The Commissioner of Taxation of the Commonwealth of Australia v Smith, Darcy Peter [1979] FCA 106

ON APPEAL from the Supreme Court of Western Australia

TIHE COMMISSTONER OF TAXATION OF | THE COMMONWEALTH OF AUSTRALIA

Appellant AND: DARCY PETER SMITH Respondent i - i ORDER .

JUDGES MAKING ORDER: Bowen C.J., Franki and Toohey JJ. DATE OF ORDER: 17 October 1979

3. The judgment of the Supreme Court be set aside and the matter be remitted to the Commissioner to re-assess in accordance with the reasons for judgment of this Court.

4. The matter is stood over generally with liberty to either party to apply, withan twenty one days' from this date, if he wishes to make any application for costs of the proceedings before the Supreme Court or before this

WESTERN AUSTRALIA DISTRICT REGISTRY) W.A. No. G2 of 1979 ')

ON APPEAL from the Supreme Court of Western Australia

THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA

BOWEN ¢.g.: I have had the advantage of reading the reasons for

judgment prepared by Toohey Jd. I agree with those reasons. Accordingly, I would allow the appeal and the cross appeal.

Thea question of costs befare us and in the proceedings below raises some difficulty. The main costs before us would relate to the arseal. he Commissioner has succeeded -in his appeal. The taxpayer was avarded his costs in the Supreme Court but our

allowance of the appeal and cross appeal negates the result in

that Court, which arose from the fact that the grounds relied upon by the taxpayer differed from the position put forward in his return. ° Nevertheless, the result of our allowance of the appeal and cross appeal will be to require an amendment of the assessment, so that it will accord with the taxpayer's return. In the circumstances, it might seem somewhat harsh if orders were made requiring the taxpayer to bear the main burden of costs.

' I would feel inclined to leave each party to bear its own edsts of the proceedings before us and the Supreme Court. However, I would be reluctant to make orders to this effect if either party wished to advance argument before us for a different result on the question of costs.

I propose the Court now makes orders allowing the appeal and cross appeal, setting aside the judgment of the Supreme Court and remitting the matter to the Commissioner to re-assess in accor- dance with the reasons for judgment of this Court. I further propose that the matter be stood over generally with liberty to either party to apply within twenty one days from this date if he wishes to make any application for costs of the proceedings before the Supreme Court or before this Court. If any such application is made the matter will be re-listed for further consideration of the question of costs either at the next

sittings of the Court in Perth or, if the parties agree, the

Court will decide any application upon written submissions.

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IN TUE FEDERAL COURT OF AUSTRALIA ) WESTERN AUSTRALIA DISTRICT RROTSTRY) W.A. G. No. 2 of 1979 GENERAL DIVISION ;

-ON APPEAL from the SUPREME COURT OF WESTERN AUSTRALIA

AUSTRALIA Appellant AND: DARCY PETER SMITH Respondent

I agree with the orders proposed by the Chief Judge. I have had the benefit of reading the reasons for judgment prepared by Toohey J. I agree with those reasons but I wish to say something in addition. It is unnecessary for

I have carefully considered what was said in Atlas Tiles Ltd. v. Briers (1978) 52 A.L.J.R. 707 and by

Gibbs J. in Groves v. United Pacific Transport Pty. Ltd.

; ~2- fi965] Qd. R. 62, but I do not find anything there which requires me to take any different view to that ex»pressed by Toohey J.

statement in Ronpibon Tin N.L. and Tongkah Compound N.L.

i} v. Federal Commissioner of Taxation (1949) 78 C.L.R. 47 at

pe 56, to which Toohey J. refers and which includes the "pre "expected", follows after a passage at pp.56-57 in the poet eoucgnens which reads:

"The words 'incurred in gaining or producing assessable income! mean

in the course of gaining or producing assessable income",

This passage has been referred to on many occasions by the

High Court. See for example Federal Cornissioner of Taxation

v. Green (1950) 81 C.L.R. 313 at p.317 and Charles Moore & Co.

