The Taxpayer and Commissioner of Taxation
[2008] AATA 325
•18 April 2008
Administrative Appeals Tribunal
DECISION AND REASONS FOR DECISION [2008] AATA 325
ADMINISTRATIVE APPEALS TRIBUNAL )
) No WT200600654-656
TAXATION APPEALS DIVISION ) Re THE TAXPAYER Applicant
And
COMMISSIONER OF TAXATION
Respondent
DECISION
Tribunal The Hon Robert Nicholson, Deputy President Date18 April 2008
PlacePerth
DecisionThe Tribunal:
1.varies the decisions under review by reducing the penalty to nil in respect of claims for deductibility of interest payments on borrowing costs for the purchase of units in a unit trust in each of the years of income ended 30 June 2000, 2001 and 2002; and
2.otherwise affirms the reviewable decisions in respect of the applicant’s liability to taxation in each of those years.
..........[Sgd Mr R Nicholson].............
Deputy President
CATCHWORDS
TAXATION – whether borrowing costs to enable investment in trust investing in income earning company qualify as allowable deductions – relevance of taxpayer’s subjective purpose in making borrowing – whether trust a fixed or discretionary trust – whether taxpayer was presently entitled to income of trust under terms of trust deed – whether penalties applicable to claim for deductibility of interest payments
TAXATION ‑ whether payment by employer company to charitable trust on occasion of taxpayer’s retirement from company an eligible termination payment – whether payment made ‘in consequence of’ taxpayer’s termination of employment – whether nevertheless the payment was deductible – whether penalties applicable to claim in respect of payment appropriate
LEGISLATION
Taxation Administration Act 1953 (Cth)
Income Tax Assessment Act 1997 (Cth)
Income Tax Assessment Act 1936 (Cth)
CASES
McCormack v Federal Commissioner of Taxation (1979) 143 CLR 284
Federal Commissioner of Taxation v Dalco (1990) 168 CLR 614
Danmark Pty Ltd v Federal Commissioner of Taxation; Forestwood Pty Ltd v Federal Commissioner of Taxation (1944) 7 ATD 333
Federal Commissioner of Taxation v Total Holdings (Australia) Pty Ltd (1979) 24 ALR 401
Ure v Federal Commissioner of Taxation (1981) 34 ALR 237
Kidston Goldmines Limited v Commissioner of Taxation (1991) 30 FCR 77
Fletcher and Ors v The Commissioner of Taxation of the Commonwealth of Australia (1991) 173 CLR 1
Commissioner of Taxation of the Commonwealth of Australia v Payne (2001) 202 CLR 93
Case M36 80 ATC 280
Reseck v The Commissioner of Taxation of the Commonwealth of Australia (1975) 133 CLR 45
McIntosh v Federal Commissioner of Taxation (1979) 25 ALR 557
Le Grand v Commissioner of Taxation (2002) 124 FCR 53
North Ryde RSL Community Club Limited v Commissioner of Taxation [2002] FCA 313
REASONS FOR DECISION
15 April 2008 The Hon Robert Nicholson, Deputy President
1. The applicant is a taxpayer who brought a notice of objection on 20 October 2005 in respect of the assessments of his taxable income for the years ended 30 June 2000, 2001 and 2002. On 28 April 2006 the applicant was notified by the respondent that he had disallowed the objections in respect of the assessments in respect of each of those years. The applicant now seeks review on the merits of those decisions.
2. The applicant’s contentions raise two principal issues. The first concerns whether borrowing costs incurred by him in relation to his investment in units in a trust (“the Trust”) should be found to be allowable deductions in each of the years in question. Also whether the penalty imposed on him by the respondent for claiming those costs as a deduction should be set aside or varied.
3. The second concerns whether a payment of $3.5million made by ABC Limited (“ABC”) to DEF Pty Ltd (“DEF”) as trustee for the GHI Trust (“GHI Trust”) should be found to be an eligible termination payment (“ETP”) to the applicant and so part of his taxable income. If so, whether the applicant is nevertheless entitled to a deduction having donated the $3.5 million to the GHI Trust. Also, whether the penalty imposed on the applicant by the respondent for not including the payment as part of his income when lodging his tax return should be set aside or varied.
WITNESSES
4. The respondent did not call any witnesses.
5. The applicant called the applicant and his wife; witnesses 1, 2 and 3, directors of ABC, with witness 3 also being the trustee of the Trust at the relevant time; and the applicant’s accountant, a partner in an accounting firm with responsibility for preparing the applicant’s tax returns for the years ended 30 Junee 2000, 2001 and 2002.
ONUS OF PROOF
6. The applicant accepts that under s 14ZZO of the Taxation Administration Act 1953 (Cth) (“TAA”) the applicant has the legal onus of proving that the assessments are excessive. However, the applicant argues that the respondent misunderstands the operation of s 14ZZO. Further that the applicant’s evidence, where it produces for him the slightest balance of probative evidence, is enough for him to succeed upon without the respondent discharging the evidential onus cast on him to make good any contrary asserted position. Also that where the respondent submits that facts should be found inconsistent with the evidence of the applicant, it was necessary for him the respondent to have cross-examined and to put his version to the witnesses.
7. The respondent argues the source of the applicant’s burden arises from s 14ZZK(b) of the TAA. It is contended this creates a rebuttable presumption which it is for the taxpayer to rebut: McCormack v Federal Commissioner of Taxation (1979) 143 CLR 284 at 323‑4. This means that the taxpayer does not discharge the onus by merely showing the Commissioner made an error in the assessment; rather the taxpayer must positively establish on the balance of probabilities that the amount in the assessment is excessive: Federal Commissioner of Taxation v Dalco (1990) 168 CLR 614 at 621.
8. In my view the respondent is correct in stating that the onus rests on the applicant throughout. There is no general evidentiary onus which once discharged shifts the burden of proof to the respondent. If it is necessary for the applicant to establish a particular fact in order to displace the assessment he must satisfy the court with respect to that fact: Danmark Pty Ltd v Federal Commissioner of Taxation; Forestwood Pty Ltd v Federal Commissioner of Taxation (1944) 7 ATD 333 at 337 per Latham CJ. If the applicant’s evidence directed to proving an assessment is excessive is rejected, it follows the applicant’s case must fail.
DEDUCTIBILITY OF INTEREST PAYMENTS ON LOANS TO APPLICANT FOR PURCHASE OF UNITS IN TRUST
factual background
9. ABC (now known by another name) was at the relevant times an exploration and mining company listed on the Australian Stock Exchange (“ASX”). It was engaged in the construction of a large mine and processing plant.
10. On 24 July 1994 the applicant was appointed a director and Chief Executive Officer of ABC. By 1999 he had also become its Deputy Chair and a substantial shareholder.
11. On 30 April 1999 the Trust Deed (“the Trust Deed”) was settled. Under the Trust Deed, witness 3 (“the Trustee”) held the trust fund (“the Fund”) on trust for unit holders and discretionary beneficiaries on the terms contained in the Trust Deed.
12. Clause 3.2 of the Trust Deed provided that:
The beneficial interest from time in the Fund is divided into the Unit Component, held on trust for the Unit Holders from time to time, and the Discretionary Component held on trust for such one or more or all of the Discretionary Beneficiaries from time to time to the exclusion of the other or others of them as the Trustee may from time to time revocably or irrevocably determine in the manner and as referred to in clause 11 and in such amount, shares, proportions or extents of either or both the Discretionary Component (and if both in the same or different amounts, share, proportions or extents) in each case as the Trustee in its absolutely and uncontrolled discretion may determine in the manner and as referred to in clause 11.
