Federal Commissioner of Taxation v James Flood Pty Ltd

88 CLR 492
1953 - 1005B - HCA

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(Judgment by: Dixon CJ, Webb J, Fullagar J, Kitto J, Taylor J)

Between: Federal Commissioner of Taxation
And: James Flood Pty Ltd

Court:

Judges:
Dixon CJ
Webb J
Fullagar J
Kitto J
Taylor J

Subject References:
Taxation and revenue
Income tax
Assessable income
Deduction
Losses and outgoings incurred
Annual leave
Holiday pay

Legislative References:
Income Tax Assessment Act 1936 No 27 - s 51(1)

Hearing date: 17 September 1953; 18 September 1953; 21 September 1953
Judgment date: 5 October 1953

MELBOURNE

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Judgment by:
Dixon CJ
Webb J
Fullagar J
Kitto J
Taylor J

This is an appeal under s. 196 of the Income Tax and Social Services Contribution Assessment Act 1936-1951 by the commissioner from a decision of a Board of Review. The appeal was referred to the Full Court pursuant to s. 18 of the Judiciary Act 1903-1950. The parties appear to have accepted the materials before the Board of Review as those upon which the matter is to be decided, adding thereto some evidence tendered in this court relating to systems of accounting. The appeal is concerned with the question whether an item of expenditure ought to be allowed as a deduction from the assessable income of the year in question or more properly belongs to the ensuing year. The year of income is that ending 30th June 1947.  

The taxpayer is a company which carries on business as a motorbody builder and general engineer. In its manufacturing account for the year ended 30th June 1947 there is shown under the general heading "manufacturing overhead" an item "holiday & sick pay, etc. PD1888 8 2". The amount of the cost of goods manufactured which the manufacturing account discloses is transferred to the trading account, the gross profit disclosed by which is in turn reflected in the profit and loss account.  

In answer to a question from the Commissioner of Taxation the taxpayer said that the item of PD1888 8s. 2d. holiday and sick pay included an amount of PD578 10s. 2d., charges which had accrued but had not been paid during the year. The Commissioner disallowed this amount as a deduction from the assessable income. The taxpayer in the grounds of its objection, after stating that the assessment was wrong in law and in fact, said that under the wages board award any employee leaving the company's service prior to the end of the year 1947 had to be paid seven and one-third hours' holiday pay for each completed month of service. The objection went on to say that at 30th June 1947 the company therefore correctly brought to account as a liability accrued holiday pay of the amount of PD578 10s. 2d. In the case of the employees who continued in the service of the company such accrual would be offset against the actual fortnight's holiday pay paid to each employee in December 1947. The objection proceeded to state as a separate ground that as the above amount was not in the nature of a provision but was a definite liability at 30th June 1947, the amount was an expense actually incurred by the business, and as such was allowable as a deduction under the provisions of the Income Tax Assessment Act 1936-1947 and in particular under s. 51 thereof.  

The reference to the wages board award was a misdescription. In fact the provision to which it was intended to refer was cl. 13A of an award of the Commonwealth Court of Conciliation and Arbitration made in a dispute to which the Vehicle Builders Employees' Federation of Australia and other organizations of employees were parties. ^[F1] Clause 13A was inserted by an amendment made on 20th December 1945.  

Unfortunately the facts placed before the Board of Review do not state with any exactness how the item of PD578 10s. 2d. was made up. Probably, so far as they go, the allegations of fact contained in the objections were accepted.  

Clause 13A of the award deals with annual leave. Its leading provision directs that, except as the clause afterwards provides, fourteen consecutive days' leave shall be allowed annually to an employee after twelve months' continuous service (less the period of annual leave) as an employee in any one or more of the occupations to which the award applies. What shall amount to continuous service is elaborately prescribed. An interruption or determination of the employment by an employer if made merely with the intention of avoiding the obligations of the clause in respect of leave of absence does not destroy its continuity. Neither does an absence from work on account of personal sickness or accident, nor does absence with reasonable cause. But the employee must prove the reasonable cause and, in the case both of reasonable cause and of personal sickness or accident, the employee must inform the employer in writing if practicable within twenty-four hours of the commencement of the absence and as far as practicable state the nature of the illness or injury or cause and the estimated duration of the absence.

