Case N91

Judges: MB Hogan Ch
P Gerber M

GW Beck M

Court:
No. 3 Board of Review

Judgment date: 23 October 1981.

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Dr. G.W. Beck (Member)

This taxpayer is a solicitor admitted to practice in 1970. He commenced practice on his own behalf on 1 March 1971 and in late October or early November of that year he became ``solicitor in charge in a caretaker capacity'' of a practice the principal of which had been struck off the roll. On 11 November 1971 the taxpayer entered into an agreement to purchase the practice and the total purchase price of $25,000 was apportioned in the contract:

                                         $

      Work in progress                 21,000

      Library, furniture and effects    4,000

                                      -------

                                      $25,000

                                      -------
        

A schedule to the contract listed the individual amounts which totalled to $21,000 work in progress. The taxpayer lodged his return for both 1972 and 1973 years on an accruals basis and total fee billings were included in income in the Profit and Loss account. He deducted in each year $7,000 in respect of ``work in progress purchased'' and attached a note to the 1972 returns as follows:

``On the purchase of the solicitors' practice of X & Co. $21,000 was paid for work in progress not yet billed. It is anticipated that the cases to which the work in progress applies will take an average of 2 to 3 years to finalize and recover the billed costs. Using this as the basis we are assuming the work in progress to be written off or recovered in profit costs equally over a three year period.

                        $

      Claim  1972     7,000

             1973     7,000

             1974     7,000

                    -------

                    $21,000

                    -------''
            

None of the work in progress had been billed to clients at date of purchase. The deduction was disallowed in both years and, the taxpayer's objections having been rejected, he asked for a review.

2. Reproduced below are the two lines of argument put forward in the objection:

``The grounds on which I rely are as follows:

• 1. The amount of $7,000 represents expenses incurred in gaining or producing assessable income.
• 2. The said amount was necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.
• 3. The said amount was not an expenditure of capital or of a capital private or domestic nature.
• 4. The said amount is an allowable deduction in accordance with Section 51(1) of the Income Tax Assessment Act, 1936-1972.

In the alternative if it is alleged that the amount of work in progress of $7,000 is a capital expense then I rely on the

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ATC 491

following grounds in support of my objection that the amount of $7,000 should be excluded from assessable income are as follows (sic):

• 1. That those part (sic) of fees charged which represent the value of work in progress in respect of those matters is a recoupment of a capital expenditure.
• 2. That such recoupment amounts to a capital receipt.
• 3. The said amount is not assessable income in accordance with Section 25(1) of the Income Tax Assessment Act 1936-1972.''

At the hearing the taxpayer's representative did not address himself to the second line of argument in the objections, and when this was brought to his attention he replied: ``No, I did not deal with that. I did not wish to deal any further with it; that is in relation to the question of whether he received income.'' I think it unfortunate for the taxpayer that attention was not given to this aspect.

3. The taxpayer's representative argued for a sec. 51 deduction using the following reasoning:

• (a) a contract between a solicitor and client is a contract of personal skill and confidence and is not one which is capable of assignment;
• (b) the work done on incomplete assignments by a vendor solicitor prior to practice disposal cannot be charged out;
• (c) work in progress is not truly an asset of the business of a solicitor because it is of no value to a vendor unless he completes it;
• (d) the work in progress at the date of purchase of a practice is just a component of the work which forms the final product and the cost of acquiring that component is a cost or outgoing deductible against the fees derived by the purchasing solicitor from the final product;
• (e) the facts in this case distinguish it from a series of cases all concerned more or less with the point decided in
  City of London Contract Corporation Ltd. v. Styles (1887) 2 T.C. 239 , viz. that the sale of unexecuted contracts was a capital transaction.

