Commissioner of Taxation v Gwynvill Properties Pty Ltd

Re: THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
And: GWYNVILL PROPERTIES PTY. LIMITED.
Re: GWYNVILL PROPERTIES PTY. LIMITED.
And: THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
No. G32 and G251 of 1985
Income Tax

COURT

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY
GENERAL DIVISION
Fisher J.
Neaves J.
Jackson J.

CATCHWORDS

Income Tax - allowable deductions - Interest prepaid on loan - Purpose of pre-payment to gain a tax advantage - Whether prepaid interest deductible - Whether outgoing necessarily incurred in carrying on business.

INCOME TAX ASSESSMENT ACT 1936 (Cth) sub.s.51(1), s.260.

HEARING

SYDNEY

#DATE 18:8:1986

ORDER

In Matter No. G32 of 1985:-

(a) The Commissioner of Taxation's appeal be allowed.

(b) The judgment of the Supreme Court of New South Wales be set aside and in lieu thereof it is ordered that

(i) the assessment be remitted to the Commissioner to be amended by remitting the amount of the additional tax described therein as payable pursuant to s.226 of the Act;

(ii) otherwise, the appeal to that Court be dismissed.

(iii) Gwynvill Properties Pty. Limited pay to the Commissioner his costs.

(c) Gwynvill Properties Pty. Limited pay to the Commissioner his costs of the appeal.

In Matter No. G251 of 1985:-

(a) The appeal of Gwynvill Properties Pty. Limited be dismissed.

(b) Gwynvill Properties Pty. Limited pay to the Commissioner his costs of the appeal.

Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

JUDGE1

This is an appeal by the Commissioner of Taxation of the Commonwealth of Australia ("the Commissioner") from the allowance by the Supreme Court of New South Wales of an appeal by Gwynvill Properties Pty. Limited ("the taxpayer") against a decision of the Commissioner. By that decision the Commissioner disallowed the taxpayer's objection to an assessment of income tax for the year of income ended 31 July 1978 which assessment rejected inter alia the taxpayer's claim to deduct payments of interest totalling $1,569,271 pursuant to sub.s.51(1) of the Income Tax Assessment Act 1936 ("the Act") and also payments of legal expenses totalling $3,702. The taxpayer also appealed to the Supreme Court against the Commissioner's decision to deny it the right to deduct one fifth of this amount of interest in each of the years ending 31 July 1978 and 31 July 1979. The allowance by the trial judge of the claim to deduct the full amount of the outgoings in the year ending 31 July 1978 required the dismissal of the taxpayer's last mentioned appeal. The taxpayer appealed to this Court against that dismissal thereby preserving its position in the event that the Commissioner's appeal to this Court was upheld. The claim to deduct legal expenses, pursuant to either sub.s.51(1) or s.67 of the Act was not separately argued, it being agreed that a decision on the deductibility of interest would determine whether that claim was allowable.

The amount of interest which the taxpayer sought to deduct comprised $69,271.23 paid on 3 February 1978 being interest payable in advance for the period to 1 May 1978 and $1,500,000 paid on 6 February 1978 being the interest for the period of 5 years from 1 May 1978. I will hereafter refer to the payment of $1,500,000 as a "prepayment" of interest, although to describe it as such is not strictly accurate as the amount was not paid voluntarily by the taxpayer but pursuant to an obligation contained in the loan agreement.
There is little room for dispute about the primary facts which were related in detail by the trial judge. For some years prior to the two years in question the taxpayer, a member of the Franklin's Group of companies, had carried on a substantial business as an investor, property owner and developer and share trader. In the year ending 31 July 1978 for example the taxpayer's gross income was in excess of $3,000,000 and its operating profit before tax just under $300,000. Its main involvement up to this time had been with projects associated with stores operating as "Franklin's Supermarkets".
Late in 1977 the taxpayer made a decision to increase its investment in real estate outside of the Franklin's Group. To this end it purchased a number of income producing properties, in particular the Westleigh Shopping Centre and a commercial office building in Crows Nest, a suburb of Sydney, for approximately $2,000,000. These purchases were made from funds borrowed within the Franklin's Group. That Group at the time as a matter of policy concentrated its funds almost exclusively in the bank account of one company, F.G. Finances Pty. Limited, which acted as the banker and financier for the Group. Monies were transferred into or out of the account of F.G. Finances daily so that generally speaking the accounts of other members of the Group were at no time either in credit or in overdraft in excess of $500.
At about the time that the taxpayer decided to increase its investment in real estate it began to look for funds outside of the Group. The taxpayer approached a number of institutions seeking a loan on which a substantial amount of interest could be prepaid, which loan could thereafter be sold at a discount. Ultimately it discussed such a loan with Herunda Finance Corporation Pty. Ltd, a company not associated with the Franklin's Group. During negotiations with this company, which took place over about a month, it was contemplated that another company in the Group, Franklin's Selfserve, could be interested in purchasing the loan. These negotiations concluded with the taxpayer obtaining the approval of Herunda to provide a loan on 3 February 1978.
The taxpayer executed an agreement for loan which was dated 3 February 1978 and on that day, a Friday, received payment of $2,400,000 which it invested, initially in a special bank account, on the short term money market for a term of 7 days. From its general account it paid on the same day interest totalling $69,271.23, being the amount payable in advance in respect of the period to 1 May 1978. On Monday 6 February 1978 Herunda gave notice pursuant to the terms of the loan agreement that it required payment forthwith of interest for the period of 5 years from 1 May 1978 and this amount, $1,500,000, was paid from the taxpayer's general account. The resulting overdraft on that account was later that day converted to a small credit by a transfer from F.G. Finances in accordance with the arrangements previously related. Also on that day Herunda assigned its interests under the loan agreement to Franklin's Selfserve for $916,729, which company also obtained its funds from F.G. Finances. On 10 February 1978 the taxpayer was repaid with interest the $2,400,000 it had invested on the short term money market, and this amount was automatically transferred to F.G. Finances. These transactions comprise what I hereafter call the extraordinary features of the matter, which were greatly relied upon by the Commissioner.
In these circumstances the taxpayer claimed to deduct the two amounts of $69,271 and $1,500,000 as outgoings, in the words of s.51(1), "necessarily incurred in carrying on a business for the purpose of gaining or producing" assessable income. It contended that the outgoings were not of capital or of a capital nature, and were therefore deductible under the second limb of sub.s.51(1). Alternatively the taxpayer claimed to be entitled to deduct one-fifth of the prepaid amount in each of its years of income ending 31 July 1978 and 1979. In finding that the amounts in question were allowable as deductions in the year of income ended 31 July 1978, the trial judge placed considerable reliance upon the evidence of Mr. Carnell, the finance director of the taxpayer, which evidence he said he accepted without reservation.
On the hearing of the appeal counsel for the Commissioner challenged two findings of the trial judge. The first was that "the taxpayer decided to borrow from outside the Franklin Group as a consequence of its changed investment policy, and that, having made that decision, the taxpayer determined to go about obtaining that loan in a way which would best give to it a tax advantage". He also challenged the finding that "in short, the need for an outside loan was perceived and the decision to obtain it was made independently of the wish to obtain a tax deduction".
Counsel contended that the correct finding should have been that the taxpayer entered into the loan agreement for the sole purpose of obtaining a tax deduction and not for any purpose connected with the earning of assessable income. Alternatively it was put that the taxpayer had not discharged the onus of establishing a connection between the entry into the loan agreement and the taxpayer's business, because the obtaining of a tax advantage was not a business end. Doubtless with an eye to the application of the doctrine of "fiscal nullity" to defeat the taxpayer's claim, the Commissioner contended that the obtaining of a tax deduction was "pre-ordained".
Counsel for the Commissioner conceded that at the end of the day it was a question of fact whether there was sufficient connection between the outgoing and the taxpayer's business. However he pointed to the external circumstances and in particular the extraordinary features as justifying his contentions.
In respect of the two findings of fact which the Commissioner challenged, it is my opinion that they should not be disturbed by this Court. The first finding, namely that the obtaining of an outside loan was desirable in the light of the taxpayer's changed investment policy, was seen by the trial judge as vital to the taxpayer's appeal. It was based on the evidence of Mr. Carnell to that effect. His evidence was accepted by the trial judge, as he said, substantially in reliance upon his demeanour. Likewise he made the firm finding that the need for a loan was perceived and the decision to obtain it was made independently of the desire to obtain a tax deduction. In my opinion these are findings of fact and not inferences from facts which would be susceptible to review by this Court (See Warren v Coombes (1979-80) 142 CLR 531).
However in making these findings the trial judge acknowledged the significance which the taxpayer attached to the obtaining of a tax advantage. He found that, the decision to borrow outside the Group having been made, the taxpayer determined to obtain a loan in a manner which would best give it a tax advantage. The form of the loan and the identity of the borrower were obviously chosen because of the tax advantages to be obtained. The question is whether in these circumstances the taxpayer is denied the deduction of the two amounts of interest under the second limb of s.51(1) of the Act. The taxpayer ultimately conceded that the first limb had no relevance.
The second limb of sub.s.51(1) provides that losses or outgoings are deductible from a taxpayer's assessable income to the extent that they are -

