Foxwood (Tolga) Pty Ltd v Commissioner of Taxation [1980] FCA 38

Federal Court of Australia|1980-03-28|Before: Davies JJ, Deane J

Appeal - Deduction - Whether payment by Taxpayer to Purchaser of its business in respect of accrued entitlement of employees for long service leave and annual holiday entitlement is an outgoing of revenue - Characterization of outgoing - Liability

of Taxpayer to make the payments in question - Object or

FOXWOOD (TOLGA) PTY. LIMITED v. THE COMMISSIONER OF TAXATION

Appellant AND: THE COMMISSIONER OF TAXATION FOR THE COMMONWEALTH OF AUSTRALIA Respondent Oo R DER JUDGES MAKING ORDER: Deane. Fisher and Davies JJ. DATE OF ORDER: 28 March, 1980.

The order of the Supreme Court of Queensland is set aside

THAT the Appeal be allowed in relation to the Appellant's claim to deduct from its assessable income for the year ended 30 June 1976 the sum of $5,984 being that part of the payment on 30 June, 1976 which related to holiday pay and that the Taxpayer's assessment in respect of that amount be remitted to the Respondent Commissioner to be amended by allowing a deduction in that amount.

THAT the Respondent pay the Appellant one half of its

costs of the appeal and of the proceedings in the Supreme Court

NEW SOUTH WALES DISTRICT REGISTRY NO. Qld. G12 of 1978

AND: THE COMMISSIONER OF TAXATION FOR THE COMMONWEALTH OF AUSTRALIA

DEANE J: This is an appeal from a decision of the Supreme Court of Queensland upholding the disallowance by the respondent Commissioner of Taxation of a deduction claimed by the appellant Foxwood (Tolga) Pty. Limited ("the taxpayer") in the assessment of

its taxable income for the year ended 30 June, 1976.

The taxpayer was, at relevant times, a subsidiary of Foxwood Limited ("Foxwood"). During the tax year, the taxpayer

employed a work-force of some 17 employees. For a fee, it made

the services of these employees available to Foxwood (Mareeba) Pty. Limited which was also a subsidiary of Foxwood and which carried on a sawmilling operation at Mareeba in northern Queensland. Apart from the fees received from Foxwood (Mareeba) Pty. Limited, the taxpayer's only income consisted of bonuses payable under worker's compensation policies and interest on

On 29 June, 1976, the taxpayer entered into an agreement with Foxwood whereby it agreed to sell to Foxwood, with effect from 30 June, 1976 and subject to an irrelevant exception of any shares in related companies, all its undertaking and business. The agreement provided, in effect, that the purchase price of pliant would be the depreciated value for income tax purposes at 30 June, 1976 as determined by Messrs. C.E. Smith & Co., and that the purchase price of the balance of the business and undertaking would be "as determined" by that firm. Clauses 24 and 25 of the

"24. The Purchaser shall take over and assume the whole of the liabilities of the vendor as at 30th June, 1976 and indemnify and save harmless the Vendor from and against the same.

The Purchaser shall take over all the Vendor's employees in the Vendor's business on the 30th June, 1976 and on and from that date the Purchaser shall be liable to make holiday, sick leave and long service leave payments accruing or owing before or after that date provided that the Vendor shall pay to the Purchaser on the 30th June, 1976 an appropriate amount as shall be determined by C.E. Smith & Co. as the employees' accrued

entitlement for long service leave and holiday sick pay".

The evidence does not disclose what, if any, price was determined by Messrs. C.E. Smith & Co., who were at the time the Foxwood Groups accountants, as the purchase price either for plant or for the balance of the business and undertaking. It does however disclose that Messrs. C.E. Smith & Co., determined that the appropriate amount to be paid by the taxpayer to Foxwood in respect of "accrued entitlement" of employees "for long service leave and holiday and sick pay" was $11,658.78. This amount was paid by the taxpayer to Foxwood on 30 June, 1976. The taxpayer claimed, and the Commissioner disallowed, $8,897.00 thereof as a deduction in the determination of the taxpayer's income for the tax year. The amount so claimed and disallowed represented the total of the amounts which the taxpayer would have been obliged to pay to employees in respect of long service leave ($2,913) and annual holiday ($5984) entitlement if their employment had simply terminated on 30 June, 1976. The issue between the taxpayer and the respondent Commissioner of Taxation concerns the taxpayer's entitlement to the benefit of that claimed deduction. That entitlement is governed by the provisions of s.51(1) of the Income

