Federal Commissioner of Taxation v Energy Resources of Australia Ltd [1996] HCA 10; (1996) 185 CLR 66 (20 June 1996)

HIGH COURT OF AUSTRALIA

COMMISSIONER OF TAXATION v ENERGY RESOURCES OF AUSTRALIA LIMITED
F.C. 96/020
Number of pages - 11

Income Tax [1996] HCA 10; (1996) 185 CLR 66

HIGH COURT OF AUSTRALIA
DAWSON, TOOHEY, GAUDRON, McHUGH AND KIRBY JJ

CATCHWORDS

Income Tax - Deductions - Promissory notes issued at discount to face value - Whether cost of discounts capital or revenue expense - Income Tax Assessment Act 1936 (Cth), s 51.

Income Tax - Deductions - Promissory notes issued at discount to face value - Method of calculation of cost of discounts when promissory notes issued and discharged in foreign currency - Whether loss arose on date of issue or maturity of promissory notes - Correct date to convert cost of discounts from foreign currency to Australian dollars for purpose of calculating loss - Relevance of exchange rate fluctuation - Relevance of Pt III Div 3B Income Tax Assessment Act 1936 (Cth) - Income Tax Assessment Act 1936 (Cth), ss 20, 21, 25, 51, 82U, 82V, 82Y, 82Z.

Income Tax Assessment Act 1936 (Cth), ss 20, 21, 25, 51, 82U, 82V, 82Y, 82Z.

HEARING

CANBERRA, 17 April 1996
20:6:1996, BRISBANE
#ADD 20:6:1996

ORDER

1. Appeal dismissed with costs.
2. The parties be at liberty to apply within 14 days in respect of any Notice: This copy of the Court's Reasons for Judgment is subject to formal revision prior to publication in the Commonwealth Law Reports.

DECISION

DAWSON, TOOHEY, GAUDRON, McHUGH AND KIRBY JJ. The Commissioner of Taxation appeals against an order of the Full Court of the Federal Court which held that Davies J, at first instance, was correct in holding that the respondent taxpayer was entitled to deduct from its assessable income the Australian dollar equivalent of the cost of issuing and retiring promissory notes in US dollars. The cost was the difference between the face value of the notes and their issue price, which was a lower sum.

2. The Commissioner does not dispute that the cost of the discount, converted to Australian dollars, is a loss or outgoing of the taxpayer "incurred in carrying on a business for the purpose of gaining or producing ... income" and is an allowable deduction for the purposes of s 51 of the Income Tax Assessment Act 1936 (Cth) ("the Act"). However, he contends that the cost of the discount is to be calculated by deducting the proceeds of the notes, converted into Australian dollars at the issue date, from the cost of discharging the notes, converted into Australian dollars at the maturity date of the notes. Alternatively, the Commissioner claims that the cost of the discount is to be calculated by converting the discount into Australian dollars at the maturity date and deducting from it the reduced value of the proceeds of the issue at the maturity date. The taxpayer, on the other hand, contends that it did not incur any loss or outgoing for the purpose of s 51 until the maturity date of the notes and that, for the purpose of s 51, that loss is the Australian dollar equivalent at that time of the cost of the discount expressed in US dollars. Because the Australian dollar generally appreciated in relation to the US dollar during the relevant periods, the allowable deduction would be less under the Commissioner's methods than under the taxpayer's method. Indeed, for some transactions, the Commissioner's methods would produce the result that the discount cost was "negative". The question in this appeal is which, if any, of these methods is the correct method for calculating the loss or outgoing admittedly incurred by the taxpayer.

Factual background
3. The taxpayer, Energy Resources of Australia Limited, issued a series of 90 day promissory notes in US dollars at a discount pursuant to an agreement ("the Euronote agreement") made between the taxpayer, ERA (Canberra) Limited (which was one of its wholly owned subsidiaries), the Commonwealth Bank and a number of foreign banks. That agreement allowed the taxpayer to instruct Credit Suisse First Boston Limited, one of the foreign banks, to issue Euronotes in the taxpayer's name. A panel of banks would then tender for the notes at a price less than the face value of the notes. Under the agreement the taxpayer agreed to pay the face value of the notes to the holders upon the maturity of the Euronotes.

