Commissioner of Taxation of the Commonwealth of Australia v Australian Guaranteee Corp Ltd

[1984] FCA 250

Re: THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
And: AUSTRALIAN GUARANTEE CORPORATION LIMITED (1984) 2 FCR 483
No. G409 of 1983
Income Tax
84 ATC 4642 / 54 ALR 209

COURT

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY
GENERAL DIVISION
Toohey(1), McGregor(2) and Beaumont(3) JJ.

CATCHWORDS

Income Tax - allowable deduction - deferred interest debentures - debenture not redeemable until expiration of 5 years - interest not paid or credited prior to maturity - interest treated by taxpayer as accrued liability during income year - whether interest outgoing incurred in relevant year - taxpayer subjected to liability to pay interest under deferred debenture notwithstanding interest not "credited" or "earned" during relevant year - accrual of interest at common law - meaning of "earned" - relevancy of accounting practice

Income Tax Assessment Act 1936 s.51

Income Tax - Allowable deductions - Interest on deferred interest debentures - Interest not paid or credited prior to maturity - Whether interest "incurred" in relevant year - Income Tax Assessment Act 1936 (Cth), s. 51(1).

HEADNOTE

The taxpayer, a finance company which raised funds by regular borrowings from the public and other sources, issued "deferred interest debentures" to the public. Under the terms of the debentures, no interest would be "paid or credited" prior to maturity or earlier redemption at which time a debenture "will earn and be credited with interest".

Held: (1) The interest which accrued on the debentures during the relevant year was "incurred" by the taxpayer in that year within the meaning of s. 51(1) of the Income Tax Assessment Act 1936 (Cth) because the taxpayer had subjected itself to a liability to pay the interest, notwithstanding that payment would not have to be made until maturity or earlier redemption.

New Zealand Flax Investments Ltd v. Federal Commissioner of Taxation (1938) 61 C.L.R. 179, applied.

Emu Bay Railway Co. Ltd v. Federal Commissioner of Taxation (1944) 71 C.L.R. 596; Nilsen Development Laboratories Pty Ltd v. Federal Commissioner of Taxation (1981) 144 C.L.R. 616, distinguished.

(2) There was nothing in the conditions attaching to the debentures to indicate an intention to displace the common law rule that interest accrues from day to day.

HEARING

Sydney, 1984, June 14, 15; August 23. #DATE 23:8:1984

APPEAL.

Appeal from a decision of the Supreme Court of New South Wales allowing the taxpayer's objection to an assessment of income tax for the year ended 30 September 1978.

K. R. Handley Q.C. and T. Bathurst, for the appellant.

A. M. Gleeson Q.C. and D. G. Hill and A. J. Sullivan, for the respondent.

Cur. adv. vult.

Solicitors for the appellant: Australian Government Solicitor.

Solicitors for the respondent: Clayton Utz.

F.P.C.

ORDER

The appeal be dismissed.

The appellant pay to the respondent its costs of the appeal.

Appeal dismissed.

JUDGE1

Deferred interest debentures are said to have the advantage to the lender that any liability for income tax for interest thereon is deferred until the debenture matures.

Whether that is so is not the issue in this appeal. The issue here is whether a borrower on the terms of such a debenture is entitled to a deduction under sub-s.51(1) of the Income Tax Assessment Act 1936 ("the Act") for interest debited annually in its accounts.

In an affidavit filed in the proceedings in the Supreme Court, the business of the taxpayer was described by its secretary in this way:

"A.G.C. is a subsidiary of Westpac Banking Corporation. A.G.C. carries on business as a financier in all the states and territories of Australia. It makes advances both secured and unsecured and provides financial accommodation to its customers. In order to be in a position to provide funds to its customers A.G.C. borrows funds in a number of ways including the issue of debentures either to the public or to the non-public".

The taxpayer's income year ends on 30 September. In the year of income ended 30 September 1978 it issued 22 certificates of Deferred Interest First Charged Debenture Stock to various investors, all maturing in 1997 and 1998. The debentures were in common form. Their precise terms are of some importance but, speaking generally, it may be said that they were issued at a simple interest rate of 11% a year for the first 5 years, a simple interest rate thereafter equal to the maximum interest rate being offered by the taxpayer for fixed term first charge debenture stock and an additional interest rate by way of bonus, the latter payable only in respect of redemption taking place after the beginning of year 6.

For the year of income the subject of this appeal, being the first year in which the taxpayer issued deferred interest debentures, the taxpayer calculated interest applicable to each investment at the rate of 11% a year for each quarter. The aggregate amount of interest for the quarter was then notified to the accounts department. That department passed general journal entries debiting interest on debentures account and crediting accrued interest on deferred debentures account with the amounts appearing in the information received. These general journal entries were then posted to the general ledger to the relevant accounts and became listed in the trial balance which was a cumulative record during the financial year of entries to all general ledger accounts, prepared as at the end of each calendar month. Debit entries to interest on debentures accounts appeared in the taxpayer's profit and loss account as an expense. Credit entries in respect of interest calculated on deferred debentures were treated as an accrued liability until disbursed in cash. This was reflected in the taxpayer's balance sheet.

The accrued liability appeared in the balance sheet in the taxpayer's annual report under the heading "Public Borrowings; Debentures Stock - Secured". The sum of $2,808 claimed as a deduction represented interest at 11% on the amount of the debentures issued during the relevant income year. This description of the taxpayer's treatment of its deferred debentures is taken from the evidence of the taxpayer's secretary.

In subsequent income years the taxpayer has continued to treat interest on deferred debentures in the same way. It returns income on an accruals basis.

The question vital to this appeal is whether the amounts of interest thus raised are "outgoings ... incurred" within sub-s.51(1) of the Act.

I think it is helpful to set out in their entirety the special conditions appearing on the taxpayer's deferred debentures.

SPECIAL CONDITIONS

The Stock comprised in this Certificate will earn and be credited with interest at redemption, which interest will then be calculated from the original date of investment viz 19 through to date of redemption on a simple interest basis; no interest will be paid or credited prior to maturity.

The interest rate to be applied in respect of the first part of the term will be per cent per annum. This rate will apply through to 31st December in the fifth year following the year of investment.

In respect of the year 1st January to 31st December which is the sixth year following the year of investment ("year six") and in respect of each succeeding year the simple rate to be applied will be the maximum interest rate being offered by Australian Guarantee Corporation Limited ("AGC") for "fixed term" first charge debenture stock in the AGC prospectus current on the first day of such year and if there be no such prospectus it will be the rate applied in respect of the last preceding period.

In addition to the simple interest specified above, a bonus will be paid on redemption in respect of the period from the original date of investment to the date of redemption. This bonus will apply only to redemptions occurring after 1st January in the sixth year following the year of investment ("year six") and will be calculated as a simple rate per cent per annum on the principal amount of the Stock. The rate will be determined by the year in which the redemption date falls in accordance with the following table:

Redemption From To Bonus date 1st January 31st December % per annum occurring in year in year of principal

6 8 3 9 11 5 12 14 6 15 17 8 18 20 10

The said Stock is redeemable at par on 19 ("the maturity date") but -

(a) the Holder may require redemption of the said Stock in full, or in part in multiples of one hundred dollars, any time after 1st January in year six by giving to AGC not less than two months prior written notice to that effect; and

(b) upon the death of a sole holder his executors or administrators may, upon fulfilment of any requirements of State or Federal legislation relating to death or succession duties, require redemption of the said Stock in full or as to a part therof being a multiple of one hundred dollars at any time thereafter; and

(c) AGC reserves the right to redeem at any time at par all or any part of the said Stock upon giving three (3) months notice in writing to the Holder. In the event of AGC exercising this right interest and bonus will not be calculated past the expiry of the three months notice but on expiry of such notice AGC will pay the Holder not only interest and a bonus to that date at the rate or rates provided above but also additional interest calculated at the rate of .25% per annum for the period commencing from the date of expiry of the three months notice until the maturity date."

It will be seen that, under the special conditions, stock earns and is credited with interest "at redemption," which interest is "then calculated from the date of investment". The conditions assert that "no interest will be paid or credited prior to maturity". It will be seen also that redemption is not confined to maturity. The stockholder may redeem from year 6 onwards; upon his death, his personal representatives may redeem; and the taxpayer itself may redeem subject to the payment of an additional amount of interest. Whether redemption occurs by reason of maturity or otherwise, it would seem that the stockholder is entitled to interest from the date of investment to redemption.

