Arthur Murray (NSW) PTY LTD v Federal Commissioner of Taxation

(1965) 114 CLR 314
14 ATD 498

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(Judgment by: Barwick C.J., Kitto and Taylor JJ.)

ARTHUR MURRAY (N.S.W.) PTY. LTD.
v FEDERAL COMMISSIONER OF TAXATION

Court:

Judge:
Barwick C.J., Kitto and Taylor JJ.

Judgment date: 18 November 1965

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Judgment by:
Barwick C.J., Kitto and Taylor JJ.

This is a case stated by the Chief Justice under the authority of s. 18 of the Judiciary Act in five pending appeals from decisions of a Board of Review under the provisions of the Income Tax and Social Services Contribution Assessment Act 1936 as amended. The years of income to which the appeals relate are those ended on the 30th June in the years 1954, 1955, 1956 and 1957. Four of the appeals are by the taxpayer company and relate to amended assessments in respect of each of the first three of those years and an original assessment in respect of the fourth. The fifth appeal is by the Commissioner and is in respect of the fourth year, the Board having directed that the assessment for that year be amended.

As the argument proceeded it became clear that only the first of the questions in the case stated requires a formal answer. The facts relevant to that question are few and simple. In the relevant years the company carried on a business of giving courses of tuition in dancing for fees of varying amounts per hour. What the case describes as basic courses of tuition available consisted of 5, 15 or 30 hours of private tuition to be taken by appointment within a year, though some students contracted for a course of 1,200 hours' tuition to be taken at any time during the student's lifetime. Payment for a course of lessons was often made in advance, either in the form of a lump sum or by instalments, a variable discount being allowed for immediate payment. For example, the fee for a lifetime course of 1,200 hours was 3,300 pounds, reducible to 3,000 pounds for immediate payment. The student was given no contractual right to a refund in the event of his not completing the course - indeed the form of contract in general use denied any such right - though in practice refunds were sometimes given. In the company's books, fees were credited immediately upon their being received to an account styled "Unearned deposits - Untaught Lessons Account", and from that account amounts corresponding with lessons taught were periodically transferred to the credit of an account styled "Earned Tuition Account". The company made up its income tax returns on the footing that fees received in advance of tuition formed no part of its assessable income at the moment of receipt, but became such as and when earned by the giving of the lessons.

The Commissioner, on the other hand, made the relevant assessments upon the view that fees received in advance of tuition possessed the character of assessable income in the company's hands from the moment of receipt, so that in respect of a given year of income there was no need to distinguish between fees for which lessons had been given during the year and fees for which at the end of the year the lessons still remained to be given. The question to be decided is, in effect, whether on the facts as stated it is open to the Justice hearing the appeals to uphold the Commissioner's view.

The problem is, in a sense, the converse of that to which the Court addressed itself in Commissioner of Taxes (S.A.) v. Executor Trustee and Agency Co. of South Australia Ltd. (Carden's Case) (1938) 63 CLR 108 . The question there was whether fees earned by a doctor in his medical practice might be treated as assessable income of the year in which they were earned even though not received in that year ; and it was held, as regards each year which had ended before the doctor's death, that earning without receipt did not make income. In the case before us the question is whether, in the circumstances, it may properly be held that receipt without earning makes income.

As Dixon J. observed in Carden's Case (1938) 63 CLR 108 : "Speaking generally, in the assessment of income the object is to discover what gains have during the period of account come home to the taxpayer in a realized or immediately realizable form" (1938) 63 CLR, at p 155 . The word "gains" is not here used in the sense of the net profits of the business, for the topic under discussion is assessable income, that is to say gross income. But neither is it synonymous with "receipts". It refers to amounts which have not only been received but have "come home" to the taxpayer; and that must surely involve, if the word "income" is to convey the notion it expresses in the practical affairs of business life, not only that the amounts received are unaffected by legal restrictions, as by reason of a trust or charge in favour of the payer - not only that they have been received beneficially - but that the situation has been reached in which they may properly be counted as gains completely made, so that there is neither legal nor business unsoundness in regarding them without qualification as income derived.

The ultimate inquiry in either kind of case, of course, must be whether that which has taken place, be it the earning or the receipt, is enough by itself to satisfy the general understanding among practical business people of what constitutes a derivation of income. A conclusion as to what that understanding is may be assisted by considering standard accountancy methods, for they have been evolved in the business community for the very purpose of reflecting received opinions as to the sound view to take of particular kinds of items. This was fully recognized and explained in Carden's Case (1938) 63 CLR 108 , especially in the judgment of Dixon J. ; but it should be remarked that the Court did not there do what we were invited to do in the course of the argument in the present case, namely to treat the issue as involving nothing more than an ascertainment of established book-keeping methods. A judicial decision as to whether an amount received but not yet earned or an amount earned but not yet received is income must depend basically upon the judicial understanding of the meaning which the word conveys to those whose concern it is to observe the distinctions it implies. What ultimately matters is the concept ; book-keeping methods are but evidence of the concept.

