Reynolds Wines Limited and Commissioner of Taxation
[2010] AATA 121
•16 February 2010
Administrative Appeals Tribunal
DECISION AND REASONS FOR DECISION [2010] AATA 121
ADMINISTRATIVE APPEALS TRIBUNAL )
) Nos: NT2004/215, 370; and
TAXATION APPEALS DIVISION ) NT2005/281, 314
ReREYNOLDS WINES LIMITED (RECEIVER AND MANAGER APPOINTED) (IN LIQUIDATION)
Applicant
And COMMISSIONER OF TAXATION
Respondent
DECISION
TribunalMr S E Frost, Senior Member
Date16 February 2010
PlaceSydney
DecisionThe objection decisions are affirmed.
..................[sgd]............................
S E Frost
Senior Member
CATCHWORDS
TAXATION AND REVENUE – income tax – investment scheme – farm and management fees – derivation of income – Part IVA – whether compensating adjustment should be made where deduction claims of investors disallowed – objection decisions under review are affirmed
Income Tax Assessment Act 1936 (Cth): s 177F
Income Tax Assessment Act 1997 (Cth): s 6-5
Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation (1965) 114 CLR 314
Australian Tea Tree Oil Research Institute Ltd (in liq) v Commissioner of Taxation [2008] FCA 1653
Business & Research Management Ltd (in liq) v Commissioner of Taxation (2008) 173 FCR 204
Commissioner of Taxes v Executor Trustee and Agency Co of South AustraliaLimited (1938) 63 CLR 108
Commissioner of Taxation v Hart (2004) 217 CLR 216
FCT v Lenzo (2008) 167 FCR 255
Finance Facilities Pty Limited v Commissioner of Taxation (1971) 127 CLR 106
Re Sharkey and Commissioner of Taxation [2007] AATA 1435; (2007) 95 ALD 509
Vincent v Commissioner of Taxation (2002) 124 FCR 350
REASONS FOR DECISION
16 February 2010
Mr S E Frost, Senior Member
The applications
1. The applicant, Reynolds Wines Limited, has applied to this Tribunal for review of certain objection decisions by the respondent (the Commissioner) concerning the quantum of income derived by the applicant from farm fees and (indirectly, as beneficiary under a trust) management fees in the 1998 and 1999 financial years and, depending on the answer to that question, whether the applicant should receive the benefit of a compensatory adjustment under s 177F(3) of the Income Tax Assessment Act 1936 (the 1936 Act).
2. There are four applications before the Tribunal:
(a)NT2004/215 relates to the derivation of income by the applicant in the year ended 30 June 1998. The applicant lodged its notice of objection to the assessment on 23 April 2003, and the Commissioner rejected that objection on 11 June 2004. The applicant applied to this Tribunal for review of that decision on 9 August 2004.
(b)NT2004/370 relates to the derivation of income by the applicant in the year ended 30 June 1999. The objection to assessment was lodged on 2 September 2004 and decided on 25 October 2004. The applicant applied to this Tribunal for review of that decision on 22 December 2004.
(c)NT2005/281 relates to the applicant’s request for a compensating adjustment under s 177F(3) of the 1936 Act in relation to the financial year ended 30 June 1998. The request was rejected and the applicant’s objection against that rejection was disallowed. The applicant applied to this Tribunal for review of the objection decision on 28 June 2005.
(d)NT2005/314 concerns the applicant’s request for a compensating adjustment under s 177F(3) of the 1936 Act in relation to the financial year ended 30 June 1999. This request was also rejected, and the applicant’s objection against the rejection was disallowed. The applicant applied to this Tribunal for review of the objection decision on 9 August 2005.
3. The essential facts of the applications are not in dispute.
Basic facts
4. The basic facts are summarised in the respondent’s findings of fact in the decisions under review and I have drawn on them in paragraphs 5 to 21. The working of Project 3 (see below) is also outlined in the decision of this Tribunal (Mr Fice, Member) on an application by an investor participant: Re Macpherson and Commissioner of Taxation (2007) 65 ATR 702.
5. The applicant is the controlling entity of the Reynolds Wines group and held 100 percent of the share capital of Central Highlands Management Limited (CML) (the manager of Central Highlands Wine Grape Project Nos 1 and 2 and the trustee of the unit trusts that were settled to manage projects 3 and 4). CML in turn held 100 percent of the share capital of CH Finance Pty Ltd (CHF), the financier of the participants in projects 3 and 4.
6. The applicant was known as Snowleaf Pty Ltd until 9 April 1999, when the company changed its name to Cabonne Limited before listing on the Australian Stock Exchange in May 1999. The company name was changed to Reynolds Wines Limited in June 2002.
7. The applicant is the registered owner of the property known as “Little Boomey”, the property upon which the vineyards were established for projects 1 to 3. The applicant also holds a 50 percent interest in the sub-lessor of “Wirrilla” and a 50 percent interest, as tenant in common, in “Angullong” which were properties upon which vineyards were established for project 4. Only projects 3 and 4 are relevant to the applications before the Tribunal.
8. CML is the trustee of the Central Highlands Management Unit Trust (CHMUT), the manager of project 3, and is the trustee of the Central Highlands Management-Wirrilla Unit Trust (CHMWUT), the manager of project 4. The applicant holds 100 percent of the capital units in CHMUT, which in turn holds 100 percent of the units in CHMWUT. For the 1999 income year, CHMWUT distributed net income of $19,838,716 to CHMUT.
9. Participants (known as “farmers”, though they were not farmers in the literal sense) in projects 3 and 4 completed a principal agreement under which they agreed to become a party to and be bound by a farm agreement with the applicant, a management agreement with CML and, where applicable, a loan deed.
10. In respect of the 1999 income year, management fees were payable by the participants to CML as trustee for CHMUT for project 3 and as trustee for CHMWUT for project 4. The distribution by CHMWUT to CHMUT included management fees derived by CHMWUT. The eventual distribution by CHMUT to the applicant thus included management fees derived by CHMUT and CHMWUT.
