EVENDEN v FC of T

Members:
KL Beddoe SM

Tribunal:
Administrative Appeals Tribunal

MEDIA NEUTRAL CITATION: [1999] AATA 731

Decision date: 1 October 1999

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KL Beddoe (Senior Member)

The applicant seeks review of objection decisions made by the respondent in relation to the years of income ended 30 June 1992, 30 June 1993, 30 June 1994 and 30 June 1995.

The statutory provisions

2. The issues to be decided arise under ss 51(1) and 70B of the Income Tax Assessment Act 1936 (``the Act'').

3. Section 51(1) of the Act, which is the general deduction section, provides for allowable deductions for losses and outgoings to the extent which they have been incurred in gaining or producing the assessable income, or have been necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. Losses or outgoings of capital, or of a capital, private or domestic nature are not deductible.

4. Less often visited is s 70B of the Act. The essence of that section is in subsection (2) which provides:

``70B(2) Where a taxpayer disposes of a traditional security or a traditional security of a taxpayer is redeemed, the amount of any loss on the disposal or redemption is allowable as a deduction from the assessable income of the taxpayer of the year of income in which the disposal or redemption takes place.''

5. By definition (s 159GP(1)) a ``security'' means, inter alia, any contract, whether or not in writing, under which a person is liable to pay an amount or amounts, whether or not the liability is secured.

6. Section 26BB(1) of the Act defines a traditional security. In so far as it is relevant the subsection says a traditional security, in relation to a taxpayer, means a security held by the taxpayer that is or was acquired by the taxpayer after 10 May 1989 and does not have an eligible return.

7. ``Eligible return'' is defined to have the same meaning as in Division 16E of the Act. Section 159GP(3) provides that for the purposes of Division 16E there shall be taken to be an eligible return in relation to a security if at the time when the security is issued it is reasonably likely, by reason that the security was issued at a discount, bears deferred interest or is capital indexed or for any other reason, having regard to the terms of the security, for the sum of all payments (other than periodic interest payments) under the security to exceed the issue price of the security, and the amount of the eligible return is the amount of the excess.

8. Subsection 70B(5) provides that the reference to disposal or redemption of a security of a taxpayer does not include a reference to the waiver or release by the taxpayer of:

• (a) the whole or part of the debt the subject of the security; or
• (b) any other right of the taxpayer under the security.

Findings of fact

9. I make the following findings of fact:

• (a) In her income tax return for the year of income ended 30 June 1992 the applicant claimed a deduction for:

              
  
  
  ``Debts incurred under guarantees relating to       $179,997
  insolvent company (`the company') of which
  I was a director and shareholder.
  
  (See Accountant's working papers)''
            

• (b) In her income tax returns for the years of income ended 30 June 1993, 30 June 1994 and 30 June 1995 the applicant claimed a deduction for carry forward losses having their genesis in the claim noted at (a) above.
• (c) Each of those claims was disallowed by the respondent and the applicant objected against consequential assessments made by the respondent. Those objections were disallowed.
• (d) The company was incorporated in South Australia on 20 July 1988. The applicant and her husband were the only shareholders.
• (e) The company took over the business of a partnership trading as ``Dr Bob's Mobile Workshop''. The partners were the applicant and her husband (Exhibit A).
• (f) That partnership was constituted by the applicant and her husband by a formal partnership agreement in writing dated 20 September 1987 (Exhibit A).
• (g) The said business was conducted on behalf of the company by the applicant and her husband. The company also employed other persons from time to time.
• (h) To establish the business the partnership entered into leasing agreements for equipment, borrowed money, gave personal guarantees and mortgaged their home.
• (i) While the company took over use of some of the leased equipment from the partnership and paid the monthly fees the leases were not assigned to the company and remained the responsibility of the applicant and her husband.
• (j) Upon the company becoming insolvent in early 1992 it ceased making the lease payments and acting through its accountant notified the lessors to collect their goods. Subsequent sales of goods failed to achieve the balance owing on the leases and the lessors formally demanded that the applicant and her husband pay the outstanding amounts.
• (k) In the course of its business the company leased assets including a motor vehicle in respect of which the applicant and her husband were required to give personal guarantees. This was done on an informal basis, without consideration and without any resolution by the company.
• (l) Upon the company ceasing trading in mid 1991, and the leased assets had been returned to the lessors, demands were made for amounts outstanding to be settled under the personal guarantees. The company was dissolved on 10 July 1992 (T22).
• (m) In particular the acquisition of a van with a tune up machine was financed through Beneficial Finance Corporation (``BFC''). Also a Holden vehicle was leased from ESANDA Finance. The acquisition of a power inverter and air flow tester was financed on a leasing arrangement with Household Finance. A telephone system was leased through BFC. All of these leased goods were used in the Mobile Workshop business. The leases with BFC and Household Finance were in the names of the applicant and her husband having been entered into while conducting the business in partnership.
• (n) The business closed for holidays Christmas 1990 during which period a vehicle and some equipment was stolen. The applicant says she drew $10,000.00 on a Custom Credit personal card to finance replacement of stolen equipment pending settlement of the insurance claim. In the result there was said to be a shortfall on the insurance payout and the applicant and her husband could not recover the $10,000.00 from the company. The oral evidence of the applicant satisfied me that the insurance payout was in fact paid to the personal bank account of the applicant and her husband. It seems the money from Custom Credit was also paid to this account. There is nothing in the material before the Tribunal that satisfies me the $10,000.00 was applied for the benefit of the company.
• (o) In April 1991 the company was apparently in breach of its lease of its business premises (Exhibit E) and the applicant and her husband decided to close the business and move to Queensland. They arranged for their accountant to informally liquidate the company. That apparently