"necessarily incurred in carrying on a business for the purpose of gaining or producing such income... except to the extent that they are losses or outgoings of capital, or of a capital, private or domestic nature...".

In this matter it was not disputed that the taxpayer had incurred the two outgoings or that it was carrying on a business for the purpose of producing assessable income. Before the trial judge the Commissioner contended that the payments were in reality payments of capital or of a capital nature. This submission was rejected by the trial judge and only faintly pursued before us In my opinion it was rightly rejected. The arguments on appeal on the s.51 question were therefore primarily confined to the question whether the taxpayer had discharged its onus under s.190 of the Act and established that the interest payments were "necessarily incurred" in the carrying on of the taxpayer's business. This was predicated by the trial judge's finding that "a major concern of the taxpayer was the tax deductibility of the payment of interest".

Both parties accepted the test to be applied as set out in the joint judgment in Magna Alloys v. Federal Commissioner of Taxation (1980-81) 33 ALR 213 at p 235 as follows:

"The controlling factor is that, viewed objectively, the outgoing must, in the circumstances, be reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of the business being carried on for the purpose of earning assessable income".

Earlier the following passage appears in the joint judgment at p.232 -

"The requirement that the claimed outgoing be 'necessarily' incurred in carrying on the relevant business does not, in the context, mean that the outgoing must be either 'unavoidable' or 'essentially necessary'. Nor does the word 'necessarily' import a requisite of logical necessity. What is required is that the relevant expenditure be appropriate and adapted for the ends of the business carried on for the purpose of earning assessable income: see, Ronpibon Tin NL v. FC of T; Tongkah Compound NL v. FC of T, supra, 78 CLR at 55-56; 4 AITR at 245; FC of T v. Snowden & Willson Pty Ltd, supra, 99 CLR at 444 and 447; 7 AITR at 317 and 320. For practical purposes and within the limits of reasonable human conduct, it is for the man who is carrying on the business to be the judge of what outgoings are necessarily to be incurred: FC of T v. Snowden & Willson Pty Ltd, supra, at 444; 317. It is no part of the function of the Act or of those who administer it to dictate to taxpayers in what business they shall engage or how to run their business profitably or economically. 'The Act must operate upon the result of a taxpayer's activities as it finds them': per Williams J, Tweddle v. FC of T (1942) 7 ATD 186 at 190."

The Commissioner's submission was, as already indicated, that the only purpose was the obtaining of a tax deduction, and that this was not a business end. Therefore it followed that there was no, or no sufficient connection between the entry into the loan agreement, or alternatively the incurring of the outgoing, and the taxpayer's business.
There are a number of grounds upon which I am satisfied that the trial judge correctly allowed the taxpayer the deduction it claimed. It is pertinent to comment at this stage that many of the factors upon which the Commissioner relied, such as the extraordinary features, could be more relevant to the question whether the transactions into which the taxpayer entered, in company with Herunda and other members of the Franklin's Group, constituted an arrangement liable to be struck down by s.260 of the Act.
In its challenge to the trial judge's decision on s.51 the Commissioner's appeal must in my view fail at the outset because the trial judge found, as I accept, that the obtaining of a tax deduction was not the only purpose of the taxpayer. The taxpayer's purpose was to obtain a loan outside of the Group in consequence of its changed investment policy. The payment of interest under this loan was, viewed objectively, capable of being seen as "desirable or appropriate" in the pursuit of the taxpayer's business ends. Moreover the trial judge found that Mr. Carnell saw it as desirable and appropriate.
The fact that it was also a major concern of the taxpayer that it achieve a deduction of the amount of interest paid and that it sought thereby a tax benefit or advantage does not deny the taxpayer a deduction under s.51(1). As Brennan J. said in Magna Alloys at p.227 after noting that the trial judge had held that it was the personal interests of the directors which provided the principal motive or reason for Magna Alloys incurring the expenditure:

"The character of the expenditure is not lost because the expenditure was apt to serve both the business purpose and the purpose of defending the directors, nor is that character lost because the principal or dominant reason for incurring the expenditure was to defend the directors."

