Henderson v. Federal Commissioner of Taxation.

Barwick CJ

McTiernan J
Menzies J

High Court (Full Court)

Judgment date: Judgment handed down 19 February 1970.

Barwick C.J.: The appellant is a member of a partnership practising the profession of accountants under the firm name of C. P. Bird & Associates. This partnership constituted during the financial years 1963/1964, 1964/1965 and 1965/1966 his sole source of income. By it he was paid a salary and a bonus but received no distribution of the profits as such. Sections 90 and 91 of the Income Tax Assessment Act 1936-1966 (the Act), however, required the appellant to pay income tax upon the full amount of his share of the income derived by partnership in each year of tax. In the years ended 30 June 1965 and 30 June 1966 respectively, the partnership determined its profits on the basis of fees earned and accounts incurred during the year. It made its returns of partnership income on the same, i.e. on an earnings, basis. It distributed to its members, 19 in all, the whole of this profit for each year by way of salary and bonuses, borrowing money to the extent to which its cash receipts for the year were inadequate to enable it to make this distribution. The appellant returned as his assessable income the amount thus received by him in each of these years from the partnership. But the respondent (the Commissioner) was of opinion that in respect of these tax years a ``cash received and accounts paid'' basis was the proper basis on which to ascertain the income of the partnership. Accordingly, he assessed the appellant on the footing that he derived income in each of those tax years to the extent of his entitlement to a share of the partnership income so ascertained. With each of his assessments made under sec. 166 of the Act, the Commissioner served on the appellant an adjustment sheet disclosing the figuring by which he had re-adjusted the figures in the partnership return to represent a computation of the partnership income on a cash basis instead of an earnings basis. The result of this conversion was to treat the partnership as having in each of the tax years suffered a loss, a result to be expected insofar as the partnership had to borrow money to distribute, in cash, profits calculated on an earnings basis.

The appellant, having objected to the assessments, appealed to this Court against them. He had returned a taxable income of $10,646 and $13,203 respectively in the years 1964/1965 and 1965/1966. The assessments were for an amount of income tax based on a taxable income of $4,674 and $10,039, bringing to account his share of the partnership loss. In the calculation of the income of the partnership on either basis, the salaries paid to the partners were treated as outgoings of the partnership and not as a distribution of profits.

The appellant's appeal against these assessments was heard by my brother Windeyer, who decided that the assessable income of the appellant would be that sum which would represent his share of the income of the partnership computed on an earnings basis. Consequently, he decided that the assessment computed upon cash received basis was erroneous. However, his Honour held that the income of the partnership for the tax year 1964/1965 ought to be calculated in a particular manner, for a reason to which I shall later advert. Suffice it to say at this point that the appellant has appealed against the order made in respect of the year ending 1965 by reason of this particular manner of calculation and that the Commissioner has appealed against his Honour's orders insofar as they are based on an income of the partnership computed on an earnings basis.

A question arose before his Honour as to whether sec. 190 casts on the taxpayer-appellant the burden of establishing that the Commissioner's assessment is erroneous where the ground of appeal is, as it was here, not that the assessment was for too much but that it was for too little. But the parties accepted the position that in the hearing of the appeal the appellant should begin and no occasion has arisen to resort to the onus of proof to resolve any question arising in the appeal. Thus, no need to discuss the operation of sec. 190 now arises.

In my opinion, his Honour was clearly right to conclude that a computation of the

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income derived by the partnership in each of the years in question upon an earnings or accrual basis would yield the correct figure for the assessable income of the appellant. The details of the manner of operation of the partnership and its relation to the company, C. P. Bird & Associates Pty. Ltd., are to be found in his Honour's reasons for judgment and need not be repeated here. But some particulars extracted from the evidence by counsel for the appellant are worth recalling as indicating the nature and extent of the operations of the partnership and to bring those operations into sharp contrast with the operations of the medical practitioner whose affairs were the subject of discussion and decision in
C. of T. (S.A.) v. Executor Trustee and Agency Co. of South Australia Ltd. (Carden's case) (1938) 63 C.L.R. 108.

