Commissioner of Taxation v Osborne

[1990] FCA 362

Re: METROPOLITAN OIL DISTRIBUTORS (SYDNEY) PTY LIMITED
And: COMMISSIONER OF TAXATION
Nos. G3396-G3399 of 1987
FED No. 362
Taxation

COURT

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY
GENERAL DIVISION
Davies J.(1)

CATCHWORDS

Taxation - Income Tax - s.51(1) of the Income Tax Assessment Act 1936 (Cth) - taxpayer borrowed money at a commercial rate of interest allegedly to acquire the land and goodwill of petroleum distributing business - whether expenditure on interest paid deductible - whether interest paid incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.

Taxation - Income tax - tax evasion - s.260 of the Income Tax Assessment Act 1936 (Cth) - whether arrangement void against Commissioner of Taxation - whether intention to gain taxation benefit precludes deductibility.

Income Tax Assessment Act 1936 (Cth) - ss.51, 260

HEARING

SYDNEY

#DATE 20:7:1990

Counsel for the applicant: Mr D.H. Bloom QC,

Mr A.H. Slater and Mr F.P. Carnovale

Solicitors for the applicant: Messrs J.W. Walker and

Mr D.K.L. Raphael

Counsel for the respondent: Mr A.R. Emmett QC and

Mr S.W. Gibb

Solicitor for the respondent: Australian Government Solicitor

ORDER

The appeals be allowed and the Commissioner's decisions on the objections be set aside and the matter be remitted to the Commissioner to be dealt with according to law.

The respondent pay the costs of the proceedings.

NOTE: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

JUDGE1

The applicant, Metropolitan Oil Distributors (Sydney) Pty Limited (MOD (Syd)) appeals against decisions of the Commissioner on its objections to assessments to income tax for the substituted accounting periods ended 31 December 1981 to 31 December 1984 inclusive. In each year, MOD (Syd) claimed that certain expenditure on interest was incurred and was deductible by virtue of s.51(1) of the Income Tax Assessment Act 1936 (Cth) ("the Act"). The Commissioner, on the other hand, considered that the sums claimed were not incurred and, if incurred, were not deductible and that, if they were otherwise allowable, the arrangements giving rise to them were struck down by s.260 of the Act. Penalties were imposed under s.226 of the Act. The question whether the penalties were properly so imposed has been set aside for separate determination in the event that MOD (Syd) is not successful in the substantive dispute.

1. During 1979 and for some years prior thereto, Metropolitan Oil Distributors Pty Limited ("MOD") carried on business as a distributor of petroleum products on land at Smithfield owned by MOD Holdings Pty Limited ("MOD Holdings"). All these companies were family companies controlled by Mr P.J. Massingham, his wife, Mrs E.M. Massingham and their son, Mr G.P. Massingham. On important matters of business, the views of Mr P.J. Massingham were dominant.

2. Towards the end of 1979, Mr P.J. Massingham became dissatisfied with the rewards of the enterprise, which I take to mean the after-tax result. Mr Massingham consulted MOD's accountant, Mr Arthur Tang, and on his advice, saw Mr D. Raphael, a solicitor.

3. Mr Massingham and Mr Tang attended on Mr Raphael on 18 December 1979. Mr Raphael proposed an arrangement that would provide both an immediate and an ongoing taxation benefit. No attempt has been made to suggest that what was done was designed for the welfare of the income earning enterprise or of the family save that less taxation would be payable.

4. Mr Raphael proposed the following scheme, some elements of which were not essential to the scheme with which we are now concerned:-
   

. MOD should cease business at the close of 31 December 1979.

. Mr P.J. Massingham should retire from his office of director of that company at that time and should be paid by the company a retiring allowance of $80,000, 5% only of which would be assessable to tax under s.26(d) of the Act. . A new company should be formed or acquired to take over the petroleum distributing business as from 1 January 1980.

. The new company should take over all the business and assets of MOD at book value save that goodwill should be acquired for a substantial value, quantified then or later at $300,000. The new company was also to acquire from MOD Holdings the land at Smithfield, presumably at its value, later quantified at $250,000. The consideration for the goodwill and the land was to remain outstanding until all the structures were in place. . A family discretionary trust to be known as the Massingham Overseas Trust was to be settled in Singapore, having in the first instance as its trustee a Singapore resident. A beneficiary of the trust was to be a company incorporated and resident in Singapore.

. The shareholders of the Singapore company were to be a company controlled by two accountants in Hong Kong. That company was to be the trustee of another family discretionary trust to be known as the Massingham Minor Trust. . At a convenient time, the Singapore company was to be replaced as trustee of the Massingham Overseas Trust by an Australian company, of which the directors were to be Mr P.J. and Mrs E.M. Massingham. . By 31 March 1980, by which time all the above steps should have been completed, the trustee of the Massingham Overseas Trust was to lend to the new petroleum distributor a sum, later quantified at $550,000, at a commercial rate of interest, that company was to pay out the consideration ($300,000) to MOD for the goodwill of the business and the consideration

($250,000) to MOD (Holdings) for the acquisition of the land. Those companies were to lend the equivalent sums to the trustee of the Massingham Overseas Trust without interest or at nominal interest. . The income being the interest paid by MOD (Syd) to the trustee of the Massingham Overseas Trust was to be distributed by the trustee of the trust by resolution to the company beneficiary being resident in Singapore. Thus 10% withholding tax was to be payable and paid on that income. The balance remaining, 90%, was to be lent back to MOD (Syd).

1. We are not now concerned with the retiring allowance paid to Mr P.J. Massingham. The sole issue is whether the steps which were taken to reduce the taxable income of the petroleum distributing business by creating a liability for the payment of a commercial rate of interest upon the sums borrowed to enable the payment out of the obligations incurred in respect of the goodwill and the land were effective for taxation purposes.

