AX01C and AX01D and Commissioner of Taxation
[2001] AATA 996
•5 December 2001
Administrative
Appeals
Tribunal
DECISION AND REASONS FOR DECISION [2001] AATA 996
ADMINISTRATIVE APPEALS TRIBUNAL) Nº AT2000/11‑19
TAXATION APPEALS DIVISION)
Applicants' names not for Re: AX01C AND AX01D
publication
Applicants
And: COMMISSIONER OF TAXATION
Respondent
DECISION
Tribunal: Mr B.H. Pascoe, Senior Member
Date: 5 December 2001
Place: Canberra
Decision:
In relation to applications AT11‑16 the Tribunal:
1.varies the decision under review in respect of year ended 30 June 1989 by reducing additional tax for incorrect return to 10 per cent of the tax shortfall;
2.sets aside the decisions in respect of the years ended 30 June 1990 and 30 June 1991 and in their stead allows the objections in full;
3.affirms the decision under review in respect of the year ended 30 June 1992; and
4.varies the decisions in relation to the years ended 30 June 1993 and 30 June 1994 by reducing the additional tax imposed under section 226G Income Tax Assessment Act 1997 from 25 per cent to 10 per cent of the tax shortfall in respect of which such additional tax was levied in the relevant assessments.
In relation to applications AT17-19 the Tribunal:
1.affirms the decision under review in respect of the year ended 30 June 1989; and
2. sets aside the decisions under review in respect of the years ended 30 June 1990 and 30 June 1991 and in their stead allows the objections in full.
The Tribunal certifies that the proceedings have terminated in a manner favourable to the applicants.
(sgd) B. H. Pascoe
Senior Member
INCOME TAX — trust income — whether assessable on amount distributed or a share of net income of trust — whether beneficiary can deduct losses of trust — whether interest on loan an allowable deduction — whether additional tax correctly imposed – whether assessments were amended assessments – whether validly issued
Income Tax Assessment Act 1997
Federal Commissioner of Taxation v Ryan 2000 ATC 4079
Batagol v Commissioner of Taxation (1963) 109 CLR 243
Zeta Force Pty Ltd v Federal Commissioner of Taxation 98 ATC 4681
Re Reynolds (1942) VLR 158
Doherty v Federal Commissioner of Taxation (1933) 48 CLR 1
Case Z35 92 ATC 326
Case 6 2000 ATC 168
REASONS FOR DECISION
5 December 2001 Mr B. H. Pascoe, Senior Member
These are applications to review decisions on objections lodged by the applicants against assessments and amended assessments of income tax based on income of the years ended 30 June 1989 and 30 June 1994 inclusive for the first applicant and the years ended 30 June 1989 to 30 June 1991 inclusive for the second applicant.
At the hearing the applications of both applicants AX01C and AX01D were, by consent, heard together. They were husband and wife and the issues relevant to the three years 1989, 1990 and 1991 were the same. AX01C represented both himself and his wife and the respondent was represented by an officer of the respondent. Pursuant to section 14ZZE of the Taxation Administration Act 1953, the applicants requested that the hearing be in private.
This matter has had a long and unfortunate history. An audit of the applicants, a company in which they were the sole shareholders and trust in which they were beneficiaries, was commenced by the respondent in 1994. Assessments and amended assessments were issued in June 1995 and the applicants lodged objections against such assessments in April 1996. It was not until February 2000, nearly four years later, that decisions on the objections were made by the respondent. The decisions allowed the objections in part for the 1989 and 1990 years and disallowed the objections in respect of the remaining years. Not surprisingly, AX01C devoted some time in his submission to what he saw as an administrative unfairness caused by the long delays in finalising the audit and, in particular, dealing with the objections. He said that his wife had been very ill since June 1996 and believed that the illness was compounded by the stress of unexpected income tax liability. He wrote to the respondent in August 1996 seeking urgent resolution of the objections without success.
