Case N91

Judges: MB Hogan Ch

P Gerber M
GW Beck M

Court:
No. 3 Board of Review

Judgment date: 23 October 1981.

---

Dr. P. Gerber (Member)

In this reference, the taxpayer, a qualified solicitor, acquired a legal practice in circumstances fully set out in the decision of my colleague, Dr. Beck. Clause 1 of the Contract of Sale, executed on the 11th November, 1971, itemized what the respective parties bought and sold as follows:

                                          $

    ``Work in progress as set out in

      Schedule `A' hereto               21,000

      Library, furniture, etc. as set

        out in Schedule `B' hereto       4,000

                                       -------

                                       $25,000''

                                       =======
    

---

ATC 488

Clause 4 provided that the vendor shall, at the expense of the purchaser -

``issue such notices and do all such things as may be necessary for personally introducing the said Purchaser to the clients... and shall execute and do all duties, acts and things which may be necessary for the purpose of vesting the full benefit of the practice and business and goodwill thereof in the said Purchaser...''

In his return for each of the two years now under review, taxpayer attached a form of receipts and expenditure account from the practice. Appropriate expenses and outgoings were then itemized, which included an amount of $7,000 shown in the 1972 return as follows:

      ``Less work in progress

           purchased                $21,000

        Less work in progress

           30th June, 1972          $14,000   $7,000.''

                                    -------
      

In an explanation appended to taxpayer's 1972 return (fully set out in para. 1 of Dr. Beck's decision), it was asserted that an amount of $21,000 was paid for ``work in progress'' as part of the consideration in the acquisition of the practice; that it was anticipated that it would take some two to three years to finalize the matters thus acquired and, ``using this as the basis, we are assuming the work in progress to be written off or recovered in profit costs equally over a three year period''. It was further asserted that ``this method was adopted after telephone discussions with officers of the Taxation Department''. In the 1973 tax year, once again an amount of $7,000 was sought to be claimed as an ``expense''. Both amounts of $7,000 were disallowed. The taxpayer objected against the disallowance of these amounts. The objection is set out in Dr. Beck's decision. In his reg. 35(1) statement, the Commissioner asserted that no part of the amount of $21,000 was an allowable deduction under sec. 51(1) and that no part of the proceeds of the practice constituted a capital receipt. Pausing here, when I pointed out to Mr. Reeves, taxpayer's counsel, at the end of his address that he had not adverted to the second limb of the taxpayer's objection, he replied: ``No, I did not deal with that. I did not wish to deal any further with it; that is in relation to the question of whether he received income''. In these circumstances, the argument cannot be seen to have been abandoned. I therefore propose to deal with it, the more so since I consider this aspect of the claim to be only one to have any substance.

2. Dealing with the argument based on sec. 51, this can be quickly disposed of. One must ask oneself ``what did the taxpayer acquire for the outgoing claimed under sec. 51?'' Whilst the problem may seem more complex in the case of a professional man like a solicitor who acquires an ongoing practice, nevertheless, it appears to me to be beyond doubt that - apart from furnishings and fittings which were separately quantified - what this taxpayer ``bought'' for $21,000 was the amount which (hopefully) the vendor's partly executed work would finally yield on completion by the taxpayer. That is the ``substance'' as disclosed by the contract of sale. It was a single payment of a lump sum paid in globo for the vendor's unexecuted work. How can such a payment - dealt with distributively as though notionally paid in equal amounts over three years - be seen as a loss or outgoing incurred in gaining or producing the assessable income? It may be, that an agreement which stipulated annual payments to be calculated on the vendor's work as it bore fruit, could create deductible outgoings of an income nature; that is not what occurred here. I find there is here no nexus between the outgoing and the derivation of income.

3. The consequence of the preceding paragraph is that the payment is of a non-deductible capital nature. That is sufficient to dispose of this reference. However, in deference to the argument - to the extent that it surfaced - I propose to deal briefly with the characterization problem which arises in this case. If, what the taxpayer acquired, could be characterized as ``ascertained book debts'', then these debts, as they come to be paid to the taxpayer, may not be subject to tax since the result would be that the taxpayer paid a capital sum for something which was restored to him as and when these several book debts were actually paid (cf. Commr. of
I.R. v. Arthur Bell & Sons Ltd. (1938) 22 T.C. 315 , a case relied on

