Re Foxwood (Tolga) Pty Limited v the Commissioner of Taxation of the Commonwealth of Australia [1980] FCA 29; (1980) 44 FLR 277 (28 March 1980)

FEDERAL COURT OF AUSTRALIA

Re: FOXWOOD (TOLGA) PTY. LIMITED
And: THE COMMISSIONER OF TAXATION FOR THE COMMONWEALTH OF AUSTRALIA
[1980] FCA 29; (1980) 44 FLR 277
No. Qld. G12 of 1978
Appeal - Income Tax

COURT

IN THE FEDERAL COURT OF AUSTRALIA
NEW SOUTH WALES DISTRICT REGISTRY
GENERAL DIVISION
Deane(1), Fisher(2) and Davies(3) JJ.

CATCHWORDS

Appeal - Deduction - Whether payment by Taxpayer to Purchaser of its business in respect of accrued entitlement of employees for long service leave and annual holiday entitlement is an outgoing of revenue - Characterization of outgoing - Liability of Taxpayer to make the payments in question - Object or advantage outgoing calculated to effect.

Income Tax Assessment Act 1936 s.51(1).

Income Tax - Allowable deduction - Sale of business on terms that taxpayer pay to purchaser a sum equivalent to its employees' accrued entitlement to long service leave and holiday pay - Whether those entitlements accrued and effect thereof - True character and effect of payments - How determined - Whether outgoings incurred in course of gaining or producing assessable income - Income Tax Assessment Act 1936 (Cth), s. 51 (1) - Industrial Conciliation and Arbitration Act 1961-1976 (Q.). The taxpayer was a subsidiary of a company, Foxwood Ltd. The taxpayer employed seventeen employees and for a fee made them available to another subsidiary of the company. Apart from these fees, the taxpayer's only income consisted of bonuses payable under workers' compensation policies and interest.

The taxpayer entered into an agreement with its parent whereby it agreed to sell "all its undertaking and business". It was a term of the agreement that the taxpayer pay to the parent an appropriate amount in respect of "accrued entitlement" of employees for long service leave and holiday and sick pay.

On appeal from a decision of the Supreme Court of Queensland disallowing the taxpayer's appeal from a disallowance by the Commissioner of its claim for an allowable deduction in respect of the payment.

Held: (1) Per Deane and Davies JJ., Fisher J. dissenting - The adjustment in respect of the liability of the taxpayer to pay holiday pay for employees was an obligation incurred in the course of gaining or producing the taxpayer's assessable income and, as such, was deductible pursuant to s. 51 (1).
(2) Per Fisher and Davies JJ., Deane J. dissenting - The adjustment in respect of the accrued long service leave entitlements of the taxpayer's employees was not an allowable deduction.

Per Deane J. - (1) The taxpayer's entitlement to the deduction falls to be determined by analysis of the object which the taxpayer had in view.

W. Nevill & Co. Ltd. v. Federal Commissioner of Taxation [1937] HCA 9; (1937), 56 CLR 290, applied.
(2) Such analysis requires the court to look at what the expenditure was calculated to effect from a practical and business point of view. Hallstroms Pty. Ltd. v. Federal Commissioner of Taxation [1946] HCA 34; (1946), 72 CLR 634; B. P. Australia Ltd. v. Federal Commissioner of Taxation, (1966) AC 224; Federal Commissioner of Taxation v. South Australian Battery Makers Pty. Ltd. (1978), 52 ALJR 640; Cliffs International Inc. v. Federal Commissioner of Taxation (1979), 53 ALJR 321, applied. In that process, the courts are constrained to look at the business and commercial substance or reality of the circumstances: B.P. Australia Ltd. v. Federal Commissioner of Taxation, (1966) AC 224; Sun Newspapers Ltd. v. Federal Commissioner of Taxation [1938] HCA 73; (1938), 61 CLR 337; Federal Commissioner of Taxation v. South Australian Battery Makers Pty. Ltd. (1978), 52 ALJR 640, followed. Europa Oil (N.Z.) Ltd. v. Inland Revenue Commissioner, (1976) 1 WLR 464, explained.
(3) If the taxpayer had continued on in business, the payments by way of holiday and long service leave so made would have been of a revenue character deductible pursuant to s. 51 (1), but that obligation would arise only when the leave was taken or the payments made.

Federal Commissioner of Taxation v. Nilsen Porcelains (Australia) Pty. Ltd. [1979] FCA 63; (1979), 41 FLR 36, referred to.
(4) The object of the payments to its parent by the taxpayer was the removal from the taxpayer of the taxpayer's obligation to employees. It was an outgoing to discharge an obligation incurred as a direct incident of employing employees and in the course of gaining or producing assessable income.

Per Davies J. (1) An apportionment should here be made as the sum to be deducted was the product of calculations with respect to its elements.

Ronpibon Tin N.L. v. Federal Commissioner of Taxation [1949] HCA 15; (1949), 78 CLR 47, applied.
(2) The loss or outgoing in respect of long service leave only arose as an obligation pursuant to the agreement between the taxpayer and its parent. That agreement was one not entered into for the purpose of gaining or producing assessable income for the taxpayer, but for the purpose of bringing its activities to an end.

Peyton v. Federal Commissioner of Taxation [1963] HCA 33; (1963), 109 CLR 315; Ronpibon Tin N.L. v. Federal Commissioner of Taxation [1949] HCA 15; (1949), 78 CLR 47; Lunney v. Federal Commissioner of Taxation [1958] HCA 5; (1958), 100 CLR 478, referred to.
(3) The provision in the agreement with respect to long service leave was no more than an adjustment made between vendor and purchaser.

Federal Commissioner of Taxation v. Morgan [1961] HCA 64; (1961), 106 CLR 517, cited.
(4) Although an adjustment made on the sale of an asset may be the subject of an allowable deduction, the subject adjustment here did not arise out of income-earning activities.
(5) In relation to holiday pay, the taxpayer incurred its liability for holiday pay when it entered into the agreement with its parent and made the payment, discharging its liabilities to its employees and, therefore, incurred the relevant obligation in the income tax year under consideration.

Per Fisher J. - (1) At the close of the financial year under consideration the taxpayer was not under a present liability to its employees to pay long service leave or holiday pay.

Industrial Conciliation and Arbitration Act 1961 (Q.); Federal Commissioner of Taxation v. Nilsen Porcelains (Australia) Pty. Ltd. [1979] FCA 63; (1979), 41 FLR 36, referred to.
(2) It must be established by the taxpayer that the expenditure is incidental and relevant to the operations regularly carried on by the taxpayer for the production of income.

Lunney v. Federal Commissioner of Taxation [1958] HCA 5; (1958), 100 CLR 478, applied.
(3) It was necessary for the court to assess the essential character of the

expenditure.

Cliffs International Inc. v. Federal Commissioner of Taxation (1979), 53 ALJR 321, applied.
(4) Although the activity which produced the obligation was the employment of a workforce, the circumstances in which the payment was made did not arise in the course of operations directed to production of assessable income but rather the ceasing of that manner of production. Peyton v. Federal Commissioner of Taxation [1963] HCA 33; (1963), 109 CLR 315, applied. Further, the liability was merely contingent; the taxpayer did not pay those amounts to those entitled; and the payments could be viewed as a set-off against an agreed purchase price.
(5) The payments so made by the taxpayer were not made in respect of an expense incurred in the business operations of the taxpayer, but as a term imposed by a purchaser and should properly be characterized as an adjustment to purchase price upon settlement of sale and, thus, upon capital account.

HEARING

Sydney, 1979, June 14-15; 1980, March 28. 28:3:1980
APPEAL.

The facts appear from the judgment of Davies J.

C. V. Cullinan and G. T. Forster (solicitors), for the appellant.

C. W. Pincus Q.C. and I. Diehm, for the respondent.

Solicitors for the appellant: MacDonnells.

Solicitor for the respondent: B. J. O'Donovan (Commonwealth Crown

Solicitor).

SUSAN KIEFEL

ORDER

The order of the Supreme Court of Queensland is set aside and in lieu thereof THE COURT ORDERS:

1. THAT the Appeal be allowed in relation to the Appellant's claim to deduct from its assessable income for the year ended 30 June 1976 the sum of $5,984 being that part of the payment on 30 June, 1976 which related to holiday pay and that the Taxpayer's assessment in respect of that amount be remitted to the Respondent Commissioner to be amended by allowing a deduction in that amount.

2. THAT the Respondent pay the Appellant one half of its costs of the appeal and of the proceedings in the Supreme Court of Queensland.

