NT1999/460] and Commissioner of Taxation
[2000] AATA 656
•4 August 2000
Administrative
Appeals
Tribunal
DECISION AND REASONS FOR DECISION [2000] AATA 656
ADMINISTRATIVE APPEALS TRIBUNAL )
TAXATION APPEALS DIVISION ) No NT1999/460
Re
THE TAXPAYER
Applicant
And
COMMISSIONER OF TAXATION
Respondent
DECISION
Tribunal Ms J A Shead Date4 August 2000
PlaceSydney
Decision
The objection decision under review is set aside.
[Sgd] Ms J A Shead
Member
CATCHWORDS
TAXATION - income tax – deduction – interest expenditure on rental investment property
Income Tax Assessment Act 1936, section 51(1)
FC of T v Roberts and Smith (1992) 37 FCR 246, (1992) 92 ATC 4380
REASONS FOR DECISION
Ms J A Shead 1. The objection decision under review in this matter is a decision made by the Respondent on 15 July 1999 refusing to allow an objection by the Applicant made on 23 March 1999 against an assessment dated 27 January 1999 which disallowed a deduction claimed for interest, in an amount of $42,771.00 in respect of rental property interest, and the imposition of penalty at the rate of 50% of the tax shortfall, related to the tax year ending June 1996 (the "relevant year").
2. The Applicant appeared personally throughout the hearing. Mr Roger Gormley, a solicitor of the Australian Taxation Office (“ATO”), appeared for the Respondent.
3. The Tribunal had before it the T Documents lodged pursuant to section 37 of the Administrative Appeals Act 1975 in evidence and numbered folios 1 to 123 (Exhibit R1) (“the T documents”). The following copies of documents were also admitted into evidence:
Exhibit A1 Letter of the Applicant’s former wife dated 14 October 1991;
Exhibit A2 Letter of the Applicant dated 12 May 2000 to the ATO;
Exhibit A3Bundle of National Australia Bank (“NAB”) account statement pages 34, 41, 42, 57 and 60; the Applicant’s letter dated 22 June 1992 to NAB; Bills System Customer Liability Record dated 9 July 1993, 11 October 1993, 5 January 1994, 11 January 1994, 11 April 1994, 23 June 1994, 29 June 1994, 28 December 1994, 16 January 1995 and 27 June 1995; NAB letter dated 25 July 1994 to the Applicant; Customer Liability Record for the Applicant dated 20 October 1995, 11 April 1996 and 11 June 1996; and Credit Memorandum dated 21 June 1996;
Exhibit A 4Photocopies of cheque forms (in blank) in respect of the Applicant’s NAB business account and NAB trust account;
Exhibit A 5Applicant’s National Mutual Royal Bank Limited Fully Drawn Advance statement pages 1 to 8; Applicant’s ANZ Bank Fully Drawn Advance statement pages 16 to 28; Applicant’s ANZ Home Loan statement pages 1 to 9; NAB letter dated 1 December 1995 to the Applicant; ANZ Bank letter dated 27 June 1996, 12 July 1994, 9 January 1995, 7 July 1995, 5 October 1995 and 2 April 1996 to the Applicant; Applicant’s ANZ Bank Business Extra Account statements pages 41, 44, 47 and 50;
Exhibit A 6Applicant’s bundle of documents;
Exhibit A 7 Applicant’s notes headed “NAB Interest per Bank Statements”;
Exhibit A 8Applicant’s notes headed “NAB Interest Alternative Basis”;
Exhibit A 9Applicant’s document headed “Trust Loans to (Applicant)”;
Exhibit A10 Applicant’s diagram relating to funding of property acquisition;
Exhibit A11 Applicant’s diagram relating to commercial bills facilities;
Exhibit A12 Bundle of the NAB Account statements from 25 June 1991 to 30 June 1992 and numbered page 30 to 60;
Exhibit A13 Bundle of NAB Account statements from 14 June 1991 to 30 June 1992 and numbered page 20 to 39;
Exhibit A14 Applicant’s response to the Respondent’s Statement of Facts and Contentions.
