Case: Commissioner of Taxes (SA) v The Executor Trustee and Agency Company of South Australia Limited [1938] HCA 69 ; (1938) 63 CLR 108
Outcome: followed
The authorities cited by the applicants are St Lucia Usines and Estates Company Limited v Colonial Treasurer of St Lucia [1924] AC 508 ( St Lucia ) at 512; Commissioner of Taxes (SA) v The Executor Trustee and Agency Company of South Australia Limited [1938] HCA 69 ; (1938) 63 CLR 108 ( Carden's Case ) at 155; Permanent Trustee Co v Federal Commissioner of Taxation (1940) 6 ATD 5 ( Prior's Case ) at 13; South Australia v Commonwealth [1992] HCA 7 ; (1992) 174 CLR 235 at 253; and Bowaters Sales Co Ltd v Commissioners of Inland Revenue (1958) 38 TC 593 ( Bowaters ) at 597 599. As well, the applicants refer to the Commissioner's Public Ruling TR 98/1 at [19], in which the Commissioner has said that as a general rule, the receipts method is appropriate to determine income derived from investments, although there are exceptions, such as in the case of interest from a business of money lending carried on by the taxpayer. 68 Like the applicants, the Commissioner relies on the seminal judgment of Dixon J in Carden's Case [1938] HCA 69 ; 63 CLR 108. The Commissioner refers to his Honour's statements to the effect that the tendency of judicial decision has been to place increasing reliance upon the conceptions of business and the principles and practices of commercial accountancy (at 153), and that unless some definite direction is discoverable in the statute, the choice of the method of ascertaining "the true income" must depend upon the method's "actual appropriateness" (at 154). 103 I turn next to the judgment of Dixon J in Carden's Case [1938] HCA 69 ; 63 CLR 108 a seminal judgment on the question of the appropriateness of the receipts or accrual method of tax accounting for income derived. 104 The case concerned the income of a medical practitioner subsequently deceased. The issue arose under the Taxation Act 1927 1935 (SA). A question before the Court was whether the earnings or accruals method of identifying the deceased's fees income was appropriate. 105 Dixon J, with whom Rich and McTiernan JJ agreed (Latham CJ dissenting), held that the receipts basis of accounting (on which Dr Carden had furnished returns) had been the appropriate method in relation to the complete years of income during Dr Carden's lifetime (the earnings basis was held appropriate for the broken period from 1 July 1935 to his death on 15 November 1935). Accordingly, Dr Carden had not been required to return as income fees earned during those years but not paid during them, which were outstanding as "book debts" at the end of those years. 106 The following propositions are to be found in the judgment of Dixon J: (1) The question which of rival methods of accounting should be employed in identifying taxable income falls for the courts to determine according to legal principles, but it is a mistake to search only the legislative text for an answer, because such notions as income, profits and gains are conceptions of the world of affairs, and particularly of business, covering an infinite variety of activities, for which no single formula can be devised (at 151 152). (2) "... in nearly every department of enterprise and employment the course of affairs and the practice of business have developed methods of estimating or computing in terms of money the result over an interval of time produced by the operations of business, by the work of the individual, or by the use of capital. The practice of these methods of computation and the general recognition of the principles upon which they proceed are responsible in a great measure for the conceptions of income, profit and gain and, therefore, may be said to enter into the determination or definition of the subject which the legislature has undertaken to tax. The courts have always regarded the ascertainment of income as governed by the principles recognized or followed in business and commerce, unless the legislature has itself made some specific provision affecting a particular matter or question" (at 152). (3) "The tendency of judicial decision has been to place increasing reliance upon the conceptions of business and the principles and practices of commercial accountancy ... But the process by which the principles and practices evolved in business or general affairs are drawn upon for the solution of questions presented to courts of law almost inevitably leads to a development in the law itself. For, under our system of precedent, a decision adopting or resorting to any given accounting principle or application of principle is almost bound to settle for the future the rule to be observed and the rule thus comes to look very like a proposition of law" (at 153 154). (4) "Unless in the statute itself some definite direction is discoverable, ... the admissibility of the method which in fact has been pursued must depend upon its actual appropriateness ... [t]he inquiry should be whether in the circumstances of the case it is calculated to give a substantially correct reflex of the taxpayer's true income. We are so accustomed to commercial accounts of manufacturing or trading operations, where the object is to show the gain upon a comparison of the respective positions at the beginning and end of a period of production or trading, that it is easy to forget the reasons which underlie the application of such a method of accounting to the purpose of ascertaining taxable income. Although the field of profit-making which it covers in practice is probably much greater than any other among the manifold forms of income or revenue, it is a system of accounting which does not represent the primary or basal position from which an investigation of income for taxation purposes begins. 