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Barlow Industries Pty Ltd v Chief Collector of Taxes [1987] PGLawRp 545; [1987] PNGLR 384 (18 December 1987)

Papua New Guinea Law Reports - 1987

[1987] PNGLR 384 - Barlow Industries Pty Ltd v Chief Collector of Taxes�

[1987] PNGLR 384

N647

PAPUA NEW GUINEA

[NATIONAL COURT OF JUSTICE]

BARLOW INDUSTRIES PTY LTD

V

CHIEF COLLECTOR OF TAXES

Waigani

Bredmeyer J

16-18 March 1987

18 December 1987

INCOME TAX - Allowable deductions - Loss from variation in exchange rate - Foreign currency borrowings by a manufacturing trading company - Whether exchange losses on revenue or capital account - Relevance of purpose for which moneys borrowed - Funds used to pay running expenses of business - Income Tax Act, s 68(1).

PRECEDENTS - Income Tax - Australian authorities to be followed - Act based on Australian Act - Australian case law predictable - Exception in principle only.

The taxpayer was a manufacturing and trading company owned by a company incorporated in Panama. The taxpayer was one of six sister companies all owned by the same parent and had some financial responsibilities towards those related companies. The taxpayer borrowed US$1 million from Barclays Bank Singapore on 30 December 1980. The money was used partly in payment of management, technical assistance, and energy fees to overseas companies, partly for on-lending at a small profit to sister companies, and partly for the purchase of a house for the manager. The taxpayer incurred an exchange loss of K58,045 in repaying the loan in the year 1983.

It claimed that the loss was deductible under s 68(1) of the Income Tax Act as incurred in gaining or producing assessable income.

On appeal from a decision of the Income Tax Review Tribunal disallowing the claim,

Held

N1>(1)����� Whether foreign exchange gains or losses made in repaying loans are related to capital or revenue items is to be determined by reference to the purpose for which the borrowing was made and not by the use to which the borrowed funds are put.

Federal Commissioner of Taxation v Hunter Douglas Ltd [1983] FCA 242; (1983) 14 ATR 629; 83 ATC 4562, adopted and applied.

N1>(2)����� Borrowing money for the purpose of carrying on a business or to pay liabilities incurred in carrying on business must prima facie be treated as augmenting the capital employed in the business, and thus foreign exchange gains or losses in repaying those loans are not assessable or deductible; where, however, borrowings are made by trading companies to purchase trading stock, or by manufacturing companies to purchase raw materials, or by finance companies to provide funds to on-lend, there may be exceptions to that general rule.

Federal Commissioner of Taxation v Hunter Douglas Ltd [1983] FCA 242; (1983) 14 ATR 629; 83 ATC 4562, followed.

N1>(3)����� In the circumstances the purpose of the borrowing was to augment the working capital of the company and the exchange loss in repaying the interest on the borrowed money was not an allowable deduction.

Held Further

N1>(4)����� Taking into account that the Income Tax Act is based on the Income Tax Assessment Act 1936 (Aust) and that many of the sections are identical, the paucity of decisions on the Income Tax Act and the body of case law made in Australia establishing principles which can be applied and extended and that a practice of following the Australian decisions would lend certainty and predictability to the law in this area, Australian authorities should be followed unless there is some good reason in principle why they should not be followed.

Cases Cited

Aluminium Union Ltd v Minister of National Revenue [1960] Ex CR 363; CTC 206; 60 DT 1138.

AVCO Financial Services Ltd v Commissioner of Taxation (Cth) (1982) 150 CLR 510; 56 ALJR 668; 41 ALR 225; 13 ATR 63; 82 ATC 4246.

Davies (HM Inspector of Taxes) v Shell Company of China Ltd [1951] TR 121; 44 R & IT 379; 32 TC 133.

International Nickel Australia Ltd v Commissioner of Taxation (Cth) [1977] HCA 49; (1977) 137 CLR 347; 51 ALJR 782; 16 ALR 585; 7 ATR 739; 77 ATC 4383.

ISE Canadian Finance Ltd v Minister of National Revenue [1986] 1 CTC 2473; 86 DTC 1344.

Radio Pictures Ltd v Inland Revenue Commissioners (1938) 22 TC 106.

Taxation, Commissioner of (Cth) v Hunter Douglas Ltd [1983] FCA 242; (1983) 50 ALR 97; 14 ATR 629; 83 ATC 4562.

Thiess Toyota Pty Ltd v Commissioner of Taxation (Cth) [1978] 1 NSWLR 723; 23 ALR 89; 9 ATR 11; 78 ATC 4463.

Thomas v Commissioner of Taxation (Cth) (1972) 46 ALJR 397; [1972-73] ALR 368; 3 ATR 165.

Appeal

This was an appeal from a decision of the Income Tax Review Tribunal which refused a claim for a deduction for an exchange loss in the year 1983, as being a loss incurred in gaining or producing assessable income under s 68(1) of the Income Tax Act.

Counsel

D G Hill QC, for the appellant.

F G A Beaumont QC, for the respondent.

Cur adv vult

18 December 1987

BREDMEYER J: This is an appeal from a decision of the Income Tax Review Tribunal. Barlow Industries Pty Ltd (hereinafter Barlow or the taxpayer), a company registered in Papua New Guinea, had borrowed US$1 million from Barclays Bank in Singapore. In repaying the loan the value of the US dollar strengthened against the kina and the company suffered an exchange loss of K58,045 in the year ending 31 December 1983. Barlow claimed that this exchange loss was a loss incurred in gaining or producing assessable income and was thus deductible under s 68(1) of the Income Tax Act which reads as follows:

�... all losses and outgoings, to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, are allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital ... nature ...�

The Chief Collector of Taxes disallowed the claim, the taxpayer requested a review, but upon review its claim was rejected by the Income Tax Review Tribunal in a 12 page decision handed down by Mr M J Brandt on 19 May 1986.

