Taxpayers and Commissioner of Taxation
[2005] AATA 1251
•16 December 2005
Administrative
Appeals
Tribunal
DECISION AND REASONS FOR DECISION [2005] AATA 1251
ADMINISTRATIVE APPEALS TRIBUNAL )
) No QT2004/186-187
TAXATION APPEALS DIVISION ) Re TAXPAYERS Applicants
And
COMMISSIONER OF TAXATION
Respondent
DECISION
Tribunal Senior Member B J McCabe Date16 December 2005
PlaceBrisbane
Decision The objection decisions under review are affirmed save as to penalties. The Tribunal sets aside the decisions to impose penalty tax in the amount of 50% on each taxpayer pursuant to s 226 of the ITAA36 and substitutes a decision to pay penalty tax of 25%. ....................[sgd]..........................
SENIOR MEMBER
CATCHWORDS
TAXES AND DUTIES – Income tax and related legislation – capital gains - sale of shares in business – election to roll over assets into company at same cost base as part of a series of transactions – sale agreements to related companies not negotiated at arms length – sales deemed to have occurred at market value – asset base lifted in value before sale – taxpayers did not incur a capital gain.
TAXES AND DUTIES – Income tax and related legislation – tax avoidance - schemes entered into for the sole or dominant purpose of obtaining a tax benefit – having regard to relevant factors a reasonable person would be satisfied the series of transactions was a scheme entered into to obtain a tax benefit – taxpayers did have an arguable case – penalty reduced.
Income Tax Assessment Act 1936 ss 177A, 177C, 177D, 226, 227
Income Tax Assessment Act 1997 ss 116.30, 122-A
Zobory v Federal Commissioner of Taxation (1995) 64 FCR 86; (1995) 129 ALR 484; (1995) 95 ATC 4251; (1995) 30 ATR 412
MacFarlane v Federal Commissioner of Taxation (1986) 13 FCR 356; (1986) 67 ALR 624; (1986) 86 ATC 4477; (1986) 17 ATR 808
Bective v Federal Commissioner of Taxation (1932) 47 CLR 417; [1932] ALR 362; (1932) 6 ALJR 110; (1932) 2 ATD 80
Snook v London and West Riding Investments Limited [1967] 2 QB 786; [1967] 1 All ER 518; [1967] 2 WLR 1020
Federal Commissioner of Taxation v Lau (1984) 54 ALR 167; (1984) 84 ATC 4618; (1984) 15 ATR 932
Richard Walter Pty Ltd v Federal Commissioner of Taxation (1996) 67 FCR 243; (1996) 96 ATC 4550; (1996) 33 ATR 97
Yanner v Eaton (1999) 201 CLR 351; (1999) 105 LGERA 71; (1999) 166 ALR 258; (1999) 73 ALJR 1518; (1999) 18 Leg Rep 2; (1999) 107 A Crim R 551; [1999] HCA 53
Macaura v Northern Assurance Co Ltd [1925] AC 619; (1925) 133 LT 152; [1925] All ER Rep 51
Salomon v Salomon & Co Ltd [1897] AC 22; (1896) 66 LJ Ch 35; (1896) 75 LT 426; (1897) 13 TLR 46; (1896) 45 WR 193; (1896) 4 Mans 89; [1895-9] All ER Rep 33
Scott v Federal Commissioner of Taxation (No 2) (1966) 40 ALJR 265; (1966) 10 AITR 290; (1966) 14 ATD 333
Miles v Bull [1969] 1 QB 258; [1968] 3 All ER 632
Federal Commissioner of Taxation v Consolidated Press Holdings Limited (2001) 207 CLR 235; (2001) 179 ALR 625; (2001) 75 ALJR 1150; (2001) 22(11) Leg Rep 10; 2001 ATC 4343; (2001) 47 ATR 229; [2001] HCA 32
Federal Commissioner of Taxation v Hart (2004) 217 CLR 216; (2004) 206 ALR 207; (2004) 78 ALJR 875; 2004 ATC 4599; (2004) 55 ATR 712; [2004] HCA 26
Federal Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404; (1996) 141 ALR 92; (1996) 71 ALJR 81; [1996] 20 Leg Rep 2; (1996) 96 ATC 5201; (1996) 34 ATR 183; [1996] HCA 34
REASONS FOR DECISION
16 December 2005 Senior Member B J McCabe
introduction
1. The Commissioner says Mr QT2004/186 and Mrs QT2004/187 (the applicants) should have included an additional $349,999 capital gain in each of their income tax returns filed in respect of the year ending 30 June 2000. Amended assessments to that effect were issued. The Commissioner argues the amount in question was not included in the original returns because the applicants entered into a CGT cost base uplift scheme promoted by their lawyers. The respondent says the scheme did not have the effect the applicants claim it had. Alternatively, the Commissioner argues the transaction ought to be regarded as a tax avoidance scheme under Part IVA of the Income Tax Assessment Act 1936 (ITAA36).
