COMPENSATION PAYMENTS; COMMERCIAL … PAYMENTS; COMMERCIAL CONTRACTS; AND THE I.T.A.A ... subject...

COMPENSATION PAYMENTS; COMMERCIAL CONTRACTS;AND THE I.T.A.A. 1936: THE GORDIAN KNOT REVISITED

By GARRY A. MUIR*

1 INTRODUCTION

In maintaining the distinction between capital and income first institutedby legislation nearly two centuries ago, the courts have occasionally facedintractable problems where pragmatism has necessarily triumphed over analysis. Sir Owen Dixon's famous Sun Newspapers] test for distinguishingbetween revenue and capital outgoings is one example, where in reality anumber of unweighted considerations were suggested, with but vague illustrations for their application. The proper manner of apportioning outgoings,and the role of purpose and intention, are others. Yet a fourth, and thesubject of this paper is the characterisation of receipts derived from the saleor loss of intangible rights.

Although less frequently considered than is the case with the other examples given above, the assessability of compensation payments still remains(as recent Supreme Court of Victoria and Federal Court of Australia decisions illustrate)2 a "hard case" category, where recitation of broad criteriais the judicial norm. The judgments of both Courts in Merv Brown Pty Ltdv Federal Commissioner of Taxation suffer no pretension of transmutingrelatively formless inquiry into principle, but they do illustrate the difficulties which the existence of a number of diverse tests can cause. In fact MervBrown was a relatively simple case, but it does provide a practical springboard for a detailed study of the relevant principles.

Merv Brown Pty Ltd, the taxpayer and appellant, was a clothing wholesaler, whose stock in trade consisted both of locally manufacturecl andimported goods. The latter were admitted into Australia under "impo.rt quotaentitlements" held by the taxpayer. These in turn entitled the holder to a lowerrate of duty on the imported goods covered by the quota. In 1980 45070 ofgross sales of $22 million was attributable to imported clothing. The quotaswere allocated by the Federal Government according to certain "classes" ofclothing and subject to its approval, transferable.

As a result of a governmental review of the quota rules in 1980, the taxpayer rationalised its business by selling those of its quotas which relatedto unprofitable lines, and acquiring by purchase others which would increaseimports of profitable items. In the fiscal year ended 30 June 1981, the taxpayer realised $1,698,740 from the sale of quotas; although it appeared thattotal sales and purchases of quotas did not exceed 3070 of the taxpayer's totalquota entitlement. Between 1980 and 1983, and partly as a consequence ofits rationalisation, total'sales more than doubled to $47 million.

*LLB (Hons) (Auckland); BCL (Oxon); Lecturer-in-Law; Australian National University.1 Sun Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337, 363.2 Merv Brown Pty Ltd v Federal Commissioner of Taxation [1984] ATe 4,394; (1985] ATC

4,080.

304 Federal Law Review [VOLUME 15

In allowing the appeal from the Commissioner's determination, and holdingthe receipts to be of a capital nature, Kaye J relied primarily on the testformulated by Lord Cave LC in British Insulated & Helsby Cables Ltd vAtherton;3 which is as follows:

... when an expenditure is made, not only once and for all, but with a viewto bringing into existence an asset or an advantage for the enduring benefit ofa trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure asproperty attributable not to revenue but to capital.

However from his -'~review of the authorities" Kaye J concluded it was alsonecessary to consider other additional matters, which could include "thenature of the business and the use made of the commodity ... in question."4 On the facts of the instant case "foremost among those matters" isthe fact that the taxpayers business did not include speculating inimportquotas. 5 Nor was it in the ordinary course of its business. For these reasonsit was held the receipts by Merv Brown Pty Ltd from the sale of its quotaswere capital items. On appeal to the Federal Court, Bowen CJ and LockhartJ held (Jenkinson J dissenting) in response to the Commissioner's argumentthat the sales of the entitlements were brought about by exigencies occurring in the ordinary course of business, that the taxpayer was not in thebusiness of dealing in such entitlements. This was so even if the transactionshad no effect upon the fundamental structure of the business. The significanceof these findings will be discussed further below.6

2 INCOME/CAPITAL DICHOTOMY

It is submitted that the reasoning of the Supreme Court in Merv Brown PtyLtd v Federal Commissioner of Taxation employs a number of tests, themselves vague in character, to a problem divorced from their intended application. It is necessary in order to understand how this has occurred to examine some basic taxation principles. In demarcating between capital andincome, the existence of certain categories of tests has become tolerably clear.The first category is "source" based; that is to say the identification of thesource of· the receipt is usually sufficient to characterise it as income. Onecan identify two such "sources"; income from property:: and income frompersonal exertion,8 although it may be correct to say that whenever the legis-

3 [1926] AC 205, 213-214.4 Supra n2, 4,405.S Idem.6 Below 333.7 Eg Dividends; rents; interest. The so called "tree-fruit" metaphor is apposite to this type

of receipt: Eisney v Macomber (1919) US 189, 206; The term "source" is obviously used in itssecondary sense as meaning the activity or corpus which produces the income.

8 Providing the services have been rendered to the payer, or the taxpayer is in an employment relationship with the payer: turner y Cuxson (1888) 2 TC 422; Dixon v Federal Commissioner of Taxation (1952) 86 CLR 541, esp 554 per Dixon & Williams JJ. The point has beenmuch confused subsequently, first by statutory language (eg Herbert v Quade [1902] 2 KB 631;Duncan's Executors v Farmer (1909) 5 TC 417); secondly by confusion with the relevant testfor distinguishing "testimonial" payments from a person to whom services had been renderedetc (eg Cooper v Blakiston [1907] 2 KB 688; [1909] AC 106); and finally by failure to identifyclearly the source of payment; (eg Seymour v Reed [1927] AC 554; Moorhouse v Dooland [1955]1 Ch 284).

1985] Compensation Payments; 305

lature brings to tax a type of activity not previously exigible, this ex faciecreates another, albeit narrow, "source" of income.9

The second category catches receipts which may derive from diversesources, but which have the incidence of recurrence. In the SunNewspapers10 case Dixon J suggested that "recurrence is not a test, it is nomore than a consideration the weight of which depends upon the nature ofthe expenditure", but like all general statements it is subject to heavy qualification. First, it was an utterance made in the context of an expenditure,and the courts have found it even more difficult to draw a reasoned linebetween capital and revenue expenditure, than they have between capital andincome receipts. Secondly, recurrence is the one factor which most determines whether the sale of property is or is not in the course of a businessand thus (if it is otherwise a capital item) exigible. Where in fact the taxpayerhas bought and sold an item without expending any other time, energy, ormoney upon it, it may indeed be the only test. 11 In such circumstances it canseen how appropriate is the style of inquiry suggested by Kaye J in MervBrown Pty Ltd; that is, is this sale in the ordinary course of a business [ofbuying and selling similar items with sufficient regularity to constitute incomeand not a capital receipt].

Exactly the same distinction underlines the Cave test in British Insulated& Helsby Cables Ltd v Atherton 12 since something bought and sold once,or which has been of an enduring benefit, will not form the subject matterof a business.

Such an analysis is exceedingly simplistic, 'but it does not necessarily diminish the importance of recurrence as a test. Other factors are sometimes saidto be relevant to ascertaining the existence of a business. 13 For example asubject matter which is usually the subject of trade, or is not usually purchased for private consumption, or for income yield, is likely to suggest abusiness of selling such items, but again repetition is necessary. Converselythose items which are not normally the subject of trade are unlikely per seto involve a presumption of business if sold; but if several are sold theweaker is the presumption of private use. Similarly other so-called 'badgesof business"14 such as the length of period of ownership, or the circum-

9 Eg ss 25A(1); 26AAA; 26(f). CfRW Parsons, "The Meaning of Income and the Structureof Income Tax Assessment Act" (1978) XIII Taxation in Australia 379.

JO Sun Newspapers v Federal Commissioner of Taxation (1938) 62 CLR 337, 362.11 See eg London Australian Investment Co Ltd v Federal Commissioner of Taxation (1977)

138 CLR 106, 130 per Jacobs J, and 117 per Gibbs J; Rutlege v Inland Revenue Commis~ioners (1929) 14 TC 490. The other controlling factor appears to be the necessity for "a purJose, intention or expectation of resale"; and as indicated by Jacobs J at 130 the two factors)f frequency and intention are interrelated. The difficulty however in placing too great an=~mphasison the latter is that the normal legal attitude in revenue law is not to regard intention15 determinative of whether a sum is capital or income. CfRe Duty on Estate ofIncorporated::ouncil of Law Reporting for England and Wales (1888) 22 QBD 279, 293 per Coleridge CJ;JrijJiths v JP Harrison (Watford) Ltd. [1936] AC 1.

12 [1926] AC 205, 213 per Cave LC.13 See generally, United Kingdom Royal Commission on Taxation of Profits and Income,

:md 9474, para 116; Fergusson v Federal Commissioner of Taxation (1979) 26 ALR 307; Blinson, Pinson on Revenue Law (14th ed, 1981) 14-20; PG Whiteman & DC Milne, Whitemanrnd Wheatcroft on Income Tax (2nd ed, 1976) 246-265.

14 Cmd 9474, ibid; Whiteman & Milne, ibid 255.


stances responsible for the realisation, are qualified and perhaps even renderednugatory by the frequency. of similar transactions, since the inference ofprivate use they raise is rebutted.

Sometimes one transaction may be said to amount to a business; but thecircumstances in which this is so do not contradict the importance of recurrence. The first example is the one-off transaction, which because it is presumed it will continue is said to be a transaction in the course of a business. 15 The other is the purchase of an item on which a great deal of work I

is done before it is resold. It may be correct linguistically to characterise thetaxpayer as-carrying on a business of modifying such items during the periodin which he is doing so, but in reality where the taxpayer himself does thework the final sale represents not so much income from a business, as incomefrom personal exertion. 16

In terms of the result in the Merv Brown case, the fact that the taxpayerdid not carryon the business of dealing in import quota entitlements wasprobably correct on the facts. But the receipts from their sale while notincome on a recurrence test, were not thereby prevented from characterisation as income on other tests.

The third category of inquiry is "intentionr' based. According to the generallaw definition of income, a receipt from the sale, otherwise than in the courseof business, of property bought with the sole l7 intention of resale at a profit I

will be assessable as an adventure in the nature of trade. IS How far this principle remains part of Australian jurisprudence after the enactment of s 26(a) I

in 1936 is unclear. More pertinent to the Merv Brown decision is the fourth I

(and according to my analysis penultimate) category which embraces a "compensation" test. 19 The concept briefly stated is that where money is derived I

in lieu of an expected receipt, the character which that latter receipt would I

have had, had it been made, will be ascribed to the compensation received I

in lieu of it. The final category, and one conjectural in its existence and I

application is "an ordingary course of business" test, which brings to tax sums i

not otherwise included under any of the above four categories. 20

15 Rutledge v Inland Revenue C.:ommissioners (1929) 14 TC 490; Fairway Estates Pty Ltd VI

Federal Commissioner of Taxation (1970) 1 ATR 726; Clark v Follet (1973) 48 TC 677; John~

stan v Heath (1970) 46 TC 463; Western Gold Mines No Liability v Commissioner of Taxationfor Western Australia (1938) 1 AITR 248, 250.

16 This conclusion is not possible in the United Kingdom because there is no general cas(catching income from personal exertion, therefore such activity must be characterised as a business. The relationship between income from personal exertion in its common usage and no's6(1) sense,. and the mere realisation of an asset, has not yet been considered.

17 See eg Inland Revenue Commissioners v Fraser (1942) 24 TC 498; 502-503; Rutledge'Inland Revenue Commissioners (1929) 14 TC 490; Edwards v Bairstow [1956] AC 14; cfBlocke.,v Federal Commissioner of Taxation (1923) 31 CLR 503, 508 per Issacs J.