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" (at 154 155). (5) The expressions "derived" and "arising or accruing" ordinarily signify receipt, but not in relation to debts due to a trading company, in which case debts due but not paid must be included as income. With regard to non-trading income there must be something "coming in", that is to say, "for income tax purposes receivability without receipt is nothing" (at 155 quoting from Sir Houldsworth Shaw &amp; Baker, Law of Income Tax p111). (6) "The reasons which underlie the practice of estimating for taxation purposes the income from trade or manufacture by means of a commercial profit and loss account consist in the impracticability of computing income in any other way and in the adoption for fiscal purposes of recognized commercial principles. The computation of profits from manufacture and trading has always proceeded upon the principle that profit may be contained in stock-in-trade and 'outstandings'" (at 155). (7) "... a tax upon the profits or income of such a business [a manufacturing or trading business] must be understood as a tax upon the profits or income computed according to the system, because, according to common understanding and commercial principles, that is the method of determining the profits" (at 156). (8) The word "derived" is the equivalent of "arising or accruing" ( Harding v Federal Commissioner of Taxation [1917] HCA 13 ; (1917) 23 CLR 119 at 133), and none of these three words, nor the words "income", "profit" or "gain" in the statute, throw any light on the question of which basis of accounting is appropriate to reflect income in the circumstances of a particular case (at 157). (9) "Where there is nothing analogous to a stock of vendible articles to be acquired or produced and carried by the taxpayer, where outstandings on the expenditure side do not correspond to, and are not naturally connected with, the outstandings on the earnings side, and where there is no fund of circulating capital from which income or profit must be detached for actual enjoyment, but where, on the contrary, the receipts represent in substance a reward for professional skill and personal work to which the expenditure on the other side of the account contributes only in a subsidiary or minor degree, then I think according to ordinary conceptions the receipts basis forms a fair and appropriate foundation for estimating professional income. But this is subject to one qualification. There must be continuity in the practice of the profession" (at 157 158). 107 The factual circumstances of Carden's Case [1938] HCA 69 ; 63 CLR 108 are also far removed from those of the present case. Dixon J's reasons suggest, however, three things. First, we should expect to be able to identify the meaning and timing of the derivation of dividend income, not necessarily simply by exploring the text of the Act, such as the term "income" or the term "derived", but by reference to relevant business and accounting practice. Second, trading and manufacturing companies have particular features that make an accrual or earnings basis appropriate for them, that are not features of a group holding company such as ABB Zurich, namely, a depletion in a stock of vendible articles on one side of the ledger that would be apt to give a misleading picture as to the company's gain or loss over a period if the corresponding earnings (book debts) arising from the depletion during that period were not shown as income on the other side of the ledger. Third, generally speaking, in order to see whether income has been derived, we should ask whether the income has come home to the taxpayer in a realised or immediately realisable form. 108 Carden's Case [1938] HCA 69 ; 63 CLR 108 suggests that in the absence of features taking the case out of the ordinary or evidence of business and accounting practice pointing to a different result, I should treat the present dividend as income derived if and when it came home to ABB Zurich in a realised or immediately realisable form. 109 Prior's Case 6 ATD 5 was concerned with the application of s 19 of the Income Tax Assessment Act 1922 33 to a capitalisation by a Deed of Dissolution of Partnership dated 13 August 1932, and therefore within the financial year ended 30 June 1933, of an amount of &#8356;2,097 that represented a balance of interest outstanding by one former partner to the other. The sum of &#8356;2,097 was included in a sum of &#8356;8,388 that was agreed to represent the total amount owing by the former partner to the other. As part of the agreement on dissolution, the amount of &#8356;8,388 was secured by a charge "on property already heavily mortgaged and quite incapable of producing a surplus out of which the amount representing interest could be paid" (at 13). 110 The interest was not paid but was carried to a capital account, and in that sense capitalised. Section 19 of the Income Tax Assessment Act 1922 1933 was all but identical to s 19 of the Act (set out at [9] above the words "or money" did not appear in the earlier version). Rich J, with whom Starke and McTiernan JJ agreed, considered that the facts showed that the taxpayer got nothing except a new obligation to pay in exchange for the existing obligation to pay, which made him "no nearer getting his money or of transferring it into anything of any value" (at 12). Rather colourfully, his Honour said: "[a]ll that happened in this case was to change a forlorn hope of interest into a still more forlorn hope of capital" (ibid). Rich J thought that in order to see whether income is being derived, "one must look to realities", adding that while usually payment of interest by cheque involves receipt of income, "payment by a valueless cheque does not" (at 13). Like Dixon J in Carden's Case [1938] HCA 69 ; 63 CLR 108, his Honour also quoted from Sir Houldsworth Shaw &amp; Baker, Law of Income Tax , p111: "for income tax purposes receivability without receipt is nothing". 111 Prior's Case 6 ATD 5 stands for the proposition that s 19 is not engaged where there is no increase in the taxpayer's resources. There was such an increase in the resources of ABB Zurich upon declaration of the dividend. It was certain that the dividend would be paid; it was ABB Zurich's decision to fix a future date for payment; and immediately after declaration of the dividend ABB Zurich was able to sell the right to be paid it. Prior's Case is therefore of little relevance to the present case. 112 Arthur Murray (NSW) Pty Ltd v Commissioner of Taxation [1965] HCA 58 ; (1965) 114 CLR 314 ( Arthur Murray ) was, in a sense, the converse of Carden's Case [1938] HCA 69 ; 63 CLR 108. The taxpayer company received fees for dancing lessons yet to be given. It placed the fees in a suspense account until the lessons were given, when it transferred them to its revenue account. The High Court held that the fees were not assessable income at the time of receipt. 