The taxpayer has appealed to this Court. An appeal to the National Court under s 255 of the Income Tax Act differs from most other appeals heard by this Court. It is an appeal de novo; it is not limited to the evidence placed before the Review Tribunal. In this case different counsel appeared before me than appeared before the Tribunal, certain facts which were agreed to before the Tribunal were not agreed to before me. The documentary evidence placed before me was also placed before the Tribunal, together with some additional material, but I also heard evidence from three witnesses called for the taxpayer who were subjected to a good deal of cross-examination. I propose to relate now some of the facts, a large part of which come from the company�s documents and which are not contested. It is also necessary that I weigh the evidence on some contested issues and make some findings of facts.

Barlow is a company registered in Papua New Guinea which carries on business as a manufacturer and importer of building products. All the shares in the company are owned by Pacific Industrial Corporation SA a company incorporated in Panama and having a box number in Geneva, Switzerland, as its postal address. Barlow has five associated or sister companies in Papua New Guinea. These are Moresby Plumbing Supplies and Services Pty Ltd, Niugini Steel Corporation Pty Ltd, Earthmovers Pty Ltd, Agricultural Supplies and Equipment Pty Ltd, and Electrical Supplies and Services Pty Ltd. All the shares in those five companies are also owned by Pacific Industrial Corporation SA. So they are sister companies with Barlow; all six have the same parent. Mr Shiam Kattapuram gave evidence. He is a chartered accountant and the Secretary of Barlow. He was hired in Singapore by Comcraft Asia Ltd, a company which will be mentioned later, and seconded to Barlow in Papua New Guinea. It is clear from his evidence that Barlow has some responsibility for the other five companies, it is the senior sister in the group. It is also clear that Mr Kattapuram, as financial controller of Barlow, has some financial responsibility over the other Papua New Guinea companies in the group.

In a document dated 30 December 1980 Barlow borrowed US$l million from Barclays Bank International Ltd in Singapore. The loan agreement was signed on behalf of Barlow by Mr Praful Chandaria under a power of attorney from the taxpayer. Mr Chandaria is a director of Barlow and a resident of Singapore. He visits Papua New Guinea annually to inspect the company�s operations. By an agreement dated 8 March 1982 Barlow borrowed a further US$1 million from Barclays Bank in Singapore and that agreement was also executed on behalf of Barlow by Mr Chandaria under a power of attorney. The assessability for income tax, or otherwise, of an exchange loss of K58,045 made in repaying the loan to Barclays Bank in Singapore is in issue in this case. That loss was made in the calendar year 1983 and counsel before me have agreed that that loss was made in repaying the first loan of 30 December 1980. It is not therefore necessary for me to consider the circumstances of the second loan of 8 March 1982.

In order to assess the character of the exchange loss in repaying the loan it is necessary to discuss the circumstances of the loan, why the money was borrowed and what it was used for. I will refer to the case law on this later. No contemporary documentary evidence on why the loan was required has been produced to me. No loan application form has been tendered. The loan agreement of 30 December 1980 does not recite any reason why the money was required and there is no resolution in the company minute book saying why the loan was required. There is no minute authorising the loan until after the event. In the minute book there is a resolution accepting the loan the day after, on 31 December 1980, which reads:

�Bank facilities

Resolved that acceptance of the loan of US$1,000,000 sanctioned by Barclays Bank International Ltd to the Company be and is hereby ratified and confirmed and documents necessary in respect thereof be executed.�

That resolution was passed at a �meeting� held over the phone between Mr Gordon Morgan, the resident director (and Manager) of Barlow in Port Moresby, and another director, Mrs Nargis Kanji, in Sydney.

The power of attorney authorising Mr Chandaria to sign the loan agreement is dated 17 December 1980 and was executed by the company seal which was affixed in the presence of Mr Morgan, Mrs Kanji and the then company secretary (not Mr Kattapuram). There is no prior resolution by the directors approving Mr Chandaria�s appointment as attorney. The power of attorney dated 17 December 1980 gave wide scope to Mr Chandaria; he was authorised to sign the loan agreement �substantially in the form of the deed annexed hereto or with such amendments as the attorney may think fit�. Mr Chandaria did not give evidence so he could not be asked about the reasons for the loan.

Mr Gordon Morgan, the resident director of the company, gave evidence about why the money was borrowed, as did Mr Shiam Kattapuram. The latter began work for the taxpayer in October 1980 and was appointed company secretary on 2 January 1981. Neither man produced any documentary evidence on why the money was required eg letters and telexes passing between the company officials in Port Moresby and the director, Mr Chandaria, in Singapore; any application for loan to the bank; nor any budget for the company for its proposed expenditure in 1981. Mr Kattapuram said that he prepared a budget for 1981 but did not produce it to the court.

The loan was drawn down at different times and spent in different ways as follows:

323,792.25

69,000.00

146,676.44

In summary the $1,000,000 was spent as follows:

$500,000, in payment of energy fees and technical and management fees (which will be described further on) � less some tax, interest and bank fees.

$280,000, was loaned to sister companies Niugini Steel Corporation Pty Ltd, Moresby Plumbing Supplies and Services Pty Ltd and Earthmovers Pty Ltd.

$220,000, towards the purchase of a house for the manager in Port Moresby.

The energy fees and technical and management fees were payable under three agreements. I take them in chronological order. The first agreement dated 15 December 1977 was between Barlow, Moresby Plumbing Supplies and Services Pty Ltd and Comcraft Asia Ltd a company incorporated in Hong Kong. The recitals in the agreement (numbered by me) are as follows:

N2>�1.����� whereas Barlow owns and operates three factories in Port Moresby, Lae and Rabaul, Papua New Guinea for the manufacture of metal roofing and cladding and other sheet metal articles.

N2>2.������ and whereas Barlow has acquired the whole of the share capital of MPSS, a company carrying on business in Port Moresby of dealer in and manufacture of plumbing supplies.

