CASE 67/96

Members:
J Block SM

Tribunal:
Administrative Appeals Tribunal

Decision date: 8 November 1996

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J Block (Senior Member)

The Applicant sought the review of a decision by the Respondent dated 21 July 1995 disallowing an objection dated 2 March 1995 against the Applicant's tax assessment for the year ended 30 June 1994. The Applicant, in his objection, had objected against the allowance by the Respondent of a foreign tax credit of $4848.93, claiming that he was entitled to a foreign tax credit of $12,282.41.

2. The Applicant was represented by Mr CJ Bevan of Counsel and the Respondent was represented by Mr M Dwyer.

3. The Tribunal accepted into evidence the documents lodged pursuant to section 37 of the Administrative Appeals Tribunal Act 1995, and also the following exhibits:

Exhibit A1 - Statement of Agreed Facts

Exhibit A2 - Statement by the Applicant

Exhibit A3 - Statement by the Applicant's accountant, who is referred to as ``S''.

4. Evidence was given by each of the Applicant and S and in which each of them confirmed the statement referable to him. The evidence of each of them was not in any way in issue; it may be noted in particular that S gave evidence (not in dispute) that in preparing the relevant return he relied, for the purpose of including the Applicant's professional income, entirely on a statement dated 21 December 1994 (which is Annexure D to Exhibit A2); that statement is a statement addressed to the Applicant setting out the details of his earnings from the legal firm in which he was a partner at the relevant time.

5. Clauses 1 to 7 (both inclusive of the Statement of Agreed Facts) Exhibit A1, edited so as to preserve an anonymity are, as a matter

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of convenience, and because they concisely furnish the background, are set out herein as follows:

``1. The applicant is a resident Australian taxpayer.

2. In the year of income ended 30 June 1994 (`the 1994 year of income') the applicant derived:

• (i) total assessable income of $172,200, which included
• (ii) total assessable foreign income of $34,677.

3. In the 1994 year of income the applicant became liable to pay tax on a taxable income of $67,986 subject to an entitlement to a credit for foreign tax paid under s 160AF(1) against that tax liability.

4. During the 1994 year of income the applicant incurred the following outgoings which were deducted against assessable income in calculating the applicant's taxable income in terms of paragraph 3 above:

• (i) gifts of $525 which were deductible under s 78(4),
• (ii) accountant's fees incurred to the applicant's tax agent in relation to the preparation of the applicant's 1993 year of income tax return of $2,150,
• (iii) premium paid to (Blank) Life Insurance Co Limited under policy no. (blank) being the premium for the taxpayer's income protection in the event of sickness and accident of $1,185, and
• (iv) superannuation contributions made by the applicant for non-employer sponsored superannuation to:
  • (a) (Blank) Reinsurance Co Limited under policy no. (blank) of $2805 giving rise to a deduction of $2805; and
  • (b) (Blank) Life Limited under policy no. (blank) of $130,000 giving rise to a deduction of $97,549.

5. The applicant's Australian source assessable income in the 1994 income year comprises three net amounts derived from five sources of:

• (a) net Australian source primary production income of $5,538;
• (b) net Australian source non-primary production income of $131,985; and
• (c) foreign source income being partnership distributions from the partnership's foreign office of $34,677. This is the only amount of foreign source income derived by the applicant during the year of income in question.

6. The applicant's foreign source of income of $34,677 for the 1994 year of income comprised exclusively of a distribution of profits from the foreign office of the partnership of solicitors of which he was then the senior partner.

7. Throughout the 1994 year of income the applicant's personal services were devoted exclusively to practising as a solicitor at the Sydney office of the partnership of solicitors of which he was then the senior partner and also to the conduct of the applicant's primary production interest at (blank) in NSW, a grazing property, and at (blank) in NSW a macadamia nut plantation.''

I note that in editing Exhibit A1 for this purpose, I have deleted various names, (of companies, places and of the legal firm) numbers, (in respect of policies) and in addition, in respect of the legal firm's non- Australian branch office, I have substituted ``foreign office'' for the name of the country in which it is conducted.

