Federal Commissioner of Taxation v. Everett.
Judges:Bowen CJ
Deane J
Fisher J
Court:
Full Federal Court
Bowen C.J.: This is an appeal by the Commissioner of Taxation from a decision of the Supreme Court of New South Wales upholding an objection by Mr. Peter R. Everett against an assessment for the income year ended 30 June 1973. The assessment increased Mr. Everett's taxable income as returned by including a sum of $11,185 shown as having been paid to his wife. In argument before the Supreme Court it appeared to be common ground that the Commissioner had also assessed Mrs. Everett upon the same amount, although her assessment was not before the Court.
The facts giving rise to the present appeal are set out in the judgments of Deane J. and Fisher J. and need not be repeated in detail. By deed of assignment dated 7 January 1969 between Mr. Everett (vendor) and Mrs. Everett (purchaser), in consideration of the sum of $3,832.50 to be paid by the vendor to the purchaser as therein provided the vendor as beneficial owner, did thereby convey and assign to the purchaser 6/13 of the vendor's share in the partnership carried on under the firm name of Dibbs Crowther and Osborne together with all those rights including the right to receive an appropriate share of the profits of the partnership to which an assignee of a share in a partnership is entitled by virtue of sec. 31 of the Partnership Act 1892. Under sec. 31 an assignment by a partner of his share in the partnership does not, as against the other partners, entitle the assignee to interfere in the management or administration of the partnership business or affairs, or to require any account of the partnership transactions or to inspect the partnership books but entitles the assignee only to receive the share of profits to which the assigning partner would otherwise be entitled.
Dibbs Crowther and Osborne are a firm of Sydney solicitors. The deed clearly expresses the intention of Mr. Everett to effect for valuable consideration a present conveyance of part of his share in the partnership to his wife. Mrs. Everett was a solicitor and a qualified person for the purposes of the Legal Practitioners Act 1898, so no breach of sec. 40F in Div VI of that Act prohibiting the sharing of profits with an unqualified person, was involved. The purchase money was paid in various amounts over a period of time, the last payment being made on 1 July 1972. It is not suggested that the assignment was a sham or that sec. 260 of the Income Tax Assessment Act 1936 (the Assessment Act) applied.
Before dealing with the effect of the assignment it is necessary to make some observations about the nature of a partnership share. As a partner Mr. Everett
ATC 4597
had a beneficial interest in the partnership assets. That interest is not to be described as a title to specific property but as a right to his proportion of the surplus after the realisation of assets and the payment of debts and liabilities (Bakewell v. D.F.C. of T. (S.A.) (1937) 58 C.L.R. 743 at p. 770 ;
Canny Gabriel Castle Jackson Advertising Pty. Ltd. v. Volume Sales (Finance) Pty. Ltd. (1974) 131 C.L.R. 321 at p. 327 ). Notwithstanding the peculiar fluctuating character of the interest of a partner, it is regarded as an interest in every asset of the partnership and is properly described as a beneficial interest (
Livingston v. Commr. of Stamp Duties (Qld.) (1960) 107 C.L.R. 411 at p. 453 ). So far as profits are concerned the partnership accounts for purposes of the agreement between partners and the income tax legislation were maintained on an accruals basis (
Henderson v. F.C. of T. 70 ATC 4016 at p. 4020; (1970) 119 C.L.R. 612 at p. 650 ). In the case where accounts are kept on this basis it may be said in one sense that a partner earns income when a bill of costs is sent out to a client. However, the partner does not gain the right to have this income detached at that point of time. His interest in it will continue to fluctuate. Indeed, if subsequent losses are made, the eventual position may be that he has no profit or income for the year in question. Both for partnership purposes and for income tax purposes the accounts of such a partnership are kept on an annual basis. It is true that in some circumstances, for example, if a partner dies, accounts may be compiled up to the date of death. Upon accounts being taken up to that date, the rights of partners to their shares of profits will crystallise then rather than in the ordinary way. In the ordinary course their rights to income will not crystallise or become detachable until the end of the accounting period. At that point of time the share of profits of each partner becomes certain in the sense that it is capable of being rendered certain and his share of the net income for purposes of Div. 5 of Pt. III of the Assessment Act becomes certain in the same sense. It is then his income whether in fact it is detached or not (
F.C. of T. v. Happ (1952) 9 A.T.D. 447 at p. 451 ). Of course, the partnership agreement may provide for advances to be made from time to time against the ultimate annual share of profits but such an arrangement does not alter the position as I have stated it.
