Hedges and Commissioner of Taxation (Taxation)
[2020] AATA 5307
•23 December 2020
Hedges and Commissioner of Taxation (Taxation) [2020] AATA 5307 (23 December 2020)
Division:Taxation and Commercial Division
File Number(s): 2018/3539
Re:Brent Hedges
APPLICANT
AndCommissioner of Taxation
RESPONDENT
DECISION
Tribunal:Deputy President McCabe
Date:23 December 2020
Date of written reasons: 23 December 2020
Place:Sydney
The objection decision is affirmed
................................SGD......................................
Deputy President McCabe
TAXATION – Capital gains tax – disposal of goodwill – work in progress amounts – reduction – disposal of capital proceeds
LEGISLATION
Income Tax Assessment Act 1997 (Cth)
Taxation Administration Act 1953 (Cth)
CASES
Airservices Australia v Ferrier [1996] HCA 54 (Compass Airlines case)
Chief Commissioner of Revenue of NSW v Dick Smith Holdings Pty Ltd (2003) 58 NSWLR 567
Ellison v Sandini [2018] FCAFC 44Click here to enter text.
REASONS FOR DECISION
Deputy President McCabe
23 December 2020
The taxpayer is a retired solicitor. He received payments from his former firm after he retired as a partner at the end of 2008. The payments were made in accordance with the terms of the partnership deed and a further deed setting out the terms and conditions of his retirement. The taxpayer did not lodge his tax returns in a timely way. The Commissioner of Taxation issued default assessments for the 2009, 2010 and 2011 years of income. Following correspondence, the taxpayer was taken to have objected to the assessment in respect of the 2009 year of income. The objection was disallowed. After further delay that necessitated an extension of time, the objection decision in relation to the year of income ending 30 June 2009 has now come before the Tribunal.
The taxpayer bears the onus of establishing the assessment is excessive. As a practical matter, s 14ZZK(b) of the Taxation Administration Act 1953 (Cth) (the Administration Act) requires the taxpayer to establish the assessment was incorrect – but he must also satisfy what is the correct (or more nearly correct) amount for which he should be assessed. That is a challenge in a case like this dealing with events that occurred more than a decade ago; memories fade and documents are lost. Perhaps because of those evidentiary challenges, the scope of the dispute narrowed by the time of the hearing. It is now agreed the key issues before the Tribunal are:
(a)Whether the taxpayer’s capital gain from the disposal of goodwill should be reduced; and
(b)Whether the work in progress amounts should be reduced?
WHAT HAPPENED?
The relevant facts were essentially agreed as between the parties. At the hearing, counsel for the taxpayer expressly accepted the factual narrative set out in Part B of the Commissioner’s amended statement of facts, issues and contentions dated 24 August 2020. The findings of fact that follow are derived from that narrative.
The taxpayer practiced law. Over time, he was a member of different partnerships including one that I will refer to as the C partnership. The terms of the C partnership were contained in a deed dated 25 September 2006. A copy of the deed was included in exhibit one. The partnership deed included provisions which governed the entitlement of partners to payments upon retirement in respect of:
·any credit in the capital and current accounts,
·a proportionate share in the goodwill of the partnership; and
·proportionate share of the amount of work in progress (i.e. the amount of work that had been completed but which had not yet been billed to clients).
The deed added that a retiring partner was required to pay to the partnership an amount equal to any shortfall in that partner’s capital account.
Further terms and conditions relating to the taxpayer’s retirement on 31 December 2008 were included in a retirement deed that was agreed between all of the partners in the C partnership. The retirement deed, which is reproduced in exhibit one at T7-22 was dated 30 September 2008.
Upon his retirement, the taxpayer became entitled to receive a number of payments. These payments were subsequently made during the course of the 2009, 2010 and 2011 financial years. He was also required to repay $197,126 in order to make good the shortfall in the capital account. (I was told the shortfall arose because the taxpayer had overdrawn his entitlements, amongst other things, but nothing turns on that.) The repayments were made over the same three-year period.
The final payments were recorded as follows:
Amount entitled to
Year ended 30 June 2009
Year ended 30 June 2010
Year ended 30 June 2011
Capital and Current Account
$0
-
-
-
Goodwill
$182,629
$54,789
$91,315
$36,525
Work in Progress
$410,320
$131,265
$218,775
$60,280
Other amounts
$3,250
$975
$1,625
$650
Repayment of capital account
($197,126)
($31,029)
($118,641)
($47,456)
Total
$399,073
$156,000
$193,074
$50,000
The taxpayer failed to lodge his income tax returns in a timely way, and his tax agent did not respond promptly to requests for information. The circumstances of that failure were explained in the course of the taxpayer’s statement of facts, issues and contentions. The document is not a conventional statement, but it was signed by the taxpayer, and nothing appears to turn on the explanation in any event. There was no suggestion from the Commissioner that the taxpayer was being elusive or, by the time of the hearing, that he was being obstructive or uncooperative.
