Magna Alloys & Research Pty Ltd v. Commissioner of Taxation of the Commonwealth of Australia [1980] FCA 180

Appellant AND : COMMISSIONER OF TAXATION OF THF COMMONWEALTH OF AUSTRALIA Respondent ORDERS JUDGES MAKING ORDERS : Brennan, Deane and Fisher JJ. DATE OF ORDERS_ : 2 December 1980. WHERE MADD : Sydney.

In Appeal No. G107 of 1978:

1. The appeal be allowed.

2. The order of the Supreme Court of New South Wales in appeal no, 68 of 1976 be set aside and in lieu thereof it he ordered that -

(a) the appeal to the Supreme Court be allowed; (b) the appellant's assessable income for the year ended 30 June 1974 be reduced by the sum of $19,459.00; (c) the assessment of the appellant to tax for that year be remitted to the respondent for amendment accordingly;

(d) the respondent pay to the appellant its costs of the appeal to the Supreme Court.

3. The respondent pay to the appellant its costs of this appeal.

2. The order of the Supreme Court of New South Wales in appeal no. 69 of 1976 be set aside and in lieu thereof it be ordered that -

(a) the appeal to the Supreme Court be allowed; (b) the appellant's assessable income for the year ended 30 June 1973 be reduced by the sum of $204,916.00; (c) the assessment of the appellant to tax for that year be remitted to the respondent for amendment accordingly; (d) the respondent pay to the appellant its costs of the appeal to the Supreme Court.

3. The respondent pay to the appellant its costs of this appeal.

2. The order of the Supreme Court of New South Wales in appcal no. 70 of 1976 be set aside and in lieu thereof it be ordered that -

(a) the appeal to the Supreme Court be allowed; (b) the appellant's assessable income for the year ended 30 June 1972 be reduced by the sum of $80,046.00; (c) the assessment of the appellant to tax for that year be remitted to the respondent for amendment accordingly; (d) the respondent pay to the appellant it» costs of the appeal to the Supreme Court.

The respondent pay to the appellant its costs of this appeal.

) NEW SOUTIl WALES DISTRICT REGISTRY No. G107-9 of 1978 )

ON APPEAL FROM THE SUPREME COURT OF NEW SOUTH WALES, ADMINISTRATIVE LAW DIVISION

BETWEEN : MAGNA ALLOYS s RESLARCII PTY. LTD. Appellant AND : COMMISSIONER OF TAXATION OF THL COMMONWCALTH OT AUSTRALIA Respondent Coram : Brennan, Deane and Fisher JJ.

BRENNAN J : Three of the appellant's directors were charged, tried on indictment, and convicted on a charge of conspiracy in Victoria. Four of 1ts agents were also charged and tried, and three were convicted on the same charge. The directors were fined and the agents were released on bonds: none was imprisoned. Two of the

directors were charged under the Secret Commissions Prohibition Act

1919 in New South Wales, but the charges were not prosecuted, 'The charges all related to the marketing methods adopted to sell the

appellant's products. The facts surrounding the prosecutions are

stated in my brothers' judgment and, having had the advantage of reading that statement, I adopt it. The directors resolved that

the appellant should pay all the defendants' legal costs, Thcy

were paid in the respective income years ended 30 June 1972, 1975 and 1974, and these appeals relate to the deductibility under s.51(1)

of the Income Tax Assessment Act 1936 of the amounts so paid.

The appeals are brought from judgments of the Supreme Court of New South Wales. Sheppard J., then sitting in that Court, heard extensive evidence and focussed his attention upon "one

substantial evidentiary issue" which he defined in this way:

"That is the question of what 1t was that really decided the taxpayer to incur the expenditure

in question. Was it, as counsel for the taapayer submitted, necessarily incurred in carrying on its business for the purpose of gaining or producing 1ts assessable income. Or was the situation rather one in which the three directors, faced personally with serious criminal charges and the possibility of imprisonment, caused the expenditure to be incurred by the taxpayer for their own personal needs and those of the agents who were also charged."

"T am unpersuaded that I should accept that the dominant, or even a principal reason, why the expenditure was incurred was the salvation of the company's business rather than the personal necds and requirements of the three directors. I have restricted that last statement to the needs of the three directors rather than all the accused because z1t seems to me that 1t was the personal need of the directors that the agents be defended; otherwise they may have pleaded guilty and given evidence against the directors."

"The circumstances were such that there was no fund available to them to mect the costs except moneys

in the control of the taxpayer. The moneys were consequently expended for this purpose. That is not

to say that the three directors were not very much concerned about the future of the companies in the group. But the essential thing, whilst the charges were pending, was for them to look after themselves, +..The problem arose and the directors without examining the matter in the detail which the affidavit suggests simply made a decision to pay the costs. The evidence, accordingly, does not persuade me, as I have said, that 1t was incurred for the purposes of the taxpayer, except in a most indirect way. "'

As I construe these findings, his Honour rejected the claim under the second limb of s.51(1) to deduct the appellant's expenditure on costs because the dominant and principal reason why the directors incurred the expenditure was to satisfy the personal need of the directors. His Honour was of the view that that finding denied to the expenditure the character of expenditure incurred in carrying on its business, although "in a most indirect way" the expenditure was incurred for the purposes of the taxpayer's business. The question thus raised by his Honour's judgment is whether the reason why the taxpayer incurred the expenditure determines whether the expenditure was incurred for the purposes of the taxpayer's business and thereby concludes the issue of its deductibility. Motive and purpose are not novel or alien concepts in ascertaining deductibility under s.51(1), though their mcaning 1s not always clear, and

"purpose"! is susceptible of ambiguity. As Lord Wright said in

Crofter Hand Woven Harris Tweed Co. v. Veitch {1942] A.C.435 at p.469 "(t)he words 'motive', 'object', 'purpose' are in application

to practical matters difficult strictly to define or distinguish."

