FEDERAL COURT OF AUSTRALIA

Commissioner of Taxation v Day [2007] FCAFC 193

TAXATION – income tax – deductions – deductibility of legal expenses – expenditure incurred in gaining or producing your assessable income – expenditure incurred in the course of gaining or producing assessable income – occasion of expenditure – incurred in the course of employment – performance of duties of employment – observance of duties of employment – purpose of incurring legal expenses – defence of income from employment – whether defence of charges is productive of assessable income – success or failure of legal proceedings irrelevant to deductibility of legal expenses – whether purpose alone is test for deductibility  - apportionment of deduction: “to the extent …”

PRACTICE & PROCEDURE – issue estoppel – consent order giving rise to issue estoppel – question in statement of facts, issues and contentions finally determined – similar but not identical questions not finally determined – onus on taxpayer to demonstrate assessment excessive

Taxation Administration Act 1953 (Cth) s 14ZZO
Income Assessment Tax Act 1997 (Cth) s 8-1
Income Tax Assessment Act 1936 (Cth)s 51
Income Tax Assessment Acts 1922-1930 (Cth) ss 23, 25
Public Service Act 1922 (Cth) ss 56, 61, and 62
Public Service Regulations 1922 (Cth)

Amalgamated Zinc (De Bavay’s) Ltd v Federal Commissioner of Taxation (1935) 54 CLR 295 considered
Chamberlain v Deputy Commissioner of Taxation (1988) 164 CLR 502 considered
Commissioner of Taxation (NSW) v Ash; Ash v Federal Commissioner of Taxation (1938) 61 CLR 263 cited
Commissioner of Taxation v Payne (2001) 202 CLR 93 applied
Commissioner of Taxation v Rowe (1995) 60 FCR 99 considered
Day v Commissioner of Taxation (2006)62ATR 530 not followed
Fletcher v Commissioner of Taxation (1991) 173 CLR 1 applied
Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946) 72 CLR 634 considered
Herald & Weekly Times Ltd v Federal Commissioner of Taxation (1932) 48 CLR 113 considered
John Fairfax & Sons Pty Ltd v  Commissioner of Taxation (1959) 101 CLR 30 applied
Lunney v Commissioner of Taxation (1957-1958) 100 CLR 478 considered
Makhoul v Barnes (1995) 60 FCR 572 considered
Murphy v Abi-Saab (1995) 37 NSWLR 280 considered
Ronpibon Tin NL and Tongkah Compound NL v Commissioner of Taxation (1949) 78 CLR 47 considered
The Herald and Weekly Times Ltd v Commissioner of Taxation (1932) 48 CLR 113 considered
W Nevill & Co Ltd v Federal Commissioner of Taxation (1937) 56 CLR 290 considered

COMMISSIONER OF TAXATION v SHANE DAY

NSD 1191 OF 2006

SPENDER, DOWSETT AND EDMONDS JJ

21 december 2007

SYDNEY

THE COURT ORDERS THAT:

1.                  The appeal and cross-appeal be allowed.

2.                  The matter be remitted to the Commissioner of Taxation for determination according to law.

3.                  There be no order as to costs.

Note:    Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

REASONS FOR JUDGMENT

SPENDER J:

1                     This is an appeal and cross-appeal from the judgment of Emmett J (the primary judge) pronounced on 30 May 2006, concerning the deductibility of legal expenses incurred by the respondent, Shane Day (the taxpayer), associated with defending three sets of charges brought against him pursuant to the now repealed Public Service Act 1922 (Cth) (Public Service Act). 

2                     The proceeding before the primary judge was an appeal against a decision by the Commissioner on an objection by the taxpayer against an assessment to tax for the year ended 30 June 2002.   His Honour’s judgment is reported at (2006)62ATR 530; [2006] FCA 655. 

3                     The primary judge disallowed the entitlement to deductibility in respect of the legal expenses associated with the first set of charges; allowed the deductibility of expenses associated with the second set of charges; and found that the legal expenses associated with the third set of charges were not deductible, but held that the Commissioner was estopped from denying their deductibility in the 2002 year.  This estoppel was found to be a consequence of a judgment entered by consent in respect of legal expenses associated with resisting the third set of charges incurred by the taxpayer in the 2001 tax year.

4                     The Commissioner appeals against the application of issue estoppel in respect of the legal expenses associated with the third set of charges.  The taxpayer cross appeals against the finding that the legal expenses in association with the first charge, and the legal expenses associated with the third set of charges were not deductible.         

Background facts

5                     In 1997, 1998 and 1999, the taxpayer was employed as a senior compliance officer with the Australian Customs Services (Customs).  As such he was “an officer” for the purposes of the Public Service Act. 

6                     Section 61(2) of the Public Service Act provided that:

Where an officer authorized by the Secretary … is of the opinion that an officer may have failed to fulfil his duty as an officer, an authorised officer shall … if he decides  that the officer should be charged …  charge the officer with the failure.

7                     Section 56 of the Public Service Act relevantly provided:

For the purposes of this Subdivision and Subdivisions B, C and E, an officer shall be taken to have failed to fulfil his duty as an officer if and only if:

…

(d)       he engages in improper conduct as an officer;

…

(f)        he contravenes or fails to comply with:

(i)         a provision … of the regulations …

8                     The facts in relation to the First Charge, as summarised in the appellant’s written submissions, are:

On 23 September 1998, Ms Williams, an authorised officer of Customs, gave written notice to the respondent of a charge pursuant to s 61(2) of the Public Service Act of having failed to fulfil his duty as an officer within the meaning of s 56(d) (“the First Charge”).

The particulars of the First Charge were that on 21 September 1998 the respondent breached the standards of conduct for Customs officers in that he presented his official customs identification card to gain access to one Barbara Baker at the Downing Centre local Court in Sydney in order to obtain information regarding a search warrant.

An enquiry into the charge was held by an officer appointed for that purpose (“the enquiry officer”) under s62(1) of the Public Service Act.  The enquiry officer found the charge proven and directed that the respondent be demoted and his salary reduced.

The respondent exercised his right of appeal to a Disciplinary Appeal Committee which on 24 February 1999 found that the first charge was proven, but varied the enquiry officer’s direction.

The respondent applied to the Federal Court for orders under the Administrative Decisions (Judicial Review) Act 1977 in respect of the decision of the Disciplinary Appeal Committee.

On 22 October 1999, Gyles J ordered that the decision of 24 February 1999 be set aside and the matter be remitted to a Disciplinary Appeal Committee to be heard according to law.  On 13 April 2000, the Full Federal Court dismissed an appeal by the Commonwealth.

The matter was remitted and on 28 December 2000 the Disciplinary Appeal Committee set aside the direction of the enquiry officer of 10 December 1998 and ordered the Commonwealth to pay the respondent’s costs.

In the year ended 30 June 2002 the respondent paid legal expenses which he had incurred for the appearance and advice of Counsel in and in relation to the hearings before the Disciplinary Appeal Committee and in the proceedings at first instance and on appeal in the Federal Court.  After giving credit for the amount recovered from the Commonwealth under the costs orders, the amount claimed by the respondent as a deduction in respect of legal expenses for the first charge was $7,903.00.

9                     The facts in relation to the second charges are:

On 13 November 1998, Ms Williams gave written notice to the respondent of further charges under s 61 of the Public Service Act (“the second charges”).  The charges related to alleged failures on the part of the respondent, on various dates in 1997 and 1998, to fulfil his duty under s 56(f)(i) of the Public Service Act, insofar as he failed to comply with the provisions of Regulation 13.  The charges alleged that he did not accurately record attendance in connection with his employment.

On 2 August 1999 the enquiry officer gave a decision that he was satisfied that the majority of the second charges were proven and directed in respect of the charges that an amount of money be deducted from his salary.

The respondent appealed to the Disciplinary Appeal Committee which on 11 February 2002 varied the decision of the enquiry officer by directing that the respondent be transferred to a position at another level within Customs and paid the salary payable to an officer at the top of the salary range fore that level.  The transfer represented a demotion and reduction in remuneration.

