BARRATT & ORS v FC of T
Judges:Neaves J
Court:
Federal Court
Neaves J
Michael MacDougall Barratt, Anthony John Clarke, Michael Andrew Harrison, Thomas Richard Davis and Dermer Evan Smith lodged objections pursuant to s. 185 of the Income Tax Assessment Act 1936 (Cth) (``the Act'') against amended assessments or, in some cases, assessments to income tax in respect of some or all of the years of income ended 30 June 1973, 1974, 1975, 1976, 1977 and 1978. Those objections having been disallowed, the Commissioner of Taxation, at the request of each of the taxpayers, treated each objection by that taxpayer as an appeal and forwarded it to this Court for determination. By consent, the various appeals were heard together.
The objections relate to the amounts included in the assessable income of the taxpayers in the relevant years of income as representing their respective shares in the ``net income'', as defined in s. 90 of the Act, of a partnership of which they were then members. At the relevant time, s. 92 of the Act provided that the assessable income of a partner in a partnership was to include so much of the individual interest of the partner in the net income of the partnership of the year of income as was attributable to a period when the partner was a resident. The expression ``net income'' in relation to a partnership was defined in s. 90 to mean the assessable income of the partnership calculated as if the partnership were a taxpayer who was a resident, less all allowable deductions except the concessional deductions and certain other deductions to which it is unnecessary to refer. It is not in dispute that at the material times each of the taxpayers was a resident.
The question that arises for determination in these appeals is the correct method of calculating the net income of the partnership in each of the relevant years of income. Each taxpayer had returned as part of his assessable income in each relevant year a proportion of the net income of the partnership ascertained on a ``cash receipts'' basis. By the amended assessments and assessments the subject of these appeals, the taxpayers were assessed on the footing that the net income of the partnership in each of the relevant years of income was properly to be assessed on an ``earnings'' or ``accruals'' basis and that the net income so ascertained was to be carried into the assessable income of the partners according to their respective shares of it.
Each of the taxpayers was, at the material times, a medical practitioner. In each of the relevant years of income a pathology practice was carried on in partnership. The partnership was formed in 1972. The members constituting the partnership varied from time to time. During the years ended 30 June 1973 and 1974, the only members of the partnership were Dr Barratt and Dr Smith. From 1 July 1974 to 31 March 1977, the partnership consisted of Dr Barratt, Dr Smith, Dr Harrison and Dr Davis. From 1 April 1977 to 30 June 1978, the partners were Dr Barratt, Dr Smith, Dr Harrison, Dr Davis and Dr Clarke. Consequently, the appeals by Dr Barratt and Dr
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Smith relate to the years of income ended 30 June 1973 to 1978 inclusive, those by Dr Harrison and Dr Davis to the years of income ended 30 June 1975 to 1978 inclusive and those by Dr Clarke to the years of income ended 30 June 1977 and 1978. Each of the appeals other than those of Dr Barratt, Dr Smith and Dr Harrison in respect of the year of income ended 30 June 1978 relates to an amended assessment. The appeals of those taxpayers in respect of the year ended 30 June 1978 are in respect of original assessments. It may also be noted that the amended assessments in respect of the year of income ended 30 June 1977 relating to Dr Barratt, Dr Smith, Dr Harrison and Dr Davis were credit assessments that resulted in a reduction of each taxpayer's taxable income from that previously assessed and in a consequent reduction in the amount of income tax payable. The objections lodged in respect of those amended assessments object only to the amount shown on the relevant notices of amended assessment as being the accumulated amount of income tax owing under the amended assessments relating to prior years after giving credit for the reduction in the amount of income tax payable in respect of the year of income ended 30 June 1977. As the amended assessments in respect of the year of income ended 30 June 1977 did not increase the liability of the relevant taxpayer in any particular, the taxpayers would appear to have had no right of objection against those amended assessments (see s. 185 of the Act).The documentary material placed before the Court is, in some respects, deficient due, perhaps, to the length of time which has elapsed since the relevant events occurred. The partnership return in respect of the year of income ended 30 June 1973 is not in evidence, the Court being informed that no copy of it can now be found. Nor have the income tax returns of the partners for any of the years in question been produced. No formal partnership agreement was tendered nor is there any evidence of the arrangements made between the partnership and the service companies to which reference will be made later in these reasons. Although the basis upon which the amended assessments and assessments the subject of the appeals were made is explicable from an adjustment sheet, it is not always easy to identify in the material before the Court all of the figures shown on that sheet. There is, however, no dispute between the parties as to those figures.
