The Taxpayer and Commissioner of Taxation

[2000] AATA 240

Administrative

Appeals

Tribunal

 

DECISION AND REASONS FOR DECISION [2000] AATA 240

ADMINISTRATIVE APPEALS TRIBUNAL      )

)          No TT1999/13-18

TAXATION       APPEALS      DIVISION		)
Re		THE TAXPAYER

Applicant

And COMMISSIONER OF TAXATION

Respondent

DECISION

Tribunal Mr B. H. Pascoe, Senior Member

Date28 March 2000

PlaceHobart

Decision The Tribunal sets aside the reviewable decision and remits the matter to the respondent to calculate the quantum of allowable deductions on the basis that 60% of the rental income be included as assessable income and the expenditure incurred by the applicant for the purpose of deriving such rental income was an allowable deduction

...…..(Sgd) B. H. Pascoe................

Senior Member

CATCHWORDS

INCOME TAX – claim for share of partnership loss – rental property – company as nominee or trustee for individuals – whether loss incurred by trust estate – whether company agent for individuals

Taxation Administration Act 1953

Income Tax Assessment Act 1936

Doherty v Federal Commissioner of Taxation (1933) 48 CLR 1

McGuiness v Federal Commissioner of Taxation 92 ATC 4006

REASONS FOR DECISION

28 March 2000   Mr B. H. Pascoe, Senior Member

1.      This is an application to review a decision of the respondent to disallow an objection by the applicant against notices of assessment of income tax for the years ended 30 June 1991 and 1992 and notices of amended assessment for the years ended 30 June 1993 to 1996 inclusive.  The objection was against the non-allowance as a deduction of a share of partnership losses in each of the relevant years.

2. At the hearing the applicant was represented by Mr T. McDermott, a solicitor, and the respondent by an officer of the respondent. Evidence was given by the applicant, two other members of the alleged partnership and an accountant who had provided advice to the applicant. Pursuant to section 14AAE of the Taxation Administration Act 1953, the applicant requested that the hearing be in private.

3.      The facts in this matter were not in dispute and a convenient summary was set out in the respondent’s statement of facts filed with the Tribunal.  Subject to appropriate alterations to conceal the identity of the applicant, the summary was as follows:

“1.       C Pty Ltd was incorporated and registered on 27 October 1987.  The directors were the Applicant and A who were both appointed on 27 July 1987.  B was also a director at some time but her date of appointment is not known.

2.        The first meeting of the board of C Pty Ltd was held on 7 August 1987.  A resolution was passed to make C Pty Ltd trustee holding the Property in trust for the Applicant, A, B, and J (the Beneficiaries) as tenants in common in the shares:

Applicant fifty two undivided one-hundredth shares
A             thirty undivided one-hundredth shares
B             sixteen undivided one-hundredth shares

C            two undivided one-hundredth shares

3.        On 11 August 1987 C Pty Ltd (as trustee) executed a deed for the purchase of the Property for a sum of $354,000 from the vendor.  On the same day a declaration of trust was executed to give effect to the board’s resolution of 7 August 1987.  The recital to the deed states that the purchase price was provided by the Beneficiaries in proportion to their shares in the trust.

4.        The purchase price was funded by a loan of $340,000 from the Bank.  The balance of the purchase price and costs were presumably paid from funds provided by the Beneficiaries.  The loan was secured by a mortgage over the Property.  The deed of mortgage was made between C Pty Ltd as mortgagor and the Bank as mortgagee.

5.        All the documentation relating to the application for the loan to purchase the Property, and the subsequent approval of the loan by the Bank, show that the borrower was C Pty Ltd.

6.        The conveyance from the vendor was registered in the name of C Pty Ltd.

7.        On or after 30 June 1990 B ceased to have an interest in the Property; her 16% beneficial interest being transferred to the applicant as to 6% and to A as to 10%.

8.        On or after 30 June 1992 J ceased to have an interest in the Property; her 2% beneficial interest being transferred to the applicant.

