Finance & Guarantee Co Ltd v Commissioner of Taxation

The first of these three appeals relates to the year ended 30 June 1964, the second to the year ended 30 June 1965 and the third to the year ended 30 June 1966. In the first of these years the taxpayer claims to have been entitled to be allowed a deduction of over £150,000 representing lossess sustained by it in connexion with the sale of a hotel - the Domino Hotel - which it had purchased in August 1960 and sold in November 1963 and on the sale of a large number of shares in R W Miller (Holdings) Ltd, a company which purchased the hotel and issued the shares to the taxpayer in satisfaction of the price. The Commissioner disallowed the claim. If the deduction claimed had been allowed the result would have been that the taxpayer would have shown a substantial loss in the 1964 tax year which it would have been entitled to have had taken into account in the following tax year and this is the basis of the second appeal.

In the third appeal the taxpayer claims to be entitled to a deduction of a loss of over $190,000 incurred by it on the sale of another hotel - the Seabreeze Hotel - which it had purchased in 1960 and sold during the year ended 30 June 1966.

The parties were in agreement that the issue to be determined on the appeals is whether these losses were trading losses or whether they were, as the Commissioner contended, losses of a capital nature. I should add that some other matters of a minor nature were raised by the appeals, but the parties agreed that these would be adjusted and that I need not concern myself with them.

The taxpayer was described as a finance company. It was incorporated in 1936 and for some years its business consisted in the main of financing hire-purchase transactions. Later it extended its business to the making of personal loans and lending money to persons who desired to purchase small businesses. Later again, it launched into other fields such as the buying and selling of land in subdivision and the sale of houses and flats erected by it on land purchased by it. Another venture was the purchase and later the resale of a hotel - the Tarro Hotel - a transaction which resulted in a loss of some £700. Profits and losses resulting from these activities (including the purchase and sale of the Tarro Hotel) were reflected each year in its profits and loss accounts and in each year, including the years to which these appeals relate, a substantial profit was shown.

I will deal first with the Domino Hotel transaction. A company, Tims Holdings Ltd, owned some land on which it was building this hotel and during 1959 and 1960 the taxpayer made a series of short-term loans to it secured by mortgages to enable these building operations to be carried out, the total amount lent being about £120,000 with interest at 18 per cent. Tims Holdings Ltd got into financial difficulties and was unable to repay the moneys owed by it to the taxpayer. In these circumstances, when the erection of the hotel was either finished or nearly finished, the taxpayer decided, in May 1960, to purchase the hotel from Tims Holdings Ltd and in August 1960 a contract to purchase the property was entered into. The price was, in round figures, £330,000, £200,000 to be paid in cash and the balance satisfied by the issue to Tims Holdings Ltd of a number of shares of 5s each in the taxpayer company at a premium of 11s 6d per share. The contract was carried out and the taxpayer went into possession of the hotel. It sought, without success, to obtain a manager to run it and finally leased it for a term of three years. The takings fell substantially and it was decided to sell the hotel on the expiration of the lease. Between May and November 1963 the taxpayer endeavoured to find a buyer and finally, in November 1963, it sold the hotel to R W Miller (Holdings) Ltd for a figure of £200,000. Payment was not to be made in cash, but by the issue to the taxpayer of 200,000 shares of 10s each in R W Miller (Holdings) Ltd The shares were then thought to be worth approximately £200,000 and it was thought that they might increase in value. The taxpayer's intention was to sell the shares as soon as possible and they were sold at various times between November 1963 and February 1964 and, in the ultimate result, realized some £21,000 less than the figure at which they were valued at the time of the sale of the hotel. I have no doubt that shares were taken in payment of the price because it had been found impossible to find a cash buyer prepared to pay anything like the figure which the taxpayer wanted to obtain. The facts stated above are not, I think, in dispute.

