Federal Commissioner of Taxation v. McCloy.Judges:
Supreme Court of New South Wales
Helsham J.: The problem is whether interest on money expended by the taxpayer and referable to the provision of a study in his home to enable him the better to perform his job, and so earn more money from it, is an outgoing incurred in gaining or producing assessable income and hence an allowable deduction under sec. 51 of the Income Tax Assessment Act. The same problem arises in relation to insurance. The Commissioner decided it was not; a Taxation Board of Review held that it was. The matter comes to this Court by way of appeal from the decision of the Board.
The relevant facts, stated, incidentally, with great clarity and at length in the reasons for the joint decision of Messrs O'Neill and Fairleigh, two members of the Board, with whose decision the chairman agreed, may be summarised as follows.
At all relevant times the respondent taxpayer was a marketing representative employed by a company that sold, installed and serviced computers. He was paid a fixed salary plus commission, the more sales he made the more he earned. The company had a base office, but the taxpayer was not required by his employer to attend there except for sales meetings each Monday, on such occasions as there was a management review, or when the taxpayer had a proposal from a prospective customer that required signature by someone from ``the management.'' Otherwise he was left almost entirely to his own devices as to the performance of his job, and in fact he performed it mostly away from the base office. This is not surprising in the light of the nature of his work and the paucity of facilities provided by the employer for doing it at the base office - no separate office for his use, merely a table or desk in a communal area containing, at the latest relevant time, forty-three desks, no separate telephone - five had to be shared with twenty-five to thirty sales representatives but later there was one between two representatives - no separate dictating units - such as there were being shared by the occupants of the forty-three desks - and other disadvantages. The evidence was that the employer encouraged its representatives to spend their time outside the base office, and to that end it induced representatives to use such facilities as they may have outside in preference to using the base office facilities.
His job required the taxpayer to spend a great deal of time in the field (as he put it), a lot of time interviewing, and a lot of time doing paperwork. He assessed his weekly working time as being spent thus, eight hours at the employer's base office, twenty hours at home performing tasks necessary for his selling and follow-up activities (correspondence, preparing proposals, interviewing, telephoning customers, and so on), and twenty-four hours in his assigned territory calling on prospective customers and those who already had machines installed.
The taxpayer was appointed a salesman with effect from 1st April, 1971. The tax year in question was the year ending 30th June, 1972. In that year up to December 1971 the taxpayer lived with his wife in a one-bedroom flat, using the lounge-dining room of the flat to work in. He had not invited customers there, but realised the need to do so, and he realised the desirability of what he termed a ``home office'' as the focal point for his business activities. In late 1971 he contracted to buy a house. It is not suggested in the evidence that he bought a house to enable him to carry out his employment, but it is asserted, and was accepted by the Board, and not challenged before me, that a choice of home was made upon the basis of the existence in the one chosen of an office; this home cost him $5,000 more than a house of virtually identical standard without an office but which probably would have been more convenient in other respects. The office comprised a room of the house which also had access from the garage, unsuitable, it is said, for this reason as a bedroom, and comprising approximately one-fifteenth of the total floor area of the house. It has been furnished as an office with a desk and office chair, two bookcases, a filing cabinet, it has a telephone, and was and is used exclusively by the taxpayer for his work. Since the tax year in question the taxpayer has bought and installed in it a dictating machine. His performance judged by results has improved each year since 1st April, 1971, when he was appointed, and consequently his income has increased. The use of this facility at home is not a requirement of his employment, but he attributes his success, and hence his income improvement, to its existence; he said he regarded the availability of his home office as essential, but by this, of course, must be meant essential if he were to do his job at the level of efficiency which he seeks and to maintain the level of income which he has achieved. Indeed he said in evidence that his business card does not show his home' phone number or address.
The claim of the taxpayer to an allowable deduction under sec. 51 of the Act was assessed and allowed by the Board in the following way: The taxpayer had borrowed money at various rates of interest to finance the purchase of the home; leaving aside bridging finance, which for good reason was disregarded because its borrowing was only necessary because of delay in selling some land owned by the taxpayer, interest on the borrowed money was $687 in the relevant year; that proportion attributable to the study or home office on a floor area basis was one-fifteenth or $46. This was allowed as a deduction by the Board. Insurance on the house and contents, calculated on a proportional basis, as a similar fraction in the case of the house, came to $5. This was also allowed as a deduction.
