Case N9

Judges:
KP Brady Ch
LC Voumard M
JE Stewart M

Court:
No. 2 Board of Review

Judgment date: 2 March 1981.

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K.P. Brady (Chairman); L.C. Voumard and J.E. Stewart (Members)

The questions arising for decision in these references concern claims which were made by the taxpayer in respect of legal fees said to have been incurred by him in defending various actions brought against him under various State statutes.

2. The claims for legal fees were made in the tax returns lodged by the taxpayer in respect of the years of income ended 30 June 1974, 1975 and 1976. Income returned in those returns was derived from salary, interest and dividends.

3. At the hearing before us the taxpayer appeared in person and gave evidence. He was not represented.

4. It appears that the legal expenses in issue and claimed as deductions in the abovementioned returns of income related back to the years 1971-1973 when, it was said, the taxpayer was a shareholder and a director in a number of companies, some or all of which were associated or interlocked through shareholdings and/or directorships, from which directors fees were derived. On the evidence before us it was not possible to indicate any details of the directors fees said to have been so derived, or whether income in the nature of salary or dividends or otherwise was derived by him in those earlier years from those or other companies. Further, it was not possible to give details of the nature and source of income that may have been derived by the taxpayer in years prior to 1971. All that the Board has before it in relation to those years is an assertion by the taxpayer that he derived directors fees.

5. However, it appears that in or about 1971 the taxpayer, in the capacity of a director, became involved with a company which, for present purposes, shall be referred to as ``X''. It appears that X may never have traded and, at all events, it appears not to have done so during the time of the taxpayer's association with it. During that period, and until it ceased to exist later in 1971 or thereabouts, X apparently did not derive profits and it did not pay directors fees or dividends.

6. It appears, however, that in the period of several months that the taxpayer was a director of X, he became involved with his co-directors on its behalf in a contract concerned with the building of an office block. Precise details of that contract were not submitted to us, but it seems that professional fees incurred in connection with it were not paid which led, in the first instance, to an allegedly unsuccessful civil action against X for non-payment. Further, it would seem that the matter of non-payment became associated somehow with what would appear to have been an improper transfer or disposal of land with at least the one objective of making the above payment impossible. It seems that that state of affairs led in due course to legal action being taken against the taxpayer and co-directors by a State authority. It is not clear from the evidence what the outcome of that action may have been.

7. In or about 1971 the taxpayer also became associated as a director with a company, herein referred to as ``Y'', from its incorporation in that year until it became publicly listed, apparently later in the same year. It appears that he was a director of Y for some two to three months until he was asked to resign just prior to its public listing. On the evidence, it is not clear whether Y was an operating company before or during the taxpayer's association with it. It seems possible that it was and that it continued in existence after that time. It would appear, however, that the taxpayer did not receive any salary or dividends from Y. It is understood that he was not paid directors fees by Y and that his resignation from it was associated in some way with convictions and fines imposed upon him for his actions as a director and for his part in failing to disclose certain information required to be furnished in the prospectus.

8. Some attention was given to a further company, herein referred to as ``Z'', with

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which the taxpayer became associated as a director for approximately four months in the 1972-1973 period. Little information was given in relation to Z, but it was said that an unknown amount of directors fees was paid to the taxpayer upon his ceasing to be a director in early 1973, and that Z ceased to trade some time after he ceased his association with it. It is understood that Z has now either been liquidated or is in the course of being liquidated. It appears that the taxpayer had legal action taken against him in connection with Z for using its funds for a benefit or purpose other than for its benefit or purpose and that that led to his conviction and a gaol sentence.

9. From the evidence it appears that the legal fees claimed as a deduction in the year of income ended 30 June 1974, were related to the matters concerning X described above, that the fees claimed as a deduction in the year of income ended 30 June 1975, were related to the matters concerning Y and Z described above, and that the fees claimed as a deduction in the year of income ended 30 June 1976, were also related to the matters concerning Y and Z described above.

10. In his submissions to us in support of his claims, the taxpayer appeared to rely upon the general proposition that a holder of a company directorship is continually at risk of legal action because of his position and is constantly exposed to action being taken against him under the various Companies Acts and to the imposition of penalties under those statutes. It was submitted by the taxpayer that, having held various directorships in years prior to those before us from which directors fees had been derived, he was a victim of the above risks with the consequence that the legal expenses claimed as deductions should be allowed under sec. 51(1) of the Income Tax Assessment Act as being normal expenditure incurred in deriving assessable income.

