The Commissioner of Taxation of the Commonwealth of Australia v Roberts; The Commissioner of Taxation of the Commonwealth of Australia v Smith

[1992] HCATrans 341

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; - ---*'~JA .lit~

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IN THE HIGH COURT OF AUSTRALIA

Office of the Registry

Hobart No H4 of 1992

B e t w e e n -

THE COMMISSIONER OF TAXATION OF

THE COMMONWEALTH OF AUSTRALIA

Applicant

and

JOAN DOROTHY ROBERTS

Respondent

Office of the Registry

Hobart No HS of 1992

B e t w e e n -

THE COMMISSIONER OF TAXATION OF

THE COMMONWEALTH OF AUSTRALIA

Applicant

and

VALENTINE ROY SMITH

Respondent

Roberts 1 13/11/92

Applications for special leave

to appeal

MASON CJ
BRENNAN J

McHUGH J

TRANSCRIPT OF PROCEEDINGS

AT MELBOURNE ON FRIDAY, 13 NOVEMBER 1992, AT 9.34 AM

Copyright in the High Court of Australia

MR J.M. BATT, QC: If the Court pleases, I appear in both

th~se mattefS with my learned friend,

MR G.T. PAG?N~, for· tte applicant. (instructed by

the Australian Government Sdlicitor)

MR D.H. BLOOM, QC: If the Court pleases, I appear with my

learned friend, MR A.J. ABBOTT, for the
respondents. (instructed by Dobson, Mitchell &

Allport)

MR BATT:  Your Honours, may I hand up copies of a decision

of the Supreme Court of Canada in Bronfman Trust

which it may be necessary to refer to later in the

..,hearing.

Your Honours, special leave is sought on two

aspects of this case: first, the deductibility of

interest and that in itself falls in two parts. It
is convenient to tak.e first the case of Mrs Roberts

who was admitted to the partnership in 1987. The

Full Court's decisio"n or, at any rate, the

majority's decisi~n in har favour to dismiss the

appeal absolutely was solely on a second ground

applicable to her only and not to Mr Smith, and

that is expressed at page 66 of the application

book starting at line 10. The essence of it is

that Mr Justice Hill, with whom, I think, the other

judges agreed and certainly Mr Justice Jenkinson on

this point, was for allowing a deduction to her
individually without reference to the partnership.

But, with respect, Their Honours were clearly wrong

on that because the interest in 1987 and in all

years was a partnership outgoing, not an individual

outgoing; it was accounted for by the partnership

and was reflected in the reduction in her share of

the net income of the partnership.

If Your Honours want me to, I could~give you numerous references to show that that is so but I may, without reading, just give you the reference

at page 24, lines 5 to 8, and page 38, lines 15 to

17 of the application book, amongst a plethora of

references.

~ Justice Hill correctly noted at pages 41 to

42 of the application book the effect of
sections 90, 91 and 92 in Division 5 of Part III of

the Tax Act as explained by this Court in

Fletcher's case, a passage which appears at page 20

in the application book. His Honour applied it

correctly in considering Mr fmith's position, but

when it came to Mrs Roberts, at page 66, in our

submission; Horner nodded. First, in not

considering the deduct_ibility from the standpoint of the partnership as though the partnership were

the taxpayer, whicq is what is requi~ed by

Division 5 - - -

Roberts 2 13/11/92

MASON CJ:  But what are you suggesting, that there was a

double deduction? That, in fact, there was a

deduction against the partnership and then - - -?

MR BATT:  No, no, I am not suggesting that at all. But

His Honour looked at the matter as though she had

paid the interest. All partners, as partners, pay

the interest and therefore you have got to

ask -

MASON CJ: So, the issue was whether or not the partnership

could deduct, not whether the individual partner

could deduct?

