New Zealand Flax Investments Ltd v Federal Commissioner of Taxation
61 CLR 179(Decision by: Dixon J)
New Zealand Flax Investments Ltd
v Federal Commissioner of Taxation
Judges:
Rich J
Starke J
Dixon JMcTiernan J
Subject References:
Taxation and revenue
Income tax
Assessable income
Deductions claimed for future interest
Payment of bonds by instalments
Legislative References:
Income Tax Assessment Act 1922 No 37 - ss 23(1); s 25
Judgment date: 22 November 1938
Sydney
Decision by:
Dixon J
If there is any ground upon which the plan adopted for conducting the operations of New Zealand Flax Investments Ltd may be extolled, it must be for the manner in which it illustrates the difficulty of applying the provisions of the Federal income-tax law when a transaction takes more than a year to complete and the true profit arising from it cannot be ascertained until it is completed or carried further towards completion than a year allows. In such cases a satisfactory estimate of the position at the end of a year may often be made, but upon commercial principles. If that is done, a suitable provision for future outlay must be made against current receipts or credits. But, under the Income Tax Assessment Act 1922-1930, the assessment must begin by taking, under the name of assessable income, the full receipts on revenue account, and only such deductions must be made as the statute in terms allows. At all events that is the interpretation which the statute has received in this court (Webster v Deputy Federal Commissioner of Taxation (W.A.) [F7] ; and cf. Shelley v Federal Commissioner of Taxation [F8] ; Federal Commissioner of Taxation v Gordon [F9] ; Amalgamated Zinc (De Bavay's) Ltd v Federal Commissioner of Taxation [F10] ). To provide out of current receipts for future expenditure may involve making a reserve fund, and s. 25 says that no deduction shall be made in respect of income carried to any reserve fund. This prohibition may, perhaps, be confined to reserves out of net income, but, in any case, positive authority seems to be needed before a deduction is allowable, and, unless the future outlay can be regarded as an outgoing or a loss already actually incurred within the meaning of s. 23 (1) (a) although not yet met or discharged, it is not easy to find an authorization which will justify a proper provision.
New Zealand Flax Investments Ltd looked to derive its profits from the making and, it is hoped, the fulfilment, of an elaborate contract with the subscribers for bonds issued by the company, or from a series of such contracts. The issue of every series of bonds involved a single transaction, an undertaking or enterprise to be kept separate and distinguished from others. There appear to have been three series issued, although it is only the first two series that concern the years of income in question. The central features of the transaction, at all events as viewed by the subscribers, were the furnishing by the company of a piece of land for growing New Zealand flax and of a mill for the treatment of the flax, its cultivation, cutting, treatment and sale by the company, and of the yearly distribution of the net proceeds among the bondholders. In arriving at the net proceeds, 5 per cent of the gross returns was to be deducted as the company's charge for administration. The number of bonds issued bore a direct proportion to the area of the land to be provided by the company. In the first issue, for every half acre of land there was one bond of PD30: in the second issue, for every quarter of an acre one bond of PD20.
The subscriber might pay for his bond either cash down on application or by instalments. Different terms for payment by instalments were allowed, but the longest would cover two and a half years from the date of the subscriber's application, if the payments were made punctually. The bonds, each series of which were issued upon the terms and conditions of a trust deed, gave the holders no more than a contractual right to the performance of the obligations undertaken by the company. The money paid by the bondholder was not repayable. It was not a loan; it became part of the funds of the company and, subject to an exception which is really negligible, there was no express restriction upon the mode in which the company might apply it. It is true that each of the trust deeds recited that, in issuing the series of bonds, the company's purpose was to provide funds, in effect, for completing the purchase of the land and establishing, planting, maintaining, cultivating, milling and marketing New Zealand flax; but the body of the instrument did not expressly confine the application of the money to those purposes.
