FC of T v GRANT & ORS
Judges:Jenkinson J
Court:
Federal Court
Jenkinson J
Consolidated appeals from the decisions of the Administrative Appeals Tribunal setting aside the decision of the applicant on an objection by each of the four respondents against his assessment to income tax for the year ended 30 June 1981 [reported as Case X20,
90 ATC 231].
The appeals concern the question whether an amount which was taken into account in the calculation of a payment made in that year to each of the respondents under an agreement regulating their retirement from a partnership formed part of his assessable income of that year. The respondents and three others constituted a partnership on 1 August 1978 to carry on a business in Victoria as chartered accountants. The respondents Grant, Falk and Thomas had been conducting such a business in partnership and the respondent Mallett had been conducting another such a business in partnership with Ronald Joseph Sicree, James Watt and Neil Leslie Curwood, who joined in the partnership formed on 1 August 1978. Each of those latter four gentlemen was credited as having contributed to the partnership the sum of $65,631.65 in respect of work done in part performance of contracts for accountancy services with the firm of which they had been partners immediately before 1 August 1978. Each of the other three gentlemen was credited as having contributed $12,475.44 in respect of work done in part performance of similar contracts with the firm of which they had been partners immediately before that date. All the remuneration derived after 1 August 1978 under all those contracts was treated as income of the partnership and an amount equal to the aggregate of the amounts credited was recorded as an asset of the new partnership at its formation and described in the partnership accounts as ``work in progress''. In the partnership accounts as at 30 June 1979 and 1980, and as at 28 February 1981, the income of the partnership in the profit and loss account was stated at the aggregate of the value of the work done during the year. That amount equalled the aggregate amount of fees for which accounts were rendered during the year plus the amount by which the value assigned work in progress at the end of the year exceeded the value assigned work in progress at the beginning of the year or minus the amount by which the value at the beginning exceeded the value at the end.
The ``net income'' of the partnership, within the meaning of that expression in Division 5 of
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Part III of the Income Tax Assessment Act 1936, was however returned, and each partner's share in it was assessed, in respect of each of the years of income ended 30 June 1979 and 1980 on the basis that the gross income of the partnership consisted of the aggregate amount of the fees for which accounts had been rendered during the year of income, in accordance with the principles expounded inHenderson v. F.C. of T. 69 ATC 4049; 70 ATC 4016; (1968-1970) 119 C.L.R. 612. When the respondents retired from the partnership during the year of income ended 30 June 1981 and partnership accounts were made up as at 28 February 1981 accounts had on or before that later date been rendered for all work done in respect of which a recoverable debt due to the firm had been created on or before that date. In accordance with the principles expounded in Henderson's Case 69 ATC at 4059-4061, 70 ATC at 4020; (1968-1970) 119 C.L.R. at 634-638, 650-651, the respondents' shares of the net income of the partnership in respect of the year of income ended 30 June 1981 included an amount calculated on the basis that the gross income of the partnership was the aggregate of the fees in respect of which accounts had been rendered between 1 July 1980 and 28 February 1981. The partnership accounts as at 28 February 1981, as adjusted in a way which I understand the parties to have accepted, revealed the value of work done but not affording any recoverable debt at 28 February 1981 to be $207,755. This amount the applicant treated as also part of the net income of the partnership in respect of that part of the year of income ended 30 June 1981 which ended on 28 February 1981 for the purpose of assessing the share of that net income of each of the respondents. The objection of each respondent against the inclusion in his assessable income of any amount referable to that sum of $207,755 was wholly disallowed by the applicant's decision, which the Administrative Appeals Tribunal set aside. The Tribunal's decision was that the objection be wholly allowed.
The written agreement in pursuance of which the seven partners commenced to carry on business on 1 August 1978 provided that the partnership should continue until it was terminated in accordance with certain procedural requirements by a resolution passed by ``at least seventy-five per cent of the partners''. It was expressly provided that the death, bankruptcy or retirement of any partner should not ``terminate or dissolve the partnership''. Several clauses of the agreement provided for cessation of membership of the partnership, without dissolution, in several kinds of circumstance. It was provided that, in the event of retirement at the mere will of the retiring partner, the continuing partners should "pay in equal shares to the retiring partner the following amounts:
- any amount outstanding to the credit of his Capital Account... and any amount standing to the credit of his Current Account including his proportion of the net earnings of the Partnership during the period from the 1st July then preceding to the date of retirement..."
The agreement provided for equal sharing among the partners of the net profits and losses of the partnership, which were to be ascertained from books of account kept ``on an accrual basis'', and which were to be credited and debited against each partner's ``Current Account''. As already noted, in the partnership accounts net profit was ascertained by reference to fees for which accounts had been rendered during the period plus or minus the change in the value of work in progress between the beginning and the end of the period.
