Commissioner of Taxation v Creer, J.N
[1986] FCA 166
•05 MAY 1986
Re: THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
And: JAMES NEILL CREER
No. G71 of 1985
Income Tax Assessment
COURT
IN THE FEDERAL COURT OF AUSTRALIA
NEW SOUTH WALES DISTRICT REGISTRY
GENERAL DIVISION
Fisher J.
Wilcox J.
Jackson J.
CATCHWORDS
Income Tax Assessment - Claim for deduction of rent and fees under s.51(1) of the Income Tax Assessment Act 1936 - Nature of outgoings made pursuant to a lease - Whether amount described as "rent" was an outgoing of a capital or income nature - Consideration of the character of the advantage sought by the taxpayer in entering into the lease - Substance of the transaction examined - Relevance of purpose.
Income Tax Assessment Act 1936 s.51(1)
Sun Newspapers Ltd and Associated Newspapers Ltd v Federal Commissioner of Taxation 61 CLR 337, Federal Commissioner of Taxation v South Australian Battery Makers Pty Ltd (1977-78) 140 CLR 645, Europa Oil (NZ) Limited v Inland Revenue Commissioner (1976) 1 WLR 464, Magna Alloys and Research Pty Ltd v Federal Commissioner of Taxation (1980) 33 ALR 213, John Fairfax and Sons Pty Limited v Federal Commissioner of Taxation (1950) 101 CLR 30, Ronpibon Tin N.L. and Tongkah Compound N.L. v Federal Commissioner of Taxation (1949) 78 CLR 47, Ure v Federal Commissioner of Taxation (1981) 34 ALR 237, Federal Commissioner of Taxation v Ilbery (1981) 38 ALR 172, Nevill and Company Limited v Federal Commissioner of Taxation (1937) 56 CLR 290, Federal Commissioner of Taxation v Midland Railway Co of Western Australia Limited (1962) 85 CLR 306 referred to.
HEARING
SYDNEY
#DATE 5:5:1986
Counsel for the Appellant: Mr R A Conti QC with Mr G W Fisher
Solicitors for the appellant: The Australian Government Solicitor
Counsel for the respondent: Mr D G Hill QC with Mr D H Bloom
Solicitors for the respondent: Messrs Allen Allen & Hemsley
ORDER
The appeal be allowed.
The order of the Supreme Court of New South Wales in matter No.625 of 1983 be set aside and in lieu thereof it be ordered that:
(a) the appeal to that Court, insofar as it deals with the sums of sixty-three thousand eight hundred dollars
($63,800.00) claimed as rent and two thousand dollars ($2,000.00) claimed as fees for advice, be dismissed;
(b) James Neill Creer pay to the Commissioner of Taxation his costs of the appeal to the Supreme Court.
The respondent pay to the appellant his costs of the appeal.
NOTE: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
JUDGE1
This appeal by the Commissioner of Taxation of the Commonwealth of Australia ("the Commissioner") is from a decision of the Supreme Court of New South Wales in its Administrative Law Division. By that decision the Supreme Court allowed an appeal by James Neill Creer ("the taxpayer") against the disallowance by the Commissioner of certain deductions claimed by him in his return of income for the year ending 30 June l977. The deductions related to a claim for rent paid in that year, fees paid for advice in respect of his income tax affairs and an amount claimed as overseas travelling expenses. Before the learned trial judge counsel for the Commissioner conceded the claim for travelling expenses and before this Court both counsel agreed that the claim in respect of income tax advice would stand or fall with the claim for rent. In these circumstances argument on the appeal before us was limited to the claim for a deduction of the rent. This claim is in respect of the sum of $63,800 paid by the taxpayer on 29 June l977 to Home Units Limited ("Home Units") as lessee under leases of four home units.
The trial Judge concluded that the outgoings in respect of rent and fees were properly deductible under sub.s.5l(l) of the Income Tax Assessment Act l936 ("the Act") and that neither the provisions of s.260 nor arguments based on "fiscal nullity" had any application. In respect of sub.s.5l(l) he was of the opinion that the payments under the lease were not outgoings of a capital nature in any shape or form. It is on this aspect of the matter that I am in disagreement with the views of the learned trial Judge, being of opinion that the outgoing under each of the leases is a capitalized sum and therefore of a capital nature. It follows that the outgoings are not deductible under sub.s.5l(l). I see each of the outgoings as a payment which the taxpayer was bound by his contract to make to Home Units for the use of the land for the term of the lease. The nature of such a payment is primarily to be ascertained according to the true construction of the lease agreement. To label the payment as "rent" does not conclude the matter, and, if anything, obscures an understanding and assessment of the true nature of the outgoing.
