Federal Commissioner of Taxation v Citibank Ltd
[1993] FCA 607
•06 SEPTEMBER 1993
COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA v. CITIBANK LIMITED;
CITICORP FINANCE PTY LIMITED and CITICORP WHOLESALE PTY LIMITED
Nos. G963-967 of 1992
FED No. 607
Number of pages - 17
Income Tax
(1993) 93 ATC 4691
(1993) 116 ALR 443
(1993) 26 ATR 423
(1993) 44 FCR 434
COURT
IN THE FEDERAL COURT OF AUSTRALIA
NEW SOUTH WALES DISTRICT REGISTRY
GENERAL DIVISION
JENKINSON(1), EINFELD(2) AND HILL(3) JJ
CATCHWORDS
Income Tax - Ascertainment of assessable income - Distinction between income and capital - "Finance lease" - Bailment of motor vehicle for an amount payable by instalments during period of bailment - Whole amount income.
Income Tax - objections - whether Full Court should permit taxpayer to amend grounds of objection where evidence supporting the assessment may have been adduced at first instance if grounds then amended.
Income Tax Assessment Act 1936: ss.25, 57AF, 59.
Companies (NSW) Code: s.269(8A).
Coles Myer Finance Ltd v Federal Commissioner of Taxation (1993) 93 ATC 4214; discussed.
Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation (1965) 114 CLR 314; applied.
Commercial and General Acceptance Ltd v Federal Commissioner of Taxation (1977) 137 CLR 373; applied.
Evans v Federal Commissioner of Taxation (1989) 89 ATC 4540; referred to.
Commissioner of Taxes (SA) v Executor Trustee and Agency Co of South Australia (Carden's case) (1938) 63 CLR 108; discussed.
HEARING
SYDNEY, 3 June 1993
#DATE 6:9:1993
Counsel and Solicitors for Appellant: A H Slater QC and S J McMillan
instructed by the Australian Government Solicitor
Counsel and Solicitors for Respondents: D H Bloom QC and B J Sullivan
instructed by P L Cooper
ORDER
Matter No. G963
THE COURT ORDERS THAT:
1. The appeal be allowed.
2. The orders made on 11 December 1992 in the proceeding No. G203 of 1991 be set aside.
3. The appeal constituting the said proceeding be dismissed.
4. The respondent pay the appellant's costs of the said proceeding and of the appeal.
Matter No. G964
THE COURT ORDERS THAT:
1. The appeal be allowed.
2. The orders made on 11 December 1992 in the proceeding No. G204 of 1991 be set aside.
3. The appeal constituting the said proceeding be dismissed.
4. The respondent pay the appellant's costs of the said proceeding and of the appeal.
Matter No. G965
THE COURT ORDERS THAT:
1. The appeal be allowed.
2. The orders made on 11 December 1992 in the proceeding No. G205 of 1991 be set aside.
3. The appeal constituting the said proceeding be dismissed.
4. The respondent pay the appellant's costs of the said proceeding and of the appeal.
Matter No. G966
THE COURT ORDERS THAT:
1. The appeal be allowed.
2. The orders made on 11 December 1992 in the proceeding No. G206 of 1991 be set aside.
3. The appeal constituting the said proceeding be dismissed.
4. The respondent pay the appellant's costs of the said proceeding and of the appeal.
Matter No. G967
THE COURT ORDERS THAT:
1. The appeal be allowed.
2. The orders made on 11 December 1992 in the proceeding No. G207 of 1991 be set aside.
3. The appeal constituting the said proceeding be dismissed.
4. The respondent pay the appellant's costs of the said proceeding and of the appeal.
Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
JUDGE1
JENKINSON J I have had the advantage of reading the reasons for judgment of Hill J. I agree, for the reasons Hill J gives, that the gross renta ls should be treated as assessable income and depreciation should be allowed in respect of the motor vehicles the subjects of the "finance leases". I agree also that no impediment to the appellant's contending for that conclusion, or to the court's giving effect to it, is created by the appellant's calculation of taxable income without obtaining, and using in the calculation, the actual amounts of gross rentals. As the parties well understood, the calculations in fact undertaken produced the result which would have been produced if the appellant had put himself and the respondents' officers to the trouble of extracting from their records those amounts, so that they could be made the subjects of calculations. There is in this case no need to consider the questions on which Davies J on the one hand and Hill and Heerey JJ on the other expressed different opinions in Australia and New Zealand Savings Bank Ltd. v. Commissioner of Taxation (1993) 93 ATC 4370 at 4372-4375, 4392-4396.
Each appeal should be allowed and the appellant's decision on the objection in each case should be restored.
JUDGE2
EINFELD J I agree with the reasons for judgment of Hill J and the orders proposed by his Honour.
JUDGE3
HILL J The appellant, the Commissioner of Taxation of the Commonwealth of Australia ("the Commissioner"), appeals from the whole of the judgment of a judge of this Court which sets aside objection decisions of the Commissioner in relation to the respondents' income tax assessments in respect of Citibank Limited for the 1986, 1987 and 1988 income tax years, in respect of Citicorp Wholesale Pty Limited for the 1987 year and in respect of Citicorp Finance Pty Limited for the 1986 year of income.
