Spratt v Commissioner of Inland Revenue (NZ)

[1964] NZLR 272
13 ATD 308

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(Judgment by: Henry J)

Spratt
v. Commissioner of Inland Revenue (NZ)

Court:

Judge:
Henry J

Judgment date: 15 November 1963

New Zealand

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Judgment by:
Henry J

Case stated pursuant to s. 32 of the Land and Income Tax Act 1954. It is convenient to refer to the appellant and the respondent as "the taxpayer" and "the Commissioner" respectively.

By his will the taxpayer's father, Michael Louis Spratt, after appointing a trustee and making certain provisions, provided as follows:

5

I give devise and bequeath all and singular my farm property at Otaraia together with all live and dead stock therein or situated upon the said farm property including therein all farm implements and machinery wool skins and crops (whether severed or growing) subject to any mortgages or other charges that may be owing thereon at the date of my death upon the following trusts that is to say to permit my wife to use and occupy during her widowhood the homestead upon the said farming property free of rent or any other charge whatsoever my Trustee keeping the said homestead in good and habitable condition and to carry on either alone or in partnership with any person or persons with whom I may be in partnership at the date of my death the business of farming carried on by me, at that date during such period as my Trustee shall think fit and to employ therein any capital which may be employed therein at the date of my death and any additional capital which my Trustee may think expedient to employ therein and to effect any improvements and erect buildings in the absolute discretion of my Trustee and my Trustee shall have the fullest discretionary power in all matters relating to the management of my said farming business as if my Trustee were the absolute proprietor thereof but the actual management thereof may be delegated to any manager appointed by my Trustee and my Trustee may pay or allow such rates of remuneration as are usual for work of that nature and my trustee shall be indemnified out of my estate in respect of all losses or liabilities sustained or incurred in carrying on or otherwise in relation to the said business and I empower my Trustee until the sale of my real and leasehold estate to let or sublet the same or any part or parts thereof from year to year or for any term of years at such rent and subject to such covenants and conditions as he shall think reasonable and to accept surrenders of leases thereof and to relet and I direct that the rents interest and yearly produce of my said farm property and all profits from my said farming business shall be held upon the following trusts and I declare that my Trustee shall be sole judge as to what constitutes annual profits from my said farming business:

(a)

To pay to my said wife thereout the sum of four hundred pounds (£400) per annum clear of all taxes during her life and so long as she shall remain my widow and I empower my Trustee if at any time it shall consider that the said sum of four hundred pounds per annum is insufficient for the proper maintenance of my said wife to have recourse to the capital of my residuary estate to make the said income up to such a sum as shall in the opinion of my Trustee be sufficient for such purpose.

(b)

To pay the balance of such income to my son the said Owen Michael James Spratt for his own use and benefit absolutely.

(c)

Upon the death or remarriage of my said wife to hold the said farm property and implements live and dead stock upon trust to sell and convert the same into money and to hold the proceeds thereof as to three fourths thereof upon trust for my son the said Owen Michael James Spratt absolutely and as to one fourth upon trust for my grandson Donald Owen Spratt on his attaining the age of twenty-one years."

By a deed of arrangement the widow's annuity was later increased to £520.

The taxpayer, by separate deeds, assigned two yearly sums of £500 to arise from the said annual profits. The present question concerns liability for tax in respect of these sums.

In the Case Stated the deeds were sufficiently summarized thus:

(1)

By deed entered into on 21st October, 1960, between the taxpayer of the first part, his wife Nancy Spratt of the second part and the trustee of the third part, the taxpayer, in consideration of the sum of £2,893, assigned to his wife the said Nancy Spratt the sum of £500 each year from and out of the income to which the taxpayer is entitled from the estate of the said Michael Louis Spratt for a period of seven years commencing on 1st July, 1960.

