Museth and Commissioner of Taxation
[2006] AATA 482
•2 June 2006
Administrative
Appeals
Tribunal
DECISION AND REASONS FOR DECISION [2006] aata 482
ADMINISTRATIVE APPEALS TRIBUNAL )
) NT2005/269-270
TAXATION APPEALS DIVISION ) Re PAUL MUSETH Applicant
And
COMMISSIONER OF TAXATION
Respondent
DECISION
Tribunal Mr Julian Block, Deputy President. Date2 June 2006
PlaceSydney
Decision The objection decision under review is affirmed.
[Sgd] Mr Julian Block
Deputy President
CATCHWORDS
TAXATION – Applicant dismissed from Police Force for reasons of integrity – Applicant sought review of that decision and matter settled – Applicant re-employed on different and lesser level by Police Force – Applicant claimed deductions relating to charges of legal advisor – whether legal expenses deductible – character of expenses must be assessed at time they were incurred – Applicant was employed and for a time engaged in other employment when expenses incurred – conduct which gave rise to dismissal cannot be said to be part of day to day activities - legal expenses incurred by the Applicant related only to his endeavours to regain a position with the Police - legal costs incurred by the Applicant are not deductible - interest deduction fails – decision under review affirmed.
Income Tax Assessment Act 1997, section 8.1, 995-1(1)
Police Act 1990, sections 181D, 181E, 18F and 181G
Industrial Relations Act 1996, section 89
Commissioner of Taxation (Cth) v Maddalena (1971) 45 ALJR 426
L26 79 ATC 126
N9 81 ATC 56
Putnin v Commissioner of Taxation (1991) 89 FCR 508
Commissioner of Taxation v Rowe 95 ATC 4691
Byrne v Australian Airlines (1995) 185 CLR 427
Herald & Weekly Times Ltd v Federal Commissioner of Taxation (1932) 48 CLR 113
Hallstroms Pty Limited v Federal Commissioner of Taxation (1946) 72 CLR 634
Inglis v Federal Commissioner of Taxation 87 ATC 2,037
Magna Alloys and Research Pty Limited v Federal Commissioner of Taxation (1980) 33 ALR 213
Federal Commissioner of Taxation v Snowden & Willson Pty Limited (1958) 99 CLR 431
John v Commissioner of Taxation (Cth) (1989) 166 CLR 417
R. W. Parsons “Income Taxation in Australia”
REASONS FOR DECISION
2 June 2006 Deputy President Julian Block Part A: Introduction.
1. The objection decision under review is the disallowance by the Respondent of objections by the Applicant against tax assessments for the years ended the 30 June 2003 and 30 June 2004. It may be noted that the Applicant did not, in his tax returns for those years, claim deductions in respect of legal expenses and interest. Those claims were raised by way of objections against the relevant assessments.
2. The Applicant was represented by Mr Ian Young of counsel instructed by Mr Eric Dixon, a tax agent while the Respondent was represented by Mr James Hmelnitsky of counsel instructed by Mr. Damien Ong of the ATO Legal Practice Group.
3. The Tribunal had before it the T-documents lodged pursuant to section 37 of the Administrative Appeals Tribunal Act 1975 together with exhibits as follows:
Exhibit A1 is a lengthy statement (inclusive of a number of annexures) by the Applicant dated 6 December 2005;
Exhibit R1 is a document entitled “Report to Parliament – Operation Jetz” which was prepared in accordance with the Police Integrity Commission Act 1996
Part B the Background.
4. The facts fall within a narrow compass. The Respondent did not initially require the Applicant for cross-examination and so that it was not originally intended that the Applicant would give oral evidence. However, and for reasons which need not be set out, a question arose as to whether, in relation to the interest deduction claimed, there was a relevant nexus with the legal expenses deductions claimed. The Applicant gave oral evidence and was cross-examined only in respect of certain financial and funding aspects.
5. The Respondent’s Amended Statement of Facts and Contentions dated 16 February 2006 contains, under the heading “Facts”, and in clauses 1 to 21 inclusive, a succinct summary (“the Summary”) of the relevant facts and as to which there does not appear to be any dispute. Those clauses are included in these reasons as follows:
“1. The applicant was employed as a police officer with the NSW Police Service.
2.On 26 June 2001 the Police Integrity Commission (the “PIC”) declared an investigation, codenamed “Operation Jetz”, into suspicions that a number of serving police officers were involved in corrupt manipulation of the NSW Police Service promotion system.
3.On 20 and 21 August 2001 the applicant gave evidence before the PIC in relation to Operation Jetz.
4.On 10 September 2001, as a result of the evidence he gave to the PIC, the Applicant was suspended from the Police Service with pay.
5.On 25 January 2002, as a further result of the evidence the Applicant gave to the PIC, the Commissioner of Police notified the applicant in accordance with section 181D(3)(a) of the Police Service Act 1990 (NSW) that he was considering the Applicant’s suitability for continuing employment.
6.Following receipt of the notice pursuant to section 181D(3)(a) of the Police Service Act 1990, the Applicant retained Jones Staff & Co, solicitors.
7.On 25 March 2002, the applicant, through his solicitors, made a submission to the Police Service in response to the notice pursuant to section 181D(3)(a) of the Police Service Act 1990.
8.By order dated 7 May 2002 pursuant to section 181D(1) of the Police Service Act 1990, the applicant was removed from the Police Service.
9.On about 28 May 2002 the applicant was paid out all accrued long service leave and annual leave entitlements.
10.On about 1 August 2002 the Applicant was paid his superannuation entitlements by State Super.
11.On about 31 May 2002 the applicant made an application in the Industrial Relations Commission of NSW pursuant to section 181E(1) of the Police Service Act 1990 in which he sought a review of the order removing him from the Police Service (the “Industrial Relations Commission proceedings”).
