Honomable Mr. Justice boehof? v PI

Evidence - proper use to be made of facis subsequent to the

THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA Appellant

ORDER. JUDCES MAKING ORDER: Northrop,Fisher and Lockhart JJ. DATE OF ORDER: 13 June, 1979 WHERE MADE: Sydney ORDER: Appeal dismissed with costs.

COMMONWEALTH OF AUSTRALIA Appellant and TOTAL HOLDINGS (AUSTRALIA) PTY. LTD. Respondent NORTHROP J. REASONS FOR JUDGMENT 13 June,1979.

In my opinion the appeal should be dismissed with costs. I concur in the reasons for judgment given by Lockhart J. and have nothing to add.

pet a tiue copy of the Eeasons for Judgment hesein of the

) ) NEW SOUTH WALES DIS?PRICT REGISTRY ) No. G77 of 1978 ) )

IN THE MATTER of the Income Tax Assessment Act 1936

THE COMMISSTONER OF TAXATION OF THE COMMONWEALTIT OF AUSTRALIA

Appellant

• and - TOTAL HOLDINGS (AUSTRALIA) PTY. LIMITED Respondent CORAM: Northrop, Fisher & Lockhart JJ. 13 June 1979. REASONS FOR JUDGMENT FISHER J.: I have had the advantage of reading the Judgment

I certify that this aadthe /5 prececing a true copy of the Reasons !9

COMMONWEALTH OF AUSTRALIA Appellant and TOTAL HOLDINGS (AUSTRALIA) PTY. LTD. Respondent LOCKHART J. REASONS FOR JUDGMENT 13 June, 1979.

This is an appeal by the Commissioner of Taxation from a decision of the Supreme Court of New South Wales in its Administrative Law Division upholding an objection by the taxpayer against an assessment to tax for the year of income ended 31 December 1972.

The appeal concerns the question whether interest paid by the taxpayer to its parent company upon moneys borrowed by the taxpayer from it are deductible under

s.51 of the Income Tax Assessment Act 1936 ("the Act").

incorporated in New South Wales on 25 January 1955 for the

purpose of acquiring and holding shares in Total Australia Limited ("TAL"). The activities of the taxpayer have been principally the acquisition and holding of shares in and the making of loans to TAL.

Since the incorporation of the taxpayer, the sole beneficial owner of its issued share capital has been Compagnie Francaise Des Petroles ("CFP"), a company incorporated in France.

TAL was incorporated in New South Wales and, since its incorporation, it has carried on the business of marketing and distributing petroleum products in various parts of Australia through service stations owned by it and others to users of petroleum products.

From 10 January 1963 to 31 December 1968 TAL was a wholly owned subsidiary of the taxpayer. Prior to 10 January 1963, the taxpayer owned beneficially variously 2,162,566 and 9,997.924 shares in the capital of TAL.

On 31 December 1968 the taxpayer and its nominees transferred the whole of the issued share capital of TAL to Total Boral Limited, the shares in which were owned equally by the taxpayer and Boral Limited.

Between 17 August 1959 and 31 December 1965 CFP advanced to the taxpayer a total sum of 22,969,875.00. Those moneys were used by the taxpayer for 3 purposes: to make loans to TAL for use by it in its business; to pay for shares acquired by the taxpayer in TAL; and to finance the operations of the taxpayer itself. The amount used

by the taxpayer for the purpose of making loans to TAL

All loans by CFP to the taxpayer during the period 17 August 1959 to 31 December 1965 were made on terms that they were repayable by equal half yearly repayments over an agreed period, being ten years in the case of loans made to 1963, and five years in the case of subsequent loans; and that the amount of the loans should bear interest at the rate of three per centum per annum.

The terms of all loans to the taxpayer extant on 31 December 1965 were varied by consolidating the same into one loan of $23,000,000.00 which was made up of capitalisation of interest and certain of the principal.

Further loans were made by CFP to the taxpayer between 1 January 1966 and 31 December 1968 such loans being made on terms that they were repayable by equal half yearly repayments over a period of ten years commencing on a date five years from the commencement of the year in which a particular loan was made; and that the amount of the loans should bear interest at the rate of three per centum per annum.