It is clear that a partner may effect an equitable assignment of his share for value and that he may do so either in whole or in part (
Norman
v.
F.C. of T.
(1963) 109 C.L.R. 9
at p. 29
;
Shepherd
v.
F.C. of T.
(1965) 113 C.L.R. 385
at p. 396
). However, the deed of assignment in the present case did not make Mrs. Everett a partner or confer upon her any right to interfere in the management or administration of the partnership (see deed of assignment;
Partnership Act
1891, sec. 31;
Dodson
v.
Downie
(1901) 2 Ch. 620
at p. 622
). So far as the deed of assignment related to assets it was, in my opinion, effective to transfer a 6/13 interest in the various rights in relation to the partnership assets. It was not, as in
Arbuckle
v.
F.C. of T.
(1964) 13 A.T.D. 378
, entirely nugatory. However, the bundle of rights which Mrs. Everett thus acquired did not include the rights of Mr. Everett as a partner to interfere in management or administration of the partnership business or affairs or to require an account of partnership transactions or to inspect the partnership books. These rights remained with Mr. Everett. Even the rights which did pass by the assignment to Mrs. Everett did not enable her to obtain access to the assets or even to have the quantity of her interest determined unless and until dissolution should occur. The question of dissolution would continue to depend upon the circumstances and the actions of the partners including Mr. Everett. The result of this, as it appears to me, is that the rights assigned are of such a nature that although the beneficial interest passed to Mrs. Everett, the actual rights themselves and the capacity to exercise them in the partnership remained in Mr. Everett, who, in relation to them, was in the position of a trustee. Circumstances might arise in which a Court of Equity would intervene at the suit of Mrs. Everett should Mr. Everett or his partners act wrongly in a manner destructive of her 6/13 interest in the assets of the partnership. If she brought proceedings she would have to join Mr. Everett as a party.
Turning to the interest of Mrs. Everett in income, it was argued that throughout the year Mrs. Everett actually derived a 6/13
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share of partnership income as bills of costs were sent out to clients. I am unable to accept this argument. There exists in relation to the interest of an assignee in a share of profits a complex of contingencies. The assignor has to continue faithfully to perform his obligations to his other partners. If he fails to do so or if he gives notice of termination he may even bring about a dissolution. The choice rests with him. He may even bring about a situation, where there arises a cross-claim for damages (Airey v. Borham (1861) 29 Beav. 620 , 54 E.R. 768 ;
Dyer v. Samman (1956) V.L.R. 49 ). To a substantial degree, therefore, the interest in profits will depend to a large extent upon the efforts of every partner and may even be affected by the action of claimants against the partnership and creditors.
In my opinion the profits of the partnership during the year ended 30th June 1973 did not constitute detachable income of the assignee prior to the end of the income year. When the year ended on 30th June 1973 the profits became ascertainable. It matters not that for practicable reasons the accounts of the partnership might not in fact be drawn up until later. Mr. Everett, at the end of that year, became a trustee of a 6/13 share of profits for Mrs. Everett (
Hocking
v.
Western Australian Bank
(1909) 9 C.L.R. 738
at pp. 743-744
). The trust attached
eo instanti
to that share of profits (
Palette Shoes Pty. Limited
v.
Krohn
(1937) 58 C.L.R. 1
at pp. 16-17 and p. 27
). At no time did the beneficial interest in the 6/13 share of profits vest in Mr. Everett. Immediately it was ascertainable it vested in Mrs. Everett.