DECISION

This is an appeal from a decision of the Supreme Court of Queensland upholding the disallowance by the respondent Commissioner of Taxation of a deduction claimed by the appellant Foxwood (Tolga) Pty. Limited ("the taxpayer") in the assessment of its taxable income for the year ended 30 June, 1976.

The taxpayer was, at relevant times, a subsidiary of Foxwood Limited ("Foxwood"). During the tax year, the taxpayer employed a work-force of some 17 employees. For a fee, it made the services of these employees available to Foxwood (Mareeba) Pty. Limited which was also a subsidiary of Foxwood and which carried on a sawmilling operation at Mareeba in northern Queensland. Apart from the fees received from Foxwood (Mareeba) Pty. Limited, the taxpayer's only income consisted of bonuses payable under worker's compensation policies and interest on moneys owing to it.

On 29 June, 1976, the taxpayer entered into an agreement with Foxwood whereby it agreed to sell to Foxwood, with effect from 30 June, 1976 and subject to an irrelevant exception of any shares in related companies, all its undertaking and business. The agreement provided, in effect, that the purchase price of plant would be the depreciated value for income tax purposes at 30 June, 1976 as determined by Messrs. C.E. Smith & Co., and that the purchase price of the balance of the business and undertaking would be "as determined" by that firm. Clauses 24 and 25 of the agreement provided:

"24. The Purchaser shall take over and assume the whole of the liabilities of the vendor as at 30th June, 1976 and indemnify and save harmless the Vendor from and against the same.

25. The Purchaser shall take over all the Vendor's employees in the Vendor's business on the 30th June, 1976 and on and from that date the Purchaser shall be liable to make holiday, sick leave and long service leave payments accruing or owing before or after that date provided that the Vendor shall pay to the Purchaser on the 30th June, 1976 an appropriate amount as shall be determined by C.E. Smith & Co. as the employees' accrued entitlement for long service leave and holiday sick pay".

The evidence does not disclose what, if any, price was determined by Messrs. C.E. Smith & Co., who were at the time the Foxwood Groups accountants, as the purchase price either for plant or for the balance of the business and undertaking. It does however disclose that Messrs. C.E. Smith & Co., determined that the appropriate amount to be paid by the taxpayer to Foxwood in respect of "accrued entitlement" of employees "for long service leave and holiday and sick pay" was $11,658.78. This amount was paid by the taxpayer to Foxwood on 30 June, 1976. The taxpayer claimed, and the Commissioner disallowed, $8,897.00 thereof as a deduction in the determination of the taxpayer's income for the tax year. The amount so claimed and disallowed represented the total of the amounts which the taxpayer would have been obliged to pay to employees in respect of long service leave ($2,913) and annual holiday ($5984) entitlement if their employment had simply terminated on 30 June, 1976. The issue between the taxpayer and the respondent Commissioner of Taxation concerns the taxpayer's entitlement to the benefit of that claimed deduction. That entitlement is governed by the provisions of s.51(1) of the Income Tax Assessment Act, 1936, and depends upon whether the relevant part of the overall payment was, for the purposes of that sub-section, an outgoing which was incurred in gaining or producing assessable income or which was necessarily incurred in carrying on a business for the purpose of gaining or producing such income and which, in either case, was not an outgoing of capital.

It is apparent from the evidence that all concerned acted on the basis that the taxpayer's employees were "taken over" by Foxwood on 30 June, 1976 and that the "taking over" of the employees did not interrupt their continuity of service for the purposes of long service leave and annual holiday entitlement. This assumed situation differed from the strict juristic position in two significant respects. The first was that the employees' employment with the taxpayer in fact continued beyond 30 June, 1976. The evidence indicates that the employees were first told of the change of employer when they received a notice advising them of it in their pay packets on 9 July, 1976 and it is difficult to see how their employment with the taxpayer could have ceased and their employment with Foxwood could have commenced before that date. The second was that while the statutory provisions regulating the employees' entitlement to long service leave provided for continuity of service in a case where "the calling carried on by a person who is an employer" was "transmitted to another person" (Industrial Conciliation & Arbitration Act (Qld) 1961, s.17(16)(a)), the Awards which regulated their entitlement to annual holidays contained no such provision. When the employees ceased to be employed by the taxpayer, the taxpayer was, under the terms of those Awards, obliged to pay to them the full amount of their accrued entitlement in respect of annual holidays. Notwithstanding these differences, the plain facts remain that the services of the employees were, for all relevant purposes, treated as having been transferred to Foxwood on 30 June, 1976 and that, for all practical purposes, Foxwood assumed, and the taxpayer was relieved of, any burden in respect of long service leave and annual holidays arising by reference to service of employees either before or after the commencement of that day. The employees for their part would appear to have accepted without question the position as seen by the taxpayer and Foxwood. Whatever may have been the correct position on juristic analysis, they apparently accepted assurances given to them on 9 July, 1976 that the change in the identity of their employer had occurred on 30 June, 1976 and that that change did not affect their continuity of service as regards either annual holidays or long service leave.

The taxpayer's entitlement to the claimed deduction falls to be determined by analysis of the object which the taxpayer, as the person making the expenditure, had in view (W. Neville & Co. Ltd. v. Federal Commissioner of Taxation [1937] HCA 9; (1937) 56 C.L.R. 290 at 301). At the heart of that analysis lies the identification of what the expenditure was "calculated to effect from a practical and business point of view, rather than . . . the juristic classification of the legal rights, if any, secured, employed or exhausted in the process" (per Dixon C.J., Hallstrom Pty. Limited v. Federal Commissioner of Taxation [1946] HCA 34; (1946) 72 C.L.R. 634 at p. 648; B.P. Australia Limited v. Federal Commissioner of Taxation (1966) A.C. 224 at p. 264; Federal Commissioner of Taxation v. South Australian Battery Makers Pty. Ltd. (1978) 78 A.T.C. 4412 at pp. 4419, 4420-1, 4424, 4427; Cliffs International Inc. v. Federal Commissioner of Taxation (1979) A.T.C. 4059 at pp. 4069, 4076, 4077 and 4078). This is not to say that the identification or juristic classification of precise legal rights will not be relevant to the determination of the question whether a particular payment satisfies the requisite description or, in a case where precise legal rights are all that were sought and obtained, conceivably conclusive of it. What the quotation recognizes is that it has long been accepted in this country that the courts in characterizing outgoings in fact incurred in a business or commercial context are both entitled and constrained to look at the business and commercial substance or reality of "the whole set of circumstances, some of which may point in one direction, some in the other" (B.P. Australia v. Federal Commissioner of Taxation supra, at p. 264 and see generally per Dixon J., Sun Newspapers Ltd. v. Federal Commissioner of Taxation [1938] HCA 73; (1938) 61 C.L.R. 337 at p.361ff. and per Gibbs A.C.J., Federal Commissioner of Taxation v. South Australian Battery Makers Pty. Ltd., supra at pp. 4416-4420). In this regard, I do not consider that anything in the judgment of the Judicial Committee of the Privy Council in Europa Oil (N.Z.) Limited (No. 2) v. Commissioner of Inland Revenue (N.Z.) (1976) 1 W.L.R. 464) is, when properly understood in context, either contrary to what has been said above or authority for the general approach that, for the purposes of the New Zealand Act under consideration in that case, the character of an outgoing must be determined by having regard only to the contractual or other legal rights that the taxpayer acquired in return for it. If I be in error in that regard, that general approach would, in my respectful view, be contrary to what has been long established by decisions of the High Court as appropriate to the Australian Act and should not be followed by this Court.

The relevant payment in the present case was made and accepted on the three-fold basis that the change in employer would take effect on 30 June, 1976, that there would be continuity of service for the purposes of both long service leave and annual holiday entitlement and that the taxpayer would be effectively relieved of the burden of any obligation to its employees on account of long service leave or annual holidays by reference either to service prior to that time or to subsequent service. All parties concerned plainly acted on that basis and, indeed, it has not been suggested that there was ever any real doubt that the calculated removal of that burden from the taxpayer would, from a practical or business point of view, be achieved. The employees' wages were paid by the taxpayer for the period up to 30 June, 1976 and by Foxwood for the period from 1 July, 1976. The employees presumably were granted, and for their part accepted, in due course, the annual holidays to which they were entitled on the assumed basis of continuity of service. There is no suggestion either that the payment itself was a sham or that the mistaken basis upon which the taxpayer, Foxwood and the employees acted was other than the result of a genuine failure to appreciate the strict legal consequences and implications of the taxpayer's actions. In the circumstances, the taxpayer's entitlement to the benefit of the claimed deduction falls to be determined rather by reference to the calculated purpose and effect which were, for all practical purposes, realized than by reference to juristic rights and liabilities which were neither perceived to exist nor, in the event, observed.

