Avco Financial Services Ltd v Federal Commissioner of Taxation

[1982] HCA 36

HIGH COURT OF AUSTRALIA

Gibbs C.J., Mason, Murphy, Aickin and Wilson JJ.

AVCO FINANCIAL SERVICES LTD. v. FEDERAL COMMISSIONER OF TAXATION

(1982) 150 CLR 510

17 June 1982

Income Tax (Cth)

Income Tax (Cth)—Assessable income—Income—Allowable deductions—Foreign currency borrowings by finance company to enable it to make loans to customers and to repay existing borrowings—Exchange gains and losses on repayment—Whether gains income—Whether losses allowable deductions—Income Tax Assessment Act 1936 (Cth), ss. 25 (1), 51 (1).

Decisions

1982, June 17.
The following written judgments were delivered: -
GIBBS C.J. Avco Financial Services Ltd. ("the appellant") carries on business in Australia as a finance company. Its business is to provide consumer credit by way of personal loans, hire-purchase transactions and consumer mortgages. It was incorporated in 1964, and since that time its business has been steadily increasing. During the relevant years of income - those which ended on 30 November 1972, 1973, 1974, 1975, 1976 and 1977 - it made loans, each comparatively small in amount, to a large number of customers. To raise money to enable it to have available the funds which it needed to make the loans, and to repay amounts already borrowed, the appellant borrowed large sums of money both in Australia and the United States. Because of fluctuations in the rate of exchange of the Australian dollar, the appellant made exchange losses and gains on the repayment of the sums it had borrowed in the United States. In the years 1972, 1973 and 1974 gains were made. In 1975 and 1976 there were both gains and losses, but in 1975 there was a net gain and in 1976 a net loss. In 1977 there was a substantial loss. The Commissioner of Taxation, by his assessments, included in the assessable income of the appellant the gains in the years 1972 to 1976 inclusive, and disallowed any deduction for the losses in the years 1975, 1976 and 1977. By its objections, the appellant claimed that the gains were not taxable income and the losses were deductible. However, when appeals by the appellant against the assessments came before the Supreme Court of New South Wales, both parties took a more moderate view and agreed that gains and losses must be treated as having the same character, so that both should be either of a capital or of a revenue nature. Kearney J., who heard the matter in the Supreme Court, held that the exchange gains and the exchange losses were on revenue account. He accordingly dismissed the appeals which related to the years 1972, 1973 and 1974, and upheld the appeal for the year 1977 and, in respect of the years 1975 and 1976, upheld the Commissioner's disallowance of the objections to the inclusion of such gains as part of the appellant's assessable income, but allowed the appellant's appeals in relation to the disallowance of objections against the Commissioner's refusal to allow the exchange losses in those years as deductions (1979) 39 FLR 414; (1979) 2 NSWLR 570; 10 ATR 322; 79 ATC 4,560 . From this decision both parties brought appeals to the Federal Court of Australia which, by a majority (Brennan and Deane JJ., Fisher J. dissenting), held that the gains and losses were of a capital nature (1980) 50 FLR 117; 33 ALR 309; 11 ATR 401; 80 ATC 4,603 , with the result that the Commissioner's appeals in respect of the disallowance of the losses succeeded and the appellant's appeals in respect of the inclusion of the gains in its assessable income were also successful. Both parties have now appealed to this Court by special leave. The appellant's appeals are in respect of the years 1975, 1976 and 1977, in which the deductions sought to be made for exchange losses were disallowed. The Commissioner, who seeks to uphold the judgment of the Federal Court, has appealed in respect of the years 1972, 1973, 1974, 1975 and 1976 so that, if the losses are held to be deductible, the gains may be treated as assessable income. (at p513)

2. The relevant facts are not in dispute. Those not already mentioned may be very shortly stated. The appellant is a subsidiary of a United States company, but during the years in question did not borrow from that parent company. Some of the borrowings made by the appellant - the commercial paper loans as they were called - were for short terms of ninety or 180 days but were in most cases extended from time to time. In those cases, the appellant would treat the loss or gain as occurring, not when the loan was extended, but when the debt was finally discharged. The second mode of borrowing by the appellant was under agreements for periods ranging from one to five years. In whatever way the borrowing was made, the appellant applied the proceeds in the course of its ordinary business and it was a constant part of its activities to ensure that it borrowed no more than was necessary to provide funds for lending to its customers and for meeting accruing obligations under earlier borrowings. Its aim of course was to avoid any unnecessary liability for interest. No borrowing was made for the purpose of a specific lending transaction; all were for the general business of the company. None of the borrowed moneys were invested. Moneys used to meet maturing obligations were usually not transmitted to Australia, but remained in the appellant's bank in the United States for a few days before being applied in discharge of the debt. (at p514)

3. The gains which resulted from variations in the rate of exchange will be assessable if they can be regarded as income in accordance with ordinary usages and concepts and so within s. 25 (1) of the Income Tax Assessment Act 1936 (Cth), as amended, ("the Act"). The losses will be deductible if they fall within s. 51 (1) of the Act, i.e., if they were losses or outgoings incurred in gaining or producing the assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing such income, and if they were not losses of a capital nature. Where, as a result of variations in the rate of exchange, a taxpayer, in the course of carrying on a continuing business, makes gains or incurs losses of a revenue and not of a capital nature, the gains are assessable income in the year in which they are realized and the losses are allowable deductions in the year in which they are incurred. This is settled by a line of authorities in this Court (Texas Co. (Australasia) Ltd. v. Federal Commissioner of Taxation (1940) 63 CLR 382 ; Armco (Australia) Pty. Ltd. v. Federal Commissioner of Taxation (1948) 76 CLR 584 ; Caltex Ltd. v. Federal Commissioner of Taxation (1960) 106 CLR 205 ; International Nickel Australia Ltd. v. Federal Commissioner of Taxation (1977) 137 CLR 347 ) and is not now in dispute. The principle has been fully discussed and explained in the cases to which I have referred and does not require elaboration. The sole question in the present case is whether the gains and losses were of a revenue or of a capital nature. (at p514)

