J. Rowe & Son Pty. Ltd. v. Federal Commissioner of Taxation.

Walsh J

High Court

Judgment date: Judgment handed down 18 December 1970.

Walsh J.: These three appeals against assessments of income tax payable by the appellant Company relate respectively to the years which ended on 30 June 1965, 30 June 1966 and 30 June 1967. I shall refer to those years as the 1965 year, the 1966 year and the 1967 year.

The appellant (the Company) conducts a retail store in the City of Toowoomba in which it sells household goods including furniture, furnishings and electrical appliances, such as television sets and refrigerators. It began about 1947 to offer goods on terms of low deposits and extended periods of payment and later it introduced a policy of requiring no deposit. Up to the end of 1959 the usual method of effecting these transactions was to use hire purchase agreements. From 1960 to 1 December 1964 a different method was adopted. Goods selected by a customer were sold by the Company to an associated company and sold by the latter company to the customer. The Company lent to the customer an amount equal to the price of the goods, repayable with interest by instalments over a period. The money so lent was paid immediately by the customer to the associated company as the price of the goods. The Company took from the customer a Bill of Sale over the goods.

From 1 December 1964 another system was used. One reason given for its adoption was the avoidance of difficulties caused by legislation regulating money-lending. A customer agreed to buy goods at a price which, in my opinion, may properly be called a ``cash price''. But it was arranged also that payment might be made over an agreed term ranging from three months to five years. A document was completed and signed by the customer. It was called an Offer to Purchase. Its form may be explained by describing the contents of one such document tendered in evidence (Exhibit 3). The name and address of the customer and the date appear on the document. There is a notation which means that the term of the agreement is to be twelve months. Under the heading ``Schedule'', descriptions are given of six different items of furnishings and opposite each are figures which show a price for the goods although not described as a price. At the foot of the Schedule figures are written which show the total of those itemised prices, which on Exhibit 3 is $90.62. Beneath the Schedule appear the printed words -

``To J. Rowe & Son Pty. Ltd. For the Goods listed above I offer the sum of $.....Payable by way of a first payment of $..... Cash and thereafter by Periodical Instalments of $.....every..... weeks/months commencing on.....


In Exhibit 3 it is not $90.62 which appears as the amount offered. It is $101.80. At the foot of the document the ``debit'' left after deducting $1 is $100.80. A first payment of $2 cash is here indicated but on other specimen offers which are in evidence the first payment is nil. The offer is filled in after the cash price and the length of the term have been fixed and the amount is obtained by using a ``Terms Ready Reckoner'', which shows for periods varying from six to sixty months appropriate terms prices corresponding to any given negotiated price. That terms price is written at the foot of the document and to that amount $1 is added to obtain the sum which the customer offers for the goods. The terms price exceeds the cash or negotiated price by 11 per cent per annum. For example, if the cash price is $100 the terms price for a period of twelve months is $111 and for a period of twenty-four months it is $122.

ATC 4003

The evidence showed that in some lines, particularly the larger appliances, such as television sets, that which I have called the cash price is not a marked or advertised price but is a negotiated price. But this does not affect the conclusion which in my opinion ought to be drawn from the evidence that in these transactions there are two identifiable components, one of which represents the sale price of the goods and the other of which represents terms charges, that is to say, an additional consideration for the deferring of the payment of the price. I think that this conclusion is not inconsistent with the acceptance of evidence that in some instances a customer may be able to buy for cash at a price below a marked or advertised price. The price marked or advertised or agreed upon after bargaining may be taken as the sale price of the goods, notwithstanding that in special cases a customer may be able to buy at a discounted price.

The Offer to Purchase which is Exhibit 2 is in a slightly different form, which seems to have been intended for use in cases in which a trade-in allowance is to be made, but the differences are of no significance.

The Offer to Purchase was accompanied by a Bill of Sale signed by the customer. Some of its provisions should be noted. There is a recital by which the grantor acknowledges the total amount agreed to be paid as being ``a valid and enforceable debt due by the Grantor to the Grantee'' payable by the particularised periodical instalments. It is provided that on any default the whole of the balance secured shall at the option of the grantee immediately become due and payable as a present debt. It is provided that the grantor undertakes to pay interest at 8 per cent per annum of any payment which may from time to time be overdue or unpaid.

Although no doubt the availability of extended terms was an important inducement to people who dealt with the Company, a great many of whom were wage earners on relatively low incomes, yet from the point of view of the Company this was not simply a lure which with reluctance but under compulsion of marketing necessity it used to entice buyers, but was a preferred method of trading, which its salesmen were exhorted to adopt when they could. Further they were encouraged to arrange a long, rather than a short, term for payment.

The Company sells also for cash or on thirty days' terms. Mr. A. T. Rowe gave evidence that the time-payment sales were 60 per cent or up to 70 per cent of all sales and that of the time-payment sales some 25 per cent were for a five year term and 51 per cent for three years or longer.

The Company advertised what it called a family protection plan. It undertook that if the bread-winner of a family died it would cancel the balance outstanding on a time-payment account. No such provision appeared in the documents.

