Sun Newspapers Ltd and Associated Newspapers Ltd v Federal

Fairfax and Sons Pty Limited v Federal Commissioner of Taxation (1950) 101 CLR 30, Ronpibon Tin N.L. and Tongkah

Compound N.L. v Federal Commissioner of Taxation (1949) 78 CLR 47, Ure v Federal Commissioner of Taxation (1981) 34 ALR 237,

Federal Commissioner of Taxation v Ilbery Commissioner of Taxation v Ilbery (1981) 38 ALR 172, Nevill and Company Limited v Federal Commissioner of Taxation (1937) 56 CLR 290, Federal Commissioner of Taxation v Midland

Railway Co of Western Australia Limited (1962) 85 CLR 306 referred to.

NSW G.71 of 1985 THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA v_JAMES NEILL CREER

ON_APPEAL FROM THE SUPREME COURT _OF NEW SOUTH WALES ADMINISTRATIVE LAW DIVISTON

BETWEEN : THE COMMISSIONER OF : TAXATION OF THE COMMONWEALTH OF AUSTRALIA

AND: JAMES NEILL CREER Respondent CORAM: FISHER, WILCOX and JACKSON JJ

-kOOY 2. ; THE COURT. ORDERS THAT:

1. The appeal be allowed.
2. The order of the Supreme Court of New South Wales in

(a) the appeal to that Court, insofar as it deals with the sums of sixty-three

thousand eight hundred dollars ($63,800.00) claimed as rent and two

(bp) James Neill Creer pay to the Commissioner of Taxation his costs of the appeal to

3. The respondent pay to the appellant his costs of the appeal.

NOTE: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

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NEW SOUTH WALES DISTRICT REGISTRY ) No. 71 of 1985 ) )

ON APPEAL FROM THE SUPREME COURT OF NEW SOUTH WALES

THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA

FISHER J.: This appeal by the Commissioner of Taxation of the Commonwealth of Australia ("the Commissioner") is from a decision of the Supreme Court of New South Wales in its Administrative Law Division. By that decision the Supreme Court allowed an appeal by James Neill Creer ("the taxpayer") against the disallowance by

the Commissioner of certain deductions claimed by him in his return of income for the year ending 30 June 1977. The

deductions related to a claim for rent paid in that year, fees

paid for advice in respect of his income tax affairs and an

amount claimed as overseas travelling expenses. Before the learned trial judge counsel for the Commissioner conceded the claim for travelling expenses and before this Court both counsel agreed that the claim in respect of income tax advice would stand or fall with the claim for rent. In these circumstances argument on the appeal before us was limited to the claim for a deduction ef the rent. This claim is in respect of the sum of $63,800 paid

by the taxpayer on 29 June 1977 to Home Units Limited ("Home

The trial Judge concluded that the outgoings in respect of rent and fees were properly deductible under sub.s.51(1) of

the Income Tax Assessment Act 1936 ("the Act") and that neither

the provisions of s.260 nor arguments based on "fiscal nullity"

had any application. In respect of sub.s.51(1) he was of the opinion that the payments under the lease were not outgoings of a capital nature in any shape or form. It is on this aspect of the matter that I am in disagreement with the views of the learned trial Judge, being of opinion that the outgoing under each of the leases is a capitalized sum and therefore of a capital nature. It follows that the outgoings are not deductible under sub.s.51(1). I see each of the outgoings as a payment which the taxpayer was bound by his contract to make to Home Units for the use of the land for the term of the lease. The nature of such a payment is primarily to be ascertained according to the true construction of the lease agreement. To label the payment as

"rent" does not conclude the matter, and, if anything, obscures

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an understanding and assessment of the true nature of the

I therefore would decide the matter by construing the terms of the contracts between the taxpayer and Home Units and by ascertaining the manner in which the parties calculated the

