Buckley & Young Ltd. v. Commissioner of Inland Revenue.

Judges:
Woodhouse J
Richardson J
Somers J

Court:
Court of Appeal (New Zealand)

Judgment date: Judgment handed down 26 July 1978.

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Judgment of Woodhouse, Richardson and Somers JJ. was delivered by Richardson J.: This is an appeal against a decision of Mahon J. upholding assessments of income tax against Buckley & Young Limited for the years ended 31 March 1969 and 31 March 1970. It concerns the deductibility of certain payments and benefits provided by the company to a former joint managing director and shareholder to whom we shall refer as ``the employee'' or ``E''. The company contended that the payments and benefits were made to get rid of an unsatisfactory employee and accordingly were revenue in character and deductible under the general provisions of sec. 111 of the Land and Income Tax Act 1954: the Commissioner contended that they were made in return for a restrictive covenant by the employee not to compete with the company and not to disclose information about its affairs and accordingly were capital in character and not deductible under sec. 111. Mahon J. held that payments were made and the benefits were provided consequentially on E's retirement, but solely in consideration of his restrictive covenant and that the expenses involved were not deductible under sec. 111. Turning to sec. 112(a), he concluded that the expenditures in question were calculated to secure to the company not the retirement itself, but protection against the business risk to its intangible assets created by that retirement and consequently were on capital account.

The Land and Income Tax Act 1954 has been repealed and replaced by the Income Tax Act 1976 but this case falls to be determined under the provisions of the 1954 Act. That statute provides a code in relation to deductibility. Section 110 bars deduction of any expenditure or loss except as expressly provided in the Act. None of the specific deduction provisions applies in this case and deductibility turns on the application of the basic deduction provision (sec. 111) and on sec. 112(a) which bars certain type of deduction that would otherwise be allowable under sec. 111 or specific deduction provisions. Section 111 and the relevant part of sec. 112(a) respectively provide:

``111. Expenditure or loss incurred in production of assessable income -

In calculating the assessable income of any taxpayer, any expenditure or loss to the extent to which it -

• (a) Is incurred in gaining or producing the assessable income for any income year; or
• (b) Is necessarily incurred in carrying on a business for the purpose of gaining or producing the assessable income for any income year - may, except as otherwise provided in this Act, be deducted from the total income derived by the taxpayer in the income year in which the expenditure or loss is incurred.

112. Certain deductions not permitted - Notwithstanding anything to the contrary in section 111 of this Act, in calculating the assessable income derived by any person from any source, no deduction shall, except as expressly provided in this Act, be made in respect of any of the following sums or matters:

• (a) Investment, expenditure, loss or withdrawal of capital;...''

It is not necessary for the purpose of this case to refer in any detail to the principles of

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ATC 6022

deductibility under those provisions. There are two features of sec. 111 which are of particular importance in this case. The first is that a deduction is available only where the expenditure has the necessary relationship both with the taxpayer concerned and with the gaining or producing of his assessable income or with the carrying on of a business for that purpose. The heart of the inquiry is the identification of the relationship between the advantage gained or sought to be gained by the expenditure and the income earning process. That in turn requires determining the true character of the payment. It then becomes a matter of degree and so a question of fact to determine whether there is a sufficient relationship between the expenditure and what it provided or sought to provide on the one hand, and the income earning process on the other, to fall within the words of the section (
C. of I.R. v. Banks 78 ATC 6001, 6007). The second feature of sec. 111 is that the statutory language contained in the phrase ``to the extent to which'' expressly contemplates apportionment. In Banks this Court said, in relation to this aspect of deductibility (p. 6006):

``A deduction is allowed to the extent that the statutory standard of deductibility is met. Furthermore, this is not restricted to expenditure which can be dissected with distinct and severable parts being directly referable to the production of assessable income. It extends to outgoings not capable of such dissection but which serve both income earning and other purposes indifferently (
Ronpibon Tin N.L. & Tongkah Compound N.L. v. F.C. of T. (1949) 78 C.L.R. 47.''

While sec. 112(a) does not expressly provide in the same way for apportionment between capital and revenue, at the same time it does not provide to the contrary, for example, by the use of the familiar qualification in taxation legislation ``wholly and exclusively''. Section 112(a) operates as a restriction on deductibility and, as a matter of construction, applies only in so far as the expenditure is of a capital character. In The
Texas Company (Australasia) Limited v. F.C. of T. (1940) 63 C.L.R. 382, 466 referring to the then counterpart of sec. 112(a) Dixon J. said:

``There is I think nothing which prevents the division or apportionment between capital and income of an outgoing which is in part of a capital nature and in part of a revenue nature.''