9.        During the years in issue, C Pty Ltd’s assessable income consisted of rents received from tenants plus small amounts of interest.

10.      During the years in issue, C Pty Ltd actively managed the Property by doing such things as taking out insurance cover, managing leases to tenants by doing such things a sending letters of demand for payment of rent, office administration and inspection of premises.  It also entered into a deed of mortgage in relation to the purchase of the Property under which it covenanted, inter alia, to repay the amount owing on the loan from time to time; to pay interest; and to insure, pay rates and taxes and other outgoings and keep in repair.

11.      C Pty Ltd did not lodge income tax returns in either its own right as a company or as trustee of a trust estate.  For all years since the incorporation of C Pty Ltd including the years in issue, partnership returns were lodged, …. .  For the years in issue the losses distributed were as follows:

Year          P/s loss        Applicant            B                   A

1991           44,045             25,546             881           17,618

1992           36,822             21,357             736           14,729

1993           18,287             10,972               Nil             7,315

1994           17,622             10,573               Nil             7,049

1995           14,917               8,950               Nil             5,967

1996           37,470             22,482               Nil           14,988

…”

4.      The applicant gave evidence that discussions were held between himself, A and B to acquire a commercial building as tenants in common.  The expectation at the time was that the purchase would be negatively geared but would appreciate in value and that, in due course, rental income would exceed outgoings.  He attended the auction and signed an agreement to purchase in the name of his law firm or nominee.  He said that the original intention was to acquire the property in individual names as tenants in common but, at the suggestion of B, it was agreed that C Pty Ltd would hold the title as nominee for the syndicate members.  At a meeting with the accountant in September 1988 it was recognised that a Declaration of Trust had not been prepared and it was subsequently executed nearly a month later although dated 11 August 1987.  The applicant said that the intention had been that the purchase would be funded primarily from borrowings with the balance funded by contributions from the syndicate members.  He said that, as a result of a recession, tenants could not be found, maintenance costs were high and the Bank exercised its rights under the mortgage and sold the property in 1996 at a substantial loss to the remaining participants.  The applicant said that rentals were paid into a trust account in the name of C Pty Ltd and the shortfall to meet interest was met by direct payment by the syndicate members to the Bank or into the trust account.

5.      Evidence from the other two participants, A and B, confirmed the applicant’s evidence that the intention and understanding of all was that C Pty Ltd was incorporated solely to act as nominee for the syndicate members who regarded themselves as owners as tenants in common.  While A could not recall what advantages, if any, were gained by use of the company as registered owner, B, who had recommended the use of the company, stated that she had been concerned that the applicant would have a majority interest in the ownership and proposed a corporate structure in which he would not be able to exercise control.

6.      It was of interest that each of the three participants in the purchase of the Property and the use of C Pty Ltd as registered owner were qualified lawyers but appeared to have very limited understanding of the role of the company in the structure that they created.  B appeared to have regarded her share of ownership as being represented by a shareholding in C Pty Ltd and that any change in equity of any participant would be accomplished by a transfer of shares.  She had not considered herself entitled to a transfer of the title to the property at any time.  Both the applicant and A appeared to have left the incorporation of the company and its Articles of Association to B to arrange.

7.      The Declaration of Trust recited that C Pty Ltd, the trustee, had acquired the property on 11 August 1987, the consideration had been paid out of monies provided by the applicant, A, B and J and that the trustee had acquired the property as trustee for the four named persons as tenants in common.  It then declared:

“NOW THESE PRESENTS WITNESS and the Trustee hereby declares that it stands seised of the said hereditaments and premises in trust for the said Applicant, A, B, J and their respective heirs and assigns as tenants in common in the shares the said applicant fifty two equal undivided one-hundredth shares the said A thirty equal undivided one-hundredth shares the said B sixteen equal undivided one-hundredth shares and the said J two equal undivided one-hundredth shares AND the Trustee hereby agrees at the request and cost of the said applicant, A, B, and J to execute all such assurances of the said hereditaments and premises to the said applicant, A, B, and J or to any other person or persons at such time or times and in such manner as the said applicant, A, B and J shall require and direct.”