6. Clause 12 of the Statement of Agreed Facts notes that:

``The `apportionable deductions' of the applicant for the 1994 year of income for the purposes of making the s 160AF(8) `adjusted net foreign income' calculation of the taxpayer for that year of income amount to $525 being the applicant's total deduction under s 78(4) for gifts made in that year of income.''

It is to be noted that, pursuant to clause 12, the applicant accepted that the charitable donations are apportionable deductions within paragraph (c) of the definition of net foreign income, and that accordingly the Respondent had in respect of the relevant assessment, dealt with them correctly; accordingly and in respect of the charitable donations there was no longer an issue between the parties.

7. The issues to be decided fall within a narrow compass: specifically it is necessary to decide whether each or any of the deductions referred to in clause 4(ii) of Exhibit A1 (``the accountant's fees''), clause 4(iii) of Exhibit A1

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(``the income protection premium'') and clause 4(iv) (collectively ``the superannuation deduction'') fall to be apportioned in accordance with paragraph (c) of the definition of ``net foreign income'' contained in section 160AF(8) of the Income Tax Assessment Act (the ``Act''). If such deductions are other deductions which are apportionable, the effect is that each of the foreign income and thus the foreign tax credit is reduced.

8. It is relevant at this point to note that the accountant's fees were deducted under section 68 of the Act, the income protection premium was deducted under section 51(1) of the Act and that the superannuation deduction was allowed under section 82AAT of the Act; put in other words, the income protection premium was deducted as an outgoing incurred in the derivation of income; each of the other deductions was allowed under a concession contained in the Act. However, and in my view, the definition of ``net foreign income'' contained in section 160AF(8) is capable of application in relation to any deduction and regardless of the section (and whether section 51(1) or otherwise) of the Tax Act, under which it is allowable.