11. The farm fees payable by the participants were payable direct to the applicant.
12. The participants in the projects were provided with the option of applying for a loan from CHF by completing a loan application form and loan deed. Nearly all participants entered into the loan deed, whereby the participants authorised the lender to pay the first three years’ management fees and farm fees to the manager and the landowner respectively.
13. There was a “round-robin” arrangement between the main parties involving the flow of management fees and farm fees. The round-robin arrangement involved a bill of exchange facility, which was effected in the books of the various parties by a series of general journal entries.
14. The lender did not have sufficient funds to pay the management fees to CML, as trustee for CHMUT and CHMWUT (the unit trusts). To enable the lender to pay the management fees to CML and the farm fees to the applicant, the lender borrowed monies via bills of exchange.
15. A bill of exchange was prepared based on the total amount of each loan settlement (related to loans borrowed by a group of participants in the projects). Each bill of exchange was drawn by the lender and payable to CML, with an associated company, Jamesgate Finance Pty Limited (Jamesgate), being the acceptor. Pursuant to a bill of acceptance facility agreement between the lender and Jamesgate, an acceptance notice was drawn up whereby Jamesgate agreed to pay up to the face value of various bills of exchange to CML.
16. Pursuant to a deposit agreement between CML and the lender, all the management fees borrowed by the participants were deposited back with the lender. This was achieved by each bill of exchange being endorsed by CML, that is, CML agreed to pay the specified amount back to the lender. Pursuant to a further deposit agreement between the lender and Jamesgate, the same amount was deposited back with Jamesgate and was to be set off against the liability owed by the lender to Jamesgate under a set-off agreement between Jamesgate and the lender. At that point, the bill of exchange was cancelled. Each bill of exchange was drawn and cancelled within two minutes.
17. The unit trusts adopted the accrual basis of accounting. The management fees payable in advance by the participants were accounted for by the unit trusts as deferred management income when receivable and brought to account in the following year when the management services were performed. For tax purposes, the management fees were also included in the assessable income of the unit trusts in the following year, in accordance with the principle in Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation (1965) 114 CLR 314. In this instance, the management fees included in the assessable income of CHMUT in the 1999 income year primarily related to the management fees claimed by participants in the 1998 income year in relation to project 3. The management fees included in the assessable income of CHMWUT in the 1999 income year related to management fees payable by participants in the 1998 income year in relation to project 4.
18. The applicant also adopted the accrual basis of accounting in relation to the farm fees payable by participants.
19. The Commissioner disallowed the deductions claimed by the participants in projects 1 to 4 in respect of management fees and farm fees.
20. The Commissioner has since settled, with the majority of investors in the projects, the tax disputes arising from the disallowance of the deductions for management fees and farm fees. The primary basis for settlement was that a deduction would be allowed for certain cash amounts outlaid by the investors in respect of their participation in the projects.
21. The majority of cash outlays made by the investors in the projects comprised repayments of principal and interest under the loans with the project lenders. Under this cash basis of settlement, the Commissioner has treated these cash outlays as being in substance payments of management fees and farm fees. It was only these funds that were available to be used in the vineyard operations.
22. The applicant lodged its tax returns for the 1998 and 1999 years of income on the basis that the whole amount of the management fees (derived by the respective manager of the unit trusts, as trustee) and farm fees were included in the applicant’s assessable income.
23. However, the applicant now argues that the effect of the above financing arrangements was such that:
· the full amount of the management fees should not have been included in the net income of the CHMUT and the CHMWUT (as the full amount of the management fees was not derived by the manager, as trustee); and
· the full amount of the farm fees should not have been included in the applicant’s assessable income (as the applicant did not derive the full amount of the farm fees).
24. In the alternative, the applicant argues that it should be entitled to a compensating adjustment under s 177F(3) of the 1936 Act to reduce the amount of the management and farm fees income by amounts in excess of the fees that were equivalent to the recourse portion of the loan.
25. The practical outcome, in either case, would be that the amount to be treated as management fee income by the manager of the trust, and as farm fee income by the applicant itself, would be no more than the total of the amounts allowed to the farmers as deductions in respect of each category. In fact, the Reynolds Wines group made a settlement proposal to the Australian Taxation Office (ATO) to treat the management fee income and the farm fee income on this “symmetrical” basis. On 15 June 2001, the Reynolds Wines group was informed that the ATO did not consider the symmetrical basis to be an appropriate basis of settlement.
Issue 1 – the “derivation of income” issue
26. Assessable income includes ordinary income “derived” by a taxpayer during the year of income: s 6-5 of the Income Tax Assessment Act 1997 (the 1997 Act).
27. The question of when income is “derived” is determined by using a method of tax accounting which, in the circumstances, is “calculated to give a substantially correct reflex of the taxpayer’s true income”: Commissioner of Taxes v Executor Trustee and Agency Co of South Australia Limited (1938) 63 CLR 108 (Carden’s case). There are two basic methods of tax accounting: the “receipts” or “cash” basis and the “earnings” or “accruals” basis. Under the receipts basis, income is not derived until it has been received by the taxpayer. Under the accruals basis an amount is derived when it becomes “due” to the taxpayer.
28. Carden’s case required a decision to be made as to which of these rival methods was the correct one for the particular taxpayer. The current case requires no such decision to be made, since the parties agree that the accruals basis is the correct one for this taxpayer. Instead the issue is how much income should be declared under the accruals basis, and in relation to that issue both parties turn to what Dixon J said in Carden’s case to support their positions.
