Federal Commissioner of Taxation v. Galland.
Mason J
Wilson J
Brennan J
Deane J
Dawson J
Full High Court
Mason and Wilson JJ.
The respondent taxpayer was at the relevant time a solicitor practising in partnership with his father under the firm name ``Bernard L. Galland & Co.'' in Goulburn, New South Wales. Each partner was entitled to 50 per cent of the capital and to the same share of profits. Neither partner was entitled, without the consent of the other, to assign his share in capital or profits. Clause 5 of the partnership agreement provided:
``5. In July in each year an account shall be taken and a balance sheet prepared showing the assets and liabilities of the partnership and the amount owing to each partner in respect of profits and as soon as possible thereafter the net profits (if any) shall be divided in the proportions hereinbefore stated.''
Clause 6 entitled each partner to draw during the year against anticipated profits of that year but with an obligation to refund drawings in excess of his share of net profits as subsequently ascertained.
In June 1980 the taxpayer obtained his father's consent to assign 49 per cent of his share of partnership capital and profits to a trust to be set up in favour of his family. Because sec. 40F(1) of the Legal Practitioners Act 1898 (N.S.W.) prohibits a solicitor, in certain circumstances, from sharing receipts from a business of a nature usually performed by a practising solicitor with an unqualified person, it was necessary to obtain the approval of the Council of the Law Society of New South Wales to the assignment pursuant to reg. 25(4) of the Solicitors (General) Regulations . The taxpayer applied for that approval on 25 June 1980. On 27 June he executed a deed whereby he assigned to Galland Services Pty. Ltd., as trustee upon discretionary trusts for the benefit of the taxpayer and members of his family, 49 per cent of the share which he then held in the partnership. It was expressly provided that the assignment would, in respect of the year ended 30 June 1980, take effect in relation to the taxpayer's share of the partnership profits for the whole year, without any apportionment, and the taxpayer's share in the partnership assets upon dissolution. The deed was delivered in escrow, conditional upon the Law Society granting approval to the assignment. On 30 June the Council of the Law Society approved the assignment.
In his return of income for the year ended 30 June 1980, the taxpayer disclosed the amount of his share in the net income of the partnership as $36,070. The disclosure was accompanied by the statement: ``Note 49% of taxpayer's income shown in Partnership return assigned to Galland Services Pty. Ltd. as trustee pursuant to Deed 27/6/80.'' The disclosed amount represented 51 per cent of the taxpayer's half-share in the net partnership income for that year, and was calculated on the basis that the deed was effective to assign 49 per cent of his share of the partnership profits for the whole of the year of income, notwithstanding that the deed was only executed on 27 June 1980. In making his assessment on 30 March 1981, the Commissioner increased the taxpayer's taxable income by $34,371, which he described in the adjustment sheet as ``Partnership Distribution'' and ``Adjusted as a result of variation in partnership distribution''. The result was to increase the taxpayer's taxable income arising from the partnership to $70,441. This figure was arrived at on the footing that the assignment was effective only from 27 June, so that the amount of $34,371 represented 49 per cent of the taxpayer's share of net partnership income up to that date.
The taxpayer objected to the assessment on various grounds. One of the grounds was that the assigned share did not form part of his assessable income for the year. The Commissioner disallowed the objection. The taxpayer's appeal to the Supreme Court of New South Wales in relation to the disallowance of the ground of objection was successful [reported at 84 ATC 4053]. The Commissioner's subsequent appeal to the Full Court of the Federal Court [reported at 84 ATC 4890] ( Bowen C.J., Fisher and Beaumont JJ.) was unsuccessful. The Commissioner appeals to this Court pursuant to the grant of special leave. By that grant this Court limited the grounds of appeal so as to exclude from the grounds points relating to sec. 102 of the Income Tax Assessment Act 1936 (Cth) (``the Act'').
At the commencement of the hearing of the appeal Mr Simos Q.C. for the Commissioner sought leave to amend the notice of appeal so as to permit the Commissioner to rely on sec. 260 of the Act and to challenge the correctness of this Court's decision in
F.C. of T.
v.
Everett
80 ATC 4076
;
(1980) 143 C.L.R. 440
. Mr
ATC 4887
Simos submitted that a decision on these grounds or one of them would resolve many pending objections in which the same issues arise. He also submitted that the argument based on sec. 260 gained some support from the Court's recept decisions inF.C. of T. v. Gulland ; Watson v. F.C. of T. and Pincus v. F.C. of T. 85 ATC 4765 ; (1985) 60 A.L.J.R. 150 ; 62 A.L.R. 545 . At first instance the Commissioner placed no reliance on sec. 260. Indeed, before the hearing in the Supreme Court, in response to an inquiry from the taxpayer, he disclaimed reliance on the section. Subsequently in the Federal Court he sought to amend his notice of appeal to rely on the section, but the application was refused. In the light of the history of the litigation and to the limited grant of special leave, we rejected the application to amend the notice of appeal.