13. The terms “Unit Component” and “Discretionary Component” and other related definitions were defined as follows in cl 1.1 of the Trust Deed:
Beneficiaries means the Unit Holders and the Discretionary beneficiaries from time to time;
Discretionary Beneficiaries means each of the beneficiaries named or referred to in Schedule 6 and each Relative, Eligible Trust and Eligible Company nominated by the Trustee (with the consent of a majority resolution of Unit Holders) to be discretionary beneficiaries in each case as shall not be an Ineligible Person and as shall not have ceased to be a Discretionary Beneficiary by virtue of a declaration made pursuant to clause 11.4;
Discretionary Component means all Income which represents realised and unrealised capital gains derived from the holding or realisation of an Investment;
Fixed Income means such of all Income other than income comprising the Discretionary Component;
Fund means the Initial Sum ($10) and all money paid for Units; all other money, property and investments; all additions and accretions; all income produced from the Fund and any accretion gains;
Income means income produced from the investment, management or realisation of the Fund (or any part of the Fund) and includes any accretion, gain (whether or not realised), payment or receipt determined by the Trustee to be Income;
Investments mean all assets including cash forming part of the Fund;
Unit Component means:
(a)that amount of the capital of the Fund which from time to time represents the aggregate Issue Price of all Units then on issue,
(b)any and all Fixed Income so long as the Trust is not treated as a company for tax purposes, and
(c)if the Trust is treated as a company for tax purposes then the Trust shall have the right to accumulate income. Such an accumulation is to be distributed to the Unit Holders.
Unit components were dealt with in cl 4. Cl 4.1 provided that the beneficial interest in the Unit component is divided in to Units. Cl 4.2 provided:
Each Ordinary Unit shall be held by a Unit Holder in accordance with this deed (subject to the rights attached to such Unit) and confers an equal interest in the Unit Component. No Unit confers any interest in any particular part of the Unit Component.
Cl 4.7 provided that notwithstanding the Issue Price for which a Unit may have been issued, all fully paid Units of the same class are of equal value.
Clause 11 dealt with Discretionary Income as well as appointment and removal of Discretionary Beneficiaries. By cl 11.2 the Trustee could make a determination that one or more Discretionary Beneficiaries were Participating Beneficiaries. Absent such a determination and provided the Trust was not being taxed as a company, the Trustee was to hold the Discretionary component on trust for one or more of the persons in Schedule 7 of the Trust Deed.
Clause 12.1 of the Trust Deed was headed ‘Determination of Income’ and provided:
The Trustee without the consent of any person (including but not limited to a Beneficiary) may at any time and from time to time determine whether:
(a)(i) any amounts received or disbursed, or any amounts of income, profit or gain or loss;
(ii)any amounts derived accrued or incurred or deemed to have been derived accrued or incurred under the Income Tax Assessment Act 1936 as amended of the Commonwealth of Australia (1936 Act) or the Income Tax Assessment Act 1997 as amended of the Commonwealth of Australia (1997 Act) for or in respect of any Financial Year;
(iii)any amounts that under the 1936 Act or the 1997 Act are capital gains or capital losses and any amounts that are assessable income or allowable deductions with respect to the net income (as that term is understood for the purposes of section 95 of the 1936 Act or the correspondence provision of the 1997 Act) of this Trust for any Financial Year,
are on capital or income account or partly on capital and partly on income account and in what proportions and the decision of the Trustee whether made in writing or implied from the acts of the Trustee shall be conclusive and binding on all persons; and
(b)Any taxes expenses outgoings losses debts or obligations due or accruing shall or ought to be paid or borne out of the capital or income of the Fund and the determination of the Trustee in this respect shall be conclusive and binding on all persons.
Schedule 6 of the Trust Deed was headed ‘Discretionary Beneficiaries.’ Six categories were listed. The applicant and his wife were the first two. The third was the trustee of a Trust (“the J Trust”) constituted on 23 December 1992 between a settlor and another proprietary company. The fourth were the children of the applicant and his wife. The fifth was each person at any time being a unit holder. The sixth was each person appointed to be a Discretionary beneficiary pursuant to clause 11.4.
14. On 30 April 1999, the Applicant applied for and was issued with 10 ordinary units in the Trust with an issue price of $1.00 each.
15. On 30 June 1999, the Applicant raised several loans ( together with loans subsequently entered into collectively described as “the Loans”) for the purpose of purchasing 4,293,000 ordinary units in the Trust at an issue price of $1.00 each. The first loan was $4,500,000 from the ANZ bank (“the ANZ loan”).
16. For the year ended 30 June 2000, the Applicant prepaid interest on the ANZ loan in the sum of $207,692.00.
17. On 24 November 2000, the ANZ loan was repaid out of money borrowed by the Applicant from the Westpac Bank for that purpose (“the Westpac loan”).
18. For the year ended 20 June 2001, the Applicant paid interest payments totalling $458 077 in respect of payments to ANZ, Westpac and NAB.
19. For the year ended 30 June 2002, the Applicant paid interest on the Westpac loan in the sum of $192,292.00.
20. The applicant claimed as deductions the interest payments referred to in paragraphs 12, 14 and 15 above.
applicant’s contentions
21. The applicant contends that the correct question to be asked (and not so asked by the respondent) is whether the interest payments were incurred for the purpose of furthering the applicant’s present or future income: s 8-1 Income Tax Assessment Act 1997 (Cth) (“ITAA 1997”). The submission asserts that the issue of whether the interest payments were incurred in gaining or producing assessable income is to be determined by reference to the applicant’s subjective purpose.
22. The submission also raises an issue of interpretation of the Trust Deed. The applicant contends that the Trust is a fixed trust and accordingly, the interest payments claimed by him are wholly deductible. He argues that, properly construed, the Trust Deed created a hybrid trust by which:
(a)the assets representing the capital subscribed by unit holders in the Trust and all income received by the Trust is held on fixed trust for the unit holders in the Trust, in proportion to the number of units held by each of the unit holders as a proportion of the total number of issued units; and
(b)all realised and unrealised capital gains derived by the Trust are held on a discretionary trust for the discretionary beneficiaries.
respondent’s contentions
23. The respondent accepts that the issue to be determined is whether the interest expenses were incurred ‘in’ gaining or producing the applicant’s assessable income. The respondent submits that turns on whether the applicant was presently entitled to the income of the Trust at the time the outgoings were incurred.
24. The respondent contends that as a consequence of cl 12, the Trust was a wholly discretionary trust. Clause 12 of the Trust Deed allowed the Trustee to conclusively determine, without recourse to any other person, whether any amounts of income, profit or gain received, derived or accrued by the Trust were on capital or income account. The respondent contends that by reason of cl 12, the Trustee was able to determine conclusively, without recourse to any other person, whether any income fell within the Unit Component. Accordingly, the applicant had no fixed or present entitlement to income derived by the Trust by reason of his purchase of units in the Trust at the time that the units were acquired or at the time that he paid interest on the loans.Therefore the respondent contends the applicant did not incur the claimed interest payments in gaining or producing assessable income in any of the three years of income in question.
applicant’s subjective intentions
25. For the interest expenses to be deductible they are required to come within s 8-1 of the ITAA 1997. Relevantly that provides that a taxpayer can deduct from assessable income as a general deduction any outgoing to the extent that (a) ‘it is incurred in gaining or producing’ the assessable income or (b) ‘it is necessarily incurred in carrying on a business for the purpose of gaining or producing’ the assessable income which is not an outgoing of capital or of a capital nature, or of a private or domestic nature.
26. The respondent accepts (and the evidence supports) that the applicant acquired units in the Trust in the expectation that it would acquire shares in ABC and in some future time that ABC would pay dividends on its issued shares.
27. So far as concerns the evidence of a payment made in error of income to a discretionary beneficiary, the applicant submits it is not a foundation upon which to disbelieve the evidence given by the applicant, his wife, witness 3 or the applicant’s accountant. He consents to an out of time amendment to his tax return for the year to 30 June 2001 to reflect the $12 010 mistakenly so paid to the J Trust to be income earned by him.
