Smith v. Federal Commissioner of Taxation.

Judges: Wilson J

Brennan J
Deane J
Toohey J
Gaudron J

Court:
Full High Court

Judgment date: Judgment handed down 13 October 1987.

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Brennan J.

The value to a taxpayer of certain "allowances, gratuities, compensations, benefits, bonuses and premiums allowed, given or granted to him" in the income year ended 30 June 1982 is brought to tax by sec. 26(e) of the Income Tax Assessment Act 1936 (Cth) ("the Act") as it then stood. In that income year, the appellant was paid an allowance (called an honorarium) of $570 by his employer, the Bank of New South Wales, in accordance with the bank's "Encouragement to Study Scheme". A scale of allowances to be paid to employees for successfully completing particular courses or subjects was prescribed by general rules promulgated by the bank. Subsequently a circular, directed to all the bank's personnel, advised them that the scale had been revised.

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The question is whether the $570 "allowed, given or granted" by the bank in accordance with the revised scale was, by reason of sec. 26(e), part of the appellant's assessable income for the year ended 30 June 1982.

The allowances the value of which is brought to tax by sec. 26(e) are allowances allowed, given or granted to an employee -

"in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by him"

whether in money or otherwise. Liability to tax under sec. 26(e) does not arise merely because the taxpayer is an employee of or has rendered services to the person from whom the allowance is received: for example, a father's employment of a child does not necessarily make the value of a gift from the father to the child part of the child's assessable income. It is necessary that there be some connection between the payment of an allowance to the taxpayer and either his employment or services he has rendered. The language of sec. 26(e) is wide indeed. In
F.C. of T. v. Dixon (1952) 86 C.L.R. 540 , Dixon C.J. and Williams J. said (at pp. 553-554):

"It is hardly necessary to say that the words `directly or indirectly' extend the operation of the words `in relation... to'. In spite of their adverbial form they mean that a direct relation or an indirect relation to the employment or services shall suffice. A direct relation may be regarded as one where the employment is the proximate cause of the payment, an indirect relation as one where the employment is a cause less proximate, or, indeed, only one contributory cause."

But their Honours held that some causal relationship is required. They said (at p. 554):

"We are not prepared to give s. 26(e) a construction which makes it unnecessary that the allowance, gratuity, compensation, benefit, bonus or premium shall in any sense be a recompense or consequence of the continued or contemporaneous existence of the relation of employer and employee or a reward for services rendered given either during the employment or at or in consequence of its termination."

It is not necessary that an allowance be paid as remuneration for the work which an employee is employed to perform; it is sufficient to attract sec. 26(e) that the allowance be paid to an employee in consequence of his employment. When is an allowance paid in consequence of employment?

In
Hayes v. F.C. of T. (1956) 96 C.L.R. 47 , Fullagar J. applied a test which appears somewhat narrower than the text of sec. 26(e) would suggest. His Honour held sec. 26(e) did not apply to a gift of shares in a public company to an accountant from one of the directors of the company when the donor of the shares was "moved very largely by a general feeling of goodwill arising from a close relationship which had both a business aspect and a personal aspect": p. 56. His Honour did not regard the donor's motive as decisive. What was decisive, in his Honour's opinion, was "the fact that it is impossible to relate the receipt of the shares by Hayes to any income-producing activity on his part": p. 56. And in
Scott v. F.C. of T. (1966) 117 C.L.R. 514 , where a solicitor received a gift of money from a grateful client, Windeyer J. held that the gift was not brought to charge. His Honour appeared to accept that the gift would fall within the literal terms of sec. 26(e) but he construed sec. 26(e) as bringing to charge only those receipts which are otherwise of an income nature. He said (at pp. 525-526):

"... the enactment makes it clear that the income of a taxpayer who is engaged in any employment or in the rendering of any services for remuneration includes the value to him of everything that he in fact gets, whether in money or in kind and however it be described, which is a product or incident of his employment or a reward for his services. If, instead of being paid fully in money, he is remunerated, in whole or in part, by allowances or advantages having a money value for him they must be taken into account. The enactment does not bring within the tax-gatherer's net moneys or moneys' worth that are not income according to general concepts. Rather it prevents receipts of moneys or moneys' worth that are in reality part of a taxpayer's income from escaping the net."

(Italics added.)

His Honour went on to say (at p. 527):

"The relation between the gift and the taxpayer's activities must be such that the

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ATC 4888

receipt is in a relevant sense a product of them."

His Honour adopted (at pp. 527-528) a test derived from a judgment of Kitto J. in
The Squatting Investment Co. Ltd. v. F.C. of T. (1953) 86 C.L.R. 570 at p. 633 :

"The distinction those decisions have drawn between taxable and non-taxable gifts is the distinction between, on the one hand, gifts made in relation to some activity or occupation of the donee of an income-producing character ... and, on the other hand, gifts referable to the attitude of the donor personally to the donee personally."