Tax Assessment Act, 1936, and depends upon whether the relevant

part of the overall payment was, for the purposes of that sub-section, an outgoing which was incurred in gaining or producing assessable income or which was necessarily incurred in carrying on a business for the purpose of gaining or producing

such income and which, in either case, was not an outgoing of

It is apparent from the evidence that all concerned acted on the basis that the taxpayer's employees were "taken over" by Foxwood on 30 June, 1976 and that the "taking over" of the employees did not interrupt their continuity of service for the purposes of long service leave and annual holiday entitlement. This assumed situation differed from the strict juristic position in two significant respects. The first was that the employees' employment with the taxpayer in fact continued beyond 30 June, 1976. The evidence indicates that the employees were first told of the change of employer when they received a notice advising them of it in their pay packets on 9 July, 1976 and it is difficult to see how their employment with the taxpayer could have

ceased and their employment with Foxwood could have commenced before that date. The second was that while the statutory provisions regulating the employees' entitlement to long service leave provided for continuity of service in a case where "the calling carried on by a person who is an employer" was

"transmitted to another person" (Industrial Conciliation &

Arbitration Act (Q1d) 1961, s.17(16)(a)), the Awards which

regulated their entitlement to annual holidays contained no such

provision. When the employees ceased to be employed by the taxpayer, the taxpayer was, under the terms of those Awards, obliged to pay to them the full amount of their accrued entitlement in respect of annual holidays. Notwithstanding these differences, the plain facts remain that the services of the

employees were, for all relevant purposes, treated as having been

transferred to Foxwood on 30 June, 1976 and that, for all practical purposes, Foxwood assumed, and the taxpayer was relieved of, any burden in respect of long service leave and annual holidays arising by reference to service of employees either before or after the commencement of that day. The employees for their part would appear to have accepted without question the position as seen by the taxpayer and Foxwood. Whatever may have been the correct position on 'juristic analysis, they apparently accepted assurances given to them on 9 July, 1976 that the change in the identity of their employer had occurred on 30 June, 1976 and that that change did not affect their continuity of service as

regards either annual holidays or long service leave.

The taxpayer's entitlement to the claimed deduction falls to be determined by analysis of the object which the taxpayer, as the person making the expenditure, had in view (W.

Neville & Co. Ltd. v. Federal Commissioner of Taxation (1937) 56

C.L.R. 290 at 301). At the heart of that analysis lies the identification of what the expenditure was "calculated to effect from a practical and business point of view, rather than ... the juristic classification of the legal rights, if any, secured, employed or exhausted in the process" (per Dixon C.J., Hallstrom

Pty. Limited v. Federal Commissioner of Taxation (1946) 72 C.L.R.

634 at p. 648; B.P. Australia Limited v. Federal Commissioner of

Taxation [1966] A.C. 224 at p. 264; Federal Commissioner of

Taxation v. South Australian Battery Makers Pty. Ltd. (1978) 78

A.T.C. 4412 at pp. 4419, 4420-1, 4424, 4427; Cliffs International

Inc. v. Federal Commissioner of Taxation [1979] A.T.C. 4059 at pp.

4069, 4076, 4077 and 4078). This is not to say that the identification or juristic classification of precise legal rights will not be relevant to the determination of the question whether a particular payment satisfies the requisite description or, in a case where precise legal rights are all that were sought and obtained, conceivably conclusive of it. What the quotation recognizes is that it has long been accepted in this country that the courts in characterizing outgoings in fact incurred in a business or commercial context are both entitled and constrained to look at the business and commercial substance or reality of "the whole set of circumstances, some of which may point in one

direction, some in the other" (B.P. Australia v. Federal

Commissioner of Taxation supra, at p. 264 and see generally per

Dixon J., Sun Newspapers Ltd. v. Federal Commissioner of Taxation

(1938) 61 C.L.R. 337 at p.361f£f. and per Gibbs A.C.dJ., Federal

Commissioner of Taxation v. South Australian Battery Makers Pty.

Ltd., supra at pp. 4416-4420). In this regard, I do not consider that anything in the judgment of the Judicial Committee of the

Privy Council in Europa Oil (N.Z.) Limited (No. 2) v. Commissioner

of Inland Revenue (N.Z.) [1976] 1 W.L.R. 464) is, when properly understood in context, either contrary to what has been said above or authority for the general approach that, for the purposes of the New Zealand Act under consideration in that case, the character of an outgoing must be determined by having regard only to the contractual or other legal rights that the taxpayer

acquired in return for it. If I be in error in that regard, that

general approach would, in my respectful view, be contrary to what has been long established by decisions of the High Court as appropriate to the Australian Act and should not be followed by

