Delvene Track and and and and and and and and Commissioner of Taxation
[2015] AATA 45
•29 January 2015
[2015] AATA 45
Division TAXATION APPEALS DIVISION File Number
2013/0627
Re
Delvene Track
APPLICANT
And
Commissioner of Taxation
RESPONDENT
File Number
2013/0628
Re
Arnold Track Company 1 Pty Ltd
APPLICANT
And
Commissioner of Taxation
RESPONDENT
File Number
2013/0629
Re
Forde Company 1 Pty Ltd
APPLICANT
And
Commissioner of Taxation
RESPONDENT
File Number
2013/0630
Re
Arnold Track
APPLICANT
And
Commissioner of Taxation
RESPONDENT
File Number
2013/0631
Re
Lillian Forde
APPLICANT
And
Commissioner of Taxation
RESPONDENT
File Number
2013/0632
Re
Carter Forde
APPLICANT
And
Commissioner of Taxation
RESPONDENT
File Number
2013/0633
Re
JS Patrick Company 1 Pty Ltd
APPLICANT
And
Commissioner of Taxation
RESPONDENT
File Number
2013/0634
Re
Michael Track Company 1 Pty Ltd
APPLICANT
And
Commissioner of Taxation
RESPONDENT
Decision
Tribunal Deputy President P E Hack SC
Date 29 January 2015 Place Brisbane 1.In each application it will be ordered that the applicant not be limited to the grounds stated in the applicant’s taxation objection.
2.In application 2013/0627 (Delvene Track) the decisions under review are affirmed.
3.In application 2013/0628 (Arnold Track Company 1 Pty Ltd) the decisions under review are set aside and decisions substituted that the objections of the applicant to the respondent’s amended assessment of 13 January 2011 and the assessment of shortfall penalty of 22 December 2010 be allowed in full.
4.In application 2013/0629 (Forde Company 1 Pty Ltd) the decisions under review are set aside and decisions substituted that the objections of the applicant to the respondent’s amended assessment of 2 May 2011 and the assessment of shortfall penalty of 2 May 2011 be allowed in full.
5.In application 2013/0630 (Arnold Track) the decisions under review are affirmed.
6.In application 2013/0631 (Lillian Forde) the decisions under review are set aside and the matters remitted to the respondent for reconsideration in accordance with a direction that Mrs Forde is assessable on two thirds of balance of the income of the Forde Family Trust after deducting $1200.
7.In application 2013/0632 (Carter Forde) the decisions under review are set aside and the matters remitted to the respondent for reconsideration in accordance with a direction that Mr Forde is assessable on one third of balance of the income of the Forde Family Trust after deducting $1200.
8.In application 2013/0633 (JS Patrick Company 1 Pty Ltd) the decisions under review are set aside and decisions substituted that the objections of the applicant to the respondent’s amended assessment of 11 March 2011 and the assessment of shortfall penalty of 11 March 2011 be allowed in full.
9.In application 2013/0634 (Michael Track Company 1 Pty Ltd) the decision under review are set aside and decisions substituted that the objections of the applicant to the respondent’s amended assessment of 17 December 2010 and the assessment of shortfall penalty of 17 December 2010 be allowed in full.
..................[Sgd]......................................................
Deputy President P E Hack SC
CATCHWORDS
TAXATION – capital gain – small business CGT concessions – net asset value test – distribution of capital – liabilities “related to” the assets – connection between two subject matters – real and substantial, not remote
TAXATION – income tax schemes to avoid tax – whether a tax benefit obtained – whether scheme was one to which Part IVA applies
TAXATION – scheme shortfall penalty assessment – imposition and remission of penalties
LEGISLATION
Income Tax Assessment Act 1997 (Cth), ss 104-10, 108-5; Division 152
Income Tax Assessment Act 1936 (Cth), s 166A; Part IVA
Taxation Administration Act 1953 (Cth), Schedule 1, s 14ZZK, subdiv 284-CCASES
AXA Asia Pacific Holdings Ltd v Commissioner of Taxation [2009] FCA 1427; 2009 ATC 20-151
Bell v Commissioner of Taxation [2012] FCA 1042; 2012 ATC 20-350
Bell v Commissioner of Taxation [2013] FCAFC 32; 2013 ATC 20-380
Commissioner of Taxation v Hart [2004] HCA 26; (2004) 217 CLR 216
Commissioner of Taxation v Roberts (1992) 37 FCR 246
Jedhar Pty Ltd v Grosse [2004] QCA 167REASONS FOR DECISION
Deputy President P E Hack SC
29 January 2015
Introduction
There are eight applications before the Tribunal to review taxation objection decisions of the Commissioner of Taxation. The objections, and the underlying assessments, arise out of a capital gain made by Track Bros Company 1 Pty Ltd[1] (Track Bros 1), in its capacity as trustee of the Track Bros Company 1 Unit Trust (the Track Bros 1 Trust), when Track Bros 1 sold its business in July 2005 for an amount in excess of $8 million.
[1] This name, together with the names of all the parties, is a pseudonym adopted to comply with s 14ZZJ of the Taxation Administration Act 1953 (Cth).
The applications were, with the agreement of the parties, heard together. They involve primary and alternative assessments. Two fundamental issues arise:
(1)Was Track Bros 1 entitled to small business capital gains tax concessions provided for by Subdivision 152–C and Subdivision 152–B of the Income Tax Assessment Act 1997 (Cth) (the 1997 Act)? The answer to that question turns on whether particular liabilities of the Track Bros 1 Trust were “related to” assets of that trust.
(2)Do the anti-avoidance provisions of Part IVA of the Income Tax Assessment Act 1936 (Cth) (the 1936 Act) operate to cancel tax benefits obtained in connection with the transaction?
There was for a time a question whether the Commissioner was entitled to make amended assessments in some cases however it is now conceded[2] that amended assessments made in application 2013/0628 (Arnold Track Company 1 Pty Ltd) and application 2013/0634 (Michael Track Company 1 Pty Ltd) were made outside the time permitted for the making of amended assessments. The Commissioner no longer argues for fraud or evasion and concedes that those objection decisions ought be set aside. Necessarily, a decision ought be made in each of those matters allowing the objection decision in full.
[2]Respondent’s Proposed Final Orders, 14 April 2014, paragraph [1].
Finally, and depending on the conclusions otherwise reached, issues of the imposition of penalties, and the remission of those penalties, arise.
One other matter ought to be noted at the outset. The applicants rely on arguments that go beyond the grounds of their objections. By operation of s 14ZZK of the Taxation Administration Act 1953 (Cth) they are limited to those grounds unless the Tribunal orders otherwise. The Commissioner does not oppose the making of such an order. There is otherwise no reason to refuse to make such an order. There will be an order in each application that the applicant not be limited to the grounds stated in the taxation objection. No further particularisation of the additional grounds seems necessary.
Factual background
The primary facts are complex but, to a very great extent, not in dispute. I do not understand what follows to be in issue. I will deal with factual controversies when I deal with the particular issues.
The case concerns the sale, for a sum in excess of $8 million, of the business conducted in 2005 by Track Bros 1, as trustee of the Track Bros 1 Trust, and Track Bros Company 2 Pty Ltd (Track Bros 2), in its capacity as trustee of the Track Bros Company 2 Unit Trust (the Track Bros 2 Trust).
The business started in the mid-1980s when two brothers, Mr Michael Track and Mr Arnold Track, commenced repairing and operating cane harvesters. The brothers were fitters by trade and, as the repair business grew, they developed an expertise in fabricating parts for harvesters. By 1988 the business was operated through a company, Track Bros Pty Ltd. The brothers’ expertise in fabricating parts led in turn to them developing an interest in rotational moulding of plastic. The business of manufacturing and selling plastic moulded tanks grew quickly.
By the mid-1990s Mr Michael Track and Mr Arnold Track had decided to expand the business by bringing three new people into the management of it. One was Mr James Patrick who had been a long term employee of Track Bros Pty Ltd. Another was Mr Carter Forde who was, until his involvement in the business, the manager of the trading bank where Track Bros Pty Ltd had conducted its accounts. There was a third person who initially participated in the newly restructured business however he later withdrew and played no part in the events that are the subject of these proceedings. For simplicity, I will call Mr Michael Track, Mr Arnold Track, Mr Patrick and Mr Forde “the principals” when speaking of them collectively.
The new venture undertaken by the principals was Track Bros S & P Pty Ltd. It was incorporated in March 1996. Each of the principals became a director of that company and, either directly or by means of a related entity, a member of it.
By the time of the events in issue in these proceedings each of the principals had an associated family discretionary trust. The Michael Track Family Trust, the Arnold Track Family Trust and the Patrick Trust were each created by separate deeds dated 12 April 2001.[3] The Forde Family Trust was incorporated in March 1996.[4] In each case the initial beneficiaries were members of the immediate family of the associated principal. Where necessary, and for simplicity, I will call them collectively the family trusts. Each of the applicants is a beneficiary of one of the four family trusts.
[3]Exhibit 5, pages 42 – 66; Exhibit 6, pages 12 – 36; Exhibit 8, pages 10 – 34.
[4]Exhibit 7, pages 9 – 36.
Mr Michael Track was the trustee of the Michael Track Family Trust from its inception until 23 March 2005 when he was replaced by Michael Track Company 2 Pty Ltd. Mr Michael Track and his spouse, Mrs Delvene Track, were the only members and directors of Michael Track Company 2 Pty Ltd. By June 2005[5] Michael Track Company 1 Pty Ltd, a company which had been incorporated on 6 June 2002, had become a beneficiary of the Michael Track Family Trust. Mrs Delvene Track was also a beneficiary of that trust.
[5]The date that Michael Track Company 1 Pty Ltd became a beneficiary is not apparent from the material. It seems likely to have been in June 2002 when it was incorporated.
The position was similar with the Arnold Track Family Trust. Mr Arnold Track was the trustee initially. On 23 March 2005 Arnold Track Company 2 Pty Ltd, a company controlled by Mr Arnold Track, became the trustee of the Arnold Track Family Trust. Arnold Track Company 1 Pty Ltd was incorporated on 6 June 2002. Mr Arnold Track was the sole director and one of two members of it.[6] He was, as well, a beneficiary of the Arnold Track Family Trust. Arnold Track Company 1 Pty Ltd was a beneficiary of the Arnold Track Family Trust by June 2005 and was likely to have been a beneficiary much earlier.
[6]The other member was Arnold Track Company 2 Pty Ltd.
Forde Company 2 Pty Ltd was, and remains, the trustee of the Forde Family Trust. By deed dated 27 June 2003 the discretionary objects of that trust were expanded to include, amongst other classes, any company of which any of the beneficiaries was a member. Forde Company 1 Pty Ltd was incorporated on 6 June 2002. On that date, Mr Forde and his spouse, Mrs Lillian Forde, became members and the directors of Forde Company 1 Pty Ltd. Each of Mr and Mrs Forde were beneficiaries of the Forde Family Trust. Again, by June 2005 (and likely much earlier), Forde Company 1 Pty Ltd had become a beneficiary of the Forde Family Trust.
Mr Patrick was, and remains, the trustee of the Patrick Trust. JS Patrick Company 1 Pty Ltd, a company incorporated on 6 June 2002, was a beneficiary of the Trust by June 2005 and likely much earlier. Mr Patrick is, and has been, the sole member and director of JS Patrick Company 1 Pty Ltd.
By 2001 the business involved the manufacture and supply of rainwater tanks, pool shells and farm products. In April 2001, there was a further restructure based on advice from Cleary Hoare, a firm of Brisbane solicitors. It is likely that the creation of the family trusts (other than the Forde Family Trust) in April 2001 was part of the overall restructure. The trusts deeds were all prepared by Cleary Hoare and a member of the firm was the settlor of them.
The business was separated into three parts. One entity (Track Bros 1, as trustee of the Track Bros 1 Trust) conducted the business and another (Track Bros 2, as trustee of the Track Bros 2 Trust) owned the majority of the property, plant and equipment. A third entity, Track Bros Company 3 Pty Ltd, as trustee of the Track Bros Company 3 Unit Trust, took over the steel parts side of the business.
