Case M57

Members: HP Stevens Ch

CF Fairleigh QC
JR Harrowell M

Tribunal:
No. 1 Board of Review

Decision date: 25 August 1980.

C.F. Fairleigh Q.C. (Member)

In its return of income for the year ended 30 June 1972 a proprietary company which carried on the business of subdivision designers and planners (i.e. it employed land surveyors and persons associated with survey work) set out that its deductible expenditure included $20,000 which was a retirement allowance paid by it to an employee/director in the year which ended on 30 June 1972.

2. The Commissioner adjusted the income as returned by allowing as a deduction $8,060 in lieu of $20,000 and a notice of assessment issued accordingly. The taxpayer objected thereto; the Commissioner decided to disallow the objection; that decision was referred to this Board for review. (This reference is the counterpart of Case M56,
80 ATC 369 by the recipient of that sum of $20,000. It may also be noted that the Board has no knowledge of the contents of a Div. 7 assessment for the year in issue, or whether in fact one did issue.)

3. The reg. 35(1) statement sets out that of the amount of $20,000, paid as a retiring allowance, $11,940 is not an allowable deduction because, in the opinion of the Commissioner formed under sec. 109 of the Income Tax Assessment Act, it exceeded an amount ( scil . $8,060) which is considered reasonable. Thus the Commissioner indicates that he made no reduction under the ``good faith'' provision in sec. 78(1)(c), or if it be relevant under sec. 51(1).

4. On the hearing of the present reference the accountant who acted as representative of the taxpayer did not call parol evidence but (with the tacit consent of the Commissioner's representative) tendered as an exhibit the transcript of evidence and all documents which became exhibits in the said counterpart reference.

5. The accountant was a witness in the said counterpart reference and (by consent of the parties) had been present in the Board room throughout the hearing.

6. The transcript and other documents which were thus tendered by the accountant as an exhibit were impliedly subject to the standard qualification of extent of relevancy and admissibility on the present reference (
N.A. Kratzmann Pty. Ltd. (in liq.) v. Tucker (1970-1971) 123 C.L.R. 257 at p. 264 ). The accountant (with the tacit consent of the Commissioner's representative) requested that findings on credibility (so far

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as here relevant) be carried into this reference from the said counterpart reference. In accordance with customary procedure the reg. 35(1) file of documents on this reference was an exhibit and marked as if tendered by this taxpayer.

7. The notice of objection on the present reference contains the following grounds:

``The amount paid, $20,000.00, should be allowed in full as such amount was in fact paid to an employee on the termination of his services from the Company.

Pursuant to Section 78(1)(c) of the Act that amount was paid as a Retiring Allowance and such sum was paid in good faith in consideration of the past services of the employee.

Alternatively should the Commissioner form the opinion that pursuant to Section 78(1)(c) that the sum of $20,000.00 is excessive then some amount greater than $8,060 should be determined and allowed as a deduction.''

8. The Commissioner's representative submitted that the grounds in the notice of objection are not specific enough to permit the taxpayer to proceed with its submissions which were based on sec. 109. In my opinion there is no need for a taxpayer to refer to any section by number, and the first ground aforesaid, together with the reference to the opinion of the Commissioner in the third such ground, enable the taxpayer to rely on its submissions which refer to sec. 109. So also, I would hold that the first ground aforesaid encompasses sec. 51(1) although it is not expressly mentioned (cf.
Sarich v. F.C. of T. 78 ATC 4646 at pp. 4652-4653 ).

9. The findings of fact which I import from my reasons in the counterpart reference ( vide para. 2 and 6 hereof) are as follows:

(a) the taxpayer was incorporated in New South Wales on 28 October 1968 and commenced business in November 1968; the register of shareholdings contains some irregularities but those are not material to the issue; the recipient of the money, a surveyor, and two other surveyors were shareholders and directors of the taxpayer at all material times; the recipient of the money was also the taxpayer's public officer;
(b) at all material times the recipient of the money (so also his family company) and each of the other two surveyors had loan accounts with the taxpayer;
(c) at the time which is material to a director's decision to make the said payment, the recipient's said family company was about $15,000 in debt to the taxpayer for services rendered;
(d) payment of the said $20,000 was made by cheque and it was supported by a consideration, although the payment was not pursuant to a contract that it be made. Such payment was made on 29 June 1972 when the cheque was handed over;
(e) the recipient of the money had been the dominant member of the three surveyors, and it was he who attracted clients to the taxpayer, and to an associated survey partnership;
(f) each of the three worked much the same hours but the recipient's time was principally devoted to the taxpayer's business, and the time of the other two surveyors to a greater extent to the partnership;
(g) the remuneration of the recipient from the taxpayer for the first seven months of operation was $3,875; for the three ensuing complete years it was $5,200; $6,881 and $4,591 respectively as wages; and as dividends $200 in 1970-71, $83 in 1971-72 and $387 in 1972-73;
(h) as at 30 June 1972 the recipient's entitlement for accrued holiday pay was $960;
(i) as at 30 June 1972 or soon thereafter the business of the taxpayer was concluded except for an informal winding-up. Whatever goodwill it had enured for the benefit of the said other two surveyors;
(j) as at 30 June 1972 or soon thereafter the business of the said partnership was concluded except for an informal winding-up. Whatever was goodwill of the partnership, it survived for the benefit of the said other two surveyors;
(k) as at 30 June 1972 the capital of the recipient stood in the books of the taxpayer at $11,869;

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(1) the recipient received the benefit of that capital in one form or another e.g. the crediting of a loan account in favour of his family company;

(m) the profit and loss account of the taxpayer indicate the position to be this:

                             1969       1970       1971       1972       1973

                              $          $          $          $          $

Survey fees received       27,537     77,423     68,831    136,288        -

Management fees

received                      -         -        15,000        -          -

Outlays (including

wages)                     18,956     67,384     83,866     126,628       -

Net profit                  8,581     10,039    Loss 35       9,660       -

(n) in the 1971 year the taxpayer had returned as its fees $28,297 which were ``properly'' the fees belonging to the partnership. Apparently there was an adjustment pursuant to (or it may be in anticipation of) what is called Henderson's case ;
(o) the revenue statement of the taxpayer for the year ended 30 June 1972 is not a trustworthy guide to the true financial position; for example no amount was charged to it or paid by it as rent in that year although $4,475 was paid by it as rent in the preceding year with respect to premises occupied at all material times by the taxpayer and by the said proprietary company. Furthermore I have no confidence at all in the fees paid or payable by clients being apportioned between the taxpayer and the partnership on a commercially realistic basis where work was done for the client, and it is said that it is being done at one point of time by the taxpayer, and at another point of time it is being done by the partnership;
(p) the wages received by that recipient as a surveyor both from the taxpayer and in addition from the said partnership were substantially less than he might have expected to receive as a surveyor employed by a government (or semi-government) body; but a simple comparison of quantum of wages would not reflect the many differences so as to indicate that he would be better off financially in government employment, leaving aside the said $20,000;
(q) the said sum of $20,000 was specifically requested by the recipient as his entitlement, not related solely to his involvement with the taxpayer for the 3 years and 7 months that it had been in business, but related on a global basis to as much as 10 years experience in private practice as a surveyor, and particularly the immediately preceding period of 5 or 6 years, and because he had been the senior partner (referring, if not exclusively yet inclusively, to the partnership) and ``he was retiring out of the profession completely'' and he ``had no intentions of coming back into the profession'',
(r) whatever mental reservations the other two surveyors may have had to the basis of the taxpayer's claim to an entitlement which related to the partnership as well as to the taxpayer's business (so also whatever reservations the said accountant may have had) the whole tenor of their discussions with the recipient was as to his entitlement for a period of time greatly in excess of his period of service with the taxpayer. (The accountant's advice was in some respects with regard to $20,000 being paid for services to the taxpayer, but that was on a notional salary and not the actual salary);
(s) the inclusion of money in lieu of accrued holidays was not during those discussions, known to be $960 but was understood to be in that vicinity;
(t) the source for the payment of the said $20,000 was not adverted to by any of the directors at any time prior to 30 June 1972 as being out of profits derived; even