It was argued for the Commissioner that the taxation of partnerships is governed by Div. 5 of Pt. III of the Assessment Act, that Mr. Everett was a partner and therefore, his individual interest in the net income of the partnership must be included in his assessable income (sec. 92). It was sought to meet the argument by saying that Mrs. Everett was a member of a ``partnership'' for income tax purposes because of the definition of ``partnership'' in sec. 6 of the Assessment Act. This definition refers to an assessment of persons in receipt of income jointly. It was submitted that she was a person in receipt of income jointly with the partners. However, it does not appear to me that Mrs. Everett falls within the words of the definition in sec. 6. For one thing, her ``receipt'' of income did not occur as 30 June 1973 ended although her beneficial interest in the income was then complete. It is at that time that Div. 5 operates. In any event, it seems that where a trustee of an estate is a partner with active duties to perform, sec. 6 does not operate so as to bring in as partners for income tax purposes beneficiaries who are presently entitled. This is a situation which may occur not infrequently. The correct approach in such a case appears to be to treat the trustee as the partner for income tax purposes and to look to other provisions of the Assessment Act such as those in Div. 6 of Pt. III to determine whether the trustee or the beneficiary is to be taxed upon the income (see
Tindal
v.
F.C. of T.
(1946) 72 C.L.R. 608
). The position may be different in the case of a bare trustee. Should Mr. Everett be treated simply as a bare trustee for Mrs. Everett's 6/13 share of profits as at the end of the year? In my opinion, although the beneficial interest in net income or profits vested in Mrs. Everett as the year ended, Mr. Everett still had rights and duties as a trustee which had to be exercised and performed at least until the partnership accounts were finalized. Furthermore, it is wrong and certainly at odds with reality to fasten upon the 6/13 share of net income or profits to the exclusion of the 6/13 interest of Mrs. Everett in the assets of the partnership from which in some degree the income or profits flowed and to the exclusion of the relationship between Mr. and Mrs. Everett in respect of that 6/13 interest in assets.
It is necessary to turn to the provisions of the Assessment Act governing taxation of trustees and beneficiaries to see how they apply in such a case. The relevant provisions are sec. 26(b) and those contained in Div. 6 of Pt. III. These provisions are often difficult to apply to particular cases (see
F.C. of T.
v.
Belford
(1952) 88 C.L.R. 589
). However, the policy of the Assessment Act is reasonably clear. Except as provided in the Assessment Act a trustee is not to be liable as trustee to pay income tax upon the income of the trust estate (sec. 96). It is the beneficiary who is presently entitled and not under any legal disability who is to be taxed (sec. 97, 26(b)). Of course, in various cases where it is not practicable and convenient to tax the beneficiary, as for example where the
ATC 4599
beneficiary is not presently entitled or is under some legal disability, provision is made for the trustee to be taxed (sec. 97, 98 and 99).In the present case, Mrs. Everett is presently entitled
F.C. of T.
v.
Whiting
(1943) 68 C.L.R. 199
). She is not under any legal disability. One might have expected Div. 5 and Div. 6 to operate together in such a case so that Mr. Everett would be taxed upon the share of the net income of the partnership to which he was beneficially entitled and Mrs. Everett would be taxed upon the share to which she was beneficially entitled. But it is said this is not so. It is argued that Div. 6 does not apply upon the ground that the income in question is not ``the net income of a trust estate'' as defined in sec. 95. Further, it is said that Div. 6 applies only where one can point to trust property which produces the income and reference is made to
Howey
v.
F.C. of T.
(1930) 44 C.L.R. 289
at p. 293
. I find this a question of some difficulty. Of course, where the corpus of the trust estate consists of income-producing property such as shares debentures or land which has been leased, there is no difficulty. At the other end of the scale, if a person employed on a salary or on a salary and emoluments, declares himself a trustee of part of his salary or emoluments, one can readily agree with the argument (see
Parkins
v.
Warwick
(1943) 25 T.C. 419
; cf.
Johnstone
v.
Commr. of I.R. (N.Z.)
(1966) 10 A.I.T.R. 222
at p. 228
;
Kelly
v.
