FEDERAL COURT OF AUSTRALIA Merrill Lynch International (Australia) Ltd v Commissioner of Taxation [2001] FCA 1127 TAXATION– income tax – "loss or outgoing" "incurred" within subs 51(1) of Income Tax Assessment Act 1936 (Cth) – taxpayers paid bonuses to their employees shortly after end of year of income – terms of contracts of employment reserved to taxpayers a discretion whether to pay bonuses – commercial circumstances made it probable that bonuses would be paid – amounts of bonuses determined shortly after end of year of income – reserves set aside progressively throughout year of income for bonus pool – whether outgoing "incurred" within that year or after it – whether "incurring" of outgoing requires that legal liability to pay it must be incurred or whether sufficient that commercially certain that it will be paid CONTRACT – distinction between a contractual promise to pay a bonus and a contractual obligation of reasonableness, good faith and fair dealing in the exercise of a discretion whether to pay a bonus WORDS AND PHRASES – "incurred" Income Tax Assessment Act 1936 (Cth) s 51(1) Vincent v Merrill Lynch Australia Pty Ltd [2000] NSWIRCom 160 discussed New Zealand Flax Investments Ltd v Federal Commissioner of Taxation (1938) 61 CLR 179 followed Federal Commissioner of Taxation v James Flood Pty Ltd (1953) 88 CLR 492 applied RACV Insurance Pty Ltd v Commissioner of Taxation [1975] VR 1 distinguished Commissioner of Taxation v Manufacturers' Mutual Insurance Ltd (1931) 31 SR (NSW) 575 distinguished Commonwealth Aluminium Corporation Ltd v Federal Commissioner of Taxation (1977) 7 ATR 376 discussed Commercial Union Assurance Co of Australia Ltd v Federal Commissioner of Taxation (1977) 14 ALR 651 distinguished Gates v WA and RJ Jacobs Ltd [1920] 1 Ch 567 cited Body Corporate Strata Plan No 4303 v Albion Insurance Co Ltd [1982] VR 699 cited Antique House Pty Ltd v Security & General Insurance Co Ltd (1984) 3 ANZInsCas 60-556 cited Nilsen Development Laboratories Pty Ltd v Federal Commissioner of Taxation (1981) 144 CLR 616 applied Federal Commissioner of Taxation v Nilsen Porcelains (Australia) Pty Ltd (1979) 41 FLR 36 cited Federal Commissioner of Taxation v Australian Guarantee Corporation Ltd (1984) 2 FCR 483 distinguished Commissioner of Inland Revenue v Lo & Lo (a firm) (Privy Council, 26 March 1984, unreported) distinguished Hooker Rex Pty Ltd v Federal Commissioner of Taxation (1988) 79 ALR 181 discussed Ogilvy and Mather Pty Ltd v Federal Commissioner of Taxation (1990) 95 ALR 663 discussed Coles Myer Finance Ltd v Commissioner of Taxation (1993) 176 CLR 640discussed Commissioner of Inland Revenue v Mitsubishi Motors New Zealand Ltd [1996] 1 AC 315 cited Commissioner of Taxation v Woolcombers (WA) Pty Ltd (1993) 47 FCR 561 discussed Commissioner of Taxation v Mercantile Mutual Insurance (Workers' Compensation) Ltd (1999) 87 FCR 536 discussed Australia and New Zealand Banking Group Ltd v Commissioner of Taxation (1994) 48 FCR 268 discussed Federal Commissioner of Taxation v Citibank Ltd (1993) 44 FCR 434 cited Renard Constructions (ME) Pty Ltd v Minister for Public Works (1992) 26 NSWLR 234 cited Hughes Aircraft Systems International v Airservices Australia (1997) 76 FCR 151 cited Alcatel Australia Ltd v Scarcella (1998) 44 NSWLR 349 cited Burger King Corporation v Hungry Jacks Pty Ltd [2001] NSWCA 187 cited MERRILL LYNCH INTERNATIONAL (AUSTRALIA) LIMITED (ACN 002 892 846) v COMMISSIONER OF TAXATION N 87 OF 2000 MERRILL LYNCH (AUSTRALIA) FUTURES LIMITED (ACN 003 639 674) v COMMISSIONER OF TAXATION N 88 OF 2000 MERRILL LYNCH (AUSTRALIA) PTY LIMITED (ACN 000 890 451) v COMMISSIONER OF TAXATION N 89 OF 2000 LINDGREN J 17 AUGUST 2001 SYDNEY IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY N 87 OF 2000 BETWEEN: MERRILL LYNCH INTERNATIONAL (AUSTRALIA) LIMITED (ACN 002 892 846) APPLICANT AND: COMMISSIONER OF TAXATION RESPONDENT JUDGE: LINDGREN J DATE OF ORDER: 17 AUGUST 2001 WHERE MADE: SYDNEY THE COURT ORDERS THAT: 1. The application be dismissed. 2. The applicant pay the respondent's costs. Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules. IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY N 88 OF 2000 BETWEEN: MERRILL LYNCH (AUSTRALIA) FUTURES LIMITED (ACN 003 639 674) APPLICANT AND: COMMISSIONER OF TAXATION RESPONDENT JUDGE: LINDGREN J DATE OF ORDER: 17 AUGUST 2001 WHERE MADE: SYDNEY THE COURT ORDERS THAT: 1. The application be dismissed. 2. The applicant pay the respondent's costs. Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules. IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY N 89 OF 2000 BETWEEN: MERRILL LYNCH (AUSTRALIA) PTY LIMITED (ACN 000 890 451) APPLICANT AND: COMMISSIONER OF TAXATION RESPONDENT JUDGE: LINDGREN J DATE OF ORDER: 17 AUGUST 2001 WHERE MADE: SYDNEY THE COURT ORDERS THAT: 1. The application be dismissed. 2. The applicant pay the respondent's costs. Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules. IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY BETWEEN: MERRILL LYNCH INTERNATIONAL N 87 OF 2000 (AUSTRALIA) LIMITED (ACN 002 892 846) APPLICANT AND: COMMISSIONER OF TAXATION RESPONDENT BETWEEN: MERRILL LYNCH (AUSTRALIA) N 88 OF 2000 FUTURES LIMITED (ACN 003 639 674) APPLICANT AND: COMMISSIONER OF TAXATION RESPONDENT BETWEEN: MERRILL LYNCH (AUSTRALIA) N 89 OF 2000 PTY LIMITED (ACN 000 890 451) APPLICANT AND: COMMISSIONER OF TAXATION RESPONDENT JUDGE: LINDGREN J DATE: 17 AUGUST 2001 PLACE: SYDNEY REASONS FOR JUDGMENT INTRODUCTION 1 In each of these three proceedings, the applicant appeals against the disallowance by the respondent Commissioner of an objection to an assessment to income tax for the year ended 31 December 1994 ("the 1994 year" – the calendar year was the applicants' substituted accounting period). Each applicant claimed a deduction under subs 51(1) of the Income Tax Assessment Act 1936 (Cth) ("the Act") being the amount of employee bonuses paid by it in respect of the 1994 year. The bonuses were not paid until late January 1995. It is not in dispute that each applicant is entitled to the benefit of a deduction for the amount then paid: the dispute is as to whether it is entitled to that benefit in its return of income for the 1994 year. That is, the issue is one of timing. The Commissioner concedes that the outgoing constituted by the bonuses paid was referable to the 1994 year. 2 On 10 March 2000 the Court ordered that the three proceedings be heard together and that evidence in each proceeding be evidence in the others. I will refer to the applicant in proceeding N 87 of 2000 as "MLIA", to the applicant in proceeding N 88 of 2000 as "MLAF", and to the applicant in proceeding N 89 of 2000 "MLA". I will use the expression "Merrill Lynch" in a general way to refer to the international and world wide Merrill Lynch group of companies and, on occasions, to each and all of the applicants as distinct from a particular one of them. 3 The case raises a distinction between what was referred to as a "jurisprudential" or "legal" approach to the concept of the "incurring" of an outgoing not paid during the year of income ("the tax year") for the purposes of subs 51(1) of the Act and a "commercial" approach to that concept. The Commissioner submits that the former is required by authority and that an outgoing is incurred only if and when a taxpayer becomes liable at law to pay it. According to the commercial approach, something less will suffice. The "something less" has been referred to as "commercial certainty". The applicants submit that the "commercial" approach is applicable and that it was not necessary in order for the bonuses to represent an outgoing incurred in the 1994 year that the applicants became liable by the end of that year to pay them. The applicants submit that it sufficed that by that time it was certain that the bonuses would be paid, and that in fact it was certain by then that they would be. But they submit, in the alternative, that they had in fact become liable by 31 December 1994 to pay the bonuses. facts 4 Merrill Lynch had three bonus schemes relevant to this case for the benefit of its staff: a "Variable Incentive Compensation Plan" ("VICP"), a "Key Employees Incentive Compensation Plan" ("KEICP") and an "Employees Incentive Plan" ("EIP"). The VICP applied to traders, management and professional staff whose work generated income directly. Senior administrative employees were entitled to participate in the KEICP, which was treated as part of the VICP. Non-executive employees were entitled to participate in the EIP. The terms of appointment of employees stipulated that payment of a bonus was at the discretion of the employer. Several letters of engagement were in evidence. Their terms relating to bonus were not identical. The following letter from MLA to Christopher P Marshall dated 3 November 1987 stated, relevantly, as follows: "Remuneration You will receive a salary package of A$50,000 per annum. You will be entitled to participate in the Company's Variable Incentive Compensation Plan ('VICP') which is a discretionary bonus scheme based on your performance. All payments to you under the VICP Plan are at the complete discretion of the Company and there can be no assurance of any payment. Payment under the VICP scheme will usually be made in February each year." The letters of engagement in evidence all described the VICP as "a discretionary bonus scheme based on your performance", although some of them stipulated that the employee was guaranteed a minimum bonus of a certain amount for the first year. (Apparently the promise of a specified minimum bonus in the first year was made only in cases where the employee was being engaged towards the end of a year and would, by accepting Merrill Lynch's offer, forfeit the possibility of receiving a bonus associated with his or her existing employment.) 5 In addition to a provision for termination for cause, the letters of engagement provided that each party had a right to terminate the employment by giving not less than 30 days' notice in writing to the other. The letters allowed the employer to pay base salary in lieu of notice and at least some of them stipulated expressly that the employee would "not be entitled to any further compensation, costs or damages resulting from such termination". 6 The applicants accept that, based on the letters of engagement alone, an employee did not have, by the end of the 1994 year, an entitlement at law to be paid a bonus. 7 Merrill Lynch's head office was in New York. The world wide operations of Merrill Lynch were divided into regions. There was varying evidence that the region relevant to this case was the "Asia Pacific" or "Australian" or "Australasian" region. Merrill Lynch's operations were also divided into "business groups" or "business units" (the terms are interchangeable). As well, there were sub-groups. In Sydney in 1994 there were four business groups and a support group known as the "Corporate Support Group" ("CSG"). The business groups were: · Debt Markets · Investment Banking · Equity Markets · Private Client Broking 8 For the 1994 year a "Bonus Pool" for the VICP and KEICP was determined by reference to a formula related to the financial performance of Merrill Lynch. A committee of the Board of Directors, known as the "Management Development and Compensation Committee" ("MDCC"), approved the allocation of the global pool for the VICP and KEICP as between the respective global business units. The head of each global business unit decided how much of the amount allocated to his or her unit would be allocated to each region. 9 The amount of the bonus for each employee in a business group was determined by the regional head of that business group, in consultation with the heads of the relevant business sub-groups in the region and the Chief Executive Officer for the region. An identical procedure was followed for the CSG. 10 In the result, the amount of the bonus received by an individual employed in, say, the Debt Markets unit in a region, would depend on four decisions: · a decision as to the amount of the VICP bonus pool world wide; · a decision of the MDCC allocating a part of that VICP bonus pool to the global Debt Markets unit; · a decision of the head of the global Debt Markets unit as to how much was to be allocated to the relevant region; · a decision by the regional head of the Debt Markets unit as to the amount of bonus to be paid to the particular employee. 11 The VICP and KEICP operated in relation to the three applicants. The arrangements for both schemes were, in substance, the same, except that they applied to different personnel. In the 1994 year, every employee who was a "producer", that is, whose work generated income directly for Merrill Lynch, such as employees in the Debt Markets, Investment Banking and Equity Markets business groups, participated in the VICP, whereas persons employed in human resources or administrative positions participated in the KEICP. 