In challenging the decision of the Supreme Court of New South Wales that the amounts of interest raised in the taxpayer's accounts fell within sub-s.51(1), the Commissioner made two principal submissions. The first was that the interest was not an outgoing incurred in the relevant year of income because the taxpayer "had not completely subjected itself to such interest". The second was that no deduction may be allowed under sub-s.51(1) "for the face value of interest payments which may not be payable for up to 20 years in the future". The taxpayer contested both propositions.

Whatever the proper resolution of this appeal, the question to be answered is no abstract one. Nor is it a question to be answered by reference to the position of the parties on maturity or on redemption. The Commissioner accepts that in those events any interest paid is an allowable deduction in the year of payment. This Court is concerned with the position of the taxpayer in a particular income year and the question to be answered is whether the amount claimed by the taxpayer answers the description of an outgoing incurred by it during the income year ended 30 September 1978.

The Court was told that the principles on which interest, not yet due and payable, is deductible under s.51 have not been considered by an Australian appellate court since Emu Bay Railway Co. Ltd. v. Federal Commissioner of Taxation (1944) 71 CLR 596. More specifically we were told that this appeal raises for the first time in an Australian appellate court the deductibility of deferred interest under s.51. Of course there have been decisions in which the High Court and other Australian courts have considered the notion of "outgoing incurred" and to some of those decisions reference will be necessary.

It is well established that an outgoing may be incurred though the sum in question has not been paid or the liability discharged. New Zealand Flax Investments Ltd. v. Federal Commissioner of Taxation (1938) 61 CLR 179 at p.207 and Federal Commissioner of Taxation v. James Flood Pty. Ltd. (1953) 88 CLR 492 at p.507. In a passage from his judgment in the former decision, referred to with approval by the Court in the latter, Dixon J. said:

"To come within that provision there must be a loss or outgoing actually incurred.

'Incurred' does not mean only defrayed, discharged, or borne, but rather it includes encountered, run into, or fallen upon. It is unsafe to attempt exhaustive definitions of a conception intended to have such a various or multifarious application. But it does not include a loss or expenditure which is no more than impending, threatened, or expected".

In James Flood at p.507 the Court, in a reference to W. Nevill & Co. Ltd. v. Federal Commissioner of Taxation (1937) 56 CLR 290, said that nothing there decided "was intended to imply that a liability to pay an ascertained sum is never incurred until the sum becomes due and payable".

It is also well established that an outgoing may be incurred in the sense that a taxpayer may completely subject himself to a liability even though the liability is defeasible. The authorities are noted by Newton J. in Commonwealth Aluminium Corporation Limited v. Federal Commissioner of Taxation (1977) 77 ATC 4151 at pp.4160-4161. Newton J. commented at p.4161:

". . . it may incidentally be remarked that all, or almost all, unpaid liabilities are in a sense defeasible, because they could in the future be forgiven by the creditor, or cancelled by Act of Parliament, or barred by any applicable statute of limitations".

In my view the Commissioner's argument does not gain support from Emu Bay Railway. But as the Commissioner relied upon it and as the judgments in that case were discussed by counsel for the Commissioner and the taxpayer, it is necessary to make some reference to the decision.

A company and trustees for its creditors entered into a debenture trust deed under which the company undertook to issue debenture stock to the creditors. Stock certificates in a form prescribed by the deed were issued. By the terms of the deed the company acknowledged itself indebted to the stockholders in a specified sum which, until redemption, was to be interest payable half yearly. Interest was expressed to be "a charge upon and payable only out of the net annual income of the company". The company covenanted to pay the amount of the stock and interest thereon in accordance with the terms of the deed and charged its assets in favour of the trustees to secure the payment thereof. The deed created a trust for sale and empowered the trustees in certain events to enter into possession of and realise the assets. It also contained a provision that, during a period which had expired before the relevant income year, the interest on the stock "shall be payable only out of the net income of the company . . . and after the expiration of such period the interest . . . shall be cumulative". The company did not in the year 1939 or thereafter pay or credit to the stockholders any sum for interest in respect of that year. It had no net income in the year in question; as appeared from its profit and loss account, it incurred a loss. But, unless it was entitled to a deduction for interest, it had a taxable income. It was held by Latham C.J., Starke and McTiernan JJ. (Rich and Williams JJ. dissenting) that the amount of interest was not deductible as an outgoing "incurred in gaining or producing the assessable income" within s.51 of the Act.

Mr. Gleeson Q.C. for the taxpayer pointed out that the difference between the decision of the majority and the minority did not lie in whether a debt which was presently due but payable in the future was incurred in the year in which the liability arose. Rather, it lay in the differing views taken by the members of the Court as to the proper construction of the trust deed. In the view of the majority, no debt or liability arose because there was not and never had been any income from which interest was payable. In the view of the minority, as a matter of construction the deed required interest to accrue as a present liability although the time for payment thereof had not arisen. This appears most clearly in the judgment of Williams J. at p.621 where his Honour said:

"If the whole liability for the interest . . . was entirely confined to the net income of that year, so that, to the extent to which that income was insufficient to meet it, that liability was discharged, then the amount of the outgoings would no doubt be the amount of the net income; but the liability for the interest is not discharged in this manner, and the interest, to the extent to which it is not met, remains an actual debt due and owing by the appellant and charged on its future net income and its assets, although it is only payable in the particular ways already mentioned".

In the light of the authorities, it is necessary to look more closely at the relationship between the taxpayer and those lending money to it under deferred interest debentures.

In the Commissioner's submission, by the terms of the contract between borrower and lender interest was neither earned nor credited until redemption. Debentures could not be redeemed by the investor or his legal personal representatives, with any legal entitlement to accrued interest, until after 5 years. Accordingly, it was said, forbearance by the investor for a minimum period of 5 years was a condition precedent to the taxpayer's liability to pay interest. Hence, it was said, the case falls within the principles expressed in Emu Bay Railway.

I do not accept that submission. To begin with, subject to any right arising from statute or equity, there is no entitlement in the stockholder to the return of the principal sum within the first 5 years, even without interest. There is of course a particular provision in the event of death. Counsel for the parties did not point to any statutory provision or equitable rule that might permit a stockholder to recover his principal during the first 5 years, apart from any rights that might arise in the event of default under the trust deed securing payment of principal and interest. In consequence, it is not right to speak of forbearance by the investor for a minimum period of 5 years as a condition precedent to the taxpayer's liability to pay interest. The investor is contractually precluded from requiring the return of the principal sum until year 6.

It is quite true that, by the terms of the special conditions, stock is expressed to "earn and be credited with interest at redemption". I do not think it is possible to read this expression disjunctively; syntax is against such a construction. It is true also that by the terms of the special conditions, "no interest will be paid or credited prior to maturity". The likely reason for this formulation has already been mentioned. And, as a matter of contract, investors may be held to the terms of the special conditions. But the question now before the Court is not one of the circumstances in which an investor is entitled to be paid interest. The question is whether during the relevant income year the taxpayer subjected itself to a liability to pay interest under the deferred debentures. In my view it did so.

Whether the debentures "earned" or were "credited with" interest prior to redemption in the sense in which that expression is used in the special conditions is a relevant consideration but it is not a determining one. If, before redemption, an investor was "credited" with interest or a debenture was expressed to "earn" interest, there would be little doubt of the taxpayer's entitlement to treat the interest so credited or earned as an outgoing incurred in the year in which it was credited or expressed to be earned. But it is another thing to say that because interest is neither credited nor expressed to be earned the taxpayer is under no present liability to pay interest. On the issue of a deferred interest debenture the taxpayer became liable to pay to the stockholder interest in accordance with the terms of the debenture and any other relevant documents. If, in the unlikely event that the stockholder held the debenture for 20 years, it would mature and interest would be paid accordingly. If, in the more likely event, at some time in year 6 or thereafter the stockholder required redemption of the stock, again interest would be paid in accordance with the special conditions. The same is true in the event of the taxpayer itself redeeming the stock or in the event of the personal representatives of a deceased stockholder requiring redemption. In each case interest is payable as from the date of investment. The taxpayer's liability to pay interest in respect of the first year of investment cannot be described as merely "impending, threatened or expected". It is in truth, in the language of some of the decisions, a debitum in praesenti solvendum in futuro.