The relevant payment in the present case was made and accepted on the three-fold basis that the change in employer would take effect on 30 June, 1976, that there would be continuity of service for the purposes of both long service leave and annual holiday entitlement and that the taxpayer would be effectively relieved of the burden of any obligation to its employees on account of long service leave or annual holidays by reference either to service prior to that time or to subsequent service. All parties concerned plainly acted on that basis and, indeed, it has not been suggested that there was ever any real doubt that the calculated removal of that burden from the taxpayer would, from a practical or business point of view, be achieved. The employees' wages were paid by the taxpayer for the period up to 30 June, 1976 and by Foxwood for the period from 1 July, 1976. The employees presumably were granted, and for their part accepted, in due course, the annual holidays to which they were entitled on the assumed basis of continuity of service. There is no suggestion either that the payment itself was a sham or that the mistaken basis upon which the taxpayer, Foxwood and the employees acted was other than the result of a genuine failure to appreciate the strict legal consequences and implications of the taxpayer's

actions. In the circumstances, the taxpayer's entitlement to the

benefit of the claimed deduction falls to be determined rather by reference to the calculated purpose and effect which were, for all practical purposes, realized than by reference to juristic rights and liabilities which were neither perceived to exist nor, in the

characterizations of the relevant outgoing in the present case. One of these characterizations leads to the rejection of the claimed deduction. The other leads, ultimately, to its allowance. I am unable to find any compelling reason in either logic or

"commonsense" (B.P. Australia Ltd. v. Federal Commissioner of

Taxation, ibid) for preferring one characterization to the other. Indeed, resort to declamations of "commonsense" would, in the present case, achieve little more than to provide a rhetorical camouflage for the fact that what 1s involved is essentially an

The first arguable characterization of the outgoing is as an adjustment of purchase price on the sale of the taxpayer's business and undertaking. The transfer of employees was an incident of the sale of the business. On the basis of what was

assumed by both the taxpayer and the purchaser, it was a disadvantage of the business and undertaking which was acquired by the purchaser that wages would need to be paid to employees during

future periods of annual leave and long service leave in respect

of service prior to the date of the purchase or that payments in

lieu of such leave would need to be made in the event of the termination of employment before leave was actually taken. on this approach, the outgoing represented a diminution of the purchase price as a result of that inherent disadvantage or detriment in what was sold. So viewed in isolation, the payment does not exhibit the character of having been incurred in gaining

or producing assessable income or as necessarily incurred in carrying on a business for the purpose of gaining or producing such income but exhibits the character of an outgoing incurred in parting with the means of earning assessable income or in disposing of the business and ceasing thereby to gain or produce

such income (see Peyton v. Federal Commissioner of Taxation (1963)

109 C.L.R. 315 at pp. 320-321). Moreover, when viewed in isolation as an adjustment of purchase price on the disposition of the business, it exhibits the character of a capital, and not a

While I can see considerable force in the argument that the relevant characterization of the outgoing is as an adjustment on the sale of the income-producing business, I have ultimately come to the conclusion that it should not be accepted. The fact that the payment may, for some purposes, be so characterized is

not, in the view I take, the end of the matter (see Federal Commissioner of Taxation v. Morgan (1961) 106 C.L.R. 517 at p.

520ff; The Herald and Weekly Times Ltd. v. Federal Commissioner

of Taxation (1932) 48 C.L.R. 113 at p. 118). The object or

advantage which the outgoing was calculted to effect can and

should be more precisely defined. That object or advantage was the removal from the taxpayer to the purchaser of the burden of the taxpayer's obligations to employees in respect of annual and long service leave on account of past periods of service. This more precise definition is supported by the manner of calculation of the amount of the outgoing, by the express words of clause 25 of the agreement which imposes the obligation to make the relevant payment as a proviso to the taking over by the purchaser of the liability to make the payments and by the overall commercial or business context in which the outgoing was incurred. From a practical or business point of view, the payment achieved the

As at 30 June, 1976, the taxpayer's primary obligation to its employees in respect of long service leave and annual holidays was to excuse them from attendance at work during future periods of annual and long service leave while continuing to pay their wages. If the taxpayer had continued to carry on business and employ its employees, it would not have been entitled to a deduction as at 30 June, 1976 in respect of that obligation to its employees: it would have been entitled to a deduction at the time when the leave was taken and the wages paid or at the time when a payment in lieu of leave was made on the premature termination of

employment (Federal Commissioner of Taxation v. Nilsen Development

Laboratories Pty. Limited [1979] A.T.c. 4520). It had however

become antecedently clear that, apart from the contingency of some

extraordinary arrangement or circumstances removing the burden of

payment from the taxpayer to another, the taxpayer would at some

stage be required to make payments of the relevant amount in respect of annual and long service leave on account of past periods of service. That obligation was, from the practical and commercial point of view, real and not illusory notwithstanding the fact that the actual obligation to make the payment was future and, at least in the case of long service leave, contingent. It arose from the past employment of the taxpayer's employees. It was incurred in gaining or producing assessable income. The discharge of that obligation by payment of wages in the ordinary course to employees when leave was taken or payment in lieu of such leave on premature termination of their employment would, if the taxpayer had continued to carry on its business, plainly have been an outgoing of a revenue character deductible pursuant to the provisions of s.51(1) of the Act. If it had been lawfully permissible so to do, the discharge of the obligation by payment of an agreed amount to the employees on 30 June, 1976 would likewise have been so deductible. (Compare the amounts paid by way of settlement which were held to be deductible in The Herald

and Weekly Times Ltd. v. Federal Commissioner of Taxation, supra).

