Australian Knitting Mills Ltd (in Liq) v Federal Commissioner of Taxation [1923] HCA 5; (1923) 31 CLR 511 (20 March 1923)

The Australian Knitting Mills Limited (in Liquidation) Appellant; and The Federal Commissioner of Taxation Respondent.

During the year 1st July 1918 to 30th June 1919 the appellant paid in respect of calls on shares in the Yarra Falls Spinning Co., which had been allotted to it in 1918, the sum of £79,500 12s. The Spinning Co. was a company carrying on operations in Australia. In its return of profits for the year in question for the purpose of the War-time Profits Tax Assessment Act 1917 the appellant claimed a deduction of £3,975, being 5 per cent. of the said sum of £79,500 so paid in calls. The respondent disallowed the deduction claimed. The question for decision is whether such deduction should have been allowed in determining the profits arising from the business of the appellant in the financial year commencing on 1st July 1918 for the purposes of the said Act. The appellant relies on the provisions of secs. 10 and 15 of the Act and sec. 18 (1) (i) of the Income Tax Assessment Act 1915-1918. The contention of the appellant may be summarized as follows:—The payment of £79,500 was an expenditure of a capital nature in respect of the business; sec. 15 (2) of the War-time Profits Tax Assessment Act by implication provides that a deduction may be allowed in respect of such expenditure if such a deduction would be allowed for the purposes of the income tax; sec. 10 of the War-time Profits Tax Assessment Act imports into the computation of profits for the purposes of that Act the provisions for computing taxable income contained in the Income Tax Assessment Act; sec. 18 (1) (i) of the Income Tax Assessment Act allows a deduction in ascertaining taxable income of 5 per cent. of the amount paid in the year in respect of calls on shares in a company carrying on operations in Australia; the amount of £79,500 paid by the appellant was paid in respect of calls on shares in such a company, and therefore 5 per cent. of that amount should be deducted in ascertaining the profits of the appellant for the purpose of assessment of war-time profits tax. This argument ignores the essential distinction between income of the taxpayer which is taxable under the Income Tax Assessment Act and profits of a business which are the subject of taxation under the War-time Profits Tax Assessment Act. Sec. 10 of the last mentioned Act provides that the profits arising from any business shall for the purposes of the Act be determined on the same principles as the profits and gains of the business are or would be determined for the purpose of Commonwealth income tax subject to certain modifications. The provision contained in sec. 18 (1) (i) of the Income Tax Assessment Act is applied, not in determining the profits of a business, but in ascertaining the taxable income of a taxpayer who may or may not derive income from a business. If a taxpayer carries on a business, then for the purpose of assessing him to income tax the profits of his business are included in his income, but these profits are ascertained by deducting from the gross receipts of the business amounts expended or allowed in respect of the matters specified in pars. (a), (d), (e), (f) and (j) of sub-sec. 1 of sec. 18 of the Income Tax Assessment Act. To the profits of the business so ascertained is added the amount of his income from other sources, e.g., from investments or property, and it is from the total so found that the deduction authorized by par. (i) is made. In no sense can the deduction authorized by par. (i) be said to be a principle, or even a provision, applying to the determination of the profits of a business for the purpose of Commonwealth income tax. Consequently I am of opinion that neither sec. 10 nor sec. 15 (2) of the War-time Profits Tax Assessment Act operates to authorize the deduction made by the appellant.

For these reasons I am of opinion that the question submitted should be answered in the negative.