It was argued by Mr. Handley Q.C. for the Commissioner that, having regard to written information made available to potential investors, no interest was payable in the event of personal representatives requiring repayment within 5 years of the issue of a debenture. I have serious reservations about accepting that submission. As a matter of construction of the special conditions, it seems to me that interest is payable whenever the personal representatives of a deceased stockholder seek repayment and that this entitlement is not excluded by the language of what is essentially an explanatory memorandum. But, for the purposes of resolving this appeal, it is unnecessary to express a concluded view on that matter.

The view I have taken, that on the issue of a deferred debenture the taxpayer subjected itself to a liability to pay interest to the stockholder, accords with the opinion expressed by Woodward J. in Alliance Holdings Ltd. v. Federal Commissioner of Taxation (1981) 81 ATC 4637 though there were some differences in the form of debenture which his Honour had to consider. It also accords with the views expressed by the learned primary Judge from whom this appeal is brought.

In Nilsen Development Laboratories Pty. Ltd. v. Federal Commissioner of Taxation (1980-1981) 144 CLR 616 at p. 623 Barwick C.J. urged that "the language of Dixon J. in New Zealand Flax Investments Ltd. v. Federal Commissioner of Taxation needs to be carefully perused and applied". In the same passage, Barwick C.J. said that:

". . . there can be no warrant for treating a liability which has not "come home" in the year of income, in the sense of a pecuniary obligation which has become due, as having been incurred in that year . . . That part of Sir Owen Dixon's statement in New Zealand Flax Investments Ltd. v. Federal Commissioner of Taxation which presently needs emphasis is that the word 'incurred' in s.51(1) 'does not include a loss or expenditure which is no more than pending, threatened or expected': and I would for myself add 'no matter how certain it is in the year of income that that loss or expenditure will occur in the future'."

At p.627 Gibbs J. referred to New Zealand Flax Investments as authority for the proposition; "It is not necessary that there should have been any actual disbursement". His Honour continued:

"Indeed, it was suggested in Federal Commissioner of Taxation v. James Flood Pty. Ltd. that it is not necessary that there should be an immediate obligation enforceable at law whether payable presently or at a future time, or that the obligation should be indefeasible. It is not now necessary to consider whether those suggestions should be accepted as correct. But what is clearly necessary is that there should be a presently existing liability".

Nilsen was concerned with the entitlement of a taxpayer to claim, as allowable deductions from its assessable income, amounts provided in its commercial accounts to represent estimates of what it would have been bound to pay its employees if they had taken long service or annual leave during the year of income, less any amounts which had been provided in relation to those items in those accounts in earlier years. In the view of the Court, since there was no liability to make payment until the employees either took the leave entitlements or ceased employment, the amounts in question were not outgoings incurred by the taxpayer in the year of income.

In that case, the primary obligation placed on the taxpayer by the terms of the Metal Industry Award and the Metal Trades (Long Service Leave) Award was, as Barwick C.J. pointed out at p.624:

". . . to give the employee who has served the requisite amount of time leave away from the employment whilst maintaining its continuity. Assuming the employer's business continues and the employee remains alive, a pecuniary liability to the employee will undoubtedly arise when, but not before, the employee enters upon a period of leave, be it annual or long service".

Barwick C.J. rejected the argument that a liability to make such a payment was accruing during the time an employee was serving the period qualifying him for leave. Again at p.624 the Chief Justice said:

"All that then can really be said is that it has become certain that, in due course when further events occur, that is to say, the time for the taking of leave is fixed and the period of leave is entered upon, a liability to pay money will arise. It is quite wrong, in my opinion, in this connexion to treat any liability as either accruing or having accrued at any time prior to the time when the employee enters upon the leave, whether it be annual or long service leave".

Commissioner of Inland Revenue v. Lo & Lo (a firm) (unreported decision of Privy Council delivered 26 March 1984) was concerned with the deductibility for profits tax purposes of sums carried to reserve to answer future retirement payments to staff. The terms of employment of employees of a Hong Kong firm of solicitors and the statutory provisions relating to tax differed from those in Nilsen. In effect, any member of the staff who left the firm's employment after 10 years service was entitled to a lump sum payment calculated by multiplying the number of years of employment by half of the average monthly salary for the last 12 months of employment. In its return for the relevant year, the firm debited to profit and loss account sums paid to employees who had retired during the year and also debited a sum transferred to reserve as "provision for staff retirement benefits". The latter sum was based on a calculation as to the total of the lump sum payments the firm might be obliged to pay other employees who had already completed the qualifying period but whose service continued. In the view of their Lordships at p.6:

"It is correct to regard a retirement benefit as a sum payable in futuro, because there is no liability to pay until a future date arrives, namely the date when the employee leaves the firm's employment. Nevertheless the employee may leave when he pleases, so that the firm has no power to defer payment for any longer than the employee wishes. The right of the employee to receive his retirement benefit is absolute, in the sense that he need do nothing whatever except give a period of notice and pick up his money. . . . He has a vested right which is defeasible only in one possible but unlikely event . The corollary of the view that the long service employee has a vested right to his accrued lump sum payment is that the firm has an accrued liability for that sum".

For the purposes of this appeal, Lo & Lo is useful in the contrast it provides with Nilsen and in the emphasis it places upon a liability which has accrued even through it may not be payable for some time.

Nilsen stresses the need for a presently existing liability before there can be an outgoing incurred within s.51. But the case is distinguishable from the matter now before this Court. It was concerned with the entitlement of employees to long service and annual leave and the obligation of the taxpayer to pay employees during the period of such leave. The employees were not entitled to the payment of money in the sense in which, as mentioned, the employees in Lo and Lo were entitled to payment. In Nilsen there was no accruing liability on the part of the employer, simply an obligation to pay wages when employees became entitled to and took leave. In the case now under appeal the taxpayer's obligation to pay interest under deferred debentures arose when the debentures were issued though subsequent events would determine the precise amount of interest to be paid.

What then of the Commissioner's further submission that a deduction is not obtainable under s.51 for the face value of interest payments which may not be payable for up to 20 years? It may be, as Mr. Gleeson suggested, that the taxpayer is entitled to a deduction, in respect of the year ended 30 September 1978, of an amount of interest calculated with reference to the entire period that the loan might run. But the taxpayer has not approached the question of deductibility in that way; it has, for the year in question, claimed as a deduction an amount of interest calculated for that year. If such an approach was in accord with sound accountancy practice, designed to give a true picture of the taxpayer's earnings and outgoings, I see no reason why the taxpayer should not be allowed a deduction accordingly, unless there is something in the Act that precludes such a course or dictates a different course.

The evidence presented to the Supreme Court established clearly enough the accounting propriety of the approach taken by the taxpayer to the matter of interest on deferred interest debentures in its accounts. In particular Mr. Myles, a chartered accountant and a partner in the firm of Coopers & Lybrand, commented:

"General accounting principles require that all costs incurred during a financial accounting period which are attributable to the operations of that period should be accrued (the accrual basis) and matched with the revenue earned during the period. That is, such costs should be taken up as a charge in the accounts irrespective of whether they have actually been paid out during the period or not. In the context of a finance company (e.g. A.G.C.), this means that the on-going liability for interest costs on borrowed funds should be accrued and matched against the interest received from lending out those funds. Proper matching in these circumstances is usually applied on a progressive basis. The objective of the use of such principles in the accounts is to ensure that the accounts best portray economic reality".

Later Mr. Myles amplified this statement by expressing the opinion that the taxpayer had, in its accounts, "followed correct accounting principles as well as generally accepted accounting practice in relation to the policies adopted by it for the accrual of interest payable on deferred interest debentures". The notion of "matching" is of particular relevance in the present case because of the taxpayer's general activities in the borrowing and lending of money.

The learned primary Judge accepted the evidence of Mr. Myles. That acceptance was not challenged before this Court though it is right to say that the Commissioner disputed the relevance of the evidence in determining the deductibility of the amounts claimed by the taxpayer.

In James Flood at pp. 506-507 the Court said:

"Commercial and accountancy practice may assist in ascertaining the true nature and incidence of the item as a step towards determining whether it answers the test laid down by s. 51(1) but it cannot be substituted for the test".

