Decision impact statement
Commissioner of Taxation v Day
-
This document incorporates revisions made since original publication. View its history and amending notices, if applicable.
Venue: High Court
Venue Reference No: S315/2008
Judge Name: Gummow, Kirby, Hayne, Heydon, Kiefel JJ
Judgment date: 13 November 2008
Appeals on foot:
N/A
Impacted Advice
Relevant Rulings/Determinations:- ATO ID 2002/665
Subject References:
Deductibility of legal expenses
Whether legal expenses incurred 'in gaining or producing' assessable income
Connection with activities productive of assessable income
Legal expenses incurred in defending charges under the Public Service Act 1922 (Cth)
Précis
Outlines the Tax Office's response to this case which concerned deductibility of legal expenses incurred by a public servant in defending charges in respect of conduct which occurred outside the course of his normal day-to-day duties
Brief summary of facts
The taxpayer claimed a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for legal expenses incurred by him in the 2002 income year in defending three sets of disciplinary charges brought against him by his employer, the Australian Customs Service (Customs), under the Public Service Act 1922.
The First Charge was brought under paragraph 56(d) of the Public Service Act 1922 and related to the alleged failure of the taxpayer to fulfil his duty as an officer in that he presented his official Customs identification card, in circumstances which were not work related, to gain access to a court officer in order to obtain information regarding a search warrant which had authorised a search of his workstation.
The Second Charges were brought under subparagraph 56(f)(i) of the Public Service Act 1922 and related to alleged failures of the taxpayer on various dates to fulfil his duty to accurately record attendance at work.
The Third Charges were brought under paragraph 56(d) of the Public Service Act 1922 and related to the alleged failures of the taxpayer to fulfil his duty as an officer in a number of instances, including that the taxpayer had failed to inform Customs of relevant information relating to a claim for a diesel fuel rebate by the partner of another Customs officer, had lent improper support and assistance to the other officer and was knowingly concerned in the creation of a false diary which supported the claim, had used a work vehicle for non-work related purposes, had falsely recorded his attendance records, and had failed to communicate certain information concerning an investigation into another person. The charges were made following the release by the Australian Federal Police (AFP) to Customs of information obtained from telephonic interceptions of the taxpayer's home and work telephones. The taxpayer initiated legal proceedings in the Federal Court and the High Court, unsuccessfully, to have the charges set aside on the basis that the information obtained from telephone interceptions was unlawfully passed to Customs by the AFP.
At first instance Emmett J held that the legal expenses incurred in relation to the First and Third Charges were not deductible, but also held that the Commissioner was estopped from contending that the expenses relating to the Third charges were deductible. His Honour held that legal expenses incurred in relation to the Second Charges were deductible.
The Commissioner appealed to the Full Federal Court against the application of estoppel in respect of the legal expenses related to the Third Charges. The Commissioner accepted that the legal expenses incurred in respect of the Second Charges were deductible. The taxpayer cross-appealed against the finding that the legal expenses incurred in respect of the First and Third Charges were not deductible.
The Full Federal Court (Spender, Dowsett and Edmonds JJ) allowed the Commissioner's appeal on the issue of estoppel. However, a majority of the Full Court, Spender and Edmonds JJ, also allowed the taxpayer's cross-appeal, holding the expenses incurred in respect of the First and Third charges to be deductible, although for different reasons.
Dowsett J, in his dissenting judgment in the Full Court, agreed with the primary judge, Emmett J, that the legal expenses incurred in relation to the First and Third Charges were not deductible.
The Commissioner applied for special leave to appeal to the High Court and leave was granted.
Issues decided by the High Court
Outgoing incurred in gaining or producing assessable income
A majority of the High Court (Gummow, Hayne, Heydon and Kiefel JJ) held that the legal expenses were incurred by the taxpayer in the course of gaining or producing his assessable income and therefore that paragraph 8-1(1)(a) of the ITAA 1997 was satisfied. Their Honours said:
"Section 8-1 is couched in terms intended to cover any number of factual and legal situations in which expenditure is incurred by a taxpayer. Its language and breadth of application do not make possible a formula capable of application to the circumstances of each case.
The question ... is: is the occasion of the outgoing found in whatever is productive of actual or expected income?
Essential to the enquiry is the determination of what it is that is productive of assessable income.
A determination of what is productive of assessable income in a particular case may need to take account of any number of positive and negative duties to be performed or observed by an employee or other salary-earner. It is that determination which provides the answer as to whether the occasion is provided for the expenditure in question.
That no narrow approach should be taken to the question of what is productive of a taxpayer's income is confirmed by cases which acknowledge that account should be taken of the whole of the operations of the business concerned in determining questions of deductibility. A similar approach should be taken to what is productive of a salary-earner's income ...
