The Taxpayer and Commissioner of Taxation
[2004] AATA 1243
•25 November 2004
Administrative
Appeals
Tribunal
DECISION AND REASONS FOR DECISION [2004] AATA 1243
ADMINISTRATIVE APPEALS TRIBUNAL
TAXATION APPEALS DIVISION NT2001/587
Re: The Taxpayer
Applicant
And:Commissioner of Taxation
Respondent
DECISION
Tribunal: P.J. Lindsay, Senior Member
Date: 25 November 2004
Place: Sydney
Decision:The objection decision under review is affirmed
. . . . . . . . . . . . . . . . . . . . . . . .
P. J. Lindsay, Senior Member
© Commonwealth of Australia (2004)
CATCHWORDS Income tax – private company - payments by a private company for the benefit of an employee – fringe benefits tax payable - whether similar payments by company to fund acquisition of house for director/shareholder represent a distribution of profits – payments not fringe benefits – payment by company to finance interest in business not considered a loan to shareholder - no grounds for remitting penalties – objection decision affirmed
Income Tax Assessment Act 1936 ss.6, 23L, 44, 108, 170AA, 222A, 226H, 226J
Fringe Benefits Tax Assessment 1986 ss.16, 20, 136, 148
Macfarlane v Commissioner of Taxation (1986) 13 FCR 356
Case 69 (1950) 1 TBRD 260
J&G Knowles and Associates Pty Limited v Commissioner of Taxation (2000) 96 FCR 402
Smith v Commissioner of Taxation (1987) 164 CLR 513
Stage Club Ltd v Millers Hotels Pty Limited (1981) 150 CLR 535
Albion Hotel Pty Ltd v Federal Commissioner of Taxation (1964-1965) 115 CLR 78
Case 3/96 96 ATC 139
Hart v Commissioner of Taxation (2003) 131 FCR 203
BRK (Bris) Pty Ltd v Commissioner of Taxation (2001) 46 ATR 347
Kenneth A Summons Pty Ltd v Federal Commissioner of Taxation (1986) 80 ALR 95
REASONS FOR DECISION
P.J. Lindsay, Senior Member
1. The applicant requested that the matter be heard in private and that the decision not identify him. I will refer to the applicant as the ‘taxpayer’ and use pseudonyms for others referred to in these reasons.
background
2. On 6 June 2001 the Commissioner of Taxation (the respondent) disallowed the taxpayer’s objection to an amended assessment for the income year ended 30 June 1996 that was issued by reference to s.108 of the Income Tax Assessment Act 1936 (the Act). The amended assessment increased the taxpayer’s assessable income by including deemed dividends of $1,602,405.
3. Although there was some dispute as to when the taxpayer became a director and shareholder in a company, ABC Pty Limited (ABC), it was nonetheless clear that he was a director and shareholder at least from around 1986. ABC’s business was in mechanical engineering, large-scale plumbing infrastructure and water treatment works.
4. The respondent formed the opinion that certain payments made by ABC on the acquisition of a house for the taxpayer and his wife and an amount provided to the taxpayer enabling his wife to buy a business, represented distributions of ABC’s profits to a shareholder as opposed to fringe benefits and loans, and thus constituted deemed dividends. The amount of the increase to assessable income, $1,602,405, comprises:
· amounts totalling $1,278,292 paid by ABC to finance the purchase of a residence held jointly by the taxpayer and his wife, including the deposit, the stamp duty and the balance of purchase money (the house payments).
· an amount of $324,113 provided by ABC to the taxpayer, whose wife used the funds to finance the purchase of her half share in a bottle shop (the bottle shop payment).
5. The taxpayer submits that the house payments are expense payment fringe benefits assessable under s.20(a) of the Fringe Benefits Tax Assessment Act 1986 (the FBT Act) or alternatively loan fringe benefits under s.16 of the FBT Act. Consequently, the payments would not be assessable to the taxpayer, being exempt income under s.23L of the Act. By analogy with the taxation treatment given to ABC’s payment in May 1995 for a house for an employee, Mr Smith, the taxpayer submits that the house payments represent part of his salary package and should be assessed as expense payment fringe benefits. It was submitted that the bottle shop payment does not represent a distribution of profits to which s.108 applies as it is a repayment of loan funds due to the taxpayer by ABC and should properly be offset against amounts standing to his credit in ABC’s books and treated as a repayment of loan funds.
6. ABC was placed into liquidation as a consequence of demands for tax made by the respondent and has been liquidated.
applicable legislation
7. In respect of the 1996 income year, s.108 of the Act reads as follows:
Loans etc. to shareholders and associates deemed to be
dividends
(1) If a private company:
(a) pays an amount to an associated person by way of an advance or loan; or
(b) pays or credits an amount on behalf of, or for the individual benefit of, an associated person;
so much (if any) of the amount paid or credited as, in the opinion of the Commissioner, represents a distribution of profits shall, for the purposes of this Act other than Division 11A of Part III and Division 4 of Part VI, be deemed to be a dividend paid by the company:
(c) to the associated person as a shareholder in the company;
(d) out of profits derived by the company; and
(e) on the last day of the year of income of the company in which the payment or credit referred to in paragraph (a) or (b) is made.
…
(2) If:
(a) an amount is deemed by subsection (1) to be a dividend paid by a company; and
(b) the company subsequently sets off the whole or a part of a dividend (in this subsection called the subsequent dividend) distributed by it in satisfaction in whole or in part of the amount;
so much of the amount of the subsequent dividend as is set off as does not exceed the unfranked part of the subsequent dividend:
(c) shall be deemed not to be a dividend for the purposes of this Act other than Part IIIAA; and
(d) shall not be taken to be exempt income for the purposes of sections 160APP and 160AQT only because of this subsection.
…
(3) For the purposes of this section:
(a) a transfer of property shall be deemed to be the payment of an amount equal to the value of the property;
(b) a reference to the unfranked part of a dividend is a reference to so much of the dividend as has not been franked in accordance with section 160AQF; and
(c) a reference to an associated person, in relation to a company, is a reference to:
(i) a shareholder in the company; or
(ii) a person who is an associate, within the meaning of section 26AAB, of a shareholder in the company.
…
8. The definition of ‘fringe benefit’ in the FBT Act relevantly provides:
fringe benefit, in relation to an employee, in relation to the employer of the employee, in relation to a year of tax, means a benefit: … provided to the employee or to an associate of an employee by:
(c) the employer; or …
in respect of the employment of the employee, but does not include …
(n) a payment of an amount that, under any provision of the Income Tax Assessment Act 1936, is deemed to be a dividend paid to the recipient; …
Section 148 of the FBT Act may be seen as attempting to make certain that the provision of benefits in particular circumstances will be subject to fringe benefits tax and relevantly provides:
Provision of benefits
(1) A reference in this Act to the provision of a benefit to a person in respect of the employment of an employee is a reference to the provision of such a benefit:
(a) whether or not the benefit is also provided in respect of, by reason of, by virtue of, or for or in relation directly or indirectly to, any other matter or thing; …
(f) whether or not the benefit is provided or used, or required to be provided or used, in connection with that employment;
(g) whether or not the provision of the benefit is, or is in the nature of, income; and
(h) whether or not the benefit is provided as a reward for services rendered, or to be rendered, by the employee.
9. Section 16 of the FBT Act provides:
Loan benefits
(1) Where a person (in this subsection referred to as the provider) makes a loan to another person (in this subsection referred to as the recipient), the making of the loan shall be taken to constitute a benefit provided by the provider to the recipient and that benefit shall be taken to be provided in respect of each year of tax during the whole or a part of which the recipient is under an obligation to repay the whole or any part of the loan.