It will nevertheless aid an cxamination of principle if a meaning be given to these terms in the context of a discussion of s.51, not in definition of statutory terms but in identification of concepts to which reference has frequently been made in applying the section. Motive means (to adapt terms which his Honour uscd) the reason why a taxpayer decides to incur the expenditure. Purpose may be either a subjective purpose - the taxpayer's purpose - where 1t means the object which the taxpayer intends to achicve by incurring the expenditure; or it may be an objective purpose, meaning the object which the incurring of the expenditure is apt to achieve. Both motive and subjective purpose are states of mind and they are to be distinguished from objective purpose, which is an attribute of a transaction. An objective purpose is attributed to a transaction by reference to all the known circumstances; whereas subjective purpose and motive, being states of mind, are susceptible of proof not by inference alone but also by direct evidence, for a state of mind may be proved by the testimony of

him whose state of mind is relevant to a fact in issue.

Though references to motive and purpose are to be found in cases arising under s.5l, neither motive nor either kind of

purpose 1s a criterion of deductibility. The statutory criteria

are expressed in the two limbs of s.51: "incurred in gaining or producing the assessable income", and "necessarily incurred in carrying on a business for the purpose of gaining or producing such income." The purpose mentioned in the second limb is not a purpose imported by the phrase "incurred in carrying on", but the purpose of the business in the carrying on of which the

deductible expenditure is incurred (John Fairfax s Sons Pty.Ltd. v.

Federal Commissioner of Taxation (1959) 101 C.L.R,.30 at p.49).

The first limb of s.51 has a longer statutory history than the second limb. The first was to be found in s.23(1)(a) of the Income Tax Assessment Act 1922, und the second was added in the 1936 consolidation. The leading exposition of the meaning of

the two limbs is the judgment of the High Court in Ronpibon Tin

N.L. and Tongkah Compound N.L. v. Federal Commissioner of Taxation (1949) 78 C.L.R.47. As to the first limb, the Court said (at

as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant

to that end. The words 'tincurred in gaining or producing the assessable income' mean in the course

of gaining or producing such income. Their operation has been explained in cases decided under the provisions of the previous enactments: see particularly Amalgamated Zinc (de Bavay's) Ltd. v. Federal Commissioner of Taxation ((1955) 34 C.D.R.295 at pp. 303-304, 307, 309, 310) and W. Nevill s Co. Ltd. v.

Federal Commissioner of Taxation ((1937) 56 C.L.R., at pp.300,301,305-306,508).

Notwithstanding the differences in other respects in the present provision, the expression 'incurred in gaining or producing the assessable income' has been

left unchanged and bears the same meaning. In brief substance, to come within the initial part of the sub-section it is both sufficient and necessary that the occasion of the loss or

outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income."

A view was then tentatively expressed (and subsequently

confirmed: Federal Commissioner of Taxation v. Snowden s Willson

Pty.Ltd. (1958) 99 C.L.R.431 at p.436) as to the difference in

"No doubt the expression 'in carrying on a business for the purpose of gaining or producing' lays down

a test that is different from that implied by the words '1in gaining or producing.' But these latter words have a very wide operation and will cover almost all the ground occupied by the alternative. The words 'such income! mean 'income of that description or kind' and perhaps they should be understood to refer not to the assessable income

of the accounting period but to assessable income generally. If they were so interpreted, they would cover a case where the business had not yet produced or had failed to produce assessable income and the alternative would then itself suffice to authorize the deduction of a loss made in a distinct business."

The requirement in the second limb that expenditure he incurred in carrying on a business parallels the requirement in

the first limb that the cxpenditure be incurred in gaining or

producing the assessable income. In A.G.C. (Advances) Ltd. v.

Federal Commissioner of Taxation (1975) 152 C.L.R.175, Mason J.

"Thus in the Ronpibon Case ((1949) 78 C.L.R., at p.57) the Court stated that 'to come within the initial part of the subsection it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income', So also it may be said that it is enough to satisfy the second part of the subsection that the occasion of the loss or outgoing is to be found in the carrying on of a business for the production of

assessable income," Whether the assessable income against which expenditure 1s sought to be deducted is produced in the carrying on of a business or in some undertaking which docs not constitute the carrying on of a

business, the same kinds of factors are material to deductibility.

