COMMISSIONER OF INLAND REVENUE v. CHINACHEM FINANCE CO. LTD.

HeadNote

Profits tax - finance company - exchange losses incurred in repayment of foreign loans - whether loans on capital or revenue account - whether losses deductible in computing profits for tax purposes - ss. 16 and 17(1)(c) of Inland Revenue Ordinance, Cap. 112.

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J U D G M E N T

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Fuad, V.-P.:

1. This is an appeal by the Commissioner of Inland Revenue ("the Commissioner") from an order dated 9th November 1991 of Godfrey, J. upon a case stated by the Board of Review ("the Board") under section 69 of the Inland Revenue Ordinance, Cap. 112 ("the Ordinance") whereby he dismissed an appeal by the Commissioner against a decision of the Board given on 10th March 1989 in favour of Chinachem Finance Company Limited ("the Taxpayer") upon a controversy relating to the computation of profits for profits tax purposes for the three tax years 1981/82, 1982/83 and 1983/84.

2. Part IV of the ordinance makes provision for the imposition and assessment of profits tax. For the purposes of this appeal, the material provisions of the Ordinance are the following:

"16. Ascertainment of chargeable profits

        (1) In ascertaining the profits in respect of which a person is chargeable to tax under this Part for any year of assessment there

shall be deducted all outgoings and expenses to the extent to which they are incurred during the basis period for that year of assessment by such person in the production of profits in respect of which he is chargeable to tax under this Part for any period, including -"

[Then follow paragraphs (a) to (h) with which we are not concerned].

"17. Deductions not allowed

(a) and (b) ...

(c) any expenditure of a capital nature or any loss or withdrawal of capital;

(d) to (j) ..."

3. The facts agreed between the Taxpayer and the Commissioner and found by the Board are as follows. The Taxpayer which belongs to a group of companies comprising 150 to 200 companies (affiliates) was incorporated on 25 May 1973. At all material times its issued and paid up capital was $20. Its activities include lending to affiliates, making mortgage loans to purchasers of property from affiliates, personal loans and financing the purchase of motor cars through hire-purchase; its principal activities are the first two. On occasion affiliated companies lent to the Taxpayer at interest. The group was at all material times controlled by Mr. T.H. Wang and his wife and the main business of the group is property development, whilst the Taxpayer plays the role of financier to the group companies. In the years in question, about 60% of the affiliates' borrowings were from the Taxpayer which was licensed to carry on the business of a money lender. In order to be able to make lendings, the Taxpayer borrowed moneys, mostly in US dollars which were converted into Hong Kong dollars and lent on to the affiliates, the interest rates on the lendings being always higher than the rates payable on the borrowings. The Taxpayer derived its profit from the interest differential. The Taxpayer chose to borrow in US dollars because the interest rates were comparatively low and stable. It was not connected or associated with any of the US dollar lenders who were four in number. Neither Mr. Wang nor his wife had any interest in any of them.

4. The relevant details of the US dollar loans and advances made by the four lenders just mentioned were as follows:

1.    Loan from West LB Asia Limited

2.    Loan from Underwriters Bank (Overseas) Limited

4.    Loan from Grand Credit Bank Limited

This loan is evidenced by a loan agreement dated 9th February 1981 providing for advances up to US$200 million. [There were 6 drawdowns of equal amounts totalling] US$120 million in May and June 1981. The loan lasted for less than 4 years, being repaid [in 5 instalments] in January 1985. The outstanding balances as at 31st March 1982, 1983 and 1984 were the same, that is US$120 million. The unfavourable US dollar exchange rates produced exchange losses of $47,800,000, $107,000,000 and $124,000,000 for the years 1981/82, 1982/83 and 1983/84 respectively. The loan, which had been personally guaranteed by Mr. T.H. Wang, was repayable on demand or on three days written notice. Although the agreement made this stipulation, it was initially contemplated to last for one year. This loan had been arranged because the property market was booming in the 1980's and there were many demands for funds from the affiliated companies.

5. In relation to the four loans, the Board also found the following additional facts. The US dollar loans after conversion were used to fund lendings in Hong Kong dollars, of which 938 or more were made to affiliates. These were short-term loans. In the year 1984/85, to avoid any further possible exchange losses, the Taxpayer repaid the four US dollar loans mentioned above and replaced them by a long-term Hong Kong dollar loan of $988,000,000, repayable on demand, from an affiliate (the Chinachem Group Company Limited) which had obtained the necessary funds, or at least a substantial proportion of them, from other affiliates in the group. The interest rates charged by the Taxpayer on loans to affiliates were fixed in accordance with the policy laid down by Mr. T.H. Wang and his wife, i.e. that an interest profit should be made. The affiliates never failed to repay any loans advanced to them although none of the loans were secured. Whenever there was the intention in the group to borrow US dollars, the loan would be undertaken by the Taxpayer.

6. The Board accepted the unchallenged expert opinion of Mr. Ian Bruce called by the Taxpayer that the accounting policy on foreign currency balances, as set out in its audited accounts for the years ended 31 March 1982, 1983, 1984, was consistent with generally accepted accounting practice in Hong Kong. The accounting policy was described in the accounts in these terms:

"Foreign currency assets and liabilities as at 31 March are translated into Hong Kong dollars at the approximate market rates of exchange ruling at the balance sheet date. Foreign currency transactions during the year are converted at the rates ruling at the dates of transactions. All exchange differences are included in the determination of profits."

7. Mr. Bruce further gave it as his opinion that the accounting treatment of exchange losses adopted by the Taxpayer was consistent with the requirements of paragraphs 19, 21 and 22 of the Statement of Standard Accounting Practice on Foreign Currency Translation (issued in January 1985 by the Hong Kong Society of Accountants). In his opinion, the exchange losses had been properly included as revenue items in the profit and loss account deriving, as they did, from the ordinary activities of the Taxpayer.

8. The Board noted that the Taxpayer had been incorporated as a finance company and that in his

determination the Commissioner had not questioned its status as a finance company; nor had he done so in past years. Moreover, it had not been disputed that in previous years the Taxpayer's exchange losses had been allowed as deductions. The Board observed that in all the years prior to 1981/82 the Taxpayer had made profits on its trading activities and had duly paid tax on those profits.

9. After summarising the opposing contentions advanced before them, the Board noted that the Taxpayer's business consisted of borrowing and lending money, thereby making a profit out of the interest differential. The borrowing of money to enable it to lend money was, in their view, an ordinary activity of running the business and indeed an integral part of the business. The exchange losses were part of the cost of the borrowings. Moreover, the US dollar loans were demand loans and therefore by nature could only be a means of temporary accommodation. While it was true that the Taxpayer was at all times in need of cash, that need was satisfied by arrangements which were liable to be terminated at any time and therefore were temporary accommodation. In the Board's view, these considerations outweighed the considerations relied on by the Revenue, such as the size of the loans as measured against the Taxpayer's own capital ($20), the length of time the loans had been outstanding (3 1/2 years in the case of Grand Credit Bank Ltd. and 9 1/2 years in the case of Jan Financiera) and the fact that the loans appeared to have been replaced by a long-term loan in 1984/85, the year next following the accounting period. The Taxpayer carried on its business by borrowing money for the purpose of on-lending. Some of these borrowings had not been repaid for long periods only because the lenders had not exercised their right to demand repayment. But that did not, in the Board's view, change the character of those loans, which were temporary accommodation on the dates when they were respectively made, and remained so until they were repaid. As for the replacement of the loans by a long-term loan in Hong Kong dollars in 1984/85, funded in whole or in part by the affiliates, this was an occurrence outside the relevant accounting period and in any event could not change the character of the US dollar loans. The Board did not therefore attach any great significance to this consideration. The Board concluded that these US dollar loans were revenue transactions and not accretions to capital.

10. In the course of the stated case, the Board discussed a number of English and Australian authorities, including Beauchamp (Inspector of Taxes) v. FW Woolworth plc (1988) STC 714, CA, Avco Financial Services Ltd. v. Federal Commissioner of Taxation (1982) 13 ATR 63, Lombard Australia Ltd. v. Federal Commissioner of Taxation (1980) 10 ART 743 and Federal Commissioner of Taxation v. Hunter Douglas Ltd. 14 ATR 629. The Board acknowledged that it was not enough simply to label the Taxpayer as "a finance company". It was necessary to determine how the Taxpayer carried on its business. The Board went on to find:

"It borrowed US dollars from lenders with whom it was not connected or associated in any way and on-lent the money after conversion, principally to companies with whom it was affiliated, and made its profit out of the interest differential. On the evidence we find (and indeed it is not disputed) that each of these three steps, that is, the borrowing, the lending and the earning of the interest differential as its income, was truly carried out. That, in our view, is enough to attract the application of the Avco principles." ... "in the years 1981/82 to 1983/84 the Taxpayer's status as a finance company remained unchanged."

