Craven and Commissioner of Taxation

[2007] AATA 1522

Administrative Appeals Tribunal

DECISION AND REASONS FOR DECISION [2007] AATA 1522

ADMINISTRATIVE APPEALS TRIBUNAL      )
  )          No VT200600238-0240

TAXATION         APPEALS         DIVISION		)
Re		NOEL CRAVEN

Applicant

And COMMISSIONER OF TAXATION

Respondent

DECISION

Tribunal Mr Egon Fice, Member

Date6 July 2007

PlaceMelbourne

Decision The Tribunal affirms the reviewable decision.

(sgd) Egon Fice

Member

TAXATION – transitional reasonable benefits limit – salary paid – highest average salary – arms length salary – associate of employer – calculation of arms length salary – use of salary survey report – salary sacrifice superannuation contributions – bonus payment

Income Tax Assessment Act 1936

Taxation Administration Act 1953

Income Tax Regulations 1936

Stevens v Brodribb Sawmilling Company Proprietary Limited (1986) 160 CLR 16

REASONS FOR DECISION

6 July 2007 Mr Egon Fice, Member       

1.      On 21 September 2004 Mr Noel Craven applied to the Commissioner of Taxation (the Commissioner) for a Reasonable Benefit Limit (RBL) under the transitional rules following his retirement as a director and employee of a number of private companies.  Mr Craven was aged 64 on 1 July 1994 and wished to establish an RBL under the pre‑1 July 1994 RBL rules, based on Highest Average Salary (HAS) as that term is defined in regulation 47 of the Income Tax Regulations 1936 (the Regulations).  The Commissioner determined that Mr Craven’s HAS would be $82,962.

2.      Mr Craven objected to the Commissioner’s determination on the grounds that his HAS was incorrectly assessed.  On 21 June 2006 the Commissioner made an objection decision disallowing Mr Craven’s objection.  Mr Craven seeks a review of the objection decision.

3.      The only issue before me is whether the Commissioner correctly calculated Mr Craven’s HAS based on an arms length salary (ALS) as that is described in regulation 47(3).

RELEVANT FACTS

4.      The law regarding the amount of a lump sum of pension benefit to be concessionally taxed was changed to a flat dollar amount commencing 1 July 1994.  From that date, any benefit which exceeded a person’s RBL has been taxed at the highest marginal rate.  RBL’s have now been abolished commencing 1 July 2007. 

5.      To ensure that taxpayers would not be disadvantaged by the 1994 amendments, the Commonwealth Government introduced grandfathering provisions.  Under those provisions, where a person would have been entitled to a higher RBL than the new flat dollar amount on 30 June 1994, that person could apply for a transitional RBL.  To be eligible, a person needed to be aged 50 years or more at the transition date.

6.      Mr Craven first applied for a transitional RBL in 1995.  On 3 February 1996 the Commissioner made a determination based on Mr Craven’s actual salary figures for the financial years ending 30 June 1991, 1992 and 1993.  This resulted in a HAS of $82,962.

7.      On 21 September 2004 Mr Craven applied for a second transitional RBL determination.  The determination was sought, not based on Mr Craven’s actual salary, but on his ALS.  That determination took into account the financial years ending 30 June 1992, 1993 and 1994.  Although the Commissioner calculated Mr Craven’s HAS based on his ALS to be $79,055, because this amount was less than the HAS calculated and granted to Mr Craven under the first determination, the Commissioner decided that Mr Craven should retain the higher HAS figure. 

8.      During 1992, 1993 and 1994, Mr Craven was a director of three companies, Craven Elliston & Hayes Pty Ltd, (Craven Elliston) Craven, Elliston & Hayes (Lithgow) Pty Ltd (Craven Elliston Lithgow) and Coal-Link Pty Ltd (Coal-Link).  In 1992, Mr Craven received $63,713 by way of salary from Craven Elliston; $36,990 from Craven Elliston Lithgow in 1993; and $31,800 from Craven Elliston Lithgow in 1994.

