Dobbs v. Commissioner of Inland Revenue.

Judges:
Cooke J

Court:
Supreme Court of New Zealand

Judgment date: Judgment handed down 8 February 1974.

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Cooke J.: This case stated relates to the expenditure which may be deducted in calculating the assessable income of a salaried taxpayer. It was described by counsel on both sides as a test case, but evidently it can be so to a limited extent only: being concerned with the income year ended 31 March 1972 it is unaffected by sec. 11 of the Land and Income Tax Amendment Act 1973, a section which for the year ending 31 March 1974 and subsequent years appears to limit the allowable deductions for salaried and wage-earning taxpayers to a maximum $50. Shortly put the question is whether in a year prior to the operation of the new section the objector is entitled to deduct legal expenses incurred in a successful appeal to the Public Service Appeal Board, as a result of which he was promoted and thereby obtained a higher salary.

The objector was formerly Assistant Director-General (Administrative) in the Department of Education. Immediately before the promotion about to be mentioned he was earning $12,486 annually. That was the highest salary then payable to an officer of his grade or position in the Public Service. In January 1971 a vacancy in the office or position of Director-General was advertised. This is one of the higher appointments required to be made by the State Services Commission when specially constituted pursuant to sec. 29 of the State Services Act 1962. The objector was one of the applicants. The Commission provisionally appointed a person who was not an officer of the Public Service. If an officer had been appointed the objector would have had no right of appeal. The effect of sec. 64(1)(a) and (2) was that, as an outsider had been appointed and as the appointment of the objector would have involved his promotion, he did have a right of appeal. The objector and another officer appealed. The principles expressly required by the Act to be followed by the Commission, and implicitly so required to be followed by the Appeal Board, are set out in sec. 26(2) and sec. 28(4) and (5) -

• 26.(2) Subject to the provisions of this Act, the Commission shall, in making appointments to the Public Service, have regard to the need to maintain and develop an efficient career service based on recruitment of applicants adequately qualified for the exacting requirements of the Service; but no appointment to the Public Service shall be made unless the Commission is satisfied that the appointment is necessary, and that the person appointed has clearly more merit for the position to be filled than any officer who is qualified and available for the position; and for the purposes of this section merit shall be determined in accordance with sub-section (5) of section 28 of this Act.
• 28.(4) In the event of 2 or more officers being available for the same position, preference shall be given to that officer who, in the opinion of the Commission, has the most merit for appointment to the position.
• (5) For the purposes of this Act, the merit of an officer for promotion shall be determined by -
• (a) Work experience and competence shown in performance of duties carried out by him; and
• (b) Personal qualities, characteristics, and attributes relevant to the position to be filled; and
• (c) Relevant educational or other qualifications;
• Provided that, where 2 or more officers who are applicants for a vacancy are adjudged to be equal in merit for promotion having regard to the matters specified in the foregoing provisions of this subsection, regard shall be given to the length of continuous permanent service of each officer.

Moreover, sec. 64(7), after laying down the general rule that in any appeal the onus of proof shall rest upon the appellant, provides that in any appeal against the appointment to the Public Service of any person who is not an officer, and in certain other appeals, the onus of proof shall rest upon the Commission. The objector's appeal was heard over nine days in July and August 1971. He was represented by counsel and so incurred the reasonable expenditure of $1842.37. Section 64(16) entitles a successful

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ATC 6003

appellant to a refund out of money appropriated by Parliament for the purpose of actual and reasonable personal travelling and accommodation expenses incurred within New Zealand in attending the hearing; and even an unsuccessful appellant may have such a refund if the Appeal Board so directs; but apparently there is no provision for reimbursement of other costs incurred by an appellant, unless the Commission is prepared to exercise its general residual discretion under reg. 57 of the Public Service Regulations 1964 - a point not touched on in the argument of the present case. It seems likely that the hearing took place during ordinary working hours and that any attendances by the objector at the hearing would have been with leave; accordingly there would have been no deductions from his salary for the periods of his absence from his usual place of employment (see reg. 32); but this matter was likewise not mentioned in argument.

On 12 August 1971 the Appeal Board delivered a decision allowing the objector's appeal. I have not seen the decision but I understand from counsel that the Board held that the Commission had not discharged the onus of proving that the provisional appointee from outside the Public Service had clearly more merit for the position. The objector thus became Director-General of Education at a salary of $16,097 as from 16 August 1971. The effect of reg. 71 of the Public Service Regulations 1964 is that he must retire on attaining 65, which will be on 5 July 1975. The objector claimed to deduct the abovementioned legal expenses in his return for the 1971-72 year, mentioning in a footnote that the appeal had led to a substantial increase in salary.