The amounts advanced by CFP to the taxpayer in the period from 1 January 1966 to 31 December 1968 were used by the taxpayer, as to the sum of $1,500, 000.00, by lending the same to TAL for use by it in its business and, as to the balance, to finance the operations of the taxpayer.

Interest on loans made by CFP to the taxpayer was payable in Paris on 30 June and 31 December each year.

taxpayer were in writing and provided that the moneys lent

me aeneetlne RRM sth tia! det The Saat Ll we ate oe

would be allocated by the taxpayer to investments in Australia approved by CFP.

The procedure adopted at all relevant times by the taxpayer in seeking advances from CFP was that towards the end of each calendar year a budget for the following calendar year was prepared by TAL and submitted to the taxpayer's board. Subject to the approval of the budget by the taxpayer's board, a request was made by the taxpayer to CFP for an advance to be made of a nominated amount. On approval of that request an agreement was entered into in Paris whereby CFP agreed to advance to the taxpayer the required amount. If the whole of the advance was not drawn down, an agreement was subsequently entered into varying the terms of the loan agreement by reducing the amount of the agreed advance. If additional amounts were required, a supplemental agreement was entered into between the taxpayer and CFP relating to the additional advance.

All loans made by the taxpayer to TAL in the period from 1 January 1960 to 31 December 1968 were on terms that the same were interest free and repayable on demand.

By agreement made on 13 August 1968 between the taxpayer and TAL, TAL agreed with the taxpayer that the whole of the amount outstanding by TAL to the taxpayer would from 1 January 1969 bear interest at the rate of seven per centum per annum.

Limited acquired a fifty percent interest in Total Boral Limited

Interest at the rate of seven per centum per annum continued to be paid by TAL to the taxpayer until the 1976 year of income notwithstanding that Boral Limited ceased to hold its interest in Total Boral Limited in the 1971 year of income. TAL again became a subsidiary of the taxpayer during the 1972 year of income.

In its return of income for the year ended 31 December 1972 the taxpayer returned a taxable income of nil arrived at after deducting losses of prior years which were carried forward and incurred as a result of the payment of interest on the loans from CFP.

The Commissioner allowed as deductions such of the losses carried forward as represented interest paid by the taxpayer to CFP on so much of the moneys advanced by CFP to the taxpayer as were subsequently employed by the taxpayer either in paying for shares it acquired in TAL or in lending monies to TAL with interest; but he disallowed as deductions such of the losses carried forward as represented interest paid to CFP on so much of the advances by CFP to the taxpayer as were subsequently lent by the taxpayer to TAL interest free.

The evidence does not disclose how the Commissioner arrived at the apportionment of losses; but it was common ground that nothing turned on this.

The Commissioner disallowed the claim for deduction of losses of prior years in the sum of $24,450.00. There is no dispute that, if the claim was properly disallowed, that is the correct figure.

which determines the deductibility or otherwise of the interest payments. Section 51, so far as relevant, provides:-

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."

The relation between the two limbs of sub- section (1) was described by Fullagar J. in John Fairfax &

Sons Pty. Ltd. v. F.C. of T. (1959) 101 C.L.R. 30 at p. AO, in these terms:-

"The two categories of s. 51 (1) are clearly not mutually exclusive, and it has indeed been said that 'in actual working! the addition

of the second category 'can add but little to the operation of the leading words "losses or outgoings to the extent to which they are incurred in gaining or producing the assessable

income": ' Ronpibon Tin N.L. and Tongkah Compound N.L. v. Federal Commissioner of Taxation Gey)

that there may be cases which fall outside the first category and within the second. The first

is directed to expenditure incurred in the actual course of producing assessable income: Amalgamated Zinc (De Bavay's) Ltd. v. Federal Commissioner of Taxation (1935) 54 C.L.R. 295, at pp. 303, 309

and W. Nevill & Co. Ltd. v. Federal Commissioner of Taxation (1957) 56 C.L.R. 290, at p. 305. It is, primarily at least, concerned with expenditure voluntarily incurred for the sake of producing income. Its scope is not, of course, confined

to cases where the income is derived from carrying on a business. The second may be thought to be concerned rather with cases where, in the carrying on of a business, some abnormal event or situation leads to an expenditure which it is not desired to make, but which is made for the purposes of the business generally and is reasonably regarded as unavoidable: Hannan, Principles of Income Taxation (1946) p. 291: Federal Commissioner oi Taxation v.

