W J & F Barnes Pty Ltd v Federal Commissioner of Taxation
96 CLR 294(Judgment by: Fullagar J)
Between: W J & F Barnes Pty Ltd
And: Federal Commissioner of Taxation
Judges:
Dixon CJ
Fullagar JKitto J
Subject References:
Taxation and revenue
Income tax
Assessment
Amendment
Payment of retiring allowances
Legislative References:
Income Tax Assessment Act 1936 (No 27) - s 109; s 170
Judgment date: 16 April 1957
SYDNEY
Judgment by:
Fullagar J
This case comes before the Full Court on a case stated by Kitto J. in an appeal by a taxpayer, which is a company incorporated in Victoria, from a decision of a board of review. The board upheld an amended assessment of income tax by the commissioner, to which the company had objected. The relevant year of income is the calendar year ended 31st December 1945, the calendar year being the company's accounting period under the Assessment Act. In that year the company paid to three directors, all of whom were of advanced age and had served the company for many years, certain sums on their retirement from the board. These sums appear to have been paid without the authority of any formal resolution, but they have been treated as retrospectively authorized by a resolution of the board passed on 27th May 1946. That resolution is in the following terms: "It was resolved that in view of the long and faithful services rendered to the company by Mr. J. B. Barnes, Mr. F. Barnes and Miss S. Barnes, these services extending over periods averaging approximately fifty years and having been rendered during periods of depression, bad trading conditions, etc., on very low rates of remuneration, they should be granted retiring allowances to make due provision for their years of old age and retirement equal to three years' salary in each case, the full allowance being: Mr. J. B. Barnes PD4,500, Mr. F. Barnes PD4,500, Miss S. Barnes PD450." The total amount paid was thus PD9,450.
The company was a private company within the meaning of Div. 7 of Pt. III of the Assessment Act. As such it was subject not only (like all other companies) to "ordinary" income tax at a flat rate, but also under Div. 7 to a further tax on "undistributed income". That is to say, if it did not within a prescribed time after the close of an accounting period make to its shareholders a sufficient distribution (as defined in the Act) of its taxable income of that accounting period, it became liable to pay the amount of tax which its shareholders would have been liable to pay if a sufficient distribution had been made to them by way of dividend. The present case is concerned with the company's assessment to tax under Div. 7, but it is necessary to refer first to the circumstances connected with its assessment to ordinary tax.
For the purpose of ascertaining its taxable income, whether for the purpose of "ordinary" company tax or for the purpose of Div. 7, the company was, of course, entitled to make all deductions which are allowable deductions under the Act. In its return of income derived in the relevant period the company claimed as a deduction the amount of PD9,450 which had been paid to the three retiring directors. Prima facie the deduction might have been supported either under s. 51 or under s. 78 (1) (c). Section 51, so far as material, provides:
"All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income."
Section 78 provides:
"The following shall, subject to this section, be allowable deductions ...
- (c)
- Sums which are not otherwise allowable deductions,
and which are paid by the taxpayer during the year of income as retiring allowances or pensions to persons who are or have been employees or dependants of employees, where such persons are residents, to the extent to which in the opinion of the commissioner those sums are paid bona fide in consideration of the past services of the employees in any business of the taxpayer."
The commissioner made inquiries as to the circumstances attending the making of the payment in question, and on 30th January 1948 made an assessment of the ordinary income tax payable by the company in which he disallowed the deduction of those payments. The notice of assessment was accompanied by an adjustment sheet in which the commissioner, after stating that the deduction of the sum of PD9,450 was disallowed, said:
"The question of allowance of this amount will receive further consideration. If, however, the company wishes to protect its legal rights an objection should be lodged within the prescribed time."
The case states that in disallowing the deduction of the sum of PD9,450 the commissioner
"treated the said sum of PD9,450 as being, by reason of the provisions of s. 109 of the said Act, not an allowable deduction, his opinion being that it was not to any extent reasonable as an allowance, gratuity or compensation in consequence of the retirement of the above-mentioned persons or any of them".
Section 109 of the Act was at the material time in the following terms:
"So much of any sum paid or credited by a private company and being, or purporting to be-
- (a)
- remuneration for services rendered by any person being a shareholder or director of the company or being a relative of any such shareholder or director; or
- (b)
- an allowance, gratuity or compensation in consequence of the retirement of that person from any office or employment held by him in that company, or upon the termination of any such office or employment,
as exceeds an amount which, in the opinion of the commissioner, is reasonable, shall not be an allowable deduction and the excess shall, for all purposes of this Act, be deemed to be a dividend paid out of profits derived by it to the recipient and received by him as a shareholder of the company."
It is to be observed at this stage that s. 109 appears to assume that there is an amount otherwise deductible under s. 51 or s. 78 (1) (c), and to authorize the commissioner, if he forms a certain opinion, to reduce the amount of the deduction in a case where the paying of the sum in question is to a shareholder or director of the company or a relative of a shareholder or director. It will be necessary to return to this point later. It would appear that the commissioner at or about the same time assessed the income of the recipients of the three sums which made up the amount of PD9,450 and treated those sums as dividends, i.e. income from property in their hands.