4. I can see a distinction between the sale of unexecuted contracts and the sale of a solicitor's work in progress in that the latter always requires the acquiescence of the client for the deemed sale value to be recoverable, while this acquiescence by third parties will not always be needed in the case of unexecuted contracts. However, I do not see that this difference has any significance given the economic reality of the events that took place here, and seem always to take place when a professional man disposes of a practice and recovers in the sale price a consideration in respect of work done and as yet unbilled. In business terms an item is an asset when it has value in exchange. Individuals might possess assets that have no value in exchange (e.g. items providing psychological satisfaction, spiritual solace and the like) but this does not apply in business where, without exception, the absence of a market means there is no asset. The converse situation - the existence of a market value for an item - means that the item is most assuredly an asset. (I should perhaps insert, to satisfy the accounting purist, that the market value might arise indirectly or be for the output of an item rather than for the item itself, but this in no way affects the argument here.) It follows that I cannot accept that a solicitor's work in progress. It is not an asset when there is evidence that the taxpayer gave valuable consideration for such work in progress. It is flying in the face of reality to claim that it is of no value to a vendor unless he completes it; here we are confronted by a solicitor obtaining value by selling the work in progress. In any case it seems to me to be in no way helpful to this taxpayer's case to deny the existence of an asset.

5. The taxpayer's representative was, of course, equating the solicitor's work in progress at date of sale to stock in trade in trading ventures; indeed, he said ``it is like the timber which is used by the craftsman, it is like the bricks that are used by the builder'' and I consider this equation to be in error. The tradesman (of whatever kind) who buys a going concern will often acquire as one of the assets some ``stock in trade'' and this stock will subsequently be used up in the course of the work done. At the same time the cost of it is charged into cost of production and it forms part of the cost of

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ATC 492

the product that is created subsequent to the date on which the business is acquired. The solicitor's work in progress is of a fundamentally different character. It is not a stock of raw materials awaiting applying to the production process but simply some accumulated cost of work already done and the right to charge clients for that work is in effect sold to the purchaser of the practice. I cannot see that it matters that the right to charge must be confirmed by the acquiescence of the clients for that aspect merely influences the degree of business risk of recovery. Whatever profit has been generated by the work done so far can be expected to be reflected in the amounts allocated for work in progress to each client by the vendor solicitor, and the presence of a profit factor also distinguishes it from a trader's purchased stock-in-trade.

6. I am in little doubt that in this case the vendor sold an asset and the purchaser acquired an asset in the form of the right to charge clients for work done by the vendor. The acquired asset is of a capital nature and therefore is not deductible under sec. 51. It is, of itself, a tree which will provide no fruit (profit) to the purchaser but, when included in the final billing at the amount agreed between vendor and purchaser and after being paid, there will be recovered to the purchaser the cost of the asset. It follows that that part of the acquired work in process which was recovered in 1972 and 1973 tax years is not part of the fees derived by the taxpayer and should not have been included in the gross fees in the Profit and Loss account. At the same time, of course, no deduction is available for the purchased work in process included in those fees. I consider the second line of argument put in the objection to be correct and had the taxpayer presented to the Board an analysis showing the precise amount of the work in progress that was recovered in each year I would have found in his favour and would excluded those receipts from gross fees. He did not do so, but simply assumed that the work in progress would be recovered in equal amounts of $7,000 over three years and put no argument in support of this assumption. The calculation of the actual amount recovered in each year would have been a simple arithmetic exercise, and in view of the onus imposed by sec. 190(b) the failure of the taxpayer to do the exercise means that he cannot succeed. It would be by the greatest coincidence that the actual recoveries of acquired work in progress were $7,000 in each of the next three tax years after acquisition of the practice.

7. A decision of this Board as then constituted, Case G37,
75 ATC 231 , traces the law subsequent to Styles' case and sets out clearly why the cost of unexecuted contracts is not deductible under sec. 51. As will be clear from my earlier reasoning I regard the expenditure for a solicitor's work in progress as a payment to acquire the right to collect the unbilled charges of that solicitor and not as a recurrent or current expense in carrying out the subsequent work. I consider the discussion of the law in Case G37, especially in para. 14 and 15, to be relevant and I respectfully accept it and have applied it to the instant facts.

8. I confirm the assessments for both 1972 and 1973 years.

Claims disallowed