FEDERAL COURT OF AUSTRALIA Bell & Moir Corp Pty Ltd v Commissioner of Taxation [1999] FCA 1009 TAXATION – deductions – s 51(1) of the Income Tax Assessment Act 1936 – whether money paid pursuant to guarantees is of a capital nature – where taxpayer not in the business of providing guarantees WORDS & PHRASES – "capital" – "of a capital nature" – "revenue" Income Tax Assessment Act 1936, s 51(1) Administrative Appeals Tribunal Act 1975, s 44 John Fairfax & Sons Pty Ltd v FCT (1959) 101 CLR 30 considered John v FCT (1988-1989) 166 CLR 417 cited Steele v DCT (1999) 161 ALR 201 referred to Sun Newspapers Ltd v FCT (1939) 61 CLR 337 applied Pine Creek Goldfields Ltd v FCT (1999) 99 ATC 4,382 cited Hooker Rex Pty Ltd v FCT (1988) 88 ATC 4,392 considered FCT v South Australian Battery Makers Pty Ltd (1978) 140 CLR 645 considered G P International Pipecoaters Pty Ltd v FCT (1989-1990) 170 CLR 124 cited Email Ltd v FCT (1999) 99 ATC 4,208 discussed Hallstroms Pty Ltd v FCT (1946) 72 CLR 634 considered Broken Hill Theatres Pty Ltd v FCT (1951-1952) 85 CLR 423 referred to Ure v FCT (1981) 81 ATC 4,100 referred to Magna Alloys & Research Pty Ltd v FCT (1980-1981) 33 ALR 213 discussed NMRSB Ltd v FCT (1998) 98 ATC 4,188 considered C I R v Shipbuilders Ltd [1968] NZLR 885 referred to FCT v Consolidated Fertilizers Ltd (1991) 101 ALR 385 referred to C I R v Huntley & Palmers Ltd (1928) 12 TC 1209 cited Ogilvy & Mather Pty Ltd v FCT (1990) 90 ATC 4,836 considered Case A58, (1969) 69 ATC 330 cited Case J63, (1958) 9 TBRD 345 cited 10 CTBR Case 72 cited 13 CTBR Case 22 cited Case B3, (1970) 70 ATC 10 cited Case C34, (1971) 71 ATC 149 cited Case L3, (1979) 79 ATC 14 cited Case Q39, (1983) 83 ATC 171 cited Case V115, (1988) 88 ATC 733 cited Case V117, (1988) 88 ATC 741 cited Case 49/95, (1995) 95 ATC 422 cited Case 56/95, (1995) 95 ATC 459 cited BELL & MOIR CORPORATION PTY LIMITED v COMMISSIONER OF TAXATION N 351 OF 1999 HELY J 28 JULY 1999 SYDNEY IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY N 351 OF 1999 BETWEEN: BELL & MOIR CORPORATION PTY LIMITED Applicant AND: COMMISSIONER OF TAXATION Respondent JUDGE: HELY J DATE OF ORDER: 28 JULY 1999 WHERE MADE: SYDNEY THE COURT ORDERS THAT: 1. The appeal is dismissed with costs. Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules. IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY N 351 OF 1999 BETWEEN: BELL & MOIR CORPORATION PTY LIMITED Applicant AND: COMMISSIONER OF TAXATION Respondent JUDGE: HELY J DATE: 28 JULY 1999 PLACE: SYDNEY REASONS FOR JUDGMENT 1 The issue which arises in this appeal is whether the Administrative Appeals Tribunal ("AAT") made an error of law in finding that losses or outgoings of $472,768 incurred by the applicant in the year of income ended 30 June 1991, as a result of payments made pursuant to guarantees which it had provided to financiers in relation to Barry Michael Motors Pty Ltd ("BMM"), are not deductible under s 51(1) of the Income Tax Assessment Act 1936, ("the Act") because they are of a capital nature. 2 It was common ground between the parties that the question whether those losses or outgoings are of a capital nature is a question of law, thus enlivening the jurisdiction of the Federal Court under s 44 of the Administrative Appeals Tribunal Act 1975 (Cth). AAT's findings 3 The facts were not in dispute. The proceedings in the AAT were conducted upon the basis of agreed facts. For present purposes it is sufficient to record that the applicant carried on the business of a motor vehicle dealer, and associated activities. BMM carried on a similar business. In February 1987 the applicant acquired a 331/3 percent shareholding interest in BMM. The applicant considered this investment to be one through which the applicant could improve its own revenues and profitability by way of a relationship with BMM involving, amongst other things, sales of products by the applicant to BMM. 4 On 20 December 1988 the applicant agreed to become a guarantor of a facility under which Ford Credit provided finance to BMM ("the Ford Guarantee"). The agreed fact in relation to the Ford Guarantee is as follows: "17. The Company agreed to act as co-guarantor because of its wish to continue with its relationship with BMM. It should be remembered that the Company's investment was only $110,000 and the entering into of the guarantee was not to protect the investment but to ensure continuity of the dealings between BMM and the Company that enabled the Company … to earn income." 