Commissioner of Taxation v Day

Commissioner of Taxation v Day - [2008] HCA 53 - HCA 2008 case summary — Zoe

[25]

The first charge, notified to the respondent on 23 September 1998 by an authorised officer of the Customs Service, was of improper conduct (s 56(d)). The respondent was suspended from duty. The particulars of that charge were that the respondent had breached the standard of conduct for officers set out in the Customs Code of Ethics and Conduct "Official Identification and Security Items" in that he presented his Customs identification card to a Clerk of the Downing Centre Local Court in New South Wales in order to obtain information with respect to a search warrant which had been executed on the Customs Service on 28 July 1998. The warrant had authorised the Australian Federal Police to search the respondent's workstation and the respondent had attempted, unsuccessfully, to obtain a copy of the search warrant. The officer conducting the inquiry found that it was improper for the respondent to have conveyed that his purpose was official.
The inquiry officer directed that the respondent be demoted and his salary consequentially reduced. The respondent exercised his right of appeal to the Disciplinary Appeal Committee[8], which found the charge proved, but varied the direction so that the respondent was to be transferred to a position and salary higher than the inquiry officer had directed. In proceedings for judicial review of that decision, brought in the Federal Court, Gyles J found that the Disciplinary Appeal Committee was able to conclude that the conduct of the respondent was conduct of an officer for the purposes of s 56(d) of the Public Service Act 1922, but that the conduct was not improper. His Honour set aside the decision and remitted it to the Committee for hearing according to law[9]. A Full Court dismissed the Commonwealth's appeal from his Honour's decision[10]. The Disciplinary Appeal Committee set aside the direction of the inquiry officer and ordered the Commonwealth to pay the respondent's costs. The respondent's other entitlements were restored as a consequence of the decision.
The seven charges making up the third set of charges were also referable to conduct described in s 56(d). On notification of these charges the respondent was suspended without salary. Three of the charges related to the respondent's conduct in connection with a claim for a diesel fuel rebate by the partner of another Customs officer. It was alleged that the respondent failed to inform Customs of relevant information, that he had lent the other officer improper support and assistance and that he was knowingly concerned in the creation of a false diary which supported the claim. The fourth charge was that he had secured access to, and acquired the use of, a work vehicle. The use included the collection and transportation of his daughter, by a fellow officer, for a non‑work‑related purpose. Two further charges involved his actions to conceal his absences from work. On one occasion he had asked a colleague to provide an excuse to his supervisor, to abstain from recording his absence and to switch his computer on. On another he submitted an attendance record which was false. The seventh charge involved a failure to communicate certain information concerning an investigation into an individual.
The charges were notified to the respondent on 22 March 1999. The respondent commenced proceedings in the Federal Court on 24 August 1999, in which it was alleged that information contained in telephonic communications, which had been intercepted by the Australian Federal Police as part of a criminal investigation, had been made available to officers of Customs including the officer who gave notice of the third charges, and that that communication was unlawful. He sought orders that the third charges be set aside and that the inquiry under s 62 of the Public Service Act 1922 be stayed, and a declaration. That application[11], an appeal to a Full Court[12], and an application for special leave to appeal to this Court were refused with costs.

[26]