MR BATT:  Yes, and His Honour did not address himself to the

issue as Your Honour has expressed it. He looked

at it as though she had paid it and he looked at it

as though - furthermore, and our second point is,

he did so by reference to hypothetical occurrences

said to be equivalent but which did not occur

because they did not involve the partnership

paying. It was not as though she paid the

interest. All the partners paid the interest. You

have to ask whether there was a sufficient nexus

between the partnership.

MASON CJ: But is this not a slip - no more than a slip?

Was the case not considered on the basis of whether or not it was a partnership deduction?

MR BATT: At the beginning of page 32 His Honour said:

there is another reason why Mrs Roberts' case

should be decided in her favour -

and he sets it out. It is a slip. In our

submission, it is a fundamental and elementary

error. But the reason why the court did not send findings of fact was because of the decision made

on page 32. That is, in our submission, an error.

It may be a slip, but it was a slip on which the

but, more importantly, this page creates confusion	decision was based. In our submission, it is inconsistent with the earlier part of the judgment	for lower courts hereafter as to the relationship
between sections 90 and 92 and 51 and we would
submit, respectfully, that this Court should grant
special leave to remove that confusion and,
secondly, it is unjust for what is a clear error to
remain uncorrected.

BRENNAN J:	What do you say about the bottom of page 65?
MR BATT:	What we say is - that begins, Your Honour, at

line 17 with the words, "If the Tribunal were to

find"?

Roberts 3 13/11/92

BRENNAN J:  Yes ..

~

MR BATT:  If that had been tl'ie sole ratio for Mrs Roberts,

there would have been ."¼ similar order for

Mrs Rober-ts, namely,·setting aside the tribunal's

decision and sending.the matter back for .finding of

b facts about capital. But that is not what the

order was for Mrs Roberts.

BRENNAN J: At the top of page 32, though, His Honour says:

Jiowever ,· I think that there is another reason

why -

MR BATT:  Ye~?, b'Llt at - ... - -

BRENNAN J: ·In other words, is not His Honour advancing two

reasons why?

MR BATT:  Yes, he is, Your Honour. The order of the court

·• at page 71 is simply that, c.'t'he appeal be

dismissed." That can only be supported by the

second of the reasons to which I have just been

addressing myself.

McHUGH J:	Your point is that apart from the second reason, her case would have gone back as well?
MR BATT:	Yes, the same, and therefore we should at least

stand the same chance with her, if I am right about

my submissions, and go back to the tribunal, at the

very least.

MASON CJ:  But this seems a very minor point. You would not

be much interested in this case, would you, if you

succeeded only on this point?

MR BATT:  We would still, as it were, have a chance before

the tribunal, Your Honour, and, secondly, what i~

said at that page for our client is important

because it affects other cases. People will pick

up on this and seek to not go through Division 5

when there are partnerships involved.

YouJ'.'I, Hono1.1rs, that is all I wish to say about

Mrs Roberts, and I come to the second aspect of the

deductibility of interest, and this is raised by

the Smith part of the decision. The facts of this

case in a nutshell were that the partnership

borrowed $125,000 as a fully drawn loan, and

divided it amongst themselves. Book entries had

..

the accounting effect of reducing the so-called

capital which was simply a balancing item for this

:. partnership - - -

BRENNAN J: What do you mean by "divided it amongst

themselves"? The partnership borrowed $125,000 and

Roberts 4 13/11/92

then a like amount was distributed by the

partnership to the partners, is that right?

MR BATT:  Yes, by five payments of $25,000. That is what I

mean, Your Honour.

BRENNAN J: $125,000 that was brought in by the borrowing

remained there.

MR BATT:	It remained as a debt to the bank.
BRENNAN J:	Remained as - as to the $125,000 - an asset of the partnership, and then - - -

MR BATT: Well, cash was increased and then cash was

reduced.

BRENNAN J: And then cash went out, that is right.

MR BATT:  Yes. But, Your Honour, the evidence makes it

clear that the partnership would not have borrowed

if it had not been going to pay out five lots of

$25,000.

BRENNAN J:  Be it so, but that is not the point, is it?