Absence on account of leave lawfully granted by the employer does not destroy the continuity. If the employee is absent from work by reason of any other cause than the foregoing the employer must either during the absence or within fourteen days of its termination notify the employee in writing that the absence will be regarded as having broken the continuity of service. Otherwise the absence shall not be deemed to break the continuity of service for the purpose of the clause. If the absence is the result of concerted or collective absenteeism it is enough to post the notification up in the plant. In other cases it must be delivered or sent by post to the individual employed. It will be seen that the award was actually made during the year preceding the year of income under consideration. It in fact came into operation on 1st January 1946 and it contains a provision for the calculation of the service by reference to service before that date.

The provision begins with the general statement that service before the date shall be taken into consideration for the purpose of calculating annual leave. It goes on, however, to state that an employee shall not be entitled to leave or payment in lieu thereof for any period in respect of which leave or payment in lieu thereof has been allowed or made under the prior provisions of the award which the clause superseded. To that, however, there is a proviso, namely that in respect of service before 1st January 1946 the annual leave shall be allowed at the rate of three and two-thirds hours for each completed month of continuous service, and in respect of service after that date, at the rate of seven and one-third hours for each completed month of continuous service.  

The clause contains a general provision that annual leave must be allowed and must be taken and that payment shall not be made or accepted in lieu of annual leave. But to this there is an exception. The exception provides that if after one month's continuous service in any qualifying twelve monthly period an employee lawfully leaves his employment or his employment is terminated by the employer through no fault of the employee, the employee shall be paid at his ordinary rate of wages for three and two-thirds hours in respect of each completed one month of continuous service before 1st January 1946 and for seven and one-third hours at the same rate in respect of each completed month of continuous service after that date, the service in each case being service in respect of which leave has not been granted under the clause. The clause deals with the time at which annual leave must be taken. The time is to be fixed by the employer but it must be within a period not exceeding six months from the date when the right to annual leave accrues and at least two weeks' notice must be given to the employee. Before going on his leave the employee must be paid two weeks' wages. The wages must be at the rate for the occupation in which the employee was ordinarily employed immediately prior to the commencement of his leave or, if his employment is terminated, before the termination of his employment.  

There is a special provision dealing with the case of an employer who closes down his plant or a section of it for the purpose of allowing annual leave to the bulk or all of his employees. It does not appear that the taxpayer closes down its plant in pursuance of this clause, but from the reference in its notice of objection to offsetting the payment against the annual fortnight's holiday pay paid to each employee in December 1947 it may be suspected that it is the taxpayer's practice to do so. The effect of the special provision is that, provided the employer gives a month's notice of his intention to do so, he may, for the duration of the close-down, stand off all his employees concerned and allow to those who are not then qualified for two full weeks' leave, paid leave on a proportionate basis of one-sixth of a week's leave for each completed month of continuous service. If an employee has at the time of the close down qualified for two full weeks' leave and has completed a further month or more of continuous service, he is to obtain his leave and be paid one-sixth of a week's wages in respect of each additional completed month of continuous service. The next period of twelve months qualifying for leave then commences from the day on which the plant or the section of the plant is re-opened for work after the close-down.  

We think the notice of objection, read in the light of the provisions of the clause, must be taken to allege that the PD578 10s. 2d. represents the total amount calculated at seven and one-third hours for each completed month of service since 1st January 1947 and that the figure is based on the completed months of continuous service of the various employees as at 30th June 1947.  

We shall proceed on the assumption that the statements of fact in the notice of objection were accepted. Apart from the documents we have mentioned and the formal notification no evidence was placed before the Board of Review. The only additional evidence given in this Court relates to accountancy practice and it does not touch the facts of the case. By some misunderstanding the case seems to have been treated before the Board of Review ^[F2] as if it depended not on the award but upon the Factories and Shops (Annual Holidays) Act 1946 (Vict.). The majority of the members of the board were of opinion that on this basis the taxpayer had, prior to 30th June 1947, incurred an outgoing in respect of the annual leave of his employees and, although the outgoing would not fall to be discharged until after that date, it was allowable as a deduction pursuant to s. 51 (1) of the Income Tax Assessment Act 1936-1947. The view taken was that it was a definite pecuniary liability arising out of the employment of the employees and that it was impossible to escape it, although in the case of individual employees contingencies might occur which would deprive them of the right to payment. As the liability arose from the employing of the men at work during the accounting period prior to 30th June 1947, it was an outgoing which should be charged against the assessable income of the year then ending.  