The question which arises is whether the payment made on that day by the taxpayer to the purchaser of its business to secure, froma practical and commercial point of view, a discharge from the obligation was likewise an outgoing of revenue deductible pursuant

When, as in the present case, a taxpayer's accounts are

on an accruals basis, the appropriate time at which a deduction should be allowed will ordinarily be the time when the absolute liability to make a payment arises. Where, however, a payment is made in advance of any absolute liability arising, the circumstances of the particular case will determine whether the payment should be regarded as a mere prepayment pending the relevant absolute liability arising or whether the payment itself was, from a practical and business point of view, calculated to extinguish a real, albeit future or contingent, liability or obligation and should itself be regarded as the relevant outgoing for the purposes of s.51(1) of the Act. Once the outgoing in the present matter is accepted as having been calculated to effect, from a practical and business point of view, a transfer of the obligation in respect of future payments on account of annual and long service leave and as, indeed, having that practical commercial effect, it partakes of the same character as would a payment to the employees direct - if that were lawfully permissible - to achieve a discharge of the obligation. It was an outgoing to discharge or escape from an obligation incurred as a direct incident of employing employees in the course of gaining or producing assessable income. It was, an outgoing of revenue which

I would allow the appeal and order that the assessment be remitted to the respondent Commissioner to be amended by allowing a deduction in the amount of $8897.00. I would order

that the respondent Commissioner pay the appellant's costs both of

this appeal and in the Supreme Court of Queensland.

THE COMMISSIONER OF TAXATION FOR THE COMMONWEALTH OF AUSTRALIA

FISHER J: This 1S an appeal by Foxwood (Tolga) Pty. Limited ("the taxpayer") from a decasion of the Supreme Court of Queensland dismissing an appeal by the taxpayer against an income tax assessment issued by the respondent the Commissioner of Taxation ("the Commissioner") for the year of income ended

30 June 1976 ("the tax year"). In issue between the taxpayer and the Commissioner 1s the taxpayer's entitlement to the benefit of a deduction of two sums totalling $8,897.00. These sums were paid in the tax year by the taxpayer to Foxwood Limited and are sald to represent the legal entitlement of the employees of the taxpayer to long service leave and holiday pay. The payments

were made by the taxpayer in the folloving circumstances,

concerning which there 1s no dispute except on the topic of the date of the alleged termination by the taxpayer of the services

Foxwood Limited 1s the holding company of a group of companies, of which the taxpayer 1s one. The group carried on business of, inter alia, saw millers in North Queensland. During the tax year Foxwood (Mareeba) Pty. Ltd. actually operated the saw mill and the taxpayer was the employer of a work force

of employees which comprised the majority of the persons working

the sawmill. Apart from receiving a fee for the provision of that .°

work force to Foxwood (Mareeba) Pty. Ltd., the only assessable income for the year of ancome of the taxpayer comprised bonuses payable under Workers' Compensation policies and interest on inter-company loans. Essentially the work force of the taxpayer was 1ts income earning asset, which asset Foxvood Limited purported

to acquire, in circumstances which follow, in the tax vear.

During the tax year a decision appears to have been made within the group that the holding company Foxwood Limited would take over the saw mill from Foxwood (Mareeba) Pty, Ltd., and the employment of the work force from the taxpayer. To this end the taxpayer sold to Foxwood Limited (hereinafter called "the purchaser") on 30 June 1976 what was described as its "undertaking and 1ts businesses" excluding any shares in related companies, which sale was evidenced by an agreement for sale and purchase dated 29 June 1976, It suffices at this stage to say that by the agreement it was arranged that the purchaser would "take over" all the taxpayer's employees, in respect of whom the purchaser would

be liable thereafter for holiday, sick leave and long service leave

payments, but that the taxpayer would pay on 30 June 1976 to the purchaser the appropriate amount for the employees' "accrued entitlement for long service leave, holiday and sick pay". This amount was, 1n accordance with the terms of the agreement, determined by Messrs C.E. Smith & Co, the then accountants for the group to amount to $11,658.78 and was duly paid by the taxpayer

on 30 June 1976 to the purchaser. The taxpayer claims that portion of this sum, namely $8,897, 1s deductible pursuant to the provisions of s.51(1) of the Income Tax Assessment Act 1936 ("the

The sum of $8,897 relates to the alleged entitlement as at 30 June 1976 of the employees of the taxpayer to long service leave and holiday pay. The former entitlement was assessed at $2,913.00 and the latter at $5,984.00 and no claim was made in

respect of sick leave. These figures are not in dispute.

