The Taxpayer and Commissioner of Taxation

[2006] AATA 941

Administrative

Appeals

Tribunal

 

DECISION AND REASONS FOR DECISION [2006] AATA 941

ADMINISTRATIVE APPEALS TRIBUNAL      )

)          No  AT2005/21
  )                 AT2005/22

TAXATION APPEALS DIVISION		)
Re		THE TAXPAYER

Applicant

And  COMMISSIONER OF TAXATION

Respondent

DECISION

Tribunal  J.W. Constance, Senior Member

Date 3 November 2006

Place Canberra

Decision  The decision of the Commissioner of Taxation made 10 March 2005 disallowing the objections of the taxpayer to the disallowance of deductions claimed for the year ended 30 June 1999 and the year ended 30 June 2000, is affirmed.

..............................................

J.W. Constance, Senior Member

CATCHWORDS

TAXATION – Deductions – Payment of management fee to related company – Whether services provided – Whether deductions allowable – Burden of proof – Burden not discharged.

Taxation Administration Act 1953 (Cth) ss 14ZZ,14ZZK

Income Tax Assessment Act 1997 (Cth) s 8-1

Income Tax Assessment Act 1936 (Cth)

Federal Commissioner for Taxation v Dalco (1990) 168 CLR 614; [1990] HCA 3

Federal Commissioner of Taxation v Ryan (2000) 201 CLR 109; [2000] HCA 4

Magna Alloys & Research v Federal Commissioner of Taxation (1980) 33 ALR 213

Ronpibon Tin NL v Federal Commissioner of Taxation (1949) 78 CLR 47; [1949] HCA 15

Lunney v Federal Commissioner of Taxation (1958) 100 CLR 478; [1958] HCA 5

Federal Commissioner of Taxation v Hatchett (1971) 125 CLR 494; [1971 HCA 47

Federal Commissioner of Taxation v Cooper (1991) 29 FCR 177

REASONS FOR DECISION

3 November 2006                 J.W. Constance, Senior Member

INTRODUCTION

1.        In assessing the income tax liability of the taxpayer, Airwave Airconditioning Pty Limited for the 1998/99 financial year the Commissioner of Taxation disallowed claimed deductions of $510,000 for management fees and $792 for interest. In respect of the year 1999/2000 a claim of $26,503 for interest was disallowed.

2.        The taxpayer objected to the decision to disallow the deductions.  By a decision of 10 March 2005 the Commissioner disallowed the objection.  The taxpayer has applied to the Tribunal to review this decision. For the reasons which follow I have decided that the decision under review should be affirmed.

LEGISLATIVE BACKGROUND

3. The application for review is made pursuant to subsection 14ZZ(b) of the Taxation Administration Act 1953 (Cth). Unless the Tribunal otherwise orders, the taxpayer is limited to the grounds stated in the taxation objection and has the burden of proving that the assessment is excessive: section 14ZZK. It is not sufficient for the taxpayer to show that the Commissioner made the assessment on a wrong basis. This section clearly states that the assessment must be shown to be excessive.

4.        In considering a previous, but similar, provision in relation to the onus of proof the High Court said:

“The majority of the Full Federal Court in the present case treated the error which they held to infect the Commissioner's assessment of the amount of the taxpayer's taxable income as concluding the question whether that amount was excessive. It did not. If this were a case where all the material facts were known and the amount of taxable income depended on the legal complexion of those facts, the taxpayer would succeed upon establishing that the Commissioner erroneously included in the assessed taxable income an amount which, on those facts, ought not to have been included. But where, as here, the taxpayer has not proved that his actual taxable income is less than the amount assessed, the Court does not know all the material facts and it cannot find that the amount assessed is wrong…. Unless the amount of the assessment is found to be excessive in the sense of being greater than the taxable income on which tax ought to have been levied, the taxpayer fails on his appeal." [1]

[1] Federal Commissioner for Taxation v Dalco (1990) 168 CLR 614 at 625.

THE TAXPAYER’S SUBMISSIONS

5.        The taxpayer has argued that the issues before me are as follows:

1)“has the Respondent assessed the Applicant as the correct taxpayer";

2)"if the Tribunal finds that the Respondent has assessed the wrong taxpayer then it must follow that the assessments under review are excessive, the application must be allowed and the assessments and amended assessments under review must be set aside";

3)"if the Tribunal finds that the Applicant is the correct taxpayer, the Tribunal has to decide whether there is any statutory power to support the action of the Respondent to amend the assessments of the Applicant pursuant to Part IVA of the Income Tax Assessment Act 1936";

4)" if the Tribunal makes a finding that there is a power to amend the tax returns of the Applicant, the Tribunal will be required to identify a relevant "tax benefit" as required by Part IVA of the Income Tax Assessment Act 1936".[2]

[2] Submissions of the Applicant, 5 June 2006.

