Case X84
Members:BJ McMahon DP
Tribunal:
Administrative Appeals Tribunal
B.J. McMahon (Deputy President)
This is a review of four objection decisions disallowing deductions for legal expenses. In the years ended 30 June 1978 and 1979, the applicant incurred legal expenses of $20,028 and $4,500 respectively. He claims to be entitled to deduct them under sec. 51 of the Income Tax Assessment Act as they were necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income and they were not outgoings of capital or of a capital, private or domestic nature. The claims were disallowed principally because it was said that the amounts were of a capital nature.
2. The applicant was a medical practitioner registered in both New South Wales and South Australia. As a result of supplying certain tablets to a person who was subsequently shown to be a drug addict, he was charged in 1976 under the Poisons Act (N.S.W.) with supplying the drug and with failure to keep a drug register. The terms of the two charges were as follows:
``That [the applicant] on the 15th April, 1976... being a medical practitioner authorised to be in the possession of and supply any drug of addiction for the purposes of his profession did fail to comply with provisions of Paragraph 1 of Regulation 53 made under Division 1 of Part 4 of the Poisons Act 1966 and did supply a drug of addiction to wit, Dextromoromide for the purpose other than that of his profession.
That [the applicant] on the 15th April, 1976 did... fail to comply with the provisions of Paragraph 1 of Regulation 58 made under Division 1 of Part 4 of the Poisons Act of 1966 as amended in that he being a person engaged in the supply of a drug of addiction to wit, Dextromoromide did not keep [records] consecutively and in or to the effect of Form 8 of the Regulations in which was entered or caused to be entered records of such drug supplied or used by him or on his behalf.''
3. Subsequently he was further charged with an indictable offence of selling a drug of addiction. This third charge arose out of the same incident. All matters were heard at a Court of Petty Sessions between 1976 and 1978. Senior counsel was engaged to defend the applicant. He was acquitted of the indictable offence. He was found guilty of failing to keep the drug register and was fined $200. The charge of supplying drugs of addiction other than for medical purposes was dismissed after the police offered no evidence. The amount of $20,028 was expended in the defence of these charges.
4. As a result of these matters further investigations took place by Commonwealth authorities. On 4 December 1978 he was convicted of the following offences which, stated shortly, were:
``1. that he on 15th April 1976 failed at... to comply with those provisions of the Regulations made under the Poisons Act 1966 requiring the keeping of a drug register, he being a person engaged in the supply of a drug of addiction
2. that he on 12th April 1976 at Sydney did present a document false in a material particular which was capable of being used in an application for payment of money under the Health Insurance Act 1973, that [A] on four specified dates did receive certain medical treatment and in respect of which [the applicant] was paid money by Medibank
3. that he on 12 April 1976, at Sydney did present a document false in a material particular in respect of [B] for the same purpose as that stated in 2
4. that he on 3rd May 1976 at Sydney did present a document false in a material
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particular in respect of [C] for the same purpose as that stated in 2.''
5. In respect of the first matter the applicant was fined $200; in respect of the second he was fined $500 and ordered to make reparation of $46.55; in respect of the third matter he was convicted and released under sec. 20 of the Crimes Act (Cth) without sentence, upon giving security by way of a recognizance in the sum of $1,000 conditional upon his being of good behaviour for three years. He was ordered to make reparation of $46.55. In respect of the fourth matter, he was fined $500 and ordered to make reparation of $9.70.
6. A third group of charges was later brought against the applicant. He was convicted of another 36 offences against the Health Insurance Act 1973 between 5 August 1977 and 25 May 1978. The substance of these charges was later summarised by a Medical Disciplinary Tribunal in the following words:
``The details and circumstances concerning the... group of thirty-six charges were not in dispute. [The applicant] had patients sign blank, partly completed or fully completed Medibank Claim Forms of which he kept a stock in his surgery. He would then have another person, an `agent,' take the claim to Medibank, obtain cash and return it to him. Often he would drive the `agent' to Medibank himself and wait for them while they obtained the benefit. The `agents' fell into three categories. Firstly, his employees whom he drove to Medibank telling them the patient for whom they were making the claim was unable themselves to get to the Medibank office. Secondly, there were patients whom he asked to make the claim as favours for other patients who were incapable themselves of getting to the Medibank office and, thirdly, there were certain patients whose friendship [the applicant] fostered and who in gratitude were willing to make the claims of other patients. Apparently shortly before his arrest [the applicant] had approached various people with processed memoranda of fees forms which they had never seen before but which related to claims which had been made in their names. He advised them to give no information to Medibank and took other steps to attempt to frustrate the investigation. Upon a search of his premises he was observed to attempt to hide sixteen memoranda of fees under a brick in his backyard.''
