PUTNIN v FC of TJudges:
Full Federal Court
Burchett, French and Lee JJ
Mr Bernard Putnin, the applicant, follows the profession of an accountant. A substantial part of his professional work is concerned with the problems of insolvency, and he is a registered trustee in bankruptcy and an official liquidator. In 1981, he became the trustee under a particular deed of arrangement. Among the debtor's assets was a share in a company, of the kind known as a governing director's share. Mr Putnin administered the estate without obtaining an assignment of the share, which was subsequently dealt with by the debtor. In 1983, a charge was laid against Mr Putnin that he had conspired with the debtor and another to defraud the Commonwealth (by some means involving the dealing with the share), and upon that charge he was committed for trial. Proceedings seem to have followed in this court for judicial review of the committal decision. Those proceedings having failed, the prosecution went ahead in September 1985. It resulted in the applicant's acquittal, following a ruling that he had no case to answer.
Under the circumstances which have been outlined, Mr Putnin incurred legal expenses, related to his defence, in each of the years ended 30 June 1984, 30 June 1985 and 30 June 1986. He claimed deductions, for the purposes of the Income Tax Assessment Act 1936, under s. 51(1), which were denied. His objections having been disallowed, the question came before a senior member of the Administrative Appeals Tribunal. The Tribunal's decision was reserved for nearly one year and a half. After that lapse of time, it is perhaps not surprising that some errors and omissions have crept into the reasons which were handed down. But, fortunately, the material facts are few, and there was no dispute about them. The question is simply whether the Tribunal fell into error of law in the grounds it gave for dismissing Mr Putnin's appeals. Although the reasons are concerned with s. 51(1), there was a subsidiary issue whether the applicant could succeed, in the alternative, to the extremely limited extent provided for by s. 64A in relation to the assessments for the second and third of the years in dispute, under which even such a deduction was denied him.
The reasons of the Tribunal commence with a summary outline of the nature of the
ATC 4099applicant's practice. It is then stated, somewhat inaccurately: ``The business was conducted by a partnership of which the applicant was a member during 1984 through to late 1986.'' Actually, the applicant was a member of such a partnership, but he also practised, throughout the period mentioned, on his own account. These facts were not at all in dispute. The reasons also understate the amount of the deduction claimed for the last of the three years by omitting to notice the full amount contended for in Mr Putnin's objection. The correct figure in respect of that year is $50,810.
The Tribunal made the following findings of fact:
``I do not need to review the evidence in detail but I am satisfied on the evidence that the applicant incurred the legal expenses first and foremost because he considered he was not guilty of the charges laid - a perfectly normal and unexceptional reason for defending charges. Secondly, he feared that his appointment as a trustee in bankruptcy was likely to be in jeopardy if convictions were recorded and he feared some detrimental effect on his business although he thought that most clients would stay with the firm irrespective of the outcome. He was also uncertain as to whether he would be able to continue as a partner in the firm especially if his standing as a professional accountant was affected.''
After referring to
Magna Alloys & Research Pty Ltd v. FC of T 80 ATC 4542; (1980) 49 FLR 183, the Tribunal commented: ``The present case is different in that the outgoings do not arise out of the business of the partnership but are of a previous business conducted by the applicant.'' (Emphasis added.) This is a curious comment, since the applicant's returns showed receipt of income for each of the years in question in the name of his sole practice, as well as receipt of income from the partnership. If it was correct to treat the deductibility of the outgoings as dependent upon whether they were claimed as outgoings of the very business conducted by the applicant at the time his professional activities gave rise to the charge, then the fact is his returns of income, in which the deductions were claimed, related to that business as well as to the subsequent partnership. The basis on which the Tribunal distinguished Magna Alloys & Research is accordingly fallacious.
