Steele v Deputy Commissioner of Taxation

IN THE HIGH COURT OF AUSTRALIA

Office of the Registry
Perth No P30 of 1998

B e t w e e n -
KATHLEEN FAYE STEELE
Appellant
and
DEPUTY COMMISSIONER OF TAXATION

Respondent

GLEESON CJ
GAUDRON J
GUMMOW J
KIRBY J
CALLINAN J

TRANSCRIPT OF PROCEEDINGS

AT PERTH ON WEDNESDAY, 21 OCTOBER 1998, AT 10.58 AM

MR J. McCUSKER, QC: May it please the Court, I appear with my learned friends, MR R.K. O’CONNOR, QC, and MR C.T. GOLLOW for the appellant. (instructed by Ilbery Barblett)

MR R.L. LE MIERE, QC: If it please the Court, I appear for the respondent, together with my learned friends, MR J.D. ALLANSON and MS L.B. PRICE. (instructed by the Australian Government Solicitor)

GLEESON CJ: Yes, Mr McCusker.

MR McCUSKER: If it please your Honours, there are two important issues that this appeal gives rise to. The first is whether interest payments on a loan made periodically to secure that loan may be described as capital or capital in nature and whether, in turn, if they can, that depends upon the purpose for which the loan was taken. In that regard, our submission will be that there is no decision of this Court, at least, that says that interest is capital or capital in nature or may be and, furthermore, that to treat interest payments as being capital or capital in nature is clearly contrary to established practice, well-established practice, and to the treatment, indeed, of interest outgoings as appears in the Income Tax Assessment Act itself in various parts which have ‑ ‑ ‑

KIRBY J: The court below were limited to points of law and the appeal, therefore, to this Court can only be on a point of law.

MR McCUSKER: That is so, your Honour.

KIRBY J: So that if questions of characterisation are involved and an evaluation of the character of this particular interest then you may be in difficulties because of the fact that the Court is not concerned with factual questions but only with that which is required as a matter of law.

MR McCUSKER: Yes, I appreciate that, your Honour, but the first point that I have mentioned, we say, is a pure question of law. It is characterisation and the issue is whether as a matter of ‑ ‑ ‑

KIRBY J: It is in every case, whatever the circumstances, is to be characterised as income in its nature.

MR McCUSKER: To be characterised, no, as an outgoing on revenue account rather than as an outgoing which is capital or capital in nature. That, in our submission, is well accepted and there is no decision in this country – from this Court, I should say, to the contrary, although there is one decision which at least suggests to the contrary. I will come to that. The second question raised is if interest cannot be characterised as capital or capital in nature as an outgoing merely because the purpose of the loan is to pay for an asset which has been acquired and which has been acquired for the purpose of development and production of assessable income, is the interest outgoing deductible as being an outgoing incurred in gaining or producing assessable income or is it only deductible under section 51 of the Act if and when the income commences to be produced or is there some halfway mark as it were?

GAUDRON J: You rely on the first leg of section 51, “losses and outgoings incurred in gaining or producing the assessable income”, not the second leg of “necessarily incurred in carrying on a business”?

MR McCUSKER: No, we do not press the proposition that we were carrying on a business at that point.

KIRBY J: It has to be “in”.

MR McCUSKER: Incurred “in”, but there is ‑ ‑ ‑

KIRBY J: That is the link.

GAUDRON J: And it is in gaining “the assessable income” although that has been glossed over in the case, has it not?

GUMMOW J: It need not be in the year of the outgoing, that is what it comes to.

MR McCUSKER: Well, the cases say not, your Honour.

GUMMOW J: Yes, that is what I am saying.

MR McCUSKER: Yes. It has been ‑ ‑ ‑

KIRBY J: Why do they say that?

MR McCUSKER: Well, on the basis that there is no reason to limit the outgoing as deductibility to assessable income incurred in that particular year. It is just the taxpayer’s assessable income so if it is incurred in gaining assessable income, notwithstanding that the income may be gained -let us suppose, for example, that the outgoing is incurred on 30 June but no income is then derived but on 1 July income is derived, the outgoing would still be deductible, notwithstanding the time difference.

GLEESON CJ: What if no income is ever derived in the events that happen?

MR McCUSKER: That still would not negative the outgoing. There are many instances where an outgoing is clearly incurred in gaining assessable income, that is, in a sense of seeking to produce assessable income and the outgoing is deductible, notwithstanding that ultimately the efforts come to nought.

GAUDRON J: But that might me because they are necessarily incurred in carrying on a business. Do they cases make that distinction?

MR McCUSKER: No, they do not, your Honour. The outgoing will be deductible provided it satisfies the test which has sometimes been put - and I see that the respondent puts it in terms of the necessary nexus or connection between the outgoing and the activity which is aimed at achieving production of assessable income.

KIRBY J: Does not the definite article, the use of “the”, rather suggest that you are looking at “the” assessable income of the year in question as distinct from assessable income at large? If the latter had been what had been intended, you would have omitted the “the”, you would have just said “in gaining or producing assessable income” whenever it was gained or produced but it is gaining or producing “the” assessable income. Has this been discussed in the cases?

MR McCUSKER: Your Honour, in Fletcher’s Case173 CLR 16, which is on our list ‑ ‑ ‑

GUMMOW J: It goes back before that, does it not?

MR McCUSKER: Yes, your Honour, and, indeed, we have included a quote from that page in Fletcher at page 11 of our outline of submissions.

GUMMOW J: It goes back at least, does it not, to Sir Anthony Mason’s judgment in AGC (Advances) which is in footnote 31 on page 16 of Fletcher?

MR McCUSKER: Yes. It has been well-established, well-accepted, law in Australia for a long time that the assessable income referred to in section 51 need not be income which is actually derived in the year of the outgoing.

KIRBY J: That is the second time you have said that but it is not at all unusual in this Court when the spotlight is put on a piece of legislation for it to be found that practice and assumptions, and expectations, are wrong. It has happened many times and I would have thought probably happened in this particular Act. So we are now focusing on what the words mean. Our duty is to give it construction whatever has been the practice or assumptions?

MR McCUSKER: Yes. May I come back to that, your Honour, because I will need to examine the earlier line of authority from which Fletcher’s Case stems, to answer that question more fully? If that authority is accepted, and I note that the respondent does not challenge that that is the accepted law at present, then the question becomes whether there is some temporal cut-off point at which the outgoing ceases to be deductible under section 51. That is to say, is it possible to draw a line and say that because the income was not derived for two, three, four, five years, therefore, the outgoing is not deductible. Our submission is on that, that that would seem to be a very artificial approach to the question and it leads to all kinds of possible anomalies. The sooner one claims the deduction, the better chance one would then have of being allowed the deduction under section 51.

If one claimed the deduction and there was some delay in the claim because of a late lodgement of the tax return, the Commissioner might then, if there is this temporal issue that decides it, say, “Well, the outgoing was incurred three years ago and you have not as yet derived income, notwithstanding that I accept that you have made a commitment to an income-producing activity and that the outgoing was incurred in connection with that activity”.

GLEESON CJ: You lost in the Full Court of the Federal Court, not on the ground that the case did not satisfy the first limb of section 51, but on the ground that the case fell within the exclusion of outgoings of capital or of a capital nature.

MR McCUSKER: That is so, yes, and, in fact ‑ ‑ ‑

KIRBY J: There is a notice of contention, is there not?

MR McCUSKER: There is a notice of contention which is why we have raised that second issue. But before the Full Court of the Federal Court, the court there accepted that there was a relevant commitment by the taxpayer to the income-producing activity. There is a considerable amount of evidence that was canvassed by the court and the court came to that view based on the facts as found by the Administrative Appeals Tribunal. The Administrative Appeals Tribunal, however, came to a different conclusion based on those facts. The facts in brief were that the taxpayer had, having found the property which had been run as a horse training complex and agistment complex but deriving very comparatively low income ‑ ‑ ‑

CALLINAN J: Three point five per cent of the total outgoings.

MR McCUSKER: Minimal, yes. Indeed, in terms of the total outgoings, minute. We accept that without question.

GLEESON CJ: Your argument would be no different if there had been no agistment income, would it not?

MR McCUSKER: It would be, yes, your Honour. The agistment income, as it were, is just one very small aspect of the case.

GLEESON CJ: It sounds as though it became something of a red herring in the Administrative Appeals Tribunal who seemed to have treated the appellant’s case as relying upon the agistment income to attract the operation of section 51.

MR McCUSKER: We put that before the AAT in the alternative, your Honour, and that is to say that, in any event, there was a business being run, an agistment business being run, and that in order for that agistment income to be derived then the interest outgoing was necessarily incurred.

KIRBY J: That was the only income, was it, on the property in the year of the tax?

MR McCUSKER: It was the only income, ever, yes, that is so, your Honour. So the taxpayer took over this – acquired the property and to do so initially, she acquired it on a contract of sale which provided for interest to be paid periodically and that was paid. In order to ultimately pay out the contract of sale she took out a loan which was secured by mortgage on the property, mortgage in favour of the bank, and interest was paid periodically under the mortgage. So it is the interest outgoings under initially the contract of sale and thereafter the mortgage which were the subject of the claim.

GLEESON CJ: That is one small thing I am not entirely clear about and I do not understand it to be a matter of dispute, but are the deductions that were in issue limited to interest?

MR McCUSKER: Yes, apart from rates and taxes, your Honour, but rates and taxes which formed a very small part of the totality.

GLEESON CJ: Are rates and taxes dealt with separately in the judgments below?

MR McCUSKER: Yes, they were, your Honour, both by the AAT and the Full Federal Court.

KIRBY J: Are we concerned with that issue?

MR McCUSKER: Not really, your Honour, no.

KIRBY J: I do not recall it ‑ ‑ ‑

MR McCUSKER: I think that the decision on the interest will carry with it ‑ ‑ ‑

GAUDRON J: The rates and taxes.

MR McCUSKER: The rates and taxes issue. At least that is our ‑ ‑ ‑

GAUDRON J: If the interest is not on revenue account it is hard to see why the rates and taxes would be.

MR McCUSKER: That is our view, your Honour. I do not know whether my learned friends agree but it formed a very small part of the issue before the court.

KIRBY J: There was some debate on the special leave application about narrowing the matter as it was to be argued in this Court. Was that resolved in a way that that problem went away or are we dealing with a confined appeal and if so, I would like to understand what the confines are?

MR McCUSKER: The confines so far as we are concerned ‑ ‑ ‑

KIRBY J: Apart from the confines of law, were there any confines on the ‑ ‑ ‑

MR McCUSKER: On the rates and taxes issue? I do not think so, your Honour, but we do not intend to press that question as a separate question but simply the issue of interest outgoings, their proper characterisation and then in the circumstances of this case, dealing with the notice of contention whether there is a sufficient nexus. We say if the interest outgoings were not properly characterised as capital or capital in nature by the Full Federal Court, then it must follow from the Full Federal Court’s views, that is, that there was a clear commitment to the income‑producing activity by the taxpayer that the interest outgoing is deductible under section 51 ‑ ‑ ‑

KIRBY J: Do you say that interest is in every case of a revenue character or that whatever the length of time, whatever the period of the interval between the raising of the - the obligations of the interest and the revenue, the income, if it is irrelevant that it might be 15 years or 20 years?

MR McCUSKER: There are two distinct questions, your Honour. The first is whether interest as an outgoing can ever be characterised as capital or capital in nature. We say the answer to that is no, it cannot, on this ‑ ‑ ‑

KIRBY J: There is said to be authority that stands against that and one case in this Court - - -

MR McCUSKER: Well, the authority that stands against it is not a case in this Court, but a case that was relied upon by the Full Federal Court, a decision of the Judicial Committee of the Privy Council, I think – or House of Lords, I am sorry, in – Privy Council - right the first time - in Wharf Properties, based, we say, on an entirely different taxation regime and a different approach to the question of interest outgoings. But, so far as this Court is concerned, there is no decision, in our submission, which supports the view that interest is capital or capital in nature. Of course, that is quite a different question from the question of whether the loan itself is capital or that the asset with which the loan is used to secure is a capital asset.

GLEESON CJ: If you borrow money to build a factory, the factory is a capital asset.

MR McCUSKER: Yes, of course.

GLEESON CJ: Are you entitled to an allowable deduction for the interest on the borrowing while you are building it?

MR McCUSKER: While you are building it, yes, your Honour, and that is consistent with ‑ ‑ ‑

GLEESON CJ: I would have thought so.

MR McCUSKER: Yes. So, that is the first point, that you are acquiring a capital asset and the use of the money so that the moneys borrowed being used to acquire the capital asset are capital or capital in nature. We accept that because the moneys are used for a capital purpose, but the interest is not used for a capital purpose. It is used to retain the use of the moneys and it is quite a different issue.

CALLINAN J: There is often project finance during the construction phase and then often that finance is replaced by long term finance when the project is commissioned. It is the common practice in mining and in development of office buildings and other buildings.

MR McCUSKER: Quite so, your Honour, although it may not necessarily be the case, although it is more common than not I would think.

GLEESON CJ: I understand that the Commissioner of Taxation withdrew a ruling in relation to that very issue as a consequence of the decision in this case. Could we be provided, in due course, with copies of the ruling as it was before it was withdrawn?

MR McCUSKER: Yes, certainly, your Honour.

GLEESON CJ: And copies of the ruling that replaced it?

MR McCUSKER: Yes.

KIRBY J: There were said to be three rulings before ‑ ‑ ‑

MR McCUSKER: There were and we will obtain copies from ‑ ‑ ‑

KIRBY J: They are said to be annexed to the submissions but they were not annexed to mine which makes one very curious.

MR McCUSKER: But, essentially, the rulings are to the effect that provided the purpose of the loan on which interest is paid is to acquire or construct an asset which is to be used for the production of assessable income, then the interest will be deductible.

GLEESON CJ: You mean that is what the rulings were.

MR McCUSKER: That is what the rulings were, yes, until this case was decided by the Full Federal Court. At that stage the ruling was withdrawn based specifically on the decision of the Full Federal Court.

GLEESON CJ: What is the position now?

MR McCUSKER: The position is that everyone is waiting with bated breath, I think, your Honours, to see what the result will be. It is a case which, or a decision, that is, that interest may be capital or capital in nature, which has excited a great deal of comment within the accounting world in particular, almost invariably negative. There are some articles which we provide in our bundle of authorities. So that the decision in Steele’s Case can be viewed as a radical change in the approach to the treatment of this. There is a draft ruling I am informed, which is not yet “the” ruling, but there is a draft ruling of the Commissioner saying that he will not treat the outgoing as capital. But whether that is going to be the final ruling is not yet determined. Now, the question of whether the interest ‑ ‑ ‑

KIRBY J: Can I just ask you: at the Administrative Appeals Tribunal there was a difference of view. Dr Gerber said that this was equivalent to Martin Luther King’s statement, “I have a dream”, and that that was all. Was that the point on which there was a difference so that we can disregard it, because that would just be a factual assessment of the intention of your client? Is that what the AAT divided upon or was there something more fundamental relevant to the legal question?

MR McCUSKER: The AAT did not divide ‑ ‑ ‑

GLEESON CJ: I thought the AAT only divided upon the question of whether or not they accepted your client’s assessments of the agistment income?

MR McCUSKER: Yes, quite so, your Honour.

GLEESON CJ: And the Full Federal Court said that the characterisation of the taxpayers activities is nothing more than a dream was grossly unfair and was contradicted by the findings of fact made by the AAT.

MR McCUSKER: That is so, your Honour.

KIRBY J: So we take it, the starting point, therefore, is that it has been found as a fact and is not challenged and cannot be challenged because the appeal is only on a matter of law, that your client had a firm intention after she went past the property and took all the steps that she did take including in terms of rezoning and the water board, and so on, her firm intention was to develop the land for the hotel/motel complex.

MR McCUSKER: That is so.

KIRBY J: And that that is a given, and we have to begin on that basis.

MR McCUSKER: That is the commitment that the Federal Court viewed as flowing from the facts as found, and said that the conclusion or characterisation by Dr Gerber, which I think the other two members may have agreed with, but I am not sure of that, but it does not really matter because the Full Federal Court’s view was that that was wrong and that there was clearly a demonstrated commitment.

GLEESON CJ: I think in fairness to Dr Gerber it was not expressed as a characterisation of this taxpayer’s purpose, it was expressed as a general proposition that could have been applied unrelated to the facts of this case.

MR McCUSKER: Yes. The area ‑ ‑ ‑

KIRBY J: Is the question, therefore, whether in that period before the property hotel/motel complex begins to earn income in accordance with the reasoning of Lord Hoffmann in the Privy Council, any funds that are devoted to its development are of a capital nature because at that stage it is simply a capital project, and that after it begins to produce revenue it can be put on to the revenue account? Is that the essential bottom line question?

MR McCUSKER: Any funds that were devoted to the construction of the motel if the construction had started, would undoubtedly have been a capital outgoing because they would have been used for the purpose of construction of the capital asset, but the interest on the moneys borrowed for that purpose remain revenue in nature. That is the issue.

