W Nevill & Co Ltd v Federal Commissioner of Taxation [1937] HCA 9; (1937) 56 CLR 290 (8 March 1937)

W. Nevill and Company Limited Appellant; and The Federal Commissioner of Taxation Respondent.

This is a case stated by Evatt J. under the Income Tax Assessment Act 1922-1932, sec. 51A (8).

The appellant is a company carrying on business in New South Wales. Before July 1930 the company had been managed by a single managing director. In that month the board of directors decided to introduce a system of joint management, and L. L. King was appointed as an additional managing director. He was engaged under an agreement, dated 11th July 1930, for a term of five years from the 1st July 1930 at a salary of £1,500 per annum with a percentage of profits. Almost immediately, in August 1930, it was determined that, as business had seriously decreased, the salaries of the managing directors should be reduced for six months, but without prejudice to rights under any service agreement. In March 1931 an arrangement was made for the resignation of King under which the company agreed to pay him a sum of £2,500 in consideration of his cancelling his agreement, £1,500 to be paid in cash and the balance of £1,000 by ten equal monthly payments of £100 up to December 1931, these payments to be covered by ten promissory notes of the company. The learned judge has found that the system of joint management did not work out satisfactorily and that it tended to impair the efficient management of the business. He also found that the main object of the directors in making the arrangement for King's resignation was to effect a saving of King's salary and that at the same time the directors believed that the abolition of the system of joint control would tend to increase the efficiency of the company. The company paid the £1,500 in cash and met the ten promissory notes for £100 each, one being paid in each month from March to December 1931.

The company seeks to deduct the said sum of £2,500 from its assessable income in respect of the income year ending 30th June 1931. The commissioner disallowed the deduction and disallowed an objection against his decision, whereupon the company appealed to the High Court. This case, stated in the appeal, asks whether upon the facts stated the deduction claimed should have been allowed.

The relevant sections of the Income Tax Assessment Act 1922-1932 are as follows:—

If the expenditure in question represents a loss or outgoing of capital it cannot be deducted under the authority of sec. 23 (1) (a) or any other provision of the Act.

In British Insulated and Helsby Cables v. Atherton[1] Viscount Cave L.C., referring to expenditures, said: "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, I think that 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." The principle here enunciated provides a positive test the application of which may show that a particular expenditure—or e converso—a particular receipt, is a capital expenditure or receipt. In Ward & Co. v. Commissioner of Taxes[2] the question was whether the deduction of expenditure by a brewing company in opposing proposals for prohibition in a public campaign should be allowed for purposes of income tax in the face of a provision prohibiting a deduction of any expenditure not exclusively incurred in the production of the assessable income from a particular source. It was held that the expenditure was directed to preventing the extinction of the business from which all the income of the company was derived and that it was therefore not incurred exclusively or at all for the production of the assessable income in question. It was directed towards the preservation of the whole of the business assets of the company. Such an expenditure is distinguishable from current expenditure upon the maintenance or repair of a particular asset. It was held in Ward's Case[3] that the expenditure was a capital outgoing. The decision in Ward's Case[4], it may be observed, raises doubts as to the soundness of some of the reasoning in Toohey's Ltd. v. Commissioner of Taxation for New South Wales[5].

In the case of receipts, the principle has been applied to moneys received, not in the ordinary way of trading, but as payment made to a taxpayer company by another company for the purpose of securing the cancellation of a set of agreements which regulated the whole conduct of the profit-making enterprise of the taxpayer company. It was held that the whole congeries of rights which the taxpayer enjoyed under these agreements was a capital asset and that the price received for the surrender of these rights must be regarded as a capital receipt (Van Den Berghs Ltd. v. Clark[6]).

Circumstances of this character are not to be found in the present case. No asset was acquired by the expenditure of the sum of £2,500. The agreement between the company and King for the employment of King was not something affecting the whole structure of the company's business. Its cancellation cannot be regarded as involving the acquisition of a capital asset. The cancelled agreement was an agreement for the employment of a servant made in the ordinary course of the company's business. I am unable to discern any reason which would justify the conclusion that the £2,500 was a capital expenditure.

