Cusack and Commissioner of Taxation
[2003] AATA 294
•28 March 2003
Administrative
Appeals
Tribunal
DECISION AND REASONS FOR DECISION [2003] AATA 294
ADMINISTRATIVE APPEALS TRIBUNAL )
) No QT2001/327
TAXATION APPEALS DIVISION ) Re PATRICK LEO CUSACK Applicant
And
COMMISSIONER OF TAXATION
Respondent
DECISION
Tribunal Mr B McCabe, Member Date28 March 2003
PlaceBrisbane
Decision The Tribunal affirms the decision under review.
.
(Sgd) B J McCabe
Member
CATCHWORDS
TAXATION – income tax – deductions – whether interest on business debts can be claimed as an allowable deduction
Income Tax Assessment Act 1936 s 51
Taxation Administration Act 1953 s 14ZZK
Income Tax Assessment Act 1997
McCormack v Federal Commissioner of Taxation (1979) 79 ATC 4111
North Australian Pastoral Co Ltd v Federal Commissioner of Taxation (1946) 71 CLR 623 Federal Commissioner of Taxation v Total Holdings (Aust) Pty Ltd (1979) 9 ATR 885
New Zealand Flax Investments Ltd v Federal Commissioner of Taxation (1938) 61 CLR 179Commonwealth Aluminium Corporation Limited v Federal Commissioner of Taxation (1977) 77 ATC 4151
Federal Commissioner of Taxation v Australian Guarantee Corporation Ltd (1984) 2 FCR 483
REASONS FOR DECISION
28 March 2003 Mr B McCabe, Member Introduction
1. The applicant, Patrick Cusack, disputes the Commissioner’s assessment relating to the year of income ending 30 June 1993. The applicant seeks a deduction under section 51(1) of the Income Tax Assessment Act 1936 (ITAA36) in respect of $125,585 interest he paid on business debts. The Commissioner says the deduction is not available.
The Material Before the Tribunal
2. The Tribunal was provided with the documents required under section 37 of the Administrative Appeals Tribunal Act 1975. Mr Cusack gave evidence. Mr Cusack’s accountants provided some additional material (financial accounts and an invoice) after the hearing under cover of a letter dated 14 November 2002. The respondents were given time to respond to the new material. The applicant was represented at the hearing by Mr McIntosh, while the respondent was represented by Mr Aftanas.
The Applicant’s Burden
3. Mr Aftanas noted in his submissions that the applicant was obliged to produce evidence that suggested the Commissioner’s assessment was excessive, or that it was otherwise inappropriate: section 14ZZK of the Taxation Administration Act 1953.
The Facts
4. Mr Cusack was employed by the University of Queensland as a professional officer prior to 1987. He gave evidence that from time to time he would become aware of inventors and others who approached the university for technical advice and assistance in relation to business ventures. On one occasion, Armand “Bill” Delaunois sought advice in relation to a rigid towing device that was designed to replace the conventional devices used to tow vehicles. The device was telescopic, so it was portable. At Mr Delaunois’ request, the applicant researched data on traffic accidents involving the ordinary kind of towing device.
5. The applicant became more interested in the device and he was engaged to carry out further testing and research, and to seek the approval of traffic authorities. He entered into an employment agreement with an entity called Teletow on 15 September 1987 to be a manager. The agreement, found at page 19 of the T documents, was signed by Mr Cusack and (it appears) Mr Delaunois, whose signature appears under the note “Signed by the Directors for Teletow”. The Tribunal was not provided with any other evidence that a company by that name was in existence at the time of the agreement. The business name “Teletow” was registered in the name of Delaunois and another man named Graeme Hodgson who also leased factory premises in Coopers Plains. Hodgson apparently worked for ANZ Bank. The applicant’s affidavit filed in winding up proceedings in the Supreme Court said Delaunois and Hodgson had contemplated going into business together but the business did not get off the ground. (The affidavit is included in the T documents at pages 134 to145).
