Tabone and Commissioner of Taxation

[2006] AATA 466

Administrative

Appeals

Tribunal

 

DECISION AND REASONS FOR DECISION [2006] AATA 466

ADMINISTRATIVE APPEALS TRIBUNAL          № VT2005/115‑119

TAXATION     APPEALS         DIVISION

Re:            PETER MARIO TABONE

Applicant

And:         COMMISSIONER OF TAXATION

Respondent

DECISION

Tribunal:       Mr B.H. Pascoe, Senior Member

Date:29 May 2006

Place:Melbourne

Decision:The Tribunal sets aside the decision under review in respect of the year ended 30 June 1999 and in its stead allows the objection in full.  The Tribunal affirms the decision under review in respect of the year ended 30 June 2000 to 2003 inclusive.

In accordance with reg 19AA(9) of the Administrative AppealsTribunal Regulations, the Tribunal certifies that the proceedings have terminated in a manner favourable to the applicant.

(sgd) B. H. Pascoe

Senior Member

INCOME TAX – residence owned by unit trust – borrowing to subscribe for units in unit trust – whether interest expense allowable deduction – whether incurred to produce income – whether of private or domestic nature – application of Part IVA – amended assessment more than four years from original assessment.

Income Tax Assessment Act 1936  

Income Tax Assessment Act 1997  

Fletcher & Ors v Federal Commissioner of Taxation (1991) ATC 4950

Ure v Federal Commissioner of Taxation (1981) ATC 4100

Federal Commissioner of Taxation v Janmor Nominees Pty Ltd (1987) ATC 4813

Vincent v Federal Commissioner of Taxation (2002) ATC 4490

REASONS FOR DECISION

29 May 2006  Mr B.H. Pascoe, Senior Member

1.      These applications are for the review of decisions of the respondent to disallow objections to amended assessments of income tax in respect of the years ended 30 June 1999 to 30 June 2003 inclusive.  The amended assessments had been issued on 22 March 2004 to disallow deductions for interest claimed in the returns of income lodged in respect of each of the relevant years.

2.      At the hearing, the applicant, Mr P. Tabone, was represented by his accountant Mr D. McMahon.  The respondent, Commissioner of Taxation, was represented by Mr G. Davies QC with Mr D. Batt of counsel.  Evidence was given by Mr Tabone.

3.      The basic factual background of this matter was not in dispute.  On 17 April 1998 the Tabone Unit Trust (Unit Trust) was established with TAB Nominees Pty Ltd as trustee.  The initial issue of units was 60 units of $1.00 each to each of Mr Tabone and his wife Mrs P. Tabone.  Prior to that date, on 1 March 1998, the Tabone Family Trust (Family Trust) was established with Mr and Mrs Tabone as trustees.  At that time the Tabones were the owners and occupiers of a home at 10 Harcourt Close Sunbury and the owners of a vacant block of land at 5 Hasluck Court Sunbury which they had purchased in November 1993.  In May 1998, the Unit Trust entered into a building contract to erect a house on 5 Hasluck Court although the trustee did not enter into a transfer of the property from the Tabones until some two weeks later.  No consideration was stated on the transfer of land. 

4.        On the 29 July 1998 Mr and Mrs Tabone entered into an owner occupied construction loan with Westpac Banking Corporation (Westpac) for the borrowing by them of $182,574.  The loan was guaranteed by the trustee of the Unit Trust which mortgaged the property at 5 Hasluck Court by way of security to Westpac.  Between November 1998 and May 1999, the Tabones progressively drew down the funds available under the loan to meet progress payments under the building contract.  While the total loan was for $182,574, $37,000 was used to pay out an existing loan on the house at 10 Harcourt Close and $4,179.90 was applied to payment of mortgage insurance, application fee and other fees and duties leaving $141,384.10 available to meet building costs of the new home.

