Parklan Pty Ltd (in liq) v Commissioner of Taxation
[1983] FCA 167
•19 JULY 1983
Re: PAKLAN PTY. LTD. (IN LIQUIDATION); McDONALD FREEMAN; TREVOR ROBERT JONES
and DOUGLAS LEONARD PARKHILL
And: THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
(1983) 67 FLR 328
Nos. VG207-210 of 1982
Taxation - Income Tax
COURT
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
GENERAL DIVISION
Franki(1), Northrop(2) and Fisher(2) JJ.
CATCHWORDS
Taxation - Appeal from assessment - Lump sums paid to taxpayers by company and by superannuation funds - Whether payment "in consequence of retirement from or termination of, any office or employment" - Whether payment an allowance, gratuity, benefit or bonus given by employer - Whether sums paid by company to taxpayers deductible from its assessable income.
Income Tax Assessment Act, ss. 26(d) (e), 78 (l) (c).
Income Tax - Assessable income - Allowable deductions - Business of company sold - Whether sums paid to former directors assessable as retiring allowances - Whether employee benefits - Whether payments deductible - Income Tax Assessment Act 1936 (Cth), ss 26(d), 26(e), 51(1), 78(1)(c), 190(b).
HEADNOTE
The appellant (Paklan) was a company of which the three other appellants had been directors (the directors). On 30 June 1977 Paklan ceased to carry on the business of consulting engineers. On 1 July 1977 another company with the same directors bought Paklan's business and started carrying it on at the same premises with the same employees. Some time later Paklan paid retiring sums to the directors. The directors also received payments from a directors' fund based partly on assurance policies. (1) Paklan claimed a deduction for the sums it paid. The Commissioner disallowed the claim and Paklan unsuccessfully appealed to the Supreme Court of Victoria, then further appealed. (2) The Commissioner assessed the directors on the retiring sums and other payments. They unsuccessfully appealed to the Supreme Court, then further appealed.
Held (by majority): Appeals allowed in part. (1) (per the Court). The payments were not deductible by Paklan under s. 51(1) of the Income Tax Assessment Act because they were paid after Paklan ceased carrying on business.
(By majority) however part of the payments were deductible under s. 78(1)(c) to the extent they were made in good faith in consideration for past services.
(2) (per the Court). The retiring sums paid to the directors were assessable under s. 26(e) because on the facts they were not paid in consequence of retirement (McIntosh v. Federal Commissioner of Taxation (1979) 45 CLR 279), (by majority). However the payments from the directors' fund were on the facts capital, and not assessable under s. 26(d) or 26(e) (Constable v. Federal Commissioner of Taxation (1952) 86 CLR 403).
HEARING
1983, March 15, 17; July 19. #DATE 19:7:1983
APPEAL
Appeal from the decision of Kaye J. of the Supreme Court of Victoria dismissing the taxpayers' appeals against the disallowance by the Commissioner of their objections to assessments in respect of the year of income ended 30 June 1978.
J.D. Merralls Q.C. and R.C. Macaw, for the appellants.
R. Merkel Q.C. and K.M. Hayne, for the respondent.
Cur. adv. vult.
Solicitor for the appellants: T.A. Sherman, Acting Commonwealth Crown Solicitor.
Solicitor for the respondent: Rail and McBain.
J.H.T.
ORDER
1. The appeal be allowed.
2. The order of the Supreme Court of Victoria be set aside.
3. The assessment be remitted to the Commissioner of Taxation for the purpose of enabling him to form an opinion as required by s. 78 (1) (c) of the Income Tax Assessment Act 1936 of the extent to which the payments to the four employees by way of retiring allowances in the sums amounting in all to $40,000 were paid in good faith in the business operations which were carried on by the taxpayer for the purpose of gaining or producing assessable income, and to be re-assessed accordingly.
4. The respondent pay one half of the appellant's costs of the appeal and of the hearing in the Supreme Court of Victoria.
1. The appeal insofar as it relates to the inclusion as assessable income of the sum of $45,373 paid to the appellant by the trustees of the Parkhill & Freeman Pty. Ltd. Directors' Superannuation Fund and the sum of $2,606 paid to the appellant by the trustees of the Parkhill & Freeman Pty. Ltd. Staff Superannuation Fund respectively be allowed, otherwise the appeal be dismissed.
2. The assessment be remitted to the Commissioner of Taxation to be re-assessed accordingly.
3. The respondent pay one half of the appellant's costs of the appeal and of the hearing in the Supreme Court of Victoria.
1. The appeal insofar as it relates to the inclusion as assessable income of the sum of $22,148 paid to the appellant by the trustees of the Parkhill & Freeman Pty. Ltd. Directors' Superannuation Fund and of the sum of $2,172 paid to the appellant by the trustees of the Parkhill & Freeman Pty. Ltd. Staff Superannuation Fund respectively be allowed, otherwise the appeal be dismissed.
2. The assessment be remitted to the Commissioner of Taxation to be re-assessed accordingly.
3. The respondent pay one half of the appellant's costs of the appeal and of the hearing in the Supreme Court of Victoria.
1. The appeal insofar as it relates to the inclusion as assessable income of the sum of $51,679 paid to the appellant by the trustees of the Parkhill & Freeman Pty. Ltd. Directors' Superannuation Fund and the sum of $2,633 paid to the appellant by the trustees of the Parkhill & Freeman Pty. Ltd. Staff Superannuation Fund respectively be allowed, otherwise the appeal be dismissed.
2. The assessment be remitted to the Commissioner of Taxation to be re-assessed accordingly.
3. The respondent pay one half of the appellant's costs of the appeal and of the hearing in the Supreme Court of Victoria. Orders accordingly.
JUDGE1
A Judge of the Supreme Court of Victoria heard four appeals by taxpayers against disallowance of their objections to assessments of income tax for the year ended 30 June 1978. By consent all appeals were heard together. The learned trial Judge dismissed all appeals and each taxpayer has appealed to this Court under the provisions of s. 200 of the Income Tax Assessment Act 1936. Again the appeals to this Court were heard together by consent.
The first appellant, Paklan Pty. Ltd. (in liquidation), is a company which changed its name from Parkhill and Freeman Pty. Ltd., and which I will call "the old company". Shortly after its incorporation in 1970 it acquired the practice of a partnership, conducted by two of the appellants, Mr McDonald Freeman and Mr Douglas Parkhill, which provided the services of consulting engineers. The other appellant, Mr Trevor Robert Jones, became an employee of the old company and also a director of it. All three individual appellants were engineers.
A company, hereinafter called "the new company", named Parkhill & Freeman Partners Pty. Ltd. was incorporated on 23 June 1977.
By agreement in writing on 1 July 1977 the new company entered into an agreement with the old company to purchase the assets and goodwill of the old company for $98,165.00 allocated as to $38,165.00 for assets and $60,000.00 for goodwill. The evidence showed that the goodwill included work in progress existing as at the date of the agreement. There was a clause in the agreement that the purchase price was to be paid in full no later than 1 July 1978. The new company was a trustee company. Pursuant to a settlement made by a company, 484 Settlement Pty. Ltd., the new company accepted the obligations under a Deed of Trust, which extended over 54 pages, and which, in substance, provided that the beneficial interest in the Trust Fund should be vested in Unit Holders in a Unit Trust known as Parkhill & Freeman Unit Trust. It appears that after 1 July 1977 the consulting engineering services which had been provided by the old company were provided by the same directors and staff through the medium of the Unit Trust.
There was also a company called Design Sixty Market Pty. Ltd. which appears to have been a company associated with the old company. Its function was mainly concerned with drafting services and it held a number of assets associated with printing and drafting.
The appeals arose from the disallowance by the Commissioner of certain payments to the three individual directors and of a deduction claimed by the old company. The three individual appellants claimed that certain amounts had been paid to them by way of retirement benefits during the relevant year. On 1 July 1973 the old company established a fund known as the "Parkhill and Freeman Proprietary Limited Superannuation Fund", hereinafter called the "directors' fund", and on 1 June 1971 the old company also established a fund called the "Working Directors and Employees Superannuation Fund", hereinafter called the "staff fund".
During the relevant tax year the following payments were made to the three individual appellants:
Retirement Directors Staff
Benefits Fund Fund
$ $ $
D.L. Parkhill 12,000.00 51,678.57 2,632.80
M. Freeman 12,000.00 45,373.11 2,605.80
T.R. Jones 8,000.00 22,147.56 2,171.70 and
1,028.60
M. Finn 8,000.00 8,686.50 -
The position of Mr Finn is not involved in this appeal. There is no need to differentiate between the position of each of the individual appellants in respect of any of the payments.
