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Federal Commissioner of Taxation v. Galland.

Mason J
Wilson J

Brennan J
Deane J
Dawson J


Full High Court

Judgment handed down 16 December 1986.

Brennan J.

The respondent taxpayer and his father carried on the practice of solicitors in Goulburn during the year ended 30 June 1980. The partnership agreement provided, inter alia:

``The capital of the partnership shall be divided into two equal parts or shares which shall belong to the partners equally and they shall in like proportion share all profits and bear all losses.''

On 27 June 1980, the taxpayer executed a deed of assignment of certain ``property'' as defined therein in favour of a company that was the trustee of a family trust. The ``property'' was defined to be 49 per cent of ``the share now held by the partner in the partnership'' including:

``that part of the right to receive the share of the profits of the Partnership to which the Partner would but for this deed have been entitled... and, in the event of dissolution of the Partnership, that part of the share of the Partnership assets to which the Partner would, as between himself and his other partners, but for this deed have been entitled.''

The appellant Commissioner assessed the taxpayer to tax in respect of the year ended 30 June 1980 on the footing that the assessable income of the taxpayer included his half-interest in the ``net income'' of the partnership (calculated in accordance with sec. 90 of the Income Tax Assessment Act 1936 (Cth)) undiminished by the 49 per cent of the profits the right to receive which he had assigned except in respect of income referable to the period 27 to 30 June 1980. The assessment was set aside on appeal to the Supreme Court of New South Wales ( Hunt J.) [84 ATC 4053] and the judgment of that Court was affirmed by the Full Court of the Federal Court ( Bowen C.J., Fisher and Beaumont JJ.) [84 ATC 4890]. On further appeal to this Court, the Commissioner sought leave for the first time to rely on sec. 260 of the Act and to challenge the decision of this Court in
F.C. of T. v. Everett 80 ATC 4076 ; (1980) 143 C.L.R.440

ATC 4889

which had affirmed the majority decision of a Full Court of the Federal Court 78 ATC 4595; (1978) 21 A.L.R. 625; 38 F.L.R. 26. The application to raise these new grounds in support of the assessment came too late and it was refused. It is therefore necessary to resolve this appeal on the basis that Everett was rightly decided and without reference to the provisions of sec. 260.

Like this case, Everett was a case of assignment by a solicitor partner of a proportion of his share in the partnership. The majority judgment in this Court held (at ATC pp. 4078-4079; C.L.R. p. 446) that the taxpayer's ``share in the partnership consists of a right to a proportion of the surplus after the realisation of the assets and payment of the debts and liabilities of the partnership'', and (at ATC p. 4079; C.L.R. p. 447) that a partner's ``interest'' in a partnership ``is a chose in action assignable in whole or in part''. Their Honours went on to hold (at ATC p. 4080; C.L.R. p. 449) that:

``... a share in a partnership carries with it the right to receive the proportion of the partnership profits to which the partner is entitled by virtue of the partnership agreement. Consequently, when the share is assigned, it carries with it the right to receive the assigning partner's proportion of those profits. In the same fashion, when a portion of a share is assigned, the portion carries with it the right to receive the proportion of profits attributable to that portion. As the right to receive profits is inherent in the partner's interest in the partnership, unless it be excluded by the partnership agreement, it is carried on assignment of the share, even though no mention of it be made in the assignment.''

(Emphasis added.)

Their Honours thus appear to have seen a partner's individual interest in the net income of the partnership as the fruit of the partner's ``share'' in the partnership, so that an assignment of a proportion of the ``share'' carried to the assignee a right to a corresponding proportion of the partner's individual interest in the net income of the partnership. That view must be accepted for the purposes of this case. Deane J., in a powerful dissenting judgment in the Federal Court said (at ATC p. 4604; A.L.R. pp. 636-637; F.L.R. p. 42):

``Where such questions [that is, questions involving the derivation of income] are involved, the determination of whether the income of a partnership should be seen as flowing primarily from the assets of the partnership or from the personal exertions of the partners or of whether a particular partner's share of profits should be regarded as flowing primarily from his `share in the partnership' or from his personal exertions as a partner will properly involve consideration of the circumstances of the particular case.''

If that view had prevailed, it would have been appropriate in the present case to hold, as his Honour held in Everett (at ATC p. 4612; A.L.R. p. 648; F.L.R. p. 56):

``The reality and the substance of the matter was that, notwithstanding the effect of the deed of assignment, the relevant part of the taxpayer's share of profits was and remained income derived by means of his own exertion, being part of his earnings derived from his professional activities and did not constitute the income of income-producing property or income of a trust estate.''

