Fletcher & Ors v The Commissioner of Taxation

[1991] HCATrans 117

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IN THE HIGH COURT OF AUSTRALIA

Office of the Registry

Sydney No Sl33 of 1990

B e t w e e n -

REGINALD SYDNEY FLETCHER,
CORAL EMILY FLETCHER,

JAMES WARREN DUNLOP and

LILIAN ANN DUNLOP

Appellants

and

THE COMMISSIONER OF TAXATION

Respondent

MASON CJ
BRENNAN J
DEANE J

DAWSON J

TOOHEY J

GAUDRON J

McHUGH J

TRANSCRIPT OF PROCEEDINGS

AT CANBERRA ON WEDNESDAY, 8 MAY 1991, AT 9.47 AM

(Continued from 7/5/91)

Copyright in the High Court of Australia

Fletcher(2) 99 8/5/91

MASON CJ:  Yes Mr Jackson.

MR JACKSON:  May it please the Court, there are four matters with which I wish to deal. The first relates to a

matter that was raised yesterday concerning the

question of partnership and the identity of

interest between partners and the partnership for

taxation purposes. Could I give Your Honours a

reference to a decision of Justice Walsh in which

the position as between partners differed because

of circumstances peculiar to one partner. The

reference is to Pool & Dight v The Commissioner of

Taxation, (1971) 122 CLR 427, the particular

reference is at page 443. Your Honours, may I

simply indicate how the issue arose and what the

facts were. It was simply that a partnership was

conducted for grazing purposes, the partnership

consisting of a taxpayer, his wife and two of his

daughters. So far as the property on which the

partnership was carried on was concerned, it was

Crown leasehold in Queensland and the freeholding fee was something which was held to be a capital outgoing, though paid by the partnership, but it

was a capital outgoing so far as the only person

who had held an interest in the lease was

concerned, that was the father; he was the only

leaseholder as between himself and the Crown. It

was a capital outgoing, so far as he was concerned.

It was not a capital outgoing so far as the

partnership overall was concerned and the daughter

was entitled to deduct it, the father was not.

Your Honours, if I could move then from that to the question raised by Your Honour Justice Deane

yesterday, relating to the reference to a mirage in
the observations of Deputy President Bannon,

appearing at page 18 in the first reasons for

judgment of the tribunal.	Your Honours, could I
just say this.	The passage commences at about 18
point 2 and goes through to 18 point 7. It is

apparent if one looks at the context in which it

was made that it relates to a discussion of the

operation of section 82KL and the related

provisions. Your Honour asked me, was it elsewhere

referred to and picked up as part of the reasons of

the second tribunal - part of the findings of the

second tribunal. The answer seems to be no, but

may I give Your Honour the references which relate

to the topic. It is referred to in the first

Full Court's reasons for judgment in a passage

which commences at about 13 point 1 and

Your Honours will see the reference at about

line 23. It commences at the top of the page,

where the first Full Court says:

Mr Bannon dealt with a submission put to the

Tribunal -

Fletcher(2) 100 8/5/91

the submission is then quoted and the submission

really is the first sentence of the quoted passage

and then his observations about it go on from

there.

Your Honours, it is also referred to at

pages 36 and 37, again in the reasons for judgment

of the first Full Court and commencing at about

line 8 on page 36, it is said:

Mr Bannon dealt with the issue arising

under Subdivision Din the following manner: Then, Your Honours will see the second paragraph of

the quotation is the same paragraph as that to

which I earlier referred with the word "mirage"

appearing on the top of page 37, line 3.

Again, at page 40, Your Honours will see,

commencing at about line 11 that the court refers

to:

findings in Mr Bannon's decision which suggest

that, if he had correctly addressed the

question of the application of section 51,

Mr Bannon may have shared the view expressed

by Mr McMahon.

The reference, again, is to "mirage" at about

lines 25 and 26, but Your Honours will see at the

top of the next page it said:

However, the findings made by Mr Bannon

were made in the context of a consideration of

the question whether the transactions fell

within Part IVA -

he was not dealing with section 51. Your Honours,

that would not mean that a finding could not be

applicable to both but it is right to say that if

one looks at the second tribunal's reasons for

decision and looks at the parts of the judgment of

the first Full Court that were referred to in it,

this passage is not referred to specifically there.

Your Honours, could I move then to the third

matter with which I wish to deal and that relates

to the concluding words of section 51(1). The

submissions which we have so far made have referred

in passing to the concluding words of

section 51(1), namely, as Your Honours will see,

the words:

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

Fletcher(2) 101 8/5/91

relation to the gaining or production of

exempt income.

Your Honours, the terms of that part of

section 51(1) contemplate specifically, of course,

that there may be assessable income and there may

be losses and outgoings incurred in the gaining or
production of assessable income but that the losses
or outgoings may be of a private or of a capital or
of a domestic nature.

Could I say, Your Honour, before saying another word about it, that as has been observed

upon a number of cases, the section has a curious
aspect in the sense that it refers to losses or
outgoings incurred in relation to the gaining or
production of exempt income when, by the operation

of the various definitions of the Act, exempt

income would seem to be, ex hypothesi, not

assessable income. But, leaving that aside,

Your Honours, there is not any particular reason,

in our submission, why there cannot be something

which is a loss or outgoing falling within the

exception but which is yet a loss or outgoing

incurred in gaining or producing the assessable

income. The easiest example, of course, relates to

losses or outgoings of capital.