However, the respondent contends there is no evidence to sustain a finding of mistake in this instance. The applicant did not know about the distribution. Neither did witness 3 or the applicant’s wife. The accountant had no knowledge of it until the distribution was raised in this application and had no recollection that assists. The respondent submits, and I accept, that what occurred with the distributions by the Trust in income year 2001 can only serve to support the applicant’s lack of any present entitlement to the income of the Trust at the time he incurred the interest payments, if that otherwise proves to be the case.
28. The applicant has always maintained that it is his purpose which is the relevant fact to determine the issue of his entitlement to the deduction he claims in respect of the interest payments. He asserts that no inference adverse to him should be drawn from the terms of the Trust Deed (if it is found to be discretionary rather than fixed) when he reasonably held his belief that the Trust Deed established a fixed trust, a belief held by his accountant who had legal advice as to concerning the proper construction of it.
29. The applicant submits that a loss or outgoing is deductible from a taxpayer’s assessable income if the loss or outgoing is ‘incurred in gaining or producing’ the taxpayer’s assessable income. The submission is that the applicant’s borrowing costs and interest expenses fall within this description as those costs were incurred ‘for the purpose of furthering his present or prospective income producing activities’: Federal Commissioner of Taxation v Total Holdings (Australia) Pty Ltd (1979) 24 ALR 401 at 406 per Lockhart J, Northrop and Fisher JJ agreeing; see also Ure v Federal Commissioner of Taxation (1981) 34 ALR 237 at 241-2 per Brennan J, 248-9 per Deane and Sheppard JJ.
30. The applicant argues that whatever the proper construction of the Trust Deed, ‘it appears to create a fixed trust of income.’ Further that the applicant and his accountant believed it did so. Also that no reason has been advanced why the applicant would have incurred the interest costs other than to earn income from the investment. This latter aspect is accepted by the respondent.
31. The respondent claims that its concession says nothing concerning who might receive distributions from the Trust generated by any dividend income and in particular, whether the applicant was presently entitled to any such income so as to establish the required connection between the interest payments incurred by him and the gaining or producing of assessable income by him.
32. I do not see how the matters on which the submissions of the applicant seek to rely can preclude a proper examination of the true effect of the Trust Deed.
The issue is the degree of connection between the outgoing and the gaining ‘in’ gaining or producing assessable income. The phrase ‘incurred in gaining or producing’ means incurred ‘in the course of’ gaining or producing: Commissioner of Taxation of the Commonwealth of Australia v Payne (2001) 202 CLR 93 at [9], 99; [16]-[17], 102 per Gleeson CJ, Kirby and Hayne JJ; and [25], 105 per Gaudron and Gummow JJ.
In determining the essential character of an interest expense regard is to be had to both the purpose of the borrowing and the application or use of the borrowed funds: Ure v FC of T at 248-9 and Kidston Goldmines Limited v Commissioner of Taxation (1991) 30 FCR 77 at 84‑5. Generally, the purpose of a borrowing can be determined from the use of borrowed funds and outgoings of interest ordinarily draw their character from that use: Fletcher and Ors v The Commissioner of Taxation of the Commonwealth of Australia (1991) 173 CLR 1. In determining deductibility regard must therefore be had to all of the objective circumstances surrounding the incurring of the expense: Fletcher at 18-19.
Trust income is taxed in accordance with the provisions in Div 6 Part III of Income Tax Assessment Act 1936 (Cth) (“ITAA 1936”). A beneficiary is assessable where presently entitled. A trustee is assessable on the net income of the trust to which no beneficiary is presently entitled. To derive assessable income a beneficiary must be presently entitled to a share of the income of the trust estate. A beneficiary will not be entitled to deduct interest expenses incurred in acquiring units in a Trust if he or she is not presently entitled to any part of the trust. This is because in such circumstances the beneficiary has at most a mere expectation of deriving income. That is insufficient to establish a connection between the outgoing and the gaining or producing of income. Cf Case M36 80 ATC 280.
33. It follows that neither the belief of the applicant nor of his accountant is sufficient of itself to establish and sustain the condition of present entitlement so as to support the applicant’s claim for deductibility. Unless the Trust Deed clearly provided for such entitlement as a matter of objective determination rather than subjective belief, the requisite condition of present entitlement may not be made out. It is therefore necessary to turn to consider the terms of the Trust Deed.
construction of the trust deed
34. An outline of the provisions of the Trust Deed has been set out above. It is necessary to examine cl 12.1 in detail.
35. The first feature of cl 12 is the heading, reading ‘Determination of Income.’ In fact the clause, while addressing various categories of income, also addresses much more than income, namely capital gains, capital losses, allowable deductions, any part of the Fund of a certain type, source, class or character, a transfer in specie of any property and any real or personal property. The heading is not therefore a reliable descriptor of the content of the clause.
Clause 1.3 provides that in the Trust Deed headings are used only for convenience and do not affect interpretation. Given both the limitation in the wording of the heading and this clause, I do not consider any reliance can be placed on the heading.
36. The contents of sub-clause 12.1(a) may be summarised as follows:
(a)It is discretionary, being at the discretion of the Trustee to exercise ‘at any time and from time to time…’
(b)It is applicable to a wide range of amounts, namely
(i)Amounts received; amounts of income, profit or gain; amounts derived, accrued or incurred or deemed to have been so under the ITA 1936 or ITA 1997; assessable income with respect to net income as understood for the purposes of s 95 of the ITA 1936 and the corresponding provision of the ITA 1997;
(ii)Amounts disbursed or the subject of a loss;
(iii)Amounts being capital gains or capital losses under the ITAA 1936 or ITAA 1997.
(c)The discretionary power is to determine whether any such amounts ‘are on capital or income account or partly on capital and partly on income account and in what proportions…’
(d)The decision of the Trustee under cl 12.1(a) whether made in writing or implied from the acts of the Trust shall be conclusive and binding on all persons.
37. The contents of sub-clause 12.1(b) may be summarised as:
(a)It is applicable to ‘any taxes expenses outgoings, losses, debts or obligations due or accruing…’
(b)The power provided by the sub-clause is to determine whether any of these ‘shall or ought to be paid or borne out of the capital or income of the fund…’
(c)The determination of the Trustee in this respect is ‘conclusive and binding on all persons.’
38. Clause 12 also requires reading with cl 13 which provides for limitation of a beneficiary’s entitlement. The effect of cl 13 is that other than as provided in the Trust Deed, neither a Unit Holder nor a Discretionary Beneficiary is entitled to interfere with any of the trusts, rights powers, authorities or discretions of the Trustee; to interfere with or question the exercise or non-exercise by the Trustee of any of them; to exercise any rights, powers or privileges in respect of any Investment or to require the transfer of any part of the Fund or an Investment.
39. The respondent contends that the effect of these provisions read in the context of all the provisions of the Trust Deed is that the Trust is a discretionary trust of income. It is this which the applicant argues is plainly wrong, contending that properly construed the Trust Deed creates the hybrid trust of a fixed trust component and of a discretionary trust component.
40. The respondent argues that the effect of cl 12.1 is to empower the Trustee, without the need for consent of any other person, to at any time and from time to time determine whether any amount received by the Trust is on capital or income account, regardless of the source of the receipt or how the amount received would otherwise be characterised (as capital or revenue) for accounting and income tax purposes. That is, for example, the Trustee could determine that a dividend received by the Trust which would ordinarily form part of the Trust’s income shall be on capital account. The consequence it is said is that the Trustee may determine at any time whether any amount received by the Trust shall form part of the Discretionary Component or Fixed Income.
The further consequence of this, argues the respondent, is that at the time the applicant incurred the interest expenses it was not possible to say whether any future dividends paid by ABC and received by the Trust would be treated as forming part of the Unit Component to which he would be entitled or as part of the Discretionary Component to which Discretionary/Participating Beneficiaries would be entitled. As the matter was entirely at the discretion of the Trustee it could not be said that at the time of incurring the expenses the applicant had any vested entitlement to a distribution of income from the Trust generated by any dividends received by the Trust. The respondent maintains the correct view is that the applicant’s entitlement was entirely contingent and represented a mere hope or expectation.
