Barham and Commissioner of Taxation
[2007] AATA 1824
•28 September 2007
Administrative Appeals Tribunal
ADMINISTRATIVE APPEALS TRIBUNAL )
) No: WT200400252-253
Taxation Appeals Division )
Re: Robert Barham
Applicant
And: Commissioner of Taxation
Respondent
SLIP RULE [2007] AATA 1824
TRIBUNAL: Mr A Sweidan, Senior Member
DATE: 13 May 2008
PLACE: Perth
The Tribunal made a decision in these applications on 28 September 2007: [2007] AATA 1824.
It has come to the Tribunal’s attention that there are obvious errors with the numbering in paragraphs 21, 22 and 23 of the Tribunal’s Reasons for Decision.
Accordingly, the Tribunal directs the Registrar, pursuant to subsection 43AA(1) of the Administrative Appeals Tribunal Act 1975 (Cth), to alter the numbering in paragraphs 21, 22 and 23 of the Tribunal’s Reasons for Decision as follows:
·The numbering is to be changed so that it consecutively follows in order, with all subsequent paragraphs to be re-numbered accordingly.
..........[Sgd Mr A Sweidan].........
Senior Member
Administrative Appeals Tribunal
DECISION AND REASONS FOR DECISION [2007] AATA 1824
ADMINISTRATIVE APPEALS TRIBUNAL )
) No WT200400252-253
TAXATION APPEALS DIVISION ) Re ROBERT BARHAM Applicant
And
COMMISSIONER OF TAXATION
Respondent
DECISION
Tribunal Mr A Sweidan, Senior Member Date28 September 2007
PlacePerth
Decision The Tribunal sets aside the decisions under review and remits the matter to the respondent to issue further amended assessments allowing a deduction only for that part of the claimed deductions which were actually paid by the applicant. .............[Sgd Mr A Sweidan].............
Senior Member
CATCHWORDS
Income Tax - deductions for amounts paid to participate in "Australian Aloe Vera Project" - whether allowable - whether Part IVA anti-avoidance provisions apply
LEGISLATION
Income Tax Assessment Act 1936
Income Tax Assessment Act 1997
Taxation Administration Act 1953
Administrative Appeals Tribunal Act 1975
CASES
Calder v Federal Commissioner of Taxation (2005) 61 ATR 267 at [91]
Eastern Nitrogen Ltd v Federal Commissioner of Taxation [80]-[84], [87]-[88]
Federal Commissioner of Taxation v Emmakell (1990) 22 FCR 157
Federal Commissioner of Taxation v Brand 1995 ATC 4633 at 4646
Federal Commissioner of Taxation v Lau (1984) 6 FCR 202 at 207.9
Federal Commissioner of Taxation v Sleight (2004) 136 FCR 211
Federal Commissioner of Taxation v Hart (2004) 217 CLR 216
Federal Commissioner of Taxation v Spotless Services Ltd at 421-422, 424
Federal Commissioner of Taxation v Consolidated Press Holdings Ltd (2001) 207 CLR 235 at [95]
Federal Commissioner of Taxation v Cooke (2004) 55 ATR 183
Puzey v Federal Commissioner of Taxation (2003) 131 FCR 244 at [50]
Vincent v Federal Commissioner of Taxation (2002) 124 FCR 350 at [62]-[65]
REASONS FOR DECISION
28 September 2007 Mr A Sweidan, Senior Member BACKGROUND
1. The applicant claimed deductions of $16,750 for the years ended 30 June 1998 (1998 year) and 30 June 1999 (1999 year) in respect of his investment in the Australian Aloe Vera Project.
2. The claimed deductions are said to comprise for each year:
(a)$13,000 in respect of marketing and management fees;
(b)$2,000 in respect of licence fee;
(c)$400 in respect of indemnity fee;
(d)$1,350 in respect of interest;
being amounts claimed to have been paid or incurred by the applicant relating to his participation in the project. The claimed deductions were disallowed as was a subsequent objection. Applicant seeks a review of those decisions.
THE ISSUES
3. Whether all or any part of the payments referred to as “Management Fees”, “Licence Fees”, “Interest expenses” and “Indemnity Fees” are deductible under subsection 51(1) of the Income Tax Assessment Act 1936 (“the 1936 Act”) or section 8-1 of the Income Tax Assessment Act 1997 (“the 1997 Act”) and in particular whether they were:
3.1incurred in gaining or producing assessable income in the years ended 30 June 1998 and 30 June 1999, or
3.2necessarily incurred in carrying on a business for the purpose of gaining or producing such income;
3.3 or whether they were:
3.3.1 losses or outgoings of capital, or of a capital nature, or
3.3.2 losses or outgoings of a private or domestic nature,
and so excluded from deductibility pursuant to section 8-1 of the 1997 Act.
4. Whether all or any part of the amounts claimed as deductions were in fact incurred in the years of income ended 30 June 1998 and 30 June 1999.
5. Whether the applicant was carrying on any business activity as a consequence of participating in the project in the years of income ended 30 June 1998 and 30 June 1999.
6. Whether Part IVA of the 1936 Act operates to disallow in whole or in part the deductibility of the Management Fees, Licence Fees, Indemnity Fees and Interest.
7. Whether penalties by way of additional tax were correctly imposed for the income years ended 30 June 1998 and 30 June 1999 and whether any remission is warranted.
8. The applicant has the onus of proving that the amount of the amended assessment for each year is excessive: s 14ZZK(b), Taxation Administration Act 1953. It is for the applicant to prove positively the facts necessary to establish that:
(a) the claimed deductions are allowable deductions under s51(1) or s8-1;
(b)Part IVA does not operate to disallow the claimed deductions if otherwise allowable;
(c) the criteria for the imposition of penalty did not exist;
(d) remission of penalty is warranted.
EVIDENCE
9. The following facts which emerge from the documents and evidence before the Tribunal are not in dispute.
The applicant
10. In about 1997 the applicant became a financial planner. His background is in Medical Laboratory Science.
11. The applicant became aware of the project through Harts Securities, a licensed dealer of Aim Financial Solutions Group (which was the organisation he worked with) and then from the prospectus and summary brochure.
