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[1997] HCA 16
High Court of Australia
1997-04-29
Brennan CJ, Kirby JJ, McHugh JJ, Taylor J, Menzies J
Original judgment source is linked above.
High Court of Australia Brennan CJ Dawson, Toohey, Gaudron, McHugh, Gummow and Kirby JJ Commissioner of Taxation (Cth) v Rowe [1997] HCA 16
29 April 1997 Brennan CJ, Dawson, Toohey and McHugh JJ.
Special leave to appeal was granted in this matter in order to test the existence of a principle of law for which the appellant contended. In the notice of appeal to this Court it was expressed as a "general principle of law that an amount paid as compensation for or reimbursement of a deductible expense is income within ordinary concepts".
Before the Full Court of the Federal Court [1] , on appeal from the Administrative Appeals Tribunal, and before this Court the appellant argued for such a principle while submitting that, in any event, in the circumstances of the case the amount received by the respondent was income according to ordinary concepts, hence assessable under s 25(1) of the Income Tax Assessment Act 1936 Cth (the Act). He further submitted that the amount was received by the respondent as compensation for, or by way of reimbursement of, a deductible expense incurred in protecting his employment, hence assessable under s 26(e) of the Act. The claim based on s 26(e) is not before this Court.
The formulation of the general principle for which the appellant contended underwent some change as the argument progressed. This was, no doubt, because of the difficulty he had in maintaining such a principle in an absolute form. And so the appellant moved in his written submissions to a substantially qualified position, expressed in the following terms:
[I]n the absence of unusual circumstances, such as: (a) a particular provision of the Income Tax Assessment Act dealing specifically with payments of the nature in question; or (b) an intention to provide family benevolence; the true position is that: (c) a payment made to reimburse or compensate for a deductible expense will ordinarily take its character from the nature of the expense for which it is reimbursement or compensation; (d) such a payment will ordinarily be of an income nature: there will be no feature of it to give it any other character; and (e) prima facie, the fact that it is such a reimbursement or compensation will make it income. The appellant changed position yet again so that at the end of the hearing the principle, as recorded in the transcript of argument, was that "where there is a finding of fact that a payment, whether made voluntarily or not, is made as a reimbursement of, or as reparation for, an amount deductible under s 51(1), the amount of the payment is income". The appellant's changes of formulation give to the principle a chameleon character.
The circumstances surrounding the allowance by the appellant of a deduction claimed by the respondent for expenses incurred in legal representation at an inquiry into his conduct under the Local Government Act 1936, and the later ex gratia payment by the Queensland Government to him of a sum roughly equivalent to the expenses incurred, are detailed in the judgment of Gaudron, Gummow and Kirby JJ. There is no need to repeat them in any detail. But it should be noted that the inquiry was held in August 1985, that the respondent unsuccessfully sought from the Livingstone Shire Council, his employer, reimbursement of his expenses and that the payment made by the Government was eventually made in 1989.
It must be said that there is no authority in this Court (or, it would appear, in any other Australian court) directly supportive of the appellant's general principle, in any of the shapes it bears. Indeed, the principle runs up against what was said in H R Sinclair & Son Pty Ltd v Federal Commissioner of Taxation [2] . In the course of his judgment in that case, Taylor J said of the question whether it was proper to take into account a particular sum for the purpose of ascertaining the gross proceeds of a business [3] :
The character of the amount which the appellant received cannot, in the absence of some appropriate statutory provision, be thought to vary according to whether or not deductions were claimed and allowed of expenditure which includes the sum now reimbursed. Menzies J did not expressly deal with the point. Owen J spoke in somewhat similar terms to Taylor J, concluding [4] : [M]any of the arguments put to us by the counsel for the Commissioner seemed to suggest that because the earlier payments had been allowed as deductions since they had been made in gaining the company's assessable income in those years, it necessarily followed that the refund was to be treated as a receipt of income. This, I think, is not the right approach. The real question is whether the amount received by way of refund was part of the company's assessable income for the year in which it was received. In the earlier decision of Allsop v Federal Commissioner of Taxation [5] there is a passage in the judgment of Barwick CJ and Taylor J which casts doubt upon the suggested nexus between deductibility and assessability but, in the circumstances of the case, no concluded view was expressed. 1. (1966) 114 CLR 537. 2. H R Sinclair (1966) 114 CLR 537 at 542-543. 3. H R Sinclair (1966) 114 CLR 537 at 545. 4. (1965) 113 CLR 341 at 350-351.
The respondent strongly contested the existence of the alleged general principle, however formulated. He contended that the receipt of a sum of money could not constitute assessable income merely by reason of the allowance of an equivalent amount as a deduction. Whether it did constitute assessable income depended, in the respondent's submission, on whether the receipt answered the description of income according to ordinary concepts.
If there is no such general principle, a question arises as to whether the appellant should be permitted to fall back on an argument that, in any event, the receipt is income according to ordinary concepts. If the argument in the appeal to the Federal Court had not included the general principle contended for, it is most unlikely that this Court would have granted special leave to appeal. The Court has said more than once that the Full Court of the Federal Court is the ultimate court of appeal in taxation matters, subject only to the exceptional cases in which the Court grants special leave to appeal.
It follows that a question of fundamental principle must arise for decision in such a matter before this court will grant special leave. [6] If the Court rejects the existence of the principle, should it nevertheless deal with the appellant's other arguments or should it, even at this stage, revoke special leave? First, it is necessary to see whether the principle exists. 1. Federal Commissioner of Taxation v Westfield Ltd (1991) 22 ATR 400 at 402
No challenge was made by the appellant to Allsop or Sinclair . Given the factual situation in Allsop , no challenge to that decision was required. Nor was it necessary to challenge the actual decision in Sinclair . But certainly this Court would need to reject the passages from the judgments of Taylor J and Owen J, quoted earlier, in order to conclude that there is any such general principle.
