CATCHWORDS INCOME TAX - assessable income - claim by taxpayer for legal expenses incurred in connection with Inquiry into his suspension from employment with local government authority - whether legal expenses allowable deduction - true nature of Inquiry - ex gratia payment from State Government covering taxpayer's legal expenses - whether gratuitous payment assessable income in accordance with general concepts or benefit under s.26(e) Income Tax Assessment Act 1936 ss25(1), 26(e), 51(1) Local Government Act 1936-1985 (Q'ld) s4A "Assessable income under s25(1)" Cases considered: TNT Skypak International (Aust) Pty Ltd v Federal Commissioner of Taxation (1988) 82 ALR 175 Federal Commissioner of Taxation v Harris (1980) 43 FLR 36 First Provincial Building Society Limited v Federal Commissioner of Taxation (1995) 95 ATC 4,145 International Nickel Australia Limited v Commissioner of Taxation (1977) 137 CLR 347 "Deductibility of legal and other expenses" Cases considered Inglis v Federal Commissioner of Taxation (1987) 87 ATC 2,037 Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946) 72 CLR 634 Dobbs v Commissioner of Inland Revenue 74 ATC 6,001 Federal Commissioner of Taxation v Maddalena (1971) 71 ATC 4,161 Kemp v Federal Commissioner of Taxation (1992) 92 ATC 4,542 Commissioner of Taxation v Raymor (NSW) Pty Ltd (1990) 24 FCR 90 Sun Newspapers Limited v Federal Commissioner of Taxation (1938) 61 CLR 337 Case distinguished Kratzmann v Federal Commissioner of Taxation (1970) 1 ATR 827 "Assessability of payment under s.26(e)" Cases considered The Squatting Investment Co Ltd v Federal Commissioner of Taxation (1953) 86 CLR 570 Hochstrasser v Mayes [1960] AC 376 Federal Commissioner of Taxation v Dixon (1952) 86 CLR 540 H.R. Sinclair & Son Pty Ltd v Commissioner of Taxation (1966) 114 CLR 537 Smith v Commissioner of Taxation (1987) 164 CLR 513 Haggarty v Federal Commissioner of Taxation (1989) 89 ATC 4,485 -2- COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA v ANTHONY JOHN POULSTON ROWE No. QG 128 of 1994 BEAUMONT, BURCHETT AND DRUMMOND JJ. SYDNEY 20 OCTOBER 1995 IN THE FEDERAL COURT OF AUSTRALIA) No. QG 128 of 1994 QUEENSLAND DISTRICT REGISTRY ) GENERAL DIVISION ) ON APPEAL FROM THE ADMINISTRATIVE APPEALS TRIBUNAL BETWEEN: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA Applicant AND: ANTHONY JOHN POULSTON ROWE Respondent MINUTES OF ORDERS JUDGES MAKING ORDER: Beaumont, Burchett and Drummond JJ DATE OF ORDER: 20 October, 1995 WHERE MADE: Brisbane THE COURT ORDERS THAT: 1. The appeal be dismissed with costs. NOTE: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules. IN THE FEDERAL COURT OF AUSTRALIA ) ) QUEENSLAND DISTRICT REGISTRY ) No. QG 128 of 1994 ) GENERAL DIVISION ) ON APPEAL FROM THE ADMINISTRATIVE APPEALS TRIBUNAL BETWEEN: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA Applicant AND: ANTHONY JOHN POULSTON ROWE Respondent CORAM: BEAUMONT, BURCHETT AND DRUMMOND JJ. DATE : 20 OCTOBER 1995 REASONS FOR JUDGMENT BEAUMONT J. INTRODUCTION AND BACKGROUND This is an appeal from a decision of the Administrative Appeals Tribunal ("the Tribunal"), constituted by Dr. P. Gerber, Deputy President, allowing a taxpayer's objection to the assessment, as income, of a sum of $24,748.24 received by the taxpayer from the Government of Queensland in April 1989 in circumstances to be mentioned shortly. The appeal is brought under s.44 of the Administrative Appeals Tribunal Act 1975. The background to the payment in question was as follows. (a) The statutory inquiry The respondent taxpayer, who was then employed by Livingstone Shire Council as its Engineer, was suspended from duty on 20 June 1985, and required by the Council to show cause why he should not be dismissed by reason of several complaints made against him. In his letter to the respondent dated 20 June 1985, the Chairman of the Council referred to an extract from the Minutes of the General Meeting of Council held on 18/19 June 1985 as follows: "Cr. M.L. Cresta made reference to the following matters: Regarding complaints against the Shire Engineer, made by or relating to:- 1. JALATEM PTY. LTD. 2. HAMILTON AND DEANE 3. R.A. & I.M. NEWLAND 4. W.H. MILLER 5. DALEBROOK PTY. LTD. 6. Justification of contribution recommendations of the following applicants' subdivisions:- (a) Taranganbah Est. Pty. Ltd. (Henry George Miller) (b) B.J. Aston (c) Saxby (d) Herriot (e) Richards (f) Hinton, contained in the dossier referred to in the resolution of council of August 1983, and tabled again at this meeting, and having regard to the matters involving:- 1. PRATTS ROAD 2. PROUSE ROAD 3. MILLERS ROAD (BYFIELD) - Justification of contribution recommendations of the following applicants' subdivisions:- (a) Rabrest Pty. Ltd. (b) Stan Barlow (c) Clare (d) Smith (e) Timba Nominees (f) Richards; the correspondence from Yeppoon Area Ratepayers' and Citizens' Association, re performance of private works on the property of Mr. and Mrs. Rowe on 22nd and 23rd June 1981, the omission for six months to disclose to Council the appeal instituted by Mr. & Mrs. Rowe against Council on 23rd March 1982, the full circumstances surrounding the proposed resumptions and later acquisition of the two Wilkins' properties, and all other relevant matters touching upon the duties of the Shire Engineer, and moved the following resolutions:- `That the Shire Engineer be suspended forthwith from employment as such, and that he be required to deliver to the Shire Clerk within 28 days, a written report replying to each and every complaint mentioned, and that he be required to show cause to Council at a Special Meeting to be convened for that purpose, why he should not be dismissed from employment by this Council;' `That during his suspension Mr. Rowe be required forthwith to surrender his shire car and Shire Office keys, and that he be denied access to the Shire Office, except in the following circumstances:- (1) He shall be allowed to clean out his office under supervision of appointees of Council; (11)He shall be entitled to such information as shall reasonably be required to enable him to report and answer fully the complaints against him, but such information shall be requested in writing by Mr. Rowe's legal advisers; (111) He shall be entitled to entry during business hours into all parts of the Shire Office which are open to the general public.' The resolutions were seconded by Cr. S.B. Dorey." In the letter, the Chairman requested that the respondent abide by these resolutions. (By s.17(1) of the Local Government Act 1936-1985 (Q'land) ("the Act"), a Local Authority is empowered to appoint, inter alios, an engineer to assist in the execution of the Act. By s.17(4) of the Act, "[t]he chairman may at any time suspend from office any officer who in his opinion is guilty of misconduct or neglect, ... . Provided that at the next meeting of the ... Authority after such suspension, the chairman ... shall report the matter to the ... Authority; and if the officer ... is dismissed by the ... Authority no salary or allowances shall be due or be paid to him from the date of his suspension.") On 27 June 1985, the Governor-in-Council pursuant to power vested in him by s.4(5) of the Act, intervened so as to rescind the resolution passed by the Council suspending the respondent. On 28 June 1985, the Director of Local Government for the State of Queensland, acting pursuant to s.4A(3) of the Act directed, at the direction of the Minister, that there be an Inquiry into the matters the subject of the resolution suspending the respondent and "into any other matters that are considered to be relevant to the matter". (By s.4A(3)(i) of the Act, the Director, (who, subject to the Minister, is charged with the administration of the Act - s.4A(2)), may make or cause to be made, inter alia, such inquiries as he thinks fit in relation to any matter respecting the administration of the Act and shall do so if so directed by the Minister. By s.4A(3)(ii) and (iii), the Director, or other person conducting any inquiry, has the powers of a commission under the Official Inquiries Evidence Acts 1910-1929 (Q'land). By s.3 of that Act, the President or Chairman of a Commission has power to summon witnesses. By s.4A(3)(v) of the Act, the person so directed by the Director to make any inquiry shall as soon as practicable furnish a full report of such inquiry to the Director.) By letter dated 28 June 1985, the Council informed the respondent of the statutory Inquiry and advised the respondent that his suspension from duty had been rescinded and that he was required to resume normal duties. The Inquiry was held in August 1985. The respondent retained a solicitor and counsel to appear for him at the Inquiry. In its report, the Inquiry "cleared [the respondent] of any charges of misconduct or neglect". The Inquiry noted that, although it had no power to award costs or recommend their payment, the respondent "ha[d] in reality been compelled to engage a solicitor and counsel to defend himself against dismissal". By letter to the Council dated 1 November 1985, the respondent applied to the Council for reimbursement of his expenses associated with the Inquiry, which then were stated to be $25,101.35. A further application to the Council was made by the respondent's solicitors by letter dated 23 April 1986, but the Council failed to accede to either of these requests. (In April 1986, the respondent was dismissed by the Council. In June 1986, he applied to the Local Government Appeals Board against the dismissal and received compensation and costs in that connection, but nothing turns on this for present purposes.) (b) The claim to deduct the legal costs In his return of income for the year ended 30 June 1986, the respondent claimed a deduction in the sum of $24,727.99, being his costs incurred in connection with the Inquiry. In his return, it was contended - "... that [this] expenditure was incidental and relevant to the gaining of assessable income. From the time of his initial suspension, it was critical from his point of view to successfully defend his