6.        I do not accept the taxpayer's statement of the issues to be determined.  I agree with the submission of the Commissioner that the question of whether the correct taxpayer has been assessed does not arise.  The taxpayer has argued that the $510,000 management fee is properly assessable as income of a related company to which it is alleged the fee was paid.  As Counsel for the Commissioner has pointed out, the taxation affairs of a related entity are not the subject of these proceedings.  The relevant issue for determination is whether the taxpayer has discharged the burden of proof to establish that the claimed outgoings are allowable deductions under section 8-1 of the Income Tax Assessment Act 1997 (Cth). 

7.        I also agree with the Commissioner’s submission in relation to the third and fourth issues raised by the taxpayer.  The assessments in question (for the year ended 30 June 1999 and the year ended 30 June 2000) were original assessments.  These assessments appear at pages 240 and 241 respectively of Exhibit A5.  The income-tax returns lodged by the taxpayer for the 1999 and 2000 financial years each disclosed a net loss. Consequently no tax was payable and there was no assessment made within the meaning of the Act: Federal Commissioner of Taxationv Ryan (2000) 201 CLR 109.[3]

HAS THE TAXPAYER DISCHARGED THE BURDEN OF PROOF TO ESTABLISH THE CLAIMED OUTGOINGS ARE ALLOWABLE DEDUCTIONS UNDER SUBSECTION 8-1(1) OF THE ACT?

[3] At 128.

8.        The evidence put before me by the taxpayer was seriously deficient and caused me to have serious concerns as to the veracity of the witnesses for the taxpayer.  I am not satisfied that the claimed outgoings of management fees and interest are allowable deductions.

Evidence on behalf of the taxpayer

9.        It is not in dispute that the taxpayer claimed deductions in the year ended 30 June 1999 of $1,240,574, which included an amount of $510,000 claimed to be management fees.

Mr McSwain

10.      Mr McSwain gave evidence.  He is an accountant by occupation and is the tax agent for the taxpayer.  He is also the accountant for the related company and has held that position for approximately 4 years.  Mr McSwain gave evidence that the company paid a management fee to the related company "for a raft, or a bundle of services." [4] He described these services as being management services provided by Mr Armstrong as an employee of the related company.  In this same year the related company paid $500,000 to United Overseas Credit Limited. The capacity of the related company to make this payment derived from the payment of the management fee by the taxpayer.

[4] Transcript of Proceedings, 4 April 2006, p. 24.

11.      In cross-examination Mr McSwain was referred to a letter of 10 November 2003 from Mr Armstrong, to the Australian Taxation Office advising as follows:

"We do not believe that [the related company] traded during the period [year ended 30/6/1997 to year ended 30/6/03] as we have not been able to locate any financial accounts prepared by our previous tax agents." [5]

[5] Exhibit A5, T42.

When asked whether he would accept that the above statement was true, Mr McSwain replied that it would be necessary to ask Mr Armstrong. Mr McSwain stated that he had prepared financial accounts for the related company for the period referred to and that he had retained copies of these accounts in his office.  Copies of the accounts were not filed in the Tribunal either before or during the hearing. These accounts covered the period of the 1998/1999 financial year, during which the related company allegedly provided the management services for which the taxpayer paid $510,000.

12.      Mr McSwain also gave evidence that the funds used by the taxpayer to pay the management fee were provided to the taxpayer by Mr Armstrong.  The funds were borrowed by Mr Armstrong from the United Overseas Credit Limited and were provided to him by way of promissory note. The funds were then transferred by journal entry from the taxpayer to the related company.    

Mr Armstrong

13.      Mr Armstrong confirmed that he is the sole director of the taxpayer and the related company and has held these positions at all relevant times.  He said that the nature of the taxpayer's business was air-conditioning duct work and installation. The nature of the business has remained the same throughout the period 1998 to the present day.

