Re Bernard Putnin v Commissioner of Taxation of the Commonwealth of Australia [1991] FCA 14; 91 Atc 4097/21 Atr 1245/98 ALR 13 27 FCR 508 (6 February 1991)

FEDERAL COURT OF AUSTRALIA

Re: BERNARD PUTNIN
And: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
Nos. WA G20, 113 and 114 of 1990
FED No. 12
Income Tax
[1991] FCA 14; 91 ATC 4097/21 ATR 1245/98 ALR 13
27 FCR 508

COURT

IN THE FEDERAL COURT OF AUSTRALIA
WESTERN AUSTRALIA DISTRICT
REGISTRY GENERAL DIVISION
Burchett(1), French(1) and Lee(1) JJ.

CATCHWORDS

Income Tax - deduction under s. 51(1) - legal costs paid by taxpayer who was an accountant and trustee in bankruptcy in respect of defence of charge of conspiracy to defraud the Commonwealth arising out of his administration of an insolvent estate - whether a change in the manner of conduct of the professional business from a sole practice to a partnership between the time of administration of the estate and incurring of the legal fees would have been relevant - whether The Herald and Weekly Times Limited v. Federal Commissioner of Taxation [1932] HCA 56; (1932) 48 CLR 113 applied - whether the expenditure was "voluntary" - circumstances in which court was able to dispose of the whole matter upon allowing the appeal without remitting it for any further hearing.

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

Administrative Appeals Tribunal Act 1975 - s. 44

HEARING

PERTH
6:2:1991

Counsel for the Applicant: Mr R.K. O'Connor QC with Mr R.G.S. Harrison

Solicitors for the Applicant: Messrs Sly and Weigall

Counsel for the Respondent: Mr M.J. Buss

Solicitor for the Respondent: Australian Government Solicitor

ORDER

Each appeal be allowed, and each decision of the Administrative Appeals Tribunal the subject of appeal be set aside;

The objection against each assessment be upheld, and each assessment be remitted to the Commissioner to be dealt with in accordance with these reasons;

The Commissioner pay the applicant's costs of the appeals.

NOTE: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

DECISION

Mr Bernard Putnin, the applicant, follows the profession of an accountant. A substantial part of his professional work is concerned with the problems of insolvency, and he is a registered trustee in bankruptcy and an official liquidator. In 1981, he became the trustee under a particular deed of arrangement. Among the debtor's assets was a share in a company, of the kind known as a governing director's share. Mr Putnin administered the estate without obtaining an assignment of the share, which was subsequently dealt with by the debtor. In 1983, a charge was laid against Mr Putnin that he had conspired with the debtor and another to defraud the Commonwealth (by some means involving the dealing with the share), and upon that charge he was committed for trial. Proceedings seem to have followed in this court for judicial review of the committal decision. Those proceedings having failed, the prosecution went ahead in September 1985. It resulted in the applicant's acquittal, following a ruling that he had no case to answer.

2. Under the circumstances which have been outlined, Mr Putnin incurred legal expenses, related to his defence, in each of the years ended 30 June 1984, 30 June 1985 and 30 June 1986. He claimed deductions, for the purposes of the Income Tax Assessment Act 1936, under s. 51(1), which were denied. His objections having been disallowed, the question came before a senior member of the Administrative Appeals Tribunal. The Tribunal's decision was reserved for nearly one year and a half. After that lapse of time, it is perhaps not surprising that some errors and omissions have crept into the reasons which were handed down. But, fortunately, the material facts are few, and there was no dispute about them. The question is simply whether the Tribunal fell into error of law in the grounds it gave for dismissing Mr Putnin's appeals. Although the reasons are concerned with s. 51(1), there was a subsidiary issue whether the applicant could succeed, in the alternative, to the extremely limited extent provided for by s. 64A in relation to the assessments for the second and third of the years in dispute, under which even such a deduction was denied him.

3. The reasons of the Tribunal commence with a summary outline of the nature of the applicant's practice. It is then stated, somewhat inaccurately: "The business was conducted by a partnership of which the applicant was a member during 1984 through to late 1986." Actually, the applicant was a member of such a partnership, but he also practised, throughout the period mentioned, on his own account. These facts were not at all in dispute. The reasons also understate the amount of the deduction claimed for the last of the three years by omitting to notice the full amount contended for in Mr Putnin's objection. The correct figure in respect of that year is $50,810.