…
Section 20 of the FBT Act deals with expense payment fringe benefits:
Expense payment benefits
Where a person (in this section referred to as the provider):
(a) makes a payment in discharge, in whole or in part, of an obligation of another person (in this section referred to as the recipient) to pay an amount to a third person in respect of expenditure incurred by the recipient; or
(b) reimburses another person (in this section also referred to as the recipient), in whole or in part, in respect of an amount of expenditure incurred by the recipient;
the making of the payment referred to in paragraph (a), or the reimbursement referred to in paragraph (b), shall be taken to constitute the provision of a benefit by the provider to the recipient.
evidence
10. The taxpayer and his wife gave evidence as did Mr Smith, who was an employee of ABC at relevant times, and is currently a co-director with the taxpayer in a company that has taken over the previous activities of ABC. The tribunal heard evidence from Ms White who was the company’s office manager and is now employed by the company in which the taxpayer and Mr Smith are directors. The external accountant for ABC, Mr Brown, was approached to give evidence but declined to do so. Mr Jones, the taxpayer’s co-director in ABC, was in prison at the time of the hearing, the convictions for revenue fraud arising out of his activities involving ABC. The respondent called one of his officers, Mr Green, who interviewed the taxpayer on a couple of occasions in the course of investigating the taxation affairs of ABC, the taxpayer and Mr Jones. The tribunal had before it the documents lodged under s.37 of the Administrative Appeals Tribunal Act 1975 (the T documents) and the exhibits tendered during the hearing.
11. The taxpayer’s statements made on 23 August 2002 and 29 January 2003 were accepted in evidence (exhibits A1 and A2). Counsel for the respondent objected to parts of the statements being accepted and the matters concerned in those sections of the statements will be discussed below. The taxpayer’s main statement is dated 23 August 2002 and reads in part (edited so as not to identify the taxpayer and to remove references to the T documents):
2. I have no qualifications in business studies and in particular have undertaken no studies in accounting. Neither I nor others regard myself as ‘financially sophisticated’. However, I do know the difference between receiving a dividend from a company, receiving a loan from a company, and having a benefit provided by a company as part of a salary package. When I refer to ‘drawings’ from a company, I simply mean something that comes from the company.
3. I was employed by [ABC] (the company) … from 1977 to June 1999 … and in 2000 it was placed into administration due to ATO demands for payment of tax … I started with Mr Jones as an apprentice in about 1973. …
5. I became a director of the company in about 1986. Prior to that time the directors were Mr Jones and Mr Smith. Mr Smith had been a shareholder since the company’s formation. …
6. I became a shareholder in the company at the same time as I became a director. I bought Mr Smith’s share for $1. The other shareholders were Mr Jones and a Mr Jones company …
7. I was paid a salary of about $140,000 for working full time as a senior supervisor for the company in the year ended 30 June, 1996. I spent most of my working week doing quotations, tenders, and supervising work on site, and was rarely in the office.
8. I was not involved in keeping the company’s books, which were looked after by the company’s office administrator, Ms White and Mr Jones and at financial year end, the external accountant, Mr Brown.
9. Ms White started work for the company in about 1993. She did not do any of the banking. Mr Jones deposited most of the cheques. Mr Jones and I were the signatories to the various bank accounts. Usually Mr Jones signed the outgoing cheques on the cheque account at National Australia Bank, Lakemba. Mr Jones had always been very much in control of the company. He always had the final word. For my part, this reflected the fact that I started with him as an apprentice.
10. Around 1994 Mr Smith returned to Australia at Mr Jones’ suggestion that some big work might become available. The company agreed to employ him full time on a salary. Because Mr Smith secured the [water treatment project] tender for the company, the company agreed to buy him a house and car as part of his salary package. … Mr Smith was a person who added credibility to the company’s ability to tender for bigger jobs than it had previously attempted. As the other director of the company I was happy with the salary package offered to Mr Smith.
11. The company bought Mr Smith a house … costing $1.5M. … He also got a Mercedes Benz 420SL car in September, 1994 which cost $109,500. When Mr Smith chose a house and car as previously agreed to be part of his salary package, I was happy for him. He deserved it for the significant work he got for the company. Even if he left the company soon after, the company wouldn’t expect to get anything back.
12. At the same time, the company agreed to double Mr Jones’, Mr Smith’s and my take home pay. …
13. The company had lodged FBT returns before the FBT year in which the benefits of the house and car were provided to Mr Smith. Those prior year returns related to various benefits provided to employees, the main ones in terms of value, being the provision of motor vehicles.
14. At the time I thought that the company paid FBT on the value of the benefit of the house [$1.5M] and car given to Mr Smith.
15. After Mr Smith left the company in 1986 I quoted, tendered, and secured many major projects for the company … Most of my time was spent managing these projects which involved living away from home and family for long periods of time. It was the success of these projects that built the reputation of the company in the industry to allow us to be considered for the tendering of [the water treatment project]. When Mr Smith returned and was instrumental in getting the [water treatment project] job, I had been doing the lead up work for years. As a result of my valued work performance for the company, it agreed to provide my wife and I with a house … in our joint names and made an interest free loan to me to on lend to my wife … for her to buy a bottle shop, as part of my salary package, just as similar benefits had been provided to Mr Smith. … My wife provided all of the purchase price, and her partner agreed to pay back his half share; I approached Mr Jones to arrange for the company to lend me some money so that my wife could buy the bottle shop. Mr Jones said that he would arrange the loan from the company to me and I could pay the loan off from my dividends paid by the company over the next few years. Mr Jones said to me to go over to the bank and pick up the cheque for $324,113.60 for the purchase of the bottle shop which I did. I agreed with the company that the loan was interest free and would be repayable out of dividends I expected from the company within the following few years in the ordinary course of events, or otherwise I would have repaid it out of the sale of assets..
…
17. … After we won the contract … and the project had been running successfully Mr Jones approached me about ABC buying Mr Smith a car and house as part of his package and I agreed with this. Some time after ABC bought Mr Smith’s car and house I approached Mr Jones about me getting the same deal as Mr Smith. I said “we’ve bought Mr Smith a house for his work in the company and we should be able to buy me a house as well on the same deal as Mr Smith” and he said “okay, go and have a look” which I did. …
18. An extract of my loan account as it existed in 1996 has been provided by the company’s former accountants. This extract reveals the following entries:
Debit
Credit
Balance
Balance brought forward
(32)
Payments in respect of liquor store
324,114
324,082
Sundry payments
25,886
349,968
Payments to Fury Group
41,269
391,237
Motor vehicle sale proceeds
13,901
377,336
Funds credited
304,503
72,833
Dividends declared
300,000
(227,167)
Half transfer of [Mr Smith’s] house loan debt
212,482
(14,675)
Total
603,760
618,404
(14,675)
19. This loan balance was included in the current liabilities ($1,656,363) disclosed in the company’s 1996 tax return at item 58. I annex as “C” the company’s financial accounts for the year ended 30 June, 1996. The balance sheet total for current liabilities is the corresponding figure ($1,656,363) and includes “shareholder loans” of $121,269.34. I annex as “D” part of the trial balance of the company which discloses this figure is made up of ledger accounts for the taxpayer ($14,674.86), Mr Jones ($65,519.15) and Mr Jones company ($41,075.33).
20. The $324,114 loan to me in relation to the bottle shop came from the company’s NAB cheque account at Lakemba.
21. The debit to my loan account for the “payments to Fury Group” should not have been made, as it related to the purchase of my Ford Fairlane, which is registered in my name, and which was provided to me as part of my salary package, and was never intended to be repayable, by the company, or me.
22. The “Half transfer of Mr Smith’s house loan debt” debited to my loan account was a misdescription. When Mr Smith got divorced from his first wife, the company agreed to pay $424,684 to her on his behalf. It was originally recorded as a debt owed by Mr Smith to the company, but as at 30 June, 1996, it was agreed by Mr Jones and I, that we would assume Mr Smith’s responsibility to repay that amount, and ultimately $212,482 was debited to each of our loan accounts with the company, and Mr Smith was accordingly relieved of his debt.