Both the company and the commissioner concur in treating all the moneys obtained by the sale of bonds as received by the company on revenue account. The company has conducted its finances upon that footing and it is not an assumption that the commissioner might be expected to deny. What the bondholders think of it does not appear. They are not represented. It is evident, however, that, upon the assumption that the bond moneys form part of the company's revenue, a full and complete provision must be made thereout to enable the company to fulfil its obligations to provide the land, plant it with flax, make a mill available and so on, before it is possible to make any fair and just computation of the net profit of the company for the year in which such bond moneys are received. The necessity of setting aside, not merely notionally, but actually, sufficient of the proceeds of the sale of bonds to enable the company to perform in the futurethe obligations it has undertaken is not made less evident by the length of time which, as the trust deeds show, may pass before the company obtains any substantial return from the work of cultivating flax. Under the first trust deed, the company has five years before it is obliged to complete the purchase of the land and in the meantime, beginning in the year after the issue of the bonds, a date fixed as 28th March 1929, it is to plant in each year only one-third of the land. Under the second trust deed, the land must be vested in the trustee for the bondholders within two years, but the time and rate of planting are the same.
The date of issue of the second series is fixed as 9th July 1930. For the first four years from those respective dates, a period presumably during which the flax is expected to grow sufficiently to provide a fund for distribution to bondholders, the company undertakes to pay the holders of fully paid bonds 7 per cent per annum. This means that, in the case of the first issue, until 28th March 1933, and, in the case of the second issue, until 9th July 1934, the company came under an obligation to pay 7 per cent per annum to every bondholder who completely paid his subscription; no source whence such payment could be met appears to have existed except moneys from the sale of bonds.
The company's obligation to furnish a mill left alternatives open and it might be fulfilled without transferring a mill to the trustee for either series of bonds. This might be done by satisfying the trustee that the company had made adequate arrangements for milling near the land. In any case, if a mill were erected on land transferred to the trustee, the latter held it only as a security for the performance of the obligation and not absolutely for bondholders.
Another security contemplated by the deeds was the deposit of the final 10 per cent paid for every bond with the Public Trustee to secure performance of certain conditions of the trust deeds. At a later stage, namely, on 17th August 1933, by deeds of variation made pursuant to a power reserved in the trust deeds, these funds were made available, subject to the approval of the trustees, for the purpose of establishing a mill which would not pass to bondholders.
The company's obligation of growing and marketing flax was limited under the second trust deed in respect of the second series of bonds to twenty years, but no limitation of time is contained in the first deed and apparently the company undertook a perpetual duty of growing flax for the holders of bonds of the first series; but it is noteworthy that the deed contains no express covenant to plant the land with flax a second time.
The first period under assessment is from 8th October 1928 to 30th June 1929, and the second from 1st July 1929 to 30th September 1930, although how it came about that such a period of fifteen months was adopted does not appear. In the first period, the company had done nothing in preparing or cultivating the land or providing a mill and had neither spent nor contracted to spend money in performance of those duties. In the second period, some actual expenditure was incurred in the work of preparing and cultivating the land. In both periods the company saw fit to make up its accounts and its returns by taking into the receipts side the entire sum representing the bonds sold, whether paid or not, and, on the other side of the account, making provision for the expenditure which ought to be made by the company at a subsequent time if it was to perform its obligations.
In making the assessments upon the company in respect of the two periods, the commissioner left standing the revenue side of the account but set aside the provision for future outlay. The company objected and, upon the commissioner disallowing the objections, requested him to refer his decision to the board of review. From that board's decision the company appeals to this court.
The reasons of the majority of the board of review contain the remark that, if the company in making its returns had submitted accounts showing as income merely the amounts received from the sale of bonds and had not included as income the portion not received, there is little doubt that only the amount received would have been regarded as assessable income.
It appears to me that the company is entitled now to go back to the basis which the board, no doubt rightly, say would have been accepted if adopted in the first instance.
In making up the accounts on the footing actually adopted, the company followed a coherent, even if not a very satisfactory, method. They took anticipated receipts in on one side and provided, on the other, for anticipated outlay, part at least of which was attributable to the anticipated receipts. When the anticipated outlay is disallowed, the company ought in reason to be permitted to put out of the account the anticipated receipts. These, however, are general considerations affecting only the choice of a method of computation where more methods than one are open. In point of law I think that it was wrong to include the future instalments unpaid on bonds sold, whether it was done by the taxpayer or the commissioner. We are not here dealing with a trader's account where goods, or other subjects of trafficking, that are on hand at the beginning and end of a period must be accompanied by purchases and sales, whether for cash or long terms, in order to show the results of trading. In the point of view adopted by the respective parties for the purpose of the returns and assessments the bond moneys must be regarded as taking on the guise of consideration or remuneration paid or payable in return for services or a combination of services, to be performed by the company over a long period in the future.
