A42-03 CATCHWORDS Taxation —- Income Tax - Exchange loss by trading company Whether deductible. Income Tax Assessment Act 1936, sub-s.51(1) Franki, Fisher and Lockhart JJ. 23 September 1983 Sydney nest en eet ne Roepe ore me ete le eer wm na, ane PPM PUI RIE IT lo ee ELE Tt ea ae IN THE FEDERAL COURT OF AUSTRALIA } NEW SOUTH WALES DISTRICT REGISTRY ) No. G.174 of 1982 GENERAL DIVISION ) ON APPEAL FROM THE SUPREME COURT OF NEW SOUTH WALES ADMINISTRATIVE LAW DIVISION THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA Appellant HUNTER DOUGLAS LIMITED Respondent ORDER JUDGES MAKING ORDER: Franki, Fisher and Lockhart JJ. DATE OF ORDER: 23 September 1983 WHERE MADE: Sydney THE COURT ORDERS THAT: 1. The appeal is upheld. 2. The orders of the Supreme Court of New South Wales in Matters No. 668 and 669 of 1981 are set aside. a yess "a The assessments to income tax of Hunter Douglas Limited for the years ended 30 June 1977 and 30 June 1978 are confirmed. Hunter Douglas Limited pay the costs of the Commissioner of Taxation of the Commonwealth of Australia of this appeal and of the proceedings in the Supreme Court of New South Wales. need ey et NL NL NI RE CON RN ONT Ramp Rep, et poet ee IN THE PenePAL couURT OF AUSTRALTA } G.174 of 1982 FROM THE SUPREME ret ol CeunT or NEW SOUTH §aLes ADMINISTRATIVE LAN DIVISION THE COMMONWEALTH O SSIONER OF TAXATION 07 je AUSTRALIA Appellant HUNTS? DOUCLAS LIMITED NEN SOUTH HALES DISTRICT REGISTFY } No. GEVERAL DIVISTSN } ON APPEAL THE COMMI , OPAM; Franti, Fisher ard Lockharc Jd. REASONS FOR JUDGMENT ct unity of +e Ihave had the ovpor of Fisher J. tsho sets out the Facts very have veacned a different conclusion, f do ey uw appeal was out upcr the bas mithing situation" and ne attremet tas su Ba) esvondent that it was an "all or da hy the Commissioner te Pere wrsne ae rouwrtiees ose, PRS TT TE ETA — ao ee mere eee BORAT HOD, (pene eg mene pene ore mest cases 39 that zn most cases the moneys were in the firse anztzunee used to discharge an overdraft liability. The effect of oO 3) N ct1] ct Le) eh this was chat the overdraft limzz was scstorced ts th: 2 sorroved money and that that borrowed woney was then alnost tn ail cases used for ordinary day to day ezpenses such as. far example, wages, travel allowances, petty cash, telephone exnenses and advertisinry. The Comnisszroner d2d not olace any celiance upor the fact that in the first instance thea moneys borrowed were ur arcs. In ry opinion the Ltda. wv. Commissioner of Pot support an argument rane mees used for this vurpose. in my majecity judgment in Ayca at "Borrowing sothes than for on-lendine or fer the revaymert of funds borrovwes for on-lending, that 1s, borrowing undertaken for caoital rather than revenue scucposes, as in "AGA, 15 an excection to the general rule." It is clear that the viev was taken that the repaywent of funds boresoied Tor on-lending fell into the same category as borrowing Tn! TPR Teton ere med ne cprsreee ayer ream meee ie 1M . RET STL WIFE poe oe ay ee, Ts een" Pyare) WATS: The OES FE Ue ek az meerperen—s ¢- a mth Om ee BEMIS, KOI 0 ween I proceed uron the basis + the trial Judge found and che concede that the vorceceads of all the satisfaction of outgoings of clearly revenue nature. It is approoriate to con by Ww ae He i pb upon which the Judges of t in Avco. That case was con deductibility under s.51(1) of under s.55 of the Act of certain 3] was agreed between the parties tna either of a capital or a revenue had arisen out of the repayment ch Su < Tore all practzcal purposes Commissioners was prevared to che dravdorns wece devoted to the taxvayer's business of a assessability and gains. it hese losses and gains shouid yacter and thar both should be natuce. The losses and gains oF money borrowed in America. The taxpayer was a finance company. a i iz] i tHe oa im) D Qan Hr un Q i) cq Q The basis of the judement in my opinion is clearly that the taxpayer azolied the proceeds of its borrow.ng 4 where it was "The taxpayer endeavoured in relation to its borrowings to raise Funds in sufficient quantities ta enable i to carry on its growing business of lerding small amounts to consumers and to meet raturing repaymencs of its borrovings." mete woo we are Nee ee nae ae ae VS Sawa COLD EERE MITES ee pales Sharon erent. aS nr The majority judgment at p.675, refeccing to Tip Top s a A ead Tarlors v. Minister of National Revenue (1975) 11 D.L.R. (2a) 289 ana Montreal Coke and Manufacturing Corrany v. Minister of National Revenue £19443 A.C. 126, contanued: ai jud as well as the an nent Top Tarlors, and ec £ ord Ma in Montreal Coke recognize, vigntly in our opinion, that the borrowing of money and the repayment of loans its business stand ina different situation from borrowings by a company not undertaken in the ordinary course of 1ts income earning business." Judge in that case that the borrowings vere "an integral part of the ordinary operation of the taxpayer's business se as to reoresent a matter of revenue rather than capital". Prequenc reference vas wade to the transactions pbeing entered into by the taxpayer "in the ordinazy course of its business" and forming "an integeal part of that business" 19.677) or words to 12 -.. we think that the better view 1s that the borrowings should be regarded as an integral part of the carrying on of the taxvayer's jel ae o uv [o) anconme-carning bus Reference was made to a distinction which could be drawn between moneys borrowed by a finance company in the ordinasy ccurse of its business {p.677) and monies borrowed for some FT ET aE Er REE er RD a SET oer menette ten ene A ere TT tT et seat nt. ee SoS a ETO rare) AG SOT oie? TALE ==rt re 5. sevecial purpose which excludes the use of the money ordinary course of the fTinanzte coruany's business, tes inted out an the judgment that this was what hapvoened Commercial and General Accevtance Ltd. v. Federai Commissioner Taxation (CAGA) 1977 137 C.L.R. 373. In that case the moneys were borrowed upon terms which prevented 65% of the borroved being used in the ordinary course o business of as Gibbs C.J. said in Avco at 7f.671: The majorzcty judemenc in Aveo poznted out the sim money in the case of a finance comeany and stock in case of a trading company. In my opinion the j monevs £ the conpary's ining of the loan was not part of by which the company overated to Lf. milarity between a famjw wD nt . wv ud oO 14. oes the net tucn on this ooint but upon che point that the cest of borrowing