Chapter 2
[2.1] This chapter is devoted to exploring the contribution to the meaning of income for purposes of the Assessment Act which is made by the ordinary usage meaning of the word as explained in judicial decisions. Sometimes this ordinary usage meaning is taken into the meaning in the Act simply through the word “income” in s. 25(1). Sometimes a specific provision of the Act will confirm the ordinary usage meaning as part of the Act’s meaning. At other times a specific provision will deny that the ordinary usage meaning is part of the Act’s meaning, or limit or modify the ordinary usage meaning that would otherwise be part of the Act’s meaning. At least this is the view taken in this Volume, which proceeds on the single meaning analysis explored earlier in Chapter 1. There is an alternative view, based on the two meanings analysis, which would say that no specific provision has this kind of operation. Indeed, the alternative view may be that no specific provision can have this kind of operation. At most, a specific provision can make what is income by ordinary usage exempt income for purposes of the Act.
[2.2] Without excluding, limiting or modifying the ordinary usage meaning that would otherwise be part of the Assessment Act’s meaning, a specific provision may add to the meaning of income for purposes of the Act.
[2.3] In the following treatment of the ordinary usage meaning, the exclusions limitations and modifications made by specific provisions in the process of receiving the ordinary usage meaning into the Act are described, and the specific provisions identified. Some of the specific provisions which add to the meaning of income in the Act are also noted, where this will assist in showing the scope of the ordinary usage meaning received into the Act. The specific provisions are listed and further dealt within in Chapters 3 and 4.
[2.4] The method adopted in what follows, after a general description, is to formulate a series of propositions which endeavour to state the ordinary usage meaning. As one might expect, the formulation cannot be expressed in definitive terms. In some instances a proposition is no more than a phrase taken from some judicial statement, to which substance can be given only by illustration.
[2.5] The propositions attempt to state the meaning of income not in some abstract sense, but as the income of a particular taxpayer. A notion of an item that is inherently income could be asserted. And the drafting of the Assessment Act lends some support to such a notion. Section 25(1), it will be recalled, refers to “income derived”, which may suggest that an item can be income without the element of derivation. There is, however, clear authority that the character of an item as income must be judged in the circumstances of its derivation by the taxpayer, and without regard to the character it would have had if it had been derived by another person (Proposition 3 below). Section 25(1) must be read in the light of this authority.
[2.6] A description of ordinary usage income which will bring together all the propositions that follow would be:
An item is income of a taxpayer, in the amount of its realisable value, if it has been derived by him and the item is a gain derived in circumstances which give it in other respects an income character.
[2.7] This description summarises a number of propositions:
Proposition 1: An item of an income character is derived when it has “come-home” to the taxpayer. The presence of illegality, immorality or ultra vires does not preclude derivation.
Proposition 2: An item of an income character that has been derived will be income in the amount of its realisable value.
Proposition 3: The character of an item as income must be judged in the circumstances of its derivation by the taxpayer, and without regard to the character it would have had if it had been derived by another person.
Proposition 4: To have the character of income an item must be a gain by the taxpayer who derived it.
Proposition 5: There is no gain unless an item is derived by the taxpayer beneficially.
Proposition 6: There is no gain if an item is derived by the taxpayer from himself: the principle of mutuality.
Proposition 7: There is no gain if an item is derived by the taxpayer as a contribution to capital.
Proposition 8: A gain which is a mere gift does not have the character of income.
Proposition 9: A mere windfall gain does not have the character of income.
Proposition 10: A capital gain does not have the character of income.
Proposition 11: A gain which is one of a number derived periodically has the character of income.
Proposition 12: A gain derived from property has the character of income.
Proposition 13: A gain which is a reward for services rendered or to be rendered has the character of income.
Proposition 14: A gain which arises from an act done in carrying on a business, or from the carrying out of an isolated business venture, has the character of income.
Proposition 15: A gain which is compensation for an item that would have had the character of income had it been derived, or for an item that has the character of a cost of deriving income, has itself the character of income.
[2.8] Proposition 1 asserts the requirement of derivation, and Proposition 2 states the method by which the amount of income derived is to be measured. The remaining propositions are concerned with the income character in other respects of an item derived. Proposition 3 asserts that the character as income of an item must be judged in the circumstances of the derivation of the item by the taxpayer. Proposition 4 asserts the requirement that to be income an item must involve a gain by the taxpayer. Propositions 5, 6 and 7 describe circumstances in which there is no gain, and where there cannot therefore be income. There is no gain by a taxpayer who does not derive the item beneficially. There can be no gain if an item is derived by the taxpayer from himself. At least this is a proposition asserted in some of the authorities. It is adopted only to begin a discussion that leads to other propositions which are a more helpful explanation of a group of cases which are said to express the principle of mutuality. Proposition 7 is expressed in terms of a phrase used in some of the cases. Again the proposition is adopted in order to begin a discussion that leads to other propositions which are more helpful. Propositions 8, 9 and 10 are negative propositions which identify gains derived which do not have an income character. They are strictly unnecessary, but will be found in the authorities as descriptions of gains derived which are not gains that are covered by the remaining propositions, that is, Propositions 11, 12, 13, 14 and 15. These remaining propositions are positive propositions, and any gain derived must be within one of them if it is to have the character of income. Propositions 8, 9 and 10 are not intended as an exhaustive statement of gains derived which do not have an income character. The fact that none of these propositions applies to designate a gain derived as non-income, does not mean that the gain is income. It must have the character of income under one of the positive propositions.
[2.9] Each of the propositions is now examined in turn, and the effect on the proposition of specific provisions of the Assessment Act in excluding limiting or modifying it as a statement of the meaning of income for purposes of the Act is considered.
[2.10] Derivation of an item is the subject of Pt III of this Volume. For the most part, the law expresses an ordinary usage notion of derivation of a receipt. It will be seen that a distinction is to be drawn in this regard between the case where a taxpayer in relation to an item is to be regarded as on a cash basis of tax accounting, and a case where he is on an accruals basis.
[2.11] The law determines which basis of accounting is appropriate, and there is a substantial body of principles and rules as to what amounts to ordinary usage derivation on each basis. The phrase “comes-home” is adopted in Proposition 1 as a convenient description of a derivation within that body of law.
[2.12] It will be seen, too, that there are specific provisions which determine what is derivation in particular contexts. On the analysis adopted in this Volume, those provisions are aspects of the meaning of income for purposes of the Assessment Act. They may confirm, limit or modify ordinary usage derivation, or perhaps add other occasions of derivation. In the latter case, there will be risks of multiplying items which are income, and a need for law which will obviate multiple taxation.
[2.13] Generally an item derived is income as to the whole of it, because it is wholly a gain, and to this extent it may be correct to say that ordinary usage income items are receipts. But on the view taken in this Volume there are occasions when an item derived is income only in part, because it is only in part that it represents a gain. Thus a gain which arises from the sale of trading stock at a profit will by ordinary usage be only part of the receipt of the proceeds of sale. It will be seen, however, in Chapter 14 that this is a context where express provisions have modified the ordinary usage notion of income so that the proceeds of sale are treated as income as to the whole of them, and there are compensating modifications to the notion of deductible expense. Where the sale is of property other than trading stock, and the sale is an act in carrying on a business or the carrying out of an isolated business venture, the proceeds of sale are income only to the extent of that part which represents a profit. And there are other illustrations, for example in the area of gains arising from movements in rates of exchange of currencies, where an item is income only as to part.
[2.14] The principles which determine the derivation of an item express a general concept of realisation as essential to income derivation. Where the item is an increase in the value of property, it would be possible to regard an unrealised gain, for example an increase in the value of land which a taxpayer owns, as income, though most opinion would be opposed to a change in the law so as to require that an increase in value be treated as income. There is, however, an election open under the trading stock provisions of the Assessment Act to treat an unrealised gain as income, and to this extent ordinary usage is displaced. The election is dealt with in Chapter 14.
[2.15] In Chapter 10 the distinction between cash accounting and accruals accounting is explored in some detail. One aspect of that distinction may be noted here: there is no derivation on a cash basis if the taxpayer merely comes to have a right to receive money. There must be an actual or constructive receipt of the money. Where the taxpayer is on an accruals basis in relation to the item, the arising of a right to receive money may however be a derivation. Generally where there is a right to some benefit or to property other than money there cannot be a derivation, whether the taxpayer is on accruals or cash, until the benefit or property has come to be vested in the taxpayer. Property for this purpose may, it seems, include a chose in action. Thus the taxpayer in Abbott v. Philbin [1961] A.C. 352 and the taxpayer in Donaldson (1974) 74 A.T.C. 4192 who came to have rights to options over shares were regarded as having derived those options at the time when a distinct set of legal relations constituting the options came into existence. There is, it seems, a difference for tax purposes between a contractual right to an issue of options which will not involve a derivation, and the actual issue of options which will involve a derivation, though Lord Denning (dissenting) in Abbott v. Philbin took a different view. He equated the options with standing offers, for example an offer under an employment contract to supply goods at a discount. An employer may be bound to maintain his standing offer, but it would be assumed that there is no derivation by the employee until he accepts the standing offer. The standing offer analysis will be the preferable analysis in most circumstances not involving options. Thus a taxpayer may be entitled under his contract, after some period of service, to a free ticket to travel on the airline conducted by his employer. There will be no derivation of income until the benefit of travel has been actually provided by his employer.
[2.16] The majority view in Abbott v. Philbin, followed in Donaldson, may possibly be explained on the ground that an option gives some kind of proprietary interest to the person holding the option, though observations will be found in Abbott, made by some judges, which suggest that the coming into existence of a right to property which subsists only in contract may be a derivation. Where a chose in action is treated as property acquired by a taxpayer, it will be held to be derived notwithstanding that there are elements of contingency in relation to the chose in action which would preclude a derivation by an accruals basis taxpayer in relation to a right to money. A derivation constituted by the arising of a right to money will be such only where there is no contingency. A derivation constituted by the vesting of a chose in action in the taxpayer will be such even though the rights given by the chose are contingent on events yet to occur. Thus in Donaldson the options were income notwithstanding that they were exercisable only if the taxpayer completed periods of service to his employer in the future.
[2.17] Abbott v. Philbin, Donaldson, and another Australian case, Constable (1952) 86 C.L.R. 402, are the most important cases on the significance of the moment of derivation as an aspect of income by ordinary usage. Clearly, where a taxpayer is on a cash basis in relation to the item and receives cash there is a derivation, and there is no further derivation when he converts the cash into some other kind of property, for example by buying goods with it. Abbott and Donaldson rejected a conclusion that there was income derived, as income from services, at the time of the sale of the options or at the time of the exercise of the options. The exercise of options in these circumstances is no different from the purchase of goods with cash already derived as income. The exercise of the options is simply the “exploitation of a valuable right”: Abbott [1961] A.C. 352 at 379, per Lord Radcliffe. Even if it be held that the exercise gives rise to a derivation, it is not a derivation in circumstances that will give it an income character as a reward for services. In Constable there was no derivation by the taxpayer until he actually received a payment from the superannuation fund. At that time the circumstances gave it the character of a simple payment from a fund in satisfaction of his rights in the fund: there was no longer a character as a reward for services attaching to that part of the receipt that could be traced to a payment into the fund by the employer.
[2.18] It does not however follow that the exercise of options may not be a step in a transaction of acquisition and subsequent sale of shares which will produce a profit which is income, the character of income flowing from Proposition 14. In such event it is necessary to ensure that the profit does not include any part of the value of the options at the time they were applied in the acquisition of the shares. In calculating the amount of the profit there should be a subtraction of the value of the options at the time of their exercise. Executor Trustee & Agency Co. of S.A. Ltd (Bristowe’s case) (1962) 36 A.L.J.R. 271 is relevant though it involved income by specific provisions in s. 26(a) (the predecessor of s. 25A(1)), and not ordinary usage income. Bath & West Counties Property Trust Ltd v. Thomas [1977] 1 W.L.R. 1423 may be a more relevant authority.
[2.19] The discussion so far assumes that the acceptance of the offer of the options is not a step in a transaction of acquisition and subsequent sale of the options, or a transaction of acquisition of the options, exercise of them,and subsequent sale of the shares, which may produce a profit that is income. The character of income would flow from Proposition 14 or s. 25A (1). There could be a derivation of profit in the sale of the options, or in the sale of the shares obtained in the exercise of the options, though probably not in the mere acquisition of the options and their exercise. If there is a derivation of a profit which is income, it will be necessary to ensure that the profit does not include any part of the value of the options that were income at the time they were acquired. In Bristowe’s case the commencement of the relevant transaction involving a derivation of income occurred at the time of the exercise of the options. If, however, the transaction commences with the acquisition of the options, there should generally be a subtraction of the value of the options at the time of acquisition, in computing the profit. Value for this purpose will be the market value and not the value to the taxpayer. However, the protection of the taxpayer against double taxation will require that if he has been taxed under s. 26 (e) on the value to the taxpayer —a concept explained in [2.33] below—and this is higher than market value, he will be entitled to a subtraction of the higher amount.
[2.20] There is a perhaps unexpected consequence of the principle in Bristowe’s case. The value of an option is in part extinguished by the exercise of it. The market value of an option to acquire at par a share whose market value is $1 more than par, will be more than $1, at least if the option is exercisable within a significant period of time. It follows that the exercise of the option and sale of the share may give rise to a loss rather than a profit, though there is no fall in the value of the share. Indeed it may give rise to a loss even though there is an increase in the value of the share.
[2.21] The exercise of options may be a step in a transaction of acquisition and subsequent sale of shares which will produce a profit that is income under s. 26AAA. Bristowe’s case will be applicable in determining the cost of the shares. There is a deemed purchase of the shares under s. 26AAA (1)(d). The acquisition of a share by way of a subscription of capital is a deemed purchase. Presumably it is the value of the options at the time of exercise of the options that will determine this element of cost. It may be possible however to see the acquisition of the options and the exercise of the options as a two-step purchase of the shares, completed at the time the options are exercised. The possibility of a two-step acquisition is endorsed by the majority in Steinberg (1975) 134 C.L.R. 640, a case concerned with s. 26(a) (the predecessor of s. 25A(1)). In which case it is the value of the options at the time of their acquisition, or, as explained in [2.19] above, their value to the taxpayer at the time of their acquisition, that will govern.
[2.22] The argument of the Revenue in Abbott v. Philbin [1961] A.C. 352 came near to an assertion that because, as the Revenue submitted, there was no derivation at the time the offer of the options was accepted, there was a derivation at the time the options were exercised and shares acquired. Such a derivation would extend to the value of the options, as found in the value of the shares, less the cost of the options. Constable (1952) 86 C.L.R. 402 demonstrates that such a proposition is not tenable. The case is authority than an item which would have been income had the element of derivation been present at some earlier time, will not be income at a later time when it is in fact derived unless the circumstances then obtaining give it the character of income. In Constable there was no derivation, in the opinion expressed, obiter, by the majority of the court, at the time the employer paid an amount to the trustee of the superannuation fund. At that time the employee had no right, not even a contingent right, to any specific amount. When the trustee exercised his discretion so as to appropriate a specific amount to the employee, there might have been a derivation, but the circumstances did not give the amount the character of income. The relevant proposition would be Proposition 13. But the action of the trustee had changed the nature of the item from a reward for services paid by an employer, into an appropriation of capital by a trustee in the exercise of his discretion as trustee. Whether there was in truth a derivation by the employee on the exercise of the discretion would raise the question whether the arising of a right to money can ever be a derivation by a cash basis taxpayer. There was a derivation in the circumstances of Constable when there was an actual payment out by the trustee to the employee. At this time, however, the original payment to the trustee by the employer, had, a fortiori, lost its character as income. There was now no more than an historical connection between the amount received and the rendering of services.
[2.23] Abbott v. Philbin must be regarded as a decision that the condition on which the options were issued, namely, that they were only exercisable while Abbott remained in the service of the company, did not relate the shares acquired in the exercise of the options with service to the company so as to make them a reward for services. It was arguable that there had been two derivations of income, one when the options were acquired and another when they were exercised. The derivation in the latter case would be confined to the further value of the options, now to be found in the shares, beyond their value at the time the options were acquired. But the decision appears to be that the condition imposed on the exercise of the right did not give a sufficient connection between the increase in the value of the options and the services, so as to make the increase in value, when derived in the acquisition of the shares, a reward for further services. In Donaldson (1974) 74 A.T.C. 4192 the options were not exercisable until various periods of service had been completed. Bowen C.J. in Eq. did not have to decide whether an increase in the value of the options, derived in the acquisition of the shares on the exercise of the options, was a reward for services. There is a differene between the defeasibility of the options in Abbott and the contingency operating in Donaldson, but it may be that the difference is not enough to justify a difference in result.
[2.24] The concept of derivation as an element in the notion of income by ordinary usage is confirmed, limited or modified by a number of specific provisions of the Assessment Act. A number of other specific provisions add to the circumstances which will give an item derived an income character, and, for this purpose, may create their own notions of derivation. Reference is made to these specific provisions later in this chapter, and some are the subject of extensive treatment in Chapter 3 and in Part III.
[2.25] Section 26AAC inserted in the Assessment Act in 1974, materially affects the ordinary usage notion of income as expressed in Abbott v. Philbin [1961] A.C. 352 and Donaldson (1974) 74 A.T.C. 4192, in the particular context of acquisition by employees of shares or rights to shares. Section 26AAC calls for discussion in connection with Proposition 3, and it is dealt with again in chapter 4. A detailed statement of the tax accounting appropriate in the operation of s. 26AAC is given in [12.165]ff. below. For the present, discussion is confined to the effect of s. 26AAC on the ordinary usage notion of derivation. The section is limited in its operation to acquisitions of shares or rights to shares under a scheme for the acquisition of shares by employees, as defined in subs. (1). Its effect is to bring about a derivation of income when the shares become free of restrictions on the right to dispose, or the rights to shares are disposed of. It thus brings about the result for which the Revenue argued in Abbott. But the method by which these results is sought is curious. Section 26(e) which, it will be seen later in this chapter and in Chapter 4, is a partial statement and partial extension of the ordinary usage notion of income in relation to benefits arising from the rendering of services, is expressly excluded by s. 26AAC(10), but there is no express exclusion of the ordinary usage notion of income imported by s. 25(1). On the single meaning analysis, an acceptable correlation of the sections is possible. Section 26(e) would be treated as a code expressing exclusively in the absence of a contrary provision the meaning of income in relation to benefits arising from the rendering of services. The exclusion of s. 26(e) would thus leave s. 26AAC to operate alone. On a two meanings analysis, the law in Abbott and Donaldson continues to apply, so that there are successive derivations, once by ordinary usage and then by s. 26AAC, the second derivation being, generally, of a greater amount, but embracing the first. Successive derivation in this way is not dealt with in the section and double taxation would need to be corrected by some general principle as yet undeveloped in the interpretation of the Assessment Act.
[2.26] Subsections (11) and (12) of s. 26AAC contemplate other problems of multiple derivation, arising from the operation of both s. 26AAC and the ordinary usage notion, or arising from the operation of both s. 26AAC and another specific provision, for example s. 25A(1) or s. 26AAA. The fact that two provisions of the Assessment Act make the same item income does not mean that it is income as to double its amount. These problems of multiple derivation are the subject of detailed examination in [12.170]-[12.177] below.
[2.27] In the formulation of Proposition 1 the observation is included that illegality, immorality or ultra vires does not preclude derivation. But the presence of one of these factors is not irrelevant. It will be seen in Chapter 11 that where the taxpayer is on an accruals basis in relation to the item, legal entitlement is said to be necessary if there is to be a derivation in advance of actual receipt. Illegality, immorality or ultra vires may prevent legal entitlement arising so that derivation would be deferred until actual receipt. The view of this Volume developed in Chapter 11 is that the arising of a claim of right should be sufficient to bring about a derivation on an accruals basis, and legal entitlement should be unnecessary. To the extent that illegality, immorality or ultra vires may in particular circumstances suggest that no claim of right has been made, it will be relevant to the question of derivation.
[2.28] Ordinary usage income does not include the value of the services rendered to a taxpayer by the house he owns and occupies, or the value of self-rendered services or self-produced goods. This is probably best explained in terms of the absence of the element of derivation. There must be a gain which has a source in an obligation undertaken by another, or in a payment of money or transfer of property by another. Otherwise the notion of “coming home” is not satisfied.
[2.29] There will be a parallel denial that the value of self-rendered services, or the value of the work done in production of self-produced goods, can be a deduction as an outgoing incurred. If an income tax system were to allow, as a cost of repairs, the value of the labour of an owner who repairs the house which he has let to a tenant, it would be necessary to treat the value of that labour as income (cf. Oram v. Johnson [1980] 1 W.L.R. 558).
An item of an income character that has been derived will be income in the amount of its realisable value.
[2.30] In some authorities, including Tennant v. Smith [1892] A.C. 150, a proposition is asserted that an item may be income only if it is money or something that can be turned into money. A proposition so formulated must be taken to be rejected by Abbott v. Philbin [1961] A.C. 352. The fact that an item has no realisable value at the time of derivation does not prevent that item having the character of income. There will be no amount of income, but there is none the less an item of income, and the mere subsequent conversion of that item into money or an item that has a money-value is not a derivation of an amount of income. In Abbott Viscount Simonds said (at 366): “… it is really irrelevant whether a value could be ascribed to [the option] or not. If it had no ascertainable value then it was a perquisite of no value ….” His observation might be reframed thus: there was an income item derived, but there was no amount of income.
[2.31] In one respect, the notion of realisable value for purposes of Proposition 2 has been given a wide meaning in United Kingdom authority: Heaton v. Bell [1969] 2 W.L.R. 735. In that respect it is wider than the meaning suggested by the judgment of Bowen C.J. in Eq. in Donaldson (1974) 74 A.T.C. 4192 at 4207 in relation to the notion of “value to the taxpayer” in s. 26(e): “what a willing but not anxious purchaser might pay for [the item].” Heaton v. Bell, admittedly involving a special situation, would treat as realisable value what a taxpayer might obtain for the item by surrendering it to the person from whom he received it.
[2.32] Proposition 2 none the less opens up the prospect that gains, in the sense of additions to a taxpayer’s command over goods and services, may fail to be included in the income tax base. There may be a substantial increase in command over goods and services—in the free use of a house or car, or the enjoyment of a subsidised meal—but because that command cannot be passed to another, there will be no amount of income brought to tax. Tennant v. Smith involved the free use of a flat which could not be assigned or sublet. Cooke and Sherden (1980) 80 A.T.C. 4140 involved a free holiday for the taxpayer and his family. Limiting the amount of income to realisable value may be explained on the ground that it provides a determinate test of amount, and ensures that the taxpayer will be able to obtain money with which to pay the tax in respect of the item. But it encourages planning by which non-money income is substituted for money income. The provision of “fringe-benefits” instead of money may give a taxpayer the same enjoyment of resources as he would have obtained by spending money-income, but there may be a vital difference in tax consequences.
[2.33] Tax planning of this kind has been qualified by the specific provision in s. 26(e), which will bring in as an amount of income “the value to the taxpayer” of an item derived which has the character of income, where the item is a benefit allowed, given or granted to the taxpayer in respect of any employment or services rendered by him. Section 26(e) is considered in this chapter in connection with Proposition 13, and again in the treatment of specific provisions in Chapter 4. It may be noted here that the meaning of the phrase “value to the taxpayer” was examined by Bowen C.J. in Eq. in Donaldson (1974) 74 A.T.C. 4192 at 4207 where he said: “I consider it is appropriate in ascertaining value to the taxpayer to determine what a prudent person in his position would be willing to give for [the item] rather than fail to obtain [it].” It may also be noted that s. 26(e) operates only in relation to benefits given in respect of an employment or services rendered by the taxpayer. A retailer does not render services to a manufacturer by selling goods acquired from the manufacturer (Cooke and Sherden), and s. 26(e) will not apply in relation to a free holiday provided by the manufacturer. A landlord may let a flat, taking in return professional services from his tenant, and s. 26(e) will not be attracted. A creditor may enjoy the use of a television receiver provided by a finance company to which he has lent money and s. 26(e) will not be attracted: Dawson v. C.I.R. (N.Z.) (1978) 78 A.T.C. 6012.
The character of an item as income must be judged in the circumstances of its derivation by the taxpayer, and without regard to the character it would have had if it had been derived by another person.
[2.34] The leading authority supporting this proposition is Federal Coke Co. Pty Ltd (1977) 77 A.T.C. 4255. In that case the holding company of the taxpayer released a customer from a contract—by which the customer agreed to purchase coke from the holding company—in exchange for a payment to the taxpayer. The taxpayer was the producer of the coke. If the payment had been made to the holding company, the holding company would very likely have derived income. The relevant principles are explained in relation to Propositions 14 and 15. But the payment had been made to the taxpayer and the circumstances of the derivation of the item by the taxpayer did not give an income character to it. Federal Coke, in this respect is foreshadowed by the judgment of Latham C.J. in Gair (1944) 71 C.L.R. 388 at 393, quoted in [13.24] below. On the facts of Federal Coke, there may be some grounds for thinking that there had been a derivation by the holding company, and an application of the item so derived by a payment to the taxpayer, in which case there would be room for a submission that the holding company had derived income. Aspects of the ordinary usage notion of derivation and the interpretation of s. 19 which may express an ordinary usage notion of constructive derivation, would be raised. These aspects are discussed in Chapter 11.
[2.35] It is possible that a stipulation in a contract for payment to another, or for the provision of some benefit to another, will avert a derivation by the person making the stipulation, and the person who receives the payment or benefit will be unaffected by the circumstances which would have given an income character to a derivation by the person making the stipulation. It may
be expected that the stipulation will require payment, or the provision of the benefit, to an associated person—a subsidiary company as in Federal Coke, or a relative of the person making the stipulation—and there is scope for tax planning. The matter is discussed in Chapter 13. Two specific provisions have a bearing. Section 26(e), to which reference was made in connection with Proposition 2, does not directly displace the ordinary usage notion as expressed in Proposition 3. But the broad words used in the provision, more particularly “benefits … given”, may defeat the kind of planning suggested by Federal Coke. School fees paid by an employer in respect of an employee’s children may involve a benefit given to the employee in the form of relief from a payment the employee would otherwise have made himself. The other specific provision is s. 26AAC, to which reference was made in connection with Proposition 1. The section displaces the ordinary usage principles of derivation flowing from Abbott v. Philbin [1961] A.C. 352 and Donaldson (1974) 74 A.T.C. 4192 in the context of schemes for the acquisition of shares by employees. In addition, it displaces the ordinary usage principle expressed in Proposition 3 where shares or rights to shares are acquired, not by an employee whose services would give an income quality to shares or rights he acquired, but by a relative of that employee. Section 26AAC provides, by the operation of subs. (1), that in these circumstances the relative derives income.
[2.36] Proposition 3 has important implications where gains are the subject of an assignment, or are derived through a trust or partnership intermediary. These implications are considered more closely in Chapter 13. The very phrase “assignment of income” sits poorly with Proposition 3. Where property from which the assignor derives gains, is assigned, and gains now flow to the assignee, no conceptual difficulties arise. The interest, devidends, rent or other passive gain items are now derived by the assignee from his property and Proposition 12 is attracted. Where only gains flowing are assigned, conceptual difficulties do arise. If the future passive gain items assigned were the subject of what might be called present rights in the assignor to future property, it may be possible to regard those items as income of the assignee when derived by him, on the ground that they are gains derived from the present rights to the future gains, so that Proposition 12 is attracted. Where, however, the assignment is of expectancies, which are not the subject of present rights held by the assignor, the flows of gains to the assignee can have the character of income only in virtue of their periodicity under Proposition 11.
[2.37] Division 5 (relating to partnerships) and Div. 6 (relating to trusts) are necessary to overcome implications of Proposition 3. In the circumstances of derivation of an item by a trustee, there would not, apart from Div. 6, be income, because there would not be a gain by the person who derived the item—Proposition 4 would deny an income character. Section 95 overcomes the consequences of Propositions 3 and 4, by deeming the trustee to be a “taxpayer” for purposes of making a calculation of “net income” of the trust estate. This deeming, it is assumed, supplies an element of beneficial derivation which is essential to give the character of income to the items derived by the trustee. Other sections of Div. 6—ss 97, 98, 99B and 101—supply derivations by the beneficiaries in virtue of their present entitlements and actual distributions to them. In the absence of these provisions there might be no derivations by beneficiaries, at least in the present entitlement situations. And there might be a derivation by a beneficiary to whom a distribution is made, that none the less lacks an income character in the circumstances of its derivation.
To have the character of income an item must be a gain by the taxpayer who derived it.
[2.38] Proposition 4 asserts a general principle which will make the tax law concept of income accord, in this respect, with the concept of income asserted by those economists who identify income with accretions to economic power. Proposition 4 is spelt out in Propositions 5, 6 and 7. It is spelt out, so far as Propositions 6 and 7 are concerned, in the language of judicial decisions expounding the ordinary usage notion of income, but the underlying reason why the items are not income is, it is submitted, the absence of gain.
[2.39] Proposition 4 is not in its terms expressed in judicial decisions. Judicial elaboration of the ordinary usage notion of income, at least in its earlier history, has been content to illustrate rather than to look for underlying reason, though the generalisation that income is “what comes in” has been offered, more as a confession of a failure to find reason than as a reflection of some insight. The judgments of the Federal Court in Everett (1978) 78 A.T.C. 4595 do not openly embrace Proposition 5, which is the most obvious expression of Proposition 4. Indeed the members of the court do not appear to be entirely persuaded that a trustee, who cannot rely on some express provision of the Assessment Act such as s. 96, may not derive income by virtue of his receipts as trustee which will be taxed to him as additions to his undoubted income. Proposition 5 is not openly embraced by the Full High Court in Everett (1980) 143 C.L.R. 440 but it does appear to be assumed.
[2.40] Proposition 4 is openly challenged by some of the decisions in relation to Proposition 11, which assert that a taxpayer may purchase a series of periodical receipts and the whole of these receipts be income, notwithstanding that they are not gains: they reflect merely a change in the form in which economic power is held. It will be seen that the consequences of these decisions is substantially corrected by s. 27H, and there is some reluctance by the courts to hold that purchased receipts are income as periodical receipts. That reluctance reflects a view, sometimes explicit, that a tax liability should not be attracted by a simple change in the form of economic power. Proposition 4 is also challenged by a number of decisions in regard to the taxation of income derived from property—Proposition 12—more especially, royalty receipts, and by a number of decisions in regard to the taxation of compensation receipts—Proposition 15.
There is no gain unless an item is derived by the taxpayer beneficially.
[2.41] Proposition 5 is the most obvious expression of Proposition 4, and the fact that it is not openly embraced is an indication that judicial elaboration of the ordinary usage notion of income has been timid about seeking underlying reason. Everett (1978) 78 A.T.C. 4595, in the Federal Court, at times reflects a view that would reject Proposition 5, and assert that a trustee derives income though he does not take beneficially: he must then rely, if he can, on some express provision, notably s. 96, to preclude liability for tax. At other times Everett in the Federal Court reflects a view that would accept Proposition 5, while asserting that there are express provisions, notably ss 92 and 44, which will displace that proposition. On this view, s. 92 will displace Proposition 5 in the context of derivation through a partnership intermediary. Section 44 will displace it in the context of derivation of dividends. Those sections will give rise to a liability to tax on a trustee, unless some other express provision, notably s. 96, excludes liability. Neither of these views has the authority of any judicial decision and they are rejected in this Volume.
[2.42] Without Proposition 5, the ordinary usage notion of income would be left without underlying reason. The assertion that Proposition 5 is valid as a statement of the ordinary usage meaning of income, but is rejected, in the context described, by ss 92 and 44, calls for an explanation of why underlying reason should be rejected in these contexts.
[2.43] The terms of s. 96 pose problems of interpretation. The section provides that “Except as provided in this Act, a trustee shall not be liable as trustee to pay income tax upon the income of the trust estate”. It will be noted that the phrase used is “the income of the trust estate” which, in its use in s. 97, is taken to refer to trust law income. Any liability to pay tax would be upon the “net income” (defined in s. 95(1)) of the trust estate. That aside, the section is concerned only with the trustee’s liability “as trustee”. If Proposition 5 is denied, a trustee would be liable not “as trustee”, but, rather, notwithstanding the fact that he is trustee. Contrary to the view at times reflected in the Federal Court judgments in Everett (1978) 78 A.T.C. 4595 that s. 96 protects the trustee from a liability which will arise if Proposition 5 is incorrect, the section may, with equal if not greater force, support Proposition 5. It supports that proposition by dealing only with liability of the trustee “as trustee”, with the implication that the proposition protects the trustee against liability as a person deriving income.
[2.44] If judicial recognition of Proposition 5 is sought, it may be found in the judgment of Dixon J. in The Countess of Bective (1932) 47 C.L.R. 417. The question was whether amounts paid to the appellant by the trustees of a trust fund were part of her assessable income. She took the amounts under some obligation requiring her to spend them in the maintenance and support of her daughter. Dixon J. said (at 423):
“The question is whether the payments to her form part of her assessable income. The income of the trust fund appears to have been included in the taxpayer’s assessment upon the view that she took it beneficially, the statement of the purpose contained in the provision for maintenance amounting to no more than an expression of the donor’s motive, or of his expectation. Its inclusion in her assessable income could be supported, if the statement of the purpose were understood as annexing to a gift to her a condition which she was bound to perform. Possibly, it might be supported also if the provision were construed as a gift of income to the taxpayer subject to a charge for maintenance. But if either of these two constructions were adopted, a corresponding deduction should be allowed for expenditure upon maintenance, a deduction which would not, of course, necessarily amount to the same sum. On the other hand, if she is not an object intended to be benefited at all by the provision for maintenance, the payments ought not, in my opinion, to be included as assessable income of the taxpayer, although, if it appeared that she had appropriated to her own use an unexpended surplus after discharging her duty of maintaining her daughter, that surplus would be taxable as part of her income.”
The statement that if the appellant was not an object intended to be benefited at all by the provision for maintenance, the payment ought not to be included in her assessable income, is made as an assertion of general principle for which no express statutory support was necessary.
There is no gain if an item is derived by the taxpayer from himself: the principle of mutuality.
[2.45] Proposition 6, the mutuality principle, is another expression of the idea of gain as an essential element in the ordinary usage notion of income. The language of the proposition, which refers to “an item derived by the taxpayer from himself”, is drawn from some of the cases, and is useful if not taken literally. The proposition may be seen as a particular application of Proposition 7, itself drawn from the cases and also an expression of the idea of gain.
[2.46] Proposition 7 would say that a receipt by one person from another of money which must be applied in serving the purposes of the person paying, any surplus being returned to him, is generally not income of the receiver. There is no gain to the receiver unless the purposes of the person paying include a benefit to the receiver, in which event Proposition 7 will apply a qualification. Mutuality is an application of Proposition 7 in the context of a receipt by an association from one of its members.
[2.47] Where the purpose of the member involves a benefit only to a third party, the application of Proposition 7 is clear. The association may receive money from a member to be applied for the benefit of a charity.
[2.48] Where the association is a co-operative and the purpose of the member is to meet the cost of goods or services supplied to him by the co-operative, the member being entitled to have any surplus of what he pays over cost returned to him, the application of Proposition 7 is again clear. The return will need to be to the member as the person who paid the amount from which the surplus arose. It will be seen that the prospect of a distribution of the surplus among members generally will defeat the operation of the mutuality principle.
[2.49] Where the association is a members’ club and the club receives a subscription from a member to be applied for the collective benefit of all members in the provision of club facilities, the operation of Proposition 7 may not be quite so clear. There is an appearance of gain to the club which is overcome only by treating the club’s apparent gain as a gain to each member. The effect of the payment of subscriptions by all members is that each member’s interest in the club is increased by a like amount, and there is, in substance, a receipt from a member to be applied for the benefit of that member. The club’s interests are identified with the interests of the members from whom the subscriptions are received. (Glasgow Corp. Water Commissioners v. I.R.C. (1875) 1 T.C. 28 at 50 per Lord Deas; New York Life Assurance Co. v. Styles (1889) 14 App. Cas. 381 at 393-4, per Lord Watson.) The receipts by the club are receipts by members from themselves. Treating receipts in this way ought not to depend on the club being an unincorporated body. Indeed income tax law generally treats an unincorporated association in the same way as an incorporated body. This flows from the definition of “company” in s. 6 of the Assessment Act. If it is appropriate to look through the unincorporated body, it should be appropriate to look through the incorporated body. In fact, incorporation has not been treated as significant in relation to mutuality: Sydney Water Board Employee’s Credit Union Ltd (1973) 129 C.L.R. 446 at 457 per Mason J.
[2.50] Where the association is a members’ club and the payment in question is made by a member for the purpose of meeting the cost of goods or services supplied by the club, any surplus of the payment being applied for the collective benefit of all members in the provision of the club facilities, the operation of Proposition 7 is less than clear. The difficulty arises in relation to the application of the surplus. The club’s interest in the surplus may be clearly identified with the interests of the members from whom the payments are received, only if all members make like payments to the club. The club’s interest is made up of the interests in the club of all members of the club. If only some members make payments for goods and services, the interests of those members cannot be identical with the interests of all members. The circumstances are like those involved in a distribution among all members of a surplus generated by the payments of some members, and these are circumstances where mutuality is not applicable. In fact disparities within a club, between those who finance facilities by their use of the club’s dining room and bar and by their addiction to poker machines, and those who enjoy those facilities, are not taken to defeat the application of mutuality. Moreover the fact that the dining room and bar are subsidised from the surplus on poker machines, is not taken to defeat mutuality. The subsidy might have been seen as a distribution among members who use the dining room and bar of the surplus provided by those members who play the poker machines.
[2.51] Consideration of the operation of mutuality will be unnecessary where the circumstances do not, in any respect, give an income character to an item. In the illustrations offered so far the item might have the character of income as one of a series of periodical receipts, for example an annual subscription received by a club; a payment for services, for example, a member’s loss on a poker machine transaction; or a business receipt, for example a payment for a meal in a club’s dining room or a payment for goods supplied by a co-operative. The effect of mutuality is to deny an income quality to an item which would, in other respects, have that quality.
[2.52] It is proposed now to consider the operation of the mutuality principle more closely in relation to:
In a number of instances the mutuality principle has been affected by specific provisions of the Assessment Act. These specific provisions are noted in appropriate contexts.
[2.53] A number of aspects have already been considered in the general discussion. Mutuality may be applicable to receipts from members by way of subscriptions, and payments for goods and services. A phrase used by Griffith C.J. in The Bohemians’ Club (1918) 24 C.L.R. 334 at 337—“advances of capital for a common purpose”—explains mutuality, in relation to subscriptions, in terms of Proposition 7. Surpluses over the cost of goods and services supplied to members will, in general, admit of the same description.
[2.54] The identification of the interests of the club with the interests of those from which receipts proceed is only appropriate where the latter are continuing members of the club. The identification in these circumstances requires a flexible principle because membership may fluctuate, but the mutuality principle is not flexible enough to extend to receipts from “temporary members”, whose membership may be limited to a single occasion. If it were to be extended to temporary members, the principle would be deprived of all substance. The notion of membership for the purposes of any formulation of the mutuality principle is not a matter of form. It is a matter of being a contributor to a fund in which the contributor has rights to participate, whether in cash or in kind.
[2.55] The mutuality principle operates in relation to receipts from members, even though there are also receipts from non-members. There may be problems as to how much of total receipts are from non-members: there is a question whether a receipt is from a member when a member pays with funds provided by his guest. The difficulty of distinguishing receipts from members and receipts from non-members gave rise to an exchange between judge and counsel in National Association of Local Government Officers v. Watkins (1934) 18 T.C. 499 at 507. The taxpayer club will carry the onus of showing that the Commissioner’s figures are wrong: s. 190(b). The Commissioner may have made assumptions from the visitors’ book and otherwise which the taxpayer may find it difficult to refute.
[2.56] Where there are receipts from non-members, an apportionment of expenses is appropriate in determining the surplus of receipts from non-members which is taxable income of the club. An apportionment was made in Carlisle & Silloth Golf Club v. Smith [1913] 3 K.B. 75 and in Adelaide Racing Club Inc. (1964) 114 C.L.R. 517. The apportionment is authorised by s. 51(1)—the general deduction provision—considered in Chapter 9, where the operation of the words “to the extent to which” in the section is discussed.
[2.57] The discussion has so far proceeded on the assumption that the club rules do not provide for the return of surplus to members whose payments have generated that surplus, nor for the payment of dividends to members. A rule providing for the return of surplus will need to ensure that the elements of identity and proportion in returns to members, considered below in relation to co-operatives, are satisfied. A rule providing for the payment of an ordinary dividend to members from the surplus will preclude the operation of mutuality.There is no basis for identifying the club’s interests with the interests of members from whom payments are received if the surplus generated by payments by some members may be distributed among all members. An ordinary dividend will be paid to all members, whether or not they are members from whom payments were received.
[2.58] A club may change its rules so as to provide for a distribution among all members from a surplus generated by payments made by only some members. The rule will have the consequences described in the last paragraph in relation to new receipts by the club. There is however a question as to the effect of the change in the rules in relation to any surplus of old receipts available at the time of the change. The operation of the mutuality principle would have been judged by reference to the rules of the club at the time of a receipt by the club. The consequences in relation to a dividend paid after the change in the rules from a surplus available before the change, is considered in [2.85] below, in dealing with co-operatives.
[2.59] Where a club’s rules provide for a distribution on winding up which will not involve a benefit to members—for example, by payment to a charity—the operation of mutuality is not affected. A provision for distribution among all those who are members at the time of winding up without regard to their contributions to that surplus would preclude the operation of mutuality.
[2.60] The fact that a payment is made to a member of an amount which is unrelated to any contribution the member has made to the club, does not necessarily preclude the operation of mutuality. It may be an object of the club to encourage sport or learning by financial support to individual players or scholars of merit, and it may happen that a player or scholar who receives support is a member of the club. The payment is not made to the member as such. There may be more difficulty about the operation of mutuality where the eligibility for financial support depends on membership of the club.
[2.61] In Fletcher v. Income Tax Commissioner [1972] A.C. 414 at 422 Lord Wilberforce, in giving the judgment of the Privy Council, observed that “many clubs collect subscriptions of different amounts according to the use expected to be made of facilities, or to age, or personal circumstances, and this is consistent with ‘mutuality’”. It is none the less essential that there is a “reasonable relationship … between what a member contributes and what … he may expect … to draw from the fund …” (at 423). Where a cash distribution is contemplated by the articles, and participation in that cash distribution will not reflect the fact of a substantial difference between the amounts of the subscriptions paid by some members and those paid by others, mutuality is not applicable. It was the prospect of a cash distribution, albeit one unlikely to be made, that resulted in the denial of mutuality in Fletcher.
[2.62] Paragraphs (g) and (h) of s. 23 of the Assessment Act are relevant to the operation of the principle of mutuality in relation to members’ clubs. Their effect is to make the income of certain clubs, for example, a club established for the encouragement of an athletic game or athletic sport in which human beings are the sole participants, exempt from tax. The exemption may mask the operation of the principle of mutuality in a particular case. But a non-income quality in some circumstances is more favourable than a quality of income that is exempt. If a payment is made to a member by a club whose income is exempt, the payment may be a dividend and income that is not exempt in the hands of the member. Section 44(1), by providing that a distribution out of profits is an income receipt, will bring about this result. To the extent that the denial of an income character is the denial of a profit character, the fact that mutuality applies to a club’s receipts will exclude the operation of s. 44(1). The exemption of income of the club will, however, extend to receipts that are not protected by the mutuality principle and which would be income and subject to tax in the hands of the club if it did not enjoy the exemption. Section 23(g) will exempt, for example, receipts of a ski club from non-members and investment income of the club.
[2.63] There are questions as to the circumstances in which a club will qualify for an exemption under s. 23(e) as “a religious, scientific, charitable, or public educational institution”; or under s. 23(g) (ii) as “a society, association or club established for musical purposes, or for the encouragement of music, art, science or literature”; or under s. 23(g) (iii) as “a society, association or club established for the encouragement or promotion of an athletic game or athletic sport in which human beings are the sole participants”; or under s. 23(h) as “a society or association not carried on for the purposes of profit or gain to the individual members thereof, established for the purpose of promoting the development of aviation or of the agricultural, pastoral, horticultural, viticultural, manufacturing or industrial resources of Australia”. One general question concerns how significant the activity which attracts an exemption must be among the total activities of the club. In “The Waratahs” Rugby Union Football Club (1979) 79 A.T.C. 4337 the club engaged in some activity that could attract an exemption under s. 23(g) (iii). At the same time it carried on an activity as a social club. Waddell J., in denying an exemption, held (at 4341) that “it must appear from the evidence that the main or real purpose for which [the club] was established during the tax years in question was for the encouragement or promotion of an athletic game or athletic sport … and that the purpose of a social club was not collateral to or independent of this purpose but merely concomitant and incidental to it”. The consequence may be that a club will be denied exemption unless the sole purpose of the club—other than a purpose “concomitant or incidental” to that sole purpose—is a purpose that would attract an exemption. It may be doubted whether the High Court in Royal Australasian College of Surgeons (1943) 68 C.L.R. 436, on which Waddell J. relied, intended such a consequence. In a reference to the fact that the College’s “other objects [were] not collateral or independent but merely concomitant and incidental to the main object”, Rich J. (at 447) may not have intended to do more than emphasise that surgical science promotion will be the main object if there is no other object that is collateral to or independent of that object.
[2.64] A club may derive income in receipts from non-members. For example, in R.A.C.V. (1973) 73 A.T.C. 4153, receipts by the Royal Automobile Club included receipts from non-members that were income. These receipts were returns from investments, receipts by way of commissions from airlines and hotels in respect of bookings made through the club and by way of commissions from insurance brokers in respect of insurance arranged through the club. There were also receipts from members in respect of road services provided for members, and receipts from one class of members in respect of social amenities provided for those members. If a club makes a cash distribution to its members from the receipts from non-members, the distributions will be within s. 44(1), and income of the members. The distribution will be income even though it is made to members in proportion to the contributions members have made. It is not a return to members of a surplus of receipts subject to the mutuality principle. Section 44(1) will possibly make the whole of the receipts by members in such a distribution income of the members, even though the distribution is only in part from receipts by the club from non-members. There is a question whether like conclusions will follow if receipts from non-members are used to subsidise the services provided to members. There was an element of subsidy of this kind in the road services provided by the club in R.A.C.V. There seems no reason to treat a distribution in kind differently from a cash distribution, though one might expect that there will be income in the nature of a dividend received by the member only to the extent of the element of the subsidy. R.A.C.V. was not concerned with the tax consequences of a distribution for members of the club.
[2.65] It was not suggested in R.A.C.V. that the contributions made by those members entitled to use road services were used to subsidise the social amenities that were available only to the class of members entitled to use those amenities. It is arguable that a subsidy of this kind to those using the amenities would exclude the application of the mutuality principle to the receipts from members entitled to use road services. The receipts from the members entitled to road services, when applied for the benefit of members entitled to use the amenities, are not in a relevant sense receipts from members.
[2.66] Where the club subsidises the provision of services to its members out of receipts from non-members, the element in the expenses incurred in the provision of services reflecting the subsidy will not be deductible in determining the taxable income arising from the receipts from non-members. To this extent there is an apparent disadvantage in a conclusion that the mutuality principle applies to the receipts by the club from its members. If none of the activities of the club attracted the mutuality principle it might be thought that the surplus of expenses over receipts in the provision of the services would go to lessen the taxable income in the receipts from non-members. But it is at least arguable that, in these circumstances, the subsidy gives rise to dividends received by members just as much as it does when mutuality applies to the receipts from members.
[2.67] The word co-operative, as used in the present context, is intended to cover an association which supplies goods, services or finance to its members for a price which is no more than an estimate of cost, the arrangement being that any surplus of the price over cost will at some time be returned to the member who paid the price. Some of these associations will be “co-operatives” as defined in ss 117 and 118 of the Assessment Act and these are identified as Assessment Act co-operatives.
[2.68] Supply of finance will involve lending to members at interest, and the co-operative engaging in this activity is generally referred to as a credit union. Credit unions are the subject of a number of judicial decisions and a specific provision of the Assessment Act, and are specially considered under the next heading.
[2.69] The mutuality principle in its application to co-operatives has its origins in a number of United Kingdom cases concerned with the insurance cover given by an association to its members. Though the principle has, by s. 121 of the Assessment Act, been displaced in part, perhaps wholly, in its application to co-operatives providing insurance cover, the United Kingdom cases remain an important source of elaboration of the mutuality principle.
[2.70] The operation of the mutuality principle has been displaced in relation to Assessment Act co-operatives by s. 119 of the Act, though, as will be seen, there may still be some scope for its operation in that context.
[2.71] The scope of the mutuality principle in its application to a co-operative, may have been qualified by a statement in the judgment of the Privy Council in English and Scottish Joint Co-operative Wholesale Society Ltd v. Commissioner of Agricultural Income-Tax, Assam [1948] A.C. 405 at 417. The statement purports to exclude the mutuality principle where an association “grows produce on its own land or manufactures goods in its own factories … and sells its produce or goods to its members exclusively”. The possible qualification is the subject of later comment.
[2.72] The mutuality principle in relation to co-operatives is a direct application of Proposition 7. There must be a receipt by the association of money which is to be used in serving the purposes of the person from whom the money is received, any surplus being held for return to that person. The requirement that any surplus must be held for return ensures that there is no benefit, and thus no gain, to the association. There is not even that appearance of benefit to the association which needs to be explained, where the association is a members’ club, by identifying a benefit to the club with benefit to the individual member from whom money is received, an identification expressed in the phrase “a payment to oneself”. And the fact that the association is incorporated presents no conceptual difficulty. It has been held to be irrelevant in cases involving credit unions discussed under the next heading.
[2.73] The concept of surplus held for return to individual members is to be distinguished from a concept of surplus held for distribution among members. Drawing this distinction has given rise to most of the cases on the application of mutuality to co-operatives.
[2.74] There may not be much difficulty in drafting the rules of a mutual insurance association so as to attract mutuality, though s. 121 of the Assessment Act has taken most of the point from the exercise. On the other hand an ordinary provision for the payment of dividends from profits in the articles of a company engaged in the business of retailing is a provision for a distribution among members, and mutuality will not be attracted simply because some shareholders have shopped at the company’s stores. It is between these poles that the difficulties are to be found.
[2.75] A strict view of the mutuality principle would require that receipts should be regarded as subject to a return of surplus to the members from whom they were received, only when the returns must be to the identical members who contributed and in exact proportion to their contributions. Tests of exact identity and proportion were expressed in the earlier United Kingdom mutual insurance cases, but the tests were thereafter considerably relaxed.
[2.76] Lord Macmillan in Municipal Mutual Insurance Ltd v. Hills (1932) 16 T.C. 430 appears to require precise identity and exact proportion. Other cases however suggest that something less, provided there is substantial identity and proportion, will be sufficient to justify the application of the mutuality principle. In Jones v. S.W. Lancashire Coal Owners’ Association Ltd [1927] A.C. 827 at 832, Viscount Cave, L.C., in holding that the mutuality principle applied in the case before him, said: “Sooner or later, in meal or in malt, the whole of the company’s receipts must go back to the policy holders as a class, though not precisely in the proportions in which they have contributed to them.” In Faulconbridge v. National Employers’ Mutual General Insurance Association Ltd (1952) 33 T.C. 103 at 125, Upjohn J. said: “I think it is clear that when Lord Macmillan speaks of the cardinal requirement being complete identity between the contributors and the participators, he is not referring to individual identity but to identity as a class, so that at any given moment of time the persons who are contributing must be identical with the persons who are entitled to participate; whereas it follows, in my judgment, that it matters not that the class has been diminished by persons going out of the scheme or that others may come in in their place in the future.” These observations should be read in relation to the facts of the cases. In S.W. Lancashire Coal Owners’ Association the substantial factor in determining a member’s entitlement to participate was the amount of his contribution, though this was qualified by other factors so that entitlement was not in exact proportion to contribution. In National Employers’ Mutual General Insurance Association Ltd the rules provided that, while the Association continued, a division of surplus might be made among members for the time being “in proportion to their surplus premiums”. On winding up, a division of surplus was to be made among members “in such proportions as shall be certified to be fair and equitable by an actuary”: (1952) 33 T.C. 103 at 115.
[2.77] Most recently in Fletcher v. Income Tax Commissioner [1972] A.C. 414 at 423 the Privy Council said:
“It may not be an essential condition of mutuality that contributions to the fund and rights in it should be equal; but if mutuality is to have any meaning there must be a reasonable relationship, contemplated or in the result, between what a member contributes and what, with due allowance for interim benefits of enjoyment, he may expect or be entitled to draw from the fund: between his liabilities and his rights.”
