Melrose v Federal Commissioner of Taxation [1919] HCA 50; (1919) 26 CLR 494 (3 October 1919)

This appeal concerns income derived during the year ending 30th June 1916. The appellant is a partner in three different firms, in two of which profits were made in the year referred to, his share of those profits, as accepted by both sides, being respectively £150 and £131, or a total of £281. The third partnership made a loss, and his share of that loss, as accepted by both sides, was £524. On his separate assessment made under sec. 25 (2) of the Act 1915-1916, it appears that he had income from property far exceeding £524. The Commissioner permitted portion of the partnership loss of £524, namely to the extent of £281, to be set against the partnership profits of £281, but the difference, namely £243, he refused to set against the income from property. The Commissioner's view was that a partnership loss can, under sec. 21, be deducted from a partnership profit, but cannot be deducted from income from property. Buchanan J. upheld that contention, and we have to consider whether that decision is correct. The case was well and tersely argued on both sides.

The Act imposing the tax (No. 37 of 1916) imposed income tax (1) in respect of income wholly derived from personal exertion, (2) in respect of income wholly derived from property, and (3) in respect of income derived partly from personal exertion and partly from property. That Act incorporated the Assessment Act. By sec. 3 of the Assessment Act certain definitions were enacted. "Income from personal exertion" included "the proceeds of any business carried on by the taxpayer either alone or as a partner with any other person." "Assessable income" meant "the gross income which is not exempt from taxation." "Taxable income" meant "the amount of income remaining after all deductions allowed by this Act have been made." "Taxpayer" meant "any person chargeable with income tax." Sec. 10 provided that income tax should be levied and paid upon "taxable income." Sec. 18 enacted that "In calculating the taxable income of a taxpayer the total assessable income derived by the taxpayer from all sources in Australia shall be taken as a basis, and from it there shall be deducted"; then follow enumerated deductions.

Before going further, it should be observed that, having regard to the definitions and provisions quoted, sec. 18 in its opening words provides that, in calculating the amount of income on which the tax is to be levied and paid, the first step is to set down the taxpayer's non-exempted gross income from all sources in Australia, and from that income to make the deductions enumerated so far as the facts justify them, the balance being the taxable income.

Sub-sec. 2 of sec. 18 provided that where the third class of income taxed by the imposition Act existed (that is, income derived from personal exertion and from property), which is the present case, certain deductions should be made from property, and all others in the section from personal exertion. Then followed a proviso: "that if the income from either source" (that is, from personal exertion or from property) "does not amount to the sum to be deducted from that source, the balance of the sum to be deducted shall be deducted from the income from the other source." As a good deal depends on this proviso, it is necessary to consider its terms at this point. It preserves the division of income into two classes only—personal exertion and property; it recognizes no subdivision of those sources: it assumes the deductions to represent in their totality one sum as to each source, and to be deducted from that source without regard to the items making up that source, and any balance of the deductible amount unapplied to that source goes over to be deducted from the other source equally without distinction of items composing that source.

The dominating idea is that the taxpayer is regarded as a receiver of income which, in its totality, represents his ability to contribute to the revenue of the country. That ability is affected by the general nature of the source—personal exertion or property—whence the income is received, but is not affected by the particular channel emanating from the given source by which the income passes to him. His ability to contribute for the year, however, is affected by the losses he has sustained in the course of his industry or other income-producing operations, and it is immaterial to his ability in which channel those losses have been sustained provided they are of the nature recognized as deductible. His resultant ability as a taxpayer is the aim of sec. 18, and so, after appropriating the deductions to their primary class, the balance is allowed to stand against the other class of income. If, therefore, section 18 stood alone, there would be no reason to refuse the taxpayer's right to deduct the sum of £243 from the property income, or, to be quite exact, so much of the £243 as remained after applying it to a sum of about £10 of personal exertion income. But it is contended that, however that might be if sec. 18 stood alone, the provisions of secs. 21 and 25 are opposed to it.

