Nilsen Development Laboratories Pty. Ltd. & Ors. v. Federal Commissioner of Taxation.

Judges: Barwick CJ

Gibbs J
Stephen J
Mason J
Murphy J
Aickin J
Wilson J

Court:
Full High Court

Judgment date: Judgment handed down 10 February 1981.

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Gibbs J.

In each of these appeals the appellant company (the taxpayer) had, in the year of income (the year ended 30 June 1974), a number of employees whose conditions of employment were regulated by the Metal Industry Award 1971 and the Metal Trades (Long Service Leave) Award 1964. Some of those employees, having completed fifteen years' service, were entitled to take long service leave under the latter award, and would be entitled to receive payment for the period of the leave when they took it. A second class of employees, having been continuously employed for over twelve months, was entitled to take annual leave under cl. 25 of the former award, and each employee would be entitled, before going on leave, to be paid the wages he would have received in respect of the ordinary time he would have worked had he not been on leave during the relevant period. None of these employees in fact took long service leave or annual leave, or received any payment in respect of any such leave, during the year of income. The question for decision is whether the taxpayer was entitled to deduct from its assessable income the amount which it was calculated that the taxpayer would be required to pay to the employees entitled to leave when they took it, or so much of that amount as was attributable to the year of income. A similar question was raised in respect of a third class of employees who, having served for less than twelve months, had no present vested entitlement to annual leave, but for reasons that will appear the answer to this question is quite clear, and in referring to the facts of the case I need not separately mention those relevant to this class.

The liability of the taxpayer to make payment to the employees in respect of long service leave or annual leave depends entirely on the provisions of the awards. Those provisions are fully discussed in the judgments of the courts below, and it is unnecessary here to refer to them in detail, since there is now no controversy as to their effect for purposes relevant to the present appeals. The employees with fifteen years' service were indefeasibly entitled to long service leave. An amount in respect of that leave would have to be paid sooner or later. It is true that the payment might not necessarily be made to the employee (since he might die) or by the taxpayer (since, theoretically at least, the employee, before taking leave, might become employed by another employer to whom the business might have been ``transmitted''). It is true also that the amount ultimately payable could not be known with certainly during the year of income because award rates might alter thereafter. However, whatever effect these matters might have had if they stood alone, there was, in addition, the crucial circumstance that the taxpayer was under no liability to make any payment until the employee took the leave, unless, before that event occurred, the employee died or his employment was terminated. Similarly, although an employee who had served continuously for a year was indefeasibly entitled to annual leave, the employer was under no liability to make any payment in respect of the leave until it was taken, or the employee's service was terminated.

It follows from what has been said, and was indeed common ground, that during the year of income the taxpayer not only did not pay, but was not liable to pay, any amount in respect of the long service leave or the annual leave which the employees were entitled to take but did not take during that year. However, the learned primary judge accepted the evidence of accountants called by the taxpayer, the effect of whose evidence, he said, was ``that prudent accounting would require that the income of a taxpayer... should be reduced in any year by a provision representing, as accurately as possible, the sum which the taxpayer, at the particular accounting period, could reasonably anticipate that he will be required to pay to employees by way of Long Service Leave pay''. It may be accepted that in ascertaining the profits of a year of income it would accord with accounting practice to have regard to that portion of the amount that the employer would be expected to pay to his employees in respect of long service leave and annual leave that could properly be related to the service of those employees during that year.

The first argument on behalf of the taxpayer was that the amount calculated to be payable to the employees in respect of leave, or alternatively the part of that amount attributable to the year of income, was a loss or outgoing ``incurred'' in the year

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of income, within the meaning of sec. 51(1) of the Income Tax Assessment Act 1936 (Cth.) as amended. The provisions of what is now subsec. (3) of sec. 51 did not form part of the section at the relevant time. The argument was that during the year of income in question the taxpayer was ``definitively committed'' to the payments in respect of the leave, and was under a present accrued liability to make the payments. The principle to be applied in deciding whether a loss or outgoing was ``incurred'' is clear enough. It is not necessary that there should have been any actual disbursement:
New Zealand Flax Investments Ltd. v. F.C. of T. (1938) 61 C.L.R. 179 , at p. 207 ;
Emu Bay Railway Co. Ltd. v. F.C. of T. (1944) 71 C.L.R. 596 , at p. 606 ;
F.C. of T. v. James Flood Pty. Ltd. (1953) 88 C.L.R. 492 , at pp. 506-7 , and see
King v. Commr. of I.R. (1973) 1 NZTC 61,107 ; (1974) 2 N.Z.L.R. 190 , at pp. 194-5 . Indeed, it was suggested in F.C. of T. v. James Flood Pty. Ltd., at p. 506, that it is not necessary that there should be an immediate obligation enforceable at law whether payable presently or at a future time, or that the obligation should be indefeasible. It is not now necessary to consider whether those suggestions should be accepted as correct. But what is clearly necessary is that there should be a presently existing liability. In F.C. of T. v. James Flood Pty. Ltd., at p. 506, this was expressed by saying that the provisions of sec. 51(1) cover ``outgoings to which the taxpayer is definitively committed in the year of income although there has been no actual disbursement'', and that those provisions ``do not admit of the deduction of charges unless... the taxpayer has completely subjected himself to them''. In other words, sec. 51(1) does not cover ``a loss or expenditure which is no more than impending, theatened or expected'': New Zealand Flax Investments Ltd. v. F.C. of T., at p. 207.