actions, because, even though dismissal could still result, the question of the receipt of compensation would rely heavily on his being exonerated." The Commissioner initially disallowed the objection, but, subsequently on 13 July 1989, after there had been a reference made to the Tribunal at the respondent's request, the Commissioner decided to allow the objection in full. (c) The ex gratia payment by the Government In the meantime, the respondent applied to the Treasurer of Queensland for reimbursement of his costs incurred in connection with the Inquiry in the sum of $24,748.24, together with interest in the sum of $13,957.53, a total of $38,705.77. By letter dated 6 March 1989, the Treasurer, Mr. Ahern, wrote to the respondent as follows: "I refer to the matter of your costs in relation to the Committee of Inquiry into your suspension as the Livingstone Shire Engineer. Cabinet has agreed in principle to the State providing you with an ex gratia payment equivalent to the costs you incurred in the conduct of the Inquiry. In order to allow a proper assessment of your costs it would be appreciated if you could request your solicitors to supply the Treasury with a statement of your costs on the same basis as would be provided to a Court Taxing Officer. A determination and ex gratia payment will be effected as soon as possible on receipt of this information." By letter dated 26 April 1989, Mr. Ahern wrote further to the respondent as follows: "I refer to the matter of your costs in relation to the Committee of Inquiry into your suspension as the Livingstone Shire Engineer. The claim for costs and interest submitted by your Solicitors has now been examined and I advise that in accordance with Cabinet's decision on this matter, an ex-gratia payment of $24,748.24 has been approved in settlement of the claim. A cheque for this amount is enclosed." THE ASSESSMENT In his return of income for the year ended 30 June 1989, the respondent disclosed receipt of the sum of $24,748.24, but sought a ruling from the Commissioner that it was received on capital account and thus not taxable as income. However, the Commissioner included this amount in his notice of assessment. The respondent objected against this assessment. The Commissioner disallowed the objection. THE DECISION OF THE TRIBUNAL Setting aside the Commissioner's decision, the Tribunal held that the receipt was not taxable income, either under s.25(1) (as income in accordance with ordinary concepts) or under s.26(e) of the Income Tax Assessment Act 1936. Section 26(e) provides that the assessable income of a taxpayer includes: "the value to the taxpayer of all allowances, gratuities, compensations, benefits, bonuses and premiums allowed, given or granted to him in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by him, whether so allowed, given or granted in money, goods, land, meals, sustenance, the use of premises or quarters or otherwise ..." The Tribunal found, and it has not been disputed, that the payment by the Treasury was ex gratia, was by way of reimbursement of the respondent's legal expenses, and was in no way referable to the claim made for lost interest. The learned Deputy President rejected a submission by the Commissioner that the sum in issue was a reimbursement of expenses which were deductible under s.51(1) and, for that reason, constituted income under s.25(1). Dr. Gerber concluded, after a consideration of the authorities, that "no such general principle exists". Turning to consider the "guiding principles" which distinguish between income and capital, Dr. Gerber, acknowledging that the distinction was one of "emphasis" or of "fact and degree", said: "The following are some of those `guiding principles' ... (a) Whether an amount is income according to ordinary concepts depends upon `a consideration of the whole of the circumstances' ... and `its quality in the hands of the recipient.' ... (b) The test to be applied is an objective rather than subjective one ... . (c) The motives of the donor of the payment are a relevant consideration but not decisive ... . (d) The regularity and periodicity or otherwise of the payment will be a relevant though not decisive consideration ... . (e) Although the cases have tended to fail in some degree to discriminate in what context use is being made of such phrases (i.e. whether in relation to sub-s 25(1) as distinct from s 26(e)), it would appear that a generally decisive consideration is whether the receipt is the `product of', `incidental to', `an incident of', `a consequence of' or `in relation to' any employment of, or services rendered by, the recipient, or of any business or any revenue producing activity of the recipient ... and it matters little that the payment is gratuitous or made by someone other than the recipient's employer." The Tribunal concluded that s.25(1) had no application, "particularly having regard to" these findings: "(a)the payment or receipt in question was a single rather than a recurrent or periodic one; (b) the payment was not made by the [respondent's] former employer, but by the State Government; (c) the payment was truly of an ex gratia nature, there being no obligation whatsoever on the part of the State Government to make the payment (either on its own behalf or on behalf of the [respondent's] former employer pursuant to the [respondent's] contract of employment or otherwise); (d) the payment was not made to the [respondent] until a substantial time after the termination of his employment by the Shire Council; (e) the money was not received by the [respondent] in return for any services rendered by him or on his behalf, or in consequence of his termination; and (f) the receipt was not 'the product of', 'a consequence of' (or any of the other oft-mentioned phrases referred to above) the [respondent's] employment or any services rendered by him. ... [A]ny connection between the receipt and the [respondent's] employment with the Shire Council was no more than a mere historical one." Dr. Gerber said, with reference to the authorities on the point, that although the issue "is not completely settled", it would appear that "the better view" is that s.26(e) is not limited to including in assessable income receipts or benefits which are, according to general concepts, of an income nature. He adopted the following summary of the cases on s.26(e) by Deputy President Layton in Case V76 88 ATC 538 (at 541-2): "(1) The language used in the section is extremely broad as indicated by the phrases `in respect of', `in relation ... to' and `directly or indirectly' ... (2) Broad though the language may be, there must be a `connection' or `a real relation' between the benefits and the employment of the taxpayer or, alternatively, the services rendered by the taxpayer ... (3) As to the words `directly or indirectly' ... `A direct relation may be regarded as one where the employment is the proximate cause of the payment, an indirect relation as one where the employment is a cause less proximate, or, indeed, only one contributory cause'... (4) It is not necessary that the benefits described be paid as remuneration for the work which an employee is employed to perform; it is sufficient to attract s.26(e) that the benefits be paid to an employee as a product, incident or consequence of employment ... (5) The word `employment' is ... `more than the activity for which an employee is remunerated: employment comprehends all aspects of the relationship of employer and employee in the particular case save those aspects which are merely personal. If a distinction is to be drawn between the income-producing activity which is an aspect of employment and the entirety which constitutes employment, s.26(e) looks to the relationship between the entirety and the payment of the allowance'... (6) The phrase `services rendered' describes work actually performed by the taxpayer, whether in the capacity as an employee, independent contractor or otherwise. The phrase must `draw in situations not encompassed by the term `employment'' ... The phrase `services rendered' should ... `consist of the doing of an act for the benefit of another, which is more than the mere making of a contract and which goes beyond the performance of an obligation undertaken in the course of an ordinary commercial contract'... (7) If the benefit is paid to a taxpayer voluntarily, it may still fall within s.26(e), but it is necessary to enquire as to why and how the gift came about. If the motive is communicated to the taxpayer employee or is known to the taxpayer, the common understanding of the motive for the payment may be cogent evidence of `how and why it came about that the gift was made'... ." Dr. Gerber went on to hold that s.26(e) was not applicable here, because, in particular, "the necessary nexus between the benefit and the [respondent's] employment ... [was] not present". THE COMMISSIONER'S GROUNDS OF APPEAL The Commissioner now challenges the Tribunal's conclusion that there is no general principle that an amount paid as compensation for, or by way of reimbursement of, a deductible expense, is income within ordinary concepts. He further contends that the Tribunal should, in any event, have held that the amount of $24,748.24 was income derived by the respondent within s.25(1). The Commissioner also submits that the Tribunal should have held that an amount received by an employee as happened here, as compensation for, or by way of reimbursement of, a deductible expense incurred in protecting his employment, is assessable as compensation granted to him in relation, directly or indirectly, to his employment within s.26(e). CONCLUSIONS ON THE APPEAL It will be convenient to consider s.25(1) first. (i) Section 25(1) As Gummow J. pointed out in TNT Skypak International (Aust) Pty Ltd v Federal Commissioner of Taxation (1988) 82 ALR 175 (at 182-3) where, in a case such as the present, there is little room for dispute about the primary facts, the characterisation of a receipt or gain in accordance with the ordinary concepts and usages of mankind is, usually, a