2. The applicants have also asked the Tribunal to reconsider the question of penalties if the decisions are affirmed.
the material before the tribunal
3. The Tribunal was provided with the documents required under s 37 of the Administrative Appeals Tribunal Act 1975. A further 23 documents were tendered as exhibits at the hearing. The Tribunal also heard oral evidence from:
·Mr QT2004/186;
·Mrs QT2004/187;
·The applicants’ accountant; and
·The applicants’ solicitor.
4. The applicants were represented by Mr Russell, QC and Mr Bickford of counsel. The respondents were represented by Mr Davies, QC and Mr Harding of counsel.
the facts
5. The applicants were a married couple. They decided to go into business with Mr TW and Mrs AW, the brother and sister-in-law (respectively) of the male applicant. D Company Pty Ltd (D Company) was incorporated to that end on 19 November 1991. Mr QT2004/186, Mrs QT2004/187, Mr TW and Mrs AW each held one $1 ordinary share in the company. All of them became directors. There were no other shareholders.
6. D Company conducted a supermarket business in a town in North Queensland. The business struggled to meet rental payments and pay suppliers. In 1998, the applicants became aware that Franklins, a rival chain, was interested in acquiring independent supermarkets. There were some discussions between the shareholders in D Company and representatives of Franklins about the possibility of a sale but nothing eventuated. The applicants said they became interested in selling their interest in the business in any event. Mr QT2004/186 said in his statement that he and his wife were having marriage difficulties and he discussed options with his accountant. Mr QT2004/186 claimed he considered a restructuring of his affairs to protect his assets against the possibility of litigation and for estate planning purposes.
7. The accountant arranged for Mr QT2004/186 to meet with a solicitor of ABC solicitors. The solicitor and the accountant provided advice on how to restructure the applicants’ affairs. Mr QT2004/186 says he did not discuss these proposals with his brother and sister-in-law.
the events of 13 – 15 april 1999
(i) Mr QT2004/186
8. The applicants say they were advised to enter into a transaction in several parts. Each applicant entered into a similar but separate arrangement. I will deal with the arrangement entered into by Mr QT2004/186 first. He agreed to sell his share in D Company to S Company Pty Ltd (S Company). The purchase price of the share was to be the market value of the share as at the date of the transaction determined in writing by the accountant. Mr QT2004/186 agreed to accept 2000 $1 ordinary shares in S Company in satisfaction of the purchase price. Mr QT2004/186 and Mrs QT2004/187 were both appointed directors of the company. Mr QT2004/186 agreed to provide a duly executed transfer document and instrument of title to his share in D Company. The sale agreement is reproduced at exhibit 1, T3.
9. Once the share was sold and the consideration (ie, the shares in the company) passed to the applicant, Mr QT2004/186 purported on 13 April 1999 to make an election that s 122-A of the Income Tax Assessment Act 1997 (ITAA97) would apply. Section 122-A says an asset rolled over into a wholly-owned company retains the same cost base or reduced cost base that it had in the taxpayer’s hands. The documents evidencing the election in each case are found at document T6 in exhibit 1.
10. The next step in the transaction involving Mr QT2004/186 was the declaration of a trust. Mr MC (as settlor) and AH Company Pty Ltd (AH Company) (as trustee) executed a trust deed establishing the A Trust. The trust deed is found at exhibit 1, T7. Clauses 3.3 and 3.4 of the deed permit the trustee to pay or apply income in certain circumstances in favour of the primary, secondary or tertiary beneficiaries under the trust. Schedule two to the deed says the primary beneficiary is the Australian Red Cross and the secondary beneficiary is the Royal Flying Doctor Service of Australia. The schedule also defines the expression tertiary beneficiary. It includes any trust in which the trustee or any of the beneficiaries under the A Trust is a beneficiary, and any corporation in which the trustee or the beneficiaries under the A Trust hold shares.
