• The impact of this case on ATO policy is discussed in Decision Impact Statement: Commissioner of Taxation v Day (Published 28 March 2011).

FC of T v DAY

Court:
Full High Court

MEDIA NEUTRAL CITATION: [2008] HCA 53

Kirby_J

44. Mr Shane Day (the respondent) was an officer of Customs and of the Australian Public Service ( " the Service ' ). He claimed that certain legal expenses incurred by him, in defending disciplinary charges brought against him pursuant to the provisions of the Public Service Act 1922 (Cth) ( " the PSA " ) ^[99] The provisions have been repealed by Sched 1 to the Public Employment (Consequential and Transitional) Amendment Act 1999 (Cth). , were deductible from his taxable income for the relevant tax years.

45. The Commissioner ' s assessment of the taxable income allowed no such deduction. The respondent ' s objection to the assessment was disallowed. He then " appealed " to the Federal Court of Australia ^[100] Taxation Administration Act 1953 (Cth), s 14ZZ(a)(ii). . At first instance, the primary judge (Emmett J) found, in substance, that the expenses were not deductible ^[101] Day v Federal Commissioner of Taxation 2006 ATC 4268 ; (2006) 62 ATR 530 . There was a complication based on a conclusion of the primary judge that the Commissioner was estopped from alleging that charges incurred in the 2001 taxation year were deductible. That conclusion was unanimously reversed by the Full Federal Court. It is not in issue in this Court. . On further appeal to the Full Court of the Federal Court, a majority ^[102] Federal Commissioner of Taxation v Day 2007 ATC 5426 ; (2007) 164 FCR 250 (Spender and Edmonds JJ; Dowsett J dissenting). allowed the appeal and held that the expenses were deductible. Orders were made that the matter be returned to the Commissioner for re-determination according to law. By special leave, the Commissioner appeals to this Court.

46. A majority of this Court has concluded that the respondent ' s legal expenses were deductible and hence that the appeal should be dismissed. Consistently with what I take to be the meaning and purpose of the provisions of s 8-1 of the Income Tax Assessment Act 1997 (Cth) ( " the ITAA " ), and the authority of this Court in
Federal Commissioner of Taxation v Payne ^[103] 2001 ATC 4027; (2001) 202 CLR 93; [ 2001 ] HCA 3. , it is my opinion that the appeal should be allowed and the decision of the primary judge restored.

The meaning of the word " in "

47. The outcome of this appeal turns on the meaning and application of the preposition " in " appearing in s 8-1(1)(a) of the ITAA. It is not unusual for large questions of frequent legal application to depend upon such little words ^[104] For example, the preposition “ by ” in s 82 of the Trade Practices Act 1974 (Cth). See eg Travel Compensation Fund v Tambree (2005) 224 CLR 627 at 645 [ 53 ] of my reasons, 653 [ 79 ] per Callinan J; [ 2005 ] HCA 69. . When such problems arise, where the Parliament has packed into a single word the operation of legislation in multiple circumstances, it is to be expected that courts will endeavour to elaborate and explain the operation of the word for the benefit of later decision-makers. Courts will proffer " principles " and synonyms in an endeavour to ensure that the legislation is applied consistently, so as to achieve its imputed parliamentary purposes ^[105] cf Federal Commissioner of Taxation v Payne 2001 ATC 4027 ; (2001) 202 CLR 93 at 105 [ 24 ] . . In their particular applications of the word, and of such " principles " and synonyms, courts and other decision-makers will sometimes differ when considering new factual situations.

48. In the uncontested facts of this case, it cannot be said that the respondent incurred his legal expenses " in " (in the sense of " in the course of " ) gaining or producing his assessable income. The matters giving rise to his expenditure on legal expenses lacked the requisite temporal or other connection with gaining or producing his assessable income ^[106] cf Amalgamated Zinc (De Bavay ’ s) Ltd v Federal Commissioner of Taxation (1935) 54 CLR 295 at 310 per Dixon J; [ 1935 ] HCA 81. The passage is cited by Dowsett J in Day 2007 ATC 5426; (2007) 164 FCR 250 at 262 [ 58 ] . . The conduct of the taxpayer that gave rise to the necessity of incurring legal expenses was " quite beyond anything contemplated as being involved in the taxpayer ' s duties " ^[107] 2007 ATC 5426; (2007) 164 FCR 250 at 269 [ 84 ] per Dowsett J. . Alternatively, the expenditure was a loss or outgoing of a private nature. The Commissioner was therefore correct in deciding that the expenses were not deductible. The Full Court erred in concluding otherwise.

The facts and legislation

49. The background facts of this case are explained in the reasons of Gummow, Hayne, Heydon and Kiefel JJ ( " the joint reasons " ) ^[108] Joint reasons at [ 2 ] , [ 6 ] - [ 10 ] . . In considering those facts it is necessary to appreciate that, in some cases, conduct contrary to express or implied prohibitions in a contract of service or (as here) contrary to the provisions of s 56 of the PSA ^[109] PSA, s 56, set out in the joint reasons at [ 6 ] . (as then applying) will nonetheless be " closely connected to the performance of particular duties so that the infringing conduct may accurately be so described " ^[110] 2007 ATC 5426; (2007) 164 FCR 250 at 267 [ 73 ] . .

50. This would most obviously be so where the alleged infringements of the officer, as charged, amounted to inefficiency or incompetence ^[111] PSA, s 56(b). ; negligence or carelessness ^[112] PSA, s 56(c). ; improper conduct that affects adversely the performance of duties or brings the Service into disrepute ^[113] PSA, s 56(d) and (e). ; patronage, favouritism or discrimination ^[114] PSA s 56(ea). ; failure to comply with provisions of the Act or terms and conditions of employment ^[115] PSA, s 56(f). ; or the provision of incorrect or misleading information in connection with the appointment to the Service ^[116] PSA, s 56(g). . Even particular cases of wilful disobedience or wilfully disregarding directions given by a person in authority might conceivably, in some circumstances, amount to an inappropriate way of endeavouring to perform duties having a relevant connection with the duties of an officer in the Service.