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  ATC 2301

  resulted in BFC seizing and selling all the company's equipment, including equipment belonging to other lessors, in particular Household Finance. As to how BFC and Household Finance resolved this situation is not before me.
• (p) The various creditors have enforced payment of the outstanding debts and the applicant has been making contributions which in turn found the basis for the revised claims in this matter.
• (q) Exhibit L satisfies me that the applicant and her husband paid some of the company's business expenses from their personal bank account in late March 1991 including a payment of $1,495.38 to ESANDA Finance (presumably in relation to the lease of the Holden car).
• (r) The applicant's evidence and Exhibit H satisfies me that the applicant and her husband paid $1,100 in the year ended 30 June 1994 and $900.00 in the year ended 30 June 1995 under the terms of the guarantee to Household Finance by agreement with Household Finance and in response to a demand from Household Finance within the terms of the guarantee.
• (s) I am satisfied that at all relevant times, ie at all times when the applicant made payments under guarantees enforced because the company was in default, the company was insolvent and unable to pay its debts (Exhibit C).

10. The applicant has now substantially modified the claim as originally made to the respondent. In a document handed up by counsel and amended during the hearing the claims are now summarised as follows (the alternative claims arise only if the claim for $25,154.00 in the 1992 year is disallowed):

SECTIONS(S)      ISSUE                                     Income   Quantum
                                                            Year       $
s.51(1)          Loss incurred under guarantee (ESANDA)    (1992)  25,154.00
s.51(1)/s.92(2)  Lease expenses incurred after (BFC)       (1992)   3,030.00
                 partnership business ceases (HFC)         (1994)   4,951.00
                 (Alternative claim)                       (1995)     450.00
s.51(1)/s.92(2)  Interest on loan from tax partnership &   (1992)     932.00
                 shareholder/director on lent to company   (1993)     532.00
                 50% claim (Custom Credit)                 (1994)     441.00
                                                           (1995)     395.00
s.79E            Carry forward loss                        (1993)  15,897.00
s.51(1)          AMOUNTS PAID                              see chart below
s.70B            Loss on disposal of traditional security  (1992)     200.00
                 (Alternative claim)                       (1993)     285.00
                       ''      ''                          (1994)     420.00
                       ''      ''                          (1995)     480.00
      

11. The Tribunal formally directed that the grounds of objection be amended as set out in the documents dated 19 June 1998. In the course of the hearing the Tribunal allowed grounds to be further amended so that they are now consistent with the summary above (Exhibit M).

12. At the hearing which took three days spread over some months the applicant was represented by Ms MacDonald of counsel and the respondent by an officer of the Australian Taxation Office.

13. Oral evidence was given by the applicant. The documents lodged in the Tribunal pursuant to s 37 of the Administrative Appeals Tribunal Act 1975 were before the Tribunal as the T documents and further documents were tendered and marked as exhibits.

The applicant's submissions

14. The applicant says that losses and outgoings incurred pursuant to the guarantees were not losses of capital or a capital nature. The amounts were incurred when the applicant became liable under the terms of the guarantee and not when payments were made. That liability arose when the lessor made demand for payment on the applicant's guarantor.

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ATC 2302

15. The applicant relies in principle on the decision in
FC of T v Total Holdings (Aust) Pty Ltd 79 ATC 4279 and the decision in
FC of T v EA Marr & Sons (Sales) Ltd 84 ATC 4580. The applicant seeks to distinguish the decision in
Hooker Rex Pty Limited v FC of T 88 ATC 4392 where, it is said, there was not the necessary nexus with the derivation of assessable income and is to be compared with the decision in
FC of T v Edwards 94 ATC 4255. That decision had nothing to do with guarantees but the applicant relies on the law as stated in the Full Court's judgment.