There are two somewhat related ideas involved here [7] . The first is that a payment which is compensation for an item that would have been assessable as income is itself assessable as income. This has been recognised in a number of cases; it is unnecessary to identify them all [8] . The second idea is the principle contended for by the appellant, namely, that compensation for an amount previously allowed as a deduction necessarily constitutes assessable income.
The argument that an amount which compensates the taxpayer for an item that has previously been allowed as a deduction necessarily has an income character is not reflected in the existing law. It has been suggested [9] that the reluctance on the part of courts to accept such a general principle is strange "when it is realised that the principle being suggested is an easier one to justify than the Carapark proposition - in fact, the refund of an allowed deduction is just Carapark from a different perspective in time." The reference is to Carapark Holdings Ltd v Federal Commissioner of Taxation [10] . The actual decision in that case is sufficiently apparent from the following passage in the judgment of the Court [11] :
[I]n general, insurance moneys are to be considered as received on revenue account where the purpose of the insurance was to fill the place of a revenue receipt which the event insured against has prevented from arising, or of any outgoing which has been incurred on revenue account in consequence of the event insured against, whether as a legal liability or as a gratuitous payment actuated only by considerations of morality or expediency. But there are different considerations operating in the case of allowed deductions; these stand in the way of an easy transition from one idea to the other. One consideration is that the Court has said that what a taxpayer has done with an amount received "is in general of no materiality in determining whether his receipt of the amount was a receipt of income or of capital" [12] . But the fundamental difficulty in the way of the "general principle" is that it diverts attention from the inquiry demanded by the Act, as that inquiry has generally been understood, namely, is the receipt income according to ordinary concepts? 1. Cooper, Krever & Vann's Income Taxation, 2nd ed (1993), par 7-11. 2. (1967) 115 CLR 653. 3. Carapark (1967) 115 CLR 653 at 663, per Kitto, Taylor and Owen JJ. 4. Carapark Holdings Ltd v Federal Commissioner of Taxation (1967) 115 CLR 653 at 660see also GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124
There are provisions in the Act whereby some refunds are assessable as income. One that may be noted is s 26(j) which includes in the assessable income of a taxpayer
any amount received by way of insurance or indemnity for or in respect of any loss:
(ii) of profit or income which would have been assessable income; if the loss had not occurred, and any amount so received for or in respect of any loss or outgoing which is an allowable deduction. [13]
The existence of specific provisions in the Act of this nature tells against the existence of a general principle. That is not to suggest any application of the expressio unius rule. The Court has more than once emphasised the need to apply that maxim with care [14] . Rather, as Hill J observed in the recent decision of Warner Music Australia Pty Ltd v Federal Commissioner of Taxation [15] : It is difficult to see, as a matter of principle, why a payment which has the character of capital becomes income in ordinary concepts, just because the payment has its origin in the refund of a previous amount which had attracted a deduction. The symmetry which such a rule suggests ignores the fact that deductions may be available for amounts which have capital character. Not all deductions are on revenue account. And, it may be added, in the case of a voluntary payment the first inquiry must be to identify what the payment is for. As Kitto J observed in Squatting Investment Co Ltd v Federal Commissioner of Taxation [16] : "it is a commonplace that a gift may or may not possess an income character in the hands of the recipient." 1. See also ss 26(k), 63(3), 72(2), 74(2); see also s 53AA. 2. See Pearce and Geddes, Statutory Interpretation in Australia, 4th ed (1996), p 107. 3. (1996) 96 ATC 5,046 at 5,051; 34 ATR 171 at 176. 4. (1953) 86 CLR 570 at 627.
The appellant has failed to make good the principle for which he contends, in any of the formulations offered. However, he attempted to make good such a principle. Furthermore, the grant of special leave was in terms which did not preclude an argument that in any event the payment constituted income according to ordinary concepts. These considerations tell against a revocation of special leave.
Although Beaumont J, who dissented in the Full Court, adverted to the general principle contended for by the appellant, his Honour preferred "to decide the present question by reference to the settled basic principles which [are] relevant to the case of a receipt by an employee or former employee" [17] . Yet his Honour's approach does come close to reliance on a general reimbursement principle by looking at what he saw as the true nature of the inquiry. If, his Honour thought, it was an investigation of the personal integrity of the respondent,
it would be difficult to demonstrate either that the expenses were deductible, or that an amount received by way of their reimbursement was assessable. On the other hand, if, in truth, the Inquiry was concerned, primarily at least, with matters of administration on a day-to-day basis, such a different complexion of the events would usually justify a characterisation of the legal expenditure, and its refund, as items on the revenue account of the taxpayer that were not of a private kind. [18] 1. Federal Commissioner of Taxation v Rowe (1995) 60 FCR 99 at 111 2. Rowe (1995) 60 FCR 99 at 112
To approach the matter in this way is to focus attention on the circumstances in which the claim for a deduction was made and allowed. And although the appellant conceded the deductibility of the legal expenses incurred by the respondent, all members of the Full Court proceeded to deal with that issue. The deductibility of the expenditure reimbursed is a necessary element of the general principle for which the appellant contended. But that was not the footing on which their Honours assessed the deductibility of the legal expenses because they did not determine the fate of the appeal by reference to the general principle. Rather, it seems to have been for the purpose of identifying whether there was a sufficient connection between the outgoing and the receipt [19] .
The fact that the payment made by the Queensland Government was ex gratia is not conclusive.
The question whether a receipt comes in as income must always depend for its answer upon a consideration of the whole of the circumstances [20] . Nevertheless, the starting point here is that the Administrative Appeals Tribunal concluded: I am satisfied that no part of the amount in issue represented anything other than an ex gratia reimbursement of legal costs incurred by the [respondent]. The Tribunal added that "any connection between the receipt and the [respondent's] employment with the Shire Council was no more than a mere historical one". Those conclusions have not been disturbed. It follows that the payment to the respondent was not in satisfaction of any obligation owed by the Government to the respondent. Nor was there any direct connection between the payment and the respondent's employment. 1. Squatting Investment Co Ltd v Federal Commissioner of Taxation (1953) 86 CLR 570 at 627, per Kitto J.