In the year ended 30 June 2002, the respondent incurred legal fees of $220.00 in respect of advice provided by Counsel in relation to his appeal to the Disciplinary Appeal Committee.

10                  The facts in relation to the third charges are:

On 22 March 1999, Ms Williams gave the respondent notice of seven further charges under s 61 of the Public Service Act which alleged that the respondent had failed to fulfil his duty as an officer within the meaning of s 56(d) at various times from 1997 to 1999 (“the third charges”).

In connection with the charges, Customs received from the Australian Federal Police copies of transcripts of telephonic interceptions of telephones used by the respondent, which had been obtained pursuant to warrants issued under the Telecommunications (Interception) Act 1979.

On 24 August 1999, the respondent commenced a proceeding in the Federal Court in which he sought orders that the third charges be set aside, the enquiry under s 62 of the Public Service Act be stayed, a declaration that the communication by the Australian Federal Police to Customs of the telephonic interceptions was unlawful, and damages.

The application to the Federal Court was dismissed by Einfeld J on 31 March 2000, and an appeal to the Full Federal Court was dismissed on 11 September 2000.  On 9 October 2000, the respondent filed an application to the High Court for special leave to appeal, which was subsequently dismissed with costs.

In the year ended 30 June 2002, the respondent paid Counsel’s fees to Mr Roberts SC in the sum of $23,014 and Mr Gageler SC in the sum of $5,940 for advice and representation in the proceedings before the Federal Court and the High Court.

11                  In the year ended 30 June 2001, the taxpayer had paid the sum of $6,000 to Mr D.F. Jackson QC for fees in respect of the third charges.  The Commissioner had assessed the respondent in respect of the year ended 30 June 2001 on the basis that the fees paid to Mr Jackson QC were not deductible.  The taxpayer objected to the assessment, which the Commissioner disallowed.  The taxpayer appealed to the Federal Court from the objection decision.  Finn J, by consent, ordered (amongst other things) that the appellant amend the respondent’s assessment for the year ended 30 June 2001 to allow the deduction of $6,000 for the legal fees paid to Mr Jackson QC.

12                  In obedience to that order, a Notice of Amended Assessment was issued on 8 January 2004 in respect of the year 2001 in which the sum of $6,000 was allowed as a deduction from the taxpayer’s assessable income for the 2001 tax year.

Estoppel

13                  It is convenient to deal with the Commissioner’s appeal against the finding by the primary judge that the Commissioner was estopped from contending that the legal expenses paid to Mr Roberts SC and Mr Gageler SC were not deductible. 

14                  The doctrine of issue estoppel is confined to the fundamental issues of fact and law that were determined in the earlier proceedings.  In Murphy v Abi-Saab (1995) 37 NSWLR 280 Gleeson CJ said at 287-8:

In Rogers v The Queen (1994) 181 CLR 251 at 261, Brennan CJ said that the essence of the doctrine of issue estoppel was defined in the following words of Dixon J in Blair v Curran (at 531):

“A judicial determination directly involving an issue of fact or of law disposes once for all of the issues, so that it cannot afterwards be raised between the same parties or their privies.”

Whether a judicial determination directly involves an issue of fact or law may be easier to decide where there are pleadings than where, as in Equity proceedings No 4685 of 1992, there was simply a summons.  However, asGummow J observed in Trawl Industries of Australia Pty Ltd (In Liq) v Effem Foods Pty Ltd (1992) 108 ALR 335 at 347, very many controversies now come before superior courts without pleadings, and it is necessary to focus upon the substance of the proceedings.  Where there are pleadings, the nature of the resulting estoppels may depend upon choices made by the parties as to what they will plead.

15                  A consent judgment may give rise to issue estoppel, but it does so only in respect of the fundamental issue or issues which were clearly determined by the judgment.  In Makhoul v Barnes (1995) 60 FCR 572 at 582, the Full Court of the Federal Court (Hill, Cooper and Branson JJ) said:  

… it seems now to be clear that a judgment entered by consent is as much a judgment as one obtained after a full argument and as such capable offounding an estoppel: see G Spencer-Bower and A K Turner, Res Judicata, (2^nd ed, 1969), p 37 and cases cited at note 5.  Thus, provided it is clear what the issues involved in the consent order may be, those issues will be taken as having been conclusively determined so as to prevent [their] being raised insubsequent proceedings:cf Thompson v Moore (1889) 23 LR Ir 599.

16                  Because the judgment was entered by consent, there is some difficulty in ascertaining what the judgment necessarily decided: see the observations in Chamberlain v DCT (1987-1988) 164 CLR 502 at 508. 

17                  In the present case, neither deductibility of the legal expenses incurred in the 2002 year, nor their connection with the gaining or producing of assessable income, was mentioned in the Court documents in the earlier proceedings, let alone raised as a fundamental issue for determination in those proceedings.

18                  The statement of facts, issues and contentions filed by the parties, and the affidavit relied on by the respondent were directly, and solely directed, to deductibility of the fees paid to Mr Jackson QC in 2001, and the connection between that fee and the gaining or producing assessable income. It is those issues and no others which were determined by the consent judgment.

19                  In those circumstances, in my opinion, there is no estoppel in relation to the issues raised in the current proceeding.  The consent judgment involved no determination of the issues as to the connection between legal expenses paid to other people for other services in a later tax year, and the gaining or producing of assessable income, or the deductibility of those expenses under s 8-1 of the Income Assessment Tax Act 1997 (Cth) (the 1997 Act).

20                  It follows, in my respectful opinion, that the primary judge, having held that the legal expenses paid to Mr Roberts SC and Mr Gageler SC in relation to the third charges were not deductible under the 1997 Act, erred in holding that the appellant was estopped, as a consequence of consent judgment of Finn J concerning the deductibility of the legal fees paid to Mr Jackson QC in the tax year ending 30 June 2001, from denying that those charges were allowable deductions.

The cross appeal

21                  It is convenient to turn to the questions raised by the cross appeal, which are whether the legal expenses paid in respect of the first charge, and the legal expenses in relation to the third charges, were deductible pursuant to the 1997 Act. 

22                  The Commissioner of Taxation no longer presses the appeal in relation to the legal expenses, which related to the second charges.  The primary judge found that these expenses were deductible.

23                  The respondent contends that the primary judge erred in holding the legal expenses paid to Mr Roberts SC in relation to the first charge, and the legal expenses paid to Mr Roberts SC and Mr Gageler SC in relation to the third charges were not deductible under s 8-1 of  the 1997 Act.  Where the case concerns the payment of legal expenses, the proper characterisation of the expenditure for tax purposes turns on a consideration of the circumstances with which the legal proceedings were concerned.

24                  Deductibility of the respondent’s legal expenses depends on satisfying the first limb of s 8-1(1), which applies if those outgoings were “incurred in gaining or producing [his] assessable income” and were not outgoings of capital or of a capital, private, or domestic nature. 

25                  The positive element is satisfied if the outgoing “has an effect in gaining or producing income” (Amalgamated Zinc (De Bavay’s) Ltd v Federal Commissioner of Taxation (1935) 54 CLR 295 at 303 per Latham CJ) and, in applying the test, “[a] very wide application should be given to the expression ‘incurred in gaining or producing the assessable income’” (at 309 per Dixon J). 

26                  The character of an outgoing in terms of this test “can be determined only in relation to the object which the person making the expenditure has in view”: W Nevill & Co Ltd v Federal Commissioner of Taxation (1937) 56 CLR 290 at 301 per Latham CJ.  In that case, the purpose was the conduct of a business on a profitable basis.

27                  In my judgment, the objective purpose of defending the first charges before the Disciplinary Appeal Committee, and the related judicial review and appeal proceedings in the Federal Court, was to protect the respondent from the consequences specified under s 62(6) of the Public Service Act,or to diminish their severity.

28                  The purpose was, therefore, to seek to protect the respondent’s recurrent employment income from diminution or loss, or other adverse impact.

29                  In Herald & Weekly Times Ltd v Federal Commissioner of Taxation (1932) 48 CLR 113 at 118, Gavin Duffy CJ and Dixon J said: 

The question whether money is 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.