The submission is said to be supported by the absence of any evidence of any understanding between the applicant and the Trustee regarding future distributions.
41. The applicant brings several arguments against this construction.
He says that there is an inconsistency between cl 3 and cl 12. I do not agree. Cl 3.2 comes into operation once the determination of relevant character is made under cl 12. The presence of cl 3 does not require cl 12 to be read down on the basis of a distinction between general and specific provisions.
Likewise it cannot be argued from the language of cl 3 that the objective intention of the parties was to create a fixed trust of income. That is because cl 12 demonstrates the contrary intention.
The applicant then submits that cl 12 confers a mere power on the Trustee while cl 3 creates a trust. It is said that the discretion conferred on the Trustee in exercising that power is limited to the scope of the power. It is argued that the power is of a fiduciary character so that it must be fairly and honestly exercised in good faith. In exercising the power on the basis of these principles the Trustee ‘had no discretion’; that is, the Trustee was bound to correctly characterise a receipt as capital or as income. The power (acknowledged by the applicant to be apparently broad) is to be understood as limited to the beneficiaries’ entitlement pursuant to the Trust.
The applicant says that the more broad expression of the power which appears in cl 12 may be explained by the evidence of the deletion from the Trust Deed of the provisions for Residual Income.
42. It is not in issue that the Trustee is required by law to exercise the power in cl 12 fairly, honestly and in good faith. That is, if an item of income has the character of a capital gain the Trustee could not lawfully exercise the power in cl 12 to declare it a non-capital item of income. Likewise, that a non-capital item of income could not be found by exercise of the power to be a capital item. The applicant therefore contends that the power cannot be exercised so as to alter the true character of a receipt, for if that occurred the Trustee would be engaging in a fraud on the power. The concept of fraud on the power is examined in Meagher, Gummow & Lehane’s Equity Doctrines and Remedies Fourth ed., (Butterworths LexisNexis, 2002) p445 and in Dal Pont and Chalmers Equity and Trusts in Australia Fourth ed., (Lawbook Co., 2007) p249.
It would appear open to argument whether an exercise of the power in cl 12 of the Trust Deed so as to alter the character which an item of income had at law, would in fact establish a fraud on the power. This is because the terms of the power confer the wide discretion on the Trustee. Assume, however, that the power could only be exercised so as to recognize the true character of the any item of income. That does not appear to me to result in a position where the discretionary power provided for in cl 12.1 can be taken at law as having been actually exercised when in fact the power has not been exercised. The problem for the applicant is that the power is provided for in very wide terms so that, until its exercise, it is not possible for it to be known in what terms the Trustee has accepted a particular item of income. Consequently, there cannot be any present entitlement. To establish present entitlement it cannot be assumed that because the power can only be exercised lawfully in one particular way that it has in fact been so exercised.
I agree with the submissions of the respondent that cl 12.1 would not be in the form in which it now appears if it had been intended that the Trustee was bound to allocate capital gains to the Discretionary Component and all other receipts to the Unit Component. The wide language of the clause requires the Trustee to determine the destination of a distribution of an amount received by the Trust. Until that has been done, the condition of present entitlement cannot be found to exist because, under the provisions of the power in the clause, there exists the real possibility that the Trustee could determine the destination of a distribution other than in accord with whether its true character was that of a capital gain or fixed Income.
43. No limitation on the terms of the power in cl 12 can arise from the deletion of the provisions concerning Residual Income. The issue is whether the power in cl 12.1 inhibits the applicant asserting present entitlement.
44. Likewise the issue whether the Trust Deed could be rectified does not arise here and the possibility that such rectification may properly be sought cannot assist the interpretation of the Trust Deed at the present time.
penalties on interest payment issues
45. On the issue of the penalties imposed with respect to the claim for deductibility of interest, the applicant contends that he obtained reasonable accounting advice to the effect that the costs he incurred in relation to the Loans were deductible from his income. Consequently, he argues it cannot be concluded he had not acted reasonably when consideration is given to imposition of penalties under ss 222C (1) and 226 of the ITAA 1936 and ss 284-10, 284-15 and 284-90 of the TAA.
46. On the issue of the penalty the respondent states that the applicant failed to take reasonable care to comply with tax laws when he claimed the deductions for the 2000 year and failed to take a position that was reasonably arguable with respect to this issue in the 2001 and 2002 years, so that a penalty of 25% of the shortfall amount is appropriate in the circumstances.
47. The sections upon which reliance is placed by the respondent for imposition of the penalties with respect to the tax shortfall caused by reliance by the taxpayer on the deductibility of the interest payments is not in dispute and are as follows.
With respect to the 2000 year of income, s 226G of the ITAA 1936, which creates a liability to pay by way of penalty additional tax equal to 25% of the amount of the shortfall where the taxpayer has not ‘acted with reasonable care.’
With respect to the 2001 and 2002 years of income, the administrative penalty provisions of the TAA had come into effect and ss 284-290 provide the relevant authority for the imposition of the penalty. These may apply where the taxpayer entity has failed to meet its obligations, in this case by ‘taking a position that is not reasonably arguable’: s 284‑10. Section 284-15(1) states that ‘a matter is reasonably arguable if it would be concluded in the circumstances, having regard to relevant authorities, that what is argued for is as likely to be correct as incorrect, or is more likely to be correct than incorrect.’
Also to be considered are IT Rulings 94/3-5 and 94/7. IT94/4 para 6 state that the reasonable care test requires a taxpayer to take the care that a reasonable, ordinary person would take in all the circumstances of the taxpayer to fulfil the taxpayer’s tax obligations. Further that provided a taxpayer may be judged to have tried his or her best to lodge a correct return, having regard to the taxpayer’s experience, education, skill and other relevant circumstances, the taxpayer will not be liable to pay a penalty. Para 14(b) states that a critical point is that the reasonable care test is not intended to be overly onerous for ordinary taxpayers. Para 14(f) states that if the taxpayer is uncertain about the correct tax treatment of an item, reasonable care requires the taxpayer to make reasonable enquiries to resolve the issue. As para 14(k) makes apparent, mere reference to a tax agent or adviser does not absolve the taxpayer from taking reasonable care, for example in maintaining appropriate records and drawing all relevant facts to the agent’s attention.
IT 94/5 para 9(a) makes clear that the reasonably arguable test does not require that the treatment given a particular matter by a taxpayer must be the better view, or be more likely than not the correct treatment. The test is said to be ‘about as likely as not.’
48. In his statement the applicant contends that he was not liable for penalties in respect of the interest expenses on the Loans claimed as deductions because he obtained reasonable accounting advice that the costs he incurred were so deductible; that advice was based on a reasonable construction of the Trust Deed and on projections of the likely dividends to be paid by ABC to the Trust; and so the conduct of the applicant and his agent (his tax accountant) acted reasonably in claiming the deductions.
49. The evidence shows that the applicant left his tax affairs to others on his staff and to his accountant, an experienced tax partner with Ernst & Young. I agree with the submission of the respondent that the applicant must rely on whatever steps were taken by his accountants to establish that he exercised reasonable care.
The accountant was cross-examined on the extent of his attention to the issue of deductibility of the interest payments. In his witness statement he referred to written advice concerning the terms of the Trust Deed but in cross-examination stated he could not ‘even be certain that there was written advice.’ His statement nevertheless stated that earlier advisers to the applicant (‘TUV’) had advised him that all income received by the Trust was held on a fixed trust for the holders of units in the Trust, a view which his own reading of the Trust Deed had confirmed.