Sec. 25 is divided into two parts. The first part, as held in Leonard v. Federal Commissioner of Taxation[1], enacts that a partnership is to be assessed as a separate entity. The reason of that is obvious. Partners carrying on a business are a business unit, and are naturally to be held jointly responsible for the tax on the business operations. But in order to avoid the manifest injustice of making—especially in a graduated tax—one partner responsible on a scale dependent on the private and separate income of the other, separate interests and incomes must be disregarded. This is what sub-sec. 1 of sec. 25 did, and the partnership income is assessed without regard to separate interests or separate rights to deductions, or separate incomes outside the particular partnership. This secured each partner from taxation on the basis of another man's income. He became jointly liable for the tax on the partnership income. Nevertheless, his totality, so to speak, as a taxpayer is even there recognized by sec. 21, which allows him to deduct total business losses from total business profits, and whether the losses and profits are made by him alone or in partnership with others. Then sub-sec. 2 of sec. 25 provided that he shall be separately assessed and liable in respect of (a) his individual interest in the partnership income, (b) any other income derived by him separately, and (c) his individual interests in the income derived by any other partnership. Again his totality as a taxpayer is recognized, and on his own personal basis. It is this separate assessment which has taken place in the present case.

Why is not sec. 18 applicable? Why does sec. 21 shut out its application? Even if sec. 21 covers some of the ground, it covers other ground too, and not only is it necessary for the just working of the first sub-section of sec. 25, but, even if it be regarded as tautologous, that is not uncommon, especially in a taxing Act, ex majori cautelâ (see per Lord Macnaghten in Commissioners for Special Purposes of Income Tax v. Pemsel[2], and per Lord Finlay L.C. in Cornelius v. Phillips[3]).

Reliance was placed on sec. 17 of Act No. 18 of 1918, which added a sub-section to sec. 21. But again, that, certainly to some extent in recognition of the totality of the taxpayer's ability, declared his right to deduct business losses from property income, the important words being "alone or otherwise." It is not at all clear that that sub-section carries his right further than does sec. 18. It must be remembered that the proviso to sec. 18, which, it is said, is complemented by sec. 21, was passed after sec. 21, namely by Act No. 47 of 1915, whereas sec. 21 had been passed by Act No. 34 of that year. Sec. 21 consequently cannot be taken as a limitation of the proviso to sec. 18.

The cardinal position of the respondent is that the sum of £524—except for the permitted deduction of £281 under sec. 21—is unalterable. But how can that be? Suppose no property income: could the taxpayer's right to deduct his own war contribution, or his insurance premiums be denied? They are expressly ignored in the joint partnership assessment, and it is inconceivable that the Legislature intended to deny them altogether. Nor is it understandable why in the separate assessment a surplus of property deductions should not be set against even partnership income. Besides, the later legislation—if that is to control interpretation—is fatal to the contention. The new sec. 25 (substituted by sec. 20 of Act No. 18 of 1918) speaks of the individual assessment of each partner in respect of (a) his individual interest in the partnership income "remaining after allowing all the deductions under this Act" except the deduction under sec. 19. If the later enactment indicates the Legislative interpretation of the earlier Act, it is clear that Parliament understood the earlier one to refer to the partnership gross income. The new section places matters like the present on a new footing; but, on the basis of the law as it stood with reference to this case, the taxpayer's contention appears to us correct and the appeal should be allowed.

Appeal allowed. Order appealed from discharged with costs. Objection of the taxpayer sustained. Respondent to pay costs here and below.

Solicitor for the respondent, Gordon H. Castle, Crown Solicitor for the Commonwealth.

[1] [1919] HCA 23; 26 C.L.R., 175.

[2] [1891] UKHL 1; (1891) A.C., 531, at p. 589.

[3] (1918) A.C., 199, at p. 204.

High Court of Australia

Melrose v Federal Commissioner of Taxation [1919] HCA 50; (1919) 26 CLR 494 (3 October 1919)

HIGH COURT OF AUSTRALIA