CATCHWORDS

TAXATION - assessable income - "debt defeasance" as a financial arrangement and taxation consequences thereof - whether a profit or gain was derived as a result of the "debt defeasance" arrangement - whether profit or gain derived was assessable income - whether profit or gain was on revenue or capital account - time of derivation.

TAXATION - capital gains tax (Part IIIA) - whether profit or gain is included under assessable income as a capital gain.

Local Government Finance Act 1983 (SA)

Income Tax Assessment Act 1936 (Cth)

Companies (NSW) Regulations

COMMISSIONER OF TAXATION v UNILEVER AUSTRALIA SECURITIES LIMITED

NG 438 of 1994

LOCKHART, BEAUMONT and HILL JJ.

SYDNEY

24 FEBRUARY 1995

IN THE FEDERAL COURT OF AUSTRALIA)

                                  )

NEW SOUTH WALES DISTRICT REGISTRY)    No.  NG438  of  1994

                                  )

GENERAL DIVISION                  )

                             ON APPEAL FROM A JUDGE OF THE FEDERAL COURT OF AUSTRALIA

                   BETWEEN:      COMMISSIONER OF TAXATION

                                      Appellant

                   AND:          UNILEVER AUSTRALIA SECURITIES LIMITED

                                      Respondent

COURT:  LOCKHART, BEAUMONT & HILL JJ.

PLACE:  SYDNEY

DATE:   24 FEBRUARY 1995

                       MINUTE OF ORDER

THE COURT ORDERS THAT:

1.   The appeal be allowed.

2.   The matter be remitted to Spender J. or other judge of the Court to determine the quantum of the profit arising in the year ended 30 June 1987; but the operation of this order be suspended for 28 days to allow the parties to agree, if possible, the amount of the profit arising.

3.   The objection decision of the Commissioner, in respect of the assessment for income tax for the year ended 30 June 1987, be set aside, and in lieu thereof, the objection be allowed in part.

4.   Subject to the determination by Spender J. or other judge of the Court, or as agreed, of the quantum of profit, the assessment be remitted to the Commissioner for reassessment in accordance with law.

                            - 2 -

5.   The respondent pay the appellant's costs of the appeal and of the proceeding at first instance.

NOTE:     Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

IN THE FEDERAL COURT OF AUSTRALIA)

                                  )

NEW SOUTH WALES DISTRICT REGISTRY)    No.  NG438  of  1994

                                  )

GENERAL DIVISION                  )

                             ON APPEAL FROM A JUDGE OF THE FEDERAL COURT OF AUSTRALIA

                   BETWEEN:       COMMISSIONER OF TAXATION

                                      Appellant

                   AND:          UNILEVER AUSTRALIA SECURITIES LIMITED

                                      Respondent

COURT:  LOCKHART, BEAUMONT & HILL JJ.

PLACE:  SYDNEY

DATE:   24 FEBRUARY 1995

                    REASONS FOR JUDGMENT

LOCKHART J.

     The facts are set out in the reasons for judgment of the other members of the Court.  I need not repeat them in detail.

     The three main questions in the appeal are first, whether Unilever Australia Securities Limited (UAS) derived a relevant profit or gain as a result of the defeasance arrangements (to be mentioned later); secondly, if it did, whether the profit or gain constitutes assessable income of UAS; and thirdly, if it does, when the profit or gain arose.

     The learned primary Judge (Spender J.) held that UAS did not derive a profit or gain as a result of the defeasance arrangements; but that, if it had done so, it would have been
on revenue account.  His Honour held also that any such profit or gain would have been derived at the time the debentures were in fact repaid to debenture holders, not when the defeasance arrangements were made.

Did UAS derive a profit or gain as a result of the defeasance arrangements?

     UAS was incorporated on 22 May 1947 and was a wholly owned subsidiary of Unilever Australia Limited (UAL), the principal operating company of the Unilever Australia group of companies.  UAS was the financing arm of UAL before the latter was converted to a public company on 15 March 1983.  UAS provided funds, not only to UAL, but to other companies within the Unilever Australia group of companies.  UAS ceased trading on the short term money market in April 1983 and thereafter its activities were confined to maintaining existing loans including the loans which UAS had made to UAL in previous years.  After UAL was converted to a public company in 1983, borrowings for the Unilever Australia group were made through UAL, not UAS. 

     The debt defeasance arrangements are described fully by the other members of the Court in their judgments so I need not recite them.  In summary, UAS issued a series of debenture stocks pursuant to a trust deed of 24 April 1967 entered into between UAS, National Mutual Life Nominees Limited as trustee and twelve other companies in the Unilever group acting as guarantors.  There were three issues of debenture stock under the deed.  The first issue was made on 24 April 1967 and the principal sum was $4,310,000 repayable on 30 June 1987.  The second issue of debenture stock was made on 7 March 1979, the principal being $3,075,000 repayable on 31 March 1989.  The third issue was made also on 7 March 1979, the principal sum was $6,725,000 repayable on 31 December 1985.  This third issue of debentures was redeemed on maturity.

     In January 1987 UAS entered into the debt defeasance arrangements with the Local Government Finance Authority of South Australia (LGFA) and the trustee for the debenture holders.  Under the arrangements LGFA agreed to assume the liability of UAS to meet its obligations under the debentures to repay principal when it fell due in exchange for a present payment of $6,301,706.  Liabilities of UAS under the trust deed as at January 1987 totalled $7,385,000.  Thus, in return for a present payment of $6,301,706, LGFA assumed liability to pay the larger sum of $7,385,000.  The debenture stock repayable on 30 June 1987 was repaid by that date, the source of the payment being LGFA.  Debenture stock repayable on 31 March 1989 was repaid, the source of the payment again being LGFA.

     The defeasance arrangements between UAS and LGFA could not in law discharge the liabilities of UAS to the trustee for debenture holders or the debenture holders themselves.  But in practical and commercial terms the effect of the defeasance
arrangements was that LGFA assumed the obligations of UAS in respect of the repayment of the debentures in return for the outlay by UAS in January 1987 of $6,301,706.

     The Commissioner assessed UAS for the year of income ended 30 June 1987 on the basis that it derived as assessable income the amount representing the net difference between the then future obligations of UAS of $7,385,000 and the consideration paid by it to LGFA of $6,301,706, namely, $1,083,294.

     The arrangement between UAS and LGFA (whereby LGFA agreed to pay $7,385,000 to the debenture holders or their trustee in discharge of UAS's liabilities, under the terms of the debenture issues, in return for the present payment of $6,301,706 by UAS) to my mind plainly produced a profit in the hands of UAS. 

     The learned primary Judge reached the contrary conclusion on the basis that, if UAS made a profit or gain by the transaction, then it must also be the case that LGFA incurred a loss of $1,083,294, the latter proposition being, in his Honour's opinion, insupportable.  But this would depend upon what LGFA did with the $6,301,706.  If, for example, it did not use it in some way to produce a return greater than the sum of $1,083,294, such as not investing the money at all, then LGFA would have incurred a loss or an outgoing.  However,
I do not regard the question of whether LGFA made a loss as the main question.  The critical point to my mind is that the sum of $6,301,706 paid by UAS to LGFA for the assumption by LGFA of UAS's obligations to pay the face value of the debentures was a smaller sum than the $7,385,000 being the face value of the debentures; the difference must constitute a profit to UAS.

     Counsel for UAS did not seek to support his Honour's finding that no profit arose as a result of the defeasance arrangements.

Was the profit or gain derived by UAS assessable income of UAS?

     The usual basis upon which a gain or profit is impressed with the character of income is that it was made in the ordinary course of carrying on the taxpayer's business with a view to profit: Federal Commissioner of Taxation v Myer Emporium Limited (1987) 163 CLR 199 at 209.  Profit or gain made otherwise than in the ordinary course of carrying on the taxpayers business may nevertheless constitute income if a taxpayer's purpose or intention was to make a profit or gain.  It depends on the facts of the case whether it does or not: Myer Emporium at 209.  As the High Court said in Myer Emporium at 209-210:

          "Whether it does [constitute income] depends very much on the circumstances of
the case.  Generally speaking, however, it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business.  Nor does the fact that a profit or gain is made as a result of an isolated venture or a 'one-off' transaction preclude it from being properly characterized as income ...  The authorities establish that a profit or gain so made will constitute income if the property generating the profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit."

     Profits or gains made by a finance company in the course of or incidental to the carrying on of its ordinary business of borrowing and lending money and repaying loans will be treated as revenue profits or gains: Avco Financial Services Limited v Commissioner of Taxation (1982) 150 CLR 510 and Coles Myer Finance Limited v Commissioner of Taxation (1993) 176 CLR 640 at 663-4.

     Although the evidence about the activities of UAS is sparse, it was the finance arm of UAL until 1983.  UAS ceased trading thereafter on the short term money market, issued no further debenture stock and made no subsequent loans to companies in the Unilever Australia group including UAL.  Nevertheless, it continued to service the loans which were still outstanding including the receipt of interest upon loans made by it to members of the UAL group and the payment of interest upon moneys borrowed by it.  I note that the report of the directors on the balance sheet and accounts of UAS for the year ended 31 December 1987 stated that UAS's principal activity was to provide finance to the Unilever group of companies through the existing issue of debentures and that there had been no significant change in the nature of UAS's activities during the year.

     In my opinion it was in the ordinary course of the business of UAS as a finance company to make the necessary arrangements to repay moneys borrowed by it and to service the payment to it of moneys lent by it.  UAS's business did not come to an end after the defeasance arrangements had been made.  Its business included always the elements of borrowing, lending and repaying moneys borrowed, servicing the loans including receipt of interest.  It was a necessary incident of UAS's business that its debts would be discharged.  UAS's business was continuing at all material times.

     The defeasance arrangements were unusual, but, they nevertheless generated profit or gain to UAS in the course of its business activities which was income according to ordinary concepts.

When was the profit or gain derived by UAS?

     In my opinion the profit or gain was derived by UAS when
the relevant debentures matured and the times of repayment of capital arose and the repayment obligations were discharged.  The profit or gain did not arise when the debt defeasance arrangements were made.  The critical point in my opinion is that UAS remained at all times liable to the trustee for the debenture holders to pay principal on maturity and interest in the meantime.  The debt defeasance arrangements did not diminish or destroy that liability.  The obligation accepted by LGFA to pay an amount equal to the face value of the debentures as a principal obligation is expressed in the defeasance arrangements as being payment made in satisfaction of the obligation of UAS.  But this could not alter the liability at all times imposed upon UAS under the terms of the trust deed and debenture issues to repay to the trustee the principal on maturity and interest in the meantime.  Although in commercial terms it was plain that LGFA would fulfil the obligations assumed by it pursuant to the debt defeasance arrangements and pay to the trustee for the debenture holders the amount due to debenture holders when the debentures matured, the obligations of UAS to the trustee for debenture holders remained. 

     Profit did not emerge in the hands of UAS until the debentures matured and the obligations of UAS were complied with, that is by repayment.

     It follows that profit was derived by UAS at the
conclusion of the year of income 30 June 1987 when the debentures which matured on that date were repaid.  The amount of that profit is not clear on the evidence.  Nor is it the subject of agreement between the parties and it was not dealt with in argument.  The quantum of the profit must be determined by the primary Judge in the event of the parties being unable to agree on the amount of it.

What is the impact of Division 16E of Part III of the Income Tax Assessment Act 1936 (the Act)?

     The Commissioner sought to raise Division 16E in argument on appeal before us.  It was not an issue before the primary Judge; nor were any submissions directed to it; nor was it the subject of any findings by the primary Judge.  The parties accepted in argument before us that the question of the application of Division 16E is one of law only. 

     It must be only in special cases that parties are allowed to raise questions on appeal which were not previously in issue between them and not the subject of argument before the trial Court or findings by the trial Judge.  The task of convincing an appellate court that it should hear argument of this kind is easier perhaps when the question involved is one of law only, as it is here.  I am not persuaded that this is an appropriate case in which the Commissioner should be allowed to raise Division 16E of Part III of the Act for the first time in this appeal.  However, if I had reached the
contrary view, I would be in agreement with the conclusion of Hill J. that Division 16E has no application on the facts of this case for the reasons which he gives.

Does Part IIIA of the Act apply (capital gains tax)?

     It is neither necessary nor appropriate to deal with this question.

     I agree with the orders proposed by Hill J.

              I certify that this and the preceding nine (9) pages are a true copy of the reasons for judgment herein of the Honourable Justice Lockhart.