12. The applicant invested in the project in the 1998 year and again in the 1999 year.
Prospectus
13. The prospectus was dated 29 May 1998. It opened with an “Introduction”:
“Australian Aloe Limited (AAL) makes the offer contained in this Prospectus for the purpose of raising funds to purchase the whole of the undertakings including the business, land, plant and equipment of Hi Tech Aloe Vera (Australia) Pty Ltd (Hi Tech). It will add to expand and improve the existing facilities and business with the intention of generating profits for its shareholders.
Hi Tech established in 1988 conducts a vertically integrated operation whereby high qualify aloe vera leaf is grown and harvested, processed into gel at its own premises and in turn sold to value adding manufacturers or used as the raw material in its own range of 36 value added products which are sold to both domestic and international markets.
Having purchased all of Hi Tech’s undertakings it will expand the existing growing and production facilities to meet the current growth in demand for Hi Tech’s products and more particularly the dramatic growth anticipated as a result of a professional and aggressive marketing strategy to be adopted with funds raised specifically for this purpose.” Prospectus, pages 4, 5
14. The prospectus described “The Offer” as:
“The offer in this prospectus is three fold, namely redeemable preference shares, ‘A’ Class shares and Interests arising out of the ownership of ‘A’ Class shares.” Prospectus, page 4
15. As to A class shares:
“2. ‘A’ Class $1 Shares
AAL intends to issue 3 million ‘A’ Class shares each fully paid to persons who subscribe under this prospectus. ‘A’ Class shares carry all of the rights to vote (that is one (1) vote for every ‘A’ Class share) and receive dividends of ordinary shares but in addition thereto each parcel of 2,000 shares entitles the holder to a Licensed Interest under which he is entitled to market and sell the whole range of AAL’s products.
3. Interests Attaching to ‘A’ Class $1 Shares
‘A’ Class shareholders who exercise the right to a Licensed Interest will engage in their own business as a licensed marketer and seller of the full range of AAL’s products. For each parcel of 2,000 ‘A’ Class shares a Licensed Interest governed by the terms and conditions of a License Agreement … can be applied for and the holder can (although there is no obligation to do so) appoint Aloe Management & Marketing Limited to manage that business under a management agreement. …
In the event that Aloe Management & Marketing Limited is appointed as Manager the interests of each Licensee under the Management Agreement are governed by an Investment Deed entered into by Aloe Management & Marketing Limited (as Manager) Australian Aloe Limited (as Owner) and Inteq Custodians (as Trustee). By entering into the Management Agreement each Licensee agrees to be bound by the terms of the Investment Deed …” Prospectus, page 4
16. The prospectus described “The Purpose of the Offer” by Australian Aloe Limited (AAL) and Aloe Management & Marketing Limited (later called Australian Aloe Marketing Limited) (AMML) as:
“1. By Australian Aloe Limited
a)To fund the acquisition of all of the assets and undertakings (the business) of Hi Tech including all production equipment and facilities, intellectual property consisting of formulates and technical production and marketing know how, all trademarks and brands, client lists and supply agreements.
b) To purchase land at 98 Scotland Street, Bundaberg
c)To erect a purpose built factory on the land capable initially, of trebling the existing aloe vera processing capacity with provision to increase to seven times the existing capacity
d)To purchase land at Bullyard and Quanaba near Bundaberg together with standing crops of aloe vera and to increase its current growing capacity
e)To purchase standing crops of aloe vera on land currently leased or owned by interests associated with Hi Tech’s directors and to ensure they are efficiently grown and harvested for use in production
f)To acquire further land by lease or purchase on which to grow crops of aloe vera in sufficient quantities to meet anticipated increase in demand for product
2. By Aloe Management & Marketing Limited
a)To offer marketing and management services to ‘A’ Class shareholders of AAL who exercise their rights to be licensed as marketers and sellers of AAL’s range of products
b)To secure and service existing markets established by Hi Tech and to embark on an aggressive marketing campaign with a view to significantly increasing its share of both the domestic and world markets for aloe vera products
c)To thoroughly research existing world market trends thereby identifying consumer needs and preferences for new and modified products and packaging.” Prospectus, page 6
17. A section headed “Three possible Income Streams” stated with respect to A class shares:
“b)Income Projections for AAL indicate that it should achieve profits from 1999 onwards from which dividends on ‘A’ Class shares can be declared. …
c)Individual’s Licensees’ businesses. Licensees who engage in the business of marketing and selling AAL’s products will do so under the terms of a License Agreement which expires on 30 June 2017. ...”
There was a “Finance Package”:
“A finance package is offered to fund 100% of Year 1 Management and Marketing Fees and 25% of Year 1 License Fees. Subject to prepaying Year 1 interest and making one principal repayment the licensee can insure against the failure by his business to generate sufficient income and profits to meet subsequent interest and principal payments. He will do so by entering into an Indemnity Agreement ….”
18. The cash payments required of a person who took the finance package were:
On application: A class share purchase $2,000 75% of year 1 license fee $1,500 Year 1 interest $1,350 Stock purchase $100 Indemnity fee $400 By 30 September: Principal repayment $2,500 $7,850
19. No further payments were required:
“All future costs are funded by the Licensee’s business. If the business does not meet its projected income and there is a shortfall in funds available to make interest and principal repayments under the loan the Indemnifier must pay them.” Prospectus, page 17
20. The prospectus was amended by supplementary prospectus dated 19 May 1999.
Applicant’s participation in the 1998 year
21. By an application form the applicant:
(a)acknowledged having read the prospectus;
(b)requested that the directors accept his application for 2,000 A class shares;
(c)indicated that he wished to exercise the rights attaching to the A class shares and to exercise the options available to him in the manner indicated on an attached option form;
(d)indicated that he wished to enter into a Management Agreement with AMML executed by AAL as his agent and a License Agreement with AAL executed by AMML as his agent.