But in order to justify a deduction under sec. 23 (1) (a) the outgoing in question must be actually incurred in gaining or producing the assessable income.

The payments in question were actually made bona fide in the course of business in the interests of the efficiency of the business. In my opinion they fall within the terms of the proposition of Viscount Cave L.C. in British Insulated and Helsby Cables v. Atherton[7]: "A sum of money expended, not of necessity and with a view to a direct and immediate benefit to the trade, but voluntarily and on the grounds of commercial expediency, and in order indirectly to facilitate the carrying on of the business, may yet be expended wholly and exclusively for the purposes of the trade." The words "for the purposes of the trade" come from Schedule D. of the English Income Tax Act 1842. They do not appear in sec. 23 (1) (a) of the Federal Act. The words in sec. 23 (1) (a) are "in gaining or producing the assessable income." The principle asserted in Viscount Cave's statement is, however, equally applicable to a case arising under sec. 23 (1) (a). The facts stated in this case show that the expenditure was actually incurred in gaining or producing the assessable income of the year in question. The expenditure was made for the purpose of increasing the efficiency of the company and therefore increasing its income producing capacity. It was not a capital expenditure, it was, in my opinion, an expenditure incurred in the course of gaining or producing assessable income (See Amalgamated Zinc (De Bavay's) Ltd. v. Federal Commissioner of Taxation[8]).

It is urged, however, that in so far as the expenditure was directed towards reducing current and future expenses by securing relief from the onerous contract to pay £1,500 to King for five years, it did not increase assessable income. Assessable income is gross income (See sec. 4). The mere reduction of expenditure, though it decreases the expenditure side of an account, does not increase the receipts side of the same account. In my opinion the answer to this contention is to be found in a recognition of the fact that it is necessary, for income tax purposes, to look at a business as a whole set of operations directed towards producing income. No expenditure, strictly and narrowly considered, in itself actually gains or produces income. It is an outgoing, not an incoming. Its character can be determined only in relation to the object which the person making the expenditure has in view. If the actual object is the conduct of the business on a profitable basis with that due regard to economy which is essential in any well-conducted business, then the expenditure (if not a capital expenditure) is an expenditure incurred in gaining or producing the assessable income. If it is not a capital expenditure it should be deducted in ascertaining the taxable income of the taxpayer.

It is now necessary to consider whether the deduction of the expenditure in question is prohibited by sec. 25 (e), which forbids the deduction of any money not wholly and exclusively expended for the production of assessable income. Under head 2 above I have already dealt to some extent with this aspect of the case and have expressed the opinion that the expenditure was incurred in gaining or producing assessable income. The question which it is now necessary to determine is whether it was wholly and exclusively laid out or expended for that purpose. The same question arose under similar circumstances in Mitchell v. B. W. Noble Ltd.[9]. In that case a company paid a sum of money as the price of getting rid of a life director whose presence on the board was regarded as detrimental to the conduct of the company's business (See the acceptance of this case as rightly decided in Van Den Berghs Ltd. v. Clark[10]). It was held that the expenditure was an income expenditure and that it could properly be deducted as money "wholly and exclusively laid out and expended for the purposes of the trade." All the relevant circumstances are the same as in the case now before the court, and, in my opinion, Mitchell's Case[11] is sufficient authority to justify the conclusion that the deduction claimed is not prohibited by reason of sec. 25 (e).