The company objected to the assessment, and on disallowance of its objection caused the matter to be referred to a board of review. The board confirmed the commissioner's assessment. It is said that the claim for a deduction under s. 51 was abandoned at the hearing. There may have been an unfortunate misunderstanding about this. It is far from obvious that the claim for a deduction under s. 51 was not sustainable. At any rate, s. 51 being supposed to be out of the way, the board held that the case did not fall within s. 78 (1) (c) because "on the facts the directors were not employees of the company". That, of course, disposed of the case, but the board went on to say that in its opinion "no part of the PD9,450 should be brought within the operation of s. 109, as it did not regard the amounts comprising it as unreasonable amounts of retiring allowances". This appears to have been no more than an obiter dictum to the effect that, if the sum in question had been deductible either under s. 51 or under s. 78 (1) (c), it ought not to have been disallowed under s. 109. The company did not appeal against this decision of the board, which was given on 23rd April 1951.
What has been so far narrated relates only to the company's assessment of ordinary income tax and is of indirect importance only. In the meantime, however, and in fact before he had completed his consideration of the company's objection to its ordinary assessment, the commissioner had made an assessment of the tax payable by the company under Div. 7, and notice of this assessment was given to the company on 22nd December 1948. In this assessment he treated the company as having distributed the sum of PD9,450 by way of dividend. The effect of this was, of course, to reduce by that amount the undistributed profits on which the company was taxable under Div. 7. The case says that he "treated the said sum of PD9,450 as deemed, by reason of the said s. 109, to be dividends paid by the company out of profits derived by it to the persons referred to ... and received by them as shareholders of the company, being still of the opinion mentioned in par. 5 hereof." The opinion mentioned in par. 5 is the opinion that by reason of the provisions of s. 109 the said sum was not an allowable deduction.
On 2nd October 1951 (i.e. some six months after the board of review had given its decision on the company's objection to its ordinary assessment, and long after the time for appealing from that decision had expired) the commissioner, doubtless inspired by the obiter dictum of the board which has been quoted, amended the company's Div. 7 assessment, treating the sum of PD9,450 as not being deemed to be dividends paid by the company. The effect of the amendment was that the company did not receive credit for the PD9,450 either as dividends or as an allowable deduction. The case states that the commissioner made the amendment "because it appeared to him that the opinion which he formerly held, as stated in par. 5 hereof, was erroneous, and for the purpose of correcting it and making consequential alterations". The company objected to this amended assessment, and, the objection being disallowed, required its objection to be referred to a board of review. The board confirmed the amended assessment, and it is from that decision that the company has appealed to this Court. It should be mentioned that the commissioner, in addition to amending the company's Div. 7 assessment in the manner stated, also amended the assessments of the three recipients of the PD9,450. In these amended assessments he treated the sums received as income from personal exertion.
The only question raised by the case stated is whether this amended assessment of 2nd October 1951 is authorized by the Assessment Act. The question turns on s. 170 of the Act, by which the power of the commissioner to amend an original assessment is delimited. The section draws a primary distinction between cases where the taxpayer has, and cases where the taxpayer has not, "made to the Commissioner a full and true disclosure of all the material facts necessary for his assessment". Here the company had, before the original assessment, made such a full and true disclosure. The sub-section of s. 170 which deals generally with such cases is sub-s. (3), which provides:
"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 three years from the date upon which the tax became due and payable under that assessment."
It is common ground that the amendment in the present case was not made to correct an error in calculation or a mistake of fact, and sub-s. (3) therefore does not authorize the amended assessment. Sub-section (8), however, provides:
"Where-
- (a)
- any provision of this Act is expressly made to depend in any particular upon a determination, opinion or judgment of the Commissioner; and
- (b)
- any assessment is affected in any particular by that determination, opinion or judgment,
then, if, after the making of the assessment it appears to the Commissioner that the determination opinion or judgment was erroneous, he may correct it and amend the assessment accordingly in the same circumstances as he could under this section amend an assessment by reason of a mistake of fact."
It is on sub-s. (8) that the commissioner relies as justifying the amendment of the original assessment. If that sub-section is applicable, then, a full and true disclosure having been made by the taxpayer, and the amendment having been made within the three years mentioned in sub-s. (3), that amendment was authorized. Sub-section (8) is somewhat obscurely expressed, but it has been assumed-rightly, I think-that that is its effect. The question is whether sub-s. (8) is applicable to the case.
The first step must be to consider the operation of s. 170 (8). The commissioner is called upon, in the making of almost any assessment, to form an opinion upon such matters as whether a particular receipt is assessable income and whether a particular expenditure is an allowable deduction. Opinions on such matters are, of course, altogether outside s. 170 (8): if they were not, that sub-section would simply stultify all the rest of s. 170. It applies only where we find a provision in the Act which expressly attaches legal consequences to the formation of an opinion by the commissioner upon some matter. There is a number of provisions of this character in the Act. If, in any such case, the commissioner forms an opinion on the relevant question and assesses the taxpayer accordingly, he may (subject, in cases of full disclosure, to sub-s. (3)) later revise his opinion, and amend the taxpayer's assessment so as to make that assessment accord with his revised opinion. But it is of great importance to bear two things in mind. The first is that an opinion of the commissioner cannot be revised under s. 170 (8) unless it is an opinion formed on the precise matter which is committed to him for the formation of an opinion. The second is that a revision of the commissioner's opinion does not throw the whole assessment open, and leave the commissioner at large to amend it in any way that seems correct to him. He can only amend it so far as its incorrectness depends upon, and arises out of, the opinion which he originally formed and which now seems to him to be erroneous. In other words, sub-s. (8) does not apply unless it necessarily follows from the revision of opinion that the original assessment was wrong in some particular respect, and then it is only in that particular respect that it may be amended.