N2>3.������ and whereas Comcraft and its associated companies called Comcraft Services Limited operating in London, England, Nairobi, Kenya and Lagos, Nigeria and Compagnie Pour Assistance Technique SA operating in Geneva and Comcraft Asia Pty Limited operating in Singapore carry on the activity of providing technical and managerial assistance to manufacturing industries and other companies.

N2>4.������ and whereas each of Barlow and MPSS is desirous of obtaining from Comcraft Managerial Assistance in the operation of Barlow�s three factories and MPSS�s business recited as aforesaid for the remuneration and on the terms and conditions as hereinafter specified.�

In these recitals MPSS stands for Moresby Plumbing Supplies & Service Pty Ltd.

In the text of the agreement Barlow and Moresby Plumbing each appointed Comcraft as from 1 April 1977 to provide managerial assistance to them for a fee of 3 per cent of the sales of each company to be paid every three months beginning on 30 June 1977.

The second agreement between the same three companies was dated 30 May 1978. Recitals 1 and 2 are the same as in the first agreement. The other recitals (numbered by me) read:

N2>�3.����� and whereas Comcraft owns or has at its disposal because of its association with Comcraft Companies in London, Geneva, Nairobi and Singapore technical knowhow information inclusive of drawings and designs necessary to improve, develop and expand the manufacturing facility at present possessed by Barlow and MPSS.

N2>4.������ and whereas each of Barlow and MPSS is desirous of obtaining from Comcraft technical assistance in the operation of Barlow�s three factories and MPSS�s business recited as aforesaid for the remuneration and on the terms and conditions as hereinafter specified.�

The text of the agreement provided that Comcraft would provide technical assistance to Barlow in its activities of manufacturing metal roofing and cladding and other sheet metal articles, and to MPSS in its business of manufacturing plumbing supplies. The agreement took effect retrospectively as from 1 April 1977 and the fee was 2 per cent of all sales of Barlow and MPSS, to be paid every three months the first to be paid on 30 June 1977.

Under these two agreements Barlow and Moresby Plumbing were each to pay a total of 5 per cent of their total sales to Comcraft for management and technical services. Each agreement was to last for five years from 1 April 1977 with a renewal clause for a further five years. The 1977 agreement was signed under the common seal of Barlow and of Moresby Plumbing; the 1978 agreement was signed on behalf of each company by Mr Chandaria under a power of attorney. Each agreement provided that the payments were to be made in US dollars at the official exchange rate prevailing at the date of remittance.

The third agreement relating to energy fees is dated 30 December 1980 between Barlow and �Interim Pacific SA a company incorporated in Panama of Boite Postale 237, 1211 Geneva 12, Switzerland�, I quote all the recitals in the agreement and the first clause in the operative part.

�WHEREAS

N2>A.������ Barlow owns and operates three factories in Port Moresby, Lae and Rabaul, Papua New Guinea for the manufacturing of metal roofing and cladding and other sheet metal articles.

N2>B.������ Barlow is registered as a foreign enterprise under the national Investment and Development Act 1974 of Papua New Guinea in respect of the manufacture of:

(i)������ metallic roofing and wall cladding;

(ii)����� louvre frames and metal louvres;

(iii)���� metal panels for assembly into huts with accessories and ceilings;

(iv)���� solar hot water heaters;

(v)����� roll form products;

(vi)���� metal holloware;

(vii)��� fire extinguishers; and

(viii) �� general sheet metal products,

and has given greater emphasis to certain of its registered activities which would enable Barlow to manufacture and/or distribute energy saving products because of the rapidly increasing cost of electricity in Papua New Guinea and energy generally.

N2>C.������ Pacific through its business connections and associated companies has access to information and has and may be able to obtain distribution rights, technical expertise and know-how in respect of energy saving products.

N2>D.������ Pacific has supplied Barlow with data, literature and other information in particular in relation to:

(i)������ solar hot water systems manufactured by the use of recently developed and improved technology, including a franchise for distribution of a certain hot water system relying largely on solar energy and continuing technical expertise and know-how for manufacture in stages of solar hot water systems;

(ii)����� the import, cutting and use of glass and treatment of glass to save energy; and

(iii)���� sheet metal panels made from high tensile, zinc-coated steel sheets or aluminium sheets for roofing and walling and ceiling systems specifically insulated in different ways to save use of energy.

N2>E.������ Barlow is desirous of providing formally for the continuation and extension of this assistance from Pacific.

NOW IT IS AGREED AS FOLLOWS

N2>1.������ Assistance to be Given by Pacific

N2>(1)����� Pacific has and shall continue to assist Barlow in its efforts to pursue the energy saving activities referred to in Recital D hereinbefore and in the production and specification for assessment of the energy saving quality of the products by Pacific providing to Barlow for its use secret manufacturing processes and designs and technical and commercial knowledge relating to the application of the products and any development or improvement thereof from time to time for the purpose of major programmes of distribution and/or manufacture of these products by Barlow.�

The agreement is for technical assistance but in order to distinguish it from the 1978 agreement for technical assistance it is convenient to follow the taxpayer�s practice and call the fees payable under it energy fees. The agreement is dated 30 December 1980 but is stated to take effect from January 1980. Barlow agreed to pay fees for the assistance of K10,000 per month payable on the last day of each month with effect from January 1980. Thus K120,000 was payable to Intermin on the signing of the agreement. The agreement had a clause authorising Barlow to deduct royalty tax under s 357 of the Income Tax Act 1959 from the payments due and to pay that to the Chief Collector of Taxes on behalf of Intermin �on the basis that the fee is a royalty within the meaning of that Act�. The agreement was to last effectively for three years, until 31 December 1982, and thereafter from year to year unless either party terminated it on three months� notice to the other. The agreement was signed by Eugene Derry on behalf of Barlow under a power of attorney. Mr Derry is a director of Pacific Industrial Corporation, Barlow�s parent company. There is no resolution in Barlow�s Minute Book authorising Mr Derry to be appointed an attorney for the company, nor any minute agreeing to execute, or to ratify, the energy agreement. He appears to be a director of Intermin Pacific SA too because he and another man signed the agreement under the following clause:

�The common seal of Intermin Pacific SA was hereto affixed by authority of its Board of Directors in the presence of:�

The common seal is not affixed on the photocopy agreement produced to me.

