REASONS FOR JUDGMENT
1 The applicant ("the Commissioner") appeals from part of a decision of the Administrative Appeals Tribunal ("the Tribunal") made on 31 July 2000 in which it was decided the Commissioner's objection decision under review for the year of income ended 30 June 1995 should be varied by remitting the matter to the Commissioner to issue an amended assessment to reduce the taxable income by $224,793 to $222,161. The respondent ("the taxpayer") cross-appeals from that part of the same decision which decided that the Commissioner's objection decision be confirmed by including a sum of $270,000, being the estimated value of the contents of a safety box, as income; not allowing a deduction in that amount; including a sum of $224,793 as income; and by not reducing the taxpayer's income to nil.
The Tribunal decision
2 The circumstances before the Tribunal were that the taxpayer had failed to lodge income tax returns for the seven years of income ended 30 June 1990 to 1996 inclusive. The Commissioner issued notices of assessment pursuant to s 167 of the Income Tax Assessment Act 1936 (Cth) ("the ITAA") in relation to each of those years. The taxpayer objected to the assessments on the basis the taxable incomes had been overstated.
3 The notices of assessment for the years ended 30 June 1990 to 1992 inclusive were based on an estimate of taxable income arrived at by the Commissioner by a process of averaging the two immediately preceding years, being years of income for which income tax returns were lodged. The notices of assessment for the years ended 30 June 1993, 1994, 1995 and 1996 were based on "T accounts". As the Tribunal's reasons recounted, the T account amount of "funds from unexplained sources" for each year of income is adjusted to include any assessable income amounts derived which were identified during the process of compiling the T accounts. The resultant amount is the Commissioner's estimate of taxable income assessed pursuant to s 167 of the ITAA.
4 The taxpayer challenged the method of estimating his taxable income for the first three years under review (which are not the subject of this appeal). He did not challenge the principle of the T account approach. However, he did challenge aspects of the calculations leading to the taxable incomes in those years and, relevantly for the purposes of this appeal, the year ended 30 June 1995. He also submitted to the Tribunal that as he had forfeited property to the value of $264,610 under the Proceeds of Crime Act 1987 (Cth), he should not be assessed for income tax to that extent.
5 The Tribunal stated that in any review of an objection decision the onus of proof rests on the taxpayer: s 14ZZK(b)(i) of the Taxation Administration Act 1953 (Cth). It said it was not sufficient for the discharge of the onus for the taxpayer merely to show there may be errors in the Commissioner's calculations of the taxable incomes. Rather, the taxpayer must show that the amount of the assessment is excessive in the sense of it being greater than the actual taxable income which he or she claims to have derived in any given year of income. Furthermore, the Commissioner is not required to mount an impregnable case in support of the assessment made pursuant to s 167 of the ITAA: George v Federal Commissioner of Taxation (1952) 86 CLR 183 at 204; Federal Commissioner of Taxation v Clarke (1927) 40 CLR 246 at 251; and Galea v Federal Commissioner of Taxation (1990) 21 ATR 1108 at 1116 - 7. It is sufficient for the Commissioner to have made reasonable inquiries to found a basis for the assessment: Briggs v Deputy Federal Commissioner of Taxation (WA) 87 ATC 4278 at 4294 - 4295.
6 The Tribunal was satisfied the Commissioner had acted reasonably in arriving at the amount of taxable incomes assessed for each of the years in question. It summarised the Commissioner's reasons for that view as follows:
"
· The taxpayer did not lodge income tax returns for any of the 7 years of income to which the objection decisions under review relate.
· The Australian Federal Police arrested the taxpayer in November 1995.
· The taxpayer was taken into custody on 5 November 1995, later; having pleaded guilty to the offences mentioned above, he was jailed on 26 April 1996. He was still in custody at the time of the hearing of this matter.
· The [Commissioner] was provided with a copy of a report compiled by Mr Kim Griffiths, Financial Analyst, Commonwealth Director of Public Prosecutions, September 1996. This report included, among other relevant information, T accounts for the years ended 30 June 1993, 1994 and 1995 and for the period 1 July 1994 to 31 October 1995.
· As a result of its own inquiries, the [Commissioner] made adjustments to each of the T accounts referred to above. …
· The [Commissioner's] own inquiries to assist it in being satisfied about the reasonableness of the T accounts and the basis for the above adjustments included:
o Obtaining ABS statistical information about the level of household expenditure by State and Territories and Capital Cities. It used this information to estimate the living expenses.
o Vouching bank transactions during the 1993 to 1996 years of income and summarising these into categories, firstly by each bank account and then overall by year.
o By reference to witness statements provided by the Australian Federal Police, summarising cash expenditure by categories for each year."