7. Convictions for these offences were deemed, under sec. 27(1A) of the Medical Practitioners' Act 1938 (N.S.W.), to be complaints. A Medical Disciplinary Tribunal subsequently held an inquiry into those complaints. After summarising the facts and arguments, the Tribunal gave these reasons for its decision:
``It is the view of the Tribunal that [the applicant] is unfit to practise his profession. The convictions disclose circumstances which lead it to the conclusion that he has little, perhaps, no regard for the law and that placed in a position where the means of cheating a public fund are readily available he has acted in a greedy, if not rapacious, manner. He has been deliberate and cunning in his fraudulent activities and the Tribunal has no confidence that he would act differently in the future if given the opportunity. The Tribunal sees the public interest best served by directing that the name of [the applicant] be removed from the Register of Medical Practitioners in New South Wales.''
8. The Tribunal exercised power conferred on it by sec. 29 of the Medical Practitioners Act which is in the following terms:
``29(1) Where any registered person has been adjudged guilty by the disciplinary tribunal, that tribunal may by order -
- (a) reprimand or caution such person or
- (b) suspend such person from practice for a period not exceeding twelve months or
- (c) direct that the name of such person be removed from the register.
(2) Where any registered person has been so adjudged guilty, the tribunal shall not make an order suspending such person from practice or directing that his name be removed from the register where the offence is such that, either from its trivial nature or from the circumstances in which it was committed, or the conduct is such that it does not, in the public interest, disqualify the person from practising his profession.
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(3) While any order of suspension from practice under this section remains in force the person concerned shall be deemed not to be registered, but forthwith on the expiry of such order his rights and privileges as a registered person shall be revived as from the date of such expiry.
(4) There shall be a right of appeal to the Supreme Court from an order of suspension or an order directing that the name of any person be removed from the register pursuant to this section or against any refusal of the restoration of any name to the register and on any such appeal the court may make such order as it thinks proper, having regard to the merits of the case and the public welfare.
Any such appeal shall be in the nature of a rehearing, and shall be made in accordance with rules of court.
(5) An order of suspension or an order directing that the name of a registered person be removed from the register shall not take effect until the expiration of a period of twenty-one days after notification in the prescribed manner by the disciplinary tribunal to the registered person of the making of such order.
If within such period the registered person gives due notice of appeal to the Supreme Court, such order shall not take effect unless and until the order is confirmed by the Supreme Court or the appeal is for any reason dismissed by that court.
Unless the Supreme Court otherwise orders the period of suspension named in the order appealed from shall commence on the day when that order commences to have effect.
(6) In any case where the court confirms or dismisses an appeal against an order directing that the name of any registered person be removed from the register, the court may fix a time after which the person whose name is removed from the register may apply to have his name restored to the register.
(7) At the expiration of such time any person whose name has been removed from the register may apply to have his name restored to the register, and all the provisions relating to applications for registration shall, so far as applicable, apply to applications for restoration.
(8) The disciplinary tribunal may, if it thinks fit, terminate any period of suspension under this section before the expiration of the period specified in the order of suspension, or, subject to subsections six and seven of this section may by order direct that any name removed from the register pursuant to this section or by the Medical Board as constituted under any Act repealed by this Act be restored to the register.
(9) The powers exercisable by the Supreme Court on appeal in accordance with this section shall also be exercisable in respect of any appeal pending which may be made against the decision of the Medical Board as constituted under any Act repealed by this Act.''
9. The applicant appealed to the Supreme Court but on 10 October 1980 the decision of the Tribunal was affirmed. In respect of the Tribunal proceedings and the Supreme Court appeal, the applicant incurred legal expenses of $4,500. This is the second claim referred to in para. 1. An application was made in 1990 for reinstatement to the register of medical practitioners in N.S.W., but was refused.