12 The allocation of a reserve among companies in different countries occurred on a progressive basis throughout the year, by a process of "accrual accounting". However, the allocation was subject to a final review and confirmation by the MDCC in early January of the following year. Allocation of the bonus pool available for each business group among qualifying employees in that group was made by the regional head of the group, based on, inter alia, an assessment of the employee's performance. 13 During the first half of January 1995 there was some reallocation of bonuses among Australian employees who participated in that part of the VICP pool allocated to the Australian companies. 14 I turn now to the EIP. The amount paid as bonuses under the EIP was calculated by reference to the "return on equity" of Merrill Lynch, world wide. Each year it was calculated in respect of each participating employee as a number of days' salary of that employee. Again, there was a process of accrual accounting throughout the year in respect of the EIP. This took place month by month. Participating employees were informed during the year that, by way of the bonus, they would have the "opportunity to share in [the] company's success", and that "the size of each employee's award [would] be based on their manager's evaluation of their job performance, as well as the number of days funded for the firm-wide pool". 15 There was evidence that the base salaries of Merrill Lynch employees were at or below average for the industry. Peter Richard Stingi ("Mr Stingi"), First Vice President, Head of Human Resources for Merrill Lynch Investment Managers, who had been Head of the Executive Compensation Department of Merrill Lynch from about July 1989 to September 1995, testified that Merrill Lynch's "competitive position over the years with respect to base salaries [had] been at or below what would be deemed to be the competitive standard", but that with the "bonus element" Merrill Lynch "would be positioned either above or well above what would be the competitive standard". Similarly, Gordon Richard Towell ("Mr Towell") who was Chief Administrative Officer of MLA in Australia from October 1986 to 1996, testified that he was aware throughout the 1994 year and the preceding years that MLA and MLIA paid "below average market salaries to its employees" in comparison to its competitors, but that to compensate for this it paid bonuses which were "above market". 16 There was expert evidence from Lynn Robert Anderson, who had experience at the relevant time in "search and recruitment" in the financial institutions sector of Russell Reynolds Associates Inc (by which he was employed) to the effect that bonus payments were widely paid by a large majority of the participants, such as Merrill Lynch, in the merchant banking and securities industry in 1994. He said that by the early 1990s, bonus payments had become "an integral part of compensation packages for almost all professional staff in the wholesale operations of commercial banks and in investment banks and securities firms". Mr Anderson further testified: "As more firms adopted performance and incentive bonuses, it became a competitive necessity for virtually all firms to adopt broadly similar schemes in order to retain key talent, who might otherwise be attracted to join the competing, bonus-paying, institutions." 17 Mr Anderson said that bonus payments exceeding 100 per cent of fixed remuneration amounts were occasionally paid to "key performers such as heads of dealing desks", and that bonuses in the range of 25 per cent to 50 per cent or more, of fixed remuneration, "were the norm for most professional staff in investment banks and securities firms when the overall competitive performance of those organisations was strong or improving significantly". 18 There was evidence that payment of bonuses was an expectation of Merrill Lynch staff. Mr Towell said that while payment of bonuses was "discretionary", it was "deemed by the business managers as being – and by the senior management team at that time as being – a certainty". However, he agreed that when people were employed they were told that bonuses were "discretionary" and "based on a number of factors". He said that new employees were told what the factors were and were "set goals and objectives ... critical objectives ...". Mr Towell claimed that paying bonuses under the schemes was essential to MLA's and MLIA's ability to retain staff because staff regarded the bonuses as "part of their total remuneration by each of MLA, MLIA and MLAF". 19 The amounts of the bonuses were fixed in US currency. The applicants rely on evidence that the exchange risk involved in the denomination of the bonus amounts in that currency was recognised and hedged against and that qualifying employees were informed of the hedge arrangements "early in the financial year so that [they might] plan their financial affairs accordingly". Progressive assessments of the amounts of bonus likely to be paid at the end of the year were made by Merrill Lynch and recognised in its accounting records by the accrual of a liability account and in variation of the currency hedge. 20 The applicants also rely upon Vincent v Merrill Lynch Australia Pty Ltd [2000] NSWIRCom 160 as showing that if Merrill Lynch had unfairly exercised the discretion referred to in the letter of engagement by refusing to pay a bonus or by paying an inadequate one, it could have been compelled, in effect, to exercise its discretion fairly. In that case, referred to in more detail later, the Industrial Relations Commission of New South Wales granted relief to an employee of MLA whose employment came to an end as a result of redundancy prior to the end of a tax year and prior to the payment of bonuses early in the following year. CHRONOLOGY OF EVENTS IN LATE 1994 AND EARLY 1995 21 The following were the salient events of late 1994 and early 1995 within Merrill Lynch relating to the fixing of the amounts payable under the VICP, KEICP and EIP, and the payment of those amounts. (1) In November and December 1994, those responsible in Australia reviewed the performance of employees eligible to participate in the VICP, KEICP and EIP. (2) On 3 November 1994 John Moser at Human Resources Finance in New York advised John Horn of MLA of the accrual figures as at the end of October 1994 for the bonus schemes. (3) On 4 November 1994 Mr Towell received a memorandum from Joyce K Greene at Corporate Compensation in New York advising him of the EIP procedure for 1994 and requesting information about staff eligible to participate in the EIP. (4) On 17 November 1994 all employees entitled to participate in the EIP were advised that a bonus of 15 to 20 days' pay for eligible employees was anticipated, but that the size of each employee's award would be based on his or her manager's evaluation. (5) On 25 November 1994 Lori Luis, of New York, sent Mr Towell a list of employees in Australia who were entitled to participate in the VICP and KEICP for 1994. (6) On 28 November 1994 Mr Towell advised Joanna Boon of Investment Banking in New York that a named employee had been omitted from the list. (7) In November 1994 Mr Towell had telephone conversations with Ron Strauss, the Chief Administrative Officer for the Asia Pacific Region, who was based in New York, and was, in effect, the head of Mr Towell's CSG. Mr Towell made recommendations in respect of CSG staff employed in Australia. Mr Strauss told Mr Towell that he could expect the bonus pool to be "broadly the same" as it had been the preceding year. (8) On 29 November 1994 Mr Towell sent a recommendation to Sheldon Guyer in New York that a particular employee receive the same amount of bonus as for 1993. (On 21 December 1994, Ms Luis advised Mr Towel that according to the then most recent VICP file, the particular employee's proposed bonus was shown as US$21,000). (9) On 5 December 1994 the MDCC met in New York. According to the minutes of the meeting, Mr Stingi, who was at the time the Head of the Executive Compensation Department, reviewed with the Committee competitive pay levels and "the preliminary projected 1994 incentive compensation pools (both VICP and stock) for managers and producers". (10) On 8 December 1994 Mr Towell e-mailed Irene Woerner and Ms Boon in New York requesting a reply to earlier inter office memos about changes to the 1994 VCIP eligibility list and he received a reply the same day. (11) On 19 December 1994 Sharon Packer of MLA e-mailed to Elizabeth Harper in New York a list of EIP participants and a summary of their performance assessments. (12) On 22 December 1994 Mr Towell received from Ms Luis an updated list of employees eligible to participate in the VICP and KEICP. (13) On 26 December 1994 Ahmass Fakahany of New York faxed Mr Horn at MLA, advising him of accrual figures for November 1994. (14) On 30 December 1994 Mr Moser of New York faxed Mr Horn of MLA accrual figures for the 1994 year. The total for MLA was US$5,444,000. The Private Client and Futures Utility amounts were in addition and were separately advised. (15) During December 1994 the heads of the business groups worked out bonus figures for individuals under the VICP, KEICP and EIP and Mr Towell compared those figures with the accrual figures received. (16) As at 31 December 1994 the accrual figure for VICP, KEICP and EIP for MLA, MLIA and MLAF was, in effect, Aud$7,021,906 (Aud$7,752,034 less Aud$730,128 which had been pre-paid to a particular identified employee). The accrual figure was divided between the three applicants as follows: MLA $2,127,073 MLIA 4,187,900 MLAF 706,933 -------------- $7,021,906 ======== (17) In early January 1995 further updated lists of eligible employees and proposed bonuses were provided to Mr Towell by Ms Luis. (18) On 16 January 1995 the MDCC met in New York and Mr Stingi reviewed with the Committee the proposed bonus amounts for each global business group and the Committee "approved the recommendations". On the same day Ms Luis e-mailed Mr Towell the results, adding that "any future changes will be communicated to you via separate CC:Mails". (19) On 23 January 1995 Ms Greene e-mailed Mr Towell, advising that the final EIP bonuses for 1994 had been set at 18.5 days' pay per eligible employee, which represented an increase of one day's pay above the previously proposed 17.5 days' pay. (20) On 24 January 1995 Denise Benson of MLA sent a memorandum to all VICP eligible employees informing them that the 1994 VICP payments were due to be released on 27 January 1995 and enclosing a statement of the bonus to be paid to the particular employee. (21) On 27 January 1995 MLA, MLIA and MLAF accounts for the year ended 23 December 1994 were signed by the directors and they included the total amount accrued by each company under the schemes. (22) On 10 February 1995 Ms Packer of MLA e-mailed to Ms Harper of New York a final list of EIP award payments. (23) From 27 February 1995 to 23 April 1995 "accrual reconciliations" were finalised. 22 Two facts of present relevance emerge from the above chronological account. The first is that the first time an employee was advised that he or she was definitely to receive a bonus for the 1994 year and of the amount of it, was on about 24 January 1995, that is, after the end of the 1994 year. The second is that adjustments were made in January 1995 so that it cannot be said that the amounts of the bonuses or even the aggregate amount of them had been determined by 31 December 1994: the determination of the aggregate was not made by the MDCC until 16 January 1995. There is documentary evidence that for all of the VICP, the KEICP and the EIP for Merrill Lynch's operations in Australia the total amounts accrued within Merrill Lynch as at the end of December 1994 for the 1994 year, and the total of the bonuses subsequently paid for that year were as follows: Accrued Paid AUD USD AUD USD 7,752,034 5,662,500 7,456,249 5,351,445 REASONING 23 Subsection 51(1) of the Act provided as follows: "All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions …" the course of authority 24 I find it convenient to address the cases to which I was referred on the meaning of the word "incurred" in chronological order. 