Track Bros 1 was incorporated on 12 April 2001. Each of the principals became a director of the company on its incorporation. The Track Bros 1 Trust was created by deed dated 19 April 2001. The trustee, initially, was Track Bros S & P Pty Ltd. The Track Bros 1 Trust was a “hybrid” trust, that is, it had characteristics of both a unit trust and a discretionary trust. The units were held by Mr Michael Track, as trustee of the Michael Track Family Trust (25.5%), Mr Arnold Track, as trustee of the Arnold Track Family Trust (25.5%), Mr Patrick, as trustee of the Patrick Trust (26.7%) and Forde Company 2 Pty Ltd (a company controlled by Mr Forde and his spouse) as trustee of the Forde Family Trust (22.3%). On 19 April 2001 the unitholders of the Track Bros 1 Trust resolved that, with effect from 1 July 2001, Track Bros S & P Pty Ltd would be removed as trustee of the Track Bros 1 Trust and be replaced by Track Bros 1.
The net income of the Track Bros 1 Trust was distributed to its unit holders in proportion to their unit holdings in each of the 2002, 2003 and 2004 income years.
The first approach regarding the possible sale of the business came from a national firm of chartered accountants in early 2005. The principals were asked if they were interested in selling. They nominated a price, (which they considered inflated), at which they were prepared to sell. By that time there had been some changes to the unit holders of the Track Bros 1 Trust. Michael Track Company 2 Pty Ltd became the trustee of the Michael Track Family Trust (and holder of 25.5% of the units in the Track Bros 1 Trust) on 23 March 2005. On the same day, Arnold Track Company 2 Pty Ltd became the trustee of the Arnold Track Family Trust (and holder of 25.5% of the units in the Track Bros 1 Trust). There were no changes to the Patrick Trust or to the Forde Family Trust.
Discussions with intermediaries concerning a possible sale led to the execution by the principals, on behalf of Track Bros 1 and on behalf of each of them as individuals, on 5 May 2005, of the document described as a “Transaction Term Sheet”. It is not necessary to analyse its legal effect; it will suffice to say that it granted to Exwhyzed Moneybags Pty Ltd an option to purchase the business and the majority of the assets of Track Bros 1 and Track Bros 2 at a base price of $7.5 million plus an “earnout” component in the nature of a performance bonus and restraint of trade payments of $125,000 to each of the principals. The option was valid for 30 days.
The prospect of a sale caused Mr Michael Track, on behalf of all of the principals, to seek further advice from Cleary Hoare. Mr Michael Track described that as “asset protection and tax advice”. As will appear, the Commissioner submits that the claimed motivation of “asset protection” should be regarded with scepticism and that what motivated the transaction was a desire to avoid paying tax on the proceeds of sale. In any event, Mr Michael Track consulted with the solicitors and conveyed the substance of that advice to the other directors. The advice of the solicitors, setting out in considerable detail the steps to be undertaken, is recorded in the letter of 21 June 2005 from Cleary Hoare to Mr Michael Track. That letter summarises the steps to be taken in this way:[7]
3.Steps 1 to 4 establish the four new trusts to be the recipient of the capital distributions from the Track Bros 1 Unit Trust.
4.Step 5 effects the capital distribution to the new trusts. This step should be implemented as soon as possible and must be entered into prior to executing any sale contract or coming to an agreement to sell the business. These documents effect a distribution of an amount equal to the cash, term deposits, and loans owing by related entities such as the trustee of the Track Bros Company 2 Unit Trust. The amount of this distribution should also include the option fee held by us in our trust account. The amount of the distribution should not be limited to the amount of cash you have available to repay the loans and pay the distribution to the new trusts.
5.Step 6 requires the repayment of amounts owing by the related entities. This step should also be implemented as soon as possible. If you do not have sufficient cash available we can make alternative arrangements for the payment of the necessary amount.
6.Step 7 requires the payment of 25% of the capital distribution to each of the new trusts. This step should also be implemented as soon as possible.
7.Step 8 contains documentation for a loan-back by the new trusts to the Track Bros 1 Unit Trust. These documents need only be executed if it is necessary for the whole or part of the Cash Amount to be lent back to the Track Bros 1 Unit Trust.
8.Step 9 contains documentation to secure the loan made to the Track Bros 1 Unit Trust. These documents are not required to be executed if no loan-back is made to the Track Bros 1 Unit Trust under Step 8. If the Deed of Charge is executed, a liability for stamp duty will arise to the extent of 0.4% of the greater of the amount lent or the maximum prospective liability specified in Clause 8.1 of the Deed of Charge.
[7]Exhibit 19, pages 13 – 14 of MJD-1.
Consistent with that advice, each of the principals set up a discretionary trust. The settlor in each case was the solicitor from Cleary Hoare who advised on the restructure. In each case the settlement sum of $10 was deposited to a bank account opened that day. In the case of Mr Michael Track, Michael Track Company 2 Pty Ltd was the trustee of the Michael Track Protection Trust and Mr Michael Track and several of his relatives were the beneficiaries. The other “protection trusts” followed a similar pattern. Arnold Track Company 2 Pty Ltd became the trustee of the Arnold Track Protection Trust, Mr Patrick the trustee of the JS Patrick Protection Trust and Forde Company 2 Pty Ltd the trustee of the Forde Protection Trust. On the advice given to Mr Michael Track it was important that the trusts to be used for the capital distribution were “clean trusts”. Each of the protection trusts was a discretionary beneficiary of the Track Bros 1 Trust. That was so because each answered the description of “Eligible Trust”.
Once the protection trusts had been established a meeting of the directors of Track Bros 1 took place at 2.15pm on 28 June 2005. Mr Accountant, the external accountant for Track Bros 1, was present. The minutes of that meeting record the following:[8]
[8]Exhibit 1, pages 548 – 549.
2.Under the Deed of Trust constituting the Trust dated 19 April 2001, as varied from time to time (“the Trust Deed”), with the consent of all Unitholders of the Trust in accordance with Clauses 14.10 and 17.6 of the Trust Deed, the Company has the power to make a distribution of net income or capital of the Trust to the Discretionary Beneficiaries.
…
5.The assets of the Trust include cash, term deposits, and loans due from the trustee of the Track Bros Company 2 Unit Trust, the trustee of the Track Bros Company 3 Unit Trust, Track Bros Company 4 Pty Ltd … and Track Bros Company 5 Pty Ltd …
6.At the date of this Resolution, the total of the cash, term deposits and loans referred to in the previous paragraph are equal to the sum of $2,561,239 (“the Cash Amount”).
7.The Company proposes to make a distribution of capital equal to the Cash Amount to the following Discretionary Beneficiaries of the Trusts as follows (“the Discretionary Distribution”):
7.1The Trustee of the Michael Track Protection Trust – 25.5%;
7.2The Trustee of the Arnold Track Protection Trust – 25.5%;
7.3The Trustee of the Forde Protection Trust – 22.3%
7.4The Trustee of the JS Patrick Protection Trust – 26.7%.
8.All of the Unit holders of the Trust have consented to the Discretionary Distribution.
IT WAS RESOLVED pursuant to the power in the Trust Deed to make distributions from the Trust, to:
9.Make the Discretionary Distribution.
10.The amount of the Discretionary Distribution is to be set aside in a separate account in the name of the beneficiary in the books of the Trust so that the beneficiary has an immediate vested indefeasible interest in the capital distributed.
The steps taken to give effect to that resolution are best explained by Mr Accountant. He described them thus:[9]
[9]Exhibit 19, paragraph [21].
(a)First, I worked out how much cash the Track Bros 1 Unit Trust had available.
(b)I then worked out how much was owing to the Track Bros 1 Unit Trust from each of Track Bros Company 2 Unit Trust, Track Bros Company 3 Unit Trust and Track Bros Company 4 Pty Ltd.
I recall that each of Track Bros Company 2 Unit Trust, Track Bros Company 3 Unit Trust and Track Bros Company 4 Pty Ltd did not, at that time, have adequate funds to repay those loans and determined that it would be necessary for the Protection Trusts to loan amounts to each of Track Bros Company 2 Unit Trust, Track Bros Company 3 Unit Trust and Track Bros Company 4 Pty Ltd to allow those loans to be repaid.
(c)The next step was to make the payments … totalling $1 million, made in the percentages stated to the Michael Track Protection Trust, Arnold Track Protection Trust, Forde Protection Trust and JS Patrick Protection Trust (Protection Trusts), (the first payment).
(d)Once cleared funds for the first payment were received by the Protection Trusts, the next step was for the Protection Trusts to loan to each of Track Bros Company 2 Unit Trust, Track Bros Company 3 Unit Trust and Track Bros Company 4 Pty Ltd the total sum of $941,393, which represented the balance owing by those three entities to the Track Bros 1 Unit Trust.…
(e)The next step involved Track Bros Company 2 Unit Trust, Track Bros Company 3 Unit Trust and Track Bros Company 4 Pty Ltd repaying their loans to the Track Bros 1 Unit Trust …
(f)… I then calculated what additional amounts were to be paid to each of the Protection Trusts which … totalled $1,561,239 (the second payment).
(g)Before taking the final step I first considered what amounts were due and payable by the Track Bros 1 Unit Trust to its creditors on or before 30 June 2005. In order to determine this, I ran an ‘Aged Payables’ report which identified that a total amount of $619,165.51 was outstanding. …
I recall that when I reviewed this report, the amount of $355,690.57 appearing at the bottom of the May column was payable before 30 June. Carter Forde advised he needed $25,000 to cover wages, an additional $30,000 for employee superannuation. Carter and I calculated that we needed to keep at least $410,000 in cash in the Track Bros 1 Unit Trust and I noted that at the bottom of the Aged Payables report. Carter and I determined that in order to provide an appropriate buffer, $500,000 should be loaned back to the Track Bros 1 Unit Trust. …
(h)The final step was for the Protection Trusts to make loans amounting to $500,000 back to the Track Bros 1 Unit Trust …
The transactions effected on 28 June 2005 are explained diagrammatically in this representation of Exhibit 22:
The transactions undertaken, and the order of them, were as follows:
(1)Track Bros 1 redeemed a call deposit in its name and deposited the proceeds of $1,002,066.37 into its bank account;
(2)In partial satisfaction of the resolution to make the “Discretionary Distribution”, cheques, totalling $1 million, were drawn from that account in favour of the protection trusts are as follows:
(i)Michael Track Protection Trust – $255,000;
(ii)Arnold Track Protection Trust – $255,000;
(iii)JS Patrick Protection Trust – $267,000; and,
(iv)Forde Protection Trust – $223,000;
(3)The four protection trusts collectively lent $941,393 to Track Bros 2, Track Bros 3 and Track Bros 4, as follows:
(i)amounts totalling $240,055 were withdrawn from the Michael Track Protection Trust and transferred to the accounts of Track Bros 2 ($111,122), Track Bros 3 ($47,333) and Track Bros 4 ($81,600);
(ii)amounts totalling $240,055 were withdrawn from the Arnold Track Protection Trust and transferred to the accounts of Track Bros 2 ($111,122), Track Bros 3 ($47,333) and Track Bros 4 ($81,600);
(iii)amounts totalling $251,353 were withdrawn from the JS Patrick Protection Trust and transferred to the accounts of Track Bros 2 ($116,352), Track Bros 3 ($49,561) and Track Bros 4 ($85,440); and,
(iv)amounts totalling $209,930 were withdrawn from the Forde Protection Trust and transferred to the accounts of Track Bros 2 ($97,177), Track Bros 3 ($41,393) and Track Bros 4 ($71,360);
(4)Track Bros 2 ($435,773), Track Bros 3 ($185,620) and Track Bros 4 ($320,000) repaid loans totalling $941,393 to Track Bros 1;
(5)Cheques, totalling $1,561,239, were drawn on the account of Track Bros 1 and deposited to the protection trusts accounts as follows:
oMichael Track Protection Trust $398,116
oArnold Track Protection Trust $398,116
oJS Patrick Protection Trust $416,851
oForde Protection Trust $348,156
(6)Next, amounts totalling $500,000 were withdrawn from the protection trusts accounts and deposited to the account of Track Bros 1. The amounts were:
oMichael Track Protection Trust $127,500
oArnold Track Protection Trust $127,500
oJS Patrick Protection Trust $133,500
oForde Protection Trust $111,500
Repayment of those loans was secured by a fixed and floating charge over all of the property of Track Bros 1, executed by the parties on 29 June 2005.