In Ronpibon Tin, supra, the Court did not explain clither limb in terms of motive or purpose, The phrases "in the course of", "incidental and relevant", and "the occasion of" appear. These phrases, though not synonyms for the statutory terms, import a connection between the incurring of expenditure on the one hand and the gaining or production of assessable income or the carrying on

of a business on the other. In Lunney v. Federal Commissioner of

Taxation (1958) 100 C.L.R.478, Walliams, Kitto and Taylor JJ said (at p.497) that the words "ancidental and relevant" stated "an attribute without which an item of expenditure cannot be regarded as deductible under the section", and their Honours said that the cited phrases were "intended as a reference, not necessarily to the purpose for which an item of expenditure has been incurred, but,

rather, to the essential character of the expenditure itself,"

The emphasis placed upon the objectivity of the test of deductibility has run through the history of s.51, and particularly through the history of its first limb, though the importance placed in particular cases upon evidence of a taxpayer's state of mind has sometimes given the appcarance of a statement of principle to what is no more than an observation upon evidentiary

The relevant history of the first limb commenced with its cnactment in s.23(1)(a) of the Income Tax Assessment Act 1922

"In calculating the taxable income of a taxpayer the total assessable income derived by the taxpayer from all sources in Australia shall be taken as a hasis, and from it there shall be deducted -

(a) all losses and outgoings (not being in the nature of losses and outgoings of capital) including commission, discount, travelling expenses, interest and expenses actually incurred in gaining or producing the assessable income;"

The operation of s.23(1)(a) was modified, however, by s.25(c).

"A deduction shall not, in any casc, be made in respect of any of the following matters: -

(ec) money not wholly and exclusively laid out or expended for the production of assessable income, "

To qualify for deduction under these provisions, 1t was necessary that expenditure should fall within s.23(1)(a) and outside s.25(e)

(Herald s Weekly Times Ltd. v. Federal Commissioner of Taxation

(1932) 48 C.L.R.113 at p.119). In Amalgamated Zinc (De Bavay's)

Ltd. v. Federal Commissioner of Taxation (1935) 54 C.L.R.295 at

p.309, in a passage to which Dixon J, referred in Federal

Commissioner of Taxation v. Finn (1961) 106 C.L.R.60 at p.66,

his Honour compared the criteria expressed by s.23(1)(a) and

"The expression 'in gaining or producing' has the force of 'in the course of gaining or producing' and looks rather to the scope of the operations or activities and the relevance thereto of the expenditure than to purpose in itself, Purpose in itself may be the criterion expressed by the word 'for' which occurs in the correlative prohibition contained in sec.25(e)." The distinction thus drawn between the criteria was one of emphasis. His Honour did not hold purpose to be irrelevant in determining under s,23(1)(a) whether expenditure was incurred in gaining or producing assessable income. But in cases decided under the 1922 Act, it was unnecessary to mention expressly that the circumstances required a reference to purpose in order to determine whether expenditure was incurred in gaining or producing assessable income, as purpose was necessarily referred to in determining the application of s.25(e). The relevance of

purpose to both sections appears in the judgment of Gavan DuffyC.J.

and Dixon J. in Herald & Weekly Times, supra at p.118, where their

Honours took the critical prepositions from each section, and

distinguished the relevant purpose from the taxpayer's immediate reason for making the payment: "The question whether money 1s expended in and for the production of assessable income cannot be determined by considering only the immediate reason for making a payment and ignoring the purpose with which the liability was incurred." (emphasis added) But when s.51 was introduced in 1936, "the principle cxpressed by the former s.25{e) Lwas] abandoned" (Ronpibon Tin, supra at p.55), and 1t became necessary to consider, according to the circumstances of each case, whether and to what extent refcrence to purpose is required or appropriate to determine deductibility under the first limb of s.51{1). Clearly enough, purpose in itself could not be the test, for the section confers deductibility upon losses involuntarily incurred where the loss is not attributable to the conduct of the taxpaver and the taxpayer is concerned to avoid incurring the loss which nevertheless befalls

him, aS in Charles Moore & Co. (W.A.) Pty.Ltd. v. Federal

Commissioner of Taxation (1956) 95 C.L.R.344 where the taxpayer

was robbed of his takings and a deduction was allowed. In that

"Phrases like the foregoing or the phrase 'incidental and relevant' when used in relation to the allowability of losses as deductions do not refer to the frequency, expectedness or likelihood of their occurrence or the antecedent risk of their being incurred, but to their nature or character, What matters is their connection with the operations which more directly gain or produce the assessable income,"

Though purpose is not the test of deductibility nor even a conception relevant to a loss involuntarily incurred, in cases where a connection between an outgoing and the taxpayer's undertaking or business is effected by the voluntary act of the taxpayer, the purpose of incurring that expenditure may constitute an element of its essential character, stamping it as expenditure of a business

Indeed, under a New Zealand provision similar to s.51, Lord Donovan and Viscount Dilhorne thought purpose tin the objective sense to be the test of whether expenditure is "exclusively incurred

in the production of assessable income" (I.R.C. v. Europa 011 (N.2.)