By a written agreement dated 24 February 1981 the partners made provision for the retirement of the other three respondents on 28 February 1981. It was provided in that agreement that in order to:
``determine the financial rights and obligations of the Partners consequent upon the retirement of the Retiring Partners... the Partners will cause to be prepared financial statements of the partnership business for the period from 1st July 1980 to 28th February 1981... in accordance with generally accepted accounting principles in Australia applied on a basis consistent with that adopted in the preparation of the financial statements of the partnership for the year ended 30th June 1980 but adjusted to take into account the matters referred to in this agreement and the relevant Schedules hereto as therein specified.''
In the final clause of the agreement this provision was made:
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``In all other respects the provisions of the Partnership Agreement shall be observed.''
It was expressly provided that ``Work in Progress'' should constitute one of the assets in the balance sheet as at 28 February 1981. Because the agreement provided for payment to each respondent by the other partners (to whom reference was made in the agreement as ``the Continuing Partners'') of the amount standing to the credit of his Current Account and the amount standing to the credit of his Capital Account (after the Capital Account of each of the seven partners had been brought to a credit balance of $25,000 by transfers between each partner's Capital and Current Accounts), there was included in the calculation of sums agreed to be paid - and in fact paid - to each respondent by the continuing partners a credit of one-seventh of the $207,755 which was the value of work in progress in the balance sheet as at 28 February 1981.
It was submitted by Mr. de Wijn of counsel for the taxpayer that the individual interest of none of the respondents in ``the net income of the partnership'', within the meaning of that expression in Division 5, of the year ended 30 June 1981 included any sum referable to work in progress as at 28 February 1981. I accept that submission. No part of the sum of $207,755 had become due and payable by that latter date and no part of it was assessable income for the purpose of calculating the net income of the partnership from 1 July 1980 to 28 February 1981. None of the respondents had any interest in the net income of the partnership which was derived after 28 February 1981. The provisions of the partnership agreement and of the agreement dated 24 February 1981 are in my opinion inconsistent with the existence after 28 February 1981 of any share or interest of any of the retiring partners in profits gained or income derived after that date. (Cf. Partnership Act 1958 (Vic.) s. 46.) But the question remains whether receipt of the amount which included a credit of one-seventh of the $207,755 constituted a derivation by each respondent of assessable income equal in amount to the amount of that credit.
Mr. de Wijn submitted that at the commencement of the partnership and on 28 February 1981 the value of work in progress was part of the capital of the partnership. Although the partnership agreement does not in terms provide for the inclusion in the capital of the partnership of the four amounts of $65,631.65 and the three amounts of $12,475.44 credited in respect of the work in progress done by the seven partners before the commencement of the partnership, that partnership agreement does provide, in clause 3.1 thereof:
``The capital of the Partnership shall be determined from time to time by unanimous decision of the partners and shall be contributed by the partners equally.''
The findings of the Administrative Appeals Tribunal -
``(i) upon the formation of the partnership, the work in progress contributed by the incoming partners constituted the partnership's major asset and was recorded as such by crediting the partners' capital accounts;
(ii) since its commencement, in compliance with generally accepted accounting principles, the partnership's financial statements were prepared on a `work performed' basis, whilst the tax returns were furnished on a `fees rendered' basis. Furthermore, each year's balance sheet disclosed a valuation for closing work in progress as a partnership asset and the movement in work in progress was brought to account as income for purposes of determining each partner's respective share of the profit;
(iii) adoption of the `work performed basis' for internal accounting purposes has the consequence that work in progress was recognised annually as a legitimate partnership asset.''
- were not challenged, and the facts so found reflect decisions taken by the partners in pursuance of clause 3.1. In my opinion the analogy is close between what the Tribunal found, in paragraph (i) of the passage I have quoted, to have been done on the formation of the partnership and what was done on the sale of an accountancy practice, to a partnership newly formed to carry on such a practice, for a single sum expressed to be consideration for assets set out in a balance sheet of the practice sold which included an item for work in progress. Of the latter transaction Heerey J., in
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Coughlan & Ors v. F.C. of T. 91 ATC 4505, observed [at 4507-4510]:
``It appears to have been accepted in these proceedings that work in progress meant work performed by the old firm, but not performed to such a stage that it was entitled to render a bill to clients....
Two questions arise in this case:
- 1. Is the sum paid for work in progress by the new firm an outgoing of a revenue nature and deductible by the members of the new firm under s. 51(1) of the Income Tax Assessment Act 1936?
- 2. If not, when the work in progress was completed by the new firm and fees charged, are the members of the new firm only assessable for that part of the fees which exceeded the amount paid to the old firm for the work in progress?
The Administrative Appeals Tribunal constituted by Deputy President IR Thompson answered both questions in the negative. In my opinion his decision was correct.
Viewed from the perspective of the purchaser of a business or professional practice, work in progress is a capital asset. It forms part of the structure which the purchaser acquires and from which he intends to produce income.
I accept that contracts for the performance of professional work such as accountancy services are not assignable without the consent of the client and I assume for the purposes of the present discussion that the contractual arrangements for the performance of the work in question had the effect that no fee was payable until the work was completed. The net result therefore is that, as between the new firm and the client, the former did not have a legal right to complete the work and charge the client for the total amount.