Could I refer Your Honours in that regard to

The Commissioner of Taxation v Hatchett,

(1971) 125 CLR 495. Your Honours, I do not think

this is on Your Honours' list but, simply, at

page 497, where there is a reference to the fact

that losses and outgoings of capital may fall

within the opening words of section 51(1) would, of

course, be excluded by reason of the later part of

it.

But could I also refer Your Honours to two

passages in the decisions to which I referred
yesterday.	The first is in Commissioner of

Taxation v Forsyth, 148 CLR 216, at about point 4,

and Your Honours will see at the bottom of page 215

and the top of page 216 there are references to

Hatchett's case and to the passage to which I was

referring a moment ago. But after that

Justice Wilson said at about point 3 on the page:

Nor, in my opinion, should it necessarily be

true of outgoings of a domestic nature.

He proceeded to say that he -

saw no reason why it would not be a proper

application of s.51 in the present case to

say -

Fletcher(2) 102 8/5/91

and Your Honours will see that he proceeds to say

that it would be an apposite application to say

that whilst it was -

an outgoing incurred in gaining or producing

the assessable income -

it was yet domestic.

Your Honours, could I also refer to Handley's case, 148 CLR 194, and a passage in Your Honour

the Chief Justice's judgment, the first new

paragraph on page 194. Your Honour agreed with

those observations leaving the question of private

nature to be dealt with in the future.

Now, Your Honours, it may well be that in most

cases, so far as expenses of a private nature are

concerned, that what would be involved is likely to

be an apportionment as distinct from there being a

removal of a deduction completely, for example.

Can I give Your Honours one example: if I were,

for the purposes of appearing in a case here, to

take a suite at a hotel, then no doubt I could

claim as a deduction the cost of that. But if I

took a suite only because I wanted to have some of

my children staying with me for them to have a

holiday, then Your Honours, it might well be

appropriate to apportion the cost of that suite

because whilst the cost was in one sense a loss or

outgoing that was incurred in gaining or producing

the assessable income which presumably one would

obtain from the occasion, at the same time part of it would be for a private nature. So, the point I

am seeking to make about that - - -

DEANE J:	The Commissioner's fees must have increased.
MR JACKSON:	Your Honour, I would not want to express a

view, apart from saying that - - -

DEANE J:	Do not go into it, I should not have said it.
MR JACKSON:	No, no, Your Honour, all I was going to say was

that one is referred more to the laws of the Medes

and Persians, in terms of their immutability over time, than to their relationship to the movements

in any ..... index however.

So that the cases are likely to result in

apportionment. Your Honours, to take another

example, I do not want to multiply examples. Again

if a businessman were to go to another city and

required to hire a car but used the car for private

purposes for part of the time, then one might say

that in respect of the hire of the car it was

something that was incurred in gaining or producing

Fletcher(2) 103 8/5/91

the assessable income because it was necessary for

him to have a car while he was there, but used some

of it for purposes of going to the zoo or art
galleries or to fill in a blank day.

Your Honours, in the present case, the finding of the tribunal was that the borrowing was for

purposes which, it is submitted, are of a private

nature, namely, the need to obtain the tax

deduction.

Your Honours, could I move then to the last

matter with which I wish to deal, and that is a

question of, what I might call shortly,

apportionment. Your Honours, I say it is the last

matter, and I will refer to one or two other

matters that I mentioned earlier that I do not

propose to say anything more about. Your Honours

will see that in Ure's case, and I propose to take

Your Honours to it briefly in just a moment, (1981)

34 ALR 247, the approach taken by the Court in that

case was to allow a deduction for so much of the

interest as was at the same rate as the on-lending.

Your Honours will recall the borrowing at various

rates, let us say 12 per cent, of money, then
on-lent at 1 per cent, and the approach taken by

the Court appears in two passages in the reasons

for judgment. The first is at page 251 in the

joint judgment of Your Honour Justice Deane and Mr

Justice Sheppard about line 11, and Your Honours will see in the paragraph commencing at line 11

that an apportionment was regarded as being

necessary and the apportionment was:

to treat the equivalent of what the taxpayer

received from re-lending -

that is the lending on at 1 per cent -

as being not of a private or domestic nature -

that is, there was a borrowing to on-lend to obtain

income from it, and the Court saw no reason for

interfering with an apportionment on that basis.

To the same effect, Your Honours, were the observations of Your Honour Justice Brennan at

page 244 in a passages which commences in the

middle of the page;

The proportion of those expenses.

Your Honours, the passage goes through the whole of that paragraph on to the top of the next page and

Your Honour, at about three-quarters of the way

down the page, agreed with the primary judge's

finding that the interest was essentially related

Fletcher(2) 104 8/5/91

to the ultimate use of the moneys for purposes

unconnected with the production of assessable

income.

Of course, the money had been borrowed so the

whole of it could be lent on.	Your Honours, we
would submit - - -

BRENNAN J:  Would you apply that case to this one,

Mr Jackson?

MR JACKSON:  I am about to do that, Your Honour. I am about

to seek to do it, perhaps I should say. Now,

Your Honours, in this case the object of the

borrowing was one which had a couple of purposes, I

suppose one would say. One was in order to pay it

out to obtain the annuity, but at the same time, the object of the borrowing was to cancel out by the need to pay interest, the amount of the

assessable income, and to obtain substantial tax

deductions in addition. Now, Your Honours, we would submit on this basis, that so far as the

assessable income - so far as the deduction of it

is concerned, the appropriate course would be to

allow a deduction of so much as would cancel out
the assessable income - and I will come to the
figures in a moment - but not to allow a deduction

of the balance.