However, it is plain the erroneous distinction drawn by the Tribunal formed a significant part of the foundation of its decision. For, after extensive citations from Magna Alloys & Research, it returned to this matter when stating the following conclusion:
``Unlike the case in Magna Alloys the facts of this case do not establish that the outgoings bear the essential character of outgoings necessarily incurred in carrying on the business of the firm of which the applicant was a member. The outgoings were personal to the applicant and did not arise out of the business of the firm. The outgoings were incurred to seek to protect the applicant's official appointments, his privileges as a professional accountant and his right to retain those privileges including his membership of the Australian Society of Accountants. I am not satisfied that the outgoings were incurred in the course of gaining or producing the assessable income or necessarily incurred in carrying on business for that purpose.''
Not only is this entirely to overlook the applicant's continuing position as a sole practitioner outside of the partnership, but also, as counsel pointed out, the strict dichotomy on which the Tribunal relied is inconsistent with views stated in the High Court in
FC of T v. Gulland 85 ATC 4765 at 4805, (1985) 160 CLR 55 at 125. There, Dawson J. (with whom Wilson J., and also, relevantly, Brennan J., agreed) said of changes in arrangements under which a professional man earned his income:
``The new arrangement did not produce a new source of income in the sense in which the cases use that term. Dr Pincus' source of income whilst he was a sole practitioner, whilst he was practising in partnership, and now under the substituted arrangement, has been, and is, the same, namely the practice of his profession as a doctor. The form of arrangement under which he has practised from time to time has not altered the source of his income in any relevant sense. The source of his income tax has been his professional activities as a medical practitioner whether he has been a sole practitioner, a partner or an employee. It is from those activities that his income has derived and his liability to tax has arisen.''
And again (at ATC 4805; CLR 126-127):
``... Dr Pincus was without interruption carrying on the practice of his profession in a manner which was essentially the same, however much the income which he derived thereby might flow through different channels.''
Gibbs C.J. (at ATC 4776; CLR 76) put the matter pithily:
``In any case it would be wrong to regard the income after the dissolution as coming from a new source; the source remained the practice by the taxpayer of his profession at Stafford Road.''
Bunting v. FC of T 89 ATC 5245 at 5254-5255, 5267-5268; (1989) 90 ALR 427 at 437, 453.
The case put forward by the applicant was really a simple one. According to his contention, the expenditure arose out of his prosecution, in which he was defending his activities in a particular operation of business by which income had been earned. That operation of business was the administration of one estate out of many of which he was the trustee. It followed, he contended, that the costs of his defence were outgoings incurred in gaining or producing assessable income within the first limb of s. 51(1), and, indeed, that they were also necessarily incurred in carrying on a business for the purpose of gaining or producing such income; and further that they were not outgoings of capital or of a capital, private or domestic nature.
It may be a natural incident of the conduct of the operations of a particular kind of business that claims of the commission of torts, or even crimes, may arise, although it is to be hoped not often, and have to be repelled. If the proprietor of such a business is sued for negligence, for example, the cost of defending the suit would arise out of the relevant business operations:
The Herald and Weekly Times Limited v. FC of T (1932) 48 CLR 113. There, the manner in which a newspaper went about the publication of news resulted in its incurring claims for alleged libel. Gavan Duffy C.J. and Dixon J. in their joint judgment (at 118-119) referred to the trial judge's description of certain payments, both of damages and of costs, as ``one of the consequences of gaining or producing the assessable income and in that sense as incidental to the carrying on of the business'' (of the publication of the newspaper). They continued:
``The liability to damages was incurred, or the claim was encountered, because of the very act of publishing the newspaper. The thing which produced the assessable income was the thing which exposed the taxpayer to the liability or claim discharged by the expenditure. It is true that when the sums were paid the taxpayer was actuated in paying them, not by any desire to produce income, but... in the case of law costs, by the desirability or urgency of defeating or diminishing... a claim. But this expenditure flows as a necessary or a natural consequence from the inclusion of the alleged defamatory matter in the newspaper and its publication....