9.      In addition to those three companies, Mr Craven claimed that he was an associated employee of Hyrock Holdings Pty Ltd (Hyrock Holdings) and Hyrock Pty Ltd (Hyrock).  Mr Craven was not a director or officer of those two companies during the relevant years and he held no shares in those companies.  He was not paid a salary by either company.

10.     The Commissioner has accepted that Mr Craven was an employee of Craven Elliston and Craven Elliston Lithgow in the relevant years.  Mr Craven in fact received salary and superannuation benefits from those two companies. 

11.     Craven Elliston and Craven Elliston Lithgow withheld PAYE tax instalments and supplied a group certificate to Mr Craven.

12.     Based on his HAS, the Commissioner calculated Mr Craven’s transitional reasonable benefit to be $590,742 (lump sum) and $950,220 (pension).  When Mr Craven retired, his excess benefit was determined based on his pension transitional benefit limit to 1 July 2004 in the amount of $1,470,984.

LEGISLATIVE SCHEME

13. Section 140ZE of the Income Tax Assessment Act 1936 (the Assessment Act) provides that in respect of calculating a person’s lump sum and pension RBL, the Regulations set out a special method of calculating that figure for a year of income where those calculations result in a greater amount that would be applicable under s 140ZD. The regulations made for the purposes of s 140ZE only apply for transitional purposes.

14.     The regulations setting out the matters to be taken into account when calculating a person’s transitional reasonable benefit limit are found in regulations 46 to 53F. 

15.     Regulation 53A applies to persons who are aged at least 50 on 1 July 1994.  An eligible person under regulation 53A has a transitional lump sum RBL if the amount of the person’s HAS-based lump sum RBL exceeds $400,000.  Also, an eligible person has a transitional pension RBL if the amount of the person’s HAS‑based pension RBL exceeds $800,000 (regulation 53A(4)).  Regulation 53A(5) provides that where an eligible person has a transitional pension RBL, the amount of the RBL is the amount of the person’s HAS-based pension RBL. 

16.     HAS is defined under regulation 47 as the highest average annual salary of the person over any three consecutive financial years before the 1994/1995 financial year.

17.     Salary is defined under regulation 47(1) to include salary, wages, commissions, bonuses, fees, allowances or gratuities paid to a person during a financial year. 

18.     Regulation 47(3)(c) provides that if a person is an associate of the person’s employer, and the person’s salary is greater or lesser than the amount that would, in the opinion of the Commissioner acting in accordance with regulation 47(4), be the person’s salary if the person had not been associate of the employer, then the person’s salary for the purposes of calculating a RBL is taken to be the ALS.  In determining the ALS under regulation 47(3), the Commissioner must have regard to:

(a)the nature of the work performed; and

(b)the hours worked; and

(c)the salary that would be payable to a person who is not an associate of the employer for performing similar work for similar hours; and

(d)any other relevant matters.

19. Section 140C of the Assessment Act which deals with definitions in relation to RBLs provides that associate is to have the same meaning as in s 26AAB of the Assessment Act.

20. Insofar as it is relevant, s 26AAB(14) of the Assessment Act provides:

In this section, unless the contrary intention appears:

associate, in relation to a person (in this definition referred to as the taxpayer) means:

(a)where the taxpayer is a natural person, other than a taxpayer in the capacity of a trustee:

…

(v)       a company where:

(A)the company is, or its directors are, accustomed or under an obligation, whether formal or informal, to act in accordance with the directions, instructions or wishes of the taxpayer, of another person who is an associate of the taxpayer by virtue of another subparagraph of this paragraph, of a company that is an associate of the taxpayer by virtue of another application of this subparagraph or of any 2 or more such persons; or

(B)the taxpayer is, the persons who are associates of the taxpayer by virtue of sub-subparagraph (A) and the preceding subparagraphs of this paragraph are, or the taxpayer and the persons who are associates of the taxpayer by virtue of that sub-subparagraph and those subparagraphs are, in a position to cast, or control the casting of, more than 50% of the maximum number of votes that might be at a general meeting of the company…

PAID EMPLOYEE

21.     The first step in determining Mr Craven’s HAS requires a finding that Mr Craven was an employee and that he was paid a salary.  If Mr Craven is able to establish he was an employee and paid a salary; and if he is also able to establish that he is an associate of the employer entity, then the provisions dealing with ALS in regulation 47(3) will apply when calculating his HAS over the three consecutive financial years in question.