              Associate

              Dated:  24 February 1995

IN THE FEDERAL COURT OF AUSTRALIA  )

                                  )

NEW SOUTH WALES DISTRICT REGISTRY  )       No. G438 of 1994

                                  )

GENERAL DIVISION                  )

         ON APPEAL FROM A JUDGE OF THE FEDERAL COURT

                        OF AUSTRALIA

                        BETWEEN:  COMMISSIONER OF TAXATION

                                  Appellant

                            AND:  UNILEVER AUSTRALIA SECURITIES LIMITED

                                  Respondent

CORAM:    LOCKHART, BEAUMONT AND HILL JJ.

DATE:     24 FEBRUARY 1995  

                    REASONS FOR JUDGMENT

BEAUMONT J.       

INTRODUCTION

          In its income tax return for the year ended 30 June 1987, the respondent disclosed what it described as a "surplus on assumption of liability" in the sum of $1,083,294 arising out of a "debt defeasance" transaction, but claimed the right to exclude the amount from its assessable income for the following reasons:

     "On 9 January 1987 the Company paid an amount of $6,301,706 to Local Government Authority of South Australia being a lump sum amount equal to the present value of the future payments of principal due in respect of debenture stock held by third party debenture stockholders.  This payment was made in consideration of Local Government Authority of South Australia agreeing to repay the Company's liability for the principal obligation in respect of that debenture stock directly to the trustee for debenture stockholders as follows:

          30 June 1987       $4,310,000

          31 March 1989      3,075,000

          Total repayment    $7,385,000

     For accounting purposes the liability has been treated as having been extinguished as at the date of payment of the sum of $6,301,706 pursuant to the agreement with Local Government Authority of South Australia.  The difference between the amount paid to Local Government Authority of South Australia and the liability has been treated in the accounts as Surplus on assumption of liability - $1,083,294.

     The Assumption by Local Government Authority of South Australia of the Company's liability to its debenture stockholders was carried out at a time when the Company had ceased operating as a finance company and was a step taken in disposing of the Company's liabilities after its business has been terminated.  Accordingly for income tax purposes the surplus on assumption of liability has been excluded from the Company's assessable income as no part of the Surplus constitutes income under the terms of section 25, 25A or any other section of the Income Tax Assessment Act including Part III A of the said Act."

          But the Commissioner disagreed and included the amount in his notice of assessment for that year.  He later disallowed the respondent's objection against the assessment.  His decision was then referred to the Court pursuant to s.187(b) of the Income Tax Assessment Act 1936 ("the Act").  Spender J., for reasons now reported at (1994) 122 ALR 402, ordered that the objection should be allowed and the matter remitted to the Commissioner for reassessment.  The Commissioner now appeals from this judgment.

THE BACKGROUND FACTS

          At first instance, it appears that there was no
significant dispute about the background facts which the learned trial Judge found to be as follows. 

          The respondent is a member of the Unilever Australia Group ("the Group") and a wholly owned subsidiary of Unilever Australia Ltd ("UAL"), which is the principal operating company of the Group.  Until 1983, the respondent was the financing vehicle for Unilever Australia Pty Ltd, as UAL was then constituted.  It also provided loan funds to other members of the Group.  Until 1986, the respondent utilised the issue of debenture stock as its principal source of external funding.  The respondent's balance sheet as at 31 December 1986 showed that its principal asset was a debt owing by UAL.  In the main, the respondent's liabilities were represented by two issues of debentures made pursuant to a Trust Deed to be described shortly ("the Trust Deed").  The debentures were payable on 30 June 1987 (after a 20 year term at 7.75% p.a.) and 31 March 1989 (after a 10 year term at 10.55% p.a.), respectively.  By the end of 1986, the respondent had determined to remove the debenture liability from its balance sheet and, accordingly, entered into the debt "defeasance" arrangements previously mentioned.  Spender J. was satisfied that this was done "for the purpose of securing relief from the onerous reporting conditions and financial ratio constraints imposed by the trust deed" (at 405).  His Honour also found that "the defeasance arrangements were not in contemplation at the time of the original borrowings, and form no part of any scheme dating from then" (at 405).  The primary Judge went on to say (at 405) that the proposal was that the respondent "would take no further part as the financing vehicle for [the Group].  Borrowing would continue to be conducted principally through UAL and the [Group] would seek to establish a more cost-effective financial structure."

          Before going to the debt "defeasance" transaction, it will be necessary to refer to the material provisions of the Trust Deed.

THE TRUST DEED

          The Trust Deed, dated 24 April 1967, was made between the respondent and National Mutual Life Nominees Limited ("NMLN") as trustee ("the Trustee").  Other members of the Group were also parties as guarantors.  The Trust Deed provided, inter alia, that the respondent could create and issue "initial" 20 year debenture stock up to the sum of $6,000,000 repayable at par on 30 June 1987, bearing interest at the rate of 7.75% p.a. (cl.3(a)).  Provision was made (cl.3(f)) for the issue of further stock, subject, in particular, to cl.4 and cl.7, which, as Spender J. noted, imposed financial ratio constraints.  All stock was to rank, in point of security, pari passu inter se (cl.3(h)).

          Clause 8 was as follows:

     "8.  (a)  The Company hereby acknowledges its
indebtedness to the Trustee in respect of the moneys hereby secured. [Emphasis added]

           (b)  The Company covenants with the Trustee that -

              (i)  as and when any of the Issued Stock shall become payable in accordance with the terms of issue thereof or on such earlier date as the security hereby constituted becomes enforceable the Company shall pay to the Trustee in Sydney aforesaid the principal interest and premium (if any) payable in respect of such Issued Stock and such payment shall operate in satisfaction of the Company's obligations to the holders thereof in respect of such Issued Stock; [Emphasis added] and

              (ii)until redemption or repayment or until interest ceases to accrue in accordance with the conditions on which any Stock is issued the Company shall pay to the Trustee in Sydney aforesaid interest on the Issued Stock at the rates specified in the terms of issue thereof computed from date of allotment or such other date as may have been specified in the said terms of issue and such payment shall operate in satisfaction of the Company's obligations to the holders of the Issued Stock in regard to the payment of interest thereon. [Emphasis added]

          (c)  Notwithstanding the provisions of sub-clause (b) hereof:-

              (i)  unless and until the Trustee requires the Company to make payments to it in accordance with sub-clause (b) of this Clause, the Company shall pay to the Stockholders the principal interest and premium (if any) payable in respect of the Issued Stock held by them in accordance with the terms of issue of such Issued Stock and such payment to the Stockholders shall operate pro tanto in satisfaction of the principal interest and premium (if any) payable in respect of the Issued Stock the indebtedness for which is acknowledged by sub-clause (a) of this Clause; [Emphasis added]

              (iii)if by the terms of issue of any Issued Stock the first payment of interest is payable only to the person to whom such Issued Stock was issued (whether such person is the registered holder of such Issued Stock at the date of the first payment of interest or not) then payment of interest by the Company to such person in accordance with the said terms of issue shall operate in satisfaction of the Company's obligations in respect of such payment of interest."

          The respondent was bound to issue to every stockholder a certificate in the form in a Schedule to the Trust Deed (cl.9(a)).  The form of the certificate, was to the effect that the person named was the registered holder of the debenture stock, fully or partly paid, as the case may be, which stock was "constituted and secured by" the Trust Deed and was "issued with the benefit of and subject to the provisions of" the Trust Deed.  The pro forma certificate further provided that the stock was repayable on a date to be specified and that interest was to be paid as stipulated.  There were provisions for, but no evidence of, the imposition of special conditions. 

          The respondent charged its assets and undertaking in favour of NMLN (by way of floating charge) to secure payment of the monies payable under the Deed (cl.10(a)).

          The Trust Deed was amended substantially by a Deed of Amendment dated 9 January 1987, as part of the "defeasance" arrangements then made.  These amendments will be described below.

THE "DEBT DEFEASANCE" TRANSACTION

          According to Garner's Dictionary of Modern Legal Usage, 1987, the more usual sense of the legal word "defeasance" is -

     "(1) `the rendering null and void (of a previous condition)'".

          Garner notes, as the second, less usual sense of the word -

     "(2) `a condition upon the performance of which a deed or other instrument is defeated or made void.'"

          For present purposes, whilst it may be convenient to use the label "debt defeasance arrangements" to describe in a short-hand fashion the series of complicated but interdependent transactions entered into in January 1987, it should not be assumed, nor is it necessary to decide, that those dealings should be characterised as a "defeasance" in any strictly legal sense (cf. Moneymen Pty. Ltd. v Federal Commissioner of Taxation (1990) 97 ALR 265 at 269).  On the other hand, it will be necessary to analyse the true legal relationship of the parties by virtue of their dealings before considering their revenue implications.  As part of that analysis, reference should initially be made to the form that the arrangements took, looking first at the material terms of the documentation executed on 9 January 1987.  It should be noted that it is accepted by both sides that the documentation was intended to take effect in accordance with its tenor, and that the parties negotiated the arrangements at arms' length. 

(a)  Liability Assumption Agreement

          The parties to this agreement, dated 9 January 1987, were the respondent, NMLN and the Local Government Finance Authority of South Australia ("LGFASA").  It provided that in consideration of the payment of $6,301,706 by the respondent to LGFASA, LGFASA agreed to assume the Principal Money Obligations (which were defined so as to exclude interest) as specified in Schedule 1 to the agreement on all Issued Debenture Stock maturing thereafter.  Schedule 1 was as follows:

                         "SCHEDULE 1

          SCHEDULE OF PRINCIPAL MONEY OBLIGATIONS -

                 MATURITY DATES AND AMOUNTS         

           Date                        Amount

         30.6.87                  $4,310,000.00

         31.3.89                  $3,075,000.00"

          It was further provided (cl.4(a)) that in performing its obligations, LGFASA -

     "shall indemnify the [respondent] in respect of the payment of such amounts ... TO THE INTENT ... that [LGFASA] shall be bound to perform ... the [respondent's] covenants ... relating ... to ... the Principal Money Obligations ... (unless directed by the Trustee in writing not less than two business days before any Payment Date that any sum payable on such date is to be paid to the Trustee) pay that sum to the [registered holder] ... AND nothing in this Agreement shall require [LGFASA] to make any payments whatsoever to the [respondent] in connection with the assumption or payment by [LGFASA] of the Principal Money Obligations."

          The liability of LGFASA was expressed to be that of a principal obligor and that liability was not to be affected by, inter alia, any release by NMLN of the respondent's obligations (cl.5).

          If it was not possible in any case for LGFASA to effect payment of a Principal Money Obligation to a stockholder, payment to NMLN would operate to satisfy the obligation (cl.6).

          The respondent agreed, inter alia, to perform the terms of the Trust Deed and, in particular, agreed to pay the interest (cl.7(h)).

          LGFASA agreed, inter alia, that, on the due dates, it would provide NMLN and the respondent with a written statement that payments had been made in accordance with cl.4(a) (cl.8(d)).

          NMLN was to have primary recourse to LGFASA in satisfaction of the Principal Money Obligations and was to accept due payment by LGFASA of those Obligations pursuant to cl.4 in satisfaction and extinguishment of the respondent's obligations under the Trust Deed (cl.9(a)).

(b)  Deed of Charge

          This deed ("the Deed of Charge") also was made between the respondent, NMLN (as trustee) and LGFASA on 9 January 1987.

          LGFASA agreed to issue to the respondent certain securities being a portfolio of promissory notes (known as "Zero Coupon Securities") described as follows:

     "Maturity                          Face Value

     31.3.87                           $162,206.25

     30.6.87                           $167,012.50

     30.9.87                           $162,206.25

     31.3.88                           $162.206.25

     30.9.88                           $162,206.25

     31.3.89                           $162,206.25"

          The respondent charged the securities to NMLN to secure payment of the Interest Obligations on the Stock (cl.4).  Upon the failure of the respondent to pay the Secured Obligations, NMLN was empowered to sell the securities (cl.5).

          Clause 6 was in these terms:

     "6.  Return of Securities

          [NMLN] shall forthwith return the Securities in whole or in part to the [respondent] to the extent that the face value of the Securities exceeds the Secured Obligations, it being the intention of the Parties that [NMLN] shall return to the [respondent] the particular Securities or any part thereof, the maturity date of which most closely corresponds with the Payment Date of any Interest Obligation."

