FLZY vs Commissioner of Taxation

Capital vs Revenue

This case concerns the tax treatment of a transaction involving the sale of a commercial office building to the value of $70m dollars.

The taxpayer, founder of the 'Doma Group', is in the business of property leasing and property development. 

In 1999, a family trust to which the taxpayer was a beneficiary acquired a commercial office building in Canberra with an accompanying carpark.

There was an issue with the carpark being that it was not compliant with the 'ACT Building Code'.  Thus, it was not legally marketable to the general public.  After several options were explored, the hard-heads of the family trust decided that it would not continue the carpark business and decided instead to build a new eight story commercial property in its place.  The re-development, named the 'Glasshouse' took place in 2005 and cost roughly $30m.

The family trust sold the Glasshouse in 2007 after receiving an offer which was simply 'too good to refuse'.¹  The taxpayer contended that the family trust never intended to sell the commercial development at any time during its period of ownership, and that the apparent re-consideration arose only after an offer far above what they ever expected to receive was offered.  It was also contended by the taxpayer that they had developed growing fears of a 'property bubble' situation arising in Canberra.

The reason that contention is important, and the reason the Commissioner argued against it, is because Westfield vs CoT and the High Court in CoT vs Myer have established that:

"A profit or gain made as a result of an isolated venture or a ‘one-off’ transaction will constitute income if the property generating a profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the
&
Where a transaction occurs outside the scope of ordinary business activities, it will be necessary to find, not merely that the transaction is ‘commercial’ but also that there was, at the time it was entered into, the intention or purpose of making a relevant profit." ²

Unless it can be shown that the construction of the glasshouse was:

(1)  In the 'ordinary course of the family trust's business', or;

(2)  That the property was purchased with the 'intention of making a profit' from selling the building upon completion, as opposed to holding it for the long term to derive rental income.

Then the property will be treated on the capital account, and taxed at half the rate.

The Decision

Deputy President of the Tribunal S E Frost found as follows:

"My view of the proper characterisation of the Doma Group’s business activities means that I must reject the Commissioner’s submissions that the Group was carrying on ‘a business of the acquisition, development and disposal of properties or, alternatively, a business which included investing in property assets’.
Neither of those characterisations, in my view, can be sustained on a proper wide survey and exact scrutiny of the Group’s activities, because they fail to acknowledge the discrete nature of the different activities that the Group was undertaking.

The first of those characterisations could hardly be less exact. It is so generalised as to be quite misleading. Admittedly, the Doma Group did all of those things – acquisition, development and disposal – but it did not do all of them with respect to all of its properties. To say that that was its business is to avoid the very careful examination of its activities that was mandated by the High Court in Western Gold Mines. It is plain from the evidence of both Ivan and Jure, which in this respect I accept, that there had been for many years, and including during the relevant period, an approach of carefully assessing the best use of a particular property and then putting the property to that use. The Commissioner attempted to gloss over that approach, suggesting that in reality what the Group was doing was to acquire a property, develop it, and then sell it when the market was right. That led the Commissioner to suggest that the reason a property would not be sold reasonably soon after its development was that the Group could not obtain a high enough price for it. That suggestion is contrary to the evidence, and I reject it.

The second characterisation – that the Group was carrying on a business which included investing in property assets – is unhelpful. Like the first characterisation, it ignores the discrete nature of the Group’s different activities and the specific allocation of a given property to an identified activity. If such a simplistic label were correct then the distinction between revenue gains and capital gains would be meaningless for any entity that carried on a business ‘which included investing in property assets’. I do not see how that can possibly be so." ³

For completeness, the Deputy President added:

"The fact is, in the case before me, that circumstances presented themselves which made selling the property a sensible thing to do, despite the desire and intention to retain the property as an income-generating asset, and despite Ivan’s resistance to selling it. The price was simply too good. And it is relevant to note that the three properties acquired on disposal of the Glasshouse are still owned by the Doma Group, almost nine years after the transaction." ⁴

The continuing trend in 'isolated transaction' related tax law is a strong focus on the intention of parties at the time of entering into the scheme.  The intention in this case was made clear by the taxpayer's correspondence with real estate agents from the beginning, various letters to St George Bank, the repeated turning down of offers over a long period of time and the taxpayer's behaviour as a businessman over that period in general. 

The precise reason as to why controllers of the family trust eventually caved in and sold the property is not of paramount importance.  As long as there was a clear change in circumstances strong enough to change the original intention (within reason), the original intention itself is all that is needed to determine the capital nature of an asset. 

However, if you carry on a property development business you should seek tax advice before making any 'capital purchases'.  Although this case was clear cut, each depends on its own facts and circumstances.

Notes:

http://www.austlii.edu.au/au/cases/cth/AATA/2016/348.html

1.  p62.
2.  p49
3.  p55-58
4.  p61

Orica Limted vs Commissioner of Taxation [2015] FCA 1399

Schemes Reducing Income Tax

This is a summary of the tax scheme engaged in by Orica from 2004 to 2006.  The figures are not meant to be exact and the descriptions of events are highly simplified.

There are four companies of concern in this case.

Orica Limited - A publically listed Australian mining services company.  It is referred to as 'Orica' in this case.

Orica Finance Limited - A subsidiary of Orica Ltd.  It is referred to as 'OFS' in this case.

Orica Explosives Holdings Pty Ltd - A subsidiary of Orica.  It is referred to as 'OEH' in this case.

Orica US Services Inc - An American subsidiary of OEH.  It is referred to as 'OUSSI' in this case.

Part IVA

The question to be determined in this case is whether or not in 2004, 2005 and 2006 Orica's tax arrangements contravened Part IVA of the Income Tax Assessment Act 1936.  Part IVA provides that where there is:

A scheme,
giving rise to a tax benefit,
entered into for the 'dominant' purpose of obtaining that benefit.