But, practically speaking, there must have been a substantial degree of probability that the client would allow his work to be completed by the new firm and would in fact pay the bill for the total amount of the work, including work done prior to the purchase of the business. This seems to me in essence no different from the acquisition of goodwill. The purchaser of goodwill has no legal right to compel clients of the vendor to continue to send their work to him. Nevertheless there is a probability that this will happen. The degree of likelihood of that probability of course depends on an infinite variety of circumstances, including the nature of the work and the personal attraction of the vendor. But it could not be suggested that goodwill is something which conceptually can have no value. It is something intangible, but nevertheless of value, and every day purchasers of businesses pay for the goodwill attached to them.
I should add that, although the purchaser might not be able to compel the client to allow him to complete the work, he would in my opinion have a remedy against the vendor if the latter were to complete the work and charge the client for it. The effect of a contract for a sale of a business including work in progress would ordinarily be that, by agreeing to receive payment for work in progress, the vendor has bound himself not to get the benefit of the work by completing it and charging the client. To do so would be a derogation from grant and an injunction would probably go to restrain the vendor from so acting: cf.
Trego v Hunt [1896] AC 7 at p. 25.The taxpayers' argument was that the payment for work in progress was in respect of work performed and therefore was of a revenue nature. It was, so the argument ran, of no consequence that the new firm paid for the work which had been done by the old firm. It was in principle no different from the new firm paying another accountant for work sub-contracted out,
In my opinion, this argument ignores the critical circumstance that work in progress was acquired by the new firm as part of the assets of a business with the intention of using those assets to produce revenue. The new firm hoped and intended that from 1 July 1979 onwards clients would come through their door attracted by the goodwill of the name Sherlock & Co and that income would be earned by doing work for those clients. The new firm paid the old firm money to obtain that opportunity. In the same way, the new firm paid money for the
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right to get access to the work that was in progress in the old firm's office and the right, from 1 July 1979, to complete that work and charge clients for it. Money was paid for goodwill and work in progress, along with other assets, to acquire a structure which could be used to produce income.The authorities to which I was referred either directly support or are consistent with the conclusion I have reached.
In
City of London Contract Corporation Limited v Styles (1887) 2 TC 239 the taxpayer purchased as a going concern a contracting and engineering business. The business `... consisted entirely of partially executed or wholly unexecuted contracts, and of the rights thereunder and the benefits to accrue therefrom'. It was argued that part of the sum which was attributed to the purchase of the contracts was deductible from the income of the purchaser for tax purposes. It was said that this was not money invested as capital:
- `You can use your capital in purchasing contracts from which you derive your annual profits. It is capital to start with, but then you use your capital wholly and exclusively for the purposes of your concern.'
Bowen L.J. interjected (at p. 243) with a comment which is equally apt for the present case. His Lordship said:
- `You do not use it `for the purpose of' your concern, which means, for the purpose of carrying on your concern, but you use it to acquire the concern.'
In delivering judgment Lord Esher M.R. said (at p. 243):
- `Now nothing can be more plain, if that be so, than that £180,000 was the capital which they embarked in that business, the money they paid for it. But then we are carried beyond that, because there is a description given of what the business is. There is an endeavour to carry out so far as to go into the description of business and to say that the £180,000 is not capital because of the description of the business, but if they bought the business, whatever it may be, and whatever it consisted of, the fact that it is the capital which they embarked in that business cannot be doubted...
- ... it is as plain as plain can be that you cannot deduct from those net profits so arrived at any part of the capital which you so invested, whether you paid it or not for the purchase of the business which you are obliged to purchase before you could begin the difference between expenditure and income year by year.'
An attempt was made to distinguish Styles on the grounds that the contracts in that case, being for building or engineering work, were assignable by vendor to purchaser without the consent of the client. However the reasoning of the Court of Appeal makes no mention of that feature. In any event, for the reasons I have mentioned, the lack of a legal right of enforcement against the client is not of itself inconsistent with work in progress acquired as part of the assets of a business being properly characterised as capital.
Styles was followed by a Board of Review in Case No. F24
(1955) 6 TBRD 149. A solicitor had purchased practices including work in progress. The purchase prices did not include any amount apportioned for that item. The book debts of the vendor were expressly excluded. The taxpayer sought to deduct from his gross income amounts representing the value of the work in progress he had acquired from the vendors. This claim was rejected. The Board said (at p. 153) that:
- `... the taxpayer made lump sum payments of capital, in each instance, for the purchase of a business, a profit yielding subject including all the advantages which the completion of partly executed professional work would yield, but excluding book debts. In due course, the businesses gave forth their yields and the gross revenue or business proceeds thereof actually received by the taxpayer in the relevant period were the full amounts of £980/12/10 and £9,393/8/8 respectively.'
