Commercial & General Acceptance Ltd v Commissioner of Taxation

High Court of Australia|1977-07-01|Before: Murphy JJ, Menzies J, Gibbs J, Mason J, Sheppard J

High Court of Australia Barwick C.J. Gibbs, Mason, Jacobs and Murphy JJ. Commercial & General Acceptance Ltd v Commissioner of Taxation (Cth) [1977] HCA 47

ORDER Appeal allowed with costs. Judgment of the Supreme Court set aside. In lieu thereof order that the assessment appealed from should be remitted to the Commissioner to be amended in accordance with this judgment, and that the respondent pay the appellant's costs of the appeal to the Supreme Court.

I have had the advantage of reading the reasons for judgment prepared in this appeal by my brother Mason. I am in entire agreement with what he has written and with the conclusion he expresses. I have elsewhere expressed myself as to the decision of Menzies J. in Australasian Catholic Assurance Co. Ltd. v. Federal Commissioner of Taxation [18] and have no need for the disposal of this appeal to examine further that decision.

Fundamentally, profit is not necessarily gross income within the operation of s. 25 (1) of the Income Tax Assessment Act, 1936, as amended ("the Act"). In some instances, because of the terms of the Act, the net profit of a transaction may form part of gross income, e.g. s. 26 (a). But unless so required, what falls within s. 25 (1) must be income. Whether a given profit is income needs then to be determined on general principles. So-called capital profits do not by the very description constitute income. If what is thought to be a profit is the result of an income-producing activity, it will not be the net profit but the gross income of the activity which will fall within the assessable income: thereafter deduction conformably to the Act may be made from the gross income as a whole. For convenience, the net result of the trading account is often carried into an income tax return as the amount of income from which specific deductions are made. But the debit side of those accounts should include only items which fall within s. 51.

I agree that the appeal should be allowed. As the conclusion expressed in my brother's reasons and in my own would preclude any inclusion of the "exchange profit" in the assessable income, the assessment should be set aside.

I have had the advantage of reading the reasons prepared by Mason J. and agree with them.

In International Nickel Australia Ltd. v. Federal Commissioner of Taxation [1] I discuss the circumstances in which a gain made by a taxpayer by reason of a variation in the rate of exchange may be treated as part of the assessable income. I need not repeat what I have there said as to the principle to be applied. It is obvious that such a gain cannot be so treated if it is of a capital nature. It can only be regarded as part of the assessable income if it was referable to expenditure incurred in or for the purpose of discharging or providing for liabilities on revenue or income account: Texas Co. (Australasia) Ltd. v. Federal Commissioner of Taxation [2] . I incline to think that an exchange gain or loss on the repayment of moneys lent will always be a capital gain or loss, and can never be taken into account in the assessment of income. That seems to have been the view of Latham C.J. in the Texas Co. Case [3] . But if that be too extreme a view, I agree with Mason J. that the repayment of the borrowing in the present case was an expenditure on the capital account, within the principles stated in the lending case, Sun Newspapers Ltd. and Associated Newspapers Ltd. v. Federal Commissioner of Taxation [4] . I think that the proper approach is to apply directly the tests suggested in that case, for the purpose of deciding whether the repayment was an expenditure referable to capital account or to revenue account, rather than to consider whether the moneys borrowed, when received, became circulating capital. The line of distinction between fixed and circulating capital is not precisely drawn, and it is of little advantage to try to answer one question by asking another to which the answer may be uncertain: cf. John Smith & Son v. Moore, per Viscount Haldane [5] , and Crompton v. Reynolds and Gibson, per Lord Reid [6] .

Ante, p. 347. 2. (1940) 63 C.L.R. 382. 3. (1940) 63 C.L.R., at p. 428. 4. (1938) 61 C.L.R. 337, at pp. 359-363. 5. [1921] 2 A.C. 13, at pp. 19-20. 6. [1952] 1 All E.R. 888, at p. 895.

The present case is clearly distinguishable from cases in which an exchange gain or loss was made in making a payment for trading stock. The gain here was referable to capital, and the appeal should be allowed.