          On 9 January 1987, the respondent wrote a letter to LGFASA setting out the following procedures, which were then agreed to in writing by LGFASA:

                    "RETURN OF SECURITIES

     This letter sets out the procedures for the return of the Securities referred to in the Deed of Charge ... .

     Procedures

     1.   Interest cheques payable to the registered holders of debenture stock will be prepared by the Company, and mailed to the holders by the Company's Auditors.

     2.   Immediately on completion of the mailing of interest cheques, the Company's Auditors will telex confirmation of posting to the Trustee, who in turn will telex instructions to the Trustee's solicitors in Adelaide, by whom the Securities will be held, to release the particular securities whose maturity date most closely corresponds with the payment date of the Interest Obligation.

     3.   The Securities released will be collected by a duly authorised representative of the Company, who will then present the Securities at the office of the Securities Issuer in Adelaide for immediate payment by cash or cheque.

     4.   The Company's representative will deposit the proceeds in a bank as instructed by the Company.

     ..."

(c)  Principal Compensation Agreement

          By this agreement ("the Principal Compensation Agreement") dated 9 January 1987 made between UAL, LGFASA and NMLN, UAL agreed to deposit with LGFASA immediately an amount equal to the Principal Money Obligations in the event that NMLN should determine that the moneys secured by the Trust Deed became enforceable on the happening of events described in cl.15 of the Trust Deed.

          By cl.15 of the Trust Deed, as then amended, several events are there described, including the making of a winding up order or the appointment of a receiver, as well as failure by the respondent to pay interest or principal within seven days of the due date.

          The deposit by UAL was to be interest-free and paid in accordance with the terms of Schedule 1 of the Liability Assumption Agreement (cl.3).  It will be recalled that Schedule 1 specified maturity dates and amounts of 30.6.1987 and $4,310,000 and 31.3.1989 and $3,075,000, respectively.

(d)  The B.T. Deed

          By a deed dated 31 December 1986, amended by deed dated 9 January 1987, made between B.T. Australia Limited ("B.T.") and LGFASA, B.T. guaranteed the obligations of UAL to make the cash deposit under the Principal Compensation Agreement by agreeing to make that deposit immediately in the event that UAL failed to do so (cl.2).

(e)  The Deed of Amendment of the Trust Deed

          This deed, also dated 9 January 1987, made pursuant to cl.34 of the Trust Deed (which empowers the respondent, NMLN and the guarantors to amend the Deed in certain circumstances), prospectively released the guarantors from their liabilities under the Trust Deed (cl.2).  The charge over the respondent's assets was released, but on the footing that the respondent remained personally liable (cl.3).  The original cl.4 and cl.7 were deleted (cl.4(b), 5).  (It will be recalled that cl.4 and cl.7 imposed financial ratio constraints).  In lieu thereof, it was provided that no debenture stock could be issued on or after 9 January 1987 (cl.5).  Original cl.3(f), which provided for the issue of further stock in certain circumstances, was deleted (cl.4(c)).

THE IMPLEMENTATION OF THE "DEFEASANCE" TRANSACTIONS

          In accordance with the provisions of the abovementioned documentation, the respondent paid $6,301,706 (funded by UAL subscribing for additional shares in the respondent's capital, which was then increased from 150,000 to 3,750,000 shares of $2 each) to LGFASA, which in turn paid the principal amounts to debenture-holders.  The respondent paid interest when due, the amounts being matched, as his Honour found (at 407), by receipts from redemption of the Zero Coupons Securities issued by LGFASA. 

THE RESPONDENT CEASES TO CARRY ON ACTIVE BUSINESS

          The respondent then, Spender J. found (at 407), ceased to carry on any active business.

THE REASONING AT FIRST INSTANCE ON THE QUESTION WHETHER THE SURPLUS WAS INCOME WITHIN s.25(1) OR s.25A(1) OF THE ACT

          His Honour first held that the surplus in question was not income in ordinary usage for the purposes of s.25(1) of the Act nor income within s.25A(1) as a profit arising from sale of property acquired for that purpose or from a profit-making undertaking or scheme.  His Honour's reasoning in this regard was as follows:

(1)  There was, in the opinion of the primary Judge (at 407) no profit or gain.  In certain circumstances, a reduction in the amount of a liability can give rise, not only to a profit or gain for accounting purposes, but also to assessable income as on revenue account (see International Nickel Australia Ltd. v Federal Commissioner of Taxation (1977) 137 CLR 347);  there, Mason J. noted (at 368) that the liability was "reduced by supervening circumstances ordinarily encountered in trade"; Mason J. distinguished (at 367-8) British Mexican Petroleum Co. Ltd. v Inland Revenue Commissioners (1932) 16 TC 570, where a liability was extinguished upon the release of a creditor, yet because this was an "unusual transaction", it was not on revenue account. But here, Spender J. held (at 408) the respondent was not released from its liability under the Trust Deed, although NMLN agreed to have primary recourse to LGFASA.

          The object, his Honour held, is to discover what gains have "come home" to the taxpayer so that, as was said in Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation (1965) 114 CLR 314 at 318, the amounts received properly may be counted as gains "completely made", so that there is "neither legal nor business unsoundness in regarding them without qualification as income derived". 

          Spender J. said (at 409):

     "The liability assumption agreement did not effect a novation of the liability.  Looking at the transactions in a practical rather than a legal way, UAS arranged for LGFA to undertake the payments of principal required to be made to the debenture holders on 30 June 1987 and on 31 March 1989.  LGFA agreed to make those payments of principal totalling $7.385 million when  payment was required to be made, in exchange for the present payment to it of $6,301,706.  The dealings between UAS and LGFA were between independent parties at arm's length and the sum paid by UAS to LGFA represented the present value as at the date of the payment of the obligations assumed by LGFA, which of course required their performance some time in the future.  In my opinion, the value to UAS of the assumption by LGFA of the primary liability to the debenture holders equalled the amount of $6,301,706 paid by UAS to LGFA.  In my opinion, there was no profit or gain that came home to UAS as a result of the 'defeasance' agreements."

          His Honour noted that in Federal Commissioner of Taxation v Myer Emporium Ltd. (1987) 163 CLR 199 at 216-7, it was held that for tax purposes the accounting basis for calculating profits and losses is historical cost rather than economic equivalence so that unless made at a discount or a premium, a loan for a stipulated period at interest is treated as exchanging the money lent for a debt of the same amount.  However, in his Honour's view, the result in Myer Emporium turned on the interdependence of the agreements, whereas here there was only one relevant transaction, based on the Liability Assumption Agreement.

          Spender J. said (at 411):

     "I do not accept the submission on behalf of the Commissioner that because the amount paid by UAS to LGFA to secure its agreement to pay the principal was less than the amount UAS was bound to pay to the debenture holders, UAS made a profit of $1,083,294.  The fact that the present value of a future obligation is less than the amount of that future obligation is hardly surprising and accords with practical business reality.  It does not in my opinion constitute a derivation of income."

(2)  Even if there was a profit or gain, his Honour held (at 411) that it did not "come home" until 30 June 1987 (in the case of the 7.75% debentures) or until 31 March 1989 (in the case of the 10.55% debentures), since the time when a profit or loss will be struck in relation to a liability is the occasion when, in substance and in reality, the liability is discharged, as explained in Caltex Limited v Federal Commissioner of Taxation (1961) 106 CLR 205.

(3)  As to the first limb of s.25A, Spender J. said (at 412) that there was no evidence that the liability to the debenture holders was brought into existence for the purpose of later sale; and as to the second limb, the "defeasance" arrangements were not entered into as the carrying out of any profit-making
undertaking or scheme.

(4)  If there was a profit, his Honour was of the view (at 411-12) that the transaction was on revenue account, rather than on capital account.  Notwithstanding the respondent's decision not to undertake new financing activities, the "defeasance" arrangements were part of the steps taken in connection with the respondent's business as a finance company.  The fact that UAS was winding down its borrowing activities did not mean that the servicing of such borrowings as remained, including making arrangements for the payment to debenture holders, were not part of its ordinary business.  It was not an "unusual" transaction in the sense used by Mason J. in International Nickel.

THE COMMISSIONER'S GROUNDS OF APPEAL WITH RESPECT TO THE APPLICATION OF THE s.25 AND s.25A

              In his grounds of appeal, the Commissioner challenges the conclusions of the primary Judge that there was no relevant profit or gain;  that no profit was derived until the liability to debenture holders was discharged by payment by LGFASA;  and that the "defeasance" arrangements were not entered into for the purpose of making a profit.  (Although not specifically mentioned in his notice of appeal, in his written submissions the Commissioner sought to rely on Division 16E of Part III of the Act; this was called in aid to determine the times at which parts of the "gain" made by the "holder" of a "security", as there defined, notionally accrues to such a taxpayer for the purpose of being included in its assessable income; Ryan J. recently dealt with this point in another debt "defeasance" case in ICI Australia Ltd. v Federal Commissioner of Taxation (1994) 125 ALR 63 at 82-7;  this aspect will be considered later.)

THE RESPONDENT'S NOTICE OF CONTENTION ON THE ABOVE ASPECTS

          The respondent has given notice that it contends that the primary Judge should have held that the liabilities the subject of the "defeasance" arrangements were on capital, rather than revenue account;  and further that his Honour should have held that the respondent's finance business had effectively ended, so that any profit from the "defeasance" transaction was on capital account.

CONCLUSIONS ON THE APPEAL WITH RESPECT TO THE APPLICATION OF s.25(1)

          It will be convenient to deal next with s.25(1). It is proposed to analyse, in the first place, the relevant relationship between the parties as constituted by the original Trust Deed before considering the effect of the changes in that relationship that were brought about on 9 January 1987.

(a)  The relevant relationship between the parties as constituted by the original Trust Deed

          The leading authority on the relationship between the borrowing company, the trustee and the debenture holders, particularly with a view to determining the extent, if any, to which the debenture holders have rights directly against the borrowing company is In Re Dunderland Iron Ore Company, Limited [1909] 1 Ch. 446.  It was there held, in a decision which has attracted criticism, that stockholders whose interest was in arrear were not entitled to present a winding-up petition as creditors.

          In Dunderland, cl.5 of the debenture stock trust deed made between the company and the trustees provided that when the stock or any part thereof was redeemed or paid off in accordance with the provisions of the trust deed, the company would pay to the stockholders the full nominal amount of the stock held by them with such premiums (if any) as would be payable in respect thereof; further, such payment would operate in satisfaction of the amount of the stock redeemed or paid off.  In the meantime, until the stock was redeemed or paid off, the company would pay to the stockholders interest on the stock held by them at six percent per year, and such interest would be paid by equal half-yearly payments on every first day of March and first day of September.

          Clause 14 provided that the trustees would be discharged upon the receipt by any stockholder of the principal moneys and interest of the stock held by the stockholder or the return to the company of the stockholder's certificate.

          On the issue of the stock, the company furnished stockholders with a certificate containing conditions, inter alia, as follows:

     "Condition 1.  The stock shall be redeemed on September 1, 1945, and the company shall set aside an accumulative sinking fund of 1 per cent. accruing from September 1, 1910, for securing the redemption of the debenture stock with power to increase such fund.  (Here followed various provisions as to redemption.)

     Condition 3.  The stock shall carry interest at the rate of 6 per cent. per annum and the company will pay to the stockholders interest on their respective amounts thereof at the rate of 6 per cent. per annum.  Such interest will be paid half-yearly on March 1 and September 1 in each year.

     ...

     Condition 5.  The company will recognize the registered holder of any stock his executors or administrators as the absolute owner thereof . . . . and the receipt of such registered holder his executors or administrators for the interest from time to time accruing due in respect thereof and for any moneys payable upon the redemption of the same shall be a good discharge to the company."

          On behalf of the petitioners, reliance was placed upon the circumstance that, under the trust deed, it was provided (by cl.5) that the company would pay the principal and interest when due, not to the trustees, but to the stockholders, whose receipt was a good discharge to the trustees (under cl.14) and to the company (under condition 5).  Although the stockholders were not covenantees, they were equitable creditors under the trust deed, and also legal creditors under the certificate.  The money was advanced direct to the company and did not go through the hands of the trustees.  There was thus an implied contract with the stockholders to pay them the interest, and they could sue, the argument ran, at common law.  The fact that there was also a covenant with the trustees that the company would pay interest direct to the stockholders was not inconsistent with that implied contract, and having regard to the receipt clauses of the trust deed, it would be impossible for the company to be sued twice for the same amount.