23. The credit for the vehicle traded in for $13,901 was on my old Ford Fairlane, when I got the new one.
24. In my record of interview with the ATO when I used the word “drawings” in relation to the money used to pay for the vehicle, I meant that I didn’t owe the company, as the car was provided as part of my salary package. The agreement with the company was it would pay any tax liability on that benefit.
25. I did not use the word “dividend” in my record of interview, as alleged in the ATO reasons for decision. I annex as “E” a statement prepared by the ATO … and signed by me on 23 June, 2000, which is not referred to in the “T” documents. At the second paragraph on page 5, the first paragraph on page 6, and the third last paragraph on page 8 of that statement, the ATO has put words in my mouth, where it repeated “was drawings or dividends and tax was paid. Why I say this is because Mr Jones told me that the tax would be fixed up at the end of the year when the books are prepared”. I did not describe these three items as dividends. At the second paragraph on page 5 dealing with the loan for the bottle shop, I never used the word “drawings” as it [sic] apparent from the ATO’s own documents. As I have noted above, to the extent it is said by the ATO that I referred to “drawings” in relation to the house, I mean that the money had come out of the company and the company was to pay the tax on the benefit provided as part of the salary package.
26. The only dividend I derived in the year ended 30 June, 1996 was the $300,000 (fully franked) credited to my loan account, and declared in the company’s 1996 tax return and in my personal tax return for 1996.
12. In his oral evidence, the taxpayer acknowledged that he has been convicted of revenue fraud for failing to disclose in his income tax return that ABC had paid a tax bill for him. This payment came about because the taxpayer asked Mr Jones to agree to ABC’s paying his tax bill. But he maintained that he did not sign the return knowing it to be false, because he was confident that the person who had prepared it, had done so properly.
13. The taxpayer said that he and Mr Jones shared ABC’s profits equally, despite his holding only one of the issued shares, while Mr Jones and his own company held the remaining two shares on issue. He and Mr Jones approved and signed the company’s accounts. They made decisions jointly and in particular they made decisions regarding their bid for the contract in the water treatment project.
14. The statement made by Mr Smith on 24 September 2002 was accepted in evidence over the objection by the respondent (exhibit A5). Mr Smith’s witness statement reads in part (edited so as not to identify the applicant and to remove references to the T documents):
8. … Because I was instrumental in securing the [water treatment project contract] for the company [ABC] and because of the highly profitable nature of the job, the company agreed to buy me a house and car as part of my salary package. … [The taxpayer] as the other director of the company, told me that he was happy with the package offered to me.
9. The company bought me a house … costing $1.5m. I also got a Mercedes Benz 420SL car in September 1994 which cost $109,500. Even if I left the company soon after, the company wouldn’t expect to get anything back.
10. About the same time, the company agreed to double [Mr Jones’, the taxpayer’s] and my take home pay.
11. It was agreed between myself and [Mr Jones] that ‘the company’ would pay any taxes and I assumed that the company paid FBT on the value of the benefit of the house ($1.5m) and car given to me.
12. [The taxpayer] was responsible for the on-site management and generally made the day to day decisions on the job. In my view he was instrumental in the success of the company through the way he managed the jobs and the customers. When I left Australia in 1984 we were already well established with Lend Lease, who gave us the [contract for the water treatment project], but the relationship had been maintained when I returned, due in large part to the [taxpayer’s] efforts as on-site manager of jobs. [The taxpayer] was involved in the tendering process and was responsible for many successful projects. Some time after I got my house [the taxpayer] told me that he was going to purchase a new home. I do recall thinking that this was a good reward for [the taxpayer’s efforts] and I assumed that it was to be provided by the company on the same basis as mine.
13. When I got divorced from my first wife, the company agreed to pay $424,684 to her on my behalf. It was originally recorded as a debt owed by me to the company, but as at 30 June, 1996, it was agreed by [Mr Jones and the taxpayer] and me, that I was relieved of that debt.
15. The tribunal heard evidence from Mr Smith, who is an engineer with particular expertise in public works involving large boiler plant and water treatment. Mr Smith said he has been a friend of Mr Jones for forty years. He said that he was employed by ABC, as well as being one of its directors and shareholders from 1977 until 1983 when he went to live overseas. He remembered the taxpayer working for ABC in 1977 but he disputed that the taxpayer was a director or shareholder in ABC in 1977.
16. The taxpayer signed ABC’s FBT return for the year ended 31 March 1995. In cross-examination he agreed that the return did not disclose the company’s payments of $109,000, to purchase a car for Mr Smith, or $150,000, the deposit on Mr Smith’s house paid by ABC’s cheque signed by the taxpayer on 28 February 1995 (exhibit R3 tab 7). He agreed that the FBT return for the following year did not disclose the payments made to complete the house purchase on 10 May 1995. He denied that the omissions were made because he did not consider the payments to be part of Mr Smith’s salary package. He thought the payments would be treated properly for taxation purposes, at the end of the relevant financial year. He said he relied on Mr Jones and Mr Brown, the external accountant, to make sure the FBT returns were correctly completed. According to Ms White’s evidence, Mr Brown sent questionnaires to ABC each year to assist his preparation of the FBT return. Her evidence was that Mr Jones dealt with the questionnaires. The taxpayer denied that the amounts were not disclosed in the returns because he and Mr Jones considered the payments to be loans by ABC to Mr Smith. However, he could not recall the words ‘salary package’ being used when he was discussing Mr Smith’s requests for the car and house. He agreed with counsel for the respondent, that Mr Jones decided that ABC would make the funds available to pay for the car and the house.
17. On his return from overseas in 1991, Mr Smith said he initially did some consulting work for several different organisations. During this period of consulting, he became involved in a consortium that was preparing a tender for a large water treatment project. Mr Smith said he put together the engineering input for the consortium and was requested by Lend Lease, a member of the consortium, to attend meetings of all the consultants concerned with the design of the water treatment/filtration plant. He said it was around 1993 that he began working as a full-time employee of ABC, who asked him to become involved in the company’s tender for a contract to design, manufacture, supply and install plant, services and service mains for the water treatment project. He said he prepared ABC’s tender. In his oral evidence he described his role for the company as being instrumental in its securing the contract and that in effect he brought the contract to ABC. He did not become a director or shareholder in ABC.
18. Mr Smith said the contract that was awarded to ABC was worth around $32m and that his estimate of the company’s profit was around 10 to 15 per cent. He did all the quotations and tendering work once ABC’s contract started, and he said that Mr Jones and the taxpayer did not become involved in the management of the project until after the contract was entered into. ABC’s work under the contract was carried out from mid 1994 to around early 1996, which was six months ahead of schedule. Mr Smith said he thought ABC earned a substantial profit from the contract, which he speculated might have been as high as $6 -7m.
19. In his oral evidence Mr Smith said that in addition to the house and the car, he received a sum of money from ABC, in the order of $300,000.
20. Mr Smith was also interviewed by the Australian Taxation Office on a number of occasions. In the record of interview taken on 27 October 1999 (attached to exhibit A2) Mr Smith was asked about his employment with ABC after he returned to Australia. He stated that he did not have a written employment contract with ABC but he thought he would stay there until his retirement. When ABC won the water treatment project contract, Mr Smith said he approached Mr Jones to request an increase in his salary and a house, to which Mr Jones agreed. There was no discussion about a price limit. Mr Smith said he then went and found a house and Mr Jones arranged for the payment. Title to the house is in the joint names of Mr Smith and his current wife.
21. Mr Smith said there were not any conditions imposed on him in relation to reimbursing ABC for the house should he have a falling out with Mr Jones or leave the company unexpectedly. In a later interview with the respondent’s officers on 29 March 2000 (also attached to exhibit A2), Mr Smith said that the house required approximately $150,000 to $160,000 in renovations and that ABC paid for the work to be done.