However, as the learned primary Judge pointed out:

"But a conclusion that, where there is a presently existing liability to pay interest in the future, the amount of interest accruing each year, up to the date of maturity, is "incurred" during the respective years, does not mean that accounting practice is being used as a substitute for the true meaning of "incurred" in s. 51(1). All it means is that accounting practice is identifying in respect of that liability, which is a present liability to pay the whole of the interest at a future time, the amount which is to be treated as an outgoing "incurred" during each year of income".

It is now nearly 50 years since, in Commissioner of Taxes (S.A.) v. Executor Trustee & Agency Co. of South Australia Ltd. (1938) 63 CLR 108 (Carden's case), Dixon J. said at pp. 152-153:

"The courts have always regarded the ascertainment of income as governed by the principles recognised or followed in business and commerce, unless the legislature has itself made some specific provision affecting a particular matter or question.

. . .

The tendency of judicial decision has been to place increasing reliance upon the conceptions of business and the principles and practices of commercial accountancy".

While Dixon J. was speaking of the ascertainment of income, the same is true of the ascertainment of expenditure unless precluded by the terms of the Act.

In New Zealand Flax the taxpayer covenanted with the holders of bonds issued by the company that it would within 5 years complete the purchase of certain land and would cultivate that land for the purpose of growing flax, and would erect a mill and necessary plant for the efficient milling, gathering and selling of the flax. The taxpayer made up its accounts and returns by taking into the receipts side the entire sum representing the bonds sold, whether paid or not, and, on the other side of the account, making provision for the expenditure which ought to be made by the company at a subsequent time if it performed its obligations i.e. for purchase of the land, the clearing and cultivation thereof, the erection and running of the mill, and the payment of interest and commission. In making an assessment, the Commissioner left standing the revenue side of the account but set aside the provision for future outlay. In remitting the matter to the Commissioner, Rich J. said at p. 193:

"In any reassessment he should include only bond moneys received in the accounting periods. With regard to the deductions claimed for future interest and deferred commission the commissioner should allow such part as is referable to the accounting periods under assessment". (emphasis added)

A similar view was expressed by Dixon J. at p. 208.

Taxpayers are required, by the terms of the Act, to make returns on an annual basis. This Court should be slow to disallow a method of calculating the amount of an outgoing if what is claimed is fairly referable to the year in question. In my view, the amount claimed by the taxpayer as interest on deferred interest debentures for the year ended 30 September 1978 was an outgoing incurred by the taxpayer in the relevant year. It was calculated in accordance with sound accounting practice, designed to give a true picture of the taxpayer's financial operations, and it was an approach not precluded by the language of the Act. It is insufficient objection to that approach to say that it is not known when interest will in fact be paid. The amount claimed as a deduction was, in terms of sub-s. 51(1), incurred in the relevant year in the sense that the taxpayer subjected itself to a liability which it assessed according to a method fairly designed to reflect the extent of the liability for the year in question.

The appeal should be dismissed with costs.

JUDGE2

THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA (the Commissioner) has appealed against a decision of the Supreme Court of New South Wales that an amount of $2,808.00 representing accrued interest for its financial year ended 30 September 1978 on Deferred Interest First Charge Debentures was properly deductible under s.51(1) of the Income Tax Assessment Act 1936 (the Act) in the hands of AUSTRALIAN GUARANTEE CORPORATION LIMITED (the taxpayer).

The facts are not in dispute and are conveniently to be found in the Reasons for Judgment against which the appeal is brought.

The evidence establishes that the taxpayer carries on business as a financier, making advances secured and unsecured and providing financial accommodation to its customers. For that purpose it borrowed funds in a number of ways including by the issue of debentures. The taxpayer borrowed funds including the sum of $60,500.00 by the issue of Deferred Interest First Charge Debenture Stock. This amount apparently was used by the taxpayer in its ordinary business of providing financial accommodation. Evidence unquestioned was that between 10 May 1978 and 25 September 1978 the taxpayer issued 22 certificates of Deferred Interest First Charge Debenture Stock to various investors at rates of interest therein specified, to mature at specified times between 21 November 1997 and 25 September 1998. Additionally, redemption, as it was called, in whole or in part, was open to an investor after five years or by the taxpayer at any time; and upon death of a debenture holder if his executors or administrators required it. In the first three circumstances interest was payable on redemption for the period then elapsed. Where redemption was by a personal representative, the situation may not be quite so clear. I refer to this later.

During the year of income which ended for the taxpayer on 30 September 1978, it adopted the accounting procedures referred to in the Reasons for Judgment in respect of interest which would ultimately become payable for the sums lent upon issue of the debentures. The accounting procedures and the "Special Conditions" appearing on the debentures are set out in the Reasons of the learned primary Judge. I do not need to repeat them here.

Evidence was given to the learned primary Judge as to accounting practice with regard to a company's liabilities which fall to be discharged in the future and in respect of the taxpayer's procedure. His Honour accepted that in all years since the company has issued Deferred Interest First Charge Debenture Stock it has accrued that interest in its account as a liability calculated on a daily basis on the principal sum lent on such debentures, notwithstanding that such interest had not been paid to the debenture holders. His Honour, in his Reasons, quoted from evidence of a Mr. Miles, a Chartered Accountant, as follows -

" . . . that general accounting principles require that all costs incurred during a financial accounting period which are attributable to the operations of that period should be accrued (the "accrual basis") and matched with the revenue earned during the period: that is, such costs should be taken up as a charge in the accounts irrespective of whether they have actually been paid out during the period or not. In the context of a finance company this means that the ongoing liability for interest costs on borrowed funds should be accrued and matched against the interest received from lending out those funds. Proper matching in those circumstances is usually applied on a progressive basis. The objective of the use of such principles in the accounts is to ensure that the accounts 'best portray economic reality.'"

Though I have not set out his Reasons fully, he found that there was no basis for rejecting an accepted accounting principle the subject of evidence unchallenged or uncontradicted, which treated as an "outgoing incurred" each year a portion of the interest ultimately to be paid on the debenture stock. He referred to authority including New Zealand Flax Investments Ltd. v. Federal Commissioner of Taxation (1938-1939) 61 C.L.R. 179 (New Zealand Flax). He decided that the amount of $2,808 was deductible under s.51(1) and that the Commissioner was in error in disallowing the objection lodged by the taxpayer.

Section 51(1) of the Act reads -

"All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income."

In his submissions, senior counsel for the Commissioner offered two principal propositions, viz. -

(a) That the interest in question was not an "outgoing incurred" in the year of income because the taxpayer had not completely subjected itself to such interest. This submission is based on the terms of the contracts between the taxpayer and the relevant investors.

(b) That a deduction is not obtainable under s.51 for the face value of interest payments which may not be payable for up to 20 years in the future.

He submitted that there were certain well settled propositions concerning s.51, viz. that an outgoing may be incurred although it has not yet been paid: Federal Commissioner of Taxation v. James Flood Pty. Ltd. (1953-1954) 88 C.L.R. 492 (James Flood) at p.507; an outgoing may be incurred although it is not due and payable (ibid at p.507); an outgoing is not necessarily incurred although it is due if it is payable in a future accounting period: W. Nevill and Co. Ltd. v. Federal Commissioner of Taxation (1936-1937) 56 C.L.R. 290 (Nevill).

