//
© 2026 Zoe. All rights reserved.
Zoe is a legal information platform. Always consult the Federal Register of Legislation for authoritative text.
[1993] HCA 29
High Court of Australia
1993-05-19
McHugh JJ, Gaudron JJ, Wilcox JJ
Original judgment source is linked above.
High Court of Australia Mason C.J. Brennan, Deane, Dawson, Toohey, Gaudron and McHugh JJ. Coles Myer Finance Ltd v Commissioner of Taxation [1993] HCA 29
ORDER Appeal allowed with costs. Set aside the orders of the Full Court of the Federal Court. Matter stood over to 19 May 1993 for the making of final orders in accordance with the reasons for judgment. Parties to bring in on or before 12 May 1993 minutes of order. The Court answered the questions in the special case as follows: The respondent to pay the appellant's costs in the special case in the Federal Court.
1993, April 29 Mason C.J., Brennan, Dawson, Toohey and Gaudron JJ.
This is an appeal by Coles Myer Finance Ltd. ("the taxpayer") against the answers given by the Full Court of the Federal Court (Sweeney, Northrop and Wilcox JJ.) to questions in a special case stated by the Administrative Appeals Tribunal ("the Tribunal") pursuant to s. 45 of the Administrative Appeals Tribunal Act 1975 Cth and O. 50 of the Federal Court Rules for the decision of the Federal Court. The questions relate to the taxpayer's appeal to the Tribunal against its amended assessment of income tax for the year ended 30 June 1984. The facts, as related in the special case, may be shortly stated. The statement which follows is very largely taken from the reasons for judgment of the Full Court of the Federal Court.
The taxpayer carries on business as a finance company, acting as financier to the Coles Myer group of companies. It has carried on that business since 1981. For the purposes of that business, it raises finance from various sources, including non-related companies. To that end, during the taxation year in question, the taxpayer drew, and sold at less than their face values, both bills of exchange and promissory notes. The majority of both the bills of exchange and the promissory notes were drawn and paid in the relevant financial year. No question arises in this case about those bills or notes. But a significant proportion were outstanding at 30 June 1984 and it is with them that this case is concerned. Bills of exchange having a face value of $70,000,000 were then outstanding. They had been discounted by the taxpayer by way of sale for $67,624,421. The face value of the outstanding promissory notes was $40,000,000. They had been discounted by way of sale for $37,640,106. In its return of income for the year ended 30 June 1984 the taxpayer claimed to deduct the difference between the face values and the sale price - $2,375,579 for the bills and $2,359,893 for the notes. The Commissioner of Taxation ("the Commissioner") disallowed that claim on the basis that no relevant loss or expenditure was incurred until the instruments were paid out in the following taxation year. The taxpayer objected to the assessment, contending that the relevant loss or expenditure was incurred when the taxpayer drew the bills and issued the notes because it then incurred a liability to pay the full face value, notwithstanding that the date for payment was a future date. On disallowance of the objection, the matter was referred to the Tribunal.
Each of the bills provided for a relatively early maturity date, the maximum period until maturity being 180 days. Immediately after each bill was drawn, the taxpayer procured its acceptance by a bank. On the same day, the bill was sold to a financial institution or investment company at a discounted price, the amount of the discount being the cost of obtaining the finance. In many cases, the bills passed through several hands before maturity, when they were paid out at face value. A similar procedure was followed in relation to the notes except that there was no acceptance of the notes by a bank. All the notes bore relatively early maturity dates. The taxpayer sold them at discounted prices to financial institutions or investors. They were redeemed by the taxpayer at maturity by payment to the holder of the face value of the note.
The two questions asked in the special case were in these terms:
On the facts stated in this special case does the amount of $2,375,579 or some other and what amount constitute, within the meaning of section 51(1) of the Income Tax Assessment Act 1936, a loss or outgoing incurred by the applicant -
(c) partly and to what extent in the year of income ended 30 June 1984 and partly and to what extent in the year of income ended 30 June 1985?
On the facts stated in this special case does the amount of $2,359,893 or some other and what amount constitute, within the meaning of section 51(1) of the Income Tax Assessment Act 1936, a loss or outgoing incurred by the applicant -
(c) partly and to what extent in the year of income ended 30 June 1984 and partly and to what extent in the year of income ended 30 June 1985?
Question 1 relates to the cost of the bills of exchange. Question 2 relates to the cost of the promissory notes.
The decision of the Full Court of the Federal Court
The Full Court of the Federal Court held that, at the time of acceptance of each bill, the taxpayer incurred a contingent liability to indemnify the accepting bank in the event that the bank was called upon to discharge the bill out of its own funds. In reaching this conclusion, the Federal Court treated the taxpayer as standing in the position of a surety and, as such, not being subject to an accrued liability in respect of each bill until the bill was paid out. The Court acknowledged that there were passages in the judgments of this Court in K. D. Morris & Sons Pty Ltd (In liq.) v Bank of Queensland Ltd. [1] , which might be read as indicating an opinion that an accommodated party becomes presently liable to an accommodating party immediately upon the acceptance of a bill. However, the Federal Court considered that the passages should not be read in that way but in conformity with what the Federal Court took to be established law, namely, that the drawer of the bill incurred no present liability in respect of the bill until it was discharged by the acceptor.
The Federal Court also held that the taxpayer did not incur a present liability under each note until the note was discharged by payment. In reaching this conclusion the Federal Court applied what it took to be the actual decision in W. Nevill & Co. Ltd. v Federal Commissioner of Taxation [2] .
In the result, the Federal Court answered the questions asked in the special case as follows: 1. (a) No; (b) Yes; (c) No. 2. (a) No; (b) Yes; (c) No.
The taxpayer was ordered to pay the Commissioner's costs of the special case.
The taxpayer contends that the Federal Court was in error in holding that the taxpayer did not incur a present liability to the accommodating party upon acceptance of the bill and that no such liability was incurred until discharge of the bill by the acceptor. Likewise, the taxpayer contends that the Federal Court was in error in holding that no present liability under each note was incurred until discharge of the note by payment. The taxpayer's primary argument is that the net deficits amounting to $2,375,579 and $2,359,893 constituted a loss within the meaning of s. 51(1) of the Income Tax Assessment Act 1936 Cth ("the Act") and, alternatively, that the liability on the bills and notes still to mature in the year ending 30 June 1985 was an outgoing in the year ended 30 June 1984 within the meaning of the sub-section. The taxpayer's secondary argument is that the relevant amounts constitute losses or outgoings incurred partly in the year of income ended 30 June 1984 and partly in the year of income ended 30 June 1985 to be apportioned on a straight line basis in accordance with generally accepted accounting practice.
On the other hand, the Commissioner sought to support the basis on which the Federal Court had reached its decision. Alternatively, the Commissioner supported the taxpayer's secondary argument calling for apportionment on a straight line basis.
However, during the course of argument it appeared that the parties had conducted the case on the agreed footing that the relevant loss on the bills and notes was incurred in gaining or producing the taxpayer's assessable income or was necessarily incurred in carrying on a business for the purpose of gaining or producing such income, and was not a loss or outgoing of capital or of a capital, private or domestic nature. It seems that this agreement regarding the net loss was reached in order to forestall the argument which lay at the centre of the decision in Avco Financial Services Ltd. v Federal Commissioner of Taxation [3] , that is, whether gains and losses on exchange transactions were on revenue account.
The Commissioner argued that the gross amounts received and paid were on capital account though the discount or loss was on revenue account and, therefore, deductible. In supplementary submissions which the Commissioner filed with the leave of the Court the Commissioner reformulated his argument as follows: (a) the gross amounts received and paid by the taxpayer were of a capital nature; (b) the gross amounts were received and paid on revenue account or for revenue purposes, that is, for the purposes of and in the course of the taxpayer's income-earning business as a finance company; (c) the cost to the taxpayer of obtaining the gross receipt (i.e., the discount) was therefore a deductible loss or outgoing, just as the interest earned by it through the use of the proceeds in the business was assessable income.
The liability of the taxpayer as drawer of the bills
It is common ground that the bills of exchange were accommodation bills. In the case of an ordinary bill of exchange the drawer is initially primarily liable upon the bill until it is formally accepted by the acceptor signing the bill. Upon acceptance, the primary responsibility for paying out the face value of the bill upon its presentment lies with the acceptor [4] . The drawer then becomes subject to a secondary liability to pay out the bill in the capacity of a surety. But the liability arises only if the acceptor fails to pay out and the requisite procedures on dishonour are taken [5] .
An acceptor who signs a bill without receiving value therefor and for the purpose of lending his or her name to some other person is an accommodation party [6] . "Value" in this context refers to the discount or part of it and does not include bank fees for services in providing accommodation [7] . An acceptor who is an accommodation party is liable on the bill to a holder for value [8] .
