Jones and Commissioner of Taxation
[2000] AATA 1154
•22 December 2000
DECISION AND REASONS FOR DECISION [2000] AATA 1154
ADMINISTRATIVE APPEALS TRIBUNAL )
) No QT1999/251-
) QT1999/256
TAXATION APPEALS DIVISION )
Re DOROTHY JONES
Applicant
And COMMISSIONER OF TAXATION
Respondent
DECISION
Tribunal Mr. D.W. Muller, Senior Member
Date22 December 2000
PlaceBrisbane
Decision The Tribunal varies the objection decision under review by determining that for the taxation years ending 30 June 1993, 1994, 1995, 1996 the interest claimed on that part of the debt attributable to the applicant's business partnership with her late husband is an allowable deduction until 22 May 1996, but not thereafter.
...............(Signed)...............................
D.W. MULLER
SENIOR MEMBER
CATCHWORDS
TAXATION – deductions – business loan – interest payments on business loan
FC of T v Brown99 ATC 4,600
REASONS FOR DECISION
22 December 2000 Mr. D.W. Muller, Senior Member
This is an application to review a decision to disallow deductions for interest payments continuing to be made on a loan originally taken out by the applicant and her late husband to purchase equipment for their business, and still being paid by the applicant after the death of her husband and consequent cessation of business. The taxation years, the subject of this review, were those ending on 30 June 1993, 1994, 1995, 1996, 1997, 1998.
The facts are not in dispute and I find as follows:
(a)The applicant, Dorothy Jones, and her husband, Thomas Jones, started a trucking and equipment hire business in partnership in 1967.
(b)The terms of the partnership were never formally reduced to writing.
(c)The partnership continued until the death of Thomas Jones on 30 December 1992.
(d)As at early May 1990, Mrs. Jones and her husband:
(i)Owed just over $7,000 to Suncorp on their home mortgage.
(ii)Owed just over $61,000 to A.G.C. because of a hire-purchase arrangement relating to a back-hoe.
(iii)Owed about $10,000 to G.M.A.H. because of a hire-purchase agreement relating to a Toyota Land Cruiser.
(iv)Owed an amount, which is not revealed in the documents, on a Hino Tipper.
(e)On 16 May 1990, Mr. and Mrs. Jones entered into a re-financing agreement with the A.N.Z. Bank in which they borrowed $70,000, with their home as security, to pay out $7,105.88 to Suncorp and $61,415.55 to A.G.C. They also negotiated an overdraft limit of $20,000 to give them a cash flow to keep the business going.
(f)The arrangement with A.N.Z. came into effect on 30 May 1990. The nature of the loan is revealed by the contents of a letter written by an officer of the Hermit Park Branch of the A.N.Z. Bank to accountants, Ernst and Young on 19 April 1991.
"RE: T.E. & D.M. JONES
RESTRUCTURE OF DEBTS FROM SUNCORP & A.G.C.
We confirm that finance was approved for the above clients for the purpose of restructuring their debts and provide working capital.
A housing loan of $70,000 was approved for a term of 10 years from 305//90. An overdraft limit of $20,000 was also provided and this facility is subject to annual review.
Settlement was effected on 30/5/90 thus clearing Suncorp's and A.G.C.'s debts. Payouts were as follows:-
SUNCORP $ 7,105.88
A.G.C. $61,415.55
The balance after draw down of the housing loan was used to cover Bank and Government fees."
(g)On 31 May 1990, Mr. and Mrs. Jones entered into a re-financing agreement with Esanda for $25,000 for a second-hand back-hoe, $10,000 for their Toyota Land Cruiser and the payout of the Hino Tipper. The instalments were $815.51 per month for the back-hoe and $326.50 per month for 48 months for the Land Cruiser.
(h)On 15 April 1991, Mr. and Mrs. Jones entered into a lease agreement with Custom Credit in relation to a 14 Metre Platform Tower Lift. The terms were 36 monthly payments at $648.07, with a residual value of $5,000.
(i)In February 1992, Thomas Jones had an operation for cancer of the bowel. After the operation, he was well for about four months but his health then began to deteriorate. By September 1992, he was very ill.
(j)In September 1992, the partnership began to sell the partnership assets to clear as much debt and overhead as possible.