The only remaining question is whether the whole sum of £2,500 should be deducted from the income derived in the year ending 30th June 1931. In that year £1,500 was paid in cash and four promissory notes for £100 each were paid. There were six promissory notes each for £100 outstanding. These fell due and were paid at dates in each month from July to December 1931. The taxpayer claims that not only the £1,900 actually paid in the year ending 30th June 1931 should be deducted but also that the further £600 payable under the six outstanding promissory notes should be deducted as outgoings actually incurred in that year. This contention raises what, in my opinion, is a difficult question. The outgoing, in order to be deducted, must be an outgoing "actually incurred" (sec. 23 (1) (a)). The word used is "incurred" and not "made" or "paid." The language lends colour to the suggestion that, if a liability to pay money as an outgoing comes into existence, the quoted words of the section are satisfied even though the liability has not been actually discharged at the relevant time. The word "actually" is not inconsistent with this view. It is only the incurring of the outgoing that must be actual; the section does not say in terms that there must be an actual outgoing—a payment out. On the other hand the section does not speak of debts or liabilities, but of losses and outgoings. As a general rule the word "outgoing" in itself would be understood to be limited to money that actually went out and not to include money which would go out at some future time. It is impossible to avoid the reflection that, if it were held that deductions could be obtained in any given year by the simple process of signing promissory notes in respéct of genuine liabilities which would not fall due until that year had expired, a taxpayer would be able, by such action, to influence the rate of tax in his own favour in an exceptionally profitable year. The question is, therefore, one of considerable importance. This question was not argued in the present case because the promissory notes outstanding on the 30th June 1931 have since been paid and the deduction can be claimed in respect of the income of the following year. The taxation of companies is at a flat rate, and therefore it is immaterial to the parties whether or not the £600 representing the later promissory notes should be deducted in respect of the earlier year. For that reason it is not necessary to give a reasoned decision upon the question mentioned. I would require to hear full argument before deciding this question. I merely state my view, not as a concluded opinion, but in order to reach a determination in this case, that the sum of £600 should be deducted from the income of the year ending 30th June 1932 and not from the income of the preceding twelve months.

The question in the case should be answered by stating that £1,900, part of the said £2,500, should be allowed as a deduction.

Case stated by Evatt J. The question propounded involves two distinct inquiries. The first is whether the sum which the taxpayer claims to deduct was an expenditure of an income or of a capital nature, and the second is whether within the meaning of sec. 25 (e) of the Income Tax Assessment Act 1922-1932 this sum was wholly and exclusively laid out or expended for the production of assessable income. In my opinion the sum constitutes an expenditure on account of income and it was wholly and exclusively laid out for the production of assessable income. The sum in question was a payment made to one of two joint managing directors of the taxpayer company in consideration of his agreeing to the rescission of a contract entitling him to retain that office for another four years or more at a salary of £1,500. The company's purpose in effecting the transaction was to save the salary and at the same time to put an end to joint control. In such an expenditure I can see no characteristics which would make it referable to capital account. There is nothing analogous to the acquisition of a fixed asset, to the enlargement of the goodwill of a company or, as in Ward's Case[12], to the rescue of the business from annihilation. The question in the present case arose in relation to the staff and although, owing to the superior position of the officer, it was an important one and unlikely to recur, in other respects it was of a description which must arise over and over again in the conduct of any business where there is a large staff many of whom have a fixed tenure under contract. The expenditure was made as an incident in the organization of the company's officers. The case law dealing with such matters will be found in Van Den Berghs Ltd. v. Clark[13] and in Anglo-Persian Oil Co. v. Dale[14]. The sum is not an expense which fulfils any of the tests laid down in those authorities for an expenditure of a capital nature. The second inquiry depends upon the purpose for which the expenditure was made. The contention for the Commonwealth is that, as admittedly the object of making the lump sum payment was to save the future expenditure of the joint managing director's salary, it could not be exclusively and wholly laid out for the production of assessable income. For it was said to avoid expenditure is not to obtain assessable income. This argument seems to me to confine the investigation of the purpose to a stage later than that to which the taxpayer is entitled to go back. The taxpayer had committed itself at an anterior date to an expenditure on salaries for its managing directors. Its sole purpose in doing so was to earn income; but later the company found that in the prosecution of this purpose it had committed itself to a future expenditure unnecessarily large. It then negotiated what may be described as a commutation of the excess future expenditure it had otherwise incurred. So regarded, the purpose of the whole transaction was to gain assessable income. The commissioner cannot rivet attention on the last stage to the exclusion of the earlier stage of the course of dealing which leads to the total expenditure.

The interesting question to which year or years the expenditure should be allocated in view of the fact that it was secured by promissory notes maturing over two years was not raised by the commissioner or argued by counsel. I do not propose to consider it and am content to adopt the course proposed by the Chief Justice without deciding the question of law.

