Steele, Kathleen Faye v Deputy Commissioner of Taxation
[1997] FCA 167
•18 MARCH 1997
CATCHWORDS
TAXATION - deductions under s.51(1) - whether interest paid on borrowings to purchase land with a view to development to include a motel was deductible on revenue account or was of a capital nature - discussion of cases dealing with the distinction between revenue and capital items with particular reference to the treatment of interest on borrowed monies - effect of the earning of a relatively very small amount of income where claim for interest expense related to a very large amount - discussion of the effect of a change of purpose in relation to the use of borrowed monies - whether interest is on capital account prior to creation of an income earning asset, and on revenue account thereafter.
Income Tax Assessment Act 1936, s 51(1)
Wharf Properties Ltd v Commissioner of Inland Revenue [1995] 2 HKLR 552
Wharf Properties Ltd v Commissioner of Inland Revenue of Hong Kong [1997] Simon's TC 351
Travelodge Papua New Guinea Ltd v Chief Collector of Taxes (1985) 85 ATC 4432
John Fairfax & Sons Pty Ltd v Federal Commissioner of Taxation (1959) 101 CLR 30
Commissioner of Taxation v Ampol Exploration Ltd (1986) 13 FCR 545
Commissioner of Taxation v Osborne (1990) 26 FCR 63
Commissioner of Taxation v Cooper (1991) 29 FCR 177
Inglis v Federal Commissioner of Taxation (1980) 80 ATC 4001
Softwood Pulp and Paper Limited v Federal Commissioner of Taxation (1976) 76 ATC 4439
Goodman Fielder Wattie Ltd v Commissioner of Taxation (1991) 29 FCR 376
F C of T v Brand (1995) 95 ATC 4633
Sun Newspapers Limited v The Federal Commissioner of Taxation (1938) 61 CLR 337
Hallstroms Proprietary Limited v The Federal Commissioner of Taxation (1946) 72 CLR 634
Foley Brothers Pty Limited v Federal Commissioner of Taxation (1965) 13 ATD 562
G.P. International Pipecoaters Proprietary Limited v The Commissioner of Taxation of the Commonwealth of Australia (1990) 170 CLR 124
The Commissioner of Taxation of the Commonwealth of Australia v South Australian Battery Makers Proprietary Limited (1978) 140 CLR 645
Labrilda Pty Ltd v Commissioner of Taxation (1996) 65 FCR 119
The Federal Commissioner of Taxation v Munro (1926) 38 CLR 153
Farmer v Scottish North American Trust, Limited [1912] AC 118
The Texas Company (Australasia) Limited v The Federal Commissioner of Taxation (1940) 63 CLR 382
Australian National Hotels Ltd v Commissioner of Taxation (1988) 19 FCR 234
Federal Commissioner of Taxation v Energy Resources of Australia Ltd (1996) 137 ALR 18
Federal Commissioner of Taxation v Total Holdings (Australia) Pty Ltd (1979) 79 ATC 4279
Federal Commissioner of Taxation v Riverside Road Pty Ltd (1990) 90 ATC 4567
Ure v Federal Commissioner of Taxation (1981) 81 ATC 4100
Federal Commissioner of Taxation v Ilbery (1981) 38 ALR 172
Fletcher v The Commissioner of Taxation of the Commonwealth of Australia (1991) 173 CLR 1
Commissioner of Taxation v Roberts (1992) 37 FCR 246
Commissioner of Taxation v Janmor Nominees Pty Ltd (1987) 15 FCR 348
Crawford v F C of T (1993) 93 ATC 5234
Madigan v F C of T (1996) 96 ATC 4640
Brian Reilly Freighters (NSW) Pty Ltd v F C of T (1996) 96 ATC 5122
Cliffs International Inc. v The Commissioner of Taxation of the Commonwealth of Australia (1979) 142 CLR 140
Christchurch Press Company Ltd v Commissioner of Inland Revenue (1993) 15 NZTC 10,206
Federal Commissioner of Taxation v Kowal (1983) 84 ATC 4001
Ronpibon Tin No Liability v Federal Commissioner of Taxation (1949) 78 CLR 47
Commissioner of Taxation v Edwards (1994) 49 FCR 318
KATHLEEN FAYE STEELE -V- DEPUTY COMMISSIONER OF TAXATION
WAG 11 & 12 of 1996
Burchett, Ryan and Carr JJ
Perth
18 March 1997
IN THE FEDERAL COURT OF AUSTRALIA )
)
WESTERN AUSTRALIA DISTRICT REGISTRY ) WAG 11 of 1996
) WAG 12 of 1996
GENERAL DIVISION )
ON APPEAL FROM A JUDGE OF THE FEDERAL COURT OF AUSTRALIA
BETWEEN:KATHLEEN FAYE STEELE
Appellant
AND:DEPUTY COMMISSIONER OF TAXATION
Respondent
CORAM: Burchett, Ryan and Carr JJ.
PLACE: Perth
DATE: 18 March 1997
MINUTE OF ORDER OF THE COURT
THE COURT ORDERS THAT:
The appeals be dismissed with costs.
NOTE: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
IN THE FEDERAL COURT OF AUSTRALIA )
)
WESTERN AUSTRALIA DISTRICT REGISTRY ) WAG 11 of 1996
) WAG 12 of 1996
GENERAL DIVISION )
ON APPEAL FROM A JUDGE OF THE FEDERAL COURT OF AUSTRALIA
BETWEEN:KATHLEEN FAYE STEELE
Appellant
AND:DEPUTY COMMISSIONER OF TAXATION
Respondent
CORAM: Burchett, Ryan and Carr JJ.
PLACE: Perth
DATE: 18 March 1997
REASONS FOR JUDGMENT
BURCHETT and RYAN JJ.:
On an inauspicious day in 1980, the appellant, Mrs Steele, drove along a main road past a property known as "Tibradden", of 7.4 hectares, in the vicinity of Perth airport, on which horses were grazing. There was a "For Sale" sign on the property, and Mrs Steele conceived the idea of purchasing it for redevelopment as something in the nature of a motel and townhouse complex. She satisfied herself by enquiries that necessary rezoning and provision of sewerage could be achieved. Then, on 18 December 1980, she entered into a contract to purchase the property for $1,000,000, the sum of $900,000 to be deferred at interest to 8 January 1982.
During the year 1981, Mrs Steele engaged in negotiations with an architect, a Mr R. Cann, and the managing director of a large construction company, Mr R.J. Williams. Plumbing and engineering reports were obtained in respect of proposed building works, to include facilities in association with motel suites, townhouses and an administration block. Approval of the principle of the development was sought from the local Council, but was refused on 10 December 1981 because of zoning and sewerage problems. The sewerage problems appear to have been solved quite promptly, and on 8 January 1982 Mrs Steele entered into an agreement with Mr Williams with a view to the project proceeding on behalf of the two of them jointly. A special bank account was opened for it, under the name "Sky Lodge". On 10 February 1982, the Council gave approval "in principle" to a varied plan, but then there was a change of architects, leading to substantial changes in the proposal. A new plan was approved by the Council in May 1982, and a cost estimate was obtained of almost $10,000,000. Negotiations relating to finance ensued, and various propositions appear to have been put by Mr Williams in late 1982, and during 1983, to enable the project to proceed. However, difficulties developed between Mrs Steele and Mr Williams during 1983, and ultimately Tibradden was put up for auction, without success, on 18 July 1984. There followed attempts to partition the property between Mrs Steele and Mr Williams, and litigation between them in the Supreme Court of Western Australia. Finally, on 17 December 1986 Mrs Steele bought out Mr Williams, after which she sold the land in two parcels, the first almost immediately, and the second some eighteen months later.
At the time of the original purchase, there was an existing business on Tibradden, involving stabling, agistment and training of horses. Improvements stood on the land, in good condition, which were related to these activities. However, no part of the purchase price was allocated to goodwill, and the reasons prepared by members of the Administrative Appeals Tribunal make it plain that Mrs Steele did not purchase Tibradden in order to conduct a business of that kind. She did, nevertheless, arrange for the agistment activities to continue, and did derive income from them to an extent sufficient to recoup about 3.5% of the annual expenses of holding the land.
In the Administrative Appeals Tribunal, on appeal to a judge of the Court, and in the present appeals, Mrs Steele has maintained that she is entitled under s 51(1) of the Income Tax Assessment Act 1936 to deduct against her income of later years the interest payments on borrowings to acquire Tibradden, together with rates and a small sum of other expenses - in all, $909,649.00.
Understanding of the Tribunal's conclusions is complicated by the fact that there were two hearings and multiple sets of reasons. However, perusal of those reasons shows the Tribunal's central conclusion to have been that Mrs Steele bought Tibradden intending to use it, as she told a taxation officer, "to build a motel and operate it by myself". The ability to recover a small part of the holding charges from agistment fees was merely an incidental advantage. The Tribunal accepted that these two matters constituted dual purposes of the acquisition, the "main or dominant purpose" being "to erect a motel upon the site" and "any activity involving horses [being] subsidiary to her main purpose". In the final set of reasons of the majority of the Tribunal, the dominant objective of Mrs Steele was described as "capital redevelopment". The reasons add:
"Her evidence makes it clear that she did not have any specific plan in mind as to how this investment might be made profitable; all that she had was an idea, at best, to develop a motel to be managed by herself. Her idea was that what she developed would produce income under her management. ... Sale of the property was imperative when, towards the end, it became economically impossible to proceed with a development. The idea to develop the investment was not incompatible with the fact that there existed on the property an agistment business which, with virtually no effort on her part, could be continued at least until redevelopment commenced and would provide income. The purpose of the applicant in acquiring the property was therefore twofold - to obtain income from 'Tibradden' so long as that was convenient (the subsidiary purpose) and to develop the property (the main purpose), an activity which would not of itself amount to a present purpose of gaining assessable income. There were too many contingencies to say with any certainty that income would ever be derived from the dominant purpose. The evidence is that this was never more than an idea or hope - plans were never finalised nor finance ever secured. The interest expense incurred to secure the property served these purposes indifferently."