12.On 9 September 2002 the Applicant paid the sum of $2,000 to his solicitors on account of their costs and disbursements in acting for him in connection with the Industrial Relations Commission proceedings.
13.The Industrial Relations Commission proceedings were set down for hearing on 13 and 14 February 2003.
14.On 12 January 2003 the Applicant and the Police Service reached an agreement in relation to the resolution of the Industrial Relations Commission proceedings.
15.On 20 February 2003 Justice Boland of the Industrial Relations Commission gave effect to the agreement by making the following declarations:
(a)The respondent shall re-employ the Applicant as a police officer with effect from 12 March 2003.
(b)Upon re-employment the Applicant shall hold the rank of Constable Level 5 and be treated as a though he held that rank since 10 May 2002.
(c )The Applicant’s employment shall be treated as having commenced on 27 March 1986 and been continuous since that time save that the period between 10 May 2002 and 12 March 2003 will not count as service and will be treated as a period of suspension without pay.
(d)The Applicant will upon re-employment be treated as having an integrity issue for promotional purposes for a period of three years from 10 May, 2002.
16.On about 28 April 2003 the applicant’s solicitors rendered a tax invoice for costs and disbursements in the total sum of $24,367.
17. On 19 August 2003 the applicant paid the sum of $22,367 to his solicitors.
18.On 20 January 2005 the respondent issued a notice of assessment to the applicant for the year ending 30 June 2004.
19.On 16 February 2005 the respondent issued a notice of assessment to the applicant for the year ending 30 June 2003.
20.On 22 February 2005 the Applicant objected against the notice of assessment for the year ending 30 June 2003 and the notice of assessment for the year ending 30 June 2004 to claim:
(a)In respect of the 2003 year, a deduction for $2,000 referable to the payment to his solicitors described in paragraph 12; and
(b)In respect of the 2004 year, deductions totalling $23,803 (together with the deductions claimed for 2003, the “Deductions”) referable to the payment to his solicitors described in paragraph 17 and interest of $1,436 on funds purportedly borrowed for the purpose of making that payment.
21.On 30 May 2005 the Respondent determined the applicant’s objections by disallowing them.”
6. Some, but not all, of the abbreviations used in the Summary have the same meanings when used in these reasons. The term “review proceedings” used in these reasons has the meaning assigned to the term “Industrial Relations Commission proceedings” used in the Summary.
7. As set out in the Summary the Applicant gave evidence before PIC. I include in respect of Exhibit R1 the first paragraph under the heading “Background to Operation Jetz” and clauses 2.15 to 2.22 which deal with the evidence of the Applicant to PIC as follows: --
"EXECUTIVE SUMMARY
BACKGROUND TO` OPERATION JETZ
In January 2001; an investigation by the NSW Police Special Crime and Internal Affairs Command (SC1A), codenamed Operation' Orwell, was established to investigate suspicions that a number of serving police officers were involved in corrupt manipulation' of the NSW Police Service ("the Service'") promotion system.
SENIOR CONSTABLE PAUL FRANCIS MUSETH
2.15 Museth was a Senior Constable at Eastwood Police Station at the time of the Jetz investigation and was a member of the Police Association executive. During evidence Menzies confirmed that his relationship with Museth was that of friendship and that he knew him through the Police Association.
2.16 Museth agreed in evidence that the Service's promotion system was merit based and that it was an essential element of providing each Applicant with a fair chance that confidentiality of the interview process and questions be maintained.36
2.17 Museth was interviewed on 5 April 2001 for Team Leader/Sergeant positions in the areas of General Duties and Transit Police. In evidence, Museth recollected being given a document about confidentiality at his interview, similar to the "Content of Interview Process" document.38 Museth was also interviewed on 9 July 2001 for a Team Leader/Sergeant position in the Water Police, at which he signed a copy of a document titled "Confidentiality of Structured Interview Questions"."
2.18 During the hearings Museth confirmed that he had received information from Menzies about the specific competencies and technical professional questions to be asked at the General. Duties interview. He also admitted receiving the additional technical professional questions relating to the Transit Police position Included in telecommunication intercept material played during the hearings was a telephone conversation between Museth and Menzies, during which Menzies reinforced to Museth that he should not share information about the questions!'
2.19 In evidence, Museth admitted:
seeking and/or obtaining information from Menzies, Graham, Scott, Whyte, Jones and Hampstead about specific questions he would be asked before attending an interview;
seeking and obtaining for Menzies information about the Duty Officer/ Inspector positions for which he was not an Applicant, and also conveying this information to Scott and to a witness known as J11 for the purpose of the hearings;
breaching the confidentiality requirements attached to questions asked at interviews;
sharing that information with a group of colleagues and attempting to confine the information to that group;
agreeing to attend the Water Police interview for the purpose of obtaining the questions for the assistance of another officer (in fact, that officer was interviewed first and provided information to Museth);
knowing that doing so was "cheating" and improper because it undermined the fairness of the system; and
not reporting his own misconduct, or that of others, despite his obligation to do so.
2.20 During the hearings Menzies confirmed that he provided Museth with his "study book" and other information, and indeed that Museth was the "prime person" to whom he would have provided information Menzies advised Museth to maintain confidence about their activities to maximise the advantage that flowed from possessing the inside information "
ASSESSMENT OF THE EVIDENCE OF MUSETH
2.21 It was submitted on behalf of Museth that, while he now understands that his conduct was improper, he did not realise so at the time. It was submitted that as the Service has in effect acknowledged flaws in the system by amending it, it is not reasonable to take severe action against Museth. The Commission rejects both of these submissions.
2.22 Museth provided assistance to the Commission by giving evidence of his own misconduct. However, the Commission is of the opinion that the evidence shows Museth to have been a central player in the misconduct examined and that he was aware of the involvement of a number of officers in that misconduct.”