[2.78] The absence of a “reasonable relationship” between the contribution by a member and the amount of an actual or possible payment by the association to the member precluded mutuality in that case. This is also an explanation of the failure of the mutuality submission in English & Scottish Joint Co-operative Wholesale Society Ltd v. Commissioner of Agricultural Income-Tax, Assam [1948] A.C. 405. Under the rules of the association surplus might be applied in a number of ways inconsistent with mutuality, including the payment of interest on share capital and appropriation to a reserve whence, presumably, it might be the subject of a dividend, or held until liquidation and then distributed among members.
[2.79] In English and Scottish Joint Co-operative Wholesale Society the Privy Council said (at 420): “there is no common fund to which the members … contribute and in which they participate.” That observation would appear to be no more than a way of stating the absence of reasonable relationship between contribution to the association and receipt from the association. It will be seen under the next heading that the reference to a “common fund” has, in the Australian authorities in relation to credit unions, been erected into a distinct aspect of the mutuality doctrine.
[2.80] In the course of argument in English and Scottish Joint Co-operative Wholesale Society it was submitted that where a payment was in fact made under a rule which provided that surplus might be applied in the making of payments to members rateably in proportion to the amount of purchases made by them from the association, this application of surplus might be treated as a discount having the effect of reducing the price of the goods sold to members. No opinion was expressed on the submission. Where goods are sold on terms that provide for the allowance of a discount for prompt payment, the application of the principle in Arthur Murray (N.S.W.) Pty Ltd (1965) 114 C.L.R. 314, discussed in Chapter 11, will withhold a conclusion that the amount of the discount is income derived until it becomes clear that the discount will not be allowed. It may be doubted that this principle would apply where there is no obligation to allow the discount at the time of the sale. Where, however, the Arthur Murray principle does apply, its operation will be similar to the mutuality principle. It should be noted that there is no limitation on the operation of the Arthur Murray principle of the kind that has been erected in the Australian authorities around the words “common fund”. The limitation is discussed below in relation to credit unions.
[2.81] Reference has already been made to a statement in English and Scottish Joint Co-operative Wholesale Society that would exclude the availability of the mutuality principle to producers of goods. The judgment does not, however, explain why mutuality is not available. If mutuality is not available to an association producing goods, it may be asked why it is available to an association that obtains and supplies goods to its members, obtains and supplies finance to its members, supplies management or investment services, or supplies sporting facilities. Sydney Water Board Employees’ Credit Union Ltd (1973) 129 C.L.R. 446 is authority that mutuality is available to an association obtaining and supplying finance. Fletcher v. Income Tax Commissioner [1972] A.C. 414 is authority that mutuality is available to an association supplying sporting facilities. These cases indicate that the availability of mutuality does not depend on what is supplied to members, but on the manner of the transaction in which the supply is effected.
[2.82] In Fletcher the question is posed (at 422): “At what point … does the relationship of mutuality end and that of trading begin?” Their Lordships accepted that mutuality is not necessarily excluded by the fact that some members are corporate bodies, or even corporate bodies engaged in trade. In this regard, they drew attention to the mutual insurance cases. The case itself concerned the application of the mutuality principle to receipts from “hotel members” of a club which provided swimming facilities for members and for guests of the “hotel members”. The Privy Council concluded that the club was trading with its hotel members because of the disparity between the interest of the hotel members in surplus and that of ordinary members. It observed (at 423): “The hotel members may be said, through the advantages gained for their guests, to derive current advantages commensurate with their subscriptions; but as regards any surplus, the disparity between their interest and that of ordinary members is one of substantial scale.” The implication of Fletcher is that there is no class of activity by an association which is inherently incapable of attracting the operation of the mutuality principle. Provided the tests of identity and proportion are satisfied in relation to any benefit to be given or payment to be made to members, the association will be held not to be trading with its members.
[2.83] Where mutuality is applicable, receipts from members, and it follows, the surplus of such receipts, will not be income of the association. And, it is submitted, those receipts will not be “profits” of the association, so that a return to a member from them will not be income as a dividend out of profits under s. 44(1). Since the receipts are not income, a return to a member from them in the liquidation of the association will not “represent income”, and will therefore not be income as a deemed dividend under s. 47. A return to a member may, however, be income of a member engaged in business as a gain in carrying on the business: H. R. Sinclair & Son Pty Ltd (1966) 114 C.L.R. 537, considered in relation to Propositions 14 and 15, is relevant. Were it not for this prospect of the return being income, the operation of the mutuality principle would open up considerable scope for tax planning.
[2.84] A member of an association who obtains goods or services from the association under transactions attracting mutuality, will, it seems, be entitled to deduct the amounts paid to the association if he obtains the goods or services in the carrying on of a business. Even though a return to him of some part of what he has paid is income on the authority of Sinclair, there may yet be a tax advantage, by way of deferral, if payment for the goods or services is made in a year earlier than the year in which the amount returned is received. There will be tax accounting issues more closely considered in Part III of this Volume. It is enough for present purposes to say that a right to a return will not give rise to income derived until the amount to be returned is ascertained. The advantage of tax deferral is of the kind at which s. 82KK, considered in [11.289]ff. below, is directed. But that section will have no application where the person paying for goods or services does not, in any sense, control the association. In Chapter 11 there is a discussion of the possibility of a development in tax accounting which would involve a principle in relation to deductions parallel with Arthur Murray (N.S.W.) Pty Ltd (1965) 114 C.L.R. 314 in relation to receipts. Such a principle would preclude the tax deferral by denying a deduction of the payment to the association to the extent that there is a prospect of return of the amount paid, and while that prospect remains. Such a development would require a reconsideration of the Sinclair principle.
[2.85] The rules of a co-operative may have been drafted, and its affairs conducted, in such a way as to attract mutuality. It may have accumulated a substantial surplus, which under the rules are to be returned to those from whom payments were received, perhaps on winding up. It may be asked what the tax consequences will be should the association now change its rules so that a distribution among members may be made. There would be company law issues raised, going to the validity of the change. But assuming the change is valid, there is a question whether the change has any effect on the operation of mutuality in the years before the change. Presumably the change could not retrospectively make receipts of earlier years income. Nor could it make those receipts profits so that a distribution from them would be income as a dividend under s. 44(1).
[2.86] The operation of the mutuality principle is, at least in some respects, displaced by Div. 9 of Pt III, in relation to co-operatives as defined in ss 117 and 118—referred to in this Volume as Assessment Act co-operatives. To be within the definition, a co-operative must, by its rules, “limit the number of shares which may be held by, or by and on behalf of, any one shareholder, and prohibit the quotation of the shares for sale or purchase at any stock exchange or in any other public manner whatever”. It will be apparent that it is not difficult for an association to put itself out of the category of Assessment Act co-operatives, and take what tax advantage there may be in drafting its rules and conducting its affairs so as to attract mutuality.
[2.87] To be within the definition of an Assessment Act co-operative in s. 117, a company must be one that in the year of income “is established for the purpose of carrying on any business having as its primary object or objects one or more of [a number of listed objects]”. As the definition is interpreted by the High Court in Brookton Co-operative Society Ltd (1981) 147 C.L.R. 441, an initial question is raised as to whether the company can be said to be “established for the purpose of carrying on [a] business” (at 445). It will, in the year of income, be established for the purpose of carrying on a business if that purpose is dominant among the purposes of its total activities, which may include investment activities. There is then a further question whether the business has as its primary object one or more of the listed objects. Presumably two listed objects pursued by the company will be treated as one object when the question is whether those objects are primary. Whether an object is primary must be determined by reference to “the actual activities of the [company]”: Revesby Credit Union Co-operative Ltd (1965) 112 C.L.R. 564 at 576, per McTiernan J., approved by Gibbs J. in Social Credit Savings & Loans Society Ltd (1971) 125 C.L.R. 560 at 567. The reference in the words “is established for the purpose” in s. 117 is to the purpose for which the company’s activities were carried on in the year of income.
[2.88] The listed objects are:
The lending of money to shareholders is not the rendering of services to shareholders: Revesby Credit. A credit union cannot therefore qualify as an Assessment Act co-operative unless its business has another object that is the rendering of services and that object is primary.
[2.89] The displacing of mutuality in relation to Assessment Act co-operatives is the general effect of s. 119 which provides:
“The assessable income of a co-operative company shall include all sums received by it, whether from shareholders or from other persons, for the storage, marketing, packing or processing of commodities, or for the rendering of services, or in payment for commodities or animals or land sold, whether on account of the company or on account of its shareholders.”
It will be noted that mutuality is not displaced by this provision in regard to receipts of interest from members by the Assessment Act co-operative. This matter is the subject of comment under the next heading.
[2.90] The consequences of the displacing of mutuality are to an extent offset by s. 120(1), which allows the Assessment Act co-operative a deduction of the amount of income distributed among members as rebates or bonuses based on business done by members with the co-operative, or distributed by the co-operative among its members as interest or dividends on shares. Probably, distributions as rebates or bonuses based on business done would be deductible without the aid of s. 120(1), though it is arguable that a rebate or bonus will not be deductible without the aid of s. 120(1) if it operates as a distribution of income derived from persons who are not members. The deduction of distributions as interest or dividends on shares would not otherwise be available.
[2.91] The special treatment of Assessment Act co-operatives provided for in s. 120(1) was sought to be attracted by the planning in the Brookton Co-operative Society Ltd (1981) 147 C.L.R. 441. The company failed to qualify as an Assessment Act co-operative because it was held not to meet the conditions specified in the definition of an Assessment Act co-operative in s. 117. It was not “established for the purpose of carrying on any business having as its primary object or objects” one or more of those listed in the section. It could only be “established for [such a] purpose” if carrying on a business was the sole or dominant purpose in its current activities. The dominant purpose in its current activities, in the view of the High Court, was investment in companies through which dividend stripping arrangements would be carried out. The case is important not only for the interpretation of s. 117, but also because of the assumption, on which the case proceeds, that a rebate or bonus, based on business done by members with the co-operative, or interest or dividends on shares, is deductible in determining the taxable income of an Assessment Act co-operative, even though the rebate, interest or dividend is paid from profits which are derived from activities that are not within the purpose which gives the Assessment Act co-operative its status as such. Provided they are distributed, such profits are not taxed to the co-operative. And if they are paid out to a shareholder by way of rebate or bonus based on purchases made by the shareholder, he will generally not be taxed on them: s. 120(2). In the result, status as an Assessment Act co-operative will enable the co-operative to escape tax on profits that could not have attracted the protection of the mutuality principle. And it may enable a member to escape tax on a distribution from such profits.
[2.92] Section 120(2) provides that the rebate or bonus to which s. 120(1) relates, and which is based on “purchases” made by a member, will not be income of the member receiving it, save where the price of the purchases made by him is allowable to him as a deduction of any year, which, presumably, includes deduction by way of depreciation.
[2.93] It is arguable that the exclusion from income of the rebate or bonus received by a member is, to a degree, unnecessary. Mutuality is displaced by s. 119 so as to make the receipts of the Assessment Act co-operative income, but mutuality, it would be said, may continue to operate to exclude the receipts from “profits”, so that payment from the receipts is not income as a dividend. The exclusion is, however, necessary if the circumstances would not attract mutuality in any event. In this respect, and in respect of the deduction available to the co-operative of distributions as interest or dividends on shares, Div. 9 confers privileged treatment on Assessment Act co-operatives.
[2.94] The proviso to s. 120(2) has the effect of limiting the operation of the subsection. It does not, however, make a rebate or bonus income where the price of purchase is allowable as a deduction. H. R. Sinclair & Son Pty Ltd (1966) 114 C.L.R. 537 is authority that a rebate or bonus received in such circumstances will generally be income.
[2.95] A credit union—an association providing finance to its members by way of loans—may be an Assessment Act co-operative: Revesby Credit Union Co-operative Ltd (1965) 112 C.L.R. 564. It may qualify under s. 117(1)(d) by reason of counselling services associated with lending to members. Lending is not itself an activity which may satisfy s. 117(1). Where the credit union is an Assessment Act co-operative, mutuality, if it is otherwise attracted, will not be displaced by s. 119. That section does not extend to interest receipts from members. The credit union, as an Assessment Act co-operative, will enjoy the privileged treatment conferred by the Act on co-operatives which is explained under the last heading, without paying the price of losing the possible application of mutuality to its interest receipts. The member will not, however, enjoy the privileged treatment conferred by s. 120(2). A rebate or bonus in respect of interest paid to the credit union will not be based on “purchases” from the credit union.
[2.96] If the rules of a credit union, and the manner in which its affairs are conducted, attract mutuality in regard to its interest receipts from members, those receipts will not be income and there will be no room for the operation of s. 23G. This is so even though the credit union is within the definition in s. 23G(1), and it is an approved credit union, the Commissioner being satisfied of the matters in s. 23G(3). Section 23G(2) exempts the interest income of an approved credit union derived from its members (other than interest derived from members who are companies), but the section does not make interest receipts income.
[2.97] Section 23G was added to the Assessment Act following the decision in Sydney Water Board Employees’ Credit Union Ltd (1973) 129 C.L.R. 446 that mutuality did not apply to the interest receipts of the Water Board Credit Union. The object of the section is to give relief where mutuality is not attracted. But attracting mutuality may still be more advantageous. Section 23G can apply only to some credit unions—those defined in s. 23G(1)—and its application depends on the exercise of a discretion by the Commissioner. Moreover, the section simply makes income exempt, with the prospect that, under s. 44(1), a payment by the association to a member from that income will be income of the member that is not exempt, as being a dividend out of profits.
[2.98] A credit union cannot enjoy the exemption under s. 23G and have the privileges accorded to an Assessment Act co-operative. This is the effect of s. 117(2). The privilege of deducting distributions would have had limited, if any, value to the credit union, where the credit union’s income is only interest income received from its members. But the privilege would have been valuable where the credit union has income received from persons other than its members, for example interest on surplus invested with an association of credit unions. A credit union that seeks status as an Assessment Act co-operative may avoid the barrier of s. 117(2) by incorporating under the Companies Act: a company incorporated under the Companies Act cannot be an approved credit union. In any case qualification as an Assessment Act co-operative may automatically exclude status as an approved credit union. It will qualify as an Assessment Act co-operative if it is established for the purpose of carrying on a business having as its primary object the rendering of services to its members: s. 117(1). It would be argued that it cannot then be an approved credit union which must have “as its principal object” or “[carry] on as its principal business the raising of money from its members and the making of loans out of those moneys to its members”: s. 23G(1)(b).
[2.99] Sydney Water Board and two cases which preceded it, Revesby Credit Union Co-operative Ltd (1965) 112 C.L.R. 564 and Social Credit Savings & Loans Society Ltd (1971) 125 C.L.R. 560, are the leading Australian authorities on the principle of mutuality. They involve issues which are raised in seeking to apply mutuality to any co-operative. In Revesby Credit and in Social Credit the failure to attract mutuality is explained without difficulty. In Revesby Credit payments were made to all members from the surplus generated by the receipts from borrowing members. In Social Credit there was a nearer approach to a “reasonable relationship” between contributions to, and receipts from, a fund. But mutuality was defeated by the circumstances that, under the rules, the surplus of contributions by borrowing members might be used to pay bonuses to officers and employees, and that a distribution of the surplus on winding up would be made to all members. Provision for a payment of bonuses to officers and employees from the fund may not always preclude mutuality. Clearly the use of the fund in the payment of expenses of administering the fund, including the wages of employees, will not preclude mutuality. Gibbs J. did not see the provision for payment of bonuses as equivalent to a provision for the payment of wages.
[2.100] In the course of his judgment in Social Credit, Gibbs J. referred (at 574) to the Privy Council decision in English and Scottish Joint Co-operative Wholesale Society Ltd v. Commissioner of Agricultural Income-Tax, Assam [1948] A.C. 405, observing that the Privy Council thought that identity of contribution and participation were not satisfied “because there was no common fund to which members of the society contributed and in which they participated”. The language of “common fund” had been used in a number of cases prior to the Privy Council decision, including Municipal Mutual Insurance Ltd v. Hills (1932) 16 T.C. 430. But until Social Credit the existence of a common fund had been seen as no more than a way of expressing a conclusion that there was a reasonable relationship between contributions and rights to return of surplus. It will be seen that in Sydney Water Board a requirement of a “common fund”, in some equity or accounting sense, appears to have become an essential element in circumstances attracting mutuality.
[2.101] Sydney Water Board is the most recent case. The principal judgment is that of Mason J., who gave a number of reasons against the application of mutuality. Some of these reasons are offered as distinguishing the case from some others in which mutuality had been held applicable, and may not be intended to establish principles. Thus, Mason J. said that the lending was under “individual contracts of loan”, and interest was paid by a borrowing member “in discharge of a legal obligation to pay it” (at 458). Contract and legal obligation would not in any case distinguish the facts of Sydney Water Board from the facts in New York Life Assurance Co. v. Styles (1889) 14 App. Cas. 381 where, as it was put by Lord Watson (at 394), the policy holder “pays according to an estimate of the amount which will be required for the common benefit; if his contribution proves to be insufficient he must make good the deficiency; if it exceeds what is ultimately found to be requisite, the excess is returned to him”. The distinction between the facts in Sydney Water Board and New York Life is not in terms of contract and legal obligation, but in the nature of the obligation in the latter case which extended to making further contribution in the event of insufficiency. In Sydney Water Board, Barwick C.J. (at 451) gave significance to this aspect of New York Life when he said of the facts in Sydney Water Board that the payment of interest by the borrowing members “cannot be regarded in any sense as being a pro forma payment, the actual amount of the interest being determined by the experience of the taxpayer as the agent of the borrowing members in the provision and management of the money from which the lending was made”. In other cases, however, an obligation to make further contributions in the event of insufficiency has not been insisted on as essential to the operation of mutuality. If it is essential, most members’ clubs will not attract mutuality.
[2.102] A further ground of distinction from other cases emphasised by Mason J. is that the contributors in Sydney Water Board were only a portion of the total class of members (at 458). One would have thought that this is to give some ritual significance to the status of “member”. What is significant is a community of contributors and participators—of obligations and rights. It should be irrelevant that some “members” stand outside that relationship. They are simply not members in the relevant sense.
[2.103] The two grounds essential to the decision in Sydney Water Board Employees Credit Union Ltd (1973) 129 C.L.R. 446 would appear to be the absence of a reasonable relationship between contributions by borrowers and receipts by borrowers, and, as a distinct ground, the absence of a “common fund”.
[2.104] It is not easy to see why there was not a reasonable relationship. The rules of the credit union had been drafted to overcome the defects that led to a denial of mutuality in Revesby Credit Union Co-operative Ltd (1965) 112 C.L.R. 564 and Social Credit Savings & Loans Society Ltd (1971) 125 C.L.R. 560. There remained, however, elements of ambiguity. The provision that payments from the surplus of interest might, on winding up, only be made to “members to whom loans had been made”, left it uncertain whether the reference was to members who at any time had borrowed and as to the basis of the payments. The provision for payment of rebates of interest paid or due by borrowing members “based on business done”, in the view of Mason J., left some doubt as to the persons entitled to rebates and as to the basis on which they were entitled to receive them (at 453). One would have thought that, whatever construction was given to the rules, “reasonable relationship” was established. At least this was so if the relaxed tests of an adequate relationship in the United Kingdom cases remain part of the Australian law.
[2.105] The ground that there was no “common fund” is also perplexing. One might have expected that the surpluses, current and accumulated, in the association’s accounts were a sufficient common fund, since only borrowing members, under the rules, had any claim on those surpluses. There is no suggestion in other cases that some real fund, be it cash or a bank account, is intended when the word “fund” is used in describing the mutuality principle. Nor is it suggested that an accounting fund, subsisting only in books of account, is necessary, at least when only contributors are entitled to share in any surplus. The statement by Mason J. (at 458) that it is “artificial” to regard the interest paid by borrowing members as the common fund, is not in itself enlightening. More significant is the observation (at 457) that “the [mutuality] principle may be invoked by an association which engages in business activities with outsiders, in addition to the transactions which it has with its members, to the extent that it is possible to sever from the business activities the fund which consists of receipts from mutual dealings”. It is important to note that the association had income earning investments with outside bodies. Another significant observation (at 458) is that the rules “make it clear that the interest [paid by the borrowing members] forms part of the funds of the taxpayer and that the borrowing members are entitled to participate in a distribution of the surplus which results from the taxpayer’s use of its general funds”. What emerges from these passages in the judgment of Mason J. is a conclusion that the association went too far in its attempt to overcome the defects in the rules of the associations in Revesby Credit and Social Credit, by confining any right to participate in surplus to borrowing members. The rules provided that the surplus of undoubted income receipts—returns from investment with outside bodies—could only be paid to borrowing members. And there was no distinction drawn in the accounts between payments from such surplus and payments from the surplus of interest from borrowing members. Any payment to borrowing members would include an element of distribution out of profits having an income quality as a dividend, and if mutuality had been held applicable the member would have had to rely on McLaurin (1961) 104 C.L.R. 381 and Allsop (1965) 113 C.L.R. 341, discussed in relation to Proposition 15, to justify a claim that the receipt by him was not income.
[2.106] There is room left by Sydney Water Board for an argument that where there are receipts that, if they were the only receipts, would attract mutuality, mutuality may be attracted to them if, at least as a matter of accounting, they are kept distinct from receipts which are undoubted income. The argument may sit awkwardly with another observation of Mason J.—that the payments of interest made to lending members cannot “with accuracy” be described as an outgoing in respect of a mutual liability of the borrowing members (at 459). If the receipts from borrowing members are segregated in the accounts, a charge in respect of interest paid to lenders which reflects the use of the money lent by lending members in making loans to borrowing members, does seem accurately described as an outgoing in respect of the liabilities of the borrowing members. It may be that Mason J. intended a reference to the possibility that the payment of interest to lending members is at a rate that is intended to effect a distribution to them of what would otherwise be a higher surplus from the receipts of interest from borrowing members. If it were evident that a credit union was paying rates of interest to lending members in excess of prevailing commercial rates, a finding that the interest is intended to effect a distribution might be appropriate and the finding would exclude the principle of mutuality.
[2.107] If mutuality is not attracted in what is otherwise a Sydney Water Board situation if the receipts which claim mutuality are kept distinct from receipts which are undoubted income, the law in relation to credit unions is less than satisfactory. The exemption which is offered by s. 23G does not encourage a policy of lending to borrowing members at minimum cost, a policy which a credit union may fairly wish to follow. If s. 23G applies, any rebate to a member will be income as a dividend. The application of s. 23G precludes status for the credit union as an Assessment Act co-operative: it would, in any event, find it difficult to qualify for such status. Credit union borrowers are thus denied the privileged treatment for their receipts from the association which s. 120(2) gives to members of other Assessment Act co-operatives.
[2.108] There may be some prospect of the law becoming satisfactory, if the discount approach already discussed in connection with English and Scottish Joint Co-operative Wholesale Society Ltd [1948] A.C. 405 is held to apply to a credit union. There will be a difficulty in the way, if the credit union is an Assessment Act co-operative: s. 119 could be construed to exclude the principle in Arthur Murray (N.S.W.) Pty Ltd (1965) 114 C.L.R. 314 on which the discount approach is based. But a credit union will not ordinarily be an Assessment Act co-operative.
[2.109] By s. 121 of the Assessment Act, the assessable income of a company carrying on the business of insurance includes all premiums derived by the company, whether from its shareholders or not, other than premiums received in respect of policies of life assurance or considerations received in respect of annuities granted. Life assurance companies are the subject of special provisions in Div. 8 of Pt III. Section 121 applies notwithstanding that the association is not incorporated: Mildura & District Dried Fruit Growers’ Hail Storm Damage Compensation Scheme (1968) 118 C.L.R. 342.
[2.110] Section 121 precludes the application of the mutuality principle to the premiums received by a mutual insurance association. The principle is to this extent denied operation in an area to which it owes much of its development. But the premiums received are not by s. 121 made profits of the association, and it may be that the mutuality principle is still relevant in determining whether a distribution by a mutual insurance association is income of its members.
[2.111] The principle of mutuality may be important in determining whether levies made by a home unit company or a statutory company under the Conveyancing (Strata Titles) Act (N.S.W.) are income. Where the whole amount of the levies is expended in repairs to the building or in other outgoings which will be deductible if the levies are income, there will be no need to consider whether the levies are income. But it may be that some of the outgoings are of a capital nature or that the outgoings do not wholly consume the amount of the levies: the corporation may wish to make a provision for future expenses.
[2.112] The mutuality principle would appear to exclude the levies from income. Holding Proposition 7 applicable is no more difficult here than in the case of subscriptions received by a member’s club. It will be important, however, in the case of a home unit company where the levies are to be used for purposes that relate to all units in the building, to ensure that levies are made on all shareholders, including the promoter if he still holds shares relating to units not yet sold.
There is no gain if an item is derived by the taxpayer as a contribution to capital
[2.113] Proposition 7, like Propositions 5 and 6, reflects the principle, asserted in Proposition 4, that to have the character of income an item must be a gain by the taxpayer who derived it. Proposition 6, the mutuality principle, has been explained as a particular application of Proposition 7. It is an application of Proposition 7 in the context of payments received by an association from its members.
[2.114] The central phrase in Proposition 7 is “contribution to capital”. A similar phrase will be found in mutuality cases, for example, The Bohemians’ Club (1918) 24 C.L.R. 334 at 337: “advances of capital for a common purpose.” A receipt by one person from another of money which must be applied in serving the purposes of the person paying, any surplus being returned to him, will generally not involve any gain by the receiver. The employee who receives an allowance for expenses incurred in carrying out his duties, and is required to vouch his expenses to his employer, does not derive income. The allowance is not in any part a gain to him. In other circumstances the applicability of the notion of contribution to capital may not be so clear. The illustration of a housewife who receives an allowance for housekeeping, referred to by Willmer L.J. in B.B.C. v. Johns [1965] Ch. 32 at 64 is not so clear, because there is some benefit to the housewife in the spending of the allowance. It may be argued that benefit to the housewife is not a purpose of the payment, so that the gain to her can be ignored just as we might ignore benefit to the employee who spends his allowance entertaining his employer’s clients, and, incidentally, himself. But such an argument is not directed to bringing the circumstances within the contribution to capital principle. It is rather directed to a denial that the receipt by the housewife has the character of income under one of the Propositions 11–15, in particular to a denial that it is a reward for services.
[2.115] It is the aspect of benefit to the receiver which creates the difficulty in regard to the application of Proposition 7, via a principle of mutuality, to a member’s club. The difficulty, it will be recalled, is overcome by identifying benefit to the club with benefit to the member who pays to the club, an identification expressed in the phrase “a payment to oneself”. The use of the amount provided by the member is in the individual interest of the member as one of the community of members so long as no part of it is or may be paid out in a distribution among members. The club has no interest distinct from the individual interests of each of the members paying to the club. Where, however, there can be a distribution of surplus among members of the club, the club embodies interests of members which are not interests of individual members paying to the club. There is thus benefit to the club, and Proposition 7 is not applicable.
[2.116] B.B.C. v. Johns is a decision that the British Broadcasting Corporation had no interest of its own to be served in the spending of the annual grant made to it by the United Kingdom Government. The B.B.C. was no more, in substance, than the agent of the Government in spending the grant, so as to provide broadcasting services to the public. The grant was not income of the Corporation, though amounts received as returns on investments made by the Corporation, and amounts received from the sale of its publications, did involve income. Those who paid amounts that were investment income of the Corporation and those who paid for the Corporation’s publications did not impose any obligation on the Corporation as to the use of the money they paid.
[2.117] In another United Kingdom case, Hochstrasser v. Mayes [1960] A.C. 376, the absence of benefit and thus gain to the receiver is not as obvious. An employee received an amount, as a member of a scheme established by his employer, by way of compensation for the loss he suffered on the sale of his home when he sold the home in the course of moving to another town where his employer now required him to work. The House of Lords unanimously decided that the amount received was not income. The judgments give diverse grounds for the decision. Some of these grounds—that the employment was only the sine qua non of the payment of the amount, not the causa causans (at 388, per Viscount Simonds), that the payment was made to the employee “in respect of his personal situation as a house-owner, who had taken advantage of the housing scheme” (at 392, per Lord Radcliffe), and that the scheme “was introduced … as part of a general staff policy to secure a contented staff” (at 395, per Lord Cohen)—are not persuasive. They do not, in any event, involve the contribution to capital principle, but rather an assertion that the receipt was not a gain in carrying on an employment.
[2.118] Another ground of decision is implicit in some observations in the judgments, and becomes explicit in the judgment of Lord Denning (at 396-7):
“My Lords, tried by the touchstone of common sense—which is, perhaps, rather a rash test to take in a revenue matter—I regard this as a plain case. No one coming fresh to it, untrammelled by cases, could regard this £350 as a profit from the employment. Mr Mayes did not make a profit on the resale of the house. He made a loss. And even if he had made a profit, it would not have been taxable. How, then, can his loss be taxable, simply because he has been indemnified against it? I can readily appreciate the case which was put in argument—namely, that if an employer, by way of reward for services, agrees to indemnify his employee against his losses on the Stock Exchange, the payments which the employee received under the indemnity would be taxable. But that would be because the losses were his own affair and nothing to do with his employment: the payments of indemnity would there be a straight reward for services. This payment of £350 was nothing of that kind. It was a loss which Mr Mayes incurred in consequence of his employment and his employers indemnified him against it. I cannot see that he gets any profit therefrom. If Mr Mayes had been injured at work and received money compensation for his injuries, no one would suggest that it was a profit from his employment. Nor so here, where all he receives is compensation for his loss.”
This ground of decision is the contribution to capital principle. The employee received an amount which his employer had agreed to provide for the purpose of meeting a cost incurred by the employee in carrying out the duties of his employment. The receipt was not different from a reimbursement the employer might have paid under an agreement to meet outgoings incurred by the employee in carrying out the duties of his employment. There is no gain to the employee in such a receipt.
[2.119] The passage quoted from the judgment of Lord Denning has, however, the seeds of confusion in the reference to the fact that a profit by the employee on the sale of the house would not have been taxable. The suggestion is that the loss in fact suffered was a capital loss, and that compensation which recoups a capital loss is not income. No such proposition can be maintained. A gain which is for an item that would have had the character of income, or for an item that has the character of a cost of deriving income, will be income under Proposition 15. But the converse is not so: it would not be correct to infer that a gain which is compensation for an item that would not have had the character of income, or for an item that does not have the character of a cost of deriving income, is not income. It is not income under Proposition 15, but it may yet be income as a reward for services under Proposition 13 or as a gain arising in carrying on a business under Proposition 14.
[2.120] There is another way of identifying the seeds of confusion in the passage quoted. An item may be income under Proposition 13, as a gain arising from employment, even though it recoups a loss which is a cost of deriving employment income, whether or not the item is a capital loss in any sense of those words. In the circumstances of Hochstrasser v. Mayes [1960] A.C. 376 a cost of moving home is more likely to be regarded as a private cost and thus not a cost of deriving income. The taxpayer is thus not at risk that Proposition 15—the compensation principle—will hold the recoupment to be income. He is at risk that the compensation will be treated as income as a gain arising from his employment. The submission of this Volume is that this consequence should not follow. It should not follow because there is no gain and it is of no consequence that the item is one arising from his employment.
[2.121] Where an employee incurs a loss or outgoing which is prima facie a cost of deriving his employment income, it will not matter, in practical consequences, that the recoupment by his employer is treated as income. None the less, the submission of this Volume is that where the contribution to capital principle is attracted, a recoupment is not income whether or not it is a recoupment of a cost that is prima facie deductible. If the recoupment is not income, there is no loss or outgoing whatever the prima facie view may be. There is no income because there is no gain. There is no loss or outgoing because there is no cost.
[2.122] The above analysis is at odds with a number of judicial decisions in United Kingdom and New Zealand concerned with payments received which are linked, in substance, with capital outgoings incurred by the taxpayer on improvements to business premises. Some, at least, reflect a growth from seeds of confusion of the kind in the passage quoted from the judgment of Lord Denning in Hochstrasser v. Mayes. Because money was received subject to an obligation to apply it in effecting improvements of a capital nature, or was received in respect of the cost of improvements of a capital nature already effected, it was not held to be income.
[2.123] In some cases it would have been enough to say that the receipts did not have the character of income under any of the principles (Propositions 11–15 in this Volume), which may give the character of income to a receipt. However, at least some of these decisions involve a distortion of the contribution to capital principle. They take that principle out of its role as an expression of the fundamental requirement that income involves a gain. In some instances the improvements did not involve any increase in the value of the premises of the taxpayer—they simply adapted the premises to their role as a place of selling the products of the person making the payments. Where payments were received subject to an obligation to use them in making these improvements, the contribution to capital principle as understood in this Volume was attracted. But where the payments were made, without prior agreement, to recoup the costs already incurred of adapting the premises, the contribution to capital principle, as understood in this Volume was not attracted.
[2.124] An even more distorted version of the contribution to capital principle was adopted in those cases where the improvements did involve an increase in the value of the taxpayer’s premises.
[2.125] The United Kingdom judicial decisions are Seaham Harbour Dock Co. v. Crook (1931) 16 T.C. 333; Boyce v. Whitwick Colliery Co. Ltd (1934) 18 T.C. 655; I.R.C. v. Coia (1959) 38 T.C. 334; McLaren v. Needham (1960) 39 T.C. 37; Walter W. Saunders Ltd v. Dixon (1962) 40 T.C. 329. The New Zealand decision is C.I.R. v. City Motor Service Ltd & Napier Motors Ltd [1969] N.Z.L.R. 1010. In their formulation of the contribution to capital principle, these decisions lead to a quite unacceptable extreme, under which a receipt for services rendered by a taxpayer will not be income if, under the contract of service or by some statement of the employer, the receipt is to be used to effect extensions to the taxpayer’s home, or is received by way of recoupment of the costs of extensions already made. It is true that in all the cases referred to, the person paying had an interest in—a benefit derived from—the improvements effected. But this purpose will not preclude an income receipt by the taxpayer receiving the payment, under the contribution to capital principle, if there is a gain to that taxpayer. Where the receipt is subject to a condition that the improvements will be made, there is a gain only to the extent that the improvements increase the value of the taxpayer’s property. Any deduction otherwise available to him, currently or by way of depreciation in respect of the improvements, will be diminished by the amount of the receipt. So far as the receipt involves a gain, it will be income. Where the receipt is not subject to a condition, the actual use by the taxpayer in effecting improvements will be irrelevant and the whole receipt will be income, if it has in other respects an income character. The same consequence will follow if the payment is made for the purpose of recouping costs already incurred by the taxpayer without any prior arrangement for recoupment.
[2.126] The fact that the person making a payment has an interest in the application of the money paid is relevant to the question whether the payment is a reward for services of the taxpayer who receives it, or is a gain arising from the carrying on of a business by the receiver. But the purpose of the person making the payment does not displace the operation of principles by which rewards for services and gains from carrying on a business are income.
[2.127] There are several United Kingdom cases concerned with contributions, from public funds, received by a taxpayer engaged in business. Where the contribution is “assistance … given for the purpose of being used in the business … so as to enable him to meet [his] trading obligations”, the contribution to capital principle will have no application (Pontypridd and Rhondda Joint Water Board v. Ostime [1946] A.C. 477 at 492, per Lord Thankerton). But Lincolnshire Sugar Co. Ltd v. Smart [1937] A.C. 697, Higgs v. Wrightson [1944] 1 All E.R. 488 and White v. Davies [1979] 1 W.L.R. 908 suggest that the contribution to capital principle will apply so as to exclude the contribution from income where: (i) the contribution is in the nature of a loan or (ii) it is intended to recoup “a capital depreciation” (Higgs v. Wrightson [1944] 1 All E.R. 488 at 489 per Macnaghten J.) rather than “to be used [by the company] in [its] business” (Lincolnshire Sugar Co. [1937] A.C. 697 at 704, per Lord Macmillan).
[2.128] In Higgs v. Wrightson the taxpayer was assessed on a wartime “ploughing grant” which he had received in connection with the ploughing of his pasture land to prepare it for intensive cultivation. His counsel argued that the intention of the legislation which provided for the payment was to compensate the taxpayer for the capital depreciation of the land which resulted from the detrimental effects of ploughing. The suggestion by Macnaghten J. in Higgs v. Wrightson [1944] 1 All E.R. 488 that a payment to recoup a “capital depreciation”, is within the contribution to capital principle and the assumption in White v. Davies [1979] 1 W.L.R. 908 that a receipt to recoup a capital loss is within the contribution to capital principle, have the same seeds of confusion as appear in the judgment of Lord Denning in Hochstrasser v. Mayes [1960] A.C. 376. The contribution to capital principle will only be attracted if the capital depreciation or capital loss was incurred in giving effect to the interests of the Government agency from which the recoupment is received. And the capital depreciation or capital loss must involve no benefit to the taxpayer, such that he might have elected to experience the depreciation or loss had he not had the expectation of the recoupment. The argument by the taxpayer in Higgs v. Wrightson was rejected as not supported by the intention of the legislation or by the facts. However, had the intention of the Act and the facts been as counsel argued, the case would have been analogous to Hochstrasser v. Mayes. In White v. Davies an argument that the receipt was to meet a capital loss in the conversion of a herd of cattle from dairy cattle to beef cattle required by E.E.C. policy was rejected. If it had been accepted, this case too would have been analogous to Hochstrasser v. Mayes. The view taken was that the receipt was to compensate the taxpayer for income lost during the conversion.
[2.129] The phrase “contribution to capital” is used as a description of a payment to a company in pursuance of a subscription for shares or debentures, or to meet calls in respect of shares or debentures. A receipt by a company in these circumstances would not have an income character under any of Propositions 11-15. It is, none the less, appropriate to note that, so far as the amount received is repayable by the company, it is within the contribution to capital principle.
[2.130] The contribution to capital principle will explain why the receipts by the trustee of a superannuation fund, which may be taxed under Div. 9B of Pt III of the Assessment Act, do not include contributions to that fund by a member or by the employer of a member.
[2.131] Section 26(g) is an express provision by which “any bounty or subsidy received in or in relation to the carrying on of a business (other than subsidy received under an agreement entered into under an Act relating to the search for petroleum)” is income. Section 26(g) is the subject of observations in the High Court in Dixon (1952) 86 C.L.R. 540, The Squatting Investment Co. Ltd (1953) 86 C.L.R. 570 and Brisbane Amateur Turf Club (1968) 118 C.L.R. 300. These observations are to the effect that the provision is inserted “simply for greater certainty” (Dixon, at 555 per Dixon C.J. and Williams J.), and does not modify or extend the meaning of income that is imported from ordinary usage. On this view, the contribution to capital principle, in its relevance to receipts that are described in the provision, is unaffected.
A gain which is a mere gift does not have the character of income.
[2.132] This proposition, and Propositions 9 and 10, provide the focus of a preliminary survey of the scope of Propositions 11-15. The latter group might be called the positive propositions which describe the items which, being gains derived, have the character of income. Propositions 8, 9 and 10 are negative propositions which are helpful in setting some of the limits of the positive propositions. They are general negatives, as distinct from particular negatives. Some particular negatives are examined in stating the scope of each of the positive propositions. Thus, a statement of the scope of Proposition 12 is assisted by a negative proposition that an item is not a gain derived from property if it involves the realisation of the property itself. Propositions 8, 9 and 10 are helpful as the focus of a preliminary survey. In addition, they, or similar propositions, are asserted in the authorities and this in itself is sufficient reason to examine them.
[2.133] Proposition 8 raises the question of how far the fact that a receipt is not one the taxpayer could have claimed as of right will take it out of a positive proposition otherwise applicable. In the discussion of policy issues at the beginning of this chapter, gifts received were identified as a class of accretions to economic power which are not within the base of the income tax, though the economists who are committed to the Simons goal of a comprehensive base would say that they should be. Given that the income tax base is not comprehensive, the task of legal analysis is to distinguish income from gifts received. Until recently gifts were the base of another tax—the federal gift duty—and too wide a definition of income raised the prospect of two taxes operating on the same receipt. There were problems of correlation, as in Scott (1966) 117 C.L.R. 514, a case considered in [2.135]ff. below.
[2.134] The line of distinction between income and gift received has not been set, as it might have been, by excluding from income any receipt which the taxpayer could not have claimed as of right. Some gifts, in the sense of payments made voluntarily, are income, and Proposition 8 asserts only that “mere” gifts are not income. The word “mere” is used in this way in the authorities. The question is always whether the item is embraced by one of the positive propositions.
[2.135] When the question is whether a gift—now used in this discussion in the sense of a payment made voluntarily—is income of the receiver under Propositions 13 or 14, as a reward for services or as a gain which arises from the carrying on of a business, the verbal issue is whether it is a “product” of the services, employment or business. The notion of product may be illustrated; it cannot be defined.
[2.136] The leading Australian authorities are Squatting Investment Co. Ltd (1954) 88 C.L.R. 413; Hayes (1956) 96 C.L.R. 47; Scott (1966) 117 C.L.R. 514; Dixon (1952) 86 C.L.R. 540; and Harris (1980) 80 A.T.C. 4238.
[2.137] Once a connection is shown between the receipt and services, employment or business, it may not be easy to establish that the receipt was not a product. None the less an employer can make a gift to his employee which will not be income of the employee. In Hayes and Harris a gift by an employer to a former employee was held not to be income. And a business association between two persons does not mean that any gift made by one to the other must be that other’s income. Whether a receipt is a product of an income-earning activity, in the view of Fullagar J. in Hayes, is to be answered by an objective assessment, although—and it may be thought there is some contradiction here—the motive of the donor is relevant, though “seldom decisive”. So too the donee’s expectation of the receipt is relevant: Squatting Investment. The receipt will not be a product if it appears that the donor acted with regard only to the “personal qualities” of the donee (Squatting Investment and Scott). There is in this connection a distinction between a gift which is a reward for services and a gift made to a taxpayer as an expression of goodwill towards him personally, the goodwill having been generated by past services: Walker v. Carnaby Harrower, Barham & Pykett [1970] 1 W.L.R. 276.
[2.138] Presumably, the dominant characterisation of the gift will prevail: there is no scope for an apportionment by which only a part of a gift is to be regarded as a product of the income-earning activity. To this extent the principle in McLaurin (1961) 104 C.L.R. 381 and Allsop (1965) 113 C.L.R. 341, discussed in [2.558]ff. below does not operate. That principle will deny an income character to the whole of a receipt where it relates in part only to an item of an income character and where no dissection or apportionment of the receipt is possible. There is thus a distinction to be drawn between a receipt that relates to two distinct items of claim, one only of which has an income character, to which McLaurin and Allsop are applicable, and a receipt that does not relate to any claim but might be thought to include in part an item of an income character, to which McLaurin and Allsop are not applicable. In the latter instance the whole will take its character from the part, if the part is dominant. Where a receipt is in part in satisfaction of a claim to an item of an income character, for example wages due but not yet received, and in part the receipt of a gift that is not a product of a process of income derivation, for example a bonus added by the employer as an expression of goodwill, the law is undetermined. Possibly McLaurin and Allsop apply, though, in the example given, one might expect that a dissection or apportionment will be made.
[2.139] Scott suggests that a legacy left, for example, by an employer to his former employee, will not be income. It may be asked whether the manner of the gift will always require that it be looked at as predominantly in recognition of the personal qualities of the donee. The magnitude of a gift inter vivos, for example the gift in Scott, may require that it be regarded as predominantly in recognition of personal qualities.
[2.140] A gift may be income to the taxpayer as a reward for his services, notwithstanding that the donor is not the person for whom the donee was contractually bound to perform the services: Hayes per Kitto J. and Dixon. An employee who receives tips or inducements in the course of his employment may thus derive income.
[2.141] The decision on the question whether a gift received is a product, may appear to turn on the weighing of objective and subjective factors, some supporting a conclusion that the gift is a product, some opposed. In Squatting Investment a conclusion that the receipt was one “resulting from the operation of wool growing”, (at 432) being a “voluntary addition to … the purchase price” of the wool (at 431), was indicated by the fact that receipts by suppliers of wool were in proportion to the supplies, and by the expectation of the taxpayer that he would, after the war, receive an addition to the price at which he had sold the wool. Against these factors it was impossible to set any suggestion that the payment was made to the taxpayer, a company, because of any personal qualities of the taxpayer.
[2.142] In Hayes the shares received were held not to be a product. It was suggested that the shares were the product of the taxpayer’s services given to the donor personally, or that they were the product of his employment by the donor’s companies. Objective factors were against a conclusion that the shares were a product of any services or employment. The donor made gifts to others at the time of his gift to the taxpayer, and those other gifts were clearly not income of the donees. There was no expectation by the taxpayer of the receipt, and this also was against the conclusion. Clearly there was goodwill on the part of the donor generated by past services, but the goodwill of the donor is a factor that tells against a conclusion that the receipt is a product of services, even though it has been generated by past services rendered.
[2.143] In Scott, where again the conclusion favoured the taxpayer, the factors in the balance were more numerous, and perhaps more subtle, but the process of decision is the same. The objective factors supporting the taxpayer included the size of the gift, the gifts made to others, the place where the gift was made, and the fact that he had been paid for the professional work he had done. Against these objective factors might have been weighed the fact that the taxpayer, who was a solicitor, had not counselled the donor to seek independent advice, but Windeyer J. did not consider that any inference from this fact could be drawn. The taxpayer had no expectation of the receipt. Again there was undoubted goodwill on the part of the donor.
[2.144] In Dixon (1952) 86 C.L.R. 540 the High Court rejected an argument that the addition to the taxpayer’s military pay provided by his former employer was a product of his former employment. The fact that the addition made up his receipts to the amount of his salary in his former employment, might be thought an objective factor pointing to product of that employment. But the suggestion made is that a further reward for the services already performed would have been in a lump sum and not received periodically. There was anticipation of the receipts, but not at the time the services under the former employment were performed. The donor’s actions suggested a motive of patriotism, not a motive to reward, at least not to reward services to the donor.
[2.145] Dixon C.J. and Williams J. in Dixon considered the possibility that the made-up pay was a reward for military service. There was an element of expectation by the taxpayer, and the motive of the former employer could be regarded as a motive to reward him for his military service. The joint judgment is, however, equivocal. It runs together the possible operations of Proposition 11 and Proposition 13. Dixon C.J. and Williams J. said (at 557):
“In the present case the employment or service, as we would emphasise, is as a soldier. The circumstances in which the taxpayer entered into that service were such as to enable him to rely with more or less confidence on the periodical payments from Macdonald, Hamilton & Co., as well as from his military pay, making up an ‘income’ of the level appropriate to civilian service. … Because the £104 was an expected periodical payment arising out of circumstances which attended the war service undertaken by the taxpayer and because it formed part of the receipts upon which he depended for the regular expenditure upon himself and his dependants and was paid to him for that purpose, it appears to us to have the character of income, and therefore to form part of the gross income within the meaning of s. 25 of the Income Tax Assessment Act 1936–1943.”
Fullagar J. was unequivocal on the question of product: “The payment does not partake in any degree of the character of a reward for services rendered or to be rendered” (at 564).
[2.146] The most recent Australian decision is Harris (1980) 80 A.T.C. 4238, involving a payment made by a bank to its retired employee. The majority in the Federal Court (Bowen C.J. and Fisher J.) thought the balance of factors was against product. There was no expectation by the taxpayer of the receipt: he did not know that amounts had been paid to other employees in the previous year. The amount he received had not been calculated with reference to the quality or length of his past services to the bank. The motive of the bank was not to reward the taxpayer for past services, but to be paternalistic—to assist the taxpayer because of the effects of inflation. The case concerned the first of several payments. Later year payments had been made to the taxpayer before the case came to court. The fact of later payments showed the likelihood that the payment in question would be repeated, but the significance of this in relation to a conclusion on the question of product is not apparent.
[2.147] The judgment of Deane J. (dissenting) in Harris runs together the product issue and the question whether the receipt was income as one of a series of periodical receipts. Indeed his judgment runs together those questions, and the question whether the receipt was income as a compensation receipt (Proposition 15). Thus, a question is raised that is possibly already raised by the judgment of Dixon C.J. and Williams J. in Dixon, namely, whether it is proper to add together partial satisfactions of a number of principles to reach a conclusion that an item is income. Deane J. adverted to the factors thought significant by Bowen C.J. and Fisher J. on the question of product, and generally admitted their force. He then listed considerations which he thought required a conclusion that the item was income, only one of these considerations being relevant to the question of product. The relevant consideration was that the item “was received by the taxpayer because he was one of a class of ex-employees of the bank whose well being the bank was, for proper commercial reasons, concerned to protect” (at 4245).
[2.148] Dixon and Harris assume, if they do not decide, that a gift may be income as a periodical receipt (Proposition 11). In this respect, Australian law differs from the United Kingdom law, as it appears in Stedeford v. Beloe [1932] A.C. 388.
[2.149] The passage quoted above from the judgment of Dixon C.J. and Williams J. in Dixon may justify a conclusion that a receipt which is one of expected periodical payments which form part of the receipts upon which the taxpayer depends for the regular expenditure upon himself and his dependants, and which are paid to him for that purpose, is income. The passage quoted does, however, include a reference to the factor that the receipt arose out of circumstances which attended the taxpayer’s war service. In this respect the conclusion may depend on the presence of a factor which, though not enough in itself to attract the operation of the product principle, will overcome the insufficiency of factors in relation to the periodical receipts principle, and thus establish an income character for the receipt. But, if this is the correct analysis, we are left uninstructed on what the insufficiency was. And we are left perplexed, as we are by the judgment of Deane J. in Harris, as to whether it is proper to add factors which are insufficient to direct an income character on any one principle, so as to reach a combination of factors which are sufficient to direct an income character on some kind of amalgam of principles.
[2.150] This aspect of the joint judgment in Dixon is not examined by Bowen C.J. or Fisher J. in Harris (1980) 80 A.T.C. 4238. Bowen C.J. was content to assert (at 4242) that (i) the receipt “was not periodical within the income year” and (ii) it did not “form part of the receipts upon which he depended for regular expenditure upon himself and his dependants”. He had, earlier in his judgment, adverted to the fact that the taxpayer, though retired from the bank, was still working as an accountant and was not in need of the amount he received from the bank. He had also observed (at 4241) that where dependence on a receipt for regular expenditure is a factor pointing to an income character, the law “place[s] the poor man at an unnecessary disadvantage”. We are left to ponder the situation of an impecunious student son receiving an allowance paid voluntarily by his father.
[2.151] Deane J. (dissenting) in Harris listed the factor that “the payment was related to an annual period and was part of one group of a series of annual groups of payments” as one factor which, with other factors relevant to other principles, required a conclusion that the receipt had an income character (at 4245). A comment on the amalgam of principles approach has already been made.
[2.152] Fisher J. thought the evidence of payments in subsequent years could only be used to confirm any indication given at the time of the first receipt that the taxpayer could expect to receive payments in the future. At the time of the first receipt, there was no indication given that the taxpayer could anticipate receipt of a like payment each year thereafter. In the result, the first receipt could not be seen as one of a series of receipts that might be within the periodical receipts principle.
[2.153] Harris is authority that the first of a series of receipts, received at a time when the taxpayer had no anticipation of the first receipt and of subsequent receipts, cannot be income as one of a series of receipts that are within the periodical receipts principle. Where the taxpayer has come to anticipate further receipts, a receipt may be income within the periodical receipts principle. The principle was applied in such circumstances by Carter J. in Blake (1984) 84 A.T.C. 4661. In the view of Carter J., a broad judgment must be made of all the circumstances. Among those are the periodicity of the receipts that are anticipated by the taxpayer and the taxpayer’s reliance on those receipts for regular expenditure on himself d his dependants. Save in the reference to the relevance of such reliance, he did not attempt any contribution to a statement of the substance of the periodicity principle.
[2.154] The judgment of Fullagar J. in Dixon (1952) 86 C.L.R. 540 is authority that the compensation principle (Proposition 15) may apply to a voluntary receipt. He said (at 567-8):
“It seems to me that the appellant’s receipts from Macdonald, Hamilton & Co. must be regarded as having the character of income. They were regular periodical payments—a matter which has been regarded in the cases as having some importance in determining whether particular receipts possess the character of income or capital in the hands of the recipient, see e.g. Seymour v. Reed [1927] A.C. 554, at 570 and Atkinson v. F.C.T. (1951) 84 C.L.R. 298. This consideration, while not unimportant, is not decisive. What is, to my mind, decisive is that the expressed object and the actual effect of the payments made was to make an addition to the earnings, the undoubted income, of the respondent. What the employing firm decided to do, and what it really did, in relation to the respondent and others in the same position, was ‘to make up the difference between their present rate of wages and the amount they will receive’. What is paid is not salary or remuneration, and it is not paid in respect of or in relation to any employment of the recipient. But it is intended to be, and is in fact, a substitute for—the equivalent pro tanto of—the salary or wages which would have been earned and paid if the enlistment had not taken place. As such, it must be income, even though it is paid voluntarily and there is not even a moral obligation to continue making the payments. It acquires the character of that for which it is substituted and that to which it is added. Perhaps the nearest parallel among the many cases cited to us is to be found in Commissioner of Taxes (Vic.) v. Phillips (1936) 55 C.L.R. 144.”