And again:
"The applicant incurred interest on a loan to secure 'Tibradden' for a dual purpose, one to derive assessable income from the agistment activities - an affair of revenue - and the other to develop a profit-yielding structure of a future business enterprise - an affair of capital."
The appellant's appeals depend upon two broad arguments, each of which was presented with reference to the payments of interest (by far, the bulk of the amount at issue) in respect of moneys borrowed to purchase Tibradden. The first argument was that the interest was deductible as an expense of the earning of the income constituted by the agistment fees. The second was that the interest was deductible, having regard to what was said to be the principle of Travelodge Papua New Guinea Ltd v Chief Collector of Taxes (1985) 85 ATC 4432, a decision of Bredmeyer J, a judge of the National Court of Papua New Guinea, on the basis that Mrs Steele, when she bought Tibradden, embarked on a business of constructing and operating for profit a development in the nature of a motel.
Travelodge (which counsel for the Deputy Commissioner submitted should not be followed, if it could not be distinguished) concerned the application of s 68 of the Income Tax Act 1981 of Papua New Guinea, which was described by the judge (at 4434) as "identical" with s 51(1) of the Australian Act. Between 1974 and 1978 the Travelodge Hotel at Port Moresby was under construction. It opened to its first guests on 25 October 1978. The cost of construction over the four years prior to that date was financed by borrowings, and the interest paid in those years was held to be deductible, under
the first limb of the section, against the income earned once the hotel was operating. The court found it unnecessary to decide whether expenditure on rent, rates and interest during the construction period came under the second limb. Bredmeyer J commented (at 4439):
"If the taxpayer's business was running a hotel then clearly it was not carrying on a business until October 1978 when the first guest arrived, or perhaps a month or two before when the rooms were fitted out and staff [were] being trained, so the outgoings mentioned were not incurred in the course of carrying on a business to produce assessable income. If, on the other hand, the taxpayer's business, correctly understood, was the construction and running of a hotel then it was carrying on a business much earlier. I consider it unnecessary to decide the point."
It is clear, however, that the argument presented by counsel for the taxpayer (which is summarised at 4435-4436) was that from the beginning "the company was committed to building and running an income-producing hotel in Port Moresby and that it never wavered from that course." The contrary argument (summarised at 4436) was "that the interest was incurred for the purpose of establishing a business structure or entity for the earning of profit, that it was a cost of acquiring the capital asset, and that the outgoing was not incurred in the course of gaining or producing assessable income."
Although the general nature of its provisions is very familiar, the precise terms of s 51(1) are worth repeating:
"All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions 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 relation to the gaining or production of exempt income."
It is convenient to leave aside, for later consideration, the issue concerned with the effect of the receipt of agistment fees. The question raised by the taxpayer's purpose of erection of a motel or similar complex, to be operated by the taxpayer so as to earn assessable income, is whether that purpose is sufficient to make payments of interest in respect of the borrowed purchase moneys deductible on revenue account under s 51(1). The Tribunal, as has been seen, answered this question in the negative on the ground that the taxpayer's object was "to develop a profit-yielding structure of a future business enterprise - an affair of capital". At the same time, the Tribunal appeared to put forward an independent ground of its decision - that "[t]here were too many contingencies to say with any certainty that income would ever be derived", and that Mrs Steele's aim "was never more than an idea or hope - plans were never finalised nor finance ever secured."
If the Deputy Commissioner's case depended upon these further propositions, we would find it difficult to accept. There does not have to be "certainty" that an endeavour will be crowned with success in order to justify, under s 51(1), a claim to deduct its expenses. The cost of sowing the crop will not be the less on revenue account because there was risk of a drought. Indeed, as Menzies J said in John Fairfax & Sons Pty Ltd v Federal Commissioner of Taxation (1959) 101 CLR 30 at 49, the deductibility of an outlay "cannot be made to depend upon the success or failure of what the outlay was intended to achieve". See also Commissioner of Taxation v Ampol Exploration Ltd (1986) 13 FCR 545 at 569-570, 574; Commissioner of Taxation v Osborne (1990) 26 FCR 63 at 68; and cf. Commissioner of Taxation v Cooper (1991) 29 FCR 177 at 197. Nor were the taxpayer's rights subject to any condition of efficiency.
The suggestion that Mrs Steele had "never more than an idea or hope" echoes more flamboyant language in the original reasons for decision of the Tribunal, which described the "motel development [as] no more than a fond hope", and commented:
"It is ... not enough to come within sub-sec 51(1) to buy some land and announce to the world 'I have a dream'"!
These passages seem intended to invoke the proposition that a sufficient connection, for the purposes of s 51(1), between an outlay and the prospect of income requires a degree of commitment to the relevant income producing activity: Inglis v Federal Commissioner of Taxation (1980) 80 ATC 4001 at 4004, per Brennan J, at 4008, 4011, per Davies J; Softwood Pulp and Paper Limited v Federal Commissioner of Taxation (1976) 76 ATC 4439 at 4450 et seq.; Goodman Fielder Wattie Ltd v Commissioner of Taxation (1991) 29 FCR 376 at 387; F C of T v Brand (1995) 95 ATC 4633 at 4646, 4649. But in fact Mrs Steele did much more than announce a dream; she obtained the Council's assent to a change of zoning, employed architects and engineers, entered into joint venture arrangements, and pursued the project with some tenacity until litigation with her collaborator put a complete stop to it. She demonstrated her "commitment" from the beginning by committing $1,000,000 to the venture plus the time, energy and considerable expense of the subsequent architectural and engineering work, and negotiations with the local Council, sewerage authority and prospective joint venturers and financiers. These matters, of course, raise questions of fact; but it appears to us there is much to be said for the proposition that the Tribunal's own findings of fact, set out in the various reasons in telling detail, suggest it was not open to the Tribunal to find in this case a relevant lack of commitment. Our concern about the absence of foundation for that conclusion is not allayed by the unfounded attribution to Mrs Steele of an announcement to the world.
However, if the Tribunal was right to treat the object of the payment of the interest as the development of a profit-yielding structure for a future business enterprise, and thus as an affair of capital, that ground alone will sustain the decision, subject to the question raised by the agistment fees. So it is necessary to examine the authorities determining the rules by which payments of interest may be assigned to capital or to revenue.
The starting point must be an understanding of the relevant principles underlying s 51(1) itself, as expounded in the two judgments of Dixon J in Sun Newspapers Limited v The Federal Commissioner of Taxation (1938) 61 CLR 337 and Hallstroms Proprietary Limited v The Federal Commissioner of Taxation (1946) 72 CLR 634. It is perhaps convenient to begin with the summary statement in the later judgment (at 647), where Dixon J referred to "the general consideration that the contrast between the two forms of expenditure [i.e., on capital account and on revenue account] corresponds to the distinction between the acquisition of the means of production and the use of them; between establishing or extending a business organization and carrying on the business; between the implements employed in work and the regular performance of the work in which they are employed; between an enterprise itself and the sustained effort of those engaged in it." In Sun Newspapers, Dixon J said (at 359 et seq.):
"The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss. ... In a trade or pursuit where little or no plant is required, it [the business structure or entity or organization] may be represented by no more than the intangible elements constituting what is commonly called goodwill ... . At the other extreme it may consist in a great aggregate of buildings, machinery and plant all assembled and systematized as the material means by which an organized body of men produce and distribute commodities or perform services. ... As general conceptions it may not be difficult to distinguish between the profit-yielding subject and the process of operating it. In the same way expenditure and outlay upon establishing, replacing and enlarging the profit-yielding subject may in a general way appear to be of a nature entirely different from the continual flow of working expenses which are or ought to be supplied continually out of the returns or revenue. The latter can be considered, estimated and determined only in relation to a period or interval of time, the former as at a point of time. For the one concerns the instrument for earning profits and the other the continuous process of its use or employment for that purpose. ...
In the attempt, by no means successful, to find some test or standard by the application of which expenditure or outgoings may be referred to capital account or to revenue account the courts have relied to some extent upon the difference between an outlay which is recurrent, repeated or continual and that which is final or made 'once for all', and to a still greater extent upon a distinction to be discovered in the nature of the asset or advantage obtained by the outlay. If what is commonly understood as a fixed capital asset is acquired the question answers itself."
The lengthy passage concludes (at 363) with the often cited statement:
"There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment."
With reference to the matter of recurrence, Dixon J said (at 362) that it "is not a test, it is no more than a consideration the weight of which depends upon the nature of the expenditure"; and at the same page he also pointed out that "the lasting character of the advantage is not necessarily a determining factor", some advantages with "a very short term" being nevertheless on capital account.
There have been many elaborations of the principles stated by Dixon J in Sun Newspapers and Hallstroms. In John Fairfax & Sons Proprietary Limited v Federal Commissioner of Taxation (1959) 101 CLR 30 at 48, Menzies J (with whose judgment Dixon CJ, Kitto and Taylor JJ expressed agreement) said (at 48):
"To make a payment to acquire or to defend the acquisition of a favourable position from which to earn income or to enter into arrangements that will yield income is not in general an outlay incurred either in gaining or in carrying on business for the purpose of gaining assessable income; such a payment in the case of a trading company, occurs at a stage too remote from the receipt of income to be so regarded. To be deductible an outlay must be part of the cost of trading operations to produce income, i.e., it must have the character of a working expense."
And his Honour added (at 50) that "the essential element [that is, for the applicability of s 51(1)] is that the expense has been incurred 'in carrying on business' rather than ... 'for the purpose of enabling a person to carry on' trade and earn profits." Similarly, in Foley Brothers Pty Limited v Federal Commissioner of Taxation (1965) 13 ATD 562 at 563, Kitto,
Taylor and Menzies JJ, in their joint judgment, said: "The true contrast is between altering the framework within which income-producing activities are for the future to be carried on and taking a step as part of those activities within the framework."
In G.P. International Pipecoaters Proprietary Limited v The Commissioner of Taxation of the Commonwealth of Australia (1990) 170 CLR 124 at 137, the joint judgment of Brennan, Dawson, Toohey, Gaudron and McHugh JJ highlights one aspect of these principles as of particular importance:
"The character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by the making of the expenditure, for the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid ... . In the present case, the taxpayer expended the amount received as establishment costs - and more - in constructing the plant which it used in pipe-coating. That was an expenditure as capital and the plant was depreciable property."
