Case M57

Members: HP Stevens Ch
CF Fairleigh QC

JR Harrowell M

Tribunal:
No. 1 Board of Review

Decision date: 25 August 1980.

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J.R. Harrowell (Member)

The taxpayer in this reference is a proprietary company incorporated on 28 October 1968 and carrying on the business of subdivision designers and planners. At relevant time its directors were A, B and C, all qualified surveyors.

2. During the year ended 30 June 1972 a retiring allowance of $20,000 was paid to A. The Commissioner by notice of assessment dated 2 November 1973 increased the taxable income by $12,652 which he detailed on the accompanying adjustment as follows:

             $

      Deduction for legal expenses

      disallowed       712



      Claim for Retiring Allowance

      reduced from $20,000 to $8,060       11,940

             -------

             $12,652

             -------
      

3. The taxpayer in due course lodged an objection in respect of the disallowance of $11,940. The disallowed legal expenses ($712) are not an issue in this case. The objection was disallowed by the Commissioner and the matter now comes before this Board.

4. The taxpayer's objection includes reliance on sec. 78(1)(c) and/or sec. 51(1).

5. The Commissioner's reasons for disallowing the amount of $11,940 were in his reg. 35(1) statement to the Board:

``Of the amount of $20,000 paid as a retiring allowance to (A) and which would otherwise be an allowable deduction, $11,940 is not an allowable deduction because in the opinion of the Commissioner formed under section 109 it exceeded an amount which is considered reasonable.''

6. I accept the facts as set out by my colleague Mr. C.F. Fairleigh Q.C. and so it is not necessary to restate them again in full. In brief, A qualified as a surveyor in 1957. He worked in the Department of Main Roads for twelve months. From there he went to the Water Board for some nine months and some time in 1959 he acquired a private practice in a Sydney suburb and commenced practice on his own account as a registered surveyor. As a result of his prior experience with the Department of Main Roads and the Water Board to specialise in development work associated with subdivisions. The practice grew and between 1962 and 1963 he broke the practice into two sections. The general surveying section was sold back to the original owner and he transfered the development section to an office in another suburb where he practised at his home through a company he had incorporated and which employed him. Sometime in 1965 B and C, who had been employed in the practice he had purchased in 1959 and who had remained in the general surveying section when sold by A, approached him to acquire a practice at that time for sale. This was done and the business he had built up was transferred over to this new firm in which A, B and C were partners. (The partnership).

7. On 28 October 1968 the taxpayer company was incorporated with A, B and C as its shareholders/directors. A, B and C were employed by the taxpayer. A and B in the relevant year received salaries of $4,591 each and C received $2,606. The smaller salary paid to C was accounted for by the fact that C was more involved in the work of the partnership which still continued to provide general survey services. The taxpayer company specialised in subdivisional survey work.

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ATC 397

8. By December 1971 A had joined the Board of a public company which was entering the real estate business. He was to be paid a salary of $15,000 per year plus superannuation benefits. Under this new arrangement A was to cease practice as a registered surveyor and this meant he had to cease working for the taxpayer and the partnership. Because of work in hand this could not be put into effect until 30 June 1972. Although A took up his new position by 31 December 1971 he continued to work for the taxpayer until 30 June 1972 when he was paid the retiring allowance of $20,000.

9. Mr. Fairleigh has dealt with the evidence relating to this retiring allowance. From the facts I also conclude that when A, B and C, at arm's length, considered the quantum of the allowance they were individually looking at his total period of service, not only with the taxpayer, but also with the partnership.

10. During A's service with the taxpayer he was paid the following sums as salary and as dividends:

                            Salary            Dividends

                              $                  $

1969 (7 months)             3,875                -

1970                        5,200                -

1971                        6,881               200

1972                        4,591                83
      

11. At 30 June 1972 A was entitled to accrued holiday pay amounting to $960. On his retirement this entitlement formed part of the $20,000 paid and so in this reference the retiring allowance amounts to $19,040.

12. I accept the evidence that A, B and C worked very long hours during the period of their association as partners and as employees of the taxpayer. I accept that A was a dominant force in this association. His experience was of value to the partnership and the company. I accept as fact that A if he had been employed by the Department of Main Roads or the Water Board he could have earned about twice the salary paid to him during his employment with the taxpayer company.

13. The Commissioner has acted under sec. 109 which reads as follows:

``So much of a sum paid or credited by a private company to a person who is or has been a shareholder or director of the company or a relative of a shareholder or director, being, or purporting to be -

• (a) remuneration for services rendered by that person; or
• (b) an allowance, gratuity or compensation in consequence of the retirement of that person from an office or employment held by him in that company, or upon the termination of any such office or employment,

as exceeds an amount which, in the opinion of the Commissioner, is reasonable, shall not be an allowable deduction and shall, for the purposes of this Act other than the purposes of Division 11A of Part III and Division 4 of Part VI, be deemed to be a dividend paid by the company on the last day of the year of income of the company in which the sum is paid or credited.''

14. For sec. 109 to apply the payment must first be an allowable deduction, in this instance under sec. 78(1)(c). Section 109 does not give the Commissioner the power to deem the whole amount paid as a dividend
W.J. & F. Barnes Pty. Ltd. v. F.C. of T. (1957) 96 C.L.R. 294 .