Although the holder for value is entitled to hold the acceptor (the principal debtor according to the instrument) primarily liable on the bill, as between the drawer and the acceptor to an accommodation bill, in equity, the drawer for whose accommodation the bill was accepted was regarded as the principal debtor in substance, the accommodation acceptor being treated as a surety so that the grant of time by the holder to the accommodated party to pay out the bill discharged the acceptor [9] . The common law rejected that view, holding that the accommodation acceptor was principally liable on the bill and that he was not discharged by indulgence shown to the drawer as the accommodated party [10] . The effect of the Judicature Acts was that, as between the drawer and the accommodation acceptor, the equitable principle prevailed but those Acts did not alter the legal rights of the holder against the acceptor. And, s. 33(2) of the Bills of Exchange Act 1909 Cth specifically preserved the liability of an accommodation party on the bill to a holder for value and went on to provide:
[I]t is immaterial whether, when such holder took the bill, he knew such party to be an accommodation party or not. 1. Chalmers and Guest on Bills of Exchange, Cheques and Promissory Notes, 14th ed. (1991), pp. 265-266; Oriental Financial Corporation (1871), L.R. 7 Ch. App., at p. 150; Davies v Stainbank (1855), 6 De G.M. & G. 679, at p. 696 [43 E.R. 1397, at p. 1404]. 2. Fentum v Pocock (1813), 5 Taunt. 192, at p. 196 [128 E.R. 660, at p. 662]; Nichols v Norris (1831), 3 B. & Ad. 41 [110 E.R. 15]; Yallop v Ebers (1831), 1 B. & Ad. 698, at pp. 702-703 [109 E.R. 946, at p. 948].
The settled principle, which reflects the equitable concept that the acceptor is a surety, is that, where the instrument is an accommodation bill, it is the duty of the party accommodated to provide funds to meet the bill at maturity or, in default of that, to indemnify the acceptor or any other party who has been compelled to pay the holder [11] . In Sleigh v Sleigh [12] , Parke B. said:
[I]f a person lends his name to another for his accommodation,the party accommodated undertakes to pay the bill at maturity, and further, to indemnify the person accommodating him, in case that person is compelled to pay the bill for him and this, no doubt, is an implied authority to such person to pay it, if he be in that situation that he may be compelled by law to pay the bill, though the holder do not actually compel him to do so; and after payment he may sue the party accommodated for money paid on his account. 1. Halsbury's Laws of England, 4th ed. (1992), vol. 4(1), par. 483. 2. (1850) 5 Ex. 514, at p. 517 [155 E.R. 224, at p. 225].
It has been said [13] that the drawer engages either to: (a) pay the face value of the bill to the acceptor before the bill matures; (b) pay the face value of the bill upon its maturity (either directly to the holder or the acceptor); or (c) indemnify the acceptor against the consequences of non-payment. The drawer's liability under (c) would not legally be enforceable until the acceptor made payment to the holder.
However, the proposition that, upon acceptance of the bill, the drawer undertakes a continuing liability to pay the amount of the bill to the acceptor finds very strong support in the authorities [14] . In Yates v Hoppe , the drawer paid to the acceptor the amount of the bill before maturity. After payment, but before maturity, the drawer became bankrupt. His trustee sought to recover the money. Maule J. observed [15] :
[T]here is an implied contract in all these cases, that the person for whose accommodation the acceptance is given shall provide for the bill, or in some way take care that the acceptor shall not be damnified by his acceptance. Maule J. went on to say [15] : [T]he drawer being under an obligation, not specifically to provide funds at a particular time to meet the bill, but one which might be performed in the whole or in part by doing so, adopts a reasonable and usual course for that purpose, by providing the acceptor beforehand with a sum of money to be applied to the payment of the bill. An act done in performance of a binding contract is not revocable. The decision establishes that the payment made by the drawer was a payment made in discharge of a then existing obligation; at that time, it was not a voluntary payment which the drawer was entitled to recover as money had and received. 1. Yates v Hoppe (1850), 9 C.B. 541 [137 E.R. 1003]; Reynolds v Doyle (1840), 1 Man. & G. 753 [133 E.R. 536]; Angrove v Tippett (1865), 11 L.T. 708. 2. (1850) 9 C.B., at p. 549 [137 E.R., at p. 1006]. 3. (1850) 9 C.B., at p. 549 [137 E.R., at p. 1006].
In Reynolds v Doyle [16] and Angrove v Tippett [17] it was held that the Statute of Limitations does not start to run in relation to the drawer's liability to the accommodation party until that party has expended money pursuant to his acceptance of the bill. There is no cause of action at the suit of the acceptor until he pays. But the decisions are quite consistent with the proposition that the liability arises and can be satisfied at an earlier time.
In K. D. Morris & Sons Pty Ltd (In liq.) v Bank of Queensland Ltd., the judgments accepted the correctness of this proposition. Stephen and Wilson JJ. said [18] :
Had the Bank been only a casual acceptor of the Company's bills, bound by no agreement to accept them and only doing so in each case as an isolated transaction, there would be no continuing liability. Instead there would be a series of unconnected relationships whereby the Bank became surety for the Company for particular accommodation bills and the Company assumed a liability to the Bank accordingly, which liability would be discharged when the Company put the Bank in funds to retire the bills on maturity. The acceptance of each new bill would give rise to a fresh liability. Aickin J. (with whom Mason J. agreed) said [19] : The liability of the Company was not dependent upon any contingency once the bills had been discounted. On the Bank paying each bill on presentation, the liability to indemnify arose by reason of the inherent characteristics of an accommodation bill. The liability of the Company under the agreement was to provide funds to the Bank in advance of the maturity date by discounting replacement bills but that was a mere consequence of the liability to indemnify the Bank. It was rather a means of satisfying the primary liability to indemnify than a separate and independent liability. 1. (1980) 146 C.L.R., at p. 175. 2. ibid., at p. 202.
Consequently, we reject the view of the Full Court of the Federal Court that the drawer of an accommodation bill does not come under a liability to the acceptor until the acceptor makes payment under the bill. The judgments in Morris were clearly inconsistent with that proposition, as the Federal Court should have recognized.
The liability of the taxpayer as maker of the promissory notes
By making the promissory note, the maker engages that he will pay it according to its tenor [20] . The obligation to pay at a future time created by such a note is clearly a present liability, there being no necessity for presentment of the note for the maker to be liable to pay out the note at maturity [21] . When the maker gives a note for the purpose of obtaining finance, the maker promises to pay a fixed amount to the payee at a future date in consideration of the immediate payment by the payee of the lesser sum. Once the maker receives that payment, the maker immediately owes the face value of the note, even though that amount is not payable until the date of maturity. So it was that this Court held in David v Malouf [22] that the amount due under a current promissory note was a debt that would ground a petition for sequestration, the amount of the note being due, though it was not payable until some future time.
On the other hand, in W. Nevill & Co. Ltd. v Federal Commissioner of Taxation [23] , this Court held that certain payments to be made by a company to a former director over a period of time pursuant to promissory notes were not deductible for tax purposes in the year in which the notes were made. Latham C.J. expressed the view, though "not as a concluded opinion", that the amount was deductible in the year in which it is paid out rather than in the year in which the note is made [24] . Rich J. agreed with the result but declined to express an opinion on the question of law [25] . Dixon J. concluded that the amounts due under notes which would mature in the next income year could not be deducted during the income year in question [26] . His Honour gave no reasons for this conclusion. McTeirnan J. agreed with the answer to the question given by Latham C.J. and stated that the deductions in the year of income should be limited to £1,900, being the amounts paid in that year [27] . Again, his Honour gave no reasons for his conclusion.
We do not consider that the decision in Nevill should be regarded as overruling David v Malouf. Whatever view may be taken of the reasons for the decision in Nevill, they do not appear to relate to the time when the liability of the maker arises under a promissory note. That approach to Nevill gains support from two later cases in which it was considered. These cases, to which we shall now refer, suggest that the decision in Nevill was based on the view that, in the particular circumstances of that case, the liability to make the payments was an outgoing properly referable to the years of income in which the payments were made rather than the year in which the liability to make the payments was actually incurred. It is convenient to refer to these cases in the context of an examination of s. 51.
In Commissioner of Taxation (N.S.W.) v Ash Dixon J. said [28] :
Where the reason for allowing a deduction is that it is a normal or recurrent expenditure or an expenditure which is fairly incident to the carrying on of the business, it is evident that it can seldom be associated with any particular item on the revenue side against which to set it, and, as the ground of its allowance is that it is an incident or accident, something concomitant to the conduct of the business, it follows that to deduct it in the year when it falls to be met is consistent with the reason for deducting it and conforms with business principles. Thus, in [Nevill ], where, although the matter was not argued, the court found it necessary to say whether the payments should be deducted in the period when they were agreed upon or that in which they were made, it was considered that the deductions should be made from the assessable income of the periods of account in which the payments were made. 1. (1938) 61 C.L.R. 263, at p. 282.