See also The Commissioner of Taxation of the Commonwealth of Australia v South Australian Battery Makers Proprietary Limited (1978) 140 CLR 645 at 656, 662; Labrilda Pty Ltd v Commissioner of Taxation (1996) 65 FCR 119 at 137.
Applying these principles, it is plain that the payment of the purchase price of Tibradden, and all payments made to architects in respect of building plans or to local authorities in respect of applications for approvals, were on
capital account. Likewise, the cost of construction, had the project proceeded, would have been on capital account. However, the appellant claims that payments of interest made in respect of moneys borrowed to provide the purchase price were, in accordance with the decision in Travelodge, on revenue account.
In The Federal Commissioner of Taxation v Munro (1926) 38 CLR 153 at 198, Isaacs J said, of interest payable in respect of a loan "to create a new enterprise owned and conducted by a new personality":
"The interest paid in respect of the loan follows accessorially the purpose of the principal sum."
Accordingly, it was not on revenue account. On the other hand, in Farmer v Scottish North American Trust, Limited [1912] AC 118, interest paid on money borrowed by an investment company for the purpose of the investments by which it earned its profits was held to be deductible. Lord Atkinson said (at 127):
"The interest is, in truth, money paid for the use or hire of an instrument of their trade, as much as is the rent paid for their office or the hire paid for a typewriting machine. It is an outgoing by means of which the company procures the use of the thing by which it makes a profit, and, like any similar outgoing, should be deducted from the receipts to ascertain the taxable profits and gains which the company earns."
This passage was applied to the Australian Income Tax Assessment Act 1922 by Starke J in The Texas Company (Australasia) Limited v The Federal Commissioner of Taxation (1940) 63 CLR 382 at 450. Dixon J (at 468-469) stated the matter more elaborately:
"Some kinds of recurrent expenditure made to secure capital or working capital are clearly deductible. Under the Australian system interest on money borrowed for the purpose forms a deduction. So does the rent of premises and the hire of plant."
He referred to the chance of a foreign exchange loss resulting from a deliberate delay, in order to augment working capital, in payment for stock purchased overseas, and said:
"[B]ut the fact that the reason for the delay related to capital does not make the outgoing a capital loss. It is rather a standing contingency representing the recurrent expenditure which must be incurred to obtain the use of the money and is much more like annual outgoings to obtain the use of capital assets, such as rent, hire or interest."
Latham CJ said in the same case (at 430):
"The Income Tax Assessment Act does not include any provision which prevents the deduction of amounts paid in order to obtain the use of capital. Sec. 23(1)(a) expressly permits the deduction of interest if an outgoing of interest is actually incurred in gaining or producing assessable income. If a liability for interest is incurred in order to introduce capital into an income-gaining business enterprise the amount of interest paid is allowable as a deduction: see Federal Commissioner of Taxation v Munro (1926) 38 CLR, at pp. 171, 197, 217, 218."
In Australian National Hotels Ltd v Commissioner of Taxation (1988) 19 FCR 234, the joint judgment of Bowen CJ and Burchett J refers (at 239-241) to the Texas Company case, making the comment:
"[T]here is a special feature of loan capital, which flows from the ephemeral nature of a loan. The cost of securing and retaining the use of the capital sum for the business, that is to say, the interest payable in respect of the loan, will be a revenue item. It creates no enduring advantage, but on the contrary is a periodic outgoing related to the continuance of the use by the business of the borrowed capital during the term of the loan. ...
Rent ... and interest are both periodic payments for the use, but not the permanent acquisition, of a capital item. Therefore, a consideration of the often-cited three matters identified by Dixon J in Sun Newspapers Limited v Federal Commissioner of Taxation [supra] assigns interest and rent to revenue: see Commissioner of Taxation (Cth) v South Australian Battery Makers Pty Ltd (1978) 140 CLR 645 at 654-655; 8 ATR 879 at 884, per Gibbs ACJ; and 662; 889, per Stephen and Aickin JJ."
This section of the joint judgment was cited with apparent approval in the High Court decision in Federal Commissioner of Taxation v Energy Resources of Australia Ltd (1996) 137 ALR 18 at 21, footnote 5.
The deductibility of interest under s 51(1) was directly in issue in Federal Commissioner of Taxation v Total Holdings (Australia) Pty Ltd (1979) 79 ATC 4279. Lockhart J (with whom Northrop and Fisher JJ agreed) said (at 4283):
"In my opinion if a taxpayer incurs a recurrent liability for interest for the purpose of furthering his present or prospective income producing activities, whether those activities are properly characterised as the carrying on of a business or not, generally the payment by him of that interest will be an allowable deduction under sec 51. ...
I say 'generally' as some qualification may be necessary in appropriate cases, for instance, where interest is paid by a taxpayer as a prelude to his being in a position whereby he may commence to derive income. In such cases the requirement that the expenditure be incidental and relevant to the derivation of income may not be satisfied."
In Federal Commissioner of Taxation v Riverside Road Pty Ltd (1990) 90 ATC 4567 at 4575, the joint judgment of Northrop, Wilcox and Hill JJ states:
"Whether interest incurred by a taxpayer will, in a particular case, satisfy the test of deductibility depends upon the facts of a particular case".
They referred to Total Holdings, and then added:
"The language of the section introduces, as Professor Parsons points out in his work Income Taxation in Australia, Law Book Company, 1985 (para 5-37 to 5-48), an element of contemporaneity. Thus an outgoing may be precluded from deductibility if it be incurred at a point too soon before the commencement of the business or income-producing activity ... ."
The primary fact to be determined, when the deductibility of payments of interest pursuant to s 51(1) comes under consideration, is the object served by the use to which the principal sum borrowed has been put during the period to which the payment of interest relates. It needs to be recognized that this object may change over the term of a loan. In Ure v Federal Commissioner of Taxation (1981) 81 ATC 4100 at 4104 Brennan J said that the answer to the question whether the incurring of interest charges on a borrowing of money was incidental to the gaining of income turned upon "an examination of the purposes for which the money was laid out", to be determined objectively from the circumstances. Deane and Sheppard JJ said (at 4109-4110):
"In a case such as the present where the outgoing claimed as a deduction is interest paid on borrowed money, one cannot ordinarily look to the direct object or advantage which the outgoing was intended to achieve for the reason that that will ordinarily be the receipt of the borrowed money which is likely to be neutral in character. One must, of necessity, look more to the objects or advantages which the application and use of the borrowed money were intended to gain (F.C. of T. v. Munro (1926) 38 C.L.R. 153 at p. 197). Where there is a difference between intended and actual use of the borrowed money or a change in use, difficulties may arise in determining what are the relevant objects or advantages which the payment of interest was calculated to procure."
The effect of a change of purpose, referred to by Deane and Sheppard JJ, was also mentioned by Toohey J in Federal Commissioner of Taxation v Ilbery (1981) 38 ALR 172 at 181, where he said (with the agreement of Northrop and Sheppard JJ) that deductible interest in respect of a borrowing to acquire income-producing property would cease to be deductible upon a change of the use of the property to a use for private purposes. There is no reason why the principle should not work the other way too. Not infrequently, the change of use will have been contemplated from the inception of the loan, and confining its purposes to the one use would be quite artificial.
The problem of the characterization of payments of interest in respect of borrowed money, for the purposes of s 51(1), came before the High Court in Fletcher v The Commissioner of Taxation of the Commonwealth of Australia (1991) 173 CLR 1. In a joint judgment of all justices it was said (at 19):
"In the present case, the outgoings of interest in the tax years were incurred in the borrowing of money. The funds borrowed did not constitute assessable income. To the extent that the outgoings of interest incurred in the borrowing can properly be characterized as of a kind referred to in the first limb of s.51(1), they must draw their character from the use of the borrowed funds".
By contrast with such statements as that of Deane and Sheppard JJ in Ure, cited above, this statement is unequivocally concerned with how the borrowed funds are used. It does not look to intention or subjective purpose. But that is not to say that subjective purpose is irrelevant. The rule is rather that it may be taken into account (as it was in Fletcher itself) where the objective facts do not yield a clear answer; but the characterisation of interest "will generally be ascertained by reference to the objective circumstances of the use to which the borrowed funds are put": Commissioner of Taxation v Roberts (1992) 37 FCR 246 at 257, per Hill J (with whom, relevantly, Jenkinson and O'Loughlin JJ agreed); and see Commissioner of Taxation v Janmor Nominees Pty Ltd (1987) 15
FCR 348; Crawford v F C of T (1993) 93 ATC 5234 at 5241; Madigan v F C of T (1996) 96 ATC 4640 at 4644; Brian Reilly Freighters (NSW) Pty Ltd v F C of T (1996) 96 ATC 5122 at 5129.
The issue under consideration in the present case turns on the true application of this test. Here, the use to which the borrowed funds were put was the purchase of a capital asset, Tibradden. The fact that it was a capital asset is not in itself, of course, conclusive, or even particularly helpful. The statements in The Texas Company and the other cases that have been cited make the deductibility in general of interest payments quite clear where the borrowed funds provide capital (and a fortiori working capital) employed in a business or in income earning activities. But Tibradden was not so used, nor was it available for such use. It was almost vacant land. (We are still leaving aside the agistment activities.) Before Tibradden could become the income-producing property that was proposed, much capital work and expenditure would be required.
When Dixon J, in the often cited passage in The Texas Company at 468-469, spoke of the way the Australian system treats interest on money borrowed to secure capital, he was speaking in the context of current income-gaining activities. He regarded interest payments as part of "the recurrent expenditure which must be incurred to obtain the use of the money", and as like other regular outgoings of the business incurred to obtain the use of capital assets, such as rent or hire. If the matter be looked at in this context, and in this way, as Bowen CJ and Burchett J pointed out in the passage cited from Australian National Hotels, interest payments may be seen to secure no enduring advantage. Like rent, they secure merely the use of the capital itself, or of premises representing it, from day to day. But interest paid in relation to the acquisition or creation of a capital asset, which is later to be utilized in income-gaining activities, is in an entirely different position. It is paid so that, when the time comes, an enduring asset (in this case, a motel complex) will be available for use in the intended activity. The fact that, while the capital asset is being created, the payments of interest are recurrent is not enough to change this conclusion. Those payments are not part of the recurrent operations of any existing business activity. Standing alone, the element of recurrence cannot be a controlling factor. Indeed, as Gibbs J pointed out in his dissenting judgment in Cliffs International Inc. v The Commissioner of Taxation of the Commonwealth of Australia (1979) 142 CLR 140 at 153, Dixon J relegated recurrence, in Sun Newspapers at 362, to the position, not of a test, but of "no more than a consideration the weight of which depends upon the nature of the expenditure".