The New Zealand case of
Jamieson v Commr of IR (NZ) (1972) 3 ATR 361 (Woodhouse J.) 74 ATC 6008 (Court of Appeal) concerned a solicitor who withdrew from a partnership under an agreement
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whereby he was entitled to a proportionate share of fees for work in progress as at the date of retirement. This share was calculated and paid to him. It was held that the payment for the share of work in progress was assessable income.It will be seen that Jamieson was not concerned with payment by a purchaser for a business, but rather with the calculation of the benefit that the taxpayer should receive from the partnership up to the time of his retirement. This appears clearly from the judgment of Woodhouse J. at p. 362. His Honour said that there was:
- `... a payment which followed from the agreement of all the partners to vary the method they had used previously for the calculation and division of profits. They agreed that a calculated sum should be included in the accounts to represent the value of work in progress and that payment should then be made to the retiring partner of his appropriate share of profits including that sum. It amounted to a variation of the partnership agreement which affected the method of dividing the profits for the period. It was done for the purpose of dissolution and the inclusion of work in progress was intended to reflect and did reflect the final share of the retiring partner in the business activities of the partnership. It enabled him to be paid out for the period from the last annual accounts up to the date of dissolution. In my opinion the calculation thus made in his favour and the payment that followed it clearly has the quality and character of income in his hands.'
At p. 364 his Honour said:
- `The real point of the case before me is not whether the uncompleted work had any present asset value but whether the share in it that was actually credited to the retiring partner was income in his hands. In my opinion it was a revenue or income sum computed to enable a fair and just distribution of the achievements of the partnership up to the date of dissolution.'
Stapleton v FC of T 89 ATC 4818 also concerned a payment representing a share of work in progress to a retiring partner. Sheppard J. considered the case before him was indistinguishable from Jamieson. His Honour, after expressly adopting the second of the two passages from the judgment of Woodhouse J. referred to above, said (at p. 4827):
- `Work in progress in this context has the particular features and characteristics described by Barwick C.J. and Windeyer J. in Henderson's case, but it is nevertheless an affair of revenue rather than capital. It represents that which will in due course of time become income when the work in question is complete.'
(Henderson v FC of T 69 ATC 4049; 70 ATC 4016 (FC); (1968-1970) 119 CLR 612 was concerned with the point in time at which professional fees of an accountancy firm should be included in assessable income - when the fee was earned or actually received. The context had nothing to do with the sale of a business.) After referring to the judgment of Brennan J. in
Federal Coke Co Pty Ltd v FC of T 77 ATC 4255 at p. 4273; (1977) 34 FLR 375 at pp. 401-402, Sheppard J. said (at p. 4827):
- `The character of the receipt may then be determined by the character, in the recipient's hands, of the matter in respect of which the moneys are received. Here the receipt is characterised by the nature of the matter in respect of which it was received, that is, work in progress which bore no relation to capital and was directly connected with or related to income.'
In the present case, counsel for the taxpayers relied particularly on this passage, but in my view the context was quite different. It is trite law that the same item may be a capital item or a revenue item and payments made or received in connection with the acquisition of the same item may be on capital or revenue account, depending on the nature of the business concerned and who makes or receives the payment. A ship is part of the capital of a shipping company and a price paid for the ship is a capital payment. For a shipbuilder, whose business is to manufacture and sell ships, the price received for the ship is on revenue account. The taxpayers in Jamieson and Stapleton were held to have received payments in the
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nature of income for work in progress because the payments were directly related to the recurrent work they did in the course of their practice. But in the present case the new firm outlaid money to acquire a business and the work in progress was simply part of the assets of that business. It was like purchasing an orchard on which there are trees growing with fruit not yet harvested.It follows from this reasoning in my view that the alternative claim of the taxpayers must also fail. The point is covered by Styles.''
As Woodhouse J. observed in Jamieson v. Inland Revenue Commr (N.Z.) (1972) 3 A.T.R. 361 at 363:
``It does not necessarily follow and I am not prepared to assume that merely because a payment by remaining partners might need to be regarded as a capital payment by them then automatically the amount becomes a capital receipt in the hands of the payee.''
Mr. de Wijn's submission was that the value assigned to work in progress as an asset in each succeeding balance sheet of the partnership, including the balance sheet as at 28 February 1981, was part of the capital of the partnership and each retiring partner's share of that capital included his share of that asset. Therefore, according to the submission, so much of the payment made by the continuing partners to each respondent as reflected his share of that asset, valued at $207,755, was capital in his hands.