The matter arose in circumstances which are not in dispute and which were fully set out in the reasons of the trial Judge. The taxpayer anda public accountant, Mr. Pursche, each gave evidence and were each subjected to cross-examination. Both were accepted as witnesses of complete credit and the issues on appeal turn on the conclusions which the trial Judge drew from their evidence and not on his findings of primary fact. I now set out briefly those facts, most of which are of little

relevance to the particular issue which I see as crucial and

The taxpayer was in 1977 a solicitor carrying on his professional practice in Sydney. In April of that year he sought residential premises which he could lease from the owners and then sublease to tenants. At all times he had in mind that he would be the head-lessee and that a family company of which he was a director and inthe shares of which he held the sole beneficial interest would purchase the properties subject to the

head-lease to him. In the preceding month of March 1977 he had

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sought professional advice concerning avenues open to him for reducing his income tax. During discussions on this matter the possibility of leasing income-producing property and paying the

introduced to a Mr. John Wilson, an employee of a firm of sharebrokers acting for Commercial & General Acceptance Limited (C.A.G.A.) in relation to residential properties in the Sydney Metropolitan area. In mid May 1977 the taxpayer received from Mr. Wilson ae schedule of available properties and their respective prices. The four properties which ultimately the taxpayer leased were home units and at that stage priced at $51,500, $55,000, $57,500 and $55,500 respectively. During June 1977 he inspected these properties as well as a number of other home units and town houses. On 22 June 1977 he inspected in company with estate agents these four properties and obtained the opinion of these agents as to their respective rental values. He was subsequently joined on the inspection by Mr. Pursche. The following day, in company again with Mr. Pursche, he conferred with his Bank Manager concerning the acquisition of the town houses and the availability of finance. At this meeting Mr.

. Pursche handed to the Bank Manager a document containing

information which the latter had at a previous interview requested. The first paragraph thereof to the extent relevant

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to occupy the premises. On 28 June 1977 the taxpayer agreed with Bareki Pty. Ltd. to grant a sub-lease of the units for three

months to that company at a weekly rent totalling $380.00. This

company paid rent of $1,646.54 for the month commencing 29 June 1977 and monthly in advance thereafter. This arrangement with Bareki Pty. Ltd. was subsequently extended for a further period of 3 months and from February 1978 the taxpayer leased the

On 1 July 1977 Edisearb executed contracts of sale and

purchase of the four units subject to the leases to the taxpayer and paid deposits to the vendor totalling $8,950. On the same

day the taxpayer entered into a loan agreement under which he borrowed $50,000 from C.A.G.A., which amounts he received on 4 duly 1977. On 29 July 1977 Edisearb completed the purchase of

the units and executed a Memorandum of Mortgage and Deed of

Equitable Charge in favour of C.A.G.A. as security for its loans

The taxpayer paid the two amounts of $7,975 described as rental in the leases on 30 June 1978 and 30 June 1979 respectively to Edisearb. Subsequently three of the leases were

surrendered by the taxpayer for considerations assessed by the

presently relevant the learned trial Judge upheld the appeal of

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case. "Purpose" may refer to the taxpayer's subjective purpose: the end which he or she seeks to achieve by incurring the expenditure. It may mean objective purpose, the object which the incurring of the expenditure is apt to achieve. As Brennan J said at p.215:

"An objective purpose is attributed toa transaction by reference to all the known circumstances; whereas subjective purpose and motive, being states of mind, are susceptible of proof not by inference alone but also by direct evidence, for a state of mind may be

proved by the testimony of him whose state of mind is relevant to a fact in issue."

where a connection between an outgoing and the taxpayer's undertaking or business is effected ' by the voluntary act of the taxpayer, the

business or income-earning kind." The evidence in the present case shows that the incurring of expenditure for "rent" was in every sense a voluntary act of the taxpayer. Not only did the taxpayer choose to enter into the transaction; he was the author of its form. '

Consequently, it is relevant to have regard to his purpose in

determining whether that expenditure should be characterised

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Here, objective purpose and subjective purpose co-incide. Subjectively, as he stated in his evidence and following a reference to the derivation of rental income, the "prime purpose" of the taxpayer "was to seek an investment for myself through Edisearb Pty Limited to purchase properties where there was a reasonable chance of good capital gain and, in regard to those two purposes, to secure for myself a tax

benefit". The "two purposes" -- rental income and capital

• gains -- being achievable without resort to pre-paid leases,

the answer makes plain that the only reason for their creation -- and the consequent incurring of expenditure for pre-paid rent -- was the desire to secure a taxation advantage.