Emmett J's holding, that the Commissioner was estopped from asserting that the legal expenses incurred by the respondent with respect to the third charges were not deductible, was based upon an order made by the Federal Court in earlier proceedings, to which the Commissioner consented, which allowed a deduction for fees paid to one counsel for legal advice in connection with the third charges. His Honour took the view that the Court must be taken thereby to have determined the deductibility of the other legal expenses referable to those charges[13]. It is not necessary to consider that aspect of his Honour's reasoning further. The Full Court upheld the Commissioner's appeal in that regard, and the respondent does not seek to raise that aspect of the Court's decision. This appeal is concerned solely with the question of the deductibility of the legal expenses by reference to s 8‑1(1).
The judges in the Federal Court were divided in their opinions on the issue of deductibility. Dowsett J, in his dissenting judgment in the Full Court, agreed with the primary judge, Emmett J, that the legal expenses were not deductible because the conduct the subject of the charges comprised acts unconnected to the duties to be performed by the respondent in the course of earning assessable income[14]. The misuse of the respondent's identity card was unrelated to the performance of his duties and none of the conduct referred to in the third charges was performed by the respondent in the discharge of his duties as a customs officer[15].
The majority in the Full Court held that the expenditure was allowable as a deduction but differed in their reasoning to that conclusion. Spender J considered it to be irrelevant whether the conduct the subject of the charges was extraneous to the discharge of his duties[16]. Because the expression "incurred in gaining or producing … assessable income" is to be given a very wide application[17], it was necessary to consider the purpose of defending the charges, his Honour reasoned. The purpose of the respondent was to protect himself from the consequences of s 62(6) of the Public Service Act 1922, and therefore to protect his recurrent employment income from diminution or loss[18]. Expenditure in defence of a taxpayer's employment satisfies the test in s 8‑1(1)(a)[19].
His Honour's reasoning[20] was to the contrary of Emmett J, who considered that the expenses were properly characterised by reference to the activity or conduct that made it necessary to incur the expenses, rather than the object sought to be achieved in the proceedings in which they were incurred. It was therefore not sufficient to say that the proceedings were taken in order to protect one's reputation or keep one's job. Dowsett J was of the same opinion. His Honour considered that it followed from the decision of this Court in Federal Commissioner of Taxation v Payne[21], that purpose alone would not suffice to permit allowance of an outgoing as a deduction.
The other member of the majority in the Full Court, Edmonds J, referred to the following passage from the majority judgment in Payne[22]:

[31]

On the Commissioner's argument, the task to be undertaken under s 8‑1(1)(a) is to identify the activity that is productive of assessable income and then to determine whether the outgoing in question can properly be regarded as having been incurred "in the course of" that activity. The argument draws upon references in the majority judgment in Payne to the words "in the course of" as relevant in establishing the requisite connection between expenditure and the activity which is productive of income.
The Commissioner submits that expenses of a legal nature have been held deductible where they were necessitated by an activity which was part of, or incidental to, the business of the taxpayer[29]. An employee's legal expenses, in connection with charges of misconduct, have been held deductible because they reflected the day‑to‑day aspects of the employment or because the employee could be said to be defending the manner of performance of his duties of employment[30]. The expenses here in question were incurred in defending conduct outside the performance of the respondent's duties, and cannot be said to have been incurred "in" or "in the course of" gaining or producing assessable income for the purposes of s 8‑1(1)(a).
The Commissioner accepts that the respondent was also under an obligation, imposed by s 56(d) of the Public Service Act 1922, not to engage in improper conduct, but submits that the observance of that duty was not itself an activity which was productive of the respondent's income and was therefore not relevant. The Commissioner submits that a positive obligation to perform tasks of employment is different from one not to engage in certain other conduct, particularly where the conduct proscribed involves private misbehaviour. The Commissioner argues that the dichotomy between conduct undertaken in performance of the tasks for which the respondent was employed and improper conduct in breach of s 56(d) of the Public Service Act 1922, which was rejected by Edmonds J, is a distinction that s 8‑1(1)(a) makes necessary. In the Commissioner's submission, the questions arising under the provision cannot be answered by identifying the occasion of the outgoing as the respondent's employment which, in a general sense, was productive of the respondent's income. The Commissioner says that the attention of s 8‑1(1) is directed to specific activities which can be said to be productive of assessable income.