1. New Zealand Flax Investments Ltd v Federal Commissioner of Taxation (1938) 61 CLR 179 ("New Zealand Flax") 25 The taxpayer's business included the sale of bonds, for which it received payment either in cash or by instalments spread over 2˝ years, and which subjected it to obligations to the bondholders to acquire land in New Zealand, to vest the land in a trustee for the bondholders and to cultivate and carry out certain works on the land, directed to the growing, cutting, milling and marketing of flax. In its return of income, the taxpayer brought to account the full amount receivable in respect of bonds sold during the tax year. Part of that amount was not receivable until after that year. In issue was the taxpayer's claim to deduct deferred commissions on the sale of the bonds (commission was not payable on an amount until the company received payment of it) and interest payable on the bonds (interest was payable on an amount from the date of payment of it by the purchaser to the date four years after the issue of the bonds), in each case to become payable after the end of the tax year. The Commissioner disallowed that deduction and the taxpayer's resulting objection. 26 Upon the taxpayer's appeal to the High Court against an unfavourable decision of the Board of Review, the assessment was set aside and remitted to the Commissioner to enable him to include as income only bond monies received in the tax year and to allow as deductions only that part, if any, of the deductions claimed for deferred commission and future interest as was referable to that tax year. The Court treated the case as one in which liability was incurred during the tax year but in which there was an unresolved question of "referability" to that year. Nevertheless, Dixon J (with whom McTiernan J agreed) also made some important observations about the "incurring" of outgoings. 27 Dixon J emphasised (at 199): · that the assessment must begin by taking the full receipts on revenue accounts as assessable income; · that "only such deductions must be made as the statute in terms allows"; and · that par 23(1)(a) of the Income Tax Assessment Act 1922 (Cth) was the source of authority for the deduction. Paragraph 23(1)(a) allowed a deduction for: "All losses and outgoings … actually incurred in gaining or producing the assessable income …" In an oft cited passage, Dixon J stated (at 207): "To come within that provision there must be a loss or outgoing actually incurred. 'Incurred' does not mean only defrayed, discharged, or borne, but rather it includes encountered, run into, or fallen upon. It is unsafe to attempt exhaustive definitions of a conception intended to have such a various or multifarious application. But it does not include a loss or expenditure which is no more than impending, threatened, or expected. In the present case I regard the obligation to pay interest to bondholders who, within the four years from the date of issue, paid up the amount of the bonds, as a definite liability contingent only on the bondholders meeting their instalments, that is, in the case of bonds subscribed for in or before the respective accounting periods the subject of assessment. There is no reason why the future liability should not be treated as incurred, if otherwise it were proper to throw it against the revenue items, as it would clearly have been if the full face value of the bonds were included in the assessable income. But I find it difficult to say upon the information before us whether any of this liability should be considered as properly attributable to the years in question. There is, I think, no objection to the commissioner's taking into consideration the actual events of the subsequent years in order to see whether, under a method of accounting by which only actual receipts from the bonds are included, the liability for interest would naturally be provided out of revenue from that source accruing in the year when the liability would be met, or whether safe or proper practice required for the purpose an appropriation and retention of part of the sums received in the accounting periods under assessment. In the same way I think that commissions payable on the sale of bonds but deferred until the receipt of later instalments involve an outgoing 'incurred', but on which does not necessarily and as a matter of course fall into the assessment of the accounting period. But the reserves on account of the mill and for the purpose of clearing, burning, draining, ploughing, cultivating, planting and for 'maintenance and general' cannot be brought within the authority of sec. 23(1)(a)." In New Zealand Flax, the taxpayer was subject to a legal liability by the end of the tax year to pay the deferred commissions and the future interest, subject to the bond holders paying the outstanding instalments. Upon payment of them, the deferred commissions would become payable and interest on the amount of those instalments would begin to run. The case is relevant for present purposes because of the following propositions enunciated by Dixon J which have not been questioned in later cases: · it is unsafe to attempt an exhaustive definition of "incurred" in the present context; · "incurred" is not limited to "defrayed, discharged or borne" and includes "encountered, run into, or fallen upon"; · there is a distinction between "incurred" outgoings and outgoings which are merely "impending, threatened, or expected"; · the setting aside by the taxpayer in the tax year of reserves to meet an outgoing does not establish that the outgoing has been incurred in that year. 28 New Zealand Flax is important for another reason. By the end of the tax year, the salesmen did not have an immediately enforceable cause of action to recover deferred commissions and the bondholders did not have an immediately enforceable cause of action to recover future interest, yet Dixon J was prepared to treat both as outgoings "incurred" within the year. In this respect the case illustrates a distinction, recognised in certain later cases, between "liability" or "legal liability", with or without the preceding adjective "present", on the one hand, and the existence of an immediately enforceable cause of action on the other. In New Zealand Flax there remained nothing for the taxpayer to do to perfect its liability and there was nothing it could do to avoid its being perfected. To use the expressions of later cases in the senses in which I think they have been used, the taxpayer had incurred a present "legal liability" for the outgoing, but not yet an "immediate obligation enforceable at law" or an "immediately enforceable obligation" (I take these two expressions to be synonymous), and whether, and if so when, the obligation would become enforceable would depend on the happening of a contingent event (payment of outstanding instalments by the bondholders), which the taxpayer was not at liberty to prevent. In these circumstances, the outgoing was incurred within the tax year. 2. Federal Commissioner of Taxation v James Flood Pty Ltd (1953) 88 CLR 492 ("James Flood") 29 Under an industrial award, the taxpayer was bound, subject to certain exceptions, to allow to each of its employees covered by the award, 14 consecutive days' leave on full pay annually after 12 months' continuous service (less the period of the annual leave itself). The annual leave had to be taken within six months of the accrual of the right to it. The employee was entitled to be paid two weeks' wages immediately prior to the commencement of the leave or the ending of the employment. Except in the case of the ending of the employment, the leave had to be allowed and taken, and payment was not to be made or accepted in its place. 30 In its return of income for the year of income ended 30 June 1947, the taxpayer claimed a deduction representing holiday pay which had accrued, but had not been paid, in that year. The Commissioner disallowed the deduction and the taxpayer's objection, but the Board of Review upheld the taxpayer's claim and ordered that the assessment be amended. The Commissioner appealed to the High Court. 31 The award provision came into effect on 1 January 1946. In December 1946, employees were allowed and took annual leave. The Court treated the taxpayer's objection as claiming a deduction calculated on a pro rata monthly basis in respect of the period from 1 January 1947 to 30 June 1947. Accordingly, there had not arisen an entitlement to take annual leave during the tax year ended 30 June 1947. 32 In a joint judgment, all members of the Court (Dixon CJ, Webb, Fullagar, Kitto and Taylor JJ) stated (at 505) as follows: "When the employees are considered not individually but collectively it is easy to understand that the taxpayer should say that it was antecedently quite certain, apart from the remote contingency of a change of ownership of the undertaking, that an expenditure on annual leave would be made in the ensuing financial year, and that an almost fixed proportion would be calculated in respect of periods of service falling within the year of income. But to say this is not enough. It shows no more than that part of the regular expenditure incurred in carrying on the undertaking is the payment of wages to men taking their annual leave and that the amount may be computed in advance with approximate accuracy because annual leave depends on twelve months' service." 33 At 506-507 their Honours stated: "The word 'outgoing' might suggest that there must be an actual disbursement. But partly because such an interpretation would produce very strange and anomalous results, and partly because of the use of the word 'incurred', the provision has been interpreted to cover outgoings to which the taxpayer is definitively committed in the year of income although there has been no actual disbursement. In James Spencer & Co v Commissioners of Inland Revenue [(1950) SLT 266 at 268; (1950) SC 345 at 352], Lord Cooper says that from an examination of the numerous cases 'the broad working rule which emerges as a guide to the crediting or debiting in a tax computation of subsequently maturing credits or debits is to inquire in which accounting period the right or liability was established, and to carry the item into the account in that year. I use the vague word 'established' advisedly, for we are now in the region of proper commercial and accountancy practice rather than of systematic jurisprudence'. This passage must be qualified in its application under the Commonwealth Act. For under our law the facts must satisfy the expression 'losses and outgoings incurred'. These words perhaps are but little more precise than the word 'established' or the expression used above 'definitively committed'. But they do not admit of the deduction of charges unless, in the course of gaining or producing the assessable income or carrying on the business, the taxpayer has completely subjected himself to them. It may be going too far to say that he must have come under an immediate obligation enforceable at law whether payable presently or at a future time. It is probably going too far to say that the obligation must be indefeasible. But it is certainly true that it is not a matter depending upon 'proper commercial and accountancy practice rather than jurisprudence'. Commercial and accountancy practice may assist in ascertaining the true nature and incidence of the item as a step towards determining whether it answers the test laid down by s 51(1) but it cannot be substituted for the test." (my emphasis) Their Honours concluded (at 507-508) as follows: "It is one thing, however, to say that it is not necessary, for the purposes of s 51(1), that an actual disbursement should have taken place. It is another thing to say that in the present case the taxpayer has incurred a loss or outgoing in the year of income in respect of the pay of its men during the annual leave to be taken in the ensuing accounting period by employees whose service had not as yet qualified them for annual leave. In respect of those employees there was no debitum in praesenti solvendum in futuro. There was not an accrued obligation, whether absolute or defeasible. There was at best an inchoate liability in process of accrual but subject to a variety of contingencies. It may be true, that regarding the labour employed as a whole, the accrual of an amount of the order claimed had, by 30th June 1947, become predictable with certainty. But that is not the test." 34 I treat James Flood as supporting the following propositions: · the meaning of "incurred" in subs 51(1) depends on "jurisprudence", not on "commercial and accountancy practice"; · commercial certainty as at the end of a tax year that an outgoing will be paid, including an outgoing referable to that year, does not signify that the outgoing was incurred during that year; · it may be going too far to insist that by the end of the tax year there be "an immediate obligation enforceable at law whether payable presently or at a future time" and it is probably going too far to say that the obligation must be "indefeasible" (in making this statement their Honours may have had in mind New Zealand Flax, to which they referred shortly afterwards); · the taxpayer must, during the year of income, have "completely subjected" or "definitively committed" itself to payment of the outgoing. 