Fresta and Commissioner of Taxation - [2002] AATA 337

DECISION AND REASONS FOR DECISION [2002] AATA 337

ADMINISTRATIVE APPEALS TRIBUNAL )

) No QT2000/161

TAXATION APPEALS DIVISION         )
           Re      ORAEIO FRESTA
  Applicant
           And    COMMISSIONER OF TAXATION
  Respondent

DECISION

Tribunal Mr K L Beddoe, Senior Member

Date13 May 2002
PlaceBrisbane

Decision      The Tribunal sets aside the decision under review and remits the matter to the respondent to reconsider the objection with a direction that Provision for income tax is to be treated as a present legal obligation in determining net assets for the purposes of section 109Y of the Income Tax Assessment Act 1936.    The proceedings have terminated in a manner favourable to the applicant.
  (Sgd) K L Beddoe
  Senior Member
Decision No: 337/2002
CATCHWORDS
TAXATION – Income Tax –assessable income - whether outstanding shareholder loan should be deemed as a dividend – whether dividend should be included in assessable income – whether Provision for income tax is a present legal obligation.
Income Tax Assessment Act 1936 s109D, 109Y

REASONS FOR DECISION

13 May 2002 Mr K L Beddoe, Senior Member

The applicant seeks review of an objection decision to the effect that an outstanding loan owing by the applicant to an associated company at 30 June 1998 was a deemed dividend to be included in the assessable income of the applicant.
Section 109D of the Income Tax Assessment Act 1936 ("the Act") came into operation with effect from 4 December 1997 ie during the relevant year of income. It provides, in effect, that a private company is taken to pay a dividend to a person at the end of the relevant year of income if:
(a)      the company makes a loan to the person during the year of income;
(b)      that loan is not fully repaid by the end of the year of income;
(c)       section 109R does not operate; and
(d)the person is a shareholder or associate of the company when the loan was made; or …..

Sub-section 109D(3) defines "loan" inclusively as follows:
(a) an advance of money; and
(b) a provision of credit or any other form of financial accommodation; and

(c)a payment of an amount for, on account of, on behalf of or at the request of an entity, if there is an express or implied obligation to repay the amount; and
(d)a transaction (whatever its terms or form) which in substance effects a loan of money.

Section 109Y has the effect of reducing the quantum of a loan to be treated as a dividend to an amount not in excess of the company's distributable surplus. Section 109Y(2) sets out the formula to determine a company's distributable surplus for the relevant year of income as follows:
Net Assets less Non Commercial Loans less Paid-up Share Value less Repayments of Non Commercial Loans. No issue on Non Commercial Loans. No issue arises here as to Non Commercial Loans but an issue does arise as to the calculation of "Net Assets".
"Net Assets" is determined by applying the definition in section 109R(2) of the Act which reads as follows:
"'net assets' means the amount (if any), at the end of the company's year of income, by which the company's assets (according to the company's accounting records) exceed the sum of:
(a)the present legal obligations of the company to persons other than the company; and
(b)the following provisions (according to the company's accounting records):
(i)provisions for depreciation;
(ii)provisions for annual leave and long service leave;
(iii)provisions for amortisation of intellectual property and trademarks;
(iv)other provisions prescribed under regulations made for the purposes of this subparagraph.
If the Commissioner considers that the company's accounting records significantly undervalue its assets or overvalue its provisions, the Commissioner may substitute a value that the Commissioner considers is appropriate."