5.        On the 29 May 1999 the Tabones and their children moved into the new house at 5 Hasluck Court.  The former home at 10 Harcourt Close was sold on 4 June 1999 and, in July 1999, $100,000 from the proceeds of the sale was deposited to the credit of the loan account.  The family has continued to occupy the new house although there is no written loan or other tenancy agreement in existence.  Mr Tabone claims that rent varying from $130 per week in May 1999 to $170 per week in the year ended 30 June 2003 has been paid.  There is no specific record of regular payments of rent and Mr Tabone thought that some had been offset against repairs and maintenance costs met by him.

6.        At some time prior to 30 June 1999, 43,300 units of $1.00 each in the Unit Trust were issued to the Family Trust and a further 182,574 units issued to Mr Tabone.  It is not clear how those units were paid for although it seems likely that the units issued to the Family Trust may have been consideration for the transfer of the vacant land.  It is noted that the units issued to Mr Tabone equalled the total amount of the loan from Westpac notwithstanding that only $141,384 was available to meet construction costs of the house.  The balance sheet of the Unit Trust at 30 June 1999 showed the only significant asset as land and buildings and furniture and fittings at a total cost of $222,850.   

7.        In August 2000, an amount of $25,000 was redrawn from the loan account for purchase of a car.  In January 2001, a further $57,000 was redrawn and apparently, was given to the Family Trust which, in turn, acquired a further 57,000 units in the Unit Trust bringing its holding to 100,300 units.  In February 2001 the Unit Trust invested $50,000 in Synergy Funds Management..

8.        The accounts of the Unit Trust showed the following results in each of the relevant years:

Rent         Other            Expenses        Net    

income

Year ended 30 June 1999                 $800  $3,630               $2,830

Year ended 30 June 2000              $6,800  $11,654             $4,854

Year ended 30 June 2001              $6,200         $837           $12,892             $5,855

Year ended 30 June 2002              $8,320      $1,746           $13,927             $3,861

Year ended 30 June 2003              $8,760      $2,796           $11,781                $225

It is noted that the expenditure included an amount of building amortisation under Division 10D of the Income Tax Assessment Act1936 (the 1936 Act).

9.        In the income tax returns of Mr Tabone he claimed deductions for interest paid on the funds borrowed:

Year ended 30 June 1999  $4,072        

Year ended 30 June 2000  $5,527

Year ended 30 June 2001  $6,429        

Year ended 30 June 2002  $6,547

Year ended 30 June 2003  $6,553

Although invited to do so, no details of the calculation of the amount claimed were provided to the Tribunal by Mr Tabone or Mr McMahon.  It appears likely that the claims for the 1999 and 2000 years was equal to the total interest charged on the loan account but the claims for 2001, 2002 and 2003 were less than the total interest charged in those years.  While Mr McMahon conceded that interest relating to the redraws of $25,000 and $57,000 was not deductible, it appears from information provided to the respondent subsequent to the hearing that the difference was an attempt to reflect interest charged on the $25,000 and $7,000 of the $57,000 which was not invested by the Unit Trust.

10.      Mr Tabone maintained that the structure adopted was to enable accumulation and protection of assets under the umbrella of the Family Trust for the future benefit of his children.  He maintained that any short term tax benefit of claiming deductions for interest would be more than offset by future tax on the capital gains if and when the property was sold by the Unit Trust.  While he accepted that the borrowing was in joint names he maintained that this was a requirement of Westpac and not a choice of his.  He maintained that by agreement with his wife, he was to be the person responsible for the debt.  No documentary evidence of this was provided.  It was submitted that the interest on the loan was deductible as representing the cost of funds used to acquire an income producing asset, namely the units in the Unit Trust.

11.      The respondent submitted that the interest was not deductible under s 8-1 of the Income Tax Assessment Act 1997 (the 1997 Act) as not having been incurred in gaining or producing assessable income and being of a private or domestic nature.  Alternatively, it was argued that Part IVA of the 1936 Act applied to disallow any deduction.  