The appellant rests its claim to have the sum of £3,975 0s. 7d. allowed as a deduction, in determining the taxable war-time profits of its business, on the provision in par. (i) of sec. 18 (1) of the Income Tax Assessment Act. That provision, it is said, is attracted by force of secs. 10 (1) and 15 (2) of the War-time Profits Tax Assessment Act, either separately or conjointly. We have, therefore, to see what those sections provide. Before reading the words relied on, it is necessary to bear in mind that, whereas the income tax is a tax on a totality of income from various sources in Australia (divided in the case of individuals for the purpose of rating into two classes), the war-time profits tax, on the other hand, is a tax on business profits only; and as to the latter tax it is essential to remember that, as I expressed it in McKellar v. Federal Commissioner of Taxation[1], "The Act, on its true construction, treats a business as a single profit-making machine." Now, when we come to the specific provisions of sec. 10 (1), we find it enacted that "the profits arising from any business shall be separately determined for the purposes of this Act." That is to say, each taxable "profit-making machine" is to be valued separately from every other. Then says the sub-section: "but shall be so determined on the same principles as the profits and gains of the business are or would be determined for the purpose of Commonwealth income tax, subject to the modifications set out in Part IV. and to any other provisions of this Act." That is, while preserving the segregation of the given "business" its results are to be ascertained just as they would be under the Income Tax Assessment Act, subject to any special provisions of the War-time Profits Tax Assessment Act. Does that attract par. (i) of sec. 18 (1) of the Income Tax Assessment Act? Clearly not, because that sub-section, in its governing introductory words, deals with "calculating the taxable income of a taxpayer," and, in order to arrive at that, "the total assessable income derived by the taxpayer from all sources in Australia" is taken as a basis. It then provides that among permissible deductions there shall be a deduction as claimed by the appellant here. But that is not described as a deduction from business receipts, or in any way connected with a business. It is not dependent on the taxpayer sustaining a loss by the expenditure; nor is it avoided if he makes a profit on the shares. It is a concession to the taxpayer on grounds of public policy, and not as a recognition of commercial justification in arriving at profits of a business. It has nothing to do with such a process. It cannot, therefore, come within the words of sec. 10 (1) of the War-time Profits Tax Assessment Act, "profits and gains of the business." If not, how is it helped by sec. 15 (2)? The appellant says, first, that in sec. 10 (1) the words "subject to the modifications set out in Part IV." bring in sec. 15 (2). So they do, but, for the purpose of "modification," that is, of modifying the principles as to "profits and gains of the business"—and, so far, sec. 15 (2) is irrelevant. But further, it is argued that sec. 15 (2) operates ex proprio vigore. It says: "Deductions for wear and tear or for any expenditure of a capital nature for renewals, or for the development of the business or otherwise in respect of the business, shall not be allowed except such as may be allowed for the purposes of the Commonwealth income tax." That, of course, is not an independent section. It is a sub-section of sec. 15, which is headed "Computation of Profits." The first sub-section shows that "actual profits" is the object sought after. But since the words "actual profits" were affirmatively enacted in sub-sec. 1, not only was a special proviso to that sub-section found necessary, but a distinct provision as to deductions was obviously required to prevent any misapprehension. Sub-sec. 2 was therefore inserted, but only in connection with the "profits" of the specific business: and other sub-sections were added with reference to the same subject. Sub-sec. 2, therefore, does not extend to anything that is not allowed for the purposes of the income tax as a deduction from the gross income from a business in order to arrive at the taxable amount of its profits. Par. (i) of sec. 18 (1) of the Income Tax Assessment Act is not of that character. It does not connote a business at all; it does not connote expenditure for a business; still less does it connote a loss in a business. It is, therefore, outside the words and scope of sec. 15 (2) of the War-time Profits Tax Assessment Act. It is for the same reason equally outside the purview of the first proviso to sec. 10 (1) of the same Act, and, of course, entirely outside the mercantile notion of a legitimate factor in arriving at the actual profits of a business. For these reasons my opinion is as I have stated.

I have come to the conclusion that the question should be answered in the negative. But there is much in Mr. Latham's argument with which I concur; and I am not at all surprised that such a question has arisen under this difficult Act. The draftsman has taken, without the usual marginal acknowledgment, sec. 15 (2) from the fourth schedule to the British Finance (No. 2) Act 1915; and the words are not quite appropriate to the provisions of the Australian Act. I agree with the argument that the acquisition of the shares in the Yarra Falls Co. was part of the business of the appellant company, under its memorandum of association; and that it is not for the Court to treat one object stated in the memorandum as being on a different level from the other objects. But, in my opinion, sec. 10 of the War-time Profits Tax Assessment Act 1917-1918 does not import into that Act the provision in question (sec. 18 (1) (i) of the Income Tax Assessment Act 1915-1918). The provision is that "in calculating the taxable income of a taxpayer the total assessable income ... shall be taken as a basis, and from it there shall be deducted ... (i) five per centum of the total amount paid in the year in which the income is derived in respect of calls on the shares of a company carrying on operations in Australia." Sec. 10 of the War-time Profits Tax Assessment Act provides that the profits arising from any business shall be determined on the same principles as the profits and gains of the business would be determined for the purpose of the Commonwealth income tax. But the provision in question does not enter into the determination of the profits and gains of the business at all; it enters into the calculation of the "taxable income" after the profits of any business have been determined, and the exemptions (sec. 11), and only as part of the subsequent "deductions" (sec. 3—definition of "income from personal exertion," "assessable income," "taxable income"). As for the other section on which stress has been laid—sec. 15 (2) of the War-time Profits Tax Assessment Act—the words are merely negative, that there shall not be deductions for wear and tear, for expenditure of a capital nature for renewals, or for the development of the business or otherwise in respect of the business, unless such as may be allowed for the purposes of the Commonwealth income tax. Whatever is to be deemed the precise meaning of the words "for the development of the business or otherwise in respect of the business" as applied to the War-time Profits Tax Assessment Act, or to the Income Tax Assessment Act, they do not, in my opinion, apply to the curious provision contained in sec. 18 (1) (i) of the latter Act.