question of law. In Federal Commissioner of Taxation v Harris (1980) 43 FLR 36, it was held (by Bowen C.J. and Fisher J., Deane J. dissenting) that a lump sum payment made by a former employer to members of its superannuation fund to compensate them for high inflation was not income. Bowen C.J. said (at 40) that - "A generally decisive consideration is whether the receipt is the product in a real sense of any employment of, or services rendered by the recipient, or of any business, or indeed, any revenue producing activity carried on by him." His Honour went on to say (at 44): "It appears to me that the circumstances of this case are insufficient to lead to the conclusion that a gift, not normally to be regarded as being of an income nature, should be so regarded because the bank as payer intended it to be, and it in fact was, a supplement to the taxpayer's pension. This is not a case where the motives of the donor throw much light on the character of the receipt in the hands of the donee. As has been stated the bank was concerned with the problems caused to its pensioners by high rates of inflation. It desired to mitigate the impact of inflation upon its pensioners, who were formerly its employees. It was not its motive to reward its pensioners for previous faithful service. The only underlying business consideration was one which concerned the bank not the pensioner, that was that it was in the business interests of the bank in relation to existing employees to be seen to be treating pensioners, who were former employees, with fairness and liberality." It may perhaps be said that there is some analogy here with the present case. In deciding to make the ex gratia payment, the Treasury could have been seen as acting so as to vindicate the public interest in ensuring that fair and liberal treatment is afforded to those citizens who participate in public inquiries (see First Provincial Building Society Limited v Federal Commissioner of Taxation 95 ATC 4,145 at 4,149 per Hill J.). On the other hand, the appearance by the respondent before the Inquiry was clearly related to the administration of the affairs of the region at the level of Local Government, and the respondent's first claim for the reimbursement of his legal expenses was made upon his employer. It may be inferred that, given the recommendation in the Inquiry's report, the State felt impelled to respond to the request for reimbursement only when the employer failed to accede to the request. It seems that before the Tribunal, and, at least to some extent, before this Court, the arguments advanced appeared to assume that the respondent was entitled to an allowable deduction for his expenses as an item on revenue, rather than capital, account. Although the Tribunal did not, on the previous reference, have then to decide the point because, in the end, the Commissioner was prepared to allow the deduction, it is apparent that this issue is not without its own complexities. In this connection, I accept, as was submitted on behalf of the applicant, that we are here concerned not merely with the fact that, as a ministerial act, the deduction was allowed by the Commissioner; we are now concerned with a substantive question, one of mixed fact and law, that is, whether the respondent was, in truth, entitled to a deduction because the payment by the respondent of his legal expenses had the essential character of an outgoing on revenue account; that is to say, it must be accepted that the Commissioner may make inconsistent assessments (see Richardson v Federal Commissioner of Taxation (1932) 48 CLR 192 at 205; Deputy Commissioner of Taxation v Richard Walter Pty. Ltd. (1995) 69 ALJR 223 per Brennan J. at 240). In Inglis v Federal Commissioner of Taxation 87 ATC 2,037 the taxpayer, employed as a permanent officer of the Commonwealth Public Service in the Parliamentary Library, claimed to deduct legal expenses incurred by her in the prosecution of civil actions brought against the Commonwealth and certain individuals. She claimed in these actions that new procedures in the Library placed unwarranted restrictions on her. The actions, which were ultimately settled, were commenced by the taxpayer because she faced a loss of status and the prospect of her chances of promotion being blocked. Although she had been transferred "sideways", she suffered, in fact, no loss of income. The Tribunal (Mr. Todd, Deputy President) held, correctly in my view, that the expenses were deductible, after concluding (at 2,047) that the expenditure was incurred by the taxpayer in gaining or producing assessable income. It was held that the "gravamen" of the dispute that was reflected, "however awkwardly", in the actions, was her "day to day situation" in the Library, so that the expenditure was incidental and relevant to the work which produced her income. A similar view was taken by the Tribunal in AAT Case 5822 (1990) 21 ATR 3357 (at 3359) in allowing a claim for legal expenses by an officer seeking to preserve his employment then under threat. In my opinion, notwithstanding the different outcome in Case 117 (1959) 8 CTBR (N.S.) 671, the approach taken in Inglis provides an appropriate analogy here. Since the Inquiry was centrally concerned with day-to-day aspects of the respondent's employment, it ought to be concluded that the respondent's cost of representation before the Inquiry was incurred by him "in" gaining assessable income. The next question is whether deductibility would have been barred by the requirement of s.51(1) that the expenditure not have been of a capital, private or domestic nature. In Hallstroms Pty. Ltd. v Federal Commissioner of Taxation (1946) 72 CLR 634 (at 647) Dixon J. said: "The claim is to deduct legal expenses, and legal expenses, we may assume, take the quality of an outgoing of a capital nature or of an outgoing on account of revenue from the cause or the purpose of incurring the expenditure. We are, therefore, remitted to a consideration of the object in view when the legal proceedings were undertaken, or of the situation which impelled the taxpayer to undertake them." In Inglis, it was held that the expenditure was clearly not private or domestic. In my view, the position in the present case would be similar. The real question would have been whether the expenditure was of a capital nature. In Inglis, Mr. Todd said (at 2047-8): "In the present case the most relevant authority in my opinion is that of Dobbs v Commr of I.R. 74 ATC 6001, a decision of Cooke J. in the Supreme Court of New Zealand. There the legal expenses were incurred by a public servant in respect of a successful appeal which resulted in a promotion which resulted in an increase in income. No such increase was of course produced in the present case, nor in my opinion need it have been. The question is whether the expenditure was of a capital nature. The important aspect of Dobbs' case is that Cooke J. relied upon F.C. of T. v Finn ... and upon F.C. of T. v Hatchett ... to reject an argument that an expenditure in relation to a person's body, mind or capacity can be described as an outlay of capital. It is true that Cooke J. pointed out ... that sec. 51(1) [of the Australian Act] ... includes the expression 'or of a capital nature', and queried whether the situation might be otherwise in Australia. In my opinion that consequence should not follow, and I refer to Hatchett's case upon which Cooke J. expressly relied. It follows that I prefer to follow the decision of the Supreme Court of New Zealand to that of Board of Review No. 3 in Case N24 ... To sum up then, the expenditure in question had a 'perceived connection' (the phrase used in Hatchett's case) with the first applicant's gaining or producing of her assessable income, and was not of a capital, private or domestic nature." Again, with respect, I agree with this aspect of Inglis and with the decision in Dobbs. In my opinion, similar reasoning should be applied in the present connection. On behalf of the respondent, reliance was placed upon the decision of Menzies J. in Kratzmann v Federal Commissioner of Taxation (1970) 1 ATR 827. There, the taxpayer incurred legal expenses in court proceedings instituted by him to prevent his public examination in connection with the liquidation of a company of which he had been a director. In rejecting the claim, Menzies J. said (at 829-30): "The taxpayer's case that the expenses were necessarily incurred in gaining his assessable income was based upon the suggestion that a public examination in the liquidation would tend to keep before the public matters which would discourage possible clients from entrusting him, or any company with which he was concerned, with building contracts and might involve him in total ruin necessitating the realization of investments from which he was receiving income. Had this been the only matter in issue I would have acceded to the Commissioner's application and dismissed the appeal as incompetent. I do not think this part of the appeal involves any question of law. The Board decided against the taxpayer on the facts and it seems to me that the Board was incontestably right that the facts showed that the expenses were not deductible under s.51 of the Income Tax Assessment Act." Counsel for the taxpayer in Kratzmann relied upon Federal Commissioner of Taxation v Snowden and Wilson (1958) 99 CLR 431, but Menzies J. distinguished it, saying (at 830): "... that decision is not in point. There a company spent money advertising to counter-press reports concerning allegations made against it in the conduct of its business and incurred legal costs in appearing before a Royal Commission to protect itself against allegations relating to the conduct of its business which, if proved, would affect it in the present and in the future conduct of its business. To allow such expenditure as deductible affords no warrant for allowing [this] taxpayer as a deduction expenditure to protect his company or his investments, if, indeed, it could be thought that it could do either. The expenditure was not an outgoing