22. Mr Smith had separated from his former wife prior to coming back to Australia in 1991. The property settlement side of the divorce was being negotiated by solicitors in 1996. As part of the settlement, Mr Smith gave his wife their house overseas, as well as the sum of $425,000. In the later record of interview, Mr Smith explained that the water treatment project job was going very well at the time, and when he told Mr Jones he did not have the money to pay his wife, Mr Jones agreed that ABC would pay it for him. Mr Smith was quite definite that the amount was not a loan to him. Mr Smith said that he did not have any discussions with the taxpayer about buying the house or the payment to his former wife.
23. Mr Smith identified a letter dated 14 March 1996 to solicitors acting for his former wife, as being in Mr Jones’ handwriting (exhibit R3). The letter stated that ABC had made loans to Mr Smith to finance the purchase of his house. Under cross-examination he was asked to explain why Mr Jones’ letter would have described the house payments as a loan, and Mr Smith said that possibly at the time it was written, the profits from the water treatment had not been worked out. Despite Mr Smith’s acknowledging that by March 1996 the contract had almost been completed and he was aware that it had been very successful, he denied that the letter was an attempt to deceive the solicitors.
24. An entry in ABC’s sundries payments on 14 November 1994 recorded two sums of $41,234, payable to the taxpayer. In cross-examination, the taxpayer could not explain the entry. A further sundry payment entry on 30 January 1995 recorded the payment of $41,374 for factory rent. He said he did not own a factory, let alone one leased to ABC. He thought it might record the company’s payment to a car dealer for the purchase of his car.
25. The taxpayer signed an objection to his amended assessment in which he claimed a larger credit balance in his loan account than $14,675. He claimed that a debit entry, ‘Half transfer of Smith house loan debt - $212,492’ had not been authorised and “ … in any event, relates to company borrowings which should not be brought to account” (T20). In oral evidence, the taxpayer sought to explain that the entry in fact recorded his share in a debt he and Mr Jones assumed, the loan having been to Smith in respect of money payable by Smith in his property settlement. The taxpayer’s written submissions asserted that another debit entry to his loan account, ‘Payments to Fury Group - $41,269’, should not have been made because it related to the purchase of a car that was claimed to have been provided as part of his salary package and was not intended to be repaid by him.
The house payments
26. The taxpayer’s wife gave evidence that she prompted her husband to talk with Mr Jones about ABC paying for a house for them. She said that she saw Mr Smith get a house and a car from the company, yet the taxpayer had been at ABC while Mr Smith was living overseas and so put the company in the position of being able to go for a job like the water treatment project. The taxpayer’s evidence was that he approached Mr Jones about ABC paying for a house for him, to which Mr Jones agreed. He said he saw the payments as money from the company which he described as “drawings” or “dividends”.
27. Unlike the bottle shop payment, there was no record in ABC’s accounts of the payments made to finance the purchase of the taxpayer’s house in December 1995. The taxpayer thought that Mr Jones told the external accountant about the house purchase payments and that the purchase would be dealt with accordingly at the end of the financial year.
28. The ATO auditor, Mr Green, gave evidence that he found that a number of term deposits in ABC’s name were not included in the company’s general ledger as at 30 June 1995. Mr Green said that the payments made for the acquisition of the taxpayer’s house, beginning with the deposit of $122,500 on 21 October 1995 and the stamp duty and balance of purchase monies later in 1995, were made from one such term deposit, referred to as account no. 4254. From his examination of the company’s records, Green concluded that there were four term deposits and one operating account that were not disclosed in the general ledger and balance sheet as at 30 June 1995. Green established that the balance in account no.4254 was recorded in the company’s financial statements at 30 June 1996 but not the transactions that resulted in that balance. The taxpayer could not explain why the term deposit, the funds in which were used to pay for the taxpayer’s house, was not disclosed to anyone outside ABC.
29. Mr Green noted that there was a cheque dated 1 September 1995 for $477,697 drawn on ABC’s general operating account payable to the National Bank. Mr Green’s analysis of ABC’s financial records found that the cheque was paid into term deposit no.4254 (exhibit R3). The external accountant had queried the cheque in November 1996. In cross-examination, Ms White, the office manager, said that after raising the matter with Mr Jones, she informed the accountant that the cheque was for “an off site payment – materials (ABS Pumps)” (T5-45). White said Jones informed her that the payment was made to a German firm for some pumps and that she described the transaction as such in the monthly payments spreadsheet she prepared for ABC (exhibit R3). White identified the writing on the cheque and the relevant cheque butt (exhibit R3) as being Jones’. The information on the cheque butt stated the payee was “Nat. Bank [Taxpayer’s] Invest acc. No. 4254” (exhibit R3).
30. The taxpayer denied knowing that the money was paid into an account, no. 4254, that was used as his investment account and that ABC had falsely claimed a deduction for the payment of $477,697. He agreed, however, that he signed letters to the bank authorising withdrawals from the term deposit to pay $52,869 for the stamp duty and $1,102,923 for the balance due on settlement of the purchase of his house in December 1995 (exhibit R3). The taxpayer agreed that the funds in the account came from progress payments made to ABC under the water treatment project contract.
Consideration and findings
31. There is no dispute and I find that ABC is a private company and that the taxpayer has been a director and shareholder in the company from at least 1986. On or about 30 October 1995 the taxpayer entered into a contract to purchase a home to be jointly owned by him and his wife. The source of the funds to effect the purchase was the term deposit account no. 4254 held by ABC at the National Australia Bank. Mr Jones, a director of ABC, requested the bank to release part of the term deposit and to issue a bank cheque $122,500 in payment of the deposit. The taxpayer requested the bank to issue bank cheques for the stamp duty of $52,869 and the balance of the price $1,102,923.
32. The taxpayer acknowledged in evidence that the money paid into term deposit no. 4254 was money received by ABC from the water treatment project contract and I so find. He could not explain why the term deposit was not disclosed to people outside ABC, such as the external accountant, at the time that the funds were being accessed for the purchase of his residence. I find that the first reference to term deposit no. 4254 in ABC’s financial records is a journal entry in ABC’s books recording the balance of funds in the account, $118,000, at 30 June 1996 (exhibit R3). The taxpayer did agree that a cheque for $477,697 drawn on ABC’s general business account was paid into that term deposit. I am satisfied that this represented a fictitious claim for a payment supposedly made to an overseas supplier. In addition to the $477,697, the term deposit comprised funds, $1,189,451, transferred in from another ABC term deposit (exhibit R3). It was not disputed that the withdrawals from term deposit no. 4254 in payment for the taxpayer’s house, had not been recorded in ABC’s books and I find accordingly.
33. I am satisfied that the taxpayer and Mr Jones regarded ABC’s funds as being available for their private purposes and they extracted funds from the company as it suited those purposes. Also relevant to this finding was the oral evidence from both the taxpayer and Mr Smith that Jones acquired a large boat, capable of entertaining ABC’s staff of 50 at Christmas parties, during the period that they received their houses, bottle shop and car. Further, the finding is supported by the following evidence, that at first discusses the taxpayer’s failure to disclose in his 1997 income tax return that ABC paid his personal income tax liability:
Senior Counsel for the Commissioner: That offence you acknowledge was an offence of dishonesty dealing with the moneys of [ABC]?
Answer: Yes, that is what I was convicted of.
Senior Counsel for the Commissioner: It was a distribution of money for your benefit from [ABC]?
Answer: It wasn't a distribution. I had a tax bill to pay and I asked [Mr Jones] for the company to pay for it.
Senior Counsel for the Commissioner: Just in the same way that you asked for money to pay for your house?
Answer: Yes.
Senior Counsel for the Commissioner: Just in the same way that you asked for money for the bottle shop?
Answer: Yes.
Senior Counsel for the Commissioner: And you took the money that was available from the profits of [ABC] to pay for your house, didn't you?
Answer: That is correct.
Senior Counsel for the Commissioner: And you took the money that was available for payment in relation to the bottle shop, didn't you?
