QT2001/442-444 and Commissioner of Taxation
[2004] AATA 349
•5 April 2004
Administrative
Appeals
Tribunal
DECISION AND REASONS FOR DECISION [2004] AATA 349
ADMINISTRATIVE APPEALS TRIBUNAL )
) No QT2001/442-444
TAXATION APPEALS DIVISION )
Re QT2001/442-444 Applicant
And
COMMISSIONER OF TAXATION
Respondent
DECISION
Tribunal Senior Member KL Beddoe Date5 April 2004
PlaceBrisbane
DecisionThe Tribunal decides:
(a)to order that the ground of objection include grounds as set out in paragraph 38 of the reasons for decision;
(b)the objection decisions relating to the assessment of taxable income are affirmed;
(c)the objection decisions relating to assessed penalty tax are set aside and the penalty tax is waived in full; and
(d)these proceedings have terminated in a manner favourable to the applicant.
…(Sgd) KL Beddoe…
Senior Member
CATCHWORDS
INCOME TAX – Assessable Income – whether pilotage fees assessable income of the company or applicant – arrangements entered defined as “scheme” – company incorporation for a legitimate purpose – objection decisions affirmed – penalty tax remitted.
Income Tax Assessment Act 1936 ss 19, 177D, 177E, 226H, 227(3)
Income Tax Assessment Act 1977 6-5(4), 6-10(3)Taxation Administration Act 1953 s14ZZK
FCT v Spotless Services Pty Ltd (1996) 186 CLR 404
BRK (Bris) Pty Ltd v FC of T [2001] ATC 4111REASONS FOR DECISION
5 April 2004 Senior Member KL Beddoe 1. The applicant seeks review of objection decisions by the respondent in relation to the years of income ended 30 June 1996, 30 June 1997 and 30 June 1998.
2. At the hearing (in camera) the applicant was represented by Mr Marks of Counsel and the respondent by Mr Robertson of Counsel. The documents lodged in the Tribunal pursuant to section 37 of the Administrative Appeals Tribunal Act 1975 were before the Tribunal as the “T” Documents and further documents were tendered and marked as exhibits. The applicant gave oral evidence on two occasions. Oral evidence was also given by his ex-wife.
3. In essence the issue before the Tribunal is whether pilotage and other fees derived from third parties are assessable income of the applicant or of a company (“O Pty Ltd”) of which the applicant is the controlling mind. Insofar as there was an issue as to management fees paid by the company, that matter was not pursued by the applicant in these proceedings.
4.Arising out of the central issue are issues as to:
(a) whether the arrangements entered into are a sham; or
(b)whether the applicant and O Pty Ltd entered into or carried out a scheme to obtain a tax benefit (section 177D Income Tax Assessment Act 1936);
(c)whether the respondent’s determination in terms of section 177F is effective to include the tax benefit in the applicant’s assessable income;
(d)in the alternative, whether income arising from the personal exertion of the applicant as a marine pilot and ship’s master is assessable income of the applicant and not the company; and
(e)whether assessed penalty by way of additional tax should be remitted in full or in part.
5. In these reasons I refer to the Income Tax Assessment Act 1936 as the “1936 Act” and the Income Tax Assessment Act 1997 as the “1997 Act”.
Findings of Fact
6.(a) The applicant is an experienced ship’s master who was approached by Queensland Coast and Torres Strait Pilots’ Association in 1993 to join the Association; the Association provided marine pilots for safe navigation of ships in the waters of the Queensland Coast, Torres Strait and New Guinea waters.
(b)On 22 June 1993 the applicant obtained a Queensland Coastal Pilot licence, under the Marine Act, to act as a Queensland Coastal Pilot for ships on the Queensland coast and Torres Strait.
(c)The applicant’s understanding as to limitation of a pilot’s liability under the Marine Act and Commonwealth legislation was uncertain but he understood that there were problems with limitation of a pilot’s legal liability in the event of accidents etc., with particular concern for liability when outside Queensland coastal waters.
(d)The Association told the applicant in 1993 that his interest in the Association should be owned by a company so as to limit any liability to claims for damage etc.
(e)In June 1993 the applicant arranged for the company to be incorporated and for that company to purchase a share in the Association as well as to seek other commercial activities which would maximise on the management skills, marine pilotage knowledge and marine contracting ability of the company’s employees.
(f)It was the applicant who had to satisfy the Queensland Marine Board in order for that Board to issue a licence to pilot ships in the Inner Great Barrier Reef, Hydrographers Passage and the Great North East Channel to the applicant.
(g)Relying on the advice of others, including professional advice, the applicant arranged for the company to be incorporated on 29 June 1993 so as to limit his liability for damages and to provide superannuation benefits.