incurred in gaining assessable income and, even upon the basis upon which the taxpayer sought to establish the expenses as deductible, they were clearly enough of a capital, or a private, nature." In my opinion, the context in Kratzmann should be distinguished from the present circumstances. Here, at material times, the taxpayer was, as in Inglis, in employment. It is true that here the inquiry or investigation was not conducted by the taxpayer's employer, at least not directly. On the other hand, the inquiry was initiated by the Central Government of the State, and it had the ultimate statutory control over, and responsibility for, Local Government. Although it was the Council which appointed the respondent as its engineer, the State Government also had a real interest in the effective performance of his duties as an important administrative aspect of efficient Local Government in the area. To this extent, the State Government was no "mere" donor (see Jeffrey Waincymer, Australian Income Tax Principles and Policy, (1991) at 90) or a disinterested spectator. On the contrary, it had a proper concern to ensure that the administration of the public affairs of the region, at the level of local government, were efficiently carried out. The functions of the Shire Engineer were an important aspect of this. It is also true that an Inquiry of the kind undertaken here may have had a dual aspect in that it may have focussed on the personal integrity of those involved, as well as on management or administrative issues. It was the emphasis on the former that was relied upon to deny the deduction in Kratzmann. In the present case, however, it appears that the latter aspect was the more important issue for the Inquiry. Although the issue of deductibility may throw light on the different question of assessability, it is an open question whether it can be determinative, at least without qualification (see Allsop v Federal Commissioner of Taxation (1965) 113 CLR 341 at 350; H.R. Sinclair & Son Pty. Ltd. v The Commissioner of Taxation (1966) 114 CLR 537 at 543, 545; TNT Skypak, above, at 188-192). But I need not pursue this as I prefer to decide the present question by reference to the settled basic principles which, relevant to the case of a receipt by an employee or former employee, may be summarised, as Hill J. did in First Provincial Building Society Limited v Federal Commissioner of Taxation, above, (at 4,148) as follows: "1. Whether a particular receipt is income is to be determined by reference to the character of that receipt in the hands of the taxpayer ... . 2. The question is not decided by determining whether the expenditure by the payer is of an income or capital nature. 3. The fact that the amount in question must be applied for a capital purpose will not determine its character as capital. ..." In seeking to apply these principles here, assistance may be derived from the line of English decisions upon the question whether gratuitous payments are assessable as profits arising out of the recipient's employment or by reason of his office, of which Kitto J. said in The Squatting Investment Co. Ltd. v Federal Commissioner of Taxation (1953) 86 CLR 570 (at 633-4): "The distinction those decisions have drawn between taxable and non-taxable gifts is the distinction between, on the one hand, gifts made in relation to some activity or occupation of the donee of an income-producing character, such gifts being variously described as accruing to the donee in virtue of his office ... or as remuneration ... or in respect of his past services ... or substantially in respect of his services ... and, on the other hand, gifts referable to the attitude of the donor personally to the donee personally, such as those which have been called mere gifts or presents made to the donee on personal grounds ... mere donations ... gifts moved by the remembrance of past services already sufficiently remunerated as services in themselves ... payments peculiarly due to the personal qualities of the particular recipient, or personal gifts as marks of esteem and respect ... ." Some of these decisions were subsequently considered by the House of Lords in Hochstrasser v Mayes [1960] A.C. 376. There, an employee received from his employer an amount under a scheme to provide housing assistance to employees. The sum, which was to compensate the employee for his loss on the sale of his home on his transfer to a new place of work, was held not to be taxable. Viscount Simonds said (at 390-1): "The question is one of substance, not form. I accept, as I am bound to do, that the test of taxability is whether from the standpoint of the person who receives it the profit accrues to him by virtue of his office ... . I do not doubt that a taxable profit may take the form of the discharge of an employee's obligation as well as of a direct payment ... nor that a lump-sum payment to directors may in some circumstances, just as in other circumstances it may not, be subject to tax. Here fine distinctions have been made which are not directly relevant to the present case. Again, there may well be cases, of which Nicoll v Austin ... is an example, where a managing director or other officer of a company is taxable in respect of the outgoings of a house occupied by him which are discharged by the company. Such cases may be near the line, as may cases in which the question is whether a payment is made to an employee as a reward for his services or (to use the words of Parker L.J.'s exception) is made out of affection or pity." The earlier English decisions were also considered by Dixon C.J. and Williams J. in Federal Commissioner of Taxation v Dixon (1952) 86 CLR 540, saying (at 556): "... it is clear that if payments are really incidental to an employment, it is unimportant whether they come from the employer or from somebody else and are obtained as of right or merely as a recognized incident of the employment or work." Applying the above principles and approaching the question as one of substance rather than form, and putting to one side for the moment the question of the significance of the burden of proof, it becomes apparent that the true nature of the Inquiry becomes a crucial consideration in the application, or otherwise, of s.25(1) in the present circumstances. That is to say, if the true nature of the Inquiry was, in substance, an investigation of the personal integrity of the respondent, it would be difficult to demonstrate either that the expenses were deductible, or that an amount received by way of their reimbursement was assessable. On the other hand, if, in truth, the Inquiry was concerned, primarily at least, with matters of administration on a day-to-day basis, such a different complexion of the events would usually justify a characterisation of the legal expenditure, and its refund, as items on the revenue account of the taxpayer that were not of a private kind. In my opinion, the latter characterisation is, as a matter of inference to be drawn from the known facts, the better view of the circumstances, when taken as a whole. Even if the personal honesty of the respondent were to have been questioned in the course of the Inquiry, it appears that this would have been no more than an incidental issue. It will be recalled that the relevant power, as found in s.4A(3)(i) of the Act, was to inquire into "any matter respecting the administration of this Act". Thus, on its face, the investigation was not limited to a review of the personal qualities of individuals, but rather was aimed at the broader agenda of the administration of a local government region. To participate in such a review would, from the responent's perspective, be to do something which was central to the performance of his duties as Shire Engineer. His involvement in the Inquiry should thus be seen as an aspect of his income-earning activity. Although the question is difficult and the present case is near the line to be drawn, his legal expenses, and their rembursement, should, I think, likewise be viewed as having a revenue, rather than a capital, character, as well as not being expenditure for a private purpose. It must follow that the respondent could not discharge the statutory onus of demonstrating that an assessment should not have been made under s.25(1). (ii) Section 26(e) Although not strictly necessary, I would add that, for similar reasons, the payment was, in my view, a "gratuity" or "compensation" or "benefit" which was "allowed" or "given" to the respondent in respect of his employment, at least indirectly (see Commissioner of Taxation v Holmes, Hill, Cooper and Kiefel JJ., 3 August 1995, unreported, at 10). It was thus assessable under s.26(e), despite the fact that it was, in strictness, voluntary (see Smith v The Commissioner of Taxation (1987) 164 CLR 513 per Brennan J. at 526). There was an "evident connexion" between the respondent's employment and the sum received (cf. Smith, above, per Toohey J. at 533) notwithstanding that, the employer having declined to pay, the State did so. Section 26(e) does not, in terms, require that the payment be made by the employer and provided, as a matter of substance, the employment nexus exists, it is not a prerequisite to the assessability of the receipt that the employer make the payment (see, Dixon, above, at 556). It is also, I think, appropriate to take into account, in this regard, the relationship between the Central and Local Governments already mentioned. PROPOSED ORDERS I propose that the appeal be allowed, with costs; that the decision of the Tribunal be set aside; and that, in lieu thereof, the Commissioner's decision disallowing the objection be confirmed. I certify that this and the preceding twenty-four (24) pages are a true copy of the Reasons for Judgment herein of his Honour Justice Beaumont. Associate Dated: 20 October 1995 IN THE FEDERAL COURT OF AUSTRALIA) ) QUEENSLAND DISTRICT REGISTRY ) QG 128 of 1994 ) GENERAL DIVISION ) ON APPEAL FROM THE ADMINISTRATIVE APPEALS TRIBUNAL BETWEEN: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA Applicant