6. The applicant began to discuss the possibility of a commercial arrangement with Delaunois at about this time. Delaunois apparently had a number of ideas for new products, including smoke and security alarms and a product called “Easydrink” that was designed to prevent insects getting into drinks. Delaunois apparently presented himself as a businessman with considerable commercial expertise who needed someone with technical ability to test and devise the products. The applicant, who admitted he was inexperienced in the commercial world, thought he could supply the technical expertise. Delaunois agreed and the parities signed a formal agreement dated 23 September 1987 setting out the terms of the relationship. The document is found at T6, pages129 to130.
7. The agreement purported to give Mr Cusack a half share in companies set up to exploit various ideas, including Teletow. Mr Cusack agreed to pay Delaunois $30,000 for the opportunity. The document also records an agreement to establish a new holding company that would control all of the companies that were established to pursue the individual ventures. The parties agreed they would refer any future business plans or opportunities to the holding company. The agreement also contains an agreement by Delaunois to indemnify Cusack against any debts incurred by any of the new companies. The agreement was apparently drawn up by Mr Cusack. In any event, the applicant says the parties did not obtain any legal advice about the form of the agreement. It was apparent from his evidence that the applicant had an uncertain grasp of legal concepts like companies and partnerships, and he acknowledged he used the terms loosely in the document.
8. A company called Telescopic Towbars Pty Ltd was registered on 10 November 1987. The applicant and Delaunois took one share each and became directors. The applicant says Delaunois did not want the company to have a role in the business. The applicant says Delaunois insisted that a partnership was the better way to proceed. In his affidavit in the winding up proceedings dated 14 April 1988, the applicant suggested (at paragraph 15) the new company was “a partnership under the guise of the company”.. A second company was registered on 4 February 1988. The second company was called Security Alarm Systems (Qld) Pty Ltd. Mr Cusack and Delaunois did not get around to establishing the holding company or the other companies referred to in the agreement dated 23 September 1987.
9. On 15 November 1987, the applicant entered into an employment agreement with Telescopic Towbars Pty Ltd. Soon after he started working in the new venture, the business got into trouble. The business was unable to pay rent on the leased premises it took over from Delaunois and his former associate. The business also had difficulties with its bankers, and ran up an overdraft. The applicant had already paid Delaunois $30,000 for a share in the business. That payment was apparently made out of a $50,000 loan from Westpac made on 18 September 1987. Mr Cusack started to borrow against the value of his home and to guarantee the company’s borrowings. He says the money was intended to provide working capital. The T documents (at pages 58 to 60) include three letters from ANZ Bank confirming:
§A fully drawn advance to Mr Cusack in the amount of $46,400 dated 24 November 1987. The advance was guaranteed by Mr Cusack and his wife and supported by a mortgage over the family home. Mr Cusack says $30,000 of that amount was used by the bank to reduce the overdraft of the business without his agreement – he originally intended to use the money for working capital. The balance was used to purchase a share in a family property from by his brother.
§A fully drawn advance to Mr and Mrs Cusack in the amount of $32,000 dated 30 November 1987. The advance was guaranteed by Mr and Mrs Cusack and supported by a mortgage over the family home. The money was used to pay out the debt to Westpac that had been incurred to buy the shares, and to pay out a mortgage over the family home;
§A fully drawn advance to Mr Cusack and Mr Delaunois in the amount of $10,000 dated 24 November 1987. The bank held the mortgage over the applicant’s home as security. The money was used to purchase two motor vehicles that Mr Cusack says were used for business purposes.
10. Mr Cusack’s accountant under cover of a letter to the Tribunal dated 7 August 2001 (in the T documents at page 10ff) suggested the arrangements with the bank were overseen by Delaunois’s former associate, Graeme Hodgson. I note that the signatory to the letters from the Bank was “R.G. Hodgson”. I was unable to draw any conclusions as to the significance of Mr Hodgson’s involvement, if any.
11. The applicant also entered into an agreement with his brother, Denis Cusack. Denis agreed to become an employee of the new business in return for an investment of $30,000. The document, which is headed “Investment and Employment contract”, was also drafted without the benefit of legal advice. The employment relationship was short-lived because the business could not afford to pay Denis. Relations between the brothers broke down.