The commissioner may remove the tax benefits obtained by a taxpayer by amending their return.

Section 23AJ

As it existed in the relevant years, s.23AJ allowed subsidiary companies to pay their Australian 'head company' dividends which would be completely non-assessable for tax purposes.

Tax Consolidated Group

Orica is the head company of a tax consolidated group, consisting of its Australian entities.  For tax purposes, Orica, OEH and OFL are considered to be part of the same entity.  Thus, if OFL make an interest payment, it is deductible by Orica.

Tax Losses

OUSSI had accumulated roughly USD$50m of tax losses in the United States due to a poorly performing North American explosives market.  (Probably close to AUD$75m)

The Scheme

The gist of the scheme is as follows.  All figures are ball-park numbers, in AUD currency.

OUSSI issued 500 million preference shares @ $1 each to OEH.

OEH transferred $500m to OUSSI.

OUSSI loaned $500m to OFL.  The interest rate was 5% ($25m).

OFL paid OUSSI $25m in interest per annum on that loan.  Orica deducted that $25m from it's taxable income in Australia - being from the same 'tax group' as OFL.

OUSSI offset its $25m interest income against unrealised tax losses.  OUSSIs tax on this income is zero.

OUSSI paid a dividend of $25 million to OEH. Non-assessable due to s.23AJ.

In summary:  A tax deduction is claimed, and the money returns without a tax bill in the USA or Australia.

This cycle repeated for three years until the US tax losses were totally utilised ($25m x 3 = $75m).  After which the loans were discharged and the equity returned.

Note (1) there are withholding tax obligations that don't ultimately impact on the above tax result.

Note (2) returning the $500m in equity back to Orica required an intricate shareholding structure, and careful timing, which was possible without ultimately impacting on the above tax result.

Did Part IVA apply

"The Commissioner contended, and Orica conceded, that the tax deductions claimed for the interest incurred by OFL in each of the three years in question were tax benefits within the meaning of s 177C(1)(b) and that they had been obtained in connection with schemes within the meaning of Part IVA." ¹

The remaining question is:  What was the dominant purpose for entering into the scheme?

The Parties' Contentions

"It was submitted for Orica that the tax deductions for the interest incurred by OFL were not the “ruling, prevailing, or most influential purpose” because from an accounting point of view the reported profits were not more attributable to any one of the three accounting components of the transactions as set out in the joint expert report. Mr Holland [The ATO expert] expressed the opinion that the deductions for the interest expense were “the reason for the increase in reported profits of $33.8 million”. Mr Stevenson [Orica's expert], in contrast, at paragraph 13 of the joint report, said that he was of the view that there was “no accounting perspective” for choosing between the three components of the transactions to determine which of them led to the increase in the reported profits of the Orica group." ²

In summary, Orica contended that utilising US tax losses, as opposed to writing them off, made accounting sense, and hence why this was predominantly an accounting decision.  In Orica's view there was no logical reason for the Commissioner to treat tax considerations above their accounting priorities.

In the Commissioner's view, the prevailing tax benefit was the dominant purpose of the transaction.

The key points of Justice Pagone's decision are summarised below.

The Decision

"The application of s 177D requires, rather, having regard to the eight matters in s 177D(b) to determine whether “it would be concluded” from those matters that a person who entered into or carried out the scheme did so for the dominant purpose of enabling the taxpayer to obtain a tax benefit in connection with the scheme. The conclusion to be reached is not a finding on the evidence that one of the persons contemplated by the section had the requisite purpose but that such a purpose is to be attributed to one of those persons by analysis of objective criteria without regard to the actual purpose or motive, ultimate or otherwise, of the relevant scheme participants...  Thus, for example, the inquiry called for by s 177D is not answered in the Commissioner’s favour by evidence of the description of the proposal as found in the 8 February 2002 initiative action template that the proposal would “[r]ealise reduced tax charges through utilisation and recognition of US tax losses”. The actual motive may explain why the taxpayers “acted as they did” but, as Gummow and Hayne JJ observed in [Hart v FCT] it does not provide an answer to the question posed by s 177D(b) which “does not require, or even permit, any inquiry into the subjective motives of the relevant taxpayers or others who entered into or carried out the scheme or any part of it”." ³

"The tax benefit was obtained by the interest payable upon the loan from OUSSI to OFL. That, for the reasons above, was “the ruling, prevailing, or most influential” purpose which overshadowed any other purpose which the schemes may have had. The utilisation of the US tax losses by Orica in this case, and their re-recognition, required the creation of a virtually certain source of income. The losses had been incurred in the US but would remain unutilised unless and until the economic benefit of the US tax losses could be enjoyed by the group by the US company deriving taxable profits. It was clear at the time that the US operations could not take advantage of the US losses by normal operation of the US business. Circumstances could be created for the US subsidiary to derive income to offset against the US tax losses but the use of the US tax losses would be of no economic benefit to the group unless the US losses had the effect of reducing the tax otherwise payable by the group on income which could not otherwise be sheltered by the US tax losses." ⁴

"Orica’s appeals against the Commissioner’s application of Part IVA will accordingly be rejected." ⁵

Notes

The case:  http://www.austlii.edu.au/au/cases/cth/FCA/2015/1399.html

1.  p15
2.  p23
3.  p19
4.  p33
5.  p34

Crown Estates (Sales) Pty Ltd v Commissioner of Taxation [2016] FCA 335

GST and Agency

In this case the Federal Court affirmed a decision from the Tribunal, which reaffirmed conventional wisdom¹ that real estate agents do not incur or charge GST for transactions they undertake on behalf of a property owner, such as the collection of rent and payment of property related expenses.  Crown Estates are better described as 'property managers', but the logic followed is for all practical purposes the same.