In 1968 the material provisions of the Land and Income Tax Act 1954 were amended so as to correspond quite closely, though not identically, with the Australian legislation. The old formula in the New Zealand sec. 111(1) provided that any expenditure or loss exclusively incurred in the production of the assessable income for any income year could, except as otherwise provided in the Act, be deducted from the total income derived for that year. This was replaced by the less rigid formula about to be quoted. The provisions calling for consideration in this case now read as follows -

• 110. Except as expressly provided in this Act, no deduction shall be made in respect of any expenditure or loss of any kind for the purpose of calculating the assessable income or the non-assessable income of any taxpayer.
• 111. In calculating the assessable income of any taxpayer, any expenditure or loss to the extent to which it -
• (a) Is incurred in gaining or producing the assessable income for any income year; or
• (b) Is necessarily incurred in carrying on a business for the purpose of gaining or producing the assessable income for any income year -
• may, except as otherwise provided in this Act, be deducted from the total income derived by the taxpayer in the income year in which the expenditure or loss is incurred.
• 112. (1) Notwithstanding anything to the contrary in section 111 of this Act, in calculating the assessable income derived by any person from any source, no deduction shall, except as expressly provided in this Act, be made in respect of any of the following sums or matters:
• (a) Investment, expenditure, loss, or withdrawal of capital; money used or intended to be used as capital; money used in the improvement of premises occupied; interest which might have been made on any such capital or money if laid out at interest:
• (i) Any expenditure or loss to the extent to which it is of a private or domestic nature:

The whole of the present sec. 111 was substituted by the Land and Income Tax Amendment Act 1968. Later in the same year the words in square brackets in sec. 110 and the whole of sec. 112(1)(i) were introduced by the Land and Income Tax Amendment Act (No. 2) 1968. The prohibition of the deduction of capital expenditure remained unchanged. It is common ground that a

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ATC 6004

taxpayer such as this objector does not carry on a business within the meaning of sec. 111(b). I agree with the opinion of the Board of Review in Case 14,
4 N.Z.T.B.R. 150, 158, that a person employed in the Public Service cannot for that reason be regarded as carrying on a business. The Commissioner contends that the expenditure in question was not to any extent incurred in gaining or producing the objector's assessable income. Further or in the alternative he contends that it was an investment or expenditure of capital.

The bearing on deductibility of a link with promotion has been referred to in a line of cases concerning educational and similar expenses incurred by salaried taxpayers. The leading case is
F.C. of T. v. Finn (1961) 106 C.L.R. 60. A High Court comprised of Dixon C.J. and Kitto and Windeyer JJ. held deductible expenses of overseas travelling incurred during a period of leave by a senior design architect employed by the Public Works Department of Western Australia. He was said to have been engaged throughout his tour exclusively in studying architecture, and he was complying with the Government's desires and as to going to South America (for which, however, the Government actually made a payment) with its request. Dixon C.J. held that four elements considered in conjunction seemed to form a firm foundation for the conclusion that the taxpayer's own expenditure was incurred in gaining or producing his assessable income. In summary, the first two of these elements were respectively an improvement in the taxpayer's promotion prospects and the fact that this formed a real and substantial element in the combination of motives which led to his going abroad; the third and fourth were respectively that the Government treated the use he made of his leave as of importance to work and that at the time he was in the employment of the Government, earning his salary and acting in accordance with the conditions of his service. ``His journey'', said the Chief Justice, ``.... was therefore in a correct sense incidental to his employment and most relevant to it''. Kitto and Windeyer JJ. each made brief references to promotion prospects suggesting, I think, that they regarded that connection as supporting the claim to deductibility. But the main ground of Kitto J.'s judgment was that it was incidental to the taxpayer's office that he should maintain a progressive acquaintance with a living and developing art; while Windeyer J.'s main ground was that even a salaried taxpayer who gains his income by exercising skill in some profession or calling is entitled to deduct expenses incurred in maintaining of increasing his learning and ability. An argument for the Commissioner that the expenditure was capital as being ``an investment in the possibility of earning higher income'' was rejected on the ground that the constant process of keeping up to date in a skilled profession does not result in the acquisition of something of an enduring nature.

