BCD Technologies Pty Ltd and Commissioner of Taxation
[2006] AATA 241
•15 March 2006
Administrative
Appeals
Tribunal
DECISION AND REASONS FOR DECISION [2006] AATA 241
ADMINISTRATIVE APPEALS TRIBUNAL )
) No QT2005/162
TAXATION APPEALS DIVISION ) Re BCD TECHNOLOGIES PTY LTD Applicant
And
COMMISSIONER OF TAXATION
Respondent
DECISION
Tribunal Senior Member B J McCabe Date15 March 2006
PlaceBrisbane
Decision The objection decision under review is set aside. The Tribunal decides in substitution that the amount of the management fee negotiated in June 1996 should be allowed as a deduction.
.......[Sgd].......
BJ McCabe
SENIOR MEMBER
CATCHWORDS
TAXATION – allowable deductions – restructuring of business – management service company arrangement – deduction claimed for pre-payment of management services – primary intention for the restructuring was to limit potential legal liability – deduction incurred during the relevant period – expenditure incurred on services was made for a business purpose
Income Tax Assessment Act 1936 s 51, s 226H
BCD Technologies Pty Ltd and Commissioner of Taxation [2004] AATA 496
Commissioner of Taxation v BCD Technologies Pty Ltd (2005) 144 FCR 457
Federal Commissioner of Taxation v Brand (1995) 95 ATC 4633
Federal Commissioner of Taxation v Ilbery (1981) 81 ATC 4661
Federal Commissioner of Taxation v Phillips (1978) 20 ALR 607
Fletcher v Federal Commissioner of Taxation (1991) 173 CLR 1
Magna Alloys and Research Pty Ltd v Federal Commissioner of Taxation (1980) 33 ALR 213
Meridian Global Funds Management v Securities Commission [1995] 2 AC 500
Newton v Federal Commissioner of Taxation (1958) 98 CLR 1
Nilsen Development Laboratories Pty Ltd v Federal Commissioner of Taxation (1981) 144 CLR 616
The Taxpayer and Commissioner of Taxation [2004] AATA 398
REASONS FOR DECISION
15 March 2006 Senior Member B J McCabe 1. BCD Technologies Pty Ltd (BCDT) is the applicant in these proceedings. BCDT claimed a deduction in the amount of $1,165,000 in respect of management fees it agreed to pay to another company in the year of income ending 30 June 1996. The tax return was lodged in November 1996. The Commissioner issued an amended assessment on 20 November 2000, some four years after the return was filed. The Commissioner disallowed the deduction and imposed a penalty on the tax shortfall that resulted.
2. The applicant argued before the Tribunal that the assessment was out of time, and of no effect. The Tribunal agreed (see BCD Technologies Pty Ltd and Commissioner of Taxation [2004] AATA 496) but that finding was set aside by the Federal Court on appeal: Commissioner of Taxation v BCD Technologies Pty Ltd (2005) 144 FCR 457. The matter was remitted to the Tribunal. The parties agreed the Tribunal should proceed on the material already before it. They declined the opportunity to present fresh evidence or make further submissions.
3. The Tribunal must now consider whether the amount of $1,165,000 is an allowable deduction under s 51(1) of the Income Tax Assessment Act 1936 (ITAA36). If it is not, the Tribunal must decide whether the taxpayer’s conduct in seeking a deduction was reckless so that a penalty under s 226H of ITAA36 was properly imposed, and (if it was properly imposed) whether that penalty should be remitted.
the material before the tribunal
4. The Tribunal was provided with the documents required under s 37 of the Administrative Appeals Tribunal Act 1975 and the contents of the appeal file from the Federal Court. The following documents were also tendered in evidence at the original hearing:
• statement of Robert Williams dated 5 June 2003;
• statement of Robert Williams dated 28 August 2003;
• statement of Robert Williams dated 4 November 2003;
• statement of Marius Krynen dated 6 June 2003
• statement of Marius Krynen dated 23 August 2003;
• statement of Catherine Brewer dated 24 June 2003;
• statement of Catherine Brewer dated 16 September 2003;
• statement of Catherine Brewer dated 4 October 2003;
• statement and resume of Darren Moore dated 6 June 2003;
• a document headed “Chester Hill Centre Pty Ltd and BCD Management Pty
Ltd”;• a document summarising the management fees relevant to the hearing;
• letter from the Australian Taxation Office to Catherine Brewer dated 29
October 2003;• a fax from Catherine Brewer to the Australian Taxation Office and a further
amended notice of objection dated 31 October 2003.