35 Clearly, their Honours did not think the "definitive commitment" and "complete subjection" of which they spoke as requiring "an immediate obligation enforceable at law". The ground which their Honours ultimately gave for the taxpayer's failure in the appeal was that the claimed deduction did not represent "an expenditure associated with the production of income before 30 June 1947 for which a liability had been completely incurred before that date" (at 508) (my emphasis). 36 The Court observed (at 504) that there were several circumstances in which an employee would not become entitled to take leave, including, for example, a sale of the business by the taxpayer or termination of the employment (if the termination was due to the employee's fault, the employee was not entitled to payment, but if not, the employee was entitled to be paid an amount which was not simply a pro rata part of the amount payable if leave was taken after a full twelve months' service). The case was therefore not one in which the taxpayer had done all it had to do in order to be liable to pay the outgoing claimed and it remained only for time to pass or, as in New Zealand Flax, for another person to do something, before such a legal liability became an obligation immediately enforceable at law. 3. RACV Insurance Pty Ltd v Commissioner of Taxation [1975] VR 1 ("RACV") 37 The taxpayer carried on business as a motor car insurer, including compulsory third-party insurance business. The Motor Car Act 1958 (Vic) required a vehicle owner to notify the authorised insurer of accidents which resulted in death or personal injury, although this was commonly not done. The insurer's liability to indemnify the driver was, in effect, absolute, whether or not the required notification was given, although, if it was not given, in very limited circumstances the insurer might seek damages from the owner or indemnity from the driver. The taxpayer claimed a deduction in respect of "unreported claims", being its estimate of the amount of its liability arising out of accidents involving death or personal injury which occurred in the tax year but had not been notified to it by the end of that year. The Commissioner disallowed the claimed deduction. 38 Menhennitt J held that once events occurred out of which the liability to indemnify arose, a loss or outgoing was incurred for the purposes of subs 51(1) of the Act. His Honour said (at 8): "Once events have occurred out of which a liability to indemnify an insured arises, it appears to me that within the meaning of s 51(1) of the Income Tax Assessment Act a loss or outgoing has been incurred. Events have occurred which have subjected it to a liability to indemnify its insured against his liability to a third person and the extent of that liability is capable of reasonable estimate. Where there is no real question of the liability of the insured to the third party and the only question is one of estimating damages, the fact that the quantum of the loss or outgoing is a matter of estimate and that the amount may have to be adjusted in the light of later events does not stand in the way of it being a loss or outgoing (…) and in a case where the liability of the insured to the third party is in issue but the amount which is likely to be payable can be reasonably estimated, it is still I think true to say that within the meaning of s 51(1) a loss or outgoing has been incurred by the insurance company." 39 His Honour said he agreed with and would apply the decision and reasons of the Full Court of the Supreme Court of New South Wales in Commissioner of Taxation v Manufacturers' Mutual Insurance Ltd (1931) 31 SR (NSW) 575, a case decided under par 19(1)(a) of the Income Tax (Management) Act 1928 (NSW). In that case the taxpayer had effected workers' compensation insurance and claimed to deduct estimates of the amounts it would be obliged to pay in respect of claims made on it during the tax year. Ferguson J, with whom Street CJ and James J agreed, had said (at 585): "In the case of the item under discussion there is no legal obligation in the sense of a cause of action immediately enforceable against the company; but from a practical business point of view, and that is the point of view from which these questions should be regarded, it is just as certain that some money will have to be paid in respect of pending claims as in respect of claims which have gone to judgment. The amount is uncertain, but apparently it is susceptible of more or less accurate estimate. Any statement of the affairs of the company professing to show the result of the year's operations, which neglected to take into account this liability, would be grossly inaccurate and misleading. In my opinion, therefore, it is an obligation standing on the same footing as an actual expenditure, which the company is entitled to deduct as a loss or outgoing actually incurred in producing the assessable income, subject of course to any necessary future adjustment." (RACV was cited with apparent approval by Mason J (with whom Aickin and Wilson JJ agreed) in Nilsen Development Laboratories Pty Ltd v Federal Commissioner of Taxation (1981) 144 CLR 616 ("Nilsen") at 632.) 40 Both RACV and the earlier Manufacturers' Mutual case proceeded on the footing that by the end of the tax year the insurer had incurred a legal liability to indemnify, and that it was only because the amount of that liability was not ascertained that there was not an immediately enforceable cause of action against the insurer. Importantly, it was beyond the capacity of the insurer unilaterally to cause quantum to be nil and so to prevent an enforceable cause of action from arising. 4. Commonwealth Aluminium Corporation Ltd v Federal Commissioner of Taxation (1977) 7 ATR 376 ("Commonwealth Aluminium") 41 In Commonwealth Aluminium Newton J in the Supreme Court of Victoria expressed the opinion that the authorities established that a taxpayer "can completely subject itself to a liability, notwithstanding that the quantum of the liability cannot be precisely ascertained, provided that it is capable of reasonable estimation", and that the quantum of a liability is "capable of reasonable estimation" if it is "capable of approximate calculation based on probabilities" (both at 386). For present purposes the case adds nothing to the principle recognised in RACV and the Manufacturers' Mutual case discussed above. (Like RACV noted above, Commonwealth Aluminium was cited with apparent approval by Mason J (with whom Aickin and Wilson JJ agreed) in Nilsen at 632 (see [39] above).) 5. Commercial Union Assurance Co of Australia Ltd v Federal Commissioner of Taxation (1977) 14 ALR 651 ("Commercial Union") 42 Merrill Lynch relies on Commercial Union. Like RACV, it was a case in which an indemnity insurer claimed to deduct the estimated amount of claims outstanding against it as at the end of the tax year. The insurance policies contained conditions requiring notice of the occurrence of an event insured against to be given to the insurer within a limited time and many of the policies made the giving of the notice within that time, a condition precedent in the sense that the insurer was not liable to indemnify unless it chose to waive or became estopped from relying on, non-performance of the condition. (No comparable condition precedent was a term of the insurance in RACV – see [1975] VR at 10.) The evidence showed, however, that the almost invariable practice was to pay claims in full, notwithstanding non-performance of the condition. It was only where some grave prejudice to the insurer had arisen from the failure to notify within the specified time that the taxpayer considered disclaiming liability. Even in those cases, liability was not always disclaimed. Newton J observed (at 660): "The reason for the practice [of not disclaiming], which at all material times has been followed by other insurers in Australia, is to be found principally in considerations of business expediency. Insurance is a very competitive business, and an insurer who chose to rely on conditions precedent as to notice would soon go out of business." 43 His Honour rejected the Commissioner's submission that in cases where, at the end of the tax year, the condition had already been breached, a deduction was not allowable, stating (at 661-662) as follows: "… the event insured against had occurred, and the position therefore was that the insurer was under a liability to indemnify the insured as provided by the policy, unless the insurer should choose to rely upon any failure to comply with the condition precedent as to notice. But the long established policy and practice ... made it certain, ... , that the claim would be paid, whether or not the condition as to notice was complied with. Payment was a matter of commercial certainty, and was not subject to any contingency which would be regarded as such in the world of ordinary business affairs. This policy and practice was based on business expediency, and it is well established that payments made for reasons of business expediency, although otherwise voluntary, are not excluded from the category of allowable deductions under s 51, because not made in pursuance of any legal obligation: see, for example, FC of T v Gordon (1930) 43 CLR 456 at 462 per Dixon J, and 470 per Starke J; and Sun Newspapers Ltd v FC of T (1938) 61 CLR 337 at 352, per Latham CJ. Indeed, an acceptance of the Commissioner's first argument would be quite out of accord with the realities of the situation. It may be observed that although the High Court in Floods Case, ..., indicated that an unpaid liability cannot be a loss or outgoing, which has been 'incurred' for the purposes of s 51, unless the taxpayer 'has completely subjected himself' to it, nevertheless the court proceeded to say: 'It may be going too far to say that he must have come under an immediate obligation enforceable at law whether payable presently or at a future time' (the italics are [his Honour's]): see 88 CLR at 506." Newton J referred (at 662) to the statement in the joint judgment in James Flood, set out earlier, that "commercial and accountancy practice may assist in ascertaining the true nature and incidence of the item as a step towards determining whether it answers the test laid down in s 51(1)". (Like RACV and Commonwealth Aluminium noted above, Commercial Union was cited with apparent approval by Mason J (with whom Aickin and Wilson JJ agreed) in Nilsen at 632 (see [39] and [41] above).) 44 The case is distinguishable from the present one in this respect: unless the insurer pleaded breach of the condition, all the elements of its liability existed. Timely notification by the insured was not an element of the insured's cause of action to be pleaded by the insured, but a matter to be put in issue by the insurer, failing which, the insured could prove the insurer's liability: Gates v WA and RJ Jacobs Ltd [1920] 1 Ch 567; Body Corporate Strata Plan No 4303 v Albion Insurance Co Ltd [1982] VR 699 at 702 (aff'd [1983] 2 VR 339); Antique House Pty Ltd v Security & General Insurance Co Ltd (1984) 3 ANZInsCas 60-556). In the case before me, however, I conclude below that there was not in place as at 31 December 1994 a legal liability of the applicants to pay the bonuses to their employees, even one which the taxpayer had a legal right to avoid. 6. Nilsen Development Laboratories Pty Ltd v Federal Commissioner of Taxation of the Commonwealth of Australia (1981) 144 CLR 616 ("Nilsen") 45 The taxpayer claimed deductions for amounts provided in its accounts as representing estimates of what it would have been bound under industrial awards to pay certain of its employees if they had taken the annual leave and long service leave which they had been entitled to take during the tax year, less any amounts that had been provided for those items in the taxpayer's accounts in previous years. The facts differed from those of James Flood in that, although, as in that case, the leave was not taken during the tax year, the qualifying period of employment had expired and the entitlement to take leave had become indefeasible, by or during that year. 46 By majority, a Full Court of this Court (Brennan and Deane JJ, Fisher J dissenting) held that the amount provided in the commercial accounts of the taxpayer as a provision against its future liability to pay money in respect of annual leave and long service leave for which its employees had already qualified, did not represent a loss or outgoing incurred within subs 51(1) of the Act (Federal Commissioner of Taxation v Nilsen Porcelains (Australia) Pty Ltd (1979) 41 FLR 36). 