The character of a receipt is assessed by reference to its character in the hands of the taxpayer, not the character of the expenditure which produces the payment to the taxpayer [21] . And this is so in the case of a voluntary payment [22] .
It is true that, in support of his claim for a deduction, the respondent had argued that the expenditure was "incidental and relevant to the gaining of assessable income" [23] . But that claim, which originally was rejected by the appellant then later allowed, does not determine the character of the money received from the Government. In the case of money received for which no consideration was given (which is the case here for the respondent gave no consideration to the Government), an inquiry into the "how and why" of the receipt may show a common understanding between payer and payee which will identify the matter in respect of which the payment was received [24] . However no common understanding was demonstrated in the present case. As Beaumont J observed [25] :
In deciding to make the ex gratia payment, the Treasury could have been seen as acting so as to vindicate the public interest in ensuring that fair and liberal treatment is afforded to those citizens who participate in public inquiries. 1. Rowe (1995) 60 FCR 99 at 104 2. Federal Coke Co Pty Ltd v Federal Commissioner of Taxation (1977) 34 FLR 375 at 402 3. Rowe (1995) 60 FCR 99 at 108
It may be that the respondent could have taken legal action against the Council in respect of the invalid suspension of his employment. But that does not help to identify the character of the receipt in the hands of the respondent. Furthermore the payment by the Government did not place the respondent in the same position as an order for costs in his favour. Interest had been claimed and the respondent was not fully indemnified for the expenses he incurred.
We are in agreement with Burchett J in the Full Court when his Honour said [26] :
The payment was in no sense a reward for his services during his employment by the Council, which had long since been determined. It was a recognition of the wrong done to him, and also of the fact that he had been forced to shoulder the task of sharing in an Inquiry undertaken by the government for public purposes. The payment was not a remuneration, but a reparation. Of course, it was far from being a complete reparation, since he had had to bear the costs, which were reimbursed without interest in the currency of some years later. Viewed in this light, there was no error of law on the part of the Tribunal in concluding that the receipt was not of an income nature. Nor did the majority in the Full Court err in reaching that conclusion. 1. Rowe (1995) 60 FCR 99 at 114at 118-121, per Drummond J.
In the course of argument reference was made to some American authorities relating to the "tax benefit rule" in the United States, particularly as discussed by the Supreme Court in Hillsboro National Bank v Commissioner of Internal Revenue [27] . In their judgment Gaudron, Gummow and Kirby JJ have analysed the rule and we gladly adopt that analysis. But, as their Honours accept, the American authorities depend very much on statutory provisions rather than characterising receipts in terms of whether they fall within income as it is understood according to ordinary notions.
This appeal is brought from a decision of the Full Court of the Federal Court of Australia [28] . Special leave was granted by this Court on terms that the respondent have his costs in any event. The Full Court was exercising original jurisdiction conferred by s 44(3) of the Administrative Appeals Tribunal Act 1975 Cth (the AAT Act). By majority (Burchett and Drummond JJ, Beaumont J dissenting), the Full Court dismissed what s 44 styled an "appeal" by the Commissioner of Taxation (the Commissioner) from a decision of the Administrative Appeals Tribunal (the AAT). The AAT had allowed the objection by the respondent, Mr Rowe, to the assessment, in respect of the year ended 30 June 1989, of a sum of $24,748.24 as his assessable income within the meaning of the Income Tax Assessment Act 1936 Cth (the Act) [29] .
This sum had been received by Mr Rowe from the Government of Queensland in April 1989. Mr Rowe has been assessed on a receipts basis, and there is no dispute that this was the appropriate footing. He disclosed the receipt in his return but unsuccessfully sought a ruling from the Commissioner that it was received on capital account. Previously, in respect of the year ended 30 June 1986, Mr Rowe had claimed and received a deduction under s 51(1) of the Act of $24,727.99 as expenses incurred in procuring his legal representation at a certain inquiry conducted pursuant to the Local Government Act 1936 Q [30] . The 1989 payment was made pursuant to a decision of the Queensland Cabinet that an ex gratia payment be made to Mr Rowe of a sum equivalent to the costs he had incurred in the conduct of the inquiry.
In this Court the Commissioner submits that the Full Court erred in denying the existence of a general principle of law that an amount paid as compensation for or in reimbursement of a deductible expense is income within the ordinary concepts and usages of mankind. Before this Court there is no issue under s 26(e) of the Act as to whether the receipt in question was included in Mr Rowe's assessable income as a gratuity or benefit with the necessary connection with his employment by the Livingstone Shire Council (the Council). The formulation of the precise proposition for which the Commissioner does contend fluctuated somewhat in the course of argument. In its final form (assumed in the address in reply), the proposition is that where there is a finding of fact that a payment, whether made voluntarily or not, is made as a reimbursement of, or as reparation for, an amount deductible under s 51(1) of the Act, the amount of the payment is income. The making of this finding of fact is said to involve a review of all the circumstances including the intention of both parties.
In its earlier form, the submission was a narrower one. The contention then was that a payment made to reimburse or compensate for a deductible expense "ordinarily" takes its character from the nature of the expense and is of an income nature. Moreover, this was said to be so "in the absence of unusual circumstances", such as an intention to provide family benevolence or a particular provision of the Act dealing with payments of the nature in question. The practical and conceptual difficulties and uncertainties to which acceptance of this formulation would give rise, disclosed in the course of argument, may have led to the simpler but broader proposition for which the Commissioner finally argued.