4. Prior to entering into the Euronote agreement, ERA (Canberra) Limited had the use of a finance facility ("the Schroder Wagg facility") with other banks under which it raised money and on lent to the taxpayer. The taxpayer used the funds so raised to finance the development and operation of the Ranger uranium mine in the Northern Territory. Funds from the issue of the first series of promissory notes were used to discharge the US dollar liabilities of ERA (Canberra) Limited under the Schroder Wagg facility. Funds from subsequent issues of the promissory notes, together with other funds of the taxpayer that it held in US dollars, were used to discharge the liabilities of the taxpayer under each preceding issue of the notes. None of the proceeds of any issue was remitted to Australia.

The discounts are to be regarded as revenue outgoings
5. The receipts from the Euronotes were not income. They were capital and not revenue receipts. The taxpayer did not trade in promissory notes; nor was it a financier. Money was not its stock in trade. Similarly, the payments made to discharge the liabilities arising from the notes were capital and not revenue payments. But that does not mean that the cost of the discounts was necessarily a capital expense. Where a taxpayer incurs loss or expense in raising funds by issuing promissory notes at a discount to their face value, its entitlement to a s 51 deduction for that loss or expense depends on the use to which the funds are to be put (1). If the funds are to be used as working capital, the cost of the discounts will be deductible as a revenue expense (2). If the funds are to be used to strengthen "the business entity, structure, or organisation set up or established for the earning of profit" (3), the cost of the discounts will generally not be deductible because they will be a capital, and not a revenue, expense (4). But sometimes the raising of capital may be such a recurrent event in the business life of a taxpayer that the cost of raising the capital will qualify as a revenue expense (5). As Dixon J pointed out in Texas Co (Australasia) Ltd v Federal Commissioner of Taxation (6): "Some kinds of recurrent expenditure made to secure capital or working capital are clearly deductible."

6. At first sight, it seems strongly arguable that the funds in this case were raised for the purpose of strengthening the capital structure of the business and not to finance its day to day operations. That was the view of Davies J at first instance and of Beaumont and Hill JJ in the Full Federal Court. In so far as the funds raised by the issue of the promissory notes were used to discharge the liabilities under the Schroder Wagg facility, they discharged liabilities that had arisen from borrowing funds for the purpose of developing and operating the Ranger uranium mine. In so far as the funds from an issue were used to repay liabilities arising from the preceding issue of Euronotes, they were mainly, perhaps wholly, used to discharge liabilities which had been substituted for the liabilities arising from the initial borrowings under the Schroder Wagg facility. Those factors seem to indicate that at least a large part of the cost of the discounts was a capital outgoing. On the other hand, it is possible that, in the overall operations of the taxpayer's business, the cost of the discounts was "a necessary outgoing made in the normal course of the continuance and maintenance of the business as an enterprise conducted for the purpose of profit" (7). It may be that the cost of raising capital was such a recurrent feature of the taxpayer's operations that it is proper to treat the cost of the discounts as a revenue item. The Commissioner - who no doubt knows more about the taxpayer's business than this Court can hope to glean from a reading of the evidence before us - accepted that the cost of the discounts was a revenue expense and, therefore, an allowable deduction under s 51 of the Act. That being so, it is impossible, having regard to the paucity of evidence in the case, to proceed on any basis other than that the discounts were a revenue expense.

The loss arose on the issue of the notes
7. The taxpayer contended that it incurred a loss or outgoing on the maturity date of each promissory note. However, that contention is contrary to the holding in Coles Myer Finance Ltd v Federal Commissioner of Taxation (8) where this Court held that, for the purpose of s 51 of the Act, a taxpayer incurs a liability in respect of a promissory note upon its issue and not upon its payment. Section 51(1) "has been interpreted to cover outgoings to which the taxpayer is definitively committed in the year of income although there has been no actual disbursement" (9). If there is a presently existing liability to pay a pecuniary sum of a revenue nature, the taxpayer incurs an outgoing for the purpose of s 51(1). Similarly, when the difference between a receipt and a later payment constitutes a loss that is an allowable deduction under the sub-section, the loss will usually, but not always, be incurred for the purpose of s 51(1) when the liability to pay becomes binding. So, in Coles Myer, the Court held that the difference between the discounted proceeds of an issue of promissory notes and the amount payable on their maturity was a loss or outgoing that was incurred when the note was issued. However, the majority in that case held that the cost of the discount was deductible in the year in which it was incurred only "to the extent to which it is incurred in gaining or producing the assessable income" (10) of that year.