18 In both Investment & Merchant Finance Co Ltd v Federal Commissioner of Taxatiot(1971) 125 CLR 249, and Federal Commissioner of Taxation v Whitfords Beach Pty Ltd (198239 ALR 521 it was held that s 25 should be applied before 26(a) [now 25A(1)]. This would appeato reincorporate the learning on adventures in the nature of trade back into Australian revenulaw.

19 See Generally, KW Ryan, Manual of the Law of Income Tax in Australia (5th ed, 198106-115; RI Barrett, Principles of Income Tax (2nd ed, 1981) 77-82; AP Molloy, Income Ta(1976) Chpt 6; Pinson, supra n13, 32-34; Whiteman & Milne, supra n13, 335-345.

20 Discussed below 330 et seq.


3 THE COMPENSATION TEST

A Preliminary principles

The word "compensation" can be used in a number of possible contexts.First a money payment may compensate the recipient in the sense of makinggood a deficiency in relation to an agreed norm or standard. Gratuities paidto a waiter may compensate for a nominal wage. Secondly a sum may compensate in the sense of counterbalancing on unwanted imposition; for example"danger money" paid in addition to normal wages .to compensate for risksor unpleasantness attendant on performing some required task. Thirdly,compensation may refer in a very general way to the quid pro quo onepartly receives for a consensual adjustment of his rights; for example forrelinquishing property rights. Of course one would not usually employ theterm "compensation" to characterise any of the above receipts; colloquiallyand legally that term is employed in a fourth manner, where an adjustmentof property or other rights· occur either non-consensually; for example bycompulsory acquisition, destruction or loss; or on the deprivation of anopportunity to earn. All four classes of compensation may however beexigible.

If the receipt is compensation in the sense of making good a deficiencyin relation to an agreed norm, or counterbalancing an unwanted imposition,then whether or not it is income according to ordinary concepts will dependprimarily upon whether it is recieved as a reward for an income producingactivity.21 Where by contrast the receipt is in respect of a detraction of preexisting rights, surrendered consensually or otherwise; whether it is incomeaccording to ordinary concepts will depend upon properly characterising thenature of the rights relinquished. It is of course possible to characterise allrights as intangible assets so that their loss is a loss of capital, but this hasnever been accepted as a universal proposition.22

Where the rights relate to tangible property, there is a presumption thata receipt compensating for the loss of those rights will be paid on capitalaccount, unless the property is trading stock of the taxpayer. 23 Where theloss is a detraction from pre-existing rights to (or as) intangible property,such as choses in action, intellectual property, and transferable licences orconcessions; then again unless the taxpayer is in the business of trading insuch property, any loss will be presumed on capital account. Merv BrownPty Ltd v Federal Commissioner of Taxation falls within this class and willbe discussed further below.

The position becomes much less clear where the right lost does not relateto any recognised legal property; for example relinquishing a right to trade

21 See eg Hayes v Federal Commissioner of Taxation (1956) 96 CLR 47; Scott v Federal Commissioner of Taxation (1966) 10 AITR 367.

22· This crucial distinction between the abstract concept of a "right" in the air so to speak,~nd the "thing" to which the right relates, is often lost sight of. A right is always to have, touse, to do, something; or not to be interfered with in something. But to characterise "the right"1S capital by reference to nomenclature is fallacious; many "rights" have no capital attributesNhatsoever.

23 California Copper Syndicate (Limited & Reduced) v Harris (1904) 5 TC 159, 165-166;Western Gold Mines No Liability v Commissioner of Taxes for Western Australia (1938) 59:LR 729, 735, 737. And see Taylor v Good (1974) 49 TC 277; Simmons v Inland Revenue Comnissioners [1980] STC 350.


either geographically or temporally or the right to hold a certain office. Insuch cases the critical question is whether the receipt is in respect of the rightlost, or in respect of the profits or gains which the retention of that rightwould have enabled the taxpayer to receive.

Two other preliminary points can be made concerning compensationreceipts. First by their very nature they are unlikely to be received in theordinary course of business. Thus the use of an "ordinary course of business"test is plainly inappropriate to determine exclusively the exigibility of suchreceipts. Second, the application of the compensation test to insurance receiptsexpressly indemnifying for loss of trading stock24 or loss of profits25 is wellsettled. Although many of the relevant decisions rather obfuscate the reasonfor including these sums in the assessable income, Lord Cave LC in Commissioners of Inland Revenue v Newcastle Breweries26 clearly suggests it tobe on the basis that although the event producing the revenue was not contemplated, the taxpayer has nonetheless been placed in the position he wouldhave been in had he sold, (rather than lost) his stock. This makes good sense,otherwise traders would have a fiscal incentive to destroy rather than to selltheir wares. There is however the question as to which provisions bring suchreceipts for lost trading stock to tax. It appears that they will not be includedunder s36,27 but will be under s25 (as are all other exigible compensationreceipts) and must also be included in the calculation under s28(1). Wherethe trading stock is however only temporarily sterilised, for example certainclasses of goods placed under a moritorium on sale pending some outcome,the stock should be regarded as still on land at the close of the income year.

B Compensation payments prima facie capital receipts

(1) General ruleSubject to one caveat (relating to trading stock), money received from the

disposition of a tangible, or an intangible but inherently transmissible right,will prima facie be a capital receipt. Although many items of property, suchas machinery or a patent, have no commercial value (save as scrap) separatefrom their ability to contribute to the production of income, nonetheless thesignal notion that property, other than property the subject of trade, shouldbe exonerated from impost, automatically characterises a receipt from thesale of such property as capital. This result would be rationalised in legaltheory by the fact that the sale was of fixed not circulating capital;28 orbecause part of the income earning structure had been sold;29 or perhaps

24 Eg Gliksten v Green [1929] AC 381; and see s 26(j).2S Eg King v British Columbia Fir & Cedar Lumber Co Ltd [1932] AC 441; and see s 26 (j).26 (1926) 12 TC 927 at 953; and see Waterloo Main Colliery Co Ltd v Inland Revenue Com-

missioners (1947) TC 235; Ensign Shipping Co Ltd v Inland Revenue Commissioners (1928)!12 TC 1169.

27 Federal Commissioner of Taxation v Wade (1951) 84 CLR 105.28 Eg John Smith & Son v Moore [1921] 2 AC 13, 19-20; Davies v Shell Co of China Ltd l

(1951) 32 TC 133 but cf Commissioner of Taxes v Nchanga Consolidated Copper Mines [1964]:AC 948, 962 per Lord Radcliffe.

29 Eg Van den Bergh'S Ltd v Clark (1935) AC 431; discussed below 317. But cf Sun News~

papers Ltd v Federal Commissioner of Taxation (1938) 41 CLR 337, 359 et seq per Dixon J.


because something which was for the enduring benefit of the trade30 hasbeen realised.

(2) Exception: Quantification otherwise than by reference to a lump sum

Where property other than trading stock is sold, the method by which thesale price is determined is generally irrelevant. Thus a sum quantified by reference to expected profits will not change the character of the receipt, 31providing a quantifiable lump sum is expressed as the consideration for thesale. If, as may occasionally happen, the consideration is expressed otherthan as a valuation of the property sold (however arrived at), but rather bysome other criteria, for instance the use to which the property will be put,then the receipt will be characterised as income, and taxed. 32 It is not at allclear whether this is because it takes on the character of income frompropertY,33 or because of the recurrent nature of the receipts. Similarly theright to an annual payment without reference to a lump sum payable grantedin exchange for property is regarded as an annuity and exigible,34 presumably on the basis that it is of a recurrent nature.

Although these principles appear tolerably correct, it must be admittedthat their application has been unsettled by the law relating to the taxationof royalties. First in relation to those receipts, the courts have often failedto distinguish between the situation where rights are granted which (to utilisean overworked metaphor), represent fruit generated from a tree left essentially intact, and rights which by their exercise, diminish the corpus of the

30 Eg British Insulated & Helsby Cables Ltd v Atherton [1926] AC 205, 213 per Cave LC.Adopted Sun Newspapers Ltd v Federal Commissioner of Taxation (1938) 41 CLR 337, 355per Latham CJ.

31 Eg Glenboig Union Fire Co Ltd v Inland Revenue Commissioners (1922) 22 TC 427, 464;Inland Revenue Commissioners v Ramsey (1935) 20 TC 79; Commissioner of Taxes v E [1942]NZLR 115. Cf Egerton- Warburton v Federal Commissioner of Taxation (1934) 51 CLR 568.

32 Commissioner of Inland Revenue v Hogarth (1940) 23 TC 491. See also Orchard Wine& Supply Co v Laynes (1952) 33 TC 97; Lamport & Holt Line Ltd v Langwell (1958) 38 TC193; United Steel Companies Ltd v Cullington (No 1) (1939) 23 TC 71. Where the paymentis expressed to be a sum equal to profits over a number of years it appears to be capital if itis not quantifiable until the period is completed: Ledgard's case ibid; but the distinction betweenthis and sums equal to annual profits over a number of years which are income, appears tobe a matter of fine distinction: Dott v Brown [1936] 1 All ER 543, 550. Where the paymentis not expressed as a sum equal to profits, but rather a per centage of the profits themselves,it is to be regarded as income. Likewise where even though expressed as a sum equal to profitsover a number of years the term is a long one. Ramsay's case ibid, but for the reference tothe capital sum would have fallen into the last category; sed quaere the capital sum or partthereof not there being payable at the time of each return, it should have been disregarded asirrelevant. It is submitted that the distinction between Legard and Hogarth is too fine to beuseful, and that as a matter of substance the courts should disregard the language of the partiesand hold that any annual payments made without reference to a capital sum certain shouldbe regarded as income.

33 Cf Egerton-Warburton v Federal Commissioner of Taxation (1934) 51 CLR 568, 579.34 Commissioners of Inland Revenue v Hogarth (1940) 23 TC 491. And see Jones v Inlandevenue Commissions (1919) 7 TC 310. Cfs 262 concerning the assessability of periodic payents, which in an earlier form was unsuccessfully invoked in Californian Oil Products (Iniq) Ltd v Federal Commissoner of Taxation (1934) 52 CLR 28.


grantor. 35 The former, such as the right to playa piece of music, demonstrably represent income from property, and one susceptible to a definitionof royalties which requires payments conterminous with the exercise of a rightgranted. But where the royalty relates to, for example, a profit aprendre,where property removed is quantified on a per ton (or similar basis), the courtshave rather adroitly avoided the conclusion that the receipt is of a capitalnature by characterising the property disposed of as a right to enter andremove, rather than as a sale. 36 This has the consequence that the "right" I

falls within the common definition of "royalty" in section 26(1) and is therebyexigible. In effect this "rights" analysis hides the fact that the receipt in sucha case would normally 'be capital according to the principles outlined above;an unhappy formula which has disturbed not a few judges. 37

(3) Exception: Rights relin;quished but not transferred

Where property or a proprietary right other than trading stock is sold,the sum is according to the above principles prima facie capital. However,where such an inherently transmissible right is not sold, but is destroyed orneutralised, then different rules may apply. A preliminary but crucial distinction must be made between a temporary and a permanent deprivation I

of property; and its importance becomes apparent in the following hypotheses I

using trading stock as an example:

1. Hypothesis: Stock is sold.Conclusion: receipt is assessable.

2. Hypothesis: Stock is destroyed, compulsorily acquired (etc.).Conclusion: receipt is assessable for reasons advanced previously.