The point may be illustrated by reference to wages, which provide an obvious example of recurring expenditure in the course of business operations by which income is earned, but nevertheless, if paid for a period when the wage earner is engaged in work directed to the creation of a capital asset, are plainly on capital account, recurrence notwithstanding: Goodman Fielder Wattie Ltd v Commissioner of Taxation (1991) 29 FCR 376 at 394; Christchurch Press Company Ltd v Commissioner of Inland Revenue (1993) 15 NZTC 10,206. Ultimately, the question is "whether the essential character of the expenditure is that it is a working expense": Goodman Fielder at 395.
To put the matter slightly differently, if, as the High Court held in G.P. International Pipecoaters at 137, the chief factor in determining the character of a payment is the character of the advantage sought by the making of the expenditure, it seems to us that, in the present case, the advantage sought by the payments of interest was the creation of a capital asset. Had the project proceeded and a motel been opened, of course, that advantage would then have been achieved; and if the loan had not been paid off, but had been continued, the advantage thereafter sought by further payments of interest would have been the continued availability of the sum borrowed to support from period to period the use of the capital asset in income-gaining activities. That is to say, the change of purpose, to which reference was made as a possibility in Ure and in Ilbery, would have occurred in fact.
This reasoning receives strong reinforcement from the decision of the Court of Appeal of Hong Kong in Wharf Properties Ltd v Commissioner of Inland Revenue [1995] 2 HKLR 552, which was affirmed by the Privy Council (Lord Browne-Wilkinson, Lord Lloyd of Berwick, Lord Nicholls of Birkenhead, Lord Steyn and Lord Hoffmann) in reasons delivered by Lord Hoffmann: Wharf Properties Ltd v Commissioner of Inland Revenue of Hong Kong (27 January 1997, reported in [1997] Simon's T.C. 351). In that case, Wharf Properties bought a tram depot at Causeway Bay, Hong Kong, financing the purchase price by means of short term loans, for the purpose of redevelopment for rental income as a commercial complex, which in due course became Times Square. Before the completion of the redevelopment, Wharf Properties sold the site, so that it never received any of the anticipated rental income. During its ownership of the site, it did derive small amounts by way of licence fees. By s 16(1) of the Inland Revenue Ordinance of Hong Kong, it was relevantly provided:
"In ascertaining the profits in respect of which a person is chargeable to tax under this Part for any year of assessment there shall be deducted all outgoings and expenses to the extent to which they are incurred during the basis period for that year of assessment by such person in the production of profits in respect of which he is chargeable to tax under this Part for any period, including -
(a)... sums payable by such person by way of interest upon any money borrowed by him for the purpose of producing such profits ... ."
Section 17(1) relevantly provided:
"For the purpose of ascertaining profits in respect of which a person is chargeable to tax under this Part no deduction shall be allowed in respect of -
(a)domestic or private expenses, including the cost of travelling between residence and place of business;
(b)any disbursements or expenses not being money expended for the purpose of producing such profit;
(c)any expenditure of a capital nature or any loss or withdrawal of capital;
... ."
Litton V.-P. referred to the loans as "borrowed from the banks for the purpose of acquiring and retaining the depot". He concluded that:
"Interest paid on money borrowed for the purpose of acquiring a redevelopment site (intended ultimately to generate rental income) is expenditure of a capital nature and therefore disallowed as a deduction under s 17(1)(c)."
Further, he held that:
"When the redevelopment is complete and is ready to generate chargeable income, or is actually generating chargeable income, any interest paid to secure that asset is expenditure of a revenue nature and is deductible if the conditions in sub-s (2) of s 16 are satisfied."
(These conditions are not presently relevant.) Litton V.-P. added, with reference to accounting guidelines issued by the Hong Kong Society of Accountants, which he regarded as
according "with accepted international standards of accountancy for the treatment of interest charges":
"Borrowing costs incurred as a consequence of a decision to acquire an asset are not intrinsically different from other costs which are commonly capitalized. If an asset requires a substantial period of time to bring it into the condition and location necessary for its intended use, the borrowing costs incurred during that period as a result of expenditure on the asset are a part of the cost of acquiring the asset."
Godfrey JA and Ching JA agreed, though each had a reservation, but not the same reservation.
When the matter went on appeal to the Privy Council, Lord Hoffmann dealt with it on the basis that the "question ... [was] whether the interest payments were expenditure of a capital nature", and commented that the statute adopted "an accounting concept as a rule of law: see Dixon J in Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946) 72 CLR 634, 646." His Lordship added that whether expenditure was of a capital nature or not was "a question of law". He said:
"[T]he present case seems to their Lordships to be relatively straightforward, in which it is sufficient to say that the cost of 'creating, acquiring or enlarging the permanent ... structure of which the income is to be the produce or fruit' is of a capital nature, while 'the cost of earning that income itself or performing the income-earning operations' is a revenue expense: see Viscount Radcliffe in Commissioner of Taxes v Nchanga Consolidated Copper Mines Ltd [1964] AC 948, 960. Applying this distinction, it seems to their Lordships to be plain that the payments of interest during the years in question were made for a capital purpose, namely, as consideration for the use of the money which enabled Wharf to acquire the tramway depot and hold it pending its conversion by redevelopment into an income-earning capital asset."
In the course of further discussion of the arguments put on the appeal, Lord Hoffmann said:
"From the point of view of the payer, ... a payment of interest may be a capital or revenue expense, depending upon the purpose for which it was paid. The fact that it is income in the hands of the recipient and a recurring and periodic payment does not necessarily mean that it must be a revenue expense. Wages and rent are income in the hands of their recipients; periodic payments, in return for services or the use of land or chattels respectively. But whether such payments are of a capital or revenue nature depends on their purpose. The wages of an electrician employed in the construction of a building by an owner who intends to retain the building as a capital investment are part of its capital cost. The wages of the same electrician employed by a construction company, or by the building owner in maintaining the building when it is completed and let, are a revenue expense.
For this purpose, their Lordships consider that there is no material distinction between interest and other periodic payments. As Lord Upjohn said in Chancery Lane Safe Deposit and Offices Co Ltd v IRC [1966] AC 85, 124 ...:
'[T]he cost of hiring money to rebuild a house is just as much a capital cost as the cost of hiring labour to do the rebuilding'.
Mr Gardiner [counsel for the appellant] said that it was not legitimate to examine the purpose for which the money was borrowed in order to ascertain whether the interest paid in consideration of the borrowing had been for a capital or revenue purpose. Their Lordships agree with Litton V.-P. that, on the contrary, there is no other way in which the nature of the interest payment can be discovered. The immediate consideration for each payment of interest is, of course, the use of money during the period in respect of which the interest has been paid, but since money is no more than a medium of exchange which may be expended for either capital or revenue purposes, the question can be answered only by ascertaining the purpose for which the loan was required during the relevant period.
...
Thus, while the question of whether money is intended to be used for a capital or revenue purpose is inconclusive as to whether its receipt is a revenue receipt or an addition to the company's capital [his Lordship had been discussing banking and finance cases], the purpose of the loan during the period for which the interest payment was made is critical to whether it counts as a capital or revenue expense. In the present case, during the whole of the two years in question, the loan was clearly being applied for the purpose of acquiring and creating a capital asset rather than holding it as an income-producing investment. It follows that the interest was being expended for a capital purpose."
Lord Hoffmann specifically stated the Board's agreement with the judgment of Litton V.-P., and particularly with his view that it was "necessary to enquire into the purpose of the loan". His Lordship added:
"Each payment of interest must be considered in relation to the purpose of the loan during the period for which the interest was paid. Once the asset has been acquired or created and is producing income, the interest is part of the cost of generating that income and therefore a revenue expense. In this respect their Lordships agree with the judgment of McMullin J in Tai On Machinery Works Ltd v CIR [1969] 1 HKTC 411 and are unable to follow the reasoning by which the National Court of Papua New Guinea arrived at a contrary conclusion in Travelodge Papua New Guinea Ltd v Chief Collector of Taxes (1985) 85 ATC 4432."
In Tai On Machinery Works, interest payments made during the construction period of an industrial building in respect of a borrowing to finance the works were held to be capital in nature, the principal sum having been "borrowed to produce an income earning asset"; but upon completion of the building and its becoming available to produce revenue, the interest was recognized as revenue in nature, the reason being, as Litton V.-P. explained in his judgment in Wharf Properties that "[u]p to the date at which the asset comes into existence as an earner of revenue every payment of interest which is made may fairly be regarded as an item paid once and for all towards the bringing of that asset into existence"; but thereafter the asset is held "for the benefit of the business".