(i)On 15 September 1992, the partnership sold the back-hoe (Esanda) for $5,000 plus "take over terms". The $5,000 was used to reduce the overdraft.
(ii)On 3 November 1992, the Tower Lift was sold for the payout figure of $15,082.41.
(k)By 25 November 1992, the overdraft had escalated to $48,476.40 and was debited to the A.N.Z. home loan account.
(l)Shortly before Thomas Jones died on 30 December 1992, the Hino Tipper was sold for $12,000. The funds were used to pay funeral expenses, loan repayments and the payout of the Toyota Land Cruiser ($5,228.45).
(m)In early 1993, Mrs. Jones received $20,000 from Colonial Mutual on her husband's superannuation policy. The $20,000 was initially put into a term deposit but on 6 September 1993, it was transferred to the A.N.Z. loan account.
(n)By September 1993, the A.N.Z. loan account stood at approximately $100,000. The $20,000 from C.M.L. reduced the loan to about $80,000.
(o)The last tax return filed on behalf of the partnership was for the tax year ending 30 June 1993.
(p)Mrs. Jones has worked as a nurse since about 1975. She worked full-time until her husband became ill. She then worked part-time for about 18 months. She has been working full-time again since 1994. Her annual earnings have been approximately $16,000 in 1994; $30,000 in 1995; $41,000 in 1996; $35,000 in 1997 and $46,000 in 1998.
(q)Mrs. Jones has been using more than half of her salary, after tax, each year to try to repay the loan.
(r)By 22 May 1996, the A.N.Z. loan stood at about $74,000. Mrs. Jones re-financed the loan through RAMS because she was able to obtain a lower interest rate. RAMS paid out the ANZ loan and Mrs. Jones then owed approximately $74,000 to RAMS.
(s)Mrs. Jones paid no penalty to A.N.Z. on the pay-out of the A.N.Z. loan. The Tribunal was informed that for the type of loan taken out by Mrs. Jones and her husband, the A.N.Z. bank charges a penalty if the loan is repaid within two years but not thereafter.
(t)As at June 1998, the loan account with RAMS stood at $71,755.
There is no question of Mrs. Jones making a voluntary decision not to repay the loan and to continue to pay interest instalments. She is attempting to repay a commercial loan on a non-commercial income. Whether or not Mrs. Jones had an entitlement to repay the loan, immediately after cessation of business, without penalty, is not relevant in her case because she simply did not have the financial capacity to do so.
The questions for determination by the Tribunal are:
(a)Whether the said interest payments made by Mrs. Jones after the death of her husband are deductible.
(b)If they are deductible, for what period of time.
These matters and the relevant case law were analysed at great length by the Full Federal Court in FC of T v Brown 99 ATC 4,600. Those parts of the judgment which are of particular relevance to Mrs. Jones' case are:
"22. The observations in Steele's case are of considerable assistance in confining, but not determining, the issues arising in the present case. Plainly, in the present case it is appropriate to approach the issue of the "occasion" of the loss or outgoing, being interest paid, by reference to the purpose of the taxpayer and his wife in borrowing the money and the use to which those borrowed funds were put. Thus, the occasion for the recurring liability for interest on the Bank loan was the Bank loan agreement the purpose of which was for the taxpayer and his wife to acquire and carry on in partnership the delicatessen business. As stated in the majority judgment in Steele (at par 46), the taxpayer may still be entitled to a deduction after the business ceased in respect of a recurrent liability for interest:
"…. Provided the occasion of a business outgoing is to be found in the business operations directed towards the gaining or production of assessable income generally."
23. Obviously, cessation of business is of factual importance. In the present case its significance relates to whether, as a result of the cessation, the occasion of the recurrent loss or outgoings in question was no longer to be found in the business operations directed towards the gaining or production of assessable income generally of the partnership business. His Honour answered that question in the negative and his reasoning may be summarised as follows.