... The question whether money is expended in and for the production of assessable income cannot be determined by considering only the immediate reason for making a payment and ignoring the purpose with which the liability was incurred.... The money was spent to answer the claims, and whether it was expended wholly and exclusively for the production of income [this question was raised at that time by an express provision of the legislation], must depend upon the manner in which the claims were incurred. When it appears that the inclusion in the newspaper of matter alleged by claimants to be defamatory is a regular and almost unavoidable incident of publishing it, so that the claims directly flow from acts done for no other purpose than earning revenue, acts forming the essence of the business, no valid reason remains for denying that the money was wholly and exclusively expended for the production of assessable income.''
The only part of their Honours' reasoning which is not directly applicable to the present case is the reference to the regularity of the claims against the newspaper. But this is not essential to the reasoning, as was made clear by Fullagar J. in
FC of T v. Snowden & Willson Pty Ltd (1958) 11 ATD 463 at 470; (1958) 99 CLR 431 at 446. That was a case factually closer to the present, since the costs in question there related to a single piece of litigation, or rather to an enquiry, a Royal Commission appointed
ATC 4101to investigate the allegedly unscrupulous conduct of the taxpayer's business. Fullagar J. said:
``The expenditure was not recurrent, and it must be regarded as abnormal: it was not a continuing and unavoidable incident of the taxpayer's business, as was the expenditure in Herald & Weekly Times Ltd. v. The Commissioner.''
He nevertheless had no difficulty, as he had made clear at ATD 469; CLR 444, in finding the same sort of relation between the expenditure and the carrying on of the business as had been found in Herald & Weekly Times. He said: ``The expenditure was incidental to the carrying on of the business.''
These cases were considered in Magna Alloys & Research (supra), where the taxpayer company was allowed a deduction in respect of legal costs paid by it, not simply on its own behalf as in the earlier decisions, but on behalf of directors and agents whose actions in the course of the company's business had led to their being accused in criminal proceedings. The trial judge had held that the protection of the personal interests of the directors and agents provided the principal motive or reason for the company's incurring of the expenditure. Nevertheless, Brennan J. (at ATC 4553; FLR 198) comments:
``But it makes no difference that, in the present case, the learned trial judge was unpersuaded that [defence of the company against attacks upon its business methods and reputation] was `the dominant, or even a principal, reason why the expenditure was incurred'. The reason why the directors incurred the expenditure does not define the scope or nature of the taxpayer's business, nor does it reveal what the expenditure was for beyond assisting to show that what was sought and obtained was legal representation to defend the directors and employees. The directors' reasons do not show or tend to show that legal representation to defend the directors and employees was not connected with the carrying on of the business.''
The court, in Magna Alloys & Research, emphasized the distinction between involuntary expenditure (where the characterisation of the expenditure as falling within s. 51(1), or not, can generally be determined without reference to the taxpayer's motive or purpose) and voluntary expenditure (where the taxpayer's purpose may assist in the task of characterisation). See per Brennan J. at ATC 4548; FLR 191, and per Deane and Fisher JJ. at ATC 4558-4560; FLR 206-209. In Magna Alloys & Research, as Deane and Fisher JJ. pointed out (at ATC 4559-4560; FLR 209), the outgoings were not involuntary. The taxpayer plainly had a choice whether or not to underwrite the legal expenses of its directors and agents. In the present case, on the other hand, the taxpayer was himself the accused, and it would be a misuse of language to suggest that payments made in respect of his defence were incurred of his own volition. They were relevantly involuntary. It follows that the objective approach taken by Gavan Duffy C.J. and Dixon J. in Herald and Weekly Times is here the appropriate approach. The purpose to be attributed to the payment is the taxpayer's purpose in the administration of the insolvent estate. That purpose was implicitly found by the Tribunal to be the pursuit of the taxpayer's business (erroneously described as his ``previous business'') when the expenditures were found to be ``outgoings... of a previous business conducted by the applicant''.
Had, however, the costs been voluntarily incurred, the reasoning of Deane and Fisher JJ. (at ATC 4561; FLR 211) would suggest they were necessarily incurred in carrying on the business of the taxpayer for the purpose of gaining or producing assessable income.