9. (a) The definitions of ``adjusted net foreign income'' and ``net foreign income'' contained in section 160AF(8) of the Act are set out in full as follows:

```adjusted net foreign income' , in relation to a taxpayer, means:

• (a) where the net foreign income of the taxpayer of the year of income exceeds the sum of the taxpayer's income of the year of income and the apportionable deductions - an amount equal to that taxable income;
• (b) where subsection (7) applies, and the amount that, but for that subsection, would be the net foreign income of the taxpayer of the year of income exceeds the sum of the taxpayer's taxable income of the year of income and the apportionable deductions - the amount that bears to the net foreign income of the taxpayer of the year of income the same proportion as the taxpayer's taxable income bears to the amount first referred to in this paragraph;
• (c) in any other case - the amount that bears to the net foreign income of the taxpayer of the year of income the same proportion as the taxpayer's taxable income of the year of income bears to the sum of that taxable income and the apportionable deductions;

...

`net foreign income' , in relation to a taxpayer, means an amount equal to so much of the taxpayer's assessable income of the year of income as is foreign income, reduced by-

• (a) any deductions allowed or allowable from that assessable income that relate exclusively to that foreign income;
• (b) any amount the subject of an election made by the taxpayer under subsection 79E(6), 80AA(5B) or 80(2C) in relation to the year of income; and
• (c) so much of any other deductions allowed or allowable from that assessable income (other than apportionable deductions) as, in the opinion of the Commissioner, may appropriately be related to that foreign income.''

(b) The most important provision for the purpose of this case is paragraph (c) of the definition of ``net foreign income'' and in particular the last eight words reading: ``may appropriately be related to that foreign income''.

10. The Applicant's counsel furnished me with a helpful ``Applicant's Outline of Submissions''. I consider it appropriate to set out in full paragraphs 7 and 8 of that Outline; I refer also, (as did Mr Bevan) to the passages from ``Statutory Interpretation in Australia''; third edition by Pearce and Geddes, which are referred to in paragraphs 7 and 8 of the Outline. Those paragraphs are as follows:

``7. There is no definition in the Act of the terms `appropriate' or `related' or of the phrase `appropriately related' so they must bear their ordinary concepts meaning for the purposes of ascertaining the proper construction of the definition `net foreign income' in s 160AF(8). The Concise Oxford Dictionary defines `appropriate' as:

appropriate : belonging to or peculiar to; suitable or proper,

and it defines `related' as:

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related : connected, allied, akin.., having reference to, stand in some relation to.

As to the role of dictionary definitions in ascertaining the ordinary meaning of words for the purposes of statutory interpretation reliance is placed on the commentary in Statutory Interpretation in Australia, Pearce & Geddes, 3rd ed, para [4.2] at pp 63-64.

8. It is submitted that the term `appropriately related' in s160AF(8) ought bear its ordinary concepts meaning under the rules of statutory construction, it not being a technical phrase but rather being an ordinary phrase:
Town v Australian Telecommunications Commission (1993) 47 ALR 137 at 155 per Sheppard J (Full Fed Ct):

`The courts should not depart from the natural and ordinary meaning of words. The danger in composing an elaborate definition of an ordinary word in the English language, if the statutory context does not show that the word is used in an unusual sense, has been warned against often enough.'

Reliance is also placed on the discussion in Pearce & Geddes (ibid) at paras [2.3] - [2.5] in relation to the literal approach to statutory interpretation.''

I agree with the submissions contained in paragraphs 7 and 8 of the Outline; in particular I find that the term ``appropriately related'' must bear the meaning given to it in accordance with ordinary concepts, and so that dictionary definitions are appropriate. Other dictionaries consulted by me in respect of the terms referred to result in meanings which are not materially dissimilar.

11. Put in succinct terms, paragraph (c) of the definition of ``net foreign income'' will apply only in respect of deductions (other than apportionable deductions) which are appropriately related, in the sense that they are connected, have reference to or stand in some relation to the foreign income. The statutory regime laid down by the definition of ``net foreign income'' may effectively be summarised to the extent relevant for the purposes of this case, as follows:

• (a) under paragraph (a) the foreign income is reduced by deductions which relate exclusively to the foreign income;
• (b) under paragraph (c):
  • (1) apportionable deductions (defined in section 6(1) of the Act) are apportioned; charitable donations fall within this regime; and
  • (2) in respect of all other deductions the words which follow the words in parentheses govern the discretion conferred on the Respondent.

The term ``connected'' must, in my view, having regard to the qualifying word ``appropriately'', mean that the relevant connection has more than a mere passing or peripheral connection. Specifically in this context, and in relation to the accountant's fee, S's undisputed evidence was that he included an amount of foreign income without question, entirely in reliance on a statement furnished to him, and so that the accountant's fee had no more than a peripheral connection with it. Each case must turn on its own facts. If S's evidence had been that he worked on aspects of the foreign income for the purpose of the return, and given that his fees were charged on a time basis, it would, in my view, be appropriate to apportion in accordance with the time spent on the foreign income aspect. But this is not the case in this instance.

