"The Taxpayer" and Commissioner of Taxation
[2007] AATA 1277
•30 April 2007
Administrative Appeals Tribunal
DECISION AND REASONS FOR DECISION [2007] AATA 1277
ADMINISTRATIVE APPEALS TRIBUNAL )
) No WT200300162
TAXATION APPEALS DIVISION ) Re “THE TAXPAYER” Applicant
And
COMMISSIONER OF TAXATION
Respondent
DECISION
Tribunal Mr A Sweidan, Senior Member Date30 April 2007
PlacePerth
Decision The Tribunal affirms the decisions under review.
..........[Sgd A Sweidan]..........
Senior Member
CATCHWORDS
Income Tax – mining operations – deductions claimed for management fees and interest – “Base Metals Project” – general anti-avoidance provisions.
LEGISLATION
Income Tax Assessment Act 1997 (Cth) s8-1; s 330-15
Income Tax Assessment Act 1936 s 79 D; Part IVA
CASES
Sleight v Commissioner of Taxation (2004) 136 FCR 211
Commissioner of Taxation v Cooke (2004) 55 ATR 183
Commissioner of Taxation v Lau (1984) 6 FCR 202
Commissioner of Taxation v Emmakell Pty Ltd (1990) 22 FCR 157
Puzey v Commissioner of Taxation (2002) 50 ATR 595; (2003) 53 ATR 614; (2003) 131 FCR 244; (2002) 194 ALR 615
Commissioner of Taxation v Brand (1995) 31 ATR 326
Commissioner of Taxation v Walker (1984) 84 ATC 4553
Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation (1980) 33 ALR 213
Fletcher v Federal Commissioner of Taxation (1991) 173 CLR 1; (1991) 173 CLR 17
Commissioner of Taxation v Ampol Exploration Limited 86 ATC 4859
Vincent v Federal Commissioner of Taxation [2002] FCAFC 291; 124 FCR 350
Clowes v Commissioner of Taxation (1954) 91 CLR 209
Milne v Commissioner of Taxation (1976) 133 CLR 526)
Nathan v Federal Commissioner of Taxation (1918) 25 CLR 183
Federal Commissioner of Taxation v Mitchum (1965) 113 CLR 401
Esquire Nominees Ltd v Federal Commissioner of Taxation (1973) 129 CLR 177
Tariff Reinsurances Ltd v Commissioner of Taxes (1938) 59 CLR 194
Federal Commissioner of Taxation v Efstathakis (1979) 38 FLR 276
Chaudhri v Commissioner of Taxation [2001] FCA 554
Australian Machinery & Investment Co Limited v Deputy Commissioner of Taxation (WA) (1946) 3AITR 359
Lovell & Christmas Limited v The Commissioner of Taxes (1908) AC 46
Mt Morgan Gold Mining Company Ltd v Commissioner of Income Tax (Queensland) (1922-1923) 33 CLR 76
Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404
Cooke v Commissioner of Taxation (2002) 51 ATR 223
Commissioner of Taxation v Hart (2004) 217 CLR 216
Vincent v Commissioner of Taxation (2002) 51 ATR 8; (2002) ATC 4490; (2002) 124 FCR 350
Stevenson v FCT 91 ATC 4476
Fletcher & Ors v FCT 84 ALR 295
Fabry v FCT (2003) ATC 4885
Drake v Minister for Immigration & Ethnic Affairs (1979) 24 ALR 577
Minister for Immigration and Ethnic Affairs v Pochi (1980) 31 ALR 666
Esso Australia Resources Ltd v Commissioner of Taxation (1998) 84 FCR
Hallstroms Pty Ltd v FCT (1947) 72 CLR 634
Cliffs International Inc v FCT (1979) 142 CLR 410
FCT v South Australian Battery Makers Pty Ltd (1978) 140 CLR 645
Commissioner of Taxation v Broken Hill Pty Company Ltd (2000) 179 ALR 593
Radaich v Smith (1959) 101 CLR 209
FCT v Hart (2004) 217 CLR 216
Federal Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404
Federal Commissioner of Taxation v Peabody (1994) 181 CLR 359
Federal Commissioner of Taxation v Hart (2004) 217 CLR 216
Eastern Nitrogen Ltd v Commissioner of Taxation (2001) 108 FCR 27
Federal Commissioner of Taxation v Consolidated Press Holdings (2001) 207 CLR 235
Calder v FCT (2005) 61 ATR 267
Hart v FCT (2004) 217 CLR 216
Commissioner of Taxation v Sleight (2004) 136 FCR 211
Peabody v Commissioner of Taxation (1993) 40 FCR 531
REASONS FOR DECISION
30 April 2007 Mr A Sweidan, Senior Member BACKGROUND
Nature of Review Application
1. This is an application for review by the Tribunal of a decision of the respondent dated 25 September 2003 disallowing the applicant’s objection dated 20 June 2000 to the amended assessment of income tax issued to the applicant for the year ended 30 June 1999.
2. The applicant was an investor in the Base Metals Exploration and Prospecting Project (the Project), and this application was heard together with four similar applications from other investors (the applicants) in the Project, the parties having agreed that the evidence in each application would also be evidence in the others.
3. The applicant invested in the Project and became a participant therein to the extent of “participating” in the year ended 30 June 1999.
4. The applicant claimed an entitlement to an allowable deduction in the amount of $76,800.00 in the 1999 year being for the following:
· $72,000.00 for management fees; and
· $4,800.00 for interest on a loan entered into for the purpose of financing the applicant’s payment of the management fees.
5. The applicant claims that he is entitled to a deduction for the outgoings for management fees and interest on the basis that they are:
(a)deductible under s 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) as:
(i) they were incurred in gaining or producing his assessable income; or
(ii)they were necessarily incurred in carrying on a business for the purpose of gaining or producing his assessable income;
(b)deductible under s330-15 of the ITAA 1997 as they were incurred on exploration or prospecting for minerals, or quarry materials, obtainable by eligible mining or quarrying operations.
6. The respondent disputes that the outgoings are deductible under either s8-1 or s 330-15.
7. The respondent also says:
(a)to the extent that a deduction is otherwise allowable to the applicant in respect of the claimed outgoings, it is reduced to nil, or a sum less than that claimed, pursuant to s79D of the Income Tax Assessment Act 1936 (ITAA 1936) ;
(b)further and alternatively, Part IVA of the ITAA 1936 operates to disallow deductions to the applicant for the management fees and interest for the 1998 year of income.
Outline of facts
8. The Project was marketed over the years 1998 and 1999 and the following facts which emerge from the documents and evidence before the Tribunal are not in dispute:
The Prospectus
9. On 11 February 1998, Base Metals Exploration NL (Base), as manager, and Explorers and Prospectors Finance Ltd (EPF), as financier, issued a prospectus inviting participation in the Base Metals project. Inteq Custodians Limited (Inteq) was named as Trustee.
10. The prospectus described the project as follows: -
“10,000 participations are offered, to take up exploration and prospecting opportunities, under management. This offer gives participants the opportunity to benefit from income derived from the proving up of a number of mining properties. Initially the [project] will be exploring and prospecting in New Caledonia and New South Wales, on properties currently held or controlled and being explored by Caledonian Pacific Minerals NL, ACN 061 219 985 (CPM), a public company listed on the Australian Stock Exchange and the Vancouver Stock Exchange”.
11. The offer contained in the prospectus was described as “an offer to invest in prescribed interests in the Project by entering into a Management Agreement with Base.”