7 The Tribunal noted that the taxpayer gave evidence about his activities and earnings for the years of income in question. He was not represented before the Tribunal. The Tribunal was of the opinion that the taxpayer's evidence could not be relied upon as on a number of occasions he seemed to change his evidence when he thought that by doing so it would assist his case. The Tribunal treated with scepticism a claim by the taxpayer that until 1994 when he began dealing in drugs his drug purchases were for his own use. It referred to his record of convictions in respect of drugs and related matters. It noted that the taxpayer, whilst not categorically denying he was involved in drug dealing, claimed that he was set up by, and dealing on behalf of, the Australian Federal Police (sometimes referred to in evidence as the National Crime Authority) (by agents Messrs Brewer and Coombes) as agent provocateur. However, in the Court of Criminal Appeal, in the Supreme Court of Western Australia, Pidgeon J, with whom Malcolm CJ and Kennedy J agreed, had found there was no suggestion of an official advance of money to conduct a controlled operation to apprehend offenders. The Tribunal said no independent evidence had been presented which would enable any contrary conclusion to be reached and it adopted the conclusions of the Court of Criminal Appeal: La Rosa (1989) 105 A Crim R 362.
8 In relation to the taxpayer's objections to the last four years of assessment, including relevantly the year ended 30 June 1995, the Tribunal had before it various T documents and exhibits. In addition it had the oral evidence of the taxpayer which it summarised in its reasons. However, it found that the taxpayer was uncooperative and aggressive in cross-examination. In light of the need for corroboration of his evidence the Tribunal called the taxpayer's daughter and son-in-law ("the Mahoneys") and the taxpayer's spouse to give evidence. The Tribunal recorded its impressions of those witnesses in relation to the taxpayer's assertion that a stolen sum of $220,000 belonged to his daughter and son-in-law. It will be necessary later to turn to the particulars of that evidence.
9 The following were the principal matters decided by the Tribunal:
(1) Taxability of profits of illegal business:
10 The Tribunal found that the taxpayer profited from drug dealing at least in the last four years of income and relevantly including the year ended 30 June 1995. It held that was sufficient for the proceeds from the sale of such drugs to be treated as assessable income pursuant to s 25(1) of the ITAA.
(2) Assessibility of allegedly stolen monies:
11 In relation to the sum of $220,000, allegedly stolen in May 1995, the Tribunal found the monies belonged to the taxpayer and that he had not discharged his onus of proof to establish they were not proceeds from drug dealing. It considered the sum was correctly included among "other payments" in the T account for the year ended 30 June 1995 having the effect of increasing the otherwise "total funds expended".
(3) Deductibility of monies stolen from illegal business:
12 In relation to the claim that the money was stolen the question arose as to whether there should be an offsetting allowable deduction for the loss. The Tribunal found there should be such a deduction in the year ended 30 June 1995. Its reasoning follows.
13 The Tribunal referred to subs 51(1) of the ITAA as allowing deductions of losses or outgoings incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing such income, except to the extent that the loss or outgoings is of capital or of a capital nature. It found that the money stolen was clearly a loss. Furthermore, it was a loss arising during activities directly connected with the carrying on of the illicit drug dealing business, the proceeds from which were assessable income pursuant to s 25(1) of the ITAA.
14 The Tribunal rejected a suggestion that any deduction would be available pursuant to s 71 as resulting from larceny (theft) perpetrated by a person employed by the taxpayer. It held that clearly that condition was not present because the evidence was that unknown persons stole the amount.
15 In the opinion of the Tribunal the amount stolen was accumulated proceeds from drug dealing. The monies had been received as income and accumulated for use in the business. It relied on Charles Moore & Co (WA) Pty Ltd v Federal Commissioner of Taxation (1956) 95 CLR 344. That was a case where deductibility was allowed in respect of a sum of money stolen at pistol point whilst being taken from the taxpayer's retail store to the nearby bank for depositing. The Tribunal considered it was not to the point here that the drug dealing business was illegal. Rather, it considered that what mattered was the connection of the robbery with the drug purchase operation and hence with the direct connection with the gaining or production of the taxpayer's assessable income. The Tribunal followed the reasoning in Charles Moore in holding that the amount stolen was not a loss of capital or of a capital nature. Furthermore, it did not consider the loss could be characterised as one incurred in the course of securing a future supply of drugs (an enduring benefit) which would be of a capital nature because the evidence was it was lost during operations to acquire trading stock. Accordingly, the Tribunal allowed the deduction pursuant to s 51(1).
(4) Assessibility of a sum in safety deposit box:
16 It also found there was sufficient evidence to be satisfied there was a further sum of at least $220,000 accumulated in a safety deposit box on behalf of the taxpayer and removed therefrom soon after his arrest in November 1995. It was satisfied the sum was an accumulation of drug dealing proceeds over time. In the absence of evidence to the contrary, it was reasonable to adopt the Commissioner's approach and treat the amount as cash on hand as at 31 October 1995 even though it had not be recovered. Therefore, it was open to the Tribunal to include both this $220,000 and the sum of $30,000 previously stored in the safety deposit box as "cash on hand" in the compilation of the T account for the period from 1 July 1995 to 31 October 1995. Consequently, no adjustment was required to the Commissioner's assessment of the taxpayer's taxable income for the year of income ended 30 June 1996.