THE LAW

Section 68(1) of our Income Tax Act is identical to s 51(1) of the Income Tax Assessment Act 1936 of Australia. It is the practice for the National Court to follow the Australian cases and there are good reasons for that practice. The sections are the same as I have said. There are very few decided tax cases in Papua New Guinea, there are many decided tax cases in Australia. There is a body of case-made law in Australia establishing principles which can be applied and extended. The practice of following Australian decisions lends certainty and predictibility to the law. It enables taxpayers to plan their business affairs for taxation advantage; it enables disputes between a taxpayer and the Chief Collector to be settled. I propose to follow the Australian authorities unless there is some good reason in principle why I should not.

The leading case is Commissioner of Taxation (Cth) v Hunter Douglas Ltd (1983) 83 ATC 4562, the facts of which bear some similarities to this case. The taxpayer was a company manufacturing, trading and marketing window coverings and building products. It borrowed money from overseas and suffered exchange losses when it repaid those loans. It claimed a deduction for the exchange losses. Rogers J of the New South Wales Supreme Court allowed the deduction. On appeal to the Federal Court Fisher and Lockhart JJ (with Franki J dissenting) reversed that decision. In that case the loan moneys were not paid in a lump sum but were drawn down from time to time as required and were used to provide funds for the day-to-day running expenses of the company. The greater part of the payments were to pay amounts which were deductible by the company in determining its assessable income, eg the payment of wages, travel allowances, petty cash, telephone and advertising.

Franki J based his decision on the use to which the funds were put. Fisher and Lockhart JJ thought that the purpose of the borrowing was more important. Fisher J at 4569 said:

�I, however, regard the purpose of the borrowings as being of more assistance in establishing the character of the loan transactions and the exchange losses incurred on repayments thereunder and in determining whether they are on capital or revenue account. The use which a borrower in fact makes from time to time of borrowed funds and the purposes for which it applies them is not necessarily conclusive of the purpose or character of the borrowing. This character will depend upon the purpose for which the borrowing is made, eg to strengthen the capital structure of the company and also the use which the company makes generally of borrowed funds in its profit-earning activities. The crucial question will frequently be whether the company uses the borrowed funds to finance its profit-earning activities or as an integral part of such activities.�

Lockhart J at 4574 said:

�Whether foreign exchange gains or losses made in repaying loans are capital or revenue items must be determined with reference to the purpose of the borrowing which supports them. They must in my view assume the same character as the borrowings which give rise to them.�

At 4576 he said:

�The essential question, when ascertaining the nature of foreign exchange gains or losses made on repayment of moneys borrowed, is to determine the purpose of the borrowing. In my view the use to which borrowed moneys are put is merely evidentiary of the purpose of those borrowings and not conclusive of it.�

Fisher and Lockhart JJ went on to say, citing Australian authorities, that if a company borrows to purchase trading stock, or � in the case of a finance company � borrows funds to lend out (those funds being its �trading stock�), then the interest paid to borrow those funds is deductible as is any exchange loss in repaying that interest. Fisher J at 4573 said:

�The position is different where the company is not a finance company but a trading or manufacturing company which incurs exchange losses or gains otherwise than through the purchase of trading stock. Here the losses or gains will in the ordinary course be on capital account. For them to be on revenue account it is necessary for the taxpayer to establish that the additional expenditure to meet exchange losses was expenditure incurred in the process of producing its income, and in the words of Mason, Aickin and Wilson JJ in AVCO set out above, as an integral part of that process.�

Lockhart J at 4575 said:

�In general, loans and repayments of loans are considered to be on capital account: �Borrowing money to carry on business or to pay liabilities incurred in carrying on business is prima facie to increase the capital employed in the business ...� per Caltex Ltd v Federal Commissioner of Taxation [1960] HCA 17; (1960) 106 CLR 205 per Menzies J (at 251); the AVCO case per Mason, Aickin and Wilson JJ (at [ATC] 4256; [ALJR] 675). This is no more than a prima facie presumption.

Borrowings by finance companies in the ordinary course of their business or borrowings by trading companies to purchase trading stock are examples of expenditure incurred in the earning of a taxpayer�s income and not for the purpose of enhancing the business or organisation of the taxpayer as an income-earning entity. It is well established that such borrowings are revenue items.

The essence of the business of a finance company is the borrowing and lending of money. Its borrowings provide funds which it turns over at a profit by lending the moneys borrowed at a higher rate of interest than is payable on the moneys which it borrows. A finance company generally borrows money for the purpose of increasing its working or circulating capital which it turns over at a profit. It deals in money. The money which it turns over by borrowing and lending is similar to trading stock. As was pointed out by the majority of the High Court in the AVCO case (at [ATC] 4258; [ALJR] 677) there are obvious differences between the �money stock� of a finance company and the trading stock of a trading company: money is not dealt with in specie as a commodity and is not included in the definition of trading stock for the purposes of the Income Tax Assessment Act 1936 (Cth) (see s 6). But there is a close similarity between the borrowing and lending of money by a finance company and the buying and selling of trading stock by a trading company.

Where a trading company buys goods which it turns over as trading stock gains or losses incurred are of a revenue nature. If moneys payable by a taxpayer are allowable deductions, in general any increase or decrease in those amounts caused by fluctuations in the exchange rate are likewise allowable deductions or assessable income as the case may be. If a trading company borrows money overseas in circumstances where the borrowing is a necessary part of and has the purpose of purchasing trading stock exchange gains or losses will be revenue items.

