Handley v. Federal Commissioner of Taxation.

Members:
Yeldham J

Tribunal:
Supreme Court of New South Wales

Decision date: Judgment handed down 25 July 1980.

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Yeldham J.

This is an appeal under sec. 196 of the Income Tax Assessment Act 1936 from a decision of the Taxation Board of Review. The appellant is Mr. K.R. Handley, an eminent Queen's Counsel, who had lodged objections to assessments of income tax payable for the years ended 30 June 1972, 1973 and 1974. Those objections were allowed in part by the Commissioner and amended assessments were issued. Being dissatisfied with the decisions made the appellant requested that they be referred to a Board of Review. On 14 November 1979, the relevant Board upheld such decisions upon the objections and confirmed the amended assessments.

The issue between the parties is whether or not the appellant is entitled to deduct a proportion of interest paid under a mortgage upon his home and of municipal and of water rates and of insurance premiums paid in respect of those premises in which, in the relevant years, he had and used a study for the purposes of his professional practice. The claim for the appropriate deductions was made under sec. 51 which provides, inter alia:

``51(1). All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income.''

The questions of law which, according to the notice of appeal, are involved are:

``1. Whether claims for outgoings incurred in maintaining a home study used for the gaining or production of assessable income or used in the course of carrying on a business for that purpose are allowable under section 51(1) of the Act.

2. Whether
F.C. of T. v. McCloy 75 ATC 4079 was correctly decided.''

The facts are set out in the joint reasons of the Board, which accepted in its entirety the evidence of the appellant and his wife. Although it was agreed between the parties to the appeal that I should deal with the matter upon the basis of those facts, counsel for the appellant did assert that in para. 12 of the reasons for decision of the Board some errors appeared as to the extent to which the study was used by the appellant and members of his family for purposes other than those associated with his profession.

The appellant purchased the house in question in 1969 as a residence for himself, his wife and their children because it met all his requirements for a home and especially because there was in it a room which he considered was suitable for use as a study. That room he used for the purpose of his professional work for something like 20 hours per week during about 45 weeks each year out of a total weekly work commitment of some 80-100 hours. Plainly, as the evidence disclosed, when the room was used at all it was used principally as a study, although on rare occasions it was employed for other purposes. The latter would not occupy more than about one hour each week on an average. The study was sometimes used as a means of ingress and egress to a concrete slab called the ``deck'', which was a kind of patio, used by the family perhaps 10 or 12 times each year. Although, in para. 12 of its reasons, the Board of Review did say that the room was ``used as an adjunct to the living room for guests who are being entertained in the living room'' this is not strictly accurate as the evidence disclosed only that on some occasions when the appellant and his wife were entertaining, the former might pour drinks from a table which was situate in the study. On rare occasions, if a large group of guests was being entertained, the study might be employed, along with other areas in the house, for that purpose. But plainly its use other than as a study was infrequent and intermittent, and basically, when it was used, it was in aid of the income-producing professional activities of the appellant.

Although the Board of Review did not express any opinion upon the matter, I was asked, even if I were to dismiss the appeal, to express a view, for the assistance of any appellate court which may come to a different conclusion, upon the appropriate percentage of the interest and other relevant outgoings which should be allowed by way of

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ATC 4353

deduction. The appellant asserted that, based upon the floor area which the study bore to the whole house, the deductions should be of one-fifteenth of the interest, rates and insurance. The Commissioner submitted that, in addition to the proportion which the floor area bore to that of the entire premises, there must be taken into account also the percentage which time spent in the study (20 hours per week) bore to the entire number of hours in each week. If the latter approach was adopted the appropriate figure would be 0.6% of the relevant outgoings.

In my opinion the only adjustment which in theory should be made to the figure of one-fifteenth, which represents the ratio of floor space occupied by the study to that of the house as a whole, is one to reflect the ratio between the number of hours in which the room is used as a study and the time when it is used for other purposes. I do not think it is realistic to compare the 20 hours weekly during which, according to the Board's findings, it is used as a study, with the total number of hours in each week. Rather should the comparison be between 20 hours and the one hour during which, on an average, it is otherwise employed. In the present case the reduction from one-fifteenth would be almost negligible and I would, in those circumstnaces, regard the correct approach as being to allow the appellant, if his appeal succeeds, one-fifteenth of the appropriate outgoings by way of deduction.