          Rejecting the stockholders' argument, Swinfen Eady J. noted (at 452-3) that the trustees and the company were the only parties to the trust deed, a document which created the stock held by the debenture stockholders.  The face of the stock certificate was the only part authenticated by the company's seal, and it did not in terms certify that the stock was issued subject to the conditions endorsed thereon.  Rather, it merely certified that it was issued subject to the provisions contained in the trust deed, which was binding upon the company and the stockholders.  The conditions of issue contained in a schedule to the trust deed were then printed on the back of the certificate.

          Swinfen Eady J. went on to hold that the true legal position was that the debenture stockholders were not creditors, because the covenant in the trust deed was between the company and the trustees, not between the company and the stockholders.  Further, the stock certificate did not contain a covenant, nor did it contain a statement beyond a copy of the conditions contained in a schedule to the trust deed.  The stockholders did not have any direct contract with the company; they were merely the registered holders of debenture stock.  He   concluded that the fact that there was a covenant between the company and the trustees that the company would pay the principal and interest to the stockholders did not entitle the stockholders to sue the company as direct creditors, nor did it make them creditors entitled to present a winding-up petition.

          Several commentators have criticised this reasoning.  In my opinion, there is considerable force in the criticism.  According to Palmer's Company Law (at 14154, 14160), the decision may have been per incuriam, citing Gandy v Gandy [1885] 30 Ch.D 57 and Re Empress Engineering Co. [1880] 16 Ch.D. 125.

          In Empress, A. and B. agreed with C. that an amount be paid to J.  It was held that J. could not claim the amount as J. was not a party to the contract.  Jessel M.R. said (at 129) that, as a general rule, an agreement between two parties that one of them will pay a certain sum to a third person, who is not a party to the agreement, will not make that third person a cestui que trust.  Indeed, such an agreement between the two parties would allow those parties to come to a new agreement the next day, thereby releasing the old agreement - a result which would not be possible if the third person was a cestui que trust.  However, he went on to hold that there may be agreements which do make the third person a cestui que trust, for example where the agreement was to pay out of property, and one of the parties to the agreement constituted himself a trustee of the property for the benefit of the third person.

          In Gandy, Bowen LJ held (at 69-70) that at law, as a general rule, if two parties contract that one will do something for the benefit of a third person who is not a party to the contract, that third person cannot enforce the contract, except in certain exceptional cases.  However, if the true intent and the true effect of the deed was to give  the third persons a beneficial right under it, that is to say, to give them a right to have covenants performed, and to call upon the trustees to protect their rights and interests under it, then the third persons would be outside the common law doctrine, and would, in a Court of Equity, be allowed to enforce their rights under the deed.

          Palmer also refers to Palmer's Company Precedents (16th ed., 1952) where it is said (at 412):

     "Actions where unsecured debenture stock.

     As regards an action to enforce payment of unsecured debenture stock, it may be premised that such stock is extremely rare.  The right to sue in the case of such stock depends on the terms of the instrument constituting it.  Where it is constituted, as it
commonly is, by trust deed, the deed usually contains a covenant by the company with the trustees that the company will pay the stockholders, and in such cases the stockholder can generally sue in equity;  prima facie the trustees are the proper persons to do so, but if the trustees make any difficulty about suing, any stockholder as cestui que trust and beneficially interested, can maintain the action.

     Notwithstanding these cases - which apparently were not cited to him - Swinfen Eady J. held in Dunderland Iron Ore Co., that a holder of debenture stock secured by a trust deed was not a creditor of the company competent to present a winding-up petition against it."

     The cases mentioned by Palmer's Company Precedents are Empress, supra, Gandy, supra, Luke v South Kensington Hotel Co. [1879] 11 Ch.D. 121, Cullen v Knowles [1898] 1 QB 380 and Re Uruguay Central Co. [1879] 11 Ch.D. 372.  In Luke, it was held that one of several mortgages can maintain an action to foreclose the mortgage, making the others co-defendants if they are unwilling to be joined as co-plaintiffs.  In Cullen it was held that one of two joint promisees can maintain an action at law on the contract, making the other joint promisee a co-defendant if, after tender of an indemnity against costs, he refused to be joined as a co-plaintiff.  In the Uruguay case, a company issued, under the provisions of a trust deed, "mortgage bonds" which were to entitle the bearer to payment of the principal and interest. It was held that the bearer of a bond was not a creditor of the company either at law or in equity.  Jessel MR said (at 380) that, as a matter of construction of the trust deed, there was not any "independent loan" made by a bondholder.  There was no contract for a loan;  rather there was a subscription of capital.  Jessel MR went on to say (at 380-1) that upon the deed the bondholders were not creditors; rather they were merely cestuis que trust of a charge, having a right to put their trustees in motion to compel payment under the covenant, but not having any independent right to sue the company either at law or in equity.

          Jessel MR also concluded (at 381) that the form of bond, which was "a very peculiar instrument indeed", was not intended to be enforceable by any individual bondholder for his or her own benefit.  The Master of the Rolls observed (at 382-3) that there was a covenant with the trustees that the company would pay interest to the bearers of the coupons in accordance with the provisions of the deed.  Under the provisions of the deed, the company did not covenant to pay the bearers of the coupons directly, but rather promised to pay through the trustees under the provisions of the deed.

          Jessel MR went on to say that the essence of the transaction was that both the share and the bond were issued as a mode of securing to the persons advancing the money for making the line certain benefits, and they took the benefits as they were given to them;  however, that did not create any direct debt from the company.  In fact, because the company was liable to pay the trustees under the deed, it could only be liable for an action brought by the trustees, not for an action brought by the holders of the coupons.  He concluded that the parties did not intend to create a debt for which the holder of the coupon could sue directly, and therefore the holder of the coupon, who brought an action for unpaid interest, was not a creditor either at law or in equity within the meaning of the Companies Acts.

          An Australian commentator (J.K. Armitage, The Law of Public Company Finance (edited by R.P. Austin and Richard Vann) (1986)) emphasises (at 266) two important differences between the deed considered in Dunderland and Australian trust deeds.  Under the usual Australian trust deed, it is customary, as was done here, for the covenant by the borrowing company with the trustee to be a covenant to pay to the trustee coupled with a permission to the company to pay direct to the debenture holders so long as the trustee does not require payment to it in accordance with the basic covenant.  It also is customary for the trust deed to contain a provision entitling debenture holders to sue for amounts due to them from the borrowing company.

          Armitage notes that although the express right for the debenture holders to sue the borrowing company has so far been considered on the basis that it is unqualified, in virtually all cases it is qualified, to a greater or lesser degree, by such words as `except where the trustee has a discretion' or `except where the trustee waives the default'.

Therefore, based on the reasoning employed in Dunderland, it might be difficult to argue (unless the terms of the debenture trust deed differ materially from the usual pattern) that a debenture holder is a "creditor" for the purposes of statutory and other references.

          But, as Armitage further observes (at 267), doubt had been cast on the correctness of Dunderland on the basis that the court overlooked the cases supporting the principle that a beneficiary can enforce contractual rights held in trust for him against the other party to the contract, and should therefore, in the type of case being considered, be regarded as a "creditor" of the borrowing company;  that both this kind of comment and the reasoning of the court in the Dunderland case, although representing contrary conclusions, seem to proceed on the basis that only one contract is involved, namely, that constituted by the trust deed between the trustee and the borrowing company;  yet it could be argued that bearing in mind that the subscription for the debentures does not itself involve the trustee, and that no moneys are actually lent to the borrowing company by the trustee, there is a separate primary underlying contract between the prospective debenture holder and the company to the effect that money will be subscribed directly to the company, but the subscriber's right to repayment and to payment of interest and all ancillary rights will be held on his behalf by the trustee on the terms of the trust deed.  Armitage points out that recognition of the existence of a primary contract of that kind "could serve to reconcile the concept of the debenture holder having the status of a creditor for certain purposes, for example in relation to a scheme of arrangement, whilst nevertheless being substantially inhibited in taking individual action against the borrowing company independently of the trustee and the other debenture holders" (at 267).

          I agree with this analysis which is consistent with the provisions of the Trust Deed and with what occurred in execution of those provisions (and see now Trident General Insurance Co. Ltd. v McNiece Bros. Pty. Ltd. (1988) 165 CLR 107;  Shin Kobe Maru v Empire Shipping Company Inc. (1994) 125 ALR 1 at 8;  cf. Winterton Constructions Pty. Ltd. v Hambros Australia Ltd. (1991) 101 ALR 363 at 367-8;  Cousins v Grant (1991) 103 FLR 236 at 244;  and for a recent vigorous criticism of the rule in Tweedle v Atkinson see Darlington Borough Council v Wiltshier Northern Ltd. [1995] 1 WLR 68 per Steyn LJ at 76-7).  It follows, in my opinion, that the reasoning in Dunderland should not be applied here;  in other words, for present purposes, each debenture-holder should have been treated as a creditor of the company, notwithstanding that such person was not a party to the Trust Deed. 

(b)  The changes to the legal relationship effected by the entry into the "defeasance" arrangements

          Although, as indicated, it is not necessary to pursue the question here, the present case appears to be an example of what has been described as "In Substance Defeasance", as distinct from "Legal Defeasance".  In the latter case, there is a formal release, whereas the former kind of transaction usually is not provided for in the original instrument and does not involve a formal release.  In this type of situation, a number of techniques may be used, including (as here) the "Assumption" method.  In the present case, LGFASA has assumed the primary liability to both NMLN and debenture holders, whilst the respondent retained its secondary liability to them.  (A further variant, not found here, but to be mentioned later, known as "Instantaneous in Substance Debt Defeasance" describes the situation where debt is incurred in one country and instantly retired by the purchase of risk-free government securities in another country.)

          As to the relationship between the respondent and LGFASA, in my opinion, the assumption of liability by LGFASA in the form of the promise given by it in the terms of cl.4(a) of the Liability Assumption Agreement would be specifically enforced, if necessary, by a court order made against LGFASA on the application of the respondent, before the respondent discharged its secondary liability to NMLN and the debenture holders (see McIntosh v Dalwood (No.4) (1930) 30 SR (NSW) 415 at 418-9;  Meagher, Gummow and Lehane, Equity Doctrines and Remedies, 3rd ed. at 501;  cf. Wardley Australia Ltd. v Western Australia (1992) 175 CLR 514 at 524).  In other words, even if not giving rise to a "debt" in the strict sense (see In re Michell Freelove v Mitchell [1913] Ch.D 201 at 206) the respondent's rights as against LGFASA in this regard had accrued before the dates for redemption of the debentures arrived.  

          However, the relationship between the respondent and the debenture-holders was a different matter.  As has been noted, although the debenture-holders were not parties to the Trust Deed, the respondent was liable to them in other capacities;  so that, even if it be assumed, as the parties now apparently accept, that the introduction of LGFASA as an assuming primary party and the release of the charge was within the amendment power of a fiduciary character contained in cl.34 of the Trust Deed (cf. Metropolitan Gas Company v The Federal Commissioner of Taxation (1932) 47 CLR 621 at 633, 635), the amendment of that Deed could not destroy or otherwise affect the rights of debenture-holders against the respondent arising otherwise.  In other words, those rights continued to subsist.

(c)  The authorities on the question whether the "surplus" arising from the arrangements was income for the purposes of s.25(1)

          (i)  The ICI Case

          ICI, supra, was, as has been noted, a case of "debt defeasance" also.  However, although Ryan J. did not refer to the decision in the present matter, a different conclusion was reached in an income tax context.  In ICI, third parties agreed to assume the liability of the holding company of the ICI Australia Group to pay principal and interest under a debenture trust deed.  The holding company was not engaged directly in manufacturing operations.  It owned land and raised long-term finance for the group's operations, mainly by the issue of debentures.  The money so borrowed was lent to subsidiaries at commercial rates of interest.  Ryan J. held (at 74) that the difference between the amount paid by ICI under the principal assumption agreement and the amount which ICI would have been required, but for that agreement, to pay to redeem the debentures was income, representing the price paid by the assumption party for the use of ICI's money over time.  His Honour further commented that whether it could be regarded as a price which was economically advantageous to ICI may depend on movements in interest rates and inflation over the same period.