The deduction claimed by the taxpayer company is for a payment made, in cash or by negotiable instrument, during the year of income in order to obtain the resignation of one of its two joint managing directors. He had been appointed at a salary of £1,500 for a term of five years of which more than four were unexpired. The system of joint managership proved undesirable, if not unworkable, and when in the depression the question arose whether the two managing directors should not consent to a reduction of salary, it was made the occasion for negotiating an arrangement with one of them for his retirement. He agreed to resign in consideration of a sum of £2,500, of which £1,500 was paid immediately and the balance of £1,000 was secured by ten promissory notes of £100 payable at intervals of a month.

The question is whether the sum of £2,500, or any part of it, should be deducted from the assessable income. The question is governed by sec. 23 (1) (a) and sec. 25 (e) of the Income Tax Assessment Act 1922-1932. Under the first of these provisions it is necessary that the expenditure should have been incurred in gaining or producing the assessable income, that is the assessable income of the given financial year or accounting period. This means that it must have been incurred in the course of gaining or producing the assessable income. It does not require that the purpose of the expenditure shall be the gaining or production of the income of that year. The condition the provision expresses is satisfied if the expenditure was made in the given year or accounting period and is incidental and relevant to the operations or activities regularly carried on for the production of income. This is explained in Amalgamated Zinc (De Bavay's) Ltd. v. Federal Commissioner of Taxation[15].

The expenditure upon the retiring allowance of the managing director appears to me to fulfil this test, except for the circumstance that some of the promissory notes fell due outside the financial year.

But sec. 23 (1) (a) imposes another and a negative condition. The expenditure must not be of a capital nature. For the commissioner it is contended that in, so to speak, buying out the managing director, the taxpayer company, in effect, commuted its loss on his future salary for an immediate capital payment. Some of the reasons given in support of the argument treated the question whether the payment of the retiring allowance by the company should be considered as part of its capital expenditure as interdependent with the question whether its receipt by the managing director should be considered part of his assessable income or as an addition to his capital. In my opinion there is no necessary connection between the two questions and, indeed, an attempt to obtain guidance in the solution of one by considering the other is not without danger. The question whether a receipt or expenditure is to be treated as on account of income or capital depends upon the relation of the taxpayer to the payment in question. If a company conducting an organized business of buying land and selling it in subdivision happens to purchase an area of land hitherto held for the purpose of agriculture, the purchase money will undoubtedly be capital in the hands of the vendor, but it will be treated as expenditure of an income nature in making up the profit and loss account of the company.

In the present case the payment of a lump sum to secure the retirement of a high executive officer may have been unusual. But it was made for the purpose of organizing the staff and as part of the necessary expenses of conducting the business. It was not made for the purpose of acquiring any new plant or for any permanent improvement in the material or immaterial assets of the concern. The purpose was transient and, although not in itself recurrent, it was connected with the ever recurring question of personnel.

Under sec. 25 (e) a different question arises. That provision forbids the deduction unless it consists of money wholly and exclusively laid out or expended for the production of assessable income. It is unnecessary that the assessable income for the production of which the expenditure was made should be that of the given year or accounting period (See De Bavay's Case[16]). But, according to the language of the paragraph, the money must be laid out for the production of assessable, not taxable, income. Upon this distinction the commissioner bases a contention that no expenditure is deductible which has for its purpose the reduction or avoidance of outgoings as distinguished from the gaining of gross income This statement may be literally true, but its application does not necessarily lead to the consequences the commissioner deduces. For it is fallacious, in my opinion, to draw a distinction between the purpose of reducing or avoiding outgoings and the purpose for which the outgoings so to be reduced or avoided are incurred. Thus, in the present case, if attention is confined to the purpose for which the lump sum payment was made to the retiring director, it may be true that it was in order to save his future salary. Indeed, the case stated says that the main object of the directors was to effect a saving of that salary, although at the same time they believed that by abolishing the system of joint control they would increase the efficiency of the company. But it is not correct to look only to the purpose actuating the expenditure in the state of facts in which it was resolved upon. The whole course of the transaction must be regarded. When an agreement was made by the company committing it to an annual expenditure for five years of £1,500 upon the managing director's salary, that obligation was undoubtedly incurred "for the production of assessable income." The company thus undertook an expenditure which, if it had gone on, would have been deductible. The purpose appears to me to govern the entire course of the transaction. On reconsideration, it appeared that the purpose would be better fulfilled by a rearrangement involving an expenditure made in commutation of that undertaken. Why should the original purpose be excluded from view and the immediate purpose alone be considered? A wide view should be taken of the meaning of sec. 25 (e). For it is intended to apply to an infinite variety of sources of income. When the expenditure avoided or reduced has been or would be incurred for the production of income, it appears to me that the substituted expenditure comes fairly within the description money exclusively laid out for the production of income.

