Creer v. Federal Commissioner of Taxation.

Lusher J

Supreme Court of New South Wales

Judgment date: Judgment handed down 14 March 1985.

Lusher J.

This is an appeal by the taxpayer, a solicitor of this Court, in respect of the disallowance of items claimed as outgoings in respect of the year of income ended 30 June 1977. The matters relate to the sum of $63,800 claimed by the taxpayer as rent to Home Units Ltd., in respect of certain leases of real property, a sum of $2,000 as moneys paid to Bareki Pty. Ltd., in respect of taxation advice received and the sum of $3,148 relating to overseas travelling expenses. This last item requires no further elaboration since Mr Conti Q.C., who appeared for the Commissioner stated at the outset that the assessment issued would be amended to except this item without further argument. There are thus two matters in dispute for consideration in this appeal, viz., the claims for rent and advice.

The following factual background emerges concerning the matter. In early April 1977 the taxpayer decided to look at residential domestic units and town houses in the Sydney

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Metropolitan area which he might lease from the owner and sublease to tenants. He had in mind that a family company might be able to purchase such a property subject to a lease to him. He knew from his own professional experience that the property market was depressed and that vendors might well be receptive to any reasonable proposals shortly prior to this. In March of 1977 he had sought advice from the member of a firm of chartered accountants as to possible avenues for reducing his liability to income tax, during the course of which discussion, among a number of alternatives, there was mentioned the possibility of leasing income producing property paying rental therefor in advance.

From mid-May 1977 onwards he began to receive schedules of properties from various persons interested in supplying properties for investment in various parts of Sydney and discussions took place as to the most suitable areas. In April, May and June further schedules were received and inquiries and discussions concerning them with interested persons took place. On 11 June 1977 town house properties were inspected at Gordon and Balgowlah and on or about 20 June 1977 he inspected a combination of residential units and town houses then under an advanced stage of construction at Darling Point and another block at Bellevue Hill. There were discussions as to the rental that was likely to be obtained from tenants of such properties. On 22 June 1977, after communication with Mr Wilson of the firm of Messrs Bain & Co., members of the Sydney Stock Exchange Ltd., whom the taxpayer understood had instructions from Commercial and General Acceptance Ltd. (C.A.G.A.) in relation to certain town houses and units in the Sydney Metropolitan area and also Coffs Harbour and with whom he had had earlier discussions, inspections and arrangements were made to inspect new units/town houses application known as ``Maison Avenue'' at Wollstonecraft. Inspection was carried out with an estate agent who gave ranges of rentals considered appropriate in respect of one town house and four units. A Mr Pursche who had offered financial advice to the taxpayer in his personal affairs over a number of years, subsequently joined him and inspected some of these units. At or about this time the taxpayer arranged for the valuation department of Richardson & Wrench Ltd., estate agents at their city office to arrange a valuation of these premises to establish both their rental and market values and this was received on 29 June 1977 although prior to that he had received the details of the figures mentioned in their report from a representative of that firm.

It is appropriate now to mention that on 6 April 1977 and again towards the middle of May of that year the taxpayer had conferred with Mr Campbell, the manager of the National Australia Bank at Castlereagh and Hunter Streets Branch and had discussed the possibility of the Bank providing finance to enable him to pay a lease rental in the event that he should purchase lease properties. At the mid-May meeting matters included overdraft facilities for the payment of an income tax assessment received on 22 April 1977 was also discussed. On that occasion there were indications of the willingness of the bank to look at the sort of proposition mentioned.

On 23 June 1977 the taxpayer again saw Mr Campbell of the National Australia Bank accompanied by Mr Pursche. On the earlier meeting Mr Campbell had mentioned that the taxpayer would need to have Mr Pursche prepare some figures for the bank to look at. The taxpayer advised of his interest in the units at Wollstonecraft subject to being able to make satisfactory arrangements with C.A.G.A. and the Bank. Mr Pursche produced figures which were discussed. In the result, Mr Campbell advised the taxpayer that assuming that a valuation was available within the next few days, he would refer the proposition to head office and he thought they would approve it. There was mention on this occasion of the shortness of time particularly as the taxpayer proposed leaving to travel overseas early in July.