The words "the assessable income" and "such income"

refer to assessable income generally of the taxpayer and

not to the assessable income of a particular accounting

period: Ronpibon Tin N.L. v. F. C. of T. (1949) 78 C.L.R. 47

per Latham C.J., Rich, Dixon, McTiernan and Webb JJ.

F.C, of T. v. Snowden & Willson Pty. Ltd. (1958) 99 C.L.R. 431

per Dixon C.J. at p. 436; John Fairfax & Sons Pty. Ltd. v. F.C. of T. (1959) 101 C.L.R. 30 per Dixon C.J. at p. 35 and

per Menzies J. at p. 46; C. of T. v. Finn (1961) 106 C.L.R.

v. F.C. of T. (1974-1975) 132 C.L.R. 175 per Barwick C.J.

As to the first limb of s. 51, the phrase "incurred

in gaining or producing the assessable income" has been

construed to mean "incurred in the course of gaining or

Limited v. F. C. of T. (1935) 54 C.L.R. 295 per Latham C.J. at

p. 303 and at p. 309 per Dixon J.; W. Nevill & Co. F.C. of T. (1937) 56 C.L.R. 290 per Dixon J. at p.

Ronpibon Tin Case (supra) per Latham C.J., Rich, Dixon,

outgoing incurred in gaining or producing the assessable

income, it must be incidental and relevant to that end:

In Charles Moore & Co. (W.A.) Pty, Ltd. v. F.C. of T

(1956) 95 C.L.R. 344 Dixon C.J., Williams, Webb, Fullagar and

For expenditure to constitute a deduction under s. 51, it is not necessary that the taxpayer carries on a business. It is sufficient for the purposes of the first limb of the sub-section that the expenditure be incurred in relation to the management of the income-producing enterprise of the taxpayer: F.C. of T. v. Green (1950) 31 C.L.R. 313 at p. 319.

As to the second limb, it is clear that there must be a relation or nexus between the expenditure and the

carrying on of the relevant business: F.C, of T. v. Snowden

In John Fairfax & Sons Pty. Ltd. v. F, C. of T,. (supra) Menzies J. said at p. 49 that in order that an

outgoing falls within the second limb of the sub-section it "must have been incurred in the carrying on of a business, that is, it must be part of the cost of trading operations." The word "necessarily" where appearing in the sub- - section means "clearly appropriate" or "adapted for ". See The Commonwealth v. The Progress Advertising and Press Agency Co, Pty. Limited (1910) 10 C.L.R. 457 per Higgins J. at p. 469; the Ronpibon Tin Case (supra) at p. 56; and F. C. of T. v.

Snowden & Willson Pty. Limited (supra) especially per Dixon C.J. at pp. 436-7 and per Fullagar J. at p. 444,

carrying on a business, need not necessarily be incurred in

a year when the taxpayer is actively carrying on that business. See A.G.C. (Advances) Limited v. F. C. of T. (supra).

The question whether interest is actually incurred in gaining or producing assessable income is one mainly of fact. See Usher's Wiltshire Brewery Limited v. Bruce 1915 A.C. 433 at p. 466; New Zealand Flax Investments Limited v. F. C. of T. (1938) 61 C.L.R. 179

at p. 198; The Texas Co. (Australasia) Limited v. F. C. of T.