The facts in each of the appeals are the same and, as a matter of convenience, I will, unless referring to a particular respondent, refer to the respondents collectively as "Citibank" as nothing turned upon the particular circumstances of the particular respondent. It suffices to say that Citicorp Finance Pty Limited and Citicorp Wholesale Pty Limited were, at all relevant times, wholly owned subsidiaries of Citibank Limited.
The primary business carried on by Citibank Limited was that of a trading bank. In that business it borrowed and lent money. It also, as part of its business activity, entered into what each of the parties in their statement of facts, issues and contentions chose to refer to as "financial transactions" and commonly referred to as "leasing finance arrangements". While neither of the remaining respondents carries on a business of banking, each carry on a business which at all material times involved principally the borrowing and lending of money. In the course of their businesses each of these respondents also entered into financial transactions structured as chattel leasing arrangements.
Strictly the word "leasing" as used in respect of these arrangements is a misnomer. What is involved is that Citibank purchased an item of equipment, in the present cases a car, and entered into a bailment agreement for a reward which the parties to the bailment agreement chose to refer to as "rent". This bailment agreement the parties chose to call a lease agreement. Nothing turns upon the use of the labels "lease" and "rent" and for convenience I too will use these labels, it being however clearly understood that in so doing I am referring to a bailment and the consideration payable to Citibank by the bailee for that bailment as the case may be.
In evidence was a pro-forma "lease agreement" used by Citibank in its leasing business. Under this standard lease, the lessee agreed to lease from Citibank the goods described in the agreement for the whole term of the lease and to pay a specified rental by instalments referred to in the agreement. That obligation to pay rental continued notwithstanding any defects in or damage to the goods leased. There was a specific acknowledgment that nothing in the agreement was to confer upon the lessee any right or property or interest in or to the goods of which the lessee was to be bailee only. The goods were to be maintained by the lessee and were at the lessee's risk, it being an obligation of the lease that the lessee effect insurance of the goods at his cost in the names of both the lessor and the lessee. At the end of the lease the agreement envisaged that the goods in question would be sold by Citibank for the best price it could obtain and if that were less than a figure shown in the schedule and referred to as "the residual value" the lessee was to pay to Citibank the difference. The sum of the interest payable and the residual value ensured to Citibank a calculable return on the money it outlaid to acquire the goods the subject of the leases.
The parties were in agreement that the leases were "finance leases" as that expression is used both in the Australian Accounting Standard 17 (AAS 17), prepared by the Accounting Standards Board and the Public Sector Accounting Standards Board of the Australian Accounting Research Foundation and issued by the National Council for the Institute of Chartered Accountants in Australia and the Australian Society of Accountants, and Approved Accounting Standard ASRB 1008, "Accounting for Leases", approved by the Accounting Standards Review Board for the purposes of Part VI of the Companies Code ("the Standards"). For its own internal purposes, Citibank employed the method of accounting for the revenue from leases described in the Standards.
In AAS 17 leases are required to be classified as either "operating" or "finance" leases. As that Standard indicates, that classification "depends upon economic substance". AAS17 states, relevantly:
"Where substantially all of the risks and benefits incident to ownership of the leased property effectively remain with the lessor, the lease is an operating lease. Where substantially all of these risks and benefits effectively pass to the lessee, a finance lease exists. The risks of property ownership include those associated with unsatisfactory performance, obsolescence, idle capacity, losses in realisable value and uninsured damage or condemnation of the property; the benefits include those obtainable from use of the property and gains in realisable value."
The Standards provide guidelines for the classification. AAS17 says, relevantly:
"The effective passing, from lessor to lessee, of substantially all of the risks and benefits incident to ownership could normally be assumed where the following criteria are satisfied:
(a) the lease is non-cancellable; and
(b) either of the following tests is met:
(i) the lease term is for 75 per cent or more of the useful life of the leased property; however, if the beginning of the lease term falls within the last 25 per cent of the total useful life of the leased property, including earlier years of use, this criterion would not be appropriate for purposes of classifying the lease; or,
(ii) the present value, at the beginning of the lease term, of the minimum lease payments equals or exceeds 90 per cent of the fair value of the leased property to the lessor at the inception of the lease. (The discount rate to be used in calculating the present value, is the interest rate implicit in the lease.)"
ASRB 1008 was initially notified in the Commonwealth Gazette dated 31 July 1986. A later version was gazetted on 20 November 1987 and this later version applied to the first financial year of a company ending on or after January 1988. Relevantly, however, for present purposes each of these Standards was similar to the other, and each was similar to AAS 17.
Under the Standards, finance leases are further classified into "direct financing, sales type or leveraged leases" and different accounting treatment is prescribed for each sub-category. The relevant sub-category in the present case is that referred to as "direct financing".