The Commissioner accepts that certain passages in Allsop v Federal Commissioner of Taxation [31] and H R Sinclair & Son Pty Ltd v Federal Commissioner of Taxation [32] generally have been treated as deciding that the circumstance that a payment was received by a taxpayer by way of compensation for or reimbursement of an amount properly deductible as an expense on revenue account under s 51(1) of the Act does not determine the question whether the receipt is itself income for the purposes of the Act. However, as is apparent from the proposition for which the Commissioner here contends, this appeal is brought to challenge that understanding of the status quo.
For his part, Mr Rowe submits that whether or not a loss or outgoing is deductible under s 51(1) depends solely upon its relationship to the gaining or producing of the assessable income and that a receipt does not bear the character of assessable income simply by reason of its relationship with a deductible loss or outgoing.
The Commissioner submitted that even if his principal submission failed to gain acceptance, nevertheless the appeal should be allowed. This would be on the uncontroversial basis of the existing authorities relied upon by Beaumont J in his dissenting judgment in the Full Court. In our view, this appeal does ultimately turn upon those authorities and the conclusion reached by Beaumont J was correct.
Section 44(1) of the AAT Act authorised an appeal "on a question of law" from a decision of the AAT. The proceeding before the AAT had been conducted on a statement of agreed facts. Upon those facts the issue was whether the payment received by Mr Rowe answered the description of "income" within the meaning of the Act so as to be included in his assessable income for the year in question. Before the AAT and the Federal Court, that presented a question of law within the meaning of s 44(1) of the AAT Act [33] . In the light of the detailed consideration of legal principle which the submissions to this Court of both parties require, the contrary would be difficult to suggest. Further, what the law requires for classification as income varies from one field of legal discourse to another. Thus, the principles of the law of trusts by which the income of the trust estate is classified for the purposes of adjustment of the rights of life tenant and remainderman, are not necessarily the same in all respects as those by which there is identified the assessable and taxable income for the purposes of liability under the Act. This point was made by Dixon J in Tindal v Federal Commissioner of Taxation [34] .
Before turning to consideration of the principal submission of the Commissioner, it is appropriate to say a little more of the facts. Mr Rowe had been employed by the Council as shire engineer. On 19 June 1985 the Council, by resolution, suspended Mr Rowe from duty and required him to show cause why he should not be dismissed by reason of several complaints made against him. On 27 June 1985, the Governor in Council, pursuant to power vested by s 4(5) of the Local Government Act, intervened so as to rescind the resolution. On the next day, the Director of Local Government for the State of Queensland, acting pursuant to s 4A(3) of the statute and at the direction of the Minister for Local Government, Main Roads and Racing, established an inquiry into the matters the subject of the resolution suspending Mr Rowe. The inquiry was held in August 1985. Mr Rowe retained a solicitor and counsel to appear for him at the inquiry. In the report, Mr Rowe was cleared of any charges of misconduct or neglect. The Council had earlier reinstated Mr Rowe but later failed to accede to his request for reimbursement of his expenses. After representations were made on his behalf to the Queensland Government, the ex gratia payment to which we have referred was made.
In Allsop , the Commissioner had sought to include in the taxpayer's assessable income an undissected lump sum received by the taxpayer in settlement of claims against the Government of New South Wales. One such claim was to recover sums paid for certain permit fees said to have been wrongly exacted under colour of office. This Court held that the lump sum was not assessable in the hands of the taxpayer as neither the whole nor any part of it could be attributed solely to a refund of the permit fees. The case thus is not immediately in point. However, the Commissioner had sought to support the assessment on the general ground that, where a refund is made to a trader in one income year of an amount or part of an amount which the trader had expended on revenue account in an earlier year and which had been allowed as a deduction in assessing taxable income, the amount of the refund constitutes income in the later year and, therefore, assessable income within the meaning of s 25 of the Act. In their joint judgment, Barwick CJ and Taylor J said [35] :
Whether or not this proposition can be accepted without qualification is open to serious question. But since, in our opinion, the factual basis for such a conclusion does not exist in this case so that acceptance of the proposition would not be decisive and as in any case the point was not fully argued, it is inadvisable for us to express any view on the matter. 1. Allsop (1965) 113 CLR 341 at 350-351
The taxpayer in Sinclair carried on business as a timber-feller and sawmiller. It was obliged to make certain royalty payments to a body established under the Forests Act 1958 Vic. The taxpayer claimed and was allowed deductions for royalty payments but, in a subsequent year of income, received a refund of a proportion of those royalties. It was held that the amount of the refund formed part of the assessable income of the taxpayer in the year of receipt and that this outcome did not depend upon the allowance of the original payments as a deduction or upon the voluntary nature of the refund.
In the course of his judgment in Sinclair , Taylor J [36] identified the issue as whether the receipt of the sum in question was properly taken into account for the purpose of ascertaining the gross "proceeds" of the business conducted by the taxpayer in the year of receipt. His Honour continued [37] :
This question is a practical one and its answer cannot be made to depend upon what deductions were or were not allowed pursuant to the Income Tax and Social Services Contribution Assessment Act 1936 Cth in assessing the taxable income of the [taxpayer] and, ultimately, its liability to tax in past years. This, it seems to me, is quite beside the point in considering the question under review. The character of the amount which the [taxpayer] received cannot, in the absence of some appropriate statutory provision, be thought to vary according to whether or not deductions were claimed and allowed of expenditure which includes the sum now reimbursed. Owen J spoke to the same effect, saying [38] : [M]any of the arguments put to us by the counsel for the Commissioner seemed to suggest that because the earlier payments had been allowed as deductions since they had been made in gaining the company's assessable income in those years, it necessarily followed that the refund was to be treated as a receipt of income. This, I think, is not the right approach. The real question is whether the amount received by way of refund was part of the company's assessable income for the year in which it was received. 1. H R Sinclair (1966) 114 CLR 537 at 542. 2. H R Sinclair (1966) 114 CLR 537 at 542-543. 3. H R Sinclair (1966) 114 CLR 537 at 545.