Mr. Nettle of counsel for the Commissioner was not concerned to contradict either the proposition that on the formation of the partnership there was a capital asset of the partnership of a value equal to the aggregate of the amounts credited to the capital accounts of the partners in respect of their several contributions of work in progress, or the proposition that on each occasion thereafter, including 28 February 1981, on which accounts were cast the balance sheet included just such an asset and in each of the capital accounts of the seven partners the balance reflected not only that partner's equal share in the value of that asset but also, indirectly, the proportion which the value assigned to that partner's contribution of work in progress at the formation of the partnership bore to the aggregate value of all the partners' contributions of work in progress at that formation. He submitted that, notwithstanding those circumstances, the sum of $207,755 in respect of work in progress at 28 February 1981 was a value assigned to income earning activity and an affair of revenue, not of capital, so that a payment to a retiring partner in the calculation of which credit was given for his proportionate interest in that valued work in progress was to the extent of that credit income in his hands. To the objection that the accounting principles in accordance with which work in progress had been characterised in the partners' accounts as a capital asset - principles which expert evidence before the Tribunal had approved - contradicted his submission, Mr. Nettle rested on the accepted legal principle that accounting methods cannot determine the characterisation of gains as capital or income. He relied on statements by Sheppard J. in Stapleton v. F.C. of T. 89 ATC 4818 at 4827, concerning a payment to a retiring partner by the continuing partners in a firm of solicitors in respect of work in progress at the time of his retirement, that:
``Work in progress in this context has the particular features and characteristics described by Barwick C.J. and Windeyer J. in Henderson's case, but it is nevertheless an affair of revenue rather than capital. It represents that which will in due course of time become income when the work in question is complete. The purpose of para. 7 of the memorandum of 1 January 1975 was to enable a retiring partner to have taken into account the value of potential income, that is, something which would not otherwise be brought to account. But para. 7 did not change the nature of what was involved. It was dealing with something which directly related to income and not to capital.''
If I were to follow the decision in Stapleton's Case I would be required to uphold the appeal, Mr. Nettle submitted.
Mr. de Wijn sought to distinguish Stapleton's Case. (Before considering the case I should observe that the distinction drawn in that case - and noticed in Henderson's Case 69 ATC 4049 at 4060-4061; 119 C.L.R. at 637-638 - between amounts included in work in progress in respect of work for which a legal
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liability to pay exists and amounts constituting work in progress in respect of work for which no such a liability exists, does not bedevil this case. The parties treated work in progress in this case as wholly referable to work in respect of which no such a liability existed. In respect of work in progress at 28 February 1981 the evidence was, and the Tribunal expressly found, that no part of the work was work in respect of which such a liability existed.) In that case the agreement in pursuance of which payment in respect of work in progress was made to a retiring partner by the continuing partners was made on his joining the firm. It cannot be said of that agreement, or of the agreement dated 24 August 1981 in this case, that it was an ``agreement of all the partners to vary the method they had used previously for the calculation and division of profits'', an observation made by Woodhouse J. in Jamieson's Case (3 A.T.R. at 362) of the agreement he was considering. But Sheppard J. does not appear to have regarded the distinction as significant. The memorandum of agreement in Stapleton's Case was in these terms:``1. PJS [the applicant] admitted a partner and acquires a 1.25% capital interest in the goodwill of the partnership, as from 1st January, 1975.
2. The value of the goodwill is fixed at $200,000.
3. The cost of that 1.25% interest is $2,500.00 and is payable by eight (8) equal half-yearly instalments of $312.50 each, commencing 1st July, 1975, subject to any mutually agreed arrangement for shorter term payment. In addition, the partner is required to contribute, in like proportion, to the Working Funds of the partnership in accordance with the basis from time to time established.
4. Salary $12,500.00 per annum, payable monthly, in addition to percentage distributions.
5. Distributions within the new partnership will be made from the distributable cash profits of the partnership (i.e. gross receipts less outgoings, which include partners' salaries) as cash funds are available.
6. The new partner (PJS) will commence to participate in the distributions from 1st January, 1975, and will acquire an entitlement to a share in `work in progress' from that date.
7(a) The amount of each retiring partner's entitlement in `work in progress' is to be paid by monthly payments continuously over the five (5) years following his retirement.
7(b) In any event the distributions (in respect of `work in progress') under this arrangement shall not exceed 15% of the total distributions in any financial year, and any `short fall' is to be added to and be proportioned over the remaining years during which the arrangement would operate so far as each partner is concerned.
8. The continuing partnership arrangements are subject to any income payments to an outgoing or retiring partner or consultant.
9. The partnership is not determined by any re-arrangement within the partnership resulting from retirement, death or otherwise, but the partnership continues as a partnership with the existing partners. The partnership cannot be terminated by any partner, but only by mutual consent.''
Here, submitted Mr. de Wijn, was no creation of any capital entitlement in respect of work in progress in the new partner PJS. His only interest in, or right with respect to, work in progress is created on the one hand by clause 6 of the memorandum, and on the other hand by clause 7(a). The entitlement under clause 6 will be satisfied, unless he were prematurely to retire from the partnership he had just joined, by distributions of profits in pursuance of clause 5. The entitlement, created by clause 7(a), to work in progress at the time of his retirement is quite different from the capital entitlement of each of the respondents in this case, according to the submission. Clause 7 constitutes an agreement specifically about work in progress at the time of retirement, an agreement unconnected with any pre-existing interest or entitlement to any capital or income of the partnership. In this case, on the other hand, the interest and entitlement of each partner in respect of the work in progress as at 28 February 1981 is created, according to the submission, by an agreement (the agreement dated 24 February 1981) which founds upon and gives effect to the capital entitlements created by, or in pursuance of, the partnership agreement.
