Reynolds v. Commissioner of State Taxation (W.A.).
86 ATC 4528
Supreme Court of Western Australia
Judgment date: Judgment handed down 7 August 1986.
Burt C.J.: Richard Malkin Bradley Reynolds - Mr Reynolds - is a legal practitioner and a member of the firm of Robinson Cox. He became a member of that firm on 15 December 1982 and as at the date of the deed to which reference will be made there were 96 shares or ``issued units'' in the partnership of which Mr Reynolds held ten.
There is no formal partnership agreement controlling the rights and obligations of the partners inter se but there is a document self-described as ``Notes on Conduct of Partnership'' which has achieved the same purpose the provisions of which relevant to this case being as follows:
- 1. The partnership is of indefinite duration and is not to be dissolved by death, retirement or expulsion of any partner nor by the assignment by any partner of his share or of ``any share'' in the partnership nor by the introduction of an additional partner.
- 2. The profit entitlement of a partner is to be determined by the number of ``units'' which he holds.
- 3. Each partner is to contribute $40,000 by way of capital ``which may vary from time to time in accordance with the actual requirements of the partnership''.
- 4. Upon retirement the retiring partner is entitled to ``have his capital returned to him and any balance in his current account paid out to him as he may agree with the Partners, or failing agreement over four years by equal monthly instalments together with interest at the rate being charged to the firm on its overdrafts by its bankers, with interest being calculated on quarterly rests. In the event of death or permanent disability of a Partner, the Partner or his Executors shall be entitled to repayment of his capital and income accounts upon receipt by the firm of the proceeds of the insurance policy held for that purpose by Clochmerle Pty. Ltd. as trustee for the continuing Partners''.
- 5. There is to be ``no item of goodwill in the partnership accounts'' and ``on leaving the partnership there is no goodwill payable''.
- 6. ``If a Partner is unable to work through sickness or injury, he will continue to be entitled to a share in the profits of the partnership and to drawings for a period of three months. At the end of that period, his drawings and profit entitlement shall be suspended until he can resume work. In respect of the period of any incapacity after three months, Partners should arrange disability income insurance. Premiums in respect of disability insurance will be paid by the firm and debited to the Partner's current account. In arranging disability income insurance preference is to be given to the scheme arranged by the Law Council of Australia.''
There are a number of other matters covered by the ``notes'' but they are of no relevance for present purposes.
By deed dated 3 December 1982 Mr Reynolds assigned to his wife, who is the appellant, ``on and with effect from 1 December 1982, twenty-five per cent (25%) of his share in the Partnership together with all those rights, including the right to receive an appropriate share of the profits of the Assignor to which an Assignee of a share in the Partnership is entitled by virtue of Section 42 of the Partnership Act 1895 to hold the assigned interest unto the Assignee absolutely''. A copy of that deed is annexed to these reasons.
This assignment was described in argument as an ``Everett scheme''. The deed is for all practical purposes in the same terms as the deed the effect of which was considered by the High Court in
F.C. of T. v. Everett 80 ATC 4076; (1980) 143 C.L.R. 440 and its evident purpose was that so much of the income as was to be attributable to the share in the partnership which Mr Reynolds had assigned to the appellant would not be his assessable income. It was, putting it bluntly, an income splitting scheme and on the authority of Everett's case it was effective to achieve that end.
86 ATC 4530
It was not suggested to me that the assignment was illegal. By sec. 79(4) of the Legal Practitioners Act:
``79. No certificated practitioner shall -
(4) except in accordance with rules made under section six of this Act, share with any person other than a certificated practitioner, or his executors or administrators, the whole or any part of the costs arising from or in connection with any act, matter, or thing which it is herein provided shall be done for profit by a certificated practitioner only.''
By sec. 6(1)(fa) of the Legal Practitioners Act:
``6(1) The Board may from time to time make all such rules as the Board may seem meet, -
- (fa) for prescribing the cases and conditions in which certificated practitioners may share the whole or any part of the costs referred to in paragraph (4) of section seventy-nine of this Act with persons other than certificated practitioners, or their executors or administrators.''
The Board has exercised that power by making rules which now stand as Pt XII of the Rules of the Barristers Board under the heading ``Sharing of Costs''. It is enough to reproduce r. 103(a) which is in these terms:
``Subject to the provisions of this Part, a certificated practitioner may share the whole or any portion of the costs referred to in paragraph (4) of Section 79 of the Act with any one or more of the following persons, not being certificated practitioners of their executors or administrators, namely,
- (a) a parent, spouse, child or grandchild of the certificated practitioner or a person to whom the certificated practitioner stands in loco parentis.''
