Federal Commissioner of Taxation v. Adler.
Judges:Rogers J
Court:
Supreme Court of New South Wales
Rogers J.
The Commissioner of Taxation appeals against a decision of the Board of Review (Case N1,
81 ATC 1) which, by majority, allowed the appeal of the respondent against the Commissioner's decision disallowing a claim for deduction from the respondent's assessable income of the sum of $10,000. That sum was paid by the respondent as premium on a Director's Liability and Indemnity Policy (``the policy'').
During the relevant year of income and since 1968, the respondent had been the Chairman of the Board of Directors and Chief Executive of F.A.I. Insurances Limited (``F.A.I.''), a publicly listed company. That company carried on the business of insurance. As well it was the holding company for a considerable number of subsidiaries. The respondent was also Chief Executive and Chairman of the Board of a great number of these subsidiaries. He
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was Chairman of the Board of Directors but not Chief Executive of Cumberland Holdings Limited and also the Saint group of companies. In addition, he was on the Board of Directors of a number of family companies. In previous years he had been a director of Vetro Industries Limited and also of Falkirk Properties Limited, both of which were publicly listed companies.On 2nd April, 1975 Washington H. Soul Pattinson Co. Limited, a minority shareholder, presented a petition to wind up Cumberland Holdings Limited. On 4th May, 1976, the then Chief Judge in Equity delivered his judgment in which he expressed the view that it was just and equitable that Cumberland Holdings Limited be wound up on the ground, inter alia, that the respondent in his capacity as a director acted in the affairs of the company in his own interests rather than in the interests of the members of the company as a whole. It is uncontested that what followed thereafter was motivated by the respondent's concern arising from this judgment, notwithstanding that subsequently the Judicial Committee of the Privy Council allowed an appeal from the judgment of the Supreme Court.
In June, 1976 the respondent sought the issue of the policy from Lloyd's of London providing cover of $500,000. A premium of $10,000 was quoted for the policy, but Lloyd's declined to accept the risk.
Thereupon the respondent informed Mr. Maclver, the professional indemnity underwriter for F.A.I., that he desired the company to issue the policy and asked for a proposal form to be prepared. Mr. MacIver constructed one and it was duly completed by the respondent. The proposal inquired as to the full name of the director to be insured and as to various items of information appertaining to that director. Question 7 required the proposer to list all companies on whose Boards of Directors he served. The answer was ``Known to company''. Question 8 required the proposer to list those companies referred to in answer to Question 7 in respect of which cover was sought and the answer was ``All companies''. The proposal was completed and dated 23rd June, 1976. After discussion between the underwriter and the reinsurance manager of F.A.I., the premium was fixed at $10,000. The proposal was accepted and 99% of the risk was reinsured with the New Hebrides Insurance Company. At the same time, F.A.I. issued director's liability and indemnity policies to two other gentlemen and reinsured in the same manner.
Mr. MacIver obtained a specimen form of the policy from Lloyd's and utilised that form for the purpose of preparing the F.A.I. policy which ultimately issued to the respondent. The policy recites that:
``Whereas it has been proposed on a signed declaration considered incorporated herein to the F.A.I. Insurances Limited by the insured named in the schedule as well in his/their own name as for and in the name and names of all and every other person or persons to whom the subject matter of this policy does may or shall appertain in part or in all to make with the said company the insurance hereinafter mentioned and described.''
The only person named in the schedule is the respondent. Cover is provided for the period from 17th June, 1976 to 17th June, 1977. Otherwise the policy appears to be undated and is signed on behalf of F.A.I. by the manager. The policy makes the proposal the basis of the contract. By cl. 1, F.A.I. agrees:
``(a) With the director directors of the company that if during the policy period any claim or claims are made against the director/directors, individually or collectively, for a Wrongful Act, the Insurer will indemnify in accordance with the terms of this policy, the director/directors or any of them, his or their Executors, Administrators or Assigns for all loss which the said director/directors or any of them shall have been obliged by law to pay.
(b) With the Company that if during the policy period any claim or claims are made against the director/directors, individually or collectively, for a Wrongful Act, the Insurer will indemnify in accordance with the terms of this policy, on behalf of the company all loss for which the company may be required or permitted by law to indemnify such director/directors.''
The reference to ``company'' is to the entity defined in cl. 4(a), meaning ``the
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company as shown in the schedule and any subsidiary or subsidiaries as defined''. The company named in the schedule is F.A.I. Clause 4(e) defines ``subsidiary'' as a company wholly owned or more than 50% owned by F.A.I. or owned by one or more of its subsidiaries.The policy therefore obviously did not apply to the family companies. To this extent, at any rate, the policy failed to give effect to the intention implicit in the answer to Question 8 of the proposal.
The indemnity was in respect of any ``Wrongful Act'' which was defined by cl. 4(c) as meaning:
``... any actual or alleged error or misstatement or misleading statement or act or omission or neglect or breach of duty by the director/directors in the discharge of their duties, individually or collectively, or any matter claimed against them solely by reason of his/their being directors of the company.''