He further stated that prior to preparing the applicant’s tax returns for each of the three years in issue he had a meeting with the applicant and witness 3, the Trustee. There is no evidence of any relevant information being communicated to him by the Trustee. The evidence also does not satisfy me that any such meeting took place in respect of the 2001 and 2002 returns, only that it did so with respect to the 2000 return. It was from that meeting that the accountant was satisfied by statements from the applicant that the interest payments were on the Loans which were for the purpose of attracting dividends to the Trust from ABC. Although the evidence of the accountant had much hesitancy in memory of these matters, I am nevertheless left with the clear impression that his specific evidence of recall of a discussion with the applicant should not be understood as subject to such hesitancies.
The accountant testified that having formed the view in the first year in issue as to the reasonable basis for the deductibility (being based on a reading of the Trust Deed and consideration of the subjective intention of the applicant) there was not any specific or detailed consideration of that view by him or his firm in subsequent years until the occasion of an audit in 2003. The claims for deductions for interest were therefore based upon the amounts of which his firm was instructed by staff members of the applicant.
(I do not consider that there is any outstanding need to address anything remaining from the objection somewhat tentatively raised by the respondent to the issue of the accountant having refreshed his memory).
The respondent nevertheless seeks to support the view that the applicant has not established that the imposition of these penalties was wrong because of matters not disclosed by the evidence. Firstly, that neither the accountant nor his firm considered it was their function to seek to obtain from the Trust the relevant minute of distribution. That is, they relied upon advice from staff for the applicant that the present entitlement was in place. However, the applicant’s case has not extended to non-existence of present entitlement save as due to the existence and non-exercise of cl 12.1 of the Trust Deed. Secondly, no private ruling was sought. While that was an option, there was then no division of opinion on the effect of cl 12.1 and the Trust Deed to make such a reference necessary. Furthermore, failure to seek a private ruling may not in the circumstances necessarily constitute a failure to take reasonable care: North Ryde RSL Community Club Limited v Commissioner of Taxation [2002] FCA 313. Thirdly, any written advice from TUV concerning the effect of the Trust Deed has not been produced and nor has any explanation why such documents are not available been produced. In these circumstances the respondent submits that the circumstances relied upon by the applicant are insufficient to establish the respondent was wrong to impose these penalties.
50. The critical issue is whether the accountant, and thereby the applicant, has been shown to have acted with reasonable care in 2000. In my view the core of that issue is whether it was unreasonable for the accountant to form and to rely upon the view he formed of the effect of cl 3.2 of the Trust Deed. The view was that the Trust was a fixed trust constituted by cl 3.2 and cl 12.1 took effect subject to cl 3.2. The accountant was not himself a legal practitioner and it was not lacking in care for him to have carefully come to the view from his reading that cl 3.2 was of dominate effect. That view was not reached without exercise of care, even though I hold the view it was wrong.
Reliance by the accountant on the view which he had formed with respect to the first year in 2000 could not in my view be said not to be reasonably arguably a correct application of the law. The view on the effect of the document (and the purpose of the investment) having been formed, there was no necessity for the accountant to either re-examine the Trust Deed or to discuss the Trust with the applicant in respect of each of these subsequent years. The view of the law on which they were founded, including the understanding of the mutual effect of cls 3.2 and 12.1, had not been called into question. That is, the view of the applicable law which he had formed on a reading of the Trust Deed for the year 2000 was as likely to be correct as incorrect in the subsequent years of 2001 and 2002.
I agree with the submission of the applicant that the assertion that he proceeded without reasonable care comes down to the proposition that the accountant formed an incorrect opinion on the effect of the Trust Deed. It is apparent that the view was formed with care and its incorrect view of the law does not vest the conduct relating to its formation with the character of unreasonableness.
In these circumstances, the applicant having sought professional advice from his accountants and the principal accountant having acted as found, I do not consider it can be concluded that the applicant either acted without reasonable care in 2000 or that his conduct with respect to his return in 2001 and 2002 was not reasonably arguable. The consequence is that I consider the penalties with respect to the interest payment deductions on the Loans are excessive and should be set aside under s 14ZZK of the ITAA 1997.
ELIGIBLE TERMINATION PAYMENT ISSUE
51. The issue is whether the payment made to DEF as trustee for the GHI Trust was an ETP made in relation to the applicant in the year ended 2002 pursuant to s 27A of the ITAA 1936. That section required that an ETP in relation to a taxpayer to include ‘any payment made in respect of the taxpayer in consequence of the termination of any employment of the taxpayer’ other than certain payments not said to be relevant here.
The issue requires the Tribunal to consider the meaning of the expression ‘in consequence of’ when used in the definition of an ETP; whether the payment by ABC was made ‘in consequence of’ the termination of the applicant’s employment as CEO of it (as the respondent contends) or whether the payment was made in consequence of the resolution of a dispute between ABC’s shareholders over the control of ABC (as the applicant contends).
factual background
52. The applicant and his family owned 8% of ABC’s issued shares. KLM limited (“KLM”) and NOP Limited (“NOP”) owned around 25% and 22% respectively, with QRS Limited (“QRS”) owning around 9%.
53. From mid-1999 the applicant had proposed giving some of his family’s shareholding in ABC to a private charitable trust. By May 2001 that proposal had not progressed, according to the applicant’s account, due to difficulties within ABC.
54. On 21 July 2000 the applicant exercised his right under an Employee Share Scheme to acquire 497,238 shares in ABC at $2.77 per share.
55. On 9 April 2001 the 497,238 ABC shares were sold at $1.37 per share. On the same day 1,992,424 ABC shares were purchased at $1.37 per share.
56. On 4 April 2001 KLM requisitioned an EGM of ABC’s shareholders. The meeting was to be held on 31 May 2001. This was the culmination of a bitterly fought battle to wrest control of the board of ABC from the applicant and those who supported him, the particularities of which it is not necessary to explore to decide this issue.
57. On the morning of 31 May 2001 the applicant was informed that QRS had given its proxy to NOP, with the consequence that the applicant and those supporting him would be defeated at the EGM.
58. The applicant and other directors of ABC then embarked on negotiations with QRS and NOP in the belief that NOP would make concessions to avoid a public vote. The result was that an agreement was reached between the major shareholders of ABC.
59. The following were the elements of the agreement:
*NOP re-affirmed its commitment to underwrite a previously announced rights issue, which KLM and QRS agreed to support.
*the applicant was to stay as CEO of ABC until the earlier of 18 November 2001 or the appointment of a replacement CEO. He was to receive his outstanding leave and similar entitlements and 10m options in ABC, exercisable at $2.50.
*the applicant was to remain as a director and deputy chairman of ABC until some time after he resigned as CEO.
*NOP agreed to contribute $3.5m for a charity to be established by the applicant. Independent ABC directors likewise agreed to a further donation in that amount. KLM agreed in principle to consider the possibility but later did not proceed with making a donation.
*a standstill agreement was entered into preventing NOP, KLM, QRS or the applicant from acquiring more than 30% of ABC until the later of 90 days after publication of a strategic review of ABC or 31 December 2001.
*a person from QRS was to be appointed Chairman and a new director was appointed to replace the former Chair as director.
*it was agreed that another director who had resigned and who had been a supporter of the applicant, would not be replaced.
*ABC’s Chief Finance Officer resigned as both an employee and director of ABC.
*KLM withdrew its resolutions to remove the applicant and his supporters as directors.
*a strategic review of ABC’s activities was to be undertaken.
*a press release was to be issued.
60. On or about 31 May 2001, the Board of Directors concluded that a redundancy payment of $3.5M be paid to the applicant as fair and reasonable, together with other severance entitlements. The Board agreed that the redundancy payment be made to him upon retirement, which was scheduled to occur on or before 18 November 2001. The applicant’s case contends that these resolutions wrongly characterised this payment of $3.5m as a payment to the applicant. Likewise a deed was entered into, which has been lost, but which the applicant accepts. In the heat of events of 31 May 2001 (with KLM’s lawyers taking the lead in drafting) it can be inferred as having wrongly characterised the payment in the same way.
