Hedges v Commissioner of Taxation

Federal Court of Australia|2022-11-23|Before: Ms J, Cheeseman J

The appeal be dismissed with costs. Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.

INTRODUCTION 1 Brent Hedges appeals from the decision of the Administrative Appeals Tribunal to affirm the objection decision of the Commissioner of Taxation, in which the Commissioner disallowed Mr Hedges' objection to his assessment of Mr Hedges' income for the 2009 tax year: Hedges and Commissioner of Taxation (Taxation) [2020] AATA 5307 (23 December 2020). 2 This appeal is brought pursuant to s 44 of the Administrative Appeals Tribunal Act 1975 (Cth) and is confined to a question of law. There have been a series of delays in the history of the matter which are detailed in the Tribunal's reasons. These are not revisited here, save to note that there was no suggestion by the Commissioner that Mr Hedges was being elusive or, by the time of the hearing, that he was being obstructive or unco-operative. 3 Mr Hedges is a retired solicitor who relevantly practiced as a partner of the Curwoods Lawyers Partnership. On his retirement from the Partnership at the end of 2008, he became entitled to a receipt for the disposal of goodwill under cl 25 of the Partnership Deed dated 25 September 2006. Under cl 26 of the Partnership Deed, the Partnership was entitled to be paid, by way of set-off, any amounts that Mr Hedges owed to it. On or about 30 September 2008, Mr Hedges and his then partners (the Ongoing Partners) executed a deed of partner's retirement (Retirement Deed). Clause 3.7 of the Retirement Deed provided that all moneys payable to the retiring partner were to be calculated in accordance with cll 25 and 26 of the Partnership Deed. 4 Under cl 25 of the Partnership Deed, Mr Hedges was entitled to a payment of $182,629 in respect of goodwill. Upon applying the set-off mechanism in cl 26 of the Partnership Deed, Mr Hedges contends that he received no payment because the goodwill amount of $182,629 was offset against an amount of $197,126 owed by Mr Hedges to the Partnership. 5 The Commissioner assessed Mr Hedges' capital gain in the 2009 tax year by taking the total capital gain of $182,629 with a cost base of $0 and reducing it by the standard CGT discount to produce a discount capital gain of $91,314. 6 On 23 December 2020, the Tribunal affirmed the Commissioner's objection decision on the basis that the assessable gain crystallised under cl 25 of the Partnership Deed before offsetting from that amount any amounts due from Mr Hedges in accordance with the set-off mechanism in cl 26 of the Partnership Deed. 7 The appeal turns on whether the capital gain crystallised before or after the operation of the set-off in cl 26 of the Partnership Deed. All other issues ventilated by Mr Hedges before the Tribunal have fallen away.

Income Tax Assessment Act 1997 (Cth) 8 Pursuant to s 102-5 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997), any capital gain forms part of Mr Hedges' assessable income. 9 Section 116-20(1) of the ITAA 1997 sets out the general rules about capital proceeds, providing: (1) The capital proceeds from a *CGT event are the total of: (a) the money you have received, or are entitled to receive, in respect of the event happening; and (b) the *market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event). Note 1: The timing rules for each event are in Division 104. Note 2: In some situations you are treated as having received money or other property, or being entitled to receive it: see section 103-10. Note 3: If you dispose of shares in a buy-back, the capital proceeds are worked out under Division 16K of the Income Tax Assessment Act 1936. 10 Section 103-10 of the ITAA 1997 provides for a constructive receipts rule: 103-10 Entitlement to receive money or property (1) This Part and Part 3-3 apply to you as if you had received money or other property if it has been applied for your benefit (including by discharging all or part of a debt you owe) or as you direct. (2) Those Parts apply to you as if you are entitled to receive money or other property: (a) if you are entitled to have it so applied; or (b) if: (i) you will not receive it until a later time; or (ii) the money is payable by instalments.

