Re Commissioner of Taxation of the Commonwealth of Australia v Hunter Douglas Limited [1983] FCA 229; (1983) 78 FLR 182 (23 September 1983)

FEDERAL COURT OF AUSTRALIA

Re: THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
And: HUNTER DOUGLAS LIMITED [1983] FCA 229; (1983) 78 FLR 182
No. G174 of 1982
Taxation - Income Tax

COURT

IN THE FEDERAL COURT OF AUSTRALIA
NEW SOUTH WALES DISTRICT REGISTRY
GENERAL DIVISION
Franki(1), Fisher(2) and Lockhart(3) JJ.

CATCHWORDS

Taxation - Income Tax - Exchange loss by trading company - Whether deductible.

Income Tax Assessment Act 1936, sub-s.51(1)

Income Tax - Allowable deductions - Exchange loss by trading company on repayment of overseas borrowing - Funds used to meet revenue outgoings - Whether exchange loss deductible - Income Tax Assessment Act 1936 (Cth), s. 51(1). The taxpayer, which was engaged in the manufacture and marketing of building products, embarked on a program of expansion of its trading activities entailing an increased turnover. To finance this expansion, it borrowed funds from overseas banks. The funds were used exclusively to meet day-to-day outgoings of a revenue nature, such as wages, and were thus used as working capital in the ordinary business operations of the taxpayer. The trial judge held that these facts, which were not disputed by the Commissioner on appeal, required the conclusion that the exchange losses suffered by the taxpayer on repayment of the borrowings were of a revenue nature and therefore allowable deductions. From this decision the Commissioner appealed.

Held, Per Fisher and Lockhart JJ. (Franki J. dissenting): (1) - Whether foreign exchange gains or losses made in repaying loans are capital or revenue items must be determined with reference to the purpose of the borrowing which supports them.

Commercial and General Acceptance Ltd v. Federal Commissioner of Taxation (1977) 137 CLR 373; Avco Financial Services Ltd v. Federal Commissioner of Taxation [1982] HCA 36; (1982) 56 ALJR 668, explained.

(2) The particular use to which borrowed money is put is merely evidentiary of the purpose of the borrowing and not conclusive of it.

Commercial and General Acceptance Ltd v. Federal Commissioner of Taxation (1977) 137 CLR 373 at 384, per Mason J., referred to.

(3) The principal purpose of the borrowing in this case was to strengthen the business structure or organisation of the taxpayer to enable it to provide a stronger base or entity with which to carry on expanded business activities. The borrowings were thus not an integral part of the ordinary profit making activities of the taxpayer but were the means of financing its activities.

Avco Financial Services Ltd v. Federal Commissioner of Taxation [1982] HCA 36; (1982) 56 ALJR 668; Thiess Toyota Pty Ltd v. Federal Commissioner of Taxation (1978) 1 NSWLR 723; Federal Commissioner of Taxation v. Cadbury-Fry Pascall (Aust.) Ltd (1979) 37 FLR 126, distinguished.

Montreal Coke and Manufacturing Co. v. Minister of National Revenue (1944) AC 126 at 134 per Lord Macmillan, approved.

Per Franki J. (dissenting) - The exchange losses were in respect of borrowings in the ordinary course of business for the payment of day-to-day revenue outgoings and were thus an integral part of the carrying on of the taxpayer's income earning business and therefore allowable deductions under s. 51(1) of the Income Tax Assessment Act 1936 (Cth).

Avco Financial Services Ltd v. Federal Commissioner of Taxation [1982] HCA 36; (1982) 56 ALJR 668 and the cases cited therein; Thiess Toyota Pty Ltd v. Federal Commissioner of Taxation (1978) 1 NSWLR 723, referred to and discussed.

HEARING

Sydney, 1983, September 23. 23:9:1983
APPEAL.

Appeals from a decision of the Supreme Court of New South Wales (Rogers J.) allowing the taxpayer's appeals against the Commissioner's disallowance of the taxpayer's objections against assessments of income tax for the years ended 30 June 1977 and 1978.

C. S. C. Sheller Q.C. and J. M. Ireland, for the appellant.

R. J. Bainton Q.C. and D. H. Bloom, for the respondent.
Cur. adv. vult.

Solicitor for the appellant: B. J. O'Donovan, Commonwealth Crown Solicitor.

Solicitors for the respondent: Allen Allen & Hemsley.

F.P.C.

ORDER

1. The appeal is upheld.

2. The orders of the Supreme Court of New South Wales in Matters No. 668 and 669 of 1981 are set aside.

3. The assessments to income tax of Hunter Douglas Limited for the years ended 30 June 1977 and 30 June 1978 are confirmed.

4. Hunter Douglas Limited pay the costs of the Commissioner of Taxation of the Commonwealth of Australia of this appeal and of the proceedings in the Supreme Court of New South Wales.

Orders accordingly.

DECISION

I have had the opportunity of reading a draft judgment of Fisher J. who sets out the facts very fully and, although I have reached a different conclusion, I do not propose to set out the facts myself.

The appeal was put upon the basis that it was an "all or nothing situation" and no attempt was made by the Commissioner to separate the exchange losses into a part allowable under s.51 and a part which was not. It appears that the moneys obtained from the borrowings were paid into accounts which were overdrawn in most cases so that in most cases the moneys were in the first instance used to discharge an overdraft liability. The effect of this was that the overdraft limit was restored to the extent of the borrowed money and that that borrowed money was then almost in all cases used for ordinary day to day expenses such as, for example, wages, travel allowances, petty cash, telephone expenses and advertising. The Commissioner did not place any reliance upon the fact that in the first instance the moneys borrowed were in most cases used to reduce overdrafts. In my opinion the judgments in Avco Financial Services Ltd. v. Commissioner of Taxation [1982] HCA 36; (1982) 56 A.L.J.R. 668 would not support an argument that there was any significance in the proposition that the moneys borrowed were in most instances used for this purpose. In my opinion this is dealt with in the majority judgment in Avco at p.675 where it is said that:
"Borrowing other than for on-lending or for the repayment of funds borrowed for on-lending, that is, borrowing undertaken for capital rather than revenue purposes, as in CAGA, is an exception to the genral rule."
(Emphasis added)
It is clear that the view was taken that the repayment of funds borrowed for on-lending fell into the same category as borrowing for on-lending.