4. The Tribunal made the following findings of fact:

"I do not need to review the evidence in detail but I am
satisfied on the evidence that the applicant incurred the
legal expenses first and foremost because he considered he
was not guilty of the charges laid - a perfectly normal and
unexceptional reason for defending charges. Secondly, he
feared that his appointment as a trustee in bankruptcy was
likely to be in jeopardy if convictions were recorded and he
feared some detrimental effect on his business although he
thought that most clients would stay with the firm
irrespective of the outcome. He was also uncertain as to
whether he would be able to continue as a partner in the
firm especially if his standing as a professional accountant
was affected."

After referring to Magna Alloys and Research Pty Ltd v. Federal Commissioner of Taxation [1980] FCA 150; (1980) 49 FLR 183, the Tribunal commented: "The present case is different in that the outgoings do not arise out of the business of the partnership but are of a previous business conducted by the applicant." (Emphasis added.) This is a curious comment, since the applicant's returns showed receipt of income for each of the years in question in the name of his sole practice, as well as receipt of income from the partnership If it was correct to treat the deductibility of the outgoings as dependent upon whether they were claimed as outgoings of the very business conducted by the applicant at the time his professional activities gave rise to the charge, then the fact is his returns of income, in which the deductions were claimed, related to that business as well as to the subsequent partnership. The basis on which the tribunal distinguished Magna Alloys and Research is accordingly fallacious.

5. However, it is plain the erroneous distinction drawn by the tribunal formed a significant part of the foundation of its decision. For, after extensive citations from Magna Alloys and Research, it returned to this matter when stating the following conclusion:

"Unlike the case in Magna Alloys the facts of this case do
not establish that the outgoings bear the essential
character of outgoings necessarily incurred in carrying on
the business of the firm of which the applicant was a
member. The outgoings were personal to the applicant and
did not arise out of the business of the firm. The
outgoings were incurred to seek to protect the applicant's
official appointments, his privileges as a professional
accountant and his right to retain those privileges
including his membership of the Australian Society of
Accountants. I am not satisfied that the outgoings were
incurred in the course of gaining or producing the
assessable income or necessarily incurred in carrying on
business for that purpose." (Emphases added.)

Not only is this entirely to overlook the applicant's continuing position as a sole practitioner outside of the partnership, but also, as counsel pointed out, the strict dichotomy on which the Tribunal relied is inconsistent with views stated in the High Court in The Commissioner of Taxation of the Commonwealth of Australia v. Gulland [1985] HCA 83; (1985) 160 CLR 55. There, Dawson J. (with whom Wilson J., and also, relevantly, Brennan J., agreed) said (at 125) of changes in arrangements under which a professional man earned his income:

"The new arrangement did not produce a new source of income
in the sense in which the cases use that term. Dr Pincus's
source of income whilst he was a sole practitioner, whilst
he was practising in partnership, and now under the
substituted arrangement, has been, and is, the same, namely
the practice of his profession as a doctor. The form of
arrangement under which he has practised from time to time
has not altered the source of his income in any relevant
sense. The source of his income tax has been his
professional activities as a medical practitioner whether he
has been a sole practitioner, a partner or an employee. It
is from those activities that his income has derived and his
liability to tax has arisen."

And again (at 126-127):

"... Dr. Pincus was without interruption carrying on the
practice of his profession in a manner which was essentially
the same, however much the income which he derived thereby
might flow through different channels."

Gibbs C.J. (at 76) put the matter pithily:

"In any case it would be wrong to regard the income after
the dissolution as coming from a new source; the source
remained the practice by the taxpayer of his profession at
Stafford Road."

Cf. Bunting v. Federal Commissioner of Taxation (1989) 90 ALR 427 at 437, 453.

6. The case put forward by the applicant was really a simple one. According to his contention, the expenditure arose out of his prosecution, in which he was defending his activities in a particular operation of business by which income had been earned. That operation of business was the administration of one estate out of many of which he was the trustee. It followed, he contended, that the costs of his defence were outgoings incurred in gaining or producing assessable income within the first limb of s. 51(1), and, indeed, that they were also necessarily incurred in carrying on a business for the purpose of gaining or producing such income; and further that they were not outgoings of capital or of a capital, private or domestic nature.