Partnership Act 1892 (NSW) 11 Mr Hedges refers in his submissions to s 39 of the Partnership Act 1892 (NSW) which provides: On the dissolution of a partnership every partner is entitled, as against the other partners in the firm, and all persons claiming through them in respect of their interests as partners, to have the property of the partnership applied in payment of the debts and liabilities of the firm, and to have the surplus assets after such payment applied in payment of what may be due to the partners respectively after deducting what may be due from them as partners to the firm; and for that purpose any partner or his or her representatives may on the termination of the partnership apply to the Court to wind up the business and affairs of the firm. 12 Section 19 of the Partnership Act provides: The mutual rights and duties of partners, whether ascertained by agreement or defined by this Act, may be varied by the consent of all the partners, and such consent may be either expressed or inferred from a course of dealing.

Agreed Facts 13 The parties have conducted the appeal with a high degree of co-operation. A comprehensive statement of facts has been agreed. 14 The capital gain in issue on this appeal is calculated at the time of the relevant CGT event giving rise to the tax liability. Mr Hedges acknowledges that the disposal of his interest in the Partnership on retirement is the relevant CGT event, and that the event occurred on about 30 September 2008 when he executed the Retirement Deed. Therefore, any capital gains liability is payable in the 2009 tax year. Before the Tribunal, there was some debate as to whether the relevant CGT event occurred on 30 September 2008 (the date of the execution of the Retirement Deed) or 31 December 2008 (the date Mr Hedges' retirement took effect). On appeal, it was common ground that the CGT event occurred on 30 September 2008. The Tribunal was correct in noting that whether the event occurred on 30 September 2008 or 31 December 2008 made no practical difference. 15 Upon his retirement, Mr Hedges became entitled to receive a number of payments, including, relevantly, in respect of his proportionate share of goodwill, which were subsequently paid in instalments during the 2009, 2010 and 2011 tax years. Mr Hedges' Partnership Interest was 12.57%: Recital C and Sch 1, Partnership Deed. The Partnership Deed provided for payment in instalments: cl 27. The Retirement Deed subsequently amended the instalment regime: cl 3.8. 16 Also upon his retirement, Mr Hedges was required to repay to the Partnership $197,126 in order to make good a shortfall in his capital account. The shortfall and its cause is not in issue in the appeal. The repayment of the capital account also occurred over the same three-year period. 17 It is agreed that the final payments were recorded as follows: Total Amount entitled Year ended 30 June 2009 Year ended 30 June 2010 Year ended 30 June 2011 Capital and Current Account $0 - - - Goodwill $182,629 $54,789 $91,315 $36,525 Work in progress $410,320 $131,265 $218,775 $60,280 Other amounts $3,250 $975 $1,625 $650 Repayment of capital account ($197,126) ($31,029) ($118,641) ($47,456) Total $399,073 $156,000 $193,074 $50,000

18 On 10 September 2014, the Commissioner issued default assessments to Mr Hedges for his 2009, 2010 and 2011 years of income. 19 Relevantly, the Commissioner assessed Mr Hedges' taxable income for the year ended 30 June 2009 to include a discount capital gain from the disposal of the goodwill in the Partnership's business in the amount of $91,314 (as mentioned above, calculated as capital proceeds of $182,629, less cost base of $0, and applying a 50% CGT discount).

The Tribunal's decision 20 On the first day of the Tribunal hearing, Mr Hedges was granted leave to amend his grounds of objection, relevantly, as follows: The 2009 assessment is excessive because: 1. the capital gain included in assessable income is based on an overstatement of the "capital proceeds" (for the purposes of s116-20(a) of the Income Tax Assessment Act 1997 (Cwth) [sic] (ITAA97) from the disposal of the Applicant's interest in the [Partnership] and in particular the goodwill asset. Under s116-20(a) the capital proceeds comprises "the money you have received, or are entitled to receive, in respect of the event happening." The Applicant says that the amount of "money" comprises the amount calculated by Curwoods Lawyers to be attributable to be goodwill less the debit in the Applicant's capital account upon retirement as required by clauses 25 and 26 of the [Partnership Deed]. 21 The Tribunal found that (at [19] to [20]): 19. … the terms and effect of the partnership deed are clear enough. Clause [25.1] says the quantum of the various payments shall be determined and those amounts 'shall be paid'. The reconciliation contemplated in Clause [26] does not occur until after the amounts payable under Clause [25] have already crystallised. At that point, those amounts become the capital proceeds from the CGT event (i.e., disposal of the goodwill) within the meaning of s 116.20. The fact the amounts might thereafter be applied towards settling a debt does not matter: s 103.10 points out you are deemed to receive monies for present purposes where those monies are applied for your benefit. 20. Clauses [25] and [26] do not operate in the way suggested by the taxpayer. The capital proceeds from the disposition of the goodwill are determined pursuant to Clause [25] and it is that figure which is relevant for present purposes. 22 The reference to "Clause [25.1]" at paragraph [19] is a slip - the Tribunal should have referred to the chapeau of cl 25. Subclauses 25.1 to 25.4 are each addressed to particular categories of payment to the Outgoing Partner. Subclause 25.4 provides for payment of a proportionate amount in respect of the value of the goodwill of the Partnership. Nothing turns on the slip.