MR BATT:  We submit it is. They could not have made those

five payments if they had not borrowed.

BRENNAN J: But if they had borrowed and not made the five

payments, they would still be liable for the

interest, would they not?

MR BATT:	Depending on what was done with the money.
BRENNAN J:	No, assuming it was just devoted to ordinary partnership purposes.

MR BATT: If it was, yes. But this borrowing was arranged,

in our respectful submission, with the express

intention, given effect to, of the money being paid

out immediately and that is made clear by a bank

record which was not, unfortunately, in the - as

exhibit to the affidavit. But it is clear that they

borrowed only for the purpose of paying themselves

$25,000 each. We submit that, in those

circumstances, this is not a borrowing for general
partnership purposes.

We submit that the Full Court was wrong in law

and that special leave should be granted because of
the wide ramifications this decision has, because
of the uncertainty it introduces as to the notion
of invested funds and because it facilitates tax

avoidance, or it will facilitate tax avoidance in

other cases.

Roberts 5 13/11/92

If I might, Your Honours, briefly amplify just

those statsillents.· We submit it is wrong because

instead of apply~ng the correct legal test laid

down by this Court in Munro and ~ore recently in

Fletcher for determining the sufficiency of the nexus between the outgoing and the production of acce~sible income, and then asking whether the

moneys borrowed were used directly.in the carrying

on of the partnership business, the Federal Court

looked at the accounting effect and came up with

what we say is, in es·sence, a fiction of the

replacement of invested funds in three passages

which are set out in Mr Mills' affidavit.

. It wo~ld be suff~cient, according to the Federal Court's decision, if the borrowed f1mds, to

use the happy phrase of my learned junior in lower proee~dings, "touched the base" of the partnership

business' books. We would submit if Munro had been

a partnership, the taxpayer woul~.have succeeded,

accorciing to the Full Fedo~al Cour~'s decision. We

submit that this decision is cont.rary to Munro and

·.&,	it is a triumph of form over substance. In our submission, the outgoing has nothing to do with the
carrying on of the business. ·

This is not a case of a subs~quent

replenishment after there has been a repayment of

capital from an account that was in credit or where

there were pre-existing over-draft facilities.

The special leave, in our submission, should

be granted because this raises, in general terms, a

first principles analysis of the nature and degree

of the nexus required to satisfy section· 51 in a

case of interest, interest being, perhaps, the

single most significant tax deduction for

taxpayers. Secondly, there is the question of the

meaning of "invested funds". Does it include

goodwill? Does it include work in progress?

Thirdly, there are the wide ramifications of this decision. It has already been much discussed

deduction. In our submission, if the partners had	amongst tax professionals. It enables an interest
borrowed money a1.d as a partnership purchase had purchased a pleasure craft, it would enable the interest on the loan to be claimed as a deduction.
The case is, in our s_ubmission, pregnant with tax
avoidance possibilities. It enables interest on a
loan made to a company in order to enable the
company to pay dividends to be deducted. It

...

e~ables a grocer who has an equity in his

gror:eJ:y -

BREN~AN J:  Do you mean to pay dividends out of capit.al? .,. -!-

......,

-"

Roberts 6 13/11/92

MR BATT:  No, out of profits which it is not able to pay for

other reasons unless it gets a loan. I am not

suggesting the company breaches the Corporations

Law or anything like that.

BRENNAN J:  What is the difference in this from a case where

there is a reduction of capital and there is a

borrowing to take the place of the capital that is

reduced?

MR BATT:  I am sorry, what is the difference - - -?

BRENNAN J: What is the difference between this case and the

case where a company reduces its capital and

borrows to replace the capital reduced?

MR BATT:  Because, in our submission, this is not a true

reduction of capital when you have regard to the

immediate use of the borrowed moneys.

BRENNAN J:  But the immediate use is to reduce the capital

accounts of the partners.

MR BATT: That is the effect, as a matter of accounting but

it was used, in our submission, to simply pay the

partners money to do as they will.