I proceed upon the basis that for all practical purposes the trial Judge found and the Commissioner was prepared to concede that the proceeds of all the drawdowns were devoted to the satisfaction of outgoings of the taxpayer's business of a clearly revenue nature.

It is appropriate to commence by ascertaining the basis upon which the Judge of the High Court reached their conclusions in Avco. That case was concerned with the question of deductibility under s.51(1) of the Act and the assessability under s.55 of the Act of certain exchange losses and gains. It was agreed between the parties that these losses and gains should be treated as having the same character and that both should be either of a capital or a revenue nature. The losses and gains had arisen out of the repayment of money borrowed in America. The taxpayer was a finance company.

I will deal first with the majority judgment of Mason, Aickin and Wilson JJ. The basis of the judgment in my opinion is clearly that the taxpayer applied the proceeds of its borrowing in its ordinary business. This was said at p.674 where it was also said:
"The taxpayer endeavoured in relation to its borrowings to raise funds in sufficient quantities to enable it to carry on its growing business of lending small amounts to consumers and to meet maturing repayments of its borrowings."

The majority judgment at p.675, referring to Tip Top Tailors v. Minister of National Revenue (1975) 11 D.L.R. (2d) 289 and Montreal Coke and Manufacturing Company v. Minister of National Revenue (1944) A.C. 126, continued:
"The majority judgments, as well as the dissenting judgment, in Tip Top Tailors, and the speech of Lord Macmillan in Montreal Coke recognize, rightly in our opinion, that the borrowing of money and the repayment of loans by a finance company in the ordinary course of its business stand in a different situation from borrowings by a company not undertaken in the ordinary course of its income earning business."

Reference was made at p.674 to the views of the trial Judge in that case that the borrowings were "an integral part of the ordinary operation of the taxpayer's business so as to represent a matter of revenue rather than capital". Frequent reference was made to the transactions being entered into by the taxpayer "in the ordinary course of its business" and forming "an integral part of that business" (p.677) or words to like effect. It was said on p. 678:
". . . we think that the better view is that the borrowings should be regarded as an integral part of the carrying on of the taxpayer's income-earning business."

Reference was made to a distinction which could be drawn between moneys borrowed by a finance company in the ordinary course of its business (p.677) and monies borrowed for some special purpose which excludes the use of the money in the ordinary course of the finance company's business. It was pointed out in the judgment that this was what happened in Commercial and General Acceptance Ltd. v. Federal Commissioner of Taxation (CAGA) 1977 137 C.L.R. 373. In that case the moneys were borrowed upon terms which prevented 65% of the moneys borrowed being used in the ordinary course of the company's business or as Gibbs C.J. said in Avco at p.671:
". . . the obtaining of the loan was not part of the process by which the company operated to obtain regular returns."
The majority judgment in Avco pointed out the similarity between money in the case of a finance company and stock in trade in the case of a trading company. In my opinion the judgment does not turn on this point but upon the point that the cost of borrowing was a cost incurred in the ordinary course of the taxpayer's business. At p.677 it was said:
"The true principle is that in the case of a finance company which borrows money overseas in the ordinary course of its business and not for some special purpose, the added cost of repayment in foreign currency caused by the devaluation or depreciation of the Australian dollar is an additional cost of the borrowing and, like other costs of the borrowing, is an allowable deduction under s.51(1)."
In my opinion the position must be the same in respect of money borrowed in the ordinary course of business for the payment of wages, stationery, telephone, and outgoings of a similar day to day basis.

The majority judgment also dealt with the question of interest and pointed out that, even where borrowing is of a capital nature, the interest on the money borrowed is deductible. The following passage appears in the majority judgment at p.675:
"The money lent, judged from the viewpoint of both borrower and lender, is in general capital; on the other hand, the interest payable on the money lent is generally income in the hands of the lender and a revenue outgoing in the hands of the borrower."

Reference was made to the judgment of Dixon J. (as he then was) in Texas Co. (Australasia) Ltd. v. Federal Commissioner of Taxation [1940] HCA 9; (1940) 63 C.L.R. 382. In that case the taxpayer, an oil company, purchased its petroleum products from its parent companies in the United States, and since its share capital was insufficient to meet its requirements for working capital, was allowed to delay payments in respect of the purchases in order to provide it with funds large enough for its needs. Before payment was made the rate of exchange moved against Australia. It was held that the fact that the increase in expenditure arose from a delay in payment designed to create a fund for working capital did not mean that the exchange loss was of a capital nature.

The following passage from Dixon J's judgment was cited in the majority judgment at p.676:
"Some kinds of recurrent expenditure made to secure capital or working capital are clearly deductible. Under the Australian system interest on money borrowed for the purpose forms a deduction. So does the rent of premises and the hire of plant."

A passage from the same judgment of Dixon J. was also cited to the effect that exchange losses or gains were ordinarily regarded as detachable from the fund borrowed. Gibbs C.J. in his judgment in Avco at p.671 pointed out that:
". . . it appears right, in a case such as the present, to regard exchange gains and losses resulting from the repayment of borrowed money as detachable from the borrowed fund, and as not necessarily sharing its character".

Gibbs C.J. came to the same view in Avco as the majority and, after dealing with CAGA and Texas, came to the conclusion that the exchange losses and gains were on revenue account.

The exchange losses in the case before us were an integral part of the carrying on the taxpayers income-earning business and in my opinion ought to have been allowed as deductions under s.51(1).

It is appropriate to refer to one or two other cases. I have already dealt with the facts in Texas where a delay in payment was held not to affect the position.

This principle was followed in Thiess Toyota Pty. Ltd. v. Commissioner of Taxation (1978) 1 N.S.W.L.R. 723 and extended to cover a case where a company importing motor vehicles paid for those vehicles with moneys advanced by a bank in the form of letters of credit in favour of the exporter in Japan, and the company had ninety days to reimburse the bank. It was held by Meares J. that the arrangements with the bank were all part of a transaction relating directly to, and having the purpose of, the purchase of trading stock and that the exchange gain was on revenue account and assessable income. This case was cited with approval by Gibbs C.J. in Avco.

