Federal Commissioner of Taxation v. Galland.

Members: Mason J
Wilson J
Brennan J
Deane J

Dawson J

Tribunal:
Full High Court

Decision date: Judgment handed down 16 December 1986.

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Dawson J.

I agree that this appeal must be dismissed. The grounds of appeal available to the appellant, the Commissioner of Taxation, precluded him from challenging the decision in
F.C. of T. v. Everett 80 ATC 4076 ; (1980) 143 C.L.R. 440 and from relying upon sec. 260 of the Income Tax Assessment Act 1936 (Cth). The question raised is, therefore, within a narrow compass.

The respondent, the taxpayer, is a solicitor who was carrying on practice in partnership with his father at the relevant time. By a deed executed on 27 June 1980, he effectively assigned 49 per cent of his interest in the partnership to the trustee of a trust fund to be set up for the benefit of his family and himself. It was expressly provided that the taxpayer's interest, for the purposes of the assignment, included his share of the partnership profits for the whole of the year in which the assignment took place ``without any apportionment''. Under the partnership agreement, accounts were to be prepared in July of each year and there is no dispute that the relevant year for the purpose of those accounts was the financial year ending on 30 June. Nor is there any dispute that the financial year was the year of income of the taxpayer for tax purposes. See sec. 6 of the Income Tax Assessment Act . The partnership agreement made provision for a partner to draw sums in anticipation of his share of the profits, but profits were to be divided upon the basis of the annual accounts.

For the year ended 30 June 1980, the taxpayer was assessed upon the basis that partnership, profits were earned by the partnership, and thus by the taxpayer partner, progressively during the year and that the assignment was ineffective to divest the taxpayer of any part of his share of those profits earned before 27 June 1980. The taxpayer contended that the effect of the assignment was otherwise and that he was entitled only to 51 per cent of his share of the profits earned by the partnership during the year ended 30 June 1980, the assignee being entitled to the remaining 49 per cent.

The Commissioner sought to justify the assessment by arguing that although partners may agree that partnership accounts are to be taken at a particular time, such as the end of the financial year, and that, as between the individual partners, entitlement to receive a share of the profits of the partnership arises only at that time, nevertheless for the purposes of the Income Tax Assessment Act, the derivation of income by the individual partners from those profits extends over the whole of the financial year and is not restricted by reference to any particular time.

The fallacy in the Commissioner's argument is immediately evident when it is recognised that the profits of a partnership in which a partner is entitled to share, are, broadly speaking, the net gain made by the partnership business during the relevant accounting period. There is no purpose to be served here in any examination of what may properly be regarded as receipts and what may properly be regarded as expenses in calculating this gain. Cf. In
re Spanish Prospecting Co. Ltd. (1911) 1 Ch. 92 . What is important is that profits can only be calculated periodically, that is to say, by reference to some defined accounting period, because they represent the amount remaining after deducting from the gross proceeds the expenses incurred in their production during that accounting period. Cf.
Shaw v. F.C. of T. (1920) 27 C.L.R. 340 . Obviously receipts and expenses will differ from time to time and the profits of a partnership will vary according to the time at which the accounts are taken. The accounting period adopted by a partnership for the ascertainment and division of profits is ordinarily annual but it is a matter for agreement by the partners or, in the absence of agreement, inference.

The customary annual basis for the preparation of partnership accounts is adopted by the Income Tax Assessment Act . The Act, for accounting purposes, although not so as to impose any liability upon the partnership to tax, treats a partnership as an entity separate from its members. Under sec. 91, a partnership is required to furnish a return of the income of the partnership and, under sec. 92, the assessable income of a partner includes ``the individual interest of the partner in the net income of the partnership of the year of income''. The Act speaks of net income rather than the profits of the partnership business although the two things

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ATC 4893

are conceptually the same in this context, and ``net income'', in relation to a partnership, is defined by sec. 90 to mean the assessable income of the partnership, calculated as if the partnership were a taxpayer who was a resident, less all allowable deductions other than concessional deductions and deductions in respect of past losses. Under sec. 6, ``year of income'' means, in relation to a person other than a company, the financial year for which income tax is levied, or the accounting period, if any, adopted under the Act in lieu of that financial year. Ordinarily (and in this case), the financial year will be the relevant year of income for tax purposes, both in relation to a partnership and its individual members.

The adoption by the Act of the financial year as the relevant period for accounting purposes does not, however, mean that the calculation of the profits of a partnership business cannot take place by reference to a date other than the end of that year. Indeed, circumstances may require accounts to be taken at a different date as, for example, upon the earlier dissolution of the partnership. In
F.C. of T. v. Happ (1952) 9 A.T.D. 447 the partnership was dissolved before the end of the financial year and, as Williams J. pointed out at p. 451:

``If the business had continued to be carried on until the end of the financial year the net income could not have been ascertained until then. But when the business was brought to a premature close the question whether net income had been earned by the partnership in the financial year depended upon the success or failure of the trading over a lesser period.''

The liability of individual partners to tax under the Income Tax Assessment Act is not dependent upon the actual division of profits or net income. As was observed in
Rowe (B. & H.G.) v. F.C. of T. 82 ATC 4243 at pp. 4243-4244; (1982) 60 F.L.R. 475 at p. 476 , if it were otherwise the partners could delay their liability in respect of a tax year by refraining from drawing up accounts until after 30 June. A partner's share in a continuing partnership is his proportion of the partnership assets upon a notional winding up, that is to say, the realisation and conversion into money of the assets and the payment of the partnership debts and liabilities:
Bolton v. F.C. of T. (1965) A.L.R. 481 at p. 485 per Windeyer J. Thus at any particular time a partner has an interest in the partnership which includes an interest in the profits, if any, were it appropriate to calculate profits at that time. The point of this case is, however, that for tax purposes the net income (or profit) of a partnership, which can only be calculated by reference to some accounting period, is to be calculated by reference to a year of income, that is to say, upon an annual basis. And it is a partner's individual interest in that net income so calculated which is included in his assessable income. Unlike gross income, which may be derived continuously, net income can only be calculated by reference to a defined period of time and so can only be brought into a partner's assessable income after that period has ended.

If, as in this case, the interest of a partner entitles him to a division of the profits of the partnership calculated by reference to the same financial year, any assignment, before the end of that financial period, of a proportion of that interest carries with it a right to that proportion of the year's profits. In Everett the assignment of a proportion of the partner's interest in the partnership was limited by the deed of assignment so that it did not carry with it any share in the accumulated profits of the partnership business up to the date of the assignment. Notwithstanding this limitation it was an assignment of a present interest carrying with it a right to income generated in the future rather than an assignment of future income. No such limitation was imposed by the deed of assignment in this case and, perhaps for that reason, there was even more clearly here an assignment of a present interest in the partnership carrying with it an entitlement to a proportion of the profits of the partnership calculated with reference to the appropriate accounting period, being in this instance the financial year.

I would dismiss the appeal.