[2.155] The passage quoted from the judgment of Fullagar J. contains two bases of decision. The first is a principle that a receipt that in its object and effect is to make an addition to the undoubted income of the taxpayer is income. It is income though it is the receipt of a voluntary payment and it is not one of a series. Bowen C.J. in Harris (1980) 80 A.T.C. 4238 at 4243 rejected a principle thus stated. He concluded that the circumstances of the case before him were “insufficient” to justify a conclusion that the receipt was income “because the bank as payer intended it to be, and it in fact was, a supplement to the taxpayer’s pension”. The further circumstances he thought necessary included an assurance, of which the taxpayer was aware—presumably at the moment of receipt—that the payment would be regularly forthcoming. Fisher J. agreed that there was no such assurance. Both judges, in effect, added an element to the principle stated by Fullagar J. The principle as it appears in the judgment of Fullagar J. has now been made a specific provision of the Assessment Act. Section 27H(1)(b) provides that “the assessable income of a taxpayer of a year of income shall include—the amount of any payment made to the taxpayer during the year of income as a supplement to an annuity, whether the payment is made voluntarily, by agreement or by compulsion of law and whether or not the payment is one of a series of recurrent payments”.
[2.156] The other basis of decision to be found in the passage quoted from the judgment of Fullagar J. is a principle that a payment “intended to be, and [which] is in fact, a substitute for—the equivalent pro tanto of—” income that would have been derived if some event had not occurred, is income. This principle is identifiable as a compensation receipts principle. In the facts before him, the income that would have been derived was the salary and wages the taxpayer would have earned had he not enlisted in the Army. The principle as stated did not require that the payment should have been one of a number of regular periodical payments but the opening words of the passage quoted at least recognise the relevance of periodicity. Bowen C.J. and Fisher J. in their insistence on periodicity must be taken to have added an element to the principle as stated by Fullagar J. Precisely what element of periodicity they would require, does not appear. Nor does it appear whether this element of periodicity is distinguishable from the element of periodicity that will attract the operation of the periodical receipts principle. Indeed neither Bowen C.J. nor Fisher J. clearly distinguishes the compensation receipts principle from the periodical receipts principle.
[2.157] A gift received may be income as a gain derived from property (Proposition 12). The connection of the gift with the letting of property, the licensing of technology or the lending of money, may be enough to deprive a gift received of a claim to be “mere”, and give it the character of income. The United Kingdom decision in I.R.C. v. Falkirk Ice Rink Ltd (1975) 51 T.C. 42 suggests an illustration. A gift was made by members of a club enjoying facilities for the sport of curling provided by the taxpayer. The purpose of the gift was that the taxpayer might continue to provide facilities and improve the standard of those facilities, but there was no obligation imposed on the taxpayer. The gift was held to be income as a product of the carrying on of a business. Where there is no business, a like conclusion may be drawn. A landlord who receives a gift which is intended to persuade him to effect repairs to premises occupied by the donor, may derive income as a gain derived from property.
A mere windfall gain does not have the character of income.
[2.158] This is the second of the general negative propositions. The word “mere” has been adopted from Proposition 8 in relation to gifts. The word “windfall” is intended to refer to receipts which are lottery or other prizes, and gambling winnings. A windfall gain will be income if it is sufficiently connected with services or a business or employment to be a product of the services, business or employment (Propositions 13 and 14), and it will be income if it can be regarded as derived from property (Proposition 12). It is hard to imagine facts which would make a windfall gain income as a periodical receipt (Proposition 11), or a compensation receipt (Proposition 15), but the possibilities exist in theory.
[2.159] The fact that mere windfall gains are not income is another difference between the base of the income tax and the comprehensive, base which some economists would favour. Windfall gains may, indirectly, have borne another kind of tax. State taxes in relation to prizes and gambling are an important source of State revenue. The surpluses on State lotteries and Lotto are in effect taxes, and racing and poker machine operations attract a variety of taxes. The tax, in each case, is not directly on the prize or winnings, but it will have limited the amount available for the prize or the winnings.
[2.160] A lottery ticket given by an employer to his employee may be income as a product of employment. So too a ticket received as a reward for services, or received in the carrying on of a business, may be income as a product of the services or of the business. But a prize won by the ticket, like the shares obtained by the exercise of the option rights in Abbott v. Philbin [1961] A.C. 352, would be seen as the proceeds of realisation of this right. It might be income on some principle other than the gain from employment principle, but the possibility is remote. The possibility that there might be income by ordinary usage as the profit from a business deal, or under the second limb of s. 25A(1) may be taken to have been rejected in Clowes (1954) 91 C.L.R. 209.
[2.161] Other prizes may be products of services, employment or business. The question will be whether competing for the prize is an aspect of the performance of the services, or of the carrying on of the business. It will be an aspect, and the prize income, if competing is the activity which the taxpayer is employed to perform, or if competing is the service which is rewarded by the prize, or if competing is the activity which is the business or profession of the taxpayer. A taxpayer who is asked to take part in a television programme involving the winning of prizes may be seen as performing a service for which the prize is a reward. A professional tennis player or racing car driver may be seen as engaged in a business of competing for prizes. Racing horses may amount to a business and the prizes won will be income, though the Commissioner has not been over ready to assert that racing horses is a business nor have the courts been over ready to find that it is a business. The same comments might be made in relation to motor-racing. A cynic might suggest that the odds are against horse racing or motor racing being profitable, and the Commissioner stands on balance to be allowing losses rather than taxing winnings if the racing is recognised as a business. There is however a distinction to be drawn between hobby activity and business activity which does have some substance. The distinction is considered in relation to Proposition 14.
[2.162] Competing for a prize may be an aspect of an employment or business, and the prize income, if it is incidental to the employment or business activity: Cooke and Sherden (1980) 80 A.T.C. 4140. An employer may have instituted an incentive scheme involving a competition for prizes among his employees. Entering for the prize is incidental to the employment. A professional golfer may devote most of his time to teaching and selling equipment. His occasional entry for a tournament may none the less be regarded as incidental to his business activity, and any prize he wins will be income. A cricketer or footballer may be employed to play cricket or football, or be engaged in a business of playing. Competing for a prize offered by some sponsor is incidental to the employment or business, and the prize is income. A motor car manufacturer may enter cars of its manufacture in a race or rally. Competing is incidental to the carrying on of its business, and any prize is income.
[2.163] A prize may be income derived from property. In the United Kingdom holders of “premium bonds” have chances to win prizes in a lottery conducted by the Government. It is at least arguable that a prize is income of a bond-holder as a gain derived from the investment in the bond. The reply may be open that the chance to win a prize is income, but the realisation of that chance does not give rise to another derivation of income. The reply would follow the analysis suggested above in relation to a lottery prize won by an employee who received the ticket as a gain from his employment.
[2.164] Observations may be made in relation to gambling which are parallel with those made in relation to prizes. Questions arise as to what will amount to a business of gambling, and as to whether gambling will be regarded as incidental to a business which is not a gambling business.
[2.165] Martin (1953) 90 C.L.R. 470 is the leading Australian authority on what will constitute a business of gambling. It is considered later in relation to Proposition 14. There is a statement in the judgment in Martin that “the taxpayer is not by occupation a bookmaker or trainer or jockey”. The statement, presumably, was intended to dispose of any suggestion that gambling was incidental to some employment or business of the taxpayer. It may be an instructive exercise to consider the circumstances in which gambling on horse races will be held to be incidental to an employment or business as a bookmaker, trainer or jockey.
A capital gain does not have the character of income.
[2.166] This is the third of the general negative propositions. There is a disposition, in some of the authorities, to refer to any gain which is not an income gain as a capital gain. The use of the word capital in this way is not helpful. If this usage were adopted, Proposition 10 would merely assert that a non-income gain is not income. It would not assist in setting the limits of the positive propositions.
[2.167] When it is said of the income tax that the base is less than comprehensive because it does not embrace capital gains, the meaning of the word capital is that intended in Proposition 10. A capital gain in this meaning is a gain from the realisation of an asset where the gain does not arise in the carrying on of a business or the carrying out of an isolated business venture. Proposition 10 thus defines some of the limits of Proposition 14. There may be no relevant business and no relevant business venture, in which event the gain is sometimes referred to as a casual gain. Where there is a business to which the gain relates, it is generally said that the gain will be a capital gain if the asset is a capital asset of that business. The most obvious illustrations are the factory premises and plant of a manufacturing business.
[2.168] The use of the word “capital” in the phrase “capital asset of a business” is accepted, though a preferable word may be “structural”, if used in a metaphorical sense. There is, however, a risk of confusion. In the ultimate analysis, identifying an asset as a capital asset of a business simply expresses a conclusion that the realisation of the asset was not an aspect of the carrying on of the business. It may be convenient to describe an asset as a capital asset if the realisation of that asset will not, in ordinary circumstances, be an aspect of carrying on a business. But in the context of an actual transaction the asset may be incorrectly described. The leading case is Rolls-Royce Ltd v. Jeffrey [1962] 1 W.L.R. 425 in which the realisation of know-how developed by a business, was held to give rise to income in the context of the actual transaction. Know-how, in ordinary circumstances, would be properly described as a capital asset. Later in this chapter the phrase “revenue asset” is adopted to describe an asset of a business which, on realisation, will in ordinary circumstances give rise to a gain which is income. Here, also, in the context of an actual transaction, the description may be shown to be inappropriate. The realisation of the stock in trade of a business, in ordinary circumstances revenue assets, will not give rise to a gain which is income by ordinary usage, if the realisation is by way of a sale of the business to another, or, perhaps, by way of a sale in a single transaction of all the stock in liquidation.
[2.169] Where there is no relevant business and no relevant isolated business venture, an asset is referred to as a capital asset, and the gain on realisation as a capital gain. The alternative phrase “casual gain” may be preferable; it helps to distinguish such a gain from the capital gain arising from the realisation of a business asset.
[2.170] Where the realisation of an asset is an aspect of carrying out an isolated business venture, the gain will be income by ordinary usage. At least this is the view of the law taken in Chapter 3 of this Volume. It is a view which equates the phrase “isolated business venture” with the phrase “adventure in the nature of trade” used in the United Kingdom income tax legislation, and treats the authorities on the interpretation of the latter phrase as authorities on a part of the meaning of income by ordinary usage. The asset realised in carrying out an isolated business venture will not be described as capital, nor will the gain be described as a capital gain.
[2.171] Section 25A(1) (formerly s. 26(a)), considered at length in Chapter 3, has some effect in giving the character of income to gains from the realisation of property, where the realisation is not an aspect of any business, whether a continuing business or an isolated business venture. It is said of s. 25A(1) that it makes some capital gains income. The intention of this statement is to assert that s. 25A(1) extends beyond the range of the ordinary usage notion of income in relation to the realisation of assets. The same observation may be made of s. 26AAA, also considered in Chapter 3. A recognition that s. 25A(1) carries the meaning of income for the purposes of the Assessment Act beyond the meaning of income by ordinary usage appears in the judgments of Gibbs C.J. and Mason J. in Whitfords Beach Pty Ltd (1982) 150 C.L.R. 355. The recognition is important as a rebuttal of a view that received strong expression in McClelland (1970) 120 C.L.R. 487. That view would have treated s. 26(a) as no more than a statement of some part of the ordinary usage meaning of income. The view of Gibbs C.J. and Mason J. asserts that s. 25A(1) has no operation where it may, in its terms, overlap the ordinary usage meaning of income. The view is important in rebutting any suggestion that, in an area of overlap, s. 25A(1) exclusively states, and may limit, that part of the meaning of income in the Assessment Act that is taken from the ordinary usage meaning of the word.
A gain which is one of a number derived periodically has the character of income.
[2.172] This is the first of what might be called the positive propositions (Propositions 11–15), which seek to specify the circumstances in which a gain derived will have the character of income. The scope of a number of these propositions has already been the subject of some exploration in the examination of the general negative propositions (Propositions 8–10), which have the role of defining the outer limits of the positive propositions.
[2.173] Two reservations in regard to Proposition 11 should be made. The word “gain” is used to keep faith with Proposition 4, which asserts that gain is an essential feature of the character of income. It has however already been conceded in this Volume that purchased periodical receipts involve an exception to Proposition 4, and to this extent the use of the word “gain” in Proposition 11 is inappropriate. Periodical receipts, though purchased, will be income to the extent in each instance of the whole amount of a receipt. Where the question is whether there is an item of income by ordinary usage, there will not be any allowance against a receipt of any part of the amount of money outlaid, or of the value of property outlaid, in the purchase of that receipt. It will be seen that s. 27H, as a specific provision defining income, may be taken to require such an allowance and, to the extent of its operation, it adopts gain as an essential element in the notion of income under the Assessment Act. If s. 27H, in this respect, could be taken to express a general principle, it would be a valuable contribution to consistency and good sense. But s. 27H, it will be seen, has a restricted operation. There are other instances of receipts included in income without abatement for any outlay that may have generated those receipts. Principally they concern royalty receipts, discussed in [2.309]–[2.366] below. The second reservation in regard to Proposition 11 is that the word “periodically” must be understood in a special sense, so as to reflect the outcome of the examination which is now undertaken of the circumstances in which receipts in a series will be income. What is attempted is a statement of a principle of periodicity giving the quality of income to receipts in a series. Some part of that statement must be by way of recalling one of the general negative propositions, and by the assertion of a particular negative which set limits to the principle of periodicity. The general negative proposition in relation to gifts may be expressed in the present context as a proposition that a series of mere gifts are not income. The particular negative, which will call for elaboration, is that a series of instalment receipts of an amount that would not be income if received in one sum, are not income.
[2.174] The periodicity which will attract the operation of the periodicity principle must be distinguished from periodicity which may be relevant in attracting the operation of another principle. Thus, the fact that there is a series of receipts may, with other circumstances, bring about the operation of Proposition 12—a gain derived from property has the character of income. A receipt that is one of a series is the more likely to be held to be interest, rent or royalties, and income in that character, rather than a gain on the realisation of the property itself, in which character it may not be income. A receipt that is one of a series is the more likely to be found to be income as compensation for income receipts, more especially income receipts that would have been derived from an asset that has been realised or surrendered or of which the taxpayer has been deprived: Proposition 15 is applicable. A receipt that is one of a series is the more likely to be found to be income as a gain which is a reward for services rendered, more especially if the services are rendered under a contract for a continuing supply of services: Proposition 13 is applicable. In these instances periodicity is not a necessary condition of the operation of the principle. It is no more than an indication that the principle is applicable, and the periodicity that is such an indication need not be the periodicity that will attract the periodical receipts principle. The question of dimension of the periodicity, considered in [2.176] below, does not arise. At least it ought not to arise. Bowen C.J. in Harris (1980) 80 A.T.C. 4238, considered in [2.155] above, does not draw a distinction between different notions of periodicity.
[2.175] The examination of Dixon (1952) 86 C.L.R. 540, in [2-144]–[2-156] above, suggests that a series of gifts may attract the principle of periodicity, where they are made for the purpose of being receipts on which the receiver depends for regular expenditure upon himself and his dependants, and the receiver in fact depends on the gifts in this way. The notion of income thus reflected is not accretion to economic power, but a notion that is reflected in usage of the word income when it is said of a person that he has covenanted, or been ordered, to make payments which will provide an income for the maintenance of a spouse from whom he has separated; or when it is said that a student has scholarship income; or when it is said that a beneficiary under a will has been provided with an income by being given an annuity; or when it is said that a person has secured for himself an income by joining a superannuation scheme which will pay him a pension, or by buying an annuity from a life insurance company.
[2.176] Dixon concerns a series of receipts. There is no suggestion of a principle that the receipt of a single isolated payment is income if it is made to provide the receiver with money which he might use for expenditure upon himself and his dependants. Periodicity in fact is thus a necessary, though not a sufficient condition of the operation of the periodicity principle. It is not sufficient because periodicity, while it may indicate, does not establish that the receipt is intended by the payer to be used by the receiver for regular expenditure, and will be relied on by the receiver. The question of dimension, beyond some observations in Harris (1980) 80 A.T.C. 4238, has not been examined in the authorities. Bowen C.J. in that case remarked that the receipt was not one of a kind that was periodical within the year, but it is not clear whether the reference is to periodicity in relation to the periodical receipts principle or the compensation receipts principle (Proposition 15). The dimension of periodicity, for purpose of the periodical receipts principle, must be drawn from the underlying notion of “an income”. The underlying notion would not embrace a number of receipts, perhaps on successive days, of a short period. Nor would it embrace a very few receipts spanning a long period of years. Beyond observations of that kind, any series of receipts should, as a matter of dimension, qualify as periodical.
[2.177] The principle of periodicity, as it is found in the judgment of Dixon C.J. and Williams J. in Dixon (1952) 86 C.L.R. 540, appears to require an actual dependence by the taxpayer on the receipts for regular expenditure upon himself and his dependants, and a purpose in the payer that they be used in this way. The prospect is that the principle will not operate if it is shown that the taxpayer had other receipts upon which he in fact depended, so that he had no need of the receipts claimed to be income. This aspect of the principle is the subject of the observation by Bowen C.J. in Harris that it seemed to discriminate against those with lower incomes.
[2.178] Actual dependence on receipts claimed to be income and a related purpose of the payer, have not been regarded as an aspect of the periodicity principle where the receipts come to the taxpayer not as gifts, but as a matter of right. Payments under a covenant to make a series of payments, or under a maintenance order, payments under a scholarship, payments as an annuity left by a deceased person under his will, pension payments by the trustees of a superannuation fund and annuity payments by a life insurance company, will be income within the periodicity principle without any showing of dependence, or purpose. The form of the receipts as a series of receipts will in these circumstances be sufficient to give them an income character. This sovereignty of form may express an assumption that receipts of these kinds are ordinarily used by the taxpayer for regular expenditure upon himself and his dependants, and are ordinarily intended to be used in this way, so that an objective inference of purpose and dependence may be drawn. In this there is some rewriting of the periodicity principle as it may appear in the Dixon judgment.
[2.179] The operation of the periodicity principle so as to give an income character to receipts may rest on their form as a series of receipts only when there is no other element of form that points to a different conclusion. A will may direct a series of payments to a beneficiary. There may be problems arising out of the interplay of the ordinary usage notion of income and the provisions of Div. 6 of Pt III, more especially when the payments are directed to be made out of income of the deceased estate, or are in fact made out of such income. Those problems are not considered in this Volume. The present concern is with the operation of the principle of periodicity where the series of payments may, because of the language used and of the directions given for payment, be regarded as in form payments of a legacy by instalments. There is a competition of forms, and on the authorities in connection with payment of a purchase price by instalments considered under the next heading, it will be necessary to resolve the competition by reference to the substance of the periodicity principle.
[2.180] The distinction between form and substance in this context, as in any other, cannot be precisely drawn. A statutory provision may employ words of precise meaning in ordinary language, or words that have been given precise meaning by a legacy of judicial interpretation such that they are already words of legal art at the time of enactment. In these circumstances form may be said to prevail, and rightly prevail, where the legal consequences for which the law provides are attached to any circumstances that are within the words employed by the statute. Primary form may be said to prevail. Thus s. 26(f), considered in [2.309]ff. and [4.114]ff. below, provides that an amount received as “royalties” is income. If the word royalties is a term of legal art, any receipt that is within its meaning will be income. There is no room for examination of the substance of any principle. Where a statutory provision expresses a broad principle, it will not employ words of precise meaning in ordinary language, or words of legal art. There is then no scope for primary form to prevail. There is room for form to prevail only where the broad principle is reduced in the process of judicial interpretation to rules which are expressed in words of precise meaning in ordinary language, or words of legal art. Form might be said to prevail, in this event, if the consequences for which the law provides are attached to any circumstances that are within the words of the rules. The form that prevails might be described as extended form, and, in the view of this Volume, it does not rightly prevail wherever the rule is an imperfect expression of the broad principle. When it is said that substance should prevail, there is a direction to return to the broad principle. Thus, it will be seen in Part II, the broad principles expressed in s. 51(1) have tended to be expressed in judicial interpretation in rules that employ words of precise meaning in ordinary language, or words of legal art. Extended form prevails and substance is ignored if a rule that in the circumstances is an imperfect expression of the broad principle is applied.
[2.181] Where the law is expressed in the statute only by the word “income” in s. 25, thus importing ordinary usage notions, there can be no primary form that might prevail. Judicial interpretation may have established a rule that items in a series of receipts are income, but that rule should never be more than a prima facie test of the income character of a receipt. Extended form should not be seen as sovereign. At least when there is competition with some other extended form, the character of a series of receipts calls for a wider investigation. It would be said that the substance of the matter must be considered. Substance may prevail over form or it may reinforce the conclusion directed by form. The substance that prevails is the broad principle in its application to the circumstances. In the present circumstances it is the notion of “an income”.
[2.182] In the instance of a will directing a series of payments to a beneficiary, there need not be a competition of forms. The form of a legacy payable by instalments could not be said to be present unless the administrator of the estate is required to set aside an amount, and to pay all of what has been set aside to the beneficiary or to his estate, albeit by a series of payments. If it is directed that the payments will cease if the beneficiary dies, the form is not satisfied. And if the will directs payments equal to the amount set aside even though the assets in which the amount is invested prove inadequate to support those payments, again the form of a legacy payable by instalments is not satisfied.
[2.183] Where the form of payment of a legacy by instalments is satisfied, the substance of the periodicity principle may yet require examination. The point has been made that the relevant substance is not necessarily that suggested by the Dixon judgment. If actual dependence on the receipts by the receiver is an essential aspect of the principle of periodicity, it will be necessary to make a separate characterisation of each receipt, as it is received, and the curious consequence will follow that a taxpayer may have income and be subject to tax because he has come to be in need of the receipt. It may be thought that the relevant substance should be the purpose of the payments in a series, determined objectively. The series of receipts will be income if their purpose may be said to be to provide the taxpayer with money on which he might rely for regular expenditure on himself and his family. In the context of a series of payments directed by a will, the frequency of payments and the period over which they are to be made, may yield an inference of that purpose.
[2.184] There is some discussion in the authorities of the significance of a description of a series of payments as an annuity in the terms of the transaction or document by which the right to the payment arises. The description may confirm what is likely to be evident in any case—that payments are to be made in a series—but it does not bear on the substance of the matter. This is the effect of the judgment of Cross J. in Vestey v. I.R.C. [1962] Ch. 861 rejecting a suggestion in Foley v. Fletcher (1853) 3 H. & N. 769; 157 E.R. 678 that the description of a series of receipts as an “annuity” must bring them within the periodicity principle.
[2.185] The greatest difficulties in defining the scope of the periodicity principle arise in relation to a particular negative proposition which would assert that a series of receipts is not income where they are instalment receipts of an amount that would not be income if received in a single sum.
[2.186] There is an initial question as to the validity of this negative proposition. In the discussion of a similar negative proposition—a series of receipts is not income if they are instalment receipts of a legacy—under the last heading, the assumption was made that a conclusion that the receipts are instalments merely raises a competition of forms which will have to be resolved by resort to substance. A like assumption may be appropriate here, so that the negative proposition should be read as leaving the substance of the periodicity principle to operate if it should be concluded that the purpose of making the payments by instalments was to provide the taxpayer with money on which he might rely for regular expenditure on himself and his dependants.
[2.187] The difficulties arise in circumstances (i) where there is an existing debt (arising from a loan or other transaction) which is not on revenue account and an agreement is entered into by which the debt is discharged in a manner which involves a series of payments, and (ii) where property is sold or rights are surrendered for a consideration that involves a series of payments, and the property is not a revenue asset.
[2.188] The exclusion of revenue account and revenue asset situations in this formulation, is necessary to limit the circumstances to those in which a single sum receipt would not be income. The notions of revenue account and of revenue asset are discussed in connection with Proposition 14 in this chapter, and in later chapters.
[2.189] One of three possible analyses may explain the circumstances of a particular case:
Where there are two distinct transactions—the one by which a right to payment of a fixed amount arises, and the other, a later transaction, by which that entitlement is applied in the acquisition of a new entitlement to a series of payments—the second analysis is clearly appropriate. The right to payment of a fixed sum has ceased to exist, and a new right to a series of receipts has arisen. Where two transactions appear to be telescoped into one, so that at the same moment a right to a fixed sum arises and is converted to a series of receipts which may be more, or may be less, in total than the fixed sum, the second analysis is not so obviously appropriate. But it might be thought to be appropriate, or, more likely, that the third analysis will be appropriate unless the fixed sum mentioned in the transaction continues to control in some respect the total amount that may be received under the right to the series of receipts. If it does control, the first analysis will be appropriate.
[2.190] The United Kingdom cases reflect some concern to hold, if possible, that the first analysis is appropriate, and to resolve the completion of forms in favour of the form of instalment receipts. This concern may be moved by an unwillingness to allow too much room for an aspect of the ordinary usage notion of income which may include in income an amount that is not a gain. The United Kingdom cases that are concerned with the periodicial receipts principle are complicated by provisions of the United Kingdom legislation, by which the periodical receipts principle may be used in effect to shift income from the payer to the receiver. This was the effect, in relation to income tax, of the transaction with which I.R.C. v. Church Commissioners for England [1977] A.C. 329 and I.R.C. v. Land Securities Investment Trust Ltd [1969] 1 W.L.R. 604 were concerned. Church Commissioners were not unhappy about the operation of the periodical receipts principle to make their receipts income, for they were an exempt body, and were entitled to a refund from the Revenue of tax they were deemed to have paid on those receipts.
[2.191] The relevant provision of the United Kingdom legislation is s. 52 of the Income and Corporation Taxes Act 1970. There have been equivalent provisions in the United Kingdom legislation for most of its history. It does not apply to a company subject to corporation tax. It will be noted that Land Securities was subject to income tax and profits tax, which at that time applied to the income of companies. The effect of s. 52 is that where “an annuity or other annual payment” subject to income tax in the hands of the receiver is payable out of profits subject to income tax in the hands of the payer, the payer is entitled on making the payment to deduct and retain out of the payment a sum representing the amount of income tax thereon. The receiver must submit to this deduction by the payer and is deemed to have received the amount deducted. The amount deducted is, however, deemed to be income tax paid to the Revenue by the receiver. The procedure does not involve a withholding tax. The payer is entitled to retain, as against the Revenue, the amount deducted. He remains liable to income tax, however, on the amount of the profits out of which the payment was made.
[2.192] The procedure will explain the form of the proceedings in some of the United Kingdom cases. In Church Commissioners the taxpayer, being a charity and exempt from tax, sought to recover from the Revenue the amount of tax it claimed was deemed to have been paid to the Revenue, and the question was whether the Church Commissioners had received annual payments that were income in their hands. In an Australian context, it might be thought curious that a taxpayer was asserting that it had derived income. In Foley v. Fletcher (1858) 3 H. & N. 769; 157 E.R. 678 the seller of property sought to recover from the buyer who was liable to make payments to her, the full amount of those payments, asserting that those payments were not annual payments subject to the income tax in her hands, but instalment payments of the sale price. The buyer was not therefore entitled to deduct and retain out of each payment a sum representing the amount of income tax on it. An income tax issue was thus raised in proceedings that did not involve the Revenue. In Vestey v. I.R.C. [1962] Ch. 861 the proceedings were between taxpayer and Revenue but concerned not income tax but surtax—an additional levy of tax on income, to which the s. 52 procedure had no application. The taxpayer claimed that the receipts in respect of shares sold were instalment receipts of the price payable for the shares, and not annual payments. In this instance the taxpayer was asserting he had not derived income, and the proceedings are not curious if seen in an Australian context. The proceedings in Secretary of State in Council of India v. Scoble [1903] A.C. 299 were like those in Foley v. Fletcher. The person entitled to the payments claimed they were not income as annual payments, and he was entitled to recover their full amount: the Secretary of State was not entitled to deduct an amount representing income tax. I.R.C. v. Ramsay (1935) 20 T.C. 79 was concerned with the liability to surtax of a person making payments in respect of the purchase of a dental practice. At the time of the payments, amounts paid that were annual payments and income of the receiver were deductible by the payer in the determination of his liability to surtax. The issue was one between the payer and the Revenue, not as to whether the payer was entitled to “deduct and retain” as against the receiver under the s. 52 procedure, but as to whether the payer, as against the Revenue was entitled to a deduction, in the Australian sense of an allowable deduction, of the payments he had made to the seller of the practice.
[2.193] Land Securities Investment Trust Ltd [1969] 1 W.L.R. 604 concerned the company’s liability to profits tax—a tax now replaced by corporation tax. The fact that the payments made to the Church Commissioners were, as ultimately found, annual payments and income of Church Commissioners was irrelevant in determining the amount on which Land Securities was subject to profits tax. The question was whether Land Securities was entitled to deductions—in the Australian sense of allowable deductions—against the Revenue of the amounts paid. That question had to be resolved in terms of whether the payments were revenue expenses of deriving the rents from the reversions Land Securities had acquired from Church Commissioners, or were expenses of acquiring those reversions and thus capital expenses.
[2.194] The Australian cases, Just (1949) 23 A.L.J 47 and Egerton-Warburton (1934) 51 C.L.R. 568 may be thought to show little reluctance to let the periodicity principle operate, and this notwithstanding that s. 27H (or its earlier equivalent) was held in each case not to be available to correct an operation of the principle which will include in income an amount that is not a gain.
[2.195] The United Kingdom cases, in seeking to find the first analysis appropriate, rather than the second or third, have given almost ritualistic significance to the mention in the transaction of what is called “a fixed gross sum”. There will always be a fixed sum indicated where the payments are made to discharge an existing debt, and it is highly likely that there will be a specification of a fixed sum in the case of a sale of property or a surrender of rights, more especially when the legal adviser to the seller has read the cases. Where there is a fixed sum, and the payments to be made are certain in amount and number, Foley v. Fletcher (1853) 3 H. & N. 769; 157 E.R. 678 is acknowledged authority that the payments are instalment payments of that fixed sum, whether or not there can be said to be any obligation to pay the fixed sum, as distinct from an obligation to make the series of payments: the fixed amount may not in any respect control the right to the series of payments.
[2.196] And Foley v. Fletcher must be taken to have decided that where payments are certain in amount and number, and they are expressed to be payments of a fixed gross sum being the purchase price of property, the form of instalment payments of the purchase price of property prevails, and there is no room for the operation of the periodicity principle.
[2.197] Foley v. Fletcher is in some contrast with the Australian authority in C. of T. (Vic.) v. Phillips (1936) 55 C.L.R. 144. As in Foley v. Fletcher there was mention of a fixed sum, but this, Dixon and Evatt JJ. observed, was only the “arithmetical equivalent” of the payments to be made (at 156). Default in payment of any of the agreed amounts would not have brought the fixed sum into operation, for example by requiring payment of the balance forthwith as in the United Kingdom decision, Vestey v. I.R.C. [1962] Ch. 861. Phillips is thus authority for Australia that the mere mention of a fixed sum does not exclude the second or third analysis. Phillips may differ from Foley v. Fletcher in another respect. Even if there had been a provision in the agreement for repayment forthwith of the balance on default in payment of any one amount, so that the fixed sum controlled, the court might yet have been disposed to find that the competition of forms should be resolved by holding the receipts to be periodical.
[2.198] The phrase “fixed gross sum” is misleading in the inclusion of the word “gross”. It might indeed suggest the arithmetical sum of a series of payments which Phillips rejects as having no relevance. The phrase appears in a much quoted passage from the judgment of Walton J. in Chadwick v. Pearl Life Insurance Co. [1905] 2 K.B. 507 at 514:
“It is obvious that there will be cases in which it will be very difficult to distinguish between an agreement to pay a debt by instalments, and an agreement for good consideration to make certain annual payments for a fixed number of years. In the one case there is an agreement for good consideration to pay a fixed gross amount and to pay it by instalments; in the other there is an agreement for good consideration not to pay any fixed gross amount, but to make a certain, or it may be an uncertain, number of annual payments. The distinction is a fine one, and seems to depend on whether the agreement between the parties involves an obligation to pay a fixed gross sum.”
The reference at the end of the passage to “an obligation to pay a fixed gross sum” may suggest some questioning of Foley v. Fletcher. In Vestey v. I.R.C. [1962] Ch. 861 there was clearly a continuing obligation to pay the fixed sum—albeit a sum calculated by adding together the payments in the series—for there was provision for payment of the balance of the sum, if there was default in payment of any instalment. Cross J. accepted Foley v. Fletcher as authority that bound him to hold that periodicity did not apply on the facts before him. In the course of his judgment he said (at 874): “… I do not think that the fact that the period here is far longer than that in Foley v. Fletcher is a good ground of distinction between the cases. The question, as I see it, is one of principle not of degree.” It might be thought that degree is an aspect of principle. A long term of payments favours periodicity in the resolution of a competition of forms by reference to the substance of the periodicity principle.
[2.199] In Foley v. Fletcher the second possible analysis would have been appropriate. The fixed sum could have been regarded as having been applied as the price of the series of payments. The case is authority against such an analysis where the payments are certain in amount and number. And it is supported in this respect by Secretary of State in Council of India v. Scoble [1903] A.C. 299. United Kingdom authority has, however, contemplated the application of the second analysis where the payments are not certain in number or amount. The leading case is I.R.C. v. Ramsay (1935) 20 T.C. 79. All members of the court thought it important to consider in what sense the payments, which were based on the profits of a professional practice, could be said to be instalment payments of the fixed sum specified as the sale price of the practice. The purchaser would in some events have been called on to pay an amount which would be the difference between the fixed sum and the total of the payments that had been made up to the time of the event. The fixed sum thus “controlled” the series of payments. It was not “otiose” or “redundant” or “surplusage”. It was a figure which “permeated” the whole contract.
[2.200] On the question of how a competition of forms is to be resolved, I.R.C. v. Ramsay is unhelpful. Lord Wright’s reference to the substance of the transaction suggests that the competition could still have been resolved in favour of the application of the periodicity principle. Romer and Greene L.JJ., on the other hand, would appear to take the view that once the competing form is established, periodicity is excluded.
[2.201] Where the number or amount of the payments is uncertain and the debt or fixed sum will not in any circumstances control what has to be paid, as in Dott v. Brown [1936] 1 All E.R. 543, the second or third analysis is clearly appropriate. In Dott v. Brown the agreement provided for discharge of an existing debt by an undertaking to make a series of payments. The payments would continue until the death of the creditor, but cease at that time. The only relevant form was a series of receipts, and at first sight that series was indistinguishable from a life annuity payable by a life insurance company. Yet the Court of Appeal held that the receipts did not attract the periodicity principle. The judgment of Scott L.J. with which the other members of the court agreed, is punctuated with assertions that the character of the receipts had to be determined by reference to the substance of the matter. He said (at 548): “A consideration of the cases shows that you have to examine the details of the particular transaction out of which the payment arises and make up your mind as to the substance of it—the reality of it.” The case is thus authority that the absence of any competing form does not require that a series of receipts should be treated as periodical, at least where there is a pre-existing debt which is discharged in the transaction out of which the receipts arise.
[2.202] The assertions of the need to look at substance are not however accompanied by any indication of what it is in the substance of the law that will justify treating a series of receipts as attracting the periodicity principle. If the relevant substance is that suggested by the judgment in Dixon (1952) 86 C.L.R. 540, more especially if it is only a matter of requiring an objective inference of dependence and purpose, the conclusion reached by the Court of Appeal is difficult to support.
[2.203] Where the payments are held not to be periodical because the competing form of instalment payments of a fixed sum prevails, a question arises as to whether any part of a payment may be treated as income of the person receiving it, as interest, within Proposition 12. Part of each receipt was treated as income for this reason in Secretary of State in Council of India v. Scoble [1903] A.C. 299, Vestey v. I.R.C. [1962] Ch. 861 and Beck v. Lord Howard de Walden (1940) 23 T.C. 384. The matter is considered further in the discussion of Proposition 12.
[2.204] The third possible analysis involves a series of payments which are themselves the consideration for the sale of property, or the consideration for the surrender of rights. The only relevant form is a series of receipts. Two Australian cases Just (1949) 23 A.L.J. 47 and Egerton-Warburton (1934) 51 C.L.R. 568 and one United Kingdom case, I.R.C. v. Church Commissioners for England [1977] A.C. 329 admit of this analysis. In all of them the receipts were held to attract the periodicity principle. In Church Commissioners property was sold for a rent charge. At some stage of the negotiations a present value of the rent charge was calculated, but the agreement did not in its terms provide for payment of this amount. In Just there was mention in the agreement of an amount as the value of the property for stamp duty purposes, but no provision of the agreement required payment of this amount. In Egerton-Warburton there was no mention of a fixed amount in any connection.
[2.205] There is some acknowledgment in these cases of the significance that might have been given to the mention of a fixed sum as a purchase price. Webb J. in Just seems to have thought that this would necessarily have excluded the principle of periodicity, even though the second analysis was appropriate. It has been seen that a ritual significance in the mention of a fixed sum is not a necessary conclusion at least from the Australian authority in C. of T. (Vic.) v. Phillips (1936) 55 C.L.R. 144.
[2.206] The question remains whether the form of a series of receipts is sovereign when there is no alternative form because the third analysis is appropriate. Dott v. Brown may be seen as persuasive authority that it is not. It is yet possible to conclude that, in substance, the series of receipts are not within the periodicity principle. The payments in Egerton-Warburton—an annuity to a father who had sold his farm to his sons—were clearly within the substance of the periodicity principle, if this is a matter of objective inference of dependence and purpose. And the payments in Church Commissioners may be within the substance of the periodicity principle if that principle is adapted to the situation of derivation by an entity that is a charity. Some further adapting of the substance of the principle will be necessary so that a trustee might be held to derive receipts that are within that principle. Just creates more difficulty. The relevant substance, however it is adapted, does not appear to be engaged. It may be that there is another aspect of the periodicity principle which will explain Just: where the amounts of a series of payments are calculated by reference to income receipts of the payer, the income quality of the receipts by the payer may be transferred to the series of payments. In Cliffs International Inc. (1979) 142 C.L.R. 140, Barwick C.J. ventured an observation that where a taxpayer has sold shares in exchange for payments calculated by reference to the exploitation of mining rights owned by the company whose shares were sold—an amount per ton of ore taken—the payments when received will be his income (at 151). There may be another basis—in Proposition 12—for a conclusion that the receipts in Cliffs are income but the character of the receipts in Just will continue to require explanation. Just involved payments of an amount calculated by reference to income being rents derived by the payer from property which was only in part the property sold. In Cliffs the payments were calculated as a fixed amount per ton of ore taken from the mine. In fact the purchaser did not itself work the mine: the payments were made from royalty income it received from others who were licensed to work the mine. Just and Cliffs in the explanation presently considered, might draw support from Jones v. I.R.C. [1920] 1 K.B. 711. The notion of transfer of income character may explain Just (1949) 23 A.L.J. 47, Cliffs and Jones v. I.R.C., though it does not sit easily with Proposition 3 [2.34]–[2.37], above. It might be thought to be a consequence of that proposition that a payment made to a taxpayer from income derived by another does not carry its income character into the hands of the taxpayer. But where payments are received under an agreement for sharing profits, there is room for an argument that the receipts are for the purpose of providing the receiver with “an income”, and are income of the receiver on the periodicity principle.
[2.207] One might ask whether receipts under a profit sharing arrangement, of the kind with which Van den Berghs Ltd v. Clark [1935] A.C. 431 was concerned, will be income of the receiver. The periodicity principle may be wide enough to embrace such receipts. Where the arrangement is reciprocal, so that a taxpayer who receives in one year may in another year be required to make a payment to the other party to the arrangement, deductibility of the payment may be explained on the basis that it is an outgoing in gaining the periodical receipts that are income in other years. Where the arrangement is not reciprocal, deductibility of the payments is difficult to justify. In Colonial Mutual Life Assurance Society Ltd (1953) 89 C.L.R. 428 the company making the payments to the person who was the taxpayer in Just was denied a deduction of the payments on the ground that they were the price of a structural asset. A deduction was allowed of the payments in Cliffs but in the special circumstances that the payments would have to be made over the whole period that the property acquired would be income producing. The special circumstances justified a conclusion that the payments were not made as consideration for the property acquired but for the use of that property. In the latter character, they were working expenses.
[2.208] A transaction which is the purchase from another of a series of promissory notes given by that other, is in form the purchase of a series of receipts. There is no competing form, though commercially the transaction would be seen as involving repayments of a loan. One of the transactions in Beck v. Lord Howard de Walden (1940) 23 T.C. 384 was of this kind, though there were associated transactions under which promissory notes were given in exchange for the release of obligations owed to the taxpayer by the company giving the notes. Wrottesley J. gave some consideration to the possibility that the receipts in these transactions were wholly income as periodical receipts. In concluding that they were not, he did not give reasons, being content to cite the authority of Foley v. Fletcher (1853) 3 H. & N. 769; 157 E.R. 678; Secretary of State in Council of India v. Scoble [1903] A.C. 299; Perrin v. Dickson [1930] 1 K.B. 107; I.R.C. v. Ramsay (1935) 20 T.C. 79. An investigation of the substance of the principle of periodicity would have been helpful. Perrin v. Dickson is a case equally lacking in any statement of reasons why the series of receipts were not income, beyond an assertion that they were not income because they were repayments of an investment. That assertion may carry with it an inference that the series of receipts did not have the purpose of providing the taxpayer with “an income”. A similar reason might be given to explain why the receipts in Lord Howard de Walden were not income. The taxpayer in Perrin had made a series of payments to a life insurance company, under a contract by which he would be entitled to payments over several years of the life of his son. The payments to be made by the company were calculated so as to give the taxpayer a return of 3 per cent compound interest on the payments he had made to the company. If the son did not survive to the relevant years, the taxpayer was to receive back what he had paid without interest. Lord Hanworth M.R. remarked (at 119):
“I do not feel at all pressed with the observations that the effect of the decision will be to release all annuities for a fixed term of years from income tax. The immunity will be given only in proper cases in which an attempt is being made wrongly to tax capital under statutes which are intended to charge income and income only, for … it cannot be taken that the legislature meant to impose a duty on that which is not profit derived from property, but the price of it.”
[2.209] If a series of receipts are income as periodical receipts, they will, it seems, be income as to the whole of each of their amounts. There may yet be room for an argument, based on a principle that an item is income only to the extent that it is a gain, which would assert that an outlay to acquire the right to periodical receipts should be spread over the series of receipts and subtracted in determining how much of each receipt is income. It has however been conceded in this Volume that, having regard to the express provisions in s. 27H, such an argument is unlikely to prevail.
[2.210] Once it is accepted that receipts are periodical receipts, it is not appropriate to treat any part of a receipt as having the character of interest on an amount receivable. Such an analysis is appropriate only when it has been concluded that the receipts are not periodical receipts. It might be thought to follow that amounts paid which are periodical receipts in the hands of the receiver, do not involve any element of interest paid by the person making the payments. A payment should not be seen as having been made by the payer for the use of the payee’s money, unless it is treated as having been received by the payee for the use of the payees’ money. In I.R.C. v. Land Securities Investment Trust Ltd [1969] 1 W.L.R. 604 such a view was taken by Lord Donovan. The case concerned a question of deductibility by the payer of amounts that were held to be periodical receipts of the payee in I.R.C. v. Church Commissioners for England [1977] A.C. 329. Cross J. at first instance had held that the payments could be dissected into capital and interest components for purposes of deciding the question of deductibility by the payer, and the interest component allowed as a deduction. Lord Donovan in the House of Lords (at 612) questioned the conclusion reached by Cross J.:
“Cross J. in the Chancery Division thought that the rent charges could, for the purposes of tax only, be dissected into capital and interest components and the latter alone allowed as a deduction. In this respect he considered that the present case was similar to Secretary of State in Council of India v. Scoble [1903] A.C. 299; and Vestey v. I.R.C. [1962] Ch. 861. Like the Court of Appeal I do not think these cases are really in point. In the former a capital sum had been agreed as the purchase price, and the inference could be drawn that the so-called “annuity” was the payment of this sum by instalments together with interest. Cross J. was able to draw a like inference in the latter case. But in the present, it is common ground that no such capital sum was agreed beforehand.”
The conclusion that the payments were periodical receipts thus precluded a conclusion that any parts of them were deductible as interest.
[2.211] A conclusion that the payments are periodical receipts in the hands of the payee does not however exclude the possibility that the payments are deductible on some basis other than payments of interest. In Cliffs International Inc. (1979) 142 C.L.R. 140 the deductibility of the payments can be explained in terms that they were payments for the use of property. That view of the facts offered a basis for a conclusion that they were income of the payee, in addition to the basis that they were periodical receipts of the payee.
[2.212] Tilley v. Wales [1943] A.C. 386 is authority that a single sum received in commutation of periodical receipts is not ordinarily income. The compensation receipts principle (Proposition 15) will not give an income character to a receipt for the relinquishment of a capital asset, and a right to periodical receipts will almost certainly be such an asset.
[2.213] The situation is different, however, when the commutation amount itself is a series of receipts. If a taxpayer receiving a pension agrees to accept commutation in the form of a different series of receipts, the new series could be held to be income as compensation receipts, even though the new series would not in themselves be income as periodical receipts—the number of receipts in the new series and the period over which they are to be received may be such that the periodicity principle is not satisfied. A taxpayer may have commuted a life pension for several annual payments, seeking thereby to escape s. 26(d) (now replaced by Subdiv. AA of Div. 2 of Pt III) in its operation on commutation receipts as in McIntosh (1979) 79 A.T.C. 4325. There will be questions of how far the new series must approximate the former series for the compensation receipts principle to be attracted. C. of T. (Vic.) v. Phillips (1936) 55 C.L.R. 144 and, more recently D. P. Smith (1981) 147 C.L.R. 578 may assist in answering this question. Harris (1980) 80 A.T.C. 4238, considered in [2.147–[2.156] above offers but little assistance.
[2.214] To the extent that a commutation receipt is not income, it affords a means of correcting the tax consequences of having purchased periodical receipts in circumstances to which the “purchase price” provisions of s. 27H—considered in [2.215]ff. and [4.106]ff. below—have no applications. Such a policy justification of a conclusion that a commutation receipt is not income by ordinary usage is not relevant if the periodical receipts that were commuted can be seen as having been an alternative to a single receipt that would have been income. Subdivision AA of Div. 2 of Pt III substantially extends the range of single receipts that are income, by its provisions in s. 27B and s. 27C applicable to payments made in consequence of the termination of any employment of a taxpayer, and payments made from a superannuation fund in respect of a taxpayer. Where the taxpayer receives an annuity that is a termination payment or a payment from a superannuation fund, there is provision within the definition of an “eligible termination payment” (in paras (d) and (g) of s. 27A(1)) by which an amount received in commutation of the annuity is income taxable under the special provisions of s. 27B and s. 27C. Unfortunately, however, para. (g) of the definition, and ss 27B and 27C have the effect of making a commutation receipt in respect of an annuity income where the annuity arose in the circumstances of Just (1949) 23 A.L.J. 47 and Egerton-Warburton (1934) 51 C.L.R. 568. An argument might have been made that there is no “eligible service period” (defined in s. 27A(1)) in such circumstances, and there must be such if s. 27B or s. 27C is to operate. But para. (d)(ii) of the definition of “eligible service period” supplies such a period if the annuity was purchased.
[2.215] Section 27H(1) (replacing the former s. 26AA(1)) gives the character of income to the amount of any “annuity”, excluding, in the case of an annuity that has been purchased, any amount that is the “deductible amount” in accordance with s. 27H(2) and (3). The deductible amount is calculated by reference to the “undeducted purchase price” of the annuity. “Undeducted purchase price” is defined in s. 27A(1). The general effect of that definition is that the “undeducted purchase price” is the purchase price less any part of that purchase price that has been or will be an allowable deduction. “Purchase price” is defined in terms of payments made to purchase the annuity, or where the annuity is a superannuation pension, contributions to a superannuation fund to obtain the superannuation pension less any part of those contributions that has been or will be an allowable deduction. A transfer of property, as in Just (1949) 23 A.L.J. 47, will be a payment. This is the effect of subs. (8) of s. 27A, or alternatively, s. 21.
[2.216] Two questions are raised by these provisions. The first concerns the possible effect of s. 27H to extend the range of series of receipts which will have the character of income, beyond the range determined by the ordinary usage notion of periodical receipts. The second concerns the possible interpretation of the word “annuity” used in the section so that it involves a more limited notion than the notion of periodical receipts that are within the periodical receipts principle.
[2.217] In Secretary of State in Council of India v. Scoble [1903] A.C. 299 and in Perrin v. Dickson [1930] 1 K.B. 107 receipts described in the documents providing for their payment as “annuities” were held not to be periodical receipts. It is apparent that in some usage the word “annuity” has a wider meaning than the notion of periodical receipts. That usage would, possibly, embrace any series of receipts. The prospect that the adoption of a wider meaning would, through s. 27H, increase the operation of the law in bringing in amounts which are not gains, is likely to inhibit the adoption of that wider meaning for the word as it is used in s. 27H.
[2.218] There is some authority which would indicate that the word “annuity” as it was used in s. 26AA(1) had in one respect a narrower meaning than periodical receipts. In Deputy Federal Commissioner of Land Tax v. Hindmarsh (1912) 14 C.L.R. 334, a case concerned with the use of the word in a statute imposing land tax, the High Court held by majority that the word should be given a technical construction drawn from Coke on Littleton, so that it will be confined to a series of receipts each of a sum certain and, presumably, the same sum certain. A like construction of the word in its use in s. 27H would significantly narrow the operation of the “purchase price” provisions of s. 27H. The purchase price provisions would have no application to a series of receipts of amounts indexed by reference to a measure of the purchasing power of money. It may be noted that Kelly J. in Knight (1983) 83 A.T.C. 4096 declined to give the word “annuity”, as it was used in s. 26AA(1), a meaning that would exclude an indexed annuity.
[2.219] The drafting of s. 27H may in any event justify a meaning for the word annuity that does include a series of receipts whose amounts are not sums certain. Section 27H(4) defines annuity for purposes of the section so that it includes “a superannuation pension”. A superannuation pension may be an indexed pension, and this circumstance may justify a meaning of the word annuity in other contexts that will include amounts that are not sums certain. At least this is one line of reasoning. It would be conceded that another line of reasoning is possible that would argue that the express inclusion of superannuation pensions, which are likely to be indexed, indicates an assumption that other indexed periodical receipts are not included by the word “annuity”.
[2.220] Webb J. in Just (1949) 23 A.L.J. 47 assumed that the word “annuity” in a section that was a predecessor of ss 26AA and 27H did extend to receipts that were not sums certain. At the same time Webb J. construed the mitigation provisions of the section in a way that restricted their availability. His judgment may be thought to mix two notions of purchase price. It has been seen that where property is sold under an agreement which provides for payment of a series of receipts, those receipts may avoid the character of periodical receipts if there is a fixed sum expressed in the agreement as the purchase price of the property. The absence of any statement of a purchase price in this sense was relevant to Webb J.’s conclusion that the series of receipts were periodical receipts. But the absence of any statement of such a purchase price does not require a conclusion that the periodical receipts did not have a purchase price. The price of the periodical receipts was the land conveyed in exchange for those receipts. That price was not in money, but s. 21 provides that where any consideration is given otherwise than in cash, the money value of that consideration shall be deemed to have been given. There is now, as already noted, an express provision having the same effect in s. 27A(8), in relation to s. 27H.
[2.221] It is true that Egerton-Warburton (1934) 51 C.L.R. 568 also involved the conclusion that there was no identifiable purchase price of the periodical receipts. But in that case the land had been sold in exchange for several promises—to pay annuities in succession to the seller and his wife, and to make a payment to be divided among their daughters. It is clear that the High Court was ready to treat the value of the land as undeducted purchase price, but it was unable to apportion that value between the several promises, so as to determine an undeducted purchase price of the annuity to be received by the seller.
