BJ McMahon SM
Administrative Appeals Tribunal
B.J. McMahon (Senior Member)
The applicant and his former partner carried on a practice as solicitors. The applicant's earnings from this practice were the principal source of his income. In 1980, they were called upon by the Statutory Committee of the Law Society of New South Wales to explain certain allegations concerning their trust account.
2. That Committee is constituted under Pt X of the Legal Practitioners Act 1898 (N.S.W.). By sec. 77 of that Act the Committee is given power to hear ``every charge or question as to the professional misconduct of any solicitor referred to the Statutory Committee'' in accordance with certain rules. The Committee is given power, after a duly constituted hearing, to make an order striking a solicitor off the roll or suspending him from practice either conditionally or otherwise. The Committee has power to impose a fine not exceeding $10,000. It also has power to require payment of costs on a conditional basis.
3. The proceedings before the Statutory Committee commenced on 27 March 1980 and concluded in August of that year. On 19 March 1981, the Committee handed down its Statement of Findings, followed by Orders in the following terms:
``THE COMMITTEE MAKES THE FOLLOWING ORDERS
1. That the name of [applicant's partner] be and the same is hereby struck off the Roll of Solicitors of the Supreme Court of New South Wales.
2. That the said [applicant] be suspended from practice at the expiration of twenty-one (21) days from the date of this order for a period of twelve (12) months.
3. That the costs of the Law Society of and incidental to this reference be taxed by the Proper Officer of the Supreme Court of New South Wales as between Solicitor and client and when so taxed and allowed be paid by the Solicitors, the said [partner] and [applicant] to the Law Society of New South Wales or its Solicitor Mr G S Lewis such costs to be inclusive of all costs and disbursements properly incurred by the Law Society of and incidental to the investigation and reports on the accounts of the Solicitors by Miss Jean Sayer and that such liability for costs be the joint and several liability of the Solicitors, [partner] and [applicant].
4. The applicant was to have been suspended from practice for a period of 12 months from the date of the order. An appeal was lodged, which had the effect of staying the operation of that order. When the appeal was withdrawn, the order became effective on and from 26 April 1981. The applicant was therefore suspended from the right to practise until 26 April 1982.''
5. By the beginning of April 1982, no certificate of taxation referred to in O. 4 had been served on the applicant. The Law Society had not produced a bill of costs and had not gone through the process of taxing such a bill. The applicant and his advisers were concerned that the period of suspension, due to expire on 26 April 1982, might continue indefinitely, if the taxed costs of the Law Society were not paid, or if some other suitable arrangement were not made. To this end, negotiations took place between solicitors for the Law Society and for the applicant, resulting in an
ATC 877agreement, that the total amount of the costs referred to in O. 3 was $21,372.10. These costs represented the Law Society's solicitor's fees, counsel's fees and fees paid to an accountant, both for preliminary investigation work and for work done subsequently as receiver of the trust account. It was a condition of the agreement that the applicant be given time to pay. Arrangements satisfactory to both parties were made for payment of monthly instalments.
6. In the years ended 30 June 1983 and 1984, the applicant paid $7,420 and $6,600 respectively of the total amount payable. The applicant claimed a deduction for these amounts under sec. 51(1) of the Income Tax Assessment Act. The claim was disallowed on the stated ground that ``none of the expenditure is deductible under sec. 51(1) of the Income Tax Assessment Act as it was not incurred in gaining or producing assessable income nor in carrying on a business for that purpose''. This application is brought to review that objection decision.
7. The applicant's case was that all of the components of the costs were in one category. For the purpose of characterising the payments, nothing turned on the fact that some of the money represented the costs of investigation and of the subsequent receivership, and that some of it represented pure legal expenses. None of the amount, of course, represented the applicant's own costs. These were not the subject of the present proceedings. Payment of the Society's costs was essential to prevent a further suspension from practice and therefore a further deprivation of the opportunity to earn income. For that reason, it was argued that payment of the costs was a necessary expense incurred in the course of a business.
8. The applicant relied, to some extent, upon
Tooheys Limited v. C. of T. for N.S.W. 39 W.N. 133. In that case, a company carrying on the business of hotel proprietors appeared before the Licences Reduction Board under sec. 17 of the Liquor (Amendment) Act 1919 to show cause why it should not be deprived of certain of its licences. The trial Judge held that the company was entitled, when calculating the amount of its taxable income, to deduct the expenses and costs of those proceedings. On appeal to a Full Bench of the New South Wales Supreme Court, that decision was upheld. However, there is little, if any, reasoning contained in the report of the decision of their Honours. In any event, there have been so many developments in this field since this case was decided in 1922, both in decisions of the High Court and in amendments to the Income Tax Assessment Act (which displaced the New South Wales legislation considered in Tooheys) that the decision can be regarded as of no assistance in determining the issues in this application.
9. More pertinently, the applicant relied upon
Magna Alloys and Research Pty. Limited v. F.C. of T. 80 ATC 4542, and particularly, upon the reasoning of Brennan J.
