Madad Pty. Limited v. Federal Commissioner of Taxation.Judges:
Supreme Court of Queensland
This is an appeal by Madad Pty. Ltd. following the partial disallowance by the Deputy Commissioner of Taxation of an objection by the appellant against an assessment to income tax based on income derived during the year ended 30 June 1979. The question which arises on the appeal is whether the sum of $21,000 being a penalty incurred by the appellant under the Trade Practices Act 1974 is an allowable deduction under sec. 51(1) of the Income Tax Assessment Act 1936.
For a number of years prior to 1977 the appellant was engaged principally in the manufacture of mattresses. In 1969 it commenced to manufacture Sealy Posturepedic mattresses under a licensing agreement made with the Sealy Company in the United States of America and it then sold those mattresses to retailers. In 1976 what is described as a price war developed in Brisbane in which a number of retailers reduced their mark up on the mattresses to ten per cent. This was regarded by Mr. Dyer, managing director of the appellant, as being undesirably low since it would result in a loss by retailers on their transactions and an endeavour was made to persuade the retailers concerned to increase their mark up.
It would appear that the action taken by the appellant for the purpose of effecting this result came to the notice of the Trade Practices Commission and in January 1978 proceedings were instituted by the Commission in the Federal Court of Australia alleging certain acts by the appellant in or about the month of March 1977 which constituted a contravention of sec. 48 of the Trade Practices Act. That section provides that a corporation or other person shall not engage in the practice of retail price maintenance. The acts which constitute engaging in such a practice are set out in sec. 96 of the Act. When the matter came before the Court in March 1979 the appellant admitted three of the allegations made. The effect of the admissions was that in three instances the appellant had attempted to induce a named retailer not to sell Sealy Posturepedic mattresses at a price less than that specified by the appellant. The learned Judge who heard the matter accepted that the conduct had been engaged in by the appellant in the belief that such conduct would be in the interests of all concerned in the industry including the financial interests of the appellant. In his evidence before me, Mr. Dyer said that when he made the decision to do whatever was done he was not aware that it was a breach of the Act and as there is no evidence which would suggest otherwise I am prepared to accept that this was the case.
The appellant was ordered to pay to the Commonwealth pecuniary penalties of $7,000 in respect of each contravention and also to pay the costs of and incidental to the proceedings. Provision for the ordering of pecuniary penalties in such a case is made by sec. 76 of the Act. Section 77 authorises the Attorney-General or the Commission to institute a proceeding in the Federal Court for the recovery on behalf of Australia of a pecuniary penalty referred to in sec. 76, and sec. 78 provides, inter alia, that criminal proceedings do not lie against a person by reason only that the person has contravened a provision of the Part of the Act in which sec. 48 is contained.
The amount of the penalty would not be an allowable deduction under sec. 51(1) if it were an outgoing of a capital nature. Mr. Hogg, a chartered accountant of many years experience, who conducted the audit of the appellant's accounts for the year in question, said in evidence that in accordance with orthodox accounting the penalty was a revenue item, being a cost of running the business and he did not accept the proposition that, if it was otherwise of a business nature, it was a payment designed to protect the capital structure of the business. It was submitted on behalf of the respondent, rather faintly I thought, that it may be that the proper characterisation of the penalty was a capital payment. In my view the penalty could not properly be characterised as a
ATC 4117payment designed to protect the business or capital assets of the appellant and it was not an outgoing of a capital nature (see
F.C. of T. v. Snowden & Willson Pty. Ltd. (1958) 11 A.T.D. 463 at pp. 469-474; (1958) 99 C.L.R. 431 at pp. 444-446 and 448-452;
Magna Alloys & Research Pty. Ltd. v. F.C. of T. 80 ATC 4542).
Accepting then that the outgoing was of a revenue character, it is not an allowable deduction unless it was incurred in gaining or producing the assessable income or was necessarily incurred in carrying on a business for the purpose of gaining or producing such income. There is no authority binding on me which decides whether or not a penalty of the nature in question here is deductible under either limb of sec. 51(1) but there are certain dicta bearing on the matter to which reference must be made in considering it.