51. In the present case, however, as Emmett J recorded at first instance, the respondent did not suggest that any of the conduct that led to the charges involved the performance by him of his duties and functions as a Customs officer ^[117] Noted 2007 ATC 5426; (2007) 164 FCR 250 at 269 [ 82 ] per Dowsett J. . This conclusion, unchallenged in the appeals (including before this Court), throws light on the statutory characterisation of the legal proceedings initiated by the respondent, in which he incurred the legal expenses for which he claims deduction.

52. In this as in other cases the facts are crucial. They require the application of the ITAA so as to fulfil its purposes. They demand that a conclusion which seems factually odd or unlikely (especially one that appears grounded in a construction that favours a special group of taxpayers, viz officers of the Service) should be carefully measured against the criteria expressed in the legislation, as explained in earlier decisions.

The charges

53. The 1998 charge ( " the first charge " ), brought pursuant to s 61(2) of the PSA, concerned a particularised breach of the Customs Code of Ethics and Conduct ( " the Code " ) applicable to " official identification and security items " . This charge related to an allegation that the respondent had presented his Customs identification card in order to gain access to an officer of the Local Court of New South Wales. The purpose of such use was to obtain information about a search warrant of interest to the respondent personally which had been executed on the Service in July 1998. It was uncontested that this conduct did not involve the performance of any of the respondent ' s duties or functions as a Customs officer. Self-evidently, to misuse a Customs identification card in such a way and for personal purposes (which did not, in the event, succeed) was seriously " improper conduct " on the part of the respondent.

54. Save for a possible approach that will shortly be mentioned ^[118] These reasons, below at [ 70 ] - [ 74 ] . , the undisputed circumstances that occasioned the subsequent legal representation of the respondent had nothing to do with the gaining or producing of his assessable income. The costs of the legal representation were thus incurred in defending the respondent from charges arising out of personal and extraneous conduct, not in the course of income-producing conduct of any kind.

55. So far as the 1999 charges ( " the third charges " ) are concerned, the position was the same. Those charges were, in every particular, related to the defence of the respondent upon charges that in no way constituted a misguided, foolish or even stupid mode of performing his employment duties or functions as an officer of the Service.

56. In a similar way (subject to what follows), if the circumstances of the third charges are relevant to throw light on whether the resulting legal defence of the respondent was a loss or outgoing incurred by him in the course of gaining or producing his assessable income, the only conclusion on the uncontested facts was that the legal expenses exhibited an " entire lack of connection between the assessable income and the expenditure " ^[119] cf Amalgamated Zinc (1935) 54 CLR 295 at 310 per Dixon J. :

• (1) Three of the seven charges in the third charges related to false claims allegedly lodged by the respondent for a diesel fuel rebate made by the partner of a Customs officer. It was contended that the respondent had lent improper support and assistance in relation to such claims; had failed to inform the Service of the false claims; and was knowingly concerned in creating a diary entry in connection with a later audit of the claims;
• (2) The fourth charge in the third charges was that the respondent secured access to, and organised the use of, a work vehicle for a non-work-related purpose;
• (3) The fifth charge was that the respondent signed and submitted a Customs Attendance Record which he knew to be false;
• (4) The sixth charge was that the respondent took steps to mislead the Service into believing that he had attended work on a day on which he did not in fact attend work; and
• (5) The seventh charge was that the respondent failed to inform his employer of matters relating to an investigation into a suspect, in circumstances where the respondent knew, or ought to have known, that the matters could be relevant to that investigation.

57. The third charges, so described, arose out of a criminal investigation undertaken by the Australian Federal Police (AFP) which involved the interception of telephonic communications with the respondent ^[120] 2006 ATC 4268; (2006) 62 ATR 530 at 535. . Transcripts of the intercepted communications had been provided by the AFP to the Service for use in connection with the investigation into the events leading to the charges. That step resulted in the charges against the respondent, giving rise to an inquiry under s 62 of the PSA. The legal proceedings in respect of which the professional fees were incurred were designed to secure a declaration that the provision of the transcripts to, and their use by, the Service were unlawful. Effectively, the respondent sought a decision excluding their use. He also claimed damages for the alleged unlawfulness ^[121] 2006 ATC 4268; (2006) 62 ATR 530 at 536. .

58. Given the circumstances that gave rise to the charges occasioning the legal proceedings and representation, the fact that the respondent did not suggest that any of this conduct involved the performance by him of his duties as a Customs Officer is not surprising. On the face of things, the respondent was defending only his personal conduct and position. There was no arguable, or even conceivable, connection of any of the circumstances in the third charges to the respondent ' s performance of his income-producing activities for the Service.

59. Whilst a defence along the lines undertaken was the respondent ' s right as a citizen and an accused, the consequential expenses were not incurred by the respondent in the course of the gaining or producing of his assessable income. The only real connection with the respondent ' s activities in the Service was so far as the legal representation might succeed in excluding the telephonic interception evidence, or otherwise defend the respondent ' s entitlement to continue receiving future income from the Service, and to avoid termination or other income-reducing consequences of his conduct.

The legislation

60. The relevant provisions of s 8-1 of the ITAA are set out in the joint reasons ^[122] Joint reasons at [ 3 ] . . The critical words, presented by the alternative ways in which the Commissioner argued this appeal, state:

• " (1) You can deduct from your assessable income any loss or outgoing to the extent that

  (a) it is incurred in gaining or producing your assessable income; or

  …

• (2) However, you cannot deduct a loss or outgoing under this section to the extent that:

  …

  (b) it is a loss or outgoing of a private or domestic nature " .