47 Barwick CJ noted (at 620) that the amount had been spoken of in argument as an "accrued liability": " ... not in the sense of a present liability but in the sense of liability which is now certain to arise in the future, ie as a money sum in the least amount which would inevitably have to be paid in the future." His Honour agreed (at 621) with the analysis by Brennan J in the Full Court of this Court in the case under appeal that the effect of the relevant award provisions was that a pecuniary liability could not arise before the time when an employee actually went on leave or his employment was terminated or he died (41 FLR 36 at 39). The Chief Justice stated (at 623-624): "In my opinion, the language of Dixon J in New Zealand Flax Investments Ltd v Federal Commissioner of Taxation [(1938) 61 CLR 179 at 207] needs to be carefully perused and applied. Granted that exhaustive definition of what may be denoted by the word 'incurred' in s 51(1) may not be possible, there can be no warrant for treating a liability which has not 'come home' in the year of income, in the sense of a pecuniary obligation which has become due, as having been incurred in that year. Sir John Latham's language in Emu Bay Railway Co Ltd v Federal Commissioner of Taxation [(1944) 71 CLR 596 at 606] clearly enough indicates that to satisfy the word 'incurred' in s 51(1) the liability must by 'presently incurred and due though not yet discharged'. The 'liability' of which Sir John speaks is of necessity a pecuniary liability and the word 'presently' refers to the year of income in respect of which a deduction is claimed. It may not disqualify the liability as a deduction that, though due, it may be paid in a later year. That part of Sir Owen Dixon's statement in New Zealand Flax Investments Ltd v Federal Commissioner of Taxation [(1938) 61 CLR 179 at 207] which presently needs emphasis is that the word 'incurred' in s 51(1) 'does not include a loss or expenditure which is no more than pending, threatened or expected': and I would for myself add 'no matter how certain it is in the year of income that the loss or expenditure will occur in the future'." (my emphasis) His Honour thought the use of the word "accruing" in the present case to be inappropriate (he also considered (at 623) that the use of the word "accrual" in the reasons for judgment in James Flood was not "so accurate" that its use could be translated into the circumstances of the instant case). The Chief Justice emphasised that all that could be said was that since the qualifying period of employment had already been served, when the time for the taking of leave was ultimately fixed and the period of leave entered upon, a liability to pay money would certainly arise. 48 Gibbs J also observed that there was no liability to make any payment until the employment was terminated, the employee died or the employee took the leave, whichever should first occur. His Honour said (at 627): "… it was suggested in Federal Commissioner of Taxation v James Flood Pty Ltd that it is not necessary that there should be an immediate obligation enforceable at law whether payable presently or at a future time, or that the obligation should be indefeasible. It is not now necessary to consider whether those suggestions should be accepted as correct. But what is clearly necessary is that there should be a presently existing liability." (my emphasis) Gibbs J regarded the reference in James Flood to the notions of "definitive commitment" and "complete subjection" as referring to a presently existing liability. Holding that the taxpayer was not under such a liability to make a payment, his Honour stated (at 628): "The employees were entitled to leave, but they were not entitled to payment. The entitlement to payment would not arise until the employees took leave (or died or left the employment). The event on which the entitlement of the employees to payment depended had not occurred. There was a certainty that a liability to make payments in respect of leave would arise in the future, but it had not arisen. The present is not a case in which there was an immediate obligation to make payment in the future, or a defeasible obligation to pay, or a present obligation which as a matter of law was unenforceable – there was no accrued obligation to make any payment at all. There was no loss or outgoing 'incurred' within s 51(1)." 49 Nilsen is a strong authority in favour of a requirement that all the conditions of a pecuniary liability must exist by the end of the tax year if an outgoing, not yet paid, is to be "incurred" within that year. If the employees had sued the taxpayer for the amount of holiday pay it was later to claim as a deduction, they would not have been in a position to allege fulfilment of all the conditions of legal liability because they could not have alleged that the period of leave had been fixed and embarked upon. Likewise, if the present applicants' employees had sued on 1 January 1995 for the amount of the bonuses which were in fact paid to them later that month or for any other amounts of bonuses, they would have failed because they would not have been in a position to allege that by 31 December 1994, Merrill Lynch had: · completely subjected or definitively committed itself to pay bonuses to its employees; and · fixed the amounts of such bonuses or fixed an objective means by which those amounts could be estimated and were later to be determined (see [100]). Nilsen is a further authority for the proposition that the setting aside of a reserve by the taxpayer does not establish the incurring of the outgoing which the reserve exists to meet. 7. Federal Commissioner of Taxation v Australian Guarantee Corporation Ltd (1984) 2 FCR 483 ("AGC") 50 The issue in AGC was whether a borrower under a "deferred interest debenture" was entitled to a deduction under subs 51(1) for interest debited annually in its accounts. In its year of income ended 30 September 1978, the taxpayer issued such debentures with maturity dates some years later. They were issued at a stated rate of interest per year. By the terms of the debentures, payment of interest was not required until the debentures matured. Accordingly, all the elements of legal liability existed by the end of the tax year, but there was not at that time a presently enforceable cause of action for the whole of the interest, because the period of the debenture had not expired. 51 A Full Court of this Court decided that in accordance with the common law rule, the interest accrued from day to day and that the taxpayer was entitled to a deduction for the interest which had accrued during a tax year. 52 Merrill Lynch relies on the case for observations made by Toohey J in relation to both Nilsen (above) and Commissioner of Inland Revenue v Lo & Lo (a firm) (Privy Council, 26 March 1984, unreported) ("Lo"). Merrill Lynch submits that the distinction which Toohey J made between Nilsen on the one hand and both Lo and AGC on the other shows that the reason why the taxpayer failed in Nilsen is that the obligation was a non-pecuniary one, whereas it was a pecuniary one in both AGC and Lo (as is that suggested in the present case). 53 In Lo any member of staff who left the employment of a Hong Kong firm of solicitors after ten years' service was entitled to a lump sum payment calculated by multiplying the number of years' employment by half of the person's average monthly salary over the last twelve months of employment. In its return for the relevant year, the firm debited to its profit and loss account, not only sums paid to employees who had in fact retired during the year, but also a sum transferred to a reserve as "provision for staff retirement benefits". The sum transferred was based on a calculation of the total of the lump sum payments the firm might be obliged to pay other employees who had also completed the qualifying period but whose service continued. Their Lordships said that those employees already had a distinct right to payment of the retirement benefit upon doing no more than "giv[ing] a period of notice and pick[ing] up [their] money", and that the corollary was that the employer had an accrued liability to pay them. Toohey J stated (at 491) that for the purposes of the case before the Full Court, Lo was useful in "the contrast it provides with Nilsen's case and in the emphasis it places upon a liability which has accrued even though it may not be payable for some time". His Honour continued (also at 491) as follows: "Nilsen's case stresses the need for a presently existing liability before there can be an outgoing incurred within s 51. But the case is distinguishable from the matter now before this court. It was concerned with the entitlement of employees to long service and annual leave and the obligation of the taxpayer to pay employees during the period of such leave. The employees were not entitled to the payment of money in the sense in which, as mentioned, the employees in Lo's case were entitled to payment. In Nilsen's case there was no accruing liability on the part of the employer, simply an obligation to pay wages when employees became entitled to and took leave. In the case now under appeal the taxpayer's obligation to pay interest under deferred debentures arose when the debentures were issued though subsequent events would determine the precise amount of interest to be paid." 54 Nilsen was distinguishable from both Lo and AGC, but so, in my view, is the present case. Unlike the employees in Lo, the applicants' employees were not, during the tax year, entitled unilaterally to enliven a pecuniary liability of their employer to pay bonuses to them by doing no more than demanding payment. And unlike the debenture holders in AGC, they could not say that all the conditions of a legal liability to them, other than the effluxion of time, had occurred by the end of the tax year. Merrill Lynch had not, by that time: · completely subjected or definitively committed itself to pay bonuses to its employees; and · fixed the amounts of such bonuses or fixed an objective means by which those amounts could be estimated and were later to be determined (see [100]). 8. Hooker Rex Pty Ltd v Federal Commissioner of Taxation (1988) 79 ALR 181 ("Hooker Rex") 55 The issue in Hooker Rex was whether amounts which a taxpayer became liable to pay under "guarantees" given by it were deductible in the tax year in which they were given (as the taxpayer contended) or in a later tax year in which demand and payment were made. A Full Court of this Court held that liability was not "incurred" during the tax year. Sweeney and Gummow JJ observed (at 191), referring to passages in James Flood and Nilsen, that: "It was said 50 years ago, and remains true, that it is unsafe to attempt exhaustive definitions of a term such as 'incurred' in s 51(1) of the Act: New Zealand Flax Investments Ltd v FCT (1938) 61 CLR 179 at 207, per Dixon J. Certainly, a liability which is due in one year may be 'incurred' in that year, although it is paid in a later year. But a loss or expenditure is not ' incurred' in the necessary sense if it is no more than contingent, pending, threatened or expected, no matter how certain it is in the year of income that the loss or expenditure will occur in the future:…" Their Honours described the guarantees as giving rise to expenditures which were, in the tax year, only "threatened or contingent" (also at 191). 