2.By the option form the applicant:
(a)indicated that he wished to utilise the finance package and to:
(i)engage in business with one Licensed Interest;
(ii)borrow $13,500 made up of $13,000 year 1 management and marketing fees and $500 for part of his year 1 license fees to be prepaid;
(iii)prepay the balance of the year 1 license fee of $1,500;
(iv)be indemnified against future personal liability under the Loan Agreement and to pay the indemnity fee of $400;
(v)purchase stock for $100;
(vi)prepay year 1 loan interest of $1,350;
(b)acknowledged that he could be called upon to personally pay a principal repayment of $2,500 due on or before 30 September 1998 or 90 days after application, whichever was the later;
(c)enclosed cheques for:
(i)$2,000 to AAL for the purchase of shares;
(ii)$2,000 to AAL for year 1 licence fees, the indemnity and stock;
(iii)$1,350 to Export Growth Finance Pty Ltd (Lender) for year 1 interest.
22. In addition to a copy of the application form, option form and cheques referred to above, the applicant has produced, by way of evidence of his participation in the 1998 year, a copy of:
(a)a letter dated 6 July 1998 from AMML which, inter alia, sets out details of the structure;
(b)an extract from The Australian Aloe Project A Class Register for the applicant as Reg No. AAL71;
(c)a Loan Indemnity Agreement, Loan Agreement, Management Agreement and License Agreement;
(d)a share certificate in AAL for 2,000 A class shares;
(e)a Challenge Bank classic account statement in the name of the applicant and his wife;
(f)a blank Licensee Product Order Form;
(g)Licensee Tax Statements for the years ended 30 June 1998 to 30 June 2002;
(h)a letter dated 23 September 2003 from the Lender demanding payment of the balance outstanding and enclosing a Borrower Loan Statement showing a balance of $8,000 for Reg No. AAL71.
Applicant’s participation in the 1999 year
3.The application has produced, by way of evidence of his participation in the 1999 year, a copy of:
(a)an application form and option form for a further 2,000 A class shares;
(b)a letter dated 18 June 1999 from AAL which, inter alia, sets out details of the structure;
(c)an extract from The Australian Aloe Project A Class Register for the applicant as Reg No. AAL571;
(d)a Loan Indemnity Agreement, Loan Agreement, Management Agreement and License Agreement;
(e)a cheque for $1,350 in favour of the Lender and two cheques for $2,000 in favour of AAL;
(f)a Challenge Bank classic account statement in the name of the applicant and his wife;
(g)Licensee Tax Statements for the years ended 30 June 1999 to 30 June 2002;
(h)a letter dated 23 September 2003 from the Lender demanding payment of the balance outstanding and enclosing a Borrower Loan Statement showing a balance of $8,000 for Reg No. AAL571.
Agreements
23. The Tribunal relies, for the purposes of this application, upon the forms of the agreements produced by the applicant.
24. The following summary of terms and conditions is based on the forms of the agreements produced in respect of the applicant’s participation in the 1998 year. The forms produced in respect of the 1999 year are relevantly similar, although the Loan Agreement produced, while dated 26 May 1999, provides for a principal repayment by 30 September 1998. This has not been explained.
License Agreement
25. The License Agreement was to be made between AAL as the Licensor and a participant as the Licensee by AMML as agent.
26. By clause 2.1, in consideration of the performance and observation of the covenants contained in the Agreement by the Licensee the Licensor granted the Licensee the right to market, distribute and sell the Products and to use the Marks for the purpose of the Business in conjunction with similar rights granted to other Licensees.
27. By clause 2.2, in consideration of the continuing right obtained under the Agreement during the Term, the Licensee was to pay the Licensor a License fee of $2,000 for each Licensed Interest for the first year commencing the date of the Agreement until 30 June 1999 and for each subsequent year a sum equivalent to 5% of the Sale Proceeds.
28. By clause 4.1, the Licensee covenanted and agreed with the Licensor with respect to certain duties, including to commence Business as soon as practical after execution of the Agreement and to actively and diligently promote the Business and to exercise best endeavours in the conduct of the Business.
29. By clause 5.1, the Licensee agreed to each month order Products from the Licensor by issuing a written purchase order stating the particular Product and amount requested.
30. By clause 8(a), the Licensee had the option of appointing the Manager (by clause 1.1, AMML or such other company approved by the Licensor) to manage the Licensee’s Interest with regard to the marketing and distribution of the Product, the performance of the Licensee’s duties under the Agreement and generally to manage the Business on the Licensee’s behalf.
Management Agreement
31. The Management Agreement was to be made between AMML as the Manager and a participant as the Licensee by AAL (referred to as the Company) as its agent.
32. Clause 3.1 stated that the Licensee has acquired by acquisition of shares in AAL rights to Licensed Interests.
33. The terms of the Management Agreement further included:
(a)by clause 3.2, the Licensee engaged the Manager to manage the Licensee’s Business;
(b)by clause 4.1, the Manager was to manage the Licensee’s Interests, market the Products as it considers appropriate and perform all management matters;
(c)by clause 4.8, the Manager was to pay the Net Proceeds of the Project to the Trustee under the Investment Deed to be divided and credited among the Licensee and Other Licensees with the intent that the Licensee shall be entitled to receive the Licensee’s Distribution (if any);
(d)by clauses 6.1, 6.2(2) and 6.3, in consideration for the Manager agreeing to carry out the services, the Licensee agreed to pay to the Manager by way of management fees:
(i)for the first 13 months (referred to as the First Period), $13,000 per Licensed Interest payable on full on the date of the Agreement;
(ii)for the next year (referred to as the Second Period), the Licensee’s Proportion (a term which was not defined) of Net Proceeds of the Project in respect of the First Period, from which the Manager was to pay:
-any License Fees, any interest on borrowings in respect of the Licensee’s Interest and any principal repayment on such borrowings;
-and if the Net Proceeds of the Project exceeded $1,500 per Licensed Interest in the First Period, the excess amount over $1,500 as to one third to the Manager by way of Management Fees and as to two thirds to be retained by the Trustee for distribution to the Licensee;
(e)by clause 6.4, for each subsequent year of the Term, the Manager was to be entitled to be paid a sum equal to 5% of the Licensee’s Net Proceeds of each previous period by way of Management Fees. By clause 2, the term of the Agreement was from the date of execution until the earlier of, amongst others, 30 June 2017 or the Licensee ceasing to market and sell Products;
(f)by clause 6.5, other than in respect of the First Period, the Manager was to have no recourse to the Licensee personally for payment of any Management Fees. See also clause 7.3.
