Foxwood (Tolga) Pty. Ltd. v. Federal Commissioner of Taxation.

Members:
Dunn J

Tribunal:
Supreme Court of Queensland

Decision date: Judgment handed down 26 May 1978.

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Dunn J.: The appellant is a subsidiary of Foxwood Limited, to which company it sold its business on 30 June, 1976. It is a member of a group of companies; one of the activities of the group was the conduct of a sawmill at Mareeba, in North Queensland. The appellant functioned as a ``service company''; it employed the work force, or much of the work force, which operated the sawmill. The sawmiller, however, was Foxwood (Mareeba) Pty. Ltd., which paid the appellant a fee for the provision by the latter of the labour force. The components of the appellant's income for the year ended June 30, 1976, were interest (on a loan due to it from another company), ``labour sales'' (meaning, the fee paid for the provision of the work force), and Workers' Compensation bonuses.

Some time before June 30, 1976, it was decided that Foxwood Limited should become the sawmiller and also the employer of the work force. This decision gave rise to a contract by which the appellant sold its undertaking to Foxwood Limited. The contract bears date 29 June, 1976. The price was an amount to be determined by the appellant's accountants and auditors, Messrs. C.E. Smith and Co. Clauses 24 and 25 of the contract provided as follows: -

``24. The Purchaser shall take over and assume the whole of the liabilities of the Vendor as at 30th June, 1976 and indemnify and save harmless the Vendor from and against the same.

25. The Purchaser shall take over all the Vendor's employees employed in the Vendor's business on the 30th June, 1976 and on and from that date the Purchaser shall be liable to make holiday, sick leave and long service leave payments accruing or owing before or after that date provided that the Vendor shall pay to the Purchaser on the 30th June, 1976, an appropriate amount as shall be determined by C.E. Smith & Co. as the employees' accrued entitlement for long service leave and holiday and sick pay.''

Messrs. C.E. Smith & Co. determined that ``the employees' accrued entitlement for long service leave and holiday and sick pay'', to use the language of cl. 25, was $11,658.78, and the

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appellant paid that amount to Foxwood Limited on 30 June. The appellant claims that $8,897.00 of the amount so paid ``is deductible under sec. 51(1) of the Income Tax Assessment Act as being a loss or outgoing incurred in gaining or producing assessable income or being an expense necessarily incurred in carrying on a business for the purpose of producing assessable income''; and that ``the payment of the said sums totalling $8,897.00 was made in pursuance of a contract entered into in the ordinary course of carrying on a business''.

The quotations are from the appellant's Notice of Objection against the respondent's assessment of income tax with respect to its income for the year ended 30 June, 1976. The references to ``the said sums'' are references to two sums totalling $8,897.00, namely $2,913.00 (said to represent ``the legal entitlement of employees to long service leave'') and $5,984.00 (said to represent ``the legal entitlement of employees to holiday pay''). It goes without saying that the appellant had claimed in its income tax return that the $8,897.00 paid was deductible, and that the respondent disallowed this claim.

Prior to the hearing, the respondent was asked to clarify the basis upon which the claim had been disallowed, and the question for determination was stated in clear and simple terms by learned Senior Counsel for the respondent as follows:

``The issue is whether the appellant is able to bring the claims for deduction within the provisions of sec. 51.''

In order to understand how the amount of $8,897.00 was arrived at, and the contention advanced on behalf of the appellant, it is necessary to refer to certain provisions of the Industrial Conciliation and Arbitration Act 1961-1976 (Qld.), and of the Awards which governed the employment of the work force (with respect to long service leave and to holiday pay); and to state some facts concerning the workers.

Section 17 of the Industrial Conciliation and Arbitration Act provides for the insertion in Awards of provisions ``entitling employees to long service leave on full pay under, subject to, and in accordance with the provisions of this section''. The Award or Awards governing the two members of its work force upon whose service (to the extent that it gave them rights with respect to long service leave) the appellant relied incorporated by reference sec. 17.

Section 17(2) is in the following terms: -

``(2) The entitlement of any and every employee to long service leave on full pay pursuant to this section shall be in respect of his continuous service with one and the same employer (whether wholly within or partly within and partly without Queensland) and the amount and further amounts of that long service leave shall -

• (a) in the case of an employee who shall have completed a period of fifteen years' continuous service with one and the same employer, be thirteen weeks;
• (b) in the case of an employee who shall have completed a period of ten years' service but less than fifteen years' service with one and the same employer and who himself terminates that service, or whose employer terminates that service for any cause other than serious misconduct, or who dies, be a proportionate amount on the basis of thirteen weeks for fifteen years' service;
• (c) in the case of an employee who, after completing the first or a subsequent period of fifteen years' service with one and the same employer, continues that service until he shall have completed a further period of fifteen years' service with that employer, be a further thirteen weeks; and
• (d) in the case of an employee who, after completing the first or a subsequent period of fifteen years' service with one and the same employer continues that service until he shall have completed at least a further five years' service but less than a further fifteen years' service with that employer, and who himself terminates that service, or whose employer terminates that service, for any cause other than serious misconduct, or who dies, be a proportionate further amount on the basis of thirteen weeks for fifteen years' service:''

There is an immaterial proviso.

