Federal Commissioner of Taxation v. Forsyth.

Murphy J

Supreme Court of Victoria

Judgment date: Judgment handed down 18 September 1979.

Murphy J.: This appeal by the Commissioner comes before this Court pursuant to sec. 196 of the Income Tax Assessment Act 1936 as amended (hereinafter termed ``the said Act'').

The Board of Review allowed objections lodged by Neil Harry Mark Forsyth against the Commissioner's assessments of his income in the years ended 30 June 1974 and 30 June 1975 respectively, and ordered that the assessments by the Commissioner be amended in accordance with its decision.

On this appeal the onus of proving that the original assessments by the Commissioner

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were excessive again rests upon the taxpayer, Forsyth (sec. 190(b)).

The single point argued before me was whether rent of $20 per week paid by the taxpayer to the owner of a house for the occupation of ``one room... and such ancillary space and facilities as he might reasonably require from time to time for the purpose of his professional practice as a barrister'' was an outgoing incurred in gaining or producing the taxpayer's assessable income, so being an allowable deduction from assessable income pursuant to sec. 51(1) of the said Act.

It was conceded by counsel for the Commissioner that the taxpayer was a tenant of the room in question, and that he made payments of rent to the extent of $840 in the year ending 30 June 1974 and $1,040 in the year ending 30 June 1975 (p. 9, transcript).

It was also conceded by counsel for the Commissioner ``that the relevant area was used entirely'' (which I have taken to mean, solely) ``for professional purposes, that is to say, working on briefs, reading for legal purposes, and otherwise in relation to the taxpayer's practice as a barrister'' (p. 10, transcript).

The taxpayer was a barrister, who customarily worked by day in the city in chambers and worked by night in the room which he had rented adjacent to his place of residence. Like most successful barristers, the taxpayer was required to work at night and at weekends occasionally either preparing for court appearances, working up opinions, settling documents, reading law reports relevant to the topic in hand, or generally researching and mastering the facts and law in any particular case. It follows that a substantial part of his assessable income is earned in this way, working in the rented room in question.

The facts were agreed by counsel to be as set out in para. 1, 2, 3, 4, 5, 8, 9, 11, 12, 16 and 17 of the joint Reasons for Decision delivered by Mr. J.L. Burke as Chairman, and Mr. R.E. O'Neill, as a Member, of the Board of Review on 6 September 1977 at Melbourne.

The circumstances in which the taxpayer came to rent this room were as follows.

A settlor had created a trust called the M.H. Forsyth Trust. The trustees purchased a house in Berry Street, East Melbourne. The trustees then rented the room in question to the taxpayer, Forsyth, for $20 per week. (Some discussion appears in the reasons for decision of the members of the Board of Review, as to the competence of the trustees to create such a tenancy, but, before me, counsel for the Commissioner expressly stated that no point was made by the Commissioner suggesting that the trustees were legally incompetent to create the tenancy, or suggesting that they did not do so.)

The trustees permitted the taxpayer and his family to occupy the other part of the house as a residence.

It was also a matter of concession between the parties that the only section of the said Act, which was relevant to the appeal, was sec. 51 (p. 16, transcript). Section 260 of the said Act was not relied upon by the Commissioner (p. 12, transcript). No submission was made that an issue of evasion of tax arose. It is difficult to see how such a submission, if made, could have been supported.
Cecil Bros. Pty. Ltd. v. F.C. of T. (1964) 111 C.L.R. 430.

Section 51(1) of the Act, insofar as relevant, reads as follows:

``51(1) All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature...''

The profession followed by the taxpayer falls within the meaning of ``business'' as defined in sec. 6(1) of the said Act. However, as was said in the joint judgment of the High Court in
Ronpibon Tin N.L. and Anor. v. F.C. of T. (1949) 78 C.L.R. 47 at pp. 56-7, the second limb of sec. 51(1) adds but little to the first.

It is necessary that the outgoing be proven by the taxpayer to be ``incidental and relevant'' to the production of assessable income. As was said in the Ronpibon case, ``it is both sufficient and necessary that the occasion of the loss or outgoing should be

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found in whatever is productive of the assessable income...'' (78 C.L.R. at p. 57).

Rent paid in respect of business (professional) rooms is commonly seen to be an outgoing incurred in gaining or producing assessable income. It has the character of a business expenditure.