11. I note Mr QT2004/186 and Mrs QT2004/187 were both directors of AH Company Pty Ltd. They each held one share in the company.
12. S Company then declared it held its interest in the share in D Company on trust and subject to the trusts of the A Trust. The declaration of trust documentation is found at exhibit 1, T9. The documents were executed on 13 April 1999.
13. Further documents were executed the following day:
·A trust deed between Ms SM as settlor and PB Company as trustee established the D Trust. The beneficiaries under that trust included charities identified as primary and secondary beneficiaries and tertiary beneficiaries that included any trustee of any settlement of which those charities or the trustee of the D Trust were beneficiaries: exhibit 1, T13. Mr QT2004/186 and Mrs QT2004/187 were both directors of PB Company.
·An agreement for sale between AH Company as trustee of the A Trust and PB Company as trustee of the D Trust: exhibit 1, T15. AH company agreed to sell its interest in the share in D Company to PB Company for $35,000. The agreement for sale acknowledged the accountant had prepared a higher valuation.
·A deed of change of trustee executed by Mr QT2004/186 under which Mr QT2004/186 replaced PB Company as trustee of the D Trust: exhibit 1, T18.
·Another trust deed was executed with Ms SM as settlor and P Company Pty Ltd (P Company) as trustee establishing the A Trust No 3: exhibit 2, T20. The directors of P Company were associated with the law firm that structured the transaction.
14. On 15 April 1999, AH Company as trustee of the A Trust resolved that the net income of the trust should be distributed to the trustee of the A Trust No 3: see exhibit 1, T21. The resolution approving the distribution noted the Australian Red Cross Society was one of the beneficiaries of the A Trust No 3, which meant that trust itself qualified as a tertiary beneficiary (and was therefore eligible to receive distributions from the A Trust).
(ii) Mrs QT2004/187
15. Mrs QT2004/187 entered into a similar sequence of transactions. The documents were all in the same form as those signed by her husband. She agreed to sell her share in D Company to PB Company in return for 2000 $1 ordinary shares in PB Company. She also agreed to provide a transfer document and evidence of title. The agreement is reproduced at exhibit 2, T3. She subsequently made an election under s 122-A of ITAA97 (exhibit 2, T6).
16. On 13 April 1999, Mr MC as settlor and AH Company as trustee established the A Trust No 2 (exhibit 2, T7). PB Company declared it held its interest in the share in D Company upon and subject to the trusts of the A Trust No 2: exhibit 2, T9.
17. A number of documents were brought into existence (or executed) the following day:
·A trust deed between Ms SM as settlor and S Company as trustee established the D Company Trust No 2. The beneficiaries under that trust included a number of charities and any trustee of any settlement of which those charities or the trustee of the D Company Trust were beneficiaries: exhibit 2, T13.
·An agreement for sale between AH Company as trustee of the A Trust No 2 and S Company as trustee of the D Company Trust No 2: exhibit 2, T15. AH Company agreed to sell its interest in the share in D Company to S Company for $35,000. The agreement for sale acknowledged the accountant had prepared a higher valuation.
·A deed of change of trustee executed by Mrs QT2004/187 under which Mrs QT2004/187 replaced S Company as trustee of the D Company Trust No 2: exhibit 2, T18.
·Another trust deed was executed with Ms SM as settlor and P Company Pty Ltd as trustee establishing the A Trust No 3: exhibit 2, T20.
18. On 15 April 1999, AH Company as trustee of the A Trust No 2 resolved that the net income of the trust should be distributed to the A Trust No 3: exhibit 2, T21.
19. The applicants say the net effect of the transactions involving Mr QT2004/186 and Mrs QT2004/187 was to transfer the legal and beneficial ownership of the share each of them owned before they resumed title to the shares as trustee.
the subsequent agreement for sale
20. In 1998 Mr TW and Mr QT2004/186 began discussing the possibility of the applicants selling their shares to Mr TW and Mrs AW: exhibit 9, paragraphs 12 and 13. Mr TW apparently made inquiries about the availability of finance early in 1999. A valuation of the applicants’ shares dated 11 June 1999 was obtained from the accountant: exhibit 5, paragraph 11. The valuation stated each share was worth $350,000. The accountant was first approached about the valuation prior to the events of 13-15 April 1999.