11. It is now well established that 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, see
Herald & Weekly Times Ltd. v. F.C. of T. (1932) 48 C.L.R. 113;
Amalgamated Zinc (De Bavay's) Ltd. v. F.C. of T. (1935) 54 C.L.R. 295;
W. Nevill & Co. Ltd. v. F.C. of T. (1937) 56 C.L.R. 290;
Sun Newspapers Ltd. v. F.C. of T. (1938) 61 C.L.R. 337;
The Texas Company (A'sia) Ltd. v. F.C. of T. (1940) 63 C.L.R. 382;
Ronpibon Tin N.L. v. F.C. of T. (1949) 78 C.L.R. 47;
F.C. of T. v. Finn (1961) 106 C.L.R. 60;
A.G.C. (Advances) Ltd. v. F.C. of T. 75 ATC 4057; (1974-75) 132 C.L.R. 175.

12. However, while this principle assists the taxpayer, it is also necessary for him, if he is to succeed in his claims, to show that the character or nature of the expenditure for each of the three years in issue in itself also satisfies 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'', per Manson J. at ATC p. 4070; C.L.R. p. 197 in the A.G.C. (Advances) Ltd. case (ante), and that it was not capital, or of a capital, private or domestic nature.

13. Even if it is assumed in the taxpayer's favour that his director's status in each of X, Y and Z exposed him to legal actions along lines indicated in para. 10 above, it would not in our view qualify the legal expenses incurred to be deductible under the first limb of sec. 51(1) of the Act. They would not so qualify even if he had retained the status of director in any one or other, or all, of the years in issue and in which it was said the expenses were incurred (or, in the alternative, even if they had been incurred) during the period in which he was in fact a director. It seems to us that in any of those situations there could be no ``perceived connection'' (
F.C. of T. v. Hatchett 71 ATC 4184 - a case which concerned the deductibility of self-education expenses of a teacher) between directors fees and other assessable income that may have been derived by the taxpayer in any year and the legal expenses in issue which were in our opinion completely dissociated from, and without any real nexus with, the gaining or producing of the assessable income of any year.

14. 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

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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.

15. The circumstances which gave rise to the expenditure in the case now before us appear to be somewhat unusual in that the taxpayer on at least two occasions is seen to be an initiator of, or, at least, a party to, a course of conduct which seemingly from most viewpoints could not have been undertaken in the best interests of X, Y or Z, or of any other company with which he may have been associated. At all events, it seems to us that the happenings which gave rise to the expenditure, irrespective of whether convictions were recorded against the taxpayer, could not be regarded as normally to be expected in ordinary business transactions or, as in the instant case, to be resorted to as a matter of course by a director or an employee working in the interests of his employer in the course of gaining or producing his personal assessable income. In these circumstances, we take the view that the expenses in issue were essentially private in character in that the need for them arose out of the taxpayer's actions above-mentioned and were incurred by him for the purposes of protecting his personal good name and reputation. Therefore, the expenses fall to be excluded as a deduction under sec. 51(1) by the proviso included therein.

16. In arriving at the above conclusion, we have had regard to many decisions of the Courts and Boards of Review. However, for present purposes, it appears to be only necessary to draw detailed attention to the recent decision of the Full Federal Court in
Magna Alloys & Research Pty. Ltd. v. F.C. of T. 80 ATC 4542, in upholding the appeal by the company against the decision in favour of the Commissioner by Sheppard J. of the New South Wales Supreme Court reported at 78 ATC 4575. This case involved claims made by the company for legal expenses incurred by it in the defence of charges laid against its directors and agents for conspiracy and certain other offences. The directors, personally faced with serious criminal charges and the possibility of imprisonment, caused the expenditure to be incurred by the taxpayer company for their own personal needs and for those of its selling agents, who were also charged.

