Commissioner of Taxation v R & D Holdings Pty Ltd
Document type: Decision Impact Statement
Venue: Federal Court of Australia (NSD 1798, 1799, 1790 of 2006)
Judgment date: 13 July 2007
Date published: 5 March 2008
Decision outcome: Partly unfavourable

Summary of decision:
This case • applied the same business test where a mortgagee had entered into possession; • concluded that interest accrued but not paid after the business had ceased and which, as a matter of commercial certainty, would never be paid, was deductible. | • applied the same business test where a mortgagee had entered into possession; • concluded that interest accrued but not paid after the business had ceased and which, as a matter of commercial certainty, would never be paid, was deductible.

Overview of facts:
In this matter, the taxpayer, R & D Holdings Pty Ltd ("R&D"), claimed to be entitled to carry forward the losses of its wholly owned subsidiary, 410 Chapel Road Pty Ltd ("Chapel Road"). | In 1987, Chapel Road, as its sole enterprise, bought land and built a commercial building in order to let it, borrowing in order to finance the purchase and construction. In March 1990, Chapel Road refinanced the loan, borrowing $14 million. | At the time of the refinancing, approximately 60 per cent of the lettable space in the building was leased to commercial tenants; some tenants had temporary rent holidays; and interest rates were at historically high levels. The rent received was insufficient to cover all of the outgoings including interest, and, from the first interest payment date after the financing, Chapel Road was in default on the loan. | In May 1990, the mortgagee exercised its rights to receive the rents of the property, which were henceforward paid directly to its agent. The property continued to be managed by the taxpayer's agent until January 1991 when the mortgagee's agent took over that role, and thereafter, the mortgagee was a mortgagee in possession. From May 1990, from the rent it received, the mortgagee paid the outgoings of the building. The mortgagee supplied Chapel Road with annual statements which showed that the net income from the property, after outgoings had been paid, was applied on a monthly basis to reduce the interest on the loan balance of Chapel Road. However, as the interest expense far exceeded the amounts so applied, with compounding, the loan balance had grown to over $20 million at the beginning of the 1992 tax year, and to over $65 million by the end of the 1997 tax year. | The mortgagee sold the building in 2000, for a price of $11.75 million. | Chapel Road, which was otherwise inactive during this period, continued to claim deductions in respect of interest and other property expenses. These deductions gave rise to tax losses that were transferred to the taxpayer. | In July 1997 there was change in the beneficial ownership of the shares in Chapel Road such that it failed the continuity of beneficial ownership test. | Before the Federal Court at first instance, the taxpayer was successful in part. Justice Finn held that in the relevant income years, Chapel Road's monthly losses in respect of interest were allowable deductions, and the taxpayer was thus entitled to a deduction for the loss transferred to it by Chapel Road in the year ended 30 June 1997. However, due to the change of ownership, for the 1998 and 1999 years, the losses were only transferable if Chapel Road satisfied the same business test and it did not do so because in those years it did not carry on a business at all. | Each of the parties appealed to the Full Court, the Commissioner in respect of His Honour's decision in respect of the 1997 year and the taxpayer in respect of the decision for the 1998 and 1999 years. The Full Court dismissed both parties' appeals, Heerey and Edmonds JJ in one judgment and Stone J in a separate judgment. | Each party applied to the High Court for special leave to appeal the decision. Special leave was denied by the High Court on 14 December 2007. | Issues decided by the court | The issues on appeal were: 1. The Commissioner argued that each interest accrual in this case, where it was a matter of commercial certainty that the accrued interest would never be paid and that the company's financial position was irretrievably lost, was not a "loss or outgoing" for the purposes of section 51(1) of the Income Tax Assessment Act 1936 . The Court did not accept the Commissioner's argument. 2. The Commissioner argued that the interest accruals were not incurred in gaining or producing assessable income, on the basis that each accrual for a period did not secure the continued use of funds for an income-producing purpose, and thus the nexus was lost. The Court did not accept the Commissioner's argument, holding that each monthly application by the mortgagee to the mortgagor's loan account was income, and that the interest accruals were incurred in gaining or producing such income. 3. The taxpayer argued that Chapel Road was carrying on a business after the mortgagee went into possession. The Court did not accept the taxpayer's argument, holding that after the mortgagee had entered into possession, Chapel Road carried on no business. 4. The taxpayer also appealed in relation to the level of penalty imposed. The Court did not uphold the taxpayer's appeal on this issue. | 1. The Commissioner argued that each interest accrual in this case, where it was a matter of commercial certainty that the accrued interest would never be paid and that the company's financial position was irretrievably lost, was not a "loss or outgoing" for the purposes of section 51(1) of the Income Tax Assessment Act 1936 . The Court did not accept the Commissioner's argument. 2. The Commissioner argued that the interest accruals were not incurred in gaining or producing assessable income, on the basis that each accrual for a period did not secure the continued use of funds for an income-producing purpose, and thus the nexus was lost. The Court did not accept the Commissioner's argument, holding that each monthly application by the mortgagee to the mortgagor's loan account was income, and that the interest accruals were incurred in gaining or producing such income. 3. The taxpayer argued that Chapel Road was carrying on a business after the mortgagee went into possession. The Court did not accept the taxpayer's argument, holding that after the mortgagee had entered into possession, Chapel Road carried on no business. 4. The taxpayer also appealed in relation to the level of penalty imposed. The Court did not uphold the taxpayer's appeal on this issue.

