Egerton-Warburton v Deputy Federal Commissioner of Taxation [1934] HCA 40

Egerton-Warburton v Deputy Federal Commissioner of Taxation [1934] HCA 40 - HCA 1934 case summary — Zoe

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thing to hold that the sums paid are expended wholly or exclusively for the production of assessable income. The contention that they are so expended is founded upon the circumstances that the annuity is charged upon the land used to earn the assessable income, that the charge was incurred as a condition attending the acquisition of the land, and that various provisions of the charge resulted in its being virtually compulsory to use the land for farming or orcharding. Any default in the payment of the annuity or in the observance of the conditions of the charge would entitle the father to enter into possession of the land, to receive the rents thereof, and to assume and to continue the management thereof to the exclusion of the sons. These circumstances are relied upon as showing that the annuity is a charge incurred in order to enable the sons to obtain possession of the land for the purpose of earning assessable income therefrom, and paid in order to enable them to retain such possession for that purpose. In Moffatt v. Webb (1), this Court held that the liability of a grazier to Federal land tax gave rise to an outgoing wholly and exclusively laid out and expended for his trade as a grazier. The reason for this decision is expressed in the judgment of Isaacs J., as he then was, in the statement that the use of the land involved the use of an instrument to which is attached by law a compulsory payment. "It seems to me," he said, " to follow naturally that the payment made under compulsion of law in respect of that necessary element of the business income is an outgoing made in the production of the income, and in the circumstances here it was made wholly and exclusively for the taxpayer's business " (2). In the present case, the obligation to pay the annuity is not attached to the land by the general law, but by the convention of the parties. It is a condition of the acquisition of the land upon which the business is carried on. The nature of the business demands the use of land, but payment of an annuity is not a necessary incident of carrying on the business. Without the land, however, the taxpayers could not carry on the business, and to acquire the land they found it necessary to submit to the liability to pay the annuity. Unlike the British Income Tax Act, the Commonwealth Income Tax Assessment Act includes in the assessable income arising from personal exertion the entire

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revenue derived from the operations conducted upon the land, without deducting or excluding therefrom any amount to represent the annual value of the land considered as the notional income from the property forming part of the undertaking. Under the British Income Tax Act 1918, except in the case of a farmer who elects to be taxed under Schedule B upon the annual value of lands occupied solely or mainly for husbandry, a clear distinction is drawn in the case of a business conducted upon land by the owner between the profits and gains in the trade or business and the taxable enjoyment of the land. Under Schedule A he is taxed on the annual value of the land. Under Schedule D, by which he is taxed on the balance of profits or gains of the trade or business, in ascertaining those profits a deduction is made of the annual value of the land. Rule 3 of the Rules applicable to Schedule D provides that, in computing the amount of profits or gains to be charged, no sum shall be deducted in respect of any disbursements or expenses not being money wholly and exclusively laid out or expended for the purposes of the trade. Sec. 25 (e) of the Commonwealth Act is derived from this provision. Under such a scheme it is evident that in considering whether an outgoing is deductible, it is important to distinguish between expenses incurred because the trade is carried on, and expenses that are incurred as a result of the ownership or occupation of the land upon which it is carried on. An expense arising out of the occupation of the land used in the business may be attributable, not to the use of the land in the business, but to its character as property or to the nature of the owner's title. However necessary the land may be for the business, such an expense could not be deducted from the profits of the business in addition to the annual value of the land. It is an expense which the owner must incur in order to provide the land for the purpose of his business, and thus obtain the deduction of its annual value from his trade profits. It has, so to speak, been already deducted in the annual value which may be regarded as containing it. In O'Shea v. Commissioner of Taxes (Vict.) (1), it was held that under the Victorian Income Tax Act 1915, in conse- quence of the special provisions of sec. 19 (2) (k), the owner of land who derived profits from a business which he conducted thereon was

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would not be consistent with the scheme of the Income Tax Acts to admit any deduction from the profits of a business higher than that regarded as the fair annual value or cost of the business premises to a person desiring to carry on business upon them. But the annual value of business premises has always been held a proper allowance in the nature of a disbursement or expense which must be deducted in ascertaining the balance of profits of a trade conducted thereon (Russell v. Town and County Bank (1), per Lord Herschell ; Stevens v. E. Boustead (2)). "A trader who utilizes, for the purposes of his trade, something belonging to him, be it chattel or real property, which he could otherwise let for money, seems to me to put himself to an expense for the purposes of his trade. Equally he does so if he hires or rents for that purpose property belonging to another. The amount of his expense is prima facie what he could have got for it by letting it in the one case, and what he pays for it when hiring it in the other. Where he gets something back for it, while employ- ing it in his trade, by receiving rent or hire for it in connection with that trade, the true amount of his expense can only be arrived at by giving credit for such receipt" (per Lord Sumner, Usher's Wiltshire Brewery Ltd. v. Bruce (3)). It is thus fully recognized that revenue loss or expenditure suffered by a taxpayer through appropriating land to the purposes of trade is a proper allowance against trade profits, but that a sum having been allowed as a deduction must be taxed as notional income from property. In the Commonwealth Act this discrimination is not adopted, but somewhat unfortunately, perhaps, the provision forbidding a deduction of sums not wholly laid out or expended for the purpose of the trade has been adopted with no greater modification than the substitution for the reference to trade of the words "for the production of assessable income." This provision must be applied to income from property as well as income from personal exertion. In the case of income from property, it is difficult to suppose that an obligation to pay an annual charge incurred as a necessary condition of acquiring the property does not amount to a deductible expenditure as money laid out for the pro- duction of assessable income. Such a case differs from that of

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Federal Commissioner of Taxation v. Munro (1), which was decided upon the ground that the obligation to pay the mortgage interest was incurred for a purpose quite unconnected with the income producing character of the land or the production of income at all. Isaacs J., as he then was, said (at p. 197) : - '' The taxpayer had already acquired and held his property as a rent-producing property to the full extent. Nothing more was necessary to gain or produce that income. Then he chose for his own purposes quite alien to that property to borrow money and incur a personal obligation to repay it with interest. So far, also, the property stood complete as arent-producing instrument. But because he secured his personal debt by means of that complete rent-producing instrument he contends that the discharge of the obligation was ' actually incurred in gaining or producing ' the rentals it yielded. The simple position is that the property and its rentals existed before the loan and remained intact and unaltered after the loan. Had the money borrowed been expended on the property so as to increase the rentals or so as to prevent depreciation which would have reduced the rentals, then it could have been properly said that the interest had been a means of gaining or producing the assessable income." The distinction was expressed by him in a sentence, " In short, the interest paid to the bank was not paid to create any of the assessable income in question: it was incurred because, among other things, that income was in a manner of speaking already in existence " (Cf. per Henchman J., Re Income Tax Acts 1924-1926 (No. 1) (2)). In such a case as the present, the land is a necessary implement for the production of income, and an expenditure, not being an outgoing of capital, which the taxpayer incurs in order to obtain the implement, seems naturally to fall under the description of money laid out for the production of income. So far as the taxpayer is concerned it is an expenditure incurred to create his assessable income. The caution required in using English authorities in the application of sec. 25 (e) has been pointed out more than once (see Federal Commissioner of Taxation v. Gordon (3); Herald & Weekly Times Ltd. y. Federal Commissioner of Taxation (4) ). But the reasoning which they contain when applied

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Judgment (91 paragraphs)