Before dealing with the legislation and the awards by virtue of which the alleged entitlements arose, it is convenient to cefer to the terms of the agreement dated 29 June 1976. It is not unfair to say that 1ts terminology is neither exact, nor certain in meaning. The agreement insofar as relevant recited at the outset that the taxpayer agreed to sell, with effect from 30 June 1976, all "the undertaking and the businesses of the vendor (excluding any shares in related companies)". As such it would be reasonable to assume that the purchaser was acquiring the benefit of all of the assets of the business of the taxpayer, subject ' to accepting the burden of its liabilities. The price for what

might be generally described as "plant" was to be the value as

determined by Messrs C.E. Smith & Co as the depreciated value for income tax purposes, and the price of the balance of the under- taking and business, a price again to be determined by Messrs C.E. Smith & Co. These prices "less the liability of the Vendor assumed by the Purchaser and any moneys owing by the Vendor to the Purchaser" were payable within 24 hours of demand. Consistent with the assumption abovementioned in respect of the benefits and the burdens of the business, there was express provision (clause 24) to the effect that the purchaser would take over the whole of the liabilities of the taxpayer as at 30 June 1976, and would indemnify the taxpayer in respect of the same. However, notwithstanding these general provisions dealing with assets and liabilitzres and the manner of determining the price to be paid for the business, the agreement concluded (clause 25) with a provision dealing specifically with the employees of the taxpayer and their accrued entitlements to long service leave, holiday and sick pay at 30 June 1976. The full terms of that clause are as follows: "25. The Purchaser shall take over all the Vendor's employees employed in the Vendor's business on the 30th June 1976 and on and from that date the Purchaser shall be liable to make holiday, sick leave and long service leave payments accruing or owing before or after that date provided that the Vendor shall pay to the Purchaser on the 30th June 1976 an appropriate amount as shall be determined by C.E. Smith & Co as the

employees' accrued entitlement for long service leave and holiday and sick pay."

It appears to me that this clause contemplates three significant matters. First, specific recognition of the fact that the purchaser desired to employ directly, as from 30 June 1976, the work force of the taxpayer, the services of which the

taxpayer had heretofore made available for a fee to Foxwood

(Mareeba) Pty. Ltd. Second, the taxpayer was to be relieved from liabilaty 1n respect of payments to be made thereafter to the employees 1n respect of holiday, sick leave and long service leave, whether the obligation to make such payments accrued prior

or subsequent to 30 June 1976. Finally, this relief from liability was subject to the taxpayer paying to the purchaser on 30 June

1976 an amount determined by Messrs C.E. Smith & Co, as "the employees' accrued entitlement for long service leave, and holiday and sick pay". Thus the taxpayer vas obliged to make a cash payment to the purchaser on 30 June 1976 and the purchaser assumed

the liability to make all subsequent payments in respect of these

These express provisions of clause 25 make 1t possible to understand clause 2(a) which was in the following terms: "2(a). The said prices less the liability of the Vendor assumed by the Purchaser and any moneys owing by the

Vendor to the Purchaser shall be due and payable within twenty four (24) hours of demand."

It 1s apparent that "the said prices" referred to the prices to be determined in accordance with the schedule by Messrs C.E. Smith & Co, an respect of plant and "the balance of the under- taking and business". These prices were by clause 2(a) to be reduced by "the liability of the Vendor assumed by the Purchaser", which referred either to the whole of the liabilities of the vendor assumed by the purchaser pursuant to clause 24 or the laability of the vendor in respect of "the employees' accrued entitlement for long service leave, holiday and sick pay" referred to in clause 25 as accruing or owing at 30 June 1976.

The reference in clause 2(a) to any moneys owing by the vendor

to the purchaser can on my reading of the agreement only refer to the moneys payable by the taxpayer under clause 25 being

the appropriate amount determined by Messrs C.E. Smith & Co as the employees' accrued entitlements to long service leave, holiday and sick pay. Whichever way one looks at it, the employees' alleged entitlement for the various forms of pay was seen aS an amount by which to adjust the price. It was a component part of "the prices payable in respect of the property hereby agreed to be sold and purchased" (clause 2) and was taken into account in determining the monies payable by the purchaser under the agreement. In respect of any amount payable by the taxpayer on this score, such amount was payable on 30 June 1976, not - withstanding that the balance purchase price was payable to the

The agreement refers to the employees' accrued entitlement for long service leave and holiday and sick pay. Any entitlement to sick pay was of no significance in the proceedings in that no deduction was claimed for the amount, if any, paid by the taxpayer on this account. The entitlement of the employees to long service leave and annual or holiday leave was governed by provisions of the Industrial Conciliation and Arbitration Act 1961 (Queensland) and relevant awards. These provisions are set out in the reasons for judgment of the learned trial judge and need not be repeated, They do not differ greatly from the corresponding provisions

considered by this Court in Federal Commissioner of Taxation v

Nilsen Development Laboratories Pty. Ltd. 1979 A.T.c. 4520.