21. The applicants suggest there was no firm offer or proposal forthcoming from Mr TW as to a sale until the middle of June 1999 – after the valuation had been received. Yet Mr TW advised the applicants at the end of May 1999 that D Company was setting aside an amount of money in a solicitor’s trust account each week to fund a purchase: exhibit 9, paragraphs 18 and 19. The accountant was contacted by the solicitor and told of the possibility D Company would lend $700,000 to Mr TW and Mrs AW to fund the purchase at the beginning of June: exhibit 5, paragraphs 15 and 16.
22. The applicants resigned as directors of D Company on 15 June 1999 before it made an application to the Australian Securities and Investments Commission (ASIC) for approval for the company to make a loan to purchase the shares. Approval was given. The shareholders in D Company resolved on 30 July 1999 that the company should loan the money to Mr TW and Mrs AW. It was understood the company would obtain an advance from a grocery wholesaler to cover the loan. The deed of sale recording the agreement to sell the two shares to Mr TW and Mrs AW for a total consideration of $700,000 was executed on 10 September 1999.
23. The applicants received the sale proceeds during the year of income in question. That result requires some explanation. Recall that both of the applicants had resumed legal ownership of the shares (in the case of Mr QT2004/186 – when he replaced PB Company as trustee of the D Company trust; in the case of Mrs QT2004/187 – when she replaced S Company). Mr QT2004/186 held the share subject to the D Company trust, and Mrs QT2004/187 held the other share subject to the D Company No 2 trust. The trustees of the D Company trust and the D Company No 2 trust (ie, Mr QT2004/186 and Mrs QT2004/187 respectively) resolved to distribute income from the trusts to the A Trust No 3. The income included the sale proceeds from the disposal of the share. The trustee of the A Trust No 3 in turn decided to distribute income to the tertiary beneficiaries under that trust. The expression tertiary beneficiaries is defined in Schedule two to the A Trust No 3 deed to include the trustee of any trust which declared P Company or the Australian Red Cross or the Royal Flying Doctor Service to be beneficiaries of the other trust. As it happens, Mr QT2004/186 and Mrs QT2004/187 were both trustees of trusts that recognised the Australian Red Cross as beneficiaries, so the applicants became eligible to receive a distribution of income.
24. The applicants say the distribution did not amount to a capital gain. That contention also requires some explanation. Recall that AH Company as trustee of the A Trust agreed to sell Mr QT2004/186’s share in D Company to PB Company as trustee of the D Company Trust for $35,000, and AH Company as trustee of the A Trust No 2 agreed to sell Mr QT2004/186’s share to S Company as trustee of the D Company Trust No 2 for $35,000. In each case, the agreements for sale acknowledged the sale price was below the market value of $350,000 identified by the accountant. Because the sale agreements were not negotiated between parties at arms’ length, s 116.30 of ITAA97 deemed the sales to have occurred at the market value (ie, $350,000 for each share). The cost base of the asset in the purchaser’s hands was thereby uplifted from $1 to $350,000. When the shares were subsequently sold to the in-laws for $350,000 each, the sellers claimed they did not incur a capital gain, and purported to distribute that same amount to the applicants.
did the taxpayers incur a capital gain?
25. The Commissioner says each of the applicants incurred a capital gain of $349,999 on 10 September 1999 (ie, the sale price of $350,000 for each share less $1, being the cost base of the share). Net capital gains are included in a taxpayer’s assessable income: s 105-5 ITAA97. The respondent says the applicants were effectively the owners of the property when the sale to Mr QT2004/186 and Mrs QT2004/187 occurred. As the Commissioner explained in paragraph 31 of the written submissions:
The events of 13-15 April were a series of pre-arranged, interrelated transactions which are not intended to, and did not, alter the applicant’s dominion over the shares. The applicants have not and cannot identify any person apart from themselves who held ownership of the shares as a result of the events of 13-15 April 1999.
26. The applicants take a different view. They say the shares were disposed of (to S Company in the case of Mr QT2004/186, and to PB Company in the case of Mrs QT2004/187) on 13 April 1999 in return for shares in those companies. Those transactions were CGT events within the meaning of 104-10 ITAA97 but the taxpayers elected in each case that s 122-A of ITAA97 should apply. The taxpayers say the fact they subsequently resumed legal ownership of the shares when they were appointed as trustees is irrelevant since they did not hold any beneficial interest in the assets. They also say the Tribunal should ignore the fact they ultimately received the proceeds of sale.
