Case U177

Members:
RD Nicholson DP

Tribunal:
Administrative Appeals Tribunal

Decision date: 15 September 1987.

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R.D. Nicholson (Deputy President)

Objection decisions under review

The applicant seeks review of a decision made by Notice of Assessment dated 17 January 1983 in respect of the 1982 year of income disallowing the claim for a deduction of $3,896 for workers' compensation claims paid. Further, he seeks review of a decision in a Notice of Assessment dated 12 January 1984 in respect of the 1983 year of income disallowing as a deduction the sum of $3,852 as workers' compensation claims paid.

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ATC 1022

Facts

There is no dispute as to the facts in this matter. Early in 1970 the applicant commenced to carry on a business of structural steel fabricating as a sole trader under the name of "A" Engineering.

During the course of the conduct of that business on 20 December 1974 a crane owned by the applicant was engaged in unloading steel sections from a truck owned by "B" Bros Pty. Ltd. ("B Bros"). The driver of the truck, one "C", an employee of "B" Bros, was helping unload the truck when he suffered an electric shock as a consequence of the crane touching overhead power lines.

A Supreme Court action was instituted in 1976 by "B" Bros claiming that pursuant to sec. 18(3) of the Workers ' Compensation Act 1912 (W.A.) it had a right of indemnity for workers' compensation payments paid by it to "C" up to and including 14 January 1977 and for future payments.

From and including 1 September 1977 the business previously conducted by the applicant was sold to a family company "D" Pty. Ltd. ("D"). The value of the assets and liabilities thus assumed by "D" were set out in the financial statements of "A" Engineering included with the applicant's return for the 1978 year of income. The applicant thereupon became an employee of "D", continuing as such until the liquidation of that company in April 1980. "D" traded in the name of "A" Engineering. Thereafter the applicant became an employee of "E" Pty. Ltd., another company owned by the applicant's family interests.

On 1 December 1977 a judgment was entered in the Supreme Court of Western Australia in favour of "B" Bros to the effect that the applicant trading as "A" Engineering was liable to pay to that company as plaintiff the sum of $11,855.40 in respect of workers' compensation paid to "C" up to and including 14 January 1977 and that the plaintiff was entitled to be indemnified by the applicant in respect of any such payments subsequent to that date.

On 23 June 1981 a further judgment was entered in favour of "B" Bros against the applicant trading as "A" Engineering in the sum of $16,865.35 as a consequence of further proceedings under the former judgment to recover workers' compensation paid after 14 January 1977. Pursuant to an agreement reached between "B" Bros as plaintiff and the applicant as defendant, the applicant has been paying off the judgment debts by way of monthly instalment payments. The payments were made on the applicant's behalf by "F" Holdings Pty. Ltd., another family company, which in turn charged the applicant's loan account with the payments.

Although the claim for deduction in the 1983 year of income was for $3,852, the amount was overstated by $700 as a consequence of taking into account cheques drawn and subsequently dishonoured and in the event of the applicant succeeding he requests that the deduction be reduced by $700.

Effect of cessation of business

The applicant claims the deductions sought are outgoings incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for such purpose (the first and second limbs of sec. 51(1) of the Income Tax Assessment Act 1936) and are allowable. The respondent in essence argues that sec. 51 does not authorise the deduction of outgoings that relate to income derived in earlier years where there has been a complete cessation of the business in the course of which that income was reduced: cf. Gibbs J. (as he then was) in
A.G.C. (Advances) Ltd. v. F.C. of T. 75 ATC 4057 at p. 4068; (1975) 132 C.L.R. 175 at p. 192. It argues that the principle in
Amalgamated Zinc (De Bavay's) Ltd. v. F.C. of T. (1935) 54 C.L.R. 295 is authority for that proposition and governs this matter.