The amounts remaining in dispute for AX01C are:
Year ended 30 June 1989 5,716 Increase in share trust income
Year ended 30 June 1990 11,514 Increase in share trust income
Year ended 30 June 1991 7,940 Increase in share trust income
Year ended 30 June 1992 12,000 Claim for distribution of trust loss
Year ended 30 June 1993 37,200 Claim for distribution of trust loss
1,351 Claim for Interest expense
Year ended 30 June 1994 46,941 Claim for distribution of trust loss
15,429 Claim for interest expense
The amounts in dispute for AX01D were identical for the 1989, 1990 and 1991 years. The adjustment for the 1989 year arose from a deduction claimed in the return of the trust for $11,433 which was income tax paid on behalf of the company. AX01C did not dispute the disallowance of such amount as a deduction. The 1990 adjustment arose from the disallowance as a deduction in the trust of a loss of $132,000 from the sale of copyright in computer software and the 1991 adjustment resulted from the disallowance of a loss carried forward from that loss on sale of copyright. In 1992, 1993 and 1994, AX01C had claimed as a deduction a distribution of loss from the trust. In 1993 and 1994 he claimed interest on money borrowed on the security of a farming property owned by him for the purpose of purchasing a residence in the city.
The issues in this case were:
(a)whether the 1989 and 1990 assessments were amended assessments and validly raised pursuant to section 170 of the Income Tax Assessment Act 1997 ("the Act");
(b)whether the additional trust income assessed in 1989, 1990 and 1991 was assessable income of the applicants being in excess of the distribution pursuant to a resolution of the trustee;
(c)whether a beneficiary can claim a distribution of a loss from the trust;
(d)whether AX01C was entitled to a deduction for interest in 1993 and 1994;
(e)whether additional tax for incorrect returns was properly levied; and
(f)whether additional tax by way of interest on a per annum basis was properly levied.
In relation to the question of whether the 1989 and 1990 assessments were valid, AX01C was aware of the decision of the High Court in Federal Commissioner of Taxation v Ryan 2000 ATC 4079. It would seem that the decision in that case was based on similar facts to those in this case. Whilst not produced in evidence, AX01C said that he received a "nil" assessment for 1989 on 22 August 1989 and a "nil" assessment for 1990 on 7 September 1990. He was unable to distinguish his facts from those in Ryan (supra). His primary concern was that the result meant that taxpayers with incomes returned below the taxable threshold were left in a position where the respondent had virtually unlimited time in which to "reassess", where those with incomes on which tax was assessed were entitled to a time limit on any reassessment. He argued that section 171 provided no assistance as, in low‑income cases, no "assessment", that is showing tax due and payable, was capable of being issued. AX01C submitted further that the respondent had deliberately delayed making a decision on the objections while awaiting the outcome of the appeal in Ryan. As such, he considered that the applicants were entitled to have their objections determined on the basis of the law as found by the Federal Court prior to the decision of the High Court. The chronology of the Ryan decision started with a decision of this Tribunal on 13 May 1996 which followed the decision in Batagol v Federal Commissioner of Taxation (1963) 109 CLR 243 and found that a "nil" assessment was not an assessment. On 25 July 1997, Spender J allowed the taxpayer's appeal by finding that it was an assessment. This decision was affirmed by the Full Court of the Federal Court on 2 April 1998. However the High Court allowed the respondent’s appeal on 3 February 2000. In essence, that decision maintained the view adopted in Batagol. It is clear that the law expressed in Batagol and Ryan is that, unless there is an amount of tax due and payable, there is no "assessment" under the Act. Such decisions mean that this interpretation has been the law at all times and the Federal Court was wrong. Consequently, the applicants claim for protection under section 170 must fail. Even if it was possible, which it is not, to apply a different interpretation for a period, which period is appropriate? Is it between the date of objection, 16 April 1996, and the date of the single judge decision in Ryan on 25 July 1997 or the period between that decision date and the date of the High Court decision, 3 February 2000? There is no doubt that the view of the law that the Tribunal in reaching its decision must take is the High Court view expressed in Ryan. Nevertheless, I must support the taxpayer in his criticism of nearly 4 years delay in determining the objection. It is clear that, as at the date of the objection, the respondent took the view ultimately supported by the High Court. This view was not dented until July 1997, more than 12 months later and well within a reasonable time.
