Handley v. Federal Commissioner of Taxation.

Stephen J

Mason J
Murphy J
Aickin J
Wilson J

Full High Court

Judgment date: Judgment handed down 1 April 1981.

Stephen J.

Section 51(1) of the Income Tax Assessment Act 1936 (as amended) is the general provision which determines what losses and outgoings incurred by a taxpayer shall be allowable deductions. Because it must deal with items of expenditure of many and varied kinds it is expressed in very general terms. It has been said that its ``language is simple enough and, in the main, little difficulty is encountered in recognizing those items of business expenditure which qualify as deductions'' -
Lunney v. F.C. of T. (1958) 100 C.L.R. 478 at p. 496.

However, perhaps because of the very simplicity of its language, difficulties have been encountered in cases involving what have been called home office expenses. Expenditures of this nature, associated with portion of taxpayers' dwellings used to a greater or lesser extent for business or professional purposes, have, when claimed as deductible, been variously treated and the principles involved and the distinctions drawn between various such expenditures have not always been immediately apparent.

The expenditures claimed as deductible by the present taxpayer, a barrister, are in the nature of home office expenses. They concern a room in his home, regularly used by him as a study for some 20 hours a week for about 45 weeks a year. The existence of this room, suitable for use as a study, was regarded by him as an essential feature affecting his decision to purchase the house. The room is only used infrequently for purposes other than as a study, but it does provide a means of access to a patio which the family use occasionally. The expenditures consist of interest on moneys borrowed on the security of a mortgage over the premises and applied in their purchase, municipal and water rates and fire insurance premiums, all in respect of the premises. In each case one-fifteenth of the total expenditure has been claimed, that being the proportion of the floor area of the house which is occupied by the study. The Commissioner allowed claimed deductions in respect of electricity and house cleaning charges apportioned in respect of the study and no question arises as to them, but he disallowed these other claimed deductions. Their disallowance was upheld by a Board of Review.

On appeal to the Supreme Court of New South Wales Yeldham J. referred to Lunney's case and to
Thomas v. F.C. of T. 72 ATC 4094;
F.C. of T. v. Faichney 72 ATC 4245, (1972) 129 C.L.R. 38;
F.C. of T. v.

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McCloy 75 ATC 4079, (1975) 1 N.S.W.L.R. 202 and the decision of the Federal Court of Australia in
F.C. of T. v. Forsyth 80 ATC 4176, now on appeal to this Court [reported at 81 ATC 4157]. It was in reliance upon McCloy, Thomas and Faichney that the Board had upheld the Commissioner's assessment.

In view of the disallowance of deductions in the earlier cases his Honour found it difficult to find a logical justification for the allowance of expenditure in Forsyth's case, with which decision he however expressed entire agreement. He nevertheless concluded that he should follow those earlier cases, adding that ``plainly the matter is one which should be resolved at an appellate level''.

Section 51(1) relies upon two sets of descriptions and upon the principle of apportionment to define those losses and outgoings which are to be deductible. It first describes a general class of losses and outgoings which are to be deductible and then goes on to describe certain specified sub-classes of expenditure which are to be excluded from the general class. In each of these descriptions it uses the phrase ``to the extent to which'', a phrase which calls for a process of apportionment whenever the facts require it.

Apportionment is necessary in the case of the general class of deductible outgoings in at least two instances: when an item of expenditure has been applied to obtain things or services of which only ``distinct and severable parts are devoted to gaining or producing assessable income'' and also when the things or services obtained serve indifferently the object of gaining or producing assessable income and also some other unrelated object -
Ronpibon Tin N.L. & Tongkah Compound N.L. v. F.C. of T. (1949) 78 C.L.R. 47 at p. 59. It may also no doubt become necessary at the later stage of applying to a particular case the description of the excluded sub-classes.

This principle of apportionment embodied in sec. 51(1) makes it clear that the mixed character of a loss or outgoing is in itself no bar to the deductibility of an appropriate portion of that loss or outgoing. Another principle important in the application of sec. 51(1) is that it is for the taxpayer and not the Commissioner to decide upon the manner and extent of expenditure incurred by the taxpayer in gaining his income: that outgoings are unwisely or excessively incurred is nothing to the point in determining whether or not they are allowable deductions. This was made clear in Ronpibon and was applied in
Cecil Bros. Pty. Ltd. v. F.C. of T. (1964) 111 C.L.R. 430 in a passage subsequently adopted by their Lordships in
Commr. of I.R. v. Europa Oil (N.Z.) Ltd. 70 ATC 6012 at p. 6019; (1971) A.C. 760 at p. 772, where it was said that ``a trader is entitled to conduct his business and to acquire his trading stock in his own way''. This may become of particular relevance in the case of home office expenses: there will be no exclusion from deductibility merely because a taxpayer might more economically have conducted his business or profession exclusively from his principal place of business: if a taxpayer's expenses are to any extent incurred in gaining or producing assessable income, thus answering the description of the general class of deductible outgoings, and are not within any excluded sub-class they will be deductible regardless of their economic wisdom or expediency.