Mr. Rowe gave evidence that the collection of money is a difficult part of the Company's business and requires extensive checking of the account and the sending out of letters and sending collectors to call on customers. When a customer finds difficulty in keeping up his payments, his agreement is sometimes varied so that the period for repayment is extended and the amount of the instalment reduced. Mr. Rowe said that in the course of a year two-thirds or up to three-fourths of the terms customers go into default at some time or other. Out of 5,000 accounts there are 1,500 changes of addresses in a year. In most cases where default continues and the contract is terminated, a voluntary return of the goods is made and it is not necessary to seize them. The goods returned are much reduced in value as compared with new goods. Some goods are lost because the goods or the customer cannot be found. The Company took out insurance against that loss but later discontinued that insurance. It is not the practice for the Company to sue for unpaid instalments, as it is considered that this would not be economically wise. Mr. Rowe said that the collection system is ``the very heart of the business'' and that it is extensive and costly. I do not think that he was deliberately untruthful in any of his evidence but on some matters his knowledge was far from precise and I think that in some respects he had a tendency towards exaggeration. The evidence showed that the collection of instalments called for an expenditure of time and money which was significant, but the cost of it, so far as this could be ascertained from the evidence, was relatively not high having regard to the size of the business. The appellant failed to provide satisfactory evidence as to the proportion of the instalments which could not be collected or as to the amount of the losses sustained in consequence of the voluntary return or the repossession of

ATC 4004

goods. I mention those features of the evidence, although I do not regard them as having in the end any effect on the result of these appeals, because in the questions put to expert witnesses and in some of the submissions made on behalf of the Company, I think that the business was treated, to an extent not fully warranted by the evidence, as being exceptional, both as to the difficulties and the expense of the collection of debts and as to the losses sustained because of default. I do not doubt that it was necessary in a business sense to attend regularly and diligently to the collection of the instalments or that risks were involved in delivering goods on extended terms to customers of the class with which the Company dealt. Nevertheless I think it is a proper conclusion on the evidence that the Company expected that it would receive a sufficient proportion of the instalments on the terms contracts to make it profitable for it to carry on that part of its business, bearing in mind that the instalments included the terms charges. Evidence has not been produced which satisfies me that that expectation was disappointed or that experience proved that the addition which ought to be made to the cash price when making these contracts had been calculated at too low a figure to compensate the Company for the delay in getting its money and for the expenses and risks involved in this type of business.

I mention one further matter of fact although I do not regard it as having great importance. A question was raised with Mr. Rowe and with the Company's accountant, Mr. Betts, as to the practice followed when a customer desired to pay out in full the balance of future instalments. It proved difficult to get a satisfactory answer to that question. Perhaps this was due to lack of sufficient knowledge rather than to an intention to be evasive, but it seemed curious that men occupying important positions with the Company were so vague about this matter. Ultimately Mr. Betts, although earlier he was disposed to insist that there was no applicable rule or practice, said in re-examination that the credit manager would offer a rebate calculated on a basis equivalent to what is known as the rule of 78, but if the customer objected to that he might be allowed a greater rebate.

Both Mr. Rowe and Mr. Betts were reluctant to accept that the differences between the total price and the marked or negotiated price could properly be described as terms charges or as interest. But it is plain on the evidence that, whatever name should be given to that difference, there was, in the total sum for which a customer offered to buy, a component which could be identified and quantified simply by examining the contract document itself and which was an addition to the price fixed (sometimes after bargaining) by the Company or its employees for the goods. The addition was calculated by reference to the length of the term and to a predetermined percentage rate. As will appear, the respondent has treated that component differently from the rest of the total sum in determining the method by which these transactions should be brought to account for tax purposes. It has been argued that there was no legal justification for his making that dissection of the transaction. But the evidence shows clearly that in point of fact it is a dissection which is not artificial but accords entirely with the real nature of the transaction and with the mode of business which the Company wished to conduct. Up to 1 December 1964 it sold goods at a price regarded as satisfactory and then for a further consideration it lent money at interest. When it changed to a different system, this did not make any substantial difference from the point of view of a customer. From the point of view of the Company, it may be said that in fact it was still continuing to engage both in the selling of goods and in the financing of sales made on extended terms. I do not accept the proposition that as a matter of law transactions of this kind must be regarded, in determining how they are to be brought to account for taxation purposes, as creating an indivisible obligation or debt payable without interest.

It is time now to state how the Company complied its income tax returns and how the respondent dealt with them. In the 1965 year the sales on instalment contracts were shown in the trading account separately from the cash sales and ``credit sales''. They were described as ``sales over a deferred future period'' and an amount called ``provision for contingencies'' was deducted. But together with the other sales, they went to make up a total figure for sales from which was derived a ``gross margin before commission'' and ultimately a ``gross margin'', which became the first item in the profit and loss account for that year. On the latter account the net trading result was shown as £56,578.3.6. In the income tax return for that year, to which were attached the trading account and the profit

ATC 4005

and loss account and other explanatory annexures, the last-mentioned figure was shown, in the statement of the taxable income, as the first item. But adjustments were then made of which I need not set out all the details. The object of the adjustments was to give effect to a view that for tax purposes the amount of the sales over a deferred future period ought not to go into the accounts in the year in which the sales were made. In relation to sales of that character all that should go in was an item described in the return as ``cash and all considerations received in respect of Sales over a deferred future period''. The amount to which that description was given has been treated by both parties as including not only cash actually received in the tax year but also the amount of all instalments which became payable within that year. The result of the adjustments made on the first page of the return was that a loss for the year of over £100,000 was shown instead of the profit which appeared as the net trading result in the Company's accounts. The explanation forwarded with the return included, in relation to the sales over a deferred period, the following statement of the Company's contentions -

``It appears that Income Tax is assessable on amounts received from these terms sales only when received. For accounting purposes it appears that the normal procedure is to regard the sale as being a normal sale and to make provision in regard to the deferred income. It appears however that the provisions of the Income Tax Act have to be considered in preparing the Income Tax Return of the Company and for this reason adjustments have been made to the taxable income which has been returned.''