McHUGH J: But it is more than a matter of accounting, is it

not? It is a change from equity to debt.

MASON CJ: Take the very example you gave earlier, that is,

replacing capital with debt and paying dividends.

Why is not the interest on the debt deductible?

MR BATT:  In our submission, the payment of dividends is a

matter that occurs after the profit has been
established and is not connected with the running

of the business.

MASON CJ:

But why does it matter that the actual moneys come from borrowed moneys when the decision is made

paid out in satisfaction of the dividend declared

that the company, as a going concern, is going to

be conducted to a greater extent on debt than

capital?

MR BATT:  Because the money is borrowed, in the example I

intended to give, for the very purpose of paying

the dividends, which is not - - -

McHUGH J:  But would it make any different if they sold an

asset to pay the dividends and then borrowed to

repurchase a similar asset?

MR BATT:  We would accept that that is deductible then. But

this is not that case and nor is it the case,

Your Honour, where there was a replenishment after

Roberts 7 13/11/92

there had been a payment out or a sale of an asset.

It is a case where they are done at-the same time

and the case was conducted at all times on the

footing that this money went in and went out.

Your Honours, also the case raise~ - perhaps

less directly, but·it raises the correctness of the

earlier South Australian decision of

Mr Acting Justice Reed in Begg's case referred to

by Mr Justice Hill and the mo=e recent decision of

Yeung's case where, in each of those cases as they
were decided - not as Mr Justice Hi~l interpreted

Yeung's case, but a~ they were decided - moneys

borrowed applied to a non-income er non-business

purpose. The interest on that was held to be

deductible because tpat enabled income-earning

assets to ta-preserved.

That was the taxpayers' alternative argument.

As the court below decided the case, it ~id not

really need to be con~idered, but that was the

taxpavers' alternative argument when this case was

heard by the Full Court in Hobart. In our

submission, this Court should consider those

decisions, especially in the light of the Bronfman

case, which we have handed to Your Honours, the

decision through the mouth of the Chief Jjstice of

Canada. At pages 48, 49 and 50 we have highlighted

the passages in that case which are contrary to

Begg and Yeung. We would say that Yeung is

distinguishable, so far as we are concerned but, in

any event, if it is not and if it means what

Mr Justice Hill said it does, it is wrong. Now

that the Supreme Court of Canada has spoken, we

would submit this matter should be c~nsidered by

this Court.

There is one other matter, Your Honours, on a

lower level admittedly, and that is the question of

the non-application of the onus provisions. Having

regard tor.he way the case was conducted, there

was, in our submission, an error .. The case was run

on the basis of a reduction of false - what we call
"false" - capital; this notional idea of capital,
and although a remitter to the tribunal was
adverted to by Mr Slater, arguing for the taxpayers
below, ~twas not asked for and it is our

submission that if further £acts are needed before

there could be a favourable decision to the

~axpayer, the taxpayer must fail on the onus.

~That, 7our Honours,. is what we say about

interest. There is a second aspect on which

special leave is sought, namely, on the

Commissiuner's object:on to com~etency of the

appeal to the rederal Court on the ground that no

question of law was involved, the tribunal having

Rc::,erts 8 MR .BATT,. QC · 13/ 11/92

found the outgoing to have been of a private

nature. In our submission, special leave should be

granted for two reasons: one is that there is a

conflict of decisions in the Full Federal Court
itself as to the interpretation and application of

Administrative Appeals of the application book and is not, with respect

section 44(1) of the

to Mr Justice Hill, distinguishable. Brixius, on

which we rely, goes one way and the decision of the

Full Court in this case and in other cases to which the Full Court refers goes the other way on

whether, when the matter is a question of fact and

degree only, there is a question of law. In our

submission, this Court should resolve that conflict

pursuant to section 35 of the Judiciary Act.