The taxpayers made their objections under s. 185 of the Act, and the Commissioner disallowed them under s. 186. Each taxpayer requested the Commissioner to treat each objection as an appeal pursuant to s. 187(b). Under s. 190(b) of the Act upon an appeal "the burden of proving that the assessment is excessive shall lie upon the taxpayer". The same burden lies upon the taxpayer in this appeal, (Federal Commissioner of Taxation v. Mantle Traders Pty. Ltd. (1980) 33 A.L.R. 276).
The only witness called by the appellants was Mr Jones. The learned trial Judge expressed the following view about Mr Jones' evidence:
"Evidence of the circumstances in which the disputed payments were made was given by Jones, who was described by Mr Ahearne, counsel for the appellants, as 'the director with his fingers on the pulse'. However, much of Jones' evidence of decisions concerning the disputed payments which were made by the directors was based upon his belief rather than recollection. At times he showed a disposition to improve evidence given by him at an earlier stage in his examination, thereby contradicting what he had previously sworn. Parts of his evidence were marked by vagueness revealing either a lack of knowledge or difficulties of recall, thereby rendering his evidence about those matters unreliable. He was not a party to some matters concerned with decisions made by others which were critical to the appeals."
I have read the evidence of Mr Jones carefully and I consider it thoroughly unsatisfactory and, with respect, I agree entirely with the learned trial Judge's assessment of his evidence.
The first directors of the directors' fund were three in number, a solicitor, a public accountant, a Mr McKenzie, and an appellant, Mr Parkhill. Mr McKenzie was an accountant who was responsible for the preparation of the income tax returns and who appeared, so far as is relevant, to be the general financial adviser to the appellants. It was he, for example, who advised the appellants to incorporate a unit trust company and it was known that this had some tax planning advantages. No books of the appellant company were put in evidence although some part of its financial records was tendered.
Mr Jones said in evidence that he believed that Freeman, Parkhill and McKenzie were all in Melbourne at least at some stage of the appeals and it appears that Freeman and Parkhill were in Court during part of the presentation of the case. Mr Jones also said that Mr McKenzie's place of practice as an accountant was in William Street and, presumably, within walking distance of the Court.
I have mentioned the unsatisfactory nature of Mr Jones' evidence. Many of the documents tendered were conflicting or capable of pointing to a variety of conclusions. In addition, I have no confidence that in many instances a document properly set forth the real facts. For example, the respondent wrote to Mr Jones on 23 February 1979 and asked:
"5. Whether you were re-employed by your employer after you retired and if so, date of re-employment and position occupied. Also state if after your retirement you were employed by a firm associated directly or indirectly with your former employer."
Mr McKenzie's firm replied to this question as follows:
"5. No. Company ceased trading on 1st July, 1977.
The new employer has no association with the previous employer directly or indirectly."
Mr Jones conceded in evidence that this answer was probably not full and frank. When one bears in mind that during the relevant year Mr Jones was employed performing precisely the same work for the same clients and that he performed this work from the same premises and in association with the same other employees, it is difficult to be prepared to draw inferences from material of this nature.
A similar letter was written to Mr Parkhill by the respondent asking the following questions:
"6. If you were re-employed after retirement state:
a. date re-employed;
b. position occupied;
c. the relationship if any, of your present employer to your former employer;
d. whether your present duties are comparable to those rendered to your former employer;
e. Name of the company by whom you were re-employed."
Mr McKenzie's firm replied on 19 June 1979 as follows:
"6. No. Company ceased trading 30/6/77.
c. None
d. Yes.
e. Parkhill & Freeman Partners Pty. Ltd."
In a case such as this where the burden rests on the appellants to prove that the assessments were excessive, an appellant who presents such an incomplete picture of the relevant financial transactions places himself at a disadvantage and indeed is subject to the inference which the learned trial Judge drew that the persons, who might have been called but who were not called, would not have supported the case the appellants sought to establish.
I will deal with each type of payment separately.
(1) Retirement Benefits
It was alleged by the individual appellants that the amounts paid to them, as a result of what was called by the respondent a "round robin", were capital amounts paid to them in consequence of retirement from, or termination of, their employment and so s. 26(d) of the Income Tax Assessment Act, 1936, ("the Act") applied and tax was only payable upon five percent of the relevant capital amount. The critical question was whether the payment of those sums was. "in consequence of retirement from, or termination of, any office or employment". The case was conducted by the individual appellants upon the basis that their employment (although not as directors) terminated at the end of June 1977. Senior counsel for the respondent presented a variety of arguments including one that if, for example, an engineer changed employers he was not retiring or terminating employment. However, I do not think it is necessary to explore matters of that nature because I am satisfied that there is no evidence sufficient to satisfy the onus provided by s. 190(b) of the Act that these amounts were paid in consequence of retirement from, or termination of, employment with the old company or if it be relevant to consider, any "office".
The taxation return of the old company for the year ended 30 June 1978 contained the following notation:
SCHEDULE 27 - Remuneration of Directors & Shareholders
NAME POSITION HRS DIRECTORS LUMP SUM
FEES ON RETIREMENT
D.L. Parkhill Director 40 12,000
McD. Freeman Director 40 12,000
T.R. Jones Director 40 8,000
M. Finn Director 40 8,000
The return also contained a Statement of Profit and Loss for the old company as at 30 June 1978. This showed, inter alia, that fees received during the year were $35,393.44 and under the category of "Expenses" appeared entries against the word "Salaries" of $35,270.00 and against the word "Superannuation" of $435.00. In a letter from Mr Jones to a firm of solicitors explaining the taxation returns for 1978 appears, inter alia, the following:
"With respect to the last paragraph of page 2 of your letter, we would advise that $40,000 was paid out as retirement allowances (lump sum) and an adjustment against previous years 'salaries' of $4,730 was made giving the figure of $35,270 shown as 'salaries' in the Profit and Loss statement for 30th June 1978."
It appeared from Mr Jones' evidence that the figure of $4,730.00 involved a return of that amount from two "Sydney directors", a Mr Muirhead and a Mr Tierney. The reason for these payments was unexplained in the evidence. The learned trial Judge took the following view:
"I further find that on some date during the first half of 1978, which the evidence did not enable me more particularly to identify, the appellants in their capacity as directors of the appellant company and with the advice of McKenzie agreed to pay out of the funds of the appellant company the sum of $40,000 by payments of $12,000 to each Parkhill and Freeman, and $8,000 to each Jones and Finn, that they agreed to characterize those payments for taxation and accounting purposes as 'retiring sums', and that those sums were paid by cheques dated 26th June, 1979 (sic) drawn on the A.N.Z. Bank by the appellant company."
His Honour further held that:
"Thereafter $35,270 of those fees was characterized as 'salaries' in the appellant company's Profit and Loss Statement. No explanation of the reason for so designating the fees was offered by the appellants or the appellant company. Furthermore, they failed to provide evidence of the source of the sum of $4,730, which was required to make up the $40,000 paid to the appellants as retirement allowances. From cross-examination of Jones and the reduction of 'Share Reserve' by a similar amount as appears in the Statement of Assets and Liabilities, I infer that the balance of $4,730 originated from payments made by the former directors, Messrs. Muirhead and Tierney. When and how payment took place was not revealed.
It is clear, however, that if the income derived from the fees had not been distributed by way of dividends or directors' fees, the appellant company would have become liable to pay, in addition to primary company tax, tax upon such undistributed amount under Part 111, Division 7 of the Act. Furthermore, if the income from the fees had been distributed among them as directors' fees or dividends, the incidence of tax for the appellants upon the amount so received by each of them would have been greater than if the same were paid as retirement allowances. It was therefore advantageous for both the appellants and the appellant company that the sum of $35,270 should have been paid out to the former by way of retirement allowances."
His Honour concluded:
". . . that the termination of their employment was not the occasion of the payments and it was not a condition of their entitlement to payments."
In my opinion there is no evidence of the reasons why these retirement benefits were paid but it is clear that the old company had in its possession at the end of June some $40,000 available for distribution and that, if not the most favourable, at least a favourable way of disposing of these funds was to make payments to the directors characterised as retirement benefits. We were referred to Reseck v. Federal Commissioner of Taxation (1975) 133 C.L.R. 45 in relation to the interpretation of s. 26(d). There is no evidence of any resolution by the directors of the company that these amounts should be paid as retiring allowances. I do not consider that, in the light of the evidence before the Court, there is any reason to deal with the law in relation to s. 26(d) in any detail.