Answer: That is correct.
Senior Counsel for the Commissioner: You knew that that was money that you should have paid tax on?
Answer: When I took the money I knew that when the - at the end of the financial year that that would have been dealt with [by Mr Jones and Mr Brown].
34. The taxpayer’s accessing of ABC’s funds for the house payments bears some similarity to the method employed by the appellant shareholder in Macfarlane v Commissioner of Taxation (1986) 13 FCR 356. There, sums of company money payable for wages and superannuation contributions for employees who were fictitious, were paid into the shareholder’s own account. Profits on company sales were not disclosed and cash from sales was appropriated for the shareholder’s own use. Beaumont J found that s.108 of the Act, as it then stood, did apply to the company’s funds that were misappropriated:
The income in question was the property of the company. That income was applied for the benefit of one of the company's shareholders with the acquiescence of the controllers of the company. The application of funds in this way may well have constituted a breach of the directors’ fiduciary duties at least so far as the company’s creditors were concerned … But whether the conduct of the company’s directors was liable to be challenged as a misfeasance is a different question. Payments were made by the company out of its funds which were for the individual benefit of one of its shareholders. That is sufficient to satisfy the opening words of s.108(1), whatever significance the conduct of those involved may have in other legal contexts. (at 373)
I accept the respondent’s submission that, just as the amounts in Macfarlane were considered payments for a shareholder’s benefit and distributions of the company’s income, the house payments represent payments by ABC for the benefit of the taxpayer and his wife.
35. Do the payments for the taxpayer’s house represent a distribution of ABC’s profits? The profit and loss account for ABC for the years ended 30 June 1995 and 30 June 1996 disclosed the amounts of profit available for appropriation to be respectively $3,486,835 and $3,911,597 (attachment C to exhibit A1). The source of the funds for the house payments was ABC’s receipts from the water treatment project that were paid into, among others, term deposit no, 4254. Even though only the balance of $118, 665.64 in the term deposit was recorded in ABC’s trial balance for the 1996 financial year, and not the transfers in and out of the deposit, Macfarlane is authority for treating undisclosed profits as being ‘profits’ for the purposes of s.108.
36. I find that the source of the funds in the term deposit and transfers from the deposit were not disclosed to the external accountant. It is clear to me that the taxpayer and Mr Jones were intent on allowing the taxpayer to access some of the company’s funds from the contract for his personal benefit and not to disclose what they were doing. For good measure, the term deposit was supplemented by the payment ostensibly made to an overseas supplier. I must agree that Mr Jones’ description of that term deposit as “the taxpayer’s investment account” was apt. The taxpayer described the house payments as money he received from the company, and in oral evidence said they were his drawings or dividends. He had no discussions with Jones as to his liability to repay the funds to ABC. There is no doubt that the house payments were not a loan from ABC. The following passage from Case 69 (1950) 1 TBRD 260 is relevant (at 263) :
For a thing to be, or to represent, a distribution of income there must be, to our minds, a getting of money into the hands of a shareholder with no idea of repayment. (cited in Commissioner of Taxation v Black (1990) 25 FCR 274).
I am satisfied that the Commissioner was justified in his opinion that the house payments represented a distribution to the taxpayer out of profits.
37. Consequently, s.108 deems the house payments of $1,278,292 to be dividends paid to the taxpayer as a shareholder in ABC out of the company’s profits on the last day of the year of income ended 30 June 1996. The deemed dividends are included in the taxpayer’s assessable income by reason of s.44 of the Act. The payments, being deemed dividends, are excluded from the scope of the expression ‘fringe benefit’ by par (n) of the definition in s.136(1) of the Fringe Benefits Tax Assessment Act 1986.
38. In reaching the conclusion that the house payments are deemed dividends I took into account the comprehensive submissions by Mr Gordon, counsel for the taxpayer, that the payments should instead be characterised as fringe benefits provided to the taxpayer in respect of his employment by ABC. Specifically, it was submitted that the payments were said to be expense payment fringe benefits under s.20(a) of the FBT Act or alternatively loan benefits covered by s.16 of that Act.
39. The Full Federal Court in J&G Knowles and Associates Pty Limited v Commissioner of Taxation (2000) 96 FCR 402 discussed the meaning of the phrase ‘in respect of employment’. It was observed that the phrase had a very wide meaning, requiring its interpretation to be derived from its context, in this case, employment. The facts involved directors of a corporate trustee who did not have a direct, beneficial interest in the assets or income of the trust business. Nevertheless the directors used the trust’s cheque account to pay for their private expenditure. These payments were debited to the director’s loan account in the books of the trust. In determining whether the loans were fringe benefits provided to the directors as employees of the corporate trustee, the Full Court said (at 408):
It cannot be said that any causal relationship between the benefit and the employment is a sufficient link so as to result in a taxable transaction. For example, a discretionary trust with a corporate trustee might be established to purchase a family home for the benefit of its directors and their family. It does not follow that the rent free occupation of that home on the authority of the directors is a benefit provided "in respect of" their employment for the purposes of the Act. While there is a causal relationship between the provision of the benefit and the employment it is not a sufficient or material relationship. The rent free occupancy arises because the trust was established for that purpose; a reason extraneous to the employment of the directors.
40. After considering the individual judgments given in the High Court’s decision in Smith v Commissioner of Taxation (1987) 164 CLR 513, a case that examined s.26(e) of the 1936 Act, and in particular the following words in that provision” … benefits … allowed, given or granted to him in respect of, or in relation directly or indirectly to, any employment of or services rendered by him …”, the difficulty in stating a test to determine whether the requisite connection or relationship with employment exists was acknowledged. However, the Full Court emphasised that, regardless of how the nexus test applying to s.26(e) was stated “ … it must be remembered that what must be established is whether there is a sufficient or material, rather than a, causal connection or relationship between the benefit and the employment.” (at 410) Moving then to the context of the FBT legislation, and taking into account the Treasurer’s second reading speech on introduction of the bill, the Full Court’s formulation of the test was as follows (at 410):
While the width of the definition of ‘fringe benefit’ was designed to capture benefits that, in truth, were other than remuneration, the stated purpose suggests that asking whether the benefit is a product or incident of the employment will be helpful. If it is not then the benefit is likely to be extraneous to the employment and will not bear FBT, notwithstanding that the employment might have been a causal factor in the provision of the benefit. In particular, the fact that a benefit is provided to a director because it was authorised by that director will not, of itself, be sufficient to characterise the benefit as one which is ‘in respect of’ the employment. Without more, it is not a product or incident in that office.
41. The taxpayer submitted that ABC’s payments for the purchase of the house as his family’s residence should be treated on the same basis as the house that the company purchased for Mr Smith, which is to say the payments are fringe benefits. In my opinion, however, Smith’s role in ABC’s winning contracts in large water treatment projects should be seen as demonstrably more important than the taxpayer’s, and thus I agree that Smith’s attributes and performance as a key employee readily justify the conclusion that the car and house were provided by his employer in respect of his employment.
42. I consider the following to be relevant factors in concluding that ABC’s payments for the taxpayer’s house were not fringe benefits and thus dictate rejecting the taxpayer’s submission:
· At relevant times, that is from around 1993 when his employment commenced with ABC following his return from overseas, Mr Smith was not a shareholder or director in ABC. The taxpayer, however, has been a shareholder and director in ABC since at least 1986 and has shared the company’s profits equally with his co-director Mr Jones. The pair made business decisions jointly and they both operated ABC’s business cheque account.
· More significantly, Smith was a consultant to the Lend Lease consortium, assisting with feasibility studies and design work that went into the bidding for the water treatment project. Smith’s expertise in engineering, tendering and design were attractive to the consortium. Later, he became the contact point for ABC with the consortium. He put together ABC’s tender. ABC had the skills required for pipe installation, plumbing, mechanical work but the water treatment project work was a new field and a change from the general type of work performed to date. Smith’s engineering and design skills and reputation in large scale water treatment works should be contrasted with that of the taxpayer and Mr Jones. The taxpayer was one of a number of ABC’s site managers. I find that Smith was crucial to ABC’s successfully tendering for the contract that was awarded to it in the water treatment project.
