Burchett J

Federal Court

Judgment date: Judgment handed down 1 May 1995

Burchett J

Putting it in plain language, the applicant in these taxation appeals stole from his employer the sum of $1 million, which he then invested at interest in bank accounts and upon deposits under his control or in his own name. Being found out, he was both prosecuted under the Crimes Act 1900 (NSW) and sued in the Supreme Court of New South Wales for the recovery of the money and for the interest earned by its use. He pleaded guilty in the prosecution, and consent orders were made against him in the Supreme Court action. But in the meantime the investments had spanned two financial years, and the question that has arisen is whether the income represented by the interest, although fully disgorged to the rightful owner of the moneys, is nevertheless taxable as the income of the applicant himself.

The essential facts fall within a very short compass. On about 15 December 1986, the applicant, who was then employed as Chief Accountant by Canon Australia Pty Limited (``Canon''), drew the sum of $1 million out of an account held by that company and deposited it into an account under his own control. As a result of a series of transactions, involving transfers to various bank accounts and deposits, substantial sums of interest were earned during each of the years of income ended 30 June 1988 and 30 June 1989 in respect of the amount of $1 million taken from Canon. In investing the moneys, the applicant also mixed them with a relatively small sum of his own moneys. At one stage, too, some of the moneys went into the purchase of a house, and were later redeposited upon its sale, but neither counsel suggested this investment had in itself any particular tax consequence.

On 29 August 1989, Canon, having discovered what had happened, instituted proceedings by summons in the Supreme Court of New South Wales against the applicant, claiming an order for payment of the sum of $1 million together with interest pursuant to s. 94 of the Supreme Court Act 1970, a declaration that all moneys held in the account into which the applicant had originally paid the sum of $1 million were held by him on trust for Canon, and ancillary relief including a declaration that any assets acquired by the use of the moneys were held on trust by the applicant for Canon. The summary of the plaintiff's contentions endorsed on the summons in the Supreme Court alleged that the applicant had fraudulently misappropriated the sum of $1 million, and then stated that Canon contended ``(t)he moneys which were misappropriated and any assets purchased with them are held on trust by [the applicant] for Canon''. On 16 November 1989, orders were made, by consent and without admissions, by the Supreme Court of New South Wales which (inter alia) required the applicant to pay to Canon the sum of $1,400,000, and charged certain assets of the applicant in favour of Canon to secure the payment of that sum.

I was told from the bar table that the applicant was also charged with an offence under s. 176A of the Crimes Act. This is the section which, relevantly, makes an officer who cheats or defrauds his own company liable to imprisonment for ten years. To that charge, the applicant pleaded guilty.

Before his crime had come to light, the applicant had submitted his income tax return for the year ended 30 June 1988. In that return, he showed interest earned on the moneys taken from Canon as part of his own income. However, by the time he submitted his return for the year ended 30 June 1989, the truth was known. In that return, the sum of $130,709 was shown as interest which, although received by the applicant, was the property of Canon. The applicant also lodged an objection, on the same basis, to the assessment which had issued to him in respect of the previous financial year. He was allowed to object out of time, but the objection failed, and in the result he was assessed as liable to income tax in respect of the whole of the interest in question for both years.

ATC 4253

The fundamental principle which must be the starting point for a consideration of this case is the rule that the general provisions of the Income Tax Assessment Act 1936 are directed to income to which a taxpayer is beneficially entitled:
MacFarlane v FC of T 86 ATC 4477; (1986) 13 FCR 356;
Countess of Bective v FC of T (1932) 2 ATD 80; (1932) 47 CLR 417;
Richardson v FC of T (1932) 1 ATD 332; (1931-1932) 48 CLR 192;
Liedig v FC of T 94 ATC 4269 at 4276;
Vegners v FC of T 91 ATC 4213. So far as a trustee is concerned, he has the protection of s. 96, and his liability (if any) to income tax arises solely pursuant to the provisions of Division 6 of Part III of the Act, in which s. 96 is found:
Union Fidelity Trustee Co of Australia Ltd & Anor v FC of T 69 ATC 4084 at 4086; (1969) 119 CLR 177 at 181, per Barwick C.J.