9. Ogilvy and Mather Pty Ltd v Federal Commissioner of Taxation (1990) 95 ALR 663 ("Ogilvy and Mather") 56 Merrill Lynch relies on Ogilvy and Mather, and, in particular, on the sixth of seven propositions which Hill J extracted in that case from the earlier authorities. His Honour decided the question of deductibility against the taxpayer by reference to his view that, whenever it was "incurred", the outgoing in question was a matter of capital. Sweeney and Ryan JJ held, however, in a joint judgment, that it was not incurred during the tax year. 57 The taxpayer was an advertising agency which reserved space in newspapers and periodicals and time on radio stations and television channels for its clients' advertisements. Many proprietors of these media were members of the Media Council of Australia or had otherwise agreed to be bound by rules promulgated by that Council. Those rules provided for the accreditation of advertising agencies and for the terms of payment for advertising placed by them. A rule provided that an accredited agent was liable for payment and that payment was due not later than the thirtieth day of the month following that of the advertising. The rules also provided that if payment was not made on or before the fifteenth day of the second month following that of the advertising, no commission should be allowed by the media proprietor to the accredited agent. The primary Judge referred to a recognition of "non-cancellation periods". In substance, his Honour found that withdrawal by an accredited agency of an advertisement within a specified number of days before the agreed date of publication did not relieve it from the obligation to pay. Relevantly, the taxpayer claimed as an allowable deduction the price of advertising orders whose non-cancellation period had commenced before the end of the year of income, although publication did not occur until after the end of that year. 58 Sweeney and Ryan JJ held that "a liability did not attach" to the taxpayer until the relevant advertisement had been published or the time or space had been made available for its publication on the agreed date. Their Honours said (at 674) that the effect of the commencement of a "non-cancellation period" was to preclude the taxpayer from unilaterally avoiding the obligation to pay for the advertisement, but that this was not to say that the liability was "incurred" in the sense that the taxpayer was "definitively committed" to discharging it once the non-cancellation period commenced. Their Honours continued (at 674-675): "… it was publication of the advertisement which definitively committed the agency to the liability, even though payment was not due ... until the thirtieth day of the month following that in which the advertising was published, broadcast or telecast. In the language used in FCT v James Flood Pty Ltd it was not until publication that there arose a debitum in praesenti solvendum in futuro, ie by the thirtieth day of the succeeding month." Their Honours said (at 677): "…the agent's obligation to pay … did not attach at the commencement of the non-cancellation period. At that time, in our view, the agent had not completely subjected itself to the liability in the sense that 'payment was a matter of commercial certainty and was not subject to any contingency which would be regarded as such in the world of ordinary business affairs': Commercial Union Assurance Co of Australia Ltd v FCT (1977) 14 ALR 651; 32 FLR 32 at 43. Here payment depended on more than the mere effluxion of time from the commencement of the non-cancellation period." 59 Hill J stated (at 700-701) the following seven propositions as propositions which could be taken to have been accepted in the authorities: "(1) An outgoing may be incurred notwithstanding the amount is not paid in the year of income provided the taxpayer has 'completely subjected himself' to that liability: Flood's case, …, at 507. (2) An outgoing may be incurred notwithstanding that at the end of the year of income it represents a present liability then due although payable in the future: FCT v Australian Guarantee Corp (1984) 2 FCR 483; 54 ALR 209. (3) An outgoing not representing a pecuniary liability of the year of income will not be incurred, notwithstanding that it is certain that the outgoing will arise as a pecuniary liability in the future: FCT v James Flood Pty Ltd and Nilsen Development Laboratories Pty Ltd v FCT, …. (4) A reasonable estimate of an outgoing payable in the future where the amount of that outgoing cannot be ascertained with precision at the end of the year of income will be incurred where it represents a pecuniary liability encountered in the year of income but provided it is capable of reasonable estimation. The amount will not be incurred in the year in which the precise quantum of the liability is ascertained: RACV Insurance Pty Ltd v FCT, …; Commercial Union Assurance Co of Australia Ltd v FCT, …, and Commonwealth Aluminium Corp Ltd v FCT, …. (5) An outgoing may be incurred in the year of income, notwithstanding that it is defeasible: Flood's case at 506-7. (6) An outgoing may be incurred notwithstanding that there is no legal liability to make payment at all at least where commercially that amount is certain to be paid in the future, provided that it is otherwise 'incurred': Commercial Union case. (7) An outgoing will not be incurred in the year of income where it is no more than contingent, pending, threatened or expected no matter how certain it may be in the year of income that the loss or expenditure will occur in the future: Flood's case at 507-8; Hooker Rex Pty Ltd v FCT [88 ATC 4392] at 4400." 60 The Commissioner submits that the sixth proposition "overstates" the position and that there must be in place by the end of the tax year a legal liability to pay, even though the amount is not then known. This submission calls for consideration of Commercial Union cited by Hill J in support of his sixth proposition. 61 In Commercial Union Newton J observed that the taxpayer was under a legal liability to indemnify the insured unless it should choose to raise the defence of breach of the notification condition. If the taxpayer raised that defence, there would, as Hill J has said, be "no legal liability to make payment at all". As noted earlier, the reference to the notion of commercial certainty in the Commercial Union case was a reference to the commercial certainty that the taxpayer would not raise the defence. In my opinion, Hill J intended by his sixth proposition to do no more than to indicate his acceptance of the correctness of Commercial Union and to summarise its effect. It is plain, to my mind, that his Honour was concerned in his sixth proposition to distinguish between cases in which, by tax year's end, it was certain that there was a legal liability to make payment of some amount but the amount could only be estimated, and other cases in which it might transpire later that there was "no legal liability to make payment at all", of which Commercial Union is the illustration cited. Another illustration might be found in an executory agreement made during the tax year under which the other party defaulted after the end of that year, relieving the taxpayer of an otherwise unconditional obligation to pay. 10. Coles Myer Finance Ltd v Commissioner of Taxation (1993) 176 CLR 640("Coles Myer") 62 In Coles Myer the taxpayer acted as financier to the Coles Myer group of companies. It raised finance from various sources. During the tax year ended 30 June 1984, it drew and sold at less than their face values, both bills of exchange and promissory notes. Most were drawn and paid within the tax year, but the case concerned those which, though so drawn, had not been paid by the end of that year. Bills of exchange having a face value of $70 million were then outstanding. The taxpayer had discounted them by way of sale during the tax year for $67,624,421. The face value of the outstanding promissory notes was $40 million and they had been discounted by way of sale during the tax year for $37,640,106. In its return of income, the taxpayer claimed to deduct the differences between the face values and sale prices - $2,375,579 for the bills and $2,359,893 for the notes. 63 The Commissioner disallowed the claim on the basis that no relevant loss or expenditure was incurred until the instruments were paid out in the following tax year. The taxpayer contended that the relevant loss or expenditure was incurred when it drew the bills and issued the notes, because it then incurred a liability to pay their full face value, even though the date for payment lay in the future. The High Court agreed with the taxpayer that legal liability, albeit to pay upon maturity, was incurred when the taxpayer accepted the bills or received payment upon sale of the promissory notes, that is to say, during the tax year. 64 In their joint judgment, Mason CJ, Brennan, Dawson, Toohey and Gaudron JJ stated (at 661-662) as follows: "In Flood, the Court pointed out that, for a deduction to fall within s 51(1), a taxpayer need not have 'come under an immediate obligation enforceable at law whether payable presently or at a future time' [(1953) 88 CLR 492 at 506]. But this statement must be understood in the light of the decision in that case. The Court held that the employees' annual holiday leave was not deductible expense. That was because [(1953) 88 CLR 492 at 507-508]: '[i]n respect of those employees there was no debitum in praesenti solvendum in futuro. There was not an accrued obligation, whether absolute or defeasible. There was at best an inchoate liability in process of accrual but subject to a variety of contingencies.' The event on which the entitlement of the employees depended had not occurred. Flood therefore stands as authority for the proposition that a liability must presently be existing in order to be 'incurred' within the meaning of s 51(1)" (my emphasis) 65 Their Honours continued by noting (at 662) that it was also accepted in Nilsen that a liability must be presently existing in order to be "incurred" within the meaning of subs 51(1), and that in both Flood and Nilsen the Court "accepted the legal or jurisprudential analysis rather than the commercial view as the correct one". Finally, their Honours said (at 662-663): "No doubt as a consequence of the Court's adoption of the legal or jurisprudential analysis in determining entitlements to a deduction under s 51(1) in preference to the commercial view, the parties did not contend in the present case for a different approach to the question." 66 The above passages are strong statements in favour of the view that the essential elements of legal liability must exist by the end of the tax year, even if, as Merrill Lynch submits, there was no suggestion in Coles Myer itself that they did not exist by then. 67 Deane J said he was in general agreement with their Honours' reasons. However, his Honour stated (at 670) as follows: "It does not follow from those cases, however, that the fact that jurisprudential analysis discloses that a particular liability to make a future payment of money is contingent necessarily means that such a contingent liability cannot constitute or found a 'loss or outgoing' which has been 'incurred' for the purposes of s 51(1). To the contrary, the weight of authority supports the conclusion that, depending upon the circumstances, a liability to pay money can constitute, or give rise to, a 'loss or outgoing' which is 'incurred' within the meaning of that sub-section notwithstanding that the money is not payable until a future time [See, eg., Federal Commission of Taxation v James Flood Pty Ltd (1953), 88 CLR, at p 506] and that the obligation to pay it is theoretically defeasible [See, eg., Federal Commission of Taxation v James Flood Pty Ltd (1953), 88 CLR, at p 506] or contingent [See, eg., Commercial Union Assurance Co of Australia Ltd v Federal Commissioner of Taxation (1977), 32 FLR 32, at pp 42-43;…Texas Co (Australasia) Ltd v Federal Commissioner of Taxation (1940), 63 CLR 382] in that it is subject to a condition which remains unfulfilled." 68 Later (at 671), Deane J stated that "the fact that a liability to make a future payment is theoretically contingent or defeasible is a relevant consideration" but is not itself decisive against deductibility, unless the contingency or defeasibility precludes the liability from constituting a "loss or outgoing" which has been "incurred" in the sense explained by Dixon J in New Zealand Flax. (His Honour's formulation of a "theoretically contingent" liability was referred to with approval by the Privy Council in Commissioner of Inland Revenue v Mitsubishi Motors New Zealand Ltd [1996] 1 AC 315 at 327.) 11. Commissioner of Taxation v Woolcombers (WA) Pty Ltd (1993) 47 FCR 561 ("Woolcombers") 69 The taxpayer was a wool trader which entered into forward contracts to purchase wool shorn or to be shorn from all the sheep on the sellers' property at the time of the signing of the contract. The purchase price was fixed at the time of contract, although a minority were variable price contracts. Property in the wool was to pass when payment was made, which was to occur after delivery. The woolgrowers agreed to indemnify the taxpayer for loss or damage suffered by a failure to deliver by the agreed date or to deliver wool in the warranted condition. 70 In the tax year ended 30 June 1988 the taxpayer claimed as a deduction the estimated amount of the payment which it would later be required to make under the forward contracts which it had entered into in that year. A Full Court of this Court held that on the proper analysis of the contract, there was an accrued obligation or present liability imposed on the taxpayer by a definite contractual commitment, and, therefore, that an outgoing was incurred during the tax year. The Court also held that there was no occasion for apportionment (the correctness of this holding was later questioned by Hill J in Commissioner of Taxation v Mercantile Mutual Insurance (Workers' Compensation) Ltd (1999) 87 FCR 536 (FC) at 554). 