Subsequently, in Federal Commissioner of Taxation v James Flood Pty Ltd [29] , the Court (Dixon C.J., Webb, Fullagar, Kitto and Taylor JJ.) said that nothing that was decided in Nevill "was intended to imply that a liability to pay an ascertained sum is never incurred until the sum becomes due and payable".
the judges looked upon the monthly payments not so much as deferred instalments of an accrued liability in a lump sum but as an attempt to spread over a period of trading an outgoing parallel with the salary that had been saved. But whatever be the rationale of the decision of the point, clearly enough it is not based on a view that no outgoing could be incurred until actual payment was made. The fact that the point was not argued and that comprehensive reasons were not given for the decision in Nevill is sufficient reason for refusing to regard that decision as decisive of the present case.
In Flood, the Court pointed out that, for a deduction to fall within s. 51(1), a taxpayer need not have "come under an immediate obligation enforceable at law whether payable presently or at a future time" [30] . But this statement must be understood in the light of the decision in that case. The Court held that the employees' annual holiday leave was not a deductible expense. That was because [31] :
[i]n respect of those employees there was no debitum in praesenti solvendum in futuro. There was not an accrued obligation, whether absolute or defeasible. There was at best an inchoate liability in process of accrual but subject to a variety of contingencies. The event on which the entitlement of the employees depended had not occurred. Flood therefore stands as authority for the proposition that a liability must presently be existing in order to be "incurred" within the meaning of s. 51(1). 1. ibid., at p. 506. 2. (1953) 88 C.L.R., at pp. 507-508.
So much was accepted in Nilsen Development Laboratories Pty Ltd v Federal Commissioner of Taxation [32] , which held that the amounts provided in the taxpayer's accounts to meet employees' long service leave entitlements were not outgoings "incurred" within the meaning of s. 51(1) because there was no liability to make payment until the employees either took the leave entitlements or ceased employment. The decisions in Flood and Nilsen proceed on the footing that the Court, in determining entitlement to a deduction under s. 51(1), accepted the legal or jurisprudential analysis rather than the commercial view as the correct one [33] . In other words, the Court concluded that the liability was the ordinary liability to pay wages to an employee in respect of a period of employment in preference to the commercial view that the liability was a progressive one, being part of the cost of labour employed from day to day. Subsequently, in Arthur Murray (N.S.W.) Pty Ltd v Federal Commissioner of Taxation , Barwick C.J., Kitto and Taylor JJ. said of Flood [34] :
The Court there held that, while commercial and accountancy practice may assist in ascertaining the true nature and incidence of an item as a step towards determining whether the item answers the test laid down in the Act for allowable deductions, it cannot be substituted for the test. No doubt as a consequence of the Court's adoption of the legal or jurisprudential analysis in determining entitlements to a deduction under s. 51(1) in preference to the commercial view, the parties did not contend in the present case for a different approach to the question. 1. (1981) 144 C.L.R. 616. 2. ibid., at p. 631, citing Deane J. in the Federal Court (1979) 27 A.L.R. 239, at p. 249. 3. (1965) 114 C.L.R. 314, at p. 320. But cf. Commissioner of Taxes (S.A.) v Executor Trustee & Agency Co. of South Australia Ltd. (Carden's Case) (1938), 63 C.L.R. 108, at pp. 152-153, per Dixon J.
Both Flood and Nilsen take up and apply the statement of Dixon J. in New Zealand Flax Investments Ltd. v Federal Commissioner of Taxation [1] :
"Incurred" does not mean only defrayed, discharged, or borne, but rather it includes encountered, run into, or fallen upon. It is unsafe to attempt exhaustive definitions of a conception intended to have such a various or multifarious application. But it does not include a loss or expenditure which is no more than impending, threatened, or expected. As his Honour said, to come within the relevant provision, which was the predecessor of s. 51(1), "there must be a loss or outgoing actually incurred" [1] . 1. (1938) 61 C.L.R. 179, at p. 207. 2. (1938) 61 C.L.R. 179, at p. 207.
But it is not enough to establish the existence of a loss or outgoing actually incurred. It must be a loss or outgoing of a revenue character and it must be properly referable to the year of income in question [2] . So it was that in New Zealand Flax the taxpayer was not entitled to deduct all payments of interest in future years notwithstanding that it had incurred a liability to pay them in the accounting period under assessment.
The judgments in this Court in Avco Financial Services Ltd. v Federal Commissioner of Taxation [3] contain statements which either state [4] or might be taken, when read in isolation, to suggest [5] that the borrowing of money and the repayment of loans by a finance company in the ordinary course of its business may amount to transactions on revenue account. However, the joint judgment of Mason, Aickin and Wilson JJ. [6] , when properly understood, like that of Gibbs C.J. [7] , proceeds on the proposition that, although such transactions by a finance company are properly to be regarded as transactions on capital account, the relevant gains and losses are nevertheless to be regarded as revenue gains and losses. That is because the gains and losses were incurred in the course of and as an incident of making repayments of the borrowed money with which the taxpayer carried on its business as a finance company. The losses or outgoings were incurred in the day-to-day conduct of the business and for the purpose of carrying it on as a going concern. Though the borrowed moneys were capital, it was working or circulating capital from which the taxpayer derived its profits by turning the borrowed money to account at higher rates of interest than those paid to the taxpayer's lenders. The borrowing, as much as the lending, was an integral part of the day-to-day conduct of the taxpayer's profit-earning business.
"Some kinds of recurrent expenditure made to secure capital or working capital are clearly deductible", as Dixon J. noted in Texas Co. (Australasia) Ltd. v Federal Commissioner of Taxation [8] . His Honour instanced interest on moneys borrowed, rent on premises and hire of plant as examples [8] . So, in Texas, the increase in expenditure occasioned by an exchange rise, due to a delay in payment for petroleum products by the taxpayer, an oil company, when the delay was designed to create a fund for working capital by arrangement with the taxpayer's parent company, did not result in the exchange loss constituting a loss of a capital nature. The increased outlay was, in the words of Latham C.J. [9] : "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." And, in Avco, it was recognized that exchange losses incurred in the borrowing and repayment of funds to purchase stock in trade and the deferment of payment to suppliers of such stock were losses on revenue account [10] .
In our view, the present case, like Avco, is an illustration of a loss or outgoing incurred for the purpose of securing working or circulating capital which is clearly deductible. There is no question but that the taxpayer issues bills and notes for the purpose of its business as a finance company, using the moneys raised by discounting the bills and notes for the purpose of providing finance, from which it earns its income. In essence, it derives its income from the profits which it makes from the provision of finance under various classes of transactions, those profits exceeding the cost to the taxpayer of the moneys which it raises from the issue of bills and notes. The taxpayer's business is therefore similar to that of a finance company which borrows moneys for lending, the rates of interest which it pays being significantly lower than those payable to it by those who have the moneys on loan. In effect, the discount offered by the taxpayer is the cost of acquiring the funds which it turns over in its business, the amount of the discount serving the same purpose as the amount of interest on borrowed moneys; the amount of the discount is the cost of those moneys. The difference between the amount payable on the bill and note and the amount received when the bill or note is discounted is a loss or outgoing made in the ordinary course of conducting the business for the purpose of profit-making.
What is the amount of taxpayer's loss or outgoing referable to the year of income?
The acceptance by this Court of the jurisprudential analysis of s. 51 does not compel the conclusion that, once a taxpayer subjects itself in the year of income on revenue account to a present legal liability to pay in a future year of income an amount which generates, or gives rise to, a net loss or outgoing, the net loss or outgoing is deductible in full in the year of income. The relevance of the present existence of a legal liability on the part of the taxpayer to meet the bills and notes at a future date is that it establishes that the taxpayer has "incurred" in the year of income an obligation to pay an amount which gives rise to a net loss or outgoing, being the recurrent cost of acquiring working or circulating capital. But there remains the question: how much of that net loss or outgoing is referable to the year of income?
Although the legal liability to pay is incurred in the year of income, the amount in question is not payable until the subsequent year of income and, more importantly, the net loss or outgoing represents the cost of acquiring funds which the taxpayer puts to profitable advantage in both years of income. The cost is incurred by the taxpayer with a view to acquiring funds with which to engage in its profit-making activities during the currency of the respective bills and notes. As between the drawer and the holder of a note or bill, the burden of the liability incurred by the drawer increases with the passage of time between the discounting of the note or bill and its maturity. In ascertaining what is the taxpayer's net income or profit for a particular year of income, it is proper to set against the taxpayer's gross income or profit for that period the net losses or outgoings referable to that period. Under s. 51(1) a loss or outgoing is a deduction only to the extent to which it is incurred in gaining or producing the assessable income. That provision has been described as: "a statutory recognition and application of the accountancy principle which all the accountants who gave evidence referred to as the matching principle", to use the words of Menhennitt J. in R.A.C.v Insurance Pty Ltd v Federal Commissioner of Taxation [11] . Apportionment of the cost over the two years of income therefore accords with both accounting principle and practice and the statutory prescription.
