CREER v FC of T

Judges:
Burchett J

Court:
Federal Court

Judgment date: Judgment handed down 28 July 1994

---

Burchett J

In his taxation return for the year ended 30 June 1991, the applicant claimed a deduction under s. 51(1) of the Income Tax Assessment Act 1936 in respect of legal fees incurred in the sum of $24,061.40. The Commissioner allowed half of that amount, taking the view that the dispute in relation to which the legal fees had been expended was of a nature which required the expenditure to be categorised as concerned both with matters of capital and with matters of revenue. The taxpayer objected that the whole sum was an allowable deduction, and when his objection was not upheld, he required the question to be referred to the Court.

The relevant circumstances lie within a small compass. For well over 30 years prior to 9 February 1990, the applicant was a partner in successively the firm of solicitors known as Messrs Abbott Tout Creer and Wilkinson and the firm in which it was merged as a result of an amalgamation, Abbott Tout Russell Kennedy. At the time the amalgamation was negotiated, he was the senior partner of the former firm. However, on 9 February 1990 a committee (or ``panel'') of the partnership charged with the function of evaluating the performance of partners, the Performance Evaluation Committee, made a decision the effect of which was to reduce the applicant's share of the profits of the partnership by thirty per cent. The Committee also suggested to him that they would wish him to retire from the partnership and accept a consultancy. He was then about 60 years of age, and in the normal course would have become due to retire compulsorily at the age of 65. Shortly afterwards, a meeting of the partners passed a resolution indicating that the applicant should resign from the partnership. This he declined to do.

The applicant sought reasons for the Performance Evaluation Committee's decision to reduce his share of the profit, but in about September 1990 the Committee refused to give reasons. The method of allocating profit employed by the partnership was by the attribution of shares of profit to units allocated to partners. The applicant had been a 100 units partner. He was reduced for the year to 30 June 1990 to a 70 units partner, and for the year to 30 June 1991 to a 50 units partner. The applicant at first reluctantly accepted the reduction to 70 units, but took advice, and when he was informed of the reduction to 50 units he referred the dispute to arbitration. The arbitrator appointed was Mr D.A. Yeldham Q.C., a former judge of the Supreme Court of New South Wales. He formed the view that the applicant had been treated very unfairly by his partners, and the result of the arbitration was plainly a triumph from the applicant's point of view. Indeed, Mr Yeldham Q.C. said of the reduction to 50 units: ``No attempt has been made in the arbitration to support such a radical reduction of Creer's units nor to explain how the panel could properly have made it.'' He added later:

``I repeat that an allocation of 50 units to Creer in the light of the material before me and that which either was before the panel or was available to be put before the panel would be regarded as so inadequate as, without more, to denote error.''

However, there was then an appeal, which was settled on terms involving some compromise, by which the applicant did retire from the partnership but received a substantial remuneration as a consultant, to be paid until about the time he would attain the age of 65 years.

---

ATC 4456

When the dispute was referred to arbitration, the question which had arisen and was the subject of the reference related to the assessment of the applicant's share of the profits of the partnership for the two years which I have mentioned. Clearly enough, the result could also have been expected to provide some guidance to the parties in respect of future income years. The applicant's contention was that the share of profit allocated to him in each year had been determined in a manner which was both improper and involved a breach of contract. He also contended that the approach of the Performance Evaluation Committee to the evaluation of his performance had failed to recognize the value of the particular form of work on behalf of the partnership which had been his responsibility. He had been much involved in the marketing of the services of the firm.

After the referral of the matter to arbitration by a notice given by the applicant on 20 November 1990, a resolution was passed by his partners on 5 February 1991 purporting to expel him from the partnership. It is important to note that, apart from a sum of four thousand dollars, which represented the applicant's half share of the arbitrator's hearing fee, the whole of the expenses claimed as a deduction had already been incurred in relation to the arbitration prior to that date. This is not disputed. But the resolution of expulsion having been passed under a particular clause (cl. 18) of the partnership agreement, the issues to be determined by the arbitrator were widened so as to embrace the validity of the applicant's expulsion. This was an issue on which the applicant succeeded before the arbitrator, who held the expulsion ``power was not exercised in good faith''. As I have indicated, the applicant also succeeded on the issue related to his income for the year to end 30 June 1991. He failed as regards the prior year, as the arbitrator found, ``simply and only by reason of his acceptance of the units allotted to him''.