2. On 18 December 1979, the plan was approved. During December, Mr Raphael dictated all the minutes which were subsequently signed. A shelf company, Shulwa (No 7) Pty Ltd, was obtained and its name was changed to Metropolitan Oil Distributors (Sydney) Pty Limited. This is the applicant taxpayer.

3. It was conceded by Mr A. Emmett QC, senior counsel for the Commissioner, that none of the transactions which thereafter occurred should be struck down as a sham.

4. On 18 December 1979, the directors of MOD resolved inter alia:-
   

"SALE OF BUSINESS:

Resolved that the Company sell to Shulwa (No. 7) Pty. Limited on terms set forth in an unexecuted document attached hereto the going concern business carried on by it including goodwill debtors plant stock fixtures and fittings. It was noted that the price for the goodwill was $300,000.00. LENDING OF MONEY:

Resolved that the Company lend the sale price interest free to Shulwa (No. 7) Pty. Limited on the basis that the same be repaid on or before 31st March next and that after repayment the same be loaned interest free repayable on demand to Shulwa (No. 5) Pty. Limited. NAME OF BUYER:

Resolved that the Company consent to Shulwa (No. 7) Pty. Limited changing its name to Metropolitan Oil Distributors (Sydney) Pty. Limited and affix its seal to any relevant consent as and when required."

1. On 21 December 1979, minutes of a meeting of the directors of MOD (Syd) (then named Shulwa (No. 7) Pty Limited), show that the two directors, who were then employees of Mr Raphael, passed the following resolutions:-
   

"BUSINESS

Resolved that the Company acquire the going concern business (including goodwill, fixtures, fittings, plant and stock) heretofore carried on by Metropolitan Oil Distributors Pty. Limited and that the terms of such acquisition be thosed (sic) set forth in the form of agreement tabled and attached to these minutes. It was specifically noted that the said form contained no signatures and that by this minute the Company simply adopted the terms thereof as being the terms and conditions governing the acquisition. It was further resolved that the acquisition of the said business is to take place on the 31st December, 1979.

BORROWING

Resolved that the Company borrow from Metropolitan Oil Distributors Pty. Limited unsecured the cost of such acquisition and that the said moneys when borrowed should bear interest at 11% per annum on daily balances and that they be repayable on one month's notice of demand and that in the meantime the interest be payable monthly in advance."

Presumably, the expression of an agreement in this form rather than the execution of a formal contract had stamp duty implications. The form of agreement attached to the minutes provided that, if no sale price was set forth in the Schedule, which it was not, then the vendor's auditor, or if none be appointed the vendor's accountant, was to act as expert and determine the respective values of the assets sold.

1. There was oral evidence, which I accept, that, in December 1979, the two directors of MOD (Syd) authorised Mr Raphael to give practical effect to the above agreement, which he did. One step taken by Mr Raphael was to arrange with MOD that the amount outstanding for the purchase of the business should remain outstanding without interest until 31 March 1980. No payment of interest was made for the period to 31 March 1980 and no obligation to pay such interest was recorded in the books of account. This is explained in an affidavit of Mr P.J. Massingham as follows:-
   

"9. I am informed by Mr David Keith Louis Raphael, solicitor, and I believe it to be true, that he was authorised by Ms Bollinger and Mrs Shepherd to conclude agreements, on behalf of Shulwa (No. 7) for the purchase of the business from Metro Oil. On 21 December 1979 I had a telephone conversation with Mr Raphael. He said:- 'Shulwa (No. 7) has passed the resolutions for the purchase of the business, in the terms of the draft minutes of which you have a copy. We have a copy of the minutes of the directors' meeting of Metropolitan Oil Distributors Pty Limited of 18 December concerning the sale of the business. There seem to be some differences. Your minutes mention the price of $300,000 for goodwill but ours do not; our minutes say that you will borrow the purchase price from us at 11% interest but your minutes say it will be interest-free; and your minutes do not mention the acquisition date as being 31 December 1979 which is mentioned in our minutes. I have full authority from Shulwa (No. 7) to agree the terms of the sale and the borrowing with you. I agree that the price for the goodwill is $300,000 and that the borrowing will be interest free. Do you agree that the acquisition date will be 31 December 1979?' I said 'Yes, I have full authority from Metro Oil to agree the terms of the sale and the borrowing. I agree with the terms you have mentioned'."

1. It is a common ground that MOD (Syd) took over the petroleum business as from 1 January 1980. Page 1 of a journal entry of MOD (Syd), dated 1 January 1980, records the taking over of all of the assets and liabilities of MOD as at 31/12/79, including such items as debtors, trade, creditors, a loan to MOD (Holdings) and moneys due to Mr P.J. Massingham. The last item recorded is a liability to MOD of $37,441.41, a balance entry representing the net amount due after the taking over of all assets and liabilities other than goodwill. It does not appear that interest was ever paid on that sum.

2. A meeting of directors of MOD (Holdings), held on 15 March 1980, resolved:-
   

"SALE OF REAL ESTATE:

Resolved that the Company sell its real estate investment known as 16 and 18 Tait Street, Smithfield to Metropolitan Oil Distributors

(Sydney) Pty. Limited at the price of $250,000 and otherwise upon the terms and conditions to be contained in a certain Declaration of Trust to be executed in the A.C.T. By the terms thereof the Company would be trustee for the purchaser of the property and the purchaser would assume all liability for the existing mortgage on the property. LOAN OF MONEYS:

Resolved that the Company lend the net sale price to be received to Shulwa (No. 5) Pty. Limited interest free repayable on three months notice."