12. Australia and New Zealand Banking Group Ltd v Commissioner of Taxation (1994) 48 FCR 268 ("ANZ" – special leave to appeal refused on 16 September 1994: (1994) 18 Leg Rep SL2) 71 The taxpayer bank was a self insurer in respect of its obligations under the Accident Compensation Act 1985 (Vic). A Full Court of this Court held that its Workcare liabilities under that Act were incurred when the obligation to make payments commenced, whether the liability was to make lump sum or periodical payments. The Court followed RACV in holding that the deductible amount need not be ascertained and that a reasonable or realistic estimate suffices, even if it is later shown to be wrong. Hill J, with whom Northrop J and Lockhart J agreed, stated (at 276) that "[t]he analysis of whether a liability has been incurred is a legal or jurisprudential, rather than a mere accounting or commercial analysis", and (at 278): "The loss or outgoing must represent a present liability, albeit not immediately payable but payable in the future, and whether or not defeasible [His Honour referred to Nilsen at 627-628 per Gibbs J, and AGC at 486-487 per Toohey J]." (my emphasis) His Honour added (also at 278): "The insurance cases, to which reference has already been made, as well as the decision of the Supreme Court of Victoria in Commonwealth Aluminium Corporation v Commissioner of Taxation (Cth) …, make it quite clear that it is irrelevant that the quantum of a loss or outgoing can not be precisely ascertained for the liability to be incurred in the year of income. It is sufficient if that liability be capable of reasonable estimation." (my emphasis) Finally, his Honour said (at 279): "Unlike the case in Nilsen there exists from the moment that an employee has suffered an injury in the course of his or her employment, a presently existing liability to make payments in the future. Such a liability, while perhaps in one sense defeasible, is nevertheless a liability incurred within the meaning of s 51(1)." (my emphasis) 72 Clearly his Honour accepted that "present legal liability" provided the test in the case before the Court of whether and when a loss or outgoing is "incurred" for the purposes of subs 51(1) of the Act. 73 His Honour referred to his discussion of the relevance of accounting evidence to questions under the Act in Ogilvy and Mather and in Federal Commissioner of Taxation v Citibank Ltd (1993) 44 FCR 434. In the latter case his Honour had said (at 444), in a judgment in which Jenkinson and Einfeld JJ agreed: "Accounting evidence may ... have particular significance in determining the timing of a deduction, that is to say not whether it is incurred, but whether it is incurred in respect of a year of income [his Honour referred to New Zealand Flax at 193 per Rich J and 208 per Dixon J as well as the orders made in that case, and AGC at 492-493 per Toohey J]." (my emphasis) 74 It is clear that Hill J saw no inconsistency between his sixth proposition in Ogilvy and Mather and his recognition that in the case before the Court, that an application of the legal or jurisprudential approach, mandated by the authorities, required that there be an existing legal liability before it could be said that a loss or outgoing was incurred for the purposes of subs 51(1) of the Act. 13. Commissioner of Taxation v Mercantile Mutual Insurance (Workers' Compensation) Ltd (1999) 87 FCR 536 ("Mercantile Mutual") 75 The taxpayer wrote employers' liability insurance. It had an accounting period ending on 30 September each year. It incurred liabilities, some of which would not be settled until after the tax year. Its practice was to calculate, on an accrual basis, the actual money amount likely to be paid by it in future years in settlement of the claims. This was described as the "inflated (undiscounted)" amount, but to allow for contingencies a "safety or prudential margin" was incorporated, being, in substance, an estimate of the value of uncertainty. It was common ground that the taxpayer was entitled to a deduction in the tax year: the dispute was over the amount. 76 The Full Court held that the taxpayer was entitled to the deduction claimed and that no error was shown in the primary Judge's treatment of the evidence as to the proper method of estimation. 77 Although the reasons for judgment were chiefly concerned with the issue of quantum, of significance for present purposes are certain observations made by Hill J relating to the test of deductibility. His Honour stated (at [13]): "It was not a prerequisite to deductibility that the insurer be under a legal obligation to pay enforceable by law. It sufficed that the taxpayer had in the year of income been subjected to the liability and had thus incurred it: cf Commissioner of Taxation (Cth) v James Flood Pty Ltd (1953) 88 CLR 492 at 506." 78 His Honour distinguished in this passage between "subjection to liability" which must exist by the end of the tax year and a "legal obligation to pay [immediately] enforceable at law" which need not exist by that time. Later (at [41]-[42]) his Honour referred to the authorities on the question when an outgoing is incurred. After noting that the Australian authorities had adopted "a legal or jurisprudential analysis ... in preference to a commercial test", his Honour stated (at [43]-[44]) as follows: "It was pointed out in James Flood at 506 that it was not a necessary precondition to a deduction that the taxpayer have an immediate obligation enforceable at law whether payable presently or at a future time. That comment must, as the High Court in Coles Myer observed, be read against the question which fell for decision in that case: see at 661-662. It is, however, necessary that a liability must be 'presently existing' before, in the relevant sense, it is incurred. (Subject to Coles Myer, discussed later, the discussion of the meaning of 'incurred' in Ogilvy & Mather Pty Ltd v Commissioner of Taxation (Cth) (1990) 95 ALR 663 in my view correctly summarises the principles which have been adopted in determining when a loss or outgoing is incurred.) There is no doubt that once an event insured against has happened (and I put to one side matters of notice and the like which may affect the generality of what is here said), the insurer comes under a legal liability to pay money to the policy holder. That legal liability is encountered the moment the event insured against happens. It is in all respects a presently existing liability, and for this purpose it matters not that the liability falls to be discharged in the future. There is no difference for this purpose between the liability of an insurer to pay money in the future in settlement of a claim and the obligation of any other taxpayer who falls under a legal liability to pay money in the future. Contrary to the Commissioner's submission, there is no gap in time between the event insured against and the liability to pay. There is a presently existing liability to pay moneys in the future, which liability, like the event which gives rise to it, occurs in the year of income." (my emphasis) (At [54]-[69] his Honour discussed Coles Myer in some detail and was "prepared [in the case before the Court] to accept" that the general principle that to be "incurred" an outgoing must be referable to the year in which the liability is incurred, applies to losses as well as to outgoings. As noted earlier, there is no issue as to referability of the bonuses to the 1994 year in the present case.) 79 Again, the passage emphasised by me indicates that Hill J saw no inconsistency between his sixth proposition in Ogilvy and Mather and an application of the "legal" or "jurisprudential" test leading to a requirement that there be, by the end of the tax year, a presently existing legal liability. Conclusion – "legal liability" or "commercial certainty" 80 It is not questioned, and on the authorities could not have been questioned, that in order for the applicants to have "incurred" by 31 December 1994 the outgoing represented by payment of the bonuses: · the applicants must have completely subjected or definitively committed themselves by that time to pay bonuses to their employees; or · that in resolving this question, a "legal" or "jurisprudential" approach must be pursued. The only relevant "commitment" in this case is one to each individual employee, not, for example, a "commitment to itself" which Merrill Lynch may be suggested to have made by the progressive accrual in its accounts of the reserve to meet bonuses. The two considerations mentioned above lead to the conclusion that in order to come within subs 51(1), the applicants must, by 31 December 1994, have incurred a legal liability to the individual employees to pay bonuses to them. 81 Moreover, in my view the authorities discussed above establish that, in order for an outgoing which is in fact paid after an accounting period to have been "incurred" within it, there must, subject to certain matters, exist by the end of that period a legal liability to pay it. 82 I will not profess to state the "matters" referred to exhaustively: to do so is to run the danger, cautioned against as early as in New Zealand Flax, of assaying an exhaustive definition of "incurred" in the present context. What is important for the decision of this case is the general requirement that, "theoretical contingencies disregarded", there must be a legal liability which the taxpayer is not entitled, of its own volition, to prevent becoming enforceable by action. 83 The cases discussed show that deductibility is not denied: · only because the quantum of the outgoing is not ascertained, and can only be estimated, at the end of the tax year (RACV; Commonwealth Aluminium; Commercial Union; Coles Myer; Woolcombers; ANZ; Mercantile Mutual); · only because the taxpayer has an available defence to an action in respect of the outgoing if the defence can, and certainly would, be waived by the taxpayer (Commercial Union; and cf Coles Myer per Deane J); · only because the liability is defeasible (James Flood); or · only because the legal liability is not yet "an immediate obligation enforceable at law" (James Flood; Commercial Union). Did THE APPLICANTS BECOME SUBJECT, BY 31 December 1994, TO a legal liability to pay the bonuses? 84 In my opinion, the answer to this question is "no". 85 The gravamen of the applicants' submission in support of an affirmative answer can be understood from the first four paragraphs of the relevant part of their written submissions. Those paragraphs are as follows: "The obligation to pay the bonuses was enforceable at law 29. Although the bonus schemes reserved to the Applicants a discretion as to the amount paid to any employee, the Applicants had an obligation throughout the 1994 year to exercise that discretion both in good faith and reasonably: Carr v McDonald's Australia Ltd [(1994) 63 FCR 358 at 372-373 approving Greenberg v Meffert (1985) 18 DLR (4th) 548 (an application for special leave to the Supreme Court of Canada was dismissed (1985) 30 DLR (4th) 768) where an employee's entitlement to a commission was at the 'sole discretion' of his employer but it was held that the employer must exercise the discretion reasonably (by reference to objective and not subjective standards), honestly and in good faith; see also Service Station Association Limited v Berg Bennett & Associates Pty Limited (1993) 45 FCR 84 at 94; Amann Aviation Pty Ltd v Commonwealth of Australia (1990) 22 FCR 527 at 532 per Davies J and 542 per Sheppard J; on appeal The Commonwealth v Amann Pty Ltd (1991) 174 CLR 64 at 96 per Mason CJ and Dawson J; Renard Constructions (ME) Pty Limited v Minister for Public Works (1991) 26 NSWLR 234 at 268 per Priestly JA and at 279-280 per Handley JA; Castlemaine Tooheys Limited v Carlton & United Breweries Limited (1987) 10 NSWLR 460 at 487]. Indeed, this obligation to act in good faith and reasonably in exercising the discretion can be seen as based on a fiduciary obligation arising out of the special position of vulnerability of employees in respect of the exercise of MLA's discretion [Hospital Products Limited v United States Surgical Corporation (1984) 156 CLR 41 at 97; Concut Pty Ltd v Worrell (2000) 75 ALJR 312 paras 17, 23 and 51 (third proposition)]. 