61. The evidence which the applicant’s case particularly relies upon in this respect is as follows:
(a)the applicant’s evidence that the agreement was that ABC and NOP both make a payment of $3.5m to a charity of the type proposed and that such was a term of the agreement by which NOP and KLM took control of ABC.
(b)Witness 2’s evidence that ABC had agreed to make the same donation as NOP and that the minutes were in error in stating the payment was to the applicant. From his perspective he said the donations by ABC, NOP and KLM were part of the terms on which the applicant gave up control of ABC. The payment was not a payment to compensate him for leaving the job; rather they were part of the price he demanded for giving up ABC without putting NOP to a public vote.
(c)Witness 3’s evidence, also to the effect that the minutes were in error and that a representative of NOP had agreed to make a donation to charity. He saw the payments to the applicant as a separate issue.
(d)Witness 1’s evidence that he understood the reference in the resolutions of the meeting of 31 May 2001 to be referrable to the donation by NOP and not ABC.
(e)the applicant’s wife’s statement also that the applicant had not mentioned ABC’s donation at the EGM but she had agreed it with him before that meeting was held.
62. In September 2001 the applicant sought to sell 7m shares in ABC at $0.50 each (being half the market price). This was subsequently explained as being to sell 3.5m shares to the GHI Trust for $1 a share and give 3.5m shares to the GHI Trust. He requested ABC to make its payment of $3.5m to the GHI Trust early (that is, before the date provided for his resignation) so that the funds could then be used by DEF to purchase shares from him and interests associated with him.
63. On 4 & 5 September 2001 the ABC Audit Committee included the following item in its minutes:
‘CEO Termination
[X] asked for clarification of the treatment of the CEO termination arrangements. [Witness 3] advised that the proposed donation by [ABC] of $3.5 million had been fully provided for in the accounts.’
64. The notes to and forming part of the financial statements for the year ending 30 June 2001 for ABC forming part of ABC’s annual report dated 12 September 2001 (preceding ABC board meetings of 25 and 26 September) stated: “Termination arrangements between the Company and [the applicant] provide, subject to finalisation, inter alia for the Company to make a donation of $3.5M to a charitable trust established by [the applicant] for the Benefit of under privileged Australian children. [NOP] has committed to making an equivalent donation with [KLM] plc considering the same”.
65. At the Director’s meetings of ABC held on 25 and 26 September 2001 a director (not aligned to the applicant) raised the question why the payment was directed to the applicant when it was intended for a charitable trust. Witness 3 said that the payment had always been disclosed as a termination payment with the applicant but he had submitted an invoice to ABC for the amount to be paid to [a charitable trust]. The applicant said that the payment (which he described as a ‘termination payment’ rather than a ‘redundancy payment’) was always to have been made direct by ABC to the nominated charity and not to him. The board agreed to enter into a new deed to correctly record that position but refused to accelerate payment of the donation to the GHI Trust.
66. DEF was incorporated on 19 September 2001. Around 28 September 2001 the applicant entered into a trust deed with DEF dated 25 September 2001, establishing the GHI Trust. It was varied by a deed of 22 January 2002.
67. Email correspondence between the solicitors for ABC, KLM and NOP respectively on 28 September 2001 records that the ‘commercial agreement’ reached on 31 May 2001 was that ABC would pay $3.5m to the GHI Trust.
68. After drafting negotiations commencing around 28 September 2001, the applicant and ABC entered into a deed (“the November Deed”) on 16 November 2001. Recital C of the November Deed stated:
‘Following negotiations between [ABC] and [the applicant] [the applicant] has decided to resign from [ABC] and agreed to enter into this deed in full and final satisfaction of all claims relating to [the applicant’s] resignation.’
It was further recited that ABC had relied upon the representations of NOP and KLM concerning the making of the donation of $3.5m in entering into the November Deed.
The November Deed provided in cl 1 that ‘in consideration of the mutual promises contained in this deed’ the applicant ‘resigns from employment with and as Chief Executive of the’ ABC and fixed the applicant’s retirement date on the earliest of 18 November 2001 or the date of commencement of a replacement CEO. In cl 2 it provided a covenant for the applicant to be paid statutory, superannuation and accrued leave entitlements (to be treated as an ETP) and, subject to requisite approval, grant to him 10m share options.
The November Deed further provided in cl 3(a) for ABC’s commitment to donate an amount of $3.5m to DEF as trustee of the GHI Trust or to any other charity for a similar purpose as the applicant may nominate, payment to be made on 16 November 2001 to the TUV Legal Trust Account pending notice from the applicant: cl 3(b). It was agreed and acknowledged between the parties in cl 4 that should the donation be treated as an ETP, all tax and other amounts would be payable by the applicant.
Clause 5 provided a mutual discharge ‘in consideration of the fulfilment of the obligations of [ABC] under clause 2 of this deed and the [applicant’s] resignation, and subject to [ABC] making the donation pursuant to clause 3…”
Additionally is should be noted that cl 18 of the November Deed provided that it constituted the entire agreement between the parties and superseded all previous ‘representations, warranties, covenants, guarantees, agreements, and other terms and conditions, not contained and recorded in this deed.’
When drafts of the November Deed were exchanged between the proposed parties, the applicant did not seek any amendment of the recitals or the operative provisions of the November Deed connecting the payment by ABC with the termination of his employment.
In addition to relying on the substance of the November Deed, the applicant’s case stresses that the fact this Deed was entered into by the board of ABC which was by then largely antagonistic to him, is strong proof that the records of the agreement reached on 31 May 2001 were in error in referring to the donation being payable to him.
69. Payment of the $3.5M was made by ABC to the TUV account on 16 November 2001, on which date the applicant resigned as CEO of ABC.
70. On 20 December 2001, the applicant by letter directed ABC to authorise TUV to pay the $3.5M to the GHI Trust, regardless of the fact that the GHI Trust had yet to be endorsed as a Deductible Gift Recipient (DGR) and Income Tax Exempt (ITE) charity. It is not in dispute that the letter constituted a direction for the purpose of s 27A(3)(a)(iii) of the ITAA 1936.
71. On 31 December 2001, the $3.5M was deposited into DEF’s Account.
72. On 15 January 2002 $3.5M was withdrawn from the DEF account and deposited into another Westpac account operated in the name of the applicant. The $3.5M was paid by DEF in an off market transaction to the applicant and related parties for the acquisition of 4,117,643 ABC shares. For the purpose of the transaction the shares were valued at 85 cents each, while on the day the ASX closing price for such shares was 74 cents. The ABC shares sold in this off market transaction to DEF included 1,976,551 owned directly by the applicant. Of the purchase price the applicant donated back $2.45m to the GHI Trust, making an effective purchase price of $3.5m.
73. On 15 February 2002 the applicant’s interests transferred 7m ABC shares to DEF for which they were paid $3.5m.
74. In about May 2002 NOP made its donation of $3.5m to a separate charitable trust for transfer to the applicant’s nominated trust.
applicable law
75. In addition to the requirement of s 27A(1) of the ITAA 1936 that the payment must be made ‘in respect of the taxpayer’ and ‘in consequence of the termination of any employment of the taxpayer’ (subject to express exceptions, none of which is contended as being relevant here), there are the provisions of s 27A(3)(a)(iii) that require application. Those latter provisions require that the payment be made during the life of the taxpayer:
(i) to or for the benefit of the taxpayer;
(ii)to or for the benefit of a dependant of the taxpayer; or
(iii)to another person at the direction or request of the taxpayer.
76. The undefined phrase ‘in consequence of’ is the subject of Taxation Ruling 2003/13. The view adopted by the Commissioner in that ruling is that a payment is made in such consequence if it ‘follows as an effect or result of’ the termination. It is said to require a causal connection between the termination and payment, although the termination need not be the dominant cause of the payment. The Ruling makes reference to a number of authorities.