Ltd. L1971] A.C.760, the first Europa case, at p.779). But their Lordships were in the minority and the judgment of the majority insisted that in cases of that kind - expenditure incurred in purchasing trading stock - the test of deductibility required "a rigorous and objective examination of the contractual arrangements under which the cxpenditure 1s made" in order to ascertain whether the taxpayer has "acquired some advantage, not identifiable as, or

related to the production of, assessable income" (ibid., p.772).

The circumstances of the first Europa case required no reference to purpose in ascertaining the character of expenditure beyond the reference to the interlocking contractual arrangements

made by Europa. In this and the later Furopa case, cxpenditure was

made pursuant to a contract for the purchase of trading stock, and reference to the legal rights thereby acquired sufficiently Fixed the character of the expenditure. As Lord Diplock said, speaking

for the majority in Europa 011 v. I.R.C. [1976] 1 W.L.R.464 - the

"Their Lordships...content themselves with emphasising that it is not the economic results sought to be obtained by making the expenditure that 1s determinative

of whether the expenditure is deductible or not; it is

the legal rights enforceable by the taxpayer that he

Though the principle may be too widely stated to be applied to s.51(1) in every case (per Gibbs A.C.J. in Federal

Commissioner of Taxation v. South Australian Battery Makcrs Pty.Ltd.

(1978) 140 C.L.R.645 at p.660), it is susceptible of application where the activities and operations by which assessable income 1s gained or produced or by which a business 1s carried on are not reasonably open to dispute, and where the relevant expenditure 1s incurred solely 1n acquiring an asset or a legal right under a contract or in discharging an antecedent legal liability. In cases of that kind, of which Cecil Bros, Pty.Ltd. v. Federal Commissioner of Taxation (1964) 111 C.L.R.430 1s an example, the connection betwcen the asset or legal right acquired or the legal liability discharged on the one hand and the gaining or production of assessable income or the carrying on of a business on the other appears from "a rigorous and objective examination", But there are

cases where expenditure 1s not incurred solely to acquire an asset

or legal right under a contract or to discharge a legal obligation, and there are cases where there 1s dispute as to the scope and nature of activities and operations by which assessable income is or is intended to be gained or produced, or by which a business is carried on. In cases of these kinds, the Europa approach does not give adequate guidance to a court in finding

whether the expenditure is deductible under s,51(1).

In the infinite variety of transactions to which the application of s.51(1) may be in question, there are many 1n which there are no contractual arrangements and many in whth contractual arrangements are but part of the background in which the character of expenditure falls for consideration, As

Gibbs A.C.J. observed in South Australian Battery Makers,

The words of the judgments in the Europa Cases, like those of any judgment, may he understood in the light of the issues which fell to be decided. Their Lordships could not have meant to suggest that in every case the character of an outgoing must be determined by having regard only to the contractual return for it. That would indeed have been inconsistent with the principle stated by Dixon J. in Hallstroms' Case ((1946) 72 C.L.R.634), and with cases too numerous to mention in which payments made 'voluntarily and on the grounds of commercial cxpediency' (to use the words of Viscount Cave L.C. in British Insulated and Helsby Cables Ltd. v. Atherton ( [1926] 1.C.205, at 5 STS} have been held deductible as outgoings of a revenuc kind although the taxpayer obtained no legally enforceable rights in return for them."

Characterization of expenditure by a contractual quid pro quo requires an analysis of the consideration passing to the taxpayer under the contract, though analysis restricted to the consideration passing to the taxpayer may prove misleading (cf.

Cliffs International Inc. v. Federal Commissioner of Taxation (1979)

79 ATC 4059). Where an advantage other than or beyond a contractual quid pro quo can be identified as an advantage for the taxpayer which the relevant expenditure is calculated to effect, an analysis of that advantage gives character to the expenditure (South Australian Battery Makers, supra at pp. 659, 660, 662). It 1s necessary to ascertain in each case what expenditure is (for, because a "bare payment of money is itself devoid of character",

as Stephen J. said in Cliffs International Inc., supra at p.4071.

When the question is whether expenditure has the character of capital or of a revenue payment, as in the two cases last cited, the advantage for which the expenditure was incurred must be

identified and the manner in which it "is to be relied upon or

enjoyed" must be considered (Sun Newspapers Ltd. and Associated

Newspapers Ltd, v. Federal Commissioner of Taxation (1938) 61

C.L.R.337 at p.363). The role of the advantage in the income- earning undertaking requires examination, Similarly, when the question is whether expenditure is incurred in gaining or producing assessable income, the connection between the advantage for the taxpayer which the incurring of the relevant expenditure is calculated to effect and the taxpayer's income-earning undertaking

or business must be considered. If the advantage can be

sufficiently identified by reference to a contract, and the taxpayer's undertaking 1s known, the connection between the incurring of the expenditure and the undertaking is manifest, and 1t would be otiose to refer to the purpose of incurring the relevant expenditure. But purpose is relevant to describe an element of connection between expenditure and a taxpayer's undertaking or business in cases where a taxpayer incurs expenditure or agrees to incur expenditure without any antecedent obligation to do so or where the occasion of the expenditure (unlike the purchase of trading stock) is not manifestly to be found in whatever is productive of assessable income or in whatever would be expected to produce assessable income, or in

In cases under the 1922 Act whcre payments were made to retiring directors or employees, purpose was critical to deductibility which depended upon the fulfilment of the condition expressed in s.23(1)(a) as well as upon the non-application of s.25(e). In W. Nevill s& Co, Ltd. v. Federal Commissioner of Taxation (1937) 56 C.L.R.290, a payment was made in order to obtain the resignation of one of the taxpayer's two joint managing directors. Latham C.J. held that the expenditure fell

"The facts stated in this case show that the expenditure was actually incurred in gaining or producing the assessable income of the ycar in question. The expenditure was made for the purpose of increasing the

efficiency of the company and therefore increasing its income producing capacity.

the course of gaining or producing assessable income..."

