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

Judges: Barwick CJ
McTiernan J

Menzies J
Gibbs J

Court:
High Court (Full Court)

Judgment date: Judgment handed down 31 August 1971.

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Menzies J.: These appeals concern the taxation of the appellant taxpayer for the years 1965, 1966 and 1967.

The taxpayer conducts, and has at all times material conducted, a retail store in Toowoomba from which it sells household goods for cash, on 30 day terms, or on terms whereby time to pay up to 5 years is given. The point of these appeals is to determine what is the proper method of calculating the income derived in each year from trading by the last-mentioned method of selling.

The Commissioner assessed tax on the footing that there must be brought into the assessable income of a year not the payments received or to be received in that year - the basis of the taxpayer's returns - but the full price to be received for goods sold in the year of income, except to the extent to which that price included interest on the instalments to be paid in future years.

An appeal to Walsh J. having been dismissed, this appeal has been brought to the Full Court.

A short statement of the method of selling, which has given rise to the problem, is necessary. A customer, having chosen the goods to be purchased and wanting time to pay for them, signs an Offer to Purchase in which the goods and the amount which would have been their cash price is set out. The offer, however, is not to purchase for that cash price, but for a higher price which is calculated by adding to it 11% thereof per annum, for the period over which the payments are to be made, and one dollar. This composite sum is payable by a first payment and, thereafter, periodical payments. In addition to signing an Offer to Purchase, the customer signs a bill of sale wherein it is acknowledged that the full sum to be paid in accordance with the Offer to Purchase is a valid enforceable debt to be paid by the instalments therein set out. Upon default the whole of the unpaid balance becomes payable as a present debt.

At the trial evidence was given about the taxpayer's earlier procedures to give its customers credit and of the class of customers and their numbers whose transactions in the years 1965 to 1967 were of the character just stated. These matters, however, have no legal significance. Evidence was also given about the cost of collecting instalments but consideration of that matter can also be disregarded. Any costs of collection would be deductible as and when incurred, Income Tax Assessment Act, sec. 51; furthermore any bad debts could be written off and deducted: sec. 63.

The taxpayer conducts a business of buying and selling goods and the provisions of the Act relating to stock in trade apply to it. It is not necessary to set out their terms; it is sufficient to point out that these provisions require trading stock to be taken into account in determining both assessable and taxable income. When the value of trading stock is higher at the end than at the beginning of a tax year, the excess is assessable income; when the value of trading stock is higher at the beginning than at the end of a tax year, the excess is an allowable deduction in calculating the taxable income of that year. The value of each item of trading stock at the end of the year is cost price, market selling value or replacement cost at the option of the taxpayer.

The foregoing provisions assume that stock on hand at the beginning of the tax year and not on hand at the end of that year will be accounted for; indeed, there is a special provision for bringing into account the value of trading stock disposed of otherwise than the ordinary course of business: sec. 36.

It is implicit in the foregoing provisions that the proceeds of any sale of stock in the ordinary course of business will be brought into account in the year in which it is sold. The problem then is to determine what are the proceeds of sales in the year in which the taxpayer sells items of trading stock to customers upon terms and takes a bill of sale to secure payment in the manner already stated.

In a system of annual accounting, ordinary business considerations would indicate that what becomes owing to a company for trading stock sold during a year should, in some way, be brought into account to balance the reduction of trading stock which the transaction effects. Any other method of accounting would lead to a misrepresentation of the trader's financial position. Furthermore, the taxpayer's system of accounting produces the odd result that, as turnover increases by the sale of more trading stock, income falls, because, when regard is had to receipts only, then

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ATC 4159

but a small proportion of the proceeds of each sale on terms is brought into account in the year of sale. The value of an item of trading stock would disappear to be replaced, for instance, merely by the deposit paid by the purchaser. We were informed that, if the turnover of the taxpayer were to increase at the rate of 20% per annum, its method of accounting would ensure a continually falling annual income.

Nevertheless, it is said on behalf of the taxpayer that, for income tax purposes, it is not only unnecessary but it is incorrect to bring into the annual account as assessable income any instalments of purchase price, for goods sold upon terms, which are neither received nor receivable in the course of the year of sale. The basis of this contention is that income is not derived until it is received. As a general proposition this is far too large. Counsel for the taxpayer did not press it to its logical conclusion which would exclude from assessable income of a year proceeds of a sale made in June of that year on 30 day terms, and paid in the following year. Moreover, the concession that proceeds of sale receivable although not received in a particular year of income constitute part of the income of that year is hardly consistent with the proposition that income is not derived until it is received.

Acceptance of the taxpayer's contention would, of course, largely destroy the accepted basis for the taxation of most trading and business concerns. It is accepted that, for taxation, as well as for business purposes, the income of such a business is derived when it is earned and the receipt of what is earned is not necessary to bring the proceeds of sale into account. The acceptance of this basis of accounting is recognised by the provisions of the Act relating to the writing off of bad debts which ``have been brought to account by the taxpayer as assessable income of any year'': see sec. 63.

