Case U96

Members:
P Gerber SM

Tribunal:
Administrative Appeals Tribunal

Decision date: 29 April 1987.

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Dr P. Gerber (Senior Member)

In these applications for review of decisions made by the Commissioner of Taxation, the taxpayer was objecting firstly to a decision made in regard to the tax year ended June 1978 that certain moneys constituted a share of partnership income, and, secondly, with reference to the tax year ended June 1981, that deductions claimed for bank charges and interest were not allowable.

1978 tax year

2. The facts relevant to the two applications are interrelated. The taxpayer, until 17 January 1978, was operating, in partnership with her de facto husband, a business producing foodstuffs,

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called for the purpose of these reasons Happy Manufacturing Company. The partnership agreement was not reduced to writing. By a deed, otherwise undated, but signed by the taxpayer on 7 March 1978 and by her de facto husband on 15 March 1978, the partnership was dissolved as from 17 January 1978. The respondent accepted that date as the date of the dissolution of the partnership. Relevant clauses of the deed read:

"1. The retiring partner acknowledges and covenants that she did on the 17th January, 1978 retire from the said partnership which was formerly conducted by the parties hereto under the style or firm name of Happy Manufacturing Company from premises situated at Surfers Paradise in the State of Queensland.

2. The retiring partner acknowledges that she has received an amount of SEVEN THOUSAND TWO HUNDRED DOLLARS ($7,200.00) in full and final satisfaction of all claims and demands which she has had or may have had in relation to the said partnership, its assets or her former interest therein.

3. The retiring partner hereby unconditionally assigns to the continuing partner all her right, title and interest in and to the assets of the partnership and she covenants that she will forthwith upon request by the continuing partner or his agent sign all necessary documents and carry out all necessary acts both positive and negative to give full force and effect to the terms hereof."

3. The taxpayer on that date, 17 January 1978, on the advice of her solicitor had withdrawn $7,200 from the partnership account, being moneys lent by her parents at the commencement of the partnership ($5,000) and half the amount of the deposit each partner had contributed to the purchase of a house ($2,200). These sums were repayments of capital and not income. The taxpayer said in evidence that she wanted nothing more from the dissolution of the partnership than those entitlements and wished otherwise to make a final break. In the event, she received no further moneys and it is understandable that she feels some ire at being assessed to income tax on moneys not actually received by her but rather spirited away by her de facto husband and former partner.

4. In evidence before the Tribunal were the return of income of the partnership for the period 1 July 1977 to 17 January 1978 and also the taxpayer's income tax return for that year. The partnership return was prepared and submitted by the accountants for her de facto husband without consultation with the applicant. That tax return recorded a division of income in equal shares amounting to $7,924 for each partner. In her own return, the taxpayer stated that income from the partnership in that period amounted to $4,400. This return was prepared by a tax agent. As an explanation of this "income" the following statement was appended to the return.

"SCHEDULE TO INCOME TAX RETURN, YEAR ENDED 30TH JUNE 1978 PARTNERSHIP - TRADING AS HAPPY MANUFACTURING COMPANY

Following upon marital disharmony, taxpayer ceased interest in the partnership as from 17th January, 1978.

A partnership return has been prepared and lodged with the Income Tax Office for the period 1st July, 1977 to 17th January, 1978; the accounts were prepared without consultation or other reference to taxpayer.

The practicalities of the matter are that taxpayer has not derived or received the sum shown as her share of the partnership income; it has been established that receipts from the partnership debtors shown to be $16,817.84 as at 17th January, 1978 have been deposited in an account opened by her de facto husband solely. In effect, this constitutes an appropriation of income.

In all the circumstances, and having regard to the fact that taxpayer has not and will not receive the sum shown in the partnership return of income, it is submitted that only the amount received from partnership funds, shown as drawings in the accounts, should be assessed; this amount has been returned at item 13."

5. At the hearing it was submitted on behalf of the applicant that this tax return prepared on advice of the tax agent and not actually signed by her was incorrect in attributing the $4,400 to income when the drawings on the partnership account up to 17 January 1978, which made up that amount, were merely withdrawals of capital or capitalised income from the previous tax year.

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6. The case law relevant to deciding this issue is quite clear and is reflected in decisions such as
F.C. of T. v. Happ (1952) 9 A.T.D. 447;
F.C. of T. v. Jefferies 80 ATC 4659;
Rowe (B. and H.G.) v. F.C. of T. 82 ATC 4243 and
F.C. of T. v. Galland 84 ATC 4890. By effect of the deed, the date of dissolution of the partnership on 17 January 1978 is the proper time for the taking of accounts and the time at which the partners' rights to the share of partnership profits crystallised. By the terms of that deed, an assignment of all interest in the partnership from that date was effected.