In reply, the applicant referred to the statement by Barwick C.J. in A.G.C. (Advances) (supra) at ATC p. 4064; C.L.R. p. 185 that:

"It is not possible now, to construe sec. 51 to mean that the expenditures and losses to be deducted must relate precisely to the assessable income which is returned for a year in which the expenditures are made or the losses are suffered. In the application of this unduly condensed provision, it has not been possible to utilize the definite article so as to require the expenditure in question to have produced or to have assisted to produce the assessable income of the particular year of the expenditure."

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ATC 1023

On the applicant's behalf reliance was also placed on qualifying words used by Mr Stevens, Chairman, in Case R65,
84 ATC 468 at p. 469:

"Whatever might be said in relation to items such as workers' compensation claims and the like that can emerge after cessation of a business but which can truly be said to arise from the day-to-day operations of the business whilst it was being actively conducted, I do not think the same can be said in relation to the borrowings made in order to purchase a business or an asset to be used for income-producing purposes."

[emphasis added]

It was also pointed out on his behalf that, as stated in
Ronpibon Tin No Liability v. F.C. of T. (1949) 78 C.L.R. 47, the decision in Amalgamated Zinc was based on the provisions of para. 23(1)(a) of the Income Tax Assessment Act 1922-1934 as it then stood and that in Case E67
(1954) 5 T.B.R.D. 415 Mr F.C. Bock (Member) declined to apply the ratio in Amalgamated Zinc to the second limb of sec. 51(1).

At the hearing it was not argued that the claimed expenditure fell within the exceptions to sec. 51(1). Specifically it was not contended on behalf of the respondent that the payment pursuant to the statutory right of indemnity was capital or in the nature of capital.

History of Amalgamated Zinc

In Amalgamated Zinc (supra) the outgoing claimed as a deduction was the amount of a contribution to a fund established under the Workmen's Compensation (Broken Hill) Act 1920 (N.S.W.) payable as an annual outgoing at a time after which the company had ceased to carry on business in which it employed the workers in respect of whom the obligation to make the contribution arose so that its assessable income was derived solely from investments. It was held the company was not entitled to the deduction claimed because it was not an outgoing "actually incurred in gaining or producing the assessable income" within the meaning of sec. 23(1)(a) of the Income Tax Assessment Act 1922-1934. The complete cessation of the income-producing operations out of which the necessity to make the outgoings arose meant that the deduction could not be claimed. As stated by Dixon J. (as he then was):

"what is important is the entire lack of connection between the assessable income and the expenditure... It was a payment independent of the production of the income, not an expenditure incurred in the course of its production."

In view of the extensive citation on behalf of the parties in this proceeding of prior cases and decisions, it is appropriate to trace the subsequent history of this decision.

In Case E67 (supra) the majority (J.L. Burke, Chairman and A.C. Leslie, Member) found that there was in fact no cessation of business because time must be allowed to wind up outstanding matters so that a business continues until sums due are collected and all debts paid (applying
Theophile v. The Solicitor General (1950) A.C. 186 at p. 201 per Lord Porter). They also distinguished Amalgamated Zinc (supra) on the ground that it dealt only with an annual charge for an indefinite period. As has been seen, the view of Mr Bock in that decision was that Amalgamated Zinc (supra) had no application to the second limb of sec. 51(1).

In Case N42
(1962) 13 T.B.R.D. 180 at p. 183, Amalgamated Zinc (supra) was cited as authority that where there is a permanent cessation of business subsequent deductions relating thereto have not been allowed.

Amalgamated Zinc (supra) was found in Case A10,
69 ATC 52;
14 C.T.B.R. (N.S.) Case 93 in 1969 (by a Board comprising A.M. Donovan, Chairman, and Members, J.D. Davies and G.R. Thompson) to preclude deduction during the 1965 year of an outgoing in respect of ex-employees believed to be due to them in respect of the 1962 year of income, the relevant business having been discontinued for some years at the time the amount, the deduction claimed, was paid.

