KL Beddoe SM
Administrative Appeals Tribunal
K.L. Beddoe (Senior Member): The applicants, who had these matters heard together, are two of three partners carrying on a nursery business specialising in tropical tree fruit propagation and culture in North Queensland.
2. The question at issue is whether legal expenses amounting to $2,146 are allowable deductions to the partnership. The respondent has allowed a deduction of $50 only leaving $2,096 in dispute.
3. The respondent having allowed the deduction of $50 within the terms of sec. 64A of the Income Tax Assessment Act (``the Act''), the only relevant statutory provision remaining is subsec. 51(1) of the Act. That subsection provides that 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 assessable income, shall be allowable deductions. Exceptions include losses and outgoings of a capital nature.
4. The expenditure in dispute was incurred by the applicants in the following circumstances. The partnership carries on business as a nursery in a well-known area of North Queensland renowned for sugar-cane farms amongst other things. The nursery was located next to a sugar-cane farm which in itself created some problems for the partnership but those problems were magnified considerably when the cane farmer sought approval of the local authority to conduct quarrying operations on certain parts of the cane farm. The quarrying operations apparently had the dual purpose of providing income from sale of the material and also levelling the land thereby increasing the capacity of the farm to grow cane.
5. The intention of the cane farmer to commence quarrying operations provoked an application to the local authority for the necessary approval which in turn resulted in the application being advertised. The local authority proposed to grant the consent subject to certain conditions.
6. The applicants perceived that the proposed quarrying operations would adversely affect their nursery in a number of ways including the deposit of contaminated dust on the nursery, adverse effect on the operation of the misting tables and similar adverse effect on the operation of the glasshouses.
7. That their perceived concerns were ultimately found to be well based is demonstrated by photographs tendered in evidence (Exhibit F). The perceived interference with the conduct of the nursery business was mitigated by the restrictions upon the quarry operations but the evidence
ATC 302established that the nursery still suffered some damage and interference from the quarry operations when they commenced. The perception of the partnership that the operations of the nursery would be adversely affected by the proposed quarry operations was well based.
8. The applicants therefore commenced proceedings in the Local Government Court objecting to the local authority granting approval for the quarrying operations. Both the findings by the Court and the evidence before this Tribunal established that the proposed quarrying operations represented a real threat to the continued profitable operation of the nursery.
9. In the result the Local Government Court upheld the objections in part by restricting the quarrying operations to that portion of the proposed site furthest away from the nursery. The applicants succeeded in part only and the Court made no order for costs. The applicants were therefore obliged to pay their own costs.
10. Proceedings before the Local Government Court took place in May 1979 over three days. There is no evidence before the Tribunal as to whether the Court reserved its decision but it can be inferred from the evidence available that the decision was given at the end of the hearing or immediately thereafter and the order as to costs made at that time. I so find.
11. The costs including disbursements incurred were as follows (cents have been ignored):
$ Counsel's fees 640 Photographs 114 Filing fees 38 Land agent 10 Photocopying 84 Court reporting 3 Postages etc. 5 ----- 896 Solicitors fees 1,250 ----- $2,146 -----
12. A bill of costs dated 6 July 1979 was rendered on the partnership for $1,932, amounts of $100 and $114 having previously been paid (pp. 44-46 transcript). There is no evidence before the Tribunal to suggest that the bill was not rendered on or about 6 July 1979. The bill of costs was paid by instalments, the first payment being on 2 November 1979, the second on 6 August 1980 and the final payment in March 1981.
