Re Richard Michael Ure v the Commissioner of Taxation of the Commonwealth of Australia [1981] FCA 9; (1980) 50 FLR 219 (11 February 1981)

FEDERAL COURT OF AUSTRALIA

Re: RICHARD MICHAEL URE
And: THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
[1981] FCA 9; (1980) 50 FLR 219
No. G52 of 1980
Income Tax

COURT

IN THE FEDERAL COURT OF AUSTRALIA
NEW SOUTH WALES DISTRICT REGISTRY
GENERAL DIVISION
Brennan(1), Deane(2) and Sheppard(2) JJ.

CATCHWORDS

Income Tax - Allowable deductions - Moneys borrowed by taxpayer and on-lent at lower rate of interest - Funds ultimately applied for allegedly private or domestic purposes - Deductibility of expenses in borrowing money and of interest payable.

Income Tax Assessment Act 1936 (Cth.), ss.51,67.

Income Tax - Allowable deductions - Borrowing at commercial rates and on-lending at one per cent - Deduction of proportion of interest paid - Deductibility of other borrowing expenses - Deductibility of guarantee fees paid to obtain loans - Income Tax Assessment Act 1936 (Cth), ss. 51 (1), 67 (1). The taxpayer borrowed money at commercial rates (up to 12.5 per cent per annum) paid interest of some $8,736 in the year of income and lent the moneys at one per cent per annum to his wife and to a family company. The taxpayer paid guarantee fees of two per cent per annum to family companies which provided guarantees and securities for two of the loans. The taxpayer also incurred legal and valuation fees in relation to obtaining the loans. The taxpayer claimed deductions for the interest and the other payments, and the Commissioner substantially disallowed the claims and allowed only a deduction of $660 for interest, that being the equivalent of the income received by the taxpayer from the on-lending. Lee J. of the Supreme Court of New South Wales disallowed the appeal, and upheld the Commissioner's allowance of only $660 deduction for interest. The taxpayer appealed.

Held, appeal allowed in part - that, as to the interest payments, the taxpayer's expenditure was not primarily incurred to produce assessable income, but was private or domestic. The expenditure should be apportioned (Ronpibon Tin N.L. v. Federal Commissioner of Taxation [1949] HCA 15; (1949), 78 CLR 47, applied) and only $660 allowed as a deduction under s. 51 (1) of the Income Tax Assessment Act 1936. As to the valuation and legal expenses, a deduction was available under s. 67 of the Act of the proportions there set out. Section 67 refers only to borrowing by the taxpayer, not the use of the money by other persons. As to the guarantee fees (by majority, Brennan J. dissenting) these were also a borrowing expense and under s. 67 a portion was deductible as there set out.

HEARING

Sydney, 1981, February 11. 11:2:1981
APPEAL.

Appeal from a decision of Lee J. of the Supreme Court of New South Wales dismissing the taxpayer's appeal against the disallowance by the Commissioner of his objection to an assessment in respect of the year of income ended 30th June, 1976.

J. S. Van Aalst, for the appellant.

L. J. Priestly Q.C. and O. B. Patterson, for the respondent.

Cur. adv. vult.

Solicitor for the appellant: R. M. Ure.

Solicitors for the respondent: B. J. O'Donovan, Commonwealth Crown

Solicitor.

J. H. TELFER

ORDER

1. The appeal be allowed.

2. The order of the Supreme Court of New South Wales be set aside and in lieu thereof it be ordered that:

(a) The assessment be remitted to the Commissioner to be amended by allowing a deduction pursuant to s.67(1) of the Income Tax Assessment Act 1936 in respect of the appropriate proportion of guarantee fees, valuation fees and legal expenses and that the appeal be otherwise dismissed.

(b) The appellant pay to the respondent one-third of the respondent's costs to be taxed.

3. The appellant pay to the respondent one-third of the respondent's costs of this appeal.

DECISION

This is an appeal from a judgment of the Supreme Court of New South Wales (Lee J.) dismissing a taxpayer's appeal against the disallowance of an objection to his assessment to tax for the income year ended 30 June 1976. The objection related to expenditure made by the taxpayer in connection with three loans made to him in earlier years.

Mr. Ure, the appellant taxpayer, was at all relevant times an employed solicitor. He and his wife resided in Balmain prior to the end of 1973. Their residence was mortgaged to the Commonwealth Savings Bank to secure the repayment of moneys which the Bank had lent to them to assist in its purchase.

On 24 September 1973, Mr. and Mrs. Ure separately entered into contracts for the purchase of a property in Epping where they resided after leaving Balmain. The Bank mortgage over the Balmain property was discharged, and mortgages were given over the Epping property to the Commonwealth Savings Bank and the Commonwealth Trading Bank to secure the repayment of an amount totalling $20,000 lent to Mr. and Mrs. Ure by those banks to assist in the purchase of the Epping property.

Although the mortgagors were ostensibly the beneficial owners of both the Balmain and the Epping properties, Mr. and Mrs. Ure had in fact executed declarations of trust of the respective interests in those properties acquired by them under the contracts into which they had entered for the purchase of those respective properties. The declarations of trust had been made contemporaneously with their entering into those contracts: a declaration of trust in favour of Listohan Services Pty. Ltd. (hereafter Listohan) in the case of the Balmain property, a declaration of trust in favour of Weston Park House Pty Limited (hereafter Weston) in the case of the Epping property.

Listohan paid the purchase price of the Balmain property and Weston paid the purchase price of the Epping property. Mr. and Mrs. Ure were, at the material times, shareholders and directors of Listohan and Weston, and the evidence tends to show that they were the only shareholders and directors. Weston, however, held all of its assets as a trustee of the Joan Honeybourne Trust, a discretionary trust in which Mr. Ure, members of his family and others were beneficiaries. During the relevant year, the net income of the trust fund was distributed between Mr. Ure's children. Weston, as trustee of the Joan Honeybourne Trust Fund, leased the Epping property to Mr. and Mrs. Ure for a nominal rental. Mr. Ure intended that the Joan Honeybourne Trust should have the benefit of capital appreciation in the value of the Epping property, and that Weston as trustee should receive income from letting it at a commercial rent when he should cease to occupy it after a few years.