I have had the advantage of reading the judgment of my brother Isaacs, and agree with it. I answer the question asked in the negative.

The War-time Profits Tax Assessment Act 1917-1918 imposes a tax upon all war-time profits from any business, calculated and computed according to the provisions of the Act. The important section for the purposes of this case is sec. 10, which provides that the profits arising from any business shall be separately determined for the purposes of the Act, but shall be so determined on the same principles as the profits and gains of the business are or would be determined for the purpose of the Commonwealth income tax subject to the modifications set out in any other provisions of the Act. Profits and gains in a commercial account are estimated "by setting against the income earned the cost of earning it" (Usher's Wiltshire Brewery Ltd. v. Bruce[2]). The problem is to determine the extent to which the War-time Profits Tax Assessment Act, coupled with the Income Tax Assessment Act, has modified or limited this method.

Part IV. of the War-time Profits Tax Assessment Act allows various deductions and restricts others. Thus sec. 15, sub-sec. 2, contains both a restriction and an allowance. The allowance, as I understood the argument, was such expenditure as might be permitted, for the purposes of the Commonwealth Income Tax Assessment Act, for the development of the business or otherwise in respect of the business. With this exception, it was not suggested that the provisions of Part IV. touched this case. We are therefore driven to a consideration of the Income Tax Assessment Act 1915-1918.

Strangely enough, we do not find in the Income Tax Assessment Act any express provisions for determining the profits and gains of a business but only for determining taxable income, which may or may not include the profits or gains of a business. Apparently the provisions of sec. 10 of the War-time Profits Tax Assessment Act were taken from the Finance (No. 2) Act 1915 (5 & 6 Geo. V. c. 89), sec. 40. But there the provision that the profits of the trade or business should be determined on the same principles as the profits and gains of the trade or business would be determined for the purpose of income tax, is intelligible; for the English income tax is imposed upon (inter alia) the annual profits or gains arising or accruing from any trade exercised within the United Kingdom. Now, the Federal Income Tax Assessment Act provides that in calculating the taxable income of a taxpayer there shall be deducted (inter alia) five per centum of the total amount paid in the year in which the income is derived in respect of calls on the shares of a company carrying on operations in Australia. The taxpayer had established knitting mills in Victoria and manufactured woollen and worsted goods of all descriptions. In 1918 it subscribed for shares in another company—a spinning company—as it was empowered to do under its memorandum of association, and paid in respect of calls on the shares a sum of £79,500. It claimed to deduct five per centum of this sum. The amount was an expenditure, as I understood the argument, in the development or otherwise in respect of the business of the company. But it was not an outgoing incurred in gaining or earning the profits of the company, and I fail to understand, apart from express statutory authority, how such expenditure could be taken into account in computing the profits of the company. Consequently the taxpayer is forced to assert that the Income Tax Assessment Act, sec. 18, sub-sec. 1 (i), coupled with the War-time Profits Tax Assessment Act, does allow this expenditure as a deduction from profits whether it was or was not an outgoing incurred in or in connection with the gaining of the profits of the company.

The object of the War-time Profits Tax Assessment Act is to ascertain the profits of a business, and the true intent of sec. 10 of the Act is to utilize for that purpose any principles set forth in the Income Tax Assessment Act for determining the profits of a business, subject to such modifications as may be found in the War-time Profits Tax Assessment Act. But the section does not enable all the deductions set forth in sec. 18 of the Income Tax Assessment Act to be deducted from profits whether they have or have not any connection with the earnings of a business. The calls paid in the present case have no connection with the earnings of the company in its business, and therefore, in my opinion, the question must be answered in the negative.

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

[1] [1922] HCA 9; (1922) 30 C.L.R., 198, at p. 205.

[2] (1915) A.C., 433, at pp. 444, 458.

High Court of Australia

Australian Knitting Mills Ltd (in Liq) v Federal Commissioner of Taxation [1923] HCA 5; (1923) 31 CLR 511 (20 March 1923)

HIGH COURT OF AUSTRALIA