84 ATC 4060 Other publishers' citations: (1984) 15 ATR 231 Max Factor and Co. v. F.C. of T. Max Factor and Co. v. Federal Commissioner of Taxation. [4060] Supreme Court of New South Wales. Judgment handed down 9 February 1984. Income tax -- Allowable deductions -- Branch office in Australia importing raw materials from U.S. head office -- Head office reimbursed by branch office -- Exchange losses arising from reimbursement -- Whether deductible -- Income Tax Assessment Act 1936-1977 -- sec. 51(1) -- Double Tax Convention with United States -- Art. III(3) and (4). This was an appeal by the taxpayer from the decision of the No. 1 Board of Review reported as Case N105, 81 ATC 577. The taxpayer, a company incorporated in the United States, carried on business in Australia through a branch office. It claimed a deduction for
exchange losses suffered when transferring funds to head office by way of reimbursement for the cost of raw materials provided by head office. The Board held that the exchange losses were not deductible and the taxpayer appealed. Held, appeal dismissed. [4061] The exchange losses were not deductible either under sec. 51(1) or Art. III(3) and (4) of the Double Tax Convention with the United States. The transfer of funds to head office was a repatriation of capital rather than a payment in discharge of a liability incurred by the branch office. Headnote by the CCH TAX EDITORS G.W. Fisher (instructed by Allen Allen & Hemsley) for the taxpayer. L.J. Priestley Q.C. with T.F. Bathurst for the Commissioner. Before: David Hunt J. David Hunt J.:
This is an appeal by the taxpayer, Max Factor and Co., from the decision of the Taxation Board of Review No. 1 [reported as Case N105, 81 ATC 577] disallowing objections lodged by the taxpayer against assessments made by the Commissioner in respect of income derived by the taxpayer in the years ended 30 June 1976 and 1977. There is no dispute by the Commissioner that the decision of the Board of Review involved a question of law and thus that an appeal from that decision lies to this Court: Income Tax Assessment Act 1936, sec. 196(1). The taxpayer is a company incorporated in the United States of America, and it carries on business in Australia through a branch office. Its appeal concerns losses which it suffered when transferring funds from its branch office here to its head office in the United States due to fluctuations in the exchange rates. The taxpayer claimed these exchange losses as a deduction upon the basis that the transfers of funds were themselves payments by its Australian branch to its head office for raw materials and packaging materials imported by it from the United States to be used by it in the manufacture here in Australia of cosmetics. The hearing before me took place shortly after Rogers J. had given judgment in Hunter Douglas Ltd. v. F.C. of T. 82 ATC 4550. As some reliance was placed upon that decision in the argument of the taxpayer in the present case, I acceded to the suggestion on behalf of the Commissioner that I withhold my judgment until after the Federal Court had decided the appeal which he had taken to that Court from the decision of Rogers J. The Federal
Court delivered its judgment late last year. F.C. of T. v. Hunter Douglas Ltd. 83 ATC 4562. The Commissioner was successful in his appeal, and the High Court has since refused special leave to the taxpayer to appeal from that decision: 18 November 1983, unreported. The background to the appeal and the facts upon which the taxpayer relies are sufficiently recorded for the purposes of this judgment in the reasons given by the Board of Review, whose decision is reported as Case N105, 81 ATC 577, and it is unnecessary for me to repeat what was there said. The Board of Review disallowed the objections upon the basis of findings made by it: (a) that the taxpayer's head office in the United States and its branch in Australia formed a single entity; (b) that the exchange losses claimed as a deduction were not incurred in the discharge of a liability incurred on revenue account, but that they related rather to a repatriation of the taxpayer's capital by the branch in Australia to its head office in the United States (and thus were not allowable deductions as losses or outgoings under sec. 51(1)); and (c) that the losses of the working or circulating capital of the taxpayer, which those losses represented, were in fact incurred by the taxpayer's head office in the United States and not by its branch in Australia (and thus were not allowable deductions under para. (3) or (4) of Art. III of the United States Convention, which is incorporated with and must be read with the Income Tax
Assessment Act: Income Tax (International Agreements) Act 1953, sec. 4(2). It is not, as I understand it, disputed that the exchange losses in question would have been properly allowable deductions if they had been incurred by the taxpayer as a trading or manufacturing company in the discharge of a liability incurred in its purchase of raw materials for packaging materials imported by it, insofar as the payments in discharge of that liability were themselves allowable deductions. That necessarily follows from the principles laid down in cases such as Commercial and General Acceptance Ltd. v. F.C. of T. 77 ATC 4375; (1977) 137 C.L.R. 373;[4062] Avco Financial Services Ltd. v. F.C. of T. 82 ATC 4246 at pp. 4249-4250 and 4256-4258. If the payments are allowable deductions, and the amount of those payments is increased by reason of a fluctuation in the exchange rates, then it is obvious that the amount of that increase (or the exchange loss) must be allowable deductions as well. The principal question in the present case is whether it is correct to say, as the Board of Review found, that the payments by the taxpayer's branch in Australia to its head office in the United States are denied the character of an allowable deduction because they did not amount to a discharge of a liability incurred by the taxpayer here. The next question, which arises only if the first question is answered in favour of the taxpayer, is whether the liability deemed to have been discharged was on revenue account rather than on capital account.