22.     The Commissioner accepts that Mr Craven was employed by Craven Elliston in 1992 and by Craven Elliston Lithgow in 1993 and 1994.  During those years, Mr Craven received salary and superannuation benefits from those two entities, PAYE tax instalments were withheld and a group certificate was supplied to him.  However, the Commissioner rejects Mr Craven’s claim that he was an employee of Hyrock Holdings, Hyrock or Coal-Link.

23.     Although Mr J Day, Director of Remuneration Strategies Group, who appeared on behalf of Mr Craven, went to considerable lengths in an attempt to establish that Mr Craven was an associate of Hyrock Holdings, Hyrock and Coal‑Link, unless it could be shown that Mr Craven was employed and paid by those companies, whether or not he is an associate becomes irrelevant.  The reason for this is that the transitional RBL is based on a person’s highest average annual salary.  Salary is defined under the Regulations to mean wages, commissions, bonuses, fees, allowances or gratuities paid to a person during a financial year including a payment made by a company by way of remuneration to a director.  That definition, which is set out in regulation 47(1), is subject to the provisions set out in regulation 47(3).  What regulation 47(3) does is to modify the definition of salary where a person is an associate of the person’s employer and the person’s salary is greater or less than the ALS that the person would have been paid if the person had not been an associate of the employer.  It commences with the phrase for the purposes of the definition of ‘salary’ in sub-regulation (1).  Quite clearly, regulation 47(3) presupposes that the person claiming to be an associate has in fact been paid a salary as that term is defined in regulation 47(1).  It goes without saying that the payment of some form of remuneration to a person is also one of a number of indicia of a relationship of employment (see Stevens v Brodribb Sawmilling Company Proprietary Limited (1986) 160 CLR 16).

24.     The problem for Mr Craven is that there was no evidence that he was paid a salary in respect of work that he may have performed for Hyrock Holdings, Hyrock or Coal-Link.  That not only casts serious doubts on whether Mr Craven could be described as an employee of those companies, but it also precludes him from taking advantage of the provisions in regulation 47(3) enabling an ALS to be substituted for his actual salary for the purpose of calculating his HAS. 

ASSOCIATE

25.     As I have mentioned above, because regulation 47(3) can only have application in relation to Craven Elliston and Craven Elliston Lithgow, there is no purpose in determining whether Mr Craven was an associate of Hyrock, Hyrock Holdings or Coal-Link. 

26.     The Commissioner concedes that Mr Craven was an associate of Craven Elliston and Craven Elliston Lithgow.  In my view, that is an appropriate concession.  Therefore, the only remaining matter in dispute is the method by which the Commissioner calculated Mr Craven’s ALS for the relevant tax years. 

CALCULATION OF ARMS LENGTH SALARY

27.     Regulation 47(4) requires the Commissioner, when determining the ALS, to have regard to the matters set out in that sub-regulation.  Taking into account all of the matters in regulation 47(4), the Commissioner calculated, by adopting a three step process, ALS figures for each of the relevant years in accordance with the following table:

1992	1993	1994
Step One ATO’s Preliminary ALS (before reduction)	$100,262	$107,681	$113,496
Step Two less ATO’s notional salary sacrifice	$44,731	$42,620	$45,140
Step Three Plus Bonus (15% of ALS before deduction)	$15,039	$16,152	$17,024
TOTAL – ATO’s ALS determination	$70,57122	$81,214	$85,380

