.

31. The construction of the water storage seems easily to fit within the meaning of the words "promoting the development of... agricultural... resources of Australia" in sec. 23(h) of the Act. There can be little doubt that the construction of a water storage designed to provide additional water supplies for sugar-cane growers is the development of an agricultural resource. The ordinary meaning of the words must lead to that conclusion.

32. There are, however, some difficulties in this case. First, the water storage was constructed by the Queensland Government through a private contractor. Secondly, the applicant had no part to play in the construction of the water storage except that it supplied what was, in effect, bridging finance. In other words it was the initial financier for the construction of the water storage and having completed that task, it is now to be wound up. However, para. 23(h) does not require that there be a development of an agricultural resource, but rather a purpose of promoting the development of an agricultural resource. In the result, we take the view that the applicant was

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incorporated for the purpose of promoting the development of an agricultural resource, namely the water storage resources of the region involved.

33. Counsel for the applicant contended that the derivation of the interest income by the applicant was entirely subsidiary to the main purposes of the applicant. We agree with this submission. The applicant is not disqualified from the exemption because it derived the interest income which was entirely incidental to the major purposes of the applicant.

34. Turning then to the remainder of para. 23(h), the question to be answered is whether the applicant was carried on for the purposes of profit or gain to the individual members of the applicant.

35. It seems to be beyond doubt, as mentioned earlier, that the motivating force behind the transactions entered into was to provide additional water resources for the cane-growers. As we have already found this is a purpose within the terms of para. 23(h). It follows that if the facility of additional water storage was all that was achieved, that would be the end of the matter.

36. However, the canegrowers who formed the membership of the applicant were an exclusive class of persons. They could not admit into their ranks any persons other than canegrowers assigned to the particular sugar mill. Thus, what was achieved was additional water storage facilities for an exclusive class of persons. Also achieved as part of the agreement with the Queensland Government was concessional prices for purchase of water from the scheme.

37. It appears that a significant proportion of the levy raised from the growers has been or will be repaid to them. However, we do not regard that as being of any significance in this case. What is more important is that cl. 33 of the constituting document provides for distribution to the shareholders in the event of a winding up. The existence of such a clause or the absence of such a clause will be of little consequence in the constituting document of an organisation which is conducted or carried on from year to year in such a manner as to make it unlikely that there will ever be a distribution to members. This would be the case in most ongoing organisations where there is no intention of winding the organisation up; cf. the discussion in the joint decision of Mr Donovan (Chairman) and Mr Davies (Member) (as he then was) in Case R38
(1965) 16 T.B.R.D. 163 at p. 167. However, that is not the case here. It was intended that the applicant be wound up as soon as possible after it had completed its financing obligations. The facts in this case are therefore quite different to the facts in
I.R. Commrs v. Yorkshire Agricultural Society (1927) 1 K.B. 611. Here, the intention was to make distributions to the members so soon as the applicant was able to do so. Whether those distributions would result in a profit to members is another matter. On our understanding of the facts, and notwithstanding the substantial income derived from investments, the members will only receive back a portion of their initial investment via the levy.

38. The facts accord with the apparent intentions. There never was any intention of making a profit for the members.

39. Different questions arise in considering whether the applicant was carried on for purposes of gain to the individual members. As already noted the members belonged to an exclusive class of persons and membership of the applicant was restricted to that class of persons.

40. The purpose of the applicant was to obtain increased available water storage for its members. In the result it obtained this increased water storage at a date earlier than it would have been provided if it had relied on Government financing. The applicant obtained these additional water allocations to its members at concessional rates of payment to the Government.

41. "Gain" means something wider than profit. Improvement, benefit and advancement are embraced within the ordinary meaning of gain whereas "profit", although having a similar meaning, requires that the improvement benefit or advancement be quantifiable in some way. That is not so with the word gain which includes other considerations of value obtained.

42. The difference was dealt with by Lord Chancellor Selborne in
Mersey Docks & Harbour Board v. Lucas (1883) 8 App. Cas. 891 at p. 905 where his Lordship stated:

"I pause there to observe that although in the Act of Parliament `profits' and `gains'

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are really equivalent terms, yet the use of the word `gains' in addition to the word `profits' furnishes an additional argument for excluding the contention of the appellants that you are to introduce into the word `profits' some ideas connected, not with the nature of the thing, but with the manner and rule of its application. What are the gains of a trade? If it could be reasonably contended that the word `profits' in these Acts has reference to some advantage which the persons carrying on the concern are to derive from it, it might be said perhaps that the same argument might have been raised upon the word `gains'; but to my mind it is reasonably plain that the gains of a trade are that which is gained by the trading, for whatever purposes it is used, whether it is gained for the benefit of a community, or for the benefit of individuals. Whether the benefit is to be obtained by dividends, or whether it is to be obtained by lightening and diminishing public burdens, it is the same."

43. We have come to the conclusion that the applicant was carried on for the purposes of gain to its members and is therefore outside the terms of para. 23(h).

44. As to the alternative argument as to whether a deduction should be allowed for interest paid to the X merchant bank, we need say little. The interest was incurred by the applicant on and from 2 March 1983 and can relate to the 1983 and 1984 years of income only. The interest was paid to the merchant bank on the funds borrowed to provide the bridging finance for construction of the water storage. The terms of the agreement with the Queensland Government were to the effect that the Government would repay the principal borrowed but not the interest incurred.

45. In this situation the interest claimed as a deduction fails the fundamental test imposed by sec. 51(1). The outgoing must be incurred in gaining or producing the assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. No relevant amounts of assessable income were derived or expected to be derived by the applicant. This is not a case where the applicant could reasonably expect to derive income from the project at some future date. In our view, the decision of the High Court in
Amalgamated Zinc (De Bavay's) Ltd. v. F.C. of T. (1935) 54 C.L.R. 295; 3 A.T.D. 288, governs this case. We therefore find that the interest paid to the X merchant bank is not an allowable deduction.

46. For these reasons, the respondent's objection decisions for the years of income ended 30 June 1982, 1983 and 1984 are affirmed.