I am satisfied that the appeals in relation to the retirement benefits should be dismissed because the individual appellants have not discharged the onus of proving the assessments excessive in this regard.
(2) Directors' Fund
The basis of each individual appellant's arguments in relation to this fund was that the old company had ceased business after 30 June 1977 and that the amounts paid out from the fund were payments of the entitlement of each member and were capital amounts not taxable under s. 26(e) of the Act in accordance with the reasoning of the High Court in Constable v. Federal Commissioner of Taxation (1952) 86 C.L.R. 402. Section 26(e) of the Act provides:
"The assessable income of a taxpayer shall include -
(e) the value to the taxpayer of all allowances, gratuities, compensations, benefits, bonuses and premiums allowed, given or granted to him in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by him, whether so allowed, given or granted in money, goods, land, meals, sustenance, the use of premises or quarters or otherwise:
Provided that this paragraph shall not apply to any allowance, gratuity or compensation which is included in the last preceding paragraph or which under any provision of this Act is deemed to be a dividend paid to the recipient."
In the joint judgment of Dixon C.J., McTiernan, Williams and Fullagar JJ. in Constable's Case their Honours said at p. 418:
"It appears to us that the taxpayer became entitled to a payment out of the fund by reason of a contingency (viz.: an alteration of the regulations curtailing the rights of members) which occurred in that year enabling him to call for the amount shown by his account. It was a contingent right that became absolute. The happening of the event which made it absolute did not, and could not, amount to an allowing giving or granting to him of any allowance, gratuity, compensation, benefit, bonus or premium. The fund existed as one to a share in which he had a contractual, if not a proprietary, title. His title was future, and indeed contingent or, at all events, conditional. All that occurred in the year of income with respect to the sum in question was that the future and contingent or conditional right became a right to present payment and payment was made accordingly. This, in our opinion, cannot bring the amount or any part of it within s. 26(e). The amount received by the taxpayer from the fund is a capital sum, and, unless it or some part of it falls under s. 26(e) (there being no other applicable imposition of liability), it is not part of the assessable income."
I pass to examine the provisions of the trust deed. The Fund was made up of an original sum of $15,034.38, set apart on 1 July 1973, and "all members' contributions and all sums which the employer may hereafter pay to the trustees to be held upon the trusts hereinafter described . . .". No payments were made to the fund by any member, all amounts being contributed by the employer. The trust deed dealt with allocated and unallocated amounts and an allocated amount was defined as:
"'allocated amount' as to each member will mean all sums contributed by that member and all sums (whether portion of the original sum or not) which the employer may contribute or hereafter direct the trustees to allocate to such member and all amounts added thereto out of the nett income of the allocated portion of the fund (as hereinafter defined) pursuant to the provisions of Clause 8 . . .".
Clause 5(a) provided:
"The employer will contribute to the fund and will pay to the trustees in each year by way of such contribution in respect of each member the maximum amount from time to time allowable under the Income Tax Assessment Act or any amendment thereof for the time being in force . . .".
There was also a proviso which appears to fix a minimum payment.
Clause 7 provided that the employer may at any time direct the trustees to allocate any sum out of the unallocated portion of the fund to a member and clause 8 provides that the nett income shall be divided in proportion to the respective allocated amounts of each member. The nett income from the unallocated portion of the fund, if any, is to be added to the unallocated portion of the fund.
Clause 14 dealt with the method of making any adjustment if the allocated portion exceeds the value of the assets and clause 15(b) provides that allocations from an unallocated portion of the fund "need not be made on any scale uniformly applicable to members . . .".
Clause 16(a) provided that a trustee shall keep proper books of account and records including particulars of amounts allocated to each member and clause 17(a) provides that immediately upon receipt of a contribution it shall be "credited to the respective accounts of the members or to the unallocated portion of the fund, as the case may be".
By clause 17(c) the expenses of the fund's administration were, in general, to be debited to the unallocated portion of the fund. Clause 18 provided for a power in the employer, subject to any conditions, restrictions or requirements of the Commissioner of Taxation, to direct the trustees to wind up the fund. An obligation was then imposed upon the trustees ". . . at the expiration of three calendar months from the receipt of such direction (to) convert the fund into money and pay to each member his allocated amount . . . and transfer and . . . the unallocated portion of the fund will be paid to such one or more of the members to the exclusion of the others in such proportions or sums as the employer may within the said period of three calendar months in writing to the trustees direct, and in default of such direction or as to such part of the unallocated portion of the fund to which such direction does not extend, the trustees will divide the same amongst the members in proportion to their respective allocated amounts and if there be no member, then among the employees equally".
Clause 19(a) provided:
"If the employer should cease business or go into liquidation (except for the purposes of amalgamation or reconstruction) the same consequences will follow as if the employer at the commencement of its winding up had directed the trustees to wind up the fund pursuant to Clause 18 hereof."
It was argued that the old company had ceased business and therefore that, by virtue of the trust deed, the individual appellants were entitled to be paid their allocated amounts together with such unallocated portion of the fund as might fall to them under the provisions of clause 18.
We have practically no evidence concerning any records of the directors' fund, nor indeed, any worthwhile evidence from any person concerning the way, if any, such payments were allocated. Mr Jones seemed happy with the amount he had received but he did not know how it had been calculated. He said:
"I know the assets of the fund have been distributed, sir. I am unfamiliar with the requirements relating to the end of superannuation funds, which I have no knowledge of what is to be done and what may have been done.
But the whole of the assets of the fund were sold and distributed in about June or July of '78? - - - Yes, in June '78.
When was the decision made to take the step of selling all the assets of the fund? - - - I don't remember, sir.
Was it too a decision that was made in the first half of 1978? - - - I was not a trustee of the fund, sir.
Who were the trustees of the fund? - - - I think, from memory, they were Mr Parkhill and Mr Freeman, sir.
Are they in Melbourne today and available to give evidence? - - - I believe they are in Melbourne, sir.
Not being a trustee, I take it you cannot say whether the decision to sell up all assets of the fund and distribute was a decision that was made on the advice of Mr McKenzie, the accountant to your company? - - - No, sir."
The case for the individual appellants can be crystallized by the statement that the amount they received was the amount they were properly entitled to under the deed and that the assessment was therefore excessive. The learned trial Judge found that:
"The state of the evidence did not enable me to find that the Fund was wound up on 30th June, 1978 and there was no evidence on which I could find that the decision to make payments out of the Directors' Superannuation Fund was made before 26th June, 1978, being the date of each of the four cheques."
A letter of 20 June 1975 from Mr McKenzie's firm to the Deputy Commissioner of Taxation was in evidence alleging that the maximum contribution payable by the old company in respect of Mr Parkhill was $9,240 and that in respect of Mr Freeman was $8,530. If these amounts had been in fact paid by the company and they had been allocated to Messrs Parkhill and Freeman respectively, I would have thought that the ultimate payments to them, subject to any question of the allocation of the initial sum of $15,034.38, would have borne the same ratio as 9,240 did to 8,530. However, this is not the position and the ratio of the payments to Parkhill and Freeman is as 1.139 is to 1 whereas that of the sums referred to in the letter of 20 June 1975 is as 1.083 is to 1. Although this figure was not the subject of any submissions, in the absence of any evidence concerning the allocations of the directors' fund to any director, it does raise a query whether the amounts ultimately paid out represented the amounts allocated to each director together with any unallocated amount which was properly payable to the director concerned under the terms of the trust deed.
One does not know how the Commissioner reached the conclusion that he did and I am not prepared to draw the inference from the evidence before the trial Judge that the amount which was paid to each individual appellant was the amount to which he was entitled under the trust deed. If this is so, assuming that the payments of the individual appellants are ones to which the principles in Constable's Case are applicable, we do not know what were the precise amounts to which the individual directors were contingently entitled under the deed and therefore we do not know to what amount they became absolutely entitled under the deed pursuant to the events which happened. The learned trial Judge cited the following passage from the income tax return of the directors' fund for the year ended 30 June 1978.
"The Company Parkhill & Freeman Pty. Ltd. which operates the above fund, ceased operations on 30th June, 1978. The fund has been wound up, all assets sold and funds distributed in the following proportions.