12. A participant could take up one or more participations.
13. A participant who entered into a management agreement was required to make an initial payment of $12,000 for each participation. All future management costs were payable out of income. The prospectus offered a Finance Package with EPF under which participants could, upon subscribing for 25 ordinary shares of $1.00 in EPF, obtain a loan for a term of 10 years of up to $12,800 per participation.
14. The prospectus described the participations as “highly speculative”, and stated the high commercial risks of the project at Part 7, including:
“The probability of finding a mine and developing a profitable project is low and its risks are considerable.
At present, the properties the subject of the Agreement do not have a known body of commercial ore and the proposed work programs include an exploratory search for ore.
[There] is no assurance that, even if commercial quantities of ore are discovered, a profitable market will exist for the sale of minerals produced.”
15. At Part 8, the prospectus set out possible tax implications, stating that the risks may be offset in part by taxation benefits. The position of participants using the finance package was set out in detail, stating that in the first year each participant using the Finance Package would, for a single participation:-
(a)borrow $12,800 being
i) $12,000 management fee; and
ii)$800 described as interest charged for the first year only (at 8.9% for 12 months)
(b)have a cash outlay of $4,050 ($25 for EPF shares + $4,025 as a single repayment due on 30 September 1998)
(c)receive tax savings of $6,208, based on the participant paying income tax at the rate of 48.5%, and
(d)have a consequential net benefit of $2,158.
Those with 10 or more participations would receive a slightly higher benefit per participation.
16. Financial projections were for income ranging from:
(a)$0 to $10,000,000 in year 2,
(b)$0 to $135,000,000 in years 6-10;
(c)$0 to $471,000,000 total over 10 years.
17. Sources of income for participants were identified in Schedule 5 as:
(a)sale of rights to mine;
(b)sale of interests in tenements; and
(c)sale of royalties to tenements.
Other project documents
18. The prospectus included:
(a)copy of an executed option agreement dated 17 December 1997 between Base and CPM and its subsidiaries;
(b)a copy of an agreement (not executed or dated) between Inteq and Core Mining NL ;
(c)a summary of principal provisions of a Trust Deed dated 5 February 1998 between Base, Inteq, and Investment Licensing Pty Ltd. relating to interests under the management agreement between participants and Base;
19. The prospectus also included pro forma documents for applying to participate, including:
(a)an application to EPF for a loan of the amount of management fees and interest for the first year for participation in the project;
(b)an application to EPF for ordinary shares in EPF;
(c)an application to Base for participation in the project;
(d)a management agreement with Base, to be executed by EPF on behalf of a participant;
(e)a loan agreement with EPF, to be executed by Inteq on behalf of a participant.
20. A Supplementary Prospectus was issued by Base and EPF dated 19 June 1998.
21. A Second Supplementary Prospectus was issued by Base and EPF dated 16 February 1999.
The option agreement between Base Metals and CPM dated 17 December 1997
22. The prospectus offered participants the chance to obtain interests in relation to the option agreement made between Base and CPM on 17 December 1997, and interests in other exploration and prospecting projects which Base may enter with others.
23. The option agreement with CPM provided, amongst other things:
(a)CPM and its subsidiaries in consideration of Base having paid $500,000, granted to Base “an option to become entitled to carry out exploration and prospecting” on certain mining tenements owned by subsidiaries of CPM on the terms and conditions set out in the agreement. ( clause 2);
(b)to exercise the option, Base was to give written notice by 30 June 1998 specifying the amount (to a maximum of $18,000,000) which it would commit to spending on exploration and prospecting on the tenements (clauses 3, 4);
(c)by exercising the option, Base would become entitled to carry out exploration and prospecting on the tenements on the terms and conditions set out in the option agreement, and was committed to spend the committed amount on exploration and prospecting in accordance with the agreement (clauses 5, 6).
24. The option agreement further provided
(a)Base must engage CPM as manager in respect of all exploration and prospecting on the tenements under the agreement, for a management fee calculated as 11.1% of the amount committed by Base, together with reimbursement of all costs expenses and liabilities incurred by CPM in the conduct of the exploration and prospecting authorised under the agreement (clauses 6.2, 8, and 9);
(b)CPM would be obliged to carry out exploration and prospecting as manager until the total costs in carrying out exploration and prospecting for Base (including management fees chargeable by CPM) equalled the amounts paid by Base (clause 5.3);
(c)all expenditure on exploration and prospecting was required to be met by Base until the whole of the committed amount had been expended (clause 6.3);
(d)once the whole of the committed amount had been expended, Base would be entitled to “a beneficial interest in the tenements” calculated by reference to the amount committed, to a maximum of 40% (clause 6.4).
25. After the committed amount had been expended, CPM was to continue as manager to carry out exploration and prospecting on the same terms, with each party required to contribute to all costs and expenses in accordance with its percentage interest (clause 12.1, 12.2). Further, if a decision was taken to establish a mine or any associated plant on a tenement, the parties were entitled to participate in accordance with their percentage interests, and were required to meet costs and expenses according to their percentage interests (clause 13.1, 13.2). A party who did not contribute to costs and expenses would have its percentage interest diluted in accordance with a formula set out in clause 14.
26. On disposal of a tenement, each party was entitled to a proportion of net proceeds equal to its percentage interest (clause 15). Net proceeds was defined as the proceeds of the sale, net of specified amounts, including amounts required to be paid under an agreement to any person who was not a party to the option agreement.
Basin Minerals joint venture agreement
27. Apart from the agreement between Base and CPM, the only other agreement for exploration and prospecting that was made by Base was a Joint Venture Farm In Agreement with Basin Minerals NL (Basin Minerals) and Swansands Pty Ltd.
28. On 5 August 1998, Base and Basin Minerals signed heads of agreement for a joint venture “farm in”, and on 19 October 1998 they signed an agreement.
29. By the joint venture agreement:
(a)Base agreed to contribute $1,500,000 by specified instalments in order to earn a 20% participating interest, called the First Farmout Interest (clause 2.1 and Schedule of payments at T157, page 744);
(b)the participating interest was an undivided interest held as a tenant in common in the joint venture property and all rights and obligations under the agreement (definition clause 1.1(16)) ;
(c)if Base made all payments required under the agreement to obtain the First Farmout Interest, then Base could give notice of its intention to proceed to “stage 2” and, by contributing $2,500,000, obtain a 49% interest (clause 2.8);
(d)the agreement provided that the joint venture was formed “for the limited purpose of acquiring, carrying out exploration and feasibility studies on [specified mineral tenements]” (clause 3.1);
(e)if the joint venturers decided to mine, there was to be a separate joint venture on terms to be agreed (clause 3.7);
(f)if Base became a party to the joint venture by earning the First Farmout Interest, it was required to contribute to expenditure after the commencement date or its interest would dilute, and may be forfeited - see clauses 4.1, 4.4 and 12;
(g)further, by clause 13, a party in default under the agreement who does not remedy the default may forfeit its rights in the joint venture property and the agreement.
The agreement between Inteq and Core Mining NL
30.The agreement between Inteq and Core Mining NL (Core Mining),
(a)recited that Inteq “is in possession of the legal title to the income from 40% of the [specified] mining tenements”, subject to the terms of the Investment Deed between Inteq and Base; and
(b)provided that, for the consideration of $10,000, Inteq granted to Core Mining an option exercisable before 30 June 2008, to purchase the interest held by Inteq in the tenements for the sum of $5,000.
31. According to the prospectus, 80% of the shareholding in Core Mining was to be held by EPF (which was wholly owned by the participating investors), and 20% by interests associated with Brian Hooker.
32. The copy of the agreement in the prospectus is not executed, and there is no evidence as to when (if ever) it was executed.