From 1 July 1972 to September 1977, the pathology practice carried on by the partnership was conducted from premises at Penrith. In September 1977 the practice moved to premises at Kingswood. In addition, the partnership maintained ``collection rooms'' at a number of other locations. Qualified nursing sisters normally worked full time at the collection rooms. Their function was to record patient details and to collect specimens and forward them to the Penrith or, later, the Kingswood premises for analysis. The number of collection rooms increased from 4 in the year ended 30 June 1973 to 21 in the year ended 30 June 1978. The number operated in each of the intervening years was respectively 6, 9, 15 and 17. By the end of the 1978 year, collection rooms (apart from that at the principal premises) were being operated by the partnership at Baulkham Hills, Blacktown, Blaxland, Camden, Condobolin, Doonside, Forbes, Katoomba, Lawson, Lithgow, Merrylands, Mt Druitt, Mudgee, Narrandera, Parkes, Parramatta, Penrith, Springwood, St Marys and Windsor. On some occasions, it was necessary for a specialist pathologist to attend on a patient to obtain a specimen and, in those cases, one of the partners would travel to the appropriate collection room.
The nursing staff engaged in the collection of specimens and the recording of patient details, whether employed at the principal premises or at the various collection rooms, were, at all relevant times, employed by the partnership. Dr Clarke was an employee of the partnership for approximately one year before becoming a partner. During the relevant years of income, no other medical practitioner was employed by the partnership for any substantial length of time. Locums were, however, engaged infrequently for short periods.
The number of nursing staff employed by the partnership increased from 9 in the year ended 30 June 1973 to 66 in the year ended 30 June 1978. The number of nursing staff employed in each of the intervening years was respectively 19, 34, 57 and 65.
The pathology practice required the use of diagnostic and testing equipment, some of which was extremely expensive, and the employment of technically qualified persons to
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carry out the testing of pathological specimens or samples, the scanning, analysis and evaluation of the test results and the preparation of the necessary reports. There was also a need for clerical, secretarial and telephonist services. A courier service for the collection of specimens and the delivery of reports was also operated.Between 1 July 1972 and 30 June 1976, these various services were provided to the partnership through a company called Bartimaeus Laboratory Services Pty Limited which purchased the equipment and was the employer of the staff. The shareholders and directors of that company were the wives of the then members of the partnership. From 1 July 1976 services of the kind formerly provided by Bartimaeus Laboratory Services Pty Limited were provided to the partnership through another company, Bartimaeus Laboratory Services (Penrith) Pty Limited. The directors of that company were the wives of the members of the partnership. The shareholders were family trusts of the partners.
In a letter dated 17 March 1989 from the solicitors for the taxpayers to the Australian Government Solicitor, the following details were given:
Year ended Medical Technicians & General Assistants
Laboratory Assistants
30/6/73 4 5
30/6/74 9 15
30/6/75 12 33
30/6/76 31 43
30/6/77 29 54
30/6/78 26 67
There was no suggestion that the numbers of staff as set out in the letter were inaccurate but Dr Smith, who gave evidence on behalf of the taxpayers, had some difficulty with the term ``General Assistant''. Dr Smith was asked:
``Can you tell us what the difference between the medical technicians on the one hand and the general assistants on the other might be?''
He answered:
``I do not like the term general assistant. I do not know what it means. I know the difference between a laboratory technician and a lab assistant. A lab assistant is trained to a certain level. I think we call them now technical aides and the technologists now are equivalent to science graduates, but general assistants, I am not too sure what that means.''
Earlier, Dr Smith had said that many of those providing the technical services for the partnership were ``science graduates or graduates of the University of Technology.''
The evidence establishes that, where a pathological test was carried out, and the results analysed by a member of the technical staff (and this could occur in any case except those involving the kind of test that required the attention of a specialist pathologist) and the analysis disclosed no abnormality or anything unusual, the staff member would prepare the necessary report and send it out in the name, and on behalf of, the partnership. In those cases there would be no involvement by any of the partners. The same procedure was followed where, as a result of examining a culture, the staff member had no problem in identifying the disclosed organism. However, where some abnormality or other unusual feature was disclosed or suspected, or where the staff member had difficulty in identifying an organism, the practice was to refer the matter to one of the partners for comment before the report was prepared and dispatched.
It is also clear from Dr Smith's evidence that, although the staff working in the laboratory, including the technical staff, were
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employees of Bartimaeus Laboratory Services Pty Limited and, later, of Bartimaeus Laboratory Services (Penrith) Pty Limited, they carried out their duties under the direction and the close supervision of the partnership. Asked whether there was any supervision by the partners of the technical staff, Dr Smith said:``Yes, there was close supervision of the technical staff at all times. The methods the technical staff use are written methods kept in method manuals and supervision of that methodology takes place. If the technician has found some problem with a test that would be reported to the pathologist and the pathologist and the technicians would then sort out the problem that had arisen.''