[32]

The terms of s 8‑1(1)(a) of the ITAA and its predecessors[31] have not been regarded as materially different[32]. They refer to a relationship between expenditure incurred and what is productive of assessable income, which is to say the connection necessary for deductibility[33]. The words "incurred in gaining or producing … assessable income", appearing in the section, have long been held to mean incurred "'in the course of' gaining or producing" income, as was observed in Payne[34]. In Amalgamated Zinc (De Bavay's) Ltd v Federal Commissioner of Taxation[35], Latham CJ explained that it was necessary to read "losses and outgoings … incurred in gaining or producing the assessable income" as incurred "in the course of" gaining or producing that income, in order to make the section[36] intelligible. Outgoings may have an effect in gaining income, but losses cannot, as they simply reduce income[37]. In Commissioner of Taxation v Cooper[38] Hill J observed that an outgoing might be referable to a year of income other than that in which it was incurred[39]. That was a reason why s 51(1) of the Income Tax Assessment Act 1936 (Cth) did not express the right to a deduction in terms of outgoings incurred to earn income[40]. The words "in the course of" therefore facilitate the application of s 8‑1(1)(a). They do not require a direct connection between the expenditure in question and an activity itself productive of income.
Dixon J in Amalgamated Zinc said that the expression "incurred in gaining or producing the assessable income" should be given a very wide application[41], although in that case the taxpayer company's continuing liability to pay monies to a compensation fund for miners it had employed lost any connection to assessable income when its business ceased. In Payne the majority confirmed that the words require more than a causal connection between the expenditure and the derivation of income; something closer and more immediate. The expenditure must be incurred "in the course of" gaining or producing the assessable income[42]. Their Honours' reference to the words "in the course of" should not be taken to suggest a closer or more direct connection between expenditure and that which is productive of assessable income than the words of the provision[43] themselves convey. Rather the words draw attention to the connection made necessary by the provision, which the majority considered on the facts of that case to be too remote.
Payne was concerned with expenses incurred by the taxpayer in travelling between his place of employment as a pilot and between the place where he conducted a deer farm. The majority held that the expenditure was not incurred in the course of either income‑producing activity. Adapting the language of Ronpibon Tin, their Honours held that neither the taxpayer's employment nor the conduct of the business of a deer farm occasioned the outgoings for travel expenses. Rather they were occasioned by the need for the taxpayer to be in a position where he could set about the tasks from which income would be derived[44]. The expenditure was incurred in the interval between income‑earning activities[45]. In Cooper, Hill J referred to an outgoing which preceded an income‑earning operation or activity and which came at a point too soon to be an incident of, or relevant to, that activity. His Honour described the expenditure as referable to getting the work, rather than doing it[46].
The facts in Payne and Cooper are far removed from this case. It may also be observed that no issue arose in those cases concerning what tasks or duties are encompassed in what is productive of assessable income, as it does here. The references in those cases to the taxpayer's activities were to all that might be encompassed in an income‑producing business or employment, not to discrete tasks. Those cases were concerned with the degree of connection to such a business or employment necessary for an expense to be deductible.
The Commissioner also sought support from cases which had dealt with the deductibility of legal expenses - being payments for legal services or of awards for damages - for both the closeness of the connection for which he contended and the identification of that which might be considered to be a necessary part of a business or employment.
In Herald & Weekly Times Ltd v Federal Commissioner of Taxation[47] it was held that a newspaper publisher's liability for defamation had the necessary connection to the business, publication being the common source of both revenue and the liability which gave rise to the expenditure[48]. McTiernan J observed that only cessation of business would free the business from such expenditure[49]. Gavan Duffy CJ and Dixon J distinguished the case from others by reference to the degree of connection present between the business carried on and what gave rise to the liability for damages[50]. Their Honours referred to statements by Lord Loreburn LC in Strong & Co v Woodifield[51] that such losses can be deducted as are connected with the business, in the sense that they are really incidental to the trade itself. The illustration provided by his Lordship was the deductibility of losses sustained by a railway company in compensating passengers for accidents whilst travelling with the railway. On the other hand injury caused to a man walking in the street by a window shutter falling from a house associated with a grocer's shop would not be deductible as an expense of the grocery business. And, as his Lordship observed, there will be cases at the margin[52].
Expenses of advertising, to counter press reports, and legal costs before a Royal Commission incurred by a company the subject of allegations as to its business practices were held to be deductible in Federal Commissioner of Taxation v Snowden & Willson Pty Ltd[53]. Dixon CJ there identified the carrying on of the business as the source of the attacks and said that the taxpayer company "could do nothing else but defend itself, if it was to sustain its business"[54]. And in Magna Alloys and Research Pty Ltd v Federal Commissioner of Taxation[55], a case concerned more with the relevance of a taxpayer's subjective purpose in relation to the expenditure, the legal expenses paid by the company for the defence of its directors from criminal charges, relating to the receipt of secret commissions, were held deductible because they were incurred in carrying on the business[56]. It may be thought that the directors' conduct there had qualities which might take it outside the scope of their proper tasks as directors. Nonetheless the connection with the taxpayer's business and the production of income is apparent.