The Tribunal Found:

"I am satisfied the document [the Client/Vendor Agreement] describes a relationship between TPM and each of its property-owning clients in which TPM acts as an agent in the classic sense of that term. The essence of agency is there for all to see: TPM is clearly in a position to “create or affect legal rights and duties as between another person, who is called [the] principal, and third parties”." ²

"I would add that if the taxpayers were liable to pay for goods and services that were found to have been supplied to TPM but which TPM subsequently on-supplied to a property-owning client, any input tax credits that could be claimed by the taxpayers would be offset by the amount of GST they were liable to pay when they were reimbursed by the clients."  ³

The decision in the Federal Court was not as straight-forward.  Decisions of the Tribunal can only be appealed based on valid questions of law. The taxpayer's notice of appeal identified the following 'questions of law' in regard GST assessments:

• "(1) Whether the Tribunal erred in properly construing and applying s 11.5 of the A New Tax System (Goods and Services Tax) Act 1999 (Cth) in concluding that the Applicants did not make creditable acquisitions in the course of their dealings with suppliers of goods and services to properties owned by the clients of the Applicants.
•  (2) Whether the Tribunal erred in construing and applying the law of agency in determining that the Applicants acted as agents in the course of all their dealings with suppliers of goods and services to properties owned by the clients of the Applicants."  ⁴

Justice Logan was not satisfied that the above submissions were valid questions of law, first quoting following authority:

"[I]t simply begs the question of law to commence it with the words ‘Whether the Tribunal erred in law’. If the question, properly analysed, is not a question of law no amount of formulary like ‘erred in law’ or ‘was open as a matter of law’ can make it into a question of law."  ⁵

Followed by His Honor's take on present case:

"A specification in a notice of appeal which does nothing more than solicit a broad and hypothetical enquiry as to the construction and operation of statutory provisions is not a specification of a question of law: Screen Australia v EME Productions No 1 Pty Ltd [2012] FCAFC 19; (2012) 200 FCR 282 at 289, [24] per Keane CJ, Finn and Gilmour JJ (Screen Australia v EME Productions).

In my view, each of the so-called questions of law in the amended notice of appeal exhibits the same vice as identified, in respect of Question 2A of the notice of appeal considered, in Lambroglou by Ryan J."  ⁶

For purposes of practicality Logan J then construed the taxpayer's submission as if it did raise valid questions of law to proceed with this case.  The Court upheld the Tribunal's decision, finding no error in its decision.

The GST Decision

"That a relationship of principal and agent existed as between TPM and its clients was, given the findings of fact which the Tribunal made, the correct conclusion in law. That, in these circumstances, it was TPM which made the creditable acquisition was the inevitable, consequential conclusion and the one made by the Tribunal."  ⁷

"The Tribunal was entitled to reach this factual conclusion. In itself, the invoice addressed to TPM was neutral as to whether, in fact, there had been an acquisition made by TPM on behalf of a client or by TPM in its own right. It was up to TPM to place evidence before the Tribunal to persuade the Tribunal that the latter was the factual position. This, TPM did not do."  ⁸

On the Subject of GST Penalty Remission

"Section 284-15 of Sch 1 to the TAA defines when a matter is “reasonably arguable”. That definition appears in Subdivision 284-A, which contains a number of general provisions relating to Div 284. It is not though expressly there stated to be a consideration applicable generally for the purposes of that Division. Rather, whether a position is reasonably arguable is expressly made a relevant consideration in relation to the assessment of some but not all amounts under Div 284. It is, for example, expressed to be a relevant consideration in relation to the determination of “shortfall amounts” for the purposes of s 284-80 but its application there is confined to income tax law or the petroleum resource rent tax law cases (see s 284-80, Items 3 and 4), which do not include GST cases. The same restriction of relevance is evident in the table for the assessment of base penalty amount in s 284-90 of Sch 1 to the TAA (see Item 4)."  ⁹

Conclusion

Important points that arise from this case include:

(a) As a general rule, agents (be it property or another kind) are not entitled to GST input tax credits.
(b) A competent appeal to the Federal Court from a decision of the Tribunal must include valid questions of law.  Vague hypothetical inquiries are not satisfactory.
(c) Section 284-15 of Schedule 1 to the Taxation Administration Act outlines remission available for taxpayers served with income tax or petroleum tax penalties.  The GST penalty regime is not concerned with those provisions. 

Notes

ATO Guidance:  http://law.ato.gov.au/atolaw/view.htm?docid=GST/GSTR200037/NAT/ATO/00001

1.  (p20)

Tribunal's Findings:  http://www.austlii.edu.au/au/cases/cth/AATA/2015/949.html

2.  (p21)
3.  (p24)

Federal Court Findings (by Logan J):  http://www.austlii.edu.au/au/cases/cth/FCA/2016/335.html

4.  (p4)
5.  (p11)
6.  (p12 & 13)
7.  (p43)
8.  (p44)
9.  (p50)

Miley vs Commissioner of Taxation AAT [2016] 73

A popular aspect of the Australian taxation system is the ability of small business owners to substantially reduce capital gains tax (CGT) payable on the sale of their small business related assets. A key idea behind this tax concession is the view that long term small business owners typically invest all of their spare capital back into their business interests, leaving them with very little spare for retirement savings.  Division 152 of the ITAA 1997 is essentially a retirement payout for small business owners.

One condition of access to the CGT concessions is satisfying the '$6 million net assets test' - to stop citizens in possession of business assets worth $6m or more from accessing reduced capital gains.  The $6 million test was the sole subject of this case before the Administrative Appeals Tribunal (AAT).