The returns for the 1966 and 1967 years were made in conformity with the same contentions. In those years the Company adopted a different procedure in compiling its own trading and profit and loss accounts and it is useful to refer to the trading account for the 1966 year. Cash sales and credit sales are shown at figures which come to a total of $866,819. A blank space is left opposite the words ``sales over a deferred future period''. A footnote states that credit sales do not include proceeds of sales made under contract which have not been realised and are not realisable at 30 June 1966 and it refers to a note on the balance sheet. The latter note states that a ``contingent asset'' amounting to $518,450 exists in relation to the amount owing on contracts for the sale of merchandise, moneys from which have not been realised and are not realisable at the date of the balance sheet. In the 1966 year the profit and loss account showed as the net trading result a loss of over $257,000. This amount, after immaterial adjustments, was shown in the return as a loss for that year. When a loss brought forward from the 1965 year was added a loss was shown of over $477,000. Subsequently an adjustment, made because of an error which had been discovered, reduced that loss. In the 1967 year the profit and loss account showed only a small loss as the net trading result, and in consequence of an adjustment shown in the return there was a surplus for that year, but the loss brought forward from the previous year was so large that the fine figure in the return was a loss, to be carried forward, of about $249,000.

The respondent did not accept the Company's method of dealing with the instalment contracts. The details of the adjustments which were made are somewhat complicated. In part they were based on supplementary information supplied by the Company on request and in part on calculations from figures appearing in the accounts furnished with the returns or in supplementary statements supplied later. Detailed explanations of the way in which the adjustments of the taxable income were made by the respondent are given in Exhibits 8 and 9. The appellant does not challenge the accuracy of the working out of those details, but challenges the basis upon which the respondent proceeded.

The respondent distinguished between amounts which he considered should be regarded as the sale price of the goods and those which constituted terms charges. The former was treated as earned when the contracts of sale were made and as being properly brought into account at that time. The terms charges were treated differently. I did not understand that any challenge was made to the particular way in which they were treated. But I think it is desirable, having regard to some of the submissions which were made, to see how the respondent dealt with the terms charges.

For the 1965 year the respondent accepted (subject to some adjustments not now material) the net profit shown in the Company's own profit and loss account as being the taxable income for the year. In arriving at that net

ATC 4006

profit the Company had deducted in its trading account, from the gross figure for the sales over a deferred future period, an amount of £45,128.5.2 described as a provision for contingencies. In the explanatory statement, which is Exhibit 8, the respondent states that this has been regarded as being the total of the terms charges or equivalent not received or receivable in that year. The respondent refused to accept the adjustments which the Company made in its return in order to arrive at its taxable income, but the respondent did not treat the provision for contingencies as having been wrongly deducted in working out the net profit. Nor did the respondent bring into the taxable income any part of the amount of the terms charges which were not in that year paid or payable. What he did treat as part of the taxable income was the net amount outstanding on instalment sales after the provision for contingencies had been deducted, regarding this as an item which should be included as being part of the sundry debts arising out of sales.

In the 1966 year the respondent made adjustments which brought into account, as part of the gross income of that year what I shall call the sale price (that is, the total amount of the face value of the sales less the terms charges component) on goods sold in that year on instalment contracts. In addition he brought into account an amount estimated to be the total amount of terms charges which in respect of such contracts were already paid or payable in that year. This amount was obtained by doing a sum in proportion, that is to say, it was based on the proportion which all the moneys received and receivable in that year bore to the gross amount of the extended terms sales including the terms charges. In the year 1967 the same method was adopted.

The primary submission on behalf of the Company was that when goods were sold by instalment contracts no income was derived from those transactions in the year in which they took place, except instalments which were paid or became payable in that year. Its alternative submission was that income was derived (a) as to so much of the price which the purchaser contracted to pay as represented the ``costs of the taxpayer'', when the sale was made; and (b) as to the ``trading profit'' component in the price, a portion thereof calculated on a profits-emerging basis, according to some accepted method, such as the rule of 78 or some equivalent.