Investment Deed between Base and Inteq
33. Base and Inteq executed an Investment Deed on 5 February 1998, which stated that it was to govern the rights and interests of the participants in the project.
34. That deed recites:
(a)that Base proposes to offer participations to explorers and prospectors by way of a prospectus;
(b)Base and Inteq have determined to establish a venture known as Base Metals Exploration and Prospecting Project;
(c)Base has an option “to carry out exploration and prospecting on tenements described hereunder [that is, the CPM tenements] and upon certain conditions to obtain an income from its interest of up to forty percent (40%) of the tenements (“the Manager’s Interest)”;
(d)Base shall to offer to participants a 1/10,000 entitlement “to exploration and prospecting rights in the net income earned from the Manager’s Interest”;
(e)Base and Inteq intend, following the execution of the deed, to enter into an agreement whereby Base grants to Inteq the Manager’s Interest, subject to the rights of participants to carry on the business of exploring and prospecting. Thereafter Inteq shall transfer that Interest to Base, subject to the rights of the participants to carry on the business of exploring and prospecting (Recital E).
35. The deed also provided that, amongst other things:
(a)a participation in the project would be established on execution by Base and the participant of the Management Agreement (clause 3.3);
(b)a participation would consist of the participant’s interest under the Management Agreement and any authorised investments held by Inteq on behalf of the participant (clause 3.4);
(c)Base was obliged to pay all application money to Inteq as soon as practicable after receipt, and Inteq was obliged to hold all application money, and all money paid pursuant to management agreements, in trust and to pay to Base all management fees provided under the management agreement. Any other money received was to be invested in authorised investments (clauses 4.2, 5.1, 5.2);
(d)if any income became payable by Base from the project to the participants, it was to be paid to Inteq, which was to receive it on trust and deal with it in accordance with clauses 26.4 and 29.5.
36. There is no evidence that Base and Inteq entered into an agreement as provided by Recital E.
The participation of the applicant
37. As noted above, the Project was marketed over the years 1998 and 1999.
38. The applicant accepted the Finance Package offered in the prospectus.
39. By applying to EPF for a loan in terms of the loan agreement contained in the prospectus, the applicant
(a)requested a loan of an amount equalling the aggregate of the fees payable by him under the management agreement and the interest payable by him for the first year of the loan; and
(b)authorised and directed Inteq to sign the loan agreement on his behalf.
40. By the share application, the applicant:
(a)subscribed for 25 ordinary shares in EPF per application at $1.00 per share, and
(b)authorised EPF to act as his agent in the execution of the management agreement.
41. By the participation application each applicant:
(a)applied to Base to participate in the project;
(b)applied to EPF for a loan to finance his participations in the project, comprising for each participation, $12,000 for management fees and $800 for prepaid interest;
(c)agreed to make one capital repayment of $4,025 for each participation not later than 30 September 1998 (for applications in 1999, the payment was to be by 30 September 1999);
(d)agreed to be bound by the terms of the Investment Deed dated 5 February 1998 between Base and Inteq; and
(e)appointed Inteq as his attorney to -
i)do in his name and on his behalf any act, matter or thing which Inteq was empowered or obliged to do under the terms of the Investment Deed, and
ii)execute a loan agreement on his behalf,
According to the participation application, the power of attorney was irrevocable for so long as the Project continued.
The Management Agreement
42. EPF, on the applicant’s behalf, and Base executed the management agreement in the form appearing in the prospectus in respect of the applicant’s number of participations in the project.
43. Terms of the management agreement included that:
(a)the agreement came into effect on the date of the agreement and terminated no later than 30 June 2008 (clause 3);
(b)Base intended to exercise its rights under the option agreement with CPM dated 17 December 1997 (clause 4.1), and would substantially establish the participation of the explorer and prospector by 30 June 1998 (clause 4.3);
(c)Base agreed to provide the applicant with services specified in the agreement;
(d)Base was entitled to delegate all or any of its functions, and to consult, appoint, employ or contract with any person to assist it in the provision of the services to the applicant (clause 5);
(e)Base would pool the income in respect of the applicant’s participations with the income in respect of each other participation, and would pay the pooled income to Inteq as trustee under the investment deed to be divided and credited to the individual participants (clause 6);
(f)the applicant agreed to pay management fees to Base as follows:
i)$12,000 per participation to be paid in advance for the initial 12 month period;
ii)20% of the gross income earned from each participation in any year or part of a year (except the first 12 month period);
iii)20% of the gross income earned from each participation in any year thereafter (clause 9); and
(g)in the event that the income earned in respect of each participation was not sufficient to pay the management fees in any year Base would have no recourse to the applicant (clause 9.3);
(h)all other expenses would be borne by Base and a participant would have no further obligation to make payment to Base in consideration of it performing its duties (clause 9.4).
The Loan Agreement
44. Pursuant to the power of attorney, Inteq executed the loan agreement with EPF on the applicant’s behalf in the form appearing in the prospectus.
45. Under the loan agreement EPF agreed to lend to the applicant the principal sum of $12,800 for each participation.
46. The loan provided:
(a)the term was 8 years from the date of execution (clause 2.3) but may be extended, to a maximum of 10 years and 6 months, should the income of the business be insufficient to pay the principal and interest by the expiration of the 8 year term (clause 5);
(b)clause 2.3 further provided “subject to clause 3.1 hereof the principal sum shall be repaid in the sums and on the dates set forth in Item 3 of Schedule A”. Item 3 provided for the payment of the $4025 per participation on 30 September of that year;
(c)interest on the principal sum was to be paid at the rate of 12% per annum paid quarterly in arrears (clause 2.1, 2.2);
(d)EPF agreed to discount the interest rate of 12% per annum to 8.9% per annum for the first year if the applicant prepaid or financed the whole of the interest due for that year;
(e)EPF agreed that it would not charge any further interest for the remaining term of the loan provided the applicant made a principal repayment of $4,025 per participation by 30 September 1998 (or 30 September 1999 for participations in that year);
(f)the applicant authorised Base to pay to EPF from the net income in respect of the applicant’s participation, the principal sum and interest and all other monies from time to time owing under the loan agreement to the lender, equivalent to 50% of the net profit of the business (clause 2.4);
(g)the whole of the principal sum remaining became payable at the option of the lender on the happening of a an event of default (clause 3.1);
(h)that should the income in respect of the applicant’s participation be insufficient to enable repayment of the principal sum and interest by the expiration of 8 years, the term of the loan would be extended until the principal sum and interest could be repaid from such income, but no longer than 10 years and 6 months from the date of execution (clause 5); and
(i)the applicant authorised EPF to apply the principal sum towards the obligations of the applicant to pay fees under the management agreement, and to apply the balance to EPF in payment of interest (clause 6.5).
47. It should be noted here that although the applicant claims that the loan from EPF was a “full recourse” loan it is the respondent’s contention that it was not envisaged that the borrowers would have a personal liability for repayment of the loan, other than the principal repayment of $4,025 by 30 September of the relevant year, because:
(a)it provided for payment of all other sums from time to time owing under the loan agreement from the net profit of the business; and
(b)as a practical consideration, the borrowers themselves held all of the issued shares in EPF, which made it highly unlikely that EFP would call upon them for payment.
Further reference to the above is made below.
All Participants
48. The project offered 10,000 participations.
49. From about February 1998 to June 1998, participants including the applicant took up 6939 participations.
50. Further participations were granted in the 1999 financial year, so that a total of 9989 participations were granted over the two years.