The ground of appeal 23 By the time the appeal was heard, it had reduced to a single issue, namely, what were the capital proceeds which Mr Hedges was entitled to receive for the purpose of s 166-20 of the ITAA 1997. 24 In his notice of appeal, Mr Hedges identifies the following question of law: Whether the Assessment was excessive or otherwise incorrect because the amount relating to goodwill that was included in the capital proceeds under s 116-20 of the Income Tax Assessment Act 1997 (Cwth) [sic] (ITAA97) that the Applicant received or was entitled to received, in respect of his disposal of his interest in the Curwoods Lawyers partnership, was excessive? 25 The relevant ground of appeal is as follows: 1. Under clauses 25 and 26 of the Curwoods Lawyers Partnership deed (the Partnership Deed) dated 25 September 2006, the amount that the Applicant received or was entitled to receive in respect of goodwill and work in progress was a net amount once amounts that shall be paid under clause 25 are set-off or reduced by the operation of clause 26. As a result of the Commissioner incorrectly including the amount calculated under clause 25 in capital proceeds without reducing that amount because of the operation of clause 26 the Assessment was excessive.

Mr Hedges' submissions 26 Mr Hedges' submissions framed the error of law on the part of the Tribunal as a misconstruction of the effect of cl 25 of the Partnership Deed when read with cl 26 of the Partnership Deed and with cl 3.7 of the Retirement Deed. 27 Mr Hedges contends that a proper construction of the Partnership Deed and the Retirement Deed commences with cl 3.7 of the Retirement Deed. He submits that the requirement in cl 3.7 that "all moneys payable to the Retiring Partner in relation to the Partnership shall be calculated in accordance with [cll] 25 and 26 of the [Partnership] Deed" implies that what the retiring partner is to be paid crystallises only after the calculations in both cl 25 and cl 26 have been applied. Mr Hedges contends that the Tribunal erred in taking a serial approach to the calculations in cll 25 and 26 and says that this is contrary to cl 3.7 of the Retirement Deed. He submits that cll 25 and 26 must be read together to crystallise "all moneys payable" under cl 3.7, and that to do so is consistent with a principled approach to construing the deeds as a whole and in context: Wilkie v Gordian Runoff Ltd (2005) 221 CLR 522 at [17]; Chief Commissioner of State Revenue (NSW) v Dick Smith Electronics Holdings [2005] HCA 3; 221 CLR 496; 79 ALJR 550. 28 Finally, Mr Hedges submits that to construe the two deeds in this way is consistent with the general law of partnership, in that a partner's interest cannot be ascertained until completion of the liquidation of the partnership upon dissolution and the identification of any surplus share. Mr Hedges submits that cll 25 and 26 operate "merely as a device to calculate the surplus moneys owing under [cl] 3.7" of the Retirement Deed. In reliance on Commissioner of State Taxation v Cyril Henschke Pty Ltd [2010] HCA 43; 242 CLR 508, Mr Hedges submits that, consistently with the analysis in Henschke, cll 25 and 26 of the Partnership Deed and cl 3.7 of the Retirement Deed have the effect that the relevant amount for the purpose of the assessment is the net amount payable under cl 3.7 of the Retirement Deed calculated in accordance with cll 25 and 26 of the Partnership Deed. As noted above, Mr Hedges points to s 39 of the Partnership Act, which is materially the same as the equivalent South Australian legislation considered in Henschke, and contends that it has the effect that the interest of each partner can only be ascertained finally after the liquidation of the partnership and the identification of any surplus share.

