W Nevill & Co Ltd v Federal Commissioner of Taxation
56 CLR 2901937 - 0308B - HCA
(Decision by: Latham CJ)
W Nevill & Co Ltd
v Federal Commissioner of Taxation
Judges:
Latham CJRich J
Dixon J
McTiernan J
Subject References:
Taxation and revenue
Income tax
Deduction
Contract of service
Termination
Income or capital expenditure
Allowance paid during two income years
When deductible
Legislative References:
Income Tax Assessment Act 1922 (Cth) No 37 - ss 23(1)(a); ss 25(e)
Judgment date: 8 March 1937;
Melbourne
Decision by:
Latham CJ
The following written judgments were delivered:
LATHAM C.J. This is a case stated by Evatt J. under the Income Tax Assessment Act 1922-1932, s. 51A (8).
The appellant is a company carrying on business in New South Wales. Before July 1930 the company had been managed by a single managing director. In that month the board of directors decided to introduce a system of joint management, and L. L. King was appointed as an additional managing director. He was engaged under an agreement, dated 11th July 1930, for a term of five years from the 1st July 1930 at a salary of PD1,500 per annum with a percentage of profits. Almost immediately, in August 1930, it was determined that, as business had seriously decreased, the salaries of the managing directors should be reduced for six months, but without prejudice to rights under any service agreement. In March 1931 an arrangement was made for the resignation of King under which the company agreed to pay him a sum of PD2,500 in consideration of his cancelling his agreement, PD1,500 to be paid in cash and the balance of PD1,000 by ten equal monthly payments of PD100 up to December 1931, these payments to be covered by ten promissory notes of the company. The learned judge has found that the system of joint management did not work out satisfactorily and that it tended to impair the efficient management of the business. He also found that the main object of the directors in making the arrangement for King's resignation was to effect a saving of King's salary and that at the same time the directors believed that the abolition of the system of joint control would tend to increase the efficiency of the company. The company paid the PD1,500 in cash and met the ten promissory notes for PD100 each, one being paid in each month from March to December 1931.
The company seeks to deduct the said sum of PD2,500 from its assessable income in respect of the income year ending 30th June 1931. The commissioner disallowed the deduction and disallowed an objection against his decision, whereupon the company appealed to the High Court. This case, stated in the appeal, asks whether upon the facts stated the deduction claimed should have been allowed.
The relevant sections of the Income Tax Assessment Act 1922-1932 are as follows:
"23. (1) In calculating the taxable income of a taxpayer the total assessable income derived by the taxpayer shall be taken as a basis, and from it there shall be deducted-(a) all losses and outgoings (including commission, discount, travelling expenses, interest and expenses, and not being in the nature of losses and outgoings of capital) actually incurred in gaining or producing the assessable income. 25. A deduction shall not, in any case, be made in respect of any of the following matters: ... (e) money not wholly and exclusively laid out or expended for the production of assessable income."
1. If the expenditure in question represents a loss or outgoing of capital it cannot be deducted under the authority of s. 23 (1) (a) or any other provision of the Act.
In British Insulated and Helsby Cables v Atherton [F1] Viscount Cave L.C., referring to expenditures, said: "When an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital." The principle here enunciated provides a positive test the application of which may show that a particular expenditure-or e converso-a particular receipt, is a capital expenditure or receipt. In Ward & Co v Commissioner of Taxes [F2] the question was whether the deduction of expenditure by a brewing company in opposing proposals for prohibition in a public campaign should be allowed for purposes of income tax in the face of a provision prohibiting a deduction of any expenditure not exclusively incurred in the production of the assessable income from a particular source. It was held that the expenditure was directed to preventing the extinction of the business from which all the income of the company was derived and that it was therefore not incurred exclusively or at all for the production of the assessable income in question. It was directed towards the preservation of the whole of the business assets of the company. Such an expenditure is distinguishable from current expenditure upon the maintenance or repair of a particular asset. It was held in Ward's Case [F3] that the expenditure was a capital outgoing. The decision in Ward's Case [F4] , it may be observed, raises doubts as to the soundness of some of the reasoning in Toohey's Ltd v Commissioner of Taxation for New South Wales [F5] .
In the case of receipts, the principle has been applied to moneys received, not in the ordinary way of trading, but as payment made to a taxpayer company by another company for the purpose of securing the cancellation of a set of agreements which regulated the whole conduct of the profit-making enterprise of the taxpayer company. It was held that the whole congeries of rights which the taxpayer enjoyed under these agreements was a capital asset and that the price received for the surrender of these rights must be regarded as a capital receipt (Van Den Berghs Ltd v Clark [F6] ).
Circumstances of this character are not to be found in the present case. No asset was acquired by the expenditure of the sum of PD2,500. The agreement between the company and King for the employment of King was not something affecting the whole structure of the company's business. Its cancellation cannot be regarded as involving the acquisition of a capital asset. The cancelled agreement was an agreement for the employment of a servant made in the ordinary course of the company's business. I am unable to discern any reason which would justify the conclusion that the PD2,500 was a capital expenditure.
2. But in order to justify a deduction under s. 23 (1) (a) the outgoing in question must be actually incurred in gaining or producing the assessable income.