(Italics added.)

The judgments in Hayes and Scott raise two related issues for consideration: first, does sec. 26(e) bring to charge only those pecuniary benefits which are "income according to general concepts"? And second, must a gift to an employee be paid in consequence of an income-producing activity on the part of the employee if it is to fall within sec. 26(e)? The first issue was left open by Gibbs J. in
Reseck v. F.C. of T. 75 ATC 4213 at p. 4215; (1975) 133 C.L.R. 45 at p. 48 , and in the Federal Court by Deane and Toohey JJ. and myself in
F.C. of T. v. Cooke and Sherden 80 ATC 4140 at p. 4150; (1980) 29 A.L.R. 202 at p. 214 . No doubt sec. 26(e) brings within the tax net benefits which might have been thought otherwise to escape by reason of the judgment of the House of Lords in
Tennant v. Smith (1892) A.C. 150 but, as Toohey J. has shown in his judgment in this case, the operation of sec. 26(e) and its statutory predecessor was not limited to covering the problem arising from Tennant v. Smith. With great respect for the view expressed by Windeyer J., I do not find in the context of sec. 26(e) any ground for holding that the scope and effect of that provision is limited to bringing into the tax net the value of those benefits which are, according to general concepts, of an income nature, being benefits received in kind rather than in money. If an allowance is paid to an employee in consequence of his employment, sec. 26(e) is attracted whether or not the allowance is of an income nature.

The second issue focuses on the activity in consequence of which a gift is made, seeking a causal relationship between the gift and the activity. Section 26(e) speaks of a relationship between the making of the gift and the donee's employment or the services rendered by him; the provision does not speak of an income-producing activity. It may be that Fullagar J. and Windeyer J. were using the term "income-producing activity" or "activity... of an income-producing character" as an embracing synonym for "employment or... services rendered"; but if their Honours intended to distinguish between an income-producing aspect of employment and other aspects of employment or between an income-producing aspect of rendering services and other aspects of rendering services, the distinction finds no support in the text of sec. 26(e). Employment is more than the activity for which an employee is remunerated: employment comprehends all aspects of the relationship of employer and employee in the particular case save those aspects which are merely personal. If a distinction is to be drawn between the income-producing activity which is an aspect of employment and the entirety which constitutes employment, sec. 26(e) looks to the relationship between the entirety and the payment of the allowance.

The difficult problem which arises under sec. 26(e) is to identify the nature and degree of the relationship, if any, between the allowing, giving or granting to a taxpayer of an allowance, etc. on the one hand and the taxpayer's employment or the services rendered by him on the other. The difficulty is the greater when the allowance is paid not in discharge of a legal obligation but voluntarily. There is no doubt that voluntary payments may fall within sec. 26(e): see per McTiernan J. in Dixon at p. 558. If an allowance is paid under a contract between the payer and the taxpayer, the consideration for the payment is usually decisive of the matter "in respect of, or for or in relation... to" which the allowance is paid, but if the allowance is paid voluntarily, it is necessary to inquire "how and why it came about that the gift was made" (to adopt the words of Kitto J. in The Squatting Investment Co. Ltd. v. F.C. of T. at p. 628). See
Federal Coke Co. Pty. Ltd. v. F.C. of T. 77 ATC 4255 ; (1977) 15 A.L.R. 449 at pp. 472-473 .

When an allowance is paid voluntarily by an employer to an employee, the ascertainment of any relationship between the payment and the employment raises some evidentiary problems. The motives of the employer might be thought

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ATC 4889

to be the most direct evidence of how and why the employer made the gift, but an unexpressed motive, uncommunicated to the employee, can hardly be determinative of the character of the receipt in the hands of the employee. The importance of evidence of mere motive was discounted by Fullagar J. in Hayes (at p. 55):

"While I would not say that the motive of the donor in making the payment or transfer is, in cases of this type, irrelevant, motive as such will seldom, if ever, in my opinion, be a decisive consideration."

However, the admissibility and cogency of evidence of motive are not questions of substantive law: they relate to the means of proving the relationship between the payment and the employment. If the motive of the employer is communicated to the employee or is known by him, the common understanding of the motive for the payment may be cogent evidence of "how and why it came about that the gift was made". Again, there may be evidence of external indicia tending to show the reason for (or cause of) the payment. It is difficult to estimate the cogency of a class of evidence in the abstract. That is not a problem in this case, for the character of the allowance paid by the bank to the appellant is not in doubt. Its character is established by the scheme promulgated by the bank and acted on by the appellant. The allowance was paid because the bank had a scheme for paying allowances to its employees and the appellant fulfilled the two requirements on which the payment of allowances under the scheme depended: the appellant was employed by the bank and he completed a prescribed course. The question of law that arises on those facts is whether such a payment was made in consequence of the appellant's employment.