8. The decision in Coles Myer leads to the inevitable conclusion that the taxpayer's method of calculating the loss is correct if the issue date is substituted for the maturity date as the date on which the loss or outgoing was incurred. The holding in that case is directly applicable to the present case because it is legally irrelevant that the liability of the taxpayer was incurred in US dollars. The taxpayer, therefore, incurred its loss in the present case when the Euronotes were issued. At that time, it received or was entitled to receive the proceeds of the sale of the notes in US dollars and incurred a present liability to pay the face value of the notes in US dollars. The difference between the two sums, when expressed in Australian dollars, was its loss for the purpose of s 51(1) and that loss arose when it incurred the liability to pay the face value of the notes. As Hill J pointed out in the Full Court of the Federal Court:

"(W)here a discounting transaction is conducted wholly in a

foreign currency, the proper way of determining the amount of deduction to which a taxpayer is entitled by virtue of the discounting, will be to take the discount in the foreign currency and then translate the result into Australian dollars for the purpose of then computing the taxable income."

9. In so far as the term of any issue of the Euronotes extended into the next financial year, the decision in Coles Myer arguably requires that the cost of the discount for that issue should be apportioned on a straight line basis between the two financial years. However, the proceeds of those issues of Euronotes whose term extended beyond the financial year were utilised by the taxpayer in the year of issue to discharge existing liabilities. Accordingly, the cost of each discount must be taken to have been incurred in the year that the liability to pay the notes was incurred. No question of apportionment arises.

10. Upon the foregoing analysis, questions concerning the conversion of the proceeds and payments in discharge of the Euronotes from US dollars to Australian dollars are irrelevant. This case has nothing to do with currency gains and losses, for the simple reason that the taxpayer dealt only in US dollars. The taxpayer made no currency gains or losses because it never converted any of the proceeds of the notes into Australian dollars. For Australian tax purposes, the only relevant conversion was the cost in Australian dollars of the loss made in US dollars when the taxpayer incurred its liability to pay the face value of the notes.

11. Curiously, the argument for the Commissioner relied heavily on the decision in Coles Myer. The Commissioner asserted, correctly in our opinion, that that case held "that the discount on bills and notes issued in Australian currency was 'incurred' for sec 51(1) purposes at the time of issue of the bills and notes when the issuer became liable upon them albeit 'referable to' and deductible over the period of the bills and notes". But the Commissioner sought to avoid the logical consequences of that decision by contending that only the liability in US dollars was fixed and that "at the time of issue of the notes the expense represented by the discount could not be determined". Only on maturity of the notes, he contended, could the amount in Australian dollars of the ultimate liability to meet the face value of the notes be determined. Only then could the expense incurred by the taxpayer be determined. But, as we have pointed out, the taxpayer incurred its expense when it incurred its liability to pay the Euronotes. There is, and was, no difficulty in determining the cost of the discount to the taxpayer at the time that it incurred the liability to pay the face value of the notes. The cost was the difference between the sum needed to pay the face value of the notes and the sum received from the issue of those notes.

12. Fundamental to the case for the Commissioner was the assumption that a notional conversion of the proceeds of each issue and a notional conversion of the payments in discharge of each issue had to be made on the day that each of those events took place and that the difference between the respective sums was the taxpayer's gain or loss. The Commissioner treated the lack of any actual conversion of the proceeds or payments as irrelevant. But there is nothing in the Act that requires the making of notional conversions of the taxpayer's transactions. Nor is there anything in the Act that precludes the application of the principles in Coles Myer to the contractual arrangements of the taxpayer in the United States.