The considerations which affect the correctness of this view must all arise from the provisions of the award. The argument before us, however, took a more general form. It was based to a great extent upon a conception of annual leave in the abstract as a period of leisure to which the employee became progressively entitled de die in diem as he worked and for which correspondingly the employer became progressively liable to pay as part of the cost of labour employed from day to day, actual payment only being deferred to the period of leave or the sooner determination of the employment.  

However serviceable generalized conceptions may be in relieving overburdened assessors and tax accountants of the need of examining particular situations, all a court can decide is the case before it. And as the nature and incidence of the liability in the case before us obviously depends on the provisions of the award it is that instrument we should consider and not the validity of some independent general proposition. Now in dealing with that instrument it is necessary at the outset to observe that under the award an employee may fail to become entitled to annual leave for a number of reasons. He may die, his employment may be terminated because of his own fault, there may be a strike, or he may be guilty of absenteeism and be unable to rely on grounds of exception or excuse. From the employer's point of view there is a further possibility. He may never become liable to give his employees two weeks' leave on full pay because he may sell his business. There is a special provision which places the obligation in such a case upon the purchaser of the business. No doubt in that case the impending obligation would result in a diminution of the price of the business but that is a different thing from discharging the obligation. It may be true that all these reasons which, so to speak, would intercept the accruing right of an employee to be paid by the taxpayer are all of a particular character, but it is difficult to say in the face of them that there is a definite obligation to make a payment, incurred in respect of each completed month on that month being completed. Further, it is to be noticed that when the employment of a man is terminated without his fault before he has served twelve months the amount he receives in respect of each completed month of service is not necessarily one twelfth of the full two weeks' pay for annual leave. The two things are calculated at different periods and the rates of pay may not be the same.  

A most important feature of the award is that leave must be taken and that it must be taken at a time which ex hypothesi in this given case falls outside the year of income. The payment is made to the employee in respect of the period of leave and forms part of his ordinary wages. The award therefore clearly regards the payment as something made in respect of the two weeks when leave is actually taken. Prima facie it prohibits the substitution of a money payment for the leave. The prima-facie position is qualified only in the case of an employee who lawfully leaves his employment or whose employment is terminated without his fault.  

These considerations all seem to point to the conclusion that in the case of no given employee who has not completed his twelve months' continuous service before 30th June 1947 could it be said that the taxpayer had incurred an outgoing consisting in a proportion of the pay which would become payable to him should he do so, that is payable on the occasion when he took his annual leave.  

When the employees are considered not individually but collectively it is easy to understand that the taxpayer should say that it was antecedently quite certain, apart from the remote contingency of a change of ownership of the undertaking, that an expenditure on annual leave would be made in the ensuing financial year, and that an almost fixed proportion would be calculated in respect of periods of service falling within the year of income. But to say this is not enough. It shows no more than that part of the regular expenditure incurred in carrying on the undertaking is the payment of wages to men taking their annual leave and that the amount may be computed in advance with approximate accuracy because annual leave depends on twelve months' service.  

In considering such questions the difference should never be overlooked between the English income tax law and the Commonwealth statute. The Report of 1936 of the Income Tax Codification Committee, par. 76, contains the following description of the English system:  

"It has often been the subject of judicial comment that the existing Acts contain no general direction as to the ascertainment of business profits. Such guidance as they give is confined to a statement that the amount to be assessed is `the balance of the profits or gains' of the business, subject to a series of provisions prohibiting certain specific deductions-some of which, being in the form of limitations, are taken as authorizations of deductions within the limits. It has been left to the Courts to lay down that `the balance of the profits or gains' must, in the absence of express provision to the contrary, be arrived at in accordance with ordinary commercial principles, and to formulate the principle that a proper debit item in a trading or in a profit and loss account is, in general, a proper debit item in an income tax computations."

 

The principle of the Commonwealth Act, on the other hand, is to calculate the taxable income as the amount remaining after deducting from the assessable income all allowable deductions and to restrict allowable deductions to deductions allowable under the Act. What losses and outgoings arising in the course of business are to be deducted is a matter which must be governed by s. 51 (1) of the Income Tax Assessment Act. Under its provisions all losses and outgoings may be deducted 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, provided, of course, they are not of a capital nature or otherwise excluded. The word "outgoing" might suggest that there must be an actual disbursement. But partly because such an interpretation would produce very strange and anomalous results, and partly because of the use of the word "incurred", the provision has been interpreted to cover outgoings to which the taxpayer is definitively committed in the year of income although there has been no actual disbursement.  