15. Section 78(1)(c) states:

``Sums which are not otherwise allowable deductions and are paid by the taxpayer during the year of income as pensions, gratuities or retiring allowances to persons who are or have been employees or dependants of employees, to the extent to which, in the opinion of the Commissioner, those sums are paid in good faith in consideration of the past services of the employees in any business operations which were carried on by the taxpayer for the purpose of gaining or producing assessable income.''

16. In this reference before sec. 109 can be applied it is first necessary for the Board to form an opinion as to the extent to which the sum of $20,000 was paid in good faith in consideration of the past service of A in the business operations of the taxpayer. Having determined the issue of good faith under sec. 78(1)(c) the sum arrived at (either $19,040 or a lesser sum) is then considered under sec. 109 to ascertain if that sum is reasonable. The Commissioner, from his reg. 35(1) statement, came to the conclusion that on the

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ATC 398

facts before him at that time the amount paid ($20,000) satisfied under sec. 78(1)(c). However, the evidence which emerged at the hearing before the Board gave a somewhat different picture. It is quite clear from the evidence that the central figure when determining the amount of the retiring allowance was A. His colleagues B and C, as it. were, waited in the wings with a certain amount of trepidation. On the facts the decision as to quantum rested in the first instance with A whilst B and C hoped that A would not set too high a figure. A sought the views of the taxpayers' accountant and kept B and C fully informed. A in evidence, when referring to his discussions with the accountant had this to say:

``I asked (the accountant) what would be a reasonable retiring allowance. I put to him on the basis I had been previously self-employed, I had retired from other practices which had continued through in the previous ten years from (a previous firm (para. 6)) to (his previous company (para. 6)) to (the present partnership (para. 6)) through to (the taxpayer), and there was a continuation of business, there was no cessation with the continuing partners and employees. I said, `well I consider that we have been involved in business for ten years, that because of my seniority and age, I felt that I would be entitled to a reasonable retiring allowance'.''

To the question as to what would be a reasonable allowance the accountant indicated that an amount representing three times A's annual salary would, on court decisions, be a reasonable figure. A pointed out to the accountant that ``over the previous five or six years, not only had I worked long hours but I had not taken any recreation leave and there were many other factors involved''. When asked what these factors were A said: ``Seniority within the firm, introduction of the major goodwill of the firm''. He was queried on the word ``firm''. He replied ``Well company, sorry. Firms and companies in the previous years''.

17. The foregoing extracts from the evidence leaves me to conclude that when arriving at the amount of the allowance to be paid A was including not only his three and a half years (approx.) service with the taxpayer but also his earlier professional service as a sole practitioner and later in partnership. In consequence I find that only part of the retiring allowance paid falls within the terms of sec. 78(1)(c) as having been paid ``in good faith in consideration of the past services of (A) in any business operations which were carried on by the taxpayer etc.''.

18. However, as has been said, the case before the Board was argued by both sides on the basis that the allowance paid met the terms of sec. 78(1)(c) but fell for consideration under sec. 109. No evidence was tendered by either party to enable me to determine the quantum of the allowance which I considered satisfied sec. 78(1)(c). An outgoing disallowed under this section of the Act becomes a disallowed deduction which has the effect of increasing the taxable income or reducing a loss. Where the taxpayer is a private company, as defined by the Act, the disallowance will have the result of increasing that company's (if taxable) distributable amount under Div. 7 of the Act. But if the amount paid meets the requirements of sec. 78(1)(c) but fails under sec. 109 the amount disallowed as a deduction, whilst also increasing the taxable income, if any, is nevertheless deemed to be a dividend for the purposes of Div. 7. (The Board had no knowledge of any action by the Commissioner in respect of the taxpayer under Div. 7 of the Act.) In my opinion the Commissioner's decision to accept the allowance under sec. 78(1)(c) but to disallow portion under sec. 109 at least provided some consequential consolation to the taxpayer company under Div. 7. For this reason as I am unable to determine the matter under sec. 78(1)(c) I too will confine my decision to sec. 109.

19. It was argued on behalf of the taxpayer that the Board should take into consideration that the salary paid each year to A was far lower than the salary he would have received from some statutory body. Quite obviously a retiring allowance of $20,000 may appear reasonable when paid to an employee with three and a half years service receiving a salary approximating that sum. Section 109 deals only with private companies and on of its purposes is to discourage misuse by companies seeking a deduction under sec. 78(1)(c) and the recipient in respect of an income benefit under sec. 26(d).

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ATC 399

20. The fixing of the quantum of a retirement allowance is a nebulous exercise more particularly when it is being paid by a private company to a director/shareholder. Under tax law, Courts and Boards of Review have tended to accept length of service and the amount of salary paid in the past as major factors when determining that quantum. Most superannuation funds directly relate the benefit to be paid to these two factors. For these reasons I do not accept the argument put forward by the representative of the taxpayer.

21. In this matter I hold the view that the allowance paid by the taxpayer should be based on the salary paid to the employee by it and not on the amount of a salary which may have been paid by some other employer. I am of the opinion that on the ordinary civil standard of proof the amount of $8,060 determined by the Commissioner is not shown to be unreasonable.

22. I would uphold the Commissioner's decision on the objection and would confirm the assessment for the year ended 30 June 1972.

Claim disallowed