Commissioner of Taxes (Vic) v Phillips [1936] HCA 11; (1936) 55 CLR 144 (27 April 1936)

HIGH COURT OF AUSTRALIA

The Commissioner of Taxes (Victoria) Appellant; and Phillips Respondent.

H C of A

On appeal from the Supreme Court of Victoria.

27 April 1936

Starke, Dixon and Evatt JJ.

Fullagar K.C. (with him Tait), for the appellant.

Wilbur Ham K.C. (with him Coppel), for the respondent.

Fullagar K.C., in reply.

The following written judgments were delivered:—

April 27

Starke J.

This is an appeal from a decision of the Supreme Court of Victoria upon a special case stated by a Judge of County Courts. Every person is liable to tax, under the Victorian Income Tax Act 1928, in respect of income, whether from property or personal exertion (secs. 10 and 3). Persons carrying on any trade in partnership are liable to make a joint return as such partners in respect of the trade which they carry on, but are liable to tax only in their separate individual capacities (sec. 53). It appears from the case stated that the taxpayer—the respondent here—and his brother carried on for many years a business in partnership, as amusement managers and directors. Directors' fees, salaries, dividends, &c., were received by them in the course of their business, and were treated as the income of the partnership. The taxpayer had an agreement with the Central Co. Theatre Pty. Ltd. (called the Central Co.) to serve it as governing director for ten years at a remuneration equivalent to 12½ per cent on the net annual profits arising from entertainments carried on by the company in a theatre to be erected in Melbourne, and afterwards known as the Capitol Theatre, in addition to the taxpayer's share of ordinary directors' fees. This remuneration was carried to the credit of the partnership accounts. The Famous Lasky Film Service Ltd. (called the Lasky Co.) took over the Capitol Theatre from the Central Co. and conducted entertainments therein. The Lasky Co. agreed to pay to the Central Co. £20,301, "which sum it was necessary for the Central Company to pay" to the taxpayer to retire him "from the service of the Central Co. as its governing director of the said theatre." The amount of £20,301 was computed on a basis of £5,252 a year for the unexpired portion of the period of ten years mentioned in the agreement between the Central Co. and the taxpayer. Prior to this last-mentioned agreement, the taxpayer had informed the Central Co. that he would expect compensation for loss of remuneration as governing director if the Lasky Co. took over the Capitol Theatre, but upon the agreement between the Central Co. and the Lasky Co. being executed, the taxpayer informed the Central Co. that he was satisfied with the arrangement contained in it, and would not claim compensation from it except to the extent to which the Lasky Co. paid the Central Co. During the year 1932 the Lasky Co. paid the Central Co. a sum of £4,444, part of the sum of £20,301, pursuant to the agreement already mentioned. The Central Theatre Co. during the same year paid to the taxpayer this sum of £4,444. The taxpayer ceased to carry on his duties as governing director of the Capitol Theatre soon after the agreement was made between the Central Co. and the Lasky Co. This sum of £4,444 was carried to the credit of the partnership accounts.

The Commissioner made an assessment of the taxable income of the taxpayer for the financial year 1932-1933. He assessed the taxable income of the taxpayer at one-half the amount at which he assessed the taxable income of the partnership for the same year, and in assessing the taxable income of the partnership he included as part of its assessable income the sum of £4,444. The question stated was: "Was the Commissioner right for the purpose of assessing the taxable income of the taxpayer for the year ended 30th June 1932, in including in the income of the partnership for that year, one-half of which was taxable income of the taxpayer, the said sum of £4,444?" The Supreme Court by a majority resolved this question in the negative: hence this appeal on the part of the Commissioner.

The services rendered by the taxpayer to the Central Co. were of a personal nature, but according to the facts stated in the case, the performance of such services was part of the partnership business, and payments made in respect thereof were rightly credited to the partnership account. Further, the case states as a fact that the sum of £4,444 was treated as belonging to the partnership, and was accordingly credited to the account of the partnership. But the question remains whether it was an income receipt for the purposes of the Income Tax Act 1928.