CALLINAN J: Mr McCusker, I do not know whether that really happens in practice, and you might be able to help me on this, but my understanding is that a lot of companies will deliberately apply - and I do not know what the Commissioner’s attitude to this is - interest payments, or they will capitalise interest payments during the construction phase and treat those interest payments as part of the capital of the project which is then depreciated, but once the project commences to produce income then whatever money is borrowed, and often it is replacement finance, then the interest on that is deducted from income. I mean, that is within a company’s own books, it is commonplace.

MR McCUSKER: It may do that, yes, and it is not uncommon but even if the company chooses to treat it that way, that does not decide the issue as to whether it is deductible.

CALLINAN J: No, but it may be relevant from the Commissioner’s point of view.

MR McCUSKER: It may be in that if the company chooses to treat it that way it is unlikely the Commissioner would ‑ ‑ ‑

CALLINAN J: To the extent that intention is relevant, if it is relevant.

MR McCUSKER: Well, in our submission, intention is not relevant to the characterisation of the interest outgoing. If the taxpayer chooses to capitalise it, it does not affect the nature, it simply chooses not to claim it as a deduction in the year in which it is incurred but rather to add it to the total cost and then apply depreciation to it. It seems a bit odd to be applying a depreciation to an interest outgoing but I have no doubt that that is accepted by the Commissioner.

KIRBY J: Given that the expenditures are, as you concede, of a capital nature, that is to say, getting the planning approvals and so on, and building the hotel, it seems a leap of faith to say then that the interest that is incurred is to be given an entirely different character from the purpose for which it is expended which is of a capital kind. The mere fact that it is periodical cannot, of itself, make it of a revenue character.

MR McCUSKER: No, we would accept that the fact that it is periodical does not determine its characterisation although the fact that it is periodical – I will withdraw that. It does not determine its characterisation although here, if it were relevant, the payments were periodical in nature. But the interest outgoing is not used to construct an asset or to acquire an asset ‑ ‑ ‑

KIRBY J: It is the sine qua non without you cannot build the capital asset.

MR McCUSKER: Yes, the asset itself is secured by purchase and the money that is borrowed is used to secure the purchase but the interest on the loan is and has always been treated, in our submission ‑ ‑ ‑

KIRBY J: That is the third time you have talked about it.

MR McCUSKER: Yes, as on revenue account.

KIRBY J: It was in a case 30 years ago in this Court where a provision in the Workers’ Compensation Act of New South Wales which had been assumed since 1926, was completely thrown aside, simply because the Court looked at what the words meant. Everybody had assumed otherwise so your third statement of what has been assumed or what is the practice, does not convince me.

MR McCUSKER: I will not say it a fourth time, your Honour, but it is relevant, however, in considering this issue that it has been accepted for so long, the Court ought not likely to overturn what has been well accepted both in practice ‑ ‑ ‑

KIRBY J: And I gather there is a provision elsewhere in the Act, a division which is difficult to work on the assumptions that the Commissioner is advancing.

MR McCUSKER: Several provisions in the Act presuppose, quite clearly, that an interest outgoing is not capital in nature.

KIRBY J: We will come to that in due course, I assume.

MR McCUSKER: Yes. Now, coming back to the question of commitment, the finding is clear and we say it is not open to challenge, and it is not challenged, as a matter of the Full Federal Court’s finding, but what is challenged by the respondent, or what is contended by the respondent, is that because of the fact that there was a change, or several changes, in the taxpayer’s intentions as to how best to go about earning assessable income from this venture that, therefore, there was something - well, that there is a change in commitment, as it were. We say that the commitment that is relevant here is a commitment to the production of assessable income, essentially by the construction of a motel and, thereafter, the operation of that motel.

In our outline, your Honours, the relevant facts are set out and the issues that I have referred to. Could I take your Honours to what the majority in the Full Federal Court said in volume 4 of the appeal book, page 768, at line 25 where the Full Federal Court placed considerable reliance upon what Justice Isaacs said in Federal Commissioner of Taxation v Munro, 38 CLR 198:

The interest paid in respect of the loan follows accessorily the purpose of the principle sum.

And the Full Federal Court then commented after that:

Accordingly, it was not on revenue account.

GLEESON CJ: If that is right, it would seem, if it is taken literally, that interest on a loan used to build and operate a factory never becomes on revenue account.

MR McCUSKER: That is the difficulty, your Honour, but that is not what Justice Isaacs was, in fact, saying. The quotation from his reasons has been used by the Full Federal Court or has been assumed by the Full Federal Court, I should say, to mean that you look at the purpose of the loan and if the borrowing is for the purpose of acquiring a capital asset then the interest paid on that borrowing is, and would remain, one must assume, capital or capital in nature.

Now, what Justice Isaacs said has to be then carefully considered and if I could ask your Honours to refer to page 196 of the report. There is a great deal of other matter in issue before the Court but this particular point is when Justice Isaacs was dealing with the case of Federal Commissioner of Taxation v Munro, at last, the objection, and he referred at about point 6 of that page, point 7, to the relevant facts:

The respondent carried on a business in Elizabeth Street, Melbourne, occupying for that purpose part of land and a building belonging to him. Other portions –

GLEESON CJ: Excuse me, what page is this?

MR McCUSKER: I am sorry, your Honour, page 196 about two-thirds of the way down the page. The taxpayer carried on the business at Melbourne:

occupying for that purpose part of land and a building belonging to him. Other portions…..he let at rentals.

Then:

promoted a limited company in Sydney to carry on business there. He took up about 2,000 shares for himself in the company and 9,000 shares for each of his two sons. He borrowed from a bank a sum which during the relevant period amounted to about £33,000, of which £20,000 approximately represented the amount paid for the shares and £13,000 the amount he advanced to the Sydney company free of interest. To secure to the bank the repayment of his loan he mortgaged the Elizabeth Street property and during the relevant accounting periods he paid interest upon his mortgage. His objection is that he should be allowed to deduct that interest from the assessable income in Melbourne – either business or property – there being no Sydney income. His right to do so is rested on sec. 23(1)(a)….. This is denied by the Commissioner, who relies also on the negative provision in sec. 25(e).

Now, section 23(1)(a), the positive provision, your Honours, referred to outgoing actually incurred in gaining or producing the assessable income and his Honour commented:

It is said for the respondent that, since it was necessary to pay the interest if the taxpayer wished to retain his right to have the income from the property –

that is the Elizabeth Street, Melbourne, property –

it was interest by which that income was gained or produced.

Interpolating there, your Honours, that that would seem a difficult argument to sustain. His Honour said:

I am not able to accept that view. The taxpayer had already acquired and held his property as a rent-producing property to the full extent. Nothing more was necessary to gain or produce that income. Then he chose for his own purposes quite alien to that property to borrow money and incur a personal obligation to repay it with interest. So far, also, the property stood complete as a rent-producing instrument. But because he secured his personal debt by means of that complete rent-producing instrument he contends that the discharge of the obligation was “actually incurred in gaining or producing” the rentals it yielded. The simple position is that the property and its rentals existed before the loan and remained intact and unaltered after the loan. Had the money borrowed been expended on the property so as to increase the rentals or so as to prevent depreciation which would have reduced the rentals, then it could have been properly said that the interest had been a means of gaining or producing the assessable income.

GLEESON CJ: That just means that assuming you are not a professional gambler, if you borrow money on the security of your factory for the purpose of paying your bookmaker, you do not get a deduction for the interest.

MR McCUSKER: That is all that it means.

KIRBY J: The words have changed but there are still three indicia of connection in section 51(1). You have to show that it is:

to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business –

so it seems to posit that you are actually carrying on a business. How can you carry on the business whilst you are still erecting the factory?

MR McCUSKER: Well, that is an alternative, yes, in carrying on a business but we do not ‑ ‑ ‑

KIRBY J: I mean, it assumes it is the income, ie, what income? The income from carrying on a business and if you are…..up the business ‑ ‑ ‑

MR McCUSKER: No, with respect, because income may be derived, not assessable income, obviously from areas other than carrying on a business. So, it is alternative rather than being joined.

But could I just take your Honours on because we have not got to the point that the majority in the Full Federal Court plucked from the judgment. His Honour Justice Isaacs went on to say:

But in employing the borrowed money for purposes independent of the property, leaving its condition entirely unaffected, that result cannot be postulated. Nor is there any ground for attaching the loan to “the assessable income” arising from the business in Melbourne. That income and the whole Melbourne business were quite unaffected by the application of the money. In short, the interest paid to the bank was not paid to create any of the assessable income in question: it was incurred because, among other things, that income was in a manner of speaking already in existence. Supposing, however, the expenditure fell within sec 23(1)(a) –

so, this is the point at which his Honour considered this question of purpose -

it would be excluded by sec 25(e).

That is a provision that was then in existence; because 25(e), your Honours, excluded from deductibility any outgoing which did not have as its only purpose the production of assessable income.

GUMMOW J: Yes, and that led to the enactment of section 51.

MR McCUSKER: Yes.

GAUDRON J: And when section 51 was enacted, the word “actual” disappeared, did it?

MR McCUSKER: Yes, it did.

GAUDRON J: And that is presumably why section 51 has been construed as not confined to the year of income.

MR McCUSKER: Not confined to the year of income, yes, I think that is the – thank you, your Honour, yes.

GUMMOW J: So, 51 has a history.

MR McCUSKER: It does. His Honour then said:

That loan was to create a new enterprise owned and conducted by a new personality, having legal results which, both as to commodum and onus, must be accepted by the taxpayer, results which are distinct from and in addition to any “assessable income.”

Then the phrase appears:

The interest paid in respect of the loan follows accessorially the purpose of the principal sum.

He was not saying that the interest was capital in nature; he was simply saying that the only purpose of the borrowing was not the production of assessable income, and that therefore the interest was not an outgoing because its sole purpose was not the production of assessable income.

KIRBY J: I do not quite understand how the omission of the adverb “actually” removes indication of the time within which the deduction is available. It says nothing. It is not an adverb of time.

MR McCUSKER: It is dealing with the question of whether, in the year of income, income has actually been derived, as distinct from ‑ ‑ ‑

GAUDRON J: Whether it might be derived in the future.

MR McCUSKER: As distinct from being derived in the future, yes. Your Honours, we will obtain on this point the further authorities that deal with this issue. I had not come prepared to argue it because I do not think it is in contention by the Commissioner.

Your Honours can see there how the Full Federal Court, at page 768, has taken, as it were, out of context, with respect, what was said by Justice Isaacs, and that has led it to a conclusion that the interest in that case was categorised as capital or capital in nature. It was not. It was dealing purely with the purpose of deductibility in that regard.

GLEESON CJ: When you are coming to those authorities, you might include amongst them Ronpibon Tin 78 CLR at pages 56 and 57.

MR McCUSKER: Yes, thank you, your Honour. Their Honours also referred at pages 768 and following to a number of other cases, and at 769 referred to The Texas Company (Australasia) Ltd Case and a quotation there from Justice Dixon, which is reproduced at 769 at lines 15 to 20.

GUMMOW J: There seem to be a number of snippets from judgments, but where is the actual conclusion?

MR McCUSKER: There is not a conclusion, your Honour, in that case.

GUMMOW J: I mean in the Federal Court joint judgment. There are a number of snippets from judgments over many years, but where do they actually reason something out of those snippets that is determinative of an issue before them?

MR McCUSKER: They start at page 774 – I think that is where they concluded their review. I should mention at 773, your Honours, they refer to Fletcher’s Case, and the quotation from Fletcher’s Case, but again, nothing in Fletcher’s Case is said to the effect that the interest outgoing was capital or capital in nature. It was simply dealing with the positive limbs of section 51(1).

GAUDRON J: The reasoning seems to be exposed at 776 by reference to GP International Pipecoaters. It means :

the character of a payment is the character of the advantage sought by the making of the expenditure ‑ ‑ ‑

MR McCUSKER: Yes.

GAUDRON J: But that was not an interest payment at all. That was a question whether money was on capital or income, was it not?

MR McCUSKER: That case did not concern the question of interest in its characterisation, no. But none of the cases, in short, that their Honours referred to have characterised an interest outgoing as being capital in nature.

GLEESON CJ: In the passage that Justice Gaudron has just referred to, the key word seems to be in line 41, the word “thereafter”.

MR McCUSKER: Yes. What their Honours did was to, in effect, divide in terms of time – they treated an interest outgoing as capital in nature, and remaining so up until the time that the capital asset which had been acquired, or developed with the loan, was producing income. So that in some way the nature, that is, the character of the outgoing, is changed, although, in our submission, that simply is not possible and certainly not in accordance with the precedent.

GLEESON CJ: But it is entirely consistent with what the Privy Council said, is it not?

MR McCUSKER: It is.

GLEESON CJ: That is where they got it from.

MR McCUSKER: Incidentally, that was decided after the case had been argued before the Full Court.

GAUDRON J: On one view, both that reasoning and the decision of the Privy Council seems to assume sub silentio that the income must be produced in the year of expenditure.

MR McCUSKER: It does seem to, yes.

KIRBY J: Do you have a copy of the Hong Kong Court of Appeal decision? Is that available to the Court?

MR McCUSKER: I do not have it, your Honour.

KIRBY J: It seems to have influenced the – they say it receives strong reinforcement from the decision of the Court of Appeal in Hong Kong, so I would like to look at it.

MR McCUSKER: Yes, I will see if we can obtain that.

GUMMOW J: Does the statute they were considering have this year‑by‑year structure of our statute?

MR McCUSKER: Yes, it does.

GAUDRON J: The provision that the Privy Council was concerned with is at (1997) AC 509. The reference is:

in the production of profits in respect of which he is chargeable to tax under this Part for any period –

So it clearly contemplates future profits.

KIRBY J: In that sense it is stronger than our statutory provision because it makes it clear that it is any period.

MR McCUSKER: Yes, in that sense it is.

KIRBY J: Do you say that the provision of the Hong Kong Inland Revenue Ordinance or the scheme and structure of that Ordinance makes what the Privy Council said in the Times Square Case inapplicable to our statute?

MR McCUSKER: Yes, your Honour.

KIRBY J: Now, why? I want you to be very clear at some stage in your argument.

MR McCUSKER: Yes, I will. But we also say that the approach of the Privy Council was based on an entirely different approach that has been taken historically to deductibility of interest in the United Kingdom to that which has been taken in Australia.

KIRBY J: That is the fourth time you have referred to assumptions.

MR McCUSKER: That is a different point, your Honour. Certainly, indeed, in the Privy Council their Lordships differed from the decision of Travelodge, which was that of a single judge, admittedly sitting in the Court of Papua New Guinea, which is referred to in our outline. That decision in Travelodge was based upon the legislation which was, for all intents and purposes, the same as Australian legislation, and where interest on moneys borrowed for the purpose of building a motel in New Guinea was allowed as a deduction there, notwithstanding that the interest outgoing was incurred at a time when the motel was not constructed or even in the course of construction, although it ultimately was constructed. In that regard our submission is that the test cannot be logically the point at which the income is being derived because the question is not what is the – there are two distinct questions which are being confused. The question is what is the character of the outgoings, and that is quite a different question from the question of what is the purpose of the outgoing. The character may be and may remain revenue in nature rather than capital, but the purpose may not be income producing, and in that regard it would fail the test under the ‑ ‑ ‑

KIRBY J: That is a bit unreal, is it not? Obviously the purpose of building the wall was to secure income.

MR McCUSKER: Yes, I accept that.

KIRBY J: The steps are twofold: one, you create the capital structure, and then, two, you secure the income. The question is whether during period one your character and purpose are of different quality than they are in step two.

MR McCUSKER: The purpose of the interest outgoing is and remains to secure the money, the loan. The purpose of the loan is to acquire a capital asset ‑ ‑ ‑

KIRBY J: And the purpose of the capital asset is to secure income.

MR McCUSKER: It may be. If it is to secure income, then the interest outgoing is deductible under the first limb of section 51. It is not capital in nature, and so it does not fail the second part of section 51.

KIRBY J: Who is such a dreamer that they will secure a vast amount of capital with no object of securing income?

MR McCUSKER: For example, someone who borrows money to construct a house.

GLEESON CJ: Or someone who borrows money to construct an Olympic stadium.

MR McCUSKER: Yes, that is a dream.

KIRBY J: We are talking in the context of this kind of case, or the Times Square Case.

MR McCUSKER: The point is, your Honour, that if you take a borrowing of money for the purpose of building something which is perhaps a museum and which is not intended to produce any income, then, although the interest on the moneys borrowed is revenue in nature and not capital, it will not be deductible because it is not incurred in gaining or producing assessable income.

KIRBY J: I was mainly picking up your point about the difference between purpose, that being the word in the Hong Kong Ordinance, and the character, that being the purpose of the Australian statute. I just find it illusive to distinguish between the purpose being, in these types of cases, the securing ultimately of revenue, of income, that you could say that there is a different meaning. Just looking at the two statutes, except that the Hong Kong statute makes its purpose clearer in a sense by saying “at any time”, the two seem to be very similar. You have asserted that the provisions of the Hong Kong Ordinance on which the Privy Council gave its advice are relevantly different from the Australian. I do not see the difference but I would like to understand the difference if there is one.