Several witnesses also gave oral testimony:
• Robert Williams;
• Marius Krynen;
• Prashant Singh; and
• Simon Wood.
5. The taxpayer was represented at the hearing by Mr Doyle, SC. Mr Hack, SC represented the Commissioner.
the facts
6. BCDT was incorporated in 1986. It was named Refwod Pty Ltd at the time. It changed its name in November 1996 to BCD Technologies Pty Ltd. Marius Krynen and Robert Williams were the directors of the applicant throughout the relevant period. They are both engineers.
7. Mr Krynen said he was principally responsible for the “technical side of the business”: exhibit five at paragraph 2. He said he left all of the “financial matters, such as superannuation, payment of accounts, taxation returns etc” to Mr Williams. Mr Krynen admitted (at paragraph 3) he did not have a clear understanding of the “finer details of transactions at the time they occur”.
8. BCDT was in the business of processing and disposing of organic pollutants. (Its name is an acronym: it stands for Base Catalysed Dechlorination.) The business was starting to grow in the mid-1990s. Mr Williams gave evidence that he met with his accountant, Mr Steve Hart, in March 1996 to discuss the need for an appropriate business structure. Mr Williams said he hoped to devise a structure that would allow the growing business to operate more efficiently: see evidence in chief transcript at pp 25-26. He says he also discussed with Mr Hart (and the other personnel from Harts who were present) the possibility of legitimately limiting the applicant’s liability to pay tax, and the desirability of using a structure that would protect the company’s assets. This last concern apparently weighed heavily on the minds of both directors. That is understandable: there would presumably be a serious risk of being sued in the clean-up business. Mr Krynen explained in his statement his concern about contamination liability. He recalled an incident where a waste drum leaked. He said that could have resulted in a large damages claim. The experience made him very nervous and served to concentrate his mind on the need for asset protection. Mr Williams also spoke about concerns over contamination liability claims in the course of his evidence in chief (transcript, pp 24-25). He confirmed in cross-examination (transcript, p 41) he was particularly concerned about protecting the company’s assets from claims by employees and former employees.
9. After a discussion with Messrs Harts, the directors of BCDT decided to establish another company that would provide management services. BCD Management Pty Ltd (BCDM) was incorporated to this end on 27 June 1996. Mr Krynen and Mr Williams were appointed as directors of the new company. For reasons that were never adequately explained, the shares in the new company were held by Harts Consulting Pty Ltd. Mr Williams said that was a matter of some concern given Mr Hart was “an acrobatic flyer” and something might happen to him: see supplementary T document 54 at p 224. Mr Williams said in his statement (exhibit 2) that Mr Hart provided a signed share transfer, which put the directors’ minds at ease.
10. The directors say the new company provided management services to BCDT. They say BCDT agreed to pay BCDM a fee for the services. A sizeable fee, as it happened: in its 1996 income tax return, BCDT claimed a deduction in the amount of $1,165,000. Mr Williams explained his understanding of the agreement in his affidavit (exhibit one at paragraph 21-25). He said the taxpayer was to enter into a commitment to pay the fee before the end of each financial year in respect of the following year’s operations. Mr Williams explained that the amount of the payment each year was calculated with reference to the expenses of the company in the preceding year. (Mr Williams said these expenses totalled around $900,000 in the year ending 30 June 1996.) He said it was easy enough to make a forecast because the company kept good records. Mr Williams said in his evidence in chief (transcript pp 31-32) it was necessary to make an estimate and commit to a pre-payment of at least a portion of the fee because BCDM was a new company and did not have any cash or assets of its own. He said a payment of $59,093 was made to BCDM before the end of the financial year to this end.