The option granted on 5 May 2005 was not exercised however the parties remained prepared to contract. According to Mr Michael Track,[10] the prospective purchaser was aiming for a 1 July 2005 completion date. On that date Track Bros 1 and Track Bros 2, as vendors, enter into a “business sale agreement” with Oz Fluid Systems Pty Ltd as purchaser for the sale of the tank manufacturing business and dissociated plant and equipment. Oz Fluid Systems was an entity associated with Exwhyzed Moneybags. Each of the principals was a party to the deed. They undertook particular obligations under the sale agreement including binding themselves to a restraint of trade clause and, as set out below, assuming a personal liability for some continuing product liability.
[10]Transcript, page 83, line 5.
By virtue of clause 2.1 each of Track Bros 1 and Track Bros 2 agreed to sell, and Oz Fluid Systems agreed to buy, the business carried on by Track Bros 1 and Track Bros 2 together with various specified assets including plant and equipment, goodwill and trade debtors, for the sum of $8 million plus or minus an “Adjustment Amount”. The applicants placed reliance on the continued obligations owed by the principals (described as “Covenantors” in the deed) by clauses 28 and 29. Those clauses provided:
28 PRODUCT LIABILITY WARRANTIES
28.1From Completion the Purchaser will, without assuming legal liability, use its best endeavours to honour all valid claims arising from product liability warranties provided to customers by the Vendors prior to Completion up to a total amount of $50,000 for each year. This is a non-accumulative annual amount.
28.2The Purchaser must take all reasonable steps to mitigate the cost of honouring the warranties, and the cost of honouring the warranties will be calculated at cost and not on a retail mark-up basis.
28.3The Vendors acknowledge that they are legally liable for all product liability warranties they have given.
29CLAIMS
29.1The Vendors and the Covenantors indemnify the Purchaser in respect of all Claims arising that relate to any matter prior to Completion provided that:
29.1.1The Purchaser must take all reasonable steps to avoid or mitigate any Loss, which might give rise to a Claim by the Purchaser under this clause including recovering from the Purchaser’s insurers or other third parties including but not limited to suppliers and manufacturers;
29.1.2The Purchaser must not pay or settle any Claim in respect of which a Claim may be made under this clause or make any admission in respect of such a Claim without the prior consent of the Vendors, such consent not to be unreasonably withheld;
29.1.3The Vendors and Covenantors are not liable to the Purchaser for any Claim under this clause unless the Purchaser has given written notice to the Vendors and Covenantors as soon as reasonably practical and such notice sets out the details of the Claim as are then known and the Purchaser keeps the Vendors and the Covenantors informed about the progress of the Claim; and
29.1.4The Vendors and the Covenantors indemnify the Purchaser under this clause for a maximum period of three (3) years from the date of Completion.
The net proceeds of sale of $8,159,808.20 were credited to the bank account of Track Bros 1 on 8 July 2005. Immediately prior to the sale the net value of the assets of the Track Bros 1 Trust was recorded as $3,812,063.[11]
[11]Exhibit 1, page 495.
On 22 July 2005, the Track Bros 1 Trust repaid loans from the protection trusts as follows:
·Michael Track Protection Trust $127,500
·Arnold Track Protection Trust $127,500
·JS Patrick Protection Trust $133,500
·Forde Protection Trust $111,500
Additionally it made payments of entitlements to beneficiaries as follows:
·Michael Track Family Trust $290,000
·Arnold Track Family Trust $290,000
·Patrick Trust $303,650
·Forde Family Trust $253,600
On 15 June 2006 the directors of Track Bros 1, in its capacity as trustee, resolved[12] to distribute the income and the capital gain of the Track Bros 1 Trust equally between Mr Forde and Mr Patrick, with $500,000 of the capital gain being paid to each of them as an eligible termination payment. On the same day Track Bros 1 executed a “Redundancy Agreement” with each of Mr Patrick and Mr Forde. Pursuant to those agreements $500,000 was paid into superannuation funds on behalf of each of them.
[12]Exhibit 1, pages 11 – 12.
It will be recalled that on 23 March 2005 Michael Track Company 2 Pty Ltd replaced Mr Michael Track as the trustee of the Michael Track Family Trust. Despite that, there is in the material[13] what purports to be a “minute” of Mr Michael Track, in the capacity as trustee of that Trust, and bearing the date 29 June 2006, resolving that the income of the Michael Track Family Trust be distributed on the basis that all capital gains be distributed to Mrs Delvene Track and that “The Remainder” be distributed to Michael Track Company 1 Pty Ltd.
[13]Section 37 documents, 2013/0627, page 55.
There were, apparently, other similar documents although I have been unable to locate them in the material. In a paper prepared by the Commissioner,[14] reference is made to a minute, described as a minute of Mr Michael Track, as trustee of the Michael Track Family Trust,[15] but apparently executed by Mr Arnold Track, bearing the date 29 June 2006 and resolving that the income of the Arnold Track Family Trust for the 2006 income year be distributed, as to capital gains and tax-free income, to Mr Arnold Track, and to Arnold Track Company 1 Pty Ltd as to the remainder.
[14]Exhibit 1, page 870.
[15]At that time neither Mr Michael Track nor Mr Arnold Track was the trustee of the Arnold Track Family Trust. Arnold Track Company 2 Pty Ltd became the trustee of the Arnold Track Family Trust on 23 March 2005.
The same paper makes reference to a minute of Mr Patrick resolving that the income of the Patrick Trust for the 2006 income year be distributed to JS Patrick Company 1 Pty Ltd and to a resolution of Forde Company 2 Pty Ltd, as trustee of the Forde Family Trust, to distribute the first $1200 of the income of that Trust equally between two of the children of Mr and Mrs Forde, to distribute the next $4500 of income between Mr Forde and Mrs Forde in shares of one third and two thirds respectively, and to distribute any remainder to Forde Company 1 Pty Ltd.
The returns and assessing processes
It is as well to start with Michael Track Company 1 Pty Ltd and Arnold Track Company 1 Pty Ltd. On 15 December 2006 Michael Track Company 1 Pty Ltd lodged its income tax return for the 2006 income year disclosing a taxable income of $68,059. On the same day Arnold Track Company 1 Pty Ltd lodged its income tax return for the 2006 income year disclosing a taxable income of $89,702. By virtue of s 166A of the 1936 Act, the Commissioner was taken to have made an assessment of the taxable income of each of them on the day on which the return was furnished.
On 17 December 2010, which is more than four years after the original assessments in each case, the Commissioner made amended assessments of the taxable income of Michael Track Company 1 Pty Ltd and Arnold Track Company 1 Pty Ltd. He could only do so more than four years after the original assessment if satisfied that there had been fraud or evasion. The Commissioner did not then purport to form such an opinion and despite initially submitting[16] that it was open now to the Tribunal to form that opinion, he no longer presses that argument and now agrees that the Michael Track Company 1 Pty Ltd and Arnold Track Company 1 Pty Ltd amended assessments[17] should be set aside. It follows that shortfall penalty assessments made in relation to the two companies must also be set aside. In light of that conclusion no further attention need be paid to Michael Track Company 1 Pty Ltd and Arnold Track Company 1 Pty Ltd.
[16]Exhibit 25, paragraph [147].
[17]There were two further amended assessments made by the Commissioner in relation to Arnold Track Company 1 Pty Ltd on 22 December 2010 and 13 January 2011.
The Track Bros 1 Trust lodged its 2006 Trust tax return in May 2007.[18] It disclosed a net income of $146,652 and a net capital gain of $460,101. The net capital gain was calculated by reference to a gross capital gain of $5,840,404.[19] That sum was reduced by the discount percentage of 50% and then further reduced by 50% on the basis that the Trust was entitled to small business CGT concessions. Finally, it was reduced by $1,000,000 representing the amounts paid to the superannuation funds on behalf of Mr Forde and Mr Patrick. The net income and the net capital gain were shown as having been distributed to Mr Patrick (income – $73,326, capital gain – $230,051) and to Mr Forde (income – $73,326, capital gain – $230,050).
[18]Exhibit 12, Annexure LWG-1.
[19]The calculation of that sum is not in issue.
The Commissioner commenced an investigation into these transactions in March 2009. That investigation led to the preparation, in December 2010, of a position paper which proposed that Part IVA of the 1936 Act be relied upon to include capital gain made from the sale of the business in the net income of the Track Bros 1 Trust on the basis that the small business CGT concessions were not available. The position paper proposed that the income and capital distributions to Mr Patrick and Mr Forde be disregarded and that the net income of $146,652 and the capital gain of $2,920,202 be treated as having been distributed to the family trusts in proportion to the units held. Thus it was postulated that $744,651 would have been distributed to each of the Michael Track Family Trust and the Arnold Track Family Trust, $779,694 to the Patrick Trust and $651,205 to the Forde Family Trust. The paper postulated that the family trusts would, in turn, have distributed the income and capital to the corporate beneficiaries of the family trusts. A “scheme shortfall” penalty of 50% pursuant to s 284-160 of Schedule 1 to the Taxation Administration Act was proposed.
Later in December 2010 the Commissioner refined his approach by proposing, and then making in relation to the Michael Track Family Trust and the Arnold Track Family Trust beneficiaries, “primary” amended assessments said to be in accordance with the various trust deeds and trust minutes of the taxable income of Mrs Delvene Track and of Mr Arnold Track, and “alternative” assessments to the corporate beneficiaries, Michael Track Company 1 Pty Ltd and Arnold Track Company 1 Pty Ltd. The paper proposed making assessments in relation to Forde Company 1 Pty Ltd and JS Patrick Company 1 Pty Ltd however those were not undertaken at that time.
On 16 December 2010 the Commissioner (by a delegate) made a determination, pursuant to Part IVA of the 1936 Act, including the amount of $2,460,101[20] in the assessable income of the Track Bros 1 Trust. On the same day similar determinations were made,
·including the amount of $1,489,302 in the assessable income of Michael Track Company 1 Pty Ltd;
·including the amount of $1,489,302 in the assessable income of Arnold Track Company 1 Pty Ltd;
·including the amount of $744,651 in the assessable income of Mrs Delvene Track; and,
·including the amount of $744,651 in the assessable income of Mr Arnold Track.
The following day, the Commissioner, gave effect to the Part IVA determinations. In addition to the amended assessments made in relation to Michael Track Company 1 Pty Ltd and Arnold Track Company 1 Pty Ltd he made an amended assessment[21] of the taxable income of Mrs Delvene Track (as a beneficiary of the Michael Track Family Trust) for the 2006 income year, increasing it by $744,651 to $766,088. On the same day an amended assessment[22] was made of the 2006 taxable income of Mr Arnold Track (as a beneficiary of the Arnold Track Family Trust) by increasing it by $744,651 to $904,024. In each case a scheme shortfall penalty of 50% was imposed.
[20]Representing the difference between the capital gain calculated without the small business concessions ($2,920,202) and the amount already included ($460,101).
[21]Section 37 documents, 2013/0627, pages 49 – 52.
[22]Section 37 documents, 2013/0630, pages 37 – 40.
Each of Mrs Delvene Track and Mr Arnold Track lodged objections to the amended assessments (including the penalty assessments) on 16 February 2011.
The Commissioner turned his attention to the other participants in March 2011. On 3 March 2011 the Commissioner made a Part IVA determination in relation to JS Patrick Company 1 Pty Ltd deeming an amount of $1,559,388 to have been included in its taxable income for the 2006 income year. On 11 March 2011 the Commissioner made an amended assessment[23] of its taxable income for that year increasing it by $1,559,388[24] to $1,638,818. A scheme shortfall penalty of 50% was assessed on the same day.
[23]Section 37 documents, 2013/0633, pages 25 – 27.
[24]The difference between the distribution of $58,553 as returned and the attributed distribution of $1,617,941.
JS Patrick Company 1 Pty Ltd lodged an objection to the amended assessment and the penalty assessment on 19 April 2011.
On 15 April 2011 the Commissioner made Part IVA determinations,
·including an amount of $1,302,410 in the taxable income of Forde Company 1 Pty Ltd for the 2006 income year;
·including an amount of $651,205 in the taxable income of Mr Forde for the 2006 income year; and
·including an amount of $651,205 in the taxable income of Mrs Forde for the 2006 income year.
On 2 May 2011 the Commissioner gave effect to the determinations in relation to Forde Company 1 Pty Ltd by making an amended assessment[25] of its 2006 taxable income in the amount of $1,317,624, an increase of $1,302,410. A scheme shortfall penalty assessment of 50% was made on the same day.
[25]Section 37 documents, 2013/0629, pages 27 – 28.