In
Tout v. I.R. Commr. (1970) 1 A.T.R. 705 Moller J. held deductible expenses incurred by an Inland Revenue inspector in attending a course of lectures on psychology and sociology. The ground of the decision was that, against the background of the new philosophy in taxation work outlined by the late Mr. Tathgen, the course of study was of a character relevant and incidental to the gaining of the objector's assessable income and was incurred wholly in achieving that end. Moller J. said there could be no doubt that in undertaking the course the appellant to some extent had his sights fixed on promotion; but the Judge did not base the decision on this factor and even indicated, I think, that if anything he was disposed to regard it as a factor telling against deductibility. He also said expressly that the decision must be understood to be on somewhat special and unusual facts and not of general application. Accordingly it would not be right to seek to base much on Tout's case. The Commissioner's argument in that case was that the expenses were of a private and domestic nature; the capital argument was not raised.

In
F.C. of T. v. Hatchett (1971) 71 ATC 4184 Menzies J. held deductible expenses incurred by a teacher employed by the Education Department of Western Australia in submitting theses for the purpose of gaining a teacher's higher certificate which forthwith entitled the taxpayer to be paid

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ATC 6005

more for doing the same work, without a change in grade; but he held that university fees for the study of Arts subjects were not deductible by this taxpayer, because having regard to his lack of success in passing university examinations it was not possible to find affirmatively that there existed any connection between the payment of the fees in 1967 and the earning of assessable income at any time in the future. The Judge said that for deductibility there must be a perceived connection between the outgoing and the assessable income. He rejected an argument that the expenditure was capital, on the ground, similar to that stated by Dixon C.J. in Finn's case, that an outlay is of that character is expended to obtain what can properly be described as capital in the economic sense; the word has no reference, Menzies J. held, to a man's body, mind or capacity.

In
Player v. I.R. Commr. (1973) 1 N.Z.L.R. 689, Perry J. held deductible expenditure by an assistant inspector of Inland Revenue in completing an accountancy qualification and thereby obtaining promotion to the rank of inspector. On reviewing the cases already cited and two decisions of Boards of Review in Australia - Case D20,
72 ATC 114 and Case D28,
72 ATC 165 - Perry J. said -

• These decisions, all of a persuasive value only, show that where the expenditure can be definitely and closely related to promotion - that is to say - where the qualification is a necessary step to a defined area of promotion, then the Courts have been willing to allow it as a deductible item. But where the study merely has the effect of improving the taxpayer in his present employment, and even although it may enhance his chance of promotion, then it has not been allowed.

Notwithstanding what I will say about Player's case at the end of the present judgment, I must own to some doubt as to whether such a clear-cut distinction can be justified. In many cases self-education expenditure would not be strictly necessary for promotion but would help both that object and the performance of the existing duties. Finn's case is an example. However, the present case is not directly concerned with educational expenditure. It should be added that in Player's case again there appears to have been no argument that the expenditure was capital. Dixon C.J.'s emphatic affirmation in Finn's case that a man's mind cannot be treated as if bricks and mortar must now, I think, be treated as firmly established.

These and other cases were fully canvassed by counsel in their careful arguments in the present case. Mr. McGrath's main submissions were that the new sec. 111 was intended by the New Zealand legislature as a liberalising measure and that for deductibility under sec. 111(a) there must be a connection between the expenditure and whatever produces the assessable income. Such a connection, he said, is present when there is a clear link between the expenditure and the prospects of promotion and salary increase. He relied principally on the reasoning in the cases of Finn, Hatchett and Player. As to sec. 112(1)(a) he submitted that `capital' is a term of accounting or economics, with very little relevance to salaried taxpayers and not applicable to legal expenses in securing promotion. Mr. Richardson's argument centred on the proposition that the test for deductibility under sec. 111(a) is whether the expenditure is part of the income-earning process. It is no disrespect to his argument in this rather difficult branch of tax law that I thought it involved some very fine distinctions. For instance, he said that expenditure on purely voluntary self-education in the employee's own time, as by attendance at seminars, might not be deductible even though it might better equip the employee to perform his existing duties; yet he sought to say that the actual decisions in Finn, Hatchett and Player could be justified on the facts of those cases, inasmuch as there was sufficient encouragement by the employer to make the studies part of the employee's obligations in some sense, even when undertaken in the employee's own time. Mr. Richardson challenged the reasoning of those three decisions to the extent that it involves the view that a link with promotion assists the case for deductibility. As to sec. 112(1)(a) he contended that there is a fundamental distinction between the source of income and the income-earning process; expenditure in

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ATC 6006

obtaining a position he characterised as capital expenditure, in that it is directed to obtaining a source of income.