D.L. PARKHILL $51,678.57 T. JONES $22,147.56 McD. FREEMAN $45,373.11 M. FINN $8,686.50"
The case was argued before us upon the basis that the old company ceased operations on 30 June 1977 after which it did not provide the services of consulting engineers. The directors were then paid salaries apparently by the new company but they remained directors of the old company.
During the year ended 30 June 1978, the old company collected fees and ultimately paid debts by what was called by the respondent a "round robin". All the payments under consideration were made, and loans were made to the new company. Payment was also made by the new company to the old company of the amount owing under the contract of sale of 1 July 1977.
As was pointed out by the learned trial Judge, the bank deposit book of the directors' superannuation fund recorded that on 6 September 1978 that fund had received SEC Interest of $52.00 and on 5 January 1979 SEC Interest of $1,026.10. This may not be of any consequence but was quite unexplained.
A possible further complication arises from the fact that, apparently, a payment to the directors' fund was received on 30 June 1978 from Design Sixty Market Pty. Ltd. Perhaps this was the repayment of a loan.
I also mention that the learned trial Judge found that the old company ceased business operations on 30 June 1977. Senior counsel for the respondent relied upon In re Sarflax Ltd. (1979) 1 Ch. 592 and submitted that, because it had thereafter engaged in a continuous conduct of collecting what was due to it from its trading operations and discharging the obligations incurred in those trading operations, it had not ceased business on that date. In any event it would appear to have ceased business by the beginning of June 1978, a date before the various payments under consideration were made, so I do not regard this aspect as significant.
If one accepts the view that the appellants received the amounts to which they were entitled from the directors' fund, their appeals should be upheld on this question. I consider that there is no satisfactory evidence of the entitlement of each appellant because of the absence of evidence concerning the allocation of amounts. As I have said, the onus is upon the appellants under s. 190(b).
The appellants have had every chance in this case to establish the facts and, if the matter be remitted to the Commissioner to reassess, it is by no means clear to me that the necessary material would be available to him. It may be that the appellants have not only to show that there has been an error but they have to show the extent of that error in a case of this nature.
Section 39 of the Income Tax Assessment Act 1922, which was the fore-runner of s. 190(b), was considered by Latham C.J. in Trautwein v. Federal Commissioner of Taxation (1936) 56 C.L.R. 63 at pp. 87-88. At p. 88 his Honour said:
"The application of sec. 39 is not, in my opinion, excluded as soon as it is shown that an element in the assessment is a guess and that it is therefore very probably wrong. It is prima facie right - and remains right until the appellant shows that it is wrong. If it were necessary to decide the point I would, as at present advised, be prepared to hold that the taxpayer must, at least as a general rule, go further and show, not only negatively that the assessment is wrong, but also positively what correction should be made in order to make it right or more nearly right."
His Honour had previously referred to the difference between showing an error in an assessment and thereby "creating a blank" and showing what should be substituted for the item alleged to be incorrect. This passage from Latham C.J. was referred to with approval by Murphy J. in Macmine Pty. Ltd. v. Commissioner of Taxation (1977) 53 A.L.J.R. 362 at pp. 378-379.
It would appear that any payments made from the directors' fund were from moneys over which the old company, apart from clause 18 of the trust deed, had no control. In these circumstances it may be that moneys received from the fund, whether of amounts corresponding with the precise entitlements of each director, or not, are not taxable.
I have read a draft judgment of Northrop and Fisher JJ. who draw the inference that the moneys paid from the directors' fund to each appellant was of the amount to which he was entitled and so, in their view, this question does not arise. I feel this question was not fully argued and, in view of the decision to which Northrop and Fisher JJ. have come, I think it is better that I do not express any conclusion upon it. It is sufficient to say that I am, at present, not prepared to uphold the appeals on this question.
(3) Staff Fund
This fund was established by a Deed of 1 June 1971 whereby the old company declared that it set up the fund for the purpose of providing, inter alia, retiring allowances or payments upon death or certain other contingencies to its present and future working directors or employees. The old company agreed to effect certain policies of assurance on the life of each member with Phoenix Life Assurance Company of Australia Limited. (Clause 4(a)). Clause 6 provided that the company and the member shall contribute in such shares and proportions as shall be mutually agreed upon the premiums of any policies effected on the life of the member. The evidence was that all premiums were paid by the old company. The company had no interest in the policies and clause 15 stated:
"In the event of an order being made or an effective resolution being passed to wind-up the Company (except for the purposes of reconstruction) or in the event of the Company for any other reason ceasing to carry on business, the Scheme shall be wound up and all Policies effected pursuant to the Scheme shall be assigned to the Member respectively entitled thereto, provided always that as from the date of the winding-up of the Scheme as aforesaid all liability of the Company under the Scheme shall cease and determine."
Pursuant to the deed, a policy of life assurance was effected on the life of each of the taxpayers as well as certain other employees.
The amount of $2,171.70 received by Jones was apparently received from the staff fund and the amount of $1,028.60 appears to have been received from a different policy with the A.M.P. taken out by Design Sixty Market Pty. Ltd. No evidence was available of the terms of any trust deeds under which this latter policy had been effected although there was some evidence that the old company in fact paid the premiums.
No evidence was before the Court concerning the activities of the trustees of this fund during the year 1978 but a letter was in evidence from a trustee company called Friends' Provident Life Office of the payments of relevant amounts to Freeman and Parkhill and of an amount of $2,171.70 to Jones. Whatever might have been the position at the end of June 1977, it seems clear that the company had ceased to carry on business on 13 July 1978, when a cheque was drawn in respect of these amounts in settlement of the surrender of certain policies. No point was taken about the date of these payments and the matter proceeded before this Court upon the basis that these payments were made during the tax year ended 30 June 1978. The learned trial Judge took the view that because no evidence had been given:
". . . proving when the decision was made to make payments out of the Fund and by what authority payments were so made, together with the expiration of twelve months from the time of cessation of their employment and the making of the payments, cause me to conclude that the payments made out of the Funds were not by way of retirement allowances."
In my opinion there is no doubt that, upon the cessation of the business of the old company, the policies effected pursuant to the scheme should have been assigned to the member respectively entitled. In my opinion the contingent rights provided in the deed to persons in respect of whom policies had been effected, upon the company ceasing business, could not depend upon whether the trustees had properly carried out the terms of the trust. In my opinion the events which had happened did not and could not fall within s. 26(e). The payments were made pursuant to a superannuation deed in which the right to payment crystallised upon the old company ceasing business. In this regard I have the misfortune to disagree with the views of the learned trial Judge and I would uphold the appeals in regard to the amounts paid under the staff fund to Parkhill and Freeman and to Jones so far as the amount of $2,171.70 is concerned but, for lack of evidence, not in relation to the amount of $1,028.60.
I pass next to the question as to whether s. 260 of the Act has any application. Considerable emphasis was placed by senior counsel for the Commissioner on what was called the "round robin" but in my opinion there is no significance in such an allegation even if true. Section 260 could not be applicable to the payments from the staff fund. Since I have held that, in my opinion, the payments of the retirement benefits and the payments from the directors' fund were properly assessed, s. 260 need not be considered. If it were relevant to consider the question of s. 260 in relation to the payment of the retirement benefits, I would be inclined to agree with the views of the trial Judge that it would appear that the change in characterisation of the sum of $35,270.00 from salaries paid to lump sums on retirement would attract the operation of s. 260. However, I do not find it necessary to express a concluded opinion on this aspect.
(4) Appeal by old company
I pass now to the appeal by the old company. By an amended assessment the Commissioner disallowed a loss of $16,790.00 and claimed that the company had a taxable income in the relevant year of $18,480.00. The addition of these two sums represents the amount of $35,270.00 shown in the Statement of Profit and Loss for the year as having been paid in relation to salaries.
The appeal is pressed on two grounds, firstly under the first leg of s. 51(1), namely that the expenditure was an outgoing incurred in gaining or producing assessable income. It is clear that whether or not the company had "ceased business" in the relevant year this amount could hardly be said to be such an outgoing. To all intents and purposes the gaining or producing of assessable income ceased on 30 June 1977 and it is clear that for a payment to fall within the category submitted by the appellants there must be a connection between the payment and the production of income. See generally Union Trustee Co. of Australia Ltd. v. Federal Commissioner of Taxation (1935) 53 Commissioner of Taxation (1935) 54 C.L.R. 295 and Peyton v. Federal Commissioner of Taxation (1963) 109 C.L.R. 315.