There may, of course, as Taylor J indicated, be appropriate statutory provisions which produce the result that the character of a receipt by the taxpayer varies according to whether or not certain deductions were allowable. In argument on this appeal, reference was made to four sets of such provisions: (i) s 71 classifies as an allowable deduction a loss of or in respect of money included in the assessable income of a taxpayer where the loss is incurred through embezzlement or other misconduct by certain persons employed by the taxpayer; any amount received by the taxpayer by way of insurance, indemnity or other reimbursement in respect of whole or part of the loss that has been allowed or is allowable under s 71 is brought into the assessable income of the taxpayer by s 26(k); (ii) the amount of the excess of the value of trading stock on hand at the beginning of the year of income over the value of all trading stock on hand at the end of that year is an allowable deduction (s 28(3)) but, in the circumstances identified in s 36(1), the value of trading stock on disposal not in the ordinary course of carrying on the taxpayer's business shall be included in the assessable income of the taxpayer; (iii) s 59 deals with the disposal, loss or destruction of depreciated property by allowing a deduction in respect of the excess of the depreciated value over the amount of any consideration receivable in respect of the disposal, loss or destruction (s 59(1)) and, if that consideration exceeds the depreciated value, by including in the assessable income that excess, to the extent of the sum of the amounts allowed and allowable in respect of depreciation (s 59(2)); (iv) s 63(1) provides for allowable deductions in respect of certain bad debts which are written off as such during the year of income, whilst s 63(3) brings into the assessable income an amount received in respect of a debt for which a deduction has been allowed to the taxpayer.
The pattern in these sets of provisions of reflecting in the assessable income receipts related to allowable deductions provides no safe guide as to any particular proposition as to the relationship between the general provisions of s 51(1) and s 25(1). Rather, each set of provisions represents a specific regime which has been created to deal with certain classes of case independently of what otherwise would be the operation of and interaction between s 51(1) and s 25(1).
Thus, debts which cannot be written off so as to attract s 63(1) may, in the particular circumstances of the case, nevertheless be written off so as to attract s 51(1) [39] . Again, s 51 may operate so as to allow deductions in respect of defalcations where none would be available under s 71 [40] . Further, apart from the trading stock provisions, the profit on the realisation of trading stock, for the purposes of winding up a business, would in most cases be a capital accretion; in the case of trading stock to which s 36 applies, such an accretion is converted into a gain on revenue account [41] . Finally, the subject of s 59 is to determine the place which should be given, in the ascertainment of taxable income, to an excess or deficiency in the real value of an asset upon which depreciation has been allowed when the taxpayer disposes of it or it is lost or destroyed [42] .
Whilst acknowledging the significance of Allsop and Sinclair , the Commissioner sought to support his case by reference to certain other strands of existing authority in this Court which were said to be consistent with and indicative of the general proposition for which he contended. He also relied, by analogy, upon the "tax benefit rule" adopted in the United States. Finally, it was said to be fundamentally wrong that taxpayers who are not in business may gain the benefit of a deduction without the obligation to bring in the amount of a refund of that outgoing. The inequity that may be involved may be conceded, but, of itself, that does not explain why the refund has the character of income according to the ordinary concepts and usages of mankind.
Before referring to the Australian authorities, it is convenient to consider the "tax benefit rule".
The Sixteenth Amendment to the Constitution of the United States, ratified in 1913, provides:
The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration. The Internal Revenue Code [43] contains a broadly expressed definition of gross income as meaning "all income from whatever source derived". In an earlier form [44] , the definition spoke of "gains or profits and income derived from any source whatever". The Supreme Court held in Commissioner of Internal Revenue v Glenshaw Glass Co [45] that such terms had been used by Congress to exert "the full measure of its taxing power". 1. 26 USC s61(a). 2. Internal Revenue Code 1939, s22(a). 3. (1955) 348 US 426 at 429.
The provenance and nature of the "tax benefit rule" has been described as follows [46] :
Originally, the tax benefit rule generally provided that if an amount deducted in one year was recovered in a later year, the recovery constituted income in the subsequent year. Congress modified the rule to provide that if the earlier deduction did not reduce income tax liability, the taxpayer could exclude the later recovery of the item from income. The general rule is commonly called the rule of inclusion, and the statutory modification is commonly called the rule of exclusion. Together, they constitute the tax benefit rule. It appears that the rule of inclusion originated in rulings by the Bureau of Internal Revenue that the recovery of a previously deducted debt constituted income if the earlier deduction had caused a reduction in taxable income. The rulings were applied and extended by court decisions. The statutory modification referred to above, with the introduction of the rule of exclusion, is predicated upon the validity of the rule of inclusion [47] . The statutory rule of exclusion is now expressed in the following terms in the Internal Revenue Code [48] :
(a) Deductions - Gross income does not include income attributable to the recovery during the taxable year of any amount deducted in any prior taxable year to the extent such amount did not reduce the amount of tax imposed by this chapter.
One end assisted by the tax benefit rule has been the accommodation of the annual accounting system applied by the Revenue to multi-year transactions. In the Opinion of the Court in Hillsboro National Bank v Commissioner of Internal Revenue [49] it was said that the basic purpose of the tax benefit rule is the achievement of "rough transactional parity in tax" and the protection of the Revenue and the taxpayer from the adverse effects of reporting a transaction on the basis of assumptions that an event in a subsequent year proves to have been erroneous. In its original form, the administrative rulings which first propounded the rule of inclusion required the taxpayer to file an amended return upon recovery of an amount related to an earlier deduction rather than to recognise a refund as income in the year of recovery [50] . In his dissenting judgment in Hillsboro [51] Blackmun J indicated that the tax benefit rule may have been developed both because the statute of limitations could have precluded adjustment in respect of the earlier year of income, and to preserve "the integrity of the annual tax return", itself the product of the annual accounting system.