Counsel for the Commissioner approached the matter in this way. First, he referred me to
Lunney v. F.C. of T. (1958) 100 C.L.R. 478 where the High Court considered the question whether fares incurred travelling to and from work and home are allowable deductions under sec. 51(1) of the said Act.

Dixon C.J. held that they were not, because this ``view has always prevailed'' (100 C.L.R. at p. 485), and he thought that it was for the legislature rather than the courts to alter ``an undisputed principle''. He expressed his ``misgivings about the conclusion'' and one gathers that if he had been approaching the matter uninhibited by prior decisions, he might have decided otherwise. McTiernan J. entertained the same misgivings, and after considering the cases came to the conclusion that there was a right to a deduction. Williams, Kitto and Taylor JJ. delivered a joint judgment. They held that although the earlier cases had used expressions which might suggest that, if an expenditure was ``incidental and relevant'' to gaining or producing assessable income, it would be deductible under sec. 51, yet it was not sufficient simply to look at the ``purpose for which an item of expenditure has been incurred, but rather'' it was necessary to look, ``to the essential character of the expenditure itself''.

Doing this, they held that although fares from home to work might be necessarily incurred if assessable income was to be derived, it did not follow that the expenditure on fares was incurred in or in the course of gaining or producing assessable income (see at pp. 498-499). They had no essential characteristics of a business expense.

Such expenses were properly characterized, the judgment continued, as living or personal expenses, rather than business expenses. They resulted from living in one place and working in another, and could not be said to be incurred in gaining or producing the assessable income.

Having examined this decision, Dr. Spry (appearing for the Commissioner) then moved to what he termed ``home office expenditure'', and submitted that expenditure by way of rent on a home office is not deductible under sec. 51(1) of the said Act, because it does not fall within either of its two limbs and because it is within the exception, and is of a ``capital, private or domestic nature''.

In support, he referred to
Thomas v. F.C. of T. 72 ATC 4094. In that case, Walsh J. held that no part of a sum of $457 paid by a barrister as interest on a bank loan was deductible under sec. 51(1). The barrister had obtained and used the bank loan for the purpose, inter alia, of defraying the cost of adding three new rooms to his home, one of which rooms was to be used and was in fact used by him as a study for professional purposes.

Walsh J. held that the payment of interest on the bank loan in these circumstances was an outgoing ``of a capital, private or domestic nature'' (at p. 4097).

His Honour said:

``In my opinion it did not lose that character merely because the appellant, like most professional men, did some of his work at home, or because he used one of the added rooms for that purpose. The appellant did not spend money in erecting premises suitable only for use as business premises. He added rooms to his house. It is natural to suppose that the addition increased the capital value of the improvements on the land.''

His Honour emphasized that the moneys borrowed in that case were used to enlarge the domestic home and to increase its capital value. For either reason he concluded that interest payable on the loan money was an outgoing ``of a capital, private or domestic nature''. That was its primary and essential character. It appears to be implicit in what his Honour said that the mere superimposing of a business use on a continuing and essentially domestic use, will not cause outgoings to change in character. The nature of the outgoing by way of interest remained the same, namely it was of a capital or domestic nature.

It might just as well have been argued that a person who develops the habit of working

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each night in bed at home, before going to sleep, is entitled to claim that outgoings incurred in connection with the cost of erection of the bedroom ``are incurred in gaining or producing the assessable income''. Such outgoings do not have the character of business expenditure. The occasion of the outgoings is not found in anything productive of the assessable income. They are not incurred in gaining or producing the assessable income, but remain of a private or domestic nature.

Similar examples readily present themselves. The cost of clothes purchased to enable a person to appear respectably in public are of a private or domestic nature, and do not become outgoings incurred in gaining or producing the assessable income simply because they are worn, and must necessarily be worn, when gaining the assessable income. Nor does the cost of having such clothes drycleaned in the ordinary course constitute such an outgoing.

On the other hand, if such clothes are only purchased to enable a person to be ``seen'' in court (such clothes being butterfly collars, bibs, gowns and the like), then certainly the cost of maintaining such ``robes'' would seem to me to have the essential characteristic of a business expenditure and to be an allowable deduction. Few people would dream of wearing them, if it were not necessary to do so in order to gain income. Nor are they worn otherwise. Again, to use the words used in Ronpibon, ``the occasion of the... outgoing'' is ``found'' in something ``productive of the assessable income''.

