Colonial Mutual Life Assurance Society Ltd v. Federal Commissioner of Taxation (13 October 1953)

89 CLR 428

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(Judgment by: Williams ACJ)

Between: Colonial Mutual Life Assurance Society Ltd
And: Federal Commissioner of Taxation

Court:

Judges:
Williams ACJWebb J
Fullagar J
Kitto J
Taylor J

Subject References:
Taxation and revenue
Income tax
Assessment
Capital or income
Deduction
Outgoings incurred
Transfer of land
Outgoing of capital nature

Legislative References:
Income Tax Assessment Act 1936 No 27 - s 51(1)

Hearing date: 9 June 1953; 10 June 1953
Judgment date: 13 October 1953

MELBOURNE

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Judgment by:
Williams ACJ

This is a case stated by Fullagar J. in an appeal from a decision of a board of review under the provisions of the Income Tax Assessment Act 1936-1943. The case submits a single question, whether a sum of PD1,100 is an allowable deduction from the assessable income derived by the appellant in the accounting period ended 31st December 1942.

The sum referred to was part of an amount of PD1,183 paid by the appellant in the accounting period to William Just and Herbert Fritz Just, called in the case the Just Brothers. The payment was made in accordance with the terms of two documents, an agreement entered into on 16th February 1934 between the appellant, the Just Brothers and a company called Turners Limited, and an instrument of encumbrance executed by the appellant in pursuance of the agreement. The appellant bases its claim to have the PD1,100 treated as an allowable deduction upon s. 51 (1) of the Income Tax Assessment Act, contending that that is the proportion of the PD1,183 which should be held to have been incurred in gaining or producing the appellant's assessable income and not to have been an outgoing of capital or of a capital nature, or incurred in relation to the gaining or production of exempt income.

The appellant is a life assurance company. At the time of the agreement of 16th February 1934 it owned a block of land in Adelaide, situated at the corner of King William Street which bounded it on the east, and Hindley Street which bounded it on the north. It desired to erect a modern building occupying not only its own block but also a block owned by the Just Brothers which adjoined it on the south. The new building was intended to provide the appellant with office accommodation for the carrying on of its business, and also, as to a substantial part of it, to provide, for renting to tenants, basement space, shops and approximately 120 offices or professional rooms. Turners Limited was in occupation of a shop on the appellant's land under a lease, and of course that lease had to be got rid of before the building project could be proceeded with. Turners Limited were apparently alleging that there was an agreement of some sort existing between the appellants and themselves, and, in addition, litigation was pending in the Supreme Court of South Australia between the Just Brothers and Turners Limited as plaintiffs and the appellant as defendant.

To deal with this situation the agreement of 16th February 1934 was made. It provided for the four essential matters, the purchase of the Just Brothers' land by the appellant, the termination of Turners Limited's lease, the rescission of the agreement alleged by that company to exist, and the discontinuance of the pending litigation. Its provisions are material in so far only as they deal with the first of these matters. The vendors were to execute forthwith a registrable transfer of their land to the appellant and deposit it with a bank to be held in escrow until the completion of three shops, with a basement beneath them, on the corner of King William and Hindley Streets, being part of the proposed new building. Upon such completion, the transfer and certificate of the title were to be delivered to the appellant for registration, and the appellant was to deliver to the vendors contemporaneously "a rent charge over the rents of the said shops and basement" in an agreed form. The appellant was to commence forthwith and complete with all reasonable speed the new building, which was referred to as being depicted and described in certain plans, elevations, sections and specifications. It was to use its best endeavours to let the three shops and basement and to collect the rents of them, and during the period of fifty years from 1st January 1935 it was to pay to the vendors an amount equal to ninety per cent of all the rents "as and when received" from tenants of these shops and basement. It was to have full control of the letting of the shops and basement, but no lease for longer than five years should be granted without the consent in writing of the vendors.