MR McCUSKER: Your Honour may say in the end that they are distinctions that do not have any relevance, but there are nevertheless some. The first is that section 16 of the Hong Kong Ordinance referred to profits rather than assessable income provided for the deduction from the profits in respect of which a person was chargeable to profits tax of expenses “incurred during the basis period for that year of assessment”, including sums payable by way of interest on moneys borrowed “for the purpose of producing such profits”, not assessable income. That is one clear distinction in terms of the legislative framework.

KIRBY J: It does not seem to be relevantly different.

MR McCUSKER: That means, of course, the concept of matching outgoings to income may be more relevant to calculation of profits for which a taxpayer is chargeable, profits tax in a relevant year, whereas in Australia accounting principles are relevant to questions arising under section 51 but they are not, in our submission, determinative. There is authority for that in Flood’s Case 88 CLR 492.

GLEESON CJ: Lord Hoffmann said exactly the same thing in this Wharf Properties Case. He said that companies’ accounts are concerned with what gives a true and fair view of the progress of the business, which is not necessarily by any means the same thing as what complies with the requirements of the Income Tax Assessment Act.

MR McCUSKER: Yes, that is right.

GLEESON CJ: Do you not have to come to grips with the proposition on the bottom of page 512 of the Wharf Properties Case, which as far as I can see almost exactly matches the proposition on the bottom of page 776 to which Justice Gaudron drew attention - the paragraph beginning with the word “Thus”.

MR McCUSKER: The proposition your Honour is referring to at page 776 by the Full Federal Court?

GLEESON CJ: Yes, which appears to be taken from the proposition at page 512 of the Wharf Properties Case in the last complete paragraph beginning with the word “Thus”, and you have to demonstrate to us either that that is wrong or that it is applicable to our Income Tax Assessment Act.

MR McCUSKER: Yes.

GAUDRON J: It seems to me it really can only be applicable if you limit your deductibility to income being derived in the year. Is that not right?

MR McCUSKER: I think that is right, your Honour.

GAUDRON J: Once you treat section 51 as looking to income whenever derived, then it seems to me that that logic must fall to the ground.

MR McCUSKER: That is so. Yes.

GUMMOW J: Hence their Lordships’ emphasis in the sentence:

during the whole of the two years in question –

they being the two years of income, but not outside that.

MR McCUSKER: No.

GUMMOW J: That seems to be the assumption.

MR McCUSKER: Yes, that must be right, and:

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.

GUMMOW J: Yes, “was being expended”, you see.

MR McCUSKER: Yes, “was being expended for a capital purpose”. It is expenditure “for a capital purpose” that their Lordships focused on there. This has been taken by the Full Federal Court as the basis for a conclusion that if the purpose of the loan is the acquisition of a capital asset, therefore the interest outgoing is for a capital purpose, and therefore it is capital in nature, and they are the steps that have been taken by the Full Federal Court.

The purpose, in our submission, of the outgoing is quite distinct from the nature of the outgoing or the character of the outgoing. It does not take its nature from the purpose for which it is applied, although the purpose for which it is applied may well deny it deductibility under section 51.

GLEESON CJ: So, on this reasoning, if you borrowed money to develop an orchard, during the years when you were planting the trees and bringing them into production the interest on the borrowing is not deductible, but it commences to be deductible when the trees commence to bear fruit.

MR McCUSKER: Yes, that is the reasoning. That is the way that reasoning would lead, and in our submission, that is wrong unless you treat the deductibility as being confined under our Act – unless you interpret section 51(1), which it has not been so far, as allowing deductibility only in respect of income derived in the particular year. That really is a linchpin of it.

KIRBY J: Has attention been given to the definite article that Justice Gaudron drew attention to earlier: “in producing the assessable income”. That rather suggests to my mind, and I may be completely wrong, that there is a notion of “the assessable income” of the year in question as distinct from “assessable income” at large. It would have been so easy to remove the word “the” and just say “in producing assessable income”, which would support your argument.

MR McCUSKER: Your Honour the Chief Justice has referred us to Ronpibon Tin 78 CLR 47, and at page 56 the Court there said, dealing with section 51, at about a quarter of the way down the page:

No doubt the expression “in carrying on a business for the purpose of gaining or producing” lays down a test that is ‑ ‑ ‑

GUMMOW J: One starts at 55, does not one?

MR McCUSKER: It does, yes.

GUMMOW J:

The answer to this question depends primarily on s 51…..is in great part made up of expressions taken from ss 23(1)(a) and 25(b) –

which is the Munro sections:

But there are many important differences - - -

MR McCUSKER: Yes.

GUMMOW J: Then the Court are very lively to the change that had come about from the 1936 Act.

MR McCUSKER: Your Honours, I am reminded that in the dissenting reasons of Justice Carr these matters are discussed at page 806 of the appeal book where his Honour referred to Ronpibon Tin at page 56 and AGC (Advances) and also Fletcher.

GAUDRON J: And the construction that is in fact given to 51 is as appears at page 57:

whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income.

MR McCUSKER: Yes, quite.

GAUDRON J: Which means in the future.

GUMMOW J: Their Lordships refer to various Australian cases – Hallstroms was one of them; Sun Newspapers was another, but Ronpibon did not seem to get a look-in.

MR McCUSKER: Did not get mentioned, no.

GUMMOW J: Unfortunately, perhaps.

MR McCUSKER: Perhaps unfortunately, because it may have illustrated to their Lordships the essential difference between the two tax regimes.

GAUDRON J: Maybe there is not an essential difference between the regimes at all. It may be that there was a failure to take account of the future application, the future income.

MR McCUSKER: Future income, yes.

GAUDRON J: The relationship between the present expenditure and future income.

MR McCUSKER: Yes. Your Honours, I have canvassed in the outline a number of other cases which were referred to by the Full Federal Court, but none of them, with respect, supports the proposition, or none of them in its terms ‑ ‑ ‑

GUMMOW J: The Commissioner does not say they do, does he?

MR McCUSKER: No, I do not think he does.

GLEESON CJ: I think in considering the Privy Council’s decision it is important to remember that they declined to go into the question of whether or not section 16 was complied with, which is the one that corresponds to the opening portion of section 51. On the top of page 509 Lord Browne‑Wilkinson said that they declined:

to hear submissions from the commissioner as to whether interest payments were not deductible under section 16(1)(a) –

which corresponds to the opening part of section 51.

MR McCUSKER: Yes, I see that. I must confess, your Honour, I had not appreciated that, but it is of some relevance.

GLEESON CJ: It may be that if they had heard submissions on that point they would have had to look at Ronpibon Tin.

MR McCUSKER: Yes, and in turn, perhaps, at least treated less harshly the decision in the Travelodge Case.

GLEESON CJ: Yes. Does that refer to Ronpibon?

MR McCUSKER: It is, your Honour. It is referred to in ‑ ‑ ‑

GUMMOW J: The Travelodge Case, did that refer to Ronpibon - the New Guinea case.

MR McCUSKER: Yes, it did, your Honour.

GUMMOW J: I thought it did. That was said to be wrong, was it not? Anyway, there is a limit to which we can set about reconstructing what might have happened in another place and another Act or another body.

MR McCUSKER: That is so. What we say, essentially, is that that decision is based on a different tax regime. It has not taken into account the relevant Australian authorities in any event, and if it were to be said that there is no appreciable difference – and I do not think it is said against us that there is no appreciable difference between the Australian section 51 and the Hong Kong Ordinance - then that decision is simply contrary to accepted authority in this country, and there is no support for a conclusion that the interest outgoing can ever be treated as capital outgoing. Whatever its purpose may be, of course, is an entirely different issue which may lead to it being non‑deductible under the first part of section 51.

We refer to Total Holdings at page 6 of the outline where in that case Justice Lockhart, with whom Justices Northrop and Fisher agreed, said at 224:

“In my opinion if a taxpayer incurs a recurrent liability for interest for the purpose of furthering his present or prospective –

I underline the word “prospective” -

income‑producing activities whether properly characterised as the carrying on of a business or not, generally the payment by him of that interest will be an allowable deduction - - -

GLEESON CJ: Excuse me, what page was that?

MR McCUSKER: That is page 6 of our outline, your Honour.

GLEESON CJ: No, what page of Total?

MR McCUSKER: At 224.

GLEESON CJ: Thank you very much.

MR McCUSKER: Justice Lockhart went on to say, dealing with the qualification generally:

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.

That is a bit enigmatic. He goes on to say:

In such cases the requirement that the expenditure be incidental and relevant to the derivation of income may not be satisfied”.

That was simply an observation which in the particular case led nowhere in terms of conclusion, because deduction for interest was allowed in that case by the court, although the funds were lent interest-free – that is the funds borrowed - to a subsidiary for nine years during which no dividends were received as income by the taxpayer in that period. So, the relevant commitment was clearly demonstrated, and that was sufficient to justify the deduction.

Your Honours, just if I could revert to the Wharf Properties Case, much of what we have been discussing is encompassed in a series of articles written by Geoffrey Lehmann and Stephen Southon in a series in the Weekly Tax Bulletin, and my instructing solicitors have provided to your Honours copies of those four articles.

KIRBY J: Do those articles criticise the Privy Council decision as wrong or simply say that the regime is different?

MR McCUSKER: The regime is different essentially, yes.

KIRBY J: Do they explain and elaborate what you have said to be ‑ ‑ ‑

MR McCUSKER: Yes, they do, your Honour.

KIRBY J: It is still illusive, at least in my eyes.

MR McCUSKER: Yes, it is. We say that the regime is essentially different.

KIRBY J: Does it all hang on purpose or characterisation, and I think that is a very illusive difference.

GUMMOW J: I am not quite sure the extent to which the Commissioner in this Court supports Wharf Properties. He might be beating a straw man, I do not know.

MR McCUSKER: I do not think the Commissioner does support it.

KIRBY J: Do you suggest that the Privy Council’s decision is wrong? Is your submission that the Privy Council’s decision on its own regime is wrong?

MR McCUSKER: We say it is arguable that there is a different tax regime.

GUMMOW J: We cannot say it is wrong.

MR McCUSKER: But it is also arguably wrong on the basis of the regime that was referred to.

GUMMOW J: We cannot say it is wrong. It is the law in Hong Kong.

MR McCUSKER: Yes, I suppose “wrong” is not perhaps an apt description.

KIRBY J: I think our old‑fashioned deference to the Privy Council need not be - if you say it is an incorrect analysis, then let us not mince words.

MR McCUSKER: It is an analysis which ought not to be followed in this Court is perhaps a better way of putting it.

GUMMOW J: If the Commissioner does not support it, why are we worrying about it at such length? If the Commissioner does not support it - he does not seem to do so apart from rather faintly in paragraph 16 of his submissions. Why are we spending so much time about it?

MR McCUSKER: The matter ultimately is a question for your Honours to consider whether there is support for the decision of the Full Federal Court. Your Honour Justice Gummow asked me whether Ronpibon Tin was referred to in Travelodge.

GUMMOW J: I do not think it was.

MR McCUSKER: It is not expressly referred to, your Honour, but at page 4434 there is a reference to the summary in Total Holdings to which I have referred.

GUMMOW J: Yes.

MR McCUSKER: That appears in the second column.

GUMMOW J: Thank you.

KIRBY J: Travelodge is referred to at 513 in the Privy Council decision. They said that they were not persuaded. But, if one stands back from this case and leaves aside, as one cannot, 50 years of tax law, and simply says, “Well, now, what is the purpose or characterisation of the payment?”, you can put it into either box. You can say its purpose is in the long run to secure income, or you can say the purpose in the immediate run is to build the capital asset. If you can put it in either box, what is it about section 51(1) that tells a court and the Tax Commissioner to put it in box A and not box B? That is what I would like to understand. The task of characterisation is - I mean we are on the head of a pin here, but on the head of the pin stands a lot of tax deductibility in this country. So, I would like to know, given that you could logically take the stand the Privy Council took and say it goes into box B, why do we in Australia put it into box A?

MR McCUSKER: With respect, to determine the nature or character of a payment, one does not go to the purpose. There are two distinct issues. An outgoing of interest is made to secure the loan - not to acquire an asset because the asset has been acquired; it is a capital asset - so the loan money and, perhaps, the deposit paid out of the purchaser’s own pocket is capital in nature. It is an outgoing but it is capital in nature even though it is paid for the purpose of acquiring an asset which will, ultimately, be income producing. It is and remains capital in nature but the interest on the loan is not paid to purchase the asset. It is paid to secure the loan itself and it is of a revenue nature, that is the outgoing is revenue in nature and remains so although it may not be deductible if the purpose of a loan is not to produce income. That is really as far as I can take it. I can appreciate your Honour’s dilemma between the two issues.

KIRBY J: Is the characterisation a matter of law, because one would think this is an evaluative exercise and here the Administrative Appeals Tribunal and the Federal Court have made their evaluation. Now that sounds awfully like a decision of fact given that – but I notice Lord Hoffmann says that there can only be one correct answer and that is the answer that the law assigns and that is a question of law so Lord Hoffmann affords you at least to that extent.

MR McCUSKER: Yes.

KIRBY J: Is that your submission, that it is a matter of law, ultimately?

MR McCUSKER: It is our submission. It is a matter of law, yes.

KIRBY J: Though it is evaluative, the characterisation is a legal characterisation and therefore a matter of law and therefore properly the subject of the appeal process.

MR McCUSKER: Yes. In a sense it is not evaluative because we say that the purpose of an interest outgoing does not cause it to become either revenue or capital. It is a revenue outgoing and remains such. The purpose of the loan may deny it deductibility but if the loan is to secure the purchase of a domestic house then the interest outgoing, although it remains revenue in nature, will be denied deductibility under the first part of section 51.

KIRBY J: But what do you do if it is a multiple purpose, that is to say, that your client was going to build a home or have a penthouse on the top of the motel?

MR McCUSKER: There is then an apportionment and that is where such cases ‑ ‑ ‑

GLEESON CJ: Section 51 in its terms requires apportionment. It uses the words “to the extent that”.

MR McCUSKER: “To the extent that”. So, if it were to be the case that the home was to be used partly for income-producing purposes, let us say 50 per cent, then the interest outgoing, albeit it is revenue in nature not capital, would be apportioned so that only 50 per cent of the interest outgoing would be deductible and that is, as his Honour the Chief Justice said, required by section 51 itself.

GUMMOW J: Now, you said there were some specific statutory provisions elsewhere in the Act which do not work.

MR McCUSKER: Yes.

GUMMOW J: Is that what you pick up at paragraph 27 of your outline?

MR McCUSKER: May I, yes, your Honour. I note that the Commissioner in his submissions accepts that with ‑ ‑ ‑

GLEESON CJ: Not quite, not quite. He says he does not agree with your analysis of those provisions but acknowledges that they would have anomalous operations if he is correct.

MR McCUSKER: I think he does not agree with one of the analyses, that is exchange, gains and losses.

GUMMOW J: I hope we do not have to comprehend the exchange, gain and losses sections en passant.

MR McCUSKER: No. Your Honours, we say shortly there that there are provisions and the Commissioner accepts that there are provisions in the Act which appear to be predicated clearly on the view that interest is of a revenue nature not a capital nature.

KIRBY J: Could you show us, just for my benefit, the best of those that makes it clear that that is the assumption on which the Act has been drafted?

MR McCUSKER: I will, your Honour. Could I come back to that, your Honour, when I get a copy of the provisions? Section 160ZH(6A) treats, it appears, interest as a non‑capital cost of the acquisition of an asset. This is for capital gains purposes. It is brought in by section 160ZH(6A) as part of the cost base for that reason. There would be no need to do that if interest was allowable. The exchange, gains and losses provisions, I note that my learned friend for the Commissioner does not agree with the analysis, but does agree that it can produce anomalous results if the position is that interest outgoing may be characterised as capital.

I have mentioned paragraph 28, your Honours. A further question arises under Division 10D of the Act dealing with depreciation, the cost of depreciable property and capital allowances. I suppose, to sum up, your Honours, the position in Australia is that hitherto – it is not to say it should not change but hitherto interest has not been treated as other than revenue in nature although the deductibility depends, of course, upon the purpose, that purpose has not been treated as characterising the nature of the outgoing for the purpose of the second part of section 51.

That that is so is shown by the Commissioner’s rulings, which we will undertake to get copies of, and also by some provisions in the Act which clearly are predicated on the view that interest is a revenue outgoing not a capital outgoing.

KIRBY J: Given the nature of this Act and its intermittent amendment of its - I hesitate to say “chaotic character”, it is, perhaps, not to be unexpected that there will be inconsistencies within it, unfortunately.

MR McCUSKER: Perhaps not, your Honour, perhaps not, but one must, I think, assume that the legislature had ‑ ‑ ‑

GUMMOW J: Knew about Ronpibon.