Section 78(1)(c) was also relied upon. The question here is whether the payment made by the taxpayer was within the words "pensions, gratuities or retiring allowances to persons who are or have been employees . . . to the extent to which, in the opinion of the Commissioner, those sums are paid in good faith in consideration of the past services of the employees in any business operations which were carried on by the taxpayer for the purpose of gaining or producing assessable income".
The first question is whether these payments fall within the category "pensions, gratuities or retiring allowances". In my view the evidence before this Court does not justify the conclusion that this amount fell into the relevant category. In the profit and loss account, as I have indicated, the amounts were designated as salaries. In the objection which was forwarded to the Commissioner it was submitted that:
"As to the said Section 78 (1)(c), the taxpayer says that if the said four several lump sums were not otherwise allowable deductions, the Commissioner (or Deputy Commissioner) should have formed the opinion that the same, being pensions, gratuities or retiring allowances paid to persons who had been employees of the taxpayer, were paid in good faith in consideration of the past services of those employees in business operations of the taxpayer for the purpose of gaining or producing assessable income and he should accordingly have allowed same as allowable deductions.
In so far as the Commissioner (or Deputy Commissioner) may assert that he effected the said adjustment by virtue of an opinion formed pursuant to Section 65, Section 109 or otherwise under the Act, that any or each (or all) of the said four several lump sums was (or were) not a reasonable amount, allowance or deduction (or reasonable amounts, allowances or deductions), then the taxpayer says that the said opinion was erroneous and should be reviewed."
One adjustment sheet, which was forwarded, referred to the amount of $16,790.00 as a claim in relation to "retiring allowances" and a second adjustment sheet referred to the balance of $18,480.00 as "retiring gratuities". The Commissioner disallowed the objection.
In my opinion it ought to be assumed that the Commissioner had considered the objections which he had been asked to consider and that he had come to the conclusion that the payments were either not "pensions, gratuities or retiring allowances" or, if they were, that they were not sums paid in good faith in consideration of the past services of the employees as required by the section. The Commissioner had had his attention directed to s. 109 of the Act, if that section be relevant.
I agree with the learned trial Judge that the appellant company has failed to make out its claims that the payments referred to were allowable deductions within the meaning of either s. 51(1) or s. 78(1)(c) as submitted. I would dismiss its appeal.
In summary I would uphold only the appeals with regard to the amounts paid under the staff fund to Parkhill and Freeman, and, in the case of Jones, only the amount of $2171.70 and not in respect of the amount of $1028.60.
The question of costs raises some difficulties. However, the only issue upon which I am prepared to find that an appellant should succeed is in relation to the staff fund, which was a fairly small part of the appeals. In my opinion it would be appropriate to make orders to the following effect:
(a) In the appeal by Paklan Pty. Ltd. (in liquidation) that company pay the costs of the Commissioner of Taxation in that appeal.
(b) In the appeals by the individual taxpayers, each individual taxpayer pay one-quarter of the costs of the Commissioner of Taxation in those appeals.
(c) The costs before the learned trial Judge be treated in the same way.
JUDGE2
This matter concerns an appeal by each of the abovenamed appellants against certain decisions of the Supreme Court of Victoria dismissing their respective appeals against disallowance by the Commissioner of their objections. In their returns for the year of income ending 30 June 1978 the three individual appellants ("the taxpayers") each disclosed lump sum amounts which they claimed they had received from various sources by way of retiring allowances. If their claims be upheld they were obliged, pursuant to s. 26(d) of the Income Tax Assessment Act 1936 ("the Act") to return only 5% of the lump sums as assessable income. In each instance the Commissioner included in his assessment of the taxable income of the particular taxpayer the balance in excess of 5% as aforesaid of the amount claimed as a retiring allowance. Each taxpayer objected against his assessment and upon the objection being disallowed requested that his objection be treated as an appeal and forwarded to the Supreme Court of Victoria.
The appellant Paklan Pty. Ltd. ("the Old Company") had been prior to the year of income ending 30 June 1978 the employer of the three taxpayers and it claimed in its return for that year to deduct from its assessable income the sum of $40,000 being that portion of the amounts returned by the taxpayers as retiring allowances which had been paid to them by the Old Company. As a result of the making of these payments the return of the Old Company disclosed a loss of $16,790.41. The Commissioner in his assessment and in the adjustment sheet annexed thereto rejected the "claim for deductions in relation to retiring allowances" to the extent of the claimed loss ($16,790), and assessed the loss for that year as nil. Subsequently he assessed the taxable income of the Old Company for that year at $18,480, disclosing by the adjustment sheet to that amended assessment that he disallowed the balance of the retiring allowances (less $4,730 subsequently explained) and in consequence increased the taxable income from nil to $18,480. The Old Company objected to this amended assessment and upon its objection being disallowed requested that it be treated as an appeal and forwarded to the Supreme Court of Victoria.
That court heard all four appeals together and in dismissing them affirmed each of the four assessments.
The following material facts were not in dispute. In December 1966 the taxpayers Freeman and Parkhill commenced to carry on in partnership the practice of consulting civil and structural engineers. The taxpayer Jones became an employee of the firm in the following year. The Old Company was incorporated on 15 September 1970, with the taxpayers as directors, and it took over the partnership business. Subsequently two engineers practising in Sydney became directors but they resigned on about 1 July 1975 and Michael Finn, an employee of the Old Company, became a director. The taxpayers and Finn held differing numbers of 'A' class shares and their wives or family companies held the 'B' class shares. One Roderick McKenzie was the adviser in accounting and taxation matters to both the Old Company and the taxpayers and he or members of his firm, R. McKenzie and Partners kept the books of account and prepared their income tax returns. The taxpayers were all working directors of the Old Company and were paid salaries as full-time employees of that company. Design Sixty Market Pty. Limited was a subsidiary company of the Old Company, for which it performed services.
On 23 June 1977 a new company Parkhill & Freeman Partners Pty. Limited ("Partners") was incorporated on the advice of McKenzie. By a written agreement dated 1 July 1977 Partners agreed to buy from the Old Company its business of consulting engineers together with what were termed its fixed assets. It was common ground that these fixed assets included work in progress and the benefit of existing contracts. The purchase price was $98,165 made up of $60,000 goodwill and $38,165.00 for the fixed assets and was payable by 1 July 1978. On 30 June 1977 the Old Company ceased to practise as consulting engineers and thereafter limited its activities to rendering accounts for concluded work and getting in its book debts preparatory to winding up. The actual work of so doing was performed for it by Partners under the supervision of the taxpayer Jones.
Partners carried on the consulting engineering business which it had acquired from the Old Company from the same premises and with the same staff including the taxpayers. There was in fact no break in the conduct of the business or the employment of the staff. Partners conducted the business as trustee for unit holders which were private companies of the families of the taxpayers and Finn.
These proceedings concern the assessability of lump sum payment received by the taxpayers shortly prior to the conclusion of the year of income ending on 30 June 1978 from the Old Company and from two Superannuation Funds. The only oral evidence in the proceedings before the Supreme Court was that of the taxpayer Jones and a perusal of the transcript makes readily understandable the trial judge's dissatisfaction with his testimony. In many instances his evidence on crucial matters was vague and hearsay in nature in that he was not a party to the making of decisions to which he referred. To the extent that it was necessary for the taxpayers and the Old Company to discharge their onus of establishing critical facts, the trial judge's finding that they failed to do so is very understandable. He was entirely justified in his criticism of the failure to call the other taxpayers and to produce the books of account of the Old Company. He was entitled to infer that the evidence of these persons and the books of account would not have supported the case of the taxpayers and the Old Company.
It is convenient to see the payments under consideration as falling into three categories and to deal with each category separately. Each of the taxpayers received a lump sum payment under each category, which categories were identified as follows in the return of income for the year ended 30 June 1978 of the taxpayer Jones. Under item 9 in his return he claimed to be assessed only on $1,667, the particulars of which were as follows:
"Item 9
Parkhill & Freeman - Retiring sum 8,000
Parkhill & Freeman Pty. Ltd.
Directors Superannuation Fund - 22,148
Parkhill & Freeman Pty. Ltd.
Staff Superannuation - 3,201
$33,349
1/20 = $1,667"
His claim to assessment on 1/20 only of the sum of $33,349 was made in reliance upon s. 26(d) of the Act which brings to account only 5% "of the capital amount of any allowance, gratuity, or compensation where that amount is paid (whether voluntarily, by agreement or by compulsion of law) in a lump sum in consequence of retirement from, or the termination of, any office or employment".