In our view the same approach is to be made whether the apportionment is under sec. 111 or between capital and revenue expenditure.

In some cases the application of sec. 111 and sec. 112(a) raises different considerations. In the present case they are two ways of analysing the same situation leading to the same result under the two provisions. This is because what is involved is the fundamental distinction between the source of income and the income earning process; between capital and income; between expenses affecting the business structure or entity and operating expenses. Whether the inquiry is under sec. 111 or sec. 112(a) the essential question is as to the true character of the payments made and the benefits provided. But, while that distinction is well recognised, it is equally established that there is no single yardstick or test. In the capital or income area the approach favoured by the courts in recent years is exemplified in the following observations of Lord Pearce in B.P.
Australia Limited v. F.C. of T. [1966] A.C. 224, 264-265:

``The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer. Although the categories of capital and income expenditure are distinct and easily ascertainable in obvious cases that lie far from the boundary, the line of distinction is often hard to draw in border-line cases; and

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ATC 6023

conflicting considerations may produce a situation where the answer turns on question of emphasis and degree. That answer `depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured employed or exhausted in the process.' (Per Dixon J. in
Hallstroms Proprietary Ltd. v. F.C. of T. (1946) 72 C.L.R. 634.) As each new case comes to be argued felicitous phrases from earlier judgments are used in argument by one side and the other; but those phrases are not the deciding factor, nor are they of unlimited application. They merely crystallise particular factors which may incline the scale in a particular case after a balance of all the considerations has been taken.''

It is not necessary to enter any twilight areas in this case for it is common ground that the alternatives clearly fall on opposite sides of the dividing line and far from the boundary. A payment made as a matter of commercial necessity or expediency to secure the removal of an unsatisfactory director or employee is referable only to the current business operations of the taxpayer in gaining its assessable income and that also stamps it with the character of a revenue and not a capital disbursement. Illustrations of this are
Mitchell v. B.W. Noble Limited [1927] 1 K.B. 719 and
W. Neville and Company Limited v. F.C. of T. (1937) 56 C.L.R. 290. But a payment made to a retiring director or employee in consideration for a restrictive covenant not to compete with the company after his retirement, which has the effect of buying off competition, of its very nature affects the value of the company's goodwill and is referable to the income earning structure rather than to the income earning process and is of a capital nature. Examples are
Associated Portland Cement Manufacturers Limited v. I.R.C. [1946] 1 All E.R. 68 and
Deverell Gibson & Hoare Limited v. Rees (1943) 25 T.C. 467. In short, the distinction is between paying a director to resign and paying him not to compete or otherwise affect the payer's competitive position. Difficulties of characterisation may arise where the director or employee agrees to resign and to give a restrictive covenant. The proper conclusion may be that the payment secures one advantage and the other provision is merely ancillary or incidental, not affecting the character of the payment (cf.
Anglo-Persian Oil Company Limited v. Dale (H.M. Inspector of Taxes) [1932] 1 K.B. 124, 139-140). In other cases distinct and separately identifiable advantages may be gained by the payment. There the payment is of a dual character. The statement of the problem highlights the importance of identifying the true character of the payment for which deduction is sought.

The first step in deciding the character of the payments and benefits provided by the company for E is to determine the true nature of the legal arrangements pursuant to which the payments were made and the benefits provided. In this case both the company and the Commissioner submitted that evidence as to the factual position in the company which gave rise to the negotiations between E and the other shareholders, the course of negotiations and the significance attached by the shareholders (other than E) and the company's solicitor to the restrictive covenant, was relevant to the determination of the character of the payments and the benefits ultimately provided for E by the company. Extensive evidence was called on those matters. But it is well established that the true nature of a transaction must be ascertained by reference to the legal arrangements actually entered into and carried out (
I.R.C. v. Duke of Westminster [1936] A.C. 1;
I.R.C. v. Wesleyan and General Assurance Society (1946) 30 T.C. 11). And in both the
Europa Oil cases (76 ATC 6001, 6006-07; [1971] N.Z.L.R. 641, 648-649 and [1976] 1 N.Z.L.R. 546, 553) the Judicial Committee stressed that it is the legal character of the transaction actually entered into determined by the contractual arrangements which is decisive, not the overall economic consequences to the parties. Referring to the doctrine of substance, Lord Russell of Killowen said in the Duke of Westminster's case (p. 25):

``If all that is meant by the doctrine is that having once ascertained the legal rights of the parties you may disregard mere

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ATC 6024

nomenclature and decide the question of taxability or non-taxability in accordance with the legal rights, well and good.... If, on the other hand, the doctrine means that you may brush aside deeds, disregard the legal rights and liabilities arising under a contract between parties, and decide the question of taxability or non-taxability upon the footing of the rights and liabilities of the parties being different from what in law they are, then I entirely dissent from such a doctrine.''