Closer to the position of an employee are the decisions in Commissioner of Taxation v Rowe[57] and Shokker v Commissioner of Taxation[58]. In Rowe a shire engineer incurred legal expenses connected with an inquiry into complaints of his misconduct. A Full Court of the Federal Court held the expenses allowable as a deduction, but for reasons which differed in their identification of the connection with the taxpayer's employment. Beaumont J considered that it lay in the inquiry being concerned with the day‑to‑day aspects of his employment[59]; Burchett J because they were expended defending the manner in which he had performed his duties[60]; and Drummond J because they were incurred to preserve his existing contract of employment so that he could retain the recurrent benefit of his salary[61]. In Shokker[62] an employee of the Commissioner of Taxation had been charged with a criminal offence, in relation to his claim for sick leave in his employment. Drummond J considered that the factors that the charge was instigated by the employer, and that it could result in his dismissal, were matters to be taken into account in determining whether the necessary connection was present[63].
Expressions used in the cases, such as "incidental and relevant", as referable to a business, should not be thought to add more to the meaning of provisions such as s 8‑1(1)(a) of the ITAA, or to narrow its operation. They should be taken to describe an attribute of an expenditure in a particular case, rather than being an exhaustive test for ascertaining the limits of the operation of the provision[64]. Reference in some cases to the expenditure having an "essential characteristic" must likewise be treated with some care. As Gaudron and Gummow JJ observed in Payne, the use of the term may avoid the evaluation which the section requires[65]. It is perhaps better understood as a statement of conclusion than of reasoning.
Section 8‑1(1)(a) is couched in terms intended to cover any number of factual and legal situations in which expenditure is incurred by a taxpayer. Its language and breadth of application do not make possible a formula capable of application to the circumstances of each case[66]. Cases are helpful to show the connection found on the facts there present, but not always to explain how the search for the requisite connection is to be undertaken. Payne directs attention to the statement made in Ronpibon Tin, as to the question posed by a provision such as s 8‑1(1)(a), as correct and appropriate to be applied. The question, as restated in Payne, is: "is the occasion of the outgoing found in whatever is productive of actual or expected income?"[67] That inquiry will provide a surer guide to ascertaining whether a loss or expenditure has been "incurred in [the course of] gaining or producing … assessable income".
Essential to the inquiry is the determination of what it is that is productive of assessable income. The dichotomy to which the Commissioner's argument refers, that between proper conduct and that which is proscribed, may pose some difficulty in the delineation of tasks which the Commissioner would describe as falling within or without the scope of a person's occupation. The present case furnishes an example. It is not clear where the Commissioner would place expenses incurred with respect to charges of inefficiency, incompetence or negligence under s 56 in the carrying out by an officer of ordinary day‑to‑day tasks.
It is not necessary to consider further the difficulties inherent in this aspect of the Commissioner's argument. The dichotomy may be relevant in other spheres of the law, but is not useful to determine the question arising under s 8‑1(1)(a), as to what it is that is productive of a person's assessable income. It does little more than characterise conduct by reference to wrongdoing. In some cases a reference to conduct which is wrongful may be to that which is remote from a person's occupation. In others, such as the present case, it will be to that which is a breach of a duty imposed by the employment itself. A determination as to what is productive of assessable income in a particular case may need to take account of any number of positive and negative duties to be performed or observed by an employee or other salary‑earner. It is that determination which provides the answer as to whether the occasion is provided for the expenditure in question.
That no narrow approach should be taken to the question of what is productive of a taxpayer's income is confirmed by cases which acknowledge that account should be taken of the whole of the operations of the business concerned in determining questions of deductibility[68]. A similar approach should be taken to what is productive of a salary‑earner's income, whether it be described as employment or by reference to a bundle of tasks to be performed and duties to be observed. In some cases those duties to be observed may extend beyond what is contained in a contract of employment. In Cooper, Hill J, referring to the statement in Ronpibon Tin, observed that it will often be necessary to analyse with some care the operations or activities regularly carried on by the taxpayer[69], and Lockhart J referred to the need to have regard to the terms and conditions of a taxpayer's employment[70]. A reference to the "day‑to‑day" activities undertaken by a taxpayer may not be a sufficient description of what their position involves. So, in Commissioner of Taxation v Finn[71] expenses of a senior design architect in the public service incurred in travelling in order to improve the taxpayer's knowledge were considered in the context of his employment by the government in accordance with his conditions of service[72], and as referable to his prospects of promotion[73]. The essential difficulty with the Commissioner's argument in this case is that it does not fully recognise the scope of the respondent's role as an officer of the Public Service and what his office exposed him to.