ALS recommended by the applicant (including 15% bonus) $291,333 $312,891 $329,787

²²The respondent initially mistakenly stated that this figure was $63,713 (which was the applicant’s actual salary for the year) but later amended it to the correct amount

Step One – Preliminary Arms Length Salary

28.In determining the preliminary ALS, the Commissioner took into account:

(a)the nature of the work performed by Mr Craven including the fact that his position was comparable to that of Chief Executive Officer (CEO); that he was responsible for up to 30 employees; and that he was responsible for the overall financial performance of the business operations of Craven Elliston and Craven Elliston Lithgow;

(b)that Mr Craven worked an average of 13 hours per week for Craven Elliston in 1992, and 26 hours per week 1993 and 1994;

(c)the salary that would be payable to a person performing similar work for similar hours by reference to a salary survey for 1994 prepared by Cullen Egan Dell (CED survey); and

(d)other relevant matters; including information provided by Mr Craven, the turnover of the two companies, the number of employees of those companies and the cash flow constraint on the companies during the relevant period. 

29.     The CED survey is based on the latest salary and benefits information for more than 90,000 job incumbents in over 700 positions, spanning a wide range of industries.  The CED survey used by the Commissioner was in fact the September quarter 1994 data.  The data is presented in tables which set out salary data showing first quartile, median and third quartile salary figures as well as an average figure.  The median is, of course, the mid-range point of all figures provided such that 50 per cent of all scores fall below that figure and 50 per cent of the scores fall above.  The first quartile is the mid-point of the lower half of the sample and it indicates that 25 per cent of the scores fall below that figure and 75 per cent above; while the third quartile indicates that 75 per cent of the scores fall below that figure and 25 per cent above it.  The average is the sum of all the scores divided by the number of scores.

30.     The Commissioner elected to use the CED survey table of CEO salary data set out in the first quartile total remuneration figure.  This is a figure of $174,152. Mr Day disputed the use of the first quartile figure, indicating that the third quartile was appropriate for Mr Craven.  The Commissioner submitted that the first quartile salary data was appropriate because Mr Craven only worked an average of 13 hours per week in 1992 and 26 hours per week in 1993 and 1994.  Furthermore, the companies, which had a total of 30 employees, were relatively small operations and remuneration was therefore more likely to be correctly reflected in the first quartile figures.  The Commissioner also submitted that the evidence provided by Mr Craven indicated that the two companies in question were experiencing cash flow constraints in the relevant tax years.  Accordingly, the Commissioner contended that the companies’ ability to pay market rate remuneration would have been affected.  I accept that, taking into account the considerations under regulation 47(4), the first quartile figures are appropriate to establish an arms length base total remuneration figure. 

31.     The Commissioner made two adjustments to the base total remuneration first quartile figure.  The first adjustment was made to reflect the annual revenue of each company in question.  The CED survey makes provision for that adjustment but only in respect of base salary and employment cost.  Base salary is not applicable because it does not include bonuses, fees, allowances and like matters which are to be regarded as salary for the purposes of regulation 47(1).  Employment costs, which the CED survey defines as total remuneration plus the cost of fringe benefits tax, cannot be used to determine the ALS as it would overstate the figure.  Therefore, the Commissioner determined the proportion of total remuneration for a CEO to the employment cost (ie $174,152 divided by $188,162) and multiplied the resultant by $136,782 which is the first quartile employment cost figure for companies with revenue less than $30,000,000.  That resulted in a figure $126,592 which, in my view, reasonably represents the total remuneration for a CEO of a company or companies with an annual revenue less than $30,000,000.

32.     The Commissioner also submitted that a further adjustment needed to be made to take into account the fact that Mr Craven was not working on a full‑time basis because the figures in the CED survey represent a full‑time employee’s remuneration.  The Commissioner reduced the ALS total remuneration of $126,592 by 26/29 to reflect the hours Mr Craven worked in 1993 and 1994.  The Commissioner did not make an additional reduction for the 1992 year, although Mr Craven only worked an average of 13 hours per week during that year.  The resultant total remuneration ALS figure is $113,496.