Clause 4(b) defined loss as:
``... any amount which the director/directors are legally obligated to pay or for which the company may be required or permitted by law to pay as indemnity to the director/directors, for a claim or claims made against the director/directors for Wrongful Acts, and shall include but not be limited to damages, judgments, settlements and costs, cost of investigation (excluding salaries of officers or employees of the company) and defence of legal actions, claim or proceedings and appeals therefrom, cost of attachment or similar bonds, provided always, however, such subject of loss shall not include fines or penalties imposed by law, or matters which may be deemed uninsurable under the law pursuant to which this policy shall be construed.''
The respondent paid the agreed premium of $10,000 on 24th June, 1976 and duly claimed a deduction therefor in his return for the year of income ended 30th June, 1976.
It is common ground between the parties that the taxpayer continued to renew the policy in subsequent years in the same form.
The appellant firstly submitted that the respondent's claim for deduction foundered because the premium was required to be apportioned and the evidence did not enable an apportionment to be made. The argument commenced by pointing to the undoubted fact that the policy provided cover not only for the taxpayer but also for a number of companies. It was submitted that expenditure to provide cover for entities other than the taxpayer is not expenditure which falls within sec. 51(1) of the Income Tax Assessment Act 1936. To the extent that the premium was attributable to such additional cover, an apportionment was required even if the respondent were otherwise entitled to a deduction in respect of so much of the premium as related to the cover obtained by him. There was no evidence, the argument ran, which enabled either the Board or the Court to make such apportionment and therefore it was submitted the entirety of the claim failed to qualify as a deduction. This was an argument that was not put forward before the Board. It is doubtful whether it is appropriately raised for determination by the Notice of Appeal. However, the question was fully argued and it is convenient that I deal with it.
For the purposes of the argument, the respondent was content to accept that by reason of cl. 1(b) of the policy the cover extended to provide indemnity not only for the respondent but also for certain of the subsidiaries. The respondent submitted that the mere circumstance that a third party may benefit from expenditure made by a taxpayer by itself does not disqualify the entirety of that expenditure from being an item of deduction or call for apportionment.
Counsel for the respondent submitted that the objective facts demonstrate that the object or purpose in taking out the policy was to obtain cover for the taxpayer himself (cf.
Ure v. F.C. of T. 81 ATC 4100, Brennan J. at p. 4104; Deane and Sheppard JJ. at p. 4108 et seq. esp. p. 4110). In order to protect himself it was necessary or expedient for the respondent to take out a standard policy which, by a side wind so to speak, gave cover to third parties as well. There was no suggestion that the respondent negotiated for cover for the subsidiary companies. There was no suggestion that had the additional cover not been provided, the premium might
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have been lower. It just happened to be part of the standard policy form of cover which the taxpayer asked for and obtained without being aware of the extension in question. The matter may be summarised thuswise:- (1) The respondent required indemnity in respect of any liability he might incur as a director.
- (2) He was desirous of obtaining this cover in the form of a standard Lloyd's policy without being aware precisely of the terms of cover.
- (3) He negotiated for and obtained cover in this form without becoming aware of the precise terms of the policy.
- (4) There was no question of any claim for contribution or reimbursement for any part of the premium from the subsidiary companies.
Thus, if one asks the relevant question, what was the object of the expenditure, the answer that must be returned is that it was to provide cover for the respondent and the respondent alone. For this reason it appears to me that it would be inappropriate in any event to seek to apportion the premium.
Further, I am of the view that on the other basis advanced by Counsel for the respondent, apportionment is inappropriate. Notwithstanding the words of the policy as a matter of law, no cover was made available to the subsidiaries. The respondent did not purport to enter into the contract of insurance as agent for the subsidiaries. No question of authority arises, he clearly did not have the requisite intention. In those circumstances, no contract ever came into existence between the subsidiaries and the insurers. Nor did he intend to enter into the contract as trustee for the subsidiaries, and therefore by reason of that fact no privity of contract arose. It was submitted by Counsel for the appellant that there might be an estoppel to preclude the insurer from contending that cover was not provided for the subsidiaries. There is a complete absence of evidence of anyone acting to its detriment on the faith of any relevant representation. In the result, it seems to me that the foundation on which the appellant's claim for apportionment is made is itself unsound.
I ought to note that the parties were united in the view that no indemnity could be available to F.A.I. itself because it could not be a party to both sides of the contract. In the circumstances, it is unnecessary to pause to examine the correctness of this view.
In all the circumstances I am of the view that the representative of the Commissioner who argued this matter before the Board of Review took the correct view of the law when he did not advance any submission that there should have been an apportionment of the premium.
The majority of the Board allowed the taxpayer's objection on the basis that the expenditure satisfied the requirements of the second limb of sec. 51(1). That, in turn, required the Board to find, as it did by majority, firstly, that the taxpayer carried on a business of a director and, secondly, that the premium was paid for the purpose of gaining or producing assessable income of that business.