          Ryan J., citing the observations in Myer Emporium (at 216-7) to the effect that historical cost is the accounting basis for calculating profits and losses for present purposes, so that the amount of a debt "is not reduced because the lender is kept out of the use and enjoyment of the money lent for the period of the loan", said (at 75) that the corollary of that proposition is that the value of the assumption of a liability is not reduced because the assumption party has the use and enjoyment of the principal's funds for the period before the liability falls to be discharged.  Referring to Lomax v Peter Dixon & Son, Limited [1943] 1 KB 671, Ryan J. mentioned instances where money was advanced on terms that it would be repaid at the end of a specified term, together with an additional amount.  In some cases, the difference could be characterised as interest, whereas in others it could be regarded as compensation for the capital risk.  The proper characterisation, Ryan J. noted, turns on features such as the length of time for which money is lent, whether the contract stipulates payment of interest independently of the premium and the degree of risk assumed by the borrower.

          Ryan J. went on to say (at 75) that, based upon the evidence, the premium notionally receivable by ICI was interest, despite the fact that ICI was not actually to receive the premium, relying on s 19 of the Act.

          Although Ryan J. was disposed to accept (at 81) that the funds raised by ICI in issuing the debentures were "permanent or long-term additions to its funds" and thus on capital account, the question remained whether because the assumption agreement contemplated the repayment of borrowings on capital account, any gain made from that transaction similarly was attributable to capital rather than income.  His Honour held (at 81-2) that ICI's "gain" was not made on the date the debentures were repaid.  Rather, the "gain" represented the difference between the advance or price paid to MMBW and the face value at which the debentures would have to be redeemed on maturity.  The fact that it was to be applied in elimination of a capital liability did not detract from its character as income.

     (ii)  The Lomax Case

           In Myer Emporium (at 217), as in ICI, reliance was placed upon the reasoning in Lomax, supra.  There, a loan to a Finnish company was secured by the company's issue of interest-bearing notes at a discount.  The notes were to bear a premium on redemption, if the company's profits permitted it.  The Court of Appeal held that both the discount and the premium were on capital account.

          Lord Greene M.R. said (at 677):

     "... there can be no general rule that any sum which a lender receives over and above the amount which he lends ought to be treated as income.  Each case must, in my opinion, depend on its own facts, and evidence dehors the contract must always be admissible to explain what the contract itself usually disregards, namely, the quality which ought to be attributed to the sum in question."

          Lord Greene summarised his conclusions (at 682-3) as follows:

(1)  Where a loan is made at or above such a reasonable commercial rate of interest as is applicable to a reasonably
sound security there is no presumption that a "discount" at which the loan is made, or a "premium" at which it is payable is in the nature of interest. 

(2)  The true nature of the "discount" or the "premium" is to be ascertained from all the circumstances of the case, and, apart from any matter of law which may bear on the question (such as the interpretation of the contract), will fall to be determined as a matter of fact by commissioners. 

(3)  In deciding the true nature of the "discount" or "premium" in so far as it is not conclusively determined by the contract, the following matters together with any other relevant circumstances are important to be considered, namely, the term of the loan, the rate of interest expressly stipulated for, the nature of the capital risk, and the extent to which, if at all, the parties expressly took or may reasonably be supposed to have taken the capital risk into account in fixing the terms of the contract.  This is confined to a case where a reasonable commercial rate of interest is charged.  Where no interest is payable as such, different considerations will, of course, apply.  In such a case, a "discount" normally will be a discount chargeable under para.(b) or r.I to case III. (Income Tax Act, 1918 (8 & 9 Geo.5, c. 40), Sch.D.)  Similarly, a "premium" normally will be interest.

     (iii)  The International Nickel Case

            In International Nickel, supra, where devaluation led to a reduction in the amount payable for trading stock, it was argued for the taxpayer (at 348) that "the saving in question ... is one in the discharge of a balance sheet item and is not the equivalent of the receipt of income".  The British Mexican case was cited but, as has been noted, distinguished by Mason J. (at 367-8) on the ground that the reduction or elimination of that outgoing "was the consequence of an unusual transaction whereby a liability was extinguished by a release on the part of the creditor ... [and did] not touch this case where the liability is reduced by supervening circumstances ordinarily encountered in trade".

     (iv)  The British Mexican Case

             The facts in British Mexican were that the taxpayer, being unable to meet in full its liability under a contract for the supply of petroleum, there being a global slump in prices, by agreement made in November 1921, paid part of the amount owing but was released from its liability to pay the balance.  The taxpayer's accounts were prepared for the year ended 30 June 1921 and for the 18 months ended 31 December 1922.  The formal accounts showed the amount then owing for the supply of petroleum.  In the latter accounts, the amount released was carried direct to the balance sheet and shown as a reserve. 

          Rowlatt J. rejected the Crown's contention that the amount released should be brought into account in computing the taxpayer's profits for revenue purposes in one or another of the accounting periods.  Rowlatt J. held (at 585-6) that the debt was fixed absolutely at the time, and had not been diminished by any consideration owing to the validity or the disputability of the debt; that the debt had been diminished "purely for collateral business reasons" and that it had "simply been forgiven and nothing else".

          The Court of Appeal dismissed an appeal by the Crown.  Lord Hanworth MR said (at 588) that the Commissioners had overlooked the clause of the agreement under which the money was paid, and had failed to observe that the clause had the distinct purpose of giving the Company relief effectively by giving it new capital. 

          A further appeal by the Crown to the House of Lords was also dismissed, but on different grounds.  Lord Thankerton said (at 592):

     "...the account to 30th June, 1921, cannot be reopened, as the amount of the liability there stated was correctly stated as the finally agreed amount of the liability and the subsequent release of the Respondents proceeds on the footing of the correctness of that statement.

     The Appellant's alternative contention, which was not seriously pressed by the Attorney-General, is equally unsound, in my opinion.  I am unable to see how the release from a liability, which liability has been finally dealt with in the preceding account, can form a trading receipt in the account for the year in which it is granted."

          Lord Macmillan said (at 593-4):

     "An account may be reopened where an item has been omitted or some other error has occurred, or an account may be kept open by describing entries in it as provisional, but here it is agreed on all hands that there was no error in the accounts of the Appellant Company for the year to 30th June, 1921, and that they were properly and finally drawn up so as to show the result of the year's trading.

     If, then, the accounts for the year to 30th June, 1921, cannot now be gone back upon, still less in my opinion can the Appellant Company be required to enter as a credit item in its accounts for the eighteen months to 31st December, 1922, the sum of [pounds] 945,232, being the extent to which the Huasteca Company agreed to release the Appellant Company's debt to it.  I say so for the short and simple reason that the Appellant Company did not, in those eighteen months, either receive payment of that sum or acquire any right to receive payment of it.  I cannot see how the extent to which a debt is forgiven can become a credit item in the trading account for the period within which the concession is made.

     I observe that of the Appellant Company's total indebtedness to the Huasteca Company, [pounds] 196,951 was incurred during the eighteen months covered by the accounts to 31st December, 1922, and that the date on which the Huasteca Company agreed to forgo [pounds] 945,232 of the Appellant Company's total indebtedness was 25th November, 1921, also within that period of eighteen months.  Now it may be that where during the currency of an accounting period a trading debt is incurred, and the creditor agrees during the currency of the same period to accept less than the full amount of the debt due to him, it is only the balance of the debt as exacted, or agreed to be exacted, which ought to enter, as a debit, the debtor's accounts for the period.  As to this I say nothing, for the present case has been argued by the Crown on the footing that the whole sum of [pounds] 945,232 ought either to be dealt with in a reopened account for the year to 30th June, 1921, or credited in the eighteen months' account to 31st December, 1922, and as, in my opinion, neither of these contentions is admissible, I concur in the motion that the appeal be dismissed."

     (v)  Myer Emporium

          As has been noted, the High Court held here (at 216-7) that the accounting position is governed by historical cost rather than economic equivalence.  Mason ACJ., Wilson, Brennan and Dawson JJ. went on to say (at 219-20):

     "... the sale of Myer's right to interest produced an immediate cash receipt. For an outlay of $80,000,000 in the transaction Myer acquired a debt of $80,000,000 owed by Myer Finance and $45,370,000 in cash from Citicorp.  It has made a profit of $45,370,000.  True it is that Myer will not now receive the interest which would have become payable to it during the period of the loan but that will be reflected only by an absence of the income by way of interest which would otherwise have been received in future years.   Myer received the profit of $45,370,000 during the 1981 income year and that receipt forms part of its assessable income for the year.

     What we have said leads to the conclusion that the amount in question formed part of the income of Myer under s.25(1) of the Act.  A similar chain of reasoning would have led to the conclusion that the amount constituted assessable income under the second limb of s.26(a)."

(d)  The authorities on the treatment for revenue purposes of dealings by a finance company

     (i)  Avco

          It is common ground that the respondent was, or was similar to, a finance company for tax purposes.  In Avco Financial Services Limited v Federal Commissioner of Taxation (1982) 150 CLR 510, a finance company borrowed money overseas to enable it to make loans to its Australian customers and to repay existing borrowings.  It was held that exchange gains and losses made on repayment of the loans were income and allowable deductions respectively.   Gibbs CJ said (at 518):

     "Where a taxpayer carries on the business of borrowing and lending money, the moneys used for that purpose are analogous 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."

          (See also the observations to the same effect by Mason, Aickin and Wilson JJ. at 527 and 530-1).

     (ii)  Coles Myer

           Avco was considered in Coles Myer Finance Ltd. v Federal Commissioner of Taxation (1993) 176 CLR 640.  Mason CJ, Brennan, Dawson, Toohey and Gaudron JJ said (at 663-4):

     "The judgments ... in Avco ... contain statements which either state ... or might be taken, when read in isolation, to suggest ... that the borrowing of money and the repayment of loans by a finance company in the ordinary course of its business may amount to transactions on revenue account.  However, the joint judgment of Mason, Aickin and Wilson JJ. ..., when properly understood, like that of Gibbs CJ. ..., proceeds on the proposition that, although such transactions by a finance company are properly to be regarded as transactions on capital account, the relevant gains and losses are nevertheless to be regarded as revenue gains and losses.  That is because the gains and losses were incurred in the course of and as an incident of making repayments of the borrowed money with which the taxpayer carried on its business as a finance company.  The losses or outgoings were incurred in the day-to-day conduct of the business and for the purpose of carrying it on as a going concern.  Though the borrowed moneys were capital, it was working or circulating capital from which the taxpayer derived its profits by turning the borrowed money to account at higher rates of interest than those paid to the taxpayer's lenders.  The borrowing, as much as the lending, was an integral part of the day-to-day conduct of the taxpayer's profit-earning business."

          Deane J. said (at 669):

     "The real importance of Avco Financial Services for present purposes is that it provides strong support for the conclusion that the taxpayer's net losses or outgoings, resulting from the discount on the face value allowed upon sale, are the kind of recurrent expenditure which is deductible pursuant to s.51(1) of the Act as a loss or outgoing incurred in gaining or producing assessable income.

     ... the outcome of the present appeal would have been the same even if the taxpayer's liability in respect of unmatured notes and bills had been, as a matter of jurisprudential analysis, a contingent one.  The reason why that is so is that it was, for practical purposes, always inevitable that any theoretical contingency, which existed at the end of the tax year and affected the taxpayer's liability to make the payment of the face value of the notes and bills, would be satisfied, unless the taxpayer subsequently repurchased the bills or notes in the market place.  Even if the taxpayer had subsequently purchased the bills or notes in the market place - and it did not - the purchase price would presumably have exceeded their 'value' as at the end of the tax year since the appropriate 'discount' on face value would be expected to decrease as the time of maturity approached."

THE APPLICATION OF s.25(1)

          In the present case, the respondent has, in essence, paid a sum of money to LGFASA in exchange for a promise by LGFASA to release the respondent from its future primary liability in a larger amount to NMLN and to the debenture-holders under the Trust Deed, but on the footing that the respondent remained secondarily liable to them in the future for that larger amount.  In other words, whilst the respondent has achieved from the transaction an effective release from its primary liability to NMLN and debenture-holders under the Trust Deed, there remained, in theory at least, (1) its future secondary liability to NMLN and debenture-holders under the Trust Deed in its amended form and (2) its future primary liability to debenture-holders under their collateral, implied contract.

          Where an obligation is incurred in the ordinary course of trade and is absolutely and unconditionally released in that year in the ordinary course of trade, usually, as Lord Macmillan observed in the British Mexican case, a profit on revenue account would then be derived by the party being released.  But, in the present case, there has not been, in point of jurisprudential analysis or in practical terms, an unconditional release.  At the same time, this is not a case where "the [original] obligation remained, for both theoretical and practical purposes, unaffected ..." (per Deane J. in Ransburg v Federal Commissioner of Taxation (1980) 29 ALR 433 at 436).  Moreover, the second group of debentures were not repayable until a subsequent year of income.