The plan formulated in the advertisement or prospectus for the sale of the bonds treated the proceeds of the flax once it had come into full growth as the source alike of the company's remuneration, consisting of 5 per cent of gross returns, and of the expenditure involved in maintenance and production. But, according to this view of the plan, what the subscribers for bonds paid for was the establishment of the undertaking as a productive enterprise, the service involved in obtaining the land and plant, bringing the land to the stage of production and setting up the requisite organization for treatment and sale. This was to be done over a period even longer than the two and a half years given as the longest term for the payment of the bond moneys by instalments. Experience of selling securities on instalments teaches that a large percentage of purchasers may always be expected to default. In all these circumstances it appears to me to be wrong to take into the account any of the instalments not payable within the accounting period. The board of review, although sharing, as it would seem, this opinion, gave only partial effect to it. It is unnecessary to discuss in detail the course involved in their decision, which, briefly stated, consisted in allowing the company to deduct from the total amount of the bonds sold the proportion of future estimated expenditure referable or proportionate to the unpaid future instalments of bond moneys.
It is possible that the board took this course owing to their view of the meaning of the relevant ground taken in the notice of objection. The commissioner contended that the ground did not cover the objection that future instalments formed no part of the assessable income. The ground is certainly obscurely and illogically worded, but its ambiguities should, I think, be resolved in favour of the taxpayer. I am, therefore, of opinion that, assuming the proceeds of the bonds to be a revenue item, only the amounts or instalments paid or payable within the accounting period should be taken into account. This means, as I understand the figures, that for the first period the figure PD2,095 10s. should be substituted for PD4,230, and, for the second, the figure PD27,989 10s. for the figure PD41,630 as the proceeds of bonds, or the figure PD6,193 10s. for the figure PD19,834 as the gross profit on trading account.
But, behind the assumption made by both parties for their respective purposes, there lies the question whether the bond moneys received formed a revenue item or were in whole or in part a capital receipt. I say "or in part," because it is, I think, possible that a single sum received in the course of the business of a company or of a natural person may be divisible and that part of it ought to be treated as capital and part of it as revenue or assessable income. Thus in Webster's Case [F11] itself, although it is said that the definition of assessable income as gross income clearly covered the gross proceeds of the sale of the wool in question, I should have thought that there was something to be said for the view that, as the sheep were purchased in wool only ten weeks before shearing, a proportion at least of the wool money should have gone into the same account as the purchase of the sheep, which was in fact a capital and not a trading account.
The plan of operations adopted by New Zealand Flax Investments Ltd presents peculiar features, one of which is that the company bound itself to bring into existence capital assets which would, according to the expectation it avowed, earn distributable profits for the bondholders and a percentage remuneration for itself, and yet, at the same time, the company proposed to make a net profit in the course of establishing these capital assets, a net profit consisting in the amount by which its expenditure on doing so was exceeded by the proceeds from the sale of the bonds, after providing commission and so-called "interest" at 7 per cent per annum on paid-up bonds during the first four years. Further, some of the capital assets, such as the mill, would or might ultimately enure for the company's exclusive benefit. In these circumstances I have felt some hesitation in adhering without inquiry to the assumption that the bond moneys form wholly a revenue item. This hesitation is increased by the consideration that, in the event of a liquidation, the bondholders might be faced by the commissioner's claim upon the assets for tax, an event which cannot be regarded as a remote contingency inasmuch as the company is said to have ceased active operations. But the notice of objection does not raise the question and I think that we are not in a position to determine a matter which is outside the objection, outside the actual dispute inter partes and outside the argument and, moreover, a matter of much doubt and difficulty.
There remain, however, the questions to which at the outset I referred. To what extent can the provisions for future expenditure or outlay by the company in fulfilling its obligations to bondholders under the trust deeds be deducted from the assessable income consisting of bond moneys? It is evident that, apart from any other difficulty in allowing such a deduction, the full provision claimed could not be allowed once it is decided that, not the full amount of the bonds sold, but only the payments receivable in the accounting periods, should be taken as assessable income. For the full provision claimed was for the total future expenditure out of the total amount of bond moneys. At best only that proportion could be allowed which was considered referable or attributable to the proceeds of the bonds taken into account as assessable income.