Doubts about the decision in Amalgamated Zinc (supra) date from the decision in the High Court in A.G.C. (Advances) (supra). That decision has been comprehensively reviewed in Case S30,
85 ATC 280 at pp. 281-283 (para. 6-9). It is only necessary to note some of what was said obiter. Barwick C.J. said at ATC pp. 4065-4066; C.L.R. p. 188:

"It may be, and I have no need to decide that question at the moment, that if a long period of years separated the two events and

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meantime the company had started a different business or become an investment company as in Amalgamated Zinc (De Bavay's) Ltd. v. F.C. of T., it may be necessary if that decision is followed in such a case to say that the relationship between the two had ceased to be sufficiently proximate. It would suffice for my present purpose that I am not satisfied that, in order to be deductible, the loss which flows from carrying on a business carried on to gain assessable income need necessarily occur in a year when the company is actively carrying on that business."

Mason J. at ATC pp. 4071-4072; C.L.R. pp. 197-198 said:

"It may be argued that if the taxpayer has ceased to carry on a particular business, a loss subsequently sustained in relation to that business cannot be described accurately as a loss incurred in carrying on that business, or at any rate one incurred in carrying it on for the purpose of gaining or producing assessable income. But the soundness of the argument depends on what is meant by `incurred'. A loss constituted by the writing off of a bad debt is no doubt incurred, in the sense that it is sustained, at the time when the debt is written off, and that may occur in a given case after the taxpayer has ceased to carry on as a going concern the business in which the debt was created. Yet even in such a case it may be correct to speak of the loss as having been incurred in the carrying on of the business. This is because the occasion for the loss is to be found in a transaction entered into in the carrying on of the business for the purpose of producing assessable income, that is, in the agreement by which the debt was created. Because the loss had its origin in such a transaction the loss may be said to be one which was incurred in the carrying on of the business for the purpose of producing assessable income, notwithstanding that its true character as a loss is not finally ascertained until the debt is written off."

He continued:

"That a loss having its origin in the course of carrying on a business for profit should only be deductible whilst the business is still in operation, though the loss may not be ascertained until a later date, seems to me to be a strange result; so strange indeed that an intention to bring it about should not be imputed to the legislature when the statute is susceptible to a sensible alternative interpretation."

Amalgamated Zinc (supra) was distinguished on the ground it was concerned with expenditure, not a loss. In these judgments therefore is obiter of the highest authority in support of the contention for the applicant that Amalgamated Zinc should not be applied to preclude its deduction in this proceeding. CCH Australian Federal Tax Reporter ¶23-455 comments on the choice offered by the broad test of deductibility accepted by Barwick C.J. and Mason J. in A.G.C. (Advances) (supra) and what it describes as the "continuing business" test used in Amalgamated Zinc (supra).

Amalgamated Zinc was cited together with A.G.C. (Advances) in
Nilsen Development Laboratories Pty. Ltd. v. F.C. of T. 78 ATC 4335 at pp. 4348-4349; (1978) 20 A.L.R. 285 at p. 305 by Murphy J. in the Supreme Court of Victoria as authority for the proposition that sec. 51 need not be restricted rigidly to the gaining or production of the assessable income of the current year. The citation from Amalgamated Zinc, however, and the context in which it is made as well as the facts of that case, show that the point is confined to the case of a continuing business. It was not cited in the appeal to the High Court (Nilsen Development Laboratories Pty. Ltd. & Ors v. F.C. of T. 81 ATC 4031; (1981) 33 A.L.R. 161) where
New Zealand Flax Investments Ltd. v. F.C. of T. (1938) 61 C.L.R. 179;
F.C. of T. v. James Flood Pty. Ltd. (1953) 88 C.L.R. 492 and
F.C. of T. v. Northern Timber & Hardware Co. Pty. Ltd. (1960) 103 C.L.R. 650 were relied upon by the Court in support of its decision that a provision in respect of leave not taken during a relevant year was not an allowable deduction.

