SUPREME COURT OF NEW ZEALAND

KELLY v INLAND REVENUE COMMISSIONER (NZ)

FREED v INLAND REVENUE COMMISSIONER (NZ)

Woodhouse, J.

9, 10 June, 20 August 1969 - Hamilton

Woodhouse, J This appeal concerns identical questions raised by four separate cases stated pursuant to s 30 of the Inland Revenue Department Amendment Act 1960. By consent they have been heard together. In its simplest form the issue is whether, by certain declarations of trust, the two appellants succeeded (for the years concerned) in alienating income yet to be earned by two of their business partnerships, or whether, for tax purposes, they themselves first derived the income and managed merely to make arrangements for its subsequent application elsewhere.

The facts may seem artificial and contrived, but they are uncomplicated. The businesses were concerned with the discounting of promissory notes and similar financial transactions, and their capacity to trade depended upon advances of money by the two partners. Profits were shared on a basis proportional to the advances each man had made during given periods, but there were no partnership agreements. Their relations being governed by the Partnership Act 1908, the partnerships were terminable at the will of either partner at any time.

On 29 March 1957 each appellant independently executed two deeds referable to one or the other of the businesses. Each appointed the other his sole trustee and each declared that he held "his interest in the said business as to such income as aforesaid from time to time earned thereby" upon trust for the other's child or (in one case) the child and two nieces of the other. Subject to an adjustment, which I will mention later, the profits were duly applied as contemplated by the deeds and neither appellant included them in his personal returns of income for the years under review. But the Commissioner of Inland Revenue held that the profits had not been effectively alienated and assessed the amounts involved to the appellants personally. The assessments were upheld by the Taxation Board of Review; hence the appeals to this Court.

Although the dispositions did not include any income-producing assets, s 105 of the Land and Income Tax Act 1954 (NZ) is inapplicable because neither appellant has named a relative of his own as a beneficiary. Conversely, each has named a relative of the other. And whatever effect s 108 could have upon the arrangements they made, that section was not relied upon by the Commissioner when making his assessments and has not been referred to at any stage of the proceedings. The Commissioner's case is simply that the documents were not immediately effective to divest the appellants of the income which still had to be earned when the documents were signed and that for tax purposes the appellants continued to derive the income as it accrued no matter what they may subsequently have done with it. The three grounds for this contention are:-

(1) that the declarations of trust relate to future property and are not, as submitted for the appellants, assignments of an existing right to receive profits yet to be made;

(2) that being referable to future property the documents do not amount to contracts to create a trust as they were made without consideration; and

(3) that in any event the income depended upon the services of the appellants and so was necessarily derived by them personally whatever they may have decided concerning its subsequent application.

The first two grounds for the stand taken by the Commissioner refer to the principle that an existing proprietary right is capable in equity of immediate effective assignment despite an absence of consideration, but a future chose in action is not. In the case of a disposition of something still to come into existence, consideration is necessary so that the assignment can operate at once as if it were a binding contract to assign the anticipated asset: then, when it does come into existence, the equitable ownership in it passes automatically to the assignee. These general principles (which have not been the subject of argument in the present case) may be found succinctly expressed and explained in Williams v Inland Revenue Commissioner (NZ) (1964), 10 AITR 601, at pp 602-3; [1965] NZLR 395, at pp 398-9; and see Salmond & Williams on Contracts, 2nd ed, at pp 461 et seq.

The first question, then, is whether the purported assignments relate to present proprietary rights or to something yet to be brought into existence. In my opinion they clearly refer to a mere expectancy. Submissions based upon the form of the deeds were advanced on behalf of the appellants that each assignment is of an existing "interest in the said business" even though that interest is stated to be limited to income; and that, unlike the intended disposition in Williams' Case, supra, of a quantified amount of future income, the assignments in the present case were designed to dispose of the whole of the income which would accrue from each partner's interest in the business concerned. But these arguments overlook the plain fact that the trusts do not purport to be assignments of any interest or share in the partnerships; they deal simply with "income from time to time earned" by the partnership activities. Such a trust cannot be regarded as an assignment of anything already existing. It is merely an intended disposition of income which still had to be earned, and something, moreover, that depended entirely upon the continued survival of a relationship between the appellants which either could terminate at any time. When the documents were executed nobody could say whether profits could or would be made, or even whether the partnerships themselves would continue to have existence. The issue, therefore, is not whether all or merely a part of the future income has been made the subject-matter of the deeds, but simply that contemplated profits at the time the deeds were executed might never arise, and so the subject-matter of each deed was no more than a mere expectancy or possibility.

The second question is whether the future income was assigned for consideration. As to this the appellants do not suggest that consideration passed from the beneficiaries or that the latter could directly enforce the trusts. Instead the submission is that consideration passed between the partners because the trusts were mutually made as the result of an exchange of promises that the respective obligations contained in the deeds would be discharged. On the basis of such a contract between the partners it is said that either could obtain specific performance of the undertaking by the other.

It is an ingenious argument, but I do not accept it for a number of reasons. First, there is the question as to whether in fact a contract was made between the partners at all. There is an absence in the documents of any reference to an agreement that the appellants intended to provide mutual benefits for one another's families or that the one set of documents had been executed in consideration of the other. Nor is there anything in the transcript of evidence which supports the claim that such a contract should be implied in the circumstances of the case. Indeed, if some of the evidence is taken literally it would tend rather to rebut such a presumption. The motive which inspired the arrangements may seem obvious enough; but whether there was consideration associated with an intention to enter into a contractual relationship is something different. It certainly is surprising to me that trouble was taken to prepare four separate but contemporaneous documents if they were intended to be interdependent; and I have serious doubts on the facts of the case as to whether any contract was actually made, whatever one might conclude as to the tax objectives the appellants had in mind. It may be helpful, nevertheless, if I go on to consider the legal implications arising from the submission advanced on behalf of the appellants and for this purpose I will assume in their favour that they made the sort of contract put forward on their behalf by Mr Mahon.