29. At 63 CLR 154-155 his Honour said:
… Unless in the statute itself some definite direction is discoverable, I think that the admissibility of the method which in fact has been pursued must depend upon its actual appropriateness. In other words, the inquiry should be whether in the circumstances of the case it is calculated to give a substantially correct reflex of the taxpayer’s true income. We are so accustomed to commercial accounts of manufacturing or trading operations, where the object is to show the gain upon a comparison of the respective positions at the beginning and end of a period of production or trading, that it is easy to forget the reasons which underlie the application of such a method of accounting to the purpose of ascertaining taxable income. Although the field of profit-making which it covers in practice is probably much greater than any other among the manifold forms of income or revenue, it is a system of accounting which does not represent the primary or basal position from which an investigation of income for taxation purposes begins. Speaking generally, in the assessment of income the object is to discover what gains have during the period of account come home to the taxpayer in a realized or immediately realizable form. …
30. The applicant in its written submissions (Applicant’s Outline of Submissions, or “AOS”) focused on the reference in that passage to the concept of amounts having “come home”, and provided the following passage from Arthur Murray (NSW) Pty Limited v Federal Commissioner of Taxation (1965) 114 CLR 314 at 318 to explain the meaning of the expression:
The word “gains” is not here used in the sense of the net profits of the business, for the topic under discussion is assessable income, that is to say gross income. But neither is it synonymous with “receipts”. It refers to amounts which have not only been received but have “come home” to the taxpayer; and that must surely involve, if the word “income” is to convey the notion it expresses in the practical affairs of business life, not only that the amounts received are unaffected by legal restrictions, as by reason of a trust or charge in favour of the payer - not only that they have been received beneficially - but that the situation has been reached in which they may properly be counted as gains completely made, so that there is neither legal nor business unsoundness in regarding them without qualification as income derived.
The ultimate inquiry in either kind of case, of course, must be whether that which has taken place, be it the earning or the receipt, is enough by itself to satisfy the general understanding among practical business people of what constitutes a derivation of income. A conclusion as to what that understanding is may be assisted by considering standard accountancy methods, for they have been evolved in the business community for the very purpose of reflecting received opinions as to the sound view to take of particular kinds of items. … (emphasis as provided by the applicant in its submissions)
31. Arthur Murray was itself a special case, concerned with the question whether amounts had been derived as income by the taxpayer when it received them from its customers, even though the services for which the amounts were paid had not yet been provided. It could therefore be described as a “receipt without earning” case, and it is in that light that one must view the reference, in the second quoted sentence, to the need for amounts to have “come home” before they are properly regarded as income derived. The case stands for the proposition that amounts will not have been derived, even though received, if they have not been earned.
32. The applicant argued at [66]-[69] of AOS:
[66]Similarly, in Permanent Trustee Company of New South Wales Ltd v Federal Commissioner of Taxation (Prior’s case) [(1940) 6 ATD 5 at 12-13] the High Court, in a case where subordinate security for an obligation to pay interest was given by the debtor, said in rejecting the Commissioner’s submission that the interest had thereby been derived by the creditor by virtue of section 19 of the 1936 Act:
The object [of s 19] is to prevent a taxpayer escaping tax though his resources have actually been increased by the accrual of the income and its transformation into some form of capital wealth or its utilization for some purpose. If when the deceased entered into the deed of dissolution of partnership he had obtained an investment for the moneys due to him including interest adequate to cover it providing him with the equivalent in a capital form of everything due to him the case might not have been very different from that of a man who obtains a cheque for interest from the debtor and hands it back to him as part of a new investment on fixed mortgage on adequate security. But here the facts show that the deceased got nothing except a new obligation to pay in exchange for an existing obligation to pay. He was no nearer getting his money or of transferring it into anything of value. His debtor could neither pay nor secure payment of the debt to him except by charging it on property already heavily mortgaged and quite incapable of producing a surplus out of which the amount representing interest could be paid. To see whether income has been derived one must look to the realities. Usually payment of interest by cheque involves a receipt of income but payment by a valueless cheque does not. [underlining provided by the applicant]
[67]The foregoing passage was cited with approval by Gibbs J (as his Honour then was) in Brent v Commissioner of Taxation [(1971) 125 CLR 418 at 430]. His Honour also said [at 427-428]:
The Act does not define the word ”derived” and does not establish a method to be adopted as a general rule to determine the amount of income derived by a taxpayer, although particular situations not relevant to the present case are dealt with. The word ”derived” is not necessarily equivalent in meaning to ”earned”. ”Derive” in its ordinary sense, according to the Oxford English Dictionary, means ”to draw, fetch, get, gain, obtain (a thing from a source)”. It has become well-established that unless the Act makes some specific provision on the point the amount of income derived is to be determined by the application of ordinary business and commercial principles and that the method of accounting to be adopted is that which ”is calculated to give a substantially correct reflex of the taxpayer’s true income” ... [underlining provided by the applicant]
[68]Reference also may be made to the observations of Callinan J in Commissioner of Taxation v McNeil [(2007) 229 CLR 656] where his Honour said [at 672]:
In my view the character of a payment for the purposes of the statutory definition of income, that is, “income according to ordinary concepts”, is not always to be, indeed cannot always be, determined simply and solely by reference to its quality in the hands of a recipient. I do not take GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation and the other cases referred to in the reasons for decision there, to be denying reference to the full circumstances leading to the receipt in the hands of the taxpayer. It will usually only be by reference to a transaction as a whole that the quality of a receipt, otherwise perhaps even unintelligible, will begin to be able to be ascertained. In GP International this Court was dealing with an argument that a receipt was disbursable by the taxpayer and should not for that reason be treated as income, and was not enjoining courts in the future from examining the whole of a transaction to identify the quality of a receipt. [footnote not included, underlining provided by the applicant]
[69]The gravamen of these authorities is, it is submitted, that the question whether a receipt, or the right to receive an amount in the future, is to be regarded as income in a particular period is not necessarily determined by merely looking at the juristic form of a transaction or transactions and the legal rights purportedly conferred by the documents evidencing that or those transactions. Rather, not unlike the enquiry necessary to determine whether an outgoing is made on revenue or capital account, it is necessary in some cases to take into account the whole factual matrix of the taxpayer’s activities, including any wider or composite transaction of which the receipt, or the right to receive an amount in the future, forms part[1].
