Federal Commissioner of Taxation v. National Commercial Banking Corporation of Australia Limited.
83 ATC 4715
Judgment date: Judgment handed down 15 November 1983.
Bowen C.J., Fisher and Lockhart JJ.
These are four appeals by the Commissioner of Taxation against the allowance by the Supreme Court of New South Wales of appeals by the taxpayer relating to four years of income (1976 to 1979) [reported at 83 ATC 4208]. The appeals concern two questions, one of which is common to all four years and the other relates only to the year ended 30 June 1977. The two questions are in no way related to each other.
The question which is common to all four years is whether interest on certain advances made by the taxpayer to its customers which had been written off as bad debts is an allowable deduction under subsec. 63(1) or 51(1) of the Income Tax Assessment Act 1936 (``the Act'').
The second question which relates only to the 1977 year is whether certain amounts received by the taxpayer as a founding member of the Bankcard Credit Card Scheme from new member banks on their joining the Scheme were assessable income under subsec. 25(1) or para. 26(j) of the Act.
The learned primary Judge found in favour of the taxpayer on both questions but, as to the first question, only in respect of subsec. 51(1). His Honour accepted the argument of the Commissioner that the interest was not an allowable deduction under subsec. 63(1). The Commissioner challenges the findings made against him by the primary Judge. The taxpayer challenges the finding as to subsec. 63(1). The appeals were, both before the Supreme Court and this Court, heard together by consent.
We turn first to the question whether interest on certain advances made by the taxpayer to its customers which were written off as bad debts were allowable deductions under subsec. 63(1).
The claim under subsec. 63(1) of the Act arose out of the taxpayer's practice in relation to the charging of interest on advances to customers. The learned trial Judge set out fully his findings in this regard which were not challenged before this Court. This practice was changed by the taxpayer shortly before the years of income involved in these appeals in so far as it related to its liability to include interest on doubtful accounts in its returns of assessable income. It is thus necessary to appreciate the procedure adopted both before and after the change. It is agreed that the change occurred as a result of the acceptance by the taxpayer of the judgment of the New Zealand Court of Appeal in
Commr. of I.R. v. The National Bank of New Zealand 77 ATC 6001.
Before applying that judgment, the taxpayer's practice in relation to interest charged on advances to customers was to debit the customer's personal ledger card with the amount of interest calculated as at 31 December and 30 June each year on a daily balance at the relevant rate. On each of these dates the amount of interest was added to the prior debit balance in the account, and the new balance was treated as the amount of the advance upon which interest was thereafter calculated. The capitalization of interest in this way was, in respect of secured accounts, authorised by security documents and there was no suggestion that this procedure was adopted otherwise than with the consent of the customer. The amount debited to the customer's personal ledger card as interest was also, except in the circumstances mentioned in the next
83 ATC 4718
paragraph, credited to the taxpayer's profit and loss account and returned by it as assessable income.
However, when there was doubt whether an individual outstanding advance would be recovered the taxpayer opened what was called a suspended interest account, and the interest, calculated as previously mentioned on the customer's advance, was credited on 31 December and 30 June to the suspended interest account and debited to the particular customer's personal ledger card. This interest was not credited to the taxpayer's profit and loss account, nor was it returned as assessable income until, in each instance, the taxpayer actually received the interest. When it became certain that the advance would not be recovered, the taxpayer wrote off as a bad debt only what it called the ``net balance'' of the customer's account. This net balance comprised the final balance shown on the customer's personal ledger card, less the final balance attributed to the customer in the suspended interest account. As is apparent, the amount written off as a bad debt did not include the amounts credited to the suspended interest account nor any part thereof because this amount was deducted from the final balance on the customer's personal ledger card to arrive at the net balance to be written off.
In 1976 an alteration was made to these practices of the taxpayer. The decision in Commr. of I.R. v. The National Bank of New Zealand required that the taxpayer bring into its assessable income interest credited to the suspended interest account in the year in which it was debited to the customer's personal ledger card. The taxpayer accepted this judgment as applicable to its operations and thereafter returned as assessable income all interest which had been added to the customer's account during the year. It continued, however, to exclude from its profit and loss account that portion of the interest credited to the suspended interest account. When it came to write off as a bad debt the final balance in the customer's personal ledger card it did not deduct, as it did previously when writing off the net balance, the amount in the suspended interest account.