17. While Brennan J. delivered a separate judgment from that of Deane and Fisher JJ., the conclusions reached in both judgments may be regarded for present purposes as being basically the same. Their Honours concluded that Sheppard J. had found on one substantial evidentiary issue that the directors, personally faced with serious charges and the possibility of imprisonment, had caused the expenditure to be incurred by the taxpayer for their own personal needs. This the learned Judge saw as their dominant and principal reason, and fatal to the claim. However, Brennan, Deane and Fisher JJ. concluded that neither motive nor objective or subjective purpose is the criterion of deductibility. The statutory tests are the two limbs of sec. 51(1). Their Honours said that purpose in itself cannot be a decisive test because deductibility is conferred on involuntary outgoings (see
Charles Moore & Co. (W.A.) Pty. Ltd. v. F.C. of T. (1956) 95 C.L.R. 344, where the taxpayer was robbed of its takings and a deduction was allowed). The taxpayer's state of mind, whether relating to his intention, purpose or motive is evidentiary only. In cases where an outgoing

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is affected by the voluntary act of the taxpayer, the purpose of incurring expenditure may constitute an element of its essential character, thus stamping it as expenditure of a business or of an income earning kind. Their Honours concluded that the ends of the business required that an attempt should be made to defend the impugned conduct of its directors and agents, and the attempt was made. The necessary connection between expenditure so incurred and the carrying on of the business was thus established.

18. In our view the case of Magna Alloys is clearly distinguishable on its facts from those to be found in the instant case. Magna Alloys was engaged in the carrying on of a business, and accordingly could rely on both limbs of sec. 51(1). In the instant case the taxpayer was not carrying on a business and could only rely upon the first limb of the subsection. The expenditure in the case of Magna Alloys was incurred by the taxpayer in the defence of its directors and agents. In the instant case the taxpayer bore his own costs of defending the charges laid against him.

19. In the Magna Alloys case the Judges of the Federal Court stated that the outgoing was reasonably capable of being regarded as desirable or appropriate from the viewpoint of the business ends of that company and those responsible for the carrying on of its business so saw it. The perceived connection between the expenditure incurred and the carrying on of the business was evident because the case involved elements transcending the mere provision of legal representation for those whose activities on behalf of the taxpayer had subjected them to criminal prosecution. The taxpayer's own reputation was under public attack, and throughout most of the criminal proceedings in the County Court in Victoria it was named as a co-conspirator.

20. From the judgments in the Federal Court it is apparent that the interests of the taxpayer were inextricably involved with those of its directors and agents, and that it was plainly in the taxpayer's own interests that the directors and agents be properly represented. The attack which was made arose out of the day to day selling activities of the taxpayer, and it was the business purpose of vindicating the method by which it was conducted which brought the expenditure within sec. 51(1).

21. In the instant case there is no evident 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. The various charges laid against him relate to actions by him which in our view must be seen as being outside the scope of his duties as a director. It is not within the scope of the normal duties of a director to act in any kind of improper or dishonest way, or to act outside the provisions of statutes which may affect a business and its operations, e.g. the Companies Act and attendant sanctions. Clearly, in our view, such actions would not normally be in the interests of a company, its shareholders or in the public interest. In these circumstances, and based upon the evidence, we see no justification for concluding on the basis of the Magna Alloys decision, that the expenditures incurred by the taxpayer in defending the charges brought against him were incurred in deriving his assessable income in any year or, in the alternative, were other than expenses of a private nature.

22. However, if we are in error in our conclusions stated above, we would disallow the taxpayer's claims on the basis that the expenditure in each year was of a capital nature in that it was expended in an endeavour to retain or restore his position as a director and with it, a right to receive fees from existing directorships and others that may arise from other companies then either in existence or which may come into existence in the indefinite future.

23. Finally, we find it necessary to say that we found the taxpayer's evidence to be disjointed and inconclusive, with the consequence that we have experienced considerable difficulty in reciting the relevant facts as completely as we would have wished. Therefore, while we do not rely upon the provisions of sec. 190(b) in support of our decision, we have grave reservations as to whether it could properly be said that the taxpayer has adequately discharged the onus imposed upon him under that subsection of proving that the assessments in issue are excessive.

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24. For the reasons given, we consider that the Commissioner's decisions upon the objections were correct and that the assessments before us should be confirmed accordingly. In this conclusion, therefore, we find it unnecessary, if not irrelevant, to discuss in our reasons some preliminary matters concerning arithmetical and transposition errors which came under notice at the hearing and which have been examined by us. For the purposes of our reasons and decision, we have proceeded on what we consider to be the proper and only basis open to us, of confining our consideration to those specific items of legal expenses and amounts which were clearly stated to be in issue by the taxpayer in his grounds of objection.

Claims disallowed