The parties before me assume it to be the case that by the deed and for the purposes of those provisions Mr Reynolds and he alone is, within the meaning of r. 103(a) sharing a part of ``the costs'' with his wife. I do not wish it to be thought that I necessarily agree with that. It could, I think, be argued that if the deed works a sharing of ``costs'' at all, and that in itself is a question, it is as an equitable assignment effective as against both Reynolds and the other partners and hence a ``sharing'' both by Reynolds and by his partners of ``costs'' with Reynolds' wife and if that is so it is not within r. 103(a). For present purposes the answer to that question can await another day.
It is common ground that for stamp duty purposes the deed is assessable to duty under the law as it was at the date of its execution and it is also common ground that the deed is a conveyance on sale within the meaning of sec. 63 of the Act and item 4(1) in the Second Schedule to that Act. Accordingly, as to the amount of the consideration the instrument is chargeable under that item and upon the amount by which the value of the assigned share exceeds the consideration it is chargeable at the same rate but under item 19 of that Schedule.
The Commissioner characterised ``the property'' the subject of the ``conveyance on sale'' as being the income to be received by the appellant which was referable to the assigned share. Based upon Mr Reynolds' share of income from the partnership for the financial year ended 30 June 1983 he fixed the income referable to the assigned share to be $20,896 and he assessed the capital value of the right to receive that income upon the basis that it would continue for seven years and by discounting that period at 6% he obtained a multiplier of 5.58226 producing a value of the property of $116,649. The seven-year period was selected by the Commissioner because it was ``the minimum period of assignment which would provide an income tax benefit''. He had in mind the definition of the ``prescribed date'' for the purposes of Div. 6A of the Income Tax Act Assessment Act.
The appellant objected to the assessment made on that basis, her contention as formulated in her notice of objection being that the property to be valued was part of her share in the partnership and that it should be valued by the ``super profit'' method. By that method, having allowed by deducting from the profit referable to Mr Reynolds' share of the profits prior to assignment $60,000 per year as an appropriate salary for him, his ``net partnership income'' was said to be $23,584 to which it was said that a multiplier of 2.7, being three
86 ATC 4531
years discounted at 10% per annum, should be applied so producing a total value of Mr Reynolds' share of $63,676 and a value of 25% of it of $15,912. By a further objection which the Commissioner accepted, it was said that alternatively to the ``super profit'' method ``the proper method of valuing the property assigned is on the basis of capitalisation of expected future maintainable profits''.
Upon the objection being disallowed the appellant appealed to this Court pursuant to sec. 33 of the Act.
The first step to be taken in assessing to duty an instrument which is a ``conveyance on sale'' is to identify the property the subject of it. As to that, since the decision of the High Court in Everett's case (above) there can be no doubt. The property assigned was present property, a chose in action, being a share in the partnership. That property, the thing assigned, carried with it the right to a proportionate share of the future income attributable to Mr Reynolds' share and the appellant upon the assignment becoming effective had, as against Mr Reynolds and the other partners, an immediate equitable entitlement to such income referable to the share assigned as might subsequently be derived. So the property is the assigned share and the value of that property is the value of the right to such income referable to it as might be subsequently derived.
The Commissioner in his argument before me approached the valuation problem by valuing the right to receive future income essentially on an annuity basis. For the purposes of that valuation he takes $13,200 to be the future maintainable profit - the profit base - referable to the assigned share. That figure for that purpose appears to me to be common ground and accordingly it is in all that follows the figure adopted by me. The Commissioner assumes that Mr Reynolds will retire at the age of 65 and having allowed for the probability of his earlier death or becoming incapacitated actuarially established he says that the appellant's right to receive the income referable to the share assigned to her will continue for 14.5 years. He capitalised that at 3% it being what he describes as the Todorovic discount rate.
Todorovic & Anor v. Waller 81 ATC 4680; (1981) 150 C.L.R. 402 - which discount rate is said by him to accommodate all other factors including, importantly, inflation. This produces a multiplier of 11.5848 which when applied to an annual payment of $13,200 produces a capital payment of $152,919 which is then said to be the capital value of the income expectation to which he adds an amount of $6,050 which is the present value of the capital which at the end of the day will be returned. In this way he arrives at a valuation of the assigned share of $158,969. This approach and this valuation was put forward by Mr Barton who is an actuary called by the Commissioner. Mr Barton is not an expert valuer. He was the only witness called by the Commissioner.