The correctness of this approach may be illustrated by example. Let us suppose that the taxpayer raises finance by long term rather than short term bills, drawing bills which mature ten years after the date on which they are drawn and discounting them immediately. The amount of the discount would be very substantial having regard to the very long life of the bills so that the deduction of the difference between the face value of the bills in the year in which they are drawn and the amount realized by discounting the bills, if permitted, would lead to a distortion of the taxpayer's operations on revenue account in the year of income in which the bills are drawn and would open the way to inflating very considerably the amount of allowable deductions under s. 51 for that year.
Once the Court rejects the approach adopted by the Full Court of the Federal Court and as well the primary argument of the taxpayer that the entire cost is an allowable deduction in the year of income, it follows that the total cost should be apportioned and, having regard to the relatively short life of the bills and notes, the apportionment should be on an accounting straight line basis over the term of the relevant note or bill. On this aspect of the case, the parties were not in dispute.
We would allow the appeal, set aside the orders made by the Full Court of the Federal Court and stand the matter over pending the parties' agreement, if possible, on the amount of the outgoings to be deducted in accordance with these reasons. If agreement is reached then answers to the questions in the special case can be formulated which give effect to that agreement. In default of that agreement it will be necessary to formulate answers in general terms. The Commissioner should pay the taxpayer's costs in the special case, both in the Federal Court and in this Court.
The detailed facts and the issues involved in this appeal are set out in the judgment of Mason C.J., Brennan, Dawson, Toohey and Gaudron JJ. I agree with their Honours' conclusion that Coles Myer Finance Ltd. ("the taxpayer") was entitled to a deduction in the tax year ended 30 June 1984 ("the tax year") of the excess of the "value" (as at that date) of its liability in respect of unmatured promissory notes and bills of exchange over the amount which it had received on the sale of those notes and bills. Subject to what is said below in relation to two matters, I am in general agreement with their Honours' reasons for that conclusion, including their reasons for holding that the taxpayer's liability in respect of the notes and bills was not merely a contingent one. The decision of the Court on the subsidiary question in W. Nevill & Co. Ltd. v Federal Commissioner of Taxation [12] should, in my view, be treated as turning on its own particular facts and as not supporting a general proposition that the maker of a promissory note cannot incur a loss or outgoing for tax purposes until the date of maturity. As Dixon C.J., Webb, Fullagar, Kitto and Taylor JJ. commented in Federal Commissioner of Taxation v James Flood Pty Ltd [13] :
The question in [W. Nevill & Co. Ltd. v Federal Commissioner of Taxation ] was whether a sum which a company had agreed to pay one of two joint managing directors to induce him to retire was an outgoing on account of capital or was deductible. Portion of the sum was to be met by monthly payments over a period extending beyond the year of income and secured by promissory notes. It was decided that the outgoing was not on account of capital and was deductible but so much of it as was payable outside the year of income belonged to the ensuing accounting period. Probably on this minor point, to which the parties do not appear to have attached importance, the judges were influenced to some extent by some of the considerations affecting their decision on the major question and looked upon the monthly payments not so much as deferred instalments of an accrued liability in a lump sum but as an attempt to spread over a period of trading an outgoing parallel with the salary that had been saved. But whatever be the rationale of the decision of the point, clearly enough it is not based on a view that no outgoing could be incurred until actual payment was made. 1. (1937) 56 C.L.R. 290. 2. (1953) 88 C.L.R. 492, at p. 507; and note Federal Commissioner of Taxation v Nilsen Porcelains (Aust.) Pty Ltd (1979), 41 F.L.R. 36, at p. 48; 27 A.L.R. 239, at p. 250; 10 A.T.R. 255, at p. 264; 79 A.T.C. 4,520, at p. 4,528.
The first matter about which I would make some comments for myself is the question whether the taxpayer's gross receipts and payments in relation to the notes and bills were on capital or revenue account.
The taxpayer's receipts and payments in respect of the notes and bills occurred in the ordinary course of its very substantial business as the financier of the Coles Myer group of companies. The purpose of its dealings with the notes and bills was to raise circulating capital for use in that business. As with the borrowing and repayment of circulating capital, the gross receipts upon sale and the gross payments upon maturity were, in my view, receipts and outgoings of capital. The surpluses of the outgoings over receipts, i.e. the discounts on sale of the bills and notes, were, however, detachable from the gross receipts and outgoings and constituted losses or outgoings of a revenue nature [14] . Those surpluses were the kind of recurrent expenditure incurred in the obtaining of the circulating capital used in a business for the earning or gaining of assessable income which is "clearly deductible" pursuant to s. 51(1) of the Income Tax Assessment Act 1936 Cth ("the Act") [15] .
There was some discussion in the course of argument about whether the decision of the Court in Avco Financial Services Ltd. v Federal Commissioner of Taxation [16] establishes that the gross borrowings and repayments of circulating capital by a finance company in the ordinary course of its business are receipts and payments of revenue with the consequence that gross receipts are assessable income and gross outgoings are deductible for taxation purposes. Careful analysis of the judgment of Gibbs C.J. [17] and the joint judgment of Mason, Aickin and Wilson JJ. [18] in that case discloses that it does not. In contrast to Murphy J. [19] , their Honours were careful to confine their conclusion about deductibility and assessibility to net losses or gains by reason of the exchange fluctuations. Thus, Mason, Aickin and Wilson JJ. made clear [20] their reliance upon quoted statements from Texas Co. (Australasia) Ltd. v Federal Commissioner of Taxation which supported the conclusion that the net exchange losses in Avco Financial Services were, like interest on "money borrowed", the kind of "recurrent expenditure" made to secure working capital which is "detachable" and deductible pursuant to s. 51(1). Their Honours went on [21] to identify "the true principle" as being:
in the case of a finance company which borrows money overseas in the ordinary course of its business and not for some special purpose, the added cost of repayment in foreign currency caused by the devaluation or depreciation of the Australian dollar is an additional cost of the borrowing and, like other costs of the borrowing, is an allowable deduction under s. 51(1). Conversely, a saving in the amount of foreign currency needed to repay an overseas loan due to a revaluation or an appreciation in the value of the Australian dollar is to be considered as income arising directly out of the finance company's ordinary business. (Emphasis added.) The real importance of Avco Financial Services for present purposes is that it provides strong support for the conclusion that the taxpayer's net losses or outgoings, resulting from the discount on the face value allowed upon sale, are the kind of recurrent expenditure which is deductible pursuant to s. 51(1) of the Act as a loss or outgoing incurred in gaining or producing assessable income. 1. (1982) 150 C.L.R. 510. 2. See, in particular, ibid., at p. 517. 3. See, in particular, ibid., at pp. 527-529. 4. See, ibid., at p. 533. 5. See, ibid., at pp. 528-529. 6. (1982) 150 C.L.R., at p. 530.
The other matter which I would mention is that I consider that, in the circumstances of this case, the outcome of the present appeal would have been the same even if the taxpayer's liability in respect of unmatured notes and bills had been, as a matter of jurisprudential analysis, a contingent one. The reason why that is so is that it was, for practical purposes, always inevitable that any theoretical contingency, which existed at the end of the tax year and affected the taxpayer's liability to make the payment of the face value of the notes and bills, would be satisfied, unless the taxpayer subsequently repurchased the bills or notes in the market place. Even if the taxpayer had subsequently purchased the bills or notes in the market place - and it did not - the purchase price would presumably have exceeded their "value" as at the end of the tax year since the appropriate "discount" on face value would be expected to decrease as the time of maturity approached.
It is true that, as was pointed out in Nilsen Development Laboratories Pty Ltd v Federal Commissioner of Taxation [22] , the courts have, for the purposes of determining whether a liability constitutes a loss or outgoing which has been incurred for the purposes of s. 51(1) of the Act, tended to favour a strict legal analysis of the nature of the relevant liability rather than a pragmatic commercial approach. Thus, in determining the deductibility of an accruing liability to make future payments in respect of long service and annual leave, the courts have preferred the legalistic view that, in so far as the payment of money is concerned, the liability is not an existing liability to pay money in the future but the ordinary prospective or future liability to pay wages to an employee in respect of a future period of employment during which the employee is entitled to be excused from working [23] . The relevant detriment in such a case is not, on that approach, sustained until that period of employment actually arrives and the employee is excused from working. It does not follow from those cases, however, that the fact that jurisprudential analysis discloses that a particular liability to make a future payment of money is contingent necessarily means that such a contingent liability cannot constitute or found a "loss or outgoing" which has been "incurred" for the purposes of s. 51(1). To the contrary, the weight of authority supports the conclusion that, depending upon the circumstances, a liability to pay money can constitute, or give rise to, a "loss or outgoing" which is "incurred" within the meaning of that sub-section notwithstanding that the money is not payable until a future time [24] and that the obligation to pay it is theoretically defeasible [24] or contingent [25] in that it is subject to a condition which remains unfulfilled.