(5) Offset of forfeited proceeds of crime:
17 Before the Tribunal the taxpayer submitted that money and real and personal property valued at $264,610 forfeited pursuant to a declaration by the Supreme Court of Western Australia under the Proceeds of Crimes Act 1987 (Cth) should be excised from his taxable income. His submissions was that both to forfeit the property and to assess it for tax was charging twice for the same amount.
18 The Tribunal understood this submission to be open to two alternate interpretations. The first was that the seizure is a payment to the Commonwealth equal to the value of the property seized and therefore, in effect, should be taken to be a discharge in part of any income tax liability arising from the disputed assessments. The Tribunal considered no such notion of discharge was applicable because the seizure was in the nature of a penalty having the character of a fine or imprisonment and was not a payment, voluntary or otherwise, in discharge of any liability, nor did it establish any rights.
19 Secondly, the Tribunal understood the submission to mean that the seizure, because of its clear connection with the crime of drug dealing giving rise to the disputed assessments, should result in a tax deduction, equal to the value of the property seized, from the assessed income from drug dealing activities. The Tribunal considered the first obstacle to this was that the "payment" if there was one occurred after the end of the years of income in which the assessed income was derived. The court order under the Proceeds of Crimes Act made on 30 October 1996 bore no temporal connection to the business activities giving rise to the income derived. The forfeiture was too late to have any relevant nexus with the assessed incomes derivation. There was, therefore, insufficient nexus between the occasion of the derivation of the income that may have been used to accumulate or purchase the property forfeited and the occasion of the loss. Unlike the loss of the money stolen, this loss was neither relevant nor incidental to the day to day activities previously carried on in the drug dealing business: see s 51(1) of the ITAA. It did not consider the deduction was excluded by s 51(4) as the forfeiture or seizure was not an amount "to be paid by the [taxpayer]". The Tribunal therefore concluded on this aspect that no reduction in taxable income arose as a consequence of the seizure of the property referred to.
20 The Tribunal therefore varied the objection decision under review in respect of the year of income ended 30 June 1995 by remitting the matter to the Commissioner to issue amended assessments reducing the taxable income by $224,793 to $222,161 and subject to adjustments to additional tax assessments.
Whether evidence to support finding funds were stolen
Ground of appeal
21 The first ground of appeal is that there was no evidence or insufficient evidence to support the Tribunal finding that the funds of the taxpayer were stolen from him in the course of purchasing prohibited drugs (and not recovered).
Commissioner's contentions
22 The findings of fact made by the Tribunal in relation to this matter were:
(a) the sum of $220,000 was stolen during an intended drug purchase.
(b) the intended drug purchase was directly connected with carrying on the taxpayer's illicit drug dealing business.
(c) the sum of $220,000 belonged to the taxpayer and was proceeds from drug dealing accumulated for use in the illicit drug dealing business.
(d) the sum of $220,000 was buried in the taxpayer's backyard and dug up for a drug deal in May 1995.
The submission for the Commissioner is that there was no material or insufficient material before the Tribunal to support its findings that the taxpayer's money of $220,000 was stolen from him during an intended drug purchase directly connected with carrying on his illicit drug dealing business. Further, it is submitted such findings were logically inconsistent with other evidence before the Tribunal and other findings of the Tribunal.
23 The case for the Commissioner then directed attention to the evidence before the Tribunal. Firstly it was said that in the taxpayer's grounds of objection and in supporting correspondence he denied receipt of the cash stolen. In referring to unsworn statements of Mr and Mrs Mahoney, he referred to their hearsay statement and said it was just a good story. Secondly, in the supporting affidavit he also denied he had ever received the sum.
24 Thirdly, in an affidavit filed in the proceedings in the Court of Criminal Appeal, the taxpayer had deposed that officers of the National Crime Authority ("NCA") had arranged the money in two bags to enable him to act as an agent provocateur. It was that money in relation to which he was set up and robbed.
25 Fourthly, there were statements by Mr and Mrs Mahoney made on 4 and 8 June 1996 respectively. Mrs Mahoney's statement was that around the beginning of May 1995 the taxpayer asked her to get together a substantial sum of money, telling her he needed to get $220,000 cash for a deal he was involved in. She gave him all the money she had been keeping for him at the house but she did not recall exactly how much money she had given him. She also stated she had been told by the taxpayer he had been robbed of the sum of $220,000. Mr Mahoney stated the taxpayer had told him he had a "deal going down" and wanted to know how much money he had. Consequently, Mr Mahoney dug up the money from his backyard and counted it. He did not recall the exact amount but to the best of his recollection there was about $220,000. After counting the money he reburied it. He also stated that on 19 May 1995 the taxpayer had told him he needed $220,000 for a "deal" and that to the best of his recollection the taxpayer told him he had buried money in the front yard of his house near the garage. While there was evidence from Mr Mahoney that might support an inference that an attempted drug deal and theft occurred, there was no probative evidence that $220,000 of the taxpayer's money was involved in those events.
26 Fifthly, the Tribunal reached an unfavourable opinion of the taxpayer's credibility generally. It said it reached that view because on a number of occasions he seemed to change his evidence when he thought that by doing so it would assist his case. As has been seen, the Tribunal rejected the taxpayer's claim that he was set up by, and dealing on behalf of, the NCA as an agent provocateur.