4. In the forefront of the argument advanced on behalf of the Commissioner is the submission that an exchange gain or loss incurred on the repayment of the principal sum borrowed is always of a capital nature. Support for this argument is found in some dicta of my own in Commercial and General Acceptance Ltd. v. Federal Commissioner of Taxation (1977) 137 CLR 373 . I there said (1977) 137 CLR, at p 377 :

"I incline to think that an exchange gain or loss on the repayment of moneys lent will always be a capital gain or loss, and can never be taken into account in the assessment of income. That seems to have been the view of Latham C.J. in the Texas Co. Case (1940) 63 CLR, at p 428 . But if that be too extreme a view, I agree with Mason J. that the repayment of the borrowing in the present case was an expenditure on the capital account, within the principles stated in the leading case, Sun Newspapers Ltd. and Associated Newspapers Ltd. v. Federal Commissioner of Taxation (1938) 61 CLR 337, at pp 359-363 ."

In the same case Murphy J. (1977) 137 CLR, at p 386 formulated a number of propositions, including the following:

"(5) If an amount receivable by a taxpayer (the principal sum) is not assessable income, then any increase or decrease in the principal sum caused by exchange rate variation is not to be taken into account in determining the taxable income of the taxpayer. (6) If an amount payable by a taxpayer (the principal sum) is not allowable expenditure, then any increase or decrease in the principal sum is not to be taken into account in determining the taxable income of the taxpayer."

Those propositions are consistent with what I said in that case, and some remarks in the judgment of Mason J. suggest that he took a similar view. He said (1977) 137 CLR, at p 383 :

"The exchange gain was in reality a saving or reduction in the amount of Australian currency equivalent which the taxpayer required to repay its indebtedness. In essence it was a windfall advantage stemming from a reduction in a liability to repay a borrowing of capital. I can see no persuasive reason for saying that the gain was a receipt of income."

Notwithstanding these statements it was not necessary for the decision in that case to hold that an exchange gain on the repayment of moneys lent will always be a capital gain. The main purpose of the borrowing in that case was to strengthen the company's business entity, structure or organization set up for the earning of profit, and the obtaining of the loan was not part of the process by which the company operated to obtain regular returns. The direct application of the tests formulated in Sun Newspapers Ltd. and Associated Newspapers Ltd. v. Federal Commissioner of Taxation (1938) 61 CLR at pp 359-363 led to the conclusion that the foreign exchange gain was not income. (at p516)

5. It does seem true to say, at least in general, that if an amount payable by a taxpayer is allowable as a deduction, then any increase or decrease in that amount caused by a variation in the rate of exchange is to be taken into account as an allowable deduction or as assessable income as the case may be: see the second of Murphy J's. propositions in Commercial and General Acceptance Ltd. v. Federal Commissioner of Taxation (1977) 137 CLR, at p 386 . In such a case, ex hypothesi the amount originally payable will not be of a capital nature. For example, there is no doubt that where the payment in connexion with which the gain or loss is made is the price of goods used by the appellant as trading stock the gain or loss will be of a revenue nature: see Texas Co. (Australasia) Ltd. v. Federal Commissioner of Taxation (1940) 63 CLR 382 and International Nickel Australia Ltd. v. Federal Commissioner of Taxation (1977) 137 CLR 347 . However, expenditure may be deductible in some cases even if it is designed to secure an advantage of a capital nature. In Texas Co. (Australasia) Ltd. v. Federal Commissioner of Taxation the taxpayer, an oil company, purchased its petroleum products from its parent companies in the United States, and since its share capital was insufficient to meet its requirements for working capital, was allowed to delay payments in respect of the purchases in order to provide it with funds large enough for its needs. Before payment was made the rate of exchange moved against Australia. It was held that the fact that the increase in expenditure arose from a delay in payment designed to create a fund for working capital did not mean that the exchange loss was of a capital nature. Dixon J., after saying that the credits and debts resulting from variations in the rate of exchange were "continually recurring variations in the position of the business in its course of profit earning" (1940) 63 CLR, at p 468 , went on as follows (1940) 63 CLR, at pp 468-469 :

"Whether the variations are on account of capital or revenue cannot depend on the purpose of the business policy or measures to which as a matter of causation the size or direction of the variation may be traceable. Some kinds of recurrent expenditure made to secure capital or working capital are clearly deductible. Under the Australian system interest on money borrowed for the purpose forms a deduction. So does the rent of premises and the hire of plant. No doubt the difficulty of assigning an outgoing to capital or income is often very great . . . Here I think there are factors which place the expenditure in the category of an outgoing on account of revenue, so far as it is not referable to capital liabilities. First among these factors is that the circumstances that the liability discharged is ex hypothesi of an income nature. Next the chance of loss or gain in the expenditure required to discharge it, owing to variations in exchange, is a matter attendant upon the use of funds transferable from one country to another, which is continual, recurrent and not independent of judgment and policy on the part of those managing a business of which such funds form a part. It is a loss or gain ordinarily regarded in business as detachable from the fund, and susceptible of treatment as a trading profit or loss."