Issues decided:
The issues on appeal were: 1. The Commissioner argued that each interest accrual in this case, where it was a matter of commercial certainty that the accrued interest would never be paid and that the company's financial position was irretrievably lost, was not a "loss or outgoing" for the purposes of section 51(1) of the Income Tax Assessment Act 1936 . The Court did not accept the Commissioner's argument. 2. The Commissioner argued that the interest accruals were not incurred in gaining or producing assessable income, on the basis that each accrual for a period did not secure the continued use of funds for an income-producing purpose, and thus the nexus was lost. The Court did not accept the Commissioner's argument, holding that each monthly application by the mortgagee to the mortgagor's loan account was income, and that the interest accruals were incurred in gaining or producing such income. 3. The taxpayer argued that Chapel Road was carrying on a business after the mortgagee went into possession. The Court did not accept the taxpayer's argument, holding that after the mortgagee had entered into possession, Chapel Road carried on no business. 4. The taxpayer also appealed in relation to the level of penalty imposed. The Court did not uphold the taxpayer's appeal on this issue. 1. The Commissioner argued that each interest accrual in this case, where it was a matter of commercial certainty that the accrued interest would never be paid and that the company's financial position was irretrievably lost, was not a "loss or outgoing" for the purposes of section 51(1) of the Income Tax Assessment Act 1936 . The Court did not accept the Commissioner's argument. 2. The Commissioner argued that the interest accruals were not incurred in gaining or producing assessable income, on the basis that each accrual for a period did not secure the continued use of funds for an income-producing purpose, and thus the nexus was lost. The Court did not accept the Commissioner's argument, holding that each monthly application by the mortgagee to the mortgagor's loan account was income, and that the interest accruals were incurred in gaining or producing such income. 3. The taxpayer argued that Chapel Road was carrying on a business after the mortgagee went into possession. The Court did not accept the taxpayer's argument, holding that after the mortgagee had entered into possession, Chapel Road carried on no business. 4. The taxpayer also appealed in relation to the level of penalty imposed. The Court did not uphold the taxpayer's appeal on this issue.

ATO view of decision:
In this matter, the Tax Office sought to test the scope of the jurisprudential approach to incurrence under the general deduction provision. The Commissioner accepts the decision of the Full Federal Court that the outcome flows from the application of established principles to the facts.

Administrative treatment:
Implications on current Public Rulings & Determinations | None.

Legislative references: Income Tax Assessment Act 1936 (Cth) 51(1) 80E 80G 226H 226K Income Tax Assessment Act 1997 (Cth) 8-1 165-10 165-13 170-35
Case references: Federal Commissioner of Taxation v Munro (1926) 38 CLR 153 Commissioner of Taxation v Smith (1981) 147 CLR 578 81 ATC 4114 11 ATR 538 Federal Commissioner of Taxation v James Flood Pty Ltd (1953) 88 CLR 492 Hart v Commissioner of Taxation (2002) 121 FCR 206 2002 ATC 4608 50 ATR 369 Commissioner of Taxation (Cth) v Citylink Melbourne Ltd (2006) 228 ALR 301 2006 ATC 4404 62 ATR 648 228 CLR 1 Steele v Deputy Federal Commissioner of Taxation (1999) 197 CLR 459 41 ATR 139 Placer Pacific Management Pty Ltd v Federal Commissioner of Taxation (1995) 31 ATR 253 95 ATC 4459 Federal Commissioner of Taxation v Brown (1999) 43 ATR 1 99 ATC 4600 Federal Commissioner of Taxation v Jones (2002) 117 FCR 95 2002 ATC 4135 49 ATR 188 Guest v Commissioner of Taxation (2007) 65 ATR 815 2007 ATC 4265 Commissioner of Taxation v Riverside Road Lodge Pty Ltd (In Liq) (1990) 23 FCR 305 90 ATC 4567 21 ATR 499 Federal Commissioner of Taxation v Total Holdings (Aust) Pty Ltd (1979) 9 ATR 885 79 ATC 4279 Fletcher v Federal Commissioner of Taxation (1991) 173 CLR 1 91 ATC 4950 22 ATR 613 Federal Commissioner of Taxation v Murry (1998) 193 CLR 605 98 ATC 4585 39 ATR 129 R v McKinnon [1959] 1 QB 150 [1958] 3 All ER 657 Pollard v Director of Public Prosecutions (1992) 28 NSWLR 659 BRK (Brisbane) Pty Ltd v Commissioner of Taxation (2001) 46 ATR 347 2001 ATC 4111 Pridecraft Pty Ltd v Federal Commissioner of Taxation (2004) 213 ALR 450 2005 ATC 4001 58 ATR 210 Walstern v Commissioner of Taxation (2003) 138 FCR 1 2003 ATC 5076 54 ATR 423
Subject references: Interest deduction interest deduction after cessation of business outgoing rental property default on mortgage mortgagee in possession loss transfer same business test