MR McCUSKER: Well, that those at least advising the legislature knew that, yes.

GUMMOW J: Yes.

GLEESON CJ: While you are preoccupied at lunchtime, you might ask Mr O’Connor to turn his mind to what Justice Brennan said in Inglis v Commissioner of Taxation 40 FLR 195 which, according to the Commissioner, although it does not specifically refer to it, covers interest. It would be interesting to know what submissions your side has to make about that passage.

MR McCUSKER: I note that the Commissioner also refers in his outline to Energy Resources and that was a case ‑ ‑ ‑

GUMMOW J: In this Court?

MR McCUSKER: Yes, 185 CLR 66.

GUMMOW J: Thank you.

MR McCUSKER: That was a case which did not concern an interest outgoing. It concerned a discount loss so it is quite a different situation.

GUMMOW J: Yes.

MR McCUSKER: In any event, the observations that were made by this Court which are referred to by the Commissioner regarding the use of the funds and the relationship between the deductibility of a discount and the use of the funds, at the end of the day was, in our submission, to the extent that the Commissioner relies upon that to support any argument that applies also to interest, really obiter because the Commissioner in that case was not contending that there was no deductibility. He conceded deductibility. It was a question of the timing.

GUMMOW J: Yes.

MR McCUSKER: That is all that it was.

GUMMOW J: Yes, that is right.

MR McCUSKER: Your Honours, the previous income tax rulings are, in fact, at tab 16 of our authorities and they are income tax ruling 166, 2374 and 2461.

GLEESON CJ: Thank you.

MR McCUSKER: Now, subject to reverting to Inglis’ Case, your Honours, and I understand that in the respondent’s list of authorities and, presumably, papers that have been handed up by the respondent, there is the current draft ruling – tab 23.

GLEESON CJ: Thank you.

KIRBY J: How do we use this, as some sort of estoppel against the statute?

MR McCUSKER: No, but nevertheless it demonstrates the established practice.

KIRBY J: That the person who would best know has made a mistake.

MR McCUSKER: We were asked to provide it.

GLEESON CJ: I suppose one of the things it usefully does is direct our attention to the kinds of practical problems that arise in relation to this issue.

MR McCUSKER: Yes. On occasions, your Honours, it has been suggested that some form of submission ought to be made as to the impact of a decision.

GLEESON CJ: Exactly.

MR McCUSKER: This is clearly such an occasion.

GUMMOW J: Yes, the Law Council did so in its written submissions for the special leave application.

MR McCUSKER: It did, your Honour.

KIRBY J: Are we to take those as before us? They were actually – I took a peek at them and they were quite useful submissions.

MR McCUSKER: Yes, I would seek to have them treated as part of the argument. I was about to say, your Honours, subject only to coming back to the question of what was said in Inglis’ Case on the subject, unless there is anything further that your Honours wish me to address in relation to this first question, I turn to the question of whether interest outgoings in this case fall within section 51(1) on the basis that they are not capital but revenue, are they deductible in the circumstance of this case.

GLEESON CJ: That was really the basis on which Justice Nicholson decided the case, is it not?

MR McCUSKER: Yes, he did, yes. He did not decide it on the basis of interest outgoing being capital, but simply on the question of whether it had a sufficient connection. I have referred already, your Honours, to the fact that in Australia the assessable income has been held - that is the phrase “the assessable income” has been held to mean not just the income for the current year and that is the year in which the deduction is ‑ ‑ ‑

GUMMOW J: Is this paragraph 30 of your submissions.

MR McCUSKER: It is, your Honour, yes.

GLEESON CJ: Thank you.

MR McCUSKER: We note in paragraph 32 what the majority said in relation to interest outgoing and I have given your Honours the references there that they found it was:

to develop a profit‑yielding structure of a future business enterprise –

and again –

the taxpayer’s purpose of erection of a motel or similar complex, to be operated by the taxpayer so as to earn assessable income.

They correctly observe, in our submission, -

“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.”

There may be, perhaps, cases where the particular endeavour is so hopeless to achieve that it may be arguable in a given case that it is not deductible because it is not really related to the production of assessable income but that is not this case.

GLEESON CJ: I suppose you could have a situation where a qualified lawyer decides that he or she might want to go into legal practice and arranges an overdraft from the bank against the possibility that, at some future stage, that practice might be started or the money might be used for an overseas trip or it might be used to buy some real estate or for any one of a number of possible purposes. Then you could have a question of connection.

MR McCUSKER: Yes, that is right, but here there is no such other purpose. Justice Nicholson’s reasoning was largely based on Ure’s Case and Fletcher’s Case where apportionments took place, but in both of those cases the apportionments occurred because there was some other purpose identified other than the production of assessable income and that is why apportionment was applied.

Here there has been no purpose identified other than the production of assessable income. It was not a case, for example, that the taxpayer borrowed the money in order to have Tibradden, in part, as her own private residence. It was always used so far as it was being used for the purpose of producing assessable income but the purpose of the acquisition was to develop it so as to gain, of course, much greater assessable income beyond the 3.5 per cent of outgoings that was gained by the agistment operation.

GLEESON CJ: I suppose, to use an expression that is not in the Act, the money was entirely borrowed for a commercial purpose.

MR McCUSKER: Yes. There was no other purpose than the production of assessable income. The question of connection seems to be related to a tacit proposition that although the Commissioner accepts that there does not have to be income derived in the year of the outgoing, if there is too great a gap between the income being derived and the outgoing, then in some way that denies deductibility.

GLEESON CJ: It could be relevant as a matter of fact.

MR McCUSKER: Yes.

GLEESON CJ: The greater the gap the easier it might be to conclude that the case was like the one I mentioned earlier.

MR McCUSKER: Quite so, yes.

GLEESON CJ: The taxpayer contemplated a number of different possible purposes to which the money might be applied.

MR McCUSKER: Yes.

KIRBY J: Is it relevant in this case that, within a very short time, the taxpayer had negotiated with Malaysian interests to sell the land for twice the value? Does that not indicate that one purpose may have been that this was just an investment?

MR McCUSKER: The negotiations with the Malaysian developers were for the purpose of a joint venture for the development of the property so it was still, although the manner in which the income-producing purpose was to be realised did change on two occasions, at least two occasions because first, she was going to do it alone for a short period, then she joined with Williams to whom she sold a half interest in the property under a contract which provided for Williams to pay interest on the outstanding purchase price and then she and Williams did deal with these Malaysians for the purpose of promoting a joint venture. At all times, as his Honour the Chief Justice has just remarked or, to use the phrase, the purpose was commercial. The Full Federal Court has found that there was a commitment to that purpose and, indeed, no other purpose has been identified by either the AAT or any other tribunal in the lower court.

The tribunal was concerned with the fact that the actual income being derived was far outweighed by the amount of the outgoing and that seems to have led them to the view that therefore there should be an apportionment, disregarding the fact that the major purpose, the dominant purpose, was still the production of assessable income but in a different way from the minor purpose which was the existing agistment business.

GLEESON CJ: Your case might have been able to be put more clearly if there had been no agistment business carried on at all.

MR McCUSKER: It would have been, yes. It would have been.

GLEESON CJ: Is that the time at which you now wanted to adjourn?

MR McCUSKER: If your Honours please, yes.

GLEESON CJ: All right then, we will adjourn until 2.15.

AT 12.30 PM LUNCHEON ADJOURNMENT

UPON RESUMING AT 2.18 PM:

GLEESON CJ: Yes, Mr McCusker.

MR McCUSKER: Your Honours, I am not sure whether my learned assistant, Mr O’Connor, has found the answer to your Honour’s question about Inglis’s Case. But I think I found it anyway. At page 195 of that report, which is in 40 FLR 191, Justice Brennan ‑ ‑ ‑

GUMMOW J: That has to be read with 194 perhaps, in the last paragraph.

MR McCUSKER: Yes, where he refers to the Ronpibon Tin Case:

Where income has not yet been gained or produced, the relevant connexion must be with the operations and activities which are expected to produce that income –

Lammermuir appears to have been, on the findings on the court, to have ceased to be operating as a pastoral property at all and simply being held. At the end of the day it appears that the court was not satisfied that the holding operation was directed towards income producing activity.

GUMMOW J: Yes. But what you say is borne out, perhaps, by Justice Davies at 201, the first paragraph on 201.

MR McCUSKER: Yes, where he refers to it as a property which could be used for a variety of purposes:

could be developed or sub‑divided. The Inglis family could use it for their own private pleasure –

and so on. There was no clear commitment to its future use for income‑producing purposes. And going back to page 195, Justice Brennan, halfway down that page at the end of the second paragraph, said:

the expenditure related to Lammermuir appears unconnected with any activity for the production of future income –

So that seems to be the important thing, that it was unrelated to activity directed to production of future income and therefore does not qualify under the first limb of section 51. It was also held not to qualify for deduction under the second limb of section 51. But, your Honours, that case was referred to in Placer Pacific Management Pty Limited v Federal Commissioner of Taxation, a case which is referred to at page 14 of our outline. In Placer Pacific at page 4465, the first column, dealing there however with the second part of the limb, or the second limb as it has sometimes been called, the business activity. The court referred to:

The case of Inglis v FC of T upon which the Commissioner relied, provides no authority to the contrary –

that is the conclusion that the court reached in Placer Pacific, but although the business activity had ceased, the deduction was still allowable. So it is the converse, as it were, of this situation:

In that case the occasion of the outgoings in question was not to be found in some prior primary production business. Indeed it had been concluded at first instance that no business had been carried on at all and that conclusion was confirmed on appeal. If anything the expenditure for which deduction was claimed was expenditure to preserve the property as a pastoral property –

so the purpose of expenditure there was not, we say, been found by the majority of the Full Federal Court here for the purpose of producing assessable income.

Analogies are often dangerous, your Honours, as, indeed, I put to Justice Nicholson in the Full Court at first instance. If one purchases, say, a home unit or a block of flats and the purpose is not for one’s own residence, one borrows money in order to purchase the block of flats, and the flats at that time are rented but the rentals are very low and the flats are purchased with a view to their redevelopment and gaining a much higher rental. The interest outgoing, in my submission, because it is clearly not of a capital nature, is an outgoing incurred but is deductible under section 51, in short.

It makes no difference that there is a larger and more dominant purpose, that is the ultimate redevelopment for the purpose of producing greater assessable income. That was the proposition that was put, and we put it again here, in relation to Tibradden, that the purpose was to acquire the property for the purpose of producing assessable income and it makes no difference that there was a minute amount of income, indeed none at all, provided that the dominant purpose can be seen to be, or the purpose can be seen to be exclusively the production of assessable income.

What did, in our respectful submission, lead the lower courts astray was the huge disparity between the actual income being derived from this property and the amount of the outgoings claimed as deductions. But as your Honour Justice Gleeson observed to me, it would have been a clearer case if there had been no assessable income at all being derived because then the only purpose would have been its redevelopment for the purpose of producing assessable income.

The cases to which reference was made by Justice Nicholson and the tribunal, which we refer to in our outline at paragraphs 36 and 37, Ure’s Case and Fletcher’s Case all justifying the apportionment approach have this quite different aspect that in each of those cases there was perceived to be some other purpose than income producing, whereas here there is not. Your Honours, for that reason we say that if it be accepted by this Court that the majority in the Full Federal Court was wrong in its categorisation or characterisation of interest as a capital outgoing, then it is clear on their finding that there was a commitment by the taxpayer. There was no thought of, “Perhaps I’ll do something else with the property”, a clear commitment to gain or produce assessable income, and therefore the outgoing of interest should be an allowable deduction. Thank you, your Honours, they are our submissions.

GLEESON CJ: Now, Mr McCusker, if you were to succeed in the arguments that you have put, the orders that you have sought on pages 827 and 828 are somewhat different, are they not, from the orders that Justice Carr would have made in his dissenting judgment?

MR McCUSKER: Yes they are, your Honour, because Justice Carr thought that the matter should go back to the court on the basis that there was just a broad profit-making objective. He took a somewhat different approach – a quite different approach to the approach which was taken by the majority.

GLEESON CJ: I think you need to explain to us why, if you were to succeed, the orders that you are entitled to are those that you have set out here rather than the ones that Justice Carr would have made.

GAUDRON J: And there may be a further question as well. Even if you succeed, do not the orders have to trace through the various proceedings and end up with an order that the objection be upheld, rather than that the assessment be set aside?

MR McCUSKER: Yes, I think that is right, your Honour.

GUMMOW J: Ultimately the question is, what order the Federal Court should have made, this being an appeal on a question of law under the AAT provisions.

MR McCUSKER: Yes, and it probably then should have sent it back.

GUMMOW J: Does it have to go back?

MR McCUSKER: I am not, at the moment, confident of the answer to respond.

GAUDRON J: If you are correct in your proposition that, as a matter of law, the outgoing cannot be characterised as an outgoing of a capital nature and you fall within the first limb of 51 - that, again, is a matter of law, is it not, on your analysis of the facts?

MR McCUSKER: Yes.

GAUDRON J: Then it would not have to go back anywhere for fact‑finding, but ultimately the order would be that the objection be upheld, I think.

MR McCUSKER: It is a question of where it goes for that order to be made, as I understand it.

GLEESON CJ: What did Justice Carr have in mind about remitting it to somebody for some purpose?

MR McCUSKER: He perceived, in the evidence, that because there was some thought of not only producing a motel which would be an income‑producing activity but also the building of some units or town

houses which could be sold and thereby also produce assessable income. He saw that other activity as related to a profit-making sale, that is profit making by sale, and thought that the court below, or the tribunal, should consider that as a basis on which the deduction should be allowed. Now, that was not, in fact, an argument which was advanced to the Full Federal Court but it was a view that he took on the facts as presented to him.

GLEESON CJ: We will see in due course what the Commissioner has to say about that but could I ask you, and those assisting you, to reapply your minds to the question of the precise orders that you say this Court ought to make in the event that you were to succeed and let us have a written note as to the orders for which you contend.

MR McCUSKER: Certainly, your Honour, I shall. What Justice Carr said is at page 820, your Honours, as to what he thought should take place, starting at line 25:

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 –

and we would respectfully agree with that approach:

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.

GUMMOW J: That might be true if it had come straight to the Federal Court from the Commissioner, but I am not sure if that sort of procedure is right when it has come to the Federal Court on a question purely of law.

MR McCUSKER: We do not press that approach to be taken. Your Honours, we have a list of authorities all of which deal with the question of assessable income not being required to be produced in the year in which the deduction is claimed, which I could hand up. It is a host of them. May it please your Honours.

GLEESON CJ: Thank you. Yes, Mr Le Miere.

MR LE MIERE: If it please the Court. The respondent submits first that the interest payments were of a capital nature. In the course of argument this morning, the Court was taken to the conclusion in the judgment of the majority in the Full Court at page 776 of the appeal book. But might I first take the Court back a few pages to page 771, commencing at about line 50 on that page, the majority said:

The primary fact to be determined, when the deductibility of payments of interest pursuant to s51(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.

GAUDRON J: That may not be correct. I mean, if you frame the question that way, then you will get the answer that was got in this in case.

MR LE MIERE: Your Honour, what I propose to do is to submit to the Court why it is correct. Indeed, I take the Court to that passage and the reason that, indeed, that was the question that the majority posed ‑ ‑ ‑

GAUDRON J: It does not seem to me to accord with the structure of section 51 or its terms. The first question is was it an outgoing related to the production of income and then what was its nature. Is that not right?

MR LE MIERE: Yes, your Honour. Perhaps I have, by jumping in at that stage, gone past the way the majority first approached the matter and that was back at page, may I take the Court to 763, perhaps I should even go earlier, back to 761. The structure of the reasons is that the majority first set out at 761 the findings of the tribunal, or what the majority took to be the two grounds upon which the tribunal had decided the matter. And at 761 at about line 31, or perhaps to make sense of it we go back to line 20:

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 s51(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”.

I pause to say, in effect the majority say that was ground 1 of the tribunal’s decision. Then they continued:

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.”

In the following pages, the judgment goes on ‑ ‑ ‑

GLEESON CJ: What are the “further propositions” referred to in the next two lines?

MR LE MIERE: I take the “further propositions” there, your Honour, where it says that:

If the Deputy Commissioner’s case depended upon these further propositions –

the reference is back to that which is set out at lines 37 through to 50 on page 761.

GLEESON CJ: So they say they would have difficulty in accepting what they described earlier as “the independent ground of appeal”?

MR LE MIERE: Yes, your Honour. The structure of the reasons is that commencing at about line 55, they then discuss what they have characterised as the “independent reasons for decision”. I will come back to those later dealing with the other matters raised in the appeal.

GLEESON CJ: Now that is the subject to your notice of contention?

MR LE MIERE: Essentially yes, your Honour. Then at the bottom on page 763, line 50, the majority say, “However” - I should pause to say the reason for the “however”, of course, is because in the pages inbetween the majority have said that they doubt that those reasons were sufficient. Indeed, I will take the Court later to precisely what they found about that. But at line 50 they go on to say:

However, if the Tribunal was right to treat the object of the payment of the interest as the development of the 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.