Loan Indemnity Agreement
34. The Loan Indemnity Agreement was to be made between AMML as the Indemnifier, the Lender and a participant as the Borrower.
35. By clause 1 and Schedule A of the Loan Agreement (which was a Schedule to the Loan Indemnity Agreement - see below), the Borrower agreed to pay to the Indemnifier a fee of $400 at the time of execution.
36. By clauses 1 and 2, provided that the Borrower prepaid the first year’s interest and the principal repayment of $2,500 in accordance with the Loan Agreement, the Indemnifier agreed to meet interest payments from year two onwards.
37. By clause 4, the Indemnifier warranted to the Lender that at the end of the term of the Loan Agreement the Indemnifier would make repayment of any principal then outstanding and save harmless the Borrower from any remaining obligations under the Loan Agreement and the Lender accepted that warranty and would not seek any further payment from the Borrower.
Loan Agreement
38. The Loan Agreement was to be made between the Lender and a participant as the Borrower.
39. By clause 2.1 and Schedule A, the Lender agreed to lend to the Borrower the Principal Sum of $13,500.
40. By clauses 2.2 and 4, the Borrower agreed to pay to the Lender interest during the first year, at the discounted rate of 10% per annum, provided the Borrower prepaid the first year’s interest and paid a principal repayment of $2,500 on or before 30 September 1998.
41. By clauses 2.3, 2.4 and 5 and Schedule A and provided the Borrower entered into the Loan Indemnity Agreement, prepaid the first year’s interest and paid the principal repayment:
(a)the Borrower was to pay to the Lender interest from year two onwards at the discounted rate of 4% per annum by 30 June in each year;
(b)the interest was payable only from the net income of the business or by the Indemnifier under the terms of the Indemnity Agreement and not look to the Borrower;
(c)the Borrower was to pay instalments of principal repayments but the Lender was to accept as repayments an amount equal to 50% of the net profit of the Business in lieu of payment;[1]
(d)the term of the loan was to be extended from 8 years to no longer than 20 years if the net profit of the Business was insufficient to pay the Principal Sum by the expiration of 8 years.
[1]By clause 1, “Business” was defined as “the marketing and selling of Aloe Vera Product by [AAL]”.
THE APPLICANT’S CASE
42. The applicant gave evidence and made submissions. His position can be summarised as follows:
43. He invested in the project as part of his long term retirement planning to derive income, believing it was a “good investment” and “a real business”.
44. The tax deductions which were represented to be available to investors and the loan indemnity meant that his risk exposure “was manageable” although the investment was speculative.
45. He received some assessable income from the project.
46. In his submissions he requested the Tribunal to allow a deduction for his cash outlay and waive the penalties imposed by the respondent.
THE LAW
S51(1) Section 8-1
47. The determination of whether an outgoing is an allowable deduction for the purposes of s51(1) or s8-1 is a matter of characterisation by reference to the advantage sought to be obtained.
48. As was pointed out in Vincent v FCT (2002) 124 FCR 350 at [62]-[65], it is incumbent upon the Tribunal to analyse all the rights and obligations, particularly what the outgoings were for, rather than to rely on the way the outgoings were styled. See also FCT v Emmakell (1990) 22 FCR 157 at 162.8; FCT v Brand 1995 ATC 4633 at 4646 and FCT v Lau (1984) 6 FCR 202 at 207.9.
49. Characterisation is a matter of fact to be determined by the facts and circumstances of the case: Puzey v FCT (2003) 131 FCR 244 at [50]; FCT v Sleight (2004) 136 FCR 211 per Hill J (Hely J agreeing) at [51].
50. In this case, the following facts are material to characterisation of the applicant’s outgoings for license fees:
(a)AAL offered A class shares in itself for sale;
(b)each parcel of 2,000 A class shares entitled the holder to a Licensed Interest under which he or she was entitled to market and sell the whole range of AAL’s products;
(c)this right to market and sell was said to arise upon the acquisition of a parcel of 2,000 A class shares and be governed by the terms and conditions of a License Agreement;
(d)but by the forms of the License Agreement, the holder of a parcel of 2,000 A class shares was to pay a license fee for the right to market and sell, although it appears the holder already possessed this right by reason of his or her acquisition of the parcel of 2,000 A class shares.
51. The evidence also shows that:
(a)the applicant signed up for the project in the 98 year by completing a standard “package” of documents offered by the prospectus and the Lender to investors. He did so by completing the application form, option form and paying the required cash payments on application. He did so again in the 99 year;
(b)the applicant did nothing further than pay the once off principal repayments of $2,500 required under each of the Loan Agreements;
(c)the applicant was granted the right to market and sell AAL’s products. By the form of the Management Agreements, the applicant engaged AMML as manager of his “Licensed Business” of “the business of marketing and selling [AAL]’s products”;
(d)there is no suggestion that the applicant himself ordered any products, or that any products were ordered by the manager on his behalf;
(e)as the directors of AAL described it, AAL’s principal activity was “to grow aloe vera, manufacture and sell aloe vera products throughout Australia and in export markets through [AMML]”;
(f)as the directors of AMML described it, AMML’s principal activity was “to act as the Manager for the Aloe Vera Project at Bundaberg”, while also acknowledging the appointment of the company as “the Manager for the Licensee’s business”;
(g)as already noted the applicant viewed the project as an investment. He invested in the project to diversify his investments and to secure funds for his retirement. He considered the project in the context of his investment portfolio and not his business activities.