When s.25(e) of the 1922 Act required a test of purpose to he applied, the test was objective. In Robert G. Nall Ltd. v. Federal

Commissioner of Taxation (1937) 57 C.L.R.695, Dixon J. applied a test

of purpose which may be taken to give the meaning of purpose in the

"But, in matters of income tax, purpose is an elusive and indefinite criterion. The purpose

.. When it is said that gaining or producing assessable income must be the purpose of the expenditure if its deduction is to be allowed,

no more can be meant than that the circumstances of the transaction must give it the complexion of money laid out in furtherance of a purpose of gaining income. "

When purpose is used in this sense, it means little more than that the incurring of cxpenditure in the circumstances in which it is incurred 1s conducive to the gaining or producing of assessable income or to the carrying on of a business by the taxpayer. But in ascertaining whether this connection exists the character of the

taxpayer's undertaking or business must be known; and in order to say

what relationship to the undertaking or business 1s borne by the

incurring of expenditure, it is necessary to identify what the expenditure is for. Thus, in Federal Commissioner of Taxation v.

The Midland Railway Co. of Western Australia Ltd. (1952) 85 C.L.R.

306, Dixon J., referring to a number of considerations which bore

upon the deductibility of the payments there in question, said

for which the outgoing was incurred from the point of view of the taxpayer company. The controlling factors are those which arise from the character of the business or undertaking and the relation which the expenditure or the liability to make it bore to the carrying on of the business or the gaining of assessable income. "'

Once the ''controlling factors" are ascertained, the business purposes for which an outgoing is incurred may be determined. In that step towards characterization, the taxpayer's state of mind has no part to play. His purpose or motive is not a controlling factor of the purpose to be attributed to the incurring of the expenditure. But 1n ascertaining the controlling factors, the taxpayer's state of mind may have a significant evidentiary role to play, and by leading to the ascertainment of the controlling factors, it may even be the determinative element in characterizing expenditure in a particular case. Nevertheless,

the taxpayer's state of mind - whether intention, or purpose, or

What the taxpayer has in mind may bear upon "the character of the business or undertaking" in showing the scope of his business or undertaking. The taxpayer is at liberty to determine for himself what the scope and nature of his business or undertaking shall be and how it shall be conducted, the Act having no effect upon those matters but taking "the result of the taxpayer's

activities as it finds them" (per Williams J. in Tweddle v. Federal

Commissioner of Taxation (1942) 7 ATD 186 at p.190). Fullagar J.,

referring to the operation of "necessarily" in the second limb of

s.51(1), sazrd in Snowden s Willson Pty. Ltd., supra (99 C.L.R. at

"It means for practical purposes that, within the limits of reasonable human conduct, the man who is carrying on the business must be the judge of what is 'necessary', " And thus what the taxpayer says are the character and scope of his

business or undertaking is evidence of what its character and scope

Similarly, the taxpayer's state of mind may be relevant evidence to show what expenditure is for in cases where the luropa approach does not give adequate guidance. The principal class of cases of this kind comprise those where puyments have been made to directors or employees of a taxpayer company on or by reason of their retirement, In Robert G, Nall Ltd., supra, Latham C.J. said

concerned, the object which they naturally have in their minds may properly be taken into consideration in determining whcther a particular expenditure is made for the production of assessable income. If, for example, (to take a simple case) B was an employee of A working for a salary and A made a gift to him which was not connected in any way with the business and which was shown to be made for purely personal reasons, those facts would prevent the view being taken that

the expenditure was made for the purpose of producing assessable income, "

In Maryborough Newspaper Co. Ltd. v. Iederal Commissioner of Taxation (1929) 43 C.L.R.450, a newspaper cditor and director of the

taxpayer was paid a retiring allowance to facilitate his retirement

in order to obtain the advantage of new and younger talent. Rich J. held the payment deductible, referring to the considerations which made the payment desirable from the business viewpoint, and to the motives

"In my opinion they were not actuated, in giving the allowance, by any other motive than by a desire to bettcr the business of the Company, and thus earn more profits."