Exhibit R 1Deed of Trust dated 31 July 1981 (“[C Trust]”);
Exhibit R 2Deed of Trust dated 24 August 1987 (“[L Trust]”).
4. The oral evidence before the Tribunal took up a hearing day, however the relevant facts and issues are not, on analysis, complex. At the conclusion of the hearing, the Applicant submitted a written response (Exhibit A14) to the Respondent’s Statement of Facts, Issues and Contentions served 6 June 2000. The Respondent’s further written reply was submitted after the conclusion of the hearing.
5. The evidence and documents have been edited to preserve anonymity. Edits are indicated by square brackets. "TS" references followed by a page number refers to the relevant pages in the Transcript.
6. The Applicant is a Chartered Accountant and a partner in a large accounting firm. In October 1991 a Mosman Bay strata unit rental investment property (“the property”) was transferred to the Applicant by his former de facto wife as part of a property settlement adjustment between them. The memorandum of transfer relating to the transfer of title of the property was dated 13 October 1991 and stated that the consideration for the transfer was $300,000.00 (T16, page 120). The consideration was stated by the Applicant to be part of a cheque for $403,968.10 paid on 24 October 1991 (Exhibit A1). The NAB took a mortgage over the property and its mortgage was dated 29th October 1991 (T16, page 122). The Applicant declared rental income each year since the property was transferred to him.
7. The Applicant’s 1996 income tax return was subject to an ATO audit regarding rental property income. After an amount of correspondence between the Applicant & the ATO, a Notice of Amended Assessment dated 27 January 1999 (T17) issued in which the Applicant’s claim for rental property interest expense of $42,771.00 was disallowed in full, and a penalty at the rate of 50% of the tax shortfall was imposed.
8. In the Applicant’s objection (T11), he stated, amongst other things, “that the whole of the amount claimed as interest in the 1996 return against property income related to interest paid in connection with rental income property purchased by (him) in 1991”.
9. The Respondent’s statement of Reasons for Decision stated:
“The deductibility of interest under subsection 51(1) of the Income Tax Assessment Act 1936 depends upon satisfying the words of the subsection. That is, being able to show that the loss or outgoing was incurred in gaining or producing assessable income. The test is one of characterisation and the essential character of an expense is a question of fact.
A tracing of the borrowed money to the purchase of an income producing asset would usually establish the interest’s deductibility.
‘The mere act of borrowing money, burdened with the obligation to pay interest, does not of itself gain or produce assessable income. The amount borrowed is not assessable income. What operates to gain or produce assessable income is the manner in which those moneys are used, so that the necessary connection between the outgoing for interest and the activities which more directly gain or produce assessable income will be found, in the ordinary case, in the use to which the borrowed funds are put’ (Hill J in FCT v Roberts; Smith v Smith 92 ATC 4280 at 4387).
The Respondent considers the that the Applicant has not provided sufficient evidence to establish the required nexus between the 1991 consideration paid of $300,000 and the 1995/96 commercial bill transactions of $350,000. Consequently, without an established nexus, the interest and charges on the commercial bills will not be allowed as a deduction against the rental income.”
10. Using an electronic white board, the Applicant drew a diagram (Exhibit A10) and told the Tribunal:
“Essentially, the property acquisition dates back to late 1991 and it was a property that costs $300,000 plus roughly $9,000 in duty. That amount was funded as to $200,000 from the National Australia Bank and the balance is more complex, but if we look perhaps at my contemporaneous bank statement which is document 6 of the section 37 document you will see that the $300,000 in fact forms part of $403,000 drawn on 25 October. You will see within a couple of days there are some proceeds there from the NAB of $198,000 and then that amount in turn is a $200,000 as I can identify, bill of exchange and to trace the bills it is necessary to go to document A3. In document A3 you will see in the bottom right hand corner starts with $198,000 and then the next document is the same bank account a month later and you will see an amount there for 200,000 bills.