77. The scope of the phrase ‘in consequence of’ as been examined in Reseck v The Commissioner of Taxation of the Commonwealth of Australia (1975) 133 CLR 45 per Gibbs J at 51 and Jacobs J at 56. Additionally by the Federal Court in McIntosh v Commissioner of Taxation (1979) 25 ALR 557 particularly by Brennan J at 560, Toohey J at 564 and Lockhart J at 571. These judgments were reviewed extensively by Goldberg J in Le Grand v Commissioner of Taxation (2002) 124 FCR 53 at 63. There his Honour said:
‘…The thrust of the judgments in Resek and McIntosh is rather to the effect that a payment is made ‘in consequence’ of a particular circumstance when the payment follows on from, and is an effect or result, in a causal sense, of that circumstance…’
His Honour also concluded that those authorities make it clear that there need not be identified only one circumstance which gives rise to a payment nor that the termination be the dominant cause of payment so long as the payment follows, in the causal sense referred to in those judgments, as an effect or result of the termination.
I cannot see any reason why I should not follow the reasoning of Goldberg J.
determination of etp issue
78. It is apparent from the reasoning in Resek, McIntosh and Le Grand that the issue of whether the payment was made ‘in consequence of’ the termination of the applicant’s employment is to be determined by reference to all of the circumstances surrounding the making of the payment.
The result is that it would not be appropriate to determine the issue concerning ETP by examination only of the events which occurred on 31 May 2001. The applicant’s contention that the events on that day establish in themselves that the agreement to pay was in consequence of the need to resolve the battle for control of ABC is not one which can be reached only by examination by the events of that day.
In any event, I agree with the respondent’s submission that when the events of that day are examined they would not support a conclusion as sought in that regard by the applicant. This is so even if one starts from the proposition that Schedule A to the minutes of the board on 31 May 2001 wrongly recorded the applicant as the intended recipient of the charitable donation.
79. I agree with the respondent’s submission and consider the evidence of the events of 31 May 2001 establishes that the decision of the board of ABC to agree to make a payment of $3.5m would not have occurred but for the applicant deciding he would resign as CEO if acceptable terms could be agreed. The evidence establishes that the payment by ABC was one of the terms the applicant bargained for in exchange for relinquishing control by resigning as CEO of ABC. The evidence of witness 2 provides further support for this conclusion. The contrary view is supportable even if it was thought at the time that the applicant’s resignation must be the dominant cause or that a payment to a third party at the applicant’s request or direction was not encompassed by the statutory provisions constituting the ETP. In my view it is clear from the evidence on 31 May 2001 alone that the payment would not have been made but for the applicant’s agreement to resign. It was part of the consideration for his resignation, arguably even in the way the applicant has presented his case in respect of the events of that day. The fact that the context for ABC agreeing to make the payment was a dispute between its shareholders does not destroy the connection between the payment and the termination of the applicant’s employment.
80. Critical among the events subsequent to 31 May 2001 was the conclusion of the November Deed. It was pursuant to that Deed that the payment in issue was made.
I agree with the respondent that it is abundantly clear from the recitals and the operative provisions of the November Deed that the payment of the $3.5m was made in consequence of the applicant’s termination of his employment in that it followed on from the termination and possessed the requisite connection with the termination. The consideration for the November Deed was expressed to be the mutual promises contained in it. These were that in consideration of the applicant resigning from his employment ABC agreed, among other things, to acknowledge its commitment to make the payments of $3.5m to DEF to make the payment by the means stipulated in cl 3(b) of the November Deed.
Further, the releases and covenants in cl 5 were expressly stated to be in respect of the applicant’s employment ‘in accordance with this deed.’ They were ‘subject to’ ABC making the payment of $3.5m. I agree with the submission of the respondent that the connection between the termination of the applicant’s employment and the payment could not be more apparent.
Additionally the making of the November Deed and its contents are entirely inconsistent with the contention now made by the applicant that the payment was in consequence of the resolution of a dispute between ABC shareholders over the control of ABC. The subject matter of the November Deed was the applicant’s termination of his employment with ABC. That Deed did not make any reference to resolution of any dispute between ABC’s shareholders over the control of ABC.
81. The position which is disclosed by the evidence is therefore that the payment was made by ABC pursuant to the November Deed. That Deed made apparent by its terms that the payment was made ‘in consequence of’ the termination of the applicant’s employment. The payment was made at the request and direction of the applicant. The conditions for the application of s 27A(3)(a)(iii) are therefore satisfied.
It is not material in these circumstances that the applicant was never to receive the benefit of the payment. The section states expressly that a payment to another person at the direction or request of the taxpayer comes within the section. The issue is not therefore resolved adversely to the applicant by any interpretative decision which fails to take account of the nature of the provision.
alternative relief of deductibility
82. In the alternative the applicant contends that if the $3.5m payment by ABC did constitute an ETP, he made a gift of the payment to the GHI Trust (by directing that the payment be made to an eligible charity) for which he is entitled to a deduction under Div 30 of the ITAA 1997 and for which neither s 78A(2)(a), (c) or (d) apply to disallow the objection. The respondent has expressly disclaimed reliance on any submission that, as ABC and not the applicant made the donation to the GHI Trust, the applicant is not the donor within Division 30.
83. Section 78A(2)(a) ITAA 1936 provides:
‘a gift of money, or of property other than money, made by a person (in this section referred to as the ‘donor’) to a fund, authority or institution is not an allowable deduction under Division 30….where –
(a)by reason of any act, transaction or circumstance that has occurred, will occur, or may reasonably be expected to occur, being an act, transaction or circumstance occurring as part of, in connection with, or as a result of –
(i)the making or receipt of a gift; or
(ii)any agreement or scheme entered into in association with the making or receipt of the gift,
the amount or value of the benefit derived by the fund, authority or institution as a consequence of the gift is, will be, or may reasonably be expected to be, less than the amount or value at the time when the gift was made of the property comprising the gift;’
The respondent contends that the applicant is not entitled to a deduction as a consequence of this paragraph as a result of the following evidence.
The applicant formed the intention that DEF as trustee of the GHI Trust would use the $3.5m to be paid by ABC to purchase shares in ABC held by the applicant and related entities. Following the direction by the applicant on 20 December 2001 for the payment to be made to DEF, it used the amount received to purchase shares in ABC from the applicant and related entities.It did so at a price of $0.85 per share on 15 January 2002 on which day the ASX closing price for ABC shares was $0.74.
The evidence supports the assertions of fact concerning the purchase of shares and the share prices and is not in dispute.
The respondent’s submissions state that the price of $0.85 per share was fixed on 28 November 2001, before the payment to DEF was made by ABC. In that month the shares in ABC were generally falling in value from about $0.80 to $0.70. When the applicant made his direction to TUV on 20 December 2001 the ABC shares were generally trading around $0.63. Consequently when the payment was received by DEF it was reasonable to expect that the value of the benefit derived from the gift would be less than $3.5m if, as DEF had agreed, the funds received were to be used to almost immediately acquire shares in ABC at a price of $0.85 per share. The respondent submits that the consequence was that the loss of benefit to the GHI Trust that resulted when the shares were purchased from the applicant and interests associated with him was caused by a transaction (the sale of the shares) that occurred or, as at 20 December 2001, would occur in connection with the making of the gift, so that s 78A(2)(a) is applicable.
The applicant contends that the receipt of the funds by DEF as trustee for the GHI Trust and the acquisition of the shares are separate transactions. It is argued that the sale of the shares constituted a separate act or transaction for the purposes of s 78A(2)(a) and (c) and it is the loss of benefit to the GHI Trust and the benefit derived by the applicant from that act or transaction that is relevant for the purposes of the section; the donation of further shares by the applicant is irrelevant to ascertaining whether there was a benefit for the purposes of it. In any event, the sale of the shares and the donation were separate transactions – that is confirmed by the circumstances leading up to and the arrangements for the making of the payment by ABC and the subsequent purchase of the shares by DEF. The sale and the donation do not form a single transaction merely because they were contemporaneous.