The first amount in item 9 of $8,000-"Parkhill & Freeman - Retiring sum", was an amount claimed to have been paid by the Old Company to the taxpayer Jones on 26 June 1978. On that date the taxpayers Parkhill & Freeman also each received $12,000 and Finn was paid $8,000 and each claimed in his return of income that the amount was a retiring sum assessable under s. 26(d). The evidence concerning the circumstances in which these payments were made is unsatisfactory and inconclusive. There was no record or minute of any decision on the part of the Old Company to make such payments, and Jones could only say that the decision to pay retiring sums to the four persons was made "in the early part of 1978". The balance sheet and profit and loss account of the Old Company as at the end of that financial year accompanied its tax return and was before the Supreme Court. However neither document made any reference to such payments. Schedule 27 of the taxation return of the Old Company was in the following terms:
"Schedule 27 - Remuneration of Directors and Shareholders
Name Position HRS Director's Lump sum on
Fees Retirement
D.L. Parkhill Director 40 - 12,000
McD. Freeman Director 40 - 12,000
T.R. Jones Director 40 - 8,000
M. Finn Director 40 - 8,000"
The trial judge made two findings which were crucial to the taxpayers' contentions, namely that they ceased their employment with the Old Company on 30 June 1977 and that company ceased carrying on business on that date.
The profit and loss account of the Old Company disclosed that it received $35,393.44 in fees during the year ended 30 June 1978 and that its expenses totalled $35,727.42. After taking into account that portion of the fees included in the assessable income of the previous year but unpaid at the commencement of the next year, namely $16,456.43 and "credits" totalling $1,180.28, a loss of $16,790.41 was disclosed for the year ending 30 June 1978. The principal expense item was "Salaries $35,270", but the evidence was that these salaries were not paid during the year and that this item in fact comprised the bulk of the sum of $40,000 paid as retiring allowances. The balance of that sum, namely $4,730, was provided out of what was denoted as a "Share Reserve" in the balance sheet, which balance amount had been received from the two retired Sydney directors during the year and applied in the reduction of the amount standing to the credit of that reserve.
Considerable significance was attached by the Commissioner to happenings at or about the time that the Old Company paid the lump sums to the taxpayers. The fact was that on 30 June 1978 Partners was obliged to pay to the Old Company the purchase price of that company's business. This debt was discharged as the last of these happenings and consequent upon the movement of a number of cheques, all presented for payment on 30 June 1978. The trial judge set out this movement, called a "round-robin" by counsel, as follows:
"1. Cheques drawn by the appellant company -
(a) for $12,000 in favour of Parkhill;
(b) for $12,000 in favour of Freeman;
(c) for $8,000 in favour of Jones;
(d) for $8,000 in favour of Finn;
By those four cheques payment was made of amounts which the appellants and the appellant company claimed were the retiring sums set out in the income tax returns.
2. Cheques drawn by the appellant company in favour of Parkhill & Freeman Pty. Ltd. Superannuation Fund for $72,588.45. By this cheque the appellant company repaid a loan advanced to it by the Directors' Superannuation Fund.
3. Cheques drawn by Parkhill & Freeman Pty. Ltd. Superannuation Fund -
(a) for $50,765 in favour of Parkhill;
(b) for $44,571 in favour of Freeman;
(c) for $21,756 in favour of Jones;
(d) for $8,533 in favour of Finn.
The amounts of those cheques were claimed by the appellants as "retiring sums".
4. Cheques totalling $132,405 in favour of Parkhill & Freeman Partners Pty. Ltd. by way of loans made to the company by the appellants and by Finn:
(a) $46,341 drawn by Mr. and Mrs. Parkhill;
(b) $46,341 drawn by Mr. and Mrs. Freeman;
(c) $26,481 drawn by Mr. and Mrs. Jones;
(d) $13,242 drawn by Finn.
5. A cheque for $113,265 drawn by Parkhill & Freeman Partners Pty. Ltd. in favour of the appellant company. By this cheque Parkhill & Freeman Partners Pty. Ltd. both discharged the debt owed by it to the appellant company under the agreement for the purchase of the business of engineering consultants, as well as repaid moneys which had been lent to it by the appellent company."
For our part, we can not see that there is anything sinister in these transactions or that they require express explanation by the taxpayers. It seems to us that they accorded with business practice to minimise in this way the amount of interest payable by any person or company involved in the transactions. However we can acknowledge that there is some justification for seeing the happenings as the occasion which prompted the payment of the retiring allowances.
In addition to receiving a lump sum retiring amount from the Old Company the taxpayer Jones was paid, as were the other taxpayers, amounts from certain Superannuation Funds. He received $22,148 from a fund styled Parkhill & Freeman Pty. Ltd. Superannuation Fund ("The Directors Fund") and $3,201 from the Parkhill & Freeman Pty. Ltd. Working Directors and Employees Superannuation Fund ("The Staff Fund"). Each of these amounts was claimed as a retiring allowance, 5% only of which it was said comprised assessable income. It is necessary to deal separately with each of these funds.
The Staff Fund was established by Deed dated 1 June 1971, whereby the Old Company declared that it set up the fund for the purpose of providing, inter alia, retiring allowances for its working directors and employees, payments to their dependants on death and payments upon other contingencies. By clause 4(2) the Old Company agreed to effect in its own name with Phoenix Life Assurance Company of Australia Limited a policy of assurance on the life of each member. Clause 2 identified a member as a working director or employee who was invited to participate in the scheme. Clause 6 provided that the Old Company and the member should contribute in such shares and proportions as should be mutually agreed the premium for a policy effected on the life of the particular member. The evidence was that all premiums were paid by the Old Company. Clause stated that the company should, subject to the provisions thereafter contained, hold every policy issued pursuant to the scheme and that no member should have any proprietary or assignable interest in such policy whilst it was subject to the provisions of the Deed. After providing for dismissal, retirement, death and other like contingencies not presently relevant, the Deed by clause 15 thereof stated as follows:
"In the event of an order being made or an effective resolution being passed to wind-up the Company (except for the purposes of reconstruction), or in the event of the Company for any other reason ceasing to carry on business, the Scheme shall be wound up and all Policies effected pursuant to the Scheme shall be assigned to the Member respectively entitled thereto, provided always that as from the date of the winding-up of the Scheme as aforesaid all liability of the Company under the Scheme shall cease and determine."
Pursuant to this Deed a policy of life assurance was effected on the life of the taxpayers as well as certain other employees.
By letter dated 13 July 1978 Jones received on behalf of the Old Company a cheque for $7,410.30 in payment of the surrender value of these policies issued for the taxpayers. On 26 July, 1978 the Old Company paid out of that sum an amount of $2,605.80 to the taxpayer Freeman, $2,632.80 to the taxpayer Parkhill and $2,171.70 to Jones. The taxpayers and the Commissioner accepted that, if assessable, these amounts should be brought to account in the year of income ending on 30 June 1978, though precisely why this should be so was not disclosed. The taxpayer Jones also received $1,028.60 from the A.M.P. Society as the surrender value of a policy probably taken out by Design Sixty Market Pty. Limited.
It is apparent that in many instances it is not possible to reconcile exactly the various figures given in evidence or in documents. However the discrepancies are in the end result of no significance.
By Deed dated 1 July 1973 the Old Company as employer established the Directors' Fund, and appointed the taxpayer Parkhill, the accountant McKenzie and a solicitor Stanley Levine as trustees. The stated purpose of the fund was to provide retiring allowances and other benefits for selected employees or their dependants. The initial contribution and all subsequent contributions to the fund were made by the Old Company. The taxpayers and Finn were the only members. Clause 2 obliged the Old Company to pay forthwith to the trustees the sum of $15,034.38 which together with all other sums the Old Company and the employees might pay, the trustees held upon trust to allocate, pay and apply the same for the benefit of the members of the fund. The relevant portion of clause 5(a) was as follows:
"The employer will contribute to the fund and will pay to the trustees in each year by way of such contribution in respect of each member the maximum amount from time to time allowable under the Income Tax Assessment Act or any amendment thereof for the time being in force." The emphasis has been added.