Those bills matured on 29 November so the 200 flows to 29 November … On 6 December you will see – there is always a couple of days lag for weekends and other things with the banks, an amount of $191,000 which is the proceeds of a 200,000 bill and that is the first, second, third page of document A3. …
Then on 30 June you will see that the 200,000 plus some other borrowings are taken in a combined bill of 400,000. You will also see as the next page of that document, a letter of mine to the bank dated June of ’92 talking about interest in advance for 12 months being 200,000 regarding Mosman Bay. So that is 200,000 of the borrowings.
The next document is simply a summary of my bill positions with the bank … you will see that the bill at all relevant dates continues, if you look at the outstanding bills column, continues to be there for 400,000 all the way through to ’94 which is a document headed in the top right, 27 June ’95. The next document – so we are up to ’94 now. Instead of rolling the bills over, I actually fixed the facility for a year and there is a letter there saying, in respect of 400,000, it has been fixed for 12 months.
MS SHEAD: That’s dated 25 July 1994?
[APPLICANT]: Correct. So then fixing 12 months forward takes us to July ’95 in rough terms. Bills are 180 days, so the dates don’t exactly match a year. The next document shows that rather than have a fixed bill, I am now back to a floating bill and it is now, the 400,000 is rolled into a total of 800. If you look at the next page, which is dated in the top right, 20 October ’95, you will see the bill draw down, the second number, 17 July ’95 totalling 800,000 and that’s the 400 plus another 400 which is not relevant to what we are discussing.
So the bill goes sort of fixed for a year and then plots back into bills and then if the Senior Member just turns quickly through the documents you will see 800,000 next year and the third page which is dated 11 June 1996, the Senior Member will see that the facility is down to 600,00 but the reason for that is explained in the bank document attached, which again refers to to this residential loan of 200,000 which is the residence – it’s not my residence, I don’t live there – is the residential 200,000 loan that I first borrowed …
… there is correspondence with the National Australia Bank in ’92 referring to the 200,000 Mosman Bay loan and as at the end of ’96 there is still ongoing reference to the residential 200,000 loan. I say at all relevant times as to the 200,000 it was funded by NAB. … “ (TS 21 – 23)
11. The Applicant put into evidence a schedule of his calculations extracted from those Bank statements which showed $46,336 interest (Exhibit A7) or if calculated on a pro rata basis of the $800,000, $50,562 interest (Exhibit A8). The Applicant noted that he had made an error in his taxation return
12. The Applicant then drew a diagram (Exhibit A11) and gave evidence as to the transactions which related to the balance of $109,000. Briefly, there were several advances, including from a trust, to the Applicant, which were then replaced by a loan from the then National Mutual Royal Bank, now the ANZ Bank, as part of debt of $1.45 million.
13. The Applicant concluded his evidence saying that the consideration for the property was funded from two streams: the NAB and the ANZ Bank, and that he had traced the borrowings for the NAB through to 1996. He told the Tribunal: “When I actually prepared my ’96 return I did not go through all this. … I looked at my National Australia Bank borrowings, calculated the interest on those, I admit clerically wrong now, … had I added up properly the NAB interest and ANZ interest I would have had a much bigger total. But having shortcut the process at the time I erred and the error resulted in the under-claiming interest deduction on the property to the tune of the best part of $20,000.” (TS 29)
14. In cross-examination, Mr Gormley put to the Applicant that his NAB business account was held in trust for the [C Trust]. The Applicant denied that suggestion pointing out that Exhibit A4 showed the two accounts had distinctive account numbers. In particular Mr Gormley questioned:
“MR GORMLEY: [Applicant], your bank statements say it’s held for the [C Trust]?
[APPLICANT]: That’s typed on both statement, Mr Gormley, but it would be unnecessary to keep two bank accounts if that was factually the case.
…
MR GORMLEY: I’ll ask the question again. Do you want the Tribunal to disregard the annotation by the bank that that is a trust account for the [C Trust] ?
[APPLICANT]: That would simplify proceedings yes.
…
MR GORMLEY: Why should the Tribunal do so ?