While the nomenclature used by the parties is not decisive, it is the legal rights and duties created by the transaction into which the parties entered and as ascertained by ordinary legal principles, taking into account surrounding circumstances, that must be determined. Thus, while it is legitimate to take into account surrounding circumstances and to refuse to be blinded by terms employed in documents, the documents themselves may be brushed aside only if and to the extent that they are shams, in the sense of not being bona fide in inception or of not having been acted upon, and are only used in whole or in part as a cloak to conceal a different transaction or if required by a provision such as sec. 99 of the Income Tax Act 1976.

The starting point is to consider the documentation embodying the transaction. ``The decision in any particular case can only be arrived at by considering what is the substance of the transaction in question, and what is the substance of that transaction can only be ascertained by a careful consideration of the contract which embodies the transaction. That being so, in our judgment what has to be done here is to examine the particular clauses of... the agreement in question, and to see what is the appropriate conclusion... to be arrived at on the consideration of that agreement''. (Lord Wright M.R. in
I.R.C. v. Ramsay (1935) 20 T.C. 79, 94; see, too,
Nicholls v. C. of I.R. [1965] N.Z.L.R. 836, 845.) A deed or other instrument must be construed as a whole and, if the transaction is embodied in a number or complex of interrelated agreements, then all the agreements must be considered together and one may be read to explain the others. Thus, in the Europa Oil cases the application of the deduction provisions of sec. 111 was determined on an analysis of the whole series of linked agreements and was not confined to consideration of the relevant purchase contract under which orders for supplies of crude oil and petroleum products were made and the expenses in question were incurred. And, as already noted, oral evidence is admissible for the purpose of ascertaining the surrounding circumstances. However, that does not mean that oral evidence may be given for the purpose of varying the written agreement or for the purpose of ascertaining the actual intention of the parties. It means that, before you construe the agreement, you are entitled to understand the setting in which it was made (
Hose v. Warwick (1946) 27 T.C. 459, 468). The inquiry is not concerned with what was in the minds of some or all of the parties at an earlier negotiating stage in relation to an inchoate transaction, or with the surrounding circumstances at that earlier time. The motives of the negotiators and the relative significance attached by them, or some of them, to various factors at the outset of negotiations are not necessarily reflected in the agreement that is eventually reached. Moreover, transactions evolve in the course of negotiations and their character may change. There are sound reasons for refusing to admit evidence of negotiations or of the views and intentions of the parties which do not appear from the concluded agreements. As it was put by Lord Wilberforce in
Prenn v. Simmonds [1971] 1 W.L.R. 1381, 1384 ``... the evidence should be restricted to evidence of the factual background known to the parties at or before the date of the contract, including evidence of the `genesis' and objectively the `aim' of the transaction.'' And the surrounding circumstances that may be relevant are those that obtain at the time the transaction under scrutiny is entered into, not those that existed at an earlier point of time.

Analysis of the documentation may not determine the true character of payments made. Indeed, the contract may be silent or equivocal as to the quality which ought to be attributed to the payment in question. In that situation evidence of surrounding circumstances may be of particular significance in determining what the contractual expenditure is calculated to effect from a practical and business point of

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ATC 6025

view - to use the language of Hallstroms' case. In other cases the essential genuineness of the documentation of the arrangements may be challenged. The court must then determine whether the substance of the transactions as reflected in the documentation is the true legal arrangement between the parties, or whether the documentation is used as a cloak intended by them to conceal, in whole or in part, the true arrangement. In that situation the court may take into account all evidence which bears on that question and is not limited to consideration of evidence admissible in the ordinary course of construction of documents. Finally, in some cases the parties may have departed from the documents, in which event questions of a new agreement or estoppel or sham in operation may arise.

After this rather lengthy preamble we turn to consider the character of the sums paid and the benefits provided by the company for E in this case. The genesis and aim of the transaction are apparent in Mahon J.'s findings of fact that dissension between the joint managing directors of the company had made it essential in the opinion of all the directors, except E, and as a matter of commercial necessity that E should leave the company and sever all his connections with it. For the reasons already given we pass over the evidence as to the negotiations that ensued and as to the views and expectations of the various witnesses and turn to the deed of 11 December 1968. It made provision for the payments to be made and the benefits to be provided by the company. The parties to it were E, the company and the other shareholders of the company at the company at the time E left the company. It is relatively short and should be set out in full:

``WHEREAS:

(A) G.R. Smout, J.K. McQuilkin, H.G. Townshend and (E) were heretofore all shareholders in the Company.