Those were the only submissions made ultimately in counsel's closing address. But in the course of making them a third basis of assessment was discussed. This was that, as at the time when the sale took place, the consideration for which it was made should be valued and the amount of the valuation brought into the income for that year. Counsel did not contend that this was the appropriate method to be used in this case for computing the taxable income, but I think it is necessary to consider it because I think it is important that I should explain why it is that in my opinion the problem in this case is not to be solved by adopting a method, which at first sight might seem better designed than any other to establish what a seller of goods does really obtain in exchange for them, when he sells them at a price payable by instalments over a period. By evidence called on its behalf, the Company sought to make out a case that its rights under the instalment contracts had no value or, at least, that it was not practicable to value them. Mr. Summerville, a manager of a large finance company, was called to say that his company does not buy traders' debts, nor do other finance companies, and that in his opinion it was almost impossible in a business sense to value book debts of this kind. This evidence was used in an endeavour to apply to this case certain authorities which were said to indicate that the method of valuation is proper if it is practicable but, if it is not, then debts should not be brought into account until the time for payment of them arrives: see
Absalom v. Talbot (1944) A.C. 204 and
Harrison v. John Cronk & Sons, Ltd. (1937) A.C. 185. To those authorities I shall refer again later. But I do not think that the evidence of Mr. Summerville about valuing the debts is of any assistance in the circumstances of this case. If it should be accepted that if the debts were taken into the market for sale then probably no one would buy them, and that it is not possible to estimate in advance what would be the price paid for them if someone did buy them, this does not provide any basis for a conclusion that the debts had no value or had a minimal value to the Company. It would be quite wrong in my opinion to conclude that the Company engaged on a large scale in the business of selling on instalment contracts and favoured that form of trading, but was really exchanging its goods for something which had practically no value. We are concerned with the trading debts of a business

ATC 4007

which is not in the course of being wound up but is a going concern. If valuation is to be regarded as relevant to the problem, the valuation must be an estimate of what, at the time to which the valuation refers, the debts are worth to the Company. I should think that this would have to be estimated by discounting the total face value of the debts to bring them to a present value and also by taking into account estimates as to the proportion of the debts which would be collected and of the losses which would probably be incurred by reason of default. Obviously it would not be practicable to value the debt created by each individual transaction. The valuing would have to be done according to a formula by which the face value of the debts was discounted to an extent which was calculated to be the proper extent, upon taking into account factors such as those to which I have referred. These factors are, of course, the same as those which it is natural to suppose that a businessman would consider when deciding the amount which in an instalment contract ought to be added as a terms charge component to the sale price of the goods. In this case it was not proved that if you applied such a method of valuation to the gross face value of the debts, the amount by which you would discount them would be the same as the amount of the terms charges, nor was it proved in my opinion that it would not be the same or approximately the same. It was suggested that the manner in which this Company conducted its business was such that no assumption could be made that, in fixing the 11 per cent per annum used in computing the terms charges, the Company paid any attention at all to what was needed to cover bad debts and collection costs and so on. I did not find this suggestion convincing. But in any event, there really was no proof that the amount of the terms charges was not adequate to cover those contingencies and to leave a reasonable return on the money outstanding on the sales. It is true that Professor Gynther, an expert witness called by the respondent, was disposed in parts of his evidence to suggest that in relation to instalment contracts an amount being a little less than the sale price component in the contracts might sometimes be the amount which in the accounts for the year in which the transactions were made would give a true reflection of the trading for that year. The suggestion was that it was proper to bring into the sales for the year the full amount of the sale price, but that there might be circumstances in which it would be right, also, to make and show in the accounts a provision for bad debts. But as I understood the evidence of this witness, he was not stating an opinion that in this case such a provision was necessary, in order that the true result of the year's trading should be shown, but was saying only that there might be cases in which such a provision ought to be made. But I need not review that part of his evidence in detail because, in the first place, I think that what he said on this point does nothing to qualify the other important evidence which he gave and to which I shall refer again and because, in the second place, counsel for the Company has not made any submission that the challenged assessments should be reduced for the reason that what this witness said about bad debts shows that there should have been brought into the income of a particular year not the ``sale prices'' of the transaction but a slightly reduced figure designed to allow for bad debts. If such a submission had been made, it might have given rise to some problems as to whether effect could be given to it consistently with the provisions of the Act. The debts payable in the future could not be treated directly as bad debts or written off as such. But probably, if it were to be decided that the proper method of arriving at the income was one in which the debts were valued as at the date of the transactions, the provisions of the Act would not preclude the valuer from taking into account, when making his valuation, the risks as to bad debts. In my opinion however that question need not be pursued. It may perhaps be thought that for practical purposes the method adopted by the respondent, by which the trade debts created by the instalment contracts were treated by bringing the ``sale price'' immediately into account and by dealing separately with the terms charges, does not differ greatly from the result which would be attained by setting out to value, as at the date of the transactions, the rights vested in the Company. But whether that be so or not, neither party has contended that it is this latter method which should be used in this case. The respondent's contention that the sale price should be brought to account in the year when the transaction takes place is based on the propositions that this accords with accepted accountancy principles applicable to trading of this kind, that it is necessary in order that a true picture may be obtained of the result of the year's trading and that what the Act

ATC 4008

requires is that the net gain of the trader in that year should be included in his income for the purposes of taxation. Those propositions are denied by the Company. In place of them it puts forward the two contentions to which I have already referred and does not seek to support any third method of dealing with the problem as being a proper one to adopt in this case.