5 On 25 September 1989 the applicant agreed to become a guarantor of a facility under which Westpac Banking Corporation Ltd provided an overdraft facility to BMM ("the Westpac Guarantee"). The respondent accepted that if the loss or outgoings under the Ford Guarantee were deductible, then so too were the losses or outgoings under the Westpac Guarantee. It is therefore unnecessary to recapitulate the agreed facts in relation to the Westpac Guarantee, which are set forth in AAT's reasons for decision. 6 In October 1990 BMM was placed into liquidation. In the year of income ending on 30 June 1991 sums totalling $470,313 and legal fees of $2,455 were paid by the applicant pursuant to the guarantees, without recoupment from BMM, or from co-guarantors. It was common ground that the rights of indemnity and contribution arising in consequence of the payments made by the applicant were valueless. 7 In its reasons for decision AAT: - accepted the respondent's concession that the payments in question can be properly characterised as outgoings, and that they constitute expenses which satisfy the nexus tests in s 51(1) of the Act. - Concluded that the guarantees were given on behalf of BMM in order to enable BMM to obtain the facilities without which BMM could not have conducted its business (par 24(a)). - Accepted that the advantage which the applicant expected to derive from the giving of the guarantees was the maintenance of the business relationship with BMM and the anticipated profits contemplated by the agreed facts (par 25). - Found that the payments were of a capital nature because: · the applicant was not in the business of giving guarantees, nor did it do so recurrently. · The guarantees "constituted a stake in BMM" which, from the applicant's viewpoint, "was structural in nature"; the stake was part of the applicant's overall structure, and would, it was hoped, produce income by increasing the applicant's turnover and income through its association with, and support of, BMM. The competing contentions 8 The applicant submitted that prior to the giving of the guarantees, the applicant's trading pattern with BMM was well established in consequence of its acquisition of a 331/3 percent shareholding interest in BMM. The advantage which the applicant sought to acquire by the giving of the guarantees was the maintenance or continuation of the trading relationship with BMM through which the applicant derived assessable income. The giving of the guarantees was not calculated to create a new asset or advantage, nor did it alter or expand the framework within which the applicant's business operated. The resultant payments were thus of a revenue nature. That would be so even if what was sought was an enhancement of the applicant's trading operations. 9 The respondent submitted that the guarantees were given for the purpose of strengthening, preserving or expanding the business structure of the applicant. As such payments made pursuant to the guarantees are of a capital nature. Unless a taxpayer is in the business of giving guarantees, then it is not entitled to a deduction arising out of payments made pursuant to a guarantee. Some principles 10 The respondent's concession assumes that the operation of the Act is such that the exception in s 51(1) with respect to losses or outgoings of a capital nature is a true exception, which can have application even if the taxpayer is able to satisfy either or both of the positive limbs of the section. That assumption is consistent with the decisions of the High Court in John Fairfax & Sons Pty Ltd v FCT (1959) 101 CLR 30, 34; John v FCT (1988-1989) 166 CLR 417, 427; Steele v DCT (1999) 161 ALR 201, 218 (Kirby J). It is not consistent with the views expressed by Professor Parsons in Income Taxation in Australia: Principles of Income, Deductibility and Tax Accounting (1985) [par 5.8; 5.12]. 11 The concession is not to be disregarded in considering whether the losses or outgoings in question are of a capital nature. Thus it is not open to the respondent to call in aid, as it seeks to do, the following observations of Professor Parsons at [par 6.245]: "Generally, the giving of the guarantee and payment under the guarantee will not be acts in carrying on a business. They are unlikely to be such where the taxpayer's interest in the entity is, for example, the interest of a shareholder in a private company. The making of the payment under the guarantee and the failure of the subrogation rights to realise the amount of the payment may involve a relevant loss, but it is not a working loss." because the case was conducted before the AAT on the basis that the giving of the guarantee was an act in the carrying on of the applicant's business, and the only issue was whether payments made pursuant to it are of a capital nature. 