The funds used to discharge the mortgage on the Balmain property and to purchase the Epping property originated in two loans: the first loan was made by a Mr. and Mrs. Williams to the appellant on or about 31 October 1973, in the amount of $17,000 for a period of 3 years at 10% per annum interest. The second loan was in the amount of $20,000 previously mentioned which Mr. and Mrs. Ure jointly borrowed from the Commonwealth Savings Bank and the Commonwealth Trading Bank. $17,500 was borrowed from the Commonwealth Savings Bank at 7.5% per annum, and $2,500 was borrowed from the Commonwealth Trading Bank at 8.5% per annum. As between Mr. and Mrs. Ure, the bank loans were treated as loans to Mr. Ure alone. The $17,000 borrowed from Mr. and Mrs. Williams was lent by Mr. Ure to Mrs. Ure at a rate of interest of 1% per annum and was repayable on demand. Mrs. Ure lent in all $17,907.25 to Listohan at 10% per annum, $6,857.25 of which Listohan applied in discharging its liability in respect of the mortgage on the Balmain property. It lent the balance, $11,050, to Weston at a rate of interest of 1% per annum.

The $20,000 originating from the banks' loan was lent by Mr. Ure to Listohan at a rate of interest of 1% per annum. Listohan lent to Weston this amount together with the $11,050 originating from the first loan at a rate of interest of 1% per annum. Weston applied these moneys in the purchase of the Epping property, the price of which was $35,950.

The appellant declared the 1% interest in respect of the amounts so lent by him to his wife and to Listohan to be part of his assessable income for the year ended 30 June 1976; and he sought to deduct from his assessable income for that year the interest on the first and second loan and some other expenditure in connection with the first loan as outgoings incurred in gaining or producing the assessable income derived from the lending of those moneys by him to Mrs. Ure and Listohan.

A third loan was obtained by Mr. Ure from his brother-in-law, Mr. Duvernet-Davis, and this loan gave rise to a similar claim for a deduction. On or about 15 August 1974, the appellant borrowed $29,000 from Mr. Duvernet-Davis at a rate of interest which fluctuated but which appears to have been of the order of 12.5% per annum. It was found that:

"The appellant loaned the $29,000 to Listohan at 1 per cent interest and Listohan then loaned moneys to Weston at 1 per cent and in due course Weston invested a sum slightly larger viz. $30,000. In the ultimate, this investment of $30,000 was placed with F.N.C.B. Waltons Corporation at 12.5 per cent. The evidence is that the amount of interest paid to Mr. Davis was slightly in excess of that received from the investment of the amount borrowed."

As against the assessable income derived from the lending at 1% interest to Listohan, Mr. Ure sought to deduct the interest of the order of 12.5% which he paid to Mr. Davis.

There were guarantor's fees paid by Mr. Ure in connection with the first and third loans. It appears that Listohan became the legal owner of the Balmain property and mortgaged that property to Mr. and Mrs. Williams guaranteeing the due performance of Mr. Ure's obligations under the first lending agreement. Mr. Ure paid to Listohan an annual guarantor's fee of 2% of the amount of the Williams loan: $340 during the relevant income year. Weston, as the guarantor of the due performance of Mr. Ure's obligations under the third lending agreement, created in favour of Mr. Davis an equitable charge over the assets comprising the Joan Honeybourne Trust Fund. Mr. Ure paid to Weston an annual guarantor's fee of 2% of the amount of the Davis loan. During the income year he paid $580 accordingly. Mr. Ure also paid legal fees of $171 and a valuation fee of $74 in order to obtain the Williams loan. Mr. Ure sought to deduct the guarantor's fees, which he paid during the income year, and a proportion of the valuation and legal fees.

During the income year, Mr. Ure received $660 interest upon the moneys lent by him: $170 from Mrs. Ure, and $490 from Listohan. He sought to deduct from his assessable income an amount of $8,736, as appears from his return of income for the year ended 30 June 1976:

"Item 24. Interest and costs of borrowing

Loan from Herbert Russell Williams and Mary Magdalene Williams of Bayswater Road, Kings Cross.

Total expenses payable over term of loan (3 years)

$ $ $

Interest 5,100
Legal expenses 171
Valuation fees 74
Guarantor's fees 1,020

To be apportioned as follows:

Year ended 30th June 1974 1,414
30th June 1975 2,122
30th June 1976 2,122 2,122
30th June 1977 707 6,365

_____

Loan from Thomas Anthony Duvernet-Davis
Australian National University,
Canberra

Amounts paid during year ended
30th June 1976

Interest 4,037

580 4,617

Commonwealth Bank 1,997

_____ _____
8,736
_____"

The respondent Commissioner in making his assessment refused to allow the

deduction in full, stating in the adjustment sheet:

"Deduction for interest payments and expenses of borrowing reduced from $8,736 to $660 the balance being deemed to be expenditure of a private nature."

It is submitted that the interest paid by Mr. Ure in respect of the three loans is deductible as expenditure incurred by him in gaining or producing assessable income, being the $660 interest received from Mrs. Ure and Listohan. The first limb of s.51 is relied upon; it is not suggested that Mr. Ure carried on any relevant business.