27. The arrangements entered into on 13-15 April 1999 suggest on their face that ownership (including all legal and beneficial interests) of the shares passed from the taxpayers to other entities. Thereafter, the taxpayers resumed legal ownership of the shares as trustees. But the applicants say they did not become beneficially entitled to the shares at that time, or at any point thereafter.
28. The applicants say the fact they do not have any beneficial interest in the shares has important implications for their liability to income tax. They rely in particular on the decision of the Federal Court in Zobory v Federal Commissioner of Taxation (1995) 129 ALR 484. In Zobory, Burchett J pointed out the taxation legislation proceeds on the basis that the burden of taxation will ordinarily fall on income to which a taxpayer is beneficially entitled: at 486. His Honour followed an earlier decision of the Full Federal Court in MacFarlane v Federal Commissioner of Taxation (1986) 67 ALR 624. The Full Court in that case took its cue from remarks of Dixon J in Countess of Bective v Federal Commissioner of Taxation (1932) 47 CLR 417 at 424.
29. Taken at face value, the sale of the shares in D Company at first instance to S Company and PB Company in return for shares in those companies had the effect of divesting the applicants of any legal and beneficial interest in the D Company shares. While the machinations of 13-15 April 1999 appear to have had the effect of restoring legal ownership of the D Company shares to the applicants (albeit as trustees), those transactions did not restore beneficial ownership of the shares to the applicants. But should the transactions be taken at their face value?
30. The respondent says the transactions that went on throughout 1999 prior to the final sale of the shares to the applicants’ in-laws were a sham. The respondent argues the transactions in question were not intended to have any legal effect, and should therefore be ignored.
31. The applicant referred me to a number of authorities on the question of sham transactions. The classic exposition of the concept of sham can be found in the decision of Diplock LJ in Snook v London and West Riding Investments Limited (1967) 2 QB 786. His Lordship explained (at 802) a transaction could be described as a sham if the documents or acts of the parties appear to give the impression of enforceable legal rights being created when the parties did not in reality intend any such result. But Connolly J explained in Federal Commissioner of Taxation v Lau (1984) 15 ATR 932 that the documents evidencing a transaction will not be disregarded as a sham if they were in fact intended to take effect and operate according to their tenor: at 936-937; affirmed on appeal (1984) 6 FCR 202. Hill J took a similar view in Richard Walter Pty Ltd v Federal Commissioner of Taxation (1996) 96 ATC 4550. In that case, his Honour observed (at 4562) a sham transaction was a transaction that involved:
“a common intention between the parties to the apparent transaction that it be a disguise for some other and real transaction or for no transaction at all”.
32. The respondent says the documents were contrived. It says the documents were never intended to affect the reality of the applicants’ ownership of the shares. The respondent’s submissions refer to the applicants’ dominion over the shares – a nod to the Roman law concept of dominium.
33. This is slippery ground – not least because the law has never really worked out a comprehensive definition of what it means to be an owner of personal property: see generally Welling, Property in Things in the Common Law System, Scribblers, Gold Coast 1996. The High Court agreed in Yanner v Eaton (1999) 166 ALR 258 (at 264, per Gleeson CJ, Gaudron, Kirby and Hayne JJ) that the concept of property was “elusive” and added:
"property" does not refer to a thing; it is a description of a legal relationship with a thing. It refers to a degree of power that is recognised in law as power permissibly exercised over the thing.
34. Their Honours cited (at 264) the views of Professor Gray who described property as “a legally endorsed concentration of power over things and resources”: Gray, "Property in Thin Air", (1991) 50 Cambridge Law Journal 252 at 299. Yet even that approach is of limited assistance where the power over resources is channelled through a legal device like a company or a trust. It is a fundamental rule of company law that a shareholder in a company – even the sole shareholder who is also the only director – does not have any property in the assets of the company: see Macaura v Northern Assurance Co Ltd [1925] AC 619. The fact many sole shareholders treat company assets in much the same way as they treat their own property does not change the legal reality that the property is owned by the company. Circumstances might arise where the company enforces its rights over the property against the shareholder (most obviously where the company is placed in the hands of an external administrator). That is the lesson of Salomon v Salomon & Co Ltd [1897] AC 22, another case in which a businessman rolled over assets into a company without altering his behaviour or presentation.