The learned trial Judge said that the conclusion which he reached was more easily reached because in his view the losses in question should, in current economic circumstances, be perceived to be in essence in the nature of interest. It is of course clear that interest is generally a revenue outgoing. (See for example Avco at p.675). Whilst it is not necessary to reach this conclusion to reject the appeal it is an approach which appears to me to have a lot to commend it although not the basis upon which Avco was decided.

It is of course necessary to test the question of whether the outgoing is of a capital nature according to the principles discussed in Sun Newspapers Ltd. v. Federal Commissioner of Taxation [1938] HCA 73; (1938) 61 C.L.R. 337. The tests developed in that case were examined by the Privy Council in B.P. Australia Ltd. v. Commissioner of Taxation (1965) 112 C.L.R. 386, particularly at p.394. In that case the Privy Council decided that a lump sum, related to the amount of petrol sold in a period of not less than three years, paid to a petrol retailer who would tie himself to the sale of approved brands of petrol only for that period was allowable under s.51(1). The average period was something under five years and the predominant number of agreements was for a five year period.

If it be necessary that exchange losses be of a recurrent nature then I am satisfied that the losses in this case are of a sufficiently recurrent nature to satisfy that requirement. In Avco certain of the amounts borrowed were for a period varying from one to five years and no member of the Court appears to have thought that this was sufficient to put those borrowings in a category which prevented exchange losses on repayment being allowable.

I would dismiss the appeal with costs.

These are two appeals by the Commissioner of Taxation ("the Commissioner") against the allowance by the Supreme Court of New South Wales of appeals by Hunter Douglas Limited ("the taxpayer") referable to income tax assessed for the years of income ended 30 June 1977 and 30 June 1978. The taxpayer had objected to the disallowance by the Commissioner in each of these years of deductions claimed in respect of losses suffered by it on currency exchange. The appeals, both before the Supreme Court and this Court, were by consent heard together.

The facts are not in dispute and what follows is taken primarily from the reasons of the trial judge. The taxpayer is engaged in Australia in the business of development, manufacture and marketing of window covering, home improvement, casual living, architectural and building products. It has as its majority shareholder a company resident in the Netherlands. In 1971 the taxpayer became aware, its Group Accountant said, that it would require additional finance to provide funds for the day to day running of its business because it was proposing an expansion of its activities, which expansion entailed increased turnover. To support the increased turnover the taxpayer felt it necessary to increase its working capital, in order to avoid what was termed a cash flow or liquidity problem during the period of its expansion. Although it had credit facilities with a number of banks in Australia the taxpayer was not satisfied that these facilities would provide sufficient funds for its expansion. This expansion and increasing turnover did in fact occur from 1971 up to the years in question. The taxpayer therefore made approaches seeking additional finance during 1971 from two overseas banks.

On 1 February 1972 Banque Europeene De Credit a Moyen Terne S.A. of Brussels ("B.E.C.") and Amsterdam - Rotterdam Bank N.V. of Amsterdam ("the Dutch Bank") entered into an agreement with the taxpayer to grant a loan of U.S. $2,000,000. The agreement recited that the loan was to be for a period of 7 years, and that the borrower accepted the loan for the purpose of financing investments in Australia. The taxpayer was entitled during the first 3 years of the loan to draw funds in multiples of U.S. $100,000 with a minimum amount of U.S. $200,000 and to repay amounts so drawn on 5 days notice. During this period a commitment fee of half of one percent per annum was payable on any part of the facility not drawn on 1 February 1972. This commitment fee was not payable subsequent to 1 February 1975 on which date any amount not drawn ceased to be available. As mentioned, the loan was for a period of 7 years, later extended to 10 years, and the amount drawn on 1 February 1975 was due for repayment no later than 1 May 1979. Interest was payable six monthly calculated "on the basis of the offered quotation to first class banks for deposits in the appropriate currency for a period in accordance with the previous paragraph plus one percent per annum", that is at an interest rate one percent higher than banks were from time to time lending to each other.

The taxpayer was entitled to switch the currency in which the loan was drawn, and it took advantage of this option. Repayment of the loan was to be made in the currency in which it was borrowed. The remaining provisions have little if any relevance to the matters before us, except to note that B.E.C. was the bank with which the taxpayer dealt and that the participation of the Dutch Bank can be disregarded for all practical purposes in respect of this loan.

The taxpayer drew on this loan in Swiss francs on 9 July and 9 November 1973 and in United States dollars on 19 July, 1 August and 19 August 1974. The first of these drawings was converted to Dutch guilders on 10 January 1977 and the drawing on 9 November 1973 was partly converted to Dutch guilders on 26 January 1977. The amounts drawn and the dates of repayment and the amounts repaid under B.E.C. loan were set out in a schedule before the trial judge. It is convenient to reproduce this schedule although only a portion thereof has direct relevance to these proceedings.
"Banque Europeene De Credit

Drawn 9.7.73 Swiss Francs 1,150.000

Australian Dollars 288,220
10.1.77 Converted to
Dutch Guilders
1,149,080

Repaid 11.7.78 456,255 168,035

Exchange loss

Drawn 9.11.73 Swiss Francs 1,500,000

Australian Dollars 321,130

Repaid 25.1.77 Swiss Francs 388,869 143,056

Exchange loss <59,804
26.1.77 Converted balance
to Dutch Guilders
1,115,408.85

Repaid 27.6.78 439,310

Exchange loss 201,432

Drawn 10.7.74 U.S. Dollars 300,000

Australian Dollars 201,342

Repaid 20.7.78 262,192

Exchange loss 60,850

Drawn 1.8.74 U.S. Dollars 200,000

Australian Dollars 134,228

Repaid 30.8.78 174,049
Exchange loss 39,821 Drawn 19.8.74 U.S. Dollars 600,000

Australian Dollars 402,766

Repaid 28.7.78 523,789
Exchange loss 121,023

The transactions which identify the exchange losses under this loan which the taxpayer claims to deduct are as follows, with the amounts claimed as deductions underlined:
"Drawn 9.11.73 Swiss Francs 1,500,000

Australian Dollars
equivalent $321,130

Repaid 25.1.77 Swiss Francs 388,869

Australian Dollars
equivalent $143,056
Exchange loss $59,804
26.1.77 Balance converted to
Dutch Guilders 1,115,408

Repaid 27.6.78 Australian Dollars $439,310
Exchange loss $201,432"

It is apparent that throughout the term of the loan the Australian dollar depreciated against the currencies in which the loans were denominated and that upon repayments being made a larger number of Australian dollars was required to be provided than was originally borrowed.