(W.A.) Pty. Ltd. v. Federal Commissioner of Taxation (1956) 95 C.L.R. 344 at p.349. In this last mentioned case the

Court was considering whether a taxpayer who carried on the business of a department store was entitled under s.51(1)

to deduct an amount representing money stolen when employees of it were carrying takings to the bank. The Court held that this loss was one incurred in gaining or producing assessable income and was an allowable deduction. The members of the

Court, by way of dicta in a joint judgment, said at p.351:

"But unfortunately it is still a familiar and recognised hazard

and there could be little doubt that if it had been insured against

the premium would have formed an allowable deduction."

Altnouen the taxpayer in that case was carrying on a business that passage appears to indicate that the Court did not give

the word "expected" the same significance as did Wickham J.

when he adopted the reasons he had given in Federal Commissioner

of Taxation v. Chapkhana (1977) 77 A.T.C. 4412. In my opinion

the relevant premium was paid in the course of gaining or

froducing assessable income. It was incidental and relevant

I do not consider that the premium was an outgoing of a capital, private or domestic nature. The essential,

character of the premium was not of any such nature.

As at present advised, had I come to the conclusion

that the payments under the policy were not income within s. 25({1) I would have held that they were income within s.26(3)

"The assessable income of a taxpayer shall include -

(3) any amount received by way of insurance or indemnily for or in respect of any loss -

i)... tO. . income which vovld have been assessable income,

if the loss had not occurred ,and any amount so received for or in respect of any loss or outgoing

£ consider that the words "Lor or in respect of" coupled with the words "by way of" indicate that the words "insurance or indemnity" are not to be given a restricted meaning. See generally Federal Commissioner of Taxation v. Wade (1951) 84 C.L.R. 105 at pp.112 and 115-116. I consider that the payments under the policy were received 'py way of insurance or indemnity in respect of a loss of / income which would have been assessable income if the

T certify thet thys and the Z ee. preceding pages are ea true copy of the Reasons for Judzment herein of his

ON APPEAL from the SUPREIZS COUR' OF WESTERN AUSTRALIA

THE COMIMSSTONER OF TAXATION OF THE COMMON EALLIT OF AUSTV ALTA

Australia (Wickham J.) and a cross appeal by the taxpayer

at Six Charles Gairdner Ilospital, Perth, he was injured

in a motor vehicle accident. He sustained several

injuries including a comminuted fracture of the left

Early in 1975, while a junior resident medical officer at the same hospital, the taxpayer had taken out an insurance policy with Australian Casualty Company Ltd. The period of insurance began on 26 February 1975; the policy was renewable on 1 June 1975. It was renewed on that date and annuaily thegeafter and was current at the time of the taxpayer's accident. °

resulting from injury or sicimess ..." The monthly indemnity was expressed to be $600, payable when, as the result of injury or sickness, the insured sustained "total disability". That expression was given a particular definition in the policy which it is as well to set out in full.

Policy means the inability of the Insured by reason of injury or sickness to perform

"each and every gainful occupation for which he is reasonably suited by edication, training or experience except that during ithe first two years of any such period of !disability the Insured-shall be deemed to be totally disabled while he is both: (1) umable to perform each and every duty of his occupation; and (2) not engaged in any occupation or employment for wage or profit".

It will be seen that the concept of total disability is geared to occupations for which the insured is reasonably suited, but that during the first two years of disability there must exist the additional

factor that the insured is not engaged in any occupation

' Thus, after two years, the insured may continue to receive the monthly indemnity even though in some occupation or employment, so long as it is not one capable of description as a gainful occupation for which the insured "is reasonably suited by education, training or experience".

The insurer accepted that by reason of the accident the taxpayer sustained total disability and it paid him in respect of the period from 19 October 1977 until 16 February 1978 save for the first 30 days, the policy prescribing a waiting period of that duration

In his income tax return for the year ended 30 June 1978, the taxpayer listed as income in the category "FEES, COMMISSIONS" the sum of $2,112.00, described as "A.C.C. Disability Insurance Benefits". At the same time he claimed as a deduction the premium of $91.00 paid in that year, described as "Loss of Income Insurances". Although the indemnity specified was $600.00 a month, the taxpayer was actually paid at the rate of $720.00 a month. In a letter written by the insurer to the taxpayer it vas explained that his monthly benefit had becn increased by 20% "due to the favourable experience enjoyed by clients of Bongiorno & Company", The taxpayer had insured as part of a group of clients of Bongiorno & Company, a firm of

accepted the inclusion in his assessable income of the sum of $2,112.00 but rejected the deduction of $91.00. An objection to the rejection was disallowed and the matter then came before the Supreme Court of Western Australia where Wickham J. upheld the disallowance but also upheld an argument the taxpayer was allowed to

raise without objection that the sum of $2,112.00 was

wrongly included as part of his assesseble incore. 'Lhe

Commissioner then appealed to this Court against the exclusion of the monthly indemnity from the taxpayer's assessable income and the taxpayer countered with a cross ouppeal that if it be held that the indemnity payments constituted assessable income, it should also be held that the premium payment was a deduction.