11. The Board explained that they "preferred" the Australian law:

"... because the relevant Australian statutory provisions are similar to ours and because the Australian cases deal with the special situation of a finance company or a company whose business is that of borrowing and lending of money. The argument is interesting and persuasive, but in the present case there is no occasion for making any choice [between English and Australian law] as our conclusion is the same whichever law we apply."

12. The Board then stated its conclusion that "the exchange losses in question are allowable deductions under section 16(1) of the Ordinance" and therefore framed the question of law for the opinion of the High Court in this way:

"The question of law for the opinion of the Court is whether, on the facts found by the Board, the Board was correct as a matter of law in holding that the exchange losses were of a revenue nature and accordingly deductible in arriving at the profits chargeable to tax."

13. The learned judge, early in his reserved judgment, referred to the decision of the House of Lords in Beauchamp (Inspector of Taxes) v. FW Woolworth plc. 61 TC 542 (on appeal from the Court of Appeal) given on 8th June 1989 and therefore about three months after the Board had reached its decision. He pointed out that the Court of Appeal had regarded the question before it as a question of fact. The House of Lords had treated the question as one of law and, on the facts, had reversed the decision of the Court of Appeal as having been erroneous in law.

14. The judge said that it did not follow that the reversal by the House of Lords of the decision of the Court of Appeal meant that the decision of the Board must have been, or even was likely to have been, wrong. It meant only that the Board had been wrong to characterise the question as one of fact. The judge went on to say:

" In any event the Board had to make its findings as to the facts of the case and then conclude what, on those facts, was the correct result. If the Board's conclusion as to the correct result had been a conclusion upon a question of fact, as the Board (following the Court of Appeal) had thought it was, the court could not have disturbed it unless it was insupportable; i.e. one to which no person, acting judicially and properly instructed as to the relevant law, could have come. Since, however (as can now be seen) that conclusion was actually a conclusion upon a question of law, I have simply to decide, as a matter of law, whether (given the facts found by the Board) it was or was not correct. The reversal by the House of Lords of the decision of the Court of Appeal in the Woolworth case has no further or other effect on the instant case, although of course I will treat as of the highest authority anything said in the House of Lords about the legal principles involved."

15. The judge, in discussing the extent to which the court could review findings of fact (and inferences drawn from the facts) by the Board, had this to say:

" The commissioner further contended (as a separate matter, if I correctly understood his argument) that while I did indeed have to take the facts of the case as found by the Board, it did not follow that I had to accept the Board's conclusions upon those facts. This muddies the waters still further. Insofar as the conclusions in issue are the Board's conclusions of fact, they must in my judgment be treated in exactly the same way as inferences drawn from the primary facts drawn by the Board (if there is any real difference between such an inference on the one hand and such a conclusion on the other hand). The inferences to be drawn from primary facts being within the exclusive competence of the Board as the tribunal of fact, it necessarily follows that so are the conclusions on matters of fact which that tribunal reaches. The commissioner here no doubt had cogent arguments which might well have persuaded the Board to reach different conclusions of fact but such arguments failed before the Board and are simply not open to him before me. Insofar as the conclusions in issue are conclusions of law based on the Board's findings of fact (including such factual inferences and conclusions as it has drawn and reached) the position is entirely different; those conclusions of law are of course reviewable by the court. The commissioner's argument (as I understood it) that all the Board's conclusions were matters of law reviewable by the court is fallacious and must be rejected. It all depends on whether the conclusion in issue was one of fact, or one of law."

16. The judge then summarised the "primary facts (including those which appear from the loan documents); and the inferences which the Board drew from them; and the conclusions of fact to which the Board came; all of which comprehensively, in my judgment, fall to be treated as the Board's findings of fact" and the conclusions of the Board.

17. The following is a summary of the remainder of the judge's primary conclusions on the main issues before him:

(a) Whether a borrowing was on capital account or revenue account was, as the Woolworth case demonstrated, a question of law to determined on the facts of the particular case. The distinction which ultimately depended on the difference between fixed capital on the one hand and circulating (or working) capital on the other hand, was easier to define in theory than to apply in practice.

(b) A gain or loss on fixed capital was an item on capital account, while a gain or loss on circulating capital was an item on revenue account. The effect of the authorities on this subject (reviewed later in.the judgment) was that in order to determine whether or not a gain or floss arising from borrowing was made on capital or revenue account one had to look, primarily, at the length and other terms of the borrowing and at the nature of the trade. If the borrowing was long-term (i.e. for over 1 year) the gain or loss was more likely to be found to be an item on capital account than on revenue account; if the borrowing was short-term (i.e. for less than 1 year) the gain or loss was more likely to be found to be an item on revenue account than on capital account.

(d) If the borrower was an ordinary trading company, a loan to it was unlikely to be treated as on revenue account unless it was temporary and fluctuating and had been incurred in meeting the ordinary running expenses of the business. If the borrower was a company such as a bank, money-lender or finance company (the stock-in-trade of which was, in, a sense, money) any borrowing which provided it with working capital for use in the ordinary course of business was likely to be held to be a borrowing on revenue account; in this respect, the position of such a company had to be distinguished from that of an ordinary trading company.

(e) The Taxpayer was a finance company and the loans were repayable on demand. The purpose of the loans, so far as material, was to provide the Taxpayer with "general working capital". That was expressly so stated in the "revolving credit facility" documentation relating to, the Taxpayer's loan from West LB Asia and the other loans were no different in nature. The borrowings did provide the company with additional working capital; but they did not add to the capital base of the business nor, to put the same point in another way, did they become part of the Taxpayer's capital structure. They were taken as required, and repaid as opportunity permitted, in the ordinary course of the Taxpayer's business.

(f) The lending of money was part of the Taxpayer's daily business, although the borrowing of money was not of frequent occurrence. But the Board had found (and was entitled to find) that the borrowing, like the lending, was part, indeed an integral part, of the Taxpayer's business. The facts of the present case did not warrant the conclusion of law for which the Commissioner contended - that the borrowings in question made by the Taxpayer "whose business is the borrowing and lending of money", must be treated as borrowings on capital account. The cost of that borrowing (including the additional cost incurred by reason of the increase in the value of the currency in which the borrowing fell to be repaid) was an outgoing by which the Taxpayer procured the costs of the thing by which it made a profit (the borrowed money), and like any other outgoing had to be deducted from the Taxpayer's receipts in computing its assessable profits.

(g) Any contention that, although the Taxpayer's business was the lending of money, the borrowings which gave rise to the exchange losses here were not part of that business, could not be entertained. This was not because such a contention would be bizarre (although he was inclined to think that it was) but because the Board's findings of fact were within its exclusive competence so long as it had acted judicially and had properly instructed itself as to the relevant law.

(h) As to the contention that it was not enough for a finance company to show that it borrowed the money and then lent it on in the course of its business as a financier - it had to be borrowing of a temporary nature, (the sort of borrowing which fluctuated from day-to-day, with money being paid in and out all the time) the judge said this:

"In my judgment that is much too narrow a view. If the borrowing is made in the ordinary course of the business rather than for some special purpose, it does not seem tome to matter that the account between lender and borrower does not exhibit daily activity. I would accept that, if made for some special purpose, the borrowing might be on capital account; for example, if it were of a long-term nature, designed to strengthen the capital base of or improve the capital structure of the company. But I do not see how a loan to a finance company which is expressly made repayable on demand can ever be of such a character even if no demand for repayment is in fact made for a very considerable time. The borrowing either is or is not a borrowing made in the ordinary course of the taxpayer's business at the date when the loan is made. It cannot in my judgment change its character from a short-term loan to a long-term loan merely because it can be seen with hindsight to have endured for a period longer than a year. Temporary accommodation remains temporary accommodation, even if it provides a roof over your head for much longer than originally intended or expected."

(i) The relevant exchange losses were revenue items. That conclusion was a matter of law and the same conclusion as had been reached by the Board.

18. The judge reviewed a considerable number of authorities, both English an Australian. He remarked that they exhibited a considerable diversity of judicial opinion. This was because, as had long been recognised, the familiar and much-discussed distinction between fixed and circulating capital, although clear enough in principle, was in practice sometimes difficult to draw on the facts of a particular case. In his judgment none of the authorities cited bound him to come to the conclusion which he had reached, but all of them were, on analysis, supportive of (or at least consistent with) his conclusion. I will here merely set out how the judge saw the decision in the Woolworth case. This is how his judgment ends:

"     In the Woolworth case (with one irrelevant exception the most recent case cited to me) the House of Lords took the view that in the case of a trading company a 'loan is only a revenue transaction if it forms part of the day-to-day incidents of carrying on the business'; it must be 'temporary and fluctuating and ... incurred in meeting the ordinary running expenses of the business' (see per Lord Templeman at p.581). But the taxpayer here is a finance company, not a trading company; and the Board has found as a fact that the borrowings were made in the ordinary course of its business. Further, the loans in the Woolworth case were at an annual interest rate of 7% and repayable after 5 years (or earlier at the taxpayer's option on payment of a premium), whereas here the loans were repayable on demand.