This is an appeal by the taxpayer from an order made by the Supreme Court of New South Wales (Sheppard J.) confirming an assessment made by the Commissioner of the taxpayer's liability to income tax based upon income derived during the year ended 30th June 1973 [7] . By his assessment the Commissioner had included in the taxpayer's taxable income a foreign exchange profit of $2,807,568, thereby increasing that income from $8,932,120 to $11,739,688. The sole issue is whether the amount in question should have been treated as assessable income.

The taxpayer, which is a finance company, was incorporated on 27th March 1958. Its principal shareholder is and always has been the Commercial Banking Company of Sydney Ltd. ("the C.B.C. Bank"). On 1st July 1970 the taxpayer issued 4,000,000 shares of $1 each, being 20 per cent of its issued capital, to the Bank of America, a large United States banking corporation which, unlike Australian banks, carries on business as a general financier. As part of the terms on which this issue of shares was made the Bank of America agreed to make a stand-by facility equivalent to $A5,000,000 in United States currency available to the taxpayer, to consider increasing the amount of the stand-by facility if requested, to give access to Bank of America techniques and financing plans and, if necessary, to make personnel available and generally to stand behind the taxpayer. This agreement with the Bank of America has given the taxpayer access to valuable techniques which its association with the C.B.C. Bank did not provide.

The amount of the stand-by facility was increased in 1974 to $US30,000,000. Loans were made by the Bank of America to the taxpayer in amounts of $US2,250,000 and $US15,700,000. There were staff exchanges and visits and a substantial exchange of information in relation to financial markets and operating techniques.

At all material times the main categories of the taxpayer's financing activities have been: (a) Property development loans for home unit construction, residential subdivision, shopping centres and other commercial developments. In some cases the taxpayer holds an equity interest which enables it to participate in profits made. (b) Instalment contracts which include unsecured personal loans, hire purchase of motor vehicles, industrial and agricultural equipment and loans secured by mortgage, principally to purchasers of developed blocks of residential land. (c) Commercial term loans. (d) The leasing of assets, in particular of motor vehicles, plant and equipment.

Up to 30th June 1970 the taxpayer had been financed by its share capital, its reserves, borrowings from the public, term deposits accepted from companies, institutions and individuals and bank overdraft accommodation with the C.B.C. Bank. The taxpayer also had the advantage of a stand-by facility provided by that Bank and after 1st July 1970 it had the benefit of the stand-by facility provided by the Bank of America.

On 30th June 1971, by a deed of agreement of that date between the Bank of America and the taxpayer and a loan agreement of the same date, the Bank of America agreed to lend to the taxpayer an amount of $US15.7 million, the second of the two loans to which I have referred. This loan was to be repaid in equal consecutive quarterly instalments beginning on 29th June 1975 and ending on 29th March 1976 and was to bear interest at a fluctuating rate per annum of 1 1/4 per cent above the offered inter-bank rate quoted by the Asia currency unit of the Bank of America. The provision for repayment was subject to cl. 3.1 of the loan agreement which gave to the taxpayer the right at its option to redeem the debenture stock and notes issued in respect of the loan without premium or penalty prior to maturity in whole by prepaying the principal of the loan or in part by prepaying multiples of $US100,000. Clause 6.6 of the loan agreement provided that so long as there was any indebtedness outstanding the taxpayer would maintain in cash and money market instruments in a form approved by the Bank an amount of not less than 65 per cent of the loan from time to time outstanding.

The amount of the loan was received on 30th June 1971 and amounted in Australian dollars to $13,906,111.60. It was included in the taxpayer's published accounts under the head of public borrowings.

The primary judge found that the reason why the taxpayer sought the loan was that the taxpayer's receivables were increasing at a time when the general liquidity of the country was diminishing. The expression "receivables" means the total to fall due under the various loan or leasing arrangements entered into by the taxpayer and not the amount presently due at any particular time. There was, due to the liquidity situation in Australia at the time, an increasing demand for finance with the result that more business was being written and at the same time an increasing difficulty was being experienced in borrowing money by way of the public issue of debentures and notes. When negotiations for the loan were commenced in January 1971 by Mr. Fletcher, the then general manager of the taxpayer, the amount sought was $US4.5 million, but the increasing low level of liquidity in the taxpayer became so great that the amount sought later increased to $US15.7 million.