AND: ANTHONY JOHN POULSTON ROWE Respondent CORAM: Beaumont, Burchett and Drummond JJ. PLACE: Brisbane DATE : 20 October 1995 REASONS FOR JUDGMENT BURCHETT J.: I have had the advantage of reading the judgments prepared by the other members of the Court, and I do not find it necessary to set out the facts for myself. On the question of the deductibility of the expenses incurred by the respondent at the inquiry, I note that the Committee of Inquiry saw these expenses as incurred by him in defending himself from dismissal from his employment. That view of the matter is, of course, correct. However, at another level, I think these expenses should be recognized as incurred by the respondent in defending the manner of his performance of his duties. It was only by so justifying himself that he could make a successful defence against dismissal. When the matter is seen in this light, it falls squarely within the rule discussed in Putnin v Commissioner of Taxation (1991) 27 FCR 508. To adapt language there quoted (at 511) from Herald and Weekly Times Limited v Federal Commissioner of Taxation (1932) 48 CLR 113 at 117-119, the liability in question was incurred, or the claim was encountered, because of the very act of performing the work by which the respondent earned assessable income. The activities which produced the assessable income were what exposed the taxpayer to the liability discharged by the expenditure. As the Court said in Putnin at 513, so here, "the ... proceedings arose from the activities by which the taxpayer earned his income, the mode of his performance of a particular task carried out in the course of business operations." To put the same point in another way, the cause or the purpose of the respondent's incurring of the expenditure was his assertion that he had faithfully performed the duties by which he had earned assessable income. In Creer v Federal Commissioner of Taxation (1994) 94 ATC 4,454 at 4,457 I cited a passage from the well known judgment of Dixon J. in Hallstroms Proprietary Limited v The Federal Commissioner of Taxation (1946) 72 CLR 634 at 647 in which the correct approach is stated in respect of the question whether legal expenses are on capital or revenue account: "The claim is to deduct legal expenses, and legal expenses, we may assume, take the quality of an outgoing of a capital nature or of an outgoing on account of revenue from the cause or the purpose of incurring the expenditure. We are, therefore, remitted to a consideration of the object in view when the legal proceedings were undertaken, or of the situation which impelled the taxpayer to undertake them." On this basis, the expenditure was deductible. On the question whether the reimbursement made to the respondent by the government of Queensland should be regarded as income within s. 25 of the Income Tax Assessment Act 1936, I am in agreement with the approach adopted by Drummond J. This is a case where the government of Queensland, having the general oversight of the activities of local government in that State, considered it to be in the interests of the State to hold an inquiry. Before that inquiry, the respondent stood accused of misconduct in the performance of his duties. He was completely exonerated. However, it was not competent for the inquiry to make an order in respect of the costs he had incurred. Several years later, the government decided to make a payment to the respondent calculated to reimburse him for the costs burden he had borne. The payment was in no sense a reward for his services during his employment by the Council, which had long since been determined. It was a recognition of the wrong done to him, and also of the fact that he had been forced to shoulder the task of sharing in an inquiry undertaken by the government for public purposes. The payment was not a remuneration, but a reparation. Of course, it was far from being a complete reparation, since he had had to bear the costs, which were reimbursed without interest in the currency of some years later. In my opinion, the nature of the payment, and the purpose it served, were inconsistent with its being regarded as a reward for services performed in the past for a body that was different from that which made it, nor, in the circumstances, was it in any other way sufficiently related to the performance of income earning activities. At any rate, it would be impossible to find an error of law impugning Dr Gerber's finding of fact: "(T)he receipt was not `the product of', `a consequence of' ... the applicant's employment or any services rendered by him. Indeed, I am satisfied that any connection between the receipt and the applicant's employment with the Shire Council was no more than a mere historical one". This finding was supported by the material before him, and is indeed the finding I would have made on that material. The same analysis of the payment requires it to be held to have been too remote from the employment to be caught by s. 26(e): see Smith v Commissioner of Taxation (1987) 164 CLR 513; Federal Commissioner of Taxation v Dixon (1952) 86 CLR 540. I certify that this and the preceding three (3) pages are a true copy of the Reasons for Judgment herein of his Honour Justice Burchett. Associate: Date: 20 October 1995 IN THE FEDERAL COURT OF AUSTRALIA) No. QG 128 of 1994 QUEENSLAND DISTRICT REGISTRY ) GENERAL DIVISION ) ON APPEAL FROM THE ADMINISTRATIVE APPEALS TRIBUNAL BETWEEN: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA Applicant AND: ANTHONY JOHN POULSTON ROWE Respondent Coram: Beaumont, Burchett and Drummond JJ Place: Brisbane Date: 20 October, 1995 REASONS FOR JUDGMENT DRUMMOND J: I have had the advantage of reading the reasons in draft of Beaumont J in which his Honour sets out the facts of the case. I agree with his Honour's conclusion that the legal expenses incurred by the respondent were properly deductible from his assessable income for 1986. But I think that the ex gratia receipt in 1989 was not income within either s. 25(1) or s. 26(e). SECTION 25(1) The Commissioner of Taxation ("the Commissioner") contended that the ex gratia payment made by the Queensland State Government in 1989 was assessable in that year pursuant to s. 25(1) as income within the ordinary meaning of that term, for two reasons: firstly, because there is a general principle that a payment made by way of reimbursement of or compensation for an expense incurred on revenue account and which is deductible under the Act is itself income under the Act. Secondly, even if there is no universal principle of the kind contended for by the Commissioner, the fact that the payment was made by way of reimbursement for outgoings so connected with the respondent's employment that they are deductible is of itself sufficient to colour that payment as income in the respondent's hands. The Commissioner's first argument was rejected in H.R. Sinclair & Son Pty. Ltd. v Commissioner of Taxation (1966) 114 C.L.R. 537. The Commissioner acknowledged in oral argument that this decision is binding on this Court as authority that no universal principle of the kind for which he contends exists. I do not accept the Commissioner's second submission either. It is necessary, in order to deal with this submission, to determine whether the legal expenses incurred by the respondent for which the ex gratia payment was made as reimbursement, were themselves properly deductible under s. 51. That the Commissioner ultimately allowed a deduction from the respondent's 1986 income for these expenses cannot, for the reasons given by Beaumont J, resolve this issue. In my opinion, the respondent's costs of legal representation before the inquiry comprised an outgoing incurred by him in gaining assessable income, within the first limb of s. 51. The issue here is whether legal expenses incurred by an employee to prevent his employer terminating his existing contract of employment are deductible under s. 51. In view of Federal Commissioner of Taxation v Maddalena (1971) 71 A.T.C. 4161, expenses incurred in obtaining a new contract of employment cannot in general be regarded as outgoings incurred in gaining assessable income because they would be incurred "at a point too soon to be properly regarded as incurred in gaining assessable income": at 4163. But where there is an existing contract of employment, legal expenses incurred in maintaining that contract are not remote in time from the gaining of assessable income. If an outgoing said to be deductible as having been incurred in gaining or producing assessable income can be seen to be incidental and relevant to that end, in the sense that there is a real connection between the incurring of the outgoing and the activities which directly result in the gain or production of income, that will generally be sufficient to make the outgoings deductible. See Ronpibon Tin No Liability v Federal Commissioner of Taxation (1949) 78 C.L.R. 47 at 56-57; Charles Moore & Co. (W.A.) Pty. Ltd. v Federal Commissioner of Taxation (1956) 95 C.L.R. 344 at 351 and Commissioner of Taxation v Cooper (1991) 29 F.C.R. 177 at 181 and 197-198. The respondent incurred the expenses in question in procuring legal representation at the inquiry. It is plain from the Livingstone Shire Council's ("the Council") actions prior to the establishment of the inquiry and from its subsequent dismissal of the respondent, that if the respondent had not been successful in obtaining a favourable outcome at the inquiry, the Council would have dismissed him then and there, rather than have waited for a further occasion to terminate his employment. His incurring of those costs can be assumed to have contributed to his success in defending himself from dismissal from his employment as Shire Engineer. They were incurred to preserve the respondent's entitlement to receive, in return for his services, assessable income. They are more closely connected with the production of that income than the legal expenses incurred to remove a legal impediment to a professional footballer engaging in the activities for which he was paid were