30                  Having regard to the purpose for which the liability to legal expenses was incurred, in my respectful opinion, the primary judge erred in his conclusion that if the conduct which resulted in the charges was not engaged in for the purposes of producing assessable income, then expenses in relation to defending those charges were not deductible. The deductibility of  legal expenses in defending charges is not so limited.

31                  In my opinion, expenses incurred in the defence of employment from that which threatens to destroy or diminish its income earning satisfies the positive test for deductibility. 

32                  In Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946) 72 CLR 634, (Hallstroms) Dixon J said at 647:

The claim is to deduct legal expenses, and legal expenses, we may assume, take the quality of an outgoing of a capital nature or of an outgoing on account of revenue from the cause or the purpose of incurring the expenditure.  We are, therefore, remitted to a consideration of the object in view when the legal proceedings were undertaken, or of the situation which impelled the taxpayer to undertake them.

33                  The object in view in respect of the incurring of legal expenses in relation to the first charge, and the object in view in relation to the legal expenses incurred in respect of the third charges, were to resist direct threats to the diminishing of, or the destruction of, the income-earning ability of  the taxpayer.

34                  The situation which impelled the taxpayer to undertake the outlaying of those expenses was the fact that he had been charged under the Public Service Act and the consequence of those charges being successful would be that his income would be diminished or lost.  It is quite irrelevant whether the content of the charges related to activities of his employment, or were extraneous to the proper discharge of his duties. 

35                  There would be no difference if a public servant was charged with being rude to customers in answering complaints, which is conduct engaged in by the public servant in the course of his or her duties, or a charge that he or she had downloaded child pornography from his or her office computer, conduct which is extraneous to the discharge of his or her duties as a public servant. 

36                  The consequence of either charge being sustained is that the public servant’s income might be diminished or lost.  The legal expenses in defending either charge fall within the test set out by Dixon J in Hallstroms.

37                  They would also fall within the test described by Drummond J in Commissioner of Taxation v Rowe (1995) 60 FCR 99 at 115-116. 

38                  There, the taxpayer had incurred costs of legal representation at an inquiry established after his employer, a Shire Council, had called on him to show cause why he should not be dismissed by reason of several complaints made against him.  Drummond J said that his expenses had the requisite nexus because “they were incurred to preserve his entitlement to receive in return for his services, assessable income”. 

39                  Burchett J also said, at 113:

On the question of the deductibility of the expenses incurred by the respondent at the inquiry, I note that the Committee of Inquiry saw these expenses as incurred by him in defending himself from dismissal from his employment.  That view of the matter is, of course, correct.

40                  It is true that Burchett J also considered that the expenses “should be recognised as incurred by the respondent in defending the manner of his performance of his duties.”  In the circumstances of that case, having regard to the charge, it was correct to say, “It was only by so justifying himself that he could make a successful defence against dismissal.” 

41                  In my view, the deductibility of legal expenses by a public servant in defending charges under the Public Service Act, which, if successful, might impact on the earnings of a taxpayer, are not to be limited to where the expenses are incurred “in defending the manner of his performance of his duties.” 

42                  The conduct of the taxpayer the subject of the two sets of charges, was conduct extraneous to and outside the activities by which he derived assessable income.  However, the incurring of the legal expenses was to protect the income of the taxpayer of his employment from the threat constituted by those charges to destroy or diminish his income earning.

43                  In my respectful opinion, and contrary to the conclusion which the primary judge in fact reached, the position as to deductibility was correctly described by the primary judge in [34] of his Honour’s reasons:

If incurring costs can be shown to contribute to the success of an employee in defending himself from dismissal from his employment and costs are incurred to preserve the employee’s entitlement to receive, in return for his services, assessable income, the costs will be deductible. (Rowe at 115-116).

44                  In the circumstances of this particular case, the defence of the first charge was productive of assessable of income, in that it restored to the taxpayer that income which had been deducted from his leave entitlements during the period of his suspension.

45                  In relation to the third charges, while it cannot be said that the expenses relating to those third charges actually restored income to the taxpayer in respect of his period of suspension, that would have been the result if the proceedings had succeeded.

46                  The success or failure of legal proceedings is irrelevant on the question of deductibility of the legal expenses incurred in the conduct of those legal proceedings.

47                  For the above reasons, the legal expenses associated with all sets of charges in this case are deductible according to s 8-1 of the 1997 Act.  

48                  The appeal and cross-appeal should be allowed, and the matter remitted to the Commissioner for determination according to law.

49                  The respondent taxpayer was provided with funding under the ATO Test Case Litigation Programme to assist him to meet his costs of the proceeding.  By the consent of the parties, it is appropriate to order that there be no order as to costs.

Associate:

Dated:         21 December 2007

REASONS FOR JUDGMENT

DOWSETT J:

50                  I have read the reasons prepared by Spender J and those prepared by Edmonds J.  The facts of the case appear sufficiently from the reasons of Spender J. 

ESTOPPEL

51                  I agree with their Honours that the Commissioner’s appeal concerning the estoppel issue should be allowed.  I need only add a few short comments concerning this aspect of the case.  It was for the respondent (the “taxpayer”) to demonstrate that the Commissioner’s assessment was excessive under s 14ZZO of the Taxation Administration Act 1953 (Cth).  At first instance the taxpayer seems not to have identified any underlying issue necessarily determined by the consent judgment of Finn J, by which I mean any issue other than the deductibility of Mr Jackson’s fee in the 2001 tax year.  That, in itself, said nothing about the deductibility of fees of other barristers incurred in connection with the same proceedings in the 2002 year.  At [72] Emmett J indicated that the Commissioner had not suggested that the fees paid to Mr Gageler SC should be treated as being in ‘any different category’ from that paid to Mr Jackson QC.  His Honour also inferred that the fees paid to Mr Roberts SC, although they ‘may be in a different category’ would also be allowable deductions.  In my view, if the taxpayer wished to rely on the judgment of Finn J as resolving the question of the deductibility of Mr Gageler and Mr Roberts’ fees in the 2002 year, it was for him to demonstrate how the decision in the earlier case did so. 

DEDUCTIBILITY OF FEES INCURRED IN CONNECTION WITH FIRST CHARGE AND THE THIRD CHARGES

52                  Emmett J was correct in concluding that the legal expenses incurred by the taxpayer in relation to the First Charge and the Third Charges were not deductible pursuant to s 8-1 of the Income Tax Assessment Act 1997 (Cth) (the “1997 Act”).  That section provides relevantly:

‘1.        You can deduct from your assessable income any loss or outgoing to the extent that:

(a)       it is incurred in gaining or producing your assessable income; or

(b)       it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

…

2.         However you cannot deduct a loss or outgoing under this section to the extent that:

(a)       it is a loss or outgoing of capital; or of a capital nature; or

(b)       it is a loss or outgoing of a private or domestic nature … .’

53                  Section 8-1 is, of course, the successor to s 51(1) of the Income Tax Assessment Act 1936 (Cth) (the “1936 Act”).  It has not been suggested that the sections are to different effect.  The decision of the High Court in Federal Commissioner of Taxation v Payne (2001) 202 CLR 93 at [16]-[17] concerned the deductibility of travel expenses incurred in connection with travel between two places of work.  The majority (Gleeson CJ, Kirby and Hayne JJ) said at [16]-[17]:

‘16.      …  The principle which … must be applied in this (case), is one which limits the allowance of a deduction for outgoings to those outgoings that are incurred in the course of deriving assessable income.  It is a principle which excludes outgoings which, although incurred for the purpose of deriving assessable income, are not incurred in the course of doing so.  Distinguishing between those two kinds of outgoing may well invite some criticism, but if it does, the criticism is directed at the legislation, not at the way in which the legislation has been interpreted. 

17.       Moreover, the distinction has long been made and it is now too late for the Court to “rip it up” and treat the section as allowing any and all deductions having some causal connection with the derivation of assessable income.  …  (T)he distinction between outgoings incurred in the course of deriving income and other outgoings is a distinction which applies generally, not just in relation to travel expenses.’