11. The fee BCDT agreed to pay to BCDM also included a 15% “mark-up” or margin. Mr Williams said the margin was added on the advice of Mr Hart: exhibit two at paragraph 21.
12. Mr Williams said Mr Hart did not explain at the time what was to happen to profits accumulating in BCDM as a result of the mark-up. Mr Williams said he was not aware until 1998 that a substantial profit was accumulating in BCDM: exhibit three at paragraph 3. Mr Krynen had an even more tenuous grasp of the details of the mark-up. In his statement, he said (exhibit 6 at paragraph 2):
At the time these arrangements were put into place, I knew there was to be some sort of mark-up on the management fees being paid by Technology to Management, but I didn’t know what the mark-up was to be, didn’t really understand it and never discussed what would happen to the profits. At the time, it didn’t even occur to me that there would be profits left over in Management.
13. In his statement to the National Crime Authority (supplementary T document 54 at p 257), Mr Williams says he recalls Mr Hart mentioning “a company of his in Sydney that had losses that could be utilised to offset profits made”. Mr Williams said Mr Hart did not mention the name of the company in question but demonstrated on a white board how the arrangement worked. Mr Hart assured Mr Williams it was all legal, and Mr Williams signed a number of documents. In his statement (exhibit three at paragraph 6) Mr Williams says he realised some time later that one of the documents he signed was a s 80G Loss Transfer Agreement. He agrees the document identified the other Hart company but says he was not aware of that at the time. Mr Williams made it clear in his evidence in chief he did not read the documents closely and relied on the advice of Mr Hart: transcript at pp 27-28.
14. The directors of BCDT say the agreement was entered into prior to the end of the financial year in question at a meeting. Mr Williams’s recollection of the meeting was hazy. He told the Tribunal during his evidence in chief that the meeting was held at the offices of Mr Hart. He said Mr Krynen was not present, but Mr Martin and Ms Ismail (employees of Mr Hart) attended along with Mr Hart. Under cross-examination, Mr Williams suggested Mr Krynen was present: transcript, p 44. Mr Williams said he kept a diary but did not have an entry noting the time or date of the meeting. He could not recall the details of the discussions, although he insisted they discussed the respective roles of BCDM and BCDT. He also says they discussed the accounts of BCDT with a view to working out the quantum of the fee to be paid to BCDM pursuant to the agreement.
15. Mr Krynen confirmed he was present at the meeting. He was unsure of the date. He recalled Mr Hart making a presentation that lacked detail. Mr Krynen said he had the impression most of the details had already been worked out with Mr Williams: transcript pp 72-73. Mr Krynen recalls the discussion covering, inter alia, asset protection and the role and benefits of using a management company. He added that he was “mostly a spectator in that meeting” (transcript, p 75). He did not clearly recollect the amount of the fee to be paid to BCDM being mentioned in the course of the discussion, although he said he had a vague recollection of Mr Williams performing a calculation: transcript p 76. He said he subsequently asked his own accountant whether it was common to pay a management company to provide services. The accountant agreed it was not unusual: transcript p 82.
16. Although a written service agreement was not executed until November 1996, the directors claim they regarded both companies as being bound by the arrangement as of late June 1996. I note the agreement provided for the payment of “a reasonable fee having regard to the services provided”: exhibit one p 58 at clause 3.1. The agreement does not specify how the reasonable fee is to be calculated, although it permits any dispute to be referred to an arbitrator. Nor does the written agreement require that the fee be pre-paid - but it clearly contemplates that occurring because it refers to the possibility of a discount in the event the fees were pre-paid: clause 3.3. Clause 3.3 says the taxpayer may assume the “forward service fee” (the pre-payment) for a given month was the same as the fee paid in the preceding month. It follows there is some inconsistency between the directors’ account of their understanding of the agreement and the terms of the written document.
