Dormer v Federal Commissioner of Taxation

[2003] HCATrans 474

[2003] HCATrans 474

IN THE HIGH COURT OF AUSTRALIA

Registry  No C19 of 2002

B e t w e e n -

JOHN DORMER

Applicant

and

FEDERAL COMMISSIONER OF TAXATION

Respondent

Application for special leave to appeal

GUMMOW J
HAYNE J

TRANSCRIPT OF PROCEEDINGS

AT CANBERRA ON FRIDAY, 14 NOVEMBER 2003, AT 10.43 AM

Copyright in the High Court of Australia

MR A.C. POWRIE:   May it please the Court, I appear for the applicant.  (instructed by Powrie & Co)

MR H.C. BURMESTER, QC:   I appear for the respondent, your Honour.  (instructed by Australian Government Solicitor)

GUMMOW J:   Yes, Mr Powrie.

MR POWRIE:   Your Honours, the matter before us today is, we say, an important case that requires special leave for a number of reasons.  We say it falls within the ambit of section 35A of the Judiciary Act and within the speech of his Honour Justice Dawson in ‑ ‑ ‑

GUMMOW J:   Wait a minute, can you go to page 49 of the application book, please.  What do you say about what is said there at page 49, under the heading “Futility”?

MR POWRIE:   Your Honour, thank you for that.  What we say about that is that the understanding – and this is one of the fifth points that we would make in our submission – the Commissioner’s argument that purports to support the assessment is fundamentally misconceived.  We suggest that the Commissioner has misconceived and misidentified the concept of “work in progress” with a crystallised debt, and this takes us back, your Honour, to the reason that we suggest that special leave should be granted in this particular case, because not only does it raise technical issues of public importance and policy considerations of public importance ‑ ‑ ‑

GUMMOW J:   What do you mean by policy considerations?  This is a tax case.

MR POWRIE:   Yes, it does, your Honour, but what is at issue here, and why this is such an important decision, is that Henderson is a case which for 20 years has stood for the proposition that certain receipts can remain untaxed, that is, they fall outside the tax net.  Your Honours, I can take you to that point at the moment or – I am in your hands as to how you want me to proceed on this, whether you want me to ‑ ‑ ‑

GUMMOW J:   It is your application.

MR POWRIE:   Thank you, your Honour.  What I would say is that the reason I would address it the way I will is because, as I said, the technical points that are raised in this case have within them certain other embedded issues.  So what we are asking the Court to look at as a question of law is the technical issue:  what is the source of income of the applicant and what was the time at which that income was derived?  They are questions quite fundamentally attached to that point that you just raised, because the misunderstanding of those two points, in our submission, has caused that argument by the Commissioner of “Futility”, and I will take you to why we say that is a flawed argument in a moment.

What we suggest is that the key point to be determined is how the applicant should have accounted for his income, whether it should be on a cash basis or upon an accruals basis.  What we say is that the two are mutually exclusive.  That is, we say, evident; a longstanding authority of IRC v Morrison (1932) 17 TC 325, and that is referred to in the submissions in the application book at page 52. We also say, and following from that ‑ following from the issue as to which accounting method is required, then comes the issue as to whether or not the taxpayer, in the circumstances, used the appropriate accounting method, and we say that yes, he did. What we say is that the issue that is of equal importance is that our tax system is periodic ‑ ‑ ‑

GUMMOW J:   What do you say about what is said on page 50, line 20, the sentence beginning “The appellant has provided no evidence”, et cetera?

MR POWRIE:   Your Honour, there are two matters there.  The first issue is that that was not an issue in the trial, whether or not there was a right to be billed.  Quite clearly, there would be a quantum meruit claim, in any event, and it is common accounting practice that most of the ‑ ‑ ‑

GUMMOW J:   You bore the onus of displacing the assessments. 

MR POWRIE:   Yes, we did, your Honour, and, prima facie, we have issued an account, and once work is done for professional fees, once an account is rendered, if you are a taxpayer accounting for tax on a cash basis, then the income is derived at the time the cash is received.  Now ‑ ‑ ‑

HAYNE J:   The account was rendered during the 1998 year.  It was not rendered during the 1997 year.  Why do you say that income represented by the amounts thus charged was derived in any year other than the 1998 year when both the account is rendered and the cash is received?