3. Hypothesis: Stock is temporarily impounded or similar.Conclusion: the goods have not actually been disposed of consensually :or non-consensually, so there is no analogy with their sale in the course:of trade. Whether the receipt is assessable depends upon whether itrepresents:(a) loss of profits suffered during the period of retention (an excess i

demand market or at least market equilibrium being assumed);38

35 It is submitted that where the corpus remains relatively intact after use, then a sum received I

for that use will also be revenue, whether in a lump sum or not. An example would be a nonexclusive licence: cf. Inland Revenue Commissioner v Longharns Green & Co. (1932) 17 T.C.,272. Where the use depletes the corpus, or substantially lessens its value, then the sum receivedImay be either a royalty or a sale price. It will be a royalty if payment is quantified by reference'to user: cf. McCauley v Federal Commissioner of Taxation {1955) 92 C.L.R. 630. Informationand non-patented information causes problems of characterisation however because it does notlfit easily into a property analysis. The only qualification to the above analysis is that true annual'payments, that is recurrent payments quantified without reference to a lump sum, will tun~

what otherwise might be a capital receipt into revenue: see generally Murray v ICI Ltd [1967~1

2 All ER 980.36 Eg McCauley v Federal Commissioner of Taxation (1944) 69 CLR 235.37 Ibid per Rich J; Moriaty v Evans Medical Supplies Ltd [1957] 3 All ER 718.38 If there was an excess supply market, the taxpayer would find it difficult to prove tha

sterilisation resulted in a loss of profits; for problems with collateral sales in excess supply market~

see Re Vic Mills [1913] 1 Ch 465; cf Charter v SuI/ivan [1957] 2 QB 117. See also Waterlo(Main Colliery Co Ltd v Inland Revenue Commissioners (1947) 29 TC 235; Ensign Shippin~

Co Ltd v Inland Revenue Commissioners (1928) 12 TC 1169.


(b) other loss suffered, for example to goodwill, out-of-pocket expensessuch as rectifying damage to the goods; damages paid to third partiesfor breach of contract;

(c) an amount which does. not compensate inasmuch as no loss has beensuffered, or has been suffered to a lesser extent than the sum received;and which therefore represents a "windfall" to the recipient.

A similar analysis would also apply to the deprivation et cetera of a capitalitem, although a number of qualifications would need to be introduced. Thus,on the first and second hypotheses, the conclusion would be capital, unlessas previously outlined, the receipt is not a lump sum (however quantifiedor payable), but rather varies according to some other criteria, such as theuse made of the article. 39

If the above model is accepted, the next difficulty is to allocate the sum,or the parts of the sum, received to the proper category. Obviously if themoney is received expressly on account of one type of loss, then providingthe sum does not over-compensate for that loss (so that the excess does notfall within the third clause of the third hypothesis), intention should bedeterminative. Even without such direction regard could be had to the methodof quantification to ascertain or infer intention. Although the correctnessof this was emphatically denied by Gavan Duffy CJ and Dixon J in California Oil Products Ltd v Federal Commissioner of Taxation,40 it is submitted for reasons developed below41 that it makes good sense when one isattempting to ascertain intention to do so..

Where a global sum is received on account of both capital and revenueloss, it appears that the proper course is to make up losses on capital accountfirst before those on revenue account. 42 However, it is presumed such a rulewill only operate where the parties have not otherwise indicated (for exampleby the method of quantification) that it should be displaced. 43 Where therule does apply, it will operate in an obvious manner where for example bothcapital and trading stock losses occur. But it is less certain where there hasbeen a retention of capital items only. If trading stock is retained therewill be a presumption that the receipt is revenue, since the item of stock wouldprobably have been sold during the period of retention. This will certainlybe so where there is an excess demand for the product, since the owner has

39 Above 309. Where the capital asset is destroyed, the compensation may include a sum forprofits lost during the period of restoration: London & Thames Haven Oil Wharves Ltd v Attwooll [1967] 2 All ER 124.

40 (1934) 52 CLR 28, 41.41 Below 329.42 McLaurin v Federal Commissioner of Taxation (1961) 104 CLR 381,391; Allsop v Federal

Commissioner of Taxation (1965) 113 CLR 341. Watson v Samson Bros. (1959) 38 TC 346.As a matter of fairness it appears proper that if a dissection was to be made of a global sumcredit should first be given against property lost, and then against loss of profits, otherwise thetaxpayer is in a worse position than he would have been but for the event causing the loss;ie he is taxed on assumed realisation, but is not thereby adequately compensated for the expenseof re-establishing the profit earning structure. But to the extent the taxpayer can claim fulldepreciation on the capital loss, the exact apportionment would be a matter of indifference tohim: s 59. And see further: G Lehmann, "The Common Law, Tax Law and MathematicalCulture" (1984) ALJ 649. Different considerations may apply where tangible assets do not requirereconstruction before revenue activities recommence.

43 McLaurin v Federal Commissioner of Taxation, ibid.


lost a sale.44 Where this is not so the receipt is more difficult to characterise.If it is brought to tax at all, it is submitted it will only be through the application of some miscellaneous category of test such as receipts "in the ordinary I

course of business". 45 But for reasons developed below it is submitted sucha category (if it exists) must only be used as an inclusionary, and not as anexclusionary test.

Where the retention is of a capital asset, the only capital loss which willbe required to be off-set is loss to goodwill,46 and this if it exists will bedifficult to prove. It may be that a third category of loss, that is, sums received '1

as recompense for out-of-pocket expenses, should as a matter of presumedintention, be accounted for prior to setting off against revenue loss, or even I

possibly capital loss. 47 Whether these sums will be exigible will depend uponthe application of section 260).48 ,

The approach of the courts to receipts derived as compensation for rights ;not consensually relinquished has, however, been rather less structured. Thereare two leading authorities which illustrate the different types of difficultywhich can arise. The first, Burmah Steamship Co v Commissioners ofInland I

Revenue49 concerns the temporary retention of a capital asset.The appellant was part owner of a motor vessel which it had placed in I

the hands of a repairer for an overhaul. There was a penalty clause in the ~

contract for the late completion which in the circumstances of the case wasinvoked. The damages recovered were calculated by reference to the estimatedprofit which would have been earned by the vessel had it been trading duringthe period when the repairs ought to have been completed. The claim was I

compromised and under the terms of the settlement the owners received a I

global sum of £3,000. This amount was held to be an income receipt, paid I

in respect of a restriction of trading opportunities, rather than the deprivation of a capital asset. This it is submitted was correct, although a fortuitous i

conclusio'n given the nature of the inquiry. The deprivation of a capital assetis the event giving rise to the loss; but it is not in itself a loss. The inquiry I

then should not have been between retention of an asset and loss of profits, I

but rather "given the retention, what are the character of the losses suffered?" I

Although Lord President Clyde's question "was the 'hole' in the capital asset, I

44 Supra n37. The normal rule in assessing damages in contract law is that in an excess i

demand market damages are only minimal if the purchaser fails to complete because the vendoris limited in potential sales by the availability of products rather than purchasers. But in the:context of sterilisation or loss, the emphasis is different, because the product is not available I

for sale to a collateral purchaser and the vendor has truly lost the opportunity of sale.45 Discussed below 330.46 Below 326.47 It would not be unreasonable, as a matter of interpretation, to assume that the parties in

tended to compensate first for actual expenses incurred, before expectation loss (loss of profit).To offset against capital before actual incidental loss, where depreciation was available, mightldeprive the taxpayer of the full benefit of the receipt.

48 And in particular whether they are "as· insurance or indemnity": Allsop v Federal Commissioner oj Taxation (1965) 113 CLR 341; and see s.72(2). It is submitted that in the absencfof statutory provisions, a refund is not exigible, regardless of whether the payment was deduct·ible, because it would be out of sympathy with the principles that there is no "matching" 01deductions to income under the Act, and that the character of an outgoing does not affect iHcharacter when received: see Allsop, 350; H R Sinclair v Federal Commissioner oj Taxation (1966114 CLR 537 should be regarded as per incuriam on this point.

49 (1930) 16 TC 67.


or was it in the profit" is somewhat more colourful, .it is less likely to leadto the right result.

Lord Sands (dissenting) produced a much keener analysis than the majority,but like it he also made the same error. 50 This was a case he suggested,where the injury was not deprivation of the use of an existing seaworthy shipcapable of earning freight, but the non-production of a seaworthy ship capable of earning freight. In the first situation the payment is really analogousto hire (the second hypothesis); in the second it is for damages for want ofsuch a vessel (the third hypothesis). One can see, however, that this is a distinction without a difference. Merely because the facts fall within the thirdhypothesis does not as Lord Sands assumed characterise them as capital.Again the mistake is to think the retention of the vessel is a loss, rather thanthe cause of it. It is still necessary to inquire what monetary loss the damagescompensate for.

The second authority is Glenboig Union Fireclay Co Ltd v Commissioners of Inland Revenue. 51 The appellants were in the business of manufacturing fireclay goods and were also sellers of raw fireclay. They also leasedcertain fireclay fields over part of which ran the Caledonian Railway. TheRailway owned the land, the appellant had a lease of mineral rights underit. The Railway commenced an action to restrain the mining of fireclay undertheir track on the ground that it was not a mineral. The House of Lordseventually decided against the Railway. The latter then exercised its statutorypowers to require part of the fireclay to be left unworked in return for theirpaying compensation to the Glenboig company.

This decision is a difficult one, because the real issue in the case was entirelyoverlooked. The facts here clearly fell within the second hypothesis. If thefireclay was trading stock then the case was on all fours with the NewcastleBreweries52 decision. What would be permanently sterilised would be circulating not fixed capital, and as the acquisition by the Railway would betantamount to a sale, it would be the "purchaser's" property that was sterilised; a matter of indifference to the "vendor". If the fireclay was a capitalasset the sum received would be capital, although it was quantified by reference to lost profits. 53

Although the court refused to accept that there was any relationshipbetween the method of quantification and the character of the receipt, this

50 That is to regard the circumstances as fairly admitting of the possibility of capital loss.The analogy which Lord Sands found most compelling was that if the £3000 paid was said tobe an abatement of the cost of repairs, "it would have been very difficult for the revenue tomaintain that the £3000 was anything else but a capital savings". It is submitted that this isa non-sequitur. If the ship had been damaged by accident, the measure of damages in tort forinjury to a profit-earning chattel includes a sum for loss of profits which is taxable: Halsbury'sLaws of England (3d) 35 para 1073; And see Inland Revenue Commissioners v West (1950)31 TC 402; Liesboch Dredger v S~ Edison [1933] AC 449; London & Thames Haven Oil WharvesLtd v Attwood [1967] 2 All ER 124. If the abatement was for late repair the income questionwould not arise because a savings is not income: British Mexican Petroleum Co Ltd v Jackson(1932) 16 T.C. 570; Tennant v Smith [1892] AC 150. But see Crabb v Blue Star Line Ltd (1961)39 TC 482.

51 (1920) 12·TC 427. cf Waterloo Main Colliery Co Ltd v Inland Revenue Commissioners(1947) 29 TC 35.

52 (1920) 12 T.C. 927.53 Above 309.


was a case where that inquiry was irrelevant. While intention may determinewhether a sum is on account of a capital or revenue loss when a global sumis received and both types of loss have been suffered;54 this was a situationwhere probably only one type of loss had been suffered and the issue wasto identify the character of the event which caused the loss. If as a questionof law the fireclay in its unsevered state was trading stock it would inexorablyfollow that the receipt was on revenue account.

Their Lordships glossed over this question in holding the sum to be capi-tal receipt. Lord Buckmaster said:

... the sum of money is the sum paid to prevent the fireclay company obtaining the full benefit of the capital value of that part of the mines which they wereprevented from working.... [T]he capital asset of the company has been sterilised and destroyed . . . .55

Likewise Lord Wrenbury:

... the right to work the area ... was part of the capital asset consisting ofthe right to work the whole area demised. Had the! abandonment extended tothe whole area, all subsequent profit ... would ... have been impossible, butit would be impossible to contend that the compensation would be other thancapital. It was the price paid for sterilising the asset from which otherwise profitmight have been obtained. What is true of the whole must be equally true ofpart. 56

It is not sufficient to paint with such broad strokes. If a shopkeeper sellshis business (to use a close analogy), he is relinquishing certain capital rights;perhaps as in Glenboig his lease and his 'right to work'; but any trading stockincluded in the sale will need to be accounted for. 57 Similarly with regardto the fireclay, if, as a matter of law, it was trading stock.