12.      The first question for consideration is whether the interest claimed was incurred in gaining or producing assessable income.  Putting aside for the moment the difficulties in this case of identifying what amount of any borrowings was invested in the Unit Trust and whether Mr Tabone incurred the total interest on funds borrowed jointly, it is appropriate to consider the general question of deductibility in the arrangement adopted in this case.  While no income was derived from the units in the relevant period, it is clear that the reasonable expectation of future income can suffice to provide a necessary nexus between an outgoing and the production of assessable income.  However, here there is considerable doubt as to the likelihood of any assessable income being generated by the investment of Mr Tabone in units in the Unit Trust whose sole amount at the time of investment was the residence of the Tabone family.  In such an instance it is difficult to see the nexus between the interest outgoings and any likely assessable income (Fletcher & Ors v Federal Commissioner of Taxation (1991) ATC 4950, and Ure and Federal Commissioner of Taxation (1981) ATC 4100).

13.      Even if such a nexus could be identified it is then a question of whether the interest expenditure was of a private or domestic nature.  Here the loan was an owner occupied construction loan said to be for the construction of a residence for the Tabone family.  The facts of this case point to a conclusion that the primary purpose of the borrowing was to provide such residence and only peripherally, if at all, for the possible purpose of deriving income from an investment in units of a Unit Trust.  As said by the High Court in Fletcher & Ors v Federal Commissioner of Taxation (1991) ATC 4950 (at page 4958):

The position may, however, well be different in a case where no relevant assessable income can be identified or where the relevant assessable income is less than the amount of the outgoing.  Even in a case where some assessable income is derived as a result of the outgoing, the disproportion between the detriment of the outgoing and the benefit of the income may give rise to a need to resolve the problem of characterization of the outgoing for the purposes of the sub-section by a weighing of the various aspects of the whole set of circumstances, including direct and indirect objects and advantages which the taxpayer sought in making the outgoing.  Where that is so, it is a ‘commonsense’ or ‘practical’ weighing of all the factors which must provide the ultimate answer.  If, upon consideration of all those factors, it appears that, notwithstanding the disproportion between outgoing and income, the whole outgoing is properly to be characterized as genuinely and not colourably incurred in gaining or producing assessable income, the entire outgoing will fall within the first limb of s 51(1) unless it is either somehow excluded by the exception of ‘outgoings of capital, or of a capital, private or domestic nature’ or ‘incurred in relation to the gaining or production of exempt income’.  If, however, that consideration reveals that the disproportion between outgoing and relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective and that part only of the outgoing can be characterized by reference to the actual or expected production of assessable income, apportionment of the outgoing between the pursuit of assessable income and the pursuit of that other objective will be necessary.

Here I am satisfied that the interest outgoings were explained by reference to the independent pursuit of the objective of providing a family residence and no part to the expected production of assessable income.

14.      Consequently, I find that the interest was not incurred for the purpose of gaining or producing assessable income and, in any event was of a private or domestic nature.  For completeness, it is appropriate to find also that the funds were borrowed jointly, both parties contributed to payment of the interest and repayment of the loan and, if any amount of the interest was deductible, Mr Tabone would be entitled to claim 50 per cent of such amount.  Any such deduction would depend on satisfying the onus of proof as to how much of the loan was used for an income producing purpose and the relevant applicable amount of interest.  As noted earlier, no evidence to this end was produced.

15.      Again for completeness and with the recognition of other similar applications before the Tribunal, it is appropriate to deal with the respondent’s alternative argument that Part IVA of the 1936 Act applied to disallow any deduction otherwise allowable under s 8-1 of the 1997 Act.  For Part IVA to apply, it is necessary to identify a scheme (s 177A(1)), identify a tax benefit (s 177C) and objectively conclude that the taxpayer entered into the scheme for the dominant purpose of obtaining the tax benefit (s 177D(b)).  Pursuant to s 177F, the respondent made the appropriate determination that the interest deductions claimed were not allowable in each of the relevant years.

16.      The respondent identified the scheme as being the steps taken by Mr Tabone, Mrs Tabone and the trustee to establish the Unit Trust, the acquisition of the land by the trustee, the issue of units to Mr Tabone, the construction of a family home in the name of the trustee, the borrowing by Mr and Mrs Tabone, the guarantee of such borrowing by the trustee and the claiming as a deduction by Mr Tabone the interest paid on such borrowing.  The Tribunal concurs with that identification of a scheme.