[33]

The incurring of legal expenses with respect to charges against an officer of the Service for failure of duty must be considered in the context of the special position which such an officer holds, the extent of the duty owed by the officer and the legislative provision for the enforcement and regulation of such duty. The public service legislation in Australia has served and serves public and constitutional purposes as well as those of employment, as Finn J observed in McManus v Scott‑Charlton[74]. Such legislation facilitates government carrying into effect its constitutional obligations to act in the public interest[75]. For reasons of that interest and of government the legislation contains a number of strictures and limitations which go beyond the implied contractual duty that would be owed to an employer by many employees. In securing values proper to a public service, those of integrity and the maintenance of public confidence in that integrity, the legislation provides for the regulation and enforcement of the private conduct of public servants[76]. This extension, to what might be called private conduct, was evident in s 56(d) and (e) of the Public Service Act 1922, which provided that an officer may be taken to have "failed to fulfil his duty as an officer" if he engages in improper conduct as an officer or in improper conduct otherwise than as an officer, in the latter case the conduct "being conduct that affects adversely the performance of his duties or brings the Service into disrepute". It is noteworthy that in McManus Finn J rejected as untenable, as a generalisation, the submission that the only limiting directions that could be given to a public servant were those which have a nexus with the performance of that person's employment duties[77].
The chief object of the Public Service Act 1922 was "to constitute a public service for the efficient, equitable and proper conduct, in accordance with sound management practices, … of the public administration of the Australian Government"[78]. The provisions relating to disciplinary action were referable to the maintenance of those standards of conduct.
An "employee" was defined by the Act, but the definition of an "officer" did not include an employee[79], whose position and terms and conditions of employment were dealt with elsewhere in the Act[80]. Part III, Div 6 of the Act was concerned with the discipline of officers of the Service. It provided, in s 55, that "misconduct", in relation to an officer, meant a failure of the officer to fulfil his[81] duty as an officer. Subdivision C was referable to disciplinary action with respect to officers other than Secretaries of Departments. Section 61(2) of the Subdivision provided for the bringing of charges against such an officer by an officer authorised by the relevant Secretary[82]. Section 62(1)‑(5) provided for the holding of an inquiry into the charge, by an officer other than the officer who gave notice of the charge, and for the procedures to be undertaken and applied to statements before the inquiry officer. Where the inquiry officer was satisfied that there had been a failure, on the part of the officer, to fulfil his duty, sub‑s (6) provided that he be counselled or that other action be taken. That action extended to admonition[83]; the deduction of a sum from salary[84]; reduction of salary[85]; transfer, with or without deduction of a sum from salary[86]; transfer to an office with reduction of salary for a period[87]; and transfer to a specified office at a lower classification[88]. The power exercised by the inquiry officer extended to dismissal[89]. In the period during which the hearing of the charge was undertaken, the officer charged might be subject to a directive that he be suspended from duties, if the relevant Secretary was of the opinion that it would be prejudicial to the effective operation of the Service, and to the interests of the public, if the officer was to continue to perform his duties[90]. An appeal to a Disciplinary Appeal Committee was provided by s 63D.