(B) By a Memorandum of Agreement dated 28 November, 1968 (E) agreed (amongst other things) to sell all his shares in the Company to G.R. Smout, J.K. McQuilkin and H.G. Townshend equally for $3.85 per share to resign from his offices of Director and Secretary in the Company and its subsidiaries, and to enter into this Deed.

(C) The Company both directly and through its subsidiary and associated Companies carries on the business of dealers in organic and inorganic chemical raw materials of all types throughout New Zealand.

THEREFORE this Deed is evidence that the parties hereto agree and covenant with each other as follows: -

1. In consideration of the covenants on the part of (E) hereinafter contained G.R. Smout, J.K. McQuilkin and H.G. Townshend covenant to procure for (E) the following benefits which shall commence on 6 December, 1968 and (subject to any contrary provisions herein contained) enure until (E) dies or attains the age of 60 years.

• (a) The appointment of (E) as a tax consultant to the company at a salary of $6,000 per annum.
• (b) The use of Jaguar Car No. DG 3300 upon the terms set out in Clauses 3, 4, 5, 6, and 7 hereof.
• (c) The payment by the Company into its A.M.P. Superannuation scheme of $800.40 per annum for the benefit of (E).
• (d) The payment of certain legal and accounting expenses incurred by (E) up to an aggregate maximum of $300.

2. In consideration of the covenants on the part of G.R. Smout, J.K. McQuilkin and H.G. Townshend hereinbefore contained and of the benefits accruing to him therefrom (E) covenants with and for the benefit of all the other parties hereto both during and after the period of his employment by the Company that he will not: -

• (a) Undertake or carry on or be employed or directly or indirectly be concerned or interested (either as Director, Principal, Partner, Manager, Employee, Servant, Consultant or Adviser whether for reward or otherwise) or engage in or induce or assist in the formation of any business which is in competition with the business (either presently or during the period of (E's) employment by the Company hereafter) carried on by the

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  ATC 6026

  Company or by any of its present subsidiaries or its present associates in any part of New Zealand where such business is now carried on.
• (b) Attempt personally or by letters advertisements or otherwise contact present customers of the Company or its present subsidiaries or its present associates.
• (c) Solicit interfere with or endeavour to entice away from the Company any employee or customer of the Company or of its present subsidiaries or present associates.
• (d) Divulge or publish without the authority of the Company any information or knowledge in connection with the Company finances, trade secrets, transactions dealings or affairs or those of its subsidiaries or associates which he may acquire or be given during or incidental to his employment (both previously and henceforth) by the Company.
• (e) Do any act matter or thing prejudicial to the interests of the Company or its present subsidiaries or its present associates.

The covenants undertaken in this Clause 2 hereof shall be observed and performed by (e) during the period commencing on the 6th day of December, 1968 and ending upon his death or attaining the age of 60 years.

3. The Company covenants to bail and deliver to (E) the motor vehicle described in the schedule hereto for a period commencing on the 6th day of December and ending when (E) attains the age of 60 years or earlier dies (subject always to the provisions of Clause 9 hereof).

4. (E) covenants that he will: -

• (a) Upon the expiration of the period of bailment or within 48 hours of its earlier determination return the vehicle to the company in good order and condition (fair wear and tear excepted). In the event of the vehicle being damaged so as to be a total or constructive total loss the period of bailment shall determine thereupon.
• (b) Arrange for all due servicing and necessary repairs and properly keep and maintain the vehicle in good serviceable condition at all times during the period of bailment at his own expense and (other than excepted herein) pay all outgoings in respect of the vehicle.
• (c) No permit or authorise or allow the vehicle to be driven by any person other than himself (and the members of his immediate family).
• (d) Not to part with possession of the vehicle nor sell, offer for sale, assign, pledge under hire, lend or otherwise deal with the vehicle or any interest therein nor allow any lien to be created upon it.
• (e) Not to remove or allow to be removed the vehicle from New Zealand.
• (f) Not to drive the car in a careless reckless or dangerous manner nor whilst under the influence of intoxicating liquors or drugs.
• (g) Comply at his own expense with the provisions of all statutes and all rules and regulations made thereunder in force in relation to the use or driving of motor vehicles.
• (h) Indemnify and keep indemnified the company against all claims injuries damages suits actions or costs arising out of this bailment of the vehicle or the use thereof.
• (i) Permit the company to inspect the vehicle at all reasonable times.

5. THE Company shall be entitled to deduct from the salary referred to in clause 1(b) hereof the cost of insuring and registering the vehicle and the Company shall be responsible for the same.

6. (E) acknowledges that he has thoroughly inspected the vehicle and that it is at the commencement of the period of bailment in good order and condition and safe and roadworthy in all respects.