As the tax benefit rule has been developed in the United States it has acquired characteristics indicative of a greater sophistication than that apparent in the broad proposition as to the operation of the Act for which the Commissioner contends before this Court. United States developments are detailed in the considerable body of academic writing to which we were referred [52] .
For example, the rule, even allowing for the operation of s 111, is not a precise way of dealing with the inequities which result from the annual accounting system. Section 111 deals only partly with the consequences of a change in tax rates between the two years in question [53] . Secondly, the rule appears to apply if a taxpayer properly uses an item in the computation of federal income tax in one year, whether as an exclusion, deduction or credit, and if relevant events occur in a subsequent tax year. This is on the footing that exclusions and credits as well as deductions may produce tax benefits [54] . Thirdly, the tax benefit rule applies not only to payments made as a reimbursement of or as reparation for an amount which has been deducted, but also to situations involving increments to net worth, for example where a taxpayer terminates a previously deducted accrued liability [55] . In addition, the proposition for which the Commissioner contends would not provide for the exclusionary aspect of the rule, given statutory force by the Congress in the manner described above.
Finally, there is the impact of the Hillsboro decision. The Supreme Court decided that the tax benefit rule cancelled the earlier deduction only when the later event was "fundamentally inconsistent" with that deduction; it was necessary to the operation of the rule that the subsequent event would have foreclosed the deduction if that event and the deduction had occurred in the same tax year. In the Opinion of the Court it said [56] :
The basic purpose of the tax benefit rule is to achieve rough transactional parity in tax and to protect the Government and the taxpayer from the adverse effects of reporting a transaction on the basis of assumptions that an event in a subsequent year proves to have been erroneous. Such an event, unforeseen at the time of an earlier deduction, may in many cases require the application of the tax benefit rule. We do not, however, agree that this consequence invariably follows. Not every unforeseen event will require the taxpayer to report income in the amount of his earlier deduction. On the contrary, the tax benefit rule will "cancel out" an earlier deduction only when a careful examination shows that the later event is indeed fundamentally inconsistent with the premise on which the deduction was initially based. That is, if that event had occurred within the same taxable year, it would have foreclosed the deduction. In some cases, a subsequent recovery by the taxpayer will be the only event that would be fundamentally inconsistent with the provision granting the deduction. In such a case, only actual recovery by the taxpayer would justify application of the tax benefit rule. On the other hand, Stevens J [57] saw the rule as a theory that appropriately characterised certain recoveries of capital as income; whilst the rule helps to accommodate the annual accounting system to multi-year transactions, it does not approximate a transactional accounting system because of the fabrication of income at the drop of a fundamentally inconsistent event. Moreover, as will readily be apparent, on the theory adopted in the Opinion of the Court there is much room for debate as to the particular application of the criterion of "fundamentally inconsistent event". 1. Hillsboro (1983) 460 US 370 at 383-384(footnotes omitted). 2. Hillsboro (1983) 460 US 370 at 403-404, 416-420.
It follows from the above that (i) the tax benefit rule appears to evolve from particular circumstances attending the operation of the United States federal income tax law, particularly with respect to amendment of assessments; (ii) it was found necessary to balance the inclusionary branch of the rule by the exclusionary branch, the latter achieving specific statutory recognition; (iii) as now developed, the rule has an operation by no means on all fours with that which might be expected of the principle propounded by the Commissioner; and (iv) the doctrinal foundation of the rule remains a matter of dispute in the United States Supreme Court.
In our view, when so understood, the tax benefit rule provides too imperfect an analogy to support the proposition for which the Commissioner contends.
The Commissioner relied upon certain Australian authorities for two related propositions. The first is that, if a "defeasible" liability be incurred in a particular year of income in respect of a deductible expense, the amount of the liability will be allowed in that year notwithstanding the possibility that the liability may later be extinguished, in whole or part. The second is that, if that possibility comes to pass in a later year of income, the necessary adjustment is to be made by inclusion of the amount of the reduction in the taxable income for that later year. If it transpires that the quantum of the liability is greater, then the adjustment is made by way of further deduction in calculating the taxable income for that later year. The authorities include passages in the judgments of Dixon J in Armco (Australia) Pty Ltd v Federal Commissioner of Taxation [58] , Fullagar J in Caltex Ltd v Federal Commissioner of Taxation [59] , Gibbs J in International Nickel Australia Ltd v Federal Commissioner of Taxation [60] , Gibbs CJ in Avco Financial Services Ltd v Federal Commissioner of Taxation [61] , and in the joint judgment of the Federal Court in Federal Commissioner of Taxation v Raymor (NSW) Pty Ltd [62] .
Those passages are concerned with the position of traders carrying on a continuing business and reflect a certain tension between the operation of the Act upon discrete years of income rather than upon what might be described as a transaction basis, and the making of assessments upon an accruals rather than a receipts basis. The propositions which they support are to be understood with this in mind. The existence of those propositions as a species does not provide any necessary support for the existence of a genus with the broad characteristics identified in the principle for which the Commissioner contends.
The same may also be said of the reasoning in authorities such as Federal Commissioner of Taxation v Dixon [63] and Carapark Holdings Ltd v Federal Commissioner of Taxation [64] . In Dixon , an employer had undertaken (in 1939) to make up to any of its employees who should enlist in the armed forces the difference between the amount of salary as an employee at the time of enlistment and the pay received as a member of the defence forces. This Court held that those differential sums formed part of the assessable income of the taxpayer, an employee who had so enlisted. Fullagar J said [65] :
What is paid is not salary or remuneration, and it is not paid in respect of or in relation to any employment of the recipient. But it is intended to be, and is in fact, a substitute for - the equivalent pro tanto of - the salary or wages which would have been earned and paid if the enlistment had not taken place. As such, it must be income, even though it is paid voluntarily and there is not even a moral obligation to continue making the payments. It acquires the character of that for which it is substituted and that to which it is added. In the joint judgment in Carapark [66] it was said: [I]n general, insurance moneys are to be considered as received on revenue account where the purpose of the insurance was to fill the place of a revenue receipt which the event insured against has prevented from arising, or of any outgoing which has been incurred on revenue account in consequence of the event insured against, whether as a legal liability or as a gratuitous payment actuated only by considerations of morality or expediency. 1. (1952) 86 CLR 540. 2. (1967) 115 CLR 653. 3. Dixon (1952) 86 CLR 540 at 568 4. (1967) 115 CLR 653 at 663, per Kitto, Taylor and Owen JJ.