The basis of the Board's decision was, to quote from the reasons of the two members -
``Here the nature of the taxpayer's income producing activities is such that that part of his home used as a study has a character which distinguishes it from the rest of his home. The study was used, virtually exclusively, for a significant part of the operations which were productive of the taxpayer's assessable income.
It follows in our opinion that he did incur an outgoing for interest `in gaining or producing the assessable income'.''
The insurance premium deduction was allowed on the same basis. The chairman put it thus -
``Shortly stated, my reason for so finding is that there has been established on the evidence a sufficient nexus between the derivation of the taxpayer's assessable income as an employee and the outgoings on interest and insurance attributable to the use of a room in his house as a `home office' to warrant deduction under sec. 51(1) of the Assessment Act.''
The question is whether the decision is correct.
It is important not to lose sight of the fact that the claim of the taxpayer relates to interest payments on money borrowed to purchase the house in which the study or home office is situated, and to insurance premiums for that house and contents. It does not relate to expenses incurred referable to the use of the study by the taxpayer, such as the cost of lighting and heating. These latter expenses were allowed by the Commissioner. If the interest and premium payments are not to be categorised as expenses of a capital, private or domestic nature, then there must be found the requisite relationship between them and the gaining or producing of assessable income to enable them to qualify as allowable deductions under sec. 51. This element of necessary relationship has been discussed in many cases, including the case of
Ronpibon Tin (N.L.) v. F.C. of T. (1949) 78 C.L.R. 47, where it was stated that the expenditure to be an allowable deduction must be incidental and relevant to the gaining or producing of the assessable
ATC 4082income; this expression was explained in the reasons for judgment of Williams, Kitto and Taylor JJ. in
Lunney v. F.C. of T. (1958) 100 C.L.R. 478, where it was put that the fact that an expenditure is a prerequisite to the earning of a taxpayer's income is not the same as saying that the expenditure is incurred in gaining or producing the assessable income. ``Whether or not it should be so characterised depends upon considerations which are concerned more with the essential character of the expenditure itself than with the fact that unless it is incurred an employee or a person pursuing a professional practice will not even begin to engage in those activities from which their respective incomes are derived'' (p. 499).
Looked at in this way it seems to me that the expenditure in question here cannot be said to have been incurred in gaining or producing the assessable income of the taxpayer. It is not sufficient that there was an expenditure referable to the provision of a study without which a portion at least of the taxpayer's income could not have been earned. The money from the obtaining of which flows the expenditure claimed as an allowable deduction was money borrowed and spent to acquire a home for the taxpayer. The purchase money was not outlaid in the first place to purchase a place of business; it was outlaid for the purchase of a home, although the choice of that home was made because it had facilities that would enable the taxpayer to carry on with greater advantage to himself his income earning activity. In this respect the case is no different from any expenditure on a home either chosen because it provides, or altered or adapted to provide, facilities which promote income because a person carries on part of his income-earning activity there. And if the initial expenditure was of this character, it is difficult to see how money necessary to be paid in order to service that expenditure, or to insure what was acquired as a result of that expenditure, can assume any other or different character, or how a portion of it can be said to assume a different character such as would make it an outgoing incurred in gaining or producing the taxpayer's assessable income. Payment of no part of the interest or insurance premium can in substance be said to be productive of the assessable income. There are occasions no doubt when portion of moneys borrowed and expended in circumstances resembling the present case can be categorised as being spent in acquiring business premises from the use of which assessable income is derived; if that is the essential character of the expenditure of such a portion, then the amount would qualify as an outgoing incurred in producing assessable income, although, of course, it would be an outgoing of capital or of a capital nature; if that were its true characterisation, then money expended to service that amount, and I suppose to protect what was acquired, would be no less outgoings incurred in producing the assessable income, and hence allowable deductions. But in the present case I am unable to give to the moneys a character other than that of being money spent in or in connection with the acquisition of the taxpayer's home.
