The Acting Commissioner of Taxation has forwarded the following memorandum for advice:

I should be glad if you would favour me with your opinion on the following case:

In the year 1901 Mr A.B., General Manager of Gordon & Gotch Pty Ltd, Melbourne, threatened to resign his position and start in opposition. To prevent this, the Company entered into an agreement which provided that Mr B. should, subject to the right to resign and the Company's right to dismiss him on certain conditions, hold his office for life and be paid at least £780 per annum, plus a percentage of profits if they exceeded 10% on capital.

Mr B. agreed that so long as the Company carried out its obligations he would not take part in opposition business.

The Company had power at any time after 1 January 1909 to terminate the agreement upon payment of an annuity of £375 for life. The agreement was terminated under this clause on 10 February 1909.

The Company claimed the payment of £375 to Mr B. as a deduction from their income, but the Department has disallowed it.

The Solicitors for the Company contend that the expenditure in question was in fact incurred in gaining the gross income, their argument being that had the Company not entered into the agreement in question its gross income would have been adversely affected.

On the point of whether an annuity payable to an ex-employee is an allowable deduction they quoted the decision in the English case Royal Insurance Co. v. Watson [1897] A.C.I, with special reference to the judgment of Lord Shand. In his judgment Lord Shand stated [at p. 9]:

... if this had been a case of a voluntary agreement between the manager of an insurance company and the company for the payment to him of a salary for so many years, to last for a definite time, but with power to the company at any time they might think fit to terminate the service by making the payment at once of a capital sum, I think there would have been much force in the argument that such a payment might properly form a deduction from gross profits in striking the balance liable to income tax; and I should make the same observation as to a case in which there has been wrongful dismissal of a person having an engagement for a term of years, and who succeeds in obtaining damages on that account.

The Solicitors also contended that the decisions of the English courts quoted by Palmer, under which a company may pay pensions as a stimulus to its staff to increased productiveness, show that these payments are in reality outgoings incurred in the production of income.

They claim that this position exists in the present case, notwithstanding that the payment is made under a written contract.

In connection with Lord Shand's judgment it might be pointed out that the wording of the English and the Federal laws differs very materially. In the former the duty is to be computed on a sum not less than the full amount of the balance of the profits or gains of a trade. In estimating the balance of profits or gains the only items specifically excluded are (1) money employed as capital (2) disbursements not being money wholly and exclusively laid out or expended for the purposes of such trade, etc. In view of the words [emphasised] it is clear that an outgoing which is not allowable as a deduction under the Federal Act may be deductible under the English law.

The Federal law only permits deductions of losses and outgoings incurred in producing the assessable income of the year. This pension was not expended to produce the assessable income. It is merely paid in fulfilment of a covenant made some years ago with a person then to be employed, but not now employed.

The view taken by the Department is that the Company purchased a business asset in the form of freedom from competition from a business that might have been established by Mr B., after the termination of his active employment with the Company. The purchase price of this asset was fixed as an annuity of £375.

In all cases . . . [of] the purchase of a capital asset in consideration of the payment of an annuity to the vendor the Department holds that the annuity is an outgoing of capital, and therefore not deductible under section 18 (1) (a).

I agree with the Acting Commissioner that the annuity is not an expense or outgoing incurred in gaining or producing the assessable income within the meaning of section 18 (1) (a) of the Income Tax Assessment Act 1915-1916.

[Vol. 15, p. 267]