There are two English cases dealing with penalties to which it is necessary to refer at the outset. In each case the question was the deductibility of the penalty as a ``loss connected with or arising out of'' the trade or business within the meaning of the relevant provision of the Income Tax Act 1842 (U.K.). In
I.R. Commrs. v. Warnes & Co. (1919) 2 K.B. 444, the taxpayers had been sued for a penalty in the King's Bench Division on an information exhibited by the Attorney-General under the provisions of the Customs Consolidation Act 1876 for an offence alleged against them in breach of certain orders and proclamations. The action was settled in Court by consent on the agreement by the taxpayers to pay a mitigated penalty of £2,000. Rowlatt J. held that a penal liability of that kind could not be regarded as a loss connected with or arising out of a trade. A similar view was taken by the Court of Appeal in
I.R. Commrs. v. von Glehn (1920) 2 K.B. 533, where also the taxpayer had been sued for penalties under the same Act and on the matter coming on for hearing had agreed to pay a sum of £3,000. Lord Sterndale M.R. said at p. 565:
``This business could perfectly well be carried on without any infraction of the law. This penalty was imposed because of an infraction of the law, and that does not seem to me to be, any more than the expense which had to be paid in
Strong & Co. v. Woodifield (1906) A.C. 448 appeared to Lord Davey to be, a disbursement or expense which was laid out or expended for the purpose of such trade, manufacture, adventure, or concern, nor does it seem to me, though this is rather more questionable, to be a sum paid on account of a loss connected with or arising out of such trade, manufacture, adventure, or concern.''
And at p. 566 he said:
``It is perhaps a little difficult to put the distinction into very exact language, but there seems to me to be a difference between a commercial loss in trading and a penalty imposed upon a person or a company for a breach of the law which they have committed in that trading.''
Warrington L.J. said at p. 569:
``Now is the expenditure in this case a loss connected with or arising out of a trade or manufacture? That it arises out of the trade I think may well be conceded. It does arise out of the trade, because if it had not been that the company were carrying on the trade they would not have had to incur this expenditure; but, in my opinion, it is not a loss connected with or arising out of the trade. It is a sum which the persons conducting the trade have had to pay because in conducting it they have so acted as to render themselves liable to this penalty. It is not a commercial loss, and I think when the Act speaks of a loss connected with or arising out of such trade it means a commercial loss connected with or arising out of the trade.''
Both of these cases, although of course decided in relation to a statutory provision which differed in its terms from that of the Income Tax Assessment Act as it then stood, and also as it now stands, were referred to by Gavan Duffy C.J. and Dixon J. (as he then was) in
Herald & Weekly Times Ltd. v. F.C. of T. (1932) 2 A.T.D. 169 at p. 172; (1932) 48 C.L.R. 113 at p. 120, as deciding that penalties imposed for breaches of the law committed in the course of exercising a trade cannot be deducted. Their Honours then said:
``The penalty is imposed as a punishment of the offender considered as a responsible person owing obedience to the law. Its nature severs it from the expenses of trading. It is inflicted on the offender as a personal deterrent, and it is not incurred by him in his character of trader.''
Their Honours then referred to the passage from the judgment of Lord Sterndale M.R. in von
ATC 4118Glehn's case (supra) at p. 566, which I have already set out.
What was there said by Gavan Duffy C.J. and Dixon J. was obiter as were also the statements in relation to penalties in F.C. of T. v. Snowden & Willson Pty. Ltd. (supra) in which the present sec. 51(1) was being considered in relation to money expended for advertising in the press to counter the effect of press reports concerning allegations made against the taxpayer company and to legal costs incurred by the company in appearing before a Royal Commission appointed to enquire into and report on the allegations. In that case, Dixon C.J. said at A.T.D. p. 465; C.L.R. p. 437:
``There is no analogy here to cases in which fines or penalties are incurred. There the character of the expenditure and the reasons why the law imposes a fine or penalty separate the expenditure from the conduct of the business. It is not to the point that the conduct penalised found its motive in business considerations. Nothing of the kind can be said of the expenditure now under consideration nor is any principle of public policy affected by allowing the deduction.''