Mr Miley sold his 1/3 share in a $17.7 million company for $5.9 million, being 1/3 of the $17.7 million sale price.  Unfortunately for him, a rental property (among other small assets) seems to have pushed Mr Miley over the $6 million threshold, hence the ATOs initial view was that he did not pass the test.

Section 152-15 titled "Maximum Net Asset Value Test" suggests that taxpayers pass the test if the market value of their assets immediately before the CGT event are worth $6 million or less.  The ATOs view is that the price paid for Miley's 1/3 share of this business being $5.9 million is the precise market value of those shares "immediately before the CGT event" (the CGT event being the sale of the shares in question...) - a reasonable proposition. 

Before proceeding, it is a good time to appreciate the intricacies of taxation law.

Mr Miley asked a valuation expert, Mr Halligan to value his 1/3 share in the business in question.  The valuation provided:

• "I adopt a discount for the relative lack of control of 16.7% for each company based on the following.
• All other things being equal, the average price per share of a controlling shareholding will be higher than the average price per share of a non-controlling shareholding because of the value of control.
• The value of control relates to the value in having the power to make decisions that affect the amount, timing, and risk of the cash flows from an investment in the equity of the company, whether listed or unlisted. Those decisions might, for example, affect the company’s strategic, operating, taxation, investment, and dividend payment policies." ¹

A16.7% discount reduces the market value of Mr Miley's sole 1/3 share, from $5.9 million to $4.9 million.  Allowing Mr Miley to easily pass the $6 million test.  So what did the tribunal member rule?

The Decision

"I think the correct enquiry is directed towards determining the market value of Mr Miley’s 100 shares alone – not as part of a package comprising the entire 300 shares in the Company.

I accept the opinion Mr Halligan expresses in [135] of his report: see [30] of these reasons. I find that the consideration that Mr Miley received for his shares, which formed part of the consideration paid by the Buyer for all the shares in the Company, is more than a hypothetical willing but not anxious purchaser would have paid if it had purchased Mr Miley’s shares alone – and that is the basis on which the market value of Mr Miley’s shares should be determined. Therefore, while the actual consideration received by Mr Miley should not be ignored as an indicator of the market value of his shares just before the time of the CGT event (Inez Investments: [26] of these reasons), it is not determinative of that market value.

The market value of Mr Miley’s shares, arrived at by reference to the correct enquiry, is $5,900,000 less 16.7% of that amount, for lack of control. That equates to $4,914,700."  ²

"The objection decisions are set aside. Instead Mr Miley’s objections are allowed in full."  ³

Notes

The case is here:  http://www.austlii.edu.au/au/cases/cth/AATA/2016/73.html#fn3

1.  (p30)

2.  (p34 - 36)

3.  (p39)

Financial Synergy Holdings Pty Ltd vs Commissioner of Taxation [2016] FCAFC 31

When consolidating a group of wholly-owned entities, taxpayer's transfer the assets of those entities into a single company.  The transfer of assets is deemed by law to be performed at arm's length prices, meaning the assets are acquired at their market value on the day of transfer - henceforth, Capital Gains Tax (CGT) events are going to occur on the transfers.  CGT rollover relief is provided in Division 122 of the ITAA 97 in respect of these transfers.  Therefore, usually the 'head company' acquires these assets at market value (with slight adjustments), and tax is 'rolled over' until presumably the assets are sold to an independent party at some point in the future.

Assets acquired 'pre-CGT' (pre-1985) are exempt from capital gains tax.  Section 122-70 provides that if these assets are transferred to another company (the 'head company') in a tax consolidation, they will retain their pre-CGT character.  There remains an accounting question subject to this case which can be framed as follows:

At what price are the pre-CGT assets transferred to the head company?  Is it zero, is it the market value on the day of transfer (as is the case with all other assets) or is it some other value?

The Case

Post-CGT assets are deemed to be transferred at their market value, and this market value is a key factor in determining the assets' cost base in the new company.

The Commissioner of Taxation contended that the cost base of pre-CGT assets should be zero, otherwise the system will allow taxpayers holding tax free assets to obtain modest tax benefits from other sections in the tax act which (presumably) in the Commisioner's opinion should only be available for assets which will eventually be taxed upon their sale (depreciation in division 40 might be one example of a benefit).

A single judge of the Federal Court agreed with the Commissioner and ruled that Pre-CGT assets are taken to be sold to the head company of a consolidated group at the market value of those assets at 24 September 1985.  This value is generally a lot closer to zero than it is to the market value on the day of transfer.

That decision was appealed by the taxpayer to the Full Court, consisting of three judges to hear the appeal. 

The Decision

Middleton and Davies JJ:

"The primary judge held that the “time of acquisition” of the units for the purposes of working out the first element of the cost base of the units in accordance with s 110-25(2) was deemed by s 122-70(3) to be “before” 20 September 1985. His Honour also held that s 122-70(3) should be construed as referring to a date “immediately” before 20 September 1985, that is, 19 September 1985.

For the reasons that follow, we have respectfully reached the different conclusion that the “time of acquisition” of the units for the purposes of working out the first element of the cost base of the units in accordance with s 110-25(2) was 29 June 2007."  ¹

"The Commissioner submitted that it would be an anomalous result for the taxpayer to have a market value cost base for the pre-CGT assets in determining allocable cost amount. It was submitted that it was antithetical to the concept of a roll-over for the cost base of a pre-CGT asset to be “freshened up” on a roll-over to the amount in fact paid or given by a taxpayer because to achieve this “freshening up”, the disposition or the CGT event is not ignored but for cost base purposes is fully embraced and that the tax consequences of the event are not thereby delayed but assumed immediately. It was submitted that it was improbable that this was what Parliament intended. It was submitted that the consequences for the purposes of the consolidation provisions in Pt 3-90 would be that taxpayers would obtain the double benefit of a market value step-up in the cost base of the membership interests of an entity joining a consolidated group (so as to permit higher depreciation deductions for its underlying assets, amongst other things) as well as an exemption from capital gains tax on the ultimate disposal of those membership interests. It was submitted that there was no extrinsic material that supported the proposition that these outcomes were intended by Parliament.