51. The participants, including the applicant, allegedly incurred the following obligations for management fees and prepaid interest:
Year
Management Fees
Prepaid interest
Total
1998
$83,268,000
$5,551,200
$88,819,200
1999
$36,600,000
$2,440,000
$39,040,000
$119,868,000
$7,991,2000
$127,859,200.00
52. However, because of the way the project was financed, these amounts were not available for the conduct of the project. Cash amounts, which were actually paid by participants, were limited to $4,025 per participation. As stated by the applicant’s witness, Brian Hooker, in cross-examination assuming all participants paid the first repayment, the total cash available to Base would have been $40,205,725 ($27,929,475 in 1998 and a further $12,276,250 in 1999) i.e. less than one-third of the amounts allegedly incurred by the participants.
The financing of the participations and the funds available to the project
53. As noted above the financier to the participants, EPF, was wholly owned by the participants. Its share capital came from the shares issued to participants – that is, $25 per participation. EPF lent the participants $12,800 per participation to pay management fees to Base, and interest.
54. EPF purportedly obtained the funds to pay the management fee to Base on behalf of the participants from Laton Corporate Pty Ltd (Laton Corporate). In each of the 1998 and 1999 years, there was a bill facility under which EPF drew bills of exchange to pay Base. The amount of the bills in each year corresponds to the management fees set out above, that is $83,268,000 in 1998 and $36,600,000 in 1999.
55. On 17 June 1998 EPF as borrower and Laton Corporate as lender, with Base as indemnifier, made a deed of loan (the Laton loan) by which:
(a)Laton Corporate agreed to advance, between 17 June and 30 June 1998, or such later date as agreed, in as many instalments as required by EPF, up to $120,000,000 (clause 3.1);
(b)the advance was to be made by way of a bill facility (clause 3.2);
(c)interest was to be paid on the advance at 8% per annum (clause 4.2) and in the first year was to be calculated on the amount of the advance at 1 July 1998 and was to be paid in advance to the lender by 31 October (clause 4.2(2)), although Laton Corporate agreed to accept a lesser amount if Base paid an indemnity amount in accordance with clause 4.4.
56. By clause 5.1 of the Laton loan, the advance was repayable on 31 December 2008 subject to the obligation of EPF to pay to Laton Corporate immediately in reduction of the advance any repayments of principal received under the Retail Loan Contracts (defined as the loan contracts between EPF and the participants by which EPF provided finance to invest in the project) (clauses 1.1(11)(definition) and 5.2).
57. Also on 17 June 1998, Base (as Depositor) and Laton Corporate made a Deposit Deed, the terms of which included:
(a)the parties stated that Laton Corporate had agreed to enter into the Laton loan (defined as the Wholesale Loan Deed) at the request of Base (clause 2.1);
(b)Base was required to deposit with Laton Corporate an amount equal to the advance under the Laton loan immediately following each instance of provision of financial accommodation under that deed (clause 2.2);
(c)Base had only limited rights of withdrawal (Recital E and clause 5).
58. Clause 5.3 of the Deposit Deed set out a formula by reference to which Laton Corporate must pay a withdrawal. This was done by requiring the balance after the withdrawal to be at least the difference between the initial deposit made by Base (i.e. the amount of the advance to EPF) and the aggregate of all amounts (other than interest) received by Laton Corporate under the Loan Deed.
59. Under those agreements:
(a)EPF gave notice to Laton Corporate by 9 Acceptance Notices that it intended to operate the bill facility under the Deed of Loan by drawing 86 bills of exchange, with Base as payee in each case, as follows:
No of bills
Face value of each
Aggregate face value
Acceptance date
32
$996,000
$31,872,000
17 June 1998
7
6 x $996,000
1 x $984,000
$6,960,000
25 June 1998
2
$996,000
$1,992,000
26 June 1998
5
4 x $996,000
1 x $984,000
$4,968,000
30 June 1998
2
1 x $996,000
1 x $972,000
$1,968,000
30 June 1998
3
$996,000
$2,988,000
30 June 1998
30
28 x $996,000
1 x $684,000
1 x $336,000
$28,908,000
30 June 1998
4
2 x $996,000
1 x $780,000
1 x $468,000
$3,240,000
30 June 1998
1
$372,000
$372,000
6 July 1998
86
$83,268,000.00
(b)EPF drew the 86 bills on its account with Laton Corporate. Each was:
(i)accepted by Laton Corporate;
(ii)accepted by Base in payment of the management fees, and endorsed by Base to Laton Corporate;
(iii)accepted by Laton Corporate as satisfying Base’s obligations under the Deposit Deed and endorsed by Laton Corporate to EPF; and
(iv)cancelled.
60. While the applicant claims that Laton Corporate was an external independent financier:
(a)there is no evidence that it had the financial resources to lend $83,268,000 and potentially up to $120,000,000;
(b)the effect of the Deed of Loan and the Deposit Deed, was that Base must deposit with Laton Corporate the whole of the amount lent by Laton Corporate to EPF.
(c)the deposit had limited rights of withdrawal. In effect, Base could only withdraw to the extent of actual cash paid by the participants or paid on their behalf out of any income earned from the project.
The result was that, as acknowledged by the applicant’s witness Mr Hooker in cross-examination, the only money available to Base to carry on any activity of exploration or prospecting was the actual cash payments made by the participants.
61. The arrangements for 1999 were the same. The documents before the Tribunal do not contain a Deed of Loan for 1999, although the acceptance notice recites a Deed of Loan dated 7 June 1999 between Laton Corporate and EPF. Further, the Base General Ledger for 1 July 1998 to 30 June 1999 records deposits with Laton on 30 June 1999 of $36,600,000.
62. Apparently pursuant to the 1999 Deed of Loan, EPF gave notice to Laton Corporate that it intended to operate a bill facility under the Deed of Loan by drawing 36 bills of exchange, payee Base in each case, as follows:
No of bills
Face value of each
Aggregate face value
Acceptance date
37
36 x $996,000
1 x $774,000
$36,600,000
10 June 1999
63. EPF drew the 37 bills on its account with Laton Corporate. Each was:
(i)accepted by Laton Corporate;
(ii)accepted by Base, apparently in payment of the management fees, and endorsed by Base to Laton Corporate;
(iii)accepted by Laton Corporate and endorsed by Laton Corporate to EPF; and
(iv)cancelled.
Again, the result was that the only money available to Base to carry on any activity of exploration and prospecting was the actual cash payments made by participants.
Base’s Subcontract of its Management Functions
64. On 21 September 1998, Base signed an agreement subcontracting to Anacon Holdings Pty Ltd and No.1 O’Connell Street Pty Ltd, trading together as Australian Base Metal Enterprises (ABME), all of its obligations, functions and duties under its various management agreements. By the terms of that subcontract, ABME was entitled to receive as consideration:
(a)$55,000,000 for the first year; and
(b)in each subsequent year, 80% of the gross income of Base from fees under the management agreements and the investment deed.
The conduct of the project
CPM
65. The agreement between Base and CPM was made on 17 December 1997. Base exercised the option under clause 3.1 and on 30 June 1998 committed a total contribution of $12,457,800 which, once it was expended in exploration and prospecting, would give it a 27.69% interest under the option agreement (Letter Base to CPM, at T149, page 474). By letter dated 12 October 1998, CPM confirmed receipt of $10,500,000 of the committed amount, with the balance of $1,957,800 outstanding. (T153 at 479). CPM agreed to extend the time for payment of the outstanding amount to 30 June 1999.