TRIBUNAL’S FINDINGS
52. The Tribunal finds that:
(a)the applicant was not conducting a business. Although he formally appointed a manager, in effect the business was to be AMML’s, alternatively AAL’s, with the investors to take no part in its operations;
(b)however, the management and license fees were not capital outgoings but were incurred by the applicant for the purpose of deriving assessable income, and are therefore deductible under s.51(1) or s.8-1
Part IVA
53. Although the Tribunal finds that the claimed deductions are allowable deductions under s51(1) or s8-1, the Tribunal is of the view that the deductions should be disallowed because of the operation of Part IVA, except to the extent of amounts actually paid by the applicant.
(a) Relevant provisions
54. Section 177F of the 1936 Act provides, inter alia, for the disallowance of a tax benefit in the form of a deduction claimed by a taxpayer in connection with a scheme to which Part IVA applies.
55. Section 177C(1), relevantly, defines a “tax benefit” in the following terms:
“Subject to this section, a reference in this Part to the obtaining by the taxpayer of a tax benefit in connection with a scheme shall be read as a reference to –
…
(b)a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out;
…
and, for the purposes of this Part, the amount of the tax benefit shall be taken to be -
…
(d)in a case to which paragraph (b) applies – the amount of the whole of the deduction or the part of the deduction, as the case may be, referred to in that paragraph.”
56. Section 177D is the key provision in Part IVA. It provides that a scheme must be entered into or carried out by a person for a purpose of the kind identified in s 177D(b): see FCT v Hart (2004) 217 CLR 216 per Gleeson CJ and McHugh J at [16], per Gummow and Hayne JJ at [34], [43], [50], [56] and per Callinan at [92]. It provides:
“This Part applies to any scheme that has been or is entered into after 27 May 1981, and to any scheme that has been or is carried out or commenced to be carried out after that date … where -
(a)a taxpayer (in this section referred to as the “relevant taxpayer”) has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and
(b)having regard to -
(i)the manner in which the scheme was entered into or carried out;
(ii)the form and substance of the scheme;
(iii)the time at which the scheme was entered into and the length of the period during which the scheme was carried out;
(iv)the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;
(v)any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;
(vi)any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;
(vii)any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and
(viii)the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi),
it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers).”
57. According to s 177A(5), the “purpose” for which a person entered into or carried out a scheme may be the sole purpose or the dominant purpose of doing so.
58. A “scheme” for the purposes of Part IVA is defined in s 177A(1) to mean:
“(a)any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and
(b) any scheme, plan, proposal, action, course of action or course of conduct.”
59. As has frequently been observed, the definition of “scheme” is very broad. See, for example, FCT v Spotless Services Ltd (1996) 186 CLR 404 at 425 per McHugh J; FCT vPeabody (1994) 181 CLR 359 at 378. See further FCT v Hart at [9] per Gleeson CJ and McHugh J, [43] per Gummow and Hayne JJ; [85], [87] per Callinan J and Eastern Nitrogen Ltd v FCT (2001) 108 FCR 27 at 43 [71] per Carr J (Lee and Sundberg JJ agreeing).
(b) Scheme
60. The making and implementation of the prospectus and the application form, the option form and agreements made in respect of each of the 1998 year and the 1999 year clearly constituted a scheme within the meaning of s 177A(1).
(c) Parties to the scheme
61. The parties to the scheme included the applicant, AAL, AMML, the Lender and the Trustee.
(d) Tax benefit
62. The tax benefits are the deductions which would not have been allowable or might reasonably be expected not to have been allowable to the applicant for the 1998 year and the 1999 year if the schemes had not been entered into or carried out.
63. The tax benefits are the claimed deductions of $16,750 for each year for:
(a) $13,000 in respect of marketing and management fees;
(b) $2,000 in respect of licence fee;
(c) $400 in respect of indemnity fee;
(d) $1,350 in respect of interest.
64. Accordingly, for each year, the applicant obtained, in connection with the scheme, tax benefits within the meaning of ss 177C(1) and 177D(a) in the amount of $16,750.
(e) Section 177D(b) factors
65. The test posited by s 177D is an objective one: FCT v Spotless Services Ltd at 421-422, 424; FCT v Consolidated Press Holdings Ltd (2001) 207 CLR 235 at [95]; Eastern Nitrogen Ltd v FCT per Carr J at [80]-[84], [87]-[88]; FCT v Sleight per Hill J (Hely J agreeing) at [67.1] and per Carr J at [205]; Calder v FCT (2005) 61 ATR 267 at [91]; FCT v Cooke (2004) 55 ATR 183 at [88]. The test does not require, or even permit, any inquiry into the subjective motives of the applicant or others who entered into or carried out the scheme or any part of it: FCT v Hart at [65].
66. By way of example, in Vincent v FCT 2002 ATC 4490 French J (at first instance) found, in relation to s 51(1) of the 36 Act, that the obtaining of a tax deduction was not Ms Vincent’s dominant purpose: at [3]. In relation to Part IVA, however:
“whatever the subjective purpose of Ms Vincent and her state of knowledge about the true nature of the scheme into which she entered, a reasonable person would conclude, having regard to the eight listed factors, that those taxpayers who entered into the project did so with the dominant purpose of obtaining a tax benefit in connection with it” : at [123]; and see [122].
67. Similarly, in Calder v FCT at [114] a taxpayer’s unawareness of the financial structuring of the project was held to be immaterial.
68. As the terms of s 177D make clear, the reference to “purpose”, objectively determined, includes not only the applicant’s purpose in entering the scheme, but also the purpose of the scheme’s promoters in enabling the applicant and other participants to obtain tax benefits in connection with the scheme. In this respect, see Vincent v FCT at [100] per Hill, Tamberlin and Hely JJ; FCT v Sleight per Hill J (Hely J agreeing) at [66], [67.3] and per Carr J at [239]-[240].