connected to the production of his income; those expenses were held in Kemp v Federal Commissioner of Taxation (1992) 92 A.T.C. 4542 at 4546, to be within the first limb of s. 51(1). The costs incurred by the respondent were, I think, incurred on revenue, rather than capital account. The Full Court, in Commissioner of Taxation v Raymor (NSW) Pty. Ltd. (1990) 24 F.C.R. 90 at 99, said that the test for determining whether expenses incurred by a taxpayer are on revenue account or capital account is that stated by Dixon J in Sun Newspapers Limited v Federal Commissioner of Taxation (1938) 61 C.L.R. 337 at 363, viz: "There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment." There, the question was whether moneys paid by a trader in metal tubing as purchaser under two contracts, made a year apart, for the delivery over time to it of stock for its business were on capital or revenue account; the contract price was in each case payable in a single lump sum, subject to a price fluctuation term. The Full Court in Raymor, supra, at 99, said, in the course of applying the Sun Newspapers test: "... The answer to the first question posed by Dixon J is not to be obtained by a jurisprudential analysis of the process of entering a contract. It can be said of every payment pursuant to a contract that it secures to the payee the contractual rights under the contract. In that sense every payment made under a contract confers upon the payee a chose in action which can be described as an asset and which contractual right is discharged by the performance of the contract. But such an analysis is of no assistance in the resolution of whether a particular outgoing is on capital or revenue account. Rather as Dixon J said in Hallstroms Pty. Ltd. v Commissioner of Taxation (Cth) (1946) 72 C.L.R. 634 at 648 the answer: "... depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.' ..." The answer to the question whether these expenses were capital or revenue outgoings depends, as Raymor, supra, shows, on the practical, rather than the juristic, characterisation of the rights and benefits that the respondent sought to preserve. The expenses here in question were described by the Committee of Inquiry as having been incurred by the respondent to defend himself from dismissal from his then existing employment. As to the first of the questions referred to in Sun Newspapers, supra, the preservation of the respondent's then existing employment would ensure receipt by him of the recurrent benefit of his ordinary fortnightly salary. It can also be assumed that the expenses were incurred to ensure that this recurrent benefit would continue to be received for some necessarily uncertain future period. While the answer to the first question thus does not point definitively to the outgoing being on one account rather than the other, the lack of certainty as to the period during which the expenditure would contribute to the continued receipt of that recurrent benefit favours the conclusion that the expenses were incurred on revenue account. As to the second question referred to in Sun Newspapers, supra, concerning the manner in which the respondent would use or enjoy the preservation of his employment, while a contract of employment exists it may, in a particular case, confer a wide range of benefits on the taxpayer in addition to the periodic receipt of remuneration, including other material ones and non-material benefits. In a particular case, a contract of employment may be so structured that the chief advantage to the taxpayer comes not from the periodic remuneration payable under it, but from the other benefits for which it provides. But in the case of an ordinary wages or salary employee, the receipt of periodic payments by way of remuneration will be such an important benefit that it should be accepted, for practical purposes, that a major reason why such an employee incurs legal expenses in defending himself from dismissal from an existing employment is to continue to receive those payments period by period, as they fall due. Cf. the comment of Dixon and Evatt JJ in Commissioner of Taxes (Victoria) v Phillips (1936) 55 C.L.R. 144 at 156 that "[a] contract of service is valuable only because of the income it will bring during the residue of its term", in explaining why a contractual entitlement to periodic payments equivalent to the periodic income the taxpayer would have received under a contract of service if it had not been cancelled was itself income and not a capital entitlement. The agreed material upon which the Administrative Appeals Tribunal reached its decision includes the Engineers (Local Governing Authorities, Queensland) Award 1959 ("the Award") incorporated in the respondent's contract of employment with the Council; a perusal of the Award provisions confirms that the contract under which the respondent was employed as a local authority engineer was an orthodox one under which the major benefit is the right to receive annual salary in fortnightly payments, in return for work done. Expenditure made by such an employee for the purpose of defending himself from dismissal cannot procure for the employee any lasting or "structural" advantage, in the sense that term was used in Kemp, supra, at 4548. It cannot entrench the employee in his employment. The expenditure here in question could not, and did not, achieve that for the respondent. All that it was capable of achieving was the preservation of the respondent's employment for an uncertain future period and his receipt, during that period, of his regular salary. The position here is in sharp contrast to Kemp, supra, at 4548, where the legal expenses were incurred to procure a permanent benefit in the form of the lifting of a bar against the taxpayer pursuing his calling in Australia. The old view was that legal expenses incurred by an employee in defending himself against dismissal from an existing employment were not deductible under s. 51 because they were expended to preserve a capital asset, viz., the office or position, whereas it was only the performance of the duties of that office or position that produced income. See, for example, Case No. K 98 (1959) 10 T.B.R.D. 525. More recently, the view has been taken that a position under an ordinary contract of employment is not something in the nature of a capital asset so that legal costs incurred in preventing dismissal from that employment could not be characterised as outgoings of a capital nature. See Board of Review Case L26 (1979) 79 A.T.C. 126 (although the deduction was not allowed there because the employee incurred the expenses in seeking reinstatement in an employment which had previously been terminated); Inglis v Federal Commissioner of Taxation (1987) 87 A.T.C. 2037 and AAT Case 5822 (1990) 21 A.T.R. 3357. In my opinion, the approach taken in the more recent Board of Review case and by the Administrative Appeals Tribunal is correct. For the reasons given, the answer to the second question points in my opinion to the expenses being incurred on revenue account. As to the third question referred to in Sun Newspapers, supra, the means adopted to obtain the advantage of preservation of his then-existing contract of employment was the incurring of legal expenses. These disbursements could not be related to the receipt of any particular salary payment or payments. Moreover, the expenses were not incurred in proceedings designed to terminate in a decision, binding on the Court and the respondent, that the respondent either retain his employment or be dismissed from it; they were incurred instead, in connection with an inquiry which had no power to determine that issue but which was set up pursuant to a statutory provision designed to ensure that the Director of Local Government who was charged by s. 4A(2) the Local Government Act 1936-1985 (Qld) with responsibility for the administration of that Act would, from the report of the inquiry, be able to obtain information necessary to discharge that particular administrative function. Both these considerations suggest that the legal expenses were not incurred on revenue account. But the responsibility of the Director of Local Government would, I think, extend to advising the Minister whether to seek the intervention by the Governor in Council in the activities of a Local Authority by rescinding a resolution of that Authority pursuant to s. 4(5)(a) the Local Government Act 1936-1985 (Qld). For that reason, a favourable outcome for the respondent from the inquiry would give rise to an expectation that, even if the Authority persisted in dismissing him, government intervention to preserve his employment for the time being would follow. In the event, the Council appears to have accepted that the outcome of the inquiry prevented it in a practical sense from dismissing the respondent, at least for a time. This suggests that the expenditure should be regarded as incurred to procure the recurrent benefit of receipt of regular salary payments for an uncertain future period, i.e., as incurred on revenue account. The answer to the third question is therefore equivocal. The different considerations relevant to the application of the Sun Newspapers test, I think, favour the conclusion that the expenditure in question should be regarded as expenditure on revenue account. Given what I have said about the relationship between the incurring of the expenses and the continued receipt of the respondent's periodic salary, there is no ground for thinking that the expenses were of a private nature. The respondent was therefore entitled, pursuant to s. 51, to the deduction of these expenses which he was ultimately allowed against his 1986 income. Even though the legal expenses which the ex gratia payment replaced were properly deductible, that in my opinion provides no ground sufficient of itself for characterising the reimbursement as income within s. 25. Whether a receipt by an employee will be income within ordinary concepts is to be determined having regard to all the circumstances of the case. That the payment here in