The appellant submitted that the Board fell into error in both respects. I will deal firstly with the question whether the respondent carried on a business. That term is defined in sec. 6 of the Act as including ``any profession, trade, employment, vocation or calling but does not include occupation as an employee''. If the evidence properly admits of either conclusion, then a decision whether or not a business is carried on is a question of fact (
N.S.W. Associated Blue-Metal Quarries Ltd. v. F.C. of T. (1956) 94 C.L.R. 509 at p. 512). In
Hope v. The Council of the City of Bathurst 80 ATC 4386, Mason J. had the concurrence of the other members of the Court when at p. 4390 he said of the phrase ``carrying on business'':
``... activities undertaken as a commercial enterprise in the nature of a going concern, that is, activities engaged in for the purpose of profit on a continuous and repetitive basis.''
Now it is true that the respondent was not a professional company director in the sense in which that term has been used in commerce. He did not hold himself out as being available and willing to take on all or any directorships. However, he spent the entirety of his working days, thereby satisfying the call for repetition, in carrying out the functions of an executive director.
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With the exception of formal meetings of the Board, it is almost impossible in a situation where a businessman is simultaneously Chairman of the Board, or a Director and Chief Executive, to divide the sum total of his activities in order to determine whether at any given point of time and in relation to any particular activity, he is acting as a Director or as a Chief Executive. He is running the business of the company. To all intents and purposes, by reason of the large shareholding in F.A.I. which the respondent held, either directly or through family companies, he was in effective control of F.A.I. and its subsidiaries. He busied himself about the business of the company and its subsidiaries because to do so redounded to his financial advantage. Thus, in every possible sense, what he did was a commercial activity carried on for profit. Part of the financial advantage was the assessable income earned as a director which, in the relevant year of income, was $8,500 from F.A.I., $3,000 from Cumberland Holdings Limited, $1,000 from Falkirk Properties Limited and $500 from Vetro Industries Limited. I should, perhaps, point out that it was simple expediency which dictated which companies in the F.A.I. Group should pay the directors' fees. In the circumstances of this case, I am satisfied that the Board was entitled to hold, and correctly held, as do I, that the respondent was at the time carrying on the business of a company director.It was next submitted that in any event the premium was not an expenditure ``necessarily incurred in carrying on a business for the purpose of gaining or producing'' assessable income. The connection required between the expenditure on the one hand and the production of assessable income has been recently and exhaustively reexamined by the Federal Court in
Magna Alloys & Research Pty. Ltd. v. F.C. of T. 80 ATC 4542
F.C. of T. v. Ilbery 81 ATC 4661. There is no need for a further excursus from me. The test has been encapsulated by the High Court in
F.C. of T. v. D.P. Smith 81 ATC 4114 at p. 4117:
``The section does not require that the purpose of the expenditure shall be the gaining of the income of that year, so long as it was made in the given year and is incidental and relevant to the operations or activities regularly carried on for the production of income. What is incidental and relevant in the sense mentioned falls to be determined not by reference to the certainty or likelihood of the outgoing resulting in the generation of income but to its nature and character and generally to its connection with the operations which more directly gain or produce the assessable income.''
Was the expenditure incidental and relevant to carrying on the business of a company director? The parties were united in the view that there is no one criterion which is determinative of this question. The nature and character of the outgoing require to be considered in the light of all the surrounding circumstances. The fact that any money produced by the indemnity provided by the policy would not be assessable income is but one matter to be taken into account (see Smith (supra) p. 4115). Counsel for the appellant submitted that it could not be reasonably incidental to the production of assessable income to incur expenditure by way of premium in circumstances where, on the one hand, indemnity was already available under the Articles of Association of the various companies and, on the other, the width of the policy was restricted by the provisions of sec. 133 of the Companies Act. However, the indemnity provided by the Articles is of no benefit if in truth the companies are insolvent. It is usually precisely in those circumstances that a call needs to be made on a policy such as the one under consideration. The indemnity under the Articles is not co-extensive with the cover under the policy. Furthermore, even giving sec. 133 a wide operation, there is ample scope left for cover to be provided by the policy of insurance. Cover provided in respect of a claim based on the principles laid down by the House of Lords in
Hedley Byrne & Co. Ltd. v. Heller & Partners Ltd. (1964) A.C. 465 is but one example, bearing in mind the nature of the business carried on by the companies and the principles recently laid down by the High Court in
Shaddock (L.) & Associates Pty. Ltd. & Anor. v. Parramatta City Council (1981) 36 A.L.R. 385. The taxpayer was entitled to take the view that his activities in earning assessable income as a director exposed him to the risk of liabilities. To expend moneys to procure indemnity against such liabilities is to my mind an
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essential facet of the carrying on of the business.I am of the opinion that the Board was correct in holding the respondent to be entitled to a deduction under the second limb of sec. 51.
I note that it was submitted on behalf of the respondent that the appeal did not involve a point of law and accordingly was incompetent. I consider that the questions of construction of the policy of insurance by themselves raise a sufficient question of law to satisfy the requirements of the Act.
The appeal is dismissed. I order the appellant to pay the respondent's costs. Exhibits may be returned if no proceedings are instituted within 28 days for a review of this judgment by the Federal Court.
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