In the same case Latham C.J. said that the increased outlay required in a subsequent year to discharge the constant debt might be regarded, not as payment of the price of the goods, but as "a necessary outgoing made in the normal course of the continuance and maintenance of the business as an enterprise conducted for the purpose of profit" (1940) 63 CLR, at p 427 . (at p517)

6. Similarly, it appears right, in a case such as the present, to regard exchange gains and losses resulting from the repayment of borrowed money as detachable from the borrowed fund, and as not necessarily sharing its character. The difficulty of adhering to the view that exchange gains and losses resulting from the repayment of borrowed money must always be of a capital nature is made manifest by comparing the case in which a taxpayer who regularly buys trading stock has ninety days after each delivery in which to pay the supplier, with the case in which the taxpayer arranges with his bank to pay the supplier each time a delivery is made and has himself ninety days in which to pay the bank. The authorities cited show that a gain or loss resulting from a change in the rate of exchange during the ninety days would be on revenue account in the former case. It would be anomalous if the gain or loss was on capital account in the latter case. In Thiess Toyota Pty. Ltd. v. Federal Commissioner of Taxation (1978) 1 NSWLR 723 , where a company which sold motor vehicles paid for the imported vehicles with moneys advanced by a bank in the form of letters of credit in favour of the exporter in Japan, and the company had ninety days to reimburse the bank, it was held by Meares J. that the arrangements with the bank were all part of a transaction relating directly to, and having the purpose of, the purchase of trading stock and that the exchange gain was on revenue account and assessable income. Meares J. followed the decision of the Supreme Court of Canada in Tip Top Tailors Ltd. v. Minister of National Revenue (1957) 11 DLR (2d) 289 , where a similar conclusion had been reached, in preference to the decision of Wilson J. of the Supreme Court of New Zealand in Nissan Motor Distributors (New Zealand) Ltd. v. Commissioner of Inland Revenue (1976) 2 NZLR 185 . In the United States, it has also been held that an exchange gain on payment of a debt due for trading stock was taxable as income: America-Southeast Asia Co. Inc. v. Commissioner of Internal Revenue (1956) 26 TC (US) 198 . (at p518)

7. Where a taxpayer carries on the business of borrowing and lending money, the moneys used for that purpose are analogous to trading stock - the taxpayer in effect deals in the money. Exchange gains and losses, regularly and frequently made and incurred, in the course of making repayments of borrowed money which is used by a taxpayer in making loans in the course of its finance business are outgoings made in the day to day conduct of the business and for the purpose of carrying on the business as a going concern. The first matter to be considered, in deciding whether a payment is of a capital or of a revenue nature, is what was the character of the advantage sought by the payment: Sun Newspapers Ltd. and Associated Newspapers Ltd. v. Federal Commissioner of Taxation (1938) 61 CLR, at p 363 . The question has to be considered from a practical and business point of view: see Federal Commissioner of Taxation v. South Australian Battery Makers Pty. Ltd. (1978) 140 CLR 645, at p 659 , and cases there cited. From that point of view, the additional moneys paid as a result of the unfavourable exchange variations - the exchange losses - were part of the price by which the appellant obtained the money which it used to make a profit - part of the process by which the appellant obtained regular returns. The payments were recurrent and frequent, although irregular, and they involved the exercise of judgment by the officers of the appellant who put its borrowing policy into effect as part of the conduct of the business. The exchange losses were in my opinion losses on revenue account, and of course the gains have the same character. The view which I expressed in Commercial and General Acceptance Ltd. v. Federal Commissioner of Taxation (1977) 137 CLR, at p 377 , that an exchange gain or loss on the repayment of moneys lent will always be a capital gain or loss, must, on reconsideration, be rejected. In a case such as the present the gains and losses do not have the same character as the repayments that produced them, and, considered separately, but in the light of all the circumstances, are seen to be revenue in character. (at p518)

8. In the Federal Court, Brennan J. raised the question whether a loss could be said to be incurred in those cases in which the Australian dollar loss had been merely calculated, and there had not been an actual outlay of Australian dollars. It was held in Caltex Ltd. v. Federal Commissioner of Taxation (1960) 106 CLR 205 that where a taxpayer did not discharge its indebtedness in the United States, but merely substituted one creditor for another, and did not suffer any loss in Australian money, no loss was incurred within s. 51 (1) of the Act. However, in the present case the parties agreed before us that this point was never in contention between them. They were content to argue the issues of principle, because in the end the American indebtedness was entirely repaid, and the details were regarded as immaterial. (at p519)

9. For these reasons in my opinion the conclusion reached by Kearney J. was correct and the appeals should be allowed. (at p519)

MASON, AICKIN AND WILSON JJ. These appeals raise the familiar question whether exchange gains and losses made and suffered by a finance company in repaying overseas loans are a capital or revenue item. As the appellant taxpayer sustained an overall loss during the relevant period of six years, it claims that gains and losses should be dealt with as revenue items. On the other hand, the Commissioner contends that they should be dealt with as capital items. (at p519)

2. Due to fluctuations in the foreign exchange rate of the Australian dollar, the taxpayer made during the relevant periods the following foreign exchange gains and losses:

1972 Gain $175,084 1973 Gain $1,579,020 1974 Gain $298,501 1975 Net gain $243,038 1976 Net loss $126,412 1977 Loss $2,799,903

These gains and losses were realized upon repayment of foreign currency borrowings by the taxpayer. (at p519)

3. The Commissioner included in the assessable income of the taxpayer the gains in the years 1972 to 1976 inclusive and disallowed any deduction for losses incurred in the years 1975 to 1977 inclusive. The Commissioner having disallowed the taxpayer's objections, the taxpayer appealed to the Supreme Court of New South Wales in its Administrative Law Division. There, Kearney J. allowed the taxpayer's appeals (1979) 39 FLR 414; (1979) 2 NSWLR 570; 10 ATR 322; 79 ATC 4,560 , holding that the gains were made and the losses were suffered on revenue account. The Commissioner then successfully appealed to the Federal Court. The Full Court of that Court by majority (Brennan and Deane JJ., Fisher J. dissenting) took a different view, holding that the items were on capital account (1980) 50 FLR 117; 33 ALR 309; 11 ATR 401; 80 ATC 4,603 . (at p520)