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In my opinion the suggested distinctions are immaterial. In this case as in Stapleton's Case the partners by contract precluded the operation of s. 36(c) of the Partnership Act 1958 (Vic.), under which one partner might have brought about dissolution at his own will, and made provision for retirement of one or more partners without dissolution. In each case contractual provision was made for a payment, to the retiring partner by the continuing partners, which was in respect of the work of the partnership in progress at the date of retirement and which was measured by reference to the agreed value of that work. In each case that provision was one term of the contract to which I have referred, and of which there were a number of terms. Those, in my opinion, are the circumstances which according to the reasoning of Sheppard J. are relevant to the determination of the question whether the payment was income in the retiring partner's hands. The circumstances that in this case the partners agreed to allow in credit to their capital accounts on the formation of the partnership amounts equal to the agreed values of work in progress brought into the firm as capital assets and thereafter cast their accounts on the basis thus laid at the time of that formation do not in my opinion influence to any different conclusion from that which Sheppard J. reached. What may be agreed to stand as a capital credit in partnership accounts is for the partners' decision. What may conveniently be treated as an asset in the casting of periodic accounts on a ``going concern'' assumption is a question for decision primarily by accountants. (Cf.
Philip Morris Ltd. v. F.C. of T. 79 ATC 4352 at 4356-4360.) But the conclusion whether a payment by continuing partners to retiring partners in respect of the value of work of the partnership in progress at the time of retirement is income or capital in the hands of the payees is not in my opinion affected by those accounting circumstances or those accounting decisions, if the conclusion is to be reached in conformity with the reasoning of Sheppard J. in Stapleton's Case. I agree in, and respectfully follow, that reasoning.
I should record that there was no evidence to suggest, or finding by the Tribunal, that any item of work in progress brought to account on the formation of the partnership was an item of work in progress on 28 February 1981. Nor did counsel refer to the possibility.
Mr. de Wijn submitted that, if the amounts in question were held to be assessable income of the respondents, the same amounts would be assessable income in the hands of the continuing partners when accounts were rendered for work which included the work in progress on 28 February 1981, and that that circumstance suggested, if it did not demonstrate, that the decisions of the Tribunal were correct. But if that ``double'' taxation were to occur - as to which I say nothing - the consideration for payments to the retiring partners, moving from them to the continuing partners, was not merely a consideration of a value equal to that of those payments. A plurality of detriments was suffered on both sides.
In my opinion the amount referable to the share of each respondent in the value of work in progress at 28 February 1981, although not part of his individual interest as a partner in the net income of the partnership within the meaning of s. 92 of the Income Tax Assessment Act 1936, was assessable income of the year of income ended 30 June 1981 under s. 25(1) of that Act.
The assessment in respect of the respondent Mervyn John Mallett, the correctness of which became the subject of consideration by the applicant on the taxpayer's objection and thereafter of consideration by the Tribunal on reference to it of the applicant's decision, was an amended assessment made on 1 May 1989. The original assessment in respect of the year ended 30 June 1981 had been made in August 1984 and had been first amended in May 1987. It was not until the amended assessment of May 1989 was made that the applicant included in Mr. Mallett's assessable income the receipt attributable to work in progress on 28 February 1981. At material times s. 170(3) of the Income Tax Assessment Act 1936 provided as follows:
``Where a taxpayer has made to the Commissioner a full and true disclosure of all the material facts necessary for his assessment, and an assessment is made after that disclosure, no amendment of the assessment increasing the liability of the taxpayer in any particular shall be made except to correct an error in calculation or a mistake of fact; and no such amendment shall be made after the expiration of 3 years from the date upon which the tax became due and payable under that assessment.''
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For reasons which will be stated later in relation to the appeal concerning the respondent Keith Henry Grant it may be taken that a full and true disclosure of all the material facts necessary for Mr. Mallett's assessment had not been made to the Commissioner when the original assessment was made. Full and true disclosure of all those material facts had been made by October 1984, but it was submitted by Mr. Nettle that the disclosure did not satisfy the introductory conditional clause of sub-section 170(3) because the disclosure was by neither the taxpayer nor by any person whose disclosure could be regarded as satisfying that clause.
The respondent Mr. Grant had lodged an income tax return of the partnership in respect of the year of income ended 30 June 1981. It did not, and Mr. Mallett's return in respect of his income of that year did not, disclose the facts required to show that his share of the value of work in progress was part of his assessable income. Later the continuing partners lodged a return of the income of the partnership in respect of that year. The accounts which the continuing partners intended should form part of that return, and which were received by the applicant not later than October 1984, did disclose the required facts. The relevant assertions of fact in the continuing partners' return included express assertions that the return lodged by Mr. Grant was incorrect.