Counsel submitted that having regard to the facts set out in the judgment of the learned primary Judge, the findings he made in respect of the contractual obligations of the taxpayer determined by reference to the Information Sheet and the "Special Conditions" set out on the back of the Debenture Certificate, which was part of the evidence before him, no liability to pay any definite amount of interest arose in the income year in question; that was the first year in which the taxpayer issued these debentures as the evidence showed. He argued that under the terms of the contract of lending, interest was neither earned nor credited until redemption; that debenture stock could not be redeemed by the investor or his representatives with a legal entitlement to accrued interest until after five years. Accordingly, he said, forbearance by the investor for that minimum period was a condition precedent to the taxpayer's liability to pay interest. Therefore, the case was within the principles established by Emu Bay Railway Co. Ltd v. Federal Commissioner of Taxation (1945-1946) 71 C.L.R. 596 (Emu Bay). He submitted further that the arguments for the taxpayer raised a question not yet considered by an Australian appellate court, viz. if there was an entitlement for deduction under s.51 in respect of deferred liabilities, such liabilities should be deductible at face value or on a present value basis; whereas, he argued, the period during which payment was postponed took it outside s.51; one could not put a face value on the deduction here. He submitted that decisions on interest deductions were inconclusive. He referred to Jolly v. Federal Commissioner of Taxation (1933-1934) 50 C.L.R. 131 (Jolly) per Dixon J., as he then was, at pp.136-7: Nevill; New Zealand Flax; Southern Railway of Peru v. Owen (Inspector of Taxes) (1957) A.C. 334 (Southern Railway of Peru) at pp.355,356-359: Absalom v. Talbot (1944) A.C. 204 (Absalom) at pp.215-216. He submitted that in the present case it would not be known when the interest would, in fact, be paid i.e. five years hence or any year thereafter until redemption at maturity. Accordingly, he submitted, the present value of the future interest payment could not be calculated. It could not be correct, he submitted, to allow a deduction at face value in 1978 of liabilities not to be discharged until e.g. 1998 and then in the currency value at that time.

Senior counsel for the taxpayer submitted that in order that a taxpayer be held to have "incurred" an outgoing, it was not necessary that that liability should have been discharged or even that the sum was due and payable. The question, he submitted, was whether the liability had been "encountered, run into, or fallen upon". He submitted it did not necessarily affect deductibility that the outgoing was in certain events defeasible. He referred to R.A.C.V. Insurance Pty. Ltd. v. Federal Commissioner of Taxation 74 ATC 4169 (R.A.C.V. Insurance); Commercial Union Assurance Company of Australia Limited v. Federal Commissioner of Taxation 77 ATC 4186 (Commercial Union); Commonwealth Aluminium Corporation Limited v. Federal Commissioner of Taxation 77 ATC 4151 (Commonwealth Aluminium) at p.4161; James Flood (at pp.506-507). It was necessary, he said, that there should be a presently existing liability, in contrast to a loss, that is more than "impending, threatened or expected". He referred to the difference between the majority and minority decisions in Emu Bay; it was as to the construction of a trust deed and not whether a debt which was presently due but was payable in the future was incurred in the year in which the present liability arose; whether on the proper construction of the deed there was an obligation at all to pay interest unless there was, in a year, net income, the majority being of the view that on the proper construction of the deed there was no debt or liability of any kind. He referred to the requirement on taxpayers to lodge annual accounts for the purpose of computing taxation annually. He submitted, therefore, that interest matured into a presently existing liability in the year of income notwithstanding that time for payment had not arrived; New Zealand Flax at p.207. On the true construction of the debenture conditions, he submitted, the holders were entitled to be paid on redemption interest calculated by reference to the number of days between the date of investment and of redemption; at common law interest on a loan accrued from day to day: cf. Conveyancing Act 1919 (N.S.W.) s.144; Chow Yoong Hong v. Choong Fah Rubber Manufactory (1962) A.C. 209 (Chow Yoong) at p.217. There was, he submitted, need to accommodate both the terms of the contractual arrangements and the operation of s.51 of the Act which (s.17) required annual accounting. These considerations, he submitted, reinforced the conclusion that what was proper financial accounting on the evidence was also appropriate tax accounting; while commercial accounting concepts could not determine whether an outgoing was within the meaning of s.51(1), they were relevant to determine whether a presently existing liability was referable to an accounting period so as to be an allowable deduction in that period. He submitted that to deny the taxpayer a deduction for interest accrued in a year of income would grossly distort its taxable income in that it would derive income from the investment of monies that had been subscribed by the debenture holders during the term of the debentures against which no deduction would be given; then in the year of redemption when no further income or minimal income was derived would obtain a deduction.

I have not attempted fully to restate the arguments of counsel.

One matter of interpretation of the "Special Conditions" subject to which the debentures are issued, arises. A key word there is "redemption", being the term used for the repayment of the investor's loan to the taxpayer at which time the interest is calculated. The opening statement under these conditions is that:-

"The Stock comprised in this Certificate will earn and be credited with interest at redemption, which interest will then be calculated from the original date of investment . . . . through to date of redemption on a simple interest basis; no interest will be paid or credited prior to maturity."

(Underlining is mine).

The "Special Conditions" continue -

"The said Stock is redeemable at par on -

(a) . . . .

(b) upon the death of a sole holder his executors or administrators may, upon fulfilment of any requirements of State or Federal legislation relating to death or succession duties, require redemption of the said Stock in full or as to a part thereof being a multiple of one hundred dollars at any time thereafter; and

(c) . . ."

Allowing for possible ambiguity because of the use of the word "maturity" (but this is used only where the full term is being referred to), the word "redemption" and its derivatives are used to mark the time and occassion when interest will be credited. It is appropriate to give them the same significance wherever appearing in the "Special Conditions". Upon the death of the sole holder, his personal representative is thus entitled at his discretion to require redemption. As stated earlier, the debenture stock is to be credited with interest at redemption. Though it may not be necessary to say so, interest calculated up to the date of redemption by the personal representative and at the rate stipulated in the debenture will, in such circumstances, I suggest, be payable. The learned primary Judge considered that the contractual obligations of the taxpayer could be determined by reference to the Information Sheet and the conditions set out on the back of the Debenture Certificate. This has not been contested before us. In the Information Sheet under a heading -

"FACTS ABOUT DEBENTURE STOCK WITH DEFERRED INTEREST

. . . .

What is the interest rate?"

it is said -

"Funds lodged in . . . deferred interest debenture stock will earn and be credited with interest at redemption . . . . "

Under a further sub-heading -

"Can I redeem before five years?"

the following words, inter alia, appear -

"Upon the death of a sole investor, AGC will if requested, pay his executors or administrators the amount invested, upon fulfilment of any requirements of State or Federal legislation relating to death or succession duties."

In view of the earlier statement, it was not necessary to specify that interest was then also payable; nor did the Information Sheet seek to exclude such a liability which I have suggested follows from the use of the word "redemption".

Interest would be thus payable on these debentures after five years and upon maturity if they run the full term, but also, it could be argued, in the event that the holder dies and his personal representatives require redemption. If it adds anything, in my view it would appear to be an attractive provision (from the point of view of the investor) offered by the taxpayer; and yet perhaps subjecting the taxpayer to little chance of a liability to pay interest before the expiry of five years. The availability of redemption at any time after five years and the words in the "Special Conditions", "interest will . . . . be calculated . . . through to date of redemption", favour the operation of the common law principle that interest accrues from day to day, referred to in Halsbury's Laws of England, 4th ed. vol. 32, par. 106. See also Conveyancing Act 1919 (N.S.W.) s. 144; Chow Yoong; Willingale v. International Bank (1978) A.C. 834 (Willingale) e.g. per Lord Fraser at p. 845. I note that the evidence given before the learned primary Judge by Mr. Fallister indicated that interest has been in fact paid to a widow on a redemption after less than five years, though at what rate is not clear to me.

Next I refer to the submission that forbearance by the lender for a minimum period of five years was a condition precedent to the taxpayer's liability to pay interest. But "forbearance" expresses a notion of a present entitlement upon which one does not immediately insist: "Act by which creditor waits for payment of debt due to him by debtor after it becomes due . . . . A delay in enforcing rights. Indulgence granted to a debtor": see Black's Law Dictionary, 5th ed. (1979), p. 580 citing American authority. Here there was no entitlement in the lender to claim either for a return of the loan or interest on it during that five year period; there being no presently available right there could therefore be no "forbearance" or "indulgence" during that period. In my opinion to treat the "Special Conditions" as expressing a condition precedent is to torture the meaning of that phrase.

It is appropriate to refer to some of the authorities which have been cited in argument. In Jolly (the facts are not relevant) it is clear from the words of Dixon J., as he then was, at p. 137, that there can be a liability accrued within an accounting period without there being any actual expenditure to extinguish the liability. His decision was affirmed by the Full Court (ibid p. 153). In Nevill at p. 302 Latham C.J. referring to s. 23, the predecessor of s. 51, said -

"The outgoing, in order to be deducted, must be an outgoing "actually incurred" (sec. 23(1)(a)). The word used is "incurred" and not "made or "paid". The language lends colour to the suggestion that, if a liability to pay money as an outgoing comes into existence, the quoted words of the section are satisfied even though the liability has not been actually discharged at the relevant time. The word "actually" is not inconsistent with this view. It is only the incurring of the outgoing that must be actual; the section does not say in terms that there must be an actual outgoing - a payment out."