4. In this Court the taxpayer does not challenge the correctness of the primary facts found and stated by Kearney J. The account which follows is taken from his Honour's judgment. (at p520)

5. The taxpayer, which was a finance company, was incorporated on 6 November 1964 in the Australian Capital Territory. It is a wholly-owned subsidiary of Avco Financial Services Inc., one of the largest consumer finance companies in the United States. The taxpayer has been and is engaged only in the provision of consumer credit in the form of personal loans, hire-purchase retail instalment and similar transactions. The taxpayer lends money in small amounts to large numbers of customers from a large number of outlets. It has not lent to any subsidiary or to any company. Since its inception the taxpayer's business has steadily increased. In 1972 it made loans to 84,000 customers approximately, the average account size being $518, the business being carried on from sixty-two branch offices, the volume of funds amounting to $39,000,000 and the number of consumer loans being 66,440. In 1977 it made loans to 142,000 customers approximately, the average account size being $1,100, the number of branches being 129, the volume of funds lent being $116,627,000 and the number of consumer loans being 126,356. (at p520)

6. The taxpayer's funds have been and are invested exclusively in consumer credit receivables, i.e., personal loans, hire-purchase transactions and consumer mortgages, save for an investment in furniture and equipment representing one per cent of total assets and for the expenditure in 1974 of $369,000 for shares in Atlantic General Insurance Company Ltd., an insurance company carrying on business in Bermuda. (at p520)

7. The capital structure of the taxpayer during the relevant periods appears from the following tables:

1972 1973 1974 ---- ---- ---- $A $A $A

Preference (redeemable) 3,500,000 5,900,000 5,900,000 Common 1,150,000 1,150,000 4,237,000
Retained earnings 2,841,049 7,862,066 6,287,848
Share Premium Reserve - - 15,935,000
Capital Redemption
Reserve - - -

------------- -------------- --------------

TOTAL STOCKHOLDERS' EQUITY 7,491,049 14,912,066 32,359,848
-------------- -------------- --------------- (at p521)

8. In 1975 the preference shares were redeemed and ordinary shares converted to stock.

1975 1976 1977 ---- ---- ---- $A $A $A

Capital stock 4,330,000 4,330,000 4,330,000 Preference (redeemable)< - - -
Common - - -
Retained earnings 9,420,824 13,426,135 22,059,450
Share Premium Reserve 16,400,000 16,400,000 16,400,000
Capital Redemption
Reserve 5,342,000 5,342,000 5,342,000

------------- -------------- --------------

TOTAL SHAREHOLDERS' EQUITY 35,492,824 39,498,135 48,131,450
-------------- -------------- -------------- (at p521)

9. In its early years the taxpayer raised most of its funds by loans from United States sources. The taxpayer is now better known amongst institutional lenders in Australia and partly because of this and partly because the taxpayer has adopted a policy of matching Australian dollar liabilities against Australian dollar assets in order to minimize the effects of foreign exchange fluctuations, the taxpayer has been deliberately converting its United States dollar borrowings into Australian dollar borrowings from Australian institutional lenders. Otherwise the taxpayer's borrowing activity and course of business has remained substantially unchanged throughout its history. (at p521)

10. The following table indicates this movement in terms of indebtedness year by year of Australian dollar indebtedness as against United States dollar indebtedness.

30/11/72 30/11/73 30/11/74 30/11/75 30/11/76 30/11/77 --------- --------- --------- --------- --------- --------- (In thousands of Australian dollars) $ $ $ $ $ $

Australian Dollar Debt 10,472 41,199 45,066 60,130 72,350 111,231
U.S. Dollar
Debt 22,916 16,577 17,833 34,524 38,797 16,852

--------- --------- --------- --------- --------- ---------

TOTAL DEBT 33,388 57,776 62,899 94,654 111,147 128,083

--------- --------- --------- --------- --------- ---------<-------

(at p522)

11. The increases in the indebtedness in United States dollars in 1975 and 1976 was due to the inability of the taxpayer to finance its planned increase in lending activities solely with Australian dollar borrowings. For this reason the taxpayer borrowed additional United States dollar funds which were then available at lower rates of interest than the rates then offered for the lending of similar funds in the Australian money market. (at p522)

12. However, the taxpayer's policy was pursued strongly after the Australian dollar devaluation in November 1976. Another factor which deterred the taxpayer from raising funds overseas was the introduction by the reserve Bank of Australia in January 1977 of the "variable deposit requirement". By this requirement overseas borrowings were not permitted unless they carried a term of two years or more and 25 per cent of the funds borrowed were placed on deposit with the Reserve Bank. The effect of the requirement was to increase by one-third the cost of borrowing money overseas. The effect of the switch to Australian borrowings is indicated by the following table:

1972 1973 1974 1975 1976 1977 --------- --------- --------- --------- --------- ---------

No. of $US loans outstanding 20 15 12 21 19 8
No. of $A loans
outstanding 7 25 31 47 62 106

---- ---- ---- ---- ---- ---- 27 40 43 68 81 114 ---- ---- ---- ---- ---- ----

By 30 November 1978 the taxpayer's United States dollar debt was reduced to $4,000,000. (at p522)

13. In its formative years the taxpayer was funded not only by the investment capital of its parent but also by commercial paper loans from its parent which were capitalized by share issues made in or about 1967. Since then the parent company has not advanced loan funds to the taxpayer. Since that time and during the years now in question the taxpayer raised funds by means of commercial paper loans and term loans. The commercial paper borrowing was in the United States money market in the form of promissory notes for a term of ninety or 180 days approximately. Promissory notes were then held in portfolio by the United States lenders or were discounted in the money market. Generally the face value of the note was paid to the company which agreed to pay interest during the term of the note. (at p523)