GAUDRON J: Is that right? There is a sort of question-begging aspect to that statement, is there not?

MR LE MIERE: Your Honour, if the tribunal was right to find that the outgoings fell within the exclusionary ‑ ‑ ‑

GAUDRON J: The question-begging part is “and thus as an affair of capital”.

MR LE MIERE: Yes, if the whole of what they conclude is correct, if your Honour is putting to me - the whole of the conclusion must be right to sustain the decision.

GAUDRON J: Yes, but there is a question-begging aspect to it, namely, that the:

development of a profit-yielding structure for a future business enterprise, and thus is an affair of capital –

that the “interest” is an affair of capital.

MR LE MIERE: Yes, that is what has to be demonstrated.

GAUDRON J: Yes.

MR LE MIERE: Yes, your Honour, and in my submission that is what the majority are then setting out to do, to address that issue. They pose the question, “If that ground”, and if I might rephrase it ‑ ‑ ‑

GAUDRON: But the object of the interest really is not to have the loan called up and on any view that is what the object of interest is.

MR LE MIERE: Yes, indeed. As your Honour says, with any loan that has been said and the next step from that, I think has been said on a number of occasions and, indeed, in the discussions that took place before lunch in Wharf Properties, the matter is expressly put that, money of itself is merely a medium of exchange. Indeed, I think it was in the Court of Appeal.

GLEESON CJ: So is gold, I suppose.

MR LE MIERE: Indeed, your Honour, it depends on what ‑ ‑ ‑

GAUDRON J: The interest is the price you pay for a loan.

MR LE MIERE: Yes, and the money of itself is of no value. It is the use to which it is put that has value in hence looking to see ‑ ‑ ‑

GAUDRON J: Or that which it discharges. The obligation in performance of which it is tendered as a discharge.

GLEESON CJ: Is it the Commissioner’s submission that where the object of the payment of interest is the development of a profit-yielding structure for a future business enterprise, then it is an affair of capital?

MR LE MIERE: Yes, your Honour.

GLEESON CJ: In all circumstances?

MR LE MIERE: There may be a situation, for example, in relation to an ongoing business where that may not be so. If, for example, the operations form part of the regular operations of the taxpayer, that may give it a revenue nature, but that is not this case.

GLEESON CJ: Suppose, interest is paid on money borrowed to construct an income-producing asset such as a block of flats where the interest is paid during the construction period during which no revenue is being received from the asset, what is the Commissioner’s submission about that?

MR LE MIERE: If that is a one-off, if there are no other factors which might give it a revenue nature, then it is capital in nature.

GLEESON CJ: Now what sort of factors might give it a revenue nature in that example?

MR LE MIERE: First of all, if the taxpayer was engaged in some business which involved the building, holding, renting out of blocks of flats ‑ ‑ ‑

GLEESON CJ: But suppose the taxpayer was a barrister and the barrister decided to go into that form of investment activity?

MR LE MIERE: Then, in that event, it remains a capital outgoing.

GAUDRON J: But what changes it? Does it ever change? Does it remain a capital outgoing forever?

MR LE MIERE: No, your Honour. If the building is rented out and starts to earn income, then at that point it becomes ‑ ‑ ‑

GAUDRON J: Then its character does not depend on purpose. Its character depends on whether income is earned in the year of the outgoing.

MR LE MIERE: No, your Honour. The character depends upon the advantage which is sought by the making of the expenditure.

GAUDRON J: But that, as Justice Kirby said earlier, is a bit like dancing on the head of a pin because you can describe it either way at any time the object sought, it is the same as purpose, and ultimately in truth, leaving aside the second limb of 51, you do come to the situation, do you not, that it depends on whether income is gained in the year in question?

MR LE MIERE: Your Honour, you must look to the period in respect of which the interest is paid. The interest outgoing or each payment of interest relates to the use of the money for a particular period and you look then to the advantage which is secured ‑ ‑ ‑

GAUDRON J: The advantage which is secured is that the loan is not called up.

MR LE MIERE: Yes, and if you then look to the use which is made of the borrowed funds, the use during a period, for example, where a building is being constructed is not being used to derive any income. It is being used to create the capital asset. The advantage being sought during that period is not the deriving of assessable income.

GUMMOW J: You use the expression “during that period”.

MR LE MIERE: Yes, your Honour. That is crucial and, indeed, your Honours ‑ ‑ ‑

GAUDRON J: Where do you find that in 51?

MR LE MIERE: In relation to the capital aspect of it, because it comes back to it being of a capital nature.

GAUDRON J: Does that talk about the object being sought?

MR LE MIERE: Not in terms, your Honour. The courts, over the years, in trying to give some meaning to - in discussion of what amounts to being an expenditure or an outgoing of a capital nature, have said that to determine the nature of the expenditure or at the outgoing, one must chiefly look to the advantage which is sought or obtained by the expenditure. That is how one ascertains the nature of the expenditure or the outgoing. As several of your Honours have said, the paying of interest, in one sense, merely prevents the calling up of the loan or discharges the obligation to pay the interest. But one looks to see what is the object of the payment of the interest. It is to secure the use of the funds during the period in which the interest payment is made.

Now in determining what gives the character to a particular outgoing, whether it be the character of a capital outgoing or of a revenue outgoing, the authorities say that the chief matter that one goes to to determine the nature of the outgoing, is the advantage which is sought by making the outgoing.

GLEESON CJ: You accept, as I understand it, that the advantage does not have to be during the year of income. If you borrow a sum of money on 29 June, or if you borrow a sum of money and make an interest payment on 29 June and you apply the money in an income-producing purpose in circumstances where the first receipt of income occurs on 29 July of the following year, you get a deduction, do you not, for the interest you paid on 29 June?

MR LE MIERE: If, your Honour, the advantage which was sought and obtained by making the expenditure relates to those activities which gain the income. Say, for example, if the flats are let out to derive income, the fact that the rents are not paid, the tenants do not pay their rents until another six months time or 12 months time, does not deny deductibility, it does not deny the fact that income is being earned from the activity of holding the flats for the purpose of renting them out, and during that period the interest payment that is being made is securing the use of the funds which, in turn, is gaining the advantage from which income is derived.

GLEESON CJ: So it is no power to the Commissioner’s case to suggest that an interest outgoing is only deductable under section 51 if it is incurred in gaining or producing assessable income in the same year?

MR LE MIERE: No, your Honour, that is not part of the – the Commissioner expressly acknowledges that the income may be earned in future years or, indeed, no income may be derived at all. It may be that income is expected to be derived but in the events that follow, no income in fact is derived.

GAUDRON J: But you do distinguish between matters preparatory and matters not preparatory, I suppose. If, for example, you bought a block of units and there were no tenants in there and for some reason you could not put any tenants in there for six months, and you had to put – let us say there was a delay with council permission, for example. That interest would all be deductible in the year. But if you build the block, it is not.

MR LE MIERE: Yes, your Honour, that is so, during the construction period. Now, when once the building ceases – perhaps I have already been through that – but once it starts to derive assessable income then ‑ ‑ ‑

GAUDRON J: Well, no, you do not say once it starts to derive assessable income, do you?

MR LE MIERE: I am sorry, your Honour is right.

GAUDRON J: You make some other distinction and it may or may not be preparatory.

MR LE MIERE: Yes.

GUMMOW J: I am not sure what that distinction is.

GAUDRON J: Yes.

GUMMOW J: Having answered the Chief Justice the way you did, I am not then sure what the distinction is that you do propound.

MR LE MIERE: Yes. If I can give two clear examples to illustrate it. In the case of Tibradden, at the time of the relevant interest payments being made there was in fact no building or no motel building on the property at all. No building had even commenced at that point. Now, the activities from which the taxpayer intended to derive income was the operation of a motel to derive income by letting out the motel to tenants. At the time when all these interest payments were made - and there is no motel on the land. As, I think, the tribunal described it as being, irrelevantly, almost a vacant block of land. At that time the taxpayer is not engaged in those activities from which income is derived.

Now, a point will arrive when the taxpayer is engaged in activities from which income is or is likely to be or is expected to be derived. It does not necessarily commence, as your Honour corrected me, at the point, necessarily, when the tenants are in the motel. At some point prior to that the taxpayer will actually be engaged in income-earning activities but at the time when the land is simply vacant it cannot be said that the taxpayer then is engaged in the activities from which income is or is likely to be derived.

GAUDRON J: Well, could I ask you this question: your argument is focused on the first limb of section 51 or on expenditure of a capital nature?

MR LE MIERE: First, your Honour, on the capital exclusion. We come – and, in particular, the notice of contention is directed to the first positive limb.

GAUDRON J: But it seems to be that the arguments are merging between the two.

MR LE MIERE: Well, they do, your Honour, and one matter that I propose to take the Court to in due course is that there are parts in the majority decision where the two matters seem to merge and, in my submission, the majority’s decision leads to the conclusion that the outgoings, the expenditure, do not satisfy the first positive limb, either, although it is expressed in terms of an exclusion, that being that it is an outgoing or an expenditure of a capital nature.

GLEESON CJ: Leaving aside the conclusion for which you contend, does the Commissioner support the reasoning of any of the judges who have dealt with this matter in the courts below?

MR LE MIERE: Yes, your Honour. The reason I paused and hesitated is that the arguments have been different at each stage of the proceedings and, with respect, the taxpayer has mounted her case differently at each stage of the proceedings, so the reasons of each of the judgments are addressing different grounds of appeal, different arguments. The decision of the majority of the Full Court was that the expenditure is a capital expenditure. That, too, has been a finding at each other level in the process but that has not figured foremost in the decisions. In the case of Justice Nicholson, because the grounds of appeal were directed principally to other matters, for example, relying heavily on the ‑ ‑ ‑

GLEESON CJ: Well, I do not think, in fairness to everybody, because the decision of the Privy Council intervened.

MR LE MIERE: Well, the point I was then making, your Honour, is not only that but, for example before Justice Nicholson, the taxpayer’s arguments focused heavily upon the agistment income and that that justified the outgoing. Now, to that extent, of course, there are different matters being addressed on the different judgments. To try and answer your Honour the Chief Justice’s question directly, the Commissioner does, with respect, say that the reasoning of Justice Nicholson was correct and, indeed, that of the majority in the Full Court.

GLEESON CJ: Except in so far as they had difficulty in accepting what is referred to as the further proposition.

MR LE MIERE: Yes, although the Commissioner – we say what the Full Court said was that they had difficulty in accepting the proposition that the appellant had no more than an idea or a hope or a fond dream of developing the motel and that the Full Court – the majority found that on the primary findings of fact at the tribunal it appeared that that finding was not open to the tribunal and in that respect the Commissioner does not seek to depart from the majority position – what is said by the majority in the Full Court. The Commissioner does not seek to now argue, to put it shortly, that there was not a commitment.

GLEESON CJ: If it is the case that there is no necessary correspondence between the time at which assessable income is produced and the time at which deductible interest is paid, then what is it about the example I gave in relation to the block of flats that produces the consequence that the moment a tenant comes in and begins to occupy one of the flats the payment of interest is converted from an affair of capital to an affair of revenue?

MR LE MIERE: Perhaps I should have – before answering that, I need to qualify, perhaps, the answer I gave to your Honour. It is correct, in the Commissioner’s submission, that once a tenant comes in then it is on revenue account but that is not to say that at no point prior to that it ceased to be capital.

GLEESON CJ: When does it cease to be capital?

MR LE MIERE: It ceases to be capital when the taxpayer is engaged in activities, or to put it more precisely, when the advantage which is obtained by the payment of the interest is directly related to activities from which the income is earned.

GLEESON CJ: Well, take the case of construction of a block of flats, when does he start to get a deduction for his interest?

MR LE MIERE: Well, he does not get it before the construction is completed. Now, at some stage between the completion of construction and the first tenant coming in, he will be engaged in the activities from which the income is to be earned. Precisely when that is will be a question of fact.

GAUDRON J: But, that is taking it as a single enterprise. In this case the appellant wanted to build 80 motel style units, or something like that.

MR LE MIERE: Yes.

GAUDRON J: Let us say they were built progressively. Do we then go back an apportion “to the extent” that, in 51(1), or is it sufficient that there was one completed and one tenant?

MR LE MIERE: With respect, your Honour, the answer is probably that it depends upon the particular facts and circumstances.

GAUDRON J: Well, we will make some up. The plan is 80 motel style units. They are, however, built in blocks of 10. The first block is completed. Tenants are brought in or occupants are brought in. Work starts on the next block of 10, and so on and so on. How much interest is deductable, on your argument, and when?

MR LE MIERE: It might be that at some point and it might be when the first block of 10 is let out that the circumstances will be such that the taxpayer is engaged in a business and that the payment is part of the recurrent outgoings of the business. That may not be so if it is a one-off operation. It may be that the ‑ ‑ ‑

GAUDRON J: Say it is a one-off operation.

MR LE MIERE: Again, I suppose one has to go back and look to see precisely what the funds were borrowed for, whether it was for the acquisition of the land, for the building and so on, but if one assumes that in some way that is all mixed in together it might be that an apportionment is necessary. The Commissioner, your Honour, accepts and, indeed, has sought to set out in the submissions that the answer which the majority arrived at gives rise to some practical difficulties and the Commissioner accepts that.

KIRBY J: Well, what are we to infer from that?

MR LE MIERE: I am sorry, your Honour?

KIRBY J: What are we to infer from that statement? The characterisation is always difficult, wherever it is, whether it is constitutional characterisation or statutory characterisation, and our job, or the job of the courts is to sort out the border land.

MR LE MIERE: Yes, your Honour.

KIRBY J: There is no getting away from that in the problem of characterisation, but what are we to take from your rather sort of gentle statement that the Commissioner accepts that there is a difficulty?

GAUDRON J: Practical difficulties.

MR LE MIERE: Practical difficulties.

KIRBY J: Practical difficulties. I mean, in the end, I suppose, this is an Act to be administered, in a vast range of cases, in so far as there can be a clear rule which it seems was the assumption of the past that at least had the merit - whether it had intellectual problems it had the merit of clarity which avoided very expensive litigation and lots of it of which there will be an abundance, on your theory – abundance, as Justice Gaudron example illustrates. There will be thousands of cases in the AAT. The marginal utility of the cost of all that litigation against the marginal cost would be enormous. I mean, the marginal utility would be small and the marginal cost enormous.

MR LE MIERE: My, as your Honour described it, “gentle statement” was not intended to go quite as far as your Honour but it was a recognition that in practice those difficulties will arise in distinguishing the particular payments.

KIRBY J: Was the decision of the Privy Council before the Full Federal Court when argument was had or did I read something in there that rather suggested it came after decision was reserved?

MR LE MIERE: It came after decision was – or at least, I will have to check when it was delivered but no reference was made to it during the arguing of the case. I think, although I have not checked, the decision itself may have been delivered after the argument but certainly it was not considered by the Full Court during the argument of the case.

GLEESON CJ: Have you got copies of the decision of the Hong Kong Court of Appeal?

MR LE MIERE: Your Honour, we have given to my learned friend Mr Cusker’s junior, Mr Gollow, a copy of the decision of the Court of Appeal in Hong Kong. One difficulty is that, on checking it before lunch, I see that there is a page missing from it – two pages.

GUMMOW J: You are correct about the Privy Council. The Privy Council’s decision was argued and delivered, both events taking place in the interval between reservation of judgment and delivery of judgment in the - - -

MR LE MIERE: Thank you, your Honour. In fact, I am told we have found the missing pages. If I give those to my friends they can be added with the other pages.

GLEESON CJ: If you just hand us up one copy, we will get enough copies made for ourselves. A high tech operation here.

KIRBY J: Are you going to help us with the submission that we received from the appellant that there is a relevant difference in the statutory scheme? Leave aside what practice and assumptions were but with the statutory scheme of section 51 of our Act and of the long learning that has accumulated around it now it is said that that makes the Privy Council’s decision inapplicable because read on its own, speaking only for myself, I thought the Privy Council’s reasoning was compelling. Now, if in fact there is a relevant statutory difference I would like to know what that is. If there is not, in your submission, I would like to know why there is not.

MR LE MIERE: Yes. Your Honour, in so far as the matter was approached by the Privy Council, it does not appear from the reasons of the Privy Council that there is any difference between the Hong Kong Ordinance and section 51(1).

KIRBY J: It is said that the difference lies in the use of the word “purpose” in the Hong Kong Ordinance and the characterisation task which our Act throws up.

MR LE MIERE: With respect, in my submission, no, your Honour. There is a difference or may be a difference which I perhaps could come to shortly but, with respect, that does not appear to be a difference. The Hong Kong section – at the bottom of the first page, section 17(1) provides:

“For the purpose of ascertaining profits in respect of which a person is chargeable to tax under this Part –

well, perhaps I should pause to say, of course, the scheme is that under section 16 of the Ordinance, section 16 provides for what profits are chargeable under the Ordinance and then the scheme, as your Honours, I think, put before lunch, that is the equivalent of or serves the same function as the positive limbs of section 51(1) in so far as it sets out what is chargeable to tax although the scheme is different. Section 17(1) has the same effect as the exclusionary provision in section 51(1). It provides that, as I started to read:

“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 –

and then various things are set out and:

(c) any expenditure of a capital nature.