I therefore would decide the matter by construing the terms of the contracts between the taxpayer and Home Units and by ascertaining the manner in which the parties calculated the amount of the outgoing.
The matter arose in circumstances which are not in dispute and which were fully set out in the reasons of the trial Judge. The taxpayer and a public accountant, Mr. Pursche, each gave evidence and were each subjected to cross-examination. Both were accepted as witnesses of complete credit and the issues on appeal turn on the conclusions which the trial Judge drew from their evidence and not on his findings of primary fact. I now set out briefly those facts, most of which are of little relevance to the particular issue which I see as crucial and conclusive.
The taxpayer was in l977 a solicitor carrying on his professional practice in Sydney. In April of that year he sought residential premises which he could lease from the owners and then sublease to tenants. At all times he had in mind that he would be the head-lessee and that a family company of which he was a director and in the shares of which he held the sole beneficial interest would purchase the properties subject to the head-lease to him. In the preceding month of March l977 he had sought professional advice concerning avenues open to him for reducing his income tax. During discussions on this matter the possibility of leasing income-producing property and paying the rental therefor in advance was mentioned.
In late April or early May l977 the taxpayer was introduced to a Mr. John Wilson, an employee of a firm of sharebrokers acting for Commercial & General Acceptance Limited (C.A.G.A.) in relation to residential properties in the Sydney Metropolitan area. In mid May l977 the taxpayer received from Mr. Wilson a schedule of available properties and their respective prices. The four properties which ultimately the taxpayer leased were home units and at that stage priced at $5l,500, $55,000, $57,500 and $55,500 respectively. During June l977 he inspected these properties as well as a number of other home units and town houses. On 22 June l977 he inspected in company with estate agents these four properties and obtained the opinion of these agents as to their respective rental values. He was subsequently joined on the inspection by Mr. Pursche. The following day, in company again with Mr. Pursche, he conferred with his Bank Manager concerning the acquisition of the town houses and the availability of finance. At this meeting Mr. Pursche handed to the Bank Manager a document containing information which the latter had at a previous interview requested. The first paragraph thereof to the extent relevant was as follows:
"
J.N. Creer Proposal for Investment in Home Units
l. Mr. Creer is interested in purchasing and leasing four(4) units at "Maison View", Home Street, Wollstonecraft, as follows:
< Price
No. 59 2 B.R. 50,000 No. 64 2 B.R. 53,000 No. 68 2 B.R. 56,000 No. 69 2 B.R. 53,000 $212,000"
The document then proceeded to indicate that it was proposed that the taxpayer would lease each of the four units for a rental of $20,000 payable in advance and that the family company, Edisearb Pty. Limited ("Edisearb") would purchase the units for the reduced consideration of $132,000. Further information was set out as to the manner in which the transactions would be financed and the extent to which it was contemplated funds would be made available from the Bank and C.A.G.A.
Shortly thereafter the taxpayer, at the request of the Bank Manager, instructed Richardson and Wrench Limited to make an urgent valuation of the rental and market value of the four units. Prior to 29 June l977, at which date he received a written valuation, the taxpayer was orally advised of these values.
Upon receipt of these figures the taxpayer instructed Mr. Pursche to calculate an "appropriate rental for each unit to be offered to the owner on the basis that the rental would be paid five (5) years in advance". He also sought advice from Mr. Pursche as to the appropriate price for Edisearb to offer to purchase the units from Home Units subject to the leases to him.
Mr. Pursche gave evidence to the effect that he made the calculations in the following manner. His starting point was the rental valuation supplied by Richardson and Wrench Limited which he adjusted to take into account possible increases of rent during the term of 5 years. He then ascertained by use of actuarial tables the present value of the future payments of these rents over the period of 5 years. To the resulting figure he then applied a discount of l0% in recognition of the fact that notionally during each year of the term rent would be paid monthly in advance. The resultant lump sum figures were then rounded off to the nearest ten dollars.
On 29 June l977 the taxpayer and Mr. Pursche met with officers of C.A.G.A. Mr. Wilson was also present. Mr. Pursche handed to the officers a document headed "Final Proposal between Creer and C.A.G.A.". The document proposed that each unit be leased on a 5 years' lease with rents totalling $63,800 payable on that day, with two further payments each totalling $7,975 payable on 29 June l978 and 29 June l979, which payments were noted as being receivable by the proposed new owner, Edisearb. That company was nominated as the purchaser of each of the units at the following prices, namely
Unit No. 59 $33,900 Unit No. 64 $36,500 Unit No. 68 $36,l50 Unit No. 69 $35,400
These prices were in each instance prices substantially less than those sought initially by Home Units and also less than the prices mentioned in the original proposal of 23 June above set out. The document also indicated the extent to which it was intended that funds be provided by the taxpayer and Edisearb, the Bank and C.A.G.A.