      The Woolworth case is not in my judgment in any way determinative of the issue I have to decide in the present case, and I am of the opinion that the authorities, on balance, overwhelmingly support the conclusion to which I have come, that on the facts of this case, where the taxpayer is a finance company and in which I am concerned with loans to the taxpayer (1) repayable on demand; and (2) found by the Board to have been made to the taxpayer in the ordinary course of its business, the decision of the Board was correct and must be upheld."

19. The Commissioner's appeal is principally founded upon the alleged failure by the judge properly to understand, and therefore to apply, the decision of the House of Lords in the Woolworth case. The correct application of the principles laid down by their Lordships would have resulted in a decision in favour of the Commissioner.

20. By his Notice of Appeal (in "skeleton argument" form) the Commissioner complains that the Board and the judge erred in focussing attention on the use which the Taxpayer made of the money borrowed rather than on how the borrowing functions in the financial structure of the taxpayer, or how the borrowing, had been carried out. This, it is suggested was the mistake made by the Court of Appeal in the Woolworth case. The House of Lords, it is contended, had clarified the law and had laid down rules which apply to borrowing in all circumstances, including the circumstances of banks, money-lenders and finance companies. These general rules were to be found in the leading speech of Lord Templeman at (1989) 61 TC 542 at p.581 B and D-E:

(a)    "A loan is only a revenue transaction if it is part of the ordinary day to day incidents of carrying on the business"

(b)    "A loan is not an 'ordinary incident of marketing' unless, as the authorities show, the loan is temporary and fluctuating and is incurred in meeting the ordinary running expenses of the business."

21. The Commissioner says that his case all along had been that on the primary facts found in this case, it could not be said that the four loans in 10 years were "part of the day to day incidents of carrying on" this finance company's business. Nor on those facts, could it be said that all or any of the loans were both "temporary" and "fluctuating".

22. It is pointed out that in Woolworth the Court of Appeal had upheld the Commissioners' decision that a fixed loan for 5 years was and could be "temporary and fluctuating". This had been found to be erroneous by the House of Lords. Since the Board did not have the benefit of the correct principles set out by the House of Lords when it made its decision, it was not surprising that it had misdirected itself, in effect, by basing its reasoning on the Court of Appeal's approach.

23. In his Notice, the Commissioner seeks to emphasise that it had never been his case that the Woolworth decision in the House of Lords meant that he must necessarily succeed. His submission had been that since the Board had misdirected itself its decision ought to be reviewed. The question then arose whether the function of the court was still to apply the Edwards v. Bairstow test or whether the court was permitted merely to conclude, after correcting the misdirection, that applying the correct legal principles the decision on the facts would be contrary to that of the Board without the appellant having to demonstrate that it was the only proper conclusion. His submission was that his appeal ought to succeed on either basis.

24. The Commissioner explains that it was not his case that simply because the Court of Appeal in Woolworth had erroneously categorised the question as one of fact, it necessarily followed that the Board had misdirected itself. The emphasis of his submission had been not on the mistaken view that a question of fact was involved but on the reasoning of Nourse L.J. in the Court of Appeal relied upon by the Board and particularly his conclusion that a fixed loan for five years could reasonably be held to be on revenue account. The Commissioner argues that the reversal by the House of Lords had demonstrated that the inferences which the Board had drawn from the`primary facts had been based on the erroneous view that a five year fixed loan could be "temporary and fluctuating" and on revenue account and that the terms of the loan could be outweighed by the use to which the loan money had been put and the other views of Nourse L.J. quoted by the Board in the stated case.

25. The Commissioner goes on to assert that the Board and the judge erred in law in deciding that an "on demand" loan must be "temporary". The real issue was the function of the loan. Prima facie all loans were an addition to capital, but this was not necessarily so in a finance . company which used money in its day to day lending activities and, if it conducted its business in such a way as to obtain loans also as part of its day to day activities, and those loans were temporary and fluctuating, the loans of a finance company or a bank or a money-lender might be on revenue account.

26. Everything depended, it was submitted, upon how the borrowing had been done, as Woolworth showed. The two-fold test had to be applied. Finance companies were not in any special position and they might, just as any other trader, also borrow on capital account.

27. The Commissioner submits that the judge was wrong in holding that the classification of the loan had to be made on the day that the loan was advanced and contends that "on demand" loans could be on capital account. The Board, and then the judge, had erred by holding that the loans were "temporary" merely because they were "on demand". Such an approach ignored the general principle that it is the function of the loan which is material.' He submits that none of the loans functioned as "temporary and fluctuating accommodation". Rather, they provided the capital funds with which the Taxpayer was able to carry out its profit making activities. The borrowing here was not an "integral part" of those profit making activities despite the fact (which was not relevant) that without the borrowing there, could not have been any profit making activities at all.

28. The Commissioner contends that the judge had erred in holding that the borrowings had not added to the capital base of the business. The capital of the Taxpayer was $20. In his Notice, the Commissioner poses the questions: "What was its 'capital base'?" and "Did the loan which provided US$11.25 million from 28th March 1975 to 22nd October 1985 not 'add to the capital base of the business'?" The judge had been in error in stating that the description of the money as "additional working capital" was sufficient to classify the loans as being on revenue account. This was looking at the use to which the money is put instead of the two-fold test approved in Woolworth.

29. As to the finding by the judge that there had been repayment as opportunity permitted in the ordinary course of the Taxpayer's business, this conclusion was, it is said, contradicted by the Board's finding that the replacement loan "was a long-term Hong Kong dollar loan of $988,000,000 (which was repayable on demand)".

30. Complaint is made about the following observations in the judge's judgment:

"In the present case the Board concluded as a matter of fact that the taxpayer's business consisted of borrowing and lending money; and that the borrowing of money was an ordinary activity of running the business and indeed an integral part of the business. I cannot disturb those findings of fact."

The Commissioner says that it was open to the judge to have found, and that he should have found, that the primary facts did not lead to those inferences and that they had been arrived at by a wrong view of the law and in particular the erroneous view of the Court of Appeal in Woolworth. There was nothing odd about a finance company borrowing money on capital account although it employed the money in its lending business.

31. The Commissioner submits that the judge was wrong to conclude that an on demand loan to a finance company could never be of a capital nature. He suggests that in this kind of case (as in cases of trade or no trade) it is indeed legitimate to look "in hindsight". It was not possible to tell whether a loan "fluctuates" except during its currency. It did not matter how the parties or the Taxpayer described their transaction or what.their intentions might be. The issue was whether the loans provided the Taxpayer with long term financial support for its business or whether they were "temporary and fluctuating", like overdrafts, or whether they were "part of the day to day incidents" of carrying on the particular business. The Commissioner's stand was that they were not, and that they were loans on capital account.

32. Before addressing the issues which divide the parties I wish to make a few observations on some features of the case before us. I think that Mr. Flesch was right to draw our attention to the expert and unchallenged accountancy evidence which demonstrated that the Taxpayer's exchange losses were correctly shown in the accounts as deductible revenue items. The matter is referred to in Hong Kong Taxation: Law and Practice (1992-3 edition) by David Flux, at p.145 in this way:

"The usual starting point for the ascertainment of the assessable profits of a business venture is the profit revealed by the commercial accounts and it is fairly well established law that ordinarily accepted accounting principles are acceptable in determining profits or losses for tax purposes except where the tax statutes require specific adjustments to those profits or losses (see Usher's Wiltshire Brewery v. Bruce, 6 TC 399). Inevitably there are differences in interpretation in the application of accounting principles and there is therefore a wide body of applicable case law on this subject, particularly in the area of greatest contention, i.e. whether a given transaction is on revenue or on capital account."

And see Morgan (HM Inspector of Taxes) v. Tate & Lyle Ltd.35 TC 367 at p.407. In Strick v. Regent Oil Co. Ltd. 43 TC 1 Lord Wilberforce observed that the accounts are a useful cross-check.

33. Of course, it is always a question of law whether an item of expenditure or loss is properly deductible but it is, perhaps, a matter for comment that in previous years the Taxpayer's exchange losses, although very much less than the relevant losses here, were allowed as deductions. We were also shown a very modest gain on an exchange translation (in 1977) added in the accounts to the Taxpayer's profits.

34. In my view, in considering the borrowing and lending activities of the Taxpayer, it would create the wrong picture if it were not recognised that these activities spanned a period of some 10 years and that during the 5 tax years between 31st March 1980 and 31st March 1984 the accounts show borrowings in Hong Kong dollars as follows: $248.5 million; $339.6 million; $283.3 million; $201.4 million and $261.2 million.