The Commissioner made an amended assessment[26] of Mr Forde’s 2006 taxable income on 4 May 2011 increasing it by $651,205 to $936,307. On the same day he made an amended assessment[27] of Mrs Forde’s taxable income, increasing it by $648,317 to $669,280.[28] Assessments of scheme shortfall penalty were made at 50% on 4 May 2011.
[26]Section 37 documents, 2013/0632, pages 38 – 41.
[27]Section 37 documents, 2013/0631, pages 37 – 40.
[28]The increase varied from that in the case of Mr Forde because a prior year capital loss of $5776 was brought to account.
Mr and Mrs Forde lodged objections to the amended assessments and the penalty assessments on 22 June 2011. Forde Company 1 Pty Ltd lodged objections to the amended assessment and the penalty assessment on 7 July 2011.
The Commissioner disallowed all objections on 12 December 2012. These proceedings were commenced on 8 February 2013.
What remains in issue?
With the applications of Michael Track Company 1 Pty Ltd and Arnold Track Company 1 Pty Ltd determined by the Commissioner’s concession, it is as well to set out what remains in issue on the basis of the assessments as now propounded by the Commissioner.
Expressed broadly, and recognising that the onus of demonstrating that the assessments are excessive remains with the applicants, the Commissioner’s case is that there was a scheme to take advantage of the small business capital gains tax concessions and that Part IVA of the 1936 Act allowed him, in effect, to treat all of the capital gain of the Track Bros 1 Trust ($2,920,202) as having been distributed to the family trusts as beneficiaries of that Trust in proportion to their unit holdings. Thus, on the Commissioner’s case,
·the Michael Track Family Trust received a grossed up capital gain of $1,489,302;
·the Arnold Track Family Trust received a grossed up capital gain of $1,489,302;
·the Forde Family Trust received a grossed up capital gain of $1,302,410; and,
·the Patrick Trust received a grossed up capital gain of $1,559,388.
The Commissioner now contends[29] that the “primary” assessments are those issued to,
·Mrs Delvene Track, as a beneficiary of the Michael Track Family Trust, on 17 December 2010, which included in her taxable income the amount of $744,651;
·Mr Arnold Track, as a beneficiary of the Arnold Track Family Trust, on 17 December 2010, which included in his taxable income the amount of $744,651;
·JS Patrick Company 1 Pty Ltd, as a beneficiary of the Patrick Trust, on 11 March 2011, which included in its taxable income the amount of $1,559,388;
·Mr Forde, as a beneficiary of the Forde Family Trust, on 4 May 2011, which included in his taxable income the amount of $651,205; or,
·alternatively to the assessment to Mr Forde, Mrs Forde, as a beneficiary of the Forde Family Trust, on 4 May 2011, which included in her taxable income the amount of $651,205.
[29]Exhibit 25, paragraph [193].
The only “alternative” assessment that remains in issue is that issued to Forde Company 1 Pty Ltd on 2 May 2011 which included in its taxable income an amount of $1,302,410.
The small business capital gains concession
The general scheme of the capital gains tax provisions found in the 1997 Act are not in dispute. An entity’s taxable income for an income year includes net capital gains made by the entity, generally discounted by 50%. An entity can make a capital gain (or suffer a capital loss) if a CGT event occurs. In a case such as the present, where Track Bros 1 sold a business, it is not in issue that “CGT event A1” occurred and that where, as here, there was a contract for the disposal of the asset, the time of the CGT event is when the entity entered into a contract. That is the effect of s 104-10 of the 1997 Act.
Division 152 of the 1997 Act, headed “Small business relief”, allows for the further reduction of capital gains in four circumstances where “basic conditions” (at least) are satisfied. Two only of those circumstances need be considered – a 50% reduction in the amount of the capital gain if all of the basic conditions are satisfied and a complete exemption of a capital gain if all the basic conditions are satisfied and the capital proceeds are used in connection with retirement. The precise mechanisms of relief are not in issue; the issue is whether one of the basic conditions was satisfied.
The “basic conditions” are set out in s 152-10 of the 1997 Act. At the time of these events it provided:
(1) A *capital gain (except a capital gain from *CGT event K7) you make may be reduced or disregarded under this Division if the following basic conditions are satisfied for the gain:
(a)a *CGT event happens in relation to a *CGT asset of yours in an income year;
Note: This condition does not apply in the case of CGT event D1: see section 152-12.
(b)the event would (apart from this Division) have resulted in the gain;
(c)you satisfy the maximum net asset value test (see section 152-15);
(d)the CGT asset satisfies the active asset test (see section 152-35).
The issue is whether the Track Bros 1 Trust satisfied the maximum net asset value test.
That test was satisfied if, “just before” the CGT event, the net value of CGT assets of the entity, other entities connected with that entity and small business CGT affiliates, did not exceed $5 million. Here, there are no connected or affiliated entities; the only issue is the net value of CGT assets of the Track Bros 1 Trust. Section 152-20 of the 1997 Act sets out the complex rules for determining the net value of CGT assets. It is only necessary to have regard to s 152-20(1). It was in these terms:
(1)The net value of the CGT assets of an entity is the amount (if any) by which the sum of the market values of those assets exceeds the sum of the liabilities of the entity that are related to the assets.
The expression “CGT asset” was explained in s 108-5 of the 1997 Act in this way:
(1) A CGT asset is:
(a)any kind of property; or
(b)a legal or equitable right that is not property.
(2)To avoid doubt, these are CGT assets:
(a)part of, or an interest in, an asset referred to in subsection (1);
(b)goodwill or an interest in it;
(c)an interest in an asset of a partnership;
(d)an interest in a partnership that is not covered by paragraph (c).
Note 1: Examples of CGT assets are:
• land and buildings;
• shares in a company and units in a unit trust;
• options;
• debts owed to you;
• a right to enforce a contractual obligation;
• foreign currency.
Neither “liabilities” nor “related to the assets” were defined in the 1997 Act. The issue that divides the parties is whether particular liabilities of the Track Bros 1 Trust were related to its CGT assets.
The Track Bros 1 Trust lodged its 2006 income tax return on the footing that it satisfied the maximum net asset value test, thus enabling it to take the benefit of the concessions. It now contends to the contrary. It says that three categories of the Trust’s liabilities – unpaid beneficiary entitlements, loans from the protection trusts and loans from Track Bros Company 4 Pty Ltd and the Track Bros Company 3 Unit Trust – were not “related to” assets of the Track Bros 1 Trust. If these liabilities are excluded the net value of the CGT assets of the Track Bros 1 Trust, so it contends, is $5,489,421.71. The Commissioner contends that each of those liabilities is related to assets of the Track Bros 1 Trust and that the net value of CGT assets was $3,812,063.
Both parties are working from the balance sheet of the Track Bros 1 Trust on 30 June 2005,[30] the day prior to the CGT event, a date undoubtedly “just before” the CGT event. It shows total assets of the Track Bros 1 Trust of $8,083,216 comprising:
[30]Exhibit 1, page 495.
Current assets
oCash on hand 8,800
oPetty cash float 300
oBusiness bank account 105,744
oSundry debtors 6,491
oTrade debtors 557,256
oFinished goods inventory 862,139
1,540,730
Intangibles
oGoodwill 6,367,875
Non-current assets
oLoan Track Bros Company 2 Unit Trust 113,000
oLoan Track Bros Company 5 Pty Ltd 61,611
174,611
Total assets 8,083,216
The balance sheet showed total liabilities of $4,271,153 made up of:
Current liabilities
oBeneficiary current accounts 1,436,418
oTrade creditors 503,120
oCustomer deposits 78,556
oEmployee entitlements 21,377
oGST payable 70,474
oPAYG withholding liability 29,316
2,139,261
Non-current liabilities
oLoan – Track Bros S & P Pty Ltd 240,000
oLoan – Michael Track Company 1 Pty Ltd 342,756
oLoan – Arnold Track Company 1 Pty Ltd 342,756
oLoan – JS Patrick Company 1 Pty Ltd 358,886
oLoan – Forde Company 1 Pty Ltd 299,744
oLoan – Michael Track Protection Trust 127,500
oLoan – Arnold Track Protection Trust 127,500
oLoan – JS Patrick Protection Trust 133,500
oLoan – Forde Protection Trust 111,500
oLoan – Track Bros Company 4 Pty Ltd 30,000
oLoan – Track Bros Company 3 Unit Trust 17,750
2,131,892
Total liabilities 4,271,153
Net assets 3,812,063
Mr Harrison QC, counsel for the applicants, identified three categories of liabilities that he submitted did not relate to the CGT assets of the Track Bros 1 Trust. The first category encompassed the unpaid present entitlement of the four family trusts totalling $1,436,418 and described as “beneficiary current accounts” in the balance sheet. In reliance on an “alternative argument” advanced in an expert opinion of an accountant, Mr Paul Green, (and contrary to what I infer was Mr Green’s primary argument) he submitted[31] that, although the income available for distribution arose as a consequence of the business activities, and the assets that related to those activities, the distributions were outstanding (that is, had not been paid to the beneficiaries) as at 30 June 2005 as a consequence of the trustee not having sufficient funds to pay the distribution, that being the consequence of the capital distribution made by the Track Bros 1 Trust to the protection trusts.
[31]Applicants’ closing submissions, paragraphs [129 (a)] and [140 (a)].
Next, he identified a total of $500,000 owed to the protection trusts. These liabilities did not relate to the assets of the Track Bros 1 Trust because they did not relate to the activities of the business or the assets which contributed to the operation of the business.[32]
[32]Ibid, paragraph [129 (d)] and [140 (b)].
Finally, the applicants submitted that the loans from Track Bros Company 4 Pty Ltd ($30,000) and from Track Bros Company 3 Unit Trust ($17,750) did not relate to the assets of the Trusts. There was no evidence to suggest that these liabilities were acquired for a particular business purpose or to fund the working capital of the business and it was to be inferred that they were required to fund, in part, capital distributions paid to the protection trusts.[33]
[33]Ibid, paragraph [129 (e)] and [140 (c)].
I should say, at the outset, that whilst Mr Green’s evidence on matters of accounting practice, if otherwise relevant, is of assistance I do not pay any particular regard to his opinions on the issue whether particular liabilities are related or not. Insofar as these matters are in contest the conclusions are conclusions on matters of mixed fact and law where I am bound to reach my own conclusions.
The submissions of both parties draw attention to, and seek assistance from, the decision in Bell v Commissioner of Taxation at first instance,[34] and on appeal.[35] There were two issues involving the proper construction of s 152-15 of the ITAA 1997 in Bell. One, concerning an offset bank account, does not presently arise. The factual basis of the other issue is described in the reasons of the Full Court in this way:
22.The issue which arises under the Commissioner’s notice of contention is whether the debt of $2,018,000 which the Trust, of which the appellant was the trustee and to the income of which he was presently entitled, owed to Barry Plant Holdings Pty Ltd (“BPH”) as trustee of the BPHT, “related to” the CGT assets of the Trust within the meaning of s 152-20(1)(a) of the ITAA. The time by reference to which that issue was to be resolved was “just before the CGT event”: s 152-15. The CGT event in question – the sale by the Trust of units which it held in the BPHT – occurred on 14 March 2007.
23.According to findings made by the Tribunal, in October 2006 the appellant decided to make a contribution to his own superannuation fund, and also to provide his partner with sufficient funds to enable her to pay out the debt on their residence, which was in her name. The appellant’s assets were substantially held by the Trust, and the Trust’s assets, in turn, were substantially in the form of units in the BPHT. In that month (October 2006), the appellant, as trustee of the Trust, resolved to distribute $2,018,000 from the capital of the Trust to himself to provide funds for the above purposes. Although the Trust’s assets were amply sufficient to make such a distribution, its cash assets were not. The appellant concluded that the Trust would need either to borrow money or to sell assets to make the distribution. The former course was preferred, at least in the first instance.
24.The relevant transactions took place on 13 March 2007. BPH had a facility with Macquarie Bank. The bank lent the sum of $2,018,000 to BPH which in turn lent the same sum to the Trust. The funds were, by direction, disbursed by the bank directly to the appellant’s superannuation fund and to the mortgage account of the appellant’s partner. Thus, by the end of 13 March 2007, the Trust owed $2,018,000 to BPH (as trustee for the BPHT), BPH (in that capacity) owed $2,018,000 to the bank and the end purpose for which the money had been borrowed had been achieved.