It appears that these proposals were acceptable to the Bank and C.A.G.A., which latter company represented at all times the interest of Home Units. On the following day the taxpayer executed the four leases, each being for the term of five years on the terms and conditions therein. At the time of execution a cheque for $63,800 being the total amount payable on that day under the four leases was handed to C.A.G.A. on the written direction of Home Units Pty. Ltd.
During the last week of June l977 discussions also took place between the taxpayer and Mr. Pursche concerning the sub-letting of the premises. As the taxpayer planned to be overseas from early in July l977 Mr. Pursche offered to make his company Bareki Pty. Ltd. available to rent the units for three months at their fair market value. It was proposed that this company would then seek out tenants during the taxpayer's absence to occupy the premises. On 28 June l977 the taxpayer agreed with Bareki Pty. Ltd. to grant a sub-lease of the units for three months to that company at a weekly rent totalling $380.00. This company paid rent of $l,646.54 for the month commencing 29 June l977 and monthly in advance thereafter. This arrangement with Bareki Pty. Ltd. was subsequently extended for a further period of 3 months and from February l978 the taxpayer leased the premises direct to tenants.
On l July l977 Edisearb executed contracts of sale and purchase of the four units subject to the leases to the taxpayer and paid deposits to the vendor totalling $8,950. On the same day the taxpayer entered into a loan agreement under which he borrowed $50,000 from C.A.G.A., which amounts he received on 4 July l977. On 29 July l977 Edisearb completed the purchase of the units and executed a Memorandum of Mortgage and Deed of Equitable Charge in favour of C.A.G.A. as security for its loans and the loan to the taxpayer.
The taxpayer paid the two amounts of $7,975 described as rental in the leases on 30 June l978 and 30 June l979 respectively to Edisearb. Subsequently three of the leases were surrendered by the taxpayer for considerations assessed by the Valuer General and units 68 and 64 were sold.
On these and other facts not in dispute and not presently relevant the learned trial Judge upheld the appeal of the taxpayer and found that each of the amounts which totalled $63,800.00 was deductible under sub.s.5l(l). As previously mentioned he accepted the evidence of the taxpayer and Mr. Pursche and he made a number of findings and drew a number of conclusions favourable to the taxpayer from the primary facts. He also noted that there was no suggestion that the leases or the sales were a sham or a subterfuge and that counsel for the Commissioner expressly disclaimed any suggestion that a sham or a premium was involved. In this latter regard I understand him to be referring to a "premium" as defined by and referred to in Part III Division 4 of the Act.
Notwithstanding the fact that he said in his reasons that none of the exceptions in sub.s.5l(l) was suggested as being relevant to the matter, the trial Judge did hear and rule on a submission by counsel for the Commissioner that "the rental claimed was a capital payment". His finding in this regard was that the payments under the lease were not outgoings of a capital nature "in any shape or form". He made reference in this regard to the decision of the High Court in Federal Commissioner of Taxation v South Australian Battery Makers Pty. Ltd. (l977-78) l40 C.L.R. 645 and held that it disposed of this contention in the taxpayer's favour. In considering the nature of the advantage sought by the taxpayer in entering into the leasethe trial Judge held that the circumstances differed considerably from those upon which counsel in that case (albeit without success) relied to require the disallowance of a deduction of the rent paid by that taxpayer.
On the appeal counsel for the Commissioner primarily concentrated upon the advantages to be achieved by the taxpayer and Edisearb, the advantage to the taxpayer being a taxation benefit and the advantage to Edisearb the acquisition of the units at a substantially reduced price. He contended that what he called the prepayment of rent was negotiated as part of a package presented by the taxpayer for the acquisition of the properties. He also sought the application of s.260.
It is in the area of deductibility that I find myself in respectful disagreement with the trial Judge.
It is, as I have already mentioned, my opinion that this outgoing of $63,800 is, in the express words of the exceptions to sub.s.5l(l), an outgoing of a capital nature notwithstanding the fact that it is in each of the leases labelled as rent. I reach this conclusion although I acknowledge that there are few questions more difficult to determine than the question whether an amount is capital or income in nature. The Master of the Rolls, Sir Wilfred Greene, said in British Salmon Aero Engines Ltd. v Inland Revenue Commissions (l938) 2 KB 482 at page 498 -
"... in many cases it is almost true to say that the spin of a coin would decide the matter almost as satisfactorily as an attempt to find reasons."
