Case U84

Members:
KL Beddoe SM

Tribunal:
Administrative Appeals Tribunal

Decision date: 14 March 1987.

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K.L. Beddoe (Senior Member)

The question at issue is whether sec. 26AD applies to an amount of $2,445 received by the applicant during the year of income ended 30 June 1980 as a lump sum payment.

2. The relevant statutory provisions in the Income Tax Assessment Act 1936 are as follows:

"26AD(1) This section applies to any amount paid after 15 August 1978 (whether voluntarily, by agreement or by compulsion of law) to a taxpayer in a lump sum in consequence of the retirement of the taxpayer after that date from any office or employment or in consequence of the termination after that date of any office or employment of the taxpayer, being an amount that is paid in respect of unused long service leave.

(2) Where -

• (a) an amount to which this section applies is paid to a taxpayer in a year of

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  ATC 486

  income in respect of unused long service leave; and
• (b) the eligible service period in relation to that unused long service leave commenced after 15 August 1978,

the assessable income of the taxpayer of the year of income shall include the amount of the payment.

...

(8) In this section, `long service leave' means -

• (a) long service leave, long leave, furlough, extended leave, or leave of a similar kind (however described) to which a person has an entitlement by virtue of a law of the Commonwealth or of a State or Territory, an award, determination or industrial agreement in force under any such law, a contract of employment or the terms of appointment to an office;
• (b) leave (other than leave that is annual leave for the purposes of section 26AC) to which a person has an entitlement by virtue of a scheme or arrangement by reason of the existence and nature of which the employer of the person has secured exemption from obligations to comply with a law of the Commonwealth or of a State or Territory relating to long service leave, long leave, furlough, extended leave or leave of a similar kind (however described); or
• (c) leave that may be made available to a person as a privilege, being leave the availability of which is determined by reference to matters similar to matters by reference to which entitlement to leave referred to in paragraphs (a) and (b) is ordinarily determined.

...

90 In this Division -

• `exempt income', in relation to a partnership, means the exempt income of the partnership calculated as if the partnership were a taxpayer who was a resident;
• `net income', in relation to a partnership, means the assessable income of the partnership, calculated as if the partnership were a taxpayer who was a resident, less all allowable deductions except the concessional deductions and deductions allowable under section 80, 80AA or 82AAT;
• `partnership loss', in relation to a partnership, means the excess (if any) of the allowable deductions, other than the concessional deductions and deductions allowable under section 80, 80AA or 82AAT, over the assessable income of the partnership calculated as if the partnership were a taxpayer who was a resident.

...

92(1) The assessable income of a partner in a partnership shall include -

• (a) so much of the individual interest of the partner in the net income of the partnership of the year of income as is attributable to a period when the partner was a resident; and
• (b) so much of the individual interest of the partner in the net income of the partnership of the year of income as is attributable to a period when the partner was not a resident and is also attributable to sources in Australia."

3. The facts of this case are relatively straightforward.

4. The applicant was appointed and employed by a firm of graziers on 15 August 1965 as full-time manager of two of the firm's cattle and sheep grazing properties. He continued to be employed as manager until 31 December 1971. During this period the applicant had no proprietary interest in the business. Salary was paid to him each year on an annual basis. As from 1 January 1972 the applicant became a minor partner (5.3% interest) in the firm (Exhibit B) so as to satisfy rural reconstruction requirements which apparently required that a grantee of concessional rate finance must be managed by a proprietor of the business. The reason for the applicant becoming a member of the firm is, however, irrelevant to the issue to be decided. It was not denied that the applicant was a partner in the firm.

5. What is relevant is that the applicant continued to occupy and perform the functions of manager of the firm's properties and he

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ATC 487

continued to draw an annual salary from the firm over and above his share of the profit of the business.

6. During the year ended 30 June 1980 (the relevant year) the firm sold both of their grazing properties. The business of winding up the partnership's affairs continued into the next financial year but what is presently relevant is that in the course of winding up those affairs the applicant was paid the amount of $2,445 during the year ended 30 June 1980. This amount was included in the amount of $11,819 described in the firm's income tax return as partners salaries being portion of the net income of the partnership distributed to the members of the partnership.