66. The whole of the committed amount was never expended.
67. In October 2000, CPM (then named Quadtel Ltd) disposed of its mineral resources to Base, and the agreement between Base and CPM was terminated
68. No income was ever derived from Base’s activities in relation to the CPM tenements.
Basin Minerals
69. The agreement between Base and Basin Minerals required Base to commence payments on or before 20 October 1998 with a payment of $360,000. It was then to pay monthly instalments of $180,000, and a final payment of $60,000 on 30 May 1999. In this way it would pay an aggregate sum of $1,500,000 before 30 June 1999 (T157, at clause 2, page 720, Schedule of payments at page 744).
70. There is evidence of payments totalling $540,000 and perhaps a further $180,000). The Base balance sheet at June 1999 records Basin Minerals as a current liability of $780,000 which is consistent with payments of $720,000.
71. Under the Joint Venture Farm In Agreement, an interest in the tenements could only be acquired by Base when the sum of $1,500,000 had been paid. That sum was not paid and Base did not acquire any interest.
72. No income was ever derived from Base’s activities in relation to the Basin Minerals tenements.
73. Base did not participate in any other projects. In September 2001, Base was placed into provisional liquidation. Inteq (then named Cardinal Financial Securities Limited) was placed in provisional liquidation in October 2001
74. The applicants each regard the project as having been wound up in about 2001.
75. None of the applicants derived income from his participation in the project in 1998 and 1999, or at any time thereafter.
Oral Evidence
76. Oral evidence was given by the five applicants and Mr Brian Hooker, from each of whom witness statements had previously been filed. A witness statement from Mr Terence Willsteed was also tendered and accepted in evidence.
77. The applicant said that:
(a) At the time of considering an investment in the Project, he was seeking to re-establish himself financially following a property settlement with his ex wife. He wanted to retire prior to the age of 65 as he did not wish to continue working in the mining industry until this age. He also wanted to diversify his investments.
(b) He undertook considerable enquiry and due diligence on the commercial aspects of the Project before deciding to invest. He understood the risks involved in the Project.
(c) He viewed this investment as a long term investment over 10 years, concurring with his goal of getting his finances on track.
(d) He considered agricultural investment but personally experienced the struggle that farmers were experiencing with respect to deriving income at the time.
(e) He grew up in Tamworth and knew the location of the tenements in New South Wales. When growing up he used to go camping in his holidays and prospected with a metal detector and pan.
(f) He chose an investment in the Project as having the potential to secure a greater commercial return to him as opposed to an investment directly in Caledonian Pacific Minerals NL.
78. Mr Brian Hooker testified that:
(a) The Project was managed for and on behalf of the applicant in a professional manner and in accordance with the obligations contained in the agreements.
(b) The management services outlined in clause 5 of the management agreement were performed in a professional manner.
(c) The project manager retained the expertise of Warwick Robinson, who at the time, was a mining industry consultant, company director and a Fellow of the Australian Institute of Mining and Metallurgy. He held degrees in Geology and had 40 years experience working in the areas of management, consulting, mining and exploration predominantly in Australia, Indonesia, the Philippines and New Caledonia. He had previously managed coal and gold mines in Australia, Indonesia and the Philippines and had also managed joint venture programs in Australia, Indonesia, Venezuela and the Philippines. His operational experience included underground copper, silver lead and zinc mines in Mount Isa, nickel mines in Windarra and had experience in exploring for copper, lead, zinc, nickel, tin, silver, gold, iron ore, uranium and coal.
(d) Exploration and prospecting activities had been carried out by CPM on behalf of the participants including the applicant in the years ending 30 June 1998, 30 June 1999 and 30 June 2000. The participants had spent $14,340,000 on exploration and prospecting activities with CPM and about $1,200,000 with Basin Minerals NL (Basin).
(e) The project manager also acquired the right to buy 49% of mineral sands tenements in the Murray Basin by agreeing to fund staged expenditure of $4 million before July 2000 under a farm in arrangement with Basin. The potential of these tenements was unfortunately never realised. The project manager contributed significant funds under the agreement with Basin and fell short by only a small proportion (around $200,000 to $300,000) of the first tranche committed under the agreement.
79. In his statement, Mr Terence Willsteed, who was put forward by the applicant as an expert witness, said that:
(a) The revenue to be derived was forecast in the Prospectus to range from nil income to $471 million over the 10 year period from the commencement of the exploration and prospecting programme. The Project forecast a mean income of $235.5 million.
(b) The revenue was projected to be derived from the sale of rights to mine, sale of interests in the tenements and the sale of royalties, which could be derived from production from the tenements.
(c) Subject to the results from the exploration and prospecting, it was reasonable at the time the applicant made his decision to invest to expect that some of the tenements could have provided the discovery of the necessary resources to support the projections, allowing for the size of the Project areas and their indicated geological and mineralisation characteristics which were believed to be comparative to very substantial mineral deposits in similar geological environments in other parts of the world. The comparative deposits were recognised as major producers of minerals with high cash flow and profitability, the discovery of one or two would have supported the revenue levels projected in the Prospectus.
(d) Although possible it may have been optimistic to have expected that the projected income would occur within the 10 year time frame, or the year-by-year cash flow schedule as tabulated in the Prospectus, because some projects could require a longer period of exploration, investigation and feasibility prior to the establishment of project value.
(e) The possibility that one or all of the tenements, once proved to the necessary ore reserve status, would have a value of $550 million is considered reasonable in the light of the geological evidence and possible comparative well known ore deposits in other parts of the world.
(f) A management fee of $12,000 per participant is reasonable in the context of each participant, to gain access to a prepared, large-scale exploration programme, experienced management and a recognised funds management scheme.
(g) The exploration areas were attractive, although speculative, with the potential for substantial upgrading.
APPLICANT’S SUBMISSIONS
The applicant submitted that:
80. The applicant has clearly incurred the obligation to make the payment of the management fees in the amount of $72,000.00 on or before 30 June 1998 for the purpose of managing his Participation Interest in the Tenements, pursuant to legal obligations imposed on him under the management agreement.
81. The evidence supports the view that the applicant had at 30 June 1998 commenced to carry on a business via his manager that included exploration and prospecting for minerals.
82. There is a plethora of authority that expenditure incurred on management fees is revenue in nature rather than capital where the taxpayer is carrying on a business and has employed a manager (over which the investor had control) or has incurred the management fee in the course of deriving assessable income (see Sleight v Commissioner of Taxation (2004) 136 FCR 211, Commissioner of Taxation v Cooke (2004) 55 ATR 183, Commissioner of Taxation v Lau (1984) 6 FCR 202 at 221 per Beaumont J, Commissioner of Taxation v Emmakell Pty Ltd (1990) 22 FCR 157, Puzey v Commissioner of Taxation (2002) 50 ATR 595; (2003) 53 ATR 614, Commissioner of Taxation v Brand (1995) 31 ATR 326, Commissioner of Taxation v Walker (1984) 84 ATC 4553 and other cases cited by the applicant.
83. It is highly relevant to note that the above authorities concerned similarly structured managed investment schemes where the taxpayer was not actively involved in the business.
84. The management fees paid by the applicant were incurred in the gaining or production of assessable income, or necessarily incurred in carrying on a business for the purpose of gaining income. The applicant asserted that the income in this case was to be derived from either or all of the following:
i) Sale of rights to mine;
ii) Sale of interests in tenements; and
iii) Sale of royalties from tenements.
85. It was contended that the income to be derived was consonant with how many exploration and prospecting ventures derive their income. To consider, as the respondent suggests, that the participants including the applicant could not derive income unless the Tenements were mined is, it was submitted, a misconceived view on the commercial fabric of an exploration and prospecting venture. The applicant was, it was claimed, satisfied that income could be derived from the revenue streams identified above, even after accepting the risks inherent in mining operations. Disposal of the Tenements was at least one option other than mining contemplated under the option agreement between CPM and Base (clause 15.1).