Consideration 29 For the reasons which follow, I am not satisfied that Mr Hedges has demonstrated that the Tribunal erred as a matter of law in its construction of the relevant deeds. It follows that I am not satisfied that Mr Hedges has demonstrated error in respect of the Tribunal's decision to affirm the Commissioner's objection decision. 30 Mr Hedges relied on Henschke, where the High Court was concerned with the meaning of "conveyance on sale" under s 60 of the Stamp Duties Act 1923 (SA). The issue in Henschke arose from the retirement of Doris Henschke from a partnership involving herself and three other winemakers which carried on the Henschke winemaking business. The relevant agreements comprised a partnership agreement dated 17 January 1986 and a separate retirement deed dated 23 December 2004. Clauses 22 and 23 of the partnership agreement provided for the retirement of partners upon the giving of particular notice, with an option for the continuing partners to purchase the share of the retiring partner, and, in default of such purchase, for the dissolution and winding up of the partnership. The retirement deed provided that Mrs Henschke retired with effect from 30 June 2003 and the other partners were to continue the partnership without purchasing Mrs Henschke's interest and without the partnership being dissolved. The deed provided for the adjustment of the remaining partners' interests in the partnership and for Mrs Henschke to receive a distribution of her partnership capital and income in the sum of $5,885,298 in full satisfaction of all claims she had against the partnership. The Commissioner of State Taxation for South Australia succeeded in establishing that the retirement deed was a "conveyance on sale" within the meaning of s 60 of the Stamp Duties Act and, as such, attracted stamp duty pursuant to s 4 of the Stamp Duties Act. 31 Unlike Henschke, the present appeal is concerned with the assessment of capital gains tax as part of the retiring partner's assessable income, not with stamp duty which is levied on instruments. Similarly to Henschke, the present appeal involves the construction of the two relevant deeds in order to determine the relevant tax consequence. It is necessary to begin by construing the relevant deeds. 32 Clause 2.5 of the Partnership Deed provides: The Partners agree that the provisions of the Partnership Act 1892 (NSW) shall only apply to the Partnership where there is no corresponding provision herein, it being the intent of the Partners that this Deed sets out the terms and conditions that shall regulate their relations as partners and this Deed shall be construed accordingly. That the mutual rights and duties of partners defined by the Partnership Act may be varied in this way is not controversial: s 19, Partnership Act. 33 Clause 3 provides: The death, retirement (including deemed retirement), expulsion or the happening of an event which results in a Partner ceasing to be a member of the Partnership does not terminate the Partnership as between the other Partners as long as there are two or more other Partners to continue the Partnership. 34 Clause 32 of the Partnership Deed provides: The partners agree that the Partnership shall continue notwithstanding the fact that 32.1 a Partner dies; 32.2 a new Partner is admitted; or 32.3 a Partner retires (by deemed retirement, expulsion or otherwise). 35 Clause 33 provides: Upon the retirement or death of a Partner, the Continuing Partners shall use their best endeavours to cause the Outgoing Partner to be released from any guarantees, bills of sale, leases hire purchase agreements or other financial obligations that have been entered into by the Outgoing Partner and the Continuing Partners shall until so released indemnify the Outgoing Partner in respect of any liability under such guarantee (and the like) after his retirement or death. 36 Clause 41 provides: 41.1 Where the Partnership is terminated, then within three (3) months of the date of termination for the Partnership, a general account shall be taken of the assets and liabilities of the Partnership and the assets (including, but without limitation, the Partnership goodwill) must be realised and sold and in settling accounts between Partners the following rules must be observed: 41.1.1 losses, including losses and deficiencies of capital, must be paid first out of profits, next out of capital and lastly, if necessary by the Partners in the Partnership Interests; and 41.1.2 the assets of the Partnership, including the sums, if any, contributed by the Partners to make up losses or deficiencies of capital, must be applied in the following manner and orders: (a) in paying the debts and liabilities of the Partnership to persons who are not members of the Partnership; (b) in repayment to each Partner (pro rata if necessary in accordance with Partnership Interests) of any actual payment or advance made by a Partner to the Partnership; (c) in payment to each Partner (pro rata if necessary in accordance with the Partnership Interests) of the final balance of his Current Account; (d) in repayment to each Partner (pro rata if necessary in accordance with the Partnership Interests) of the balance of his Capital Account; and (e) the balance, if any, remaining after the above amounts have been paid in full shall be divided between the Partners in accordance with the Partnership Interests. 