This comparison between the view which prevailed and the view which was rejected reveals the hypothesis on which it is necessary to decide this case. The hypothesis is that ``the individual interest of the partner in the net income of the partnership of the year of income'' - the subject matter of sec. 92(1) - is the product of the partner's share of the partnership so that an assignment of part of the share entitles the assignee to a corresponding part of the net income of the partnership. On that hypothesis, it is immaterial whether the partners earned most of the net income of the partnership before the date of the assignment; what is material is the part of the net income of the partnership of the year of income to which the assignee becomes entitled beneficially in virtue of the assignment of the part of the partner's share. The part of the net income to which the assignee becomes entitled beneficially is the net income of a trust estate within the meaning of sec. 95 of the Act and does not attract a liability to tax in the hands of the assigning partner: sec. 96.

The net income of the partnership of the year of income is calculated, in accordance with sec. 90, by deducting allowable deductions (except

ATC 4890

for concessional deductions and deductions allowable under sec. 80, 80AA or 82AAT) from ``the assessable income of the partnership''. The net income of a year of income is not the aggregate of net incomes derived during the intermediate periods of a year; the net income of a year of a single amount ascertained for the whole year on a basis appropriate for the particular partnership business. As Windeyer J. said in
Peterson v. F.C. of T. (1960) 106 C.L.R. 395 at p. 404 :

``In any continuing business, income is ascertained periodically over accounting periods, and the various items of expenditure in any accounting period that are directly connected with gaining the amounts received, or expected to be received, from the ordinary conduct of the business must be taken into account. It is only the `net balance ascertained according to the usual and recognized principles of accounting' that is income.''

Adopting that approach to the ascertainment of the net income of a partnership of a year of income, the whole of the assessable income of the year must be aggregated and from that sum the aggregate of the deductions allowable conformably with sec. 90 must be deducted. The net income of a partnership of a year of income can be ascertained whether or not the partnership agreement requires accounts to be taken at the end of the year of income and whether or not the taxpayer partner is then entitled under the terms of that agreement to be paid his share of the net income. In
Rose v. F.C. of T. (1951) 84 C.L.R. 118 at p. 124 , the Court said:

``Division 5 of Part III, which deals with partnerships, is based upon the view that the collective income earned by the partnership belongs according to their shares to the partners regardless of its liberation from the funds of the partnership, that is, its actual distribution.''

The individual interest of a partner in the net income so calculated is included in the assessable income of a resident partner by sec. 92(1) irrespective of the period of the year in which the assessable income is earned and of the period of the year in which the partnership made the expenditures or incurred the liabilities which constitute the relevant deductions. It is unnecessary to consider whether the ``year of income'' mentioned in sec. 92 when used in reference to a continuing partnership must be identified for the purposes of that section as a year ended on 30 June or whether a taxpayer partner's year of income or a year of income specified by the partnership agreement may be adopted if either of those periods does not expire on 30 June. That question does not arise in this case for the taxpayer's year of income and the partnership year of income ended on 30 June 1980.

On the hypothesis by which this case is governed, the taxpayer partner's ``individual interest... in the net income of the partnership of the year of income'' was not derived by reason of the partners' exertions in carrying on the solicitors' practice but by reason of his ownership of a share in the partnership. If it were open to regard the net income of the partnership as the fruit of the partners' exertions rather than as the fruit of their shares, it would be open to argue that at least so much of the taxpayer partner's interest in the net income of the partnership of the year of income as reflected the assessable income of the partnership earned prior to the assignment was unaffected by the assignment. But that argument is inconsistent with the governing hypothesis. If the taxpayer partner's interest in the net income of the partnership must be regarded as the fruit of his share in the partnership, and the net income of the partnership becomes ascertainable only at the close of the income year, the interest in the net income must be determined by reference to the share which the partner then holds. It follows that the proportion of the interest which is to be treated as the net income of a trust estate within the meaning of sec. 95 must be determined by reference to the proportion of the share which the partner has then assigned. As the taxpayer had assigned 49 per cent of his share at 30 June 1980, a corresponding proportion of the partner's interest in the net income of the partnership of the year ended 30 June 1980 must be regarded as the fruit of the assigned part of the share and as income of a trust estate. The governing hypothesis requires that 49 per cent of the net income of the partnership of the year ended 30 June 1980 be treated as not attracting tax in the hands of the taxpayer.

The appeal must be dismissed.