69. Each of the factors set out in s 177D(b) must be considered. However, as Hill J pointed out in Peabody v FCT (1993) 112 ALR 247 (Ryan and Cooper JJ agreeing) at 258:
“This does not mean that each of those matters must point to the necessary purpose referred to in s 177D(b). Some of the matters may point in one direction and others may point in another direction. It is the evaluation of these matters, alone or in combination, some for, some against, that s 177D requires in order to reach the conclusion to which s 177D refers.”
See also FCT v Sleight per Hill J at [67].
70. Nevertheless, the relevant purpose may be so apparent on the evidence taken as a whole that consideration of the factors can be collapsed into a global assessment of purpose: FCT v Consolidated Press Holdings Ltd at [94] and FCT v Sleight per Hill J at [67]. Echoing what the High Court stated in FCT v Consolidated Press Holdings Ltd at [94], the Full Court in Calder v FCT at [79]-[80] stated:
“It is important, however, to bear in mind that the ultimate judgment as to purpose under s177D is holistic, albeit it requires that regard be paid to each of the eight factors listed in s177D(b). Indeed it can be expressed as a global or overall judgment provided that it is apparent that those factors have been considered.”
71. Critically, the pursuit of a commercial objective is not inconsistent with the existence of a dominant purpose of enabling the taxpayer to obtain a tax benefit. This has been pointed out:
(a)from the earliest authority, FCT v Spotless Services Ltd at 415, 416 (and see FCT v Consolidated Press Holdings Ltd at [96]);
(b)through the authorities concerning agricultural investments structured in substantially the same way as this one: FCT v Sleight per Hill J at [67.6] (Hely J agreeing) and per Carr J [206]; Calder v FCT at [92]; FCT v Cooke at [93];
(c)and, ultimately, confirmed by the High Court in FCT v Hart per Gleeson CJ and McHugh J at [16]-[18] per Gummow and Hayne JJ at [52], [68], [71]; per Callinan J at [93]-[96].
In both FCT v Spotless Services Ltd and FCT v Hart, the High Court emphasised the shape or form taken by the scheme as pointing to its purpose.
72. In light of the above, the applicant’s assertion that it “was a real business” begs the question posed by s 177D(b), as FCT v Hart indicates. There, Mr and Mrs Hart borrowed funds for, inter alia, an investment property. There is no question that the funds were borrowed for a commercial purpose or that they would secure an acceptable commercial return. Nevertheless, the form the loan took and the consequent tax advantages it secured founded the conclusion that the dominant purpose of the Harts in entering into and carrying out the scheme was to obtain tax benefits.
73. Here, as the prospectus made clear, in the section headed “Possible Taxation Implications for a Licensee engaging in Business”, for a Licensee who took the finance package and was on a 48.5% tax rate, the tax savings after deductions had been claimed exceeded the cash payments required.
74. The only requirements of a Licensee were the initial cash payments required on application and the later principal reduction. Payments in respect of license and management fees and further payments in respect of the loan were to be met only from the proceeds of the project.
75. Accordingly, a Licensee would keep the benefit of the tax savings without further risk and regardless of the outcome of the project. In the event, the commercial performance of the project was not material.
76. Moreover, the loans were not supported by cash and no actual funds were advanced by the Lender in respect of them. In the result, the project could only be conducted using cash payments made by Licensees. As such, the large up-front fees clearly had no commercial function.
77. The Tribunal is of the view that the only possible function of the initial fees and the loans was to gear up the available deductions.
Section 177D(b)(i): the manner in which the scheme was entered into or carried out
78. As noted above participation in the project was offered by a prospectus dated 29 May 1998 and amended by supplementary prospectus dated 19 May 1999.
79. As outlined above, the prospectus spelt out the positive net cash position as a result of deductions available to participants in the project regardless of its performance.
80. The applicant read the prospectus. He viewed the tax considerations as important.
81. The applicant signed up for the project the 1998 year and again in the 1999 year by completing the standard application form, option form and paying the required cash payments.
82. Nothing further was required of the applicant in order to participate.
83. The only other requirements of the applicant were made by the Loan Agreements, being payment of the once off principal repayments of $2,500. Subject to making those payments and the cash payments required on application, all other amounts were payable only from proceeds of the project with no personal obligation attaching to the applicant.
84. Accordingly, the carrying out of the project required nothing beyond making an application and the required cash payments. The applicant and other participants were then able to take the benefit of the available tax deductions regardless of the outcome of the project. There was no risk even if the project did not make any money.
85. The Lender was to advance funds to satisfy the obligations of the applicant and other participants who chose the finance package in respect of the year 1 management fees and part of the year 1 license fees.
86. The Lender purported to advance funds, but, as was intended, it did so without cash.
87. The sum of $13,500 per Licensed Interest was to be advanced as to:
(a)$13,000 for year 1 management fees;
(b)$500 for 25% of year 1 license fees.
88. Project entities’ financial reports for the 98 year indicate that for the 98 year there were 954 Licensees and loans of $12,879,000 (954 x $13,500) or $12,402,000 for year 1 management fees and $477,000 for 25% of year 1 license fees.
89. The evidence shows that the project entities resorted to a “round robin” of cheques which were drawn and exchanged but not cashed.
90. The T documents include a copy of an Agreement for Loan dated 30 June 1998 which was to be made between AMML as a lender and the Lender as a borrower under which AMML was to advance funds to the Lender to enable it to advance funds to participants in respect of the year 1 management fees.
91. The T documents also include a copy of the Investment Deed under which monies in respect of management fees were to be provided to the Trustee and the Trustee was to make payments to AMML.
92. Bank statements and other documents produced to the Tribunal show that a “round robin” of cheques which was put into place by AMML, the Lender and the Trustee, as follows:
(a)cheques from AMML to the Lender;
-cheque for $11,056,500 on 30 June 1998;
-cheque for $1,079,000 on 30 June 1998;
-cheque for $266,500 on 23 September 1998;
(b)cheques from the Lender to the Trustee:
-16 cheques for $650,000 each and one cheque for $656,500 on 30 June 1998;
-cheque for $650,000 and cheque for $429,000 on 8 July 1998;
-cheque for $266,500 on 22 September 1998;
(c)cheques from the Trustee back to AMML:
-cheque for $11,056,500 on 1 July 1998;
-cheque for $1,079,000 on 9 July 1998;
-cheque for $266,500 on 24 September 1998.