In New Zealand Flax the taxpayer agreed with the holders of bonds issued that it would within five years complete the purchase of land and carry out certain other activities. Subscribers for the bonds had the option of paying for their bonds either cash down or by instalments spread over 2-1/2 years. For four years from the date of issue, the holders of fully subscribed bonds were entitled to interest. Dixon J., referring also to s. 23, said at p. 207 -

"To come within that provision there must be a loss or outgoing actually incurred. "Incurred" does not mean only defrayed, discharged, or borne, but rather it includes encountered, run into, or fallen upon. It is unsafe to attempt exhaustive definitions of a conception intended to have such a various or multifarious application. But it does not include a loss or expenditure which is no more than impending, threatened, or expected."

In Emu Bay a company and trustees for its creditors entered into a debenture trust deed whereby the company undertook to issue debenture stock to certain creditors. The deed contained a provision that, during a period which had expired before the income year 1939, the interest on the stock "shall be payable only out of the net income of the company . . . . and after the expiration of such period the interest . . . shall be cumulative." In the year 1939 the company had no net income. It did not in that year or thereafter pay or credit the stock holders any sum for interest in respect of that year. Unless it was entitled to a deduction in respect of the interest, the company had a taxable income for the purposes of the Act and was assessed to tax. The Commissioner refused to allow any deduction in respect of the interest. By a majority of 3 to 2, it was held that the amount of interest was not deductible as an outgoing within the meaning of s. 51. As counsel argued, the decision turned upon the interpretation of the deed rather than of the section. Latham C.J., who was in the majority, said at p. 606 -

"The words "outgoings incurred" should not be limited to expenditure actually made. They include a liability presently incurred and due though not yet discharged . . . "

He referred to Jolly and Nevill as cases on provisions which, though not quite identical with s. 51, did not differ in any material way. He continued -

"It may be argued that the words include a liability which falls within the description debitum in praesenti, solvendum in futuro."

He also found that there existed at the then present time only the possibility of a liability. He was not disposed to find that this could be described as an "outgoing incurred". McTiernan J., who was also of the majority, said at p. 613 -

"The question that arises is . . . . whether the taxpayer incurred an obligation which in the accounting period ending 31st December 1939 resulted in a debt for interest which was then due and presently payable. In my opinion, it did not incur an obligation of that nature."

Williams J., who was in the minority, said at p. 621 -

"Outgoings, which is a word of the widest import, must include debts. A taxpayer incurs a debt when it becomes due and owing, although it may not be immediately payable, so that debts incurred during the year of income are outgoings incurred in that year within the meaning of the section whether they are paid or payable in that period or not."

He referred to authority.

Having regard to the conclusions as to the deed by the majority, e.g. Latham C.J., " . . . there exists (only) . . . . the possibility of a liability accruing in the future"; Starke J., " . . . . the taxpayer incurred no liability . . . . in the relevant year"; McTiernan J., "As there was no such fund in the (relevant year), the taxpayer was not under an obligation resulting in a debt due and payable in that year . . . . ", I have found this case of less assistance than perhaps others though the reasoning of the minority might be said to support the taxpayer's arguments.

James Flood concerned an Award whereby a company was bound, subject to certain exceptions, to allow its employees fourteen consecutive days leave on full pay annually after twelve months' continuous service. The leave was to be allowed and taken and payment not to be made or accepted in lieu except that, if after one month's continuous service in any qualifying twelve monthly period an employee lawfully left his employment or it was terminated through no fault of his, then he was to be paid at his ordinary rate of wage for three and two-thirds hours in respect of each completed month of continuous service. For the year ended 30 June 1947, the taxpayer claimed a deduction under s. 51 in respect of an amount representing a provision for holiday pay for a period in the year of income which in the case of employees who continued in its service would be offset against the fortnight's holiday pay paid to each employee in December 1947. In the Reasons for Judgment it was noted that under the Award, an employee might fail for various reasons to become entitled to annual leave including death and termination of employment; or perhaps the employer might sell his business. In the face of these matters the Court found it difficult to say that there was any definite obligation to make a payment incurred in respect of each completed month on that month being completed. The Court said (p. 505) -

"These considerations all seem to point to the conclusion that in the case of no given employee who has not completed his twelve months' continuous service before 30th June 1947 could it be said that the taxpayer had incurred an outgoing consisting in a proportion of the pay which would become payable to him should he do so, that is payable on the occasion when he took his annual leave."

This case also discussed the role of accountancy practice in such matters, to which I shall refer later.

Nilsen Development Laboratories Pty. Ltd. v. Federal Commissioner of Taxation (1979-1980) 144 C.L.R. 616 (Nilsen Development) was concerned with long service leave. Under one Award some employees, having completed fifteen years' service, were entitled to take long service leave and to receive payment during the period of leave at the rate of wages then current. Under another Award, those who had been continuously employed for over twelve months were entitled to take annual leave and during it to receive the wages they would have otherwise received if working. Each type of entitlement became indefeasible after the expiration of the relevant qualifying period. None of the employees took the leave or received payment. The taxpayer claimed as allowable deductions amounts provided in its accounts to represent estimates of what it would have been bound to pay employees if they had been on leave during the year of income less any amounts which had been provided in relation to those items in earlier years. It was held there had not been any liability to make payment until the employees either took the leave entitlement or ceased employment; therefore the amounts provided were not outgoings incurred in the year of income within the meaning of s. 51. Barwick C.J. at p. 623 said -

" . . . there can be no warrant for treating a liability which has not "come home" in the year of income, in the sense of a pecuniary obligation which has become due, as having been incurred in that year."

He referred to Latham C.J.'s judgment in Emu Bay as indicating that to satisfy the word "incurred" the liability must be "presently incurred and due though not yet discharged". He said:-

"It may not disqualify the liability as a deduction that, though due, it may be paid in a later year."

He referred to the passage already quoted in the Reasons for Judgment of Dixon J. in New Zealand Flax. Barwick C.J.'s Reasons, as I read them, depended upon his finding that under the Award the pecuniary liability to the employee did not arise until that employee entered upon the period of leave. To the same effect is the judgment of Gibbs J. at pp. 626 and 628. He referred at p. 626 to " . . . . the crucial circumstance that the taxpayer was under no liability to make any payment until the employee took the leave . . . . " and at p. 628 he stated -

"The present is not a case in which there was an immediate obligation to make payment in the future, or a defeasible obligation to pay, or a present obligation which as a matter of law was unenforceable - there was no accrued obligation to make any payment at all. There was no loss or outgoing "incurred" within s. 51(1)."

He distinguished Southern Railway of Peru. Stephen J. agreed with the reasons of Gibbs J., and Mason J. with those of the Chief Justice.

Such is the variety of facts found in these authorities that no case on all fours with the present has emerged; yet there is, I suggest, clear guidance as to the operation of the word "incurred" in s. 51 to be found in e.g. Nevill per Latham C.J., New Zealand Flax per Dixon J., and the words of Latham C.J. in Emu Bay at p. 606 to which earlier I have referred.

The amount for which the taxpayer has claimed a deduction is the total interest referable to a year and not any sum purporting to be a present value calculation of interest payable at some future time. It would not be possible to make an exact calculation of such a sum unless the date of redemption was known. Difficulties of calculation are enhanced by an obligation in later years to pay a bonus calculated as interest and a variation in interest rates after five years. The recording in annual financial statements of interest as an outgoing is an incident of the accepted (and statutorily required for tax purposes), even arbitary, period of financial accounting being the fiscal year. There has not been raised in the Grounds of Appeal any contention that the failure to call evidence to put some present value on the interest claim makes the deduction impermissible. Counsel indicated that he would not wish to submit that the inability to place any value on the interest liability would of itself mean it was not an outgoing incurred. In this regard he said that where a liability was presently payable, though not actually payable on or before the last day of the financial year, it was fair enough to bring it in, if incurred, at face value and to allow it under s. 51; but to do so where there were liabilities which might be deferred for up to 20 years was to produce a distortion; the accrual basis of accounting did not provide any satisfactory legal answer to the problem of whether the taxpayer's obligations have been incurred in the year of income. He was not submitting that if all else failed the matter should go back to the Commissioner to allow a deduction on some basis the Court might direct; though it was always part of the Commissioner's attack that the period during which payment was postponed took it outside s. 51, the Court was not asked to consider remission for assessment on a particular basis; it was really "face value or nothing". So the parties have not put forward any formula which if applied would reduce the figure for interest claimed as a deduction. In a different context there is the so-called "Rule of 78" used by finance companies to allocate the interest received on loans or instalment contracts to various months of the year - discussed e.g. in "The Cost Penalty of Premature Loan Repayment" Australian Accountant Vol. 53 No. 6, July 1983, p. 448. This Court, in view of the submissions made, is not concerned to undertake any such task even if it could do so.

