Egan and Commissioner of Taxation
[2002] AATA 563
•10 July 2002
DECISION AND REASONS FOR DECISION [2002] AATA 563
ADMINISTRATIVE APPEALS TRIBUNAL Nº VT2000/54-56
TAXATION APPEALS DIVISION
Re: MICHAEL JOHN EGAN
Applicant
And: COMMISSIONER OF TAXATION
Respondent
DECISION
Tribunal: Mr B.H. Pascoe, Senior Member
Date: 10 July 2002
Place: Melbourne
Decision:Further to the decision of 25 May 2001, the remittal to the respondent of part of the reviewable decisions and the review of the decisions on such reconsideration, the Tribunal varies the decisions under review to the extent of finding that deductions of $2810 in the year ended 30 June 1995, $2810 in the year ended 30 June 1996 and $2655 in the year ended 30 June 1997 should be allowed pursuant to s.177F(3)(b) of the Income Tax Assessment Act 1936 ("the Act") and remitting additional tax by way of penalty from 25 per cent to 15 per cent of the tax shortfall in each year pursuant to s.227 of the Act.
Pursuant to regulation 19(7)(b) of the Administrative Appeals Tribunal Regulations, the Tribunal certifies that these proceedings have terminated in a manner favourable to the applicant.
(sgd) B.H. Pascoe
Senior Member
INCOME TAX – scheme to obtain tax benefit – whether fair and reasonable to exclude amounts from assessable income – whether further deductions allowable – whether additional tax should be remitted
Income Tax Assessment Act 1936
Re Egan and Commissioner of Taxation [2001] AATA 449
REASONS FOR DECISION
10 July 2002 Mr B.H. Pascoe, Senior Member
This is an application to review a decision of the respondent, which was remitted for reconsideration pursuant to the Decision of the Tribunal in Re Egan and Commissioner of Taxation [2001] AATA 449. At the hearing preceding that decision, it was agreed by the parties that the Tribunal should consider only the question of whether amounts were currently included in the applicant's assessable income pursuant to s.177F(1) of the Income Tax Assessment Act 1936 ("the Act") and to remit the questions of the amount of allowable deductions pursuant to s.177F(3)(b) and the remission, if any, of additional tax. The respondent affirmed the original decision on reconsideration and these two remaining questions now require review by the Tribunal.
At the resumed hearing, the applicant was represented by Mr K. James, a solicitor, and the respondent by Mr T. Murphy, of counsel. No further evidence was adduced. It was agreed between the parties that it was appropriate for the Tribunal to consider the possible application of paragraph (a) of subsection(3) of s.177F of the Act in addition to paragraph (b). The relevant provisions of s.177F(3) are:
177F(3) Where the Commissioner has made a determination under subsection (1) or (2A) in respect of a taxpayer in relation to a scheme to which this Part applies, the Commissioner may, in relation to any taxpayer (in this subsection referred to as the "relevant taxpayer")—
(a)if, in the opinion of the Commissioner—
(i)there has been included, or would but for this subsection be included, in the assessable income of the relevant taxpayer of a year of income an amount that would not have been included or would not be included, as the case may be, in the assessable income of the relevant taxpayer of that year of income if the scheme had not been entered into or carried out; and
(ii)it is fair and reasonable that that amount or a part of that amount should not be included in the assessable income of the relevant taxpayer of that year of income;
determine that that amount or that part of that amount, as the case may be, should not have been included or shall not be included, as the case may be, in the assessable income of the relevant taxpayer of that year of income; or
(b)if, in the opinion of the Commissioner—
(i)an amount would have been allowed or would be allowable to the relevant taxpayer as a deduction in relation to a year of income if the scheme had not been entered into or carried out, being an amount that was not allowed or would not, but for this subsection, be allowable, as the case may be, as a deduction to the relevant taxpayer in relation to that year of income; and
(ii)it is fair and reasonable that that amount or a part of that amount should be allowable as a deduction to the relevant taxpayer in relation to that year of income;