At page 236 the following passage appears in the joint judgment.

"In our view however, the identification of the dominant motive of the directors in deciding to incur the expenditure was not the essential question which arose for determination. There is no necessary dichotomy between what can properly be regarded as incidental and relevant to the business ends of a business and that which advances the personal interests of those persons who are employed or otherwise involved in that business."

I have emphasized the word "motive" because in my opinion in this matter also it is not the essential question for determination.

I adopt this as the proper approach to a claim for a deduction under s.51 even if the obtaining of a tax advantage, contrary, in this instance to the trial judge's finding of fact, was the principal or dominant reason for incurring the expenditure. As Gibbs J. (as he then was) said in Federal Commissioner of Taxation v Patcorp Investments Limited (1968) 140 CLR 247 at 290:

"The so-called extraordinary features of these transactions go only to show that the motive that inspired the appellant companies to enter into the transactions, and the effect which they were intended to achieve, was to improve their taxation position by taking advantage of the provisions of s.46 of the Act. In addition it might be said, in relation to the shares in Austin and possibly also in relation to those in Yarra, that it was not intended to make a commercial gain, i.e. that the only object of those transactions was to derive a fiscal benefit. However, the fact that a dividend-stripping operation is carried out for the purpose of obtaining taxation advantages, and not to make a profit, does not mean that it must be regarded as outside the scope of the taxpayer's share trading business, or that the shares cannot be treated as trading stock."

Later on page 292 he said:

"The only reason advanced for isolating the transactions in question from the general run of the business of the appellant companies was that they were designed for the purpose of tax avoidance, but for the reasons I have given I consider that that reason cannot be accepted, apart from s.260."

The trial judge referred to a number of additional authorities for this proposition which I need not repeat because, with the exception of two hereafter mentioned, they are all to the same effect. Furthermore counsel for the Commissioner did not on the appeal support his contrary contention with any authority. The two cases which on the face of them might appear to support a contrary conclusion are Federal Commissioner of Taxation v Ilbery (1981) 81 ATC 4661 and Deane v Federal Commissioner of Taxation (1982) 40 ALR 499. In my view each case was convincingly distinguished by the trial judge, particularly on their respective facts, and I need do no more than adopt his reasoning.

It follows that in my opinion the trial judge correctly allowed the two payments of interest as deductions from the assessable income of the taxpayer in the year of income which ended on 31 July 1978.

Counsel for the Commissioner also contended that even if the payments of interest were allowable deductions under sub.s.51(1), the application of the principle known as the "doctrine of fiscal nullity" denied entitlement to a deduction. He also submitted that the trial judge should have held that the arrangements between the taxpayer and Herunda were void against the Commissioner by virtue of s.260 of the Act. In each instance he acknowledged that he had to contend with contrary decisions of the Full Court of this Court and he said little more on the substance of the two points than to make formal submissions to preserve his position on any further appeal. This was certainly the case in relation to fiscal nullity in that the Commissioner was faced with the unanimous decision of the Full Court in Oakey Abattoir Pty. Ltd. v Federal Commissioner of Taxation (1984) 55 ALR 291 in which the doctrine of fiscal nullity was rejected. It must also be rejected by this Court as inapplicable in this matter.
Counsel for the Commissioner said little in relation to s.260 in his initial submissions. He was however subsequently granted leave to make further submissions after taking instructions. He contended that notwithstanding a number of decisions of the Full Court of this Court and the decision of the High Court in Cecil Bros Pty. Ltd. v Federal Commissioner of Taxation (1964) 111 CLR 430, s.260 could be used to deny a deduction otherwise allowable under sub.s.51(1). It is my opinion that we should consider ourselves bound by these decisions to hold to the contrary, notwithstanding the recent decisions of the High Court on s.260 in the matters of Gulland, Watson and Pincus v Commissioner of Taxation (1985) 62 ALR 545. These decisions may require reconsideration of the general statements which have been made, frequently obiter, indicating difficulties in applying s.260 "to extinguish a deduction otherwise properly allowable under s.51" (per Kitto J. in Cecil Bros supra at p.438). In Federal Commissioner of Taxation v Lau (1984) 57 ALR 107 the Full Court of this Court refused to apply s.260 to deny a s.51(1) deduction. Beaumont J. who gave specific consideration to the question said at p.129:

"Finally, the Commissioner invokes s.260. There are obvious difficulties in seeking to apply s.260 to deny a deduction to a payment which qualifies as an allowable deduction. The question was considered by a Full High Court in Cecil Bros Pty. Ltd. v F.C.T. (1964) 111 CLR 430, per Dixon C.J. at p.438; per Kitto J. at p.438; per Taylor J. at p.438. Although, in strictness, their Honours did not need to decide that s.260 could not apply to defeat or reduce any deduction otherwise truly allowable under s.51, their expressions of opinion on the point should be treated as authoritative for present purposes."

Jenkinson J. concurred in these reasons and the presiding judge Fox J. said as follows on the topic of s.260 at p.116:

"Certainly, it achieved for the taxpayer a large deduction and an income tax loss, part of which he could carry forward, but, even if a deduction can be the subject of s.260, it is far short of satisfying the requirements of that section."

It is my opinion that we should not be persuaded by the arguments of the Commissioner to consider whether s.260 is available to the Commissioner to deny the taxpayer its deductions. Section 260 is in my opinion the only ground upon which they could be denied, and what I have called the extraordinary features might support the application of the section. However in deference to the difficulties perceived by the High Court and the expressions of opinion by members of this Court we should not enter the arena, particularly as there was no exhaustive argument on the matter. The Commissioner limited his comments to the applicability of s.260 to s.51 deductions, and the relationship of s.51 to the "choice principle". Counsel for the taxpayer made what he termed an "equally formal submission" to the effect that s.260 could not apply to the circumstances of this case and that it was not open to this Court to hold that the section could operate to disallow the deduction.
It follows that in my opinion the trial judge's decision that the deductions are allowable under s.51 was correct and the appeal of the Commissioner should be dismissed with costs. The formal appeal of the taxpayer must, it follows, also be dismissed but I would make no order in relation to the costs of that appeal.

JUDGE2

On 29 January 1985 the Supreme Court of New South Wales gave judgment upon appeals by Gwynvill Properties Pty. Limited ("the taxpayer") against the disallowance of objections against assessments to income tax in respect of the years of income ended 31 July 1978 and 31 July 1979. In respect of the year of income ended 31 July 1978, the Supreme Court allowed the taxpayer's appeal, holding that the taxpayer was entitled, pursuant to sub-s.51(1) of the Income Tax Assessment Act 1936 (Cth), to deduct from its assessable income of that year amounts of $69,271 and $1,500,000 representing interest paid in that year to Herunda Finance Corporation Pty. Limited ("Herunda") under a loan agreement dated 3 February 1978 and an amount of $3,702 being legal costs incurred in connection with the loan transaction.