Section 51 requires that a deductible expenditure be incurred "in" gaining assessable income, that is to say, it must be incidental and relevant to the gaining of that income (Ronpibon Tin N.L. and Tongkah Compound N.L. v. Federal Commissioner of Taxation [1949] HCA 15; (1949) 78 C.L.R. 47 at p.56). An outgoing of interest may be incidental and relevant to the gaining of assessable income where the borrowed money is laid out for the purpose of gaining that income (Federal Commissioner of Taxation v. Munro [1926] HCA 58; (1926) 38 C.L.R. 153 at pp.170, 171, 197; Texas Co. (Australasia) Ltd. v. Federal Commissioner of Taxation [1940] HCA 9; (1940) 63 C.L.R. 382 at p.468). The laying out of the borrowed money for the purpose of gaining assessable income furnishes the required connection between the interest paid upon it by the taxpayer and the income derived by him from its use.

In the present case a question arises as to whether it can truly be said that the incurring of interest charges at rates of 7.5%, 8.5%, 10% and 12.5% per annum is incidental to the gaining of income by way of interest at the rate of 1% per annum. The answer to that question does not turn directly upon the disparity in interest rates, but upon an examination of the purposes for which the money was laid out. The disparity in interest rates is itself eloquent to suggest the existence of purposes ulterior to the earning of interest at the rate of 1% per annum, and the evidence confirms the existence of further purposes. The loans of the borrowed moneys made by Mr. Ure were calculated to achieve the further purposes of providing some income to Mrs. Ure, of enhancing the profits of Listohan, of providing Mr. Ure and his family with the Epping residence at a nominal rental, and of enabling the Joan Honeybourne Trust to take the benefit of any increment in the capital value of the Epping property and to enjoy the rents and profits of that property when it became available for letting at a commercial rental.

Of course, the achievement of these further purposes required the co-operative action of Mrs. Ure, Listohan and Weston, but where a question arises as to the purpose for which money is laid out by a taxpayer, it is erroneous to exclude as irrelevant evidence of the use of that money, albeit by others, in conformity with arrangements made by the taxpayer. That is not to deny the separate identity of those who use the borrowed money, nor to attribute vicariously to the taxpayer the activities of others. It is simply to take some relevant factors into account in determining the purposes for which money is laid out. Those purposes do not depend upon the state of the taxpayer's mind but upon what the taxpayer in the circumstances of the case is ascertained to have done in using and arranging for the use of the borrowed moneys.

The purposes for which money is laid out is an issue of fact, turning upon the objective circumstances which human experience would judge to be relevant to the issue (cf. Magna Alloys and Research Pty. Ltd. v. Federal Commissioner of Taxation [1980] FCA 150; (1980) 80 ATC 4542 at p.4549). In the present case, there is an air of unreality about the proposition that the borrowed moneys were laid out wholly for the purpose of earning a return of 1% per annum. Rather is it right to say that the purpose for which the borrowed moneys were laid out included all the purposes earlier mentioned, only one of which was to earn a return of 1% per annum.

If the borrowed moneys had been laid out solely for the purpose of gaining assessable income, the interest would be wholly deductible; but as they were laid out in part for that purpose, and in part for other purposes, the interest charges must be apportioned. They are items of expenditure of the kind secondly described in the following passage in the judgment of the High Court in Ronpibon Tin N.L. and Tongkah Compound N.L. v. Federal Commissioner of Taxation (supra at p.59):

"It is perhaps desirable to remark that there are at least two kinds of items of expenditure that require apportionment. One kind consists in undivided items of expenditure in respect of things or services of which distinct and severable parts are devoted to gaining or producing assessable income and distinct and severable parts to some other cause. In such cases it may be possible to divide the expenditure in accordance with the applications which have been made of the things or services. The other kind of apportionable items consists in those involving a single outlay or charge which serves both objects indifferently. Of this directors' fees may be an example. With the latter kind there must be some fair and reasonable assessment of the extent of the relation of the outlay to assessable income. It is an indiscriminate sum apportionable, but hardly capable of arithmetical or ratable division because it is common to both objects."

Lee J. upheld the Commissioner's apportionment of interest and other charges. It will be necessary to return to the question of apportionment, but it is convenient first to refer to the guarantor's fees which were submitted to be deductible under s.51. Lee J. rejected that submission, holding that the guarantor's fees paid to Listohan and Weston were "expenditure necessary to obtain the loans", and that the obtaining of the guarantees was "a step preparatory to the earning of income". In reliance upon Canadian authority (Bennett & White Construction Limited v. M.N.R. (1949) Can.T.C.1), his Honour held that the guarantor's fees were expenditure of a capital nature. Some guarantor's fees may be of a capital nature, especially when they are paid once and for all as an expense in establishing a continuing facility, but in the present case the evidence (which was extremely sketchy) shows no more than annual payments to the guarantors. His Honour found (and the finding is not challenged) that the guarantor's fees were payable annually during the currency of the loan. Though a guarantor may be unable unilaterally to revoke his guarantee or to procure the discharge of any security he has given over his assets while the guarantee stands, an annual guarantor's fee may not be payable if the liability of the principal debtor is discharged during the year or if the guarantor fails to perform the obligations imposed by the contract of guarantee. The liability to pay and the time when it arises depend upon the terms of the agreement between the principal debtor and the guarantor. But if the annual fee be payable as consideration for the due performance of the guarantor's obligations during the year, that factor tends to stamp the fee with the character of a revenue payment: it is part of the price paid by the debtor for the use of the borrowed money during the period to which the payment relates. In the absence of any evidence as to the terms of the agreement relating to guarantor's fees between Mr. Ure on the one hand and Listohan and Weston respectively on the other, the inference I draw from his Honour's finding that the payments were annual payments is that each payment was the price not of the giving of the guarantee but consideration for the due performance of the guarantee during the period to which the payment relates. I would thus hold that each payment was of a revenue nature and the guarantor's fees fall to be apportioned under s.51 in the same way as the interest charges.