25.The question which then arose was whether the Trust’s liability of $2,018,000 related to its CGT assets. The appellant’s case in the Tribunal was that the Trust had an obligation to pay the capital distribution (resolved upon in October 2006) to himself, which obligation attached to the whole of trust fund. That liability related to the CGT assets of the Trust because the loan preserved and freed up those assets.
[34][2012] FCA 1042; 2012 ATC 20-350.
[35]Bell v Commissioner of Taxation [2013] FCAFC 32; 2013 ATC 20-380.
The Tribunal did not accept that the liability of $2,018,000 related to the Trust’s CGT assets. On the taxpayer’s appeal from that decision, the primary judge concluded that the Tribunal had “ignored or misunderstood the legal effect” of the various transactions. As the Full Court observed:[36]
Her Honour held that, upon the passing of the resolution for a capital distribution in favour of the appellant (in October 2006), the appellant was “presently entitled to a portion of the corpus of the Trust to the extent of the distribution and entitled to call for it”, referring in this regard to Saunders v Vautier (footnote omitted)
The Commissioner, in his notice of contention on the appeal, suggested two reasons why this conclusion was incorrect. The first, which involved the proper construction of the trust deed, was rejected by the Full Court and need not be further considered. The Full Court described the Commissioner’s second argument in this way:[37]
The second aspect of the Commissioner’s submission was that, even if the Trust’s liability to pay the distribution sum to the appellant related to the CGT assets of the Trust, the liability which existed on 14 March 2007 did not so relate. That was a liability to the BPHT created by the loan made to the Trust the previous day. Albeit that the purpose of the loan was to put the Trust in funds to discharge its obligation to make a distribution of the corresponding sum to the appellant, the result, and therefore the position which obtained immediately before the CGT event, was that the debt owing to the BPHT was a general one, and bore no relation to the assets of the fund. As is apparent from the passages from her Honour’s reasons set out above, the primary judge held (or, more accurately, noted) that the $2,018,000 debt was “necessary to meet the obligation and thereby protect or maintain the CGT assets of the Trust”. In the view of her Honour, that provided the relationship required by s 152-20.
[36]Ibid at [27].
[37]Ibid at [34].
Whilst lengthy, it is desirable to set out the reasoning on the Full Court on this question (noting that special leave to appeal to the High Court was refused[38]). Their Honours said:
35.In addressing this question of relationship, it is useful to return to, and to develop a little, some of the matters discussed by the primary judge in [65] and [66] of her reasons, set out above. The starting point must be the Trust with net CGT assets of, say, $X. Once the trustee resolved to distribute $2.018m to the appellant, the net asset position was ($X−$2.018m) because, as explained above, the resolution gave rise to a liability which related to the assets of the fund. Had that liability been discharged by payment to the appellant, the net assets would still be ($X−$2.018m), but in a different way: the liability which “related” to the assets would no longer exist, but the Trust would be $2.018m the poorer for having made the distribution. Had the Trust then borrowed $2.018m to restore its cash position, its net assets would still be ($X−$2.018m), made up of $X in assets and a new liability of $2.018m to the lender. As to this last scenario, we do not understand the Commissioner to contend that a debt brought into existence by the borrowing of funds would not relate to those funds as an asset in the hands of the borrower.
36.Next, let the order of things subsequent to the resolution to distribute the $2.018m to the appellant be reversed. Instead of paying the appellant immediately, suppose the Trust to have borrowed to make that payment. Having received the funds from the lender, the net asset position of the Trust would have been ($X+$2.018m−$2.018m−$2.018m), ie ($X−2.018m). That is to say, in addition to its original assets of $X, the Trust would have had the cash received from the lender. It would still have been in debt to the appellant in the amount of $2.018m because of the unpaid distribution; and it would now also be in debt to the lender in the amount of $2.018m. Each of those liabilities would have related to the assets of the Trust: the first because it was based on a resolution to distribute capital to a beneficiary, and the second because it corresponded with the funds received from the lender. If, having reached this stage, the Trust then made the payment of the distribution to the appellant, the Trust’s net asset position would be ($X – $2.018m) because its cash position would have moved adversely by $2.018m, but it would no longer have a liability to the appellant.
37.As a matter of analysis, it is at this point that the Commissioner’s case parts company with the reasons of the primary judge. As we understand it, her Honour would have it that the $2.018m debt to the lender would still relate to the assets of the Trust because it came into existence to preserve those assets in circumstances where they would otherwise have been diminished by the discharge of a liability which itself (while it existed) related to the assets. The Commissioner submits that this is not enough to invoke the operation of s 152-20. He would contend, in such a situation as is here proposed, that the debt to the lender related not to the assets of the Trust generally but to the cash which had been received by way of loan. Once that cash had been disbursed, there was no longer an asset in the Trust to which the liability represented by the debt could, or did in the circumstances postulated, relate.
38.The clarity of the central issues which require consideration here is compromised somewhat by the circumstance that, where money is borrowed, the “asset” may well, and will usually, have been added to the general cash assets of the entity in question. The position presents more clearly if it be assumed that the borrowing was for the purpose of acquiring a tangible asset, say a motor vehicle. Its indebtedness under the borrowing would then be a liability which related to the vehicle. If the vehicle were traded in on a second vehicle (assuming, perhaps unrealistically, that this was a straight swap without money changing hands), it might then be the case that the liability to the original lender related to the second vehicle. However, if, instead of trading in the first vehicle, the Trust sold it and used the cash to make a distribution to a beneficiary under cl 12.7(a), the asset to which the loan liability had originally related would no longer exist. It could not then be said that the liability related to assets of the Trust.
39.It follows from the above discussion that we do not agree with the primary judge that a liability would forever relate to assets of the Trust by reason only of having been undertaken to preserve existing assets of the Trust, in the sense of having been necessary to avoid the need for the Trust to spend its existing cash on a particular outlay. If the outlay, made with borrowed funds, was to purchase an asset, then the liability represented by the borrowing would relate to the asset, but only for so long as that asset was held by the Trust. If the borrowing was for another purpose, such as to discharge an income tax obligation (and was immediately and identifiably used only for that purpose), the corresponding liability would not, in our view, relate to any asset of the Trust.
40.Returning to the facts of the present case, there is no need for us to investigate the issues which potentially arise where the asset arising from a borrowing is the cash itself, mixed into and used as part of the general cash resources of the taxpayer concerned. What actually happened here was that, as part of the one series of transactions on a single day, the borrowed funds were applied directly by Macquarie Bank to the appellant’s own end purposes. Although, as a matter of accounting, the records of the Trust ultimately (although not, it seems, originally – as the result of a mistake) showed that the sum of $2,018,000 had been disbursed to the appellant pursuant to the distribution resolution of October 2006, in fact no money ever passed through the Trust. It may be correct to conclude that the Trust never had an asset to which the debt to the BPHT related. It is, however, sufficient to note that any such asset had been disposed of (to the appellant) on 13 March 2007, and that, “just before the CGT event” there was no asset to which the liability to the BPHT related.
41.The error into which the primary judge fell, in our respectful view, was to regard the Trust’s purpose – that of preserving its existing assets – as dispositive of the question arising under s 152-20. In a situation in which the trustee of the Trust had resolved to make a distribution of capital, his decision to borrow funds rather than to use the existing resources of the Trust gave rise to a relation between the liability arising from the borrowing and the borrowed funds in the hands of the Trust. But, that purpose having been effected by disposing of the cash which represented the borrowing, there was not, in our view, a relevant ongoing relation between the liability and the generality of the assets of the Trust for no other reason than that the decision to borrow was made in the alternative to using existing resources. This conclusion, and the analysis on which it is based, is not affected by characterising the thinking of the trustee as one involving the protection or maintenance of the existing CGT assets of the Trust. (emphasis added)
[38]Bell v Commissioner of Taxation (Cth) [2013] HCATrans 179.
The applicants here acknowledge that the present circumstances are more complex than those in Bell however they identify the passage emphasised in paragraph 41 of Bell as a principle that can and should be applied to the present circumstances. Those circumstances include, in particular, that the largest single asset, goodwill, itself exceeded the maximum net asset value of $5 million. The value of goodwill, it was said, increased from the amount of $45,000 at the time of settlement of the Track Bros 1 Trust to $6,367,875 as a result of a goodwill revaluation undertaken in anticipation of the sale of the business of the Track Bros 1 Trust.[39] What had to be established was a “real, and substantial, not remote” relationship between the increased goodwill value and the excess of liabilities over other assets in the Track Bros 1 Trust.[40] An analogy was drawn with the cases concerning deductibility of interest because in such cases,
… a deduction for interest on the loan is characterised “by reference to the objective circumstances of the use to which the borrowed funds are put” [41]
In that area, as the decision in Federal Commissioner of Taxation v Roberts illustrates, liabilities used to fund the distribution of unrealised gains on the revaluation of goodwill of the business (or partnership) will not satisfy the interest deductibility test.
[39]Applicants’ closing submissions, paragraph [122].
[40]Ibid, paragraph [136].
[41]Ibid, paragraph [138]. The internal quotation is from Federal Commissioner of Taxation v Roberts (1992) 37 FCR 246, 257.
There will be many cases where the analogy is apt. A loan to acquire an asset used in a business, or an overdraft used to provide working capital of a business, are obvious examples where the use to which the borrowed funds are put demonstrate that the liability is related to the assets of the business. But, as it seems to me, an enquiry into purpose does not necessarily answer the question of relationship. More importantly, an enquiry into purpose may distract from the enquiry required by the legislation – is the liability related to the assets of the entity. In Bell, at first instance Gordon J discussed the meaning of “related to” in the present statutory context. Whilst the Full Court held that her Honour had erred in the application of the test, the judgement does not question the correctness of these observations of Gordon J:[42]
48.Phrases like “in relation to” and “related to” signify some connection between two subject matters. The subject matters are prescribed by the legislation. The relationship, connection or association between those two subject matters may be direct, indirect, substantial or real. The sufficiency of the connection between those subject matters depends on the subject matters, the statutory framework of the inquiry and the facts…
49.Here, it is an inquiry about the connection between the CGT assets of an entity on the one hand and the liabilities related to those CGT assets on the other hand. What is the necessary relationship between the CGT assets of an entity on the one hand and the liabilities related to those CGT assets on the other hand required by s 152-20?
50.First, the language of s 152-20. As already noted, s 152-20 was directed at calculating the “net value of the CGT assets” of an entity for the purposes of the MNAV test. The entity was the Trust. The first subject matter is the “CGT assets” of that entity. Only CGT assets of that entity, the identified entity, are included. Other assets of the Trust are not included.
51. The phrase “CGT asset” was defined in s 108-5 of the 1997 Act. In relation to the Trust, the relevant CGT assets were those assets listed in the table under the heading “Bell Family Trust”: see [24] above. Next, s 152-20 required the identification of the liabilities of the entity that are related to the CGT assets of that entity. In other words, the second subject matter is identified. It is the liability of the entity identified at the outset of the section – in this case, the Trust. However, it is insufficient for that subject matter – the liability – to be simply a liability of the entity. It must be a liability related to those assets. And those assets are the CGT assets identified as the first subject matter. Again, those liabilities are listed in the table under the heading “Bell Family Trust” and are identifiable by the “( )” around the number in the right hand column: see [24] above.
52.This necessary relationship between the CGT assets of the Trust and the liabilities of the Trust related to those CGT assets is not surprising. As the Explanatory Memorandum accompanying the A New Business Tax System (Capital Gains Tax) Bill 1999 (Cth) stated at [1.12], the purpose of the MNAV was to “treat the small business and all of its related entities as a single economic unit”. As the Commissioner submitted, it would be inconsistent with the purpose of Div 152 of the 1997 Act if all liabilities of an entity were included in the MNAV calculation, even if they did not have a real relationship with the relevant assets.
53.It would not accord with the structure and purpose of the legislation if all liabilities of an entity, including those that did not have a sufficient connection with the CGT assets of the entity, were included in the calculation. Why? Because if they were included, the resulting calculation would not be the net value of the CGT assets but a net calculation of some other amount. It is difficult to identify what that other amount would in fact reflect. Or, put another way, the resulting calculation would not result in a true reflection of the economic value of the business in determining whether the MNAV test was met. (emphasis added)
54.Accordingly, by reference to that statutory context and legislative purpose, to satisfy s 152-20, there must be a defined relationship or connection between the CGT assets of a particular entity and the liability or liabilities related to those CGT assets. As the Commissioner submitted, it must be real and substantial, not remote. What then were the facts in this case?