41.2 Each Partner must sign all documents and do all acts as are reasonably required in connection with the winding up of the Partnership. 37 Clauses 3.4 to 3.7 of the Retirement Deed provide for mutual releases and indemnities between Mr Hedges and the Ongoing Partners. 38 The effect of cll 3, 32 and 33 of the Partnership Deed and cll 3.4 to 3,7 of the Retirement Deed is to bring about a "technical" dissolution of the Partnership upon Mr Hedges' retirement, rather than a "general" dissolution of the Partnership as contemplated by cl 41of the Partnership Deed in the sense described by the High Court in Henschke at [11] to [12] (footnotes omitted): 11. The general principles with respect to retirement of partners were explained as follows by Eichelbaum CJ in Hadlee v Commissioner of Inland Revenue (NZ): "In law the retirement of a partner, or the admission of a new partner, constitutes the dissolution of the old partnership and the formation of a new one. Here, upon the happening of such events there were no overt signs of dissolution; the partnership's financial structure and arrangements were such that none was required but that does not alter the underlying legal significance of any retirement or new admission. Nor, in my opinion, is it possible to avoid those legal propositions by the terms of the partnership agreement: no doubt it is competent for partners to agree in advance that in the event of a retirement the remaining partners will continue to practise in partnership but that does not overcome the consequence that the partnership practising the day after the retirement is a different one from that in business the previous day." 12. These propositions reflect the distinction between what may be called a "technical" dissolution usually brought about by agreement, such as that in the Retirement Deed, and a "general" dissolution with a winding up of the partnership. 39 The High Court in Henschke recognised that it is competent for partners to agree in advance that in the event of a retirement, the remaining partners will continue to practice in partnership. In the Partnership Deed, the partners have agreed what is to occur in the event of the retirement of a partner which includes that the Partnership - although differently constituted and technically dissolved, and reconstituted afresh - will continue. Retirement of a partner does not cause the Partnership to be dissolved in the general sense, that is to say, terminated, and cl 41 is not triggered. Rather, the dissolution of the Partnership is "technical" in the sense described in Henschke and the retiring partner's rights and obligations are ascertained in accordance with the regime agreed between the partners in the Partnership Deed and the Retirement Deed. 40 Clause 24 provides for a partner to retire by giving a written notice. The Retirement Deed records that Mr Hedges is retiring from the Partnership "upon" 31 December 2008, which is described as the "Departure Date". 41 Clause 25 provides for what is to happen upon a partner's retirement: 25. EFFECT OF RETIREMENT AND PAYMENT Upon the retirement of a Partner under clauses 22, 23, or 24 hereof, or otherwise however arising, or, upon the death of a Partner, he, or his legal personal representative, shall be paid: 25.1 the amount standing to the credit of his Capital Account in the books of the Partnership; 25.2 the amount standing to the credit of his Current Account in the books of the Partnership; 25.3 his proportionate part calculated in accordance with the Partnership Interests of the Work in Progress. The value of the Work in Progress for the purposes of this clause shall be determined either by the Partners, including the Outgoing Partner, or in the absence of such agreement by an independent costs consultant appointed by the President for the time being of the Law Society of New South Wales (or nominee), which consultant shall act as an expert and not as a mediator or arbitrator and whose decision shall be binding on the Partners unless in the case of a manifest and material error of fact. The costs of such consultant shall be a Partnership expense; and 25.4 his proportionate part calculated in accordance with the Partnership Interests for the goodwill of the Partnership, the value of the goodwill shall be the equivalent of 50% of the annual net trading profit of the Partnership (as opposed to the net taxable profit) averaged over the preceding three (3) years. For the purposes of calculating such net trading profit salaries paid to Equity Partners