The Commissioner's notice of appeal challenged, on a number of grounds, the conclusion reached by Wickhan J. In argument, counsel for the Comnissioner developed two main propositions. The first was that

the / payments by vay of monthly indemnity were in the

nature of income according to ordinary concepts and so

assessable under s.25 of the Income Tax Assessment Act 1936, Alternatively, they constituted amounts received by way of insurance or indemity for or in respect of a loss of income which would have been assessable income 4£ the loss hed not occurred, hence assessable under s.26(j}) of the Act.

Wickham J. reached his conclusion in this way. The policy of insurance was not a contract of indemnity. It was a contract to pay specific sums upon the happening o£ specified events and was not related to actual

or incapacity. Eorning ability or capacity is a capttal

asset, The policy of insurance was an insurance against loss of an ability, the only apparent connection between

t : it and other income being the provision that benefits under the policy were to be reduced by any amounts paid under workers! compensation or similar legislation. The payments did not fall within s.26(4); they were receivec, not in place or instead of loss of income, but for loss of an ability.

money received by the taxpayer fell within s.25 of the

Act, that is whether it constituted income according to ordinary concepts.

to be considered as received on revenue account where the purpose of the insurance was to fill the place of a revenue receipt which the evenc insured against has prevented from arising, or of any outgoing which has been incurred on revenue account in consequence of the event insured against, whether as a legal liability or as a gratuicots persient ectuated only by consideracions of inorality or expedience."

undertaken in relation to s.26(a) of the Act. The

latter speaks of the purpose of acquisition and for

_that reason it becomes vital to focus upon the mind

of the taxpayer. The terms of any document under which property was acquired may throw little, if any, light on that purpose. In my view, the purpose

spoken of in Carapark Holdings Ltd. is a more objective

one in which the terms of any document by which the taxpayer receives money (in the present case, an

' in determining the nature of the receipt, - however, is the purpose which in actual fact the insurance serves" (Carapark Holdings Ltd. at p.664).

That is not to say that other circumstances may not be relevant. In the present case, for instance, the position of the taxpayer as an employed medical practitioner, his conditions of employment including provision for sick leave, and the sort of financial loss he might be expected to suffer as a result of a disabling accident, may all prove material to the inquiry whether the moneys paid constituted income.

In that ztespect I differ from the view- expressed by

"this ... is not a case where the characlerisation of the receipt requires consideration of the purpose for which the taxpayer entered into the contract

motives that led to the taking out of the insurance policy, I am in substantial agreement with him. 'The taxpayer's own evidence threw no great light on that matter. In evidence in chief he explained that he took out the policy because in the event of sickness he might well be left without a source of money to live on. In cross examination he agreed that he saw the need to replace income he might lose because of a:disability, adding -

"When I take out a policy like this I am covering myself to provide money if the situation should occur whereby I cannot earn that income, or that amount of money",

policy, notwithstanding its description, was not truly

a contract of indemnity but rather one to pay specific

sums upon the happening of specified events, the insurer's liability arising not by reason of actual pecuniary loss but only because of a disability or

. respect, that does not dispose of the matter. The

injury or sickness because he might then be precluded

practitioner in circumstances where his entitlement

to sick leave would not provide adequate replacement

and where no other source was available to compensate

him for the earnings he lost. The purpose served by

in part, of those lost earnings and to do so by monthly

the' insurance policy was to fill the place, if only

(1952) 86 C.L.R. 540 the Court was concerned with the

character of a sum provided by an employer to make up,

during 'the war, the difference between the military

"What is paid is not salary or remuneration, and it is not paid in respect of or in relation to any crployisent of the recipient. But it is intended to be, and is in fact, a substitute for - the equivalent pro tanto of ~ the salary oer wazes vhich vould have been carned and