61. These paragraphs express both the " positive " and " negative " limbs of the deductibility provisions. Those features were present in the language of the predecessor provision, namely s 51(1) of the Income Tax Assessment Act 1936 (Cth) ( " the 1936 Act " ). It was common ground that there was no material difference between the succeeding provisions of the two statutes. The authorities on s 51(1) of the 1936 Act are available to help elucidate the meaning of s 8-1 of the ITAA.

62. The joint reasons describe the relevant provisions of the PSA and the Code ^[123] Joint reasons at [ 6 ] - [ 7 ] . . There is no need for me to repeat any of these provisions.

The decisional history

63. The joint reasons also explain the history of the litigation in which the respondent became embroiled, once he faced the successive charges of failure to fulfil his duties as an officer of the Service ^[124] Joint reasons at [ 7 ] - [ 10 ] . , including the decisions of the judges of the Federal Court, both at first instance and on appeal ^[125] Joint reasons at [ 11 ] - [ 17 ] . .

64. It is unnecessary for me to repeat that chronicle. Essentially, the majority in the Full Court of the Federal Court concluded that the legal expenses claimed by the respondent were of the requisite positive character to allow deductibility from the respondent ' s assessable income under s 8-1(1)(a) of the ITAA and lacked the negative characteristics mentioned in the disqualifying provisions of s 8-1(2)(b) of the ITAA. However, the judges in the majority in the Full Court of the Federal Court reached their respective conclusions by different lines of reasoning.

65. The presiding judge, Spender J, explained his reasons without referring to the most recent decision of this Court in Payne ' s case ^[126] 2001 ATC 4027; (2001) 202 CLR 93. on the ambit of deductibility. Edmonds J, on the other hand, referred to and extracted, passages from Payne ' s case at the forefront of his reasons ^[127] 2007 ATC 5426; (2007) 164 FCR 250 at 270 [ 88 ] - [ 89 ] . . Correctly, he accepted that it was necessary for the respondent, in order to establish deductibility, to bring his case within the reasoning of the majority in Payne . In the result, Edmonds J concluded this could, and should, be done. He said ^[128] 2007 ATC 5426; (2007) 164 FCR 250 at 273-274 [ 101 ] - [ 102 ] , [ 105 ] (citations omitted). :

" [ T ] he test for deductibility of legal expenses is not whether the employee ' s conduct of activity that resulted in the need to take defensive proceedings was conduct or activity engaged in for the purpose of producing assessable income … ; rather, as explained in Payne, it is whether the expenditure was incurred in the course of gaining or producing the assessable income, in the sense that the occasion of the expenditure is to be found in what is productive of assessable income.

… [ I ] t is the taxpayer ' s employment which is the occasion of the expenditure and the taxpayer ' s performance and observance of the duties of that employment is undoubtedly productive of assessable income.

… In the case of defensive expenditure such as the legal expenses incurred here, it is the ' occasion ' of the incurrence of these expenses which is determinative, rather than the identification of the antecedent activities which gave rise to the proceedings and the bifurcation of those activities into duties of performance, expenditure on the defence of which is deductible, and duties of observance, expenditure on the defence of which is not deductible. "

66. Although in his reasons at first instance Emmett J did not specifically refer to Payne his general approach was, in my view, consistent with the analysis of this Court in that case ^[129] It should be noted that Emmett J was not referred in argument to this Court ’ s decision in Payne . . In the Full Court, Dowsett J, in his dissent, also placed Payne at the forefront of his reasons ^[130] 2007 ATC 5426; (2007) 164 FCR 250 at 266-267 [ 70 ] - [ 73 ] . . He affirmed the duty to apply Payne to the extent that it was, or might appear to be, different from earlier authority of this Court ^[131] 2007 ATC 5426; (2007) 164 FCR 250 at 264 [ 62 ] referring to W Nevill & Co Ltd v Federal Commissioner of Taxation (1937) 56 CLR 290 at 304-305, 308; [ 1937 ] HCA 9. or other and different authority in the Federal Court ^[132] See eg W Nevill & Co Ltd v Federal Commissioner of Taxation (1937) 56 CLR 290 . .

The issues

67. From the foregoing, it follows that two issues are presented to this Court. They concern whether the Full Court erred in upholding the respondent ' s claim to the deductibility of legal expenses he incurred in defending himself against the first and third charges:

• (1) By concluding that such legal expenses were a loss or outgoing " incurred in gaining or producing [ his ] assessable income " ; or
• (2) By deciding that such loss or outgoing was not of a " private or domestic nature " .

68. A cross-appeal, raising a different issue, originally propounded by the respondent was not ultimately pressed ^[133] See also joint reasons at [ 11 ] . .