"No doubt these considerations were not expressly canvassed by the directors, but

in such situations, At any rate I am satisfied that no other purpose than the production of more income prompted the agreement to pay the retiring allowance. "

In Union Trustee Co. of Australia Ltd. v. Federal Commissioner of

Taxation (1935) 53 C.L.R.263, Dixon J. (at pp.270, 271) noted a test

formulated by Rich J. 1n Maryborough Newspaper Co., supra, and said°

"Tried by that test, the claim to bring the payment within the deduction allowed as a result of secs. 23(1)(a) and 25(e) must fail. There is nothing to show that it was not a purely voluntary grant to Lecky made by Black out of proper feelings of gratitude for long service of a confidential nature. There is nothing to establish a connection between the payment and the production of income. "'

In Finn, supra, Dixon C.J. implied that a taxpayer's

motive or purpose may be material when, in evaluating the conclusions which might be considered to govern the character of the expenditure there in question, he used the phrase (at p.67) "so far as motive or purpose is material". And in cases not falling under s.51, where the issue was the income character of a gift in the donee's hands, the donor's motive was regarded as relevant evidence, though the characterization test is objective

(see Hayes v. Federal Commissioner of Taxation (1956) 96 C.L,.R.47

However, the evidentiary effect of a taxpayer's state of Mind is to be distinguished from the objective purpose of expenditure incurred, The distinction between the two is

illustrated by the judgment of McTiernan J. in Federal Commissioner

of Taxation v. Robinson s Mitchell Pty. Ltd. (1941) 64 C.L.R.612,

another case of a retirement allowance, where his Honour found

"The only purpose indicated by these facts for which the sum of £660 was paid, was to provide an allowance for 1ts managing director upon his withdrawal from its management, in

agreeing to the payment of the allowance cannot affect the purpose or the tendency

of the payment, The evidence of their motive merely shows why they voted, perhaps reluctantly, for the payment of a retiring allowance of a larger amount than they thought

was warranted by the financial position of the company. "

In W. Nevill s Co. Ltd., supra, the taxpayer company

agreed to pay a retirement allowance to one of two joint managing directors in order to procure his retirement, and thereby to save his future salary and to 1ncrease the efficiency of the taxpayer's business. The objects which the directors had in mind in incurring the expenditure threw light on the question of what the expenditure was for, and from that finding it was an easy step to show the connection of the expenditure with the operations hy which the

taxpayer gained its assessable income, Latham C.J. said at p.301:

"No expenditure, strictly and narrowly considered, in 1tself actually gains or produces income. It 1s an outgoing, not an incoming. Its character can be determined only in relation to the object which the person making the expenditure has in view. If the actual object is the conduct of the business on a profitable basis with that due regard to economy which is essential in any well- conducted business, then the expenditure (if not a capital expenditure) is an expenditure incurred in gaining or producing the assessable income,"

His Honour's remarks are to be construed, of course, in the light of the circumstances to which they are directed. Though his Honour's judgment 1s open to a different construction, I do not

take his reference to "the object which the person making the

expenditure has in view"' to be a test for the application of s.25(1)(a) or s.25(e) of the 1922 Act, or to be asserting that a taxpayer's object 1s more than relevant evidence in ascertaining the objective purpose to be attributed to the incurring of the expenditure. Indeed some few months after publishing this judgment,

Latham C.J., in Robert G. Nall Ltd., supra, appears to have denicd

that a taxpayer's purpose in making expenditure was the test of purpose under s.25(e). Immediately following the passage from his

judgment earlier cited, his Honour said (57 C.L.R., at p.705):

The provision in question 1s directed to the relation between the expenditure of the taxpayer and the income produced in the course of the income-earning enterprise of the taxpayer. The section contemplates a test which may be applied objectively and independently of subjective states of mind, even though there may be room for differences of opinion in applying any objective criterion and though the application even of an objective criterion may be affected in the case ot natural persons, who are capable of having states of mind, by consideration of those states of mind."

No doubt his Honour's observations were affected by a view that a corporation is incapable of forming a state of mind. [t

is not material to canvass that view here, but in the light of his

Honour's observations in Robert G. Nall Ltd.,supra, I do not read

what he said in W. Nevill s Co.Ltd., supra, as saying more than that

the taxpayer's state of mind 1s evidentiary of what expenditure 1s for and of the character and scope of the taxpayer's business or

undertaking. Dixon J,, in Robert G. Nall Ltd. referred to purpose

in a context which shows that he was using the term in its objective

sense. He said (at p.305) that under s.23(1)(a) of the 1922 Act

regularly carried on for the production of income,"

Given a sufficient identification of what the expenditure

is for and the character and scope of the taxpayer's income-earning undertaking or business, the question whether expenditure is incurred for the purpose of carrying on a business or for the purpose of gaining or producing assessable income docs not depend upon the taxpayer's state of mind. The relationship between what the expenditure is for and the taxpayer's undertaking or business determines objectively the purpose of the expenditure. In cases to which a reference to purpose is required or appropriate, objective purpose will be found to be an element 1n determining whether expenditure is incurred in gaining or producing assessable income or in carrying on business. If the purpose of incurring expenditure is not the gaining or producing of assessable income or the carrying on of a business, the expenditure cannot be said to be "incidental and relevant" to gaining or producing assessable income

or carrying on business; or to be incurred "in the course of

gaining or producing" assessable income or of carrying on a business,

nor can the undertaking or business be seen to be "the occasion

In the present case, the character and scope of the taxpayer's business is known without reference to its state of mind, Equally, it is objectively certain that the relevant expenditure was incurred to defray the legal costs of the directors and agents in the criminal proceedings brought against them. The connection between the legal services thus acquired and the taxpayer's business neither requires nor permits reference to the taxpayer's state of mind, The nature of that connection is to be found in the objective facts found by his Honour or not