93. The key elements were:
(a)the purported funding of $13,000 per Licensed Interest with respect to year 1 management fees was effected by way of an exchange of cheques;
(b)the cheques were not cashed. Accordingly, there was no actual flow of funds.
94. There are not sufficient records of the project entities with respect to the balance of the amount to be lent for the 1998 year, or the amount to be lent for the 1999 year.
95. However, the Tribunal infers that the same process of “round robins” was implemented with respect of the balance of the amount to be lent for the 98 year, and repeated with respect to the amount to be lent for 99 year.
96. In the result, the only cash which was available to the project entities was that which was provided by the participants themselves, which, for those who took the finance package, was:
On application: Share purchase $2,000 75% of year 1 license fee $1,500 Year 1 interest $1,350 Stock purchase $100 Indemnity fee $400 By 30 September: Principal repayment $2,500 $7,850
97. The flow of funds into the project was thus confined to the cash payments made by the applicant and other participants. Accordingly, the license and management fees charged did not serve the commercial purposes of the project. Their only function was in the Tribunal’s opinion to inflate the amount of tax deductions that they might claim.
Section 177D(b)(ii) – the form and substance of the scheme
98. The scheme took the form of a business of “licensed marketer and seller of the full range of AAL’s products” which was commenced by the acquisition of a parcel of 2,000 A class shares and the appointment of a manager.
99. In substance, however, the project took a shape which was not necessary to achieve this outcome. That shape ensured deductions for large, initial license and management fees incurred but which, by the terms of the finance package, were never required to be met. The loan did not serve the commercial outcome of the project as obligations in respect of the license and management fees were not actually paid.
100. The following passage from Hill J’s judgment in FCT v Sleight makes the above point as well as articulating the relevant “alternative postulate” contemplated by Gummow and Hayne JJ in FCT v Hart at [66]. At [80] of his judgement in FCT v Sleight, Hill J stated as follows:
“Finally, it should be noted that the financial structure that the management agreement, loan agreement and indemnity agreement created was not necessary to the success of a tea tree project. Presumably the promoters, for example, could still have received the same amount of return by limiting the first year management fee to the actual cash outlay of the investor, and then adjusting the management fee in subsequent years to achieve this result. Arguably, an investor would thus have a legitimate, albeit significantly reduced, tax deduction for his cash outlay because it was actually a necessary cost of the project. This fact points towards a dominant tax incentive purpose because it could be objectively determined or concluded that an investor, who had a dominant commercial purpose, would prefer the project with a normal structure, rather than one which was so structured that it maximised the deductions available by the use of a somewhat artificial structure.” And see [82].
101. And see Calder v FCT at [69] and [117]. Participants in those schemes and here were, in substance, passive investors “in what, once the tax features are removed, is a managed fund where no deduction would be available …” (per Hill J in FCT v Sleight at [81]).
Section 177D(b)(iii) – the time at which the scheme was entered into and the length of the period during which the scheme was carried out
102. The prospectus was dated 28 May 1998 offering investment in the project which was to run to 2017.
103. The applicant applied to participate in the project in late June 1998 and again in late 1999.
104. After the once off principal repayments had been paid, the applicant’s participation in the project effectively ceased.
Section 177D(b)(iv) – the result in relation to the operation of this Act that, but for this Part would be achieved by the scheme
105. But for Part IVA, the result of the scheme was that the applicant became entitled, in each of the 98 year and the 99 year, to deductions totalling $16,750 in respect of license and management fees, interest and indemnity fee.
Section 177D(b)(v) – any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme
106. Beyond the required cash payments, the applicant did not have to contribute any more money. License and management fees were to be recouped only from such gross income as the project might generate. So too principal and interest payments on the balance of the loan.
107. The applicant generated deductions sufficient to recoup most of the cash payments required of him. On a total cash outlay of $15,700 the applicant was able to recoup $14,039.48, calculated as:
1998 year Tax and Medicare Levy less rebates and credits on original assessment $138.72 Tax and Medicare Levy less rebates and credits on amended assessment $6,228.53 Tax saving $6,089.81 1999 year Tax and Medicare Levy less rebates and credits on original assessment $1,587.82 Tax and Medicare Levy less rebates and credits on amended assessment $9,537.49 Tax saving $7,949.67
108. The statements of income and expenditure produced by the applicant show income of:
(a)in respect of his investment in the 1998 year - $458, $188.26; $362.79 and $682.65;
(b)in respect of his investment in the 1999 year - $188.26, $362.69 and $682.65,
set off against license, management fees and other charges, resulting in a net deficit to be carried forward.
109. Accordingly, the applicant’s participation in the project has not resulted in any change in his financial position beyond the benefit created by the deductions claimed by him.
110. The deductions clearly had a considerable value to the applicant, particularly if the other deductions claimed by him were not allowable. See FCT v Sleight per Hill J at [88] (Hely J agreeing) and Carr J at [225].
111. Moreover, as Carr J observed, in FCT v Sleight at [224]:
“on a proper construction of s 177D(b) the assessment should be made, in respect of this factor … as at the time of entry into the scheme. A reasonable person would be entitled to draw his conclusion about dominant purpose on the basis that [Mr Sleight] entered into three schemes at the one time and that each of those schemes would result (but for Part IVA) in the allowance of the deductions claimed.”
112. In FCT v Sleight the Court contrasted the availability of deductions with the uncertainty of the investment yields which the project there might realise (see Hill J at [88], [93], [94] and per Carr J at [216], [226]–[227]).
113. Beyond the cash advantages afforded by the tax savings, it could not be reasonably expected that there would be any material change in the financial position of the applicant and other participants as a result of their participation.