A provision couched in terms similar to sec. 26(e) was considered by the Supreme Court of Canada in
Reg. v. Savage 83 DTC 5409 . The taxpayer in that case, like the appellant in this case, had received a payment from her employer for successfully completing some courses designed to improve her work abilities. The Canadian Act included in a taxpayer's "income from an office or employment" the value of "benefits of any kind whatever... received or enjoyed by him in the year in respect of, in the course of, or by virtue of an office or employment". The payment was held to fall within the provision. Speaking for the majority, Dickson J. (as he then was) rejected the applicability of English authorities construing a provision which did not contain the wide phrase "in respect of". He distinguished an earlier Canadian case (
Estate of Phaneuf v. The Queen (1978) 2 F.C. 564 (T.D.) ; 78 DTC 6001 ) in which an employee received a beneficial option to acquire shares in his employer company under the will of the principal shareholder. The point of distinction was that in Savage "there was no element of gift, personal bounty or of considerations extraneous to Mrs Savage's employment". In my opinion, this approach is applicable to cases arising under sec. 26(e) where an allowance is made voluntarily by an employer to an employee. An allowance paid voluntarily to an employee for reasons extraneous to the employment is outside sec. 26(e). But if the payment of the allowance is made because of some aspect of the employment it is within the tax net, whether or not the material aspect of the employment is an income-producing activity. The same approach is exemplified by the decision of this Court in Dixon.

In Dixon, where an employer gave to employees who enlisted for service during the Second World War a sum to make up the difference between service pay and the pay which the serviceman had received as an employee prior to enlistment, it was held by Dixon C.J. and Williams J., who were in the majority, that the payments were made in respect of or in relation to the payee's employment or service as a soldier, but the Court was unanimously of the opinion that the payments were not made in respect of or in relation to the payee's employment by his erstwhile employer. To adopt the words of McTiernan J. (at p. 559), although the scheme "grew out of" the employment relationship, the scheme was "ultra that relationship". His Honour said (at p. 560):

"The fact that the payment was voluntary is not per se a reason why the sum should not be taxable. It is an element in the scheme. The sum was a special contribution made to the respondent by reason of the circumstance that he sacrificed some of his income by enlisting. This was the dominant and determining factor. The sum was in a sense paid to him honoris causa."

Fullagar J. explained the reason for the payment in this way (at p. 564):

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ATC 4890

"The whole substance of the matter is accurately stated by Fair J. in
Louisson v. Commissioner of Taxes ( (1942) N.Z.L.R. 30 at p. 34 ), where his Honour speaks of such moneys as `given out of a sense of appreciation of sacrifices made on the enlistment of employees... and as a recognition of their public spirit in doing so'. The fact of the respondent's employment explains the selection of him as a recipient, but it in no degree characterizes the payment."

Of course, it will frequently be a difficult question of fact to decide whether a particular allowance which is paid voluntarily is paid for a reason which brings the allowance into or for a reason which carries it out of the tax net. But if the employment (or some aspect of the employment) is the reason or one of the reasons why the allowance is paid, the allowance falls within sec. 26(e). A reason which is an insubstantial cause of the payment is immaterial, as the judgments in Dixon illustrate. But if an employee's employment or some aspect of that employment is a substantial reason why the allowance is paid, it cannot be said that the allowance is merely personal or that the payment is made for reasons extraneous to - or ultra - the employment. As the requisite relationship may be indirect as well as direct, it is immaterial that there is another reason why the allowance is paid or even that the other reason is the dominant one.

In this case, an allowance was payable only to those in the bank's employment, and the scheme provided for payment of the allowance to any employee who qualified by completing a prescribed course. Although no course of study was mandatory for any employee, the approved courses were calculated to improve the skills of the bank's employees. The scheme was an aspect of their employment. The allowance was not paid as a mere mark of an employer's personal esteem for particular employees. I am quite unable to say that the allowance was paid for considerations extraneous to the employment. On the contrary, the allowance was paid because it was an incentive to an employee to improve his skills to his own advantage and to the anticipated advantage of the bank. The relationship between the employment of the appellant and the payment of the allowance was substantial. In my opinion, the employment was a direct cause of the payment. It follows that the allowance was paid "in consequence of" the employment, and thus was paid "in respect of... or in relation... to" the employment. The relationship prescribed by sec. 26(e) was established. The appeal should be dismissed.