It will be apparent that, if the question before me were to be determined solely by reference to the issues which arose in the arbitration at the time the applicant incurred the legal expenses it involved, the applicant would win this appeal. For all his own legal fees had been incurred before any question arose other than a question relating to the quantum of his share of income, and even the remaining four thousand dollars in respect of the arbitrator's hearing fee was an expense to which he must have been already committed before any other issue arose. That cannot be in doubt, since he was committed to a hearing. But the Commissioner argues that the dispute should be seen as involving wider issues. The applicant, who gave his evidence frankly and straightforwardly, acknowledged in cross-examination that when his income was reduced it appeared that a device ``was emerging to try and force my retirement by the reduction of my income''. Asked:

``But you did understand then, or at least your understanding of the device was that it was in fact a device employed by at least some of your fellow partners for whatever reason to have you removed from the partnership?''

he answered:

``Yes it was denied by some of them that it was a device; they claimed otherwise, but I didn't believe them.''

He was also asked:

``Mr Creer, in invoking the arbitration clause, as you did, on 20 November 1990, you were seeking, were you not, not simply an additional share of profits but also to establish through an independent person that the evaluation procedures adopted in relation to you were unfair?''

He answered:

``Yes, they were some of the elements, yes.''

As I understand the argument, the Commissioner suggests that, from the beginning of the dispute, it was apparent that the applicant's position as a partner was at risk, and the legal fees spent upon the arbitration should therefore be regarded as having a concern with a matter of capital. It is contended that they were spent with a view to securing the applicant's position as a partner.

However, it was not suggested to the applicant that he ever thought the power of expulsion could be validly used against him in the particular circumstances, nor that its use would be attempted, until the attempt was actually made. The finding of the arbitrator on that issue shows that there was no good reason why he should have expected the resolution which, as things actually turned out, was adopted by his partners. The arbitrator held that ``no matters exist which constituted reasonable

---

ATC 4457

grounds for the exercise of the power of compulsory retirement'' purportedly exercised. Why, then, should the applicant have foreseen this particular attack upon him? On the other hand, he had but a very short future in the partnership in any event, since his attainment of the age of 65 years was approaching. In the meantime, if his partners could validly reduce his income, undoubtedly the ultimate effect might be to put pressure on him to resign from the partnership, as they apparently wished him to do. I think this is a matter to which he was referring in the answers relied upon by the Commissioner. But the only question (though it was put in various ways) to be determined or in any way envisaged, at the time the arbitrator was appointed, and at the time the legal fees now at issue were incurred, was the question of the proper calculation of the applicant's income. To have that question settled was the object of the arbitration and thus of the expenditure.

It seems to me that this would remain true even if I were to conclude that the applicant had also in mind that the achievement of a favourable decision would be a stepping stone to some further and ultimate success in his conflict with the majority of his partners. However, I am far from finding that he had any such ultimate design. I think it is more likely that he was taking the dispute one round at a time, and concentrating on the particular issue which had been raised. After all, it must have been impossible for him to foresee his partners' reaction. If he had concentrated on the maintenance of his position as a partner for the few years remaining to him under the partnership agreement, he might well have thought his best course would have been to conciliate rather than to confront his partners by a notice to arbitrate.

What the applicant actually achieved as a result of the arbitration, and of the subsequent settlement of his partners' appeal, was a reinstatement of his entitlement to share as a 100 units partner for the year ended 30 June 1991, after which he was to retire as a partner but be appointed as a consultant effective as of 1 July 1991 until 31 December 1994, his consultancy fees to be equal to the entitlement of a 100 unit partner (adjusted for interest on a working capital loan) but to be not less than one hundred and fifty thousand dollars per annum. Since he had to retire at the age of 65, unless (as was most unlikely to occur) his partners resolved otherwise, the settlement virtually restored him, from a financial point of view, to the position before the dispute arose.