35. It will be recalled that it was an agreed fact that the Taxpayer was not connected or associated with any of the 4 US dollar lenders and that neither Mr. T.H. Wang nor his wife had any connection with them. There- was never any suggestion that anything underhand was going on or that appearances belied what in fact was happening. It came as a surprise, therefore, when Mr. Barlow (who did not appear in the court below) sought to draw our attention to the "fact" as he put it, that the agreements for the Jan Financiera and the Grand Credit Bank loans, although executed respectively in the Philippines and Honolulu came "from the same word processor." When I ventured to ask whether a submission of this kind was properly made for the first time in the appellate court, Mr. Barlow contended that although the point had not been made, either before the Board or the judge, the similarities were there for everyone to see. He went so far as to suggest that the Board and the judge should, unaided, have noticed them. I confess that I was so certain that this point not raised below and about which no prior notice had been given, could not properly be taken before us, that I did not afford counsel an opportunity of telling us what inference,he would have asked us to draw if we had been prepared to flout ordinary principles of fairness and practice (and, indeed, become our own experts) but it is plain that we would have been invited to draw some form of inference adverse to the Taxpayer. I would have put down the matter to a misconceived flight of advocacy and have said no more about it but for the fact that counsel expressly wished to reserve the point he sought to raise in the event that this case went further.

36. I mention here that both parties made it clear during the hearing that all along they had agreed that the decision of the courts should treat all the 4 loans on the same basis.

37. I think it is desirable to discuss the role of the High Court on a case stated of the kind before us. Of course, the court has no original jurisdiction on questions of fact - they are for the Board. The same goes for inferences properly drawn from the primary facts. I think it is helpful to cite a passage from the speech of Lord Brightman in Furniss v. Dawson [1984] AC 474. At p.527-8 he had this to say:

"    The formulation [by Lord Diplock in Inland Revenue Commissioners v. Burmah Oil Co. Ltd. [1982] STC 30, 33], therefore, involves two findings of fact, first, whether there was a preordained series of transactions, i.e. a single composite transaction, secondly, whether that transaction contained steps which were inserted without any commercial or business purpose apart from a tax advantage. Those are facts to be found by the commissioners. They may be primary facts or, more probably, inferences to be drawn from the primary facts. If they are inferences, they are nevertheless facts to be found by the commissioners. Such inferences of fact cannot be disturbed by the court save on Edwards v. Bairstow [1956] AC 14 principles.

     In Marriott v. Oxford and District Co-operative Society Ltd. (No.2) [1970] 1 QB 186, Lord Denning M.R. said, at p.192:

'the primary facts were not in dispute. The only question was what was the proper inference from them. That is a question of law with which this court can and should interfere.'

Similar observations occur in other reported cases. I agree with the proposition only if it means that an appellate court, whose jurisdiction is limited to questions of law, can and should interfere with an inference of fact drawn by the fact-finding tribunal which cannot be justified by the primary facts. I do not agree with it if it is intended to mean that, if the primary facts justify alternative inferences of fact, an appellate court can substitute its own preferred inference for the inference drawn by the fact-finding tribunal. I think this is clear from the tenor of the speeches in this House in Edwards v. Bairstow. The point does not seem to have been the subject matter of explicit pronouncement in any of the reported cases, at least your Lordships have been referred to none, and both propositions have from time to time emerged in judgments as a matter of assumption rather than decision. But for my part I have no doubt that the correct approach in this type of case, where inferences have to the drawn, is for the commissioners to determine (infer) from their findings of primary fact the further fact whether there was a single composite transaction in the sense in which I have used that expression, and whether that transaction contains steps which were inserted without any commercial or business purpose apart from a tax advantage; and for the appellate court to interfere with that inference of fact only in a case where it is insupportable on the basis of the primary facts found."

38. Mr. Barlow drew our attention to a passage from the speech of Lord Edmund Davies in Tucker v. Granada Motorway Services Ltd. [1979] 1 WLR 683, cited with approval by Lord Templeman at p.576 of Woolworth:

"In respect of each of these propositions the Special Commissioners cited authorities in support. In so far as the propositions embody statements of fact they must be treated as unassailable unless they do not measure up to the well-known test propounded by Viscount Simonds in Edwards v. Bairstow [1956] AC 14, 29. But the relevance of any facts found, the means adopted in evaluating them, and, finally, the acceptability of the test evolved by the Special Commissioners in determining whether the expenditure was of a capital or revenue nature are all questions of law and, as such, freely appealable."

39. It seems to me that these observations are entirely consistent with Lord Brightman's propositions.

40. In my view, in a case governed by the decision of the House of Lords in Woolworth, to adopt Lord Brightman's approach in Furniss v. Dawson, Lord Templeman's formulation at p.581 involves these findings of fact: whether the loan is part of the ordinary day to day incidents of carrying on the business and whether the loan is temporary and fluctuating and is incurred in meeting the ordinary running expenses of the business so that it can properly be regarded as an ordinary incident of marketing.

41. In my judgment, therefore, by analogy, Godfrey J. was perfectly right when he said, at p.17 of the transcript of his judgment:

"In the present case the Board concluded as a matter of fact that the taxpayer's business consisted of borrowing and lending money; and that the borrowing of money was an ordinary activity of running the business and indeed an integral part of the business. I cannot disturb those findings of fact." (Emphasis supplied.)

42. It seems to me quite impossible successfully to maintain a submission that those findings of fact (possibly involving inferences as well) were not justified on the evidence and material before the Board. Indeed, I venture to suggest that contrary findings might have been regarded as perverse.

43. As regards Mr. Barlow's submissions about the effect upon the Board's decision of the overruling by the House of Lords of the judgments of the Court of Appeal in the Woolworth case, I do not consider the matter to be capable of much elaboration and I entirely agree with the views expressed by Godfrey, J. on this point at p.3 of his judgment. It seems to me that provided it is shown that the Board found facts (and drew legitimate inferences from them) which were justified on the evidence before it, such findings are not vitiated or open to review because the Board reached its decision before the House of Lords held that the question whether the loan transactions were of a revenue or capital nature was a question of law. Of course, if the Board had been asked whether the conclusion they had expressed at the end of paragraph 9.2 of the case stated ("In our view, these US dollar loans were revenue transactions and not accretions of capital") was a matter of fact or law, the answer would have been that it was the latter. The Board was, therefore, to that extent led into error by the Court of Appeal's uncorrected decision.

44. In my view the re-statement by the House of Lords that a question of law was involved in the ultimate decision on the principal issue (revenue or capital) which arose in the Woolworth case is of cardinal importance as governing the juridical (and indeed the jurisdictional) approach of the courts, whether at first instance or on appeal, to the Board's decision. The fact that the Board was under the erroneous impression that it was a question of fact cannot effect the validity of its findings of fact on the way to announcing that ultimate decision.

45. Of course, if the Board's decision on any finding of fact is based upon a proposition which is not sound in law, or if the Board misdirects itself over a matter, for example, such as the burden of establishing a certain fact, the position will be different.

46. Put another way, the courts cannot intervene, it seems to me, unless it appears that a misconception on a matter of law is the reason why the Board arrived at a wrong finding of fact.

47. I am unable to accept any of Mr. Barlow's submissions on behalf of the Commissioner which depend upon the overruling by the House of Lords of the Court of Appeal's decision in Woolworth after the Board had determined the matter.

48. I turn now to discuss the Woolworth case (1989) 61 TC 542 which is central to the Commissioner's contentions and upon which he places great reliance. "Woolworths" runs a well known chain of retail shops in the United Kingdom selling all sorts of goods. In June 1971 they raised a loan of 50 million Swiss francs from a consortium of Swiss banks, carrying interest at 7% and repayable at par after 5 years (or earlier at Woolworths' option on payment of a premium). In February 1972 they raised a further loan of the same amount, but carrying interest at 6%. The first loan was repaid 6 months early in 1976 with the consent of the Bank of England (needed because of exchange control regulations then in force). The second loan was repaid on the clue date. In each case Woolworths converted the loan proceeds into sterling immediately and used the money for the general purposes of its business. For repayment it bought Swiss francs out of its general funds. The exchange transactions gave rise to losses of about E11.4m.

49. The purpose of the borrowing and the actual use Woolworths made of the money is usefully and succinctly summarised by Hoffmann J. in his judgment allowing the Crown's appeal from the decision of the Special Commissioners who had held that the exchange losses were allowable deductions. At p.561 he said:

"The money was raised because the Company needed additional cash for its business. The purposes for which cash was required included both revenue items, like financing stock, and capital items, like enlarging shops. In the letter of 14 June 1971 which was written by Lazard Brothers to the Bank of England asking for exchange control permission they said: 'It is the intention of Woolworth to apply the proceeds of the issue to its continuing programme of expansion and modernisation of its stores throughout the United Kingdom'. That suggests a capital flavour, but there is no doubt that the Company was able to spend, and probably did spend, some of the money on revenue items as well. The agreements under which the notes were issued said that the proceeds were to be utilised wholly for the purposes of activities of the Company's trade. The Bank of England, giving exchange control consent for the second loan in a letter dated 9 February 1972, said that it was understood that the proceeds of the issue 'are to be used by the above-named Company for working capital purposes'. That seems to me an accurate description."