[1] Dickenson v Federal Commissioner of Taxation (1958) 98 CLR 460 at 482; Reuter v Federal Commissioner of Taxation 93 ATC 5030 at 5036 – 5037; Macquarie Finance Ltd v Commissioner of Taxation (2005) 146 FCR 77 at [109-111], [169-170], [251-3]: Federal Coke Co Pty Ltd v. Federal Commissioner of Taxation (1977) 34 FLR 375 at 385; Commissioner of Taxation v Cooling (1990) 22 FCR 42 at 53 and Business& Research Management Ltd (in liq) v Federal Commissioner of Taxation (2008) 173 FCR 204
33. The argument was then developed in the following way:
· one should not analyse only the legal form of transactions, but should have regard also to the “whole matrix of facts and circumstances surrounding the transactions themselves” (AOS [74]);
· the bills of exchange were not “unconditional” orders in writing, and were therefore not true bills of exchange (see s 8(1) of the Bills of Exchange Act 1909 (Cth)), because CHF only agreed to make loans to the farmers on condition that CML lodged with CHF a security deposit for each loan to a farmer made pursuant to a loan deed (AOS [82]);
· an inference should be drawn that CHF had limited financial liquidity and was not in a position to make a cash advance to the investors, nor to pay cash amounts to CML on behalf of investors for farm fees and management fees (AOS [83]);
· an inference should be drawn that in these circumstances CHF entered into arrangements with the applicant, CML and Jamesgate under which CHF drew a series of bills of exchange on the understanding that they would be accepted by Jamesgate and then endorsed to CML (AOS [84]);
· an inference should be drawn that the pieces of paper brought into existence were not intended to operate as enforceable negotiable instruments (AOS [89]);
· the arrangements not only demonstrate that the payments were never intended to constitute counterbalancing set-offs of credit and debit amounts, they were such that the so-called bills of exchange were of no legal effect and a nullity (AOS [95]).
34. The consequence, according to AOS [96], is that:
… none of the entries made in the accounts of the relevant parties correctly reflected the financial position of the parties. It follows that accounts and tax returns prepared on this basis are also incorrect. It also follows that the only amounts which “came home” to the Applicant is the payments it received from the cash payments made by the Investors.
35. The submissions continued at [98]:
Alternatively, if the Tribunal finds that the bills of exchange were intended to and did have some legal effect, it is noted that a bill of exchange is a form of property (that is, a negotiable instrument) but it is not cash. In these circumstances section 21 of the 1936 Act provides that where the consideration for a transaction [is] not cash the money value of the property (in this case the bill of exchange) is deemed to have been paid or given. This calls for an assessment of the “fair value” of the bill.
36. At [103], the applicant submitted:
As a consequence of these matters, all forming part of the whole matrix of facts and circumstances surrounding the transactions themselves, the Applicant submits that the accounts prepared for the Management Trust, the Wirrilla Trust and the Applicant did not reflect the true position as to what was likely to “c[o]me home” as income to the Applicant. Once the fact that it was not probable that any profits from Farms would eventuate, the practical reality of the situation was that the only amount that would ever be received by the Applicant in respect of Farm Fees and Management Fees was limited to the cash payments made by the Farmers. Certainly they were the only amount to “come home” to the taxpayer in those years. (my emphasis)
37. This is not a mere slip on the part of the author of the submissions. It is, in my view, an accurate representation of what the author regards as the proper test to determine the amount of income that has been derived. However, the question is not what was likely to come home but what had in fact come home. In this regard, the submissions of the Commissioner perhaps put it most succinctly (Respondent’s Outline of Submissions, or “ROS”; some references omitted):
[36] Under the Farm Agreement, Farm Fees are paid in consideration for the grant of the right to farm wine grapes.
[37] Under the Management Agreement the Manager promises to perform, inter alia, all of the farmer’s obligations under the Farm Agreement in consideration for payment of remuneration.
[38] Farm Fees and Management Fees are paid in advance of the respective obligations of the Applicant under the Farm Agreement and CHM under the Management Agreement.
[39] Payment in advance of the performance of services leads to derivation of income by an accruals basis taxpayer as the services are performed: Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation (1965) 114 CLR 314 at 319.
[40] Parsons at [11.52] (Income Taxation in Australia, LBC, 1985) describes the “right to a receivable” as describing derivation by an accruals basis taxpayer. If services are performed and the taxpayer asserts a right to a reward there will be an immediate derivation.
[41] The Farm Fees and the Management Fees are earned during the course of the year in which the farm is made available (in the case of farm fees) and the services are performed (in the case of management fees) irrespective of whether or not the payment is collected.
[42] The above principles are entirely consistent with the judgments of Edmonds J in [Business & Research Management Ltd (in liq) v Commissioner of Taxation (2008) 173 FCR 204 (the BARM case)] and [Australian Tea Tree Oil Research Institute Ltd (in liq) v Commissioner of Taxation [2008] FCA 1653 (the ATTORI case)]: see BARM at [111].
[43] It is not in dispute in the present case that the Applicant and CML as trustee of the Unit Trusts were assessable on an accruals basis, and that the accruals method would give “a substantially correct reflex of the taxpayer’s income”.
[44] As an accruals basis taxpayer, the Applicant derived amounts as income at such time or times as debts became due to it, even though such amounts may not yet have been paid.
[45] The consequence of those considerations is that the point of time at which the Manager of the Unit Trusts derived the Management Fees, and the Applicant derived the Farm fees (subject to the operation of the Arthur Murray principle) was the time at which those management fees became due to the Manager and the Applicant. As a result, neither the time at which payment was made, nor the mode by which payment was made, were matters which affected the derivation of the fees as income.
38. Two of the cases referred to in ROS [42] are BARM and ATTORI, the circumstances of the first of which, at least, bear what the applicant describes as “more than a passing resemblance” (AOS [112]) to those in the present proceedings. Indeed, many of the individuals involved in the Budplan scheme at the heart of the BARM case were involved also in structuring the Central Highlands Wine Grape projects.