I understand that no additional categories of provisions have been prescribed by regulation and in particular provisions for income tax have not been so prescribed.
At the hearing Mr Teitzel represented the applicant and Mr Aftanas represented the respondent. The documents lodged in the Tribunal pursuant to section 37 of the Administrative Appeals Tribunal Act 1975 and further tendered documents marked as exhibits were before the Tribunal. Oral evidence was given by the applicant. The parties made submissions at the hearing which was eventually adjourned to allow the respondent to make further submissions in writing. The applicant's representative subsequently lodged written submissions in reply.
The Facts
While the issue is contentions, the facts are not really in dispute albeit that the respondent did not have a clear understanding of the facts prior to the hearing.
The applicant owns a farm property growing mangoes and avocados. He operates the farm under a share-farming arrangement with his family company of which he is the controlling mind. The gross proceeds of the farming business are divided as to 80% to the company and 20% to the applicant. The share-farming agreement provides for the applicant to provide machinery, equipment and facilities to the company to allow the company to operate the business.
Expenses of the business are paid by the company or the applicant and adjustments as to respective shares are made in the company's accounts and reflected in those accounts. The portion of expenses (and I assume income) attributable to the applicant is reflected in an account classified as a current asset in the 1998 balance sheet and described as "Receivables Loan – (the applicant) - $85,655.56" (T6).
The balance sheet as at 30 June 1999 (T8) shows comparative 1998 figures with the loan being $114,075 which is the figure adopted in the interest calculation schedule and the loan schedule.
The balance sheets indicate that the company was a trading entity without assets other than financial assets offset by financial liabilities including a provision for income tax. A revised balance sheet shows the amount of $67,562.66 as a "Receivable" (Exhibit 2). I am not satisfied that I can correctly quantify the loan but that is not an ultimate issue. I am satisfied that the loan account in the applicant's name reflects the adjustments required under the share-farming agreement as between the applicant and the company. The applicant's oral evidence suggested this was the extent of the transactions in the loan account. However the applicant's signed statement of facts indicates that the applicant used the company account more as a bank account and this is confirmed by a consideration of Exhibit 3. Clearly the company paid expenses which it expected, would be reimbursed in whole or in part by the applicant.
Exhibit 1 is a copy of a minute of a meeting of directors of the company held on 30 June 1998. It includes the following:
"Through the financial year various accounts are paid by (the applicant) on behalf of the company and visa versa which are at time unavoidable. From this a loan account may arise from time to time and a balance may arise owing at the years end.
Should a balance remain in this account at the 30th June each year, then a loan statement is to be prepared with the balance owing and interest charged at the rate applied to fringe benefits loans to directors in the regulations and Tax Act.
It is acknowledged that the loan arises out of day to day transactions and where a specified amount is loaned that such amounts are to be repaid to the company.
It is resolved to prepare the required loan statement."
The applicant does not suggest that there is any other written document relevant to the debt owing by the applicant to the company.
There is no dispute that the company is a private company and that the applicant is a director and shareholder of that company. There is also no dispute that the applicant and the company are parties to a share-farming agreement sharing gross proceeds on an 80/20 basis. There is also no dispute that the company pays expenses incurred by the applicant under the share-farming agreement and otherwise.
The Applicant's submissions
Section 109D was not intended to cover any accounting between share-farmers so that an amount owing by one share-farmer is to be construed as a loan made by the other.
The company minute in relation to the loan was a written agreement within the terms of section 109N(1)(a) and the other relevant provisions of section 109N are satisfied so that there is a loan not to be regarded as payment of a dividend within the terms of section 109D.
The provision for income tax should be taken into account in the quantification of "net assets" in the determination of the distributable surplus. See Whitney v ARC (1926) AC 37 at 52, Re Sutherland, (1963) ACT 235, Jones v DFCT, 98 ATC 4897, and Re Duggy (1949) Ch 28 at 36-38.
The Respondent's Submissions
The loan balance of $67,562. 66 is a loan within the terms of section 109D(3). Section 109D(1) operates to determine that the company is taken to pay a dividend to the applicant at the end of the year of income. Section 109N does not apply in this case because there is no relevant written agreement or because the loans were made prior to the making of the minute by the company. In any event the loans do not have a maximum term.
For the purposes of calculating the net assets of the company the present legal obligations of the company to others is $34,072 being $62,013.15 total liabilities less provision for income tax of $27,940.66.
Provision for income tax is not a present legal obligation because it has not crystallised. See Foxwood (Tolga) Pty Ltd v FCT 80 ATC 4096 at 4105, and Coles Myer Finance v FCT, 93 ATC 4214 at 4223.
"Present legal obligation" refers to a debt that has crystallised and is actually owing (although perhaps not payable until a future date Taylor v DFCT, 87 ATC 4441 at 4446).
A present legal obligation is different to a liability which is not contingent so that it only embraces a liability which is a presently existing obligation, not a future obligation. Further a present liability for unassessed tax is not an obligation albeit that there will eventually be an obligation to pay the tax which would be a present legal obligation.
Consideration
As a matter of fact the applicant, as the controlling mind of the company, must be taken to have arranged for the company to pay creditors who would otherwise look to the applicant for payment and he must be taken to have arranged that the company pay creditors for his share of the share-farming expenses. I do not see that any other finding is open on the facts of this case.
While I am satisfied that the company probably did not make advances of money to the applicant, I am satisfied that it is more likely than not that the company:
(a)provided credit to the applicant; and
(b)paid amounts for, on account of, or on behalf of the applicant.