For the 1989 year, the applicants accept, as they must, that the payment of company income tax by the trust was not allowable as a deduction. Section 95 of the Act defines "net income" in relation to a trust estate as:
. . . the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions . . .
Section 97 provides, in so far as is relevant to this matter, that:
97(1) Where a beneficiary of a trust estate . . . is presently entitled to a share of the income of the trust estate—
(a)the assessable income of the beneficiary shall include—
(i)so much of that share of the net income of the trust estate . . .
Although not produced in evidence, I accept the statement of AX01C that, in respect of the year ended 30 June 1989, the trustee of the trust formally resolved to distribute a specific money amount, assumed to be one half of the net income shown in the return lodged, to each of himself and his wife. Clause 3 of the Trust Deed provided that the trustee had a discretion to pay or apply such part of the trust income to such of the eligible beneficiaries as the trustee determined in writing on or before the last day of the relevant year of income. If the trustee failed to make such determination then the income was to be held on trust for AX01C and AX01D in equal shares. On either the basis of the trustee resolution or the terms of the Trust Deed, AX01C and AX01D were clearly presently entitled to one half of the income of the trust. If the payment of income tax was an acceptable expense in the terms of the trust so that it reduced the distributable income of the trust for trust law purposes, AX01C and AX01D were presently entitled to 50 per cent in the terms of the trustee's resolution. If it was not, they still had an entitlement to 50 per cent each of the greater amount of income under the terms of the Trust Deed. It is clear from the decision in Zeta Force Pty Ltd v Federal Commissioner of Taxation 98 ATC 4681 that section 97 requires a process of establishing the share of the distributable income of the trust to which a beneficiary is entitled, establishing the "net income" of the trust under section 95 of the Act and then applying the percentage share of distributable income of a beneficiary to that net income. Here both AX01C and AX01D were entitled to 50 per cent of the distributable income so that section 97 includes in each of their assessable incomes 50 per cent of the net income for tax purposes. This is what happened here and is a correct application of the law. It should be said that AX01C is not alone in arguing an inequity in being taxed on income that he has not received and cannot be received but, as I have commented in other decisions, the construction of section 97 is clear notwithstanding such possible anomalies and inequities. In passing, it should be mentioned that resolutions of the trustee in relation to the years ended 30 June 1992 and 30 June 1993, which were in evidence, were dated 20 July 1992 and 5 August 1993 respectively. On this basis, it is likely that the resolution for 1989 was dated after 30 June. Under clause 3 of the Deed, any determination to be effective was required to be made in writing "on or before the last day of that year". Consequently, it is likely that the determination made was ineffective under trust law. As indicated earlier, it makes no difference in this case as a result of the default provision giving AX01C and AX01D an entitlement to half each of the year's income.
For 1990 the position is not clear. Apparently, prior to 1988 the copyright in a particular computer software was owned by a company. The trust was established in 1982 and operated a business of developing and exploiting computer software. In 1988, AX01C decided to merge the company's business with that of the trust. An amount of $150,000 was determined as the purchase price of the company's asset, the computer software package. It was accepted by the respondent and I accept accordingly that an asset, copyright was purchased, although the resolutions and paperwork produce some confusion. In 1990 the copyright was sold to a third party for $18,000 generating a loss of $132,000. This loss was treated by the respondent as a loss of capital and not deductible. In the original assessments, the respondent included the $18,000 as income but, in the objection decision, accepted that it represented proceeds of the sale of a capital asset. Unfortunately, neither the income tax returns nor the financial statements of the trust for the 1990 year were in evidence. However, it is a reasonable assumption that the loss of $132,000 was treated as an expense in the year ended 30 June 1990. In the 1992 profit and loss statement of the trust a carry forward loss of $92,790 was shown. If the net incomes of the trust for 1990 and 1992 of $23,028 and $15,880 are added to that figure, we arrive at $131,699 which seems a clear indication that the loss of $132,000 was treated as a trust expense in 1990. Clause 7(j) of the Trust Deed gave power to the trustee:
. . .