I turn to the matter of substance which was raised by the appeal.

In
I.R. Commrs. v. Korner & Ors. (1969) 1 W.L.R. 554 Lord Upjohn, with whom Lord Donovan expressly agreed, said, in a case concerning the Income Tax Act 1951 (U.K.), at p. 558:

``Thus speaking generally the grocer living above his shop, the doctor who has a surgery in his house and the barrister who works in his house where he keeps or brings his law books and works on his brief in the evenings and at week-ends is allowed by the Crown a reasonable sum in respect of the necessary upkeep of his dwelling as being properly attributable to his trading or professional activities.''

His Lordship prefaced these remarks by saying that ``the practice is very old, works great justice between the Crown and the subject and I trust will never be disturbed''.

But in this country, unlike the United Kingdom and New Zealand, according to decisions which it is submitted I should follow and to which I will refer, the situation is different, at least so far as outgoings such as interest, rates and insurance are concerned. In the present case the appellant was permitted deductions for items like electricity and cleaning, insofar as they related to the room used as a study.

In
Lunney v. F.C. of T. (1958) 100 C.L.R. 478 at p. 497 Williams, Kitto and Taylor JJ., after referring to a number of earlier authorities of the High Court, including
Ronpibon Tin (N.L.) & Anor. v. F.C. of T. (1949) 78 C.L.R. 47 at p. 56 (where it was said ``For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end'') said, at p. 497:

``Examination of these cases, however, readily shows that the expression `incidental and relevant' was not used in an attempt to formulate an exclusive and exhaustive test for ascertaining the extent of the operation of the section; the words were merely used in stating an attribute without which an item of expenditure cannot be regarded as deductible under the section.''

In
Thomas v. F.C. of T. 72 ATC 4094 Walsh J., in dealing with a claim by a barrister that (inter alia) he should be allowed a deduction in respect of interest paid upon a bank loan for the purpose of adding new rooms to his home, one of which was used by him as a study, said, at p. 4097:

``... in my opinion, the house should not be regarded in the circumstances of this case as being or as including part of the business premises of the appellant and the loan should not be regarded as having been raised for the purpose of providing him with business premises. Payment of the interest, insofar as it was an outgoing connected with the cost of extensions to the house was, in my opinion, an outgoing `of a capital, private or domestic nature' within the meaning of sec. 51(1) of the Act. In my opinion it did not lose that character merely because the

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ATC 4354

appellant, like most professional men, did some of his work at home, or because he used one of the added rooms for that purpose. The appellant did not spend money in erecting premises suitable only for use as business premises. He added rooms to his house.''

In
F.C. of T. v. Faichney 72 ATC 4245; (1972) 129 C.L.R. 38, where the taxpayer, who was a professional scientist, claimed deduction of mortgage interest payments and certain other outgoings on the ground that they related, either in whole or in part, to a room used as a study in his home, Mason J., at ATC pp. 4248-4249; C.L.R. p. 43 said:

``To my mind, a study in a taxpayer's home, no matter how great the extent of its dedication in point of use to the pursuit of those activities from which the taxpayer earns his income, is a part of that home. Expenditure incurred in the erection of the study or in its renovation is as much of an outgoing of a capital, private or domestic nature as expenditure on any part of the home. The view which I have expressed is, I think, in accord with the decision of Walsh J. in Thomas v. F.C. of T....

In the course of argument reference was made to expenditure incurred by a doctor in erecting a house which contained his surgery or for the purpose of renovating a house containing such a surgery. In my opinion there is no analogy between the example given and the circumstances of the present case. As I have said, a study does not cease to be part of a taxpayer's home because it is used by the taxpayer for the pursuit of activities from which he earns his income. However, the doctor's surgery is not in a relevant sense part of his home; it is his place of business, if I may be permitted so to describe the premises at which a doctor carries on his profession.''