In determining whether a liability to make a future payment represents, for the purpose of ascertaining taxable income on an accruals basis, a loss or outgoing which has been "incurred" as required by s. 51(1), the critical question is not whether, as a matter of legal analysis, the liability is theoretically contingent or defeasible. It is whether the taxpayer is, as a practical matter, "definitively committed" or "completely subjected" to the obligation to make the payment in the future even though it has not come under "an immediate obligation enforceable at law" to do so [26] As Dixon J. (with the concurrence of McTiernan J.) stressed in New Zealand Flax Investments Ltd. v Federal Commissioner of Taxation [27] , in a passage subsequently adopted by the Court in Federal Commissioner of Taxation v James Flood Pty Ltd [28] :
To come within that provision there must be a loss or outgoing actually incurred. "Incurred" does not mean only defrayed, discharged, or borne, but rather it includes encountered, run into, or fallen upon. It is unsafe to attempt exhaustive definitions of a conception intended to have such a various or multifarious application. But it does not include a loss or expenditure which is no more than impending, threatened, or expected. Obviously, the fact that a liability to make a future payment is theoretically contingent or defeasible is a relevant consideration. For the purpose of ascertaining taxable income on an accruals basis, however, it will not of itself be decisive against deductibility under s. 51(1) unless, in the circumstances of the particular case, the contingency or defeasibility precludes the liability from constituting, or giving rise to, a "loss or outgoing" which has been "incurred" in the sense explained by Dixon J. in the above passage, that is to say, "encountered, run into, or fallen upon" as distinct from being "no more than impending, threatened, or expected". In that regard, it is important to bear in mind that Dixon J.'s explanation of the import of the words "loss or outgoing incurred" in a taxation provision [29] which relevantly corresponded with s. 51(1) was propounded by his Honour in the context of determining the deductibility of a liability to pay interest at a future time which his Honour expressly recognized as being theoretically "contingent". Indeed, the actual decision of the Court in New Zealand Flax was that so much of that contingent liability to pay money in the future as was "referable" [30] or "properly attributable" [31] to the tax year in question was deductible as a "loss or outgoing" which had been "incurred". 1. See Federal Commissioner of Taxation v James Flood Pty Ltd (1953), 88 C.L.R., at p. 506; Commercial Union Assurance Co. of Australia Ltd. v Federal Commissioner of Taxation (1977), 32 F.L.R., at p. 43; 14 A.L.R., at pp. 661-662; 7 A.T.R., at p. 444; 77 A.T.C. 4186, at p. 4193. 2. (1938) 61 C.L.R. 179, at pp. 207, 208. 3. (1953) 88 C.L.R., at p. 507. 4. Income Tax Assessment Act 1922-1934 Cth, s. 23(1)(a). 5. (1938) 61 C.L.R., at p. 193, per Rich J. 6. ibid., at p. 207, per Dixon J.
The most obvious category of case in which the fact that a liability to make a future payment is, as a matter of jurisprudential theory, contingent will not prevent deductibility under s. 51(1) is the case where a particular taxpayer is subject to a number of complementary or "mirror" contingent liabilities. If, for example, a taxpayer is under a liability to pay $1,000 to Y if a rainfall of ten points is recorded at a particular place during a particular future period and is under a quite independent liability to pay $1,000 to Z if a rainfall of ten points is not recorded at that place within that period, the jurisprudential analysis which would characterize each liability as contingent obviously could not base a conclusion that the taxpayer had "incurred" no liability for the purposes of s. 51(1). In such a case, the inevitable conclusion would be that a "loss or outgoing" had been "incurred" for the reason that the two contingent liabilities together represented an inevitable obligation to pay $1,000 at the future time. The obvious category of case in which the fact that a single liability is contingent will not necessarily prevent it from, of itself, constituting or founding a "loss or outgoing" which has been "incurred" for the purposes of s. 51(1) is where it is apparent that a condition giving rise to theoretical contingency can be treated, for practical purposes, as certain to be satisfied. If, to take an extreme example, a taxpayer were to acquire a valuable item of stock-in-trade in exchange for a binding promise to pay $1 million on 1 July 2005 if, but only if, the population of Australia exceeded two thousand persons on that day, the fact that the obligation to make the future payment was theoretically contingent could not prevent the conclusion that the taxpayer had "incurred" it for all practical purposes. Indeed, it would be absurd if, for taxation purposes, the value of the item of stock-in-trade had to be brought to account but the quid pro quo of the existing contingent liability to make the future payment had to be disregarded until 1 July 2005 for the reason that, until that date, the obligation to make the future payment of $1 million, to which the taxpayer had "completely subjected" himself, remained theoretically contingent.
That does not, of course, mean that where a theoretically contingent liability to make a future payment constitutes or founds an outgoing or loss for tax purposes, the amount of the loss or outgoing which has been "incurred" at the end of the relevant tax year will be the amount which will eventually have to be paid. Where, for example, two contingent liabilities to pay a particular amount combine to make an ultimate obligation to pay that amount inevitable, the amount of the loss or outgoing "incurred" will not exceed the single amount. Moreover, regardless of whether it be absolute or contingent, the amount of loss or outgoing which has been incurred at the end of the tax year will depend, in the case of an obligation to pay a future amount, upon the circumstances of the particular case. If, for example, interest at a commercial rate is payable in respect of the period up until the time of payment, the quantum of the loss or outgoing "incurred" at the end of a particular tax year is likely to correspond with the amount which must eventually be paid. On the other hand, if no such interest is payable, the circumstances may well be such that the amount or "value" of the loss or outgoing "incurred" at the end of the relevant tax year is clearly less than the full amount of the ultimate liability. Thus, in the example given above, the liability to pay $1 million on 1 July 2005 could not properly be treated, for the purposes of the tax year ending 30 June 1993, as a loss or outgoing, of $1 million. For the purposes of that tax year, the amount of the liability would be the amount which represented the appropriate valuation of the liability as at 30 June 1993. Necessarily, that amount would reflect the fact that no interest was payable on the $1 million until the time when it would actually have to be paid.
I agree with the orders proposed by Mason C.J., Brennan, Dawson, Toohey and Gaudron JJ.
The question in this appeal is whether the losses incurred by a finance company in selling at a discount bills of exchange and promissory notes drawn by it are deductible under s. 51 of the Income Tax Assessment Act 1936 Cth ("the Act") in the year of sale or in the year when each bill or note matures. Also involved in the appeal are the questions whether the receipts of the proceeds of a sale of bills or notes by a finance company are to be brought to account in the year of sale and whether moneys paid to meet the liabilities under the bills and notes are to be brought to account in the year when they mature.
The appellant ("Coles") carried on business as a financier to the Coles Myer Group of companies. During the year of income ended 30 June 1984, Coles drew and sold bank accepted bills of exchange with a total face value of $354,000,000 for sums which were less than their respective face values. During the same year of income, Coles signed and sold promissory notes with a total face value of $140,000,000 for sums which were less than their respective face values. Of the bills and notes issued in the year ending 30 June 1984, bills with a face value of $70,000,000 and notes with a face value of $40,000,000, were outstanding at the end of that year. Coles had received $67,624,421 from the sale of those bills and $37,640,106 from the sale of those notes. In its income tax return for the year ended 30 June 1984, Coles claimed the difference between the face value of the bills and notes and the proceeds of their sale as a loss or outgoing in that year.
The bills of exchange were accommodation bills accepted by one or other of three banks for the accommodation of Coles. To raise finance, Coles would determine the face value and maturity date of a proposed issue of bills and invite tenders from financial institutions and investment companies for their purchase after they had been drawn and accepted. After the close of tenders, Coles typed the bills on a printed form provided by the accepting bank, signed the bills and presented them to that bank for acceptance. Coles paid a fee to the bank in return for acceptance of the bills. When the bills were returned to Coles, it handed them over to the successful tenderer in exchange for a cheque for the purchase price. Purchasers of the bills commonly sold them prior to their maturity date. A bill was often sold several times before maturity. However, Coles did not re-purchase bills which it had drawn. On the maturity date, the holder of a bill presented it to the accepting bank for payment. On the same day, the accepting bank debited Coles' account with an amount equal to the face value of the bill. One bank did so shortly after a bill was presented and paid. The other two banks did so shortly after the commencement of business on that day - usually before the bill was presented or paid.
To raise finance, Coles also invited tenders for the purchase of its promissory notes. After accepting a tender, Coles typed the notes on a form which it had had printed, signed the notes, and handed them to the successful tenderer or tenderers in exchange for a cheque for the purchase price. Purchasers of the notes commonly sold them prior to their maturity date. A note was often sold several times before that date. Since Coles was incorporated in 1978, it has re-purchased notes on only four occasions. None of the notes involved in these proceedings was re-purchased. On maturity date, the holder of a note presented it to the bank at which it was payable. The bank paid the face value of the note to the holder. Subsequently, the bank debited Coles' account with the amount of the note.
The respondent, the Commissioner of Taxation, does not dispute that Coles has suffered an income loss which is deductible under s. 51 of the Act. However, he contends that any loss was deductible only in the year when the bill or note matured. When Coles was assessed for taxation on that basis for the 1984 year, it lodged an objection to the assessment. Subsequently, the objection came before the Administrative Appeals Tribunal where one of its members stated a case for the opinion of the Federal Court.