In the middle of 1973 the taxpayer became aware, as related by the Group Accountant and as found by the trial judge, that additional credit facilities were required for the purpose of providing further "working capital". These facilities were not available in Australia. In July 1974 the Dutch company which held the majority of the shares in the taxpayer entered into a loan agreement dated 3 July 1974 with Orion Term Bank Limited of the United Kingdom ("Orion"). This agreement provided that the credit facility of U.S. $6,000,000 thereunder could in certain circumstances be drawn by a subsidiary of the borrower either in United States dollars or any other freely convertible Euro currency. The borrower was entitled from time to time to draw against the loan in multiples of U.S. $100,000 but with a minimum amount of U.S. $300,000 and repayment was to be made in the currency in which the particular borrowing was at the time of borrowing then denominated. In this instance the rate of interest payable by the borrower was three quarters of one percent over the interbank rate quoted for dollars of the particular currency in which the borrowing was denominated. All transactions under this loan were in United States dollars which during the period of the loan appreciated as against the Australian dollar. The consequence again was that on each repayment a loss was suffered by the taxpayer which had, as an "additional borrower" under the loan agreement, drawn the funds. The transactions between the taxpayer and Orion were also conveniently set out in a schedule as hereunder.
"Orion Bank Limited, London

Drawn 4.12.74 U.S. Dollars 1,000,000 Australian Dollars 759,301 Repaid 30.8.78 869,565 Exchange loss 110,264 Drawn 13.12.74 U.S. Dollars 500,000 Australian Dollars 378,530 Repaid 14.12.77 442,752 Exchange loss 64,222 Drawn 22.8.75 U.S. Dollars 1,000,000 Australian Dollars 779,606 Repaid 27.9.78 867,679 Exchange loss 88,073"

For the purpose of these appeals we are concerned with the drawing under the Orion loan of U.S. $500,000 made on 13 December 1974 and repaid on 14 December 1977 which produced an exchange loss of $64,222. The taxpayer claimed to deduct this amount of $64,222 from its assessable income for the year of income ending 30 June 1978 in addition to $201,432 being the exchange loss incurred in repaying a B.E.C. loan on 27 June 1978. For the year ended 30 June 1977 an exchange loss under a B.E.C. loan of $59,084 was claimed as deductible and in each instance the Commissioner by assessment or amended assessment disallowed the claim. Upon disallowance by the Commissioner of its objections, the taxpayer required the Commissioner to treat them as appeals and forward them to the Supreme Court of New South Wales.

The essence of the case for the taxpayer was that by reason of the use to which the borrowed moneys were from time to time put by the taxpayer, the exchange losses were of a revenue nature and were not losses of capital. This use and the purpose of the borrowings were described in the following terms by the Group Accountant Mr. Barlow in his affidavit.
"36. All drawdowns of the B.E.C. Loan and the Orion Loan referred to above were made on the basis of the budget projections prepared by the Company during the period in which the drawdowns were made as part of its usual financial planning. At the end of each month these six-monthly projections were prepared using the annual Budget adjusted to current and projected trends showing the anticipated cash position of the Company for a period of six months ahead. Drawdowns on the credit facilities provided by B.E.C. and Orion were made where these projections showed a cash deficiency and other local finance was not available.

37. All drawdowns of the B.E.C. Loan and the Orion Loan were used by the Company for the purpose of providing funds for the day-to-day running expenses of the Company's business in respect of the itemised expenses in the Schedules annexed hereto. Some of these payments may have been non-deductible to the Company but the great balance of payments consisted of the payment of amounts which were deductible to the Company in determining its assessable income."

Each drawing after conversion into Australian dollars was paid into one or other of the current accounts which the taxpayer held with its Australian bankers.

The taxpayer gave details in the schedule referred to in paragraph 37 above of all cheques drawn on and payments made from the relevant bank account during the month immediately prior to crediting the drawing and the month subsequent thereto. The trial judge found and the Commissioner was prepared to concede for the purpose of these appeals that the proceeds of all the drawings were devoted to the satisfaction of outgoings of the taxpayer's business of a clearly revenue nature. He further found that the monies were utilised as working capital in the course of the taxpayer's business. It was on the basis of these findings of fact which were not disputed before us that the trial judge came to his conclusion that the exchange losses incurred on repayment of the loans were on revenue account and therefore allowable deductions to the taxpayer.

The trial judge was of opinion that this conclusion was the necessary consequence of his finding that the monies were utilised as working capital in the taxpayer's business. He said:
"It (the working capital) was utilised in the activities by which the taxpayer earned its income.

Applying as best as I can the principles I have mentioned to the purpose and nature of the transaction, I am of the view that the borrowings in question were just as clearly required for application in the taxpayer's business of satisfying day-to-day outgoings as was the utilisation of borrowed funds in Avco. True it is that the moneys themselves were not paid out as loans, but they were utilised in enabling the profits of the taxpayer to be earned."

It is clear that the trial judge concluded that the exchange losses were on revenue account because of the use which the taxpayer made from time to time of drawings of the borrowed funds. He saw them as being applied directly in the payment of the day to day business expenses of the taxpayer and therefore held that the exchange loss which occurred when the particular drawing was repaid was deductible. He did not regard the drawings as a means of financing the business of the taxpayer but rather that they were utilised in enabling the profits of the taxpayer to be earned. He thus saw them as having the same characteristics as drawings by a finance company as in the Avco case (Avco Financial Services Limited v Commissioner of Taxation [1982] HCA 36; (1982) 56 A.L.J.R. 668).

I however regard the purpose of the borrowings as being of more assistance in establishing the character of the loan transactions and the exchange losses incurred on repayments thereunder and in determining whether they are on capital or revenue account. The use which a borrower in fact makes from time to time of borrowed funds and the purposes for which it applies them is not necessarily conclusive of the purpose or character of the borrowing. This character will depend upon the purpose for which the borrowing is made e.g. to strengthen the capital structure of the company and also the use which the company makes generally of borrowed funds in its profit earning activities. The crucial question will frequently be whether the company uses the borrowed funds to finance its profit earning activities or as an integral part of such activities.