Hence the claim for deduction in relation to interest paid was disallowed, a claim for expenditure on light and power being upheld.

The foregoing authorities, and others to which I need not refer, were reviewed by Helsham J. in F.C. of T. v. McCloy 75 ATC 4079; (1975) 1 N.S.W.L.R. 202. There the taxpayer was a marketing representative employed, partly on a fixed salary and partly on commission, by a computer company. He had purchased a house to provide him and his family with a residence but, in particular, to provide him with a study which he formerly had lacked and which he utilised for the purpose of increasing his assessable income. His claim for a deduction of portion of the interest payable on borrowed money expended on the purchase of the home and for a proportion of the insurance premiums was allowed by a Board of Review but an appeal by the Commissioner was upheld. Helsham J., at ATC pp. 4081-4082; N.S.W.L.R. p. 205 said:

``It is important not to lose sight of the fact that the claim of the taxpayer relates to interest payments on money borrowed to purchase the house in which a study or home office is situated, and to insurance premiums for that house and contents. It does not relate to expenses incurred referable to the use of the study by the taxpayer, such as the cost of lighting and heating. These latter expenses were allowed by the Commissioner. If the interest and premium payments are not to be categorised as expenses of a capital, private or domestic nature, then there must be found the requisite relationship between them and the gaining or producing of assessable income to enable them to qualify as allowable deductions under sec. 51. This element of necessary relationship has been discussed in many cases, including the case of Ronpibon Tin (N.L.) v. F.C. of T.... where it was stated that the expenditure to be an allowable deduction must be incidental and relevant to the gaining or producing of the assessable income....''

His Honour went on to refer to Lunney v. F.C. of T. (supra) and to the passage at p. 499 in the joint judgment where it was said that whether or not expenditure should be characterised as incurred in or in the course of gaining or producing income ``depends upon considerations which are concerned more with the essential character of the expenditure itself than with the fact that unless it is incurred an employee or a person pursuing a professional practice will not even begin to engage in those activities from which their respective incomes are derived''.

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Helsham J. proceeded:

``Looked at in this way it seems to me that the expenditure in question here cannot be said to have been incurred in gaining or producing the assessable income of the taxpayer. It is not sufficient that there was an expenditure referable to the provision of a study without which a portion at least of the taxpayer's income could not have been earned. The money from the obtaining of which flows the expenditure claimed as an allowable deduction was money borrowed and spent to acquire a home for the taxpayer. The purchase money was not outlaid in the first place to purchase a place of business; it was outlaid for the purchase of a home... Payment of no part of the interest or insurance premium can in substance be said to be productive of the assessable income.''

His Honour said that he was unable to give to the moneys in question a character other than that of being moneys spent in or in connection with the acquisition of the taxpayer's home.

After referring to the decisions of Walsh J. and Mason J. his Honour reiterated, at ATC p. 4083; N.S.W.L.R. p. 207:

``In my view the same reasoning applies in the present case, and the expenditure, in interest and insurance, referable to the provision of the taxpayer's home office, does not bear the essential character of being an outgoing incurred in gaining or producing the assessable income of the taxpayer.''

Since the decision of the Board of Review in the present case was given, the Federal Court of Australia has given judgment in
F.C. of T. v. Forsyth 80 ATC 4176, in which it dismissed an appeal from the decision of Murphy J. of the Victorian Supreme Court to which reference had been made in argument. There the taxpayer was a barrister who, with his wife, purchased a house as trustees of a family trust. In return for a payment of $20 a week the trustees agreed to allow the taxpayer to occupy one room of the premises as a study and to occupy the remainder as a residence provided he paid all outgoings including interest under the mortgage. That claim was upheld by Murphy J. and Federal Court. The latter (Bowen C.J., Deane and Fisher JJ.) at p. 4178 said:

``... it is clear that the relevant outgoings were both incurred by the taxpayer in gaining and producing assessable income and necessarily incurred in the course of carrying on his profession... for the purposes of gaining or producing such income. There remains for consideration the question whether the outgoings were of a capital, private or domestic nature and, for that reason, within the exclusion of the proviso to sec. 51(1).''