In his dissenting judgment in
Hallstroms Pty Ltd v. FC of T (1946) 8 ATD 190 at 194-195; (1946) 72 CLR 634 at 647, Dixon J. said:

``The claim is to deduct legal expenses, and legal expenses, we may assume, take the quality of an outgoing of a capital nature or of an outgoing on account of revenue from the cause or the purpose of incurring the expenditure. We are, therefore, remitted to a consideration of the object in view when the legal proceedings were undertaken, or of the situation which impelled the taxpayer to undertake them.''

Later in the same judgment [at ATD p 196; CLR p 648], Dixon J. said:

``What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.''

Although these words were uttered in a dissenting judgment, they have since been regarded as expressing the correct principle. Applying them to the present case, the cause of the incurring of the expenditure here was the reduction of the applicant's income entitlement from the partnership, and its purpose was the restoration of that entitlement. No attack was involved at that point upon his position as a partner, nor upon his right to practise the profession from the practice of which his earnings arose. It is true he had been asked to resign, but that was a request which acknowledged his right to choose, and upon his refusing, there the matter rested. The object he had in view when the legal proceedings were undertaken was undoubtedly the establishment of his right to an income entitlement, and the situation which impelled him to undertake the proceedings was the denial of a proportion of his hitherto accepted share of income. The reason why he was eager to pursue that object, and the strategic implications he saw in that situation, do not detract from the reality of these facts. From a practical and business point of view, whatever motivations the parties may have had and however their rights should be

---

ATC 4458

classified from a juristic point of view, the expenditure of the legal fees was calculated, at the time they were expended, to achieve a restoration of the level of the applicant's income, and not to vary by one hair's breadth his position as a solicitor in practice as a partner in the firm to which he belonged.

A passage in the judgment of Brennan J. in
Magna Alloys & Research Pty Ltd v. FC of T 80 ATC 4542 at 4553; (1980) 49 FLR 183 at 198, which was cited in the joint judgment of the Full Court in
Putnin v. FC of T 91 ATC 4097 at 4101; (1991) 27 FCR 508 at 512, makes it clear that the subjective reason for voluntary action is not necessarily determinative of whether expenditure involved in that action was incurred as an outgoing falling within s. 51(1). But here, as in Putnin (as the Court recognised at ATC 4101; FCR 512-513), ``it would be a misuse of language to suggest that payments made in respect of [Mr Creer's appeal to arbitration] were incurred of his own volition. They were relevantly involuntary''. A purpose must therefore be attributed objectively to the expenditure, having regard to its occasion. The mere fact that, beyond that occasion, ``indirect consequences that might or might not have happened'' (ATC 4102; FCR 513) may have been in contemplation is not enough to change the purpose which is properly to be attributed to the expenditure, having regard to the event which occasioned it.

Indeed, the joint judgment of Deane and Fisher JJ. in Magna Alloys makes it clear (at ATC 4560; FLR 209) that even a ``dominant motive'' outside of the pursuit of the relevant business purpose need not deny the appropriate character to an outgoing which otherwise falls within s. 51(1). The kind of ultimate strategic motive relied upon by the Commissioner in the present case seems to me to have no greater capacity to have an impact upon the true character of the expenditure than did the ``dominant motive'' in question in Magna Alloys. The matter can really be summed up in the often cited words used in
Ronpibon Tin NL & Tongkah Compound NL v. FC of T (1949) 8 ATD 431 at 436; (1949) 78 CLR 47 at 57:

``In brief substance, to come within the initial part of the sub-section it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income.''

The occasion of the expenditure of the legal fees was the arbitration which produced an increase in the income allocated to the taxpayer for the relevant years. That is sufficient.

For these reasons, the applicant succeeds. The only order I make at this stage, however, is that the applicant bring in, on a date to be fixed, short minutes of orders appropriate to reflect the reasons of the Court.