Case: Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation [1965] HCA 58 ; (1965) 114 CLR 314
Outcome: distinguished
Central to the concept of derivation is the proposition that there must be a gain in the sense of an amount which has 'come home' to the taxpayer, i.e. it is available for the taxpayer's separate use, benefit and disposal: Federal Commissioner of Taxation v Montgomery [1999] HCA 34 ; (1999) 198 CLR 639 at [65] and [117]-[118]; Commissioner of Taxes (SA) v Executor Trustee and Agency Co of South Australia (' Carden ') [1938] HCA 69 ; (1938) 63 CLR 108 at 155; Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation [1965] HCA 58 ; (1965) 114 CLR 314 at 318; Eisner v Macomber [1919] USSC 118 ; (1920) 252 US 189 at 207 applied in Montgomery at [117]. That is, receipt of itself is not sufficient to constitute a gain or an amount as income derived: Arthur Murray at 318. 79 In order to determine whether a receipt has come home the enquiry is focused upon the general understanding among practical business people as to whether the receipt has come home for the separate use, benefit and disposal of the taxpayer: Arthur Murray at 318; Montgomery at [117]. 81 A receipt will not come home where the amount received is affected by a legal or equitable restriction affecting the separate use, benefit or enjoyment of the recipient: Arthur Murray at 318; Barratt v Federal Commissioner of Taxation [1992] FCA 271 ; (1992) 36 FCR 222 at 231; RW Parsons, Income Taxation in Australia : Principles of Income, Deductibility and Tax Accounting , Law Book Company, Sydney (1985) at [11.49]. For example, where the receipt is affected by a constructive trust (see, MacFarlane v Federal Commissioner of Taxation (1986) 13 FCR 356) or where the recipient is not the beneficial object of the receipt (see The Countess of Bective v Federal Commissioner of Taxation (1932) 47 CLR 417 at 424). 82 Further, even where there is no legal or equitable restriction affecting the receipt, the receipt may not come home where: (a) the practical 'realities' prevent the taxpayer from the separate use, benefit or enjoyment of a gain because the obligor cannot meet their legal or contractual obligations to the taxpayer (see Prior at 13); or (b) it would be unsound from a business or legal perspective, to recognise the receipt as income because the receipt did not give a 'substantially correct reflex of the taxpayer's true income': see Carden at 145; Arthur Murray at 318; Ballarat Brewing Company Limited v Federal Commissioner of Taxation [1951] HCA 35 ; (1951) 82 CLR 364 at 368, 369. 90 The consequence is that BARM derived income represented by the management fees payable pursuant to the Syndicate Deeds (subject to the operation of the ' Arthur Murray principle' discussed below) at the time at which the management fees became due to it by Participants; so understood, neither the time at which the payment obligation was discharged, nor the mode by which the payment obligation was discharged, were matters which affected the derivation by BARM of the income represented by the management fees. 94 The present state of authority recognises only a very limited class of cases in that payments may be actually received by a taxpayer, but only derived as income at later points in time. The relevant class of cases are those coming within the principle recognised in Arthur Murray . 95 It is not disputed here that, to the extent that BARM received management fees in one year that related in part to the provision by it of management services in the next year, the principle recognised in Arthur Murray would apply to defer the derivation of that part of the management fees until the later year, when the services in connection with those management fees were actually performed. Indeed, that is how it returned the income represented by the management fees. 96 The present case is, however, an attempt by BARM in reliance on Arthur Murray , to advance a broader proposition, namely, that notwithstanding: (i) the incurring by Participants of debts in favour of BARM in respect of management fees; and (ii) the discharge of those debts by delivery of the bills to BARM; there was no derivation of income by BARM in respect of the management fees. 97 Unlike Arthur Murray , the foundation for this broader proposition does not relate to the time of performance by BARM of the management services. Rather, it rests on the following circumstances: (a) BARM's conduct in entering into commercial transactions (i.e. loans) that were distinct and separate from the provision of the management services; (b) the utilisation of the consideration received by BARM from Participants in respect of management fees in making those loans to PGF; and (c) the circumstance that, by agreement with the borrower (PGF), BARM had limited or restricted its ability to enforce repayment of the loans. 98 The Commissioner submitted that the flaw in BARM's argument is that it attempts to conflate, for taxation purposes, the consequences of distinct and separate transactions being: (i) the arrangement under which BARM provided management services to the Participants; and (ii) the arrangement under which BARM made loans to PGF. 99 The first of those arrangements resulted in BARM agreeing to perform management activities which constituted the provision of services in the ordinary course of the business that it carried on and that resulted in the Participants discharging their payment obligations to it. 108 The argument underlying alternative (2) involves the deferral of derivation of income represented by the management fees to the time BARM receives payments of interest and repayments of principal on the deposit with PGF. For an accruals basis taxpayer, the point of derivation of such income would normally be, as the Commissioner contended, when the management fees fell due, subject of course to the principle that comes out of Arthur Murray that, even if received, there will be no derivation until the receipt is earned. As indicated in [95] above, that latter principle was observed in the way in which BARM returned the income represented by the management fees. 109 The argument for deferral to the time BARM receives payments of interest and repayments of principal on the deposit with PGF is said to '... look to realities' to use the words of Rich J in Prior at 13. What it effectively asserts is that BARM should be treated as a cash basis taxpayer in respect of such income and then only for the amount of money received. Reliance for this argument is placed on the process of reasoning in Arthur Murray , albeit for a very different principle, Prior and Barratt . I deal with each of these cases below. 