[34]

The respondent's position as an officer subject to the Public Service Act 1922 obliged him to observe standards of conduct extending beyond those in the performance of tasks associated with his office and exposed him to disciplinary procedures within the Service which might have consequences for the retention of his office or his salary. What was productive of his income must be understood in this light. It is neither realistic nor possible to excise from the scope of the respondent's service as an officer elements which may be associated with tasks and so identify them as income‑producing. What was productive of his income by way of salary is to be found in all the incidents of his office in the Service to which the Act referred, including his obligation to observe standards of conduct, breach of which might entail disciplinary charges. The respondent's outgoings, by way of legal expenses, followed upon the bringing of the charges with respect to his conduct, or misconduct, as an officer. He was exposed to those charges and consequential expenses, by reason of his office. The charges cannot be considered as remote from his office, in the way that private conduct giving rise to criminal or other sanctions may be[91].
It was necessary for the respondent to obtain legal advice and representation in order to answer the charges and to preserve his position, in the same way that the company in Snowden & Willson[92] was obliged to act defensively. Whether the charges were well‑founded, a fact which had not been established by the time the Full Court determined this matter, is not relevant to the question of deductibility[93]. The incurring of expenditure by an employee to defend a charge because it may result in his or her dismissal may not itself be sufficient in every case to establish the necessary connection to the employment or service which is productive of income. Much will depend upon what is entailed in the employment and the duties which it imposes upon an employee. In the present case the requisite connection is present.

[39]

The background facts of this case are explained in the reasons of Gummow, Hayne, Heydon and Kiefel JJ ("the joint reasons")[108]. In considering those facts it is necessary to appreciate that, in some cases, conduct contrary to express or implied prohibitions in a contract of service or (as here) contrary to the provisions of s 56 of the PSA[109] (as then applying) will nonetheless be "closely connected to the performance of particular duties so that the infringing conduct may accurately be so described"[110].
This would most obviously be so where the alleged infringements of the officer, as charged, amounted to inefficiency or incompetence[111]; negligence or carelessness[112]; improper conduct that affects adversely the performance of duties or brings the Service into disrepute[113]; patronage, favouritism or discrimination[114]; failure to comply with provisions of the Act or terms and conditions of employment[115]; or the provision of incorrect or misleading information in connection with the appointment to the Service[116]. Even particular cases of wilful disobedience or wilfully disregarding directions given by a person in authority might conceivably, in some circumstances, amount to an inappropriate way of endeavouring to perform duties having a relevant connection with the duties of an officer in the Service.
In the present case, however, as Emmett J recorded at first instance, the respondent did not suggest that any of the conduct that led to the charges involved the performance by him of his duties and functions as a Customs officer[117]. This conclusion, unchallenged in the appeals (including before this Court), throws light on the statutory characterisation of the legal proceedings initiated by the respondent, in which he incurred the legal expenses for which he claims deduction.
In this as in other cases the facts are crucial. They require the application of the ITAA so as to fulfil its purposes. They demand that a conclusion which seems factually odd or unlikely (especially one that appears grounded in a construction that favours a special group of taxpayers, viz officers of the Service) should be carefully measured against the criteria expressed in the legislation, as explained in earlier decisions.