Following the above meeting, the taxpayer instructed Mr Wilson to make specific offers to C.A.G.A. to lease the four home units respectively to him and also to make specific offers on behalf of Edisarb Pty. Ltd., to purchase the respective units, subject to the bank approving loan arrangements. At about the same time Mr Pursche had advised the taxpayer that it would be better if he arranged to lease the units before 30 June. The taxpayer said there were difficulties because of the time factor and his projected overseas visit. Mr Pursche then suggested that he could assist by making his own company, Bareki Pty. Ltd.,

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available to rent the units at their fair market rentals and Bareki Pty. Ltd., could then enter into leases, or rather sub-leases, with tenants as soon as possible. He also advised that the taxpayer should make immediate inquiries as to lettings and that instructions should be left with someone with whom dealings could be made during his absence overseas. The taxpayer said he would endeavour to do this with the Crows Nest Branch of L.J. Hooker Real Estate organisation.

On or about 28 June 1977 the taxpayer caused Mr Pursche to calculate an appropriate rent for each unit to be offered to the owner on the basis that the rental should be paid five years in advance and having regard to the rental values advised by Richardson & Wrench Ltd., and further to calculate the appropriate prices for Edisarb to offer for each unit in order to purchase the units subject to the lease to himself. Mr Pursche made this calculation and gave the results to the taxpayer. These figures were calculated actuarially based on life tables, current interest rates, less a discount and so were conservative, real and true present value calculations and did not in any way include a premium.

On 28 June 1977 he agreed with Bareki Pty. Ltd. to grant it a sub-lease of the units for three months at a weekly rental totalling $380. Bareki Pty. Ltd. prepaid the rent of $164.54 for the month commencing 29 June 1977, and monthly in advance thereafter. Also on 29 June 1977 the taxpayer saw Mr Lewington, C.A.G.A.'s Finance Director, and a Mr Marshall, a Senior Executive of that Company, together with Mr Pursche. Mr Wilson was also present and the figures produced by Mr Pursche were discussed. The representatives of C.A.G.A. specified in broad terms that the offers on the terms set out in Mr Pursche's document were acceptable to C.A.G.A. provided the whole transaction could be finalised as soon as possible. Arrangements were made for the solicitors for C.A.G.A. to prepare the necessary documentation.

On 30 June 1977 the taxpayer entered into four leases with Home Units Australia Pty. Ltd., the Registered Proprietor of the units each for a term of five years commencing on 30 June 1977, expiring 29 June 1982 at the respective rent set forth therein. Each lease provided in express terms for a total rental for the term payable as to amounts on the 30 June 1977, 30 June 1978 and 30 June 1979, the larger amount being the first payment. At the time of entering into the leases duly executed by the lessor a bank cheque was paid over, drawn from funds provided from the taxpayer's current account with the bank for $63,800 in favour of C.A.G.A. in respect of the rentals payable under the terms of the leases on 30 June 1977. The bank cheque was drawn in favour of C.A.G.A. at the written direction of Home Units of Australia Pty. Ltd., and a receipt from the lessor's solicitors for the amount was given.

In the entering into the leases the taxpayer says, and I accept, that he had regard to the income from the rentals which he expected to obtain during the course of the leases from sub-lettings and had no intention to terminate the leases but expected that they would run their full term.

On 1 July 1977 Edisarb Pty. Ltd., of which the taxpayer is a director and the sole beneficial shareholder, executed and caused to be exchanged the four contracts of sale between it and Home Units of Australia Pty. Ltd., in respect of these home units and paid deposits totalling in all $8,950 to the vendor's solicitors as stake-holder. Also on 1 July, the taxpayer executed a loan agreement of that date whereby he borrowed $50,000 from C.A.G.A. which sum was advanced to him on or about 4 July 1977. On 29 July 1977 Edisarb executed a memorandum of mortgage and deed of equitable charge in favour of C.A.G.A. to secure the loans to Edisarb. The contracts of sale were duly completed on 29 July 1977. Before the taxpayer left for overseas as he in fact did in July, he left a memorandum with Mr Gregory of his office relating to the rental arrangements for each unit which figures were those suggested by the representative of L.J. Hooker, Crows Nest office. All the units were subsequently sub-let by Bareki Pty. Ltd.