[2.222] Where the analysis of the circumstances is the second analysis explained in [2.189] above, it may be appropriate to treat the specified fixed sum as the purchase price of the periodical receipts. But in this regard a distinction should be drawn between the two situations referred to in explaining the second analysis. If there are in fact two distinct transactions, the specified fixed amount to which the taxpayer is entitled under the first transaction may be treated as purchase price. But where there are two transactions telescoped into one, treating the fixed amount as the purchase price for purposes of s. 27H will open the prospect of tax planning to exploit s. 27H so that it is used to preclude the taxing of what are in fact gains. The fixed amount may be set at a figure which will ensure that the element of gain in the periodical receipts will be excluded from tax. The fixed amount may be set at a figure which is equal to the sum of the periodical receipts anticipated. It ought not to be beyond judicial construction of the words “purchase price” in s. 27H to hold in these circumstances that the value of the property sold is the purchase price of the periodical receipts.
[2.223] Were it not for words now added to s. 25(1), to which reference was made in [1.39] above, it would be the most likely construction of s. 27H that it is intended to cover the field of receipts that may be income in virtue of their periodicity. It would follow that the ordinary usage meaning of income is displaced to the extent that it would bring about the inclusion in assessable income of that part of an annuity receipt which is not made income by s. 27H—that part which is excluded as a “deductible amount”. The words added to s. 25(1) in 1984, expressly excluding the operation of that section in relation, inter alia, to “eligible termination payments”, might have left the provisions of Subdiv. AA relating to eligible termination payments to operate as a code. But, by inference, they appear to have excluded the possibility that s. 27H operates as a code. The consequence may now be inescapable that a receipt of an amount of an annuity is income as to the whole of its amount, if it is a receipt within the ordinary usage meaning of income, unabated by any exclusion of a part of the purchase price of the annuity.
The operation of s. 262 of the Assessment Act in determining whether the whole or part of a series of receipts is income is not the subject of any judicial decision. The section applies “Where under any contract agreement or arrangement … a person assigns, conveys, transfers or disposes of any property on terms and conditions which include the payment for the assignment, conveyance, transfer or disposal of the property by periodical payments”. It would appear, on a literal reading, to give the Commissioner a power to attribute the quality of income to the whole or part of such payments by forming the opinion that they are wholly or in part “really in the nature of income”. The section was not referred to in Egerton-Warburton or Just. The predecessor of the section in the 1922 Act was the subject of a submission in Californian Oil Products Ltd (In Liquidation) (1934) 52 C.L.R. 28, but the judgments in that case provide no assistance in the interpretation of the section.
[2.225] It may be assumed that the section would not be construed so as to give the Commisioner a power to attribute the quality of income to a receipt. The section must however have some operation in displacing McLaurin (1961) 104 C.L.R. 381 and Allsop (1965) 113 C.L.R. 341 discussed in [2.558]-[2.570] below in relation to Proposition 15, which allow very little room for separating out an income element from a composite receipt. In this operation the section may enable the Commissioner, despite McLaurin and Allsop, to follow United Kingdom authority so as to separate out and bring to tax an interest element in an instalment payment of a purchase price of property, or perhaps in an instalment payment of a debt.
[2.226] Section 23(1) assumes that payments by way of alimony or maintenance will be income in the hands of the receiver as periodical receipts, and makes them exempt where they are received by a woman from her husband or former husband. The effect is to preclude what might be thought to be double taxation, when the husband has made the payments out of income which has been taxed to him. There is a proviso which denies the exemption when the payments are in effect made from income that has not been taxed to the husband. He may have shifted income by transferring to a trustee property which produces the income, or by making an assignment of income. The assignment will defeat the exemption only when the husband has “diverted from himself income upon which he would otherwise have been liable to tax”. The tax consequence of assignments is considered in Chapter 13. If the form of assignment adopted brings about a derivation of income by the husband, the exemption will not be affected.
[2.227] The section does not deal with payments received by a man from his wife or former wife, though the assumption in the section that such receipts are income in the case of receipt by a wife from a husband may be thought to extend to a like receipt by a husband from his wife. In form the receipts are a series and there is no competing forms. If an element of substance must be satisfied, the purpose of the payments may be seen as providing the receiver with money on which he might depend for regular expenditure upon himself.
A gain derived from property has the character of income.
[2.228] The operation of the principle that a gain derived from property is income is consistent with Proposition 4, though inflation may cause distortion in this context, as in others. The effect of inflation is considered generally in Chapter 15. The whole amount of interest received will be income notwithstanding that there has been a decline in real terms of the value of the principal sum. Indeed the whole amount will be income notwithstanding that the interest is less than the decline in value of the principal sum, so that in effect the taxpayer has suffered a loss.
[2.229] The principle reflects a metaphor which has its origin in the experience of an agricultural community. It expresses what, in the Memorandum of Dissent contained in the United Kingdom Royal Commission’s Final Report (p. 358), referred to in [1.47] above, is identified as “the ancient constricted conception of income as something which recurrently emerges and is separated off from its perpetual source, like the harvest from the soil, [which] has lingered in the tax code from times when, by and large, income was the harvest from the soil”.
[2.230] The metaphor is very evident in a frequently quoted passage from the judgment of Pitney J. in the United States Supreme Court in Eisner v. Macomber 252 U.S. 189 (1919) at 206-7:
“The fundamental relation of ‘capital’ to ‘income’ has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time …
… Here we have the essential matter: not a gain accruing to capital, not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value, proceeding from the property, severed from the capital however invested or employed, and coming in, being ‘derived’, that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal;—that is income derived from property. Nothing else answers the description.” (Emphasis in original.)
[2.231] The metaphor would suggest a principle wide enough to embrace gains which are not simply returns to an owner who waits passively for his return from property, but involve an input of effort to make the property yield a return, or to increase that return. Where gains arise at least in part from the effort of a taxpayer, it will be necessary to judge their income quality not only by Proposition 12, but also by Proposition 14. In its operation Proposition 14 may give an income quality to gains which are a realisation of an increment in value of property itself, and are not within Pitney J.’s formulation of the gains from property principle.
[2.232] In general, gains within Proposition 12 will be “passive” gains, in the sense that there will be minimal effort by the taxpayer beyond selection of an “investment”. But the distinction between passive gains and effort gains, or between unearned income, sometimes called investment income, and earned income, can never be definitively drawn without a degree of arbitrariness. The distinction is drawn in the Assessment Act in the definitions in s. 6 of “income from property” and “income from personal exertion”, the relevance of those definitions being confined to the operation of Div. 7 of Pt III concerned with the undistributed profits tax on private companies. It was drawn at one time for purposes of imposing a higher rate of tax on unearned income.
[2.233] The distinction took on significance, at least in the Federal Court, in Everett (1978) 78 A.T.C. 4595 ((1980) 143 C.L.R. 440, High Court). Division 6 of Pt III operates in relation to “net income of a trust estate”. There is some authority that “estate” should be equated with “property”, so that Div. 6 may only operate where there is property vested in the trustee from which income is derived. And, presumably, if there is such property, the Division will apply only to the income derived from it and to no other items. The Federal Court judgments wrestle with the question whether income attributable to a share in a partnership is income from a trust estate, or is income from personal exertion. Drawing the distinction between passive gains and effort gains in the context of the phrase “income of a trust estate”, seems especially inappropriate. The words are “of a trust estate” not “from a trust estate”. The use of the words in the drafting of Div. 6 may be thought to have been concerned with ensuring that the calculation is made by reference to an entity distinct from the person who is trustee, and not with restricting the kind of items to which the Division would apply. A view that “trust estate” refers to an entity might be thought to have been confirmed by the definition of a resident trust estate in s. 95(2) and by other recent drafting, for example the drafting in s. 26AAA(2A) and s. 25A(2) considered in Chapter 3. It is also confirmed by the Federal Court decision in Totledge (1982) 82 A.T.C. 4168.
[2.234] Gains derived from property include gains to which the words “dividends”, “interest”, “rent” and “royalties” may be appropriate. But the principle may have a wider operation. Reference has already been made to the question not resolved in Cliffs International Inc. (1979) 142 C.L.R. 140 —whether those who sold the shares, and thus the mine, derived income when they received payments from the buyer calculated by reference to the amount of ore taken from the mine. In addition to the periodical receipts principle (Proposition 11), already discussed, and the compensation receipts principle (Proposition 15), yet to be considered, the gains from property principle may make those receipts income.
[2.235] The ordinary usage notion of a dividend as an item of income derived from property has been examined in Australian authorities as an aspect of the interpretation of s. 44(1) and s. 47. Section 44(1) gives an income character to a dividend paid to a shareholder in a company, if it is paid out of profits derived by the company. “Dividend” is defined in s. 6 so that it includes, inter alia, any distribution by the company to a shareholder “whether in money or other property”. “Shareholder” includes member or stockholder. Section 47 gives an income character to a distribution by a company in a formal liquidation where the distribution represents income derived by the company. The distribution is deemed to be dividends paid by the company out of profits.
[2.236] In the interpretation of s. 44(1) and the definition of dividend in s. 6, the Australian courts have drawn heavily on an assumed notion of a dividend as an item of income by ordinary usage. They have not, however, decided that an item is income for purposes of the Assessment Act simply because it fits this assumed notion.
[2.237] Three matters arise for consideration:
[2.238] The notion of a dividend that is an item of income by ordinary usage may be inferred from a number of observations made by the High Court in relation to the notion of a dividend that is income under Subdiv. D of Div. 2 of Pt III of the Assessment Act. These observations reflect a fundamental distinction between a receipt in satisfaction of rights which make up the taxpayer’s property in a share, and a receipt which is derived from that property. The latter, in the metaphor of Eisner v. Macomber 252 U.S. 189 (1919), is fruit of that property, or in another metaphor, produce of that property, and income. The observations include the following:
“If the … company had detached any part of its profits and distributed that part among shareholders, the portion received by each shareholder would have become part of the income of such shareholder”: per Knox C.J., Gavan Duffy and Starke JJ. in Webb (1922) 30 C.L.R. 450 at 461. “[There will be a dividend if] profits are … detached, released or liberated, leaving the share intact as a piece of property”: per Rich, Dixon and McTiernan JJ. in Stevenson (1937) 59 C.L.R. 80 at 99. “[There must be a] detachment or severance from the funds of the company of money or other assets as representing a profit made by the company. [In the present case] there was simply a realisation of a share investment”: per Fullagar J. in Blakely (1951) 82 C.L.R. 388 at 407. “[There must be a] distribution of moneys as the produce of shares which should remain nevertheless intact”: per Kitto J. in Uther (1965) 112 C.L.R. 630 at 634.
The notion requires that one examine a distribution, at least primarily, from the point of view of the shareholder to ascertain whether the item is a receipt that comes to him as produce of his shares, as distinct from a receipt that comes to him in satisfaction in whole or in part, of the rights which make up his share. The concept of rights which make up the share presents some difficulty. The right to a dividend, or, more accurately, the expectation of a dividend is part of the rights which make up a share. Yet a dividend once declared is clearly produce. It seems that a receipt is a receipt in satisfaction of a right to dividends, and is not produce, only if it is in extinguishment, in whole or in part, of the right to dividends. Conceivably, a company might make a payment to a shareholder in extinguishment, in whole or in part, of his right to dividends carried by his shares. The right to a return of capital is a right which makes up a share. Uther is authority. A receipt of a payment by which the right to a return of capital is wholly or partly extinguished cannot, it seems, be produce of a share.
[2.239] The observations quoted in the preceding paragraph are all concerned with a company that has a share capital. Where a company does not have a share capital, the distinction between produce of a share and a receipt in payment to a shareholder for his shareholding may not admit of a simple rewriting in terms of produce of membership and a payment to a member for his membership. The judgment of Dawson J. in Slater Holdings Ltd (No. 2) (1984) 84 A.T.C. 4883, and the judgment of Gibbs C.J. with which Dawson J. and all the other members of the court agreed, leave the impression that a receipt by a member in winding up may be seen as a payment for his membership, but a receipt while the company is a going-concern cannot be seen in this way. The payment in Slater Holdings (No. 2) had been made to the taxpayer, who was a member, in pursuance of one of the company’s articles that provided that the company might make a payment “upon a person ceasing to be a member”. Dawson J. said (at 4890):
“Under s. 47, of course, a distribution by the liquidator in the course of a winding up would be deemed to be a dividend paid to the member by the company out of profits derived by it. But the payment of an amount by the company when the company was clearly not being wound up could not represent a payment for property in the sense that payment to a shareholder of his proportion of the surplus assets of a company might be regarded as payment for his shareholding and the replacement of one capital asset in his hands with another. No res ceased to exist by reason of payment by the company to the taxpayer in this case.”
The description of the effect of s. 47 is hardly an accurate statement. In any case it is not directly relevant to the question whether a distribution in liquidation is a distribution in satisfacton of the rights of a member and thus not produce. And the observation in regard to a payment when a company is not being wound up may go further than Dawson J. intended. A payment to a member under an article which provided for the making of a payment, and provided that the member would on that payment cease to be a member, may be treated differently from the actual payment in Slater Holdings (No. 2).
[2.240] The observations quoted in [2.238] above, involve another element—that the distribution has been made “out of profits”. This element requires that the matter be looked at from the company’s point of view, so as to determine the source of the produce of the shares. There is a tendency in some of the observations to assume that produce to the shareholder must necessarily be from profits of the company, perhaps because the company law principle of maintenance of capital will generally demand that it be so. But a notion of a dividend that is income for tax purposes cannot be confined to distributions that involve the company law principle. The notion must be relevant, for example, to an unlimited liability company.
[2.241] An ordinary usage notion of a dividend that is income could be imagined that will include in relation to any company, whether or not it has a share capital, an element requiring that a distribution have been made from profits. But the explanation of the observations quoted may be simply an importing into the interpretation of the definition of dividend in the Act elements drawn both from the ordinary usage notion and from the requirement “out of profits” that now appears in s. 44(1).
[2.242] Examination in the cases of the scope of the ordinary usage notion of a dividend that is income has been concentrated on distributions that have been expressed to be in reduction of share capital, or have been received by a shareholder in the appropriation of the company’s assets in an informal liquidation of the company. Uther (1965) 112 C.L.R. 630 is authority that the ordinary usage requirement that a distribution must be produce of shares was an essential element in the notion of a dividend as defined in the Assessment Act at the time of the decision. If that element was not satisfied there could not be a dividend as defined, even though the distribution could be said to be out of profits. In reaching the conclusion that the distribution in that case was not received as produce of the taxpayer’s shares, the majority in the High Court (Taylor and Menzies JJ.) took an extended form approach—an approach explained in [2.420]ff. above. The requirement that the receipt must be produce comes to be explained in a rule of contradistinction: that a receipt which is in satisfaction of a right to a return of paid-up capital is not produce of a share. The fact that the amount received greatly exceeded the amount by which the shareholder’s paid-up capital was reduced, did not allow a conclusion that some at least of what was received was produce of the share.
[2.243] Subsequent to Uther a new definition of dividend was inserted in s. 6. It may be inferred from the new definition that a return of paid-up capital is a dividend to the extent that the distribution is of an amount that exceeds the amount by which the amount paid-up on the share is reduced. A like provision is included to deal with the case where a share is cancelled or redeemed. To this extent the ordinary usage notion that a distribution to be income must be received as produce has been expurgated from the definition of dividend.
[2.224] The other cases in which the ordinary usage notion of a dividend that is income has been examined as an aspect of the definition of a dividend, concern liquidations, more especially informal liquidations. A distribution in formal liquidation is a distribution in satisfaction of the rights that make up a share. It is not produce. If a requirement that the distribution must be out of profits is an element of the ordinary usage notion, it cannot be satisfied, at least if the company law principle that a company ceases to have profits once a liquidation supervenes is regarded as applicable. Section 47 of the Assessment Act has made special provision in regard to formal liquidations which leaves no room for the ordinary usage notion, and denies any significance to the absence of profits, by substituting a requirement that distributions must represent “income”.
[2.245] Where the distribution is made in an informal liquidation as in Blakely (1951) 82 C.L.R. 388—a simple appropriation of the company’s assets by its shareholders or members—it is not so obvious that the notion of produce cannot be satisfied. The High Court in Blakely held that no part of the receipts by the shareholders were income as dividends out of profits. On one view of the judgments in that case, the decision rested not on the absence of an element of produce, but on the absence of profits whence the distributions could be made. The company law principle that a company in liquidation does not have profits was extended to the tax law of an informal liquidation.
[2.246] An argument that the amendments to the definition of dividend, made to overcome the decision in Uther, had written out the ordinary usage notion of produce from the meaning of dividend as defined in s. 6 did not have to be considered in Slater Holdings (No. 2) (1984) 84 A.T.C. 4883. The payment having regard to its form, could only be characterised as produce. The definition might now be thought to express the assumption made by para. (e) of the definition that a distribution in reduction of capital is a dividend, except to the extent that it is a distribution of the amount of capital expressed to be reduced. The exception would be unnecessary if a distribution by way of repayment by the company of moneys paid-up on a share were not otherwise a dividend. If a distribution by way of repayment by the company of moneys paid-up on a share is a dividend apart from the exception, it would appear to follow that a distribution paid to a member in full satisfaction of his rights as member is a dividend.
[2.247] Whether bonus shares or the amount appropriated to pay them up are income by the ordinary usage concept of income gave rise to differing opinions in W. E. Fuller Pty Ltd (1959) 101 C.L.R. 403. It might be thought that the form of the issue suggests a detachment which is received by the shareholder, transmogrified it is true into more shares, but none the less as the produce of his original shares. In substance, however, there is merely a reframing of the shareholder’s interest in the company, and this view has been taken by the United States Supreme Court in Eisner v. Macomber 252 U.S. 189 (1919) and by the House of Lords in I.R.C. v. Blott [1921] 2 A.C. 171. In Fuller all the judges agreed that the bonus shares were not income by the general usage concept. Fullagar and Menzies JJ. however, took the view that the amount of the notional distribution appropriated to pay-up the bonus shares was income by the general usage concept. But they did not have the support of Dixon C.J., whose view was upheld in Gibb (1966) 118 C.L.R. 628. The question whether rights or options issued to a shareholder as shareholder are ordinary usage income of the shareholder as income derived from his shares has not been considered in any authority. There might be thought to be a detachment from his shares as produce of his shares, though the notion of reframing of his interest is the more likely characterisation. In any case if a requirement that the distribution should be out of profits is an element of the ordinary usage notion of a dividend that is income, it is hard to see how that requirement could be said to be satisfied.
[2.248] A description of the ordinary usage notion of a dividend that is income may now be attempted. One aspect of the notion requires that the distribution received should be produce of a taxpayer’s shares or his membership of the company. In the application of this notion the High Court has taken an extended form approach. That approach assumes a rule defining the scope of the notion. The rule would assert that a receipt which is in terms the consideration for the surrender or the extinguishment of rights which make up a share or a membership is not a dividend that is income. A view of the facts that reflects a commercial judgment that the distribution is in part, indeed that it is almost entirely, produce of a share or membership is irrelevant. Such a view might well have been taken of the facts in Uther (1965) 112 C.L.R. 630. If the form of the distribution is not a payment for the surrender or extinguishment of rights which make up a share or membership, it will be held to be produce of the share or membership. If there is no attempt to cast a distribution in any form, a commercial judgment will prevail. This is the effect of Blakely, in which the appropriation of the assets of the company by its shareholders was treated as a distribution in extinguishment of rights as shareholders.
[2.249] There has been no discussion in the authorities of a further element in the ordinary usage notion of a dividend that is income, which may require that the distribution must be out of profits. Such an element is suggested by the statements quoted in [2.238] above. It may be that a distribution that is in form produce—there is a distribution but no surrender or extinguishment of rights—is not an ordinary usage dividend unless it is, in some sense, out of profits. One possible sense is the accounting notion of a debit to a profit account. Another sense would cover any distribution that is produce if there are profits to support it, whatever be the accounting debit. The law of maintenance of capital would suggest the second sense in the case of a company that is subject to that law. But it would not suggest it where the company is not subject to that law. The company may be an unlimited liability company or an unincorporated association.
[2.250] Some detail of the specific provisions will have emerged from the discussion in [2.238]-[2.249] above. The detail may be summarised in a number of propositions. A distribution to a shareholder or member that is not in form or in commercial judgment made for the surrender of, or in extinguishment of, rights that make up a share or a membership of a company, and which is made out of profits, is income by the operation of s. 44(1) taken with the definition of dividend. The word “shareholder”, as defined in s. 6, includes a member. An issue of rights or options made to a shareholder as shareholder is presumably not made out of profits and is not income by the operation of s. 44(1).
[2.251] A distribution made to a shareholder that is in form or in commercial judgment for the surrender of, or in extinguishment of, rights making up a share may be income by specific provision if the distribution is by way of repayment by the company of moneys paid up on a share. It will be income to the extent that it exceeds the amount repaid by the distribution. The element of “out of profits” required by s. 44(1) is supplied by s. 44(1B).
[2.252] A distribution to a shareholder or member that is made in a formal liquidation of a company will be income to the extent that it represents income derived by the company (s. 47).
[2.253] A distribution that is made by a company in an informal liquidation, as in the facts of Blakely (1951) 82 C.L.R. 388, will not be income. This is to assume that the provisions of para. (e) in the definition of a dividend have not written out from the definition the requirement, imported from the concept of a dividend that is income by ordinary usage, that the distribution must be produce of a share or membership. It also assumes that distributions in an informal liquidation are distributions by the company, so that s. 47(2B) has no application. Section 47(2B) is based on a misreading of the decision in Blakely. That decision in fact proceeded on the basis that the appropriations by the shareholders were distributions by the company.
[2.254] A distribution made by a company to a shareholder which is debited against a share premium account of the company is not income. “Share premium account” for this purpose has the meaning it is given by the definition in s. 6. There is an exception provided for in subs. (4) of s. 6. Where that exception operates a distribution from the share premium account will be income. The element of “out of profits” is supplied by s. 44(1B).
[2.255] Statements about “distributions” in the above paragraphs are equally applicable to a “crediting” by a company to any of its shareholders or members. It follows that the amounts credited in the notional distributions made in a bonus issue will be income, if the crediting is made out of profits.
[2.256] A distribution or crediting must in all cases be made to a shareholder or member if it is to give rise to a dividend that is income under the specific provisions. “Shareholder” has a meaning established by the decision of the High Court in Patcorp Investments Ltd (1976) 140 C.L.R. 247 so that it is confined to a person who is registered as a shareholder or who is entitled against the company to be registered as a shareholder. “Member”, presumably, would be given a parallel meaning.
[2.257] A number of differences may be noted between the ordinary usage notion of income applicable to distributions by a company and the distributions that are income by the specific provisions. Thus, a distribution in a formal liquidation may be income by specific provision under s. 47. It is not income within the ordinary usage notion.
[2.258] A distribution in a formal reduction of capital may be income by specific provision under para. (e) of the definition of dividend and s. 44(1) and s. 44(1B). It is not income within the ordinary usage notion of income.
[2.259] A distribution (in this instance a crediting) in paying up shares issued as bonus shares may be income by specific provision (cf. s. 44(2)). A bonus issue, it seems, is not in any aspect within the ordinary usage notion.
[2.260] A distribution that is received by a taxpayer other than a shareholder or member is not income by specific provision. It may be income within the ordinary usage notion, where it is received by a taxpayer who is beneficially entitled to a share.
[2.261] A distribution from share premium account is not income by specific provision, save where subs. (4) of s. 6 applies, where the distribution is debited against an amount standing to the credit of a share premium account as defined in s. 6. Such a distribution may be income within the ordinary usage notion. In this instance a question is raised whether a distribution, to be income by ordinary usage, must be made from profits, and whether a share premium account is a profit account. Slater Holdings Ltd (No. 2) (1984) 84 A.T.C. 4883 may have increased the likelihood that a share premium account is a profit account. It was held that an amount received by a company by way of a gift is a profit for purposes of that word as it is used in s. 44(1) of the Assessment Act.
[2.262] Two situations were noted above where an item would be income if the ordinary usage concept of a dividend that is income could determine income character for the purposes of the Assessment Act. The items would be income though they are not income by the specific provisions of Subdiv. D. The items involve a distribution to a shareholder from a share premium account, and a distribution to a taxpayer who is not a shareholder.
[2.263] There may be other illustrations, if the ordinary usage notion of a dividend that is income does not require that the distribution be in some sense out of profits, or if any requirement that the distribution be out of profits is more easily satisfied than the like requirement in regard to a dividend that is income by specific provision of Subdiv. D. Section 44(1B) supplies the element of “out of profits” in some circumstances where Subdiv. D operates. For the rest, the meaning of the words “out of profits” is left in considerable doubt. Kitto J. in Uther (1965) 112 C.L.R. 630 was prepared to take the view that the words were satisfied, though the distribution did not fit any form that might be thought to be required by the words. In Uther the debit in the making of the distribution had been made to “a capital realisation account” which, in effect, amounted to the company standing mute as to the source, within company funds, of the distribution. An extended form approach might adopt an interpretation of the phrase “out of profits” suggested by para. (f) of the definition of “dividend” in s. 6, so that it would require a debit to a profit account. In which event standing mute would exclude a distribution being income under Subdiv. D. There is a suggestion in the judgment of Gibbs C.J. in Slater Holdings (No. 2) (1984) 84 A.T.C. 4883 that a payment will not be held to be out of profits unless it is made wholly out of profits. Gibbs C.J. said (at 4888):
“… what appears to be implicit in the judgment of Taylor J. in F.C.T. v. Uther is the suggestion that to come within s. 44(1)(a) the distribution must have been made wholly out of profits; it is not enough that there is a distribution of a mass of assets which contains profits. This view may be supported by the fact that the section does not refer to ‘dividends to the extent to which they were paid to him by the company out of profits’, since, in the light of the construction given to s. 51 of the Act, the inclusion of the phrase ‘to the extent to which’ would no doubt have allowed a dissection or apportionment to be made of the distribution. …”
The suggestion by Gibbs C.J. invites action by an unlimited liability company to make a distribution expressed to be partly from share capital and partly from revenue profits, and to refrain from any immediate accounting entries that would show debits to the relevant accounts.
[2.264] Whether the ordinary usage notion of a dividend does in any circumstances give an income character, for purposes of the Act, to a distribution will depend on the answers that are given to the question whether Subdiv. D is a code, and as to the field of that code. All the provisions of Subdiv. D, other than s. 45, relate to distributions to a shareholder or member, and a possible field for any code would be distributions to shareholders and members. Another possible field would be broader: it would extend to all distributions by a company.
[2.265] There is no case in which Subdiv. D has been held to be a code covering the field of distributions to shareholders and members. There is one authority in which the assumption appears to be that it is not such a code. Reference has been made to W. E. Fuller Pty Ltd (1959) 101 C.L.R. 403. The discussion in that case of the question whether a bonus issue is in any respect within the ordinary usage notion of income proceeds on the assumption that it could, in the relevant respect, be income for purposes of the Assessment Act, though the effect of s. 44(2) might be to make it exempt income.
[2.266] In all recent decisions the question whether an item would be within the ordinary usage notion of income has been raised in the interpretation of the provisions of Subdiv. D. A conclusion that the item was not within the ordinary usage notion became a conclusion that it was not income by force of the Subdivision. There is no inference to be drawn that if the item had been within the ordinary usage notion, it could have been income for purposes of the Act, otherwise than by the operation of Subdiv. D. It is, however, unlikely that a court would find that a distribution from share premium account is income for purposes of the Assessment Act as an item of income in ordinary usage, where it is expressly excluded from the distributions that are made income by Subdiv. D. The approach of the majority in Reseck (1975) 133 C.L.R. 45, an approach which in the present context would make Subdiv. D a code, is the more likely. It might be thought equally unlikely than an item will be held income for purposes of the Act if it satisfies a more flexible notion of “out of profits” than the notion which will satisfy Subdiv. D. All these observations are made without regard to the words added to s. 25(1) in 1984. While those words remain in s. 25(1), they carry a near inescapable inference that Subdiv. D cannot be a code covering the field of distributions to shareholders. The effect of those amendments is discussed at [2.223] above and [2.369] below.
[2.267] There is authority from which it may be inferred that Subdiv. D is not a code in relation to a distribution to a taxpayer who is not a shareholder. It was not questioned in Angus (1961) 105 C.L.R. 489 that the taxpayer had derived income in the receipt of a distribution by a company which the trustee for him, who was the shareholder, had directed the company to pay to him. There was a receipt by the taxpayer under the ordinary usage concept of income as produce of the beneficial interest in the shares which he had as life-tenant.
[2.268] The taxpayer, on the law as it stood at the time of Angus, was entitled, under s. 23(q), to exemption from tax on the distribution: the distribution had a foreign source and was taxed in the country of source. Subsequent to Angus, s. 23(q) was amended so that it now has no application to “income … attributable to a dividend”—defined in s. 6B in a way that will include the receipt by a person in the situation of Angus. And s. 45 was amended so as to allow a credit for foreign tax on income attributable to a dividend. As it was previously framed, s. 45 allowed a credit only in respect of a dividend as defined in s. 6, which is confined to a distribution made to a shareholder.
[2.269] At the time Angus was decided the trust provisions in Div. 6 of Pt III had no application to foreign source income derived by the trustee of a trust estate. The changes made to Div. 6 in 1979 make the Division applicable to a distribution of the kind made in Angus. It would now be income derived by the trust entity by virtue of derivation by the trustee shareholder. It would be income by the operation of s. 95 and the deeming of the trustee to be a taxpayer, combined with the operation of Subdiv. D, without any operation of the ordinary usage notion of a dividend that is income. The lifetenant would derive income under s. 97 of Div. 6. He would be entitled to a credit for the foreign tax under s. 45.
[2.270] Any item expressly described in an agreement, or order of court, as “interest” will be within the gains from property principle, unless the description is contradicted by the terms and circumstances of the agreement or order under which it is payable. The contradiction in the terms and circumstances will need to show that the item is not within the substance of the gains from property principle. The metaphors of fruit and tree and of land and produce by which the principle is described are limited in their usefulness as expressions of that substance. The substance is perhaps better expressed as a payment received for the use of one’s property by another, as distinct from a payment received for the partial giving-up of one’s property to another. The distinction between a return for allowing use by another and a receipt for the partial giving-up of property is reflected in a distinction between “interest” properly used to identify gains from property, and a “premium” reflecting a receipt from a partial realisation of property itself. The distinction here suggested as a means of isolating the substance of the gains derived from property principle, may be thought to exist only in words. It is, however, a kind of distinction that is ubiquitous in income tax law. A related distinction is drawn in identifying, for purposes of Proposition 14, a gain which arises from the carrying on of a business. Such a gain is to be distinguished from a receipt which arises from the realisation of a part of the business itself. If distinctions of this kind do not reflect substance, a great deal of judicial discussion which assumes that they do can only be regarded as futile.
[2.271] The substance of the principle concerns the function of the payment, which is primarily at least a matter of objective inference. Receipts in a series are more likely to be regarded as gains from property than a single receipt, more especially when they are payable only while the use by another continues. A single receipt which is not subject to adjustment if the use by another does not continue for the intended time, is more likely to be regarded as a receipt for the giving up of one’s property to another.
[2.272] In the case of interest, the relevant property is money—money lent, or money otherwise the subject of a debt. The distinction between a payment received for the use of one’s property by another and a payment received for the partial giving up of one’s property to another, will be thought irrelevant if strict notions of property and alienation of property are applied. Money lent becomes the property of the borrower, and it will be said that the interest he pays cannot be regarded as being for the use of that property. Principles of tax law are almost inevitably framed in language which attracts the possible application of principles belonging to some other area of law. The interpretation of principles of tax law in this manner is unacceptable, more especially when the principle is no more than an attempt to formulate the ordinary usage notion of income. Where a receipt is for the use of one’s money by another, the notion of one’s money being understood in a way that transcends strict notions of property, it may be described as interest as a term of tax law identifying one kind of gain derived from property and income in that character.
[2.273] Just as the express description of an item as interest in any agreement will prima facie put it within the gains from property principle, an express description of an item as a premium will prima facie put it outside that principle. The latter description may, however, be contradicted by the terms and circumstances of the transaction. The relevance of circumstances calls for a wider inquiry in the application of the substance of the gains from property principle than that thought appropriate in relation to the application of s. 51(1). In this respect, the interpretation of s. 51(1) has undergone an unacceptable development. That interpretation is considered in [9.17]ff. below. To confine the inquiry to legal relations which arise in a transaction, which is the tendency in relation to s. 51(1), is to invite action to defeat what policy there may be in the principle applied. Thus an amount payable under an agreement may, if the terms of the agreement are alone considered, be a premium in a tax law sense that will put it outside the gains from property principle. But regard to the circumstances—more especially the circumstance that a less than commercial rate of interest is reserved by the agreement—may contradict that conclusion. The matter is considered in [2.285]-[2.289] below.
[2.274] In all of Foley v. Fletcher (1853) 3 H. & N. 769; 157 E.R. 678, Secretary of State in Council of India v. Scoble [1903] A.C. 299, Vestey v. I.R.C. [1962] Ch. 861 and Lord Howard de Walden v. Beck (1940) 23 T.C. 384, considered in relation to Proposition 11, the payments were treated as instalment receipts of a debt or sale price of property, and not as periodical receipts. In all but the earliest of them—Foley—it was either conceded (Scoble) or held (Vestey and Lord Howard de Walden) that a part of each instalment represented interest on the debt or sale price, and was income. No interest had been expressly provided for in the terms of the relevant transaction.
[2.275] In Foley the only question raised was whether the whole of each payment was income in the hands of the seller as a payment that was one of a series of periodical receipts. The court was not asked to consider “whether income tax might be payable in respect of such part of each instalment as consists of interest” (3 H. & N. at 788, per Channell B.).
[2.276] In Foley there was no express provision for payment of interest on the sale price, though there was a provision for payment of interest on an overdue instalment. The case was tried on demurrer, and there was nothing in the record to show that in fact the land sold by the plaintiff was worth less than the sale price. In Vestey, Cross J. refused to accept statements by Pollock C.B. and Bramwell B. in Foley that even if it had been proved or admitted that the plaintiff’s land had been worth far less at the time of sale than the sale price, it would not have been proper to treat as income an interest element in each instalment receipt.
[2.277] Vestey was concerned with a sale of shares for an annual sum of £44,000 over 125 years—a total payment of £5,500,000. The total payment controlled the payment by instalments: there was provision that on default in payment of any one instalment, the balance of all the instalments would immediately become due and payable. There was evidence that the accountants advising the father of the vendor had put a value on the shares of £2,000,000, on the basis of a sale under which the sale price would be payable immediately. There was, however, no evidence that the vendor was aware of this advice. Cross J. affirmed the decision of the special commissioners ([1962] Ch. 861 at 867) that the annual payments (other than the first which was payable on transfer of the shares) contained an interest element “to be calculated upon the method laid down in … Scoble”, the figures to be agreed in accordance with the decision. The fact that the balance of instalments, including the interest element in those instalments, would become payable on default in payment of any instalment was held not to preclude the separating out of interest. The payment of interest in these circumstances was to be explained as a penalty.
[2.278] Scoble, in which it was conceded that separating out an interest element was proper, differs from Vestey in that the Scoble agreement provided for options available to the buyer. He might pay the value of the shares in one sum, the value to be ascertained in accordance with the agreement. Or he might pay for the shares by a series of payments over 99 years, “the interest to be used in calculating [the series of payments] being determined by the average rate of interest during the preceding two years received in London upon public obligations of the East India Company”. The buyer had exercised the latter option. The agreement in the circumstances of the option exercised thus required the determination of the value of the shares and specified an interest rate to be used in calculating the amounts of the series of payments. It may be assumed that the interest rate applied in Vestey was that used by the accountants advising the seller’s father in calculating the amounts of the payments in a series—the rate that would give a present value of £2,000,000. Neither that rate, nor the value of the shares from which it might be calculated, was to be found in the agreement.
[2.279] The method of separating out the interest element in each instalment followed in Scoble involved treating each instalment as a payment of interest on the amount of the value of the shares remaining outstanding at the time of payment, and as to the remainder a payment of part of the value outstanding. In Lord Howard de Walden the taxpayer argued for a different method. The case concerned the purchase, from the maker, of a series of promissory notes. The consideration given by the taxpayer for one set of notes was a cash payment. The consideration for another set was a cash payment and the release of certain obligations to the taxpayer owed by the maker of the notes. The taxpayer argued that any interest element should be determined in relation to each note, so that the interest element in early receipts would be less than in later receipts. Wrottesley J. held that in the absence of any agreement between the parties, either at the time when the agreement was made or at the time of his decision, the Scoble method should prevail. He observed that he would have been willing to approve another system, had it been put before him, a system “which results in interest and capital being distributed over each payment practically in the same proportion” ((1940) 23 T.C. 384 at 401).
[2.280] In Lord Howard de Walden there was some evidence of the value of the obligations owed to the taxpayer which were released as part consideration for some of the notes. That value was used in calculating that the promissory notes included an interest element of 4 per cent on the consideration given for the notes. The case supports Vestey in the use of evidence of value in this way, though the judgment of Wrottesley J. rather begs the question in the manner in which he dismissed a submission by the taxpayer that evidence of value could not be used. The release of obligations, he said (at 400), was not a circumstance which affected his decision “provided that the element of interest can still be segregated”.
[2.281] In Foley it was assumed that the agreement was a sale for an amount to be paid by instalments without interest. The separating out of an interest element would have contradicted the words of the agreement. Such a contradiction was in fact involved in the decision in Vestey. In Lord Howard de Walden there might appear to have been a contradiction, so far as the terms of the promissory notes were concerned. But the agreement as a whole involved on its facts, at least in relation to the promissory notes purchased entirely for cash, payments in excess of the consideration given. The agreement thus took the form of an outlay of $X for a series of receipts amounting to $X + Y, and the $Y, whether or not called interest, appear as a gain derived from property. The distinction between interest on each of the promissory notes and interest on the transaction as a whole, would have been important if the promissory notes had been negotiated to a third party, and the Revenue had sought to find an interest element in the receipt of the amount of the notes by the person to whom they had been negotiated. The receipt by him might have included an element of profit on the transaction of purchase and receipt of payment, but it would not, it seems, have included a gain within the gains from property principle. The matter is further considered in [2.292]-[2.296], [6.308]ff. and [12.183]ff. below.
[2.282] There is a question as to the kind of evidence of value that will bring a case within Vestey and Lord Howard de Walden. The suggestion in Lord Howard de Walden is that it must be evidence of the amount some person, who may be the actual buyer, would have paid in cash immediately. Wrottesley J. said (at 398), referring to I.R.C. v. Ramsay (1935) 20 T.C. 79:
“A dentist desirous of selling his practice may know that purchasers for cash down are not to be found at all, and may arrive at the terms at which he will sell, not along the lines of cash down at all, knowing that his only chance of obtaining a good price is by accepting it in instalments. … The difficulty of assessment may well account for the fact that hitherto no claim has been made in respect of that part of a purchase price which takes care of the delay attending its payment. I am not going to say that such a sum, if ascertainable, is not interest. It would depend on the facts of the case.”
The suggestion is that there is not necessarily income derived from property simply because a creditor waits for his money. It must be evident that he could have had an amount earlier, but preferred to wait for a greater amount. The difficulty with such a rule is that there will always be some amount the creditor could have had earlier, though it might have been an unacceptably low amount. There is need, none the less, for some reconciliation with a view that a creditor is not obliged to charge interest. The reconciliation can only be achieved by asking whether the substance of the gains from property principle is satisfied. Is it to be inferred, at least objectively, from the terms and circumstances of the transaction that the creditor accepted delay in return for a greater receipt?
[2.283] In none of Scoble, Vestey and Lord Howard de Walden is there any discussion of the possible application of a principle, considered below in [2.285]ff. in relation to the repayment of a loan, which would treat an amount received in excess of the money lent as a receipt to cover the risk of loss of his capital which the lender takes when making a loan. Attracting that principle may be assisted by the description of the amount as a “premium”, though the description will not necessarily prevail. It would be consistent with that principle, in a Scoble, Vestey or Lord Howard de Walden situation where the interest element that would otherwise be separated out is more than a commercial rate, to treat some part of that element as being for the capital risk and thus not a gain derived from property. The receipt is not in respect of the use of money by another, but for the partial giving up of one’s property to that other.
[2.284] There is no Australian case like Scoble, Vestey or Lord Howard de Walden in which an interest element has been separated out and brought to tax. Were it not for s. 262 of the Assessment Act, McLaurin (1961) 104 C.L.R. 381 and Allsop (1965) 113 C.L.R. 341, considered below in relation to Proposition 15, might have precluded such separation. Section 262 would appear to be applicable in Scoble and Vestey situations, and to empower the Commissioner to separate out and tax an interest element. The application of the section in a Lord Howard de Walden situation may be doubtful. The payments may not be within the words of the section: “payment[s] for the assignment, conveyance, transfer or disposal of … property.”
[2.285] Where money is lent and a debt is acknowledged by the borrower of a greater amount than the amount of the moneys lent so that the borrower may be said to have allowed a discount, or the moneys lent are repayable at a premium, some or all of the discount or premium may, according to United Kingdom authorities, be income and subject to tax. The leading cases are I.R.C. v. Thomas Nelson & Sons Ltd (1938) 22 T.C. 175 and Lomax v. Peter Dixon & Son Ltd [1943] 1 K.B. 671. Where a reasonable commercial rate of interest is not reserved, some or all of the discount or premium may properly be regarded as interest and income subject to tax. The true nature of the discount or premium must be ascertained from all the circumstances. It will not be regarded as interest where it is in respect of the risk of capital depreciation which the lender takes in making the loan. It will be relevant to consider whether the parties have expressly stipulated that the discount or premium is in respect of the risk of capital depreciation, and the measure of that risk which may arise from the length of the period of the loan, political or international circumstances affecting the loan, the instability and prospect of inflation of the currency in which it is payable, and the prospect of depreciation of that currency in relation to the currency from which the loan has been made.
[2.286] There is a question whether any part of an amount described as interest may be regarded as being for the capital risk, and thus not income under the gains from property principle. It is agreed that the description may be contradicted by the terms and circumstances of the transaction under which the amount is payable. Where, however, the amount is one of a series of amounts payable only while the loan is outstanding, or where it is a single amount that will abate in part if the loan is repaid before the agreed date for repayment, it is likely that the whole of the amount is a gain from property. Tax law does not control the amount of a gain that may be derived from property, and the fact that the amount reflects a rate of interest beyond a commercial rate is unlikely in itself to be sufficient to show that in substance part of it is for the capital risk.
[2.287] None the less, if the terms and the circumstances of the lending are considered, there may be grounds for saying that some part of the interest rate fixed by the terms of the loan was intended to cover the anticipated fall in the value of money during the period of the loan. The agreement for a loan may have referred to a rate of interest to be determined by the addition to a specified rate, of a further rate reflecting the rate of inflation at the time of the agreement. The United Kingdom authorities indicate that these circumstances will not displace the character as interest which follows from the description as interest. The parties, it is said, have chosen to express the payment for the capital risk as interest. The reason may be thought simply to beg the question.
[2.288] It is sometimes suggested that the principle by which a receipt for the capital risk experienced by the lender in conditions of inflation will be outside the gains from property principle, offers a general basis for denying tax consequences to unreal gains. But it is a most inadequate basis, because it stops short of challenging the assumption of stable money values upon which the income tax is built. An adequate basis will involve expressing all items in the returns of all taxpayers in terms of the current purchasing power of money. Principles might then be developed on this basis. Short of this, any new principles or new provisions of the Assessment Act will be only palliatives. The Taxation Review Committee’s Full Report (A.G.P.S., Canberra, 1975, para. 9.80) suggested, as a palliative, a new provision in the Assessment Act which would allow a limited deduction against interest income. This would make some contribution to correcting the taxation of the unreal gains, which arise in times of inflation when the return on money lent is wholly expressed as interest. The matter is further considered in Chapter 15.
[2.289] There is no Australian case in which a discount given or premium received has been separated into elements of gain derived from property and receipt for capital risk. The decisions in McLaurin (1961) 104 C.L.R. 381 and Allsop (1965) 113 C.L.R. 341 may stand in the way, and s. 262, in these circumstances, may not authorise the separation. It should be noted that the Taxation Review Committee recommended that the Act be amended to displace the McLaurin and Allsop decisions: Full Report, para. 7.101.
[2.290] The conclusion reached in [2.209]-[2.210] above is that receipts which are within the periodical receipts principle are income in the whole of their amounts. Any separation out of an interest element requires the operation of s. 27H.
[2.291] In I.R.C. v. Land Securities Investment Trust [1969] 1 W.L.R. 604 payments were made that were held in I.R.C. v. Church Commissioners [1977] A.C. 329 to be periodical receipts of the receiver. The payments in Land Securities were held not deductible, though the Crown agreed to allow as an expense the “interest content” of the payments. The manner in which such an interest content might be separated out, and the basis in principle, are not evident. The matter is considered in [2.210] above
[2.292] A taxpayer acquires a security—in this context a debenture—evidencing or acknowledging the indebtedness of another person. The obvious illustration is a Government issued bond. He pays an amount which involves a discount on the amount of the indebtedness. A discount is appropriate because the rate of interest on the indebtedness is low when compared with current rates of interest. Thereafter he receives the amount of the indebtedness when the security is redeemed, or he sells the security for an amount greater than he paid for it. It may be asked whether any part of the amount received on redemption or sale of the security is income as a gain derived from property.
[2.293] It would be argued that there is no income derived from property, though, to the extent that the amount received is greater than the amount paid, there is a profit that might be income of a person whose business includes buying and selling securities, or of a person who carries on a business to which buying and selling securities is incidental. Indeed that person might have acquired a security as trading stock, and the trading stock provisions will apply to give an income character to the whole receipt, while allowing a deduction for the cost of the security. The relevant principle is Proposition 14 applicable to gains in carrying on a business. And the profit might be income, in the circumstances of a sale of the security, by virtue of s. 25A(1) (formerly s. 26(a)) or s. 26AAA, considered in Chapter 3.
[2.294] The possibility that the profit is a gain derived from property, so that it may be income in the hands of a person who is not engaged in business operations, and does not act in a way that will bring s. 25A(1) or s. 26AAA into operation, cannot be excluded. Where the security has been originally issued to the taxpayer at a discount and he holds until redemption, principles considered in [2.285]-[2.289] above will be attracted. But there are analytical problems in treating the profit as income derived from property when the taxpayer has acquired a security already issued, more especially if he has sold the security as distinct from receiving payment on redemption. The proceeds of sale appear to be proceeds of realisation of the property itself. And there are tax accounting problems considered in Chapter 12 ([12.183]ff. below).
[2.295] None the less, s. 23J of the Assessment Act assumes that the profit is income, presumably as a gain derived from property. Section 23J provides that no part of an amount received by a person upon the sale or redemption of a security of the kind now considered, acquired on or before 30 June 1982, shall be taken to be income derived by the person. There is an exception of any part of the amount received as accrued interest. The section goes on to provide that it has no application to a transaction that is part of or is incidental to, the carrying on of a business that includes buying and selling securities of any kind, and that the section does not operate to deny an income character that arises from the operation of s. 25A(1) (formerly s. 26(a)), s. 26AAA or s. 26C.
[2.296] Section 23J was enacted subsequent to a statement by the Commissioner made prior to 30 June 1982, that the profit in the circumstances with which the section deals was income as a receipt “in the nature of interest”. The purpose of the section was to give immunity to persons who had acquired securities on or before 30 June 1982 which would include persons who had acquired before the Commissioner’s statement. It may be asked whether the assumption that lies behind the giving of an exemption is thereby made law.
[2.297] The distinctions drawn, and the issues raised, under the last heading in relation to “interest” in respect of allowing the use of money by another and “premium” in respect of the capital risk in giving up one’s property to another, have their parallels in relation to “rent” and “premium” (or “fine” or “foregift”) in respect of a lease of land or chattels.
[2.298] A receipt described as “rent” will ordinarily be within the gains derived from property principle. The word will identify a receipt for allowing the use by another of one’s property. The possibility that a receipt described as rent may be outside the principle is remote, but ought not to be excluded. If the receipt is a single sum and does not abate if there is a termination of the lease before the agreed date, the terms of the lease will go some way to contradicting the description. If, in addition, the lease provides for other payments, whether or not they are also described as rent, which are within the gains from property principle, the contradiction may be complete.
[2.299] A receipt described as a “premium”, “fine” or “foregift”—terms ordinarily used to identify receipts for giving up one’s property to another—may none the less be within the gains from property principle. An amount described as a premium payable in a series of amounts, which will cease if there is a termination before the agreed date, more especially if there is no provision for other payments which are gains from property, stands to be treated as a gain from property.
[2.300] The distinction between what is in substance rent—a receipt for allowing the use by another for one’s property—and what is in substance premium—a receipt for giving one’s property to another—is even more difficult to define than the distinction between interest and premium. There are hazards in losing control of one’s money by lending it, which are not matched by the hazards of losing control of one’s land, or perhaps a chattel, by leasing it. What is in substance a premium may in the latter context be so much the more difficult to identify. Where substance is difficult to identify, words of description are the more likely to prevail. Difficulty in identifying what is in substance a premium may explain the differing conclusions of the Australian Royal Commission on Taxation (Third Report, 1934, Section XL) and of the Final Report of the United Kingdom Royal Commission on the Taxation of Profits and Income (Cmd. 9474, 1955, p. 259). The former considered that premiums were within the gains from property principle. The latter thought they were not.
[2.301] Where an amount that is in substance rent has been received by a lessor, and that amount is less than a commercial rent, there is some basis for questioning whether the whole of another amount received by the lessor and described as a premium is a premium in substance. Lomax v. Peter Dixon & Son Ltd [1943] K.B. 671 may suggest that in these circumstances part of the amount described as a premium should be separated out and treated as gain derived from property. McLaurin (1961) 104 C.L.R. 381 and Allsop (1965) 113 C.L.R. 341 may be a barrier to this separating out, unless the Commissioner can call on s. 262. In this regard, it may be argued that a lease is not an “assignment, conveyance, transfer or disposal of the property”, though “transfer” would appear to be a word of wide meaning. And s. 262 will only be available where the amount described as a premium is payable by “periodical payments”.
[2.302] The Assessment Act contains two sets of provisions relating to “premiums” in respect of leases of property. These are Div. 4 of Pt III, inserted in the Act following recommendations by the 1934 Royal Commission, and s. 26AB. Div. 4 of Pt III is applicable only to leases granted on or before 22 October 1964, and its application to such leases is limited in ways specified in s. 83AA. The discontinuance of Div. 4 in 1964 followed criticisms of its operation made in 1961 by the Ligertwood Committee (Report of the Commonwealth Committee on Taxation, Ch. 6). Section 26AB applies to all premiums as defined in the section, with the exceptions specified in s. 26AB(5). Among these exceptions is a premium in relation to which Div. 4 applies.
[2.303] Division 4 in s. 84 makes a premium, as defined, income, and makes special provision as to the manner in which the premium is brought to tax. The definition of premium in the Division (s. 83), is substantially the same as in the more recent provisions of s. 26AB.
[2.304] The definition of premium in s. 26AB(1) is:
“In this section, ‘premium’ means a consideration payable in one amount, or each amount of a consideration payable in more than one amount, where the consideration is—
but does not include an amount in respect of goodwill or a licence.”
Section 26AB(2) gives the character of income to a premium received by a taxpayer where the property the subject of the lease was not, at the date of the agreement to grant or assign the lease or the date of assent to the grant or assignment, intended by the grantee or assignee to be used by the grantee or assignee or some other person for the purpose of gaining or producing assessable income. Where some use for the purpose of gaining or producing assessable income and some use for other purposes is intended, such part of the premium will be income as the Commissioner considers may reasonably be attributed to the intended use of the property for those other purposes (s. 26AB(3)). The section makes the character as income depend on the intention, in regard to the use of the property, of a person other than the taxpayer. Section 26AB(4) allows the Commissioner to apply the section on the basis that an intention to use for the purpose of producing assessable income existed, if the taxpayer satisfies him that at the relevant time he believed on reasonable grounds that such an intention existed.
[2.305] The theory of s. 26AB is that a person who pays a premium in respect of the lease of property he intends to use for the purpose of producing assessable income, will not be entitled to a deduction under s. 51. He would have been entitled to a deduction had he paid rent. In the circumstances it is appropriate that the person receiving the premium should not be treated as receiving income. A person who makes a payment in respect of the lease of property that he does not intend to use for the purpose of producing assessable income, will not be entitled to a deduction whether the payment is in the form of a premium or rent. In these circumstances it is appropriate that the person receiving the premium should be treated as receiving income. Otherwise the receipt of a premium rather than rent would become a method of tax planning.