It is in the context of these principles that the characterization of particular losses and outgoings which sec. 51(1) calls for is to be undertaken. That characterization will involve the analysis of particular losses or outgoings so as to determine first whether they are in whole or in part business expenditures (to adopt the shorthand phrase used in Lunney's case at p. 496) and then, to the extent that they are, to determine whether any part of them nevertheless falls within an excluded sub-class.

It is principally with the decisions in Thomas and in Faichney that this appeal must be concerned. In Thomas a barrister had borrowed money to meet the cost of adding rooms to his house, one of which he used as a study. In denying him a deduction for any part of the interest on the borrowed money Walsh J. said, at p. 4097, that the house ``should not be regarded in the circumstances of this case as being or as including part of the business premises of the appellant''. Accordingly the interest incurred was of a capital, private or domestic nature and hence excluded from deductibility. It did not lose that character because the appellant ``like most professional men, did

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some of his work at home, or because he used one of the added rooms for that purpose''. The appellant had not spent money ``in erecting premises suitable only for use as business premises. He added rooms to his house''.

In Faichney Mason J. said, at ATC p. 4249; C.L.R. p. 43, that a study in a home was a part of that home ``no matter how great the extent of its dedication in point of use to the pursuit of these activities from which the taxpayer earns his income''. His Honour, at ATC p. 4249; C.L.R. p. 44, distinguished the case of a doctor's surgery integral with his home. He observed that ``a study does not cease to be part of a taxpayer's home because it is used by the taxpayer for the pursuit of activities from which he earns his income. However, the doctor's surgery is not in a relevant sense part of his home; it is his place of business...''.

As I read those judgments the above represents the substance of the reasoning which led in each case to disallowance of the claim to deduct interest. In Thomas the decision was squarely based upon the expenditure being of a capital, private or domestic nature; likewise in Faichney, save that Mason J. was at pains to point out that he was not thereby to be taken as assuming that the outgoing would in any event have fallen within the general class of business expenses.

In each of these cases the use made by the taxpayer of the room in question was not regarded as the critical feature. Rather it seems to have been the physical character of that room, forming as it did an integral part of the taxpayer's home, which was regarded as decisive. However Mason J. would not regard mere physical unity as necessarily disqualifying, as was shown by his remarks concerning a doctor's surgery. With respect, this must clearly be correct: it cannot matter that the proprietor of a small suburban shop lives behind that shop in premises integral with it; the rent attributable to the shop will none the less surely be deductible. Nor can it matter to what degree the two parts intercommunicate; sec. 51(1) cannot be affected by vagaries of architecture or design.

Wherein then lies the distinction between shop or surgery on the one hand and so-called home office on the other? It can scarcely reside in the fact that in addition to the home office the taxpayer maintains elsewhere another and principal place of business. A surgery will be none the less a surgery, properly regarded as a place of business, although the doctor conducts most of his practice at some central clinic or larger surgery distant from his home. A fruiterer is not to be denied deductions in respect of the suburban fruit shop behind which he lives because he also conducts a more substantial business at a lock-up fruit shop in some nearby shopping centre.

Again, while it is true that to sell fruit or to attend to patients involves direct contact with the public, whereas a study may seldom if ever be entered by customers or clients, this distinction is surely irrelevant in the application of sec. 51(1). It only reflects the different character of work involved in different income-earning pursuits. Thus a caterer may prepare in the kitchen of his own home all the food which he supplies to meet orders and may derive a substantial income from his business but he will not be denied deductions because no customers visit his kitchen.

Moreover, to take the same example, the fact that such a caterer uses one and the same kitchen both to prepare the food which he delivers to customers in the course of his business and to cook his own meals, while it may call for apportionment of outgoings, will not disqualify him from entitlement to a due proportion of those outgoings. Likewise with many small business (and local chiropodists, physiotherapists and the like come to mind) which, perhaps only after-hours or on week-ends, involve attending to customers in a room in the house which at other times may be used as an ordinary living room. These are occasions for apportionment, not for exclusion from deductibility. Incidentally, the foregoing examples suggest that the term ``home office'' may be a misnomer if thought of as describing some unique situation; there seems in fact little to differentiate a so-called home office from any other business use of a home, whether it be used conjointly with a principal place of business located elsewhere or as the sole place of business.