However, for my part the reasoning of Dixon J., as he then was, in the case which is the accepted authority in this area of the law (the Sun Newspapers case, infra) can be applied to decide this matter. I will come to this reasoning after referring to the statutory provisions and the terms of the leases.
Sub-section 5l(l) of the Act is in the following terms: "(l) 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.
It is obvious, and, to my mind significant, that the word "rent" is not referred to in the section. However, if premises are used in the gaining or production of assessable income, or in a business conducted for such purpose, it goes almost without saying that "rent" as such, being a recurring outgoing, is normally an allowable deduction. To start from this point is, to my mind, frequently to render more difficult the task of ascertaining the correct answer. The question is whether the amount paid by the taxpayer, admittedly described as "rent", is more correctly to be classified as an outgoing of a capital nature.
On this point it is worth noting that although the word "rent" does not specifically appear as an allowable deduction under sub.s.5l(l) or any other provision of the Act, it is expressly stated as an item of assessable income in Division 4 of Part III, a Division dealing with leases. The word is not defined but s.84 provides -
"84. The assessable income of a taxpayer shall include, in addition to rent, a premium received by him in the year of income."
As previously related C.A.G.A. accepted with the proposals put forward by the taxpayer and the leases into which the parties entered reflected, to the extent relevant, these proposals. The lease documents were in similar and what I understand to be standard form in New South Wales. I shall only refer to the lease of unit 59. The crucial provision is as follows:
"The lessee holds as tenant for a term of 5 years commencing on the 30th day of June l977 and terminating on the 29th day of June l982 at the yearly total rent of eighteen thousand two hundred and sixty dollars
($l8,260.00) without any deduction or abatement whatsoever payable as follows - $l4,608 on the 30th June l977, $l,826.00 on the 30th day of June, l978 and $l,826.00 on the 30th day of June, l979."
The word "yearly" appeared in the printed form of lease but was struck out and the word "total" was substituted and typed in.
Two further clauses in the lease are worthy of note. Clause 8 provided a right to renew the term as follows:
"8. IF the Lessee shall desire to take a renewal Lease of the demised premises for a further period of five years from the expiration of the term of this Lease and shall give to the Lessor not less than three (3) months' previous notice in writing thereof and shall during the term of this Lease duly and punctually pay the rent reserved by this Lease at the times hereinbefore appointed for payment thereof and shall duly observe and perform the covenants and agreements by and on the part of the Lessee expressed or implied in this Lease up to the expiration of the term hereof the Lessor shall at the cost and expense of the Lessee lease to the Lessee the demised premises of the same covenants agreements and provisions as are herein contained except for this clause and at the same rent except that the rent shall be paid by equal successive monthly instalments in advance."
Clause 6 provides for the circumstance of a holding over in the following terms -
"6. IN the event of the Lessee holding over after the expiration or sooner determination of the term hereby granted with the consent of the Lessor the Lessee shall become a monthly tenant only of the Lessor and at a monthly rent of Three hundred and one dollars ($30l.00) payable monthly in advance and otherwise on the same terms and conditions mutatis mutandis as those herein contained as far as applicable such tenancy being determinable at the will either of the Lessor or the Lessee by one week's notice in writing expiring at any time."
To my mind the first question for determination in this matter is whether the sum called rent and which is described as the "total rent" and is payable by three instalments is an outgoing on revenue account. Alternatively, is it more correctly to be seen as a capitalized amount and thus an outgoing of a capital nature?
The greatest assistance that is available in this area of the law is to be found in the judgment of Dixon J. in Sun Newspapers Ltd. and Associated Newspapers Ltd. v Federal Commissioner of Taxation (l938-39) 6l C.L.R. 337 at p.363. The following is accepted as the classic statement of principle -
"Again, the cases which distinguish between capital sums payable by instalments and periodical payments analogous to rent payable on revenue account illustrate the fact that rights and advantages of the same duration and nature may be the subject of recurrent payments which are referable to capital expenditure or income expenditure according to the true character of the consideration given, that is, whether on the one hand it is a capitalized sum payable by deferred instalments or on the other hire or rent accruing de die in diem, or at other intervals, for the use of the thing: Compare Ogden v Medway Cinemas Ltd. (l934) l8 Tax Cas. 69l. with Inland Revenue Commissioners v Adam
(l928) S.C. 738; l4 Tax Cas. 34 and Green v Favourite Cinemas Ltd. (l930) 15 Tax Cas. 390.
There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment."
I have emphasized the words and phrases which I see as most significant.
In his argument on the appeal counsel for the taxpayer primarily concentrated on the first of three matters, namely the character of the advantage sought. In so doing he compared the fact situation in this case with that in the S.A. Battery Makers case and adopted as analagous the reasoning therein.