Their Honours then referred to the decision of Walsh J. in Thomas's case and of Mason J. in Faichney's case and continued (at pp. 4178-4179):

``In the present case, the relevant outgoings were incurred in respect of the use by the taxpayer of the study and associated facilities for professional purposes. They did not, as in the abovementioned cases, constitute part of a larger payment which could, in its entirety, be related to the taxpayer's purchase, erection or extension of his residence. No question of apportionment arises and it is not possible to characterize the outgoing in respect of which a deduction is claimed by reference to a larger outgoing of which it formed part. If the relevant outgoings are, in the present case, to be excluded from the provisions of sec. 51(1) for the reason that they are of a `capital, private or domestic nature', it must be because they are of that nature in themselves and not by reason of their constituting part of larger outgoings which can, in their entirety, properly be so described.

The outgoings in the present case were incurred as the cost to the taxpayer of using, for professional purposes, part of a residence held by the taxpayer and his wife as Trustees under a family trust. True it is that the study and those associated facilities can properly be regarded as part of the residence which the taxpayer and his family occupy. That is not, however, to the point in the present case for the reason that the payments were not related either to the residence as a whole or to the general use by the taxpayer and his family of that residence

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as their home. In this regard, the outgoings were more akin to the payment of the cost of lighting and heating the study in Faichney's case... than to the payment of part of the interest on the money borrowed to permit the erection of the house. They were specifically and genuinely for the use by the taxpayer of the study and associated facilities for professional purposes, that is to say, for the purpose of earning assessable income. They were revenue outgoings of a professional or business nature and were not outgoings of a capital, private or domestic nature. They were properly deductible pursuant to the provisions of sec. 51(1).''

This, then, being the state of the relevant authorities, the critical question is whether I should follow the reasoning of Walsh J., Mason J. and Helsham J. and hold that the expenditure in question was an outgoing of a capital, private or domestic nature, or whether I should allow it as a deduction. Counsel for the appellant argued that the expenditure could not be dismissed simply by saying that the appellant ``added rooms to his house'' and that the object of the expenditure ``retains its essential character as part of the taxpayer's home''. He submitted that such questions may evoke an answer which was really irrelevant to the matters the Court was required to examine by the words used in sec. 51(1). He argued that, to the extent to which interest and insurance payments related to the study or could be apportioned to it, they were ``incurred in gaining or producing the assessable income'' and that merely because the study itself formed part of the private home of the appellant, they should not be characterised as being ``of a capital, private or domestic nature''.

Senior counsel for the Commissioner, on the other hand, submitted that the basic principle, at least in Australia, is that one must look at the essential character of the expense and that, when so examined, it should be held, in accordance with the authorities to which I have referred, to be of a private or domestic nature.

The matter is one in respect of which I have experienced some difficulty. The difficulty relates, in the main, to finding a logical justification for the allowance of expenditure such as that with which the Federal Court of Australia was concerned in Forsyth's case (with which, with great respect, I entirely agree), on the one hand, and the disallowance of a proportion of payments directly made for items such as interest, rates and insurance, merely because the study happens to form part of the taxpayer's home and is not a separate entity, on the other. I have difficulty also in concluding that merely because a professional man ``added rooms to his house'', which rooms were used solely or principally in connection with his profession, the expenditure incurred is not ``in gaining or producing the assessable income'' and is ``of a... capital or domestic nature''. But in the end I have come to the conclusion that, because of my own uncertainty as to the proper construction of sec. 51 and of its proper application to facts such as those in the present appeal, I should follow and apply the principles enunciated by Walsh J., Mason J. and Helsham J. in the cases to which I have referred. Those principles, as was conceded before me, require that this appeal be dismissed.

But plainly the matter is one which should be resolved at an appellate level. This the parties themselves recognised by informing me that, whatever my decision should be, the matter would undoubtedly be the subject of an application to the Federal Court for leave to appeal under sec. 196.

I dismiss the appeal and confirm the amended assessments. As the matter is one which should be regarded as being in the nature of a test case, I order the parties to bear their own costs.