7. It may be a natural incident of the conduct of the operations of a particular kind of business that claims of the commission of torts, or even crimes, may arise, although it is to be hoped not often, and have to be repelled. If the proprietor of such a business is sued for negligence, for example, the cost of defending the suit would arise out of the relevant business operations: The Herald and Weekly Times Limited v. The Federal Commissioner of Taxation [1932] HCA 56; (1932) 48 CLR 113. There, the manner in which a newspaper went about the publication of news resulted in its incurring claims for alleged libel. Gavan Duffy C.J. and Dixon J. in their joint judgment (at 117-119) referred to the trial judge's description of certain payments, both of damages and of costs, as "one of the consequences of gaining or producing the assessable income and in that sense as incidental to the carrying on of the business" (of the publication of the newspaper). They continued:

"The liability to damages was incurred, or the claim was
encountered, because of the very act of publishing the
newspaper. The thing which produced the assessable income
was the thing which exposed the taxpayer to the liability or
claim discharged by the expenditure. It is true that when
the sums were paid the taxpayer was actuated in paying them,
not by any desire to produce income, but ... in the case of
law costs, by the desirability or urgency of defeating or
diminishing ... a claim. But this expenditure flows as a
necessary or a natural consequence from the inclusion of the
alleged defamatory matter in the newspaper and its
publication. ...
... The question whether money is expended in and for the
production of assessable income cannot be determined by
considering only the immediate reason for making a payment
and ignoring the purpose with which the liability was
incurred. ... The money was spent to answer the claims,
and whether it was expended wholly and exclusively for the
production of income (this question was raised at that time
by an express provision of the legislation), must depend
upon the manner in which the claims were incurred. When it
appears that the inclusion in the newspaper of matter
alleged by claimants to be defamatory is a regular and
almost unavoidable incident of publishing it, so that the
claims directly flow from acts done for no other purpose
than earning revenue, acts forming the essence of the
business, no valid reason remains for denying that the money
was wholly and exclusively expended for the production of
assessable income."

8. The only part of their Honours' reasoning which is not directly applicable to the present case is the reference to the regularity of the claims against the newspaper. But this is not essential to the reasoning, as was made clear by Fullagar J. in Federal Commissioner of Taxation v. Snowden and Willson Proprietary Limited [1958] HCA 23; (1958) 99 CLR 431 at 446. That was a case factually closer to the present, since the costs in question there related to a single piece of litigation, or rather to an enquiry, a Royal Commission appointed to investigate the allegedly unscrupulous conduct of the taxpayer's business. Fullagar J. (at 446) said:

"The expenditure was not recurrent, and it must be regarded
as abnormal: it was not a continuing and unavoidable
incident of the taxpayer's business, as was the expenditure
in Herald and Weekly Times Ltd v. Federal Commissioner of
Taxation."

He nevertheless had no difficulty, as he had made clear at 444, in finding the same sort of relation between the expenditure and the carrying on of the business as had been found in Herald and Weekly Times. He said: "The expenditure was incidental to the carrying on of the business."

9. These cases were considered in Magna Alloys and Research (supra), where the taxpayer company was allowed a deduction in respect of legal costs paid by it, not simply on its own behalf as in the earlier decisions, but on behalf of directors and agents whose actions in the course of the company's business had led to their being accused in criminal proceedings. The trial judge had held that the protection of the personal interests of the directors and agents provided the principal motive or reason for the company's incurring of the expenditure. Nevertheless, Brennan J. (at 198) comments:

"But it makes no difference that, in the present case, the
learned trial judge was unpersuaded that (defence of the
company against attacks upon its business methods and
reputation) was `the dominant, or even a principal reason,
why the expenditure was incurred'. The reason why the
directors incurred the expenditure does not define the scope
or nature of the taxpayer's business, nor does it reveal
what the expenditure was for beyond assisting to show that
what was sought and obtained was legal representation to
defend the directors and employees. The directors' reasons
do not show or tend to show that legal representation to
defend the directors and employees was not connected with
the carrying on of the business."

10. The court, in Magna Alloys and Research, emphasized the distinction between involuntary expenditure (where the characterisation of the expenditure as falling within s. 51(1), or not, can generally be determined without reference to the taxpayer's motive or purpose) and voluntary expenditure (where the taxpayer's purpose may assist in the task of characterisation). See per Brennan J. at 191, and per Deane and Fisher JJ. at 206-209. In Magna Alloys and Research, as Deane and Fisher JJ. pointed out (at 209), the outgoings were not involuntary. The taxpayer plainly had a choice whether or not to underwrite the legal expenses of its directors and agents. In the present case, on the other hand, the taxpayer was himself the accused, and it would be a misuse of language to suggest that payments made in respect of his defence were incurred of his own volition. They were relevantly involuntary. It follows that the objective approach taken by Gavan Duffy C.J. and Dixon J. in Herald and Weekly Times is here the appropriate approach. The purpose to be attributed to the payment is the taxpayer's purpose in the administration of the insolvent estate. That purpose was implicitly found by the Tribunal to be the pursuit of the taxpayer's business (erroneously described as his "previous business") when the expenditures were found to be "outgoings ... of a previous business conducted by the applicant".