The common applicable principles

69. I agree with many of the principles referred to in the joint reasons. Thus, I agree that:

• (1) The governing obligation of the decision-maker is to give effect to s 8-1 of the ITAA, specifically, by reference to sub-s (1)(a) and sub-s (2)(b). The foundation for the resolution of all questions presented by the law, when expressed in legislation, is the legislation. For the sake of consistency it is proper and natural that courts and administrators will examine earlier decisions involving the application of the legislation, in order to endeavour to arrive at compatible conclusions in analogous circumstances. However, the essential duty is to apply the law as enacted by the Parliament ^[134] See eg Central Bayside General Practice Association Ltd v Commissioner of State Revenue (Vic) 2006 ATC 4610 ; (2006) 228 CLR 168 at 198, fn 86 and cases there cited; [ 2006 ] HCA 43. . This requires scrutiny of the enacted words in their context and in the light of any relevant considerations of history or of legislative purpose ^[135] eg CIC Insurance Ltd v Bankstown Football Club Ltd (1997) 187 CLR 384 at 408; [ 1997 ] HCA 2; Newcastle City Council v GIO General Ltd (1997) 191 CLR 85 at 112-113; [ 1997 ] HCA 53; Project Blue Sky Inc v Australian Broadcasting Corporation (1998) 194 CLR 355 at 381 [ 69 ] , 384 [ 78 ] ; [ 1998 ] HCA 28. ;
• (2) In the course of explaining the outcomes in succeeding factual circumstances, courts have sometimes offered synonyms, explanations and suggested tests or " principles " for applying the statute to the case in hand. Such endeavours, however well meaning, have to be approached with care ^[136] As explained by Gaudron and Gummow JJ (dissenting) in Payne 2001 ATC 4027; (2001) 202 CLR 93 at 110 [ 42 ] , 111 [ 48 ] citing Parsons, Income Taxation in Australia: Principles of Income, Deductibility and Tax Accounting (1985) at [ 8.62 ] . See joint reasons at [ 29 ] . . The decision-maker is ultimately driven back to the application of the statutory test, rather than judicial or other reasoning;
• (3) Given the very large variety of circumstances to which the abbreviated language of s 8-1 of the ITAA needs to be applied, it remains the case that " [ a ] very wide application should be given to the expression ' incurred in gaining or producing the assessable income ' " ^[137] Amalgamated Zinc (1935) 54 CLR 295 at 309 per Dixon J. See joint reasons at [ 13 ] . ;
• (4) The result of an intersection of a myriad of often complex facts and an extremely brief statutory criterion is that whether the loss or outgoing is deductible will often be contestable. Informed decision-makers will sometimes reach contradictory opinions on the subject. Many decisions will arise at the margin ^[138] Strong & Co v Woodifield [ 1906 ] AC 448 at 452 per Lord Loreburn LC [ “ Many cases might be put near the line, and no degree of ingenuity can frame a formula so precise and comprehensive as to solve at sight all the cases that may arise ” ] . . Certainty of outcomes cannot be assured;
• (5) For a very long time, this Court has adopted a view of the preposition " in ' , appearing in s 8-1 of the ITAA, as meaning " in the course of " . Thus, in Payne , Gaudron and Gummow JJ pointed out that ^[139] 2001 ATC 4027; (2001) 202 CLR 93 at 105 [ 25 ] . :

  " Long before
  Lodge [ v Federal Commissioner of Taxation ^[140] 72 ATC 4174; (1972) 128 CLR 171 at 175; [ 1972 ] HCA 49. ] the preposition ' in ' was said in this Court here to have the force of ' in the course of ' and to look to the relevance of the expenditure to the operations or activities in question rather than to purpose in itself. "

  The majority in Payne ^[141] Gleeson CJ, Hayne J and myself at 2001 ATC 4027; (2001) 202 CLR 93 at 99 [ 9 ] . drew attention to the fact that the statute ^[142] Referring to s 51(1) of the 1936 Act having the same application as s 8-1(1) of the ITAA. :

  " does not speak of outgoings incurred ' in connection with ' the derivation of assessable income or outgoings incurred ' for the purpose of ' deriving assessable income. It has long been established that ' incurred in gaining or producing ' is to be understood as meaning incurred ' in the course of ' gaining or producing ^[143] Amalgamated Zinc (1935) 54 CLR 295 at 303 per Latham CJ, 309 per Dixon J; Ronpibon Tin NL and Tongkah Compound NL v Federal Commissioner of Taxation (1949) 78 CLR 47 at 56-57; [ 1949 ] HCA 15; Charles Moore & Co (WA) Pty Ltd v Federal Commissioner of Taxation (1956) 95 CLR 344 at 350; [ 1956 ] HCA 77. . "

  What is meant by incurred " in the course of " gaining or producing income was amplified in
  Ronpibon Tin NL and Tongkah Compound NL v Federal Commissioner of Taxation ^[144] (1949) 78 CLR 47 at 57 (emphasis added). :

  " [ T ] o come within the initial part of [ s 51(1) ] it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income. "

• (6) Having regard to the purpose of s 8-1(1), and to the context (including s 8-1(2)(b)) essential to whether a loss or expenditure has been " incurred in [ the course of ] gaining or producing assessable income " is the determination of what it is that is productive of assessable income ^[145] cf joint reasons at [ 30 ] . . However, the interposition of the words " in the course of " in the legislation places emphasis upon a temporal and functional connection between the gaining or production of the assessable income and the incurring of the propounded deduction. It is not enough that the deduction claimed has some general, even causative , connection with the derivation of income. Nor is it enough that the outgoings were incurred for the purpose of deriving, or continuing to derive, the income. This has not been the discrimen accepted by this Court in decisions going back three-quarters of a century. Neither party in this appeal suggested that this Court should revisit the correctness of its decision in Payne . Given that equivalent language was adopted in the ITAA, substantively re-enacting the approach of s 51(1) of the 1936 Act, there are overwhelming reasons why this Court would not re-open the foregoing approach but should apply it; and
• (7) So far as the provisions of s 8-1(2)(b) of the ITAA are concerned, it can be accepted that there will rarely be a case where an outgoing, incurred in gaining or producing assessable income, is also an outgoing of a purely " private " [ or " domestic " ] nature ^[146] See Federal Commissioner of Taxation v Hatchett 71 ATC 4184 ; (1971) 125 CLR 494 at 498; [ 1971 ] HCA 47. See also John v Federal Commissioner of Taxation 89 ATC 4101 ; (1989) 166 CLR 417 at 431; [ 1989 ] HCA 5; cf Parsons, Income Taxation in Australia: Principles of Income, Deductibility and Tax Accounting (1985) at [ 8.2 ] . . Whatever may be the case in other circumstances, in the present instance the issue to be decided is to be resolved by the application first of s 8-1(1)(a) of the ITAA and not by s 8 1(2)(b) of that Act. By the same token, the language of the latter provision, being part of the immediate textual context of the legislation to be applied, may be taken into account in giving meaning to an immediately preceding statutory provision. The minimum contextual consideration for deriving meaning, certainly in the English language, is the sentence and its surrounding provisions. It is not a contested word taken out of context ^[147] Collector of Customs v Agfa-Gevaert Ltd (1996) 186 CLR 389 at 396-397; [ 1996 ] HCA 36 applying R v Brown [ 1996 ] 1 AC 543 at 561 per Lord Hoffmann. . The reference to " private " losses or outgoings (inferentially by contrast to notions such as " working expenses " ^[148] See Handley v Federal Commissioner of Taxation 81 ATC 4165 ; (1981) 148 CLR 182 ; [ 1981 ] HCA 16 ; Federal Commissioner of Taxation v Forsyth 81 ATC 4157 ; (1981) 148 CLR 203 ; [ 1981 ] HCA 15 ; Federal Commissioner of Taxation v Cooper 91 ATC 4396 ; (1991) 29 FCR 177 . ) may throw light on what the Parliament was intending by providing for deductions in s 8-1(1)(a). So may the indication in s 8-1(1)(b) providing for a deduction where " it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income " . The emphasis is upon a relationship between the income and the loss or outgoing. But what precisely must that relationship be?