The decisions of the House of Lords in British Insulated and Helsby Cables Ltd. v. Atherton[1], and Van den Berghs Ltd. v. Clark[2], state the general considerations which govern the determination of the question. "When an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade ... there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital"[3]. But whether a receipt is an income or a capital receipt is substantially a question of fact. Now, as was asked in Van den Berghs' Case[4], what was the taxpayer giving up? It is very relevant to inquire whether the thing in respect of which the taxpayer received the sum in question here is a deprivation of one of the capital assets of the trading enterprise, or, short of that, the deprivation of an opportunity of earning profits in the ordinary course of the business (Burmah Steam Ship Co. v. Commissioners of Inland Revenue[5]; Short Bros. Ltd. v. Commissioners of Inland Revenue[6]). The service agreement which was given up, in the present case, was one made in the ordinary course of the partnership business: it was not, as in Van den Berghs' Case[7] and in Californian Oil Products Ltd. (in Liquidation) v. Federal Commissioner of Taxation[8], the basis or the foundation of the trading activities of the taxpayer. It does not follow that the payment of the sum of £4,444 made to the taxpayer necessarily represented income because it was measured by the stipulations contained in the service agreement, but nevertheless the taxpayer received, in an agreed sum and by instalments, the remuneration which would otherwise have been received under that agreement over a series of years. In the course of the partnership business and with reference to the service agreement only, the taxpayer gave up the opportunity of earning remuneration under that agreement, for the agreed sum, payable by instalments. Sums received under such an arrangement are in my judgment revenue or income receipts and not receipts of a capital nature.

The appeal should be allowed, and the question stated in the case answered in the affirmative.

Dixon and Evatt JJ.

The taxpayer's calling is described as that of amusement manager and director. In 1920 he undertook to manage and direct a large theatre about to be erected by a company which was then formed. He was a member of the company's board of directors. An agreement was entered into between the taxpayer and the company by which for a period of ten years from the opening of the theatre he agreed to serve, and the company to employ him, as governing director of the theatre. His duties included the management and control of the theatre and of all entertainments, exhibitions and shows held therein by or on behalf of the company. As remuneration for his services as governing director of the theatre he was to receive a percentage of the profits of the undertaking. The percentage was independent of his fees as a director of the company. His remuneration as governing director of the theatre was fixed by the agreement at twelve and a half per cent of the annual net profits arising from the amusements carried on in the theatre by or on behalf of the company. It was payable monthly. The theatre was opened on 7th November 1924. The term of the taxpayer's agreement, therefore, would expire on 7th November 1934.

After the company had carried on the theatre for six years, it agreed to lease the theatre to another concern for a period of ten years, beginning on 26th December 1930, with an option of purchase exercisable within four years. Before this agreement was completed, the taxpayer stated that he expected compensation for loss of his remuneration as governing director of the theatre. The company's board of directors did not dispute his right to damages if the transaction went through and no agreement upon the amount of his compensation were made. After discussion with the taxpayer, they did agree upon an amount of £20,301. The unexpired period of his agreement was three years and forty-five weeks. Having regard to the amounts he had received in the past, the annual amount the taxpayer was likely to receive in the future, if his agreement were to go on, was estimated at £5,252, that is, £101 a week. It was on this basis that the amount was fixed at £20,301, which is the total of £101 a week for the residue of the term. The board of directors agreed to and did procure the inclusion of the following provision in the agreement between the company and the lessee which took over the theatre, viz.:—"The lessee hereby undertakes and agrees that in addition to the aforesaid moneys it will pay to the lessor the sum of twenty thousand three hundred and one pounds which sum it is necessary for the lessor to pay to" the taxpayer "in order to retire the said" taxpayer "from the service of the lessor as its governing director of the said theatre and the said sum of twenty thousand three hundred and one pounds shall be paid as follows: Four hundred and four pounds on the twenty-third day of January one thousand nine hundred and thirty-one and thereafter by equal payments of four hundred and four pounds every four weeks until the final payment which shall be one hundred and one pounds."

In the taxpayer's assessment for Victorian income tax derived during the twelve months ended 30th June 1932, the Commissioner has included the amounts derived by him from payments received pursuant to this arrangement. A partnership existed between the taxpayer and his brother under the terms of which they shared equally their receipts from all sources. Accordingly the amount carried into the assessment represented only half the sums which the company received from the lessee and paid to the taxpayer.

The question is whether the sums so included in the assessment formed part of the taxpayer's assessable income. In our opinion the sum does form part of his assessable income.