17.      The tax benefit identified was the expectation of a deduction being allowable for interest paid on the borrowing which would not have been allowable if the interest was paid on the direct acquisition of a private residence.

18. Having regard to the eight matters set out in s 177D(b), I have concluded that Mr Tabone entered into the scheme for the dominant purpose of obtaining a tax benefit in connection with the scheme. Apart from the expectation of obtaining a deduction for interest on a loan, the purpose of which was the erection of a residence for himself and his family, the scheme, if effective, would also provide a deduction under Division 10D of the 1936 Act which would not be available if owned directly by Mr and/or Mrs Tabone. Mr Tabone argued that any tax benefit sought from deduction of interest was more than offset by the potential liability to tax on any subsequent sale and capital gain by the Unit Trust which would not apply if the residence was owned personally. However, whether such liability will arise will depend on whether and when such a sale is made and the regime then existing for the taxation of capital gains. All the evidence indicates an intention to retain ownership of the residence in the long term with no prospective sale on any distant horizon. I am not satisfied that this argument negates that view of obtaining a tax benefit under the scheme. Mr Tabone argued further that the dominant purpose of the Unit Trust arrangement was the accumulation and protection of assets for the future benefit of his children. I am unable to see how the interpolation of the Unit Trust does anything to accomplish such a purpose. Both Mr and Mrs Tabone are employees of arms length employers with little likely risk of litigation. The property is mortgaged to secure the loan. The arrangement simply changed his asset from ownership of a house to ownership of units in the Unit Trust which owned the house. So far as providing for children, I am unable to see that the structure created to own the residence does anything to enhance this objective. Direct ownership of the residence and appropriate clauses in the couple’s wills would accomplish the same objective.

19.      Mr McMahon and Mr Tabone sought to rely on the decision in Federal Commissioner of Taxation v Janmor Nominees Pty Ltd (1987) ATC 4813 as authority for Part IVA not applying to his arrangement. However, this decision can be distinguished from the facts of this case. In Janmor, it was the trustee who owned the property, borrowed the money and sought a deduction for interest against rental income set on a commercial basis.  Here, it is a unit holder seeking deductions for interest on borrowings said to be for the purpose of acquiring units in a Unit Trust which owns the property.  No acceptable evidence was provided of actual payment of rent or a commercial method of setting the quantum of rent.  Finally, Janmor was decided under s 260 of the 1936 Act, not Part IVA.  I am unable to see that this decision is of any assistance to Mr Tabone.

20.      It was conceded by the respondent that, if the deductions claimed were not allowable under s 8-1 of the 1997 Act, the amended assessment for the year ended 30 June 1999 was invalid having been issued outside the period allowed for amendment under s 170 of the 1936 Act.  Having found that the interest was not allowable, it follows that the decision under review disallowing objections against such disallowance for the year ended 30 June 2000, 2001, 2002 and 2003 should be affirmed.  The decision in relation to the year ended 30 June 1999 should be set aside on the grounds that the amended assessment was out of time.  The decision in Vincent v Federal Commissioner of Taxation (2002) ATC 4490 makes it clear that, if the primary finding is that a deduction is not allowable, a further finding that Part IVA could apply cannot extend that time for amendment.

21.       The only penalty imposed on the amended assessments which stand was a penalty of 10 per cent of the tax shortfall in the year ended 30 June 2002.  No argument was raised in relation to this penalty and no alteration is appropriate.

I certify that the twenty-one [21] preceding paragraphs are a true copy of the reasons for the decision herein of

Mr B.H. Pascoe, Senior Member

(sgd)      Lydia Zozula

Associate

Date of Hearing:  7 April 2006

Date of Decision:  29 May 2006
Counsel for the applicant:            Mr D. McMahon
Solicitors for the applicant:          McMahon Osborne Consulting
Counsel for the respondent:        Mr G. Davies QC & Mr D. Batt

Solicitors for the respondent:       Australian Government Solicitor