27 Sixthly, the Tribunal preferred the evidence of Mr Mahoney in regard to the origin of the allegedly stolen sum of about $220,000. It found no evidence in support of the taxpayer's claims that the various sums he attributed to having been sourced from Mr and Mrs Mahoney (his daughter and son-in-law) in fact came from them. Rather, the Tribunal found they came from cash available to the taxpayer alone.
28 The position therefore, it is said, is that there was no evidence other than that which came from the taxpayer (either directly or indirectly through his statement to others) as to the source of the money in his physical possession on the night (not necessarily the money held in the backyard by the Mahoneys); the use intended for the money on the night; and the theft of the money on the night. Given the Tribunal's findings as to the taxpayer's credibility it is submitted it was not open to it to rely upon or draw inferences from hearsay as to what the taxpayer had said. It is submitted the finding which the Tribunal should have made at law was that on the relevant material before it there was no evidence or insufficient evidence that on the alleged night in May 1995, $220,000 of the taxpayer's money had been in his physical possession and had been stolen from him during an intended drug deal directly connected with carrying on the taxpayer's illicit drug dealing business. Consequently, it is submitted the Tribunal was required to find that there was no established factual basis upon which it could apply s 51(1) of the ITAA to allow a deduction for the alleged loss. Accordingly, the taxpayer could not discharge the onus of proof that his assessment for the income year ended 30 June 1995 was excessive to the extent of $220,000.
Contentions for taxpayer
29 Firstly, it is said for the taxpayer that the Tribunal was entitled to rely on the unsworn statements of Mr and Mrs Mahoney as these were relied upon by the Commissioner to support the assessments and disallow the objection, nor was this aspect of their evidence the subject of a challenge before the Tribunal.
30 Secondly, reliance is placed on the evidence in the affidavit by the taxpayer before the Court of Criminal Appeal. The matters were put to him in cross-examination before the Tribunal but there was no challenge to the transaction or theft-taking place, only to his claims regarding ownership of the funds. The taxpayer sought to call corroborating evidence from the alleged owners of the money (the officers of the NCA) but was dissuaded from doing so by the Tribunal.
31 Thirdly for the taxpayer it is said it is not correct that the evidence of Mr and Mrs Mahoney was each based on information from the taxpayer. Her evidence included her observations of the movements of the parties and the physical state of the taxpayer at the end of the night. His evidence included a description of his part in the transaction, being given a weapon, observation of the taxpayer's physical state and going with the taxpayer to seek the alleged thief at a later date. None of these matters are hearsay from the taxpayer and all are items of evidence that could reasonably support an inference that a robbery took place.
32 Furthermore, neither the evidence of Mr or Mrs Mahoney was challenged in the Tribunal with respect to the robbery or the events of the night in question. That was an opportunity for the Commissioner to correct the unsworn nature of their statements. However, questions were confined to the issue of the ownership of the money.
33 Next, it is submitted the statements by the taxpayer that the money was not his are to be understood as consistent with his attempt throughout to say the money belonged to officers of National Crime Authority or Australian Federal Police. This was disbelieved by the Tribunal. It is not appropriate for this Court, it is submitted, to reverse the Tribunal's finding on credibility.
34 Additionally, reliance is placed on the fact that the T accounts included the sum of $220,000 on the basis of the Mahoneys' evidence so that it always was the Commissioner's case that sum should be brought to account. The additional point is made that if there is no evidence, the sum should not have been included in the T account.
35 In relation to the credibility finding adverse to the taxpayer, it is pointed out for him that the Tribunal based that finding on the taxpayer changing his story to suit himself "in the hearing". However, the statements relevant to the present issue come from outside the hearing. Furthermore, the Tribunal was not bound by the rules of evidence and was entitled to rely on hearsay evidence: s 33 Administrative Appeals Tribunal Act 1975 (Cth).
36 Finally, it is submitted that because there is clear independent evidence of a theft it is not material whether or not the evidence establishes the exact amount that was involved because the amount that was stolen is the amount that both goes into the T accounts and is to be taken out again.
Requirements at law for ground to be made out
37 According to the Australian authorities a lack of logical reasoning does not necessarily constitute an error of law. If the particular inference is reasonably open, that is, if there exists some basis for the inference, there is no basis for judicial review (see Australian Broadcasting Tribunal v Bond (1990) 170 CLR 321 per Mason CJ at 356 with whom Brennan, Toohey and Gaudron JJ agreed on this point; cf Minister for Immigration and Multicultural Affairs v Epeabaka (1998) 84 FCR 411 at 422.
38 Therefore a finding of fact will be reviewable on the ground that there is no probative evidence to support it and an inference will be reviewable on the ground that it was not reasonably open on the facts, which amounts to the same thing (Bond per Mason CJ at 359-360).
