Commissioner of Inland Revenue v. Robert P. Burns

HCIA000004/1979

Revenue - salaries tax - deductible outgoings and expenses - legal expenses incurred by racehorse trainer in having disqualification removed - not "incurred in the production of the assessable income".

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Coram: Huggins, J.A., Yang and Zimmern, JJ.

Date of Judgment: 6 February 1980

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JUDGMENT

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Huggins, J.A.:

1. The Board of Review reversed the decision of the Commissioner of Inland Revenue upon a short point arising in relation to the outgoings and expenses which may be deducted from the assessable income for the purposes of salaries tax. By leave of the Chief Justice the Commissioner now appeals directly to this court.

2. The relevant statutory provision is s.12(1)(a) of the Inland Revenue Ordinance, which reads:

"In ascertaining the net chargeable income in respect of which a person is chargeable to tax under this Part for any year of assessment, there shall be deducted from the assessable income of that person -

The facts are that the Respondent is a racehorse trainer employed by the Royal Hong Kong Jockey Club. On 26th February 1977 he was charged before the Stewards with contravening one of the Rules of Racing and was disqualified for six months. He appealed against this decision and was successful in having the disqualification set aside. In prosecuting that appeal, however, he incurred legal expenses amounting to $40,000 and it is that sum which the Board of Review has now held he is entitled to deduct from his assessable income for the year of assessment 1976/77. We are asked to say whether the Board of Review was wrong.

3. The Board of Review was referred to four cases - Australian Board of Review Case 49 8 C.T.B.R. (N.S.) 235, The Federal Commissioner of Taxation v Snowden (1958) 7 A.I.T.R. 308, Morgan v Tate & Lyle Ltd. 1955 A.C. 21 and Ward v Commissioners of Inland Revenue 1923 A.C. 145. The Board appears to have thought that all these cases were distinguishable; they emphasized that all the taxpayer's "income was extinguished unless his appeal [to the stewards] was successful" and they held on the facts "that the taxpayer's appeal was necessary for the production of his assessable income and "that the expenditure on legal fees for the appeal was wholly, exclusively and necessarily incurred in the production of his assessable income".

4. The substance of the argument on behalf of the Commissioner is that the Board of Review misdirected itself when it considered whether the appeal was necessary "for" the production of the assessable income. As I understand it, the contention is that, having held that the appeal was necessary for the production of the income, the Board proceeded to conclude that the expenditure on legal fees was therefore incurred in the production of that income. Mr. Barlow submits that this was a non sequitur and that although the expenses were incurred in order to place the Respondent in a position in which he was able to earn part of the assessable income they were not incurred in the production of it. He points out that the removal of the disqualification upon the appeal did not make the Respondent as much as one cent richer, but it did enable him to continue training horses and thus to earn further salary.

5. In support of his argument Mr. Barlow cited a number of cases which were not drawn to the attention of the Board of Review. Perhaps that which demonstrates his point most clearly is Federal Commissioner of Taxation v Hatchett (1971) 125 C.L.R. 494. There the taxpayer was a teacher. With a view to advancing himself in his profession he took two steps, (1) he submitted some theses for the purpose of gaining a Teacher's Higher Certificate and (2) he took a course at a university. In connection with each of these steps he incurred expenses and he sought to deduct some or all of those expenses from his assessable income for income tax. It was held by the High Court of Australia that the expenses of submitting the theses were deductible, because the grant of the Teacher's Higher Certificate automatically entitled him forthwith to be paid more for doing the same type of work without any change in his grade and the outgoings were thus incurred in producing the assessable income. On the other hand, the expenses of the university course were not deductible be cause, although the additional qualification which the taxpayer obtained might make him a better teacher and in course of time might lead to promotion, there was no "perceived connection" between the outgoing and the assessable income.

6. In Lunney v Commissioner of Taxation (1957) 100 C.L.R. 478 the majority of the court thought that there was an important distinction between an expense incurred in gaining income and one incurred necessarily for the purpose of gaining it. In that case the question was whether a taxpayer could deduct the expenses of travelling backwards and forwards to his place of work from his home. In a combined judgment Williams, Kitto and Taylor, JJ. said at p. 498:

"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 characterised 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."

That seems to me in line with the decision in Commissioner of Taxation v Hatchett. The Full Court of Hong Kong came to a similar conclusion in relation to travelling expenses in Commissioner of Inland Revenue v Humphrey (1970) H.K.T.C. 451, although the ratio decidendi there appears to have been that the taxpayer was not on duty when the expenses were incurred. In practice there is probably no real distinction between this "on duty test" and the "perceived connection test" of the Australian courts. As I understand the approach of McTiernan, J. in Lunney's Case it was that he was prepared to recognise a looser "perceived connection" between the expenditure and the assessable income than were the other judges, for he said at p.490:

"In my opinion it is an unduly narrow construction of the initial part of s. 51(1), in the case of an employment, to confine its operation to expenditure made by the taxpayer within the bare physical or temperal limits within which he performs his work or labour and to disregard any expenditure made outside those limits even though it has a necessary relation to the purpose of earning income for which the taxpayer carries on the employment. It is shown by the stated case that the taxpayer could not in the circumstances under which he was situated earn any assessable income by his employment without incurring the cost of travelling which he claims to be an allowable deduction. I cannot see the difference in principle between an expense incurred in gaining income and one incurred necessarily for the purpose of gaining it."

That is an approach which has much to be said for it, but I think the weight of authority is against it. Thus the expense of a baby-sitter was disallowed in Lodge v Federal Commissioner of Taxation (1972) A.T.R. 251, legal expenses to recover remuneration under a service agreement were disallowed in Eagles v Levy (1934) 19 R.T.C. 23 and legal expenses incurred by a solicitor in defending an action brought against him by a former employer on the ground that he had committed a breach of his duty of good faith under the contract of employment and that he had solicited one of the employer's clients were disallowed in Knight v Parry (1972) 48 T.C. 580. In the last of these cases the judge found for the plaintiff on the first ground but for the defendant on the second. Upon these findings the Law Society declined to take any proceedings against the defendant for unprofessional conduct, the Society having previously said that it would not decide whether to institute disciplinary proceedings until the employer had brought a civil action in the courts. The judge gave as his first reason for his decision that the expenses were not deductible that

"even the purpose of protecting himself professionally was not a purpose wholly and exclusively referable to the carrying on of his practice as a solicitor, but for the purpose of seeing that he was not precluded from doing so." (sic)

Although some may regard this as an artificial distinction, there is weighty authority for drawing it and I think that authority ought to be followed.

7. For these reasons I think the answer to the question put to us should be "Yes". I would allow the appeal and restore the decision of the Commissioner.

Yang, J.:

8. I agree.

Zimmern, J.:

9. I also agree.

6th February 1980.