CATCHWORDS Income Tax - Allowable Deductions - Bad debts - Interest on loans in ordinary course of business credited to suspended unterest account when debts thought doubtful and written-off when they became bad - Interest not brought to account by Bank as assessable income - Change of accountancy procedure - Whether available as source of deduction under sub-s.63(1) or sub-s.51(1) - Whether interest 1s "1n respect of money lent". Income Tax - Assessable income - Lump sum payments made by new members to old members of Bankcard Scheme - Whether payments are income in hands of old members ~ Whether payments are reimbursement of expenses previously claimed as deductions. COMMISSIONER OF TAXATION OF COMMONWEALTH v NATIONAL COMMERCIAL BANKING CORPORATION OF AUSTRALIA LIMITED Nos. G119 of 1983, G288-290 of 1983. Bowen C.J., Fisher and Lockhart J.J. Sydney 15 November 1983 "? IN THE FEDERAL COURT OF AUSTRALIA No. NSW G119 of 1983 No. NSW G288 of 1983 No. NSW G289 of 1983 No. NSW G290 of 1983 NEW SOUTH WALES DISTRICT REGISTRY GENERAL DIVISION BETWEEN : COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA Appellant AND: NATIONAL COMMERCIAL BANKING CORPORATION OF AUSTRALIA LIMITED Respondent ORDER Judges Making Order: Bowen C.J., Fisher and Lockhart J.J. Date of Order: 15 November 1983 Where Made: Sydney THE COURT ORDERS THAT: 1. The appeals be dismissed. 2. The Commissioner of Taxation of the Commonwealth of Australia pay to the National Commercial Banking Corporation of Australia Limited its costs of the appeal. IN THE FEDERAL COURT OF AUSTRALIA ) > No. G119 of 1983 NEW SQUTH WALES DISTRICT REGISTRY >) No. G288 of 1983 ) ) No. G23 af 1983 GENERAL [DT IVISTON No. G290 of 1983 RETWEEN COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA Appellant AND NATIQNAL COMMERCIAL BANKING CORPORATION OF AUSTRALIA LIMITED Respondent CORAM: Bowen C.d., Fisher and Lockhart Jd. 15 November, 1983 REASONS FOR JUUGMENT THE COURT: These are four appeals by the Commissioner of Taxation against the sllowance by the Supreme Court of New South Wales of appeals by the taxpayer relating ta four years of income (1976 Lo 1979). The sppesals concern two questions, one of which 18 common to all four years and the other relates only to tne year ended 30 June 1977. The two questions sre an mo way related to each other. The question which 15 common tao all four years 18 whether anterest om certain advances msde by tne taxpayer to ats customers which had been written off as tad debts ais sn allowable deduction under subs. 63¢1) or subes. TS1(1) of the Income Tax Assessment Act 1936 ("the Act"). The second question which relates only to the 41977 year 1s whether certain amounts received ty the taxpayer 3s a founding member of the Kankeard Credit Card Scheme from new member banks on their joining the Scheme were assessable income under sub-s. 25(1) or para. 26(3) of the Act. The learned primary Judge found an favour of the taxpayer on both questions tut, as to the first question, only in respect of sube-s. S1¢1). His Honour sccepted the argument of the Commissioner that the ainterest was not an allowable deduction under sut-s. 6341). The Commissioner challenges the findings made against him by the primary Judge. The taxpayer challenges the finding as tao sub-s. 63(1), The appeals were, both before the Supreme Court amd this Court, heard tagetner by consent. We turn first to the question whether interest on cert3in advances made by the taxpayer toa its customers which were written off as bad debts were sllowable deductions under sub-s. 63(1)., The claim under sub-s. 63(1) of the Act arose out of the taxpayer's practice in relation +o the charging of anterest on advances to customers. The learned trial Judge set out fully nis findings im this regard which were not challenged before this Court. This practice was changed by the taxpayer shortly before the years at income aunvolved in these appesls aim so far 38 1% related to its liability to aunclude interesh on doubtful accounts an its returns of assessable ancome. It 13 thus necessary to sppreciste the procedure 3. adopted both before and after the charge. It 18 39reed that the change oceurred as a result of the acceptance ty the taxpayer of the judgment of the New Zealsnd Court of Appeal in Commissioner of Inland Revenue v. The National Bank of New Zealand (1976) 77 A.T.C. 6001. Before applying that yudgment, the taxpsyer's practice ain relation to interest charged om advances to customers was to debit the customer's personal ledger card with the amount of anterest calculated 25 at 31 December and 30 June each yesr om a daily balance 3t the relevant rate. On each of these dates the amount of aunterest was added to the prior debit balance im the account, amd the new talance was treated as the amount of the sdvance upon which interest was thereafter calculated. The capita3zlization of ainmterest im this way waS, im respect of secured accounts, authorised by securaty documents and there was no suggestion that this procedure was