It is my opinion that two matters support the finding that the borrowings here were on capital account and that the exchange losses were not detachable and thus on revenue account. The purpose of the borrowings was to finance the expansion of the taxpayer's business and to provide the additional working capital which this expansion required. Thus the borrowing transactions themselves were not on revenue account. Furthermore the funds borrowed were not used in or as an integral part of the profit making activities of the taxpayer i.e. as part of the process by which it operated to obtain its regular returns but in the financing of such activities. In particular they were undertaken with a view to expanding such activities.

These borrowings may in fact have been used to pay the day to day expenses, or in reimbursing a bank account from which such expenses were paid. However in my opinion this does not determine conclusively the part that borrowed funds played in the profit making activities of the taxpayer or the true character of the loan transactions. The words of Mason J. in the CAGA case (Commercial and General Acceptance Ltd. v Federal Commissioner of Taxation (1976) 137 C.L.R. 373) are in point. He said at page 384:
"No doubt the effect of the loan was to enable the taxpayer to divert other funds into the more profitable channels of its finance business, but this does not affect the character of the loan transaction itself."

The evidence of the Group Accountant in cross-examination is of relevance. I refer in particular to the following questions and answers:
"Q. Would it be correct to say that during the period from 1971 through to 1975, in fact the company's business did expand?
A. To the best of my recollection, yes sir.
Q. And would it be correct to say that in making those forecasts in 1971, the company was taking account of the forecast expansion?
A. Forecast expansion, to the extent of increased turnover.
Q. And as part of that increased turnover, it was felt necessary to increase the working capital?
A. Yes sir.
Q. And it was recognised that unless that could be done, there might be cash flow problems?
A. Yes.
Q. Or liquidity problems?
A. Yes.
Q. Now again, you say that it became obvious, based on the company's budgets and cash forecasts, that the company would require additional credit facilities for the purpose of providing working capital?
A. Yes.
Q. And again is it right to say that that forecast was based on a continued anticipated expansion of the company's business?
A. It would have been.
Q. And on the basis of that, I think in July 1974 the arrangement was made whereunder the Orion finance could be used by the company?
A. That is correct.
Q. So again would it be right to say that these forecasts were looking at working capital on a fairly long-term basis?
A. Yes."

The trial judge treated the use which the taxpayer made of the borrowed funds as equivalent to the use which the finance company made of such funds in the Avco case. It is my opinion that the use which the taxpayer on the one hand and Avco on the other made of borrowed funds was very different and does not warrant the same conclusion in each instance.

Counsel for the Commissioner distinguished, in my opinion correctly, the Avco case on the ground that the High Court there had under consideration the activities of a finance company which used its borrowings directly in the course of its profit earning activities as though they were trading stock. In the present matter the borrowings and their repayment, counsel contended, were not on revenue account because they were not part of the profit making process. Reliance was placed on the classic statement of the difference between outgoings on capital and revenue account of Dixon J. (as he then was) in Sun Newspapers Limited v Federal Commissioner of Taxation [1938] HCA 73; (1938) 61 C.L.R. 337 at page 359 where he contrasted the strengthening of "the business entity, structure or organization set up or established for the earning of profit" with the process by which the organisation operated to obtain regular returns.

In my opinion the High Court in Avco was at pains to distinguish the position of a finance company from a trading or manufacturing company and to reiterate that in the latter instance unless the repayment was of itself on revenue account and thus deductible, the exchange loss was not deductible. In this case the taxpayer did not argue that the borrowings themselves were on revenue account i.e. the receipt being assessable income and the repayment an allowable deduction. Rather it was said that the exchange loss was detachable from the capital sum repaid and was on revenue account.

The words of Mason J. in the CAGA case at page 383, if adapted to apply to an exchange loss, indicate the essential features of an exchange gain or loss. He said:
"The exchange gain was in reality a saving or reduction in the amount of Australian currency equivalent which the taxpayer required to repay its indebtedness. In essence it was a windfall advantage stemming from a reduction in a liability to repay a borrowing of capital."
In this matter the exchange loss was an increase in the amount of Australian currency required to repay the borrowing. It was a windfall disadvantage stemming from an increase in the liability to repay.

The usual situation is that the treatment of an exchange gain or loss for income tax purposes depends upon the character of the payment i.e. whether it is on capital or revenue account and thus whether or not it is an allowable deduction for such purposes. As Gibbs C.J. said in the Avco case at page 671,

"It does seem true to say, at least in general, that if an amount payable by a taxpayer is allowable as a deduction, then any increase or decrease in that amount caused by a variation in the rate of exchange is to be taken into account as an allowable deduction or as assessable income."

This proposition has particular application when trading stock is acquired and also doubtless services. However on repayment of a loan the general position is that the exchange gain or loss is on capital account. But this is not always the case (see the Avco case per Gibbs C.J. at page 671 and Mason, Aickin and Wilson J.J. at page 675). As the Chief Justice said on that page it will depend upon "The direct application of the tests formulated in Sun Newspapers Limited and Associated Newspapers Ltd. v Federal Commissioner of Taxation". It was the application of these tests which led the High Court to the conclusion in the CAGA case that the foreign exchange gain there was not on revenue account and not assessable and in the Avco case that the gains or losses were on revenue account and thus assessable or deductible, as the case may be Counsel for the Commissioner urged on appeal that these tests be applied in this matter. It was necessary, he said, for the Court to determine whether the borrowing of money by the taxpayer was part of its day to day profit earning process. If it was not, this would determine the purpose of the borrowing and the fact that the exchange losses were not on revenue account. The fact that the taxpayer was not a finance company borrowing for the purpose of lending to its customers nor were its borrowings linked with the purchase of trading stock means that it can not bring itself within two apparent exceptions to the general principle that exchange losses on repayment of loans are on capital account. Thus its situation can be distinguished from cases in which trading stock is bought in foreign currency which appreciates before payment is made. These cases are referred to in the CAGA case by Mason J, at page 385 and Gibbs J. in the Avco case at page 670 and need not be further discussed.