Asked whether any attempt was made to ensure what might be described as quality control, Dr Smith said:
``Yes, there is internal and external quality control. The College of Pathologists of Australia runs a comprehensive annual system where they send us specimens that are totally unknown to us and we examine them and give them our results and then later on they tell us how we have performed and there is also internal quality control. We purchase from time to time commercial specimens that have a known value and we put them through our laboratories unknown to the technical staff that they are a control and they are the two forms of laboratory supervision and control.''
Asked what part the partners played in that quality control, Dr Smith said:
``Well, the results of it would be shown to them and if our test results were not good, well they would immediately investigate why and find the problem and correct it.''
The pathology practice increased year by year. This is illustrated by reference to the number of patients for whom services were provided by the partnership in each of the relevant years. Those numbers were:
Year Number of Patients
1973 6,000
1974 9,000
1975 14,000
1976 72,000
1977 79,000
1978 92,000
The evidence discloses that the above figures were provided by Dr Clarke who said that "the figures for 1977 and 1978 were accurate but that other figures were estimated and the estimates for 1974 and 1975 ``may be a bit low''' (affidavit of Robert Graham Walker affirmed 16 February 1990, para. 20). It is obvious that the services provided to that number of patients could not be provided by the partners alone.
The profit and loss statements for the partnership in respect of the years of income in question disclose the following:
Year ended Gross fees Expenses (including depreciation)
Net profit
30 June rec'd Laboratory fees Salaries Other
$ $ $ $ $
1973 223,423 175,155 13,773 6,848 27,647
1974 348,471 252,503 32,264 15,959 47,745
1975 715,517 480,599 62,094 37,151 135,673
1976 1,949,189 1,385,998 144,619 66,814 355,452
1977 2,485,792 1,612,965 318,748 146,923 430,476
1978 2,098,333 1,518,349 333,495 158,193 110,080
The figures for the year ended 30 June 1977 represent the aggregate of the figures shown in the profit and loss statement for the period from 1 July 1976 to 31 March 1977 and those shown in the profit and loss statement for the period from 1 April 1977, when Dr Clarke became a
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partner, to 30 June 1977. During each of the years ended 30 June 1976, 1977 and 1978 the partnership received gross amounts by way of interest and rent but those amounts are not included in the figures shown in the above table.The amounts shown in the table under the sub-heading ``Laboratory fees'' represent amounts paid by the partnership to the relevant service company. As has already been mentioned, the evidence does not disclose details of the arrangements pursuant to which those payments were made. In particular, it does not appear whether the obligation of the partnership was to make payment upon completion of the work done by the technical staff employed by the service company or whether the partnership's obligation arose only after payment of the account rendered by it to the patient.
A comparison in respect of each of the relevant years of income between the accounts rendered and the fees received by the partnership is shown in the following table:
Year ended Accounts rendered Fees received
30 June $ $
1973 234,559 223,423
1974 416,969 348,471
1975 879,297 715,517
1976 2,162,321 1,949,189
1977 2,523,654 2,485,792
1978 2,407,749 2,098,333
In each of the years of income in question other than the year ended 30 June 1973 for which the figures are not available, the partners' drawings exceeded the amount of the net profit of the partnership for that year as disclosed in the relevant profit and loss statement. The relevant figures are:
Year ended Net profit on Partners' drawings Partnership capital
30 June "receipts" basis account
$ $ $
1973 27,648 (not available) (10,752)
1974 47,746 78,287 (41,293)
1975 135,673 141,277 (46,897)
1976 355,452 397,540 (88,986)
1977 430,476 576,386 (253,814)
1978 111,080 364,637 (545,118)
The figures shown for the partnership capital account exclude goodwill adjustments as shown in the relevant balance sheets. The brackets denote that the figures enclosed therein are debit balances.
Dr Smith gave evidence as to the work on which he personally was engaged as a member of the partnership. It is convenient to set out certain of the paragraphs of his affidavit sworn on 14 October 1988. Those paragraphs read as follows:
``7. During the period from 1st July, 1972 to 30th June, 1978, I was engaged full time in discharging my duties as a member of the Partnership. Throughout the period, I took approximately six weeks holiday per year. During each working week, I would have worked approximately 50 to 55 hours. The conduct of a specialist pathology practice,
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like other areas of medical practice, requires substantial personal involvement on the part of a medical practitioner. In addition, we are `on-call' at all times. On occasions, I am requested to attend hospital operating theatres in the middle of the night to provide urgent pathology services and advice.8. As a specialist pathology practice, the Partnership is engaged substantially in pathological examination of specimens or samples taken from patients. However, in addition to carrying out such examinations and tests, substantial consultative work is also involved.