After the making of the loan the Australian dollar appreciated in value against the United States dollar and the taxpayer opened in its books an account entitled "Exchange Fluctuation Reserve". To this account were credited from time to time the amounts by which the liability to repay the debt was reduced as the result of exchange fluctuations.

By the beginning of 1973 the taxpayer's liquidity problem had been overcome. The amount borrowed was no longer required to enable the taxpayer to demonstrate a sound liquidity position. The condition set out in cl. 6.6. of the loan agreement prevented 65 per cent of the amount borrowed being put to commercial use and in fact the total amount of the loan was held in short term money market securities and was not put to use in the ordinary lending and financing business of the taxpayer. The interest received under the money market instruments in which the loan funds were invested was less than the interest payable under the loan agreement. Accordingly, in 1973 it was decided to repay the loan. It was repaid on 27th February 1973 by payment of $A11,239,587.75, being the Australian dollar equivalent of $US15,899,520.83, being repayment of the principal together with interest of $US199,520.83.

According to Mr. Fletcher's evidence, which was accepted by his Honour, the loan transaction between the Bank of America and the taxpayer differed from any other borrowing transaction entered into by the taxpayer in that it was a special loan for a large amount for a particular purpose from a foreign bank with which the taxpayer had a special relationship. Apart from an earlier short term loan of $US2,250,000 borrowed from the Bank of America in January 1971 the taxpayer did not enter into any other borrowing transaction overseas. At the time it entered into the transaction there was no intention or expectation of making a gain on fluctuations in exchange rates.

His Honour concluded that the exchange gain was income of the taxpayer within the meaning of s. 25 (1) of the Income Tax Assessment Act 1936, as amended, according to the ordinary usages and concepts of mankind. His reasons for reaching this conclusion may be summarized as follows:

(1) That the amount of the loan was circulating capital derived by the company in the course of carrying on its business (Ammonia Soda Co. Ltd. v. Chamberlain [8] ), notwithstanding that there was a limitation upon the use to which 65 per cent of the borrowing could be put, because the entire amount of the loan increased the taxpayer's financial standing and entitled it to borrow and lend far greater amounts than would otherwise have proved possible.

(2) That in some circumstances a profit or gain is gross income falling within s. 25 (1) of the Income Tax Assessment Act. For this proposition his Honour found support in the decision of Menzies J. in Australasian Catholic Assurance Co. Ltd. v. Federal Commissioner of Taxation [9] where it was held that a profit on sale made in the ordinary course of the company's business was assessable income as a profit according to the ordinary usages and concepts of mankind.

(3) That no distinction can be drawn between foreign exchange gains made out of debts for trading stock - which have been held to constitute assessable income (see Caltex Ltd. v. Federal Commissioner of Taxation [10] ) - and foreign exchange gains made out of other debts.

[1918] 1 Ch. 266, at pp. 286-287. 2. (1959) 100 C.L.R. 502, at pp. 505-509. 3. (1960) 106 C.L.R. 205.

The Income Tax Assessment Act 1936, as amended ("the 1936 Act") provides for a method of arriving at a taxpayer's taxable income which is artificial in that it is based on the taxpayer's assessable income from which are subtracted the deductions allowed by the Act (s. 48). The expression "assessable income" is defined by s. 6 so as to mean "all the amounts which under the provisions of this Act are included in the assessable income". The Act contains a series of specific provisions including a variety of amounts in the assessable income of a taxpayer. Of these specific provisions s. 25 (1) is the most important; it includes in the assessable income the gross income of the taxpayer. It is followed by a number of provisions whose effect is to include in the assessable income receipts or profits made in particular circumstances, e.g. s. 26 (a). All losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, or are necessarily incurred in carrying on a business for that purpose are, subject to certain exceptions, allowable deductions (s. 51).