Shulwa (No 5) Pty Limited, another shelf company, was by then the Australian trustee of the Massingham Overseas Trust. According to the minutes of MOD (Syd), on 15 March 1980, the directors, who were still the employees of Mr Raphael, resolved -

"PURCHASE OF REAL ESTATE:

Resolved that the Company acquire from Metropolitan Oil Distributors Pty. Limited the real estate known as 16-18 Tait Street, Smithfield for the net price of $250,000.00. The property was acquired to enable the Company to carry on the going concern business which it had likewise acquired from the company. POWER OF ATTORNEY:

Resolved that the Company do and does affix its seal to a Power of Attorney whereby W.S. Bowd of Canberra in the A.C.T. is authorised to execute a Declaration of Trust on the Company's behalf as Purchaser of the fee simple to the said land. It was noted that the reason for so doing was to maintain the present excellent loan which existed over 18 Tait Street, Smithfield."

The reference to MOD rather than MOD Holdings was a typist's error. It also appears that the minute was not signed until some years later. However, Mr Emmett disclaimed reliance upon this point.

1. As can be seen, it was intended that the transfer of the real estate would be effected by a declaration of trust executed and held in the Australian Capital Territory, where it would not attract New South Wales stamp duty. The transaction was carried out in this manner but the particular plan foundered when, during the course of these proceedings, Mr Raphael was asked for and gave an undertaking to the Court that duty would be paid in New South Wales.

2. It had been intended that the payment of the liabilities for the land and goodwill would be effected by way of an exchange of cheques. However, this became impossible because of what MOD (Syd)'s bank understood to be a direction from the Treasurer, presumably a direction or statement relating to tax-avoidance schemes. Therefore, MOD (Syd) had to carry out the essential step in a different manner.

3. There are in evidence Minutes of a meeting of directors of Shulwa (No. 5) Pty Limited, the trustee of the Massingham Overseas Trust, held on 31 March 1980, which resolved as follows:-
   

"BORROWING OF MONEY:

Resolved that the Company in its capacity as Trustee of the Mssingham (sic) Overseas Trust borrow from the parties listed hereunder the sums of money set beside the name of each on the basis that the same is borrowed interest free and repayable on three month's (sic) notice of demand save that as regards the moneys borrowed from Metropolitan Oil Distributors (Sydney) 121DA Superannuation Fund these shall be repayable on demand and bear interest at 5% per annum on daily balances. Metropolitan Oil Distributors 121DA Fund ... $ 31,328.00 P.J. Massingham ... $ 80,000.00 M.O.D. Holdings Pty Limited ... $250,000.00 Metropolitan Oil Distributors Pty. Limited ... $300,000.00 LENDING OF MONEY:

Resolved that the Company in such capacity lend unsecured the moneys referred to above namely $661,328.00 to Metropolitan Oil Distributors (Sydney) Pty. Limited repayable on 13 months notice of demand or such earlier time as the borrower in its discretion decides and that the said moneys until repaid are to bear interest at 12% per annum on daily balances six months in advance the first payment of interest to be made immediately and thereafter on six monthly intervals in advance in each succeeding year during the currency of the loan."

Notwithstanding the reference in those minutes to the sum of $661,328 lent, it is common ground that the only sum lent, if any moneys were lent, was $550,000.

1. Mr P.J. Massingham gave evidence that he and his wife, the directors of Shulwa (No 5) Pty Ltd, held, at Mr Raphael's direction, a meeting to pass a resolution for the lending of the $550,000 to MOD (Syd). He said that the additional sums of $31,328 and $80,000 referred to in the Minutes had been lent to Shulwa (No 5) Pty Ltd but they were not on-lent to MOD (Syd). He could give no explanation as to why $661,328 was the sum expressed to be lent on to MOD (Syd). In cross-examination he agreed with Mr Emmett that it appeared that the arrangement had been altered during the course of 31 March 1980. However, that does not seem to be a probable explanation of the discrepancy. I did not take Mr Emmett to suggest seriously that any variation in the scheme actually occurred on that day.

2. There is no Minute of a meeting of the directors of MOD (Syd) reflecting the minute of Shulwa (No. 5) Pty Limited of 31 March 1980. The Minute may have been overlooked by Mr Raphael when he dictated the other Minutes in December 1979. However, in an affidavit sworn on 14 February 1989, Mr P.J. Massingham, after dealing with the resolution of Shulwa (No. 5) Pty Limited, said:-
   

"18. In relation to the reference in the minutes to proposed loans of $250,000 and $300,000 to which I have already referred, I say the following. At 31 March 1980, the directors of Metro Sydney were Mrs Massingham, Mr G.P. Massingham and myself, the directors of Metro Oil were Mrs Massingham and Mr G.P. Massingham, and the directors of M.O.D. Holdings were Mrs Massingham and myself. On 31 March 1980, some time after the directors' meeting earlier that day to which I have referred, I had a conversation with Mrs Massingham and Mr G.P. Massingham. I said: 'As you would know, Metro Sydney owes $300,000 to Metro Oil for the purchase of goodwill of the business, and it owes M.O.D. Holdings $250,000 for the purchase of the Smithfield property. I am proposing that Shulwa lend $550,000 to Metro Sydney on the terms set out in the minutes of this morning's meeting of directors of Shulwa, that Metro Sydney pay the money to Metro Oil to pay off its indebtedness to that company, and that Metro Oil then lend the money to Shulwa on the other terms set out in those minutes. However, we will not actually draw any cheques. Instead I propose that Metro Sydney agrees to owe Shulwa $550,000 upon the terms set out in the minutes. Shulwa agrees to owe $300,000 to Metro Oil and $250,000 to M.O.D. Holdings upon the other terms set out in the minutes, and that the existing indebtedness of Metro Sydney to Metro Oil and M.O.D. Holdings be treated as discharged. I propose that this should occur as from tomorrow 1 April 1980. Do you agree with my proposal?' Each of them said: 'Yes. I agree'."