(2)

By deed entered into on 15th November, 1960, between the taxpayer of the first part and the trustee of the second part, the taxpayer, in consideration of the sum of £4,949,. assigned to the trustee for the period from 1st July, 1960 and expiring on 23rd July, 1974, the sum of £500 each year from and out of the income to which the taxpayer is entitled in such year from the estate of the said Michael Louis Spratt subject to the said recited assignment in favour of the taxpayer's wife and further requested and directed the trustee to appropriate and set aside such sum each year to be held upon the trusts set out in a deed of trust dated 15th November, 1960, made between the taxpayer and the trustee.

The annual profits for the year ended 30th June, 1961 (which was the permitted balance date) payable in respect of the taxpayer's interest under the will amounted to £4,205 17s. 11d. The taxpayer, who returned the sum of £3,205 17s. 11d. in respect of income from the estate, claimed that the balance of £1,000, having been assigned, was not taxable in his hands. The Commissioner included the said sum of £1,000 in the taxpayer's annual return of income and assessed tax accordingly. The question is whether the Commissioner was wrong in so assessing the taxpayer for income tax.

The grounds upon which the Commissioner claims that the said two sums of £500 are taxable in the hands of the taxpayer are:

(1)

That the said deeds do not operate to assign such amounts until after the said amounts of income have been derived by the taxpayer.

(2)

That insofar as the amount of £500 assigned by the taxpayer under the deed entered into on 15th November, 1960, is concerned such amount is, pursuant to s. 105 of the Land and Income Tax Act 1954, deemed to be income derived by the taxpayer and by no other person as if the assignment had not been made.

(3)

That if ground (1) is rejected, in so far as the assignments of income under the deeds relate to income to which the taxpayer is entitled from the estate of the said Michael Louis Spratt from and after the dates the deeds were respectively entered into, the said two amounts of income were derived by the taxpayer before he entered into either of the deeds.

Ground (2) refers to the second deed only, whilst the third ground applies only to the assessed year. The first ground is of general application throughout the respective periods of assignment so the general question so raised will be dealt with at once.

Section 77 (1) imposes income tax on all income derived by a taxpayer in each income year. The word "derived" is extended by s. 92 which enacts:

For the purposes of this Act every person shall be deemed to have derived income although it has not been actually paid to or received by him, or already become due or receivable, but has been credited in account, or reinvested, or accumulated, or capitalized, or carried to any reserve, sinking, or insurance fund, or otherwise dealt with in his interest or on his behalf.

Although the ultimate answer depends upon construction of a statute and the application of such construction to the facts of this case, nevertheless certain concepts have emerged from decided cases and are accepted by the parties. Some matters are also either conceded or are common ground. Accordingly it is convenient to state what has been so accepted and then to formulate the general question which arises under (1) above. The deeds are admitted to be absolute assignments for value according to their tenor and to be valid as such in law and in equity. Assessable income may be alienated so that it does not attract income tax in the hands of an assignor and this may be done without also assigning the corpus which produces the income. If the assignor retains any control or right to control either the destination, application or use of the assigned income or any part thereof, whether such control is exercised or not, the assigned income remains taxable in his hands. No taxpayer can, by way of assignment, escape assessment of tax on income resulting from his personal activities-such income always remains truly his income and is derived by him irrespective of the method he may adopt to dispose of it.