MR POWRIE:   With respect, your Honour, if I can take you to the affidavit evidence at page 2 of the application book, paragraph 10.  It says, your Honours:

Under the terms of Clause 5 of the Sale Agreement, all clients of John Dormer and Associates were billed [for] their work in progress as at 30 June 1997 – 

If I can take your Honours then to paragraph 17 of the affidavit, it says:

On or about 30 July 1997, in accordance with advice received from Mike Hehir, I wrote to the former clients of John Dormer and Associates and advised them that I had sent them a bill for work that I had undertaken for them before the new partnership – 

So what we say is, the accounts were rendered and billed at that point of up to 30 June.  It is a normal course of commercial practice that if you get an account – if a bill is sent, it can be for work up till 30 June and may not include work that you might have done on 1 July or 2 July, notwithstanding that the actual account is received by you at a later date.  There could be issues, for example, the mail could have gone astray for any reason ‑ ‑ ‑

HAYNE J:   The bill was not sent until the 1998 year and the cash was not received until the 1998 year.  Now, that seems to me to be the hurdle you have to surmount.  How do you get over it?

MR POWRIE:   With respect, your Honour, we say that the account was rendered for the period of time, and so it is the period of time ended 30 July 1997.  That is the period.  We have a periodic system of annual taxation, and that is evidenced by the definitions in section 6 of the Act and also, if I can take you to – on that point – and this, we say, is a material problem with the case that is before us – that issue was addressed by the High Court in Henderson. 

In Henderson, where the Court was reviewing the decision at first instance of his Honour Justice Windeyer, at page 17 of the application book, your Honours, if I can take you to approximately line 30 – it starts at line 25.  His Honour Chief Justice Barwick, in his opinion ‑ Justices McTiernan and Menzies agreed – stated:

The reason that his Honour – 

referring to Justice Windeyer – 

in those circumstances thought that these outstanding fees should be included in the earnings of the year ended 30^th June 1965 was that the income of a continuing business such as that under consideration – 

and these are the emphatic words – 

could not be regarded as “ . . . an annual crop –

That, I think, your Honour, is one of the points as to why we say that the case operates in the way we do.  Also, there is support for our submission on that point, your Honours, in the decision of Commercial Union, which is in the list of cases that you have.  It was a decision of Justice Lindgren, and it was reported as Commercial Union v Commissioner of Taxation (1996) 69 FCR 331. If I could take your Honours to the analysis which we say is apposite to this case, it commences on page 336 of that decision. If I can take your Honours to the foot of the page, where it commences “Reasoning”.

His Honour Justice Lindgren, it is submitted, provides a very succinct and useful analysis of the issue that we say and the approach that is applicable to this case.  His Honour said in that decision:

It is convenient at the outset to refer to the distinction between the “receipts” or “cash” basis and the “accruals” or “earnings” basis of the derivation of income.  Questions can arise as to which provides the appropriate basis on which to identify income derived by a taxpayer – 

and he refers to Carden’s Case – 

particularly when a taxpayer changes from one basis to another.  The “change of basis” situations can be illustrated as follows – 

and I take you only to the first point which is:

Year 1
Cash basis

and there is an arrow to:

Accruals basis          Amounts earned in year 1 and received in year 2   are not assessable income in either year –

That is the key, we say, to the issue before us.  The point, your Honours, is – and if I can put this into some sharp reflex – the Commissioner has modified the law in other areas.  Particularly in a point called the small taxation system and also in the GST regime, the Commissioner has closed this anomaly.  This anomaly currently exists, and we submit that if the bill specifies a period, and a period of time is identified, then all of that work which is done and billed at 30 June, that is the time which fixes and crystallises the debt. 

We say that that is when the debt crystallises for that work.  Once that debt crystallises, on a cash basis, we argue that then, according to Henderson’s Case, if you change accounting methods – which is what happened in the instant case, and, by virtue of an expansion of practice, the two former employees coming into the practice – at that point, the taxpayer, on the principles enunciated in the decision of Carden, then becomes an accruals basis taxpayer.  At that point, the income would be derived once the account is sent, irrespective of the period.  It is once the account is sent.  So there is a distinction, your Honours, in the way the system operates on that basis.

The second point that we say with respect to the case before us is what we consider to be an issue with the characterisation that was made by his Honour Justice Gyles at first instance, and also by the Full Federal Court.  That was the point where both of those courts recognised that particular quote that I emphasised, that it is an “annual crop”.  It is a once a year situation.

What we do say, also, with respect to the argument of what is the source of the income, we say this is another important technical point that needs to be considered by the Court, because if you look at the decision of Justice Gyles at page 18 of the application book, if I can take your Honours to line 15, Justice Gyles said:

However, in the present circumstances, it seems to me that the accountancy practice as such did continue, and the substance of what occurred was that the applicant introduced two former employees as partners.  Otherwise, the business carried on as before, with goodwill and assets transferred to the new partnership.  Thereafter, no accountancy practice was conducted – 

Now, I submit that it is at odds with his Honour’s statement at the foot of that page, page 18, where his Honour says:

In my opinion, the partnership is properly seen as a new venture which derives income which has no relationship with work done in the previous accounting period.

So that may answer part of your Honour’s earlier query, that Justice Gyles found that it had no relationship with the work done in the previous accounting period.