determine that that amount or that part, as the case may be, should have been allowed or shall be allowable, as the case may be, as a deduction to the relevant taxpayer in relation to that year of income; or
The facts of this matter were set out in the previous decision. Briefly, they can be summarised as Tenth Mounpro Pty Ltd ("TM") was a company jointly owned by the applicant, Mr Egan, and his wife. TM owned a half interest in Australian Out Sourcing Pty Ltd ("AOS"); a company providing computer consulting services and the sale and maintenance of software. During the years ended 30 June 1995 to 1998, AOS paid a fee to TM which was held to be income of Mr Egan pursuant to s.177F(1). In the amended assessments, issued pursuant to the respondent's determination under that provision, certain expenditure was allowed as a deduction under s.177(3)(b). This expenditure represented some, but not all, of the expenditure incurred by TM. That expenditure and the amounts allowed to Mr Egan were as follows:
Your ended 30 June 1995 1996 1997
Allowed as deduction to Mr Egan
Accountancy 880 1190 2070
Advertising - 280 -
Bank Charges 1382 2182 1767
Computer Software 119 - 350
Depreciation – Office Equipment 1701 1846 1846
Donations 630 668 244
Electricity and Gas (20 per cent) - 91 86
Filing Fees 175 385 195
General Expenses 1190 150 -
Insurance 745 469 63
Office Expenses 809 898 -
Staff Amenities 100 130 -
Travelling Expenses 334 943 2524
Telephone 187 694
____ ____ ____8065 9419 9848
____ ____ ____
Expenditure not allowed
Electricity and Gas (80 per cent) 270 256
Interest 3955 6516 4250
Motor Vehicle Depreciation 2295 17,524 -
Motor Vehicle Expenses 13,433 11,960 27,922
Rent 6240 17,810 -
Repairs and Maintenance - 3574 3728
Superannuation 15,550 35,477 6750
Wages 71,240 37,900 65,000
WorkCare 120 58 -
Storage - 413 -
Freight and Cartage - - 424
Rates - - 154
______ ______ ______
112,833 131,502 108,484
______ ______ ______
120,898 140,921 118,332
______ ______ ______The primary contention on behalf of Mr Egan was that, in applying s.177F(3) of the Act, Mr Egan should be regarded as an employer of AOS. As such, it was submitted, AOS would have been expected to provide superannuation, a motor vehicle and other benefits and such benefits would have been accomplished by Mr Egan sacrificing part of what has been treated as his income from AOS. It was said that Mr Egan was a director of AOS and, as such, an employee of AOS and, by virtue of the association, AOS was aware that TM was providing benefits to Mr Egan out of the fees paid by AOS to TM. It was submitted that it was appropriate, in considering whether exclusion of amounts from assessable income or allowing deductions against assessable income would be fair and reasonable, to either recognise the salary sacrifice arrangements between Mr Egan and TM or, alternatively, assume that AOS would have made the same payments by way of salary sacrifice. Mr James argued that Mr Egan could have been paid the same salary by AOS as he had been paid by TM without any taxation implications even though it may have been less than an arms-length, market value salary, with AOS also paying his motor vehicle expenses, superannuation, rent, etc. Much of Mr James's submission was based on the view that, as compared with the former s.260 of the Act, Part IVA allows reconstruction and Mr Egan should be treated on the basis that he was an employee of AOS and, if properly advised, would have taken advantage of opportunities available to minimise legitimately the impact of taxation.
While s.177(3)(a) and (b) uses the words "fair and reasonable", the acceptance of Mr James's submission would require the respondent and the Tribunal to act in the capacity of an advisor to Mr Egan, AOS, and TM and make assumptions of an arrangement between the three which might have happened if the advice was properly given, accepted by the parties and acted upon. It requires an assumption that the parties would or may have entered into transactions differently to those which actually happened. While Mr Egan was a director and, therefore, in relation to some provisions of the Act, an employer of AOS, this does not mean that AOS would have paid a particular level of salary, contributed the same amount to superannuation, provided a motor vehicle and provided rented premises closer to its office than was the residence of Mr Egan. It may well have done but it is difficult to accept that s.177F(3) allows pure conjecture to be "fair and reasonable".