17. A number of steps were taken which are consistent with the directors’ account of events. Mr Williams’s statement (exhibit 2, paragraph 17) records that a bank account was opened in the name of BCDM in late June 1996. He pointed out “[r]eal money was deposited, there was no round robin of cheques”. He added “all expenses were paid out of this account from 1 July 1996”. Copies of the bank statements relating to the account were annexed to the affidavit of Mr Williams.
18. Mr Williams went on to claim any new financial agreements were entered into in BCDM’s name. That company wrote letters on its own letterhead and made credit applications in its own name. It purchased stock and employed the taxpayer’s employees. The affidavit of Mr Williams annexes employee declarations completed in respect of several employees identifying BCDM as the employer. Those documents were completed in July and August 1996.
19. A member of the firm who replaced Messrs Hart and Co as accountants for the taxpayer also provided a statement. Mr Darren Moore said his firm conducted a careful review of the books of BCDT and BCDM when they took over from Harts in 2001. He concluded:
It was clear from the review of the accounts that from the beginning of the 1997 financial year, Management was the entity that attended to the financial side of the business. The Applicant still remained as the entity that invoiced all the sales to its customers and incurred the ongoing direct costs in terms of research and development. However, Management took over and paid for all the other running costs of the business, such as staff wages, superannuation, rent, Workcover expenses, hire of equipment, freight and cartage, laboratory costs, repairs and maintenance.
20. Mr Williams conceded (exhibit two at paragraph 18) his own role did not change in a practical sense but he insisted that role was now performed on behalf of BCDM.
21. Mr Williams acknowledged in his statement (exhibit 2, at paragraph 17) it took about a year to formally substitute the name of BCDM for BCDT on each and every document or agreement. But he made it clear that as of 1 July 1996 BCDM:
…made all the decisions in relation to the management of the business including financial decisions and has also paid all the expenses of the business.
22. After taking into account a deduction in respect of that payment, the applicant’s tax return for the year of income ending 30 June 1996 disclosed nil taxable income. The return was filed on or about 18 November 1996.
23. Mr Williams said (exhibit two at paragraph 23) BCDT continued to pay a fee to BCDM pursuant to the agreement until 2001 based on a forecast of expenditures. The amount of the fee actually paid each year was set out in exhibit 12.
24. Mr Williams said the arrangement worked well. He explained in his statement (exhibit two at paragraph 35):
…setting up of the management company alleviated a considerable amount of pressure on the operating company in respect of its accounting and other business activities and I considered that the introduction of the management company was an extremely good and efficient idea.
25. The directors decided to end the arrangement after discussion with the Commissioner’s officers in 2001: exhibit two, paragraph 36.
26. The respondent disputes the taxpayer’s claim that it agreed to pay the management fee prior to the end of the financial year. Mr Hack, for the respondent, suggested to Mr Williams there was no oral agreement concluded in June 1996. Mr Hack pointed out the document evidencing the agreement signed in November that year did not refer to an earlier oral agreement. He also asked about the reference in the document to BCDM being the owner of certain property which he suggested it did not in fact own: transcript at p 50-51. Mr Williams was not able to offer a clear response – although he was able to suggest to Mr Doyle in re-examination that BCDT’s balance sheet for June 1997 showed the company did not hold plant, equipment or motor vehicles because they had been transferred to BCDM.
27. Mr Williams conceded he did not have an accurate recollection of how he arrived at the estimate of costs that was used to calculate the fee, but he insists he did it at the meeting: transcript at pp 55-56.
28. Mr Williams also conceded Harts did not appear to record the payment of $59,093 to BCDM at the end of June in the accounts. Mr Williams said that was presumably an error on the part of Harts – one of many, he said: transcript at p 56.
29. Mr Hack asked Mr Williams about the size of the fee paid to Mr Hart’s firm for its services. Harts had been paid at least $300,000 in the year of income in question. Mr Williams said Mr Hart’s firm has provided accounting and other business advice. Mr Williams at first denied this was an unusually large amount to pay a financial adviser: transcript p 59. He later said he thought the fee was extravagant: transcript p 60. Mr Hack asked whether the fee was calculated with reference to the amount of tax saved. Mr Williams said it was not.