(Whether the actual cost of purchasing the ``robes'' would be an outgoing falling within sec. 51(1) or a depreciable item under sec. 54 of the said Act as property, (being ``plant or articles''), may give rise to debate.)

It was the nature or character of the expenditure to which Walsh J. was, in my opinion, directing attention, mainly to determine whether the outgoing was ``of a capital, private or domestic nature''. He did not find that the study was a ``home office''. He found that ``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''. (See 72 ATC at p. 4097.)

The next case to which I referred was
F.C. of T. v. Faichney 72 ATC 4245; (1972) 129 C.L.R. 38. This case was decided by Mason J., some six months after Walsh J.'s decision in the previous case.

Faichney was a scientist, employed at a salary by the C.S.I.R.O. Though not required by his contract to work at home, he did so, both in order to do his job properly and in order to gain advancement. When planning to build his home, he included a room for use by him as a study for the purposes of his work. When building the home, he raised a mortgage to defray the cost of the home, and then claimed a deduction of a proportionate part of the interest payable on the loan (referable to the study), as an outgoing falling within sec. 51(1).

Again, Mason J. found it convenient to examine whether the interest payment under the mortgage was a loss or outgoing ``of a capital, private or domestic nature'', so being excepted from the application of sec. 51(1) of the said Act.

He said:

``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 those activities from which the taxpayer earns his income, is a part of that home. Expenditure incurred in the erection of the study or in its renovation is as much an outgoing of a capital, private or domestic nature as expenditure on any other part of the home.''

(at pp. 4249-4250; 43)

Later in his judgment his Honour turned to consider a doctor's surgery and said, ``However, the doctor's surgery is not in a relevant sense part of his home; it is his place of business, if I may be permitted so to describe the premises at which a doctor carries on his profession''.

Here again it appears to me that his Honour was contrasting the exclusive use to which a surgery is put, in order to stress that the mere use of a room in what was, as a whole, essentially a private home, for the purpose of working in it, did not change a domestic or capital outgoing (in the nature of interest on a mortgage) or any part of it into one incurred in gaining or producing the assessable income. The use by the scientist of the room in the home was merely a

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coincidental use of the space in part of the private home. The occasion of the incurring of the obligation to pay interest on the mortgage was not the gaining or producing of the assessable income.

Both in Thomas' case and in Faichney's case the private home of the taxpayer encompassed that part of the home which he utilized as a study. The home was built on land owned by him, for private occupation as a home.

Mason J. approached the matter in the same way when considering whether the cost of ``light and heating'' provided in the ``study'' whilst the taxpayer was working, was or was not an outgoing falling within the exception specified in sec. 51(1). (See at p. 4250; 45.) He found that it was an allowable deduction.

The idea implicit in this reasoning is, I find, most suitably conveyed by Mason J.'s reference to the outgoing by way of rent of a private home. Such a payment was, he thought, clearly a payment of a private or domestic nature, even through part of the house rented might happen to be used also for the performance of work, producing assessable income. The private home was rented as a whole. The rent paid for a home has the same essential character, irrespective of the use to which part of the home may be coincidentally put from time to time. The outgoing on the home remains of a private or domestic nature, notwithstanding the coincidental use to which part of the home is thereafter put from time to time, even using it as a place in which to work, earning assessable income.

The character of the payment could alter, wholly or to some extent, if the whole home or portion of it was no longer used as a home, but was used exclusively for business purposes in the gaining of the assessable income. The nature of the rent - its characterization for the purpose of sec. 51(1) - would be altered.

Caffrey v. F.C. of T. 73 ATC 4144 at p. 4146 Wickham J. expressed the view that each of the above decision to which I have referred was simply ``a decision of fact''.

They clearly were decisions on the facts in the particular cases, but I think that in each case statements of principle, which are most helpful when considering sec. 51(1), emerge.

The view taken was that the mere fact that a taxpayer coincidentally uses what are essentially to be characterized as private premises, for the purposes of gaining the assessable income does not mean that expenses necessarily incurred in connection with the erection, occupation or upkeep of the private premises are allowable deductions under sec. 51.