As at 30 June 1975 interest credited to suspended interest accounts amounted to $4,088,327. Since that date $1,210,145 has been received by the taxpayer. However, no portion of the sum of $4,088,327 had at any time been included in the assessable income of the taxpayer and, in particular, no portion of the sum of $1,210,145 subsequently recovered has been so included. In each of the four years of income ending 30 June 1976-1979 respectively various amounts which included the balance of the interest credited to the suspended interest account, totalling $2,878,182, were written off. The taxpayer claimed to deduct each of these amounts pursuant to subsec. 63(1) of the Act as bad debts written off in the relevant year. It claimed them in the alternative as deductible under subsec. 51(1) of the Act. There was no dispute that the advances made by the taxpayer upon which the interest accrued amounted to money lent by the taxpayer in the ordinary course of its business of lending money. Likewise it was accepted that the amounts of interest were in fact written off as bad debts in the relevant years of income.
Subsection 63(1) of the Act provides:
``63(1) Debts which are bad debts and are written off as such during the year of income, and -
- (a) have been brought to account by the taxpayer as assessable income of any year; or
- (b) are in respect of money lent in the ordinary course of the business of the lending of money by a taxpayer who carries on that business,
shall be allowable deductions.''
The subsection specifies three conditions which must be satisfied in order that bad debts may be allowable deductions:
- (a) the debt must be bad;
- (b) the debt must be written off as a bad debt during the year of income in respect of which the deduction is claimed; and
- (c) the debt must have been brought to account by the taxpayer as assessable income of any year or it must have been in respect of money lent in the ordinary course of the business of the lending of money by a taxpayer who carries on that business.
A taxpayer who furnishes returns of income on the basis of cash receipts will not
83 ATC 4719
be entitled to a deduction for bad debts because the ``debts'' have not been brought to account by him as assessable income. For the same reason a person who buys a business and takes over the vendor's book debts will not be entitled to a deduction in respect of debts which turn out to be bad. If bad debts are not deductible under sec. 63 a deduction may be available in appropriate cases under subsec. 51(1) for losses in respect of the bad debts: see
Fairway Estates Pty. Ltd. v. F.C. of T. 70 ATC 4061; (1970) 123 C.L.R. 153 per Barwick C.J. (at ATC p. 4066; C.L.R. p. 162). The only basis for the deductibility of a bad debt prior to the Income Tax and Social Services Contribution Assessment Act (No. 2) 1963 (Cth.), Act No. 69 of 1963, was sec. 63, but that Act amended subsec. 63(1) by excluding the words ``and no other bad debts'' which previously appeared in the subsection immediately before the words ``shall be allowable deductions''.
Counsel for the Commissioner submitted that para. 63(1)(b) should be construed as not including the interest component of a debt. He argued that the words in the paragraph ``... are in respect of money lent...'' by a money lender included, according to their ordinary and natural meaning, the principal component of the debt and related charges, costs and expenses, but not interest. A person carrying on a money lending business would ordinarily bring to account as assessable income interest on outstanding debts. Hence, in the case of a money lender who writes off debts as bad debts, the interest would be deductible under para. 63(1)(a) and the principal and related charges under para. 63(1)(b). Paragraphs (a) and (b) are mutually exclusive. This sufficiently summarises the argument advanced on behalf of the Commissioner.
The construction contended for by the Commissioner does not accord with the ordinary and natural meaning of the language of subsec. 63(1). Bad debts which are ``in respect of money lent in the ordinary course'' of a money lending business would in ordinary parlance encompass all constituents of the debt including principal and interest. To exclude interest from the subject matter of para. (b) is to depart from the natural and ordinary sense of the provisions. The Commissioner did not assert that principal is not included within para. (b). Nor would such an assertion be tenable as the language of the paragraph plainly includes the principal. Once it is clear that the principal amount of the loan is within the scope of the paragraph then it becomes impossible in our view to construe the paragraph by including items such as costs and charges but excluding a basic component of the loan, namely interest. Nor can we discern any legislative purpose underlying sec. 63 which would support the Commissioner's construction of the section.
These considerations are themselves sufficient to answer this question in favour of the taxpayer but there are other matters which support this conclusion.
Paragraphs 63(1)(a) and (b) deal with different but related subject matters, the difference being the nature of the taxpayer's business. Receipts of interest, but not receipts on account of the principal amount of a loan, are assessable income in the case of a taxpayer carrying on the business of money lending. Losses of the principal component of loans are, however, losses incurred by a money lender in the course of carrying on his business. The taxpayer in the present case prepared its accounts and furnished its returns on this basis.
The work done by para. 63(1)(b) is to relax the requirement that a bad debt to be deductible must have been brought to account as assessable income. Paragraph (b) is intended to allow to persons carrying on a money lending business the deduction of any of the components of debts which answer the description of bad debts written off during the relevant year of income in respect of money lent in the ordinary course of the taxpayer's money lending business.