An alternative approach

70. Justice Spender ' s approach : In his reasons in the Full Court, Spender J adopted an approach significantly different from that adopted by any of the other judges.

71. In effect, Spender J concluded that the legal expenses incurred by the respondent were incurred in order to resist the potential consequences of the disciplinary charges against the respondent that might destroy, or adversely affect, his income source. It was on that footing that his Honour concluded that the respondent ' s legal costs were losses incurred in gaining or producing his assessable income. If there were no employment (or different or lesser employment following demotion, suspension or damage to career prospects) an obvious financial consequence would follow both for the respondent and for the revenue. Each was dependent on the continuing flow of the respondent ' s income derived from its source.

72. For a time, during argument, I found this approach attractive. I shall therefore explain Spender J ' s reasoning and indicate why, ultimately, I reject it.

73. Justice Spender ' s reasoning : In the course of his reasons, Spender J said ^[149] 2007 ATC 5426; (2007) 164 FCR 250 at 256-257 [ 23 ] - [ 38 ] . The quotations have been compressed. :

" Where the case concerns the payment of legal expenses, the proper characterisation of the expenditure for tax purposes turns on a consideration of the circumstances with which the legal proceedings were concerned … In my judgment, the objective purpose of defending the … charges … was to protect the respondent from the consequences specified under s 62(6) of the [ PSA ] , or to diminish their severity. The purpose was, therefore, to seek to protect the respondent ' s recurrent employment income from diminution or loss, or other adverse impact … In my opinion, expenses incurred in the defence of employment from that which threatens to destroy or diminish its income earning satisfies the positive test for deductibility. … The object in view in respect of the incurring of legal expenses in relation to the … charge [ s ] was to resist direct threats to the diminishing of, or the destruction of, the income-earning ability of the taxpayer. The situation which impelled the taxpayer to undertake the outlaying of those expenses was the fact that he had been charged under the [ PSA ] and the consequence of those charges being successful would be that his income would be diminished or lost. It is quite irrelevant whether the content of the charges related to activities of his employment, or were extraneous to the proper discharge of his duties. There would be no difference if a public servant was charged with being rude to customers in answering complaints, which is conduct engaged in by the public servant in the course of his or her duties, or a charge that he or she had downloaded child pornography from his or her office computer, conduct which is extraneous to the discharge of his or her duties as a public servant. The consequence of either charge being sustained is that the public servant ' s income might be diminished or lost. The legal expenses in defending either charge fall within the test set out by Dixon J in [
Hallstroms Pty Ltd v Federal Commissioner of Taxation ] ^[150] (1946) 72 CLR 634 at 645-652; [ 1946 ] HCA 34. … [ and ] by Drummond J in
Federal Commissioner of Taxation v Rowe ^[151] 95 ATC 4691; (1995) 60 FCR 99 at 115-116. … Drummond J said that [ such ] expenses had the requisite nexus because ' they were incurred to preserve his entitlement to receive in return for his services, assessable income ' . "