1. AGC (Advances) Ltd established that bad debts may be written off as a loss and give rise to an allowable deduction under s 51(1) notwithstanding that the debt was written off, and therefore the loss incurred, after the taxpayer has ceased to carry on, as a going concern, the business in which the debt was created. As Mason J said at ATC 4072; CLR 198:
"…Yet even in such a case it may be correct to speak of the loss as having been incurred in the carrying on of the business. This is because the occasion for the loss is to be found in a transaction entered into in the carrying on of the business for the purpose of producing assessable income, that is, in the agreement, by which the debt was created. Because the loss had its origin in such a transaction the loss may be said to be one which was incurred in the carrying on of the business for the purpose of producing assessable income, notwithstanding that its true character as a loss is not finally ascertained until the debt is written off."
2. In Placer a Full Court (at 4464) said of AGC:
"In our view AGC should be taken as establishing the proposition that provided the occasion of a business outgoing is to be found in the business operations directed towards the gaining or production of assessable income generally, the fact that that outgoing was incurred in a year later than the year in which the income was incurred and the fact that in the meantime business in the ordinary sense may have ceased will not determine the issue of deductibility. There is no relevant distinction to be drawn between losses and outgoings. Provided the occasion for the loss or outgoing is to be found in the business operations directed to gaining or producing assessable income, that loss or outgoing will be deductible unless it is capital or of a capital nature."
In Placer the taxpayer had sold the relevant business and assets of its conveyor belt division but continued to be liable in respect of any claims arising from the conduct of the business before its sale. After the sale of the business, a claim against the taxpayer for a defective conveyor system was settled on terms which required the taxpayer to pay $325,000 plus legal fees of $58,379. The taxpayer claimed a deduction for those amounts in its return of income. The Full Court held that the amounts payable under the terms of settlement and the legal costs were allowable deductions under the "second limb" of s 51(1) saying (at 4464):
"On the facts of the present case the occasion of the loss or outgoing ultimately incurred in the year of income was the business arrangement entered into between Placer and NWCC [the coal company] for the supply of the conveyor belt which was alleged to be defective. The fact that the division had subsequently been sold and its active manufacturing business terminated does not deny deductibility to the outgoing."
3. Recurrent expenditure of interest was considered by another Full Court in Riverside Road Pty Ltd. The taxpayer claimed that certain interest paid on secured and unsecured loans were allowable deductions, even after the sale, on 1 February 1979, of the land and the motel business conducted by the taxpayer upon the land. In relation to the interest paid on the secured loan, the Full Court (at ATC 4576; FCR 315) relevantly, for present purposes said:
"A question arises in this case as to when the interest outgoings cease to have the necessary character of incidental and relevant outgoings. As at 1 February 1979 the loan to Perpetual Trustees was repayable on 1 May 1979. It was in fact repaid on that date. The remaining interest was incurred pursuant to the terms of a new borrowing entered into after the restructuring. It seems to us that it does not follow... that the mere fact that the land and buildings were sold necessarily results in the conclusion that as and from the date of sale the whole of the interest incurred was not deductible. The respondent, pursuant to the contractural arrangements it had entered into, was obliged when it was an owner/operator to continue to pay interest until 1 May 1979. Had it sought to discharge its obligation to the mortgagee, it could have been required to pay interest to this date. In the circumstances of the present case, therefore, it cannot be said that the change in character of the business activity of the respondent immediately excluded the interest payable by it to the mortgagee from deductibility. Rather, it seems to us that the respondent was entitled to a deduction of such part of the disallowed interest as related to the borrowing of moneys reflected in the Perpetual Trustees' mortgage until 1 May 1979 and as related to the land and buildings upon which the motel was situated."
4. His Honour concluded that the occasion for the loss, being the payments of interest, was to be found in a transaction, being the Bank loan, entered into in the carrying on by the partnership of the business for the purpose of producing assessable income. His Honour then concluded [at 4703]:
"….The application of the principles or guidelines explained in AGC (Advances) Ltd, Placer and Riverside Road Pty Ltd to the facts of the present matter means, in my opinion, that the interest payments in the years in question were deductible under the second limb of s 51(1)."
24. We can find no error in his Honour's approach. It accords with, and is fully supported by, the approach to deductibility of interest under s 51(1) (albeit the first limb) in Steele. In particular his Honour, in determining that the occasion for the loss or outgoing in question was the payment of interest which the taxpayer was obliged to pay under the Bank loan contract, was applying the principles established in AGC, Placer and Riverside Road to the undisputed facts of the present case. It was not suggested before us that the Bank loan was not on ordinary commercial terms.