There was much correspondence before the trial judge of earlier negotiations between the Old Company and the Commissioner which resulted in an agreement by the Commissioner as to an appropriate retiring allowance for each of the taxpayers and in consequence the maximum contribution which would be allowable as a deduction to the Old Company. Clause 7 provided that the employer might at any time direct the trustees to allocate any sum out of the unallocated portion of the fund to a member and the trustees agreed to allocate in accordance with the directions. The Deed proceeded to deal with retirement, dismissal, death and other contingencies and obliged the trustees to keep proper books of account and particulars of the allocated amounts of members. There was no evidence that the trustees complied with these obligations. Clause 19(a) provided that if the employer should cease business or go into liquidation (except for the purposes of amalgamation or reconstruction) the same consequence would follow as if the employer at the commencement of its winding up had directed the trustees to wind up the fund pursuant to clause 18. This clause, in the submission of the taxpayers, was crucial to the determination of their rights and counsel for the Commissioner went to some lengths in an effort to deny its significance. Set out in full it is as follows:
"18. Subject to any conditions, restrictions, or requirements that may be imposed by the Commissioner of Taxation the employer may at any time in writing direct the trustees to wind up the fund, in which case the trustees will be at the expiration of three calendar months from the receipt of such direction convert the fund into money and pay to each member his allocated amount less any sum or sums which will have been paid out of such member's allocated amount pursuant to the provisions of either or both Clauses 9 and 12(c) hereof, and transfer and assign to such member the benefit of any policy on the life of such member the premiums for which will have been paid pursuant to the provisions of Clause 9 hereof out of the allocated amount of such member, AND the unallocated portion of the fund will be paid to such one or more of the members to the exclusion of the others in such proportions or sums as the employer may within the said period of three calendar months in writing to the trustees direct, and in default of such direction or as to such part of the unallocated portion of the fund to which such direction does not extend, the trustees will divide the same amongst the members in proportion to their respective allocated amounts and if there be no member, then among the employees equally."
We have added the emphasis to certain relevant portions of this clause.
It would appear that on 27 June 1978 $19,475.70 was paid to the credit of the account of the trustees of the Directors' Fund at the A.N.Z. Bank and $102,384.09 being the proceeds of sale of investment and repayments of loans made by the trustees to Partners was likewise paid on 30 June 1978. The trustees distributed the full amount in their hands at the time by cheques drawn in favour of the taxpayers and Finn on 28 June 1978. Each of the taxpayers claimed the amount paid to him in his income tax return as a retiring allowance. However, as was noted by the trial judge, further sums of $52 and $1,026.10 being in each instance interest received from the State Electricity Commission were received by the trustees on 6 September 1978 and 5 January 1979. In reliance upon the receipt of these amounts subsequent to 30 June 1978 the trial judge found that the Directors' Fund had not been wound up, pursuant to the provisions of the Deed, at the time when the payments were made by the trustees to the taxpayers and Finn.
It was in these circumstances that the taxpayers claimed that the amounts they received from the Old Company and from the two funds were retiring allowances and thus assessable income only to the extent of 5% thereof in accordance with s.26(d). The trial judge was not prepared to accept the contentions of the taxpayers on this score, and in each instance concluded that the various amounts were assessable income by virtue of s. 26(e) of the Act.
In respect of the lump sums paid by the Old Company the trial judge was not satisfied that they were paid in consequence of retirement from or termination of the employment of the taxpayers. He referred to the statement of Gibbs J., as he then was, in Reseck Federal Commissioner of Taxation (1975) 133 C.L.R. 45 at p. 51, when he said of this question:
"Within the ordinary meaning of the words a sum is paid in consequence of the termination of employment when the payment follows as an effect or result of the termination." Emphasis added.
The trial judge referred to the reasoning of Jacobs J. at page 56 of Reseck's case where he gave to the expression "in consequence of" the meaning of "following on". This line of reasoning was followed by Brennan J. in McIntosh v Federal Commissioner of Taxation (1979) 45 F.L.R. 279 at p. 283 when he referred to the judgment of Jacobs J:
"His Honour denies the necessity to show that retirement is the dominant cause, but he does not allow a temporal sequence alone to suffice as the nexus."
The trial judge set out and relied upon the balance of that paragraph in the judgment of Brennan J., and concluded that the question before him in respect of the taxpayer's claim was
"Whether the taxpayers' retirement was the occasion of and a condition of entitlement to the capital amount."
To the extent that he formulated the test as being whether the retirement of the taxpayers was the occasion of the capital payment, the trial judge was in our opinion correct. However as Brennan J. said of the words "condition of entitlement", on page 283 of McIntosh's case:
"It may not be appropriate to speak of conditions if a payment is made voluntarily, but if a payment is made to satisfy a payee's entitlement, the phrase 'in consequence of retirement' requires that the retirement be the occasion of, and a condition of, entitlement to the payment. A sufficient causal nexus between the payment and the retirement is thus established."
In the present case it can not be said that the taxpayers had any entitlement, in the sense of enforceable entitlement, to be paid the lump sums. They were essentially voluntary and gratuitous payments by the Old Company. Thus in our view the question is, in circumstances such as the present, whether there was sufficient causal nexus between the payment and the retirement to make the retirement the occasion of the payment. This is essentially a question of fact. The trial judge saw as a relevant circumstance the fact that it was more than six months after the retirement of the taxpayers before a decision was made to pay the retiring sums. This as it happens was at the time when the bulk, if not all of the book debts totalling $35,393.44 had been got in by the Old Company. Moreover virtually twelve months had expired before the various retiring amounts were paid. If there was any "occasion" to which it might be said the payments were referable or linked it was in our opinion the time when funds had to be found to enable Partners to pay the outstanding purchase money. The trial judge concluded in reliance on these and other circumstances that the termination of the taxpayers' employment was not the occasion of the payments, and in our opinion he rightly so concluded. It is hardly surprising that, in the light of such inadequate evidence, the learned judge found that the taxpayers had not discharged the onus of establishing that their assessments in this respect were excessive. The taxpayers appeals in respect of these lump sum payments received from the Old Company must be dismissed and the payments are assessable in full under s. 26(e) of the Act.
A totally different question arises in respect of the lump sums received by the taxpayers from the Directors' Fund and the Staff Fund. The taxpayers again returned these lump sums under s. 26(d), assessable as to 5% thereof. The Commissioner contended that each amount was assessable under s. 26(e) of the Act. In respect of these amounts it can not be disputed that each of the taxpayers had, in law, pursuant to the terms of each of the Trust Deeds, a contingent or conditional entitlement. Counsel for the taxpayers based his submissions upon the statement of principle of the majority of the High Court in Constable v Federal Commissioner of Taxation (1952) 86 C.L.R. 403 when dealing with what in our opinion was a very similar situation. In Constable's case the taxpayer was in certain specified circumstances entitled to withdraw from the fund and obtain payment of his benefits. In the present case the taxpayers contended they were, on the Old Company ceasing business, each entitled to require payment of his respective share of the assets of the particular fund. At page 418 of Constable's case Dixon C.J. McTiernan, Williams and Fullagar J.J. said of the taxpayer's entitlement under the provisions of that fund:
"It appears to us that the taxpayer became entitled to a payment out of the fund by reason of a contingency (viz: an alteration of the regulations curtailing the rights of members) which occurred in that year enabling him to call for the amount shown by his account. It was a contingent right that became absolute. The happening of the event which made it absolute did not, and could not, amount to an allowing, giving or granting to him of any allowance, gratuity, compensation benefit, bonus or premium. The fund existed as one to a share in which he had a contractual, if not a proprietary title. His title was future and indeed contingent or, at all events, conditional. All that occurred in the year of income with respect to the sum in question was that the future and contingent or conditional right became a right to present payment and payment was made accordingly. This, in our opinion, cannot bring the amount or any part of it within 26(e). The amount received by the taxpayer from the fund is a capital sum, and unless it or some part of it falls under 26(e) (there being no other applicable imposition of liability) it is not part of the assessable income."
The trial judge declined to apply this reasoning to the present matter because in his view the only circumstance which would have justified the trustees or the Old Company making payment out to the taxpayers was upon the winding up of the particular fund. In our opinion this reasoning is not sound, and it is nothing to the point that the taxpayers failed to establish that the trustees or the Old Company had not complied with the winding up procedures. The taxpayers were entitled to call for the funds upon the Old Company ceasing business and a delay in or departure from the procedures required of the trustees could not affect their rights in law. The rights of the taxpayers accrued to them, not on the winding up of the fund, but on the occurrence of an event which gave them an indefeasible vested right to require payment.