12. The relationship between Delaunois and the applicant was also deteriorating. The applicant decided to buy out Delaunois. He entered into an agreement to sell Delaunois a share in the family property the applicant owned as tenant in common with, amongst others, his brother Denis. Delaunois agreed to transfer his shares in the two companies to the applicant. It appears those agreements never took effect. It seems the applicant had not been able to secure the share he wanted to sell from his brother. In any event, the applicant applied to wind up Telescopic Towbars Pty Ltd and liquidators were appointed on 20 April 1988.
13. The liquidator sold up the small amount of stock and other assets. Unsecured creditors claimed to be owed $51,442.54. The bank claimed it was owed considerably more. In a letter from its solicitors included in the T documents at page 57, the bank said the applicant was liable to pay $313,219.86, of which $66,810.10 was in respect of legal fees and other costs. The applicant’s house was sold at a mortgagee sale and the proceeds were applied in reduction of the amount outstanding. The sale occurred in 1993. The applicant says $125,585.24 of the final amount was interest. It was paid in one instalment following the mortgagee’s sale, although it had been accruing since 1987.
The Issues in Dispute
14. The applicant says interest he paid on the money borrowed to fund the Teletow business should be deductible in the year of income ending 30 June 1993, since that was the year in which the money was repaid to the bank. In the objection decision, the respondent took the view:
(a)He was not satisfied the borrowed money (apart from the Westpac advance that funded the purchase of the share in the business) was used to purchase income producing assets, or expended in the course of income producing activity.
(b)Even if the interest is deductible, it is only deductible in the year of income it was incurred, not in the years of income it was paid.
15. The Commissioner has also disputed whether the fees and charges that formed part of the amount paid to ANZ were properly deductible.
16. It was clear from the evidence that at least part of the monies advanced by ANZ were not paid into the business at all. Some of the money was used to pay out the Westpac loan and discharge the mortgage, for example. Some of it was borrowed to fund the purchase of an interest in the family property, although I note the transaction was apparently connected with the applicant’s attempts to buy out his co-venturer. It was ultimately difficult to tell precisely how much was paid into the business, and for what purpose. I also note from the liquidator’s report at page 16 of the T documents that a substantial amount of money paid into the business was paid out to the co-venturers. That money was not used in connection with any business purpose.
17. It is difficult in all the circumstances to establish a nexus between the expenditure of all the money by the business (and the resultant liability to pay interest) and the earning of assessable income as required under section 51(1). Establishing a nexus is the taxpayer’s responsibility: see McCormack v Federal Commissioner of Taxation(1979) 79 ATC 4111 at 4121. The taxpayer has therefore failed to discharge the onus of proof he bears under section 14ZZK.
18. It is appropriate to consider the taxpayer’s business arrangements since so much of the evidence was directed to establishing, or disproving, that the applicant carried on business through the medium of a partnership. Mr Aftanas argued in his oral submissions that the evidence showed the business was carried on through a company. He said the decision to lend money to the company or to pay its debts did not amount to expenditure “incurred in gaining or producing…assessable income”: section 51(1) of ITAA36. It was the company’s business, and the company’s income. He relied on the decision of Dixon J in North Australian Pastoral Co Ltd v Federal Commissioner of Taxation(1946) 71 CLR 623 at 635.
19. There was some argument over the effect of the decision of the Full Federal Court in Federal Commissioner of Taxation v Total Holdings (Aust) Pty Ltd (1979) 9 ATR 885. In that case a holding company borrowed money and on-lent it to a subsidiary without charging interest. The Court allowed a deduction in respect of the holding company’s liability to pay interest. Lockhart J, with whom the other judges agreed, emphasised that the holding company’s decision to loan money to the subsidiary was part of its business as a holding company. Even though the loan was made on an interest-free basis, the loan could be recalled and interest charged at any time. That is different to the situation in which an individual taxpayer loans money to a family company, or pays its debts, out of his or her own pocket. He or she is not carrying on a business of holding shares in the same way as a holding company.