12 In determining whether a payment made by a taxpayer has a capital or revenue nature, consideration must be given to a range of matters of which the most important are the character of the advantage sought to be secured by the payment (including its lasting qualities), the manner in which it is to be used or enjoyed, and the means adopted to obtain it: Sun Newspapers Ltd v FCT (1939) 61 CLR 337 at 363. The basic question is whether the outgoing is one which relates to the business structure, when it will ordinarily be capital, or whether it relates to the business operation, when it will ordinarily be revenue: Pine Creek Goldfields Ltd v FCT (1999) 99 ATC 4,382, 4,386. 13 Here, the payments in question were made in discharge of liabilities earlier assumed by the applicant, rather than with a view to securing any particular advantage. In such a case, it is appropriate to examine the nature of the benefit or advantage which the taxpayer sought to secure by the giving of the guarantees, in order to characterise the payments made pursuant to them as being of a capital, or revenue nature: Hooker Rex Pty Ltd v FCT (1988) 88 ATC 4,392, 4,403-4,404. The importance of that examination is highlighted by the different conclusions reached in that case in relation to payments made under the "Shangri-la" guarantee, and under the "Bowden & Schadel" guarantee. A deduction was denied in relation to the former because the nature of the benefit or advantage sought to be derived from the giving of the "Shangri-la" guarantee was an increase in the asset backing of the shares which the taxpayer held in its subsidiary company, hence payments pursuant to the guarantee were on capital account. A deduction was allowed in relation to the latter because the nature of the benefit or advantage sought to be derived by the giving of the "Bowden & Schadel" guarantee was the acquisition of trading stock by the taxpayer. 14 It is the character of the advantage sought by the taxpayer for itself by making the outgoing for which deduction is sought which is the chief factor in determining whether the outgoing is on revenue or capital account. The mere fact that someone else incidentally derives an advantage of a capital kind in which the taxpayer does not share is not enough to give to an outgoing the character of capital: FCT v South Australian Battery Makers Pty Ltd (1978) 140 CLR 645, 656-7, 660, 662; G.P. International Pipecoaters Pty Ltd v FCT (1989-1990) 170 CLR 124, 137; Email Ltd v FCT (1999) 99 ATC 4,208, 4,216. 15 The character of the advantage sought is to be determined from a practical and business point of view: Hallstroms Pty Ltd v FCT (1946) 72 CLR 634, 648. Where what is sought to be obtained is not an asset, but a practical though intangible business advantage, then that too must be analysed to determine its nature, as, for example, whether it is an enduring advantage for the benefit of the business: South Australian Battery Makers at p 662. 16 Expenditure may be on capital account even if it is not calculated to produce an asset or enduring advantage for the benefit of the business: John Fairfax & Sons Pty Ltd at p 36; Broken Hill Theatres Pty Ltd v FCT (1951-1952) 85 CLR 423, 434. 17 In BP Australia Ltd v FCT (1965) 112 CLR 386, 397 Lord Pearce said: "The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer. Although the categories of capital and income expenditure are distinct and easily ascertainable in obvious cases that lie far from the boundary, the line of distinction is often hard to draw in border line cases; and conflicting considerations may produce a situation where the answer turns on questions of emphasis and degree." Consideration 18 The first step is the identification of the benefit or advantage expected to accrue to the applicant in return for the provision of the guarantees in question. The provision of the guarantees was a voluntary act on the part of the applicant. The immediate advantage flowing therefrom was the provision of the facilities by Ford Credit and Westpac to BMM which were supported by the guarantees. In a practical business sense the provision of those facilities to BMM was of benefit to the applicant, both by reason of its investment in BMM, and by reason of the trading relationship which subsisted between the two companies. It is not a case of BMM "incidentally deriv[ing] an advantage of a capital kind" from the provision of the guarantees "in which the taxpayer does not share" (South