(h)The company purchased an interest in the Association on 3 November 1993 having previously entered into an arrangement, evidenced in writing, on 6 August 1993 to provide the applicant’s services as a pilot to perform such pilotage contracts as may be allocated to the applicant by the Association acting as the agent of the applicant.
(i)The applicant signed a form (“Pilot’s Declared Availability Form”) on 6 August 1993 stating, in effect, that he made himself available to accept pilotage assignments for “all days” during the period 1 July 1993 to 30 September 1993 – the form being addressed to the Association.
(j)The applicant and his then wife were the sole shareholders, directors and employees of the company.
(k)The applicant commenced work as a pilot on 23 August 1993, i.e. after the company had commenced to carry on business.
(l)Initially there appears to have been an informal arrangement between the applicant and the Association whereby the company was assigned pilotage work to be performed by the applicant, but on or about 21 December 1995 the arrangement was formalised so that the arrangement was set out in a written contract between the company and Queensland Coastal Pilot Service Pty Ltd (T6) which included provisions to the following general effect – all based on the defined (but incorrect) supposition that the company is a marine pilot licensed under the Australian Maritime Safety Authority Act 1990 –
(i)the Queensland Coastal Pilot Service Pty Ltd (“the Pilot Service”) was to be the manager providing services for an on behalf of the pilot with particular reference to arranging vessels for pilotage and arranging for the pilot to carry out the pilotage duties;
(ii)the Pilot Service was responsible for collection of pilotage fees from owners of vessels piloted by the pilot;
(iii)the Pilot Service was to pay 90% of pilotage fees collected to the pilot and retain 10% on its own account – in Exhibit J the applicant said that as an assumed sole trader he would have received the same amount in cash as the company did from trading;
(iv)the pilot was to maintain and advise periods of readiness to undertake pilotage services to the Pilot Service;
(v)the pilot was required to send the Pilot Service all pilotage invoices when the pilotage was completed together with expenses claims;
(vi)under the agreement responsibility for payment of tax instalment deductions was said to be that of the pilot as were sickness, accident and worker’s compensation insurance premiums, the superannuation guarantee levy and leave entitlements.
(m)A further agreement was entered into, dated 1 February 1997, by the company and the Pilot Service in generally similar terms to the earlier agreement.
(n)The applicant performed the pilot duties for which the company had entered into in the above agreements.
(o)As part of the applicant’s responsibilities as a marine pilot, he was required to maintain up-to-date navigation charts and for this purpose the company employed the applicant’s then wife to undertake the updating of the charts, other purposes including office work duties and banking etc duties and driving the applicant, as required, to the airport.
(p)The applicant’s then wife did not perform any duties directly relevant to the duties of a marine pilot and in particular the duties undertaken by the applicant except in relation to updating of navigation charts as required.
(q)From time to time the applicant also did work as a ship’s master and other work on behalf of the company which treated the fees derived as part of its assessable income (Exhibit 2 and Exhibit 3).
(r)The company conducted its own bank account and payments received in respect of work actually performed for the company by the applicant was deposited in the company’s bank account.
(s)Each year the company paid “salaries” to the applicant and his wife on a distribution basis i.e. drawings were made during the year and the actual amount of the salary was determined at the end of the year (Exhibit E and Exhibit F).
(t)The Association appears to have standard pilotage fees for intermediate coastal voyages for each Queensland port (Exhibit B).
(u)I accept as a fact that the applicant received advice that satisfied him that he should operate the pilotage business through a company – something he would not have done if he had continued as a ship’s master whether as an employee or as a contractor.
(v)If it is relevant, I do not accept that the company would have been required to employ another person if it had not employed the applicant’s former wife because it is not apparent that the work done by the applicant’s wife could not be done by the applicant personally, given his expertise and first hand knowledge of the work ancillary to the primary function of ship’s pilot, on the one hand, and the essentially private nature of activities such as driving the applicant to the airport on the other hand.
(w)While the applicant sought to distinguish the legal obligations of a marine pilot from the legal obligations of a ship’s captain, I am not satisfied that the distinction is anything more than a distinction without a difference – if either is negligent then in general terms liability for damages may well arise in either occupation.
(x)The applicant established the company because, on the basis of informal advice from the Association and other pilots, he was satisfied that he needed to protect his personal liability, particularly in respect of work done outside Australian waters, and incorporation of a company to be the contractor was said to be the way of achieving protection from personal liability as contended by other marine pilots.
(y)The applicant did not seek specific legal advice on the incorporation of the company.
(z)I am satisfied that the applicant made the arrangements to carry on the business of marine pilot through the company because he understood that was the way things were done by marine pilots in relation to the Association on which they depended for their work.
7. The applicant was cross-examined about his arrangements in 2000 and 2001. On reflection I have decided this evidence is not relevant to the issues before the Tribunal and I have not taken it into account.