AAS 17 makes the following comments concerning accounting for "direct financing leases":
"65 A finance lease establishes the lessor's right to receive a series of lease payments from the lessee in return for effectively conveying to the lessee substantially all of the risks and benefits incident to ownership of the leased property. Accordingly, the lessor records an asset equal to his investment in the lease as at the beginning of the lease term and apportions minimum lease payments received over the lease term between reduction in the investment and recognition of finance revenue. 66 The lessor's investment in the lease, which is essentially in the nature of a receivable, may be recorded as the total of the present value of the minimum lease payments receivable and the present value of the unguaranteed residual value, if any, expected to accrue to the benefit of the lessor at the end of the lease term. The discount rate to be used in determining the present value is the interest rate implicit in the lease. The amount so recorded will, by definition, be equal to the fair value of the leased property at the inception of the lease. 67 The difference between the sum of the total minimum lease payments receivable and the amount of any unguaranteed residual value expected to accrue to the benefit of the lessor, and the fair value of the leased property at the inception of the lease, represents the finance revenue to be brought to account progressively over the lease term. The interest component of each lease payment can be determined on an actuarial basis by applying the interest rate implicit inn the lease to the balance of the lessor's investment in the lease at the beginning of the period covered by each payment... 68 The lessor's investment in the lease may, alternatively, be recorded on a gross basis. This approach involves recording a lease receivable as at the beginning of the lease term equal to the total minimum lease payments receivable and the amount of any unguaranteed residual value expected to accrue to the benefit of the lessor, with unearned finance revenue recorded separately. For the purposes of presentation in the balance sheet, or statement of financial position, the unearned revenue would be shown as a deduction from the lessor's gross investment in the lease. As each periodic rental falls due, the interest component thereof is transferred out of unearned revenue and into revenue for the period. The periodic rental is accounted for as a reduction of the lease receivable...".
The method of accounting adopted by Citibank was that described in para.67. It chose as well to adopt this method of accounting for income tax purposes and indeed authority so to do was to be found in a Ruling of the Commissioner (Ruling IT 2162) originating as a Head Office memorandum of 28 August 1974 to the effect that for income tax purposes finance and leasing companies would be allowed to use the same method of accounting for income from chattel leasing transactions as they used in their published accounts, that method being referred to as the "financial or actuarial method". This method was accepted in place of what the Commissioner saw as being the traditional method of accounting for the taxable income of a finance company engaged in leasing transactions, namely by bringing into account as assessable income the gross rentals and allowing, by way of deduction, depreciation and any adjustment necessary at the time of disposal of the leased property pursuant to s.59 of the Income Tax Assessment Act 1936 (as amended) ("the Act").
It must be said that prior to the introduction into the Act of s.57AF, while the two methods of accounting for taxable income created differences of timing, over the full term of the lease, and taking into account any loss on disposal of the leased property, each produced in total the same taxable income.
Section 57AF(2) was introduced into the Act by the Income Tax Assessment Amendment Act (No 2) 1980. It is unnecessary to consider in detail the terms of the section. Suffice it to say that it provided a monetary ceiling upon the figure to be used as the cost of cars for the purposes of calculating the depreciation allowable to a taxpayer on those cars. That initial ceiling was $18,000 indexed for inflation thereafter. The clear object of the section was to reduce the amount of depreciation allowable in respect of what were regarded as luxury cars costing more than the ceiling figure. At the same time s.59 of the Act was amended to ensure, relevant to present purposes, that when an item of depreciable property, being a car to which the provisions of s.57AF applied, was sold, a taxpayer, instead of being entitled to a deduction for the difference between the depreciable value and the consideration received on the sale of the item, became entitled to a reduced deduction which took into account the motor vehicle depreciation limit.
It will be apparent that a consequence of s.57AF being inserted into the Act was that the competing methods of accounting for taxable income no longer produced over the term of the lease the same result (at least if the Commissioner's view that s.59 provided an exclusive code for the deduction of the loss on sale of the leased item be accepted: cf Australia and New Zealand Banking Group Limited v Federal Commissioner of Taxation No 2 (1993) 93 ATC 4238 per Sweeney J, an appeal from which decision is presently pending in the Court). Accordingly in a further Ruling (Ruling IT 2105) the Commissioner indicated that he would continue to accept returns being furnished on a basis using the finance or actuarial method of calculating taxable income save that he required an adjustment to be made to reflect the depreciation limit. That adjustment, which involved the use of a formula, effectively equated the financial or actuarial basis of calculation with the method which commenced with gross rental received and deducted therefrom depreciation. Indeed calculations made by Citibank between the time the assessment was made and the Commissioner's decision on the objection demonstrate that the two methods produce the same overall result provided no account is taken of that part of the loss disallowed by virtue of s.59(6), the subject of the Australia and New Zealand Banking Group Limited (No 2) case.
The assessments objected to and ultimately the subject of the present appeals were all made by taking the taxable income as returned by Citibank and adding thereto an adjustment on the basis of the formula. The description of what was done, as set out in the various adjustment sheets that accompanied the assessments, was not always uniform but neither of the parties were under any doubt at all as to what was being done. In essence the Commissioner increased the taxable income of Citibank by a figure which resulted in the same ultimate taxable income figure as would have been brought about had Citibank returned its rentals from the finance leases as gross income and deducted therefrom depreciation as limited by s.59(6).