35. Many dealings in property are not discernible to the naked eye. The re-ordering of relationships involved in a transfer of proprietary interests might not lead to changes in behaviour on the part of those who hold or manage the assets in question. But that tells us little about the legal import of the dealings. It is only where the documents can effectively be divorced from the underlying reality of the dealings between the parties – where the paperwork was a disguise - that a court will set aside the documents as a sham: Scott v Federal Commissioner of Taxation (No 2) (1966) 40 ALJR 265 at 279.
36. In this case, it appears the applicants intended the documents to have their full effect – indeed, the taxpayers depended on the documents taking effect according to their tenor in order that they might be placed in a position to exploit the taxation (and perhaps other) advantages that would become available when a sale of the shares in the business to a third party was completed. The nature or worthiness of the objective is irrelevant: see Miles v Bull (1969) 1 QB 258 at 264 per Megarry J.
37. The respondent argued it was clear the taxpayers did not understand the mechanics of the process they initiated, nor did they understand the immediate effect of any of the documents they signed or the resolutions they passed. I do not think that matters. Business people often have an imperfect understanding of the details of the legal transactions they enter into. That is why they hire lawyers, and good lawyers are sometimes able to offer unprompted advice on transactions, structures or courses of action that would advantage their clients. In this case, the applicants became aware of a result they wanted to achieve and gave instructions to their professional advisers to prepare the necessary steps.
38. I note the applicants (through their solicitors) complied with a number of the usual requirements imposed in relation to dealings in shares. The relevant documents were presented for stamping, and stamp duty was paid. This evidence is consistent with my conclusion that the parties intended the documents to be taken seriously. It is true the share transfers were not produced to the companies so that the changes might be recorded in the register. The applicants’ solicitor was not asked to explain this failure. The applicants had nothing to say on the issue; they presumably relied on their solicitors. Mr Russell pointed out in his submissions that the share register in D Company had not been rectified to reflect the fact the shares had been transferred to the applicants’ in-laws some time after that transaction plainly occurred. I note the respondent’s suggestion that the failure to notify the companies of the “true” position with respect to the shares left the applicants in a position where they could walk away from the transactions if they wished to do so. That is a troubling possibility, but I am satisfied after hearing all the evidence that the applicants regarded themselves as committed to the transactions and reaping whatever benefits might flow. I accept their failure to comply with the detailed notice requirements reflects nothing more than a lack of attention to corporate secretarial functions. That lack of attention may well have consequences under the companies legislation but the validity of the transfers for present purposes was not affected.
39. Subject to the operation of Part IVA of ITAA36, I accept each of the taxpayers did not incur a capital gain in the amount of $349,999 following the sale of the D Company shares as a result of the transactions they entered into.
the operation of part iva
40. Part IVA of ITAA36 applies to schemes entered into for the sole or dominant purpose of obtaining a tax benefit. The Commissioner says there is a scheme and a tax benefit within the meaning of the provisions of Part IVA if the applicants’ transactions meant they were not liable to pay tax that would have been payable if the applicants had disposed of the shares themselves to the ultimate purchaser.
41. The expression scheme is defined in s 177A 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.
42. Hill J in Macquarie Finance Ltd v Federal Commissioner of Taxation [2004] ATC 4866 observed:
The definition of ‘scheme’ is very wide. It may include a course of conduct or it may include just ‘an action’.
43. The Commissioner accepts the sale of a share or other asset to a wholly-owned company in return for shares in that company would not of itself amount to a scheme: see Taxation Determination 95/4. But the taxpayers do more than that in this case. They set in train a series of steps beginning with the disposition of the shares in D Company to the wholly-owned companies, including the disposition of the shares to the applicants’ in-laws and ending with the gains being distributed to them by the trust which received the proceeds of sale. The taxpayers are involved in person or as trustees or directors of trustee companies at most of those steps.
44. The Commissioner says the scheme is comprised of the series of transactions that preceded the ultimate sale of the share in each case – that is, all of the dealings up to but not including the actual sale of the shares to the in-laws. I think the Commissioner is right. I do not think it matters that the scheme is not taken to include every step up to and including the distribution of the proceeds of sale. The High Court has signalled it is permissible in appropriate cases to include within the definition of the scheme “part only of the total plan or course of conduct”: Federal Commissioner of Taxation v Consolidated Press Holdings Limited (2001) 207 CLR 235 at 254 per Gleeson CJ, Gaudron, Gummow, Hayne and Callinan JJ; see also Federal Commissioner of Taxation v Hart (2004) 217 CLR 216 at 237ff per Gummow and Hayne JJ; cf Gleeson CJ and McHugh J (at 223). I am satisfied that, taken together, the steps identified by the Commissioner constitute a scheme for the purposes of Part IVA.