was acost incurzed in the ordinary course of business. At p.677 it tias said: in the cas at rrows money ove it "The true principle is thi fanance company 'vh1 2n the ordinary course s business a for s50me special purpo the added c repayment in foreign currency caused devaluation or depreciation of the Aust dollar is an additional cost cf the bor and, like other costs of the borrowing, allowable deduction under s.51(1)." the taxpayer's eora cseas nd not ost of by the ralian roving is an ce en en ere + we Pena ered eee ee Se een poe gm Tae LTTE TE a i cee ae ot + ee cee iv we mewn - wages, stationery, telephone, and outgoings of a similar day to day basis. The majority judgment also dealt with the question of aintecest and pointed out that, even where borrowing is of a capital nature, the interest on the money borrowed is deductible. The following passage appears in the majority judgment at p.675: "The money lent, + judged from the viewpoint of both borrorer and lender, is in general capital; on the other hand, the interest payable an the money lent 1s generally income in the hands of the lender anda revenue outgoing in the hands of the borrower." Reference was mada to the judgment oF Dixon J. (as he then was) in Texas Co. (Australasia) Ltd. v. Federal Commissioner of Taxation (1940) 63 C.L.R. 382. In that case the taxpayer, an oil company, purchased its vetroleum products from its parent companies in the United States, and since its share capital was insufficient to meet its requirements for working capital, was allowed to delay payments in respect of the purchases in order to provide it with funds large enough for its needs. Before sayment was made the rate of exchange moved against Australia. It was held that the fact that the increase in expenditure arose froma delay in payment designed to create a fund for working casital did not mean that the exchange loss was of a capital nature. The following passage from Dixon J's judgment was cited AA NAC ee eR He o— in the majority judgment at p.467?: chat integral business "Some kinds of recurrent exnenditure made to secure capital or working capital are clearly deductible. Under che Australian system interest on woney borrowed for the vurpose forms a deduction. So does the rent of voremises and the hire Fh re] B iyel ' B passage from the same judgnent or Dizon J. was also the effect that exchange losses or gains were ordinarily as detachable from the fund borrowed. Gibbs C.7. in his 1 Avoca at 9.671 pointed out that: ",.. 20 appears cight, in a case such as the present, to regard exchange gains and losses resulting from the revayment of bocrowed money as detachable from the borrowed fund, and as not necessarily sharing it haractec", Gibbs C.d. came to the same view; in Avco as the majority xy g@ealing with CAGR and Texas, came to the conclusion FECHANGS losses and gals were on revenue account. Tre exchange losses in the case before us w La) ch i) su vart of the carrying on of the taxpayers income-earning and in my opinion ought to have been allowed as deductions under s.51(1). Te 2 wu appropriate to rere: te one or two ather cases. [ already dealt wath the facts in Texas where a deiay in A re to ater reer ana eeneen tetli emf pee et ete Nee SA LEG Oe a ME Er OT wet payment was held not to affect the position. This peincipls was followed in Thiess Tovota Pty. Ltd. t= v. Commisszoner oa zazation £19783 1 N.S.A.L.R. 723 and extended te cover a case vhere a comoany imvorcing moter vehicles eaid for those vehicles with moneys advanced by a bank in the forn of letters of credit in favour of the exporter in Japan, and the company had ninety cays to reimburse the bank. It was held by purchase of trading stocx and that the exchange gain was on revenue account and assessable income. This case was cited wrt! he reached was more easily reached because in his view the losses in questicn should, in current economic circumstances, be perceived to be un essence in the nature of interest. It 1s of corcss clear that interest 15 generally a revenue outgoing. (See for example Avco at ».675). Whilst it is not necessary zo seach this conclusion to reject the appeal it is an avproach (D t raihich avpears to me to hav a loc te commend it although not the basis upon which Avco was decided. It is of coucse necessary to test the question of rmether the outgeing is of a capital nature according to the Principles discussed in Sun Newsvacers Lee. v. Fedezal TRIE SUNN Tye Se nae en Sav * 3S CADIS RET ISS AEE pre vevmaey Commissioners of Yaryation (1938) 61 C. tests developed in that case were suamined by th BP. Australia Les. v. Commissioner of Taxation 355, particularly at 90.394. In that case the Council decided trat a lump sum, related to the amount of erica ef not less than three years, paid to a pe oa r gy ie) el ™ tr eu ra) t+. i] wo s !o x fot a) fis tie himself to thea sale of approved brands of petrol only for that perioc was allowable under s.51(1). The average period was something under five years and the predominant number of agreements tas for a Five year If at be necessary that exchange losse ft 7 w lowfe) Fh » recurrent nature then I am satisfied that the losses in this case ar? or a sufticiently recurrent natures to satisiy that requicement. In Avce certain cr the amounts Derrowed were far a Period varying from one to five years and no ma; wd per of the Court anpears to have thougnt that this was sufficient to put those borrowings 2n a category which oworevented exchange losses on repayment being allowable. I would dismiss the apoeaal with costs. I certify that this and the eq ce@> i preceding coses are a true copy of the ' Peasons for Judgment herein of his Honour Mr. Justice Frauk, Cty oe Associate Dated: Seplemlaer 19g3, | Pit wae 68 foe eaten te ee ray I UT IE GENT VE LT wet ae on re rere LS. nt IN THE FEDERAL COURT OF AUSTRALIA ) ) NEW SOUTH WALES DISTRICT REGISTRY ) No. G.174 of 1982 ) GENERAL DIVISION ) - ON APPEAL FROM THE SUPREME COURT OF NEW SOUTH WALES BETWEEN: THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA Appellant - and - HUNTER DOUGLAS LIMITED Respondent CORAM: Franki, Fisher and Lockhart J.J. 23 September 1983 REASONS FOR JUDGMENT FISHER J.: These are two appeals by the Commissioner of Taxation ("the Commissioner") against the allowance by the Supreme Court of New South Wales of appeals by Hunter Douglas Limited ("the taxpayer") referable to income tax assessed for the years of income ended 30 June 1977 and 30 