Reference has been made in argument to evidence, uncontradicted, of Mr. Miles that the taxpayer had in its accounts followed correct and generally accepted accounting principles in relation to its policies adopted for the accrual of interest payable on these debentures. The use to be made of or the regard to be paid to commercial and accounting practices for tax purposes has been referred to in various authorities. The learned primary Judge used accepted accounting principles, of which he had heard evidence from Mr. Miles, as supporting the accrual basis for determining the extent of an outgoing in the circumstances of a loan payable at a future date lent out with interest. In James Flood at p. 506 it is said that commercial and accountancy practice may assist in determining the "true nature and incidence of the item as a step towards determining whether it answers the test laid down by s. 51(1), but it cannot be substituted for the test." See also Commissioner of Taxes (S.A.) v. Executor Trustee and Agency Co. of South Australia Ltd. (1940) 63 C.L.R. 108 (Carden's case) particularly at p. 152 et seq. and Arthur Murray (N.S.W.) Pty. Ltd. v. Federal Commissioner of Taxation (1965) 114 C.L.R. 314 which was concerned with earnings or receipts and not outgoings. But statements in it are, I consider, helpful. Barwick C.J. at p. 318 said -

"The ultimate inquiry in either kind of case, of course, must be whether that which has taken place, be it the earning or the receipt, is enough by itself to satisfy the general understanding among practical business people of what constitutes a derivation of income. A conclusion as to what that understanding is may be assisted by considering standard accountancy methods, for they have been evolved in the business community for the very purpose of reflecting received opinions as to the sound view to take of particular kinds of items.

. . . .

A judicial decision as to whether an amount received but not yet earned or an amount earned but not yet received is income must depend basically upon the judicial understanding of the meaning which the word conveys to those whose concern it is to observe the distinctions it implies. What ultimately matters is the concept; book-keeping methods are but evidence of the concept."

The case is not otherwise helpful. Prepaid fees there were not appropriately to be treated as assessable income until "the discharge of the obligations for which they are the prepayment justifies their being treated as having finally acquired the character of income" (ibid p. 319). His Honour had discussed the possibility of repaying what had been prepaid; but there is no possibility in the instant case of not having to pay out the interest in compliance with the "Special Conditions".

A long established practice of insurance companies of including among losses in each year's accounts the estimates of liabilities from unreported claims arising out of events occurring in the year of income was thought by Menhennitt J. to reinforce "the conclusion that the true nature and incidence of such claims was that they were losses and outgoings within the meaning of (s. 51)", i.e. in the year of income. See R.A.C.V. Insurance at p. 4181. I observe there was evidence that although some of such claims would come to fruition, there was no certainty in respect of any one claim; and the quantum of any one would be (notoriously) difficult to estimate.

Some of the English cases on this subject are referred to in Pinson on Revenue Law, 13th ed. (1980), p. 26. There is a caution in Nilsen Development at p. 628 against using English decisions in relation to their different legislation and the necessity under it to compute profits and gains. Gibbs J., as he then was, there was referring to submissions made by the appellants in respect of Southern Railway of Peru. Thus Lord Radcliffe's statement at p. 360 -

" . . . I should view with dismay the assertion of legal theories as to the ascertainment of true annual profits which were in conflict with current accountancy practice and were not required by some special statutory provision of the Income Tax Acts."

must, quite apart from its reference to profits and not specifically to s. 51 losses etc., be discounted. See also Willingale at p. 843. However, the accountancy evidence here was used and, with respect, correctly, by the learned primary Judge in reaching his decision. With due deference I am similarly assisted.

The taxpayer's arguments received support from Alliance Holdings Ltd. v. Federal Commissioner of Taxation (1981) 37 ALR 430; and see the reference by Woodward J. in that case to Webb v. Stenton (1882-1883) 11 Q.B.D. 518 per Lindley L.J. at p. 527, quoted, apparently with approval, by Forster J. in Law v. Coburn (1972) 1 W.L.R. 1238 at p. 1243.

In my opinion the taxpayer by seeking and accepting the loans from investors in terms of the contract documents to which I have referred subjected itself to the payment of the interest already accrued in the relevant year as a cost of obtaining and using funds which it then lent out in the process of gaining assessable income in its business as a financier. It "incurred", within the meaning of s. 51(1), an outgoing in the relevant year even though not paid or payable in that period.

I propose that the appeal be dismissed with costs.

JUDGE3

I have had the advantage of reading a draft of the judgment of Toohey, J. and need not repeat what he has said in relation to this appeal.

The question for decision is whether interest at the rate of 11% per annum on the debenture stock should be allowed as a deduction in the taxpayer's year of income ended 30 September 1978. The stock was issued between 10 May 1978 and 25 September 1978 to various investors at progressive rates of interest described later. The stock matured at specified dates between 21 November 1997 and 25 September 1998.

The dispute between the parties arises against the background that the Income Tax Assessment Act, in imposing liability to income tax "adopts the basic method of imposing taxation in respect of annual periods of time. This necessarily involves assigning to a period of a year both income and losses or liabilities." (See RACV Insurance Pty. Ltd. v. Federal Commissioner of Taxation (1974) 4 A.T.R. 610 at p. 618.)

No question arises in this proceeding as to any other type of interest or bonus provided in the conditions under which the stock was issued. Further, no question arises here whether the interest the subject of this appeal is taxable as income earned or derived by the stockholders in that period, whether by virtue of s. 19 of the Act or otherwise: the case is to be determined exclusively by reference to the provisions of s. 51(1) in their operation upon the affairs of the taxpayer, irrespective of whether stockholders are taxed on the same amount as income in their hands.

As Toohey, J. has already emphasised, the contest between the parties centres on the point of time, in terms of income year, in which the interest should be allowed as a deduction under s. 51(1), rather than deductibility as such: that is to say, deductibility is accepted by the Commissioner but only on maturity or earlier redemption should it occur.

The analysis by Toohey, J. shows that, in determining whether an outgoing has been "incurred" for the purposes of s. 51(1), the settled course of authority in this country has fastened upon a "presently existing liability" of the taxpayer to discharge an obligation as the test for deductibility. It follows, in my view, that the present question falls to be resolved primarily as a matter of construction of the contract constituted by the conditions governing the issue of the debenture stock.

By the Special Conditions, it is first provided that the stock "will earn and be credited with interest at redemption, which interest will then be calculated from the original date of investment through to date of redemption on a simple interest basis; no interest will be paid or credited prior to maturity". An interest rate is specified to apply in respect of the first part of the term through to 31 December in the fifth year following the year of investment. Thereafter, the interest to be applied is the taxpayer's appropriate maximum rate then current. Further, a bonus is payable on redemption in respect of the period from the original date of investment to the date of redemption, save that such bonus is to apply only to redemptions occurring after the commencement of the sixth year of investment. The bonus is payable on a sliding scale expressed as a percentage per annum up to year twenty.

The stock is redeemable at par on the maturity date but the holder may require redemption on giving two months' notice after the commencement of the sixth year. Upon the death of a sole holder, his executors or administrators may require redemption. The taxpayer may redeem at par at any time on three month's notice, in which event, in addition to interest and any bonus otherwise payable, an additional bonus is payable.

In the construction of the conditions dealing with the first part of the term, no assistance is to be derived, in my view, from the subsequent provisions to which reference has been made. In principle, the scheme for the payment of interest in the first term is self-contained and it is apparent that the language used in the subsequent provisions can throw no light on the meaning of the different expressions used in the earlier conditions. The enquiry is thus confined to the provisions dealing with the first part of the term.