10. I would agree that the order to pay the sum of money to the Law Society to which I have referred, is civil and not criminal in its nature. Although sec. 77 of the Legal Practitioners Act empowers the Statutory Committee to impose a penalty, it does not appear from any of the orders to which I have referred that any such penalty was imposed. Under sec. 84 of the said Act, any sum of money whatever payable to the Society under the Act is to be recovered ``as a debt due to the Society''. I agree therefore that the reservations expressed in Magna Alloys that moneys paid by way of penalties could not be deducted, would seem to have no application in the present circumstances. Brennan J. was, in any event, of the opinion that there was only ``slender support for the view that the principle with respect to the non-deductibility of criminal penalties extends to the costs incurred in defending the proceedings in which the penalty is imposed''.
11. It seems to me however, that the proceedings that were defended in Magna Alloys were peripheral to the company's business. Had the directors been convicted and had the convictions been allowed to stand, the business of the company would not have come to a halt. In that case, the taxpayer company was one of a group of companies which supplied ``maintenance'' products to industry. In a series of articles, a Melbourne newspaper alleged that the group's agents were inducing employees, including employees of government departments and public authorities, to purchase good from the group in return for gifts or prizes for their own personal use. An investigation followed these allegations and three of the taxpayer's directors and four of its agents were subsequently charged with criminal conspiracy and certain other offences. The
ATC 878directors were fined $2,000 each and three of the agents placed on good behaviour bonds. The deductibility of the costs of defending the proceedings against the directors was the subject matter of the appeal in Magna Alloys. In the present application, the costs are not those of the defendant. Furthermore, the obligation to pay the Law Society's costs was fundamental to the applicant's continuing right to derive his principal source of income through the practise of his profession. It was not a peripheral or incidental obligation of his practice. That right or privilege to earn money through certain activities, prohibited to those not similarly licensed, can be regarded as a profit-yielding subject or as a structural asset. Expenses of defending or acquiring structural assets are capital expenses.
Broken Hill Theatres Pty. Limited v. F.C. of T. (1952) 85 C.L.R. 423 the Court recognised that the grant of a licence to a competitor to operate a picture theatre would have significantly threatened the taxpayer's goodwill and the occasion of threat was special. The legal expenses of opposing the grant were denied deductions. The Court, in that case, approved the dissenting judgment of Dixon J. in
Hallstroms Pty. Limited v. F.C. of T. (1946) 72 C.L.R. 634 in which his Honour had taken the view that the expenses of opposing the grant of extension of a patent were capital in nature.
13. When considering payments made in respect of structural assets, a distinction must be drawn between defence expenditure and maintenance expenses. In seeking to justify the present claims, counsel for the applicant relied upon
Snowden and Willson Pty. Limited v. F.C. of T. (1958) 99 C.L.R. 431 as justification for his submission that the expenses presently under consideration were properly classifiable as maintenance expenses. In that case, the class to which the expense belonged was ongoing expenses of obtaining payment from customers. A failure to resist the challenge to the company's business operations, which was involved in the inquiry by the Royal Commission, would have led to refusals by customers to pay instalments under contracts they had entered into and to challenge those contracts. The decision can be justified as an example of a class of act which may be described as acts in carrying on the operations whence income is derived. The fact that in some sense they relate to structure does not displace their character as working expenses.
14. Expenses of defence which are structural will relate to a special challenge to the continuance of a business or the holding of property whence income is derived. It is enough that a significant element of a taxpayer's business operations are subject to some special challenge. In his book Income Taxation in Australia, at para. 7.69 Professor Parsons instances expenses of a builder in resisting an action brought by a customer as generally classifiable as working expenses. But expenses of appearance in proceedings brought by a licensing authority to deregister the builder may well be non-working. In Snowden and Willson the High Court expressly negated the view of the facts that would have seen the appearance before the Royal Commission as a matter of defence in a situation of peril.
15. The distinction was illustrated in Case N65,
81 ATC 335, a case whose facts bear a marked resemblance to the facts presently under consideration. The taxpayer had arranged the affairs of a chain of pharmacies in order to avoid certain obligations imposed by the Medical Act. A State Pharmacy Board instituted an inquiry and found that the taxpayer was guilty of conduct discreditable to a pharmaceutical chemist, in conspiring to bring about breaches of the Act. The Board cancelled the taxpayer's registration, and ordered him to pay two-thirds of the Board's legal costs as a penalty.
16. In considering the distinction, to which I have referred, between expenditure of a capital nature and expenditure of a revenue nature, the Board of Review said in para. 10 and 11 of its decision [ATC p. 339]:
``10. We were referred to a number of cases which have considered the various criteria by which, have hopefully, one might distinguish outgoings on revenue account from outgoings on capital account. Having considered and reconsidered them, we are of the opinion that the outgoings, being incurred (if they were incurred by the taxpayer) in an endeavour to preserve intact the business structure that the taxpayer had set up in State B, represent outgoings of capital or of a capital nature. It follows that they are excluded from deduction. It is not necessary to do more, by way of support for
ATC 879this conclusion, than refer to the judgment of Dixon J., as he then was in
Sun Newspapers Ltd. and Associated Newspapers Ltd. v. F.C. of T. (1938) 61 C.L.R. 337 at pp. 359-364. There, his Honour described the distinction between the business entity, structure, or organisation set up or established for the earning of profit and the process by which such an organisation operates to obtain regular returns by means of regular outlay', then discussed various tests - the once and for all test, the enduring benefit test, and character of the advantage sought - and went on:
- There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may lay a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.'