The appellant called Keith Jones who is a chartered accountant and a graduate from the Western Australian Institute of Technology, he having graduated from that institute in 1978 with the Degree of Bachelor of Business. He has been valuing businesses for about eight years but not on a full-time basis. He made a valuation of a property assigned by the deed. He adopted two methods, each being described by him as an income capitalisation method. The first method is described by him as a ``super profits valuation''.
The steps in this method, as I understand them, is to ascertain the total annual income coming into the hands of Mr Reynolds by reason of his being a member of the partnership. This income comes from three sources, they being:
- 1. His share of the profits of the partnership.
- 2. His share of an administration fee which is paid by the partnership to a proprietary company - Clochmerle Pty. Ltd. - for administration services which that company provides for the partnership; and
- 3. His share of the profits of a trust - 20 Howard Street Trust - which also is said to provide equipment and services to the partnership.
In this way Mr Jones ``calculated Mr Reynolds' total notional annual income from the partnership and its associated entities'' - Clochmerle Pty. Ltd. and 20 Howard Street Trust - based upon 31 December 1982 management accounts as being $98,256, rounded off to $98,000. He then adopted a 30% capitalisation rate, to which I will return, and he applied that to the $98,000 less $60,000 which he took to be a salary which Mr Reynolds could have obtained ``were he to
86 ATC 4532
have sought a salaried position'' so producing a ``computed value'' of $126,666 rounded off to $127,000 for the whole of Mr Reynolds' interest in the partnership, 25% of which was $31,750 which is then said to be the value of the assigned property.
I cannot accept that method of valuing the assigned share. The appellant did not by the assignment obtain any interest in either Clochmerle Pty. Ltd. or in 20 Howard Street Trust and whatever income Mr Reynolds may have obtained from those sources they have no bearing at all upon the value of the share in the partnership which was assigned and I can see no reason for bringing into account his notional salary. The method may have some validity to the valuation of Mr Reynolds' interest in the partnership and ``its associated entities'' when viewed through the eyes of a legal practitioner minded to buy his entire interest in the partnership together with his interest in ``its associated enterprises'' with a view to becoming a working partner but it has, in my opinion, no validity at all for present purposes.
The other method adopted by Mr Jones was called the ``future maintainable profits'' method. It is a comparatively simple method and is really composed of two moving parts. The first enquiry is to ascertain the income which a buyer could expect to obtain by purchasing the share in the partnership the subject of the assignment. This is said to be $13,200 a year and is the figure used by the Commissioner and hence appears to be common ground and, as I have said, I will adopt it. The only other moving part, as I have called it, to arrive at a capital value is the appropriate capitalisation rate or multiplier. Mr Jones adopted a capitalisation rate for the purposes of this exercise to be 40%. For the purposes of his ``super profits'' method he adopted a capitalisation rate of 30%. The capitalisation rate in Mr Jones' opinion was arrived at by asking what rate of interest a hypothetical buyer would require on his investment and it is arrived at by taking the rate which he could obtain in the market by investing in what Mr Jones calls ``a non-risk'' investment and adding to that the additional rate that he would look for, having regard to all the risk factors. The rate which such a buyer could obtain on a ``non-risk'' investment is said to be 13.5% per annum. The risks associated with the acquisition of the assigned property are said to be:
``Potential Loss of Business:
- The acquisition of the business of Robinson Cox from the then current partners could result in substantial client loss which would deplete the income and profitability of the business. An independent acquirer would require compensation for this risk.
- The limited ability to transfer or realise the investment once made is a further discount factor in the determination of the value of the investment.
- The funds when committed, are not available for alternative purposes. This limit on transferability is inherent in most non-public business investments. In the case of a legal practice, transferability is further limited by the Legal Practitioners Act and the Barristers Board Rules.
- The investment in a legal practice carries the special risks that are associated with legal practices. These include the potential for negligence or other damages claims. Action against a legal practice could result in the firm losing all assets if a substantial claim was made and is a factor that requires allowance in my calculation.''
In addition it was said that Mr Reynolds might die or retire so eliminating any goodwill component, that the acquirer of the assigned interest has no control over the assets and cannot participate in decisions affecting their use, that the assignee is liable for future capital contributions to be made by Mr Reynolds and that the only potential market for the property assigned would be other qualified practitioners or the wife or children of Mr Reynolds.
Having regard to all of these factors the hypothetical purchaser of the assigned interest would, in Mr Jones' opinion, require a 40% per annum return on his investment so producing in effect a multiplier of 2.5 on a capital value of $33,000.
So the difference between the parties can be seen to lie in the multiplier. The Commissioner
86 ATC 4533
says that it ought to be 11.5848 this being the multiplier applicable to a period of 14.5 years at 3%. The appellant for the reasons mentioned says that the multiplier ought to be 2.5.