For the appellants it is submitted on the authority of Beswick v Beswick, [1967] 2 All ER 1197, that a contract made by A with B to benefit C is specifically enforceable by B; and accordingly that each partner could ensure that the other did in fact pass over the appropriate share of income for the beneficiaries concerned. But in my opinion this argument circumvents the real issue involved. The central question in the case is whether for tax purposes the appellants derived the partnership income as it accrued and before it was applied elsewhere or whether (as they must contend) the arrangements they had made had the effect of automatically alienating the income in advance, or at least as it accrued. It is not to the point that the income must eventually be applied in terms of some bargain arrived at independently of the volunteer assignees concerned. Rather it is whether the partners' right to the income was disposed of in such a way that they did not themselves derive it before its application. In the one case the disposition of the income in favour of the intended assignee could not be enforced until it had been derived, and then only by the voluntary intervention of the other party to the contract. In the other the equitable ownership must be shown to have passed automatically as soon as the anticipated property comes into existence.

As Turner, J, pointed out in the joint judgment of North, P, and himself in Williams' Case (10 AITR, at p 602; [1965] NZLR, at p 399) equity will not recognize "in favour of a volunteer" an assignment of future property; but if made for consideration an agreement to assign such property will be immediately effective because equity is able to assist the assignee by regarding him as having the equitable interest in it as soon as it comes into existence. In my judgment this principle has no application to independent arrangements concerning future property which may have been for the benefit of third party volunteers and which would require the co-operation of other persons for enforcement. For this reason alone I am satisfied that if, in fact, the appellants did make a contract concerning the intended dispositions of income, nevertheless the income was first derived by them for tax purposes and before it was subsequently applied in terms of the arrangement they had decided upon.

But other difficulties face the appellants. Their case depends upon a purported alienation of a right to partnership income in isolation from the interest which the parties continued to enjoy in their partnership business. The question thus arises as to whether a right to share in partnership income can exist independently of the specified share in the partnership. I do not think this to be possible. For reasons explained by Windeyer, J, in Bolton v Federal Commissioner of Taxation (1964), 9 AITR 385, at pp 389 and 395(and see Johnstone v Inland Revenue Commissioner (NZ) (1966), 10 AITR 222; [1966] NZLR 833), it is clear enough that one partner's interest in the capital of a partnership is not something which can be quantified and assigned separately from the share in the partnership itself. During the continuance of the partnership a partner can assign all or part of his share in it and consequentially the right to prospective profits and any interest he may have in partnership capital. But such a share is not a thing separate from the share of another partner. It is a fractional interest in a surplus of assets over liabilities on a winding-up and a fractional interest in the future profits of the partnership business. Accordingly, "if A and B, being partners in equal shares, purport to exchange their shares one for another they accomplish nothing" (see Bolton's Case, supra, at p 395). If this be the position concerning a capital interest or the fractional share in the partnership a fortiori it must be the position in relation to shares in prospective partnership income. In the case of one of the two partnerships in the present case the profits were shared equally because the advances by each partner were of equal sums. In so far as this partnership is concerned the purported transpositions of similar fractional shares of income from the one man as a partner to the other as trustee were meaningless; and on this ground arguments fall down, in my opinion, that valuable consideration passed from one partner to the other. In the other partnership the profits were shared unequally; but here the partners took steps to prevent any effective disposition of each share in favour of the relative of the other. In fact and in law, therefore, it is my opinion that each appellant really dealt throughout with his own shares of income and for tax purposes the transactions were nugatory.

A final issue should be mentioned. It relates to the third of the grounds relied upon by the Commissioner to the effect that the income depended upon the services of the appellants and so was necessarily derived by them personally. I think that this must be so. The partnership earnings were dependent upon the organization and personal effort of the partners. The gross income of the businesses necessarily was earned by and belonged to the partners and unless it could be said that those businesses were being carried on as such for the beneficiaries (a suggestion which the documents specifically reject) then I am unable to avoid the conclusion that the appellants in their capacity as partners derived the residual net income or profit. As Henry, J, said in Spratt v Inland Revenue Commissioner (NZ) (1963), 9 AITR 277, at p 280; [1964] NZLR 272, at p 277: "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 matter he may adopt to dispose of it."

In my opinion a passage to be found in Cunningham and Thompson's Taxation Laws of New Zealand, 6th ed, vol 3, at p 3059, correctly states the law. There it is said: "Income from personal exertion such as salary, wages, income from business or income from a partnership cannot be assigned so that it is not first received as income by the assignor. There can be no present capital right, no existing right to receive future income from these sources. All an assignor can do is to bind himself to earn the income and to hand it over, i.e. apply it, when he receives it. When he receives it he receives it as owner. It is his income."

For the various reasons which I have given, I am of the opinion that the assessments of the Commissioner were correct and that the Taxation Board of Review reached the correct conclusions concerning those assessments. The formal answers contained in the cases stated will be answered accordingly. Each appellant must pay $60 costs to the respondent upon the present appeals.