In the Ronpibon Tin Case (supra) Latham C.J., Rich, Dixon, McTiernan and Webb JJ. said at p. 59:-

If a liability for interest 1s incurred for the purpose of introducing capital into an income gaining business, the payment of interest is allowable as a deduction. See F. C. of T. v. Munro (1926) 38 C.L.R. 153 at pp. 171, 197, 217-218; The Texas Co. (Australasia) Limited v. F.C. of T. (supra) per Latham C.J. at p. 430 and per Dixon J. at p. 468 where his Honour said:-

deductible. Under the Australian system, interest on money borrowed for the purpose

a liability for interest being incidental to or connected

with the operations or activities regularly carried on

for the production of income, the interest is an allowable deduction. The circumstance that each item of expenditure cannot be traced to a particular item of income does not prevent the deduction of the expenditure. See Ward & Co.

Ltd. v. Commissioner of Taxes (1923) A.C. 145 at p. 148;

De Bavay's Case (supra) at p. 307; W. Nevill & Co. Ltd. v. F.C. of T. (supra) at p. 305; and The Texas Co. (Australasia) Ltd. v. F. C. of T. (supra) per Starke J.

In my opinion if a taxpayer incurs a recurrent liability for interest for the purpose of furthering his present or prospective income producing activities, whether those activities are properly characterised as the carrying on of a business or not, generally the payment by him of that interest will be an allowable deduction under s. 51. See Munroe's Case (supra); The Texas Co, (Australasia) Ltd. v. F.C. of T. (supra); F.C. of T. v. Green (1950) 81 C.L.R. 313 per Latham C.J., McTiernan, Webb, Fullagar and Kitto JJ. at p. 319; and Usher's Wiltshire Brewery Limited v. Bruce (supra).

I say "generally" as some qualification may be necessary in appropriate cases, for instance, where interest is paid by a taxpayer as a prelude to his being in a position whereby he may commence to derive income. In such cases the requirement that the expenditure be incidental and relevant to the derivation of income may not be satisfied. See Lodge v. F.C. of T. (1972) 128 C.L.R. 171; C. of T. v. Hatchett (1971) 125 C.L.R. 494.

taxpayer to deduct so much of the interest paid to CFP as is oe /11

referable to the moneys borrowed from CFP which were in turn, or their monetary equivalent was, used by the taxpayer to acquire, by purchase or allotment, shares or further shares in TAL. As the shares held by the taxpayer in TAL were by their very nature inherently capable of generating dividends from TAL, whether in the short or long term, when profits were made by TAL, the moneys thus expended, the Commissioner agreed, were outgoings incurred in carrying on the taxpayer's business of a holding company or were directly related to the income producing activities of the taxpayer.

Nor does the Commissioner deny the taxpayer the deductibility of interest paid to CFP on moneys lent by it to the taxpayer which were, or the monetary equivalent was, then lent to TAL with interest atseven per centum per

The Commissioner asserts that the position is different as to moneys advanced by the taxpayer to TAL free of interest. Although conceding that the taxpayer carried on a business, namely holding shares in TAL, he contends that there is no direct nexus between any income producing activities of the taxpayer and the making of advances interest-free to TAL. The Commissioner concedes that, if the advances were made with interest, there would be a relevant nexus between moneys received from CFP and moneys advanced to TAL, because the interest paid on the loan from CFP of 3% would be measured, to some extent, the exact

proportion not being relevant in the Commissioner's view,

In support of his contention the Commissioner asserts that the purpose of the taxpayer in borrowing from CFP and lending to TAL free of interest was to render TAL profitable as soon as possible so that some of the shares held by the taxpayer in TAL could be disposed of to a purchaser outside the Total group for a capital profit. The Commissioner disavowed that the profits arising from such disposition of shares in TAL would answer the description of income according to ordinary concepts or would fall for tax under s. 26 (a) of the Act.