In this respect the scheme of the 1936 Act is broadly similar to the scheme of the Income Tax Assessment Act 1922, as amended ("the 1922 Act"), although its provisions are less elaborate than the provisions of the 1936 Act. Both Acts differ from the United Kingdom Income Tax Act which taxes the profits or gains of a business. The differences between the two methods of arriving at the taxable income of a taxpayer have been discussed in such cases as Federal Commissioner of Taxation v. Gordon [11] and New Zealand Flax Investments Ltd. v. Federal Commissioner of Taxation [12] .

(1930) 43 C.L.R. 456, at p. 461. 2. (1938) 61 C.L.R. 179, at pp. 199, 206.

The judgment appealed from proceeds upon the footing that, notwithstanding the reference to "gross income" in s. 25 (1), the sub-section catches net profit in some circumstances at least. At first glance it might be thought that this view of s. 25 (1) fails to take account of the presence of s. 51 (1) which provides for the deduction of outgoings from a taxpayer's assessable income. In the ordinary case in the process of arriving at the amount of net profit outgoings are deducted. To say that net profit falls within gross income and is therefore within assessable income seemingly is to say that outgoings are deducted before arriving at the assessable income whereas s. 51 requires that they be deducted from that income.

However, in the Flax Investments Case, Dixon J. said [13] :

But, as the Income Tax Assessment Act 1922-1930 has been interpreted, authority for the deduction must be found not in general principles but under some provision of the statute. In par. ba of the definition of income in sec. 4 "profit" is specially brought into the assessable income and this involves a preliminary account of the particular transaction, which, no doubt, is a departure from the general scheme ascribed to the Act. There may be other similar examples and perhaps, apart from such express provisions, instances of special businesses and transactions may be found where nothing but the net profit could be regarded as a revenue item. But, generally speaking, the gross receipts on account of revenue must be taken into the assessable income and therefrom the deductions allowed by the Act must be made and no others. Although there are differences between the 1936 Act and the 1922 Act, they do not in themselves necessarily dispose of his Honour's observations. To the extent to which there are cases in which the character of income may attach to a net profit which is derived from a gross receipt which lacks the character of income, the inclusion of the net profit, if otherwise authorized by the Act, can be reconciled with s. 51 (1). The antecedent deduction of outgoings from the gross amount received so as to ascertain the net profit figure would not involve the application of s. 51 because the gross amount received is ex hypothesi neither gross income nor assessable income. And if it is the net profit only which is taken into assessable income there is no outgoing which has been incurred in relation to that figure which can be deducted. 1. (1938) 61 C.L.R., at p. 206.

There is a problem in accommodating the language of s. 25 (1) to the notion that an amount of net profit forms part of gross income. Is the reference in the sub-section confined to the gross receipts only of the taxpayer which possess the character of income or does it also include a net amount having that character, provided that the net amount is not itself derived from gross income? The expression "gross income" in relation to a taxpayer conveys the sense of entire income of a taxpayer. No doubt in the context of the Act that income is to be ascertained in the first instance by reference to the gross income receipts of the taxpayer, but in my view it also includes a net amount which is income according to the ordinary concepts and usages of mankind, when the net amount alone has that character, not being derived from gross receipts that are revenue receipts.

It was suggested that the decision of Menzies J. in Australasian Catholic Assurance Co. Ltd. v. Federal Commissioner of Taxation [14] supports this view. I doubt whether it does; the judgment is not explicit upon the point. Be that as it may, the decision can be explained on the footing that the investment was part of the taxpayer's insurance business.

However, the conclusion to which I have come is that the amount in question does not possess the character of income and that it is not caught by s. 25 (1), even if, as I have suggested, that sub-section includes net profit in some circumstances, as, for example, where it is derived from a gross receipt which is not income.

The exchange gain was in reality a saving or reduction in the amount of Australian currency equivalent which the taxpayer required to repay its indebtedness. In essence it was a windfall advantage stemming from a reduction in a liability to repay a borrowing of capital. I can see no persuasive reason for saying that the gain was a receipt of income.