In Arcus v. Commissioner of Inland Revenue (1962) 13 ATD 101; (1963) N.Z.L.R. 324, Hardie Boys, J. exhaustively reviewed the cases on the topic now under discussion. The Arcus Case is not decisive of the present case. It is useful only in so far as it discusses the question generally and classifies what appears to be the general trend of judicial decision. His Honour said: "Wherever an alienation has been upheld for tax exemption purposes, it will be found that (subject to some special statutory exceptions in a case like Firth 2 , the settlor had by one means or another put it out of his power to revoke the alienation and divert the income back to himself. Conversely, wherever the income assigned to others has been held still to be taxable as settlor's own, it will be found that one or other of two situations exists: either the settlor has retained such a control of the income or of the fund producing it that it is within his power to divert the income back to himself, or else the arrangement is so clearly a mere application and disposition of income payable direct to the settlor, that it does not qualify as an alienation within an often used phrase ' so that it is no longer his income but that of another'. This is so notwithstanding future benefits to others that accrue from the arrangement: Commissioners of Inland Revenue v. Parsons (1925) 13 Tax Cas. 700, 707, 708. (a decision upheld on appeal to the Court of Appeal)" (ibid., 327). Again his Honour said: "All the cases where the Courts have ruled against alienation lack one or other of the essential elements, i.e., the interposition between the settlor and the fund of a trustee for other persons, or an inviolate disposal by some other means of settlor's control. Here there is no transfer or trust of the income-producing property, no trustee is interposed between the settlor and the sources of his income and there is no covenant for payment made either with the donees or any trustee for them. On the contrary, it was always within his power to render the effect of the deeds nugatory" (ibid., 331). Earlier in the Arcus Case the learned Judge had said: "It is not a question of a good assignment or an imperfect one, such as sometimes occurs where notice has not been given or the assignment is not absolute, but a question whether the assignment was of a nature such that it could no longer be said that the income was the taxpayer's own, or whether it was an assignment of something already taxable in the taxpayer's hands" (ibid., 326). Counsel for the Commissioner submitted that this was the test to be applied in the instant case. It may be the test but it leaves undefined the term "already taxable in the taxpayer's hands" which is the crux of the present case. I feel I must restate the main problem which I have to solve and then proceed to its solution on the facts of this case.

The problem can be shortly stated. It is this: Since, on unimpeachable authority, income may be assigned (without assigning the corpus) so that it does not attract tax in the hands of the assignor, do the present absolute and valid assignments for value have that effect? Once it is conceded that such an assignment may be made and that the instant assignments are for value and valid and absolute, it must follow that the income so assigned ceases to be income in the hands of the assignor unless there is some basis for holding that, notwithstanding the absolute assignments, the assigned income is nevertheless still derived by the taxpayer himself in each year before it passes on. This involves an examination of the grounds put forward by the Commissioner in support of his contention that the assessment is correct.

The Commissioner contends that the assignments do not operate so as to dispose of the annual sums until after they are "derived" as income by the taxpayer. This contention is first based on the operative words of the deeds, and further upon a contention that the deeds do no more than apply and dispose of income payable direct to the taxpayer and particularly that the assignments are caught by the concluding words of s. 92 in that the income is "dealt with in the interest of the taxpayer or on his behalf".

Each deed recites that the taxpayer is desirous of selling "the right to receive from his share of the income in the estate of the testator to which he (the taxpayer) is entitled". The operative clause assigns absolutely "the named sums from and out of the income to which (the taxpayer) is entitled in each year from the said estate". These words are descriptive of the interest passing by the assignment. At the moment of assignment, and up till that moment, such interests are properly so described. I can see no reason for holding that the use of such a term preserved the interest thereafter as being one to which the assignor is still entitled but which passes in each year first to the taxpayer and then from him to the assignee so that it is still technically "derived" by the taxpayer. Each assignment is absolute and takes effect according to its tenor from the moment of delivery although the actual moneys payable thereunder may not arise until a future time. I cannot agree that a description (correct at the time of assignment) can operate to retain the identity of the interest as that of the assignor after the assignment (in which that description has been used) has become operative.