I must now consider the two contentions upon which the Company relies. The first is that nothing can be brought into account before it is paid or payable. Counsel argued that accounting concepts were not relevant. It was said that the Act taxes ``income derived'' and that concepts and methods which are applicable to the ascertainment of ``profits'' or ``profits and gains'' are not appropriate under the Commonwealth Act, as they are under legislation in the United Kingdom. There are important differences between the legislation in force here and that in force in England. But I am of opinion that there is not really a difference between the concept of income and that of profit or of gain which is significant for the purpose of answering the questions raised by these appeals. One important difference which is asserted by the argument to exist is that, whereas in a computation of profits the matching of costs or expenditure against revenue is accepted as essential, there is no need and no legal justification for any such requirement in computing ``income'' for the purposes of the Act. To my mind it seems clear that the method which the Company adopted for arriving at its income produced a result entirely contrary to the true result of the trading of a particular year. Stock went out from the Company's ownership and possession and to a large extent nothing appeared in the accounts to replace it. To illustrate this point, an example was used in evidence of a transaction, supposed to occur just before the close of a tax year, in which the total sum offered for goods was supposed to be $240, of which $200 was the ``sale price'' and $40 the terms charge. It was supposed that the cost of the goods which would be included in the expenditure side of the account was $150 and that no instalment was yet paid or payable at the close of the year. According to the Company's method there would be in that year's accounts a loss on the transaction, because goods worth $150 had gone and nothing had come in to match them. If the Act has the effect that for its purposes that is the result of such a transaction that must of course be accepted. But I do not think that it has that effect. Later I shall refer to some judicial statements which, if applied to this case, might indicate that the Act does have that effect, and might suggest that in the example given it could properly be said that no income had been derived during the year in question. But I do not think that I am required by authority to take that view, and I do not think that it should be accepted as applicable in the circumstances of this case. I think that it would perhaps be easier to accept it, if the stock in hand of a trader were to be regarded as a capital asset and if increases and decreases in it were merely additions to or subtractions from the trader's capital and were therefore irrevelant to questions of income and income tax. But this is not so. The difference between the value of trading stock on hand at the beginning and at the end of the year is included in the assessable income or is an allowable deduction as the case may be (sec. 28). Mr. Mahoney sought to rely on the provisions of sec. 28 in aid of his argument but I think they tell against it. They give to movements of stock a direct effect on the assessable income. This seems to me to weaken the argument that although an outgoing of stock may need to be matched by revenue in order to provide a true account of the profit of the year, it need not be so matched in order to provide a true account of the ``income'' of the year. At all events I cannot regard the Act as giving ``some definite direction'' which operates to preclude the use in dealing with these transactions of the method of inquiry which seems in the circumstances of the case to be ``calculated to give a substantially correct reflex of the taxpayer's true income''. The words just quoted appear in the judgment of Dixon J. in
The Commissioner of Taxes (S.A.) v. The Executor Trustee and Agency Company of South Australia Ltd. (commonly called Carden's Case) (1938) 63 C.L.R. 108 at p. 154.

That case does not provide for me the answer to the question raised by the present appeals, but for several reasons I think it is important to make some examination of it. In the first place I think it indicates that the differences between the Commonwealth Act and the English income tax law may more often be of importance in deciding questions as to the allowance of deductions (as for example in
F.C. of T. v. James Flood Pty. Ltd. (1953) 88 C.L.R. 492)

ATC 4009

than in determining the manner in which, or the period at which, items of revenue should be taken into account in computing income (or profits) and in particular in determining the use which may properly be made of the principles and methods recognised and followed in making those computations in business and in commerce. I do not mean that questions as to income or as to profits cannot be affected by special provisions in a particular Act. But generally speaking I am of opinion that Carden's Case and other cases suggest that when a decision is required as to the time at which a transaction is to be brought to account or as to the extent to which accepted business and accountancy methods are relevant, the making of such a decision is not greatly affected by any distinction between the ascertainment of the profit of the year and the ascertainment of the income of the year. The South Australian Act considered in Carden's Case provided that income included ``every kind of profit and every kind of gain''. In this respect it was closer to English legislation than to the terms of the Commonwealth Act. But most of what Dixon J. said at pp. 151-156 of the report as to the use of commercial and accountancy principles appears to me to be as much applicable to the Commonwealth Act as to the South Australian Act or the English legislation. It is appropriate to add at this point that it was affirmed in the judgment of the Court in
Arthur Murray (N.S.W.) Limited v. F.C. of T. (1965) 114 C.L.R. 314 at p. 320, that in determining what is income for the purposes of the Commonwealth Act regard may be had to accounting and commercial principles.

It is recognised in Carden's Case and also in other cases that, although it may be natural to think of income as being confined to something actually received it has nevertheless been accepted that the book debts of a trader may be treated as part of his income. Without setting out the passages, I refer to pp. 124-126 in the dissenting judgment of Latham C.J. and to pp. 155-156 in the judgment of Dixon J. In the judgments to which I have just referred, statements are made which raise the question whether the established principle that income may include trade debts is limited in its application to trade debts which have already become due. This is a question which has caused me a good deal of difficulty. In Carden's Case at p. 124, Latham C.J. said that it is well established that book debts of a trader are to be taken into account as income ``at least where those book debts fall due during the year in respect of which he is making his return''. That statement leaves the question open. But elsewhere his Honour used phrases which suggest that what forms part of the income is limited to debts which in the relevant period have become due (see pp. 125 and 126). See also the judgment of Dixon J at pp. 155, 156. But in Carden's Case no question was at issue which required a decision to be made as to the precise application of the rule that a trader's book debts are to be taken into account in computing his income. The question was whether income should be reckoned only by cash receipts or should be reckoned on an earnings basis. In the recent case of
Henderson v. F.C. of T. (1969-70) 69 ATC 4049; 44 A.L.J.R. 115 the question at issue was a similar one but in the circumstances of that case it was held (at p. 117) that, ``what such a business earns in a year will represent its income derived in that year for the purposes of the Act.'' Later it was stated (at p. 118) that, ``only fees which have matured into recoverable debts should be included as earnings''. But the point there being made was that an allowance ought not to be included for ``work in progress'', where the fees had not yet been earned, because the work which had to be done to entitle the taxpayer to payment had not been completed. At the end of his reasons Barwick C.J. explained the sense in which he had used the word ``recoverable''.