Where a finance company borrows money overseas and then lends it in the course of its business as a financier, exchange losses made in the course of repaying the borrowed moneys are outgoings made for the purpose of carrying on the business as a going concern and accordingly will be revenue items.�

At 4576-4577 Lockhart J said:

�Borrowing money to carry on business must prima facie be treated as augmenting the capital employed in the business. Borrowings by finance companies to then lend to their customers, and borrowings by trading companies to finance the purchase of trading stock, are exceptions to this general rule. Such borrowings are an integral part of the ordinary conduct of the company�s business and are thus revenue, not capital, items. Moneys borrowed by a finance company are turned over by making loans to its customers. Moneys borrowed by a trading company for the purpose of financing the purchase of trading stock are borrowed with a view to disposal of the stock at a profit. They are in each case part of the company�s circulating capital.

Borrowings are prima facie part of a company�s fixed capital. The distinction is between the capital which enables a business enterprise to be conducted and the activities by which the income of the business is earned. Expenditure incurred in relation to the financing of a business is not expenditure incurred in the earning of the income of that business: Montreal Coke and Manufacturing Co v Minister of National Revenue [1944] AC 126 per Lord Macmillan at 134.�

Mr Hill QC, for the taxpayer, argued that I should not follow the majority views of Fisher and Lockhart JJ but should follow the view of the trial judge, Rogers J, who was reversed on appeal, and the view of Franki J who dissented on appeal. Obviously when two judges differ from two others, all of whom have high reputations in Australia, the authority of Fisher and Lockhart JJ is weakened, especially as their majority view is not binding on me. I have read all the cases cited to me by counsel which precede Hunter Douglas and consider that the majority views on appeal accurately state the Australian law.

Then Mr Hill urged me to prefer the English and Canadian views to that of the majority in Hunter Douglas. He cited two English cases and two Canadian cases. The first was Radio Pictures Ltd v Inland Revenue Commissioners (1938) 22 TC 106 in which the taxpayer was the United Kingdom subsidiary of the American motion picture company RKO. The taxpayer had exclusive rights to distribute RKO films in United Kingdom for which it paid a royalty in US dollars. Due to the depression and England going off the gold standard the company had to pay many more pounds than it originally contracted to pay. The English Court of Appeal allowed the exchange loss as a deduction. There was no borrowing in that case and consequently no exchange loss in repaying the loan. But the case seems to me to be consistent with Australian authority. The company showed in its income tax return as an expense the sterling amount of royalties it was contracted to pay. It was later able to prove that it contracted to pay the royalties in US dollars and that the initial royalty payments returned were not correct. The result would have been the same under Australian law; the company was entitled to show as a revenue deduction the real sterling amount paid to the American company for royalties. The second case, Davies (HM Inspector of Taxes) v The Shell Company of China Ltd (1951) 32 TC 133, was cited to me as it is quoted in Thiess Toyota Pty Ltd v Commissioner of Taxation (Cth) (1978) 78 ATC 4463 at 4466. In that case Jenkins LJ said (at 4466):

�(Where) a British company in the course of its trade engages in a trading transaction such as the purchase of goods abroad, which involves as a necessary incident of the transaction itself, the purchase of currency of the foreign country concerned, then any profit resulting from an appreciation or loss resulting from a depreciation of the foreign currency embarked in the transaction as compared with sterling will prima facie be a trading profit or a trading loss for Income Tax purposes as an integral part of the trading transaction.�

I consider that that statement of principle is consistent with the Australian trading stock cases. The decision itself on the facts is also consistent with the Australian cases. The taxpayer was an English company which sold petroleum products in China. It required its agents to deposit a sum of money with it in Chinese dollars which was repayable when the agency came to an end. Owing to the depreciation of the Chinese dollar with respect to sterling the amounts required to repay the agency deposits were much less than when the deposits were made and the company made a substantial profit. It was held that this exchange profit was a capital profit and not subject to income tax. The result would have been the same in Australia. The exchange gain did not come from trading stock.

Mr Hill urged me to follow the reasoning of two Canadian cases in preference to that of Devies and Lockhart JJ in Hunter Douglas. The first case does, I think, differ in principle from Hunter Douglas; the second does not. In Aluminium Union Ltd v Minister of National Revenue (1960) 60 DTC 1138 the taxpayer was a Canadian company which sold aluminium products. It opened a branch office in Japan to sell aluminium there. In 1938 it borrowed 300,000 yen for the purposes of its branch office. The money was used to pay duties on goods imported to Japan from Canada and for general administration, salaries, travelling expenses and office furnishings. The loan was then worth about 175,000 Canadian dollars. Owing to the outbreak of war the loan was not repaid until 1952 when it was repaid in yen which cost only $2,000. It was held by the Exchequer Court of Canada that the exchange profit of $173,000 was assessable.

At 1140, Fournier J said the test to determine whether an exchange gain is taxable is whether the gain is derived from funds forming part of the capital assets. If so it is not taxable, but if the profit results from funds received on revenue account it is taxable. He held (at 1142) that the moneys were borrowed by the taxpayer from the bank to run its business operations, for the purpose of gaining income for the company. So the exchange profit was made from funds received on revenue account. The decision would have been different in Australia where an exchange gain is generally only assessable if it arises out of the purchase of trading stock or on the borrowing of working funds by a finance company.

The second Canadian case cited was ISE Canadian Finance Ltd v Minister of National Revenue (1986) 86 DTC 1344. The taxpayer�s business consisted of borrowing funds, some of them in US dollars, and loaning them to its Canadian affiliates. In the course of two tax years the taxpayer engaged in about 4,600 borrowing and lending activities. It was held that the exchange gains and losses were on account of income, a result consistent with the Australian finance company cases eg AVCO Financial Services Ltd v Commissioner of Taxation (Cth) (1982) 82 ATC 4246.