          As has been seen, in International Nickel, Mason J. explained the outcome in the British Mexican case on the basis that the release, although dealing with a revenue item, was an "unusual" transaction.  The same may be said of a debt "defeasance" transaction of the present kind where undertaken by a trader, notwithstanding, with respect, the contrary opinion expressed in the ICI case.

          But here, in technical terms at least, it appears that the ordinary activities of the respondent may be described as similar to those of a finance company.  In the case of a financier, a refinancing arrangement of an orthodox kind may not be regarded as anything out of the ordinary or "unusual" in the conduct of such a special kind of business activity, where money is in the nature of its stock in trade.  But whether the subject dealings, that is, debt "defeasance" by the "assumption" method, should be regarded as something "ordinarily encountered [by this financier] in trade" is, I think, the critical issue here.

          In my opinion, although the question is a difficult one, even in the case of a financier, a partial release in the form of debt "defeasance" by the complex "assumption" method used in the present circumstances to relieve the respondent of some of its primary responsibility, both in legal and practical terms, with a view to winding down its activities, should not be regarded as something "ordinarily encountered" in that business.  It should thus be treated as having taken place on capital account so that any gain would not, in my view, constitute income.  Refinancing by other methods may well have a different quality, but that is another matter.

          Another way of looking at the question is to take into account the tests propounded in this area in Lomax, supra.  Where, as here, the receipt of the "surplus" is not actual, but merely notional, and where the object of the exercise, as the trial Judge found, is to remove financial constraints and, at the same time, to wind down the taxpayer's activity, it is difficult to infer from the circumstances that the quality to be attributed to the amount was income.  On its face at least, the payment of an amount in exchange for the particular promises given here, complex as they were, do not suggest, as a matter of common sense or otherwise, that any difference should be regarded as income in the hands of the respondent.  Nor, in my view, is there anything in the surrounding circumstances to indicate that such an inference should be drawn.  On the contrary, the documentation and the extraordinary extrinsic circumstances provide an explanation for what occurred that is inconsistent with the inference  that income, in the form of the notional "surplus", was being generated in the hands of the respondent.

THE APPLICATION OF s.25A

          I agree with Spender J., for the reasons his Honour gave, that the relevant purpose was not present here.  This is not to say that other methods of debt "defeasance", for instance, the "instantaneous" kind previously mentioned, may not fall within the Myer Emporium principle, but that is another question.

DIVISION 16E

          Having had the advantage of reading the judgment of Hill J., I agree with his Honour's conclusions on this issue for the reasons he gives.

CAPITAL GAINS TAX

          On behalf of the Commissioner, it is contended that the rights acquired by the respondent under the debt "defeasance" transaction were an "asset" within s.160A of the Act, and that the respondent disposed of the asset so acquired within the meaning of s.160M(3) of the Act when LGFASA performed its obligations under the assumption arrangement.

          I have difficulty accepting the argument in the present context.

          Spender J. said (at 414):

     "It seems to me that UAS, pursuant to the agreement, acquired a proprietary right and therefore an asset for the purposes of Pt IIIA of the Act.  However, in my opinion, that right was not disposed of by LGFA's performance of its obligations under that agreement.  It seems impossible to contend, as the primary formulation of the Commissioner on capital gain seeks to do, that any disposal occurred at the time of the making of the liability assumption agreement."

          His Honour went on to say (at 415):

     "In my opinion, it cannot be said that on performance, a capital gain of $1,083,294, or of any amount, has been made.  On performance, the asset alleged by the Commissioner, namely the right to compel performance is no longer owned by anyone.  It ceases to exist: cf s.160N.

     There is no entitlement under the liability assumption agreement in UAS to receive money or other consideration on the performance of LGFA of its obligations under that agreement: cf s.160M(7).  There is no basis, in my view for concluding that the $7,385,000 paid by LGFA is the consideration that UAS receives or is entitled to receive on the 'disposal' of the right in UAS to compel LGFA to perform its obligations under the liability assumption agreement."

          In ICI, Ryan J. held (at 92) that no asset existed in the sense explained in Hepples case (1990) 22 FCR 1;  (1990) 173 CLR 492.  However, his Honour went on (at 93) to express the view that the definition of change of ownership in s.160M(3)(b) would have been satisfied here since the definition -

     "...has been cast as widely as possible to embrace all means by which the owner of a debt, chose in action or cognate right can bring about, or allow to be brought about, its extinguishment.  On this view payment of the debt or performance of the obligee's obligation under some other form of contract embodying the right amounts to a discharge or satisfaction of the right which constitutes the asset contemplated by para (b)."

          In my opinion, even if it be assumed that the rights acquired by the respondent under the assumption arrangement were an "asset" within s.160A owned by the respondent, there was no change in that ownership within s.160M and, in particular, within s.160M(3)(b).

          It is true, as Ryan J. pointed out, that s.160M(3)(b) extends to many ways in which a debt or chose in

action may be disposed of, with a consequent change of ownership -

     "...the cancellation, release, discharge, satisfaction, surrender, forfeiture, expiry or abandonment, at law or in equity, of the asset."

          These are all well-known legal concepts and none of them, I think, fit the events that occurred here, where another party promised to meet the primary liability of the respondent and subsequently met that liability.  The respondent's contractual right to have this done was not cancelled, released etc.

          On the other hand, s.160M(3) is not an exclusive definition and s.160M(2) extends to a change in ownership that occurs in any way; even so, there must be a change in ownership of the respondent's rights in some way or other.  But, in my view, there was no such change.  At all times, the respondent's rights remained vested in the respondent.  The rights were never divested and there was no change in their ownership.

          It follows that there was no liability for capital gains tax.

ORDERS PROPOSED

          I would propose that the appeal be dismissed, with costs.

                   I certify that this and the preceding forty-six (46)) pages are a true copy of the Reasons for Judgment herein of his Honour Justice Beaumont.

                   Associate

                   Dated:    24 February 1995

IN THE FEDERAL COURT OF AUSTRALIA  )

                                   )

NEW SOUTH WALES DISTRICT REGISTRY  )     No NG 438 of 1994

                                   )

GENERAL DIVISION                   )

                ON APPEAL FROM A SINGLE JUDGE

              OF THE FEDERAL COURT OF AUSTRALIA

              BETWEEN:      COMMISSIONER OF TAXATION

                             Applicant

                  AND:      UNILEVER AUSTRALIA SECURITIES LIMITED

                             Respondent

CORAM:    LOCKHART, BEAUMONT & HILL JJ

PLACE:    SYDNEY

DATED:    24 FEBRUARY 1995

                    REASONS FOR JUDGMENT

HILL J:

          The 1980s spawned many innovative financial arrangements.  In part, at least, these grew from the climate of rising interest rates and increased inflation and would have been unthinkable in more stable times.  One such financial arrangement was known as "debt defeasance".  Not surprisingly, income tax questions are raised.

          Underlying debt defeasance is the notion of the time cost of money.  Companies with long term borrowings at relatively low rates of interests could obtain a financial advantage if those borrowings could be repaid because the present value of the liability was less than the face value repayable.  Where the long term borrowings were obtained by the issue of debentures to the public secured by debenture trust deeds, debt defeasance had another advantage.  Debenture trust deeds typically provided a constraint upon the operations of the borrowing company which was required to maintain a stipulated ratio of liabilities to assets.  There were usually, as well, onerous reporting obligations on the borrowing company to provide information to the trustee for debenture holders.

          Where early redemption of debentures was a theoretical possibility, the ratio constraints and reporting requirements continued unless all debentures were redeemed.  [Debt defeasance, on the other hand, provided an opportunity for a borrowing company to free itself from such constraints.

          Debt defeasance is somewhat of a misnomer.  In simple terms it involved a borrowing company making a payment to a third party in consideration of that third party accepting responsibility for the borrowing company's obligation to repay debentures on maturity.  However, the liability of the borrowing company was not, in a legal sense, defeased at all.  The borrowing company continued to be liable to meet the debentures on maturity, but the assumption of liability by the third party of good financial standing had the practical consequence that the liability of the borrowing company would be satisfied by payment by the third party directly to the debenture holders.  The "defeasance" was practical rather than legal.

          Unilever Australia Securities Limited ("UAS") was incorporated on 22 May 1947 and was at all times a wholly owned subsidiary of Unilever Australia Limited ("UAL"), the principal operating company of the Unilever Australia group of companies.  Not a great deal is known of the activities of UAS.  It was the financing vehicle for UAL and provided funds not only to UAL but to other companies within the Unilever Australia group.

          The activities of UAL were funded, in part, by the issue of debenture stock secured by the terms of a debenture trust deed dated 24 April 1967 to which National Mutual Life Nominees Limited, as trustee, and twelve other Unilever group companies as guarantors were parties.  There were three issues of debentures made under this deed.  The first was an issue of 7.75% debenture stock, the principal being $4,310,000, repayable on 30 June 1987.  This stock was created and issued on 24 April 1967.  The second and third issues were each made on 7 March 1979, being an issue of 10.55% debenture stock, the principal being $3,075,000, repayable on 31 March 1989 and 10.40% debenture stock, the principal being $6,725,000, redeemable on 31 December 1985.  The last mentioned debentures were redeemed on maturity prior to UAL entering into a debt defeasance arrangement.

          Until 1983 UAS functioned, according to the evidence of a director, at the time also the financial director of UAL, as a "standard sort of finance company".  In addition to the advances it made to Unilever companies, it put out some of its funds on the short term money market.  In 1983 a decision was made to convert UAL to a public company.  From that time new borrowings for the group were made through UAL rather than UAS.  UAS ceased trading on the short term money market and thereafter issued no new debenture stock nor made further loans to UAL or other companies in the Unilever group.  Apart from the debt defeasance transaction, with which the present appeal is concerned, it would seem that thereafter UAS's only activity was the receipt of interest upon loans made by it to companies in the UAL group and servicing the interest which it was required to meet upon debentures.  As already indicated, it in fact redeemed on maturity the 10.40% debentures that had been issued in 1979.

          The Report of the Directors on the accounts of UAS for the year ended 31 December 1987, in which year the debt defeasance arrangement took place, stated that the principal activity of the company was the provision of finance to the Unilever group of companies through an existing issue of debentures.  It said that there had been no significant change in the nature of the company's activities in the year.  It referred additionally to an offer made on 14 December 1987 by the company to purchase the issued share capital of Bushells Holdings Limited under a takeover scheme.

          After the redemption of the 10.40% debenture stock, there remained outstanding $7.385M in debenture stock.  The Financial Director of UAL saw the financial constraints and reporting requirements of the debenture trust deed as onerous, costly and time consuming.  They imposed, he said:

          "... a significant impediment to the Unilever group in Australia borrowing further moneys to fund its ongoing business operations as well as its planned long term strategic expansion."

          Towards the latter part of 1986 he became aware of the possibility of debt defeasance and in the result agreements were entered into in January 1987, with which the present appeal is concerned, the matter at first instance being reported as Unilever Australia Securities Limited v Federal Commissioner of Taxation (1994) 122 ALR 402.

          Before detailing the agreements required to implement the debt defeasance, it is useful to say something about the structure of the debenture trust deed before its amendment.  The trust deed provided for the creation, in the first instance, of an aggregate amount of $6M of stock on terms stated in it and for further stock to be issued thereafter.  By cl.8, UAS (in the trust deed referred to as "the Company") covenanted with the trustee to pay to it the principal and interest under issued stock.  Clause 8(c) then provided:

          "Notwithstanding the provisions of sub-clause (b) hereof:-

          (i)  unless and until the Trustee requires the Company to make payments to it in accordance with sub-clause (b) of this Clause, the Company shall pay to the Stockholders the principal interest and premium (if any) payable in respect of the Issued Stock held by them in accordance with the terms of issue of such Issued Stock and such payment to the Stockholders shall operate pro tanto in satisfaction of the principal interest and premium (if any) payable in the respect of the Issued Stock the indebtedness for which is acknowledged by sub-clause (a) of this Clause;".

          There was no evidence of the contractual or other arrangements between UAS and stockholders such as might be recorded in the terms of issue of debentures.

          Under the debenture stock deed, UAS charged its undertaking and assets in favour of the trustee for debenture holders and the guaranteeing companies guaranteed the obligation of UAS to the trustee under the deed.  Otherwise the deed was in fairly common form, particularly in providing as it did for ratio constraints and reporting to the trustee.