question was made to reimburse the respondent for an outgoing deductible from his assessable income does suggest that there is a connection between the reimbursement payment and the respondent's employment. But that is only one circumstance. That it was paid by a person other than his employer and that it was paid ex gratia are other considerations just as relevant to the question whether it was itself income in the respondent's hands. In any event, the cases relied on by the Commissioner, in which receipts that reduce the amount of deductible outgoings have been characterised as themselves income, provide no support for the proposition that the connection suggested by the fact that the ex gratia payment was made to reimburse deductible outgoings is sufficient, in a case like the present, to colour the ex gratia payment as income. These cases are all cases in which the outgoings and receipts in question were transactions that occurred in the course of carrying on a continuing business. As Mason J said in International Nickel Australia Limited v Commissioner of Taxation (1977) 137 C.L.R. 347 at 366, there is a general concept of income for the purposes of s. 25 which "includes within its embrace a reduction in the amount of an outgoing on revenue account". But that is so, as his Honour's comments at 367 and those of Gibbs J at 354 make clear, only in the context of a continuing business: the periodic income of such a business, i.e., the gains that have become available to the taxpayer in a realised form during the period of account, is most accurately ascertained, for taxation purposes, on an accruals basis. It is of the nature of a continuing business that some liabilities on revenue account will be incurred in one period of assessment for tax purposes but will only be discharged in a later period. Such liabilities are variously described as "liabilities ... not fixed in their monetary expression ... because of contingencies or because they are payable in foreign currency" - The Texas Company (Australasia) Limited v Federal Commissioner of Taxation (1940) 63 C.L.R. 382 at 465 and "defeasible liabilities" - Commonwealth Aluminium Corporation Ltd. v Federal Commissioner of Taxation (1977) 32 F.L.R. 210 at 224. An inflated picture of the assessable income of an enterprise for a period will be produced if expenses incurred in that period, but not discharged until a later period, are not taken into account in the first period in reduction of the revenue gains, since the object of assessment of income for taxation purposes is to ascertain the revenue gains truly realised by the taxpayer in each period of assessment. See International Nickel, supra, at 366; Barratt v Commissioner of Taxation (1992) 36 F.C.R. 222 at 224-225. In the second period, when the expenses are discharged and their precise amounts thus ascertained, any increases or decreases in the estimates of those expenses taken up in the first period as deductions from income, are themselves taken into account in the later period as allowable deductions or assessable income respectively, in order to ascertain the revenue gains truly realised in that later period. They are not regarded as necessitating an adjustment to the estimates taken into account in the first period but are treated "as incidents of the system" of continuing trading and as belonging to the period in which they are realised. See Armco (Australia) Proprietary Limited v Federal Commissioner of Taxation (1948) 76 C.L.R. 584 at 618 and International Nickel, supra, per Gibbs J at 352-355; per Mason J at 362-363 and 366-368; per Murphy J at 370-372. Where it is appropriate for a person's periodic income to be assessed on the basis of his receipts in the period, however, there is, in my opinion, no justification for characterising any of his receipts as income by the application of a principle designed to enable an accurate estimate to be made of a taxpayer's income for a period where there is a gap in time between the incurring of a liability on revenue account and the accurate ascertainment of the amount of that liability and thus the ascertainment of the gains truly realised in the particular period. Whether a particular receipt by a taxpayer who is assessable to income tax on a cash basis will be income in the period in question within the ordinary concept of income, depends on whether its receipt was the product of the performance of services by the taxpayer for his employer. A payment made to reimburse a cost met by the employee in performing his duties in one period (which would generally but not invariably be deductible from his income for the period in which he met, i.e., paid that cost) would be income in the period in which it was received because it was a receipt closely connected with the performance of his duties from which he derives assessable income. If a receipt has some connection with an outgoing which was an allowable deduction against the taxpayer's income for the same or an earlier period, that is a relevant factor in deciding whether the receipt is itself income. But it can rarely, if ever, be decisive of the question whether a receipt is income in the circumstances of a particular case. Counsel for the Commissioner also submitted that, while the Court in H.R. Sinclair, supra, rejected the proposition the Commissioner put forward in his first argument, it reached its conclusion that the receipt there in issue was assessable as income in reliance on the fact that it was a refund of outgoings which had been allowed as deductions against the income of previous years. But it was not that that caused the receipt to be treated as income. Taylor and Owen JJ, at 544 and 547 respectively, both held that the fact that it was a refund of royalties paid in previous years identified it as a receipt produced by the activity of carrying on the taxpayer's business: it was for that reason that it was characterised as income. A gift may or may not be income within ordinary concepts. In The Squatting Investment Company Limited v Federal Commissioner of Taxation (1953) 86 C.L.R. 570, Kitto J, at 627-628, said: "... a gift may or may not possess an income character in the hands of the recipient. The question whether a receipt comes in as income must always depend for its answer upon a consideration of the whole of the circumstances; and even in respect of a true gift it is necessary to inquire how and why it came about that the gift was made." The cases identify various considerations which provide indications as to whether a gift, in the sense of a voluntary payment made without any legal obligation resting on the donor, will be income in the hands of the donee. A gift will rarely constitute income of the donee if it is a mere gift made to the donee on personal grounds: see Squatting Investment, supra, at 633-634. If a gift should be regarded as the product of any employment of, or services rendered by, or any revenue producing activity carried on by, the recipient, that is a strong indication that it is income. In Federal Commissioner of Taxation v Harris (1980) 43 F.L.R. 36, Bowen CJ, at 40, said that this is "[a] generally decisive consideration". The need for there to be a connection between the receipt of a gift and the income-producing activities of the taxpayer before the gift itself will be income of the taxpayer within the ordinary concept of income in s. 25 was emphasised by Hill J, with whom the other members of the Full Court agreed, in First Provincial Building Society Limited v Federal Commissioner of Taxation (1995) 95 A.T.C. 4145 at 4149, in holding that an ex gratia payment made to a building society on the winding up of a statutory prudential fund to which it had contributed was not assessable as income within s. 25. Deputy President Gerber was entitled to reach the conclusion that the ex gratia payment here in question was not income in the respondent's hands, within the ordinary meaning of that term. While the payment was not made as a gift on personal grounds to the respondent, it cannot be regarded in any relevant sense as the product of the respondent's employment as Shire Engineer. The only connection between the ex gratia payment and the respondent's former employment was that the payment was made in reimbursement of costs he incurred in defending himself from dismissal from that employment in an inquiry set up at the direction of a member of the donor-government. That is too remote a connection, in the circumstances of this case, to make it a product of that employment. The ex gratia payment cannot be said to have been made for the same purpose for which I consider the respondent incurred the legal expenses, viz., to ensure the continued receipt of the respondent's salary, period by period. It was made long after his employment by the Council had ceased. The evidence shows that it was only paid because the respondent's former employer refused to reimburse these expenses and because the respondent was exonerated of the allegations against him which the inquiry was set up to investigate. SECTION 26(e) In my opinion, the receipt in question was not assessable under s. 26(e). The effect of this provision was considered by the High Court in Smith v Commissioner of Taxation (1987) 164 C.L.R. 513. In order to identify whether a nexus exists between a receipt that answers the description of one of those listed in s. 26(e) and "any employment of" the taxpayer or "any ... services rendered by him" that is sufficient to make the receipt assessable under the section, it is necessary to keep in mind that the words used in the section to describe the necessary nexus - "in respect of", "for or in relation ... to", "directly or indirectly" - are words of the widest import. Smith, supra, at 525, 530 and 533. See also Commissioner of Taxation v Holmes (Full Court, unreported, 3 August, 1995). The nexus will be found if there is a sufficient link between the receipt and the employer/employee relationship: there need not be any link between the receipt and "any particular service rendered to the