However, it was submitted that the guarantor's fees fell within s.67(1) and that a deduction calculated in accordance with that sub-section should be allowed. The sub-section provides:

"Subject to this section, so much of the expenditure incurred by the taxpayer in borrowing money used by him for the purpose of producing assessable income as bears to the whole of that expenditure the same proportion as the part of the period for which the money was borrowed that is in the year of income bears to the whole of that period shall be an allowable deduction."

The sub-section permits the apportionment over the period for which the money is borrowed of expenditure which has been incurred in borrowing the money. The sub-section does not permit the apportionment of expenditure which has not been incurred in borrowing the money. Once the money has been borrowed, no liability thereafter incurred qualifies for apportionment under the sub-section, for a liability to pay which is first incurred after the money is borrowed is not incurred in the borrowing. Of course, a payment made after the borrowing can qualify if it be made in discharge of a liability to pay antecedently incurred: Emu Bay Railway Co. Ltd. v. Federal Commissioner of Taxation [1944] HCA 28; (1945) 71 C.L.R. 596 at p.606; Federal Commissioner of Taxation v. Nilsen Development Laboratories Pty. Ltd. (1979) 79 ATC 4520. The respondent was not concerned to deny that the guarantor's fees had not been incurred at the time of the borrowing, but it follows from the view which I have expressed as to the character of the guarantor's fees that the liability to pay them arose annually. The liability to pay them had not arisen when the money was borrowed. Therefore, those fees do not fall within and may not be apportioned under s.67(1).

If the sub-section did not require that the liability to make the qualifying expenditure be complete when the money is borrowed, the incurring of a liability in later years would require the reopening of the accounts of earlier years in order to apportion to those earlier years an appropriate part of the expenditure so incurred. So incongruous an operation of the sub-section is avoided if it be construed as applying only to a liability to pay which is not incurred after the money is borrowed.

The legal and valuation fees, however, clearly fall within the classes of expenditure to which s.67(1) applies if those expenses were incurred by Mr. Ure in borrowing money "used by him for the purpose of producing assessable income". Although the purposes for which the borrowed moneys were laid out in the instant case included the use by others of the borrowed moneys, the only way in which Mr. Ure himself used the borrowed moneys was the lending of them to produce 1% interest being part of his assessable income. The "purpose" referred to in s.67(1) is not the purpose of the laying out of the borrowed moneys but the purpose of the use of those moneys in the hands of the taxpayer. Mr. Ure used the borrowed moneys for the purpose of producing assessable income and it follows that the legal expenses and valuation fees fall within s.67, and that a proportion of those expenses and fees are deductible.

The proportion of those expenses and fees to be deducted under s.67 is to be calculated mathematically, but the apportionment under s.51 of the interest and guarantor's fees requires "a fair apportionment to each object of the . . . actual expenditure" (Ronpibon Tin N.L. and Tongkah Compound N.L. v. Federal Commissioner of Taxation (supra at p.60). Lee J., though he held that interest alone might be apportioned and a part of it allowed as a deduction, nevertheless upheld the Commissioner's assessment. The Commissioner had allowed a deduction of $660 equivalent to the assessable income earned by the lending of the borrowed moneys without differentiating between the classes of expenditure for which a deduction was claimed. His Honour approached the question of apportionment under s.51 in a common sense way, holding that the interest paid by Mr. Ure was only fractionally related to the earning of the 1% per annum interest income, and that the interest paid by Mr. Ure was "essentially related to the ultimate use of the moneys for purposes unconnected with the production of assessable income." I agree. An object of the expenditure was to return to the taxpayer 1% per annum on the borrowed moneys: no more and no less. The expenditure to be apportioned must be taken to have been made principally for objects other than the earning of 1% per annum interest and in truth the borrowed moneys were used during the income year to achieve those other objects subject to the payment of $660 paid to Mr. Ure. Unless it were shown that the expenditure to be apportioned was a commercially unreasonable price to pay for the use of the borrowed moneys during the income year, it would not be fair to apportion to the object of earning the $660 any different amount. The balance which is thus apportioned to the other objects is a commercially reasonable price to pay for the use of the borrowed money in achieving those objects. I would not disturb his Honour's upholding of the Commissioner's allowance of a deduction of $660 in respect of expenditure falling within s.51.

But s.67, operating upon the legal expenses and valuation fees, requires the relevant proportion of these expenses of borrowing to be deducted and the assessment should be amended accordingly. To that extent, the appeal must be allowed. The respondent has largely but not entirely succeeded in the appeal. He should have a proportion of his costs both in this Court and in the Supreme Court, allowing some set off in respect of the costs of issues on which he failed. I would order that the appellant pay the respondent one-third of his costs of the appeal to the Supreme Court and of the appeal to this Court.

On or about 31 October, 1973, the appellant, who was at relevant times an employed solicitor, borrowed $17,000 from a Mr. and Mrs. Williams at a rate of interest of 10% per annum. We shall refer to this transaction as "the first loan". On or about 5 November 1973, the appellant and his wife jointly borrowed $17,500 from the Commonwealth Savings Bank at a rate of interest of 7.5% per annum and $2500 from the Commonwealth Trading Bank at a rate of interest of 8.5% per annum. As between the appellant and his wife, these two loans were treated as loans to the appellant who assumed full responsibility in respect of the repayment of principal and payment of interest under them. We shall refer to them collectively as "the second loan". On or about 15 August, 1974, the appellant borrowed $29,000 from a Mr. Davis at a rate of interest to be negotiated from time to time but which, in the event, averaged approximately 12.5% per annum. We shall refer to this transaction as "the third loan".