In the view I take, there are two competiting characterizations of the relevant outgoing in the present case. One of these characterizations leads to the rejection of the claimed deduction. The other leads, ultimately, to its allowance. I am unable to find any compelling reason in either logic or "commonsense" (B.P. Australia Ltd. v. Federal Commissioner of Taxation, ibid) for preferring one characterization to the other. Indeed, resort to declamations of "commonsense" would, in the present case, achieve little more than to provide a rhetorical camouflage for the fact that what is involved is essentially an eclectic process.

The first arguable characterization of the outgoing is as an adjustment of purchase price on the sale of the taxpayer's business and undertaking. The transfer of employees was an incident of the sale of the business. On the basis of what was assumed by both the taxpayer and the purchaser, it was a disadvantage of the business and undertaking which was acquired by the purchaser that wages would need to be paid to employees during future periods of annual leave and long service leave in respect of service prior to the date of the purchase or that payments in lieu of such leave would need to be made in the event of the termination of employment before leave was actually taken. On this approach, the outgoing represented a diminution of the purchase price as a result of that inherent disadvantage or detriment in what was sold. So viewed in isolation, the payment does not exhibit the character of having been incurred in gaining or producing assessable income or as necessarily incurred in carrying on a business for the purpose of gaining or producing such income but exhibits the character of an outgoing incurred in parting with the means of earning assessable income or in disposing of the business and ceasing thereby to gain or produce such income (see Peyton v. Federal Commissioner of Taxation [1963] HCA 33; (1963) 109 C.L.R. 315 at pp. 320-321). Moreover, when viewed in isolation as an adjustment of purchase price on the disposition of the business, it exhibits the character of a capital, and not a revenue, outgoing.

While I can see considerable force in the argument that the relevant characterization of the outgoing is as an adjustment on the sale of the income-producing business, I have ultimately come to the conclusion that it should not be accepted. The fact that the payment may, for some purposes, be so characterized is not, in the view I take, the end of the matter (see Federal Commissioner of Taxation v. Morgan [1961] HCA 64; (1961) 106 C.L.R. 517 at p. 520ff; The Herald and Weekly Times Ltd. v. Federal Commissioner of Taxation [1932] HCA 56; (1932) 48 C.L.R. 113 at p. 118). The object or advantage which the outgoing was calculted to effect can and should be more precisely defined. That object or advantage was the removal from the taxpayer to the purchaser of the burden of the taxpayer's obligations to employees in respect of annual and long service leave on account of past periods of service. This more precise definition is supported by the manner of calculation of the amount of the outgoing, by the express words of clause 25 of the agreement which imposes the obligation to make the relevant payment as a proviso to the taking over by the purchaser of the liability to make the payments and by the overall commercial or business context in which the outgoing was incurred. From a practical or business point of view, the payment achieved the object or advantage as more precisely defined.

As at 30 June, 1976, the taxpayer's primary obligation to its employees in respect of long service leave and annual holidays was to excuse them from attendance at work during future periods of annual and long service leave while continuing to pay their wages. If the taxpayer had continued to carry on business and employ its employees, it would not have been entitled to a deduction as at 30 June, 1976 in respect of that obligation to its employees: it would have been entitled to a deduction at the time when the leave was taken and the wages paid or at the time when a payment in lieu of leave was made on the premature termination of employment (Federal Commissioner of Taxation v. Nilsen Development Laboratories Pty. Limited (1979) A.T.C. 4520). It had however become antecedently clear that, apart from the contingency of some extraordinary arrangement or circumstances removing the burden of payment from the taxpayer to another, the taxpayer would at some stage be required to make payments of the relevant amount in respect of annual and long service leave on account of past periods of service. That obligation was, from the practical and commercial point of view, real and not illusory notwithstanding the fact that the actual obligation to make the payment was future and, at least in the case of long service leave, contingent. It arose from the past employment of the taxpayer's employees. It was incurred in gaining or producing assessable income. The discharge of that obligation by payment of wages in the ordinary course to employees when leave was taken or payment in lieu of such leave on premature termination of their employment would, if the taxpayer had continued to carry on its business, plainly have been an outgoing of a revenue character deductible pursuant to the provisions of s.51(1) of the Act. If it had been lawfully permissible so to do, the discharge of the obligation by payment of an agreed amount to the employees on 30 June, 1976 would likewise have been so deductible. (Compare the amounts paid by way of settlement which were held to be deductible in The Herald and Weekly Times Ltd. v. Federal Commissioner of Taxation, supra). The question which arises is whether the payment made on that day by the taxpayer to the purchaser of its business to secure, from a practical and commercial point of view, a discharge from the obligation was likewise an outgoing of revenue deductible pursuant to s.51(1). In my view, it was.

When, as in the present case, a taxpayer's accounts are on an accruals basis, the appropriate time at which a deduction should be allowed will ordinarily be the time when the absolute liability to make a payment arises. Where, however, a payment is made in advance of any absolute liability arising, the circumstances of the particular case will determine whether the payment should be regarded as a mere prepayment pending the relevant absolute liability arising or whether the payment itself was, from a practical and business point of view, calculated to extinguish a real, albeit future or contingent, liability or obligation and should itself be regarded as the relevant outgoing for the purposes of s.51(1) of the Act. Once the outgoing in the present matter is accepted as having been calculated to effect, from a practical and business point of view, a transfer of the obligation in respect of future payments on account of annual and long service leave and as, indeed, having that practical commercial effect, it partakes of the same character as would a payment to the employees direct - if that were lawfully permissible - to achieve a discharge of the obligation. It was an outgoing to discharge or escape from an obligation incurred as a direct incident of employing employees in the course of gaining or producing assessable income. It was, an outgoing of revenue which was deductible pursuant to s.51(1) of the Act.

I would allow the appeal and order that the assessment be remitted to the respondent Commissioner to be amended by allowing a deduction in the amount of $8897.00. I would order that the respondent Commissioner pay the appellant's costs both of this appeal and in the Supreme Court of Queensland.

This is an appeal by Foxwood (Tolga) Pty. Limited ("the taxpayer") from a decision of the Supreme Court of Queensland dismissing an appeal by the taxpayer against an income tax assessment issued by the respondent the Commissioner of Taxation ("the Commissioner") for the year of income ended 30 June 1976 ("the tax year"). In issue between the taxpayer and the Commissioner is the taxpayer's entitlement to the benefit of a deduction of two sums totalling $8,897.00. These sums were paid in the tax year by the taxpayer to Foxwood Limited and are said to represent the legal entitlement of the employees of the taxpayer to long service leave and holiday pay. The payments were made by the taxpayer in the following circumstances. concerning which there is no dispute except on the topic of the date of the alleged termination by the taxpayer of the services of those employees.

Foxwood Limited is the holding company of a group of companies, of which the taxpayer is one. The group carried on business of, inter alia, saw millers in North Queensland. During the tax year Foxwood (Mareeba) Pty. Ltd. actually operated the saw mill and the taxpayer was the employer of a work force of employees which comprised the majority of the persons working the saw mill. Apart from receiving a fee for the provision of that work force to Foxwood (Mareeba) Pty. Ltd., the only assessable income for the year of income of the taxpayer comprised bonuses payable under Workers' Compensation policies and interest on inter-company loans. Essentially the work force of the taxpayer was its income earning asset, which asset Foxwood Limited purported to acquire, in circumstances which follow, in the tax year.

During the tax year a decision appears to have been made within the group that the holding company Foxwood Limited would take over the saw mill from Foxwood (Mareeba) Pty. Ltd., and the employment of the work force from the taxpayer. To this end the taxpayer sold to Foxwood Limited (hereinafter called "the purchaser") on 30 June 1976 what was described as its "undertaking and its businesses" excluding any shares in related companies, which sale was evidenced by an agreement for sale and purchase dated 29 June 1976. It suffices at this stage to say that by the agreement it was arranged that the purchaser would "take over" all the taxpayer's employees, in respect of whom the purchaser would be liable thereafter for holiday, sick leave and long service leave payments, but that the taxpayer would pay on 30 June 1976 to the purchaser the appropriate amount for the employees' "accrued entitlement for long service leave, holiday and sick pay". This amount was, in accordance with the terms of the agreement, determined by Messrs C.E. Smith & Co, the then accountants for the group to amount to $11,658.78 and was duly paid by the taxpayer on 30 June 1976 to the purchaser. The taxpayer claims that portion of this sum, namely $8,897, is deductible pursuant to the provisions of s.51(1) of the Income Tax Assessment Act 1936 ("the Act"). The Commissioner disputes this claim.