So, the reference to “purpose” there has nothing to do with the reference to the capital. The question which is posed by the provision is whether or not the expenditure is an expenditure of a capital nature.

GLEESON CJ: Can I go back to this concept of profits because I am not sure I understand how it operates in relation to the Hong Kong system but section 16 – and I am only reading from the headnote of the law report – it is set out - - -

MR LE MIERE: I think your Honour probably does not have it, yet. It is set out in a little more detail in the Hong Kong Court of Appeal.

GLEESON CJ: Yes, well, we have not got that, yet.

MR LE MIERE: No.

GLEESON CJ: But, just reading what is available to us at the moment, the scheme seems to be that you are looking for deductions from profits chargeable to profits tax during a particular year and what you deduct from those profits which, by hypothesis, as I would understand it, are derived during that year, are expenses incurred. Now, that sounds as though it might be quite different from the scheme of section 51, bearing in mind your concession that what we are looking for there is deductions from assessable income that may not have yet been earned and may never be earned.

MR LE MIERE: Yes. Your Honour, first, we say that if there is that distinction it does not bear upon the reasoning of the Privy Council in the decision. It appears, your Honour - and I confess to having read the Hong Kong Court of Appeal rather quickly, but the matter appears to be slightly complicated in this way that, on my reading, the decision at first instance which was subsequently appealed to the Hong Kong Court of Appeal, found that the expenditure fell within section 16 which both set out - it is headed, “Ascertainment of chargeable profits” and it provides for certain expenses to be deducted in calculating the assessable profits. At first instance, as I understand it, it was held that the expenditures met complied with the provisions of section 16.

GLEESON CJ: And so it was held on appeal and it was because of concurrent findings the Privy Council refused to hear argument on the point from the Commissioner.

MR LE MIERE: Yes. However, your Honour, on appeal, Vice‑President Litton, as I read it, in the course of his judgment, expressed doubt and perhaps indeed suggested that that was wrong, that it may not have fallen within section 16, for the reasons that your Honour the Chief Justice has been postulating, but decided the question on the basis that it did fall within section 16. So that, in a sense, we have the situation that the scheme might be different but it appears that the way in which it was dealt with by the Privy Council, because of the way in which it had been dealt with below, was dealt with on the basis, essentially, that there is no difference because it had been found at first instance that the expenditure did comply with section 16, that it was not an expenditure within the permitted period and even though Vice-President Litton appears to have thought that that decision might be, or is wrong, he found it not necessary to decide it on that basis but simply to uphold the decision that it was capital. Then the Privy Council, because the matter then was argued on the basis and decided on the basis that the expenditure did fall within section 16, and hence was an expenditure within the relevant period, held that it was capital.

So that, at the end, it would appear that there may well be a distinction between the two regimes but it is one which did not intrude into the reasoning of the Privy Council. I hope that helps rather than further confuses the position. Your Honours, if I might go through the steps which, in our submission, demonstrate that the way in which the majority in the Full Court posed the question at the bottom of page 771 is correct and, in effect, their answer on page 776 is correct. I would remind your Honours at 771, about line 50, is set out what was described as:

The primary fact to be determined, when the deductibility of payments of interest pursuant to s 51(1) comes under consideration –

and that, in the context, is I think the way I had got into this, their Honours had earlier set out that they were dealing now with, if I can call it, “the capital question” that being the ground on which the tribunal had found, which the majority found, that they were able to uphold the decision.

GLEESON CJ: You are supporting the proposition on the bottom of 771?

MR LE MIERE: Yes.

GLEESON CJ: Well, now, what is the meaning of the expression “during the period”?

MR LE MIERE: Yes, “during the period to which the payment of interest relates”?

GLEESON CJ: Yes. What is the period? Is that just the tax year?

MR LE MIERE: No, your Honour, not necessarily. If we take the whole phrase, “the object served by the use to which the principal sum borrowed has been put”.

GLEESON CJ: Yes, “has been put?

MR LE MIERE: Yes, “during the period to which the payment of interest relates.”

GLEESON CJ: Yes.

MR LE MIERE: So one looks to – “the period to which the payment of interest relates” means the period in respect of which you pay interest so that if the interest has been paid in arrears and you made a payment of interest - - -

GLEESON CJ: Well, suppose you do not put it to any use at all? I am trying to get away from buildings and profit-yielding structures. Suppose a professional gambler borrows money from the bank for the purpose of gambling with it and he borrows it during the year ended 30 June 1998 and he does not start to gamble with it until the year commencing 1 July 1998, so he has put it to no use at all during the year ended 30 June 1998. On this formula, he is not entitled to a deduction for interest during that year although he has not created any profit-yielding structure, he has just put money in his bank.

MR LE MIERE: Yes. If your Honour is drawing any particular significance to the fact that the payment may have been made on 30 June and he commences on 1 July to engage in the particular activities - - -

GLEESON CJ: What about 1 September?

MR LE MIERE: Well, it may be in that case that it is simply being held - that the gambler is not putting the money to any use during that period, it is simply being held for capital purposes. If, on the other hand, he starts to employ it in his gambling activities in – I suppose if one used the notion of working capital, if it becomes part of his working capital, then it will be not of a capital nature.

GLEESON CJ: One of the reasons behind the principle which you accept established in cases such as Ronpibon Tin is the artificiality of relating the year-by-year system of the Income Tax Assessment Act to practical operations and that is why, as I understand it, the courts have rejected the idea that you cannot get a deduction for interest in year one unless you have actually derived some income in year one.

MR LE MIERE: In our submission, your Honour, you must be engaged – or, rather, in year one to get a deduction, the money or the funds which have been secured by the payment of interest, must be being used in some income-earning activity. Now, that does not mean that the income must be earned during that period but you must be engaged in the activities which are leading or expected to lead to the derivation of income.

GLEESON CJ: Unless the activities constitute “building” a profit‑yielding structure.

MR LE MIERE: Well, it is a question, then – in our submission, I think it perhaps starts to come into that area which his Honour Justice Kirby was referring to before lunch as to which box you put it in. In our submission, the matter should be approached this way or perhaps illustrated by reference to the facts of this case. Where the money has been borrowed to purchase land and the land is merely vacant land, the building of the motel has not even commence, we say at that point it cannot be said that the advantage secured by the payment of the interest is the use of funds to derive income.

GLEESON CJ: Suppose you borrow money to build a gas pipeline from South Australia to Sydney and it takes years to do it, at what stage in that process do you become entitled to a deduction for the interest?

MR LE MIERE: Is your Honour assuming that the builder of the gas pipeline is going to be the operator of it and derive - - -

GLEESON CJ: Yes, a new company has been set up.

MR LE MIERE: To derive income from the - - -

GLEESON CJ: - - - from transportation of gas from South Australia to Sydney.

MR LE MIERE: Yes. Well, we have to say, during the construction phase, that is when if what is being done is the construction of the pipeline and nothing more, then it is still on capital account.

GLEESON CJ: And it becomes on revenue account when you start deriving some assessable income from the operation of the pipeline?

MR LE MIERE: Well, not necessarily, your Honour. It certainly would, at that point, but it might in fact be at a point earlier when the commissioning of the pipe is under way or something of that sort. It would be a question then of characterising the activities which are then being engaged in by the owner and operator of the pipeline.

KIRBY J: It does, though, throw up the problem, does it not, of introducing a rather nebulous problem of characterisation which, for all of its faults, conceptually, the previous assumptions did not present?

MR LE MIERE: What your Honour describes as “the previous assumptions” are much easier to apply. Yes, the Commissioner accepts that.

KIRBY J: If that is so, given that we are dealing with a statute which has to have a very broad application to thousands or millions of people in their infinitely varied investments, there is a strong argument, is there not, from everybody’s point of view, including your clients, of a clear and simple rule rather than one which calls forth in every case a task of characterisation? Really, to alter what has so long been assumed, one has to have very compelling intellectual arguments to substitute the infinite variety characterisation which is then called for.

MR LE MIERE: Your Honour, we concede that the matters which your Honour earlier put, the ease with which one can distinguish the – in the case of a simple test previous applied, is an argument in favour of it. We accept that but, in our submission, notwithstanding that, upon the proper analysis of the law as it has been developed, requires a finding in this case that the expenditure was on capital account, notwithstanding those matters, but one must look to see not just what the practical difficulties may or may not be thrown up in a particular case but it is necessary to go back and analyse what indeed constitutes an expenditure of a capital nature because, of course, those concepts used in section 51(1) will apply to many expenditures.

GLEESON CJ: On the subject of a possible difference in the statutory regimes between Australia and Hong Kong, what do you say to the submission put against you that there are provisions in the Income Tax Assessment Act, especially provisions in the capital gains tax portions of the Act, which appear to proceed upon the assumption that payments of interest are always on revenue account?

MR LE MIERE: Your Honour, indeed the Commissioner drew attention to section 160ZH(6A) on the special leave application, and that is set out in those paragraphs in our outline of submissions in which we say we agree with what the appellant says in paragraph 27 of the appellant’s submission in relation to the capital gains tax, although not in relation to the foreign exchange matters.

In brief, your Honours, we put to the Court on the special leave application that under section 160ZH(6A) contemplates that the interest cost in acquiring a capital asset may be non-capital, that is, a revenue cost and that – in brief, your Honour, sections 160ZH(1BA) and (2BA) include in the cost of an asset - leaving aside personal use assets - the amount of non‑capital costs to the taxpayer of the ownership of the asset and then sections 160ZH(6A) and (6B) define non-capital costs.

GLEESON CJ: If a commercial enterprise buys an operating factory and borrows money for the purpose of the purchase, the interest on the borrowing is deductable, is it not?

MR LE MIERE: Yes, your Honour, because the factory is going to be used, or will be used, on acquisition in the derivation of income.

GLEESON CJ: Yes. So the critical difference in terms of deductibility of interest is between buying a factory and building a factory.

MR LE MIERE: There is a critical difference between the two, your Honour.

GLEESON CJ: Now, what is the sense of that?

KIRBY J: I assume you would say that because when you get a ready‑made factory you are right into immediate income production, whereas when you are building it you have your capital asset which you are going to develop and then, in due course, it will turn from a capital asset alone into a capital asset which is income producing.

GLEESON CJ: That is the difference, but what is the sense of the difference? Why is it sensible to distinguish between the deductibility of interest in those two circumstances? Why is it rational legislation to do it?

MR LE MIERE: Because in the one situation that is where the factory is operating, assessable income is being earned and is subject ‑ ‑ ‑

GLEESON CJ: Exactly, it is the importance you attach, is it not, to deriving assessable income in the year in which the deduction is allowed?

MR LE MIERE: Not necessarily in the year in which the deduction is allowed, your Honour, but income is being earned.

KIRBY J: I have exactly the same problem the Chief Justice has been putting to you, you see. Once you make that concession you have to him, if we were ‑ ‑ ‑

MR LE MIERE: I am sorry, your Honour, “make the concession”?

KIRBY J: The concession that you made earlier to the Chief Justice of not having to have the deduction of your income, that once you have that then it is very difficult to reconcile your theory of the operation of the Act, as it seems to me, if one were starting with a blank page and going back to the words of section 51, then the words of the Privy Council seem to me to be compelling. But, against the background of this long list that Mr O’Connor has produced and the assumptions that have apparently existed since 1912 that you do not have to have it in the same year and you have very properly made that concession, then your pack of cards seems to collapse.

MR LE MIERE: Well, your Honour, in the case of where there is a capital asset which has not been used in income-producing activities, then there is not the requisite connection. The advantage being sought by the expenditure is not the derivation of income. It might be that the taxpayer will never derive ‑ ‑ ‑

GLEESON CJ: This is your notice of contention point.

MR LE MIERE: Well, the matter of contention is directed to whether or not the expenditure falls within the positive limbs. But, I think, your Honour the Chief Justice was putting to me, in a sense, what sense there might be behind the distinction and I was saying to your Honours that one distinction is in the case of an asset which is earning income then it is already involved in operations which will produce assessable income, not necessarily during the year in which the expenditure is incurred but there is income which will be earned and brought to account. That makes sense that an expenditure made to gain that income will be deductible.

KIRBY J: But take the factory example, at what point in the building of the factory - the dream, the conception, the planning authority, the raising of the funds, the laying of the foundation, the putting up of the infrastructure, and then you get to the final point where you have your work force and you are making the money, now, at what point along that line before you are making the income would you allow that you are in the situation where you can deduct the interest?

GAUDRON J: And can you deduct all of it?

MR LE MIERE: At the point, your Honour, if we are dealing with a factory rather than separate units, at the point where the ‑ ‑ ‑

GAUDRON J: Take a pulp and paper mill, you can make pulp but you cannot make paper at a certain point.

KIRBY J: It is a whole spectrum. Now, where on this spectrum – you are not yet making income because you have allowed - you do not have to have the income in order to get the deductions. At what point can you make ‑ ‑ ‑

MR LE MIERE: At the point in which - and it is then a question of fact to determine what the use is, but it is at the point ‑ ‑ ‑

GUMMOW J: Who determines it?

CALLINAN J: The Commissioner of Taxation.

MR LE MIERE: Or the tribunal, your Honour.

KIRBY J: This is like transubstantiation, at what point does it turn? I mean, where is the change?

MR LE MIERE: Well, similar questions, if I can step to one side for a moment, your Honour, arise in relation to the positive limbs of section 51(1). At what point is an expenditure incurred in gaining assessable income? It is not enough that a taxpayer intends, at some stage in the future, to derive assessable income from some project and that the taxpayer has embarked upon the project.

GLEESON CJ: Yes, but we are giving you easy examples. There can be difficult examples with individuals, for example, who borrow money for purposes that may be quite different, some might be commercial, some might be personal, they might not have made up their minds what they want to do with the money yet, but we are giving you the easy example of a purpose that is entirely commercial. There is no other ultimate object in view than the gaining or producing of assessable income.

MR LE MIERE: Well, with respect, your Honour, it is not enough that there be a commercial purpose because that, of course, ignores the distinction between capital income.

GLEESON CJ: I simply mean no ultimate purpose other than gaining or producing assessable income.

MR LE MIERE: But, in one sense, your Honour – I was going to say all – many capital expenditures have as their ultimate purpose, or many of them have as their ultimate purpose the gaining of assessable income.

GLEESON CJ: Yes.

MR LE MIERE: They are nonetheless, not at that point either income‑earning activities and the expenditure is not a revenue expenditure.

GLEESON CJ: Nobody suggests that the expenditure on building the pulp and paper mill is other than capital expenditure. The question is whether the interest on the money borrowed which funds that expenditure is of a capital or revenue nature.

MR LE MIERE: And the respondent says, your Honour, that at that time when the mill is being constructed or the plans are being drawn up prior to that, the advantage sought by the payment of the interest is not the deriving of income in the same way as the payment of the purchase price or, as your Honour put, the sum paid for the construction of the mill. In one sense, the payment of the capital sum to purchase the mill has as its ultimate purpose, the deriving of assessable income.

GLEESON CJ: No, the acquisition of an item of capital.

MR LE MIERE: Yes, and in one sense, ultimately, from that capital asset is intended to derive assessable income. But the object of the payment of the purchase price is the acquisition of the capital asset. Similarly, the payment of the ‑ ‑ ‑

KIRBY J: It is both really, is it not? It is both. They want the capital asset but they also, at the end of the day, want the income. That is what I said earlier, this is a typical….characterisation. You can theoretically put it in both boxes but we have to choose one. Now, why do we choose, given the complications that have been demonstrated even in the simple examples which out of its mercy the Court has confined itself to so far, why would one not stick to the tried and trusted approach of the past which has the great merit of simplicity?

MR LE MIERE: It might be simple, your Honour, but it is not necessarily right. In this case, if I can go back to the example the Chief Justice was talking about, the purchase price of a capital asset, again as your Honour puts it to me, in one sense, ultimately, it is intended to derive income from it but that does not lead to the conclusion that we call it a revenue item because the Act, in particular section 51(1) is predicated upon the fact that some expenditures are expenditures in gaining or producing assessable income but, nonetheless, are capital. So that the fact that an expenditure is an expenditure in gaining or producing assessable income does not mean that it, therefore, is not capital. Rather, a distinction is drawn that between the – going back to Sun Newspapers, and so on, the distinction is between, on the one hand, the acquiring of the - or improving of the business structure, and on the other hand, the operation of it.

GLEESON CJ: Was Sun Newspapers the case in which Sir Owen Dixon talked about trees and fruit?

MR LE MIERE: I think it is, your Honour.

GLEESON CJ: All right. Suppose an orchardist borrows money from the bank in order to develop an orchard, clear the land, plant trees. As I understand your argument, the orchardist first becomes entitled to a deduction of the interest when the trees bear fruit.