It is however in my view more important in this matter to consider the nature of the payment in consideration of which the taxpayer obtained the use and occupation of the premises for the term of 5 years, together with an option to renew for a further term. Did the payment of $18,260 in three instalments as provided by the lease amount to a "periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payments" or was it more correctly "a final provision or payment so as to secure its future use or enjoyment"?
Gibbs A.C.J. referred in the S.A.Battery Makers case supra at page 654 to Dixon J's classic statement and at page 655 he said as follows:
"However the present case cannot be resolved simply by applying these tests. The real problem in the case is not to determine the character of the advantage sought, once it has been identified, but to decide what was the advantage sought by the taxpayer by making the payments. If the only advantage sought was the right to possession under the lease, and what was called 'rent' really answered that description, clearly the outgoings were entirely of a revenue nature. If on the other hand one advantage sought by the outgoings was the acquisition of a capital asset (the land and buildings), the fact that the payments were called 'rent', and were made periodically, would not necessarily prevent them from being in part outgoings of a capital nature - see Colonial Mutual Life Assurance Society Ltd. v Federal Commissioner of Taxation (l953) 89 C.L.R. 428; Poole and Dight v Federal Commissioner of Taxation (l970) 122 C.L.R. 427; and A.P.A. Fixed Trust Co. Ltd. v Federal Commissioner of Taxation (l948) 4 A.I.T.R. l05, at p.l07."
I have again emphasized the significant words.
His Honour acknowledged that to call something "rent" does not conclude the matter, but that it was necessary to determine whether what was called "rent" really answered that description. Likewise as he said "the fact that the payments were called 'rent' and were made periodically, would not necessarily prevent them from being in part outgoings of a capital nature". Nor in my opinion does it conclude the matter to find that that which the taxpayer sought was the right to possession under a lease. I read the Acting Chief Justice as saying that it is only if that which is sought is a leasehold interest and also that which is paid is properly called rent, then and then only is the outgoing necessarily on revenue account.
The test adopted by Dixon J. in Sun Newspapers supra is equally helpful, namely to determine whether the amount is a "capitalized sum payable by instalments" or "rent accruing de die in diem for the use of the thing". The word "capitalized" has dictionary meanings which are presently apt, namely "converted into capital" or "computed present value of income".
In my opinion, on the true construction of the lease aided by the evidence as the manner in which the total payment was calculated, it is apparent that the amount called "total rent" is in the words used by Sir Owen Dixon "a capitalized sum" which was made payable as to 80% forthwith and thereafter by two instalments each of l0% on the anniversaries of the first payment.This conclusion is supported by the evidence of Mr. Pursche as to the method he adopted in calculating the payments and to the effect that the only reason he provided for three instalments was that one payment appeared "commercially unrealistic".
I do not see the amount of the "total rent", whether payable as one lump sum or by instalments, as rent "accruing per die in diem" or as a "periodic outlay" covering the use of the premises for "periods commensurate with the payments". It is a capitalized sum and thus not an allowable deduction.
It follows that the Commissioner's appeal must be allowed, both in respect of "rent" and the fees for income tax advice, with costs both here and in the Court below.
JUDGE2
I agree with the order proposed by Fisher J and with his reasons but I wish to make some additional observations relating to the character of the advantage sought.
Some emphasis was placed by counsel for the respondent, in their submissions, upon the categorisation, as between the taxpayer and Home Units, of the sum of $63,800 as "rent". But, as Fisher J points out, the label is not decisive: see Federal Commissioner of Taxation v South Australian Battery Makers Pty Limited (1978) 140 CLR 645 at p.655, Europa Oil (N.Z.) Limited v Inland Revenue Commissioner (1976) 1 WLR 464 at p.472. Ordinarily, of course, rental payments, made to obtain the right to occupy premises used for the purpose of earning assessable income, are deductible. But ordinarily such payments are recurrent; and ordinarily they bear a relationship to the income expected to be earned by virtue of that occupation during the relevant accounting period. Where those features are absent, it is better to set aside nomenclature and to examine the substance of the transaction and -- where relevant -- the purpose for which it was undertaken.
It was pointed out in Magna Alloys and Research Pty Limited v Federal Commissioner of Taxation (1980) 33 ALR 213 that the word "purpose", in this context, is ambiguous and that the nature of the relevant purpose will vary from case to case. "Purpose" may refer to the taxpayer's subjective purpose: the end which he or she seeks to achieve by incurring the expenditure. It may mean objective purpose, the object which the incurring of the expenditure is apt to achieve. As Brennan J said at p.215:
"An objective purpose is attributed to a transaction by reference to all the known circumstances; whereas subjective purpose and motive, being states of mind, are susceptible of proof not by inference alone but also by direct evidence, for a state of mind may be proved by the testimony of him whose state of mind is relevant to a fact in issue."