The sum of $8,897 relates to the alleged entitlement as at 30 June 1976 of the employees of the taxpayer to long service leave and holiday pay. The former entitlement was assessed at $2,913.00 and the latter at $5,984.00 and no claim was made in respect of sick leave. These figures are not in dispute.

Before dealing with the legislation and the awards by virtue of which the alleged entitlements arose, it is convenient to refer to the terms of the agreement dated 29 June 1976. It is not unfair to say that its terminology is neither exact, nor certain in meaning. The agreement insofar as relevant recited at the outset that the taxpayer agreed to sell, with effect from 30 June 1976, all "the undertaking and the businesses of the vendor (excluding any shares in related companies)". As such it would be reasonable to assume that the purchaser was acquiring the benefit of all of the assets of the business of the taxpayer, subject to accepting the burden of its liabilities. The price for what might be generally described as "plant" was to be the value as determined by Messrs C.E. Smith & Co as the depreciated value for income tax purposes, and the price of the balance of the undertaking and business, a price again to be determined by Messrs C.E. Smith & Co. These prices "less the liability of the Vendor assumed by the Purchaser and any moneys owing by the Vendor to the Purchaser" were payable within 24 hours of demand. Consistent with the assumption abovementioned in respect of the benefits and the burdens of the business, there was express provision (clause 24) to the effect that the purchaser would take over the whole of the liabilities of the taxpayer as at 30 June 1976, and would indemnify the taxpayer in respect of the same. However, notwithstanding these general provisions dealing with assets and liabilities and the manner of determining the price to be paid for the business, the agreement concluded (clause 25) with a provision dealing specifically with the employees of the taxpayer and their accrued entitlements to long service leave, holiday and sick pay at 30 June 1976. The full terms of that clause are as follows:

"25. The Purchaser shall take over all the Vendor's employees employed in the Vendor's business on the 30th June 1976 and on and from that date the Purchaser shall be liable to make holiday, sick leave and long service leave payments accruing or owing before or after that date provided that the Vendor shall pay to the Purchaser on the 30th June 1976 an appropriate amount as shall be determined by C.E. Smith & Co as the employees' accrued entitlement for long service leave and holiday and sick pay."

It appears to me that this clause contemplates three significant matters. First, specific recognition of the fact that the purchaser desired to employ directly, as from 30 June 1976, the work force of the taxpayer, the services of which the taxpayer had heretofore made available for a fee to Foxwood (Mareeba) Pty. Ltd. Second, the taxpayer was to be relieved from liability in respect of payments to be made thereafter to the employees in respect of holiday, sick leave and long service leave, whether the obligation to make such payments accrued prior or subsequent to 30 June 1976. Finally, this relief from liability was subject to the taxpayer paying to the purchaser on 30 June 1976 an amount determined by Messrs C.E. Smith & Co, as "the employees' accrued entitlement for long service leave, and holiday and sick pay". Thus the taxpayer was obliged to make a cash payment to the purchaser on 30 June 1976 and the purchaser assumed the liability to make all subsequent payments in respect of these items to the employees.

These express provisions of clause 25 make it possible to understand clause 2(a) which was in the following terms:

"2(a). The said prices less the liability of the Vendor assumed by the Purchaser and any moneys owing by the Vendor to the Purchaser shall be due and payable within twenty four (24) hours of demand."

It is apparent that "the said prices" referred to the prices to be determined in accordance with the schedule by Messrs C.E. Smith & Co, in respect of plant and "the balance of the undertaking and business". These prices were by clause 2(a) to be reduced by "the liability of the Vendor assumed by the Purchaser", which referred either to the whole of the liabilities of the vendor assumed by the purchaser pursuant to clause 24 or the liability of the vendor in respect of "the employees' accrued entitlement for long service leave, holiday and sick pay" referred to in clause 25 as accruing or owing at 30 June 1976. The reference in clause 2(a) to any moneys owing by the vendor to the purchaser can on my reading of the agreement only refer to the moneys payable by the taxpayer under clause 25 being the appropriate amount determined by Messrs C.E. Smith & Co as the employees' accrued entitlements to long service leave, holiday and sick pay. Whichever way one looks at it, the employees' alleged entitlement for the various forms of pay was seen as an amount by which to adjust the price. It was a component part of "the prices payable in respect of the property hereby agreed to be sold and purchased" (clause 2) and was taken into account in determining the monies payable by the purchaser under the agreement. In respect of any amount payable by the taxpayer on this score, such amount was payable on 30 June 1976, notwithstanding that the balance purchase price was payable to the taxpayer within twenty four hours of demand.

The agreement refers to the employees' accrued entitlement for long service leave and holiday and sick pay. Any entitlement to sick pay was of no significance in the proceedings in that no deduction was claimed for the amount, if any, paid by the taxpayer on this account. The entitlement of the employees to long service leave and annual or holiday leave was governed by provisions of the Industrial Conciliation and Arbitration Act 1961 (Queensland) and relevant awards. These provisions are set out in the reasons for judgment of the learned trial judge and need not be repeated. They do not differ greatly from the corresponding provisions considered by this Court in Federal Commissioner of Taxation v Nilsen Development Laboratories Pty. Ltd. 1979 A.T.C. 4520. Essentially in respect of long service leave the employee is entitled by virtue of his award to thirteen weeks leave on full pay after 15 years continuous service, and a proportionate amount after 10 years continuous service if such service was terminated by the employee or by the employer otherwise than for serious misconduct, or the death of the employee. Somewhat similar provisions apply to service after completition of the initial period of fifteen years. By two sub-sections of the Industrial Conciliation and Arbitration Act (sub-sections 17 (7) (b) and 17 (16)) if the services of an employee are transferred by one employer to a second employer or the calling of the first employer is "transmitted" whether by operation of law or agreement to a second employer, the service of the employee with the two employers is deemed to be continuous. Ultimately more detailed consideration will be required to be given to these provisions, which hereafter I shall refer to as "the transmission provisions".

Entitlement for holiday leave is also provided for by the combined effect of the Industrial Conciliation and Arbitration Act (s.15) and the relevant award. Employees are entitled to four weeks' holiday leave on full pay, and to be paid for that leave or a proportionate amount if employment is terminated. There are no provisions which correspond to the transmission provisions in respect of long service leave.

At 30 June 1976 the taxpayer had seventeen employees in respect of all of whom the taxpayer paid the amount of their "entitlement" to holiday leave to the purchaser. However only one of these employees had become entitled to take his annual holiday as at 30 June 1976, the remainder not having served the qualifying period since last taking leave, thus becoming entitled during the succeeding year of income. The amount paid to the purchaser was calculated on the basis of the amount which would have been payable under the award to the employees if their services had been terminated by the taxpayer on 30 June 1976.

On that date a payment was made by the taxpayer to the purchaser in respect of the long service leave "entitlement" of two employees, and the amount of the payment was calculated on the basis of the amount payable to them if their services had then been terminated. None of the other fifteen employees had served the taxpayer or its predecessors for the necessary qualifying period of ten years and no portion of the payment was attributed to them. It is pertinent to note that of the two employees who were accepted as having an "entitlement", the service of one comprised in part "deemed continuous service" with Foxwood (Mareeba) Pty. Ltd., and the other employee had had "deemed continuous service" with a firm Lawson & Son and then with Foxwood (Mareeba) Pty. Ltd.

The taxpayer claimed to deduct the amount of these two payments pursuant to the provisions of s.51(1) of the Act as outgoings "incurred in gaining or producing assessable income" or "necessarily incurred in carrying on a business for the purpose of gaining or producing such income". In the argument before us counsel did not distinguish, and there was in my view no need to distinguish, between these two limbs of s.51(1). Moreover the claim was essentially based on the making of the payments, and not on the existence of a liability or the making of a provision. This matter therefore differs on its facts from those considered by this court in Nilsen's case supra, where the contest centred around the entitlement of the taxpayer to deduct a liability in respect of which the taxpayer had made provision in its accounts. Another significant difference was that in Nilsen's case the liability of the taxpayer in circumstances where the services of the employees might have been terminated was not under consideration. However the decision of the court was that a deduction under s.51(1) was not available until such time as a payment was made to an employee when he took his leave or his services were terminated. The majority of the court was of opinion that at no stage prior to payment consequent upon taking of leave or termination of services was the taxpayer under such a present liability to pay as would entitle it to a deduction on the basis of an "outgoing incurred".