113 In their joint judgment, Barwick CJ, Kitto and Taylor JJ said that Dixon J's reference in Carden's Case [1938] HCA 69 ; 63 CLR 108 to monies having "come home" to the taxpayer, was a reference, not simply to receipt, but to the reaching of a situation in which monies received might properly be counted as gains completely made, so that there was neither legal nor business unsoundness in regarding them, without qualification, as income derived. Their Honours stated (at 318): The ultimate inquiry in either kind of case, of course, must be whether that which has taken place, be it the earning or the receipt, is enough by itself to satisfy the general understanding among practical business people of what constitutes a derivation of income. A conclusion as to what that understanding is may be assisted by considering standard accountancy methods, for they have been evolved in the business community for the very purpose of reflecting received opinions as to the sound view to take of particular kinds of items. ... A judicial decision as to whether an amount received but not yet earned or an amount earned but not yet received is income must depend basically upon the judicial understanding of the meaning which the word conveys to those whose concern it is to observe the distinctions it implies. What ultimately matters is the concept; book-keeping methods are but evidence of the concept. Their Honours noted that it was agreed that according to established accountancy and commercial principles, in the case of a business selling goods or supplying services, amounts received in advance of the goods being delivered or the services supplied are not regarded as income until the goods are delivered or the services supplied. 114 Their Honours recognised that where statute lays down a test for the inclusion of particular kinds of receipts in assessable income, commercial and accounting practice cannot be substituted for the test, but said there was no such test in the case before the Court, the only relevant word being "income", which was to be understood according to "the vocabulary of business affairs" (at 320). 115 Subsection (1) of s 128B does not, in my view, lay down a test of the kind contemplated by their Honours. The subsection invokes the notion of "income ... derived", and I am required to have regard to general commercial and accounting practice, if evidence of it is put before the Court, as to when income consisting of a dividend declared in the circumstances of the present case is regarded as having "come home" to the parent company. 116 In South Australia v Commonwealth [1992] HCA 7 ; (1992) 174 CLR 235, Dixon J's judgment in Carden's Case was again referred to by the High Court. In a joint judgment, Mason CJ, Deane, Toohey and Gaudron JJ said (at 252) that in accordance with Dixon J's statement in Carden's Case [1938] HCA 69 ; 63 CLR 108 at 152 (see [106] (1), (2) above), "the courts have placed reliance upon the conceptions of business and the principles and practices of commercial accountancy in order to arrive at an assessment of income, the object being 'to discover what gains have during the period of account come home to the taxpayer in a realised or immediately realizable form'" (their Honours were quoting from Dixon J in Carden's Case [1938] HCA 69 ; 63 CLR 108 at 155). 146 In Commissioner of Taxation v Citibank Ltd (1993) 44 FCR 434, Hill J, with whom Jenkinson and Einfeld JJ agreed, cautioned against a too ready reliance on business and accounting practice relating to preparation of the company's profit and loss account required in accordance with s 269(1) of the Companies (New South Wales) Code (at 443 446). His Honour stated (at 445 446): With respect to his Honour, who presumably must be taken as having decided otherwise, I do not think that the accounting evidence in the present case establishes that the amount derived each year by applying the financial or actuarial method represents income in ordinary concepts. What that evidence establishes is that the outcome of the finance or actuarial method is an appropriate figure to be used in the preparation of the profit and loss account of the respondent for the year in accordance with the Companies (New South Wales) Code : s 269(1). If the relevant issue were the determination of the profit of the respondents, or whether that profit was to be seen as on revenue account, the evidence would clearly be most cogent. But it must be remembered that the role of the accounting standards is in the determination of profit so as to ensure that financial statements, required to be prepared by statute, give a true and fair view and not the determination of "income", notwithstanding that those two concepts may, as will be seen, sometimes overlap. Thus Professor Walker [an expert witness] states that he has been asked to advise as to the correct method of accounting in relation to the leases in question. But his affidavit and subsequent explanation makes it clear that he has answered that question by reference to the companies law for the purposes of which the relevant standards have been prepared and with which of course each of the respondents was obliged to comply. Mr Westworth's affidavit [regarding accounting practices] makes clear that he too has addressed himself to that issue, not relevant in the present proceedings. All that may be said is that if there be no impediment in the Act to bringing into account, in a case such as the present, a net profit figure as gross income, then that profit figure will need to be calculated in accordance with the accounting standards. The real issue for decision is rather a question of construction of the Act, namely, whether in a case such as the present, the scheme of the Act precludes treating as gross income the net profit calculated in accordance with the financial or actuarial method. Hill J noted earlier, however, that accounting evidence was often relevant and often highly significant in resolving issues under the Act. He gave as an example the issue whether a cash receipts or accruals basis of accounting will give "a true reflex of the income derived by a taxpayer" (at 443, citing Carden's Case [1938] HCA 69 ; 63 CLR 108 his Honour also cited Arthur Murray [1965] HCA 58 ; 114 CLR 314).