7. In Jefferies' case, his Honour Matthews J. said at pp. 4661-4662:

"When a partnership determines, and irrespective of what partners had decided as an appropriate accounting day or time, the time for the taking of accounts has ordinarily arrived and a partner is then entitled to his share of the determined profit. This is why in F.C. of T. v. Happ 5 A.I.T.R. 290, Williams J. said at pp. 293-294:

• `Now the partnership under discussion continued in fact until 22 December 1944 and therefore for a considerable period of the financial year ended 30 June 1945. It was then dissolved by the agreement of 22 December 1944. Businesses are carried on by the individuals who are in partnership and not by the partnership firm as a separate conception. After 22 December the business was carried on by a different partnership... The old business, that of the four partners, came to an end, and the business carried on by the two remaining partners began. It was a new business:
  Commissioners for General Purposes of Income Tax for City of London v. Gibbs (1942), A.C. 402 at pp. 413, 415, 416, 421, 430 and 432;
  Rose v. Commissioner of Taxation (1951), 5 A.I.T.R. 197 at p. 201. If the carrying on of the business until 22 December 1944 was profitable and net income was earned within the meaning of s. 90 the assessable income of the respondent for the year ended 30 June 1945 must have included his individual interest in that net income. Section 19 of the Income Tax Assessment Act provides that -
  • `Income shall be deemed to have been derived by a person although it is not actually paid over to him but is... otherwise dealt with on his behalf or as he directs.""

8. Apart from sec. 19, as outlined above, the relevant provisions of the Income Tax Assessment Act are sec. 90 and 92(1)(a).

"90 In this Division -

• `net income', in relation to a partnership, means the assessable income of the partnership, calculated as if the partnership were a taxpayer who was a resident, less all allowable deductions..."

• "92(1) The assessable income of a partner in a partnership shall include -
• (a) so much of the individual interest of the partner in the net income of the partnership of the year of income as is attributable to a period when the partner was a resident;"

9. In Happ's case the agreement to dissolve the partnership provided that in consideration of the payment to the retiring partners of £2,695, being made up of sums from the capital account and a sum representing a share in the goodwill of the business, the retiring partners assigned to the two remaining partners their respective shares and interest in the business. The retiring partners wanted no share of the profits in the ongoing financial year in which the dissolution occurred; they wanted only the capital amount. They were later assessed to income tax on such profits as had accrued. Williams J., after making the remarks cited above in Jefferies' case went on to say of these facts that by the assignment the retiring partners thereby dealt with their individual interest in the net income for purposes of sec. 19. He said:

"The mere fact that the agreement of 22nd December, 1944 does not provide for any payment to the respondent in respect of his share of the net income earned up to that date does not free him from liability to pay income tax on his share of the net income that was in fact earned... they were disposing of property which was their assessable income under the provisions of ss. 90 and 92 of the Income Tax Assessment Act. These sections occur in Divn. 5 of Part III of that Act. In Rose v. Commissioner of

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Taxation, supra, this Court said that Divn. 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."

10. The effect of these decisions is that where a partnership is determined (in the present case at 17 January 1978), the rights of a partner to share in the profits accrue to him or her at the time of that determination, and his/her share of the profits must be treated as then having fallen into his/her hands whether or not - and as it appears in this case they did not - they actually fall into the hands of specific partners.

11. Happ's case was applied to this effect by Board of Review No. 3 in Case C100
(1953) 3 T.B.R.D. 592. In that case the taxpayer during the year of income sold his interest in a partnership for a lump sum. Before that date, the partnership had earned certain profits but no share of the profits had been received by him. Messrs Fletcher and Antcliff, Members, in a joint decision said at p. 592:

"He received a lump sum for his interest in the partnership as at the date of dissolution, but the fact that he did not receive his share of the profits from the partnership does not affect his liability to income tax."

12. The respondent was therefore correct in assessing the applicant to tax on 50% of the profits of the partnership until 17 January 1978 and the Tribunal therefore affirms the decision under review in respect of the 1978 tax year.

1981 tax year

13. The further relevant facts relating to the objection that arose to the assessment in the 1981 tax year are that it appears that the applicant's former partner continued to pay bills out of the former partnership's account up to the limit of the overdraft of $12,000. The bank was not informed until late in January 1978 of the existence of the deed dissolving the partnership. The account was then frozen. From the bank's point of view, no notice having been given, both partners under the old partnership agreement remained liable for the debt, and the applicant was called on to contribute to the payment of the sum outstanding. She did so contribute firstly by a lump sum payment and then by monthly payments until the payments became too onerous for her and the bank realised the security held against the overdraft.

14. In her tax return for the year of income ended 30 June 1981, she claimed as deductions bank charges and interest on the overdraft amounting to $414, as being losses or outgoings incurred by the taxpayer in gaining or producing assessable income. I said during the hearing, and this remains an insuperable barrier to the allowability of this deduction, that the taxpayer cannot have the best of both worlds. She cannot, on the one hand, assert that the partnership was dissolved and on the other hand seek to claim deductions relating to a period after the date of dissolution simply because she remained liable to a third party for the debt. In no sense can an outgoing, incurred after the dissolution of the partnership, be said to have been incurred in the derivation of assessable income from the partnership. It follows, therefore, that the decision under review in relation to the 1981 tax year is also affirmed. The result is unfortunate for the taxpayer, but inevitable as the law now stands.