So far, the matter has been considered without regard to the relatively tiny amount of income which the taxpayer received by virtue of the agistment activities conducted on the land. It is now necessary to move to the issues raised by the receipt of that return from the outlays relating to Tibradden. The learned judge affirmed the view of the Tribunal that the taxpayer's agistment activities amounted to a subsidiary purpose only of the borrowing, which should be reflected in an apportionment of the interest claimed as a deduction, upon the same basis which was adopted in Ure. In our opinion, his Honour was right in so holding. The words "to the extent to which they are incurred in gaining or producing the assessable income", in s 51(1), contemplate apportionment in some circumstances. Ure was a case where a disproportionately small amount of income was earned by a borrowing at a substantial rate of interest. The taxpayer was allowed a deduction of so much only of the interest paid as equalled the assessable income earned. Brennan J (at 4106) and Deane and Sheppard JJ (at 4111) held this approach to be appropriate, on the footing that the disparity between the earnings and their cost in itself suggested the existence of purposes ulterior to those of earning income, and that in all the circumstances the criteria of s 51(1) were not met in respect of the balance of the interest. Its payment was not incidental to the gaining of income. In Fletcher v Federal Commissioner of Taxation (supra), the joint judgment of the High Court (at 18-19), having referred to cases involving expenditure to which s 51(1) is applicable, continued:
"The position may, however, well be different in a case where no relevant assessable income can be identified or where the relevant assessable income is less than the amount of the outgoing. Even in a case where some assessable income is derived as a result of the outgoing, the disproportion between the detriment of the outgoing and the benefit of the income may give rise to a need to resolve the problem of characterization of the outgoing for the purposes of the sub-section by a weighing of the various aspects of the whole set of circumstances, including direct and indirect objects and advantages which the taxpayer sought in making the outgoing. Where that is so, it is a 'commonsense' or 'practical' weighing of all the factors which must provide the ultimate answer. ... If ... that consideration reveals that the disproportion between outgoing and relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective and that part only of the outgoing can be characterized by reference to the actual or expected production of assessable income, apportionment of the outgoing between the pursuit of assessable income and the pursuit of that other objective will be necessary."
The same approach was adopted by the Privy Council in Wharf Properties with respect to the small amount of income from licence fees. Lord Hoffmann said of this:
"But earning this income was not the purpose for which Wharf acquired the depot, borrowed the money or paid the interest. It was an adventitious benefit unconnected with its larger ambitions. Their Lordships think that the justice of the case was more than adequately met by the Commissioner treating it as a subsidiary purpose and allowing a deduction of the equivalent amount of interest."
See also Federal Commissioner of Taxation v Kowal (1983) 84 ATC 4001; Ronpibon Tin No Liability v Federal Commissioner of Taxation (1949) 78 CLR 47 at 59; Madigan v F C of T (supra, at 4644-4645).
Counsel for the appellant sought to persuade the Court to take a contrary view on the basis that Fletcher could be distinguished as concerned only with the first limb of s 51(1), and that, by contrast with Fletcher and Ure, this case involved a genuine and quite ordinary, if very small, business activity. But the distinction between the limbs of s 51(1) does not require the Court to treat the disparity between a great outgoing and a tiny receipt differently according as the deduction is claimed under the first or the second limb of the provision. The absence of artifice and the presence of real commercial considerations put a stronger foundation under the submission. It should need no emphasis that apportionment does not follow because outgoings exceed income, even by a considerable margin. Only if the disproportion, when weighed
with circumstances that cast light on it, is revealed as pointing to some objective different from any which attracts s 51(1), does the question of apportionment arise. That is not a usual situation. But the exposition in Fletcher refutes counsel's suggestion that a colourable transaction is required. A case, such as the present, involving extreme disparity and an acknowledged dominant purpose which is in reality of a capital nature, so that the little business relied on is a mere sideshow, though not colourable, raises the very considerations discussed in Fletcher. The whole of the outgoing does not meet the criteria for deduction; apportionment is required; and, being required, has been applied in a manner appropriate to the particular case: cf. Commissioner of Taxation v Edwards (1994) 49 FCR 318 at 322-323.
For these reasons the appeals should be dismissed with costs.
I certify that this and the preceding thirty (30) pages are a true copy of the Reasons for Judgment herein of their Honours Justice Burchett and Justice Ryan.
Associate:
Date: 18 March 1997
IN THE FEDERAL COURT )
OF AUSTRALIA )
WESTERN AUSTRALIA ) No. WAG 11 of 1996
DISTRICT REGISTRY )
GENERAL DIVISION ) Consolidated with
No. WAG 12 of 1996
ON APPEAL FROM A SINGLE JUDGE OF THE FEDERAL COURT
OF AUSTRALIA
BETWEEN: KATHLEEN FAYE STEELE
Appellant
AND: DEPUTY COMMISSIONER OF
TAXATION
Respondent
CORAM: BURCHETT, RYAN & CARR JJ.
PLACE: PERTH
DATE: 18 MARCH 1997
REASONS FOR JUDGMENT
Introduction
CARR J:
This is an appeal from a judgment of a single Judge of the Court, given on 19 January 1996, in an appeal brought by the appellant, Mrs Kathleen Faye Steele, from a decision of the Administrative Appeals Tribunal [constituted by Dr P Gerber (Deputy President) and Messrs R D Fayle and S D Hotop (Senior Members)] on 4 March 1994. The Tribunal, to a very limited extent, allowed the taxpayer's appeal against the disallowance of her objection, dated 7 July 1989, to the Commissioner of Taxation's assessment (dated 8 May 1989) of her liability for income tax in respect of the year ended 30 June 1987. The effect of the disallowance was to deny the appellant deductions totalling $909,649 in respect of losses said to have been incurred in that
year and in each of the six years ended 30 June 1981 to 30 June 1986 - see s.80 of the Income Tax Assessment Act 1936 (Cth) ("the Act"). The outgoings upon which the deductions were claimed as allowable and giving rise to such losses comprised mainly interest payments, but included payments of municipal rates and rent. The Tribunal set aside the Commissioner's decision on the objection and remitted the matter to the Commissioner to be dealt with in accordance with its reasons. This was because the Tribunal (by majority) found that a slightly greater, but unquantified, proportion of the outgoings should have been allowed as deductions than the Commissioner had allowed. In issue is whether the payments of interest, municipal rates and rent were allowable deductions under s.51(1) of the Act. The appeal at first instance in this Court was brought under s.44 of the Administrative Appeals Tribunal Act 1975 (Cth) ("the AAT Act") and was accordingly "on a question of law". This appeal from his Honour's decision is equally so restricted. In short, the question is whether the Tribunal erred in law.
Factual Background
The following narration of the facts is taken either from express findings made by the Tribunal, or comprises matters which were common ground. In my view, this is one of those tax cases where the facts require particularly close examination.
For many years Mrs Steele (to whom I shall refer variously also as "the appellant" or "the taxpayer") was engaged in various businesses either as a manager, sole owner or as a partner. The businesses were principally in the catering and hospitality industry. One such engagement involved the taxpayer managing (for a period of some six weeks)
a hotel which was part of an equestrian complex providing tourist accommodation and entertainment. During the period between about 1974 and 1979 the taxpayer managed the catering facility for the Guild of Undergraduates at the University of Western Australia. By early to mid 1980 the taxpayer had sold a business which she had until then been conducting. Whilst driving along Great Eastern Highway, South Guildford she noticed a "For Sale" sign on a property known as "Tibradden" near Perth Airport. The property had an area of 7.4 hectares and was owned by Western Australian Bloodstock Agency Pty Ltd ("the Company"). The taxpayer knew two of the directors of the Company through her connection with the Western Australian Turf Club. "Tibradden's" improvements comprised twelve brick stables, twenty-five separate yards, feed preparation and tack rooms, eight separate horse exercise paddocks, a large training ring, a smaller breaking-in ring and two houses (one used as accommodation for trainers and jockeys, the other as the manager's residence and office). Part of the training track was located on adjoining land which the Company leased from the Metropolitan Region Planning Authority ("MRPA"). The improvements were in good repair, the fences painted white and the gardens and lawns were at that time maintained in good condition.
Shortly thereafter the taxpayer made the following oral inquiries:
.to the local council, about the rezoning of "Tibradden" to permit its use both for agistment and as a motel development. She was told that "there probably would not be a problem in getting it rezoned"; and
.the Metropolitan Water Supply, Sewerage and Drainage Board ("the Water Board"), concerning possible connection of sewerage.
On 28 November 1980 the taxpayer wrote to the MRPA about taking a tenancy of the land currently leased by the Company for the training track and also about the future development of "Tibradden". At about the same time the taxpayer made an oral inquiry to the MRPA about the possibility of a land exchange whereby, if she acquired "Tibradden", she would swap an area of land with a frontage to Great Eastern Highway for a much larger area owned by the MRPA at the rear of the property.
On 18 December 1980 the taxpayer entered into a contract to purchase "Tibradden" ("the Contract of Sale"). The purchase price was $1 million payable by a deposit of $5,000, a further payment of $95,000 on or before 8 January 1981 with the balance of $900,000 due on 8 January 1982. The property was at that time subject to a mortgage in favour of Finance Corporation of Australia Ltd. The Contract of Sale obliged the taxpayer to pay interest on the balance of purchase moneys owing from 16 December 1980 at "the maximum allowable bank rate from time to time on business overdrafts under $100,000 plus one per centum". The taxpayer took possession of the property on 18 December 1980, in accordance with the terms of that contract.
In January 1981 the taxpayer negotiated a tenancy from the MRPA of part of the training tracks. At the same time negotiations commenced for the proposed land exchange. On 13 February 1981 the Secretary of the MRPA sent a letter to Mrs Steele enclosing a copy of a plan which showed that proposed land exchange.
The Tribunal found that from the time when the taxpayer took possession of "Tibradden" in December 1980 through to the eventual disposal of her remaining interest in the property in May 1987, she conducted on it the business of agisting horses. The expression "agistment" was accepted as including stabling. The Tribunal (by majority) found that there were at all times, on average, between 20 and 30 horses so agisted on "Tibradden". Although the Tribunal was unable to find the precise assessable income derived from this business during those years, it accepted as "approximate estimates" of the appellant's one half share in such income, the following:
Year Amount
1981 $4024
1982 $6954
1983 $ 595
1984 $3693
1985 $6812
1986 $3474
1987 $3391
There were two hearings before the Tribunal which resulted in what was described as "the first decision" and "the second decision". The first decision was unanimous. The second decision resulted in the publication of two sets of reasons; the majority reasons and those of Dr Gerber. After the first hearing the Tribunal had concluded that from January 1982 there had not been an agistment business conducted on "Tibradden". As a result of further evidence, heard at the second hearing, the Tribunal modified its findings in that regard. I set out below some of those (later) findings:
"17.On the basis of the fresh evidence, a preferred conclusion is that whilst the main or dominant purpose for which "Tibradden" was held was its redevelopment, nonetheless, at all material times assessable income was derived from a business being carried on. That business had no other objective than to derive assessable income which, subjectively, helped to defray the expenses of running that business and of holding the property. It is on this basis that the issue of apportionment is to be determined.