33.     Although Mr Craven objected to the use of the CED survey data on the basis that it was biased towards the general manufacturing industry, and that it may be inappropriate to use that data in industries which command higher salary packages or fall into specialist activities, there was no evidence put before me of any resulting distortion.  In fact, I agree with the Commissioner’s submission that there is nothing unusual in Mr Craven’s circumstances which might require alternative data surveys to be adopted.  Mr Craven also objected to reliance on the 1994 CED survey data for the purpose of determining his salary for 1992 and 1993.  In my view, while it may have been possible to rely on CED surveys for 1992 and 1993, discounting the 1994 data by the rate of increase in remuneration as at 1994 is not an unacceptable method for calculating ALS for those earlier years.  Further, as the Commissioner submitted, there was no evidence from Mr Craven that he was disadvantaged by that methodology.

34.     In my view, the methodology adopted by the Commissioner in calculating the preliminary ALS for the years 1992, 1993 and 1994 was fair and reasonable. 

Step 2 – Notional Salary Sacrifice

35.     During the relevant years, Craven Elliston and Craven Elliston Lithgow made superannuation contributions by way of salary sacrifice on behalf of Mr Craven.  As the Commissioner submitted, these amounts are not included in the definition of salary in regulation 47(1), as that definition is restricted to amounts paid to a person during a financial year.  The salary sacrifice contributions were paid directly to Mr Craven’s superannuation fund.  The Commissioner has published an ATO Interpretive Decision (ATO ID 2003/16) dealing with this point.  That decision clearly sets out the Commissioner’s position that salary sacrifice payments cannot be included as salary in the calculation of HAS for RBL purposes.  Therefore, as the Commissioner contends, it is equitable to treat associates of employers in the same way as non‑associate taxpayers. 

36.     Mr Craven also objected to the deduction of superannuation payments made by way of salary sacrifice on the ground that there is a double discounting of that sum.  That cannot be correct.  The Commissioner calculated the preliminary ALS using the CED survey.  The Commissioner then used the total remuneration for the first quartile and that figure includes company contribution superannuation payments and salary sacrifice superannuation payments.  It follows that a deduction must be made from the total remuneration figure (as adjusted by the Commissioner) for the purposes of calculating ALS under regulation 47(3).

37.     Mr Craven also disputed the amount of the deduction from the preliminary ALS for the superannuation salary sacrifice amount.  Rather than simply deducting the actual salary sacrifice made in the relevant years, the Commissioner has determined a notional salary sacrifice and deducted the notional figure.  The differences are set out in the following table. 

1992	1993	1994
Total actual salary received by the applicant	$63,713	$36,990	$31,800
Actual salary Sacrifice	$51,321	$24,231	$21,000
Notional salary sacrifice	$44,731	$42,620	$45,140

38.     The Commissioner calculated a notional salary sacrifice deduction for each relevant year by first calculating the percentage that the actual salary sacrifice is of the total actual salary received by Mr Craven (inclusive of the pre-salary sacrifice amount); and then applying that percentage to the preliminary ALS to arrive at the notional salary sacrifice figure. 

39.     The effect of this calculation is to maintain the proportionality of the salary sacrifice figure when the actual salary is adjusted by adopting an ALS.  As the Commissioner submitted, neither the Act nor the Regulations set out a methodology to be used when making an ALS determination.  The Commissioner nevertheless submitted that the purpose or object of regulation 47(4) is to provide fairness to associates who have not received full remuneration because of their being associated with the employer.  By maintaining proportionality, the Commissioner contends that the deduction of the notional amount is the only fair way of arriving at the salary sacrifice figure to be deducted from the preliminary ALS.  Furthermore, the Commissioner directed my attention to ATO Interpretive Decision (ATO ID 2002/91) indicating that methodology has been consistently adopted.