In the present case the position cannot be put so strongly. Although it was clear enough from the taxpayer's evidence, including the proposal which led to the making of the contract of insurance, that the taxpayer sought to cover himself in respect of about two-thirds of his salary ("The sum insured for I thought would be sufficient to cover my conmitnents at the time"), the amount of monthly inderaity bore no

since payments under the policy might continue for many years in the event of an accident producing serious disability, after two years the taxpayer would continue to receive payments even though he was earning an income, so long as it were not from work to which he was "reasonably suited" in terms of the policy. Nevertheless, a consideration of the terms of the policy and the circumstances in which it was taken out shows that what is to be paid is substantially to replace earnings lost by the taxpayer. The entitlement to regular monthly payments is important allLhougn not

decisive. Federal Comnissioner of Taxacion v. Dixon

supra at p.568. Borrowing and adeptirg the Languege

of Fullagar J. in that case, what is decisive is that the object and effect of payments under the policy are to provide something in substitution for earnings lost by the insured. For the first two years of total disability it is necessary that the insured be not engaged in any occupation or employment foc wage or profit. It is true that on the face of the policy the monthly indemnity need have no pacticular relationship to

payments. And it is not without significance that one of the questions asked in the proposal for the policy was -

represent?" The proposal provided for an answer "under 50%", "50-75%" or "over 75%". The taxpayer answered "50-75%".

period of two years has passed an insured may still continue to receive monthly payments (at least, under

the present policy, in the case of accident) even Lhough

he may be ea:ning as wuch as he Would in his pre-.wecrdaente

occupation. That may be so but it would be wrong

to see the imsurance as "a mere gamble, having no I

Holdings Utd. v. Federal Comnissioner of Taxation supra at p.662). The probabilities are that a gainful occupation for which an insured is not reasonably suited by education, training or experience will not produce earnings as great as one for which he is

capacity or ability, his Honour referred to Atlas Tiles Ltd. v. Briers (1978) 21 A.L.R. 129 to support the proposition that the earning capacity is a capital asset. That decision presents difficulties of analysis, partly because of the different views taken by the members of the Court, and also because what was an action for damages in contract for wrongful dismissal led the Court into a discussion of the concept of loss of carnings in actions in tort. But in any event, the judgments in that case do net throw much light upon the question which this Court has to resolve. To characterise earning capacity as a capital asset does not resolve the dilemma whether money has been received to fill

In Federal Commissioner of Taxation v. Hatchett (1971) 125 C.L.R. 494,Menzies J. was concerned with the deductibility under s.51 of the Act of items of expenditure by an employed teacher. In the course of his judgment his Honour said:

"There has been some suggestion that to equip the taxpayer's mind in order that he may have higher earning capacity is an affair of capital ... This is, I think, & misunderstanding. It seems to me that it would be wrong to consider any of the expenditure here under consideration as an outgoing of capital or of a capital nature. An outlay is of that character when it is expended to obtain what can

/ properly be described as capital in the economic sense ...- In the field of taxation, as in the field of business, "capital" is used in contrast with "yevenue'; it has no reference to a man's body, mind, or capacity." (at p.497).

In that sense, the monthly indemnity paid to the taxpayer in the present case was received on account of revenue. It was intended to compensate him (not necessarily in full) for earnings he might be expected to lose by reason of his injuries, those payments to continue so long as he was unable to carry out any occupation for which he'was reasonably suited by education, training or experience.

can be drawn in regard to the $120 a month the taxpayer

14, received as a "bonus", Although a voluntary payment by the insurer, it arose from the policy and was intended to serve the same purpose as the money payable as a matter of contract under the policy. It was expressed by the insurer to be and was calculated as a 20% increase on the "monthly benefit". It too was received on revenue account.

These conclusions make it unnecessary for me to consider the arguments addressed in relation to s.26(j) of the Act. But the view I have taken of the object and effect of payments under the policy seems to me to lead inevitably to the result that those payments were received by way of insurance or indemnity for or at any rate in respect of a loss of income which would have been assessable income.

Having decided that the appeal by the Commissioner should be upheld, the taxpayer's cross appeal arises for consideration. Since the taxpayer is an employed medical practitioner, the premium is

an allowable deduction under s.51(1i) of the Act only

' 15. "All losses and outgoings to the extent to which thcy are incurred in gaining or producing the assessable income ... except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature ..."