· According to Smith’s oral evidence, the taxpayer and Mr Jones did not become involved in the management of the contract until after it had been was signed. I infer that, although their actions may have been necessary for ABC to perform the contract, they were not nearly as important to the success of ABC in this new area of work as Smith’s. He was a key member of ABC’s staff, which increased to around 50 during the course of the contract. When Smith requested financial assistance by way of the purchase of a house and car, it was readily provided because of his crucial role as an employee in winning and maintaining the successful performance of the contract. I find specific support for this conclusion in the record of interview of Jones with the ATO auditors on 14 October 1999 (annexure to exhibit A2) where Jones said:
Well, without him [Mr Smith] we wouldn’t have been able to do … [the water treatment project contract] … I mean we’d never done work like that … I mean it just created our company … in the water industry … but I didn’t feel that buying a house for him plus his wage packet was um anything out of the ordinary. … He had the experience and the engineering knowledge, and without that … I don’t think without that I would have been able to tender the job.
· I am satisfied that Smith did not regard the wages that he enjoyed after ABC won its contract as sufficient reward for his efforts in winning and keeping the contract. Once ABC’s work on the water treatment project was proceeding successfully, Smith initiated discussions with Mr Jones with a view to being provided with a car and a house. His demands were met, in September 1994 with a car and from February 1995 with the deposit on the house and eventually the balance payable. At the interview on 27 October 1999 with the ATO’s Mr Green (attached to exhibit A2), Smith was asked whether he had to contribute to the price of the house and he replied “ … well I was contributing to, because we’d won thirty million dollar worth job, and we were looking at … I was looking at other major projects in Adelaide, and South East Asia, and few around Sydney, Victoria, and I said, you know there was, I thought there would be a fairly nice profit margin in [the water project treatment contract], so that was my sort of contribution to the whole thing.”
· The taxpayer’s evidence was that, at the time of the discussions, he and Mr Jones had to keep Smith at ABC because they were in the middle of the contract. The inference that I draw is that Smith’s continued employment was crucial to ABC successfully performing the contract and so the taxpayer and Jones agreed to the payments for the car and later the house. Moreover Jones wanted Smith to stay with ABC so that the company could successfully tender for other large scale water treatment projects that were being planned in Adelaide and Brisbane. Jones said in his record of interview on 14 October 1999 (attached to exhibit A2):
Well I wouldn’t have been able to do the size of them, so I would have had to walk away from those bigger jobs …
· The house payments were made from a term deposit account that was not disclosed to the external accountant yet the major deposits to the term deposit came from progress payments received from performance of the water treatment project contract. There was no evidence, written or oral, that the house payments were regarded by Jones or the taxpayer as being part of the remuneration for his services. Further, the payments were not disclosed in ABC’s financial records for the year ended 30 June 1996 nor its FBT return for the year ended 31 March 1996.
· The mere fact that the taxpayer, as a director, was able to direct that ABC make the house payments for him is not of itself sufficient to categorise the benefits as a fringe benefit (Knowles). On the facts as found, there was not a material or sufficient relationship between the provision of the house payments and the employment.
The bottle shop payment
43. The taxpayer’s oral evidence was that he approached Mr Jones and said he wanted some money out of the company because his wife wanted to buy a bottle shop. It was decided that he could use the company’s funds. The taxpayer recalled only that Jones said the tax would be fixed up at the end of the year when the books were prepared. So, on 17 July 1995 the taxpayer drew a cheque for $324,113.62 on ABC’s general account at the bank’s Lakemba branch. This enabled him to obtain a bank cheque for the purchase. He gave the money to his wife to finance her share in the bottle shop. He did not expect her to repay the money. He agreed with counsel for the respondent that he did not ask for a loan nor did Jones refer to ABC’s payment as a loan in their discussions. He said there was no mention of his having to repay the money and, in amplification, his evidence was that he had no intention of repaying ABC. It was put to him that he did not tell the Australian Taxation Office auditor at an interview on 23 June 2000 (attachment E to exhibit A1) that his discussion with Jones about the proposed purchase of a bottle shop, concerned a loan to him from the company. The taxpayer agreed.
44. His wife’s oral evidence was that the money was a gift from him. She added that the bottle shop has since been sold. She received the entire sale proceeds of approximately $350,000, which she has invested and has not repaid any of the money she received from her husband. Her witness statement dated 24 September 2002 (exhibit A4) reads “[the taxpayer] told me that his loan from the company was interest free and would be repayable out of dividends [the taxpayer] expected from the company within the following couple of years in the ordinary course of events, or otherwise [the taxpayer] said he would have repaid it out of the sale of assets.” She contradicted this in her oral evidence, saying that she did not have a discussion with the taxpayer concerning his having to repay the money to ABC.
45. There being no documentation recording the payment of $324,113.62 to the taxpayer, in November 1996 the external accountant, Mr Brown, sought information from ABC. Ms White, ABC’s office manager from 1993, said she got the accountant’s request and discussed the payment with Mr Jones but not with the taxpayer. Her note back to the accountant stated “Purchase Taxpayer Bottle Shop” (T5-45). The taxpayer denied giving instructions for the payment to be recorded as a loan in his loan account and said Jones would have made the decision to do so. When the ATO interviewed Brown on 21 June 2000, he could not recall a specific discussion with either the taxpayer or Jones concerning the payment (T16-143). The taxpayer’s oral evidence was rather cryptic, simply saying that this was the way the payment was handled in his loan account. However, he could not explain the apparent contradiction between that entry and the objection he signed and dated 13 February 2001 (T20) claiming the payment of $324,113.62 “ … is a repayment of loan funds due to the taxpayer by the company and should properly be offset against amounts standing to the taxpayer’s credit in the company’s books and treated as a repayment of loan funds”.
Consideration and findings
46. My conclusion, after taking into account the oral and written evidence and submissions, is that I am not satisfied on the balance of probabilities that the bottle shop payment was a loan by ABC to the taxpayer. A number of factors have led to this conclusion.
47. First, the funds were given by the taxpayer to his wife to purchase a half share in a bottle shop business with no obligation on her to pay him back. While this factor alone is not determinative of the characterisation issue, it suggests that at the time of the payment to the taxpayer, there was no intention by him or on the part of the company through Mr Jones, that the money would be repaid.
48. Secondly, there has been some controversy, dealt with in depth by counsel, regarding the taxpayer’s understanding of the payment of $324,113.62, as recorded in a number of interviews with the ATO auditors. In par 25 of the taxpayer’s statement (exhibit A1) he denied he used the word ‘dividends’ in a statement prepared by ATO auditor Mr Blue on 23 June 2000. The words in that statement that the taxpayer claims he did not say are “I believed that the money which came from [ABC] to purchase the bottle shop was drawings or dividends and tax was paid. Why I say this is because [Mr Jones] told me that the tax would be fixed up at the end of the year when the books are prepared” (annexure E to exhibit A1) The taxpayer’s statement filed in these proceedings asserted that he did not describe the payment as a dividend nor did he refer to it as ‘drawings’. Mr Green, another ATO auditor, was conducting a separate investigation into ABC, Mr Jones, Mr Smith and the taxpayer. Mr Green’s statement dated 20 December 2002 tendered in these proceedings (exhibit R9) referred to a telephone interview with the taxpayer on 24 May 2000 and, in relation to the payment of $324,113.62, he recorded the taxpayer as saying “It was not a loan, I considered it drawings from the company”. Green’s statement referred to a further telephone interview on 1 June 2000 when the taxpayer said “There were no discussions, I assumed the payment would be drawings or earnings”. In oral evidence Green sought to correct that part of his statement because his hand written note of the interview on 1 June 2000, which was accepted in evidence (exhibit R10), recorded the words “dividends or earnings” rather than “drawings or earnings”.