The moneys which the appellant borrowed, or, in the case of the second loan, which the appellant and his wife borrowed, were lent either to the appellant's wife (in the case of the first loan) or to a family company, Listohan Services Pty. Limited (in the case of the second and third loans). In each case, the rate of interest was 1% per annum. The taxpayer's wife re-lent the amount of the first loan to Listohan Services Pty. Limited ("Listohan") at a rate of interest of 10% per annum. Part of the proceeds of this loan from the appellant's wife was applied by Listohan in discharging a mortgage over a residence at Balmain of which that company was the beneficial owner. The balance of the first and second loan was lent by Listohan to another family company, Weston Park House Pty. Limited ("Weston"), in its capacity as trustee of a family trust. The moneys were applied by Weston towards the purchase of a residence at Epping, New South Wales. The property at Balmain was the home of the appellant and his wife. It was thought by them to be too small for their needs. The property at Epping was purchased as a new home. The proceeds of the third loan were also lent by Listohan to Weston in its capacity as trustee and were placed, by Weston, on interest bearing deposits with public companies. The rate of interest charged by Listohan in respect of the loans to Weston was that being paid by Listohan, namely, 10% per annum in the case of so much of the proceeds of the first loan as was lent to Weston and 1% per annum in the case of the proceeds of the second and third loans.

It is clear that the moneys which were borrowed by the appellant and by the appellant and his wife were borrowed for the objects to which they were applied. The explanation of why the appellant should borrow at rates of interest up to an average 12.5% per annum to lend at a rate of interest of 1% per annum is to be found in the appellant's desire to benefit his wife and the family trust at the same time as obtaining for himself the benefit of a tax deduction in respect of the legal expenses, guarantee fees and valuation fees incurred in relation to the loans and in respect of the interest which he paid on the borrowed moneys. The present appeal concerns the appellant's entitlement to the benefit of a deduction in respect of that interest and those fees and expenses. The relevant year of income is the year ended 30 June, 1976 ("the tax year").

The appellant claims to be entitled to deduct the whole of the interest and guarantee fees paid in the tax year pursuant to the provisions of s.51(1) of the Income Tax Assessment Act, 1936 ("the Act"). He claims to be entitled to deduct the appropriate proportion of valuation fees and legal costs paid in relation to the loans pursuant to the provisions of s.67 of the Act. If he is not entitled to deduct the interest and guarantee fees pursuant to s.51(1), he alternatively claims to be entitled also to deduct the appropriate proportion of those outgoings pursuant to s.67.

The total of the relevant deductions claimed by the appellant in his return for the tax year was $8,156 being the sum of $2,122 in respect of the first loan, $1,997 in respect of the second loan and $4,037 in respect of the third loan. The Commissioner allowed an overall deduction of $660 in respect of all three loans, that being equivalent to the amount of interest received by the taxpayer during the tax year on the loans made at 1% per annum to his wife and to Listohan. The Commissioner having disallowed an objection by the appellant, the appellant appealed to the Supreme Court of New South Wales. The Supreme Court (Lee J.) confirmed the assessment and dismissed the appeal. The appellant appeals to this Court from the decision and order of the Supreme Court.

Section 51(1) of the Act provides, so far as is material, that all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income shall be allowable deductions except to the extent to which they are losses or outgoings of capital or of a capital, private or domestic nature. It is common ground that the appellant was not carrying on any business at any relevant time. The primary issue between the parties, in so far as s.51(1) is concerned, is to what, if any, extent the interest and the guarantee fees were, for the purposes of the sub-section, losses or outgoings incurred by the taxpayer in gaining or producing the assessable income not being losses or outgoings of capital or of a capital, private or domestic nature. If they were partially, but not wholly, of such a character, a further question arises as to "the extent to which" they are deductible under the sub-section.

Lee J., in the New South Wales Supreme Court, held that, to the extent disallowed by the Commissioner, the payment of interest was an outgoing of a private or domestic nature. He also held that the payment of the guarantee fees was an outgoing of a capital nature. In the result, his Honour concluded that the only deduction allowable under s.51(1) was so much of the total interest paid as equalled the amount of interest which the taxpayer was entitled to receive on the re-lending of the money. His Honour also found that the taxpayer was not entitled to the benefit of a deduction pursuant to the provisions of s.67 of the Act.

In considering the deductibility, pursuant to s.51(1), of the interest paid by the taxpayer, it is important to be mindful of the fact that an outgoing which is claimed to have been incurred in earning assessable income is only deductible, pursuant to the sub-section, "to the extent to which" it was so incurred and "to the extent to which" it cannot properly be characterized as being of a private or domestic nature. Where an outgoing was partially so incurred or should be partially so characterized, the sub-section requires apportionment between what, not being of a private or domestic nature, should properly be regarded as incurred in earning the assessable income and what should not.

The fact that money is re-lent at a lower rate of interest than the rate at which it was borrowed does not necessarily mean that the liability to pay the interest cannot properly be seen as having been incurred wholly in earning the assessable income and as being of neither a private nor domestic nature. Even where no business is carried on, circumstances can obviously exist in which money borrowed wholly for the purposes of earning income by way of re-lending can only, in the event, be re-lent at a rate of interest lower than the rate payable in respect of the original loan. Again, notwithstanding the fact that it may always have been intended to re-lend borrowed money at a rate of interest lower than that payable in respect of the original borrowing, the liability to pay the interest may plainly have been wholly incurred in earning assessable income where it is expected or hoped that the re-lending will also lead to assessable income in another form being derived or preserved, such as, for example, dividends on shares held in the company to which the money is lent at a favourable rate. Yet again, plain miscalculation or lack of business understanding or anticipated subsequent lending at higher rates could conceivably lead to the position where it was plain that a liability to pay interest on borrowed money at a higher rate than the rate payable in respect of an immediate re-lending had been incurred wholly in earning assessable income.