C Rights not inherently tra,nsmissible

Rights which fall into this category include contractual rights where vicarious performance is not possible, and such "esoteric" rights as the 'right towork' and 'the right to trade'. They differ from transmissible rights or propertyin that if the holder of the right agrees to forego it, the promisee does notthereby acquire the right. It is true that atrader promising,to restrict his rightto trade, or to relinquish an advantageous trading contract, may indirectlycause the promisee to enlarge his trade, but this is not a direct or positivegain· in the sense that something is given and taken.58 The promise willusually have to enjoy the competition benefits in common with all othersin the market and may indeed be unable to capitalise on the market enlarge-

54 Eg destruction or sterilisation of tangible or transferable intangible property used in theproduction of income; or capital loss eg to goodwill existing dehors the loss of non-transferableright. See below, 329.

55 (1920) 12 TC 427, 463.56 Ibid 465.57 S 36 ITAA 1936.58 So that there is an abandonment, but no sale or disposition which would involve a property

analysis. This dichotomy between direct and indirect gains has caused the High Court somedifficulty on a number of occasions; see eg Hallstrom Pty Ltd v Federal Commissioner of Taxation(1946) 72 CLR 634; Dickerson v Federal Commissioner of Taxation (1958) 98 CLR 460.


ment caused by the partial withdrawal of the promisor. Contrast, however,the sale or compulsory .acquisition of a transmissible right. The transfereecan enjoy this to the exclusion of all others, even if as in Glenboig he choosesmerely to sterilise it.

The issue for taxation purposes is whether this distinction is important.When a recognised transmissible property right is sold or compulsorilyacquired the receipt is capital, even though the item may have little instrinsicvalue apart from its ability to contribute towards the production of profits,and even though it may also be quantified by reference to anticipatedprofits. 59 This 'exonerating' effect which also extends by analogy to thereceipt of compensation for property destroyed may be the product eitherof its character as proprietary simpliciter, or of it having a marketable (capital) value. To adopt the second of these rationes would give rise to few difficulties since it so obviously excludes non-transmissible rights. However, the factthat a capital item may be compulsorily acquired or destroyed which theowner had no intention of selling, tends to suggest the former. The mattercan be tested this way. The destruction of certain non-trading property, forexample a building, is the loss of a capital item, even though the buildingwas held under a settlement which prevented its transmission or sale. Therefore in respect of some property at least it is true that transmissibility is notessential to allow this 'exonerating' effect. Compare however the "loss" ofa non-transmissible intangible right, where the law has no coherentproprietary theory. 60 In this case it appears that marketability may be anecessarY,61 although by no means sufficient,62 attribute to attractproprietary consequences where the circumstances relate to the appropriation of commercial opportunity. 63 But in other contexts, for example theprotection of private information, private enjoyment, or reputation, theconcept of property which allows appropriate relief does not require transmissibility rather than an investment of effort,64 or an exclusiveness of

59 Above 309.60 See generally: DF Libling, "The Concept of Property: Property in Intangibles" (1978) 94

LQR 103; R Sackville & M Neave, Property Law: Cases & Materials (3rd ed, 1981) 1-52. Industrial Property is a concept which can be distinguished but need not be discussed. The legalmonopoly rights under a Patent, Registered Trademark, or Registered Design can not be destroyedor sterilised without legal justification. For goodwill below 326.

61 See eg Exchange Telegraph Co Ltd v Gregory & Co {l896] 1 QB 147, 152-153; TheExchange Telegraph Co Ltd v Howard (1906) 22 TLR 375; Exchange Telegraph Co v CentralNews Ltd [1897] 2 Ch 48,53; Henderson v Radio Corporation Pty Ltd (1960) 60 SR (NSW)576; Samuelson v Producers Distributing Co Ltd [1932] 1 Ch 201, 209; Federal Commissionerof Taxation v United Aircraft Corporation (1943) 68 CLR 525, 547-548.

62 In some cases the courts refuse to recognise the existence of a 'proprietary' right despiteits marketability: see eg Victoria Park Racing and Recreation Grounds Co Ltd v Taylor (1937)58 CLR 479; Federal Commissioner of Taxation v United Aircraft Corporation (1943) 68 CLR525, 534 per Latham CJ (diss).

63 Supra n61; Vokes Ltd v Evans (1931) 49 RPC 140; and see Dr Barnado's Homes v Barnardo Amalgamated Industries Ltd (1949)66 RPC 103; and British Legion v British LegionClub (Street) Ltd (1931) 48 RPC 555, both of which Libling Supra n60 argues are explicableon the investment of effort criteria, 114.

64 See Libling, ibid 114-119; Morris v Ashbee (1868) LR 7 Eq 34; Hamilton, "PropertyAccording to Locke" (1932) 41 Yale LJ 864. In addition the 'right' generated must not be a"social good"; that is a benefit inherently capable of joint consumption: see eg Huntley & Palmerv The Reading Biscuit Co Ltd (1893) 10 RPC 277. But cf Sports and General Press AgencyLtd v "Our Dogs" Publishing Co Ltd [1917] 2 KB 125; Victoria Park Racing and RecreationGrounds Co Ltd v Taylor & Others (1937) 58 CLR 479.


knowledge communicated in circumstances of confidence.6s Indeed it maybe that one of the latter concepts must always be present, and that marketability is in the circumstances of some cases, by the nature of the loss claimed,merely an additional element.

Obviously an inquiry into the definition of property is to be avoided ifpossible, as so often with such problems there is not one answer but several,each depending upon the context in which the answer is asked and the natureof the premises assumed. For example property or proprietary right has beenheld for the purposes of the Stamp Duties Act 1920 (NSW) not to includeinformation,66 whereas in other contexts courts have been prepared toaccord to information at least some of the incidents normally incumbent inproperty. Beyond indicating the consequences that follow from a 'property'or 'not property' conclusion there is no necessary reason in the assessabilityof compensation context for preferring one to the other. And it would bewrong to construe the Act as expressing a policy bias in favour of capitalor income.67

It is submitted that the proper, and less confusing approach, is a functional one; namely should a right (which would have no value if it providedno opportunity for profit) nonetheless support a presumption that compensation for its loss relates to its 'capital' value rather than the lost opportunityfor profit?

The argument in favour of a property characterisation runs as follows:the issue is the character of the receipt in the hands of the recipient, not thenature of the advantage in the payer's hands; the recipient is in no differentposition personally than had he been able to sell the right and had in factdone so, since in both examples it is lost to him. The weakness in this typeof analysis is that it assumes the presence of the very attribute which distinguishes non-transmissible" rights, namely that they cannot be sold. Nor is thisa mere exercise in knocking down carefully erected straw arguments. An"examination of the leading authorities will expose a paucity of any morecogent arguments in favour of a property character.

In the absence of such explanation, it is submitted that the way is openfor the courts to re-examine the issues involved in this category of cases. Sincewhat the writer regards as the true issue is res integra, the tentative opiriionis advanced (and assumed in the following discussion), that a non-marketableintangible right, being valuable only because it creates the opportunity forprofit-making, causes an income loss if it is destroyed. Further, to regardthe loss as capital is to adopt a property analysis which is patently too wide,as being capable of explaining every adjustment of an obligatory orproprietary nature.

Assuming·then that such rights are not in this context property, then thetypes of loss which the relinquishment of the right gives rise must approximate to those clauses listed above under the hypothesis of a temporary reten-

65 EgSeager v Copydex Ltd [1967] 1 WLR 923; Duchess of Argyll v Duke of Argyll [1967]Ch 302; Prince Albert v Strange (1849) 1 H & T 1.

66 JV (Crows Nest) Pty Ltd v Commissioner of Stamp Duties (NSW) [1985] ATC 4198; cfFederal Commissioner of Taxation v United Aircraft Corporation (1943) 68 CLR 525.

67 See eg Tennant v Smith [1892] AC 150, 154 per Lord Halsbury LC; Cape Brandy Syndicate v IRC [1921] 1 KB 64, 71; cf Coultness Iron Co v Black (1881) 6 App Cas 315.

1985] Compensation Payments,· 317

tion of a capital asset. The task would then be to allocate the receipt amongthe three classes. Unless there is a loss of goodwill, the sum can not be oncapital account as there is otherwise no capital loss. Goodwill is of coursea transmissible right, but unlike other such rights it may be deletoriouslyaffected by the extinction of non-transmissible rights. 68 Again where thereare different classes of loss suffered and the sum is sufficient to compensatefor only part of the loss, it is necessary to develop rules for allocation. I havealready suggested that in the absence of express or implied direction, capitalfirst then revenue appears the proper order. Where out-of-pocket expenseshave been incurred it may be that an intention should be presumed that theybe set-off before expectation losses (revenue), or perhaps even goodwill(capital) loss.

(1) Compensation for contractual rights

The leading decision is Van den Berghs Ltd v Clark. 69 The taxpayer wasa manufacturer of margarine. It entered into an agreement with a rival Dutchcompany to share profits and losses at an agreed rate. There were a numberof amendments and extensions to the original agreement, but it remainedessentially a classic producer cartel. Unfortunately a dispute arose which theparties were unable to resolve. They agreed to rescind the agreements, andthe Dutch company agreed to pay their English counterpart £450,000 "asdamages" without specifying the cause of action in respect of which they werepaid.

Lord MacMillan delivered the principal judgment. He asked the question'what did the rights given up represent?' The possibility that they representedpotential profits was considered unlikely since the agreements did more thanentitle them to share profits, nor was the method of quantification to beregarded as determinative. But in his opinion at least two criteria indicateda capital receipt. First they were contracts nor normally entered in the ordinarycourse of business; and secondly:

[H]ere the agreements related to the whole structure of the appellant's profitmaking apparatus. They regulated the appellant's activities, defined what theymight and what they might not do, and affected the whole conduct of their business .... I have difficulty in seeing how ... money received for the cancellation of so fundamental an. organisation of a trader's activities can be regardedas an income . . . receipt. 70

There are a number of difficulties with this "whole structure of business"approach. Certainly in order to fulfill the agreement certain structural changeshad to be made by the appellant and no doubt as a consequence of its cancellation those changes would need to be removed. But while they relatedto the agreement, they were not part of the bargained for consideration. Each

68 For a discussion of goodwill, below 326.69 (1935) 19 TC 390; cf the decision in In/and Revenue Commissioners v Northfleet Coal and

Ballast Co Ltd (1927) 12 TC 1102 which accords more with the analysis suggested by the writer;see also Greyhound Racing Association (Liverpool) Ltd v Cooper (1936) 20 TC 373; Shadholjv Salmon Estate (Kingsbury) Ltd (1943) 25 TC 52; Renfrew Town Council v In/and RevenueCommissioners (1934) 19 TC 13.

70 Ibid 431-432.


party no doubt made the changes in its 0 erations as it saw fit. It would havedoubtless made those changes even if the ontract had, contrary to Lord MacMillan's interpretation, expressly been a agreement to share profits, and ifthe damages had expressly been paid in espect of lost profits. If the moneywas paid here as damages for the costs he appellant incurred in returningto his normal operations they would ha e been reliance damages, althoughthere must be a presumption against their 0 being, since expectation damagesare the normal rule. 71 And secondly, be I ause it is difficult to see how therewas any reliance loss at all arising from the breach, since Van den BerghsLtd would inevitably have run into the cost of re-establishment when theagreements ended.

There is one other problem with Lord MacMillan's argument. If the moneypaid by the Dutch company ,had been paid as damages for breach of contract it would have been expectation damages; that is sufficient compensation to put the innocent party in the position he would have been in had thecontract been performed. But had the contract been fully performed theinnocent party would have had ,an accumulation of profits but no existingcontract, which would of course have by then expired. In other words thecontract itself has no value in assessing damages.