Now, Your Honours, the situation would, on

that basis, differ in the years later than the

years which are the subject of the present appeals,

but in respect of the years the subject of the

present appeals, what one would have is a situation

where the borrowing and the payment of interest is

attributable to a number of causes, one of them

being that found to be the purpose, which we would

submit was a private purpose, of obtaining

substantial tax deductions and Your Honours, to the

extent to which that occurs, that is something

which we would submit defeats the outgoing as

falling within section 51(1).

Your Honours, the figures to which I am

referring may be seen in the appeal book at

page 44, annexure B. Your Honours will see, in

respect of 1982, that the assessable income is the

figure of $35,333 after deducting the undeducted

purchase price, but the proportional interest

is $283,000.	The balance, of course, is the loss
of $247,000.	The figure that would be allowed as a

deduction on this approach would be a figure equal

to, being a figure of, $35,333, but the balance

claimed would not be allowed, that is, the amount

which would not be allowed is the figure in

brackets beside Income/Loss.

Fletcher(2) 105 8/5/91

BRENNAN J:  Would that then - loan - run across the years

from then on?

MR JACKSON:	Yes, Your Honour.
BRENNAN J:	And, from 1992 onwards?

MR JACKSON: In 1992 onwards, Your Honour, the situation

would then be, if it were still going, that one had

assessable income which exceeded the deduction and

the issue would have gone away. What I mean by

that, is that the assessable income would be for

the $504,250.

BRENNAN J: Yes.

MR JACKSON: 

Your Honours, I had mentioned - - -

GAUDRON J: 

Mr Jackson, are you suggesting that this Court

can make that apportionment - should make that
apportionment, that that apportionment is implicit

in somebody else's decision?  I simply do not

follow.

MR JACKSON: Well, Your Honour, what I am submitting is that

we have essentially two arguments which we are

seeking to advance to the Court: the first,

Your Honour, is this, that none of the amount

claimed is an allowable deduction; the second is,

if that is wrong, then the allowable deduction is a

lesser sum, being the $34,000. Now Your Honour, we

submit there is no reason why the Court could not

form that view.

GAUDRON J: Well, I do not know why.

MR JACKSON: Well, the appeal would succeed in part only.

GAUDRON J: But there were 14 notices of objection, which

were before the tribunal, were there not?

MR JACKSON:	Yes, I think that is the number, yes.
GAUDRON J:	I have assumed that they cover more than one

year.

MR JACKSON:  Your Honour, I think, in fact, they cover the years going to 1985.

GAUDRON J: Well, the order was that the objections were

withheld or the assessment set aside by the

tribunal?

MR JACKSON: Well, Your Honour, I would have to look at the

precise form of order. What the tribunal did was

to, at page 84, affirm the decisions under review,

Fletcher(2) 106 8/5/91

that appears to be the formal decision, and then

the decision, the subject of the - - -

GAUDRON J: Well that would seem to indicate, would it not,

on what you have just said - or I am sorry, Unless

I have misunderstood you - your submissions say

that that same result would apply up until 1985?

No, you suggest otherwise, do you not?

MR JACKSON: Yes I do, Your Honour, yes. That is on our

second approach.

GAUDRON J:  And that would seem not to have been decided by

anybody. Just not to have been a decision. We are

ultimately concerned with the decision of the

tribunal, not with the assessment as such.

MR JACKSON: Well, with the decision of the Federal Court,

with respect.

GAUDRON J: Well, yes.

MR JACKSON:  And the decision of the Federal Court was that

the appeal be dismissed. That is at page 108 and

the appeal from which was being dismissed by the

Federal Court was the decision that the

Commissioner's determination be affirmed. Now the

appeal to the Court is, if Your Honour looks at

page 110, on the ground, for example, that:

The Court erred in disallowing ..... the

deduction for interest claimed.

Now, Your Honour, all that we are saying, on our

second basis, is that the result would be that the

appeal would be allowed in part in the sense that

the Commissioner would then be held to have erred

in not allowing the deduction in part.

Now, Your Honour, the consequence of that

would be that the matter would be - Your Honour,

perhaps the right order would be for the Court then
to order that the matter be remitted to the

Administrative Appeals Tribunal to work out the

exact figures. I mean, there would be no

difficulty in working out the figures, but - - -

GAUDRON J: Well, of course, because you might be giving

away an argument if we were to allow the appeal in

part and otherwise dismiss it. You would then be

precluded from your section 87KL argument, would

you not?

MR JACKSON: Perhaps Your Honour is right. If we were

correct on that point, what the Court would be

doing would be simply saying that in so far as the

Full Court of the Federal Court was of the view

Fletcher(2) 107 8/5/91

that the tribunal had not erred in its decision

under section 51 then nothing would happen; presumably the appeal to the Court would be

dismissed. It would be a question of the Court's

reasons, I suspect, in the end.

TOOHEY J: But if you have got a decision from the Court in

favour of apportionment, Mr Jackson, what would it

do to your Part IVA argument?

MR JACKSON: Well, Your Honour, we would still be in a

position where that argument remains open.

Your Honour, could I seek to indicate why? What we

would be saying - all that would have been decided,

in effect, was that the result of the transaction

was that some deduction was available under

section 51. It would then be a question whether it

was desired, in effect, to seek to apply Part IVA

to that because the only result of applying

Part IVA would be that, possibly, one would seek to

get the assessable income, the $170,000, or tax -

or get that included in the assessable income.