In the present case however, there is neither suggestion of miscalculation or lack of business understanding nor suggestion of anticipation or hope of income being derived by the taxpayer either in another form or by way of interest at a higher rate. The money was borrowed by the taxpayer at rates of interest of up to 12.5% per annum with the object of being lent at a rate of interest of 1% per annum. The explanation of the lending at the lower rate is to be found in private and domestic considerations. These included the provision of financial benefits to the taxpayer's wife and to a family trust, the provision, in the case of the first and second loans, of a residence for the taxpayer and his family and the reduction of the taxpayer's taxable income. On the assumption that the Commissioner's concession that s.260 of the Act has no application in the circumstances is correct and in the absence of any relevant business being carried on, the appeal raises for consideration a question of principle of some importance. That question is whether the liability to pay interest on money borrowed is, for the purposes of s.51(1) of the Act, an outgoing wholly incurred in earning the assessable income not being of a private or domestic nature notwithstanding that the only assessable income which was ever received or in contemplation was interest to be received on a planned re-lending at a much lower rate than the rate payable in respect of the borrowing in circumstances where the explanation of the prima facie improvident conduct of the taxpayer is to be found in private or domestic considerations including a desire to minimize liability to pay income tax.

In Ronpibon Tin N.L. and Tongkah Compound N.L. v. Federal Commissioner of Taxation ((1949) [1949] HCA 15; 78 C.L.R. 47 at pp. 56-57) the Full Court of the High Court of Australia provided guidance on the meaning of the words "incurred in gaining or producing the assessable income" in the context of s.51(1) of the Act. Their Honours said:

"For the expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end. The words "incurred in gaining or producing the assessable income" mean in the course of gaining or producing such income. Their operation has been explained in cases decided under the provisions of the previous enactments: see particularly Amalgamated Zinc (de Bavay's) Ltd. v. Federal Commissioner of Taxation and W. Nevill & Co. Ltd. v. Federal Commissioner of Taxation.

Notwithstanding the differences in other respects in the present provision, the expression "incurred in gaining or producing the assessable income" has been left unchanged and bears the same meaning. In brief substance, to come within the initial part of the sub-section it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income".

The question whether an outgoing should properly be seen as being wholly or in part "incidental and relevant" to the "end" of gaining or producing the assessable income and the question whether the outgoing is wholly or in part of a private or domestic nature are both questions of characterization. Where liability to make the outgoing has been voluntarily incurred, those questions of characterization will ordinarily be determined by reference to "the object" which the taxpayer had in view (Latham C.J., W. Nevill & Co. Limited v. Federal Commissioner of Taxation [1937] HCA 9; (1937) 56 C.L.R. 290 at p. 301), the "result aimed at" by the taxpayer (per McTiernan J., ibid, at p. 308) or "the advantage which the expenditure was intended to gain, directly or indirectly, for the taxpayer" (per Gibbs J., Federal Commissioner of Taxation v. South Australian Battery Makers [1978] HCA 32; (1978) 140 C.L.R. 645 at p. 660) in the context of the relevant facts and circumstances. In the ordinary case where the income which is expected to flow from an outgoing offers an obvious commercial explanation for incurring it the relevant characterization can readily be determined by reference to the gaining or producing of that income. In the more complex case however, where there is no such obvious commercial explanation, the solution of the problem of characterization must be derived from a weighing of the many aspects of the whole set of circumstances including direct and indirect objects and advantages which the taxpayer sought in making the outgoing. Some of those circumstances may point in one direction, some in the other. In such a case, as was said by the Privy Council in B.P. Australia Limited v. Federal Commissioner of Taxation ((1965) 112 C.L.R. 386 at p. 397) in relation to the question whether a particular outgoing was of income or capital according to ordinary concepts, it is "a common sense appreciation of all the guiding features which must provide the ultimate answer".

In a case such as the present where the outgoing claimed as a deduction is interest paid on borrowed money, one cannot ordinarily look to the direct object or advantage which the outgoing was intended to achieve for the reason that that will ordinarily be the receipt of the borrowed money which is likely to be neutral in character. One must, of necessity, look more to the objects or advantages which the application and use of the borrowed money were intended to gain (Federal Commissioner of Taxation v. Munro [1926] HCA 58; (1926) 38 C.L.R. 153 at p. 197). Where there is a difference between intended and actual use of the borrowed money or a change in use, difficulties may arise in determining what are the relevant objects or advantages which the payment of interest was calculated to procure. These problems do not arise in the present case however for the reason that there is neither suggestion that there was any difference between the proposed and the actual use of the borrowed money or between the objects or advantages which the borrowed money was intended to achieve and those which it in fact achieved nor suggestion that there was ever any relevant change in the use of the borrowed money.

One of the most difficult aspects of the problem of characterizing an outgoing is the assessment of what, if any, weight is to be given to indirect objects which a taxpayer had in mind in incurring the outgoing. Such objects form part of the relevant circumstances by reference to which the problem of characterization must be resolved. There is however no rigid principle which can be applied in determining what, if any, weight should be given to them. In the ordinary case, such as, for example, where the immediate object achieved by the outgoing is the production of assessable income which is commensurate with the amount of the outgoing or where it is clear that the outgoing was for the purchase of stock-in-trade or the acquisition of services or hire of equipment used in earning assessable income, indirect objects or motives of a personal or domestic character will plainly not prevent the characterization of the outgoing as having been incurred in earning assessable income (see, for example, Cecil Bros. Pty. Limited v. Federal Commissioner of Taxation [1964] HCA 82; (1964) 111 C.L.R. 430; Phillips v. Federal Commissioner of Taxation [1978] FCA 28; (1978) 8 A.T.R. 783). In other cases, the immediate object or effect of an outgoing will not suffice either to explain or to characterize it. In such cases, indirect objects or motives can assume a sometimes decisive importance.