MacFarlane is perhaps particularly relevant to the present case because Beaumont J., with whom Fisher J. and I agreed on this point, made it clear (at ATC 4486; FCR 367) that a constructive trust, as well as an express trust or resulting trust, would be fully effective to divert the liability to income tax to the beneficiary. This was so there notwithstanding that (as appears at ATC 4487; FCR 368) the returns ``were silent on the topic of any beneficial entitlement which [the beneficiary] might or might not have had to the business or to the investments [in question]''. An argument that the taxpayer was estopped as a result was firmly rejected by the Court. It was not suggested in MacFarlane that the receipt of the income, to all appearances, by the legal (although not beneficial) owner, without any acknowledgment by him that the beneficial entitlement lay elsewhere, had any effect on the tax liability that flowed from the relevant beneficial rights. Nor was it suggested in Liedig that the receipt by the taxpayer of the income of the business, and his claim to have paid wages out of it to his wife, as asserted in his original return of income, in any way precluded his success upon a later objection that the moneys the subject of the alleged payments of salary really represented income derived as trustee for his wife, assessable, not to him, but to his wife under s. 97.

Accordingly, the applicant's case was very simple. It asserted that the moneys taken from Canon were held upon a constructive trust, of which Canon was the beneficiary. The interest earned was income of a trust estate, and was not income derived by the applicant personally. It followed that the objections should have been upheld. So stated, the argument had the support of
Black v S Freedman & Company (1910) 12 CLR 105 at 110, where O'Connor J. said:

``Where money has been stolen, it is trust money in the hands of the thief, and he cannot divest it of that character.''

a dictum accepted by Bryson J. in
Australian Postal Corporation v Lutak (1991) 21 NSWLR 584 at 589, although it is criticized by Millett L.J. (as he now is) extra - judicially in his Tracing the Proceeds of Fraud, published in Equity and Contemporary Legal Developments (1992, edited by S. Goldstein) 407 at 413 footnote 17. However, Millett L.J. in the same article (at 413) makes clear his view that, whatever may be the position in a case of simple theft, a person such as the applicant, who was Canon's Chief Accountant, is a fiduciary upon whom the obligations of a constructive trustee may fall. That view is reflected in his decision in
Agip (Africa) Ltd v Jackson [1990] Ch. 265 at 289-291, which was affirmed on appeal by the Court of Appeal: see 1991 Ch. 547 at 566-567, per Fox L.J.

In the context, not of theft, but of the taking of a bribe, the Privy Council has now disapproved of
Lister & Co v Stubbs (1890) 45 Ch. D. 1 (but see
Daly v Sydney Stock Exchange Ltd (1985-1986) 160 CLR 371, as to which see also
Heraudeau v Law Institute of Victoria [1991] 2 VR 518 and
Australian Securities Commission v Melbourne Asset Management Nominees Pty Ltd (Receiver and Manager Appointed) (1994) 12 ACLC 364 at 382-383), and has held that ``(a)s soon as the bribe was received, whether in cash or in kind, the false fiduciary held the bribe on a constructive trust for the person injured'':
Attorney-General for Hong Kong v Reid [1994] 1 AC 324 at 331. It was expressly declared that the existence of a debt in equity was not inconsistent with the co-existence of such a trust, since ``there [was] no reason why equity should not provide two remedies, so long as they do not result in double recovery''. Again (at 336) Lord Templeman, speaking for their Lordships, affirmed that ``the bribe and the property from time to time representing the bribe are held on a constructive trust for the person injured''. He cited (at 334) the well known passage from the judgment of Jessel

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M.R. in
In re Caerphilly Colliery Co (Pearson's Case) (1877) 5 Ch. D. 336 at 340-341, where it was said of an agent and trustee for purchasers who had received a benefit from the vendor:

``He must be deemed to have obtained it under circumstances which made him liable, at the option of the cestui que trust, to account either for the value at the time of the present he was receiving, or to account for the thing itself and its proceeds if it had increased in value.''

Lord Templeman commented:

``This is an emphatic pronouncement by the most distinguished equity judge of his generation that the recipient of a bribe holds the bribe and the property representing the bribe in trust for the injured person.''