[40]

The 1998 charge ("the first charge"), brought pursuant to s 61(2) of the PSA, concerned a particularised breach of the Customs Code of Ethics and Conduct ("the Code") applicable to "official identification and security items". This charge related to an allegation that the respondent had presented his Customs identification card in order to gain access to an officer of the Local Court of New South Wales. The purpose of such use was to obtain information about a search warrant of interest to the respondent personally which had been executed on the Service in July 1998. It was uncontested that this conduct did not involve the performance of any of the respondent's duties or functions as a Customs officer. Self-evidently, to misuse a Customs identification card in such a way and for personal purposes (which did not, in the event, succeed) was seriously "improper conduct" on the part of the respondent.
Save for a possible approach that will shortly be mentioned[118], the undisputed circumstances that occasioned the subsequent legal representation of the respondent had nothing to do with the gaining or producing of his assessable income. The costs of the legal representation were thus incurred in defending the respondent from charges arising out of personal and extraneous conduct, not in the course of income-producing conduct of any kind.
So far as the 1999 charges ("the third charges") are concerned, the position was the same. Those charges were, in every particular, related to the defence of the respondent upon charges that in no way constituted a misguided, foolish or even stupid mode of performing his employment duties or functions as an officer of the Service.
In a similar way (subject to what follows), if the circumstances of the third charges are relevant to throw light on whether the resulting legal defence of the respondent was a loss or outgoing incurred by him in the course of gaining or producing his assessable income, the only conclusion on the uncontested facts was that the legal expenses exhibited an "entire lack of connection between the assessable income and the expenditure"[119]:

[76]

"Where the case concerns the payment of legal expenses, the proper characterisation of the expenditure for tax purposes turns on a consideration of the circumstances with which the legal proceedings were concerned … In my judgment, the objective purpose of defending the … charges … was to protect the respondent from the consequences specified under s 62(6) of the [PSA], or to diminish their severity. The purpose was, therefore, to seek to protect the respondent's recurrent employment income from diminution or loss, or other adverse impact … In my opinion, expenses incurred in the defence of employment from that which threatens to destroy or diminish its income earning satisfies the positive test for deductibility. … The object in view in respect of the incurring of legal expenses in relation to the … charge[s] was to resist direct threats to the diminishing of, or the destruction of, the income-earning ability of the taxpayer. The situation which impelled the taxpayer to undertake the outlaying of those expenses was the fact that he had been charged under the [PSA] and the consequence of those charges being successful would be that his income would be diminished or lost. It is quite irrelevant whether the content of the charges related to activities of his employment, or were extraneous to the proper discharge of his duties. There would be no difference if a public servant was charged with being rude to customers in answering complaints, which is conduct engaged in by the public servant in the course of his or her duties, or a charge that he or she had downloaded child pornography from his or her office computer, conduct which is extraneous to the discharge of his or her duties as a public servant. The consequence of either charge being sustained is that the public servant's income might be diminished or lost. The legal expenses in defending either charge fall within the test set out by Dixon J in [Hallstroms Pty Ltd v Federal Commissioner of Taxation][150] … [and] by Drummond J in Federal Commissioner of Taxation v Rowe[151] … Drummond J said that [such] expenses had the requisite nexus because 'they were incurred to preserve his entitlement to receive in return for his services, assessable income'."