The notion that the "whole structure" must be affected is so obviously anattempt to draw parallels with the principle in British Insulated & HelsbyCables Ltd v Atherton72 and the so-called tree/fruit metaphor. But neitheris apposite here. The Atherton notion of something being for the enduringbenefit of trade is appropriate for discriminating between fixed and circulating capital, either in relation to expenditure or receipt. The tree/fruitmetaphor is of peculiar application to income from property, and it wouldbe a very strange tree indeed on the Van den Berghs facts. Once all the fruitwas picked the tree would disappear; the tree has no value apart from itsfruit; the tree is ajictionalejuris in that it is conjured in and out of existenceaccording to the agreement or actions of the parties.

If one accepts the writer's thesis that a receipt for the relinquishment ofa non-transmissible right should be analysed in terms of the classes of lossenumerated under the third hypothesis, there is no magic in the fact thatthe contract compromised affects the whole structure of the taxpayer's business, or that it is relatively minor. The cancellation is the event causing loss;the issue is to identify the (monetary) loss caused by the event. By definitionsuch contracts cannot be the subject of trade, and therefore the loss of evenseveral does not suggest that the taxpayer would otherwise have sold themand have had to bring the receipts to tax.

In uncritically introducing property notions, and also a test more properlyused for determining between fixed and circulating capital, Lord MacMillan'sjudgment forms the apex of an inverted pyramid, upon which most subsequent judgments balance precariously. A number were cited by Kaye J inMerv Brown Pty Ltd v Federal Commissioner of Taxation. 73 John Smith& Son v Moore74 concerned the purchase of contractual rights, and it was

71 Robinson v Harman (1848) 1 Ex 850.72 (1926] AC 205.73 [1984] ATC 4,394, 4,402.74 [1921] 2 AC 13.


rightly concluded that since the appellant was not in the business of dealingin such cpntracts, the sum was on capital account. But this was not a compensation case.

Short Bros Ltd v Inland Revenue Commissioners75 is a much more inconclusive case. The appellants had received an order to build two steamers,but the contracts were later cancelled and £100,000 was received as compensation. They were taxed as to "profits arising from any trade or business".At the initial hearing the appellants argued that this was not compensationfor loss of profits, but for the loss of the right to carryon their trade. TheCommissioners disagreed. 76 Rowlatt J on appeal to King's Bench, thoughtthe payment was neither for loss of profits nor for not being able to carryon their business, nor for a capital loss, but taxable simply because it wasa receipt in the ordinary course of an ongoing business. 77 In the Court ofAppeal the argument was· not as to whether it was capital or income, butwhether it was in the course of business to receive money in respect of cancelled contracts. 78 Thus, it would appear that counsel for the taxpayer hadaccepted the finding of the Commissioners as to income, but were arguingthat the receipt did not comply with the terms of the statute which requiredthat it arisefrom the business, not outside it. The Court of Appeal concludedit did comply. If this decision had been heard in Australia where tax is leviedon income received, and not (as in in England) onprofit, it would have beenmuch easier for Rowlatt J to accept that the money was received in lieu ofincome. One of the reasons why in Short Bros some of the Judges werereluctant to characterise it as received in lieu of profits was because there wasno guarantee profits would have been made. 79 That difficulty does not arisein this jurisdiction.

Kelsall Parsons & Co v Inland Revenue Commissioners80 concerned a firmof agents who held a number of (non-transmissible) agency contracts. Thecourt reached the right conclusion for (it is submitted) the wrong reason infinding a sum received as compensation for the cancellation of one of itsagency agreements assessable. The reasons given in judgment were that thecancelled agreement was not something which was of an enduring nature;nor did it relate to the whole structure of the business. 81 The subsequentdecisions in Wideburgh v Domville82 and Inland Revenue Commissioners vFleming & Co (Machinery) Ltd83 are open to identical criticism. Barr,

75 (1927) 12 TC 955.76 Ibid 964.77 Ibid 968-969.78 Ibid 972, per Lord Hanworth MR; 944 per Sargant LJ; 975 per Lawrence LJ.79 Cf ibid 974.80 [1938] SC 238. See also Elson v James G Johnston Ltd (1965) 42 TC 544; Anglo-french

Exploration Co Ltd v Clayson [1956] 1 All ER81 Eg ibid 246; 248. It is submitted the better basis of decision would have been that, the con

tracts being neither tangible nor transmissible, a proprietary analysis was completely inapposite:above 000.

82 [1956] 1 WLR 312.83 (1951) 33 TC 57. See also Bush, Beach and Gent Ltd v Read (1939) 22 TC 519; Black

burn v Close Brothers Ltd (1960) 39 TC 164. In Fleming Lord President Cooper suggested thatthe fact that the cancellation left him free to devote his energies to replacing the contract tendedtowards an income characterisation. It is submitted that this point is rather neutral. The problemis discussed more fully below 324 et seq.


Crombie & Com Ltd v Inland Revenue CommissionersM and Fleming v Bellow Machine Co Ltd85 were decisions on all fours with Van den BerghsLt(]86 yet only in the former was it found that the cancelled contract formeda substantial part of the taxpayer's business.

Two Australian cases which in contrast are much more sympathetic to theanalysis suggested by the writer are Commissioner of Taxes (NSW) vMeeksK' and Heavy Minerals Pty Ltd v Federal Commissioner of Taxation88

In the former decision a mining company in New South Wales entered intoa contract of sale with an English company in respect of 120,000 tons ofBroken Hill slime concentrates. Payments of £63,000 were made in advanceunder the contract, but the purchases defaulted on further advances and nodelivery was made. The parties agreed to cancel the contract and the £63,000already received was settled against any claims the vendor might have. GiffithsCJ observed:89

[D]amages received as compensation for non-performance of a business contract stand on the same footing as the profits for the loss of which the damagesare paid. It cannot therefore make any difference in principle whether the moneyis actually earned as a profit, ascertained by deducting expenses from receipts,or paid as compensation for the loss of the opportunity of earning that profit,or, in the latter case whether the amount of compensation is assessed by a juryor by mutual agreement.

Windeyer J in Heavy Minerals (a similar case) expressly approved this passage; and in response to the appellant's argument that the receipt was fora loss of "capital structure" described this and similar phrases "as used tobeg the question". 90

A cautionary note should be sounded against uncritically applying testsformulated for distinguishing between revenue and capital expenditure toan income inquiry. Not only is the deductibility of an outgoing irrelevantto its character in the hands of the recipient, but likewise while (for example) an outgoing which meets a continuous demand may be deductible,91 areceipt is not thereby capital because it is non-recurrent or unusual. Aninsurance payment for a loss of trading stock through fire would be exigiblenotwithstanding its unsual features. The fact that the compensation test hasno application to expenditures (as does in contrast the recurrence, enduringbenefit, or (perhaps) the tree/fruit tests) should indicate the dangers involvedin assuming a relationship between income and revenue.

There is a final difficulty. If the cancellation is made as a result of the payer's financial circumstances, for example where to perform the contract wouldresult in greater loss to him than the payment of compensation to the taxpayer, the taxpayer may well be able to recover a sum in excess of his own

84 [1945] SC 271.85 [1965] 1 WLR 873.86 (1935) 19 TC 390. See also John Mills Production Ltd v Matthias (1967) 44 TC 441. Cf

comments in Strick v Regent Oil Co Ltd [1966] AC 295, 318-319; 344-345.87 (1915) 19 CLR 568.88 (1966) 115 CLR 512.'89 Supra n86, 580.90 Supra n87, 517; cf Commissioner of Taxes v Nchanga Consolidated Copper Mines Ltd

[1964] AC 948, 959 per Lord Radcliffe.91 See eg Sun Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337,362.


loss from cancellation, because theoretically he can "hold out" against cancellation and extract any sum from the payee which is less than the cost tothe payee of continuing the contract. This will be particularly so where thetaxpayer can mitigate his loss by obtaining a substitute contract and substituteprofits. In such circumstances it could be said that the taxpayer has reallymade a windfall profit, providing that he would not have had both contractsif there had been no cancellation, (in which case he really has lost his profits),and providing that the sum received does not exceed the profits he wouldhave otherwise made.

To take an obvious example,. the labour of one man is a finite resource.If he contracts to paint a house for $100, and the owner of the house thenfinds that he can get someone else to do the same job for $50, the first paintercan probably demand and receive any sum up to $50 as compensation forbreaking the contract, because that would still result in a gain to the houseowner. If the expected profit from the job for our painter was only $20, anyexcess is in reality a windfall profit. If the housepainter quickly finds a substitute job which gives him a $20 profit, then in reality the whole sum receivedas compensation from the first contract is a windfall. Of course the ownerof the first house might prefer to break the contract, by excluding the taxpayer from his property. In the circumstances described the damages he wouldhave to pay to the taxpayer would only be nominal. That would not be sohowever if the taxpayer had been able to do both jobs at once, because thenhe would truly have lost the profits from the first.

Two points can be made from this analysis. First, if one accepts the concept of the windfall profit, there appears to be a symmetry between theassessable component of the payment, the expectation profits, and the liabilityof the payer, had he broken the contract instead of compromised it, to payexpectation damages. And secondly, the compensation test must be qualified,because the mere circumstance that the money has been paid in lieu of profitsexpected, need not of itself give the receipt an income character.

(2) Compensation for >Rights to Trade

The leading authorities on the assessibility of receipts derived for thevoluntary restriction on the right to trade or to work are Dickenson v FederalCommissioner of TaxationCIl and Higgs v Olivier. 93 In Dickenson the appellant was a retailer of petrol. He agreed:(i) to lease his premises to a wholesaler of petrol, and to take back a

sub-lease;(ii) to sell only the products of that wholesaler for ten years;(iii) not to operate any other petrol outlet in the area save those selling the

wholesaler's brand.The promisor received £4,000, but the money was said to be paid in respect

of the third promise only. The majority, however, held that viewing thesubstance of the agreement as a whole the sum was received in return forboth the second and third promise; an agreed rental being payable in respect

92 (1958) 98 CLR 460. Cf Thompson v Magnesium Elektron Ltd (1944) 26 TC 1; Hibbell vCommissioners of Inland Revenue.

I 93 [1952] 1 Ch 311.


of the first. 94 But assume for argument that it had only been for the lastpromise. There are two ways to approach its characterisation. First, aproprietary analysis might be applied, or secondly, the court might adoptthe style of inquiry suggested by the writer; that is to ask 'what losses has :the payee incurred?' A subjective inquiry would probably have indicated on I

the facts in Dickenson that the payee had no intention of opening anotherstation nearby, nor that he had suffered any loss of profits as a result of theagreement, rather it was the wholesaler who was protecting his profits bymaking the tie. This result would appear to place the £4,000 in the third classunder the last hypothesis above, so that it would only be taxable if miscellaneous receipts in the course of business are caught. 95

As discussed in relation to the cancellation of contracts, such an approach I

is predicated on the assumption that the right surrendered cannot be regarded I

as property, since that would suggest a capital receipt simpliciter. 96 Thereason against a property analysis in respect of cancelled contracts was saidto be that on ordinary contractual principles the contract itself was notregarded as having any intrinsic value. That obviously will not apply to thesurrender of a non-transmissible but non-contractual right of the type nowunder discussion, but it is suggested that there are two other reasons for nottreating such rights as proprietary. First, it introduces a concept of almostunlimited application, since any agreement requires an adjustment of "rights" I

held by the contractors. As a matter of principle if one is giving up a right(which because it is a "right" is capital on a property analysis) when arestriction on trade is accepted, why can one not be giving up a right to tradewhen, for example, trading stock is compulsorily acquired? Secondly as ageneral principle requiring qualification it introduces confusing distinctions :such as whether the promise is positive or negative in substance or form.

Dickenson must always be read in the light of the complicating factor thatthe taxpayer suffered no discernable material or monetary loss. On the basis ;that the money was received solely for the promise not to operate other outlets ;save those selling the wholesaler's brand the court regarded the sum as capital I

either because there was no loss of profits flowing from the· agreement, or 'because the promise was positive in imposing no restriction. If, as the majority'preferred, the sum was also receivea for the promise to buy only the wholesaler's brand for ten years, Taylor J. as judge 'illone97 and Webb and I

McTiernan J on appeal regarded the sum as income, either because it was:an ordinary incidence of carrying on such a business to receive such sums,97 I

or because it was paid for conducting the business, or employing its assets \in a certain way. 98 If, however, there had been a significant loss of profits:resulting from the agreement there is a suggestion that all three judges wouldhave regarded the sum as capita1. 99 If a non-proprietary analysis was;adopted the conclusion would of course be the other way.