(j)To determine whether any sums received or disbursed are on account of capital or income or partly on account of one and partly on account of the other and in what proportions and the decision of the Trustee whether made in writing or implied for any act or omission of the Trustee shall be conclusive and binding;
As a result of the foregoing, it seems clear that the trust had no net distributable income in the years ended 30 June 1990 so that it cannot be said that either AX01Cor AX01D was presently entitled to any "share of the income of the trust estate". Consequently, section 97 of the Act can have no application to include in their assessable income any share of the net income for tax purposes.
The 1991 year produces a different problem. Again, with no financial statements in evidence, I must assume that such financial statements showed a net income for the year of $15,880 and a loss carried forward from 1990 of some $108,671 (being $131,699 less the 1990 income of $23,028). The Trust Deed is completely silent on what the trustee may do if a loss is incurred in a year. Without a specific power, the question arises as to whether the trustee is entitled to recoup losses from income of a subsequent year or would be required to set off the loss against corpus. In the text Principles of Law of Trusts by H.A.J. Ford and W.R. Lee 3rd Edition, the authors state, at paragraph 11280:
Where a business incurs losses the rule is that they must be recouped out of profits in subsequent years: Holt v Brown (1884) 26 Ch D 588; Re Jex‑Blake [1939] NZLR 256; GLR 159; Re Reynolds [1942] VLR 158. To the extent that Holt v Brown suggests that the rule does not apply where there is a trust to sell coupled with a power to postpone sale, doubts have been expressed in Re Reynolds [1942] VLR 158. The rule gives way to any contrary provision in the trust instrument: Re Nairn [1935] NZLR S134; GLR 634; Rutherford v CIR [1965] NZLR 444 (CA).
In Re Reynolds (1942) VLR 158, O'Bryan J, in the Supreme Court of Victoria, said (at pp.169 and 170):
In the case before me the word "profits" is not used—the testator simply directs his trustees to apply and pay the "income" from unconverted property in a certain way, and I think I should follow the principle of Upton v. Brown (a) and hold that in the absence of some indication that the testator intended otherwise, the income of any one year is ascertained after losses in a previous year have been paid out of current profits. The mere fact that the business is being carried on under a power to postpone conversion with a direction to apply income in the meantime in a particular way is not enough to indicate a contrary intention, and in this case there is no evidence that the testator himself conducted his business by writing losses off against capital, nor is there in the words of the will itself or the relationship of the testator to the persons entitled to income and residue respectively anything to suggest that the testator did not intend that the capital assets should be kept intact so far as profits in one year were available to make up previous losses. I, therefore, think that the trustees acted properly in deducting from profits in one year losses incurred in previous years.
In this case, the evidence indicated that the sale of the copyright occurred in the process of winding up the business carried on by the trust. As such, apart from being a loss of capital for income tax purposes, normal accounting treatment would have been to treat it as a loss on sale of a capital asset to be set off against the trust corpus. However, this is not what the trustee did and, in the circumstances, I am not prepared to say that it was an improper exercise of the trustee power under clause 7(j) of the Trust Deed. The accounts of the trust for the year ended 30 June 1992, the first year of accounts in evidence, show a gross business income of $8356, indicating that the trust continued to carry on a business, at least to that year. 1993 showed no gross income. Consequently, for the 1990 year of income, there was no distributable income of the trust to which a beneficiary was entitled and, therefore, no share of net income to be included in a beneficiary's assessable income.