7. (E) shall not be entitled to recover from the company any sum for delay inconvenience or loss of any kind due to accident breakdown or defect in the vehicle during the period of bailment.

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ATC 6027

8. ALL the parties hereto mutually agree and acknowledge that the covenants herein contained are both fair and reasonable and for the mutual benefit of all concerned and further that the same are in the public interest.

9. IN the event of any breach by (E) of any of the covenants on his part hereinbefore contained then and in any such case the Company may at its sole option forthwith without notice determine the appointment and the benefits referred to in Clause 1(a) to (d) hereof and any such determination shall be without prejudice to the continuity and enforceability of the covenants by (E) hereinbefore contained and also without prejudice to any other claims which the Company may have against him.

10. NEITHER time nor any other indulgence granted by the company shall affect or prejudice the rights of the company hereunder or otherwise as law.

11. IT is acknowledged by (E) that references to `subsidiaries' or `associates' of the company include (but not by way of limitation) the following companies: - Sandox Pharma Limited, B.F. Goodrich Chemical (N.Z.) Limited, Colour & Synthetics Limited, Ring Proprietary Limited and Buckley and Young Properties Limited.''

The parties to the Memorandum of Agreement of 28 November 1968 were the shareholders, but not the company itself. E was described as the vendor and the other three shareholders as purchasers. It recited the agreement between the parties that the purchasers would purchase all the vendor's shares in the company and went on to provide:

``1. THE vendor's shares shall be transferred to the purchasers in equal shares at the agreed price of THREE DOLLARS EIGHTY FIVE CENTS ($3.85) per share. There shall be deducted from the purchase price of the shares any moneys owing by the vendor to Buckley & Young Limited.

2. THE date for settlement shall be December 6th 1968.

3. ON settlement the vendor will resign as Secretary of Buckley & Young Limited as Secretary of Sandox Pharma Limited and as a director of Buckley & Young Limited, B.F. Goodrich Chemical (N.Z.) Limited, Colour & Synthetics Limited, Ring Proprietary Limited and Buckley & Young Properties Limited. At the same time the vendor will hand over to the purchasers or their nominee all papers and documents relating to the above companies in his possession.

4. ON settlement the vendor will execute an undertaking to be prepared by Butler, White & Hanna on such terms as they think fit that he will not in New Zealand prior to attainment of the age of sixty (60) years either engage whether directly or indirectly in any employment or other activity and whether in partnership as a director or otherwise which is in competition with the business of Buckley & Young Limited and its subsidiaries or associates or do any act matter or thing prejudicial to the interests of Buckley & Young Limited its subsidiaries and associates or divulge or publish any information or knowledge imparted to him or acquired by him during his association with Buckley & Young Limited its subsidiaries and associates concerning their business, finances, trade secrets, transactions, dealings or affairs.

5. THE purchasers will procure Buckley & Young Limited to employ the vendor as tax consultant from the date of settlement until he attains the age of sixty years or sooner dies at a salary at the rate of SIX THOUSAND DOLLARS ($6,000) per annum. Such salary and appointment shall commence from the 6th day of December 1968 on which date the vendor shall be entitled to all holiday pay due to him up to that date.

6. THE purchasers will procure that Buckley & Young Limited permit the vendor to continue using Jaguar Car No. DG3300 during the period that he is employed as tax consultant subject to his keeping the same in good order repair and condition having regard to its condition at the date of settlement and excepting injury or deterioration occasioned by fair wear and tear. The vendor will be required on settlement to execute such document as Butler, White & Hanna shall in the circumstances consider reasonable

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ATC 6028

to cover the car. All running expenses in respect of the said car will be the vendor's responsibility.

7. THE purchasers will ensure that Buckley & Young Limited as from the date of settlement until the vendor attains the age of 60 years or sooner dies will pay its contribution to its AMP Superannuation Scheme for the vendor's benefit at the rate of $800.40 per annum.

8. THE purchasers will ensure that Buckley & Young Limited pay the vendor legal and accountant's costs in connection with the negotiations leading up to this settlement and all documents and other matters required to complete settlement of the transaction up to an aggregate maximum of $300.''

The two documents are inter-related and the deed of 11 December 1968 should not be read in isolation. The second recital provides an express link and records that under the agreement E agreed to enter into the deed. It also records that the agreement provided for E to sell his shares to the other shareholders and to resign his offices of director and secretary in the company and in its subsidiary companies. In terms of the agreement the sale of shares and E's resignation had already been effected. For that reason the deed is accordingly concerned with the implementation of other and remaining matters provided for in the agreement. In these circumstances it would clearly be unreal and contrary to the manifest intentions of the parties to dissociate the deed from the agreement and to determine for what the payments and benefits were made having regard to the provisions of the deed alone without regard to the provisions of the agreement in that respect.