9. Patients are invariably referred to our practice by other medical practitioners, either general practitioners or specialists. Referrals are almost invariably instigated by a written request from the other medical practitioner. The written referral specifies the tests or examinations which we are requested to carry out. However, in my experience, it is not uncommon that before sending a referral, a medical practitioner will telephone me and seek my advice as to the examinations or tests that may be appropriate having regard to the symptoms which he has observed in the patient. In addition, it is frequently necessary for me to contact a referring medical practitioner, after a referral has been received, for the purpose of obtaining necessary information not included in the referral.
10. It is also a fairly common occurrence for me to discuss the results of tests with a referring medical practitioner. Once the test results are known, a written report is prepared and forwarded to the referring medical practitioner. It has always been my practice to telephone a referring practitioner to inform him of significant abnormal results. Alternatively, he may telephone me to discuss various matters arising from those test results. Matters discussed are commonly one or more of the following:
- (a) Whether any further pathological examinations are appropriate and, if so, which ones;
- (b) The interpretation and clinical significance of abnormal test results;
- (c) Appropriate treatment (by drugs or other therapy) for a condition revealed by tests;
- (d) Advice as to prognosis in respect of certain conditions revealed by tests - This is particularly important in relation to histology specimens (i.e., pieces of tissue removed for diagnosis of cancer and other conditions);
- (e) Advice as to various other problems arising in relation to the investigation of disease processes.
In a typical working day, I estimate that 10% of my time was spent discussing matters with referring medical practitioners.
11. The partners of the Partnership each have certain areas of interest or specialty. My particular specialty was in the 1973 to 1978 years of income and still is anatomical pathology. That consists of two main areas, histopathology and cytology. Histopathology is the microscopic examination of pieces of tissue removed at surgery resulting in a precise diagnosis which is essential for the optimum treatment of the patient particularly in the case of cancer where different histopathological types of cancer require different treatment. Frequently during the 1973 to 1978 years of income, I was requested by surgeons to perform a particular type of histopathology which involved examining frozen sections using portable equipment and resulting in a very rapid histopathological diagnosis being available to the surgeon (paragraph 13(a) - see below).
Cytology is mainly concerned with the diagnosis of cancer by microscopic examination of individual cells in smears taken from body surfaces and often results in cancer being detected at an early curable stage. Histopathology and cytology findings often resulted in consultations between myself and surgeons and oncologists (cancer therapists) regarding prognosis and optimum treatment. I estimate that during the 1973 to 1978 years of income 70% of my working time was spent on histopathology and cytology work.
12. During the 1973 to 1978 years of income I spent an estimated 10% of my working time seeing patients. Sometimes a referring medical practitioner would request that I see the patient clinically and advise the doctor of my clinical impressions and the appropriate tests. At other times, I saw
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the patient in order to take certain specimens from that patient which were required for certain tests.13. There [is] a number of activities which must always be carried out by a qualified pathologist. Those activities include the following:
- (a) Reporting on histological specimens. That may comprise either examination of specimens forwarded to the Partnership's premises or, alternatively, examination of a specimen at hospital premises during the course of surgery. Where a surgeon is operating on a patient and he knows that histopathological diagnosis will be required, he will request that I be available during the operation. Tissue is removed from the patient, a frozen section is prepared, and I make a diagnosis while the operation is taking place. Consultations will have taken place between myself and the surgeon prior to the operation to discuss diagnostic possibilities and, on occasions, I will have examined the patient together with the surgeon before the operation. The frozen section diagnosis influences greatly the type of surgery the surgeon finally decides to perform;
- (b) Examination of and reporting all non-gynaecological cancer smears and all abnormal gynaecological cancer smears - results of those tests are very frequently discussed subsequently with the referring medical practitioner;
- (c) Taking certain cytology specimens for the diagnosis of cancer and other diseases from patients where a pathologist's expertise is essential for the obtaining of an adequate specimen;
- (d) Taking of bone marrow samples - taking of such samples involves the pathologist inserting a needle into the bone marrow after administering a local anaesthetic;
- (e) Taking samples following suprapubic bladder punctures - that procedure involved the pathologist inserting a needle into the patient's bladder to obtain a urine sample;
- (f) All hormone infusions;
- (g) Taking of certain samples to test for venereal diseases and the subsequent examination of those samples;
- (h) Huhner's test (an infertility examination performed on female patients).''