In approaching a problem about deductions one is taught to be wary of generalising. In Finn's case Dixon C.J. said that unfortunately such cases cannot be determined by any very broad proposition of law and that in the end the decision will often depend on the facts of the given case. In
Strick v. Regent Oil Co. Ltd. (1966) A.C. 295, 313, Lord Reid said that ``no one test or principle or rule of thumb is paramount. The question must ultimately be a question of law for the court, but is a question which must be answered in the light of all the circumstances which it is reasonable to take into account, and the weight which must be given to a particular circumstance in a particular case must depend rather on common sense than on a strict application of any single legal principle''. Much the same was said by the Privy Council in B.P.
Australia Ltd. v. F.C. of T. (1966) A.C. 224, 264. In
Heather v. P-E Consulting Group Ltd. (1973) 1 All E.R. 8, 10 Lord Denning M.R. said -

• The question - revenue expenditure or capital expenditure - is a question which is being repeatedly asked by men of business, by accountants and by lawyers. In many cases the answer is easy; but in others it is difficult. The difficulty arises because of the nature of the question. It assumes that all expenditure can be put correctly into one category or the other; but this is simply not possible. Some cases lie on the border between the two; and this border is not a line clearly marked out; it is a blurred and undefined area in which anyone can get lost. Different minds may come to different conclusions with equal propriety. It is like the border between day and night, or between red and orange. Everyone can tell the difference except in the marginal cases; and then everyone is in doubt. Each can come down either way. When these marginal cases arise, then the practitioners - be they accountants or lawyers - must of necessity put them into one category or the other; and then, by custom or by law, by practice or by precept, the border is staked out with more certainty. In this area, at least, where no decision can be said to be right or wrong, the only safe rule is to go by precedent. So the thing to do is search through the cases and see whether the instant problem has come up before. If so, go by it. If not, go by the nearest you can find.

This recommendation that in a marginal area the only safe thing is to go by precedent is particularly striking because evidently it is not one which the Master of the Rolls would necessarily apply to other branches of the law. It is significant that those three Judges - each, one might perhaps respectfully say, a master of a particular kind of approach to legal problems - should all advise against trying to formulate precise rules to solve the present sort of problem. Bearing that in mind, and also the danger of notionally substituting another phrase for the words actually used in the statute, I do not find either the suggested connection test or the suggested income-earning process test of paramount importance. I accept that each suggests an aspect that may usefully be considered; but one must bear in mind the desirability expressed by McCarthy J. in
Levin & Co. Ltd. v. Commr. of I.R. (1963) N.Z.L.R. 801, 837, of ``applying wherever possible the words of the relevant sections direct to the facts without the doubtful assistance of the many glosses which have been put on the words of those sections''.

As to going by the nearest case that can be found, no decision by a court on appeal expenses was cited. Mr. Richardson made no more than passing reference to the Board of Review decision in Case 14,
4 N.Z.T.B.R. 156 - party because although that was a decision against the deductibility of expenses of an (unsuccessful) appeal by a salaried public servant, the Board was careful to point out that it was a decision on the old sec. 111 and not on the new provisions, at that stage in Bill form, introduced on the recommendation on the Ross Committee. Apart from Case 16,
5 N.Z.T.B.R. 138, which is readily distinguishable on the facts, the only other case on appeal expenses that was cited was the decision of a Commonwealth Board of Review in
13 T.B.R.D. 24 Case N24. The taxpayer was a

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ATC 6007

police constable who made several unsuccessful appeals, to a Board constituted under the relevant Police Act, against promotions of other officers to sergeants. Eventually he was promoted to that rank, with a salary increase. In a briefly reasoned decision the Board said that it was more likely that but for the appeals his promotion would have been overlooked. Citing Finn's case, the Board therefore held that the expenditure was incurred in gaining or producing assessable income, in that the occasion of the outgoing was to be found in what was expected to produce such income. But the Board went on to hold that the taxpayer's position as a police constable was akin to a profit-yielding subject, the operation of which (by the carrying out of his specified duties) yielded him income. "His subsequent promotion to sergeant was an enlargement of such profit-yielding subject, and the expenditure of £90 was thus of a capital nature:
Sun Newspapers Ltd. v. F.C. of T. (1938) 61 C.L.R. 337 at pp. 359-63".

