Clarke v Federal Commissioner of Taxation [1932] HCA 46; (1932) 48 CLR 56 (15 September 1932)

The taxpayer complains of an assessment based upon the year of income ended 30th June 1925 in which the Commissioner included two sums of money as premiums or consideration in the nature of premiums demanded and received in connection with leasehold estates.

The taxpayer was owner in fee simple of licensed premises called the Burwood Hotel. In April 1924 he sought a lease of other licensed premises called the St. George Hotel. This hotel was owned by a company of brewers and occupied by a tenant under a lease expiring in that month. In carrying on their business it was the practice of the brewers not to refuse to renew the lease of a tenant except in very special circumstances. They acted upon this practice in their negotiations with the taxpayer who was informed that, subject to his acquiring from the tenant of the St. George Hotel the brief residue of his term, the brewers would grant to the taxpayer a new lease for ten years for the following consideration, namely, (i.) payment at the commencement of the lease of a sum of £12,000, (ii.) reservation of a weekly rent of £42, (iii.) a covenant by the taxpayer with the brewers operating to "tie" the Burwood Hotel to the brewers for a period of twenty years. The taxpayer accepted these terms. To the previous tenant he paid the sum of £7,500 for the few remaining days of his lease. The "tie" which he created over his own hotel—the Burwood Hotel—was a detriment which diminished its value to an extent measurable in money. In the following September the taxpayer granted a sub-lease of the St. George Hotel for a period of four years and seven and a-half months, retaining a term of five years in the head lease expectant on the expiration of this sub-lease. The sub-lease reserved a weekly rent of £42, but for granting it the sub-lessee paid the taxpayer a further consideration of £11,572. This amount is the first of two sums which the Commissioner has included in the taxpayer's assessable income as premiums in connection with leaseholds. The provision upon which their inclusion depends is sec. 16 (d) of the Income Tax Assessment Act 1922-1925, which is as follows:—"The assessable income of any person shall include ... (d) money derived by way of royalty or bonuses, and premiums fines or foregifts or consideration in the nature of premiums fines or foregifts demanded and given in connection with leasehold estates."