Part C: Relevant statutory provisions
8. Section 8.1 of the Income Tax Assessment Act 1997 (“Tax Act”) reads as follows:
“(1)You can deduct from your assessable income any loss or outgoing to the extent that:
(a) it is incurred in gaining or producing your assessable income; or
(b)it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.
…….
(2)However, you cannot deduct a loss or outgoing under this section to the extent that:
(a) it is a loss or outgoing of capital, or of a capital nature; or
(b) it is a loss or outgoing of a private or domestic nature; or
(c)it is incurred in relation to gaining or producing your exempt income or your non‑assessable non‑exempt income; or
(d) a provision of this Act prevents you from deducting it
…”
9. Section 8.1 relevantly includes two positive limbs and two negative limbs. Only the first positive limb applies in this case because “occupation as an employee” is specifically excluded from the definition of “business” in section 995-1(1).of the Tax Act
10. In respect of the Police Act 1990 (referred to in the Summary as the Police Service Act 1990) I include Sections 181D, 181E, 181F and 181G as follows::
“181D Commissioner may remove police officers
(1)The Commissioner may, by order in writing, remove a police officer from NSW Police if the Commissioner does not have confidence in the police officer’s suitability to continue as a police officer, having regard to the police officer’s competence, integrity, performance or conduct.
(2)Action may not be taken under subsection (1) in relation to a Deputy Commissioner or Assistant Commissioner except with the approval of the Minister.
(3) Before making an order under this section, the Commissioner:
(a)must give the police officer a notice setting out the grounds on which the Commissioner does not have confidence in the officer’s suitability to continue as a police officer, and
(b)must give the police officer at least 21 days within which to make written submissions to the Commissioner in relation to the proposed action, and
(c)must take into consideration any written submissions received from the police officer during that period.
(4)The order must set out the reasons for which the Commissioner has decided to remove the police officer from NSW Police.
(5) The removal takes effect when the order is made.
(7) Except as provided by Division 1C:
(a)no Tribunal has jurisdiction or power to review or consider any decision or order of the Commissioner under this section, and
(b)no appeal lies to any Tribunal in connection with any decision or order of the Commissioner under this section.
In this subsection, "Tribunal" means a court, Tribunal or administrative review body, and (without limitation) includes GREAT and the Industrial Relations Commission.
(7A)Nothing in this section limits or otherwise affects the jurisdiction of the Supreme Court to review administrative action.
(7B)Nothing in Division 1C limits or otherwise affects the Commissioner’s power to vary or revoke an order in force under this section.
(8)For the purposes of this Act, removal of a police officer from NSW Police under this section has the same effect as if the police officer had resigned (or, in the case of a police officer who is of or above the age of 55 years, had retired) from NSW Police.
(9)The Commissioner may take action under this section despite any action with respect to the removal or dismissal of the police officer that is in progress under some other provision of this Act and despite the decision of any court with respect to any such action.
181E Review generally
(1)A police officer who is removed from NSW Police by an order under section 181D may apply to the Industrial Relations Commission (referred to in this Division as the "Commission") for a review of the order on the ground that the removal is harsh, unreasonable or unjust.
(2)An application under this section does not operate to stay the operation of the order in respect of which it is made.
(3)Except to the extent to which the regulations otherwise provide, it is the duty of the Commissioner to make available to the Applicant all of the documents and other material on which the Commissioner has relied in deciding that the Commissioner does not have confidence in the Applicant’s suitability to continue as a police officer, as referred to in section 181D (1).
181F Proceedings on a review
(1)In conducting a review under this Division, the Commission must proceed as follows:
(a)firstly, it must consider the Commissioner’s reasons for the decision to remove the Applicant from NSW Police,
(b)secondly, it must consider the case presented by the Applicant as to why the removal is harsh, unreasonable or unjust,
(c)thirdly, it must consider the case presented by the Commissioner in answer to the Applicant’s case.
(2)The Applicant has at all times the burden of establishing that the removal of the Applicant from NSW Police is harsh, unreasonable or unjust. This subsection has effect despite any law or practice to the contrary.
(3)Without limiting the matters to which the Commission is otherwise required or permitted to have regard in making its decision, the Commission must have regard to:
(a) the interests of the Applicant, and
(b)the public interest (which is taken to include the interest of maintaining the integrity of NSW Police, and the fact that the Commissioner made the order pursuant to section 181D (1)).
181G Application of Industrial Relations Act 1996 to reviews
(1)The provisions of the Industrial Relations Act 1996 apply to an application for a review under this Division in the same way as they apply to an application under Part 6 (Unfair dismissals) of Chapter 2 of that Act, subject to this Division and to the following modifications:
(a)section 83 (Application of Part) is to be read as if subsection (3) were omitted,
(b) section 85 (Time for making applications) is to be read:
(i)as if a reference to 21 days in that section were instead a reference to 14 days, starting from the day on which the Applicant is given a copy of the order to which the application relates, and
(ii) as if subsection (3) were omitted,
(c)section 86 (Conciliation of applications) is to be read as if it provided that a judicial member of the Commission who is involved in any endeavour to settle the Applicant’s claim by conciliation must not subsequently be involved in the conduct of proceedings on the review,
(d)section 89 is to be read as if subsection (7) (Threat of dismissal) were omitted,
(e)section 162 (Procedure generally) is to be read as if the requirement of subsection (2) (a) of that section that the Commission is to act as quickly as is practicable were instead a requirement for the Commission to commence hearing the application within 4 weeks after the application is made,
(f)section 163 (Rules of evidence and legal formality) is to be read as if it provided that new evidence may not be adduced before the Commission unless:
(i)notice of intention to do so, and of the substance of the new evidence, has been given in accordance with the regulations under this Act, or
(ii) the Commission gives leave.