The Full Court of the Federal Court unanimously upheld the assessment. It held that no liability was incurred in respect of the bills until Coles was called upon to indemnify the accepting banks. The Full Court also held that the deduction claimed in respect of the promissory notes was rightly rejected on the authority of this Court's decision in W. Nevill & Co. Ltd. v Federal Commissioner of Taxation [32] although the Full Court said that that decision could "hardly be regarded as a satisfactory authority".
All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income.
If s. 51(1) were to be construed without reference to the case law which expounds its meaning, one of two interpretations might be thought to give effect to the natural meaning of the sub-section. The first interpretation would place emphasis on the words "losses or outgoings". If emphasis was placed on those words, the section might be interpreted so as to require an actual disbursement of money or loss of property before a deduction was allowable. The second interpretation would place emphasis on the words "incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income". If emphasis was placed on these words, the section might be interpreted so as to require the allowance of all or part of the expenses directly related to the earning of income during the relevant financial year and to require the courts to apply the "matching principle" of accounting doctrine. That principle seeks to ascertain the net gain of a business during a particular year by matching against the income earned during that period the expenses and losses which, from a business point of view, were directly related to the earning of income during that period.
However, this Court has rejected both these interpretations of s. 51(1). Instead, it has adopted an approach which seems more appropriate for determining the assets and liabilities of the taxpayer at the end of the income period than ascertaining what expenses and losses were really incurred by the taxpayer in earning income during that period. The Court has insisted that, for the purpose of s. 51(1), a loss or outgoing is not incurred until there is a presently existing liability to pay a pecuniary sum, no matter how certain it is from a business viewpoint that an expense was incurred or accrued during the year of income. By reason of this interpretation, accountancy and business practice is only a guide as to whether a loss or outgoing has been incurred. As Deane J. said in the Full Court of the Federal Court in Federal Commissioner of Taxation v Nilsen Porcelains (Aust.) Pty Ltd [33] :
In determining entitlement to a deduction under s. 51(1) of the Act, [the High Court has] accepted the jurisprudential analysis as the relevant one. No doubt the jurisprudential analysis of s. 51(1) is the natural result of the doctrine of legal formalism which dominated Anglo-Australian legal thought for much of this century and which has been rejected by this Court only in recent years [34] . As has so often been said, legal formalism represents the triumph of form over substance. 1. (1979) 27 A.L.R. 239, at p. 249. 2. See Zines, The High Court and the Constitution, 3rd ed. (1992), pp. 359-362.
Counsel for Coles did not invite the Court to approach the construction of s. 51(1) in the light of the changed approach of this Court in recent years to the doctrine of legal formalism. He was content to base his submissions on the traditional doctrine of s. 51(1). Indeed, counsel for both parties were agreed as to the principles to be applied in interpreting the sub-section. They differed only as to the result of applying those principles. Consequently, the present case is not one which calls for a re-evaluation of the principles concerning the allowance of deductions under s. 51(1). This case must be determined by applying the established principles.
For the purposes of s. 51(1), a loss or outgoing may be incurred in the year of income although no sum of money was paid or payable in that year [35] The sub-section "has been interpreted to cover outgoings to which the taxpayer is definitively committed in the year of income although there has been no actual disbursement" [36] . In New Zealand Flax Investments Ltd. v Federal Commissioner of Taxation [37] , Dixon J. said that the term "incurred" included "encountered, run into, or fallen upon". That statement was cited with approval in the unanimous judgment of the Court in Federal Commissioner of Taxation v James Flood Pty Ltd [38] .
However, as I have already indicated, authority establishes that, for the purpose of s. 51(1), a loss or outgoing is only incurred in the year of income if, during that year, the taxpayer has become liable to pay a pecuniary sum [39] . This proposition is said to derive from the statement of Dixon J. in New Zealand Flax [37] where his Honour said that "incurred" did not "include a loss or expenditure which is no more than impending, threatened, or expected".
In James Flood, the Court held that a taxpayer was not entitled under s. 51(1) to claim a deduction in respect of a provision in its accounts for the payment of annual leave because, under the terms of the relevant industrial award, no liability to pay the leave arose until an employee had commenced leave, left the employment or died. The Court said [40] that there "was at best an inchoate liability in process of accrual but subject to a variety of contingencies". It rejected the proposition that a liability had been incurred for the purpose of s. 51(1) because, by the end of the relevant financial year, "the accrual of an amount of the order claimed had become predictable with certainty".
In Nilsen Development Laboratories Pty Ltd v Federal Commissioner of Taxation, the Court again held that an amount provided in the accounts of the taxpayer for the payment of annual and long service leave was not deductible even though the employees in question were qualified to take their leave. Barwick C.J., who gave the leading judgment, said [41] that there was "no warrant for treating a liability which has not "come home" in the year of income, in the sense of a pecuniary obligation which has become due, as having been incurred in that year". Because the terms of the industrial award made it plain that no liability accrued for the annual and long service leave entitlements until the employee entered upon his leave, the amount was not deductible. Gibbs J. said [42] that "[t]he employees were entitled to leave, but they were not entitled to payment", the latter only arising when they took their leave. Consequently, the employer had not incurred any outgoing.
However, the cases draw a distinction between the incurring of a liability and its quantification. A loss or outgoing may have been incurred for the purpose of s. 51(1) although the amount of the loss or outgoing in that period can only be estimated [43] . In Commonwealth Aluminium Corporation Ltd. v Federal Commissioner of Taxation [44] , Newton J. held that the taxpayer was entitled to a deduction for a royalty payable in respect of a mining venture during the relevant income year, even though during the year of income the royalty had not been paid and "the average Alcan World value per tonne of the metal aluminium" on which the royalty was based had not been determined. His Honour held that the royalty was payable because the effect of the relevant legislation was to impose on the taxpayer an obligation to pay the royalty on each tonne of aluminium mined and that "a reasonable estimation could have been made as at [the end of the financial year] of the amount of the liability" [45] .
Furthermore, if two insurance cases correctly apply ratio decidendi of James Flood and Nilsen Development Laboratories, an amount may be deductible under s. 51(1) even though the legal liability which it represents is a matter of estimation and not proof. In R.A.C.v Insurance Pty Ltd v Federal Commissioner of Taxation [46] , Menhennitt J., sitting in the Supreme Court of Victoria, held that, pursuant to the provisions of s. 51(1), an insurer was entitled to a deduction in respect of amounts put aside in the income year to meet compulsory third party claims which had been reported but not met. He also held that the insurer was entitled to a deduction in respect of amounts put aside to meet claims which, on the basis of actuarial calculations, must have been incurred by, although not yet reported to, the insurer. His Honour said [47] that a loss or outgoing within the meaning of s. 51(1) had occurred because there was "an unanswerable liability to indemnify the driver of the vehicle once the personal injury occurs". The extent of the liability was "capable of reasonable estimate" [48] . The learned judge said [49] that the facts in James Flood were "in marked contrast with the position where an absolute liability to indemnify arises under an insurance policy upon the happening of events which result in the death of or bodily injury to a third person".
In Commercial Union Assurance Co. of Australia Ltd. v Federal Commissioner of Taxation [50] , Newton J., sitting in the Supreme Court of Victoria, held that an insurer was entitled to a deduction under s. 51(1) for amounts set aside to meet claims incurred during the financial year whether reported or not, even though the claims were in breach of a condition precedent as to notice. Because his Honour was satisfied that the long established policy and practice of the insurer was to meet a claim, although it was in breach of the notice condition, payment of the claims in question "was a matter of commercial certainty, and was not subject to any contingency which would be regarded as such in the world of ordinary business affairs" [51] .
Although the results in these cases appear to be eminently sensible, they were reached only by a strained application of the rules laid down in James Flood and Nilsen Development Laboratories. That a sensible result can only be achieved by a strained application of those decisions must throw doubt on the validity of the principles which decided them.
Upon the promissory notes being sold and delivered to the successful tenderers, Coles came under an unconditional liability to pay the face value of the notes on their due dates [52] . Delivery of the notes created a presently existing debt payable at a future time [53] . Thus, in David v Malouf, the Court held that the holder of a promissory note, not yet due for payment, could petition for the sequestration of the estate of the maker of the note under a statute [54] which provided that "the debt of the petitioning creditor must be a liquidated sum due at law or in equity, payable either immediately or at some certain future time".
Because the sale and delivery of the notes created debts, Coles necessarily incurred liabilities in the year of income in which the debts were created. In accordance with the principles expounded in New Zealand Flax, James Flood and Nilsen Development Laboratories, Coles would seem to be entitled to a deduction under s. 51(1) in respect of the year of income in which the debts were incurred. Whether the correct approach is to treat the proceeds of the sale of the notes as income and the debts as outgoings or whether the correct approach is to treat the difference between the proceeds of sale and the debts as losses is a matter to be dealt with later. But whichever approach is correct, it seems impossible to deny Coles a deduction under s. 51(1) in respect of the year when the debts were created. The Commissioner does not contend that the losses were capital losses. Yet in Nevill, this Court held that a promissory note is not "incurred" in the income year of its creation if it matures after the expiration of that year.