54                  For present purposes it is helpful to consider that passage in conjunction with the decision in Fletcher v Commissioner of Taxation (1991) 173 CLR 1 where, at [17]-[19], the High Court said:

‘17.      The question whether an outgoing was, for the purposes of section 51(1), wholly or partly “incurred in gaining or producing the assessable income” is a question of characterization.  The relationship between the outgoing and the assessable income must be such as to impart to the outgoing the character of an outgoing of the relevant kind.  It has been pointed out on many occasions in the cases that an outgoing will not properly be characterized as having been incurred in gaining or producing assessable income unless it was “incidental and relevant to that end” … .  It has also been said that the test of deductibility under the first limb of section 51(1) is that “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” … .  So to say is not, however, to exclude the motive of the taxpayer in making the outgoing as a possibly relevant factor in characterization for the purposes of the first limb of section 51(1).  At least in a case where the outgoing has been voluntarily incurred, the end which a taxpayer subjectively had in view in incurring it may, depending upon the circumstances of the particular case, constitute an element, and possibility the decisive element, in characterization of either the whole or part of the outgoing for the purposes of the subsection … .  In that regard and in the context of the sub-section’s clear contemplation of apportionment, statements in the cases to the effect that it is sufficient for the purposes of section 51(1) that the production of assessable income is “the occasion” of the outgoing … or that the outgoing is a “cost of a step taken in the process of gaining or producing income” … are to be understood as referring to a genuine and not colourable relationship between the whole of the expenditure and the production of such income.

18.       Nonetheless, it is commonly possible to characterize an outgoing as being wholly of the kind referred to in the first limb of section 51(1) without any need to refer to the taxpayer’s subjective thought processes.  That is ordinarily so in a case where the outgoing gives rise to the receipt of a larger amount of assessable income.  In such a case, the characterization of the particular outgoing as wholly of a kind referred to in section 51(1) will ordinarily not be affected by consideration of the taxpayer’s subjective motivation.  If, for example, a particular item of assessable income can be earned by making a lesser outgoing in one of two possible ways, one of which is a loss or outgoing of the kind described in section 51(1) and the other of which is not, it will ordinarily be irrelevant that the taxpayer’s choice of the method which was tax deductible was motivated by taxation considerations or that the non-deductible outgoing would have been less than the deductible one.  In such a case, the objective relationship between the outgoing actually made and the greater amount of assessable income actually earned suffices, without more, to characterize the whole outgoing as one which was incurred in gaining or producing assessable income.  If the outgoing can properly be wholly so characterized, it “is not for the Court or the commissioner to say how much a taxpayer ought to spend in obtaining his income, but only how much he has spent” … .

19.       The position may, however, well be different in a case where no relevant assessable income can be identified or where the relevant assessable income is less than the amount of the outgoing.  Even in a case where some assessable income is derived as a result of the outgoing, the disproportion between the detriment of the outgoing and the benefit of the income may give rise to a need to resolve the problem of characterization of the outgoing for the purposes of the subsection by a weighing of the various aspects of the whole set of circumstances, including direct and indirect objects and advantages which the taxpayer sought in making the outgoing … .  Where that it so, it is a “commonsense” or “practical” weighing of all the factors which must provide the ultimate answer … .  If, upon consideration of all those factors, it appears that, notwithstanding the disproportion between outgoing and income, the whole outgoing is properly to be characterized as genuinely and not colourably incurred in gaining or producing assessable income, the entire outgoing will fall within the first limb of section 51(1) unless it is either somehow excluded by the exception of “outgoings of capital, or of a capital, private or domestic nature” or “incurred in relation to the gaining or production of exempt income”.’

55                  The decision in Payne demonstrates that an outgoing will only be an allowable deduction if it is incurred in the course of deriving assessable income.  An outgoing incurred for the purpose of doing so will not, by reason of such purpose alone, be an allowable deduction.  However Fletcher establishes that subjective purpose may be a relevant consideration in deciding whether an outgoing was incurred in the course of deriving assessable income.  An example of this is the situation in which an outgoing appears to be disproportionate to the income derived as a result of it.  This fact may suggest that the outgoing was not really incurred in deriving assessable income, but in some other context.  In that situation, evidence of subjective purpose may be relevant.  Fletcher does not detract from the proposition established by Payne that purpose, alone, is not the test for deductibility.

56                  Both Payne and Fletcher reflect a long-standing approach to this question.  An early decision under the Income Tax Assessment Acts 1922-1930 (Cth) (the “1922 Act”) was the decision of the High Court in The Herald and Weekly Times Ltd v Federal Commissioner of Taxation (1932) 48 CLR 113.  The relevant provision, s 23 was in similar but not identical terms to s 51 of the 1936 Act.  That case concerned the deductibility of legal expenses incurred by the proprietor and publisher of an evening newspaper, defending proceedings for defamatory material published in the newspaper.  At 119, Gavan Duffy CJ and Dixon J said:

‘The money was spent to answer the claims, and whether it was expended wholly and exclusively for the production of income, must depend upon the manner in which the claims were incurred.  When it appears that the inclusion in the newspaper of matter alleged by claimants to be defamatory is a regular and almost unavoidable incident of publishing it, so that the claims directly flow from acts done for no other purpose than earning revenue, acts forming the essence of the business, no valid reason remains for denying that the money was wholly and exclusively expended for the production of assessable income.’

57                  The words ‘no other purpose’ should be treated with care.  They may have referred to s 25 which denied deductibility where an outgoing was not laid out ‘wholly and exclusively’ for the production of assessable income.  In Amalgamated Zinc (De Bavay’s) Ltd v The Federal Commissioner of Taxation (1935) 54 CLR 295, the Court considered the deductibility of outgoings incurred by a company which had operated a zinc mine but had ceased to do so at the time of the relevant expenditure.  Because it had previously employed workers in zinc mining it continued to be liable to make payments to a workers’ compensation fund.  The High Court held that such payments, made as a result of previous involvement in the conduct of that business, were not deductible under the 1922 Act.  At 309, Dixon J said:

‘A very wide application should be given to the expression “incurred in gaining or producing the assessable income.”  …  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.’

58                  At 310 his Honour continued:

‘In the present case, the actual expenditure was met in the current year.  But it was completely dissociated from the gaining or producing of the assessable income of that year.  The payment, in effect, did no more than keep down an annual charge arising out of a business which had closed.  …  What is important is the entire lack of connection between the assessable income and the expenditure.  None of the assessable income arose out of the business in the course of which the taxpayer became liable to the charge.  The sources from which the assessable income did arise included no operations in the course of which the payment was made.  It was a payment independent of the production of income, not an expenditure incurred in the course of its production.’

59                  In Ronpibon Tin NL v Federal Commissioner of Taxation (1949) 78 CLR 47, the High Court considered the applicability of s 51(1) of the 1936 Act.  The taxpayer company had, prior to the outbreak of hostilities with Japan, conducted tin mining operations in Siam from which it derived income.  Following the occupation of Siam by the Japanese it derived no income from that activity but maintained an administrative structure in Australia, paying outgoings such as directors’ fees and expenses of management.  It claimed to deduct those expenses from other income earned by it in the relevant tax year.  The Commissioner allowed only a small percentage as a deduction.  At 56-57, the Court observed:

‘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 “in gaining or producing”.  But these latter words have a very wide operation and will cover almost all the ground occupied by the alternative.  …

For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end.  The words “incurred in gaining or producing the assessable income” mean in the course of gaining or producing such income.  …

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.  It is by this standard that the question raised by the present cases must be determined.’

60                  The decision in Lunney v Commissioner of Taxation (1957-1958) 100 CLR 478 concerned expenses incurred in travelling between home and the place of work.  Dixon CJ considered the matter to be settled and beyond argument.  The majority (Williams, Kitto and Taylor JJ) said, at 495-6:

‘The fact that s.51 was intended to deal with a great variety of items of expenditure made it inevitable that it should be couched in general terms and both that section and its immediate predecessor have been the subject of judicial consideration on a number of occasions.  In terms, the section provides that all losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private, or domestic nature.  The language is simple enough and, in the main, little difficulty is encountered in recognising those items of business expenditure which qualify as deductions.  But in the nature of things it has been impossible to devise, as a substitute for the words of the section, a simple formula which will readily and precisely mark the limits of the operation of the section.  Yet, in the course of dealing with individual cases, it has been necessary to devote particular attention to the words “in gaining or producing the assessable income” and “incurred in carrying on a business for the purpose of gaining or producing such income” and to attempt to express precisely what those words mean.