Applying the reasoning of Nilsen's case supra, to the facts of this matter, the taxpayer was not at 30 June 1976 under a present liability in respect of the long service leave and holiday pay "entitlements" of its employees. It was contingently obliged to make payment in the succeeding year to such of them as took annual holidays or long service leave whilst in its employment. Likewise it was obliged to make payment to any employees whose services were terminated on that date or during the ensuing year. However it was not until this contingent liability crystallized into an actual liability by virtue of a payment to the employee on termination of his services or upon his taking his leave that the taxpayer would be entitled to the benefit of a deduction under s.51(1) of the Act on the basis that it had "incurred a loss or outgoing".

It seems to me that the claim of the taxpayer to a deduction must be considered under two separate heads. First, the question arises whether, if the contingent liability to pay for holiday leave and annual leave had crystallized by termination on 30 June 1976 into an actual liability in respect of one or both forms of leave, such liability was discharged by the payments to the purchaser. To the extent that the taxpayer was under no present liability, consideration must also be given to the question whether the making of the payments to the purchaser in consideration of the latter undertaking to make payments to employees as and when they fell due in the future, amounted to the incurring of an outgoing for the purposes of s.51(1).

It is necessary to deal, on the question of possible termination of services, with each form of leave entitlement. If however the conclusion is that employees' services were "terminated" in the requisite sense, then I am of opinion that such termination occurred prior to 30 June 1976. The termination of such services by the taxpayer was qua the employees a unilateral act on the part of the taxpayer performed in conjunction with the purchaser when the latter agreed to re-employ them. Admittedly, the employees' express or implied consent was necessary and they were entitled to object, but they did not do so. Subject to the rights of employees to assert impropriety on the part of the taxpayer, I am of opinion that they ceased to be employed by the taxpayer on 30 June 1976, and became employees of the purchaser on 1 July 1976. In fact all employees acquiesced in the arrangements.

The provisions in the award covering long service leave deal with the concept of transmission of a business and of the employees of the business to a new employer with no loss of continuity of service. Admittedly employees would be entitled to refuse to be transmitted, in which case they would opt for termination. Even though strictly "transmission" connotes termination of employment by one employer and re-employment by another, in my view the services of an employee who does not object to transmission have not been "terminated" in the sense in which that word is used in the relevant Act as incorporated in the award. In these circumstances the taxpayer was not at 30 June 1976 under a present liability to make a payment to any of its employees in respect of an entitlement to long service leave.

The position is more difficult in respect of holiday leave, for there are no provisions concerning transmission of a business or an employee to a third party. There are for consideration the provisions of three awards each covering one or more of the employees. However they are not dissimilar in their terminology. Technically, it is doubtless correct to say that the services of each employee were "terminated" and there was thus an obligation on the taxpayer to make payment forthwith to each employee of his entitlement to four weeks or less annual leave. No employee was in fact paid, and all employees acquiesced when they became aware, at the latest on 9 July 1976, of their change of employer. Yet in truth it was virtually only a change in name, for the new employer was the holding company for the taxpayer, with only a minor difference in name, and the company to whom they had in fact been providing their services in consequence of the arrangements within the group had a name only slightly different. A further possible consideration is that, if the services of employees had been terminated, each would have become entitled to a certain payment. However with the implied consent or acquiescense of each employee, his due amount was paid to the purchaser. The question arises whether each employee is deemed to have derived his entitlement as assessable income by virtue of s.19 of the Act. All of these matters confirm my view that in the circumstances of this matter there had not been a "termination" by the taxpayer of the services of its employees in the sense in which that word is used in the relevant awards as entitling employees to receive payments and obliging the taxpayer to make such payments. This was almost certainly the understanding of the employees.

It follows that in my opinion the obligation of the taxpayer at 30 June 1976 was not a present obligation to make a pecuniary payment to each of its employees in respect of their entitlement at that date to long service leave or holiday leave. The position therefore is that in respect of each employee the taxpayer had a liability in the process of accrual, which liability it purported to discharge by making payment to the purchaser. The purchaser for its part agreed to indemnify and save harmless the taxpayer in respect of this liability. The question might in other circumstances arise, whether in any way the taxpayer remained liable to the employees if the purchaser failed to make payments to them or any of them at the appropriate time. If employees have lost their rights against the taxpayer, for example in consequence of the transmission provisions, a fact which seems to be contemplated by the Industrial Conciliation and Arbitration Act, it must surely be in consequence of employees having acquiesced in the transmission and as a result of such acquiescence having relinquished their rights against the taxpayer in exchange for rights against the purchaser. Fortunately this problem does not arise for consideration, though it is significant on the question whether the consequence of the payment to the purchaser was that the taxpayer discharged its liability to the employees. For my part I am not satisfied that it did, particularly in respect of holiday leave. Moreover I believe a court would strain to uphold an employee's claim against the taxpayer which transmitted its business and its employees to a related company if the latter company failed to meet its obligations to employees in respect of entitlements accrued during service with the taxpayer.

Upon my analysis of the matter, the position at 30 June 1976 was that the taxpayer was under an obligation to make payments to its employees at the time when each employee took his entitlement of leave. The obligation had not accrued at 30 June 1976, and its ultimate accrual was postponed to the time of making payment. By agreement with the purchaser of its business the taxpayer purported to have the former accept its liability at 30 June 1976 in this regard, and the consideration for the acceptance by the purchaser of the liability was the payment of a sum of money. It is not disputed that the liability arose out of the employment by the taxpayer in preceding years of its work force, which was essential to its earning of assessable income. Likewise it is not disputed that the amount paid to the purchaser was calculated as the sum of the amounts payable to the employees at 30 June 1976 if they became entitled to be paid on that date. The question for determination is whether the making of this payment entitled the taxpayer to a deduction under s.51(1) as an outgoing "incurred in gaining or producing" its assessable income or "as necessarily incurred in carrying on a business for the purpose of gaining or producing such income".

The tests for determining whether a payment qualifies as an allowable deduction under the section have been variously stated. The legislation requires that it be incurred in the gaining or production of assessable income or in the carrying on of a business directed to that end. Moreover it must be made on revenue and not capital account. According to the authorities it must be established that the expenditure is incidental and relevant to the operations regularly carried on by the taxpayer for the production of income: Lunney v Commissioner of Taxation [1958] HCA 5; (1958) 100 C.L.R. 478 at p.496 per Williams Kitto & Taylor JJ.). Assuming the payment qualifies in this regard, it is necessary to assess the essential character of the expenditure i.e. to determine what is its place in the entirety of operations of the taxpayer. An essential characteristic of a payment is its object, what it is calculated to effect or achieve from a practical or business point of view: Cliffs International v Commissioner of Taxation (1979) A.T.C. 4059 at p.4066 per Gibbs J.

It seems to me that the payment has the following exceptional features, to which to my mind significance must be attached for the purpose of assisting to make the appropriate determination.

(a) It had relevance to the income producing operations of the taxpayer to the extent that the activity which produced the obligation was the employment in past years of the work force. An inevitable feature of the engagement of a work force, and, in the present instance, the making available of its services to a third party, was the obligation of the taxpayer to comply with the provisions of the Industrial Conciliation and Arbitration Act and relevant awards. This entails making payments at the appropriate times to employees in respect of periods when they are not working.

(b) The obligation was not a present obligation or liability to pay money to its work force, but a liability, which probably but not necessarily would be discharged in part sometime in the succeeding year of income. It could be said that it was a liability which had contingently but not actually accrued.

(c) In so far as the taxpayer contemplated that it was relieving itself of the liability, it did not make payment to those whose entitlement was the foundation of the obligation. It could not be said with certainty that the payment discharged the liability. Circumstances can be foreshadowed in which notwithstanding the payment to the purchaser, the taxpayer might be compelled to make additional payments, this time to the employees or one or more of them.

(d) The circumstances in which the payment was made did not arise in the course of operations directed to the production of assessable income. Rather the taxpayer had decided to cease production of assessable income, or perhaps more correctly to cease production of assessable income by the hiring out of its work force. Thus the occasion which made the payment appropriate was the ceasing of this manner of production of assessable income and the disposal of its work force, Peyton v Federal Commissioner of Taxation [1963] HCA 33; (1963) 109 C.L.R. 315 at pp. 320-321. This I see as a very significant feature.