TOOHEY J:  But it would seem to be more satisfactory if the

court was with you on the question of apportionment

in principle to simply espouse the principle and

for the matter generally to go back to the court.

MR JACKSON: Well, Your Honour, I think I have moved from

the first position I adopted, and I think that is
what in the end I was saying. It is a question of
what the court's reasons would say. Your Honours,

those are our submissions.

DEANE J:  Mr Jackson, before you sit down could I take you

back to annexure B? Can I take you to the

income/(loss) line which, as I understand it, you see as one of the critical lines? Assume, simply for the sake of argument, that this whole matter

had arisen in 1997 and the projections in that

would not even be arguable for the Commissioner, income/(loss) line had been proved correct. It

would it, that there should be an apportionment?

When one looks at it, the outcome of the

arrangement has been favourable from the
Commissioner's point of view, in that the

assessable income in the last five years far

exceeds the deductions in the first ten years.

MR JACKSON:  Your Honour, one would have losses over a

number of years, over a period of ten years on this

assumption, and if you add together - Your Honour

will see there are, for example, very large losses

in, say, the first two years. Now, they would

cancel out if one treated dollars as not changing

in value. They would cancel out, for example - and

I am speaking broadly - the figures in, say, the

Fletcher(2) 108 8/5/91

1992 year. And, Your Honour, it may be that in

the end the number of dollars that was arrived at

in terms of what net was income as compared with

loss is higher, but one is talking about - - -

DEANE J: But vastly higher.

MR JACKSON: Well, Your Honour, it is higher. I have not

added up the figures personally, but I would accept

what Your Honour says. But one is talking about

higher tomorrow compared with lower earlier, and if

one has the advantage of the losses over a period.

DEANE J:  What my question is directed to is, I can follow

the force of your argument if we were free to look

at this and say in terms of the later years, this

is all unreal, the whole thing is a mirage, to

adopt what Mr Bannon said, but I cannot quite see

that in the light of the findings that it is not a

sham and of any further findings by the second

tribunal or to the extent it could have interpreted

findings by the Full Court. I really just do not

see how we can do that. Unless we can do that,
looking at that line there, unless my maths are

sadly astray - - -

MR JACKSON:  They have proved effective so far, Your Honour.

DEANE J: Well no, I was just looking at it. It seems to me

if one were looking at this in 1997, and as it all

happened, the reaction would be "That was a

disaster tax wise".

MR JACKSON:  Yes, Your Honour, of course, that is if it had

all happened but the probability - - -

DEANE J: But I am bringing you right back to the question

of that mirage point because, as I say, I have

trouble seeing that it is open to this Court to

proceed on that basis in this case.

MR JACKSON:  Yes, well, Your Honour, could I just say - I

will not go through what the tribunal actually

found - but Your Honour will recall that all that

happened really, in relation to the mirage part of

it, was the second tribunal did not specifically

refer to that finding and so one accepts that in

the way in which they put their findings that it was not - that finding was one that they did not

themselves make.

Having said that, Your Honour, there were

findings that they did make or did adopt. They

found, for example, that no money changed hands or,

in effect, was to change hands - I have taken

Your Honours to the reference to that - there would

always be actually the round robin of transactions.

Fletcher(2) 109 8/5/91

Also, the fact that the obligations of the borrowers were not secured obligations but also

carried with them the right to obtain a commutation

of the annuity in a period before that five years

and the probability, of course, was that that would
be done because of the taxation liability which

would accrue in circumstances where, if one looks,

as one sees from annexure A, there was likely to

be, if I can use the expression I used yesterday, a

circumstance where "the cupboard was pretty bare".

Your Honour, one also has to bear in mind the

findings in strong terms that were made that

related to that, of course, that the purpose of the

transaction was to the tax deductions obtained.

Now, Your Honour, one would think, as the

tribunal obviously thought, that no one in his

right mind would be likely to be continuing on with

the situation after the first 10 years.

DEANE J: Well, was there ever any suggestion - I mean,

looking at this one would have thought if one were

advising people who had gone into this sort of

thing, your advice would be, "Well, bring it to an

end after 1986, because after that there is just

nothing in it": was there ever any suggestion of

that in evidence, or in findings?

MR JACKSON:  Yes, Your Honour. In evidence the witnesses

were asked about that. Those propositions were put

to them and, Your Honour, the findings are those to

which I have already referred. I would need to go

through it again with Your Honour which I shall not

do unless Your Honour wants me to, but I referred

yesterday to the finqings of the tribunal in

relation to, amongst other things, the likelihood

that persons would continue. There was really no

advantage for them in doing it.

DEANE J: Thank you.

BRENNAN J:  Mr Jackson, I take it that there were findings

by the tribunal which closed the circle of the
round robin as between the annuity company and the

lender?

MR JACKSON: Yes. Well, Your Honour, yes. That appears, I

think, in the recitation or the adoption by the

tribunal of the statements by the Full Court in the

first case. Your Honour, it appears, I think, at

page 51, the second new paragraph on the page.

BRENNAN J:	Does that indicate an arrangement between the annuity company and the lender which would have the
effect in each year of closing the circle?

Fletcher(2) 110 8/5/91

MR JACKSON: Well, Your Honour, it is perhaps easier to do

it by looking at the bills, in effect, and I will

give Your Honour a reference to that in a moment, but what one sees is the bills - the short answer

is yes, Your Honour. I would accept it does. But

I am happy to go to the detail of it, if

Your Honour wants me to.