I turn next to the contention that the deeds do no more than apply and dispose of income payable direct to the taxpayer. This seems to me to be an unnecessarily restrictive description of the effect and purport of the deeds. Certainly the income is, in the absence of the deeds, payable to the taxpayer. That is a common feature of any such assignment, but there is no ground for saying that "to assign" is necessarily equivalent to "to apply and dispose of" in the sense that this term is used in taxation cases, where the question is whether or not the income is still "derived" by the assignor notwithstanding the assignment. The income is absolutely assigned and the payment thereof in each year by the trustee is putting the assignment into actual effect. Once it is conceded that income may be assigned so that it ceases to be income derived by the assignor, then, as a matter of logic, something more than a prior right to the assigned income is necessary if it is to remain income in the hands of the assignor even though he has assigned it. What then is the additional factor or factors which prevent the deeds from being an alienation so that the income assigned is no longer that of the taxpayer but that of another? I have already dealt with the words of the deeds themselves and held they do not preserve the original identity of the income-the words used were then only presently descriptive of the interest assigned. Nor does s. 92 help the Commissioner. The deeds do not require that the income be dealt with "in the interest or on behalf of" the taxpayer, except in the sense that the assignment requires payment to the assignees; that is a feature common to all assignments. It is not suggested that s. 92 picks up every assignment of income. It picks up (inter alia) those in which the income is not only assigned but in which it is also assigned in the interest of and on behalf of the taxpayer so that its application is towards some matter or thing concerning the taxpayer. In this respect, of course, I am not referring to income in the nature of income from personal effort. The deeds effect something different from an application of the income or a dealing with it in the interests of or on behalf of the taxpayer-they alienate such income so that the taxpayer retains no further possible control or interest in its destination or application or use. It ceases to be his and he no longer has, nor can have, any interest or control in its application or use, and the assignee is free in his turn to deal with and apply it at pleasure.

Next, it is necessary to consider whether or not there is any other ground for holding that the income is still derived by the taxpayer notwithstanding the absoluteness of the assignments. That is to say, are such sums still derived by the taxpayer in the ordinary sense of that term? The income arises from the employment of estate assets by a trustee in the administration of a deceased estate. After providing for a life annuity to the widow, the balance of the annual profits are bequeathed to the taxpayer. It is an equitable interest arising under a will and is in the nature of a chose in action. It is agreed that there is a valid and absolute assignnent for value of a stated annual sum from such interest. If that be so, then the right to receive the respective sums is passed to the assignees (or their trustee) immediately the sum comes into existence as a sum to which the taxpayer is otherwise entitled under the will. The assignments are complete now and are poised to operate on the subject-matter as soon as it comes into existence. The taxpayer can have no interest in the income assigned save that he is the person through whom the assignees take their title. I do not think that it can be said that the income is derived by the taxpayer who then year by year passes it on to the assignees in terms of the deeds. I do not agree that the fact that it is a stated sum and not a specified aliquot share makes any difference. The annual profits of the estate are earned by a trustee who holds the assets in trust and who conducts the business of the estate for the benefit of all beneficiaries. When profits arise and are declared each year, the trustee then holds the same on the trusts of the will varied by the respective deeds executed in respect thereof and binding upon him as a party. The funds in his hands, as they arrive at the point of distribution, must be distributed and paid by him according to the trusts or as varied by valid assignments binding upon him. I cannot see that it makes any difference how the respective sums are fixed or how they may rank as to priority inter se provided they are effectively assigned. This argument, in my view, fails.

Finally, it was argued that the taxpayer exercised control, or some measure of control, over the income so that it is brought within the class of which the Arcus Case is an example. The only factual matter raised here was the employment of the taxpayer in the estate business-an employment for which he neither asked for nor received remuneration. The sole control was retained and always remained in the trustee for the estate who has the income earning assets vested in him in trust. Whether or not the taxpayer is employed is a matter within the discretion of the trustee. The taxpayer has no right other than a right to receive income after it is earned and declared by the trustee to constitute annual profits. The employment of the taxpayer is purely incidental as is also the fact that he has not required payment for his services. I can see no reason for holding that a power in any sense of the term has been retained by the taxpayer to control the income or its destination. It must follow the assignment; all rights in respect of the assigned income are absolutely passed on, and, without a valid consensual variation of the deeds, the taxpayer can do nothing to affect the rights of the assignee. Whether or not he is paid for his services may or may not affect the quantum of income earned. If so, it is only one of many factors arising from the cost of producing the income which might do so in any year. I do not agree that this fact will make the estate income personal emoluments on the principle applied in Parkins v. Warwick (1943) 25 Tax Cas. 419.. That case is essentially different in its facts from the instant case.