The answer to these submissions is that the need to determine cost base for the purposes of the consolidation provisions arises in a separate and different context. The cost base is used to work out the allocable cost amount that is used in resetting the cost base for the assets of a joining entity. The object of the process is “to recognise the *head company’s cost of becoming the holder of the joining entity’s assets as an amount reflecting the group’s cost of acquiring the entity”: s 705-10(2). The taxpayer’s construction gives effect to and is consistent with that object."  ²

Logan JJ:

"The controversy present in this case may perhaps be the result of an omission of express provision for the harmonious operation of two ameliorating Divisions within the 1997 Act; the provisions of Div 705 (tax cost setting amount for assets where entities become subsidiary members of consolidated groups) within the consolidated group provisions of Pt 3-90 on the one hand and, on the other, the capital gains tax (CGT) rollover relief provisions within Div 122 of Pt 3-3 within the CGT regime found in ch 3. Such is the intricacy of these two ameliorating Divisions that they were always fraught with the prospect that a statutory construction controversy might be generated by an omission of specific provision for a particular occurrence. The presence of ameliorating provisions is conducive to a particular ordering of business and personal affairs in order to have the advantage of them. Apart from challenging the limits of human comprehension, one of the difficulties of the contemporary preference for intricacy in the 1997 Act is the difficulty of predicting in advance and making related provision in advance for all of the ways in which this ordering of affairs might occur.

Flowing from the absence of this express provision, there is a certain attraction in the construction favoured by the learned primary judge, responsive to a submission by the Commissioner that it negated what would otherwise be a form of “double-dipping” by the appellant, i.e. the obtaining of a “market-value step up” under Subdiv 705-A while at the same time retaining pre-CGT status for the relevant asset.

In my view, characterisations of relevant provisions offered by the taxpayer in its submissions correctly reflect how they are to be construed and operate to negate the attraction just mentioned. The taxpayer submitted that, read in the context of the object of the Division in which each was located, s 110-25 was to be characterised as a quantitative valuation provision, whereas s 122-70(3) was to be characterised as a qualitative provision, each respectively linking, without conflict, to separate groups of provisions in the 1997 Act. I agree."  ³

Notes

The case is here:  http://www.austlii.edu.au/au/cases/cth/FCAFC/2016/31.html

1.  (p3 & 4)
2.  (p37 & 38)
3.  (p42 - 44)

Lee Group Charters vs Commissioner of Taxation [2016] FCA 332

This case concerns what constitutes the 'carrying on' of a super yacht charter 'business'.  The entities of Mr Lee which conducted the alleged super yacht business include Lee Group Charters Pty Ltd (LGC) and Kerri Lee Charters Pty Ltd (KLC).  These two entities also happened to be beneficiaries of profitable trusts presumably controlled by Mr Lee at all relevant times, leaving it open for Mr Lee to offset potentially taxable income residing in these trusts against potential losses made by either of his yacht chartering enterprises.

As it happened the yacht chartering business lost money from inception in 2006 until the Commissioner's most recent tax amendment to LGC in 2013.  While the Australian Taxation Office (ATO) were no fan of this tax framework, that is besides the point.  Taxation law explicitly prevents deducting expenses incurred from boating activities that are not 'carried on as a business' (s.26-47), at least to the extent they are not being offset against income from the boat or yacht itself.  Hence, the ATO argued that LGC were ineligible to deduct their yacht chartering tax losses against profits from Mr Lee's other more profitable business ventures which were transferred in by way of a trust distribution.

Taxpayer's Contentions

The legal argument from the taxpayer's perspective is as follows:

Section 26-47(2) provides that boating expenditure exceeding boating income shall be quarantined to be offset against boating profits in future years if they may arise.

Section 26-47(3) provides that there are exceptions to the above rule, including exclusion (b) being an entity which uses a boat 'mainly' for letting it on hire in the ordinary course of a business.

The taxpayer (LGC) at all relevant times advertised the fully-manned super yacht for charter to the public, performed the required administrative tasks itself as any other yacht charter business would, acted commercially & professionally at all times and continually invested in the business venture with a clear goal of becoming a leading yacht charter brand in tropical Queensland and nearby pacific islands.

Commissioner's Contentions

The exception found in s.26-47(3) only applies if the taxpayer 'mainly' holds a boat for letting it on hire in the ordinary course of a business.  The usual meaning of the word 'mainly' is "for the most part". 

The Commissioner predominantly relied on the fact that Mr Lee appeared to be in most (potentially all) years LGCs main client and that the business as it existed did not have a reasonable prospect of making a profit.  The Commissioner concluded that the yacht was not held 'mainly' or 'for the most part' to be used in carrying on a business.  Rather, this was venture was more of a personal hobby for Mr Lee and his family.

The Decision

(Justice Logan)

"First and foremost, Mr Lee is an honest man who gave generally reliable evidence, to the best of his recollection. Secondly, Mr Lee is, characteristically, laconic. Thirdly, though he is entrepreneurial and decisive in matters of business, he seeks out what he considers to be sources of relevant advice and experience before making decisions. Fourthly, he has a very particular respect for the taste, business judgment and attention to detail of his wife, Mrs Keri Craig Lee, especially in matters of decoration, presentation, durability and suitability of fit out for charter operations and standards of crew turnout and service. Theirs is a long and enduring marriage. They will celebrate their 30th wedding anniversary this year."  ¹

"A feature of the charters of the Keri Lee III is that the predominant charter party is Mr Lee (other charterers were Lenda Finance SA and a Mr Jeff Jacobs).