(2)The Commission may grant leave as referred to in subsection (1) (f) (ii) in such circumstances as it thinks fit and having regard to the nature of proceedings under section 181F, and without limiting the generality of the foregoing, the Commission must grant leave in the following circumstances:
(a)where the Commission is satisfied that there is a real probability that the Applicant may be able to show that the Commissioner has acted upon wrong or mistaken information,
(b)where the Commission is satisfied that there is cogent evidence to suggest that the information before the Commissioner was unreliable, having been placed before the Commissioner maliciously, fraudulently or vexatiously,
(c)where the Commission is satisfied that the new evidence might materially have affected the Commissioner’s decision.”
11. Having regard to the reference in section 181G of the Police Act 1990 to the Industrial Relations Act 1996, section 89 of the latter statute is included as follows:
“89 Orders for reinstatement, re-employment, remuneration, compensation
(1)Reinstatement The Commission may order the employer to reinstate the Applicant in his or her former position on terms not less favourable to the Applicant than those that would have been applicable if the Applicant had not been dismissed.
(2)Re-employment If the Commission considers that it would be impracticable to reinstate the Applicant, the Commission may order the employer to re-employ the Applicant in another position that the employer has available and that, in the Commission’s opinion, is suitable.
(3)Remuneration If the Commission orders reinstatement or re-employment, it may order the employer to pay to the Applicant an amount stated in the order that does not exceed the remuneration the Applicant would, but for being dismissed, have received before being reinstated or re-employed in accordance with the order.
(4)Continuity If the Commission orders reinstatement or re-employment, it may order that the period of employment of the Applicant with the employer is taken not to have been broken by the dismissal.
(5)Compensation If the Commission considers that it would be impracticable to make an order for reinstatement or re-employment, the Commission may order the employer to pay to the Applicant an amount of compensation not exceeding the amount of remuneration of the Applicant during the period of 6 months immediately before being dismissed. If the Applicant was on leave without full pay during any part of that period, the maximum amount of compensation is to be determined as if the Applicant had received full pay while on leave.
(6)When assessing any compensation payable, the Commission is to take into account whether the Applicant made a reasonable attempt to find alternative employment and the remuneration received in alternative employment, or that would have been payable if the Applicant had succeeded in obtaining alternative employment.
(7)Threat of dismissal In determining a claim relating to a threat of dismissal, the Commission may order the employer not to dismiss the employee in accordance with that threat.
(8)An order under this section may be made on such terms and conditions as the Commission determines.”
Part D.: The submissions and case law
12. It was always clear that the case law in this area would be relevant and, in all probability, crucial.
13. The Applicant noted that the Respondent had in his reasons for decision referred in particular to two Board of Review cases, L26 79 ATC 126 and N9 81 ATC 56 He referred to those decisions in clauses 6 and 7 of his written submissions as follows:
“6.A number of points of distinction and observations may be made. First, in Case L26 the taxpayer’s appeal was unsuccessful. Here Mr. Museth was, by agreement, reinstated, albeit at lower rank and with promotion restrictions. Most importantly, Mr. Museth was on “suspension without pay” and he was to have “an unbroken employment record with NSWP”[1]. Second, if Case L26 is correct, legal expenses for proceedings commenced one nanosecond before dismissal to prevent such dismissal may qualify for deduction, but expenses for proceedings commenced one nanosecond after dismissal to secure reinstatement do not[2]. Third, deductibility should depend on the substantive nature of the proceedings and not when they were commenced or the form of the proceedings. Fourth, the Board decision is fractured. Mr. Fairleigh held the expenses were non deductible under the first limb, but were neither capital[3] or private[4]. Mr. Harrowell held it was deductible under the second limb[5].
7.Case N9[6] proceeds on the basis the expense was denied because there was no “perceived connection” between the expenses and the income earning activities. That test has been subsequently discounted”.
[1] Museth witness statement at page 57
[2] See T3 page 6
[3] Case L 26 at paragraph 27
[4] At paragraph 28
[5] At page 131 paragraph 25
[6] 81 ATC 56
14. The Applicant contended, in particular, that more recent Federal Court authority in this area focuses rather on the substantive nature and effect of the relevant proceedings. I refer to clauses 8 to 16 of the Applicant’s submissions as follows:
“8. In the Applicant’s submission subsequent decisions of the Federal Court have focussed on the substantive nature and effect of the proceedings. In Putnin v Commissioner of Taxation[7] the taxpayer was an accountant. He sought a deduction for legal costs of his defence to a criminal charge arising out of his administration as a trustee in bankruptcy. The Court observed[8]:
[7] (1991) 27 FCR 508
[8] At page 511
The case put forward by the Applicant was really a simple one. According to his contention, the expenditure arose out of his prosecution, in which he was defending his activities in a particular operation of business by which income had been earned. That operation of business was the administration of one estate out of many of which he was the trustee. It followed, he contended, that the costs of his defence were outgoings incurred in gaining or producing assessable income within the first limb of s 51(1), and, indeed that they were also necessarily incurred in carrying on a business” .
9. Their Honours continued “It may be a natural incident of the conduct of the operations of a particular kind of business that claims of the commission of torts, or even crimes, may arise … and have to be repelled.” The true test was what was the money spent for, and was it to answer claims arising in the course of earning income.
10. The facts in Putnin concern an accountant in business for himself. He was not an employee. However the deduction was allowed under both[9] limbs of s.51(1).
[9] See page 508 and 511
11. However Putnin was applied and followed in the subsequent Full Federal Court case of Commissioner of Taxation v Rowe[10]. There an employee, a shire council engineer incurred legal expenses at a Commission of Inquiry regarding complaints against him in the performance of his duties as shire engineer.
[10] (1995) 60 FCR 99
12. Rowe is thus like Mr. Museth’s case in that he is an employee.
13. But it differs in that it involves expenses to prevent suspension or dismissal from duties and not reinstatement. In Rowe the taxpayer was suspended and required by his employer to show cause why he should be dismissed[11]. By Executive order that notice was overturned and the Executive Council directed there be an inquiry into the matters the subject of the suspension[12]. Rowe incurred legal expenses at that enquiry. Shortly after the inquiry he was dismissed[13].