86. In characterising the applicant’s payment of the management fees in the 1998 year it is necessary to identify what the expenditure was for Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation (1980) 33 ALR 213. The applicant asserted that upon a consideration of the evidence, it is clear that the expenditure was incurred to retain a manager to conduct the day to day operations of the applicant to essentially explore, prospect and find and sell the minerals extracted from the Tenements which the applicant had a proportionate interest in.
87. By clauses 5.1(e) and 5.5 of the management agreement between Base as manager and the applicant, the manager was to perform its duties on behalf of the applicant professionally and in accordance with good business practice (see also clauses 11.1 and 13.2 of the Trust Deed – see T Docs 115). The applicant had the power, by clause 7.2 of the management agreement, to instruct Base as to how to undertake the various management services. Moreover, if the applicant was not satisfied with Base’s performance or if Base was in default of its obligations under the management agreement, by clauses 10.2 and 14.3 (see also clauses 9.11 and 16.2 of the Trust Deed), the applicant was empowered to determine the agreement and remove the manager. The applicant then had the power to appoint some other corporation to be the manager of his Participation Interest (see clause 14.4) of the management agreement.
88. The applicant contended that the respondent’s contention that the applicant was not “actively” involved and therefore not himself carrying on a business is misguided. The applicant said that is the point of appointing a manager. In Lau, Brand, Sleight, Emmakell, Walker, Puzey and Cooke, the taxpayers were passive and did not actively make decisions or hold the business records. The applicant claimed that the critical point is that the applicant had the power to dismiss the manager and the power to give instructions to the manager.
89. The applicant argued further that to the extent that the applicant’s subjective purpose is relevant to the characterisation of these outgoings (Fletcher v Federal Commissioner of Taxation (1991) 173 CLR 1), it does not differ from this purpose. According to the applicant this is not a case where it can be said objectively that at the time of the investment there was no prospect of obtaining a sum of assessable income greater than the outgoings (see forecast projections in the prospectus). Nor it was claimed is this a case where it can be said that at the time of the outlay it was not expected that the Project would run its course. The applicant claims that the evidence demonstrates that it was reasonable for the applicant to expect that he would earn assessable income for the duration of the Project.
90. The applicant asserted that the existence of the required nexus between the outlays and the gaining of income is confirmed by the Prospectus, the project agreements and by the evidence of Mr Brian Hooker and Mr Terence Willsteed. According to the applicant there was a reasonable basis to expect to derive income from his participation in the Project. The respondent it was claimed has not provided any evidence to support the contention that it was “unreasonable” for the applicant to expect he would derive income from the Project.
91. It was pointed out that there is authority (see Commissioner of Taxation v Ampol Exploration Limited 86 ATC 4859) that exploration and prospecting expenditure may be allowable under section 8-1 of the 1997 Act and it was further claimed that this is not a situation where the character of the advantage sought was long lasting or enduring or that the character of the advantage was one in the nature of a passive investment (cf with Puzey in the second year, cf also with Clowes v Commissioner of Taxation (1954) 91 CLR 209 and Milne v Commissioner of Taxation (1976) 133 CLR 526).
92. The applicant said that unlike Clowes and Milne the participants in the Project including the applicant appointed a manager to undertake his Participation Interest in the exploration and prospecting on the Tenements to derive assessable income therefrom over a 10 year period, as opposed to the applicant participating by investing a sum of money on the expectation of a capital increment at the conclusion of the Project. Furthermore, it was claimed that the applicant and all other participants could participate in the control of the manager’s exploration and prospecting over the Tenements and had the right to terminate the manager’s services, unlike in Clowes and Milne (see paragraph 24 above).
93. In Puzey on appeal, Hill and Carr J at [58] concluded that “there is no doubt that a contractual payment to a manager to manage such a scheme [managed investment scheme] would be deductible” notwithstanding that the taxpayer in Puzey was found not to be carrying on a business due to the restructuring of the scheme imposed by the Australian Securities and Investment Commission and the establishment of a trust to operate the business. However the applicant pointed out that unlike in Puzey the participants of the Project including the applicant were not unit holders in a unit trust entitled to a share of the profits (if any) of the trust. The trust in that case being the entity which was carrying on the activities of the project, engaging the manager and undertaking the sale of the harvested produce. The applicant claimed that the structure of this Project involves each participant including the applicant being an explorer and prospector, engaging a manager to undertake the exploring and prospecting on the Tenements with de jure control over the manager.
94. The applicant said that the facts in the case of Vincent v Federal Commissioner of Taxation [2002] FCAFC 291 are dissimilar to the facts of this case. It was claimed that neither in form nor in substance did the applicant acquire a capital asset in connection with the payment of the management fees. It was claimed that in both form and substance the applicant sought and obtained management services in relation to the exploration, finding and selling of the minerals extracted from the relevant exploration or mining authority or production license for a period of 13 months. It was argued that like the management fee in Lau, Brand, Merchant, Puzey, Sleight, Cooke and Emmakell the management fees in this case are revenue in nature for a service period of 12 months and that no enduring benefit would have been obtained by the applicant in relation to the payment of the $12,000 management fee.
95. The applicant pointed out that the respondent places emphasis on the pooling of the applicant’s participation interest with other investors in the Project. It was clear under the Prospectus and recognised by the applicant that the applicant’s interest in the exploration and prospecting operation was to be pooled. The applicant’s share of pooled income was calculated as a proportion of the number of participation interests held by the applicant as a proportion of the total revenue derived. The applicant pointed out that the Full Federal Court in Emmakell (at 164) rejected a similar argument submitted by the Commissioner in a tea tree oil project, and that Hill and Carr JJ rejected a similar argument in the Sleight case. (Also see Cooke at first instance [60] – [65] and Lau and Brand).
96. It was asserted that the amount of $800.00 being prepaid interest paid by the applicant to Exploration and Prospecting Finance Pty Ltd is deductible under section 8-1 of the 1997 Act as it was necessarily incurred in the course of earning income, or necessarily incurred in carrying on a business (Steele v Deputy Commissioner of Taxation (1999) 197 CLR 459, Sleight, Cooke).
Applicant’s submissions regarding Division 330 of the 1997 Act (now repealed) – Exploration and Prospecting entitlement to deductions
97. Subdivision 330A of the 1997 Act provides a deduction for expenditure incurred on exploration and prospecting even if the expenditure is capital or of a capital nature. In order to be eligible for the deductions, the taxpayer must be carrying on “eligible mining” or it is reasonable to conclude that the taxpayer proposed to carry on such operations. A taxpayer can also be eligible for the deductions if during the year the taxpayer carried on a business of or a business that included exploration or prospecting for minerals obtainable by “eligible mining” and the expenditure was necessarily incurred in carrying on that business.
98. “Exploration or prospecting” is defined in s 330-20 of the 1997 Act to include:
“……
(a)in the case of mining in general and quarrying:
(i)geological mapping, geophysical surveys, systematic search for areas containing *minerals (other than *petroleum) or *quarry materials, and search by drilling or other means for such minerals or materials within those areas; and
(ii)search for ore within, or in the vicinity of, an ore-body or search for *quarry materials by drives, shafts, cross-cuts, winzes, rises and drilling; and
(b)in the case of *petroleum mining:
(i)geological, geophysical and geochemical surveys; and
(ii)exploration drilling and appraisal drilling; and
(c)feasibility studies to evaluate the economic feasibility of mining *minerals or *quarry materials once they have been discovered.