49. Counsel for the taxpayer challenged Green about his account of the interviews they had. Green was cross-examined about this change in what was suggested was a highly sensitive choice of words: “dividends” instead of “drawings”. In particular, it was put to him that, in reference to the bottle shop payment, his recollection of the taxpayer’s use of the word ‘dividends’ at interview on 1 June 2000 was wrong. He was also referred to his report of the audit, a document dated 4 December 2000 (T19), which noted the bottle shop payment was not a loan and the taxpayer considered it part of his drawings. Specifically, the report did not mention ‘dividends’. Green explained that his note of the interview on 1 June 2000 was correct and, when he realised his statement did not refer ‘dividends’, he corrected the statement.
50. If, as he asserted in par 2 of his statement (exhibit A1), the taxpayer knew the difference between a loan from the company and a dividend, it is surprising he did not point out in any of the ATO interviews, or in evidence, that he thought the payment was a loan or part of his remuneration. The taxpayer’s evidence was that he regarded both dividends and drawings as money from the company. I look on that statement as important in this controversy since it neatly sums up his attitude to payments he received from the company, as demonstrated by his failure to disclose the company’s payment of his tax liability, the offence for which he was convicted, or the house payments until after the ATO began its enquiries. The taxpayer claimed someone else, Jones or Brown, would determine whether a payment he received from the company attracted a tax liability. That was a convenient way of avoiding his responsibility. I find the taxpayer gave inconsistent evidence about his understanding of ABC’s taxation arrangements for employees and its directors. At par 14 of his statement of 23 August 2002 (exhibit A1), the taxpayer said that at the time, he thought FBT was paid on Mr Smith’s company provided car and house. But he was unable to justify that statement in relation to the car, given that he signed ABC’s FBT return for the 1995 FBT year and that car benefit was not reported. His evidence was that if either he or Jones needed something, they would discuss it and draw out the money from the company and this was how they ran the business. Although he frequently asserted that he left the taxation treatment of that money for someone else to deal with later, I cannot accept that evidence as an honestly held belief. More likely, the taxpayer and Jones agreed that this payment, used for the bottle shop, was a means by which he could access ABC’s receipts from the water treatment project and it was not to be repaid.
51. Thirdly, the applicant’s counsel submitted that the company’s books for the 1996 financial year reflected a considered view of the transaction. The bottle shop payment had been disclosed as a loan for some years before the ATO started their enquiries. Further he submitted that, by signing the financial statements reflecting the transaction as a loan, the taxpayer was acknowledging that this was an indebtedness, albeit offset by later credits (Stage Club Ltd v Millers Hotels Pty Limited (1981) 150 CLR 535). The character of the payment was ratified by the directors’ (that is, his and Mr Jones’) adoption of the accounts. However, in coming to a conclusion about the nature of the taxpayer’s withdrawal of $324,113.62 from the company’s bank account, I am mindful of the following passage from the High Court’s judgment in Albion Hotel Pty Ltd v Federal Commissioner of Taxation (1964-1965) 115 CLR 78 that “ …entries in books of account should evidence real transactions. They are evidence only. Their proper purpose is to record transactions having legal consequences. Making entries does not make such transactions” (at 92).
52. The accountant Brown at first posted this payment to a suspense account since he could not identify what the cheque was for. The only documentation that Brown held in response to his enquiry was a hand written notation from ABC that merely named the taxpayer and the bottle shop, nothing more. Brown could not recall specifically discussing the payment with Jones or the taxpayer. The absence of written authorisation for recording the payment as a loan and the taxpayer’s evidence that he did not consider he had to repay the amount, support my finding that there was no underlying arrangement that justified the payment’s treatment as a debit entry in ABC’s shareholder loan account.
53. Fourthly, on examining the loan account for the year ended 30 June 1996, there were other entries that required some explanation. The taxpayer was asked about the journal entry putting a credit through his loan account, ‘Funds credited - $304,503’. The amount of $304,503 was not returned as assessable income. Counsel for the Commissioner took him to a document dated 9 February 1996 (exhibit R3) that transferred a slightly larger amount, $309,503, from the term deposit no. 4254, which Mr Jones had noted as the “taxpayer’s investment account”, into another of the company’s term deposits, no. 3532. It will be recalled that term deposit no. 4254 was styled “[the taxpayer’s] investment account” on one of the company’s cheque butts. Also, the taxpayer’s Christian name was handwritten on one of the bank statements for the term deposit (exhibit R3 tab 14). The taxpayer was asked to explain why the balance of his investment account had been transferred by journal entry into a different term deposit, yet the transferred amount was treated as a credit in his loan account. Perhaps unremarkably, he could not explain the transaction. All he could do was acknowledge that the source of the funds being transferred was ABC’s trading revenue. But there was no evidence or other explanation proffered by the taxpayer to clarify the transaction. The ATO auditor Mr Green analysed the term deposits and provided an overview of the transfers into and out of the deposits (exhibit R10). He found that a separate amount of $309,503 had been transferred into account no. 3532, this time out of term deposit no. 4094. It was suggested by the respondent that this transfer represented the funds of approximately $300,000 that Mr Smith acknowledged he received from ABC. Whether or not that be the case regarding Smith, on the state of the evidence before me I am unable to be satisfied on balance that the journal entry crediting $304,503 in the taxpayer’s loan account evidences a real transaction involving the company’s giving credit to the taxpayer for an entitlement.
54. The taxpayer’s submissions maintain that the debit entry for $41,269 in respect of a payment for a car was simply wrong. Through his objection he raised another doubt concerning the accuracy of entries in the loan account. The objection queried whether the debit entry for $212,482 should be brought to account, though answers in oral evidence seemed to acknowledge that the debit was properly raised. Mr Smith’s clearly stated in his record of interview with the auditors on 29 March 2000 (attachment 5 to exhibit A2) that the sum of $425,000 was never a loan to him from ABC. Having regard to these discrepancies in treatment and recollection, as well as the lack of evidence from the taxpayer to explain the large credit item of $304,503, I am unable to be satisfied on balance that the loan account is an accurate record of transactions entered into between ABC and the taxpayer. Specifically in relation to the bottle shop payment, I accept the respondent’s submission that the loan account record is a construct made by Brown in an attempt to make sense of a transaction for which meaningful instructions had not been given.
55. A final matter of relevance has been the taxpayer’s inconsistent treatment of the bottle shop payment. His objection to the assessment referred to it as a repayment of money owed to him by the company. However, on 17 July 1995 when the payment was made, there was a credit balance in the loan account of only $32 (exhibit A1). There was no explanation for that inconsistency and it persuades me to accept the respondent’s submission that the recording of the bottle shop payment as a loan cannot be regarded as manifesting the true underlying transaction.
56. Counsel for the taxpayer submitted that there is no basis for finding that the bottle shop payment represents a distribution of profits to the taxpayer, as required by s.108, because there was not “ … a permanent dealing out or bestowing of something upon the shareholder or associates” or “ … a getting of money into the hands of a shareholder (or associate) with no idea of repayment”. (‘Private Company Loans’, KJ Burges, 26 October 1995, Taxation Institute of Australia, cited with approval in Case 3/96 96 ATC 139 at 144). It was emphasised that ABC is not a family company. Moreover, it was submitted that a shareholder would not draw monies out of the company as he saw fit, without committing a fraud on the other shareholder. I do not accept that submission, since the premise is inapplicable. This is not an instance where the shareholders have been acting with lofty ideals of fiscal or corporate responsibility uppermost. While they may not have engaged in conduct to deceive one another, both were convicted of offences involving fraud on the revenue arising from their misuse of ABC’s funds, for their own benefit.