The substance of what the taxpayer obtained under the agreement he made was a right to receive a monthly payment of £404 during the unexpired residue of his agreement of service with the company. The agreement of cancellation or rescission substituted this payment for the monthly payments which he would have earned by directing the theatre, payments of uncertain amount representing 12½ per cent of the profits. An estimate of these future payments of uncertain amount produced the regular monthly sum of £404. He gave up the right to the future payments calculated upon the profits and was relieved of the duties of management. While, if his agreement had gone on, the performance of that agreement would have been the proximate source of the income and its amount would have fluctuated, under the new arrangement the receipts were derived from the mere subsistence of the contract, which needed no performance on the part of the taxpayer, and the amount of the monthly payment was fixed. It appears to us that, for future income which he had a right to earn by performing the agreement, he exchanged a right to receive, through the same duration of time and at the same intervals of time, amounts estimated as equivalent to the income otherwise payable to him. It is true that to treat a sum of money as income because it is computed or measured by reference to loss of future income is an erroneous method of reasoning (cf. Californian Oil Products Ltd. (in Liquidation) v. Federal Commissioner of Taxation[9]; Van den Berghs Ltd. v. Clark[10]). It is erroneous because, for example, the right to future income may be an asset of a capital nature and the sum measured by reference to the loss of the future income may be a capital payment made to replace that right. Or, again, the computation may be done for the purpose of ascertaining what capitalized equivalent should be paid for the future income. But, where one right to future periodical payments during a term of years is exchanged for another right to payments of the same periodicity over the same term of years, the fact that the new payments are an estimated equivalent of the old cannot but have weight in considering whether they have the character of income which the old would have possessed. Even in the case of a sale of land, the parties may, if they choose, adopt a consideration consisting of annual payments which are income and not merely deferred payments of capital (see Eqerton-Warburton v. Deputy Federal Commissioner of Taxation[11] and the cases there cited). A contract of service is valuable only because of the income it will bring during the residue of its term. It is not a piece of marketable property. Unless it is rescinded or broken, it is not usually possible to obtain a lump sum or any other consideration representing its value. When such an occasion arises its value is likely to be expressed in terms of income and is by no means certain to be translated into capital. No prima facie reason exists for regarding as instalments of capital annual payments which are taken in place of the contractual rights such a contract gave.

In the present case, the contract expressed the total of the monthly payments as a lump sum. But the period being fixed, the rate of payment being estimated and the intervals being already established, the statement is no more than an arithmetical equivalent. Indeed, it is not the present value of the future payments but merely their sum. In Van den Berghs Ltd. v. Clark[12] Lord Macmillan says: "If the" taxpayers "were merely receiving in one sum down the aggregate of profits which they would otherwise have received over a series of years the lump sum might be regarded as of the same nature as the ingredients of which it was composed."

In the present case, there is no lump sum down: there are monthly payments estimated to correspond in amount with the monthly payment which otherwise the taxpayer would have received and the payments are to be made over the same period of time. In these circumstances they must, in our opinion, be regarded as of the same nature as the payments they replace. They are of an income nature.

For these reasons we think the appeal should be allowed, the order of the Supreme Court discharged and the question in the special case answered in the affirmative, and the special case with that answer should be remitted to the County Court.

The taxpayer, the respondent to this appeal, should pay the costs of this appeal and of the special case in the Supreme Court.

Appeal allowed. Judgment of Supreme Court of Victoria dated 31st October 1935 set aside. Question stated in case answered: "Yes." Case remitted to County Court at Melbourne with the answer aforesaid. Order that respondent, Phillips, pay costs of and incidental to preparation, and reference to and hearing by the Supreme Court, of the special case, and the costs of the appeal to this Court.

Solicitor for the appellant, F. G. Menzies, Crown Solicitor for Victoria.

Solicitors for the respondent, Arthur Robinson & Co.

[1] (1926) A.C. 205.

[2] (1935) A.C. 431.

[3] (1926) A.C., at pp. 213, 214; (1935) A.C., at pp. 439, 440.

[4] (1935) A.C. 431.

[5] (1931) S.C. 156.

[6] (1927) 12 Tax Cas. 955.

[7] (1935) A.C. 431.

[8] [1934] HCA 35; (1934) 52 C.L.R. 28.

[9] (1934) 52 C.L.R., at pp. 46, 49, 51.

[10] (1935) A.C., at p. 442.

[11] [1934] HCA 40; (1934) 51 C.L.R. 568, at pp. 572, 573.

[12] (1935) A.C., at p. 442.