June 1978. The taxpayer had objected to the disallowance by the Commissioner in each of these years of deductions claimed in respect of losses suffered by it on currency exchange. The appeals, both before the Supreme Court and this Court,were by consent heard together. The facts are not 1n dispute and what follows is taken primarily from the reasons of the trial judge. The taxpayer is engaged in Australia in the business of development, manufacture and marketing of window covering, home improvement, casual living, architectural and building products. It has as its majority shareholder a company resident in the Netherlands. In 1971 the taxpayer became aware, its Group Accountant said, that 1t would require additional finance' to provide funds for the day to day running of its business because it was proposing an expansion of its activities, which expansion entailed increased turnover. To support the increased turnover the taxpayer felt it necessary to increase its working capital, in order to avoid what was termed a cash flow or laguidaity problem during the period of its ' expansion. Although it had credit facilities with a number of banks in Australia the taxpayer was not satisfied that these facilities would provide sufficient funds for its expansion. This expansion and zuncreasing turnover did in fact occur from 1971 up to the years in question. The taxpayer therefore made approaches seeking additional fanance during 1971 from two overseas banks. On 1 February 1972 Banque Europeene De Credit a Moyen Terne S.A. ef Brussels ("B.E.C.") and Amsterdam - Rotterdam Bank N.V. of Amsterdam ("the Dutch Bank") entered into an agreement with the taxpayer to grant a loan of U.S. $2,000,000. The agreement recited that the loan was to be for a period of 7 years, and that the borrower accepted the loan for the purpose of financing investments in Australia. The taxpayer was entitled during the first 3 years of the loan to draw funds in multiples of U.S. $100,000 with a minimum amount of U.S. $200,000 and to repay amounts so drawn on 5 days notice. During this period a commitment fee of half of one percent per annum was payable on any part of the facility not drawn on 1 February 1972. This commitment fee was not payable subsequent to 1 February 1975 on which date any amount not drawn ceased to be available. As mentioned, the loan was for a period of 7 years, later extended to 10 years, and the amount drawn on 1 February 1975 was due for repayment no later than l May 1979. Interest was payable six monthly calculated "on the basis of the offered quotation to first class banks for deposits in the appropriate currency for a period in accordance with the previous paragraph plus one percent per annum", that is at an interest rate one percent higher than banks were from time to time lending to each other. The taxpayer was entitled to switch the currency in which the loan was drawn, and it took advantage of this option. Repayment of the loan was to be made in the currency in which it was borrowed. The remaining provisions have little if any relevance to the matters before us, except to note that B.E,C. was the bank with which the taxpayer dealt and that the participation of the Dutch Bank ean be disregarded for all practical purposes in respect of this loan. The taxpayer drew on this loan in Swiss francs on 9 July and 9 November 1973 and in United States dollars on 19 July, 1 August and 19 August 1974. The first of these drawings was converted to Dutch guilders on 10 January 1977 and the drawing on 9 November 1973 was partly converted to Dutch guilders on 26 January 1977. The amounts drawn and the dates of repayment and the amounts repaid under B.E.C. loan were set out in a schedule before the trial judge. It is convenient to reproduce this schedule although only a portion thereof has direct relevance to these proceedings. "Banque Europeene De Credit Drawn Repaid Drawn Repaid Repaid Drawn Repaid Drawn Repaid Drawn Repaid 9. 10. ll. 7.73 1.77 7.78 9.11.73 25. 26. 27. 10. 20. 1. 30. 19. 28. 1.77 1.77 6.78 7.74 7.78 8.74 8.78 8.74 7.78 Swiss Francs Australian Dollars Converted to Dutch Guilders 1,149,080 Exchange loss Swiss Francs Australian Dollars Swiss Francs 388,869 Exchange loss Converted balance to Dutch Guilders 1,115,408.85 Exchange loss U.S. Dollars Australian Dollars Exchange loss U.S. Dollars Australian Dollars Exchange loss U.S. Dollars Austrai1an Dollars Exchange loss 456,255 523,789 7150.000 288,220 168,035 7,500,000 321,130 143,056 59,804 439,310 201,432 300,000 201,342 262,192 60,850 200,000 134,228 174,049 39,821 600,000 402,766 121,023 " The transactions which identify the exchange lesses under this loan which the taxpayer claims to deduct are as follows, with the amounts claimed as deductions underlined: "Drawn Repaid 9.11.73 25.1.77 Swiss Francs Australian Dollars equivalent Swiss Francs Australian dollars equivalent Excnange loss $ $ 1,500,000 321,130 388,869 143,056 $59,804 26.1.77 Balance converted to Dutch Guilders 1,115,408 Repaid 27.6.78 Australian dollars $ 439,310 . Exchange loss $201,432°" It is apparent that throughout the term of the loan the Australia dollar depreciated against the currencies in which the loans were denominated and that upon repayments being made a larger number of Australian dollars was required to be provided than was originally borrowed. In the middle of 1973 the taxpayer became aware, as related by the Group Accountant and as found by the trial judge, that additional credit facilities were required for the purpose of providing further "working capital". These facilities were not available in Australia. In July 1974 the Dutch company which held the majority of the shares in the taxpayer entered into a loan agreement dated 3 July 1974 with Orion Term Bank Limited of the United Kingdom ("Orion"). This agreement provided that the credit facility of U.S. $6,000,000 thereunder could in certain circumstances be drawn by a sub- sidiary of the borrower either in United States dollars or any other freely convertible Euro currency. The borrower was entitled from time to time to draw against the loan in multiples of U.S. $100,000 but with a minimum amount of U.S. $300,000 and repayment was to be made in the currency in which the particular borrowing was at the time of borrowing then denominated. In this instance the rate of interest payable by the borrower was three quarters of one percent over the interbank rate quoted for dollars of the particular