The arrangement with Bareki in fact continued on until February 1978 when it ceased. The taxpayer then leased the units to various tenants at fair market rentals through the agency of L.J. Hooker, Crows Nest office and subsequently through the agency of Henderson & Horning Pty. Ltd., and they continued to be almost continuously leased thereafter until such time as the respective units were sold.

On or about 30 June 1978 and 1979 the taxpayer paid Edisarb rental in the amount of

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$7,975 for each respective year in accordance with the terms of the leases above referred to. That rental is shown in the Profit and Loss Account of Edisarb as income for those years.

The taxpayer received an income tax assessment for the financial year ending 30 June 1978 and for some previous outstanding tax in dispute amounting to a large sum. Thereafter, after consultation with his accountants and bank manager concerning ways and means of finding the funds to meet the assessment as he had then insufficient funds or other material resources to assist him to pay it, on their advice it was decided that Edisarb should sell two of the units and this was done, one being sold for $64,500 and the other for $62,000 and the sales were completed in October of 1979. The funds generated thereby were used in part to reduce the indebtedness of Edisarb to C.A.G.A., mentioned earlier herein, and in part ultimately to assist the taxpayer in meeting the assessment. The leases between Edisarb and the taxpayer in respect of those units were surrendered in July 1979, they not having run their full term, for a consideration of $14,250 in respect of one unit and $13,750 in respect of the other. These amounts were determined from valuations made by the Valuer-General for N.S.W. In the same way, another unit was sold in September 1981 for $108,500 and the surrender of that lease was made for the consideration of $5,715, this amount also being determined as above mentioned. The remaining unit was sold in February 1983 for $95,000 after the lease had expired.

The taxpayer was cross-examined and there was no challenge to his credit by the defendant. He is accepted by me as a witness of complete credit. A deal of material was put to him in cross-examination which does not affect the matter.

The same applies to Mr Pursche and I also accept him fully as a witness.

The matter reduced itself to the following. It is accepted that the taxpayer sought an investment on property at a time when real property market was depressed and there were vendors with substantial holdings of property receptive to purchaser proposals and who could accommodate purchases with finance. The taxpayer after inspection and with professional advice took leases in his own name of the units involved from the owners for a period of years on terms as to what is said to be a partial prepayment of rent. The properties were then sub-leased. The taxpayer's family company purchased the reversion in the case of each property from the owners. Finance was arranged in respect of these matters.

The question is whether the payment of rent amounting to $63,000 on 30 June 1977 is a deduction under sec. 51.

It is however necessary to begin with the appropriate sections of the Income Tax Assessment Act 1936 as amended.

A starting point is sec. 6(1). Taxable income means (a) the amount after deducting from the assessable income all allowable deductions. Division 2 of Pt III deals with assessable income which by sec. 6 means all the amounts which under the provisions of the Act are included in the assessable income. Division 2 subdiv. A deals with assessable income generally. By sec. 25(1)(a) it includes the gross income derived directly or indirectly from all sources whether in or out of Australia, which is not exempt income. Thus rent received from property is income and the Commissioner properly accepted the receipt of the $1,600 rent received in these matters as being income for the year in question.

Section 51(1) provides that ``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...''. Then follows exceptions none of which are suggested as being relevant.

There are of course two limbs to the section, the first being outgoings incurred or gaining or producing the assessable income. The second, those necessarily incurred in carrying on business for the purpose of gaining or producing such income. Purpose is irrelevant to the first, it is relevant to the second in so far as the subsection requires a purpose of gaining or producing income. On the first limb it is plain that there was an outgoing in the form of payment of rent under the lease and it was incurred in gaining income in the form of rent for a period under the terms of the sub-lease. On this basis in my opinion the payment was an outgoing.

