W J & F Barnes Pty Ltd v Federal Commissioner of Taxation

96 CLR 294

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(Judgment by: Kitto J)

Between: W J & F Barnes Pty Ltd
And: Federal Commissioner of Taxation

Court:

Judges: Dixon CJ
Fullagar J

Kitto J

Subject References:
Taxation and revenue
Income tax
Assessment
Amendment
Payment of retiring allowances

Legislative References:
Income Tax Assessment Act 1936 (No 27) - s 109; s 170

Hearing date: MELBOURNE 22 February 1957; 25 February 1957
Judgment date: 16 April 1957

SYDNEY

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Judgment by:
Kitto J

The question before us is whether an amended assessment of the additional tax payable by a private company under Div. 7 of Pt. III of the Income Tax Assessment Act 1936-1946 (Cth.) was authorized by the provisions of s. 170 of that Act.  

The relevant year of income was the twelve months ended 31st December 1945. The original assessment of Div. 7 tax was made by taking the following steps. (1) The company's taxable income of the year of income was taken to be "as assessed" (as the notice of assessment expressed it), that is to say it was taken from the assessment of ordinary income tax. The figure was PD15,618. (2) From that figure the deductions required by the definition of "distributable income" in s. 103 were made. They came to PD4,680; so that the "distributable income" was taken to be PD10,938. (3) A sum of PD9,450 was then deducted as being the amount of dividends paid by the company out of its taxable income within the prescribed period. The "undistributed amount" was thus ascertained, in accordance with the definition of that expression in s. 103, at PD1,488. (4) To that amount the appropriate rates of tax and contribution were applied.  

No dividend, in the sense attributed to that word by the definition in s. 6 (1), had in fact been paid by the company in the prescribed period, but amounts aggregating PD9,450 had been paid in that period to three retiring directors. The commissioner's reason for treating each of these amounts as a dividend paid out of the company's taxable income was that he held the opinion that the amount was not to any extent reasonable as an allowance, gratuity or compensation in consequence of the retirement of the recipient from his office in the company, and he considered that by reason of the provisions of s. 109 of the Act a consequence of his holding this opinion was that the whole amount was to be deemed a dividend paid out of the company's profits and received by the recipient as a shareholder.  

The section is in these terms:

"So much of any sum paid or credited by a private company and being, or purporting to be

(a)

remuneration for services rendered by any person being a shareholder or director of the company or being a relative of any such shareholder or director; or

(b)

an allowance, gratuity or compensation in consequence of the retirement of that person from any office or employment held by him in that company, or upon the termination of any such office or employment,

as exceeds an amount which, in the opinion of the Commissioner, is reasonable, shall not be an allowable deduction and the excess shall, for all purposes of this Act, be deemed to be a dividend paid out of profits derived by it to the recipient and received by him as a shareholder of the company."

Some time before making the assessment of Div. 7 tax, the commissioner had assessed the ordinary income tax payable by the company, and in doing so, since he then held the opinion above-mentioned concerning the PD9,450, he had treated the whole of that sum as excluded by s. 109 from the category of allowable deductions.  

Within three years from the date upon which the Div. 7 tax became due and payable under the original assessment which has been described, the commissioner came to the conclusion that his opinion as to the reasonableness of the payments made to the retiring directors was erroneous. He did not thereupon proceed to amend the assessment of ordinary income tax so as to allow the payments as deductions in ascertaining taxable income. He was right in not doing so, for a board of review had affirmed that assessment, and in doing so had decided that, even if the amounts were (as the board thought they were) wholly reasonable, they were not allowable deductions under s. 51 or under s. 78 (1) (c), and that s. 109 should not itself be construed as creating by implication an additional head of deductibility. But the commissioner, upon altering his opinion as to the reasonableness of the amounts, did proceed to amend the assessment of Div. 7 tax. The amendment that he made was to omit step (3) from the process; and the result, of course, was that the "undistributed amount" became the full amount of the "distributable income", namely PD10,938, and the taxes payable were increased accordingly.  

The power of amendment which the commissioner purported to exercise was that conferred by sub-s. (8) of s. 170, and it is clear that if the amendment was not within that power it was not authorized by the Act at all. The provision is as follows:

"Where-

(a)

any provision of this Act is expressly made to depend in any particular upon a determination, opinion or judgment of the Commissioner; and

(b)

any assessment is effected in any particular by that determination, opinion or judgment,

then if, after the making of the assessment it appears to the Commissioner that the determination, opinion or judgment was erroneous, he may correct it and amend the assessment accordingly in the same circumstances as he could under this section amend an assessment by reason of a mistake of fact."