30. Counsel for the respondent also questioned Mr Williams about inconsistencies between his evidence about the expenses of the taxpayer in the 1996 year of income and the figures referred to in the Amended Notice of Objection included at p 28 of the T documents. Mr Williams was unable to explain the discrepancy. He admitted sheepishly that he had signed the document without reading it on the advice of Mr Hart. He explained away other discrepancies in the same way.
31. Mr Hack questioned Mr Krynen about his understanding of the tax implications of the arrangement the taxpayer had entered into. It was apparent from Mr Krynen’s answers that he had a limited appreciation of the tax implications: see transcript at p 83ff. He said he trusted his accountant and Mr Williams.
32. The respondent says the taxpayer and its accountant devised the agreement after 30 June 1996 when the company’s accounts were being prepared. The respondent says the amount of the management fee was calculated so as to reduce the amount of taxable income to nil. The Commissioner questions the claim that the arrangement was motivated at least in part by a desire to protect assets. It was pointed out the agreement which was eventually signed appeared to compromise that protection by including an indemnity from BCDT in respect of employees’ claims against BCDM: exhibit one at p 62, clause 9. The directors’ evidence suggests they did not read that document before signing it. There is no other evidence to suggest an indemnity formed part of the agreement the directors say the taxpayer struck at the end of June 1996.
33. Mr Doyle noted in his submissions that an attempt had been made by the applicant to have Mr Hart give evidence. Mr Hart declined.
observations about the evidence and findings of fact
34. I am satisfied Messrs Williams and Krynen were truthful witnesses, although both of them had a poor recollection of some of the events. That is explained in part by the passage of time: the key events occurred several years ago. But I think the real reason for their difficulty in recalling the detail of all the events lay in the fact they were not paying particularly close attention at the time. Mr Krynen made it clear he left the financial matters to Mr Williams, who was clearly the directing mind and will of the company on these questions: see Meridian Global Funds Management v Securities Commission [1995] 2 AC 500; see also The Taxpayer and Commissioner of Taxation [2004] AATA 398. Mr Krynen said he preferred to concentrate on the operational side of the business. Mr Williams, for his part, struck me as being out of his depth in his dealings with Mr Hart. Mr Williams admitted he did not always read the documents he was asked to sign. He said – and, after hearing his evidence, I accept – he trusted Mr Hart’s advice about the suitability and effect of the arrangements the company entered into. It appears some of those arrangements at least did not do what Mr Hart said they would: for example, the taxpayer’s stated objective of using BCDM to protect BCDT from risk was compromised by the terms of the agreement between the companies which provided for an indemnity. I accept Mr Williams’s claim he was unaware of that provision or its implications.
35. I am satisfied the applicant entered into an oral agreement prior to the end of June 1996 committing it to pay a management fee to BCDM. I accept Mr Williams’s explanation that he thought that was appropriate given BCDM was a new company without assets or income of its own, and that it needed some assurance it would be able to meet its obligations over the course of the financial year. I think the existence of an agreement (albeit one that was not documented until later in the year) is the best explanation for the conduct of BCDT and BCDM in the months that followed, including:
·BCDM opening a bank account and paying expenses of BCDT using monies transferred to it by BCDT;
·BCDM employing staff working for BCDT; and
·BCDM entering into other arrangements for the benefit of BCDT.
36. I am also satisfied the amount of the fee payable in respect of the expenses for the 1997 year of income was calculated at the end of June 1996. I accept Mr Williams’s evidence that he performed a “back of the envelope” calculation at a meeting held with Mr Hart and others and provided an estimate to which was added a 15% premium, and that the first instalment of the fee was paid before the end of the financial year. I note the written agreement did not on its terms expressly require that the taxpayer commit to paying the full amount of the following year’s fee to BCDM prior to the end of the financial year. Even so, I accept the evidence of Mr Williams that he understood BCDT became obliged in June 1996 to pay the full amount of the fee, albeit that the whole amount was not paid over immediately.