BRENNAN J: Well, is that the page at which the relevant

findings are to be found?

MR JACKSON:  Yes, Your Honour, and it goes on to page 52 as

well, and, Your Honour, paragraph 11 also on

page 68.

BRENNAN J:  Mr Jackson, where does one find the terms of any

agreement between annuity and Doowarf as distinct

from the circulation of bills of exchange?

MR JACKSON:  Your Honour, it is referred to at page 51, I

think, Your Honour, at the end of the paragraph to

which I have referred, as being in satisfaction of

an arrangement between those parties, and at

page 662 of the Federal Court appeal book -

Your Honour excuse me just a moment - the

reference I gave was to the document between the

managing partner of the annuity investments

partnership. Your Honour, I am sorry, the document

should be at page 662, I think -

BRENNAN J: Yes, that seems to be the - - -

MR JACKSON:  Yes. Your Honour, the reason why I had some

hesitation about it was that in the original books the wrong document was put in. I seem to have one

of the original books, but I understand the

document that Your Honours have - - -

BRENNAN J:  The only problem about it is that it is a

document which bears the date 30 June 1987.

MR JACKSON: It is 1982, Your Honour. It is impossible
BRENNAN J: 1982, is it? It may be in the photocopying.	I

see.

MR JACKSON:  I said I would give a reference to the bills of

exchange themselves.	They appear at page 575 and
page 576.	Now, if Your Honours see - the front

page of three bills is at page 575; the back pages

or the endorsements, appear correspondingly on the

next page, and the first one is the $2 million one

and Your Honours will see it has been drawn by

Mr Tucker, the bottom right corner. ·It is payable

on demand; it is payable to the order of the

Fletcher(2) 111 8/5/91

partnership; it is addressed to Doowarf Nominees;

it is accepted, as Your Honours will see, on the

left side by that company and then the endorsements

on the back of it, on page 576, are that Annuity

Investments partnership endorses it to Annuity

Investments, which endorses it to Doowarf Nominees.

Now, Your Honours, I said yesterday that I had

intended to make some submissions in relation to

the last paragraph of our outline of submissions and the question arising under section 66 of the

Bills of Exchange Act.	I do not propose to address
those submissions.

DEANE J:  Mr Jackson, can I ask you one final question and

that is this:  am I right that Part IVA is unlike

section 260 used to be in that it is not

self-executing?

MR JACKSON:	Yes, that is right, Your Honour.
McHUGH J:	You are not relying on the bills of exchange

point, Mr Jackson?

MR JACKSON: No, Your Honour.

MASON CJ: Yes, Mr Bloom.

MR BLOOM:  Your Honours, might I deal first with the point,

last but one, raised by my learned friend about

apportionment and say this, that if one takes the

ordinary example of what is commonly known as

negative gearing, it is a situation where one

intends that the outgoing on account of interest

shall be less than the rental to be produced and

that there shall be some capital gain to the

property which is purchased with the outlayed

funds.

Now, in determining whether the interest is

deductible, the question there, as here, is whether

the money borrowed is outlayed on some income

producing thing; and it is. The next question is whether the income is relevantly commensurate with the outgoing. Relevantly may allow one to look, I

think, as we have said in Ure's case or Ilbery's

case, at questions like best market rental

available and this might be the best market rental

that can be obtained, albeit it is far less than

the amount of the outgoing with the result that
there is a net loss in relation to that

transaction.

Negative gearing was specifically, for a

while, outlawed by specific provisions of
Subdivision G of Division 3 of Part III of the Act.

Those provisions have now been repealed in terms of

Fletcher(2) 112 8/5/91

current operation. But the point is that no one

could suggest, with respect to my learned friend, that one could reduce the amount of the allowable deduction to the amount of the assessable income

simply because of the disparity. That is really

what his submission about apportionment amounted

to. While there is a disparity, you reduce the

amount of the allowable deduction but when the

disparity works in the Commissioner's favour, you

do not.

DEANE J:  You are not saying that you could not apportion in

the case of a planned negative gearing, are you?

MR BLOOM:  A planned negative gearing, Your Honour?

DEANE J: The one you referred to; that is, when you

purchase on the basis that your income will not

equal your interest but that you are going to get

your real profit by the capital gain at the end of

it.

MR BLOOM: Subject to the assessment of the capital gain, of

course, Your Honour .. Yes, I am suggesting, with

respect, that one cannot apportion in those

circumstances; that the outgoing is - - -

DEANE J:  It may be different now in cases where capital

gain is assessable - put that aside.

MR BLOOM: Well, those specific provisions were inserted

into the Act because it was obviously felt that

section 51(1) was not there to deal with that

situation.

DEANE J: It may have been felt that - and I know what the

practice is - but it is difficult to see how you

justify that in principle.

MR BLOOM: Well, the answer is, no doubt, Your Honour, the

market rental that is being obtained as opposed to

the cost of the money borrowed.

DEANE J:  We need not take time, but it seems to me to be

quite inconsistent with the thesis underlying the

majority judgment in Ure's case.

MR BLOOM: Although one of the circumstances which was there

referred to were things like prevailing market

conditions and that sort of thing, Your Honour.

DEANE J:  You have raised it, but it is possibly a

different - - -

MR BLOOM:  It may be, and I do not need to defend that

position, but really here one looks over the entire

period at the income and sees relevantly

Fletcher(2) 113 8/5/91

commensurate assessable income, and so I do not
need really to deal with a case where the income is
not commensurate, although I hope Your Honour is

wrong.