The pith and substance of the case for the Commissioner is that the deeds are a medium for passing to the assignees assessable income which is in truth the income of the taxpayer. If this were so, I have no doubt but that the taxpayer would be assessable on the assigned amounts. But that is not the position. The income is that arising from the assets of his father's estate held by a separate trustee upon the trusts of the will. It is taxable in the taxpayer's hands because he is entitled to such income when declared. After being declared by the trustee, it is paid to or held on behalf of or in the interests of the taxpayer and is accordingly income derived by him. But the assignments being valid and absolute, they pass the income affected thereby (when it arises and becomes ripe for distribution) to the assignees or to be held on their behalf or in their interests. It is, in truth, never held by the trustee on behalf of the taxpayer or for any ulterior purpose of his. Except that the assignments are links in the chain of entitlement, they do not otherwise control or affect the application or use of the moneys assigned which pass freed from all possible control or interest or ulterior purpose of the taxpayer. I think that, in the fullest sense of the term, it can be said that, by the assignments, that portion of the estate income is no longer the income of the taxpayer but is, by the operation of the deeds, the income of the assignees who have purchased a stated annual amount of income from an income producing estate.

In the event of the general question being answered against the Commissioner, as it has been, it is argued that the second deed is caught by s. 105. Subsection (2) reads:

Where by the terms of any settlement made by any person (in this section referred to as the settlor) the income of the settled property or of any property substituted therefor is payable to or to be applied or accumulated for the benefit of a relative of the settlor or any related company for a period that is less than the prescribed period and the settlor remains the beneficial owner of the corpus of that property or the settlement provides that that corpus shall revert to the settlor or to the wife or husband of the settlor or that the right to dispose of that corpus shall be reserved to the settlor or to the wife or husband of the settlor, the income from the settled property or from any property substituted therefor shall, so long as the income is derived by a beneficiary who is not entitled to the corpus, be deemed to be income derived by the settlor and by no other person as if the settlement had not been made.

The only point in issue is whether or not the second deed is a "settlement" within that term as it is used in sub-s. (2). The word "settlement" has an extended meaning by virtue of sub-s. (6). It is not necessary to consider that meaning because it is admittedly wide enough to include the deed in question if the transaction itself is otherwise within sub-s. (2). The contention of taxpayer's counsel is that a simple absolute assignment of income from an existing trust by the beneficiary of that income does not come within sub-s. (2). That contention is, I think, a sound one. Subsection (2) concerns settlements which settle property and then deal with the income "from the settled property" whilst retaining the corpus or dealing with the corpus of the settled property in certain defined ways. I can see no ground for holding that a simple absolute assignment of income from an existing trust fund comes within the class of transactions comprehended by sub-s. (2).