Although it is clear that the parties intended that the payment or crediting of interest was to be deferred until redemption occurred, nothing of any consequence for taxation purposes flows from this. The Commissioner accepts that an outgoing may be incurred although it has not yet been paid and although it is not due and payable, so that merely to defer the payment or crediting of interest would not deprive the taxpayer of a deduction on that account (see Federal Commissioner of Taxation v. James Flood Pty. Limited (1953) 88 C.L.R. 492 at p.507). But the position as to the point of time or the period during which interest is being or will be earned is not so obvious. In particular, the question arises whether interest had already accrued due as at 30 September 1978.

The conditions provide that the stock "will earn and be credited with interest at redemption". It is true, as Toohey, J. has pointed out, that the syntax suggests that, taken literally, no interest will be "earned" until redemption. But does it follow from this language alone that no presently existing liability arises in respect of the interest until that time?

Ordinarily, interest accrues from day to day even if payable only at intervals (see Chow Yoong Hong v. Choong Fah Rubber Manufactory (1962) A.C. 209 at p.217; Willingdale (Inspector of Taxes) v. International Commercial Bank Ltd. (1978) A.C. 834 at p.841). It is, therefore, apportionable under the general law in respect of time (see Halsbury's Laws of England, 4th Ed., Vol.32 at p.53; Vol.16 at p.836; cf. Conveyancing Act, 1919 (N.S.W.), s.144(1)).

In In Re Rogers' Trusts (1860) 1 DR. & SM. 338; 62 E.R. 408; Sir R.T. Kindersley, V.-C., in holding that interest was apportionable, said (at p.341; p.409):

"In the present case the interest payable on the debentures, though payable half-yearly, is not an entirety, but is an accumulation of each day's interest, which accrues de die in diem; and which, though not presently payable, is still due."

It must be accepted, as Lord Russell of Killowen observed in Willingdale (at p. 848), that "earn" is not a word of universal application in the same sense in all circumstances. In its relevant dictionary meaning, "earn" means "to gain as a due return or profit" (Macquarie Dictionary). But the immediate question is one of timing, namely to determine when the interest was "earned", and the ordinary meaning of "earn" is equivocal in that sense: it describes the fact of gaining a return without necessarily indicating the period to which it is referable.

Although the bare statement that interest is, or will be, "earned" is not itself determinative of the time at which or the period during which interest will be derived, ordinarily, where interest is accruing from day to day, it is, I think, appropriate to describe that interest as being "earned" on such a daily basis in point of time, even if not payable until a later date. Further, in my opinion, the period in which interest is accruing due may properly be regarded as the period in which interest is thus being earned.

In Willingdale, supra, Lord Russell of Killowen (at p. 847) gave an example of an advance to be repaid at the expiration of a fixed term of three years with simple interest thereon at a rate per centum per annum, the obligation to pay the interest being, however, postponed to the date for repayment of the loan. In his Lordship's view (admittedly in dissent, but this is not presently of consequence) interest was "earned" by the lender in year one of the transaction notwithstanding that payment of the amount was deferred until year three.

A different view seems to have been taken by the Full Court of the Victorian Supreme Court in In The Matter of the Income Tax Act (1897) 23 V.L.R. 312. It was there held that interest upon deposit receipts in a bank is earned on only the last day or the due date of the receipt. The term of each of the deposits in question was twelve months and in response to the argument of the Commissioner of Taxes that interest was not accruing de diem in diem, and that there was no scope for apportionment, Madden, C.J., in apparent agreement, remarked (at p. 315) that "(the) bargain is for twelve months." Hodges, J. observed (at p. 315), similarly, that the income was "in the course of being earned . . . but was not completely earned" until maturity. The reasons for judgment of the Court are shortly expressed. The Court concluded, without any discussion, that "interest upon deposit receipts in a bank is earned on only the last or due date of the receipt." However, it seems that counsel for the unsuccessful taxpayer put no argument of the kind advanced by Lord Russell in Willingdale. Moreover, the case should be seen in the statutory context that income was brought to account when it was "earned, derived or received" and can perhaps be distinguished for that reason. In any event, the present question must be one of the construction of the Special Conditions themselves, so that decisions in other cases can be of limited assistance only.

In the present case, interest is expressed to be calculated from the date of investment. In my opinion, it accrued due from that date notwithstanding the specification of a future date for its payment (see Banner v. Lowe (1806) 13 Ves. 135 at p. 136; Pearly v. Smith (1745) 3 ATK. 260 at p. 261). But can it be said that, when the Special Conditions provide that stock "will earn . . . interest at redemption," the parties were intending to do more than merely defer the point of time at which interest would be received or credited? Specifically, were they intending to go further and to eliminate altogether any entitlement to interest, and thus, any liability in that behalf, until redemption had occurred?

It is possible to imagine a case where, on the true construction of their contract, parties make provision for the payment or crediting of a special kind of premium, entitlement to which springs into existence for the first time at a remote future date. It would be a feature of such a contract that, if it did not run its full term, because, say, insolvency or even voluntary liquidation intervened before the due date, (time would be of the essence), the lender would have no entitlement to interest as such. At best, the lender would be able to claim for general damages on the footing that a valuation of his future claim would be required. Certainly, he could not claim for interest accrued due at that point of time (cf. In Re Theo Garvin Limited (1969) 1 Ch. 624; and see In Re Panama, New Zealand and Australian Royal Mail Company (1870) L.R. 5 Ch.App.318; Hodson v. Tea Company (1880) 14 Ch.D.859; Wallace v. Universal Automatic Machines Company (1894) 2 Ch.457). Unattractive features of this kind suggest that a special agreement along these lines is unlikely to be made, at least between parties at arms' length.

To revert to the present case, it is true that the condition stipulates that interest will be calculated at the date of redemption. On the other hand, although it was open to the parties to agree that, in lieu of interest, a premium of the kind already mentioned should be paid to stockholders (see, e.g., Tomkins v. Tomkins (1978) C.L.Y.B. para.2402; "The Times" 24 May 1978 (Megarry V.-C.)), the amount dealt with here was described as "interest". By providing that the stockholder's entitlement is to be calculated from the date of investment, the parties have given another indication that what was intended to be dealt with was interest in the conventional sense, that is, compensation for the loss of use of the money over the period in question (see Bond v. Barrow Haematite Steel Company (1902) 1 Ch.353; Pannam, The Law of Moneylenders in Australia and New Zealand at p.229).

The language employed emphasises that the primary objective of the draftsman of the Special Conditions was to defer the payment or crediting of interest until redemption. But it does not follow that no liability to pay interest arose until the redemption date arrived. In my view, consistently with his primary objective, the draftsman did not intend to disturb the ordinary position that interest accrues due on a daily basis over the period of the investment. It is significant, in this regard, first, that what was being dealt with was interest in the conventional sense and, secondly, that it was to be calculated from the date of investment. In my view, the use of the future tense ("will earn . . . at redemption"), does not affect the position that, in this case, interest was intended to be derived throughout the whole of the first term. In this context, the use of the future tense was, I think, intended to draw attention to the date of redemption as the future point of time at which interest would be calculated and then credited or paid. It was not, in my opinion, intended to convert the subject of the transaction from interest, accruing due on a daily basis, into some sort of premium, liability for which was to spring into existence, for the first time, when the day for redemption occurred. To arrive at the latter position would, in my view, require the most explicit language to that effect. No such language is found here except, perhaps, in the prefatory statement "will earn . . . interest at redemption . . . ". As has been said, this can be explained by its context.

In short, I do not think that it is possible to discern in the Special Conditions any intention to disturb the ordinary rule that interest accrues due on a daily basis, even if payment is deferred to a future date. Since the interest was accruing due on such a daily basis, it must follow that, looking at the position as at 30 September 1978, interest at the rate of 11% per annum computed from the date of investment had already accrued due.

In this sense, it can be said the stock had already earned this amount of interest as at 30 September 1978. It follows that there was then a present liability on that account. For that reason, in addition to the other reasons given by Toohey, J., I would reject the Commissioner's first argument.

It follows, for the same reasons and for the reasons given by Toohey, J. that I also reject the second argument advanced by the Commissioner.

The appeal should be dismissed with costs.