(e) An essential element in the disposal of its work force was the burden necessarily to be assumed by the purchaser in consequence of the number of years service of the employees with the taxpayer which was productive of entitlements to periods of pay without work. The payment would appear to be directly related to an understandable requirement of the purchaser that the taxpayer accept this obligation in so far as it arose prior to the date of acquisition and make an appropriate payment to the purchaser. Alternatively, and, one would be entitled to think, more usually, there would be a set-off of the amount of this entitlement against the agreed purchase price for the purpose of determining the actual amount payable on settlement.

(f) As I read the terms of the agreement for sale and purchase this set-off was in substance what was agreed. However the form of the arrangement was that after arriving at the price to be paid for the business or undertaking (which would be the value of the business assets less the liabilities) the assessed amount of a particular liability was extracted. This extracted amount was subjected to separate treatment in that it was paid in cash, and the balance of the purchase price was payable not in cash but on demand.

In my opinion the crucial factors are that in respect of a liability not yet due, a payment was made on the occasion and as a term of the disposal of the business undertaking which payment was made to a person other than the person to whom the taxpayer was contingently liable and in circumstances where the payment did not have the consequence of discharging the liability. I see the payment as made not in respect of an expense incurred in the business operations of the taxpayer and in discharge of that expense but as a term imposed by the purchaser as a condition of its acquisition from the taxpayer of the assets of its business and in particular its income producing asset, namely its work force.

In these circumstances it is in my view not correct to regard the sum in question as incurred in carrying on the taxpayer's business. It should be characterised as an adjustment to purchase price upon settlement of the sale of the taxpayer's business and thus was on capital account.

In my opinion the appeal should be dismissed with costs.

This is an appeal from a decision of the Supreme Court of Queensland which disallowed an appeal from a decision of the Deputy Commissioner of Taxation upon the appellant's objection dated 3 March 1978 against an assessment dated 22 March 1977 to income tax based on income derived by it during the year ended 30 June 1976. In the subject year of income, the appellant, Foxwood (Tolga) Pty. Limited, was one of the Foxwood group of companies. Its activity was to employ the employees who worked at the group's Mareeba mill and to pay their salaries. The appellant was remunerated by a service fee and also derived workers' compensation bonuses. Towards the end of the subject year, the financial year ended 30 June 1976, a decision was made by the Foxwood directors to phase out the subsidiary companies of the group and, from the end of the year, to carry on business through the holding company, Foxwood Limited. Pursuant to a resolution of directors, a written agreement dated 29 June 1976, was executed whereby Foxwood (Tolga) Pty. Limited sold to Foxwood Limited, with effect from 30 June 1976, ". . . all that the undertaking and businesses of the Vendor (excluding any shares in related companies) including but not limited to those assets referred to in the Schedule hereto". The agreement provided that the prices payable for the property agreed to be sold would be ascertained in the manner provided in the schedule. The schedule referred to mobile and other plant but the evidence given to the learned trial judge suggested that there was no plant to transfer. The schedule also referred to, "The whole of the balance of the undertaking and business of the Vendor including therein but not limited to Stock-in-Trade, Debts, amounts recoverable from related companies and investments for prices determined by C.E. Smith & Co." Apart from an inter-company loan of $263,744, perhaps nothing tangible was available for transfer save the contracts of service of the employees. The evidence does not disclose what price was determined by C.E. Smith & Company. However, the learned trial judge found as a fact that

"The price was, as contemplated by the contract, determined by Messrs. C.E. Smith & Co. not long after 30 June, and book entries were made to establish the indebtedness of the purchaser company."

Paragraph 25 of the agreement provided:

"25. The Purchaser shall take over all the Vendor's employees employed in the Vendor's business on the 30th June, 1976 and on and from that date the Purchaser shall be liable to make holiday, sick leave and long service leave payments accruing or owing before or after that date provided that the Vendor shall pay to the Purchaser on the 30th June, 1976 an appropriate amount as shall be determined by C.E. Smith & Co. as the employees' accrued entitlement for long service leave and holiday and sick pay."

On 30 June 1976, pursuant to this agreement, Foxwood (Tolga) Pty. Limited paid to the credit of Foxwood Limited an amount of $11,658.78 in respect of holiday pay, long service leave and sick pay. Notwithstanding the lack of evidence as to what was transferred to Foxwood Limited and what was the price paid by that company to the appellant, I take the principal provision of the agreement to be the sale of the business and undertaking to Foxwood Limited. I read clause 25 of the agreement as an incidental or ancillary provision and not as the main effective clause thereof.

In its return of income, the company claimed as a deduction $5,984 in respect of holiday pay and $2,913 in respect of long service leave, these sums being said to represent the liability of the company accrued at the conclusion of the year ended 30 June 1976. It did not claim the balance of the sum, representing long service leave and sick pay, in respect of which the employees were said not to have an absolute entitlement to payment. In his assessment, the respondent disallowed the deduction sought. In the notice of objection, no claim was made for the deduction of any sum not an accrued liability for which provision might properly have been made in the accounts of the company. Nor is it, in my opinion, open to this Court to conclude that an amount, set aside in the annual accounts of a company to meet accruing holiday pay and long service leave liabilities in so far as they are related to the employment during the year of income, is or may be a loss or outgoing incurred in that year in gaining or producing assessable income or necessarily incurred in that year in carrying on business for that purpose. In Federal Commissioner of Taxation v. James Flood Proprietary Limited [1953] HCA 65; (1953) 88 CLR 492, the Full High Court rejected such a contention in relation both to a provision for holiday pay and a provision for long service leave. The decision in that case has been followed and applied in this Court in Federal Commissioner of Taxation v. Nilsen Porcelains (Aust.) Pty. Ltd. 27 ALR 239. I am bound to follow those decisions.

Argument before this Court proceeded on the footing that, for the purposes of s.51(1) of the Income Tax Assessment Act 1936, the sum of $11,658.78 could be apportioned according to its constituent parts. In my view, such an apportionment should be made. The sum was not a single indivisible sum but the product of calculations made by E.C. Smith & Company with respect to its elements. See Ronpibon Tin N.L. and Tongkah Compound N.L. v. Federal Commissioner of Taxation [1949] HCA 15; (1949) 78 CLR 47 at pp. 59-60.

I shall deal first with the claim in respect of long service leave. Section 17(2) of the Queensland Industrial Conciliation and Arbitration Act 1961-1976 provided that,

"The entitlement of any and every employee to long service leave on full pay pursuant to this section shall be in respect of his continuous service with one and the same employer . . . and the amount and further amounts of that long service leave shall -

(a) in the case of an employee who shall have completed a period of fifteen years' continuous service with one and the same employer, be thirteen weeks;

. . . . .

(d) in the case of an employee who, after completing the first or a subsequent period of fifteen years' service with one and the same employer continues that service until he shall have completed at least a further five years' service but less than a further fifteen years' service with that employer, and who himself terminates that service, or whose employer terminates that service for any cause other than serious misconduct, or who dies, be a proportionate further amount on the basis of thirteen weeks for fifteen years' service:"

Section 17(13) provided:

"For the purposes of this section -

(a) where the calling carried on by a person who is an employer shall have been before, or shall be on or after, the said date transmitted to another person by operation of law or by agreement between them, that transmission shall be deemed not to have broken or otherwise affected, or to break or otherwise affect, the continuity of the service of any employee whose service shall have been or shall be, upon the transmission aforesaid, transmitted from the one to the other person aforesaid; and

(b) the respective periods of the service of that employee with each of the aforesaid persons shall be taken into account in calculating the length of the continuous service had by him with the person to whom his service shall have been or shall be transmitted as aforesaid."

I take the effect of this provision to be that, after the transmission, the transmittee employer undertakes full responsibility for the long service leave of the employee and the transmittor employer is no longer liable in respect of it. The latter aspect was not specifically stated but I take it to be a necessary implication from the provision.