As to the principle which, if the statute allowed it, ought to be applied in reference to the deductions claimed, I agree that the statement of Lush J. in London Cemetery Co v Barnes [F12] is in point. "It seems to me," his Lordship says, "that in a case like the present the true profit earned by the appellants is the profit which remains when they have discharged and met the expenditure they have undertaken to discharge and meet in consideration of the payments, and although-as the appellants admit-the sums received are income and not capital, yet it would be wrong to treat the whole of the moneys received as profit or money earned; but against the payments which the appellants receive ought to be set off the expenses they will incur in order to earn the money so paid."
But, as the Income Tax Assessment Act 1922-1930 has been interpreted, authority for the deduction must be found not in general principles but under some provision of the statute. In par. ba of the definition of income in s. 4 "profit" is specially brought into the assessable income and this involves a preliminary account of the particular transaction, which, no doubt, is a departure from the general scheme ascribed to the Act. There may be other similar examples and perhaps, apart from such express provisions, instances of special businesses and transactions may be found where nothing but the net profit could be regarded as a revenue item. But, generally speaking, the gross receipts on account of revenue must be taken into the assessable income and therefrom the deductions allowed by the Act must be made and no others. For the purpose in hand I think that s. 23 (1) (a) must be the source in which the company must seek authority for the deductions. To come within that provision there must be a loss or outgoing actually incurred. "Incurred" does not mean only defrayed, discharged, or borne, but rather it includes encountered, run into, or fallen upon. It is unsafe to attempt exhaustive definitions of a conception intended to have such a various or multifarious application. But it does not include a loss or expenditure which is no more than impending, threatened, or expected.
In the present case I regard the obligation to pay interest to bondholders who, within the four years from the date of issue, paid up the amount of the bonds, as a definite liability contingent only on the bondholders meeting their instalments, that is, in the case of bonds subscribed for in or before the respective accounting periods the subject of assessment. There is no reason why the future liability should not be treated as incurred, if otherwise it were proper to throw it against the revenue items, as it would clearly have been if the full face value of the bonds were included in the assessable income. But I find it difficult to say upon the information before us whether any of this liability should be considered as properly attributable to the years in question. There is, I think, no objection to the commissioner's taking into consideration the actual events of the subsequent years in order to see whether, under a method of accounting by which only actual receipts from the bonds are included, the liability for interest would naturally be provided out of revenue from that source accruing in the year when the liability would be met, or whether safe or proper practice required for the purpose an appropriation and retention of part of the sums received in the accounting periods under assessment. In the same way I think that the commissions payable on the sale of bonds but deferred until the receipt of later instalments involve an outgoing "incurred," but one which does not necessarily and as a matter of course fall into the assessment of the accounting period.
But the reserves on account of the mill and for the purpose of clearing, burning, draining, ploughing, cultivating, planting and for "maintenance and general" cannot be brought within the authority of s. 23 (1) (a). The business propriety of making such an allowance may be made clear by stating the dilemma which affects the use of the funds represented by the suggested reserves. For either they should be expended in the work described by the headings mentioned, or else they should be repaid to the bondholders as damages or otherwise. Clearly the company should not retain the money or divide it between the Crown and their shareholders under the respective descriptions of income tax and dividends, whether dividends in a liquidation or in a going concern. But the Income Tax Assessment Act is not framed to give effect to such considerations. It is for this reason that I began by remarking upon the manner in which the plan of operations adopted by the company illustrates the application of the Federal Act to transactions extending over a greater period than the accounting period assessed.
In my opinion the most satisfactory way of dealing with the appeal is to set aside the assessments and to remit them to the commissioner for reassessment, so as to enable him to include only bond moneys received in the accounting periods and to allow whatever part, if any, of the deductions claimed for future interest and deferred commission appears referable to the accounting periods under assessment.
The proceeding before us consists of the appeals from the board of review directed to be argued before us under s. 18 of the Judiciary Act 1903-1937. We can, therefore, deal finally with the appeals. The specific questions mentioned in the statement of facts upon which the case was argued and described by the title "reference" afford guidance to the court but are not the questions of a stated case and do not require categorical answers.