As to the use to which the money was actually put, the Commissioners had said this in the case stated:

"Our understanding is that some of the money raised on each occasion went on meeting expenditure which for tax purposes would be classified as capital expenditure, such as enlargement or improvement of shop premises, some on expenditure which would be deductible, such as the repair and refurnishing of shop premises, and the balance simply on meeting the day to day cash needs of the company's business

50. Hoffmann J. held that in attaching importance to what the company was seeking to do, rather than to what it actually did, the Commissioners had misdirected themselves. The fact that the object of the borrowings had been to deal with a temporary shortage of cash was irrelevant if the solution actually adopted was to make an addition to the company's liquid resources sufficiently permanent to be regarded as an accretion to its capital. It was irrelevant that the company had borrowed for 5 years because for one reason or another it was not possible or convenient to obtain accommodation for a shorter period: what mattered was what the company had actually.done. The loans were fixed in amount and term and were for substantial periods. They could not reasonably be regarded as anything other than accretions to the company's capital as distinct from a.mere temporary accommodation. The exchange losses incurred in repayment of the loans were not deductible in computing the company's profits.

51. The Court of Appeal allowed the company's appeal, holding that the question whether the exchange losses were deductible depended on general principles, i.e. whether the loans were revenue transactions, as being a means of fluctuating and temporary accommodation, or an accretion to capital, which the authorities showed to be a question of fact. It was impossible to say that the facts found by the Commissioners were such that no person acting judicially and properly instructed as to the relevant law could have come to the conclusion which they had reached.

52. The House of Lords allowed the Crown's appeal and restored Hoffmann J.'s order, holding that:

1.    The weight of authority supported the proposition that the question whether the loan transactions were of a revenue or capital nature was a question of law to be determined in the light of the facts found by the Commissioners.

2.    A loan was only a revenue transaction if it was temporary and fluctuating and incurred in meeting the ordinary running expenses of the taxpayer's trade.

3.    The borrowing of a definite sum for a fixed term of 5 years was not part of the taxpayer's day to day activities in earning profits but an increase of its capital, and the exchange loss incurred in connection with it was therefore not allowable.

53. It is necessary closely to examine Lord Templeman's speech in the Woolworth case (Lord Keith, Lord Brandon, Lord Oliver and Lord Goff agreed with him) to decide whether the Commissioner's stand, urged upon us so forcefully by Mr. Barlow, that Lord Templeman was laying down rules of general application which apply to the borrowing of money in all circumstances, is right. If such were the case then, of course, we are effectively bound by the principles he enunciated. On the other hand it is trite to say that judgments must necessarily be governed and qualified by the particular factual matrix of the case. It seems to me unlikely that in this difficult area of the law the trade or commercial activity in connection with which a loan is raised or utilised is irrelevant. This is not to say that it cannot be said with certainty, in the light of authority, that certain items are to be taken as capital expenditure without regard to the nature of the business activities of the organisation concerned. For example, I think it is well settled that a company's formation expenses or a payment made to a retiring director for a restrictive covenant not to compete with the corporation he is leaving will be capital expenditure.

54. Mr. Flesch has drawn our attention to a number of factors which, in his submission, make the Woolworth case plainly distinguishable, and which point to the fact that Lord Templeman did not have the position of a finance company in mind when laying down the principles upon which the Commissioner relies. Firstly it was necessary to acknowledge the very different nature of the business conducted by the Taxpayer here - a distinction apparently recognised in principle by the Revenue in Woolworth for, as the stated case showed (p.555 of the report)., it was the Revenue's contention that one of-the factors to be considered in resolving whether the borrowings were on capital or revenue account was:

"c. The nature of the trade; since anything more formal than an overdraft is unlikely to be on revenue account unless the trade is of a financial character which includes borrowing and lending money."

55. It is also to be noticed that Lord Templeman, at p.574 observed that Woolworths "carries on the trade of providing and selling by retail a wide range of articles from its numerous well known chain of shops" and then said at p.577:

"My Lords, in the course of business a trading company of the type exemplified by Woolworths can only earn profits if it provides for the payment of trading expenses and for the receipt of trading revenue. The most common form of provision is by means of a current account which may be in credit when earnings are received and in debit when expenses are paid out. The bank charges for providing the facilities afforded by the current account and for the sums involved in accepting cheques drawn on the account when it is overdrawn. The temporary and fluctuating borrowings incurred in transacting business are revenue transactions. On the other hand, a trading company which borrows unconditionally a fixed amount for a definite period may use the money generally for the purposes of its business or for any other purpose authorised by its constitution, and even when the money is employed in the business, the money may be laid out on income expenditure or capital expenditure." [Emphasis supplied]

56. Mr. Flesch also points out Lord Templeman, in discussing Lord Atkinson's speech in Scottish North American Trust Ltd. v. Farmer 5 TC 693, was at pains, at p.579, to say:

"Lord Atkinson distinguished the decision in Anglo-Continental Guano Works v. Bell, 3 TC 239 by saying, at pp. 128-129:

'It does not appear to me that the reasoning on which this decision is based can apply to a bank whose business is the borrowing and lending of money, or to an investment company whose business is conducted as is that of the respondents in the present case.'"

The fact that Lord Templeman had cited this passage was an indication, counsel suggested, that he was recognising that different considerations might apply when an organisation whose business is the borrowing and lending of money is involved.

57. Mr. Flesch also relies upon the difference that Woolworths borrowed fixed amounts for fixed 5 year periods on the two occasions in question. Here the Taxpayer drew down on loan facilities and all the borrowings were repayable on demand. Lord Templeman had emphasised the significance of the Woolworths loans being for fixed periods of 5 years:

" ... a trader who borrows 100 million Swiss francs for a fixed period of five years thereby enlarges the capital employed in the trade." (at p.575).

"The authorities do not support the proposition that a borrowing of a definite sum for a fixed term of five years can be an income transaction." (at p.577).

58. Counsel also contended that had Lord Templeman intended his decision to embrace the kind of case before us, he would surely have made some reference to Pattison (HM Inspector of Taxes) v. Marine Midland ltd. (1983) 57 TC 219, which involved a bank and exchange losses, and where he had given the leading speech.

59. It was apparent too, that Woolworths had employed some of the money they borrowed for what was undoubtedly capital expenditure; such was not the case here for the Taxpayer drew down on the facilities which had been arranged to lend on in furtherance of commercial activity as a finance company.

60. And for what it was worth, Mr. Flesch pointed out, at p.561 Hoffmann, J. had observed: "The view that the loans formed an addition to the Company's capital is confirmed by the wat the Company's auditors dealt with them in the account..."

61. Mr. Barlow's submission was that it was clear that Lord Templeman had intended to lay down rules which applied to borrowing in all circumstances from the language he used and also from the fact that he had made express referenceto, and had discussed, Texas Land and Mortgage Co. v. Holtham (1894) 3TC 255, the [1911] Scottish North American Trust case and European Investment Trust Co. Ltd. v. Jackson (1932) 18 TC 1, all cases in which "finance companies" were involved. I will say here that I do not think it is helpful to employ labels of this kind; it is necessary to consider precisely how the taxpayer carries on its business.

62. As Mr. Flesch pointed out, the report of the Texas Land case shows that Mathew J. had thought that the question before him had been "entirely concluded" in the Anglo-Continental Guano case and yet Lord Templeman, as we have seen, referred to the observations made by Lord Atkinson in Scottish North American about that case, where he had expressed the view that its reasoning could not apply to a bank whose business was the borrowing and lending of money. In the Scottish North American case itself the company carried on an investment business. In European Investment Trust the company was certainly a finance company but it sold motor vehicles on hire purchase and borrowed money for the purpose of financing the purchase of vehicles to be sold in this way.

63. It is clear to me that none of the corporations in those cases was carrying on the business of borrowing and lending money in the way the Taxpayer was in our case.

64. I am unable to accept that the mention of those cases by Lord Templeman is any indication that he had the position of finance companies of the kind exemplified by the Taxpayer in mind and had intended his observations to apply, as well to them - I do not believe that they were of unlimited application.

65. As I understand the Woolworth case, against the background of the company's business, the fact that the loans were for fixed sums, and for terms of as long as 5 years, were factors which pointed so plainly to the transactions being of a capital nature that they dominated and outweighed any other factors which might have indicated the contrary.

66. I respectfully and entirely agree with Godfrey J.'s expressed view that the Woolworth case was not determinative of the issues before him although I do not necessarily accept that it assists the Taxpayer.