The conduct of the directors and employees which was impugned by the laying and prosecuting of the charges was conduct by which a part of the appellant's business was carricd on, Allegations reflecting on the integrity of those conducting the appellant's business and their conduct in carrying on that business reflected on the appellant and its reputation, True enough, the allegations carricd the risk of conviction and punishment only for those accused of offences. Apart from a time during the trial when the taxpayer was joined as a defendant on the indictment, the allegations did not carry the same risk to it, but the allegations nevertheless attacked its business

methods. The interests of the taxpayer and of the accused were

inseparable, The expenditure furnished a defence for both the accused and the appellant. If the learned trial judge had found that the reason why the expenditure on costs was incurred was the defence of the appellant's trading reputation, in my view the

case would not have been distinguishable from Snowden s Willson Pty.Ltd., supra. In that case, expenditure was incurred to defray the cost of advertising and the professional fees of counsel and solicitors in representing the company and its officers before a Royal Commission, as well as the fees of valuers, a surveyor and accountants. Thus the expenditure in that case furnished a defence against the allegations there made not only for the company but

Dixon C.J., after referring to the instinctive desire to defend a trading reputation, adopted an objective approach to the deductibility of the expenditure under the second limb of

in fact and according to the ordinary conduct of affairs is incidental to the conduct of a business, The word 'necessarily! does, however, seem to me

1s to place a qualification upon the degree of connexion betweeen the expenditure and the carrying on of the business which might suffice in the

absence of such a qualification. In 'he Commonwealth and The Post-Master-General v. Progress Advertising & Press Agency Co.Pty.I td. ((1910) 10 C.L.R.457)

iggins J. supplied an interpretation of 'necessary! as not meaning essentially necessary but as meaning appropriate, plainly adapted to the needs of a

department carrying out an Act ((1910) 10 C.L.R., at p.469),. That was in another connexion but the phrase was availed of by the Court in the Ronpibon Tin Case ((1949) 78 C.L.R., at p.56) as throwing light on the use of the word 'necessarily' in s.51(1). Clearly the expression is used in relation to business, Logical necessity is not a thing to be predicated of business expenditure, What is meant by the qualification is that the expenditure must be dictated by the business ends to which it is directed, those ends forming part of or being truly incidental to the business.

In the present case 1t appears to me that the taxpayer company could do nothing else but defend itself, if it was to sustain its business and continue carrying it on in anything like the same volume or according to the same plan, That seems to me to be enough, "

Fullagar and Taylor JJ. were of the same opinion (see pp. 444, 447, 448). In that case, it was assumed that the directors would instinctively wish to defend the company against attacks upon its business methods and reputation. But it makes no difference that, 1n the present case, the learned trial judge was unpersuaded that that was "the dominant, or even a principal reason, why the expenditure was incurred", The reason why the directors incurred the expenditure does not define the scope or nature of the taxpayer's business, nor does it reveal what the cxpenditure nas for beyond assisting to show that what was sought and obtained was legal representation to defend the directors and employees. The directors' reasons do not show or tend to show that legal representation to defend the directors and ecmployces was not

connected with the carrying on of the business. Quite the contrary.

The ends of the business required that an attempt be made to defend

the impugned conduct, and the attempt was made. The necessary connection between the expenditure and the carrying on of the

It may be noted that Sheppard J. was at pains in his judgment to show that the interests of the companies and of the directors and agents who were charged were interwoven, though it was the protection of the personal interests of the directors and agents which provided the principal motive or reason for Magna's

In the circumstances of the present case, the expenditure bears the character of expenditure necessarily incurred in the carrying on of Magna's business. This conclusion is a conclusion of fact, but it does no violence to the findings of fact made by the learned trial judge, nor does it set aside any inference actually drawn by him. The character of the expenditure is not lost because the expenditure was apt to serve both the business purpose and the purpose of defending the directors, nor is that character lost because the principal or dominant reason for incurring the expenditure was to defend the

It 1s said, however, that expenditure in connection with breaches of the law 1s in a separate category from other

expenditure incurred in carrying on a business, and that the

weight of judicial authority denies a deduction to a taxpayer who incurs expenditure with respect to a breach of the criminal law. The learned trial judge so held, finding that what was said by Rowlatt J. in Inland Revenue Commissioners v. Warnes s& Co. [ 1919}

2 K.B. 444 and by the Court of Appeal in Inland Revenue Commissioners v. von Glehn [1920] 2 K.B.553, had application to the facts of the present case. It was submitted that these decisions

were expressly approved by the High Court in Ilerald s& Weckly Times,

In the High Court, the majority of the judgments confines the operation of the English cases to the payment of penalties imposed as a punishment upon the taxpayer. And here, of course, there is no claim to deduct moneys paid as a penalty.