and the profit component of management fees paid by the Partnership to any associated service entity shall be excluded and shall be added back. In the event of a dispute concerning the proper basis for and/or the calculation of the net trading profit then such dispute shall be determined by the nominee of the accountants for the partnership (and being a member of that firm) who shall act as an expert and not a mediator or arbitrator and whose decision shall be binding on the Partners unless in the case of manifest and material error of fact. The costs of such accountants shall be a Partnership expense. If such accountants decline to so act then by an accountant appointed by the President for the time being of the Law Society of New South Wales (or nominee), which accountant shall act as an expert and not as a mediator or arbitrator and whose decision shall be binding on the Partners unless in the case of manifest and material error of fact. The assessment decision in issue on this appeal relates to the payment in respect of goodwill pursuant to cl 25.4 upon Mr Hedges' retirement. Upon his retirement, Mr Hedges was entitled - "shall be paid" - to a payment of his proportionate part of the value of the goodwill of the Partnership calculated in accordance with cl 25.4. It is common ground that Mr Hedges' proportionate goodwill payment was $182,629. 42 Clause 25 is an example of the contractual modification of the process by which, and the basis upon which, the plus side of a retiring partner's ledger is to be determined. In Henschke, the High Court observed at [22] (footnotes omitted): The significance of the interplay between the law of contract and the doctrines and remedies of equity was further explained by Lord Millett in Hurst v Bryk. His Lordship observed that disputes between partners and the dissolution and winding up of partnerships have always fallen within the jurisdiction of the Court of Chancery, and continued: This is because, while partnership is a consensual arrangement based on agreement, it is more than a simple contract (to use the expression of Dixon J in McDonald v Dennys Lascelles Ltd); it is a continuing personal as well as commercial relationship. Neither during the continuance of the relationship nor after its determination has any partner any cause of action at law to recover moneys due to him from his fellow partners. The amount owing to a partner by his fellow partners is recoverable only by the taking of an account in equity after the partnership has been dissolved. Only the Court of Chancery was equipped with the machinery necessary to enable such an account to be taken, and the basis upon which the account was taken reflected equitable principles. These could be modified by agreement, but they did not find their source in contract. 43 Clause 26 of the Partnership Deed relevantly provides that: SET-OFF Upon the retirement … of any partner, any moneys owing by such Partner as at retirement…shall be determined and shall be offset against any amount found owing to the Outgoing Partner as at the date of retirement … 44 Pausing here, as noted above, at the time of his retirement Mr Hedges owed the Partnership $197,126 as a debt in respect of amounts drawn on his capital account which he was required to repay. This amount was required to be offset against the amounts due to Mr Hedges in respect of goodwill. 45 Clause 3.7 of the Retirement Deed provides that: "… all moneys payable to the Retiring Partner in relation to the Partnership shall be calculated in accordance with Clauses 25 and 26 of the [Partnership] Deed …". 46 Clause 27 of the Partnership Deed provides for "Terms of Payment" as follows: Subject to clauses 25 and 26 hereof the amount payable to the Outgoing Partner shall be paid by three (3) equal consecutive six (6) monthly instalments the first to be paid six (6) months after the date of retirement or death of the Outgoing Partner provided that: 27.1 in respect of the instalments or any or all of them, if the same are not paid within seven (7) days of the due date interest shall be payable in respect of such unpaid instalments at the rate for the time being charged to the Partnership on its bank overdraft account from the date on which the payment was due to the date of payment (and if the Partnership does not have an overdraft, then at the prescribed rate of interest payable on Judgments of the Supreme Court of new South Wales); and 27.2 irrespective of the provisions contained in this clause, the Continuing Partners shall use their best endeavours to discharge their liability hereunder within six (6) months, or such earlier time than eighteen (18) months as may be practicable, having regard to the overall financial position of the Partnership provided that it is not the intention of the Partners that this clause shall operate as a legally enforceable commitment to do so. 47 Clause 27 was modified by cl 3.8 of the Retirement Deed, which provides: 3.8 