adopted atherwise than with the consent of the customer. The amount debited to the customer's personal ledger card as aunmterest was also, except in the circumstances mentianed aim the next paragraph, credited to the taxpayer's profit amd loss account and returned ty at as assessable income, However, when there was doubt whether ano andavidusd Qutstanding advance would be recovered the taxpayer cpened what was called 3 suspended interest sccount, and the interest, calculated as previously mentioned om the customer's advance, was credited on 31 Necember and 30 June to the suspended interest account and debated to the particular customer's personal ledger card. This interest was not p p 4. credited to the taxpayer's profit and loss account, nor was it returned as assessable income until, ain each instance, the taxpayer sctunlly received the anterest. When ait became certain thst the advance would moet te recovered, the taxpayer wrote off 35 a bad debt only what it called the 'net balance" of the customer's account. This net balance comprised the final balance shown om tne customer's personal ledger card, less the finsi balance attributed to the customer ain the suspended interest account. As 15 apparent, the amount wratten off 35 3 bad debt dad mot anclude the smounts credatew to the suspended ianterest account mor any part thereof tecause this amount was deducted from the finsl balance om the customer's personal ledger card to arrive 3t the net balance to be written off. In 1976 an alteration was made to these practices of the taxpayer. The decision ain Commissioner of Inland Revenue v. National Kank of New Zealand required that the taxpayer bring anto its assessable imcome anterest credited to the suspended interest szccount im the year in which 1t was debited to the customer's personal ledger card. The taxpayer sccepted this judgment 38 applicable ta i1%5 operations and thereafter returned as assessable anmcome all interest which fad been added to the customer's sccount during the year. It continued, however, to exclude from its profit and loss account that portion of the interest credited to the suspended interest account. When it came to write off a5 3 bad debt the final balance ain the customer's personsi ledger card at did mot deduct, as at dar previously when writing off the met talance, the amount im the suspended anterest account. As at 30 June 1975 anterest credited to suspended interest aecounts amounted to $4,088,327. Since that date $1,210,145 has been received by the taxpayer. However, mo portion of tne sum of $4,088,327 had at any time been included im the assessable income of the taxpayer and, in particular, mo portion of the sum of $1,210,145 subsequently recovered has been so included. In each of the four years of income ending 30 Jure 1976~1979 respectively varicqus amounts which included the balance of the interest credited to the suspended interest asccount, totalling $2,878,182, were weitten off. The taxpayer claimed to deduct each of these amounts pursuant to subs. 63(1) of the Act 35 bad debts written off an the relevant year. It elsimed them aim the alternstive as deductible winder sub-s. S1¢1) of the Act. There was mo dispute thst the advances made ty the taxpayer upon which the interest accrued amounted to money lent by the taxpayer in the ordinary course of its business of lending money. Likewise 1t was accepted that the amounts of ainterest were in fact written off as bad debts in the relevant years of income. Subt-section 63¢(1) of the Act provides:- "63¢1) Tlebts whach are bad debts and sre wratten off as such duping the year of income, and ~ (3) nave teen brought to account by the taxpayer as assessable income of any year; or (b) sre aim respect of money lent im the ordinary course of the business af tne landing af money Ry 3 taxpayer who carries on that business, shall te allowstle deductions." The sub-section specifies three conditions which must be 6. satisfied an order that bad debts may be allowsble deductions:- (3) the debt must be bad: (b> the debt must be written off a8 8 bad debt during the year of income ain respect of which the deduction 15 claimed; and (c) the debt must have been brought to account by the taxpayer as assessable income of any year or it must have beer in respect of momey lent ain the ordinary course of the business of the lending of money by a taxpayer who carries on that busaness. A taxpayer who furnishes returns of income om tne basis of c3sh receipts will not be entitled to 3 deduction for Had debts because the 'debts' have rot teen brought ta account by him as assessable income. For the same resson a person who buys 3 business and takes over the vendor's book debts will not be entitle! taa deduction in respect of debts which turn out to be bad. If tad debts are mot deductible under ¢. 