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assuming that the profit and loss account which was compiled after the close of the relevant financial year reflects a payment made out of profits derived ( vide subpara. (o) hereof);
(u) factually the payment of the said $20,000 was dependent on the availability of the bank overdraft and the management fees owed by the recipient's said family company to the taxpayer;
(v) as the said $20,000 (or more precisely $19,040) related, on the evidence of recipient, to his work for the said partnership as well as for the taxpayer, and, indeed, to a period of private employment of up to 10 years, that money was not intended to be a reasonable retirement allowance from service solely with the taxpayer;
(w) the said sum of $20,000 (or more precisely $19,040) has not been shown to be, on ordinary civil standard of proof, a reasonable retirement allowance for the recipient, looked at solely from the point of view of his association with the taxpayer (and leaving aside his association with the partnership etc.);
(x) accepting the common understanding that the payment cannot be supported under sec. 51(1) and must be dependent on sec. 78(1)(c), the said sum of $20,000 was paid in one sense in good faith. (As to the meaning of ``good faith'' see the authorities which are collected in Case K8,
78 ATC 87 at pp. 96-97.)

10. The Commissioner's representative did not address the Board on good faith as in sec. 78(1)(c); and it may be noted that good faith is impliedly present also in sec. 51(1) vide
Nevill & Co. Ltd. v. F.C. of T. (1936-37) 56 C.L.R. 290 at p. 300; 4 A.T.D. 187 at p. 193 per Latham C.J. ``But in order to justify a deduction... the outgoing... must be... made bona fide in the course of the business''.

11. It is established that sec. 109 is applicable only where an outlay is deductible by the private company and under either sec. 51(1) or sec. 78(1)(c). Furthermore if the taxpayer making the claim for a deduction is an individual, a partnership, or a public company, then sec. 109 is not reached in the course of assessment.

12. In making an assessment for a private company there is a decision as to an outlay in good faith under sec. 51(1) or under sec. 78(1)(c) and it may be that, in a particular case, the outlay can be supported under either of those provisions, perhaps in toto and perhaps in part. Where the outlay is supportable only in part under such provision it is conceivable that it could be supported as to the same part only or as to a different part under sec. 109. That is to say, what is paid in good faith within the concept of sec. 78(1)(c) or of sec. 51(1), is not inevitably what is reasonable within the opinion of the Commissioner or of a Board of Review acting pursuant to sec. 109.

13. (a) Whether the factors which result in a reduction under sec. 109 would result in the same reduction under sec. 78(1)(c) in the opinion of the Commissioner is a matter of pure speculation.
(b) So far as I have to consider what reduction would or could be made under sec. 78(1)(c) (prior to reaching sec. 109) my initial thought is that I will not fall into the trap of applying a formula rigidly; all the more so when I cannot see any reason why that formula used twenty years as a base rather than some other period of time, or why that formula uses a factor of seven rather than another factor. Doubtless the Commissioner, due to the exigencies of administration may resort to such expedients, but the Board acting inter partes may not do so.
(c) The Commissioner has not formed any opinion for a reduction under sec. 78(1)(c).
(d) I consider that some reduction may (on one understanding of the meaning of good faith, vide the authorities collected in Case K8), be made under sec. 78(1)(c).
(e) The evidence does not enable me to do more than speculate as to the amount of that reduction. On the ordinary civil standard of proof the evidence does not enable a quantification to be made of any reduction under sec. 78(1)(c) so also if it be relevant, under sec. 51(1).

14. Once it is decided that some unquantifiable part of the lump sum payment was paid in good faith under sec. 78(1)(c) (so also if under sec. 51(1)), the sum

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of money which then falls for consideration under sec. 109 is the whole $20,000.

15. Accordingly, it is appropriate to proceed as the Commissioner has done i.e. to turn to sec. 109 without making any reduction to $20,000 under sec. 78(1)(c). Thereupon the question is whether the evidence on the ordinary civil standard of proof shows both that the Commissioner's figure of $8,060 is unreasonable and that another ascertainable sum of money should be substituted for $8,060.

16. The evidence does no more than show that some substantial part of $19,040 was unreasonable for the taxpayer to pay to the recipient, because the total was for services rendered not only to the taxpayer for 3 years and 7 months but also to partnerships and others for a period up to 10 years.

17. The consequence is that the Commissioner's decision on the objection has not been shown to be wrong and the assessment should be confirmed.

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