Section 109 contains one of the provisions of the Act under which the assessment of a taxpayer may be affected by an opinion formed by the commissioner. It is clearly one of the provisions referred to in s. 170 (8). It is, however, apparent on its face that it is concerned only with the quantum of a particular class of allowable deduction. It is aimed at a well-known type of case, which is exemplified in Aspro Ltd v Commissioner of Taxes. [F4] It first made its appearance in the Act (in a somewhat simpler form) in 1934 as s. 31H. A private company, having two or three directors who hold all the shares, and making large profits, would naturally desire to pay to its directors and shareholders as much as possible under the name of remuneration, and as little as possible under the name of dividends. The advantage was, of course, twofold. There was advantage to the company, because remuneration paid for services was deductible in arriving at its taxable income: and there was advantage to the shareholders, because remuneration received for services was taxed at personal exertion rates, whereas dividends were taxed at property rates. Section 109 requires the commissioner in such cases to form an opinion as to how much of any sum ostensibly paid by a private company to a director or shareholder or relative as remuneration is reasonable in relation to services rendered. When he has formed his opinion on that matter, he must disallow as a deduction in the company's assessment any excess over what he thinks is reasonable, and must treat that excess for all purposes as a dividend paid by the company to a shareholder. The important point is that s. 109 presupposes a payment which, apart from s. 109 itself, would be an allowable deduction to the company. Unless there is a payment of that character, the commissioner is neither commanded nor authorized to form any opinion under that section. It is the reasonableness of the payment as a reward for services that he must consider, and it would be absurd to require him to consider that question if the amount paid were, as a matter of law and apart altogether from its reasonableness, not deductible. On the one hand, s. 170 (8) can operate only with respect to a change in an original opinion, the formation of which is authorized by the Act and made by the Act a criterion of liability to tax. On the other hand, when s. 170 (8) does operate, it authorizes only such an amendment as will make the assessment what it necessarily must have been if the commissioner's changed opinion had been the opinion originally held by him.
The case states that the commissioner treated the sum in question as being "by reason of the provisions of s. 109 not an allowable deduction, his opinion being that it was not to any extent reasonable". It thus appears, in my opinion, that the commissioner did not apply his mind to the question on which s. 109 requires him to form an opinion. He ran, so to speak, two questions into one, misconceiving his function under s. 109. The question of the allowability of a payment as a deduction is one question, and it is a question as to which s. 109 does not authorize the commissioner to form an opinion binding on the taxpayer or an opinion to which s. 170 (8) applies. The question whether an otherwise allowable deduction should be reduced because it is unreasonable in amount is another question. It is a distinct and different question, and it is on that question alone that the commissioner is authorized by s. 109 to form an opinion binding on the taxpayer. Since he never really formed an opinion on that question, there could be no such subsequent change of opinion as would justify an amendment of the assessment under s. 170 (8).
It may be objected that the view above expressed holds the commissioner too strictly and literally to the language of the case stated. It appears to me to treat the case as meaning just what it says. But, in any case, the only other possible alternative interpretations of the commissioner's process of reasoning leave him in no better position. He may have refrained from considering whether the payments in question were, apart from s. 109, allowable deductions, and said that, whether they were otherwise allowable deductions or not, they were unreasonable in amount. But, on this view again, he has not addressed himself to the question committed to him by s. 109. For that section does not authorize him to form an opinion as to the reasonableness of a payment unless that payment is, apart from his opinion as to its reasonableness, an allowable deduction. The only other possible view seems to be that the commissioner did regard the payments in question as otherwise allowable deductions, but was of opinion that it was not reasonable to make any payment at all. On this view, if it be assumed that he could form an opinion resulting in total disallowance as distinct from reduction, it may be said that he did form an opinion which was authorized by s. 109 and an opinion to which s. 170 (8) applied. He could then change that opinion, and amend the assessment under s. 170 (8). But s. 170 (8) would authorize only such an amendment as would give effect to a new opinion that the amounts paid were reasonable in whole or in part. It would not authorize an amendment giving effect both to a changed opinion that the payments were reasonable in amount and a changed opinion that, apart altogether from s. 109, they were not allowable deductions under the Act. In other words, the only amendment which s. 170 (8) would justify would be an amendment allowing the deduction of the whole or part of the sum of PD9,450 from the company's assessable income.
In my opinion, the amendment of the company's Div. 7 assessment was not authorized by s. 170 (8), and the question asked by the case stated should be answered: No.