14. The term loans were made pursuant to agreements. The majority of these loans have been longer term loans. Overall the period of these loans ranged from one year to five years, the average duration being two and a half years. (at p523)

15. The commercial paper loans, which were far more numerous than the term loans, after being drawn down, were in most instances subsequently "rolled over" either with or without draw-down, being finally repaid by an advance from another lender or by cash payment from the taxpayer or by a combination of both. In most instances the rolling over has occurred several times, frequently on five or six occasions. (at p523)

16. The taxpayer participated in many hundreds of transactions involving these features. On the other hand, the term loans were few in number. (at p523)

17. In the cases involving a roll-over the obligation under a particular agreement which was due to mature was extended on like terms without formal repayment and re-drawing of funds. In such a case the taxpayer drew a cheque in favour of the lender for the amount of the accrued interest at the date of maturity and received the original promissory note duly cancelled, in exchange for a new promissory note. (at p523)

18. The taxpayer has not treated any foreign exchange discrepancy at the point of time of roll-over as constituting a realization of any exchange gain or loss. Instead, it has treated the gain or loss as having been realized on final discharge of the debt owing to the lender, whether by a cash payment by the taxpayer or by a repayment through an advance by another lender, or by a combination of both. (at p523)

19. The taxpayer applied the proceeds of its borrowings in its ordinary business. The term loan agreements in particular usually contained a condition or undertaking that the moneys would be used in this fashion. The taxpayer endeavoured in relation to its borrowings to raise funds in sufficient quantities to enable it to carry on its growing business of lending small amounts to consumers and to meet maturing repayments of its borrowings. Thus, in the majority of instances of overseas borrowings the moneys raised have not been transmitted to the taxpayer in Australia, but have remained in its bank in the United States for perhaps one or two days to be applied then in meeting a maturing loan obligation. This procedure has also been followed on the rolling over of such loans. (at p524)

20. The taxpayer took particular action to gear its borrowing programme so as to accommodate both the requirement of funds for onlending by it to its consumer customers and the requirement for available funds to meet accruing repayments for earlier loans both in Australia and overseas. This action to match its requirements with the making of borrowing arrangements was taken by the taxpayer in order to maximize profits without incurring any unnecessary liability for interest on maturing borrowings. The action included the creation of a committee of executives known as the "Treasury Department" whose function was to make estimates of anticipated needs and to monitor developments. (at p524)

21. During the years in question the amounts borrowed in commercial paper loans, apart from several involving $2,000,000 or more, ranged from $100,000 approximately to $1,000,000. The amounts of the term loans were usually of the order of $2,000,000 or $3,000,000 but some were for larger amounts. (at p524)

22. As at 30 November 1976 the total short term loan indebtedness of the taxpayer (repayable in less than twelve months from balance date) was $A55,946,000 and its total long term loan indebtedness was $A55,201,000. As at 30 November 1977 its total short term loan indebtedness was $A36,058,000 and its long term indebtedness was $A92,025,000. (at p524)

23. Throughout the case the Commissioner's primary submission has been that an exchange gain or loss on the repayment of a loan must necessarily be a capital gain or loss. The submission is based on the preferred view expressed by Gibbs J. in Commercial and General Acceptance Ltd. v. Federal Commissioner of Taxation ("CAGA") (1977) 137 CLR 373, at p 377 that "an exchange gain or loss on the repayment of moneys lent will always be a capital gain or loss, and can never be taken into account in the assessment of income". Kearney J. rejected the Commissioner's primary submission largely because he thought that it was at variance with the judgment of Mason J. in CAGA, Barwick C.J. and Jacobs J. agreeing with that judgment. Then, applying the principles enunciated by Dixon J. in Sun Newspapers Ltd. v. Federal Commissioner of Taxation (1938) 61 CLR 337, at pp 359-363 , and by the Privy Council in B.P. Australia Ltd. v. Federal Commissioner of Taxation (1965) 112 CLR 386, at pp 394, 397; (1966) AC 224, at pp 261, 264 , Kearney J. concluded that the borrowings were "an integral part of the ordinary operation of the taxpayer's business so as to represent a matter of revenue rather than capital". Accordingly, he held that the disallowance by the Commissioner of the taxpayer's objections to the assessments for the years 1972 to 1974 inclusive should be upheld and the appeals relating to those years dismissed. He also upheld the Commissioner's disallowance of objections to the inclusion of exchange gains in the years 1975 and 1976 as part of the taxpayer's assessable income but allowed the appeals in relation to the disallowance of objections against the Commissioner's refusal to allowexchange losses in these years as deductions. He allowed the appeal in respect of the 1977 year. (at p525)

24. In the Full Court of the Federal Court divergent views were expressed. Brennan J. agreed with the approach favoured by Gibbs J. in CAGA that all borrowings by a finance company are on capital account. Deane J. left this question open but concluded that the borrowings were a capital item because, as he saw it, the borrowings in the years in question were undertaken with a view to establishing or setting up the business of the company. On the other hand, Fisher J. rejected the Commissioner's primary submission and adopted an approach similar to that taken by Kearney J. at first instance. (at p525)

25. The Commissioner's primary submission derives support not only from Gibbs J. in CAGA but also from Latham C.J. in Texas Co. (Australasia) Ltd. v. Federal Commissioner of Taxation (1940) 63 CLR 382, at p 428 , where the Chief Justice said that "no exchange . . . should be allowed" in respect of "remittances sent by the company to America in repayment of moneys lent or in payment for plant which became part of the capital assets of the company". Latham C.J.'s observation, unlike that of Gibbs J., was not directed to the situation of a finance company. It reflects the view that a loan and the repayment of a loan are generally an affair of capital. And so they are. The money lent, judged from the viewpoint of both borrower and lender, is in general capital; on the other hand, the interest payable on the money lent is generally income in the hands of the lender and a revenue outgoing in the hands of the borrower. (at p525)