24. As his Honour pointed out there may come as period of time between cessation of business and the payment of interest which is such that, in all the circumstances of the case, the payment is no longer sufficiently proximate to the activities of the business to be deductible under s 51(1) with the consequence that those activities no longer provide the occasion for the outgoing. However, the evidence in the present case did not establish that that point had been arrived at during the 1993 or 1994 financial years. Answers to such questions depend upon a "commonsense" or "practical" weighing of all the factors: see Fletcher at ATC 4958; CLR 18.
26. Accordingly, the present case was determined against the Commissioner because the cessation of business did not have the consequence that the "occasion" for the liability to pay interest no longer remained the original liability to pay that interest under the Bank loan.
27. We turn to the Commissioner's reliance on the "entitlement" of the partners to pay out the loan. The fact that the Bank might as a matter of practicability rather than legal obligation, allow early repayment does not alter the analysis in the present case. In our view his Honour was correct in characterising the occasion for the liability in such circumstances as depending upon the terms of the contract rather than upon whether or not the partners might or might not have availed themselves of an opportunity to repay the loan on a particular day because of an indulgence shown by the lender on that occasion. In that regard, it is significant that the partners did apply the net proceeds of sale in repayment of the loan and his Honour did not appear to be prepared to find that the taxpayer and his wife had any other partnership assets which were available, had the Bank agreed, to discharge the loan when, or even after, the partnership business ceased.
28. Had the loan agreement in question been a "roll over" business loan facility which entitled the taxpayer conducting the business, on the date of each monthly payment, to elect to repay the principal and thereby avoid incurring liability for interest or to "roll over" the loan and continue to be liable for interest, that may have been a different situation. In that circumstance there may be considerable force in a contention that the occasion of the liability was the election to "roll over" the loan on each monthly payment date, rather than any liability arising under the terms of the original loan agreement establishing the terms of the "roll over" facility. In such a case the cessation of the business or sale of the income-producing asset acquired with the borrowed funds might properly be regarded as breaking the nexus in much the same way as certain post cessation interest payments were not allowed as deductions in Riverside Road. However, as explained earlier, that is not the situation in the present case.
29. In the circumstances, his Honour was not in error in not regarding the cessation of the business as having broken the nexus between the carrying on of the business and the incurring of the liability for interest under the Bank loan and the meeting of that liability by the payment of interest during the 1993 and 1994 financial years. As stated by his Honour, it was unnecessary to consider whether the outgoings would also be deductible under the first limb of s 51."
I find:
(a)That the "occasion" of the claimed loss or outgoing, being interest paid because of the recurring liability for interest on the ANZ loan, was the ANZ loan agreement, the purpose of which was for Mrs. Jones and her late husband to carry on in partnership the trucking and hire business.
(b)That Mrs. Jones was obliged to pay under the ANZ loan agreement after the death of her husband, that is, after cessation of the partnership business.
(c)That the liability to pay interest remained the original liability to pay that interest under the ANZ loan.
(d)That Mrs. Jones had no capacity to repay all of the loan after she reduced the loan by selling all of the business assets.
(e)That the period of time between the cessation of business and the payment of interest was sufficiently proximate to the activities of the business to be deductible until the loan arrangement with ANZ came to an end on 22 May 1996.
(f)That the new loan arrangement entered into by Mrs. Jones with RAMS on 22 May 1996 and the simultaneous payout of the ANZ loan broke the nexus between the interest payments (now made to RAMS) and the original liability to ANZ Bank which directly related to the trucking and hire business.
The objection decision is varied by allowing as deductions the claimed interest payments on that part of the liability to the ANZ bank attributable to the business partnership between the taxpayer and her late husband until 22 May 1996, but not thereafter.
I certify that the 7 preceding paragraphs are a true copy of the reasons for the decision herein of Mr. D.W. Muller, Senior Member
Signed: .....................................................................................
R. Hayes, AssociateDate/s of Hearing 18 August 2000
Date of Decision 22 December 2000
Applicant Mrs. Jones, herself and Mr. Coco
Respondent Ms. L. Gilligan, departmental advocate
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