The obligation imposed by s. 91 of the Income Tax Assessment Act - ``A partnership shall furnish a return of the income of the partnership, but shall not be liable to pay tax thereon'' - in my opinion falls on each of the persons resident in Australia who was a member of the firm during the period in respect of which the return is required by law to be furnished. (It is unnecessary for present purposes to consider whether the obligation falls also on other persons, as for example a person who was a member of the partnership during some part of the period in respect of which the return is required to be furnished.) Regulation 13 (as it was numbered at relevant times, now Regulation 20) of the Income Tax Regulations enables the obligation imposed on all to be discharged by one of them. The return furnished by the continuing partners was in my opinion the return which was required by s. 91, the Regulations and the requirement by the Commissioner which s. 163 of the Act and Regulation 13 contemplated.
I would understand s. 170(3) as comprehending within what the ``taxpayer'' to which the sub-section refers has disclosed all that has been disclosed in a partnership return, in respect of the relevant year of income, furnished before assessment of the taxpayer in respect of that year if the taxpayer has before assessment is made disclosed to the Commissioner that he was, or that he has been alleged to have been, a member of the partnership during the whole, or during part, of that year. Unless s. 170(3) is so understood the operation of the Act and Regulations would be quite stultified. It would be pointless to impose the obligation expressed in s. 91 if the taxpayer were to be under an obligation, implied from a different construction of s. 170(3), himself to disclose (whether by annexing to his return a copy of the partnership return or by other means) all the material facts necessary for his assessment which are required to be disclosed, or which are in fact disclosed, in the partnership return. The return forms provided by the Commissioner do not contemplate the existence of any such an obligation.
If the construction of s. 170(3) which I have stated be correct, Mr. Mallett had made to the applicant a full and true disclosure of all the material facts necessary for his assessment not later than October 1984. An assessment was made after that disclosure, namely the amended assessment of May 1987. The further amendment made by the assessment of May 1989, which increased the liability of Mr. Mallett by including in his assessable income an amount having reference to his share of work in progress on 28 February 1981, was made before the expiration of three years from the date upon which the tax became due and payable under the 1987 assessment. But it was not submitted by Mr. Nettle that the amendment made in May 1989 was made to correct an error in calculation or a mistake of fact. (The amendment of s. 170(3) by which the words, ``except to correct an error in calculation or a mistake of fact; and no such amendment shall be made'', were omitted applies to assessments in respect of income of the year of income that commenced on 1 July 1985 or of any subsequent year of income: Taxation Laws Amendment Act 1986, ss. 20(b) and 25(1).) Accordingly the assessment of
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August 1989 was forbidden by s. 170(3) and the appeal in respect of Mr. Mallett should be dismissed.The respondent Keith Henry Grant's first assessment in respect of the year of income ended 30 June 1981 was made on 11 May 1984, after the partnership return prepared by him and his own personal income tax return had been furnished to the applicant. But those returns failed to make that full and true disclosure to which s. 170(3) refers. The assessment was made after the partnership return prepared by the continuing partners had been also furnished to the applicant. But there was documentary evidence before the Tribunal to justify an inferred finding that the sheets of paper containing accounts which did effect that full and true disclosure had not been included in that return, although the continuing partners had intended that they should. The Tribunal's reasons for decision do not show that it did make that finding. I am persuaded that the finding was not only one which the evidence permitted, but also one which the evidence compelled as a matter of law.
Mr. de Wijn submitted that a full and true disclosure satisfying the condition expressed in the introductory clause of s. 170(3) had been made to the applicant in May 1983, notwithstanding the accidental omission of the sheets of accounts from the partnership return furnished to him by the continuing partners in that month. The continuing partners Messieurs Sicree and Curwood sent with that return a letter in these terms:
``Further to our letter of 11th March, we are enclosing income tax return of the above partnership for the period 1 July 1980 to 28 February 1981, showing a taxable income of $196,523, contrasting to the taxable income of $2,768 disclosed on the purported return lodged on behalf of the retired partners.
As previously indicated, we are of the opinion that the retired partners have no legal rights or standing to lodge a return for the firm for the period in question and that the purported return they have lodged has no legal force or effect.
Mr. E.E. Falk retired from the partnership on 31 December 1980 and Messrs. K.H. Grant, J. Watt, M.J. Mallett and J.O. Thomas retired on the 28 February 1981 from which respective dates their rights as partners ceased and their entitlements to capital and income of the former partnership were defined in the retirement agreement dated 24 February 1981.
A dispute has arisen between the former partners as to the correctness of the financial accounts and the financial entitlement of the retired partners in the former partnership and the matters in dispute have, in the terms of the partnership agreement, been referred to an Arbitrator for determination. The matter was originally set down for hearing on 2 July 1982 but for reasons beyond our control, the hearing has been postponed on several occasions and was recently fixed to commence on 15 April but was again postponed. The hearing has been refixed to commence on 15 June 1983.
Because of the unauthorised action of the retired partners in lodging a return, and on the advice of Counsel, we do not believe we should now await the determination by the Arbitrator and accordingly we are now enclosing the return for the period to date of retirement setting out our view of the correct net income of the partnership.