Two additional cases are Thiess Toyota Pty. Ltd. v Commissioner of Taxation (1978) 1 N.S.W.L.R. 723 and Federal Commissioner of Taxation v Cadbury-Fry-Pascall (Australia) Ltd. 1979 A.T.C. 4,346. In respect to each of these cases it can be said, in the words of Jenkinson J. in the Cadbury-Fry-Pascall case at page 4,351, that the repayment was "in substance part of the regular outlay of the respondent (taxpayer) for raw materials regularly acquired by it". In that case, from which the trial judge said he gained much assistance, the repayments in reduction of a loan were essentially "part of the regular outlay" of the taxpayer for raw materials regularly required and thus made on revenue account. It is significant that the court's attention was there directed to the true nature of the repayment and this accords with the approach of Gibbs C.J. in the Avco case.

Gibbs C.J. at page 671 of Avco referred with approval to the decision of Meares J. in the Thiess Toyota case when illustrating the difficulty in accepting that exchange losses or gains on borrowings are always on capital account. He said:
"The difficulty of adhering to the view that exchange gains and losses resulting from the repayment of borrowed money must always be of a capital nature is made manifest by comparing the case in which a taxpayer who regularly buys trading stock has ninety days after each delivery in which to pay the supplier, with the case in which the taxpayer arranges with his bank to pay the supplier each time a delivery is made and has himself ninety days in which to pay the bank. The authorities cited show that a gain or loss resulting from a change in the rate of exchange during the ninety days would be on revenue account in the former case. It would be anomalous if the gain or loss was on capital account in the latter case. In Thiess Toyota Pty. Ltd. v Commissioner of Taxation (1978) 1 N.S..W.L.R. 723, where a company which sold motor vehicles paid for the imported vehicles with moneys advanced by a bank in the form of letters of credit in favour of the exporter in Japan, and the company had ninety days to reimburse the bank, it was held by Meares J. that the arrangements with the bank were all part of a transaction relating directly to, and having the purpose of, the purchase of trading stock and the exchange gain was on revenue account and assessable income."

The fact that a finance company may in respect of its borrowings be in a different position from a manufacturing or trading company is made very clear by the High Court in the CAGA case and the Avco case. In the CAGA case because the principal purpose of the borrowings was to strengthen the taxpayer's business structure and was not part of the process by which it operated to obtain regular returns the High Court held that the borrowings were on capital account and the exchange gain was assessable. By way of contrast in the Avco case the borrowings in question were held to have been undertaken in the ordinary course of the taxpayer's income-earning business and the resultant exchange losses or gains were deductible or assessable. In that case the High Court went to lengths to indicate the special position of a finance company borrowing as part of its day to day operations for the purpose of re-lending. Gibbs C.J. referred to the circumstances of a finance company on page 672 when he said:
"Where a taxpayer carries on the business of borrowing and lending money, the moneys used for that purpose are analagous to trading stock - the taxpayer in effect deals in the money. Exchange gains and losses, regularly and frequently made and incurred, in the course of making repayments of borrowed money which is used by a taxpayer in making loans in the course of its finance business are outgoings made in the day to day conduct of the business and for the purpose of carrying on the business as a going concern. . . The exchange losses were in my opinion losses on revenue account, and of course the gains have the same character."
Mason, Aickin and Wilson J.J. acknowledged the different situation of a finance company on two occasions in their reasons for judgment. On page 675 they said:
"The majority judgments, as well as the dissenting judgment, in Tip Top Tailors, and the speech of Lord Macmillan in Montreal Coke recognize, rightly in our opinion, that the borrowing of money and the repayment of loans by a finance company in the ordinary course of its business stand in a different situation from borrowings by a company not undertaken in the ordinary course of its income-earning business. . . There is therefore an important and material difference between borrowing by a finance company in the ordinary course of its business and borrowing by a manufacturing or trading company."
On page 676 they said:
"With respect to those who think otherwise, the proposition that exchange variations affecting the repayment of loans in foreign currencies are always an affair of capital in the case of a finance company is supported neither by principle nor by authority. . . Like the borrowing transactions with which they are associated, the foreign exchange transactions are entered into by the taxpayer in the ordinary course of its business and form an integral part of that business. The gains and losses made and sustained in these transactions are therefore made in the ordinary course of carrying on that business, the more so because the gains and losses are an ordinary incident of transactions of this kind."

The position is different where the company is not a finance company but a trading or manufacturing company which incurs exchange losses or gains otherwise than through the purchase of trading stock. Here the losses or gains will in the ordinary course be on capital account. For them to be on revenue account it is necessary for the taxpayer to establish that the additional expenditure to meet exchange losses was expenditure incurred in the process of producing its income, and in the words of Mason, Aickin and Wilson J.J. in Avco set out above, as an integral part of that process. It is not sufficient, with all respect to the learned trial judge, to rely upon the finding that in fact the borrowed monies were used to satisfy day to day outgoings. The borrowings in such a case are prima facie an addition to the capital employed in the business.

This is made clear by the joint judgment in Avco at page 675 when citing the passage from the judgment of Latham C.J. in the Texas case at page 428 where he said that ". . . 'no exchange. . . should be allowed' in respect of 'remittances sent by the Company to America in repayment of moneys lent'. . . " Mason, Aickin and Wilson J.J. went on to say
"Latham C.J.'s observation, . . . was not directed to the situation of a finance company. It reflects the view that a loan and the repayment of a loan are generally an affair of capital. And so they are."

The joint judgment then cited from the judgment of Menzies J. in Caltex at p.251: "Borrowing money to carry on business or to pay liabilities incurred in carrying on business is prima facie to increase the capital employed in the business. . . " Even more on point in the present matter are the remarks of Lord Macmillan in Montreal Coke and Manufacturing Company v Minister of National Revenue (1944) A.C. 126 at p.134.
"It is not the business of either of the appellants to engage in financial operations. . . Of course, like other business people, they must have capital to enable them to conduct their enterprises, but their financial arrangements are quite distinct from the activities by which they earn their income."
The joint judgment commented:
"The consequence was, in Montreal Coke, to use the words of Lord Macmillan, that 'expenditure incurred in relation to the financing of their businesses is not. . . expenditure incurred in the earning of their income'."