39 In addition to referring to the above two mentioned authorities counsel for the Commissioner drew attention to two decisions in the taxation context. The first was Federal Commissioner of Taxation v McCabe (1990) 26 FCR 431 where at 442 Davies J said, in the context of the application of s 44 of the Administrative Appeals Tribunal Act 1975 (Cth), that Mason CJ's comments in Bond were a warning not to blur the distinction between unreasonableness or perverseness on the one hand and want of logic on the other. He added that a strong case is necessary to upset a factual finding. In Collis v Commissioner of Taxation 96 ATC 4831 at 4846 - 4847 the observations of Mason CJ in Bond at 355 - 356 were applied by Jenkinson J.
40 Counsel for the taxpayer did not submit that there was illogicality in the decision of the Tribunal, rather there was no basis for the inference it drew.
Reasoning on this ground
41 In my view the case for the taxpayer on this point makes apparent that the case for the Commissioner on the point is not of the strong character (cf McCabe at 442) necessary to upset a factual finding. This is not a case where the weight of evidence is all one way against the finding (cf McCabe at 442 again). There was evidence of theft and of the quantum of money involved. None of this was put in issue before the Tribunal in a way relevant to resolution of this ground. There was therefore some evidence upon which the findings of the Tribunal can be seen as reasonably open (cf Bond at 355). I therefore consider the ground of appeal does not succeed.
42 I do not consider that it is correct that the Tribunal's findings in relation to the taxpayer's credibility generally has the consequence that there was no evidence before the Tribunal on which it could base its findings. That is, I consider there was evidence other than that which came from the taxpayer. Mr Mahoney said in his statement that the taxpayer had told him he needed $220,000 for the drug deal and had instructed his wife to dig it up. He also told Mr Mahoney he had buried money in the front yard of his house (and it was this his wife did not wish to have to dig up). He then gave evidence relative to the attempted drug deal and theft, the inferences from which are not challenged by the submissions for the Commissioner. He continued by stating the theft had related to "the money", a reference back to the money previously identified. Mrs Mahoney's statement said she had given the taxpayer all the money she had been keeping for him, and although she could not say the exact amount, it was in response to his request for $220,000. Mr Mahoney said in his statement that when he had dug up the money from the backyard it was to the best of his recollection about $220,000. The written submissions for the Commissioner accept that the sum so dug up is the amount here in issue. In examination in chief the taxpayer put to Mr Mahoney the question of who owned the $220,000 stolen and he replied it was the taxpayer's. There was no cross-examination of Mr Mahoney on this issue. Once the Tribunal disbelieved the taxpayer's claim that the sum of $220,000 stolen was money supplied by Messrs Brewer and Coombes, there was evidence from which it could reasonably conclude the sum belonged to the taxpayer and was in the order of the amount so identified.
43 I therefore do not consider this ground of appeal succeeds.
Eligibility of stolen funds for deduction
Ground of appeal
44 The Commissioner's amended notice of appeal then seeks to challenge the allowance by the Tribunal of the deduction of the stolen funds. The ground alleges the Tribunal erred in law in finding the sum was an outgoing incurred in gaining or producing the taxpayer's assessable income or was necessarily incurred in carrying on a business for the purpose of gaining or producing such income.
Relevant statutory provisions
45 Subsection 51(1) in well known words provides that "all losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income". Subsection 51(4) provides:
"51(4)A deduction is not allowable under subsection (1) in respect of:
(a) an amount, however described, payable, or expressed to be payable, by way of penalty under a law of the Commonwealth, a State, a Territory or a foreign country; or
(b) an amount ordered by a court, upon the conviction of a person for an offence against a law of the Commonwealth, a State, a Territory or a foreign country, to be paid by the person."
46 "Assessable income" is defined by s 6(1) of the ITAA for income years prior to 1997/1998 as all amounts which under the provisions of the ITAA are included in the assessable income.
Contentions for Commissioner
47 It is submitted that the losses and outgoings encompassed by the terms of s 51(1) are those arising out of "legitimate activity" to gain or produce assessable income. That is, it is said that the occasion of the alleged loss is properly explained by the taxpayer's exercise of his choice to personally engage in criminal activity and not by any legitimate activity to gain or produce assessable income. The loss allegedly occurred while the taxpayer was attempting to engage in criminal activity and it is submitted that a motive of that kind does not turn a criminal act into an income-producing act.
48 The contentions for the Commissioner urge the Court to find support for these views in decisions showing a reluctance to allow deductions under s 51(1) for fines and penalties, to which reference will be made below.
49 It is also submitted that as the taxpayer said he intended to purchase $220,000 worth of prohibited drugs on the night but instead the "deal" turned out to be a set up by other criminals who intended and succeeded in robbing him of his money, there was no legal and commercial transaction on that occasion from which the loss was "incurred" in the gaining or producing of assessable income. It is submitted there was not, therefore, the required sufficient connection between the alleged theft and the production of assessable income for the purposes of s 51(1): cf Charles Moore at 350 - 351.
50 In using the word "legitimate" in these submissions counsel for the Commissioner said it was intended to have a broader meaning than "lawful" because it would encompass occurrences such as a breach of statute which would not be seen as reprehensible.