12. The Respondent has from the outset taken the view that the relevant deductions should be apportioned between the foreign income and the Australian income on a mathematical basis. Mr Dwyer argued that such an approach is in accordance with the discretion conferred on the Respondent by the section in that, so long as the Respondent is not acting capriciously, he is entitled to adopt that method of calculation which he considers most appropriate.

13. There is very little authority on the point. It may be noted in this context that the CCH Reporter illustrates the manner in which the provision might be applied by reference to an example (adopted from Australian Taxation Law by Woellner, Vella, Burns and Chippendale (Third Edition) (and set out in full although not all of it is material in this case) which appears at pages 45886 and 45887 of CCH as follows:

`` Example : Irene is an Australian resident who carries on business as a sole trader. During the 1991/92 year of income, Irene derived the following income (the amounts

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have already been converted to Australian dollars):

Income                                                  $

Gross business receipts from Australian operations   150,000
Gross business receipts from UK operations            75,000
Interest from deposits with US banks                  10,000

Expenses

Cost of goods sold in Australia                       50,000
Cost of goods sold in the UK                          30,000
Selling expenses                                      25,000
Administrative expenses                               20,000
      

Irene has paid the equivalent of $12,250 in UK tax and is subject to US withholding tax on the interest at the rate of 10%. She has also made a gift of $6,000 to an Australian charity.

Step 1 : Conversion of foreign income and taxes to A$ using the rules in sec 20. This has already been done on the facts supplied.

Step 2 : Determine the average rate of Australian tax.

                                           $
Assessable income                       235,000
Allowable deductions                    131,000
Taxable income                          104,000
Tax payable (including Medicare levy)    42,415

Average rate of Aust tax =  42,415
                           -------
                           104,000

                         = 40.78%
      

Step 3 : Is there more than one class of foreign income? For the purposes of determining the FTC limit, Irene has two classes of income under sec 160AF(7), namely passive (ie interest) income and other income.

Step 4 : Calculate the ``net foreign income for each class of foreign income''. The net foreign passive income is $10,000. Query whether it may be appropriate to allocate some part, albeit small, of the administrative expenses to the foreign passive income?

The net foreign other income depends on the allocation of deductions under sec 160AF(8). The cost of goods sold in the UK will be exclusively related to the UK trading income. Further, there needs to be an allocation of the selling and administrative expenses to the UK trading income. Assume that it is appropriate to allocate on the basis of gross trading revenue. This means that one-third of the expenses (ie $15,000) are allocated to the UK trading income.

Net foreign other income is therefore:

                                         $
Foreign assessable income             75,000
Allocated deductions
Exclusively related        30,000
Appropriately related      15,000     45,000
                           ------     ------
Net foreign other income              30,000
                                      ------
      

The example sets out that on the facts, the selling expenses and administrative expenses (which related to both Australian business operations and also UK business operations) might appropriately be apportioned on the basis of the relevant gross trading revenue figures. The important factor is that it relates (and is in the words of the definition ``appropriately related'') to an expense referable to both the United Kingdom and the Australian operations.

14. My attention was drawn to Taxation Ruling IT 2446 which favours the Applicant's view; clause 11 of IT 2446 is in the following terms:

``Deductions that clearly relate exclusively to income other than the relevant foreign income should be excluded from consideration. Only those allowable deductions which can clearly be viewed as related to the derivation by the taxpayer of both the relevant foreign income and other income are to be subject to apportionment . An example would be general administration or head office expenses incurred by a taxpayer who conducts business activities both in Australia and overseas and which are incidental or relevant to the conduct of each of those activities. Another example may be an expense such as interest on borrowed funds which have been used to purchase income-producing assets, including assets used to derive foreign income.''

(Emphasis added)

15. I was also referred to Taxation Determination TD 95/36 which while it does not deal with section 160AF, of the Act does

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refer to section 23AG of the Act which might, in loose terms, be referred to as the obverse of section 160AF(8) of the Act. Clause 5 of TD 95/36 is in the following terms:

``Superannuation contributions and tax agents' fees are not considered to relate exclusively to either the production of assessable income or exempt foreign earnings. It is arguable that being concessional in nature they do not `relate to' assessable income at all. They are not `apportionable deductions' as defined in subsection 6(1). It follows that those deductions are to be taken into account for the purposes of the definition of `Other Taxable Income' in paragraphs 23AF(17A)(e) and 23AG(3)(e). In that regard, conceptual and practical considerations require that the extent to which they may be appropriately related to the taxpayer's assessable income be determined in the same manner as is prescribed in subsections 23AF(17B) and 23AG(4) for apportionable deductions.''