The taxpayer's objection against the assessment in respect of the year of income ended 31 July 1979 was based on the assumption that, as the sum of $1,500,000 represented income calculated in respect of a period of 5 years, only a proportionate part thereof might be allowable as a deduction in the earlier year. On that assumption, the taxpayer claimed that a further proportionate part of that sum would be an allowable deduction in the year of income ended 31 July 1979. As the Supreme Court allowed the whole sum as a deduction in the first of the two years, it was inevitable that the appeal in respect of the later year should be dismissed and the Court so ordered.
The Commissioner of Taxation ("the Commissioner") has appealed to this Court from the judgment of the Supreme Court in so far as it deals with the objection against the assessment in respect of the year of income ended 31 July 1978. The taxpayer has filed what is, in effect, a protective appeal in respect of that part of the judgment that dismissed its appeal in respect of the year of income ended 31 July 1979.
The basic facts are in a comparatively short compass.
At the material time the taxpayer (which was then known as A.F.Q. Pty. Limited) was one of a group of companies which were connected by common shareholding and which may conveniently be referred to as the Franklin's Group. Other companies in the group were F.G. Finances Pty. Limited ("F.G. Finances"), Franklin's Selfserve Pty. Limited ("Franklin's Selfserve"), Franklin's Stores Pty. Limited ("Franklin's Stores") and Norman Harold Pty. Limited which subsequently changed its name to Gwynvill Securities Pty. Limited ("Gwynvill Securities"). The taxpayer carried on a substantial business as an investor, a property owner and developer, and a share trader. Franklin's Stores conducted a retail grocery supermarket business of that name in some eighty different locations. The role that Franklin's Selfserve played in the activities of the group was as lessee of the properties at which the supermarket business was carried on, Franklin's Stores, however, being responsible for the payment of the rent. F.G. Finances acted as financier to the group. Gwynvill Securities was, until 1979, a dormant company.
Evidence concerning the loan transaction and the events leading up to it - evidence which the primary judge accepted - was given by Ross Frederick Carnell. Mr Carnell was the finance director of the taxpayer and during 1977 and 1978 was a director of Franklin's Stores and Franklin's Selfserve. He said that in 1977 the directors of the taxpayer carried out an examination of the future of investment in Australia following which the taxpayer made a policy decision that in future it would develop existing properties, acquire further prime real estate and acquire redevelopment sites, all with a view to producing growth in its income from rents. Thereafter, he said, the taxpayer expended money on redeveloping existing properties and in acquiring additional income producing properties. It purchased the Westleigh Shopping Centre for $1,134,513 in August 1977, a commercial office building in Crows Nest for $879,470 in the following month, properties at Brighton and Caringbah in October and December 1977 for $72,210 and $340,798 respectively and a further property at Caringbah in June 1978 for $131,915.
Mr Carnell also gave evidence that late in 1977, following a conversation with Mr Robin Speed, the taxpayer's solicitor, who was also a director of the company, approaches were made unsuccessfully to a number of companies with a proposal that the taxpayer borrow funds for a term in excess of 10 years. As his Honour found, "(w)hat was sought by the taxpayer was a loan in which a substantial amount of interest could be prepaid and which could itself be sold at a discount price".
Subsequently, negotiations began with Herunda, a company which was not associated with the Franklin's Group. Those negotiations continued over a period of about one month. The taxpayer was informed that funds were available for a term of 25 years with Herunda requiring that it have the right to have the interest referable to a five year period paid in advance. During the course of the negotiations, the assignment of the loan following the advance payment of interest for the five year period was also discussed. Mr Carnell informed Herunda that he was a director of a company that would be interested in buying the loan. Following a decision by the directors of Franklin's Selfserve that it was interested in buying the loan, discussions took place between the taxpayer and Herunda as to the price at which Herunda would sell. Prior to 3 February 1978 the consideration which would be payable in the event of the loan being assigned to Franklin's Selfserve was agreed at $916,729.
Before detailing the events of 2 February 1978 and subsequent days, some reference should be made to the financial arrangements that were in place as between the companies in the Franklin's Group and between them and their bankers. The primary judge described those financial arrangements in the following way:

"Large sums of money were daily paid in and out of the general bank accounts which the various members of the Franklins Group (other than Franklins Selfserve) held with the National Bank of Australia (as it was then known). Franklins Selfserve did not have a general bank account. At the end of each day, by arrangement with the Bank, any funds in credit above $500 held by a member of the Franklins Group were automatically transferred by the Bank to the account of F.G. Finances. The amount so transferred would be a multiple of $500, so that the balance would be an odd sum not exceeding $500. Similarly, where any member of the Franklins Group was in overdraft to an extent of more than $500, funds were automatically transferred by the Bank from F.G. Finances to reduce that overdraft to approximately that sum. Again, the amount transferred would be a multiple of $500, so that the balance would be an odd sum not exceeding $500. As a matter of convenience, the bank statements would show these transfers as having taken place at the commencement of the following day. F.G. Finances in 1978 had an overdraft limit of some $200,000. In addition to that overdraft (and a generous tolerance on the part of the Bank), that company together with the taxpayer and Franklins Selfserve also had substantial funds available to them on the money market. Moreover, Franklins Stores was given substantial credit by its suppliers, exceeding $8m. Mr Ross Carnell, the Franklins Group's finance director, made daily decisions (in consultation with the manager of the Bank) as to whether to put money out with, or to bring it back from, the money market."