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I have thus far described, and in turn discarded, a variety of factors which might be thought to disqualify a taxpayer from deductions for home office expenses: the physical unity of the home with the office, the one being integral with the other; the existence of intercommunication between the two; the presence elsewhere of another and principal place of business; the absence of visits by clients or customers to the home office; its use in part for purely domestic purposes. It would no doubt be possible to conceive of others.

The reason why none of these features provides a satisfactory criterion for the denial of deductibility is because the problem posed by sec. 51(1) is not of a kind to be answered by specific criteria such as these. The text of sec. 51(1) itself provides the only criterion of deductibility. Disregarding for the moment the exclusion of particular sub-classes, it is that there should exist a particular relationship between a loss or outgoing and the gaining or producing of the taxpayer's assessable income (I need here refer only to the first limb of the description of the general class of deductibility). That relationship must be such that the loss or outgoing is of a nature or character which is incidental and relevant to the gaining of assessable income and must have been incurred ``in the course of gaining or producing'' it. Whether or not on each occasion the loss or outgoing is sufficiently incidental or relevant will depend upon a variety of factors. In some circumstances the purpose for which the advantage occasioning the loss or outgoing is sought may evidence a sufficient relationship with the income-earning process, as for instance where interest is payable on borrowed money. On other occasions, the purpose may be of little assistance; it will be necessary to look to other factors to see what role, if any, the loss or outgoing plays in the conduct of the income-earning activities. As Dixon J. said in
Amalgamated Zinc (De Bavay's) Ltd. v. F.C. of T. (1935) 54 C.L.R. 295 at p. 309:

``The expression `in gaining or producing' has the force of `in the course of gaining or producing' and looks rather to the scope of the operations or activities and the relevance thereto of the expenditure than to purpose itself.''

See also the judgment of the Court in
Charles Moore & Co. (W.A.) Pty. Ltd. v. F.C. of T. (1956) 95 C.L.R. 344 at p. 351.

In the present case, the advantage sought to be obtained by the outgoing can only be enjoyed by use: whether or not there exists a sufficient relationship between this outgoing and the income-earning activities of the taxpayer is therefore best determined by looking to the use to which the home study was put. If on examination more than one use is disclosed, it will mean only that this is a case for apportionment. There is, in this regard, no conflict between this examination of use and the determination of essential character referred to in Lunney at p. 497: the effect of an analysis of relevant factors, in this case primarily of use, is to determine whether the ``essential character'' of a deductible sum is that of ``business expenditure''.

In the present case it requires no close analysis to discern an intimate relationship between each of the present taxpayer's claimed outgoings and his earning of assessable income. It is not and could not be disputed that what he does by way of use of his study is directly concerned with the earning of his income. That part of the interest which he pays which is apportionable to the study provides him with the surroundings which he needs in which to carry on part of his income-earning activities. The rates and fire insurance premiums which he pays are, to the extent that they may be apportioned to the study, no less referable to his income-earning activities.

It follows that I regard an appropriately apportioned part of each of these expenditures as falling within the general class of deductible losses and outgoings described in sec. 51(1). If the decisions in Thomas or in Faichney are to be regarded as leading to the contrary conclusion I would with respect decline to follow them. Their reliance upon criteria concerned with the location of the home office, integral with the taxpayer's home, and their disregard of the use to which a home office is put appears to me to find no support in the terms of sec. 51(1).

There remains the effect of that part of sec. 51(1) which excludes from deductibility

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that sub-class of losses or outgoings which are of a ``private or domestic nature''. In both Thomas and Faichney this was the express ground of decision. So far as I am aware there has been no close examination of this exclusion by any court. However the difficulty of assigning to it any subject matter upon which to operate, expressed as it is as excluding losses and outgoings otherwise falling within the general class of allowable deductions, has been adverted to in the cases. In Faichney Mason J. observed at ATC p. 4249; C.L.R. p. 44 that such examples of private or domestic expenditure as leapt to the mind were such as ``could not conceivably be incurred in gaining assessable income''. In
F.C. of T. v. Hatchett 71 ATC 4184 at p. 4186; (1971) 125 C.L.R. 494 at p. 498, Menzies J. said that:

``It must be a rare case where an outgoing incurred in gaining assessable income is also an outgoing of a private nature. In most cases the categories would seem to be exclusive.''