…  In particular, it was said, expenditure is invested with the requisite character if it may properly be regarded as “incidental or relevant” to the derivation of assessable income.  This expression has been used in a variety of cases where it has been necessary to deal with problems arising under the section.  For instance in dealing with the immediate predecessor of s.51 in [Amalgamated Zinc] it was said: “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 … .”  In dealing with the same section in W. Neville & Co. Ltd. V. Federal Commissioner of Taxation … it was said that:  “it is necessary that the expenditure should have been incurred in gaining or producing the assessable income, that is the assessable income of the given financial year or accounting period.  This means that it must have been incurred in the course of gaining or producing the assessable income.  It does not require that the purpose of the expenditure shall be the gaining or production of the income of that year.  The condition the provision expresses is satisfied if the expenditure was made in the given year or accounting period and is incidental and relevant to the operations or activities regularly carried on for the production of income … .”  The same expression was again used in [Ronpibon] … when it became necessary to solve a problem arising under s.51.  In that case it was said that “For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end”.  …  Examination of these cases, however, readily shows that the expression “incidental and relevant” was not used in an attempt to formulate an exclusive and exhaustive test for ascertaining the extent of the operation of the section;  the words were merely used in stating an attribute without which an item of expenditure cannot be regarded as deductible under the section.  That this is so appears from some of the brief passages already quoted and is made quite clear by consideration of the reasons in the cases referred to.  In [Ronpibon] … the passage quoted above … was immediately followed by the observation “The words ‘incurred in gaining or producing the assessable income’ mean in the course of gaining or producing such income” … .  Thereafter, it was said: “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” … .  In the context in which they have been used the expressions relied upon by the appellants have been 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.’

61                  At 498-499 their Honours continued:

‘The question whether the fares which were paid by the appellants are deductible under s.51 should not and, indeed, cannot be solved simply by a process of reasoning which asserts that because expenditure on fares from a taxpayer’s residence to his place of employment or place of business is necessary if assessable income is to be derived, such expenditure must be regarded as “incidental and relevant” to the derivation of such income.  No doubt both of the propositions involved in this contention may, in a limited sense, be conceded but it by no means follows that, in the words of the section, such expenditure is “incurred in gaining or producing the assessable income” or “necessarily incurred in carrying on a business for the purpose of gaining or producing such income”.  It is, of course, beyond question that unless an employee attends at his place of employment he will not derive assessable income and, in one sense, he makes the journey to his place of employment in order that he may earn his income.  But to say that expenditure on fares is a prerequisite to the earning of a taxpayer’s income is not to say that such expenditure is incurred in or in the course of gaining or producing his income.  Whether or not it should be so characterized depends upon considerations which are concerned more with the essential character of the expenditure itself than with the fact that unless it is incurred an employee or a person pursuing a professional practice will not even begin to engage in those activities from which their respective incomes are derived.’

62                  I should refer to three other cases which are mentioned in the reasons prepared by Spender J.  The first is the decision in W Neville & Co Ltd v Federal Commissioner of Taxation (1937) 56 CLR 290 which is also referred to in Lunney.  Spender J cites a passage from the judgment of Latham CJ at 301 to the effect that the character of an outgoing ‘can be determined only in relation to the object which the person making the expenditure has in view.’  In that case the taxpayer company agreed with one of two joint managing directors that he should resign in consideration of the payment of a certain sum.  The taxpayer’s purpose was to reduce its outgoings and to resolve an unsatisfactory management situation.  At 300, Latham J concluded that the payments in question ‘were actually made bona fide in the course of business in the interests of the efficiency of the business’, and that such expenditure was incurred in the course of gaining or producing assessable income.  His Honour then dealt with the Commissioner’s argument that such expenditure was directed towards reducing expenses by securing relief from the contract of employment and did not increase assessable income.  The passage quoted by Spender J appears to have related solely to that argument.  At 304 and 308 respectively, Rich and McTiernan JJ seem also to have treated intention as relevant.  However, at 305 Dixon J said:

‘The question is whether the sum of ₤2,500, or any part of it, should be deducted from the assessable income.  The question is governed by sec.23(1)(a) and sec 25(e) of the Income Tax Assessment Act 1922-1932.  Under the first of these provisions it is necessary that the expenditure should have been incurred in gaining or producing the assessable income, that is the assessable income of the given financial year or accounting period.  This means that it must have been incurred in the course of gaining or producing the assessable income.  It does not require that the purpose of the expenditure shall be the gaining or production of the income of that year.  The condition the provision expresses is satisfied if the expenditure was made in the given year or accounting period and is incidental and relevant to the operations or activities regularly carried on for the production of income.  …’

63                  This may have been a case of the kind contemplated by the High Court in Henderson where purpose was relevant to the question of whether the outgoing was incurred in gaining assessable income but not, alone, determinative of it.  In any event the decision cannot detract from the authority of the clear statement of principle in Payne.

64                  The second case is Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946) 72 CLR 634.  That case involved legal expenses incurred by the taxpayer in resisting an application by a trade competitor to extend a patent.  Had such application been successful the taxpayer’s business would have suffered significantly.  The case was primarily concerned with whether such outgoing should be characterized as on capital or revenue account. 

65                  The third case is Commissioner of Taxation v Rowe (1995) 60 FCR 99.  That case was primarily concerned with an ex gratia payment made by the state government to the taxpayer, a shire engineer, as reimbursement for costs incurred by him in being legally represented at an inquiry.  As the result of certain complaints concerning his work he was suspended by the shire council but subsequently reinstated by the Governor in Council.  The state government directed that there be an inquiry into the circumstances surrounding the resolution to suspend him.  That inquiry involved an examination of his performance of his duties.  He engaged legal representation.  In its findings the committee of inquiry noted that the taxpayer had, in reality, been compelled to engage a solicitor and counsel to defend himself against dismissal.  The taxpayer applied unsuccessfully to the council for reimbursement of his legal expenses.  He subsequently sought and received an ex gratia payment from the state government.  On 26 April 1989 an amount of $24,748.24 was paid to him.  In his tax return for the year ended 30 June 1986 he had claimed legal expenses in the amount of $24,727.99 as a deduction.  This was initially disallowed by the Commissioner but subsequently allowed in full.  He disclosed the ex gratia payment in his return for the year ended 30 June 1989 but sought a ruling that it was received on capital account and was not taxable.  The Commissioner included the amount as income, and the taxpayer objected.  The Commissioner disallowed the objection, but the Administrative Appeals Tribunal eventually upheld it.

66                  On appeal from the decision of the Administrative Appeals Tribunal this Court considered three separate questions, namely:

·                    whether or not the ex gratia payment was taxable income;

·                    whether or not the outgoings were incurred in gaining assessable income; and

·                    if such outgoings were so incurred, whether they were on capital or revenue amount.

67                  The second and third questions are potentially relevant for present purposes, but it will be necessary that I consider only the second question.  Concerning that question, Beaumont J observed at 109:

‘Since the inquiry was centrally concerned with day-to-day aspects of the respondent’s employment, it ought to be concluded that the respondent’s cost of representation before the Inquiry was incurred by him “in” gaining assessable income.’