MR LE MIERE: Not necessarily, your Honour. There is a point when he is engaged in the operations which derive the income from the sale of the fruit and that does not start at the point in which he takes the apples off the trees.

GLEESON CJ: I see. So if he pre-contracted the sale of his fruit to IXL then he would start to become entitled to deduct the interest when he entered into the contract?

MR LE MIERE: No, your Honour. It was not the contract to sell that I was referring to, but the activities of the orchardist himself, when the orchardist is engaged. Say the operations from which he derives income start at a point earlier than pulling the apple off the tree just as the wheat farmer who derives his income from the sale of wheat, the income-earning activities start at a point prior to putting the harvester through and getting the grain out of the field.

GAUDRON J: But when do they start? When he puts the seed in the ground; when he puts the harrow through to put the seed in the ground; when he puts the fences up to keep the kangaroos out? These are problems you are going to have to answer on your analysis.

MR LE MIERE: These are problems, your Honour, but not just – these are problems which exist in any event because if ‑ ‑ ‑

GAUDRON J: Well, no, if a man borrows money to put up the fence to keep the kangaroos out or if he borrows money to pay for a subcontractor to come and put the harrow through the land, the problems will arise.

MR LE MIERE: Your Honour, if one leaves aside for a moment the borrowing of money, if he pays for the putting up of a fence or for the contractor to do various things, it must be determined whether or not these expenditures are capital or revenue in any event.

GAUDRON J: You may be able to identify that but you do not need to put the fence up for any purpose other than to keep the kangaroos out. The only reason you need to keep the kangaroos out is so that you can make some income so that there will be some wheat there that you can make some income from.

MR LE MIERE: Yes, but that question, your Honour, that is the question of whether or not the ‑ ‑ ‑

GAUDRON J: The point is that there are some capital items, the only conceivable purpose of which can be gaining assessable income. Even so.

MR LE MIERE: Yes, but that does not make an expenditure to acquire that asset anything other than a capital expenditure.

GLEESON CJ: Yes, building a fence is an affair of capital. But the question is whether borrowing the money from the bank and paying interest on the borrowed money is on revenue or capital account?

MR LE MIERE: Indeed, your Honour, that is the question which your Honours ‑ ‑ ‑

GUMMOW J: We do not seem to be progressing towards an answer.

KIRBY J: May I just ask this? I notice in my print of the Act that section 51(1)(AA) says that subsection (1) does not apply as from 1977. Are we lavishing this loving attention on section 51(1) without profit? I mean, is there going to be an income from all our capital labours here?

MR LE MIERE: No, your Honour, the new section 8(1) essentially - certainly, is intended to be and, for all intents and purposes, is the same as section 51(1). So that the ‑ ‑ ‑

KIRBY J: There has been no change that indicates any legislative purpose to make clear that upon which we are labouring here.

MR LE MIERE: No, your Honour. The new form of section 8(1):

You can deduct from your assessable income any loss or outgoing to the extent that:
(a) it is incurred in gaining or producing your assessable income; or
(b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

Subsection (2):

However, you cannot deduct a loss or outgoing under this section to the extent that:
(a) it is a loss or outgoing of capital, or of a capital nature.

So, it is a slight rewording but in substance it is the same as the old subsection 51(1).

GLEESON CJ: That covered what you want to say about your first point?

MR LE MIERE: No, it does not, your Honour, with respect. I need to cover or to go over, really, the substantial points that I was trying to make about this finding of the Full Federal Court. In my respectful submission, that statement at the bottom of 771 of the issue and the finding or the answer to that question at 776 has notionally four aspects to it. The first is that the character of an expenditure is chiefly determined by the character of the advantage sought by the making of the expenditure.

KIRBY J: That states the problem, it does not solve it because you can say the character of the advantage here is to acquire a block of land on which you can build motels, et cetera, or you can say the character of the advantage here is to do those things in order in due course to get an income. So, it states, it does not solve the problem.

MR LE MIERE: That problem is assisted somewhat, your Honour, by the following propositions. The second one relating to the matter, particularly to interest, is that the payments of interest draw their character from the use of the borrowed funds.

GAUDRON J: Where does that proposition come from, as such? I see where it is in the judgment but what leads to that conclusion? What is the major premise that brings about that result?

MR LE MIERE: I hope to take your Honours to the authorities which support it in a few minutes but to try and answer, I think, what your Honour is putting to me is something that comes before that. It is because, your Honour, that the – it follows on from the first point that in determining whether something is of a capital nature or character, that question is to be determined chiefly by the character of the advantage sought by the making of the expenditure. That then drives one to try and answer that question in relation to a payment of interest because the first thing that can be said is, I think your Honour Justice Gummow put earlier in one sense, or the only advantage sought by the payment of the interest is to - sorry, all that is done by the payment of interest is to discharge an obligation. In another sense ‑ ‑ ‑

GLEESON CJ: But when you borrow money to build a block of flats, the use to which the borrowed funds are put does not change when the first tenants come in, does it?

MR LE MIERE: It does, indeed, change over time, which I propose to take your Honours to. Not necessarily when the first tenant came in as I was trying to put to the Court earlier but at some point the character ‑ ‑ ‑

GLEESON CJ: All right. When you borrow a sum of money which is wholly applied for the construction of a block of flats which are going to last for 30 years, the use that you are making of the borrowed funds does not change, does it?

MR LE MIERE: Well, in this case, your Honour, we are talking about the borrowed flats, of course, the case might be more easily illustrated with reference to this case where the borrowed funds were to purchase the land upon which a motel at some time in the future was to be built. I remind the Court no project finance had been obtained. We are not talking about, in this case, the loans taken out to build the motel. The interest that was paid in this case was interest on the money paid to buy the land. So that the – we call it going back to the advantage which is gained by the use of the funds, that is the borrowed funds, is the acquisition of the land during this period and nothing more.

GLEESON CJ: And it would not change when the time came, if it had come, when these motels were built and off and operating.

MR LE MIERE: It may do, your Honour. It would do if a motel is constructed and is being operated from which to derive assessable income.

GLEESON CJ: We are talking about the money that was borrowed to buy the real estate, the land, the fee simple.

MR LE MIERE: Yes, but the motel, of course, is constructed on the land and one can see that. Now, the use of the funds - one has to see that the use of the funds is the acquisition and holding of the land. So that, if you ‑ ‑ ‑

GUMMOW J: We are talking in terms of practical and business concepts, are we not?

MR LE MIERE: Yes.

GUMMOW J: When I said the object of paying the interest is to stop the loan being called up, that is right. That is the legal character of it but the message of Sun Newspapers is it runs beyond that.

MR LE MIERE: Yes, indeed, and perhaps your Honour ‑ ‑ ‑

GUMMOW J: Let us try to be practical about it.

MR LE MIERE: Yes, perhaps one illustration might be the ‑ ‑ ‑

GUMMOW J: And I do not think you are being practical when you truncate things in this way.

MR LE MIERE: I am trying, indeed, not to truncate, your Honour, but to put it to the practical purpose and I might I illustrate it by this way: reference to the Riverside Road Lodge Case is a case where money was borrowed to purchase a motel and the motel was operated; successful income is derived from it. At that point the interest paid on the loans is deductible. Later the taxpayer sold the motel to a unit trust and leased it back but did not discharge the loan.

Now, at that point, as your Honour Justice Gummow put to me, plainly, the interest payments are still to discharge the obligation on the loan, but in a business practical point of view, whereas previously prior to the transfer, the sum of money, the use to which the funds are being put is the holding of the land and the motel from which income is being earned. When once that has been sold that is no longer the case., notwithstanding that it is still the same loan with the same loan obligations in a business practical sense. One cannot say that the use of the funds, at that point, is the same as it was before. Now, that is an example of the other end of the picture.

Similarly, in this case, we say at the time when the land is simply vacant land, from a business practical point of view, it cannot be said that the use to which the funds are being put is the derivation of income or that they are being used to carry out activities from which income is expected to be derived. Whereas, at a point when the motel has been built and is operating, from a business practical point of view, it can be said that the use of the funds is to own and operate the motel from which income is being derived.

KIRBY J: Do you say that a reason behind that approach is that otherwise, as it were, there is no stimulus to the taxpayer to convert a nebulous and vague held dream or hope or expectation or intention into something which will actually produce the income for which the deduction is relevant?

MR LE MIERE: That may be so, although I do not necessarily say that is the reason.

KIRBY J: All of this would fit in if it were for a theory from year to year; all of this would fit in very comfortably with a theory which has not been embraced by Australian tax law. That is that you get your deduction, but you only get it in the year of income in respect of that income. Now, that is a very rational system and, speaking personally, there seems to be language in the Act which gives support to it, but it stands in the face of 70 years of contrary authority and you concede to that authority. It is not going to go back to taws, especially as you are rewriting the Act and planning and have every opportunity to change that which has been long established.

MR LE MIERE: Can I take the Court to some authorities in support of the propositions which I put to the Court, or one which I put and the other which I ‑ ‑ ‑

GUMMOW J: Well, are we leaving the majority of the Full Court?

MR LE MIERE: No, your Honour. The proposition that your Honours ‑ ‑ ‑

GUMMOW J: We need some signposts, I think, with the ‑ ‑ ‑

MR LE MIERE: Yes. I am still dealing with this question of whether the outgoing is of a capital nature and more particularly the proposition which your Honour Justice Gaudron, I think, first put to me, and other of your Honours have put, that the nature of the expenditure or of the use of the borrowed funds may change. Indeed, the two propositions that we put in relation to that is, first, that the relevant advantage from the expenditure of the interest is the advantage in the period of the interest payments. Hand in hand with that is, as your Honours have been putting to me, that the use of loan funds may change and the nature of the interest payments may change accordingly.

Might I take your Honours to the decision of the Full Federal Court in Ure’s Case 34 ALR. In that case, your Honours, the taxpayer had borrowed money at commercial rates of interest and then lent the borrowed money at 1 per cent interest, either to his wife or to a family company controlled by he and his wife ‑ ‑ ‑

GUMMOW J: This is a “to the extent that” case, is it not?

MR LE MIERE: That certainly is a matter that – yes, indeed, your Honour, that does arise in this case, but there is, in particular, propositions that I wanted to take your Honours to. The question, of course, concerned the deductibility of the interest payments paid by the taxpayer. At page 249 ‑ ‑ ‑

GUMMOW J: I suspect we can read these cases for ourselves from time to time and I suspect also we will not find in them any direct support for your submission. If they did give it, the Full Court judgment would not have come as such a shock.

MR LE MIERE: Could I draw your Honours’ attention to a particular passage commencing at about line 26 in the joint judgment of Justices Deane and Sheppard.

GUMMOW J: Do any of these passages settle the proposition you say we should accept?

MR LE MIERE: Well, they lead to them, with respect, your Honour. What their Honours there said is:

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.

KIRBY J: What page is that, I am sorry?

MR LE MIERE: Page 249, I am sorry, your Honour. This is in 34 ALR; this is the Full Court decision.

GLEESON CJ: Yes, we have it at page 249, line 30.

MR LE MIERE: That is it, yes, your Honour. Page 249, line 30, the passage beginning “Where there is a difference”. Plainly there, in our submission, their Honours recognised that in the course of a loan, interest payments may change in character and, in our submission, that, as the Full Court in this case found, may be so when the loan is obtained to acquire or create a capital asset and later the asset is employed in income-producing activities.

Another case which supports that proposition is another decision of the Full Court in Ilbery 38 ALR, again a decision of the Full Court of the Federal Court. It was a case in which the taxpayer had purchased a property, he borrowed $20,000 for 30 years at 14 per cent from a money lender which he used to purchase the property. Immediately after receiving the loan he exercised for a consideration of some $14,000 an option contained in the loan agreement to prepay interest for a period of five years. That had the effect of reducing the interest payable from some 14 per cent down to 4 per cent. The money lender then, for a consideration of some $6,140, assigned the loan to a company controlled by the taxpayer and his wife. The taxpayer had borrowed the $14,000 by way of a loan from a bank and he had claimed a deduction for that $14,000, being the interest prepayment to the money lender.

And, in our submission, the passage from the judgment of his Honour Justice Toohey, which supports the proposition that the nature of the interest payments may change when there is a change in the use of the borrowed funds. In particular, at page 181 at about line 17, his Honour said:

The Commissioner did not contest the proposition that so long as the Galway Street property was held for an income-producing purpose, interest paid on a loan to acquire that property was deductible under section 51.

GUMMOW J: This is another apportionment case.

MR LE MIERE: I am sorry, your Honour.

GUMMOW J: Apportionment is being flagged.

MR LE MIERE: Indeed, your Honour. His Honour went on:

But if, for instance, the taxpayer decided in later years to occupy the property himself, payments of interest made thereafter would not be deductible.

So once again, his Honour recognising that a change in the use of the borrowed funds brings about a change in the character of the advantage sought by the expenditure and hence a change in the character of the interest payments.

Thirdly, might I take your Honours to that decision which was referred to this morning, Inglis 40 FLR. Your Honours have already been referred to the facts of the case. It was indeed the case that the taxpayers owned this property, Lammermuir, that had previously been operating as a pastoral property during the time when they made certain expenditure. It was found as a fact that it was not then being engaged in activities as a pastoral property. The taxpayers gave evidence that it was their intention to resume the carrying on of pastoral activities on the property in the future and it was held in that case that the deductions claimed were not deductible. It can be seen in some brief parts of the judgment that the deductions included payments of interest. That is set out in passages on page 201 in the judgment of Justice Davies at about point 7 on the page in the paragraph at the beginning of the page:

The deductions sought for the 1973-1974 year of income were for depreciation of plant and machinery and for outgoings, being travelling expenses and cost of printing and stationery. For the year ended 30th June, 1975, the objection claimed a deduction of depreciation on plant and deductions ‑ ‑ ‑

GUMMOW J: Yes, we see the word “interest” there, Mr Le Miere. We can read that.

MR LE MIERE: Yes indeed, and then again at the bottom of the page, your Honour, so that was part of the deductions being claimed. Then the passages I think your Honours have already drawn attention to, and I will not read them to your Honours, but I draw your Honours’ attention to ‑ ‑ ‑

GUMMOW J: No, not a good idea really.

MR LE MIERE: No, your Honour. Pages 195, 202 and 205 to 206 are to the effect that the present use of the property, Lammermuir, was not being used for income-earning activities. The fact that there was an intention to use it in the future to derive income as a pastoral property was not sufficient to qualify for a deduction and ‑ ‑ ‑

KIRBY J: Is this by some rule of thumb, that if the distance between the intent and the actuality is one year, two years, five years, seven years, that that takes it out of one characterisation and puts it in another?

MR LE MIERE: No, your Honour, there is a question I will come to later, this question of whether expenditure is incurred too soon, but in this case the point was that the expenditure was being made to retain the pastoral property and the property was not then being used to derive assessable income. That is, the use of the funds in this case, the payment of the interest, was to hold the pastoral property, but that was not being used to derive assessable income. That is, the activities were not being engaged in from which income would be derived, whether now or at some time in the future. It is not sufficient that some time in the future activities might be engaged in from which assessable income will be derived. So the distinction I draw is not a matter of when the income is to be derived, but when the activities from which the income is to be derived are engaged in. That, in my submission, is what is being said by Justice Brennan and Justice Davies. In our submission, both the decision and the reasoning in Inglis lead to the conclusion that if a capital asset is not presently being used to produce assessable income ‑ ‑ ‑

GUMMOW J: No, no, devoted towards that end; that is what Justice Davies is talking about.

MR LE MIERE: Justice Davies indeed uses the expression “devoted”, your Honour ‑ ‑ ‑

GUMMOW J: They had not made up their mind what they were going to do with it; that is what he is saying.

MR LE MIERE: It is also said, your Honour - Justice Brennan at page 195 says it does not matter that it is intended to be used to gain or produce assessable income in the future. At about point 4 on page 195 Justice Brennan said:

If a capital asset is not being used to produce assessable income, though it is intended for use in the future to produce assessable income, expenditure in merely preserving the asset until it is so used is not deductible. Rather, being expenditure upon a capital asset not employed in producing income, it has the character of a capital outgoing. The expenditure related to Lammermuir appears unconnected with any activity for the production of future income, and does not qualify for deduction under the first limb of section 51(1).

GUMMOW J: Yes I know, we had that read before.

MR LE MIERE: Yes, I am sorry, your Honour. Well, I will take that point.

KIRBY J: But if the object here, as has been fond, was to secure an income-producing asset, then from the very beginning, from day one, reinforced by the steps that were taken, the planning steps and the alter steps and all the others, then it really is not analogous to Inglis.

MR LE MIERE: Your Honour, in this case, that is in the case we are dealing with, the interest payments were made not to secure an income‑producing asset, but to secure a capital asset from which in the future the taxpayer intended to develop and, in a developed state, produce assessable income.