currency in which the borrowing was denominated. All transactions under this loan were 1n United States dollars which during the period of the loan appreciated as against the Australian dollar. The consequence again was that on each repayment a loss was suffered by the taxpayer which had, as an "additional borrower" under the loan agreement, drawn the funds. The transactions between the taxpayer and Orion were also conveniently set out in a schedule as hereunder. "Orion Bank Limited, London Drawn 4.12.74 U.S. Dollars 1,000,000 Australian Dollars 759,301 Repaid 30.8.78 869,565 Exchange loss 110,264 Drawn 13.12.74 U.S. Dollars 500,000 Australian Dollars 378,530 Repaid 14.12.77 442,752 Exchange loss 64,222 Drawn 22.8.75 U.S. Dollars 1,000,000 Australian Dollars 779,606 Repaid 27.9.78 867,679 Exchange loss 88,073 " For the purpose of these appeals we are concered with the draw- ung under the Orion loan of U.S. $500,000 made on 13 December 1974 and repaid on 14 December 1977 which produced an exchange loss of $64,222. The taxpayer claimed to deduct this amount of $64,222 from 1ts assessable 1uncome for the year of income ending 30 June 1978 in addition to $201,432 being the exchange loss incurred in repaying a B.E.C. loan on 27 June 1978. For the year ended 30 June 1977 an exchange loss under a B.E.C. loan of $59,084 was claimed as deductible and in each instance the Commissioner by assessment or amended assessment disallowed the claim. Upon disallowance by the Commissioner of its objections, the taxpayer required the Commissioner to treat them as appeals and forward them to the Supreme Court of New South Wales. The essence of the case for the taxpayer was that by reason of the use to which the borrowed moneys were from time to time put by the taxpayer, the exchange losses were of a revenue nature and were- not losses of capital. This use and the purpose of the borrowings were described in the following terms by the Group Accountant Mr. Barlow in his affidavit. "36. All drawdowns of the B.E.C. Loan and the Orion Loan referred to above were made on the basis of the budget projections prepared by the Company during the period in which the drawdowns were made as part of its usual financia planning. At the end of each month these six-monthly projections were prepared using the annual Budget adjusted to current and projected trends showing the anticipated cash position of the Company for a period of six months ahead. Drawdowns on the credit facilities provided by B.E.C. and Orion were made where these projections showed a cash deficiency and other local fanance was not available 37. All drawdowns of the B.E.C. Loan and the Orion Loan were used by the Company for the purpose of providing funds for the day-to-day running expenses of the Company's business in respect of the itemised expenses in the Schedules annexed hereto. Some of these payments may have been non-deductible to the Company but the great balance of payments consisted of the payment of amounts which were deductible to the Company in determining its assessable income." Each drawing after conversion into Australian dollars was paid into one or other of the current accounts which the taxpayer held with its Australian bankers. The taxpayer gave details in the schedule referred to in paragrar 37 above of all cheques drawn on and payments made from the relevant bank account during the month immediately prior to crediting the drawing and the month subsequent thereto; The trial judge found and the Commissioner was prepared to concede for the purpose of these appeais that the proceeds of all the drawings were devoted to the satisfaction of outgoings of the taxpayer's business of a clearly revenue nature. He further found that the monies were utilised as working capital in the course of the taxpayer's business. It was on the basis of these findings of fact which were not disputed before us that the trial judge came to his conclusion that the exchange losses incurred on repayment of the loans were on revenue account and therefore allowable deductions to the taxpayer. The trial judge was of opinion that this conclusion was the necessary consequence of his finding that the monies were utilised as working capital in the taxpayer's business. He said: "It (the working capital) was utilised in the activities by which the taxpayer earned its income. Applying as best as I can the principles I have mentioned to the purpose and nature of the transaction, I am of the view that the borrowings in question were just as clearly required for application in the taxpayer's business of satisfying day- to-day outgoings as was the utilisation of borrowed funds in Avco. True it is that the moneys themselves were not paid out ' as loans, but they were utilised in enabling the profits of the taxpayer to be earned." It 1s clear that the trial judge concluded that the exchange losses were @i revenue account because of the use which the taxpayer made from time to time of drawings of the borrowed funds. He saw them as being applied directly in the payment of the day to day business expenses of the taxpayer and therefore held that the exchange loss which occurred when the particular drawing was repaid was deductible. He did not regard the drawings as a means of financing the business of the taxpayer but rather that they were utilised in enabling the profits of the taxpayer to he earned. He thus saw them as having the same characteristics as drawings by a finance company as in the Avco case (Ayco Financial Services Limited v Commissioner of Taxation (1982) 56 A.L.J.R. 668). I however regard the purpose of the borrowings as being of more assistance in establishing the character of the loan transactions and the exchange losses incurred on repayments thereunder and in determining whether they are on capital or revenue account. The use which a borrower in fact makes from time to time of borrowed funds and the purposes for which it applies them is not necessarily conclusive of the purpose or character of the borrowing. This character will depend upon the purpose for which the borrowing is made e.g. to strengthen the capital structure of the company and also the use which the company makes generally of borrowed funds in its profit earning activities. The crucial question will frequently be whether the company uses the borrowed funds to finance its profit earning activities or as an integral part of such activities. It is my opinion that two matters support the finding that the borrowings here were on capital account and that the exchange losses were not detachable and thus on revenue account. The purpose of the borrowings was to finance the expansion of the taxpayer's business and to provide the additional working capital which this expansion required. Thus the borrowing transactions themselves were not on revenue account. Furthermore the funds borrowed were not used in or as an integral part of the profit making activities of the taxpayer i.e. as part of the process by which it operated to obtain its regular returns but in the financing of such activities. In particular they were undertaken with a view to expanding such activities. 