Essentially in respect of long service leave the employee is enmutled

by virtue of his award to thirteen weeks leave on full pay after

15 years continuous service, and a proportionate amount after

10 years continuous service if such service was terminated by the employee or by the employer otherwise than for serious misconduct, or the death of the employee. Somewhat similar provisions apply to service after completition of the initial period of fifteen years. By two sub-sections of the Industrial Conciliation and Arbitration Act (sub-sections 17 (7)(b) and 17(16)) 1f the services of an employee are transferred by one employer to a second employer or the calling of the first employer is "transmitted" whether by operation of law or agreement to a second employer, the service of the employee with the two employers is deemed to be continuous. Ultimately more detailed consideration will be required to be given to these provisions, which here-

after I shall refer to as "the transmission provisions".

Entitlement for holiday leave 1s also provided for by the combined effect of the Industrial Conciliation and Arbitration Act (s.15) and the relevant award. Employees are entitled to four weeks' holiday leave on full pay, and to be paid for that leave or a proportionate amount if employment is terminated.

There are no provisions which correspond to the transmission

At 30 June 1976 the taxpayer had seventeen employees in respect of all of whom the taxpayer paid the amount of their "entitlement" to holiday leave to the purchaser. However only one of these employees had become entitled to take his annual holiday as at 30 June 1976, the remainder not having served the qualifying period since last taking leave, thus becoming

entitled during the succeeding year of income. The amount paid

to the purchaser was calculated on the basis of the amount which would have been payable under the award to the employees if

their services had been terminated by the taxpayer on 30 June 1976.

On that date a payment was made by the taxpayer to the purchaser 1n respect of the long service leave 'entitlement" of two employees, and the amount of the payment was calculated on the basis of the amount payable to them if their services had then been terminated. None of the other £1fteen employees had served the taxpayer or its predecessors for the necessary qualifying period of ten years and no portion of the payment was attributed to them. It 1s pertinent to note that of the two employees who were accepted as having an "entitlement", the service of one comprised in part "deemed continuous service" with Foxwood (Mareeba) Pty. Ltd., and the other employee had had "deemed continuous service" with a firm Lawson & Son and then

The taxpayer claimed to deduct the amount of these two payments pursuant to the provisions of s.51(1) of the Act as 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". In the argument before us counsel did not distinguish, and there was in my view no need to distinguish, between these two limbs of s.51(1). Moreover the claim was essentially based on the making of the payments, and not on the existence of a liability or the making

of a provision. This matter therefore differs on its

facts from those considered by this court in Nilsen's case supra, where the contest centred around the entitlement of

the taxpayer to deduct a liability 1n respect of which the taxpayer had made provision in 1ts accounts. Another significant difference was that in Nilsen's case the liability of the taxpayer in circumstances where the services of the employees might have been terminated was not under consideration. However the decision of the court was that a deduction under s.51(1) was not available until such time as a payment was made to an employee when he took his leave or his services were terminated, The majority of the court was of opinion that at no stage prior to payment consequent upon taking of leave or termination of services was the taxpayer under such

a present liability to pay as would entitle it to a deduction

Applying the reasoning of Nilsen's case supra, to the facts of this matter, the taxpayer was not at 30 June 1976 under a present liability in respect of the long service leave and holiday pay "entitlements" of its employees. It was contingently obliged to make payment in the succeeding year to such of them as took annual holidays or long service leave whilst in its employment. Likewise 1t was obliged to make payment to any employees whose services were terminated on that date or during the ensuing year. However 1t was not until this contingent liability crystallized into an actual laability by virtue of a payment to the employee on termination of his services or upon his taking his leave that the taxpayer

would be entitled to the benefit of a deduction under s.51(1)

of the Act on the basis that it had "incurred a loss or

It seems to me that the claim of the taxpayer to a deduction must be considered under two separate heads. First, the question arises whether, 1f the contingent liability to pay for holiday leave and annual leave had crystallized by termination on 30 June 1976 into an actual liability in respect of one or both forms of leave, such liability was discharged by the payments to the purchaser, To the extent that the taxpayer was under no present liability, consideration must also be given to the question whether the making of the payments to the purchaser in consideration of the latter undertaking to make payments to employees as and when they fell due in the future, amounted to the incurring of an outgoing for the purposes of