63 a deduction may be available in appropriate cases under sub-s. 51(1) for losses in respect of the bar debts: See Fairway Estates Pty. Limited v. Commissioner of Taxation (1970) 123 C.L.R. 153 per Barwick C.d. (at p. 162). The only basis for the deductibility of 3 bad debt praor to the Income Tax and Social Services Contribution Assessment Act (No. 2) 1963 (Cth.), Act No. 69 of 1963, was s. 63, But that Act amended sub-s. 63¢1) By excluding the words 'and mo wather bad debts," which previously appeared in the sub-section immediately before the words "shall te allowable deductions". Counsel for the Commissioner submitted that para. G3C1) (bh) should be construed as not including the interest component of a debt. He argued that the words in the parsgrapn "...are im respect of money lemt...." by 3 money lender ancluded, according to their ordinary and nMatural meaning, the principal component of the debt and related charges, costs amd expenses, but not interest. A person carrying om 3 money lending business would ordinarily brang to account as assessable lmcome anterest on outstanding debts. Hence, im the case of 3 maney lender who writes off debts a5 Ead debts, the anterest would be deductible under para. 63¢1)¢5) and the princip3l and related charges under para. 63¢1)(b). Parsgraphs (3a) and (b) are mutually exclusive. This sufficrently summarises the argument advanced om tehalf of the Commassioner. The construction contended for hy the Commissioner does not accord with the ordinary and matural meaning of the language of sub-s. 63(¢1). Kad debts which are 'in respect of money lent im the ordinary course" of a money lending business would in ordinary parlance encompass all constituents of the debt ancluding principsl = and interest. To exclude interest from the subject matter of para. (bt) 15 to depart from the nmitural and ordinary sense of the provisions. The Commissioner did not assert that principal 15 mot ancluded within para (he). Nor would such an assertion be tenable as the language of the 8. paragraph plainly anciudes the principal. Once it is clear thst the principal amount of the loan is within the scope of the paragraph then it becomes impossible ain our view to construe the paragraph by including items such as cests and charges but excluding a basic component of the loan, mamely interest. Nor can we discern any legislative purpose underlying $. 63 which would support the Commissioner's construction of the section. These considerations are themselves sufficiemt to answer this question in favour of the taxpayer but there are other matters which Support this conclusion. Paragraphs 63(1)¢3) and (bh) deal with different but related subject matters, the difference being the mature of the taxpayer's business. Receipts of interest, but not receipts om sccount of the principal amount of a loam, ar2 assessable imcome aim the case of 4 taxpayer carrying on the business of money lending. Losses of the principal component of loans are, however, losses incurred ky a money lender ain the course of carrying on his business. The taxp3yer in the present case prepared its accounts and furnished ats returns on this basis. The work done by para. G3¢1)(b) 1s to relax the requirement that a bad debt to tbe deductible must have teen brought to account 35 assessable income. Paragraph (6b) as antended to sliow to persons carrying on 3a money tending business the deduction of any of the components af debts which answer the description of bad debts written a. off during the relevant year of income in respect of money lent in the ordinary course of the taxpayer's money lending business. Y y 9 14 15 contrary to the plain language of the section that when a bad debt 1s written off 1t must be severed inta two components under sub-s. 63¢1)5 one for interest deductible under pars. (3) and the other for principal and charges deductible under para. (tb). The resl problem an the present case arose tecsuse the taxpayer did not bring to account as assessable income interest om the relevant advances in previous years of income. This ais explained ty the fact that it had met then changed its accounting methods as it did later following the judgment of the Court of Appeal of New Zealand am Commissioner of Inland Revenue v. The National Bamk of New Zealand (supra). If the Commissioner was entitled to amend his assessment pursuant to s. 170 of the Act then im the normal course of events he would doubtless have done so, trested the anterest 35 assessable income and allowed the deduction of the tad debts under para. 631) (bh). But the Commissioner did mot take this course. Tt was suggested by counsel for the taxpsyer that this was because the Commissioner would be met with the argument thst the taxpsyer had made full and true disclosure, so mo amended assessment could be made. We express mo view om this since the matter was mot argued and does not call for a decision. In our opinion sub-s. 631) affords a deduction to the taxpayer for the anterest om advances made by wb to ats customers 10. which it has written off as bad debts during the four years in questian. It 15 mot mecessary for us to consider therefore whether Sub—-s. Sl(1) 18 an alternative saurce of