67. Mr. Flesch cited Overseas Containers (Finance) Ltd. v. Stoker 61 TC 473 where Vinelott J. suggested, without deciding, that when the capital or revenue question arises for decision, the fact that the taxpayer's business was dealing in money might be relevant. At pp.528-9, Vinelott J. said:

"I think that in directing their attention to the question whether the borrowings by OCFL were mere temporary accommodations the Commissioners failed to direct their minds to the real question. It is quite plain that in the case of a company which carried on a trade other than that of dealing in money borrowing on the terms on which OCFL borrowed from sources outside the OCL group would almost inevitably be a borrowing on capital account; it would be irrelevant to enquire whether the monies borrowed had been utilised on capital account or embarked in its trade as (in the language used in the older cases) circulating capital. While the use made of borrowed money may throw some light on the character of the borrowing in a doubtful case, if the borrowing is clearly stamped as a borrowing on capital account it is not relevant to enquire whether the monies borrowed were used for a capital or a revenue purpose (see the recent decision of Hoffmann J. in Beauchamp (Inspector of'Taxes) v. F.W. Woolworth plc. [1987] STC 279 at page 285)."

Pausing there for a moment, of course, Vinelott J. was  giving judgment before the Woolworth case reached the Court of Appeal and the House of Lords. I mention in passing that the passage he relied upon in Hoffmann J.'s judgment was expressly approved by Lord Templeman in the Woolworth case at p.582 although it can be seen from p. 577 of his speech that he did not "attach any importance in the present circumstances to the intentions of the taxpayer or to the actual use made of the money in the present circumstances."

68. To return to Vinelott J.'s judgment, he went on to observe, also at p.529:

"However the whole question in this case is whether a borrowing in these terms by a company whose business is dealing in money is similarly to be treated as a borrowing on capital account or whether the borrowing should not be treated as analogous to the acquisition of stock in trade ... There is prima facie a distinction between monies borrowed in order to put the borrower in a position to carry on the business of dealing in money (which was I think the way in which the borrowing by the taxpayer company was treated by Finlay J. and by the Court of Appeal in European Investment Trust Company, Ltd. v. Jackson) and money borrowed in the course of carrying on that business ..."

69. Mr. Flesch tells us that this is the only English exchange loss case in which Australian authorities were cited, in particular the Avco case, and points out that before citing passages from the judgments in that case, Vinelott J. had remarked that Avco was a case "where the distinction between monies borrowed for use in and monies borrowed by a finance company in the course of its trade was very clearly made".

70. Vinelott J. concluded (and his judgment was upheld in the Court of Appeal) that the Commissioners had rightly held that "the transactions entered into by OCFL in its main field of activity were not trading transactions". He said, therefore, at p.531:

"... it is unnecessary for me to express any concluded opinion on the question whether, if OCFL had been carrying on the trade of borrowing and lending money, these exchange losses and gains would have been losses and gains on revenue.or on capital account ... I think the right course therefore is to leave this question to be determined when it arises in the light of evidence as to the nature of the trade and of the proper accounting treatment of the borrowing ..."

71. Mr. Flesch argues that in our case there is clear evidence of the kind envisaged by Vinelott J. On the facts found, the Taxpayer's trade was a commercial reality; US dollars were borrowed because interest rates had been cheap and stable; the borrowings were for the purpose of lending on for an interest profit; they were made in the ordinary course of business and were an integral part of the business; there was no fiction here, for the transactions had been genuinely carried out. As regards "the proper accounting treatment of the borrowing", the independent expert evidence was clear and unchallenged.

72. Mr. Flesch contends that on much weaker grounds put forward by the taxpayer than the Taxpayer relies upon in our case, the report showed that Vinelott J. was inclined in favour of the view that exchange losses were on revenue account. Mr. Flesch's impression is supported by that formed by Sir Nicholas Browne-Wilkinson, V.-C. (as he then was) giving the leading judgment in the Court of Appeal  at p. 535D he remarked: "[Vinelott J.] was also inclined to, but did not, decide that the losses, if trading losses,.were losses on revenue income." In my respectful opinion the importance of that case is that a very experienced judge recognised that the nature of the business of a financecompany could well be relevant to a capital/revenue issue which arises.

73. Before the Board, the judge, and before us, the Taxpayer relied heavily on the Australian case of Avco Financial Services Ltd. v. Federal Commissioner of Taxation (1982) 13 ATR 63. Since the Board and the judge found that decision relevant and persuasive, I will cite extensively from the judgments. I take the facts from the headnote. Avco was a wholly owned subsidiary of an American corporation and was incorporated in 1964 in Australia. It was engaged in the provision of consumer credit in the form of personal loans, hire purchase retail instalments and similar transactions. Avco had dealings with a large number of customers from a large number of outlets and lent individually small amounts. Save for some minor expenditure on furniture and equipment and a relatively small investment in a Bermudan insurance company, Avco invested its funds exclusively in consumer credit receivables. Until 1967 Avco's parent company lent funds to Avco in addition to its investment in Avco's share capital. Since 1967 Avco raised funds by borrowing in the USA and in Australia. Its borrowing programme was so arranged as to meet the requirement for funds for lending to its customers and the requirement for funds to meet accruing obligations for repayment of earlier loans both in Australia and in the USA. Some loans were extended beyond their original term or renewed for a further term before the debt owing to the lender was finally discharged. When a particular creditor of a US dollar debt was finally paid out, Avco calculated the gain or loss which it realized on the borrowing df the principal sum due to fluctuations in the exchange rate of the Australian dollar. In the income years 1972, to 1976 inclusive, it made exchange gains while in the income years 1975, 1976 and 1977 it suffered exchange losses. The Commissioner assessed Avco to tax on the footing that the gains were not assessable income and the losses were not allowable deductions. Avco objected contending that the gains were ,not assessable income and the losses were allowable deductions. Upon the disallowance of the objections, Avco appealed to the Supreme Court of New South Wales. Kearney J. found that the borrowings were an integral part of the ordinary operation of Avco's business and represented a matter of revenue rather than capital and so the gains were held part of Avco's taxable income, and the losses were held deductible under the relevant statutory provisions. Both Avco and the Commissioner appealed from this decision to the Federal Court, which by majority allowed the appeals, holding that the gains and losses were of a capital nature. Both parties appealed to the High Court.

74. In the High Court, both appeals were allowed and Kearney J.'s decision restored. At p.68, Gibbs, C.J.:

"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. The first matter to be considered, in deciding whether a payment is of a capital or of a revenue nature, is what was the character of the advantage sought by the payment: Sun Newspapers Ltd and Associated Newspapers Ltd. v. FCT, supra, at (AITR) 413; (CLR) 363. The question has to be considered from a practical and business point of view: see FCT v. South Australian Battery Makers Pty Ltd (1978) 8 ATR 879 at 887; 140 CLR 645 at 659, and cases there cited. From that point of:, "view, the additional moneys paid as a result of. the unfavourable exchange variations the exchange losses were part of the price by which the appellant obtained the money which it used to make a profit part of the process by which the appellant obtained regular returns. The payments were recurrent and frequent, although irregular, and they involved the exercise of judgment by the officers of the appellant who put its borrowing policy into effect as part of the conduct of the business. The exchange losses were in my opinion losses on revenue account, and of course the gains have the same character. The view which I expressed in Commercial and General Acceptance Ltd v. FCT, supra, at (ATR) 718; (CLR) 377, that an exchange gain of loss on the repayment of moneys lent will always be a capital gain or loss, must, on reconsideration, be rejected. In a case such as the present the gains and losses do not have the same character as the repayments that produced them, and, considered separately, but in the light of all the circumstances, are seen to be revenue in character."

75. I cite the following passages from the joint judgment of Mason, Aickin and Wilson JJ. (Murphy J. gave a short concurring judgment). At pp.74-75 the three judges say:

" The majority judgments, as well as the dissenting judgment, in Tip Top Tailors, and the speech of Lord Macmillan in Montreal Coke recognize, rightly in our opinion, that the borrowing of money and the repayment of loans by a finance company in the ordinary course of its business stand in a different situation from borrowings by a company not undertaken in the ordinary course of its income-earning business. The essence of the business of a finance company as carried on by the taxpayer is the borrowing and lending of money, the rate of interest payable on money lent being significantly higher than the rates payable on the money borrowed, for it is from the difference in the rates that the company generates its profit, after making provision for bad debts. There is therefore an important and material difference between borrowing by a finance. company in the ordinary course of its business and borrowing by a manufacturing or trading company. In general the finance company's borrowings provide money which it turns over at a profit. Borrowing otherwise than for on-lending or for the repayment of funds borrowed for on-lending, that is, borrowing undertaken for capital rather than revenue purposes, as in GAGA, supra, is an exception to the general rule. On the other hand, borrowing by a manufacturing or trading company is often undertaken to strengthen the capital or profit-earning structure of the company. A finance company usually borrows in order to increase its working capital which is then turned over at a profit; the manufacturing or trading company frequently borrows to strengthen its permanent capital.