Similarly, in
Lipkin Gorman v Karpnale Ltd [1991] 2 AC 548, where cash cheques were drawn on the client account of a firm of solicitors by a partner Cass, acting without authority and dishonestly, and the money was paid to him by the bank, Lord Goff of Chieveley said (at 572):

``Of course there is no doubt that, even if legal title to the money did vest in Cass immediately on receipt, nevertheless he would have held it on trust for his partners, who would accordingly have been entitled to trace it in equity into the hands of the respondents [owners of a club where the moneys were gambled away].''

For the Commissioner, it was submitted that the admixture of some of the applicant's own funds made an important difference. The Commissioner's argument appeared to treat constructive trust as merely a remedy imposed by the court, rather than as also a species of trust attaching to the property at the time of its taking and to the income at the time it was earned. Viewing the matter in this way, the Commissioner contended that a charge might be imposed for the recoupment of the moneys, instead of a constructive trust conferring a beneficial interest upon Canon. The notion that the existence of one remedy denies that of the other is inconsistent with Attorney-General for Hong Kong v Reid, where it was held equity confers more than one remedy, ensuring justice by permitting only one recovery. It was, however, further argued that the remedy existed for the protection of the true owner, but that equity would not impose a constructive trust for the benefit of a thief, or, as the argument was also put, that the applicant did not come with ``clean hands''.

But the equitable ownership of the moneys taken and invested by the applicant does not depend upon a court declaring the existence of a constructive trust. This was pointed out by Beaumont J. in MacFarlane at 368, where he cited the judgment of Deane J. in
Muschinski v Dodds, now reported at(1985) 160 CLR 583 at 614:

``Equity acts consistently and in accordance with principle. The old maxim that equity regards as done that which ought to be done is as applicable to enforce equitable obligations as it is to create them and, notwithstanding that the constructive trust is remedial in both origin and nature, there does not need to have been a curial declaration or order before equity will recognize the prior existence of a constructive trust: cf. Scott, Law of Trusts, 3rd ed. (1967), vol. V, par. 462.4. Where an equity court would retrospectively impose a constructive trust by way of equitable remedy, its availability as such a remedy provides the basis for, and governs the content of, its existence inter partes independently of any formal order declaring or enforcing it.''

The passage in Scott on Trusts to which Deane J. refers includes the following:

``Where the title to property is acquired by one person under such circumstances that he is under a duty to surrender it, a constructive trust immediately arises... The beneficial interest in the property is from the beginning in the person who has been wronged. The constructive trust arises from the situation in which he is entitled to the remedy of restitution, and it arises as soon as that situation is created.''

So clear is this proposition that it was possible for A.J. Oakley in his learned article The Precise Effect of the Imposition of a Constructive Trust, published in Equity and Contemporary Legal Developments 427, to state (at 433) that ``it seems to be universally accepted that the general rule is that a constructive trust takes effect from the moment at which the conduct which has given rise to its imposition occurs''. For this rule, he cites the decision of the Supreme Court of Canada in

ATC 4255

Rawluk v Rawluk (1990) 65 DLR 4th 161, where Cory J., with the concurrence of Dickson C.J.C., Wilson and L'Heureux-Dubé JJ., expressed (at 176) his complete agreement with the view of Professor Scott that ``(t)he beneficial interest in the property is from the beginning in the person who has been wronged''. It is true that the court has power, in its discretion, to vary this position to meet the requirements of competing claims or for some other sufficient reason: Muschinski v Dodds (supra) at 615, 623.

The admixture of the applicant's own money or property, to some extent, with the trust moneys held by him does not seem to me to assist the Commissioner's case. If the result were that there is now an inextricably intermixed fund, the consequence would simply be that the whole of it is held on trust. This conclusion has been repeatedly stated. In
Hospital Products Ltd v United States Surgical Corporation (1984) 156 CLR 41 at 109-110, Mason J. referred to ``the situation where the fiduciary has so mixed an indeterminate profit with his own property as to render the identification of the gain impossible''. He said:

``There `... the whole will be treated as trust property, except so far as he may be able to distinguish what is his own'
Brady v. Stapleton (1952) 88 CLR 322, at p. 336, quoting Page Wood V.-C. in
Frith v. Cartland (1856) 2 H. & M. 417, at p. 420 [71 E.R. 525, at p. 526]. The proposition [ that equity does not punish a fiduciary by making him account for more than he actually received as a result of his breach of fiduciary duty] may also need to be modified to take account of a profit acquired by a fraudulent fiduciary through a combination of trust property and his own property or efforts. It may well be that equity in such circumstances will not seek to apportion the gain.''