In James Spencer & Co v Commissioners of Inland Revenue, ^[F3] at p. 352. Lord Cooper says that from an examination of the numerous cases

"the broad working rule which emerges as a guide to the crediting or debiting in a tax computation of subsequently maturing credits or debits is to inquire in which accounting period the right or liability was established, and to carry the item into the account in that year. I use the vague word `established' advisedly, for we are now in the region of proper commercial and accountancy practice rather than of systematic jurisprudence."

This passage must be qualified in its application under the Commonwealth Act. For under our law the facts must satisfy the expression "losses and outgoings incurred". These words perhaps are but little more precise than the word "established" or the expression used above "definitively committed". But they do not admit of the deduction of charges unless, in the course of gaining or producing the assessable income or carrying on the business, the taxpayer has completely subjected himself to them. It may be going too far to say that he must have come under an immediate obligation enforceable at law whether payable presently or at a future time. It is probably going too far to say that the obligation must be indefeasible. But it is certainly true that it is not a matter depending upon "proper commercial and accountancy practice rather than jurisprudence". Commercial and accountancy practice may assist in ascertaining the true nature and incidence of the item as a step towards determining whether it answers the test laid down by s. 51 (1) but it cannot be substituted for the test.  

To repeat what has been said before in relation to an analogous provision in the Act of 1922-1934:

"To come within that provision there must be a loss or outgoing actually incurred. `Incurred' does not mean only defrayed, discharged, or borne, but rather it includes encountered, run into, or fallen upon. It is unsafe to attempt exhaustive definitions of a conception intended to have such a various or multifarious application. But it does not include a loss or expenditure which is no more than impending, threatened, or expected."

New Zealand Flax Investments Ltd v Federal Commissioner of Taxation, ^[F4] at p. 207.

Nothing that was decided in W. Nevill & Co Ltd v Federal Commissioner of Taxation ^[F5] was intended to imply that a liability to pay an ascertained sum is never incurred until the sum becomes due and payable. The question in that case was whether a sum which a company had agreed to pay one of two joint managing directors to induce him to retire was an outgoing on account of capital or was deductible. Portion of the sum was to be met by monthly payments over a period extending beyond the year of income and secured by promissory notes. It was decided that the outgoing was not on account of capital and was deductible but so much of it as was payable outside the year of income belonged to the ensuing accounting period. Probably on this minor point, to which the parties do not appear to have attached importance, the judges were influenced to some extent by some of the considerations affecting their decision on the major question and looked upon the monthly payments not so much as deferred instalments of an accrued liability in a lump sum but as an attempt to spread over a period of trading an outgoing parallel with the salary that had been saved.

But whatever be the rationale of the decision of the point, clearly enough it is not based on a view that no outgoing could be incurred until actual payment was made. It is one thing, however, to say that it is not necessary, for the purposes of s. 51 (1), that an actual disbursement should have taken place. It is another thing to say that in the present case the taxpayer had incurred a loss or outgoing in the year of income in respect of the pay of its men during the annual leave to be taken in the ensuing accounting period by employees whose service had not as yet qualified them for annual leave. In respect of those employees there was no debitum in praesenti solvendum in futuro. There was not an accrued obligation, whether absolute or defeasible. There was at best an inchoate liability in process of accrual but subject to a variety of contingencies. It may be true, that regarding the labour employed as a whole, the accrual of an amount of the order claimed had, by 30th June 1947, become predictable with certainty. But that is not the test. If it be regarded nevertheless as an evidentiary consideration having some weight then it cannot be divorced from the further consideration that the source of the accruing liability, the award, imposes it as an obligation to pay wages for a period of time in the future during which the employee must be given leave. That means that it is imposed in the form of a liability associated with the operations of the taxpayer for the ensuing year. In short the deduction claimed of PD578 10s. 2d. does not represent an expenditure associated with the production of income before 30th June 1947 for which a liability had been completely incurred before that date.  

On this ground the taxpayer fails. This conclusion only means that pay for annual leave is deductible year by year as it is paid, not that the taxpayer has not the benefit of a deduction. Why it is important to the taxpayer does not appear.  

The appeal should be allowed, the decision of the Board of Review set aside and the assessment restored.