[2.306] The theory of the section, as so explained, makes two assumptions:
[2.307] In the House of Lords decision in Strick v. Regent Oil Co. Ltd [1966] A.C. 295 discussed in Chapter 6 below, the payment of a premium in respect of property intended to be used for the purpose of producing income was held not to be a deductible expense. But the case is not authority that the payment of a premium in such circumstances can never be a deductible expense. The second assumption—that a premium received cannot be income by ordinary usage—is not supported by the discussion in [2.297]-[2.308] above of the gains from property principle. A receipt called a premium may be income where it is within the substance of the gains from property principle. And a receipt called a premium which is a premium in substance, and is thus not within the gains from property principle, may be income under Proposition 14 as a gain in carrying on a business. A person who deals in land who takes a premium on the grant of a lease derives income from a partial realisation of rights in land in which he deals: Kosciusko Thredbo Pty Ltd (1984) 84 A.T.C. 4043 at 4052, per Rogers J.
[2.308] The assumptions that may explain s. 26AB are not made law by s. 26AB. Deductibility of a premium paid continues to depend on the operation of s. 51, and a premium which is not income by force of s. 26AB may yet be income as a gain derived from property, or may include income as a gain from carrying on a business.
[2.309] Receipts which are royalties in the narrow meaning Australian courts have given to the word, and other receipts which might be covered by a more extended meaning of the word, may be within the gains from property principle. In this context, as in the contexts of interest and rent, identifying the substance of the principle must rest on a distinction between receipts for property, and receipts for the use of property.
[2.310] The present concern is whether receipts are income in ordinary usage and not whether they fit within some meaning of the word “royalties”. The Assessment Act includes a definition of royalties in s. 6. The definition is relevant to the operation of s. 6C, s. 26(f), s. 124J, s. 256 and some other sections. The definition is an “includes” definition and may in any case be displaced by the context. It is partially displaced in the terms of s. 26(f), considered in [4.114]-[4.120] below. In the result it becomes necessary to identify the meaning that the word royalties carries unaided by the definition in order to determine the effect of s. 26(f) in making items, described as royalties, income. It is necessary to identify the meaning the word carries unaided by the definition in order to determine the effect of other provisions, the most important being s. 6C (in relation to giving income a source in Australia), which attracts the definition, but extends also to items which are within the unaided meaning. Reference is made in what follows to a number of decisions on the meaning of royalties unaided by the definition.
[2.311] Some of the receipts considered in the survey that follows will be income under Proposition 14—gains in carrying on business—whether or not they are within the gains from property principle. Thus a single amount received for the supply of know-how, unaccompanied by any associated withdrawal from business in the area in which the know-how will be used, may be income as a gain from a business activity of selling know-how. A single amount received in these circumstances was held to be income in Rolls-Royce v. Jeffrey [1962] 1 W.L.R. 425. Such a receipt may not be income as a gain derived from property. But one of a series of amounts, each amount becoming payable because of the use of know-how supplied in the like circumstances, may be income both as a gain from a business activity of selling know-how and as a gain from property. The gains in White (1968) 120 C.L.R. 191, involving dispositions of timber effected by the method in Stanton (1955) 92 C.L.R. 630 ([2.315] below), were income as gains from carrying on business, though they may not have been gains derived from property. Had the dispositions been effected by the method in McCauley (1944) 69 C.L.R. 235 ([2.314] below) the gains would presumably have been income as gains from carrying on business and as gains derived from property.
[2.312] The observation in the last paragraph that an item may be income both as a gain derived from property and as a business gain may appear to assume that on either basis the amount of the gain will be the same. That assumption will be correct if the gain derived from property is pure gain, so that it is not in any part referable to the realisation of the property. So far as the gains from property principle will characterise as gain a receipt which is in part referable to the realisation of property, the principle may give an income quality to a greater amount than the business gain principle. The latter, it will be submitted, gives an income quality only to the profit element in the receipt. In some circumstances, the gains from property principle may treat as a gain an element in a receipt which is proceeds of realisation of the property. So far as the principle operates in this way, there is a conflict with the principle that gain is an essential quality of income. The conflict is of the kind that arises in the operation of Proposition 11 when an annuity is purchased. In some circumstances the defeat of the principle that gain is an essential quality of income is mitigated by specific provisions allowing amortisation deductions. These are s. 124J, in relation to timber, and Div. 10B of Pt III in relation to commercial and industrial property. Section 124J will allow such deductions when the receipts are as or by way of royalties, within the meaning given to that word in judicial decisions, and any extended meaning that may arise from the definition of the word in s. 6. The scope of s. 124J is considered in [6.184], [6.198], [6.199], [7.19] and [7.28] below. Division 10B allows deductions in respect of expenditure of a capital nature, by the owner, on items of commercial or industrial property which are used by him to produce assessable income. There may be no operation of the Division in the contexts now considered. The scope of Div. 10B is considered in [10.235]ff. below, where it is suggested that the Division only applies where there is a direct use by the owner of the item of property. It does not operate where he licences another to use the item of property.
[2.313] It is necessary to draw distinctions which may assist in defining the operation of the gains from property principle. It is not intended to adopt technical distinctions which may be drawn in the law of real property, though the latter may be in parallel.
[2.314] The receipts may be in a series, each payment being the consequence of acts by another which would infringe the taxpayer’s rights if he had not given his consent. “Consequence” may be too broad a term. The payments to which reference is intended are, in effect, triggered by the acts of the other. The payments in McCauley (1944) 69 C.L.R. 235 are an example. The taxpayer by the agreement in that case consented to another entering and taking timber from his land. The payments were due under the agreement as timber was taken, and the amount of each payment was determined by the amount of timber that had been taken. The decision in the case was that the receipts were income under s. 26(f) because they had been received “as or by way of royalty”. The case is thus authority on the meaning of the word “royalty” as it is used in the Assessment Act, and not on the scope of the gains from property principle.
[2.315] The receipts in McCauley admit of the description that they are “for the use” of property and for this reason may be within the gains from property principle, though the distinction between McCauley and Stanton (1955) 92 C.L.R. 630, borders on the verbal. In Stanton, where the payments were for timber which the purchaser was allowed to enter and take, the payments not being triggered by the taking, the conclusion was that the receipts were not “as or by way of royalty” under s. 26(f). The case does not in terms decide that the receipts were not income by ordinary usage.
[2.316] Timber is a renewing resource and the notion of a gain derived from property might be thought applicable whether or not the payments are triggered by the taking of the timber. White (1968) 120 C.L.R. 191 is authority that the renewing resource aspect is relevant to a conclusion that the taxpayer is engaged in a business of growing and selling timber, so that receipts for timber will be income under Proposition 14. The case did not consider the question whether the receipts were income under the gains from property principle. It seems to have been assumed that Stanton precluded any conclusion that the gains from property principle applied.
[2.317] The scope of the gains from property principle, in its assumed application in the McCauley facts, may be tested by posing the question whether receipts, under a McCauley type agreement which relates to the taking of sand and blue metal, would be income derived from property. The question is of course obscured in the operation of the Assessment Act by the assumption, founded on observations in McCauley, that such receipts would be royalties and income under s. 26(f). The question might also be posed in relation to the taking of other minerals to which a taxpayer as owner of land has title, or the taking of minerals to which the taxpayer has the mining rights. In all these cases what is taken is not a renewing resource, and, whatever the form of the transaction, the taxpayer has in fact disposed of some of his permanent physical property or rights to permanent physical property. The notion of realisation of a gain derived from property may be thought inapplicable. The gain, if any, should be the profit realised by the disposal of the property, and that gain will be income by ordinary usage only where the disposal is in the carrying on of a business.
[2.318] An agreement concerned with a non-renewing resource may be in the Stanton form with the difference that the payment for what is taken is in more than one amount. In fact in Stanton there were instalment payments of a fixed amount. I.R.C. v. British Salmson Aero Engines Ltd [1938] 2 K.B. 482 may suggest that receipts in a series not expressed to be instalments of a fixed amount, may be regarded as for the use of property and thus income derived from property: the conclusion that they are for the use of property would be drawn from the element of recurrence of receipts. Where the receipts relate to non-renewing land resource, a conclusion that they are income as gains from property may be thought inappropriate. There is no gain, save to the extent of any profit which would be income under Proposition 14. A conclusion that the receipts are income derived from property is no more appropriate than a conclusion that they are an annuity within the periodical receipts principle, when there would be equal conflict with the principle that gain is an essential quality of income.
[2.319] There is other authority, considered later in relation to receipts in respect of commercial and industrial property, which would suggest that a single amount will be income if it is calculated by reference to actual use already made of the taxpayer’s property, or, perhaps, by reference to prospective user. The cases are Constantinesco v. R. (1927) 11 T.C. 730 and Mills v. Jones (1929) 14 T.C. 769. In British Salmson, Greene M.R. cast doubt on the authority of the second case so far as it concerned a receipt for prospective user, pointing out that in that case the House of Lords said that the amount for prospective user was so negligible that it might be disregarded. The doubt appears to be forgotten in later pronouncements by the same judge in Nethersole v. Withers [1946] 1 All E.R. 711 and by Lord Denning M.R. in Murray v. I.C.I. Ltd [1967] Ch. 1038 at 1052, referring to Nethersole v. Withers. Lord Denning said: “If, and in so far as, he disposes of the patent rights outright for a lump sum, which is arrived at by reference to some anticipated quantum of user, it will normally be income in the hands of the recipient (see the judgment of Greene M.R. in Withers v. Nethersole sub nom. Nethersole v. Withers [1946] 1 All E.R. 711 at 716; approved by Viscount Simon in the House of Lords [[1948] 1 All E.R. 400]).” The approval by Lord Simon did not extend to the specific statement by Greene M.R. (at 716) that: “If the lump sum is arrived at by reference to some anticipated quantum of user it will, we think, normally be income in the hands of the recipient.” Indeed Lord Simon drew attention (at 403) to the fact that in Mills v. Jones the amount for anticipated user was negligible.
[2.320] If the pronouncement by Greene M.R., approved by Lord Denning, is correct, the actual circumstances in Stanton may attract the gains from property principle. The amount of the consideration was calculated by reference to the amount of timber thought to be in the stand of timber the buyer was authorised to take. There was provision that if the stand of timber did not include as much as was anticipated, there would be an abatement of the amount to be paid by the buyer.
[2.321] If it is relevant that an amount has been calculated by reference to past user or to anticipated user, the question will arise as to how it is to be determined that an amount was so calculated. The view of Greene M.R. in British Salmson Aero Engines [1938] 2 K.B. 482 at 495 is that it is proper to pursue a wide inquiry, which may extend beyond the terms of the contract. He said: “Nothing that I say must be taken to be expressing the view that, in ascertaining the answer to the question whether or not a payment is to be regarded as a capital or an income payment, it is illegitimate to look outside the terms of the contract. I do not wish to lay down any such proposition. What has to be ascertained in these cases is the true nature of a payment; that is to say, the true nature from an accountancy point of view, and that is a question of fact. I do not wish to say anything which will have the effect of circumscribing the matters which may properly be looked into in answering that question of fact.”
[2.322] Where an amount is received in a single payment in respect of the taxpayer’s rights, and is not shown to be calculated by reference to user, it would be assumed, based on inference from Stanton and White, that the receipt is not a gain derived from property. Again, however, cases concerned with receipts in respect of commercial and industrial property may be difficult to reconcile with the assumption. Those cases may appear to stand for a proposition that a single amount received for the grant of a non-exclusive licence will be income. A passage from the judgment of Lord Denning M.R. in Murray v. I.C.I. Ltd [1967] Ch. 1038 at 1052 may summarise the effect of the cases: “If, and in so far, as [a taxpayer] disposes of [patent rights] outright for a lump sum which has no reference to anticipated user, it would normally be capital (such as the payment of £25,000 in the British Salmson case). It is different when a man does not dispose of his patent rights, but retains them and grants a non-exclusive licence. He does not then dispose of a capital asset. He retains the asset and he uses it to bring in money for him. A lump sum may in those cases be a revenue receipt: see Rustproof Metal Window Co. Ltd v. Inland Revenue Commissioners [1947] 2 All E.R. 454 at 459 per Lord Greene M.R., who emphasised that it was a non-exclusive licence there. Similarly, a lump sum for ‘know-how’ may be a revenue receipt. The capital asset remains with the owner. All that he does is to put it to use” (emphasis in original).
[2.323] It may not be clear from the passage quoted that the income quality of the receipt is given by the gains from property principle. The observations about a lump sum for know-how are based principally on Rolls-Royce v. Jeffrey [1962] 1 W.L.R. 425, where statements are made to the effect that the taxpayer had gone into business selling its know-how. In Rustproof Metal Window, however, there was no basis for any suggestion that the taxpayer had gone into business of granting non-exclusive licences. And indeed the lump sum amount in that case was held to be investment income, which would suggest that the relevant principle was the gains from property principle.
[2.324] It would seem to follow that a receipt in the circumstances of Stanton is income under the gains from property principle, whether or not it is calculated by reference to anticipated user. There is, however, a difference to be drawn between the use of land by taking something from the land, and a use which does not involve any such taking. The facts in Stanton may be contrasted with a simple licence to enter the property of another. The latter may be seen as the equivalent of the licence in Rustproof Metal Window.
[2.325] The discussion under the previous heading has been concerned with circumstances in which rights have been retained by the taxpayer who has given a licence to another. The licence in those circumstances will make lawful, acts done in exercise of the licence, but it will not preclude the continued exercise of his rights by the taxpayer, so far at least as this exercise does not deny the exercise by the other of the licence.
[2.326] Attention is now directed to circumstances in which rights are transferred to another. Where rights are transferred by the taxpayer in a lease or sub-lease the characterisation of receipts will depend in part on the operation of the principles already discussed under the heading “rent”. It may be, however, that in addition to giving possession under a lease, the lessor has given the lessee the right to cut the timber on land or to take minerals from it, or to exercise mining rights that the taxpayer may have been granted by the Crown. These circumstances are one step further removed from the idea of allowing the user of rights (as in the simple licence) than McCauley or Stanton. For this reason one might have expected an unwillingness to see any receipt as a gain derived from property. However, authorities in relation to exclusive licences in respect of commercial and industrial property rights may suggest that in some instances where possession has been given, with rights to take timber or minerals from land, or to exercise mining rights, receipts will be income as gains derived from property.
[2.327] A series of payments triggered by the actual exercise of rights by the person to whom rights have in substance been transferred by the taxpayer will be income of the taxpayer where the rights are those inhering in items of commercial or industrial property. There is a transfer in substance where an exclusive licence is given—exclusive in relation to others and the taxpayer himself—reinforced perhaps by a keep-out covenant. It went without question in Murray v. I.C.I. Ltd [1967] Ch. 1038 that the payments called “royalties” relating to the exclusive sub-licences, were gains derived from property. And there was a clear assumption that the payments made by I.C.I. for the exclusive head-licence from the Calico Printers’ Association were income derived from property in the hands of the Association. An exclusive licence in respect of an item of commercial or industrial property is in substance a partial disposition of rights inhering in the item of property, at least when the item, as in the case of a patent or copyright, has only a limited life. To regard the receipts called royalties in Murray v. I.C.I. as income derived from property is to treat as pure gains, receipts which may in truth be gains only to the extent of an element of profit. The consequence is parallel with the consequence of treating purchased annuity receipts as income.
[2.328] It would follow from the treatment of payments triggered by the use of commercial or industrial property rights under an exclusive licence, that payments triggered by the use of land where possession has been given with a right to take timber or minerals from the land, or where there has been a lease of mining rights, will be income.
[2.329] In the context of commercial and industrial property rights, I.R.C. v. British Salmson Aero Engines Ltd [1938] 2 K.B. 482, discussed in this connection in [2.318] above, is authority that a series of receipts not triggered by use, provided they are not instalment receipts of a fixed amount, will be regarded as being for the use of property and thus income derived from property. British Salmson involved an exclusive licence in respect of patent rights, and it may establish a principle equally applicable to an exclusive licence in respect of land of the kind now under discussion. Again the consequence that the series of receipts are income derived from property may be thought inappropriate. The receipts are not pure gain, more especially when the use under the licence involves taking a non-renewing resource such as minerals. A conclusion that the receipts are income derived from property is no more appropriate than a conclusion that they are an annuity. The latter conclusion will also conflict with the principle that gain is an essential quality of income.
[2.330] The possibility that a single sum receipt for giving possession of land with a right to take timber or minerals from the land, or for the grant of a lease of mining rights, will be income derived from property where it is calculated by reference to user, cannot be dismissed. The effect of the decisions and of the observations made in Constantinesco v. R. (1927) 11 T.C. 730, Mills v. Jones (1929) 14 T.C. 769, I.R.C. v. British Salmson Aero Engines Ltd, Withers v. Nethersole [1948] 1 All E.R. 400 and Murray v. I.C.I. [1967] Ch. 1038 were considered above in [2.319]. It may be assumed that the law in relation to exclusive licences in respect of items of commercial or industrial property is transferable to the giving of possession of land with rights to take from the land. Here too the consequence that the receipt will be income may be thought inappropriate.
[2.331] In one instance the law in relation to exclusive licences in respect of commercial and industrial property yields an appropriate result when transferred to the giving of possession of land. Murray v. I.C.I. is authority that the grant of an exclusive licence for the remainder of the term is not to be distinguished from an outright disposition of patent rights, and an outright disposition for a single sum that has no reference to anticipated use “will normally be capital” (at 1052, per Lord Denning M.R.). The words quoted leave the possibility that the taxpayer is dealing in patent rights, or for some other reason the patent is a revenue asset of a business. In which event the single sum receipt may reflect a profit which is income under Proposition 14. What is true of a single sum in respect of an exclusive licence for the remainder of the term is also true of a single sum in respect of an exclusive licence for a lesser period. In British Salmson, the period was 10 years.
[2.332] If there is difficulty in accepting principles established in relation to exclusive licences in respect of commercial and industral property where ownership is retained by the taxpayer, there is even greater difficulty in accepting those principles if they are extended to circumstances in which there has been an outright disposition of the rights comprised in such property. Yet it seems they will be so extended. Murray v. I.C.I., in effect, equates the giving of an exclusive licence for the remainder of the term of a patent with the disposition of the patent itself, and would regard principles applicable to exclusive licences generally as applicable to outright dispositions. The question now is the relevance of those principles where there has been an outright disposition of land.
[2.333] In Cliffs International Inc. (1979) 142 C.L.R. 140 at 151 Barwick C.J. offered the observation that Howmet and Mt Enid would derive income when they received the payments by Cliffs International: “I would find it difficult to accept that [the receipts were] capital receipt[s] in the hands of the vendor.” Howmet and Mt Enid had sold their shares—amounting to all the shares—in a company, Basic, which had mining rights. Part of the consideration for the sale of the shares involved payments by the buyer, Cliffs, which would be triggered by the taking of ore in exercise of the mining rights. Cliffs had obtained title to the mining rights by liquidating Basic, and had then licensed other companies to exercise the mining rights. Barwick C.J. did not give reasons in support of his observation save what might be inferred from statements that the receipts were in the “nature of royalties” and that Cliffs had admitted the vendors “to participation in the result of the mining”. The idea of royalties in the sense of payments for user has become in this context, extremely remote. The more likely reason is that the vendor of the shares is participating in another’s income. A principle that receipts in a series are income where they involve sharing in another’s income was examined in [2.205]-[2.206] above.
[2.334] Minister of National Revenue v. Spooner [1933] A.C. 684 was concerned with a sale of land in consideration of which the purchaser agreed to give the vendor, inter alia, a percentage share of the oil to be obtained from the land sold. The question was whether amounts received by the vendor from the purchaser in respect of her share of the oil as it was produced, were income of the vendor. The Privy Council observed that “capital may … be expended in the acquisition of an income which, in the recipient’s hands becomes a proper subject of income tax” (at 689). Reference was made to the decision of Rowlatt J. in Jones v. I.R.C. [1920] 1 K.B. 711 ([2.206] above). To this point the judgment supports the outcome in Just (1949) 23 A.L.J. 47 and would support a conclusion of income character for the receipts in Cliffs International. The Privy Council however proceeded (at 690) to cite I.R.C. v. Marine Turbine Co. Ltd [1920] 1 K.B. 193 where Rowlatt J. had reached a conclusion apparently at odds with his own decision in Jones v. I.R.C. The liquidators of one company had sold its assets, including certain patent rights, to a new company for a sum in cash, a block of shares and a “royalty” on every machine sold. Rowlatt J. characterised the royalties as being “in effect payment by instalments of part of the price of the property” disposed of to the new company. The Privy Council declined to alter the decision of the Canadian court from which the appeal had been taken, a decision in line with Marine Turbine, saying that it had not been shown to be “manifestly wrong”. In the result the Privy Council decision makes no contribution to principle.
[2.335] It is temptingly simple to treat receipts triggered by user as income derived from property, even though the receipts are evidently proceeds of realisation of property. The tax accounting problems in calculating a profit are avoided, and there will be income as to the whole of the receipts when the profit might escape as a capital gain. But simplicity is achieved at a cost to the principle that gain is an essential quality of income, and to the principle that the quality of a receipt as income must be judged in the hands of the person who derived it. Where the receipts are in respect of a partial disposition of rights, as in the case of an exclusive licence which is for part only of the term for which the rights will subsist, there may be some reason to say that the receipts are for the gains that would have been derived from the use of the property had the exclusive licence not been given. There is support for such an approach in the operation of Proposition 15 (the compensation receipts principle) as demonstrated in London and Thames Haven Oil Wharves Ltd v. Attwooll [1967] Ch. 772, involving the partial destruction of property. Where, however, rights are wholly disposed of, a characterisation of receipts as for the gains that would have been derived leads to conclusions which will destroy the distinction between an asset and the income flows which that asset may generate. Where an asset is disposed of, the purchase price will reflect the income flows which that asset might be expected to generate, but it would not be suggested that the proceeds of sale received in a single amount are therefore income. It may then be asked why it should make a difference that there is not one but several receipts.
[2.336] It may be that the observation of Barwick C.J. in Cliffs International could be supported by pointing to the circumstances that persuaded Jacobs J. that the payments were deductible. Howmet and Mt Enid would continue to receive amounts for the whole period of the remaining life of the mine. It was therefore appropriate to regard the receipts as being for the gains that would have been derived if the property had been retained and exploited. In this regard the corporate veil between the shareholders, Howmet and Mt Enid, and Basic would need to be ignored.
[2.337] Where rights are disposed of in exchange for receipts in a series, though not triggered by use, I.R.C. v. British Salmson Aero Engines [1938] 2 K.B. 482, considered in [2.318]ff. above, may require that the receipts be regarded as income. British Salmson involved an exclusive licence for a period less than the remaining life of the patent and not an outright disposition of the patent, and there may be reason for distinguishing the case on that ground. The possibility that the series of receipts will be income as periodical receipts is raised in the judgment of Lord Denning M.R. in Murray v. I.C.I. [1967] Ch. 1038 at 1052: “A man may dispose of a capital asset outright for a lump sum, which is then a capital receipt. Or he may dispose of it in return for an annuity, in which case the annual payments are revenue receipts.” The context involved the grant of an exclusive licence for the remaining term of a patent. It was evident in the discussion, earlier in this Volume, of the periodical receipts principle (Proposition 11), that the United Kingdom authorities have shown an unwillingness to treat as periodical receipts a series of receipts which are the consideration on the sale of an asset. In this respect, the United Kingdom courts have been moved by an unwillingness to reach a conclusion which will offend the principle that gain is an essential quality of income. The Australian courts may appear to be less unwilling. But the Australian cases—Just (1949) 23 A.L.J. 47 and Egerton-Warburton (1934) 51 C.L.R. 568–do not justify a conclusion that a series of receipts, fixed in number and amount, will be income where they are the consideration on the sale of an asset.
[2.338] There is some prospect, based on the United Kingdom commercial and industrial property cases, that a single sum calculated by reference to user will be income though it is the consideration for the outright disposition of rights. The United Kingdom cases are discussed above in [2.319]ff. and [2.371]ff. There is authority outside of the commercial and industrial property context and the present context of rights to take timber or minerals, which would assert that it is not enough to give an income quality to an amount received in exchange for an asset that the amount was calculated by reference to the income that the asset might have generated. In one of the cases, Van den Berghs Ltd v. Clark [1935] A.C. 431, the receipt was in exchange for giving up an asset—a profit-sharing contract—which had a limited life. It may be thought unlikely, therefore, that a single sum receipt following the outright disposition of mining rights, however it is calculated, will be income as a gain derived from property. There will remain the prospect that the receipt is income, to the extent of any profit, under Proposition 14.
[2.339] A single amount received on the outright disposition of mining rights which is not calculated by reference to use will not be income as a gain derived from property. It may, however, to the extent of any profit, be income under Proposition 14.
[2.340] Discussion under this heading has been to a degree anticipated in dealing with receipts in respect of rights relating to land.
[2.341] It is necessary to draw distinctions which follow the distinctions drawn in dealing with rights relating to land.
[2.342] A non-exclusive licence, in the words of Greene M.R. in I.R.C. v. British Salmson Aero Engines Ltd [1938] 2 K.B. 482 at 494, referring to a patent licence, is an undertaking not to “complain of what would otherwise have been an infringement”. A series of receipts triggered by the licensee’s actions in reliance on that undertaking are gains derived from property and income within Proposition 12. Such receipts will normally be called “royalties” in the licence agreement. Receipts of this kind were, for example, called royalties in the agreements in Rustproof Metal Window Co. v. I.R.C. [1947] 2 All E.R. 454 and Murray v. I.C.I. Ltd [1967] Ch. 1038. This is a use of the word recognised as appropriate by the High Court in Sherritt Gordon Mines Ltd (1977) 137 C.L.R. 612. The idea of receipts in respect of the use of one’s property by another is satisfied. The receipts are pure gains, and there is no conflict with the principle in Proposition 4 that gain is an essential quality of income.
[2.343] Receipts in a series, which are not expressed to be instalments of a fixed amount, are gains derived from property and thus income even though they are not triggered by the licensee’s actions. Such receipts will not normally be called “royalties” though they were so called in the agreement in British Salmson. Sherritt Gordon Mines does not answer the question whether the use of the word in this context is appropriate though it may suggest that it is not. The conclusion that the receipts are for the use of property is drawn from the element of periodicity. The series of receipts in British Salmson was £2,500 payable each year during the currency of the licence. The receipts were in respect of an exclusive licence which may justify some questioning of the conclusion that they were income. But in the context of a non-exclusive licence a conclusion that a series of receipts of this kind are income would not be questioned. The receipts are pure gains, and there is no conflict with the principle that gain is an essential quality of income.
[2.344] Where the consideration for a non-exclusive licence is a single amount which has been calculated by reference to actual use already made of the taxpayer’s monopoly rights, or by reference to prospective use, the single amount will be within the gains from property principle. Observations by Greene M.R. in British Salmson and in Nethersole v. Withers [1946] 1 All E.R. 711 and by Lord Denning M.R. in Murray v. I.C.I. were referred to and commented on in [2.319]ff. above. Those observations suggest that a single amount so calculated will be income even though the licence is exclusive, and to that extent there may be reason to question them. Where, however, the single sum is received under a non-exclusive licence, a conclusion that it is for the use of the monopoly rights would not be questioned. The receipt is pure gain. At least one of the cases referred to in the observations by Greene M.R. and Lord Denning M.R., namely, Constantinesco v. R. (1927) 11 T.C. 730, did not involve an exclusive licence.
[2.345] Where the consideration for a non-exclusive licence is a single amount not calculated by reference to past or future use, it may be income as a gain derived from property. A relevant passage from the judgment of Lord Denning M.R. in Murray v. I.C.I. was quoted in [2.322] above. Lord Denning M.R. referred to Rustproof Metal Window Company Ltd v. I.R.C. where a single amount was held to be income when received in respect of a non-exclusive licence. The possibility that the receipt will be income only where it is a business receipt was considered in [2.323] above, but rejected.
[2.346] The intention is to deal under this heading with receipts under exclusive licences. It was assumed without question in Murray v. I.C.I. Ltd [1967] Ch. 1038 that the payments called “royalties” relating to the exclusive sub-licences were income as gains derived from property. The payments were triggered by sales of the product to which the patent related. It may be inferred from Sherritt Gordon Mines Ltd (1977) 137 C.L.R. 612 that such payments would properly be described as “royalties” in the hands of the licensor. Whether they should be regarded as gains derived from property and thus income by ordinary usage is a distinct issue. The suggestion was made in [2.327] above that to regard them as income is to treat as pure gains receipts which may be gains only to the extent of an element of profit. There is the same offence to a principle that gain is an essential quality of income as there is in treating the whole of the receipts of a purchased annuity as income.
[2.347] It may be thought that the series of receipts now considered are indistinguishable in principle from rent paid under a lease of land. This may be true where the item of commercial or industrial property is perpetual, like a trade-mark. Where however the item of property, as in the case of a copyright or patent, has only a limited life, the series of receipts are distinguishable from rent. These receipts, most obviously when the exclusive licence is for the whole of the remaining term of the item of property, are in substance proceeds of the realisation of the item of property.
[2.348] I.R.C. v. British Salmson Aero Engines Ltd [1938] 2 K.B. 482 is authority that a series of receipts under an exclusive licence, though not triggered by use, will be income derived from property, provided they are not instalment receipts of a fixed amount. There is a conflict with the principle that gain is an essential quality of income. Sherritt Gordon Mines Ltd (1977) 137 C.L.R. 612 does not answer the question whether such receipts would properly be called royalties, though it may suggest that they would not. They were referred to as “annual payments” by Lord Denning in Murray v. I.C.I.
[2.349] The distinction between instalment receipts of a fixed amount and a series of receipts, which must be drawn in this context, has its parallel in the distinction between instalment receipts of a fixed amount and periodical receipts considered in relation to Proposition 11. It may be noted that in British Salmson the payments made under the agreement to pay £25,000, as to £15,000 on the signing of the agreement and two amounts of £5,000 at intervals of 6 months, were held to be instalments of the £25,000. On the other hand payments under the agreement to pay £2,500 during each year of the currency of the licence, were treated as a series. It may be asked whether like payments required only for the first 9 years of the currency of the 10 year licence would have been treated as a series. In the discussion of the receipts by Howmet and Mt Enid in Cliffs International Inc. (1979) 142 C.L.R. 140 in [2.336] above, it is suggested that payments which are called for during the whole of the life of the rights transferred might be treated differently from payments required over a different period.
[2.350] A single amount received in respect of past use under an exclusive licence, and calculated by reference to that use, will, it seems, be income, equally with a series of receipts triggered by use. The authority is statements by Greene M.R. in British Salmson and in Nethersole v. Withers [1946] 1 All E.R. 711, and by Lord Denning M.R. in Murray v. I.C.I. Those statements were considered above in [2.319]ff. It is doubtful whether a single amount received in respect of future use under an exclusive licence will be income simply because it has been calculated by reference to anticipated future use. Greene M.R. in British Salmson was unwilling to draw a conclusion from Mills v. Jones (1929) 14 T.C. 769, that a single amount of this kind is income derived from property. That case was concerned with a payment in respect of use made by the Crown of a patent under a provision in the patents legislation allowing use for the services of the Crown. The use was not, it seems, exclusive as a matter of legal right, though it may have been exclusive in fact. Later in Nethersole v. Withers Greene M.R. appeared to accept Mills v. Jones as authority in regard to an exclusive licence. Though his judgment was not endorsed by Viscount Simon in the House of Lords (sub nom. Withers v. Nethersole [1948] 1 All E.R. 400), it was accepted as a correct statement of the law in Murray v. I.C.I. by Lord Denning, who mistakenly treated it as endorsed by Viscount Simon. Whatever the effect of the authorities, it may be said that treating a single amount for an exclusive licence as income derived from property, simply because it has been calculated by reference to an estimate of future use, would be an unjustified extension of the notion of income derived from property.
[2.351] A single amount received for the grant of an exclusive licence which has not been calculated by reference to past or prospective use, will not be income derived from property. British Salmson is authority for this proposition. It is accepted as authority by Lord Denning M.R. in Murray v. I.C.I. [1967] Ch. 1038 at 1052 and by Cross J. in the same case at first instance ([1967] 1 W.L.R. 304 at 313). It is accepted by Campbell J. in Kwikspan Purlin System Pty Ltd (1984) 84 A.T.C. 4282.
[2.352] If a receipt in respect of an exclusive licence in relation to monopoly rights is not income derived from property, a like receipt in respect of an outright disposition of monopoly rights will not be income derived from property.
[2.353] If a receipt in respect of an exclusive licence is income derived from property, it may yet be held that a different conclusion is appropriate where the receipt is in respect of an outright disposition. Whatever relevance it may have in the context of an exclusive licence, the notion of a receipt for the use of property seems not to be relevant when there has been an outright disposition of the property to the person who uses it. None the less it would appear accepted that a series of payments triggered by use of monopoly rights by the person who now owns those rights is income of the former owner as income derived from property. Thus, in Murray v. I.C.I. Ltd [1967] Ch. 1038 at 1052, Lord Denning said: “it seems to me fairly clear that if, and in so far as, a man disposes of patent rights outright … and receives in return royalties calculated by reference to the actual user, the royalties are clearly revenue receipts.” The description “calculated by reference to actual user” is, presumably, equivalent to the description adopted in [2.314] as “triggered” by actual use. There is an offence to the principle that gain is an essential quality of income if the whole of the receipts are treated as income. The notion of income is not accretions to economic power but, it seems, the receipt of a share of income of another explained in [2.333] above, and again in [2.363]ff. below.
[2.354] It may be inferred from Sherritt Gordon Mines Ltd (1977) 137 C.L.R. 612 and from language used in the quotation in the last paragraph from the judgment of Lord Denning, that the use of the word “royalties” is appropriate to describe receipts triggered by the use of monopoly rights which have been the subject of an outright disposition. The receipts would thus be income under s. 26(f) whatever view is taken of their character as income derived from property.
[2.355] If it is accepted that receipts triggered by user are income derived from property notwithstanding that there has been an outright disposition of the property, it must follow that other receipts in respect of an outright disposition will be income derived from property, if they are receipts which would have an income quality as receipts in respect of an exclusive licence. Again the judgment of Lord Denning in Murray v. I.C.I. may be relied upon. He said (at 1052): “If, and in so far as, he disposes [of patent rights outright] for annual payments over the period, which can fairly be regarded as compensation for the user during the period, then those also are revenue receipts.” And he added: “If, and in so far as, he disposes of the patent rights outright for a lump sum, which is arrived at by reference to some anticipated quantum of user, it will normally be income in the hands of the recipient.” It has been suggested above, that the latter quotation may go further than the authorities warrant. Both quotations, involve some offence to the principle that gain is an essential quality of income.
[2.356] In the discussion so far under the heading “royalties” a number of references have been made to the decision of the High Court in Sherritt Gordon Mines Ltd (1977) 137 C.L.R. 612 as to the meaning of the word “royalties” used in s. 6C of the Assessment Act. The court was called on to give the word a meaning without the aid of the definition in s. 6 which, as it was then drafted, was held to be inapplicable. Mason J. (who with Gibbs A.C.J. constituted the majority) described the court’s role as one of determining the scope of “ordinary royalties”. He relied (at 626) on Stanton (1955) 92 C.L.R. 630 for a conclusion that “it is of the essence of a royalty that the payments should be made in consideration of the grant of a right, that they should be made in respect of particular exercises of the right and therefore should be calculated in the manner stated”. The “manner stated” is a reference to that described in Stanton (at 642) as “in respect of the quantity or value taken or the occasions upon which the right is exercised”.
[2.357] As so identified, royalties will cover all the payments triggered by use so far examined, where the use is by virtue of a non-exclusive licence given to the payer by the payee. The meaning may be wider. It very likely extends to payments triggered under exclusive licence arrangements. Indeed, the “grant of right” is a more apt description of an exclusive licence than of a non-exclusive licence. In I.R.C. v. British Salmson Aero Engines Ltd [1938] 2 K.B. 482 Greene M.R. referred to a non-exclusive patent licence as an undertaking not “to complain of what would otherwise have been an infringement”. The licensee, it could be argued, does not have a right granted to him. He merely has an undertaking that the owner of the right will not complain.
[2.358] There is a question whether Mason J. intended his description to cover a situation where the right granted is granted as part of an outright disposition of the relevant congeries of rights—the patent, copyright or trademark itself. If he did, it would follow that all the uses of the word “royalties” in the passages quoted above from the judgment of Lord Denning in Murray v. I.C.I. would be correct uses. And it would follow that whatever might be the scope of the ordinary usage notion of income derived from property where the congeries of rights has been disposed of, payments triggered by the exercise of rights acquired from another and made to that other will be his income under s. 26(f).
[2.359] Sherritt Gordon Mines is authority that the word “royalties” in its ordinary sense does not extend to payments which cannot be described as payments in respect of the exercise of rights granted to the payer by the payee. “Right” requires some extended meaning in the context to cover the correlative of a contractual undertaking not to complain, but there is no grant of a right where there is merely a “provision of technical assistance and information which [the payer is] entitled to use once it [is] supplied, without the grant of any additional right so to do” (at 626). It follows that the payments in respect of the provision of technical information and assistance in United Aircraft Corp. (1943) 68 C.L.R. 525 were not royalties in the ordinary sense of the word. Nor were the payments in consideration of the supply of technical knowledge to manufacture aircraft engines in Rolls-Royce v. Jeffrey [1962] 1 W.L.R. 425 properly described as royalties.
[2.360] The view of the majority in Sherritt Gordon Mines contrasts with the view of the minority judge, Jacobs J., who took the view (at 631) that “[t]he essential feature of royalties in its ordinary acceptation is that the payments are calculated proportionately to the use or the production extraction or treatment consequent upon the use of that which is provided, not the legal quality of that for which the payment is made”.
[2.361] The conclusion that receipts for technical assistance and information, though calculated proportionately to the use or production consequent on the use of the assistance and information, are not royalties, prevents an operation of s. 26(f) to make them income. But it does not preclude a conclusion that they are income by ordinary usage. It was assumed in Rolls-Royce that such receipts were income. The case was concerned with single amount payments for supplies of know-how. These were held to be income. The decision is considered more closely in relation to Proposition 14. One explanation, and the most likely, is that Rolls-Royce had entered on a business of selling its know-how. If this is the only explanation, the case is not helpful in fixing the scope of the notion of income derived from property. The so-called royalties and the single sum amounts would be income as business gains. There is another possible explanation. The supply of know-how was a service performed by Rolls-Royce for the payer. The income nature of rewards for services is explored under Proposition 13. If this is the explanation, the case is still unhelpful in fixing the scope of the notion of income derived from property. In Kwikspan Purlin System Pty Ltd (1984) 84 A.T.C. 4282 Campbell J. held that lump sum receipts for know-how were not proceeds of a business. But the receipts in that case related not only to the supply of know-how but also to exclusive licences of patent rights. The supply of know-how in each case was auxiliary to the grant of the exclusive licence. The possibility that some part of each lump sum receipt was a reward for services was not considered in Kwikspan Purlin.
[2.362] There is, however, a third possible explanation of Rolls-Royce: that the single sum receipts were income for the same reason as single sum receipts for the grant of non-exclusive licences of commercial and industrial property are income. The single sums are for the use of know-how which is property in the sense of that word in the formulation of the ordinary usage notion of income derived from property, and it is property retained by the grantor. If a single sum receipt is income for this reason, a series of receipts calculated proportionately to the use or production consequent on the use are a fortiori income.
[2.363] Even if a single amount receipt for know-how fails to qualify as income under the income from property principle, a series of receipts calculated proportionately to the use or production may yet be income derived from property because they are within an extension of the principle which will bring it to the borders of, if not into, the periodical receipts principle. Its link with the periodical receipts principle was considered in [2.333] above. It was suggested that the receipts by Howmet and Mt Enid in the facts of Cliffs International Inc. (1979) 142 C.L.R. 140 were income because they involved a sharing by those companies in the profits made by Cliffs International. It is true that in Cliffs International there had been indirectly a grant of mining rights by Howmet and Mt Enid. Those companies had owned shares in Basic and had sold those shares to Cliffs. The mining rights were at the time owned by Basic. Afterwards they were acquired by Cliffs by liquidation of Basic. The payments could therefore be described as made in respect of the exercise of rights granted to the payer by the payee. But the reasoning is forced. It would be more appropriate to recognise a principle which perhaps straddles the principle of income derived from property and the periodical receipts principle. This principle would assert that a series of receipts by which a payee shares in the income receipts of the payer are income of the payee, whether or not the consideration furnished by the payee was the grant of a right. The principle would give an income quality to the receipts by Howmet and Mt Enid and to the receipts by the taxpayer in Just (1949) 23 A.L.J. 47. The idea of sharing does not require that the payments be deductible in determining the taxable income of the payer though the fact that a deduction is not available to the person who pays must have a bearing on the question whether the principle of sharing applies to the taxpayer who receives. In Colonial Mutual Life Assurance Society Ltd (1953) 89 C.L.R. 428 the payer of the money, held to be income of the payee in Just, was denied a deduction. The principle of sharing would none the less offer a reason for treating as income, receipts for know-how supplied to another when the receipts are a series calculated proportionately to the use, or production resulting from use, of the know-how.
[2.364] Like some applications of the periodical receipts principle, and of the income derived from property principle, the principle of sharing may treat as pure gain, receipts which are gain only to the extent of profit.
[2.365] The principle that a series of receipts by which a payee shares in the income receipts of the payer are income of the payee, may explain why the receipts in Aktiebolaget Volvo (1978) 78 A.T.C. 4316 should be regarded as income. The question raised before Jenkinson J. was whether the receipts had an Australian source, and there was no attention given to whether they were income. The Swedish parent of Volvo Australia received annual payments from Volvo Australia calculated as a percentage of the value of sales of Volvo products in Australia by Volvo Australia. Answering the question of source in Australia called for a conclusion as to whether the receipts were royalties in the ordinary meaning of the word, so that they would have a source in Australia under s. 6C. A conclusion that they were such royalties would also have been a conclusion that they were income under s. 26(f). Jenkinson J. concluded that the receipts were not royalties within the meaning given to the word by the majority in Sherritt Gordon Mines Ltd (1977) 137 C.L.R. 612. One observation made in the course of reaching that conclusion is surprising. He said (at 4321): “The remedies which the agreement affords Volvo Australia for competition in its trade in Volvo products are only against the appellant, not against others who engage in selling the products in Australia.” An inference would be that payments triggered by the exercise of a non-exclusive licence are not royalties, because the grant of a non-exclusive licence does not normally give rights save against the grantor.
[2.366] A licence to use the parent company’s Australian trade mark and associated goodwill might have been implied from the supply of cars to Volvo Australia. That licence was in effect converted into an exclusive licence by the agreement under which the payments were made. The consideration for the payments under the agreement was a covenant by the parent company not to supply any other person so that it might distribute Volvo products in Australia—in effect a keep-out covenant. Such a covenant in the view of Jenkinson J. did not involve the grant of a right, so that the receipts were not royalties. The Commissioner had argued that even if the receipts were not royalties, they were income and had a source in Australia. Jenkinson J. did not decide the question whether they were income, because he concluded that they did not have an Australian source under general principles. It would however be possible to argue that the receipts were income as payments for the exclusive use of the parent company’s goodwill in Australia, in a sense property of the parent made available to Volvo Australia by the keep-out covenant. The more embracing argument would be that, whether or not there had been a grant of a right or a covenant indirectly making property available to Volvo Australia, the receipts by the parent were income as receipts by which it shared in the income of Volvo Australia.
A gain which is a reward for services rendered or to be rendered has the character of income.
[2.367] Proposition 13 is expressed, at least in part, in the specific provisions of s. 26(e). There are questions still unresolved as to the relationship between the ordinary usage principle and s. 26(e). In its terms, s. 26(e) applies only to benefits for “services rendered”. But it might yet be construed to extend to situations where services are to be rendered after the time of derivation of the benefit. There is authority (for example, in Scott (1966) 117 C.L.R. 514, Hayes (1956) 96 C.L.R. 47 and Dixon (1952) 86 C.L.R. 540) that the connection between services and benefit which will make the item income as a reward for services, is no different under s. 26(e) than it is under the ordinary usage principle. In one respect s. 26(e) is wider in its operation than the ordinary usage principle: s. 26(e), in the circumstances covered by the provision, displaces the ordinary usage principle that an item of an income character, that has been derived, is income only in the amount of its realisable value. The provision makes a benefit income in the amount of its “value to the taxpayer”. In other respects s. 26(e) may be narrower. Thus the words “allowed given or granted” may have a narrower operation than the principles of derivation applicable to ordinary usage income. Provisos to s. 26(e) exclude from the operation of the provision benefits which are covered by the “eligible termination payment” provisions of Subdiv. AA of Div. 2 of Pt III, or by s. 26AC or s. 26AD, or which are treated as dividends under any section of the Act. Where s. 26(e), within the field left to it by express provisions, has a narrower scope than the ordinary usage meaning of income in relation to rewards for services, the question is posed whether s. 26(e) is a code and the ordinary usage meaning of income is denied any operation. The matter is considered in [4.18] and [4.42] below.
[2.368] The drafting of s. 26AAC(10), discussed in [2.25] above appears to assume that were it not for s. 26AAC, s. 26(e) would be a code in relation to shares or rights to shares acquired “under a scheme for the acquisition of shares by employees”. A conclusion that s. 26(e) is intended to be a code may leave unresolved questions as to the consequences of that conclusion. In relation to the former s. 26(d), Reseck (1975) 133 C.L.R. 45, by majority, held that the ordinary usage principle is simply excluded by the specific provision from any operation. The minority opinion of Stephen J., however, would regard as exempt income those benefits covered by the ordinary usage principle which are not made income by the code, though within its intended field of operation. The minority opinion expresses a view of the general relationship of ordinary usage principles and specific statutory provisions which is referred to at the outset of this chapter as the two meanings and parallel provisions analyses of the meaning of income and structure of the Assessment Act.
[2.369] Amendments to the Assessment Act in 1984 repealed s. 26(d) and replaced it by the “eligible termination payment” provisions of Subdiv. AA of Div. 2 of Pt III. Associated with the repeal and replacement, words were added to s. 25(1) which except from its operation “an amount to which s. 26AC or s. 26AD applies, or an eligible termination payment within the meaning of Subdiv. AA”. Comment on this addition to s. 25(1) has been made in [1.39] and [2.223] above. It does deny the central provision analysis of the Assessment Act argued for in this Volume, with resulting destructive consequences for the operation of the jurisdictional bases adopted by the Assessment Act. And the addition would appear to deny the single meaning analysis. If it does deny the single meaning analysis, reconciliation between s. 25(1) and specific provisions is possible only by further express exceptions to s. 25(1). Meanwhile s. 25(1) and specific provisions, other than those now listed in s. 25(1), enter upon a chaotic competition for precedence, with the only prospect of relief being that afforded by the analysis of Stephen J. in Reseck: where a specific provision has a narrower operation in a field than the ordinary usage concept, the difference becomes exempt income, a relief that could never have been intended and which no one would welcome. It would be a strange conclusion indeed that s. 26AAC has made a receipt of options within Abbott v. Philbin [1961] A.C. 352 exempt income.
[2.370] The problems of reconciliation between the operation of ordinary usage principles and specific provisions are no different from the problems of reconciliation of specific provisions. They ought where possible to be solved by express provisions like those in the provisos to s. 26(e). Where there is no express provision, principles of statutory interpretation and what policies may be evident in the Assessment Act and legislative history must govern. There is a problem, for example, of reconciling s. 26AAC and the eligible termination payment provisions which must be solved in this way. An eligible termination payment may be a transfer of shares to which s. 26AAC on its facts applies (s. 27A(8)).
[2.371] The words added to s. 25(1) should be replaced by words in Subdiv. AA, s. 26AC and s. 26AD themselves, which will state their relationship to the ordinary usage meaning of income. It will be a happy bonus that the central provision and single meaning analyses will be restored, and the jurisdictional bases of the Assessment Act repaired.
[2.372] The view adopted in this Volume—that there is only one meaning of income for purposes of the Act and that s. 25 is a central provision which in its use of the word “income” refers to all items which are income for purposes of the Act—simplifies the solution of the problems of relationship. The majority view in Reseck is explained as a decision that s. 26(d) exclusively determined when a benefit to which the provision applied was income. Section 26AAC(10), in partially excluding the operation of s. 26(e), is seen as denying an income quality to items which are within that exclusion and which are not given an income quality by s. 26AAC.
[2.373] Whatever may be the scope remaining for the ordinary usage notion of income so far as it concerns rewards for services, it must continue to be indirectly relevant in the interpreting of the specific provisions. The point has already been made that the words “in respect of, or for or in relation directly or indirectly to” in s. 26(e) will be taken to reflect the tests of connection which in relation to the ordinary usage notion are described as tests of whether a benefit is a product of services. The idea of product of services where the benefit is in the nature of a gift received by the taxpayer who performs services, has already been examined under Proposition 8.
[2.374] The ordinary usage principle that a reward for services is income, like the specific provision in s. 26(e), applies whether or not the services are rendered in some employment relationship. And it applies though the services are rendered in some isolated transaction which is not part of a continuing business or profession of rendering services.
[2.375] The first of these statements hardly requires authority. For the second the Australian authority is Brent (1971) 125 C.L.R. 418. The issue in the case, as it was seen by Gibbs J., was whether Mrs Brent, in communicating her story to the newspaper, was rendering a service or disposing of property. If the correct conclusion was that she was disposing of property the income quality of the receipt would have turned on the operation of Proposition 14—gain from carrying on a business or carrying out an isolated business venture—or, conceivably, on the specific provisions in s. 26(a) (now s. 25A(1)) and s. 26AAA. Proposition 14, it will be seen, would not give an income quality to any part of the the proceeds of sale unless a business is being carried on and the sale is an aspect of carrying on the business, or is incidental to carrying on the business, or the sale is the carrying out of an isolated business venture. There was no suggestion that Mrs Brent had entered on a business of selling stories or was carrying out an isolated business venture, and neither s. 26(a) nor s. 26AAA could possibly have been relevant. Seen as a disposition of property, the selling of the story could not therefore have involved a gain that was income. Gibbs J. held that the communicating of the story was the performance of a service, and the reward she would receive would therefore have an income character. He relied on the United Kingdom cases of Hobbs v. Hussey [1942] 1 K.B. 491 and Housden v. Marshall [1959] 1 W.L.R. 1, and quoted (at 426) from the judgment of Lawrence J. in Hobbs v. Hussey:
“… the performance of services, although they may involve some subsidiary sale of property (e.g. dentures sold by a dentist) are in their essence of a revenue nature since they are the fruit of the individual’s capacity which may be regarded in a sense as his capital but are not the capital itself.”
The distinction between selling property and selling services in circumstances such as Brent may appear artificial and complicating. If Mrs Brent had sold the family photo album as well as her story, an awkward problem of determining what is principal and what is subsidiary would have been posed.
[2.376] None the less, the consequence of Brent is that the distinction between selling services and selling property becomes of fundamental importance in income tax law. A reward for an isolated act of service—occasionally acting as a baby-sitter, or returning lost property to its owner—which may fairly be regarded as a product of that service, will be income. Presumably, it will not be regarded as a product unless the act is performed in a commercial context to the extent that the taxpayer expected a reward. But gain from selling property (save where s. 25A(1) or s. 26AAA operates) will be income only where the property is a revenue asset of a business, or is realised in carrying out an isolated business venture.
[2.377] The implications of the distinction drawn in Brent are not always clearly seen. A passage from the judgment of Fullagar J. in Hayes (1956) 96 C.L.R. 47 at 57–58 calls for quotation at length:
“The only other way, so far as I can see, in which the case can be put for the commissioner is to say that the gift of the shares represented a reward or recompense for the general advice and guidance given informally on a number of occasions to Richardson personally, and proving of benefit in the long run to Richardson himself or to the company in which he had a controlling interest. I think that the gift was intended in part, though only in part, as such reward or recompense. But surely it is utterly unreal to say that, whenever Hayes expressed a particular opinion or recommended a particular course, he was engaging in an activity capable of producing income for him. Such an idea is foreign to the whole idea of what constitutes income from personal exertion. If Hayes had been employed to give such advice or guidance, or if he had carried on a business of giving such advice or guidance, the position might well have been different. But he was doing neither of those things. If A tells his friend B in a casual conversation that he thinks that the shares of the Z company will rise greatly in a short time, and B buys shares in the Z company and makes a large profit, it will be impossible to contend that a gift of £1,000 by a grateful B to his friend A is income earned by A. A has earned the money only in the loose sense that he has done something for which B is grateful. He has not earned it in the sense—the only relevant sense—that it is the product of a revenue-earning activity on his part.”