It was asserted by Dr Smith, and not challenged, that, during the relevant years, the partners maintained a close personal clinical involvement in the work of the partnership and that this personal involvement contributed substantially to the partnership having an excellent reputation for contributing to the clinical diagnosis and management of the patients of referring doctors. Dr Barratt's affidavit was to the same effect.
Each of the other partners, in affidavits respectively sworn by them, gave evidence as to the manner in which the partnership business was conducted, including evidence as to the work in which they personally engaged. So far as matters relevant to the issue that arises in these proceedings are concerned, their evidence was substantially to the same effect as that given by Dr Smith. They did not, of course, all have the same areas of specialty.
Evidence was also given by Julie Angela Preskett who was the office manager for the partnership during the years of income from 1972 to 1978. She said that, as office manager, she handled and supervised accounts payable and receivable, banking, insurance, wages and other general matters. Paragraph 2 of her affidavit sworn on 14 October 1988 was in the following terms:
``2. The Partnership's source of payments was as follows:
- A. The patients in the period 1972 to 30th June, 1975 prior to the introduction of the Medibank system were always billed directly for services rendered.
- B. The amount billed was the full schedule fee. Payment of the amount rendered would be by means of cash or cheque received from the following sources:
- (i) If the patient was uninsured, the total amount, if paid, would be paid by the patient.
- (ii) If the patient was insured, he could:
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- (a) pay the full amount rendered and then make a claim from the health insurance fund for a benefit payable to him; or
- (b) take the account to the health insurance fund who would make out a benefit cheque payable to the Partnership. The benefit cheque payable to the Partnership would generally amount to 90% of the schedule fee and would be given to the patient to be forwarded to the Partnership. It was the patient's obligation to forward to the Partnership both that cheque and his own cheque for the balance of 10%.
- C. A form of Medibank was introduced on 1st July, 1975. During the period 1st July, 1975 to 30th September, 1976, the patients were billed for the full schedule fee with payment being received by means of cash or cheque from the following sources:
- (i) If the patient was uninsured, he could:
- (a) pay the full amount rendered and receive a reimbursement of generally 85% of the schedule fee from Medibank;
- (b) take the account to Medibank and receive a cheque for generally 85% of the schedule fee to be forwarded by him to the Partnership. The difference between the amount Medibank paid and the schedule fee would have to be met by the patient;
- (c) allow the Partnership to submit a claim form to Medibank. This together with the account for the full schedule fee was lodged with Medibank and a cheque would be sent to the Partnership for generally 85% of the schedule fee which would be accepted as full payment;
- (d) after approximately six (6) months, the practice referred to in paragraph (c) above ceased and the Partnership started bulk billing some of the patients. Bulk billing meant that the Commonwealth was billed for generally 85% of the schedule fee. I estimate that less than 10% of all bills during this period were bulk billed.
- (ii) If the patient was insured, he could:
- (a) pay the full account rendered and then make a claim from his health insurance fund for a benefit payable to him; or
- (b) take the account to the health insurance fund which would give him a cheque for the full schedule fee payable to the Partnership to be forwarded by him to the Partnership.
- D. For the period 1st October, 1976 to 30th June, 1978, Medibank operated in a modified form and patients were either bulk billed or rendered an account for the full schedule fee. Payment was received by means of cash or cheque from the following sources:
- (i) Patients who were uninsured had to pay the health insurance levy and could:
- (a) pay the full amount rendered and receive reimbursement of generally 85% of the schedule fee from Medibank; or
- (b) take the account to Medibank and receive a cheque for generally 85% of the schedule fee to be forwarded to the Partnership. The difference between the amount Medibank paid and the schedule fee would have to be met by the patient.
- (ii) If the patient was insured, he could:
- (a) pay the full account rendered and then make a claim from his health insurance fund for a benefit payable to him; or
- (b) take the account to the health insurance fund which would give him a cheque for the full schedule fee payable to the Partnership to be forwarded by him to the Partnership.''