10. These borrowings may in fact have been used to pay the day to day expenses, or in reimbursing a bank account from which such expenses were paid. However in my opinion this does not determine conclusively the part that borrowed funds played in the profit making activities of the taxpayer or the true character of the loan transactions. The words of Mason J. in the CAGA case (Commercial and General Acceptance Ltd. v Federal Commissioner of Taxation (1976) 137 C.L.R. 373) are in point. He said at page 384: "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." The evidence of the Group Accountant in cross-examination is of relevance. I refer in particular to the following questions and answers: "Q. Would it be correct to say that during the period from 1971 through to 1975, in fact the company's business did expand? A. To the best of my recollection, yes sir, Q. And would it be correct to say that in making those forecasts in 1971, the company was taking account of the forecast expansion? A. Forecast expansion, to the extent of increased turnover. Q. And as part of that increased turnover, it was felt necessary to increase the working capital? A. Yes sir. Q. And 1t was recognised that unless that could be done, there might be cash flow problems? A. Yes. Q. Or liquidity problems? A. Yes. Q. Now again, you say that it became obvious, based on the company's budgets and cash forecasts, that the company would ll. require additional credit facilities for the purpose of providing working capital? A. Yes. Q. And again is 1t right to say that that forecast was based on a continued anticipated expansion of the company's business? A. It would have been. Q. And on the basis of that, I think in July 1974 the arrangement was made whereunder the Orion finance could be used by the company? A. That is correct. Q. So again would it be right to say that these forecasts were looking at working capital on a fairly long-term basis? A. Yes." The trial judge treated the use which the taxpayer made of the borrowed funds as equivalent to the use which the finance company made of such funds in the Avco case. It 1s my opinion that the use which the taxpayer on the one hand and Avco on the other made of borrowed funds was very different and does not warrant the same conclusion in each instance. Counsel for the Commissioner distinguished, in my opinion correctly, the Avco case on the ground that the High Court there had under consideration the activities of a finance company which used its borrowings directly in the course of its profit earning activities as though they were trading stock. In the present matter the borrowings and their repayment, counsel contended, were not on revenue account because they were not part of the profit making process. Reliance was placed on the classic statement of the difference between outgoings on capital and revenue account of Dixon J. (as he then was) in Sun Newspapers Limited v Federal 12. Commissioner of Taxation (1938) 61 C.L.R. 337 at page 359 where he contrasted the strengthening of "the business entity, structure or organization set up or established for the earning of profit" with the process by which the organisation operated to obtain regular returns. In my opinion the High Court in Avco was at pains to dintinguish the position of a finance company from a trading or manufacturing company and to reiterate that in the latter instance unless the repayment was of itself on revenue account and thus deductible, the exchange loss was not deductible. In this case the taxpayer dad not argue that the borrowings themselves were on revenue account 1.e. the receipt being assessable income and the repayment an allowable deduction. Rather it was said that the exchange loss was detachable from the capital sum repaid and was on revenue account. The words of Mason J. in the CAGA case at page 383, 1f adapted to apply to an exchange loss, indicate the essential features of an exchange gain or loss. He said: "The exchange gain was 1n 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." In this matter the exchange loss was an increase in the amount of Australian currency required to repay the horrowing. It was a windfall disadvantage stemming from an increase in the liability to repay. 13. The usual situation is that the treatment of an exchange gain or loss for income tax purposes depends upon the character of the payment i.e. whether it is on capital or revenue account and thus whether or not it is an allowable deduction for such purposes. As Gibbs C.J. said in the Avco case at page 671, "It does seem true to say, at least in general, that if an amount payable by a taxpayer is allowable as a deduction, then any increase or decrease in that amount caused by a variation in the rate of exchange is to be taken into account as an allowable deduction or as assessable income." This proposition has particular application when trading stock is acquired and also doubtless services. However on repayment of a loan the general position 1s that the exchange gain or loss is on capital account. But this is not always the case (see the Avco case per Gibbs C.J. at page 671 and Mason, Aickin and Wilson J.J. at page 675). As the Chief Justice said on that page it will depend upon "The direct application of the tests formulated in Sun Newspapers Limited and Associated Newspapers Ltd. v Federal Commissioner of Taxation". It was the application of these tests which led the High Court to the conclusion in the CAGA case that the foreign exchange gain there was not on revenue account and not assessable and in the Avco case that the gains or losses were on revenue account and thus assessable or deductible, as the case may be. Counsel for the Commissioner urged on appeal that these tests be applied in this matter. It