Counsel for the Commissioner contended on a number of grounds that the taxpayers had not acquired such rights. He submitted that the trial judge had made incorrect findings of fact on matters which were crucial to the success of the taxpayers' case.
He contended that the Old Company had not ceased business on 1 July 1977 or at any relevant time and that the taxpayers had not established that, even if the Old Company had ceased business, they were indefeasibly entitled to the particular amounts paid to them. We are not prepared to accept either of these arguments. The Old Company did without doubt cease business as consulting engineers on 1 July 1977 and thereafter its only activity was the rendering of accounts and collecting debts due. Even this limited activity was performed on its behalf by Partners and in our opinion the authority of Re Sarflex (1979) 1 Ch 592 does not advance the Commissioner's case. There is no ground upon which we would depart from this finding of the trial judge.
Upon the Old Company ceasing business each taxpayer acquired a vested right to participate in a distribution of the assets of the Directors' Fund. However counsel for the Commissioner contended that we should not be satisfied that each had a vested interest in the particular amounts paid to him. For our part all of the available evidence, mainly circumstantial, supports the drawing of an affirmative inference and we can not see that to infer to the contrary assists the Commissioner. The fact that one or more taxpayers may have been overpaid does not necessarily convert the amount of the overpayment into assessable income. Admittedly they may each have been paid an amount on account and not in final settlement of their respective entitlements, but to our mind all of the relevant circumstances support the inference that the division of the monies in the hands of the trustees was not arbitrarily determined. We would find that the Old Company, having ascertained from the Commissioner the acceptable amount of a retiring allowance for each taxpayer and the annual contribution necessary to provide this amount on retirement, paid such contribution each year on behalf of each taxpayer to the trustees. There is in fact positive evidence to this effect in respect of the year ending 30 June 1977, and the Old Company was obliged under the terms of the trust deed to make such payments each year. The trustees were, for their part, obliged to credit these amounts to the account of the taxpayers in the fund, and the taxpayer Jones referred in his evidence to the amount he received as being "his entitlement". This statement was not challenged in cross-examination nor was the entitlement of the taxpayers to the particular amounts received a matter in issue before the trial judge. We agree that the failure to call available witnesses may support the drawing of an unfavourable inference but this can not be the case in relation to matters which are not in issue between the parties.
Having carefully considered all the evidence, such as it is, in this regard and bearing in mind that the onus which lies on the taxpayers under s. 190(b) of the Act is no higher than the ordinary civil onus of balance of probabilities we are prepared to infer that each taxpayer was entitled to the particular sum which he received from the trustees of the Directors' Fund.
Counsel for the Commissioner sought to distinguish Constable's case on the ground that in this matter, by way of contrast with the facts of Constable's case, the act which effected the indefeasible vesting, namely the cessation of business, was the act of the Old Company. In our opinion this is nothing to the point, and in any event as it happens the relevant act in Constable's case was effected by the trustees with the consent of the companies and for the purpose of relieving them from their obligations under the terms of the Deed. The relevant question is whether the act or event which caused the indefeasible vesting could be characterized as the granting of an allowance or gratuity and not the extent to which the Old Company was, directly or indirectly, a party to the particular event. We reject this submission as we would reject the attempt to distinguish Constable's case on the ground that there the employee's act or election brought about the vesting. In our opinion there is no ground upon which Constable's case can be distinguished either in reliance upon a different fact situation or the terms of the particular deeds. The end result is that the taxpayers' appeal should in respect of payments received from the Directors' Fund and the Staff Fund be allowed, on the ground that s. 26(e) has no application and each amount is a capital sum.
There were certain other amounts received and claimed as retiring allowances by some or all of the taxpayers either expressly from Design Sixty or the A.M.P. Society. In respect of these amounts the evidence was quite inadequate to establish the nature or circumstances of the payments or the entitlements of the taxpayers thereto. The Commissioner's assessment of these receipts must stand as each of the taxpayers has failed to discharge the onus of establishing that in these respects the assessments or any of them are excessive.
In respect of the lump sum payments to directors of the Old Company we have already found that they were assessable in full against the taxpayers pursuant to the provisions of s. 26(e). The question arises whether they are deductible to the Old Company under s. 51(1) or s. 78(1)(c) of the Act. The trial judge found that they were not deductible under either section. He held, in reliance upon Peyton v Federal Commissioner of Taxation (1963) 109 C.L.R. 315 that they were not deductible under s. 51(1) because they were not incurred in gaining or producing the Old Company's assessable income but in the course of disposing of or closing down the business by which it gained its income. The facts in Peyton's case were very different from those in this case but the principle is in our opinion equally applicable.
Counsel for the Old Company contended before us that the sums were outgoings incurred in gaining or producing assessable income within the first limb of s. 51(1). However before a sum can be claimed as a deduction under this limb it must be established that there is "a connection between the purpose of the payment and the further pursuit of gain, the production of income. There must be some facts which justify the inference that the outgoing was incurred to conduce that end", Union Trustee Co of Australia Ltd v Federal Commissioner of Taxation (1935) 53 C.L.R. 263 at p. 269. Generally it can be said that an employer is only entitled to a deduction if the business is continuing and the payment is productive of further income; if the business has been disposed of or discontinued no deduction is available, Amalgamated Zinc (de Bavay's) Limited v Federal Commissioner of Taxation (1935) 54 C.L.R. 295. In the present matter the sums paid were completely disassociated from the gaining or producing of assessable income and there are no facts which support an inference "that the outgoing was incurred to conduce that end" see Union Trustee Co. case supra at p. 269. They were payments in the nature of voluntary grants for past services. The Old Company has not established a sufficient or any connection between the payment of these funds and the gaining or producing of income. The trial judge correctly dismissed the claim for a deduction based upon s. 51(1).
The trial judge did not allow the claim to deduct sums under s. 78(1)(c) because he was not satisfied that they were retiring allowances under s. 26(d). That by itself, however, does not deny the application of s. 78(1)(c). The latter provision refers to sums which are not otherwise allowable deductions and are paid by the taxpayer as "pensions, gratuities or retiring allowances to persons who . . . have been employees . . . to the extent to which, in the opinion of the Commissioner, those sums are paid in good faith in consideration of the past services of the employees in any business operations which were carried on by the taxpayer for the purpose of gaining or producing assessable income". The trial judge did not consider whether the sums paid were properly characterized as gratuities or retiring allowances under that paragraph. The trial judge's correct earlier decision based on s. 26(d) in our opinion does not conclude the matter. We see these amounts as retiring allowances or gratuities which are deductible to the extent that the Commissioner forms the opinion that they were made in good faith and in consideration of past services. The matter of these deductions should be remitted to the Commissioner to enable him to form an opinion in this respect.
The upshot is that we would confirm the trial judge's finding that the amounts paid by the Old Company to the taxpayers were not retiring allowances assessable under s. 26(d) as to 5% thereof. We would allow the taxpayers' appeals against the assessment of the amounts received by them from the Directors' Fund and the Staff Fund. We would allow the appeal against the decision of the trial judge that the Old Company is not entitled to a deduction of the sums paid to the taxpayers and Finn and substitute a finding that these amounts are deductible under s. 78(1)(c) of the Act. It follows that the assessment of the Old Company must be remitted to the Commissioner to enable him to form an opinion as required in that section. There is in the circumstances no need to consider the impact of s. 260 of the Act upon the four sums paid by the Old Company to the taxpayers and Finn.
On the question of costs we are of opinion that justice will in the circumstances be done if we direct the Commissioner to pay to the Old Company and the taxpayers one half of their costs both on appeal and of the hearing in the Court below.
The orders we propose are as follows:
(a) the appeals by the taxpayers against the inclusion as assessable income of the sums paid to them by the appellant Paklan Pty. Ltd. are dismissed.
(b) the appeals by the taxpayers against the inclusion as assessable income of the sums paid to them by the trustees of the Directors' Fund and of the Staff Fund are allowed.
(c) the appeal by the appellant Paklan Pty. Ltd. against the disallowance as a deduction of the sum of $40,000 paid by it as retiring allowances is allowed and the assessment is remitted to the Commissioner for the purpose of enabling him to form an opinion as required by s. 78(1)(c) of the Act of the extent to which the payments were made in good faith and in consideration of past services.
(d) the Commissioner to pay to Paklan Pty. Ltd. and the taxpayers one half of their costs both of the appeal and of the hearing in the Supreme Court.
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