I said earlier that I thought the outlay, and the money necessary to service it or protect what was acquired, was no different from other cases where money has been outlaid in connection with the provision of accommodation at home which is for the purpose of promoting, and does promote, the earning of assessable income because a taxpayer can there carry on part of his income-earning activity. In such cases interest on moneys so outlaid has not been held to be an allowable deduction under sec. 51. In
Thomas v. F.C. of T. 72 ATC 4094; 46 A.L.J.R. 397 Walsh J. held that interest on money borrowed to enable additions to the home of the taxpayer to be made was not allowable as a deduction although one room so added was used as a study for professional purposes. His Honour said (at p. 4097) -
``But, in my opinion, the house should not be regarded in the circumstances of this case as being or as including part of the business premises of the appellant and the loan should not be regarded as having been raised for the purpose of providing him with business premises... The appellant did not spend money in erecting premises suitable only for use as business premises. He added rooms to his house.''
F.C. of T. v. Faichney 72 ATC 4245; 47 A.L.J.R. 35, Mason J. held that interest payments on moneys borrowed to enable a taxpayer to erect a house to live in, but referable to the provision of a study used in substance exclusively by him in his income-earning activities, which use contributed to his success in his work and promotion, hence to an increase in assessable income, were not allowable deductions. His Honour said (pp. 4248-9) -
``To my mind, a study in a taxpayer's home, no matter how great the extent of its dedication in point of use to the pursuit of
ATC 4083those activities from which the taxpayer earns his income, is a part of that home.''
Later on, in the course of giving his reasons as to why a proportionate part of the cost of lighting and heating referable to use by the taxpayer of the study should be ruled allowable deductions under sec. 51, his Honour said (p. 4250) -
``It is enough that light and heating was provided in the study whilst the taxpayer was working on matters which fell within the scope of his employment. In that respect the expenditure differs from costs incurred in providing the study, for in that case what is provided retains its essential character as part of the taxpayer's home.''
In my view the same reasoning applies in the present case, and the expenditure, in interest and insurance, referable to the provision of the taxpayer's home office, does not bear the essential character of being an outgoing incurred in gaining or producing the assessable income of the taxpayer.
As in the case before Mason J. the analogy of the doctor's surgery attached to his home was attempted to be used to support the claim. But in the present case the taxpayer was not in any real sense carrying on his business in a separate part of his home any more than the barrister or the scientist were in the two cases referred to, nor was there a separate business establishment adapted solely for business use to which any expenditure, capital or otherwise, could be seen to be referable. To say that to maintain the income from his employment the taxpayer here had to have somewhere that he exclusively could use to work away from his place of employment, and found it convenient to provide this in his home, is not sufficient to turn outgoings referable to the provision of a home into outgoings incurred in gaining or producing that income.
I have been referred to other authorities, and it is convenient to look shortly at some of them. In an unreserved judgment Wickham J. in the Supreme Court of Western Australia declined to apply the two cases which I have referred to above, and held that part of the rent payable by a taxpayer for his home and referable to one room in it set up by and used exclusively by him as a study was an allowable deduction -
Caffrey v. F.C. of T. 73 ATC 4144. It is difficult to know what weight I should give to that decision, seeing that the facts which his Honour described as leading to ``a clear and simple case'' turned out to be complete fabrications, and an appeal was allowed by consent (74 ATC 4275); in any event I believe that guided by the separate decisions of the two Justices of the High Court I should come to the decision which I have reached. In the Supreme Court of New Zealand, Beattie J. in
Commr. of I.R. (N.Z.) v. Castle (1971) 2 A.T.R. 481, also reached a conclusion contrary to that which I believe I am bound to reach guided by the two High Court decisions. His Honour, of course, did not have the benefit of those two decisions to assist him. I do not think the English cases assist greatly. And decisions of the Tax Appeal Board of Canada, although consonant with the conclusion I have reached, were based upon different tax provisions.
In my view the claim of the taxpayer to a proportion of moneys spent on interest and insurance as an allowable deduction under sec. 51 fails. The appeal will be allowed and the amended assessment of the Commissioner of Taxation of 16th April, 1973, will be confirmed.
As the Commissioner regards this as a test case he agreed to pay the costs of the taxpayer.