114. The project was a speculative venture, marketing and selling aloe vera products. Achievement of the projected income was stated to be dependent upon agricultural risks, selling price and production levels.
115. As the prospectus noted, AAL was a newly formed company. It had no business. Nor did AMML.
116. The income projections were no more than bare illustrations extrapolated over 19 years from a four year estimate.
117. The projections were by their very nature unreliable. Being made over 19 years, they, necessarily, were no more than predictions the further out they purported to state returns. Moreover, they unrealistically predicted increasing returns notwithstanding the vagaries of business, agriculture and the market. As noted above, the achievement of those returns was dependent on the coming together of a number of uncertain variables.
118. How the internal rate of return of 19.5% was calculated was not made clear. Nor when the initial investment might be recouped, by contrast to the early tax advantages. Apart from the early tax advantages, it was not clear when a participant might expect a return on his or her investment.
119. In the end, participants could not in the Tribunal’s view reasonably expect any material return beyond the early tax benefits their participation yielded. Indeed, because of the early tax benefits and the limited recourse terms of the loans, participants could participate in the project without any risk to their own funds. Accordingly, participants could take a chance on the commercial performance of the project. Its actual performance was of limited concern. Any return achieved was an additional benefit but by no means certain compared with the expected tax benefits.
Section 177D(b)(vi) – any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result from the scheme
120. In the initial years of the project, beyond the cash payments sourced from participants’ tax savings, the financial position of the project entities did not change as a result of the scheme. Loan funds were not made available and were not intended to be.
121. From any income derived from the project, until the loan was repaid, the promoter entities were to apply income in payment of license and management fees and interest and payments under the loan (the balance payable to the participant would have to be applied to meet his or her tax liabilities on that income).
122. In addition, AMML was to receive under the Management Agreement a further management fee or fees out of the net proceeds.
Section 177D(b)(vii) – any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out
123. It appears that there was no other relevant consequence.
Section 177D(b)(viii) – the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi),
124. The Company searches reveal that AAL, AMML and the Lender had directors in common. There were various shareholders. There may have been other connections.
Section 177D(b) – conclusion
125. The above consideration of the s 177D(b) factors reveals that the scheme took:
“such a form that there is a particular scheme in respect of which a conclusion of the kind described in s 177D is required, even though the particular scheme also advances a wider commercial objective”.
See FCT v Hart per Gleeson CJ and McHugh J at [16].
126. The following aspects of the scheme were extraneous to the substance of an investment in a commercial project:
(a) large up-front charges of a revenue character;
(b) funded by a loan;
(c) made on limited recourse terms; and
(d)ongoing project charges to be met only from the proceeds of the project.
127. These aspects served no purpose except to create large tax deductions from which the project could be funded, without further demand being made on the participants. They certainly did not fund the commercial conduct of the project. The loans were not supported by cash. In the result, the project could only be conducted using cash payments made by participants. The commercial performance of the project was not material.
128. Accordingly, it would be concluded that:
(a)the dominant purpose of the applicant, in entering into or carrying out the scheme, was to obtain the tax benefits;
(b)the dominant purpose of the project entities, in entering into or carrying out the scheme, was to obtain the tax benefits for the applicant as a participant in the project. It is not to the point that the overall commercial objective of the project entities was to make money. They achieved their commercial purpose by creating a structure to which the attractiveness of the tax advantages it secured was central. Obiter comments made in the Full Court decisions in Vincent v FCT at [100] and FCT v Sleight at [95]‑[96] must now be read in light of the High Court’s decision in FCT v Hart.
Conclusion with respect to Part IVA
129. It follows from the foregoing that in the Tribunal’s opinion in respect of each of the 1998 year and the 1999 year, the respondent was authorised and entitled under s 177F(1)(b) to determine that the claimed deductions were not allowable.
130. As the reasons for decision show and the applicant acknowledges, the respondent made the determinations in connection with his consideration of the applicant’s objections against the amended assessments for each year: see s 169A(3) of the 36 Act.
131. As the Tribunal finds that the claimed deductions are allowable under s51(1) or s 8-1 and that Part IVA operates to disallow the claimed deductions, reflecting the reasoning in FCT v Sleight per Hill J at [112]-[115] (Hely J agreeing) and per Carr J at [246], the Tribunal may, in the exercise of discretion under s 177F(1)(b), determine to cancel only that amount which the applicant borrowed in each year and the Tribunal does so determine. As a result, the applicant’s cash payments of $3,250 ($16,750 less $13,500) and the additional amount of $2,500 should be allowed.
Additional tax
132. The respondent imposed additional tax by way of penalty pursuant to s 226L, alternatively s 226, of the 36 Act at the rate of 50% of the tax shortfall, reduced by 80% to 10% for voluntary disclosure.
133. The Tribunal is of the view that there is nothing in the applicant’s material which supports a remission or different penalty.
Settlement offer
134. Contrary to what the applicant claims (see, for example, pars 96-97 of the applicant’s statement of facts, issues and contentions) no issue can or does arise as to whether the applicant should have access to the terms of a settlement offer announced in February 2002 to participants in the project. The role of the Tribunal is to review the merits of the objection decisions before it: s 14ZZ of the Taxation Administration Act 1953; s 43 of the Administrative Appeals Tribunal Act 1975. How the respondent may have settled disputes with other taxpayers is not relevant to any issue which arises in this application.
DECISION
135. The Tribunal sets aside the decisions under review to the extent that the amounts paid by the applicant in cash should be allowed as a deduction but the assessment should otherwise stand and remits the matter to the respondent to issue further amended assessments to the applicant to give effect to the Tribunal’s decision.
I certify that the 135 preceding paragraphs are a true copy of the reasons for the decision herein of Mr A Sweidan, Senior Member
Signed: ................[Sgd Ms C Skinner].........................
AssociateDate/s of Hearing 3 May 2007
Date of Decision 28 September 2007
Solicitor for the Applicant Self-represented
Counsel for the Respondent Ms D Harding
Solicitor for the Respondent Australian Government Solicitor
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