. . .
20.In the present case there is a considerable disproportion between the amount of assessable income and the allowable deductions claimed. However, there is no suggestion that in the case at hand there was not a genuine business relationship between the applicant (and her arm's length partner) and the lending institution to which the liability to pay interest was incurred as a consequence of a commercial agreement to borrow and lend money in the ordinary course of business. There is no suggestion that the mortgage loan in question was other than genuine. There is no question here of a colourable arrangement designed to disguise other purposes lying behind the applicant's dominant purpose of redevelopment and the subsidiary purpose of deriving income from the "horse" business. Therefore, in the absence of any of the "colourable" unreal or disingenuous arrangements of the sort which featured in Fletcher [a reference to Fletcher v. Federal Commissioner of Taxation (1991) 173 CLR 1] and Ure v. FCT (1981) 34 ALR 237, we turn to other decisions for direction in relation to the appropriate consideration to be given to the purpose of the applicant in deciding on what basis apportionment is to be made in the given circumstances."
The taxpayer has always and readily conceded that the moneys borrowed by her (including the credit extended by the Company as vendor) were not wholly laid out to earn fees from agistment and that her predominant purpose in purchasing "Tibradden" was for its future potential as a motel complex. I return to the narrative.
In July 1981 the taxpayer engaged a firm of architects, Messrs Robert Cann and Associates ("Cann"), to prepare schematic designs for eighty townhouses. The agreement with Cann referred to a "Residential Development with Community Facilities, Restaurant, Office Accommodation, Recreation Sports and Riding". At about the same time, the taxpayer had discussions with a Mr Robert John Williams, the managing director of a large construction company. The taxpayer had an earlier business involvement with Mr Williams in the form of a submission for the establishment of a casino - a matter quite unrelated to "Tibradden". Mr Williams,
although having no legal or equitable interest in "Tibradden" at that stage, took some initiatives in relation to the possible development of the property. This included attending a meeting on 10 November 1981 with the taxpayer and Mr Robert Cann and two of his associates. The minutes of the meeting indicate that Mr Williams and the taxpayer outlined a "brief" to Cann to the effect that the complex would incorporate a "central administration with motel-suites in close proximity, surrounded by townhouse-type units for sale as strata titles to investors, these would be run by the motel management" (emphasis added). The minutes indicate a two-stage involvement for Cann. The first stage was described as a "Broad Brush approach for 150 units". The second stage was to include detailed sketch plans and their submission to the local council with sufficient information for costing. Other matters referred to in the minutes included:
. sewerage;
. MRPA land swap;
. zoning; and
. road closures.
In September and October 1981 the taxpayer and Mr Williams discussed the sale by her of a half interest in "Tibradden" to Mr Williams. In the meantime, in October or November 1981, Mrs Steele had a meeting with the Commissioner of the Water Board with a view to resolving the sewerage requirements for the development of "Tibradden".
In December 1981 the taxpayer and Mr Williams received advice from plumbing consultants and civil and structural engineers on the proposed project for "Tibradden".
The plumbing consultants had been engaged by Cann, on behalf of the taxpayer, in July of that year. On 8 December 1981, on behalf of the taxpayer and Mr Williams, Cann applied to the City of Belmont (the local municipality) for planning approval in respect of the construction of 40 units of motel-style accommodation including administration and restaurant facilities together with 110 free-standing units which could either be self-contained or serviced from the motel administration centre. On 10 December 1981 the City of Belmont refused approval on grounds related to zoning and sewerage requirements. On 8 January 1982 the taxpayer and Mr Williams executed an agreement whereby Mr Williams bought a half interest in "Tibradden". The purchase price for that half interest was $650,000 payable by a deposit of $200,000 upon execution of the agreement and the balance by Mr Williams assuming one-half of the taxpayer's liability to the Company (under the Contract of Sale) and to the MRPA (under the lease of the land used for the training track) as from 8 January 1982. Mrs Steele and Mr Williams executed what appears to be a "side agreement" on the same date ("the Supplementary Agreement"). By that document Mr Williams agreed, on certain conditions, to pay Mrs Steele a further $350,000 for the half interest in "Tibradden". One such condition was "... if the project proceeds to profitable completion". "Profitable completion" was defined as meaning "gross proceeds exceed the cost of the development". It would seem that disagreements arose later between Mrs Steele and Mr Williams about the intent and effect of the Supplementary Agreement. I mention the Supplementary Agreement at this stage because, in my view, it conveys something of the nature of the activity in which the taxpayer and her partner, Mr Williams, were then engaged.
In January 1982 Cann made a further submission to the City of Belmont for approval in principle of the proposed motel development. On 10 February 1982 the City of Belmont gave approval in principle to that development.
Events which took place during the remainder of the calendar year 1982 included:
.Mr Williams dismissing Cann as architects and appointing a Mr Andrews as a substitute architect;
.Mr Andrews submitting a substitute motel development project to the City of Belmont for approval. That proposal included livestock stables and a yearling sales complex;
.the City of Belmont approving the concept;
.settlement with the Company of the purchase of "Tibradden" and the transfer of an estate in fee simple in that property to the taxpayer and Mr Williams;
.the assumption by the taxpayer and Mr Williams of the Company's former obligations under its mortgage of "Tibradden" to Finance Corporation of Australia Ltd;
.the preparation, by Ralph & Beattie, Bosworth Pty Ltd (Quantity Surveyors and Building Cost Consultants) of an estimate for the construction of a 200 room motel;
.negotiations with Southern Pacific Hotel Corporation Ltd for that company to take an interest in the 200 room motel and to manage it;
The events of the calendar year 1983 included:
.further negotiations with Southern Pacific Hotel Corporation Ltd;
.negotiations with Malaysian interests for the formation of a company as a vehicle for the joint development of a 208 room hotel;
.the reinstatement of Cann as architect to the project;
.an application to the City of Belmont for approval in principle to the development of a motel and country club resort, rezoning and road closure. The application received conditional approval on 9 August 1983;
.completion of the land exchange with the MRPA to comply with City of Belmont conditions;
.a dispute between the taxpayer and Mr Williams arising out of the Supplementary Agreement;
.a "memorandum of intentions" executed with Malaysian investors for the proposed purchase and development of "Tibradden". The proposal did not proceed further;
.a further estimate, in December 1983, from Ralph & Beattie, Bosworth Pty Ltd for the cost of constructing 208 residential units plus a central building including a manager's flat and squash court; and
.preliminary approval by the Minister for Town Planning to proposed rezoning of "Tibradden".
The taxpayer was unhappy with the estimated development cost provided in December 1983. Negotiations took place between the taxpayer and Mr Williams to resolve their differences. Alternative resolutions included the sale back to the taxpayer of Mr Williams' interest, auctioning the property (an unsuccessful auction was held in July 1984) and partition of the property. In the meantime, on 6 July 1984, the Minister for Planning granted final approval for rezoning of "Tibradden" from "Residential A" to "Highway Development".
The relationship between Mrs Steele and Mr Williams appears to have deteriorated to the extent that she sued Mr Williams in the Supreme Court for partition or sale of the property. On 10 November 1986 the Supreme Court ordered that "Tibradden" be auctioned publicly. The auction took place on 17 December 1986. Mrs Steele was the successful bidder. It would appear that she had a prior arrangement for the sale of one half of the property to a third party. That arrangement fell through. Mrs Steele then sold a half interest in "Tibradden" to another party. Settlement of that transaction took place on 1 May 1987. She sold the remaining half interest some eighteen months later.
The Tribunal's Decisions
In its reasons for the second decision, the Tribunal expressly confirmed the following paragraph of its reasons for the first decision:
"50.We accept that in 1979, S [the taxpayer], having sold her business, was looking round for an investment which would provide her a good income. However, we reject S's assertion that her equestrian interests played any role in her initial search. Indeed, we are satisfied that when she discovered that Tibradden was on the market, her interests were focused on its commercial possibilities as a motel site, and the fact that the property was presently used for agisting horses was merely fortuitous. We therefore accept as accurate - and accurately reflecting S's intention - the answer she gave to Mr T [an officer from the Australian Taxation Office] as to how she intended to use Tibradden, vis: "my intention was to build a motel and operate it by myself. It was my belief that another motel business in that area would be profitable, given the proximity to the airport and the city." The fact that Tibradden was used for agistment purposes was thus a lucky coincidence - lucky in the sense that it coincided both with her own interests, as well as contributing, however modestly, to the holding costs whilst the motel plans were being developed. It also provided accommodation and an occupation for S's sister."
It would appear (see paragraphs 44 and 45 of the reasons for the first decision) that although the taxpayer's objection to the disallowance of the deductions claimed was based on the fact that she purchased "Tibradden" with the intention of building a motel on the property and operating that motel for the purpose of producing assessable income, the case before the Tribunal was conducted on a different basis. Before the
Tribunal, (and to a considerable extent in this Court) the case was conducted on the basis that the deductions were allowable because they were outgoings necessarily incurred in carrying on a business (the agistment business) for the purpose of gaining or producing assessable income and thus fell within the second limb of s.51(1) of the Act.