Warman International Ltd v Dwyer (1995) 128 ALR 201 at 212, the joint judgment of the High Court states:

``It is for the defendant to establish that it is inequitable to order an account of the entire profits. If the defendant does not establish that that would be so, then the defendant must bear the consequences of mingling the profits attributable to the defendant's breach of fiduciary duty and the profits attributable to those earned by the defendant's efforts in investment, in the same way that a trustee of a mixed fund bears the onus of distinguishing what is his own.''

But there is no reason to think that the investment of a relatively small proportion of his own funds, together with the funds taken from Canon, has in fact put the applicant in a position where, according to the principles of equity, no disentanglement can be effected. In Attorney-General for Hong Kong v Reid (supra) it was suggested (at 330) that ``part of the costs of [three freehold properties] might not be derived from bribes'' Lord Templeman commented:

``If so, the courts have ample means of discovering by means of accounts and inquiries the amount (if any) of innocent money invested in the properties and the proportion of the present value of the properties attributable to innocent money.''

In Brady v Stapleton (at 336-339), Dixon C.J. and Fullagar J. examined in detail the methods available for disentangling trust funds from other property. They concluded:

``The real distinction which equity draws is between the case where it is, and the case where it is not, practicable to give effect to the rights of the cestui que trust by appropriating to him a specific severable part of the available property.''

Australian Postal Corporation v Lutak (1991) 21 NSWLR 584 at 596-597, Bryson J. said:

``Some investments which are made with funds arising from the unauthorised admixture of trust moneys with the money of trustees are readily severable. In those cases the part of the profits or gains attributable to the trust moneys can be readily identified, it can readily be seen what part of the profits the beneficiaries have a claim to, and they have no claim to the rest. Many financial investments would be readily severable, and where the mixed fund is represented by a deposit in a bank or financial institution which has been augmented by interest there is no difficulty about using arithmetic to identify the part of the fund, and of the profits or gains, which belong to the beneficiaries. For many financial investments including deposits at interest and purchases of parcels of publicly- listed shares severability is readily available

ATC 4256

and trustees are under no difficulty in discharging the burden which rests on them of identifying what parts of the profits or gains belong to the beneficiaries and what parts belong to the trustees.''

In my opinion, if I come to the conclusion that the assessments cannot stand insofar as they relate to so much of the income attributed to the applicant in each year as was earned by the use of the moneys held on constructive trust for Canon, there will in fact be no practical difficulty in effecting an appropriate apportionment of the various sums of interest.

The Commissioner's argument appeared at times to be suggesting that because a wronged beneficiary may have a charge over property acquired by the wrongful use of trust moneys, that therefore there is no relevant constructive trust affecting any profit earned. But the beneficiary may choose the remedy of a charge as a means of enforcing his right. The right itself does not grow out of the beneficiary's choice. He is able to choose the remedy because he already has the right. The profits of which he elects to have an account, and which he elects to secure by a charge, are ``the product or consequence of the plaintiff's property'', as it was put in Warman v Dwyer at 211. Cf. Lord Templeman's comment in Attorney-General for Hong Kong v Reid cited above on a passage from the judgment of Jessel M.R. in Pearson's Case, which treats the liability to account as necessarily based on the existence of a constructive trust.