94 Supra n92, 474 per Dixon CJ; 482 per Webb J; 487 per Williams J; 490 per Kitto J. Pe,contra 477 per McTiernan J.

95 Below 330 ct. Evans v Wheatley (1958) 38 TC 216; Strick v Regent Oil Co Ltd [1966:AC 29, 325 per Lord Reid.

96 Above 315.97 Supra n92, 477 per McTiernan J.98 Ibid 469 per Taylor J; 487 per Webb J.99 Ibid 477-478 per McTiernan J; 487 per Webb J.


Of the majority, it appears from the tenor of their judgments that theywould have reached the same conclusions whether there had been an effecton profits or not. Kitto J applied a rights analysis,l°O and regarded therestriction as a substantial and enduring detraction from pre-existing rights.Dixon J 101 also regarded it as significant that the business would have to berestored at the end of the ten years; but this consideration as it appearedin the Van den Bergh-s decision has been criticised above. In any event heconcluded even if it did represent in part compensation for loss of futureprofits, the sum paid amounted to a capitalisation of that element. 102 Butif this is accepted, it is difficult to see what scope the compensation principlecan have at all. Williams J preferred to equate a capital character with a lumpsum payment, and income with recurring payments,103 although it is suggested this is simply an exanlple of using one test to the exclusion of all others.

Higgs v Olivier concerned an actor who agreed in consideration of thepayment of £15,000 not to act in, or produce, or direct any film anywherein the world for a period of eighteen months, except at the request of thepayer. The English Court of Appeal held they were bound by the findingof the Special Commissioners that the sum received was not a profit or gainarising or accruing "from" his profession or vocation as an Clctor, andtherefore was not caught by the relevant Case and Schedule of the UnitedKingdom Income Tax Act 1918. 104 The principal judgment of Evershed MRthen, like that of Rowlatt J in Short Bros, must be cited very carefully, sincethe question of capital or income was not directly addressed.

However, it is possible to ascertain what the character of the receipt wouldhave been had the case been heard in Australia. There are at least three reasons why Olivier may have accepted this sum. First, he may have estimatedthat his expected earnings from films over the specified period to be £15,000.The compensation for that loss should be regarded as income. lOS Secondly,he may have had little or no intention of acting (etc.) in films over that period,but he may have 'held out' for the large sum knowing that the payer stoodto lose a larger amount if he did not pay it. This type of receipt does notrelate to any income producing activity, nor in any meaningful way to thesurrender of any right or property, so unless there is some miscellaneous testfor catching it, like the £4,000 in Dickenson it will escape tax. Thirdly, Oliviermay have enjoyed acting, and even if he was not intending to earn £15,000in the ensuing eighteen months, nonetheless he would not have relinquishedhis chance to act for less than that sum. Although this type of "idiosyncratic"valuation is unlikely to occur in a commercial contract, nonetheless it does

100 Ibid 492.101 Ibid 475.102 Ibid 474.103 Ibid 483.104 Schedule D, Case II; s 108. Cf an employee who receives a sum purportedly as a restricted

covenant, but where in order to be assessable the character must be much more of a remunerative one: Beak v Robson [1943] AC 352. The type of analysis applied in the text to Higgs v

livier could equally be applied to Murray v ICI Ltd (1967) 2 All ER 980; and Vaughan-NeilInland Revenue Commissioners (1979) 3 All ER 481.105 Because a "rights" analysis is artificial where the contract can not be performed vicari

usly (and can not therefore be sold); and any "right to work" has no basis of valuation apartrom profits expected from it: above 000; cf Commissioner of Taxes (Vic) v Phillips (1936) 55LR 144, 156.


not differ from the second reason above. The enjoyment of acting providesthe motive for 'holding out', whereas in the second category it is merely avaricewhich does so; but unless one falls into the fallacy of a rights/propertyanalysis, the two situations are very similar.

D Some Qualifications

(1) The Complete Cessation of Business

Californian Oil Products Ltd (In Liquidation) v Federal Commissionerof Taxation 106 introduces another complication into the above analysis. Thedecision stands for the supposed principle that where the receipt is in respectof a complete cessation of business, then the payment will per se be of acapital nature. 107 The taxpayer received £70,000 payable in ten six-monthlyrests in respect of the cancellation of an exclusive ag~ncy agreement, andfor a restrictive covenant on the future activities of the former agent. Theagency was the sole business of the taxpayer, and after the cancellation ofthe agreement it went into liquidation.

In stating this proposition, the court relied on two lines of authority. Thefirst is the loss of office cases. For example, an extract from Rowlatt J'sdecision in the early English case of Chibbitt v Joseph Robinson & Sons l08

was adopted approvingly by the court in Californian Oil, 109 where he said"a payment to make up for the cessation in the future of annual taxable profitis,.not in itself an annual payment at, all". However, there are considerabledangers in liberal abstraction from such decisions, because the issues thereare much more complex than those which arise in relation to the cessationof a business involving independant merchants. In the apparently simpleexample of a payment to an office holder for early retirement, not only isit relevant to characterise the office or rights relinquished as proprietary ornot, but there are also issues as to whether the payment is for past serviceshitherto unremunerated; 110; whether it is for future services to be performed; whether it is in the nature of a testimonial; III and in the earlyEnglish decisions whether it having been paid for the cessation of an office,it could be said, within the literal meaning of the taxing statute, to be paidas "profits . . . arising from any office . . .".. 112 In fact, as appears from hissubsequent comments in Hunter v Dewhurst, 113 Rowlatt J had predicatedhis comments in Chibbitt (and subsequently approved in Californian Oil)on such a literal interpretation.

It is submitted that an office, not being generally capable of vicarious dis-

106 (1934) 52 CLR 28.107 Ibid 47 per Gavan Duffy CJ & Dixon J; 49 per Starke J; 51 per Evatt & McTiernan JJ.108 (1924) 9 TC 48,61.109 Supra nl06, 47, 51.110 Cf discussion in Hayes v Federal Commissioner of Taxation (1956) 96 CLR 47 on this I

possibility, and see the Court of Appeal decision in Hunter v Dewhurst (1932) 16 TC 605, 6261et seq.

III Eg Cooper v Blakiston [1909] AC 106; Dixon v Federal Commissioner of Taxation (1952)186 CLR 541; Louisson v Commissioner of Taxation [1942] NZLR 30.

112 Eg Duncan's Executors v Farmer (1909) 5 TC 417; Chibbitt v Joseph Robinson & Sons(1924) 9 TC 48; Stedeford v.Beloe [1952] AC 388.

113 (1932) 16 TC 605, 625.


charge, should be regarded as a non-transmissible right, and paymentsreceived for its premature termination should be characterised as made insubstitution of income potentially receivable; assuming that on a preliminary inquiry it has already been ascertained that the receipt is not for servicesrendered (or to be rendered), nor in the nature of a testimonial. 114

Although Californian Oil was followed in Scott v Commissioner of Taxes(NSW),115 it is submitted that the decision in Phillips v Commissioner ofTaxes (ViC)116 is to be preferred. In particular the finding that "a contractof services is valuable only because of the income it will bring during theresidence of its term. It is not a piece of marketable property," accords withthe judgment of Lord MacMillian in Hunter v Dewhurst; who, alone amongsttheir Lordships, addressed in isolation the nature of the rights relinquishedin exchange for the receipt. 117

The other line of cases relied on in Californian Oil for the propositionthat a complete cessation of business brought about by the termination ofa contract will always result in a capital receipt is comprised of the "agency"cases. However these decisions, of which HA Roberts Ltd v MNR118 andBarr, Crombie & Co Ltd v Inland Revenue Commissionersl19 are examples,while generically faithful to such a proposition, nonetheless are explicableof different grounds. It has not been the complete cessation assuch whichhas resulted in a capital characterisation, rather than that the event causingthe termination has "affected the entire or a substantial part of the incomeearning structure or apparatus"; 120 or that "the assets of the business havebeen permanently sterilised".121 For the reasons discussed above,122 boththese explanations rest on a fallacy as to the nature of the rights affected.If the agency is marketable, and likely to be sold as part of a business ofselling such contracts, then rights analogous to trading stock have beensterilised. Where, however, this is not so, the contract has no value apartfrom the profits which it will produce; and to nonetheless describe the contract as proprietary is to accord to all adjustments of rights a proprietaryand thus capital character.

Where as a result of the cancellation, capital assets of the taxpayer becomeidle, there is no analogy with the position where a competitor actually paysfor their permanent sterilisation. Rather as in Van den Berghs Ltd v Clarkthis idleness really only accelerates a result which would have occurred in

114 That is to say it is not capable of a "rights analysis", cf supra n116. And see Phillips vCommissioner of Taxes (Vic) (1936) 55 CLR 144, 156:

"... a contract of services is valuable only because of the income it will bring during theresidue of the term. It is not a piece of marketable property."

lIS (1935) 35 SR (NSW) 215.116 (1936) 55 CLR 144. But see Bennett v Federal Commissioner of Taxation 450.117 Only Lord MacMillan directly posed the question "for the substitution of what rights was

.he payment paid?" Lords MacMillan and Dunedin also approach the cases on the basis ofNhether, as a matter of substance, the sum might be for services rendered, even though It was~or loss of office. Lords Atkin and Thankerton did not on the facts think it was a loss of office;ase at all. It is more difficult to explain the basis of Lord Warrington of Clyde's judgment.

118 [1969] SCR 719.119 [1945] SC 271.120 Van den Bergh v Clark [1935] AC 431.

I 121 Glenboig Union Fireclay Co Ltd v Inland Revenue Commissioners (1922) 12 TC 427.122 Above 316.

326 Federal Law Review [VOLUME 15 I

any event at the conclusion of the contract. In substance what the taxpayer I

received is the lost profits.But even without unravelling the confusion which the Van den Burghs I

property analysis has introduced into the inquiry, the "complete cessation I

of business" test is open to attack on two other grounds. First, it would appear I

to result not from the consequence of cancellation as much as from the preexisting circumstance that the taxpayer has no other business, or no other I

agencies. This consideration appears to make exigibility dependent not onthe character of the receipt, rather than on the individual circumstances ofthe taxpayer. Secondly, in relation to the "loss of office cases" there mustnecessarily have been a complete cessation of business by the employee, even i

if only temporarily; however, this fact has not prevented the courts in ,I

appropriate circumstances from characterising the payment as income for I

loss of income. 123

Where the lost profits are less than the sum actually received by the taxpayer, this should not however be construed as evidence that the excess should 'I

be regarded as income simply because the payment is not intended to transfer I

capital rights to the payer. Rather, like the payment in Dickenson,124 the:money is not to compensate the taxpayer for any demonstrable loss, rather I

than to ensure benefits for the payer. Whether such a sum is assessable will I

depend upon whether there is any income test catching miscellaneous payments accruing in the ordinary course of business.

The above (pristine) analysis is, however, somewhat complicated by the:problem of loss of goodwill. Where the contract cancellation results in a complete or near complete cessation of business there will be an inevitable loss i

of goodwill, which is a capital item. Where this loss is significant the courts i

have been influenced to regard the receipt as on capital account. 125 If the:payer purchases assets of the taxpayer, of which goodwill may be one~ then I

clearly the sum is not assessable. Where, however, the goodwill is sterilised!because of a contract cancellation, this should be regarded as with idle ,I

machinery as a consequence of the agreement rather than the quid pro quo I

for the payment.If, however, the goodwill, rather than being sterilised, accrues to the payer,

different considerations apply. This is likely to occur where an agency 1

agreement is cancelled, and the ,principal is thereby able to enjoy a corresponding enlargement of the market, together with the benefits of any goodwill I

generated by the agent. There are a number of major factors to be considered; I

first, whether the agreement is terminated by the principal exercising an!existing right, or whether the release has had to be negotiated; secondly"whether the goodwill is generated by the agent, or whether it accrues by virtue~

of elasticity of demand, lack of substitutes, geographic dominance or similar;and thirdly, whether the principal intends to capitalise on the goodwill whichhe receives on cancellation of the agreement.