However, it was submitted for the Commissioner that the outgoings were of a capital nature. A similar argument was tersely rejected in Magna Alloys & Research, by Brennan J. at 201, and by Deane and Fisher JJ. at ATC 4562; FLR 213. Deane and Fisher JJ. said:
``Except in the most indirect way, the criminal proceedings imperilled neither the business nor the capital assets of the taxpayer.... The criminal proceedings in respect of which the outgoings were incurred arose out of the day to day business activities of the taxpayer. The outgoings did not involve the acquisition of any enduring or tangible assets. They represented expenditure incurred in carrying on the taxpayer's business which should properly be seen as being of a revenue character.''
In the argument presented to this Court, great emphasis was laid on the possibility that the taxpayer might, if he had been convicted, have incurred professional censure and cancellation of his registration as a trustee in bankruptcy or as an official liquidator. As a result, his partnership might have been dissolved. But these were all indirect consequences that might or might not have happened. They were neither the object of the prosecution, nor could it be said they would inevitably have followed upon its success. As in Magna Alloys & Research, the criminal proceedings arose from the activities by which the taxpayer earned his income, the mode of his performance of a particular task carried out in the course of business operations. Something of that kind is quite remote from capital, and the outgoings secured for the applicant no enduring or tangible asset. The last matter, though not conclusive, may be of significance as an indication that an expense is chargeable to revenue and not to capital.
Australian National Hotels Ltd v. FC of T 88 ATC 4627 at 4633-4634; (1988) 19 FCR 234 at 241;
FC of T v. Ampol Exploration Ltd 86 ATC 4859 at 4882-4884; (1986) 13 FCR 545 at 575-577. The true view is that it is not a determinative factor, but it is a pointer to the conclusion that expenditure is not on capital account. In
Consolidated Fertilisers Ltd v. FC of T 90 ATC 5021 at 5028; (1990) 21 ATR 1,056 at 1,064 Pincus J. said: ``Snowden and Willson, and even more strongly the Magna Alloys case, support the deductibility of expenditures, even if of an unique kind, to protect commercial reputation.'' If that is generally so, there is no sound basis for treating the costs paid in this case as of a capital nature merely because, in incurring them, the applicant may have been protecting his professional reputation. Under the circumstances, it was not open to the Tribunal to regard the outgoings as outgoings of capital or of a capital nature.
The reasoning of the Tribunal misapprehends Magna Alloys & Research, and the distinction it attempts to draw in respect of that case is erroneous. The question which arises is whether the decisions should simply be set aside, and the appeals against disallowance of the objections be referred back for reconsideration according to law, or whether this court should, pursuant to s. 44(4) of the Administrative Appeals Tribunal Act 1975, make orders determining the matter. There is a discussion of some of the relevant authorities in
Ogilvy and Mather Pty Ltd v. FC of T 90 ATC 4836 at 4855-4856. In the present case the facts, upon the legal complexion of which the result depends, have been found, or are undisputed. As has already been pointed out, the Tribunal expressly decided that the expenditures in question are ``outgoings... of a previous business conducted by the applicant'', that is, of his business as a sole practitioner, loosely (and wrongly) described, though continuing, as his previous business because in existence before his partnership. Contrary to the view of the Tribunal, the formation of the partnership, in the circumstances of this case, could make no difference to the deductibility of the expenditures. Accordingly, the ``appropriate'' orders, under s. 44(4), will provide for the allowance of the applicant's objections. The appeals should be upheld with costs, and orders should be made establishing the applicant's right to the claimed deductions, in respect of the year ended 30 June 1984, of $21,993, in respect of the year ended 30 June 1985, of $7,495, and in respect of the year ended 30 June 1986, of $50,810.
THE COURT ORDERS THAT:
1. Each appeal be allowed, and each decision of the Administrative Appeals Tribunal the subject of appeal be set aside;
2. The objection against each assessment be upheld, and each assessment be remitted to the Commissioner to be dealt with in accordance with these reasons;
3. The Commissioner pay the applicant's costs of the appeals.