In the circumstances of the present case, the payment received by Mr Rowe from the Queensland Government may be seen as "filling the place" of the outgoing for legal expenses incurred on revenue account. It was designed to that end by the payer in response to representations which had been made for the payee. Nevertheless, the payment, unlike those in situations with which Carapark was concerned, was not to fill a "hole" or an outgoing causing a "hole" in revenue or profits of a business conducted by the taxpayer. Nor did it have the quality of periodicity as was the case in Dixon .
Taken together, all these considerations confirm the understanding that, in characterising a receipt in the hands of the taxpayer as one on revenue account, the circumstances of the particular case may be such that various factors are important and, individually or collectively, decisive. These may include periodicity, substitution for what would have been a revenue receipt, return of an outgoing, payment for or in connection with the provision of services, the performance of employment, the engagement in business or other sufficient connection with any revenue producing activity carried on by the taxpayer.
To a significant degree the operation of the Act turns upon the identification of income by the imprecise criterion of the ordinary concepts and usages of mankind. Whilst that state of affairs remains, it is not to be expected that there will be the symmetry between s 25(1) and s 51(1) for which the Commissioner contends with the proposition that a payment is income in the hands of the recipient if, whether made voluntarily or not, it is a reimbursement of or a reparation for an amount allowable as a deduction under s 51(1).
The lack of symmetry, if that be the correct description, between s 25(1) and s 51(1) is illustrated by the well-established proposition that a receipt may be income in the hands of a payee whether or not it is an expenditure of a capital nature by the payer [67] . The lack of a determinative nexus between the two provisions is emphasised in the passage from the judgment of Taylor J in Sinclair set out earlier in these reasons.
An amount is not an allowable deduction merely because of an overstatement of income in a preceding year [68] . Nor is a receipt income simply because of the previous allowance of a deduction, for which outgoing the receipt is recompense. The answer from the point of view of the revenue may be in amendment of the earlier assessment. But, in each case, the question whether such a course was open would have to be answered by reference to the specific provisions of the Act relating to amendments.
In a case such as the present, it is necessary to look at what Dixon CJ and Williams J identified in Dixon as "the total situation of the taxpayer" [69] . The proper inquiry is that indicated by Kitto J in Squatting Investment Co Ltd v Federal Commissioner of Taxation [70] where his Honour said:
The question whether a receipt comes in as income must always depend for its answer upon a consideration of the whole of the circumstances; and even in respect of a true gift it is necessary to inquire how and why it came about that the gift was made. When, as in the present case, the word "gift", if it is to be used at all, must be used by way of imperfect analogy, it is specially important to recognise how inconclusive is that word for the purpose of deciding whether the receipt is of an income nature. The inquiry into the "how and why" of such a receipt, including any common understanding between the payer and the payee, may reveal the matter in respect of which the gratuitous payment is received [71] . Thus, in our view, the necessity to inquire how and why it came about that the ex gratia payment was made to Mr Rowe involves more than the characterisation of the payment as a receipt which was the return of an outgoing to which s 51(1) had applied. 1. Dixon (1952) 86 CLR 540 at 555 2. (1953) 86 CLR 570 at 627-628. 3. Federal Coke Co Pty Ltd v Federal Commissioner of Taxation (1977) 34 FLR 375 at 402
It was by application of what is to be regarded as previously settled principle in this area that, in his dissenting judgment in the Full Federal Court, Beaumont J concluded that the AAT had erred in law in allowing the objection by Mr Rowe and that in place of the decision of the AAT, the Commissioner's decision disallowing Mr Rowe's objection should be confirmed.
His Honour said, in a passage with which we agree [72] :
[T]he inquiry was initiated by the Central Government of the State, and it had the ultimate statutory control over, and responsibility for, Local Government. Although it was the Council which appointed the respondent as its engineer, the State Government also had a real interest in the effective performance of his duties as an important administrative aspect of efficient Local Government in the area. To this extent, the State Government was no "mere" donor or a disinterested spectator. On the contrary, it had a proper concern to ensure that the administration of the public affairs of the region, at the level of local government, were efficiently carried out. The functions of the Shire Engineer were an important aspect of this. 1. Rowe (1995) 60 FCR 99 at 110-111
Section 4A of the Local Government Act provided for the appointment by the Governor in Council of a Director of Local Government for the State of Queensland (the Director) (sub-s (1)) and charged him "subject to the Minister" with the administration of that Act (sub-s (2)). Section 4A(3) was in the following terms:
(i) The Director may make or cause to be made such inspections, investigations, and inquiries as he thinks fit in relation to any matter respecting the administration of this Act, and shall make or cause to be made such inspections, investigations, and inquiries as are directed by the Minister.
(ii) When any inspection, investigation, or inquiry is made by the Director he shall for the purposes of making such inspection, investigation, or inquiry, have and may exercise all the powers, authorities, protection, and jurisdiction of a commission under " The Official Inquiries Evidence Acts, 1910 to 1929 ", and may enter and inspect any building, premises, or place the entry or inspection whereof appears to be requisite for the purposes of such inspection, investigation, or inquiry.
(iii) When any inspection, investigation, or inquiry is directed to be made by the Minister or the Director the person directed to make the same shall for the purposes of making such inspection, investigation, or inquiry have and may exercise all the powers, authorities, protection, and jurisdiction conferred upon the Director by this subsection.