8. The approach of the respondent in disallowing the applicant’s claim for a share of the partnership loss was that a trust had been established by the Declaration of Trust and the income was income of a trust estate and fell to be assessed under Division 6 of Part III of the Income Tax Assessment Act 1936.  As such, losses generated by the activities of the trust could not be distributed to beneficiaries but deducted only from income of the trust in subsequent years.

9.      It was submitted for the applicant that, particularly in the years relevant to this application, the applicant and A proceeded on the basis that they, at all times, controlled and made decisions in relation to the property as partners not as directors of a company.  It was said that C Pty Ltd was either a bare trustee or agent for the partners and those partners were obliged to either indemnify the trustee for any shortfall of income to meet expenses or to pay the expenses in pursuit of an income generating endeavour of the parties.  To the extent that there was a duty to indemnify the trustee, it was submitted that there could be no loss incurred by the trustee.  It was argued further that C Pty Ltd was simply an agent for the principals who indemnified it for all outgoings and such expenditure was incurred to earn assessable income of those principals.

10.     It is clear that, where there is a trust estate and the trustee carries on a business which incurs a loss, a share of such loss cannot be deducted by a beneficiary from other income.  As far back as 1933 the High Court in Doherty v Federal Commissioner of Taxation (1933) 48 CLR 1 had no difficulty in coming to that conclusion. In that case, the taxpayer was one of four beneficiaries under the will of her brother and the executor carried on a pastoral business in the period from date of death until they were in a position to hand over possession of the property to the beneficiaries. Starke J found that it could not be said that the executors were the agents or representatives of the beneficiaries but derived their authority and their powers from the will of the testator, and were his representatives. There are, in my view, significant differences between the trust in Doherty’s case and this matter.

11.     A somewhat similar position to that under consideration here came before the Federal Court in McGuiness v Federal Commissioner of Taxation 92 ATC 4006. The factual background to that case, taken from the head note, was:

“The taxpayer was one of two directors and principal shareholders in a property development group of four companies (the ‘Realty Projects Group’).  To overcome financing problems arising from the group’s structure, the taxpayer and his fellow director, Mr Satchell, were advised to form another company, Raymag Pty Ltd (‘Raymag’), for the purpose of acquiring shares in a listed public company as an indirect way of obtaining a listing of the group’s assets.

Raymag acquired 92% of the issued share capital in Bunny Industries Ltd (‘Bunny’).  A part of the share acquisition was financed by a $1.3m loan from a merchant bank and the rest of the shares were obtained by way of a share swap between the six shareholders of the companies in the Reality Projects Group and the Bunny family.

For the 1973/74 income year the taxpayer returned dividends of $18,916 received from Bunny and claimed deductions under sec 51(1) or 67(1) for his share of the expenses related to the financing of the Bunny share acquisition.  The ‘borrowing expenses’ consisted of loan interest of $34,106, management fees of $5,265, borrowing expenses of $3,910 and an unused limit fee of $196.  He claimed that Raymag had borrowed the funds used to acquire the Bunny shares on behalf of himself and Mr Satchell and that the Bunny shares were acquired by Raymag as a nominee for himself and Mr Satchell.”

Spender J said (at pages 4011 and 4012):

“When Raymag borrowed from IPC, it did so (as to half of the borrowings) as the agent of the taxpayer.  When an agent expends on the principal’s behalf, the principal is primarily liable for those expenses.  The principal is under a general duty to indemnify his agent for all liabilities incurred while acting within the scope of his actual, implied or customary authority:  Bowstead on Agency, 14^th Ed. p. 201.  The taxpayer would be under an obligation to indemnify Raymag for those borrowing expenses.  As such, in my opinion, the outgoing was incurred by the taxpayer.