13. The accounts of the business are, to say the least, confusing. It is necessary that the accounts be set out in detail because of one of the issues arising. The trading profit and loss account for the year ended 30 June 1979 is as follows:
INCOME: $ $ Sales 35,753 Less: Cost of sales Opening stock 3,730 Purchases & materials 15,356 ------ 19,086 Less closing stock 1,600 17,486 ------ ------ 18,267 EXPENSES: Accountancy fees 380 Advertising, postage and stationery 952 Bank charges 101 Depreciation 1,264 Entertaining and promotion 337 Fertilisers, poisons & sprays 539 Fuel & oil 456 Insurance 69 Interest -- bank 20 Leasehold land rent 225 Light & power ($597 less private) 357 Legal fees 2,146 Magazines, journals & nursery publications 300 Motor vehicle expenses 1,465 Quarantine fees 120 Rates 171 Repairs loose tools & yard maintenance 883 Telephone 454 Wages -- casuals 30 10,269 ----- ------ net profit $7,998 ------
14. It will be apparent that the legal costs of $2,146 had been brought to account as an expense incurred, however, no liability for the unpaid amount appears in the balance sheet of the partnership which read as follows as at 30 June 1979:
$ $ Net ownership equity 14,182 represented by CURRENT ASSETS: Bank 627 Stocks on hand 1,600 Prepaid expenses 3,930 ----- 6,157 CURRENT LIABILITIES: Trade creditors 2,832 Loan 500 Advance deposits 1,000 4,332 ----- ----- 1,825 FIXED ASSETS: Owners' values Cost Accum. 1/1/78 addns depn $ $ $ Motor vehicles 2,420 756 1,664 Plant & equipment 3,140 490 577 3,053 Bore 700 85 615 Nursery buildings 5,818 1,676 469 7,025 12,357 ----- ----- --- ----- ------- $14,182 -------
The accounts were certified as having been prepared by a firm of chartered accountants.
15. In evidence the applicants were unable to explain the basis on which the accounts had been prepared. It became apparent that the general rule was that the income was recognised when it was received and the outgoings were recognised when incurred. Given the cash sales nature of the business it appears, on the limited evidence available, that the method of accounting is appropriate to the business. However, no explanation was given to the Tribunal as to why the debt owing to the solicitors, having been brought to account as an expense incurred, was not then shown in the balance sheet. The problem was carefully explained to the applicants by the Tribunal during the course of the hearing but they elected not to take the matter any further.
16. It was submitted for the respondent that the amount of $1,932 was not incurred by the partnership during the year ended 30 June 1979. It was said that the taxpayer must be definitively committed in the year of income although there has been no actual disbursement. Reliance was placed upon the decision in
F.C. of T. v. James Flood Pty. Ltd. (1953) 88 C.L.R. 492 at p. 506. In support the respondent's representative submitted ``that it is fair to say that proper commercial or accountancy practice for general businesses conducted on an accruals basis is that an expense is incurred when an account is received. It is not usual or proper commercial or accountancy practice, I would submit, for these types of businesses to make estimates of expenses at 30 June each year, and to make claims in their income tax returns on this basis''.
17. There is no evidence before the Tribunal as to commercial and accounting practice but the Tribunal doubts that submission as having any factual basis. Nor can I see that the Commissioner's submission that the partnership had not incurred the expenses because the bill of costs had not been received derives any support from the Tribunal's decision in Case U19,
87 ATC 181, a decision similar on the facts to the present case, as the Commissioner's representative sought to show.
18. The present case differs from Case U19, because, on the evidence, the liability to the
ATC 304solicitor was not quantified until 6 July 1979. However, that liability to pay the costs had existed at least from 15 May 1979 when the Local Government Court ordered that each party bear its own costs. The partnership had a contractual obligation to pay the costs and the court order meant that the partnership was liable for the costs and could not seek restitution from another party to the proceedings.
19. In F.C. of T. v. James Flood Pty. Ltd. (supra) at pp. 506-507 the High Court stated the basic principles as to the meaning of ``incurred'' as follows:
James Spencer & Co. v. Commissioners of Inland Revenue (1950) S.L.T. 266, at p. 268; (1950) S.C. 345, 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 (1938) 61 C.L.R. 179, at p. 207. Nothing that was decided in
W. Nevill & Co. Ltd. v. Federal Commissioner of Taxation (1937) 56 C.L.R. 290 was intended to imply that a liability to pay an ascertained sum is never incurred until the sum becomes due and payable.''