26. Thus Menzies J. said in Caltex Ltd. v. Federal Commissioner of Taxation (1960) 106 CLR 205, at p 251 : "Borrowing money to carry on business or to pay liabilities incurred in carrying on business is prima facie to increase the capital employed in the business . . ." Jenkins L.J. (with whom Cohen and Singleton L.JJ. concurred) had expressed a similar view in Davies (H.M. Inspector of Taxes) v. Shell Company of China Ltd. (1951) 32 TC 133, at p 157 , saying that it was perhaps "only another way of saying that they" (i.e. loans) "must prima facie be considered as part of the Company's fixed and not of its circulating capital". In that case the company sold petroleum products in China to agents who paid as the products were sold. To secure the seller's position the agents were required to deposit sums in Chinese dollars with the seller who transferred the deposits to London and converted them into sterling. Later, when the business in China was closed, the amounts due to the agents in Chinese currency were repaid to them. The value of that currency had declined and the company realized a substantial benefit in pounds sterling. It was held not to be taxable. (at p526)

27. But it is one thing to say that a borrowing of money and the repayment of a loan are generally an affair of capital. It is quite another thing to say that they are always an affair of capital. In his dissenting judgment in Tip Top Tailors Ltd. v. Minister of National Revenue (1957) 11 DLR (2d) 289, at p 300 , Cartwright J. said: ". . . in the case of a taxpayer carrying on a commercial undertaking such as that of the appellant, whose business is not that of dealing in foreign exchange or borrowing and lending money, a gain or loss related to dealings between borrower and lender is prima facie one of capital and not of income." There the taxpayer, a clothing manufacturer which purchased materials in the United Kingdom, expecting a devaluation of sterling, arranged a large sterling overdraft with a London bank from which the vendors of the material were paid by the bank from the overdraft account. After devaluation the taxpayer paid off the overdraft in Canadian dollars, the amount required being $160,000 less than it would have been under the old rate of exchange. The majority held that the profit was taxable. They drew a distinction between the capital machinery within and by means of which the business earning the income is carried on and the business itself, fluctuations in the value of the former having no bearing on profits and losses from the business. (at p526)

28. Rand J. (with whom Fauteux J. agreed) referred to the remarks of Lord Macmillan in Montreal Coke and Manufacturing Co. v. Minister of National Revenue (1944) AC 126, at p 134 :
"It is not the business of either of the appellants to engage in financial operations. . . . Of course, like other business people, they must have capital to enable them to conduct their enterprises, but their financial arrangements are quite distinct from the activities by which they earn their income."
The consequence was, in Montreal Coke, to use the words of Lord Macmillan, that "expenditure incurred in relation to the financing of their businesses is not . . . expenditure incurred in the earning of their income". By way of contrast, in Tip Top Tailors the "loan produced working capital used in the course of the company's business" (1957) 11 DLR (2d), at p 292 . (at p527)

29. The majority judgments, as well as the dissenting judgment, in Tip Top Tailors, and the speech of Lord Macmillan in Montreal Coke recognize, rightly in our opinion, that the borrowing of money and the repayment of loans by a finance company in the ordinary course of its business stand in a different situation from borrowings by a company not undertaken in the ordinary course of its income-earning business. The essence of the business of a finance company as carried on by the taxpayer is the borrowing and lending of money, the rates of interest payable on money lent being significantly higher than the rates payable on the money borrowed, for it is from the difference in the rates that the company generates its profit, after making provision for bad debts. There is therefore an important and material difference between borrowing by a finance company in the ordinary course of its business and borrowing by a manufacturing or trading company. In general the finance company's borrowings provide money which it turns over at a profit. Borrowing otherwise than for on-lending or for the repayment of funds borrowed for on-lending, that is, borrowing undertaken for capital rather than revenue purposes, as in CAGA (1977) 137 CLR 373 , is an exception to the general rule. On the other hand, borrowing by a manufacturing or trading company is often undertaken to strengthen the capital or profit-earning structure of the company. A finance company usually borrows in order to increase its working capital which is then turned over at a profit; the manufacturing or trading company frequently borrows to strengthen its permanent capital. (at p527)

30. Exchange gains and losses are an ordinary incident of overseas borrowings by a finance company. If an overseas loan, the proceeds of which are to be used in the Australian business of the finance company, is to be repaid in the foreign currency, the company has, in the first instance, to exchange the foreign currencies for Australian dollars, and later to buy the foreign currency with Australian dollars. Exchange gains and losses are therefore an incident of the borrowing. (at p528)

31. The Commissioner's primary submission begins with the proposition that a distinction is to be drawn between exchange fluctuations affecting liabilities on revenue account and those affecting liabilities on capital account. He asserts, rightly, that by virtue of the Income Tax Assessment Act 1936 (Cth) ("the Act") fluctuations in the value of trading stock are taken into account in arriving at a taxpayer's assessable income. He then makes the point that the stock of money of a finance company available for on-lending is not "trading stock" for the purposes of the Act and that the consequence must be that fluctuations in the amount of money needed to repay borrowed money due to variations in the exchange rate cannot be taken into account in ascertaining the taxpayer's assessable or taxable income under the Act. (at p528)

32. The answer to this argument is to be found in the judgment of Dixon J. in Texas where the issue was whether the taxpayer could deduct the increased outlay in Australian dollars necessary to discharge debts in United States dollars incurred in respect of stock-in-trade and supplies, the increased outlay having been caused by devaluation of the Australian dollar in the period of one year which elapsed between the incurring of the debts and their payment. The Commissioner argued that because the purpose of the delay in payment was to provide the taxpayer with more working capital, the amount in question was capital. (at p528)

33. Dixon J. acknowledged that "the true nature of the deduction claimed is for the increase in the cost of discharging a past liability for which provision in the accounts was made at a lower figure" (51). He noted that the variations in the cost of exchange were "continually recurring variations in the position of the business in its course of profit earning". He went on to say (1940) 63 CLR, at p 468 :

"Some kinds of recurrent expenditure made to secure capital or working capital are clearly debuctible. Under the Australian system interest on money borrowed for the purpose forms a deduction. So does the rent of premises and the hire of plant."