These provisions were duly carried into effect, and in due course the appellant gave the so-called rent charge to the vendors. It was in the form of a registered encumbrance under the Real Property Act 1886-1929 (S.A.), and it was expressed as encumbering the land occupied by the three shops and basement with a rent charge for the amount, and to be raised and paid, as therein set forth. It provided that "the said rent charge" should be for a period of fifty years from 1st January 1935 and should be for an amount equal to ninety per cent of the whole of the amount of rent to be received by or on behalf of the appellant in each year during the said period in respect of the three shops and basement. The amount was to be paid to the chargees on the first day of every month, the first of such payments "if any rents have then been received" to be made on 1st February 1935. Other provisions corresponded substantially with the agreement of sale.

The building having been erected, a proportion of it, which has been agreed at ninety-three per cent of the whole, was let to tenants during the accounting period now in question, and the remaining seven per cent was occupied by the appellant itself. In that period the rents received by the appellant in respect of the three shops and basement amounted to PD1,314 and the appellant duly paid to the vendors ninety per cent of that sum, viz., PD1,183. In its income tax return, the appellant included the PD1,314 in its assessable income, and claimed as an allowable deduction ninety-three per cent of the PD1,183, viz., PD1,100. It is the lastmentioned sum which is the subject of the question asked in the case.

It is incontestable on the facts before us that the appellant acquired the Just Brothers' land for the purpose of retaining it as part of a fixed capital asset, producing rents and providing facilities for the conduct of its life assurance business. The court was invited by counsel for the commissioner to hold that this is enough to impart a capital nature to every payment made by the appellant to the Just Brothers in performance of the obligation which formed the consideration for the purchase. A payment for the purchase of an asset acquired for a capital purpose, it was said, must necessarily be an outgoing on capital account. It is unnecessary to decide whether this proposition is universally true for I am satisfied that on the facts of this particular case the payment under appeal is an outgoing of a capital nature within the meaning of s. 51 (1) of the Income Tax Assessment Act. The payment represents one of a series of annual payments which the appellant agreed to make to the Just Brothers for the acquisition of their land. In Just v  Commissioner of Taxation, ^[F1] Webb J. held that the sums received by the Just Brothers from the appellant each year formed part of their assessable income. No doubt this decision was correct.

That the sale of a capital asset may result in the seller receiving either capital or income has long been clearly established. The classic statement on the subject in the judgment of Rowlatt J. in Jones v  Commissioners of Inland Revenue, ^[F2] at pp. 714-715, need not be repeated here; it was quoted with approval and applied by this Court in Egerton-Warburton v  Deputy Federal Commissioner of Taxation, ^[F3] at p. 572. In the simple case of a sale of an asset for a lump sum price, the character of the asset naturally determines the character of the receipt; but where the sale produces a series of payments it is a question to be decided upon an examination of the particular transaction whether those amounts come to the seller as instalments of an agreed principal sum constituting the price, or as income the right to which has been acquired by the sale. In the former case, the character of the asset sold must again be the decisive consideration, for parts of a principal sum must have the same nature as the sum itself would possess if paid in one amount. In the latter case, however, the payments received have the intrinsic character of income notwithstanding that the right to receive them has been acquired as the consideration for the disposal of a capital asset. Romer L.J. put the matter in these words in Inland Revenue Commissioners v  Ramsay: ^[F4]

"If a man has some property which he wishes to sell on terms which will result in his receiving for the next twenty years an annual sum of PD500, he can do it in either of two methods. He can either sell his property in consideration of a payment by the purchaser to him of an annuity of PD500 for the next twenty years, or he can sell his property to the purchaser for PD10,000, the PD10,000 to be paid by equal instalments of PD500 over the next twenty years. If he adopts the former of the two methods, then the sums of PD500 received by him each year are exigible to income tax. If he adopts the second method, then the sums of PD500 received by him in each year are not liable to income tax, and they do not become liable to income tax by it being said that in substance the transaction is the same as though he had sold for an annuity. The vendor has the power of choosing which of the two methods he will adopt, and he can adopt the second method if he thinks fit, for the purpose of avoiding having to pay income tax on the PD500 a year. The question which method has been adopted must be a question of the proper construction to be placed upon the documents by which the transaction is carried out". ^[F5]