The taxpayer's first contention is that the provision does not extend to sums obtained by a lessor as part of the consideration for a grant of a new lease, but that it is confined to exactions after a lease has been granted and the relation of landlord and tenant has thus been established; as for instance the exaction of a fine upon consenting to an assignment. In support of this construction some expressions used by Isaacs J. (as he then was) in Dalrymple v. Commissioner[1] are relied upon. But it is by no means clear that they bear this meaning, and the better view appears to be that expressly stated in the judgment of Knox C.J., Gavan Duffy and Starke JJ. in the same case[2], that "The object ... is to include in the income of a lessor all sums paid by a tenant other than the rent reserved by the lease, such as sums which are demanded on the renewal or surrender of a lease or on the giving of a new lease." Accordingly, the sum of £11,572 was properly included in the taxpayer's assessable income. This being so, the taxpayer's next contention is that an answerable deduction should be allowed in the assessment under sec. 23 (1) (a), which provides that from the assessable income there shall be deducted all losses and outgoings (not being in the nature of losses and outgoings of capital) including commission, discount, travelling expenses, interest and expenses actually incurred in gaining or producing the assessable income. He claims that at least a proportion of the sums paid to the brewers and to the previous tenant and of the money equivalent of the "tie" should be deducted under this provision, because they were outgoings in the acquisition of the head-lease without which the under-lease could not have been granted. It is a sufficient answer to this claim that the outgoings were of a capital nature. They represented the present price of the future enjoyment of an interest in land of long duration. It is quite true that the premium is an anticipated rent. That means, however, that what otherwise might have been part of the rent reserved has been capitalized. No doubt it is capital expended in the acquisition of an asset of a diminishing or wasting nature and therefore requiring in a proper account a provision for depreciation. But the annual loss which would so be provided for out of revenue would none the less be a loss of capital. (See MacTaggart v. Strump[3].) Further, sec. 25 (i) forbids, subject to a proviso, any deduction in respect of any wastage or depreciation of a lease or in respect of any loss occasioned by the expiration of any lease. It is upon the proviso to this enactment that the taxpayer must depend for his right to claim a deduction in respect of the consideration given for the head-lease. The material portions of this clause enable the Commissioner, when the taxpayer has paid a fine, premium or foregift or consideration in the nature of a fine premium or foregift for a lease, to allow, as a deduction for the purpose of arriving at the income, the amount obtained by dividing the sum so paid by the number of years of the unexpired period of the lease at the date of payment. The word "paid" and the expression "the sum so paid" create an insuperable obstacle to the taxpayer's claim to a deduction in respect of the detriment measurable in money which the value of his fee simple in the St. George Hotel suffered through the covenant "tying" it to the brewers. In J. C. Williamson's Tivoli Vaudeville Pty. Ltd. v. Federal Commissioner of Taxation[4] observations were made as to the possibility of giving a wide meaning to this expression (see per Rich J., at p. 479, and per Starke J., at p. 480). But no reasonable latitude of interpretation could dispense with the need which arises from the terms of the proviso that a money sum should in some way be nominated or ascertained as the expression by the parties of the value given for or in connection with the lease. An unascertained loss in value resulting from a detriment incurred as part of the consideration for the lease supplies no "sum so paid" which could be divided by the unexpired term of the lease. The taxpayer's claim under the proviso to a deduction in respect of the sum of £7,500 paid to the former tenant must fail for another reason. This sum was paid to acquire the residue of the tenant's term, brief as it was. It was not paid because the lessor exacted it, or required the payment to be made, but because an expectation of renewal was annexed to the expiring lease by the practice of the brewers in dealing with their tenants. The sum was, therefore, not paid as a consideration in the nature of a fine, premium or foregift.

The taxpayer's claim to a deduction in respect of the remaining portion of the consideration which he gave for the head-lease, namely, the sum of £12,000, has been allowed by the Commissioner.

The second sum which has been included in the taxpayer's assessable income under sec. 16 (d) gives rise to other questions. On 19th February 1925 one McDonough became, by transfer from the taxpayer, licensee of the Burwood Hotel and went into occupation. He obtained a lease of it with a currency of five years from 1st July 1924 at a weekly rent of £30, for which he paid into the taxpayer's bank account the sum of £10,000, being part of a consideration of £20,000. At the same time, or shortly afterwards, a further lease to take effect on the expiry of this lease was granted to him for a term equal to the period which had expired since 1st July 1924 so that together they would make up five years. The taxpayer applied the money paid into his account to his own use. The amount of £8,651, which the Commissioner has included in his assessable income, is the net balance of this sum after proper deductions. If no more appeared, the sum would be considered a premium demanded and given in connection with a leasehold or a consideration in that nature. But the taxpayer relies upon the following additional facts: (1) The lease for five years from 1st July 1924 was not granted directly to McDonough, but to a company of which the taxpayer was governing director and sole beneficial shareholder and by that Company forthwith assigned to McDonough; (2) the Company in its books treated the sum as payable to it and afterwards, when it went into voluntary liquidation, credited him, as shareholder, with an equivalent amount as on a distribution of its surplus assets. Upon the argument it was assumed by the parties that, if the sum was treated as an amount paid by the Company in its liquidation to its sole beneficial member, it should not be included in his assessable income. But as the Company gave nothing for the lease and, upon this assumption, received the entire sum for its immediate assignment, the amount would form profits of the Company and, moreover, these profits would not arise "from the sale of assets which were not acquired for ... resale at a profit." Sec. 16 (b) (i.) includes the word "distributed" which was not contained in sec. 14 (b) of the Act of 1915-1918 upon which Webb v. Federal Commissioner of Taxation[5] was decided. Inland Revenue Commissioners v. Burrell[6] does not necessarily conclude the question whether the language of sec. 16 (b) (i.) covers a distribution of profits in the guise of surplus assets in a liquidation, and, in spite of the judgment of Higgins J. in Webb's Case[7], the question appears susceptible of argument. It is not, however, necessary to consider it in the present case. Facts have been found which, in our opinion, bring it under the operation of sec. 93 (c). This difficult provision is expressed to make absolutely void, but without prejudice to its validity in any other respect or for any other purpose, every contract, agreement or arrangement so far as it has or purports to have the purpose or effect of in any way directly or indirectly avoiding any duty or liability imposed on any person by the Income Tax Assessment Act. In its application perhaps it can do no more than destroy a contract, agreement, or arrangement in the absence of which a duty or liability would subsist. Where circumstances are such that a choice is presented to a prospective taxpayer between two courses of which one will, and the other will not, expose him to liability to taxation, his deliberate choice of the second course cannot readily be made a ground of the application of the provision. In such a case it cannot be said that, but for the contract, agreement or arrangement impeached, a liability under the Act would exist. To invalidate the transaction into which the prospective taxpayer in fact entered is not enough to impose upon him a liability which could only arise out of another transaction into which he might have entered but in fact did not enter. Where, however, the annihilation of an agreement or arrangement so far as it has the purpose or effect of avoiding liability to income tax leaves exposed a set of actual facts from which that liability does arise, the provision effectively operates to remove the obstacle from the path of the Commissioner and to enable him to enforce the liability.