When a sale of goods has been made and the goods have been delivered. I think it is correct to regard the sale price as having been ``earned''. If it be argued that it cannot be said to have been earned, because the Company is required to do further work in order to collect it or because there may be default in the payment of it, the same reasons would require that it should also be said that instalments which have fallen due but have not been paid have not been earned and should not be included as income. Of course in some circumstances debts not actually paid on the due date may nevertheless be regarded as being as good as money in hand. But where, as in this case, stress is laid by the Company upon the difficulties of collection, the chance of collecting an instalment already overdue would appear to be more doubtful than the chance of collecting one which is not yet payable. There seems to me to be no legal principle that makes it legitimate to treat as

ATC 4010

income trading debts already payable but not debts which are not yet payable but in respect of which no further step has to be taken by the seller of the goods to entitle it to payment. The question is in my opinion a question of fact rather than a question of law and it is a question upon which evidence of business practice is of assistance.

I have come to the conclusion that I am not constrained by anything said in Carden's Case or in Henderson's Case to uphold the primary submission of the Company. I do not think that by reason of any definite meaning placed on the word ``income'' or on the word ``derived'' as used in the Act, by any of the provisions of the Act itself or by judicial exposition in the cases to which I have referred, I am bound to uphold that submission or to deny the validity of the method adopted by the respondent. I am of opinion that I am required to decide for myself the question raised by the submission, with such assistance as I find in the expert evidence which I have heard: see the Arthur Murray Case 114
C.I.R. at p. 318.

The Company relied upon two cases in this Court to which I have not yet referred and upon three cases in England of which the latest was Absalom v. Talbot (supra). The first of the cases in this Court is
Perrott v. F.C. of T. (N.S.W.) (1925) 40 C.L.R. 450. I do not regard it as being of any assistance to the Company's argument. In the Supreme Court of New South Wales it had been held, in respect of subdivisional sales made by the appellant upon terms that the price was to be paid with interest over a period of years, that a profit calculated by reference to the full sale price could be treated immediately as income, that it was not necessary that it be spread over the period of instalments, and that it was not correct to say that no account of it could be taken until sufficient instalments had actually been received to return a profit. But as the Commissioner of Taxation had accepted the method adopted by the taxpayer of calculating a proportion of the total prices representing profit and of treating that proposition of the instalments as profit arising as instalments were paid, the Supreme Court allowed that calculation to stand and dismissed the taxpayer's appeal. The brief judgments in this Court, which dismissed an appeal to it, do nothing to resolve the problem which I have to decide in this case.

F.C. of T. v. Thorogood (1927) 40 C.L.R. 454, subdivisional sales of land were made on extended terms. Part of the price was, in some cases, secured by a second mortgage after part of the price had been obtained by raising money on first mortgage and transferring the land to the purchaser subject to the mortgage. A Board of Review decided that the profit on the sale should be apportioned as between the amount actually received by the vendor and the amount outstanding on second mortgage and the latter part of the profit should be spread over the period of the mortgage. In this Court it was held that whether it should be so spread or should be all placed in the year of sale, as the taxpayer himself had placed it in his books, was a question of fact and that the finding of the Board ought not to be disturbed. It was held, also, that there was no principle of law by which the taxpayer was bound by what appeared in his books. This decision does not help the Company in the present case. Indeed, I regard it as showing that there is no principle of law that instalments, payable in the future under a contract but not yet due, can never be brought into account in ascertaining the income of the year of the contract. If the Court had recognised any such principle I should think that it would not have treated the question which the Board had decided as being simply a question of fact, depending on the circumstances of the particular case.

I must now refer to three English decisions upon which the Company relied. Two of these have recently been discussed, together with the two cases in this Court, upon which I have just commented, by the Supreme Court of New Zealand in
Fincon (Construction) Ltd. v. I.R. Commrs. (N.Z.) (1969) 69 ATC 6034.

John Emery and Sons v. I.R. Commrs. (1937) A.C. 91 a perpetual annuity was received from a purchaser as part of the price of land. This was a marketable security with a well-known market value. It was held that that value had to be added to the receipts credited in the accounts, for the purpose of ascertaining the amount of trading profits. It seems clear that this has no bearing on the present problem. Harrison v. John Cronk and Sons, Limited (1937) A.C. 185 sales were made of land with houses erected on them. The purchasers borrowed the purchase price from a building society on mortgage. The