112 Whatever else it might support, nothing was said in Arthur Murray which supports the argument underlying alternative (2). Arthur Murray was a case stated by Barwick CJ in five pending appeals from decisions of the Board of Review. The facts relevant to the only question that had to be formally answered were few and simple. They are recited in the judgment of the Court in the following terms at 316: 'In the relevant years the company carried on a business of giving courses of tuition in dancing for fees of varying amounts per hour. What the case describes as basic courses of tuition available consisted of 5, 15 or 30 hours of private tuition to be taken by appointment within a year, though some students contracted for a course of 1,200 hours' tuition to be taken at any time during the student's lifetime. Payment for a course of lessons was often made in advance, either in the form of a lump sum or by instalments, a variable discount being allowed for immediate payment. For example, the fee for a lifetime course of 1,200 hours was [sterling]3,300, reducible to [sterling]3,000 for immediate payment. The student was given no contractual right to a refund in the event of his not completing the course--indeed the form of contract in general use denied any such right--though in practice refunds were sometimes given. In the company's books, fees were credited immediately upon their being received to an account styled "Unearned deposits--Untaught Lessons Account", and from that account amounts corresponding with lessons taught were periodically transferred to the credit of an account styled "Earned Tuition Account". The company made up its income tax returns on the footing that fees received in advance of tuition formed no part of its assessable income at the moment of receipt, but became such as and when earned by the giving of the lessons. The Commissioner, on the other hand, made the relevant assessments upon the view that fees received in advance of tuition possessed the character of assessable income in the company's hands from the moment of receipt, so that in respect of a given year of income there was no need to distinguish between fees for which lessons had been given during the year and fees for which at the end of the year the lessons still remained to be given. The question to be decided is, in effect, whether on the facts as stated it is open to the Justice hearing the appeals to uphold the Commissioner's view.' 113 The Court answered that question 'no' by declaring that on the facts appearing in the case stated the conclusion is not open that a receipt of fees for a specified number of dancing lessons to be given over a period subsequent to the receipt is a derivation of assessable income. In the course of their reasons, the Court said at 320: 'Nothing in the Act is contradicted or ignored when a receipt of money as a prepayment under a contract for future services is said not to constitute by itself a derivation of assessable income. On the contrary, if the statement accords with ordinary business concepts in the community--and we are bound by the case stated to accept that it does--it applies the provisions of the Act according to their true meaning.' 114 Earlier in their reasons, the Court had said at 318: 'As Dixon J. observed in Carden's Case: "Speaking generally, in the assessment of income the object is to discover what gains have during the period of account come home to the taxpayer in a realized or immediately realizable form". The word "gains" is not here used in the sense of the net profits of the business, for the topic under discussion is assessable income, that is to say gross income. But neither is it synonymous with "receipts". It refers to amounts which have not only been received but have "come home" to the taxpayer; and that must surely involve, if the word "income" is to convey the notion it expresses in the practical affairs of business life, not only that the amounts received are unaffected by legal restrictions, as by reason of a trust or charge in favour of the payer--not only that they have been received beneficially--but that the situation has been reached in which they may properly be counted as gains completely made, so that there is neither legal nor business unsoundness in regarding them without qualification as income derived.' 117 In my view, there is no process of reasoning in, or principle coming out of, Arthur Murray which supports the argument underlying alternative (2). And this would be the case whether BARM is an accruals basis or cash basis taxpayer, assuming of course that the principle coming out of Arthur Murray applies equally to both. While Arthur Murray concerned an accruals basis taxpayer, there seems to be no reason why the principle does not equally apply to a cash basis taxpayer. 118 Prior concerned a cash basis taxpayer who, during his lifetime, was a member of a partnership which was dissolved by a deed. His sole co-partner had borrowed money from him on his private account and the deceased had lent money to the partnership. An account was made up of the dealings between them on the dissolution and the result was shown as leaving the co-partner indebted to the deceased in the sum of [sterling]8,388, which included a sum of [sterling]2,535 made up of two amounts: (1) [sterling]1,462 interest, said to be owing at 13 August 1932 by the co-partner on his personal account. (2) [sterling]1,073 interest, said to be the deceased's half share of the interest owing to him by the partnership at the time. By the deed, he undertook a personal liability to the deceased for the amount and secured it over a certain property already mortgaged, for part of the sum. The property was actually worth only [sterling]3,295 and by reason of his financial position the co-partner was unable to pay even the arrears of interest included in the sum and no payment had ever been made in respect of the sum. 119 The Commissioner contended that the interest referred to represented interest derived by the deceased during the account period ended 30 June 1932 but capitalised by means of the deed dated the 13 August 1932 affecting the dissolution of the partnership. Under the deed, the interest had been carried to the capital account. 126 In conclusion, my view is that, consistent with BARM being an accruals basis taxpayer, the income represented by the management fees was derived by BARM when those fees fell due; or, in the case of fees which related to the provision of services in a year of income after the year in which the fees fell due, consistent with the principle that comes out of Arthur Murray , in the year of income in which those services were provided. That is, as I understand the evidence, how BARM returned the income represented by the management fees. Even if BARM were to be taxed on the management fee income as a cash basis taxpayer, and as indicated in [111] above, I do not think such a basis is appropriate, that would only defer derivation to the date of delivery of the bills of exchange or, in the case of fees which related to the provision of services in a year of income after the year in which the fees were received, consistent with the principle that comes out of Arthur Murray , in the year of income in which these services were provided. 127 Moreover, in the absence of evidence that the money value of the bills at the time of delivery to BARM was less than their face value, no deferral would also result in a reduction in the quantum of the amount derived. 128 BARM's position in relation to Issue 1 cannot be sustained; and it follows that its position in relation to Issue 2 must also fail.