GUMMOW J: Yes, well that is what we – that is where we started off ‑ ‑ ‑

MR LE MIERE: In my submission, the position is analogous to that in Inglis’s Case. Your Honours, the proposition that we put, that the relevant advantage is the advantage in the period of the interest payments and that the use of the loan funds may change and the nature change accordingly, the further authority in support of that, of course, is Wharf Properties, which your Honours have been referred to earlier. May I take your Honours briefly to Wharf Properties and indicate those parts of the judgment which, in our submission, support the proposition which we put.

MR McCUSKER: Your Honours, we do have five copies of the Court of Appeal decision.

GLEESON CJ: Yes, thank you, Mr McCusker.

MR LE MIERE: May I draw your Honours’ attention to the Privy Council decision in the 1997 Appeal Cases Report. At page 512G, Lord Hoffmann said there:

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, 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 ‑ ‑ ‑

GUMMOW J: Well, we have had that passage read too.

MR LE MIERE: And finally, your Honours, at page 513F – I do not think your Honours have been taken to the passage. Again, attention is drawn to looking to the use or objective purpose of the loan during the period for which the interest is made and, of course, in that case, their Lordships expressly accepted that the use may change over time and as the use of the…..changed, so the character or nature of the interest expenditure also changed. Your Honours, we submit that the decision of the majority that the outgoing of interest expenses and nature of capital is supported by the decision of this Court in the Energy Resources Case.

GUMMOW J: Well, what do you say about the point Mr McCusker made about Energy Resources?

MR LE MIERE: As I understood it, Mr McCusker was saying in essence that discount is different than - or two things: that what the Court had to say in relation to the nature of the discount loss was obiter, and we say with respect to that, it is the reasoning of the Court from which we derive assistance. Secondly, Mr McCusker said, in effect, that discount costs are different than interest costs. But again, I say it is what the Court had to say at pages 73 to 74 which, in our submission, supports the proposition that we put. If I could take your Honours there, in essence, at the bottom of page 73 the Court said, starting about five lines from the bottom:

Similarly, the payments made to discharge the liabilities arising from the notes were capital and not revenue payments. But that does not mean that the cost of the discounts was necessarily a capital expense. Where a taxpayer incurs loss or expense in raising funds by issuing promissory notes at a discount to their face value, its entitlement to a section 51 deduction for that loss or expense depends on the use to which the funds are to be put.

And we pause to say the same applies to interest payments. The Court continued:

If the funds are to be used as working capital, the cost of the discounts will be deductible as a revenue expense.

On the other hand:

If the funds are to be used to strengthen “the business entity, structure, or organisation set up or established for the earning of profit” the cost of the discounts will generally not be deductible because they will be a capital, and not a revenue, expense.

Their Honours added then the qualification which applied in the case under consideration:

But sometimes the raising of capital may be such a recurrent event in the business life of a taxpayer that the cost of raising the capital will qualify as a revenue expense.

Their Honours continued then that it appeared, on the facts of the case:

At first sight, it seems strongly arguable that the funds in this case were raised for the purpose of strengthening the capital structure of the business and not to finance its day to day operations. that was the view of Justice Davies at first instance and of Justices Beaumont and Hill in the Full Federal Court. In so far as the funds raised by the issue of the promissory notes were used to discharge the liabilities under the Schroder Wagg facility, they discharged liabilities that had arisen from borrowing funds for the purpose of developing and operating the Ranger uranium mine. In so far as the funds from an issue were used to repay liabilities arising from the preceding issue of Euronotes, they were mainly, perhaps wholly, used to discharge liabilities which had been substituted for the liabilities arising from the initial borrowings under the Schroder Wagg facility. Those factors seem to indicate that at least a large part of the cost of the discounts was a capital outgoing.

The Court then went on to say, however:

On the other hand, it is possible that, in the overall operations of the taxpayer’s business, the cost of the discounts was “a necessary outgoing made in the normal course of the continuance and maintenance of the business as an enterprise conducted for the purpose of profit”. It may be that the cost of raising capital was such a recurrent feature of the taxpayer’s operations that it is proper to treat the cost of the discounts as a revenue item. The Commissioner – who no doubt knows more about the taxpayer’s business than this Court…..accepted that the cost of the discounts was a revenue expense and, therefore, an allowable deduction under section 51 of the Act. That being so, it is impossible –

to find otherwise.

There, your Honours, the Court in effect concluded that, except where the raising of capital is such a recurrent event in the business of a taxpayer, the cost of raising capital is a revenue expense, where the funds which are raised are used to acquire or maintain a capital asset, as in that case. We say in the outline of submissions, with respect, in relation to Mr McCusker’s point, that discount costs are different than interest. We say that interest on capital raised by way of loan and the cost of discounts on promissory notes used to raise finance, have the same commercial attributes and refer to the judgment of Justice Hill in Crawford, in relation to that.

In essence, we say that what is there said by the Court in ERA supports the proposition that the cost of borrowed funds, which read the interest paid on borrowed funds, which are used or to be used to strengthen the business entity or structure, we say, in this case, that interest payments used for that purpose should receive the same taxation treatment as discount expense incurred in the same circumstances.

There are one or two further points to make briefly in relation to the capital point. Your Honours, my learned friend, Mr McCusker, said, I think this morning, no decisions of this Court to the effect that interest payments were capital in nature. I think in the submissions we were taking issue with the statement that there were no decisions in Australia to that effect. We draw attention to the decision of the Full Court of the Federal Court in Associated Minerals Consolidated Ltd v Federal Commissioner of Taxation.

GUMMOW J: Is this in your written submissions?

MR LE MIERE: Yes, your Honour.

GUMMOW J: Which paragraph?

MR LE MIERE: Paragraph 17, your Honour.

GUMMOW J: Yes.

MR LE MIERE: There we say that in that case the Full Court upheld the decision of the trial judge, that interest payments were of a capital nature and where the trial judge found that the principal object of the borrowing was to enable an exchange rate gain arising from an investment in the US to be crystallised by obtaining a matching loan. So there was a capital. The object served by the funds was a capital object. In that case the Full Court found that the interest payments were capital in nature.

We have also referred to in the outline of Inglis’ Case. I have taken your Honour to that case too, and it was found expenditures in that case included interest payments. We have also referred to, in the outline, the decision of Justice Merkel in Temelli, in which his Honour held that interest costs were incurred prior to proposed investments having income-earning capacity. That was a case involving the purchase of land to build a luxury house and rent it out, and again the interest payments were held to be of capital nature, following both Steele and Wharf Properties.

Your Honours, we have set out in the outline of submissions the respondent’s response to the appellant’s statements that previously the Commissioner has treated interest payments as being on revenue account and the other matters that the appellant has drawn attention to. Your Honours should have amongst the materials that we provided to the Court a copy of the draft tax ruling ‑ ‑ ‑

GLEESON CJ: It is behind tab 23, I think.

MR LE MIERE: Yes, your Honour, and that sets out in there the Commissioner’s position in relation to those matters. If it please, your Honours, those complete the submissions that I wish to make on the capital point.

GLEESON CJ: Are you moving now to your notice of contention?

MR LE MIERE: Well, not quite, your Honour. Both: the notice of contention overlaps with what is said to be ground 2(b) in the notice of appeal.

GLEESON CJ: What, you are moving onto ground 2(b) and the notice of contention?

MR LE MIERE: Yes, your Honour.

GLEESON CJ: Yes.Keep going.

MR LE MIERE: Your Honour, the question, as your Honour Justice Gaudron made plain earlier this afternoon in relation to section 51(1) in the positive limb, the question is whether or not the interest payment is incurred in gaining or producing the assessable income. The authorities make plain that that is a question of characterisation and again we have set out in the outline of submissions the reference to Fletcher’s Case, in particular, in which it is said that that is a question of characterisation.

KIRBY J: Do you accept that that question is a question of law?

MR LE MIERE: Yes, your Honour, In essence, yes, we do, your Honour. Of course, it involves, as it were, two aspects: one is questions of fact and the other is the proper legal standard to be applied in determining what the proper character of the outgoings is.

KIRBY J: There is authority in other contexts that even perverse applications of the law do not raise questions of fact in terms of the application of statutes; however, if you do not challenge it, it has the authority of Lord Hoffmann and no one is contesting it here. I think that is how we proceed.

MR LE MIERE: Now, can I take the Court to the decision in Fletcher.

KIRBY J: What is your proposition first?

MR LE MIERE: Two: whether or not any expenditure is incurred in gaining or producing assessable income as a question of characterisation; further, that the characterisation depends upon the relationship between the outgoing and the production of assessable income, in particular, that to be incurred in the gaining of assessable income. The production of assessable income must be the occasion of the outgoing or the outgoing is a cost of a step taken in the process of gaining or producing assessable income.

GUMMOW J: Well this is trite law, is it not?

MR LE MIERE: It is, your Honour, and indeed we referred to Fletcher, Roberts and Smith and the other cases.

GUMMOW J: But we do not have to be assailed with trite law.

MR LE MIERE: If I could take your Honours then to the findings that were made, in relation to that, your Honour. Now, the first question is, what finding the Full Court made in relation to this question, that is, whether or not the outgoings came within the positive limbs of section 51(1). It is not clear whether the majority made a finding in relation to the positive limbs. As we say, at page 762, the Full Court, as it were, criticised the observations of the tribunal to the effect that the appellant never had more than an idea or a fond hope of proceeding with the motel, and the Full Court said at about line 50 that:

These passages seem intended to invoke the proposition that a sufficient connection, for the purposes of section 51(1), between an outlay and the prospect of income requires a degree of commitment –

and so on, and it goes on to find, in effect, if the tribunal’s decision depended upon that, then it was doubtful that it could be upheld. The court in fact said, at page 763 that:

Mrs Steele did much more than announce a dream.

And so on. That:

She demonstrated her “commitment” – - -

GUMMOW J: Is this paragraph 30 of your submissions? I mean, one begins with a proposition that ‑ ‑ ‑

MR LE MIERE: Paragraphs 23 and 24, your Honour. We there set out what the Full Court said.

GUMMOW J: Well, exactly.

MR LE MIERE: And then the court went on to say, however, as I have taken the court to before, that the court could decide the matter, in any event, upon, what it described as, the second ground of the decision. The court said, in effect, that if the tribunal was right on the first ground it was not necessary to decide the second ground. Then the court found that the character at the advantage sought by the payments of interest was the creation of a capital asset and hence, that the payment was of a capital nature. Then at page 785, your Honour, the court said, at line 25:

The whole of the outgoing does not meet the criteria for deduction; apportionment is required.

Now it is not plain there whether the majority are referring to by “the criteria”, which is used in the plural, to the fact that the outgoings met neither the exclusionary limb nor the positive limbs of section 51(1). We refer to in the written submissions in paragraph 24 the passage in the judgment of Justice Ryan, who was one of the two majority judgments in Stamoulis, where his Honour appeared to say that the majority in Steele’s Case had found that the outgoing did not meet the positive limb either.

In any event, in our submission, the findings which were made by the Full Court lead to the conclusion that the outgoings do not satisfy the positive limbs.

GUMMOW J: Well, that is the question.

MR LE MIERE: Yes. Your Honours, the appellant says, in paragraph 32 of their submissions, in effect, that but for the majority’s finding that the interest was of a capital nature, the majority in the Full Court would have accepted that the interest was deductible, and we say that that is not so. The majority found, as I have indicated many times, the advantage sought by the payment of the interest was the creation of a capital asset. So, not only do we say that that not only leads to a conclusion that the expenditure falls within the exclusionary limb, but it also leads to the conclusion that it does not satisfy the requirements of the positive limbs of section 51(1), because, as your Honour Justice Gummow was putting to me before, we say, with respect, that it is trite law that for an outgoing to come within the positive limbs of section 51(1), the expenditure must be incurred in the activities which directly produce the assessable income, and the tribunal found, in this case, that the advantage sought by the payment of the interest did not lead to the derivation of any assessable income. The use of the funds during the relevant period did not themselves lead to the derivation of assessable income. Not like in the case where the motel is being operated or at some point prior to that.

GUMMOW J: Have you some year of income argument?

MR LE MIERE: Well, it is the same point, your Honour; the Commissioner, as your Honour is aware, does not say the income must be derived in the same year. We say that ‑ ‑ ‑

GLEESON CJ: Or at all.

MR LE MIERE: Or at all, yes, indeed, your Honour. The authorities, in our submission, establish that for an outgoing or expenditure to be incurred in gaining or producing assessable income, it is necessary that the expenditure should have been in activities which themselves produce assessable income. It is not so that, in the case of the factory, the operation of the factory produces assessable income, but the steps taken earlier in the acquisition of the land and the holding of the land is not itself the derivation or the activities from which income is derived. So we say, for that reason too, the finding by the tribunal that the interest expenditure were made, incurred in producing a capital asset or acquiring and creating a capital asset, namely the land, necessarily leads to the finding that they were not incurred in gaining or producing assessable income, in this case.

The final aspect of the respondent’s case is that directly raised by the notice of contention, which relates to the nexus, and I move to that. It relates to the nexus between the deriving of income and the particular expenditure under consideration.

KIRBY J: What is the word of nexus, is it “in”? What is the word that you latch onto in the statute?

MR LE MIERE: “In”, yes, your Honour, and indeed in a number of authorities, sometimes the word “nexus” is used, sometimes the word “connection” is used but, of course, the point has been made, the point is that it is not a separate test; it is simply another way of exploring, setting out, why, in the circumstances, the test of Ure’s is whether the expenditure is in incurring the assessable income or producing assessable income, and it is said that in Ronpibon, of course, expenditure must be relevant and incidental to the derivation of assessable income. It is alternatively put that there must be a sufficient connection between the expenditure and the deriving of assessable income in order for it to be properly said that the expenditure is incurred in gaining or producing accessible income.

The submission which the respondent makes is that an outgoing may not be incurred in producing assessable income if it is incurred too soon before the commencement of the business or income-earning activities. In paragraph 27 of our submissions we say it is not simply a matter of a period of time; it is a question of the circumstances and extent of any lapse of time between the incurring of the expenditure and the commencement of the relevant income-producing activity, is relevant to determining whether or not there is a sufficient connection.

GUMMOW J: It comes down to some factual debate, does it not, really, and what you say about that appears at paragraph 35, does it not?

MR LE MIERE: In our submissions, your Honour?

GUMMOW J: Yes. All this is construing the word “in”, as Justice Kirby put to you. In the end you have got to come to paragraph 35, I suppose.

MR LE MIERE: It does, your Honour. In essence the tribunal found that there was not a sufficient “nexus” - is the word the tribunal used - between the expenditure and the income-earning activity, for it to be an expenditure incurred in gaining or producing assessable income. Now that finding, we say, is a finding of fact in our favour. The appellant, as we understand it, seeks to overcome that obstacle by reference to the findings or observations of the Full Court in relation to commitment. Now, to say, all the Full Court did was to say, in effect, that the observations of the tribunal, or the statements of the tribunal, in characterising what the appellant did as being no more than a “fond hope” and a “dream”, was unfair and that she was committed to the project.

We say, that does not get the appellant where she needs to go; a finding that she was committed to some project ‑ ‑ ‑

KIRBY J: Does this run into jurisdictional problems, in the sense that the appeal lies only on a question of law? I do not want to be harking at this, but this is a very common problem in the appellate courts when it is limited to a point of law when a factual issue can turn into a point of law.

MR LE MIERE: Well, in our submission, your Honour, in a sense - yes, the answer to that is yes; we say that the relevant findings made by the tribunal are findings of fact and that the ‑ ‑ ‑

KIRBY J: You better bring some authorities tomorrow on this issue, because this is a tricky area. I mean Hope’s Case is one that springs to mind, in this Court.

MR LE MIERE: Well, your Honour, we do not contest the proposition in Hope’s Case is, we say, in a sense, gives rise to what is said by the Full Court to the effect that the findings were not open to the tribunal, but that finding that the Full Court is referring to is the finding that the ‑ ‑ ‑

KIRBY J: It was just a dream.

MR LE MIERE: Yes, and that she was not committed ‑ ‑ ‑

KIRBY J: That was not simply a particular finding of fact; that does not deal with the characterisation problem.

MR LE MIERE: No, and we do not ‑ ‑ ‑

GLEESON CJ: I am not sure that that was a finding of fact about this taxpayer; it was a comment made. It was said, “It is not enough for a taxpayer to say.”

MR LE MIERE: Yes.

GLEESON CJ: Mr Le Miere, how long do you think you require to complete your argument?

MR LE MIERE: I would have thought about half and hour, your Honour.

GLEESON CJ: And, Mr McCusker?

MR McCUSKER: About 15 minutes, I would think at the most, your Honour.

GLEESON CJ: Well then, we will adjourn until 9.30 am in the morning.

AT 4.31 PM THE MATTER WAS ADJOURNED
UNTIL THURSDAY, 22 OCTOBER 1998

[1998] HCATrans 371

Key Legal Topics

Areas of Law

Tax Law

Administrative Law

Civil Procedure

Legal Concepts

Judicial Review

Appeal

Jurisdiction

Statutory Construction

Procedural Fairness