Your Honour the Chief Justice yesterday asked

the source of a statement by the tribunal at

page 82 about the imprimatur of the Federal Court,

that is, the first Federal Court.	That appears,
Your Honour, from pages 80 to 81.	At paragraph 19
towards the bottom of page 80:

However, having concluded that the claimed

deductions were not incurred in gaining the

taxpayers' assessable income so that sec 51

does not apply, no concluded opinion on

ss 82KH-82KL is required. This view finds

ample support in the decision of the Federal

Court on appeal, where their Honours noted:

If the payments are not deductible under

section 51 that is the end of the matter.	The
taxpayers' appeals must fail.

And that, we anticipate Your Honours, was what they

were referring to.

Your Honour also asked whether there were any

other Federal Court cases in which this same??

approach had been taken, and we informed Your

Honour of one in which it had been taken and one in

which it had been argued. It has also been taken
in the tribunal in a decision of Mr McMahon which

was delivered only this week, and in which if I

might just read one paragraph from that decision,

he says:

I am bound by decisions of the Federal Court

and the High Court. I am aware that special

leave has been granted by the High Court to

appeal from the judgment of the Federal Court

in Fletcher. This, however, cannot diminish

the authority of that decision in the

meantime. I am therefore bound to take into

account purpose in characterizing the subject

payment.

And Fletcher's case is also ~eferred to in two

public rulings released by the Commissioner in

relation to deductibility, Your Honour.

Your Honour Justice Deane yesterday asked about the nature of an annuity, whether it was

income according to personal exertion or income

from property.	We gave Your Honour a reference to
Hannan.	Might I just hand to Your Honours copies

of the relevant pages of Hannan from which

Fletcher(2) 114 8/5/91

Your Honours will see that annuities are put on the

same footing as rents derived from property,

interest on money lent and dividends. It is

pages 10 to 11 of the 1946 Edition.

MASON CJ:	Thank you.
MR BLOOM:	Your Honours, questions were also raised

yesterday as to what was the procedure in the

second tribunal so far as concerned findings of

fact.

What had happened, Your Honours, is that the

first Full Court stated the facts as found by the
first tribunal and noted that there were some

matters that were found by one member and not the

other, therefore not constituting findings of fact

by the tribunal, there being no casting vote in the

deputy president.	The Mirage point was one such
matter.	It had not been adopted by Mr McMahon.

They upheld the finding that the agreements

were not shams after considerable argument on the

point, and that they had their legal effect and

found it necessary to state in sending the matter

back to the tribunal what the legal effect was of

those documents.

And it then sent the matter back to the

tribunal with the findings of fact, the statement

of legal effect of the documents and asked the

tribunal to deal with specific issues - that is
the 51(1) issue, the Part IVA issue and

section 82KL and, as Your Honour Justice McHugh

pointed out yesterday, that was the way the second

tribunal did it. It adopted those findings of fact

and applied what the Federal Court had said was the

legal effect of the documents, including the effect

which is stated at page 50 of the appeal book, of

the loan document, namely that that agreement

imposed an obligation upon the partnership to pay

interest, and therefore, it follows, of course,

that the obligation was something that was incurred

for the purpose of 51(1).

Your Honours, my learned friend reminded the

Court that a partnership is, of course, not a legal

entity, separate from its members. We do not

suggest to the contrary of that. We do not suggest that the Income Tax Assessment Act makes any change

to that position. What the Income Tax Assessment

Act does do, however, is it imposes for the purpose

of enabling assessment of partners on partnership

income, a special regime which is more an

accounting regime and is very much akin to the way

that accountants do it. It does the same, for

instance, with trusts in Division 6, and if I could

Fletcher(2) 115 8/5/91

give Your Honours a reference to a judgment of

Mr Justice Stephen of this Court in Tikva

Investments Pty Ltd v Federal Commissioner of

Taxation, 128 CLR, especially at 167 to 168, where

His Honour dealt with the nature of a partnership

for legal and calculation of its income purposes.

Might I also hand up to Your Honours a copy of

portion of the judgment of Sir Nigel Bowen in the

Federal Court in Everett's case? His Honour being the only judge in the courts to really deal with

this aspect. Your Honours, at page 627, about

line 21, he says:

Before dealing with the effect of the

assignment it is necessary to make some
observations about the nature of a partnership

share. As a partner Mr Everett had a

beneficial interest in the partnership assets.

That interest is not to be described as a

title to specific property but as a right to

his proportion of the surplus after the

realization of assets and the payment of debts

and liabilities. Notwithstanding the peculiar

fluctuating character of the interest of a

partner, it is regarded as an interest in

every asset of the partnership and is properly

described as a beneficial interest. So far as

profits are concerned the partnership accounts for purposes of the agreement between partners

and the income tax legislation were maintained
on an accruals basis. In the case where

accounts are kept on this basis it may be said

in one sense that a partner earns income when

a bill of costs is sent out to a client.

However, the partner does not gain the right

to have this income detached at that point of

time. His interest in it will continue to

fluctuate. Indeed, if subsequent losses are

made, the eventual position may be that he has

no profit or income for the year in question.

And the same must apply to the outgoings of the

partnership. The partners do not individually

incur those at the point of time at which the

partnership does. All the partner may have at the

end of the year is his individual interest in the

net result of the whole year's trading.