39. In BARM, Edmonds J held at [126]:
In conclusion, my view is that, consistent with BARM being an accruals basis taxpayer, the income represented by the management fees was derived by BARM when those fees fell due; or, in the case of fees which related to the provision of services in a year of income after the year in which the fees fell due, consistent with the principle that comes out of Arthur Murray, in the year of income in which those services were provided. …
40. Mr Fraser, who appeared for the taxpayer in the current proceedings, sought to distinguish BARM on several grounds, but I do not agree that the case is distinguishable. His attacks on the validity, efficacy and value of the bills of exchange are, with respect, irrelevant, for they focus not on the derivation of the management fees and the farm fees, but rather on the means by which the right to receive those fees was discharged.
41. For the same reason, there is no substance in the argument based on s 21(1) of the 1936 Act, which provides:
Where, upon any transaction, any consideration is paid or given otherwise than in cash, the money value of that consideration shall, for the purposes of this Act, be deemed to have been paid or given.
42. That may be an issue in relation to how much the recipient of the bill of exchange received; it has nothing to do with the question as to how much income the recipient derived.
43. During the hearing there was a considerable amount of evidence given by various experts, including:
· Mr David Sinclair, Dr David Jordan, Mr Robert Paul, Mr Ian Struthers and Mr Bradley Higgs, for the taxpayer; and
· Mr Wayne Lonergan, for the Commissioner.
44. Mr Sinclair and Mr Lonergan gave expert accounting evidence but, with great respect to both of them, I found their evidence of little assistance on the question of income derivation. I should note that, in my view, Mr Sinclair’s approach, described as one of “substance over form”, does, as Mr McGovern SC for the Commissioner suggested, conflate the two distinct transactions involved here – the first being the performance of the services (which gives rise to the entitlement to the fees) and the second being the payment for those services under the deposit agreement. The proper approach is to recognise, as income derived, the quantum specified in the farming agreement or the management agreement.
45. Mr Higgs gave evidence about the value of the bills of exchange, and I found that evidence to be of little assistance.
46. Dr Jordan is a viticultural consultant who reported on the reasonableness of the projected grape yields and the projected income as set out in the project prospectuses. Mr Paul, who has extensive experience as a winemaker and as an adviser to wine businesses, reported on the likely profitability of the projects. Mr Struthers, the receiver and manager appointed for Reynolds Wines Limited, was able to provide information on the actual plantings of grapes in projects 3 and 4, and certain financial information in relation to both projects over several years. At the end of the day I found this evidence to be of marginal relevance and assistance.
47. On the first issue, the income derivation issue, I agree with the thrust of the Commissioner’s submissions as set out in [37] above. There is no reason why the conclusion in this case should be any different from the conclusion drawn by Edmonds J in BARM. It follows that the objection decisions are correct insofar as they relate to the quantum of income derived.
Issue 2 – the “compensating adjustment” issue
48. The Central Highlands Wine Grape Projects 3 and 4 were identified by the Commissioner as mass marketed investment schemes which had the potential to be caught by Part IVA of the 1936 Act (the so-called general anti-avoidance provisions). For that reason the Commissioner made determinations under s 177F(1) (which is within Part IVA) to disallow the deductions claimed by farmers in respect of management fees, farm fees and associated amounts.
49. Those determinations (which were made in the case of almost every farmer) might be regarded as “protective” or “precautionary” determinations because, as appears from the affidavit of Jeffrey Walter Bartley, one of the Commissioner’s officers (Exhibit R5), the farmers’ deduction claims were denied on alternative bases:
· one, that the amounts were not deductible under either s 51(1) of the 1936 Act or s 8-1 of the 1997 Act; or
· in the alternative, if the amounts were so deductible, then the whole of the amount of the deductions were tax benefits which were liable to be cancelled pursuant to Part IVA of the 1936 Act.
50. The Commissioner’s denial of the deductions led to a large number of disputes between the Commissioner and the farmers. Most of these disputes were settled as a result of settlement offers made to the participant farmers in late 2000 (the first offer of settlement) and early 2002 (the second offer of settlement).
51. As Mr Bartley explains in his affidavit, at [18]:
Where a Farmer accepted settlement under the first or second offer of settlement:
18.1.the Farmer was allowed deductions, in year 1 of the Farmer’s investment, for the total amount of the cash outlaid in relation to their investment in Project 3 and Project 4; and
18.2.no deduction was allowed for the remaining amount of the deductions originally claimed.
52. At [20] of his affidavit Mr Bartley notes that 96% of the farmers in relation to Project 3, and 91% of the farmers in relation to project 4, had resolved their disputes with the Commissioner by 30 June 2004.
53. The Commissioner made a third, less favourable, settlement offer some time after 1 January 2005 and this offer was accepted by many, but not all, of the farmers who had not accepted the first or second offer. Those farmers who, even after the third offer, had not settled, then had their objections determined. The Commissioner’s objection decisions accepted that the farmers were carrying on a business, and accordingly that deductions for the full amounts of management fees, farm fees and associated amounts were allowable pursuant to s 51(1) of the 1936 Act or s 8-1 of the 1997 Act. However, the difference between the amount of the cash outlays and the total amount of deductions claimed was the amount of the tax benefit that was liable to be cancelled under Part IVA.
54. In addition, the Commissioner made determinations under s 177F(3)(b) of the 1936 Act to allow the farmer a compensating adjustment in cases where the amount of the deduction to be allowed exceeded the total amount of the deductions originally claimed in the relevant year.
55. It is against this background that the applicant has applied for a “compensating adjustment” to be made, under s 177F(3) of the 1936 Act, to the applicant’s assessable income for the relevant income years.
56. Section 177F(3) provides relevantly:
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
…
and the Commissioner shall take such action as he considers necessary to give effect to any such determination.