Fundamental to the Commissioner's argument is the evidence of Monsieur Dalemont. Monsieur Dalemont gave evidence both by affidavit and orally. He was cross-examined briefly; but not only is there no suggestion that his evidence ought not to be accepted, the Commissioner in fact relies on it. Monsieur Dalemont was employed by CFP as one of its general managers in charge of foreign refining and foreign marketing operations and as general manager of operations of CFP. He was also a director of CFP from January 1973 until January 1977. He was a director of TAL from June 1955 until November 1968. He formed the opinion that TAL would commence to earn a profit around the end of the 1960's and he so informed the board of CFP, as did other directors of TAL. Monsieur Dalemont gave evidence that it has been the policy of the Total group to establish trading subsidiaries in various countries throughout the world and

make them profitable, or as lf pul it "stand on their own

feet", as soon as possible. Sometimes the group had disposed,

in one form or another, of portion of its holding in

the trading subsidiary to outside interests for capital

profit. This was always a possibility in the case of the

investment in the Australian trading subsidiary; but it

was not a purpose or object in establishing that subsidiary,

or, indeed, in its being funded by the taxpayer from time

to time over the relevant years. It may not have been

profitable. If it was, then portion of the taxpayer's

shareholding may have been disposed of; but again it may nob. Monsieur Dalemont deposed in his affidavit to

having discussed the subject of borrowings between the

taxpayer and TAL with one of the directors of the taxpayer

who subsequently became its chairman. He said that he

recalls they discussed the need for TAL to finance its oil

stocks in Australia in the short term with Australian

panks or other finance institutions. Monsieur Dalemont

said that he negotiated overdraft facilities for the taxpayer

with the Banque Nationale de Paris initially to a limit of

$500,000.00 which was varied later from time to time. He

said that, to enable the most advantageous arrangements to

be made, it was essential that the operating results of TAL

appeared "no worse than was unavoidable" and that this

played a part 1n the decision by the taxpayer to lend moneys

to TAL free of anterest. He said that, when the decision

was made by the board of the taxpayer that its loans to TAL

would be free of interest, the taxpayer's board considered

the then and future needs of TAL to borrow money in Australia

from banks or other finance institutions to finance its

purchase and holding of crude and refined oil in Australia; and also considered the desirability from the point of view of TAL, and therefore of the taxpayer, and ultimately of CFP, of TAL's accounts revealing an operating profit as soon as possible. He said that the funding of TAL by interest-free loans was the best and most obvious means of establishing TAL as a profit-making subsidiary as soon as possible and of presenting its accounts in the most favourable light.

From 1957 until 1968; when Boral Limited acquired its holding of 50% of the share capital of Total Boral Limited, moneys were from time to time borrowed by the taxpayer from CFP at an interest rate of 3% for the purpose of funding the marketing operations of TAL. Monsieur Dalemont said that in lending money interest-free to TAL the taxpayer acted as an arm of CFP having the objective of bringing profits to TAL more quickly, so that, in due course profits would be received by the taxpayer by way of dividend or interest, and ultimately those profits would be paid by the taxpayer to CFP. He said that the purpose was to bring about a faster return to the taxpayer on the funds invested by it in TAL and correspondingly a faster return on the moneys invested by CFP.

Monsieur Dalemont said that at all times from 1955 until 1977, CFP has followed "a policy of dividend flow for its affiliated companies."

it became apparent that it was no longer as profitable

as before for TAL to import refined oil products into Australia, and that it was less expensive to bring crude oil into Australia in larger tankers. Boral Limited had a refinery but no outlet for petroleum products. TAL had outlets for petroleum products but no refinery. Hence the arrangement was reached for a combined refining and marketing operation between Boral Limited and the Total Group. Under that arrangement, crude oil was to be imported into Australia at world market prices (posted prices) less rebates, on a basis that meant that the Australian joint investment would receive crude oil at competitive prices. In the arrangements between the two groups, discussions took place as to the rate of interest that should be charged by both Boral Limited and the taxpayer on loans made to TAL. Monsieur Dalemont said that as Boral Limited was a public company, 1t would not consider lending money at no interest. He said that he arranged for loans from the taxpayer to TAL to be at the same rate of interest as loans from Boral Limited to Total Boral Refineries Limited. The rate finally determined was 7% per annum being a relatively low long term interest rate. All loans by the taxpayer to TAL were repayable on demand, so that there was nothing to prevent the taxpayer, at any time it wished, saying to TAL that, if 1t wished to retain the use of the loan moneys, it would henceforth be

obliged to pay interest. This is precisely what happened

in 1968 when Boral Limited took up its 50% shareholding

in Total Boral Limited. Interest was thereafter repayable at 7 per centum per annum and was in fact charged, not only whilst the joint enterprise with Boral subsisted but, after its termination in 1972, when interest at 7% continued to be charged through to the income year 1976, notwithstanding that TAL had become again a subsidiary of the taxpayer. Thus, after 1968 the taxpayer derived assessable income from

the payments of interest at the rate of 7% per annum by TAL and, during the same years, paid interest to CFP at