It is also worth noting, Your Honours, that

because of a problem that arose with this notional

or hypothetical taxpayer in relation to the trust

provisions of Division 6, it has been found

necessary to specify that this notional taxpayer

which is a partnership is to be treated as a

resident notional taxpayer as not having a

Fletcher(2) 116 8/5/91

residence. That appears from the definitions in

section 90 of net income and partnership loss.

Your Honours, my learned friend read at length

from the judgments of the members of the

Federal Court in Magna, Ure and Ilbery and there are, with respect, two things to be borne in mind in reading those cases. Firstly, the reference to

taxpayer, where it appears there, should be read

relevantly as reference to the partnership and not

to the individual partners. Secondly, however, the

judgments particularly in Magna are concerned with

the second limb of section 51(1), not the first

limb and the particular concepts in the second limb

of necessarily and business, which do not appear in
the first limb, may have influenced some of the
things that were said not only in the judgments in

Magna, but in the judgments in the various cases

that were cited with approval in Magna. In

particular, the distinction between "voluntary" and

"involuntary" was formulated in the context of

outgoings necessarily incurred in carrying on a

business.

Your Honours, as to the question of essential

character, yesterday my learned friend really put,

as we understood his proposition, that you do not

get into section 51(1) if the essential character

of an outgoing is private or domestic. Today, he

put it somewhat differently. The clear position

is, as set out in John's case at page 431, where

this Court says you do usually come within one of

the first or second positive limbs and then exit

via the negative limbs if it turns out that the
essential character of the expenditure is private

or domestic, essentiality being the test used to

determine that question, but it is not the test

used to determine whether you come into the first

positive limbs of the section.

Your Honours, we point out that in Lunney,

where essential character first emerged, at

page 497 in the passage first using the expression

"it is expressly distinguished from purpose".

If we might remind Your Honours that

Justice Wilson said in Forsyth's case that in any case essential character cannot dictate the answer.

Your Honours, there was some reference by my

learned friend to the transactions, although being

real and not sham transactions, being bizarre.

Now, we are not sure what our learned friend intended to do with this but in Littlewood, it is a

word which is used by Lord Reid - Littlewoods Mail

Order Stores ltd v IRC, (1963) AC. At the bottom

Fletcher(2) 117 8/5/91

of page 154, three lines from the bottom,

Your Honours, Lord Reid said this:

The result was a bizarre series of six deeds.

But none of these deeds was a sham. Each had

the effect which it purported to have, and if

the parties chose to proceed in this way, they

were quite entitled to do so.

BRENNAN J: 

Mr Bloom, to arrive at the character of the

expenditure in this case, it is necessary to see
that the money is outlaid in the relevant sense in
the acquisition of the annuity.

MR BLOOM: 

Yes, Your Honour.

BRENNAN J: If one looks at the whole of the contractual

circumstances and sees that it is outlaid for the purposes of acquiring the annuity, that of course

makes your case.

MR BLOOM:  Yes, Your Honour.

BRENNAN J: But if one looks around the circle and sees that

it is for the acquisition of the right of the
annuity, and then there is the relationship between
the annuity company and the lending company and
then from the lending company, closing the circle,

back to the taxpayer. Does one, at the same time,

establish that there was, in fact, no expenditure?

MR BLOOM:  No, Your Honour, because if one adopts the word,

a "bizarre" series of documents, which are not

shams, and gives each one of them its separate

effect, and what one cannot do, with respect, is to

look at the end result of various steps. This was

what Lord Wilberforce said, Your Honour will

recall, in the first Europa case, (1971) AC, the

passage appears at page 772. He was speaking of

the New Zealand equivalent to section 51(1) and he

said: 

Taxation by end result, or by economic

equivalence, is not what the section achieves.

Now those words were referred to, with approval, by

Sir Harry Gibbs in South Australian Battery Makers,

140 CLR, which is on Your Honours' list, and

His Honour in South Australian Battery Makers did

refer to the nature of this particular scheme as a

tax avoidance scheme, but said, "Look, if anything
is to be raised to deal with it, it must be

section 260", the anti-avoidance provision.

BRENNAN J: Well, I appreciate the argument about economic

equivalence, but if one looks at the·words of

Fletcher(2) 118 8/5/91

section 51(1), there has to be a loss or outgoing,

and it has to have a certain character.

MR BLOOM:	Yes, Your Honour.
BRENNAN J:	Now, if one must look at the contractual

framework in order to ascertain the character, and

at the same time, by looking at that contractual

framework one finds that there is not any loss or
outgoing, either intended or affected, does that

not have some problems?

MR BLOOM: Well, if one found that and one was entitled to

find it, with respect, Your Honour, yes, but the

difficulty that we have with that is this: one

goes to the contract of loan and finds an

obligation to pay interest and that is, for the

purposes of section 51(1), an outgoing incurred.

It need not be discharged, although the assumption

is that thereafter it is with these bills of

exchange, which are, after all, intended to be and

are no more than an exchange of cheques, something

which, back in 1933, the High Court first dealt
with and said was a payment, in Joseph v Campbell.

But, Your Honour, you cannot go outside that

contract, with respect, and say that that outgoing,

having been incurred, is to be treated as not
incurred, as a result of something else that has

happened.

BRENNAN J:  I take the force of what you are saying. the case where there are only two, not three Take

parties, to the transaction. Your first agreement

was one between the annuity company and the

taxpayer and it was in the terms of the loan
agreement, and the second, of course, was the

annuity agreement.

MR BLOOM:  Yes.

BRENNAN J: So, that the annuity company lent the money, it

was entitled to the interest that that contract

referred to it, and it was then under an obligation

to pay the annuity, and the two cancelled out.