was necessary, he said, for the Court to determine whether the borrowing of money by the taxpayer was part of its day to day profit earning process. If it was not, this would determine the purpose of the borrowing and the fact that the exchange losses were not on revenue account, 14. The fact that the taxpayer was not a finance company borrowing for the purpose of lending to its customers nor were its borrowings linked with the purchase of trading stock means that it can not bring itself within two apparent exceptions to the general principle that exchange losses on repayment of loans are on capital account. Thus its situation can be distinguished from cases in which trading stock is bought in foreign currency which appreciates before payment is made. These cases are referred to in the CAGA case by Mason J, at page 385 and Gibbs J. in the Avco case at page 670 and need not be further discussed, Two additional cases are Thiess Toyota Pty. Ltd. vy Commissioner of Taxation [1978] 1 N.S.W.L.R. 723 and Federal Commissioner of Taxation v Cadbury-Fry-Pascall (Australia) Ltd.1979 A.T.c. 4,346. In respect to each of these cases it can be said, in the words of Jenkinson J. in the Cadbury-Fry~Pascall case at page 4,351, that the repayment was "in substance part of the regular outlay of the respondent (taxpayer) for raw materials regularly acquired by it". In that case, from which the trial judge said he gained much assistance, the repayments in reduction of a loan were essentially "part of the regular outlay" of the taxpayer for raw materials regularly required md thus made on revenue account. It is significant that the court's attention was there directed to the true nature of the repayment and this accords with the approach of Gibbs C.J, in the Avco case. Gibbs C.J. at page 671 of Avco referred with approval to the decision of Meares J. in the Thiess Toyota case when 15. illustrating the difficulty in accepting that exchange losses or gains on borrowings are always on capital account. He said: "The difficulty of adhering to the view that exchange gains and losses resulting from the repayment of borrowed money must always be of a capital nature is made manifest by comparing the case in which a taxpayer who regularly buys trading stock has ninety days after each delivery in which to pay the supplier, with the case in which the taxpayer arranges with his bank to pay the supplier each time a delivery is made and has himself ninety days in which to pay the bank. The authorities cited show that a gain or loss resulting from a change in the rate of ' exchange during the ninety days would be on revenue account in the former case. It would be anomalous if the gain or loss was on capital account in the latter case. In Thiess Toyota Pty. Ltd. v Commissioner of Taxation [1978] 1 N.S..W.L.R. 723, where a company which sold motor vehicles paid for the imported vehicles with moneys advanced by a bank in the form of letters of credit in favour of the . exporter 1n Japan, and the company had ninety days to reimburse the bank, it was held by Meares J. that the arrangements with the bank were all part of a transaction relating directly to, and having the purpose of, the purchase of trading stock and the exchange gain was on revenue account and assessable income." The fact that a finance company may in respect of its borrowings be in a different position from a manufacturing or trading company 1s made very clear by the High Court in the CAGA case and \ the Avco case. In the CAGA case because the principal purpose of the borrowings was to strengthen the taxpayer's business structure and was not part of the process by which it operated to obtain regular returns the High Court held that the borrowings were on capital account and the exchange gain was assessable. By way of contrast in the Avco case the borrowings in question were held to have been undertaken in the ordinary course of the taxpayer's income-earning business and the resultant exchange losses or gains were deductible or assessable. [In that case the High Court went to lengths to indicate the special position of a finance company borrowing as part - of its day to day operations for the purpose of re-lending, 16. Gibbs C.J. referred to the circumstances of a finance company on page 672 when he said: "Where a taxpayer carries on the business of borrowing and lending money, the moreys used for that purpose are analagous to trading stock - the taxpayer in effect deals in the money. Exchange gains and losses, regularly and frequently made and incurred, in the course of making repayments of borrowed money which is used by a taxpayer in making loans in the course of its finance business are outgoings made in the day to day conduct of the business and for the purpose of carrying on the business as a going concern... The exchange losses were in my opinion losses on revenue account, and of course the gains have the same character." Mason, Aickin and Wilson J.J. acknowledged the different situation of a finance company on two occasions in their reasons for judgment. On page 675 they said: "The majority judgments, as well as the dissenting judgment, in Tip Top Tailors, and the speech of Lord Macmillan in Montreal Coke recognize, rightly in our opinion, that the borrowing of money and the repayment of loans by a finance company in the ordinary course of its business stand in a different situation from borrowings by a company not undertaken in the ordinary course of its income-earning business... There 1s therefore an important and material difference between borrowing by a finance company in the ordinary course of its business and borrowing by a manufacturing or trading company." On page 676 they said: "With respect to those who think otherwise, the proposition that exchange variations affecting the repayment of loans in foreign currencies are always an affair of capital in the case of a finance company is supported neither by principle nor by authority... Like the borrowing transactions with which they are associated, the foreign exchange transactions are entered into by the taxpayer in the ordinary course of its business and form an integral part of that business. The gains and losses made and sustained in these transactions are therefore made in the ordinary course of carrying on that business, the more so because the gains and losses are an ordinary incident of transactions of this kind." 17. The positiom is different where the company 1s not a finance company but a trading or manufacturing company which incurs exchange losses or gains otherwise than through the purchase of trading stock. Here the losses or gains will in the ordinary course be on capital account. For them to be on revenue account it is necessary for the taxpayer to establish that the additional expenditure to meet exchange losses was expenditure incurred in the process of producing its income, and in the words of Mason, Aickin and Wilson J.J. in Avco set out above, as an integral part of that process. It is not sufficient, with all respect to the learned trial judge, to rely upon the finding that in fact the borrowed monies were used to satisfy day to day outgoings. The borrowings in such a case are prima facie an addition to the capital employed in the business. This 1s made clear by the joint judgment in Avco at page 675 when citing the passage from the judgment of Latham C.J. in the Texas case at page 428 where he said that "... 