It was in the above described manner that the taxpayer ordered his affairs. There is no suggestion that the leases or the sales were a

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sham or subterfuge. He was bound by the terms of each of the leases and its covenants. The Commissioner treated the amount received as rent from the sub-leasing as income during the year in question. The premises were tenanted and in the next two ensuing years produced income to the taxpayer from lessees of $20,620 and $16,800. These were taxable as assessable income items. These amounts were not reduced by deductions claimed in respect of rent in any substantial amount by reason of the earlier payment of rent in the year ending 30 June 1977. I suppose that had there been an agreed postponement of payment of rent in the leases into larger amounts in later years and a smaller payment in the year in question that no question of an outgoing in these years would arise. It is both legitimate and proper and also lawful for a lessor and a lessee to make their own arrangements as to the manner of payment of rent. Escalation clauses are quite common as are consents to postponement or delays in payment and as to the prepayment. Rent payment periodically in advance is virtually a practice, it becomes a question of degree, of agreement. Which of the parties is in the stronger position at the time of negotiating will depend on a variety of factors, none constant, including market conditions. An agreement to pay rent in advance is not really a prepayment of rent. That latter phrase assumes rent is not due until some later date but is paid before the same becomes due.

The time of the transaction is pointed to. A writ issued a day before the expiration of a statutory period of limitation is nevertheless still a valid writ. A life insurance premium taken out towards the expiration of a financial year is likewise a valid deduction. Similarly a rental payment under a lease requiring rent payable on that day by a lessee of business premises does not cease to be a deduction because the due date falls on or shortly before the 30 June.

On the acceptable material here it is unlikely and unreal that the amount of rental received by the lessor-owner on 30 June 1977 pursuant to the terms of the leases could be regarded as other than income received by it in the year in question, bearing in mind the terms of the lease. Equally, it is inconceivable that the owner or taxpayer or Edisarb could have the lease or the sales set aside, or that rectification in some form could be sought so as to dispute the payment as income received. The circumstance that it could be assessable income in such circumstances in a lessor's hands but not an outgoing in a lessee's hands does not necessarily assist a resolution of the problem of either - it merely exposes a degree of incongruity and artificiality that struggles with consistency but which is not necessarily achieved in such situations.

The lease for each of the four units is in the registrable form and is duly stamped and registered under the provisions of the Real Property Act. In each case the lease is for a term of five years commencing on 30 June 1977. The rental is expressed in terms, taking unit 59 as an example, at the total rent of $18,260 for the term without any deduction or abatement whatsoever, payable as follows: $14,608 on the 30 June 1977 and $1,826 on the 30 June 1978 and 1979. The other leases are in similar terms. Senior counsel for the defendant expressly disclaimed any suggestions that a sham or premium was involved.

This is not strange. In
Ferguson v. F.C. of T. 79 ATC 4261 the leasing fees for the ensuing 12 months were paid in advance notwithstanding that the agreement was entered into on 21 June 1973 and provided for monthly payments. The rents fixed were commercially realistic, the means and methods used in reaching the rentals agreed upon were appropriate and not excessive as between lessor and lessee and could not be challenged as unreal beyond market consideration. (See
F.C. of T. v. Phillips 78 ATC 4361 at p. 4362.)

The sub-lease from the taxpayer to Bareki was entered into at a time that the taxpayer was about to go overseas and in the circumstances I find nothing unusual in it. The sub-lease left an area of profit for the sub-lessee, there was a need to pay for services. It is significant that the relationship continued for a period of six to eight months and that the sub-lessee undertook lettings and management, found tenants and entered into leases and showed some concern when this was not achieved.

The submission of the defendant is that the rental claimed was not put as a premium but was a capital payment. This is said notwithstanding there is no submission that the leases registered on the titles and out of which the payments spring are a sham. The submission is that rent has been held to be