---

ATC 489

by the taxpayer). The Commissioner, on the other hand, relied on
City of London Contract Corporation Ltd. v. Styles (1887) 2 T.C. 239 , and its exegesis in Case F24,
6 T.B.R.D. 149 . This argument, as I understand it, assumes that where a business consists in the main of partially executed contracts, then the purchase price of that business is an affair of capital, and the consideration cannot be deducted from the profits of the business. In Styles' case, the taxpayer company was incorporated to buy as a going concern the business of a firm of contractors for £ 180,000, including plant, materials and contracts. The business consisted entirely of partially executed or wholly unexecuted contracts and of the rights thereunder and the benefits to accrue therefrom. The purchase's profit on the contracts amounted to some £ 128,000, and it sought to reduce this by £ 80,000 as substantially representing a portion of the purchase-money paid to the firm for the purchase of the contracts and business on which the £ 128,000 net profit was realized. The claim did not succeed. Lord Esher M.R. said (at p. 243):

``The £ 180,000, as a figure, was the figure they agreed to pay for the business. Now nothing can be more plain, if that is so, than that £ 180,000 was the capital which they embarked in that business, the money they paid for it.''

Again, at p. 244, he said:

``Here is a clear statement that the difference between money expended in the year in order to earn income which was to be received in the year, and the income so received, was £ 128,000. That is the net profit within the year, that is the sum upon which income tax is to be paid; and it is plain as plain can be that you cannot deduct from those net profits so arrived at any part of the capital which you so invested, whether you paid it or not for the purchase of the business which you were obliged to purchase before you could begin the difference between expenditure and income year by year. If you do not darken it with words, it is as plain as plain can be.''

4. I am not persuaded that in this case, a reference to ``ascertained book debts'' or ``partially executed contracts'' does much to illuminate the issue, having regard to the peculiar problems which face professionals, such as solicitors. Thus, a solicitor is not entitled to charge for work until completed, and no income is ``derived'' until the services rendered have matured into a debt recoverable at law, which is, generally, when the work is finalized. This emerges clearly from
Henderson v. F.C. of T. 69 ATC 4049 ; (1968-70) 119 C.L.R. 612 , where Windeyer J. (at ATC p. 4060; C.L.R. p. 636) stated:

``But when a professional man is, according to the terms of his engagement, not to be paid until his task is completed, I do not think he can be said to have earned anything by that task until then. A lawyer retained to write an opinion or draw a deed cannot ordinarily say that he has earned any income by his work until he has produced the result of it.''

On appeal (70 ATC 4016; 119 C.L.R. 642) this finding was in no way challenged. Thus Barwick C.J., with whom the rest of the Court agreed, stated (at ATC p. 4020; C.L.R. p. 650):

``In ascertaining such earnings, only fees which have matured into recoverable debts should be included as earnings. In presenting figures before his Honour, allowance was made for what was termed `work in progress'. But this, in my opinion, is an entirely inappropriate concept in relation to the performance of such professional services as are accorded in an accountancy practice when ascertaining the income derived by the person or persons performing the work. When the service is so far performed that according to the agreement of the parties or in default thereof, according to the general law, a fee or fees have been earned and it or they will be income derived in the period of time in which it or they have become recoverable. But until that time has arrived, there is, in my opinion, no basis when determining the income derived in a period for estimating the value of the services so far performed but for which payment cannot properly be demanded and treating that value as part of the earnings of the professional practice up to that time and as part of the income derived in that period.''

---

ATC 490

It follows from the above that what the taxpayer bought was in no sense a ``debt'' - ascertainable or otherwise - nor a chose in action capable of assignment. Nor was it a novation since, in the absence of consent of the clients, no new contracts came about by which the purchaser was subsituted for the vendor; an agreement to introduce a purchaser to the vendor's clients cannot constitute a novation. Even if it were held that the purchaser had acquired ``book debts'', in the case of contracts for personal service, it must be shown that the annulment of one debt in its place. This was not done in this case. A contract between solicitor and client is one involving personal skill and confidence, and is incapable of assignment without the consent of the client. At its highest, what this taxpayer obtained for his $21,000 was an expectancy - a fond hope that all or most of the clients of the office would remain with the firm notwithstanding a change of solicitors. In the words of Lord Esher M.R. in Styles the $21,000 was the money the taxpayer agreed to pay for that expectancy. ``Now nothing can be more plain, if that is so, than that ($21,000) was the capital which (he) embarked in that business, the money (he) paid for it.'' It follows that the Commissioner was correct in his decision on objection. For these reasons, I would hold that the taxpayer cannot succeed.