57. The conditions that must exist for the applicant to receive a compensating adjustment are:
(a) the Commissioner has made a determination under s 177F(1) in respect of a taxpayer;
(b) that determination is in relation to a scheme to which Part IVA applies;
(c) the Commissioner is of the opinion that there has been included in the assessable income of the applicant an amount that would not have been included if the scheme had not been entered into or carried out; and
(d) the Commissioner is of the opinion that it is fair and reasonable that that amount or a part of that amount should not be included in the applicant’s assessable income.
58. If those four conditions exist, then the Commissioner (or, on review, the Tribunal) may determine that the amount (or part of it) should not be included in the applicant’s assessable income.
59. Because of the terms of s 14ZZK(b)(iii) of the Taxation Administration Act 1953 (the Administration Act), the taxpayer has the burden of proving that the taxation decision concerned (that is, the Commissioner’s decision not to make a compensating adjustment) should not have been made or should have been made differently.
60. In Re Sharkey and Commissioner of Taxation [2007] AATA 1435; (2007) 95 ALD 509, Senior Member Taylor SC said of this provision, at [22]:
What subsection 14ZZK(b) of the Taxation Administration Act 1953 requires is that an applicant has the burden of satisfying the Tribunal that the original decision - in the sense of the result of that decision - is not the appropriate outcome. That satisfaction may be derived from significant new or additional material that was not before the Commissioner. It may also be derived from a re-evaluation of the appropriateness of the result of the original decision, or of a different evaluation of elements of the reasoning by which the impugned result had been achieved. However derived, the satisfaction required is that the Commissioner’s decision “should” have been different and in that sense is not an appropriate result of the exercise of the statutory power or discretion. The language of subsection 14ZZK(b) of the Taxation Administration Act 1953 suggests that the required satisfaction will not be attained, consistent with the apparent purpose of the “burden of proving” requirement, by an assessment that some other result of the exercise of the discretionary decision is merely marginally preferable in all the circumstances. But the practical reality in most cases is more likely to be that proper consideration of all of the material will lead the Tribunal to a state of comfortable satisfaction that a particular outcome is either “correct or preferable” in all the circumstances.
Condition (a) – Has the Commissioner made a determination?
61. Although the Commissioner accepts that s 177F(1) determinations were “originally” made, he submitted at ROS [123.1] that:
Part IVA ultimately did not apply, and compensating adjustments are accordingly not available, in relation to the Management Fees and Farm Fees payable by those Farmers who settled their disputes with the Commissioner.
62. In summary, the Commissioner’s premise is that, in relation to the farmers who settled their disputes with the Commissioner, the cash payments by the farmers were allowable deductions under s 51(1) of the 1936 Act or s 8-1 of the 1997 Act, but the amounts claimed in excess of those outlays were simply not deductible. Since those excess amounts were not deductible in the first place, the Commissioner concludes that the farmers could not have derived a “tax benefit” equal to those excess amounts, and therefore there is no amount of allowable deduction that is available to be cancelled by the determinations.
63. If the Commissioner’s premise were correct, then so would be the conclusion: Vincent v Commissioner of Taxation (2002) 124 FCR 350. However, it is not clear that the premise is correct.
64. The Commissioner readily conceded that, in relation to the farmers who did not settle their disputes with the Commissioner, the objection decisions were based on the disallowance of those excess amounts under Part IVA: see [53] of these reasons and ROS [146]. Indeed, Ms Macpherson was one such farmer, and the Tribunal’s decision in that case confirms that the objection decision was upheld on the basis that Part IVA applied.
65. These differing positions that the Commissioner sought to take between the farmers who settled their disputes and those who did not, suggest that the farmers who held out longer against the Commissioner should somehow be regarded as having stronger claims to deductibility under s 51(1) or s 8-1 than those who settled their disputes early. That seems an incongruous outcome.
66. The Commissioner submitted (at ROS [143]) that it is “clear” that Part IVA had no operation in relation to the disputes that were settled, but I do not agree.
67. The sample Deed of Settlement in relation to Project 3 (Tab 5 of Exhibit R5) provides that, in order to dispose of the matters in dispute between the Commissioner and the sample taxpayer, the Commissioner will issue a notice of amended assessment to:
Allow a deduction for all the Cash Payments per the original contractual arrangements, and disallow the balance of the Total Deductions;
…
68. In the Deed, the expression “Total Deductions” is defined as follows:
“Total Deductions” means, in respect of a year of income, the total deductions claimed by the Taxpayer (other than in accordance with the terms of this Deed) for that year relating to the Taxpayer’s investment or participation in Central Highlands Wine Grape Project No 3;
69. The Deed therefore leaves open the question whether the Commissioner disallowed the claims in reliance on s 51(1) of the 1936 Act (or s 8-1 of the 1997 Act) or whether he accepted that the claims were prima facie allowable under those provisions, and then determined to disallow them under Part IVA.
70. I can see no reason why the farmers who settled their disputes should be treated any differently from those who did not. The Commissioner made Part IVA determinations in relation to both categories, and yet he now argues that the determinations made in relation to one of those categories have no operation. There is no logic in the distinction, nor any support for it, in the Deed of Settlement. I conclude that, contrary to the Commissioner’s submission in ROS [123.1] (see [61] above), Part IVA ultimately did apply in relation to all farmers. Condition (a) in s 177F(3) exists.
Condition (b) – Was the determination made in relation to a scheme to which Part IVA applies?
71. Yes, quite plainly it was. Section 177D sets out the category of scheme to which Part IVA applies. The two criteria (aside from the requirement that the scheme be entered into or carried out after 27 May 1981) are:
(a) that a taxpayer (the relevant taxpayer) has obtained a tax benefit in connection with the scheme; and
(b) having regard to the eight matters specified in s 177D(b), it would be concluded that the person, or one of the persons, who entered into or carried out the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme.
72. These are exactly the questions considered, and answered in the affirmative, by Member Fice in Macpherson in relation to Project 3. (For the purposes of Member Fice’s enquiry, Ms Macpherson was the relevant taxpayer.) Given the similarity in structure, documentation and implementation between Project 3 and Project 4, it is inconceivable that the same conclusion would not be drawn, under s 177D, in relation to Project 4.