Australian Battery Makers at p 656-7). The quid pro quo which the applicant expected to derive from Ford and Westpac in return for its guarantees was the extension of credit facilities to BMM. 19 On the agreed facts, a motive for the provision of the guarantees, or an indirect objective which the applicant hoped to secure as a result of the provision of the guarantees, was the continuation of the trading relationship which subsisted between itself and BMM and from which it derived assessable income. Although the agreed facts state that the objective was not to protect the company's investment in BMM, but was to ensure the continuity of the income producing dealings between the two companies, achievement of the latter objective would probably secure the former. 20 If the benefit or advantage expected to accrue to the applicant in return for the provision of the guarantees was the provision of financial facilities to BMM, or the preservation of its shareholding interest in BMM, then its liability under the guarantees would be capital in nature. If the benefit or advantage expected to accrue was the continuation of the trading relationship between the two companies then its characterisation of the liability may depend upon whether the provision of the guarantees is seen as a normal incident of the applicant's trading activities, or whether it is seen as a non recurring transaction of a special character intended to secure an enduring advantage for the applicant's business. 21 It will be apparent from the above that the selection or identification of the benefit or advantage expected to accrue to the applicant from the provision of the guarantees at least influences, and may determine, the characterisation of payments made under the guarantee, subject to the second and third of the considerations referred to by Dixon J in Sun Newspapers. 22 "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": Ure v FCT (1981) 81 ATC 4,100, 4,110 per Deane and Sheppard JJ; cf Magna Alloys & Research Pty Ltd v FCT (1980-1981) 33 ALR 213, 235 where Deane and Fisher JJ accepted that both direct and indirect objectives, and irrespective of whether pursuit of them should be seen in terms of "purpose" or "object" or "motive", may be taken into account in determining whether an outgoing is properly deductible under the second limb of s 51(1) of the Act. In NMRSB Ltd v FCT (1998) 98 ATC 4,188, 4,204-4,205 Sackville J, whilst declining to accept a submission that the character of the advantage obtained by a taxpayer is to be determined exclusively by reference to the contractual or other legal rights the taxpayer received for the payment, nonetheless thought it appropriate, in the circumstances of that case, to determine the character of the advantage by reference to the contractual quid pro quo obtained for the payment in question. His Honour agreed with the observation of Brennan J in Magna Alloys & Research that "other than perhaps in unusual cases" whether s 51(1) is satisfied does not depend upon the taxpayer's state of mind, at least where the payment is not voluntary. 23 The giving of the guarantees is, however, analogous to the making of a voluntary payment. In the present case, a description of the benefit or advantage expected to accrue to the applicant as a result of the giving of the guarantees which left out of account the anticipated beneficial effects upon its income would involve a distortion of the practical realities of the situation. The benefit or advantage expected to accrue to the applicant as a result of the giving of the guarantees can thus be described as the provision of funds to BMM so as to provide it with a stronger base from which to carry on its business, including purchase of goods from the applicant in the expectation that the applicant would continue to derive assessable income from its dealings with BMM. 24 The giving of a guarantee is analogous to the applicant making a loan of the funds guaranteed to BMM. "Losses incurred as the result of loans made to another company in order to secure a fixed source of supply or other enduring benefit are to be regarded as capital losses and not deductible": C.I.R. v Shipbuilders Ltd [1968] NZLR 885 at 901, unless it is part of the regular business of the company to engage in money lending. 