To these assessments Citibank objected. In some cases more than one objection was lodged in respect of the same assessment, each within the time permitted. Nothing however turns upon this. The objections were disallowed and Citibank duly requested that the objection decisions be referred to this Court.
At first instance there was no dispute as to the issue tendered for decision. It was whether, as Citibank contended, the proper method of accounting was the financial or actuarial method or whether, as the Commissioner contended, the proper method of accounting required the determination first of the gross rents and the deduction therefrom of an amount for depreciation, to which amount the provisions of s.57AF applied. There was no disagreement between the parties as to the mathematics. It was agreed that if the Commissioner's contention was correct, the taxable income of Citibank was that reached by the application of the formula to which I have made reference. In the end result the amounts of adjustment to taxable income in dispute were as follows:
YEAR COMPANY AMOUNT INVOLVED ($) 1986 Citibank 6,471,108 1987 Citibank 16,446,588 1988 Citibank 15,001,316 1986 Citicorp Finance 1,292,131 1987 Citicorp Wholesale 873,861
At the hearing accounting evidence was adduced in the form of an affidavit sworn by Professor Walker, Professor of Accounting at the University of New South Wales, and an affidavit of a Mr Westworth, a chartered accountant. This evidence was objected to by the Commissioner but admitted into evidence over that objection. It was Professor Walker's evidence that Citibank was obliged, having regard to s.269(8A) of the Companies Code, to comply with ASRB 1008 in respect of the year of income with the consequence that it would:
"(i) treat each transaction as simply involving (as in my opinion it does) the 'financing' of the purchase of a motor vehicle by the lessee. That means that the (taxpayer) would not be regarded as having 'assets' in the form of motor vehicles, even though the (taxpayer) might, strictly speaking, retain legal title to those vehicles. Rather, the (taxpayer) would be regarded as having 'assets' in the form of amounts owing by lessees - commonly described as 'lease receivables' (but sometimes referred to as 'investments in lease'). On that basis it would not be the
(taxpayer) but the lessees which would depreciate the motor vehicle.
(ii) bring revenues from the transactions to account progressively over the term of the lease. The amounts received as periodic lease payments would be regarded as being partly repayment of the 'principal' (the moneys advanced to assist the lessee in acquiring a motor vehicle) and as partly repayments of 'interest'. The calculation of the amounts of individual instalments to be treated as repayments of principal, and the amounts which were to be treated as 'interest', would be made by reference to the (taxpayer's) implicit lending rate - ie. the effective annual interest rate which when used to calculate the present value of a stream of projected lease payments would produce a sum equal to the amount advanced to the lessee under the lease."
Mr Westworth said, relevantly:
"6. Recognition of an arrangement as a 'finance lease' under (AAS 17 and ASRB 1008) is recognition that the arrangement is, in substance, a financing transaction; that it is, in truth, a loan or money lending transaction.
7. Accordingly, the (taxpayer) should treat the arrangement as though it gave rise to a receivable for accounting purposes with no amortisation of that receivable according to equipment amortisation rules. Rather the cash received under the leasing arrangement should be applied in part to reduce the capital amount of the debt on the actuarial method and in part to be taken up as income on that method. This accounting treatment is set down by AAS 17, the accounting standard issued by the professional bodies in Australia which obtains its authority from, inter alia, APS1 entitled 'Conformity with Statements of Accounting Standards' and by ASRB 1008, the approved accounting standard set under the Companies Code."
The Commissioner in his grounds of appeal claimed that this evidence, together with accounting standards ASRB 1008 and AAS 17 and various Rulings of the Commissioner, were erroneously admitted into evidence.
So far as the Rulings are concerned it is difficult to see how they were relevant to the proceedings, except so far as they explained to the Court what the parties in any event agreed upon, namely, the basis upon which the assessments were actually made. Save so far as they may now, as a result of legislation, be relevant to the imposition of penalties in a self-assessment regime, Rulings have no legal significance. They do no more than represent the considered views of the Commissioner, one of the parties to the litigation in which they are tendered. Sometimes the Rulings are arguably wrong. Sometimes the Rulings appear to take the view that issues of law decided by courts adversely to the Commissioner may nevertheless be ignored. They undoubtedly, however, are a useful reference point for practitioners and those affected by the income tax law in ascertaining what view the Commissioner is likely to adopt in respect of a particular transaction. In the present case, and to the extent that the Rulings explain the mathematical basis upon which the assessments were made, they were not wholly irrelevant and were admissible for the sole purpose of explaining that matter. In any event I do not see that his Honour in any way afforded to the Rulings in his judgment any significance relative to the real issue in dispute so that even if his Honour may be said to have erred in admitting the Rulings, that error played no part in the ultimate result.
The accounting evidence and the evidence of the accounting standards is in a different position. As will shortly be explained, accounting evidence may be of assistance in the characterisation of a particular item as being income or capital. With respect I agree with the learned trial judge that the evidence was relevant in an adjectival sense and thus admissible, notwithstanding that the ultimate question before his Honour was one of law for the Court's determination.