A ledger account was maintained during the financial year showing, in respect of each period of four weeks, the net result over that period of the transfer of funds between F.G. Finances and the taxpayer in accordance with the above procedure. At the end of the financial year, arrangements were made so that any balance shown by the ledger account in favour of F.G. Finances was converted into a loan to the taxpayer by Franklin's Selfserve. The taxpayer paid in each financial year an amount representing interest on the balance of such loan account at the beginning of that year, there being an upper limit on the amount of interest payable, that limit being the net profit of the taxpayer for the year. It was always in the contemplation of the parties that amounts treated in accordance with the above procedure as moneys loaned by Franklin's Selfserve to the taxpayer would not be repaid unless subsequent unforeseen events made that course necessary or desirable.
By inadvertence, the procedure for converting to a loan to the taxpayer by Franklin's Selfserve the amount shown by the ledger account in favour of F.G. Finances as at the end of the financial year ended 31 July 1977 was not carried out. The necessary adjustments in respect of that and the next year were, however, made at the end of the next financial year.
On 2 February 1978 the directors of the taxpayer resolved to enter into a loan agreement with Herunda and to invest the resultant funds "initially on the short term money market and then to finance the acquisition of 10-12 Clarke Street, Crows Nest, the Westleigh Shopping Centre and other income producing properties".
On the following day, 3 February 1978, which was a Friday, at about 9 a.m. Mr Carnell and Mr Speed attended at the office of Herunda. Mr Speed produced a form of loan agreement setting out the terms and conditions on which the taxpayer was willing to borrow $2,400,000 from Herunda. The terms of the loan agreement were found to be satisfactory and it was then executed by Herunda. (The agreement was apparently executed on behalf of the taxpayer sometime later at Canberra.) In the agreement the taxpayer was referred to as "the Borrower" and Herunda as "the Lender". The principal sum (being an amount of $2,400,000) was expressed to be repayable on a date in January 2003 described in the agreement as the "Maturity Date". Interest on the principal sum was payable at 12.25% per annum in respect of the period from 3 February 1978 to 1 May 1978 and at the rate of 12.5% per annum thereafter. Interest was payable quarterly at the commencement of the period to which it related. Clauses 7 and 8 of the agreement were in the following terms:

"7. At any time after the date hereof but prior to the First day of May, 1978 the Lender shall be entitled by notice in writing to the Borrower to require the Borrower to pay to the Lender, in one amount, interest on the Principal Sum for five years at the rate of twelve and one half per centum (12.5%) per annum in respect of the period from First day of May, 1978 to the First day of May, 1983, and the Borrower shall notwithstanding anything else contained in this Agreement pay to the Lender such amount of interest immediately upon receipt of the said notice.

8. Notwithstanding anything else contained in this Agreement if the Borrower pays the said amount of interest in accordance with clause 7 hereof:-

(a) the Borrower shall pay interest to the Lender at the rate of seven and three-quarters per centum (7.75%) per annum in lieu of twelve and one half per centum

(12.5%) per annum in respect of the period from the First day of May 1983 to the Maturity Date; and

(b) the next payment of interest shall be payable on the First day of May, 1983 for the succeeding quarter and thereafter on the First day of each and every succeeding August, November, February and May in each year up to and including the Maturity Date."

Clause 18 was expressed to confer on Herunda the right at any time to assign all or any part of the benefits accruing to it under the agreement.

During the morning of the same day, Mr Carnell arranged to open two special bank accounts at the Broadway Branch of the National Bank of Australasia Limited, one in the name of the taxpayer and one in the name of Franklin's Selfserve. The opening of the account in the name of Franklin's Selfserve was said to be necessary as that company did not have a general bank account. The purpose of opening the special account in the name of the taxpayer (and, indeed, of the investment of the loan moneys on the short term money market) was, as the primary judge found, "to isolate the amount of the loan so as to be able later to demonstrate (to the Commissioner) that funds for the prepayment of interest came from another source and not from the loan itself". A deposit of $1,000,000 was made to the account in the name of Franklin's Selfserve, the necessary funds being provided by F.G. Finances.
At about lunch time Mr Carnell received from Herunda a bank cheque for $2,400,000 which was then deposited to the credit of the special account in the name of the taxpayer to which reference has been made. The total amount was then invested on the short term money market for a fixed term of seven days, three cheques being drawn on the above account for that purpose. Also on the same day, the taxpayer paid to Herunda an amount of $69,271 being the interest payable under the loan agreement in respect of the period to 1 May 1978.
On Monday, 6 February 1978 Herunda gave notice in writing to the taxpayer, pursuant to clause 7 of the agreement dated 3 February 1978, that it required payment of interest on the principal sum in respect of the period of five years commencing on 1 May 1978. That interest amounted to $1,500,000 and was paid on 6 February 1978 from the taxpayer's general bank account. Effectively, the payment was made by the transfer of funds from F.G. Finances in accordance with the banking and financial arrangements to which reference has already been made. This may be seen from the fact that, as the result of the transactions which took place on the taxpayer's general bank account on 6 February 1978, that account was overdrawn to the extent of $1,491,543.50. An amount of $1,492,000 was then automatically credited to that account by transfer from F.G. Finances.
Further events also took place on 6 February 1978. Herunda offered to assign to Franklin's Selfserve for $916,729 the principal sum referred to in the loan agreement dated 3 February 1978, all interest to become payable thereon, and the full benefit and advantage arising under or in consequence of that agreement. The directors of Franklin's Selfserve then met and accepted the offer. A cheque for $916,729 was then drawn on the special account in the name of Franklin's Selfserve that had been opened on 3 February 1978 and was delivered to Herunda. Notice of the assignment was given to the taxpayer on the same day although, somewhat curiously, the document of assignment bears date 14 February 1978.

It was conceded, as the primary judge records, that, "notwithstanding the absence of any legal obligation upon Herunda to do so, the taxpayer at all times expected and anticipated that Herunda would in fact decide to give the notice requiring prepayment of interest relevant to the period of five years and that Herunda would also in fact thereafter assign its benefits under the loan to Franklin's Selfserve".
On 10 February 1978 the amount of $2,400,000 invested by the taxpayer in the short term money market was repaid to it (with some interest) and banked in its general bank account. At the end of the day, as a result of that and other transactions, the taxpayer's general bank account stood in credit to the extent of $2,215,188.85. In accordance with the procedures outlined above, $2,215,000 of that amount was automatically transferred to F.G. Finances.
For completeness it may be mentioned that, in July 1979, the supermarket business conducted by Franklin's Stores and the shares in Franklin's Selfserve were sold. In anticipation of the sale of the shares in Franklin's Selfserve, the benefits under the loan agreement were assigned by that company to Gwynvill Securities.
Sub-section 51(1) of the Income Tax Assessment Act 1936 (Cth) ("the Act") provides -

"(1) 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."

The question at issue is whether the payments of $69,271 and $1,500,000 are properly characterised as outgoings necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. It is not suggested that the amounts are outgoings of capital, or of a capital, private or domestic nature, or were incurred in relation to the gaining or production of exempt income. It may here be noted that no separate question arises as to the taxpayer's entitlement to a deduction in respect of the amount of $3,702 representing legal costs incurred in connection with the loan transaction. The parties are agreed that a decision on the claim in respect of that sum should follow the decision in respect of the claim to deduct the sums of $69,271 and $1,500,000.
In Magna Alloys and Research Pty. Ltd. v. Federal Commissioner of Taxation (1980) 49 FLR 183 Deane and Fisher JJ., speaking of the "second limb" of sub-s.51(1), said at p.208:

"The controlling factor is that, viewed objectively, the outgoing must, in the circumstances, be reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of the business being carried on for the purpose of earning assessable income. Provided it comes within that wide ambit, it will for the purposes of s.51(1), be necessarily incurred in carrying on that business if those responsible for carrying on the business so saw it."