In my opinion, the borrowing expenses are properly to be analysed on the basis of a relationship of principal and agent, although Raymag holds the shares as trustee for Mr Satchell and the taxpayer.  As to the right of a trustee to look to the beneficiary for liabilities incurred by the trustee by the retention of the trust property, Lord Lindley, speaking for the Privy Council said, in Hardoon v. Belilios [1901] A.C. 118 at 124:

‘…where the only cestui que trust is a person sui juris, the right of the trustee to indemnity by him against liabilities incurred by the trustee by his retention of the trust property has never been limited to the trust property; it extends further, and imposes upon the cestui que trust a personal obligation enforceable in equity to indemnify his trustee.  This is no new principle, but is as old as trusts themselves.

In Balsh v. Hyham (1728) 2 P.Wms 453, 24 E.R. 810, the trustee sought indemnity in equity, not against a liability incidental to the ownership of the trust property, but against a liability incurred by him by borrowing money at the request and for the benefit of his cestui que trust.  The Court decided that the plaintiff was entitled in equity to the relief which he sought on the broad ground “that a cestui que trust ought to save his trustee harmless as to all damages relating to the trust.”  This language (although open to criticism if applied to cestuis que trustent who are not sui juris and also sole beneficial owners) shews plainly enough that it was taken for granted as well settled that, speaking generally, absolute beneficial owners of property must in equity bear the burdens incidental to its ownership and not throw such burdens on their trustees.’  

…”

His Honour found that the dividend was received by Raymag as a bare trustee for the taxpayer who, being sui juris, was a beneficiary who was presently entitled under section 97(1) and that the dividend was properly included as part of the taxpayer’s income.  He found, further, that the management fee, borrowing expenses unused limit fee and interest claimed by the taxpayer should be allowed as deductions.  Although not stated as such in the judgement, it would seem that these expenses claimed represented the taxpayer’s proportion of the total of such expenses relevant to the borrowings in the name of Raymag.

12.     It is difficult to distinguished McGuiness’ case from the circumstances of this matter.  Here all of the members of the syndicate were sui juris and beneficial owners of the property. C Pty Ltd had a right to be indemnified against liabilities incurred by it on behalf of the beneficial owners. The simple answer is that C Pty Ltd did not incur a loss as trustee. It received the rental income as bare trustee and any expenditure out of that income was made as agent for the beneficial owners. Any excess of expenditure over the available income was paid either direct to the creditor by the individuals or paid by them into a trust account for disbursement by C Pty Ltd as their agent. If Division 6 applies to this situation it applies solely to the receipt of income. The expenditure was not expenditure as a trustee but as agent for the beneficial owners. As is the case of McGuiness, the borrowing from the Bank was as agent for the principals.  The expenditure either by way of C Pty Ltd or direct was an allowable deduction to the applicant as expenditure incurred in order to derive his share of the trust rental income.

13.     There appeared to be some confusion as to the precise amount of expenditure incurred by the applicant.  The claim appeared to be for 60% of the excess of expenditure over income as a partnership.  However, the applicant was a tenant of the building for part of the relevant period and owing to some dispute between himself and A paid no rent at times and part rent at other times.  Payments were made direct by the applicant to the Bank and other creditors.  Consequently it is appropriate that the matter be remitted to the respondent to calculate the quantum of allowable deductions on the basis that 60% of the rental income be included as assessable income and the expenditure incurred by the applicant for the purpose of deriving such rental income was an allowable deduction.  If there is any dispute as to the quantum, the parties have liberty to apply to the Tribunal to resolve such dispute.

I certify that the thirteen (13) preceding paragraphs are a true copy of the reasons for the decision herein of

Mr B. H. Pascoe, Senior Member

Signed:         

…..............Lou Coffey........................................

Personal Assistant

Date of Hearing  21 February 2000
Date of Decision  28 March 2000
Counsel for the Applicant         Mr T. McDermott
Solicitor for the Applicant          Wong McDermott & White
Solicitor for the Respondent     An officer of the respondent