13. The Commissioner relied on s 20(1) of the Act to justify the conversion of all references to US dollars to Australian dollars. That sub-section provides:

"For all the purposes of this Act, income wherever derived

and any expenses wherever incurred shall be expressed in terms of Australian currency."
However, the proceeds of the Euronote issues were not income. The proceeds of each issue were on capital account. Nor, within the meaning of s 20(1), did the taxpayer incur expenses in discharging the liabilities arising from the issue of the notes. In that section, "expenses" mean expenses of a revenue nature and are synonymous with "losses and outgoings" in s 51. A case such as the present - where money was not the taxpayer's stock in trade - is different from a case where a trader buys and sells goods in another country. In the case of the trader, the receipts from the sales (income) and the cost of purchases (an expense) are revenue items and s 20(1) requires that they be converted into Australian dollars. But the receipts and payments in this case were on capital account. The only relevant "expense" in this case was the cost of the discount, an amount that was the product of subtracting the proceeds of an issue in US dollars from the sum needed in US dollars to pay the face value of the notes.

14. Recognising that this was so, counsel for the Commissioner contended, as we have said, that the expense represented by the discount could not be determined until the maturity of the notes. But, for the reasons that we have given, the taxpayer incurred its expense when it incurred its liability to pay the face value of the Euronotes. At that point, s 20(1) required the expense (being the difference between the sum received and the sum needed to pay the face value of the notes expressed in US dollars) to be "expressed in terms of Australian currency". But that sub-section did not require the proceeds of the issues and the payments in discharge to be expressed in Australian currency. It did not do so because they were not income or expenses. Section 20(1) operates only when an expense has been incurred. That is to say, in a case like the present, after the taxpayer has incurred a present liability to repay a greater sum of US dollars than it has contracted to receive from the issue of the Euronotes. Section 20, therefore, does not assist the Commissioner's contentions.

15. The Commissioner also relied on s 21 of the Act and the decision of this Court in Caltex Ltd v Federal Commissioner of Taxation (11) to support his contention that the cost of the discount could not be calculated until the receipts and payments were converted from US dollars to Australian dollars. Section 21(1) provides:

"Where, upon any transaction, any consideration is paid or

given otherwise than in cash, the money value of that consideration shall, for the purposes of this Act, be deemed to have been paid or given."

16. The Commissioner contended that US dollars are not cash and that s 21(1) required any reference to US dollars in the course of executing the Euronote agreement to be converted to Australian dollars. In the Full Court of the Federal Court, Hill J expressly rejected this argument. His Honour held that a taxpayer carrying on business abroad was not required to rewrite all books of account into Australian dollars as transactions occurred. His Honour said that such a taxpayer was entitled to calculate the profits of the business "in the unit of account in which that business is transacted but then is required to translate the result into Australian dollars". It is unnecessary to express any opinion as to whether his Honour's view as to the effect of s 21(1) is the correct view. The Commissioner's contention that United States dollars paid or received in the course of a transaction in that country are not cash for the purpose of s 21(1) would have practical significance for this case only if the taxpayer had incurred its loss when the notes matured.

17. Once the conclusion is reached that the taxpayer's loss was incurred upon the issue and not the maturity of the notes, the Commissioner's argument has no practical significance. Acceptance of his argument would be significant only if there was a time gap between the taxpayer acquiring the legal right to receive the proceeds of the discounted issues and the taxpayer incurring the liability to pay the face value of the notes. Even then it would be significant only if the rate of exchange had moved during that period. However, there appears to have been no time gap between the acquisition of the right to receive the proceeds of an issue and the incurring of the liability to repay the face value of the notes in the present case.

18. The Commissioner also contended that the decision of this Court in Caltex (12) required that, to calculate "the gain or loss occasioned to a taxpayer by reason of the payments made on maturity of the notes in a case such as the present, there is to be taken into account the value in Australian dollars of the proceeds of the notes, at the time of receipt of such proceeds, as well as their value in Australian dollars at the time of maturity". The short answer to this submission is that the taxpayer's loss was incurred at the time of issuing the Euronotes.