The Commissioner's principal submission in support of the appeal is that partners, like individual taxpayers, derive income when they can sue for it, so that they derive income for the purposes of the Act before the accounts of the partnership are prepared for the year of income and the amount of the distribution to each partner is ascertained.
This submission cannot be sustained. Section 92(1)(a) of the Act includes in the assessable income of a partner, not his share of the gross income derived, but his individual interest in the net income of the partnership for the year of income. The expression ``net income'' is defined by sec. 90, in relation to a partnership, to mean ``the assessable income of the partnership, calculated as if the partnership were a taxpayer who was a resident, less all allowable deductions'' except certain concessional and other deductions. These provisions are essentially for accounting purposes. They reflect the basic legal principle that the profits or net income of a partnership are the profits or net income of those who constitute it. It follows that, although a partner is not usually entitled to call for a distribution of profits or net income until accounts have been prepared, he has an individual interest in the net income of the partnership, notwithstanding that the precise amount of his interest cannot be determined until the accounts are prepared in respect of the relevant period. All this is made clear by the judgment of the Federal Court in
Rowe (B.
&
H.G.)
v.
F.C. of T.
82 ATC 4243
at p. 4244;
(1982) 60 F.L.R. 475
at p. 476
and the decision of this Court in
Rose
v.
F.C. of T.
(1951) 84 C.L.R. 118
at p. 124
.
The judgment in Rowe then makes the fundamental point that net income must ordinarily be related to a period and that for tax purposes, in the case of a partnership, that means the relevant year of income. The judgment continues (at ATC p. 4244; F.L.R. pp. 476-477):
``That does not, however, necessarily mean that that is the only, or the critical, relevant period for taxation purposes. Where, for example, a partnership business has been carried on by one partnership for part of a tax year and by a different partnership for the residue of the tax year, there will, for taxation purposes, be two periods in respect of which net income will be required to be ascertained so as to divide overall income between the two partnerships. The fact that the accounts in relation to the first period are not drawn up until after the period has expired, will not alter the prima facie position that the persons who, as partners, derive the income during that period will be the persons in whose assessable incomes the net income of that period falls to be included, according to their respective interests, pursuant to sec. 92(1) of the Act.''
The flaw in the Commissioner's argument is that, by virtue of sec. 92, a partner's assessable income is ascertained by reference to the net income, not the gross income of the partnership for the year of income. Therefore it matters not that the partner derives gross income when the partnership earns recoverable fees during the year of income. The point is that, in general, the partner's assessable income for the year of income can only be ascertained at the end of that year when the net income of the partnership is ascertained. Accounts for that purpose cannot be taken until the expiration of the year of income, unless there is some independent reason for taking accounts at an earlier date, as, for example, a dissolution of the partnership.
Mr Simos sought to overcome this hurdle by submitting that partnership accounts could be taken at any time in order to ascertain the net income of the partnership and the assessable income of the partners during the year of income up to a particular date. In support of
ATC 4888
this submission he pointed to decisions in which it has been accepted that the accounts of a partnership were correctly taken at a date other than the expiration of the year of income as required by the partnership agreement. However, as Beaumont J. correctly pointed out in his judgment in the Federal Court, these cases -Rowe; C. of T. v. Melrose (1923) 26 W.A.L.R. 22 and
F.C. of T. v. Happ (1952) A.L.R. 382 at p. 386 - are all instances of dissolution or notional dissolution of partnership in the course of what would otherwise have been the partnership's year of income. Accordingly, there was an independent obligation or reason to take partnership accounts on the dates when they were taken. The decisions provide no support at all for the proposition that in cases such as the present, where these factors do not operate, the net income of the partnership and the assessable income of the partners must be ascertained at a date which differs from that provided for in the partnership agreement, or, perhaps, a date otherwise agreed by the partners.
Although the assignment in Everett differed from this assignment, in that in Everett the assignor assigned a share of his interest in the partnership, including the right to receive a share of the profits of the partnership as from the date of the assignment (i.e. future profits), the reasoning on which the decision is based is fatal to the Commissioner's argument. Barwick C.J., Stephen, Mason and Wilson JJ. pointed out (at ATC p. 4082; C.L.R. p. 452) that because the assignment was of present property, a share of an interest in the partnership carrying with it a right to future income, it operated immediately as a present equitable assignment. Their Honours distinguished the case from other decisions in which there were assignments of future income dissociated from the property or proprietary right to which that income was attributable. The references to future income are explained by the fact that the Everett assignment purported to assign only an entitlement to future income. The important point for present purposes is that an assignment of a share of an interest in a partnership carries with it the income attributable to that share unless the assignment limits the entitlement to income as it did in Everett . The decision therefore establishes that a partner may during the year of income of a partnership assign a share of his interest in the partnership so that the assessable income attributable to that share during the year of income is that of the assignee, not of the assignor, for tax purposes.
For these reasons the appeal must be dismissed.