10. The applicant then moved to South Australia. For the years ended 30 June 1983 and 1984, he incurred legal expenses of $4,441 and $6,000 respectively in that State. These were also claimed as deductions in the relevant years and were disallowed for the same reasons.
11. Deregistration proceedings were taken before a Medical Disciplinary Tribunal in South Australia following the findings in New South Wales. Although no detailed evidence was presented to me, it seems likely that the grounds for the proceedings were the same as those that were before the New South Wales Tribunal. The applicant said in evidence that because of local differences in requirements to keep a poisons register (for example) he was successful in retaining his registration in South Australia. He still maintains that status. The first amount of legal expenses was incurred in these proceedings.
12. He was later charged in South Australia with assaulting two female patients who were
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said to be prostitutes and drug addicts. He was committed for trial by a stipendiary magistrate but was found not guilty by a judge and jury. The second amount of legal expenses was incurred in defending these charges.13. In all cases, the applicant has said in his returns, in his objections and in his evidence that it was necessary to defend the proceedings brought against him because failure would have resulted in his deregistration as a medical practitioner thereby depriving him of his sole source of income. In each of the proceedings referred to, he had a real fear of this result. In New South Wales, as it transpired, that fear was justified.
14. In seeking to distinguish these expenses from capital expenditure, the applicant's counsel relied on a number of cases. He referred to the often quoted exposition of the Federal Court in
F.C. of T. v. Cliffs International Inc. 77 ATC 4564; 16 A.L.R. 681. In particular, he referred to a passage of Bowen C.J. at ATC p. 4576; A.L.R. pp. 696-697:
``It remains to consider whether the legal expenses amounting to $16,638 incurred in the year ended 31st December 1974 were deductible under sec. 51(1). I have already stated the circumstances in which they were incurred. It appears to me they were losses or outgoings necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. They were not losses or outgoings of capital. Nor does it appear to me they were losses or outgoings of a capital nature. They did bear a relationship to the deferred payments made to Howmet, which I have concluded were payments of a capital nature. The advice related to the deduction of withholding tax from these payments. But this relationship is, in my opinion, insufficient to make the legal expenses an affair of capital. They were not paid for an asset and they were not incurred in relation to the business entity, structure or organisation set up for the earning of profits (see
John Fairfax & Sons Pty. Limited v. F.C. of T. (1959) 101 C.L.R. 30). They were incurred by Cliffs in the course of managing its affairs directed generally to the production of revenue and the avoidance of loss. In my opinion the legal expenses are an allowable deduction under sec. 51(1).''
15. The fate of the claim for legal expenses in that case however depended upon the fate of the claim for the principal sums to which they were related. In considering what those principal sums were really paid for, his Honour came to the conclusion that they were directed generally to the production of revenue. As will be seen from the passage quoted however, his Honour clearly recognised that if the principal sums had been paid for an asset or were incurred in relation to the business entity, structure or organisation set up for the earning of profits, then neither the capital payments nor the ancillary legal expenses would have been deductible.
16. Counsel also relied upon
Magna Alloys & Research Pty. Ltd. v. F.C. of T., 80 ATC 4542. It seems to me however that the proceedings that were defended in that case 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. I referred to that distinction in Case V140,
88 ATC 875 at para. 11. Similarly the legal expenses referred to in Case V116,
88 ATC 737 for defending defamation proceedings were incurred in matters that were peripheral to the taxpayer's profession. Had he been unsuccessful in the defamation proceedings, his ability to act as a director and his registration as a solicitor would not have been affected.