11. We are satisfied that the principal object of the expenditure in issue was to preserve the taxpayer's existing business organisation from dislocation and impairment. This included the endeavour to prevent the loss of the taxpayer's and Mr K's, registration as pharmacists. As previously noted, the Pharmacy Board's findings led to the collapse of the State B businesses; it is fair to say that the outgoings here in question were aimed at preventing that collapse - that is, they were aimed at preserving intact the existing business structure, the `profit yielding subject'. The expenditure could not properly be characterised as an expenditure upon the process of operating that subject or to adopt a statement made by Menzies J. in
John Fairfax & Sons Pty. Ltd. v. F.C. of T. (1958-1959) 101 C.L.R. 30 at p. 49, the outgoing had the character of an outgoing in the course of maintaining or preserving the taxpayer's business rather than that of a working expense in the carrying on of his business. For that reason the amount of legal expenses is not an allowable deduction within the scope of sec. 51(1), being rather an outgoing of `capital or of a capital nature'.''
17. I respectfully share the views of that Board of Review as to the distinction to be drawn between the facts in that case (and indeed the facts in this case) on the one hand and those examined in Snowden and Willson on the other. At para. 12 the Board gave these views [ATC p. 340]:
``12. It might be objected that the outgoing now under consideration ought to be held to be deductible on the ground that it was similar to the legal expenses in question in
F.C. of T. v. Snowden & Willson Pty. Ltd. (1958) 99 C.L.R. 431. In that case the Full High Court held that costs of advertising, and legal expenses incurred by the taxpayer company in connection with allegations about its method of carrying on its business, and the proceedings of a Royal Commission before which it appeared were `necessarily incurred in carrying on its business for the purpose of gaining or producing' income and were, moreover, of a revenue nature. The amount was therefore an allowable deduction under sec. 51(1). But this conclusion, we think, was arrived at on the basis that the matters provoking the expenditure were no more than incidental to the taxpayer's business. Thus, at p. 436. Dixon C.J. was at pains to point out that:
- `The case does not appear... to depend... upon anything but an understanding of what in fact and according to the ordinary conduct of affairs is incidental to the conduct of a business.'
In the case before us what was at stake was the continued existence of the business and the retention of the taxpayer's right to carry on business as a pharmaceutical chemist. These matters are far more fundamental.''
18. The cases to which I have referred so far, deal with expenses of defending a structural asset. The same principles apply to the expenses of acquiring such an asset. It is possible to view the costs in the present application in the alternative as acquisition costs. Had they not been paid, the applicant would not have been entitled to resume the exercise of his statutory privileges as a solicitor. In a sense, they can be looked at as identical, from a fiscal point of view, with the cost of readmission. The costs of gaining initial
ATC 880admission as a solicitor have been considered in two cases before Boards of Review. In Case J30,
77 ATC 282 the general reasoning of Dr Gerber (now a Deputy President of this Tribunal) supports the proposition that such expenditure is capital in nature. In Case L38,
79 ATC 208 the Board characterised the costs associated with gaining admission as a solicitor in these terms:
``Upon his admission he achieved the new status of a duly qualified legal practitioner, which entitled him to take up his appointment of legal officer with the concomitant advantage of being able to command an additional allowance and higher salary.''
19. Phrases such as ``an asset of enduring benefit'' recur throughout the cases. They echo the words of Dixon J. in Sun Newspapers Limited v. F.C. of T. (1939) 61 C.L.R. 337 at p. 363 (quoted in para. 16 of these Reasons).
20. It is instructive to apply the three tests referred to by his Honour to the facts of the present application. The advantage sought is either the grant or the restitution of the statutory privilege of earning money by doing acts which would otherwise be illegal unless carried out by some one upon whom this privilege is bestowed. The right to practise as a solicitor is lasting, subject to good conduct. It is not limited by reference to time or even by reference to continuing skills. Once acquired, or reacquired, the status of solicitor is a basis from which one can turn one's actions into an income-earning account.
21. The manner in which that status is to be used is primarily for the purpose of earning a recurring income. It differs in its nature from other skills, such as those of a champion tennis player, which may be turned to account in the gaining of income. Sporting skills decline. Status continues indefinitely, subject to the observation of rules designed for public protection.
22. The means adopted to obtain that status in the present case is through a once and for all payment, notwithstanding that the global amount of that payment was to be met by way of smaller instalments over a period. The periodical instalments were not linked in any way to the use or enjoyment of the status of solicitor which these payments secured.
23. Having regard to these three tests, I have come to the conclusion that the payments made by the applicant in the years in question were of a capital nature and are therefore not deductible under sec. 51(1) of the Income Tax Assessment Act. The objection decisions under review are therefore affirmed.