In any event, the Commissioner issued default assessments for the 2009, 2010 and 2011 years of income. Of particular relevance here, the Commissioner assessed the taxpayer’s taxable income for the year ended 30 June 2009 as $522,175. That amount was comprised of:
·A partnership distribution from the partnership of $299,596;
·A discount capital gain from the disposal of the goodwill in the partnership’s business in the amount of $91,314; and
·An amount of $131,265 being the taxpayer’s share of the partnership’s profits representing work in progress.
I should pause to explain the way in which the capital gain was calculated. The total capital gain was $182,629. The cost base was $0, The total was reduced by the standard 50% CGT discount to produce a net or discount capital gain of $91,314.
The taxpayer objected and the objection decision has now been brought before the Tribunal for review. At the outset of the hearing, Mr Burston, counsel for the taxpayer, formally sought leave to amend the grounds of objection. The Commissioner did not demur, and the taxpayer was given leave pursuant to s 14ZZK(a) of the Administration Act.Mr Burston also confirmed there would be no submissions about whether any of the assets in question were pre-CGT assets, and there was to be no argument about the cost base.
The taxpayer was briefly cross-examined about aspects of the partnership accounts and other financial records of what happened upon his retirement. I mean no disrespect when I say his evidence was not particularly illuminating. The detailed records related to events that occurred years before, and – as he pointed out – he was a solicitor, not an accountant.
THE TREATMENT OF GOODWILL
The Commissioner’s case is relatively straightforward. It starts from the proposition that the taxpayer effectively disposed of the entirety of his goodwill in the partnership when he retired. The Commissioner initially said the disposition occurred on 31 December 2008 when the retirement took effect, and is properly regarded as CGT event A1 pursuant to s 104-10 of the Income Tax Assessment Act 1997 (Cth) (ITAA97).[1] Mr Burston argued in oral submissions that CGT Event A1 occurred on the date of the retirement deed, being 30 September 2008. In oral submissions, Ms Gatland (who appeared for the Commissioner) conceded that point: transcript at p 29. It makes no practical difference in the present proceedings because both parties agreed CGT Event A1 occurred in the latter part of 2009.
[1] Section 104-10(1) provides CGT event 1 occurs when you dispose of a CGT asset. Section 108.5 says the expression ‘CGT asset’ includes any kind of property or legal or equitable right that is not property. To remove doubt, s 108.10(2) says the expression ‘CGT asset’ includes an interest in a partnership or partnership asset, and goodwill, or any interest in goodwill.
The Commissioner explained the capital proceeds of that disposal were $182,629 because that was the amount the taxpayer received (or was entitled to receive) in respect of the transaction which constituted CGT event A1: see the general rules about capital proceeds in s 116.20. The Commissioner pointed out in written submissions that the taxpayer has not provided any evidence going to the cost base of the of the goodwill, nor is there evidence the goodwill (or any part of it) was acquired prior to 20 September 1985 (which means there can be no argument it was a pre-CGT asset). In those circumstances, the amount of $91,314 – being half the amount of the capital gain accruing to the taxpayer on 31 December 2008 – was properly included in the taxpayer’s assessable income in the 2009 year of income as a discount capital gain within the meaning Division 115 of the ITAA97. The Commissioner says that is the end of it: quod erat demonstradum.
The taxpayer, for his part, acknowledged he has no evidence going to the cost base. He also accepted he was unable to demonstrate the goodwill was wholly or even partly acquired prior to 20 September 1985. He also does not dispute that any amount regarded as a discount capital gain should be included in the 2009 year of income. He does not argue the amount of gain should be spread out over 2009-2011 just because he received the payments with respect to goodwill in a series of instalments over the longer period. (That submission is consistent with s 103-10(2)(b).) But he argues the Commissioner is still wrong.