[42]Bell v Commissioner of Taxation [2012] FCA 1042; 2012 ATC 20-350.
The passage from paragraph 53 emphasised above seems to me to be important. The underlying task is to determine the economic value of a business for the purpose of determining whether the entity satisfies a test decided by the Parliament to determine those entities that are small businesses and thus entitled to a concession in the application of the CGT provisions.
In the ordinary course of events, the balance sheet of a business should demonstrate the economic value of a business, at least in a general sense. Here the net assets of the Track Bros 1 Trust just before the CGT event were $3.8m. But the assets had been reduced to that level because it had been resolved to make a capital distribution of $2.56m. The resolution to distribute created a liability. That liability was discharged by the creation of two further categories of liability. The first was the liability owed to the beneficiaries, represented by the amounts totalling $1.43m in the beneficiary current accounts. The other was the liability of $0.5m represented by the loans made to the Track Bros 1 Trust by the protection trusts.
The decision to borrow to fund the distribution, as the Full Court in Bell reasoned,[43] gave rise to a relation between the liability arising from the borrowing and the borrowed funds in the hands of the Track Bros 1 Trust. The present case is factually distinguishable from that in Bell because it is not at all clear, as it was in Bell, that the cash that represented the borrowing had been disposed of. On the contrary, the aim of the strategy seems to have been to avoid actually disposing of cash until after settlement of the sale in the following financial year. Moreover, as Dr Mellifont QC, who led Ms Allen of counsel for the Commissioner, submitted, the tax agent for the Track Bros 1 Trust described the distribution as “a capital distribution of surplus liquid assets”.[44]
[43]Ibid at [41].
[44]Exhibit 1, page 543.
I am not satisfied that the unpaid present entitlements and the loans of $500,000 from the protection trusts were not related to the CGT assets of the Track Bros 1 Trust. In my view it is more likely that they were related to the CGT assets of the Trust.
The remaining liabilities are the loans from Track Bros Company 4 Pty Ltd and Track Bros Company 3 Unit Trust. It is not for the Commissioner to put on evidence to show that these liabilities were acquired for a particular business purpose or to fund working capital of the business. It is for the applicants, who bear the onus, to show that the liabilities were not related to the CGT assets of the Track Bros 1 Trust. In the absence of such evidence (and none was drawn to my attention), I am not prepared to draw the inference suggested in the applicants’ submissions.
In the result the applicants have not satisfied me that the Track Bros 1 Trust did not, contrary to their earlier position, satisfy the maximum net asset value test. The arrangements effected to satisfy the test were, to that extent, effective.
The anti-avoidance provisions
The legislation
Part IVA of the 1936 Act deals with schemes to reduce income tax. Section 177F, within that Part, is the operative provision. So far as is presently relevant it reads:
(1) Where a tax benefit has been obtained, or would but for this section be obtained, by a taxpayer in connection with a scheme to which this Part applies the Commissioner may:
(a)in the case of a tax benefit that is referable to an amount not being included in the assessable income of the taxpayer of a year of income—determine that the whole or a part of that amount shall be included in the assessable income of the taxpayer of that year of income; or
(b) …
…
and, where the Commissioner makes such a determination, he shall take such action as he considers necessary to give effect to that determination.
The subsection draws attention to two other concepts – that of “a scheme to which this Part applies” and the obtaining of a tax benefit.
A “scheme” is defined in s 177A(1) of the 1936 Act to mean (unless the contrary intention appears):
(a)any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and
(b)any scheme, plan, proposal, action, course of action or course of conduct.
Mr Harrison accepted that the arrangements in issue here satisfied the definition of scheme. A scheme to which Part IVA applies is explained in s 177D of the 1936 Act in this way:
This Part applies to any scheme that has been or is entered into after 27 May 1981, and to any scheme that has been or is carried out or commenced to be carried out after that date (other than a scheme that was entered into on or before that date), whether the scheme has been or is entered into or carried out in Australia or outside Australia or partly in Australia and partly outside Australia, where:
(a)a taxpayer (in this section referred to as the relevant taxpayer) has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and
(b) having regard to:
(i) the manner in which the scheme was entered into or carried out;
(ii) the form and substance of the scheme;
(iii)the time at which the scheme was entered into and the length of the period during which the scheme was carried out;
(iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;
(v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;
(vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;
(vii)any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and
(viii)the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi);
it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers).
A “tax benefit” is defined in s 177C(1) of the 1936 Act. It is sufficient for present purposes to set out paragraph (a) of that subsection. It provides:
(1)Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to:
(a)an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out
The notion of the purpose of a scheme is dealt with by s 177A(5) of the 1936 Act in this way:
(5)A reference in this Part to a scheme or a part of the scheme being entered into or carried out by a person for a particular purpose shall be read as including a reference to the scheme on the part of the scheme being entered into or carried out by the person for 2 or more purposes of which that particular purpose is the dominant purpose.
The Commissioner’s formulation of the scheme
The Commissioner identified the scheme as having the object of enabling the Track Bros 1 Trust to obtain access to the small business CGT concessions. To achieve this, it was said,[45] the scheme reduced the Trust’s assets and increased its liabilities to ensure that the Trust’s net assets at the time of the business sale were less than $5m. The Commissioner identified[46] the scheme as comprising these steps:
[45]Exhibit 14, paragraph [29].
[46]Exhibit 14, paragraph [30].
a.the signing by [Track Bros 1 Trust] on 5 May 2005 of the option to purchase the business;
b.on 27 June 2005 the settlement of the full Protection Trusts three days before the CGT event, each of which was a discretionary beneficiary of the [Track Bros 1 Trust]:
c.the resolution passed on 28 June 2005, two days before the CGT event, by the directors of Track Bros 1 as trustee for [Track Bros 1 Trust] to make the Capital Distribution to the Protection Trusts in the amount of $2,561,239 in the same proportion as the unit holdings of the family trusts;
d.the payment on 28 June 2005 of the following amounts from the [Track Bros 1 Trust] into separate accounts so that the Protection Trusts as beneficiaries of [Track Bros 1 Trust] had an immediate vested indefeasible interest in the capital distributed:
i.Michael Track Protection Trust $398,116 & $255,000 = $653,116
ii.Arnold Track Protection Trust $398,116 & $255,000 = $653,116
iii.JS Patrick Protection Trust $416,851 & $267,000 = $683,851
iv.Forde Protection Trust $348,156 & $223,000 = $571,156
e.the deposits into the business bank account of [Track Bros 1 Trust] from the following associated entities on 28 June 2005:
i.Michael Track Protection Trust $127,500
ii.Arnold Track Protection Trust $127,500
iii.JS Patrick Protection Trust $133,500
iv.Forde Protection Trust $111,500
v.Track Bros Company 2 Unit Trust $435,773
vi.Track Bros Company 3 Unit Trust $185,620
vii.Track Bros Company 4 Pty Ltd $320,000
Total $1,441,393
f.the loans to Track Bros Company 2 Unit Trust from [Track Bros 2 Trust] of the following additional amounts:
i.$80,000 on 29 June 2005;
ii.$33,000 on 30 June 2005.
g.the loan of $17,750 from Track Bros 3 on 27 June 2005;
h.the further $30,000 loaned from Track Bros 4 on 30 June 2005.
i.the sale of the Business for $8,159,808.20 on 1 July 2005 and the receipt of proceeds from the sale of 7 July 2005;
j.the distribution of 50% of income and capital of [Track Bros 1 Trust] from the 2006 tax year to each of Carter Forde and James Patrick;
k.the reduction of the capital gain on active assets of $5,840,404 to $460,101 by use of the 50% general discount, the 50% active asset reduction in the $1,000,000 retirement exemption.
l.the repayment of the following loans to associated entities on 22 July 2005:
i.Michael Track Protection Trust $127,500
ii.Arnold Track Protection Trust $127,500
iii.JS Patrick Protection Trust $133,500
iv.Forde Protection Trust $111,500
v.Michael Track Family Trust $290,000
vi.Arnold Track Family Trust $290,000
vii.Patrick Trust $303,650
viii.The Forde Family Trust $253,600
ix.Track Bros Company 2 Unit Trust $820,000
x.Track Bros Company 3 Unit Trust $17,750
xi.Track Bros Company 4 Pty Ltd $160,000
xii.Track Bros Company 4 Pty Ltd $30,000
xiii.Track Bros S & P Pty Ltd $240,000
xiv.Michael Track Company 1 Pty Ltd $344,316
xv.Arnold Track Company 1 Pty Ltd $344,316
xvi.JS Patrick Company 1 Pty Ltd $360,519
xvii.Forde Company 1 Pty Ltd $301,108.
It is not open to doubt that those steps constitute a “scheme” as that term is defined.
The Commissioner identified the tax benefit in this way:[47]
33.The Respondent considers it is reasonable to expect that if the scheme described above was not entered into or carried out, then [Track Bros 1 Trust] would have sold the Business to OFS without making the Capital Distribution and without receiving the Loans. Consequently, [Track Bros 1 Trust] would not have met the small business CGT concessions test and it would have been assessed for the 2006 tax year on the entire capital gain made on the sale.
34.That is, [Track Bros 1 Trust] would have included in its assessable income an additional $2,459,901 which the Respondent considers would reasonably have been distributed to the family trusts who in turn would have distributed it to their beneficiaries.
35.Therefore, as a consequence of the scheme, the Applicants, as beneficiaries of the family trusts, obtained tax benefits in connection with the scheme as defined in section 177C(1) ITAA 36.
[47]Exhibit 14, paragraphs [33] – [35].
Was there a tax benefit?
Given that there was a scheme, it next becomes necessary to identify a “tax benefit” obtained in connection with the scheme. The submissions of both parties drew attention to this passage from the reasons in the judgement of Gummow and Hayne JJ in Commissioner of Taxation v Hart:[48]
… the inquiry directed by Pt IVA requires comparison between the scheme in question and an alternative postulate. To draw a conclusion about purpose from the eight matters identified in s 177D(b) will require consideration of what other possibilities existed.
The submissions of the Commissioner also drew attention to these observations of Jessup J in AXA Asia Pacific Holdings Ltd v Commissioner of Taxation:[49]
In my view, Lenzo[[50]] is authority for the proposition that the starting point under s 177C(1)(a) is one which the whole scheme identified by the Commissioner must be assumed out of existence. The question then arises: what then might reasonably have been expected to have been included in the assessable income of the taxpayer? Here the court is engaged in a “prediction as to events which would have taken place” in the absence of the scheme: Commissioner of Taxation v Peabody (1994).[[51]] The exercise thus postulated, in my view, is wholly one of fact-finding. A fact is not disqualified, a priori as it were, from consideration merely by reason of it having been an element of the scheme which was in place. To the contrary: what the taxpayer and his or her associates in fact did in the commercial circumstances which existed is likely to shed much light on what they would have done in the absence of the scheme, and in some cases to be, as a matter of prediction, elements of that counterfactual. Nothing in Lenzo requires me to hold otherwise. Indeed, the way Sackville J approached the task of prediction was entirely consistent with the counterfactual in any particular case involving elements of the presumptively discarded scheme, assuming always that the facts of the case indicated such an outcome.
[48][2004] HCA 26; (2004) 217 CLR 216 at [66].
[49][2009] FCA 1427; 2009 ATC 20-151 at [118].
[50]Commissioner of Taxation v Lenzo [2008] FCAFC 50; (2008) 167 FCR 255.
[51][1994] HCA 43; (1994) 181 CLR 359, 385.
Here, the Commissioner contends[52] that, had the scheme not been carried out:
[52]Exhibit 25, paragraph [94].
a.The Capital Distribution would not have occurred.
b.The deposits made on 28 June 2005 by Track Bros 2, Track Bros 3 and Track Bros 4 would not have occurred.
c.[Track Bros 1 Trust] would have sold its business to Oz Fluid Systems Pty Ltd.
d.The net assets of [Track Bros 1 Trust] would have exceeded the threshold of $5 million for the net asset value test and [Track Bros 1 Trust] would not have qualified for the small business CGT concessions.
e.The capital gain made on the disposal of the business would have been reduced by the 50% general discount to $2,920,202.
f.The assessable income of [Track Bros 1 Trust] would have included the capital gain of $2,920,202 for the year ended 30 June 2006.
g.[Track Bros 1 Trust] would have distributed the amount of capital gain to the Family Trusts (as it had done in previous years) and that the Family Trusts would in turn distribute the amounts to their corporate beneficiaries.