In the present case the question is whether the course adopted by the taxpayer amounts to an arrangement of this nature which, when avoided, leaves him in the character of a recipient of a premium, fine or foregift, or consideration of that nature demanded and given in connection with a leasehold estate. On the whole, we think that the facts stated in the special case do disclose such an arrangement. The transaction which resulted in the payment by McDonough of the £10,000 to the taxpayer began in a negotiation or contract with another intending lessee, one Plasto. On 6th May 1924 the taxpayer had incorporated his Company. He and six nominees had executed the memorandum of association in respect of one share, but no further capital had been issued. Nevertheless, from that date the Company, as a weekly tenant at a rental, took over and conducted the business of the Burwood Hotel, the taxpayer retaining the character of licensee. The special case states that in the month of October 1924 it was agreed between the taxpayer and Plasto that the taxpayer would grant or cause to be granted to Plasto a five years' lease of the hotel for a cash payment of £20,000 and a weekly rental of £30; that it was part of such agreement (1) that Plasto should pay to the taxpayer £20,000 for his 2,001 shares in the Company, (2) that when the shares were transferred, the Company itself should be the lessee of the hotel for the agreed period of five years at the rental of £30 per week, and (3) that the details of the agreement should be arranged by the legal advisers of the taxpayer and Plasto. The special case further states that on or about 27th October 1924, and after the making of the said agreement between the taxpayer and Plasto, the Company and the taxpayer agreed that the hotel should be leased by the taxpayer to the Company for a period of five years as from a date to be agreed upon and at a rental of £30 per week. On 27th October 1924, accordingly, the taxpayer, who under the Company's articles was permanent governing director possessing all powers and authorities and discretions to carry on its business, allotted to himself 2,000 fully paid up shares of £1 each.