Speaking of the factors which led him to the conclusion that the increased costs were an allowable deduction, after first mentioning that the liability discharged was of an income nature, his Honour said (1940) 63 CLR, at p 469 : "Next the chance of loss or gain in the expenditure required to discharge it, owing to variations in exchange, is a matter attendant upon the use of funds transferable from one country to another, which is...recurrent... It is a loss or gain ordinarily regarded in business as detachable from the fund, and susceptible of treatment as a trading profit or loss....the fact that the reason for the delay related to capital does not make the outgoing a capital loss. It is rather a standing contingency representing the recurrent expenditure which must be incurred to obtain the use of the money and is much more like annual outgoings to obtain the use of capital assets, such as rent, hire or interest." (at p529)

34. Starke J. (1940) 63 CLR, at p 450 , in rejecting the Commissioner's argument in Texas, took a similar view, describing the payments as "outgoings incurred in connection with the trading operations of the taxpayer: the purchase of the stock in which it traded", akin, as he said, to "the interest payments in respect of borrowed money, which were allowed in Farmer v. Scottish North American Trust Ltd. (1912) AC 118 ". There, Lord Atkinson said of the interest payments (1912) AC, at p 127 : "It is an outgoing by means of which the company procures the use of the thing by which it makes a profit, and, like any similar outgoing, should be deducted ..." (at p529)

35. In the United States it has been decided that a gain made by a taxpayer in repaying a sterling loan made by a bank to enable the taxpayer to buy burlap in India in the ordinary course of its business of importing and selling burlap, sterling having been devalued before repayment of the loan, was taxable as income on the ground that it was a gain which arose directly out of the taxpayer's trade or business (America-Southeast Asia Co. Inc. v. Commissioner of Internal Revenue (1956) 26 TC (US) 198 ). In that case Rice J. after noting that the taxpayer entered into two transactions - one a purchase of burlap, the other a foreign exchange transaction, said (1956) 26 TC (US), at p 200 :
"...the nub of its argument here is that because there were two transactions, the gain in question must be taxed as a capital gain, since it was a dealer in burlap and not a dealer in foreign exchange. We do not think that necessarily follows. While we recognize the presence of two transactions and agree with petitioner that there is a marked similarity to its trading in foreign exchange and a short sale, we think the fact of overriding importance here is that petitioner's transaction in foreign exchange was an integral part of its ordinary trade or business and that the gain in question must, therefore, be taxed as ordinary income realized in such trade or business." See also Bevmore Corporation v. Commissioner (1956) 15 TCM 513 . (at p529)

36. With respect to those who think otherwise, the proposition that exchange variations affecting the repayment of loans in foreign currencies are always an affair of capital in the case of a finance company is supported neither by principle nor by authority. The true principle is that in the case of a finance company which borrows money overseas in the ordinary course of its business and not for some special purpose, the added cost of repayment in foreign currency caused by the devaluation or depreciation of the Australian dollar is an additional cost of the borrowing and, like other costs of the borrowing, is an allowable deduction under s. 51 (1). Conversely, a saving in the amount of foreign currency needed to repay an overseas loan due to a revaluation or an appreciation in the value of the Australian dollar is to be considered as income arising directly out of the finance company's ordinary business. (at p530)

37. As we have already observed, the borrowing and repayment of a loan in an overseas currency involves connected exchange transactions when the proceeds of the loan are to be employed in Australia - the finance company first buys Australian dollars with the foreign currency and later buys the foreign currency with Australian dollars in order to effect repayment. Like the borrowing transactions with which they are associated, the foreign exchange transactions are entered into by the taxpayer in the ordinary course of its business and form an integral part of that business. The gains and losses made and sustained in these transactions are therefore made in the ordinary course of carrying on that business, the more so because the gains and losses are an ordinary incident of transactions of this kind. (at p530)

38. In the argument emphasis was given to the notion that the money stock of a finance company is similar to the trading stock of a trading company. There are some obvious similarities. However, there are some differences. Money is not dealt with in specie as a commodity and money is not included in the definition of "trading stock" for the purposes of the Act - see s. 6. Despite these differences, what is of immediate importance is the strong similarity between the getting in and the turning over of trading stock by a trading company and the borrowing and on-lending of money by a finance company. This similarity is so strong as to suggest that just as exchange gains and losses on the acquisition of trading stock are gains and losses in connexion with the borrowing and repayment of loans by a finance company, are also to be included in its assessable income. (at p530)

39. Avco's business may properly be described as money-lending, with the possible exception of its hire-purchase operations - as to which see Transport and General Credit Corporation v. Morgan (1939) 1 Ch 531, at p 551 , per Simonds J. and Austin Distributors Ltd. v. A.H. Paterson Car Sales Pty. Ltd. (1941) 65 CLR 118 . (at p531)

40. The relative proportions of the three major types of activity engaged in by Avco do not appear, but for present purposes hire-purchase transactions bear a sufficient resemblance to money-lending to be treated as in the same category for present purposes. It involves an outlay of money which is recovered from the customer by periodical payments rather than in a lump sum at the end of a period. (at p531)

41. There is also a common feature between Avco's business and that of bankers. Each borrows money for the purposes of lending it to its customers, or repaying former lenders whose loans are due for repayment. (at p531)