37. I also accept the explanation of Messrs Krynen and Williams that a desire to protect assets was the taxpayer’s principal motivation in agreeing to the establishment of a service company arrangement with BCDM. I acknowledge the fine print of the agreement when it finally appeared compromised the achievement of that object, however I am satisfied the directors were not conscious of the anomaly when they authorised the agreement at the end of June 1996. I accept the directors were also attracted to the possibility of a more stream-lined, efficient structure (although it is doubtful whether that was the result). I do not think either of the directors thought about this objective very deeply: they appeared to accept the arrangement uncritically as an incident of a growing business, as evidenced by Mr Krynen’s discussion with his own accountant about whether this sort of arrangement was normal.
38. I accept the directors welcomed the prospect of paying less tax. But I think this objective was ultimately of secondary importance: they were motivated by a desire to insulate themselves and their assets against claims by employees and others. I am satisfied they would have proceeded with an arrangement like this even if there was no tax advantage in prospect. The concern about liability claims was almost certainly a reasonable one. The prospect of a tax benefit was an added feature of the arrangement for the taxpayer rather than a primary objective. Whether Mr Hart saw the arrangement in the same terms is necessarily a matter of speculation.
39. Experienced directors might have been more cautious in their dealings with Mr Hart. They would have examined his proposals with a more critical eye, particularly given the size of the fees Mr Hart was charging. Messrs Krynen and Williams were engineers trying to manage a successful and rapidly growing small business. Mr Williams in particular bore the burden of this task. He put his trust in Mr Hart. That was a mistake.
the legislation
40. The Commissioner did not press an allegation that the agreement in question was caught under Part IVA of ITAA36.
41. Section 51(1) of ITAA36 governs deductions claimed in the period under review. The section provides:
All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income.
42. I must first decide whether the amount of the fees was incurred in the 1996 year of income in circumstances when only a portion of that agreed amount was actually paid before 30 June 1996. Given the findings of fact I have made, it seems clear enough the whole amount claimed as a deduction was actually incurred during the relevant period because the applicant agreed to pay the money. The High Court has made it clear in cases like Nilsen Development Laboratories Pty Ltd v Federal Commissioner of Taxation (1981) 144 CLR 616 that a presently existing liability to pay may amount to incurring the expenditure even though the liability is not discharged until some future point: at 627, per Gibbs J. In this case, the agreement to pay a particular amount was made prior to the end of the financial year. Some of the money was paid; the balance remained payable, and was recorded as a loan in the books of the companies. An enforceable obligation to pay the whole amount came into existence during the year of income, and was therefore incurred at that point.
43. The Commissioner says the taxpayer should not be able to claim a deduction because the commitment to make the payment was not entered into with the purpose of gaining or producing assessable income. (There is no suggestion the outgoings were losses or outgoings of capital, or of a capital, private or domestic nature.) The applicant disagrees: it says the payments were made to secure services from BCDM which were necessary to carry on BCDT’s business and derive assessable income.
44. The High Court explained in Fletcher v Federal Commissioner of Taxation (1991) 173 CLR 1 (at 17 per Mason CJ, Brennan, Deane, Dawson, Toohey, Gaudron and McHugh JJ) that:
The question whether an outgoing was, for the purposes of s.51(1), wholly or partly "incurred in gaining or producing the assessable income" is a question of characterization.
45. In the course of answering that question, the High Court said it may be permissible to have regard to the subjective purpose of the taxpayer in making the expenditure. Their Honours explained (at 17):
At least in a case where the outgoing has been voluntarily incurred, the end which the taxpayer subjectively had in view in incurring it may, depending upon the circumstances of the particular case, constitute an element, and possibly the decisive element, in characterization of either the whole or part of the outgoing for the purposes of the sub-section.