In my view, to support the assessment it is not enough to say that the gain was made when the moneys borrowed formed part of the taxpayer's circulating capital. The distinction between fixed and circulating capital was described by Jenkins L.J. in Reynolds and Gibson v. Crompton [15] as "debatable". His Lordship went on to say that "circulating capital" is "simply an expression used to denote capital expended in the course of the trade with a view to disposal at a profit of the assets produced or acquired by means of such expenditure, and represented at different stages of its career by cash, assets into which the cash has been converted, and debts owing from customers to whom those assets have been sold". See the same case on appeal Crompton v. Reynolds and Gibson [16] . As I have said, the taxpayer's exchange gain was a reduction in the taxpayer's liability to repay; it was not a gain made on the investments in which the moneys borrowed were placed or in those assets which might be said to be the taxpayer's circulating capital from time to time.

(1950) 33 Tax Cas. 288, at p. 303. 2. [1952] 1 All E.R. at pp. 893-895.

The evidence accepted by his Honour established that the principal purpose of the borrowing was not to arm the taxpayer with more funds to lend or apply in the ordinary course of its finance business - 35 per cent only of the loan could be so applied - but rather to provide a base of additional assets which would generally strengthen the taxpayer's financial standing and enable it the more readily to borrow moneys from the public by demonstrating that it was free of liquidity problems. Indeed, the evidence shows that by reason of the condition contained in cl. 6.6. of the loan agreement, that 65 per cent of the amount of the loan should be kept in cash and money market instruments, it was inevitable that the interest payable under the loan would exceed the income to be derived from it. This was because the interest charges payable to the Bank of America were those appropriate to a long-term loan, whereas the interest payable on money market securities was at a lower rate appropriate to short-term securities. No doubt the effect of the loan was to enable the taxpayer to divert other funds into the more profitable channels of its finance business, but this does not affect the character of the loan transaction itself.

In these circumstances the principal purpose of the borrowing was to strengthen "the business entity, structure, or organization set up or established for the earning of profit"; it was not part of the process by which the organization operated to obtain regular returns, this being the distinction drawn by Dixon J. in Sun Newspapers Ltd. v. Federal Commissioner of Taxation [17] in elaborating the difference between expenditure and outgoings on revenue account and on capital account. In truth the transaction was designed to strengthen the framework within which the taxpayer intended to carry on business - see Commissioner of Taxes v. Nchanga Consolidated Copper Mines Ltd. [18] ; B.P. Australia Ltd. v. Federal Commissioner of Taxation [19] .

(1938) 61 C.L.R. 337, at p. 359. 2. [1964] A.C. 948, at p. 959. 3. (1965) 112 C.L.R. 386, at p. 392; [1966] A.C. 224, at p. 232.

It remains only to dispose of the suggestion made in support of the Commissioner's case that money borrowed by the taxpayer should be regarded as trading stock. In this event, the reduction in the amount required to repay the liability would be reflected by a corresponding increase in the taxpayer's assessable income - see s. 28. As trading stock does not ordinarily embrace money, the submission was based on the statutory definition of trading stock contained in s. 6. The definition includes "anything produced, manufactured, acquired or purchased for purposes of manufacture, sale or exchange, and also includes live stock". Although the decision in Investment and Merchant Finance Corporation Ltd. v. Commissioner of Taxation [20] shows that "trading stock" in its statutory sense includes choses in action such as shares and is not confined to goods and commodities, the definition is not wide enough in my opinion to comprehend money borrowed by a finance company for use in its business, in particular for the use to which the taxpayer applied the moneys which it borrowed from the Bank of America. Even if the moneys were "anything acquired", they were not acquired for purposes of "exchange", as the Commissioner argued. What the taxpayer did with the moneys which it borrowed could not, by any feat of imagination, be accurately described as an "exchange of money".

The present case is to be distinguished from cases in which a manufacturer or trader buys or sells stock-in-trade for a price payable in a foreign currency which appreciates or depreciates before payment is made. Then there is a case for saying that the exchange gain or loss forms part of the taxpayer's assessable income or is an outgoing in gaining or producing assessable income (Texas Co. (Australasia) Ltd. v. Federal Commissioner of Taxation [21] ; cf. Armco (Australia) Pty. Ltd. v. Federal Commissioner of Taxation [22] ; Caltex Ltd. v. Federal Commissioner of Taxation [23] ).