If the principal has exercised a right to cancel the agreement, the goodwillaccumulated by the agent will, providing the product enjoys some degree

123 Eg Phillips v Commissioner of Taxes (Vic) (1936) CLR 144; Hunter v Dewhlfrst (193216 TC 605 per Rowlatt J. app'd Court of Appeal at 626. '

124 (1958) 98 CLR 460.125 Eg Parsons-Steiner v MNR [1962] Ex CR 174.

1985) Compensation Payments; 327

of market stability, accrue to the principal without more. If, as a conditionof exercising the right to cancel, the principal must pay a sum of money underthe contract, in the absence of contrary intention it would be an obviouspresumption in such circumstances that the money was primarily to compensate the agent for lost profits, and costs in developing the goodwill (nowthrown away), and the balance only as a windfall to the taxpayer. 126 If, onthe contrary, the principal has had to bargain for the contract release, thegoodwill does not automatically accrue as a consequence of the exercise ofan existing right, and it is more realistic to regard the release of the goodwillas the quid pro quo for the payment. 127 Certainly, the payer will so regardit, although whether the receipt should be characterised as capital will dependon whether the analogy with the sale of a proprietary right is sufficientlyclose. 128

Where, however, the principal does not intend to utilise the goodwill, forexample, where he himself is going out of business, the property analogyis less obvious. The goodwill appears much closer in this situation to a rightnot inherently transmissible,129 because the payer is seeking only to "repurchase" the rights originally given to the agent, and the wasting of goodwillgenerated by the agent during its currency is rather a consequence of, thanthe consideration for, the agreement to release those rights. Therefore, thereceipt by the agent should be regarded primarily as compensating for lostprofits, than as a windfall as to any surplus.

The above analysis does not, however, hold where the goodwill has notbeen generated by the agent, but rather exists as a result of market conditionssuch as inelasticity of demand, barriers to entry, and the others mentionedabove. In these circumstances the goodwill should in substance be regardedas having continued in "ownership" of the principal,130 and the agent in anegotiating situation will be seeking compensation for lost profits; andpossibly also "holding out" for an additional sum if he calculates that theloss to the principal of not cancelling the contract is greater than the pricedemanded for doing so.

Consistent with earlier comments131 the penultimate comment concernsthe cancellation of the agency agreement under which the agent has beenselling in a competitive market products homogeneous with those of othervendors. In these circumstances there is unlikely to be any goodwill attached

126 Cf below 329. The money would not compensate the agent for loss of goodwill (capital),since if the contract is not marketable the goodwill really belongs to the principal, a conclusionreinforced by the right of the principal to terminate by exercise of an existing right.

127 Although the agent may have no right to sell the agency, so that again the goodwill mightJe seen as really belonging to the principal, the element of bargaining tends to give the agent1 right which the principal regards as valuable, and which the agent can withhold.

128 Although the agency may not be capable of vicarious performance, the agent has generlted something of 'value dehors the contract, namely goodwill, which may be used to producencome, but also where the principal bargains for it, is capable of transfer; even if only to oneJerson (namely the principal).

129 Above 314.130 Since it will exist even if the contract was not created or cancelled, and the principal in

o sense seeks to recover its use from the agent. He merely seeks to terminate the agent's righto it. The fact that the principal may then licence someone else to enter the market in a profitaIe way is a character of the market, not of the release of the first agent. Therefore a propertynalysis is not possible.

131 Above 326.


to the agreement (although some may attach to the site), and the principalfar from enjoying any positive gain, must compete with the other competitorsfor the market share left by the agent's withdrawal. This makes it difficultto suggest that the agent has relinquished something with a proprietarycharacter. 132

Finally, the issue is raised133 whether the complete cessation of business i

cases are explicable not on any abstract capital/income inquiry, but by virtue :of statutory interpretation. This is particularly apposite under the EnglishSchedule D, which was so worded that post-cessation receipts escaped tax. 134

However the Australian legislation only refers in section 6 to "the proceeds :of any business carried on by the taxpayer ..."135 and in section 26(g) to I

"... any bounty or subsidy received in or in relation to the carrying on ofa business ..."; 136 and neither provision excludes post-cessation receipts.Receipts representing income from income producing activity, derived in anincome year subsequent to the activity, will be assessable under the Australian I

Act, notwithstanding that in the year of receipt no business is carried on. 137 }

(2) Commutation

The suggestion was made by Lord Wrenbury in the Glenboig decision 138 I

that the payment of a sum in redemption of an annuity would not be exigible. In Australia redeemed annuities will be taxed as "eligible termination I

payments"; 139 but to the extent to which the receipt represents the return of(unused) undeducted purchase price the payment will probably be taxfree. 140 Without the new Subdivision AA (Division 2, Part III) it is submitted that the dicta of Lord Wrenbury is incorrect insofar as he considers a I

commutation of an annuity to be capital, since it is the recurrent nature ofan annuity alone which gives it an income ftavour. 141 Without that elementit becomes something akin to a gift or settlement. But Lord Wrenbury goes i

too far in drawing on analogy between this situation and Glenboig itself.

132 Supra n130.133 Above 324.134 Eg Gospel v Purchase [1952] AC 280; Carson v Cheyney's Executors [1959] AC 412. See:

now ss 143-151 Income and Corporation Taxes Act 1970 (UK)135 Emphasis added. The limited operation of s 6 "income from personal exertion" was dis

cussed in Scott v C of T (NSW) (1935) SR (NSW) 215 t 220; Federal Commissioner of Taxation I

v Dixon (1952) 86 CLR 540 t 564 per Fullager; and 555 per Dixon J.136 Emphasis added. the provision is limited in scope by the words 'bounty or subsidy\ andl

appears to be merely declaratory in that it does not bring to tax amounts which are not otherwise exigible under ordinary concepts. For a full discussion of the relevant authorities: CCHIFederal Tax Reporter 14-150.

137 This must follow from the assessability of income in the hands of an assignee, who, likethe discontinued business entityt have not earned the income in the year of receipt.

138 (1922) 12 TC 427 (HC) 465-466.139 s 27A(l) "eligible termination payment" (d)-G); CCH The New 1984 Retirement Tax (1984:

55-57; and see s 27A(l) "eligible termination paymenC' (a)(ii).140 Ibid; 27H (2) - (3). The latter provisions do not adopt "unused" in relation to th{

undeducted purchase price: see s 27A(l) "undeducted purchase price", "unused undeductedpurchase price". The purchase price may be fully discounted on redemption under s 27H (2:- (3). If it is not, and the payment is caught by s 27A(l) "eligible termination paymenC' (d'- G), the purchase price will be discounted by those provisions.

141 The capital purchase sum is extinguished by the purchase of the annuity eg Scobie v Secretary of State for India [1903] 1 KB 504.


A sum paid on account of lost profits is income, because it "stands in theshoes" of the foregone profits, or more correctly, because it fulfils thepromisee taxpayer's expectation interest. 142 Whether the sum is paid in alump sum or recurrantly the result is identical. A lump sum commutationof an indemnity. however accelerates a series of payments which, had theybeen paid in a lump sum would not be exigible. Ergo there is no incomeearning activity with reference to which that sum can be said to be income.

(3) Quantification

There are many examples of dicta to the effect that quantification is notdeterminative of income character; 143 fewer per contra. 144 For the most_partit is submitted, this criteria has been indiscriminately applied, usually in favourof a capital determination. If one acceptf: the basic proposition of the writerthat a non-marketable (intangible) right should not be characterised asproperty, but rather that the inquiry should be directed to the existence ofany ultimate cash loss, then the following propositions would appear tofollow. First, there are categories where the character of the compensationreceipt will be unaffected by the manner of quantification. Capital examplesare payments with no relation to any post or future income earning activitydirected to the payer; 145 and physical injury.146 Income examples are loss ofprofits, income, or trading stock. 147 Secondly there are instances where thereis a presumption of capital, but if the payments are quantified by someextraneous criteria then income will be assumed. 148 The parties havemanifest an intention to compensate for the profit loss rather than the capitalloss. Examples are the loss (but not sale)149 of non-trading assets, providingthey are tangible,lso or if intangible are transmissible. 151 In the case ofpartial sterilisation the method of quantification will assist the court in

142 Ie it puts him in the position he would have been in had the contract been performed,and more particularly protects the profit he would otherwise have made: Robinson v Harman(1848) 1 Ex 850, 855.

143 Eg Californian Oil Products Ltd v Federal Commissioner of Taxation (1934) 52CLR 28,41; Glenboig Union Fireclay Co Ltd v Inland Revenue Commissioners (1922) 12 TC 427; BurmahS5 Co v Inland Revenue Commissioners (1930) 16 TC 67; Short Bros Ltd v Inland RevenueCommissioner (1927) 12 TC 955. Cf CCH Federal Tax Reporter para 11-860.

144Eg Commissioner of Taxes (Vic) v Phillips (1936) 55 CLR 144, 156.145 Eg Federal Commissioner of Taxation v Dixon (1952) 86 CLR 540.146 British Transport Commission v Gouley (1955) 3 All ER 796; Cullen v Trappell [1980]

ATC 4185, Gill v Australian Wheat Board [1981] ATC 4217. The-analysis which would beconsistent with principle would be that damages for loss of earnings (but not. for eg pain andsuffering) be regarded as paid as compensation for loss of income and assessable. This wouldremove the problem of taking taxation into account in assessing personal injury damages; howeverthe courts have preferred another approach. For a different view in a non-injury case see Pennant Hills Restaurants Pty Ltd v Barrell Insurances Pty Ltd [1981] ATC 4152.

147 Above 308.148 Supra nn 31-32.149 Since the sale price of an asset may be a sum quantified with reference to some antici

pated scale; eg a sum equai to 50070 of profits for the first year: Inland Revenue Commissionersv Ledgard [1937} 2 All ER 492; although a different result would occur if the payments weretrue annual sums, or expressed without reference to a capital sum: eg 25070 of profits for 3 years.

150 If they are tangible they need not be also transmissible to have a property character:lSI Above 315.


ascertaining the true loss which the payment is intended to indemnify. 152Where the right lost is both intangible and non-transmissible, then it issubmitted that the "right" has no proprietary character, and providing someloss has been sustained,153 the receipt should be income regardless of themethod of quantification. These conclusions are stated schematically in theappendix to this paper.

Where damages for lost income are paid, or where the damages are quantified by 'presumed lost income, and are therefore income and prima facieassessable, the question arises whether only that proportion of the receiptrepresenting anticipated (net) profit should be assessable. 154 It is submittedthat the whole sum should be returned, as the taxpayer will be able to claimthe expenses thrown away as deductions. 155 Where the sum, though paid orquantified by reference to lost income in fact grossly exceeds the possibleloss, the courts will need to determine whether or not the taxpayer is stoppedfrom claiming an apportionment based on partial non-compensation. Theexperience in related issues appears to be that estoppels will operate in favourof the commissioner, but not against him; 156 but there are circumstances,of which Commissioner of Internal Revenue v Glenshaw Glass C0 157 is anexample, where such a fiction would be far too blunt.

4 THE ORDINARY COURSE OF BUSINESS TEST

It is sometimes suggested158 that there is an income test which catchespayments received in the ordinary course of business. In the context of thispaper an example would be amounts paid for the cancellation of agreementswhich go beyond compensating the taxpayer for any conceivable loss, whetheron capital or revenue account. 159 The reference to the ordinary course ofbusiness is not intended however to refer to receipts ordinarily received inthe course of [this] business, which indicates such an element of repetitionas is sometimes necessary, but always sufficient to establish trading activity

152 Above 310.153 Above 316. If no loss has been sustained the payment will represent a windfall to the

taxpayer. Whether it is assessable depends on whether there is a principle making receipts inthe ordinary course of business exigible.