In some cases those duties to be observed may extend beyond what is contained in the contract of employment. ...[I]t will often be necessary to analyse with some care the operations or activities regularly carried on by the taxpayer ...
The essential difficulty with the Commissioner's argument in this case is that it does not fully recognise the scope of the respondent's role as an officer of the Public Service and what his office exposed him to.
The respondent's position as an officer subject to the Public Service Act 1922 obliged him to observe standards of conduct extending beyond those in the performance of the tasks associated with his office and exposed him to disciplinary procedures within the Service which might have consequences for the retention of his office or his salary. What was productive of income must be understood in this light.
He was exposed to ... charges [with respect to his conduct, or misconduct, as an officer] and consequential expenses by reason of his office. The charges cannot be considered remote from his office, in the way that private conduct giving rise to criminal or other sanctions may be.
The incurring of expenditure by an employee to defend a charge because it may result in his or her dismissal may not itself be sufficient in every case to establish the necessary connection to the employment or service which is productive of income. Much will depend upon what is entailed in the employment and duties which it imposes upon an employee. In the present case the requisite connection is present."
The majority also considered that in most cases whether expenses are incurred in gaining or producing assessable income looks to the scope of the operations or activities and their relevance to expenditure, rather than to a taxpayer's reason for the expenditure.
Not an outgoing of a private nature
The majority also held that the expenses were not of a private nature, because they were incurred in connection with the taxpayer's position as a public servant and were not unconnected to his service like some fines and penalties are.
Kirby J held that the taxpayer had not incurred the legal expenses in gaining or producing his assessable income. The matters giving rise to the expenditure lacked the requisite temporal or other connection with gaining or producing his assessable income. Alternatively, the expenditure was a loss or outgoing of a private nature and therefore excluded from deductibility.
Tax Office view of Decision
Outgoing incurred in gaining or producing assessable income
As noted by the High Court, section 8-1 is intended to cover such a wide variety of cases it is impossible to provide a formula capable of application to every case. The decision does not lay down any rule for the deduction of legal expenses by an employee beyond the requirement that the occasion for the expenses must be found in what is productive of the assessable income of the employee, which will turn on consideration of the scope of the taxpayer's employment.
The scope of a particular taxpayer's employment is a question of fact and degree. It is not confined to the day-to-day activities performed by the employee. In the circumstances of Day the majority had regard to the nature of the employment (in particular the role of public servants), the terms and conditions of the employment and the tasks performed and duties to be observed under the employment. Of significance was the fact that the legal expenses were incurred in responding to disciplinary action internal to the employment relationship and existing for no other purpose. The taxpayer was exposed to the action by reason of his employment as a public servant, and the consequences of the action only affected his employment.
Where legal expenses are incurred by the employee in an ongoing employment relationship the majority's decision clarifies that the requisite connection required by paragraph 8-1(1)(a) of the ITAA 1997 will not only be satisfied where the connection between the outgoing and the income is identified as being incurred to defend the manner of performance of positive duties, or as arising out of the day-to-day activities of employment. The decision establishes that where the connection between the legal expenses and the income is identified as being incurred to answer allegations of breaching negative duties imposed under the terms of the employment this may also be sufficient to satisfy paragraph 8-1(1)(a) of the ITAA 1997. It may be generalised that where employment or service is conducted on terms that standards of conduct be observed in a taxpayer's personal life on pain of dismissal or reduction in salary, legal expenses incurred in resisting civil disciplinary or legal action will be deductible.
Where the terms of employment do not oblige a taxpayer to observe certain standards of conduct, as the High Court observed, the incurring of expenditure by an employee to defend a charge because it may result in his or her dismissal may not itself be sufficient in every case to establish the necessary connection to the employment or service which is productive of income. Although the legal expenses in such a case may be incurred for a purpose of deriving employment income it does not necessarily follow that they were incurred in the course of gaining or producing that income. In particular, the Commissioner considers that the costs of defending criminal proceedings will rarely, if ever, be deductible under section 8-1.
Not an outgoing of a private nature
The Court found, on the facts of this case, that the legal expenses incurred by the taxpayer in relation to the disciplinary action taken by his employer are not outgoings of a private or domestic nature. Crucial to this view was the fact that the terms of employment exposed the taxpayer as an employee to the employer action, and therefore to the need to incur the legal expenses. The employer brought the action and the legal expenses were incurred in respect of proceedings internal to the employment relationship. The consequences of the disciplinary action, if proven, for the taxpayer principally affected the terms or existence of his employment as a customs officer. However, the criminal law applies regardless of any employment obligation, and the duty to obey it and to respond to criminal proceedings is owed by every man or woman to the Crown as a subject of the law, and not as an employee to the employer. Costs incurred in defending criminal proceedings, in the Commissioner's opinion, are private expenses even when an employee is liable to be dismissed from employment on conviction.