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In her oral evidence Miss Preskett said that the general practice followed was for an account to be rendered to the patient after the tests had been completed. She said that she would delegate staff to issue the accounts and follow them up routinely, though it was only on odd occasions that she would be personally involved in speaking to patients who had not paid. She said that it frequently happened that the partnership accepted in full satisfaction of the account the amount recoverable by the patient under Medibank or insurance. She also said that a lenient attitude was taken to those who could not pay. In this regard, Dr Smith gave evidence that any request for a reduction in the fee payable because of a patient's poor circumstances would be referred to a partner. He said that such requests had been referred to him and he had reduced the fee payable. He said, however, that such requests had been referred to him only occasionally. He was not able to speak as to the experience of the other partners. Dr Smith also said that the partnership had not, so far as he was aware, ever taken legal action to recover fees.
During the course of his evidence, Dr Smith said that it would not be correct to say that, during the period from 1973 to 1978, the partnership adopted a dilatory attitude in relation to the collection of debts. Asked who Mrs Myrtle Vallis is or was, Dr Smith gave the following answer:
``Yes, Mrs Myrtle Vallis was a clerk and she was employed in the period 72 to 78, approximately 75 to 78 and during a considerable part of that period her total duty was to chase up slow payers, bad debts, whatever you like to call them. After the initial bill had been sent out if we did not receive payment further bills would be sent out and then if that did not produce any payment Mrs Vallis would telephone the people and speak to them personally and encourage them to pay the account. Also, she worked at that time with a debt collecting agency and the debt collecting agency would tell Mrs Vallis, you know, when patients had paid money so that she could adjust the records.''
The following evidence was also given:
``Q. Was the debt collection agency used throughout the entirety of the period in question?
A. No, I think it was used for the - probably about two years prior to September 77, but I stress that I cannot be certain, but I think it was for a period of approximately two years.
Q. Was it specifically discontinued?
A. Yes, it was discontinued. We had concerns that overdue pressure might be exerted on patients and that perhaps the vigorous pursuit of these bills might have transferred into harassment or intimidation. That was a concern to us.
Q. Was that a matter you discussed with your partners?
A. Yes, that was discussed.
Q. Was there, doctor, during the period in question, any policy of the partnership to defer the rendering of bills beyond the point of time at which tests had been completed?
A. No, no.''
Dr Smith agreed that, after the advent of Medibank, any question of the reduction of the fee payable by a patient would have related only to the so-called ``gap'' between the fee charged by the partnership and the amount payable under the Medibank scheme. The position would have been the same under the Medicare scheme.
It appears from the evidence that prior to 1 January 1978, when the accounting system of the partnership was computerised, an individual ledger card was maintained for each patient on which was recorded details of the patient and of the test or tests performed, the fee payable and any amounts paid. From the ledger card the amount (if any) owing by the particular patient at any time could be ascertained. The ledger cards were filed in two sections, ``unpaid'' and ``paid''. Cards were transferred from the ``unpaid'' section to the ``paid'' section when appropriate. It was from those ledger cards, and from the computer records maintained after 1 January 1978, that Miss Preskett, with the assistance of staff under her control, prepared, at the request of the Commissioner of Taxation, lists of outstanding debtors as at 30 June in the years of income 1973 to 1978 inclusive. The amount of the outstanding debts at the end of each of those years of income and the amount of the debts which at the end of each of those years of income had been outstanding for more than twelve months are shown in the following table:
The amounts shown as debts outstanding for more than 12 months were treated by the Commissioner of Taxation for assessment purposes as having been written off. The figures as at 30 June 1972 are not in evidence.
Alfred John Walker, the accountant of the partnership from 1972 to the date on which he swore his affidavit, said in an affidavit sworn on 13 October 1988:
``5. The patients' ledger card [sic] produced under the manual accounting system in force until January, 1978 distinguish debtors only on the basis of the age of the outstanding debt. No debts were written off in the 1973 to 1978 years of income. No record of total amount rendered for any year of income under the manual accounting system was kept though a record of debtors outstanding was kept.''
It was common ground that, in respect of the relevant years of income, neither the books of account of the partnership nor the partnership accounts recorded the total amount, as at any particular date, of the outstanding debts of the partnership.
What has been set out above is based upon the evidence received concerning the operations of the partnership during the relevant years of income. The taxpayers sought to adduce evidence as to the operations of the partnership during subsequent years of income. That evidence was, initially, ruled inadmissible but was subsequently admitted subject to relevance. Having given the matter further consideration, I confirm the original ruling that the evidence tendered is inadmissible. I might add, however, that I do not regard that evidence as requiring any departure from the conclusions I have reached.