Mr Creer's statement 1s consistent with the history of the matter. The evidence shows that at all times it was fundamental to the taxpayer's interest in the Wollstonecraft units that he be able to capture, either personally or through a company controlled by him, any future increases in capital values; but it was equally important to him that the purchases should be structured in such a manner as to make a portion of their cost tax deductible in the current year of income. In his affidavit Mr Creer said that in April 1977, when he first decided to look at residential properties, he knew "that the property market at the time was depressed". He "formed the view that vendors, particularly vendors who had borrowed money under mortgage, might be receptive to any

reasonable proposal that I might put". At that time he had

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already discussed with his accountant "possible avenues for reducing my liability to income tax" and the accountant "had mentioned among a number of alternatives the possibility of leasing income producing properties and paying the rental in advance". In and after April Mr Creer inspected various properties, the consideration for which was always quoted in terms of a lump sum purchase price. He had a number of discussions with his bank and with CAGA, each of which proceeded upon the basis of lump sum values being assigned to each unit; but the values being apportioned by Mr Creer in various ways as between amounts of pre-paid rentals for five year leases and of consideration for the purchase of the freeholds of the units subject to those leases. The negotiations with CAGA reached finality on 29 July 1977 when, "at a meeting attended by Mr Creer, Mr Pursche handed to representatives of CAGA a document entitled "Final Proposal between Creer and CAGA". This document detailed a series of proposed dealings involving the taking of five year leases by Mr Creer over each of the four units and the purchase by Edisearb Pty Limited of the freehold of each unit, finance being provided both to Mr Creer and to Edisearb by CAGA. Mr Creer's affidavit evidence was that, after examination of this document, one of the two CAGA representatives responded: "We "are satisfied that your offers on the terms set out in Bill Pursche's document are acceptable to CAGA provided that the whole transaction can be finalised as soon as possible". The

meeting concluded with discussion about the mechanics of the

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preparation of the necessary leases and contracts for sale. It is clear that both Mr Creer and CAGA regarded the various

leases, sales and mortgages as a complex of interconnected dealings forming what Mr Creer described in his evidence as

The object which the incurring of the relevant expenditure is apt to achieve is consistent with the proved subjective purpose of the taxpayer. Considering the matter objectively, the properties were lettable and so capable of yeturning income. There were prospects of capital gains. But these ends could have been achieved without the taking of leases. Any desire to split, as between the taxpayer and Edisearb, the two benefits -- income and capital gains -- could have been accommodated by leases upon usual terms. The pre-payment of a rental equal to 80% of that payable under the leases for the full five years had no tendency other than to transform into expenditure incurred on revenue account in the

1977 financial year expenditure which would otherwise be

incurred on capital account -- whether in or after the 1977 financial year -- or on revenue account in a later financial year.

The second limb of s.51(1) makes deductible losses and outgoings to the extent to which they are "necessarily

incurred in carrying on a business for the purpose of gaining

or producing" assessable income. The relevance of purpose to

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that limb is apparent. But the relevant purpose is the purpose for which the business is carried on, not the purpose of the

particular expenditure: see John Fairfax and Sons Pty Limited

v_ Federal Commissioner of Taxation (1950) 101 CLR 30 at p.49.

In the present case this limb may be ignored. As Menzies J explained at that page the second limb requires that "the outlay must have been incurred in the carrying on of a business, that is, it must be part of the cost of trading operations". The only business of the taxpayer disclosed by the evidence was that of a solicitor. The rental outgoing had nothing to do with that business. It was incurred in

connection with a real estate investment not involving trading

The word "purpose" does not appear in the first limb of s.51(1), which simply refers to "losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income". But there is ample authority for the proposition that, in determining whether particular - expenditure falls within this description, it ig material to determine the objective purpose for which it was incurred. In Ronpibon Tin N.L. and Tongkah Compound N.L. v Federal Commissioner of Taxation (1949) 78 CLR 47 at p.57 Latham CJ, Rich, Dixon, McTiernan and Webb Jd, said that to come within this limb "it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever

is productive of the assessable income or, if none be

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oo. 8. produced, would be expected to produce assessable income". In

South Australian Battery Makers, a3 Gibbs ACJ pointed out in

the passage at p.655 quoted by Fisher J, the critical question

was the nature of the advantage sought by the taxpayer.