In
Inglis v. F.C. of T. 80 ATC 4001 deductions for expenses relating to a pastoral property failed under the first limb of sec. 51(1) as the expenditure was found to have no connection with income which had been or was being or would be produced on the property. The cessation of the pastoral business precluded a deduction under the second limb. The cessation of business was therefore considered to be determinative only with the application of the second limb. Davies J., with whom St John

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ATC 1025

J. agreed, relied upon the statement in Ronpibon (supra) at p. 56 that the first limb has a very wide operation and covers almost all the ground occupied by the second limb so that fact did not materially limit the appellant's claims. The approach to the first limb was therefore to whether the necessary connection might be established. As expressed by Brennan J. at pp. 4003-4004 of Inglis, there was an absence of income-producing activities during the relevant income years and the earlier income-producing activities were so remote in time that no connection between the claimed expenditures and the earlier operations appeared. As he said, the existence or otherwise of the necessary connection is a question of fact (citing
F.C. of T. v. Gordon (1930) 43 C.L.R. 456 at p. 462) and the appellant had not shown the making of expenditure on any relevant item was incidental or relevant to the operations which, in earlier years, produced assessable income.

In
Somers Bay Investment Pty. Ltd. v. F.C. of T. 80 ATC 4411, Jones J. in the Supreme Court of Western Australia relied upon Amalgamated Zinc (supra) and Ronpibon (supra) and other authorities as establishing that the reference to "the assessable income" in sec. 51(1) is a reference to income generally and not only to the assessable income of the accounting period in relation to which the outgoing is claimed.

In Case N9,
81 ATC 56 it was held that legal expenses of a taxpayer/director incurred in defending various actions brought against him as a result of his activities as a director were not deductible under sec. 51(1) because there was no perceived connection between the expenditure in any year in defending the charges laid against the taxpayer and his income earning activities whether as a director or otherwise. Any relationship which may have existed between the legal expenses and assessable income of earlier years "had ceased to be sufficiently proximate" so that they could not on the basis of proximity or relevance fall for deduction in the years in issue. The Board (K.P. Brady, Chairman; L.C. Voumard and J.E. Stewart, Members) considered the authorities required it to determine whether the expenditure satisfied the requirements of sec. 51(1) in that it was incurred in gaining or producing assessable income with or "without regard to division into accounting periods": A.G.C. (Advances) (supra) at ATC p. 4071; C.L.R. p. 197. However, it then continued (at pp. 58-59):

"It is our view of the evidence also that any relationship for the purposes of the Act that may have existed between the legal expenses in issue and assessable income of earlier years `had ceased to be sufficiently proximate' (per Barwick C.J. at [ATC pp. 4065-4066; C.L.R.] p. 188 in the A.G.C. (Advances) Ltd. case (ante)), with the consequence that they could not on the basis of proximity or of relevance fall for deduction in the years in issue. Certainly the expenses were not, to use the words of Dixon J. (as he then was) in the Amalgamated Zinc case (ante) at p. 309, incurred `in the course of gaining or producing' assessable income and they were, as Dixon J. said in the same case at p. 310, `independent of the production of the income (and were) not (expenses) incurred in the course of its production'. It is relevant to note that, although the High Court in the A.G.C. (Advances) Ltd. case expressed certain reservations about the application of the Amalgamated Zinc decision, it did not overrule that decision but rather distinguished it on the basis that it was concerned with expenditure and not losses and that, unlike the High Court in the Amalgamated Zinc case and the decision therein, it was concerned with `a business' which on the facts found in the case before it had not ceased its income-producing activities. In the circumstances, we regard the decision in the Amalgamated Zinc case to be particularly apposite in the instant case."

In
Freeman & Ors. v. F.C. of T. 83 ATC 4456 certain payments made by the appellant company were held not to be deductible under sec. 51(1) because they were made at a time when the company had ceased business operations and was being prepared for its dissolution so that its activities then were not directed to gaining assessable income. Franki J. regarded it as clear that for a payment to fall within the category submitted there must be a connection between the payment and the production of income, citing, inter alia, Amalgamated Zinc (supra). Northrop and Fisher JJ. said at p. 4475:

"Generally it can be said that an employer is only entitled to a deduction if the business

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ATC 1026

is continuing and the payment is productive of further income; if the business has been disposed of or discontinued no deduction is available, Amalgamated Zinc (supra)."