But it does not follow that the converse proposition is also true-that is to say it does not follow that, because the payments are assessable income of the seller, they are outgoings which qualify as allowable deductions for the purposes of s. 51 (1). This subsection has two limbs the meaning of which has been discussed in Ronpibon Tin (N.L.) v  Federal Commissioner of Taxation, ^[F6] at pp. 55-57; Federal Commissioner of Taxation v  Green; ^[F7] Broken Hill Theatres Pty  Ltd  v  Federal Commissioner of Taxation, ^[F8] at pp. 428-429, and particularly in the first of these cases. There can be no doubt that the payments which the appellant agreed to make to the Just Brothers for fifty years are payments which fall within both limbs of s. 51 (1) if they are not of a capital nature. The rents which the appellant receives from the portion of the building which is let are part of its assessable income from property and the appellant was only able to erect the building and let this portion because it was able to acquire the land on which part of the building stands from the Just Brothers. The payments it has agreed to make to the Just Brothers can therefore be said to be incurred in gaining or producing the assessable income in the sense that the occasion of the outgoing is to be found in what is productive of the assessable income. The payments are also outgoings within the second limb because they are in this sense appropriate or adapted for producing assessable income. But all this could be said of many payments which are clearly of a capital nature. It could be said of all instalments of purchase money paid for the purchase of a fixed capital asset which the purchaser acquired and used to produce assessable income. No assistance in solving the present problem is really derived from the English cases which were cited to us relating to the right of a payer of an annuity or other annual payment to deduct income tax from the annuity or annual payment before making the payment to the payee and retain the deduction for himself, or to deduct such payment from his total income for the purposes of super-tax or surtax. This is because the annuities or other annual payments are in effect the profits of the recipient who bears the tax, and they are not also to be treated as profits of the person paying them. If no tax can be deducted on behalf of the recipient, the payments cannot be treated as profits of the recipient and must be treated as paid out of the profits of the person paying them who is therefore to be taxed thereon: Sugden v  Leeds Corporation, ^[F9] at pp. 490-491; Earl Howe v  Commissioners of Inland Revenue, ^[F10] at p. 352; Allchin v  Coulthard, ^[F11] at p. 619. Under Schedule D Case 1 the tax is computed on the full amount of the balance of the profits or gains. Rule 1 provides that the tax shall be charged without any other deduction than is by the Act allowed. Rule 3 provides that in computing the amount of the profits or gains to be charged, no sum shall be deducted in respect of (a) any disbursements or expenses, not being money wholly and exclusively laid out or expended for the purposes of the trade, profession, employment, or vocation; or (1) any annual interest, or any annuity, or other annual payment payable out of the profits or gains. In Delage v  Nugget Polish Co  Ltd, ^[F12] by an agreement between the plaintiffs and the defendants, the defendants acquired the exclusive right of selling and manufacturing articles by a secret process and agreed to pay to the plaintiffs for forty years a sum equal to eight per cent of the amount of the gross receipts received by them on the sale of these articles. The question at issue was whether the defendants could deduct income tax from the sums payable to the plaintiffs under the agreement. Phillimore J., as he then was, decided that they could. He held that these payments were annuities or annual sums payable out of the profits or gains brought into charge and were income in the hands of the recipients. Accordingly the defendants could deduct the income tax payable on these sums. But his Lordship also considered the character of the payments as outgoings and held they were of a capital nature. He said:

"In the year 1903, which is the year in question in this case, the defendants made a very large sum of money in the form of gross takings, and they made also, as is agreed between the parties, a considerable sum of money in the form of net profits larger than 8 per cent. of the gross takings. They were compelled by the Crown, and as it seems to me rightly compelled by the Crown, to pay on their net profits without deducting the sum of money which they had to pay away as the 8 per cent. Rightly were they so compelled because that sum of money was at any rate as between the Crown and the taxpayer to be viewed as no deduction from profits, but as part payment in the way of capital expenditure for the article originally bought, out of which they made their profit". ^[F13]

A similar point arose in Tata Hydro-Electric Agencies Ltd , Bombay v  Commissioner of Income Tax, Bombay Presidency and Aden. ^[F14] There the appellant company, which carried on the business of managing agents of A. company, had acquired the agency from B. company under an assignment whereby B. company transferred to the appellants their whole rights and interest as agents of A. company, subject, however, to the obligations of B. company to pay to both D. and E. companies twelve and one-half per cent of the commission earned by B. company under their agency agreement with A. company. The question at issue was whether this twenty-five per cent commission was expenditure incurred "solely for the purpose of earning ... profits or gains" within the meaning of s. 10 (2) (ix) of the Income-tax Act, 1922 (India), so as to entitle them to deduct it in computing their profits or gains for tax purposes. It was contended by counsel for the Crown that the obligation to make the payments in question was taken over by the appellants as part of the transaction whereby they acquired the agency business and the payments were therefore made not for the purpose of earning profits in the conduct of the agency business but in fulfilment of the terms on which they purchased the business. Their Lordships upheld this contention. They said:

"In short, the obligation to make these payments was undertaken by the appellants in consideration of their acquisition of the right and opportunity to earn profits, that is, of the right to conduct the business, and not for the purpose of producing profits in the conduct of the business". ^[F15]

This is, it would seem, another way of saying that the expenditure was of a capital nature. It is impossible to distinguish the facts of the present case from those in Delage's Case ^[F16] and the Tata Case. ^[F17] The application of the principles laid down in these decisions indicates that the present expenditure is of a capital nature. If we apply the principles stated by Dixon J., as he then was, in Sun Newspapers Ltd  v  Federal Commissioner of Taxation; Associated Newspapers Ltd  v  Federal Commissioner of Taxation, ^[F18] the same result follows. He said:"The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss". ^[F19]

The only authority cited to us that may appear at first sight to support the appellant's case is Egerton-Warburton v  Deputy Federal Commissioner of Taxation. ^[F20] There the appellants were a father and two sons. The father had been the owner of land upon which farming and orcharding were carried on. His two sons formed a partnership to take over the enterprise. The father entered into an agreement with them in which he was described as the vendor and they were described as the purchasers. In the joint judgment of Rich, Dixon and McTiernan JJ. it is said:"He (the father) agreed to sell to them, on a walk-in walk-out basis, the land together with all stock, chattels and effects thereon. Briefly stated, the consideration for the sale was as follows. The sons were required to pay (a) an annuity to the father during his life of PD1,200 by quarterly payments; (b) after his death an annuity to his widow of PD1,000 by quarterly payments; (c) after the death of both the father and his widow, the sum of PD10,000 to his three daughters and the children of a deceased daughter in such shares and upon such terms as he might by deed or will appoint, and, in default of appointment, in shares of one quarter to each of the three daughters, and one quarter to the children of the deceased daughter". ^[F21]

It was held that the annuity paid by the sons to the father formed part of his assessable income. It was also held that the sons were entitled to deduct the payment from their assessable income as representing money laid out in the production of that income. It is with the views expressed in the joint reasons with respect to this deduction that we are here concerned. The question arose under ss. 23 (1) (a) and 25 (e) of the Income Tax Assessment Act 1922-1933. The first of these provisions authorized the deduction from the assessable income of all outgoings (not being in the nature of outgoings of capital) actually incurred in gaining or producing the assessable income. Section 25 (e) forbad the deduction of money not wholly or exclusively laid out for the production of assessable income. Their Honours said:"We do not think the annual payments made by the sons are outgoings of their capital. The payments may properly be considered as made by them on revenue account. But it is another thing to hold that the sums paid are expended wholly or exclusively for the production of assessable income". ^[F22]