Evidence concerning accountancy principles and practice was given, on affidavit, by Paul Merewyn Greenwood, Chartered Accountant, and Robert Graham Walker, Professor of Accounting at the University of New South Wales, on behalf of the taxpayers and by Graeme Leslie Herring, Chartered Accountant, on behalf of the Commissioner. Each of the deponents was cross-examined. I do not find it necessary to set out in these reasons the somewhat different approaches taken by these witnesses. I have given careful consideration to what each of them had to say but, in the result, I have a strong preference for the approach taken by Mr Herring based, as it is, on considerable practical experience in relation to the manner in which, from an accounting standpoint, medical practices have been conducted and administered.
During the course of argument, reference was made to the judgments of the High Court in
Commissioner of Taxes (S.A.) v. Executor Trustee and Agency Co. of South Australia Ltd (Carden's Case) (1938) 63 C.L.R. 108,
Arthur Murray (N.S.W.) Pty Limited v. FC of T (1965) 14 ATD 98; (1965) 114 C.L.R. 314;
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Henderson v. FC of T 69 ATC 4049; 70 ATC 4016; (1968-1970) 119 C.L.R. 612 and J. Rowe and
Son Pty Limited v. FC of T 71 ATC 4001; (1970-1971) 124 C.L.R. 421, to the judgment of the Supreme Court of Victoria in
FC of T v. Firstenberg 76 ATC 4141; (1976) 11 A.L.R. 377 and to the judgment of this Court in
FC of T v. Dunn 89 ATC 4141; (1989) 85 A.L.R. 244. A number of those judgments identified criteria which, in the particular circumstances in which the question arose, were considered relevant to be taken into account in determining the question whether a ``cash receipts'' or an ``accruals'' basis was, to adopt the language of Dixon J. in Carden's Case, ``calculated to give a substantially correct reflex of the taxpayer's true income''.
In three of the cases cited, namely Carden, Firstenberg and Dunn, the ``cash receipts'' basis was held to be the appropriate method. In Henderson, and Rowe, the ``accruals'' basis was held appropriate. Dr Carden was, as Davies J. described him in Dunn at ATC p. 4145; A.L.R. p. 248, ``a medical practitioner carrying on private practice during the difficult 1930s''. He did not practise in partnership. Firstenberg was a solicitor carrying on, on his own account, a ``one-man practice'' with only one employee who acted as his secretary, typist and telephonist. Mr Dunn was a chartered accountant carrying on a small practice with a number of employees including his wife and his daughter-in-law, both of whom were employed on a part-time basis, and his son. Mr Henderson was a member of a partnership practising the profession of accountants and employing, at the relevant times, a total of 295 persons of whom about 150 were qualified accountants. J. Rowe and Son Pty Ltd conducted a retail store selling goods for cash and on credit. It is apparent from what has been said earlier in these reasons that the present case is, on the facts, clearly distinguishable from the cases cited.
There can be no doubt, on the evidence, that the partnership was, in the relevant years of income, carrying on a large pathology practice. To illustrate this it is sufficient to refer to the number of collecting rooms, the number of staff, the number of patients and the accounts rendered and gross fees received, remembering that those amounts are expressed in the money values of the 1970s.
It is also apparent that the exercise by the partners personally of their respective professional skills and experience was not the only source of the net income of the partnership in the relevant years. In this regard, it is appropriate to look to the relationship which existed between the partnership and the relevant service company. Clearly, a large part of the activities which produced the net income of the partnership was performed without the direct intervention of any of the partners. That work was performed by specialist and other technical staff employed by the relevant service company but it was work performed for, and in the name of, the partnership.
The evidence does not dissect the amount of fees received in any year so as to disclose the proportion which arose from work in which the partners had no direct involvement and that in which one or other of the partners was the provider of the service rendered to the patient. However, some guidance as to the proportion of the work performed otherwise than by the partners is to be gained from a consideration of the amounts paid in each year to the relevant service company by way of laboratory fees and the proportion which those payments bore to the total amount of fees received in that year by the partnership for pathology services. Those figures are set out earlier in these reasons.
Whatever may be said as to the work performed by the nursing staff, who were employees of the partnership, it cannot be said that the services rendered by the technical staff employed in the laboratory contributed in only a subsidiary or limited way to the professional work for which fees were charged by the partnership.
It is also relevant to take into account that the composition of the partnership varied from time to time. During the relevant years of income, variations took place on 1 July 1974 and 1 April 1977.