40.     Although Mr Day objected to any deductions being made from the preliminary ALS for salary sacrifice contributions, it is clear to me that such a deduction must be made in order to comply with regulation 47(1).  Furthermore, Mr Day considered it most unfair that the notional salary sacrifice figures for the years 1993 and 1994 exceeded, by a substantial amount, the actual salary sacrifice made.  However, given that the Commissioner is required to determine what is in effect a notional salary based on the arm’s length calculation, it seems to me that maintaining the proportionality between actual salary sacrifice and actual salary received (including salary sacrifice amount) is a fair method of allocating (and for the purposes of the calculation, deducting) the salary sacrifice figure.  It is reasonable to assume that were a higher actual salary paid to Mr Craven, he would have sought a higher salary sacrifice contribution to his superannuation. 

Step 3 – Added Bonus

41.     The Commissioner has added a bonus comprising 15 per cent of the ALS before deduction, in each of the relevant years.  The bonus reflects the risks and responsibilities associated with Mr Craven’s position in the two companies concerned.

42.     As the Commissioner submitted, the addition of the bonus is not intended to reflect the amount of any bonus that Mr Craven may have received from the two companies had he worked on an arms length basis.  Given that the CED survey total remuneration figures include bonuses, after the notional salary sacrifice amount is deducted, retention of the full salary package, including likely bonus payments, is consistent with the definition of salary in regulation 47(1) and it forms part of the preliminary ALS.  It is therefore, in my opinion, appropriate to calculate a bonus amount, being a percentage of the preliminary ALS figure, as a separate amount to reflect the risks and responsibilities associated with Mr Craven’s position.  I am satisfied that 15 per cent is an appropriate figure. 

CONCLUSION

43.     For the purposes of calculating Mr Craven’s transitional RBL in accordance with the Regulations, the Commissioner is required to calculate Mr Craven’s HAS for any three consecutive financial years before the 1994/1995 financial year.  The years chosen by Mr Craven were 1992, 1993 and 1994. 

44.     The term salary is defined in regulation 47(1).  However, where a person is an associate of that person’s employer and the person’s actual salary is greater or less than an ALS that person could have received, then the Commissioner may adopt an ALS for the purposes of the HAS calculation.  In doing so, the Commissioner must have regard to the matters set out in regulation 47(4). 

45.     In my opinion, the use of the CED survey to establish a preliminary ALS figure complies with regulation 47(4).  Furthermore, I am of the view that it is appropriate to deduct a notional salary sacrifice figure from the preliminary ALS figure for each year, based on maintaining the proportionality between the actual salary sacrifice made on behalf of Mr Craven and his actual total salary figures.  It is also my view that it is appropriate to add a 15 per cent bonus to the preliminary ASL figures prior to deducting the notional salary sacrifice figures.  It follows that I agree with the Commissioner’s calculation regarding Mr Craven’s ALS for the years 1992, 1993 and 1994 being $70,571, $81,214 and $85,380 respectively.  This results in a HAS of $79,055, which is less than the sum which the Commissioner allowed to Mr Craven under the first determination made on 3 February 1996.  That amount was $82,962.  I see no reason to disturb the Commissioner’s decision to allow Mr Craven to retain that higher HAS figure.

46. Accordingly, Mr Craven has not discharged the onus of proof in accordance with s 14ZZK of the Taxation Administration Act 1953. I therefore affirm the objection decision made by the Commissioner on 21 June 2006.

I certify that the forty‑six [46] preceding paragraphs are a true copy of the reasons for the decision herein of

Mr Egon Fice, Member

(sgd)       Olympia Sarrinikolaou

Clerk

Dates of Hearing:  16 March 2007 and 14 May 2007

Date of Decision:  6 July 2007

Advocate for the applicant:          Mr J. Day and Mr G. Fitton,

Remuneration Strategies Group

Counsel for the respondent:        Ms M. Wall

Solicitor for the respondent:         Ms J. Gatland, ATO Legal Services Branch