At pp.218-219 his Honour said:
"Though purpose is not the test of deductibility nor even a conception relevant to a loss involuntarily incurred, in cases where a connection between an outgoing and the taxpayer's undertaking or business is effected by the voluntary act of the taxpayer, the purpose of incurring that expenditure may constitute an element of its essential character, stamping it as expenditure of a business or income-earning kind."
The evidence in the present case shows that the incurring of expenditure for "rent" was in every sense a voluntary act of the taxpayer. Not only did the taxpayer choose to enter into the transaction; he was the author of its form. Consequently, it is relevant to have regard to his purpose in determining whether that expenditure should be characterised as being upon capital or revenue account.
Here, objective purpose and subjective purpose co-incide. Subjectively, as he stated in his evidence and following a reference to the derivation of rental income, the "prime purpose" of the taxpayer "was to seek an investment for myself through Edisearb Pty Limited to purchase properties where there was a reasonable chance of good capital gain and, in regard to those two purposes, to secure for myself a tax benefit". The "two purposes" -- rental income and capital gains -- being achievable without resort to pre-paid leases, the answer makes plain that the only reason for their creation -- and the consequent incurring of expenditure for pre-paid rent -- was the desire to secure a taxation advantage.
Mr Creer's statement is consistent with the history of the matter. The evidence shows that at all times it was fundamental to the taxpayer's interest in the Wollstonecraft units that he be able to capture, either personally or through a company controlled by him, any future increases in capital values; but it was equally important to him that the purchases should be structured in such a manner as to make a portion of their cost tax deductible in the current year of income. In his affidavit Mr Creer said that in April 1977, when he first decided to look at residential properties, he knew "that the property market at the time was depressed". He "formed the view that vendors, particularly vendors who had borrowed money under mortgage, might be receptive to any reasonable proposal that I might put". At that time he had already discussed with his accountant "possible avenues for reducing my liability to income tax" and the accountant "had mentioned among a number of alternatives the possibility of leasing income producing properties and paying the rental in advance". In and after April Mr Creer inspected various properties, the consideration for which was always quoted in terms of a lump sum purchase price. He had a number of discussions with his bank and with CAGA, each of which proceeded upon the basis of lump sum values being assigned to each unit; but the values being apportioned by Mr Creer in various ways as between amounts of pre-paid rentals for five year leases and of consideration for the purchase of the freeholds of the units subject to those leases. The negotiations with CAGA reached finality on 29 July 1977 when, at a meeting attended by Mr Creer, Mr Pursche handed to representatives of CAGA a document entitled "Final Proposal between Creer and CAGA". This document detailed a series of proposed dealings involving the taking of five year leases by Mr Creer over each of the four units and the purchase by Edisearb Pty Limited of the freehold of each unit, finance being provided both to Mr Creer and to Edisearb by CAGA. Mr Creer's affidavit evidence was that, after examination of this document, one of the two CAGA representatives responded: "We are satisfied that your offers on the terms set out in Bill Pursche's document are acceptable to CAGA provided that the whole transaction can be finalised as soon as possible". The meeting concluded with discussion about the mechanics of the preparation of the necessary leases and contracts for sale. It is clear that both Mr Creer and CAGA regarded the various leases, sales and mortgages as a complex of interconnected dealings forming what Mr Creer described in his evidence as "the overall transaction".
The object which the incurring of the relevant expenditure is apt to achieve is consistent with the proved subjective purpose of the taxpayer. Considering the matter objectively, the properties were lettable and so capable of returning income. There were prospects of capital gains. But these ends could have been achieved without the taking of leases. Any desire to split, as between the taxpayer and Edisearb, the two benefits -- income and capital gains -- could have been accommodated by leases upon usual terms. The pre-payment of a rental equal to 80% of that payable under the leases for the full five years had no tendency other than to transform into expenditure incurred on revenue account in the 1977 financial year expenditure which would otherwise be incurred on capital account -- whether in or after the 1977 financial year -- or on revenue account in a later financial year.
The second limb of s.51(1) makes deductible losses and outgoings to the extent to which they are "necessarily incurred in carrying on a business for the purpose of gaining or producing" assessable income. The relevance of purpose to that limb is apparent. But the relevant purpose is the purpose for which the business is carried on, not the purpose of the particular expenditure: see John Fairfax and Sons Pty Limited v Federal Commissioner of Taxation (1950) 101 CLR 30 at p.49. In the present case this limb may be ignored. As Menzies J explained at that page the second limb requires that "the outlay must have been incurred in the carrying on of a business, that is, it must be part of the cost of trading operations". The only business of the taxpayer disclosed by the evidence was that of a solicitor. The rental outgoing had nothing to do with that business. It was incurred in connection with a real estate investment not involving trading operations.