Secondly, we say that the point is important

for tax appeals, this question of law: the

jurisdictional foundation of every appeal to the

Federal Court and, indeed, for the application of the Administrative Appeals Act generally because it affects the extent of the Federal Court's

jurisdiction.

BRENNAN J: What is the new fact that the Federal Court

purported to find?

MR BATT:  My point was that Dr Gerber had found that the use

was private - the application of moneys was

private, and as Your Honour has said an error of

finding of fact is not an error of law.	But we
would say - - -

BRENNAN J: But that was an attribution of law to the facts

that he found, was it not?

MR BATT:  We would say the meaning of the word "private" is

rather like Brutus v Cozens.	It is a word of no
technical meaning and whether	something is private

or not is a question of fact,	it being reasonably
open to say it was private.

BRENNAN J: Put it to another test: was there any aspect of

the circumstances which could not be the subject of

evidence found by the Federal Court different from

that found by Dr Gerber? I am not sure that I put
that as clearly as I might, but what I mean is

would it have made any different if any other

witness had given any evidence?

MR BATT:  Only on the question that the Federal Court itself

left open, whether there was enough capital there

but that is, I think, not what Your Honour is

asking me. No, Your·Honour, I do not think it

would but I would like to come back to what you

first asked me on this point. The Federal Court,

Roberts 9 13/11/92

in our submission, made a finding that Dr Gerber

had not made, namely, tha~ there was a reduction of

capital; that capital was being reduced.

On this question of fact or law, we would note

in passing that in a passage set out at page 57 of

the application book, in Kidston, Mr Justice Hill

himself said that it was essentially a question of

fact whether section 51 was satisfied. That is in

his earlier single justice decision in Kidston, and it is at lines 8 to 10 of that page.

This is a troublesome matter, whether thG

question r~ised by an appeal from the t=ibunal- to the lederal Court at first instance- is one of law or not. It often arises and, in our submission,

this Court should grdnt special leave to decide

· whether the·point we took before

Mr Justice Northrop, although it is no~ adverted to

in his judgment,- and we took again in the

Full 'Federal Court is right, uamely, that the

appeal was incompetent. If the point is good, of

course, we win entirely.

If the Court pleases, unless the Court has any

further questions, those are out submissions.

MASON CJ: Yes, thank you, Mr Batt. Mr Bloom, what do you

say about the first matter that was raised by

Mr Batt, that is, tl4e actual order that was made in

the Roberts' case. •

MR BLOOM:  Your Honour, at first blush, there may appear to

be an inconsistency but we submit with respect that

there is not. Could I hand to Your Honours a copy.

of the Court's decision in Galland and ask

Your Honours to look to Justice Deane's decision at

page 421. At about point 8 of that page, in the

middle of a sentence there is a reference to

Everett's case:	the importance of Everett's Case for present
purposes seems to me to lie as much in what it
rejected as in what it accepted.  The
conclusion reached by the majority of this
Court was that it was "a misnomer to speak of
the [taxpayer's] share of the income as having
been gained by his personal exertion": the
taxpayer's proportionate share of the net profits of the partnership was properly to be
seen as payable to him as the owner of an
interesr. in the capital of the partnership.
Now, what His Honour is really saying there is

- that t;_he partner's interest in the pa-tnership ii:;

income prod11cing property and -...,hat Mr Justice Hill here saia is that ·if, and only if, thi-s was not an .. '; ... _

Rc,;.,,erts 10 13/11/92

amount which is properly allowable as a deduction

in calculating a partnership's income, then in the

context where Mrs Roberts took over what was a

joint and several liability for this interest, her

proportion of the liability could be seen to be a

cost to her in earning her income from her share in the partnership, in other words, a cost in deriving

income from income-producing property.

With respect, on that basis the two are not

inconsistent and therefore the order made is

appropriate in as much as if it is found that the
amount is deductible to the partnership, then it

was the correct order, and if not, then it is the

correct order because she is entitled to a

deduction on this alternative basis.	I cannot say
more on that point, Your Honour.