11. Had, however, the costs been voluntarily incurred, the reasoning of Deane and Fisher JJ. (at 211) would suggest they were necessarily incurred in carrying on the business of the taxpayer for the purpose of gaining or producing assessable income.

12. However, it was submitted for the Commissioner that the outgoings were of a capital nature. A similar argument was tersely rejected in Magna Alloys and Research, by Brennan J. at 201, and by Deane and Fisher JJ. at 213. Deane and Fisher JJ. said:

"Except in the most indirect way, the criminal proceedings
imperilled neither the business nor the capital assets of
the taxpayer. ... The criminal proceedings in respect of
which the outgoings were incurred arose out of the day to
day business activities of the taxpayer. The outgoings did
not involve the acquisition of any enduring or tangible
assets. They represented expenditure incurred in carrying
on the taxpayer's business which should properly be seen as
being of a revenue character."

13. In the argument presented to this Court, great emphasis was laid on the possibility that the taxpayer might, if he had been convicted, have incurred professional censure and cancellation of his registration as a trustee in bankruptcy or as an official liquidator. As a result, his partnership might have been dissolved. But these were all indirect consequences that might or might not have happened. They were neither the object of the prosecution, nor could it be said they would inevitably have followed upon its success. As in Magna Alloys and Research, the criminal proceedings arose from the activities by which the taxpayer earned his income, the mode of his performance of a particular task carried out in the course of business operations. Something of that kind is quite remote from capital, and the outgoings secured for the applicant no enduring or tangible asset. The last matter, though not conclusive, may be of significance as an indication that an expense is chargeable to revenue and not to capital: Australian National Hotels Ltd v. Commissioner of Taxation (1988) 19 FCR 234 at 241; Commissioner of Taxation v. Ampol Exploration Ltd (1986) 13 FCR 545 at 575-577. The true view is that it is not a determinative factor, but it is a pointer to the conclusion that expenditure is not on capital account. In Consolidated Fertilisers Ltd v. Federal Commissioner of Taxation (1990) 21 ATR 1,056 at 1,064 Pincus J. said: "Snowden and Willson, and even more strongly the Magna Alloys case, support the deductibility of expenditures, even if of an unique kind, to protect commercial reputation." If that is generally so, there is no sound basis for treating the costs paid in this case as of a capital nature merely because, in incurring them, the applicant may have been protecting his professional reputation. Under the circumstances, it was not open to the Tribunal to regard the outgoings as outgoings of capital or of a capital nature.

14. The reasoning of the Tribunal misapprehends Magna Alloys and Research, and the distinction it attempts to draw in respect of that case is erroneous. The question which arises is whether the decisions should simply be set aside, and the appeals against disallowance of the objections be referred back for reconsideration according to law, or whether this court should, pursuant to s. 44(4) of the Administrative Appeals Tribunal Act 1975, make orders determining the matter. There is a discussion of some of the relevant authorities in Ogilvy and Mather Pty Ltd v. Federal Commissioner of Taxation (1990) 90 ATC 4,836 at 4,855-4,856. In the present case the facts, upon the legal complexion of which the result depends, have been found, or are undisputed. As has already been pointed out, the Tribunal expressly decided that the expenditures in question are "outgoings ... of a previous business conducted by the applicant", that is, of his business as a sole practitioner, loosely (and wrongly) described, though continuing, as his previous business because in existence before his partnership. Contrary to the view of the Tribunal, the formation of the partnership, in the circumstances of this case, could make no difference to the deductibility of the expenditures. Accordingly, the "appropriate" orders, under s. 44(4), will provide for the allowance of the applicant's objections. The appeals should be upheld with costs, and orders should be made establishing the applicant's right to the claimed deductions, in respect of the year ended 30 June 1984, of $21,993, in respect of the year ended 30 June 1985, of $7,495, and in respect of the year ended 30 June 1986, of $50,810.