It is for this Court to ``determine'' the appeal - sec. 33(3) of the Act - and if it determines the assessment of duty to be an error ``it shall assess the duty chargeable under this Act''. Section 33(4).
I think that the assessment is an error. The valuation must, I think, be viewed through the eyes of a hypothetical buyer and I think that the general approach adopted by Mr Jones in his ``future maintainable profits'' is an acceptable way in which to arrive at that valuation. The question is what would a hypothetical buyer be fairly expected to pay for the assigned interest? I think that for the purposes of this case the question can be further refined by asking: What rate of interest having regard to all the risks and disadvantages of the investment would a buyer expect to receive in order to move him to buy?
If that be the general question then the Commissioner's valuation is in my opinion self-evidently too high because, accepting the common ``profit base'' to be $13,200 the interest on the money invested if the value or purchase price be as the Commissioner claims $152,919 would be 8.6% per annum and that, in my opinion, would fall far short of attracting a buyer at that price.
On the other hand I cannot accept Mr Jones' capitalisation rate of 40%. That rate, in my opinion, overstates the risks attaching to the continued profitability of what I am told is a well established legal firm of long standing and of impeccable repute. In my opinion a capitalisation rate of double the ``non-risk'' investment rate would be enough. That rate would then be 27% and when that is applied to the ``profit base'' the value of the assigned share, rounded off, is $48,000 and that is the value which I would place upon it. The result can be expressed in another way by saying that the appropriate and fair multiplier is 3.63.
That having been done I would ask counsel to prepare a minute of the orders which should be made both as to the assessment and as to such other matters within subsec. (4) and (5) of sec. 33 as may be necessary.
Annexure to Reasons for Judgment delivered by Burt C.J.
DEED dated the 31st day of December 1982 made between -
RICHARD MALKIN BRADLEY REYNOLDS of 101 Melvista Avenue, Nedlands, Western Australia (``the Assignor''); and
JUDITH CONSTANCE REYNOLDS of 101 Melvista Avenue, Nedlands, Western Australia (``the Assignee'');
- (A) The Assignor is a member of the partnership carrying on business under the name of ``Robinson Cox'' of Level 27, 140 St. George's Terrace, Perth (``the Partnership'') and is possessed of a share in the Partnership as at the date of this Deed, which share will be variable from time to time in accordance with the terms of the Partnership.
- (B) The Assignor has agreed to assign to the Assignee a 25% share of the Assignor's interest in the Partnership for the time being on the terms of this Deed.
NOW THEREFORE THIS DEED WITNESSES as follows:
- 1. In consideration of the sum of ten thousand dollars ($10,000.00) paid or caused to be paid by the Assignee to Robinson Cox at the request and direction of the Assignor on 5th November 1982, as part of the capital contribution payable by the Assignor in respect of his share in the Partnership, and further in consideration of the covenant on the part of the Assignee herein contained, the Assignor hereby conveys and assigns to the Assignee on and with effect from 1st December 1982 twenty-five per cent (25%) of his share in the Partnership together with all those rights, including the right to receive an appropriate share of the profits of the Assignor to which an Assignee of a share in the Partnership is entitled by virtue of Section 42 of the Partnership Act 1895 to hold the assigned interest unto the Assignee absolutely Provided However that -
- (a) Nothing herein contained shall entitle the Assignee to any share of the
86 ATC 4534
prospective profits accumulated in the books of the Partnership and held subject only to distribution thereof (as reflected in the figures of costs and disbursements of the control accounts in the Partnership books) until such time as the share therein of the Assignor at 1st December 1982 has been distributed to the Assignor.
- (b) Nothing herein contained or any other fact or circumstance shall constitute or be deemed to constitute the Assignee a member of the Partnership or to entitle the Assignee in any way to interfere in the management or administration of the Partnership business or affairs or entitle the Assignee as against the other members of the Partnership to require any accounts of the Partnership transactions or to inspect the Partnership books but this Deed shall entitle the Assignee only to receive a proportionate part of the share of the profits to which the Assignor would otherwise be entitled and the Assignee shall accept the account of profits agreed by the partners from time to time comprising the Partnership.
- 2. As further consideration for the assignment provided for by this Deed, the Assignee hereby covenants with the Assignor to pay to the Partnership a 25% share of all additional capital contributions from time to time payable by the Assignor to the Partnership in respect of his share in the Partnership.
EXECUTED by the parties hereto as a Deed.
SIGNED by the said
in the presence of:
SIGNED by the said
REYNOLDS in the