Two employees, a Mr. Edwards and a Mr. Dodds, were relevant to the long service leave claim. The history of their employment and their entitlements to long service leave were stated as follows:

"E. EDWARDS

EMPLOYER PERIOD OF EMPLOYMENT
(a) Foxwood (Mareeba) Pty. Ltd. 20. 4.55 to 30. 6.73
(b) Foxwood (Tolga) Pty. Ltd. 1. 7.73 to 30. 6.76
(c) Foxwood Limited - Mareeba Branch 1. 7.76 and

currently employed

Amounts transferred or paid to new employer at date of
transfer

Item (a) above to (b) $1,029.21
Item (b) above to (c) $2,252.39

Entitlements due had employee left employ after :-

(d) 10 years continuous service due
on 19.4.65 $277.00
(e) Equivalent of 10 years continuous
service due on 29.6.67 (under 13
weeks for every 15 years) $415.00
(f) 15 years continuous service due
on 19.4.70 $624.00
(g) Equivalent of 15 years continuous
service due on 29.6.72 (under 13
weeks for every 15 years) $893.88
(h) Amount due had employee terminated
on 30.6.76 the date of Foxwood
Limited takeover $1,784.38

J.M. DODDS

EMPLOYER PERIOD OF EMPLOYMENT
(i) Lawson & Son - (Partnership) 4.3.46 to 15.6.49
(j) Foxwood Mareeba Pty. Ltd. 16.6.49 to 30.6.65
(k) Foxwood Tolga Pty. Ltd. 1.7.65 to 30.6.76
(l) Foxwood Limited 1.7.76 and
currently employed

Amounts transferred or paid to new employer at date of
transfer
by Item (i) to (j) $nil
by Item (j) to (k) $700.00
by Item (k) to (l) $1,171.57

Entitlements due had employee left employ after :-
(m) 10 years continuous service due
on 4.3.56 $162.00
(n) 15 years continuous service due
on 4.3.61 $429.00
(o) 20 years continuous service due
on 4.3.66 $778.00
(p) Sufficient service to cover 13
weeks service fell on 6.1.66 $754.00
(q) Long Service Leave of 13 weeks
taken 9.4.75 to 8.7.75 $1,258.01
(r) Long Service Leave entitlement
at 30.6.76 $1,128.51."

The two sums of $1,784.38 and $1,128.51 totalled the sum of $2,912.89 which comprised the sum of $2,913 claimed in the notice of objection.

It will be noted that the sum claimed as a deduction in relation to long service leave pay not only did not relate wholly to the year of income ended 30 June 1976 but was calculated partly by reference to employment with other employers. Thus, Mr. Edwards was employed by Foxwood (Mareeba) Pty. Limited from 20 April 1955 to 30 June 1973. In relation to this, the period of his employment with the appellant was brief. Mr. Dodds was employed by other employers from 4 March 1946 to 30 June 1965.

In my view, the subject loss or outgoing in respect of long service leave did not arise out of the income earning activities of the appellant. Apart from clause 25 of the agreement with Foxwood Limited, there was no liability on the appellant to make a payment with respect to long service leave. No other obligation to make such a payment was pending. Under the operation of the Industrial Conciliation and Arbitration Act, no fixed liability to make a payment ever arose so far as the appellant was concerned. Foxwood Limited, by taking over the employees, took over their periods of continuous service. The relevant obligation respecting long service leave thus arose only under the contract dated 29 June 1976. This contract was not one which was entered into for the purpose of gaining or producing assessable income for Foxwood (Tolga) Pty. Limited.

It was entered into for the purpose of bringing the activities of the appellant to an end. Indeed, under it, the appellant lost its source of income. The evidence suggests that, since 30 June 1976, the appellant has been a shell. Whether or not this be the case, the agreement was not made for the purpose of gaining or producing assessable income for Foxwood (Tolga) Pty. Limited or in the course of gaining or producing such income or in carrying on a business for that purpose. The obligation, which arose under the agreement and only because of the agreement, was therefore not an allowable deduction under s.51(1). See Peyton v. Federal Commissioner of Taxation [1963] HCA 33; (1963) 109 CLR 315 where, at p.321, Kitto, Taylor and Owen JJ, said,

"He incurred the loss or outgoing, therefore, not in gaining or producing the assessable income but in parting with the means by which he had been gained and producing it; not in carrying on the business for the purpose of gaining or producing such income, but in disposing of the business and ceasing thereby to gain or produce such income."

See also Ronpibon Tin N.L. and Tongkah Compound N.L. v. Federal Commissioner of Taxation (cited above) at pp.56-7, Latham CJ and Rich, Dixon, McTiernan and Webb JJ said,

"For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end. The words 'incurred in gaining or producing the assessable income' mean in the course of gaining or producing such income.

. . . . .

In brief substance, to come within the initial part of the sub-section it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income."

Their Honours were speaking of the first limb of s.51(1) but, of the alternative, they had earlier said, at p.56,

"The alternative in s.51(1) therefore covers a wide description of activities. But in actual working it can add but little to the operation of the leading words, 'losses or outgoings to the extent to which they are incurred in gaining or producing the assessable income'. No doubt the expression 'in carrying on a business for the purpose of gaining or producing' lays down a test that is different from that implied by the words 'in gaining or producing'. But these latter words have a very wide operation and will cover almost all the ground occupied by the alternative."

Subsequently, in Lunney v. Commissioner of Taxation [1958] HCA 5; (1957-8) 100 CLR 478, Williams, Kitto and Taylor JJ, after referring to what had been said in the Ronpibon case and to like passages in other authorities, said, at p.497,

"In the context in which they have been used the expressions relied upon by the appellants have been intended as a reference, not necessarily to the purpose for which an item of expenditure has been incurred, but, rather, to the essential character of the expenditure itself."

The provision in the agreement with respect to long service leave was, in my opinion, no more than an adjustment made between a vendor and a purchaser on the sale of a business. I accept that an adjustment made on the sale of a capital asset may, in a proper case, be the subject of an allowable deduction or of an income receipt. See Federal Commissioner of Taxation v. Morgan [1961] HCA 64; (1961) 106 CLR 517. However, the subject adjustment did not arise out of the income earning activities of the year and it was not made in the course of or for the purpose of gaining or producing assessable income or necessarily made in carrying on business for that purpose. The adjustment was simply part of an arrangement which brought the income earning enterprise to an end. I do not look upon the payment made as one which took the place of outgoings, long service leave payments, which, but for the agreement, would have fallen upon the company by virtue of its income earning activities. There is no evidence before the Court that the agreement of 29 June 1976 was made or the specific provision in the agreement introduced to avoid impending long service leave payments. Nor was that the effect of the agreement or of the provisions. No long service leave payments were then pending. And the end achieved by the agreement, the transmission of the undertaking of the appellant to Foxwood Limited, removed the possibility that such an obligation would, in the future, fall upon the company.

I turn now to the claim in so far as it relates to holiday pay. Seventeen employees were employed under three awards, the Sawmilling Award, the Engine Drivers' Award and the Carting Trade Award, each of which provided for annual holidays as a condition of employment. The Sawmilling Award provided, inter alia,

"ANNUAL HOLIDAYS AS FROM 3RD DECEMBER, 1973

(2) (1) Every employee (other than a casual employee) covered by this Award shall at the end of each year of his employment be entitled to an annual holiday on full pay of four weeks.

. . . . .

If the employment of any employee is terminated before the expiration of a full year of employment, such employee shall be paid, in addition to all other amounts due to him, an amount equal to one-twelfth of his pay for the period of his employment calculated in accordance with paragraph (2) hereof.

. . . . .

Except as hereinbefore provided it shall not be lawful for the employer to give or for any employee to receive payment in lieu of annual holidays."

The other two awards contained similar provisions. The awards contained no provision for the transfer of the business from one employer to another or for the transfer of employment from one employer to another. Under the awards, if employment was terminated on 30 June 1976, employees were entitled to payments totalling $5,984, the total of the amounts payable on the termination of the employments prior to the expiration of the full year of employment. The actual calculation of this sum need not concern me.

Having regard to the provisions of the awards, holidays and holiday pay on termination of employment were not matters which, during the subject year of income, arose accidentally or haphazardly or irregularly in the conduct of a business. It was a normal and regular incident of the business that annual holidays be provided or holiday pay in lieu of holidays be paid on termination of employment. There were to be annual holidays of four weeks on full pay or, in the event of termination of employment prior to the expiration of the full year of employment, the employee was to be paid an amount equal to one-twelfth of his pay for the relevant period of employment. Such an amount did not equal precisely but approximated the cost of providing four weeks' holiday on full pay at the end of twelve months of employment. Therefore, the engagement of an employee involved more than the payment of the weekly wage. With every week of employment there adhered an additional cost which sooner or later had to be met by way of payment to the employee of a wage during a period of leave or a payment made in lieu of leave. The liability to meet the cost did not crystallize or fix until the period of employment extended beyond twelve months or the employment was terminated within that time. But, as each week of employment passed, the liability, though inchoate, increased.

If the fact were that the contracts of employment terminated on 30 June 1976, then the appellant would, in my view, under the awards, have been definitively committed in the year to the payment of the holiday pay and, in my view, the liability would have been a revenue outgoing which arose out of the income earning activities of the year, though crystallized by the transfer of the business. It was submitted by counsel for the respondent that, if the contracts of employment were terminated on 30 June 1976, the obligation under the awards might not have arisen until after midnight on that day. However, when the awards provided for payment in lieu of holiday pay to be made on termination of employment, I think they had in mind that the payment would be made when each employee ceased to work in the employment, e.g. 5.00 pm on 30 June 1976. It may be that an employee would not have been entitled in law to take legal proceedings for the recovery of the sum until the following day. That may be so. I do not need to decide the point. In my view, neither the intent of the awards nor s.51 (1) are to be read with that technicality.