The principal matter in dispute between the partners concerns the treatment of the `work-in-progress' of the partnership as at the date of the retirement of the retiring partners.
The retirement agreement provided inter alia as follows:
- `The final accounts shall be prepared in accordance with generally accepted accounting principles in Australia applied on a basis consistent with that adopted in the preparation of the financial statements of the partnership for the year ended 30 June 1980 but adjusted to take into account the matters referred to in this agreement and the relevant schedules hereto as therein specified.'
The attached accounts have been prepared in accordance with this requirement as a consequence of which `work-in-progress' at 28 February 1981 has been brought to account and the appropriate share of income credited to the current account of each of the partners for the purpose of determining his entitlement in the partnership as at date of
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retirement. The income tax return lodged on behalf of the retired partners ignores `work-in-progress' on the basis that `work-in-progress' has not been brought to account as income in previous returns.In our view, the attached return correctly sets out the taxable income derived by the partnership during the period 1 July 1980 to 28 February 1981 and in our view as the continuing partners, we are the only persons who should be recognized as having legal capacity to lodge a return on behalf of the partnership. We suggest that individual partners should be assessed on the basis of their true and actual share of the income disclosed in this return.''
It was not until October 1984 that the applicant advised the continuing partners that the sheets of accounts had not been enclosed with the return. In the meantime the applicant made his assessment in respect of Mr. Grant on 11 May 1984. The date upon which the tax became due and payable under that assessment was 13 June 1984. The amended assessment increasing Mr. Grant's liability by reference to his share in the value of work in progress on 28 February 1981 was made after the expiration of three years from 13 June 1984, on 24 July 1987. By the letter which accompanied their return the continuing partners - and through them Mr. Grant - had disclosed to the applicant the true state of affairs, Mr. de Wijn submitted, and had given warning to the applicant that that state of affairs might be changed in consequence of the pending determination of an arbitrator. That was, in Mr. de Wijn's submission, to make the disclosure which s. 170(3) specified.
Even if it be accepted that the letter states approximately the amount to be attributed to work in progress on 28 February 1981 ($196,523 minus $2,768) and an outline of the argument justifying the assertion that that amount was to be included in the calculation of the retiring partners' assessable incomes, the letter and the other material in the applicant's hands when he read it affords, in my opinion, ``less than full disclosure of all the material facts, and a disclosure which leaves the Commissioner to speculate as to some of the material facts'', if I may adopt the words of Menzies J. in
Austin Distributors Pty. Ltd. v. F.C. of T. (1964) 13 A.T.D. 429 at 432. That learned judge said of the introductory clause in s. 170(3) (13 A.T.D. at 433):
``The matter can be tested in this way. If advice were to have been sought by the taxpayer whether or not the sum in question was a taxable premium, would the person from whom that advice was sought have required more information than this return disclosed to the Commissioner? I cannot escape the conclusion that he would...''
Substituting the word ``receipt'' for the word ``premium'' and the word ``material'' for the word ``return'', I ask the same question and return the same answer.
Accordingly the assessment increasing Mr. Grant's liability by including an amount in respect of work in progress on 28 February 1981 - that is, the amended assessment of July 1987 - was the first assessment made after Mr. Grant had made, in October 1984, the full and true disclosure of which s. 170(3) speaks. In the case of Mr. Grant therefore the appeal must be allowed, the decision of the Tribunal set aside and an order of this court made that the decision of the applicant be affirmed.
In like case is the appeal in respect of the respondent Jeffrey Owen Thomas. It was not disputed that the assessment increasing his liability by reference to the work in progress was the first assessment made after October 1984. So also in the appeal in respect of the respondent Edward Eugene Falk. In each of those appeals the orders will be in the same terms as the orders in the appeal in respect of Mr. Grant.
In accordance with Mr. Nettle's request, I will order in each appeal that the applicant pay the respondent's costs.
THE COURT ORDERS THAT:
1(a) The appeal in respect of Keith Henry Grant be allowed.
(b) The decision of the Administrative Appeals Tribunal the subject of the said appeal be set aside.
(c) The decision the subject of review by the said Tribunal be affirmed.
(d) The respondent's costs of the said appeal (including reserved costs) be paid by the applicant.
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2(a) The appeal in respect of Edward Eugene Falk be allowed.
(b) The decision of the Administrative Appeals Tribunal the subject of the said appeal be set aside.
(c) The decision the subject of review by the said Tribunal be affirmed.
(d) The respondent's costs of the said appeal (including reserved costs) be paid by the applicant.
3(a) The appeal in respect of Jeffrey Owen Thomas be allowed.
(b) The decision of the Administrative Appeals Tribunal the subject of the said appeal be set aside.
(c) The decision the subject of review by the said Tribunal be affirmed.
(d) The respondent's costs of the said appeal (including reserved costs) be paid by the applicant.
4(a) The appeal in respect of Mervyn John Mallett be dismissed.
(b) The respondent's costs of the said appeal (including reserved costs) be paid by the applicant.
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