During the course of his cross-examination, Mr Lee was taken to three of these (charters). These (three) do entail charters for less than the publically advertised rate for the Keri Lee III (US$175,000 per week, fixed in response to the persistent adverse impact of the GFC on demand). Mr Lee’s evidence was that there would have been a good commercial reason why those particular charters were below the ordinary rate. At the time when these charters were undertaken, Mr Lee had no particular reason to expect that, some four years later, he would be asked to recall the precise occasion for these particular charters and the particular, related reason for these charter fees. As I have now stated more than once, I regard Mr Lee as an honest witness. On this subject, one reason why I accept his evidence as accurate is that, over the period in question and in respect of both LGC and KLC he was meticulous in ensuring that he paid a commercial charter rate."  ²

"In late 2009 or early 2010, KLC was approached by a movie producing company who advised that they were interested in using the Keri Lee Ill for a movie. Mr Lee recalls that this was part of the “X-Men” movie series starring Hugh Jackman."  ³

"Mr Lee’s answers were, in my view, honest and candid. They were also revealing. When he came to cause LGC and the KLC to embark upon these ventures, Mr Lee brought a very particular background of experience to bear upon his decision-making. That background lay not just in his gradually developing and evolving belief, described above, that it would be possible to operate a super yacht charter business based in Australia which looked to charters in Australian and South Pacific waters. It also lay in his earlier business experience, derived from the successful operation of a rurally based business, of the vicissitudes that can attend such a business and a correlative disposition on his part to take a long term view as to profitability. I find that this informed and continued to inform his thinking about the super yacht venture. He brought that same disposition to the operations of each of the taxpayers. Mr Lee was, in effect, backing a value judgment which he made in respect of what he considered, in the long term, would eventually prove to be a profitable business. Further, returns which others might not regard as acceptable were, in light of his rural experience, acceptable to him."  ⁴

"What is evident over this period (as it is also in respect of the later ownership and operation of the Keri Lee II and Keri Lee III), is that Mr Lee was not rigidly following a pre-ordained business plan in respect of charter operations for the vessels. He was reacting to circumstances and to an ever growing understanding of the super yacht charter industry...[C]ases such as this are not to be resolved by resort to some mechanical annotation of a checklist for the presence or absence of factors, one of which is the presence or otherwise of an anterior business plan. There is nothing in s 26-47 of the ITAA97 which mandates that there must be some sort of formal business plan for dedications not to be quarantined. Even were there a formal plan written in advance, if the evidence in practice showed an unexplained disregard of that plan and uses inconsistent with the operation of the vessel as a business, form could not triumph over substance in terms of the conclusion to be drawn. On the whole of the evidence in relation to the period from when the idea of a super yacht operation first occurred to Mr Lee to the first charter of the Keri Lee I, the irresistible conclusion, in my view, is that Mr Lee did not cause the acquisition of or operate that vessel as a private venture, as opposed to for and as a business. Further, his end, which was that of LGC, was that the vessel would be operated at a profit. "  ⁵

"It bears repetition that the rule and the material exception to the rule established by s 26-47 of the ITAA97 do not preclude charters to related parties. The rule and the exception are neither to be construed nor administered as if they did. That a pattern of related party chartering is evident is neither more nor less than one relevant part of an overall factual matrix against which one must measure whether the activity concerned is within or outside the terms of an exception. When, as here, another feature of that pattern is the great predominance of charters at commercial rates, its role becomes supportive rather than destructive of a conclusion that the vessel is being used or held mainly for letting on hire in the ordinary course of a business being carried on by KLC."  ⁶

"Mr Lee was...scrupulous in ensuring that the use of each vessel was at commercial charter rates. When not under charter, each vessel was held for that purpose (for letting on hire). Each of the taxpayers continuously presented themselves to the world at large and operated and was administered internally as a business. That presentation, operation and administration was a reality, not a façade. They were a manifestation of the expectation and purpose of making a profit."  ⁷

"[E]ach vessel was used or held, certainly mainly, but in my view, exclusively, for letting on hire in the ordinary course of a business carried on by LGC and by KLC."  ⁸

Logan J held that the taxpayer's appeal should be allowed in full.  LGC was, and is carrying on a business. 

Whether or not one of an entity's most frequent customers is a related party is not a key consideration in determining whether or not a business is being carried on.  In fact, many businesses which solely service related parties are treated as companies under both the Corperations Act and Taxation Laws.  This "I only service related parties" line certainly wouldn't be a viable excuse for a profitable company attempting to define itself outside of particular taxation laws (i.e. GST).

The other noticeable point is that this case proceeded from ATO objection directly to the Federal Court.  Taxpayers generally have a right to have their objection heard by the Adminstrative Appeals Tribunal before proceeding to the Federal Court, although it is not a necessary precursor.  These are signs of a confident taxpayer who appeared unhappy with the ATOs audit and conclusions.  The most advantageous aspect of appealing directly to the Federal Court is that the taxpayer can recoup all costs incurred during the appeal proceeding from the ATOs objection decision.  An order to costs is not available in the tribunal, this might be considered another 'win' for the taxpayer.

Appendix

The case is here:  http://www.austlii.edu.au/au/cases/cth/FCA/2016/322.html

1.  (p18)

2.  (p118 & 119)

3.  (p105)

4.  (p85)

5.  (p59 & 60)
6.  (p123)
7.  (p128)
8.  (p129)

All legislative references are to the Income Tax Assessment Act 1997.