The approach which the Tribunal adopted to decide the matter was, in summary, as follows:
.the Tribunal noted that "there would be no doubt about allowing the entire interest expense incurred should it happen to have been less than the actual assessable income derived" [citing Cecil Bros Pty Ltd v. Federal Commissioner of Taxation (1964) 111 CLR 430; F.C.T. v. South Australian Battery Makers Pty Ltd (1978) 140 CLR 645 and I.R.C. v. Europa Oil (NZ) Ltd (No. 1) [1971] AC 760];
.the Tribunal cited Fletcher as authority for the proposition that where there is a disproportion between an outgoing incurred and the income derived in a particular year it was relevant to examine the purpose of the taxpayer;
.the Tribunal found that the "mortgage loan" was genuine and that there was no question of a colourable arrangement (see paragraph 20 set out above);
.the Tribunal decided to turn to "other decisions for direction in relation to the appropriate consideration to be given to the purpose of the applicant in deciding on what basis apportionment is to be made in the given circumstances." [It is to be noted that the Tribunal, at this stage of its reasoning on the second occasion, did not decide whether an apportionment should be made but "on what basis apportionment is to be made". However, by reading paragraphs 56 and 57 of its first decision and paragraphs 23 to 26 of its second decision it would appear that the Tribunal decided that apportionment was appropriate because the use to which the borrowed funds was put was to be characterised as being predominantly of a capital nature. I return to this aspect further below];
.the Tribunal accepted that the subjective intention of the taxpayer would not normally play a role in deciding "deductibility" except where the outgoing was disproportionately higher than the income;
.the Tribunal decided that "in those instances" it was relevant to undertake a review of the circumstances of the taxpayer to decide whether there existed objectives other than the derivation of assessable income which might be expected. Where that was so, then apportionment was required; and
.the Tribunal found that the principal outgoing sought to be deducted under s.51(1) of the Act was interest incurred on borrowing to secure the purchase of "Tibradden".
The Tribunal concluded its reasoning as follows:
"25.We are mindful that the Act, at least in its generic form, sets out to tax the difference between "assessable income" and "allowable deductions", provided that the appropriate nexus exists between the two. Receipts of capital (putting aside Part IIIA), exempt income and income from private or domestic activities are not in the nature of income, and so it follows in s.51(1) that neither may outgoings of the same character be deducted. Dissection or even apportionment of outgoings is required where the outgoing is directed in part to achieving a non-assessable income objective.
26.The evidence in the present case indicates that the applicant, in purchasing "Tibradden", had a dual objective, the dominant one of which was capital redevelopment. Therefore, for losses or outgoings to qualify for deduction under s.51(1), dissection or apportionment must occur". (Emphasis added). The applicant's evidence was that she acquired "Tibradden" as an investment for development. Her evidence makes it clear that she did not have any specific plan in mind as to how this investment might be made profitable; all that she had was an idea, at best, to develop a motel to be managed by herself. Her idea was that what she developed would produce income under her management. Whilst that idea was far from crystallised, the evidence indicates that there was no thought on her part, nor later of her partner Williams, to sell the property for profit. Sale of the property was imperative when, towards the end, it became economically impossible to proceed with a development. The idea to develop the investment was not incompatible with the fact that there existed on the property an agistment business which, with virtually no effort on her part, could be continued at least until redevelopment commenced and would provide income. The purpose of the applicant in acquiring the property was therefore twofold - to obtain income from "Tibradden" so long as that was convenient (the subsidiary purpose) and to develop the property (the main purpose), an
activity which would not of itself amount to a present purpose of gaining assessable income. There were too many contingencies to say with any certainty that income would ever be derived from the dominant purpose. The evidence is that this was never more than an idea or hope - plans were never finalised nor finance ever secured. The interest expense incurred to secure the property served these purposes indifferently."
Although the matter is not entirely free from doubt, it seems to me that the Tribunal reached its decision on the following basis:-
The nexus between the interest outlay and the generation of income from the proposed motel development was too remote for that expense to fall within the first limb of s.51(1). See paragraph 57 of its first set of reasons:
"We are satisfied that, to the extent that S relies on any future income to be derived from any motel complex, the nexus - to use a hallowed concept from the law of tort - is too remote. It is, in our view, not enough to come within sub-sec 51(1) to buy some land and announce to the world "I have a dream". [I would interpolate here that if this was supposed to be a description of the facts as found by the Tribunal, it was a grossly unfair description]. Nor is the case assisted by the fact that this dream turned into a nightmare. We have therefore concluded that to the extent that the holding costs of Tibradden relate to the motel project - the first "limb" of the applicant's argument - they are not an allowable deduction."
So far as the second limb of s.51(1) was concerned, the disproportion between the income derived from agistment and the interest expense made it relevant to examine the taxpayer's purposes in purchasing "Tibradden". An examination of those purposes showed that the dominant objective of the taxpayer was capital redevelopment, therefore so the Tribunal held, there had to be an apportionment.
The remoteness referred to above may also have been part of the Tribunal's justification for apportionment (see the last few lines of the portion of paragraph 26 set out above).
The Statutory Framework
Section 6 of the Act defines "business" in the following terms:
"`business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee."
Section 51(1) provides as follows:
"51(1)[Deductions for losses and outgoings]
All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions 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 relation to the gaining or production of exempt income."
Commissioner of Taxation v. Edwards (1993) 119 ALR 375 at p.380 [affirmed on appeal (1994) 49 FCR 318]:
"However, as Lockhart J and Hill J pointed out in their judgments in FCT v. Cooper [(1991) 29 FCR 177 at p.184, 198-9], the result of decisions such as Lunney [(1958) 100 CLR 478] and Lodge v. FCT (1972) 128 CLR 171, is that it is not sufficient to fix particular expenditure with the necessary character that it is a pre-requisite to the earning of the taxpayer's assessable income, in the sense that it is necessary if the assessable income is to be derived. The expenditure must also be "incidental and relevant" to the derivation of income; in particular, it is necessary to determine the "essential character" of the expenditure itself and it is not sufficient that unless the expenditure is incurred the taxpayer will be unable to engage in the activity from which the income is derived.
This concentration upon the characterisation of the expenditure incurred was said by Mason J in Lodge (at 175) to be founded "largely on the presence of the word `in' in the principal parts of the subsection"."
See also Federal Commissioner of Taxation v. Riverside Road Lodge Pty Ltd (1990) 23 FCR 305 at p.314.
I acknowledge that Edwards, Cooper, Lunney and Lodge were all decisions involving the application of the first limb of s.51(1). However, both limbs are introduced by the word "in" which governs the relationship required.
In my view, it would be quite unrealistic to characterise the interest expenditure in this case as being "in" the business of agistment of horses. The circumstances of the transaction do not give it the complexion of money laid out wholly in carrying on that business. Neither the essential character of the interest expenditure nor the occasion of that outgoing is to be found in the carrying on by the appellant of the horse agistment business. The circumstances were such that the essential character of the outgoing was as the cost for the use of money laid out in buying "Tibradden" as part of a venture or undertaking whereby that property was to be turned to profitable account. To some small extent, but by no means wholly, that included the conduct of the horse agistment business as an interim part of that venture or undertaking. To the extent that it can be so characterised, the taxpayer is entitled to an allowable deduction on the basis of the horse agistment business alone. Cases exemplified by Cecil Bros Pty Ltd v. Federal Commissioner of Taxation (1964) 111 CLR 430 (upon which the appellant relies for an allowable deduction of all the expenditure) are to be distinguished. In those cases there can be discerned the connection between the legal right acquired (e.g. in Cecil Bros property in shoes) and the carrying on of a business (retailing shoes) even though more was paid for the shoes than need have been paid. Owen J in Cecil Bros at first instance, and each member of the Full Court on appeal, held that the fact that the taxpayer paid more for its purchases than it would have, had it dealt direct with manufacturers, did not prevent the outgoing from being an allowable deduction under the second limb of s.51(1). The distinction which I would make in relation to the present matter arises out of the gross disparity between the income of the horse agistment business and the outgoing. It was not in issue that the gross income amounted only to about 3.5% of the outgoing. In bringing to bear what was described in Fletcher (at p.20) as "... a common sense appreciation of the overall factual context in which the outgoings were incurred" it is just not sensible to characterise the whole of the interest outgoing as being incurred in carrying on the horse agistment business.
It may well be, however, that the true nature of the business which the appellant was carrying on was that of a property developer. Mrs Steele went about the acquisition of "Tibradden" in a businesslike way. All her dealings with the property were directed towards turning it to profitable account one way or another, again in a businesslike way. The local council and the Water Board were approached, before the purchase was made, to overcome the problems of zoning and sewerage respectively. And the evidence is that eventually those problems were largely overcome. Within two months of buying "Tibradden", Mrs Steele had arranged a partial land swap with the Water Board. Mrs Steele turned half her interest in the land to what appears to have been profitable account when she sold that interest to Mr Williams. Thereafter they engaged in a joint endeavour to make a profit, one way or another, out of the property. A small part of that composite business could be said to have included horse agistment for reward on an interim basis. If all those activities can be regarded as the carrying on of a business then I would have little difficulty in characterising the interest outgoing in respect of moneys borrowed to buy the land as being an allowable deduction under the second limb of s.51(1). However, it is not necessary to decide that matter because, in my view, the first limb of s.51(1) more appropriately applies to the deductions claimed.
As Brennan J observed in Magna Alloys (at p.217):
"Whether the assessable income against which expenditure is sought to be deducted is produced in the carrying on of a business or in some undertaking which does not constitute the carrying on of a business, the same kinds of factors are material to deductibility."
On that note, I turn to the application of the first limb of s.51(1).
In my opinion the Tribunal erred in law in drawing the following key conclusions:
"26.The evidence in the present case indicates that the applicant, in purchasing "Tibradden", had a dual objective, the dominant one of which was capital redevelopment. Therefore, for losses or outgoings to qualify for deduction under s.51(1), dissection or apportionment must occur ...
...
27.The applicant incurred interest on a loan to secure "Tibradden" for a dual purpose, one to derive assessable income from the agistment activities - an affair of revenue - and the other to develop a profit-yielding structure of a future business enterprise - an affair of capital."
In my opinion, the Tribunal moved too quickly from the finding of the taxpayer's dominant purpose (which was always conceded) to the conclusion that the interest and other holding charges were of a capital nature.
In Cliffs International Inc v. Federal Commissioner of Taxation (1979) 142 CLR 140, Barwick CJ after referring to Egerton-Warburton v. Deputy Federal Commissioner of Taxation (1934) 51 CLR 568 at pp.572-573 and the cases there cited said (at p.148):
"... it clearly and, in my opinion, correctly appears that the fact that payments are made or received in performance of a promise given as part of the consideration for the acquisition of a capital asset does not necessarily mean that the payments are themselves of a capital nature."
As Brennan J observed in Magna Alloys (at p.222):
"What the taxpayer has in mind may bear upon "the character of the business or undertaking" in showing the scope of his business or undertaking."