19. Another answer is that, since the taxpayer dealt only in US dollars, any loss or gain could only be in US dollars, and it was that loss or gain that the Act required to be converted into Australian dollars, not some hypothetical loss or gain arising from fluctuations in the US/Australian exchange rate. The taxpayer received US dollars, paid in US dollars, and did not convert the US dollars into Australian dollars. Where a taxpayer borrows money on capital account in US dollars and repays the loan in US dollars, it makes no revenue profit or loss from the borrowing even though the exchange rate may be different at each date. Indeed, arguably it makes no profit or loss (13). If it converts the US dollars that it receives into Australian dollars and then converts Australian dollars into US dollars to repay the loan, it may make a profit or loss on the transaction. But the profit or loss results from the exchange transaction and not from the borrowing. Where there is no exchange transaction and the loan is on capital account, the taxpayer makes no loss or gain for the purpose of s 25 or s 51 of the Act simply because the rate of exchange has changed between the date of borrowing and the date of repayment. There was, therefore, no revenue loss or gain to the taxpayer from fluctuations in the rate of exchange during the 90 day periods. For income tax purposes, the fluctuations of the US/Australia exchange rate were as irrelevant to the taxpayer's transactions as the fluctuations in the Japan/Australia exchange rate.

20. The Commissioner contended that the decision in Caltex (14) showed "that the movement in the exchange rates is to be taken into account one way or the other" and that the reasons of the Justices in that case showed that "actual conversion to Australian or any other currency is not ... a necessary requirement". The Commissioner relied particularly on a passage in the judgment of Fullagar J in Caltex (15) where his Honour said:

"I would think it quite possible that an Australian trader

might make a real exchange loss as a consequence of receipts and payments of dollars in New York without any actual exchange operation."
His Honour went on to give an example of a trader who bought and sold goods in New York for the same price but who, by reason of a change in the rate of exchange between purchase and sale, had made a profit in Australian pounds. His Honour then said (16):

"On the face of things A. has made a trading profit of

A50,000 pounds, but the dollars which he used to pay for the goods bought were worth not A200,000 pounds(the figure at which the goods purchased stand in his books) but A250,000 pounds, and it may well be that A. could be said to have made an exchange loss of A50,000 pounds, which could be set off against the nominal trading profit of A50,000 pounds."
It is unnecessary to examine the correctness of this example or the facts and decision in Caltex because both the example and the facts in Caltex concerned a trader buying and selling its stock in trade. Caltex has nothing to say concerning a person who receives and pays moneys on capital account.

Division 3B
21. The Commissioner also contended that, if "any profit or loss is not on revenue account, then it is necessary to decide that question in relation to the application of Division 3B (in Part III of the Act) which applies to currency exchange gains and losses made under 'eligible' contracts".

22. The relevant provisions of Div 3B are:

"Application
82U. (1) This Division applies in relation to gains and

losses only to the extent to which they are of a capital nature.

(2) This Division does not apply to a loss incurred by a

taxpayer except to the extent to which, if the loss were not of a capital nature, a deduction would be allowable to the taxpayer under section 51 in respect of the loss.

(3) This Division does not apply to a gain made by a

taxpayer under a contract except to the extent to which, if the taxpayer had incurred a loss under the contract and that loss had not been of a capital nature, a deduction would have been allowable to the taxpayer under section 51 in respect of the loss.

(4) This Division applies according to its tenor in relation

to gains made and losses incurred before or after the commencement of this Division. Interpretation

82V. (1) In this Division, unless the contrary intention

appears-

...

'commencing day' means 19 February 1986;

...

'currency exchange gain' means a gain to the extent to which

it is attributable to currency exchange rate fluctuations;

'currency exchange loss' means a loss to the extent to which

it is attributable to currency exchange rate fluctuations;

'eligible contract', in relation to a taxpayer, means -
(a) a contract entered into by the taxpayer on or after the

commencing day, other than a hedging contract; or

(b) a hedging contract entered into by the taxpayer, on or

after the commencing day, in relation to a contract to which paragraph (a) applies;

'hedging contract', in relation to a taxpayer, means a

contract that is entered into by the taxpayer for the sole purpose of eliminating or reducing the risk of adverse financial consequences that might result for the taxpayer or an associate of the taxpayer, under another contract, from currency exchange rate fluctuations.