[2.378] The reasoning in the passage quoted shifts between two lines. One of these is that the receipt by Hayes was not a product of the services: the absence of an expectation of the receipt by Hayes, and the motive of gratitude rather than the giving of reward that may have moved Richardson, were relevant. The other line of reasoning is reflected in the hypothesis and conclusion that: “If Hayes had been employed to give such advice or guidance, or if he had carried on a business of giving such advice or guidance, … the position might well have been different.” This second line of reasoning is inconsistent with the decision in Brent. It assumes that a reward for services is income only when the services are performed in an employment relationship or as an activity of a business. The reasoning in Maddalena (1971) 45 A.L.J.R. 426 may also be inconsistent with Brent. The question was whether the taxpayer, a professional footballer, was entitled to deduct expenses incurred by him in seeking and obtaining a new contract with a new club to play football. In the view of the court a taxpayer who has no business of providing services has no income earning activity of providing services until he has an employment contract. On the authority of Brent there ought to have been some consideration given to whether the expenses were expenses of an activity of performing services from which he might derive rewards that were income. In fact the reasoning in Maddalena assumed that the expenses could only be deductible as expenses of an employment or as expenses of a business of rendering services. They were “incurred in getting, not in doing, work as an employee”. They were not the latter because, on a technical view of the distinction between a contract of service and a contract for services, the taxpayer was seeking employment and thus could not have a business. Menzies J. (with whom all the other judges agreed) said (at 427):
“There is a difference of first importance for present purposes between an electrician who seeks work as an employee and an electrician who seeks contracts to do work as a principal. In the former case the electrician would not have a business; in the latter he would. In the latter, therefore, what he spent to obtain contracts to do electrical work would be properly regarded as an outgoing of his business. There is, however, a clear distinction between the two cases.”
Granted that there is a distinction thus drawn by Menzies J., it may yet be asked whether there is a relevant distinction. The distinction will not be significant if the rendering of services, irrespective of any business context, is an activity that may produce income. The fact that expenses are directed to obtaining a contract of employment that will provide continuing opportunities to provide services for reward, is not significant in determining deductibility save so far as it bears on the question whether the expenses are working expenses. They may not be working expenses because the employment contract is of such importance that it is structural to the taxpayer’s activity. In the same way the expenses of an electrician in obtaining a contract to do electrical work as an independent contractor may be structural, if the contract will provide a very substantial part of the outlet for his services. The matter is considered in [2.478]–[2.491] in connection with a distinction between revenue assets and structural assets of a business.
[2.379] There is a question whether the distinction between selling services and selling property is relevant where actual services are provided, not by the taxpayer, but by another person who may be contractually bound to the taxpayer to perform services at the latter’s direction. A service trust, such as that involved in the facts of Phillips (1978) 78 A.T.C. 4361, may provide the services of its employees as an activity of a business and any reward is proceeds of that business. But a casual act of providing services—the services of the taxpayer’s secretary to take notes at a company meeting, the taxpayer being a director of the company—may not attract the principle in Brent.
[2.380] The distinction of fundamental importance drawn in Brent (1971) 125 C.L.R. 418 between performance of services and supply of property, must bring its share of problems. In Hobbs v. Hussey [1942] 1 K.B. 491 the sale of the copyright under the contract by which the services were supplied was held to be merely ancillary. There will be other cases where such a conclusion is not so easily reached.
[2.381 In some cases it will not be necessary to draw the distinction because the taxpayer is in business and the property is a revenue asset of that business, or because the property is property to which s. 25A(1) applies: Austrotel Corp. Ltd (1976) 76 A.T.C. 4245. The gain will be income whether it results from the performance of services or the supply of property.
[2.382] The importance of identifying occasions of the supply of services has been accentuated by the specific provision in s. 26(e), which displaces the principle expressed in Proposition 2, where an item is income as a reward for services. In Cooke and Sherden (1980) 80 A.T.C. 4140 the question was whether an item which had no realisable value, but which had a substantial value to the taxpayer, might be brought to tax as a reward for services. The taxpayer was technically a self-employed person acquiring property from a supplier for resale as his own property. The reward in question was a holiday paid for by his supplier. Section 26(e) was held to be inapplicable: to buy goods from another is not to perform a service for that other.
[2.383] An examination of the meaning of income in ordinary usage requires that a distinction be drawn between a receipt that is a reward for services, and a receipt that is the consideration for giving up a contract to perform services. It also requires that a distinction be drawn between a receipt that is a reward for services and a receipt that is the consideration for accepting a restriction on capacity to perform services.
[2.384] Where the taxpayer’s actions amount to a business of performing services, a contract under which services are performed may be a revenue asset of that business and a receipt for giving up the contract will be income to the extent that it involves a gain. Its character as a revenue asset will depend on the significance of the contract to the business. The notion of revenue asset is explained in [2.478]–[2.491] below. A contract of employment may be a revenue asset as distinct from a structural asset of a business of providing services though the occasions when it will be a revenue asset are likely to be few. A conclusion that the contract of employment was a revenue asset of a business was reached by Starke J. in C. of T. (Vic.) v. Phillips (1936) 55 C.L.R. 144.
[2.385] Where a taxpayer is not engaged in a business of providing services, there is room for a characterisation of a contract to perform services which will parallel the characterisation of an asset as a revenue asset of a business. It may be enough to identify it in this characterisation as a non-structural asset. A contract which does not engage a significant part of a taxpayer’s capacity to perform services may be non-structural, and a receipt for giving up the contract will be income. A contract of employment might be seen in some circumstances as non-structural. It was suggested in [2.378] above that the contract of employment entered into by the taxpayer in Maddalena (1971) 45 A.L.J.R. 426 could be seen as non-structural. There is no magic about a contract of employment which will require that it be always treated as structural. The technical distinction between an employment contract and a contract as an independent contractor should not be a definitive distinction in this part of the law. A contract of employment will normally be structural, however, and it is assumed to be such in the discussions that follow, whether it is or is not an asset of a business.
[2.386] A receipt for giving up a contract to perform services that is a structural asset of a business, or an activity of providing services, will not be income under the ordinary usage concept, but it may be income under Subdiv. AA of Div. 2 of Pt III which includes a code of provisions that relate to an “eligible termination of payment” as defined in s. 27A(1). Those provisions are made a code by words added to s. 25(1) in 1984 which have been the subject of comment in [1.39], [2.223] and [2.369] above. Subdivision AA is more closely considered in [2.419] and [4.138]ff. below where the range of its operation in excluding aspects of the ordinary usage concept of income from the meaning of income for purposes of the Assessment Act, is examined. With some exceptions, an “eligible termination payment” includes “a payment made in respect of the taxpayer in consequence of the termination of any employment of the taxpayer”. “Employment” is defined so that it includes “the holding of an office”. One function of Subdiv. AA is to give an income character to a receipt which is not income by ordinary usage, because it is a receipt for giving up a contract to perform services that is a structural asset. In addition Subdiv. AA, in conjunction with the words added to s.25(1) in 1984, will exclude from the character of income under the Act as income by ordinary usage an “eligible termination payment” that is a receipt for giving up a contract that is a revenue asset. And it will exclude from the character of income as income by ordinary usage a reward for services that is “an eligible termination payment”. An “eligible termination payment” is, however, income and subject to tax under ss 27B and 27C of Subdiv. AA which, when read with s. 160AA, afford various degrees of relief from tax.
[2.387] In what follows, the ordinary usage principles are examined, with some references forward to the treatment in [4.138]ff. of Subdiv. AA of Div. 2 of Pt III.
[2.388] Where a taxpayer gives up all rights under a service agreement in exchange for a single sum of money, and ceases to perform services for the other party to the agreement, characterising the receipt as being for giving up the contract involves no difficulty. If the service agreement is structural, there will be no income within the ordinary usage meaning. There may however, be income in the form of an “eligible termination payment” under Subdiv. AA. If the taxpayer continues to render services under what may be seen as a modified agreement, or under a new agreement, a characterising of the receipt as being for the services to be performed in the future under the modified agreement, or under the new agreement, may appear to be open: Henley v. Murray [1950] 1 All E.R. 908. Where the only significant change in legal relations is that the taxpayer will hereafter work for a lower salary, the substance of the matter may be thought to be that the taxpayer has received a reward for services in advance of performing services. In Cameron v. Prendergast [1940] A.C. 549, the House of Lords, after some obeisance to the authority of I.R.C. v. Duke of Westminster [1936] A.C. 1, concluded that the agreement which modified the service agreement involved in “form and substance” a promise to continue to serve and the receipt was for that promise: it thus arose from his office as director and was income. In Tilley v. Wales [1943] A.C. 386 the agreement which modified the service agreement provided that the taxpayer would serve the company “as managing director as from the date of these presents at a reduced salary of two thousand pounds per annum”, and in consideration he would receive the sum of £40,000. The £40,000 was held to be income. Without referring to Duke of Westminster, Viscount Simon L.C. (at 393) concluded that the quality of income is not escaped “because an arrangement is made to reduce for the future the annual payments while paying a lump sum down to represent the difference”. If it is assumed that the payments of the kind in Cameron v. Prendergast and Tilley v. Wales are not made in consequence of the termination of an employment, the receipts, as ordinary usage income, will be income for purposes of the Assessment Act.
[2.389] The prospect that a receipt will be held to be for giving up a contract to perform services is considerably diminished, if not extinguished, if the payment is provided for in the contract to perform services. A contract of service may provide that if services are terminated for any reason the taxpayer will receive an amount “as compensation for the surrender of his rights under the agreement”. A number of United Kingdom authorities support the view that the receipt is further compensation for services, more especially where the amount is calculated by reference to the period for which services have already been performed and the rate of reward for those services. Henry v. Foster (1932) 16 T.C. 605 is the leading case. It was applied by the Court of Appeal in Dale v. de Soissons (1950) 2 All E.R. 460, in circumstances where the amount was calculated by reference to the period of services still to run under the service agreement at the time of the termination. Dale v. de Soissons comes near to asserting a proposition that a receipt stipulated for in a contract of service can never be a receipt for the surrender of rights under the contract. The receipt is in satisfaction of a contractual right, not for the surrender of contractual rights.
[2.390] Payments of the kind in Henry v. Foster and Dale v. de Soissons would appear to be payments made “in consequence of termination of an employment of the taxpayer” and thus subject to tax, not as ordinary usage income, but under the provisions of SS 27B and 27C.
[2.391] In Bennett (1947) 75 C.L.R. 480 the taxpayer continued to render services under a new agreement entered into on the same day as the agreement cancelling the former agreement. The agreement to cancel the former agreement provided for payments to be made to the taxpayer. These payments, under the new agreement, were refundable by him if he exercised options to extend the period of his service under the new agreement. Williams J. declined to hold that the payments were remuneration for his services under the new agreement. He relied on the provision in the new agreement for refunds if the options were exercised, and on the fact that under the new agreement the taxpayer did not have the position of control of the company’s business that he enjoyed under the former agreement. The emphasis given to the new agreement, an agreement independent of the cancellation agreement, is a rejection of a view that the form of the cancellation agreement is paramount. If it be assumed that a payment of the kind received in Bennett is not a payment in consequence of termination of an employment of the taxpayer, it will not be income under s. 27B or s. 27C. It will thus not be income on any ground.
[2.392] If an agreement to perform services is a revenue asset of a business, or a non-structural asset of an activity of providing services, an amount received for surrendering rights under the agreement will be income, not as a reward for services, but as a gain from an act done in carrying on a business, or in carrying on the activity of performing services. The notion of an activity of performing services distinct from a business of providing services is necessary to accommodate the decision in Brent (1971) 125 C.L.R. 418 discussed in [2.375] above.
[2.393] Where the taxpayer, most likely a full-time employee, has rights under only one contract to provide services as an employee, it is hard to conceive that he could be held to have a business of rendering services, and the question whether the contract is a revenue asset does not arise. There is, none the less an assumption in this observation that an agreement to render services as an employee may in some circumstances be an asset of a business. This might be thought to conflict with the definition of a “business” in s. 6 of the Act, which excludes occupation as an employee. The definition in s. 6 does not, however, have any relevance to principles stated in describing the ordinary usage meaning of income.
[2.394] Where a taxpayer as an employee has rights under several contracts to provide services to different employers, a conclusion that he is in business providing services and that an individual contract is a revenue asset of that business is possible. It may be more likely if he has entered into agreements as a self-employed person as well as an employee. In C. of T. (Vic.) v. Phillips (1936) 55 C.L.R. 144 Starke J. concluded that the taxpayer was in business providing services as an employee, and that the particular contract with which the case was concerned was a revenue asset of that business. The receipts for surrender of those rights were income. The case is curious in that it was assumed by all members of the court (Dixon, Evatt, Starke JJ.) that the taxpayer was in business in partnership with his brother. There may be some difficulty in regarding an agreement to serve as an employee as an agreement entered into in carrying on business in common with another. If it can be so regarded the opportunities for income splitting through partnerships would be increased many fold.
[2.395] The possibility remains that the contract to provide services as an employee, though not a revenue asset of a business, is a non-structural asset of an activity of providing services. The possibility is raised in [2.385] above in relation to the decision in Maddalena (1971) 45 A.L.J.R. 426. An amount for surrendering rights under such an agreement will be income within the ordinary usage notion of income.
[2.396] Where the payment on the surrender of rights under the agreement to provide services as an employee is made in consequence of termination within the meaning of those words in the definition of “eligble termination payment” in s. 27A(1), the question whether there is ordinary usage income arising from the surrender will not be significant. The receipt will be income under s. 27B or s. 27C, and the operation of ordinary usage principles will be excluded. In C. of T. (Vic.) v. Phillips there were several payments and this might take them out of the definition of “eligible termination payment” as “an annuity … to which s. 27H applies”. Dixon and Evatt JJ. seemed persuaded that the receipts were periodical receipts within the ordinary usage principle. Ordinary usage may none the less be excluded by a conclusion that s. 27H is a code. The matter was considered in [2.223] above.
[2.397] Where the taxpayer as a self-employed person has rights under only one agreement to provide services, it is arguable that he has no business. It would be relevant to ask whether he has commercial capacity to enter into other agreements—he may have agreed not to perform services for persons other than the other party to the agreement. In any case, where there is only one agreement a conclusion is to be expected that the agreement is not a revenue but a structural asset of the business.
[2.398] Where a self-employed person enters into contracts to provide services to a number of persons, each contract of service will generally be a revenue asset of a business, and a gain from surrendering rights under the contract will be income. The electrician’s contracts considered in Maddalena (1971) 45 A.L.J.R. 426 at 427 are revenue assets. It may be, however, that a particular contract gives rise to a very substantial part of the taxpayer’s business activity, such that it is to be regarded as a structural asset of his business, and a gain from surrendering rights under that contract will not be ordinary usage income.
[2.399] Where there is no business, the possibility must again be considered that the contract is a non-structural asset of an activity of rendering services. A receipt for surrendering rights under such a contract would, presumably, be income within the ordinary usage notion.
[2.400] Where the payment on the surrender of rights is made in consequence of termination of an “office” within the meaning of that word in the definition of “eligible termination payment” in s. 27A(1), imported by the definition of “employment” in s. 27A(1), the question whether there is ordinary usage income arising from surrender will not be significant. The receipt will be income under s. 27B or s. 27C, and the operation of ordinary usage principles will be excluded. The meaning of “office” in this connection is considered in [4.151] below.
[2.401] There are a number of cases concerned with giving up agency agreements. A taxpayer who has exclusive rights under an agreement to sell the products of a manufacturer in a particular area may receive an amount for giving up rights under that agreement. The case will be a reward-for-services case only where the taxpayer sells on commission as distinct from buys and sells as principal, which may afford another illustration of the technicality of the distinction between the supply of services and the supply of property. The “agent” who buys and sells does not supply services: Cooke and Sherden (1980) 80 A.T.C. 4140. The United Kingdom authorities have adopted tests for determining whether the agency agreement is a revenue asset. These tests are essentially mathematical, taking into account the period of the agency agreement still to run at the time of the surrender and the proportion which business under the agreement is of total business done by the taxpayer. Some of the leading cases are Kelsall Parsons & Co. v. I.R.C. (1938) 21 T.C. 608 and Barr, Crombie & Co. v. I.R.C. (1945) 26 T.C. 406. In some instances, for example Wiseburgh v. Domville [1956] 1 W.L.R. 312, the importance of the agency agreement to the goodwill of the taxpayer’s business is recognised. It will be important if the taxpayer’s customers are customers specifically for goods of the manufacturer for whom he is agent. The significance of goodwill associated with the agency was the subject of some comment in I.R.C. v. Fleming & Co. (1951) 33 T.C. 57. Lord President Cooper drew attention to the fact that by the surrender agreement the major part of the consideration was attributed to the surrender and only a small part to a restrictive covenant given by the taxpayer. Having regard to the fact that suppliers of explosives are few, and that the taxpayer’s principal, Imperial Chemical Industries, proposed to distribute its products in Scotland itself, it might have been thought that the taxpayer’s goodwill was given up by surrender of the agency and not by the restrictive covenant. It is a curious manifestation of a form approach that the taxpayer was held to be defeated by the attribution of consideration in the agreement. What he received for surrender of the agency was income. He might have arranged for a greater amount to be attributed to the restrictive covenant, and that amount would not have been income.
[2.402] Sabine v. Lookers Ltd (1958) 38 T.C. 120 is a recognition of the element of goodwill bound up with an agency agreement when it relates to motorcars of a particular manufacture.
[2.403] There is a question of how the test of significance of the agency agreement, in terms of proportion of business under the agreement to the business activity as a whole, is to be applied. It may be asked whether all business activities are relevant or only those which are, in some sense, of the same kind as that with which the surrendered agreement was concerned. What is the business activity as a whole where the agreement surrendered is one of a number of agency agreements and the taxpayer also operates a foundry? The question was raised by the facts in Fleming v. Bellow Machine Co. Ltd [1965] 1 W.L.R. 873, but by agreement between counsel was put aside.
[2.404] Any test of a revenue asset which depends for its operation on the relative importance of that asset, whether in terms of the amount of business activity it generates or the amount of goodwill bound up with it, offers scope for planning which relies on the multiplication of taxpayers by setting up companies and distributing business activity among them. In this connection Californian Oil Products Ltd (In liquidation) (1934) 52 C.L.R. 28 is instructive.
[2.405] There may not be a business of which the agreement to render services is an asset, or, if there is a business, the agreement may be a structural asset of that business. Yet in some circumstances the principle expressed in Proposition 15 will operate to make a receipt for the surrender of rights under the agreement an income receipt. The receipt may be regarded as compensation for the rewards that would have been received as income if the agreement had not been terminated. The most likely circumstances in which the principle will operate involve a series of receipts. Some of the significance of receipts in a series has already been explored in relation to the periodicity principle (Proposition 11), and the gains from the property principle (Proposition 12). The significance of receipts in a series now noted lies in attracting the operation of the compensation principle (Proposition 15).
[2.406] The leading case, where there is a surrender of rights, is C. of T. (Vic.) v. Phillips (1936) 55 C.L.R. 144. The case concerned a contract to manage a theatre as an employee. The surrender was for a series of receipts calculated so as to approximate the salary receipts that would have flowed to the taxpayer from the agreement terminated, the payment of each amount being made at the time a salary payment would have been made. Starke J., it has already been noted, gave as a ground for holding that the receipts were income that they were in respect of the surrender of rights which constituted a revenue asset. It has also been noted that Dixon and Evatt JJ. considered that the receipts were an annuity, the “fixed gross sum” being only the arithmetical sum of the series of receipts. All members of the court gave the compensation receipts principle as a further ground that the receipts were income. The value of an asset, an economist might say, is simply the present value of the expected flows of income the asset will produce. To say that a present receipt of that value is compensation for those income flows would be to allow the compensation receipts principle to ravish much of the other established principles of income tax law. But there is a place for the operation of the compensation receipts principle when a receipt corresponds in time and amount with an income flow.
[2.407] There is of course a question of the degree of correspondence that is necessary to attract the principle. Phillips involves a near complete correspondence. Some of the judments in Dickenson (1958) 98 C.L.R. 460 which concerned the giving up of capacity to conduct business operations refer to Phillips and contemplate that a series of receipts might have attracted the compensation receipts principle. But any close examination of the degree of correspondence required was not undertaken. Nor is it undertaken in any other case.
[2.408] Where the taxpayer is an employee, as he was in Phillips, or the holder of an office, there is a prospect that any receipt is an “eligible termination payment” as defined in s. 27A(1) so that the operation of ss 27B and 27C are attracted. It will be such if it can be said to be a payment made “in consequence of the termination of any employment [or the holding of an office] of the taxpayer” and it is not within one of the exceptions listed in the definition. If ss 27B and 27C apply the question whether any receipt is income by ordinary usage becomes irrelevant. Where the receipt is one of a series as in Phillips the receipt may be excluded from the definition of “eligible termination payment” by the exception “of an annuity, or supplement, to which s. 27H applies”. In which event the question raised in [2.223] above as to whether s. 27H can be seen as a code excluding the ordinary usage notion of income is raised.
[2.409] It is assumed in the cases that a receipt for accepting a restriction on one’s capacity to perform services is not a reward for services. The cases for the most part are concerned with restrictive covenants, and the question is whether the receipt should be regarded as being for the restriction or for the performance of services under some associated agreement to serve. There is, however, a reference in the judgment of Harman J. in Higgs v. Olivier [1951] Ch. 899 at 901 to a suggestion by the Crown that not performing services, because of an undertaking given to another which restricts the performance of services, is itself a service, and the receipt for accepting the restriction is a reward for that service: “The Crown had to face the fact that the agreement … was an agreement not to act, and their answer was that money might be made by refraining just as by ceasing to refrain, and that this was an incident in the career of a popular actor by which he exploited his personality, just as he might have exploited it in the opposite way, by acting.”
[2.410] In Jarrold v. Boustead [1964] 1 W.L.R. 1357 the taxpayer, who had until then been an amateur footballer, agreed to play professional football for a club. Under the same agreement he received an amount “on signing professional forms”. The Court of Appeal held that this amount was for the permanent loss of his freedom to play sport as an amateur, which resulted from his becoming a professional. In the later case of Riley v. Coglan [1967] 1 W.L.R. 1300 an amount, also expressed to be payable “on signing professional forms” was held by Ungoed-Thomas J. to be a reward in advance for playing football for the club. Part of the amount was repayable to the Club if the taxpayer failed to carry out his agreement to play for the club. Woite 82 A.T.C. 4578 contrasts with Riley v. Coglan. In Woite the taxpayer did not enter into a contract to play football for the club making the payment to him. He played football in South Australia, and continued at all relevant times to do so. He entered into a restrictive covenant not to play football for any football club in Victoria except the club making the payment to him. A characterisation as a reward for services was therefore not open, except on the analysis referred to in the judgment of Harman J. in Higgs v. Olivier [1951] Ch. 899 at 901. Mitchell J., in holding that the receipt was not income, did not consider that possible analysis. Pritchard v. Arundale [1972] 1 Ch. 229 involved a receipt by a solicitor of a number of shares “in consideration of” his “undertaking to serve” a company full-time as a joint managing director. Megarry J. held that the receipt was not a reward for services to be performed in the office, but for giving up his practice as a solicitor. He expressed the view that in characterising the receipt the terms of the agreement were entitled to be given full weight, but only as part of the surrounding circumstances. The case may thus be seen as concerned with the substance of the rule that a receipt for accepting a restriction on one’s capacity to perform services is not a reward for services.
[2.411] Pritchard v. Arundale [1972] 1 Ch. 229 bears some comparison with Moriarty v. Evans Medical Supplies [1958] 1 W.L.R. 66 and, among Australian cases, with Dickenson (1958) 98 C.L.R. 460. In Evans Medical Supplies the receipt was expressed to be for the giving of information to the Burmese Government about the manufacture of certain drugs used in veterinary medicine. None the less, it was held that the receipt was not a reward for this service, but for the loss of the taxpayer company’s trade in Burma, a loss which could be predicted as a commercial consequence of equipping the Burmese Government with the know-how, so that it might itself manufacture the drugs. The case might be thought to be a model illustration of characterising by reference to all the circumstances, and a consequent neutralisation, if not contradiction, of the terms of the agreement under which the amount was received. The receipts in Dickenson were expressly linked with the giving of restrictive covenants. The High Court’s characterisation was consistent with those links. It was, none the less, made by reference to all the circumstances. Kitto J. observed (at 493): “[The amounts] were really payable in connection with the whole machinery by which the desired tie to the Shell Company was accomplished, and not with any one part of that machinery considered by itself.”
[2.412] A number of United Kingdom cases are concerned with the characterising of receipts expressed to be for covenants entered into by employees restricting rights to perform services for others. In both Beak v. Robson [1943] A.C. 352 and Higgs v. Olivier [1952] Ch. 311 (Court of Appeal) the receipt was held to be for the restriction. In neither case, however, was the form of the agreement under which the payment was made treated as definitive. The circumstance that the restriction, though provided for in the service agreement, commenced on the termination of the service agreement was regarded as important in making the characterisation in Beak v. Robson. In Higgs v. Olivier Evershed M.R. expressed a view that a receipt in respect of a restriction to run during service is the more likely to be regarded as a reward for services. Higgs v. Olivier involved a payment expressed to be for a restriction commencing after the completion of services. Where a restrictive covenant is provided for in the service agreement and the covenant is to run during service, a conclusion that the amount of the consideration attributed to the covenant is a reward for services is near inescapable. Where the law would imply a covenant not to work for others during the currency of the agreement, the taxpayer’s promise in the restrictive covenant is a promise to do what he is in any case bound to do in serving his employer.
[2.413] The conclusion in Beak v. Robson [1943] A.C. 352 that a payment for a restrictive covenant to run from the termination of a service agreement and provided for in the agreement, may be held not to be income, raises the prospect that part of the consideration described as salary in a service agreement that provides for a restrictive covenant but does not attribute any consideration to the covenant, is not income. The Revenue argued in Beak v. Robson that the taxpayer’s case required a logical inference that salary receipts would need to be apportioned between reward for services, which would be income, and consideration for the restrictive covenant which would not. The inference in Australia, beset by the principle in McLaurin (1961) 104 C.L.R. 381 and Allsop (1965) 113 C.L.R. 341 considered in [2.558]ff. below, may be that no part of the salary receipts is income because the income element cannot be dissected or apportioned from them.
[2.414] The validity of a restrictive covenant may be affected by common law principles and trade practices legislation. The fact that a restrictive covenant is not enforceable in its terms will bear on the issue whether the consideration attributed to the restrictive covenant should be seen as a receipt for services, or a receipt for accepting a restriction on capacity to perform services. But it does not dictate a conclusion. A receipt for undertaking an obligation that the taxpayer regards as binding on him may be a receipt for accepting a restriction on his capacity to perform services, notwithstanding that the obligation cannot be enforced against him. Observations in Dickenson (1958) 98 C.L.R. 460 are sufficient authority: per Williams J. at 481-2; per Kitto J. at 490.
[2.415] The possibility that a receipt for accepting a restriction on one’s capacity to perform services is an “eligible termination payment” within the definition in s. 27A(1), and is thus subject to ss 27B and 27C is considered in [4.138]ff., especially [4.182] below.
[2.416] There is no Australian judicial decision concerned with a restrictive covenant limiting a taxpayer’s capacity to perform services.
[2.417] A conclusion that a receipt is not a reward for services, but is a receipt for a restriction on capacity to render services, does not necessarily mean that the receipt is not income. It may be income as a gain from an act done in carrying on a business. The accepting of restrictions may conceivably be a business in itself. More likely, it may be held to be incidental to some other business activity. In Higgs v. Olivier [1952] Ch. 311 at 315 there is a recognition of the possibility that the giving of a covenant not to perform, for a period, in any film or play might be regarded as “in the ordinary run of the profession or vocation of actors”, though the covenant in the facts of the case was of an unusual character and could not be so regarded. Dickenson was concerned with the first occasion on which the taxpayer had entered into a tie by which he agreed to sell only a particular oil company’s product. The system of ties between garage proprietor and oil companies was in course of being established. Dixon C.J. remarked that receiving an amount for a tie in these circumstances was not a normal or natural incident of carrying on business as a garage proprietor. The possibility cannot be excluded that in modern conditions when entering into a tie agreement is a universal experience in the business of a garage proprietor, receiving an amount for a tie is incidental to carrying on that business. The capacity to accept a restriction is, in effect, a revenue asset.
[2.418] In some circumstances the principle expressed in Proposition 15 will operate to make a receipt for accepting a restriction an income receipt. Where the receipt is one of a series it may be regarded as compensation for an income flow which might have been received if the restriction had not been accepted. C. of T. (Vic.) v. Phillips (1936) 55 C.L.R. 144 and Dickenson (1958) 98 C.L.R. 460 in this regard, are considered above in [2.405]-[2.408].
[2.419] Where a restrictive covenant is entered into while service by an employee continues, it is unlikely that the payment for the covenant could be said to be a receipt by the taxpayer “in consequence of the termination of [an] employment”. The payment may be in contemplation of termination, but it is hardly in consequence. Sections 27B and 27C will thus not displace the operation of ordinary usage principles. Where the payment is made on termination and admits of the description as a payment in consequence of the termination of the taxpayer’s employment, ss 27B and 27C may still not be operative. Paragraph (m) of the definition of “eligible termination payment” in s. 27A(1), excludes “consideration of a capital nature for, or in respect of, a legally enforceable contract in restraint of trade by the taxpayer, to the extent to which the amount or value of the consideration is, in the opinion of the Commissioner, reasonable having regard to the nature and extent of the restraint”. Where the payment would be income of the taxpayer as a reward for services, para. (m) can have no application. The receipt by the taxpayer is not of a capital nature. It may then be within the definition of eligible termination payment and subject to s. 27B and s. 27C.
[2.420] In the discussion of the problems of characterising a receipt as a reward for services or as a receipt for surrender of rights, and of the problem of characterising a receipt as reward for services or as a receipt for accepting a restriction, some observations were made on the significance that may be accorded to form. Generally the form of the agreement has been regarded as merely one fact that may be relevant in determining the characterisation, though the doctrine of form in I.R.C. v. Duke of Westminster [1936] A.C. 1 has not gone unnoticed.In I.R.C. v. Fleming & Co. (1951) 33 T.C. 57, the allocation in the agreement of an amount as being for the surrender of contractual rights, when it might have been allocated to a restrictive covenant, was thought to require the operation of form to the disadvantage of the taxpayer.
[2.421] There would appear to be no role for the Duke of Westminster doctrine of form in this context. The doctrine remains part of United Kingdom law, though it has been explained recently in a way that may make it less of a support in tax planning than formerly: W. T. Ramsay Ltd v. I.R.C. [1982] A.C. 300; I.R.C. v. Burmah Oil Co. (1982) S.T.C. 30; Furniss v. Dawson [1984] 2 W.L.R. 226. The doctrine continues to be applied in the High Court: Westraders (1979) 144 C.L.R. 55. But its role should be confined to the context of a specific statutory provision which attaches tax consequences to the adoption of a legal form. The doctrine does no more than say that a taxpayer, who has, in a transaction which is not a sham, adopted that legal form, is benefited or burdened by those tax consequences. The question in Duke of Westminster was whether the payment was an “annuity or … annual payment … payable wholly out of profits or gains brought into charge”. There was room for debate about the meaning of the words “any annuity or annual payment”, but if the taxpayer’s actions were within that meaning he was entitled to the tax consequences. Where the context is the ordinary usage meaning of income and the only relevant statutory provision is the word “income” itself in s. 25, there is no role for the Duke of Westminster doctrine. The question is whether the facts come within some rather vague notions which the courts have sought to express in principles and rules. A formulation in a judgment of a court of a rule that a receipt for a restrictive covenant is not income as a reward for services, is very different from a specific provision in the Assessment Act. In this context a conclusion that the receipt was not “really” or “in substance” for the restrictive covenant, though it was such in form, involves an assertion that the idea of receipt for a restrictive covenant expressed in the rule transcends the legal forms that have been used in expressing it. That idea may require reference to the intentions of the parties: could it have been expected that the taxpayer would have received the amount in any event, under the form of a payment for services, if he had not entered into the restrictive covenant? Reference to these intentions may require a conclusion that the “substance” of the transaction was a reward for services, or, which amounts to the same thing, that the transaction was within the substance of the principle that a reward for services is income. Tax law which is made to operate mechanically through legal forms must invite defeat of any principles it may seek to express.
[2.422] The doctrine of form is as irrelevant in the characterising of a receipt as income within the ordinary usage notion of income as it is in the characterising of an outgoing as deductible under the general deduction provision in s. 51. The chaos that has resulted from importing the doctrine of form into that context is considered at length in Chapter 9, [9.17] below. Thus a rule that interest on money borrowed to invest in income producing property is deductible may be a useful judge made rule expressing the broad principle in s. 51. But to treat a payment which is in form interest on such money as deductible simply because it has that form, is to mechanise the tax system and confound principle.
[2.423] A distinction may be drawn between a doctrine of primary form and a doctrine of secondary form. Primary form concerns only those provisions of the Assessment Act that attribute tax consequences to actions which are within specific words that have a definitive legal meaning. Thus the courts have found a definitive meaning for the word “royalties” and a taxpayer who enters a transaction of the kind adopted by the taxpayer in McCauley (1944) 69 C.L.R. 235 must accept the consequence that he derives income, though the adoption of another transaction which followed the precedent of Stanton (1955) 92 C.L.R. 630 might have enabled him to avoid that consequence. A taxpayer whose transaction fits the words of legal art in the phrase “subscriptions for shares” in a mining company is entitled to the deduction that the law may give for such a subscription. The doctrine of primary form will support him. Mullens (1976) 135 C.L.R. 290, a case mentioned again in Chapter 16, involved an attempt by the Commissioner to overcome the primary form doctrine by resort to the general provisions of s. 260 (now displaced by Pt IVA), in circumstances of a subscription for shares. There are those who would say that the primary form doctrine should prevail over any attempt to defeat it by reference to a policy of the Act, whether by a direct application of a policy or by means of a general anti-avoidance provision. Values expressed in the phrase “the rule of law” are at stake. The matter is considered again in Chapter 16.
[2.424] A doctrine of secondary form ought not to attract the same support. Such a doctrine concerns, not definitive words of the Assessment Act, but definitive words that may have been adopted in judicial interpretation in expressing a broad principle reflected in words of the Act that are not in themselves definitive. That interpretation will most often have concentrated on the ordinary usage concept of income that is attracted by the word “income” in s. 25(1), and the broad concept of deductibility expressed in the words “incurred in gaining” in s. 51(1).
[2.425] Most often judicial interpretation of broad concepts will not have come to be settled in rules expressed in definitive words, though there is a constant demand for interpretation that is expressed in definitive words. And there is generally enough flexibility in judicial precedent to recommit any rule to a new formulation. There are, however, illustrations in judicial decisions of the assertion of rules in definitive words which will dictate a result that may be thought to be in conflict with a due regard for the broad concept. Most commonly the rule is expressed in terms of the basic elements of contract law. Thus the rule may say that a receipt that is the consideration for a restrictive covenant and creates a binding obligation to observe the restriction does not have an income character. A rule of this kind will explain the observation of Lord Cooper in I.R.C. v. Fleming & Co. Ltd (1951) 33 T.C. 57 that to the extent that the receipt by the taxpayer had been in the contract attributed to the restrictive covenant it would not have been income. It would not have mattered that in all the circumstances the receipt was not, in a broad judgment of its links with the covenant, for the covenant. Extended form would thus prevail over the broad concept of income. The extended form approach evident in Fleming contrasts with the approach taken by Megarry J. in Pritchard v. Arundale [1972] 1 Ch. 229. The contract may have identified the receipt as the consideration for a promise by the taxpayer to provide services to a company. But in all the circumstances Megarry J. judged the receipt to be for the giving up of his professional practice in order to be free to undertake the provision of services as managing director of the company. Megarry J. expressly rejected an extended form approach, at the same time denying that there was any rule that the consideration provided for in a contract to perform services was income. Any rule that expressed the concept of income would in his view need to be framed, not in terms of consideration, but in terms of a more flexible notion of cause.
[2.426] Great issues of the validity of a secondary form approach to the interpretation and operation of the Assessment Act have arisen in recent years in Europa Oil (N.Z.) Ltd v. I.R.C. (No. 2) (1976) 76 A.T.C. 6001 and South Australian Battery Makers Pty Ltd (1978) 140 C.L.R. 645. The judgment of the Privy Council in Europa Oil (No. 2) is a triumph for extended form. The broad principle of s. 51 comes to be expressed in the context as a rule that the consideration given under a contract solely for the supply of trading stock is deductible. The fact that there were other purposes to be served by the making of the payment that could be inferred from all the circumstances was thus irrelevant. South Australian Battery Makers is a qualified triumph for extended form. The qualification is in the judgment of Gibbs J. who wanted to leave some room for the views of Dixon J. in Hallstroms Pty Ltd (1946) 72 C.L.R. 634 that issues as to deductibility should be approached from a practical and business point of view, rather than by reference to legal relations that arise. Those views are a rejection of extended form. The relevant rule of extended form in South Australian Battery Makers was that a payment that is the consideration under a lease solely for the use of the property leased is deductible. The qualification of Gibbs J. was that notwithstanding the terms of the lease, the payment might in part he denied deduction where in all the circumstances a conclusion could be reached that the payment was in part to secure some advantage to the taxpayer beyond the use of the property leased.
[2.427] A doctrine of extended form merges into another doctrine that might be identified as the “blinkers” doctrine. A rule may be expressed in terms that maintain the flexibility of the broad concept adopted by the Act. Thus it may be asserted that a payment which has as its purpose the acquisition of trading stock is deductible. The blinkers doctrine will destroy that flexibility by insisting that whenever a transaction has been cast in a legal form—a lease, a contract or other form—the purpose of the payment must be found within the expression of the transaction in that legal form. Europa Oil (No. 2) can be explained in its outcome as either an application of the extended form doctrine or the blinkers doctrine. Lord Wilberforce, who dissented in Europa Oil (No. 2), rejected the blinkers doctrine in a statement of what he saw as “familiar principles” in W. T. Ramsay [1982] A.C. 300 at 323: “The well-known principle in I.R.C. v. Duke of Westminster … while obliging the court to accept documents or transactions, found to be genuine, as such, … does not compel the court to look at a document or transaction in blinkers, isolated from any context to which it properly belongs.”
[2.428] The extended form doctrine may equally merge with the blinkers doctrine where the issue is the character of an item as income. Thus the observation by Lord Cooper in I.R.C. v. Fleming & Co. Ltd (1951) 33 T.C. 57 referred to in [2.425] above could be explained as an assertion of the blinkers doctrine. Even though the relevant rule is expressed in the flexible notion of cause—that a receipt whose cause is the giving of a restrictive covenant is not income—it will yield the same result as extended form if the transaction in which the restrictive covenant is given is cast in the form of a contract by which the receipt is the consideration for the giving of a restrictive covenant.
A gain which arises from an act done in carrying on a business, or from the carrying out of an isolated business venture, has the character of income.
[2.429] The word “business” used in this proposition, and in the “business gains” principle which it seeks to express, identifies a notion which is part of the ordinary usage meaning of income. That notion is not necessarily described expressly in the definition of “business” in s. 6 of the Assessment Act, or by implication in other provisions which use the word business and attract, prima facie, that definition. The definition in s. 6 excludes “occupation as an employee” with the consequence, there being no contrary intention, that the so-called second limb of s. 51 does not apply to an employee seeking a deduction of employment expenses. In the outcome the definition has offered some basis for distinguishing between a self-employed person who provides services, and an employed person who provides services, and for discriminating against the latter in the allowing of deductions of expenses. Where, however, the question is whether there is a business of performing services of which a contract is a revenue asset, the fact that the contract is an employment contract does not preclude a conclusion that there is a business. The matter was the subject of some comment in [2.394] above.
[2.430] The notion of business in the ordinary usage principle will embrace activities which, in a status-conscious use of words, would be described as a profession.
[2.431] There is a distinction to be drawn between a continuing business and what is referred to in Proposition 14 as an isolated business venture. The distinction is drawn within the ordinary usage business gains principle. And both continuing business and isolated business venture have, it seems, operations that exclude the operation of the specific provisions of s. 25A(1) (formerly s. 26(a)) and s. 52. Clearly the notion of a continuing business must exclude the specific provisions of s. 25A(1) and s. 52. In Investment & Merchant Finance Corp. Ltd (1971) 125 C.L.R. 249, Barwick C.J. observed that these provisions deal with transactions which are entire in themselves, and do not form part of a more extensive business. The sections in the result have no application in circumstances where the trading stock provisions (Subdiv. B of Div. 2 of Pt III) of the Act apply, provisions which, it is assumed, apply only in continuing business situations. If s. 25A(1) and s. 52 did apply in continuing business situations, there would be irreconcilable conflicts with the trading stock provisions. More recent authority, in Whitfords Beach Pty Ltd (1982) 150 C.L.R. 355, may require a conclusion that an “isolated business venture” as an aspect of the ordinary usage meaning of income has an operation that excludes the operation of s. 25A(1) and s. 52. The relationship between the notion of an isolated business venture and s. 25A(1) is examined in [3.4]ff. below. Observations in Whitfords Beach indicate that s. 25A(1) can only operate where the notion of an isolated business venture is not satisfied. There is no overlap in this respect between ordinary usage and the specific provisions.
[2.432] The notion of a continuing business involves a pattern of transactions, and an appraisal of that pattern as distinct from an appraisal of each transaction as if it stood alone. Thus a taxpayer may have a continuing business of buying and selling land. In the carrying on of that business he sells other land which he may have inherited. The sale of the inherited land will generate gains which are income, though the transaction of selling the inherited land, if it stood alone, would not have been an isolated business venture or a transaction within s. 25A(1). A conclusion that there was an isolated business venture or a transaction within s. 25A(1) might have been excluded by the “advantageous realisation” doctrine considered in [2.501] and [3.68] below.
[2.433] The law reports are peppered with statements as to what may be a “business”. The statements give significance to a variety of factors, but offer very little in the way of determinate rule: no factor is said to be necessary, and no combination of factors conclusive. One statement collects other statements, which may have been made in a different context. Where the question is whether there is a continuing business within ordinary usage principles, statements about the meaning of the word “business” in relation to an isolated business venture, or as used in some specific provision in the Assessment Act or in some other taxing Act, or indeed in an Act not concerned with tax, are of limited relevance.
[2.434] The United Kingdom Royal Commission on the Taxation of Profits and Income sought to state the “badges of trade” for purposes of the United Kingdom income tax: Final Report (1955, Cmnd 9474, p. 39). Its statement has been frequently quoted without a recognition of the fact that the Commission was not seeking to distinguish in the language of the United Kingdom statute, between continuing “trade” and an “adventure in the nature of trade”. A statement that is wide enough to describe continuing business and isolated business venture will offer very little in the way of determinate rule. The system that will give the character of business to continuing activity is necessarily different from the system that will give the character of business to an isolated business venture. In the case of a continuing business the system is to be found in the factors that link the transactions, none of which is in itself necessarily a business. In the case of an isolated business venture the system must be found in the transaction itself.
[2.435] If the absence of determinate rules is exasperating, there may be some comfort in realising that it is, to a degree, inevitable. Where the realisation of property is involved, the issue of business or no-business is the issue of income gain or capital gain. In policy terms, a conclusion that there is a business will equate the tax treatment of a person who makes gains from the realisation of property with a person who makes gains from performing services. A conclusion that there is not a business will encourage an investor by giving him immunity from income tax on any gain from the realisation of his investment. This immunity—it can be seen as a tax subsidy—jars with another policy which would say that gains which arise without effort should not only be taxed, but taxed more than others because the taxpayer derives his gain without sacrifice of leisure. This other policy finds expression in some tax systems in a surcharge on property income. Strangely, in those systems capital gains continue to be at least favourably treated. The confusion of conflicting policies must be reflected in the law.
[2.436] Australia has twice dallied with a surcharge on property income, and once came close to taxing capital gains. It has pushed the meaning of income some degree into the field regarded by ordinary usage as capital gain. This has been done by s. 26(a) (now s. 25A(1)) and s. 26AAA in ways considered in Chapter 3. But the issue of business or no business remains the battle ground of policies.
[2.437] It is not proposed to gather a further collection of statements about the meaning of business. The present concern is, in any case, only with the notion of continuing business. And any collection of statements would quarrel with any new statement of the kind now attempted that seeks even a modest degree of determinateness.
[2.438] A continuing business involves a number of transactions which are repetitive and systematic and are overall moved by a purpose to profit. If authority is necessary it may be found in Martin (1953) 90 C.L.R. 470, so far as the elements of number, repetition and system are concerned, and in London Australia Investment Co. Ltd (1977) 138 C.L.R. 106, so far as the overall purpose to profit is concerned, though the case may leave some doubts as to what gains are profit in this context.
[2.439] In the joint judgment of Williams A.C.J., Kitto and Taylor JJ. in Martin it is said (at 479):
“The onus … is on the appellant to satisfy the court that the extent to which he indulged in betting and racing and breeding racehorses was not so considerable and systematic and organised that it could be said to exceed the activities of a keen follower of the turf and amount to the carrying on of a business.”
Later cases have lessened the emphasis on the size of the operations. Indeed the first transaction, if a number are contemplated which will be of the same kind and systematic, may be regarded as a transaction of a continuing business. Fairway Estates Pty Ltd (1970) 123 C.L.R. 153 concerned with a business of money lending, is authority. Cases which lessen the emphasis on the size of the operations in the passage quoted from Martin are Thomas (1972) 46 A.L.J.R. 397, Ferguson (1979) 79 A.T.C. 4261 and Mullins (1981) 81 A.T.C. 4192. In each of the latter three cases it was the taxpayer who was asserting that there was a continuing business—in each case a primary production business—in order that he might have a deduction for expenses which exceeded any gains. It may be easier to find the elements of repetition and system where animals are husbanded, or land is made to produce a crop. In other circumstances, for example selling the land itself or a static product of land such as blue metal, or selling goods or shares, or horseracing and gambling as in Martin, the size of the operations will be more important in establishing repetition and system.
[2.440] The Commissioner’s argument in Ferguson was that the taxpayer’s actions were only preliminary. He was acquiring cattle under an arrangement by which he was entitled to the progeny of leased cattle agisted on another’s land under a management agreement. He sold the bull calves, and retained the heifers to stock land of his own he would ultimately acquire. Cases considered in Chapter 5 of this Volume indicate that there may be activity which is prior to commencement of a business and which is not part of that business. It is not easy to see how the acquisition of stock could be activity of such a kind. The Federal Court concluded that the activity was activity of a preliminary business, which may be thought an unnecessary complexity. There will be accounting problems when the preliminary business ends, and the permanent business commences, involving the possible operation of s. 36 and the principle in Sharkey v. Wernher [1956] A.C. 58 considered in Chapter 14.
[2.441] A continuing business must in the logic of the notion commence with a single transaction. The point is recognised in the judgment of Barwick C.J. in Fairway Estates (1970) 70 A.T.C. 4061. There must be a first lending by someone whose continuing activities require a conclusion that he is engaged in a business of money lending. Its character as a transaction of a continuing business is the result of inferences to be drawn from later activity in which the elements of number of transactions and system and organisation come to be satisfied. It may be that the first transaction is in fact the only transaction, the taxpayer having died thereafter or abandoned an intention to proceed. It is unlikely that the circumstances of a single transaction will yield inferences of intention to engage in repetitive transactions and of system and organisation, though it is not impossible. If the circumstances of a single transaction do not yield the necessary inferences, the subjective purpose of the taxpayer may assist him. At least this would be an appropriate extension of the decisions in Ferguson (1979) 79 A.T.C. 4261 and Mullins (1981) 81 A.T.C. 4192.
[2.442] Southern Estates Pty Ltd (1967) 117 C.L.R. 481 involved a question whether there can be a business even though the repetitive transactions from which profits will directly flow have not yet commenced. The taxpayer was engaged in clearing land that might thereafter be used in a business of cattle raising and sale. He sought deductions only available to a taxpayer “engaged in a business of primary production”. The judgment in Southern Estates involved a variety of views. In one view, identified as the view of Barwick C.J., it would be enough to give the clearing activity a character of business activity that the taxpayer already engaged on other land, whether or not adjoining, in cattle raising and sale. Another view, identified as the view of Windeyer J., was that an inference of purpose, or a subjective purpose, to engage in cattle raising and sale on the land when cleared will be enough to give a business character to the clearing activity. The view of Windeyer J. would justify a conclusion that the taxpayer is in business though he does not as yet engage in cattle raising and sale on any land. And it justifies a conclusion that whatever are his activities on other land he will not be held to be in business in relation to the clearing operations if the inference of purpose, or his subjective purpose, show that he intended to sell the land immediately it was cleared. Which is not to say that the clearing and sale may not be an isolated business venture. It will more likely be so if the land has been acquired for the purpose of clearing and sale. And there will be questions of the interrelations between isolated business venture and s. 25A(1), a matter explored in [3.4]ff. below.
[2.443] A business may continue though repetitive activity is not presently evident. AGC (Advances) Ltd (1975) 132 C.L.R. 175 is authority that a business may be “suspended”. There must, however, be an inference to be drawn, or, perhaps, a subjective purpose, that the activity will be resumed. Otherwise the notion of cessation would be deprived of meaning.
[2.444] The relevant purpose is an overall profit purpose. It is different when the issue is the existence of an isolated business venture, where there must be a profit purpose in the particular transaction. There is a distinction between a profit purpose and a profit motivation. It is not necessary that the taxpayer be motivated by a desire to profit. United Kingdom authorities holding that religious societies, a law society publishing law reports, and public utilities are in business do not reject a requirement of profit purpose. Realising a surplus so as to establish and maintain a reserve is a profit purpose. Where however prices are deliberately pitched so as to subsidise persons who buy the goods or services provided by the taxpayer, there is no business.
[2.445] The authority for the requirement of profit purpose given above was London Australia Investment Co. Ltd (1977) 138 C.L.R. 106. Other authority is Thomas (1972) 46 A.L.J.R. 397 at 401 where Walsh J. held the growing of pine trees not to be a business because it lacked a “significant commercial purpose or character”. A more guarded observation was made by Fisher J. in Ferguson (1979) 79 A.T.C. 4261 at 4270:
“[It] is certainly relevant to ascertain if the operations of the taxpayer have a commercial purpose, i.e. pursuit of profit or gain rather than pleasure or recreation.”
[2.446] In most of the cases in courts, it is the taxpayer who is asserting the existence of a business. It has been noted that Thomas, Ferguson and Mullins (1981) 81 A.T.C. 4192 are such cases, and there are many others. The taxpayer seeks to establish a loss, in the sense of deductible expenses exceeding gains from the alleged business, a loss that he may deduct against other income. The Commissioner’s view is likely to be that the activities amount only to a “hobby” and not to a “business”. Implicit in this is an asserton that there was no overall profit purpose.
[2.447] The authorities on profit purpose suggest that it is enough that an objective inference of profit purpose can be drawn. One basis of inference will be the size of the activities on which the taxpayer is engaged. In this connection size of operations has significance, in addition to any significance it may have in regard to repetition and system. In Ferguson Fisher J. said (at 4269):
“[T]he conclusion is open to be drawn that a taxpayer is engaged in business activities notwithstanding the fact that he is operating in a very small way i.e. on a few acres, with very few trees or with a very small number of stock. I would be of opinion that the size of the operation could be of significance for the purpose of testing whether a taxpayer is conducting a hobby rather than a business, but that size is certainly not the determining factor.”
None the less, the taxpayer’s evidence of his subjective purpose may establish profit purpose where an objective inference would not be drawn: Scott v. C. of T. (N.S.W.) (1935) 3 A.T.D. 142; Tweddle (1942) 7 A.T.D. 186. The relevance of subjective purpose will arise in a case where the taxpayer is seeking to establish that he is engaged in business so that he might be allowed a loss. The objective inference may be against a finding of profit purpose, because the operations conducted do not indicate any reasonable prospect that they will be commercially viable: there is no immediate or ultimate prospect of profit. It may be that the taxpayer’s assertion that he had a profit purpose will be received with caution where the evidence is against any reasonable prospect of commercial viability. But if he is believed, the element of profit purpose is satisfied and in this respect the Australian law is different from New Zealand law. New Zealand courts have taken the view that whatever was the taxpayer’s subjective purpose, there will not be a business unless there is a reasonable prospect of making a profit: Hanley v. C.I.R. (N.Z.) (1971) N.Z.L.R. 482; Prosser v. C.I.R. (N.Z.) (1973) 73 A.T.C. 6006. In Tweddle Williams J. in the Australian High Court rejected this view on the ground that it would require the Commissioner to be the judge of the viability of a commercial enterprise.