[11] See page 102.2
[12] See page 103.8
[13] See page 104.4
14. At issue in the appeal was the assessability of the ex gratia reimbursement of the expenses. The Full Court considered the preliminary question as to whether the expenses were deductible.
15. However there are passages in each of the judgments, which provide support for deductibility for Mr. Museth’s expenses. At page 108.9 and following Beaumont J said:
Since the Inquiry was centrally concerned with day-to-day aspects of the Respondent's employment, it ought to be concluded that the Respondent's cost of representation before the Inquiry was incurred by him "in" gaining assessable income.
16. In the same case Burchett J said at page 113 as follows:
I note that the Committee of Inquiry saw these expenses as incurred by him in defending himself from dismissal from his employment. That view of the matter is, of course, correct. However, at another level, I think these expenses should be recognised as incurred by the Respondent in defending the manner of his performance of his duties. It was only by so justifying himself that he could make a successful defence against dismissal.
[The] liability in question was incurred, or the claim was encountered, because of the very act of performing the work by which the Respondent earned assessable income. The activities which produced the assessable income were what exposed the taxpayer to the liability discharged by the expenditure. As the Court said in Putnin at 513, so here, "the ... proceedings arose from the activities by which the taxpayer earned his income, the mode of his performance of a particular task carried out in the course of business operations".
To put the same point in another way, the cause or the purpose of the Respondent's incurring of the expenditure was his assertion that he had faithfully performed the duties by which he had earned assessable income.”
15. The Respondent also referred in some detail to each of Putnin v Commissioner of Taxation (1991) 89 FCR 508 and Commissioner of Taxation v Rowe 95 ATC 4691; I refer in this context to later parts of this Part D.
16. Mr Young in his oral submissions focused to some extent on what occurred after the Applicant was dismissed from the New South Wales Police Service (referred to in brief as the “Police”); this occurred on 10 May 2002 in consequence of a notice under section 181D of the Police Act 1990 (served after the Applicant had been afforded and taken an opportunity to make representations). The Applicant sought the review of that decision under Division 1C of the Police Act 1990. Thereafter, the review having been listed for hearing, a settlement was reached and that settlement was made an order of court (Annexure F to Exhibit A1) and pursuant to which the Applicant was re-employed by the police on a different and lesser basis. The full terms of the relevant court order are set out in the Summary.
17. There is an important aspect of the Applicant’s written submissions which can conveniently be dealt with at this early stage. Clause 6 of the Applicant’s submissions specifies that the Applicant was “by agreement reinstated”; he was not reinstated; he was re-employed by the police at a lower rank and subject to certain limitations as regards promotion; the distinction is relevant.
18. Some of the annexure to Exhibit A1 deal with matters which arose post re-employment. Page 54 of Exhibit A1 is a letter by State Super to the Applicant in which it stated (incorrectly) that the Applicant had been reinstated into the Police and that accordingly he was required to repay the lump sum superannuation amount which had been paid to him on 1 August 2002. (The Applicant when he was dismissed received payment of superannuation, leave pay and other entitlements) Page 57 of Exhibit A1, by way of another example, is a memorandum by Adele Gray which recorded in clause 2 that: “In relation to the period between 10 May 2002 and 12 March 2003 this period is specifically stated not to count as service and as such there is no accrual of entitlements, including leave entitlements. The purpose of the period being treated as “suspension without pay” was to create an unbroken employment record of Museth with NSWP”
19. The Tribunal considers that it is necessary to consider (and in an objective manner), the character of the relevant expenditure at the time when it was incurred. It will be recalled that the Applicant was dismissed in May 2002; he sought review and for that purpose engaged solicitors and barristers. The deductions claimed by him relate (leaving aside a comparatively minor amount in respect of interest) to the charges of his legal advisers. At the time when those charges were incurred, the Applicant could not know whether the review proceedings would result in success or failure or, and as matters transpired, what in the end result might be described as partial success. The question of whether or not legal expenses are deductible cannot be determined with hindsight and by reference to the results of the review proceedings. It follows that much of Exhibit A1 and the submissions made in relation to some of its content (and be in particular events after his re-employment) are of very limited, if any, significance.
20. It must be remembered, as I have said, that the Applicant was removed from the Police under an order made pursuant to section 181D of the Police Act 1990. Under section 181D(5) of the Police Act 1990 the removal took effect when the order was made. In accordance with section 181D(7) review was available only under Division 1C. Section 89 of the Industrial Relations Act 1996, incorporated by reference, allowed the Commission to make orders of various kinds and including orders for reinstatement or re-employment. The eventual order, which was in fact made, was for re-employment. During the period when he was not employed by the Police the Applicant was able, but for part of that period only, to obtain other employment although at a lower salary. He was re-employed as a constable whereas when removed he was a senior constable. Moreover his opportunities for promotion were limited.
21. The Tribunal also considers that, having regard to the cases, it is important to remember that the Applicant was not, in relation to the review proceedings, seeking to preserve or retain his job. Moreover (and again having regard to the cases) the review proceedings did not relate to the performance by the Applicant of his day-to-day duties as a senior constable. The review proceedings were concerned essentially and only with integrity. The Applicant conceded (albeit somewhat belatedly) that the conduct which gave rise to his removal was wrong; in essence his complaint was no more or less than a complaint that his punishment was too harsh. It is relevant in this context to note that in clause 2.21 of Exhibit R1 the PIC did not accept the Applicant’s argument that he did not realise his conduct was improper at the time he engaged in it. In paragraph 2.22, the PIC found that the Applicant was a “central player in the misconduct”.