The judgment appealed against
24. His Honour was of the view that the material business activity of Citibank was the provision of finance to its clients through the medium or vehicle of a leasing arrangement. His Honour accepted a submission that the leases were in truth a "financing device", borrowing that expression from the judgment of Hutley JA in Austin v United Dominions Corp Limited (1984) 2 NSWLR 612 at 614. Having regard to the unchallenged expert evidence, his Honour was of the view that Citibank was justified in treating the leasing transactions in accordance with the provisions of the relevant standards, bringing the finance revenue to account progressively over the term of the lease having regard to an actuarial determination of the interest component. In his Honour's view that interest component so determined was "income" within the meaning of s.25 of the Act. In so holding his Honour placed weight upon the accounting evidence.
It is clear that his Honour placed considerable weight upon the characterisation of the amount determined in accordance with the standards as being an "interest component". So, his Honour said:
"As Bowen CJ, Fisher and Lockhart JJ have pointed out (in Federal Commissioner of Taxation v National Commercial Banking Corporation of Australia Ltd. (1983) 50 ALR 322 at 326): 'Receipts of interest, but not receipts on account of the principal amount of a loan, are assessable income in the case of a taxpayer carrying on the business of money lending.' These observations are applicable in the present context. The relevant inquiry is to determine what, for our purposes, is the interest component."
Finally, his Honour considered whether s.57AF in some way precluded Citibank from adopting the tax accounting treatment which his Honour thought was appropriate. His Honour held that it did not, saying:
"In my view, all that can be inferred from the legislation is that the true object of s.57AF is to limit a taxpayer's claim for depreciation in certain circumstances. But where, as here, the depreciation provisions themselves have no application at all, no question of subversion or frustration of the legislative purpose can arise. In my opinion, there is nothing in the provisions of the Act which would render inappropriate the tax accounting treatment provided for in the accounting standards which were adopted by the taxpayer. It follows that s.57AF(2) has no application here."
The real question on the appeal is the same as that tendered for decision below, namely, whether the assessable income of Citibank in each year of a finance lease included the net amount, which his Honour referred to as "the interest component", being calculated in accordance with the financial or actuarial method, as contended for by Citibank, or whether the assessable income of Citibank was the gross rental which it derived in the year from which was to be deducted depreciation calculated having regard to s.57AF of the Act. That issue was stated in the written submissions of the respondents as being:
"What is the proper method for the recognition of income of each of the Respondents from the chattel leasing transactions entered into in the ordinary course of that Respondent's business as a borrower and lender of money?"
The respondents, however, raised an alternative issue which is summarised in the respondents' outline of submissions as follows:
"...the Respondents say that the Appellant cannot support his assessments by reliance upon the inclusion under s.25 of a larger amount than that assessed and allowing deductions under the depreciation provisions which have not even been claimed, let alone allowed in fact. Alternatively, if the Appellant can do this then he may be bound to allow further deductions under s.51(1) representing the loss on disposal of the vehicles. Whether he is so required to allow those further deductions is the matter to be determined by the Full Court in the appeal from the decision of Sweeney J in ANZ Banking Group Ltd v FCT (1993) 93 ATC 4238."
The alternative submission seeks to rely upon observations of mine in Evans v Federal Commissioner of Taxation (1989) 89 ATC 4540 at 4544-5.
This alternative issue is very much a side issue. I turn therefore to consider the real issue between the parties.
The tax treatment of finance leases
31. There is no doubt that accounting evidence is often relevant and indeed often highly significant in resolving issues which arise under the Act. Thus accounting evidence may be relevant in determining whether the bringing in to assessable income of cash receipts rather than amounts accrued due will give a true reflex of the income derived by a taxpayer: Commissioner of Taxes (SA) v Executor Trustee and Agency Co of South Australia (Carden's case) (1938) 63 CLR 108. Such evidence was highly significant in determining whether an amount prepaid for services represented income derived by the taxpayer at the date of receipt: Arthur Murray (NSW) Pty Ltd v Commissioner of Taxation (1965) 114 CLR 314 at 318, because the bookkeeping methods were evidence of the concept of what constituted income derived in the year of income.
While in the area of s.51(1) of the Act the courts have, as was pointed out in Coles Myer Finance Ltd v Federal Commissioner of Taxation (1993) 93 ATC 4214 at 4221, adopted a legal or jurisprudential analysis rather than a commercial view, this does not mean that accounting evidence has been seen to be irrelevant, the true position being, as Barwick CJ, Kitto and Taylor JJ said in the Arthur Murray case (at 320), speaking of the decision of the High Court in Federal Commissioner of Taxation v James Flood Pty Ltd (1953) 88 CLR 492:
"The Court there held that, while commercial and accountancy practice may assist in ascertaining the true nature and incidence of an item as a step towards determining whether the item answers the test laid down in the Act for allowable deductions, it cannot be substituted for the test."
Thus while accounting evidence shows that accrued holiday leave or long service leave should be taken up in the accounts as a liability prior to the leave itself becoming due, no deduction may be claimed under the Act for the accrued value of such leave because the ordinary liability to pay wages to the employee for holidays and long service leave was not incurred, for the purposes of s.51(1) of the Act, until the liability in fact arose: Flood's case (supra) and Nilsen Development Laboratories Pty Ltd v Federal Commissioner of Taxation (1980-1) 144 CLR 616.