'no exchange... should be allowed' in respect of 'remittances sent by the Company to America in repayment of moneys lent''..." Mason, Aickin and Wilson J.J. went on to say "Latham C.J.'s observation, ... was not directed to the situation of a finance company. It reflects the view that a loan and the repayment of a loan are generally an affair of capital. And so they are." The joint judgment then cited from the judgment of Menzies J. in Caltex at p.251: "Borrowing money to carry on business or to pay liabilities iuncurred in carrying on business is prima facie to increase the capital employed in the business... Even more on point in the present matter are the remarks of Lord Macmillan in 18. Montreal Coke and Manufacturing Company v Minister of National Revenue [1944] A.C. 126 at p.134. "It 2s not the business of either of the appellants to engage in financial operations... Of course, like other business people, they must have capital to enable them to conduct their enterprises, but their financial arrangements are quite distinct from the activities hy which they earn their income." The joint judgment commented: "The consequence was, 1n Montreal Coke, to use the words of Lord Macmillan, that'expenditure incurred in relation to the financing of their businesses is not... expenditure incurred in the earning of their income'." In my opinion this reference to expenditure incurred in relation to the financing of a business indicates the correct conclusion on the facts of this matter. Stated in terms of the above extracts from the joint judgment in Avco the correct finding is that the borrowing of the moneys and the repayment thereof in this matter was expenditure in relation to the financing of the taxpayer's business hy augmenting 1ts working capital. It was money borrowed to pay liabilities incurred in carrying on and expanding the business, as part and parcel of the taxpayer's financial as opposed to its trading activities. The borrowings and their exchange losses were not an integral part of the ordinary operation of the taxpayer's business, They were borrowings arranged for special purposes, on only two occasions, and 1n consequence the obligation to make repayments was not an obligation regularly or frequently incurred, The borrowings resulted in relatively few transactions over the period from 1972 to 1978 and were of an exceptional nature rather than normal day to day occurrences. The evidence discloses 8 repayments in approximately 5 years on the B.E.C. loan and 3 repayments in about 4 years on the Orion loan. In my opinion the borrowings and repayments were not aA 19. on revenue account. In my opinion the two appeals should be allowed and the Commissioner's assessments restored. The respondent taxpayer must pay the Commissioner's costs. BS i : {cerity that this and the " preceding pages ate a true copy of the Reasons 'or . Judgment of Mr Justice Fisher. . an a RR OT TI - ' . whens ' 1 =%, Assduiats a NEW S0uUTH PALES DIsPPs t oO tae] 'ct iy Gi re wn '3 nd re} Ea QQ ja ~ sf do i \-1 'O w tJ G ON_APPEAT, PROM THE SUSREME COURT OF NEW SOUTH HALES BETHEEN: THE COMMISSTONEP THE COMMCNPEALTH a fu no G iP) he ia ly ty Tr ao LOCPHART gf. These appeals raise the Familiar vuestion whethec iw ib | ol oO Ur mn w in ro) c bay bh iu by i) Q fen '¢ » io) ia) By a} aa) i6 @ i & a t+ i] Wy fe) <¢ f63] , Ge 1D fo 133) ju is) i) i] ut By ts, ow fy Due to Fluctuacions wn foreign exchange rates of the Australian dollar the taxwaver sustsined axchange losses during the fiscal years ended 30 Tune 1977 and 36 Tune 1975 unor repayment of 4 owe eyes maces nee ene wen ot aye 6 mee ene eae tee wreT eat ste Tear nt que a he iri) SDSS re St ote tae ao 3 o> i lu to tr ty revenue them. Loss wea cate ment Ac wu 03) nature 3 ir ish} i '3 rs} = a cr wv wr iD o a] wl be a) ra rd Noe tm Fluctuatz 51¢_) under su Sa pes aeteoom mesera an wanch wae me ysoavers Lamit t re et ad Fleer » % fn cat Re repa aed ve Aha adh beens! 3. Outstarding overseas loans arc ocersesninding seductions of ine liabriity to vervay thet. Exchange losses are ain reality an addition to the amount cf Australian currency which a borrower reduires to resay his forsign incebtecress Similarciv an exchange gain is a By< In ry 0) fe br1 ty fuOo rs oO ny e7) iv) -ct by fo ca wa Pe iB) c ie) Su ¢: u iw p by' Me a) 14, {ns c n cr a pr) cr rm Q te a ao r tp excnangs rate will also be an aliovabie deducricn or w ut th D in in tu it fa om o fel iaD The ouzschase of Foreign currency by an Australian taxpayer to a eevay aloan that was obtained fror an overseas lender will bea reverae 1tem if the loan vas 1tself part of the taxpayer's trading In general, loans anc resayrents of leans are considered toa -—va. ee Ta PRT ee eine et er wa mromamannectus: "Rorrowing money to liabilatres incursead facie to increase business..." pec Caltex Linited v. Federal Commissisper of Taxation 1960 106 C.L.P-. hy P Ie iw Q th cy q 3) ct o n ~ N ee I be 07) {4 whie)=) ty oO ct by Hn) nm a 'S tyyu a) hw ie) i ny . gstccsz are examples of expenditu.2 incurred an tne earning of a taxpayec's income and not For the purpose of enhancing the business or organisation of the taxvayer as an iacove earning anciiy. It is vell established that such borrowings are sevenue items. The essence of the business of thy] a) finance company 1s the borcw7ing and lending ot money. Its btorsovings vrovide funds thach it @ moneys borrowed at a higher sate moneys which it boc.ow:. A finance workirg of circulatiag canital which 26 Turns over at a wsrofit. Ft deals in money. The money which it turns over by borrowirg and lending is simziar to trading stock. 