    Exchange gains and losses are an ordinary incident of overseas borrowings by a finance company. If an overseas loan, the proceeds of which are to be used in the Australian business of the finance company, is to be repaid in the foreign currency, the company has, in the first instance, to exchange the foreign currencies for Australian dollars, and later to buy the foreign currency with Australian dollars. Exchange gains and losses are therefore an incident of the borrowing."

At pp. 76-77 we find:

"     With respect to those who think otherwise, the proposition that exchange variations affecting the repayment of loans in foreign currencies are always an affair of capital in the case of a finance company is supported neither by principle nor by authority. The true principle is that in the case of a finance company which borrows money overseas in the ordinary course of its business and not for some special purpose, the added cost of repayment in foreign currency caused by the devaluation or depreciation of the Australian dollar is an additional cost of the borrowing and, like other costs of the borrowing, is an allowable deduction under s 51(1). Conversely, a saving in the amount of foreign currency needed to repay an overseas loan due to a revaluation or an appreciation in the value of the Australian dollar is to be considered as income arising directly out of the finance company's ordinary business.

    As we already observed, the borrowing and repayment of a loan in an overseas currency involves connected exchange transactions when the proceeds of the loan are to be employed in Australia - the finance company first buys Australian dollars with the foreign currency and later buys the foreign currency with Australian dollars in order to effect repayment. Like the borrowing transactions with which they are associated, the foreign exchange transactions are entered into by the taxpayer in the ordinary course of its business and form an integral part of that business. The gains and losses made and sustained in these transactions are therefore made in the ordinary course of carrying on that business, the more so because the gains and losses are an ordinary incident of transactions of this kind.

    In the argument emphasis was given to the notion that the money stock of a finance company is similar to the trading stock of a trading company. There are some obvious similarities. However, there are some differences. Money is not dealt with in specie as a commodity and money is not included in the definition of 'trading stock' for the purposes of the Act - see s 6. Despite these differences, what is of immediate importance is the strong similarity between the getting in and the turning over of trading stock by a trading company and the borrowing and on-lending of money by a finance company. This similarity is so strong as to suggest that just as exchange gains and losses on the acquisition of trading stock are to be included in the assessable income of a trading company, like gains and losses in connexion with the borrowing and repayment of loans by a finance company, are also to be included in its assessable income.

And later at p.77:

"     The point of this analysis of Avco's business is that it has been said on a number of occasions that, money is the stock-in-trade of bankers and moneylenders. Thus in Income Tax Comr v. Singh [1942] 1 All ER 362 at 365, Lord Thankerton, speaking for the Privy Council, said: 'It has to be remembered that money is the stock-in-trade of a moneylender.'

    In Guinea Airways Ltd v. FCT (1950) 5 AITR 58 at 62; 83 CLR 584 at 593, Kitto J. said:

'In the case of a banker, money is his stock in trade, and any profit or loss he makes in dealing with money in the course of his business is on revenue account, notwithstanding that the money is in a sense held in reserve.'"

The final passage I cite from that judgment is to be found later still at p. 77 and at p.78:

"    A distinction is to be drawn between moneys borrowed by a finance company in the ordinary course of its business and moneys borrowed for some special purpose which excludes the use of the money in the ordinary course of the finance company's business, eg, for on-lending or for the repayment of a loan the proceeds of which have been employed in the ordinary course of its business. CAGA, supra, was an instance of a borrowing for a special purpose, the company undertaking not to use the funds for on-lending and to employ them in such a way that they could be regarded as part of the permanent capital structure of the business.

     There is a question whether for present purposes a distinction should be drawn between moneys borrowed for the purpose of on-lending and moneys borrowed for the purpose of repaying loans previously borrowed for on-lending. In our view no such distinction should be drawn. In each instance the transactions are continuously and regularly entered into in the ordinary course of the finance company's business; they are an integral part of that business. The gearing of the borrowing programme to accommodate the requirement for funds for on-lending and the requirement for funds to meet repayment of maturing loans so as to maximise profits without incurring an unnecessary liability for interest on such loans shows that it would be impractical to draw a distinction. Borrowing for the two purposes is inter-related and a fundamental element in the business of generating the taxpayer's income."

76. I will also cite extensively from the judgments of the Federal Court of Australia in Federal Commissioner of Taxation v. Hunter Douglas Ltd. 14 ATR 629 because it helpfully discusses the Avco decision and emphasises the distinction, as seen in the Australian courts, between finance companies and a company such as a trading company. The facts need not detain us. At p.638 Fisher J. said this:

"Counsel for the Commissioner distinguished, in my opinion correctly, the Avco case on the ground that the High Court there had under consideration the activities of a finance company which used its borrowings directly in the course of its profit earning activities as though they were trading stock. In the present matter the borrowings and their repayment, counsel contended, were not on revenue account because they were not part of the profit making process. Reliance was placed on the classic statement of the difference between outgoings on capital and revenue account of Dixon J (as he then was) in Sun Newspapers Ltd v. FCT; Associated Newspapers Ltd v. FCT (1938) T AITR 403 at 410; 61 CLR 337 at 359 where he contrasted the strengthening of 'the business entity, structure or organisation set up or established for the earning of profit' with the process by which the organisation operated to obtain regular returns."

And at p. 639:

"The fact that the taxpayer was not a finance company borrowing for the purpose of lending to its customers nor were its borrowings linked with the purchase of trading stock means that it cannot bring itself within two apparent exceptions to the general principle that exchange losses on repayment of loans are on capital account. Thus its situation can be distinguished from cases in which trading stock is bought in foreign currency which appreciates before repayment is made."

At p. 640, Fisher J. said:

"The fact that a finance company may in respect of its borrowings be in a different position from a manufacturing or trading company is made very clear by the High Court in the GAGA case and the Avco case. In the GAGA case because the principal purpose of the borrowings was to strengthen the taxpayer's business structure and was not part of the process by which it operated to obtain regular returns the High Court held that the borrowings were on capital account and the exchange gain was assessable. By way of contrast in the Avco case the borrowings in question were held to have been undertaken in the ordinary course of the taxpayer's income-earning business and the resultant exchange losses or gains were deductible or assessable. In that case the High Court went to lengths to indicate the special position of a finance company borrowing as part of its day to day operations for the purpose of re-lending."

At p. 641, he observed:

    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. It is not sufficient, with all' respect to the learned trial judge, to rely upon the finding that in fact the borrowed moneys were used to satisfy day to day outgoings. The borrowings in such a case are prima facie an addition to the capital employed in the business.

    This is made clear by the joint judgment in Avco at (ATR) 73; (ALJR) 675 when citing the passage from the judgment of Latham CJ in the Texas case, supra, at (AITR) 15; (CLR) 428 where he said that '... 'no exchange ... should be allowed' in respect of 'remittances sent by the company to America in repayment of moneys lent ' ...' Mason, Aickin and Wilson JJ went on to say: 'Latham CJ's observation, ... was not directed to the situation of a finance company. It reflects the view that a loan and the repayment of a loan are generally an affair of capital. And so they are.'"

At p. 643 Lockhart J. had this to say:

"      The purchase of foreign currency by an Australian taxpayer to repay a loan that was obtained from an overseas lender will be a revenue item if the loan was itself part of the taxpayer's trading activities.

    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. FCT (1960) 8 AITR 25 at 62; 106 CLR 205 at 251 per Menzies J; Avco per Mason, Aickin and Wilson JJ at (ATR) 68; (ALJR) 672. 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 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 (ATR) 77; (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 Act: 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."

The final passage I wish to quote from Lockhart J.'s judgment is to be found at p. 645:

"     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 & Manufacturing Co v. Minister of National Revenue [1944] AC 126 per Lord Macmillan at 134.

    The taxpayer is not a finance company. It is a trading company engaged in the business of developing, manufacturing and marketing window coverings and a variety of other building products. The taxpayer borrowed funds from overseas to finance an expansion of its business activities and to provide additional funds or working capital required by the expansion. The taxpayer borrowed the funds to increase its working capital for the purpose of avoiding a cash flow or liquidity problem during the period of its expansion. The borrowings were not part of the process by which the taxpayer operated to purchase trading stock. They were themselves not revenue items. They were not an integral part of the ordinary operations of the taxpayer's business so as to represent a matter of revenue rather than capital': the Avco case per Gibbs CJ at (ATR) 63; (ALJR) 674."

77. Godfrey J. rightly, of course, concluded that on the Board's findings of fact, the Avco case was strong authority in favour of the Taxpayer against the Commissioner and expressly adopted the reasoning of; Lockhart J. in the Hunter Douglas case. Despite Mr. Barlow's helpful submissions, in my respectful opinion the approach of the Australian courts as demonstrated in those cases is cogent and compelling and should be applied to the facts found in this case.