45. The next step is to determine whether a tax benefit arises in connection with that scheme. The respondent’s position is simple: but for the scheme that was entered into, the taxpayers would each have been required to include $349,999 (being the sale price of each share less their cost base of $1) in their assessable income. The respondent adds the taxpayers’ dominant motive for entering into the scheme was to avoid that tax liability. The applicants disagree.
46. The expression tax benefits is defined in s 177C. On the face of it, the scheme appears to generate a tax benefit within the meaning of s 177C(1)(a) in that the operation of the scheme has resulted in an amount not being included in the assessable income of the taxpayer where it would otherwise be included. If the taxpayers had not entered into any of the transactions involving the companies and trusts and merely sold their shares to their in-laws at the agreed price, they would have incurred a substantial capital gain. But the applicant says there is no tax benefit here because of the exceptions contained in s 177C(2)(a).
47. Section 177C(2)(a) provides:
A reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as not including a reference to:
(a) the assessable income of the taxpayer of a year of income not including an amount that would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out where:
(i) the non-inclusion of the amount in the assessable income of the taxpayer is attributable to the making of an agreement, choice, declaration, agreement, election, selection or choice, the giving of a notice or the exercise of an option (expressly provided for by this Act other than section 160ZP or 160ZZO or the Income Tax Assessment Act 1997 ) by any person, except one under Subdivision 126-B, 170-B or 960-D of the Income Tax Assessment Act 1997 ; and
(ii) the scheme was not entered into or carried out by any person for the purpose of creating any circumstance or state of affairs the existence of which is necessary to enable the declaration, agreement, election, selection, choice, notice or option to be made, given or exercised, as the case may be;
48. The applicants say an election under s 122-A ITAA97 is an election referred to in s 177C(2)(a)(i). The elections in these cases meant each of the wholly-owned companies took the rolled-over asset subject to the same cost basis it had in the hands of the applicant who transferred the share. When each company sold its share in due course, the capital gain (if any) made by the company on the sale would be calculated subject to the same cost base as that of the applicant (ie, $1). The applicants would not be obliged to pay tax on any gains following those sales since the gains were made by someone else. The applicants say that whatever happens to the assets after they were rolled-over has no tax consequences for them.
49. The difficulty here is that the applicants did contrive to receive the proceeds of the sale of the shares to their in-laws. In particular, they each received $349,999 more than they paid for the shares in the first place. Yet they claimed they did not make a taxable capital gain.
50. That cannot be right. While it is true the applicants did not make an assessable capital gain on the sale to the wholly-owned companies by reason of the election, the tax benefit in question here arises out of the subsequent steps in the scheme that led to an uplift in the cost base of the share – namely (in the case of Mr QT2004/186) the sale of the share by AH Company on behalf of the A Trust to the trustee of the D Company trust for a deemed price of $350,000. (In the case of Mrs QT2004/187, it was the sale of the share by AH Company as trustee of the A Trust No 2 to the trustee of the D Company No 2 trust at the same deemed price.)
51. It follows the applicants are unable to bring themselves within the exception provided for in s 177C(2)(a)(i). I am therefore satisfied they have derived a tax benefit within the meaning of the legislation in the amount of $349,999. But that is not the end of the matter. Section 177D requires that the decision-maker consider whether – having obtained a tax benefit – the taxpayer entered into the scheme in question for the purpose of enabling the taxpayer to obtain a tax benefit in connection with the scheme. In doing so, the decision-maker must have regard to the factors mentioned in s 177D(b)(i)-(viii).
52. The purpose referred to in s 177D(b) is the sole or dominant purpose. As the High Court explained in Federal Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404 at 423 per Brennan CJ, Dawson, Toohey, Gaudron, Gummow and Kirby JJ, the real question is whether:
…a reasonable person would conclude that the taxpayers in entering into and carrying out the particular scheme had, as their most influential and prevailing or ruling purpose, and thus their dominant purpose, the obtaining thereby of a tax benefit, in the statutory sense.