…..”
99. “Eligible mining operations” is defined in section 330-30 of the 1997 Act to mean:
“ …..
(a)mining operations on a mining property for extracting *minerals (other than *petroleum) from their natural site for the *purpose of producing assessable income; or
(b)mining operations for the purpose of obtaining *petroleum for the *purpose of producing assessable income”
100. Although the “eligible mining” operations can be carried out either in Australia or outside Australia, it is necessary for the mining operations to be carried on for the purposes of producing assessable income.
101. Division 330 is not hypothesised on the presumption that the expenditure to which it is directed to, that is, expenditure on exploration and prospecting, is of a capital nature. All the Division does is provide a deduction for such expenditure, whatever the character of the expenditure is. (see Ampol at 4874)
102. It was claimed that the expenditure incurred on the Tenements by Base on behalf of the applicant and the other participants clearly qualifies as exploration and prospecting expenditure as defined in s 330-20 of the 1997 Act.
103. It was asserted that s 330-595 allows the applicant to claim deductions for his expenditure under s 330-15 notwithstanding that it was carried out by a contractor on behalf of the applicant. This statutory allowance it was contended concurs with previous authority regarding the ability of a taxpayer to be carrying on a business through an agent or manager (see Sleight, Lau, Brand, Cooke, Puzey, Emmakell, Walker, Distravel, Madison Pacific).
104. The applicant said that the deductions are allowable against any income of the applicant and they are not quarantined to the extent of income derived from the exploration and prospecting operations. Deductions are also allowable for expenditure incurred in exploration and prospecting whether it is related to activities in Australia or outside of Australia. (see Ampol)
105. Accordingly, it was claimed that in the circumstances the applicant’s expenditure incurred to his manager of $12,000 in the 1998 year to explore and prospect on the Tenements is an allowable deduction under s 330-15 of the 1997 Act.
Applicant’s submission on Section 79D of the 1936 Act
106. Section 79D of the 1936 Act raises the question of the source of income. In Federal Commissioner of Taxation v French (1957) 98 CLR 398, Kitto J said at 417:
“[The Act] assumes that it is possible to identify, with respect to every amount of income, some activity, event or thing which may properly, though metaphorically, be described as the source from which the income has been derived.”
107. The question of “source” is not a legal concept. It has been described as “something which a practical man would regard as a real source of income” and a “practical, hard matter of fact”. (Nathan v Federal Commissioner of Taxation (1918) 25 CLR 183, at 189-190; see also Studebaker Corporation of Australasia Ltd v Commissioner of Taxation (1921) 29 CLR 225; Federal Commissioner of Taxation v Mitchum (1965) 113 CLR 401. Esquire Nominees Ltd v Federal Commissioner of Taxation (1973) 129 CLR 177).
108. The process of identifying the locality of a source of income may differ depending upon the nature of the income in question. The various relevant factors may include any “contracts, agreements and other acts matters and things existing in the law”. (Tariff Reinsurances Ltd v Commissioner of Taxes (1938) 59 CLR 194, Rich J at 208). Where income is derived from the performance of work pursuant to a contract, the place of performance, the place of payment and the locus of the contract may all affect the question of source. (Esquire Nominees Ltd v Commissioner of Taxation, Stephen J at 224; Federal Commissioner of Taxation v French, Taylor J at 422. See also Federal Commissioner of Taxation v Efstathakis (1979) 38 FLR 276; Chaudhri v Commissioner of Taxation [2001] FCA 554).
109. Starke J in Australian Machinery & Investment Co Limited v Deputy Commissioner of Taxation (WA) (1946) 3AITR 359 considered that the issue of source relating to the earning of income arising otherwise than from the sale of goods is governed by Lovell & Christmas Limited v The Commissioner of Taxes (1908) AC 46:
“One rule deducible from the decided cases is that where the essence of the business ordinarily consists in making certain classes of contracts and in carrying these contracts into operation with a view to profit or income then for the purposes of Income Tax Acts, such as here under consideration, the business is carried on within the locality where such contracts are habitually made, which is the course of the profit or income”.
110. In Mt Morgan Gold Mining Company Ltd v Commissioner of Income Tax (Queensland) (1922-1923) 33 CLR 76, Starke J at 110 observed:
“This interpretation brings the present case into line with the decisions under the Income Tax (Management) Acts, 1912-1914, of New South Wales (Kirk’s case; Meek’s case) and upon the Land and Income Tax Assessment Act, 1900, of New Zealand (Lovell’s case). The various Acts are not identical in language but they are sufficiently close in this respect to warrant an application of the principles laid down in the cases mentioned. The income must, as I understand the cases, arise or accrue directly from the operations carried on in Queensland. But the Acts do not contemplate going further back for the purpose of taxation than the locality of the business operations from which the profits are directly derived. If contracts form “the essence of the business” (Lovell’s case) then for the purpose of determining the locality from which the income is derived you look no further back than the place where the contracts are made. But as was pointed out in substance by my brother Isaacs in Meek’s case, if the essence of the business is a “whole set of operations” from production to realization then the place where one operation is performed – be it the extraction of ore from the earth or the making of a contract – cannot be fastened upon as the locality from which the whole income is derived. All these operations are “necessary stages which terminate in money, and the income is the money resulting less the expenses attendant on all stages (Kirk’s case).
244. The form of the scheme enabled each applicant to obtain tax deductions for an aggregate amount that was well in excess of the amount outlaid by him. In substance, the participants were passive investors, whose cash contributions to the project were less than the tax savings made available by the form of the scheme.
Section 177D(b)(iii) – the time at which the scheme was entered into and the length of the period during which the scheme was carried out
245. The scheme was entered into before 30 June in each year - as early as March in some cases. In each year, however, the applicant was required to contribute only the cost of $25 per participation to obtain shares in EPF before 30 June. Although $12,800 in management fees and interest per participation was purportedly incurred before 30 June, all further payment was deferred until 30 September when the repayment of $4025 of the principal sum was required.
246. The payment by EPF to Base of management fees was effected by the round robin under the bill facility and deposit with Laton Corporate on or before 30 June in each year.
247. Further, although the Project was nominally for 10 years and 5 months, a participant was required to do nothing further after the payment in 30 September of the year in which he joined. Further management fees were payable only out of income (if any).
248. The exchange of bills by which the payment of the participants’ management fees was purportedly paid to Base, and then deposited in Laton Corporate, provided no funds for the operation of the business in the year of joining. The funds were not available to Base under the deposit deed with Laton Corporate until actual cash payments were made in September of each year, but gave the participant his deduction for the year of joining.
Section 177D(b)(iv) – the result in relation to the operation of this Act that, but for this Part would be achieved by the scheme
249. But for the operation of Part IVA, in the 1998 year of income the applicant would be entitled to deductions for the following amounts as a result of the scheme: ie $24,000 for the so called Application fee and $1,600 for interest compared with the amount of $4,025 actually paid by the applicant.
250. Thus, but for Part IVA, the applicant would be entitled to deductions in an aggregate amount that was well in excess of the amount actually expended by him.
Section 177D(b)(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
251. The applicant was required to make a cash outlay of $25 for purchase of shares, and $4025 principal repayment for each participation he held. The financial position of the applicant was improved by the tax savings which the scheme generated. The applicant received immediate tax savings which exceeded his cash outlays in respect of the scheme in the 1998 year of income.
252. The applicant did not derive any income from his investment in the scheme.
Section 177D(b)(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
253. By 30 June 1998, Base was insolvent. In the following years, the money which became available to Base to meet it’s obligations for exploration and prospecting was limited to the $4025 per participation which was paid by the participants in September 1998 and September 1999. In the event, the whole project collapsed. Base was placed in liquidation, and EPF was dissolved.