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capital (see per Gibbs C.J. in
F.C. of T. v. South Australian Battery Makers Pty. Ltd. 78 ATC 4412 at p. 4417; (1978) 140 C.L.R. 645 at p. 655; and cases there referred to). Reference was also made to a decision of Walsh J. in
Poole and Dight v. F.C. of T. 70 ATC 4047; (1970) 122 C.L.R. 427 where payments of ``annual rent'' by a Crown lessee for a ``grazing Homestead freehold lease'' held under the conditions of The Land Acts 1962-1968 of Queensland were held to be outgoings of a capital nature within sec. 51 being presently considered. This, however, was because of the construction placed upon sections of that legislation and of its structure, which referred to ``purchase price'', ``completion of purchase'' and the entitlement to a grant of fee simple. His Honour was able to conclude that the central feature was the acquisition of the land as an asset to which the purchaser obtains a title and became entitled so to do. This is made clear at ATC p. 4053; C.L.R. p. 438 where his Honour said each annual payment was an outgoing of capital because by means thereof the lessee was paying off part of the purchase price for the fee simple and even though he was under no obligation to pay the whole and to complete the acquisition of the fee simple his position was not different for the purpose of sec. 51. Obviously once construed as the price of a capital asset a payment by instalments is a payment of a capital nature. A similar case is
Cooper v. F.C. of T. (1957) 97 C.L.R. 397. There the matter, an involved transaction, was looked at by Kitto J. at p. 405 as ``a purchase and nothing else''. In the Battery case Gibbs C.J. said at ATC p. 4417; C.L.R. p. 655, ``If the only advantage sought was the right to possession under the lease and what was called `rent' really answered that description clearly the outgoings were entirely of a revenue nature''. That was in relation to considering the advantage sought by the taxpayer in making the payment and in relation to whether an advantage sought was the acquisition of a capital asset. There the argument of the defendant that the group of companies of which that taxpayer was a member derived a benefit, part of that must accrue to the taxpayer, was rejected.

In the instant case, the parties to the leases and the purchase are different; the taxpayer has rights and liabilities personal to himself and acquired no interest other than as a lessee under the leases and as a lessor under the sub-leases which are not related to Edisarb. Edisarb in turn had rights and liabilities under the purchase transfers and mortgages different again which did not touch the taxpayer in his personal capacity.

In my opinion, the payments under the lease were not outgoings of a capital nature in any shape or form. Further, in my opinion the Battery case disposes of this aspect in the taxpayer's favour. Further, in looking at the aspect of the character of the advantage sought as being that sought by the taxpayer for himself in making the outgoing the argument presented as an advantage by the defendant fails since there is not even present here any use of the rent paid being available to reduce the price under the option to purchase such as existed in Battery, nor is it shown that any advantage even occurred to Edisarb who purchased a reversion for value from a party other than the taxpayer.

The argument was put that an alternative view of the transactions was to regard the transactions as a package between Home Units and C.A.G.A. on the one hand and the taxpayer and Edisarb on the other and that consensus was reached. The argument was intricate and sought to conclude that Edisarb acquired the freehold at a lesser price than normal, whatever normal may be in this depressed market. This conclusion passes by the reality that Edisarb acquired a reversion not a freehold and as to which there was no evidence of market or value. There is some force in the submission of counsel for the taxpayer that this amounts to an argument which whilst not suggesting the leases are a sham resurrects a sham in another form.

This hypothesis as developed in argument was not put in cross-examination or if and to the extent that it was it was not accepted by the taxpayer. By way of illustration, in relation to material in correspondence between the taxpayer and the solicitors for the owner which was rejected by the taxpayer and as counsel conceded, he accepted and was bound by the taxpayer's answers, submissions were still based on that material. Similarly, arguments were founded on notations on documents, the purport of which were not accepted by the taxpayer. There was also submissions as to what must have happened rather than what the evidence established.

The alternative argument put was that the purpose of the prepayment of rent was entirely

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a tax consideration and had no commercial purpose. It might be asked what defence the taxpayer would have if he had not paid the amount in question having been given possession. The commercial purpose was that it achieved the grant of a lease and incurred a liability. Pressed, counsel said the same argument would be available if the lease provided for prepayment of rent for a year or a quarter or a month.

Senior counsel for the defendant also submitted that the transaction should be struck down under sec. 260 of the Act and that for that reason the deductions fail.

The initial question on such a submission is whether sec. 260 has any application to sec. 51. Section 51 is concerned with outgoings and expenditure and if the items claimed are so found to be within that section it is difficult to see any room for the application thereto of sec. 260. This question was considered in
Cecil Bros. Pty. Ltd. v. F.C. of T. (1964) 111 C.L.R. 430 and subsequently by Menzies J., who formed part of that court and dissented, when he came to deal with
Franklin's Selfserve Pty. Ltd. v. F.C. of T. 70 ATC 4079 at p. 4092; (1970) 125 C.L.R. 52 at p. 74. Section 260 seems to be directed towards alterations designed towards the incidence of tax whereas sec. 51 is not. Its purpose is to determine the outgoings so as to arrive at assessable income. The assessable income having been determined the incidence of taxation then follows.