53. I will address each of the matters referred to in s 177D(b)(i)-(viii) in turn.
(i) the manner in which the scheme was entered into or carried out
54. The applicants did not so much enter into a series of transactions as acquire a packaged solution from their solicitors. The instructions with the package required that they execute a series of pro-forma documents over the course of two days.
(ii) the form and substance of the scheme
55. The scheme involved the creation of a series of discretionary trusts. The applicants’ continued to control the shares, and D Company was not notified of the change in status of its shareholders.
(iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out
56. The scheme was entered into in April 1999. The taxpayers were already contemplating the sale of the property. Although an agreement to sell was still some way off, the sale was very much in prospect.
(iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme
57. Each of the taxpayers made a tax free gain of $349,999 on the sale of their share.
(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
58. Each of the applicants improved their financial position by the amount of the tax saved through the scheme on the proceeds of the sale of their share.
(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
59. The applicants’ professional advisers improved their financial position as a result of the transactions. They were paid for their advice. The other companies involved in the process did not experience a change in their financial position.
(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
60. There were no other consequences – apart from the gain for taxpayers.
(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)
61. The applicants were both directors of S Company, PB Company and AH Company. Mr QT2004/186 was also the sole shareholder in S Company, while Mrs QT2004/187 was the sole shareholder in PB Company. Individuals associated with the applicants’ legal advisers were directors of the other company that made the final distribution.
conclusions with respect to purpose
62. After having regard to all the matters set out in s 177D(b)(i)-(viii), a reasonable person would be satisfied the taxpayers’ entry into the scheme is explained by the prospect of a tax benefit. The applicants suggested in their evidence that they had other objectives in mind, including estate planning and the need to restructure their affairs given the state of their marriage. While those objectives might be legitimate, they do not explain the nature of the transactions that were entered into. The only rational explanation for the flurry of activity on 13-15 April was a desire to obtain a tax benefit.
63. I am satisfied the applicants entered into the transactions at a time when the sale of the shares was in prospect, even if the terms of an acceptable sale had not been finalised. The taxpayers and their in-laws were clearly anticipating a deal would be concluded: the evidence shows their discussions commenced in 1998, and inquiries were being made in March 1999 about the possibility of obtaining finance. The in-laws began setting money aside to fund the purchase of the shares in May 1999. I do not accept the flurry of activity in April was part of a separate process of estate planning, or restructuring in anticipation of matrimonial difficulties. The arrangements were designed to reap a tax advantage upon the sale of the shares.
64. I was not made aware of any other reasons that would suggest the Commissioner was wrong to exercise the discretion under s 177F to include the amount of $349,999 in the assessable income of each taxpayer in the year of income ending 30 June 2000. I therefore affirm his decisions to exercise the discretion to cancel the tax benefits.
penalties
65. That leaves only the question of penalties. The Commissioner imposed administrative penalties under s 226 ITAA36 equal to 50% of the tax shortfall. The Commissioner argued in the alternative that penalties under s 226L were appropriate because the taxpayers’ position was not reasonably arguable.
66. Section 226 is applicable where a tax avoidance scheme has been struck down. Section 226(2) sets the penalty percentage (the proportion of the tax shortfall that is to be collected as a penalty in addition to the total amount of the tax shortfall) at 50% unless it is reasonably arguable that Part IVA does not apply – in which case the penalty percentage is 25%.
67. I think the applicants did have a reasonably arguable case. The point they raised in relation to the effect of the election under s 122-A of ITAA97 was not easy to refute. I think they are entitled to have the penalty percentage reduced to 25% in the circumstances.
68. I do not think it is appropriate to remit the additional tax. I was not referred to any facts or circumstances that would justify the exercise of the discretion in s 227 of ITAA36.
conclusion
69. The objection decisions under review are affirmed save as to penalties. The Tribunal sets aside the decisions to impose penalty tax in the amount of 50% on each taxpayer pursuant to s 226 of the ITAA36 and substitutes a decision to pay penalty tax of 25%.
I certify that the 69 preceding paragraphs are a true copy of the reasons for the decision herein of
Signed: .....................................................................................
Associate: Sam J AppletonDates of Hearing 15-16 June 2005
Date of Decision 16 December 2005
The applicants were represented by Mr Russell, QC and Mr Bickford of counsel.
The respondent was represented by Mr Davies, QC and Mr Harding of counsel.
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