The previous finding was that the amount paid by AOS was for the services of Mr Egan and that s.177F(1) allowed that fee to be included in the assessable income of Mr Egan. The question that s.177F(3) then poses is whether it is fair and reasonable to exclude any amount from assessable income or to allow deductions against assessable income for amounts which would not have been so included or which would have been allowed if the scheme had not been entered into. The scheme, as identified in the previous decision, was the payment by AOS of a fee to TM, the payment of a modest salary to Mr Egan by TM, the payment of a salary to Mrs Egan and, the contributions by TM for superannuation by both and the retention of the balance of the fee to be taxed at corporate rates of tax. If the scheme had not been entered into, the same fee would have been paid direct to Mr Egan. It is not possible for the respondent or the Tribunal to guess what AOS and Mr Egan may have agreed as a basis of remuneration if they had considered that the provisions of Part IVA of the Act would apply. All that can be done is to look at the facts and to then consider what expenditure was incurred by TM which, if it were not for the scheme, would have been incurred by Mr Egan. These expenses fall into five categories, as follows:
Interest on borrowed funds
Motor vehicle depreciation and expenses
Salary to Mrs Egan
Expenses relating to rented accommodation
Superannuation contributions
In relation to paragraph (a) of subsection (3) of s.177F, the only part which it can play is to exclude from assessable income the salary paid to Mr Egan by TM, it being fair and reasonable that it should not be so included where the whole of the fee from AOS is so included under s.177F(1).
From the report of the respondent's auditor (T67), it appears that the interest claimed by TM related to funds borrowed for the purchase of a motor vehicle so that such interest falls to be considered with the question of deduction of motor vehicle depreciation and other motor vehicle expenses. The report notes also that there were two motor vehicles involved with the presumption that one was for the use of Mr Egan and the other for Mrs Egan. This was confirmed by Mr Egan in his witness statement (exh A2) at page 14. It is clear from the evidence that the motor vehicle used by Mr Egan was used for travel between his home near Maldon, some three hours drive from both Telstra Corporation ("Telstra") and AOS offices, a rented house in which Mr Egan resided during week days, the offices of Telstra and AOS, the airport and offices of other clients of AOS. Clearly, the cost of travel from either his home near Maldon or the rented premises in Wantirna or Brunswick to his place of work on that day is not a deductible cost. It is equally clear that some deductible travel was incurred and this was accepted by the respondent although it was noted that no evidence had been led to allow a calculation of the appropriate amount. At the commencement of his submission, Mr James proposed that the Tribunal consider only the underlying legal principles with either the calculation of quantum to be remitted to the respondent or leave granted to the parties to submit further evidence. Given the length of time that this matter has taken to date and the fact that, after the first hearing, leave was given to return to the Tribunal if the application of s.177F(3) could not be agreed between the parties, I am not disposed to delay finalisation of proceedings before this Tribunal any longer by acceding to such a proposal. It could be rightly said that the applicant has the onus of proving that the assessments are excessive and the amount by which they are excessive and that onus has not been discharged in relation to a deduction for motor vehicle expenses. However, in the circumstances of this case, I am prepared to accept that one motor vehicle was used for the purpose of producing assessable income and, in the absence of detail, I am also prepared to accept that it travelled 5000 kilometres in such use and allow a deduction pursuant to s.82KX of the Act. Again, I am prepared to make an assumption, in order to finalise this issue, that the cubic capacity of the motor vehicle was between 2000cc and 2600cc and, at the rate of 56.2 cents per kilometres for the years ended 30 June 1995 and 1996 and 53.1 cents per kilometres for the year ended 30 June 1997, a deduction of $2810 in each of the first two years and $2655 for the third year should be allowed.
Having found in the previous decision that the contribution by Mrs Egan was minimal and her contribution to the derivation of assessable income from AOS was little more, if any, than a spouse of a busy consultant might provide, I am unable to see that any deduction for a salary to Mrs Egan is appropriate under s.177F(3)(b).