(iv) When the Minister has directed an inspection, investigation, or inquiry the Director shall as soon as possible furnish a full report of such inspection, investigation, or inquiry to the Minister.
(v) The person so directed by the Director to make any inspection, investigation, or inquiry shall as soon as practicable furnish a full report of such inspection, investigation, or inquiry to the Director.
It was pursuant to this provision that the Director, at the direction of the Minister for Local Government, Main Roads and Racing, directed a member of the Queensland Bar and a professional engineer to inquire into matters recorded in the minutes of the meeting of the Council held on 19 June 1985. A resolution passed by the Council on that date was the basis by which Mr Rowe was suspended from employment as shire engineer. This inquiry was established, as indicated earlier in these reasons, the day following the rescission of the resolution pursuant to the power conferred by s 4(5) of the Local Government Act. This provided that the Governor in Council may at any time suspend or rescind any resolution or order of a Local Authority. On the day the inquiry was established, 28 June, the Council wrote to Mr Rowe informing him that the resolution had been rescinded and stating that he was required "to resume [his] normal duties as from Monday 1st July, 1985". The payment enclosed with the letter of the Treasurer to Mr Rowe of 26 April 1989 followed the supply to the Treasury of a statement of Mr Rowe's costs formulated on the same basis as would be provided to a Court Taxing Officer. This was in response to a letter from the Treasurer to Mr Rowe of 6 March 1989.
In acting as it did, the State may be taken to have borne in mind comments made in the report furnished to the Director pursuant to s 4A(3)(v) of the Local Government Act. This read in part:
It is obvious that this Inquiry has cleared Mr Rowe of any charges of misconduct or neglect. We, of course, have no power whatsoever to award costs to him who might well be characterised as the "successful party", but, in the present matter, Mr Rowe has in reality been compelled to engage a solicitor and counsel to defend himself against dismissal. The length of the proceedings has been dictated by the ill-defined numerous complaints made against him. It was then pointed out that, with reference to the course taken in Sullivan v Casino Municipal Council [73] , had the resolution of suspension of Mr Rowe of 19 June 1985 not been rescinded by the Governor in Council, there would have been open to Mr Rowe the avenue of litigation in the Supreme Court of Queensland, seeking injunctive and declarative relief. In that event he could have expected to recover his costs by court order. 1. [1973] 2 NSWLR 708.
Mr Rowe was not employed by the State of Queensland. His direct relationship was with the Council. Nevertheless, the incidents of that relationship were not merely those arising from a contract between employer and employee. As Jacobs J explained in Howes v Gosford Shire Council [74] , with reference to the position under the Local Government Act 1919 NSW of the shire clerk of the defendant council, in such cases the effect of the legislation may be to give to a person such as Mr Rowe a special right or interest to continue in service until validly suspended or dismissed. In the present case, it was the Governor in Council, in exercise of statutory power, who rescinded the resolution suspending Mr Rowe, thereby leading to his resumption of normal duties and it was the Director, acting pursuant to a statutory direction by the responsible Minister, who set up the inquiry which cleared Mr Rowe of any charges of misconduct or neglect.
The payment by the State to Mr Rowe was not fortuitous in the manner of an act of benevolence by one family member to another. The legal regime which underpinned the discharge of his duties as shire engineer was one for which the Executive Government of the State, pursuant to State legislation, provided important and essential integers. The payment by the State was "really incidental" to Mr Rowe's employment and, that being so, it was not determinative of the character of the receipt that it came from a party other than the Council [75] .
Moreover, it is apparent that the "common understanding" of the State and of Mr Rowe (within the meaning of Federal Coke Co Pty Ltd v Federal Commissioner of Taxation [76] ) was that the payment would put him in the same position as if, rather than his employment having been protected by the statutory steps and procedures taken or initiated by the Executive Government, Mr Rowe had resorted to litigation against the Council to restrain his invalid suspension.
Further, in respect of the expenses which had been incurred, Mr Rowe had sought and obtained a deduction in a previous year of income and the practical effect of the payment by the State was to recoup that expenditure.
Upon a consideration of the whole of the circumstances, the payment by the State gave rise to an income receipt in the hands of Mr Rowe.
The appeal should be allowed. The order of the Full Court of the Federal Court, in so far as it dismissed the appeal by the Commissioner to that Court, should be set aside. In place thereof there should be orders (i) setting aside the decision of the AAT dated 22 August 1994 which set aside the objection decision under review and allowed in full Mr Rowe's objection to the Notice of Assessment issued 5 August 1991; and (ii) disallowing in full that objection. The dismissal of the appeal to the Federal Court carried with it an order for costs in favour of Mr Rowe. This Court was informed that the Commissioner has agreed to pay the costs of Mr Rowe in any event, both in this Court and the Full Court. Accordingly, the Full Court costs order should not be disturbed and there should be no order against Mr Rowe in this Court.
Commissioner of Taxation (Cth)
Rowe
(1995) 60 FCR 99
(1966) 114 CLR 537
(1965) 113 CLR 341
(1952) 86 CLR 540
(1987) 163 CLR 199
(1967) 115 CLR 653
(1990) 170 CLR 124
(1953) 86 CLR 570
(1966) 117 CLR 514
(1951) 84 CLR 105
(1977) 34 FLR 375
(1956) 96 CLR 47
(1971) 124 CLR 343
(1980) 144 CLR 1
(1989) 24 FCR 53
(1991) 29 FCR 177
(1946) 72 CLR 608
(1975) 132 CLR 175
(1961) 106 CLR 448
(1956) 95 CLR 344
(1958) 98 CLR 187
(1990) 24 FCR 90
(1951) 84 CLR 118
(1948) 76 CLR 584
(1960) 106 CLR 205
(1977) 137 CLR 347
(1982) 150 CLR 510
(1968) 117 CLR 162