Commr. of I.R. (N.Z.)
(1969) 1 A.T.R. 380
at p. 384
).
Where there is a trust in respect of assets of a business but the income produced flows not simply from those assets but also significantly from the efforts of partners including the trustee, the case is more difficult. Such cases cover a wide range. It may be a grazing business where sheep also play a significant part by producing wool. It may be a pharmacy where turnover of stock and the provision of professional services both contribute. It may be a legal practice where the firm name and goodwill (including wills in the strongroom) contribute significantly to income and where the premises, library, furniture and office equipment as well as the efforts of employees also contribute but where the provision of professional services by the partners is the most significant factor. In the case of doctors and lawyers there is an additional difficulty as was noted by
Menzies
J. in
Peate
v.
F.C. of T.
(1964) 111 C.L.R. 443
at p. 446
in that they are subject to both professional and statutory controls.
Where there is a trust in respect of a partnership share in such a business, it appears to me that the beneficial interest in the income referable to that partnership share falls to be taxed under Div. 6 or in appropriate cases under that Division and sec. 26(b). It would hardly be possible to disentangle what part of the income of the business was attributable to different factors, say, to goodwill or to the personal effort of partners. And it would be wrong, in my opinion, to attempt to introduce into Div. 6 notions of ``income from property'' and ``income from personal exertion'' at one time important in the Assessment Act for the purpose of determining differential rates of tax.
It is true that in the present case we are concerned with a trust in respect of a 6/13 share in the income of a partnership and that this income was not in itself a trust estate for the purposes of Div. 5. But it does not appear to me to be correct for income tax purposes to regard the 6/13 share of income separately from the 6/13 share in the assets. Mrs. Everett's interest in income was based upon the deed of assignment but the income flowed in substance from the 6/13 partnership share for which she paid. Although she was an assignee of the rights in relation to partnership assets, these rights were of such a character that Mr. Everett remained the partner, with rights of management and administration. I have previously described the relationship between Mr. and Mrs. Everett. As I have said, it appears to me to be a trust relationship. Having regard to the purpose and effect of the words used in Div. 6, I am of opinion, they should be held to cover such a case. In my view Mrs. Everett's 6/13 share of net income was a share of net income of a trust estate for the purposes of Div. 6 and Mr. Everett was not liable to income tax upon it.
Two further points should be mentioned. It is said that Mrs. Everett's share of the net income of the partnership calculated for the purposes of Div. 5 will not necessarily correspond with her share in partnership
ATC 4600
profits calculated according to the agreement between the partners. Clearly this is so. It may be greater or it may be less. If it is less, then because the greater includes the less, no problem will arise. If it is greater, then it is clear that there is a part of the net income of the partnership for tax purposes to which Mrs. Everett is not entitled under the assignment and on which she should not be taxed but upon which Mr. Everett should be taxed. However, no evidence has been given which would enable the Court to say whether the latter is the case, or if so, to what extent there is any difference. Indeed, the assessments raised against Mr. and Mrs. Everett appear from what was said in argument before the Supreme Court to be for the same amount. In the circumstances I am unable to give any effect to this argument.Finally, it is submitted that sec. 19 of the Assessment Act requires the assigned share of income to be deemed to be derived by Mr. Everett, although not actually paid over to him but dealt with as he directed. However, it appears to me that sec. 19 begs the present question. The object of that section has been stated to be to prevent a taxpayer escaping tax though his resources have actually been increased by the accrual of income and its transformation into some form of capital wealth or its utilisation for some purpose (
Permanent Trustee Co. of New South Wales Ltd.
v.
F.C. of T.
(1950) 6 A.T.D. 5
at p. 12
). In my opinion, sec. 19 is not so expressed as to render an assignor liable to income tax where he has executed an assignment of income in advance for valuable consideration and either the character of the income is such that it is capable of immediate assignment or its character is such that the assignee becomes the immediate beneficial owner of it the instant it is ascertainable.
In the result I would dismiss the appeal with costs.
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