14.      Mr Armstrong agreed that he paid approximately $500,000 to the taxpayer, having borrowed this sum from the United Overseas Credit Limited. The loan was for a fixed term with interest only payments quarterly in arrears. He said that he did not recall how the funds were received by him or how they were paid by him to the taxpayer. Nor did he recall whether he had a bank account into which the funds from the promissory note were deposited at any time.  Mr Armstrong did not recall whether he had retained a copy of the promissory note.  The taxpayer did not provide any documentary evidence of the loan to Mr Armstrong and/or the transfer of funds from Mr Armstrong to the taxpayer. Mr Armstrong also agreed that there was no formal documentation of a management agreement between the taxpayer and the related company. 

15.      Exhibit A5 document T32 is a copy of a letter of 16 May 2001 from United Overseas Credit Limited to Mr Armstrong.  The letter is headed "Confirmation for Audit Purposes" and includes the following:

“According to our records, the details of our loan to you as at 30 June 2000 are as follows:

Date of drawdown:  04-Jun-99

Loan amount:  AUD$            500,000

Interest payable:                AUD$            32,136.99

Term:  10 years

Interest rate per annum  6.0%

Security:Legal charge over European Grande Assurance S.A. Insurance Bond Policy

We appreciated that you may have settled the interest after the date mentioned above, but we still appreciate your confirmation that the balance is correct."

16.      Document T34 in Exhibit A5 is a copy of a statement from United Overseas Credit Limited of the interest owing on the loan from 30 December 1998 to 31 December 2002.  Contrary to the letter referred to above, the statement shows that the amount of interest owing at 30 June 2000 was $7,500.  The statement also showed a number of payments of interest which were made in the financial year ended 30 June 1999 and the financial year ended 30 June 2000 which Mr Armstrong confirmed he did make. Neither the interest payments made, nor the interest charged, in the 1999/2000 financial year amounted to $22,500.  The same statement discloses that on 31 December 2002 there was a debit of $500 described as an "Early Loan Cancellation Fee".  Mr Armstrong said that he only learned that the loan had been cancelled whilst giving evidence during this hearing.  He also said that since 27 April 2000 he had not paid any interest on the loan.

17.      In cross-examination Mr Armstrong agreed that he paid the $500,000 he had borrowed to the taxpayer which then made the payment of $510,000 for management to the related company.  He also agreed that the related company used the money for the purpose of purchasing a life policy on his life from National Employee Trust (New Zealand) Limited.

18.      Mr Armstrong gave evidence that he believed the $510,000 management fee paid to the related company by the taxpayer, comprised two amounts.  These were $10,000 for wages (which was paid by the related company to him) and the remaining $500,000 which was used by the related company to make the $500,000 payment for the insurance policy.  Mr McSwain said that Mr Armstrong was paid $10,000 by way of wages for a month’s employment, although he later changed his evidence to indicate that the $10,000 related to all expenses associated with the management services.  If I accept the former version of events put forward on behalf of the taxpayer, it would appear that Mr Armstrong was paid $10,000 for employment during one month or less and that his management services for the same period were paid for by the taxpayer in the sum of $510,000.

WHAT DEDUCTIONS FROM ASSESSABLE INCOME ARE ALLOWABLE?

19.      Subsection 8-1(1) of the Income Tax Assessment Act 1997 (Cth) provides:

“You can deduct from your assessable income any loss or outgoing

to the extent that:

(a) it is incurred in gaining or producing your assessable income;

or

(b) it is necessarily incurred in carrying on a *business for the

purpose of gaining or producing your assessable income."

20.      As submitted on behalf of the Commissioner, the courts have recognised three tests for characterising an outgoing as falling within the above subsection.  These are:

a)the outgoing is "incidental and relevant" to the taxpayer's income producing/business operations;[6]

b)the outgoing has the "essential character" of an income producing/business expense;[7]

c)the outgoing has a "perceived connection" with the gaining or producing of income.[8]

[6] Ronpibon Tin NL v Federal Commissioner of Taxation (1949) 78 CLR 47.

[7] Lunney v Federal Commissioner of Taxation (1958) 100 CLR 478.

[8] Federal Commissioner of Taxation v Hatchett (1971) 125 CLR 494.

21.      The Commissioner also referred me to the decision of the Federal Court in Magna Alloys & Research v Federal Commissioner of Taxation (1980) 33 ALR 213  in which the Court said in relation to the "essential character" test:

“In cases where a connection between the outgoing and the taxpayer's undertaking or business is affected by the voluntary act of the taxpayer, the purpose of incurring that expenditure may constitute an element of its essential character, stamping it as expenditure of a business or income-producing kind." [9]

[9] At 218-219.