4s '7S pointed out by the Majority of the High Court in the Avyco Case fat p. 677) there are n mo-ey stack" of a finance company and the treading stock of a trading comnany: money is nor dealt with in un 'd p ia) B Lu to 3 a commodity and is not incluced in the definition of trading stock for the vurposes o ry the Act (seas. 6). But there is a clase PY, are Nn one pret omen ne Sener we gees ee ee Oa we ont eens eee MORI aa TE ine arn hal MRA MITTS RELA ee ¢ gee Slrilserty becveen the borrowing and lending of ponsy by a finance corsan ana tne buying and selling of trading stock by a trading Weere & trading ccmeany Euys goods which 1t turns aver a) ul i4 tr tradire stock gains or losses incurred are of a revenue nature. moneys payable by a taxpayer are allavable deductions, in general BY) si s a hese amounts caused by Tlucctuations in tn or assessable income o i4 Feyiw S ™ cr 1D su " oD I~ re st D q pe us Ltt) w4 fan a a by ia m fey La p ie ig) cr BH ie)nh 13) A1s m a oO br ra 1s as the cwase nay be. Tf 3 teading company barrows mores l b clrcmstances where 'the horroving is a necassary part of arid has the pursos2 if purchasing trading stack exchange gains or lesses will be =~ m Lb ty 2) wo th Fe S os wo fo) 1D tt Q a 'S At oD att vy [a] " 's cay a mn =} Q '3 w MAa <4 v hy G igi] ia ta ju el fen ct i) pe] re D m vu Not ali borrowings by a finance company ace nade in tne ordinary course of its business. Moneys may be borrowed by ait for n,a c a he Qq on 8) id is) Fh +iT i) ie) ns Del g x a pu3 ) nt u 3 tam ee Ne a Noy eee met eo . oa be ree ree baker Teg teers UAL rotag Da REia" SID ET ear rs ADE HEE. a. bhe _2an because the Austealian aga'tisct the U.S. dollar after the the «ryh Court that the srincipal arm .\GA with more funds to lend cr apyly in the ordinary course of from the public by demonstrating thar ait was free of Ilicuidiry iJ Hew wo he2 fe] Cc) pay en i)an fu ft I a mn ctfe at fe oO Pai is) my fy mh ool3 a) wo cy QOGS wo o i st rt i te fi 1? bor' -7ad moneys from the Unitec States for the general business of the -om7-.7 as 4 fin to Avec ~9 borrow no more than was necessary ta prov.de funds for laendinc 2 ccstorers and for meeting accruing cbligaticns under earlier bo yr. cings. Avrze made Fereion exchance gains anid losses on the revs enb of ths monsys wh2ch ait hac borrowed ir tae United States. Pre .ish Court held that the and inosses vere revenue The tazpaver in the vresent case cslied strongly on the Avco Cas= .9 Support its argument that che excharnze losses it suffered were een re eee rt eee ee ers me Te ee ne ee pen ee ee % ame ee een whe a LITO Cmbete mete a Sat pie end ad "The true prancizle is that in the case of a Finance corrany which borrows money overs2as zn the ordinary course of its BSusiness and net for some speczal purpose. the added cost of cepayment in foreign currency caused by the devaluation arc depreciation of the Australian dollar ais an additional cost of the borrowing and, like other costs of the borrowing, is an allowabl= deduction under =. S1(1))." It was subvitted that the reneys borrowed by the taxoayer in * course of ifs business and used for the payrent of 'vages, telephone, stationery and other outgoings were in the sane posicion. Ths Principal argumant of the tazparer cas that the exchange losses ere cevenus in because cr the use te which the ber-ronved revenis ttems and therefore allovwanle deductions. In coneluding that the axchangs losses were of a rerenue natuca 1b is chart bhe primacy Judcee olaced strong emphasize or The fact that the berrorned moneys were in Fact used by the taxyvayer to pay the running exyenses of its business. fal question whan ascertai "y Vi wy cr ry iyfy or i La fii)Hr ry fore1gn exchanye gains or lcsses made cn reeayment o xf purcvose of the correowing. In my view the uss vo Kenn tee Pn pa ein ae em ee a nem Sr eye yee er oo ae ate rt ge tEnaey of €& y the CAG. "No doubt the effect of the loan was cto ep taxpayer to divert other funds inte the more ar of its finance buliness, bub this vacter of the loan transaction it *%2 purcpa Cas2 Mas pay iy cr Orr crab 1h pos md ew Ao ocr m0 Ot ua hy ta Oo circumstances the princival pursose of che La strengthen 't business entity, or organizayion set up ar established for the profit'; 1t was not va ef the process by organization a ted to cbhtain cegqulas being the di ction dr:iwn by Dixon 3. cers Limared Federal Conmissione. of elaborating he difference betresr me: nd cubgou: vavenue s3cccunt and on apital account. In ty transaction was cesigned o strendthen the fran thin which the tac:oaye ntended to carr on - see Cormrissiones ases ov. Nchanca Co d Cooter tinnes Linz 1964.1 A.C. 948 at p. 22. Advstralia Lirmrted edecal Comszssione: of ian (1965) 122 C.L.R, at ». 392." trsatecd as augmenting che capital enoloyed in . 'orcowicgys by finance companzes to then lend to their ec borroeinys by tracing ccmpanres to finance the purchas ace thus revenues, not casital, iter?. Moneys borrowed company are turned over by making icans ro its custo bocrowed by tad re Ss Ne PORTE GE AD A AT ans AOL ALT Feata ne oe wo tans Borcowlrcs ace of2 Tre distinction is betwe anterprise to be conducted the business is earnec. firancing of a business 15 ie) I a it nes or coveany engaged in the business of tL '3 p. 7 bet par noane ae LT OTA TENT TX ho Tere —Wrtaiae' 2 x = Pa *. os If 2s useful to contrasr with the facts of the oresent case Ps the facts ain Thress Tovata Cty. Liwined v. Cormiss.cner of Taxation (1978) | NVS.HVE.R. 723: fun Too Tayior3y Limited v. Minister of ne TE ANI EE SOE LAO tee erg SEE OA UT PATI FONTS STE PLY rhc be Kalbe tala 0 a at A.T.C. 6346. fn the Caaktury-Pry Pasenil Case Jenkinson 2. the réosayrents 12 seduction cf a lean ware 'in sabstarce @ vegular outlay of the respondent fo. r2r7 materials Q C ly ty a] urQ rh a ry Ww ir ia} s n Qeyve] KB a] a we fe uw i] ia) un iw pay wu al a it to provide a stronger base or entity with which to Carry 274 tt and earn profit. The nature of the borrowings detercm1 nes of the forsign exchange tosses fiseal orooses, As the capital items so wera the latter. would allor the appeals ari restc.s the Canmissionse 'sg The taxcayer must pay the Commissicner's costs of cha Sb ntlece) ko he | I 2340 SEPTONER (FaF AY ee woe oe mee eee ne ete { Aa DULEEOEN DE" RAT TAT abe FD TALS Bk e———— NE NE whe Sa eh |