Consideration
8. For reasons set out below I am satisfied that the issue is whether there was a scheme to which Part IVA of the 1936 Act applies.
9. Part IVA applies to any scheme that has been entered into after 27 May 1981 or commenced to be carried out after that date. Section 177D makes Part IVA applicable where the following criteria are satisfied:
“(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).”
10. “Scheme” is defined in section 177A(1) to mean:-
“(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.”
11. Sub-section 177A(3) provides, in effect, that the definition of scheme extends to a unilateral scheme, plan, proposal, action, course of action or course of conduct as the case may be.
12. “Tax benefit” is relevantly to be read as a reference to an amount not being included in the assessable income of the taxpayer where that amount would have been included, or might reasonably be expected to have been so included if the scheme had not been entered into or carried out (sub-section 177C(1)).
13. Section 177F confers a discretion on the respondent to cancel a tax benefit by making a determination in writing, that the whole or part of a tax benefit, referable to an amount not being included in the assessable income, shall be included in the assessable income of the taxpayer of a year of income.
14. Sub-section 177F(3) provides for compensating adjustments for amounts included in assessable income which would not have been included if the scheme had not been entered into.
15. While it can be accepted that things may have been done differently if the applicant and the company had better professional advice, I do not accept that the documents in relation to the company were not intended to have legal effect.
16. On the balance of probabilities I am satisfied that the arrangements in relation to the company were not based on sham documents, i.e. documents intended only to disguise the real transactions or to create a facade or false front. To paraphrase an assertion for the applicant, it is unreasonable to expect practical men of the sea to contract in terms settled by a Chancery Silk. Rather, this is the realm of printed form documents and salt spray. Whatever there limitations, the documents were intended to have effect. In particular, it was intended that the company carry on a business of supplying the services of a licensed marine pilot as arranged by the Association; not that the company itself was a licensed marine pilot as asserted in some inappropriately worded documents.
17. I am satisfied that there was no intention to represent the company as a licensed marine pilot and the relevant persons understood the company to not be so licensed and that it was the applicant who performed the work as marine pilot and ship’s master for which he was appropriately licensed. It follows, in my view, that the applicant thereby also had personal obligations in relation to his work as a marine pilot and ship’s master because he was the licensed person. In his oral evidence the applicant confirmed that he did not represent that the company was the licensed pilot (transcript page 49).
18. However, I am satisfied on the balance of probabilities that the applicant arranged for the company to be incorporated (purchased as a shelf company) and for it to be interposed as the entity supplying pilotage services because he was satisfied he would thereby limit, in particular, any potential liability at law arising from extra-territorial work as a marine pilot. In Exhibit 1, Mr Hoiberg says the company was incorporated as a vehicle to minimise business risk from the marine association as well as to provide a corporate vehicle. I do not understand that evidence to be inconsistent with my finding.
19. During the years of income before the Tribunal, the applicant and the company conducted their affairs on the basis that it was the company that had contracted to supply marine pilot services. I am also satisfied, on the balance of probabilities, that was also the understanding of the Association.
20. It follows, in my view, that the assessable income was derived by the company because the company had contracted to supply the service and the income was derived when that service was provided. In these circumstances actual receipt, at some later time, of payment for the service supplied is not relevant to determining derivation of income. Insofar as the respondent asserts that section 19 of the 1936 Act and sub-sections 6-5(4) and 6-10(3) of the 1997 Act (Division 86 not relevant to the year of income before the Tribunal) are relevant, I am not satisfied those provisions have any operation on the facts of this case because it was the company that contracted to supply the service.
21. I have proceeded to this point on the basis that there was a contract of service between the applicant and the company and valid contracts for service between the company and the Association (and other third parties) by which the company derived assessable income.
22. The respondent made submissions about the legality of some of these contracts on the basis that they were in breach of the Navigation Act. I have not come to any view about these submissions because it is unnecessary to do so to decide this matter.
23. In relation to Part IVA the respondent, somewhat belatedly, asserted that there are two separate schemes as defined – a broad scheme and a narrow scheme.
24. The broad scheme is said to be the arrangement whereby the company was interposed between the applicant and the Association (and other contractors). If the company had not been interposed it would be reasonable to expect that the pilotage and master mariner fees would have been derived by the applicant personally.
25. On the facts of this case I am satisfied that it is not open to find that those fees would not have been derived by the applicant if the company had not been interposed (see FCT v Spotless Services Pty Ltd (1996) 186 CLR 404 at 423-4).
26. I am satisfied that it is sufficient that the amount of pilotage fees and master mariner fees derived by the company in each year of income might reasonably have been included in the applicant’s assessable income if the company had not been interposed.