The taxpayer says one must have careful regard to clauses [25] and [26] of the partnership agreement. A copy of the agreement is reproduced in exhibit one at p 46. Clause [25] deals with the effect of retirement and the obligation on the partnership to make certain payments – in respect of amounts standing to his credit in the current account, and his shares in the goodwill and work-in-progress. Clause [26] is headed ‘SET-OFF’. It provides:
Upon the treatment or death of any Partner, any moneys owing by such partner as at retirement or death shall be determined and shall be offset against any treatment found owing to the Outgoing Partner as at the date or retirement or death.
Mr Burston argued clause [26] was significant because it had the effect of reducing the amount of the gain which was assessable in the taxpayer’s hands by the amount he owed. Mr Burston said that was appropriate in light of authorities including Chief Commissioner of Revenue of NSW v Dick Smith Holdings Pty Ltd (2003) 58 NSWLR 567 which emphasised the importance of focusing on the net effect of a contract when interpreting the individual provisions of an agreement which contemplated amounts being exchanged. (Mr Burston acknowledged Dick Smith was a stamp duty case, but he drew an analogy with this case because the legislative provision in question that required a determination of total consideration received was in broadly similar terms to s 116-20 of ITAA97.)
On this argument, it was inappropriate for the Commissioner to focus on the amounts payable under clause [25] without having regard to the set-off contemplated in clause [26]. The taxpayer says that, conceptually, clauses [25] and [26] together contemplated a running account as between the partnership and the retiring partner, with only the net amount payable under that account being the relevant amount for present purposes. Mr Burston relied on what he said was the classic judicial definition of a running account discussed in Airservices Australia v Ferrier [1996] HCA 54 (Compass Airlines case) in support of his case although he acknowledged it might be possible to regard what was agreed as a set-off like that which would be familiar to experienced litigators. It ultimately made no difference, he argued, because in either event the taxpayer’s capital gain on the goodwill was effectively cancelled out by the amount he was required to repay under clause [26].
Mr Burston and Ms Gatland both debated the application of the reasoning of Jagot J in Ellison v Sandini [2018] FCAFC 44. As it happens, I am satisfied I do not need to resolve that dispute because I am satisfied the terms and effect of the partnership deed are clear enough. Clause [25.1] says the quantum of the various payments shall be determined and those amounts ‘shall be paid’. The reconciliation contemplated in clause [26] does not occur until after the amounts payable under clause [25] have already crystallised. At that point, those amounts become the capital proceeds from the CGT event (i.e., disposal of the goodwill) within the meaning of s 116.20. The fact the amounts might thereafter be applied towards settling a debt does not matter: s 103.10 points out you are deemed to receive monies for present purposes where those monies are applied for your benefit.
Clauses [25] and [26] do not operate in the way suggested by the taxpayer. The capital proceeds from the disposition of the goodwill are determined pursuant to clause [25] and it is that figure which is relevant for present purposes.
THE TREATMENT OF WORK IN PROGRESS
The Commissioner included an amount of $131,265 in the taxpayer’s assessable income in the 2009 year but the taxpayer argued he only actually received $100,236 because the balance of $31,029 was diverted to meet the taxpayer’s other obligations pursuant to clause [26] of the partnership deed. In those circumstances, for the reasons I have already explained above, the taxpayer argued $31,029 should not have been included in the assessment in that year.
The Commissioner disagrees, and he is right. Ms Gatland started by referring to s 15.50 of the ITAA97 which provides: “Your assessable income includes a work in progress amount that you receive”. The expression ‘work in progress amount’ is defined in s 25.95(3).[2] Section 6.5(4) provides:
In working out whether you have derived an amount of * ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct.
[2] Section 25.95 (3) provides:
(3) An amount is a work in progress amount to the extent that:
(a) an entity agrees to pay the amount to another entity (the recipient ); and
(b) the amount can be identified as being in respect of work (but not goods) that has been partially performed by the recipient for a third entity but not yet completed to the stage where a recoverable debt has arisen in respect of the completion or partial completion of the work.
It follows the taxpayer in this case should be taken to have received the amount calculated under clause [25] at the point the monies came into his hands or where they were applied at his direction or for his benefit – which would mean for present purposes the point at which they were applied pursuant to clause [26]. Since that occurred in the 2009 financial year, those amounts must be included.
CONCLUSION
The objection decision is affirmed.
I certify that the preceding 24 (twenty -four) paragraphs are a true copy of the reasons for the decision herein of Deputy President Bernard J McCabe.
..........................SGD............................................
Associate
Dated: 23 December 2020
Date(s) of hearing: 8 October 2020 Counsel for the Applicant: Mr Michael Bersten Counsel for the Respondent: Ms Jill Gatland Solicitors for the Respondent: Self Represented