employer": Smith, supra, per Wilson J at 519 or "the income-producing activity", which is only one aspect of that relationship: Smith, supra, per Brennan J at 523 and also at 525. Brennan J also said, at 526: "Of course, it will frequently be a difficult question of fact to decide whether a particular allowance which is paid voluntarily is paid for a reason which brings the allowance into or for a reason which carries it out of the tax net. But if the employment (or some aspect of the employment) is the reason or one of the reasons why the allowance is paid, the allowance falls within s. 26(e). A reason which is an insubstantial cause of the payment is immaterial, as the judgments in Dixon illustrate. But if an employee's employment or some aspect of that employment is a substantial reason why the allowance is paid, it cannot be said that the allowance is merely personal or that the payment is made for reasons extraneous to - or ultra - the employment. As the requisite relationship may be indirect as well as direct, it is immaterial that there is another reason why the allowance is paid or even that the other reason is the dominant one." Toohey J said, at 532: "What can be derived from the passage quoted from the judgment of Dixon CJ and Williams J [in Dixon], and perhaps all that can be derived, is the notion that for s. 26(e) to operate the allowance or benefit must in some sense be a recompense or consequence of the continued or contemporaneous existence of the relation of employer and employee." Wilson J, who agreed with Toohey J, also said, at 519: "Toohey J finds it helpful to ask whether the benefit allowed, given or granted is a consequence of the employment of the taxpayer: see also Dixon CJ and Williams J in Dixon. So do I. I also find it helpful to ask whether the benefit is a product or incident of the employment, as did Fullagar J in Hayes, and Windeyer J in Scott." Their Honours there identified the need for there to be a causal element in the nexus between a receipt and the taxpayer's employment, if s. 26(e) is to apply to the receipt. Their Honours made these comments in a case in which the question was whether certain payments made by an employer to one of its existing employees under an employee study incentive scheme operated by the employer for the mutual benefit of both were assessable in the employee's hands under s. 26(e). But that does not detract from the guidance given as to the nature of the nexus that must exist for s. 26(e) to apply. In my view, the wide words of the section prevent it being read down so as to apply only to receipts by an employee when the relationship of employer and employee is subsisting and from being read down so as to apply only to payments made by the employer or former or prospective employer. It is accepted that if a payment is so related to the employment that it would be income in the employee's hands within the ordinary meaning of that term in s. 25, the fact that the payment is made not by the employer but by a third party is irrelevant. Federal Commissioner of Taxation v Dixon (1952) 86 C.L.R. 540 at 556; Hayes v Federal Commissioner of Taxation (1956) 96 C.L.R. 47 at 57. If s. 26(e) applies only to receipts that constitute income within the ordinary meaning of that term, the fact that the receipt comes from a source other than the employer cannot therefore matter. If s. 26(e) catches a wider range of receipts than that (a view which Brennan J considered was the correct one in Smith, supra, at 523, as did Hill J in an obiter statement in his judgment in First Provincial Building Society, supra, at 4153, with which Black CJ and Carr J agreed), it is difficult to see why the wide operation of the provision should be limited, by a restriction found by a process of implication, to benefits provided by the employer or former employer. In my respectful opinion, Wilcox J in Haggarty v Federal Commissioner of Taxation (1989) 89 A.T.C. 4485 at 4491-2 was correct in focusing on whether there was a sufficient nexus between the taxpayers' employments and the payments made to them to bring them within s. 26(e) and ignoring the fact that the payments were made by a party other than their employer. It follows from what was said in Smith, supra, that, provided there is a causal connection between the receipt and any employment in the sense that the existence of an employer/employee relationship between someone and the taxpayer, either at the time the payment was made or at some other time, can be seen to provide a reason why the payment was made, the receipt will be assessable under s. 26(e); but if the receipt was paid to the recipient in circumstances in which the existence, at some time, of an employer/employee relationship involving the recipient was no more than a background fact to the making of the payment, that will not bring it within s. 26(e). It will be enough that the existence of that relationship was only indirectly a reason for the making of the payment: but it must still be seen to be a reason for that being done. A mere connection between the employment relationship and the payment that does not have this causal element to it will not suffice to bring the payment within s. 26(e). Dixon, supra, at 540, is an example of a case in which the employment relationship between the payer and the taxpayer recipient was a mere background fact to the making of the payment and was not causally linked to the payment. There, it was held that s. 26(e) did not apply to payments made by an employer to a former employee to bring his army pay up to the salary he received when last employed. Dixon CJ and Williams J said, at 554, that the "mere historical connection" that existed between the employment and the payments was insufficient to bring the supplement within the section. They said that, to be so assessable, a benefit must at least amount to "a recompense or consequence of the continued or contemporaneous existence of the relation of employer and employee or a reward for services rendered given either during the employment or at or in consequence of its termination". The supplement there in question was received in the 1943 financial year, while the employment relationship had terminated in July 1940 and there was no expectation that the taxpayer would, on discharge, return to his former employment. In Smith, supra, even though Brennan J accepted that the scheme under which the taxpayer in Dixon, supra, received the payments in question grew out of the employment relationship, he regarded that case as one in which the taxpayer's previous employment did not provide any substantial reason for the payment: see Smith, supra, at 525-526. Toohey J, at 532, saw Dixon, supra, as authority for the proposition that s. 26(e) only caught benefits which could be seen to be, in some sense, a recompense or consequence of the continued or contemporaneous existence of the relation of employer and employee: the payments there in question were not made in consequence of the continuance of the employment that once existed between the person making the payment and the taxpayer. Deputy President Gerber found that the payment to the respondent was, in its entirety, an ex gratia reimbursement of legal costs incurred by the respondent in procuring legal representation at the inquiry and he concluded that the necessary nexus between the receipt and a relationship of employer/employee to which the respondent was a party did not exist. It was open to him to reach that conclusion. The employer/employee relationship between the Council and the respondent was in my view merely part of the background facts against which the ex gratia payment was made. The respondent had incurred the legal expenses for which the payment was made by way of reimbursement to prevent termination of that relationship. But the relationship ceased to exist in 1986, about three years before the ex gratia payment was made. That payment was made because the respondent had incurred the legal expenses in connection with appearing before the inquiry set up at the direction of a member of the donor-government and had been exonerated by the inquiry of the complaints against him which were the subject matter of the inquiry. The gentlemen appointed to conduct the inquiry stated in their report: "It is obvious that this Inquiry has cleared [the respondent] of any charges of misconduct or neglect. We, of course, have no power whatsoever to award costs to him who might well be characterised as the `successful party', but, in the present matter, [the respondent] has in reality been compelled to engage a solicitor and counsel to defend himself against dismissal." While acknowledging that they had no power to award costs to the respondent or even to make a recommendation in regard to the payment of costs to him, they recorded an argument that the respondent would have been able to obtain an order against the Council for his costs, if the Governor in Council had not rescinded the Council decision to suspend him and if the respondent had challenged that decision in the Court. It was these considerations together with the Council's refusal to reimburse the respondent's legal expenses that caused the Queensland State Government to do that. The inquiry was into the way the respondent had performed his duties under the contract of employment he once had: but that formed no significant part of the reasons why the ex gratia payment was made. That the subject matter of the inquiry was connected with a past employer/employee relationship that involved the respondent does not explain why the ex gratia payment was made. I would therefore dismiss the appeal. I certify that this and the preceding 23 pages are a true copy of the reasons for judgment herein of the Honourable Justice Drummond. Associate: Date: 20 October, 1995 Counsel for the applicant: D.F. Jackson Q.C. and W.G. Muddle Solicitor for the applicant: Australian Government Solicitor Counsel for the respondent: D.G. Russell Q.C. and H.L. Alexander Solicitors for the respondent: Hunt and Hunt Date of Hearing: 24 April, 1995