16. The fact of cessation of business is not a relevant factor and the applicant relies on the decision in
Placer Pacific Management Pty Limited v FC of T 95 ATC 4459.

17. The applicant's case also relies on the second positive limb of s 51(1) of the Act on the basis that the partnership continued to support the family business conducted by the company and the partnership therefore continued to carry on business in this limited way. In particular, the leases with Household Finance and BFC were entered into by the applicant and her husband as partners when the partnership was carrying on the business. The amounts were therefore incurred under contracts entered into while carrying on business. The applicant relies in particular on the decision in
Brown v FC of T 98 ATC 4695.

18. In so far as the applicant says that s 70B applies I understood that claim to be made in the alternative and on the basis that if the Tribunal held that the promise to answer for the company's obligations characterised the accrued obligations as of a capital nature being in the nature of a loan.

19. The applicant had an accrued right of indemnity from the company upon meeting payments under the guarantee. That right of indemnity is the security which by definition is a traditional security. The loss on the traditional security arose because the company was unable to meet its obligation under the indemnity.

The respondent's submissions

20. The respondent relies on the decision in
Amalgamated Zinc (de Bavays) Ltd v FC of T (1935) 3 ATD 288; (1935) 54 CLR 295, where claims for deduction of moneys paid for workers compensation were disallowed because the company had ceased carrying on its mining business at Broken Hill.

21. The respondent, like the applicant, cited a number of Board of Review and Tribunal cases which, in my view, depend upon their own particular facts and do not reveal a consistent approach to the correct characterisation of debts incurred under the terms of a guarantee.

22. The respondent also relies on the commentary by Professor Parsons, ``Income Taxation in Australia'', 1985, at 6.247.

23. The respondent characterised the applicant's payments under the guarantees as outlays rather than outgoings, such outlays recoverable in terms of the indemnity arising from the guarantee and if not recovered then resulting in a loss.

24. The respondent agrees that the guarantor's right of indemnity is a traditional security because it comes within paragraph (d) of the definition of security in s 159GP(1) of the Act. The respondent submits that the right of indemnity crystallises on payment made by the surety. But s 70B(2) is not satisfied where there has been no disposal of the security. The respondent refers to and relies on the decision in Case 23/95,
95 ATC 249. In any event s 70B(4) operates to prevent deductions for so much of a loss as is a capital loss on disposal of a traditional security.

25. Given that the company was dissolved on 10 July 1992 it is submitted that no right of indemnity could arise after that date given the non-existence of the debtor.

26. In relationship to the leases entered into by the partnership the respondent said the obligations under the leases were effectively taken over by the company but the respondent does not point to any evidence of assignment or consent by the lessors. The respondent relies on the decision in Case U96,
87 ATC 581 at 584. That was a case where a positive step was taken to dissolve a partnership.

27. In relation to the loan from Custom Credit the respondent says that it was a personal loan and the interest expense was not incurred in gaining or producing the applicant's assessable income.

Consideration

(a) The Partnership Leases

28. The leases of goods entered into by the partnership with BFC and Household Finance must be considered in the light of the Federal Court decision in Placer Pacific Management Pty Limited v FC of T 95 ATC 4459. The Full

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ATC 2303

Court referred to the High Court decisions in Amalgamated Zinc (de Bavays) Ltd v FC of T (supra) and
AGC (Advances) Ltd v FC of T 75 ATC 4057; (1975) 132 CLR 175. At page 4464-4465 the Court set out its understanding of the law following the AGC decision as follows:

``In our view AGC should be taken as establishing the proposition that provided the occasion of a business outgoing is to be found in the business operations directed towards the gaining or production of assessable income generally, the fact that that outgoing was incurred in a year later than the year in which the income was incurred and the fact that in the meantime business in the ordinary sense may have ceased will not determine the issue of deductibility. There is no relevant distinction to be drawn between losses and outgoings. Provided the occasion for the loss or outgoing is to be found in the business operations directed to gaining or producing assessable income, that loss or outgoing will be deductible unless it is capital or of a capital nature.

On the facts of the present case the occasion of the loss or outgoing ultimately incurred in the year of income was the business arrangement entered into between Placer and NWCC for the supply of the conveyor belt which was alleged to be defective. The fact that the division had subsequently been sold and its active manufacturing business terminated does not deny deductibility to the outgoing. A finding to the contrary would lead to great inequity. Many businesses generate liabilities which may arise in the considerable future. Such liabilities are sometimes referred to as `long tail liabilities'. To preclude deductibility when those liabilities come to fruition on the basis that the active trading business which gave rise to them had ceased would be unjust.