They found that the company had not established a sufficient or any connection between the payment of the funds and the gaining or producing of income.

Inspection of the language used in 1984 in Case R65 (supra) by Mr Stevens, Chairman (supra), makes clear that if workers' compensation claims were to be deductible after cessation of business it would be only where "they can truly be said to arise from the day-to-day operations of the business whilst it was being actively conducted". Amalgamated Zinc (supra) was also considered in that year in
F.C. of T. v. E.A. Marr & Sons (Sales) Ltd. 84 ATC 4580. In their joint judgment Bowen C.J., Toohey and Lockhart JJ. said of the decision in Amalgamated Zinc (supra) that "the sources from which the assessable income of the taxpayer arose in that case included no business operations in the course of which the relevant payments were made. It was a payment made independently of the production of the income and not an expenditure incurred in the course of its production". Amalgamated Zinc (supra) was distinguished on its facts on the basis it was not clear that the taxpayer in Marr's case had ceased altogether to carry on business. In addition the Court said that even if the taxpayer was not carrying on business when the payments were made, it would not necessarily follow that those payments were not on revenue account, citing
South Behar Co. Ltd. v. C. of I.R. (1925) A.C. 476 per Lord Sumner at p. 488. Examination of that citation shows that when the Court used the words "not carrying on business" they were not dealing with a case of cessation of business but a case where there was inactivity in the business together with a presumption that a company continues to carry on business as long as it is engaged in collecting debts periodically falling due to it in the course of its former business. There is, therefore, no inherent conflict between the sentence used by the Court and the views expressed in Theophile (supra).

In 1985 in Case S30 (supra) Dr P. Gerber (with whom Mr M.B. Hogan and Dr G.W. Beck agreed) dealt with the potential conflict between A.G.C. (Advances) (supra) and Amalgamated Zinc (supra) in the following terms (at p. 283):

"10. It is clear that the A.G.C. case depended on its own peculiar facts. It also seems to me that on the fact finding made by Gibbs J., the learned Chief Justice and Mason J. would have reached the same result, since both stressed that in that case there was no discontinuity of the same business in order to break the relevant nexus between derivation and outgoing. In other words, the difference between the minority and the majority turns on a different view taken of the facts rather than a disagreement on the law."

From this review of the decisions in which Amalgamated Zinc (supra) has been cited, it appears to this Tribunal that:

• (i) an expenditure or an outgoing which may be incidental to, and relevant to, the gaining or producing of assessable income in an earlier year(s) is not precluded simply because of that fact from being an allowable deduction from assessable income under sec. 51(1) in arriving at the taxable income(s) of a later year or years;
• (ii) allowing therefore that sec. 51(1) enables deduction of expenditure incurred in gaining or producing assessable income with or "without regard to division into accounting periods" - A.G.C. (Advances) (supra) per Mason J. at ATC p. 4071; C.L.R. p. 197 - it is still necessary for the taxpayer to establish the relevant nexus in terms of that section between derivation and outgoings;
• (iii) where a cessation of business has occurred:
  • (a) it is first necessary to ascertain whether there has been truly a cessation of business or whether the business could still be considered to be carried on after the cessation of activity;
  • (b) where the business has truly ceased, the second limb of sec. 51(1) has no application;
  • (c) whether the first limb of sec. 51(1) then applies requires an examination of all the circumstances of the matter to determine the degree of proximity between the claimed expenditures and the earlier operation of the business and

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    whether as a question of fact there is the connection made necessary by sec. 51(1) pursuant to which the deduction is sought. The question is whether the discontinuity of business has alone broken the nexus between derivation and outgoing or whether that nexus, in the context of particular facts, endures;
  • (d) where the business has ceased in circumstances on all fours with the circumstances in Amalgamated Zinc (supra), that decision will be authority precluding the deduction in relation to the first limb of sec. 51(1).