GUMMOW J:   You have to read that with page 33, have you not?

MR POWRIE:   Yes, thank you, your Honour.

GUMMOW J:   Paragraph 17 in the Full Court. 

MR POWRIE:   Yes, thank you.  Your Honour, I was about to take you to that line, and I suggest that is where you say ‑ your Honour, at paragraph 17, the Full Federal Court says:

With respect, having regard to the terms of the Sale Agreement, it seems more accurate to say that a new practice, operated by the three partners, immediately replaced the old practice –

Further down, they say:

However, as a matter of law, it seems to us, the old “one‑man practice” was replaced by a new partnership practice.

GUMMOW J:   They come back to that at page 34, paragraph 20.

MR POWRIE:   They do, your Honour, and I am indebted to you to point that out, because that is where they say:

It is true that both businesses were accountancy practices and that the later business used the same premises and, substantially, the same employees as the first; but that is immaterial if the businesses were, in law, different –

Now, your Honours, one of the fundamental issues that we seek leave upon is that the source of the income, in our submission, must be the personal exertion of John Dormer.  That is the way the cases go, and if I can take your Honours to page 53 of the application book, your Honours will note that we have set out there, at paragraph 9 and continuing, we say that one of the reasons that we contend that the income is that personal exertion income, the source of which is John Dormer, flows from the obiter that are identified in paragraph 9 and subsequently.  The second point, your Honours, is that, if I can take you to an article ‑ ‑ ‑

GUMMOW J:   Paragraph 8 on page 53 is not quite right, is it?

MR POWRIE:   Sorry, paragraph 8?

GUMMOW J:   Yes, at page 53:

partnership is merely a reporting entity –

for tax purposes.  That is not right, is it?

MR POWRIE:   Yes, it is, your Honour, and that is a point that we want to raise as well, because that is the secondary issue.  A partnership is not a legal entity, and whilst the Full Court ‑ ‑ ‑

GUMMOW J:   No, that is quite right.  We are talking about how the Income Tax Act operates ‑ ‑ ‑

MR POWRIE:   That is right, your Honour, and in fact there are statutory extensions to the concept of partnership under section 6 of the Income Tax Act.  What we say is that due to the fact that it ultimately is a reporting entity, the deriving entity is the individual partners, and that is the key to our point.  They are the same as in the doctors’ cases.  Notwithstanding the conversion to trusts, the ultimate deriving partners, the persons who derived the income, were the doctors. 

If I could take your Honours to an article by a very learned tax counsel – and this is another reason that we suggest that this should get special leave because there have been something like 10 or 12 articles published on this particular decision, one of which is by an academic, Dale Boccabella, which I will take you to in a minute, but the other by Mr Rob O’Connor.  If I can take you to Mr O’Connor’s article, he states, at page 3 of that article, which was reproduced in the Weekly Tax Bulletin:

In my opinion, the following dicta from those cases show that the
Dormer case should not be distinguished from Henderson.

If I can just explain, your Honours, why the submissions are identical, because Mr O’Connor paid me the courtesy of sending me this article prior to its being published, so I could not acknowledge it as having been published.  But I had spoken to him and he agreed that it could be introduced into our submissions, and, if leave is granted, he has agreed to accept the brief to appear.

Your Honours, the second issue, as I said, is that there were and are policy reasons, and if I can take your Honours to the article by Mr Dale Boccabella, also in the Weekly Tax Bulletin, this article is what prompted – there is a significant debate – this prompted Mr O’Connor of Her Majesty’s Counsel’s response.  Mr Boccabella says, in paragraph 1:

Dormer . . . provides a reminder of one of the longest standing anomalies under Australia’s income tax.  That anomaly involves the principle set out in the Full High Court –

Again, Mr Boccabella goes on and reiterates the points that I was saying, that the Commissioner has amended the legislation in certain areas and modified that.  However, I take you also back to Mr O’Connor’s point, and it is a point that we raise, where they both – at paragraph 20, the Full Federal Court say they find it “curious” that the decision ‑ ‑ ‑

GUMMOW J:   The red light is on.

MR POWRIE:   Sorry, your Honour.

GUMMOW J:   Just finish up.

MR POWRIE:   That the decision could be followed, yet what we say is, really, this remedy requires an Act of Parliament, and the court, in our submission, could not have found the way it did on the current legislation or the statutory regime.

GUMMOW J:   Thank you.

MR POWRIE:   Thank you, your Honours.

GUMMOW J:   We do not need to call on you, Mr Burmester.

The order of the Full Court of the Federal Court is not attended by doubt.  The issues which the applicant seeks to agitate would not necessarily fall for decision if special leave were granted.  Accordingly, special leave is refused with costs.

AT 11.07 AM THE MATTER WAS CONCLUDED