The approach we take is consistent with that taken by another Full Court of this Court in
FC of T v EA Marr & Sons (Sales) Ltd 84 ATC 4580; (1984) 2 FCR 326 where the Court comprising Bowen CJ, Toohey and Lockhart JJ unanimously allowed a deduction to a company in liquidation at a time when it might have ceased to carry on business of amounts owing to leasing financiers. The Court regarded De Bavay's case as plainly distinguishable, as indeed it was. However, what is more important is that the payments were deductible because the occasion of the outgoings was to be found in the carrying on of the taxpayer's leasing activities.

It is unnecessary in the present case to consider whether the same result would arise under the first limb of s 51(1) in a case where the taxpayer carried on no business activity: cf FC of T v Riverside Road at ATC 4576; FCR 315.

The case of
Inglis v FC of T 80 ATC 4001; (1979) 28 ALR 425 upon which the Commissioner relied, provides no authority to the contrary. It is clearly distinguishable. In that case the occasion of the outgoings in question was not to be found in some prior primary production business. Indeed it had been concluded at first instance that no business had been carried on at all and that conclusion was confirmed on appeal. If anything the expenditure for which deduction was claimed was expenditure to preserve the property as a pastoral property and had the character of capital.''

29. In the present case the leases were terminated when the goods were repossessed by BFC. From that time the applicant and her husband were required to pay any amounts outstanding within the terms of the leases entered into while they were carrying on business in partnership. Bearing in mind that the goods had been repossessed and that BFC (acting through the State Bank which notified a shortfall) apparently made no formal demands for payment it is only necessary to consider the demand by Household Finance and the satisfaction of that demand by payment of $2,000.00 in monthly instalments of $100.00.

30. I am satisfied that the applicant did not incur the balance of the lease payments on termination of the lease. What she became liable for was a demand by the lessor within the terms of the lease for payment of any residual amount.

31. Such a demand was made by Household Finance and that was satisfied by payment of $2,000.00. The applicant is entitled to a deduction of her share of those outgoings in the year of income in which the outgoings were paid to the lessor.

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ATC 2304

32. I am not satisfied that any further amount which has not been required to be paid by a lessor can be said to be a loss or outgoing incurred by the applicant.

33. I am not satisfied that any issue arises under s 70B in relation to the leases entered into by the partnership because the company was not a party to those leases and the applicant could not therefore claim an indemnity against the company. It follows that there was no security as defined.

34. The loan obtained from Custom Credit was in essence a personal loan obtained by the applicant and her husband to provide short term finance to the company to allow it to replace assets the subject of an insurance claim. I am not satisfied that the company entered into a contract to pay interest to the applicant and her husband so that it is not correct to say that they loaned the money to the company for the purpose of deriving assessable income. In my view the funds are correctly characterised as a shareholder's loan without any obligation to pay interest to the shareholders.

35. In so far as the applicant has incurred losses and outgoings to Custom Credit in relation to the personal loan I am not satisfied that those losses and outgoings have been incurred for the purpose of gaining or producing assessable income (cf.
Crawford v FC of T 93 ATC 5234).

36. In relation to the lease of the Holden car through ESANDA Finance the car was repossessed in 1991 with a balance of $25,154.47 due under the terms of the lease. Formal demand was made by ESANDA Finance on 19 August 1991 in a Notice of Demand addressed to the applicant and her husband (Exhibit F). Payments of $20.00 per month were made commencing in September 1991. The payments increased to $25.00 per month from October 1992 until October 1993 and then increased to $40.00 per month from November 1993.

37. Payments made up to 10 July 1992 only could give rise to a right of indemnity from the company. I am not satisfied that any right of indemnity could arise after the company was dissolved. Nor am I satisfied that there is any right of indemnity that arises before a guarantor makes a payment within the terms of the guarantee. That guarantee was effectively a promise to answer for the company's debt under the lease. The indemnity arises in respect of loss suffered in satisfying obligations under the guarantee. In this case the indemnity by the company expired when the company was dissolved.

38. In the year ended 30 June 1992 the applicant and her husband paid $200.00 by arrangement with ESANDA Finance in satisfaction of their obligations as guarantors under the lease. As Purvis J explained in Case 23/95, 95 ATC 249 the payments totalling $200.00 resulted in a security as defined and because the indemnity contract was not and could not be satisfied there was a loss of a traditional security.

39. That loss is limited to the amount the company was liable to pay under the indemnity.

40. It follows that I should allow a deduction for loss of a traditional security in the year of income ended 30 June 1992.

41. I will set aside the objection decisions under review and remit the matters to the respondent to decide the objections in accordance with these reasons for decision.

42. Liberty to apply will be reserved to the parties.