The payments in question were actually made bona fide in the course of business in the interests of the efficiency of the business. In my opinion they fall within the terms of the proposition of Viscount Cave L.C. in British Insulated and Helsby Cables v Atherton [F7] : "A sum of money expended, not of necessity and with a view to a direct and immediate benefit to the trade, but voluntarily and on the grounds of commercial expediency, and in order indirectly to facilitate the carrying on of the business, may yet be expended wholly and exclusively for the purposes of the trade." The words "for the purposes of the trade" come from Schedule D. of the English Income Tax Act 1842. They do not appear in s. 23 (1) (a) of the Federal Act. The words in s. 23 (1) (a) are "in gaining or producing the assessable income." The principle asserted in Viscount Cave's statement is, however, equally applicable to a case arising under s. 23 (1) (a). The facts stated in this case show that the expenditure was actually incurred in gaining or producing the assessable income of the year in question. The expenditure was made for the purpose of increasing the efficiency of the company and therefore increasing its income producing capacity. It was not a capital expenditure, it was, in my opinion, an expenditure incurred in the course of gaining or producing assessable income (See Amalgamated Zinc (De Bavay's) Ltd v Federal Commissioner of Taxation [F8] ).
It is urged, however, that in so far as the expenditure was directed towards reducing current and future expenses by securing relief from the onerous contract to pay PD1,500 to King for five years, it did not increase assessable income. Assessable income is gross income (See s. 4). The mere reduction of expenditure, though it decreases the expenditure side of an account, does not increase the receipts side of the same account. In my opinion the answer to this contention is to be found in a recognition of the fact that it is necessary, for income tax purposes, to look at a business as a whole set of operations directed towards producing income. No expenditure, strictly and narrowly considered, in itself actually gains or produces income. It is an outgoing, not an incoming. Its character can be determined only in relation to the object which the person making the expenditure has in view. If the actual object is the conduct of the business on a profitable basis with that due regard to economy which is essential in any well-conducted business, then the expenditure (if not a capital expenditure) is an expenditure incurred in gaining or producing the assessable income. If it is not a capital expenditure it should be deducted in ascertaining the taxable income of the taxpayer.
3. It is now necessary to consider whether the deduction of the expenditure in question is prohibited by s. 25 (e), which forbids the deduction of any money not wholly and exclusively expended for the production of assessable income. Under head 2 above I have already dealt to some extent with this aspect of the case and have expressed the opinion that the expenditure was incurred in gaining or producing assessable income. The question which it is now necessary to determine is whether it was wholly and exclusively laid out or expended for that purpose. The same question arose under similar circumstances in Mitchell v B. W. Noble Ltd [F9] . In that case a company paid a sum of money as the price of getting rid of a life director whose presence on the board was regarded as detrimental to the conduct of the company's business (See the acceptance of this case as rightly decided in Van Den Berghs Ltd v Clark [F10] ). It was held that the expenditure was an income expenditure and that it could properly be deducted as money "wholly and exclusively laid out and expended for the purposes of the trade." All the relevant circumstances are the same as in the case now before the court, and, in my opinion, Mitchell's Case [F11] is sufficient authority to justify the conclusion that the deduction claimed is not prohibited by reason of s. 25 (e).
4. The only remaining question is whether the whole sum of PD2,500 should be deducted from the income derived in the year ending 30th June 1931. In that year PD1,500 was paid in cash and four promissory notes for PD100 each were paid. There were six promissory notes each for PD100 outstanding. These fell due and were paid at dates in each month from July to December 1931. The taxpayer claims that not only the PD1,900 actually paid in the year ending 30th June 1931 should be deducted but also that the further PD600 payable under the six outstanding promissory notes should be deducted as outgoings actually incurred in that year. This contention raises what, in my opinion, is a difficult question. The outgoing, in order to be deducted, must be an outgoing "actually incurred" (s. 23 (1) (a)). The word used is "incurred" and not "made" or "paid." The language lends colour to the suggestion that, if a liability to pay money as an outgoing comes into existence, the quoted words of the section are satisfied even though the liability has not been actually discharged at the relevant time. The word "actually" is not inconsistent with this view. It is only the incurring of the outgoing that must be actual; the section does not say in terms that there must be an actual outgoing-a payment out. On the other hand the section does not speak of debts or liabilities, but of losses and outgoings. As a general rule the word "outgoing" in itself would be understood to be limited to money that actually went out and not to include money which would go out at some future time. It is impossible to avoid the reflection that, if it were held that deductions could be obtained in any given year by the simple process of signing promissory notes in respect of genuine liabilities which would not fall due until that year had expired, a taxpayer would be able, by such action, to influence the rate of tax in his own favour in an exceptionally profitable year. The question is, therefore, one of considerable importance. This question was not argued in the present case because the promissory notes outstanding on the 30th June 1931 have since been paid and the deduction can be claimed in respect of the income of the following year. The taxation of companies is at a flat rate, and therefore it is immaterial to the parties whether or not the PD600 representing the later promissory notes should be deducted in respect of the earlier year. For that reason it is not necessary to give a reasoned decision upon the question mentioned. I would require to hear full argument before deciding this question. I merely state my view, not as a concluded opinion, but in order to reach a determination in this case, that the sum of PD600 should be deducted from the income of the year ending 30th June 1932 and not from the income of the preceding twelve months.
The question in the case should be answered by stating that PD1,900, part of the said PD2,500, should be allowed as a deduction.