In my opinion this reference to expenditure incurred in relation to the financing of a business indicates the correct conclusion on the facts of this matter. Stated in terms of the above extracts from the joint judgment in Avco the correct finding is that the borrowing of the moneys and the repayment thereof in this matter was expenditure in relation to the financing of the taxpayer's business by augmenting its working capital. It was money borrowed to pay liabilities incurred in carrying on and expanding the business, as part and parcel of the taxpayer's financial as opposed to its trading activities. The borrowings and their exchange losses were not an integral part of the ordinary operation of the taxpayer's business. They were borrowings arranged for special purposes, on only two occasions, and in consequence the obligation to make repayments was not an obligation regularly or frequently incurred. The borrowings resulted in relatively few transactions over the period from 1972 to 1978 and were of an exceptional nature rather than normal day to day occurrences. The evidence discloses 8 repayments in approximately 5 years on the B.E.C. loan and 3 repayments in about 4 years on the Orion loan. In my opinion the borrowings and repayments were not on revenue account.

In my opinion the two appeals should be allowed and the Commissioner's assessments restored. The respondent taxpayer must pay the Commissioner's costs.

These appeals raise the familiar question whether exchange losses suffered by a company in repaying overseas loans are a capital or revenue item.

Due to fluctuations in foreign exchange rates of the Australian dollar the taxpayer sustained exchange losses during the fiscal years ended 30 June 1977 and 30 June 1978 upon repayment of borrowings made by it in foreign currency.

The Commissioner disallowed deductions claimed by the taxpayer in respect of these currency losses, contending that they were capital losses. The taxpayer appealed to the Supreme Court of New South Wales which allowed the appeal, holding that the losses were of a revenue nature. The Commissioner then appealed to this Court. The facts are set out in the judgment of Fisher J., so I will not repeat them.

Losses incurred as a result of fluctuations in foreign exchange rates are deductible under sub-s. 51(1) of the Income Tax Assessment Act 1936 as amended ("the Act") to the extent to which they are incurred in gaining or producing the taxpayer's assessable income or are necessarily incurred in carrying on his business for the purpose of gaining or producing such income. Gains incurred as a result of fluctuations in the exchange rate will be assessable under sub-s. 25(1) of the Act if they are income according to ordinary concepts. In determining whether a payment by a taxpayer has a capital or revenue nature, consideration must be given to various matters including the character of the advantage sought by the payment, the manner in which it is to be used and the means adopted to obtain it: Sun Newspapers Limited v. Federal Commissioner of Taxation [1938] HCA 73; (1938) 61 C.L.R. 337 per Dixon J. (at p.363).

In the present case the foreign exchange losses were suffered as an incident of the repayment of loans made to the taxpayer. The advantages sought by the repayments were periodic reductions in outstanding overseas loans and corresponding reductions of the liability to repay them. Exchange losses are in reality an addition to the amount of Australian currency which a borrower requires to repay his foreign indebtedness. Similarly an exchange gain is a reduction in the amount of Australian currency which a borrower requires to repay his foreign indebtedness.

Whether foreign exchange gains or losses made in repaying loans are capital or revenue items must be determined with reference to the purpose of the borrowing which supports them. They must in my view assume the same character as the borrowings which give rise to them: Commercial and General Acceptance Limited v. Federal Commissioner of Taxation (1976) 137 C.L.R. 373 and Avco Financial Services Limited v. Commissioner of Taxation [1982] HCA 36; (1982) 56 A.L.J.R. 668. If an amount payable by a taxpayer is allowable as a deduction then any increase or decrease in that amount caused by a fluctuation in the exchange rate will also be an allowable deduction or assessable income as the case may be.

The purchase of foreign currency by an Australian taxpayer to repay a loan that was obtained from an overseas lender will be a revenue item if the loan was itself part of the taxpayer's trading activities.

In general, loans and repayments of loans are considered to be on capital account:
"Borrowing money to carry on business or to pay liabilities incurred in carrying on business is prima facie to increase the capital employed in the business. . . "
per Caltex Limited v. Federal Commissioner of Taxation [1960] HCA 17; 1960 106 C.L.R. 205 per Menzies J. (at p. 251); The Avco Case per Mason, Aickin and Wilson JJ. (at p. 672). This is no more than a prima facie presumption.

Borrowings by finance companies in the ordinary course of their business or borrowings by trading companies to purchase trading stock are examples of expenditure incurred in the earning of a taxpayer's income and not for the purpose of enhancing the business or organisation of the taxpayer as an income earning entity. It is well established that such borrowings are revenue items.

The essence of the business of a finance company is the borrowing and lending of money. Its borrowings provide funds which it turns over at a profit by lending the moneys borrowed at a higher rate of interest than is payable on the moneys which it borrows. A finance company generally borrows money for the purpose of increasing its working or circulating capital which it turns over at a profit. It deals in money. The money which it turns over by borrowing and lending is similar to trading stock. As was pointed out by the majority of the High Court in the Avco Case (at p. 677) there are obvious differences between the "money stock" of a finance company and the trading stock of a trading company: money is not dealt with in specie as a commodity and is not included in the definition of trading stock for the purposes of the Act (see s. 6). But there is a close similarity between the borrowing and lending of money by a finance company and the buying and selling of trading stock by a trading company.

Where a trading company buys goods which it turns over as trading stock gains or losses incurred are of a revenue nature. If moneys payable by a taxpayer are allowable deductions, in general any increase or decrease in those amounts caused by fluctuations in the exchange rate are likewise allowable deductions or assessable income as the case may be. If a trading company borrows money overseas in circumstances where the borrowing is a necessary part of and has the purpose of purchasing trading stock exchange gains or losses will be revenue items.

Where a finance company borrows money overseas and then lends it in the course of its business as a financier, exchange losses made in the course of repaying the borrowed moneys are outgoings made for the purpose of carrying on the business as a going concern and accordingly will be revenue items.