73. It follows that condition (b) in s 177F(3) exists.
Condition (c) – Is the Commissioner (Tribunal) of the opinion that there has been included in the assessable income of the applicant an amount that would not have been included if the scheme had not been entered into or carried out?
74. In relation to this question, the applicant’s case originally rested on the following proposition (Applicant’s Statement of Facts, Issues and Contentions filed in application NT2005/314 on 10 August 2005, at [102]):
If the scheme was not entered into in relation to Projects 3 and 4, CHMUT and CHMWUT and the Applicant as the person presently entitled to the net income of those entities would not have included the non-cash component of the farm and management fees in their respective assessable income.
75. Implicitly, the applicant was asserting that the cash component of the fees would have been included in assessable income.
76. More recently, the applicant has submitted (Applicant’s Reply (“AR”) at [47]):
An Investor’s application under the Principal Agreement was subject to acceptance by the Applicant and CML, and, in cases where a loan was applied for, by CHF: see clauses 1.2 and 1.3 of the Principal Agreement. As loans were applied for in all cases, it can be stated with certainty that the investments would not have gone ahead unless the loans were approved. It follows in those circumstances that no amounts would have been include[d] by the Applicant in relation to Farm Fees or Management Fees. However, in recognition of the fact that some amounts were received from Investors, the Applicant, in effect, seeks a compensating adjustment only in respect of the difference between the amount it included as income directly and indirectly in respect of Farm Fees and Management Fees and the amounts it received from Investors.
77. The Commissioner submitted (ROS [152]) that the enquiry directed by s 177F(3)(a)(i) is similar to that directed by s 177C(1)(a), the relevant “tax benefit” provision. That enquiry, the Commissioner submitted, requires a comparison between the consequences of the scheme in question and the consequences of what has been described as the “alternative postulate” (e.g. Commissioner of Taxation v Hart (2004) 217 CLR 216) or the “counterfactual” (e.g. FCT v Lenzo (2008) 167 FCR 255).
78. In response to that position, the applicant noted that there is a critical difference in language between s 177F(3) and s 177C(1), in that the latter contains, but the former does not contain, references to the question whether particular circumstances “might reasonably be expected” to have existed, and not just whether the circumstances “would have” existed. According to the applicant, it is the words in s 177C(1) referring to that reasonable expectation that lead to the enquiry as to the “alternative postulate” or the “counterfactual”. There is no such requirement in s 177F(3): the enquiry is “an objective one” (AR [44] and [46]).
79. That is not my understanding of the authorities that deal with the identification of an “alternative postulate” or “counterfactual”: see, for example, the analysis of “tax benefit” undertaken in Lenzo by Sackville J (with whose reasoning Heerey and Siopis JJ agreed) at [129]-[137], and especially at [134]. In any event, the formulation of the applicant’s current position ([76] above) suggests that the applicant is propounding an “alternative postulate” that the farmers would have done nothing. In other words, if the scheme had not been entered into or carried out, there would have been no money invested, there would have been no funding of any of the proposed activities, and so there could have been no assessable income derived by the applicant or by either of the unit trusts.
80. One would ordinarily need to identify the “scheme” with some specificity to enable the comparison to be drawn between the consequences of the scheme and the consequences “if the scheme had not been entered into or carried out”. Neither orally nor in writing in these proceedings has either party sought to identify, in a specific way, the steps involved in the “scheme”. What, then, are the steps that constitute the “scheme”? Is it all the steps involved in the Project, or only some of them, and if only some of them, which ones? Does the “scheme” include any steps leading up to the entry into the Project, such as the decision to initiate the Project, or (from an investor’s perspective) the decision to invest? There are no clear answers to these questions.
81. My reading of the reasons for decision in Macpherson indicates that the Tribunal there considered the “scheme” to consist of all the activities involved in the Project, including those referred to in the principal agreement, the farm agreement, the management agreement, the loan deed, the round robin arrangement involving the bill of exchange facility and the deposit agreement.
82. It might be argued (and, indeed, it may have been assumed by the applicant) that, for the sake of administrative consistency, I should adopt the same course here, in relation not only to Project 3 but also to Project 4. If I did that, then it would follow that the applicant’s comparison between the consequences of the scheme and the consequences “if the scheme had not been entered into or carried out” would be soundly based. But it would also mean that the applicant, in seeking to bring the Tribunal to the state of “comfortable satisfaction” of which Senior Member Taylor spoke in Sharkey, would have satisfied this particular element of the s 177F(3) enquiry without addressing the identification of the scheme in any substantive way at all. Mr McGovern argued against that outcome in his closing address:
The idea then that says, well, the alternative is do nothing, that, in a sense, would be kind of rewriting history here because what we know here is that there were farm activities undertaken, a vineyard was established, management services were provided, on our derivation argument management services were derived. (Transcript 10 December 2009, 128.16-128.20)
…
In the present circumstances, we see the matter as being such that whether one looked at it as a broad or a narrow scheme, the inclusion of the round robin bills of exchange is a critical step, and looking at a question of an alternative postulate, when one takes the round robin out of the equation and the farmers were paying real money, if they were to have said that the fees that would have been paid would have been only equivalent to the actual cash outlays, then that would be an alternative postulate which would enable 177F(3)(a)(i) to work, if you like, so that there would be a true alternative postulate. The difficulty here is that there is no evidence of the alternative. (Transcript 10 December 2009, 132.26-132.34)
83. I agree with the Commissioner’s submission that the “do nothing” option is not an appropriate alternative postulate, as explained by Mr McGovern in the first of those passages. The result is that, in the absence of a detailed definition of the “scheme” and an appropriate “alternative postulate”, the applicant has not been able to pinpoint “an amount” that was included in the applicant’s assessable income that would not have been included but for the scheme. It follows that condition (c) in s 177F(3) does not exist.
Condition (d) – Is the Commissioner (Tribunal) of the opinion that it is fair and reasonable that that amount or a part of that amount should not be included in the applicant’s assessable income?