Seymour vs Commisioner of Taxation [2016] FCAFC 18

On appeal from the Federal Court, the Full Federal Court has disallowed an appeal from Mr and Mrs Seymour, who fled to Mauritius upon finalisation of an audit into their Australian tax affairs under Part IVA (fraud and evasion) of the Income Tax Assessment Act 1936.  The case concerned their right to appeal their taxation assessments from Mauritius via video link.

This was a split decision between the three justices (Siopis, Griffiths and Pagone JJ), which will make an appeal to the High Court of Australia both tempting and likely (given the fact it has come this far - one would assume money is not an issue for the taxpayer - especially since no tax has yet been paid).

The Tribunal

The Administrative Appeals Tribunal (AAT) is waiting to hear a case into the suspected fraud and evasion of taxation by Mr and Mrs Seymour.  They submitted to the tribunal that traveling to Australia in order to commence litigation against the ATO was out of the question, because they feared the Commissioner would invoke his power under s 14S of the TAA 1953 to levy a 'departure prohibition order' (DPO), removing their right to leave Australia until all tax debts are paid, or are dismissed by a court.  The Tribunal granted this application, which has been appealed and is subject to the current case.  The AAT cannot commence Part IVA proceedings until the question of whether or not video link services are available to the taxpayers has been answered by the Federal Court (or higher court) on appeal by the Commissioner.

The Federal Court

The Federal Court quashed the AATs decision allowing the Seymours to give evidence from Mauritius on two grounds:

(1)  The AATs decision took into account irrelevant considerations.

(2)  The AATs decision denied the Commissioner procedural fairness.

"[W]here a party to proceedings in the AAT puts a request to give video evidence on the basis that the party wishes to avoid any possibility of legitimate action taken by taxation, regulatory or prosecuting authorities in Australia, I do not see how such a matter (which remains the declared position of the taxpayers regardless of the position of the Commissioner about DPOs) could normally be relied upon as relevant, much less decisive, by the AAT."  ¹

The Full Federal Court

The Full Federal Court upheld the decision of the Federal Court by a majority of 2-1.  Siopis and Griffiths JJ upheld the decision, albeit for different reasons in relation to ground (1).  Pagone J dissented and would have allowed the appeal in full, holding a view that the AAT exercised its discretion on this matter without making any errors.

Ground (1)

Justice Siopis found:

"The primary judge characterised the Tribunal's error as taking into account an irrelevant consideration...I would, however, prefer to characterise the Tribunal's error slightly differently, namely, as the failure by the tribunal to have regard to the public interest and proper administration of the Taxation Administration Act 1953, in particular, and to the administration of justice in general." ²

"Whilst it is the case, as the appellants contend, that in making the impugned orders, the Tribunal did not “assist” the appellants to avoid the operation of Australian law – this was achieved by the appellants’ own conduct in fleeing Australia; nevertheless, in my view, the making of orders permitting the appellants to give evidence from abroad has a tendency to undermine the operation of the Taxation Administration Act."   ³  (emphasis added)

Justice Griffiths found:

"In my respectful view, the appellants have not established any appealable error in respect of the primary judge’s reasons and finding that the AAT fell into jurisdictional error in taking into account in the particular circumstances of this case the appellants’ refusal to come to Australia if they did not receive an assurance from the Commissioner that they would not be issued with a DPO. The appellants’ own stated and clear position was that they would not return to Australia in any event unless additional conditions were also met to address their concerns that they would be arrested and detained in Australia for tax offences." ⁴

Justice Pagone found:

"The House of Lords in Polanski v Condé Nast Publications Ltd held that, in general, in respect of proceedings which are properly brought in a domestic court, a claimant’s unwillingness to be present in court because he was “a fugitive from justice” was a valid reason, and could be a sufficient reason, for making a video conference order...There is no reason to adopt a different approach in relation to the Tribunal considering the exercise of its power to receive evidence by video link under s 35A of the Tribunal Act. Each case must, of course, be decided on its own facts, and in some cases a wish to avoid action by regulatory authorities may militate against an application by the fugitive to pursue a case by giving evidence by video rather than by attendance in person, but permitting the giving of evidence by video in general furthers the proper administration of justice. There is nothing in the Tribunal Act which requires a rule to the contrary." ⁵

Justice Griffiths responded:

"With respect, I consider that there is considerable force in the dissenting views in Polanski. More significantly, however, Polanski necessarily reflects its own particular facts. The Seymours are in a different position, having chosen to leave Australia lawfully before initiating Pt IVC proceedings and then indicating that they will not return to Australia to give evidence in that proceeding unless all the elements of their letter of demand are met. Ultimately, therefore, it is unnecessary to state whether the majority view in Polanski is correct because the facts are distinguishable." ⁶

All three judges appear to agree that the 'proper administration of justice' is a central concern to this case.  The two competing views can be neatly summed up by the following two quotes from Polanski, the case referred to in the judgement of Justice Pagone:

"A fugitive from justice is not as such precluded from enforcing his rights through the courts of this country. This is so whether the fugitive is claimant or defendant. Mr Polanski’s status as a fugitive offender does not deprive him of any rights he would otherwise possess in respect of the subject matter of this action. His flight from California in 1978, and the steps he has taken ever since to remain beyond the reach of the Californian court, do not preclude him from bringing proceedings in England in respect of damage to his reputation flowing from publication of defamatory material in this country." - Lord Nicholls ⁷