Thus, under the Commissioner’s alternative postulate, a capital gain of $2,920,202, rather than $460,101 (as returned), would have been included in the net income of the Track Bros 1 Trust. And, it is said, having regard to the distributions made to the “family trusts”[53] in the 2002, 2003 and 2004 income years it is reasonable to postulate that the capital gain would have been distributed to the family trusts in proportion to the unit holdings. Next it is said[54] that, based on the distributions made by the family trusts in the 2002 to 2005 years, it is reasonable to expect that the family trusts would have distributed, in turn, to the corporate beneficiaries – Michael Track Company 1 Pty Ltd, Arnold Track Company 1 Pty Ltd, JS Patrick Company 1 Pty Ltd and Forde Company 1 Pty Ltd.
[53]The Arnold Track Family Trust – 25.5%; the Michael Track Family Trust – 25.5%; the Forde Family Trust – 22.3%; the Patrick Trust – 26.7%.
[54]Exhibit 25, paragraph [96].
There is, though, an alternative formulation of this aspect of the matter[55] which is that, but for the scheme, the family trusts, having received the distribution from the Track Bros 1 Trust, would have distributed in accordance with the resolutions passed by the family trusts. As I have earlier observed,[56] these resolutions are poorly evidenced in the material before me however I proceed on the basis that there were, in fact, resolutions of the various family trusts,
·that resolved to distribute capital gains of the Michael Track Family Trust to Mrs Delvene Track;
·that resolved to distribute capital gains of the Arnold Track Family Trust to Mr Arnold Track;
·that resolved to distribute the income of the Patrick Trust to JS Patrick Company 1 Pty Ltd; and,
·that resolved to distribute the first $1200 of the income of the Forde Family Trust equally between two of the children of Mr and Mrs Forde, to distribute the next $4500 of income between Mr Forde and Mrs Forde in shares of one third and two thirds respectively, and to distribute any remainder to Forde Company 1 Pty Ltd.
[55]Exhibit 25, paragraph [192].
[56]See paragraph [33] – [35] above.
The applicants argue[57] that there is no tax benefit evident on the Commissioner’s alternative postulate. They seek to demonstrate[58] that, if the Commissioner’s formulation of what would have occurred absent the scheme is adopted, the Track Bros 1 Trust’s maximum net asset value exceeded $5 million in any event with the result that there was no tax benefit. I find it difficult to comprehend the argument. If it goes no further than that based on the decision in Bell, I reject it for the same reasons I rejected the applicants’ earlier argument; however if, as I infer is the case, Schedule 5 to Exhibit 21 is intended to be an alternative demonstration of why there was no tax benefit, I reject that argument as well.
[57]Exhibit 21, paragraphs [152] – [158].
[58]Exhibit 21, Schedule 5.
Schedule 5 seeks to demonstrate that the net asset value of the Track Bros 1 Trust was $5,489,421 if the capital distributions and the loans from the protection trusts had not been made. That, as it seems to me, is the Commissioner’s point – the Trust undertook those transactions to enable it to satisfy the maximum net asset value as is demonstrated by its balance sheet as at 30 June 2005.[59] Absent those transactions, as Schedule 5 demonstrates, the net asset value exceeded $5 million.
[59]Exhibit 1, page 495.
Additionally, the applicants submit[60] that the alternative postulate is unreasonable as it is based on the premise that Track Bros 1, as trustee, would have been assessed under s 99 of the 1936 Act at the top marginal rate, that is, on the basis that no beneficiary of the trust was presently entitled to the net income of the trust. I do not accept that as an accurate description of the Commissioner’s case. Whilst paragraph 33 of the Commissioner’s Statement of Facts and Contentions[61] is perhaps poorly worded, the following paragraphs make it clear that the Commissioner’s alternative postulate had the additional capital gain of $2,459,901 distributed by the Track Bros 1 Trust to the family trusts and thereafter to beneficiaries of the family trusts.
[60]Exhibit 21, paragraph [159 (a)].
[61]Exhibit 14.
Finally, it is said[62] that the alternative postulate is unreasonable as, had it not been implemented, no asset protection would have been achieved. It is said that without the establishment of the protection trusts as “clean trusts”, payments to the family trusts were liable to be set aside in the event of warranty claims or as a result of other liabilities “coming home to roost”. Despite the evidence of the principals about the claimed needed asset protection I am well short of being satisfied that this arrangement had anything to do with asset protection. I will deal with this aspect of the matter in greater detail when considering the s 177D factors.
[62]Exhibit 21, paragraph [159 (b)].
It is my view that it makes perfect sense, once the scheme is assumed out of existence, to conclude that the Track Bros 1 Trust would have distributed to the family trusts. To not do so made no sense (because of the higher tax rate) and was contrary to the established pattern and the practical reality of the pre-existing structure. The more difficult questions concern the actions of the four family trusts or, more realistically, the four principals who effectively controlled those trusts.
It seems to be common ground that in each of the 2002, 2003 and 2004 income years each family trust distributed to the corporate beneficiary of the particular family trust. Similarly, it seems to be common ground that in late June 2005 each of the family trusts made a distribution resolution. The terms of the various resolutions are set out in paragraph 84 above. However it is to be borne in mind that those resolutions were informed by the view that the small business CGT concessions were available. It must also be borne in mind, as Mr Green points out,[63] that the ability of the ultimate recipient to utilise the 50% discount was likely to have been a very important consideration.
[63]Exhibit 9, paragraph [5.2.6].
Mr Green was asked to consider the available distribution patterns that might have been expected to have been recommended to the trustee of the Track Bros 1 Trust and those that might have been expected to have been recommended to the trustees of the family trusts. He concluded, unsurprisingly, that the likely recommendation in the case of the Track Bros 1 Trust would have been to distribute in accordance with the unit holdings in that trust. In answer to the second part of the question he said:[64]
[64]Exhibit 9, paragraphs [5.2.5 – 5.2.7].
5.2.5We note that, assuming that the Track Bros 1 Unit Trust was eligible for the General 50% CGT Discount and unable to utilise the Small Business CGT Concessions in the year ended 30 June 2006:
·the majority (95.2%) of income distributed from the Track Bros 1 Unit Trust would be discount capital gains; and
·the income of the unit holding trusts (including capital gains), when viewed in isolation, is negligible in comparison to the possible distributions of income from the Track Bros 1 Unit Trust.
5.2.6Therefore, from an accounting and taxation perspective the primary consideration when determining what distribution patterns would have been expected to have been recommended to the trustees of the unit holding trusts would have been the ability of the ultimate recipients of the distributions to be able to utilise the 50% CGT discount.
5.2.7With this in mind and assuming that the Track Bros 1 Unit Trust distributed all income from the year ended 30 June 2006 to the Family Trusts (as discussed above), it is considered likely that the following distribution patterns could have been expected to have been recommended to the trustee:
Distribution pattern # 1:
Trust
Beneficiary
Share of income
Michael Track Family Trust
Michael Track
50%
Delvene Track
50%
Arnold Track Family Trust
Arnold Track
100%
Patrick Trust
James Patrick
100%
Forde Family Trust
Carter Forde
50%
Lillian Forde
50%
This distribution pattern may have been recommended so as to distribute all income to individual taxpayers and, therefore, utilise the 50% CGT discount. This distribution pattern would result in a total tax payable across a number of taxpayers of $1,693,836.
Distribution pattern # 2:
Trust
Beneficiary
Share of income
Michael Track Family Trust
Michael Track Protection Trust
100%
Arnold Track Family Trust
Arnold Track Protection Trust
100%
Patrick Trust
J.S. Patrick Protection Trust
100%
Forde Family Trust
Forde Protection Trust
100%
Where each of the ‘Protection Trusts’ was recommended the following distribution pattern:
Trust
Beneficiary
Share of income
Michael Track Protection Trust
Michael Track
50%
Delvene Track
50%
Arnold Track Protection Trust
Arnold Track
100%
J.S. Patrick Protection Trust
James Patrick
100%
Forde Protection Trust
Carter Forde
50%
Lillian Forde
50%
This distribution pattern may have been recommended so as to ultimately distribute all income to individual taxpayers while distributing the income from the unit holding trusts to the Protection Trusts in order to enable the distributed funds to be either held by or distributed by the Protection Trusts as an asset protection measure. This distribution pattern would result in a total tax payable across a number of taxpayers of $1,704,723.
Alternatively, where each of the ‘Protection Trusts’ was recommended the following distribution pattern:
Trust
Beneficiary
Share of income
Michael Track Protection Trust
Michael Track Company 1 Pty Ltd
100%
Arnold Track Protection Trust
Arnold Track Company 1 Pty Ltd
100%
J.S. Patrick Protection Trust
JS Patrick Company 1 Pty Ltd
100%
Forde Protection Trust
Forde Company 1 Pty Ltd
100%
This distribution pattern may have been recommended so as to provide the family groups with additional asset protection, however, would result in increased tax cost as the corporate beneficiaries would not be entitled to the general 50% CGT discount. This distribution pattern would result in a total tax payable across the companies of $2,016,272.
Given that the premise is that the scheme is assumed out of existence and that the protection trusts are part of the scheme, Mr Green’s distribution pattern # 2 may be disregarded.
Mr Horan, who in 2005 and 2006 worked for the accountants who acted for the Track Bros 1 Trust, gave evidence that, on the assumptions set out in Mr Green’s report, he would have made the recommendations suggested by Mr Green. Each of Mr Michael Track, Mr Arnold Track, Mr Patrick and Mr Forde gave evidence to the effect that, in matters involving trust distributions, it was their practice to seek professional advice and generally act upon that advice.[65]
[65]Exhibit 5, paragraph [104]; Exhibit 6, paragraph [59]; Exhibit 8, paragraph [48]; and Exhibit 7, paragraph [45].
The applicants submit[66] that it is not reasonable to expect that the capital gain realised on the sale would have been distributed by the family trusts to any corporate beneficiaries given that those beneficiaries could not access the general 50% CGT discount. The Commissioner submits[67] that, based on the distributions made in the earlier years, it is reasonable to expect that the family trusts would have distributed to the corporate beneficiaries.
[66]Exhibit 21, paragraph [161].
[67]Exhibit 25, paragraph [96].
In my view the applicants’ submissions must be accepted. What had occurred in prior years in dealing with trust income is not a reliable guide in predicting what would have taken place when the applicants and their advisors were required to deal with income that predominantly comprised discount capital gains. In circumstances where the corporate beneficiaries were not able to access the discount, but the natural person beneficiaries were, the evidence of Mr Green satisfies me that any competent advisor would have recommended a distribution by the family trust in favour of natural person beneficiaries and would have recommended against a distribution to a corporate beneficiary. The evidence of the principals satisfies me that they would have accepted such advice. I conclude that it is not reasonable to expect that any amount of the distribution from the Track Bros 1 Trust to the various family trusts would have been distributed in turn by the family trusts to the corporate beneficiaries. That conclusion is reinforced, in the case of the Michael Track Family Trust, the Arnold Track Family Trust and the Forde Family Trust, by the distributions that actually took place. As Jessup J observed in AXA Asia Pacific Holdings Pty Ltd,[68] what a taxpayer in fact did in the commercial circumstances which existed is likely to shed much light on what they would have done in the absence of the scheme.
[68]AXA Asia Pacific Holdings Pty Ltd v Commissioner of Taxation [2009] FCA 1427; 2009 ATC 20-151 at [118]; see paragraph [82] above.
The result is that I conclude that none of the corporate beneficiaries received a tax benefit but that the natural person beneficiaries did. And, in those latter cases, it is reasonable to postulate that the distributions would have been made, in substance at least, on the basis of the resolutions that were seemingly prepared in June 2006. That means, in the case of the Michael Track Family Trust, that all capital gains would have been distributed to Mrs Delvene Track; in the case of the Arnold Track Family Trust, that all capital gains would have been distributed to Mr Arnold Track and, in the case of the Forde Family Trust, capital gains, after the first $1200, distributed between Mr and Mrs Forde in shares of one third and two thirds respectively. I do not consider it reasonable to assume, as Mr Green postulated, that the Arnold Track Family Trust and the Forde Family Trust would have distributed equally; what was, in fact, done is a sounder guide.