But is the applicant defeated by the ``clean hands'' doctrine? I was referred to
FAI Insurances Ltd v Pioneer Concrete Services Ltd (1987) 15 NSWLR 552 at 561;
Dewhirst v Edwards [1983] 1 NSWLR 34 at 51;
Collier Constructions Pty Ltd v Foskett Pty Ltd (1990) 97 ALR 460 at 474; and to the dissenting judgment of Gummow J. in
Corrs Pavey Whiting & Byrne v Collector of Customs (Vic) (1987) 14 FCR 434 at 456-457, and his Honour's article
Abuse of Monopoly: Industrial Property and Trade Practices Control (1973-1976) 7 Syd. L.R. 339 at 351-352. But these cases and this article are concerned with a discretionary defence available in answer to a claim for equitable relief. To regard reliance upon the taxation consequences of trusteeship as involving the assertion by the trustee of an equitable interest that is barred by the discretionary defence of want of ``clean hands'' would seem to me to be an extraordinary inversion of the principles of equity. The applicant is not seeking equitable relief. He has been assessed to income tax on a basis that he says is inconsistent with the Income Tax Assessment Act. The applicant is entitled to appeal to the ``clear distinction... between cases where the plaintiff has a legal right... and cases... where the plaintiff's only remedy is equitable, and where in order to obtain any relief he must come into Equity and invoke the discretionary remedy, in which case he is subject to the Equity maxim that he who comes into equity must come with clean hands'':
Kettles and Gas Appliances Ltd v Anthony Hordern & Sons Ltd (1934) 35 SR(NSW) 108 at 129, per Long Innes J. Nor does establishment of a constructive trust require more than proof that the moneys invested belonged in fact to Canon, proof of which does not require reliance upon the applicant's own wrong: cf.
Weston v Beaufils (No. 2) (1994) 50 FCR 476 at 498.

The final point raised on behalf of the Commissioner was that the applicant had purported to earn the income, and must be taken to have derived it notwithstanding that he had no right to it under the general law. Counsel relied on a line of cases to which I referred in my judgment in MacFarlane (supra) at 380 et seq. I there considered that the profits of an illegal business could be the source, for the purposes of s. 44(1)(a) of the Income Tax Assessment Act, of a payment deemed to be a dividend. I relied on cases which justify the proposition that the illegal nature of a receipt does not deny its taxability. However, it seems to me that these cases say nothing at all about the position which has arisen in the present appeals. Though belatedly, the applicant has acknowledged the rights of Canon, and has restored its property, including the interest earned upon investments which is presently in question. I do not think the annual basis upon which the income of a taxpayer for a particular period is computed (see
Henderson v FC of T 70 ATC 4016 at 4020; (1970) 119 CLR 612 at 650) requires the true facts to be ignored because not revealed until after the end of the year of income. Counsel for the Commissioner cited the decision of the Supreme Court of the United States in
Healy v Commissioner of Internal Revenue (1953) 345 US 278, where moneys, of which the taxpayers were

ATC 4257

subsequently found to be constructive trustees, were nevertheless held to be taxable as their own on the basis that they had made a ``claim of right'' to the moneys during the relevant year of income within the doctrine which obtains in the United States. But the Supreme Court conceded (at 284) that there were ``inequities of treating an amount as income which eventually turns out not to be income''. Those inequities led, as appears from the decision of the United States Court of Appeals, Sixth Circuit, in
Van Cleave v United States (1983) 718 F. 2d 193 at 195, to the enactment of s. 1,341 of the Internal Revenue Code ``by Congress to mitigate the sometimes harsh result of the application of the `claim of right' doctrine''. An examination of the decision in Van Cleave shows just how complex an adjustment was required to achieve this purpose. The ``claim of right'' doctrine has not so far been adopted in Australia, and no such mitigating legislation has been enacted in order to make it palatable in the context of the Australian taxation laws. If this doctrine is to be adopted by judicial decision, I do not think it is for a judge at first instance to take so momentous a step. I note that Hill J. stated a similar view in Liedig (supra) at 4,279, when he also was asked to apply in Australia a novel principle of tax law said to have been established overseas, in that case in New Zealand.

For these reasons, I uphold the applicant's contention that he is not liable to the assessments which have issued in respect of the income the product of the sum of $1 million taken by him from Canon. The appeals are allowed. I think orders in a form similar to that adopted by Dixon J. in his judgment in
Australian Machinery & Investment Co Ltd v DFC of T (1946) 8 ATD 81 at 108 are appropriate. It is ordered in each appeal that the decision of the Commissioner upon the objection be set aside, and that the objection be remitted to the Commissioner for reconsideration and redetermination conformably with the reasons of the Court. The applicant is entitled to his costs.


1. The appeals be allowed.

2. In each appeal the decision of the Commissioner upon the objection be set aside, and the objection be remitted to the Commissioner for reconsideration and redetermination conformably with the reasons of the Court.

3. In each appeal, the respondent pay the applicant's costs of and incidental to the appeal.

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