It 1S necessary to deal, on the question of possible termination of services, with each form of leave entitlement. If however the conclusion is that employees' services were "terminated" in the requisite sense, then I am of opinion that such termination occurred prior to 30 June 1976. The termination of such services by the taxpayer was qua the employees a unilateral act on the part of the taxpayer performed in conjunction wath the purchaser when the latter agreed to re-employ them. Admittedly, the employees' express or implied consent was necessary and they were entitled to object, but they did not do so. Subject to the rights of employees to assert impropriety on the part of

the taxpayer, I am of opinion that they ceased to be employed

by the taxpayer on 30 June 1976, and became employees of the purchaser on 1 July 1976. In fact all employees acquiesced

The provisions in the award covering long service leave

deal with the concept of transmission of a business and of the employees of the business to a new employer with no loss of continu1rty of service. Admittedly employees would be entitled to refuse to be transmitted, in which case they would opt for termination. Even though strictly "transmission" connotes termination of employment by one employer and re-employment

by another, in my view the servicesof an employee who does not object to transmission have not been "terminated" in the sense in which that word is used in the relevant Act as incorporated in

the avard. In these circumstances the taxpayer was not at 30

June 1976 under a present liability to make a payment to any of its

employees 1n respect of an entitlement to long service leave.

The position 1s more difficult in respect of holiday leave, for there are no provisions concerning transmission of a business or an employee to a third party. There are for consideration the provisions of three awards each covering one or more of the employees. However they are not dissimilar in their terminology. Technically, it is doubtless correct to say that the services of each employee were "terminated" and there was thus an obligation on the taxpayer to make payment forthwith to each employee of his entitlement to four weeks or less annual leave. No employee was in fact paid, and all employees acquiesced when they became aware, at the latest on 9 July 1976, of their

change of employer. Yet in truth it was virtually only a change

an name, for the new employer was the holding company for the taxpayer, with only a minor difference in name, and the company to whom they had 1n fact been providing their services in consequence of the arrangements within the group had a name only slightly different. A further possible consideration 1s that,

if the servicesof employees had been terminated, each would have become entitled to a certain payment. However with the implied consent or acquiescense of each employee, his due amount was paid to the purchaser. The question arises whether each employee 1s deemed to have derived his entitlement as assessable income by virtue of s.19 of the Act. All of these matters confirm my view that in the circumstances of this matter there had not been ' a "termination" by the taxpayer of the services of its employees in the sense in which that word 1s used in the relevant awards

as entitling employees to receive payments and obliging the taxpayer to make such payments. This was almost certainly the

It follows that in my opinion the obligation of the taxpayer at 30 June 1976 was not a pregent obligation to make a pecuniary payment to each of its employees in respect of their entitlement at that date to long service leave or holiday leave. The position therefore is that 1n respect of each employee the taxpayer had a laability in the process of accrual, which liability it purported to discharge by making payment to the purchaser. The purchaser for its part agreed to indemnify and save harmless the taxpayer an respect of this liability. The question might in other circumstances arise, whether in any way the taxpayer remained liable to the employees if the purchaser failed to make payments to

them or any of them at the appropriate time. If employees have lost

their rights against the taxpayer, for example in consequence of the '

transmission provisions, a fact which seems to be contemplated by the

Industrial Conciliation and Arbitration Act, it must surely

be 1n consequence of employees having acquiesced in the transmission and as a result of such acquiescence having relinquished their rights against the taxpayer in exchange

for rights against the purchaser. Fortunately this problem does not arise for consideration, though it is significant on the question whether the consequence of the payment to the purchaser was that the taxpayer discharged its liability to the employees. For my part I am not satisfied that it did, particularly in respect of holiday leave. Moreover I believe

a court would strain to uphold an employee's claim against ' the taxpayer which transmitted its business and its employees to a related company 1f the latter company failed to meet its obligations to employees in respect of entitlements accrued

Upon my analysis of the matter, the position at 30 June 1976 was that the taxpayer was under an obligation to make payments to its employees at the time when each employee took his entitlement of leave. The obligation had not accrued at 30 June 1976, and its ultimate accrual was postponed to the time of making payment, By agreement with the purchaser of its business the taxpayer purported to have the former accept its liability at 30 June 1976 1n this regard, and the consideration for the acceptance by the purchaser of the liability was the payment of a sum of money. It is not disputed that the liability arose out of the employment -fy the taxpayer in preceding years of its work force, which was essential to its earning of assessable income. Likewise it 1s not disputed that the

amount paid to the purchaser was calculated as the sum of the

amounts payable to the employees at 30 June 1976 if they became entitled to be paid on that date. The question for determination 1S whether the making of this payment entitied the taxpayer to a deduction under s.51(1) as an outgoing "ancurred 1n gaining or producing" its assessable income or "as necessarily incurred in carrying on a business for the