17. The applicant's counsel also relied on Case U4,
87 ATC 122. This decision (given extempore) also concerned the legal costs of a medical practitioner incurred in defending proceedings. It seems to me however that the nature of the facts in that case were nowhere near as serious as the nature of the facts in the present application. They were summarised by the Tribunal at para. 6 and 7. The applicant in his obstetric practice used an echogram of foreign manufacture, an instrument not widely used in this country in the later 70s. For the purposes of the Health Insurance Act, two schedules were provided for, one for uni-dimensional echography, and the other for bi-dimensional echography. As a result of a subsequent investigation, the Health Commission formed the view that the applicant performed a uni-dimensional investigation but charged for a bi-dimensional one. The applicant did not accept the allegation and defended
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himself against the proceedings brought under the Health Insurance Act.18. The Tribunal in para. 11 observed:
``It is not for us to speculate on the likely and, indeed, hypothetical outcome had the applicant been convicted. The outgoings were, in a real sense, directed towards preserving his earning capacity, and therefore readily distinguishable from Case N9,
81 ATC 56, relied on by the respondent, where a Taxation Board of Review was unable to find a perceived connection between the expenditure in any year in defending the charges laid against the taxpayer and his income earning activities as a director.''
19. I find myself unable to agree wholeheartedly with this observation. Indeed when considering legal expenses, I think it is absolutely necessary to view the nature of the proceedings in respect of which the expenses were incurred, to determine whether the likely outcome threatened the existence of a structural asset. As Brennan J. pointed out in Magna Alloys (p. 4550) it is necessary to establish the objective purpose of the expenditure incurred. The taxpayer's state of mind is not necessarily a sufficient indication. To establish the purpose, one must look at the facts behind the expenditure and analyse them.
20. In Case V140 I observed at para. 11:
``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 practice 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.''
21. In
F.C. of T. v. Snowden & Willson Proprietary Limited (1958) 99 C.L.R. 431 (upon which counsel for the applicant also relied) the High Court considered the facts, and expressly negated a view of them that would have seen the appearance before the Royal Commission referred to in that case as a matter of defence in a situation of peril. The Commission was not a special challenge to the continuance of a business or the holding of property from which income was derived. The purpose of the legal expenses was to prevent a situation arising in which customers might refuse to pay instalments under contracts into which they had entered.
22. The distinction between expenses to protect revenue and expenses to withstand a special challenge to the existence of the revenue-earning structure was again illustrated in Case N65,
81 ATC 335 where a State Pharmacy Board found that the taxpayer was guilty of conduct discreditable to a pharmaceutical chemist in conspiring to bring about breaches of the relevant Act. The Board cancelled his registration.
23. It is not necessary in considering the nature of legal expenses (and many of them would be deductible) to have regard to the question whether the defence was successful or not. An objective consideration of the nature of the facts involved will give an indication of whether the structuralasset is at risk. If of course deregistration does come about then that in retrospect reinforces or justifies that objective view. Here the Act allowed a variety of punishments in N.S.W., of which deregistration was the most severe. A consideration of the facts which I have recited must lead to the conclusion that there was indeed a special challenge to continued registration.
24. In each of the claims under consideration the applicant, by his own account, was risking his continuing right to derive his principal source of income through the practice of his profession. In New South Wales, he lost that right. The seriousness of the facts is illustrated by his failure to obtain re-registration some 10 years later. In South Australia, he retained his registration. In both cases however the charges brought were of such seriousness that any observer must have viewed them as a serious risk to the fundamental right to practise. That being so, expenses incurred in defending that right must be regarded as capital expenses.
25. The respondent also argued that the expenses were not deductible because there was an insufficient nexus between the expenditure and the income-producing process. It is clear from the decision in
Madad Pty. Ltd. v. F.C. of T. 84 ATC 4739
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that a penalty imposed for a breach of the law is not an allowable deduction. The Court speculated that this approach might well have its origins in public policy considerations. If that were so, then clearly expenses incurred in defending criminal proceedings should also not be allowable. Brennan J. gave early support to that view in Magna Alloys (p. 4554). It is said they cannot stand in a better position than the penalty imposed. The Commissioner argued that the prohibition of deductions for penalties was not based on public policy but was based on relevance. It was submitted that the conduct of the applicant in the present proceedings was so inappropriate as not to be relevant to his medical practice. His conduct stood outside the ordinary standards of conduct of a medical practice, to such an extent that what he did could not be said to be connected with his work.26. In my view it is not necessary to examine this argument and its foundation. I have come to the conclusion that all four parcels of expenditure were in defence of a structural asset and were therefore capital in nature. On this ground alone, they fall within the exception in sec. 51 and are not deductible. Accordingly the objection decisions under review are affirmed.
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