Would one say there that the same result followed?

MR BLOOM:	If the transaction is not a sham and it must be given the effect of the document, then that is its
legal effect. Your Honour, the fact that there is
again an economic equivalence cannot decide
questions about section 51(1), with respect. They
are decided here, we have documents which for all
purposes are accepted as creating obligations to
pay interest and rights to receive annuities, and
the effect for the purpose of section 51(1) must,
with respect, be judged upon that basis. It will
be different if the documents were shams, or it

Fletcher(2) 119 8/5/91

would be different if the anti-avoidance provisions

applied, because they then allow one to look at the
purposes behind the obtaining of the benefit being
the tax deduction, although of course the benefit

of a tax deduction is what every taxpayer who

incurs deductible expense gets.	Your Honours, that
is all I wish to say in reply.

DEANE J:	Mr Bloom, before you sit down, can I take you,
just for one moment, to page 44 again, that is the
chart.
MR BLOOM:	Yes, Your Honour.

DEANE J: Now, is the position this: that it is common

ground that if at the end of the 1991 tax year your

clients had wished to bring this arrangement to an

end, they were entitled to do so with no financial

consequences one way or the other?

MR BLOOM:  With limited financial consequences.

DEANE J: Well, what were the limited financial

consequences?

MR BLOOM:  Whatever the pay out figure was on the page that

my learned friend took Your Honour to.

DEANE J: They had received some money?

MR BLOOM:  Yes, Your Honour, $80,000. Your Honour does not

ask me financial consequences for whom, but, yes.

DEANE J: But apart from receiving some money, at the end of

1991 they could say, "It's all over" and that was

the end of anybody's rights under the continuing

bizarre arrangement.

MR BLOOM: Well, that was a part of the bizarre arrangement,

yes, Your Honour.

DEANE J:  I do not want to just set you back at the

beginning, but I just cannot see how anybody

looking at this could conceive that it would go

beyond 1991.

MR BLOOM: Well, Your Honour, it may and one may have to

adopt a see-pray attitude to it and see. It is

obviously very much in the interest of the partners

that it be determined at that point but that is not

equivalent to it having been determined or being

determined.

DEANE J: Yes, but if you have contractual arrangements over

a period of 15 years which one party is entitled to

determine after 10 years and when it is obviously

overwhelmingly in his interests that he does

Fletcher(2) 120 8/5/91

determined it after 10 years, why should you not,

in assessing or in determining tax liability, work

on the overwhelming probabilities?

MR BLOOM:  Because Your Honour makes an assumption, with

respect. If this were to continue and the

partnership were to receive this substantial amount

of assessable income, they would have more than
enough to pay the tax on that assessable income and

have the balance over. So, Your Honour makes an

assumption that it is not going to be paid.

DEANE J:  I am sorry. Take the 1992 year and treat it as

one taxpayer.	The taxable income would be
$504,000.	The tax would be, what, $200,000?

MR BLOOM:  Yes, Your Honour.

DEANE J: Well, where do they get the $200,000?

MR BLOOM:  Your Honour makes the additional assumption that

if the matter continues they will not receive

$504,000, out of which they can pay $250,000 in tax

and keep $250,000. Your Honour makes that

assumption because of the round-robin of the

transactions in the earlier years. So, Your Honour

has to make further assumptions than the one

Your Honour put to me, with respect.

DEANE J:  But that is the taxable income for that year, but

I was under the impression that the excess they had

received was the $34,080 cash surplus, which means that they have to find $200,000 out of $34,080. I mean the taxable income is a notional figure.

MR BLOOM:  Your Honour, I do not know where that $34,000

figure comes from.

BRENNAN J: Page 43.

MR BLOOM:  Yes, Your Honour.

DEANE J:  The answer to all this may be that it is none of

our business, but -

MR BLOOM: Well, I would not make that submission,

Your Honour, not in those terms.

DEANE J:	- - - it concerns me very much, I must say.
MR BLOOM:	Yes, Your Honour, but the difficulty with this sort of speculation is it really is the sort of
matter that ought to be dealt with by the tribunal
in the first instance. No reliance, again, was
placed upon that factor to this point. It goes
back to the mirage point, I think, which was Mr Bannon's point in connection with an examination

Fletcher(2) 121 8/5/91

of section 82KH, by which he first assumed that the
outgoing was an allowable deduction under 51(1) to

get to that point, and he then said, "Well, to me

it is all a mirage". That was not, however,

adopted by the other member and thereafter ceased

to be anything playing a part in these proceedings

until here.

DEANE J: Might I just say this: if I am guilty of some

obvious factual error when I say that the only

amount to pay the $200,000 of tax received would be

the $34,000, I would be grateful if you could draw

my attention to it by a short written note

subsequently.

MR BLOOM: Certainly, Your Honour, although it may be worth

saying that no doubt the bulk of the money to come

in would also be used in discharging obligations

under the loan agreements and that may be the

reason that only - - -

DEANE J:  I am assuming that all that is done, that all they

would get would be $34,000, with a - - -

MR BLOOM: If we can find some factual dissuasion for

Your Honour, we will endeavour to do so.

DEANE J:  Good, thank you.

MR BLOOM: If Your Honour pleases.

MASON CJ: Thank you, Mr Bloom. The Court will consider its

decision in this matter.

AT 10.59 PM THE MATTER WAS ADJOURNED SINE DIE

Fletcher(2) 122 8/5/91