The taxpayer's case concentrates upon the terms of the loan agreement. It submits that the payments were made to satisfy its legal obligation under that agreement to pay interest to Herunda upon the loan, that it obtained the loan in the course of the business it was carrying on for the purpose of gaining or producing assessable income and that the amounts expended are properly to be regarded as "incidental or relevant" to the derivation of such income. If there were no more in the case than that, the taxpayer would be entitled to the deductions claimed, subject only to the question whether the whole of the sum of $1,500,000 is properly allowable as a deduction in the year of income ended 31 July 1978 or whether it should be apportioned over five income years. But to approach the matter in this way is, in my opinion, to have regard to part only of the relevant transaction and to treat as of no consequence the other events to which reference has been made.
The primary judge was satisfied that the transaction in question was different to any which the taxpayer had previously undertaken. The most important departure, his Honour said, was that the taxpayer had not previously borrowed from outside the Franklin's Group. After referring to the purchase by the taxpayer of the Westleigh Shopping Centre and the office building at Crows Nest, his Honour said:

"The need for an outside loan was seen at the time of settlement of these purchases. The amount owing by the taxpayer to F.G. Finances and to Franklins Selfserve was such that, at the end of the financial year when that amount crystallized (as earlier outlined), either an outside loan or a substantial sale of assets by the taxpayer was seen to be desirable, in the light of the changed investment policy of the taxpayer to move away from projects associated with stores operated as Franklins Supermarkets and to move more heavily into the investment market."

In the light of the findings of the primary judge it must be accepted that in late 1977 when the taxpayer began negotiations with certain financial institutions, including Herunda, the taxpayer perceived that the funds necessary to support its property investment activities to the close of the financial year and beyond might not be available to it from its traditional sources, namely its trading profits, the sale of assets and moneys available to it from within the Franklin's Group. In such circumstances, it could well be seen to be desirable that the funds available to the taxpayer from those sources should be supplemented by borrowing outside the Group. The question arises, however, whether what was done thereafter, when viewed objectively, is explicable in those terms.
In considering the "essential character" of the payments in question attention must be given to the following significant features of the transaction. In the first place, there is the finding that what the taxpayer was seeking was an arrangement whereby, in addition to a requirement that a substantial amount of interest be prepaid, the loan itself would be sold at a discount price. That this was part of the taxpayer's concern is shown by the inclusion by the taxpayer's solicitor in the form of loan agreement submitted to Herunda of clause 18 providing that the lender might at any time assign its benefits thereunder. One may ask why, if the taxpayer's sole interest was to obtain funds from outside the Franklin's Group, it was of any concern to it that the loan itself, after the prepayment of interest, would be sold at a discount. The only possible explanation is that it was concerned to arrange, if possible, that, after the prepayment of interest, the loan would be sold at a discount to another member of the Franklin's Group, as indeed, in fact occurred.
Secondly, there is the circumstance that a sale of the loan to a member of the Franklin's Group was raised by Mr Carnell in his discussions with Herunda and the consideration for an assignment of the loan was negotiated during the course of the negotiations for the loan itself.
Thirdly, notwithstanding the absence of any legal obligation upon Herunda to do so, the taxpayer at all times expected and anticipated that Herunda would not only require the prepayment of interest but would thereafter assign the benefits under the loan agreement to Franklin's Selfserve. The taxpayer's expectation in this regard, and indeed that of the other members of the Franklin's Group, is evident from the fact that F.G. Finances made funds amounting to $1,000,000 available to Franklin's Selfserve on the morning of 3 February 1978 at about the time the loan agreement was executed by Herunda.
Fourthly, there is the finding that the investment of the loan moneys of $2,400,000 in the short-term money market for seven days was never intended to be regarded as part of the taxpayer's ordinary course of business and was clearly intended to isolate the amount of the loan so as to assist in the claim that the expenditure of the sum of $1,500,000 was an allowable deduction.
Fifthly, by reason of the course of dealing adopted by the taxpayer and the other members of the Franklin's Group in relation to the arrangement of their financial affairs, the effect of the transaction as a whole was that F.G. Finances received, through the taxpayer, the sum of $2,400,000 (slightly adjusted to take account of other transactions occurring in the general account of the taxpayer with its bank on 10 February 1978) and financed the expenditure of the amounts of $69,271 and $1,500,000 paid to Herunda by the taxpayer and the amount of $916,729 paid to Herunda by Franklin's Selfserve.
Taking these matters into consideration, I am unable to conclude that the transaction as a whole is explicable as being appropriate to achieve the espoused business end of supplementing from an outside source the funds available to the taxpayer from its own resources and those of the Franklin's Group. Whatever else the transaction may have achieved, it did not achieve that result and was not capable of doing so. If the purpose of the taxpayer was to obtain such funds, the transaction was not apt to achieve that purpose.
In the result, I am not satisfied that the taxpayer has established that the interest payments were "necessarily incurred in carrying on a business for the purpose of gaining or producing" assessable income so as to be allowable as deductions under sub-s.51(1) of the Act. In reaching this conclusion I have accepted all the findings of primary fact made by the primary judge. I differ from him, however, as to the proper conclusion to be drawn from those primary facts.
The Commissioner's appeal in respect of the year of income ended 31 July 1978, therefore, succeeds in so far as it relates to the deductibility in that year of the amounts of $69,271, $1,500,000 and $3,702. The Commissioner also appealed against that part of the judgment in respect of that year as held that the taxpayer was not liable to pay additional tax pursuant to s.226 of the Act. That part of the Commissioner's appeal was, however, not pursued, the Commissioner agreeing to remit the amount of the penalty in full.
In these circumstances, the appropriate order in respect of the year of income ended 31 July 1978 would be to allow the Commissioner's appeal to this Court with costs, to set aside the judgment of the Supreme Court and in lieu thereof to order -

(a) that the assessment be remitted to the Commissioner to be amended by remitting the amount of the additional tax described therein as payable pursuant to s.226 of the Act;

(b) that, otherwise, the appeal to that Court be dismissed; and

(c) that the taxpayer pay the Commissioner's costs of the appeal to that Court.

The taxpayer's appeal to this Court in respect of the year of income ended 31 July 1979 should be dismissed with costs.

JUDGE3

These appeals are concerned with the question whether amounts payable as interest under a loan agreement entered into on 3rd February 1978 between Herunda Finance Corporation Pty Ltd ("Herunda") as lender and Gwynvill Properties Pty Ltd (which I shall call "the respondent") as borrower were in whole or in part allowable deductions of the respondent for the purpose of the Income Tax Assessment Act 1936 in the respondent's year of income which ended 31st July 1978 or in the immediately following year of income.