It will be noted that fifteen years' continuous service gives an employee an entitlement to a period of long service leave of thirteen weeks. Prior to 1964, the legislation

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provided that an entitlement to thirteen weeks long service leave accrued upon the completion of twenty years' continuous service. Provision is made by subsec. (6) of sec. 17 for calculating periods of service, and entitlements, of employees employed before and after 11 May, 1964 (the date upon which the ``fifteen years' continuous service'' provision took the place of the earlier provision).

Section 17(7) provides as follows: -

``For the purposes of this section -

• (a)...
• (b) where the services of an employee are transferred by one employer to another employer (in this paragraph called the `second employer') the periods of service had with them respectively by that employee which, if they were one and the same employer would aggregate unbroken continuous service shall be taken into account in calculating the length of the continuous service had by that employee with the second employer, and shall be deemed to be service had by him with that employer.
• (c)...

Notwithstanding anything hereinbefore contained in this subsection, in the case of any employee to whom paragraph (b) of this subsection applies, any period of service with the employer who transferred his services in respect whereof that employee has received long service leave on full pay pursuant to his entitlement thereto under this section, shall not be taken into account in calculating the aggregate of the service to which paragraph (b) of this subsection is expressed to apply had by him.''

Section 17(16) provides that, for the purposes of sec. 17, ``where the calling carried on by a person who is an employer shall have been before, or shall be on or after, the said date transmitted to another person by operation of law or by agreement between them, that transmission shall be deemed not to have broken or otherwise affected or to break or otherwise affect, the continuity of the service of any employee whose service shall have been or shall be, upon the transmission aforesaid, transmitted from the one to the other person aforesaid...'' The meaning of the expression ``the said date'' is immaterial.

The appellant had two employees each of whom had served a succession of employers and whose service was, on 30 June, 1976, because of the provisions which I have quoted, deemed to have been continuous service with the appellant. A Mr. Edwards was one. He had first commenced employment with Foxwood (Mareeba) Pty. Ltd. on 20 April, 1955, and had not taken any of his long service leave entitlement. It was calculated (and the accuracy of the calculation was not disputed) that had his employment been terminated by the appellant on 30 June, 1976, and had he then been paid his long service leave entitlement, the amount would have been $1,784.38. A Mr. Dodds was the other. He had first commenced work on 4 March, 1946, for Messrs. Lawson and Son, a partnership, and his services had been transferred to Foxwood (Mareeba) Pty. Ltd., and thereafter to the appellant. He took a period of long service leave of thirteen weeks between 9 April, 1975, and 8 July, 1975. It was calculated (and again the accuracy of the calculation was not disputed) that had he ceased his employment with the appellant on 30 June, 1976, and had he then been paid what was due to him in respect of long service leave, the amount would have been $1,128.51. None of the other employees had completed a period of ten years' service, and consequently none of the others had the right (albeit a defeasible right) to ``pro rata'' long service leave which might have been given by sec. 17(2)(b) of the legislation.

Section 15 of the Industrial Conciliation and Arbitration Act makes provision for annual holidays, and there were provisions in this regard in the Awards which governed the appellant's workers. Each employee was entitled to three weeks' annual holiday. The provisions had the effect that, when the employment of an employee who had not taken his holiday was terminated, the employer was deemed to have given him the holiday on the date of termination of the employment, and was obliged to pay him holiday pay. If the employment of an employee was terminated before the end of a year of service which would entitle him to three weeks' holiday, the employee was entitled to be paid an appropriate fraction of full holiday pay, calculated by reference to the date of commencement of employment or the date when he had last become entitled to his annual holiday.

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On 30 June, 1976, the appellant had seventeen employees. A Mr. V.R. Troughton had become entitled to his annual holiday on 9 June, but had not taken it. The others would become entitled to annual holidays later in 1976 or during the first half of 1977. Had the employment of all workers been terminated on 30 June, 1976, and had they then been paid what would have been due to them by way of holiday pay, the total amount paid (as calculated by the appellant) would have been $5,984.01. The correctness of this calculation was not disputed by the respondent.