The passage cited from the Sun case occurs in the judgment of Dixon J. and deals with what he describes as ``the distinction between the business entity, structure, or organisation set up or established for the earning of profit and the process by which such an organisation operates to obtain regular returns by means of regular outlay, the difference between outlay and returns representing profit or loss''. So the passage is not directly in point where the taxpayer does not carry on a business or trade. Indeed Mr. Richardson told me that he knew of no case in which a court has held expenditure by a salaried taxpayer to be capital. There are other decisions by Boards of Review in Australia in which expenditure by a salaried taxpayer has been held to be of a capital nature. Examples are
10 T.B.R.D. 98 Case K98 (expenses of successful defence of charges which could have led to demotion or dismissal of a State employee); Case C15,
71 ATC 70 (travelling expenses incurred by man employed as mining surveyor, in connection with obtaining qualification in mining); Case C47,
71 ATC 219 (expenses of university lecturer in connection with Ph.D. degree). But such decisions are likewise based on the analogy of the Sun case and other cases concerned with businesses. Further, there may be more room for using this sort of analogy in Australia. The Commonwealth provision, sec. 51(1) of the Income Tax Assessment Act 1936-1968, expressly prohibits the deduction not only of outgoings of capital but also of outgoings of a capital nature. The corresponding New Zealand prohibition, which is of earlier origin, does not add the latter phrase. Whatever the law may be in Australia, it seems to me that in New Zealand one is concerned under this head simply with whether there has been an investment or expenditure of capital in the ordinary and natural sense of that word. It is common ground that the test is what is produced by the expenditure. ``The word `capital' qualifies the character of the expenditure, and not the fund or source out of which it comes. It is the nature of the expenditure and the object on which it is spent that is referred to'':
R. v. Wraith (1907) 2 K.B. 756, 763 per A.T. Lawrence J. ``When sec. 51 denies the deduction of an outgoing of a capital nature it directs attention to what an outlay provides rather than to the source of what is outlaid'':
F.C. of T. v. Hatchett 71 ATC 4184 per Menzies J. Is the office of Director-General of Education the objector's capital in the ordinary and natural sense? I think not. At best there is no more than a somewhat remote analogy with a business entity, structure or organisation. With equal plausibility it might be suggested that the objector's capital is his mind, capacity and experience. These, it could be said, he puts to use to earn income. But the cases of Finn and Hatchett reject that analogy, even under the Commonwealth legislation.

It is true that the objector's office can be described as a source of income, but expenditure to secure a source of income is not necessarily capital, even when incurred in carrying on a business:
B.P. Australia Ltd. v. F.C. of T. (1966) A.C. 224. As Mr. Richardson pointed out, every officer of the Public Service other than an apprentice is deemed to be a three-monthly employee; but, dismissal for misconduct or the like aside, the Commission may terminate his employment by three months' notice only on the ground of redundancy or to effect

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ATC 6008

retirement in accordance with retirement policy: State Services Act 1962, sec. 40. That security, together with the references to work experience and continuous permanent service in the criteria of merit in sec. 28 and the degree of protection against outside appointments given by sec. 26(2), means that in this career service the statutory rights of an officer carry with them substantial prospects of promotion from time to time. It seems to me artificial to say that every time an officer climbs another step on the ladder his capital changes. More naturally the obtaining of promotion in accordance with statutory rights may be regarded as part of the income-earning process which begins when the status of officer is achieved.
British Transport Commissioner v. Gourley (1956) A.C. 185 and other decisions in which it has been accepted that damages for loss of earnings are not taxable in the hands of the recipient seem to me too distant from the question of promotion expenses to provide any real help. For these reasons I do not think that the appeal expenditure falls within sec. 112(1)(a) of the Land and Income Tax Act 1954.

It is not suggested by the respondent Commissioner that the expenditure here was to any extent of a private or domestic nature. Indisputably it was incurred in connection with the taxpayer's employment or occupation, and I have held it not to be capital expenditure. No doubt, in theory at least, expenditure in such a connection, although not capital, could still be too indirectly connected with the gaining of income to be treated as incidental and relevant thereto or as falling within sec. 111(a). This depends on whether a broad or narrow view is taken: see the B.P. Australia Ltd. case at p. 274. Where, as here, increase of income forms a real and substantial element in the motives leading the taxpayer to seek promotion and the expenditure immediately (or virtually so) results in promotion, I think that the words of the statute are open to and should receive an interpretation broad enough to cover the expenditure.
Henderson Shortt v. McIlgorm (1945) 1 All E.R. 391 is distinguishable. There commission payable to an employment agency out of the first year's salary from the post obtained was held by Wrottesley J. not to be money expended ``wholly, exclusively and necessarily in the performance of the duties...'' The New Zealand provision is manifestly more liberal. In any event that was not a promotion case. The weight of authority appears to support a broad interpretation and the view that promotion expenses in a career service governed by statute may be within sec. 111(a). I refer particularly to the cases of Finn, Hatchett and Player. Quite apart from the respect that one naturally has for those decisions, I am not persuaded that there is anything wrong with the reasoning of Dixon C.J. in Finn's case. Clearly he regarded the link with promotion as in the taxpayer's favour.

The question in the case stated is accordingly answered in favour of the objector, to whom costs of $150 will be allowed.