20. The applicant says he was carrying on the business as a partner. He says the establishment of the company was irrelevant because it did nothing. He says the reference to setting up companies in the original agreement between he and Delaunois was the product of his misunderstanding of company law and the concept of the separate legal person. He adds that references in his affidavit filed in the winding up proceedings to the role of the Telescopic Towbars Pty Ltd should not be given any weight as the document was drafted by his lawyers and did not necessarily reflect his confused understanding of the law.
21. The liquidator of the company took the view that the Teletow business was carried on by the company. The company clearly incurred debts in its own name, including phone bills, which suggest trading activity. I also note the applicant accepted employment from the company on 15 November 1987. That is all inconsistent with the applicant’s account of the company being sidelined, or being little more than a shell.
22. The applicant’s insistence that he entered into a partnership counts for little since he clearly did not understand the nature of a partnership and how it was distinguished from a company. The evidence points to the company as being the entity that carried on the business pursuant to what was, in effect, a pre-incorporation contract dated 23 September 1987. I accept the applicant probably took the view he was participating in a partnership because of his misapprehension as to the effect of the agreement and the introduction of the corporate structure. That is often the way with small businesses, particularly where the participants are inexperienced.
23. For the sake of completeness, I will deal with the second and third issues referred to in the objection decision although I have already concluded the deductions were properly disallowed.
24. If the interest paid on the loans was deductible, what is the correct timing of the deduction? The applicant says the full amount of the interest was deductible in the year of income in question because that is when it was paid. The Commissioner says the interest liability should have been deducted each year in which it was accrued.
25. Section 51(1) refers to losses and outgoings being “incurred”. The courts have resisted defining the word “incurred”: see New Zealand Flax Investments Ltd v Federal Commissioner of Taxation (1938) 61 CLR 179 at 207 per Dixon J. But it seems clear the outgoing may be incurred before it is actually paid if the liability to pay has arisen at that earlier point: see Commonwealth Aluminium Corporation Limited v Federal Commissioner of Taxation (1977) 77 ATC 4151 at pages 4160 to 4161 per Newton J; see also Federal Commissioner of Taxation v Australian Guarantee Corporation Ltd (1984) 2 FCR 483.
26. In this case it appears the liability to pay interest first arose when the money was borrowed, and it seems the terms of the loan agreements provided for the imposition of interest charges on a periodic basis. The fact that the whole amount was paid as a lump sum following the mortgagee’s sale does not mean the outgoing was incurred at that point. A deduction should only be permitted in respect of the amount of interest liability that accrued in each year of income.
27. The final question is whether the payments made to the bank in 1993 in respect of legal and other expenses apart from interest should be deductible even if the interest payments were properly allowed as deductions. The law on this point was set out in section 67A of ITAA36, although that section has now been replaced by sections 25 to 30 of the Income Tax Assessment Act 1997 (ITAA97). The legislation says the taxpayer may claim a deduction in respect of the costs of discharging a mortgage.
28. The Commissioner says it is unclear from the breakdown of costs provided by the bank though its solicitors in the letter in the T documents at page 57 whether the amount of $66,810.10 was attributable to the costs of discharging the mortgage. The Commissioner says some or all of those costs arose out of the necessity to exercise the power of sale and involve the lawyers following the applicant’s default.
29. It seems likely that a part of those costs may be attributed to the cost of discharging the mortgage, which would typically include agents’ fees and other costs arising out of the sale. It would not include the legal fees arising out the loan defaults. A detailed breakdown of the lawyers’ costs would be necessary before it was possible to determine how much ought to be allowed as a deduction. In the absence of that information, the taxpayer is unable to discharge the onus of establishing the amount of the assessment was incorrect.
Conclusion
30. The objection decision under review is affirmed.
I certify that the 30 preceding paragraphs are a true copy of the reasons for the decision herein of Mr B McCabe, Member
Signed: .......................................................................................
AssociateDate of Hearing 24 September 2002
Date of Decision 28 March 2003For the Applicant Mr McIntosh
For the Respondent Mr Aftanas
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