78. As to the reliance I have placed upon the Australian authorities (particularly the Avco case) I gratefully adopt the observations of Vinelott J. at p.531 of the Overseas Containers case:

    It is, of course, dangerous to place too much weight on the observations of Judges however distinguished dealing with different taxing provisions in a different legislative context. On the other hand the distinction between expenditure on capital and expenditure on revenue account is one shared by the two systems and (as the frequency with which the judgments of Dixon J. in Sun Newspapers Ltd. v. Federal Commissioner of Taxation, [1938] 61 CLR 337 and Hallstroms Proprietary Ltd. v. Federal Commissioner of Taxation, [1946] 72 CLR 634, are cited demonstrates) there is a measure of common jurisprudence."

79. The Australian Income Tax Assessment Act 1936-1977 provides by section 25 that the assessable income of the taxpayer shall include gross income derived directly or indirectly from all sources whether in or out of Australia, which is not exempt income. Section 51(1) provides:

"    51(1) 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 such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income."

I have set out sections 16 and 17(1)(c) of our Ordinance at the beginning of my judgment. I express the hope that I have exercised the appropriate measure of caution, but my examination of the governing Australian and Hong Kong statutory regimes has not revealed material distinctions which themselves would justify differing approaches to the capital/revenue question in the two jurisdictions.

80. If it is right to adopt the approach and the reasoning of the Australian courts in the cases from which I have cited so fully, then it seems to me that on the facts found by the Board, and left undisturbed by the judge, the exchange losses were properly held to be of a revenue nature. I respectfully agree with the. judge's observations on the English authorities he discusses between pages 10-21 of his judgment. None of them addressed the precise situation presented by the.facts in the instant case.

81. I will refer to only one of.the those cases, European Investment Trust Co. Ltd. v. Jackson (1932) 18 TC 1. As I mentioned in the context of the Woolworth case, although in one sense European Investment was a "finance company", it did not simply borrow money and lend on as did the Taxpayer here. Certainly, Vinelott J., in the Overseas Containers case, thought that the courts in the European Investment case had treated the monies borrowed by the taxpayer as having been borrowed "to put the borrower in a position to carry on the business of dealing in money" as distinct from "money borrowed in the course of carrying on that business" (see the passage I cited earlier from p.529 of Vinelott J.'s judgment).

82. Moreover, as Mr. Flesch rightly.points out, all three judges in the Court of Appeal (Lord Hanworth, M.R., Slessor and Romer L.JJ.) regarded the issue as one of fact and to that extent, the case is inconsistent with Woolworth. The judges did not feel that they could-intervene and, interestingly, Slessor L.J. at p.16 said: "It does not follow necessarily that this Court would have come to the same conclusion". Like the judge, I do not think that European Investment is of any great assistance.

83. We were referred to three cases by Mr. Flesch in support of the judge's observation that if the borrowing was a borrowing at the date it was made in the ordinary course of its business, it could not change its character from a short term loan to a long term loan because, with hindsight, it could be seen to have endured for a longer time than one year. In Imperial Tobacco Co. (of Great Britain and Ireland) Ltd. v. Kelly (HM Inspector of Taxes 25 TC 292 there was a finding of fact as to the purpose for which US dollars were bought - as a first step in carrying out an intended commercial transaction, i.e. to buy tobacco leaf. The contemplated transactions could not be carried out and so the taxpayer had more dollars than it needed. At p.300,Lord Greene M.R. said this:

"     In these circumstances, they sell this surplus stock of dollars: and it seems to me quite impossible to say that the dollars have lost the revenue characteristicwhich attached to them when they were originally bought, and in some mysterious way have acquired a capital character. ...

To reduce the matter to its simplest elements, the Appellant Company has sold a surplus stock of dollars which it had acquired for the purpose of effecting a transaction on revenue account. If the transaction is regarded in that light, it seems to me it is precisely on all fours with the case of any trader who, having acquired commodities for the purpose of carrying out a contract, which falls under the head of revenue for the purpose of assessment under Schedule D, Case I, then finds that he has bought more than he ultimately needs and proceeds to sell the surplus. In that case it could not be suggested that the profit so made was anything but income. It had an income character impressed-upon it from the very first."

84. Huggins J. (as he then was) made much the same point in Commissioner of Inland Revenue v. Hang Seng Bank Ltd. 1 HKTL 583, at p.591.

85. In Davies (HM Inspector of Taxes v. The Shell Company of China Ltd. 32 TC 133 we find a helpful passage on this point at pp.154-5 of Jenkins L.J.'s judgment:

"     The real issue is whether the taking of each deposit on the terms of the relative deposit agreement was a trading transaction or not. Sir Andrew Clark said (and with the reservation. mentioned below I agree with him) that what was subsequently done with the deposits once they were received could not be material if their receipt was in origin properly to be regarded as a trading receipt. That he said must determine the character of the profit made by reason of their repayment in depreciated Chinese dollars.

    As regards the use in fact made of the deposits the matter stands thus: It is clear I think that under the terms of the deposit agreements the Company was under no obligation to segregate the deposits from its other assets or earmark as between itself and the depositors any particular funds for the purpose of providing for the deposits. It was free to use the sums in question as it liked in its business in any way though it remained of course subject to the obligation of repaying these in the event of the agencies being brought to an end.

    As I have said, Sir Andrew Clark contends that that is an irrelevant consideration, and I agree with him, subject to this reservation. The Company might conceivably have used these deposits in such a way as to mingle them with the capital employed in its trading in petrol and petroleum products. It might have invested the deposits in the purchase of petroleum, treating the depositors as trade creditors, the deposits as trade receipts, and repayments of deposits as trade outgoing. If that had been so then it might well have been said, it seems to me, that whatever the nature of the transaction was at the outset the Company had so dealt with the deposits in question as to make them part of its circulating or trading capital, with the result that any profit which accrued through reduction in the Company's liabilities in respect of the deposits owing to the alteration in the rate of exchange could be nothing else but a trading profit.

86. Jenkins L.J.'s reservation is an important one and would have to be given effect to if the circumstances warranted it but, on the facts of this case nothing happened to justify a departure from the basic premise enunciated in the three cases cited to us.

87. As to the length of time that the loans, all repayable on demand, were left outstanding, I simply do not understand what point can validly be made against the Taxpayer in relation to the two loans which were repaid respectively in just under, and in just over, 12 months after they were drawn down. As to the loans from Jan Financiera and Grand Credit Bank I do not consider that the longer periods during which the loans were left outstanding can alter the position, once it is demonstrated that the "on demand" terms were genuine and unchanging features of the transactions, and that the loans were obtained in the course of carrying on the Taxpayer's business and used (not for some special purpose) but to lend on for the purpose of gain. In such circumstances, it does not seem to me to matter whether the Taxpayer borrows, say every year for a period of 5 years, or draws down 5 times on a facility which is left open for 5 years.

88. However, I am unable to accept the proposition that a loan to a finance company expressly made repayable on demand could never be regarded as being on capital account. Of course, the judge's remark to that effect must be read in the context of the carefully formulated paragraph in which it appears, but I would respectfully adopt the principle behind the reservation expressed by Jenkins L.J. in the Shell Company case.

89. In my judgment, the question whether a loan is "temporary and fluctuating", while, as Woolworth shows, a vital consideration where the taxpayer is a trading or manufacturing organisation, is not a factor which is decisive in the circumstances addressed by the Australian authorities, and which arise in the present case.

90. Both the Board and the judge appreciated that the Taxpayer's paid up share capital was only $20. But, in my view, if, as has been accepted, everything was above board, on the facts found, I do not see how what should otherwise properly be regarded as being on revenue account could cease to be so in the light of the size of the taxpayer's share capital. Nor do I consider that the manner in which the Taxpayer repaid the US dollar loans and replaced them with a long term Hong Kong dollar loan can affect the position.

The Board accepted that the Taxpayer did this "to avoid any further possible exchange losses" which seems practical and business-like.

91. I have not dealt with every submission made by Mr. Barlow on behalf of the Commissioner but have sought to address the matters which I consider decisive.

92. I have reached the conclusion that the arguments of Mr. Flesch in support of the decision of Godfrey J. were unanswerable and must prevail. In my respectful opinion the judge's decision, on an admirably stated case, is unassailable.

93. I would dismiss the appeal.

Penlington, J.A.:

94. For the reasons set out by Fuad V.P. and in the judgment of Godfrey J., I would also dismiss this appeal. The distinction referred to by Vinelott J. in Overseas Containers (Finance) Ltd. v. Stoker between monies borrowed "in order to put the borrower in a position to carry on business of dealing in money and money borrowed in the course of carrying on that business", which was the basis for the decision in European Investment Trust. Co. v. Jackson, must often be very fine and cause difficulty for both taxpayers and the taxing authorities. I consider that the Australian cases, in particular Avco, provide clear and cogent answers to those problems and should be followed.

Nazareth, J.A.:

95. I also would dismiss the appeal for the reasons given and upon the authorities exhaustively cited by my Lord the Vice-President. I do not think there is anything I could usefully add to them.

Fuad, V.-P.:

96. The appeal is therefore dismissed. In handing down thses jndgments, we make an order nisi that the Taxpayer shall have its costs.