7. In the applicant's income tax return for the year ended 30 June 1980 he returned the amount of $2,445 as follows:

7A     Payment in respect of unused annual leave (including leave
       bonus) and for unused long service leave which accrued
       after 15 August 1978                                              $284
7B     5% of payments other than those shown in Item 7A (total
       received $21,610 1/20)                                            $108
NOTE:  Lump sum is in respect of period 15/8/65 to 30/4/80             $2,445
       4749 days to 15/8/77 (sic)                                      $2,161
       624 days after 15/8/77 (sic)                                      $284
      

8. The respondent Commissioner added back an amount of $2,053 as assessable income thereby assessing in full the amount of $2,445. No doubt the Commissioner either wittingly or unwittingly was following the decision of Taxation Board of Review No. 3 in Case C22
(1952) 3 T.B.R.D. 142 which applied the law as stated by the High Court in
Rose v. F.C. of T. (1951) 84 C.L.R. 118; 9 A.T.D. 334. The factual situation in Case C22 was identical in all material respects to the facts of this application.

9. The applicant failed to establish at the hearing the basis for calculation of the payment of the amount of $2,445. Evidence was before the Tribunal of a letter (Document T6) from the senior partner of the firm (now deceased) to a Deputy Commissioner of Taxation in the following terms (edited to maintain confidentiality):

"(Applicant) was employed to manage our family partnership from 15 August 1965 to 30 April 1980.

Until the end he received no long service leave, or cash in lieu thereof. When it seemed certain we had sold the properties in 1980, I asked our accountants (a professional firm), to work out the long service leave due to him. They advised me to pay him $2,445, which is for leave over the whole period."

10. No evidence was given as to how the $2,445 was calculated. It was established that the applicant was not employed under an industrial award and that there was in fact no award for station managers.

11. The Tribunal adjourned the hearing to allow the applicant to put written submissions on the basis of the calculation by the accountants. The applicant's representative seized this opportunity to obtain further information on the whole issue, not from the accountants, but from the United Graziers Association of Queensland and submitted a letter from that Association dated after the date of the hearing of this application together with attachments. The principal attachment was a copy of relevant parts of the Industrial Conciliation and Arbitration Act 1961-1976. Copies of those documents were served on the Commissioner of Taxation and the Commissioner has responded to the documents.

12. The letter with attachments has been marked for identification as MF1 A. In essence the Industrial Officer of the United Graziers Association of Queensland seeks to assert answers to the questions to be determined by this Tribunal. The documents marked MF1 A have not been admitted as evidence.

13. It is trite to say that there is nothing in partnership law nor the Income Tax Assessment Act to warrant treating a partnership as a separate legal entity from its members (Rose v.

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ATC 488

F.C. of T., supra). In other words the "argument on behalf of the applicant in this appeal appears to involve a legal impossibility, namely, that the same person can occupy the position of being both master and servant, employer and employed" per Mathew L.J. in
Ellis v. Joseph Ellis and Co. (1905) 1 K.B. 324 at p. 329.

14. The Queensland Parliament has sought to overcome the legal impossibility, referred to by Mathew L.J., in the Industrial Conciliation and Arbitration Act ("the Act").

15. Section 19 of the Act provides for the provision of long service leave for employees not governed by awards or industrial agreements. The effect of the section is to confer long service leave entitlements on such employees. These entitlements are set out in sec. 17 of the Act. Subsection 19(2) reads as follows:

"(2) Every employee to whom this section applies shall be entitled to long service leave on full pay under, subject to, and in accordance with the provisions of this section and of sub-sections two to seven, both inclusive, and eleven to seventeen, both inclusive, of section seventeen of this Act:

• Provided that -
• [provisos do not appear to be relevant to the facts of this case]."