Contentions for taxpayer
51 Firstly it is said for the taxpayer that it is significant s 51(1) of the ITAA provides for a deduction for "all" losses and outgoings. The intent is an inclusive one and relates to the gaining or producing of "assessable income".
52 It is denied that the cases on fines and penalties are indicative of a broader principle which could deny deduction here.
53 It is said that the cases demonstrate three different situations namely:
- A legal business where the outgoing is the result of an illegal activity.
- An illegal business where the outgoing is of a legal nature.
- An illegal business where the outgoing is of an illegal nature.
It is said to follow from Charles Moore and Gold Band Services Ltd v Inland Revenue Commissioner (NZ) (1961) NZLR 467thatillegality of the loss does not prevent deductibility by its nature. Accordingly, a denial of the loss must arise only from the illegality of the business activity. It is submitted there is no basis to distinguish between legal and illegal outgoings. The ITAA, it is said, provides no foundation for this distinction. There is no basis for reading words into it which are not there.
Cases on fines and penalties
54 The foundation for the approach to non-deductibility of fines and penalties derives from two English cases, Commissioners of Inland Revenue v Warnes & Company, Limited [1919] 2 KB 444, a decision of Rowlet J and Commissioners of Inland Revenue v Von Glehn & Company, Limited [1920] 2 KB 553. (This latter decision attracted the criticism of the House of Lords in Minister of Finance v Smith [1927] AC 193 at 198, but only in respect of dicta by Scrutton LJ that income tax acts are necessarily restricted in their application to law for businesses only). These authorities and subsequent Australian and New Zealand authorities were fully explored by the Full Court in Madad Pty Ltd v Commissioner of Taxation (1984) 4 FCR 420. They also received close examination by Ormiston J in Mayne Nickless Ltd v Commissioner of Taxation [1984] VR 863. I rely on those descriptions of the authorities which relieve me from the task of repeating the detail of them here.
55 The rationale of the authorities was identified by Gavan Duffy CJ and Dixon J in The Herald & Weekly Times Limited v The Federal Commissioner of Taxation (1932) 48 CLR 113 at 120 as being that:
"the penalty is imposed as a punishment of the offender considered as a responsible person owing obedience to the law. Its nature severs it from the expenses of trading. It is inflicted on the offender as a personal deterrent, and it is not incurred by him in his character of trader."
In Federal Commissioner of Taxation v Snowden & Willson Proprietary Limited (1958) 99 CLR 431 at 437 (where the deductibility of monies expended by a company on advertising in the press to counter the effect of press reports concerning allegations against it and legal costs in respect of a royal commission were in issue) Dixon J said:
"There is no analogy here to cases in which fines or penalties are incurred. There the character of the expenditure and the reasons why the law imposes a fine or penalty separate the expenditure from the conduct of the business. It is not to the point that the conduct penalised found its motive in business considerations. Nothing of the kind can be said of the expenditure now under consideration…"
Fullagar J, with whom Williams J concurred, was of the same view and expressed approval of the explanation given by Gavan Duffy CJ and Dixon J in Herald & Weekly Times.
56 The rationale of the penalty cases received further consideration by members of the Full Court in Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation (1980) 49 FLR 183. There it was contended that expenditure in connection with breaches of the law was in a separate category from other expenditure incurred in carrying on a business and that the weight of judicial authority denies a deduction to a taxpayer who incurs expenditure with respect to a breach of the criminal law. Reliance was placed on the aforementioned authorities. Brennan J said in relation to that at 199:
"In the High Court, the majority of the judgments confines the operation of the English cases to the payment of penalties imposed as a punishment upon the taxpayer."
Deane and Fisher JJ said at 214 - 215:
"It is somewhat difficult to understand how it can be maintained, as an unqualified proposition, that the nature of a penalty severs it from the expenses of trading. Recurrent penalties for parking infringements incurred by a deliveryman and per diem penalties for unlawfully using premises for business or commercial purposes in contravention of zoning requirements are not, for example, logically severed from the expenses of trading. The same can be said of fines imposed for actually engaging in some unlawful activities, such as illegal bookmaking or soliciting, for the purpose of earning assessable income. If, when the matter directly arises for decision in the Australian courts, it is to be held that all fines and penalties are to be denied deductibility under the Act, it would seem preferable that it be on the basis of some perceived overriding consideration of public policy which precludes deductibility."
57 In Mayne Nickless,Ormiston J was prepared to follow the line of authority that it was the nature of the penalty and the character of the expenditure which takes such outgoings outside the expenses of trading, although he did so significantly because he did not consider it appropriate to depart from observations of so many judges of the High Court: at 878 - 879.
58 It follows that I should understand that the rule reflected in the English cases in relation to penalties is not open to wider analogy and indeed may not find ongoing support in Australian law if it arose directly for decision. I do not consider, therefore, that law is available for me to analogise from, in relation to the taxpayer's claim for a deduction of the stolen sum of $220,000.