1. This paragraph did not appear in Mr Massingham's first affidavit sworn 13 April 1988, a factor which, in association with the lack of any minute, gives cause to doubt its veracity. However, it has been pointed out that the first affidavit was filed within the short time allowed by a Judge of the Court when he ordered that, if affidavits were not promptly filed setting out the applicant's case, the applications would be dismissed. The first affidavit may reflect the urgency engendered by this order.

2. I have heard the oral evidence of Mr P.J. Massingham, of Mrs E.M. Massingham and of Mr G.P. Massingham. Mrs E.M. Massingham's recall of the events was hazy but she was a patently honest witness. Mr G.P. Massingham gave evidence substantially in accord with the details set out in his father's affidavit. He appeared to me to give his evidence honestly. I was also satisfied with the evidence of Mr P.J. Massingham. No doubt there are parts of Mr P.J. Massingham's affidavit of 14 February 1989 and of the oral evidence by P.J. and G.P. Massingham which might be thought to be strained, having regard to the time that has elapsed since the events occurred. However, the witnesses appeared to me to be genuine in their evidence and their evidence was not improbable. I accept the substance thereof.

3. In substance it was said that, in March 1980, Mr P.J. Massingham had been told by Mr Raphael that it was essential that there be resolutions both by Shulwa (No. 5) Pty Limited and by MOD (Syd) with respect to the lending by Shulwa (No. 5) Pty Limited and the borrowing by MOD (Syd) of the subject moneys. I pause to state that it seems probable that Mr Massingham did speak to Mr Raphael during March 1980 at the time when the structure was finalised and also probable that Mr Raphael made it clear that both companies must pass the appropriate resolutions. Mr Massingham gave evidence that, on the 31st March, he had before him the written Minute prepared for Shulwa (No. 5) Pty Limited and that he and his wife, as directors of Shulwa (No. 5) Pty Limited, met and passed the resolutions for the borrowing and lending of the moneys. It is not improbable that they did so. Mr P.J. Massingham and his son gave evidence that, although there was no written minute for MOD (Syd) of that date, nevertheless, Mr P.J. Massingham, his wife and his son sat down together after dinner and passed the necessary resolution. Again, this is probable, for the borrowing of the money was the essential step which was necessary to give to the applicant the ongoing taxation deduction, and therefore to reduce the taxable income of the business enterprise. I accept the evidence given.

4. Both Mr P.J. Massingham and Mr G.P. Massingham said that the meeting was somewhat informal. However, in the conduct of the affairs of private companies, such a degree of informality is not unusual. Mr Emmett made no challenge to the validity of the meeting, if it was held, as I accept it was. As Mr and Mrs Massingham constituted the directors of Shulwa (No. 5) Pty Limited and as Mr and Mrs Massingham and their son constituted the directors of MOD (Syd), it could not be said that there was not a binding agreement between the two companies arrived at on that day. The lending of the $550,000 by Shulwa (No 5) Pty Ltd to MOD (Syd) was recorded in the accounts of Shulwa (No 5) Pty Ltd for the year ended 30 June 1980. The indebtedness of MOD (Syd) and its obligation to pay interest to Shulwa (No. 5) Pty Ltd was recognised in the accounts of MOD (Syd) from December 1980 onwards. The indebtedness was recorded in journal entry made early in 1981, as at 31 December 1980. So for all the years with which we are concerned, the indebtedness with respect to principal and interest was recorded in both companies' accounts. If any liquidator subsequently came to investigate the affairs of MOD (Syd), he could not query the obligation on the part of the applicant to pay $550,000 to Shulwa (No. 5) Pty Limited, notwithstanding any informality in the way in which the affair was managed.

5. The journal entry for MOD (Syd) for the month of December 1980 recorded the taking over of goodwill for the sum of $300,000, land and buildings for the sum of $250,000 and, associated therewith, a loan from Shulwa (No. 5) Pty Limited of $550,000. These three items were noted as "being goodwill and land and bldg acquired". This entry did not record all the steps alleged to have been taken in the course of the acquisition, the payment out of the liability, the borrowing of money and so on, but evidence has been given by a chartered accountant that it is not uncommon for accountants simply to record the end result.

6. It was common ground between the parties that, as was required by the minutes of Shulwa (No 5) Pty Ltd of 31 March 1980, interest at 12% per annum was paid by MOD (Syd) to Shulwa (No 5) Pty Ltd in each year of income. It was also common ground that the plan was carried out that that income would be allocated by Shulwa (No 5) Pty Ltd to the overseas beneficiary, that 10% withholding tax would be paid and that the 90% balance would be lent back to MOD (Syd). The lending back was dealt with in a minute of Shulwa (No 5) Pty Ltd of 28 December 1980:-
   

"LENDING OF MONEY:

Resolved that the Company in its capacity as Trustee of the Massingham Overseas Trust lend back to Metropolitan Oil Distributors (Sydney) Pty. Limited a sum of money equal to 90% of the net income of the Trust for the present income tax year calculated by reference to the tests contained in the provisions of Section 95 of the Income Tax Assessment Act, 1936 and which income is referable to interest received from Metropolitan Oil Distributors (Sydney) Pty. Limited and that those moneys so lent shall bear interest at the rate of 12% per annum until repaid and that the terms of such loan be evidenced by unsecured notes issued by the borrower company which notes shall contain the same terms and conditions as are contained in a specimen note tabled by Mr Massingham and which same had been prepared by the Company's solicitor, Mr D. Raphael. The Company took the step of retaining 10% on Mr Raphael's advice as in the event that the company as such trustee exercised its discretion in favour of a non-resident beneficiary it would be necessary to pay withholding tax on that amount to the Commissioner of Taxation."