In Nevill, the taxpayer company claimed deductions under the predecessor of s. 51(1) in respect of payments made under the termination of the contract of service of a managing director during the relevant year of income. The payments consisted of a cash sum and ten promissory notes, six of which were payable after the expiration of the income year ended 30 June 1931. The Commissioner claimed that none of the payments was deductible. This Court held that the cash sum and the amount paid in respect of the four promissory notes were deductible in the year of income but that the amounts represented by the other six notes were deductible only in the following year when they were paid. Latham C.J. said [55] that the question of timing had not been argued and he would require full argument before deciding the question. Without expressing a concluded opinion upon the point, his Honour held that the amounts represented by the six notes could not be deducted in the year in which they were created. Rich J. also said [56] that neither the Commissioner nor his counsel had raised the question as to which years the expenditure should be allocated. Without deciding the point, he said that he was content to follow the course proposed by the Chief Justice. Dixon J. said [57] that the retiring allowance was deductible. But, without giving any reasons, he said that he did not think "that so much of it as was represented by promissory notes payable after 30th June 1931 can be deducted in the assessment for the financial year ending 30th June 1932 [sic]". McTiernan J. said [58] that the deduction for the 1931 financial year should be limited to the amounts represented by the cash payment and the four promissory notes which had been paid in that year. He gave no reasons for this conclusion.
In my opinion, so much of the decision in Nevill as held that the amount of the promissory notes was not deductible in the year of income ending 30 June 1931 should be overruled. Because the Court gave no reasons for its decision, it is an authority only on a materially identical set of facts. Curiously, although Latham C.J. and Rich J. said that the matter was not argued by counsel, the Commonwealth Law Report [59] records counsel for the Commissioner as submitting that, if the allowance was deductible, a deduction in respect of the promissory notes could only be made in the year when they were met. Counsel also submitted that the "money represented by each particular note is not a loss or outgoing "actually incurred" within the meaning of [s. 51(1)] until the note is actually met." [59] However, it seems likely that no detailed argument was put in support of the submission because counsel for the Commissioner is also reported as saying that, as the taxpayer was a company and the flat rate of tax applied, the matter was "not of any material importance" [59] . Accordingly, it seems correct to conclude that the decision was reached without the benefit of argument [60] . In these circumstances, I do not think that this Court should hesitate to overrule so much of the decision as relates to the deductibility of the promissory notes maturing after the end of the income year once it is accepted, as I think it should be, that the decision is in conflict with the application of the principles which govern the interpretation of s. 51(1).
During argument the question was raised whether Coles should be treated as having received income when the promissory notes were sold and as having incurred an outgoing when it indemnified the bank which had paid out the holder of the notes. In my opinion, the correct approach is to treat the money raised by the sale of the notes as a raising of capital and the cost of meeting the notes as a repayment of capital. But this does not mean that the difference between the two sums was a capital loss. The difference between the sale value and the repayment value of the notes was an expense incurred in the ordinary operation of the financier's business. While the sale of the notes was not a borrowing of money or anything like it [61] , the discount was a revenue expense. It was part of the recurring expense of obtaining and lending money for profit in the same way that the payment of interest on funds borrowed by a financier is a recurring revenue expense. Once Coles sold the notes it came under an immediate liability to pay the face value of the notes. The difference between that liability and the proceeds of the sale represented its loss. In Avco Financial Services Ltd. v Federal Commissioner of Taxation [62] , this Court held that a financier was entitled to a deduction under s. 51 in respect of the additional cost of repaying a loan which had been brought about by a devaluation of the currency. Mason, Aickin and Wilson JJ. said [63] :
Avco's borrowings to obtain funds to finance its lending and hire-purchase business bear a sufficiently close resemblance to the borrowing of funds to purchase physical stock-in-trade and the deferring of payments due to suppliers of such stock to require exchange gains and losses to be treated in the same way, i.e., as being on revenue account. The case for treating the loss of the sale of promissory notes by a financier as a revenue expense appears just as strong as the case for treating losses on the devaluation of funds borrowed by a financier as a revenue expense. 1. K. D. Morris & Sons Pty Ltd (In liq.) v Bank of Queensland Ltd. (1980), 146 C.L.R. 165, at p. 194. 2. (1982) 150 C.L.R. 510. 3. ibid., at p. 532.
It is not to the point that before the maturity date Coles might have purchased the notes in the market at a sum below the face value of the notes. Simultaneously with the sale of the notes, it came under a liability to redeem the notes at their face value. The difference between the two sums represented a loss which Coles had incurred. If, for any reason, Coles elected to purchase the notes before their maturity, the difference between the face value and the purchase price would be income for the purpose of the Act [64] .
Paradoxically, if the proper approach was to treat the proceeds of the sale of the notes as a revenue receipt, the case for holding that Coles was entitled to a deduction in the year of sale would seem stronger than if the proceeds of the sale and the repayment of the notes were treated as capital receipts and expenditures. On the hypothesis that the proceeds of sale were on revenue account, the face value of the notes would be a present liability payable at a future date and an outgoing for the purpose of s. 51(1).
Accordingly, Coles was entitled to a deduction in the year ending 30 June 1984 for the losses it suffered when it sold and delivered the promissory notes at a discount to their face value.
A bill of exchange is an unconditional order in writing addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand or at a fixed or determinable future time, a sum certain in money to or to the order of a specified person or to bearer [65] . The acceptor of a bill promises that he or she will pay it "according to the tenor of his acceptance" (s. 59). The drawer of a bill promises that, if the bill is dishonoured, that he or she will compensate the holder or any indorser who is compelled to pay it. The indorser promises that, if the bill is dishonoured, he or she will compensate the holder or any subsequent indorser of the bill who is compelled to pay it (s. 60).
The bills in the present case were accommodation bills, that is, they were bills accepted by a party for the accommodation of the drawer. Section 33 of the Bills of Exchange Act 1909 Cth defines an accommodation bill as follows:
(1) An accommodation party to a bill is a person who has signed a bill as drawer, acceptor, or indorser, without receiving value therefor, and for the purpose of lending his name to some other person.
(2) An accommodation party is liable on the bill to a holder for value; and it is immaterial whether, when such holder took the bill, he knew such party to be an accommodation party or not.
Payment of a fee to the acceptor in return for providing the accommodation does not constitute the giving of value for the purpose of s. 33 [1] . So these bills were accommodation bills even though Coles paid the banks a fee in return for accepting them.
Although s. 33(2) states that an accommodation party is liable on the bill to a holder for value, it has long been established that in equity, as between the accommodation party and the person accommodated, the accommodation party is a surety. Consequently, in the absence of an agreement to the contrary, if the person accommodated is given time to pay by the holder of the bill, the accommodation party is discharged in equity from liability [2] . In Davies v Stainbank [3] , Turner L.J. said that in equity it was "a fraud in a creditor to proceed at law against a surety, after he has agreed with the principal debtor to enlarge the time for payment of the debt; and this Court relieves against the fraud". However, at law, the accommodation acceptor was the principal debtor and not a surety. No doubt this was what his Lordship had in mind when he went on to say that, if the matter had been heard before a court of law, "the case might have been different" [3] . The case would certainly "have been different" in the courts of common law because apart from two nisi prius decisions of Lord Ellenborough C.J. [4] , which were soon overruled [5] , those courts recognized the accommodation acceptor as the person principally liable on the bill [6] . In Yallop v Ebers [7] , Lord Tenterden C.J. said "Laxton v Peat, where it was held that an accommodation acceptor might be considered as a surety, has been long overruled."
Since the passing of the Judicature Acts where "there is any conflict or variance between the Rules of Equity and the Rules of the Common Law with reference to the same matter, the Rules of Equity shall prevail" [8] . Consequently, where the holder of a bill gives the party accommodated time to pay, the holder cannot enforce the bill against the accommodation acceptor either at law or in equity in the absence of an agreement with the accommodation acceptor to the contrary. However, the enactment of the Judicature Acts did not affect the legal rights of the parties to an accommodation bill of exchange. Before the passing of the Judicature Acts, equity intervened to prevent the enforcement of the legal rights of the parties to an accommodation bill only when the enforcement of those rights was unconscionable. In Pooley v Harradine [9] , Coleridge J. said:
We do not see that by the doctrine asserted in Courts of equity the primary liability is at all altered. In truth, the defence, either at law or in equity, does not arise by any alteration of the original contract, which indeed it assumes and relies on in its original terms, but that the creditor cannot fairly or equitably sue the surety where, knowing of the existence of the relation of suretyship, he has voluntarily tied up his hands from proceeding against the principal. Nothing in the Judicature Acts alters that position. The accommodation acceptor is the party principally liable on the bill. Unless the holder has been guilty of inequitable conduct, equity has no jurisdiction to prevent the holder from enforcing the bill against the accommodation acceptor even if the holder had notice of the accommodation [10] . 1. Judicature Act 1873 Eng, s. 25(11). 2. (1857) 7 El. & Bl., at p. 442 [119 E.R., at p. 1311]. 3. See Bills of Exchange Act 1909 Cth, s. 33.