All relevant circumstances should be considered when applying this test.[10]

[10] Federal Commissioner of Taxation v Cooper (1991) 29 FCR 177 at 188.

22.      Bearing in mind the onus on the taxpayer, I am not satisfied that either of the outgoings in question (the management fee or the interest) satisfied any of the tests referred to and consequently I am not satisfied that either payment (assuming that in fact payment took place) is deductible under section 8-1.

The management fee

23.      The taxpayer did not provide any evidence of the services for which it claimed to have paid $510,000 other than the very general description of management services provided by Mr Armstrong.  In view of the onus being on the taxpayer, I expected that Mr Armstrong would have provided considerable detail as to the work it is claimed he undertook.  Mr Armstrong was the sole director of each of the subject companies at the time the fee was said to have been paid. It is reasonable to expect, in those circumstances, that evidence would be available as to precisely what was done by Mr Armstrong in return for the payment by the taxpayer to the related company. I also regard it of considerable significance in reaching this decision that there was no documentation produced relating to the claimed management agreement.  

24.        I have taken into account also the written advice from Mr Armstrong to the Australian Taxation Office of 10 November 2003 that the related company, which was said to have been providing the services to the taxpayer, did not trade during the relevant period.  Although Mr McSwain said he had prepared financial accounts for the related company for this period they were not provided to the Tribunal.  Again, I would have expected this to have occurred in view of the advice of 10 November 2003.

25.      On the other hand, the evidence strongly suggests that the payment of $510,000 by the taxpayer was simply a journal entry to provide funds to the related company to enter into some form of superannuation arrangement in respect of which ultimately no deduction was claimed. This was on advice of the legal representatives of the related company.  It is not necessary that I make a positive finding in this regard.  I simply note that the evidence in relation to the transaction raises considerable doubt in my mind as to the veracity of the claim that the payment was for a management fee.  As I have said, Mr Armstrong did not provide the evidence one would have expected he could, as to the services he is said to have provided. He was extremely vague regarding the transaction in which the money was advanced to him, then paid to the taxpayer and ultimately paid to the related company. He did acknowledge that the related company used the money for the purpose of purchasing a life policy on his life.

The interest payment

26.      The evidence on behalf of the applicant in relation to the claimed deduction for interest is equally unsatisfactory and I am not satisfied that the taxpayer has discharged the burden of showing that it meets any of the tests to entitle it to the deduction claimed.  The letter of 16 May 2001 from United Overseas Credit Limited entitled "Confirmation for Order to Purposes", when compared with the statement of the interest payments of 31 December 2002 [11] strongly suggests to me that this was not an arm's length transaction.  In any event, it appears that the interest payments were made by Mr Armstrong, and not the taxpayer.  In addition, neither the interest payments made in the relevant financial years amount to the deductions claimed.  In light of the evidence that the loan had been cancelled for a number of years before Mr Armstrong became aware of this fact, together with Mr Armstrong's failure to pay interest for a number of years without a satisfactory explanation, leaves me in doubt as to the true nature of this transaction and the interest for which the deduction is claimed.  Again, the onus is on the taxpayer to show that the deductions claimed are lawful deductions. I am not satisfied of this.

[11] Exhibit A5, T34.

THE ALLEGATION THAT THE ASSESSMENTS WERE MADE MALA FIDES

27.      Having made this allegation, the taxpayer did not put any evidence before me which could justify the making of the claim.  In the absence of any such evidence it was inappropriate that the claim was made in the first place.

28.      I am satisfied that the taxpayer did not do all it could to assist the Commissioner by way of providing documents requested of it.  The Commissioner was perfectly entitled to make the assessments of the basis of the material before him.  The evidence of both Mr Armstrong and Mr McSwain as to why various documents were unavailable was confused and I and unable to make any findings favourable to the taxpayer based on their evidence.

DECISION

29.      The decision of the Commissioner of Taxation made 10 March 2005 disallowing the objections of the taxpayer to the disallowance of deductions claimed for the year ended 30 June 1999 and the year ended 30 June 2000, is affirmed.   

I certify that the 29 preceding paragraphs are a true copy of the reasons for the decision herein of J.W. Constance, Senior Member.

Signed:         .....................................................................................

  Joe Meagher, Associate

Date/s of Hearing  4 April 2006
Date of Final Submissions             28 August 2006
Date of Decision  3 November 2006
Solicitor for the Applicant                Mr A. Powrie
Counsel for the Respondent          Ms M. Brennan
Solicitor for the Respondent         ATO Legal Services