20. The facts of this case show that the partnership had encountered the liability on 15 May 1979 when the Court made its order. The only question thereafter was the quantum of the bill of costs to be submitted to the partnership. As was said in
R.A.C.V. Insurance Pty. Ltd. v. F.C. of T. 74 ATC 4169 at p. 4176:
``Once events have occurred out of which a liability to indemnify an insured arises, it appears to me that within the meaning of sec. 51(1) of the Income Tax Assessment Act a loss or outgoing has been incurred. Events have occurred which have subjected it to a liability to indemnify its insured against his liability to a third person and the extent of that liability is capable of reasonable estimate. Where there is no real question of the liability of the insured to the third party and the only question is one of estimating damages, the fact that the quantum of the loss or outgoing is a matter of estimate and that the amount may have to be adjusted in the light of later events does not stand in the way of it being a loss or outgoing (see New Zealand Flax Investments Ltd. v. F.C. of T. 61 C.L.R. 179 at p. 199 and
Texas Co. (Australasia) Ltd. v. F.C. of T. 63 C.L.R. 382 at p. 465 to 466)...''
The Tribunal is therefore satisfied that the whole of the amount claimed was incurred during the year of income.
21. I turn now to the question as to whether the balance of the claim not allowed by the respondent is an allowable deduction within the terms of sec. 51(1). It is sufficient for present purposes to consider the second positive limb of the subsection as the partnership was clearly carrying on a business. Section 90 of the Act provides that the net income of the partnership is the assessable income of the partnership, calculated as if the partnership were a taxpayer who was a resident, less all allowable deductions. Given that the partnership was carrying on a business the question is whether the legal costs were necessarily incurred in carrying on the business for the purpose of gaining or producing the assessable income.
John Fairfax & Sons Pty. Ltd. v. F.C. of T. (1959) 101 C.L.R. 30; 11 A.T.D. 510 the question at issue was the deductibility of legal expenses incurred by a newspaper proprietor in defending an action brought for rectification of the share register of another company by deleting the shares in that company held by the taxpayer. The action was eventually dismissed by consent but the taxpayer had to bear its own costs and claimed a deduction in respect of those costs. The High Court was unanimous in finding that the claim was not allowable.
23. In the course of his judgment Fullagar J. said at C.L.R. p. 40; A.T.D. p. 514:
``The two categories of s. 51(1) are clearly not mutually exclusive, and it has indeed been said that `in actual working' the addition of the second category can `add but little to the operation of the leading words `losses or outgoings to the extent to which they are incurred in gaining or producing the assessable income':
Ronpibon Tin No Liability v. Commissioner of Taxation (1949) 78 C.L.R. 47, at p. 56; 8 A.T.D. 431. But it was not denied that there may be cases which fall outside the first category and within the second. The first is directed to expenditure incurred in the actual course of producing assessable income:
Amalgamated Zinc (De Bavay's) Ltd. v. Commissioner of Taxation (1935) 54 C.L.R. 295, at pp. 303, 309; 3 A.T.D. 288; W. Nevill & Co. Ltd. v. Commissioner of Taxation (1936) 56 C.L.R. 290, at p. 305; 4 A.T.D. 187. It is, primarily at least, concerned with expenditure voluntarily incurred for the sake of producing income. Its scope is not, of course, confined to cases where the income is derived from carrying on a business. The second may be thought to be concerned rather with cases where, in the carrying on of a business, some abnormal event or situation leads to an expenditure which it is not desired to make, but which is made for the purposes of the business generally and is reasonably regarded as unavoidable: Hannan, Principles of Income Taxation, p. 291;
Commissioner of Taxation v. Snowden & Willson Pty. Ltd. (1958) A.L.R. 533; 11 A.T.D. 463.''
The paragraph referred to by his Honour in Dr Hannan's work reads as follows:
``The meaning of `necessarily' in that context is probably not limited to compulsion in a legal sense (e.g. under statute, judgment, or award) and may extend to business expenditure arising out of exigencies created by unusual or difficult circumstances.''