          The debt defeasance arrangement was carried out through a number of related agreements.  First, very substantial amendments were made to the debenture trust deed.  Group guarantors were released and securities discharged.  It was agreed that no debenture stock would be issued after 9 January 1987 and, in particular, the ratio and reporting requirements ceased to apply.  In place of the stringent reporting requirements was substituted merely the requirement to lodge an audited balance sheet and profit and loss account and to notify whether an event of default had occurred under the deed.  Those circumstances which constituted an event of default were severely limited.  The provisions of cl.8, to which reference is made above, however, remained.

          The principal document for implementing the debt defeasance arrangement was the Liability Assumption Agreement, an agreement between UAS, the trustee for debenture holders, and the Local Government Finance Authority of South Australia (LGFA) therein referred to as "the counter-party".  LGFA was a statutory corporation constituted to the provision of the Local Government Finance Act 1983 (SA) and its liabilities were guaranteed by the South Australian government.

          The substantial operative provision of the Liability Assumption Agreement was cl.4(a) which provided as follows:

          "In consideration of the payment on or before the date hereof by the Company [UAS] to the Counter-Party [LGFA] of the Sum (receipt of which is hereby acknowledged), the Counter-Party hereby agrees with the Company and the Trustee to assume the Principal Money Obligations on all Issued Debenture Stock and maturing after the date hereof subject to the terms and upon such conditions as hereinafter provided, provided that in performing its obligations the Counter-Party shall
indemnify the Company in respect of the payment of such amounts to the extent hereinafter provided TO THE INTENT and effect that the Counter-Party shall be bound to perform and observe the covenants on the part of the Company under the Trust Deed relating directly or indirectly to the payment of the Principal Money Obligations from time to time payable and the Counter-Party shall (unless directed by the Trustee in writing not less than two business days before any Payment Date that any sum payable on such date is to be paid to the Trustee) pay that sum to the person who is, at the Payment Date, notified by the Company and verified by the Auditors of the Company as recorded in the Register as the holder of the Debenture Stock to which the sum relates ... AND nothing in this Agreement shall require the Counter-Party to make any payments whatsoever to the Company in connection with the assumption or payment by the Counter-Party of the Principal Money Obligations."

          The expression "Principal Money Obligations" was defined as meaning the company's obligation under the trust deed to redeem or otherwise satisfy the principal due, owing and payable to debenture stockholders.  It did not include obligations to pay interest.  It was further provided by the liability assumption agreement that the liability of LGFA was to be that of a principal obligor.  For its part UAS covenanted to continue to observe and perform the covenants in the trust deed, particularly the covenant to pay interest.

          To deal with interest, LGFA issued UAS with various promissory notes called in the documentation "Zero Coupon Securities".  UAS were to pay interest amounts when due with LGFA to issue a receipt of redemption for the promissory notes which were charged to the trustee as security for payment by UAS of the interest on the debentures.  In the event that UAS failed to meet its obligations to debenture holders to pay interest, the trustees could sell the promissory notes and make payment.

          There were, in addition, ancillary agreements entered into which require no comment here.

          The result of the transactions was that UAS paid to LGFA $6,301,706 in exchange for the covenant on the part of LGFA to meet UAS' principal obligations on the debentures as if the principal obligor.  However, UAS remained liable (at least unless and until required by the trustee to make payments to it in accordance with sub-cl.8(b) of the Debenture Trust Deed) to pay both the principal and the interest on the debenture stock issued to stockholders.  Payment by LGFA of principal operated to satisfy UAS' obligation under the Debenture Trust Deed.  Likewise UAS remained liable to pay interest, although the trustee held LGFA promissory notes as security to ensure this happened.

          By the end of the year of income ended 30 June 1987, the 7.75% debenture stock repayable on 30 June 1987 had been repaid, the payment emanating from LGFA.  There remained only
the 10.55% debenture stock repayable on 31 March 1989 yet to be redeemed.

          The Commissioner assessed UAS in the year ended 30 June 1987 by including in its assessable income the sum of $1,083,294, described in the adjustment sheet accompanying the Notice of Assessment as "surplus on assumption of liability included in assessable income".  That figure, it will be observed, is the difference between the amount paid by UAS to LGFA under the defeasance arrangement and the face value of the debentures outstanding at the time the defeasance arrangement was entered into.  The issues in the case are whether that amount was assessable income and, if so, in what year of income.

The judgment appealed from

          UAS was wholly successful before Spender J.  His Honour was of the view that no profit at all arose to UAS as a result of the transaction because the sum paid by UAS to LGFA represented the present value as at the date of the payment of the obligations assumed by LGFA which required performance in the future.  Thus the value of the assumption by LGFA of the primary liability to the debenture holders equalled the amount paid and gave rise to no profit or gain.

          Although unnecessary to his Honour's decision, his Honour expressed the view that if there had been a profit or gain arising to the taxpayer as a result of the arrangements, that gain would only have occurred at the time the debentures were in fact repaid to debenture holders.  This was in part in the year ended 30 June 1987 and in part in the year of taxation in which 31 March 1989 fell.  His Honour also held that costs and outlays would need to have been taken into account to determine the profit if it were to be included in the taxable income of UAS.

          Further, his Honour found that, had there been a profit, that profit would have been on revenue account.  His Honour said (at 441-2):

          "UAS was a finance company, and notwithstanding there had been a decision made that it would not undertake new financing activities in future, the defeasance arrangements were part of the steps taken in connection with its business as a finance company.  After the defeasance arrangements were entered into, UAS remained obliged to repay the principal of the debentures, but also was obliged to make the payments of interest falling due from time to time, which it did in 1987, 1988 and 1989.  Those payments and the cost of the defeasance arrangements it deducted for tax purposes from its income, which was a course of conduct consistent with the continuation of its business activities after the defeasance arrangements were in place.  The fact that UAS was winding down its borrowing activities did not mean that the servicing of such borrowings as remained, including making arrangements for the
payment to debenture holders, were not part of its ordinary business."

          Finally his Honour discussed whether any capital gain arose to UAS under Part IIIA of the Income Tax Assessment Act 1936 (Cth) ("the Act").  His Honour considered arguments advanced on behalf of the Commissioner that a disposition of property had arisen either by force of s.160M(3) or s.160M(7) of the Act and rejected those submissions.  From this decision the Commissioner appealed to the full court of this Court.

The submissions

          Before this Court counsel for UAS conceded that his Honour had erred in holding that no profit arose as a result of the defeasance arrangements.  In my view that concession was properly made.  At the very least, when the time came for the debentures to be repaid, UAS had been relieved of an obligation to pay the face value of the debentures.  The amount it paid for the obligation of LGFA under the assumption agreement was less than the face value of the debentures and the difference clearly represented a profit.  The real question is whether that profit was derived on revenue account as the Commissioner submitted, or on capital account as UAS submitted.  A related issue is whether the profit arose at the time the Liability Assumption Agreement was entered into or whether it arose only as and when debentures were redeemed.

          The Commissioner sought leave to argue, for the first time before us, the application of Pt.III, Div.16E of the Act, concerned, inter alia, with the question of timing of the inclusion of amounts in assessable income.  He was, no doubt, encouraged so to do by the decision of Ryan J in ICI Australia Limited v Federal Commissioner of Taxation (1994) 94 ATC 4600, a case decided shortly after judgment in the present case had been handed down and in which Ryan J held, contrary to the views of Spender J, that a profit on revenue account had arisen to ICI Australia Limited at the time a similar debt defeasance arrangement had been entered into.  As an alternative basis for his decision, Ryan J held that Pt.III Div.16E of the Act had application.

          Finally, the Commissioner repeated the submissions made below as to the application of Pt.IIIA of the Act, (relating to capital gains) to the facts of the case.

When did the profit arise?

          The starting point for the Commissioner's submission that a gain arose to UAS at the time the debt defeasance arrangements were entered into, was that those arrangements produced the legal and commercial consequence that UAS would have to pay in the future an amount less than it otherwise would have been obliged to pay.  That part of the submission which suggested that it was a legal consequence that UAS would in the future have to pay a lesser amount than the face value of the debentures, flowed, it was said, out of the very extensive amendments made to the trust deed and the assumption by LGFA of the principal money obligations on all issued debenture stock.

          It was not suggested, nor could it be, that the amendments to the trust deed operated as an accord and satisfaction so as to bring to an end the original liability which UAS had and substitute for it a new liability.  Those amendments operated by way of variation only, leaving intact, for presently relevant purposes, the obligation of UAS: Tallerman and Company Proprietary Limited v Nathan's Merchandise (Victoria) Proprietary Limited (1956-57) 98 CLR 93; Morris v Baron & Company (1918) AC 1; United Dominions Corporation (Jamaica) Ltd v Shoucair (1969) 1 AC 340 and Federal Commissioner of Taxation v Mercantile Credits Limited (1986) 86 ATC 4119.  Even if there were no separate contractual right in law in the debenture holders to sue for payment of the moneys owing at maturity of their debentures (cf In re Dunderland Iron Ore Company, Limited [1909] 1 Ch 446, a question that may depend upon the particular contractual relations involved), there was a clear right in the trustee to payment of interest and principal on maturity or default if demanded and those rights continued, notwithstanding the amendments to the trust deed.  The fact that LGFA became obliged to pay an amount equal to the face value of the debentures as a principal obligation, such payment being in satisfaction of UAS' obligation, did not change the legal liability imposed upon UAS.  The submission that that initial liability had gone and been replaced by what was in substance a new liability, does not explain in what way a new liability arose.

          So far as the submission was based upon commercial consequences, it likewise encounters difficulty.  It may well be the case, as was said from the bar table, that accountants will (after similar debt defeasance arrangements have been entered into) be prepared to certify accounts which exclude the liability of a borrowing company under a debenture trust deed and exclude also from those accounts as an asset the rights which the borrowing company has against the party undertaking the obligation to make payments of principal under debentures.  Certainly there was no evidence of any such accounting practice.  The only evidence there was, was contained in the audited accounts of UAS for the year ended 31 December 1987.  UAS auditors expressed the view that those accounts, which showed no liability to debenture holders, gave a true and fair view of the state of affairs of the company and had been drawn up in accordance with Australian Accounting Standards and applicable approved accounting standards.  A note attached to those accounts, however, under the heading "Debentures", read as follows:

          "Unilever Australia Securities Limited, with the agreement of the Trustee for the debenture holders, entered into a debt restructuring arrangement, whereby its obligations, in respect of principal and interest, arising from the secured debenture stock of $7,385,000 on issue at the time of the arrangement have been the subject of a defeasance.  The surplus, arising from the transaction has been brought to account during the year."

          The profit and loss account, brought to account as a profit, the sum of $120,915, under the heading "Profit on debenture defeasance".  Although a document in evidence purported to explain how this figure was arrived at, neither counsel for the Commissioner nor counsel for the taxpayer were confident in their explanations.  All that one can say is that the figure was based on a present value calculation.

          Schedule 7 of the Companies (NSW) Regulations applicable to UAS at the time of the defeasance arrangement, required the balance sheet to set out liabilities of a corporation distinguishing between current liabilities and non-current liabilities: cl.5(2).  Prima facie, that requirement would have led to the conclusion that the UAS liability on maturing of the debentures be disclosed in the balance sheet itself.  However, the Schedule did permit, at the time, departure from the required format, at least where that departure was necessary to give a true and fair view of the state of affairs of a company, provided information was specified separately in a note forming part of the accounts.  Whether the present was an appropriate case for that course to be adopted was not debated before us and I offer no view on that question.  The matter is clearly arguable.

          The Act operates, in respect of an amount which is income in ordinary concepts, to include that income in assessable income only when it is derived: s.25(1).  In determining whether income has been derived by a taxpayer at a particular point of time, regard may be had to the evidence of businessmen and accountants: Commissioner of Taxes (South Australia) v Executor Trustee and Agency Company of South Australia Limited (Carden's Case) (1938) 63 CLR 108 at 152 per Dixon J, Arthur Murray (NSW) Pty Limited v Federal Commissioner of Taxation (1965) 114 CLR 314 at 318.  But care must also be taken to ensure that the result is one which is "calculated to give a substantially correct reflex of the taxpayer's true income": Carden's case at 154.

          The present is not a case where expert accounting and commercial evidence has in fact been given and it would be dangerous to extrapolate from the manner in which the taxpayer has treated the transaction in its accounts that there is an accepted and commercial practice, in a case such as the present, to treat a borrowing company as having derived a profit at the time a debt defeasance arrangement, of the kind presently entered into, was executed.