[84]

Flaws in the alternative theory: There is a fundamental difficulty in the alternative theory propounded by Spender J. Ultimately it is a difficulty that leads me to reject his Honour's analysis. The problem is exposed in the reasons of Dowsett J in the Full Court of the Federal Court. Essentially, it flows from the long-standing interpretation by this Court of s 8-1(1)(a) of the ITAA, and its predecessor provision. Specifically, it flows from the insistence, repeated most recently in Payne, that the word "in", as stated in s 8-1(1)(a), is to be read as equivalent to "in the course of". It is not to be read as "in connection with" or "for the purpose of" deriving the relevant assessable income[154].
Payne was a case concerned with a claim to deduct travelling expenses incurred by the taxpayer in travelling between two unrelated places of work, from each of which, separately, the taxpayer derived income. It was in that context that it became necessary for this Court to examine the theory of deductibility of expenses that are based upon the relevant purpose of the outgoings incurred or their connection with the derivation of assessable income. If such criteria had been adopted, the taxpayer in Payne would have had a very strong argument to be entitled to deduction. Clearly enough, the purpose of incurring the expenses in that case, of travelling from his residence on a rural farm to his place of employment as an airline pilot at the Sydney airport was to be able to earn both incomes. Moreover, the travel involved expenses incurred "in connection with" the latter employment and "for the purpose of" deriving assessable income from it.
The majority in Payne acknowledged the concerns that have been expressed over the years regarding the interpretation of deductibility under s 51(1) of the 1936 Act, specifically of travelling expenses incurred to get to and from a place of employment, particularly if the employment is remote from the taxpayer's ordinary residence. In Lunney v Commissioner of Taxation[155], Dixon CJ confessed to misgivings about the rule established by this Court for the interpretation of the provision of the Act in this respect. Dixon CJ even hinted that the rule might not be logically supportable and that "if the matter were to be worked out all over again"[156], a different approach might be taken. This notwithstanding, the Court in Lunney adhered to its insistence that "in", in the statutory provision, meant "in the course of" deriving the assessable income. It did not mean "for the purpose of" doing so or "in connection with" doing so.
In Payne, the majority of this Court reaffirmed that approach. They did so notwithstanding the problems and obscurities that it presented. Moreover, they did so knowing full well that the ruling had application far beyond travelling expenses, such as were in issue in that case[157]:

[103]

There remains the Commissioner's alternative reliance on s 8-1(2)(b) of the ITAA. He argued that, if, contrary to his submission, a deduction arose under s 8-1(1)(a) it would nonetheless be disallowed by virtue of the disqualification expressed in s 8-1(2)(b) of losses or outgoings "of a private … nature". The interconnection between the two paragraphs is plain.
If I had been of the view (otherwise than by way of the inadmissible reasoning of defending the income stream) that the respondent's legal expenses were incurred in some way in the course of gaining or producing his assessable income, I would have concluded that such losses or outcomes were nevertheless of a private nature and so precluded from deduction.
Given the statutory dichotomy between outgoings incurred in gaining or producing assessable income (deductible) and outgoings of a private nature (non-deductible), the respondent's legal expenses fell on the "private" side of the line. The language and structure of s 8-1 of the ITAA supports this conclusion. Payment for legal representation to defend purely personal conduct is clearly of a "private" nature within the category stated in s 8-1(2)(b) of the ITAA. If it can somehow fall within the first (positive) limb of the section (as sub-s (2) necessarily postulates will sometimes occur), it nonetheless falls outside deductibility if its essential character is "private".
The situation might have been different if the basic facts were being contested by the respondent; or where some of them were disputed and others not; or where the respondent sought to throw a new and different light on his conduct or somehow to associate the conduct with "the course of" his duties as an officer. However, all such complications can be disregarded in the circumstances of the respondent's case. It was clear and simple. Either on the positive or negative limb of s 8-1(1) or (2) of the ITAA, the deductions were correctly disallowed by the Commissioner. It follows that on one or other of the Commissioner's arguments he was entitled to succeed.

At a glance

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Catchwords

Judgment (192 paragraphs)

Parties

Legislation Cited (8)

Cases Cited (68)

Cited By (8)