(2) For the purpose of this Division -
(a) a currency exchange gain made, or a currency exchange

loss incurred, in respect of currency purchased under a contract shall be taken to have been made or incurred under that contract;

(b) a gain shall be taken to have been made, or a loss to

have been incurred, at the time when it was realised, and

(c) a reference to a person acquiring rights or obligations

arising under a contract is a reference to the person acquiring such rights or obligations otherwise than by reason of having entered into the contract.

...

Gains to be included in assessable income

82Y. The assessable income of a taxpayer of a year of income

shall include any currency exchange gain made by the taxpayer in the year of income under an eligible contract.

Losses to be allowable deductions

82Z. (1) Subject to this section, a currency exchange loss

incurred by a taxpayer in a year of income under an eligible contract is an allowable deduction in respect of the year of income."

23. Division 3B has no application to the present case. In so far as the cost of the discount represents a loss to the taxpayer, it was a revenue loss. Consequently, Div 3B has no application (17). Furthermore, for the reasons that we have already given, the taxpayer made no currency exchange gain or loss. The unit of account and the unit of payment under the contract or contracts involved in this case were US dollars. The taxpayer made no gain or loss under those contracts that was "attributable to currency exchange rate fluctuations".

Order
24. The appeal should be dismissed with costs. It is true that the orders made by the Full Court, which varied the orders made by Davies J, were based on the assumption that the losses of the taxpayer were incurred on the maturity dates of the notes. Nevertheless, nothing seems to turn on this difference so far as the order of this Court is concerned. Relevantly, the Full Court ordered that the matter be remitted to the Commissioner "with the direction that the applicant's assessments be further amended to exclude from the applicant's taxable assessable income in the years 30 June 1987 and 30 June 1988 the sums of A$1,110,859 and A$7,905,110 respectively". These were the additional amounts of taxable income, based on the Commissioner's approach, for which the taxpayer was assessed. However, each party should have liberty to apply within 14 days in respect of the form of order.

1 Federal Commissioner of Taxation v Munro; British Imperial Oil Co Ltd v Federal Commissioner of Taxation [1926] HCA 58; (1926) 38 CLR 153 at 197; Commercial and General Acceptance Ltd v Federal Commissioner of Taxation (1977) 137 CLR 373 at 384; Ure v Federal Commissioner of Taxation [1981] FCA 9; (1981) 50 FLR 219 at 223, 232; Fletcher v Federal Commissioner of Taxation [1991] HCA 42; (1991) 173 CLR 1 at 19.
2 Crawford v Federal Commissioner of Taxation [1993] FCA 647; (1993) 93 ATC 5234; Coles Myer Finance Ltd v Federal Commissioner of Taxation [1993] HCA 29; (1993) 176 CLR 640 at 664-665, 668-669.
3 Sun Newspapers Ltd and Associated Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337 at 359.
4 cf Federal Commissioner of Taxation v Hunter Douglas Ltd [1983] FCA 229; (1983) 78 FLR 182 at 191, 194-195, 201; Associated Minerals Consolidated Ltd v Commissioner of Taxation [1994] FCA 1282; (1994) 53 FCR 115 at 117-118.
5 Australian National Hotels Ltd v Commissioner of Taxation (1988) 19 FCR 234 at 239-241.
6 [1940] HCA 9; (1940) 63 CLR 382 at 468.
7 Texas Co [1940] HCA 9; (1940) 63 CLR 382 at 427 per Latham CJ.
8 [1993] HCA 29; (1993) 176 CLR 640 at 659-660, 665.
9 Federal Commissioner of Taxation v James Flood Pty Ltd [1953] HCA 65; (1953) 88 CLR 492 at 506.
10 Coles Myer [1993] HCA 29; (1993) 176 CLR 640 at 665.
11 (1960) 106 CLR 205.
12 (1960) 106 CLR 205.
13 Pattison (Inspector of Taxes) v Marine Midland Ltd (1984) AC 362 at 372-373.
14 [1960] HCA 17; (1960) 106 CLR 205.
15 [1960] HCA 17; (1960) 106 CLR 205 at 228.
16 [1960] HCA 17; (1960) 106 CLR 205 at 228.
17 s 82U(1).