1. Apparently, the first interest paid was incorrectly calculated on the $661,328 appearing in the minutes of Shulwa (No 5) Pty Ltd of 31 March 1980. Mr Tang was unable to give any explanation of how this came about other than that it was a mistake. Thereafter the interest was calculated both on the original sum lent, plus the amounts of interest lent back annually, less certain amounts treated as paid by MOD (Syd) on behalf of Shulwa (No. 5) Pty Ltd. The interest was:-
   

Date Interest Interest wrongly now calculated calculated 29 Dec 80 59,520 49,500 23 Dec 81 72,301 71,099 24 Dec 82 79,908 78,543 Date Interest Interest wrongly now calculated calculated 22 Dec 83 88,277 86,760 21 Dec 84 94,755 93,066

1. The first issue is whether the interest payable to Shulwa (No. 5) Pty Limited was deductible under s.51(1) of the Act. I need not set out the well known terms of that sub-section.

2. The deductibility of interest principally depends upon the purpose to which the capital, in respect of which the interest was payable, was put. In Ure v. Federal Commissioner of Taxation (1981) 34 ALR 237 at pp 249-50, Deane and Sheppard JJ. discussed the issue in these terms:-
   

"In a case such as the present where the outgoing claimed as a deduction is interest paid on borrowed money, one cannot ordinarily look to the direct object or advantage which the outgoing was intended to achieve for the reason that that will ordinarily be the receipt of the borrowed money which is likely to be neutral in character. One must, of necessity, look more to the objects or advantages which the application and use of the borrowed money were intended to gain: F.C. of T. v Munro (1926) 38 CLR 153 at 197. ...

One of the most difficult aspects of the problem of characterizing an outgoing is the assessment of what, if any, weight is to be given to indirect objects which a taxpayer had in mind in incurring the outgoing. Such objects form part of the relevant circumstances by reference to which the problem of characterization must be resolved. There is however no rigid principle which can be applied in determining what, if any, weight should be given to them. In the ordinary case, such as, for example, where the immediate object achieved by the outgoing is the production of assessable income which is commensurate with the amount of the outgoing or where it is clear that the outgoing was for the purchase of stock-in-trade or the acquisition of services or hire of equipment used in earning assessable income, indirect objects or motives of a personal or domestic character will plainly not prevent the characterization of the outgoing as having been incurred in earning assessable income: for example, Cecil Bros Pty Ltd v F.C. of T.

(1964) 111 CLR 430; 9 AITR 246; F.C. of T. v Phillips (1978) 20 ALR 607; 8 ATR 783. In other cases, the immediate object or effect of an outgoing will not suffice either to explain or to characterize it. In such cases, indirect objects or motives can assume a sometimes decisive importance."

1. In Ure's case and in Federal Commissioner of Taxation v. Ilbery (1981) 38 ALR 172, the taxpayer's desire to obtain a taxation advantage played an important role in the rejection by the Court of the claim that interest paid had been incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing such income.

2. On the other hand, the cases to which Deane and Sheppard JJ. referred, Cecil Bros Pty Ltd v. Federal Commissioner of Taxation (1964) 111 CLR 430 and Federal Commissioner of Taxation v. Phillips (1978) 20 ALR 607, illustrate the point that, if an outgoing is so incurred, then the mere fact that it will and was intended to be productive of a taxation benefit will not preclude deductibility. See also Fletcher and Ors v. Federal Commissioner of Taxation (Lockhart, Wilcox and Lee JJ. delivered 28 June 1990).

3. Counsel for the Commissioner submitted that the incurring of the obligation to pay the interest was not a business matter undertaken for a commercial end but was undertaken to obtain a taxation deduction and that, if Mr P.J. Massingham had decided that MOD (Syd) should not purchase the land for $250,000 or should not pay $300,000 for the goodwill, he could at any time prior to the incurring of the interest, have so arranged affairs. Counsel also submitted with some force that, had Mr P.J. Massingham decided that the taxpayer should not borrow the $550,000 at a commercial rate of interest, but free of interest, he could have so arranged affairs. In cross-examination, Mr Massingham conceded in substance that, if at any time he had decided that the transaction should be differently managed, he could, after speaking with his wife and son, have so arranged affairs. It should also be noted that, although the Commissioner made no attack on the quantum of the sums paid for the land and for the goodwill, it may be accepted that, if Mr P.J. Massingham, Mr Raphael and Mr Tang had decided that the taxpayer should not pay $550,000 for these assets, the taxpayer would not have done so. There was no commercial necessity for it to do so.

4. However, MOD (Syd) did acquire the land on which its business was carried on and it did acquire the goodwill, as well as the other assets of the business. It is not in issue that these assets were acquired by MOD (Syd) or that the assets formed part of its income-earning structure, the business from which it derived its assessable income.