Section 177D(b)(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
254. There was no other relevant consequence.
Section 177D(b)(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)
255. The connection between the applicants and each of Base and EPF was embodied in the legal rights and obligations created by the prospectus and the applications and agreements referred to above. There is no evidence of any other connection between them.
256. In addition, as part of the scheme the applicants, together with each of the other participants in the project, became shareholders in EPF.
Section 177D(b) - conclusion
257. The respondent submitted that having regard to the matters referred to in s 177D(b) referred to above a reasonable person would conclude that:
(a)the dominant purpose of the applicants, in entering into the scheme and carrying it out in the 1998 year of income and, where relevant, the 1999 year of income was to obtain the tax benefits in connection with the scheme; and
(b)the dominant purpose of the project entities, Base and EPF, was to enable the applicant to obtain the tax benefits in connection with the scheme. It is not to the point if the overall commercial objective of the project entities was to make money. They achieved their commercial purpose by creating a structure to which the attractiveness of the tax advantages it secured was central.
258. It follows from the foregoing that the respondent was authorised and entitled under s 177F(1)(b) of the ITAA 1936 to determine that the tax deductions claimed by the applicant in relation to the scheme for the year ended 30 June 1998 were not allowable.
Additional tax
259. The amount of assessed additional tax is not excessive
260. The applicant is liable to pay the amount of penalty and additional tax included in the amended assessment by reason of ss 226 and/or 226L of ITAA 1936.
261. It was not at the time each applicant lodged his return and it is not now reasonably arguable, within the meaning of ss 226 and 226L, that the applicant is entitled to the claimed deductions under s 8-1 of the ITAA 1997 or s 330-15 of the ITAA 1997 or, alternatively, that Part IVA does not apply.
TRIBUNAL’S FINDINGS
262. The Tribunal has carefully considered all the evidence and the submissions made on behalf of the applicant and the respondent as set out above. The Tribunal makes the following findings:
1. Findings of Fact:
The Tribunal is of the view that the evidence strongly supports the respondent’s contentions as to the relevant facts and the conclusions of fact to be drawn therefrom as set out in the respondent’s submissions on all the matters in issue between the parties. The Tribunal accordingly rejects the applicant’s assertions to the contrary.
2. Issues of Law
Section 8 -1 Income Assessment Act 1936
2.1In the Tribunal’s opinion for the reasons set out in the respondent’s contentions, the claimed outgoings are not deductible under either the first or the second limb of s 8-1 as they were not necessarily incurred in gaining or producing assessable income or in the course of a business carried on for the purpose of gaining or producing assessable income, alternatively they were of capital or of a capital nature.
Section 330-15 Income Tax Assessment Act 1997 and s 79D Income Tax Assessment Act 1936
2.2For the reasons set out in the respondent’s contentions the Tribunal also finds that the claimed outgoings are not deductible under s 330-15 of the Income Tax Assessment Act 1997, alternatively any amount that may otherwise be allowable is reduced to nil pursuant to s 79D of the Income Tax Assessment Act 1936.
3. Part iva
263. The Tribunal having found that the deductions claimed by the applicant should not be allowed for the reasons stated above there is strictly speaking no need for the Tribunal to consider the provisions of Part IVA of the Income Tax Assessment Act 1936.
264. However, it should be stated that if it had been necessary to decide the matter under Part IVA then the Tribunal would have found that, for the reasons contended by the respondent as set out above, Part IVA operates to deny a deduction. Amounts actually paid by the applicant would, however in the context of s 177F of the Act have been allowed, if the matter fell to be decided under Part IVA.
265. It should also be noted that as set out earlier a further argument on behalf of the applicant was that the formal determination by the respondent pursuant to s 177F of the Act was made after the date of issue of the relevant amended assessment. It was said that the amended assessment was, therefore, not issued to give effect to such determination and the respondent could not rely on Part IVA of the Act in relation to such assessment. It was argued further that the time limit had expired to make a fresh determination and to give effect to such determination in an amended assessment.
266. Section 177F provides that where a tax benefit has been obtained, or would but for this section be obtained, by a taxpayer in connection with a scheme to which Part IVA applies, the Commissioner may determine that the whole or a part of the deduction shall not be allowable to the taxpayer in relation to the year of income. It is generally accepted that such determination is part of the process of making an assessment and is followed by an assessment. However, s 169A(3) provides:-
In determining whether an assessment is correct, any determination, opinion or judgment of the Commissioner made, held or formed in connection with the consideration of an objection against the assessment shall be deemed to have been made, held or formed when the assessment was made.
In deciding the objection to the relevant amended assessment, the respondent relied on Part IVA as a ground for disallowing the objection. In the Tribunal’s view the positive statement as to that ground is such a determination under s 177F which by virtue of s 169A(3) is deemed to have been made when the amended assessment was made. The amended assessment was issued within the time limits permitted by s 170.
267. Even if it could be said that no such determination was made, which the Tribunal does not accept, the determination can be made by the Tribunal. The Tribunal has the powers and discretions conferred by the Act on the Commissioner and, in reviewing an objection decision to make the correct or preferable decision on that objection. Consequently, any determination made by the Tribunal in its decision is a determination referred to in s 169A. In Fletcher v Commissioner of Taxation (1988) 19 FCR 442 no determination under s 177F had been made by the Commissioner. Part IVA had not been relied upon in the objection decision nor before the Tribunal. Nevertheless, the Tribunal’s decision was by reference to Part IVA. The Full Federal Court said (at p 453):
It follows that, in determining an objection to an assessment, the Commissioner is entitled to make a determination under s 177F of the Act; and thereafter to give effect to that determination by an appropriate decision under section 186.
By force of s 43 of the Administrative Appeals Tribunal Act, the Tribunal has all the powers and discretions that are conferred by s 186 of the Income Tax Assessment Act upon the Commissioner. In exercising those powers and discretions the Tribunal was bound to consider the facts as they were proved in evidence before the Tribunal, making the decision which, upon that evidence and at that time, was the correct or preferable decision to be made in considering the objection. The Tribunal was not confined either to the material which was before the Commissioner, as primary decision-maker, or the events which had occurred up to that time …
Once it is understood that, in exercising his powers under s 186, the Commissioner would have been free to exercise a discretion under s 177F of the Income Tax Assessment Act, it follows that, in reviewing the Commissioner’s decision under s 186, the Tribunal is free to exercise that same discretion if, upon the material then before it, it seems proper to take that course.
In the Tribunal’s opinion it is clear that the Tribunal may, as part of its role, make a determination pursuant to s 177F and that determination is, pursuant to s 169A(3) deemed to have been made when the relevant amended assessment was made. The applicant’s assertions to the contrary are rejected.
DECISION
268. The Tribunal concludes that having regard to it’s findings as set out above the applicant has failed to discharge the onus which rests on him to show that, on the balance of probabilities, the amended assessment is excessive.
269. Accordingly, the correct or preferable decision is that the decision of the respondent under review should be affirmed.
I certify that the 269 preceding paragraphs are a true copy of the reasons for the decision herein of Mr A Sweidan, Senior Member
Signed: ..........[Sgd R Riberi]................
AssociateDates of Hearing 18 – 19 December 2006
Date of Decision 30 April 2007
Counsel for the applicant Mr F Wilson/ Mr D Romano
Solicitor for the applicant Wilson & Atkinson
Counsel for the respondent Mr G Davies SC/ Mr J AllansonSolicitor for the respondent Australian Government Solicitor
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