42. The point of this analysis of Avco's business is that it has been said on a number of occasions that money is the stock-in-trade of bankers and money-lenders. Thus in Income Tax Commissioner v. Singh (1942) 1 All ER 362, at p 365 , Lord Thankerton, speaking for the Privy Council, said: "It has to be remembered that money is the stock-in-trade of a money-lender." (at p531)

43. In Guinea Airways Ltd. v. Federal Commissioner of Taxation (1950) 83 CLR 584, at p 593 , Kitto J. said:
"In the case of a banker, money is his stock in trade, and any profit or loss he makes in dealing with money in the course of his business is on revenue account, notwithstanding that the money is in a sense held in reserve." (at p531)

44. In Modern Permanent Building and Investment Society (In liq.) v. Federal Commissioner of Taxation (1958) 98 CLR 187, at p 191 , Williams J. referred to those two cases and said:
"No doubt money can in a somewhat metaphorical sense be said to be the stock-in-trade of a moneylender or a bank. It is dealing in money and in that which it represents, that is to say, the debts which are owed to it as a result of putting out its money at interest. Any loss upon a loan that such a trader might incur in the course of carrying on its business would be a loss incurred in gaining or producing the assessable income and be an allowable deduction under s. 63 of the Act. But a loss incurred upon the realisation of such loans in order to put an end to the business or part of it would, in the absence of legislation to the contrary, be a capital loss." (at p531)

45. The decision in Texas (1940) 63 CLR 382 established that exchange gains and losses encountered in financing the purchase of trading stock are to be regarded as on revenue account. Avco's borrowings to obtain funds to finance its lending and hire-purchase business bear a sufficiently close resemblance to the borrowing of funds to purchase physical stock-in-trade and the deferring of payments due to suppliers of such stock to require exchange gains and losses to be treated in the same way, i.e., as being on revenue account. (at p532)

46. A distinction is to be drawn between moneys borrowed by a finance company in the ordinary course of its business and moneys borrowed for some special purpose which excludes the use of the money in the ordinary course of the finance company's business, e.g., for on-lending or for the repayment of a loan the proceeds of which have been employed in the ordinary course of its business. CAGA (1977) 137 CLR 373 was an instance of a borrowing for a special purpose, the company undertaking not to use the funds for on-lending and to employ them in such a way that they could be regarded as part of the permanent capital structure of the business. (at p532)

47. There is a question whether for present purposes a distinction should be drawn between moneys borrowed for the purpose of on-lending and moneys borrowed for the purpose of repaying loans previously borrowed for on-lending. In our view no such distinction should be drawn. In each instance the transactions are continuously and regularly entered into in the ordinary course of the finance company's business; they are an integral part of that business. The gearing of the borrowing programme to accommodate the requirement for funds for on-lending and the requirement for funds to meet repayment of maturing loans so as to maximize profits without incurring an unnecessary liability for interest on such loans shows that it would be impractical to draw a distinction. Borrowing for the two purposes is inter-related and a fundamental element in the business of generating the taxpayer's income. (at p532)

48. We would therefore reject the Commissioner's primary submission that exchange gains and losses in connexion with overseas borrowings by a finance company are always an affair of capital. Indeed, the application of the principles discussed in Sun Newspapers, Texas, Armco (Australia) Pty. Ltd. v. Federal Commissioner of Taxation (1948) 76 CLR 584 , Caltex (1960) 106 CLR 205 and CAGA to borrowings by a finance company in the situation of the taxpayer will generally result in the exchange gains and losses being characterized as revenue items. The result in CAGA depended on its special circumstances. Our discussion of the principles and their application in the present case shows that the exchange gains and losses of the taxpayer were revenue items and that Kearney J. and Fisher J. were right in so holding. (at p533)

49. In stating this conclusion we do not overlook the view of Deane J. in the Federal Court that the borrowings should be regarded as capital items because they were in large amounts and were logically anterior to and distinct from the numerous transactions to which the taxpayer devoted its subscribed and borrowed capital and that the surplus proceeds of the United States borrowings brought to Australia "should properly be seen as representing part of the capital structure of that business rather than the proceeds of borrowings made as an incident of carrying it on". Although we acknowledge the force of his Honour's remarks, we think that the better view is that the borrowings should be regarded as an integral part of the carrying on of the taxpayer's income-earning business. (at p533)

50. For these reasons we would allow the appeals, set aside the order of the Federal Court and restore the orders made by Kearney J. (at p533)

MURPHY J. Rightly or not, in Commercial and General Acceptance Ltd. v. Federal Commissioner of Taxation (1977) 137 CLR 373 the borrowing was treated as a capital transaction, and I accepted this. It was on that somewhat dubious basis that the taxpayer succeeded. Had the overseas borrowing not been treated as a capital transaction, the taxpayer should have failed. In the present case, the taxpayer was dealing in money and the borrowings were not capital. In Commercial and General Acceptance Ltd. v. Federal Commissioner of Taxation (1977) 137 CLR, at p 386 I set out six principles which, in general, govern the assessment of exchange gains and losses. The first and second (at p533) were-

2. 1. If an amount receivable by a taxpayer (the principal sum) is assessable income, then any increase or decrease in the principal sum caused by exchange rate variation is to be taken into account (in determining the taxable income of the taxpayer) as assessable income or allowable expenditure; and (at p533)

3. 2. If an amount payable by a taxpayer (the principal sum) is allowable expenditure, then any increase or decrease in the principal sum caused by exchange rate variation is to be taken into account (in determining the taxable income of the taxpayer) as allowable expenditure or assessable income. (at p533)

4. As there is no special feature justifying departure from these general principles, their application requires the conclusion that the taxpayer should succeed. (at p533)

5. The appeals should be allowed. (at p534)

Orders

Appeals allowed.

Order of the Full Court of the Federal Court set aside, and in lieu thereof order that the appeals to that court be dismissed. Order that the Commissioner of Taxation pay the costs of all appeals to the Federal Court and to this Court.