The expenses claimed by TM of electricity, rent, repairs and maintenance, storage, freight and cartage and rates all appear to relate to premises at Wantirna rented from a third party, premises at Brunswick rented from the TM Superannuation Fund and the costs of moving between the two. Both premises were used by Mr Egan for his personal accommodation during week days to obviate the need to travel the long distance from his family home to work. As such, I have no difficulty in finding that this was the result of personal choice of a place of residence and would not be an allowable deduction to Mr Egan. Consequently, no compensating adjustment involving any deduction under s.177F(3)(b) is appropriate.
In relation to the question of superannuation, the argument for the applicant is that s.177F(3)(a) should be applied to exclude the equivalent of the amount contributed by TM for the benefit of Mr Egan thus leaving TM as having received that amount as income from AOS and being entitled to the same amount as a deduction. Alternatively, the argument was that AOS should be deemed to have made such contribution and the equivalent amount excluded from Mr Egan's income. That second option of assuming a state of affairs different from the facts is not, in my view, contemplated or possible under s.177F(3)(a). The first option requires a different assumption of what could have occurred. It appears to require an assumption that the relevant fee was paid by AOS to TM and, in turn, TM paid this total amount by way of salary to Mr Egan less the amount contributed to superannuation. Whilst it is accepted that, if that set of facts had existed, it is unlikely that s.177F would have any application at all, that was not the situation. The finding has been that the amounts of fees paid by AOS for the services of Mr Egan were correctly included in his income under s.177F(1). Again, I am unable to see that s.177F(3)(a) can allow the degree of reconstruction of the facts sought by the applicant.
The next question is whether s.177F(3)(b) can apply to allow a deduction for the superannuation contribution against the assessable income of Mr Egan. It would seem that the only way in which this could happen would be to assume that Mr Egan made a contribution of an equivalent amount to that made by TM which could be deductible under s.82AAT of the Act. Apart from the same difficulties with relying on assumptions, there are significant legislative difficulties in arriving at the allowance of a deduction. These are a consequence of the very specific and limited regime governing contribution to superannuation funds and the treatment of such contributions within the funds. First, a contribution was made by TM to a fund on the basis of Mr Egan being an employee. As a director of TM, he was an employee (s.82AAA(2)) and TM was entitled to a deduction for the contribution within the limits of s.82AAC. Section 82AAR provides that:
… a deduction is not allowable under any provision of this Act other than this Subdivision in respect of an amount paid by a taxpayer as a contribution to a superannuation fund for the purpose of making provision for superannuation benefits for, or for dependants of an employee or employees.
Given that the contribution was and remained a deduction to TM, it is difficult to see how such amount can be allowed also as a deduction to Mr Egan either as "fair and reasonable" or in contravention of s.82AAR. The second problem is that s.82AAT requires Mr Egan to be an "eligible person", requires a specific legislative requirement to be satisfied and allowing a deduction to him involves ignoring the taxation consequences to the fund to which contributions were made. I am unable to see that s.177F(3)(b) can allow any such deduction.
In his submission, Mr James argued that the approach of the respondent had denied to Mrs Egan any share of the economic activity of AOS, superannuation as an employee of TM, remuneration for service provided or compensation for agreeing to have her house at risk as security for borrowings by TM for the benefit of AOS. I must disagree, TM was and remains a shareholder of AOS. As such, it has benefited from the economic actively of AOS, the retention of profits by AOS, the acquisition of shares in AOS by a third party, EMC Corporation, and the consequent ability to derive dividends and/or capital gain from the investment in AOS. Mrs Egan is a director and shareholder of TM. As a director, an ability to make superannuation contributions is a matter for TM. The only effect of the respondent's decision has been to exclude from the income of Mrs Egan a direct share of the fee paid by AOS for the services of Mrs Egan.