24. The type of case contemplated by the learned author and by his Honour had already manifested itself in
F.C. of T. v. Snowden & Willson Pty. Ltd. (1958) 99 C.L.R. 431; 11 A.T.D. 463. Allegations were made that the company had engaged in unfair and dishonest trading practices which resulted in the appointment of a Royal Commission to enquire into the allegations. The company incurred advertising expenses in refuting the allegations and also incurred legal expenses by its appearance before the Royal Commission and claimed these expenses were deductible under sec. 51. The High Court (Webb J. dissenting) held that the expenditure in question was an outgoing necessarily incurred by the company in carrying on its business for the purpose of gaining or producing assessable income and was therefore deductible. The majority also found that the expenditure was on revenue account and not of a capital nature. Fullagar J. (with whom Williams J. agreed) referred at C.L.R. pp. 443-444; A.T.D. pp. 468-469 to the word necessarily in the second limb of subsec. 51(1) as meaning for practical purposes that, within the limits of human conduct the person carrying on the business is to be the judge of what is ``necessary'', the revenue
ATC 306being adequately safeguarded by the exclusion of expenditure of a capital nature.
25. Dixon C.J. came to a conclusion which emphasised an objective approach in the following passage at C.L.R. p. 437; A.T.D. pp. 464-465:
``Clearly the expression is used in relation to business. Logical necessity is not a thing to be predicated of business expenditure. What is meant by the qualification is that the expenditure must be dictated by the business ends to which it is directed, those ends forming part of or being truly incidental to the business.
In the present case it appears to me that the taxpayer company could do nothing else but defend itself, if it was to sustain its business and continue carrying it on in anything like the same volume or according to the same plan. That seems to me to be enough.''
The dicta of Dixon C.J. is apt to the facts of this case.
26. The partnership incurred the expenses in dispute for the purpose of enabling it to continue to carry on the nursery business. It was not seeking to do anything different than it had been doing in the past and merely sought retention of the status quo so as to avoid perceived damage to its business. Clearly the expenses were necessarily incurred in carrying on the business of the partnership for the purpose of producing assessable income.
27. Were the expenses outgoings of a capital nature? In this case the advantage sought by the partnership was continued quiet enjoyment of the property on which it conducted its business. No new advantage or right was sought, merely the continuation of that quiet enjoyment.
Sun Newspapers Ltd. v. F.C. of T. (1938) 61 C.L.R. 337 at p. 363 Dixon J. stated three tests to assist in determining whether an outgoing was a capital sum:
``Again, the cases which distinguish between capital sums payable by instalments and periodical payments analogous to rent payable on revenue account illustrate the fact that rights and advantages of the same duration and nature may be the subject of recurrent payments which are referable to capital expenditure or income expenditure according to the true character of the consideration given, that is, whether on the one hand it is a capitalized sum payable by deferred instalments or on the other hire or rent accruing de die indiem, or at other intervals, for the use of the thing: compare
Ogden v. Medway Cinemas Ltd. (1934) 18 Tax Cas. 691 with Inland
Revenue Commissioners v. Adam (1928) S.C. 738; 14 Tax Cas. 34 and
Green v. Favourite Cinemas Ltd. (1930) 15 Tax Cas. 390.
There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play 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.''
29. Applying those tests to the facts of this case:
- (i) the amounts claimed were incurred because the exigencies of the business demanded that the partnership take action to ensure no undue interruption to its business - no asset was acquired and all that accrued to the partnership was the limitation of the nuisance which would otherwise have occurred;
- (ii) a nursery business is likely to incur expenditure to limit adverse effects upon its business at any time; and
- (iii) the outgoings were incurred because of the application to quarry and the likely consent to that application - no added benefit accrued to the partnership.
30. I am satisfied that the expenditure in question was necessarily incurred in carrying on the nursery business from which the [partnership] derived assessable income at all relevant times and that the outgoings were not of capital or of a capital nature.
31. The Commissioner's representative submitted that some portion of the costs incurred related to the private dwelling on the nursery premises occupied by the applicants. No basis of apportionment was suggested to the Tribunal and none is apparent on the evidence.
ATC 307Nor does the evidence support the Commissioner's submission, there being nothing to suggest that the partnership was concerned other than to protect the nursery - de minimis non curat lex.
32. The objection decision under review will be set aside and the objection allowed.