30. Further, and independently of that obligation, the employees of the Applicants in New South Wales were entitled to bring proceedings under former s 275 of the Industrial Relations Act 1991 (NSW) in the event that the Applicants administered the bonus schemes unfairly. That Act was repealed in 1996 by the Industrial Relations Act 1996 (NSW) which includes in ss 105 and 106 of that Act provisions which substantially re-enact former s 275. Former s 275(1) provided relevantly as follows: '(1) The Industrial Court may make an order declaring wholly or partly void, or varying, either from its commencement or from some other time, any contract or arrangement or any related condition or collateral arrangement under which a person performs work in any industry if the Industrial Court finds that the contract or arrangement or any related condition or collateral arrangement: (a) is unfair; or (b) is harsh or unconscionable; or (c) is against the public interest; or (d) provides or has provided a total remuneration less than a person performing the work would have received as an employee performing the work ...' 31. The evidence establishes that the bonus schemes were an integral part of the basis on which the Applicants remunerated their employees. As a consequence, participation in the relevant bonus schemes formed, at the very least, a related condition of or a collateral arrangement for the purposes of both s 106 of the Industrial Relations Act 1996 and former s 275 of the Industrial Relations Act 1991: Moray Vincent v Merrill Lynch Australia Pty Ltd [[2000] NSW IRComm 160 at para 101; see also Daley v New South Wales Rugby League Ltd (1995) 78 IR 247 at 278-280]. 32. Unfairness may arise either from the terms of the contract or arrangement itself (or any related condition or collateral arrangement), the surrounding circumstances or the manner of performance or operation of the contract [Daley v New South Wales Rugby League Ltd (1995) 78 IR 247 at 287 citing Incitec v Industrial Court of New South Wales (1992) 45 IR 143 at 146]. Unfairness in this context is determined according to 'the common sense approach characteristic of the ordinary juryman ... It is a plain matter of morals not law [ibid at 287]." 86 The applicants' submissions proceeded with an account of Vincent v Merrill Lynch Australia Pty Ltd [2000] NSWIRComm 160 ("Vincent"). The applicants contended that they "were under an obligation in 1994 to exercise their discretion in relation to the bonus schemes in accordance with ordinary standards of fairness", that if they failed to do so an employee would have been entitled to bring a proceeding under the former s 275 of the Industrial Relations Act 1991 (NSW),and that the Industrial Relations Commission of New South Wales "would have been likely to intervene to require payment of a bonus". 87 In Vincent, Moray Vincent applied under s 106 of the Industrial Relations Act 1996 (NSW) for relief against MLA in respect of his contract of employment with that company. On 26 October 1995 he had signed a letter of engagement by MLA as a junior trader. He was entitled to participate in the VICP. The letter of engagement provided for payment of bonuses to be at the complete discretion of MLA and for termination of the employment by either party's giving thirty days' written notice of termination or payment in lieu of notice. 88 In January 1996 Mr Vincent was paid a bonus of US$20,000. In November 1996 he was promoted to the position of "Assistant Vice President". In January 1997 he was paid a bonus of US$120,000 in respect of the 1996 year. 89 In 1997, Mr Vincent became Head of the Credit Trading Bank. In July 1997 his salary package was increased from $83,000 to $103,000. 90 In January 1998 Mr Vincent received a bonus of US$120,000 for the 1997 year. During 1998 he was promoted from Assistant Vice President to "Vice President" and his salary was increased from $103,000 to $115,000. 91 During 1998, Mr Vincent encountered difficulties, which I need not discuss, at MLA. On 14 October 1998 he was told that he was being made redundant, was required to leave MLA's employment that day, and was offered a redundancy package of one month's pay in lieu of notice, five months' pay as a "redundancy package" (both calculated on his salary package of $115,000), and a "1998 bonus" of US$36,000, which was said to have been calculated as a percentage of his 1997 VICP bonus. 92 In the Industrial Relations Commission of New South Wales Marks J found the contract to be unfair because, although the bonus was an integral part of Mr Vincent's remuneration, his employment could be terminated for redundancy without his being entitled to any bonus. His Honour made the following orders: "1. I declare so much of the contract of employment between the applicant and the respondent which allowed for termination by the respondent upon giving 30 days' notice to the applicant to be void. 2. The respondent is to pay the applicant an amount calculated by reference to six months pay in lieu of notice based on an annual salary package of $115,000 and annual putative bonus for 1998 of US$100,000. 3. The contract of employment made on 26 October 1995 between the applicant and the respondent is varied from its commencement by inserting the following provision, namely: Provided that in the event your employment is terminated by Merrill Lynch Australia Pty Ltd by reason of redundancy you will be entitled to the payment of an amount assessed to the best of the ability of Merrill Lynch Australia Pty Ltd being such proportion of the bonus which would become payable referable to the relevant year in which termination is effected as bears to that part of that year during which you were employed. 4. The respondent shall pay to the applicant that part of US$100,000 that the number of days between 1 January 1998 and 14 October 1998 inclusive bears to 365 days. 5. The conversion rate for the calculation of the Australian dollar equivalent to the amounts expressed in US$ shall be that applied by National Australia Bank Ltd on 14 October 1998. [There followed orders for payment by MLA to Mr Vincent of interest and costs.]" 93 In my opinion, a requirement that by tax year's end there be in place a legal liability to pay an outgoing is not satisfied by the existence at that time of a likelihood that an employee will, if he or she makes an application, obtain relief from the Commission. Jurisprudential or legal analysis, which the authorities require, exposes a clear distinction between a legal right to be paid a bonus and the corresponding legal obligation to pay one on the one hand, and standing to apply for a discretionary remedy on the other. Even if it were very likely by the end of the tax year that a discretionary remedy would be granted if applied for, this is at most "commercial certainty", and commercial certainty is distinct from a legal liability to pay, in respect of which there is an entitlement to a curial remedy as of right. This distinction was recognised in Vincent itself, when Marks J found unfairness in the fact that MLA was entitled to terminate Mr Vincent's employment for redundancy without paying him a bonus. (A further difficulty with the applicants' submission is that it assumes, without discussion or elaboration, that the New South Wales statutory provision was available to all the applicants' employees throughout Australia.) 94 Separately from the statutory provision, the applicants rely on an implied contractual obligation of reasonableness, good faith and fair dealing. Whether under Australian law such a contractual obligation is to be implied has been much discussed in the cases and in extra-curial writings in recent years: cf Renard Constructions (ME) Pty Ltd v Minister for Public Works (1992) 26 NSWLR 234 (CA) esp per Priestley JA; Hughes Aircraft Systems International v Airservices Australia (1997) 76 FCR 151 (Finn J) at 188-198; Alcatel Australia Ltd v Scarcella (1998) 44 NSWLR 349 (CA) at 363-369 per Sheller JA, with whom Powell and Beazley JJA agreed; Burger King Corporation v Hungry Jacks Pty Ltd [2001] NSWCA 187 at [141]-[187]; the most recent academic discussion seems to be that of Elisabeth Peden in "Incorporating Terms of Good Faith in Contract Law in Australia" (2001) 23 Syd L Rev 222. 95 It is not necessary for me to decide whether it was an implied term of all the contracts of employment between the applicants and their respective employees that the applicants would act reasonably, fairly and in good faith in relation to the discretion to pay a bonus. I will assume that it was. Nonetheless, the existence of the term would not have produced the result that by 31 December 1994 the applicants were liable to pay bonuses to their employees. 96 Under the general law, the curial remedies for breach of contract are unliquidated damages and the discretionary remedy of specific performance. Neither remedy can be equated with the existence by 31 December 1994 of a legal liability of the applicants to pay bonuses to their respective individual employees, let alone a legal liability to pay bonuses in the amounts which were in fact paid to them in late January 1995. 97 Quite apart from the issue of quantification, legal liability to pay an outgoing of a certain description is conceptually distinct from a liability in damages for breach of contract. A contractual promise "to pay a bonus" is conceptually distinct from a contractual promise to exercise a contractual discretion reasonably, fairly and in good faith. In my opinion, at least the former would have to be found before it could be concluded that the applicants had completely subjected and definitively committed themselves to pay the outgoings sought to be deducted in the present case. 98 The significance of the distinction of principle is highlighted by the following considerations. The circumstances of the employees no doubt varied greatly. Some, such as newly engaged employees, would not have received a bonus from Merrill Lynch previously. Therefore, unlike Mr Vincent in the case referred to above, they could not sustain a claim based on the fact or amount of payment in the immediately preceding year. Some may have been paid base salaries equal to the market remuneration being paid to persons in their positions. Others may have been paid base salaries which fell below market remuneration for the positions held to varying extents and it can not be assumed that the aggregate of all the shortfalls would have been equal to the aggregate amount paid in late January 1995. The point is that in the absence of evidence of the circumstances touching each employee, we do not know the significance of all the hypothetical proceedings for general damages or for specific performance for breach of the supposed implied obligation. 99 I have concluded above that there was not a legal liability to pay bonuses and therefore no incurring, by 31 December 1994, of the outgoing claimed. I would have reached that conclusion even if Merrill Lynch had, without more, determined, for its own purposes, upon the amounts of the bonuses by 31 December 1994, or if the fact that it had not done so meant that the case fell into the same category as RACV or Commercial Union, for example. 100 But in my opinion the present case does not belong to the same category as those cases in any event, because the amounts of the bonuses payable were inherently incapable of independent "ascertainment" and were not, at the end of the tax year, capable of being "estimated", in the sense in which those terms are used in the authorities. In the insurance cases mentioned, the taxpayers had promised to indemnify their insureds, and it was possible, by reference to objective criteria, for a court to determine the money amount which that promise required the taxpayers to pay and for an estimate to be made of that amount at tax year's end. The present case is different. The problem is not, as it was in RACV for example, simply that the amount required to be paid had not been ascertained by 31 December 1994. Even if the applicants had promised to pay their employees "a bonus", the amount of it would have been inherently incapable of "ascertainment" or of "estimation" because the exercise by Merrill Lynch of its discretion was an essential step in the process of the determination of the amount. 101 This is a further reason why the applicants did not, by 31 December 1994, incur the outgoing for which they claim a deduction. CONCLUSION 102 For the above reasons the application in each of the three matters should be dismissed with costs. I certify that the preceding one hundred and two (102) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Lindgren. Associate: Dated: 17 August 2001 Counsel for the Applicants: A H Slater QC and M Richmond Solicitor for the Applicants: Allen Allen & Hemsley Counsel for the Respondent: D H Bloom QC, S J Gageler SC and S J McMillan Solicitor for the Respondent: Australian Government Solicitor Dates of Hearing: 18, 19 June 2001 Date of Last Submission Received: 25 June 2001 Date of Judgment: 17 August 2001