The point in the decision of the Federal Court in F.C. of T. v. Hunter Douglas Ltd. (supra), as it ultimately turned out, was whether the exchange losses suffered by the taxpayer in that case in the repayment of overseas loans were, as that taxpayer claimed, on revenue account because of the use to which the funds were put in meeting the company's running expenses, or on capital account, as the Commissioner claimed, because the purpose of the losses was to provide additional working capital. The Federal Court upheld the Commissioner's argument. Despite having waited so long for that judgment at the suggestion of the Commissioner, I do not find it of any real assistance in the resolution of the questions which arise in the present case. The present case is not one which involves the repayment of a loan, and thus does not give rise to the sometimes acute problem (as the cases show) of whether such repayment is on capital or revenue account. I turn then to the first of the questions which do arise in the present case. The taxpayer, as I have said, relied for its claim that the exchange losses were an allowable deduction upon both sec. 51(1) and para. (3) and (4) of Art. III of the United States Convention. The taxpayer has a problem here. It did not, in its Notice of Objection for the year ended 30 June 1976, expressly rely upon the Convention, although it did so for the succeeding year. In the Board of Review, Mr. Harrowell formed the view that the Convention was nevertheless relevant to a determination of whether the losses were allowable deductions under sec.
51(1), but Mr. Pape would not have permitted the taxpayer to rely upon the Convention in relation to the 1976 year. There was no third member of the Board for the hearing of that Reference. In the view which I have formed of the appeal, however, it is unnecessary for me to resolve this difference between them. As to sec. 51(1), I agree with the view of the Board of Review that the taxpayer must fail, upon the basis that the transfers of funds from the taxpayer's branch in Australia to its head office in the United States amounted to no more than purely internal transactions; there was, in my view, no payment by the Australian Branch in discharge of a liability incurred by it to the taxpayer's head office in the United States. The payment was no more than a reimbursement by the Australian branch to the head office in the United States for a payment made by it to the supplier in that country. On this point, I am content to adopt the reasoning of Mr. Pape in the Board of Review. As to the United States Convention, para. (3) and (4) of Art. III are in the following terms: "(3) There shall be allowed in determining the industrial or commercial profits attributable to a permanent establishment in one of the Contracting States all expenses of a type allowed as a deduction by that State and which are reasonably attributable to the permanent establishment including executive and general administrative expenses so attributable, except that, in the case of
Australia, there shall be applied the principle underlying section 38 of the Australian Income Tax and Social Services Contribution Assessment Act 1936-1953. (4) Where an enterprise of one of the Contracting States is engaged in trade or business in the other Contracting State through a permanent establishment in that other State, there shall be attributed to that permanent establishment the industrial or commercial profits which that enterprise might be expected to derive in that other State if it were an independent enterprise engaged in the same or similar activities and its dealings with the enterprise of which it is a permanent establishment were dealings at arm's length with that enterprise or an independent enterprise; and the profits so[4063] attributed shall be deemed to be income of that permanent establishment and shall be taxed accordingly." The taxpayer's argument is that para. (4) treats payments made by its Australian branch to its head office in the United States as if they were made by an independent enterprise in Australia dealing at arm's length with another enterprise in the United States. The payments which were made should, it is argued, be deemed therefore to be payments which were made in discharge of a liability incurred by the Australian branch to its head office in the United States. The Commissioner, on the other hand, says that para. (4) does not translate a transfer of funds from the taxpayer's Australian branch to its head office
in the United States in order to cover an expense incurred by that head office in the United States into an expense incurred here by the Australian branch. It does not permit the head office to claim a tax deduction for that expense in the United States and the Australian branch to claim a second tax deduction in Australia for the same expense. For the deduction to be allowed, the Commissioner says, the expense must be incurred here in Australia (that is, there must be a discharge of a liability incurred here) and the expense must relate to the profits derived by the Australian branch here in Australia. Those profits are the taxable income derived from its activity or business (that is, here in Australia): Income Tax (International Agreements) Act, sec. 3(2). This, the Commissioner says, is made clear by the terms of para. (3), which refers only to expenses of that type. I accept the Commissioner's argument. I am satisfied that, in the present case, the liability in relation to the raw materials and the packaging materials imported by the taxpayer's Australian branch was discharged by payment by the head office in the United States to the supplier in the United States, and not by the transfer of funds by the taxpayer's Australian branch to its head office in the United States to cover that payment. There was thus no expense incurred in Australia in discharge of a liability incurred here which could be deemed by para. (4) of Art. III to affect the profits attributed to the Australian branch. The provisions of the United States Convention do not assist the taxpayer.
It is therefore unnecessary for me to deal with the second question which arose in the appeal -- namely, whether the liability if deemed to have been discharged by the Australian branch was on revenue account rather than on capital account. I should, however, record the concession made on behalf of the Commissioner that he did not wish to argue that, if the branch office and the head office of the taxpayer were independent entities each with its own circulating capital, the exchange loss was other than on revenue account. I dismiss the taxpayer's appeal. I order it to pay the Commissioner's costs.