The third ground depends upon a contention that the income from the estate, which reaches the hands of the taxpayer as a result of each year's operations of the trustee, accrues to the taxpayer from day to day throughout the income year. The income year commenced on 1st July, 1960. The assignments, although the income as from 1st July, 1960, is affected, are dated respectively 21st October, 1960 and 15th November, 1960. The Commissioner claims that the taxpayer is taxable with a proportionate part of the year's income calculated on the annual returns as if the profits had arisen by equal daily sums throughout the period. The argument seems to predicate that each sum of £500 was actually derived by the taxpayer before the respective deeds were signed. This argument proceeds on the basis that the year's income must be taken as having accrued day by day and that the widow's income would first be met, and that before the first deed was signed, a further £500 would have accrued and being the next charge would be caught up by the deed. Then by the time the second deed was signed, at least a further £500 had accrued and this would, upon the signing of the second deed, be caught. Thus in both cases it was argued that the effect of the assignments was that each assigned a sum already earned and therefore derived by the taxpayer before it was assigned so that he was assigning income to which he was then entitled even though not then declared as income. There is no proof that any or sufficient profit had been earned at either relevant date to satisfy the respective assignments. The Court is asked to deduce from the result at the end of the year that this was so because the year's results would, if then translated back on to an even day by day basis, support a figure sufficient to satisfy each assignment at the time of assignment for the first year. This process, by the nature of the business, will not necessarily bear any relation to actual fact. Almost certainly it will give a picture which is completely contrary to fact. Being substantially the result of the sale and realization of seasonal farm produce and depending also upon the number of stock on hand at the beginning and end of the year, it is clear that any such contention would be contrary to fact. There would be no day to day gain. It is also clear that incomings are usually confined to large seasonal sales. There is no evidence that the farming operations on the respective dates of the said deeds resulted in any profit or that the ultimate result of the year by the following 30th June would yield the taxpayer any income at all. In the event it did. It was a very high probability that nothing short of a disastrous season or happening would make the result other than a substantial one in favour of the taxpayer, nevertheless there is no evidence to support any such accrual of profits at the material times. In my view, I ought to hold there is no ground for assessing income on a day to day basis in the instant case.

Unless I were compelled by authority so to apportion the income I would refuse to adopt such an artificial unreal computation. No such authority has been cited to me. It is common ground that the Property Law Act 1952 has no application. Marshall v. Commissioner of Inland Revenue (1959) 11 ATD 563 .; (1959) N.Z.L.R. 609, which was cited, is a special case on its own facts. For myself I find it difficult to accept that, in a farming business, the selling value of wool is to be treated as "income derived" by the act of shearing the sheep and storing the wool in a shed. However, we have not even that fact in the instant case. Commissioners of Inland Revenue v. Roberts (1925) 9 Tax. Cas. 603., does not help the Commissioner. In that case the taxpayer earned profits as a partner in a firm, and during the tax year, the business was sold to a company. The profits for the whole year were paid by means of dividends from the company. It was held that the dividends included the profits earned before the sale, but the Court upheld the Commissioners' finding that the taxpayer derived a portion of the dividends from his efforts as a partner in the firm and that a day to day basis was a proper method of assessing the amount.

I now turn to the deeds themselves and their application to the facts of this case. The sum which becomes the assessable income derived by the taxpayer is the sum declared by the trustee as yearly profits and after the prior charge of the widow has been satisfied. I am unable to agree that it can be said that on the respective dates of the deeds the taxpayer had derived any income from the estate either in its primary meaning or as extended by s. 92. It may well be different where the taxpayer employs his own assets either in a partnership or otherwise. On that I am not called upon to pass an opinion. There was no power in the trustee to declare profits or to make a distribution at any time before the end of the year. The will required an annual distribution only after the annual profits had been settled by the trustee in his discretion and then the payments to the widow took priority. All sums were, by the terms of the trusts, ascertained and distributable on an annual basis, with no power to make any interim distribution. In my view, on the special facts of this case, the taxpayer could not be said to have derived income from the trust funds on a day to day basis and there is no binding authority which requires this Court to make an artificial and probably incorrect apportionment of profit on any intermediate date or dates. There is no basis, on the Case Stated, upon which it can be found that profits had been earned on the respective dates of the deeds. An arithmetical calculation on a day to day basis is not a sufficient factual basis for any such assessment, so I reject it. On this question, I have been aided by a passage in the speech of Lord Hodson in C.H.W. (Huddersfield) Ltd. v. Inland Revenue Commissioners (1963) 2 All E.R. 952, 957. The expressions there under consideration were not identical but the passage nevertheless supports the line of reasoning which I have adopted.

In the result I find that the Commissioner acted wrongly in including the said two amounts of £500 each and that the assessment ought to be amended accordingly. The Commissioner will pay costs in the sum of 60 guineas.

ORDER

Judgment accordingly.