I not only conclude that the present taxpayer's apportioned outgoings are within the category of outgoings incurred in gaining his assessable income; I also regard them, in the circumstances of this case, as by their nature excluded from the category of private or domestic outgoings. Adopting the analysis which I have and discarding as insignificant matters such as the integral nature of the study and the home, nothing remains as a feature of duly apportioned parts of these outgoings which would at all answer the description of expenditure of a private or domestic nature.

If this conclusion would seem substantially to deprive of effective operation the sub-class of private or domestic expenditure as an exception to the general class of deductible expenditure, this may not be as surprising as it seems at first sight. Another sub-class mentioned in sec. 51(1), that related to expenditure incurred in gaining exempt income, has plainly enough no effective operation as an exception to the general class. In Ronpibon the Court pointed out, at p. 56, that ``exempt income can never be assessable income. They are mutually exclusive categories''. The explanation there given by the Court for this specific exclusion was the legislation's ``desire to declare expressly that so much of the losses and outgoings as might be referable to exempt income should not be deductible from the assessable income''. While admittedly illogical to express such a declaration in the form of an exemption, it was said to serve ``the not unimportant purpose of making an express contrast''. The same explanation may apply to the presence in sec. 51(1) of the exclusion of expenditure of a private or domestic nature. Even if this be not so, and Boards of Review have on occasions discerned instances where this exclusion may operate as a true exception, I am, for the reasons earlier stated, satisfied that it does not operate to except the present home office outgoings.

It remains only to say something of Lunney and of the concept of a base of operations which was there referred to and which was relied on by the respondent. Lunney was concerned exclusively with the question of whether the expense of travelling between home and place of work was an allowable deduction. This is a question to which the traditional answer given, that it is not, is said to owe its origin to social conditions of over 150 years ago. This is explained in the dissenting judgment of McTiernan J. in Lunney at pp. 492-493 and by Denning L.J. in
Newsom v. Robertson (1953) 1 Ch. 7 at pp. 15-16. As Dixon C.J. said in Lunney at p. 486, bare reason must lead to misgivings about disallowing such outgoings, but, the principle having been settled long ago, it was, he thought, for the legislature and not the Courts to alter it. Williams, Kitto and Taylor JJ., in their joint judgment, were in no doubt but that such expenses of travel were not ``by any process of reasoning a business expense'' - at p. 501. They had earlier said, at p. 499, that the purpose of such journeys was at least as much to enable the taxpayer to reside at his home as to attend his place of work and in that connexion they cited a lengthy passage from the judgment of Denning L.J. in Newsom's case. His Lordship there refers to the notion of the geographic base of a taxpayer's trading operation. For a barrister this is said to be his chambers, not his home; so too the expense of travel to chambers is incurred because he lives at a distance from his base and is incurred for the purpose of living in that fashion and not for the purpose of his profession.

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What was said in the joint judgment in Lunney was, of course, directed exclusively to the single question before the Court, relating to the expense of travelling to work. If, despite the careful reasoning in the dissenting judgment of McTiernan J. and the misgivings expressed by Dixon J., the disallowance of such travelling expenses can be justified in modern conditions as a matter of logic, rather than as a question of adherence to well settled authority, the logic applicable to this quite special context cannot, I think, be applied in other areas. In particular, it cannot be applied to the quite different case of home office expenses, as was sought to be done by the respondent, regarding those expenses as incurred for the purpose of living at home and hence as domestic or private in nature. Apart from the inappropriateness of such a transfer of reasoning from one area to another, such a transfer may in many cases be found to result in conflict with the principle that it is ``not for the Court or the commissioner to say how much a taxpayer ought to spend in obtaining his income, but only how much he has spent'' - Ronpibon at p. 60.

So far as concerns the actual apportionment made by Yeldham J., it is enough to say that nothing said in argument would lead me to disturb it. This is not to say that the approach to apportionment taken by his Honour was the only correct method or that it would be appropriate in all circumstances. Other equally acceptable methods might well produce somewhat different results; after all, any apportionment of the kind contemplated by sec. 51(1) must necessarily very often be a rough and ready process.

I would allow the appeal; the deductions claimed by the taxpayer should have been allowed to the extent of one-fifteenth of his total outgoings in respect of interest, municipal and water rates and insurance premiums.

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