Fincon (Construction) Ltd. v. Commissioner of Inland Revenue.

Judges:
Wild CJ

Court:
Supreme Court of New Zealand

Judgment date: Judgment handed down 22 July 1969.

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Wild C.J.: This is a case stated on a question of law by the Board of Review under sec. 30 of the Inland Revenue Department Amendment Act 1960.

The appellant company (which I shall call the objector) carries on business as a building contractor at Masterton. Its annual balance date is 31 December, and the Commissioner accepts from it a return of income for any year ending on that day as being in respect of the year ending on the following 31 March. In 1966, in response to an advertisement by a motel company, the objector submitted a tender to build four motel units. Its price was about £10,000. Two other tenders were submitted by other builders but the motel company, which had only £7,000 available, rejected all three tenders as being too high. It then approached the objector to see whether, with the £7,000 available, it could still get its motel units erected. It happened that the objector had recently completed two large contracts and had other tenders in prospect a few months ahead but, just at that time, had no other work in hand. To bridge the gap and to avoid having to pay off staff it was therefore prepared to negotiate with the motel company. In the result the objector concluded a contract under which, as its managing director and main shareholder said in evidence before the Board, it ``agreed to leave (part of the price) in the motels''. Having made this arrangement the managing director next day saw his accountant and asked him to obtain what security he could.

The formal contract entered into and dated August 1966 was in the standard printed form prepared for the use of members of a Master Builders' Association affiliated

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to the New Zealand Master Builder's Federation. It recorded the work as being the erection of four motel units, the consideration as £9,740, and the contemplated date for completion as being 30 November 1966. To the normal conditions of contract (which are not material to this case) was added the following special provision-

``34. That notwithstanding the provisions of clause 21 hereof or the provisions elsewhere herein contained the Employer shall not by way of progress payments or by way of liens retention moneys pay to the Contractor more than the sum of Seven thousand pounds (£7,000). The balance of the contract price shall bear interest at Seven pounds (£7) per centum per annum as from the date of completion such interest shall be payable quarterly and such balance shall be repaid by equal quarterly payments over the period between the third and sixth years following the date for completion in accordance with arrangements agreed upon between the parties hereto and the Employer shall arrange for the execution of the necessary documents to give effect to this arrangement.''

The work was completed about the end of October and the motel company paid £7,000 to the objector. The balance of the price, £2,740, together with ``extras'' left a total of £3,000 owing. By way of security the wife of the managing director gave the objector a formal guarantee of the due payment of that £3,000 and interest, but her total liability was not to exceed the total value from time to time of her shares in the motel company. She also gave the objector a mortgage over her 1,000 shares in the motel company. These two documents were dated 22 December 1966.

In due course the objector's accountant sent to the Commissioner the objector's return of income for the year ended 31 December 1966. The profit and loss account enclosed with the return did not include the £3,000 owing by the motel company. The balance sheet showed it under the heading ``Short Term Assets'' as a ``deferred amount due on completed contract'' and, on the other side, under the heading ``Income Provision Account'' with the same notation. The reason for this was explained in a letter of 12 April 1967, enclosing the return of income in which the accountant said-

``... the company was faced with the decision to either take a contract with a deferred payment of £3,000 or have staff idle. It was decided that the Company would be better off to have a debt, as the costs of idle staff were very nearly the same.

The facts are:

• (a) A contract was completed for the Golden Shears Luxury Motels Limited.
• (b) There is £3,000 unpaid.
• (c) The contractee cannot give a registerable charge but a minor shareholder has given a guarantee and a charge over the shareholding.
• (d) Payments of the amount outstanding will commence on 28 February 1970 by quarterly payments of £375.

We consider that the debt is most certainly at this date of no value, due to the financial arrangements and position of the contractee Company and also due to the facts that the earning capacity of the Company is largely personal (i.e., Major Noon as major shareholder, is a personality) and that the company is not permitted (pursuant to an undertaking given) to grant securities for debts incurred or advances made to it. Therefore we have deleted this amount from the Profit & Loss Account, recorded it in the Balance Sheet and apply for your approval to the repayments being treated as income in the year in which they are received.''

The Commissioner would not accept this arrangement. He considered that the £3,000 was assessable income of the objector in the year ended 31 December 1966, and he made an assessment accordingly. To this assessment the objector objected on the ground that it was incorrect in fact and law. The objection being disallowed, the Commissioner was required to state a case to the Board on the question whether he had acted correctly and, if not, then in what respects the assessment should be amended. The Board heard the case and on 11 September 1968 delivered a lengthy reserved decision in which it confirmed the assessment. The question for the Court is whether that decision is erroneous in law.

Sec. 88(1)(a) provides-

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``Without in any way limiting the meaning of the term, the assessable income of any person shall for the purposes of this Act be deemed to include, save so far as express provision is made in this Act to the contrary-

• (a) All profits or gains derived from any business....''

The objector was deriving profits from a business. As its accounts for the year in question show, it adopted the normal accounting method of ascertaining its profits from that business by setting up a profit and loss account which showed its earnings from building contracts (and other minor recoveries) on the one side, and its purchases, sub-contracts, salaries and wages, and other expenses on the other. The Board found that the £3,000 in question arose in the normal course of the objector's business. It was in fact ``the balance of the contract price'' referred to in clause 34 of the contract. The £3,000 ought therefore in principle to have been brought into the profit and loss account on the incomings side just as the cost of the labour and materials employed on the same contract were doubtless included on the outgoings side. The contention that the objector was entitled to exclude the £3,000 from the profit and loss account for the year simply because the amount was not payable during that year seems to me entirely illogical. It is contrary to the established principle a recent statement of which appears in the speech of Lord Simonds in
Whitworth Park Coal Co. Ltd. (In Liq.) v. I. R. Commrs. (1959) 3 All E.R. 703 (H.L.) at 713-

``It appears to me to be quite settled that, in computing a trader's income, account must be taken of trading debts which have not yet been received by the trader. The price of goods sold or services rendered is included in the year's profit and loss account although that price has not yet been paid. One reason may be that the price has already been earned and that it would give a false picture to put the cost of producing the goods or rendering the services into his accounts as an outgoing but to put nothing against that until the price has been paid. Good accounting practice may require some exceptions, I do not know, but the general principle has long been recognised. And if in the end the price is not paid it can be written off in a subsequent year as a bad debt.''