The amount of $8,897.00, claimed to be deductible, is made up by adding together the long service leave ``entitlements'' of Messrs. Dodds and Edwards (totalling $2,913.00) and adding to this total the holiday pay ``entitlement'' of the work force ($5,984.00). The payment to Foxwood Limited was, as has been said, $11,658.78. The difference between the amount of the payment and the amount claimed to be deductible is accounted for by the circumstances that $2,762.00 of what was paid related to long service leave to which ``the employees did not have an absolute entitlement'', to use the language used by the appellant in its return, and that $173.00 of what was paid represented sick pay, to which ``the employees did not have an absolute entitlement''. What was meant by that term was that the employees' entitlement was in the process of accruing. (It was thought appropriate to make provision in the appellant's accounts for what would, in all probability, become an entitlement of the employees.)

For the sake of completeness, some further facts concerning the sale to Foxwood Limited and the employment of the work force should be stated. The price was, as contemplated by the contract, determined by Messrs. C.E. Smith & Co. not long after 30 June, and book entries were made to establish the indebtedness of the purchaser company. It is not, however, suggested that the transaction was other than bona fide. The work force was paid on 2 July (Friday) by the appellant, the pay covering one week's work concluding on the previous Wednesday (which was, coincidentally, 30 June). Foxwood Limited next paid the workers, on 9 July, for work done during the week ending 7 July.

On that day, each worker was given a pro forma document which read as follows: -

``The Foxwood Group of Companies has been re-arranged to streamline administrative functions. The effective date is July 1, 1976, and as from that date you are employed by Foxwood Limited. Your continuity of service as regards long service leave, holidays and sick leave will not be affected.

We confirm that your transfer to Foxwood Limited is on the following terms: -''

There followed details concerning the wage payable, allowances and an ``attendance payment''. The document concluded with the words, ``Please confirm these terms by signing this form''. It does not appear that any worker failed to sign the form.

I do not regard any of the foregoing events as destructive of the appellant's claim, if it be otherwise valid.

Section 51(1) of the Income Tax Assessment Act provides as follows: -

``All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income.''

I was referred to many decided cases by Counsel. I have read them all, but it does not seem to me to be necessary to do more than state the principles which are relevant to the determination of this appeal. (I shall, however, refer to one case at the end of these reasons.) The principles appear to me to be these: -

1. To be deductible, the expenditure must be incidental and relevant to the operations or activities regularly carried on for the production of income.

2. The words ``the assessable income'' in sec. 51 mean assessable income of the taxpayer generally, without regard to division into accounting periods.

3. A liability may be a loss or outgoing which has been ``incurred'' within the meaning of sec. 51, even though it remains unpaid, provided that the taxpayer has completely subjected himself to the liability; he may completely subject himself to the liability, notwithstanding that the liability is defeasible.

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4. There may be cases in which a payment, though made ``once and for all'', will be properly chargeable against receipts.

5. The true legal character of a payment must be examined in order to determine whether the payment is deductible, and not the economic result sought to be obtained by making the payment.

The effect of the transfer of the appellant's business to Foxwood Limited was that the appellant ceased to be liable to pay anything in respect of long service leave to either Mr. Edwards or Mr. Dodds, for the service which those gentlemen had with the appellant is now deemed to be service with Foxwood Limited. This being so, the payment to Foxwood Limited of so much of what was paid (pursuant to cl. 25 of the contract) as related to that company's impending liability to those gentlemen cannot, in my opinion, fairly be described as incidental and relevant to their employment by the appellant (which employment was of course with a view to the production of income). Rather was it incidental and relevant to the transfer of the business.

As to holiday pay, the appellant became liable to pay such pay to all of its workers, and it has never paid it. Instead, it paid to Foxwood Limited an amount equal to its liability to the workers. The contract does not to my mind bear the construction (nor was it argued) that Foxwood Limited took the money as trustee for the workers. I regard the purpose of the payment as being to enable Foxwood Limited to make provision for payment of holiday pay, in due course, to the workers whom it ``took over''. That being so, I do not regard the payment as incidental and relevant to the past employment of the work force (which was of course employed with a view to the production of income). I regard the payment as incidental and relevant to the transfer of the business.

The loss or outgoing of $8,897.00 was analogous with the loss or outgoing referred to in
Peyton v. F.C. of T. (1963) 109 C.L.R. 315. In that case, this passage occurs at p. 321: -

``He incurred the loss or outgoing, therefore, not in gaining or producing the assessable income but in parting with the means by which he had been gaining and producing it; not in carrying on the business for the purpose of gaining or producing such income, but in disposing of the business and ceasing thereby to gain or produce such income.''

The loss or outgoing was incurred in turning the appellant into a ``shell'' of a company, to use the expressive language used by one witness. The appeal is therefore dismissed.