5. In Cecil Bros Pty Limited v. Federal Commissioner of Taxation, cited above, a retailer of shoes had purchased trading stock from an associated company at a price greater than the price charged for such stock by other wholesalers. At first instance, Owen J. rejected the contention that the whole of the sums paid was not deductible under s.51(1). His Honour said, at p 434:-
   

"That amount was paid, so it was argued, not as part of the purchase price of goods supplied but to provide Breckler Pty. Ltd. (the associated company) with income. I do not agree with this submission. The fact that the taxpayer paid more for its purchases than it would have paid had it dealt direct with the manufacturers or wholesalers in order that Breckler Pty. Ltd. might make a profit out of the transactions does not, in my opinion, prevent the amount which it in fact paid from being regarded, for the purposes of s.51(1), as an outgoing incurred in gaining its assessable income. It seems to me that the contention really is that the taxpayer paid more for its goods than it should have. But 'it is not for the Court or the Commissioner to say how much a taxpayer ought to spend in obtaining his income, but only how much he has spent'. (Ronpibon Tin N.L. and Tongkah Compound N.L. v. Federal Commissioner of Taxation (1949) 78 CLR 47, at p 60 and the cases therein cited)."

His Honour also rejected the contention that s.260 applied to the transaction. On appeal, the s.260 issue was considered again; but the court constituted by Dixon C.J., Kitto, Taylor, Menzies and Windeyer JJ. expressed no dissent from the view expressed by Owen J. that the sum paid for the trading stock was deductible under s.51(1). At p 438, Dixon C.J. said:-

"I have great difficulty in seeing how it

(s.260) could apply to defeat or reduce any deduction otherwise truly allowable under s.51."

At p 439, Taylor J. said:-

"... I fail to see how its annihilation (the arrangements) could, on the proved facts, be said to result in any increase in the taxable income of the appellant."

1. In Federal Commissioner of Taxation v. Phillips, (1978) 20 ALR 607, the members of a firm of chartered accountants had established a service company, as trustee of a unit trust in which units were held by the families of and companies associated with the parties, to provide secretarial and other support services to the firm. The new arrangement increased the expenditure of the firm and achieved certain non-income producing ends, including a taxation advantage. Bowen C.J., Deane and Fisher JJ. held that the deductions claimed were allowable under s.51(1) of the Act. At p 609, Bowen C.J. and Deane J. said:-
   

"The findings of the learned judge at first instance that the agreed rates for the relevant services were realistic and not excessive and that the rate fixed for hire of plant and furniture likewise could not be said to be excessive have not been challenged before us. The rates of interest charged on moneys accrued due were plainly reasonable. In these circumstances, the payments and liabilities were, in the relevant sense, necessarily incurred in carrying on the accountancy business for the purpose of gaining or producing assessable income (see Ronpibon Tin NL and Tongkah Compound NL v F.C. of T. (1949) 78 CLR 47 at 56 and F.C. of T. v Snowden and Willson Pty Ltd (1958) 99 CLR 431 at 436-7). It is not to the point that the reasonable commercial profits which the trust derived as a result of its contractual arrangements with the partnership could reasonably have been expected to have accrued to the partnership if the re-arrangement had not been effected or that those profits would, in due course, be credited or distributed either to a partner or to individuals, trusts or companies with which one or more of the partners were associated. Nor, in the absence of any questions involving the effect of s.260 of the Act, is it to the point that the overall re-arrangement had, with taxation and estate planning considerations in view, been effected to achieve, inter alia, those very results."

At p 617, Fisher J. said:-

"A crucially important circumstance in the present matter is the unchallenged finding of the trial judge that the charges paid by the firm were realistic and not in excess of commercial rates. The services were essential to the conduct of the firm's business and the fact that the charges paid were commercially realistic raises at least the presumption that they were a real and genuine cost of earning the firm's income and the cost of that alone. It strongly supports the view that the expenditure was exclusively for business purposes. Without doubt the cost of acquisition of the services was 'necessarily incurred' in the sense that it was 'clearly appropriate or adapted for' the production of the assessable income: Ronpibon Tin NL and Tongkah Compound NL v F.C. of T. (1949) 78 CLR 47 at 56. Doubtless the converse would apply, namely, if the expenditure was grossly excessive it would raise the presumption that it was not wholly payable for the services and equipment provided, but was for some other purpose. Such is not the case here. A circumstance relied upon by counsel for the Commissioner was that the amount of the charge was such that it enabled the provider of the services to make a profit. Additionally the charge exceeded the cost which the firm would incur if it reverted to its original practice of employing its own staff and owning the plant and equipment. The relevance of this circumstance in determining the complexion of the expenditure, especially when the expenditure is found to be commercially realistic, is denied by the authority of the Ronpibon Tin case, supra at p 60, when the court said: 'It is not for the court or the Commissioner to say how much a taxpayer ought to spend in obtaining his income, but only how much he has spent.' This statement received the approval of the High Court in Cecil Bros Pty Ltd v F.C. of T. (1964) 111 CLR 430 at 434 and 441 and the Privy Council in Inland Revenue Commissioner (NZ) v Europa Oil (NZ) Ltd (1971) AC 760 at 772; 70 ATC 6012 at 6019; 1 ATR 737 at 744, and in the Europa Oil (No 2) case, (1976) 76 ATC 6001 at 6010; 5 ATR 744 at 754."

1. In the present case, moneys were borrowed at a commercial rate of interest to acquire assets that were wholly of a business character and were used in and formed part of the taxpayer's income earning enterprise. These income earning assets, the land and premises on which the business was conducted, and the goodwill of the business were acquired by MOD (Syd) for the purpose of its business. The expenditure thereon was thus incurred in gaining or producing the assessable income and was necessarily incurred in acquiring and carrying on the business for that purpose. It would be inconsistent with the authorities I have mentioned to hold that, because Mr P.J. Massingham could have arranged affairs differently, MOD (Syd) was not entitled to the ordinary taxation consequence flowing from the acquisition on commercial terms of business assets which were acquired for use in and were used in the income earning enterprise.

1. As Latham C.J., Rich, Dixon, McTiernan and Webb JJ. said in Ronpibon Tin NL and Tongkah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47 at pp 56-7:-
   

"For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end. ...