In Magna Alloys Brennan J elaborated his comments upon the significance of purpose by saying at pp.220-221:

"When the question is whether expenditure has the character of capital or of a revenue payment ... the advantage for which the expenditure was incurred must be identified and the manner in which it 'is to be relied upon or enjoyed' must be considered ... The role of the advantage in the income-earning undertaking requires examination. Similarly, when the question is whether expenditure is incurred in gaining or producing assessable income, the connection between the advantage for the taxpayer which the incurring of the relevant expenditure is calculated to effect and the taxpayer's income-earning undertaking or business must be considered. If the advantage can be sufficiently identified by reference to a contract, and the taxpayer's undertaking is known, the connection between the incurring of the expenditure and the undertaking is manifest, and it would be otiose to refer to the purpose of incurring the relevant expenditure. But purpose is relevant to describe an element of connection between expenditure and a taxpayer's undertaking or business in cases where a taxpayer incurs expenditure or agrees to incur expenditure without any antecedent obligation to do so or where the occasion of the expenditure ... is not manifestly to be found in whatever is productive of assessable income or in whatever would be expected to produce

assessable income, or in the carrying on of a business."

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His Honour went on to refer to a passage in the judgment of Dixon J in Federal Commissioner of Taxation v Midland Railway Co of Western Australia Limited (1952) 85 CLR 306 at p.313 in which his Honour, in discussing whether particular expenditure fell within 3.51(1) referred to the "controlling factors" as being those which arise from the character of the business or undertaking and the relation which the expenditure bore to the carrying on of the business or the gaining of assessable income. Brennan J commented that, although the taxpayer's state of mind has no relevance once the "controlling factors" are established, "in ascertaining the controlling factors, the taxpayer's state of mind may have a significant evidentiary role to play, and by leading to the ascertainment of the controlling factors, it may even be the determinative element in characterizing expenditure in a particular case". And see

also the judgment of Deane and Fisher JJ in the same case at

The Magna Alloys approach may be applied to the facts of the present case by saying that, in determining one of the "controlling factors", that is the relationship between the incurring of the pre-paid expenditure and the gaining of assessable income, the taxpayer's state of mind has a significant part to play, confirming the inference which would anyway arise from the nature of the transaction,

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regard has been paid to collateral advantages sought to be

gained by a taxpayer from the incurring of expenditure claimed as deductible under s.51(1). In Ure v Federal Commissioner of Taxation (1981) 34 ALR 237 the claim was to deduct interest payable on loans raised by the taxpayer at commercial rates and then on-lent by the taxpayer to his

wife or to his family company at 1% per annum, the moneys being eventually used for various purposes beneficial to the

"One of the most difficult aspects of the problem of characterizing an outgoing is the assessment of what, if any, weight is to be given to indirect objects which a taxpayer had in mind in incurring the outgoing. Such objects form part of the relevant circumstances by reference to which the problem of characterization must be resolved. There is however no rigid principle which can be applied in determining what, if any, weight should be given to them. In the ordinary case, such as, for example, where the immediate object achieved by the outgoing is the production of assessable income which is commensurate with the amount of the outgoing or where it is clear that the outgoing was for the purchase of stock-in-trade or the acquisition of services or hire of equipment used in earning assessable income, indirect -objects or motives of a personal or domestic character will plainly not prevent the characterization of the outgoing as having been incurred in earning assessable income:

-. In other cases, the immediate object or

effect of an outgoing will not suffice either . to explain or to characterize it. In such cases, indirect objects or motives can assume a sometimes decisive importance."

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Their Honours said that 1t would be a "misleading half-truth" to say that "the object which the taxpayer had in mind or the advantage which he sought in incurring the liability" to pay interest at 7.5% or more was the

derivation by him of interest at 1% per annum by re-lending

"That was, no doubt, an object which the taxpayer had in mind: it was an advantage which he sought. In the circumstances however, characterization of the outgoing cannot properly be effected by reference to that object or advantage alone. The incurring of the outgoing can only be explained by reference also to less direct objects and

advantages which the taxpayer sought to achieve and which plainly were of paramount importance. These indirect objects or advantages were, in so far as the taxpayer was concerned, not of an income-earning character

It can be accepted in the present case that the earning of rental income by the sub-leasing of the four

units at Wollstonecraft was an object which Mr Creer had in

mind, an advantage which he sought. But the incurring, on the last day of the financial year, of a lump sum outgoing amounting to a pre-payment of 80% of the total rent payable over five years, can only be explained by non-income earning

objects and advantages which Mr Creer sought to achieve.