It follows, in my view, that the amount described in the balance sheet as "Receivables" (Exhibit 2) is correctly characterised as a "loan" within the terms of sub-section 109D(3).

It also follows, in my view, that the company must be said to have made a loan to the applicant during the year of income and that loan had not been fully repaid as at 30 June 1998.
It is not suggested, nor can I see, that sections 109H to 109R have any operation on the facts of this case.
It is beyond argument that the applicant is a shareholder in the company and was a shareholder at all relevant times.
Therefore it must be accepted that the amount outstanding at 30 June 1998 as between the applicant and the company was a loan caught be section 109D.
The amount deemed, in effect, to be a dividend paid to the applicant is subject to the operation of section 109Y. The effect is to ensure that the amount assessed as income of the applicant does not exceed the distributable surplus of the company.
The only issue is whether the Provision for Income Tax should be taken into account because it is a present legal obligation of the company to persons other than the company.
A number of authorities have been relied on by the parties but in my view the answer to the problem is to distinguish between whether the income tax is due on the one hand and whether the income tax is payable on the other. It is clear enough on the authorities that the tax was not payable until the subject of an assessment notified by the respondent.
However, as at 30 June 1998, the taxable income of the company was ascertainable, albeit that it may not have been actually ascertained. Given that taxable income had been established by the facts it was also possible to calculate tax payable on that taxable income in accordance with the current rates of the company tax.
It follows, in my view, that there was a clear liability for income tax as at the 30 June 1998 even though the tax would not be payable until assessed.
In my view, and with respect, the law is correctly stated by Branson J in Jones v FC of T 98 ATC 4897 at 4900-01 as follows:
"There is plainly a distinction between the existence of an obligation sufficient to found a debt on the one hand, and the existence of a debt that is due, whether or not payable, on the other. Cases such as Commissioner of Stamps (WA) v The Western Australian Trustee Executor and Agency Co Ltd (1926) 38 CLR 63; DFC of T v Brown (1958) 11 ATD 374; (1957-1958) 100 CLR 32 and Clyne v DFC of T are concerned with when income tax is due rather than with the time at which the obligation to pay such tax arises.
In Commissioner of Stamps (WA) v The Western Australian Trustee Executor and Agency Co Ltd (Mortimer Kelly's case) (1925) 36 CLR 98 the High Court gave consideration to whether liability to income tax not assessed at the time of an individual's death was a debt 'due by the deceased person', so as to be deductible from the value of the estate of the deceased for the purpose of the calculation of the duty payable and the value of the estate under the Administration Act 1903 (WA). The majority of the Court (Knox CJ, Higgins and Starke JJ) held that it was. Knox CJ, at 104, said of the Income Tax Act 1922(Cth):
'In my opinion, the Income Tax Act imposed on every person who during the year ending 30 June 1922 derived from sources in Australia income which was 'taxable' according to the provisions of the Assessment Act an obligation to pay income tax at the rate declared. The obligation, I think, existed from the moment when the Income Tax Act became law.'
Higgins J at 114-115 and Starke J at 117 also expressed the view that the relevant Income Tax Acts imposed obligations on the deceased during his life although the amounts to be paid had not been ascertained or included in assessment during his life. It is necessary to note that Mortimer Kelly's case was concerned only with income tax payable in respect of financial years which had ended before the death of the taxpayer. The deceased, Mortimer Kelly, died on 18 November 1922. After his death assessments to income tax issued for the years ended 30 June 1919, 30 June 1920 and 30 June 1922. The tax in respect of the income derived during the year ended 30 June 1919 was imposed by the Income Tax Act 1919 (Cth); that in respect of income derived during the year ended 30 June 1920 was imposed by the Income Tax Act 1920 (Cth); and that in respect of income derived during the year ended 30 June 1922 was imposed by the Income Tax Act 1922 (Cth). The Income Tax Act 1922 (Cth) came into force on 18 October 1922 (ie during the lifetime of the deceased). It provided by s 2 that it was to be read as one with the Income Tax Assessment Act 1922(Cth). That is, in contrast with the ITAA, the Income Tax Assessment Act 1922 (Cth) levied income tax for a financial year not on the taxable income of a taxpayer derived during that year, but on his or her taxable income derived during the previous financial year (s 13(1) of the Income Tax Assessment Act 1922(Cth)).
In DFC of T v Brown, a case in which the taxpayer had died nine days into a financial year, only Kitto and Taylor JJ (both in dissent) gave consideration to Mortimer Kelly's case. As can be seen most clearly from a passage from the judgment of Kitto J, their Honours understood Mortimer Kelly's case to be authority for the proposition that the taxing Acts there under consideration imposed a liability during the course of a financial year for payment of income tax on the income derived during that financial year. Kitto J said at ATD 386; CLR 58:
'…it may be observed that the deceased was at the time of his death under an actual liability, under taxing Acts already in force, to pay tax on all the income to which the amended assessments and the original assessment relate. Even as to the income of the last nine days this was so…'