[APPLICANT]: …Firstly, the cheque accounts and the deposit accounts are clearly labelled as to what they are. Secondly, if you examine the accounts you will see a [firm] cheque paid to what I class as my business account on a relatively regular basis. That happens to be my partnership profit share. That is clearly not an amount that would be banked to a trust. That is mine. Next there are numerous outgoings on that account and most of the pages if you look at them rather simply are full of outgoings and large numbers of cheques indicating amounts down as low as $40 and all sorts of trivia indicating that it is precisely what the cheque book statements say it is – sorry, precisely what the cheque books say it is, precisely what the bank deposit slips say it is and precisely what I say it is, it is my business account.” (Transcript, pp 32-33)
15. During further cross examination, the Applicant said that the annotations made on the NAB Account statement pages (Exhibit A3) were contemporaneous to the time when the Applicant checked his bank statements. In response to assertions by Mr Gormley that the Applicant had been exceedingly careless in his explanation to the Commissioner, the Applicant did not agree saying that in his initial responses to the ATO he made a mistake because the matters went back almost a decade, and that subsequently he had made bona fide attempts to clarify matters, and that his answers had been based on incomplete information. The Applicant agreed that it was not until 2 December 1999 that the matters given in evidence at the hearing by the Applicant and referred in paragraph 9 were presented to the Tribunal (Exhibit A6) and the Commissioner.
TRIBUNAL’S CONSIDERATIONS AND REASONS
16. The Applicant gave evidence and was cross-examined as to the history of transactions giving rise to the interest expenditure. The Tribunal noted the Applicant gave evidence in a straightforward manner and generally the Tribunal accepts that evidence. The Tribunal also acknowledges that previous responses by the Applicant to queries by the ATO were incomplete and observes that the Applicant did not appear to have exercised an early degree of due diligence to clarify his position. Certainly the Applicant’s explanation is belated. The Applicant’s explanation of the transactions before the Tribunal was consistent with the documents referred to by him.
17. Notwithstanding that the Applicant took the property by transfer from his former de facto wife, the Tribunal is satisfied that the transaction was akin to the purchase of a rental investment property. The Tribunal noted that it was not disputed that at all relevant times the property was a rental investment property.
18. Ultimately the issue was whether the Applicant’s NAB business account was held by him for the [C Trust] with the result that interest payments from the account were obstensibly incurred by the [C Trust] and not by the applicant. The Tribunal finds that that the NAB business account statements (Exhibit A12) are entitled “[The Applicant] ATF C Trust” is not significant; they are also entitled “”Flexiplus mortgage” and “Business Account”. The other account, the NAB trust account, is similarly entitled. There is also other correspondence where the Bank appears to intermingle names of entities and accounts; for example the Credit Memorandum dated 21/06/96 (Exhibit A3). Having regard to the oral evidence of the Applicant and the schematic diagrams (Exhibit A10), the Tribunal is reasonably satisfied that the documents referred to by the Applicant, are evidence of the original borrowing by him for the transfer of the property to him and his tracing of the changes to those borrowings satisfied the Tribunal. In particular the Tribunal is satisfied from his evidence that he had traced the borrowings for the NAB stream of borrowings through to 1996. The Tribunal noted that in FC of T v Roberts & Smith (1992) 37 FCR 246, 92 ATC 4380, Hill J stated that a rigid “tracing of funds” will not always be necessary.
19. The Tribunal had the benefit of Mr Gormley’s closing arguments and case law list however having regard to the facts as found by the Tribunal, it is unnecessary for the Tribunal to deal with the arguments submitted on behalf of the Respondent. Having regard to the oral evidence of the Applicant, and the Tribunal having reviewed the exhibit documents, the Tribunal is satisfied there was a satisfactory nexus between the funds borrowed for the transfer of the property and the commercial bills for which interest and related expenses were claimed. The calculation of the NAB interest (Exhibit A7) was not disputed. The Applicant is entitled to the deduction of the NAB interest expenses in relation to the property.
20. Accordingly it follows from the foregoing reasons, that the objection decision under review is set aside.
I certify that the 20 preceding paragraphs are a true copy of the reasons for the decision herein of Ms J A Shead.
Signed: .....................................................................................
AssociateDate/s of Hearing 8 June 2000
Date of Decision 4 August 2000
Representative for the Applicant Self-representedRepresentative for the Respondent Mr R Gormley, Australian Taxation Office solicitor
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