(1940) 63 C.L.R. 382. 2. (1948) 76 C.L.R. 584. 3. (1960) 106 C.L.R. 205.

In my opinion the exchange profit was a capital profit. I agree with the reasons which Mason J. has expressed in reaching this conclusion. That being so, the profit is not brought to tax under any provision of the Income Tax Assessment Act 1936. It is certainly not a profit under the first limb of s. 26 (a). It is certainly not a profit arising from the carrying out of a profit-making scheme under the second limb of s. 26 (a). There was no scheme of profit making in respect of the relevant loan. Nor is it a profit arising from the carrying on of a profit-making undertaking within the second limb of s. 26 (a). The only "profit making undertaking" within the meaning to be ascribed to those words (see McClelland v. Federal Commissioner of Taxation [24] ) was in this case the general business undertaking of the taxpayer. The profits of that business undertaking do not include capital profits but only include profits to revenue account. Likewise, even if a net profit from an income producing activity can be gross income under s. 25, the net profit will here be in no different case from a profit arising from the carrying on of the business of the taxpayer. Therefore, if there is in the relevant circumstances no profit arising from the carrying on of the taxpayer's business undertaking, there is likewise no income falling within s. 25.

(1970) 120 C.L.R. 487; [1971] 1 W.L.R. 191; [1971] 1 All E.R. 969.

I have considered the Income Tax Assessment Act 1936, as amended, and the authorities and come to the following conclusions that, in general:

(1) If an amount receivable by a taxpayer (the principal sum) is assessable income, then any increase or decrease in the principal sum caused by exchange rate variation is to be taken into account (in determining the taxable income of the taxpayer) as assessable income or allowable expenditure, in accordance with (3) and (4) below.

(2) If an amount payable by a taxpayer (the principal sum) is allowable expenditure, then any increase or decrease in the principal sum caused by exchange rate variation is to be taken into account (in determining the taxable income of the taxpayer) as allowable expenditure or assessable income, in accordance with (3) and (4) below.

(3) If the variation occurs in the year of income in which the amount receivable or payable is taken into account, adjustment should be made to reflect the actual income or expenditure.

(4) If the variation occurs in a later year of income, any exchange gain (that is, an excess of the amount actually received over the amount receivable, or an excess of the amount payable over the amount actually paid) is assessable income; any exchange loss (that is, an excess of the amount receivable over the amount actually received, or an excess of the amount actually paid over the amount payable) is allowable expenditure.

(5) If an amount receivable by a taxpayer (the principal sum) is not assessable income, then any increase or decrease in the principal sum caused by exchange rate variation is not to be taken into account in determining the taxable income of the taxpayer.

(6) If an amount payable by a taxpayer (the principal sum) is not allowable expenditure, then any increase or decrease in the principal sum is not to be taken into account in determining the taxable income of the taxpayer.

This means different treatment when an exchange variation effects a gain or loss in both a non-deductible repayment of capital (it is ignored) and a deductible payment of interest on it (it is treated as above). Thus, if interest payable on a borrowed sum were deductible, exchange variation which effected a saving would result in assessable income (unless occurring in the income year in which the interest is taken into account in which case the allowable expenditure is reduced to reflect what was actually expended).

There is no conceptual difficulty when the variation occurs in the income year in which the income or expenditure is taken into account. There is a conceptual difficulty in treating a decrease in income as deductible expenditure and a decrease in expenditure as assessable income when the variation occurs in a later income year but this gives a rational operation to the Act. This would also be achieved by treating the decrease in income (or expenditure) as negative income (or negative expenditure) and deducting it from assessable income (or allowable expenditure). I have not dealt with what should be done when intermediate exchange rate variation occurs.

I accept that the appellant's overseas borrowing was a capital transaction, unlike its local borrowings and lendings. The repayment of the borrowed sum was a capital transaction and was not allowable expenditure. It follows that on the repayment of the capital the saving or gain from exchange variation was not to be taken into account in assessing income.

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