68                  Concerning the same question Burchett J said at 113:

‘On the question of the deductibility of the expenses incurred by the respondent at the inquiry, I note that the Committee of Inquiry saw these expenses as incurred by him in defending himself from dismissal from his employment.  That view of the matter is, of course, correct.  However, at another level, I think these expenses should be recognized as incurred by the respondent in defending the manner of his performance of his duties.  It was only by so justifying himself that he could make a successful defence against dismissal.  When the matter is seen in this light, it falls squarely within the rule discussed in Putnin v Commissioner of Taxation (1991) 27 FCR 508.  To adapt language there quoted (at 511) from [Herald & Weekly Times], the liabilityin question was incurred, or the claim was encountered, because of the very act of performing the work by which the respondent earned assessable income.  The activities which produced the assessable income were what exposed the taxpayer to the liability discharged by the expenditure.  As the Court said in Putnin at 513, so here, “the … proceedings arose from the activities by which the taxpayer earned his income, the mode of his performance of a particular task carried out in the course of business operations”.

To put the same point in another way, the cause or the purpose of the respondent’s incurring of the expenditure was his assertion that he had faithfully performed the duties by which he had earned assessable income.’

69                  His Honour then turned to the question of whether or not the expenditure was on capital or revenue account, considering the decision in Hallstroms to which I have previously referred. 

70                  I should say that I do not understand the reference by Burchett J in the first sentence quoted above, to the Committee of Inquiry’s opinion concerning the taxpayer’s legal expenses, to have been part of his Honour’s reasons.  As appears from the observations made by Beaumont J at 108, the tax significance of the outgoings was not addressed by the Tribunal, it having assumed that such payments were properly allowable deductions.  I suspect that the reference by Burchett J was relevant to the Commissioner’s assertion that such outgoings ought to be treated as on capital account, notwithstanding his own treatment of them.  The reasons advanced by both Beaumont and Burchett JJ are consistent with the approach taken by the High Court in Payne.  They look to the connection between the work performed to earn assessable income and the incurrence of the liability to which the legal costs relate.

71                  I apprehend that in the present case, the taxpayer submits that Drummond J took a different view.  At [24] and [25] of his written submissions, the taxpayer refers to the decision in Rowe and, in particular, to the judgment of Drummond J as establishing that expenses incurred to defend the taxpayer from ‘something which threatens to destroy or diminish his or her income-earning’ will satisfy the test for deductibility.  The taxpayer seems to accept that Beaumont and Burchett JJ did not adopt such an approach but submits that their reasons do not exclude it.

72                  It is true that in the fourth paragraph on p 115, under the heading ‘Section 25(1)’ Drummond J addresses the broad question ‘… whether legal expenses incurred by an employee to prevent his employer terminating his existing contract of employment are deductible under s 51’.  However, in the next paragraph, his Honour observed that ‘… a real connection between the incurring of the outgoing and the activities which directly result in the gain or production of income …’ will generally be sufficient to make an outgoing deductible.  In assessing the connection between the two propositions one must keep in mind the observation by Beaumont J that the inquiry concerned the ‘day-to-day aspects of the respondent’s employment’, and that by Burchett J, that the costs were incurred in ‘defending the manner of his performance of his duties’.  It may be that Drummond J favoured the wider proposition that costs incurred in defence of employment were, by reason of that purpose alone, deductible.  However the decision was made on facts which justified the conclusion that such costs had been incurred in gaining assessable income.  With all due respect, I am concerned that a test which focuses on whether costs were incurred to defend the taxpayer from loss of employment or diminution in income is a test based on purpose, and therefore inconsistent with the decision in Payne. 

73                  To adopt the language of Payne, in this case it is necessary to identify the course by which the taxpayer derived assessable income.  To adopt the language of Fletcher and Ronpibon, it is necessary to identify that which was productive of such income.  It is relatively clear that the answer to both enquiries is that the taxpayer derived his assessable income from the performance of his duties as a Customs officer.  Conduct in the course of deriving assessable income for the purposes of the test prescribed in Payne would be conduct undertaken in performance of those duties.  Similarly, for the purposes of the test as expressed in Fletcher and Ronpibon, such performance would be that which produced his assessable income.  I find it difficult to construe the language in the cases as necessarily establishing that conduct contrary to express prohibitions in a contract of service, and unconnected to the duties to be performed by the taxpayer, will be conduct in the course of earning assessable income.  In some cases, the relevant prohibited conduct may be closely connected to the performance of particular duties so that the infringing conduct may accurately be so described.  Negligence in such performance is a possible example.  However, when the conduct is completely beyond the scope of the contract, and even forbidden by it, it does violence to language to describe that conduct as being in the course of earning assessable income.

74                  In this case, little attention has been paid to the actual circumstances in which the liability to incur legal costs arose.  The focus has rather been upon the disciplinary charges and, to a lesser extent, their resolution.  The relevant question for taxation purposes may not necessarily be answered by such an approach. The facts out of which the exposure to legal expenses arose must be determined in the manner prescribed by taxation legislation.  Only rarely will the Commissioner have been a party to the taxpayer’s disciplinary proceedings and therefore bound by the outcome.  The taxation legislation looks to the actual factual situation in which the outgoings were incurred, not necessarily to the facts as alleged in legal or disciplinary proceedings, or as found in such proceedings. 

75                  When the costs in question are incurred in disciplinary proceedings, a significant matter in determining whether they are deductible will be whether the alleged facts are true.  An employee may be charged with misconduct, being acts unrelated to his duties, but inconsistent with his continued employment upon existing conditions.  If the allegations are true, then it will be at least arguable that any costs incurred in defending the charge arose out of his or her extraneous conduct and not in the course of earning assessable income.  However, if the allegations are, in fact, false, then there was no such extraneous conduct.  In that situation, it may be more likely that the source of the charge is to be found in the performance of the taxpayer’s duties or in the circumstances in which he or she has performed such duties.  The facts surrounding the incurrence of the costs being different, the question of the deductibility of those costs may be answered differently.

76                  For present purposes it is necessary to identify the circumstances out of which arose the taxpayer’s need to incur the legal expenses in question.  It is then necessary to consider the relationship between those circumstances and the conduct by which the taxpayer earned assessable income.

77                  All of the relevant charges arose under s 61 of the Public Service Act 1922 (Cth) (the “Public Service Act”).  That section provides that an officer may be charged with failure to fulfil his or her duty.  Section 56 gives substance to s 61 by identifying circumstances in which a person may be taken to have failed to perform such duty.  Paragraph 56(d) provides that one such circumstance is where the officer engages in improper conduct as an officer.  The First Charge was that the taxpayer failed to fulfil his duty as an officer by engaging in improper conduct.  It was alleged that he breached the Customs Code of Ethics and Conduct by using his identity card in order to obtain information from a Local Court officer regarding a search warrant executed upon his computer. 

78                  Emmett J considered that the relevant conduct had not occurred in the course of discharge of the taxpayer’s duties.  Although the alleged misconduct may have been described by reference to obligations related to his employment, it does not follow that the outgoings incurred in defending the charge arose out of conduct in the course of earning assessable income.  The taxpayer’s misuse of his identity card was unrelated to the performance of his duties.  Further, unlike the position in Herald and Weekly Times,  there could be no suggestion that such misuse or a charge of misconduct was ‘a regular and almost unavoidable incident’ of performing his duties.  It is likely that the taxpayer’s purpose in incurring such legal expenses was to protect himself from dismissal, reduction in rank or reduction in pay scale, but that is not itself, sufficient to satisfy the test.  His position is more akin to that of a taxpayer who has paid travelling expenses between home and place of work or, as in Payne, between places of performance of unrelated work.  Whilst such expenses are incurred for the purpose of deriving assessable income, they are not incurred in the course of doing so. 

79                  All but one of the Third Charges involved an allegation that the taxpayer had failed to fulfil his duty as an officer  by engaging in improper conduct as an officer contrary to subs 56(d) of the Public Service Act.  The other charge also alleged breach of that subsection but did not, in terms, allege improper conduct.  Nonetheless, the reference to subs 56(d) demonstrates that such an allegation was intended.  

80                  Three of the charges concerned the taxpayer’s alleged conduct in connection with a claim to a diesel fuel rebate by one Tony Panto.  Mr Panto was the partner of Ms Blake, another customs officer.  The first charge was that the taxpayer had failed to inform Customs of certain information given to him by Ms Blake concerning Mr Panto’s claim.  The second charge was that he rendered improper support and assistance to Ms Blake in connection with Mr Panto’s claim.  The third charge was that he was knowingly concerned in the creation of a false diary for use as ‘supposedly contemporaneous records of business-related diesel fuel consumption’. 