ATC 4011

vendor guaranteed the repayment to the society of part of the advance. All or part of the sum guaranteed was retained by the lender as a deposit, on terms that it would be released to the vendor when an agreed amount had been repaid by the purchaser. It was held that the sums forming the deposits ought not to be treated as receipts of the vendor's trade at the time of the sales. If they could be valued as at that time the value should then be brought into account. If this were not practicable, they should be brought in as and when they were released. I do not think that the case states any principle which governs the present case. I have discussed earlier the question whether the contractual rights of the Company should be valued and have given reasons for putting aside in this case that method of dealing with the sales. I do not doubt that in some cases money payable at a future date ought to be left out of account until it is received or perhaps until it falls due. But the question is not whether this should ever be done but whether it should be done in relation to trading debts in the circumstances of the present case. Those observations apply also to the case of Absalom v. Talbot (1944) A.C. 204, to which I have already referred. The divergent views there expressed depended in part on provisions in the legislation under review differing from those of the Commonwealth Act. In my opinion the facts of the case were substantially different from those of this case. It is worth noticing that Lord Atkin (at p. 215) drew a distinction between sales of goods ``on terms of ordinary commercial credit, three or six months or even more'' on the one hand and ``credits extending over many years'' on the other. His Lordship's discussion of the question appears to me to reinforce the view which I think may be derived from the Australian cases, namely, that it is really a question of fact whether the debts created by the instalment contracts in this case, so far as they represent the sale price of the goods, should be brought in as part of the revenue of the year in which the contracts were made or should be dealt with in some other way.

I do not think I am required by authority to hold as a matter of law either that the Company's primary submission should be accepted or that it should be rejected. I have reached the conclusion that there is no principle which binds me to hold that amounts not yet paid or payable cannot be brought into account in ascertaining the trading profit for the year and in ascertaining for tax purposes the gross income of the business. I have indicated already the view that the Company's computation gives a result which is in fact greatly at variance with the true results of the trading for each of the relevant years. It is plain that the losses shown in the return were not actually suffered. I have given reasons for my opinion that the Act does not make necessary in the circumstances of this case a computation of income or of loss for tax purposes, which is unrelated to the profit or the loss of the trading business.

The view that the method adopted by the Company does not give a ``substantially correct reflex of the taxpayer's true income'' (63 C.L.R. at p. 154) is supported by the evidence of Professor Gynther, which in general I found to be acceptable and very persuasive. I need not refer to it in great detail. The witness said that the ``trading profit'' (the difference between the normal sale price and the cost price) should be brought to account at the time of the sale and the terms charges should be brought to account ``on some basis, possibly the 78 rule or some other actuarial basis for the life of the debt''. He added a qualification that ``one would need to make some allowance for the probability of non-payment of the debt''. A few comments on that evidence are required to explain how I think it should be understood and what assistance may be derived from it. It was made plain by his evidence as a whole that by his reference to ``trading profit'' he did not mean to suggest that it was the profit component alone which should be brought to account at the time of the sale. Subject to the qualification he made about an allowance ``for the probability of non-payment'', he meant that the whole of the normal sale price (including the cost element) should be taken into account at the time of the sale. I have already discussed the qualification relating to doubtful debts. For reasons which I have given. I do not think it affects the question I am now considering. It is to be observed that what the witness said about the treatment of the terms charges on some actuarial basis did not coincide precisely with the respondent's treatment of those charges which has been described above. This is a point however which is not relevant to the consideration of the Company's primary submission. There has not been a separate submission that the assessment should be reconsidered simply because of the manner in

ATC 4012

which this witness stated his opinion as to the way in which the terms charges should be brought to account. It is not the treatment by the respondent of the terms charges which has been challenged, but the treatment of the sale price.

The evidence of this witness included further opinions which may be stated briefly as follows. The accounting procedure adopted by the Company is entirely incorrect. It is not in accordance with generally accepted accounting principles and practice. It is something that the witness had never seen. It makes no endeavour to match costs with revenue. The basis of the assessments made by the respondent accords with correct commercial and accounting principles. In explaining why he thought it was proper to bring in the normal sale price as revenue at the time of the sale, notwithstanding that the receipt of it would be deferred, the witness said that he saw the trader in two different sorts of business, that is selling and financing. In the example mentioned earlier of goods sold for a total sum of $240, the debt is not immediately worth $240 but it is reasonable to treat it as being worth $200 and to bring that amount into revenue forthwith. The costs of collection and other contingencies are matched against the income which flows from ``the financing function that is the terms charges. I need not refer further to the evidence of this witness. I have considered all of it but I think there was nothing in it which cut down the opinions which I have just outlined.''

An experienced accountant, Mr. Wylie, was called on behalf of the Company. He was an independent witness and completely honest, but in so far as his views on matters relevant to the present problem differed from those of Professor Gynther, I found the evidence of the latter to be more persuasive. When an outline of the facts of the Company's trading was given to Mr. Wylie, he said that he thought the sales should be brought to account ``to the extent that they fall due for payment''. This was in view of the total circumstances of the Company. He emphasized that his opinion depended on the circumstances and it was evident that what had been put to him concerning the problems of collection weighed heavily with him. He said also that he would not like to try to put a value on the debts. I have already stated my views as to evidence about their value. When questioned about what should be done with regard to the trading stock involved in the instalment sales Mr. Wylie said he would not include this in the balance sheet ``as trading stock as such''. It would be put, in effect, into a suspense account under some such title as ``equity in stock on deferred sales''. This means that there would be a balancing item in respect of the equity in stock that had gone out from the store and been delivered to buyers. On cross-examination about a hypothetical sale on twenty-four months' terms for a total of $240 of an article which had cost the Company $150, he agreed that a loss of $150 could not properly be shown. He agreed that if the $150 were shown as a loss on 30 June in the year of the sale, then in the Company's accounts over the next two years a profit of $240 would be shown and he said he could not agree with that approach. I have considered that evidence and the further explanations given by Mr. Wylie in re-examination as to what he meant by a balancing item in respect of the equity in stock. I am satisfied that in so far as the question before me is to be decided by reference to accepted commercial and accountancy practice, Mr. Wylie's evidence does not support the first submission for the Company and is indeed in conflict with it.