The circumstances giving rise to the question may be stated relatively shortly and it is convenient to commence with the terms of the loan agreement as to payment of principal and interest.
By cl.2 the loan agreement provided that the principal, a sum of $2,400,000 which had been advanced on the date of the loan agreement, was to be repaid on 31st January 2003 or such earlier date in that month as might be nominated by the lender, the date on which it was to be repaid being described in the loan agreement as the "Maturity Date". The interest payable on the loan was at the rate of 12 1/4 percent per annum in respect of the period from the date of the loan agreement to 1st May 1978 and at the rate of 12 1/2 percent per annum in respect of the period thereafter until the Maturity Date. Interest in respect of the period until 31st May 1978 was payable on the date of the agreement and it was in fact so paid, the amount paid being $69,271. The interest payable in respect of the period after 1st May 1978 was payable quarterly in advance, but cl.7 of the agreement conferred on the lender a power to require that so much of that interest as related to the period 1st May 1978 to 1st May 1983 be paid at a time before 1st May 1978. If that power were exercised and the interest in respect of that period paid in accordance with that requirement, the rate of interest payable in respect of the period 1st May 1983 to the Maturity Date reduced to 7 3/4 percent per annum.
As I have said the loan agreement was entered into on 3rd February 1978. On the following Monday (6th February 1978) Herunda gave notice requiring that the interest for the five year period to 1st May 1983 (an amount of $1,500,000) be paid, and on the same day that notice was complied with by the payment by the respondent to Herunda of $1,500,000.
It should be noted at this point that the loan agreement, by cl.18, provided that the lender might at any time assign all "or any part" of its rights thereunder and on 6th February 1978 Herunda offered to assign all its benefits under the agreement to Franklins Selfserve Pty Limited (a company associated with the respondent) for $916,729. Franklins Selfserve Pty Limited accepted that offer, paying that sum to Herunda on the same day.
As the primary Judge noted it was conceded that:-

"... notwithstanding the absence of any legal obligation upon Herunda to do so, the taypayer at all times expected and anticipated that Herunda would in fact decide to give the notice requiring prepayment of interest relevant to the period of five years and that Herunda would also in fact thereafter assign its benefits under the loan to Franklins Selfserve."

In its income tax return for the year ended 31st July 1978 the respondent claimed as allowable deductions both the $69,271 and the $1,500,000. In respect of the year ended 31st July 1979 the respondent claimed as an allowable deduction $300,000 being one fifth of the interest for the five year period to 1st May 1983. These claims were disallowed by the Commissioner, as was a claim for legal expenses in respect of the loan. Additional tax pursuant to s.226(2) of the Act became payable and the Commissioner declined to remit it.
The respondent appealed to the Supreme Court of New South Wales against the decisions of the Commissioner to which I have referred and the primray Judge held that both the $69,271 and the $1,500,000 were allowable deductions in respect of the year ended 31st July 1978. He also allowed the appeal in respect of legal expenses and in respect of the additional tax.
The Commissioner has appealed to the Court against the decisions of the Supreme Court to which I have referred and the respondent has also appealed against the primary Judge's decision that no part of the total of $1,569,271 was an allowable deduction in the year ended 31st July 1979, a decision which was, of course, a consequence of his finding that those sums were allowable deductions in respect of the preceding year.
It is thus convenient to turn first to the Commissioner's contentions in his appeal in respect of the year ended 31st July 1978. Those contentions, stated in broad outline, are three. First it is contended that on the true interpretation of s.51(1) of the Income Tax Assessment Act neither the payment of $1,500,000 nor the payment of $69,271 is an allowable deduction. Secondly it is contended that the transactions to which I have referred were transactions attracting the operation of s.260 of that Act. Thirdly the doctrine of "fiscal nullity" is relied on.
The second and third submissions were not argued before us, the Commissioner advancing them for the purpose of preserving his position if the matter should go to the High Court. It is thus unnecessary for us to deal with those submissions and accordingly I turn immediately to s.51(1), which provides relevantly that:-

"(1) 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 ... nature..."

The decisions on s.51(1) recognize that interest on borrowed money may be an allowable deduction under either limb of s.51(1). See Texas Co. (Australasia) Ltd v. Federal Commissioner of Taxation (1940) 63 CLR 382 at 468, Federal Commissioner of Taxation v. Total Holdings (Australia) Pty Ltd (1979) 24 ALR 401 at 406, Ure v. Federal Commissioner of Taxation (1981) 34 ALR 237 and Federal Commissioner of Taxation v. Ilbery (1981) 38 ALR 172 at 180. In this case it is the second limb of s.51(1) which is primarily, though not exclusively, relied on by the respondent.
As Deane and Fisher JJ. said in Magna Alloys and Research Pty Ltd v. Federal Commissioner of Taxation (1980) 49 FLR 183 at 205 the requirement of s.51(1) that an outgoing claimed as a deduction be "necessarily" incurred in carrying on the relevant business:-

"does not, in the context, mean that the outgoing must be either "unavoidable" or "essentially necessary". Nor does the word "necessarily" import a requisite of logical necessity. What is required is that the relevant expenditure be appropriate and adapted for the ends of the business carried on for the purpose of earning assessable income (see, Ronpibon Tin N.L. v. Federal Commissioner of Taxation; Federal Commissioner of Taxation v. Snowden & Willson Pty. Ltd.). For practical purposes and within the limits of reasonable human conduct, it is for the man who is carrying on the business to be the judge of what outgoings are necessarily to be incurred (Federal Commissioner of Taxation v. Snowden & Willson Pty. Ltd.). It is no part of the function of the Act or of those who administer it to dictate to taxpayers in what business they shall engage or how to run their business profitably or economically."

(See too Federal Commissioner of Taxation v. Total Holdings (Australia) Pty Ltd (supra) at 405.)

The passage which I have just quoted deals with the degree of "essentiality" required by the use of the term "necessarily" in the second limb of s.51(1). What it and other cases recognize also, however, is that there should be some objectively discernible relationship between the expenditure incurred and the carrying on of the business in question. See Magna Alloys and Research Pty Ltd v. Federal Commissioner of Taxation (supra), where Deane and Fisher JJ. (at 208) stated the requirement as being that:-

"The controlling factor is that, viewed objectively, the outgoing must, in the circumstances, be reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of the business being carried on for the purpose of earning assessable income. Provided it comes within that wide ambit, it will, for the purposes of s.51(1), be necessarily incurred in carrying on that business if those responsible for carrying on the business so saw it."