Was there a scheme to which Part IVA applied?
Before considering the various factors listed in s 177D(b) of the 1936 Act it is as well to make some general observations regarding the evidence adduced by the applicants.
First, it is pertinent to note that none of the principals, nor indeed Mr Accountant, was able to give any detailed explanation of the purpose of the particular steps in the scheme nor the way in which those steps contributed to the asserted motive of “asset protection”. In particular, there was no evidence from Mr Festa, the solicitor from Cleary Hoare who appears to have designed the structure, that explained the relevance of particular steps. As the Commissioner submits, if the arrangements were motivated by a desire to protect assets, it may be wondered how that purpose was served when the proceeds of sale were deposited to, and largely stayed in, a deposit account of Track Bros 1 Trust. I need not go so far as to draw an adverse inference from the failure to call Mr Festa; it is enough to say that his absence makes it more difficult to accept that asset protection played any role in the design or implementation of the scheme.
Additionally, I found the evidence of a need for asset protection unconvincing. Each of the principals gave evidence of an incident, some time earlier, where a customer had a particularly frightening experience when a large molasses tank split.[69] It is not difficult to conceive how Track Bros 1 might be faced with a product liability claim, even a considerable claim. And there was some evidence of claims having been made after completion of the sale in reliance on the contractual warranty. But there was no satisfactory explanation of why the principals, or the sale proceeds, might be at risk from a product liability claim, or any satisfactory reason why insurance against such a risk was not available or adequate. I should add that whilst these reasons are being delivered considerable time after the principals gave their evidence, the delay has not affected my capacity to gauge the reliability of their evidence. Those conclusions were drawn and noted at the time of the hearing. They flow more from what is absent from the evidence rather than any impression I might have gained from the demeanour of the particular witnesses.
[69]See, for example, Exhibit 5, paragraph [58].
It is a further curiosity of the transaction that Mr Accountant, who was the primary accountant advising the Track Bros 1 Trust in 2005[70] and who had acted for Mr Michael Track for over 20 years,[71] was not involved in, nor even aware of, the planning undertaken by Cleary Hoare beyond being present at a meeting in, he thought, March or April 2005, with a solicitor from the firm. The accounting functions performed by Mr Accountant in the last days of the 2005 income year were undertaken without him even being aware of the likelihood of the sale of the business. He became aware of that sale only after it had been completed.
[70]See Exhibit 19, paragraph [11].
[71]See Exhibit 19, paragraph [7].
I turned then to a consideration of the statutory factors, using an abbreviated description of those factors.
The manner in which the scheme was entered into or carried out
The applicants’ submissions place considerable emphasis on the claimed concerns to protect assets, the fact that they took advice from solicitors concerning the protection of their assets from potential future claims and that they acted in accordance with that advice in setting up the four protection trusts as “clean trusts”, resolving to distribute capital in excess of $2.5 million and distributing that capital. It is said that the manner in which the scheme was entered into, and the creation of the protection trusts to receive those payments, evidence the desire to ensure that payments to the family trusts were not liable to be set aside either as a voluntary conveyance to defeat creditors[72] or as a voidable transaction.[73]
[72]See s 228, Property Law Act 1974 (Qld).
[73]See Part 5.7B, Corporations Act 2001 (Cth).
I have difficulty in accepting that submission. The applicants made no attempt to demonstrate why the risk of setting aside payments to beneficiaries existed nor why the arrangements entered into abated those risks. There was no evidence of actual or potential creditors’ claims at the time of the transactions. It is an element of the former cause of action that there be an intention, at least, to defraud persons whose claims are likely to mature into a debt in the immediate or foreseeable future.[74] And, as to claims under one of the causes of action in Part 5.7B of the Corporations Act, there must, at least, be a company in liquidation. Moreover, I find it impossible to conceive how distribution by trustee to beneficiaries could be successfully set aside by a liquidator where there was no claim or even the hint of a claim at the time of the distribution or why the presence of “clean trusts” improved the position. But beyond that, the evidence of the principals does not satisfy me that there was, in 2005, either a need for asset protection or a view, genuinely held on reasonable grounds, that there was a need for asset protection. Mr Forde, who might be thought to have the best grasp of the commercial ramifications of the transactions, acknowledged in his evidence that advice was sought “in order to pay as little tax as possible” whilst at the same time asserting the need for asset protection.
[74]See Jedhar Pty Ltd v Grosse [2004] QCA 167 at [4].
The manner in which the scheme was entered into, or carried out, points strongly to a contrivance, designed to take advantage of the small business concession threshold, in circumstances where the sale then in prospect clearly demonstrated that the assets of the business exceeded that threshold by a considerable amount. The fact of capital distributions having been made in one financial year, prior to the sale in the following financial year, merely emphasises the contrivance and that the contrivance was directed to obtaining a tax benefit in connection with the scheme.
The form and substance of the scheme
The form and substance of the scheme has been set out at length. The complexity of the scheme points to the purpose of obtaining a tax benefit. It is not explicable, as the applicants’ contend, on the basis that it was designed in a way that would not be voidable. Where that purpose is rejected, the only other objectively reasonable purpose is that of obtaining a tax benefit.
The time and duration of the scheme
The submissions of the applicants[75] appeared to accept that if the asset protection purpose is rejected the timing of certain steps in the scheme might suggest that the capital distribution was made for the dominant purpose of meeting the CGT concession threshold. I agree. And, having rejected asset protection, conclude that the timing of the distributions, in advance of and in the income year prior to the sale, points very strongly to that purpose.
The tax result
[75]Exhibit 21, paragraph [172].
It is sufficient to say that the scheme allowed the Track Bros 1 Trust to access the 50% small business CGT concession in circumstances where it otherwise was not entitled to do so. That produced a very considerable tax benefit, a reduction in the capital gain from $2,920,202 to $460,101.
Change in financial position of the taxpayers
It is only necessary to consider the position of the natural persons – Mrs Delvene Track, Mr Arnold Track, Mr Carter Forde and Mrs Lillian Forde. They were each beneficiaries of their respective protection trusts and, to that extent, stood to benefit from the favourable exercise of the trustee’s discretion, bearing in mind that in each case they were, either alone or with their spouse, the directors of the trustee company. Beyond that Mr Forde directly benefited by the payment of $500,000 to his superannuation fund.
Change in the financial position of others
The applicants submit that the assets of the Track Bros 1 Trust available to future creditors were reduced on 28 June 2005 by some $2.5 million. That may be so but I regard it as irrelevant and, in any event, it must have the consequence that other entities connected to the principals have had their assets increased by a similar amount.
Any other consequences
The applicants submit[76] that, objectively viewed, there were two dominant purposes of the capital distribution in the 2005 income year:
(1)To make a real and actual distribution of value from the Track Bros 1 Trust to 4 protection trusts; and
(2)to quarantine the value thereby extracted from the risks of the Track Bros 1 Trust business.
As I have said, Mr Festa, who was in the best position to explain these matters, was not called to give evidence. Neither of those purposes is evident to me. The applicants next submit that, where Part IVA of the 1936 Act has potential application, a taxpayer must show that there is good reason for seeking the asset protection and the mechanism by which the structure adopted achieved that asset protection. I do not consider that the authority cited, Re MacMahon & Commissioner of Taxation,[77] supports the proposition in such absolute terms. Nonetheless, in circumstances where the applicants bear the onus, and assert that asset protection was the subjective and objective reason for the scheme, it is certainly desirable that they demonstrate each of those matters. Here, in my view, they have failed to do so.
The connection between the taxpayers and other persons
[76]Exhibit 21, paragraph [180].
[77][2011] AATA 809; 2011 ATC 10-218.
There is considerable overlap between the entities. In reality, the various entities and personalities involved revolve around the four principals. They had business connections with one another and family and other connections to the entities within the respective groups.
Conclusions
The applicants submit that, on balance, their purpose of obtaining a tax benefit was no more than the asset protection purpose. The Commissioner, they say, does not suggest any plausible alternative way of obtaining asset protection that would not have resulted in the tax benefit. I reject the first proposition. The second proposition wrongly puts the onus on the Commissioner. I am entirely unable to see how the scheme could be regarded as having any purpose other than obtaining a tax benefit. The applicants have not satisfied me that asset protection was required or that the scheme achieved any asset protection purpose. It is for them to do so; it is not for the Commissioner to suggest alternative mechanisms.
In the result I conclude, assuming it necessary to do so, that the scheme was entered into the purpose of obtaining a tax benefit – that of concessional CGT treatment.
The decisions that ought be made
I have concluded that none of the corporate beneficiaries received a tax benefit. That being so, Part IVA of the 1936 Act has no application to Forde Company 1 Pty Ltd or JS Patrick Company 1 Pty Ltd. Their objections to the Commissioner’s amended assessment and penalty assessment of 11 March 2011 (JS Patrick Company 1 Pty Ltd) and the amended assessment and penalty assessment of 2 May 2011 (Forde Company 1 Pty Ltd) should be allowed in full.
In the case of Mrs Delvene Track and Mr Arnold Track the applicants accept[78] that the conclusions I have reached require that the objection decisions dealing with their amended assessments of 17 December 2010 ought be affirmed.
[78]Exhibit 21, Schedule 3, paragraph [1 (c)].
Finally in the case of Mr and Mrs Forde, it seems to me that the relevant tax benefit to be cancelled by operation of Part IVA of the 1936 Act is the income of the Forde Family Trust, after the first $1200, in shares of one third and two thirds respectively. In each of those applications decisions will be made setting aside the objection decision and remitting the matter to the Commissioner with directions accordingly.
Imposition and remission of penalties
As a consequence of my conclusions regarding Part IVA of the 1936 Act it is necessary to have regard to Subdivision 284-C of Schedule 1 to the Taxation Administration Act. No detailed analysis of its provisions is required as the applicants accept that the preconditions for the imposition of a “scheme penalty” are satisfied in the case of Mrs Delvene Track, Mr Arnold Track, Mr Carter Forde and Mrs Lillian Forde. The contest is whether it was “reasonably arguable” that Part IVA of the 1936 Act did not apply.[79] The applicants submit that their position was reasonably arguable although the basis of the submission does not clearly emerge;[80] the Commissioner submits that it was not.
[79]Exhibit 21, paragraph [228 (b)].
[80]Paragraph [229] of the applicants’ submissions places reliance on paragraphs [204] – [219] of those submissions to support their contention that it was reasonably arguable that Part IVA of the 1936 Act did not apply. Those paragraphs, though, address the issue of the imposition of penalties on the assumption that I had concluded that Part IVA did not apply. The submissions are directed to a different issue, whether it was reasonably arguable that the small business CGT concessions were available.
The expression is defined in s 284-15(1) of Schedule 1 in this way:
A matter is reasonably arguable if it would be concluded in the circumstances, having regard to relevant authorities, that what is argued for is about as likely to be correct as incorrect, or is more likely to be correct than incorrect.
I have no difficulty in concluding that the applicants’ position was not arguable. There is no suggestion that they, or any of them, or anyone on their behalf, sought advice from competent advisors about their position. On Mr Forde’s evidence the advice sought was directed to minimising tax. Subjectively viewed, these transactions were motivated by a desire to avoid tax, not protect assets. It was an artifice and did not come anywhere near “reasonably arguable”. The Commissioner’s objection, in each case, should be affirmed although in the case of Mr Carter Forde and Mrs Lillian Forde there will be adjustments to the amount of the penalty.
The applicants advance no relevant reason why the discretion to remit ought be exercised favourably to them. The document lodged by the applicants on 14 April 2014, setting out the terms of the decisions that the applicants contend for in a variety of possible scenarios, leads me to conclude that the applicants have abandoned their reliance on a claim for remission. Even if they have not done so, there is nothing that I can see in the circumstances of the particular applicants that would warrant the exercise of the discretion to remit.
I certify that the preceding 119 (one hundred and nineteen)paragraphs are a true copy of the reasons for the decision herein of Deputy President P E Hack SC ...................[Sgd].....................................................
Associate
Dated 29 January 2015
Dates of hearing 4, 5 & 6 November 2013, 15 January 2014, 13 March 2014 Date final submissions received 14 April 2014 Counsel for the Applicant Mr FL Harrison QC Solicitors for the Applicant McCullough Robertson Counsel for the Respondent Dr KA Mellifont QC & Ms L Allen Solicitors for the Respondent Australian Government Solicitor
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