Wickham J. upheld the Commissioner in this respect and he did so on two grounds. The first was that the payment of the premium was not incurred in gaining or producing assessable income because it was paid for insurance against a future risk. The second was that it was not incurred in gaining or producing the assessable income because the payments under the policy did not constitute income. In view of the

conclusion I have reached regarding the assessability

of the payments, the second objection no longer stands. f

' There is one factual matter to be mentioned. The relevant tax'year is thac ended 30 June 1976. The taxpayer's entitlement to be paid the monthly sum of $600 prescribed by the policy arose 30 days after his accident, that is 30 days after 19 October 1977. The policy fell due for renevzal on 1 June each year so that the payments made to the taxpayer were by reason of the renewal effected on 1 June 1977. The premium claimed as a deduction was vhet paid on 1 June 2978. However, the lack of a direct connection between the

particclar premius claimed and the assessable income

of the taxpayer is not fatal to the taxpayer's clain,

"The better view, however, is that s.51 as now drawn does not in either limb require a rigid restriction to the gaining or production of assessable income of the current year." (Commissioner of Taxation v. Finn (1961) 106 C.L.R. €0 per Dixon C.J. at p.68).

See also A.G.G. (Advances) Ltd. v. Federal Commissioaoer

of Taxation (1974-1975) 132 C.L.R. 175 per Mason J. at

pp. 196-197. In words that have been referred to in so meny

+++ to come within the initial part of the sub-section it is both sufficient and necessary that the occasion of the loss

Tin N.L. and fTonckah Cowoound H.L. v. Federal Coxwnissiones of Taration (1949)

In rejecting the taxpayer's claim to a deduction, Wickham J. adopted the reasons he expressed in Federal

Commissioner of Taxation v. Chapthana (1977) 77 A.T.C. 4412.

That case concerned preiniums paid on a persona] disability policy by a legal pracritioner in the employ of the Crown.

His Honour's approach was that in taking out such an

insurance policy, the taxpayer recognised the possibility

of loss if he did not insure but did not expect to produce income from that source.

be assessed in the context that any payments made under the policy constitute assessable income. It

is true, as his Honour suggested, that money payable under the policy is only forthcoming in the event that certain contingencies are satisfied. But that

is not inconsistent with the expectation of assessable income. There is nothing in the languase used by the

Court in Ronpibon Tin N.L. supra or in other cases to

like effect that requires the production of income to be free from contingencies. I agree with the dilemma posed by lr. Todd, a member of the Board that heard the objection of Lr. Chapkhang, when he said:

"I' find the greatest difficulty in concluding that a periodical payment outlaid, as previously stated, to no other end and for no other purpose than the production of periodical payments, themselves constituting assessable income upon the happening of events specified in the contract of insurance, constitutes an outgoing of a private nature." (Case J.20 (1977) 77 A.T.C. 186 at p.189). . )

Federal Gommissioner of Taxation (1935) 54 C.L.R. 295

expenditure. In Ronpibon Tin N.L. and Tongkah Compound

N.L. v. Federal Commissioner of Taxation supra at p.56

"For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidencal and relevant to that end".

• In Charles Moore & Co. (.A.) Pty. Ltd. v. Federal

Commissioner of Taxation (1956) 95 C.L.R. 344 at p.35],

(does) not refer to the frequency, expectedness or likelihood of their occurrence or the antecedent risk of their being incurred, but to thezr nature or character. What matters is their connection with the operations which more directly gain or produce the assessable income".

policy premiums may be paid year after year without

ever producing assessable income. But to say that is

not to say that there is lacking a connection betwecn

the two. Once the events postulated in the policy have

occurred, money will be paid and that money will constitute assessable income. In my view that represents a sufficienl connection between the payment of premiums and the production of income.

For reasons already given, I do not regard the premium in question as an outgoing of a private nature. Nor was it of a capital nature, The advantage which the expenditure was intended to gain was monthly paymenls in the event of Lotal

income the taxpayer stood to lose by reason of that

disability. It was an advantage of a revenue character.

See federal Commissioner of Taxation v. South Austral ian

Battery Nakers Pry. Lid. (1978) 21 A.L.R. 59, especially

allowed. I agree with the orders proposed by the Chief