The respondent argued that this overlooks the width of the working of s 78A(2)(a). The acquisition of the shares was an ‘act, transaction or circumstance’ that occurred either as part of, or in connection with, or as a result of the making or receipt of the gift. It was also the subject of an agreement or scheme entered into and associated with the making or receipt of the gift. The purpose of the application by the applicant to ABC for advance payment of the $3.5m in September 2001 was to enable DEF to be put in funds to purchase the shares so that the applicant could pay off debts. The arrangements made for the funds to be paid to DEF and the minutes of it further establish the connection, scheme or agreement.
In my view the respondent’s contentions are correct. The ‘act, transaction or circumstance’ is the acquisition of shares by DEF for the GHI Trust. The evidence establishes that it occurred ‘as part of, in connection with, or as a result of’ ‘the making or receipt of’ the gift. Alternatively, as the consequence of agreement or scheme entered into in association with the making or receipt of the gift. The amount or value of the benefit derived by the GHI Trust as a consequence of the gift is less than the amount or value at the time when the gift was made. Para (a) of S 78A(2) would therefore apply to preclude an allowable deduction in respect of the gift.
84. Section 78A(2)(c) of the ITAA 1936 provides that an allowable deduction will not be available where:
‘by reason of any act, transaction or circumstance of the kind referred to in paragraph (a), the donor or an associate of the donor has obtained, will obtain or may reasonably be expected to obtain any benefit, advantage, right or privilege other than the benefit of any deduction that, but for this section, would be allowable from the assessable income of the donor under Division 30 of the’ ITAA 97.
The applicant denies that he obtained a benefit from the sale. He says this is because the sale of the shares was only part of the transaction. It is submitted by him that the transaction as a whole was the combined sale and gift of a total of 7m ABC shares at an average price of $0.50 a share, a substantial discount to the market price of the shares on each day the GHI Trust resolved to buy the shares and accept a gift of shares, and on the day of the transfer of the shares. He argues that it was not suggested in cross-examination that the sale and gift were separate transactions. Rather the paragraph should be understood as requiring that the interests of a donor and his associates be combined in assessing whether a benefit, advantage, right or privilege is obtained by making the gift. On the transfer of the 7m ABC shares to the GHI Trust, the average price of the transfer was significantly below market value of the shares, so that no benefit was obtained by the applicant. Also, he received no benefit from the combined sale and gift as the value of his interest as beneficiary of GHI Trust which also transferred shares with him was decreased by the value of the ABC shares given to the GHI Trust.
The respondent contends that from the circumstances relied upon in relation to s 78A(2)(a) it is apparent that the applicant derived a benefit from the sale of the shares, being the proceeds from the sale and also the sale of the shares at an inflated price, and DEF acquired property from the applicant.
I consider the respondent’s submissions correctly state the position.
85. Section 78A(2)(d) of the ITAA 1936 reads no allowable deduction is available where:
‘(d) by reason of any agreement or scheme entered into as part of or in association with the making of the gift, any property, other than property comprising the gift, has been acquired or will be acquired, whether directly or indirectly, from the donor or an associate of the donor of that fund, authority or institution or by another fund, authority or institution.’
The applicant contends that this paragraph cannot be applicable because there is no evidence of a scheme or agreement ‘entered into as part of or in association with the making of the gift.’ He says no scheme or agreement was put to him or his wife. Rather the applicant asserts the evidence establishes that the ‘making of the gift’ was as a result of the commercial settlement reached on 31 May 2001. Only later did the applicant (in September 2001) decide to sell some of his ABC shares to the GHI Trust. The sale was a later transaction, only connected with the gift to the GHI Trust as the money used by the GHI Trust to buy the shares happened to be the same money paid by ABC to the GHI Trust.
The assertions upon which the applicant relies concerning the effect of the evidence are not in accord with the findings which I have previously made in these reasons. I have found that the making of the gift was not the result of the commercial settlement reached on 31 May 2001 and has to be understood in the wider evidentiary context, including the evidence relating to the November Deed. The contentions upon which the applicant relies to resist the application of this paragraph of s 78A(2) are not made out.
penalties on etp issue
86. The respondent concluded that the applicant acted recklessly in not including the payment by ABC to the GHI Trust in his income and that a penalty of 50% of the additional tax was payable. The respondent in doing so equated recklessness with gross carelessness, a paraphrase which the applicant accepts for present purposes.
87. The applicant contends that this outcome is prima facie surprising, even if correct. This is said to be because it is inconsistent with the intention of the commercial parties and their legal representative; it leads to the unlikely result that a payment to which the applicant was never entitled and which was not intended to be for his benefit becomes taxable under a provision whose evident purpose is to treat ETPs concessionally. As previously stated, this contention misstates the effect of the relevant provisions: see s 27A(1) and (3). It also ignores the effect of cl 4 of the November Deed where the possibility of an ETP being found is expressly contemplated.
88. Then the applicant argues that his accountant turned his mind carefully to the position, having in mind the tax audit and having been put on notice of the view that the payment was an ETP. Therefore he, and through him the applicant, should be seen as having been careful and as having reasonably formed a view. One of the commercial solicitors had expressed the opinion the payment was not an ETP. This is said to support the conclusion the approach was reasonable.
89. The evidence of the accountant was that he was dependent on information provided by the applicant. He could not recall any specific discussion with the applicant about the letter to the respondent but that his firm would have ensured it accorded with the applicant’s understanding before it was lodged. The applicant had no specific recollection of the letter or the giving of instructions about its contents. Consequently he could not give evidence of why his position on the issue had shifted from the submission to his accountant explaining why the payment was not an ETP. Prior to the submission of the applicant’s income tax return for 2002 income year the applicant only provided his accountant with a group certificate issued by ABC and the November Deed.
90. The respondent submits that the failure of the applicant to submit the minutes of the meetings of the directors of ABC on 31 May and 25 and 26 September 2001 or the correspondence in December 2001 between the applicant and ABC containing the applicant’s direction or the minutes of DEF from October 2001 to January 2002 can only be described as reckless. It is said to have been a reckless disregard of his obligation to put those responsible for preparing his tax return in a position to properly advise him about the return and ensure that it was accurately prepared and his obligation to satisfy himself that his return was accurate. Therefore it is argued that submission that the accountant and the applicant were ‘careful and formed a reasonable view’ should be rejected.
91. In my opinion, the circumstances establish that the applicant was reckless in respect to the ETP issue. The plain facts are that the applicant did not carefully instruct his adviser and his adviser was not put upon further inquiry and investigation. Clause 4 of the November Deed should have alerted both of them to the need for examination of the question concerning the possible characterisation of the payment as an ETP. In all the circumstances the condition of recklessness is established. There is no foundation on which to find the assessment excessive because of the imposition of these penalties or to reduce them in quantum.
conclusion
92. For the above reasons I consider that the decisions under review should be affirmed, save with respect to those imposing penalty on borrowing costs for the purchase of units in the Trust in each of the years of income ended 30 June 2000, 2001 and 2002 which should each be varied by reducing those penalties to nil.
I certify that the 92 preceding paragraphs are a true copy of the reasons for the decision herein of Deputy President Robert Nicholson
Signed: .......................[Sgd Ms C Skinner].............................
AssociateDate/s of Hearing 13, 14 & 17 December 2007 and
25 February 2008Date of Decision 18 April 2008
Counsel for the Applicant David Russell QC
Solicitor for the Applicant Troika Legal
Counsel for the Respondent Michael Corboy
Solicitor for the Respondent Australian Government Solicitor