The leading cases on the subject are
The Commissioner of Taxes (South Australia) v. The Executor Trustee and Agency Company of South Australia Ltd. (1938) 63 C.L.R. 108 -
Garden's case and Henderson v. F.C. of T. (1969-70) 70 ATC 4016 ; 119 C.L.R. 612 - Henderson's case.

In Carden's case the High Court decided, upon South Australian legislation framed like the Income Tax Assessment Act, that ``When there is nothing analogous to a stock of vendible articles to be acquired or produced and carried by a taxpayer, where outstandings on the expenditure side do not correspond to, and are not naturally connected with, the outstandings on the earnings side, and where there is no fund of circulating capital from which income or profit must be detached for actual enjoyment, but where, on the contrary, the receipts represent in substance a reward for professional skill and personal work to which the expenditure on the other side contributes in only a minor or subsidiary degree, the receipts basis forms a fair and appropriate basis for estimating professional income for the purpose of the Taxation Act 1927-1935 (S.A.), provided there be continuity in the practice of the profession.'' In so deciding it was recognised that, when what is subject to tax is income not derived from trading, ``there must be something `coming in'; that is for income tax purposes receivability without receipt is nothing'': see Dixon J. at pp. 154 and 155. His Honour, however, stated very clearly the basis upon which trading concerns are taxed upon earnings rather than receipts. It was said at p. 156 -

``The basis of a trading account is stock on hand at the beginning and end of the period and sales and purchases. In such an account book debts represent what before sale was trading stock and it is almost inevitable that they should be taken into consideration upon an accrual and not a cash basis.''

Earlier, at p. 155, his Honour had said -

``The reasons which underlie the practice of estimating for taxation purposes the income from trade or manufacture by means of a commercial profit and loss account consist in the impracticability of computing income in any other way and in the adoption for fiscal purposes of recognized commercial principles. The computation of profits from manufacture and trading has always proceeded upon the principle that the profit may be contained in stock-in-trade and `outstandings'.''

Latham C.J., who dissented, did so for reasons which are of weight here. The Chief Justice said at p. 123 -

``In the case of traders, where tax is imposed upon the profits of a trade, profits are calculated both in Australia and in England on an earnings basis; that is to say, the trade debts which fall due to the taxpayer during the year are credited and allowance is made for bad debts.''

Later, at p. 124, it was said

``In the case of a trader it is well established that he must take into account book debts owed to him as part of his income, at least where those book debts fall due during the year in respect of which he is making his return.''

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ATC 4160

And at p. 125 -

``...trade debts which have accrued due in the relevant year but which have not been paid must be included for the purpose of ascertaining whether or not the business has earned a profit for the year, just as stock in trade at the beginning and end of the year must be taken into account for the same purpose.''

In a statute which made no distinction between traders and professional men, the basis of his Honour's dissent from the decision of the Court was that both groups should be taxed alike, i.e. on earnings. His Honour, however, as will have been seen, left open the possibility that trading debts not payable within the year of tax do not form part of the income of that year. For reasons indicated earlier, I consider income from the sale of stock is derived when the stock is sold and a debt is created. It need not be payable in the year of income.

Carden's case is therefore against the taxpayer's contention.

So is Henderson's case. There it was decided that the proper basis for the taxation of a professional partnership employing staff and needing capital was the earnings of the year, not the receipts of the year.

It follows that I consider that the taxpayer's main contention is opposed to ordinary principles of accounting, to the scheme of the Act and to authority. It must, therefore, be rejected.

The taxpayer put forward a more limited argument, viz. that what should be brought into account in a year is the value of the profit element to be extracted from the contracts to pay by instalments made during the tax year. This was described as the ``profit emerging'' basis of assessment. For this reliance was placed upon
F.C. of T. v. Thorogood (1927) 40 C.L.R. 454 .

It seems to me, however, that the basic scheme of the Act is that taxable income is calculated by deducting allowable deductions from assessable income. It is only when it is expressly authorised that outgoings are taken into account in determining what is to be included in assessable income. An instance where a procedure of this sort is expressly required is sec.26(a) of the Act where it is provided that a calculated profit is to be treated as assessable income. In my opinion, however, the fundamental scheme of the Act is inconsistent with attempts to calculate the profit element in each transaction undertaken by a taxpayer in the course of its business and to aggregate those profits to arrive at taxable income, or, at something which is neither taxable income nor assessable income, but is a sum from which further deductions would have to be made to arrive at taxable income.

For the foregoing reasons it is not possible to accept the taxpayer's alternative contention.

Accordingly, I am of the opinion that the appeal should be dismissed.