84. Strictly speaking, having found against the applicant in relation to condition (c), it is not necessary for me to address this fourth condition. It is also, in a sense, impossible to form the required opinion because the “amount” which (either wholly or in part) would be the subject of the opinion has not been identified. However, since the matter was argued by the parties, I should at least provide some indication of my view of the “fair and reasonable” question.
85. It seems to me that the applicant’s case rose no higher than an exhortation to treat the income in a way that reflected the treatment of the deduction claims. In other words, it was an appeal to symmetry – the deduction claims were disallowed, so the income should be reduced. That is not a sufficient basis for the forming of an opinion that it would be “fair and reasonable” to reduce the assessable income.
86. On the broader question as to whether, if all four conditions in s 177F(3) are satisfied, the compensating adjustment should be made, the applicant submitted that, in the context in which the word appears in s 177F(3), “may” means “must”. It put a similar proposition in a slightly different way when it argued that, where all the conditions of s 177F(3) are satisfied, the Commissioner is required to make a compensating adjustment unless it would not be “fair and reasonable” to do so (AOS [145]).
87. On the “may” equals “must” argument, the applicant relied on the reasoning of the High Court in Finance Facilities Pty Limited v Commissioner of Taxation (1971) 127 CLR 106. The question there was whether the Commissioner should take action under s 46(3) of the 1936 Act. That provision stated that:
… the Commissioner may allow . . . a private company . . . a further rebate … if the Commissioner is satisfied that -
(a)the shareholder has not paid, and will not pay, a dividend during the period commencing at the beginning of the year of income of the shareholder and ending at the expiration of ten months after that year of income to another private company;
(b) . . . (not relevant in present matter); or
(c)having regard to all the circumstances, it would be reasonable to allow the further rebate.
88. At 133-135 Windeyer J said:
In the present case condition (a) was fulfilled. Of that the Commissioner was in fact satisfied. He could not have been otherwise than satisfied. Condition (c) is thus irrelevant, except for such light as it throws upon the critical question in the case, which is, the Commissioner being satisfied of the matters set out as (a), must he allow the further rebate provided for in the sub-section or has he a discretion to refuse to do so? The case for the Commissioner is that, as the Act says that he “may allow a further rebate” he is not bound to do so notwithstanding that a condition precedent be met. The case for the taxpayer, the appellant, is that, if the condition be fulfilled to the satisfaction of the Commissioner, he must allow the rebate. “May”, it was said, should be read as if it were “shall”. The Commissioner’s answer was that the word “may” prima facie imports a discretion to do or not to do. … The question, which comes back to the words “may allow”, is not to be solved by concentrating on the word “may” apart from its context. Still less is the question answered by saying that “may” here means “shall”. While Parliament uses the English language the word “may” in a statute means may. Used of a person having an official position, it is a word of permission, an authority to do something which otherwise he could not lawfully do. If the scope of the permission be not circumscribed by context or circumstances it enables the doing, or abstaining from doing, at discretion, of the thing so authorized. But the discretion must be exercised bona fide, having regard to the policy and purpose of the statute conferring the authority and the duties of the officer to whom it was given: it may not be exercised for the promotion of some end foreign to that policy and purpose or those duties. However, that general proposition is irrelevant in this case. Here the scope of the permission or power given is circumscribed. Conditions precedent for its exercise are specified as alternatives. The question then is, must the permitted power be exercised if one of those conditions be fulfilled?
This does not depend on the abstract meaning of the word “may” but of whether the particular context of words and circumstance make it not only an empowering word but indicate circumstances in which the power is to be exercised - so that in those events the “may” becomes a “must”. Illustrative cases go back to 1663. … But I select one other reference out of a multitude: Macdougall v Paterson (1851) 11 CB 755 (138 ER 672). There Jervis CJ said in the course of the argument (1851) 11 CB, at p 766 (138 ER, at p 677) “The word ‘may’ is merely used to confer the authority: and the authority must be exercised, if the circumstances are such as to call for its exercise”. And, giving judgment, he said (1851) 11 CB, at p 773 (138 ER, at p 679):
“We are of opinion that the word ‘may’ is not used to give a discretion, but to confer a power upon the court and judges; and that the exercise of such power depends, not upon the discretion of the court or judge, but upon the proof of the particular case out of which such power arises.”
I consider that to be directly applicable to the present case. If the Commissioner, having considered the matter, is satisfied of facts out of which the power to allow a rebate arises, he cannot nevertheless refuse to allow it. That is obvious in the case of condition (c): and it seems to me to be so also in the case of the alternatives (a) and (b).
89. This approach appears also to be the correct approach for s 177F(3). The power to make a determination in s 177F(3)(a) is circumscribed by the considerations in subparagraphs (i) and (ii), so that, if the Commissioner forms the requisite opinions, he should – must – make the appropriate determination. A refusal to make the determination would, in that case, appear to be based on an improper use of the power.
90. But that is a long way from saying that satisfaction of subparagraph (i) should necessarily lead to the forming of an opinion, favourable to the taxpayer, under subparagraph (ii). Nor does satisfaction of subparagraph (i) turn the “fair and reasonable” condition in subparagraph (ii) on its head as the applicant seems to suggest (see [86] above).
91. On the second issue, the compensating adjustment issue, the applicant has failed to satisfy me that a determination under s 177F(3) should be made.
Decision
92. The objection decisions are affirmed.
I certify that the 92 preceding paragraphs are a true copy of the reasons for the decision herein of Mr S E Frost, Senior Member.
Signed: .......[sgd]....................................................................
AssociateDates of Hearing: 10-12, 14, 17 November 2008,
7-8, 10-11 December 2009
Date of Decision: 16 February 2010
Solicitor for the Applicant: Piper Alderman
Counsel for the Applicant: P M Fraser
Solicitor for the Respondent: Australian Government Solicitor
Counsel for the Respondent: D B McGovern SC, A J O’Brien
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