74. Attractions of the theory: Spender J ' s approach to the problem presented in this appeal has undoubted attractions:

• • It offers a test for the recovery of legal expenses which is much simpler and more straightforward than that accepted by Edmonds J, the other judge in the majority in the Full Court of the Federal Court. Edmonds J ' s criterion for the deductibility of legal expenses was whether the taxpayer ' s employment was " the occasion of the expenditure and the taxpayer ' s performance and [ whether ] observance of the duties of that employment [ was ] … productive of assessable income " ^[152] See Day 2007 ATC 5426; (2007) 164 FCR 250 at 274 [ 105 ] (emphasis added). The reference to the “ occasion ” of the occurrence of these expenses appears to derive from the passage in this Court ’ s reasons in Ronpibon Tin NL (1949) 78 CLR 47 at 57 cited above these reasons at [ 69 ] . . However, identifying the " occasion " , as distinct from the motive and purpose, necessarily takes a court into a verbal analysis that is illusory or self-fulfilling. Spender J ' s approach avoids this;
• • Spender J ' s approach also, upon one view, reflects a purposive analysis of the provision of s 8-1(1) of the ITAA. If the underlying object of that provision is to permit a taxpayer to offset losses and outgoings that have been incurred in the gaining or producing of assessable income, there can be no such more important loss or outgoing than that incurred in attempting to ensure that the flow of assessable income will continue, or remain at its previous level;
• • Spender J ' s approach also arguably takes into account the particular perils of employment discipline faced by federal officials, including officers of the Service. Whilst all employment involves possible action resulting in dismissal, suspension, demotion and loss of benefits, employees who are officers of the Service face an additional and special danger in maintaining the source of their income. This included (at the applicable time) defending disciplinary proceedings under the PSA. To protect the income source in such proceedings might thus be seen as a particular incident of this particular type of employment ( " office " );
• • The approach favoured by Spender J also avoids pre-judgment or collateral assessment of the antecedent conduct of the officer concerned, before allowing a deduction for any legal expenses. At the time of the claim for deduction, in many cases (as in that of the respondent himself), the full facts and evidence of the disciplinary proceedings will not be known when the claim for deduction is made. Similarly, at the time of the Commissioner ' s assessment, it must be decided a priori . It could not therefore depend upon a final resolution of the antecedent conduct or the charges based upon it. It is not part of the function of the ITAA, or taxation law generally, to add to the punishment of an office-holder embroiled in disciplinary proceedings;
• • To the extent that there is uncertainty about the operation of s 8-1(1)(a), it is appropriate, in a society such as ours, to favour an interpretation of legislation that upholds the rule of law. This includes the practical entitlement of employees/officers to defend themselves against disciplinary charges, some of which may be contested on the facts. Some of those facts may also be disputed as to their seriousness or significance for continued employment, income and promotion. Even in disobedience and misconduct cases, the line between " purely private " wrongdoings and those that have some relevant nexus with the employment, will sometimes be difficult to draw. Spender J ' s approach concentrates on whether, in the circumstances, it can be concluded that the purpose (and hence the character) of the " loss or outgoing " expended on legal expenses, is to protect income source: a relatively simple and straightforward criterion to apply; and
• • If the Parliament were dissatisfied with this approach to the meaning of s 8-1(1)(a), and concerned that it might over-extend the entitlement to deduct legal expenses for unmeritorious defences of purely private non-employment conduct giving rise to disciplinary charges against an employee or officer, it would be open to it to enact a more precise disqualifying provision. This, in effect, is what the Parliament did when, in 2005, it enacted s 26-54 of the ITAA. That amendment followed a decision of this Court refusing special leave to appeal from the judgment of the Full Court of the Federal Court in
  Commissioner of Taxation v La Rosa ^[153] 2003 ATC 4510; (2003) 129 FCR 494 . The Parliament enacted a special provision disallowing deductions for " a loss or outgoing to the extent that it was incurred in the furtherance of, or directly in relation to, a physical element of an offence against an Australian law of which you have been convicted if the offence was, or could have been, prosecuted on indictment " . A special enactment could, if desired, be enacted to disallow deductions for legal expenses incurred in defending purely personal conduct having no relevant nexus to the employment and relating to purely personal activities of the taxpayer.

75. Flaws in the alternative theory : There is a fundamental difficulty in the alternative theory propounded by Spender J. Ultimately it is a difficulty that leads me to reject his Honour ' s analysis. The problem is exposed in the reasons of Dowsett J in the Full Court of the Federal Court. Essentially, it flows from the long-standing interpretation by this Court of s 8-1(1)(a) of the ITAA, and its predecessor provision. Specifically, it flows from the insistence, repeated most recently in Payne , that the word " in " , as stated in s 8-1(1)(a), is to be read as equivalent to " in the course of " . It is not to be read as " in connection with " or " for the purpose of " deriving the relevant assessable income ^[154] Payne 2001 ATC 4027; (2001) 202 CLR 93 at 99 [ 9 ] .

76. Payne was a case concerned with a claim to deduct travelling expenses incurred by the taxpayer in travelling between two unrelated places of work, from each of which, separately, the taxpayer derived income. It was in that context that it became necessary for this Court to examine the theory of deductibility of expenses that are based upon the relevant purpose of the outgoings incurred or their connection with the derivation of assessable income. If such criteria had been adopted, the taxpayer in Payne would have had a very strong argument to be entitled to deduction. Clearly enough, the purpose of incurring the expenses in that case, of travelling from his residence on a rural farm to his place of employment as an airline pilot at the Sydney airport was to be able to earn both incomes. Moreover, the travel involved expenses incurred " in connection with " the latter employment and " for the purpose of " deriving assessable income from it.

77. The majority in Payne acknowledged the concerns that have been expressed over the years regarding the interpretation of deductibility under s 51(1) of the 1936 Act, specifically of travelling expenses incurred to get to and from a place of employment, particularly if the employment is remote from the taxpayer ' s ordinary residence. In
Lunney v Commissioner of Taxation ^[155] (1958) 100 CLR 478; [ 1958 ] HCA 5 , Dixon CJ confessed to misgivings about the rule established by this Court for the interpretation of the provision of the Act in this respect. Dixon CJ even hinted that the rule might not be logically supportable and that " if the matter were to be worked out all over again " ^[156] (1958) 100 CLR 478 at 486. , a different approach might be taken. This notwithstanding, the Court in Lunney adhered to its insistence that " in " , in the statutory provision, meant " in the course of " deriving the assessable income. It did not mean " for the purpose of " doing so or " in connection with " doing so.

78. In Payne , the majority of this Court reaffirmed that approach. They did so notwithstanding the problems and obscurities that it presented. Moreover, they did so knowing full well that the ruling had application far beyond travelling expenses, such as were in issue in that case ^[157] Payne 2001 ATC 4027; (2001) 202 CLR 93 at 102-103 [ 17 ] . :

" [ T ] he distinction has long been made and it is now too late for the Court to ' rip it up ' and treat the section as allowing any and all deductions having some causal connection with the derivation of assessable income. [ The ] cases … show [ that ] the distinction between outgoings incurred in the course of deriving income and other outgoings is a distinction which applies generally, not just in relation to travel expenses ^[158] Fletcher v Federal Commissioner of Taxation 91 ATC 4950 ; (1991) 173 CLR 1 at 17; [ 1991 ] HCA 42. . Once the distinction is recognised, it follows that the expenditure which was in issue in this case could not be held to be an allowable deduction. " '

79. Whilst the authority culminating in Payne stands, it is fatal to the basis upon which Spender J sought to justify the deductibility of the legal expenses incurred by the respondent. Even if it were conceded that such legal expenses were incurred " for the purpose of " ensuring the continuation of the derivation of the respondent ' s income or " in connection with " that purpose or the income that it produced, in the undisputed facts of the respondent ' s case it could not be said that the expense was incurred in the course of deriving the assessable income. The only way that that characteristic of the applicable loss or outgoing could be adopted would be to treat all such legal expenses as incurred in the course of deriving the relevant income. However, that approach would render the requirement of having to demonstrate the relationship between the loss or outgoing and the gaining or producing of the income meaningless.