22. The Respondent described the expenses in question as the “re- employment expenses”. He contended (correctly) in my view) that they were incurred too early to make them deductible. The Respondent contended, moreover, that they fall squarely into the category of expenditure considered by the High Court in Commissioner of Taxation v Maddalena (1971) 45 ALJR 426. In that case, the Court considered the deductibility of a footballer’s expenses of travelling to Sydney to negotiate a contract with a new club and his solicitor’s costs of the negotiation of the contract. The High Court allowed the Commissioner’s appeal. The reasons of the Court were stated principally by Menzies J, although the principle for which the case is so often cited was stated succinctly by Barwick CJ as follows”
“The cost to an employee of obtaining his employment does not form an outgoing incurred in the course of earning the wages payable in the employment. That cost is not deductible under s. 51 of the Income Tax Assessment Act 1936”.
23. As I have noted, the character of the expenses must be assessed at the time when they were incurred. The review proceedings commenced and were conducted during the period when the Applicant was not an employee of the Police. During that time, he was, as I noted, for a time unemployed and for a time engaged in other employment.
24. As the Respondent submitted, the Industrial Relations Commission did not order a reinstatement; equally it did not revoke the order made under section 181D of the Police Act 1990. The Applicant was re-employed, in fact, in a different position, and in particular on a lower rank and on less favourable terms. Put succinctly the Applicant succeeded in obtaining a new contract of employment; Maddalena is directly in point...
25. The Tribunal agrees with the Respondent’s contention that it is not relevant that the Applicant’s service was referred to (inter alia) by the superannuation fund as having been continuous since 1986. A continuity order serves merely to ensure that benefits which are related to length of service are calculated from a date which is earlier in point of time than the date of the order.
26. A dismissal is not a nullity. This is so even in the case of a wrongful dismissal Byrne v Australian Airlines (1995) 185 CLR 427. As set out previously, it is relevant in this context also that the Applicant was removed under section 181D(5) of the Police Act 1990 and that that removal order was not revoked. Moreover and to the extent (if any) that this aspect is relevant in this context, the removal was not wrongful; it was based upon the Applicant’s own admitted misconduct.
27. I note that in respect of some of the content of this part D I have drawn on and am thus indebted to the Respondent’s written submissions.
28. In Herald & Weekly Times Ltd v Federal Commissioner of Taxation (1932) 48 CLR 113 at 118 Gavan Duffy CJ and Dixon J said:
“The question whether money is expended in and for the production of assessable income cannot be determined by considering only the immediate reason for making a payment and ignoring the purpose with which the liability was incurred.”
29. The distinction between the “immediate reason” and the underlying “purpose” in the case of deductions for legal expenses was specifically addressed by Dixon J in Hallstroms Pty Limited v Federal Commissioner of Taxation (1946) 72 CLR 634. In that case, speaking of the distinction between revenue and capital expenditure, his Honour said at 647:
“The claim is to deduct legal expenses, and legal expenses, we may assume, take the quality of an outgoing of a capital nature or of an outgoing on account of revenue from the cause or the purpose of incurring the expenditure. We are, therefore, remitted to a consideration of the object in view when the legal proceedings were undertaken, or of the situation which impelled the taxpayer to undertake them.” (Emphasis added by the Tribunal)
30. The Respondent, in referring to Putnin, noted that the Full Federal Court considered a claim for a deduction of legal expenses incurred by an accountant in resisting criminal charges arising out of his administration of an estate. The legal expenses claimed in that case were, in a very strict sense, incurred in order to defend the criminal charges. However, consistent with the principles described above, their Honours came to the view that:
“The purpose to be attributed to the payment is the administration of the insolvent estate.”
31. In other words, their Honours in Putnin considered that the objective purpose for which the expenses were incurred was to be found in the acts which the taxpayer did which gave rise to the proceedings in the first place. Having so identified the purpose of the expenditure, their Honours had little difficulty in concluding that the taxpayer’s relevant objective purpose (i.e. administering an insolvent estate) was sufficiently connected with the gaining of assessable income to fall within the provision.
32. It is fair to say that both parties treated Rowe’s case in the Full Federal Court is be of particular significance:
(a) I refer the first instance to the judgment of Beaumont J. in clause 6 as follows:
“On 28 June 1985, the Director of Local Government for the State of Queensland, acting pursuant to s.4A (3) of the Act directed, at the direction of the Minister, that there be an Inquiry into the matters the subject of the resolution suspending the Respondent and "into any other matters that are considered to be relevant to the matter".
(b) Beaumont J. referred to Inglis v Federal Commissioner of Taxation 87 ATC 2,037; I include clause 31 and also clause 32 and 33 as follows:
“31. In Inglis v Federal Commissioner of Taxation 87 ATC 2,037 the taxpayer, employed as a permanent officer of the Commonwealth Public Service in the Parliamentary Library, claimed to deduct legal expenses incurred by her in the prosecution of civil actions brought against the Commonwealth and certain individuals. She claimed in these actions that new procedures in the Library placed unwarranted restrictions on her. The actions, which were ultimately settled, were commenced by the taxpayer because she faced a loss of status and the prospect of her chances of promotion being blocked. Although she had been transferred "sideways", she suffered, in fact, no loss of income. The Tribunal (Mr. Todd, Deputy President) held, correctly in my view, that the expenses were deductible, after concluding (at 2,047) that the expenditure was incurred by the taxpayer in gaining or producing assessable income. It was held that the "gravamen" of the dispute that was reflected, "however awkwardly", in the actions, was her "day to day situation" in the Library, so that the expenditure was incidental and relevant to the work which produced her income.
32. A similar view was taken by the Tribunal in AAT Case 5822 (1990) 21 ATR 3357 (at 3359) in allowing a claim for legal expenses by an officer seeking to preserve his employment then under threat.
33. In my opinion, notwithstanding the different outcome in Case 117 (1959) 8 CTBR (NS) 671, the approach taken in Inglis provides an appropriate analogy here. Since the Inquiry was centrally concerned with day-to-day aspects of the Respondent's employment, it ought to be concluded that the Respondent's cost of representation before the Inquiry was incurred by him "in" gaining assessable income.”