It should be noted that Mr James argued that it was inequitable that the respondent had accepted the equivalent arrangements between AOS, Mr Doubtfire and his company, 81st Patriot Pty Ltd ("81P"). It was submitted that the respondent was in breach of his own charter to treat taxpayers in identical situations equally. This argument can be disposed of simply. I have no evidence of the arrangements between Mr Doubtfire and 81P, whether Mrs Doubtfire is an employee of 81P and what contribution, if any, she has made to its activities. I have no evidence or knowledge of whether or not the respondent has sought to tax Mr Doubtfire on any basis other than that disclosed in his income tax returns nor what those returns disclosed. In any event, even if the circumstances of Mr Doubtfire were the same as Mr Egan and the respondent has not sought to make any determination under s.177F, this cannot act as any sort of estoppel to a determination under that section in relation to another taxpayer.
The final issue in this case is the matter of additional tax. The respondent imposed additional tax pursuant to s.226L of the Act at the rate of 25 per cent of the tax shortfall in respect of each of the relevant years. Under this section, that rate of additional tax is provided when a taxpayer has been subject to a s.177F determination but has a reasonably arguable position. There is no doubt that Mr Egan circumstances fit within s.226L. It was argued on his behalf that the additional tax should be remitted pursuant to s.227 of the Act to a much lower percentage, preferably nil. It was said that the matter had been complicated by the misconception of the respondent that fees paid by Telstra constituted a significant part of the scheme, leaving Mr Egan in a position of not knowing the case which he had to face. Secondly, it was said that the differential treatment of Mr Doubtfire had led to considerable inequities between the two principals of the business. Thirdly, it was argued that the end result of the application of s.177F was that Mr Egan was required to pay considerably more by way of income tax than that which he would have incurred if properly advised at the outset and had structured his affairs in an acceptable but tax effective way. It is clear that the circumstances of this case fall clearly within s.226L. This section provides for additional tax of 50 per cent where it is not reasonably arguable that the taxpayer's view of the law was correct and 25 per cent where it is so reasonably arguable. The only basis for reduction of this level of penalty is the exercise of a discretion under s.227 to remit the whole or any part of such additional tax. It is clear that some special circumstances which can differentiate the circumstances of a particular taxpayer from others who have been subject to a s.177F determination is required for such discretion to be exercised. Further, the additional tax is by way of monetary penalty for incorrect return of income.
The first reason for remittal advanced for Mr Egan has, in my view, some relevance. There was clear confusion and some considerable time spent by his advisors and representatives as a result of the respondent, prior to the hearing, continually referring to fees from Telstra rather than AOS. It is likely that this misapprehension caused some time and costs in seeking to resolve the actual issues to be dealt with. The second reason advanced is not one which, in my view, bears any relationship to the question of additional tax. As previously stated, there is no evidence or hard information relating to the arrangements entered into by Mr Doubtfire or of the respondent's view of them. In any event, the treatment of one taxpayer cannot influence the application of the law to another taxpayer. The third reason does have some relevance. The arguments of Mr James relating to the application of s.177F(3)(a), while innovative and initially attractive but, on reflection, not acceptable, have some relevance to the question of fairness and equity. While having come to the view that this legislative provision provides no reduction in the income assessed, the arguments put demonstrate that, properly advised, Mr Egan could have legitimately produced a lower taxable income than the arrangements successfully attacked by the respondent. As such, I accept that he has suffered a financial penalty. Considering both those relevant reasons, I am of the view that the additional tax of 25 per cent is not justified. Some penalty is appropriate, nevertheless, and I am prepared to find that the additional tax imposed under s.226L should be remitted to 15 per cent of the tax shortfall pursuant to s.227 of the Act.
It follows that the decision under review should be varied by allowing further deductions under s.177F(3)(b) of $2810 in the year ended 30 June 1995, $2810 in the year ended 30 June 1996 and $2655 in the year ended 30 June 1997 and remitting additional tax to 15 per cent of the tax shortfall of each year.
I certify that the sixteen [16] preceding paragraphs are a true copy of the reasons for the decision herein of
Mr B.H. Pascoe, Senior Member(sgd) Catherine Thomas
ClerkDate of Hearing 2 April 20002
Date of Decision 10 July 2002
Solicitor for the Applicant Mr K. James, Messrs Hall & Wilcox
Counsel for the Respondent Mr T. Murphy
Solicitor for the Respondent Australian Government Solicitor
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