There may be some question as to the use that may be made of evidence as to events occuring in years of income after the year ended 31 December 1972, although evidence of those events was admitted before the learned trial judge without objection, and it was not submitted to this court that such evidence could not be taken into consideration. Tf use 1s to be made of it at all, it is to determine the proper weight to attach to relevant events occuring during the years of income up to and including the year of income ended 31 December 1972: See Willis v. The Commonwealth (1946)

73 C.L.R. 105 per Dixon J. at p. 116; and Nelungaloo Pty.

Limited v. The Commonwealth (1947) 75 C.L.R. 495 per Williams

J. at p. 515. The conclusions I have reached would be the same whether or not events after 31 December 1972 are taken into consideration.

inference to be drawn that it was the dominant or, for that

matter, any purpose of the taxpayer, in making interest-free loans to TAL that once TAL became profitable, a substantial portion of the shares held by the taxpayer in TAL would be disposed of to some outsider for capital profit. Even if the evidence did warrant the drawing of this inference,

I am far from satisfied that it would operate to deny a business or income producing character to the interest-free loans over such a long period of time. However, not only does the evidence not justify the drawing of the inference sought by the Commissioner; rather it establishes that the making of the interest-free loans to TAL was incidental

and relevant to the derivation of income by the taxpayer and formed part of its business activities.

This is a case of a large group of companies with international affiliations establishing through the taxpayer a trading subsidiary in Australia, requiring the outlay of large sums of moneys over a long period of time. Indeed, some $23,000,000.00 had been advanced by CFP to the taxpayer by 31 December 1965. When a fifty percent interest in TAL was sold to Boral Limited in 1968 interest was charged by the taxpayer on the loans outstanding by TAL at 7% per annum and continued to be charged after the 1972 tax year notwithstanding that Boral Limited withdrew from the joint enterprise in 1972. When the taxpayer received the moneys advanced by CFP it used them in one of three ways: by taking up shares or purchasing shares in TAL, keeping moneys for its own running expenses and as to the greater part by making interest-free loans to TAL.

required, by the terms of the loan agreements, to be allocated by the taxpayer to investments in Australia approved by CFP. The loans were all long term loans so structured that the taxpayer had the use of the money for

a long period of time. In my opinion, it is clear from

the evidence that the moneys borrowed by the taxpayer from CFP were to be used by it for financing TAL in whatever way was regarded as appropriate from time to time, whether this be by taking up shares in TAL or making advances to it with or without interest and, if with interest, at whatever rate of interest might be thought appropriate. It was regarded as appropriate to fund TAL primarily by interest-free loans, not only to place it in the best light so far as its accounts were concerned, but to minimuse the tax consequences that would flow from the acquisition of further shares by the taxpayer in TAL and the consequent payment of dividends by TAL to it, assuming there were sufficient profits. Those

demand. Thus it was within the power of the taxpayer, at any time it wished, to restructure the financing of TAL by calling up the loans and using the funds in some other way, whether by taking up further shares in TAL or

the making of loans at an appropriate rate of interest. Also, there was no guarantee that the many millions of dollars which the taxpayer had invested an TAL would ultimately produce a profitable trading entity.

render TAL profitable as soon as commercially feasible and to promote the generation of income by TAL and its subsequent derivation by the taxpayer and thence CFP. In my opinion the liability for interest of the taxpayer to CFP was incidental and relevant to the derivation of its income and was part of its business activities. The payment of interest satisfied the tests required in respect of each limb of s. 51. For these reasons, in my opinion the appeal