Clauses 1 and 2 of the agreement are concerned with the sale of the shares. Clauses 3 and 4 are covenants by E, cl. 3 providing for the retirement of E from his offices of profit in the companies and cl. 4 for execution by him of a restrictive covenant, in each case on settlement, that is, on 6 December 1968. Then para. 5 to 8 specify benefits to be provided for E. The significant benefits for present purposes are salary, use of a particular motor vehicle, and continuation of the company's contributions to a superannuation scheme. In each case it is the company which is to become liable to E and the other shareholders undertake to procure its compliance. And the term of the benefits is the period of almost four years from his retirement to his 60th birthday at which time E is to become entitled to superannuation.

One complicating factor is that cl. 3 provides for E to resign as secretary and director not only of the company, but also of other named companies. The relevance of this is that, in so far as the covenant relates to other companies, any expenditure referable to that is concerned with gaining or producing assessable income of the other companies. To that extent there is not the necessary relationship between the expenditure and the assessable income of Buckley & Young Limited required for the allowance of a deduction to that company under sec. 111. However, Mr. Smout, the other joint managing director, said in his evidence that E was a nominee of Buckley & Young Limited in the other companies, two of which were no longer trading, and could have been removed from his office in those companies but resignation was a tidier way of dealing with the situation. In these circumstances his evidence that the resignation of E from the other companies was entirely peripheral should be accepted and any expenditure referable to the performance of the covenant should be treated as relating wholly to E's resignation as secretary and director of Buckley & Young Limited.

There is no suggestion in the evidence that the restrictive covenant was not part of the bargain reached at that time and that it could properly be disregarded as a sham. It is sufficient to say that Mahon J. expressly found and in our view was entitled to find, first, that Mr. Smout and the other directors were anxious as to the damage to the company's reputation and thus its goodwill which E could do after leaving the company and secondly, (referring to both documents) that compliance with the restrictive covenants was intended by all parties to be real.

But it was common ground that it was never intended by the parties that E should undertake any duties as a tax consultant and

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ATC 6029

the claim to a deduction was not advanced on the basis that it was a ``salary''. Mahon J. accordingly found that the purported appointment of E as a consultant was illusory and the description of the annual payments as salary was concomitant misdescription. It does not matter whether the reference to the $6,000 per year being salary as a tax consultant is described as a veneer, as Mr. Molloy for the appellant submitted, or illusory and a misdescription as Mahon J. found. As a cloak or facade to conceal the true nature of the payment, the qualifying reference to the $6,000 per year must be brushed aside as not reflecting the true intentions of the parties. That step does not leave a vacuum. It becomes necessary to determine for what the payments were to be made. Just as oral evidence is always admissible in support of an argument that a transaction is in whole or in part a sham, so, too, that evidence may at the same time assist in determining what was the positive common intention of the parties in that regard.

In this case that evidence does not take that matter any further than appears from consideration of the agreement itself: that E agreed to provide two considerations, namely, retirement from office and entry into a restrictive covenant in return for the payment of $6,000 per year. And analysis of the agreement leads to a like conclusion that the other benefits, which the other shareholders undertook to procure for E from the company, were also in return for these two considerations to be provided by E. The nexus between the benefits to E provided for in cl. 5 to 7 and the consideration given by E in cl. 3 and 4 derives emphasis from the fact that they all began on 6 December 1968 and expired on his 60th birthday. What the agreement does not do is to provide any guidance as to the relevant significance of cl. 3 and 4 vis-a-vis those benefits provided for in para. 5 to 7. But it is sufficient to say at this point that under the agreement the payments and the benefits are of a dual character referable to the advantages sought and provided in cl. 3 and 4. Finally, and unlike the position in James Snook & Co. Ltd. v. I.R.C. (1952) 33 T.C. 244, 250-251, it is clear that, although the retirement and restrictive covenant provisions and the provisions for payment and allied benefits to E are contained in an agreement which also provides for the sale of E's shares in the company, they are independent provisions and not ancillary to the sale of the shares.

Up to this point we have been concentrating on the agreement. We do not think the nature of the payments and the benefits is essentially different under the deed. The company is, of course, a party to the deed. It is immediately liable to E. That in itself is not material for present purposes. And, inasmuch as one of the considerations for the payments and benefits to be provided by the company, namely, the retirement by E from his offices of profit in the companies, had been fulfilled by the time the deed was executed, absence of further reference to that consideration in the deed is readily explainable. The undertaking to retire was more than an inducement by E to the company for it to provide benefits to him in return for a restrictive covenant: it was part of the compound consideration given and received for those benefits. It would be quite contrary to the intentions of the parties to say that the restrictive covenant, which had been provided for in the agreement, became the sole consideration for the $6,000 per year payments and other benefits provided by the company. Equally, would it be unrealistic to say that, when the company provided the payments and benefits for E, it did so uninfluenced by the resignation covenant in the agreement.