During the course of the hearing, the Tribunal raised the question of whether all or part of the loss on sale of copyright could be an allowable deduction under Division 10B of the Act. Not unexpectedly, AX01C, being unrepresented and with a limited understanding of income tax law, made no submission in relation to that question. No submission, other than a general view that the division was not applicable, was made for the respondent. Whilst it would appear that the copyright in question was a unit of industrial property, the Tribunal is in no position to come to any reasoned conclusion as to whether any part of the loss may have constituted an allowable deduction. The details of the purchase are unclear, the purchase was not arms length and the provisions of section 124R(2) may well reduce the cost of the copyright significantly, it is not clear that the copyright was used by the trust for the purpose of producing assessable income and there is no information as to its treatment in the hands of the vendor company.
In the 1992, 1993 and 1994 years, AX01C claimed as a deduction an alleged distribution of a loss in each year. Resolutions purporting to distribute such amounts of loss were made by the trustee. It is noted that the amounts of loss purportedly distributed were not the loss of the then current year but part of the loss carried forward from 1990. AX01C maintained that the notes published by the respondent to assist in completion of trust income tax returns in 1992 and 1993 clearly implied that it was possible to distribute a loss from a trust. He argued that his case could be distinguished from the facts in Doherty v Federal Commissioner of Taxation (1993) 48 CLR 1 which was relied upon by the respondent and related to a deceased estate rather than an ongoing business. He was critical of the respondent in not raising this issue much earlier and allowing the option of continuing to earn income in the trust to recoup such losses. In relation to this latter concern it should be noted that the bulk, if not all, of the losses referred to were of a capital nature and not able to be deducted in any event from future assessable income of the trust.
It is clear, even without the assistance of the decision in Doherty (supra) that the losses here could not be "distributed" to a beneficiary. The beneficiaries entitlement under the Trust Deed was to income and was contingent on the trustee either exercising the discretion to provide such entitlement by way of resolution or by operation of clause 3 of the Deed if such discretion was not exercised in favour of other beneficiaries. The trustee was not acting as agent of the applicants or any other beneficiary in carrying on the business. The trustee was holding and using the trust properly under the terms of the Trust Deed for the benefit of the beneficiaries as a class of such beneficiaries having a contingent interest in income and/or corpus. It is simply not possible for a trustee to distribute something he does not have available for distribution such as a loss, being the excess of expenses over income. It is not different to the impossibility of a trustee distributing a liability incurred by the trustee. The decision in Doherty (supra) is authority, if needed, for the proposition that losses incurred in a trust cannot be distributed and deducted by a beneficiary and that decision has been followed in more recent decisions of this Tribunal in Case Z35 92 ATC 326 and Case 6 2000 ATC 168.
In the 1993 and 1994 years, AX01C claimed a deduction for interest. This represented interest on money borrowed on security of a farming property owned by him with the funds used to purchase a residence in the city. It was argued by AX01C that the interest was an allowable deduction as it was incurred to enable him to retain the farm on which an income producing business was being carried on. It should be said for the benefit of AX01C that he is not the first to argue deductibility of interest on funds borrowed for private purposes such as purchase of a home on the grounds that such borrowing avoided the necessity to sell an income producing asset. However, it is clear that deduction or not of interest depends on the purpose to which the funds borrowed were put. If, as in this case, the funds were used for private or domestic purposes, the interest cannot be deducted. It is the essential character of the expenditure which is the relevant issue and here the essential character is interest on funds used to purchase a private residence. It is unnecessary, in my view, to deal with the many decisions of the Courts and Tribunal to support this now well established principle of income tax law.