16. TD 95/36 is a public ruling and the regime applicable to public rulings applies. It is of course true to say that TD 95/36 takes a view which is different from that taken in IT 2446. However TD 95/36 is not binding on the Applicant or the Tribunal and in any event deals with different sections. At least insofar as it is contended that it favours the method of assessment contended for by the Respondent in this case, I consider that it is not correct.

17. (a) In respect of the income protection premium, the Applicant's statement (Annexure E) sets out that the policy owner is the legal firm; however and as set out in clause 3 of the Applicant's statement, the amount of $1185 was paid by the legal firm to the life company ``on my behalf (and debited to my drawings account) to provide me with income continuance on disability...''

(b) The evidence indicated that as between the various offices of the legal firm earnings might differ from year to year; in particular the foreign office has not always operated at a profit. The Applicant argued that this particular deduction would have obtained, whether or not there was foreign income. That argument must be rejected; the Applicant was a partner in the legal firm; as such he was entitled to a share of the earnings not only of the Sydney office, but also the Brisbane office and the foreign office, regardless of whether he was ever in either of those other offices. The relevant expense was incurred in order to procure continuity of all of his income, and in the circumstances there is, in my view, an appropriate relationship between the expense and the foreign income sufficient to attract paragraph (c) of the definition of ``net foreign income''. The Respondent's calculation of the appropriate deduction from foreign income by reference to the mathematical relationship between the foreign income and the Australian income, was, in my view, correct and a proper exercise of the Respondent's discretion.

18. I find that the Respondent does not (as argued on his behalf) have an unfettered discretion in respect of other deductions such that, so long as he does not exercise his discretion capriciously, he is entitled to exercise that discretion as he thinks fit. On the contrary, his discretion is governed and limited by the last eight words of paragraph (c) of the definition of ``net foreign income'' and so that a deduction against foreign income will be properly made only where there is an appropriate relationship between the relevant deduction and the foreign income.

19. I do not think, as argued for the Respondent, that anything turns on the fact that paragraph (c) of the definition of ``adjusted net foreign income'' requires a mathematical calculation. The calculation to be made of adjusted net foreign income depends on the calculation, in the first instance, of the net foreign income. There is nothing in paragraph (c) of the latter definition, which requires or even allows for a mathematical calculation, in respect of other deductions which are not apportionable deductions. On the contrary the very fact that apportionable deductions are carved out to be dealt with by a mathematical apportionment calculation supports my view that in respect of other deductions a different regime is intended. If the legislature had intended that in respect of other deductions a mathematical calculation should apply, the provision whereby apportionable deductions are dealt with by apportionment would be redundant, and so that all deductions not exclusively attributable to the foreign income would be apportionable. The wording of paragraph (c) makes it clear that a different regime was intended.

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20. Mr Dwyer argued that the Respondent is entitled to exercise his discretion having regard in each particular case, to the circumstances, and where relevant by reference to the amount involved. Mr Dwyer sought to draw an inference from the fact that the amounts paid for superannuation were high in relation to income. This is undoubtedly so; however, the argument is not tenable. It must be so that taxpayers in the same situation are treated alike; the Respondent is required to determine on a reasonable basis, the part of a deduction to be taken against foreign income, but only where the deduction is appropriately related. The method used may differ from case to case depending on the nature of the deductions, the nature of the appropriate relationship, and the nature of the foreign income. I do not think though that the amount of the relevant deduction can, in any way, be determinative of the issue.

21. The accountants fees, on the evidence, related entirely to the preparation of the Australian return, and simply included details of the legal firm earnings in accordance with the statement furnished to S. The evidence on this point was not in any way questioned. In the circumstances the accountants fees did not have an appropriate relationship for the purposes of paragraph (c). Similarly the superannuation deduction was not appropriately or for that matter in any way connected with the derivation of the foreign income. Accordingly the definition of ``net foreign income'' will not in respect of either deduction permit an apportionment and the deduction of any part of these deductions against foreign income.

22. In summary I hold that the income protection premium was properly apportioned in the assessment but the accountant's fees and the superannuation deduction were not. In respect of each of the accountant's fees, and the superannuation deduction, no part is apportionable to the foreign income.

23. Accordingly, the objection decision is set aside and the relevant assessment is remitted to the Respondent for reassessment in accordance with this decision.