In brief substance, to come within the initial part of the sub-section it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income."

In A.G.C. (Advances) Ltd v. Federal Commissioner of Taxation (1975) 132 CLR 175 at p 198, after citing that last passage, Mason J. went on to say:-

"So also it may be said that it is enough to satisfy the second part of the subsection that the occasion of the loss or outgoing is to be found in the carrying on of a business for the production of assessable income."

1. Section 51(1) is not primarily directed to purpose or motive, though they may play a part in marginal cases, particularly in the case of voluntary expenditure, to give a character to expenditure which makes it deductible or non-deductible. The effect of purpose or motive was fully considered by Lockhart, Wilcox and Lee JJ. in Fletcher and Ors v. Federal Commissioner of Taxation (delivered 28 June 1990). Their Honours said, at p 16 of the as yet unreported decision:-
   

"In our opinion in determining the essential character of an expenditure, purpose is not necessarily the criterion or test of deductibility. But in cases of voluntary expenditure, the purpose for which the expenditure was incurred may be relevant. The extent of the relevance and the weight placed upon the evidence with respect to it will vary according to the circumstances of each case. In some cases, (for example, Ilbery) it may be critical; but at the other end of the spectrum, where the connection between expenditure and the gaining or producing of assessable income is clear by references to the objective facts, it may be superfluous to consider the purpose for which the expenditure was incurred."

1. In the present case, the payment by MOD (Syd) of a commercial rate of interest on moneys borrowed to pay the price of the goodwill and the loan acquired by MOD (Syd) was incidental and relevant to the gaining or producing of its assessable income. MOD (Syd) was entitled to the deduction under s.51(1) notwithstanding that the simultaneous lending of $250,000 by MOD Holdings and $300,000 by MOD to Shulwa (No. 5) Pty Ltd at no or only a minimal rate of interest and the proposed distribution by Shulwa (No. 5) Pty Ltd of the interest income to the overseas resident had and was intended to have the effect overall of reducing the tax payable by the Massingham group. Certainly, the lending back of 90% of the interest paid is an important matter to consider. But it does not affect the genuineness of what occurred and it was not suggested by Mr Emmett that the sums lent back were not employed in the business of MOD (Syd).

2. The next issue is the application of s.260 of the Act, which provides:-
   

"(1) Every contract, agreement, or arrangement made or entered into, orally or in writing, whether before or after the commencement of this Act, shall so far as it has or purports to have the purpose or effect of in any way, directly or indirectly -

(a) altering the incidence of any income tax;

(b) relieving any person from liability to pay any income tax or make any return;

(c) defeating, evading, or avoiding any duty or liability imposed on any person by this Act; or

(d) preventing the operation of this Act in any respect,

be absolutely void, as against the Commissioner, or in regard to any proceeding under this Act, but without prejudice to such validity as it may have in any other respect or for any other purpose."

1. On this aspect of the case, Mr Emmett faced some difficulty, for, as the present assessment is against MOD (Syd), Mr Emmett did not and could not contend that the whole arrangement devised on 18 December 1979 should be struck down. See W.P. Keighery Pty Ltd v. Federal Commissioner of Taxation (1957) 100 CLR 66 at p 94. Therefore, we start with the position that the acquisition by MOD (Syd) of the goodwill of the business and of the land is not challenged; nor is the acquisition of the goodwill and of the land for a total of $550,000.

2. Mr Emmett submitted, however, that the arrangements which were put into place in March 1980 whereby the payment of that purchase price was satisfied and the interest was incurred was void by reason of the operation of s.260. Mr Emmett submitted that, in accordance with the pre-existing arrangement, the sums outstanding for the land and for the goodwill were to remain outstanding to 31 March 1980 free of interest. He submitted that the borrowing of moneys at 12% per annum to pay off the obligations was an arrangement made in March 1980 which altered the incidence of the taxpayer's taxation liability and that the incurring of the obligation had the purpose or effect of reducing the taxable income of the taxpayer.

3. However, what was done in March 1980 was not a separate transaction engrafted onto what had already occurred and what already had been planned. It was simply the end step in the whole arrangement which had been planned on 18 December 1979. The incurring of the interest by the taxpayer and the payment of that interest to the Massingham Overseas Trust was designed to reduce the overall rate of tax which the members of the Massingham family and their structures paid. This step provided the ongoing benefit which Mr P.J. Massingham had sought when he consulted Mr Tang and Mr Raphael. It would be unrealistic to separate just this one step, the step of borrowing money at a commercial rate of interest, and to say that that was an arrangement for the altering of the incidence of income tax which was struck down by s.260.

4. In circumstances such as the present, the contract, agreement or arrangement encompasses both the initial plan and all steps subsequently taken to give effect to it. See Newton and Ors v. Federal Commissioner of Taxation (1958) 98 CLR 1, where Lord Denning said, at pp 7-8:-
   

"But it (the arrangement) must in this section comprehend, not only the initial plan, but also all the transactions by which it is carried into effect - all the transactions, that is, which have the effect of avoiding taxation, be they conveyances, transfers or anything else. It would be useless for the commissioner to avoid the arrangment and leave the transactions still standing. The word 'purpose' means, not motive, but the effect which it is sought to achieve - the end in view. The word 'effect' means the end accomplished or achieved. The whole set of words denotes concerted action to an end - the end of avoiding tax."

What is struck down then is the arrangement which had or purported to have the effect specified in paragraphs (a) to (d) of the sub-section.

1. In the present case, the Commissioner has not sought to strike down the whole of what was originally planned. The taking over of the business by MOD (Syd) was part of the original plan and no challenge is made to that. So far as MOD (Syd) is concerned, the overall effect of what occurred was to increase its taxation burden, for it acquired a business and from that business earned income which it had not previously derived. Accordingly, the overall effect of what was done was not to reduce its taxation burden.