If the outgoings are of a capital, private or domestic nature, then the mere fact that, coincidentally, the premises or portions of them to which the outgoings relate are used in gaining or producing the assessable income does not mean that the outgoings are incurred in gaining or producing the assessable income.

Such outgoings as are incurred for private or domestic purposes and as are constant (e.g. rent, insurance premiums) irrespective of the use to which the private premises are put, do not change their essential character because another use is superimposed, and that superimposed use is the gaining of assessable income.

Again, when the outgoing is one such as interest on money borrowed to erect a home or to add rooms to be a residence, it seems to me also to be implicit in Thomas' case that the outgoing or interest payable on the loan is ``of a capital nature''. The capital value of the land has been increased by the erection or addition. Quicquid plantatur solo, solo cedit.

The use of part of the residence as a study does not mean that part of the interest payable on a loan or a mortgage ceases to be of a capital nature and becomes an outgoing incurred in gaining or producing the assessable income.

The approach adopted by both Walsh J. and Mason J. in these two cases is to look at the purpose for which the outgoing is incurred, and considering all the circumstances to arrive at a conclusion as to the essential character of the outgoing. If this essential character once determined remains constant, then the use to which premises or part of premises happen to be put will not make the outgoing in respect of them any the more or less an allowable deduction under sec. 51(1).

The principle applies both ways. A taxpayer who pays rent for a factory leased

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by him to manufacture goods can claim such outgoing as an allowable deduction from his assessable income. The fact that the taxpayer also sleeps in part of the premises, does not alter the nature of the outgoing of rent.

Conversely, if the outgoing is ``of a capital, private or domestic nature'' (and so excepted from sec. 51(1)) ``it must be a rare case'' where it is also an ``outgoing incurred in gaining assessable incomes''.
F.C. of T. v. Hatchett 71 ATC 4186 at p. 4186; (1971) 125 C.L.R. 498 at p. 498.

The answer to the question, what is the essential character of the outgoing or what is its nature, may depend upon matters of fact and degree.

It appears to me that, if an outgoing is incurred for the purpose of renting or building a private home, it is prima facie an outgoing of a capital or private or domestic nature, and as such is excepted from sec. 51(1).

F.C. of T. v. McCloy 75 ATC 4079, Helsham J. applied the reasoning in Thomas' case and Faichney's case, and said:

``... in the present case the taxpayer was not in any real sense carrying on his business in a separate part of his house 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.''

(75 ATC at p. 4083)

I am not of the opinion that adaption ``solely for business use'' is a prerequisite necessary to characterize an outgoing as an allowable deduction under sec. 51(1). ``Light and heating'' expenses relating to a study at home incurred so as to enable the earning of assessable income are allowable deductions.

There are decisions of the Court of Appeal in New Zealand which do not adopt this approach apparent in Thomas' case and Faichney's case but prefer to follow the reasoning in
Commr. of I.R. (N.Z.) v. Castle (1971) 2 A.T.R. 481. Although the words used in the Land & Income Tax Act 1954 (N.Z.) are a little different from the words in sec. 51(1) in the Commonwealth Act, counsel suggested that any differences are immaterial.

Commr. of I.R. v. Banks 78 ATC 6001 at 6008-6009 the Court of Appeal in New Zealand in a joint judgment said:

``In the case of premises serving as a family home there are many instances where a workshop, surgery or study, or other part of the premises, is physically set up for income earning activities. That may be cogent evidence of an intention to use that part of the premises for income related purposes and may support the contention that to that extent the premises have that character. But physical change is not always necessary to allow the use of premises in the income earning process. The physical setting will doubtless be a consideration in determining whether the claimant for a deduction has established that he qualifies under sec. 111. But it cannot be determinative, at least where the assets are reasonably capable of use for the income earning purposes of the taxpayer. We see no distinction in principle between two cases; one, where a room is formally set aside for income purposes and the other, where it is simply used for income related activities. Nor is it essential that its primary use be for income earning purposes. There is no such qualification in the statute. Indeed, the expression `to the extent' and `so far as' demonstrate the absence of a statutory minimum applicable in all cases.

But it is not sufficient that income related activities take place in the premises... there must be an inquiry into the degree of connections between income related activities and the asset or advantage gained or sought to be gained by the expenditure... It is a question of fact and degree.''