27. The respondent also asserts that there is a narrow scheme which assumes that the income was derived by the company but relates to the arrangements within the company whereby a relatively small salary was paid to the applicant and a salary paid to the applicant’s then wife who was the other director and shareholder. This narrow scheme looks to the net income of the company and the respondent asserts there was a tax benefit because that net income was not paid to the applicant for his service. The applicant was paid a salary considerably less than the net income, part of which was paid to the applicant’s then wife and part of which was retained in the company.
28. The respondent has not assessed the applicant on the basis of the narrow scheme. The narrow scheme can only be relevant if I am satisfied that the broad scheme does not apply.
29. I therefore return to the broad scheme to determine whether the criteria in section 177D have been satisfied.
30. I am satisfied that in each year of income the applicant obtained a tax benefit in connection with the interposition of the company which I am satisfied was an arrangement within the definition of “scheme”. The applicant obtained the tax benefit because fees included in the company’s assessable income might reasonably have been included in the applicant’s assessable income if he had not entered into the arrangement to interpose the company.
31. The scheme was entered into for purposes that included the purpose of seeking to ensure that the applicant was not the entity deriving the income and therefore the person liable in the event of claims for damages. It is clear enough that the company was incorporated for the purpose of interposing it between the applicant and potential customers on a long term basis and with the intention of ensuring the fees were not derived by the applicant with the consequence that the applicant’s assessable income was dramatically reduced and the company’s assessable income increased.
32. The readily apparent consequence of the arrangement was that the applicant obtained a tax benefit.
33. I can see no basis for interfering with the respondent’s compensating adjustments.
34. In the result, I am not satisfied that the relevant assessments are excessive and I will affirm the relevant objection decisions.
35. In relation to penalties, the respondent asserts that section 226H of the 1936 Act applies on the facts of this case.
36. In BRK (Bris) Pty Ltd v FC of T [2001] ATC 4111 at 4129, Cooper J considered the operation of section 226H as being applicable in circumstances described at paragraph 77 as follows:
“77. In s 226H of the Act the recklessness of the taxpayer, or of a registered tax agent, must be with regard to the correct operation of the Act. In the context of s 226H, the definitions in s 222A(1) to which reference has been made, and Part VII of the Act generally, it is necessary in my view that the conduct which gives rise to the tax shortfall must be reckless as to whether or not the Act or regulations will operate correctly so as to lead to an assessment of the proper tax payable by a taxpayer. Recklessness in this context means to include in a tax statement material upon which the Act or regulations are to operate, knowing that there is a real, as opposed to a fanciful, risk that the material may be incorrect, or be grossly indifferent as to whether or not the material is true and correct, and that a reasonable person in the position of the statement-maker would see there was a real risk that the Act and regulations may not operate correctly to lead to the assessment of the proper tax payable because of the content of the tax statement. So understood, the proscribed conduct is more than mere negligence and must amount to gross carelessness.”
37. So instructed, I am satisfied the section does not operate, on the facts of this case because the applicant, and his tax agent, entered into an arrangement and reported that arrangement on the basis that it was the normal practice for Torres Strait pilots to interpose a company between themselves as individuals and their customers.
38. Section 226 clearly applies on the basis that there is a determination in terms of Part IVA in relation to each year of income. The applicant’s objections are deficient in that no objection was taken to the assessment of penalty. The applicant’s statement of facts and contentions includes the following:
“59.The penalty has been imposed under s226, on the basis that Part IVA applied. This cannot have been the case, as the respondent supports the assessment on the basis that the income in question was simply that of the applicant. Part IVA is simply posed as an alternative means of supporting the assessment.
60.In light of this anomaly, the imposition of penalty ought be set aside.”
39. That was said in response to the respondent’s contention asserting that penalties had been imposed correctly and there is no cause for the remission or further remission pursuant to sub-section 227(3) of the 1936 Act. I am satisfied that the question of penalties was in issue before me. However, to formalise the matter I will order that paragraphs 59 and 60 as set out in paragraph 38 above be treated as if they are grounds of objection (section 14ZZK – Taxation Administration Act 1953).
40. Because I am satisfied that the applicant was at all relevant times primarily seeking to fall into line with what he understood to be established practice for Torres Strait pilots working through the Association I am satisfied that the assessed penalty should be remitted.
41. The objection decisions are affirmed as to assessment of taxable income but varied so as to remit the assessed penalty tax pursuant to sub-section 227(3) of the 1936 Act. These proceedings have terminated in a manner favourable to the applicant.
I certify that the 41 preceding paragraphs are a true copy of the reasons for the decision herein of Senior Member KL Beddoe
Signed: Sam Appleton.
Associate
Date/s of Hearing 13 and 16 December 2002; 9 July 2003
Date of Decision 5 April 2004Counsel for the Applicant Mr Marks
Solicitor for the Applicant McCullough Robertson
Counsel for the Respondent Mr Robertson
Solicitor for the Respondent ATO Legal Practice
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