As the submissions made seek to explain Cecil's case on a finding of fact, that properly understood the Court there refused on the facts found by the primary judge to predicate that the overt act of purchase of shoes at an overvalue was a purchase made in order to obtain a tax deduction, whilst not saying that this particular submission does not reflect a consequence of this decision, in my opinion the observations of the majority in relation to sec. 51 were more pointed than this submission would concede.

Assuming, however, in the defendant's favour that sec. 260 has application there is a further problem that the section requires another or a substituted transaction which does not exist here as I find (cf.
Mullens & Ors v. F.C. of T. 76 ATC 4288; (1976) 135 C.L.R. 290 and
Slutzkin & Ors v. F.C. of T. 77 ATC 4076; (1977) 140 C.L.R. 314).

The submission is also made on behalf of the defendant that the so-called choice principle as explained in
Cridland v. F.C. of T. 77 ATC 4538; (1977) 140 C.L.R. 330 does not extend to a case where sec. 51 is relied upon by a taxpayer, the argument here being that sec. 51 is a general and not a specific provision (
John Fairfax & Sons Pty. Ltd. v. F.C. of T. (1959) 101 C.L.R. 30), a submission which does not conclude the matter so far as sec. 260 is concerned. The submission continues that there can be ``arrangements'' which involve sec. 51 in which case the operation of sec. 260 is to be determined by the tests as best understood in
Newton v. F.C. of T. (1958) 98 C.L.R. 1. This argument takes a different approach to Cecil's case (supra) as previously indicated.

In respect to the Newton criteria the argument of the defendant is that the means used by the present taxpayer were unusual and artificial and indeed were more expensive to him than would have been the case had the ordinary method of carrying out the arrangements been followed. This submission of course assumes an arrangement which I have not found, and does not proceed to deal with what is referred to as the ordinary method, to my satisfaction. The argument deals with the effect of legal fees, stamp duty and the like and other alleged complexities to show artificiality and involvement and submits that they were materially different from the steps a reasonable person would use to achieve the commercial or family effect which was in fact achieved. This of course assumes that what was sought to be achieved was something different to leases in the taxpayer and resulting reversions in the owner-lessors and ultimately in Edisarb. All this in my opinion is answered in the view I have formed that there was no arrangement in the sense submitted or in the sense used in the cases under sec. 260. This opinion is quite independent of the view that sec. 260 does not enable a reconstruction to be effected so as to create or involve different liabilities and results in different or other parties.

I accordingly reject the submissions made in this case by the defendant so far as they relate to sec. 260 and the arguments consequently thereon and in relation to fiscal nullity. I adhere to the views expressed in
Walker v. F.C. of T. (83 ATC 4168) on this aspect generally and to the observation of the Full Court of the Federal Court on appeal [reported at 84 ATC 4553] in respect of which leave to appeal to the High Court was subsequently refused.

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There remains to deal with the claim for a deduction in the amount of $2,000 paid by the taxpayer to Mr Pursche in respect of advice given to the taxpayer. The argument presented in relation to this was that it was advice substantially in relation to an affair of capital rather than of income. It was specifically stated that it was not suggested it was any sham or any subtle arrangement. Having regard to all the circumstances and having seen and heard the witnesses I have no doubt the amount was paid in respect of advice obtained in relation to income producing matters and is properly regarded as an outgoing. No challenge was made as to its reasonableness although there was a faint suggestion that some of it may have been related to letting advice.

In the result the taxpayer has succeeded in the matter, in particular the submission of senior counsel for the taxpayer is accepted, namely that fundamentally what this matter is concerned with is outgoings by way of rent and that the same is properly deductible as for example in Walker's case (supra). I find that the taxpayer succeeds in bringing the deductions under both limbs of sec. 51. The order of the court is that the matter be remitted to the defendant to amend the assessments in accordance with the purport of this judgment, namely that an outgoing in respect of the sum of $63,800 be allowed in respect of the rent question and that the further sum of $2,000 in respect of fees for advice paid to Mr Pursche be likewise allowed.

The defendant is ordered to pay the taxpayer's costs of the appeal. Exhibits may be returned.

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