Their Honours then proceeded to discuss at some length the question whether the payments were expended wholly or exclusively for the production of assessable income. They said:"In such a case as the present, the land is a necessary implement for the production of income, and an expenditure, not being an outgoing of capital, which the taxpayer incurs in order to obtain the implement, seems naturally to fall under the description of money laid out for the production of income. So far as the taxpayer is concerned it is an expenditure incurred to create his assessable income". ^[F23]

The only portion of this reasoning which applies to the present problem is the statement ^[F24] that the annual payments made by the sons might properly be considered as made by them on revenue account. After that the whole of the reasoning is directed to the question whether the expenditure was actually incurred in gaining or producing the assessable income. As I have already said, if this was the only question, the payments which the appellant agreed to make to the Just Brothers would qualify as deductions. But the crucial question is whether the payments are of a capital nature. On this question the opinion expressed in the Egerton-Warburton Case ^[F25] that the payments made by the sons to the father were made on revenue account would seem to depend on the particular facts of the case. Weight must be given to the statement ^[F26] that the transaction bore all the marks of a family settlement. Under the agreement the father reserved the right to use and occupy a dwelling house upon the land. The sons agreed upon the completion of the purchase to execute a mortgage over the land to secure the payment of the annuity and of the sum of PD10,000. So the annuities and the sum of PD10,000 were charged on the land which it was necessary for the sons to occupy in order to carry on their business. They could not complete the payment of the purchase money until their father and mother had died and the post mortem distribution of the PD10,000 had been made. In these circumstances their Honours evidently considered that the annuities, being charged on the land and payable during the lives of the father and mother, were in the nature of rents which the sons had to pay during this period in order to occupy the land and carry on their business. So considered the payments were not outgoings of capital and qualified as deductions under ss. 23 (1) (a) and 25 (e) of the Income Tax Assessment Act 1922-1933.

In the present case the payments to the Just Brothers are dependent upon the appellant receiving rent for the three shops and basement. The Just Brothers are to receive amounts equal to ninety per cent of the whole amount of this rent. It may be that, as a matter of accountancy, the appellant would debit these payments to revenue account. But this does not necessarily make the outgoings of a revenue nature. In Associated Portland Cement Manufacturers Ltd  v  Inland Revenue Commissioners; Associated Portland Cement Manufacturers Ltd  v  Kerr, ^[F27] Lord Greene M.R. said: "it must never be forgotten than an asset which may properly, and quite correctly, appear, and only appear, in the balance sheet as an asset may be acquired out of revenue". ^[F28] The payments to the Just Brothers are recurring payments but recurrence of a payment does not mean that it is necessarily of a revenue and not of a capital nature: the Sun Newspapers Case, ^[F29] at p. 362; Grant v  Commissioner of Taxes, ^[F30] at p. 880. In Southwell v  Savill Brothers Ltd ^[F31] and Oswald v  Magistrates of Kirkcaldy, ^[F32] the payments were of indefinite amounts and for indefinite periods but they were held to be of a capital nature. The present case seems to be one in which it is proper to apply the test laid down by Lord Clyde in Robert Addie & Sons' Collieries Ltd  v  Commissioners of Inland Revenue: ^[F33] Are the sums in question part of the trader's working expenses, are they expenditure laid out as part of the process of profit-earning; or, on the other hand, are they capital outlays, are they expenditure necessary for the acquisition of property or of rights of a permanent character the possession of which is a condition of carrying on the trade at all?. ^[F34] The acquisition of land is an acquisition of property of the most permanent character and the acquisition of the Just Brothers' land was a condition of erecting the new building and carrying on there the business of letting shops and offices and other space.

For these reasons the question asked in the case stated should be answered in the negative.