[2.448] In the last paragraph the observations made relate to inferences to be drawn from, and subjective purpose of the taxpayer in regard to, the operations conducted by the taxpayer in the year of income. Where the objective inference is that there will be expanded operations which will be commercially viable, and the present operations are a step in the building up of a business, profit purpose will, it is submitted, be satisfied. The present operations should not be regarded in the way in which feasibility studies have been regarded. A feasibility study is not a business operation: it precedes the commencement of busness. Where, however, an objective inference that operations will be expanded cannot be drawn—the land presently owned and devoted to the business by the taxpayer may be inadequate—a question arises whether the taxpayer’s subjective purpose to expand the operations, if necessary by acquiring more land, will go to establish that there is a present business. Ferguson and Mullins would support a view that it is relevant, and that a subjective purpose to develop present operations into operations which will yield a profit is a sufficient profit purpose. The authority of Ferguson is confused by the conclusion that the taxpayer was engaged in a “preliminary” business, but it admits of explanation in the way suggested.
[2.449] The idea of profit so far assumed is an excess of gains—which may be profits in the more specific sense of receipts exceeding costs of particular transactions—over the expenses of the operations in which those gains are derived. It is an overall profit—the profit shown in a profit and loss account. A purpose to achieve such an overall profit is necessary. It is not necessary that each individual transaction should have been moved by a purpose to profit by that transaction. A purpose to profit in an individual transaction is essential only when it is sought to characterise that transaction as an isolated business venture. A so-called “loss-leader” transaction in a retailing business is a transaction of that business. The point was made by Barwick C.J. in Investment & Merchant Finance Co. Ltd (1971) 125 C.L.R. 249 at 255: “neither the attainment of profit nor the expectation of it is essential for a particular commercial transaction to form part of the business of dealing in the commodity purchased.”
[2.450] There is, none the less, a question whether a particular transaction does form part of a continuing business. Barwick C.J. qualified his statement by referring to a “commercial” transaction. The suggestion intended may have been that any transaction which is “commercial” will be regarded as part of any business otherwise established. If so, the necessary relationship with undoubted business operations, must be too broadly stated whatever meaning was intended for the word “commercial”. The transaction must be incidental to the undoubted business transactions. The loss leader transaction is clearly incidental to a retail business. On the other hand, the transaction of acquiring and disposing of shares by a dividend stripper, as in Investment & Merchant Finance, is not incidental to the taxpayer’s share trading business. Whether assessed objectively or subjectively, the taxpayer’s purpose is not to further the gaining of profits in other transactions. The taxpayer’s purpose is to obtain tax advantage, which would not have been thought prior to Investment & Merchant Finance, to be a profit in any sense relevant to the ordinary usage notion of income. (Cf. Loxton (1973) 47 A.L.J.R. 95.) If it be accepted that profit is not the purpose in the share stripping transaction, the transaction can only be part of the taxpayer’s business of share dealing if it can be regarded as incidental to the business. It can only be incidental if the word is understood in a sense that would carry principle far beyond the loss-leader illustration.
[2.451] Investment & Merchant Finance is one of the most unfortunate decisions in Australian tax law. It led to tax avoidance on a major scale. It had some support, at the time of the decision, in United Kingdom cases also concerned with dividend stripping: Griffiths v. J. P. Harrison (Watford) Ltd [1963] A.C. 1. Those decisions were thereafter reversed by the House of Lords: Thomson v. Gurneville Securities Ltd [1972] A.C. 661. The High Court was asked in Patcorp Investments Ltd (1976) 140 C.L.R. 247 to reverse Investment & Merchant Finance so as to hold that dividend stripping transactions are not incidental to share trading. The High Court refused, asserting that correcting the law, if correction is necessary, was a matter for Parliament. Legislative endeavours to correct Investment & Merchant Finance have added their share of complexity to the Act, and such correction as has been achieved required several essays in amendment. Investment & Merchant Finance is one of a number of decisions of the High Court in recent years which have damaged basic principles. Curran (1974) 131 C.L.R. 409 and South Australian Battery Makers Ltd (1978) 140 C.L.R. 645 are others. Legislative correction has been attempted in many steps, and correction would seem never to be complete. The lesson may be that damage done by courts to basic principles must be repaired by courts: it is beyond repair by statutory provisions.
[2.452] The notion of profit relevant to the characterising of operations as a continuing business is overall profit—an excess of gains over the expenses of the operations in which those gains are derived. The gains that are income from those operations will include gains to which those operations were immediately directed and gains which are incidental to those operations. Gains, for this purpose, will include exchange gains which arise in the receipt of payment of a debt on revenue account, or the discharge of a revenue liability. The gain, or loss which will be deductible, in this instance arises from a transaction which is incidental to transactions—the acquisition and sale of goods, or the provision of services—which are the core transactions of the business and moved by the profit purpose. International Nickel Aust. Ltd (1977) 137 C.L.R. 347 is the leading case. Others are Commercial & General Acceptance (1977) 137 C.L.R. 373 and AVCO Financial Services Ltd (1982) 150 C.L.R. 510. They are considered more closely in Chapters 6 and 12 below. Meanwhile, it may be noted that they vindicate the view taken in this Volume that the ordinary usage notion of income is concerned with gains. Where goods are sold there is a gain to the extent that the proceeds of sale receivable exceed the cost of those goods. Equally where payment is received there is a gain to the extent that the actual receipt exceeds the amount receivable at the time of the sale. In exchange gain situations the gain will have arisen because the proceeds of sale are receivable in a foreign currency, which has increased in value between the time of sale and the time of receipt of payment. The ordinary usage notion of income in this respect is displaced to a degree by the trading stock provisions of the Assessment Act examined in Chapter 14 but otherwise remains part of our law.
[2.453] In the computing of business gains which are income, the notion of cost is historical cost. Developments in accounting practice which provide alternatives to historical cost are not relevant to the ordinary usage notion of income gains. It will be seen in Chapter 15 that some correction of the ordinary usage notion was attempted during the period 1977–79 following recommendations made by the Mathews Committee (Report of the Committee of Enquiry into Inflation and Taxation, A.G.P.S., Canberra, 1975). But currently no correction is applied.
[2.454] There is a question whether the gains which will be relevant in determining whether there is a profit purpose, so as to justify a conclusion that there is a continuing business, include gains which are income derived from property. A general conclusion that they do, would mean that the ordinary usage notion of income would extend far into the area of what have been regarded as capital gains. There are decisions which hold that investing to derive interest, dividends or rents, if done on a sufficient scale, constitutes a business. But the notion of business in these decisions is not necessarily the notion which is an aspect of the business gains principle in the ordinary usage meaning of income. If it were held that there is a business in the ordinary usage sense where the activity is the deriving of income from property and the profit purpose is simply to derive that income, it would be difficult to resist a conclusion that the acquisition and disposition of property whence the income is derived is a transaction incidental to the business, so that any gain from that transaction is income within the business gains principle. In fact no court has held, in the circumstances envisaged, that there is a business in the ordinary usage sense.
[2.455] The so-called “banking” and “life insurance” company cases considered under the next heading might be thought to be contrary to the assertion just made. Putting aside collateral activities, a bank borrows money from customers to lend to others, or to invest in other ways—by acquiring rent producing property or shares. The core activity might therefore be said to be simply to derive income from property. Yet it is established that banking is a business, and that gains on realising of investments are income as being incidental to that business. A similar observation may be made in regard to the life-insurance cases. Clearly the possibility of there being what might be called a “business of investing” requires closer examination.
[2.456] It may be accepted that there is no business, within the ordinary usage business gains principle, where an investment or any number of investments have been made with the purpose simply of obtaining income derived from property—interest, rent, dividends—which attends the investment. To treat this income as supplying a profit purpose, so as to make the investing a business, would be to bring about a radical extension of the concept of income into the field of capital gains. A purpose simply to obtain income derived from property, it was submitted above, is not a profit purpose. In any case, on the hypothesis that the purpose is simply to obtain that income, there will not be any system in the taxpayer’s activity such that a change in his investments can be seen as part of or as incidental to it. Sometimes the taxpayer will cease to hold the investment because he has been repaid money he has lent, or the company in which he invested has been liquidated. Sometimes he will have realised his investment because he has need, for some private purpose, of the money he had invested. None of these events is part of or incidental to whatever system there may be in obtaining the income derived from the investments.
[2.457] A relatively small variation in the hypothesis about the taxpayer’s purpose will require a re-examination of the conclusion that there is no business. Four variations have been considered in the authorities:
[2.458] Variation (1) has its parallel in the “classical” business of a merchant, save that the latter physically handles the stock in which he deals. It would be agreed that variation (1) is a business in which realisation is inherent.
[2.459] Each transaction of acquisition and realisation would, very likely, if it stood alone, be a transaction within the first limb of s. 25A(1). The reservation in the words “very likely” is intended only to accommodate the interpretation of the first limb of s. 25A(1), which insists that the relevant purpose under that limb is subjective purpose. It is the number of transactions and an element of system that links them which must distinguish a continuing business—a business of “dealing” in investments—from several s. 25A(1) transactions. The distinction is not always easily drawn. Yet there are important differences in consequences. A business of dealing in investments attracts the trading stock provisions. Section 25A(1) transactions do not. A loss on an individual realisation is deductible if there is a business of dealing. If the transaction is a s. 25A(1) transaction the availability of a loss is qualified by s. 52.
[2.460] The element of system might be supplied by constant monitoring of the performance of all the investments traded, or by a practice of operating within the limits of funds regarded as available for trading, or by a combination of these and perhaps other practices. In theory, at least, a taxpayer may have one “portfolio” of investments in which he trades, another portfolio made up of investments to which s. 25A(1) applies, and yet another portfolio of “pure” investments.
[2.461] A business of dealing would appear to be the explanation of the conclusion reached by Jacobs J. in London Australia Investment Co. Ltd (1977) 138 C.L.R. 106 that the investment company had derived income in the form of gains on realisation of its investments. The company’s policy was to realise an investment in shares whenever the dividend yield (the dividend as a percentage of the market value of the shares) on the shares fell below 4 per cent. In the stock market conditions which prevailed in the early part of the 1970s—a period of rising share values—this policy in fact involved the sale of shares that had increased in value. An increase in value, which might reflect an anticipation of a higher dividend on the next occasion of a dividend declaration, will cause a decrease in dividend yield, the dividend yield being calculated on the last dividend declared. Some passages in the judgment of Jacobs J. might suggest that he regarded the share transactions as a collection of s. 26(a) (now s. 25A(1)) second limb transactions, but this suggestion would appear to be contradicted by his acceptance of the principle of Curran (1974) 131 C.L.R. 409 in calculating the gains made by the taxpayer. Curran is the subject of comment in a number of contexts in this Volume including [12.85] below. For present purposes, it is enough to say that the case concerned a share trader.
[2.462] There may be thought to be some difficulty, irrespective of whether London Australia is taken as a share trading or as a s. 26(a) case, in treating a policy going to the realisation of investments, as distinct from acquisition and realisation, as a policy which will make gains on realisation income. The difficulty in relation to a conclusion of share trading was expressed by Barwick C.J. (who dissented) in this way (at 113): “Those realisations could be said, in my opinion, to be a result of the nature of the company’s business, but not part of that nature.” The answer may be that the policy of the taxpayer involved both acquisition and realisation. The policy to sell shares whose dividend yield had fallen, was also a policy to buy shares that, in the conditions of the market at the time, would suffer a fall in dividend yield, because of a rise in values. In this event a conclusion that there was a business of dealing would be the more clearly justified.
[2.463] London Australia has been referred to as authority for the view that an overall purpose to profit is an essential element in the concept of business in the business gains principle. The examination of purpose in all judgments can only be explained in that way. The difference between Jacobs J. and Barwick C.J. is in the need for purpose at the time of acquisition, where the profit purpose asserted is a purpose to profit by realisation. The difference between these judges and Gibbs J. is that Gibbs J. thought that a purpose to maximise income from property by switching of investments was a sufficient profit purpose.
[2.464] Variation (2) is not enough to convert “pure” investing into a business. Charles (1954) 90 C.L.R. 598 remains authority to this extent. In London Australia both Gibbs J. and Jacobs J. explained Charles on the ground that the evidence established that the policy was to sell only when a fall in value was anticipated. So explained, the case reinforces the obvious. An investor does not have to wait till his conviction that a share investment has gone bad is confirmed, before he sells. There is a distinction between selling to realise an increase in value that has occurred, and selling to realise an increase in value that has been sought. The explanation of Charles given by Jacobs J. may indicate that, as suggested above, he saw the policy of the company in London Australia as a policy to buy shares that would suffer a fall in dividend yield because of a rise in value.
[2.465] Variation (3) raises the question of the correctness of the view of Gibbs J. in London Australia that the profit purpose that will convert pure investment into a business includes a purpose to maximise income derived from property. Maximising income flows will require a change from an investment whose flow of income is low in relation to its value, to another investment offering a higher flow. The greater flow sought by the switching is a profit which will supply the element of profit purpose, and give rise to a business within the business gains principle. The realisation of existing investments is incidental to the derivation of the greater income from property, and any gain made by that realisation, or loss suffered, is income or deductible.
[2.466] The view taken by Gibbs J. enabled him to find for the Commissioner, the taxpayer having made gains on realisation, by an interpretation of the policy pursued by the investment company which is more readily accepted than the interpretation adopted by Jacobs J. The latter involves some extended inference from the circumstances of a rising share market. Gibbs J. sought authority in the banking and life insurance cases considered below in relation to variation (4). Both Jacobs J. and Barwick C.J. thought those cases were to be explained on a different basis. One at least of the cases, Australasian Catholic Assurance Co. Ltd (1959) 100 C.L.R. 502, would not appear to admit of explanation on the basis of switching. The view of Gibbs J. may, none the less, be the preferable basis.
[2.467] Variation (4) is an attempt to specify the circumstances which have been thought, at least by Barwick C.J. and Jacobs J., to explain the banking and life insurance cases. A bank, collateral activities aside, depends for its profit on a greater income flow from its investments than the cost of servicing borrowed money it has invested. It is implicit in its operations that it must be ready to effect some change in its investments to meet a call for a return of their money by those who have lent to it. Generally, the call can be met by some tightening of overdraft accommodation, and the consequent repayment by a customer of a loan will not generate a gain unless the loan has been made in a foreign currency and there is an exchange gain. But the failure to obtain repayment will generate a loss on the lending transaction which the bank will wish to deduct. Deductibility is a corollary of a conclusion that there would have been income had there been a gain. The deduction of a loss under s. 51 is thus linked with the existence of a business within the ordinary usage business gains principle. The Barwick C.J. and Jacobs J. explanation of the banking cases is that the obtaining repayment of a loan made by a bank, or the realisation of an investment it has made, is incidental to the making of a profit by a margin of income flows over the costs of servicing. A similar analysis may be made in relation to a life insurance business. The principal banking and life insurance cases are referred to in the judgments in London Australia. They are Punjab Co-operative Bank Ltd v. Income Tax Commissioner, Lahore [1940] A.C. 1055, Commercial Banking Co. of Sydney Ltd (1927) 27 S.R. (N.S.W.) 231, Colonial Mutual Life Assurance Society Ltd (1946) 73 C.L.R. 604, Australasian Catholic Assurance Co. Ltd (1959) 100 C.L.R. 502.
[2.468] So explained, the investments, changes in which will be acts in carrying on the business, will be those made in contemplation of the need to change in order to meet calls by customers for the return of their deposits, or by policy holders for the proceeds of their policies. An investment in shares so as to control a company will not ordinarily be such an investment: The National Bank of Australia Ltd (1969) 118 C.L.R. 529.
[2.469] Assuming that the banking and life insurance cases are to be explained in this way, there is a question of how far the principle that they express extends. It would be assumed that the prospect that an investment company may have to realise investments, in order to finance a dividend paid to shareholders, is not enough to attract the principle. It may be asked whether the situation of the trustees of a unit trust, or the situation of a mutual fund which is an unlimited liability company, is different. In each case, there may be a need to realise investments to buy out a unit holder or a shareholder, under provisions which give the unit holder or shareholder a right to redeem.
[2.470] Where an investment company uses borrowed funds in making investments, the banking cases may require a conclusion that gains on changes in investments are income. If it is agreed that, generally, the explanation of the banking cases would have no application to a company using its shareholders’ funds in investment, there will be problems of severing this investment activity from other investment activity by the same company using borrowed funds. Tracing of funds, so as to distinguish business investment from pure investment, would be impossible, and any apportionment of profits from realisation so as to distinguish income from non-income elements, may be precluded by the decisions in McLaurin (1961) 104 C.L.R. 381 and Allsop (1965) 113 C.L.R. 341, considered in relation to Proposition 15. The banking cases do not, however, dictate a conclusion that gains on the realisation of investments by an investment company in order to repay a borrowing, are income. The repayment of borrowings is not a regular experience of the business in the way in which meeting the calls of depositors is a regular experience of banking business.
[2.471] If the banking and life insurance company cases have no application to a company using its shareholders’ funds in investment, there may be room for banks and life companies to avoid the operation of those cases by a reorganisation which will pass the investment activity to a wholly owned subsidiary, which will realise investments when asked by the parent, and will make funds available to the parent, perhaps by way of loan. It should not, however, be beyond judicial decision to attribute to the subsidiary the purpose in realisation that would be the purpose of the holding company.
[2.472] If a company lending its own funds is not in a business, so as to attract the business gains principle, it will follow, a fortiori, that an individual money lender using his own funds is not in business. At least this is so if the banking and life insurance cases need to be relied on. It is possible that money lending in some circumstances involves system and profit purpose sufficient to make the lending a business. The money lender will generally wish to claim that there is a business so as to attract a loss deduction, if he is not repaid the money he has lent. It should be noted that s. 63 is a specific provision which may allow him a loss. The word “business” in that section will attract the definition in s. 6, and possibly does not have the meaning it has in the ordinary usage gains from business principle.
[2.473] A conclusion that a money lender is in business, because turning over of his lendings involves system directed to achieving the maximum return from his lendings, would follow from the view of Gibbs J. in London Australia Investment Co. Ltd (1977) 138 C.L.R. 106. Switching directed to maximum return from investment is a business activity that may yield profits that are income or losses that are deductible. And that view offers an alternative explanation of the banking and life insurance cases, an explanation preferred by Gibbs J. The explanation has its parallel in the explanation of the income character and the deductibility of exchange gains and losses offered in the discussion in [6.329] and [12.192] below of AVCO Financial Services Ltd (1982) 150 C.L.R. 510 and Hunter Douglas Ltd (1983) 83 A.T.C. 4562. The function of the borrowings in AVCO was their use in a business of lending. It is suggested in the discussion that it was not this that gave a revenue character to the liabilities to repay. It was the fact that the company engaged in a repetitive activity of borrowing directed to minimising its costs of borrowing. If AVCO is to be explained in terms of the function of the borrowing, Hunter Douglas may be thought to be wrongly decided. But there is enough in the judgments in AVCO and in Hunter Douglas to explain those decisions on the ground that the borrowings were a number of repeated and systematic borrowings directed to minimising the costs of borrowing.
[2.474] The Federal Court decision in The Chamber of Manufacturers Insurance Ltd (1984) 84 A.T.C. 4315 has extended the principle of the banking and life insurance cases to other insurances. The court quoted from Colonial Mutual Life Assurance Society Ltd (1946) 73 C.L.R. 604 at 618 in support of this extension, though the support given by the quotation is little more than what might be drawn from the absence of the word “life” before “insurance” in referring to the principle. There are, however, United Kingdom decisions, including General Reinsurance Co. Ltd v. Tomlinson [1970] 1 W.L.R. 566, which would support the extension. In Chamber of Manufacturers the insurance business was primarily in the field of workers’ compensation. The case concentrates on a concept of a “reserve fund” of investments which will be treated as revenue assets. Banking and life companies must hold assets to meet inevitable calls by depositors and policy-holders. In both instances they are calls, in effect, for return of moneys vested in the company by the depositors or policy-holders, more obviously so, perhaps, in the case of a bank than in the case of a life company. The extension of the principle to other insurance companies modifies the principle, so that it now extends to assets held to meet contingencies whose occurrence may be statistically predictable but which are not inevitable in the way the claim of a depositor in a bank or policy-holder in a life company is inevitable. The extension paves the way for yet another modification which would treat assets as revenue assets whenever a business need to realise them may be fairly anticipated. As so modified the principle would extend to assets that represent a temporary investment during a period of excess liquidity of a business, due, for example, to seasonal factors. And it might extend to any assets of a taxpayer carrying on a business: they stand available to meet claims made against the company, whether by creditors or others. The reasoning in Chamber of Manufacturers suggests that in the illustration of excess liquidity, the assets are a reserve fund. The court considered that for various reasons, including the possibility of legislative exclusion from the industry, the company might have to realise some of its investments, presumably so as to diversify into some other business activity to replace the lost insurance activity. In this there is an assumption that investments of money which may need to be redeployed in the business activities of a taxpayer are revenue assets. The assumption challenges the very existence of a distinction between revenue assets and capital assets. The illustration of assets treated as revenue assets because they stand available to meet claims made against the company by any creditor will abandon the distinction.
[2.475] The notion of “reserve fund”, as it is used in Chamber of Manufacturers, is ill-defined. It must refer to assets representing a reserve to meet claims. Not all assets of an insurance company will be treated as a “reserve fund”. Assets, referred to in the case as hard-core funds, that will be called on to meet current expenses are assumed by the Federal Court to be revenue assets, however they are designated. The test here is presumably the manner in which the assets are called on to meet expenses. They are called on as a matter of the regular experience of the business. What assets are a reserve fund in this way is a matter of objective inference, though the proclaimed intention of the taxpayer in regard to the assets may assist the characterisation. Where the asset is money held in a trading account with a bank a conclusion that the asset is a revenue asset is most likely to be drawn. The character of such an asset as a revenue asset is the subject of some discussion in [6.52]–[6.77] below where the question is the deductibility of a loss incurred on the deprivation of the asset.
[2.476] In regard to other assets, reserve fund character according to Chamber of Manufacturers is at least prima facie a matter of designation by the taxpayer, though the nature of an asset may be the basis of an objective characterisation. Thus the investment in shares in National Bank referred to in [2.468] above would not generally be part of the reserve fund. Nor would the investment in the head office building of an insurance company be part of its reserve fund. in Chamber of Manufacturers it was argued that investment in shares carried a designation of the shares as not being part of the reserve fund, when there were other investments that were fixed return investments, more especially if the fixed return investments were in fact called on to meet claims. The Federal Court did not accept the argument. Some express designation by classification in the books of account may be necessary to ensure that assets are outside the reserve fund. The designation will not, it seems, be definitive unless the assets designated as reserve are “demonstrably sufficient to meet claims and expenses in all reasonably foreseeable contingencies” (1984) 84 A.T.C. 4315 at 4318-9. The notion of “sufficient to meet claims and expenses in all reasonably foreseeable contingencies” is broad indeed and suggests the possibility referred to in [2.473] above of a reserve fund characterisation of all assets applicable to all taxpayers engaged in business.
[2.477] The words quoted from Chamber of Manufacturers suggest that a designation of assets as pure investments, and thus not part of the reserve fund, will not be accepted where the assets designated as reserve fund are not “demonstrably sufficient to meet claims and expenses in all reasonably foreseeable contingencies”. There is some parallel with the view expressed in Lomax v. Peter Dixon & Son [1943] K.B. 671 that a premium will not be treated as a receipt for the capital risk in lending, and thus not income, unless a commercial rate of interest is payable on the money lent. If the designation as pure investments is not accepted, there will be a question whether the whole of the assets designated as pure investments must be treated as reserve fund. Chamber of Manufacturers may suggest that they must be. Which raises a question of the validity of a principle that would take an asset out of reserve fund status if its inherent character, as in the case of the shares in The National Bank of Australia Ltd (1969) 118 C.L.R. 529, or the head office building in the illustration given in Chamber of Manufacturers, makes it a pure investment. At this point, if not earlier in this discussion, there appears reason to doubt the extension of the banking and life insurance cases attempted in Chamber of Manufacturers.
[2.478] In the foregoing discussion a concept has emerged of an asset whose realisation is inherent in, or incidental to, the carrying on of a business. The phrase adopted to identify such an asset is “revenue asset”. It is to be distinguished from a “structural asset”, which forms part of the “profit yielding subject” of the business. The words “structural” and “profit-yielding subject” have become accepted in our law through a number of judgments of Dixon C.J. which are referred to in Chapter 7 below. The phrase “revenue asset” is a coinage of this Volume. The case law has adopted a phrase “liability on revenue account” or “revenue liability” for purposes of explaining the law in regard to exchange gains and losses. It is a short step to the use of the phrases “asset on revenue account”, or “revenue asset”.
[2.479] The phrase revenue asset is helpful as identifying all assets of a business that are not structural. Revenue assets will include stock-in-trade but that phrase is too specific in its meaning to be useful in identifying all nonstructural assets of a business.
[2.480] In the discussion of Proposition 13, the possibility that a contract to provide services is a revenue asset of a busines of providing services was explored. A contract under which an accountant is entitled to do accounting and audit work for his client may be a revenue asset: Ellis v. Lucas [1966] 3 W.L.R. 382, cf. Walker v. Carnaby Harrower, Barham & Pykett [1970] 1 W.L.R. 276.
[2.481] An amount received for the surrender of rights under such a contract by the proprietor of the business, so far as it exceeds any costs which were not deductible, will be an income receipt as a gain which arises from an act in carrying on the business. The reference to costs which were not deductible is intended to preserve the principle expressed in Proposition 4. Most often there will not be any such costs. The costs of obtaining the contract will have been immediately deductible and not required to be treated as costs that must be deferred until the asset is realised. But in some circumstances the cost must be deferred, and will be substractable not under the general deduction section—s. 51—but as a cost which enters the determination of the amount of any receipt on realisation which is a gain as a profit on realisation. Thus an amount paid for the assignment of an agency, or for the grant of a sub-agency, is a cost which should be deferred. It will be subtracted in determining how much of an amount received for a surrender of rights under the agency or sub-agency is income.
[2.482] These matters are more closely explored in Chapters 5 and 12 below. It is enough for present purposes to say that not every expenditure is pure expense, or in the language of s. 51, an outgoing. Nor is every receipt pure gain. An expenditure which is immediately represented by an asset acquired by that expenditure, is not an outgoing, at least when the asset is not a wasting asset—an asset that may be said to be consumed in the process of deriving income. It will, however, be a cost that must be allowed in determining how much of a receipt on realisation of the asset is a gain and thus income, or a loss and deductible under s. 51(1). Where an expenditure less directly contributes to the acquisition of an asset, it is more appropriate to treat it as a pure expense deductible under s. 51. Legal costs associated with obtaining a contract to provide services which is a revenue asset may be treated in this way, and the proceeds of surrender of rights under the contract will be gain as to the whole of the amount.
[2.483] Section 82 of the Assessment Act will preclude any cost allowed as a deduction being treated as a cost in determining the gain from the surrender of rights. Where expenditure is immediately represented in trading stock as defined in the Assessment Act, ss 28ff. and s. 51(2) displace the principle that the expenditure is not an outgoing. It is immediately deductible but, it will be seen, a countervailing item brought in as income has the effect of requiring a deferral of the outgoing, if the stock is not realised until a subsequent year. In effect the deduction of the outgoing and the bringing in of the proceeds of realisation are made to occur in the same year of income.
[2.484] The range of assets that may be revenue assets of a business is without limit. Attention has been given in [2.456]–[2.477] above in relation to the present proposition, to the circumstances in which investments will be revenue assets of a business. The circumstances in which an agency contract may be a revenue asset were considered, in relation to Proposition 13, in [2.384]–[2.407] above, and there was some discussion of the question whether one’s freedom of action may be seen as an asset whose realisation can give rise to income.
[2.485] There may be a contract under which the taxpayer is entitled to distribute the goods of a particular manufacturer. The typical case is I.R.C. v. Fleming & Co. (Machinery) (1951) 33 T.C. 57 involving an agency to distribute in Scotland explosives manufactured by Imperial Chemical Industries. The contract will be a revenue asset, unless it represents a very substantial part of the taxpayer’s business. The cases have tended to make some kind of mathematical assessment of significance, in terms of the proportion that business under the contract is of the taxpayer’s total business activity, the period of the contract still to run, how far it is terminable, and the prospect of renewal. A question of what is the relevant business activity for this purpose is raised. The cases, principally Fleming, Wiseburgh v. Domville [1956] 1 W.L.R. 312 and Sabine v. Lookers (1958) 38 T.C. 120, do not decide whether it is all the business activity carried on by the taxpayer, or business activity involving agencies of a kind similar to that with which the case is concerned. The test of the significance of the contract adopted in Fleming is whether its loss will “cripple” the taxpayer’s business. The giving up of an agency must necessarily involve the loss to the taxpayer of the goodwill he has built up as a seller of the goods of his manufacturer. No special attention has been given in the cases to the significance of this loss of goodwill. Yet, it seems, a restrictive covenant that the taxpayer may undertake as an aspect of the agreement by which he ceases to be agent is of special significance. What he receives under the agreement for giving up his capacity to deal in goods of the kind supplied by his manufacturer is unlikely to be an income receipt. His capacity will be seen as a structural, not a revenue asset. Fleming would suggest that this is so even though his manufacturer has a virtual monopoly in the manufacture of the goods in question, and the loss of the agency will itself involve a loss of what capacity he had to deal in goods of the kind supplied by the manufacturer. In this regard a rule of extended form seems to be applied to an agreement to give up capacity.
[2.486] The agency agreement may be one by which the taxpayer has an outlet for his services in the selling of another’s goods, in advertising another’s goods or in the management of the business of another. The United Kingdom cases, in particular Barr, Crombie & Co. v. I.R.C. (1945) 26 T.C. 406—a case involving a contract to manage the shipping business of another—suggest that the principles applicable are the same as those applicable where the contract is one by which the taxpayer obtains the supply of goods to sell. It is a matter of the significance of the contract as an asset of the taxpayer’s business. The Australian authority, Heavy Minerals Pty Ltd (1966) 115 C.L.R. 512, referred to in the next paragraph, may however suggest that an agency contract by which a taxpayer has an outlet for the services he supplies attracts different principles, and will always be a revenue asset. An import or export entitlement may be thought to be analogous to rights under an agency agreement. In Merv Brown Pty Ltd (1984) 84 A.T.C. 4394 importing under import entitlement at a concession rate of customs duty made up some 40 per cent of the taxpayer’s business. The conclusion reached that the import entitlements were structural assets does not sit easily with the agency cases, more especially since several distinct entitlements were judged together in determining their significance. And the relevance of the observation by Kaye J. that sales of import entitlements were not “normal incidents” (at 4406) of the taxpayer’s trading activities, is not apparent. That observation could as well have been made of the giving up of the agency agreement in Fleming or Wiseburgh.
[2.487] It is apparent from the agency cases just considered that a receipt for giving up one’s freedom of action is unlikely to be held income, though Higgs v. Olivier [1952] Ch. 311 would indicate that a partial giving up of freedom of action may in some circumstances be an income receipt. Freedom of action may be a revenue asset if the partial giving up can be regarded “as in the ordinary run of the profession or vocation” of the taxpayer: Evershed M.R. at 315. There is a like suggestion in the judgment of Dixon C.J. in Dickenson (1958) 98 C.L.R. 460, a case considered in [2.411]–[2.415] above. Characterisation of a submission, by an agreement, to a restriction on freedom of action will not necessarily be determined by the form of the agreement. A receipt for a restrictive covenant not to remain in or enter a particular market should not be treated as a receipt for giving up freedom of action if in fact the taxpayer has no business in that market, and no prospect of such business. If the agreement in Rolls-Royce v. Jeffrey (1962) 1 W.L.R. 425 by which Rolls-Royce supplied aircraft engines to particular buyers in various markets had included restrictive covenants against supply to others in those markets, characterisation of receipts for those restrictive covenants as receipts for the giving up of freedom of action would rightly have been rejected. The evidence established that there were no other potential buyers in those markets.
[2.488] A contract under which a merchant is entitled to the supply of goods may be a revenue asset. The agency cases will afford what principles there may be to determine the character of the contract. A contract under which a taxpayer is entitled to supply goods to another may be a revenue asset: Heavy Minerals suggests there is a distinction between a contract under which stock is obtained, and a contract which merely assures an outlet. The former may be structural. The latter, the case suggests, will always be revenue. But where the person with whom the taxpayer has a contract to supply is one of a very few possible customers for the taxpayer’s goods, there may be reason to regard the contract as structural. A long term supply agreement between an Australian mining company and a Japanese importer might be regarded differently from the agreement in Heavy Minerals. It may be asked whether it is appropriate to distinguish the export entitlements of a meat exporter from the import quotas of a merchant, where the entitlements and quotas are of equal importance to the taxpayer concerned.
[2.489] The leading case in which a contract was held to be a structural asset is Van den Berghs v. Clark [1935] A.C. 431. The contract implemented a cartel arrangement between the taxpayer, a manufacturer of margarine, and a Dutch company, also a manufacturer of margarine. Two quotations may indicate the reasons for the conclusion that the contract was structural (at 442–443):
“The three agreements which the appellants consented to cancel were not ordinary commercial contracts made in the course of carrying on their trade; they were not contracts for the disposal of their products, or for the engagement of agents or other employees necessary for the conduct of their business; nor were they merely agreements as to how their trading profits when earned should be distributed as between the contracting parties. On the contrary the cancelled agreements related to the whole structure of the appellants’ profit-making apparatus. They regulated the appellants’ activities, defined what they might and what they might not do, and affected the whole conduct of their business. I have difficulty in seeing how money laid out to secure, or money received for the cancellation of, so fundamental an organisation of a trader’s activities can be regarded as an income disbursement or an income receipt.… The agreements formed the fixed framework within which their circulating capital operated; they were not incidental to the working of their profit-making machine but were essential parts of the mechanism itself. They provided the means of making profits, but they themselves did not yield profits. The profits of the appellants arose from manufacturing and dealing in margarine.”
The impression that remains is that the characterisation, as revenue or structural, where the asset is a contract, is a matter of degree of importance of the contract to the operations of the business. Being a matter of degree, the conclusion in a marginal situation must always be perplexing, however reinforced it may be by repetition and forceful statement.
[2.490] One explanation of Rolls-Royce v. Jeffrey [1962] 1 W.L.R. 425 is that the company had made the selling of its know-how an activity of its business. What would otherwise have been a structural asset had, in the circumstances, become a revenue asset. The suggestion is that any characterisation of an asset is not final. It must be made in the context of the particular act of realisation. Rolls-Royce, it must be admitted, is capable of other explanations. One of these would assume that the know-how of the taxpayer remained a structural asset and the transactions under which the know-how was sold were equivalent to non-exclusive licences to use the asset. The receipts were thus income derived from property. This would appear to be the explanation of the case in others that have followed it: Musker v. English Electric Co. Ltd (1964) 41 T.C. 556, Coalite & Chemical Products Ltd v. Treeby (1971) 48 T.C. 171, John & E. Sturge Ltd v. Hessel (1975) 51 T.C. 183, Thomsons (Carron) Ltd v. I.R.C. (1976) 51 T.C. 506. Yet another explanation is offered in dealing with Proposition 13. There was no asset sold or made available to the buyer. The company simply performed a service for the buyer—instructing the buyer in methods of manufacture—and the receipts were income as rewards for services.
[2.491] None the less, the notion of a structural asset becoming a revenue asset in the circumstances of realisation cannot be dismissed, though the tax accounting problems that will arise are formidable. A distributor of motor vehicles may use a new motor vehicle as a “demonstrator”. Thereafter he may sell the vehicle as an item of his stock of new and used vehicles. A view that the item is at all times a structural asset will leave the depreciation provisions of the Assessment Act to operate alone. Some complications will arise if the vehicle is treated as having been at all times a revenue asset. It is arguable that the acquisition and sale of a demonstrator is incidental to the carrying on of a business of selling new motor vehicles just as a demonstration home may be a revenue asset of a project builder. The complications will involve the interrelations of the depreciation provisions—which can, it seems, operate where the cost of plant is revenue expenditure—the ordinary usage business gains principle and the trading stock provisions. There will be even greater complications if the analysis adopted is that the item is a structural asset while it is used as a demonstrator, and becomes a revenue asset and trading stock at the time it becomes available for sale. There will need to be a valuation at this time to determine the cost of the item for purposes of the trading stock provisions. It would make for a sensible interrelationship between the depreciation provisions and the trading stock provisions, if the fact that the item becomes available for sale were treated as a disposition of the item so that a balancing charge, or an allowable deduction, might then arise under s. 59. But the notions of disposition in s. 59 may not be flexible enough. These matters are raised again in [12.99]ff. and [14.38] below.
[2.492] In [2.431] above, a distinction was drawn between a continuing business and an isolated business venture. That distinction and its significance call for closer examination. And it is necessary to examine the correlation between the law in regard to an isolated business venture and the specific provisions of s. 25A (formerly s. 26(a)). The latter provisions are the subject of detailed study in Chapter 3 below.
[2.493] Whitfords Beach Pty Ltd (1982) 150 C.L.R. 355 is a landmark decision in its holding that there is a part of the ordinary usage meaning of income that is concerned with the notion of profit from an isolated business venture, and this is an element of the meaning of income for purposes of the Assessment Act. It is such an element as part of the ordinary usage meaning of income, and not by reason of the specific provisions of s. 25A(1), which may in their terms appear to cover some of the same field. Gibbs C.J. and Mason J. decided Whitfords Beach by the application of the isolated business venture notion and not by the application of s. 26(a). Wilson J. was content to rely on the second limb of s. 26(a) without rejecting the possible operation of the ordinary usage notion. Wilson J. did not have to consider the consequences of a conflict between the ordinary usage notion and s. 26(a), because none arose in relation to the facts of the case. For the same reason Gibbs C.J. and Mason J. did not need to consider possible conflict. They were, however, conscious of the possibility of conflict in other circumstances, and they sought to lay the basis in doctrine for avoiding conflict by asserting that s. 26(a) had no application where the notion of isolated business venture will bring in a profit as income for purposes of the Assessment Act. Gibbs C.J. said (at 366–367):
“However, the fact that the profits yielded by some transactions which fall within the literal meaning of the words of s. 26(a) will not be brought to tax under that provision, since the transactions form part of a more extensive business, supports the view that s. 26(a) does not apply where s. 25(1) is applicable. Moreover, any business conducted for profit can be described as a profit-making undertaking or scheme, but it is impossible to suppose that the Parliament intended (contrary to settled practice) that the profits of every business should be dealt with under s. 26(a) rather than under the general provisions of s. 25. Not without some doubt I have therefore reached the conclusion that although the provisions of s. 26(a), if given full effect, would overlap those of s. 25, the second limb of s. 26(a) applies only to ‘profits not attributable to gross income that has already been captured by s. 25’, to use the words of Mason J. in … Bidencope (1978) 140 C.L.R. at 555. It is implicit in what I have said that I consider that the second limb of s. 26(a) includes profits which would not otherwise have fallen within s. 25, because they could not be described as income in the ordinary sense. I have discussed that question in … Bidencope (1978) 140 C.L.R. at 551–552, and adhere to what I there said in relation to this aspect of the matter.”
Mason J. said (at 382–383):
“One view is that s. 26(a) should be applied to the cases which fall within its terms, to the exclusion of s. 25(1)—see Reseck … (1975) 133 C.L.R. 45 at 49, 57. After all, s. 26(a) is a specific provision introduced for the purpose of catching profits yielded by the transactions which it describes. Moreover, it has generally been applied to cases falling within its terms without the court examining in detail whether s. 25(1) might also have had an application (Steinberg (1975) 134 C.L.R. at 710; Bidencope (1978) 140 C.L.R. at 552; … St Hubert’s Island Pty Ltd (In liq.) (1978) 138 C.L.R. 210, at 229–230; Pascoe … (1956) 30 A.L.J. 402).
The second view is that s. 26(a) will only operate when s. 25(1) does not do so (Investment and Merchant Finance (1971) 125 C.L.R. at 255, 264; Steinberg (1975) 134 C.L.R. at 688). This is the view which I have been disposed to favour in the past (see St Hubert’s Island (1978) 138 C.L.R. at 229–230; Bidencope (1940) 140 C.L.R. at 555). Its rationale is that s. 26(a) should be considered as supplementary to s. 25(1) which continues to operate as the principal statutory provision on the revenue side. As I have already indicated, it was no part of the purpose of s. 26(a) to limit the operation of s. 25(1). Indeed, in large measure its object was to ensure that the Revenue did not suffer in the event that s. 25(1) received a more restricted application than it was then thought to have. I am still inclined to think that this is the preferable view and that, accordingly, the second limb of s. 26(a) applies only to ‘profits not attributable to gross income that has already been captured by s. 25’ (Bidencope (1978) 140 C.L.R. at 555).”
[2.494] It may be expected that the law that governs the notion of an isolated business venture will be drawn from principles that may be expressed in United Kingdom case law that has grown around the reference in the United Kingdom Income & Corporation Taxes Act 1970, s. 526 (and its previous equivalents), to an “adventure in the nature of trade”. The submissions by the Solicitor-General to the Privy Council in McClelland (1970) 120 C.L.R. 487 made the assumption that this case law did express principles which were part of the Australian law.
[2.495] Any attempt to state the United Kingdom law on the meaning of trade in the context of an isolated venture is fraught with difficulties. Authorities seem to go in pairs, the one appearing to stand for some proposition, the other contradicting that proposition. The explanation of the seeming contradictions, we are told, is that the United Kingdom regards the existence of a trade in a particular case as a question of fact, and it follows from the United Kingdom system of appeals that a court, which must find an error of law, cannot upset the finding by the Commissioners, save where the only reasonable conclusion on the basis of the state case contradicts the conclusion of the Commissioners. Presumably, trade is a concept of law, but one so lacking in definition that there is a broad marginal area within which the decision of the Commissioners must stand. Another difficulty is that the United Kingdom authorities, while recognising the distinction between continuing business activities and an isolated venture, have not sought to formulate that distinction. In what follows, principles have simply been drawn from cases where there is no indication that there was any element of repetition, at any rate repetition of the acquisition of property of the kind which was realised in the venture. And the assumption has been made that these cases are those which explain the scope of what is identified by the phrase “adventure in the nature of trade”.
[2.496] Whether or not there is an adventure in the nature of trade is, it seems, a matter of objective inference. None the less, it is said that the subjective purpose of the taxpayer is important, though not conclusive. The reconciliation of these two propositions is not easy. The first is associated with statements that a purpose to profit is not an esential quality of trade. These statements have parallels in our continuing business law. But both in the United Kingdom and in the Australian law they need to be received with some caution. An overall purpose to profit, objectively inferred, is a necessary quality of trade, though it is not enough to require a conclusion that there is a trade. Where an objective inference of purpose to profit cannot be drawn, a subjective purpose to profit may make an isolated venture a trade. But a subjective purpose is neither necessary (I.R.C. v. Incorporated Council of Law Reporting (1888) 22 Q.B.D. 279), nor sufficient (Jones v. Leeming [1930] A.C. 415).
[2.497] The transaction must “exhibit features which give it the character of a business deal”. The phrase is taken from the Privy Council’s judgment in McClelland (1970) 120 C.L.R. 487 at 495. In the context it is evident that the Privy Council saw it as a requirement of adventure in the nature of trade. Another phrase used by the Privy Council which, presumably, is synonymous, is a “trade of dealing … albeit on one occasion only” (at 496). Neither phrase is exactly definitive. Some of the United Kingdom cases which bear on the meaning of these phrases are concerned with the principle already stated that there will not be a “business” or “trade” unless an objective inference of profit-making is to be drawn. (Cooke v. Haddock (1960) 39 T.C. 64, Johnston v. Heath (1970) 1 W.L.R. 1567.) These cases draw a distinction between “business” and “investment”, a distinction which does not always sit well with the aspect of the Australian notion of continuing business seen in the judgment of Gibbs J. in London Australia Investment Co. Ltd (1977) 138 C.L.R. 106. But it is clearly a relevant distinction in the context of an isolated venture. In the same cases and others a distinction is drawn between holding for “business” and holding for “enjoyment” or “pride of possession”. The latter may cover the holding of broad acres which are not let to another or put to any productive use.
[2.498] But the features which are necessary to give a transaction the character of a business deal or of a trade of dealing on a single occasion, include an elusive factor that is more than purpose to profit. This elusive factor may not be capable of any more precise defining than to say that the transaction must be the sort of thing a business man or man in trade does. In this context “business man” or “man in trade” brings in received ideas in the community about how such people behave.
[2.499] A taxpayer may acquire and sell land and not engage in trade, provided there is a decent interval between acquisition and disposition so that he does not appear too concerned about his profit, or, if circumstances have required him to sell soon after acquisition, he did not contemplate quick sale when he acquired (Turner v. Last (1965) 42 T.C. 517, Eames v. Stepnell Properties Ltd [1967] 1 W.L.R. 593). A taxpayer may acquire shares and not engage in trade. Indeed as a director of a company he may be required to own some shares. A taxpayer may sell shares and not engage in trade, provided he is not too hasty about it. But a taxpayer does engage in trade if he buys “a large quantity of a commodity like whisky, greatly in excess of what could be used by himself, his family and friends, a commodity which yields no pride of possession, which cannot be turned to account except by a process or realisation”. The words quoted are from the judgment of Lord Normand, in I.R.C. v. Fraser (1942) 24 T.C. 498 at 502–503. Lord Normand added that he could not consider a person who did this as “other than an adventurer in a transaction in the nature of a trade”. A taxpayer does engage in trade if he buys one million rolls of toilet paper (Rutledge v. I.R.C. (1929) 14 T.C. 490), or if he buys the Government’s surplus stock of aeroplane linen and embarks on its sale to more than one thousand purchasers: Martin v. Lowry [1927] A.C. 312. A taxpayer may engage in trade if he sets up an elaborate selling organisation to effect the sales. He may engage in trade if he carries out some manufacturing process and sells the manufactured goods (I.R.C. v. Livingston (1926) 11 T.C. 538 at 543–544, per Lord Sands).
[2.500] The cases may suggest that it is less likely that a conclusion that there is a trade will be reached if the transaction is in shares or land rather than in some other kind of property. Shares and land are traditional subjects of investment activity—activity that is not directed to profit-making in the turning over of the property acquired. An isolated transaction in land or shares does not necessarily yield an objective inference of profit purpose, when the same transaction in another kind of property may yield such an inference. A subjective purpose of profit-making, of which there may be evidence, will not in itself give the character of trade: Jones v. Leeming [1930] A.C. 415.
[2.501] A taxpayer may not engage in trade even though he spends money to enhance the value of land before selling it, and thus realises the land in an advantageous way (Taylor v. Good [1974] 1 W.L.R. 556; Rand v. Alberni Land Co. (1920) 7 T.C. 629). The money may have been spent in clearing, subdivision, forming roads and provision of esential services. But he may engage in trade if he acquires property to be dealt with in this way and then sells it (Pilkington v. Randall (1966) 42 T.C. 662). Where he has not acquired for the purpose of development and sale, but the development extends to building houses on the land, a taxpayer may engage in trade though there is no authority that directs such a conclusion. The basis of a distinction between circumstances which are a “mere” advantageous realisation and circumstances which are an advantageous realisation that amounts to a trade, is not evident in the cases. The very word “advantageous” in the description of the circumstances indicates that an objective inference of profit purpose can be drawn. The word “advantageous” must go to purpose. It is not a matter simply of advantageous in fact. The description “mere” advantageous realisation may be concerned to express the lack of a sufficient demonstration of system and organisation in the circumstances to make them a trade. Where the question is whether there is a continuing business, repetition supplies an element which must be found in the case of an isolated business venture in the isolated venture itself. If a conclusion that there is a business does not admit of any definitive answer, a judgment must be made in terms of the facts and precedent, rather than principle.
[2.502] The scope of the notion of advantageous realisation as an aspect of Australian isolated business venture law was the principal concern of the High Court’s decision in Whitfords Beach Pty Ltd (1982) 150 C.L.R. 355. The absence of any precedent that will explain the conclusions of Gibbs C.J. and Mason J. that there was an isolated business venture is starkly evident in the way each judge made use of authority. Gibbs C.J. concluded there was an isolated business venture after rejecting Official Receiver (Fox’s case) (1956) 96 C.L.R. 370 and accepting Scottish Australian Mining Co. Ltd (1950) 81 C.L.R. 188. Mason J. reached the same conclusion after accepting Fox’s case and rejecting Scottish Australian Mining. Both considered that there was something specially significant in a circumstance in Whitfords Beach that was not present in Scottish Australian Mining: there had been a change in proprietorship of the taxpayer company closely associated with the change in the purpose for which the taxpayer held the property, a change from a purpose to provide access to other properties owned by its shareholders, to a purpose of development to provide a profit which would be available for distribution to its new shareholders. An assertion of the significance of a change of purpose of the company, reflecting a change to a new set of proprietors with a new purpose, introduces a new factor, which goes not to the characterisation of facts but to a widening of the facts that have to be characterised. In effect both judges treated the case as if there had been a new acquisition of the land by the company, this time for the purpose of development and sale, because the new proprietors of the company had acquired the shares in the company for the purpose of moving the company to undertake the development and sale of the land. The decision thus involves a “piercing of the corporate veil” so as to find an acquisition by the company for the purpose of development and sale in the acquisition of shares by the new proprietors. In the result the case does not assist in determining the degree of system and organisation that will take circumstances out of the mere advantageous realisation notion, beyond a confirmation that acquisition for development and sale may be seen differently from development and sale of property that had been acquired for some other purpose. If there had been no change in shareholding in Whitfords Beach, and the old shareholders had moved the company to undertake the development, the circumstances would presumably have been held by all judges to be a mere advantageous realisation.
[2.503] The difference between the views expressed by Gibbs C.J. and the views expressed by Mason J. on the precedents of Fox’s case and Scottish Australian Mining leaves the law even less determinate than ever, where piercing the coroporate veil is not appropriate or necessary. If the view of Mason J. had been the view of both judges, Fox’s case might have been taken to justify a conclusion that a venture which involves some substantial physical change in property—in Fox’s case the realisation of land by draining and filling —is an isolated business venture. And if the view of Mason J. in relation to Scottish Australian Mining had been the view of both judges, that case might have been taken to justify a conclusion that a venture which involves more than basic development is an isolated business venture, though there would remain room for argument as to what is basic development. Under modern conditions of the grant of development approval, the provision of roads, footpaths and services of water and electricity would be seen as basic. The building of houses may go beyond basic development, though possibly not where they are limited in number in relation to the size of the development. The dedication of land for churches and parks may go beyond basic development.
[2.504] While most of the cases that have applied the advantageous realisation principle have been concerned with land development, the principle has a wider operation. Jacobs J., it will be seen, was ready to apply the advantageous realisation principle to the realisation of options by the subscription for shares in the exercise of the options and the sale of the shares: Macmine Pty Ltd (1979) 53 A.L.J.R. 362 at 376.
[2.505] It is apparent from his judgment in Whitfords Beach Pty Ltd (1982) 150 C.L.R. 355 at 371, more especially his views on Fox’s case and Scottish Australian Mining that Mason J. would find the concept of an isolated business venture more easily satisfied than would any other judge. At one stage in his judgment (at 376) he made the suggestion that Jones v. Leeming was not correctly decided, and that an acquisition of property with a subjective purpose of profit making by sale and a sale of that property is an isolated business venture. Jones v. Leeming, he thought, was rejected by the later decision in Edwards v. Bairstow [1956] A.C. 14. It has already been noted that Gibbs C.J. and Mason J. expressed the view that the specific provisions of s. 26(a) (now s. 25A) and s. 52 have no operation where the field is covered by the concept of an isolated business venture. If this is the correct view, and Jones v. Leeming is rejected, s. 25A will be stripped of most of its significance. The correlation between the isolated business venture concept and s. 25A is considered in [3.4]–[3.11] below.
A gain which is compensation for an item that would have had the character of income, or for an item that has the character of a cost of deriving income, has itself the character of income.
[2.506] There will be overlaps between the operations of Propositions 14 and 15, the extent of the overlaps depending on how wide the notion of “compensation” is taken to be. It is arguable that where a taxpayer has realised an asset by disposing of it to another, and has received an amount as proceeds of that realisation, the only relevant proposition, of the two propositions, is Proposition 14 expressing the gains from business principle. There is no case which applies the compensation principle in a realisation of an asset situation, as distinct from a surrender of rights situation. But there is clear authority that the principle is relevant in a surrender of rights situation: C. of T. (Vic.) v. Phillips (1936) 55 C.L.R. 144 and Dickenson (1958) 98 C.L.R. 460. And there is no reason why the compensation principle should apply in a surrender of rights situation, but not in a realisation of rights situation. It will be seen that the application of the compensation receipts principle in the facts of Cliffs International Inc. (1979) 142 C.L.R. 140 affords a reason for concluding that the series of receipts by Howmet and Mt Enid in respect of the realisation of the shares they held in Basic were income receipts.