The relationship of the party accommodated to the accommodation acceptor
In the Federal Court, the Full Court in its unanimous judgment held that Coles "incurred no present liability in respect of each of the subject bills until that bill was discharged by the acceptor." The learned judges accepted the submission on behalf of the Commissioner that, at the time of the acceptance of each bill, Coles incurred no more than "a contingent liability to indemnify the acceptor bank in the event that the bank was called upon to discharge the bill out of its own funds." This submission was in turn based upon the general rule that, in the absence of an agreement to the contrary, a debtor incurs no liability to indemnify a surety until the surety has paid out the debt [11] .
However, with great respect to the learned judges of the Full Court, the relationship between a true surety and a principal debtor and the relationship between an accommodation acceptor and the party accommodated are fundamentally different. In the case of a true surety relationship, the debtor is the principal party. The third party creditor looks principally to the debtor for payment. The liability of the surety to the third party is contingent upon the debtor failing to meet his or her obligation. Consequently, the surety has no right to proceed against the debtor until the contingency occurs and the surety pays the debt. But in the case of an accommodation bill, the acceptor is the person principally liable to the third party. The acceptor, although treated in equity as if he or she was a surety, incurs a binding liability upon accepting the bill. Unless the holder of the bill has been guilty of inequitable conduct, that person may proceed against the acceptor whatever arrangements have been made between the drawer and the acceptor.
The difference between the relationship of a true surety and debtor and the relationship of accommodation acceptor and party accommodated means that the rights of the respective parties are different. The rights of an accommodation acceptor and the party accommodated depend on the terms of the contract between them and are not determined by treating them as though their relationship was that of debtor and surety. If the contract is in express terms, their relationship will be governed by those terms. If there is no express contract, the law implies terms which make the relationship of acceptor and drawer quite different from that of a true surety-debtor relationship. In Sleigh v Sleigh [12] , Parke B. explained the nature of the implied contract between the parties to an accommodation bill. His Lordship said [13] :
if a person lends his name to another for his accommodation, the party accommodated undertakes to pay the bill at maturity, and further, to indemnify the person accommodating him, in case that person is compelled to pay the bill for him ; and this, no doubt, is an implied authority to such person to pay it, if he be in that situation that he may be compelled by law to pay the bill, though the holder do not actually compel him to do so; and after payment he may sue the party accommodated for money paid on his account; for such payment is, in truth, under the implied authority given by the contract of accommodation between the parties; and whether this be a payment of the whole bill, or of only a part of it, makes no difference. This passage brings out the important point that the party accommodated undertakes to the acceptor that he or she will pay the bill at maturity and that the obligation to indemnify is consequential upon the failure to do so. Thus the party accommodated comes under a present obligation to pay the face value of the bill at its maturity date. The liability of the party accommodated is not a contingent liability like the liability of a true surety. Furthermore, the contract between the parties authorizes the accommodation acceptor to pay the amount of the bill although the holder does not compel the acceptor to do so. The liability of the party accommodated is fixed upon the acceptance of the bill and continues until the party accommodated discharges it in one of a number of ways. Thus, Byles on Bills of Exchange [14] states: A party who procures another to lend his acceptance thereby undertakes to take up the bill or else within a reasonable time before the bill becomes due to provide the accommodation acceptor with funds for so doing or, lastly, to indemnify the accommodation acceptor against the consequence of non-payment. 1. (1850) 5 Ex. 514 [155 E.R. 224]. 2. ibid., at p. 517 [p. 225 of E.R.]. 3. 26th ed. (1988), p. 264.
The three alternatives illustrate the modes by which the party accommodated can discharge his or her liability to the accommodation acceptor, a liability which is no way dependent upon the acceptor first paying out the bill. This is illustrated by the line of cases which hold that, if the person accommodated pays the acceptor a sum of money to discharge the liability or gives a security for the accommodation, the sum or security cannot be recovered while the bill is outstanding even if the claim on the bill is statute barred or the party accommodated becomes bankrupt [15] .
In Yates v Hoppe , the drawer of an accommodation bill paid the acceptor the amount of the bill before maturity. Before the bill became due, the drawer became bankrupt. The Court of Common Pleas held that the trustee in bankruptcy could not recover the sum paid to the acceptor. The case is an express authority for the proposition that the party accommodated becomes under an immediate obligation to the acceptor which he can elect to discharge in a number of ways and which is in no way dependent upon the acceptor paying out the bill. It necessarily denies the proposition that the liability of the party accommodated is merely a contingent liability. Maule J. said [16] :
the drawer of the bill, being under an obligation, not specifically to provide funds at a particular time to meet the bill, but one which might be performed in the whole or in part by doing so, adopts a reasonable and usual course for that purpose, by providing the acceptor beforehand with a sum of money to be applied in payment of the bill. An act done in performance of a binding contract is not revocable An ordinary mode of indemnification is, to provide funds to meet the bill the drawer, by handing to the acceptor the sum necessary to meet the bill, discharged himself by performance of his contract. As he could not have recalled the payment, so neither can his assignees. 1. Yates (1850), 9 C.B., at pp. 549-550 [137 E.R., at p. 1006].
Dicta in this Court in K. D. Morris & Sons Pty Ltd (In liq.) v Bank of Queensland Ltd. [17] also deny the proposition that the liability of the party accommodated is merely a contingent liability. In Morris, the relationship between the parties was governed by an express contract and provided for the rolling over of bills under a bills facility. But Stephen and Wilson JJ. made [18] the following observation as to the situation if there had been no express contract between the parties:
Instead there would be a series of unconnected relationships whereby the Bank became surety for the Company for particular accommodation bills and the Company assumed a liability to the Bank accordingly, which liability would be discharged when the Company put the Bank in funds to retire the bills on maturity. The acceptance of each new bill would give rise to a fresh liability. (My emphasis.) Although their Honours referred to the Bank as a surety, it is clear that they perceived the obligation of the Company as an immediate, and not a contingent, obligation. Aickin J., with whose judgment Mason J. agreed, said [19] : The liability of the Company was not dependent upon any contingency once the bills had been discounted. On the Bank paying each bill on presentation, the liability to indemnify arose by reason of the inherent characteristics of an accommodation bill. The liability of the Company under the agreement was to provide funds to the Bank in advance of the maturity date by discounting replacement bills but that was a mere consequence of the liability to indemnify the Bank. It was rather a means of satisfying the primary liability to indemnify than a separate and independent liability. 1. (1980) 146 C.L.R. 165. 2. ibid., at p. 175. 3. ibid., at p. 202.
The learned judges of the Full Court of the Federal Court said that, although there were passages in the judgments in K. D. Morris which might be read as indicating "that an accommodated party becomes presently liable to an accommodation party immediately upon the acceptance of a bill", the passages were unclear. Furthermore, since "any such view would depart from the well understood earlier law, the correct course is to decline to construe these passages in this way". With great respect to the learned judges of the Full Court, the statements of the members of this Court in K. D. Morris were doing no more than stating the law as it has been expounded in the cases for nearly 200 years.
According to the stated case, the contracts between the accepting banks and Coles were partly in writing and partly to be implied. The written part of each contract arose from a letter written by the bank and in one case a reply by Coles. Nothing in these letters cuts down the obligations which Coles would be obliged to fulfil if the letters had not been written. So much of each contract as was implied arose "from the fact that the relevant bills were accommodation bills accepted by [the bank] for the accommodation of" Coles.
Upon the facts in the stated case, the only conclusion which can be drawn is that, upon the acceptance of the bills by the banks, Coles came under an immediate obligation to pay the face value of the bills at a time no later than their maturity date. That is to say, during the financial year ending 30 June 1984, Coles came under a present obligation to pay a definite sum at a future time. For the purposes of s. 51(1) of the Act, that means that, upon the sale of the notes, Coles incurred a loss represented by the difference between the proceeds of the sale of the notes and its present liability to pay the face value of the bills. If the matter had to be determined by the application of the matching principle, the correct result might well be that the losses had to be spread over the two income years. But in accordance with current doctrine, Coles is entitled to a deduction in the year in which its legal obligation to pay the face value of the bills arose.
The appeal should be allowed. The answers to the Full Court to the stated case should be set aside. In lieu thereof, the questions should be answered as follows:
(a) The amount of $2,375,579 was a loss incurred by the applicant in the year of income ended 30 June 1984.
(a) The amount of $2,359,893 was a loss incurred by the applicant in the year ended 30 June 1984.
Coles Myer Finance Ltd
Commissioner of Taxation