I turn now to the Seabreeze Hotel transaction. This was purchased by the taxpayer in June 1960 for over £190,000 and, having completed the purchase, it granted a lease of the hotel for a period of either three months or three years. The evidence did not make it clear which of these was the term granted. Whatever was the length of the lease, the lessee could not carry on and so, it was said, "walked out". After some difficulty another lessee was found to whom a five-year lease was given. The takings, however, steadily decreased, the lessee sought reductions in the rent and in 1963 the taxpayer decided to sell the property. After much exertion a buyer was found in May 1966 and the hotel was sold for £86,000. Expressed in dollars the total loss claimed in respect of this transaction was over $190,000. These facts, again, are not I think in dispute.

Oral evidence was given on behalf of the taxpayer by three persons two of whom, Weekley and Forsythe, were at all material times directors of the taxpayer. Mr Forsythe was and is an accountant practising his profession in Newcastle and Weekley also had some accountancy qualifications. The third witness was a Mr Langsworth, who was a member of the firm which audited the taxpayer's accounts and was, to some extent at least, its financial adviser. The evidence of these witnesses was directed to show that the purchases and sales of the Domino and Seabreeze Hotels were carried out in the course of, and as part of the taxpayer's trading activities. The purpose was, they said, to buy the hotels, build up the takings and sell the properties at a profit as part of the taxpayer's trading activities, and not to hold them as investments. In effect, they claimed, the taxpayer had gone into the business of buying and selling hotels and, if their evidence is accepted, it is agreed that the appeals should be allowed. Counsel for the Commissioner disclaimed any suggestion that these witnesses were endeavouring to mislead the Court, but pointed out that they were referring to happenings which occurred a considerable time ago and submitted that in view of certain documentary evidence which he put before me, and to some of which I shall presently refer, their recollections of events could not be relied upon as correct. That documentary evidence, he contended, clearly pointed to the conclusion that the hotels were purchased with the intention of holding them as investments and that the losses made on the sales were lossess of a capital nature.

The documentary evidence to which he referred begins with a minute of a resolution passed at the meeting of the directors of the taxpayer on 25 May 1960. There were present at the meeting a Mr Potts, who was then the Chairman of Directors, and three other Directors including Forsythe and Weekley. I interpose here to say that evidence was given, which I accepted, that Potts' state of health was such that he could not be called as a witness. The minute is in these terms: "The chairman referred to informal discussions which the directors had had on several occasions regarding the company purchasing hotels and gave details of the Seabreeze Hotel, Tom Ugly's Point and Domino Hotel, Riverwood, both of which he believed could be purchased by the company. After considerable discussion IT WAS RESOLVED that in view of our desire to diversify the company's sources of income and having regard to the profitable character of the Seabreeze and Domino Hotels that efforts be made to purchase either or both hotels for the purpose of deriving income from them …."

This certainly seems to me to point to the fact that the proposal was to purchase the hotels as investments and not to earn profits as a trader in hotel properties. This is confirmed by the next document to which I refer. It sets out the chairman's address to the shareholders of the taxpayer at its annual general meeting held on 20 September 1960, and copies of it were, I gather, supplied to the authorities of the Stock Exchange on which the taxpayer's shares were listed. In the course of his address the chairman said: "Whilst the year has been a satisfactory one for our company, competition has been keen, largely because of the entry into the general finance field of companies formerly engaged solely in hire purchase and who have found these activities becoming increasingly difficult and less profitable. For this reason your directors have sought to further diversify the company's activities into fields other than finance and by using the high premium on the company's shares, have been able to effect several very satisfactory deals. In this connexion, I would mention that purchase of both the Seabreeze and Domino Hotels has been completed since balancing date. It is not the company's policy to run these hotels, but merely to hold them as an investment and both hotels have already been leased on terms which will provide a very satisfactory return on cost."