On appeal (99 ATC 4373) the Full Court set aside the declaration made by Branson J and substituted the following declaration:
"Income tax in respect of the period from 1 July 1996 to 9 January 1997 is a liability provable in the bankruptcy of Dr Roger Graham within the meaning of section 82 of the Bankruptcy Act 1966 (Cth)."

At paragraph 34 of its judgment the Full Court said:
"34. While it is true that income tax is an annual tax which is usually assessed annually by reference to taxable income, it is also a tax which, in the event of bankruptcy can be assessed by reference to the period from the commencement of the income tax year until the moment of bankruptcy. Hence, for present purposes it can be said that as at the moment of bankruptcy there exists an obligation to pay income tax on the taxable income derived from the commencement of the year of income until the commencement of the bankruptcy, which only matures as a debt due and payable after assessment under s 168. In our opinion, her Honour was correct, therefore, in concluding that the Commissioner was entitled to prove in the bankruptcy."

So instructed I am satisfied that as at 30 June 1998 the company had a present legal obligation for tax on its taxable income so that the calculation of "net assets" should take into account the provision for income tax (properly ascertained) as a present legal obligation.
The decision under review will be set aside and the matter remitted to the respondent to reconsider the objection. There will be a direction that Provision for income tax is to be treated as a present legal obligation in determining net assets for the purposes of section 109Y of the Act.
I will certify that these proceedings have terminated in a manner favourable to the applicant.
I certify that the 38 preceding paragraphs are a true copy of the reasons for the decision herein of Mr K L Beddoe, Senior Member
Signed:         .....................................................................................
  Associate
Date/s of Hearing  29 March 2001
Date of Decision  13 May 2002
For the Applicant  Mr Teitzel
For the Respondent                 Mr Aftanas