Given the taxpayer's purposes in acquiring "Tibradden", it is very difficult to imagine any circumstances in which any profit (had she made a profit) generated from her activities in relation to the property would not constitute assessable income. The
whole of the taxpayer's undertaking in this matter was commercial in character. It was a "business deal" or "operation of business" even assuming that the acquisition was not a transaction entered into in the course of carrying on a business. The distinction was pointed out by Mason J in Federal Commissioner of Taxation v. Whitfords Beach Pty Ltd (1982) 150 CLR 355 at 379. It could not be contended, on the facts of this matter, that had the taxpayer sold "Tibradden" for a profit, such profit would have been treated as a capital gain, not assessable income. In my view, any such profit would have been assessable income by virtue of the operation of s.25(1) or s.26(a) of the Act (or its successor s.25A, depending upon when the property was sold). As Mason J observed in Whitfords Beach (at p.381):
"There will be cases in which property will be acquired for the purpose of profit-making otherwise than by sale. Then so long as the acquisition is an element in a profit-making undertaking or scheme the resultant profit will be caught by the second limb [of s.26(a)], even though the undertaking or scheme lacks the repetitive or recurrent characteristics that are regarded as the hallmark of business activity."
In my opinion, in the particular circumstances of this case, the taxpayer had set in motion a profit-making undertaking or scheme at the very latest in July 1981 when she engaged Cann to prepare schematic designs for eighty townhouses. The undisputed evidence shows that she was determined to turn "Tibradden" to account for profit in a commercial way as best she could. To that end the taxpayer, within 13 months of its acquisition, sold a half interest in the property on terms which were, at least potentially, of financial advantage to her. I consider that, in combination, those circumstances provide the necessary nexus between the interest outgoings and the gaining of assessable income. It may even be that, given her profit-making purpose, the profit-making undertaking or scheme came into existence when the taxpayer bought
"Tibradden". The purchase of that property might well be seen as the first "step taken in the process of gaining or producing income" [John v. Federal Commissioner of Taxation (1989) 166 CLR 417 at p.427.] The fact that there were changes to the content or form of the taxpayer's financial plan or venture is not inconsistent, in my view, with a conclusion that from the outset she was committed to a plan, however broad or flexible, to earn assessable income from the land and any development that might be carried out upon it. It is sufficient, for present purposes, to point to the likelihood that, in all of the above circumstances, the gross receipts of the taxpayer's enterprise would have been income by ordinary usage under s.25(1) of the Act. Accordingly there is no need further to consider the application of s.26(a) or its successor, s.25A. Nor is it necessary to consider at length matters such as whether the taxpayer gave notice to the respondent under the relevant provisions which condition an allowable deduction for losses incurred where those sections apply - see for example s.52(1) of the Act. Professor Parsons in "Income Taxation in Australia" (Law Book Company Ltd, 1985) at para 10.274 expressed the opinion that:
"The "abortion" of an isolated venture from which a profit that is income may have been derived will preclude the derivation of income and equally, preclude the incurring of a deductible loss."
It is not entirely clear whether Professor Parsons was referring to a loss incurred on disposal of the land. Given the context of a series of references to Whitfords Beach, I am inclined to think that was the case. The facts of the present case are different. There is no claim for any deficiency between the purchase price and the proceeds of sale. The claim is for deductions for payments of a recurring nature (mainly in respect of interest) made over a number of years. In the immediately following
paragraphs Professor Parsons debated the question whether s.52(1) applies to isolated business ventures falling within s.25A but which might also give rise to income by ordinary usage.
As is apparent from these reasons, my view is that if the relevant income is or would have been brought to tax as income by ordinary usage [by s.25(1) of the Act] then s.51(1) applies and s.52(1) has no application. As this question was not considered before the Tribunal or at first instance, I do not consider that it is appropriate for me to elaborate upon my reasons for that view.
The respondent relied upon cases which involved preliminary expenses. These included Federal Commissioner of Taxation v. Maddalena (1971) 71 ATC 4161 (expenses of travelling to employment interview), Softwood Pulp and Paper Ltd v. Federal Commissioner of Taxation (1976) 76 ATC 4,439 and Griffin Coal Mining Company Ltd v. Federal Commissioner of Taxation (1990) 90 ATC 4,870 (both being cases in which the expenses of feasibility studies for new ventures were disallowed). I would distinguish those cases on the basis that the profit-making undertaking, in which the appellant in this case was engaged, started before the interest and other holding charges were incurred. When viewed as a whole, the taxpayer's operations were, in my opinion, sufficiently linked to the derivation of assessable income to be quite capable of falling within the first limb of s.51(1). In my opinion, the Tribunal did not ask itself the right questions. In so doing it erred in law.
The learned primary judge (see page 15) thought (and I respectfully agree) that it was implicit in the Tribunal's rejection of the applicability of Travelodge that it considered that the outgoings were not sufficiently proximate in time to the earning of assessable income to give them the requisite character. In other words the expenditure came at a point too soon before the commencement of any business or income-producing activity.
In its reasons for the first decision (see paras 54 and 55) the Tribunal seems to have been under the impression that Bredmeyer J in Travelodge had found that the taxpayer in that case was engaged in the business of running hotels. It distinguished Travelodge on that basis as having "no bearing" on the present matter. In fact, the taxpayer in Travelodge was not engaged in the business of running hotels at the relevant time. Bredmeyer J decided that case under the first limb of the PNG equivalent to s.51(1) and did not consider it necessary to decide which business the taxpayer was carrying on (see p.4,439).
In Federal Commissioner of Taxation v. Brand (1995) 95 ATC 4633 at p.4646 a Full Court of this Court said that a temporal hiatus constitutes a relevant factor whose cogency will vary from case to case. It depends, as the Full Court explained,
"... on more than a mere measuring of a period. The temporal hiatus may suggest that the outgoing was incurred for some purpose other than the gaining or producing of assessable income."
In my view, the temporal hiatus in the present matter has been well and truly explained by reference to the problems which the taxpayer encountered with her joint venturer Mr Williams and also in attracting third parties to take an interest in the venture. That temporal hiatus does not suggest that the outgoings of interest and the like were for some purpose other than the gaining or producing of assessable income in one way or another.
The Tribunal seems to have been influenced, in its decision-making process, by the fact that the moneys borrowed were applied for what they regarded as a capital purpose. First, that assessment ignores the fact that a portion of the proposed project involved the building of some eighty townhouses for sale to investors. As mentioned above, this was a matter upon which the respondent relied in argument before us. Furthermore, in my opinion, it confuses the character of the moneys expended on acquiring "Tibradden" with the character of the interest paid on the moneys so borrowed. The fact that the former might (on one view) be of a capital nature does not require the same characterisation of the latter, interest payments. This can be seen in cases such as Federal Commissioner of Taxation v. Total Holdings (Australia) Pty Ltd (1979) 79 ATC 4279. In that case the taxpayer borrowed money at interest from its parent company and on-lent part of that money over a period of some eleven years interest- free to a wholly-owned subsidiary. The Full Court accepted (see p.4,285) that the taxpayer's objective in so doing was to cause the subsidiary's activities to result more quickly in profits so that in due course profits would be received by the taxpayer by way of dividend or interest. The Full Court of this Court unanimously held that the interest paid by the taxpayer to its parent company was an allowable deduction.
In my opinion, the Tribunal in the present matter erred in equating the taxpayer's objective of capital redevelopment with the characterisation of the interest payable on
the loan used to acquire "Tibradden". The mere fact that the subject matter of a purchase is a capital asset does not determine the characterisation of an outgoing incurred as part of the purchase arrangements: Cliffs International Inc v. Federal Commissioner of Taxation (1979) 142 CLR 140 at pp.150-151. In the present matter the interest was, of course, not part of the purchase price of the property from which agistment income was derived and other income was planned to be derived. The interest was the price paid for the use of money to purchase that property.
In my view, the matter should be remitted to the Tribunal for it to consider the appellant's business activities as a whole from the time of acquisition of "Tibradden" to its disposal. In doing so, it should not focus on the horse agistment business for the purposes of contrasting it with the appellant's main objective. The appellant is entitled to have all of her activities taken into account as a whole. In my opinion, an important part of those activities was her purpose and plan to construct eighty townhouses for resale to investors. Any profit so realised would have to have been assessable income. Furthermore, the indications are that income was also to be generated from the management of those townhouses after such sale. The uncontested evidence points to a conclusion that the appellant's intention at all times in entering into the various transactions was to make a profit or gain. Focussing on one or other separate but related business activity can (as I think happened here) result in the total picture being overlooked. An overall view of the business activity is required; see for example G.P. International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124 at p.138.
As Lockhart J said Total Holdings (at p.4,283):
"The question whether interest is actually incurred in gaining or producing assessable income is one mainly of fact."
However, the legal error which I see in the Tribunal's decision was to dismiss too readily as "... not of itself amount[ing] to a present purpose of gaining assessable income" the taxpayer's main purpose of redeveloping the property.
I would allow the appeal, set aside the Tribunal's decision and remit the appellant's appeal against the Commissioner's disallowance of her objection to the Tribunal to be decided again, with or without the hearing of further evidence as the Tribunal may determine.
Postscript
Since writing most of the above reasons I have had the advantage of reading the joint reasons for judgment of Burchett and Ryan JJ. There is no point of legal principle expressed in those reasons with which I would disagree. I find myself in respectful disagreement only on the question whether the Tribunal correctly applied those principles to the facts of this matter. I would distinguish Wharf Properties, again respectfully, on the facts. There was, for example, no suggestion in that case of any re-sale of the commercial properties to investors.
I certify that this and the preceding thirty-six
(36) pages are a true copy of the Reasons for
Judgment of Justice Carr.
A/g Associate:
Date: 18 March 1997
Counsel for the Appellant: Mr M.J.McCusker QC (with him Mr.C.T.Gollow)
Solicitors for the Appellant: Ilbery Barblett
Counsel for the Respondent: Mr R.L.Le Miere QC (with him Mr.K.J.Morgan)
Solicitors for the Respondent: Australian Government Solicitor
Date of Hearing: 22 July 1996
Date of Judgment: 18 March 1997
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