80. All of this was well said by Dowsett J in the Full Court of the Federal Court ^[159] 2007 ATC 5426; (2007) 164 FCR 250 at 267 [ 72 ] - [ 73 ] (emphasis added). :

" With all due respect, I am concerned that a test which focuses on whether costs were incurred to defend the taxpayer from loss of employment or diminution in income is a test based on purpose, and therefore inconsistent with the decision in Payne …

I find it difficult to construe the language in the cases as necessarily establishing that conduct contrary to express prohibitions in a contract of service, and unconnected to the duties to be performed by the taxpayer, will be conduct in the course of earning assessable income. In some cases, the relevant prohibited conduct may be closely connected to the performance of particular duties so that the infringing conduct may accurately be so described. Negligence in such performance is a possible example. However, when the conduct is completely beyond the scope of the contract, and even forbidden by it, it does violence to language to describe that conduct as being in the course of earning assessable income. "

81. Conclusion: alternative theory rejected: Freed from earlier authority, there might be arguable reasons of textual analysis, legal principle and policy to support the approach favoured by Spender J. However, his Honour ' s reasoning cannot be accepted consistently with the unchallenged approach expressed by the majority in Payne . This being so, one of the two judicial opinions relied on in the Federal Court to sustain the majority orders must be rejected.

82. But can the decision be supported on the reasoning of the other judge in the majority, Edmonds J, or upon any other view of the legislation, read consistently with Payne ?

Conclusion: the legal expenses are not deductible

83. The analysis of Justice Edmonds : In his reasons, Edmonds J looked to whether the respondent ' s employment was the " occasion " of the expenditure on the legal expenses. If this protean word were intended to mean the reasons for the circumstance giving rise to the need to pay legal expenses, it would run into the same difficulties as were explained in Payne . If " occasion " is a synonym for " purpose " , such that the respondent was entitled to defend the ongoing employment as the source of his income, it evidences the same error as that of Spender J.

84. The essential reasons that Edmonds J gave for his conclusion appears in the following passage of his reasons ^[160] 2007 ATC 5426; (2007) 164 FCR 250 at 274 [ 104 ] (emphasis added). :

" [ T ] he taxpayer is incurring expenditure (legal expenses) defending … his performance of duties of his employment, and … his observance of duties of his employment. The performance of one kind of duty and the observance of the other kind of duty equally contribute to the taxpayer ' s continued employment which is productive of assessable income, and expenditure incurred in defence of either performance or observance of a duty is, in my view, occasioned by that employment. For that reason such expenditure is an allowable deduction. "

85. As Dowsett J remarked, this reasoning in substance involves the adoption of a test based on purpose . It ignores the need for the taxpayer claiming the deduction, where it is contested, to demonstrate that the expenditure of the propounded deductions was incurred in the course of gaining or producing the assessable income.

86. The nexus is rejected : At least in the uncontested facts of this case, once this error is identified it is impossible to characterise the respondent ' s losses and outgoings as incurred in the course of gaining or producing the assessable income. The character of the respondent ' s legal proceedings is inescapably coloured by their subject matter which was to defend, or explain, the respondent ' s identified conduct which was never suggested to have involved the performance of his duties as a Customs officer. In that sense, within the authorities, the respondent ' s expenditure on legal representation cannot be classified as " incidental and relevant " to the winning or producing of the assessable income ^[161] Ronpibon (1949) 78 CLR 47 at 56 cited in Lunney v Commissioner of Taxation (1958) 100 CLR 478 at 497. . Instead, it must be classified (as Spender J had recognised) as a legal expense incurred so as to protect the respondent from dismissal, reduction in rank or reduction in pay. That is not sufficient to render the losses and outgoings incurred deductible. I agree with Dowsett J ^[162] 2007 ATC 5426; (2007) 164 FCR 250 at 268 [ 78 ] , 269 [ 84 ] . :

" Whilst such expenses are incurred for the purpose of deriving assessable income, they are not incurred in the course of doing so.

…

[ W ] here the conduct in question is quite beyond anything contemplated as being involved in the taxpayer ' s duties, it will be very difficult to apply the test established in Payne in such a way as to render the outgoings deductible. "

87. Justification of the conclusion : The foregoing conclusion can, in my opinion, be readily justified in the application of s 8-1(1)(a) to the circumstances of the present case:

• • It gives effect to the decision and reasoning of this Court in Payne and to the longstanding earlier authority affirmed there;
• • Once the focus of attention is placed, as Payne requires, on the " course " of the gaining or producing of the assessable income, it is fatal to the respondent ' s argument on the facts of this case. The alternative proposition, that all legal expenses incurred by officers are deductible, is mistaken. It would involve an entitlement to legal expenses (and possibly others) disjoined from " the course of " income gaining and producing activities. That is not only contrary to authority. It is alien to the ascertained purpose and intention of s 8-1(1)(a) of the ITAA. Logically, it would extend deductibility of legal expenses to cases of the kind mentioned by Spender J ^[163] See 2007 ATC 5426; (2007) 164 FCR 250 at 257 [ 35 ] per Spender J. (or to other purely private circumstances, such as a courier who becomes intoxicated in his own time and therefore risks losing his driving licence essential to his continuing employment). To allow deductibility in such cases would ignore the requirement of demonstrating a link to " the course of " the gaining or production of the assessable income. Once Spender J ' s alternative thesis is rejected, as Payne demands, the unlikelihood of allowing a deduction in circumstances such as the present is made clear;
• • Any suggestion that, because the respondent was an officer of the Service, he thereby secured a special and privileged position for deduction of legal expenses should be firmly rejected. Many private employees face procedures if they are caught doing things extraneous to their employment. These may not involve procedures as formal as the statutory inquiry under the PSA but they may just as readily involve other procedures that occasion legal expenses to defend the employee ' s position. With respect, the distinction drawn in the joint reasons is not justified. It is certainly not desirable because it creates for a limited class of taxpayers a privileged position that is not spelt out in, or suggested by, the ITAA;
• • As Dowsett J acknowledged, and as past decisions show, expenses incurred in the course of deriving assessable income will be deductible. Clear examples of such expenses are the legal costs incurred by a media publisher in defending defamation proceedings brought against it ^[164] Herald & Weekly Times Ltd v Federal Commissioner of Taxation (1932) 48 CLR 113 at 127; [ 1932 ] HCA 56 (an ordinary expense of such a business) or legal costs incurred by a company obliged, exceptionally, to defend itself from public attack ^[165] Federal Commissioner of Taxation v Snowden & Willson Pty Ltd (1958) 99 CLR 431 at 437; [ 1958 ] HCA 23; cf Magna Alloys and Research Ltd v Federal Commissioner of Taxation 80 ATC 4542 ; (1980) 33 ALR 213 . . Securing legal representation in proceedings concerned with incompetence, negligence or even sometimes improper and wilful activity on the part of an employee might also attract deductibility by the Payne criterion. But in the uncontested facts of the present case, the requisite nexus is not established;
• • Whatever may be the entitlement of the taxpayer in other cases, the respondent ' s legal expenses related to circumstances disjoined from " the course of " the income-producing activity. They were purely personal to the respondent. They were correctly so classified by the primary judge ^[166] Day 2006 ATC 4268; (2006) 62 ATR 530 at 538. . Whilst it may be conceded that difficult and contestable decisions will occasionally fall to be decided by the application of the Payne criterion, the present is not such a case given that the respondent did not suggest that any of his conduct resulting in his legal representation, involved the course of the performance of his duties as a Customs officer; and
• • If the foregoing conclusion is reached, derived from an application of s 8-1(1)(a) of the ITAA read in the light of Payne , the outcome causes neither inconvenience nor surprise. Inconvenience and surprise are considerations often taken into account to check the correctness of a statutory interpretation reached by a process of legal analysis. To the contrary, the opposite conclusion would cause surprise, and even astonishment. Whatever may be the justification of permitting deductions from assessable income for legal expenses necessarily incurred in the course of deriving the income, to provide such deductions where the " occasion " of the proceedings involving the legal representation had nothing to do with the course of the income-producing employment (or " office " ) appears fundamentally alien to the purposes of the deductions for which s 8-1(1)(a) of the ITAA provides.

88. Why, it might be asked rhetorically, should the revenue (and therefore effectively other taxpayers) support legal proceedings brought by a Customs officer in respect of conduct on his part which, if proved, was concededly unconnected with the performance of his functions and duties and wholly alien to such duties? This was not a case of an arguably relevant connection with " the course of " the respondent ' s income producing employment. The only connection was that of defending and protecting the income stream. Once that justification is set aside, as incompatible with the language of s 8-1(1)(a) as explained by Payne , the character of the deductions claimed is revealed in stark relief. There is no relevant connection between the assessable income and the expenditure ^[167] Amalgamated Zinc (1935) 54 CLR 295 at 310. . The payment for the legal expenses was " independent of the production of the income, not an expenditure incurred in the course of its production " ^[168] (1935) 54 CLR 295 at 310. . It therefore fell outside the positive limb of s 8-1(1). It follows that the deduction was correctly disallowed.

The negative limb - private losses or outgoings

89. There remains the Commissioner ' s alternative reliance on s 8-1(2)(b) of the ITAA. He argued that, if, contrary to his submission, a deduction arose under s 8-1(1)(a) it would nonetheless be disallowed by virtue of the disqualification expressed in s 8-1(2)(b) of losses or outgoings " of a private … nature " . The interconnection between the two paragraphs is plain.

90. If I had been of the view (otherwise than by way of the inadmissible reasoning of defending the income stream) that the respondent ' s legal expenses were incurred in some way in the course of gaining or producing his assessable income, I would have concluded that such losses or outcomes were nevertheless of a private nature and so precluded from deduction.

91. Given the statutory dichotomy between outgoings incurred in gaining or producing assessable income (deductible) and outgoings of a private nature (non-deductible), the respondent ' s legal expenses fell on the " private " side of the line. The language and structure of s 8-1 of the ITAA supports this conclusion. Payment for legal representation to defend purely personal conduct is clearly of a " private " nature within the category stated in s 8-1(2)(b) of the ITAA. If it can somehow fall within the first (positive) limb of the section (as sub-s (2) necessarily postulates will sometimes occur), it nonetheless falls outside deductibility if its essential character is " private " .

92. The situation might have been different if the basic facts were being contested by the respondent; or where some of them were disputed and others not; or where the respondent sought to throw a new and different light on his conduct or somehow to associate the conduct with " the course of " his duties as an officer. However, all such complications can be disregarded in the circumstances of the respondent ' s case. It was clear and simple. Either on the positive or negative limb of s 8-1(1) or (2) of the ITAA, the deductions were correctly disallowed by the Commissioner. It follows that on one or other of the Commissioner ' s arguments he was entitled to succeed.

Orders

93. Because of the conditions as to costs attached to the grant of special leave, the following orders should be made. The appeal from the judgment of the Full Court of the Federal Court of Australia should be allowed. Orders 1 and 2 of that court, made on 21 December 2007, should be set aside. In their place, this Court should order that the appeal to that court and the cross-appeal be dismissed. The appellant should pay the costs of the respondent in this Court.