In the case of a ``home office'', if the outgoing is not seen in the first place to have been incurred as an incident of establishing, setting up, adding to or maintaining the taxpayer's private home as such, I agree that questions of fact and degree are necessarily involved when considering the question of ``outgoings'' associated with ``home offices''.

However, if the outgoing is constant (e.g. interest on a mortgage or building loan) and is seen initially to be of a capital, domestic or private nature, then, in my view, the fact that

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a part of a home is at a later date coincidentally used when earning or producing assessable income does not change the essential character of the constant outgoing. It remains as it was. The purpose or character of its incurrence is not altered simply because another use of the premises is superimposed.

If the use of the premises is radically altered so that their essential character can be seen to be changed (and this may be a matter of fact and degree) then the nature of the outgoing will also be altered.

But if the outgoing is inconstant and changes proportionate to the use to which premises or facilities are put, it will always be a question of ``fact and degree'' whether the outgoing (such as, for example, the cost of supplying lighting and heat in a study) or any and what part of it is an ``outgoing'' incurred in gaining or producing the assessable income. This will be so, even though the outgoing (such as the cost of the lighting or heat), is an outgoing incurred when the taxpayer is using a part of premises, which as a whole can only be generically described or characterized as a private home, to gain assessable income.

Outgoings by way of improvements to a residence such as the addition to it of a room for use as a study or even of bookshelves and the like accoutrements of a study, will generally, if fixtures, be of a ``capital nature'' and could also be classified as outgoings of a private or domestic nature. Considerations of this sort must involve ``questions of fact and degree''.

Bearing in mind these considerations, and turning to the case before me, it is conceded that the taxpayer rented the room in question and paid rent for it of $20 per week. It is also conceded that he used the room ``entirely for professional purposes'', i.e. in the gaining of assessable income. In Mr. Shaw's submission, that is an end of the matter. The essential character of the outgoing is that it is of a business nature.

It has not been suggested that I should look at the matter in any way other than the way in which it appears from the legal documentation.

That being so, I find that the room in question is not part of the taxpayer's home. It is of course a convenient adjunct to it but it is a separate (or, as Dr. Spry accurately termed it, ``discrete'') unit within the same building. It is not part of his residence. Outgoings incurred as rent in connection with it cannot, as I see the matter, be characterized as being of a capital, private or domestic nature.

It goes, without argument, that a doctor's surgery, even if occupied as part of premises characterized as his home, should be characterized as business premises, and outgoings properly attributable to the establishment, occupation, upkeep and maintenance of the surgery are properly to be considered as allowable deductions falling within sec. 51(1) of the said Act.

A fortiori, outgoings incidental to separately (discretely) rented premises which are used entirely for professional purposes, must I think be similarly characterized.

I know of no principle which suggests that the mere fact that rented premises such as these are within the confines of a building, the balance of which is occupied as the taxpayer's home, causes the premises separately rented by the taxpayer and used by him ``entirely for professional purposes'', to be characterized as private or domestic and part of his home. They are simply not part of his home. Nor is rent payable in respect of them to be characterized as an outgoing of a capital, domestic or private nature. The rent payable is both incidental and relevant to the earning or producing of assessable income, and in my opinion, has the essential character of a business outgoing.

It was conceded by counsel for the Commissioner that the rent paid for these premises was appropriate, and in all the circumstances, I can see no reason at all why the rent paid for them does not constitute an outgoing which is an allowable deduction under sec. 51(1) of the said Act. The problem arising from the coincidental use of rooms in a home for business purposes does not arise here. Nor is there any question of capital outlay. The occasion of the outgoing is found in the necessity to have a room with warmth and light and reference books in order to produce the assessable income.

Leaving aside the question whether any and what principle or principles is or are to be drawn from the decided cases, it appears clear to me that the facts of the present case

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are such that, having regard to the terms of sec. 51(1) itself, the rent payable for those premises is an outgoing which constitutes an allowable deduction from the taxpayer's assessable income.

It was incurred by the taxpayer in the gaining or producing of the assessable income.

Accordingly I am satisfied that the original assessments for the taxpayer in the year ending 30 June 1974 and the year ending 30 June 1975 were excessive.

The appeal will stand dismissed.

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