(c) In respect of the judgment of Burchett J, I refer to clause 14 above which includes (in part) clauses 2 and 3: Although to do so involves some degree of repetition I include as a matter of convenience clauses 2 and 3 in full as follows:
“2. On the question of the deductibility of the expenses incurred by the Respondent at the inquiry, I note that the Committee of Inquiry saw these expenses as incurred by him in defending himself from dismissal from his employment. That view of the matter is, of course, correct. However, at another level, I think these expenses should be recognized as incurred by the Respondent in defending the manner of his performance of his duties. It was only by so justifying himself that he could make a successful defence against dismissal. When the matter is seen in this light, it falls squarely within the rule discussed in Putnin v Commissioner of Taxation (1991) 27 FCR 508. To adapt language there quoted (at 511) from Herald and Weekly Times Limited v Federal Commissioner of Taxation (1932) 48 CLR 113 at 117-119, the liability in question was incurred, or the claim was encountered, because of the very act of performing the work by which the Respondent earned assessable income. The activities which produced the assessable income were what exposed the taxpayer to the liability discharged by the expenditure. As the Court said in Putnin at 513, so here, "the ... proceedings arose from the activities by which the taxpayer earned his income, the mode of his performance of a particular task carried out in the course of business operations."
3. To put the same point in another way, the cause or the purpose of the Respondent's incurring of the expenditure was his assertion that he had faithfully performed the duties by which he had earned assessable income. In Creer v Federal Commissioner of Taxation (1994) 94 ATC 4,454 at 4,457 I cited a passage from the well known judgment of Dixon J in Hallstroms Proprietary Limited v The Federal Commissioner of Taxation (1946) 72 CLR 634 at 647 in which the correct approach is stated in respect of the question whether legal expenses are on capital or revenue account:
"The claim is to deduct legal expenses, and legal expenses, we may assume, take the quality of an outgoing of a capital nature or of an outgoing on account of revenue from the cause or the purpose of incurring the expenditure. We are, therefore, remitted to a consideration of the object in view when the legal proceedings were undertaken, or of the situation which impelled the taxpayer to undertake them."
On this basis, the expenditure was deductible.”
(d) Drummond J in his judgment said in clauses 5, 6 and 7:
“5. In my opinion, the Respondent's costs of legal representation before the inquiry comprised an outgoing incurred by him in gaining assessable income, within the first limb of s. 51. The issue here is whether legal expenses incurred by an employee to prevent his employer terminating his existing contract of employment are deductible under s. 51. In view of Federal Commissioner of Taxation v Maddalena (1971) 71 ATC 4161, expenses incurred in obtaining a new contract of employment cannot in general be regarded as outgoings incurred in gaining assessable income because they would be incurred "at a point too soon to be properly regarded as incurred in gaining assessable income": at 4163. But where there is an existing contract of employment, legal expenses incurred in maintaining that contract are not remote in time from the gaining of assessable income.
6. If an outgoing said to be deductible as having been incurred in gaining or producing assessable income can be seen to be incidental and relevant to that end, in the sense that there is a real connection between the incurring of the outgoing and the activities which directly result in the gain or production of income, that will generally be sufficient to make the outgoings deductible. See Ronpibon Tin No Liability v Federal Commissioner of Taxation (1949) 78 CLR 47 at 56-57; Charles Moore and Co. (WA) Pty. Ltd. v Federal Commissioner of Taxation (1956) 95 CLR 344 at 351 and Commissioner of Taxation v Cooper (1991)29 FCR 177 at 181 and 197-198.
7. The Respondent incurred the expenses in question in procuring legal representation at the inquiry. It is plain from the Livingstone Shire Council's ("the Council") actions prior to the establishment of the inquiry and from its subsequent dismissal of the Respondent, that if the Respondent had not been successful in obtaining a favourable outcome at the inquiry, the Council would have dismissed him then and there, rather than have waited for a further occasion to terminate his employment. His incurring of those costs can be assumed to have contributed to his success in defending himself from dismissal from his employment as Shire Engineer. They were incurred to preserve the Respondent's entitlement to receive, in return for his services, assessable income. They are more closely connected with the production of that income than the legal expenses incurred to remove a legal impediment to a professional footballer engaging in the activities for which he was paid were connected to the production of his income; those expenses were held in Kemp v Federal Commissioner of Taxation (1992) 92 ATC 4542 at 4546, to be within the first limb of s. 51(1).z’”
33. The Applicant sought to draw particular comfort from the judgment of Burchett J in Rowe. Mr Young however conceded (and that concession was altogether fair) that it could hardly be said that the cause or purpose of the expenditure in this case was an assertion by the Applicant that he had “faithfully performed the duties.”
34. The Respondent contended (again correctly) that the cases referred to concerned, in the main, expenses incurred by a taxpayer in defending an attack while an employee. Moreover the Respondent contended that the cases in question relate, in the main, to the performance by taxpayers of their day-to-day duties and not to their integrity. The Applicant (also correctly) noted that, while Mr Rowe was defending an attack which might have resulted in the loss of his position, there were aspects of his conduct which did indeed reflect on his integrity.
35. Whatever else can be said about the Applicant’s conduct (and I refer here to the conduct which gave rise to his dismissal from the Police) it can hardly be said to have been conduct which was part of his day-to-day duties. The day-to-day activities of a policeman will vary depending on his rank and position and the area and branch in which he serves, but they will not extend, in the case of the Applicant, to the conduct which brought about his removal.