46. I have already concluded the taxpayer’s objective in entering into the arrangement with BCDM was to protect BCDT assets in the event of a claim. The prospect of a tax advantage might have acted as an extra incentive to adopt the structure suggested by Mr Hart and make a commitment with respect to the fees prior to the end of June 1996, but I accept the company’s decision to proceed with the arrangement in the first place was made with a view to accomplishing a commercial objective (ie, limiting liability). To borrow the language of Lord Denning in Newton v Federal Commissioner of Taxation (1958) 98 CLR 1 at 8, the arrangement was explicable “by reference to ordinary business or family dealing”. Whether or not the arrangements adopted were the best or wisest way of achieving the taxpayer’s legitimate objective is beside the point: see Magna Alloys and Research Pty Ltd v Federal Commissioner of Taxation (1980) 33 ALR 213 at 232-233 per Deane and Fisher JJ. Once the arrangements were in place, with a separation of functions between the management and service companies, BCDT had no choice but to acquire the services it needed in order to carry on its business – much as the taxpayer in Federal Commissioner of Taxation v Phillips (1978) 20 ALR 607 had no choice but to deal with the service company he and his partners had created in the course of running an accountancy practice. It follows the expenditure incurred on the acquisition of services in this case was made for a business purpose.
47. The Commissioner disputes that view, but focuses in any event on one aspect of the transaction: the timing of the commitment to pay the fee. He says the decision to commit to a payment of the fee prior to the end of June 1996 casts the whole of the transaction in a different light. The applicant says the High Court’s decision in Fletcher suggests it is artificial to focus on one aspect of the transaction when ascertaining the purpose of the expenditure.
48. The Full Federal Court considered the approach to deductions in respect of pre-payments in its decision in Federal Commissioner of Taxation v Brand (1995) 95 ATC 4633. In that case, an investor in a prawn farming business chose to pre-pay an obligation at the end of one year of income and claimed a deduction of the whole amount. The Court rejected a submission by the Commissioner that an expense must be contemporaneous with the process by which the income is derived or is to be derived: at 4645-4646 per Lee and Lindgren JJ. Even so, the Court acknowledged a “temporal hiatus” between incurring the expenditure and the activity to which it is directed “may suggest that the outgoing was incurred for some purpose other than the gaining or producing of assessable income”: at 4646.
49. The Court accepted there were good commercial reasons for the pre-payment in Brand. In this case, the applicant did not pre-pay the whole of the amount it has claimed as a deduction; it pre-paid a portion of the amount at the end of June 1996 and allowed the management company to draw down on the amount BCDT committed to pay as the expenses were incurred by BCDM throughout 1997.
50. The taxpayer’s decision to commit to paying the full amount of the fee – ie, the timing of the payment - may have been influenced by the prospect of a tax advantage, but that does not necessarily change the character of the expenditure. Practically every business and family structuring and their workings involve tax saving considerations. It is a normal incident of business activities to keep an eye out for the tax effects of decisions and for opportunities to lawfully minimise taxes. This does not disqualify the outgoings as to deductions, even in part.
51. I am satisfied the prospect of the tax advantage to be derived from entering into a commitment in June 1996 with respect to the whole of the following year’s expenses does not change the character of the expenditure in this case. As in Brand, I accept there was a commercial explanation for the decision: the applicant wished to ensure the service company had the resources it needed to do its job. I accept the taxpayer knew it would derive a tax benefit by accepting an obligation in June 1996, but I do not accept the prospect of a tax advantage assumed such importance that it became the purpose of the expenditure – even if it was a purpose of the timing of the expenditure: see Corkery, Section 51(1) – the rock of purpose amid storms of form and waves of inconsistency, Taxation Institute Convention Papers, April 1984, p22. As I have already pointed out, I accept the applicant would have pursued an arrangement like this in any event in order to protect its assets from claims arising out of the risky nature of the business. The case can be contrasted with the decision in Federal Commissioner of Taxation v Ilbery (1981) 81 ATC 4661. In that case, the Full Federal Court concluded a prepayment of interest was not deductible because it was made exclusively for the purpose of securing a tax advantage.
conclusion
52. The objection decision under review should be set aside. I find in substitution that the amount of the management fee negotiated in June 1996 should be allowed as a deduction.
I certify that the 52 preceding paragraphs are a true copy of the reasons for the decision herein of Senior Member B J McCabe
Signed: Associate Adam Ryan
Date of Decision 15 March 2006
Matter heard on the papers.
0
11
0