The leading Australian statement of principle on this issue comes from Fisher and Lockhart JJ in Hunter Douglas. I have read the dissenting view of Franki J and of Rogers J in the court below. I have read the Australian cases which preceded Hunter Douglas and the English and Canadian cases referred to me. I can see no reason why I should not follow the principles enunciated by Fisher and Lockhart JJ who clearly state when exchange gains and losses are assessable and deductible. Those principles do not lead to any unjust or unfair result and I propose to follow and apply them to this case. To follow them, rather than the dissenting opposite view, is also consistent with the long-standing practice in Papua New Guinea that the Chief Collector, the Review Tribunal and this Court normally follow Australian decisions on sections of the Australian Act identical to our own.

THE AGREEMENTS WITH COMCRAFT ASIA LTD AND INTERMIN PACIFIC SA

I have already described the two agreements Barlow made with Comcraft and the agreement with Intermin. I desire now to analyse the true purpose of those agreements and I will refer to the evidence of Shiam Kattapuram and Gordon Morgan. Mr Kattapuram impressed me as a sharp and competent man but I thought a number of his answers less than truthful. I consider that he knows much more about the relationship between Barlow, Pacific Industrial Corporation (the parent of Barlow), Comcraft and Intermin than he was prepared to tell. He was recruited in India to work for Comcraft. He spent a week in Comcraft offices in Singapore. He must have learnt much about the company structure there and he has had seven years of dealings with Mr Chandaria. Gordon Morgan, the resident director is a joiner by trade. He is the technical man running the taxpayer�s technical operations. He has less knowledge of the company�s financial affairs but was I thought a more truthful witness on the taxpayer�s relationships with the other companies. I think he was less aware of how damaging any admission could be.

What is the relationship between the taxpayer and Comcraft and Intermin? There are two Comcraft companies, Comcraft Asia Ltd and Comcraft Services Ltd. Comcraft Asia is a party to two of the agreements mentioned, and Comcraft Services ltd is a director of Barlow. Mr Chandaria is the representative director of Comcraft Services based in Singapore. If Mr Kattapuram or Mr Morgan wish to contact either Comcraft company on any matter they contact Mr Chandaria. All the shares in Barlow and its five sister companies in Papua New Guinea are owned by Pacific Industrial Corporation. Under a tough and fast cross-examination Mr Kattapuram said the shares of Comcraft Services were owned by Pacific Industrial Corporation SA. He was asked, �exactly the same parent as you have�? He answered �Yes�, and then said, �I am unaware of the shareholders of Comcraft Services�. I think the former answer, given in the heat of the moment, correct and the latter answer false. That the Comcraft companies have a common ownership with Barlow fits in with a number of facts. Comcraft and Barlow are in no sense arms-length parties. Mr Kattapuram said that he did not know of the relationship between Comcraft Services and Comcraft Asia and he was not sure if Mr Chandaria had anything to do with Comcraft Asia. I do not accept those answers as truthful. It is highly likely that they are related companies and that Mr Chandaria is involved in both. Mr Kattapuram said he was hired by Comcraft Asia in Singapore and seconded to Barlow here. Comcraft Services, as I have said, is a director of Barlow. I think he would know the relationship between the two companies.

What is the relationship between Intermin Pacific and Comcraft? As related above the intermin agreement was signed by Mr Derry under power of attorney for Barlow. Mr Derry is a director of Pacific Industrial Corporation, the parent of Barlow, and as I have mentioned above, from his signature on the intermin agreement he appears to be a director of Intermin Pacific. Pacific Industrial Corporation and Intermin are both incorporated in Panama and both have the same post box number as their address in Geneva.

Mr Morgan, in evidence in chief, said he regarded Intermin as an offshoot of Comcraft but he did not know the shareholders of Intermin. In cross-examination he said Comcraft has a connection with the owners of Barlow. Although he has been a director since 1979 he had nothing to do with the negotiation of the Intermin agreement of 30 December 1980. He said he had no idea how the agreement came to be signed and he did not give any authority for anyone to sign on behalf of Barlow. The minute book bears this out, there is no director�s resolution about this agreement. No fellow director discused the Intermin agreement with him. If Intermin and Barlow are arms-length parties this is surely an amazing fact. The production manager of the company, concerned no doubt with keeping costs down, and the only director resident in Papua New Guinea, knew nothing of an agreement which added K10,000 a month to the costs of the operation for overseas technical assistance and knew nothing of the fact that this assistance had been apparently �supplied� for the past 12 months.

Mr Morgan says he regards Comcraft Asia and Comcraft Pacific as the same thing. Intermin is an offshoot of Comcraft. If he wants to contact any of the three companies he goes through Mr Chandaria. After describing the various services provided to Barlow by Comcraft Mr Morgan readily agreed in cross-examination that he regarded Comcraft basically as the parent company. He said in conducting the company affairs he and other officials never use the word Intermin. If they want some assistance they contact Comcraft. Mr Chandaria attends some of Barlow�s board meetings on behalf of Comcraft; he regards Mr Chandaria as an important owner of Comcraft.

I accept the evidence presented to me that Comcraft does have offices in Singapore, Hong Kong, London, Geneva and Nairobi and that it has provided services to Barlow. Comcraft has assisted Barlow in sourcing materials, finding out the availability of prices of materials used in making roofing iron, guttering, aluminium joinery and the like. When the government Energy Commission (now defunct) wanted to order a charcoal cooker, Comcraft obtained a prototype from Nairobi and Barlow made 10,000 of them for the government. Some are still held by the company unsold. The company makes aluminium joinery and wanted to install a bulk glass handling facility. Comcraft sourced alternatives from Canada, Australia and Europe. Morgan made his own investigation in Australia and eventually bought the Australian machine but he said it was useful to have the knowledge of comparable products.