          Counsel for the Commissioner eschewed the view that to treat the amount as being a profit at the time a debt defeasance transaction was entered into would, at the very least, require consideration in each case of the financial stability of the party contracting with the borrowing company.

          The Commissioner's submission seems to have stemmed from the fact that in the profit and loss account accompanying the income tax return for the year ended 30 June 1987, UAS had disclosed a surplus of $1,083,294 prior to this amount being written back in a reconciliation between the profit and loss account and taxable income.  That profit and loss account differed in its manner of presentation from the statutory profit and loss account which was also in evidence in the proceedings.  No attempt was sought to examine any witness on the discrepancy of principle.  Further, there are dangers in treating, as income derived, profits which, while practically certain to arise, have not yet arisen.  It has not been suggested that a professional person should bring to account work in progress which a client is most likely to pay purely on the basis of that likelihood to pay: cf Henderson v Commissioner of Taxation (1968-70) 119 CLR 612 at 650-51.  So too it has been held by the full Court of this Court that assessable income does not arise to a taxpayer trading in land as trading stock, when that taxpayer enters into a contract for the sale of land, no matter how likely it may be that the contract will be completed: Gasparin v Federal Commissioner of Taxation (1994) 121 ALR 179; but cf in the case of goods J Rowe & Son Pty Limited v Commissioner of Taxation (1970-71) 124 CLR 421 where, however, it had been found that any other method of accounting would lead to a misrepresentation of the trader's financial position.

          The cases have rather concentrated upon whether a debt had been brought into existence.  Where an element of contingency arises, there would ordinarily be no derivation before that contingency is satisfied: Parsons Income Taxation in Australia, Law Book Co., 1985, para.11.49; Barratt v Federal Commissioner of Taxation (1992) 107 ALR 385 at 393-4 per Gummow J, with whom the other members of the Court agreed.

          In my view, notwithstanding that there was practical certainly that LGFA would perform the obligations undertaken by it as and when the debentures matured, for income tax purposes, the profit to UAS only came home to the taxpayer at the time of maturity of the debentures when those obligations were indeed complied with.  There is room for an alternative view that the profit emerged over time, but neither of the parties before us contended for this immediate position.

          This does not, however, mean that no profit was derived by UAS in the year of income.  The 1987 debentures were paid out as at 30 June 1987 and some part of the profit to UAS clearly came home to it at that time.  The precise quantum of that profit is the subject of dispute and has not been argued before us.  If that profit be assessable income, it would be necessary for the matter to be remitted to the trial judge to determine the extent of that profit in the event that the parties are unable to agree.

Was the profit assessable income?

          Gains made and losses incurred by a finance company in the course and as an incident of its ordinary business of borrowing money, lending it out and repaying moneys borrowed, are treated as revenue gains and losses: Coles Myer Finance Limited v Commissioner of Taxation (1992-93) 176 CLR 640 at 663; Avco Financial Services Limited v Commissioner of Taxation (1981-82) 150 CLR 510.  As the full High Court said in Coles Myer (at 664):

          "The borrowing, as much as the lending, was an integral part of the day-to-day conduct of the taxpayer's profit-earning business."

          A question may arise whether a particular company should be seen to be a "finance company" so that its gains and losses fall to be so treated.  A taxpayer which borrowed money from a particular source and lent it to a related company may not be so treated: cf, however, Federal Commissioner of Taxation v Bivona Pty Limited (1990) 90 ATC 4168 where it was held that a taxpayer which borrowed moneys and lent the money
borrowed to members of a corporate group was properly to be described as having a principal business consisting of the lending of money.  The question requires an exact scrutiny of the taxpayer's business.

          Having regard to the concession made in the course of evidence and the lack of any factual evidence to the contrary adduced by the respondent, I am prepared to accept, in the present case, that, at least until 1983, UAS should be treated as a company carrying on a business of borrowing and lending so that gains or losses made by it in the course of that business were on revenue account.

          Counsel for UAS submitted, however, that the company's business suffered a change, at the latest, by the time the defeasance arrangements were entered into because its activities as a finance company had then ceased.  The submission challenged the finding made by Spender J that the defeasance arrangements were properly to be seen as part of the steps taken in connection with its business as a finance company.  In making this submission counsel properly stressed that it was not suggested that UAS had ceased carrying on any business at the time the defeasance arrangements were entered into, merely that it was then not carrying on business as a finance company so that profits made which, if made when it was carrying on a business as a finance company would have been assessable, no longer were so.

          With respect I do not agree.  At the heart of the submissions for UAS is the well-settled principle restated by the full High Court in Commissioner of Taxation v Myer Emporium Limited (1986-87) 163 CLR 199, that a profit or gain made in the ordinary course of carrying on a business will constitute income.  The corollary to that principle is that a gain made otherwise in the ordinary conduct of a business will not necessarily constitute income.  As the High Court said in that case (at 209); "Whether it does depends very much on the circumstances of the case."

          It was early held, for example, that a profit or gain made not in the course of a business but in the course of going out of business was not, absent statutory provision, a gain on income account.  Thus where a pastoralist sold his property, livestock and plant as a going concern for the purpose of putting an end to the business, no part of the purchase money, including profit on the sale of former trading stock, was income: Commissioner of Taxation (WA) v Newman (1921) 29 CLR 484.  As Starke J said in that case the question was one of fact: did the transaction out of which the profit arose amount to the carrying on or carrying out of the trade or business of the taxpayer?  Section 36 of the Act was enacted to overcome this and similar decisions at the time.

          The principle was not limited to cases involving the disposal of former trading stock.  The case of Modern Permanent Building and Investment Society (In Liquidation) v Federal Commissioner of Taxation (1958) 98 CLR 187 concerned a building society which, prior to going into voluntary dissolution, sold its outstanding loans to another building society at a discount.  It sought to have allowed to it, as a deduction under s.51(1), the amount of the discount and failed.  In upholding the assessment, Williams J said (at 191):

          "It [the taxpayer] is dealing in money and in that which it represents, that is to say, the debts which are owed to it as a result of putting out its money at interest.  Any loss upon a loan that such a trader might incur in the course of carrying on its business would be a loss incurred in gaining or producing the assessable income and be an allowable deduction under s.63 of the Act.  But a loss incurred upon the realisation of such loans in order to put an end to the business or part of it would, in the absence of legislation to the contrary, be a capital loss.  Apart from legislation, the profit or loss on the realisation of trading stock, for the purposes of winding up a business, would in most cases be a capital accretion or loss.  Section 36 of the Act in the case of trading stock to which it applies converts such an accretion or loss into a profit or loss on revenue account.  But I can find no warrant for applying its provisions by analogy or otherwise to the disposal by sale of the appellant's outstanding loans with a view to dissolution, even if money can be regarded for some purposes as the stock-in-trade of a money lender and the appellant was a money lender."

          Later, after expressing the view that the taxpayer was not carrying on the business of a money lender in the ordinary acceptation of the term, but rather an investment business his Honour said (at 192):

          "Whatever the position might be if a profit or loss was made upon an assignment of one or more of the loans in the course of the appellant's business, a mass sale of them in order to put an end to that business could not be other than a sale of capital assets."

          The present is not a case where UAS, in the relevant sense, put an end to its business by virtue of the defeasance transaction.  Rather, although UAS had resolved not to expand its business but run it down, its business was still continuing.  That business included the receipt of interest on funds lent out by it and the payment of interest on moneys borrowed by it.  It continued at the least until the moneys borrowed had been repaid and indeed perhaps thereafter, or at least while moneys were owing to it, by Unilever related companies.

          I would accordingly find that the profit in question was a profit derived by UAS in the course of its business activity and was a proceed of that activity.  Accordingly it was income in ordinary concepts.  It is therefore unnecessary for me to determine whether, as the Commissioner submitted in the alternative, the profit made by UAS arose from a profit-making undertaking or scheme and for that reason was assessable either under s.25(1) or s.25A of the Act.

Division 16E

          I am of the view that leave should be given to the Commissioner to raise, for the first time on appeal, Div.16E of Pt.III.  It is conceded by counsel for the Commissioner that the question is one of law only and turns upon the proper interpretation of s.159GP(1).  No additional fact is relevant to the dispute.

          The background to Division 16E is discussed in my judgment in ANZ Savings Bank Limited v Federal Commissioner of Taxation (1993) 42 FCR 535 at 561 ff, a judgment with which both Davies and Heerey JJ agreed, the former dissenting on another point.  Special leave to appeal that decision, so far as it related to Div.16E, was refused by the High Court.

          The parties are agreed, in the present case, that all of the elements of Division 16E are satisfied if UAS was the holder of a security being the liability assumption agreement.  The expression "holder" is defined in s.159GP(1) in the following terms:

          "`holder', in relation to a security at a particular time, means the person who, if the amount or amounts payable under the security were due and payable at that time, would be entitled to receive payment of the amount or amounts;".

          It is submitted for the Commissioner that UAS was, within the meaning of that definition, entitled to receive payment of the amounts which LGFA was obliged to pay to debenture holders.  The submission was made, notwithstanding the specific provisions of the liability assumption agreement, prohibiting LGFA from paying UAS.

          The Commissioner's submission relied upon the reasoning of Ryan J in ICI Australia (supra).  In that case, Ryan J said (at 4620):

          "Although the Trustee is nominated as the recipient of the payment, it is ICI's obligations which are pro tanto to be discharged by the payment and it is ICI which has provided consideration for the promise by the assumption party to procure that discharge. ...  The principle assumption agreement did not, from the date of its execution, discharge ICI's primary liability to the Trustee for the debenture holders.  It simply provided a mechanism where that liability could be discharged pro tanto by a new co-principle as payments by way of redemption were made by ... the assumption party on behalf of, or at the direction of, ICI.  Each payment so made is one which ICI, in relation to the principle assumption agreement, is entitled to receive."

          His Honour referred to some comments of Lord Jenkins in Elmdene Estates Ltd v White [1960] AC 528 concerning landlord and tenancy to the effect that there is no difference between a case where a landlord receives money by way of premium for the grant of the lease or directs the prospective tenant to make payment to a third party.  That case operates in quite a different field of discourse to the present.

          The language of the definition of "holder" in s.159GP(1) is not ambiguous.  It means what it says.  For a person to be a holder for the purposes of the Division in relation to a security, that person must, at a relevant time, be entitled to receive payment of amounts payable under the security.  UAS was never, at any relevant time, so entitled.  Nor does s.19 of the Act, as the Commissioner submitted, assist.  That section does not operate to deem a person to be entitled to receive payment of an amount.  It deems money to be derived: cf Howell v Federal Commissioner of Taxation (1994) 94 ATC 4186 at 4189-90 for a discussion of that section.

          In my opinion, UAS was not a holder and accordingly Division 16E can have no application.

Capital Gains Tax

          Although the application of Part IIIA of the Act was argued before us, it is inappropriate, in my view, to deal with the argument.  If the argument were correct that UAS had, for the purposes of Part IIIA, made a disposition which resulted in there being a gain accruing to UAS, s.160ZA(4) would operate to reduce that capital gain to nil, having regard to the fact that a gain of equal amount was, in any event, included in assessable income under s.25 of the Act.

          I would accordingly propose the following orders.

(1)  Appeal allowed.

(2)  Remit to Spender J or other judge of the Court to determine the quantum of the profit arising in the year ended 30 June 1987 but suspend the operation of this order for 28 days to allow the parties to agree, if possible, the amount of the profit arising.

(3)  Order that the objection decision of the Commissioner, in respect of the assessment for income tax for the year ended 30 June 1987, be set aside and, in lieu thereof, the objection be allowed in part.

(4)  Subject to the determination by Spender J or other judge of the Court, or as agreed, of the quantum of profit, remit the assessment to the Commissioner for reassessment in accordance with law.

(5)  The respondent to pay the appellant's costs of the appeal and of the proceeding at first instance.

I certify that this and the

preceding twenty-seven (27) pages

are a true copy of the Reasons

for Judgment herein of his Honour

Justice Hill.

Associate:

Date:  24 February 1995

Counsel and Solicitors       BJ Shaw QC with GT Pagone

for Applicant:               instructed by Australian Government Solicitor

Counsel and Solicitors       RF Edmonds with KJ Burges

for Respondent:              instructed by Mallesons Stephen Jaques

Date of Hearing:             28 November 1994

Date Judgment Delivered:          24 February 1995