2. It was submitted that the last step, the step whereby MOD (Syd) borrowed moneys and paid out its liabilities for income earning assets, was a step having the effect of altering the taxation burden of MOD (Syd) because, until that step was taken, MOD (Syd) paid no interest upon the moneys outstanding. But there are two problems with regarding the matter in this way. The first is that the moneys were outstanding interest free only until 31 March 1980. All that happened was that the taxpayer borrowed moneys at a commercial rate of interest to pay for assets which were an integral part of the business which it carried on. It is difficult to see how this step can be predicated to have any of the results of which s.260 speaks.

3. In Newton's case, at pp 8-9, Lord Denning said:-
   

"In applying the section you must, by the very words of it, look at the arrangement itself and see which is its effect - which it does - irrespective of the motives of the persons who made it. Williams J. put it well when he said 'The purpose of a contract, agreement or arrangement must be what it is intended to effect and that intention must be ascertained from its terms. These terms may be oral or written or may have to be inferred from the circumstances but, when they have been ascertained, their purpose must be what they effect' (1957) 96 CLR, at p 630. In order to bring the arrangement within the section you must be able to predicate - by looking at the overt acts by which it was implemented - that it was implemented in that particular way so as to avoid tax. If you cannot so predicate, but have to acknowledge that the transactions are capable of explanation by reference to ordinary business or family dealing, without necessarily being labelled as a means to avoid tax, then the arrangement does not come within the section. Thus, no one, by looking at a transfer of shares cum dividend, can predicate that the transfer was made to avoid tax. Nor can anyone, by seeing a private company turned into a non-private company, predicate that it was done to avoid Div. 7 tax, see W.P. Keighery Pty. Ltd. v. Commissioner of Taxation (1958) 32 ALJR 118; 11 ATD 359. Nor could anyone, on seeing a declaration of trust made by a father in favour of his wife and daughter, predicate that it was done to avoid tax, see Deputy Federal Commissioner of Taxation v. Purcell

(1921) 29 CLR 464. But when one looks at the way the transactions were effected in Jaques v. Federal Commissioner of Taxation

(1924) 34 CLR 328; Clarke v. Federal Commissioner of Taxation (1932) 48 CLR 56, and Bell v. Federal Commisioner of Taxation

(1953) 87 CLR 548 - the way cheques were exchanged for like amounts and so forth - there can be no doubt at all that the purpose and effect of that way of doing things was to avoid tax."

1. MOD (Syd) had no entitlement to acquire the land and the goodwill free of charge. The Commissioner does not challenge the price which was arranged. That leaves the Commissioner in the position where the only matter to annihilate is the arrangement for the payment out of the liability by a borrowing of moneys at a commercial rate of interest. It is impossible to predicate of such an arrangement that it had or purported to have any of the purposes or effects specified in s.260.

2. It will be a rare case when expenditure which is an allowable deduction under s.51(1) of the Act can be struck down by s.260 of the Act. I need not cite further from Cecil Bros, some relevant aspects of which I have set out above. To the same effect were remarks in Europa Oil (No 2) and the remarks in Ilbery's case of Northrop and Sheppard JJ. at p 173 and of Toohey J. at p 183. Barwick C.J. put the matter succinctly when he said, in Federal Commissioner of Taxation v. Casuarina Pty Ltd (1971) 127 CLR 62 at p 81:-
   

"I should merely wish to say that there is, in my opinion, no room for the application of s.260 where the taxpayer has become liable for the amount of tax appropriate under the terms of the Assessment Act to the state of affairs obtaining at the date made relevant by that Act for the ascertainment of the taxpayer's liability. Steps taken to bring about that state of affairs cannot, in my opinion, qualify as action under s.260 to achieve any of the four purposes or effects described in the section."

In John v. Federal Commissioner of Taxation (1989) 166 CLR 417, Mason C.J., Wilson, Dawson, Toohey and Gaudron JJ. said at pp 433-4:-

"It may be that, because the question of deductibility under s.51 is always to be answered by the ascertainment of a past event (i.e. a loss or outgoing having been incurred), s.260 cannot 'apply to defeat or reduce any deduction otherwise truly allowable under s.51', as was suggested in Cecil Bros. Pty Ltd. v. Federal Commissioner of Taxation

(1964) 111 CLR 430, at p 438; but cf. Hooker-Rex Pty. Ltd. v. Federal Commissioner of Taxation ;(1970) 123 CLR 71, at p 86, per McTiernan J.; Franklin's Selfserve Pty. Ltd. v. Federal Commissioner of Taxation

(1970) 125 CLR 52, at p 74 per Menzies J. However, this is not a matter that need here be explored."

1. Thus, notwithstanding the disposition of the business from one company to another, when there was no commercial reason for doing so, and the establishment of trusts and companies in Singapore and Hong Kong, which could scarcely be characterised as ordinary family or business dealings, s.260 does not apply in the present case. The borrowing of the money at a commercial rate of interest to pay for the assets of the petroleum distributing business was simply a part of the overall scheme pursuant to which MOD (Syd) took over that business. There being no challenge to the overall arrangement, the borrowing did not alter the incidence of income tax, for there was no antecedent taxation position which was altered, and the borrowing did not relieve any person from liability to pay income tax or avoid any liability imposed by the Act or prevent the operation of the Act in any respect. The burden of tax fell as the Act intended.

2. For these reasons, the appeals should be allowed. The Commissioner's decisions on the objections will be set aside and the matters will be remitted to the Commissioner to be dealt with according to law. The Commissioner should pay the costs of the proceedings.