In the present case, it would be a misleading half-truth to say that the object which the taxpayer had in mind or the advantage which he sought in incurring the liability to pay interest at rates of 7.5% or more was the derivation by him of interest at the rate of 1% per annum by re-lending the money which he borrowed. That was, no doubt, an object which the taxpayer had in mind: it was an advantage which he sought. In the circumstances however, characterization of the outgoing cannot properly be effected by reference to that object or advantage alone. The incurring of the outgoing can only be explained by reference also to less direct objects and advantages which the taxpayer sought to achieve and which plainly were of paramount importance. These indirect objects or advantages were, in so far as the taxpayer was concerned, not of an income-earning character in that they involved the provision of accommodation for the taxpayer and his family, the financial benefit of the taxpayer's wife and a family trust and a reduction in the taxpayer's personal liability to pay income tax.

In the result, the outlays of interest can be seen as servicing a number of objects indifferently. The predominant, though indirect, objects were not concerned with earning assessable income for the taxpayer but were, for the purposes of s.51(1), of a private and domestic nature. The object of earning assessable income in the form of interest was present in a subordinate role. If, in these circumstances, apportionment were not possible and it were necessary to give a single characterization to the whole of the interest which was paid, we would conclude that the interest could not be characterized as having been incurred in earning assessable income and that its primary characterization was as being of a private or domestic character. It is however established that apportionment is, in these circumstances not only permissible but required.

In Ronpibon Tin N.L. and Tongkah Compound N.L. v. Federal Commissioner of Taxation (supra, at p. 59), their Honours said:

" . . . the provision contained in s.51(1), as has been already said, contemplates apportionment. The question what expenditure is incurred in gaining or producing assessable income is reduced to a question of fact when once the legal standard or criterion is ascertained and understood. This is particularly true when the problem is to apportion outgoings which have a double aspect, outgoings that are in part attributable to the gaining of assessable income and in part to some other end or activity. It is perhaps desirable to remark that there are at least two kinds of items of expenditure that require apportionment. One kind consists in undivided items of expenditure in respect of things or services of which distinct and severable parts are devoted to gaining or producing assessable income and distinct and severable parts to some other cause. In such cases it may be possible to divide the expenditure in accordance with the applications which have been made of the things or services. The other kind of apportionable items consists in those involving a single outlay or charge which serves both objects indifferently. Of this directors' fees may be an example. With the latter kind there must be some fair and reasonable assessment of the extent of the relation of the outlay to assessable income. It is an indiscriminate sum apportionable, but hardly capable of arithmetical or ratable division because it is common to both objects".

Applying the approach implicit in the above passage to the present case, it is necessary to apportion the outgoings in respect of interest between what can properly be regarded as incurred in gaining or producing assessable income and as not being of a private or domestic nature and what cannot properly be so regarded. Lee J., in the Supreme Court, reached the conclusion that the appropriate apportionment was to treat the equivalent of what the taxpayer received from re-lending ($660) as being not of a private or domestic nature and to treat the balance of the interest paid by the taxpayer as being of a private or domestic nature. We can see no reason for interfering with this approach or for declining to accept that sum as the appropriate amount to be apportioned to what was incurred in earning assessable income. In the result, we conclude that the sum of $660.00 paid by the taxpayer in the tax year on account of interest was incurred in earning assessable income and was not of a private or domestic nature. We conclude that the balance of the interest paid by the taxpayer was not incurred in earning assessable income and was of a private or domestic nature.

The claim for a deduction pursuant to s.51(1) in respect of the guarantee fees raises the additional question whether the outgoings in respect of them should properly be seen as outgoings of capital. These guarantee fees were paid in respect of the first and the third loans.

In relation to the first loan transaction, the advantage sought and obtained by the incurring of the obligation to pay guarantee fees was the provision by Listohan of a guarantor's mortgage over its Balmain property. In the third loan transaction, the advantage sought and obtained by the incurring of the obligation to pay guarantee fees was the provision by Weston of a guarantor's charge "by way of floating security" over the assets of the family trust. In each case, the guarantee and security were presumably given once and for all and would continue to subsist regardless of whether any guarantee fees payable by the taxpayer to the guarantor were paid. As, presumbly, the provision of security was essential in the case of each loan, the outgoings incurred to procure the guarantees and securities were expenditure for the establishment, rather than the maintenance, of the loans. They were expenses of obtaining the loan rather than part of the price payable to the relevant lender for the use of his money. It is common ground that the appellant was not carrying on a business involving the obtaining of loans.

All of the above considerations tend to support Lee J's conclusion that the guarantee fees should properly be characterized as outgoings of capital. The significant consideration tending to militate against that view is that the guarantee fees were apparently payable to the guarantors on an annual basis and were calculated by reference to a percentage of the principal of the relevant loan.

The bare fact that the guarantee fees were payable on an annual basis as a percentage of the principal of the relevant loan would not, as a matter of necessity, preclude their being characterized as outgoings of capital if other relevant factors were, on the assessment of all relevant considerations, found to warrant that conclusion. In the assessment of relevant factors, it would be important to know the precise nature and content of the agreement pursuant to which the guarantee fees were payable. No material containing that information is before this Court.

In these circumstances, we would, as at present advised, be disinclined to dissent from Lee J's conclusion that the guarantee fees should properly be characterized as outgoings of capital. It is, however, unnecessary that we form or express any final view on that question since, as will appear, we are of the view that a deduction pursuant to s.67 of the Act should be allowed in respect of the guarantee fees and it is clear that the considerations which lead us to accept Lee J's conclusion that only $660 of the interest was allowable as a deduction under s.51(1) would result in a lesser deduction being allowed pursuant to s.51(1) in respect of the guarantee fees than that which is allowable under s.67 or in the view being taken that the overall deduction under s.51(1) should not be increased beyond the $660. In the circumstances, it is plainly appropriate to allow the larger deduction under the special provisions of s.67 than any smaller deduction under the general provisions of s.51(1).