If these principles are applied to the present case, the question is whether the taxpayer was under a present liability to make a payment to its employees in respect of leave. The answer is that it was not. The employees were entitled to leave, but they were not entitled to payment. The entitlement to payment would not rise until the employees took leave (or died or left the employment). The event on which the entitlement of the employees to payment depended had not occurred. There was a certainty that a liability to make payments in respect of leave would arise in the future, but it had not arisen. The present is not case in which there was an immediate obligation to make payment in the future, or a defeasible obligation to pay, or a present obligation which as a matter of law was unenforceable - there was no accrued obligation to make any payment at all. There was no loss or outgoing ``incurred'' within sec. 51(1).

We were referred to the decision of the House of Lords in
Southern Railway of Peru Ltd. v. Owen (Inspector of Taxes) (1957) A.C. 334 , where it was held that the taxpayer was entitled to charge against each year's receipts the cost of making provision for the retirement payments which would ultimately be payable to its employees, as it had the benefit of the employees' services during that year, provided the present value of the future payments could be fairly estimated. This decision may be explained by the fact that under the English legislation it is necessary to compute the profits or gains of the taxpayer in the year in question. To enable the true profit to be determined it is necessary to deduct from receipts any sum which is an essential charge against those receipts. In deciding how the profits are to be ascertained the courts have regard to ordinary commercial principles. Under the Australian legislation, however, the question what losses and outgoing arising in the course of a business are to be deducted is a matter which is covered by sec. 51(1) and depends, inter alia, on the question whether the loss or outgoing has been ``incurred''. The difference between the English and the Australian legislation in this regard was explained in F.C. of T. v. James Flood Pty. Ltd., at pp. 505-6.

On behalf of the taxpayer there was advanced an alternative argument with which it is convenient to deal without pausing to consider whether the notices of objection entitled the taxpayer to rely upon it. This argument was that to enable the assessable income of the taxpayer to be ascertained it was necessary to take into account the sums that would be payable in respect of leave, since the application of recognized commercial

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principles and standard accounting methods would require those sums to be taken into account in order to arrive at the true income. It was further submitted that where the taxpayer had properly lodged a return of income on an earnings or accruals basis, the income was the same as the balance of profits or gains and should be ascertained accordingly. Reliance was placed on such cases as
Ballarat Brewing Co. Ltd. v. F.C. of T. (1951) 82 C.L.R. 364 and
International Nickel Australia Ltd. v. F.C. of T. 77 ATC 4383 especially at pp. 4386-7, 4394; (1977) 137 C.L.R. 347 , at pp. 352-4, 366-7 . They were cases where the question was one of ascertaining income, and not of deciding what deductions were allowable from income once it was ascertained. The income was ascertained by means of a commercial profit and loss account. In relation to cases of that kind, I said, in International Nickel, ATC 4386; C.L.R. p. 352:

``Where the income of the taxpayer is derived from trade, there is not really a difference between the concept of income and that of profit which is significant for the purpose of answering questions arising under the Act, as Walsh J, pointed out in
J. Rowe & Son Pty. Ltd. v. F.C. of T. 71 ATC 4001 , at p. 4008; (1971) 124 C.L.R. 421 , at p. 433 .''

My remarks, like those of Walsh J., were directed to the case where the question, properly regarded, was the ascertainment of income. They obviously do not mean that a trader who submits returns on an earnings basis can successfully claim that all deductions which might on commercial principles be considered in ascertaining profit can be made in determining the income, whether or not those deductions fall within sec. 51. Such an approach would leave little scope for the operation of the section, and would be contrary to the approach which the courts have consistently adopted in Australia. In J. Rowe & Son Pty. Ltd. v. F.C. of T., Walsh J., after making the remarks to which reference has been made above, went on, at ATC pp. 4008-9; C.L.R. p. 434, to say:

``... the differences between the Commonwealth Act and the English income tax law may more often be of importance in deciding questions as to the allowance of deductions (as for example in F.C. of T. v. James Flood Pty. Ltd. ) than in determining the manner in which, or the period at which, items of revenue should be taken into account in computing income (or profits) and in particular in determining the use which may properly be made of the principles and methods recognized and followed in making those computations in business and in commerce.''

In Ballarat Brewing Co. Ltd. v. F.C. of T., it was because Fullagar J. considered that the matter was one of arriving at the correct figure representing income, and that sec. 51 really had no bearing on the case (see at p. 368), that he held that the case depended on ``the conceptions of business and the principles and practices of commercial accountancy''. For once income has been ascertained, and the question is whether a deduction is allowable, ``it is not a matter depending upon proper commercial principles or accountancy practice but upon the legal criterion set by sec. 51(1)'':
Caltex Ltd. v. F.C. of T. (1960) 106 C.L.R. 205 , at p. 218 .

In the present case it would be unreal to say that the income of the taxpayer could only be determined by having regard to the amounts payable in the future in respect of leave due to its employees. The true question is whether the amounts could properly be claimed as deductions under sec. 51. That this was the correct approach is clearly recognized by F.C. of T. v. James Flood Pty. Ltd. and
F.C. of T. v. The Northern Timber and Hardware Co. Pty. Ltd. (1960) 103 C.L.R. 650 , at p. 655 . It appears that in F.C. of T. v. James Flood Pty. Ltd. the employees had not sufficient service to qualify them for leave during the year in question, so that the decision covers only the situation of the third class of employees in the present case. However, for the reasons which I have given, the principles there expounded lead to the conclusion that none of the amounts claimed, in respect of any of the classes of employees here in question, are deductible.

In my opinion, the conclusion reached by the majority of the learned judges in the Federal Court was correct and the appeals should be dismissed.

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