36. The Respondent concedes that there is, on occasion, an additional consideration and being the purpose which motivates the expenditure. Evidence of subjective purpose or motive might, in the case of voluntary expenditure, be a relevant matter in characterising the loss or outgoing: see Magna Alloys and Research Pty Limited v Federal Commissioner of Taxation (1980) 33 ALR 213 especially per Brennan J at 221. However even in those cases where it is permissible to take subjective purpose or motive into account, those matters are said only to have “evidentiary” value. In Magna Alloys Brennan J said at 221 that the “…taxpayer’s state of mind – whether intention, or purpose, or motive – is evidentiary only”. His Honour also pointed out that the subjective purpose is not to be confused with the objective purpose of the expenditure: (at 223). The reasons of Deane and Fisher JJ are to like effect, particularly at 234-235.
37. The Respondent contends (again correctly in my view) that In this case, both the underlying reason for the expenditure and the Applicant’s motive or purpose so far as it is revealed by the evidence in commencing the review proceedings, compel the conclusion that the Deductions are not deductible.
38. It is relevant also that the Applicant did not dispute the findings of the PIC that he engaged in conduct which was unacceptable and that as a result he was removed from office. The legal expenses were incurred in an attempt to regain an office with the Police and of which he had for cause, been deprived.
39. As the Respondent contends this case is readily distinguishable from cases such as Putnin, Federal Commissioner of Taxation v Snowden & Willson Pty Limited (1958) 99 CLR 431 and Magna Alloys, all of which ultimately involved the defence of business practices or commercial reputation. In all of those cases, the legal expenses were incurred in defending the very activities which generated the taxpayer’s income.
40. Professor Parsons has noted that “the occasions when [a contract of employment] will be a revenue asset is likely to be few”: paragraph 2.384 of “Income Taxation in Australia”.
41. In clause 46 of his written submissions the Respondent contended (and in my view correctly) that “In this case, the overriding purpose of the Re-employment Proceedings was to secure a structural benefit for the Applicant, namely a new contract of employment”. .
42. I find then that the legal expenses were not deductible in accordance with section 8.1(a) of the Tax Act. This being so it is unnecessary for me to consider the negative limbs. Having made this point I would incline to the view that if I am wrong and section 8.1(a) of the Tax Act does apply, the expenses are of a capital nature. In the alternative there is no necessary natural antipathy between expenses incurred in gaining assessable income and those of a private nature: John v Commissioner of Taxation (Cth) (1989) 166 CLR 417 at 431.
Part E; The interest deduction.
43. Having found that the deductibility claim in respect of legal expenses must fail, the claim in respect of interest must also fail and it is not necessary for me to deal with this aspect in detail. I do so, albeit briefly, in part in case my conclusion as to the deductibility of the legal expenses is incorrect, and in part in the interests of completeness.
44. I commence by noting that the evidence of the Applicant was not impressive. It was often vague, and especially in cross-examination, met on a number of occasions with “I don’t remember” answers. It was also, and at times, incorrect even in relation to important aspects such as the month in 2002 in which his removal from the Police took place
45. The Applicant’s (not always coherent) evidence would have me accept that when he received his lump sum superannuation payment consequent upon his removal, he placed that amount of approximately $50000 in a separate account; as Mr Young put it, he “quarantined it”. The Applicant said that it was necessary to do so because he knew that he would be returning to the Police. As to how he could at that time know that a return was certain is unclear. He received a final bill inclusive of counsel’s fees from his solicitors in April 2003; the aggregate amount of the tax invoice was $24367 and of which he had previously and by way of deposit paid $2000. On 26 June 2003 (and see page 40 of Exhibit A1) the Applicant secured a “Flexible Mortgage Facility” from National Australia Bank (“NAB”) in an amount of $50000; that latter facility was referable in its terms to a differently numbered account. His evidence was that moneys were transferred from one account to another on various occasions and as needed and that he paid the outstanding balance of his legal expenses out of the NAB facility and then used the balance for living expenses. The Summary indicates that he paid the balance of legal expenses on 19 August 2003. He said that he repaid the superannuation fund out of the other or quarantined account. Relevant bank statements in support of this evidence would have been helpful. It is sufficient to conclude that the Applicant did not discharge the onus of demonstrating a relevant nexus between the interest expense and the legal expenses. It may be noted that the interest deduction amount arose from a calculation made by the Applicant and was not an amount charged by the NAB. During the course of the hearing Mr. Young made a quick calculation (on an ex tempore basis) of interest at 7% (the rate applicable to the NAB facility) and considered that the amount claimed was correct. In the course of preparing these reasons I calculated interest on $22367 from 19 August 2003 to 30 June 2004 at 7% and arrived at a figure which was lower by an appreciable amount than the amount in fact claimed.
Part F Conclusion
46. It is clear to me then that the legal expenses incurred by the Applicant related squarely and only to his endeavours to regain a position with the Police. He succeeded eventually in obtaining another but lesser position. The fact that his service was in some respects (and for benefits reasons) treated as continuous cannot alter the fact that his new position was just that; a new and different position. Maddalena is altogether relevant in this context. Moreover and in any event Putnin and Rowe do not assist him, because he was not the defendant in respect of an attack against him and referable to an existing position, but rather by contrast he was the plaintiff who was seeking to obtain a position. He had been dismissed on integrity grounds, and was seeking to obtain a position on the basis that his punishment was unduly harsh. His dismissal did not arise in any way from his day-to-day activities. The legal costs incurred by him are not deductible and similarly the interest deduction fails.
47. Accordingly the decision under review must be affirmed.
I certify that the 47 preceding paragraphs are a true copy of the reasons for the decision herein of Mr Julian Block, Deputy President
Signed: A. Krilis Associate
Date/s of Hearing 24 May 2006
Date of Decision 2 June 2006
Counsel for the Applicant Mr I Young
Solicitor for the Applicant Mr E Dixon
Counsel for the Respondent Mr J Hmelnitsky
Solicitor for the Respondent Mr D Ong
Key Legal Topics
Areas of Law
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Taxation Law
Legal Concepts
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Income Tax Assessment Act 1997
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Deductible Expenses
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Character of Expenses
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