Nevertheless accounting and business practice will be relevant in determining the appropriate treatment under the Act for determining the deductibility of amounts of insurance claims incurred but not reported (RACV Insurance Pty Ltd v Federal Commissioner of Taxation (1974) 74 ATC 4169; Commercial Union Assurance Company of Australia Ltd v Federal Commissioner of Taxation (1977) 77 ATC 4186). So too the issue of whether a liability is capable of reasonable estimation raised in Commonwealth Aluminium Corp Ltd v Federal Commissioner of Taxation (1977) 77 ATC 4151 at 4161 will likewise be susceptible to business and accounting evidence.
In Hooker Rex Pty Ltd v Federal Commissioner of Taxation (1988) 88 ATC 4392 accounting evidence was admitted to reinforce the conclusion that it was only proper to include a contingent liability in accounts where there was a reasonable probability of that liability maturing into an absolute indebtedness. As the Full Court pointed out in that case (at 4399):
"...the tendency of judicial decision has been to place increasing reliance upon the concepts of business and the principles and practices of commercial accountancy, not only in the ascertainment of income, but also in the ascertainment of expenditure...".
Accounting evidence may also have particular significance in determining the timing of a deduction, that is to say not whether it is incurred, but whether it is incurred in respect of a year of income. So much appeared from a short comment in the judgment of Rich J in New Zealand Flax Investments Ltd v Federal Commissioner of Taxation (1938) 61 CLR 179 (at 193) and Dixon J (at 208) as well as in the orders made by the Court. A similar approach was taken by the Full Court of this Court in Federal Commissioner of Taxation v Australian Guarantee Corporation Ltd (1984) 84 ATC 4642, per Toohey J at 4649. The judgment anticipated the test ultimately applied by the majority of the High Court in Coles Myer where the determination of how much of the loss on discounted bills and promissory notes was referable to the year of income was clearly to be resolved by adopting what the majority of the Court (Mason CJ, Brennan, Dawson, Toohey and Gaudron JJ) referred to (at 4223) as the:
"accounting straight line basis over the term of the relevant note or bill".
Accounting evidence may also assist to elucidate the meaning of a commercial expression used in the Act and thereby to aid in determining an issue of characterisation. Thus accounting evidence was relevant in determining whether cars on floor plan constituted "trading stock" (Federal Commissioner of Taxation v Suttons Motors (Chullora) Wholesale Pty Ltd (1985) 157 CLR 277) and likewise a case could be conceived where accounting evidence could be relevant in determining whether a particular item of property was "plant" for the purposes of s.54 of the Act. So too it might be relevant in determining whether a particular receipt was on capital account; cf Strick v Regent Oil Co Ltd (1966) AC 295 at 321-2 per Lord Reid. This use of accounting evidence to aid the process of characterisation was envisaged by Sir Owen Dixon as long ago as Carden's case where his Honour said (at 152):
"Income, profits and gains are conceptions of the world of affairs and particularly of business. They are conceptions which cover an almost infinite variety of activities... No single formula could be devised which would effectually reduce to the just expression of a net money sum the annual result of every kind of pursuit or activity by which the members of a community seek livelihood or wealth. But in nearly every department of enterprise and employment the course of affairs and the practice of business have developed methods of estimating or computing in terms of money the result over an interval of time produced by the operations of business, by the work of the individual, or by the use of capital."
The acceptance that concepts of business, which may be elucidated by accounting evidence, are relevant to the question of determining whether a particular item is income is inherent in the well-known passage from the judgment of Jordan CJ in Scott v Commissioner of Taxation (NSW) (1935) 3 ATD 142 at 144-5 where his Honour said:
"The word 'Income' is not a term of art, and what forms of receipt are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income, must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of receipts...".
Two questions arise out of the above survey of cases. The first is whether in the present case the accountancy evidence adduced by the respondents can be taken as evidence that in accordance with the ordinary usages and practices of businessmen, of whom accountants represent an informed sub-set, the amount obtained by applying the financial or actuarial method to the business of the respondents is income in ordinary usage. The second, which arises only if that question is answered in the affirmative, is whether the Act requires some other amount to be treated as "gross income" for the purposes of s.25(1) of the Act.
With respect to his Honour, who presumably must be taken as having decided otherwise, I do not think that the accounting evidence in the present case establishes that the amount derived each year by applying the financial or actuarial method represents income in ordinary concepts. What that evidence establishes is that the outcome of the finance or actuarial method is an appropriate figure to be used in the preparation of the profit and loss account of the respondent for the year in accordance with the Companies (NSW) Code: s.269(1). If the relevant issue were the determination of the profit of the respondents, or whether that profit was to be seen as on revenue account, the evidence would clearly be most cogent. But it must be remembered that the role of the accounting standards is in the determination of profit so as to ensure that financial statements, required to be prepared by statute, give a true and fair view and not the determination of "income", notwithstanding that those two concepts may, as will be seen, sometimes overlap. Thus Professor Walker states that he has been asked to advise as to the correct method of accounting in relation to the leases in question. But his affidavit and subsequent explanation makes it clear that he has answered that question by reference to the companies law for the purposes of which the relevant standards have been prepared and with which of course each of the respondents was obliged to comply. Mr Westworth's affidavit makes clear that he too has addressed himself to that issue, not relevant in the present proceedings.