Not all borrowings by a finance company are made in the ordinary course of its business. Moneys may be borrowed by it for some special purpose so that the borrowings are part of the capital structure of the business. The CAGA Case is a useful example of this. In that case CAGA borrowed money in the U.S.A. The terms of the loan precluded it from using 65% of the borrowed moneys in the ordinary course of its business. CAGA made an exchange gain on repayment of the loan because the Australian dollar had appreciated in value against the U.S. dollar after the making of the loan. It was held by the High Court that the principal purpose of the borrowing was not to arm CAGA with more funds to lend or apply in the ordinary course of its business as a financier, "but rather to provide a base of additional assets which would generally strengthen the taxpayer's financial standing and enable it the more readily to borrow moneys from the public by demonstrating that it was free of liquidity problems": per Mason J. at p. 384. The foreign exchange gain was therefore not income within s.25.

The Avco Case is an illustration of a finance company which borrowed moneys from the United States for the general business of the company as a financier by then lending the borrowings or by repaying moneys previously borrowed. It was a constant part of the business of Avco to borrow no more than was necessary to provide funds for lending to customers and for meeting accruing obligations under earlier borrowings. Avco made foreign exchange gains and losses on the repayment of the moneys which it had borrowed in the United States. The High Court held that the exchange gains and losses were revenue items.

The taxpayer in the present case relied strongly on the Avco Case to support its argument that the exchange losses it suffered were revenue items. It was submitted that those exchange losses suffered upon repayment of the taxpayer's earlier borrowings, were incurred in the ordinary course of its business. The following passage from the majority judgment in Avco (at p.677) was cited:
"The true principle is that in the case of a finance company which borrows money overseas in the ordinary course of its business and not for some special purpose, the added cost of repayment in foreign currency caused by the devaluation or depreciation of the Australian dollar is an additional cost of the borrowing and, like other costs of the borrowing, is an allowable deduction under s. 51(1))."

It was submitted that the moneys borrowed by the taxpayer in the course of its business and used for the payment of wages, telephone, stationery and other outgoings were in the same position. The principal argument of the taxpayer was that the exchange losses were revenue in character because of the use to which the borrowed moneys were put from time to time by the taxpayer namely, to provide funds for the day to day running expenses of the business. The learned primary Judge found that the proceeds of all the loans were applied to satisfy outgoings of the taxpayer's business of a revenue character. His Honour also found that the loans were applied by the taxpayer as part of its working capital. The Commissioner did not dispute these findings before us. The primary Judge concluded that the exchange losses sustained on repaying the overseas loans were revenue items and therefore allowable deductions. In concluding that the exchange losses were of a revenue nature it is plain that the primary Judge placed strong emphasis on the fact that the borrowed moneys were in fact used by the taxpayer to pay the running expenses of its business.

The essential question when ascertaining the nature of foreign exchange gains or losses made on repayment of moneys borrowed, is to determine the purpose of the borrowing. In my view the use to which borrowed moneys are put is merely evidentiary of the purpose of those borrowings and not conclusive of it. In the CAGA Case Mason J. said (at p. 384):-
"No doubt the effect of the loan was to enable the taxpayer to divert other funds into the more profitable channels of its finance business, but this does not affect the character of the loan transaction itself.
In these circumstances the principal purpose of the borrowing was to strengthen the business entity, structure or organization set up or established for the earning of profit; it was not part of the process by which the organization operated to obtain regular returns, this being the distinction drawn by Dixon J. in Sun Newspapers Limited v. Federal Commissioner of Taxation in elaborating the difference between expenditure and outgoings on revenue account and on capital account. In truth the transaction was designed to strengthen the framework within which the taxpayer intended to carry on business - see Commissioner of Taxes v. Nchanoa Consolidated Copper Mines Limited (1964) A.C. 948 at p. 959; B.P. Australia Limited v. Federal Commissioner of Taxation (1965) 112 C.L.R. 386 at p. 392."

Borrowing money to carry on business must prima facie be treated as augmenting the capital employed in the business. Borrowings by finance companies to then lend to their customers, and borrowings by trading companies to finance the purchase of trading stock, are exceptions to this general rule. Such borrowings are an integral part of the ordinary conduct of the company's business and are thus revenue, not capital, items. Moneys borrowed by a finance company are turned over by making loans to its customers. Moneys borrowed by a trading company for the purpose of financing the purchase of trading stock are borrowed with a view to disposal of the stock at a profit. They are in each case part of the company's circulating capital.

Borrowings are prima facie part of a company's fixed capital. The distinction is between the capital which enables a business enterprise to be conducted and the activities by which the income of the business is earned. Expenditure incurred in relation to the financing of a business is not expenditure incurred in the earning of the income of that business: Montreal Coke and Manufacturing Company v. Minister of National Revenue (1944) A.C. 126 per Lord MacMillan (at p. 134).

The taxpayer is not a finance company. It is a trading company engaged in the business of developing, manufacturing and marketing window coverings and a variety of other building products. The taxpayer borrowed funds from overseas to finance an expansion of its business activities and to provide additional funds or working capital required by the expansion. The taxpayer borrowed the funds to increase its working capital for the purpose of avoiding a cash flow or liquidity problem during the period of its expansion. The borrowings were not part of the process by which the taxpayer operated to purchase trading stock. They were themselves not revenue items. They were not "an integral part of the ordinary operations of the taxpayer's business so as to represent a matter of revenue rather than capital": the Avco Case per Gibbs C.J. (at p. 674).

It is useful to contrast with the facts of the present case the facts in Thiess Toyota Pty. Limited v. Commissioner of Taxation (1978) 1 N.S.W.L.R. 723; Tip Top Taylors Limited v. Minister of National Revenue (1957) 11 DLR. 289; and Cadbury-Fry Pascall Australia Limited 79 A.T.C. 4346. In the Cadbury-Fry Pascall Case Jenkinson J. found that the repayments in reduction of a loan were in substance part of the regular outlay of the respondent for raw materials regularly required by it" (at p. 4351) and were thus revenue items.

The principal purpose of the borrowing in this case was to strengthen the business structure or organisation of the taxpayer to enable it to provide a stronger base or entity with which to carry on its business and earn profit. The nature of the borrowings determine the nature of the foreign exchange losses for fiscal purposes. As the former were capital items so were the latter.

I would allow the appeals and restore the Commissioner's assessments. The taxpayer must pay the Commissioner's costs of the appeals both to the Supreme Court and this Court.