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Federal Commissioner of Taxation v Ilbery (1981) 38 ALR 172 is a case having some factual similarity to the present appeal. The question in that case was the deductibility of a pre-payment of five years' interest. It was accepted that the interest would have been deductible if paid in the ordinary way; the relevant loan having been used to purchase an income producing property. It was contended on behalf of the taxpayer that one result of the pre-payment was to reduce the interest payable over the whole period of the loan. Toohey J, with whom Northrop and Sheppard JJ agreed, commented at p.181:

"That may well have been a consequence of the prepayment of interest, but it was not suggested by the taxpayer as his reason for doing so, nor as the purpose sought to be achieved; nor in my view does it say anything about the character of the payment. The taxpayer never tried to conceal that his object in paying five years' interest in one year was to obtain the tax advantages thought to flow from that course. To the extent then that purpose is relevant to throw light upon the character of a payment, no purpose can be discovered here other than that of gaining a tax advantage.

It is, I think, necessary to distinguish between the prepayment of interest in the present case and the character that payment would have if spread over a number of years as interest on money borrowed for the purpose of purchasing a property as a source of income. The character of one does not necessarily determine that of the other. ...

. tell a taxpayer how much he should spend on outgoings in the course of gaining an assessable income or whether he should incur those outgoings in one or more than one tax years, a question may still arise whether, in respect of a particular year, an outgoing incurred by a taxpayer can truly be said to have heen incurred in gaining or producing the assessable income."

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Sou 0 , . 13. Toohey J went on to mention the reference by Latham CJ, in W

Nevill and Company Limited v Federal Commissioner of

Taxation (1937) 56 CLR 290 at p.301, to "the object which

the person making the expenditure has in view" but he

commented that he did not understand the Chief Justice to have been saying that the matter is to be resolved on the

basis of the taxpayer's own statement without regard to the

surrounding circumstances. His Honour then concluded at

p.182 with a summary of the position which may be applied directly to the facts of this case:

"In the present case, however, the taxpayer's own statement and the surrounding

circumstances point unequivocally to a payment made for the purpose of securing a tax advantage and no other.

At the time of the prepayment of interest the "taxpayer had not acquired any property from which he hoped to derive income. There was no rélevant income-earning undertaking or business in existence. That is not necessarily fatal to an argument that an outgoing incurred is 'incidental and relevant' to gaining or producing the assessable income. But what is under consideration here is a prepayment of interest made at a time when no relevant income-producing activity had begun

and not made for any purpose connected with such an activity. The money was not outlaid

to gain income; it was not incidental or relevant to the gaining of income."

Finally, I observe that it was submitted that any . collateral purpose of obtaining for Edisearb the freehold of

the units must be disregarded. South Australian Battery

Makers was cited in support of that submission. But that

was an entirely different situation. The whole point of the

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majority view in that case was that the payments in question

did not enable the taxpayer, or any subsidiary of the taxpayer, to acquire the freehold estate. The majority held that it was not enough that another member of the same group of companies might acquire the freehold. Significantly, for present purposes, Gibbs ACJ distinguished at p.655 the case of an advantage flowing to a subsidiary of the taxpayer:

"Of course it cannot be denied that the circumstances may be such that one company may benefit from the fact that its subsidiary receives an advantage; the control which the parent company exerts over its subsidiary may ensure that the benefit flows on from the latter to the former."

Mr Creer's control of Edisearb has the potential to

ensure that the benefit flowing to that company of acquisition of the freehold flows on to hin.

by Fisher J, it should be held that the relevant expenditures do not fall within s.51(1) of the Income Tax

I certify that this and the thirteen (13) preceding pages are a true copy of

tee Lene treaties entice cheb irra rem Sn tear ml we te The A dete walle matin

' ) " NEW SOUTH WALES DISTRICT REGISTRY ) No. 71 of 1985

THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA

CORAM: FISHER, WILCOX & JACKSON JJ. DATE: 5 MAY 1986 PLACE: SYDNEY

JACKSON J: I agree with the Reasons for Judgment of Fisher J.

Reasons for Judgment herein of his Honour Mr Justice Jackson.

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• mo i" . .
  "4 ; ' ae he ' : a . 15. > ' ° Counsel for the Appellant: Mr RA Conti QC with Mr GW Fisher Solicitors for the appellant: The Australian Government Solicitor . Counsel for the respondent: Mr DG Hill QC with

Mr DH Bloom Solicitors for the respondent: Messrs Allen Allen & Hemsley