One of the most profitable ventures undertaken by the taxpayer has been the distribution of Solahart hot water systems yet, despite the agreement, Intermin played no part in it. Solahart is an Australian company based in Perth but with sales offices in each part of Australia. Its hot water units are only manufactured in Perth. In 1978-79 there was the Arab hike in oil prices which prompted great interest in solar energy. The taxpayer had been manufacturing a hot water unit in a small way since 1966. The solahart product was superior. A representative from Solahart, Brisbane, visited the taxpayer and suggested a joint venture whereby Barlow would sell Solahart units in Papua New Guinea. The two companies secured a government contract in late 1979 with yearly renewal options. They sold 100 units a month in 1979 and 1980. In 1981 the two companies won a contract to supply 1,600 units to BCL in Arawa and Panguna. Barlow installed these units in nine weeks and made K1.5 million. A large part in the increase in the gross sales of Barlow in the period 1978 to 1981 was due to the success of the Solahart sales. Note the sales trend.

Gross sales

But the taxpayer was not content with distributing Solahart units; it wanted to manufacture them or components of them in Papua New Guinea and to this end Comcraft was contacted in Singapore and Mr Chandaria visited Perth and inspected Solahart�s factory there. No deal could be reached. Solahart was not interested in Barlow manufacturing its product, the relationship between the two companies ceased and now Barlow makes a somewhat similar unit.

I consider that Comcraft does provide real services to Barlow (and Moresby Plumbing Supplies) under the two agreements. At the same time the companies are controlled by the same parent and, in practical terms, by the same man Mr Chandaria, and as well as providing services to Barlow, the two agreements are a way of repatriating profits from the taxpayer to the �parent� companies offshore. The same is also true, indeed even more clearly so, for Intermin. The reasons for this view are clear. I have already mentioned the connections between Barlow, Comcraft and Intermin. They are not arms-length parties. Secondly, all three agreements were retrospective in effect. The first Comcraft agreement is dated 15 December 1977 but the obligation to pay the 3 per cent of gross sales as management fees is said to commence from 1 April 1977. The second agreement is dated 30 May 1978 but the obligation to pay 2 per cent of gross sales as technical assistance fees is said to also commence from 1 April 1977. The Intermin agreement of 30.12.80, which requires the company to pay K10,000 a month to Intermin for technical assistance on energy saving products such as the hot water units, is stated to commence from January 1980. No arms-length party would provide such expensive services (eg in the case of Intermin to the value of K120,000) without any prior agreement.

In the third place, it is highly significant that the taxpayer paid no dividend to its shareholders in the years 1978 to 1983 yet in those years sent the following moneys overseas to the �parent� companies under the agreements.

Fourthly, the three agreements required the fees to be paid quarterly. This has never been done. No invoices have been issued by Comcraft and Intermin. The payments are always in arrears. K668,000 was owing under the agreements at the end of 1983. The payments due have never been reduced to nil since 1980. This confirms my view that the agreements are not between arms-length parties but between related companies in a group-sending home funds to the controller of the group when it suits to do so.

As a fifth reason, the non-production of documents relating to the reason for these agreements, is highly significant. No doubt such documents exist, correspondence with lawyers (all three agreements were drawn by Dawson Waldron in Sydney), accountants, and with Comcraft and Mr Chandaria in Singapore. It is highly significant too that Mr Morgan, the only resident director of the taxpayer in Papua New Guinea had no knowledge whatsoever of the Intermin agreement. He did not know that his company was getting any benefits from Intermin or that his company had agreed to pay for these services at the sum of K10,000 a month. He was not asked and he did not authorise the agreement in any way. He did not seem unduly perturbed about the matter because clearly, I infer, this was not an outlay for real services kept secret from him, but a tax planning device to pay some profits to the parent free of the income tax payable on company profits and dividends. He left these financial matters to Mr Kattapuram and Mr Chandaria. Intermin is of course a separate legal entity from Comcraft but Morgan knew nothing of its activities or personnel, save that it was an offshoot of Comcraft. I am convinced that it has no offices around the world ready to give technical advice to Barlow. The recital in the agreement hints at this; it states that Intermin:

�through it business connections and associated companies has access to information and may be able to obtain distribution rights, technical expertise and knowhow in respect of energy products.�

I consider that the words italicised refer to the Comcraft companies with their wide-spread offices already mentioned. I consider that no assistance came to Barlow under the Intermin agreement which would not have come anyway to Barlow under the technical assistance agreement with Comcraft. I consider that the purpose of the two Comcraft agreements was partly to supply technical advice and management assistance to Barlow and partly to avoid taxation � to get some �profits� to the �parent� company without paying tax on them. I consider that the sole purpose of the Intermin agreement was as a tax planning device � to get profits to the parent. I consider it highly likely that the controllers of Barlow in late 1980 realised that the company had had a very successful year (profits were up on the previous year), and could expect an even better year in 1981, so they devised the energy fees agreement to get profits to the owners in a tax-free way (apart from the payment of royalty tax expressly mentioned in the agreement).

THE PURPOSE OF THE LOAN

The appellant led oral evidence from Messrs Kattapuram and Morgan that the purpose of the $1 million loan was to pay to outstanding fees to Comcraft and for on-lending to its related companies in Papua New Guinea. In support of that evidence of purpose, I note that the loan was largely used for those purposes, the principal exception being the $220,000 utilised towards the purchase of a house for the manager. In view of the non-production of documentary evidence which I have mentioned earlier, evidence which should exist, and the bad credit of Mr Kattapuram, to which I have referred, I am unwilling to accept that view in full. I also consider that around December 1980 was a time of great expansion for the company. I have already quoted the gross sales figures for 1979, 1980 and 1981. At the end of 1980 when the loan was negotiated it must have been clear that 1980 was going to be a record sales year and that 1981 promised to be even better. Both predictions proved to be true; the 1980 sales were 32 per cent up on 1979 sales and 1981 sales of K5,880,852 were 64 per cent up on the 1980 figures. It was a time of expansion for the company. In 1981 the company began the installation of more rolling mills for the manufacture of long-run gutters and set up its bulk handling glass facility. It was also doing well with its sale of Solahart hot water units. It planned to manufacture the Solahart hot water unit in Papua New Guinea.

A recital in the Intermin agreement of 30 December 1980 shows that Barlow saw itself poised for expansion.