In my opinion the retiring allowance is a deductible outgoing. But I do not think that so much of it as was represented by promissory notes payable after 30th June 1931 can be deducted in the assessment for the financial year ending 30th June 1932.

In my opinion the question in the case stated should be answered: Yes, £1,900 thereof.

I agree that the answer to the question should be as stated in the judgment of the Chief Justice. The assessable income of the company was necessarily gained through the agency of its employees and it follows that the expense of providing and maintaining such an organization is to be attributed to the operation of producing the company's income. The maintenance of this income-earning agency involves its adjustment to conditions which arise such as those mentioned in the stated case. The expense incurred in effecting these adjustments is also to be attributed to the earning of the company's income. Upon the facts appearing in the stated case I think that the expenditure with regard to which the present question arises is within the scope of sec. 23 (1) (a). These facts show that the expenditure was incurred to adapt the managerial part of the company's organization for making profits to conditions affecting its business and as such was incidental to its income-earning activities.

The expenditure was made in the relevant accounting period, but it is not necessary that the assessable income for the gaining of which the expenditure was made was income of that period (De Bavay's Case[17]).

There is no substance in the contention that the deduction claimed was an outgoing of capital. The only ground on which it was sought to support that contention was that the moneys were capital in the hands of the recipient. Even if that view were correct it would furnish no reason for ascribing to the expenditure the character of a capital payment by the company.

The result aimed at by the company in expending the moneys now in question was to obtain the resignation of the recipient, he having been appointed at an annual salary for a term which had not expired. Although money expended may be within sec. 23 (1) (a), it is provided by sec. 25 (e) that a deduction shall not in any case be made in respect of money not wholly or exclusively laid out or expended for the production of assessable income. It is true, as contended by the commissioner, that the payment of the compensation resulted in the production of taxable income because it removed the salary formerly payable to the recipient of the compensation from the list of allowable deductions. But it does not follow that the amount of the compensation itself cannot be allowed as a deduction for the reason that it was not wholly or exclusively laid out or expended for the "production of assessable income." It is a very narrow view of the facts to confine the purpose of the payment of the compensation to the elimination of the salary of its recipient from the expenses of the company. That was a practical consequence, but the fair view on all the facts is that the purpose of such payment was to adjust and reorganise the income-earning agency of the company to meet the conditions which it found affecting its operations. In this view of its purpose the deduction is not prohibited by sec. 25 (e).

I agree that the deduction for the year ending 30th June 1932 should be limited to £1,900.

Question answered: Yes, a deduction of £1,900, part of the said sum of £2,500. Case remitted. Costs to be costs in the appeal.

[1] (1926) A.C., at pp. 213, 214.

[2] (1923) A.C. 145.

[3] (1923) A.C. 145.

[4] (1923) A.C. 145.

[5] (1922) 22 S.R. (N.S.W.) 432.

[6] (1935) A.C., at p. 443.

[7] (1926) A.C., at p. 212.

[8] [1935] HCA 81; (1935) 54 C.L.R. 295.

[9] (1927) 1 K.B. 719.

[10] (1935) A.C., at p. 441.

[11] (1927) 1 K.B. 719.

[12] (1923) A.C. 145.

[13] (1935) A.C. 431.

[14] (1932) 1 K.B. 124.

[15] (1935) 54 C.L.R., at pp. 303, 307, 309, 310.

[16] (1935) 54 C.L.R., at p. 309.

[17] [1935] HCA 81; (1935) 54 C.L.R. 295.

High Court of Australia

W Nevill & Co Ltd v Federal Commissioner of Taxation [1937] HCA 9; (1937) 56 CLR 290 (8 March 1937)

HIGH COURT OF AUSTRALIA