25 In Barrett & Green's "Principles of Income Taxation" (5th Edn) (1996) the matter is put this way at par 9.54: "The principle emerging from the Snowden & Wilson case and the John Fairfax case, as well as the earlier authorities, is that where expenditure is directed towards the maintenance of the taxpayer's position in a given field or facilitating its continued operations in that field (as in the cases of Hallstroms and Snowden & Wilson) it will generally be regarded as an outgoing on revenue account deductible under s 51(1). Where, on the other hand, the outgoing is directed towards the improvement of the taxpayer's position or the acquisition of some additional asset, right or business advantage, including the forestalling of potential competition, it should be regarded as an outgoing of capital. The nature and scope of the taxpayer's existing income-producing activities will be indicative of the character to be given to the outgoing." In FCT v Consolidated Fertilizers Ltd (1991) 101 ALR 385, 399-400 the Court said: "… a distinction must be made between expenditure incurred for the purpose of preserving and protecting a business as such, being expenditure for a particular purpose on an isolated occasion, and expenditure which the nature of business may require as part of the prudent management thereof." 26 In John Fairfax & Sons Pty Ltd at p 48 Menzies J said: "To make a payment to acquire or to defend the acquisition of a favourable position from which to earn income or to enter into arrangements that will yield income is not in general an outlay incurred either in gaining or in carrying on business for the purpose of gaining assessable income; such a payment in the case of a trading company, occurs at a stage too remote from the receipt of income to be so regarded. To be deductible an outlay must be part of the cost of trading operations to produce income, ie, it must have the character of a working expense." It is true that this observation was made in the context of the positive limbs of s 51(1), and I have already referred to the significance of the concession made by the respondent in this respect. Nonetheless, in my view the observations which I have quoted are of assistance in determining whether the payments made pursuant to the guarantee are of a capital nature. 27 The liability was incurred once and for all, for a potentially large amount. The extent of the liability was unrelated to the trading operations between the applicant and BMM. The liability was not one which was incurred to BMM, but to its financiers. These are factors which are relevant to the third of the matters referred to by Dixon J in Sun Newspapers, namely the means adopted to secure the advantage. 28 The liability was not, as a matter of substance, in the nature of a marketing expense. It was incurred because BMM needed, or sought, external assistance in connection with the raising of funds with which to carry on its business. A liability incurred on that account is generally a capital risk: C.I.R. v Huntley & Palmers Ltd (1928) 12 T.C. 1209, 1221. The nature of the benefit or advantage sought was the propping up of BMM so that the applicant could continue to trade with it. That is the type of enduring benefit which will ordinarily result in the cost of acquiring it as being characterised as capital in nature. It does not matter, in my view, that BMM was already a customer of the applicant's, because the issue is not whether the object was to enable the applicant to carry on its business profitably, but whether the means adopted to achieve that end involved the incurring of liabilities which were capital in character. 29 In my opinion, AAT correctly characterised the payments made pursuant to the guarantee as being of a capital nature, and its decision in that respect was not infected by any error of law. In view of that conclusion, and the way in which the matter has been argued (see par 2 above) it has not been necessary to consider whether AAT's decision is more properly regarded as being one of fact, such that the issue for this Court is whether the decision reached is one which was reasonably open to AAT. The competing views on this question are referred to in Hallstroms Pty Ltd v FCT (1946) 72 CLR 634, 645, 646, 652, 656. In Steele (at p 205) the High Court acted on a concession that whether the outgoing was of a capital nature is a question of law. Guarantee cases 30 The fact that the liability in question arose as a result of the giving of a guarantee cannot be determinative of the character of the payments made under it, although the fact that the liability arose in that way may be relevant to the third of the factors identified by Dixon J in Sun Newspapers. 