All that may be said is that if there be no impediment in the Act to bringing into account, in a case such as the present, a net profit figure as gross income, then that profit figure will need to be calculated in accordance with the accounting standards. The real issue for decision is rather a question of construction of the Act, namely, whether in a case such as the present, the scheme of the Act precludes treating as gross income the net profit calculated in accordance with the financial or actuarial method.
It must be borne in mind that the Act ensures that tax is to be assessed and paid by reference to the "taxable income" of a taxpayer: s.166. The determination of taxable income requires there first to be ascertained the "assessable income" and then for there to be subtracted therefrom all allowable deductions: s.48. For present purposes the assessable income requires regard to be had only to s.25(1) of the Act which relevantly requires the assessable income to include in the case of a resident:
"the gross income derived directly or indirectly from all sources whether in or out of Australia".
The present case requires a determination to be made as to whether the "gross income" of the respondents comprises, as the Commissioner contends, the rentals received by the respondents or, as the respondents contend, only the profit amounts calculated in accordance with the financial or actuarial method.
There are many cases where gross income equates with net profits. Examples include the net profits of finance and banking companies: Colonial Mutual Life Assurance Society Ltd v Federal Commissioner of Taxation (1946) 73 CLR 604; The Chamber of Manufacturers Insurance Ltd v Federal Commissioner of Taxation (1984) 2 FCR 455; Federal Commissioner of Taxation v Employers' Mutual Indemnity Association Ltd (1990) 90 ATC 4787 and cases discussed therein; the profits of an investment company where the shares in question are not trading stock: London Australia Investment Company Ltd v Federal Commissioner of Taxation (1976-7) 138 CLR 106; exchange gains and losses where the moneys advanced themselves are capital: Avco Financial Services Pty Ltd v Federal Commissioner of Taxation (1982) 150 CLR 510; the sale as a business activity of property originally not purchased for the purpose of resale at a profit or as trading stock: Federal Commissioner of Taxation v Whitfords Beach Pty Ltd (1982) 150 CLR 355; and profits made as a regular incident of a taxpayer's business where plant is disposed of: Federal Commissioner of Taxation v GKN Kwikform Services Pty Ltd (1991) 91 ATC 4336; Memorex Pty Ltd v Federal Commissioner of Taxation (1987) 87 ATC 5034.
What all these cases have in common, and what indeed is a necessary requirement of bringing into assessable income a net profit, is that the gross receipts used in the calculation of net profit was itself not income in ordinary concepts. That this is a requirement for a net profit being treated as gross income emerges clearly from the judgment of Mason J, initially in Commercial and General Acceptance Ltd v Federal Commissioner of Taxation (1977) 137 CLR 373 at 382-3 and subsequently in Whitfords Beach (supra) at 371-2. In the former of these cases his Honour said:
"There is a problem in accommodating the language of s.25(1) to the notion that an amount of net profit forms part of gross income. Is the reference in the sub-section confined to the gross receipts only of the taxpayer which possess the character of income or does it also include a net amount having that character, provided that the net amount is not itself derived from gross income? The expression 'gross income' in relation to a taxpayer conveys the sense of entire income of a taxpayer. No doubt in the context of the Act that income is to be ascertained in the first instance by reference to the gross income receipts of the taxpayer, but in my view it also includes a net amount which is income according to the ordinary concepts and usage of mankind, when the net amount alone has that character, not being derived from gross receipts that are revenue receipts." (emphasis added)
The respondents' submissions can only succeed therefore if the rent derived by them from the leases is not of itself gross income. It is conceded by the respondents that only one amount can be gross income and that the Act does not permit of a choice between, alternatively, bringing into account, in a case such as the present, the rental receipts or bringing into account the net profit.
It may be conceded as the respondents submit, that characterisation of an amount as income may well in a particular case require a careful analysis of the business of the taxpayer said to derive that income: London Australia at 118. It may also be accepted that in determining whether a particular item has the character of income the question in each case will be the character of the receipt in the hands of the recipient: Hayes v Federal Commissioner of Taxation (1956) 96 CLR 47 at 55. But neither of these propositions compel the conclusion that the periodical reward received by a taxpayer, whose business is borrowing and turning funds to account by lending them or otherwise engaging in financial transactions of the present kind, will not be income. Rent received on a chattel lease by a company carrying on a business such as that carried on by the respondents is as much income in ordinary concepts as is rental from premises. If the respondents were to enter into possession of a security and rent that security out, it could not be said that the rent received by it in the course of its business was any the less income or that it should account in respect of the financial transaction of loan by reference to its net profit.