Fullagar J. said at A.T.D. p. 470; C.L.R. p. 446:
``I do not agree with the dissenting member of the Board (of Review) that the present case bears any analogy to cases in which penalties and costs have been incurred in connexion with prosecutions for infringements of the law. The distinction between cases of that kind and such a case as the present was explained by Gavan Duffy C.J. and Dixon J. in Herald & Weekly Times Ltd. v. F.C. of T. (1932) 48 C.L.R. 113 where their Honours referred to I.R. Commrs. v. von Glehn & Co. Ltd. (1920) 2 K.B. 553 and I.R. Commrs. v. Warnes & Co. (1919) 2 K.B. 444.''
and the learned Judge then set out the passage in the judgment of Gavan Duffy C.J. and Dixon J. to which I have already referred.
The matter of penalties was referred to in the Full Court of the Federal Court of Australia in Magna Alloys & Research Pty. Ltd. v. F.C. of T. (supra) by Deane and Fisher JJ. What was there said was again obiter as the case was concerned with the question of whether costs incurred in defending criminal proceedings brought against the directors and agents of the taxpayer company were deductible by the company under sec. 51(1). The Court held that the costs were deductible. After referring to the cases with which I have already dealt and setting out the passage from the judgment of Gavan Duffy C.J. and Dixon J. in the Herald & Weekly Times case to which I have also referred, their Honours said at p. 4563:
``It is somewhat difficult to understand how it can be maintained, as an unqualified proposition, that the nature of a penalty severs it from the expenses of trading. Recurrent penalties for parking infringements incurred by a delivery man and per diem penalties for unlawfully using premises for business or commercial purposes in contravention of zoning requirements are not, for example, logically severed from the expenses of trading. The same can be said of fines imposed for actually engaging in some unlawful activities, such as illegal bookmaking or soliciting, for the purpose of earning assessable income. If, when the matter directly arises for decision in the Australian courts, it is to be held that all fines and penalties are to be denied deductibility under the Act, it would seem preferable that it be on the basis of some perceived overriding consideration of public policy which precludes deductibility.''
The learned Judges again referred to public policy at p. 4564 when they said:
``Whatever may be the position as regards the payment of fines or penalties, there is no basis in public policy for any overriding principle of non-deductibility of legal costs incurred in the defence of directors, employees or agents on criminal charges arising out of activities on the taxpayer's behalf.''
To my mind it follows from what was said by Gavan Duffy C.J. and Dixon J. in the Herald & Weekly Times case (supra) and by Dixon C.J. in the Snowden & Willson case, with some support from the reasoning in the passages in the judgment of Lord Sterndale M.R. and Warrington L.J. in the von Glehn case (supra), albeit in relation to a statutory provision in different terms from sec. 51(1), that the view could properly be taken that a penalty which is imposed as a punishment, even though the conduct penalised may have found its motive in business considerations, is not from its nature
ATC 4119expenditure incurred in the conduct of the business. On that view, a penalty could not then be said to be an outgoing incurred in gaining or producing the assessable income nor could it be said to be an outgoing necessarily incurred in carrying on a business for the purpose of gaining or producing such income. On that view, it would not be necessary to have recourse to considerations of public policy, despite the observations of Deane and Fisher JJ. in the Magna Alloys & Research case which would seem to indicate that this should be the basis on which the question would be determined, although it must be observed that the question was expressly left open and, of course, it was one which differed from that of the deductibility of costs with which the Court was there concerned.
I would adopt the view which I have indicated and so determine the matter without reference to public policy. I hold that the sum of $21,000 paid by the appellant by way of penalty is not an allowable deduction under sec. 51(1) and I accordingly dismiss the appeal.
The appeal is dismissed with costs to be taxed.