Some delay occurred in carrying through this transaction, and in December 1924 Plasto procured McDonough to take his place in it. But first a written agreement between the taxpayer and Plasto was executed, bearing date 12th December 1924. The effect of this agreement was that Plasto should buy and the taxpayer should sell 2,000 shares in the Company for £20,000 payable, as to £1,000 in cash as a deposit, as to £9,000 upon transfer of the licence, delivery of the scrip indorsed with a transfer and the giving of possession of the hotel and furniture, and, as to the balance of £10,000, by various instalments, the greater part of which were to be satisfied by the taxpayer procuring from the brewers an advance to the Company and applying it as directed by the brewers and himself. The agreement then provided that on the termination of what it described as "the existing lease of five years granted" by the taxpayer to the Company, Plasto would resell the 2,000 shares to the taxpayer at a price equal to the value of the hotel furniture. In the meantime no further shares were to be issued. Possession was to be given, as nearly as possible, on 15th December 1924. In fact, no lease had been granted to the Company. By an agreement dated 15th December 1924 between Plasto and McDonough, the latter agreed to take over this contract from the former. Further delays, however, occurred, and at length, in January 1925, McDonough objected to complete the purchase of shares. As the special case states:—"It was then arranged that the transaction securing to McDonough a five years' lease of the hotel would be carried out thus: (a) the Company to take a five years' lease from the appellant, from 1st July 1924 to 1st July 1929, at a rental of £30 per week. The commencing point of the lease between the appellant and the Company was thus fixed as at 1st July 1924; (b) the Company to transfer immediately the whole of its interest in such lease to McDonough for £20,000, and (c) the appellant to lease the hotel to McDonough at £30 per week from 1st July 1929 to such a date in 1930 as would make up to McDonough the balance of the agreed term of five years." This agreement necessarily involved the rescission of the former agreement and the termination of the Company's weekly tenancy. The taxpayer could have granted a five years' lease directly to McDonough. He adopted the course which he in fact pursued because, as it was found by the special case, he believed and intended that he would become liable to pay in the aggregate a less sum in respect of Federal income tax. When in May 1924 he registered his Company, he did so partly in view of a provision of the licensing law which forbids holding an interest in more than one licence and partly because of the probability of so lessening his obligations under State and Federal income tax legislation. The purpose, therefore, clearly appears of avoiding the liability which was imposed by the requirement of sec. 16 (d) that assessable income shall include consideration in the nature of a premium demanded and given in connection with leaseholds. McDonough definitely sought and obtained a leasehold interest in the Burwood Hotel, which the taxpayer granted to satisfy that very purpose. He gave, as a consideration for that leasehold interest, a premium. He paid the premium directly into the taxpayer's hands and the taxpayer retained the money. But to avoid the application of sec. 16 (d) which these facts would otherwise require, the taxpayer interposed his Company as a conduit for the assurance of the leasehold interest and as an imputed recipient of the premium. The grant of the lease to the Company, his automaton, and its immediate assignment to the intending lessee, and the subsequent liquidation of the Company, and the entries in the books of the Company narrating the taxpayer's accountability to it for the money and the accountability of himself as the Company's liquidator in a like sum, all amount to an arrangement adopted for the sole purpose of intercepting the liability to income tax which would otherwise flow from the payment to him of a consideration actually demanded and actually given in connection with a leasehold. For these reasons the sum of £8,651 formed part of the taxpayer's assessable income.

The questions in the special case should be answered as follows:—(1) Yes, the whole. (2) Yes, the whole. (3) No such deduction should be made under sec. 23 (1) (a) of the Income Tax Assessment Act 1922-1925 independently of sec. 25 (i). (4) No. (5) Having regard to the foregoing answers, an answer to this question is not necessary. The costs of the special case should be made costs in the appeal.

[1] (1924) 34 C.L.R., at p. 291.

[2] (1924) 34 C.L.R., at pp. 287, 288.

[3] (1925) S.C. 599; 10 Tax Cas. 17.

[4] [1929] HCA 33; (1929) 42 C.L.R. 452.

[5] [1922] HCA 27; (1922) 30 C.L.R. 450.

[6] (1924) 2 K.B. 52.

[7] (1922) 30 C.L.R., at pp. 481 et seqq.

High Court of Australia

Clarke v Federal Commissioner of Taxation [1932] HCA 46; (1932) 48 CLR 56 (15 September 1932)

HIGH COURT OF AUSTRALIA