It was put by counsel that in order to prevent tax from falling in a later year on an excessive income figure, because of the coming in of the instalments including amounts referable to the cost to the taxpayer of the stock, it is necessary that in the earlier year when the stock has gone out from the store that the taxpayer should be able to take advantage of sec. 28(3) of the Act as to throw up a loss in that earlier year which can be carried forward into the year or years in which the instalments are received. But the supposed problem in the later year, namely, that receipts of money which were only in part profit would inflate the income of that year because the recoupment to the taxpayer of the costs of the goods would be treated in effect as profit, would not arise if the sale price were brought to account in the earlier year, as the respondent contends that it should be. In that event the cost to the trader would (generally) be reflected in the figures for that year on the expenditure side of the account and the sale price (cost and profit) on the revenue side. What the Company claims is that the cost should appear in the figures for that year but that most of the sale price should not. It does

ATC 4013

not seem right to say that you ought by using this method to show a trading result for the earlier year which is much worse than the real position, so that you may be able in a later year to offset that result against a revenue figure which, it is said, would appear (unless this were done) to be much better than it really ought to be.

I am of opinion that the primary submission for the Company should not be accepted. I must deal also with the alternative submission. This is that a dissection should be made of the total price shown in an instalment contract into a ``cost'' component and a ``trading profit'' component. Unlike the dissection made in the respondent's treatment of the transactions, this is a dissection which is not assisted by anything appearing on the face of the contracts. I do not say that this necessarily precludes it from being made. But it does raise questions as to how it is to be made and whether it is practicable to make it. This submission has the merit, as compared with the Company's primary submission, that if it be adopted there would be a balancing in the accounts of outgoings in respect of the goods and a return obtained from the sale of them. In theory it seems to me to be quite possible that the use of some type of profits-emerging formula might produce a result which would be a fairly accurate estimation of the profit made in the trading of a particular year. But I do not find myself able to go further than that and to find affirmatively that this would produce a satisfactory result, or to feel satisfied that it would provide, in the circumstances of this case, a method of estimation better suited than the method adopted by the respondent to the task of determining as accurately as possible what the assessable income was in fact (cf. Henderson v. F.C. of T. (1969-70) 69 ATC 4049; 44 A.L.J.R. 115 at p. 117).

As I understood the argument, counsel for the Company meant by ``the cost to the taxpayer'' not merely the wholesale price which the Company paid for its stock to those from whom it bought it, but the total of all the outgoings, up to the time of the sale by the Company of the goods, which were necessary to enable the sale to be made. It was described as ``the costs up to the point of sale''. But no evidence was directed to showing, even in general terms, how that cost was to be ascertained or to showing whether the books and records had been kept in such a manner that the calculations could now be made which would be necessary, if the argument were accepted. The submissions for the Company did not define precisely how effect ought to be given to this alternative basis of computation. Counsel said that if it were accepted in principle, the matter could be remitted to the respondent for further consideration and there might be a subsequent agreement between the parties as to how it ought to be worked out. I do not doubt that in many cases, where the Court is satisfied that a wrong basis of assessment has been used and is satisfied that some other basis is correct in principle, but the evidence does not prove in detail the results to be obtained by the use of that other basis, the Court may deal with the matter by remitting it for further consideration. Nevertheless I think that it is incumbent upon an appellant taxpayer to establish with some degree of particularity what the proposed basis of assessment is and to establish that it is probable that it will be practicable to apply it in the circumstances of the particular case. I am of opinion that there is much force in the submission of counsel for the respondent that the Company has not shown that the application of the profits-emerging principle to these transactions is feasible and in the further submission that there would be no point in requiring the respondent to attempt now to apply that principle, as he has not the information to enable this to be done and it is not shown that that information is available. I do not think that an appellant is entitled to succeed if no more is shown than a possibility that if the matter were remitted for calculation of the tax on a suggested basis, that method could be applied and might perhaps be preferable to that which had previously been used. It has to be remembered that the Company used and supported a basis of computation quite different from the alternative basis now proposed. So far as appears, it has not brought forward during the lengthy investigations of the matter or at the hearing of the appeals any analysis of these transactions on a profits-emerging basis.

Apart from the difficulties to which I have just referred this basis for treating the transactions was not supported in my opinion by either of the expert witnesses who gave evidence as to commercial and accounting practice. After full consideration of the question I am not satisfied that it has been

ATC 4014

shown that the basis for making the assessment was wrong or that the method of treating the profit component of the transactions on a profits-emerging basis ought to be preferred. I am therefore of opinion that the appeals fail.

In each appeal I order that the appeal be dismissed with costs and that the assessment be confirmed.


Appeals dismissed with costs. Assessments confirmed. Usual order with respect to exhibits.

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