It was Dixon J.'s understanding of the concept that is reflected in his Honour's judgment in Carden's Case (1938) 63 CLR 108 where he said: "If in a given medical practice there is but little certainty about the payment of fees, I should have thought that a receipts basis of accounting would alone reflect truly the income and for most professional incomes it is the more appropriate" (1938) 63 CLR, at p 159 . Thus, in determining whether in such a case actual receipt had to be added to earning in order to find income, uncertainty of receipt, inherent in the circumstances of the earning, appeared to his Honour to be decisive. Likewise, as it seems to us, in determining whether actual earning has to be added to receipt in order to find income, the answer must be given in the light of the necessity for earning which is inherent in the circumstances of the receipt. It is true that in a case like the present the circumstances of the receipt do not prevent the amount received from becoming immediately the beneficial property of the company; for the fact that it has been paid in advance is not enough to affect it with any trust or charge, or to place any legal impediment in the way of the recipient's dealing with it as he will. But those circumstances nevertheless make it surely necessary, as a matter of business good sense, that the recipient should treat each amount of fees received but not yet earned as subject to the contingency that the whole or some part of it may have in effect to be paid back, even if only as damages, should the agreed quid pro quo not be rendered in due course. The possibility of having to make such a payment back (we speak, of course, in practical terms) is an inherent characteristic of the receipt itself. In our opinion it would be out of accord with the realities of the situation to hold, while the possibility remains, that the amount received has the quality of income derived by the company.

For that reason it is not surprising to find, as the parties in the present case agree is the fact, that according to established accountancy and commercial principles in the community the books of a business either selling go ods or providing services are so kept with respect to amounts received in advance of the goods being sold or of the services being provided that the amounts are not entered to the credit of any revenue account until the sale takes place or the services are rendered: in the meantime they are credited to what is in effect a suspense account, and their transfer to an income account takes place only when the discharge of the obligations for which they are the prepayment justifies their being treated as having finally acquired the character of income.

The paragraph of the case stated in which the established principles are described does not leave to inference why it is that books are kept in this manner. It is there specifically stated, as an agreed fact, that according to established accounting and commercial principles, in the case of a business either selling goods or supplying services, amounts received in advance of the goods being delivered or the services being supplied are not regarded as income. We have not been able to see any reason which should lead the courts to differ from accountants and commercial men on the point. Neither, apparently, has the Taxation Department seen any reason in principle, for we are told that the Department was accustomed to take the view we have expressed until an opinion grew up that to do so was in some way inconsistent with the judgment of this Court in the case of Federal Commissioner of Taxation v. James Flood Pty. Ltd. (1953) 88 CLR 492 . The Court there held that, while commercial and accountancy practice may assist in ascertaining the true nature and incidence of an item as a step towards determining whether the item answers the test laid down in the Act for allowable deductions, it cannot be substituted for the test. In so far as the Act lays down a test for the inclusion of particular kinds of receipts in assessable income it is likewise true that commercial and accountancy practice cannot be substituted for the test. But the Act lays down no test for such a case as the present. The word "income", being used without relevant definition, is left to be understood in the sense which it has in the vocabulary of business affairs. To apply the concept which the word in that sense expresses is not to substitute some other test for the one prescribed in the Act; it is to give effect to the Act as it stands. Nothing in the Act is contradicted or ignored when a receipt of money as a prepayment under a contract for future services is said not to constitute by itself a derivation of assessable income.

On the contrary, if the statement accords with ordinary business concepts in the community - and we are bound by the case stated to accept that it does - it applies the provisions of the Act according to their true meaning.

We have been referred to the case of Schlude v. Commissioner of Internal Revenue (1963) 372 US 128 (9 Law Ed 2d 633) , but a careful reading of the judgments in that case and the earlier cases mentioned in it, and particularly the judgments in the Court of Appeals for the Eight Circuit (1960) 283 F 2 nd 234 , seems to us to show that because of differences between the United States and Australian systems of income tax law no substantial assistance in the present case is to be gained from the American cases.

In our opinion, on the facts appearing in the case stated the conclusion is not open that a receipt of fees for a specified number of dancing lessons to be given over a future period is a derivation of assessable income.

We would answer Question 1 accordingly.