However, it was further submitted for the respondent that the employment of each of the employees was not terminated, in the sense used in the awards, on 30 June 1976. The learned trial judge did not express a clear finding of fact on this point. His Honour said, "As to holiday pay, the appellant became liable to pay such pay to all of its workers, and it has never paid it. Instead, it paid to Foxwood Limited an amount equal to its liability to the workers." However, this is not a clear finding that the contracts of service were terminated on 30 June 1976. Earlier in his judgment, the learned trial judge set out the relevant facts relating to the last payments of salary and the note given and confirmed on 9 July 1976 and said, "I do not regard any of the foregoing events as destructive of the appellant's claim, if it be otherwise valid." This suggests that His Honour may have been of the view that the employments terminated on 30 June 1976. However, there being doubt as to whether His Honour came to a conclusion on this point, I think I should myself examine the evidence and make my own finding on it.

The employees worked at the Foxwood Mareeba Mill but neither that mill nor the business of the mill was owned or operated by the appellant. Foxwood (Tolga) Pty. Limited merely paid the employees. The employees may have had no more knowledge of the appellant company than that each received a group certificate at the end of the financial year from it. There is no evidence that the employees were told that the appellant ceased to employ them on 30 June 1976. In fact, they received payment from the appellant, Foxwood (Tolga) Pty. Limited, as usual on Friday, 2 July in accordance with the practice which was to make payments of pay on a Friday, though the period of employment ended on a Wednesday. On Friday, 9 July 1976, each of the employees confirmed in writing a note from the secretary of Foxwood Limited stating, "The Foxwood group of companies has been re-arranged to streamline administrative functions. The effective date is July 1, 1976. As from that date you are employed by Foxwood Limited. Your continuity of service as regards long service leave, holidays and sick leave will not be affected." Each note then went on to state, "We confirm that your transfer to Foxwood Limited is on the following terms . . ." and set out the wage payable to each employee. Having regard both to the lack of evidence as to the making of any communication to the employees concerning the matter and to the payment of wages on 2 July 1976, I conclude that the contracts of service of the employees were not terminated on 30 June 1976. Therefore, no liability to make the payments was incurred under the awards during or at the close of the year of income.

I have said above, in relation to holiday pay that, with every week of employment, there adhered an additional cost which sooner or later had to be met by way of payment to the employee of a wage during a period of leave or a payment made in lieu of leave.

Because of this, the company's accounts for the year of income properly contained a provision in relation to holiday pay which included the sum claimed as a deduction. However, as mentioned above, I am bound by the decision of the Full High Court in Federal Commissioner of Taxation v. James Flood Proprietary Limited (cited above) and the decision of the Full Court of this Court in Federal Commissioner of Taxation v. Nilsen Porcelains (Aust.) Pty. Ltd. (cited above) to hold that provisions in company accounts with respect to long service leave and holiday pay, not representing actual liabilities due and payable, although they may properly be made in the accounts, are not allowable deductions under s.51 (1) of the Income Tax Assessment Act 1936. It is not necessary or useful for me to examine the reasons behind those decisions. Their effect is clear.

The substance of the case put for the appellant was that, if the contracts of service had terminated in the year ended 30 June 1976, the sums payable to the employees for long service leave and for pay in lieu of holiday pay would have been allowable deductions under s.51 (1) of the Income Tax Assessment Act 1936. It was put that the amount paid under the agreement took the place of, or was a mere substitution for, the obligation which the appellant would have had under the awards and that the payment under the agreement had the same character as if payments had been made directly to the employees themselves. It was put that the losses or outgoings disallowed in Federal Commissioner of Taxation v. James Flood Proprietary Limited (cited above) and Federal Commissioner of Taxation v. Nilsen Porcelains (Aust.) Pty. Ltd. (cited above) were so disallowed because, on the facts of those two cases, there was not a sum due and owing, there was merely a provision made in respect of an incohate liability. It was submitted that, in the present case, the terms of the agreement fixed the liability and made it due and payable.

In my opinion, if the contracts of employment had terminated on 30 June 1976 and if the sums had become payable to the employees as a result of the operation of the awards, those sums would have been allowable deductions. The mere fact that they were payable on the termination of the business would not have transformed them into payments of capital or of a capital nature. The payments of pay in lieu of holidays would have been payments of a revenue nature which arose in the course of the income earning activities of the appellant. They would have been due to, have arisen out of the income earning activities of the appellant though crystallized by the termination of the business.

I have said that, in my view, the contracts of employment were not terminated on 30 June 1976. Nevertheless, the regular process of gaining income during the income period had given rise to inchoate liabilities which sooner or later had to be met or provided for. Transmission of the employees would not, of itself, effect a transfer of this liability. And the appellant, contemplating the transmission of its employees to Foxwood Limited, must have recognised that the inchoate liabilities would crystalize when the contracts of employment terminated, in the sense used in the awards, which, in my view, they did on 9 July 1976. Clause 25 of the agreement of 29 June 1976, in so far as it dealt with holiday pay, effectively provided a means for the discharge of this liability. By reason of the agreement and of what was intended to be done in implementation of it - the steps in implementation being taken not necessarily in compliance with precise terms of the agreement but nevertheless in accordance with its purport and effect - the appellant, in a practical way, met its liabilities to its employees with respect to pay in lieu of holidays.

In my opinion, the issue is basically one as to the date of incurrence. Did the appellant incur its liability with respect to pay in lieu of leave when the contracts of employment terminated on 9 July 1976 or did it incur the liability in the preceding year of income when it entered into the agreement of 29 June 1976 and made the payment under clause 25 thereof? In my view, the latter view is the better. The payment made on 30 June 1976 was the only relevant payment which the appellant was called upon to make. By the agreement and that payment it effectively discharged, in a practical way, its liability to its employees. In my opinion, therefore, it incurred the relevant obligation in the year of income ended 30 June 1976. That obligation was incurred in the course of gaining or producing its assessable income and the obligation was not of a capital nature.

It was submitted by counsel for the respondent that the outgoing for which the awards provided was not in fact met, the appellant entering into an arrangement which had the effect of transferring the contracts of service and of ensuring that the transferee took over the liability in respect of holidays. It is true that the employees did not receive holiday pay but, in their employment with Foxwood Limited, were granted the benefit of their terms of employment with Foxwood (Tolga) Pty. Limited and, at the conclusion of the twelve months' periods of employment so computed, received from Foxwood Limited holidays on full pay. It was put that, whatever was done between Foxwood (Tolga) Pty. Limited and Foxwood Limited, their arrangement did not extinguish the liability, if any, which Foxwood (Tolga) Pty. Limited had under the awards. Nevertheless, what was done by and under the agreement of 29 June 1976 was designed to have the effect of and did have the effect of meeting, not precisely but in substance, the liability for which the awards provided. As the agreement of 29 June 1976 and the steps taken in its implementation had the effect of providing for the holiday pay and pay in lieu of holidays of the employees, I think it would not be proper to characterise the obligation under the agreement of 29 June 1976 as different from and independent of the obligation under the awards. An effect, and an intended one, of the making of the payment under clause 25 of the agreement of 29 June 1976, was that the appellant was not called upon to discharge its liability under the awards. By making the payment, it discharged, in a practical way, that liability. In my view, the payment of 30 June 1976, in so far as it related to holiday pay, should be attributed the same character, for the purposes of s.51(1), as pay in lieu of holidays would have had if paid by the appellant to its employees on the termination of their employment on 9 July 1976.

In respect of long service leave, no payment was pending and the transmission of the business and undertaking of the appellant, including the employees, put an end to the prospect that payments in respect of long service leave might be incurred. However, in respect of holiday pay, the transmission of the business and of the employees did not of itself end the impending holiday pay liability. Rather, clause 25 of the agreement of 29 June 1976 and the payment of 30 June 1976 took its place.

For these reasons, I am of the opinion that the appeal should be allowed in relation to the appellant's claim to deduct from its assessable income for the year ended 30 June 1976 the sum of $5,984 being that part of the payment on 30 June 1976 which related to holiday pay. The remainder of the appeal should be dismissed.

As the appellant has but partial success in its claim, I am of the view that the appellant should recover from the respondent one half of its taxed costs of this appeal and of the trial below.