An analogy might be made to the purchase of an annuity and the receipt by the purchaser of instalments of that annuity. The argument of the respondents parallels that made to the High Court in Egerton-Warburton v Deputy Federal Commissioner of Taxation (1934) 51 CLR 568 where a taxpayer deriving an annuity sought to include only that part of the annuity receipts as represented its actual "interest". The argument was rejected. Unless the Act operated to provide to the taxpayer a deduction (and on the facts of that case it then did not), the whole of the annuity receipt was income and not only such part of it as represented the interest component. It is no answer to say, as senior counsel for the respondents said, that that case would be decided differently today.
With respect to his Honour, to point to the fact that there is an "interest component" in the gross receipts does not provide authority for the exclusion of those gross receipts from assessable income and the inclusion in their place of the net figure. The gross rental receipts are income because they represent a return from property put out to an income producing use by the respondents and have the character of periodicity. Indeed it is difficult to see how it would be possible to argue that the rental receipts had the character of capital.
Counsel for the respondents faintly submitted that if the rental proceeds were income then no deduction would be available for depreciation because in a relevant sense the cars themselves were not "plant" or other articles used by the taxpayer in gaining or producing assessable income. It was said that the so-called passive use of the respondents by making the cars the subject of bailment agreements was not sufficient. It is unnecessary to decide whether within the classical test of what constitutes "plant" contained in Yarmouth v France (1887) 19 QBD 647 at 658, the cars in question would be "plant", for they clearly would fall within the words "other articles". Further it is hard to see why it is not correct to say that a taxpayer who purchases a car and gains income from the transaction by entering into a bailment of that car for reward does not "use" the car for the purposes of gaining or producing assessable income, notwithstanding that the taxpayer never obtains possession of the car nor contemplates that it will, and notwithstanding that the bailment agreement passes to the bailee all obligations and risks in respect of the car: cf Tourapark Pty Ltd v Federal Commissioner of Taxation (1982) 149 CLR 176.
I am accordingly of the view that the proper method of accounting to be adopted in determining the taxable income of the respondents was not to treat as assessable income the profit component of each of the car leases but to treat as assessable income the gross rentals and to deduct therefrom any available allowable deductions, including depreciation.
The alternative submission
50. Counsel for the respondents by way of an alternative submission argued that what the Commissioner had done in the present case was to include a single amount in assessable income, being the difference obtained by the Commissioner's formula, so that the Commissioner was restricted, having regard to what I had said in Evans v Federal Commissioner of Taxation (1989) 89 ATC 4540 at 4544-5, to arguing the correctness of the inclusion of that amount in assessable income and could not support the assessment by saying that what should have been included as assessable income was the gross amount of the rentals and that there should then be deducted from this figure all allowable deductions to arrive at the taxable income.
There is no foundation for this submission. The correspondence and other material tendered in evidence made it clear that what the Commissioner did in adopting the formula was to produce at the end of the day a taxable income which was the same as if the gross rentals had been treated as assessable income and depreciation had been allowed as a deduction from that assessable income. The Commissioner did not start with actual figures for gross rental and calculate depreciation for two reasons. First the Commissioner was not given that information, although of course he could have obtained it had he wished. Second and more importantly, the mathematical calculation, producing as the parties both agreed, the same result, rendered it unnecessary to obtain the detailed figures which in any event could have been quite an onerous task for the taxpayer who had accounted differently for the transactions.
The comments made in Evans were of course obiter and did not arise for decision in that case. Although I repeated these comments in Australia and New Zealand Savings Bank Ltd v The Commissioner of Taxation (No 1) (unreported, 10 June 1993, Full Court) in a judgment with which Heerey J agreed (Davies J dissenting on this point) I did so in a different context, the point in issue having been accepted by the Commissioner after objection had been taken and an amended assessment had been made taking into account that acceptance. I did not need to consider in that case and do not need to consider in the present case, what the situation would have been in Australia and New Zealand Savings Bank Ltd (No 1) if the Commissioner had not initially allowed the objection.
The real point of the respondents' submission, as I understood it, was to support an argument that if the proper method of accounting was the inclusion in assessable income of the gross rentals, then as and when the vehicles leased were sold, the loss on that sale should be treated as an allowable deduction under s.51(1). The argument then continues that s.59(6) of the Act has no application to the calculation of a loss under s.51(1). It was this issue which was considered by Sweeney J at first instance in Australia and New Zealand Savings Bank Ltd (No 2) to which reference was made earlier in these reasons.
Counsel for the respondents sought leave to amend the grounds of objection to claim a deduction for such a loss. It was not in issue between the parties that the Full Court could in an appropriate case grant such leave. The present case, however, was not an appropriate case because the point was not taken at first instance in circumstances where, had it been taken, evidence might well have been admissible on the question. Indeed, in the present situation there is no evidence before the Court at all as to whether there were any sales in the three years of income in issue and if so whether such sales were made at a loss. It would be impossible for the Court to determine, or for that matter the taxpayer to show, the extent of any deduction and a fortiori therefore the extent to which the assessments made were excessive. To permit the respondents now to agitate that question would prejudice the Commissioner and in these circumstances the application was refused.
I would accordingly propose in each case the following orders.
(1) That the orders of Beaumont J be set aside.
(2) That the respondents' applications be dismissed.
(3) That the respondents pay the appellant's costs of the
appeals and of the proceedings before Beaumont J.
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