81                  The fourth charge alleged that the taxpayer had secured access to, and organized the use of, a work vehicle for the collection and transportation of his daughter for a non-work-related purpose.  The fifth charge was that the taxpayer, being absent from his workplace, asked a colleague to inform his supervisor that he was taking his wife to the doctor, not to record his absence and to turn on his computer, presumably to conceal his absence.  The sixth charge was that he signed and submitted a Customs attendance record which recorded him as being in attendance on 12 June 1998 when he was not.  The seventh charge was that he failed to communicate to Customs certain information concerning an investigation into the affairs of a Mr Partridge.

82                  Some of these charges involved conduct more closely associated with the performance by the taxpayer of his duties, and therefore his derivation of income, than others.  Although the matter seems not to have been pursued, the failure to provide information concerning Mr Panto’s false claims might well be described as conduct in the performance of his duties, as might his failure to provide information in connection with Mr Partridge.  Providing improper support and assistance to Ms Blake in connection with Mr Panto’s claim could not easily be so described.  Participating in the creation of a false diary, use of a work vehicle for an unauthorized private purpose, procuring Mr Andrews to conceal his absence and signing a false attendance record bear varying degrees of relationship to his earning of income.  However it seems that the case was conducted upon the basis that all of the Third Charges should be treated uniformly.  Emmett J observed in his reasons that the taxpayer had not suggested that any of this conduct had involved the performance of his duties as a Customs officer.

83                  In any event the taxpayer took pre-emptive action to prevent the charges proceeding.  He became aware that evidence against him had been obtained by intercepts on his home and work telephones.  He sought to have the charges set aside, to have an inquiry pursuant to s 62 of the Public Service Act aborted and a declaration that communication of the intercepted information to Customs was unlawful.  He did not challenge the lawfulness of the intercepts themselves.  The relevant legal fees were incurred in connection with these proceedings.  The question, then, is whether the claimed deductions flowed from acts done in the course of earning assessable income.

84                  I agree with Emmett J that none of the conduct to which the Third Charges related was performed in discharge of his duties as a Customs officer.  Indeed, all such conduct was clearly motivated by personal interest or, perhaps, a desire to obstruct Customs.  To describe such conduct as being in the course of earning assessable income is, to say the least, counter-intuitive.  That is not to say that outgoings incurred in connection with alleged breaches of a contract of service will necessarily always be excluded from deductibility.  However, where the conduct in question is quite beyond anything contemplated as being involved in the taxpayer’s duties, it will be very difficult to apply the test established in Payne in such a way as to render the outgoings deductible. 

85                  The taxpayer has not demonstrated that the legal expenses incurred in connection with the First Charge and the Third Charges were allowable deductions.  He has therefore not demonstrated that in respect of such deductions, the assessment was excessive.

ORDERS

86                  I have considered the orders which would reflect my reasons, had they prevailed in this appeal.  Emmett J ordered that the objection decision be set aside and that the matter be remitted to the Commissioner for determination according to law.  His Honour had it in mind that the subsequent determination would be in connection with the Second and Third Charges.  Had my view prevailed, only the claimed deductions relating to the Second Charges would have required further consideration.  Nonetheless the orders made by Emmett J would have, effectively and appropriately, disposed of the matter.  This suggests that the appeal, the cross appeal and the notice of contention should have been dismissed.  The parties have agreed as to the costs of the appeal, and so I would not have had to consider them.  However my conclusions may have led to a different order as to the costs at first instance.  That matter was not canvassed before us.  Had my views prevailed, I would have allowed the parties to make further submissions as to the appropriate disposition of the costs below.

Associate:

Dated:         21 December 2007

REASONS FOR JUDGMENT

EDMONDS J:

87                  I have had the advantage of reading a draft of the reasons for judgment of Spender J and gratefully adopt his Honour’s summation of the background facts.  I agree, for the reasons given by his Honour, that the Commissioner’s appeal on the estoppel issue should be allowed.  I also agree with his Honour’s conclusion that the legal expenses incurred by the respondent/cross-appellant (‘the taxpayer’) in relation to the first charge and in relation to the third charges are deductible under s 8-1 of the Income Tax Assessment Act 1997 (Cth) (‘the 1997 Act’) although my reasons for this conclusion are not entirely conterminous with those of his Honour.

88                  The taxpayer is an employee and if the legal expenses are deductible at all, they must be deductible under the first limb of s 8-1; they must be incurred “in gaining or producing your assessable income”.  This has been interpreted by the Courts for over 70 years as requiring that the expenditure be incurred “in the course of” gaining or producing the assessable income and this was recently confirmed by the High Court in Commissioner of Taxation v Payne (2001) 202 CLR 93 at [13] – [17].  As Gleeson CJ, Kirby and Hayne JJ said at [16]:

“It is a principle which excludes outgoings which, although incurred for the purpose of deriving assessable income, are not incurred in the course of doing so.  Distinguishing between those two kinds of outgoing may well invite some criticism, but if it does, the criticism is directed at the legislation, not at the way the legislation has been interpreted.”

(Emphasis in original.)

89                  In Payne, the outgoings in issue were expenditure on travel and accommodation incurred by the taxpayer, a pilot, between the property on which he carried on the business of deer farming in country New South Wales and Sydney airport where he reported for flying duties.  They were his two sources of income.  The majority said (at [14]):

“When, as here, the travel is between two places of unrelated income derivation, the expense cannot be said to be incurred ‘in the course of’ deriving income from either activity.  As the majority of the Full Court recognised in this case:

‘The expenditure was incurred before [the taxpayer] began to perform his duties as a pilot, or after he had fulfilled those duties.  Similarly, in relation to the deer farming business.’

“The expenditure was, as the majority of the Full Court rightly said, ‘not incurred in the course of his employment as a pilot, nor in the course of his deer farming business’.  The taxpayer’s travel occurred in the intervals between the two income-producing activities.  The travel did not occur while the taxpayer was engaged in either activity.  To adopt and adapt the language used in Ronpibon, neither the taxpayer’s employment as a pilot nor the conduct of his business farming deer occasioned the outgoings for travel expenses.  These outgoings were occasioned by the need to be in a position where the taxpayer could set about the tasks by which assessable income would be derived.  In this respect they were no different from expenses incurred in travelling from home to work.”  (Footnotes omitted)

90                  The majority’s reference to the outgoings being ‘occasioned’ by neither the taxpayer’s employment as a pilot nor the conduct of his business farming deer is a reference back to what was said in Ronpibon Tin NL and Tongkah Compound NL v Federal Commissioner of Taxation (1949) 78 CLR 47 at 57:

“… to come within the initial part of [s 51(1)] 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.”

91                  The test as articulated and confirmed in Payne – that the deductibility of expenditure will turn on whether the expenditure is incurred in the course of gaining or producing the assessable income – may be readily applied to disenfranchise expenditure incurred on travel and accommodation between two different sources of income: see Payne at [14].  As a test, it cannot be so readily applied to expenses incurred in defending legal proceedings because the decision to defend those proceedings is divorced from the activities which are productive of that income; this is where the Ronpibon test is helpful – the expenditure will be deductible where the occasion of its incurrence is productive of assessable income.  In the present case, it is the employment of the taxpayer that is the occasion of its incurrence.

92                  With this in mind, it is instructive to look at how the primary judge approached the issue.

The Primary Judge

93                  Speaking generally, his Honour said (at [32]):

“If that which produces assessable income for a taxpayer is what exposes the taxpayer to a liability or claim that is discharged by expenditure, that expenditure will be deductible.  … The question of whether money is expended in and for the production of assessable income is not to be determined by considering only the immediate reason for making the payment …”

94                  The provenance of this as a correct statement of principle in the context of trade or business can be traced back to what was said by Gavan Duffy CJ and Dixon J in Herald & Weekly Times Ltd v Federal Commissioner of Taxation [1932] 48 CLR 113 at 119:

“When it appears that the inclusion in the newspaper of matter alleged by claimants to be defamatory is a regular and almost unavoidable incident of publishing it, so that the claims directly flow from acts done for no other purpose than earning revenue, acts forming the essence of the business, no valid reason remains for denying that the money was wholly and exclusively expended for the production of assessable income.”

and by Rich J in Commissioner of Taxation (NSW) v Ash; Ash v Federal Commissioner of Taxation (1938) 61 CLR 263 at 277:

“There is no difficulty in understanding the view that involuntary outgoings and unforeseen or unavoidable losses should be allowed as deductions when they represent that kind of casualty, mischance or misfortune which is a natural or recognized incident of a particular trade or business the profits of which are in question.”