On this analysis the true nature of the advantage which the company acquired pursuant to the agreement and the deed is evident. The company obtained the retirement of E from the affairs of the companies and it obtained the benefit of the restrictive covenant against competition and disclosure for the stipulated period of some four years. For those advantages it has paid over that same period a cash sum at the rate of $6,000 per year, made superannuation payments at the rate of $800 per year, provided E with a motor vehicle and met his legal expenses in relation to the transaction. The nexus between the payments by the company and the benefits to the company is clear and direct. The payments have a dual character, being referable both to the retirement and to the restrictive covenants. Accordingly, they are deductible in so far as

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ATC 6030

they are referable to securing E's retirement from the company and are not deductible to the extent that they are referable to the restrictive covenants.

The remaining questions relate to apportionment of the amounts for which deductions are claimed. Mr. Bridger for the Commissioner did not suggest that this Court lacked jurisdiction to consider apportionment at all but, having regard to the discussion of this question in
Evans Medical Supplies Ltd. v. Moriarty (1957) 37 T.C. 540; [1957] 3 All E.R. 718 and Europa Oil (N.Z.) Ltd. v. C. of I.R. 76 ATC 6001; [1976] 1 N.Z.L.R. 563 - incidentally both were apportionment cases - it is necessary for the Court to satisfy itself as to its jurisdiction. Is the Court precluded from considering apportionment either by the form of the company's objection to the assessments, or by the course of proceedings in the Supreme Court? The formal objection was put on the ground that the Commissioner had disallowed ``the cost of inducing an incompatible director to retire [which] is deductible under sec. 111'' and the question posed in the Case Stated was in two parts: did the Commissioner act incorrectly in making the assessments, and if so, ``in what respects should the assessments be varied''? In our view this wording left it open for the company to contend that at least part of the expenditure disallowed by the Commissioner was deductible under sec. 111, even if the whole was not. It is a case where the objection to refusal of the full deduction should be treated as including objection to the refusal of any part of the deduction. The second part of the question involves the application in this case of the rule that an appellate court will not ordinarily allow a new point to be raised except on a question of law which no evidence could alter. In the Supreme Court neither the company nor the Commissioner advanced any submissions as to the position that would arise if the payments and benefits were held to be of a dual character. And in the conclusion he reached, Mahon J. did not have to consider that matter. This Court has the power given by Rule 42 of the Court of Appeal Rules 1955 to ``give any judgment and make any order which ought to have been given or made, and to make such other order or further order as the case may require.'' And it is not a matter of remitting the case to the Supreme Court to allow the parties to adduce further evidence. It is common ground that there is no further evidence available to assist in the quantification of the deductible portion of the expenditures. For these reasons we are satisfied that there is no jurisdictional bar to the consideration of apportionment.

The purpose of an apportionment is to ascertain how much of the sum actually expended is attributable to the deductible item. It is not a question of what a reasonable and prudent taxpayer would have expended. It is what this taxpayer in fact paid. The proposition enunciated by the High Court of Australia in
Cecil Bros. Pty. Ltd. v. F.C. of T. (1964) 111 C.L.R. 430, 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'' was approved by the Judicial Committee in both the Europa Oil cases (76 ATC 6001 at p. 6006; [1971] N.Z.L.R. 641 at p. 649 and [1976] 1 N.Z.L.R. 546 at p. 552); and in Ronpibon Tin NL & Tongkah Compound NL v. F.C. of T. (1949) 78 C.L.R. 47, 60 the High Court of Australia said:

``The actual expenditure in gaining the assessable income, if and when ascertained, must be accepted. The problem is to ascertain it by an apportionment.... The question of fact is therefore to make a fair apportionment of each object of the companies' actual expenditure where items are not in themselves referable to one object or the other. But this must be done as a matter of fact...''

The circumstances of the particular case will usually determine what is the most apt way of deciding how much of the expenditure is attributable to the deductible item. For example, where an asset, such as a house or car, is used for both business and private purposes, the apportionment of total expenses may fairly be based on the use (and in some cases availability for use) for business purposes and private purposes respectively. Even so, it is impossible to prescribe any precise formula applicable to all cases. Each such case depends on its own circumstances. It is the yardstick of factual use, or availability for use for business

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purposes, that satisfies the requirements that the apportionment must be fair, not arbitrary, and must be done as a matter of fact. Again, where the values of two advantages secured by the expenditure are readily ascertainable, it may not be difficult to determine the proportion of the total expenditure referable to the deductible item though, if the aggregate of the values is greater or less than the sum expended, it will be necessary to scale them up or down as the case may require, as was done in
Hansen v. C. of I.R. [1973] 1 N.Z.L.R. 483. Then there is the case where the value of one advantage is unknown but the other advantage has an immediate cash value and is equivalent to cash in the hands of the taxpayer. In that situation it may be sufficient, in order to arrive at a fair apportionment on a factual basis, to deduct the cash value of the other benefit from the total expenditure incurred and quantify the other benefit in that way.