The word "purpose" does not appear in the first limb of s.51(1), which simply refers to "losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income". But there is ample authority for the proposition that, in determining whether particular expenditure falls within this description, it is material to determine the objective purpose for which it was incurred. In Ronpibon Tin N.L. and Tongkah Compound N.L. v Federal Commissioner of Taxation (1949) 78 CLR 47 at p.57 Latham CJ, Rich, Dixon, McTiernan and Webb JJ, said that to come within this limb "it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income". In South Australian Battery Makers, as Gibbs ACJ pointed out in the passage at p.655 quoted by Fisher J, the critical question was the nature of the advantage sought by the taxpayer.
In Magna Alloys Brennan J elaborated his comments upon the significance of purpose by saying at pp.220-221:
"When the question is whether expenditure has the character of capital or of a revenue payment ... the advantage for which the expenditure was incurred must be identified and the manner in which it 'is to be relied upon or enjoyed@ must be considered ... The role of the advantage in the income-earning undertaking requires examination. Similarly, when the question is whether expenditure is incurred in gaining or producing assessable income, the connection between the advantage for the taxpayer which the incurring of the relevant expenditure is calculated to effect and the taxpayer's income-earning undertaking or business must be considered. If the advantage can be sufficiently identified by reference to a contract, and the taxpayer's undertaking is known, the connection between the incurring of the expenditure and the undertaking is manifest, and it would be otiose to refer to the purpose of incurring the relevant expenditure. But purpose is relevant to describe an element of connection between expenditure and a taxpayer's undertaking or business in cases where a taxpayer incurs expenditure or agrees to incur expenditure without any antecedent obligation to do so or where the occasion of the expenditure ... is not manifestly to be found in whatever is productive of assessable income or in whatever would be expected to produce assessable income, or in the carrying on of a business."
His Honour went on to refer to a passage in the judgment of Dixon J in Federal Commissioner of Taxation v Midland Railway Co of Western Australia Limited (1952) 85 CLR 306 at p.313 in which his Honour, in discussing whether particular expenditure fell within s.51(1) referred to the "controlling factors" as being those which arise from the character of the business or undertaking and the relation which the expenditure bore to the carrying on of the business or the gaining of assessable income. Brennan J commented that, although the taxpayer's state of mind has no relevance once the "controlling factors" are established, "in ascertaining the controlling factors, the taxpayer's state of mind may have a significant evidentiary role to play, and by leading to the ascertainment of the controlling factors, it may even be the determinative element in characterizing expenditure in a particular case". And see also the judgment of Deane and Fisher JJ in the same case at pp.234-235.
The Magna Alloys approach may be applied to the facts of the present case by saying that, in determining one of the "controlling factors", that is the relationship between the incurring of the pre-paid expenditure and the gaining of assessable income, the taxpayer's state of mind has a significant part to play, confirming the inference which would anyway arise from the nature of the transaction, that the latter was not the purpose of the former.
In two cases in this Court, since Magna Alloys, regard has been paid to collateral advantages sought to be gained by a taxpayer from the incurring of expenditure claimed as deductible under s.51(1). In Ure v Federal Commissioner of Taxation (1981) 34 ALR 237 the claim was to deduct interest payable on loans raised by the taxpayer at commercial rates and then on-lent by the taxpayer to his wife or to his family company at 1% per annum, the moneys being eventually used for various purposes beneficial to the family. At pp.249-250 Deane and Sheppard JJ said:
"One of the most difficult aspects of the problem of characterizing an outgoing is the assessment of what, if any, weight is to be given to indirect objects which a taxpayer had in mind in incurring the outgoing. Such objects form part of the relevant circumstances by reference to which the problem of characterization must be resolved. There is however no rigid principle which can be applied in determining what, if any, weight should be given to them. In the ordinary case, such as, for example, where the immediate object achieved by the outgoing is the production of assessable income which is commensurate with the amount of the outgoing or where it is clear that the outgoing was for the purchase of stock-in-trade or the acquisition of services or hire of equipment used in earning assessable income, indirect objects or motives of a personal or domestic character will plainly not prevent the characterization of the outgoing as having been incurred in earning assessable income: ... In other cases, the immediate object or effect of an outgoing will not suffice either to explain or to characterize it. In such cases, indirect objects or motives can assume a sometimes decisive importance."