Objection was taken by counsel for the taxpayer to the admission of this document, the objection being based upon the decision in Re Devala Provident Gold Mining Co (1883), 22 Ch D 593, in which it was held that what was said in a chairman's address to a meeting of shareholders was to be regarded as a confidential report by an agent to his principal and was not admissible as an admission in favour of third parties. With respect, I feel some doubt as to the correctness of the decision but, in any event, I am of opinion that at the present day when it is a common practice for a chairman's address to shareholders at an annual meeting of a public company to be supplied to the Stock Exchange and to the public through the medium of the press, it would be contrary to common sense to hold that such an address cannot be used in evidence in proceedings by a third party, assuming of course it is relevant to a fact which that third party is seeking to establish.

I go next to 1965 when the taxpayer was proposing to make an issue of debenture stock. The then Chairman of Directors, a Mr Auswild, in a letter dated 30 July 1965 directed to a firm of share brokers who were to underwrite the issue, made a report for inclusion in the prospectus to be published in connexion with the debenture issue. In the course of it he said: "In 1960 the company diversified by moving into the engineering industry with the acquisition of CA Burgmann Pty Ltd … Also in 1960 two suburban hotel properties in the Sydney area were acquired, and the company undertook the erection of a large block of home units. The hotel properties were not as profitable as expected and one was sold during the year ended 30 June 1964, whilst the value of the other was written down to a current figure. It is not the Board's intention to continue investment in this field. … The company has traded profitably in every year since its inception and the Board is confident that future profits will adequately cover the interest commitments of this and the previous debenture issue and enable payment of dividends to the company's shareholders to be maintained."

In the prospectus, as issued, there appeared the following passage: "In 1960 the company acquired the old established Newcastle engineering business of C A Burgmann Pty Ltd and two Sydney suburban hotel properties. However, it is not the company's intention to continue in the latter field and one hotel has been sold …" Later in the prospectus it was said: "The company has traded profitably in every year since its inception and has maintained an unbroken dividend record despite difficulties encountered during the transition from hire purchase and small business finance to the more specialized functions now undertaken."

If the purchases and sales of these hotels were undertaken as part of the taxpayer's trading activities as a dealer in real estate, it would not be correct to say that it had traded profitably in every year since its inception.

In the following year, that is 1966, the directors made a report to the trustee for the debenture holders, in the course of which it was stated that: "No material trading or capital loss has been sustained by the borrowing company or any guaranteeing subsidiary. However, as you are aware a capital loss of $43,006.30 was sustained by the borrowing company on the sale of the Sea Breeze Hotel." The amount of this "capital loss" was arrived at after writing down a substantial amount the value at which the hotel had earlier stood in the taxpayer's books, and this was mentioned in the letter of 30 July 1965 to which I have already referred.

I cannot reconcile these various statements with the idea that the buying and selling of the Domino and Seabreeze Hotels and the transactions in the shares in R W Miller (Holdings) Ltd associated with the sale of the Domino Hotel were part of the taxpayer's trading activities. Counsel referred also to a number of other statements in the documentary evidence in support of his submissions. I think I need only mention two of them. One is that the assets represented by the hotels, whilst owned by the taxpayer, appeared in the balance sheets under the heading of "Investments", and the other that at no time were the losses on the transactions with which the case is concerned reflected, as was the loss on the sale of the Tarro Hotel, in the taxpayer's profit and loss accounts.

The witnesses called for the taxpayer endeavoured to explain how it came about that the documents took the form that they did, but I was not impressed by their explanations. In the result, I am not satisfied that the taxpayer has made out its case that the purchases and sales of the two hotels were part of its trading activities, rather do I think that the proper conclusion is that the losses incurred were of a capital nature. As to the loss on the sale of the shares in R W Miller (Holdings) Ltd, I am of opinion that it is to be regarded as part and parcel of the losses made on the sale of the Domino Hotel. The taxpayer was not a trader in shares and had to acquire these shares if it was to rid itself of the hotel. While it, doubtless, hoped that the value of the shares would appreciate I am not prepared to find in favour of the alternative claim that the acquisition was undertaken for the purpose of profit-making by sale or the carrying out of a profit-making undertaking or scheme.

In each case, the appeal should be dismissed with costs.