95                  Speaking of legal expenses, his Honour the primary judge said (at [33]):

“If legal expenses are properly treated as having been incurred by a taxpayer in defending the manner of his performance of his duties, the expenses will be deductible.  If a liability is incurred, or a claim is encountered, because of the very act of performing the work by which a taxpayer earns assessable income, the expense will be deductible.  If a proceeding in respect of which legal expenses are incurred arises from activities by which a taxpayer earns his income or the mode of his performance of a particular task carried out in the course of earning his income, the legal expenses incurred in relation to that proceeding will be deductible.  That is to say, if the cause or the purpose of a taxpayer’s incurring of legal expenses is his assertion that he had faithfully performed the duties by which he had earned assessable income, the expenditure will be deductible (Commissioner of Taxation v Rowe (1995) 60 FCR 99 at 113 (‘Rowe’).”

What his Honour says here is undoubtedly correct.  Legal expenses incurred in defending the manner of the employee’s performance of his duties are clearly incurred “in the course of” gaining or producing the assessable income and therefore deductible.

96                  In the very next paragraph of his reasons, his Honour said (at [34]):

“If incurring costs can be shown to contribute to the success of an employee in defending himself from dismissal from his employment and costs are incurred to preserve the employee’s entitlement to receive, in return for his services, assessable income, the costs will be deductible (Rowe at 115-116).” 

97                  But in the paragraph immediately following, his Honour said (at [35]):

“The proper characterisation of legal expenses depends upon the circumstances with which the proceedings in relation to which the expenses were incurred were concerned.  It is not sufficient to limit the question to the object or purpose, whether subjective or objective, that the proceedings themselves were intended or were hoped to achieve.  A distinction must be drawn between the immediate object sought to be achieved by the particular proceedings in which the legal expenses are incurred and the situation that impelled the Taxpayer to undertake them.  It is not sufficient to say that the proceedings were undertaken in order to … keep one’s job.  The relevant inquiry is what gave rise to the circumstances that made it necessary to incur the expenses in order to protect the reputation or keep the job.  If the activity or conduct that resulted in the need to take such defensive proceedings was an activity or conduct engaged in for the purposes of producing assessable income, that might be one thing.  However, if the activity or conduct was not engaged in for the purposes of producing or deriving assessable income, that would be a different matter.” 

(Emphasis added.)

With respect, it seems to me that this passage from his Honour’s reasons is inconsistent with what his Honour said in the first sentence of the immediately preceding paragraph, set out in [9] above.

98                  Putting this observation to one side, it followed, the primary judge reasoned, that it was necessary to examine the conduct or activity of the taxpayer that was the subject of the charges under the Public Service Act 1922 (Cth) (‘PSA’) to determine whether it was engaged in by the taxpayer for the purpose of, or in the discharge of, his duties as an officer of Customs; if so, the taxpayer may be entitled to claim that the legal expenses were deductible; but if such conduct was not engaged in in the discharge of his duties as an officer of Customs, the expenses were not, on his Honour’s reasoning, deductible (at [36]).

99                  In relation to the first charge, his Honour concluded (at [43]):

“… it is clear that the First Charge was made by reason of conduct that was not engaged in in the performance or discharge of the Taxpayer’s duties as an officer of Customs.  While Gyles J concluded, with considerable hesitation, that the conduct was engaged in as an officer of Customs, it was not engaged in for the purpose of discharging or performing duties as an officer.  It was engaged in in order to find out information concerning his own personal affairs, namely, the reasons for the search of his workstation.  I do not consider that the legal expenses attributable to the First charge were deductible.”

100               In relation to the third charges, his Honour concluded (at [52]):

“The only information before the Court concerning the conduct that was the subject of the Third Charges consists of the particulars furnished to the Taxpayer in connection with the Third Charges and the reasons of Einfeld J and the Full Court.  It was not suggested on behalf of the Taxpayer that the conduct described in the Third Charges involved the performance by the Taxpayer of his duties as an officer.  It could not be said that, in defending the Third Charges, the Taxpayer was defending the manner of his performance of his duties as an officer of Customs.  I would be disposed to conclude, therefore, that the defence of the Third Charges cannot fairly be characterised as a defence by the Taxpayer of the manner of his performance of his duties as an officer of Customs.  Accordingly, legal expenses incurred in relation to the Third Charges would not be deductible.”

Analysis

101               In my view, the test for deductibility of legal expenses is not whether the employee’s conduct or activity that resulted in the need to take defensive proceedings was conduct or activity engaged in for the purpose of producing assessable income – contrary to the extract at [97] above from the primary judge’s reasons at [35]; rather, as explained in Payne, it is whether the expenditure was incurred in the course of gaining or producing the assessable income, in the sense that the occasion of the expenditure is to be found in what is productive of assessable income.

102               In the present case, it is the taxpayer’s employment which is the occasion of the expenditure and the taxpayer’s performance and observance of the duties of that employment is undoubtedly productive of assessable income.  In this regard, the duties of the taxpayer’s employment are not confined to the performance of the tasks of the job description for which he is employed, but extend to the observance of all those duties listed in s 56 of the PSA, non-compliance with any of which, may lead to a charge of ‘misconduct’ under s 61 of the PSA.  Using the present case by way of example, such duties extend to observance of the duty not to engage in improper conduct (s 56(d) of the PSA), the subject of the first charge, and to observance of the duty not to contravene or fail to comply with a provision of the Public Service Regulations 1935 (Cth) (s 56(f)(i) of the PSA), the subject of the third charges. 

103               I am also of the view that the suggestion in [98] above, leading to the conclusions in [99] and [100] above, that legal expenses will be deductible if the conduct or activity of the taxpayer that was the subject of the charges was engaged in by the taxpayer for the purpose of, or in the discharge of, his duties as an officer of Customs, but not otherwise, is not the correct test.  It would set up a dichotomy between conduct and activity undertaken in the performance of the tasks of the job description for which the taxpayer is employed, albeit in breach of s 56(c) of the PSA because it was discharged negligently or carelessly, and conduct or activity which failed to observe the other duties of his employment such as the duty of not engaging in improper conduct as an officer in breach of s 56(d) of the PSA.

104               In both cases, the taxpayer is incurring expenditure (legal expenses) defending, in the first case, his performance of duties of his employment, and in the second case, his observance of duties of his employment.  The performance of one kind of duty and the observance of the other kind of duty equally contribute to the taxpayer’s continued employment which is productive of assessable income, and expenditure incurred in defence of either performance or observance of a duty is, in my view, occasioned by that employment.  For that reason, such expenditure is an allowable deduction.

105               Deductibility of legal expenses, like the deductibility of any other expenditure, cannot be made to depend on the success or failure of achieving the object for which the expenses were incurred.  In other words, on the facts of the present case, the deductibility of the legal expenses cannot be made to depend on whether or not the taxpayer was successful in defending the charges brought against him: see John Fairfax & Sons Pty Ltd v F C of T (1959) 101 CLR 30 at 49 per Menzies J.  In the case of defensive expenditure such as the legal expenses incurred here, it is the ‘occasion’ of the incurrence of these expenses which is determinative, rather than the identification of the antecedent activities which gave rise to the proceedings and the bifurcation of those activities into duties of performance, expenditure on the defence of which is deductible, and duties of observance, expenditure on the defence of which is not deductible.

106               The Commissioner’s appeal should be allowed; as should the taxpayer’s cross-appeal.

Associate:

Dated:    21 December 2007