At relevant times the partnership employed a total of 295 persons of whom about 150 were qualified accountants. Fees earned for the year ending 30 June 1965 amounted to $1,181,166 and in the year ending 30 June 1966 to $1,374,000. Bad debts in the year ending 30 June 1965 amounted to $98 and in the year ending 30 June 1966 to $641. Its disbursements, excluding salaries to partners, for the year ending 30 June 1965 amounted to $1,045,358 and for the year ending 30 June 1966 to $1,074,567. The accountancy practice which it conducted in various centres was said to be the largest in Western Australia and one of the largest in Australia.

It is apparent, in my opinion, that what such a business earns in a year will represent its income derived in that year for the purposes of the Act. The circumstances which led the majority of the Court to conclude in Carden's case, supra, that a cash basis was appropriate to determine the income of the professional practice carried on by the taxpayer personally are not present in this case.

It is necessary, however, to deal with a particular submission made on behalf of the Commissioner. Pointing to sec. 166, 167 and 190 of the Act, it was claimed that the Act gave the Commissioner, as counsel said, an ``initiative'' to determine the assessable income of a taxpayer and that, so long as in determining that income he employed a method which was not inconsistent with any of the provisions of the Act, there would be no ground for setting aside the figure at which he arrived for that income. He then says, using the view of the majority in Carden's case, supra, that the computation of the income of a professional practice upon a cash basis is an appropriate method of ascertaining the income derived in the year of tax and not in any respect inconsistent with the provisions of the Act. Consequently, it was argued that it is not enough for the appellant to establish that a computation on an earnings basis is also appropriate, or even that the figure of assessable income which it produces is a better indication of that income than the figure at which the Commissioner assessed by a computation upon a cash basis. Nothing short of establishing that the basis of calculation was inconsistent with the provisions of the Act will suffice, according to the argument, to warrant the setting aside of the assessment.

This argument, strongly pressed before us, is, in my opinion, clearly untenable. The Act, by sec. 17, levies income tax upon the amount of taxable income derived by the taxpayer in the year of tax. The taxable income results from the application of the provisions of the Act to what is in fact the assessable income of the taxpayer: that in the case of a taxpayer resident in Australia is the whole of the income which is not expressly exempted by the Act, which the taxpayer has derived during the year of tax from any source whether within or beyond Australia. That assessable income when ascertained must be expressed in a figure. There cannot in fact be alternative figures for such assessable income. The figure determined as that income may be the result of estimation, as well as of calculation, and its determination may involve the acceptance of opinions, expert or otherwise. In the long run it may be the outcome of an exercise of judgment. But however arrived at, the result is a figure, the assessable income in fact of the particular taxpayer for the year of tax.

Of course, the Commissioner has the capacity under the Act to make an assessment of the income tax payable by the taxpayer, that process involving the formation of opinion or judgment as to the taxpayer's assessable income and, having regard to the terms of sec. 190, it must rest on the taxpayer in an appeal against an assessment based on the amount of the assessable income so determined to show that the Commissioner's figure for that income is wrong. But the question of onus apart, the issue on such an appeal is what in fact is the assessable income of the

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taxpayer derived in the relevant year of tax. No doubt, where the Commissioner's figure is the result of the application of some method of computation to figures not otherwise in dispute, the contest may appear to be one as to the appropriate method of computation of the income derived: and the determination of such a method of computation will resolve the issue, which is what is the amount of the assessable income derived. But unless the method of computation yields what is in fact the correct figure for that income, it cannot be said to be appropriate in the circumstances or to be not inconsistent with the provisions of the Act. Whilst opinion may differ as to that fact, ultimately the opinion of this Court will determine it.

In the present case, as I have said, in my opinion, the figure of assessable income computed on the footing of the net earnings of the partnership in each of the years in question was the correct figure and the figure adopted by the Commissioner as that assessable income was a wrong figure. In my opinion, therefore, the assessments of the Commissioner were properly set aside. That means that the Commissioner's cross-appeal should be dismissed.

However, the appellant's appeal remains to be dealt with. This arises out of the qualification which his Honour made to the computation made on an earnings basis of the partnership income derived in the year ended 30 June 1965. His Honour thought that, in respect of this year, the amount of fees earned but uncollected at the end of the year ended 30 June 1964, less the amount of unpaid obligations, to the extent to which the fees were collected during the year ended 30 June 1965, should be added to the net fees earned during that year in order to arrive at the income derived by the partnership in that year.