The tests for determining whether a payment qualifies as an allowable deduction under the section have been variously stated. The legislation requires that it be incurred in the gaining or production of assessable 1ncome or in the carrying on of a business directed to that end. Moreover it must be made on revenue and not capital account. According to the authorities 1t must be established that the expenditure is ancidental and relevant to the operations regularly carried on by the taxpayer for the production of income: Lunney v Commissi1oner of Taxation (1958) 100 C.L.R. 478 at p.496 per Williams Kitto & Taylor JJ.). Assuming the payment qualifies in this regard, it 1s necessary to assess the essential character of the expenditure 1.e. to determine what is its place in the entirety of operations of the taxpayer. An essential characteristic of a payment is its object, what it 1s calculated to effect or achieve from a practical or business point of view:

Ciiffs International v Commissioner of Taxation {1979} A.T.C.

It seems to me that the payment has the following exceptional features, to which to my mind significance must be attached !

for the purpose of assisting to make the appropriate

It had relevance to the ancome producing operations

of the taxpayer to the extent that the activity which produced the obligation was the employment in past

the engagement of a work force, and, in the present instance, the making available of its services to a third party, was the obligation of the taxpayer to comply wath the provisions of the Industrial Conciliatim

and Arbitration Act and relevant awards. This entails

making payments at the appropriate times to employees

The obligation was not a present obligation or liability to pay money to its work force, but a liability, which probably but not necessarily would be discharged in part sometime in the succeeding year of ancome. It could be said that 1t was a liability which had contingently but not actually accrued.

relieving 1tself of the liability, ait did not make payment to those whose entitlement was the foundation of the obligation. It could not be said with certainty that the payment discharged the liability. Circumsterces' can be foreshadowed in which notwithstanding the

payment to the purchaser, the taxpayer might he compelled to make additional payments, this time to the , employees or one or more of them.

The circumstances 1n which the payment was made did

not arise in the course of operations directed to the

production of assessable income. Rather the taxpayer

had decided to cease production of assessable income,

or perhaps more correctly to cease production of assessable income by the hiring out of its work force. Thus the occasion which made the payment appropriate

was the ceasing of this manner of production of assessable uncome and the disposal of its work force, Peyton v

Federal Commissioner of Taxation (1963) 109 C.L.R. 315

at pp. 320-321. Thas I see as a very significant feature. An essential element in the disposal of its work force was the bucden necessarily to be assumed by the purchaser in consequence of the number of years service of the employees with the taxpayer which was productive of entitlements to periods of pay without work. The payment would appear to be directly related to an understandable requirement of the purchaser that the taxpayer accept

this obligation in so far as 1t arose prior to the date

of acquisition and make an appropriate payment to the purchaser. Alternatively, and, one would be entitled

to think, more usually, there would be a set-off of the amount of this entitlement against the agreed purchase price for the purpose of determining the actual amount payable on settlement.

As I read the terms of the agreement for sale and purchase this set-off was 1n°substance what was agreed. However the form of the arrangement was that after arriving at the price to be paid for the business or undertaking (which would be the value of the business assets less the liabilities) the assessed amount of a particular liability was extracted. This extracted amount was subjected to

separate treatment in that 1t was paid in cash, and the

In my opinion the crucial factors are that in respect of a liability not yet due, a payment was made on the occasion and as a term of the disposal of the business undertaking which payment was made to a person other than the person to whom the taxpayer was contingently liable and in circumstances where the payment did not have the consequence of discharging the laabality. I see the payment as made not in respect of an expense uncurred in the business operations of the taxpayer and an dascharge of that expense but as a term imposed by the ' purchaser as a condition of its acquisition from the taxpayer of the assets of its business and 1n particular its income

In these circumstances 1t 1S in my vlew not correct to regard the sum in question as incurred in carrying on the taxpayer's business. It should be characterised as an adjust-
ment to purchase price upon settlement of the sale of the

taxpayer's business and thus was on capital account.

In my opinion the appeal should be dismissed with costs.

| certify that this and the LE preceding pages are a true copy of the Reasons for Judgment of Mr Justice Fisher.

IN THE MATTER of the Income Tax Assessment Act 1936

AND IN THE MATTER of an appeal thereunder against an assessment to income tax based

upon income derived during the year ended 30 June 1976

At a glance

Court

Decision date

Before

Source

Judgment (344 paragraphs)

Cases Cited (4)

Cited By (3)