It is contrary to the plain language of the section that when a bad debt is written off it must be severed into two components under subsec. 63(1): one for interest deductible under para. (a) and the other for principal and charges deductible under para. (b).
The real problem in the present case arose because the taxpayer did not bring to account as assessable income interest on the relevant advances in previous years of income. This is explained by the fact that it had not then changed its accounting methods as it did later following the judgment of the Court of
83 ATC 4720
Appeal of New Zealand in Commr. of I.R. v. The National Bank of New Zealand (supra). If the Commissioner was entitled to amend his assessment pursuant to sec. 170 of the Act then in the normal course of events he would doubtless have done so, treated the interest as assessable income and allowed the deduction of the bad debts under para. 63(1)(b). But the Commissioner did not take this course. It was suggested by counsel for the taxpayer that this was because the Commissioner would be met with the argument that the taxpayer had made full and true disclosure, so no amended assessment could be made. We express no view on this since the matter was not argued and does not call for a decision.
In our opinion subsec. 63(1) affords a deduction to the taxpayer for the interest on advances made by it to its customers which it has written off as bad debts during the four years in question.
It is not necessary for us to consider therefore whether subsec. 51(1) is an alternative source of deduction for these bad debts.
We turn to the second question, whether certain amounts received by the taxpayer during the 1977 year as a founding member of the Bankcard Scheme from new member banks on their joining the Scheme were assessable income under subsec. 25(1) or para. 26(j) of the Act. There was some dispute about the findings of fact made by the trial Judge, but the following facts are uncontroversial. The Bankcard Scheme at present comprises fourteen separate but co-ordinated nationwide charge card schemes operated by members of the Scheme with the aid of a common computer scheme, common rules, common procedure and mutual recognition so as to create at minimum cost an efficient operation on an Australia-wide basis. It was founded in 1972 by a consortium of trading banks. A company was incorporated as Charge Card Services Limited to carry out the common and centralized functions of the Scheme, with the founding banks accepting responsibility for expenses prior to commencement of operation of the Scheme. The total expense incurred by them at that stage was $734,284. In respect of this amount counsel for the taxpayer made a concession at the trial in the following terms:
``Mr. Priestley stated that in the third column of the table, which was part of annexure Q to the affidavit, it was admitted by the Bank that the sum was in its component parts claimed by the seven founder banks, save as to the part attributable to each bank as an allowable deduction.''
The third column of the table identifies the amount of $734,284 as the amount claimed as an allowable deduction by the founding banks. This was the only evidence on this topic.
Since 1972 other Australian banks have been admitted to the Scheme. In 1973 two banks were admitted and in 1976 a further five banks. A term of admission was that each new member pay to the existing members an entry fee. As the trial Judge explained, the basis upon which the fees were calculated was not completely consistent. However it was accepted by the taxpayer for the purposes of the appeals that ``the total amount paid to it by the new members bears a proportional relationship to the amount which it had expended and previously claimed as a deduction''. The amount which the trial Judge had earlier found had been expended and previously claimed as a deduction was $734,284. He further found that the taxpayer had paid $97,459 of this amount. It follows that the taxpayer accepted that its proportion of the fees paid to the consortium by the new members was $97,459/$734,284, i.e. approximately 13%, of the total fees received. This amount had not been quantified at the date of the hearing but that has no significance on the question for determination.
The agreement entered into by the first two new members described the payments they made to the consortium as an assessment of their share (or a portion thereof) of the establishment and initial operating costs of the founding banks. This is what they in fact were. The five members who joined the Scheme in 1976 were charged a lump sum fee, which in the correspondence with them was on occasions called ``a share of establishment and development costs''.
83 ATC 4721
The Commissioner's contention, upon which he based his primary submissions on this aspect of the appeal, was that the lump sum joining fee paid by the five new members wholly represented expenses paid on revenue account by the founding banks and claimed by them and allowed as deductions.
In our opinion this contention finds no support in the evidence which to date we have recited. It also runs counter to additional findings made by the trial Judge in relation to a subsequent submission of the Commissioner. His Honour found that some new members paid a direct proportion of the total expenditure incurred prior to the commencement of the Scheme. This expenditure he had earlier found to be $734,284. He reiterated that it was incurred upon research and development or establishment or initial operating costs. Other new members, which included the five admitted in 1976, each paid a lump sum in the computation of which the trial Judge said other factors were considered. These factors were additional to the costs mentioned earlier as having been incurred prior to the commencement of the Scheme. His Honour found that it was impossible to dissect the lump sum and to apportion it amongst the heads to which it related. He also found that it was impossible to attribute to portions of the lump sum an income or non-income nature or to determine whether or not they were in the nature of reimbursement of expenses.