The occasion which prompted this course was that the partnership had computed its income for the year ended 30 June 1964 upon a cash received basis, the partnership had made its taxation return on that footing and the appellant had returned his income accordingly. The Commissioner had accepted these returns and assessed the appellant to income tax on the basis of them. Fees outstanding at the end of that year were thus not brought to tax in that year. If the partnership income were computed for the year ending 30 June 1965 upon an earnings basis and the relevant earnings were confined to the earnings of that tax year, those fees outstanding, which amounted to a considerable sum in the order of $179,000, if no other action should be taken, would be collected without ever being brought to tax.

The reason that his Honour in those circumstances thought that these outstanding fees should be included in the earnings of the year ended 30 June 1965 was that the income of a continuing business such as that under consideration could not be regarded as ``... an annual crop. It is merely so much of a continuous incoming as is attributable to a particular year....'' Referring to the exclusion by the partnership from its 1965 return of the fees outstanding at the end of the year 1964, his Honour said-

``It is this kind of result of changing from a cash basis to an earnings basis, and then regarding the next year in isolation, that prevents the partnership return for the year ending 30 June 1965 being a true reflex of income. It is not a true reflex, simply because taking the income there shown with the income shown in the previous year the two together do not reflect the true income over the period of two years combined.''

But, with due respect to his Honour, there cannot be any warrant in a scheme of annual taxation upon the income derived in each year of taxation for combining the results of more than one year in order to obtain the assessable income for a particular year of tax. Of course, the experience of a prior year may be reflected in the opening figures of the relevant year but they become and are figures of that year and not figures of two years in combination. Once it is decided that the partnership income derived in the year in question will be the net amount of its earnings of that year, it is, in my opinion, only the earnings of that year which can be included in the computation. There was some question raised in argument as to when and to what extent these outstanding fees had in fact been collected: but, as I see the case, nothing presently turns on the determination of that question. I shall deal separately with an unrelated question as to what has been referred to in argument as ``work in progress''.

As the income of the partnership derived in the year ending 30 June 1965 is properly the amount of its net earnings in that year

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and as those factors which make a computation of such earnings appropriate to determine that income were equally present in the preceding year, it follows that the figure at which the partnership income for the latter year was arrived at on a cash received basis was not the proper amount of the partnership income derived in that year. Consequently, the assessment of the appellant for income tax for the year ended 30 June 1964 was erroneous and could have been rectified by the respondent by an amended assessment within three years of its making: see sec. 170. The fact that that course may now be impossible by reason of the lapse of time affords no reason, in my opinion, for any departure from the annual basis on which the income of the tax year in question is to be computed. The uncollected fees in question apparently were earned in a year prior to the year ending 30 June 1965 and there is, in my opinion, no basis for the inclusion of any part of them in fees earned in that year. Accordingly, in my opinion, the appellant should succeed in his appeal.

There remains a question as to the appropriate order to be made. The assessments should be set aside and the matter remitted to the Commissioner for re-assessment of the appellant's taxable income in each of the years under appeal by including in his assessable income his share of the net earnings of the partnership in each of such years.

In ascertaining such earnings, only fees which have matured into recoverable debts should be included as earnings. In presenting figures before his Honour, allowance was made for what was termed ``work in progress''. But this, in my opinion, is an entirely inappropriate concept in relation to the performance of such professional services as are accorded in an accountancy practice when ascertaining the income derived by the person or persons performing the work. When the service is so far performed that according to the agreement of the parties or in default thereof, according to the general law, a fee or fees have been earned, then it or they will be income derived in the period of time in which it or they have become recoverable. But until that time has arrived, there is, in my opinion, no basis, when determining the income derived in a period, for estimating the value of the services so far performed but for which payment cannot properly be demanded, and treating that value as part of the earnings of the professional practice up to that time and as part of the income derived in that period. It may be that a different course can be taken if an estimation of profits is being made for some other purpose than the present. Consequently, in determining the income of the partnership in either of the years in question for the purposes of assessment of tax, only accrued fees may be included in that income. I have used the word ``recoverable'' to describe the point at which income is derived by the performance of services. I ought to add that fees would be relatively recoverable though by reason of special arrangements between the partnership and the client, time to pay was afforded.

In the result, the appeal should be allowed and the cross-appeal dismissed. The assessments should be set aside and the matter remitted to the respondent to re-assess the appellant conformably to the Court's reasons for judgment.

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