We turn to the consideration of the question of the taxpayer's claim to a deduction under s.67 of the Act in respect of the appropriate proportion of the interest which he paid in respect of all three loans and in respect of the guarantee fees, valuation fees and legal expenses which were incurred in relation to the first and third loans.

Section 67(1) of the Act provides:

"Subject to this section, so much of the expenditure incurred by the taxpayer in borrowing money used by him for the purpose of producing assessable income as bears to the whole of that expenditure the same proportion as the part of the period for which the money was borrowed that is in the year of income bears to the whole of that period shall be an allowable deduction".

Two broad questions arise for determination under this sub-section. The first is whether all or any of the interest, guarantee fees, the valuation fees and legal expenses were, for the purposes of the sub-section, "expenditure incurred by the taxpayer in borrowing money". The second is whether, if they were, the borrowed money was used by the taxpayer "for the purpose of producing assessable income". In the Supreme Court, Lee J. was of the view that the guarantee fees, valuation fees and legal expenses were, for the purposes of the sub-section, expenditure incurred by the taxpayer in borrowing money but that the interest did not constitute such expenditure. His Honour was, however, of the view that no deduction was properly allowable pursuant to s.67(1) for the reason that the purpose referred to in the sub-section was "the dominant purpose of the taxpayer in the use" of the borrowed moneys and that, in the circumstances of the present matter, it could not properly be said that the dominant purpose in the use of the borrowed moneys was gaining or producing assessable income.

The words "expenditure incurred . . . in borrowing money" in the context of s.67(1) of the Act, refer in our view, to the "cost" of the borrowing as distinct from the "cost" of the money. The expenditure on account of legal expenses and valuation fees was plainly a "cost" of the borrowing: it was incurred in relation to the actual establishment of the relevant loan. On the other hand, interest payable to the lender represented a "cost" of the money: it was the price payable to the lender for the use of the money lent. The legal expenses and valuation fees were, and the interest was not, "expenditure incurred . . . in borrowing money" for the purposes of s.67(1).

Ordinarily, we would have little hesitation in concluding that guarantee fees paid by a borrower in respect of a guarantee necessary for the establishment of a loan were expenditure incurred in borrowing the money for the purposes of s.67(1) of the Act. As has been mentioned however, the guarantee fees in the present case were not paid or payable in a single amount at the time of establishment of the loans. They were payable on a recurrent basis during the life of the loans. The question which arises is whether that factor precludes them from being properly regarded as expenditure incurred in borrowing money for the purposes of s.67(1). In our view, it does not.

It is true that the apportionment provisions of s.67(1) are ill-designed to deal with a case where the obligation to pay outgoings incurred in borrowing money is to pay either on a periodical basis or subsequently to the commencement of the loan. We do not, however, consider that that difficulty warrants the conclusion that a deduction is only allowable in respect of a cost of borrowing if the payment was either made or due at the time of the loan. In our view, it is unlikely that it was the legislative intent that the deductibility of expenditure incurred in borrowing should be governed by reference to whether actual payment was made or due at the time of the loan. It seems to us to be preferable to interpret the reference to expenditure incurred in borrowing as including payment to be made during the life of the loan pursuant to a contractual obligation which was incurred at the time of borrowing as an incident of establishing the loan.

While the evidence before the Court is unsatisfactory, we do not consider that the fact that the guarantee fees were payable to the relevant guarantor on an annual basis prevents the liability to pay them from being properly regarded, for the purposes of s.67(1), as having been incurred in borrowing the relevant money. Indeed, as we followed the argument, the respondent Commissioner did not advance any reason for interfering with Lee J's conclusion to that effect. We turn to the question whether the money borrowed was used in the manner required by the sub-section.

Section 67(1) does not refer to the use made by persons other than the taxpayer of the money borrowed by the taxpayer. It refers to the use made of that money by the taxpayer himself. In the present case, the only use which the taxpayer himself made of the moneys borrowed was to lend them either to his wife or to Listohan at a rate of interest of 1% per annum. In these circumstances, we consider that the moneys were used by the taxpayer for the purpose of earning assessable income. It follows that the taxpayer was entitled to a deduction, pursuant to s.67(1) of the Act, in respect of the appropriate proportion of the guarantee fees, valuation fees and legal expenses.

The precise mathematics of the application of the apportionment provisions of s.67 to the circumstances of the present matter were not debated before us. It was not, however, suggested by either party that there would be any practical difficulty in applying those provisions in the event that the taxpayer was found to be entitled to a deduction pursuant to the section or that the calculation of the relevant amount was not a matter which could conveniently be left to be dealt with by the Commissioner when amending the assessment. The relevant proportions will be one year over three years in the case of the first loan and one year over the deemed period of five years (s.67(1)) in the case of the third loan. The amounts to be apportioned will be the total of the guarantee and valuation fees and legal expenses payable over the period of three years in the case of the first loan and over the deemed period of five years in the case of the third loan. If, in the event, either loan does not subsist for the relevant period or deemed period, the upper limit of the total deductions allowable under the section will be the total of the fees and expenses which are, in the event, paid. We leave the actual calculation of the deductions under s.67 to be dealt with by the Commissioner when issuing an amended assessment.

In the result, the taxpayer was entitled to an overall deduction greater than the $660.00 allowed by the Commissioner. The appeal should be allowed, the order of the Supreme Court should be set aside and the assessment should be remitted to the Commissioner to be amended in accordance with these reasons for judgment.

In so far as costs are concerned, the Commissioner has succeeded on the principal question involving the taxpayer's entitlement to deductions under s.51(1) of the Act. The taxpayer has had partial success on the question of his entitlement to deductions under s.67 of the Act and has succeeded in establishing that the Commissioner's assessment was excessive. We are of the view that the appropriate order as to costs is that the taxpayer pays one third of the Commissioner's costs both in the Supreme Court and in this Court.