In our opinion his Honour clearly acknowledged that he could not find that the lump sums comprised exclusively amounts paid on revenue account and that they were allowable deductions. This was, in our opinion, a finding of fact by the trial Judge which was not successfully challenged before us and which destroys the foundation upon which the Commissioner based his primary submission on the second question in the appeal relating to both subsec. 25(1) and para. 26(j).
The Commissioner submitted also that even if the joining fees are not properly characterised as wholly representing expenses paid on revenue account by the founding banks and claimed by them as allowable deductions, nevertheless the payments received by the taxpayer are income according to ordinary concepts. It was not a capital asset sold by the taxpayer but merely a sum received on revenue account in the course of the taxpayer's participation in the business of conducting the Bankcard Scheme. The money received was said to fill ``the hole'' created by the earlier expenditure of the founding banks. Reliance was placed on the judgment of the Court of Session in
Burmah Steamship Co. Ltd. v. I.R. Commrs. (1931) 16 T.C. 67 where there had been a claim for damages calculated by reference to the estimated profit which would have been earned by a vessel during the time beyond that in which the defendants had undertaken to complete their overhaul. The Burmah Steamship Company Limited had received a sum of money in settlement of its claim and this was held to be taxable. The Lord President (Lord Clyde) said (at p. 71):
``Suppose some one who chartered one of the Appellant's vessels breached the charter and exposed himself to a claim of damages at the Appellant's instance, there could, I imagine, be no doubt that the damages recovered would properly enter the Appellant's profit and loss account for the year. The reason would be that the breach of the charter was an injury inflicted on the Appellant's trading, making (so to speak) a hole in the Appellant's profits, and the damages recovered could not therefore be reasonably or appropriately put by the Appellant - in accordance with the principles of sound commercial accounting - to any other purpose than to fill that hole.''
The receipt by the taxpayer of the lump sum joining fees from entrant banks cannot in our view be likened to the receipt by Burmah Steamship Company Limited of moneys in settlement of its claims. The joining fees filled no hole created by a loss of income or profits. The joining fee cannot, for the reasons given by us earlier, be treated as reimbursement of expenses in view of the trial Judge's finding that it was impossible to dissect the lump sum and to apportion it amongst the heads to which it related. Even if the fees could be so characterized it is doubtful if the Burmah Steamship case would avail the Commissioner because that was a case of ``a hole'' in profits being filled
83 ATC 4722
by subsequent receipts on revenue account. In this case it is not profits or income that were lost to the taxpayer but items of expenditure incurred by it. Once the founding banks expended moneys to establish and develop the Bankcard Scheme they received revenue from carrying on the Scheme so that ``the hole'', to use the metaphor of the Lord President in the Burmah Steamship case, was filled by that revenue and, to the extent of the deficiency, if any, may have been topped up by the entry fees from the entrant banks. This case illustrates the care with which the use of metaphors must be approached. They are often convenient to use but can be misleading.
It is true that the amount of the joining fee was calculated at least to some extent by reference to expenditure incurred on revenue account, but the character of the receipt, for the purposes of the Act, is a capital receipt representing the price paid by the entrant banks for joining the Bankcard Scheme and obtaining the benefit of what it offered, in particular its assets and goodwill including the right to use the Bankcard logo.
These considerations also answer the Commissioner's arguments in relation to para. 26(j). That provision has been considered in various cases including
F.C. of T. v. Wade (1951) 9 A.T.D. 337; (1951) 84 C.L.R. 105;
Robert v. Collier's Bulk Liquid Transport Pty. Ltd. (1959) V.R. 280 per Gavan Duffy J. (at pp. 284-285);
Melbourne Saw Manufacturing Co. Pty. Ltd. v. Melbourne and Metropolitan Board of Works (1970) V.R. 394 per Barber J. (at p. 399) and
Goldsbrough Mort & Co. Ltd. v. F.C. of T. 76 ATC 4343 per Walters J. (at pp. 4348-4350). See also the article by Mr. C.W. Pincus Q.C. ``Taxation of Compensatory Payments and Judgments'' (1979) 53 A.L.J. 365 (at p. 366).
We do not find it necessary to determine the scope of para. 26(j) or the meaning of any of its words and phrases, in particular the word ``indemnity''. Even if it were given its widest meaning of reimbursement to the taxpayer of an outgoing which was an allowable deduction (see in particular the judgment of Walters J. in the Goldsbrough Mort case) the joining fee would not answer that description for the reasons already given by us.
We would dismiss the appeals with costs.
THE COURT ORDERS THAT:
1. The appeals be dismissed.
2. The Commissioner of Taxation of the Commonwealth of Australia pay to the National Commercial Banking Corporation of Australia Limited its costs of the appeal.