154 Where there is an identifiable element of interest involved this will clearly be assessable:Vestey v Inland Revenue Commissioners [1961] 3 All ER 978; Riches v Westminster Bank Ltd[1947] 1 All ER 469; the decisions in Inland Revenue Commissioner v Ballatine (1924) 8 TC595; Simpson v Executors ofBonner Maurice (1929) 14 TC 580 may be explicable on the basisthat the courts were merely awarding a capital sum valued at the date of judgment, and thereference to interest modum aestimationis merely assists in arrriving at that valuation.

ISS the solution will be more obvious where the payment is only for lost profits, or for theloss of trading stock.

IS6 The Commissioner clearly will not be bound where the parties· adopt incorrect nomenclature: Inland Revenue Commissioners v Thomas Nelson & Sons (1938) 22 TC 175; FederalCommissioner of Taxation v McPhail (1968) 117 CLR 111; but the reverse does not alwaysapply; see eg Commissioner of Taxes (Vic) v The Melbourne Trust Ltd [1914] AC 1001, 1011;Lomax v Peter Dixon & Son Ltd (1943) 25 TC 353, 367 per Lord Green MR (1).

IS7 (1955) 348 US 426; cf Murray v Goodhews [1976] 2 All ER 296.IS8 Eg Short Bros Ltd v Inland Revenue Commissioners (1927) 12 TC 955; Dickerson v

Federal Commissioner of Taxation (1958) 98 CLR 460; HR Sinclair v Federal Commissionerof Taxation (1966) 114 CLR 537.

IS9 Eg Dickerson v Federal Commissioner of Taxation (1958) 98 CLR 460; and see Federa/l

Coke Co Ltd v Federal Commissioner of Taxation (1977) 15 ALR 449.


in certain items. 100 Rather the receipt is one which does not occur often, butnonetheless if it does occur, has an obvious nexus with the operations ofthe business. Nor is it intended to refer to the taxpayer who purchases propertyfor income production by selling or leasing in one manner, but is later forcedto realise it in another. 161

Two preliminary points should be made. First it is obvious that if sucha test has any application in Australia it must be inclusionary and not exclusionary in operation. Many receipts are exigible, for example; insurancepayments, notwithstanding their unusual and non-recurrent nature. 162

Secondly, since the receipts allegedly caught are something of a miscellany,it would appear appropriate to apply the test only when the receipt is clearlynot income or capital on the application of any other recognised inquiry.

The notion that such receipts be assessable clearly had its genesis in thewording of the Schedules and Cases to the English Finance Acts; in particular the nomenclature ". . . arising from. . .". 163 But its reception intoAustralia, with our absence of similar statutory touchstone, has beenambiguous. In Dickerson for example the Justices who considered the issue(including Taylor J) were divided as to whether the £4000 was a normalincidence of carrying on a business or not; and there are other examples ofantipathy in its application. 164 It is suggested that such an inquiry is far tooinsensitive to raise the pertinent issues. For example as between the alternatives "sums received in the ordinary course of business" and "sums ordinarilyreceived in the course of business" one searches vainly for any plausible basison which to make a choice.

Where a one-off sum is paid,165 and is not income according to the recognised tests for determining such, then assessability should be determinedaccording to whether a sum, having no relation to foregone profits or incomeproducing activity, should nevertheless, as a matter of policy or analogy,be an income receipt. The closest analogy is with gift which is not assessible,and the only distinguishing factor is that the type of casual receipts in questionarise because the payer's motive in making them is not altruist, but ratherdictated by business ends. That as such should not alter their chaFacter inthe hands of the· taxpayer. 166 As far as policy considerations are concerned,there does not appear to be any linguistic convention which would regard

160 See eg Federa/Commissioner of Taxation v Merv Brown Pty Ltd [1985] ATC 4,080, 4,086per Lockhart J; Pickford v Quirke (1927) 13 TC 251.

161 E'gAustrote/ Corporation Pty Ltd v Federal Commissioner of Taxation [1976] ATe 4,245,per Stephen J.

162 Eg G/iksten v Green [1929] AC 381; King v British Columbia Fir & Cedar Lumber CoLtd [1932] AC 441.

163 Schedule D, Cases, I & II; Schedule E.164 Eg Federal Commissioner of Taxation v Merv Brown Pty Ltd [1985] ATC 4080.165 Whether in a lump sum, or in instalments quantified by reference to a lump sum. Where

the payment is not so quantified, it is fairly open to characterisation as revenue on the basisof recurrance (eg Federal Commissioner of Taxation v Dixon (1952) 86 CLR 540), or as anannual sum (eg Egerton- Warburton v Federal Commissioner of Taxation (1934) 51 CLR 568.)

166 It is a well recognised rule that is the character of the receipt in the hands of the recipient,not the motive of the payer which is determinative. A gratuity for services rendered is intendedas a gift, but assessable nonetheless. There is however a line of English authority which suggests that voluntary payments made to subsidise trading operations may be assessable: PretoriaPetersbury Rly Co v Elwood (1908) 6 TC 508; Charles Brown & Co v Inland Revenue Commissioners (1930) 12 TC 1256. Some of these are discussed in CCHFederal Tax Reporter para 11-840.


these sums as income according to ordinary usage. Nor is there any dangerof taxpayers using non-assessability of such receipts as a tax avoidance device,since the payments in question are inherently fortuitous.

However, it is possible to argue that the sum, far from being a compensation payment, and even accepting it as gratuitous, nonetheless is a sumreceived in return for performing income producing activities for the payer.To use a rather facile example, if the taxpayer distributes products exclusively for one principal, he has given up a right to do the same for others;but where he is using his time fully for the one principal,167 and has sufferedno profits loss through the agreement, then sums paid to the agent primafacie partake of a reward for services rendered. 168 Only if one can point tosome testimonial element, which would be difficult in business relationships,could this conclusion be avoided. Where the money is paid for not doingsomething, a completely different inquiry would need to be instigated. 169 Ofcourse where the taxpayer is not an agent or employee, the sum may notbe for services rendered, rather than as a· refund on the purchase price ofgoods bought.170 But the authorities suggest that to be exigible, such a summust be received under the purchase contract. 171

But often these payments which have the apparent character of gift,nonetheless have conditions of use attached to them; for example money paidby an oil company to a garage proprietor on condition the sum is used topaint the premises in the company's colours. 172 It is submitted that theelement of control exercised by the donor reinforces the conclusion that thesum will be a gift;173"but it can not of course, dilute the presumption thatit is in return for services rendered, where the payee does something for thepayee. Nor is it legitimate in this regard to take into account the use to whichthe money is put, since the crucial issue to characterise the sum at the pointof receipt. How a taxpayer uses a gift or an income receipt can not possiblyaffect its character. 174

5 CONCLUSION

In Merv Brown Ply Ltd v Federal Commissioner of Taxation Kaye J foundthat the appellant was not trading in import licences. As an issue of mixed

167 Thus negating any inference that the taxpayer had "sterilised" part of his profit earningtime, although it is difficult to see how this argument could be efficacious.

168 Eg Austrotel Corporation Pty Ltd v Federal Commissioner of Taxation [1976] ATC 4245.169 Eg Higgs v Olivier [1952] 1 Ch 311, on the hypothesis that Olivier "held out" for a sum

which went further than compensating him for any loss; and therefore was not income according to an application of the compensation principle.

170 Cf Europa Oil (NZ) Ltd v Commissioner of Inland Revenue (No 1) [1970] ATC 6012;Case 56 [1985] ATC 117; and see further Commissioner ofInland Revenue v Dunlop's WanganuiLtd [1970] NZLR 1125.

171 Europa Oil (NZ) Ltd v Commissioner of Inland Revenue (No.2) [1976] ATC 6010; Federral Commissioner of Taxation v South Australian Battery Makers Pty Ltd [1978] ATC 4412;but cf Phillips vFederal Commissioner of Taxation [1978] ATC 4361.

172 Eg Commissioner of Inland Revenue v City Motor Services Ltd [1969] NZLR 1010; Commissioners of Inland Revenue v Coia (1959) 38 TC 334; McLaren v Needham (1960) 39 TC37; Saunders v Dixon (1962) 40 TC 329.

173 See eg Barclays Bank Ltd v Qui/close Investments Ltd [1968] 3 All ER 651.174 Supra n166. However the courts have often been influenced by this factor: see eg Maney

& Sons De Luxe Service Station Ltd v Commissioner of Inland Revenue [1969] NZLR 116.And see the English authorities discussed by Whiterman & Milne Supra n13 343-345; CCHFederalTax Reporter para 11-810.


fact and lawl75 that would appear correct, just as the sale of three per centof a company's income producing machinery per year, for example anewspaper's presses, would not involve the implication that they were tradingin them. 176 Given this finding, is the receipt nonetheless rendered assessableunder the compensation principle? Because the contracts were inherentlymarketable, and were sold, it seems impossible to give that principle anyapplication, and a property analysis is unavoidable. Such an analysis isexceedingly simple, but it reaches on a logical basis, and by a much lesscircumlocutory route, the same conclusion as Kaye J.

On appeal it was sought to destroy this analysis by pointing to theephemeral nature of the entitlements, and to the fact that the transactionshad no effect upon the "nature or fundamental structure of its business", 177

but the majority refused to overturn the lower court judgment. However thethrust of argument was obviously away from a compensation based inquirywhich had so exercised Kaye J, and much more towards the issue of businessor no.

But more difficult cases, of which Van den Berghs and Dickerson areexamples, require a more penetrating analysis, first to ascertain whether thetaxpayer has suffered any probable loss as a result of some wrongful repudiation or act by the payer, and if he has, secondly to distinguish between thenature of the actual loss and the mere event causing the loss. Such an analysisavoids the "rights/property analysis" which has dogged this already difficultarea, and hopefully forecloses recourses to such parenthetic tests as the effecton business structure of cancellation.

175 Eg Federal Commissioner of Taxation v Walker [1985] ATC 4,179.176 But in more extreme cases,. a taxpayer can both use an item as part of his income produc

ing structure, but nonetheless be in the business of selling such items: see eg J Bolson & SonLtd v Farrelly [1953] 1 Lloyd's Rep 258. Cf Crole v Lloyd (1950) 31 TC 338.

177 [1985] ATC 4080, 4085. Bowen CJ adopts this argument, but turns it around to find therewas a fundamental effect on the business. Lockhart J however appears not to rely on it. It issubmitted that such a test may be useful as an exclusionary test of income, providing it is notconsidered to be an exhaustive test. Some receipts may be capital, despite the fact they do notaffect the structure of the business. How for example would one characterise the sale of anobsolete office typewriter?


APPENDIX

non-lump lump sum lumpsum e.g. quantified sumquantified byby reference referenceto user to profits l

Non-trading sold2 y K Ktangible destroyed3 y y Kasset

temporarilysterilised y y y

Non-trading destro~ed3 y K Ktangible but non-transmissible temporarilyasset sterilised y y y

non-trading sold2 y K Kintangibleassets destroyed3 y* y* K

non-trading destroyed3 y* y* y*intangible butnot transmissibleasset

special Personalcases injury K K

tradingstock Y Y Y

1. OR income

2. OR compulsorily acquired

3. OR sterilised permanently

·Where there has been no loss to the taxpayer, or a loss less than the sum paid, theexcess can be regarded as a windfall, although it may nonetheless be accessible asa gratuity received for services rendered, or as a refund on trading stock acquired;above 332. .

Key: Y = IncomeK = Capital

COMPENSATION PAYMENTS; COMMERCIAL … PAYMENTS; COMMERCIAL CONTRACTS; AND THE I.T.A.A ... subject...

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