 

Condition (a) was fulfilled, for s. 109 is a provision of the Act which is expressly made to depend (i.e. for its application to a particular payment) upon an opinion of the commissioner. But was condition (b) fulfilled? True it is that the original assessment of Div. 7 tax was affected by the opinion which the commissioner formed on the question of the reasonableness of the payments made to the directors. But was that opinion such an opinion as s. 109 requires for its application? It was, on either of two hypotheses: first, that the section applies to any sum paid by a private company and falling within one of the descriptions given, whether the sum is or is not an allowable deduction under other provisions of the Act; or, secondly, that the section applies only to a sum which is an allowable deduction according to other provisions of the Act and the sums here in question were such allowable deductions. The first hypothesis, however, must be discarded, for the sense of s. 109 is that it operates to convert a portion of a payment which would otherwise be an allowable deduction into a notional dividend paid to a shareholder. As to so much of any sum falling within the given descriptions as the commissioner thinks reasonable, the plain implication of the language used is, not (as the commissioner seems to have thought at one stage) that it is made an allowable deduction by force of the section itself, but that it retains the quality of deductibility which it is assumed to have by force of some other provision of the Act.  

The opinion upon which s. 109 is made to depend is therefore an opinion as to some amount, not of a sum which the commissioner or a board of review thinks is an allowable deduction apart from the section, but of a sum which actually is an allowable deduction apart from the section. (I do not stay to consider whether the opinion may be that no portion at all of the sum is reasonable; I assume that the commissioner was right in thinking that it might be.) Accordingly it cannot be said that the opinion upon which the commissioner acted in making his original assessment of Div. 7 tax in the present case was an opinion upon which s. 109 operates unless it can be affirmed that the payments to which it related were allowable deductions under s. 51 or s. 78 (1) (c). On the material before us, that cannot be affirmed. We know that the board of review, when considering the company's assessment to ordinary income tax, considered that the payments were not allowable deductions on any ground. The board's decision was not, of course, an adjudication; it was administrative in character, and could not create an issue-estoppel. But everything that we know points to its being correct; and if it was correct the conclusion is inevitable that the original assessment was not affected by such an opinion as s. 109 depends upon, and that accordingly the amended assessment was not authorized by the Act.  

Suppose, however, that the payments were allowable deductions, either under s. 51 or s. 78 (1) (c). If they were, both the conditions of sub-s. (8) of s. 170 were fulfilled, and the power of amendment conferred by that sub-section was accordingly exercisable. But the question then arises whether the power supports the amendment which was made. It is a power to correct an opinion formerly held, and to "amend the assessment accordingly". That must mean that it is a power to remove from the assessment every effect which flowed from the existence of the former opinion. It is not a power to make a partial correction by amending the former assessment as to some or one only of several particulars in which it was affected by the erroneous opinion. In what particular or particulars, then, was the original assessment of Div. 7 tax affected by the opinion that no part of the payments to the directors was reasonable? The commissioner's answer is: in one particular only, viz. the deduction of the payments to the directors on the footing that they were dividends. The reason that is given on his behalf in justification of this answer is that he was bound, in making the original assessment of Div. 7 tax, to accept as correct the amount of taxable income which had been assessed for the purposes of ordinary income tax, and that therefore his determination of the taxable income in the course of assessing the Div. 7 tax was not affected by his opinion as to the deductibility of the relevant payments.  

In my opinion, however, it is not correct to say that he was bound to accept the figure of taxable income as conclusively established by the assessment of ordinary income tax. Section 177 was referred to in argument, but I do not think it has any application to the problem. No doubt in practice the sensible course in assessing Div. 7 tax is to start with the taxable income as already assessed for ordinary income tax. It would ordinarily be foolish to go through the process again. But when the commissioner does start with the taxable income as assessed, he is not obeying any positive requirement of the Act that he shall do so; he is simply adopting, for the purpose of the assessment which he is engaged in making, that which he has already done for another purpose. This means that if his working out of taxable income for ordinary tax purposes was affected in any particular by an opinion upon which a provision of the Act is expressly made to depend, it is still so affected when he uses it for the purposes of Div. 7 tax, and therefore his Div. 7 assessment is affected in that particular by the opinion.  

In my opinion the true view in the present case, if the PD9,450 was an allowable deduction apart from s. 109, is that the original assessment of Div. 7 tax was affected at two points by the opinion which the commissioner formed under that section, the two points being the exclusion of the sum from allowable deductions and the treatment of it as a dividend; and if that be so no amendment was authorized by s. 170 (8) in consequence of the alteration of the opinion unless it was an amendment making the assessment one which treated the payments to the directors as allowable deductions and not as dividends. (Such an amendment would not affect the "undistributed amount", and therefore it would not affect the amount of tax payable. For that reason, even such an amendment may be unauthorized having regard to the words which follow "accordingly" in sub-s. (8), read with sub-ss. (3) and (4). But it is not necessary to form a concluded view on this point.) If the payments were allowable deductions apart from s. 109, the amendment which the commissioner made, since although it eliminated one of the effects of the erroneous opinion it proceeded upon the view that the other could not be eliminated, was not such an amendment as s. 170 (8) empowered him to make.  

For these reasons I am of opinion that, whether the payments to the directors were or were not allowable deductions under s. 51 or s. 78 (1) (c), the amended assessment of Div. 7 tax was not authorized by the Act, and the question in the case stated should be so answered.