�whereas ...

N2>D.������ (Intermin) has supplied Barlow with data, literature and other information in particular in relation to:

distribution of a certain hot water system relying largely on solar energy and continuing technical expertise and know-how for manufacture in stages of solar hot water systems;

(ii)����� the import, cutting and use of glass and treatment of glass to save energy; and

(iii)���� sheet metal panels made from high tensile, zinc � coated steel sheets or aluminium sheets for roofing and walling and ceiling systems specifically insulated in different ways to save use of energy.�

I believe Mr Kattapuram when he says at the end of 1980 the company could not pay all its debts. The bank loan and the Intermin agreement were signed on the one day and of course drafted in the weeks before. Although Mr Morgan knew nothing of the Intermin agreement it would have been obvious to Messrs Kattapuram and Chandaria that signing the Intermin agreement meant accepting an obligation to pay K120,000 immediately. Because $500,000 was drawn down in December, presumably 30 or 31 December, immediately after the loan agreement was signed, largely for payment of management and technical and energy fees, I consider it reasonable to infer that that use was intended when the loan was obtained. I consider that the rest of the loan facility, namely K500,000, was intended as working capital for the company in December 1980 when the loan was obtained. I do not believe Mr Kattapuram that the rest of the loan facility was intended for on-lending to related companies. His failure to produce any contemporary documents, especially his 1981 budget, is against him. I consider that the purpose of the balance of the loan facility was as working capital for the company, and the fact that K150,000 was loaned to a related company in January 1981, and that K130,000 was loaned to related companies in July to October, does not dissuade me from that view. It was simply a credit facility obtained for future use by the company as it thought fit.

CONCLUSIONS

I consider that $500,000 of the total loan was borrowed to pay the Comcraft and Intermin fees and that the other $500,000 was borrowed as working capital, which was spent partly in on-lending to sister companies and partly on the purchase of a capital asset, viz a house for the manager. And as I have said, an unspecified part of the money borrowed to pay the Comcraft fees, and all of money borrowed to pay the Intermin fees, was intended to repatriate profits to the overseas owner. Can the taxpayer come within either of the two exceptions to the general rule as stated in Hunter Douglas?

A trading company which purchases goods to sell from overseas and makes an exchange gain or loss in paying for these goods will have the gain taxed and the loss deducted. Hunter Douglas affirmed that exception, see the passages quoted above. That has been well established in earlier cases which were accepted by the judges in Hunter Douglas, and the principle not only applies to a trading company purchasing manufactured goods to sell, but also to a manufacturing company purchasing raw materials to manufacture and then sell: see, for example, references by Fisher J, in Hunter Douglas at 4572 and 4573 to a manufacturing company, and to dicta of Gibbs J in International Nickel Australia Ltd v Commissioner of Taxation (Cth) (1977) 77 ATC 4383 at 4387.

The taxpayer is both a trading company and a manufacturing company and I can see that the cost of raw materials can properly include freight and insurance, but I regard the fees to Comcraft and Intermin for management fees and technical expertise as different in kind from the purchase of raw materials, freight and insurance. They are more akin to the payment of wages, telephone and rent of premises. To support its claim that these fees are a part of the cost of trading stock, the taxpayer showed from its accounts that these fees are included in the company�s accounts in the absorption cost method of valuing stock. How a company treats an item of expenditure is a factor to consider but is not determinative of the true character of that item. I thought the attempt clumsy and unconvincing and I thought Mr Beaumont�s cross-examination of Mr Kattapuram very forceful and his arguments on this point telling. The true character of these fees are that they do not relate to the purchase of trading stock, they are normal running expenses like wages. They are an expense and shown as such in the 1983 Detailed Trading and Profit and Loss Account. When a company borrows to pay such items the loan is simply working capital to pay the running expenses of the company, and the interest paid to service that working capital is not deductible. Likewise an exchange loss in repaying that interest in a foreign currency is not deductible.

Can the taxpayer come under the exception of the finance company cases? Barlow is not a finance company, its main business is manufacturing and trading in building products. It is true that the taxpayer did lend to its sister companies at a small profit on a regular basis. It made 82 such loans to its sister companies in the period May 1978 to December 1985. It made 17 such loans in 1981 and 1978 to December 1985. It made 17 such loans in 1981 and 19 in 1983. Some of the loans are repayable on demand; others are repayable on terms of up to five years. Not all of the 17 loans made by the taxpayer in 1981 were from moneys borrowed from Barclay�s Bank. The company�s practice in on-lending to a related company was to charge interest on the loans slightly higher than it was paying itself for the loan thus giving a small profit to the taxpayer.

Barlow is not a finance company. It was not carrying on business as a money lender or financier in the sense of offering that service to the public. Neither was its on-lending service to its related companies a significant part of its business. Its profits from on-lending (taken from exhibit G) were as follows:

In 1981 it collected K24,456 interest from all its loans to related companies compared to gross sales of K5,880,852. Mr Morgan, the director, was unaware of the interest rates charged. The on-lending was a very insignificant part of its business. Mr Hill, for the appellant, cited to me Thomas v Commissioner of Taxation (Cth) (1972) 72 ATC 4094 as authority for the proposition that a person may be carrying on a certain kind of business even though that business is only a very small part of his activities. In that case a barrister had a farm and claimed deductions as a primary producer. It was held that even though he only devoted a small amount of his time to the farm, and the returns to be expected from it would be small compared to his income as a barrister, he was a primary producer. I do not propose to follow that case. The overriding consideration in this case is that the on-lending to related companies was such a minor part of its business that it should, in my view, be ignored.

The taxpayer appellant has failed to bring itself within either of the two exceptions of the Hunter Douglas principle. I dismiss the appeal with costs granted to the respondent and certify the case as a suitable one to engage overseas senior counsel.

Appeal dismissed

Lawyers for the appellant: Beresford, Love, Francis & Co.

Lawyer for the respondent: B O Emos, State Solicitor.