Concept of legitimacy
59 Woven into the submissions for the Commissioner in relation to this contention of non-deductibility of the stolen funds is the concept of legitimacy. I can find no basis in law for that concept. As put to the Court it involves vague and ill-defined limits because it is intended to encompass some matters that are not lawful but which are not excessively unlawful. To adopt the use of legitimacy would seem to introduce a measure of subjectivism which would give rise to uncertainty in the application in the law. More fundamentally, the contentions for it do not disclose any foundation either in case law or in the wording of the ITAA upon which such a concept could be approached. In my view it is essential to adhere to application of the words of the ITAA in s 51(1).
Authorities on deductibility
60 In Charles Moore the High Court, in allowing deductibility of the monies stolen on the way to the bank as a loss incurred in gaining or producing assessable income, said (at 350) that:
"Properly understood the place which the banking of money takes in a merchandising business brings the operation within the principle [of the subsection]. It is an essential, or at all events highly expedient, part of the conduct of the business, a necessary or recognised incident or concomitant, and is relevant as well as incidental to the end in view, the gaining of the assessable income. The "occasion of the loss" in the present case was the course pursued in banking the money."
61 In Gold Band Services a deduction was allowed in respect of cash monies robbed in the operation of a service station, being part of weekend takings. Haslam J held that the instance was indistinguishable from Charles Moore's case because the occasion for the loss was the operation of its business "in the normal way". The facts showed that a dishonest removal of such funds was a "reasonably incidental risk" to the production of assessable income in that locality at that time.
62 If the argument touching on "legitimacy" is intended to be directed to the manner of the operation of the business and to suggest that the occasion of the loss was not a necessary part of the conduct of the business I do not consider that the argument has been made properly in those terms nor is it supported by the facts. The findings of the Tribunal are that the occasion of the loss occurred during an intended drug purchase and was directly connected with the carrying on of the taxpayer's illicit drug dealing business. The inference from those findings is that occasion for the loss was the operation of that (illegal) business in a way normal to it.
63 For these reasons I do not consider that this ground of appeal as pressed can succeed.
Whether deductibility contrary to public policy
Ground of appeal
64 The grounds of appeal then contend that in applying s 51(1) of the ITAA to allow the taxpayer the deduction for the stolen monies in connection with the transaction which was criminal and conducted in the course of criminal activity was contrary to public policy. It is further contended that the provisions providing for deductibility are intended to provide concessions for legitimate business activity, not for criminal activity. For the deduction to be allowed, it is contended in the grounds, provides an incentive and not a deterrent or additional penalty against criminal activity.
65 In relation to these grounds of appeal it is convenient to address the contentions for the Commissioner and the taxpayer under the sub-headings which follow.
Whether public policy can limit deductibility pursuant to s 51(1)
66 I accept the submission for the Commissioner that there is recognition in Australian taxation law that s 51(1) may be limited by public policy considerations. That much was suggested by Deane and Fisher JJ in Magna Alloys at 215 in the passage previously quoted. However, their Honours went on to say in that particular case that there were no considerations of public policy providing support for the Commissioner's submissions urging non-deductibility of legal costs incurred in the defence of directors, employees or agents on criminal charges arising out of activities on the taxpayer's behalf. Their Honours found there were sound arguments to support the view that, in the absence of any question of inducement to criminal activity, an outgoing designed to achieve the result that a citizen charged with a criminal offence has proper and adequate legal representation was positively in the public interest.
67 In Mayne Nickless Ormiston J held that fines and penalties for various motoring offences upon employees and independent contractors and paid by the taxpayer, while falling within s 51(1), could not be allowed as deductions because to do so would be against the policy of the law because that would frustrate the legislative intent in that the punishment imposed would be, or would be seen to be, diminished or lightened. In reaching that view, Ormiston J said (at 883):
"It follows in my opinion that the policy of the law should support the enforcement of the criminal law whether that be the historical common law of crime or the widening array of regulatory offences, and should strive to see that punishments for breaches of the law are not defeated or frustrated by direct or indirect means. About this there could be little argument."
68 This latter passage was cited by the Full Court in Madad at 426.
United States authorities
69 Although the immediately preceding authorities arguably provide some support for contentions for the Commissioner on this present point, reliance was nevertheless placed upon three authorities from the United States. To some extent the arguments for the Commissioner were shaped in terms of the dicta in those cases. The first case was Burrows BLDG. Material Co v Commissioner for Internal Revenue 47F(2d) 178 (1931). There it was held that fines and costs paid by a taxpayer for violation of laws relating to price fixing are not deductible as ordinary and necessary expenses. Reliance was there placed inter alia on the authorities in Von Glehn and Warnes. The court regarded the disallowance as properly resting on a refusal to sanction expenditures of the character there in issue on grounds of public policy (at 180).
70 The second was Tank Truck Rentals, Inc v Commissioner of Internal Revenue 356 US 30 (1958). There, fines imposed on, and paid by the owners of Tank Trucks (and their drivers, who were reimbursed by the owners) for violation of state maximum weight laws were held to be not deductible by the truck owners as "ordinary and necessary" business expenses. The opinion of the court made reference to the policy of several States being "evidenced" by penal statutes enacted to protect their highways from damage and to ensure the safety of all persons using them. The court said it would not presume that the Congress, in allowing deductions for income tax purposes, intended to encourage a business enterprise to violate declared policy of a State. It went on to say that the test of non-deductibility always is "the severity and immediacy of the frustration" resulting from the allowance of the deduction. It considered the frustration of State policy was most complete and direct when the expenditure for which deduction is sought is itself prohibited by a statute. In the case of a penalty, being expenditure not itself an illegal act, it was only slightly less remote.