The issue is not so much a case of contrast between broad test of deductibility as advanced in A.G.C. (Advances) and a continuing business test as applied in Amalgamated Zinc (supra), but rather a case of applying the test of deductibility in the terms of the Act in the specific instance where there is proven cessation of business. As an examination of the judgments in Amalgamated Zinc makes apparent, the significance of the cessation of business is that it prevents the necessary connection between assessable income and expenditure arising. It is but one instance of circumstances in which the nexus may not exist but the particular facts must be examined to ascertain both whether there actually has been a cessation of business and whether, in any event, the necessary nexus can be found.

Examination of the nexus

This applicant is precluded from succeeding in the claim for deductibility pursuant to the second limb of sec. 51(1) because there was a complete cessation of the carrying on of the business.

In examining the existence of the nexus pursuant to the first limb of sec. 51(1), it is apparent on the facts that the applicant cannot succeed on any argument that the outgoings claimed are incurred in gaining or producing assessable income in the years in which those outgoings were claimed. The only question is whether the outgoings claimed in the 1982 and 1983 years of income are said to have been incurred in gaining or producing assessable income at the time at which the accident causing the injury to "C" arose in 1974. The applicant seeks to establish the nexus therefore with the argument that it was in the nature of a contingent liability during that period. Alternatively it was argued that the issue of Supreme Court proceedings in 1976 prior to the cessation of business in 1977 provided the necessary nexus. The submission is that the judgment in December 1977 after cessation of the business merely quantified the liability which had arisen prior to the cessation of business. In the applicant's submission, this was sufficient to establish that the deductions can be truly said to arise from the day-to-day operations of the business whilst it was being actively conducted (Case R65 at p. 469).

The Tribunal therefore considers each of the claimed bases for the nexus:

• (1) The accident in 1974; and
• (2) The issue of proceedings in 1976.

In the view of the Tribunal it is not correct to say that the required nexus can be found on the basis that some liability of a contingent inchoate nature existed prior to the cessation of business as a consequence of the occurrence of the accident in 1974 and the issue of proceedings in 1976. It was not until the judgment of the Supreme Court of Western Australia on 1 December 1977 that a judgment debt was created and liability to repayment arose. While there was a contingency prior to cessation of business there was no liability then in existence. A "contingent debt" refers to a case where there is a doubt if there will be any debt at all - per Mellish L.J.,
Ex parte Ruffle 8 Ch. 1001.

The mere contingency cannot provide the nexus between the outgoings and the gaining or production of assessable income in those years. The fact that it was merely a contingency prevents it from being incurred in the requisite manner because as a contingency it is not truly "incurred": cf. A.G.C. (Advances) (supra) at ATC pp. 4072-4073; C.L.R. pp. 197-198 per Mason J.

The word "incurred" in sec. 51(1) does not warrant treating a liability which does not "come home" in the year of income in the sense of a pecuniary obligation which has become due, as having been incurred in that year: Nilsen Laboratories (1981) (supra) at ATC pp. 4034-4035; A.L.R. p. 165 per Barwick C.J. An expenditure which is no more than impending, threatened or expected is not within the meaning of the word "incurred": New Zealand Flax Investments Ltd. (supra) at p. 207; James Flood (supra) at p. 507.

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(3) Judgment in December 1977

The judgment in December 1977 was proximate to the cessation of business in September 1977. Furthermore, a connection does appear between the claimed expenditure and the earlier operations - the judgment debt arose from an event during those operations. It is possible that had a claim been raised in the 1978 or 1979 years of income the applicant may have been entitled to succeed.

The position is, however, different because the expenditures are claimed in relation to years of income four and five years later. In the opinion of the Tribunal, it can be properly said the earlier income-producing activities are so remote in time that the requisite connection between the claimed expenditures and the earlier operations cannot be established. It is not that the applicant's claim is defeated by the law or any prior decision but rather that, as a question of fact, he is unable to establish the nexus required by sec. 51(1) in circumstances where so much time has elapsed between the cessation of income-producing activity and the claimed expenditures.

Conclusion

For the reasons given, the applicant cannot succeed. Accordingly the objection decisions under review will be affirmed.