The more difficult class of case is where each advantage is intangible and does not lend itself to measurement against any conventional yardstick. It then becomes a matter of deciding whether there is any and if so sufficient, evidence to justify a conclusion that some particular part of the total expenditure is actually attributable to a deductible item, or at the least that a minimum fractional share of the total expenditure can be recognised as so attributable. If there is insufficient evidence to arrive at a conclusion, any answer must be mere speculation and the taxpayer will have failed to discharge the onus of proof upon him (Land and Income Tax Act 1954 sec. 32(10); Inland Revenue Department Act 1974 sec. 36). Where the assessment is made in terms of sec. 19 he is liable to pay the tax assessed by the Commissioner ``save in so far as he establishes on objection that the assessment is excessive.'' it was held in
C. of T. v. McCoard [1952] N.Z.L.R. 263 that the effect of that onus is to require the taxpayer to show not only that the assessment is wrong but also by how much it is wrong. This burden applies equally to an amended assessment under sec. 22 as it does to the original assessment (
Babington v. C. of I.R. [1957] N.Z.L.R. 861). It follows that in apportionment cases the taxpayer has the burden of establishing the extent to which the amount claimed to be deductible satisfies sec. 111 (
Aspro Ltd. v. C. of T. [1932] A.C. 683; Europa Oil (N.Z.) Ltd. v. C. of I.R. (74 ATC 6045, 6071). As it was put by Moller J. in
Lancaster v. C. of I.R. [1969] N.Z.L.R. 589, 591, the onus of proof on the taxpayer in objection proceedings requires that the final question must always be: ``On all the evidence, has the taxpayer discharged the onus of demonstrating that the Commissioner's assessment was wrong, and, if so, why it was wrong, and how far it was wrong?''

The reason for this statutory onus is obvious enough. The Commissioner could not sensibly be expected to bear the onus of proof of matters which originate with the taxpayer and which usually are peculiarly within his knowledge and power. Thus, there are sound if not compelling practical reasons why the legislation requires him to provide satisfactory evidence to support his calculation of his assessable income. If he fails or is unable to provide sufficient evidence to discharge that onus, his objection to the Commissioner's assessment will fail.

In Evans Medical Supplies Ltd. v. Moriarty (1957) 37 T.C. 540, 580 Viscount Simonds remarked that he thought ``it would pass the wit of man to apportion the sum'' under consideration in that case. But such a situation is likely to be rare and the mere fact that an apportionment might be difficult would not of itself be reason for failing to provide an answer upon evidence proffered in support of it. A fair balance must be maintained in this kind of case. As Cooke J. observed in
Duggan v. C. of I.R. [1973] 1 N.Z.L.R. 682, 686, the onus of proof must be applied in a broad and commonsense way. So that in such an apportionment case as the present the taxpayer must be able to point to some intelligible basis upon which a positive finding can be made that a defined part of the total sum is deductible. Where the Commissioner has refused a deduction and his assessment is challenged, then the taxpayer must establish that the decision is wrong and the extent to which the assessment should be varied. That last matter does not require an answer of absolute precision or one that has been calculated by some kind of scientific process but, unless the taxpayer can demonstrate affirmatively that at least a minimum quantifiable sum is deductible, he

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will have failed to discharge the onus that for good practical reasons has been placed upon him by the legislature.

In the present case this last issue was scarcely touched upon in argument, probably because the parties themselves had not turned their minds to it. Towards the end of the hearing we were invited to consider the matter in that alternative fashion. But the parties made no apportionment in the documents; the benefits are intangible; and they are not readily susceptible to valuation. Moreover, the case was put before the Supreme Court on an all or nothing basis and there is no evidence at all upon which an affirmative finding could properly be made. It is clear enough that part of the payments arise from the deductible element. It is equally clear that a substantial part of the expenditures in question is not deductible. But any attempt to make a rational and proper apportionment inevitably involves speculation. In the circumstances the company has failed to discharge the onus on it to establish what part of the relevant amounts was attributable to E's retirement.

The appeal must be dismissed. The respondent is entitled to costs which are fixed at $300 together with reasonable disbursements including travelling expenses to be fixed by the Registrar.