57. In conclusion I am satisfied that, after considering the circumstances in which it was made, the bottle shop payment of $324,113.62 was not a payment by way of advance or loan but a getting out of the company’s money to the taxpayer with no intention on his part of repaying the company. At the time of the payment, there were no discussions between the taxpayer and Mr Jones that they understood it to be a loan. His wife had no discussions with him regarding the payment being a loan to him from the company. I find that ABC, through its funds being applied in the acquisition of the interest in the bottle shop, paid an amount for the individual benefit of associated persons in relation to the company (s.108(1)(b)) and the payment represented a distribution of ABC’s profits. In agreeing that the Commissioner was right to form the opinion that the payment, said to be a loan, represented a distribution of profits, I am mindful of what Beaumont J said in Macfarlane: “The mischief aimed at by s.108(1) was the avoidance of tax on informal or ‘de facto’ dividends – payments disguised as a different transaction but, in substance, dividends, because the payments in fact made over profits or income of the company” (at 375). The payment is thus deemed a dividend by s.108 and included in the taxpayer’s assessable income under s.44 in the year of income ended 30 June 1996.
Penalty
58. The report of the audit into the taxpayer’s income tax affairs in the income year ended 30 June 1996 was completed on 4 December 2000 (T19). The report noted that the examination of the income tax affairs of ABC was continuing.
59. On 15 December 2000 the Commissioner issued an amended assessment (exhibit R14) that increased taxable income by $1,602,405, an amount comprising the s.108 deemed dividends in respect of the house payments ($1,278,292) and the bottle shop payment ($324,113). The corresponding increase in the amount of tax payable was $777,166.42. In addition, the Commissioner imposed a penalty at the rate of 50 per cent of the tax shortfall, being the sum of $388,583.20. This penalty was imposed under s.226H of the Act. There was also interest on the tax shortfall under s.170AA of the Act, calculated as $336,318.19. In view of the findings concerning the house payments and the bottle shop payment, I find that there was a tax shortfall in the 1996 income year arising from the taxpayer’s failure to include all amounts of assessable income in his return. Thus the tax payable under the return as assessed was less than the tax properly payable (refer to s.222A of the Act).
60. Section 226H states:
Penalty tax where shortfall caused by recklessness
Subject to this Part, if:
(a) a taxpayer has a tax shortfall for a year; and
(b) the shortfall or part of it was caused by the recklessness of the taxpayer or of a registered tax agent with regard to the correct operation of this Act or the regulations;
the taxpayer is liable to pay, by way of penalty, additional tax equal to 50% of the amount of the shortfall or part.
As an alternative to s.226H, the Commissioner could have imposed a penalty under s.226K of the Act, at the rate of 25 per cent of the tax shortfall, if the taxpayer was considered not to have a reasonably arguable case. Going to the other end of the scale of culpability, had the taxpayer acted with intentional disregard for the taxation law, a penalty of 75 per cent of the tax shortfall could have been levied (s.226J).
61. The Full Federal Court in Hart v Commissioner of Taxation (2003) 131 FCR 203 recently examined the penalty provisions in Part VII of the Act. In their joint judgment, Hill and Hely JJ cited the decision of Cooper J in BRK (Bris) Pty Ltd v Commissioner of Taxation (2001) 46 ATR 347 where the following was said about the meaning of ‘recklessness’:
In s 226H of the ITAA 1936 the recklessness of the taxpayer, or of a registered tax agent, must be with regard to the correct operation of the ITAA 1936 In the context of s 226H, the definitions in s 222A(1) to which reference has been made, and Part VII of the ITAA 1936 generally, it is necessary in my view that the conduct which gives rise to the tax shortfall must be reckless as to whether or not the Act or regulations will operate correctly so as to lead to an assessment of the proper tax payable by a taxpayer. Recklessness in this context means to include in a tax statement material upon which the ITAA 1936 or regulations are to operate, knowing that there is a real, as opposed to a fanciful, risk that the material may be incorrect, or be grossly indifferent as to whether or not the material is true and correct, and that a reasonable person in the position of the statement-maker would see there was a real risk that the ITAA 1936 and regulations may not operate correctly to lead to the assessment of the proper tax payable because of the content of the tax statement. So understood, the proscribed conduct is more than mere negligence and must amount to gross carelessness.(at 364)
After referring to the relevant Explanatory Memorandum for the bill that introduced Part VII into the Act, Hill and Hely JJ concluded that a finding of dishonesty is not necessary for a taxpayer to be subject to a penalty under s.226H.
62. So far as the house payments are concerned, the taxpayer submits that he has a reasonably arguable position regarding the exemption under s.23L of the Act given his contention that the payments are properly taxable to ABC as expense payment fringe benefits.
63. I do not accept that the taxpayer has a reasonably arguable position for the reasons given earlier when rejecting the submission that the house payments were made in respect of the taxpayer’s employment. In brief, it was not reasonably arguable to compare the payments, with those made by ABC in acquiring Mr Smith’s house and car. I accept the respondent’s submission that the taxpayer’s claim that the house payments were fringe benefits, is an ex post facto rationalisation. The relevant circumstances are that the accountant, Mr Brown, was unaware of the house payments until the ATO’s audit began. It was Brown who acted as accountant and tax agent for ABC in relation to its income tax and FBT liabilities, as well as being the tax agent who prepared the taxpayer’s income tax returns, including his 1996 income year return (T4). Whether or not this failure to inform Brown was an act of dishonesty on the taxpayer’s part, I consider that the taxpayer should have ensured that distributions for his benefit, in total exceeding the substantial sum of $1.2m, were declared to the respondent. He shut his eyes and, at the least, was grossly indifferent to what he should have done and to the taxation consequences flowing from benefiting in this fashion. Accordingly, I am satisfied that the taxpayer acted recklessly within the meaning of s.226H by not bringing to Brown’s attention the fact that he received a benefit of such a large amount through helping himself to the company’s funds, with the direct consequence that the payments were not disclosed in his 1996 return.
64. In relation to the bottle shop payment, the taxpayer submitted that, as the payment was a loan and was offset in the same income year by credits to his loan account, s.108 should not have been applied. At the very least it was submitted that the taxpayer has a ‘reasonably arguable’ position, as that expression is defined in s.222C of the Act, because there is no reported decision that has upheld a s.108 assessment in such circumstances.
65. Contrary to the applicant’s submission, however, I have found that the payment was not intended to be repaid. It ought not be regarded as a loan. Rather, it was a payment by ABC for the individual benefit of the taxpayer and his wife that was disguised as a loan in the company’s financial records. Given the finding that there was no intention of repayment, the payment may well have been assessed as being a dividend within the meaning of that term in s.6 of the Act and thus included in assessable income through s.44 (see Kenneth A Summons Pty Ltd v Federal Commissioner of Taxation (1986) 80 ALR 95). The taxpayer’s submission should be rejected for the further reason that I reached my conclusion under s.108, in part by forming an adverse view of his credit. I have found he did not honestly believe he need do nothing more as to his taxation responsibilities in respect of the payment, simply because, as he claimed, he thought Mr Jones and Mr Brown would attend to everything required to ensure that tax was paid. There is no justification for reducing the penalty as I find that his non disclosure of the payment in his income tax return, at a minimum, was reckless if not demonstrating his intentional disregard for the taxation law.
66. The ascertainment of $336,318.19, the interest payable in relation to the amended assessment under s.170AA(4) of the Act, is not reviewable by the tribunal as it does not form part of the assessment (s.170AA(13)) and so cannot be the subject of a reviewable objection decision.
67. The objection decision under review is affirmed.
I certify that the 67 preceding paragraphs are a true copy of the reasons for decision herein of P. J. Lindsay, Senior Member:
Signed:
..................................................................................……………………………….Associate
Hearing 10, 11, 12 and 13 November 2003
Decision 25 November 2004
Applicant’s counsel R Gordon
Respondent’s counsel D McGovern SC
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