In Herald s Weekly Times, supra, Gavan Duffy C.J. and Dixon J,

said with reference to the English cases (at p.120):

"The penalty 1s imposed as a punishment of the offender considered as a responsible person owing obedience to the law. Its nature severs it from the cxpenses of

trading. It is inflicted on the offender as a personal deterrent, and it is not incurred by him in his character of trader."

The cases were not cited in the other judgments. In Snowden s

Willson Pty,Ltd., supra, the same principle was expressed by

There is no analogy here to cases in which fines or penalties are incurred. There the character of the expenditure and the reasons why the law imposes a fine or penalty separate the expenditure from the conduct of the business,

It 1s not to the point that the conduct penalised found its motive in business considerations. Nothing of the kind can be said of the expenditure now under consideration nor is any principle of public policy affected by allowing the deduction."

Fullagar J. (at p.446), with whom Williams J. agreed, was content to cite the passage in Herald s Weekly Times cited above, and Taylor J. alone referred to costs as well as penalties in his judgment (at p.452):

" The final observation which I wish to make is concerned with the argument that, as the expenditure was incurred in an endeavour to rebut the charges of fraud which were implicit in the allegations made by Mr. Oldfield, the company is not entitled to the deduction claimed, It was sought to support this argument by reference to cases concerned with legal costs and penalties incurred in criminal proceedings. It is, I think, sufficient to say that there 1s no analogy between the two classes of cases and,

accordingly, that there is no substance in this submission. (See Inland Revenue Commissioners Vv. Warnes s Co. ((1919) 2 K.B.444); Commissioners of Inland Revenue v. von Glehn s& Co. Ltd. ((1920) 2 K.B. 553); Minister of Finance v, Smith ((1927) A.C.193, at pp.197, 198). "

This passage furnishes slender support for the view that the principle with respect to the non-deductibility of criminal penalties extends

to the costs incurred in defending the proceedings in which the penalty is imposed. It 1s worthy of note that, although there were legal costs in issue in Warnes s Co., supra (being costs ordered to

be paid to a prosecutor) and in von Glehn, supra (costs of the defence)

the non-deductibility of the costs in hoth cases was regarded by

Wrottesley J. in Spofforth and Prince v. Golder (H.M. Inspector of Taxes) (1945) 26 T.C.310 at p.314, as turning not upon the

principle with respect to deduction of penalties but upon an application of a wider principle expressed by Lord Davey in Strong v. Woodifield [1906] A.C. 448. The particular test which Wrottesley J. drew from Lord Davey's specch was "for the purpose of earning the profits". But this 1s not the test under the

second limb of s.51(1) (John Fairfax s& Sons, supra, per Menzies J.

at p.50), and accordingly the English cases provide no authority

to determine the deductibility of legal costs under the second

lamb of s,51(1). Snowden s Willson Pty.Ltd., supra, was decided

under s.51(1), and it was held in that case that expenditure on costs calculated to effect the repelling of a public attack upon the taxpayer's methods of carrying on its business was deductible.

In the present case, the expenditure was calculated to achieve the

same results and also to vindicate the appellant's business

methods other than those impugned by the prosecution. There is no reason why the deductibility of expenditure on costs in the present case should be affected by the circumstance that the attacks upon

the appellant and its reputation led up to and were pursued in a

The respondent further relied upon the exceptions to s.51(1) submitting that the expenditure was of a privute or of a

capital nature. As Menzies J, said in Federal Commissioner of

Taxation v. Hatchett (1971) 125 C.L.R.494 at p.498:

"It must be a rare case where an outgoing incurred in gaining assessable income is also an outgoing of a private nature. In most cases the categories would secm to be exclusive. "

What his Honour said with respect to outgoings incurred in gaining assessable income may be said of outgoings necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, Expenditure falling under the second limb of s.51(1) is incidental to the carrying on of a business and 1t must be a rare case where the same expenditure can at once possess

that character and be an outgoing of @ private nature, This is

Nor was the expenditure an outgoing of a capital nature. The capital of the business was in no way increased by the expenditure incurred. True it is that the expenditure protected the reputation and goodwill of Magna's business, but the attack which was made arose out of the day to day selling activities of that business and it was the business purpose of vindicating the methods by which it was conducted that brings the expenditure within s.51(1). Though goodwill is a capital asset of a business it is frequently earned and maintained by the daily activities of those engaged in the business. The valuable if intangible asset of goodwill frequently grows out of activitics the cost of which

is a charge on revenue account (sce Sun Newspapers, supra at pp,

360, 361). Expenditure incurred in attempting to vindicute the

business methods of the taxpayer, overcoming the obstacle to its

trading which had been raised by the prosecutions 15 properly

Supreme Court in respect of the income years ended 30 June 1972

and 30 June 1973 should be set aside and in lieu thereof it should be ordered that the appellant's assessable income for those years be reduced by the amounts held deductible in this appeal. The judgment of the Supreme Court in respect of the income year ended 30 June 1974 should be varied by ordering that in addition to the amount held deductible by the Supreme Court the amount held deductible in this appeal be deducted from the appellant's assessable income for that year. The

appellant should have its costs both here and in the Supreme

I certify that this and the 31 preceding pages are a true copy of the Reasons for Judgment herein of his Honour Mr. Justice Brennan,