deduction for these tad debts. We turn to the second question, whether certsimn amounts received by the taxpayer during the 1977 year as a founding member of the Bankcard Scheme from new member banks on their joining the Scheme were assessable income under sub-s, 25(1) or para. 26()) of the Act. There was some dispute about the findings of fsct made ty the trial Judge, tut the following facts are uncontroversial. Tne Bankcard Scheme at present comprises fourteen separate tut co-ordinated nationwide charge card schemes operated by members of the Scheme with the 3140 of 3 commorm computer scheme, common rules, common procedure and mutual recognition so 35 to creste at minimum cost an efficient operation an an Australia-wide basis. lt was founded in 1972 by a consortium of trading tanks. A company was incorporated as Charge Card Services Limited to carry out the common and centralise functions of the Scheme, with the founding hanks accepting responsibility for expenses prior to commencement of operation of the Scheme, The total expense ancurred by them at that stage was $734,284. In respect of this amount counsel for the taxpayer made a concession at the trial in the following terms: "Mr. Priestley stated that an the thard column of the bable, which was part of annexure to the affidavit, ll. at was admitted by the Kank that the sim was an its component parts claimed Ey the seven founder tanks, save as to the part abtratutsble to esch bark as an allowable deduction." The third column of the table identifies the amount of $734,284 as the amount claimed as am allowable deduction by the founding banks. This was the only evidence on this topic. Since 1972 other Australisnm Banks have been admitted to the Scheme. In 1973 two tanks were admitted and im 1976 a further five banks. A term of admission was that each mew member pay to the existing members an entry fee. As the trial Judge explained, the basis upom which the fees were caslculsted was mot completely comsistent. However 1t was sccepted by the taxpayer for the purposes of the appesls that 'the totsl amount paid to it by the new members tears a proportional relationship to the smounk which 1t had expended and previcusly claimed as a deduction". Tie amount which the trial Judge had earlier found had teen expended and previously claimed as a deduction was $734,284, He further found that the taxpsyer had paid $97,459 of this amaunt. It follows that the taxpayer accepted that 1ts proportion of the fees paid to the consortium by the new mentbers Was $97,459/%$734,284, i.e. approximately 13K, of the total fees received, This amount had mot been quantified st the date of the hearing tut that has no significance on the question for determination. The agreement entered anto by the first two new members descrited Lhe gayments they made ta the cansartium as an assessment of ae) aan their share tor a portion thereof) of the establishment and imitial operating costs of the founding banks. This 15 whst they aim fact were. The five members who joined the Scheme in 197G were charged 4 lump sum fee, which in the correspondence with them was om occasions called *3 snmsre of establishment and development costs'. The Commissioner's contention, upon which he based his Primary submissions om this aspect of the appeal, was that the lump sum joining fee paid by the five mew members wholly represented expenses paid on revenue sccount by the founding banks and claimed ty them and allowed as deductions. In our opinion thas contention finds no support an the evidence which to date we have recited. It also runs counter to additiomal findings made by the trasl Judge am relatzon to a subsequent submisszom of the Commissioner. His Honour found that some new members paid s darect proportion of the totsl expenditure incurred prior to the commencement of the scheme. Tnis expenditure he had earlier found to be $734,284. He reiterated that it was incurred upon research and development or establishment or initial operating ¢asts. Qther new members, which ancluded the five admitted im 1976, each paid a lump sum ain the computation of which the trial Judge $3109 other factors were considered, These factors were additsonal to the costs mentioned earlier as having been incurred prior to the commencement of the Scheme. His Honour found that at was impossible to dissect the lump sum and to spportion 1% amongst the heads to which it related. He also found that 1+ was impossitle to attribute to portions of the 13. lump sum an anmcome or mon-ancome mature or to determine whether or not they were in the mature of reimbursement of expenses, In our opiniom his Honour clearly acknowledged that he cauld not find that the lump sums comprised exclusively amounts paid on revenye account and tnat they were allowsble deductions. This was, if our opinion, a finding of fact by the trial Judge which was not successfully challenged before us and which destroys the foundation upon which the Commissioner based his primary submission om this second question