16. The definition of "employee" in sec. 5 of the Act includes the following:

"In this Act, unless the context otherwise indicates or requires, the following terms have the meaning respectively set against them, that is to say: -

• ...
• `Employee' - Any employee, whether on wages or piecework rates, or a member of a buttygang:...
• In every case where four or more persons being or alleging themselves to be partners, are working in association in any calling or industry, each of such persons shall be classed as and be deemed to be an employee; and the partnership firm constituted by them or alleged so to be shall be deemed to be the employer of each such person;"

17. In the overall context of the Act it is clear that the Parliament has sought to grant working partners, such as the applicant, rights to long service leave as if those working partners were employees in the ordinary sense of that word. It was not established before the Tribunal whether any other partners were working partners. Exhibit 1 which is the partnership income tax return for the year ended 30 June 1980 discloses that the applicant was paid a salary of $11,819 and another partner was paid a salary of $750. This is relevant in considering the words "working in association". Is a distinction to be drawn between those partnerships where there are four or more working partners who are paid a salary and those partnerships where, as in the present case, only two partners are paid a salary? I think the words working in association refer to active participation in an industry. I am prepared to infer that the definition applies in this case. The consequence is that the applicant is an employee and the firm an employer for the purposes of the Act.

18. Whether that analysis is correct or not it shows that the partnership had grounds for believing that it was liable under the Act for long service leave due upon termination of the applicant's services as manager. The liability was in respect of long service leave under an entitlement by virtue of the Queensland Industrial Conciliation and Arbitration Act and coming within the terms of para. 26AD(8)(a). If I be wrong on the question of liability it certainly came within the terms of para. 26AD(8)(c).

19. It is also clear enough from the evidence that there was a retirement by the applicant from the office of manager of the business of the firm when the firm sold its properties. Clearly there was a retirement from the partnership also but the evidence established that the position of manager had been occupied by the applicant well before he became a partner and he continued to occupy the position after he became a partner. The applicant had been the holder of a designated office for the purposes of subsec. 26AD(1) and retired from that office during the year ended 30 June 1980. There is no question of an illusory retirement. The business of the firm was wound up by the sale of its properties (the applicant purchased one of the properties jointly with his wife) and

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ATC 489

the position of manager was therefore abolished.

20. Although there could be no retirement from employment, the applicant being a partner in the firm, there was a retirement from an office, namely the position of manager of the firm. In this regard I rely on the following dicta in Case 9,
15 C.T.B.R. 74 (Vol. 4 C.T.B.R. reprint 238) at pp. 76-77:

"The words `office or employment' as they occur in the section are used in their ordinary sense. They are used disjunctively or alternatively. The word `office' in the context as applied to the circumstances before us means, in my opinion, the particular post or position held by the taxpayer in the bank's service, namely, the post or position of bank manager. The word `employment' is, I think, used in a much wider sense - a sense wide enough to include a particular office in a general employment. In that sense it will not fit the circumstances of this case and must therefore be discarded; for the taxpayer did not lose his employment, he continued to be employed by the bank. But he did lose the office he held in that employment. The juxtaposition of the two words `office' and `employment' is significant. In my view a man may lose the one and retain the other and still be entitled to the relief the section provides."

That passage was approved by Taxation Board of Review No. 2 in Case S14,
17 T.B.R.D. 70 at p. 73. The dicta applies to para. 26(d) but applies equally to subsec. 26AD(1). As already noted the position of manager was abolished upon sale of the firm's properties. I am therefore satisfied that the payment to the applicant prima facie falls within the terms of subsec. 26AD(1) and is included in his assessable income by subsec. 26AD(2).

21. In summary then the applicant received a lump sum payment for unused long service leave in consequence of his retirement from the office of manager of the firm upon the termination of that office.

22. I turn now to consider whether, as the respondent's representative submitted, the payment was a distribution to a partner.

23. For present purposes the assessable income of a partner in a partnership includes the individual interest of the partner in the net income of the partnership.

24. Net income in relation to a partnership means the assessable income of the partnership, calculated as if the partnership were a taxpayer who was a resident less all allowable deductions except certain classes of deductions not relevant to this application.

25. It is clear enough, on the authority of Rose v. F.C. of T. (1951) 84 C.L.R. 118; 9 A.T.D. 334, that sec. 90 to 92 of the Income Tax Assessment Act do not alter the general principle of law that a partnership is not a separate legal entity from the members of the partnership. It follows, as was submitted very ably by the respondent's representative, that where because of the terms of the partnership agreement a partner is entitled to be paid a "salary" he is merely entitled to an advance allocation of the partnership profits prior to the general distribution of profits amongst the members of the partnership. This proposition is really no more than an example of the general proposition that a man cannot make a contract with himself.