Administrative Treatment
ATO ID 2002/665, which concerns the deductibility of legal expenses incurred in defending disciplinary charges, was withdrawn on 24 July 2009.
Implications on current Public Rulings & Determinations
The Tax Office has reviewed its public rulings to ensure that they are consistent with the reasons of the High Court and confirms that no changes were required.
Implications on Law Administration Practice Statements
None
Court citation:
[2008] HCA 53
(2008) 250 ALR 388
(2008) 236 CLR 163
2008 ATC 20-064
(2008) 70 ATR 14
Legislative References:
Income Assessment Tax Act 1997 (Cth)
8-1
Public Service Act 1922 (Cth)
55
56
61
62
63B
63D
Case References:
Amalgamated Zinc (De Bavay's) Ltd v Federal Commissioner of Taxation
[1935] HCA 81
54 CLR 295
Charles Moore & Co (WA) Pty Ltd v Federal Commissioner of Taxation
[1956] HCA 77
95 CLR 344
CIC Insurance Ltd v Bankstown Football Club Ltd
[1997] HCA 2
187 CLR 384
Collector of Customs v Agfa-Gevaert Ltd
[1996] HCA 36
186 CLR 389
35 ATR 249
96 ATC 5240
Commissioner of Taxation v Cooper
29 FCR 177
91 ATC 4396
21 ATR 1616
Commissioner of Taxation v Shokker
[1999] FCA 600
92 FCR 54
42 ATR 257
99 ATC 4504
Commissioner of Taxation v Rowe
60 FCR 99
31 ATR 392
95 ATC 4691
Day v Federal Commissioner of Taxation
62 ATR 530
[2006] FCA 655
2006 ATC 4268
Federal Commissioner of Taxation v Day
164 FCR 250
67 ATR 936
2007 ATC 5426
Federal Commissioner of Taxation v Hatchett
[1971] HCA 47
125 CLR 494
2 ATR 557
71 ATC 4184
Federal Commissioner of Taxation v Payne
[2001] HCA 3
202 CLR 93
2001 ATC 4027
46 ATR 228
Federal Commissioner of Taxation v Snowden & Willson Pty Ltd
[1958] HCA 23
99 CLR 431
Federal Commissioner of Taxation v Citylink Melbourne Ltd
228 CLR 1
[2006] HCA 35
62 ATR 648
2006 ATC 4404
Federal Commissioner of Taxation v Smith
147 CLR 578
[1981] HCA 10
11 ATR 538
81 ATC 4114
Federal Commissioner of Taxation v Snowden & Willson Pty Ltd
[1958] HCA 23
99 CLR 431
Fletcher v Federal Commissioner of Taxation
[1991] HCA 42
173 CLR 1
22 ATR 613
91 ATC 4950
Handley v Federal Commissioner of Taxation
148 CLR 182
[1981] HCA 16
Federal Commissioner of Taxation v Forsyth
148 CLR 203
[1981] HCA 15
11 ATR 657
81 ATC 4157
Herald & Weekly Times Ltd v Federal Commissioner of Taxation
[1932] HCA 56
48 CLR 113
John v Federal Commissioner of Taxation
[1989] HCA 5
166 CLR 417
20 ATR 1
89 ATC 4101
Lunney v Commissioner of Taxation
[1958] HCA 5
100 CLR 478
Magna Alloys and Research Pty Ltd v Federal Commissioner of Taxation
33 ALR 213
11 ATR 276
80 ATC 4542
[1980] FCA 150
McManus v Scott-Charlton
(1996) 70 FCR 16
140 ALR 625
Newcastle City Council v GIO General Ltd
[1997] HCA 53
191 CLR 85
Project Blue Sky Inc v Australian Broadcasting Corporation
[1998] HCA 28
194 CLR 355
Putnin v Commissioner of Taxation
27 FCR 508
21 ATR 1245
91 ATC 4097
Ronpibon Tin NL and Tongkah Compound NL v Federal Commissioner of Taxation
[1949] HCA 15
78 CLR 47
Steele v Deputy Commissioner of Taxation
[1999] HCA 7
197 CLR 459
41 ATR 139
99 ATC 4242
Strong & Co v Woodifield
[1906] AC 448
W Nevill & Co Ltd v Federal Commissioner of Taxation
[1937] HCA 9
56 CLR 290