in the appeal relsting to both sub- s. 25¢(1) and para. 26). The Commissioner submitted siso that even if the joining fees are mot properly characterised as wholly representing expenses paid an revenue sccount by the founding banks and claimed by them as allowable deductions, mevertheless the payments received ty the taxpayer are income sccording to ordinary concepts. It was mot s capital asset sold ty the taxpayer but merely a sum received on revenue account ain the course of the taxpayer's participation an the kusiness of conducting toe Kankcard Scheme. The money received was said ta Fill "the hole" created by the esrlier expenditure of the founding banks. Reliance was placed on the judgment of the Court of Session aim Burmah Steamship Company Limited v. Commissioners Gf Inland Revenue (1930) 16 T.C. 67 where there had been 3 claim for damages calculated by reference tao the estimated profit whoien would have been earned hy a vessel during the time beyond that am which the defendants had undertaken to complete their overhaul. The Burman Steamship Company 14, Limited had received 3 sum of money in settlement of its claim and this was held to be taxable. Tne Lord President (Lord Clyde) said (ab p» 71l)i- "Suppose some one who chartered one of the Appellant's vessels breached the charter and exposed himself to 4 claim of damages at the Appellant's anstamce, there could, I imagine, be mo doubt that the damages recovered would properly enter the Appellant's profit amd loss account for the year. The reason would te that the breach of the charter was san injury inflicted on the Appellant's trading, making (sa to spaak) a hole in the Appellant's profits, and the damages recovered could not therefore be ressonably or appropriately put Ky the Appellant - 1m accordance with the principles of sound commercial accounting ~ to amy other purpose than to fill that hole.' The receipt by the taxpayer of the lump sum joining fees from entrant Banks cannot in our view te likened to the recerpt by Burman Steamship Company Limited of moneys ain settlement of 1%5 claims. The joining fees filled mo hole created by a loss of income or profits. The joining fee cannot, for the reasons given by us earlier, te treated as reimbursement of expenses ain view of the trial Judge's finding that 1t w3s impossible to dissect the lump sum snd to apportion 1t amongst tne heads to which 1t related. Even if the fees could be so characterised 1t 12s doubtful af the Rurman Steamship Case wolild avail the Commissioner because that was 3 case of "a hole* in profits being filled by subsequent receipts on revenue account. In this case it 215 not profits or income that were lost to the taxpayer but atems of expenditure ancurred by it. Once the founding banks expended moneys to establish and develop the Rankcard Scheme they Fd recelved revenue from carrying om the Scheme so that 'the hole", te use the metaphor of the Lord President im the Lturmah Steamship Case, was filled by that revenue and, ta the extent of the deficiency, if any, may have teen topped up by the entry fees from the entrant banks. This case illustrates the care with which the use of metaphors must be approached. They sre often convenient to use but cam te misleading. Tk 18 true that the amount of the joining fee was calculated at least to some extent by reference to expenditure incurred on revenue account, tut the character of the receipt. for the purposes of the Act, 15 3 capital receipt representing the price paid ty the entrant banks for joining the Hankcard Scheme and obtaining the benefit of what ait offered, in particular its assets and goodwall including the right to use the Bankcard logo. These considerstions 31so answer the Commissioner's arguments im relation to para. 26(j). That provision has been considered in various cases aincluding Federal Commissioner of Taxation v. Wade (1951) 84 C.L.R. 105, Robert v. Collier's Bulk Liquid Transport Pty. Lamited £19591] V.R. 380 per Gavan Tuffy J. (st po. 284-5), Melbourne £ +! Saw Manufacturing Co. Ply. Limited v. Melbourne and Metropolitan Board of Works [1970] VU.R. 394 per Barter J, (at p. 399) and Goldstorqugh Mort & Co. Limited v.« Faderal Commissiomer of Tasatian (1976) G A.T.R. 580 per Walters J. (at pp. 586-587). See slso the article by Mr C.W. Fineus Q@.C., "Taxation of Compensatory Payments and Judgments" (1979) $3 A.L.T. 365 (at p. 366). We do not find it necessary to determine the scope of para, lo. 26¢)) or the meaning of any of its words and phrases, in particular the word 'indemnity'. Even aif 1t were given its widest meaning of reimbursement to the taxpayer of an outgoing which was san 3llowatle deduction (see ain particular the judgment of Walters J. in the Goldsborough Mort Case) the joining fee would mot answer that description for the ressons already given ty us. We would dismiss the appeals with costs. | certify that this and the |S" preceding pages are a true copy of the reasons for Judgment herein of the Court Be UF pasa Badd = s/,; /32 ~-