26. However, this application goes beyond the general proposition relied on for the respondent. This is because of the provisions of the Queensland Act which make the partnership liable for the payment in lieu of long service leave. Quite clearly the liability was incurred by the partnership as the "employer". This view is supported by the decision of Fullagar J. in
Crowe v. F.C. of T. (1958) 100 C.L.R. 532 where his Honour held (as per the headnote) that the premium on the policy on the life of a partner was not an allowable deduction from the income of that partner under sec. 82H(1)(a)(i) of the Assessment Act because it was not paid by the taxpayer but was paid and payable by the partnership, and that fact could not be altered or affected by any antecedent or subsequent agreement among the partners as to the manner in which, as between themselves, it should be borne. At p. 535 his Honour stated:

"The apparent difficulty of the case arises, I think, from two factors. The first is that a partnership has, in English law, no legal personality distinct from those of the individual partners. This, however, does not mean that there is not a very real difference between a right or obligation of a

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partnership (or partners as such) and a right or obligation of an individual member of a partnership."

27. With respect, his Honour's view coincides with the words of the definition of "net income".

28. The amount in question received by the applicant was paid because of the partnership's statutory obligation to him as the manager and not as a mere distribution of profits. The applicant was granted rights by the statute vis-a-vis the partnership and the payment was in settlement of those rights.

29. The consequences of this finding have been explained by Mason and Wilson JJ. in
F.C. of T. v. Galland 86 ATC 4885 at p. 4887; (1986) 68 A.L.R. 403 at p. 406 where their Honours stated:

"Section 92(1)(a) of the Act includes in the assessable income of a partner, not his share of the gross income derived, but his individual interest in the net income of the partnership for the year of income. The expression `net income' is defined by sec. 90, in relation to a partnership, to mean `the assessable income of the partnership, calculated as if the partnership were a taxpayer who was a resident, less all allowable deductions' except certain concessional and other deductions. These provisions are essentially for accounting purposes. They reflect the basic legal principle that the profits or net income of a partnership are the profits or net income of those who constitute it. It follows that, although a partner is not usually entitled to call for a distribution of profits or net income until accounts have been prepared, he has an individual interest in the net income of the partnership, notwithstanding that the precise amount of his interest cannot be determined until the accounts are prepared in respect of the relevant period."

and at ATC p. 4887; A.L.R. p. 407:

"The flaw in the Commissioner's argument is that, by virtue of sec. 92, a partner's assessable income is ascertained by reference to the net income, not the gross income of the partnership for the year of income. Therefore it matters not that the partner derives gross income when the partnership earns recoverable fees during the year of income. The point is that, in general, the partner's assessable income for the year of income can only be ascertained at the end of that year when the net income of the partnership is ascertained. Accounts for that purpose cannot be taken until the expiration of the year of income, unless there is some independent reason for taking accounts at an earlier date, as, for example, a dissolution of the partnership."

30. The payment of $2,445 was assessable to the applicant in accordance with sec. 26AD and not sec. 92, the payment not forming part of the applicant's individual interest in the net income of the partnership for the year of income.

31. The result is that the submission for the respondent that the payment in lieu of long service leave received by the applicant should be treated as a distribution of part of the applicant's share of the partnership net income is rejected and the applicant's claim upheld in principle.

32. As I noted at para. 11 the applicant was asked to lodge a written submission on the basis upon which the amount of $2,445 was calculated. That submission was not forthcoming. However, having had my attention directed to the provisions of the Queensland legislation I have been able to satisfy myself that the amount of $2,445 was, on the balance of probabilities, calculated in accordance with that legislation. The respondent has made no issue as to the quantum. I am satisfied that the amount of $2,445 is a bona fide quantification of the partnership's liability to the applicant.

33. Subsection 26AD(3) provides the formula for determining the proportion of the amount of $2,445 which is included in assessable income under that subsection. On the facts of this application the amount is ascertained as follows:

            2,445       624 (88 + 0)
            -----  x  [ ------------ ]
             88            5,373
                    = $284
      

The amount assessable under subsec. 26AD(5) (5% of the amount remaining) is ascertained as follows:

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      $2,445
      -  284
      ------
      $2,161    1
      ------ x -- = $108
         1     20
    

34. The objection decision will be set aside and the objection allowed in full.