Their Honours said that it would be a "misleading half-truth" to say that "the object which the taxpayer had in mind or the advantage which he sought in incurring the liability" to pay interest at 7.5% or more was the derivation by him of interest at 1% per annum by re-lending the money which he borrowed. They went on:
"That was, no doubt, an object which the taxpayer had in mind: it was an advantage which he sought. In the circumstances however, characterization of the outgoing cannot properly be effected by reference to that object or advantage alone. The incurring of the outgoing can only be explained by reference also to less direct objects and advantages which the taxpayer sought to achieve and which plainly were of paramount importance. These indirect objects or advantages were, in so far as the taxpayer was concerned, not of an income-earning character ..."
In the result it was held that the claim should be apportioned.
It can be accepted in the present case that the earning of rental income by the sub-leasing of the four units at Wollstonecraft was an object which Mr Creer had in mind, an advantage which he sought. But the incurring, on the last day of the financial year, of a lump sum outgoing amounting to a pre-payment of 80% of the total rent payable over five years, can only be explained by non-income earning objects and advantages which Mr Creer sought to achieve.
Federal Commissioner of Taxation v Ilbery (1981) 38 ALR 172 is a case having some factual similarity to the present appeal. The question in that case was the deductibility of a pre-payment of five years' interest. It was accepted that the interest would have been deductible if paid in the ordinary way; the relevant loan having been used to purchase an income producing property. It was contended on behalf of the taxpayer that one result of the pre-payment was to reduce the interest payable over the whole period of the loan. Toohey J, with whom Northrop and Sheppard JJ agreed, commented at p.181:
"That may well have been a consequence of the prepayment of interest, but it was not suggested by the taxpayer as his reason for doing so, nor as the purpose sought to be achieved; nor in my view does it say anything about the character of the payment. The taxpayer never tried to conceal that his object in paying five years' interest in one year was to obtain the tax advantages thought to flow from that course. To the extent then that purpose is relevant to throw light upon the character of a payment, no purpose can be discovered here other than that of gaining a tax advantage.
It is, I think, necessary to distinguish between the prepayment of interest in the present case and the character that payment would have if spread over a number of years as interest on money borrowed for the purpose of purchasing a property as a source of income. The character of one does not necessarily determine that of the other. ...
While it may not be for the Commissioner to tell a taxpayer how much he should spend on outgoings in the course of gaining an assessable income or whether he should incur those outgoings in one or more than one tax years, a question may still arise whether, in respect of a particular year, an outgoing incurred by a taxpayer can truly be said to have been incurred in gaining or producing the assessable income."
Toohey J went on to mention the reference by Latham CJ, in W Nevill and Company Limited v Federal Commissioner of Taxation (1937) 56 CLR 290 at p.301, to "the object which the person making the expenditure has in view" but he commented that he did not understand the Chief Justice to have been saying that the matter is to be resolved on the basis of the taxpayer's own statement without regard to the surrounding circumstances. His Honour then concluded at p.182 with a summary of the position which may be applied directly to the facts of this case:
"In the present case, however, the taxpayer's own statement and the surrounding circumstances point unequivocally to a payment made for the purpose of securing a tax advantage and no other.
At the time of the prepayment of interest the taxpayer had not acquired any property from which he hoped to derive income. There was no relevant income-earning undertaking or business in existence. That is not necessarily fatal to an argument that an outgoing incurred is 'incidental and relevant@ to gaining or producing the assessable income. But what is under consideration here is a prepayment of interest made at a time when no relevant income-producing activity had begun and not made for any purpose connected with such an activity. The money was not outlaid to gain income; it was not incidental or relevant to the gaining of income."
Finally, I observe that it was submitted that any collateral purpose of obtaining for Edisearb the freehold of the units must be disregarded. South Australian Battery Makers was cited in support of that submission. But that was an entirely different situation. The whole point of the majority view in that case was that the payments in question did not enable the taxpayer, or any subsidiary of the taxpayer, to acquire the freehold estate. The majority held that it was not enough that another member of the same group of companies might acquire the freehold. Significantly, for present purposes, Gibbs ACJ distinguished at p.655 the case of an advantage flowing to a subsidiary of the taxpayer:
"Of course it cannot be denied that the circumstances may be such that one company may benefit from the fact that its subsidiary receives an advantage; the control which the parent company exerts over its subsidiary may ensure that the benefit flows on from the latter to the former."
Mr Creer's control of Edisearb has the potential to ensure that the benefit flowing to that company of acquisition of the freehold flows on to him.
For the above reasons, in addition to those stated by Fisher J, it should be held that the relevant expenditures do not fall within s.51(1) of the Income Tax Assessment Act.
JUDGE3
I agree with the Reasons for Judgment of Fisher J. and with the orders proposed by him.
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