In order to deal with the first requirement so referred to it is necessary to go to the material before the primary Judge. His Honour found that the respondent had carried on business as an investor, property owner and developer, and as a share trader during the year ended 31st July 1978 and in preceding years but that in early 1977 it adopted a policy that in the future it would increase its investment in real estate with a view to obtaining growth in rents, and in pursuance of that policy acquired a number of properties in the year ended 31st July 1978. Included amongst those properties were the Westleigh Shopping Centre, acquired on 9th August 1977 for $1,134,513, and an office building at Crows Nest acquired on 1st September 1977 for $879,470. Properties at Brighton and Caringbah were purchased in October and December 1977 for $72,210 and $340,798 respectively and a further property at Caringbah was purchased in June 1978 for $131,915.
Until the time of the loan agreement earlier referred to the respondent had not borrowed from outside the Franklins group and, as the primary Judge said:-

"Its principal lender had been Franklins Selfserve. It had also used funds supplied by F.G. Finances. In relation to both of those companies, the financial arrangement was that the taxpayer paid a commercial rate of interest to the lender based upon the balance owing at the commencement of each financial year, it being agreed that the amount of such interest would not exceed the nett income of the taxpayer, and that the interest would be paid before the end of that financial year."

The primary Judge also said in relation to the loan from Herunda:-

"The amount owing by the taxpayer to F.G. Finances and to Franklins Selfserve was such that, at the end of the financial year when that amount crystallized (as earlier outlined), either an outside loan or a substantial sale of assets by the taxpayer was seen to be desirable, in the light of the changed investment policy of the taxpayer to move away from projects associated with stores operated as Franklins Supermarkets and to move more heavily into the investment market."

Assuming those findings, there are yet, however, considerable difficulties in regarding the payment of the total amount of $1,569,271 as satisfying the first part of the test stated by Deane and Fisher JJ. in the passage from Magna Alloys and Research Pty Ltd v. Federal Commissioner of Taxation (supra) at 208 to which I have referred.
In this regard I accept, as did counsel for the Commissioner and the primary Judge, that the loan agreement and the payments made thereunder were not shams. Further, cases such as Mullens v. Federal Commissioner of Taxation (1975-76) 135 CLR 290 at 301 make it apparent that in some - no doubt in many - contexts under the Income Tax Assessment Act it is inappropriate to take into account that the same economic result might have been achieved for the taxpayer if he had adopted different, or simpler, means but means which resulted in a different liability to taxation. Having said that, however, there seems no reason why the economic results achieved by the transactions may not be examined in order to cast some light on whether the outgoings by way of interest were capable of being regarded as desirable or appropriate from the point of view of the business ends of the respondent's business as a property owner, developer etc.
In this regard the result of the transactions to which I have so far referred was that the respondent had received $2,400,000 from Herunda by way of loan. It did not have the $2,400,000 immediately available to it to invest in property or elsewhere for at the time of receiving that $2,400,000 it immediately paid $69,271 to the lender and on the next business day paid a further $1,500,000 for interest in respect of the next five year period.
It is no doubt true to say that for some purposes (compare Baystone Investments Pty Ltd v. Commissioner of Stamp Duties (1978) 1 NSWLR 441) the amount of the loan should be treated as being $2,400,000 and not as being that sum reduced by the pre-payments of interest. Again, it is true to say that the respondent made the pre-payments of interest from money which it had kept separate from the $2,400,000. Neither of these matters, however, requires one to regard the amount actually available to the respondent in consequence of the "outside loan" as being $2,400,000 when in fact the nett amount immediately available as the "outside loan" was $830,729, i.e. the $2,400,000 reduced by the payments of $69,271 and $1,500,000. When one adds to that the fact that on the first business day after the making of the loan, the "outside" lender, Hereunda, assigned its right under the loan agreement to a company associated with the respondent, and which had been one of the usual "non-outside" lenders to it, one is left with the clear impression that the payment of interest is not "in the circumstances reasonably capable of being seen as desirable or appropriate from the point of view of the business ends of the business". Rather the outgoings appear reasonably capable only of being seen as an attempt to obtain a large tax deduction for the borrower in the year ended 31st July 1978 at a nett cost to the group of some $86,000 odd.
In these circumstances I am of the view that the whole of the payments of $69,271 and $1,500,000 did not satisfy the requirements of the second limb of s.51(1). Nor in my view could they be regarded as being in toto "losses and outgoings ... incurred in gaining or producing the assessable income" in terms of the first limb of s.51(1). The outgoings in toto were simply incurred in seeking to gain an allowable deduction. Compare Federal Commissioner of Taxation v. Ilbery (supra) at 181.
It is necessary in this case, however, to answer a question which it was not necessary for the Court to decide in Federal Commissioner of Taxation v. Ilbery (supra), namely whether the $1,569,271 is in part an allowable deduction.
S.51(1), by its use of the words "to the extent to which" in the two places in which they appear in the provision, places two limitations on the circumstances in which losses and outgoings will be allowable deductions. First, the loss or outgoing will only be an allowable deduction to the extent to which it is incurred in gaining or producing the assessable income or is necessarily incurred in carrying on a business for the purpose of gaining or producing such income. Secondly such a loss or outgoing will not be an allowable deduction to the extent to which it is a loss or outgoing of capital, or of a capital, private or domestic nature, or was incurred in relation to the gaining or production of exempt income. Ure v. Federal Commissioner of Taxation (supra) is an instance of an apportionment of an outgoing required by s.51(1).
On one view the $69,271 and an appropriate part of the interest payable under the loan agreement for the period 1st May 1978 - 31st July 1978 should be allowed as deductions in the year ended 31st July 1978 and $300,000 should be an allowable deduction in respect of the succeeding year. For the reasons which I have given earlier, however, I regard the whole of the outgoings by way of interest as designed simply to obtain an allowable deduction and not as being within either limb of s.51(1). There is thus not, in my view, any room for an apportionment and I am of the opinion that the Commissioner's appeal should succeed in respect of the sums of $69,271 and $1,500,000.
The parties were agreed before the primary Judge and before us that the respondent's claim for legal expenses concerning the loan stood or fell with the success or failure of the claim to deduct the two amounts, and the Commissioner's appeal should succeed in respect of those sums also.
The Commissioner did not pursue before us his appeal on the question of additional tax, no doubt for the reasons referred to by the primary Judge in the last two paragraphs of his Reasons for Judgment.
It follows from the reasons set out above that the respondent's appeal should also fail.
In my view, the appeals should be dealt with in the manner proposed by Neaves J.

[1986] FCA 349

18 AUGUST 1986