Notwithstanding that it was the principal matter upon which Mr Greenwood relied in support of his opinion that the ``cash receipts'' basis was the appropriate method by which to ascertain the net income of the partnership, the evidence does not establish to my satisfaction that there was, in a significant number of instances, uncertainty as to the amount of the revenue to be received by way of fees in respect of the pathological services provided by the
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partnership. Certainly in cases where the partnership had agreed in advance to accept the amount payable by the patient's insurer, or had itself submitted the appropriate claim form to Medibank, or had bulk billed, it was aware of the percentage of the schedule fee it would receive. It may be accepted that, in some instances, the amount of the fee was reduced after the account had been rendered to the patient but the evidence does not suggest that that was a frequent occurrence or involved significant amounts when one has regard to the total amount of the accounts rendered in each year.Another significant matter, a matter already adverted to, concerns the amount of the drawings made by the partners in the relevant years of income and the circumstance that the drawings exceeded the amount of fees actually received in the relevant year. The source of the funds enabling the drawings to be made by the partners appears from the partnership balance sheets to have been loans from one or other of the service companies. The partners must, therefore, be taken to have recognised that there were substantial amounts by way of fees to come in to the partnership for pathology services provided and that the receipt of those fees was sufficiently certain to justify drawings being made against them.
For the taxpayers it was submitted that a relevant matter which supported a ``cash receipts'' basis as the appropriate method for calculating the net income of the partnership was to be found in the provisions of ss. 35 and 36 of the Medical Practitioners Act 1938 (N.S.W.). Section 35 provided:
``35(1) Every registered medical practitioner shall be entitled to sue in any court of competent jurisdiction for the recovery of the charge or remuneration for any medical or surgical advice, service, attendance, or operation rendered or performed by him.
35(2) No action or suit for the recovery of fees or remuneration for professional services of any kind as a registered medical practitioner shall be commenced until the expiration of 6 months after a bill setting out the amount claimed and containing a brief statement, indicating the nature of the professional services in respect of which such amount is claimed, has been served personally or by post on the person to be charged with the same.''
Section 36 relevantly provided:
``36(1) Within the 6 months next following the service upon any person of a bill for the professional services of a registered medical practitioner, that person or that person's spouse may apply in the prescribed manner to the committee to review the bill.
36(2) Where an application is made pursuant to subsection (1) to review a bill the committee shall proceed to review the bill and certify what, upon such review, is found to be a reasonable charge or remuneration in respect of the medical or surgical advice, service, attendance, or operation to which the bill relates.''
These provisions were said to support the proposition that uncertainty attended the receipt of the fees the subject of accounts rendered by the partnership.
It is common ground that before an account was rendered by the partnership the pathological services to which it related had been completely performed. In my opinion, upon the rendering of the account, the partnership became entitled to payment of the fee specified in the account. That conclusion is not affected by the circumstance that there might subsequently be an agreement to reduce the amount of the fee or by the further circumstance that a similar result might be effected by the operation of the provisions of s. 36 of the Medical Practitioners Act. I do not regard the provisions of that Act as supporting the taxpayers' case that a ``cash receipts'' basis is the appropriate method to be applied in this case.
The various aspects of the matter to which I have referred considered in combination compel me to the conclusion that the ``accruals'' basis is the appropriate method by which to ascertain the net income of the partnership in respect of each of the years of income ended 30 June 1973 to 1978 inclusive.
In the light of that conclusion, it is necessary to turn to a further submission by counsel for the taxpayers. Counsel drew from Henderson's Case (supra) the proposition that a fee does not form part of assessable income, even on an ``accruals'' basis, before it has matured into a recoverable debt. He submitted that a debt did
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not answer the description of a recoverable debt where there was a statutory impediment, such as that contained in s. 35 of the Medical Practitioners Act, upon the right to sue for its recovery. He further submitted that it was in that sense that Barwick C.J. had used the word ``recoverable'' when his Honour said (at ATC p. 4020; C.L.R. p. 650) that, in ascertaining the net earnings of the partnership of which Henderson was a member, ``only fees which have matured into recoverable debts should be included as earnings''.I am unable to accept that the Chief Justice was using the word ``recoverable'' in the sense contended for by counsel for the taxpayers. No question arose in Henderson's Case concerning a restriction on the right of the partnership to sue for fees said to be owing to it. The Chief Justice made plain the sense in which he was using the word. At ATC p. 4020; C.L.R. p. 651 his Honour said:
``I have used the word `recoverable' to describe the point at which income is derived by the performance of services. I ought to add that fees would be relevantly recoverable though by reason of special arrangements between the partnership and the client, time to pay was afforded.''
In my opinion, for the purposes of determining the net income of the partnership on an ``accruals'' basis, the fees are to be treated as having accrued due and as having become recoverable when the relevant account was furnished to the patient.
For these reasons, the decisions disallowing the objections to the relevant assessments and amended assessments are confirmed. The taxpayers must pay the Commissioner's costs of the proceedings.
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