MASON CJ:  We need not trouble you as to the other aspects of the case.

MR BLOOM: If Your Honour please.

MASON CJ:  Mr Batt, what do you want to say?

MR BATT: This, Your Honour, that the deduction claimed was

not claimed in her personal return. The deduction

flowed through; was claimed directly, to use the

words of this Court in Fletcher, in the partnership

return and only indirectly flowed through to her by

reason of the reduction of the net income of the
partnership or her share of it. The simple fact of
the matter is that the Federal Court was wrong and

the order, in the form it is made, is only

supported by a wrong reason and that order must be.

removed.

BRENNAN J:  Mr Batt, let it be assumed for the moment that

the Commissioner were to succeed on the Smith case

basis, what - - -

MR BATT:  You mean before the tribunal?

BRENNAN J:  Yes. Now, what would then be the position of

Mrs Roberts?

MR BATT:  The Commissioner would have lost and she would

have a tax deduction which her partners do not have. Her case is not to go back to the - - -

BRENNAN J:  No, I appreciate that. I put my question badly.

Let it be assumed that it is found in favour of the

Commissioner that the amount which was borrowed was

not paid to the partners by way of return of any capital but the partn·ership was simply a conduit

through which the money passed from the bank to the

partners but that Mrs Roberts was admitted to the

Roberts 11 13/11/92

partnership only upon terms that she met the
liability to the bank for her ratable proportion of
the liability to the bank, what would be her tax

position? Leaving aside the form in which her tax

return was lodged, what would be the true position

of Mrs Roberts?

MR BATT:  The true position would be, in our respectful

submission, that she would not get either a tax

deduction or the benefit of a reduction through the

partnership because she has assumed the same

liabilities as her co-partners assumed and she

cannot be, in our submission, in any way different

from them. The loan, in our submission, has not

lost its identity. Its original use and character

remains. The loan was a separate borrowing and

kept s~parate both by the bank and the partnership,

and there is a reference to that at page 7, right

at the end of the application book, but there is

better eviden~e in the accounts which are not

before the Court.

BRENNAN J: But is not the incurring of her liability

through the partnership in respect of interest an

outgoing or a liability which she incurs in order

to gain her assessable income?

MR BATT:  We would submit that it is not when the interest

is paid by the partnership. Could I take my
"pleasure boat" case, Your Honou=, the example of

that, earlier: if the original - Id~ not mean the

1834 partnership but I mean about the 1984

partnership, if it had borrowed moneys and bought a
pleasure boat out of partnership funds for use by

the partners and if our submission were accepted

that the interest on that borrowing could not be

deductible, then she later came into the

partnership in the way Your Honour has put to me,

in our submission, it could not follow that she

would get a deduction of her aliquot share of the

interest on the loan that had been used to buy the

boat.

BRENNAN J: Not if she had an aliquot share of the boat.

MR BATT:  No. I intended to mean that that would be kept as

a partnership asset. That shows, in our

submission, that there has not been a change and

that she should be in no different position from

the continuing partners. If the Court pleases.

MASON CJ:  The Court is of opinion that these applications

for special leave to appeal should be refusad. In the cas~ of Smith, the Court ie not persuaded that the decision of the Full Court of the Federal Court

is ~ttended with sufficient doubt to justify the

grant of special !eave to appeal.

Roberts 12 13/11/92

In the case of Roberts, if the decision is

attended with doubt, that is only because the
decision does not reflect the form of the

taxpayer's return. It would not be appropriate

to grant special leave to appeal to ventilate what

is a question of form and is not a question of

substance.

The applications are therefore refused.

MR BATT: If Your Honour pleases.

MR BLOOM:	Could we have costs, Your Honour.
MASON CJ:	Not opposed?
MR BATT:	I cannot oppose that.
MASON CJ:	The applications are refused with costs.

AT 10.08 AM THE MATTER WAS ADJOURNED SINE DIE

Roberts 13 13/11/92