[2.507] The compensation principle has an operation in circumstances where Proposition 14 could not be applicable, because there is no business of any kind relevant to the business gains principle: Phillips and Dixon (1952) 86 C.L.R. 540 are authority. It might, however, be noted that in the judgment in Carapark Holdings Ltd (1967) 115 C.L.R. 653 there is a passage which seems to assume that the compensation principle is simply a special application of the business gains principle, and that it has no independent operation. It was said (at 663):
“Accordingly the insurance moneys which the appellant received in respect of the death of Williams must be considered as having been gained in the course of its business, using ‘business’ in the broad sense which makes it relevant to the tax problem, that is to say as meaning the continuous course of conduct which the appellant was following for the derivation of income.” The taxpayer company was a holding company and had no business in a sense relevant to the gains from business principle, and this, one would think, was the only sense in which business was “relevant to the tax problem”.
[2.508] Proposition 15 is framed in the language of “gain”. A compensation receipt is income only to the extent that it involves a gain. Where a compensation receipt substitutes for a revenue asset that has been realised, or for a revenue asset that has been destroyed, it is the excess of compensation over the cost of the asset that is income, or if the compensation is less than cost, it is the shortfall that is deductible as a loss under s. 51. At least this is the ordinary usage principle. Reference has already been made to the specific provisions of the Assessment Act in ss 28ff. and s. 51(2) in relation to trading stock as defined in s. 6 which, by implication, displace the principle. Those provisions are more closely considered in Chapter 14 below. Where the trading stock provisions do not apply, the principle is unaffected. If Australasian Catholic Assurance Co. Ltd (1959) 100 C.L.R. 502 had been concerned with an insurance receipt, the block of flats having been destroyed by fire, the receipt could only have been income to the extent of any surplus over cost of the building. There would, no doubt, have been problems in identifying the cost of the building as distinct from the land and building, and it may have been necessary to apply a profit emerging principle, explained in Chapter 12 below, so that the insurance receipt is to be regarded as part of the proceeds of realisation of the land and building. But, however approached as a matter of tax accounting, the principle remains applicable that it is only the gain or profit element in the insurance receipt that is income.
[2.509] The assertion of principle in the last paragraph requires qualification where there is a realisation of an asset, or there is an insurance recovery or a recovery of damages in respect of an asset, and a number of receipts are held to be income as substituting for the income receipts that would have been derived had the asset been retained, or retained undamaged. It seems that the receipts will be income as to the whole of their amounts, and in this there is a contradiction of the principle that gain is an essential quality of income. To avoid that contradiction, in the case of a revenue asset, there should be a subtraction, against each receipt, of part of the cost of the asset so that only the profit emerging is brought to tax. Where the asset is not a revenue asset, there should be a subtraction in the same manner of the value of the asset at the time it was realised or damaged, in order to avoid the contradiction, and to protect the principle that a capital gain is not income.
[2.510] If the asset realised is a revenue asset of a business, the proceeds, to the extent of any gain, will be income under the business gains principle and under the compensation receipts principle. Where the asset is not an asset of any business, or where it is a capital asset of a business, the compensation principle may hold a gain to be income which would not be income under the business gains principle.
[2.511] In theory, a single sum receipt in respect of an asset that is not a revenue asset could be income under the compensation principle. It is, perhaps, unlikely. Reference has already been made to the economists’ view that the value of any asset is simply the present value of the flows of income it might be expected to produce. If the proceeds of realisation of any asset are overtly calculated as compensation for the flows of income which the asset would have produced had it been retained, there is some risk that the proceeds will be held to be income. Clearly there is risk of confounding the income tax law. The courts have been wary of going too far with the economists. The judgment of Lord Macmillan in the House of Lords in Van den Berghs Ltd v. Clark [1935] A.C. 431 insists on a distinction between compensation for an asset and compensation for the income flows the asset would have produced. The fact that the value of an asset is calculated by reference to the probable income flows, we are told, does not mean that the value received by the taxpayer substitutes for those income flows. To argue that it does, Lord Macmillan insisted, is to confuse the measure of a compensation receipt with the quality of the receipt. The distinction, as drawn by Lord Macmillan, is referred to by both Sugerman J. and Walsh J. in Williamson v. Commissioner of Railways [1960] S.R. (N.S.W.) 252 though, in applying it, they arrive at opposing conclusions. It will not easily be concluded that compensation is for the anticipated flows of income when it is received in one amount in advance of any such flows. A conclusion that a lump sum is for the flows may depend, in a damages compensation situation, on the way the taxpayer has framed his claim to damages: Robert v. Collier’s Bulk Liquid Transport Pty Ltd (1959) 33 V.L.R. 280.
[2.512] The cases just referred to involve damages compensation. There is no case which has treated a single amount on realisation of an asset as compensation for future income flows, but the possibility cannot be excluded. In the passage in Van den Berghs in which Lord Macmillan drew the distinction between measure and quality, the possibility is not excluded (at 442):
“If the appellants were merely receiving in one sum down the aggregate of profits which they would otherwise have received over a series of years the lump sum might be regarded as of the same nature as the ingredients of which it was composed. But even if a payment is measured by annual receipts, it is not necessarily in itself an item of income. As Lord Buckmaster pointed out in the case of the Glenboig Union Fireclay Co. v. Commissioners of Inland Revenue [(1922) 12 T.C. 427 at 464]: ‘There is no relation between the measure that is used for the purpose of calculating a particular result and the quality of the figure that is arrived at by means of the application of that test.’”
[2.513] If the single amount receipt is held to be income, it will presumably be income as to the whole of its amount and there will be the prospect of contradiction of the principle that gain is an essential quality of income. Where the asset is a revenue asset, there should be a subtraction of the cost of the asset. Where it is not a revenue asset, there should be a subtraction of the value of the asset at the time of realisation, if the conflict is to be avoided and the principle that a capital gain is not income is to be protected. The subtraction of value will in most cases mean that there is no amount of income brought to tax. An amount calculated as the present value of the future flows of income from the asset and the amount of the value of the asset, may be expected to be the same.
[2.514] The authorities indicate that a series of receipts is likely to be regarded as for the income receipts that would have flowed to the taxpayer had he not disposed of the asset. It will be recalled that a series of receipts in respect of an exclusive licence and, presumably in respect of an outright disposition, of an item of commercial or industrial property have been held to be income as gains derived from property: I.R.C. v. British Salmson Aero Engines Ltd [1938] 2 K.B. 482 and Murray v. I.C.I. Ltd [1967] Ch. 1038 were considered above in [2.346]–[2.353]. The authorities offer no detailed guidance on the extent of the recurrence that is necessary to make the series of receipts income. The suggestion was made above that recurrence extending over the whole life of the rights disposed of—it may be an exclusive licence for 10 years—may justify a conclusion that the receipts are for the use of the asset, and on this basis income derived from property.
[2.515] Recurrence of receipts has a like significance in requiring that the receipts should be treated as compensation for the income that would have been derived from the property, had it not been disposed of. Indeed the gains from property principle and the compensation receipts principle, in this context, coalesce: any difference between them is merely verbal. Two possible explanations of how the receipts by Howmet and Mt Enid in Cliffs International Inc. (1979) 142 C.L.R. 140 might be held to be income have been debated in [2.333] above. One of these is that they were income as periodical receipts, by which Howmet and Mt Enid shared in the profits generated by the property they had sold. The second explanation would be that they were income derived from property. This and the third explanation now suggested—that they were compensation for income flows—may be regarded as the same explanation. In fact in Cliffs International the receipts were to extend over the whole period of life of the rights disposed of; at least they can be so regarded if one treats the disposal of the shares in Basic as a disposal of the mining rights held by Basic. If recurrence ever justifies a conclusion that receipts are income within any of the periodical receipts, gains from property or compensation receipts principles, the recurrence would justify such a conclusion on the facts of Cliffs International. Recurrence extending over a less period than the life of the rights disposed of may be enough to engage the periodical receipts principle. To engage the gains from property and compensation receipts principles, however, it may be that the series must extend substantially over the life of the asset.
[2.516] Where the series of receipts are income under the periodical receipts principle, there is an acknowledged contradiction of the principle that gain is an essential quality of income. There is some mitigation, however, by s. 27H where that section applies. Where the series are income as gains from property or compenscation receipts, there is the prospect of contradiction unless there is a subtraction in determining the amount of income, as explained in [2.513] above. The mitigation by amortisation of costs provided for in Div. 10B of Pt III, examined in [10.212]ff. below is available only where the asset is an item of commercial or industrial property, and will not in any event have any application in the circumstances now considered. There may be mitigation in the operation of s. 59 of the depreciation provisions considered in [10.188]ff. below. But those provisions have limited application.
[2.517] The possibility that an amount received on realisation of an asset will be income as compensation for outgoings on revenue account incurred in bringing the asset into existence cannot be excluded. In National Commercial Banking Corp. of Australia Ltd (1983) 83 A.T.C. 4715 the Commissioner argued that an amount received by a bank from another bank, on the admission of the latter bank to the “Bankcard” scheme of which the taxpayer was a member, was received in compensation for outgoings on revenue account incurred by the taxpayer bank in building up the Bankcard scheme operations. The Federal Court held that the finding of the trial judge that the amount received had only in part been calculated by reference to outgoings that had been incurred on revenue account, and that it was impossible to dissect the amount received so as to attribute a part to outgoings on revenue account, prevented a conclusion that the whole or any part of the amount received was income. This aspect of the decision is referred to in [2.570] below. But the possibility is raised that, in an appropriate case, it may be held that a receipt which is akin to a receipt on a partial disposition of goodwill is a receipt of income as compensation for outgoings on revenue account incurred in building up the asset realised. The manner in which the distinction between a receipt for the asset and a receipt in compensation for the outgoings on revenue account might be made is not explored in the case. Recurrence of receipts could not have significance as it has in indicating that receipts are for income that would have been derived.
[2.518] The issues of principle in relation to receipts for the surrender of rights parallel the issues detailed under the last heading. Indeed Van den Berghs Ltd v. Clark [1935] A.C. 431 and Glenboig Union Fireclay Co. Ltd (1922) 12 T.C. 427, which are referred to there, are surrender of rights cases.
[2.519] An illustration of the operation of the gains from property principle in a series of receipts situation involving a surrender of rights, may not be readily imagined. Aktiebolaget Volvo (1978) 78 A.T.C. 4316 may afford an illustration. The surrender of rights in that case had, as its consequence, the making of rights available to another. The restrictive covenant left the beneficiary of the covenant with the exclusive use of the taxpayer’s goodwill in Australia. The series of payments by the beneficiary to the taxpayer might thus be seen as gains derived by the taxpayer from property. And they might equally well be seen to be compensation for the gains that the taxpayer might have made by itself exploiting that goodwill. Again the gains from property principle and the compensation receipts principle coalesce.
[2.520] Two cases concerned with surrender of rights, raise the question of the scope of the recurrence that will attract the compensation receipts principle. They are Dickenson (1958) 98 C.L.R. 460 and C. of T. (Vic.) v. Phillips (1936) 55 C.L.R. 144. In Dickenson there were two sums, each of £2,000, paid on successive days. The possibility that the receipts were, in the words of Dixon C.J., “compensatory for the loss of future profits” that the restrictive covenants might involve, was considered but rejected. In this regard, all members of the majority drew attention to the fact that the receipts were not “recurrent”. Thus, Dixon C.J. said (at 475): “There is nothing recurrent, in the nature of the payment”. Williams J. said (at 483): “If the consideration takes the form of recurring payments, these payments may well be considered to be a quid pro quo for the profits the covenantee would have made if he had not withdrawn from such activities and be income.” Kitto J. observed (at 492): “The consideration for it was paid to the appellant in two sums but was otherwise non-recurring.” If the agreement had required that payments continue substantially over the period of the restrictive covenant, there would have been room for the compensation receipts principle, on the authority of Phillips. The payments in respect of surrender of rights under the service agreement were, in that case, not only the estimated amounts that the taxpayer would have received under the service agreement, but were to be made at the same times as amounts would have been received under the service agreement. Dixon and Evatt JJ. said (at 156): “But, where one right to future periodical payments during a term of years is exchanged for another right to payments of the same periodicity over the same term of years, the fact that the new payments are an estimated equivalent of the old cannot but have weight in considering whether they have the character of income which the old would have possessed.”
[2.521] The application of the compensation receipts principle in a surrender of rights situation, as in Van den Berghs, Glenboig, Dickenson and Phillips, raises issues in regard to the principle that gain is an essential quality of income. If a subtraction is to be allowed to reflect the cost or value of the rights surrendered, there will be problems of fixing a cost or value. In this context, the notion of gain is itself tested. The economist’s concept of accretion to economic power is painted with a broad brush. He might be uncertain, if asked to define the extent of an accretion where freedom of action or rights under a contract to perform services are surrendered for consideration. There is much to be said for a view that a receipt for giving up rights under a service agreement is, substantially, pure gain. In Phillips the receipts were the equivalent of the amounts that would have been received had services been performed under the contract. They were received though the services had not been performed. If the service agreement is to be seen as an asset notionally realised by the surrender, the value of that asset, even if the rights to serve were transferable, would not be the present value of the amounts that could be earned. In any event the appropriate subtraction will not always be the value of the service agreement. In [2.378] and [2.384]–[2.385] above the possibility was raised that costs of obtaining an employment contract are deductible because the employment contract is a revenue asset of a business of providing services under contracts of employment. And the possibility was also raised that the costs of obtaining an employment contract are deductible, even though there is no business of providing services, as costs of a non-structural contract of service, rewards for which are income. Where the service agreement is a revenue asset or a non-structural asset, there can be no question of subtracting the value of the agreement from the proceeds of realisation: the whole proceeds are an income gain. Where, however, the service agreement is a structural asset, as it normally will be, or the case involves the surrender of freedom of action which in the circumstances is a structural asset, there is in theory a need to subtract value from the proceeds that are held to be income as compensation receipts. The determination of that value, more especially where freedom of action is surrendered, is a daunting prospect and should not, in the view of this Volume, be attempted. Valuing freedom of action would require an excursion into matters that are irrelevant to any commercial idea of value. To say that we are valuing “human capital” does not assist. It merely identifies the problem.
[2.522] There are problems of determining cost or value in a Ven den Berghs or Glenboig situation if the compensation receipts situation will, in the circumstances, given an income character to receipts. In a Van den Berghs situation they would be no less than in a Phillips situation. In a Gleinboig situation the problem is manageable. The protection of the principle that income involves a gain will require a deduction of the value of the right sterilised, which would be the value of the mineral as it lies in the ground. That value, if market value is appropriate, would be small. The questions raised in this and the last paragraph, test to the limit the notion of gain and the distinction between income gain and capital gain. The logical culmination of the Simons concept of gain ([1.46]ff. above) would require an annual valuation of all assets, including an employment contract and human capital, though Simons might have baulked at the former and retreated to a position that would confine gain to realised gain. And he might have adopted an exception that would put gains in human capital out of reckoning. The notion of a realised gain requires an exclusion of gains already realised and outlaid in producing proceeds in which a further gain may be realised. And if a distinction is drawn between an income gain and a capital gain the calculation of a realised income gain requires an exclusion of a capital gain that has not been realised that is outlaid in producing proceeds which are to be treated as an income gain.
[2.523] Compensation under a statutory compensation scheme, or under an insurance policy, where the compensation relates to some physical asset such as land or a chattel, raises problems of analysis parallel with those already considered in dealing with compensation on the realisation of an asset. Characterising the compensation as for the asset or for the income flows that would have been derived, in that context, centred on the terms of any agreement—whether it provided for calculation of the compensation by reference to the amount of the anticipated flows, and whether the compensation was payable in a series of amounts. When the receipt is under a statutory provision or under an insurance policy, characterising must centre on the statutory provisions or the insurance policy.
[2.524] In Wade (1951) 84 C.L.R. 105 the statutory compensation related to livestock that were trading stock, and thus were revenue assets. Characterising was therefore not complicated by any need to distinguish compensation for the asset from compensation for income flows. Characterising an insurance receipt in the like circumstances would be similarly uncomplicated.
[2.525] Where there is a capital asset to which the compensation receipt relates, characterising will require a determination of the function of the compensation—whether to compensate for the asset or for the income that would have been derived from the asset. There is a question whether some objective or subjective purpose will explain that function. In the case of statutory compensation, the provisions of the statute may reflect a purpose objectively determined. The provisions of the statute were explained in the judgments of the High Court in Wade though, the assets being revenue assets, no analysis of purpose was called for. The case is valuable primarily for its formulation of principle in the judgment of Dixon and Fullagar JJ. (at 112): “moneys recovered from any source representing items of a revenue account must be regarded as received by way of revenue.” In Higgs v. Wrightson [1944] 1 All E.R. 488 the taxpayer asserted that the function of a ploughing grant he had received from the Crown was compensation for a capital loss he had suffered by the ploughing. The ploughing of pasture land, it was said, partly destroys the fertility of that land. Macnaughton J. rejected the taxpayer’s submission after an examination of the terms of the relevant legislation. In neither case was there any suggestion that the function might have been determined by going behind the legislation to some subjective purpose of parliament reflected in the legislative history.
[2.526] In Slaven (1984) 84 A.T.C. 4077, however, the Federal Court did make some search for the subjective purposes of Parliament. In Tinkler (1979) 79 A.T.C. 4641 the taxpayer had received a number of amounts under the Victorian Motor Accidents Act 1973. The amounts were paid as compensation in respect of physical injuries suffered in a motor accident. The court concluded, after a review of the terms of the Motor Accidents Act, that the payments were in substitution for income which the taxpayer would have earned were it not for the accident. The provisions of the Motor Accidents Act were thereafter amended so that the compensation under that Act was now described as compensation for loss of earning capacity. The Federal Court in Slaven made reference to the second reading speeches in relation to the amendment, and observed (at 4084) that “it is plain beyond argument that the principal problem which the [amending] Act was intended to overcome was the attraction of income tax to benefits paid under the Act”. The court further observed (at 4085): “The Parliament of Victoria cannot determine by its own legislation whether the receipt of a statutory payment answers the description of income or capital in the hands of the recipient … But the purpose of a statutory payment, as disclosed by the terms of the statute itself, must be a powerful, though not conclusive, aid to the determination of the character of the payment and in particular as to whether its receipt constitutes income in the hands of a taxpayer.” The passage last quoted shows a return to a more conventional approach to statutory interpretation than that suggested by the earlier reference to the Ministers’ speeches. And it would appear that characterisation ultimately depends not solely on the purpose of the statute, but on a combination of factors, and the language of “function” of the receipt by the taxpayer remains appropriate. Among the circumstances considered in Slaven was the fact that several payments had been made to the taxpayer in respect of the injury. A series of payments may indicate that the function of the payments is to compensate the taxpayer for income he would have earned were it not for the accident, but it seems that it is no more determinative than is the purpose of Parliament.
[2.527] There is some suggestion in Carapark Holdings Ltd (1967) 115 C.L.R. 653 that the subjective purpose of the taxpayer in effecting insurance may determine the function of the compensation received under that insurance. The court observed that no form of proposal had been submitted by the taxpayer at the time when a cover note was issued, and the insured event occurred before any formal proposal had been made. And the court observed that no information was available as to anything that passed between the taxpayer and the insurance company in the course of the negotiations for the cover. The court also looked to the manner in which the taxpayer applied the money received under the policy, as throwing light on “the purpose for which the taxpayer entered into [the] contract” (at 660).
[2.528] Carapark also carries some suggestion that the deductibility of a premium, or, more likely, the claim to deduct the premium, bears on the characterisation of a receipt under a policy. The suggestion probably amounts to very little—it is no more than what might be inferred from the statement in the case that the taxpayer had claimed a deduction of the premium. The claim to deduct may be evidence of the taxpayer’s subjective purpose, though it is not easy to see what significance it might have. However, any principle that would draw a conclusion from deductibility of a premium that a receipt under the policy is of a revenue character, cannot be accepted. It will be seen in [6.217]–[6.219] below that a premium on insurance of factory premises used by the taxpayer to produce income is probably deductible. It would be a bizarre conclusion that compensation received under the policy must be income. The principal judgment in the Federal Court in D. P. Smith (1979) 79 A.T.C. 4553 also carries a suggestion of a connection between deductibility and the receipt being income. In this instance, however, the suggestion is that the income quality of the receipt is relevant to the deductibility of the premium. The suggestion is repeated in the High Court judgment: (1981) 147 C.L.R. 578.
[2.529] The High Court in Carapark (at 662–663) speculated on what the function of the insurance might be, indicating that only two possibilities were “worth considering”:
“One is that when the insurance was being negotiated the motivating consideration on the part of the appellant was that in any of the events insured against the receipt of the policy moneys would place the appellant in a position to do exactly the kind of thing it did in this instance, namely to extend an appropriate degree of generous treatment to the employee or his dependants. If any such notion existed, it was left to be further considered when the time should arrive. The only other possibility seems to be that as regards employees of subsidiaries the insurance was effected in order that in any of the events insured against the appellant should receive money to take the place of that which it would otherwise have derived from a continuance of the services of the employee to the subsidiary.”
The insurance had been taken out by a holding company against death by air accident of a senior employee of a subsidiary. The possibilities, as so framed, suggest subjective purpose.
[2.530] The court’s statement of principle is however framed in the language of objective purpose. It said (at 663):
“The reasons may be summarised by saying that, in general, insurance moneys are to be considered as received on revenue account where the purpose of the insurance was to fill the place of a revenue receipt which the event insured against has prevented from arising, or of any outgoing which has been incurred on revenue account in consequence of the event insured against, whether as a legal liability or as a gratuitous payment actuated only by considerations of morality or expediency.”
At the same time, reference elsewhere in the judgment (at 663) to “the true purpose” (suggesting subjective purpose), and the statement (at 664) that “the purpose which has to be considered in determining the nature of the receipt … is the purpose which in actual fact the insurance serves” (suggesting objective purpose), leave the question of the manner of determination of the function of insurance unresolved.
[2.531] One would think that a determination by reference to subjective purpose at the time of effecting insurance is unsatisfactory. If the employee had left the taxpayer’s service at the time he was killed in the accident, the conclusion reached in Carapark that the receipt was income could hardly have been appropriate. The detailed examination by Menzies J. in Development Underwriting Ltd (1971) 71 A.T.C. 4125 of the circumstances in which the policy in that case was taken out was directed to determining the purpose of the taxpayer in effecting the insurance. His conclusion was that the policy was taken out so that the taxpayer might have funds with which to repay a loan on the death of the life insured and he held that the proceeds of the policy were therefore not income. Menzies J. admitted evidence to the effect that a deduction had been claimed of the premiums paid on the policy. Clearly he thought this was a relevant fact in determining the taxpayer’s purpose, but it did not displace the inference he drew from other evidence.
[2.532] Toohey J., in delivering the principal judgment in the Federal Court in D. P. Smith (1979) 79 A.T.C. 4553, observed (at 4556) that the purpose spoken of in Carapark is “a more objective one” than the purpose that is relevant to s. 26(a) (now s. 25A(1)). The taxpayer had received monthly payments under a personal disability insurance policy following an injury in a traffic accident. Toohey J. concluded, primarily from the terms of the insurance policy but without excluding the relevance of other circumstances, that “the purpose served by the insurance policy was to fill the place, if only in part, of … earnings [as an employed medical practitioner]”. In the High Court in D. P. Smith (1981) 147 C.L.R. 578 the assumption appears to be that the determination of function is solely a matter of objective inference from the terms of the policy. The court approved (at 583) a conclusion that had been reached by Wickham J. “from his review of the [insurance policy]”.
[2.533] In Carapark there was only one payment. In D. P. Smith there were monthly payments over four months. In the view of Toohey J. “the entitlement to regular monthly payments is important although not decisive”: (1979) 79 A.T.C. 4553 at 4557. The contribution that recurrence of payments may make to a conclusion that compensation receipts are income is thus recognised.
[2.534] There is authority that would indicate that where property is insured and that property is damaged but not destroyed, it is a possible inference that the function of the payment of compensation was to substitute for the loss of income suffered during the time the property was under repair. The inference will be the stronger if there is a distinct payment under the policy to cover the costs of repair. These are implications, in the insurance context, of the decision in London & Thames Haven Oil Wharves Ltd v. Attwooll [1967] Ch. 772, a case concerned with the recovery of damages in satisfaction of claims arising from damage done by a ship to a wharf owned by the taxpayer. The Court of Appeal, in holding that part of the amount received was income as compensation for profits lost during the time the wharf could not be used, distinguished Glenboig Union Fireclay Co. Ltd (1922) 12 T.C. 427 on the ground that the latter case was concerned with permanent deprivation of the capital asset used by the trader for purposes of his trade: the trader had abandoned that part of his trade which involved the use of the capital asset of which he had been deprived. In the words of Diplock L.J. in the London & Thomas (at 818):
“Even if the compensation payable for loss of the capital asset has been calculated in whole or in part by taking into consideration what profits he would have made had he continued to carry on a trade involving the use or exploitation of the asset, this does not alter the identity of what the compensation is paid for, to wit, the permanent removal from his business of a capital asset which would otherwise have continued to be exploited in the business: see the Glenboig case.”
[2.535] The same idea is expressed in the language of fruit and tree by the High Court in D. P. Smith (1981) 147 C.L.R. 578 at 583:
“If the ability to earn is the tree, and income the fruit thereof, a policy of insurance against impairment of the fruit-bearing capacity of the tree may well take the form of providing the fruit until such time as the tree recovers its proper role. The degree of correspondence, if any, between the moneys payable under the policy and the actual pecuniary loss of revenue suffered by the insured is a relevant factor, but it is not necessary to look for an idemnity measured with any precision against the loss. Any fruit is better than none, whether or not it represents adequate compensation for the loss.”
[2.536] The references to Carapark Holdings Pty Ltd (1967) 115 C.L.R. 653 and D. P. Smith in the survey of how the function of an insurance receipt is to be determined has taken the discussion into areas where the insurance receipt is not directly related to the loss of an asset. In Carapark it might have been argued that the right to the services of the deceased employee was a structural asset, an argument that might be given more colour by an insurance policy which purports to give “key-man” insurance. The argument would seek to bring the circumstances within Van den Berghs Ltd v. Clark [1935] A.C. 431. It was not however attempted in Carapark. An argument was made by counsel for the taxpayer in D. P. Smith in the High Court that the moneys received under the insurance policy represented payments made for the loss of a capital asset, namely “the taxpayer’s ability to work as a medical practitioner, carrying with it the capacity to earn income” (at 582). The conclusion of the court was that the purpose of the policy and thus the function of the compensation, was to provide a monthly indemnity against the income loss arising from the inability to earn. Such a conclusion, like the conclusion as to the function of the insurance in Carapark, makes the character of the asset as a structural asset irrelevant.
[2.537] In cases where the framework of loss of an asset is inappropriate, the choice in determining function will be between (i) substitute for a revenue item of receipt or outgoing, (ii) substitute for a non-revenue item of receipt or outgoing, and (iii) not a substitute at all. In Carapark the choice made was substitute for the dividends that might have been derived by the holding company had the subsidiary continued to have the advantage of the employee’s services, or for the revenue expenses associated with the loss of the employee. The alternative that the receipt was a windfall gain was rejected. In D. P. Smith there was some basis for arguing that the receipts were not a substitute for any item: the amount received was not measured with any precision against the loss. If this argument had been accepted it would have been necessary to inquire whether the receipts were income within the periodical receipts principle, but they would not have been income as compensation receipts.
[2.538] In Carapark it was considered that a function of the insurance receipt was to put the taxpayer “in a position to do exactly the kind of thing it did in this instance, namely extend an appropriate degree of generous treatment to the employee or his dependants” (at 662), and that this would be enough to give the receipt an income quality. The statement of principle in the case may be thought to require a more specific function for the receipt: it must fill the place of an “outgoing which has been incurred on revenue account in consequence of the event insured against, whether as a legal liability or as a gratuitous payment actuated only by considerations of morality or expediency” (at 663). The amount received was in fact settled by the taxpayer on terms that provided for an annuity for 10 years to be paid to the widow of the employee, charged on the capital and income. On the expiration of the 10 years any amount of capital or income not used in paying the annuity was to be returned to the taxpayer. Whether or not the settlement of the insurance receipt would be an “outgoing on revenue account”, words which assume an accounting concept of deductibility, may be doubted. The inference may be that the High Court did not intend that the operation of the principle should depend on the actual use of the insurance money. To require that there be actual use would encourage the taxpayer receiving an amount as in Carapark, to see to it that the money received was not used in accordance with the function it was intended to serve. The actual use of the money or, indeed, the use of other money to effect a revenue outgoing related to the insured event should not be a condition of the operation of the principle, however significant it may be in determining the function of the insurance receipt.
[2.539] If an actual use of the insurance money, or some other money, to effect an outgoing on revenue account is necessary, there will be problems as to what is “an outgoing on revenue account”, and how far this concept may differ from the concept of deductibility expressed in s. 51. The question has been raised above whether the actual use in Carapark was “on revenue account”. Ransburg Aust. Pty Ltd (1980) 80 A.T.C. 4114 may be thought to be authority that the actual use did not involve a deductible expense under s. 51. John Fairfax & Sons Pty Ltd (1959) 101 C.L.R. 30 affords another illustration of what may be an outgoing on revenue account—legal expenses associated with the acquisition of a controlling interest in another company—which, as was held in the case, was not deductible under s. 51.
[2.540] The operation of the compensation principle to a receipt by way of damages will follow the analysis under the last heading. London & Thames Haven Oil Wharves Ltd v. Attwooll [1967] 1 Ch. 772, considered under the last heading, is in fact a damages case.
[2.541] The subjective purpose of the taxpayer in effecting insurance has no parallel in the damages compensation situation. But the roles of subjective purpose and objective inference of purpose, and the relevance of the actual use of the compensation moneys, are again raised. There is a question, perhaps especially relevant in the present context, but not without relevance also in realisation, surrender of rights, and insurance contexts: how far is the form of a damages award, or an agreement settling a claim for damages, definitive on the issue of function? Dickenson (1958) 98 C.L.R. 460, in the surrender of rights context, is authority that a broad view is to be taken and that the form chosen—in that case receipts for a restrictive covenant—is not definitive. In Carapark and in London & Thames Haven Oil Wharves there was no element of form that might have been regarded as definitive. Allsop (1965) 113 C.L.R. 341, yet to be considered, may suggest that form is definitive. Observations on form and substance made earlier in [2.420]–[2.428] above, are relevant here.
[2.542] It would be assumed that a single sum award for economic loss arising from personal injury is not income as a compensation receipt. There is, in any case, a problem of dissection or apportionment, a matter considered below, if the amount for economic loss is not distinguished in the award. The view that the damages award for economic loss is not income, relies on authorities which say that the damages are awarded for loss of earning capacity, and that this is a capital asset. These authorities begin with Paff v. Speed (1961) 105 C.L.R. 549, (esp. per Fullagar J. at 559). They are confirmed by statements in the judgment of Barwick C.J. in Cullen v. Trappell (1980) 146 C.L.R. 1 and in the judgment of the Federal Court in Slaven (1984) 84 A.T.C. 4077, where the authorities are collected. The fact that the damages are calculated by reference to the earnings the taxpayer might have derived if he had not lost the capacity to earn, does not displace the conclusion that their function is to compensate for the loss of capacity. In this context, the significance of calculation by reference to profits is different from what it may be in cases such as Glenboig Union Fireclay Co. v. I.R.C. (1922) 12 T.C. 427 and C. of T. (Vic.) v. Phillips (1936) 55 C.L.R. 144. The comments made above in [2.521]–[2.523] in regard to Glenboig and Phillips require some elaboration. The fireclay in Glenboig may be regarded as an asset. And so far as the calculation of compensation simply reflected what would have been paid by another for the opportunity to mine the deposit of clay, the compensation may be said to be for the asset. But where the calculation reflects profits the taxpayer might have made by mining and selling the clay—the value to be added by those activities—the compensation may well be regarded as for those profits. This is not to confuse quality and measure of compensation but to indicate the bearing measure may have on quality. The compensation is for the potential profits to be made by exploiting the asset. Such a significance cannot be given to a like calculation in the economic loss for personal injury situation, because the asset for which the damages may be said to be compensation embraces the capacity to make those profits. The actual decision in Glenboig may turn on the fact that the clay was in situ and the taxpayer was already engaged in exploiting other parts of the deposit. The asset might then be regarded as including the capacity to exploit. Compensation in respect of raw materials used by a manufacturer which can be readily replaced might fairly be said to be for the profits, if it is calculated by reference to profits. The asset itself does not include a capacity to exploit which may be said to have been lost. The point will not of course be significant in the case of trading stock as it is in a Glenboig situation. The trading stock and, one would think, the capacity to exploit it are revenue assets.
[2.543] It follows from analysis of this kind that the compensation in Phillips might have been held to be for the salary receipts even though it had been received in a single sum. The taxpayer’s capacity to earn was not lost by his surrender of rights under the service agreement. If a contract to perform services were assignable, no buyer would pay for that contract the estimated profits to be made from performing services under the contract. If he has paid that amount, there will be no room for him to gain by performing the services, and the function of the payment would need to be explained in terms other than consideration for the contract. The conclusion, here suggested, that a golden-handshake receipt calculated by reference to the earnings that would have been derived are ordinary usage income as compensation receipts, will not be generally accepted. And Subdiv. AA of Div. II of Pt III and the words added to s. 25(1) referred to in [2.369] may have excluded the possibility of any judicial examination of the question. A golden-handshake receipt will, at least generally, be income as “an eligible termination payment” and its income character exclusively determined by ss 27B and 27C.
[2.544] In applying the rule in British Transport Commission v. Gourley [1956] A.C. 185 in actions for damages, the Australian courts have had to decide an issue as to whether compensation receipts will be income, on a number of occasions. The decisions in regard to damages for economic loss in personal injury cases have already been mentioned. In Pennant Hills Restaurants Pty Ltd v. Barrell Insurances Pty Ltd (1978) 78 A.T.C. 4032 the Supreme Court of New South Wales expressed a variety of views on the question whether an award of damages against an insurance broker for failing to keep the plaintiff insured against workers’ compensation liability, was income. The amount had been calculated by reference to payments the plaintiff would have to make under an Uninsured Liability Scheme. Reynolds J.A. thought the award was income by ordinary usage. Hutley J.A. thought it was income, not by ordinary usage, but under the specific provision in s. 26(j). Mahoney J.A. thought it was not income, whether by ordinary usage or under s. 26(j). The question whether the damages award was income was not argued in the High Court: (1981) 145 C.L.R. 625. The payments in Barrell Insurances would continue for a number of years, and indeed might cease to be revenue outgoings because the plaintiff’s business had been discontinued. Whether receipts in respect of such outgoings are income by ordinary usage raises issues considered in observations on Carapark Holdings Pty Ltd (1967) 115 C.L.R. 653. Would an intention, or legal obligation undertaken, to pay an annuity to the widow have required a different conclusion in Carapark on the issue of compensation for a revenue outgoing? The deductibility, and, presumably, the revenue character, of those payments would cease if the business were disposed of or discontinued. Amalgamated Zinc (De Bavay’s) Ltd (1935) 54 C.L.R. 295 considered in [5.37]–[5.38] below is authority.
[2.545] Dixon (1952) 86 C.L.R. 540 was considered above in [2.172]–[2.178] in dealing with periodical receipts. The case is also important as the source of authority for a proposition that a series of voluntary payments may be income as compensation receipts. That authority is in the judgment of Fullagar J., but the proposition is not inconsistent with the decisions of Dixon C.J. and Williams J. Fullagar J. said (at 568):
“What is paid is not salary or remuneration, and it is not paid in respect of or in relation to any employment of the recipient. But it is intended to be, and is in fact, a substitute for—the equivalent pro tanto of—the salary or wages which would have been earned and paid if the enlistment had not taken place. As such, it must be income, even though it is paid voluntarily and there is not even a moral obligation to continue making the payments. It acquires the character of that for which it is substituted and that to which it is added. Perhaps the nearest parallel among the many cases cited to us is to be found in Commissioner of Taxes (Vic.) v. Phillips (1936) 55 C.L.R. 144.”
Dixon is referred to in Harris (1980) 80 A.T.C. 4238 and in the Federal Court in D. P. Smith (1979) 79 A.T.C. 4553, but the extension of the compensation receipts principle to voluntary payments is not questioned.
[2.546] There will be questions as to the circumstances which are relevant in determining the function of the payments, of the kind considered in [2.523]ff. in relation to compensation under statute or insurance.
[2.547] The impression that is left by the cases considered under earlier headings is that the compensation receipts principle has a very wide operation. However, H. R. Sinclair & Son Pty Ltd (1966) 114 C.L.R. 537 is authority for a limitation on the principle which would deny its relevance in what might be called a refund situation—the return of the whole or part of an outgoing. One would have thought that Dixon, Phillips and Carapark—indeed all the cases so far referred to in relation to compensation receipts—directed a conclusion that an amount paid and received as a refund substituted for the outgoing and was income, if the outgoing was on revenue account. Yet Sinclair, without reference to the compensation receipt cases, decided that there was no principle that a refund of an amount that was an allowable deduction is income. There had been warning that the High Court would take such a view in observations made in Allsop (1965) 113 C.L.R. 341 referred to below. In Sinclair, Owen J. said (at 545):
“But the fact that the amounts so paid were propertly claimed and allowed as deductions in assessing the company to tax in those earlier years does not determine the question whether the amount refunded is to be regarded as part of the company’s assessable income for the year in which the refund was received. … But it does not follow that the amount refunded must therefore be regarded as part of the company’s assessable income of the year in which the refund was made. I mention this because many of the arguments put to us by counsel for the Commissioner seemed to suggest that because the earlier payments had been allowed as deductions since they had been made in gaining the company’s assessable income in those years, it necessarily followed that the refund was to be treated as a receipt of income. This, I think, is not the right approach. The real question is whether the amount received by way of refund was part of the company’s assessable income for the year in which it was received.”
[2.548] In fact the court held that the refund was income under the business gains principle, but that principle will not assist in producing what might be thought to be the correct outcome where there is no business. The refund may be of an outgoing deductible by an employee, or by a person deriving investment income. In any case, if the judgment of Taylor J. is emphasised, Sinclair is authority that the refund is income as a business gain only where there has been activity directed to the obtaining of the refund: it is not income where the refund has not been sought. Taylor J. said (at 544):
“[The taxpayer’s] attempts—which in the end were successful—to obtain a refund of amounts which it contended had been exacted as the result of the misapplication of the formula were just as much an activity of the business as would have been an attempt to avoid an overcharge in the first instance and the amount recovered in the year ended under review must be taken to have formed part of the appellant’s income for that year.”
[2.549] There are references, in the judgments of Taylor and Owen JJ., to the specific provisions in ss 72(2) and 74(2), dealing with refunds in particular situations, which, in the words of Owen J. “appear to recognise that the refund of an amount which has been allowed as a deduction from the assessable income of an earlier year is not necessarily part of the assessable income in the year of receipt” (at 546). One would have thought this a slim basis of inference to displace a principle of the ordinary usage meaning of income otherwise recognised as part of the law. Those provisions, in any case, can be explained as concerned with refunds of deductions which may not be “outgoings on revenue account”, and therefore not covered by the ordinary usage principle.
[2.550] The operation of the compensation receipts principle in refund situations would contribute to a rational system of tax accounting. The amount claimed as an accrual or as an actual payment in an earlier year may have been greater than the correct amount of the liability. The Commissioner may have no power to amend the earlier assessment under s. 170. A power to bring a refund to tax is necessary to ensure correction. The view is put forward in [11.73]ff. below, that a liability acknowledged in response to a claim of right by a creditor will constitute an accrual, whether or not there was a legal liability to pay: legal liability is not an essential condition of an accrual of a liability or of a receivable. It would follow that the amount claimed as a deduction in the earlier year will have been correctly allowed, and no amendment could be made by the Commissioner.
[2.551] In his judgment in Sinclair Owen J. referred to the judgment of Rowlatt J. in English Dairies Ltd v. I.R.C. (1927) 11 T.C. 597, where a proposition is asserted which would limit the operation of the business gains approach to dealing with refunds. Rowlatt J. said (at 605): “It is not a commercial operation to suffer extortion and it is not a commercial receipt to have the money handed back to you.” It may follow that any refund of an amount which the taxpayer was not legally liable to pay is not a business receipt. Thus in Allsop (1965) 113 C.L.R. 341, considered below in [2.567]–[2.569] a simple refund of the fees would not have been income of the taxpayer.
[2.552] The operation of the compensation receipts principle in refund situations may not be finally foreclosed by Sinclair. Adjustments to amounts payable or to amounts receivable, giving rise to exchange gains and losses, have come to be recognised as income and deductible. A number of recent cases, beginning with International Nickel Aust. Ltd (1977) 137 C.L.R. 347, have confirmed earlier decisions of the High Court in this regard. It is a short step from treating an exchange gain as income to treating a refund as income.
[2.553] Some part of the ordinary usage compensation receipts principle is expressed in s. 26(j). A submission that it was a code in relation to receipts of these kinds was put by the taxpayer in proceedings before the Board of Review in Carapark, but was not renewed in the appeal to the High Court.
[2.554] The interpretation of the section is considered below in [4.204]ff. Two points might be made now. The first is that the section relates to a “loss or outgoing which is an allowable deduction”. The ordinary usage principle, it will be recalled, is expressed in the language of loss or outgoing on revenue account.
[2.555] The second point is that the section relates only to an amount received by way of “insurance or indemnity”. The consequence may be that its operation is confined to circumstances where there is a right to compensation under specific statutory provision, the general law or a contract, which already exists before the event occurs which gives rise to a claim for compensation. This would be the view of Hunt J. in Commercial Banking Co. of Sydney Ltd (1983) 83 A.T.C. 4208. The section could thus apply to a receipt in the circumstances of Higgs v. Wrightson [1944] 1 All E.R. 488 or Wade (1951) 84 C.L.R. 105 where a statute provided for a payment to the taxpayer if he took certain action or certain events occurred. It could apply to a receipt under the general law of damages. It could apply in the circumstances of Carapark Holdings Pty Ltd (1967) 115 C.L.R. 653 where an insurance policy provided for a payment if certain insured events occurred. But the section could not apply to a receipt on the surrender of rights as in C. of T. (Vic.) v. Phillips (1936) 55 C.L.R. 144, a voluntary payment by another as in Dixon (1952) 86 C.L.R. 540 or to a receipt under a contract which was entered into after the event in respect of which the payment is to be made, as in the Commercial Banking Co. or in Goldsbrough Mort & Co. Ltd (1976) 76 A.T.C. 4343.
[2.556] In the latter case, s. 26(j) was held applicable by Walters J. The case concerned an adjustment received from the purchaser in respect of rates already paid by the vendor before entering the contract of sale that provided for the adjustment. Goldsbrough Mort was expressly rejected by Hunt J. in deciding the Commercial Banking Co. case. The Federal Court on appeal from the decision of Hunt J. (sub nom. National Commercial Banking Corp. of Aust. (1983) 83 A.T.C. 4715) did not find it necessary to consider this aspect of the judgment of Hunt J. The Commissioner had claimed that receipts by the taxpayer bank for allowing another bank to participate in an organisation—Bankcard—by which credit was provided for consumer purchases, was compensation for deductible expenses incurred in setting up the organisation. The Federal Court held that the amount received was not compensation for deductible outgoings, but a receipt for a partial vesting in another of assets and goodwill making up the Bankcard organisation. It could not therefore be within the ordinary usage principle or s. 26(j).
[2.557] The conflict between Walters J. and Hunt J. remains unresolved. An ultimate resolution in favour of Hunt J. would not however affect the operation of the ordinary usage compensation principle in the circumstances of Dixon or Phillips. And it would leave the possibility that the Goldsbrough Mort decision could yet be supported on the basis of the ordinary usage principle.
[2.558] Two decisions of the High Court—McLaurin (1961) 104 C.L.R. 381 and Allsop (1965) 113 C.L.R. 341—appear to have settled a principle that where a compensation receipt is in respect of items some of which are of a revenue kind and others not, and an amount in respect of the revenue items cannot be dissected or apportioned out of the receipt, no part of the receipt is income.
[2.559] The principle thus settled contradicts the decision of the House of Lords in Tilley v. Wales [1943] A.C. 386. That case was referred to by the High Court in McLaurin, but no attention was given to the contradiction. It will be noted that in Tilley v. Wales the House of Lords took the view that an apportionment was proper because the Attorney-General had conceded that it should be made. Clearly the Attorney-General’s concession could relieve the court of the obligation to decide whether or not an apportionment was proper only if the court took the view that the alternative to an apportionment was that the whole of the compensation was income. The judgment of Windeyer J. in National Mutual Life Association of Australasia Ltd (1959) 102 C.L.R. 29 is in line with the view taken by the House of Lords: Windeyer J. (at 50) was disposed to hold that if the premium could not be dissected or apportioned the consequence would be “not that no part of the total premium should be included in the assessable income, but that all of it should be”.
[2.560] It is not clear whether, in McLaurin, the High Court regarded the compensation as having been given for the specific items in the taxpayer’s claim or for damage to the structure of his business. Some of the property destroyed—sheep and other animals—was trading stock. But the argument is open, that the trading stock were capital assets in the context of the suffering of the loss. It will be seen in Chapter 14 below that trading stock disposed of in the sale of a business are, so far as ordinary usage principle is concerned, to be regarded as capital assets.
[2.561] In Allsop there is, however, an assumption that McLaurin was concerned with compensation for the specific items in the taxpayer’s claim, and the case is an authority as to when dissection or apportionment of compensation, so as to distribute it among the specific items, is appropriate.
[2.562] Dissection, it would seem, is only appropriate where the taxpayer can be said to have assented to several amounts in respect of specific items of an income character. It may be asked whether there would have been such assent in the circumstances of McLaurin if the Commissioner had written to McLaurin, after McLaurin had supplied particulars, offering to settle the case for a lump sum of £30,240, and McLaurin had accepted. And it may be asked whether there would have been such an assent if the Commissioner in making the offer of £12,350 had accompanied his offer by a statement setting out how he had arrived at the figure.
[2.563] Assuming that a dissection is not appropriate, the question becomes whether there may be an apportionment so as to bring in part of the sum received in compensation as appropriate to the items of an income character. In denying that an apportionment was proper on the facts of McLaurin the High Court said:
“While it may be appropriate to [apportion] where the … receipt is in settlement of distinct claims of which some at least are liquidated, cf. Carter v. Wadman (1946) 28 T.C. 41, or are otherwise ascertainable by calculation: cf. Tilley v. Wales [1943] A.C. 386, it cannot be appropriate where the payment or receipt is in respect of a claim or claims for unliquidated damages only and is made or accepted under a compromise which treats it as a single, undissected amount of damages” ((1961) 104 C.L.R. 381 at 391).
The passage quoted is consistent with the view that the court did not think that any dissection or apportionment was proper in McLaurin, because the whole receipt had a homogeneous character—it was compensation for a capital asset. But if it is treated, as it was treated by the High Court in Allsop, as a decision on the possibility of apportionment when the receipt is of a mixed character, the reason why an apportionment was not possible needs to be examined.
[2.564] It may be asked why the words “ascertainable by calculation” were not satisfied in McLaurin. The High Court referred, apparently without disapproval, to Carter v. Wadman where one of the claims was for a share in profits up to the time of termination of the contract—and thus of a revenue nature—and the other was for surrender of contractual rights of a capital nature. The Court of Appeal held an apportionment was proper. The calculation of the profits no doubt required valuation of the stock in trade of the hotel. And it could only be an estimate since it related to a past year, when the actual profit would be calculated for a full year.
[2.565] The High Court judgment in McLaurin (1961) 104 C.L.R. 381 leaves unanswered a number of other questions: Which claims must be liquidated or ascertainable by calculation, those of an income nature or those of a non-income nature or all of them? Is apportionment appropriate where some only of the claims of a non-income nature are liquidated or ascertainable by calculation or where some only of the claims of a non-income nature are liquidated or ascertainable by calculation? No definitive answer to these questions is afforded by the judgments in Allsop (1965) 113 C.L.R. 341. Carter v. Wadman (1946) 28 T.C. 41 would appear to require that the amount of each claim should be ascertainable by calculation. The total amount received by the taxpayer was distributed between the claims on the basis of the fraction the value of each claim was of the total value of the claims. National Mutual Life Association of Australasia Ltd (1959) 102 C.L.R. 29, decided before McLaurin, might support a requirement that the amount of each claim should be ascertainable. The Commissioner conceded in the case that a total premium paid in respect of a policy of life insurance with additional benefits in the event of disability or death by accident, could be apportioned so as to separate and exempt under s. 111 of the Assessment Act what Windeyer J. described (at 51) as “the true actuarially established premium for the life insurance element”. Other members of the court did not question the Commissioner’s concession, and Windeyer J. expressly agreed. If a premium for the life insurance element could be calculated actuarally, so could a premium for the additional element. It would then be possible to apportion the actual premium by the method in Carter v. Wadman. A view that the values of all elements must be capable of ascertainment by calculation is open within the pronouncement by the High Court quoted in [2.563] above, if emphasis is placed on the words “some, at least”.
[2.566] Allsop purports to apply McLaurin and can be explained as a decision that apportionment was not possible because the value of the claims for “interference” with the taxpayer’s business were not ascertainable by calculation.
[2.567] McLaurin and Allsop offer an encouragement to practices in the settlement of claims to compensation which the well-advised may follow in tax planning. They offer the prospect that if there can be shown to be a real claim in respect of a non-income item, the receipt in settlement of this and other claims in respect of items of an income nature may escape tax. The prospect is offered whether the items of an income nature are such by ordinary usage or by some specific provision, for example, s. 72: Allsop.
[2.568] In H. R. Sinclair & Son (1966) 114 C.L.R. 537 an assertion was made by the taxpayer that the receipt related to other claims, as well as to the claim for refund of royalties. Owen J. dismissed the assertion, saying (at 546): “The case cannot be treated as though the payment of the refund had been made in settlement of a variety of claims, some relating to the past and some to the future. In no way can it be said to resemble McLaurin’s case or Allsop’s case.” The case indicates the importance of finding and making a claim which does not relate to a revenue item, and following the form of settlement used in Allsop.
[2.569] If the taxpayer in Allsop had pressed his action to recover the fees as money had and received, and had been successful, the amount recovered would, it seems, have been income as a business gain. Sinclair is the authority, subject, however, to a reservation expressed in [2.551] above. But the form of release by which his claim was in fact resolved, covered not only his claim in respect of the fees he had paid but also “all claims for anything done in purported pursuance of the State Transport (Co-ordination) Act”. Barwick C.J. and Taylor J. found sufficient in the case stated “to enable it to be said that during the period in question there had been unlawful interferences with the appellant’s vehicles and his business operations and in respect of these matters he had valid claims” ((1965) 113 C.L.R. 341 at 351). One would have thought it was necessary to go on to consider whether an amount received in respect of these matters would be income if it stood alone. Such an amount could be characterised as compensation for profits that would have been derived (cf. Gill v. Australian Wheat Board (1981) 81 A.T.C. 4217). Barwick C.J. and Taylor J. concluded that “the amount payable was an entire sum paid by way of compromise of all these claims and no part of it can be attributed solely to a refund of the fees paid …” (at 351). But they cannot have intended to decide that an “entire sum” which relates to several items all of a revenue character, is not income, simply because no part of it can be attributed solely to a particular item.
[2.570] The principle in McLaurin and Allsop was most recently applied in National Commercial Banking Corp. of Aust. Ltd (1983) 83 A.T.C. 4715 though there is no reference to those cases in the judgments of the Federal Court. The facts of National Commercial Banking will appear from the discussion in [2.517] above. The trial judge, as his findings were interpreted by the Federal Court (at 4721), had found that it was impossible “to dissect the lump sum [received] and to apportion it among the heads to which it related”. The trial judge had also found that “it was impossible to attribute to portions of the lump sum an income or non-income nature or to determine whether or not they were in the nature of reimbursement of expenses”. It followed that the foundation of the Commissioner’s submission that the amount received was income as compensation for the outgoings incurred in building up the Bankcard scheme was destroyed. The reasoning may appear to reverse the onus the taxpayer carries under s. 190(b) of the Assessment Act. One would have thought that the onus on the taxpayer to show that the assessment was excessive, required him to show that the lump sum included an amount of a non-income nature. The taxpayer would have had the same difficulties as the Commissioner had, and he would have failed to show the assessment was excessive. The question of onus of proof was equally passed over in the judgments of the High Court in Allsop.