Mr. Cunningham, while claiming to accept that general principle, contended that the amount here in question was within the exceptions referred to by Lord Simonds. He argued that the objector was entitled to have the debt taken into account at the valuation of £1,000 put upon it by a public accountant called in evidence before the Board as the price that a prudent purchaser would pay for the debt if it were sold; or, if valuation were held to be impracticable, that the objector should be taxed on the debt as repayment was received. The authorities he relied on were
Harrison (Inspector of Taxes) v. John Cronk & Sons Ltd. (1937) A.C. 185 and
Absalom v. Talbot (1944) A.C. 204.

Both these cases were quite different from the present. They each concerned a speculative builder who was in the business of erecting small dwellings and selling them to persons of slender means, long term financial arrangements being made through a building society. In Cronk's case the building society advanced virtually the whole of the purchase money on mortgage to the purchaser. Part only of this, however, was paid to the builder. The balance was retained by the building society until the purchaser, by instalments over a period, had paid the building society an agreed sum, when the building society would release the balance to the builder. The House of Lords held that that balance should for taxation purposes be brought into account at a valuation at the time of the sale or, if valuation were impracticable, treated as received by the builder as and when it was released to him. In Absalom v. Talbot the building society also made an advance on mortgage but the balance of the purchase money (except for a small deposit by the purchaser) remained owing by the purchaser to the builder on second mortgage payable by instalments which might again extend for many years. The House of Lords held by a majority of 3 to 2 (reversing the Court of Appeal which, by a majority of 3 to 2, had affirmed the Judge at first instance) that the amount remaining to be paid to the builder by instalments was not taxable at face value for the year of the sale. Two of their Lordships thought the amount should be taxable at valuation, and one that the builder should be taxed in the years of payment.

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I do not think that either of these decisions governs this case. In each of them the builder might have had to wait for some 20 years for payment of his price and accordingly for an accurate assessment of his profit. In each of them that was his regular method of business. But in the present case the deferred payment of £3,000 is a special and indeed unique arrangement. It is the exception and not the rule in the objector's business.

Mr. Cunningham also relied on three Australian cases relating to the sale of land. The first in point of time was a decision of the Full Court of N.S.W. in
Perrott v. C. of T. (N.S.W.) 23 S.R. (N.S.W.) 118. That case was decided on the terms of the statutory provision there applicable which made income tax payable in respect of taxable income which has been ``received'' during an income year. It cannot be applied to the different statutory provisions applicable in this case. Nevertheless it may be noted that arising apparently out of a later assessment on the same facts James J. held that the appellant's income from the sale of land should be assessed as soon as his profit was ascertained by the making of sales contracts, and that the assessment need not be spread over the time for the payment of instalments of purchase money. That decision was affirmed by the High Court: Perrott v. D.C. of T. (N.S.W.) (1925) 40 C.L.R. 450. Mr. Cunningham's second case was
F.C. of T. v. Thorogood (1927) 40 C.L.R. 454. The essence of that judgment was the High Court's rejection of a contention by the Commissioner that a taxpayer is bound as a rule of law if he shows a transaction in his books as resulting in a stated profit, unless the Commissioner is prepared to permit an inquiry into the actual results. The point made was that in the case of profits on a sale of land on extended terms the amount of assessable income is a question of fact depending on the circumstances. There is nothing in that contrary to the view I take here. The third case cited was In
re Income Tax Acts (No. 2) (1930) V.L.R. 233. This concerned a company which was in the regular business of buying and subdividing land and selling it on extended terms. The company adopted a system of accounts which did not provide for the inclusion of the whole of the profit on a sale in the income year in which the sale took place: it brought into account merely the instalments actually received in that year. The Commissioner sought to bring in to the ascertainment of profits in each year the total sale price of land sold in that year. The Court rejected this, holding that only the amounts received in each year should be brought into account. It is clear from the judgments that the Court considered that method to be a natural and rational way to assess the profits of that particular business which, as I have said, provided for payment of purchase prices by instalments. In that respect it was a method of business entirely different from that of the objector in this case. I therefore consider the decision of no relevance here.

In my opinion the essential point of this case is that, for its own good reasons and in an isolated instance, the objector agreed to allow part of its price on one contract to remain due for deferred payment at interest. As the managing director said, ``it agreed to leave'' the £3,000 ``in the motels''. In my view that cannot alter the objector's obligation to bring the £3,000 into account in determining its business profit for the year. As Lord Trayner said in
Californian Copper Syndicate Ltd. v. Harris (1904) 5 T.C. 159.

``I cannot think that Income Tax is due or not according to the manner in which the person making the profit pleases to deal with it. Suppose, for example, a seller made a profit on a trade transaction, but leaves the price (including the profit) in the hands of the buyer at so much per cent. interest. That he so deals with it, rather than take the cash into his own pocket, would not affect the claim of the Revenue for the tax payable on the profit.''

In my judgment the Board of Review was right in its conclusion and the appeal must therefore be dismissed. The appellant must pay the Commissioner's costs which I fix at $100.