71 Thirdly, reference was made to Commissioner of Internal Revenue v Tellier 383 US 687 (1966). There, the Supreme Court held that deduction of expenses for legal fees incurred by a securities dealer in defending his prosecution for violations of the Securities Act 1933 involved no offence to public policy because he was exercising his constitutional right to employ counsel to defend criminal charges. The court said that "only where the allowance of a deduction would 'frustrate sharply defined national or state policies prescribing particular types of conduct' have we upheld its disallowance". Further, it said that the policies frustrated must be national or state policies evidenced by some governmental declaration of them. It affirmed the test of non-deductibility was the severity and immediacy of the frustration resulting from allowance of the deduction.
72 The relevance of American authorities was discussed by Ormiston J in Mayne Nickless at 885 - 887. He considered, in particular, the decision in Tank Truck and in Tellier as well as the further decision of Hoover Motor Express Co v United States 356 US 38 (1958). Ormiston J concluded after that review that the views there expressed and the manner in which the principles were applied seemed to him to express a proper basis for the policy of the law in disallowing deductions such as those there claimed. While he accepted the cases were not strictly authoritative, he nevertheless considered they expressed in large measure the reasons why it is against the public interest in Australia to allow such deductions, whether for penalties imposed on the taxpayer or its employees or contractors. The focus of his consideration as indeed of the American authorities was on issues relating to fines and penalties and not with a broader category of expense, a fact relied upon for the taxpayer. I have regard to the American authorities in the same light as Ormiston J did and with their circumstances in mind.
73 It should be added that the contentions for the Commissioner rely on the description given by the Supreme Court of the United States in Tank Truck at 35 of the necessity for "severity and immediacy of the frustration" in order to allow for the application of public policy against what would otherwise be an allowable deduction. By that approach the Commissioner seeks to counter contentions for the taxpayer that the Commissioner seeks to rewrite s 51(1) in some wide expansive way.
How is public policy identified?
74 In Mayne Nickless at 879 - 884 Ormiston J explored the question of what was the public policy applicable to the allowance of deductions under the ITAA. He found himself "much oppressed by the question of what is public policy". He was convinced that the principle of public policy invoked before him was not identical to that applied in relation to invalidity of contracts, although it may spring from the same roots. He considered that what was called in aid may have been described as "the public interest" or at least the general policy of the law. He said the problem was whether the contravention of one statute, or a number of statutes, should have any consequence in considering the proper application of another statute (in this case the ITAA). He considered there was not any general question of morality which must be ascertained, but what is in fact a consequence of the clear and admitted breach of a number of statutes or regulations. He then moved on to reach his view, previously quoted, that the policy of the law should support the enforcement of the criminal law. He saw the policy of the law as denying the right to claim deductions on the ground that they would frustrate the legislative intent that punishment imposed would be, or would be seen to be, diminished or lightened.
75 In reaching that view, Ormiston J did so on the basis (stated at 881) that what was in issue before him was the effect or consequences of a payment of a fine or penalty for contravention of a statute or regulation. (Here, what is in issue is the effect or consequences of the provision of money by the taxpayer for the purpose of entering into an intended drug purchase).
76 The analysis by Ormiston J in Mayne Nickless of public policy in the above terms was the only such analysis relied on in argument before this Court.
Relevant public policy here
77 In oral submissions the taxpayer submitted that public policy as described by Ormiston J in Mayne Nickless ought not to be seen as a touch-stone readily available to the courts, nor a rule that can be readily identified. Further, it was said that in seeking to establish whether a public policy issue arises in respect of a specific case, that authority shows that the particular application of an alleged ground of public policy must first be identified. I accept those submissions.
78 For the Commissioner it is submitted that the enactment by Parliament of s 51(4) of the ITAA reflects public policy that penal statutes are not to be frustrated by the allowance to offenders of deductions for fines and penalties pursuant to s 51(1). Subsection 51(4) was inserted into the ITAA in 1984. It provides a statutory base for not allowing a deduction under s 51(1) in respect of an amount payable by way of penalty under a Commonwealth, State, Territory or foreign country law or an amount ordered by a court, upon conviction for an offence against a law of any of those entities, to be paid by the person.
79 For the taxpayer it is submitted that the introduction of s 51(4) shows that where there is a public policy requirement it can and should be reflected by a statutory amendment. Consequently, Parliament should be taken as having completely rejected the operation of the public policy principle in relation to s 51(1) to the extent of the scope of the matters in s 51(4).
80 In my opinion the introduction of s 51(4) is illustrative of the fact that Parliament may exclude an allowable deduction by legislative amendment. It does not provide a foundation for a more general inference that Parliament intended by that enactment to exclude the application of public policy principles if they are applicable otherwise at law.