Notwithstanding Clause 27 of the Deed, in lieu of three (3) instalments payable thereunder on account of the Retirement Moneys the Ongoing Partners agree to pay or cause to be paid the Retirement Moneys as follows: 3.8.1 Instalment 1 - or before 31 March 2009 - 15% thereof; 3.8.2 Instalment 2 - on or before 30 June 2009 - 15% thereof; 3.8.3 Instalment 3 - on or before 30 September 2009 - 15% thereof; 3.8.4 Instalment 4 - on or before 31 December 2009 - 20% thereof; 3.8.5 Instalment 5 - on or before 31 March 2010 - 15% and; 3.8.6 Instalment 6 - on or before 30 June 2010 - 20% PROVIDED THAT in the period commencing 1 January 2009 and ending 30 June 2009 the Ongoing Partners shall pay on account of instalment 1 and Instalment 2 of the Retirement Moneys $12,000 each fortnight in arrears until Instalment 1 and Instalment 2 have been paid in full ("the Payments") PROVIDED FURTHER THAT if at a time prior to Instalment 2 falling due the sum of the Payments so made equals the sum of Instalment 1 and Instalment 2 THEN the Ongoing Partners shall be relieved of making any further payments AND if the Payments so made shall be in excess of the sum of Instalment 1 and Instalment 2 then the Ongoing Partners shall offset the overpayment made by them against the next instalment of any other moneys becoming due and payable to the Retiring Partner hereunder on any account. 48 Clause 25 of the Partnership Deed is under the heading "Effect of retirement and payment". In plain terms, it provides that upon the happening of the designated event - here, retirement - the Partner shall be paid the amounts specified in cll 25.1 to 25.4. The amount that "shall be paid" "upon retirement" in respect of goodwill is Mr Hedges' proportionate part, calculated in accordance with his Partnership Interest of 12.57%, of the goodwill of the Partnership, the value of which is calculated as the equivalent of 50% of the annual net trading profit of the Partnership, averaged over the preceding three years. Clause 25 is the source of Mr Hedges' right to be paid an amount in respect of his proportionate share in the goodwill of the Partnership upon his retirement. 49 Clause 26 does not confer on Mr Hedges a right to receive payment upon his retirement in respect of, relevantly, goodwill. Clause 26 is directed to providing a set-off mechanism. It requires that "any moneys owing" by an Outgoing Partner "shall be determined" and "shall be offset against any amount found owing to" the Outgoing Partner. Clause 26 requires the determination of amounts owing by and to an Outgoing Partner, but it is not the source of the relevant obligations in respect of such payments. Clause 26 is merely a mechanism that provides a convenient method by which the Partnership can recover amounts owed by Outgoing Partners to the Partnership on their retirement. 50 Clause 3.7 of the Retirement Deed is similarly directed to the "calculation" of "the Retirement Moneys" which are "all moneys payable" to the Outgoing Partner. Clause 3.7 is directed to the net payment position. Of itself, cl 3.7 does not establish a right to the component payments. Clause 3.7 says that the Retirement Moneys "shall be calculated in accordance with [cll] 25 and 26 of the [Partnership] Deed". Attention is directed back to cl 25, which is the source of the entitlement to the four categories of payments identified in cll 25.1 to 25.4 (inclusive), and to cl 26, which addresses the mechanism by which the net payment is calculated after applying the contractually agreed set-off mechanism by which debts owed by the Outgoing Partner are recovered. The Tribunal was correct to construe the relevant deeds as giving Mr Hedges an entitlement upon his retirement to the goodwill payment which derived from cl 25, specifically cl 25.4. The relevant event for the purpose of s 116-20(1)(a) of the ITAA 1997 was Mr Hedges' retirement. Upon this event, Mr Hedges became "entitled to receive" the goodwill payment within the meaning of s 116-20(1)(a) of the ITAA 1997. 51 The Tribunal was also correct to recognise that, notwithstanding that the goodwill payment was liable to be applied to offset Mr Hedges' obligation to repay the debt due on the capital account, the capital proceeds of the CGT event were not reduced by the reason of the offset. The effect of s 103-10 of the ITAA 1997 was that Mr Hedges was deemed to receive the goodwill payment at the time it was applied for his benefit in reducing his debt in respect of the capital account.

Conclusion 52 For these reasons, the appeal must be dismissed. Mr Hedges has not demonstrated that the Tribunal's decision was affected by an error of law. I will make orders accordingly. I certify that the preceding fifty-two (52) numbered paragraphs are a true copy of the Reasons for Judgment of the Honourable Justice Cheeseman.

Income Tax Assessment Act 1997(Cth)ss 116-20(1), 103-10

Partnership Act 1892(NSW)ss 19, 39

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