31 In Email Ltd v FCT (1999) 99 ATC 4,208, O'Loughlin J refers to three cases from the United Kingdom where payments under guarantees were accepted as being payments on revenue account. But none of those cases is authority for any principle which is of assistance to the applicant here, except, perhaps for the very general proposition that the circumstance that the payments for which a deduction is sought were made pursuant to a guarantee does not necessarily determine the character of payments made pursuant to the guarantee. 32 There have been a series of cases in this country, decided by Boards of Review, or the AAT, in which the issue of deductibility of payments made pursuant to guarantees has fallen for consideration. The only one which I have found where the issue was determined favourably to the taxpayer (by a majority) is Case A58, (1969) 69 ATC 330. But that was a case in which the giving of guarantees was a regular and normal incident of the taxpayer's income earning activities, and the decision turned on that fact. It was part of the ordinary business of a holding company to guarantee the bank overdrafts of tenants of its hotels as an inducement to the tenant to continue to purchase its liquor supplies from the taxpayer's subsidiaries. 33 Cases which have gone the other way include Case J63, (1958)9 TBRD 345 (capital loss); 10 CTBR Case 72 (capital loss and in any event not a business expense); 13 CTBR Case 22 (capital loss); Case B3, (1970) 70 ATC 10 (Case A58, (1969) 69 ATC 330 distinguished upon the basis that the guarantees were regarded by the majority as a regular and normal part of the taxpayer's income earning activities: insofar as the guarantee is undertaken to secure a source of income the payments required to be made under the guarantee are associated with the acquisition of a position from which to earn income rather than with the day to day revenue costs of deriving income); Case C34, (1971) 71 ATC 149 (preservation of the profit yielding structure of a business entity in which the guarantors were shareholders); Case L3, (1979) 79 ATC 14 (not a business expense, and in any event capital in character); Case Q39, (1983) 83 ATC 171 (not a business expense and, in any event, as the purpose of furnishing the guarantee was to establish a clientele and from such to secure a source of income any payment under the guarantee would be associated with the acquisition of a position from which income is to be yielded rather than the day to day revenue costs of deriving income); Case V115, (1988) 88 ATC 733 (not a business expense); Case V117, (1988) 88 ATC 741 (an expense of a capital nature, in the same way that a loan to, or subscription for shares in, the company whose debts were guaranteed would have been capital in nature); Case 49/95, (1995) 95 ATC 422 (a once and for all payment to obtain the possibility of a long term income stream is capital in character); Case 56/95, (1995) 95 ATC 459 (payments made pursuant to a guarantee given to preserve the future profitability of the enterprise are capital in character). 34 The respondent relied upon dicta of Hill J in Ogilvy & Mather Pty Ltd v FCT (1990) 90 ATC 4,836 (which predated the decision of the High Court in Coles Myer Finance Ltd v FCT (1992-1993) 176 CLR 640, 663). At p 4,858 Hill J said: "In the ordinary case of a trading company (not being a bank or finance company) the payment of a guarantee obligation will be on capital, rather than on revenue, account where unrelated to guarantees for the purchase of its trading stock: Hooker Rex Pty Ltd v FC of T 88 ATC 4392 and cf Case V115, 88 ATC 733; Case V116, 88 ATC 737 and Case V117, 88 ATC 741." But later on that page his Honour indicated that, depending on the circumstances of a particular case, a loss sustained on a transaction analogous to that of a guarantee may be on revenue, rather than on capital account. The case with which his Honour was concerned was not one which involved a claim to deduct a loss, but an outgoing, hence it was not necessary to pursue this aspect of the matter further. 35 Having regard to the concessions made by the respondent before AAT, the issue which I have to determine is a narrower, and possibly different issue than that to which his Honour's remarks were directed, but they point in the same direction as the conclusion which I have reached. I certify that the preceding thirty-five (35) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Hely. Associate: Dated: 28 July 1999 Counsel for the Applicant: P M Fraser Solicitor for the Applicant: Baker & McKenzie Counsel for the Respondent: M Christie and M White Solicitor for the Respondent: Australian Government Solicitor Date of Hearing: 13 July 1999 Date of Judgment: 28 July 1999