In the 1989, 1990 and 1991, the respondent did not levy any additional tax for incorrect returns in relation to AX01D. For AX01C, additional tax of 25 per cent for 1989 and 10 per cent for each of 1990 and 1991 was levied. For 1992 and 1993, no additional tax was levied in respect of the claim for trust losses but 25 per cent was charged in relation to the claim for interest. For 1994, additional tax of 25 per cent was charged in relation to the claims for trust losses and interest. The non‑imposition of additional tax in relation to the claim for trust losses in 1992 and 1993 reflected a recognition by the respondent that the official notes and forms issued by the respondent in those years may have misled a person not skilled in taxation matters. However, for 1994, the respondent maintained that AX01C had been told by the auditor prior to lodgement of a return for that year that no deduction could be claimed for trust losses. AX01C said that, while that was true, the auditor had departed without finalising the audit and, prior to finalising the 1994 returns he had telephoned the respondent’s inquiry line and was told that the tax was deductible when winding up a trust which had happened in that year. He also argued generally against the imposition of additional tax on the grounds that he at all times attempted to follow the instructions on the income tax return forms, the long delays in finalising the audit and objections and that any faults lay with the trustee not himself.
The additional tax for the 1989, 1990 and 1991 years was imposed under section 223 of the Act. For the 1993 and 1994 years, the relevant provision was section 226G. This latter section provides for additional tax of 25 per cent where a tax shortfall was caused by a failure to take reasonable care to comply with the Act. In respect of all years, section 227 provides a discretion to remit all or part of the additional tax. I do not accept that AX01C can blame the trustee. The trustee was a company of which AX01C was a director. He prepared and signed the resolutions of the trustee and the trust income tax returns. While accepting his limits in a full understanding of tax laws, his was the guiding hand in all of the relevant transactions without seeking professional advice. I accept his statement that his business was making little money and he could not afford the services of an accountant or lawyer as had been provided in earlier years. I believe that he was honest in his beliefs that the information in the returns lodged was correct. I am critical of the excess time taken by the respondent in resolving the issues, particularly in determining the objections.
To a degree I am influenced in my considerations of whether it is appropriate to exercise the discretion to remit any of the additional tax by the recently announced settlement guidelines for taxpayers involved in mass marketed investment schemes. However, I am more influenced in such considerations by both accepting the truthfulness of AX01C and criticism of the respondent taking until February 2000 to resolve objections lodged in 1996 and relative to years from 1989 to 1994. Consequently, I would allow the objections of AX01C to the extent of exercising the discretion under section 227 to remit additional tax from 25 per cent where imposed to 10 per cent.
The Tribunal has no jurisdiction to deal with the per annum penalties or interest also imposed. However, I would urge the respondent to give consideration to some alleviation of such interest penalty either by levying the interest from a later date only or reducing the rate of interest somewhat in line with that being offered to participants in mass marketed schemes.
The result of the foregoing is that, in relation to AX01D, the objection decision in relation to the year ended 30 June1989 should be affirmed and the decisions in relation to the years ended 30 June 1990 and 30 June 1991 should be set aside and the objections allowed in full. In relation to AX01C, the objection decision in relation to the year ended 30 June1989 should be varied by reducing additional tax to 10 per cent of the tax shortfall, the decisions in relation to the years ended 30 June 1990 and 30 June 1991 should be set aside and allowed in full, the decision in relation to the year ended 30 June 1992 should be affirmed and the decisions in relation to the years ended 30 June 1993 and 30 June 1994 should be varied by reducing additional tax from 25 per cent to 10 per cent of the relevant tax shortfalls.
It is noted that the consequence of the decision in relation to the years ended 30 June 1990 and 30 June 1991 is that there were amounts of net income of the trust to which no beneficiary was presently entitled and would fall to be assessed to the trustee under section 99 or section 99A of the Act. Given the time that has passed and the apparent dissolution some years ago of both the corporate trustee and the trust, it may not be possible for the respondent to recover such tax. However, that is not a matter which is before me and may well be a consequence of the inexplicable delays by the respondent in bringing these issues to conclusion.
I certify that the nineteen (19) preceding paragraphs are a true copy of the reasons for the decision herein of
Mr B. H. Pascoe, Senior Member
Sgd: Rhona Hammond .....................................................................................
Personal Assistant
Date/s of Hearing 15 November 2001
Date of Decision 5 December 2001
Counsel for the Applicant Self represented
Solicitor for the Applicant N/A
Counsel for the Respondent Diana Russo James, Departmental Advocate
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