"The task of the Court here is one of balancing different policy considerations and not merely deciding case management. Where a person convicted on his own admission flees the jurisdiction, it seems to me that in the absence of special factors compelling a different result, a video link conference may and should here be refused where the sole reason for asking for it is that he wishes to escape conviction or sentence in the country where he has commenced proceedings or to avoid extradition to another country for the same reason. The mere fact that the person cannot pursue proceedings here does not necessarily mean that a video link must or should be granted. The policy requirement of satisfying the criminal sentence is by no means less important than the desirability of his suing in libel for an allegation which is serious but no more serious than the criminal offence of which he has been convicted. The possibility of suing in France is a further contraindication to any obligation to grant such a video link." - Lord Slynn ⁷

Ground 2

Although it was then unnecessary to consider the second ground of quashing the AATs decision, Griffiths J, with whom Siopis J agreed, ruled that the Seymours once more had failed to establish any appealable error in relation to the findings of the Federal Court. ⁸

Pagone J dissented in ruling that:

"The Tribunal took into account a number of factors in reaching that conclusion which were open and appropriate for it to take into account." ⁹

"That conclusion was reached in the context of the Tribunal’s evaluation of the issues and materials from which the Tribunal concluded that the evidence of Mr and Mrs Seymour was unlikely to be determinative notwithstanding that their credit may be in issue. The Tribunal specifically considered that cross-examination by the Commissioner of Mr and Mrs Seymour would not be impeded if they gave evidence by video link. That was a conclusion that was open to the Tribunal." ¹⁰

"His Honour’s conclusion that the decision by the Tribunal “was a denial of procedural fairness” was not a conclusion which was open to his Honour on the material before the Tribunal. There was no material before his Honour about the live issues in the Tribunal proceedings." ¹¹

"The decision made by the Tribunal to permit evidence by video link may not be the paradigm for a system of justice steeped in the common law tradition. There is, however, no rule of law or of practice that a party is entitled to insist on the physical presence of another party for cross-examination." ¹²

Appeal to the High Court

Although this case has little to do with taxation, it has implications on AAT proceedings involving overseas taxpayers.  Some sense of finality to this genuine dispute with regard to the balance of the public interest and the administration of justice in society would appear appropriate to resolve, and would save more arguments on this point in the future.  My gut feeling is that the taxpayer is in no rush to see an end to this dispute, and may well appeal if resources provide.  Otherwise, given how much technology has taken over the lives of human beings, I doubt this split decision is going to provide a solid precedent moving forward, so in any case we may well see the issue raised in Polanski appear in Australian courts again in the future.

Footnotes

http://www.austlii.edu.au/au/cases/cth/FCAFC/2016/18.html
http://www.bailii.org/uk/cases/UKHL/2005/10.html

1.  p 19
2.  p 23
3.  p 29
4.  p 55
5.  p 107
6.  p 72
7.  [2005] UKHL 10
8.  p 77
9.  p 108
10.  p 110
11.  p 109
12.  p110

Clemens vs Federal Commissioner of Taxation [2015] AATA 124

In this case a backpacker (Maximillian Clemens) was found to be non-resident despite travelling and working around Australia for more than half of the year (183 days).  This was because his usual place of abode was found to be in Germany, rather than Australia.  The judge determined that for Mr Clemens to claim tax residency status in Australia, before leaving home he was required to completely abandon his parents' German residence, and upon arrival in Australia, to reside in a dwelling of some quality and permanence.

Deputy President of the AAT R Deutsch:

"In my view it is not possible to have two or more usual places of abode at the same time. Where there are two competing places of abode it needs to be assessed based on all the available facts as to which one is “usual”. "
  (p 37)

"Nonetheless this Tribunal concludes that during the whole of the year ended 30 June 2013, the Applicants’ usual place of abode was his parents' house in Germany. "  (p 40)

"While the Parliamentary intentions are not always relevant to examine it is worth noting that the various qualifications to the 183 day rule were enacted by Parliament “in order that there may be no danger of treating as residents persons who are purely visitors”: Explanatory Notes on Amendments contained in the Income Tax Assessment Bill 1930 to amend the Income Tax Assessment Act 1922-29, page 11. Thus, overseas visitors on holidays or working in Australia who are in Australia for more than 183 days would not be residents during their stay under this test, as they would usually have a usual place of abode elsewhere and would not have an intention of taking up residence in Australia."  (p 48)

"This lends support to the conclusions I have reached. It is only if the Applicant had completely abandoned his usual place of abode overseas in Germany during the year ended 30 June 2013 that the result might be otherwise."  (p 49)


http://www.austlii.edu.au/au/cases/cth/AATA/2015/124.html

John Holland Group Pty Ltd vs Federal Commissioner of Taxation [2015] FCAFC 82

A long long time ago, in a galaxy far far away, a man named Mr Lunney attempted to deduct the cost of his train tickets to and from work each day from his assessable income for tax purposes, and was disallowed by the High Court because these costs amounted to "living expenses".  The majority of the High Court ruled that once Mr Lunney reached his company's place of work, further travel expenses incurred on that day between different places of work was deductible as it directly related to the production of his assessable income.

The question posed in this case amounts to weather or not a rail maintenance worker can claim that his work 'begins at Perth airport', and hence can deduct the cost of plane tickets to and from work-sites.  If so, the ITAA 1997 provides that John Holland Group can deduct the cost of plane tickets which would be deductible in the hands of an employee.  The income of John Holland Group employees amounts to consideration paid to him for work performed according to a contract with John Holland Group, which specifies that he begins getting paid on arrival at Perth airport.  Was this enough to convince the Full Federal Court that gaining his assessable income included flying to a work-site?  Yes.

"The cost of travel for which Mr Lunney claimed a deduction, and which the court did not allow, was not the travel from the company’s office at No. 11 Darling Harbour to the various ports to carry out his work, but from his domestic residence in Narraweena to his employer’s office at No. 11 Darling Harbour. Counsel for John Holland Group and John Holland contended that the equivalent outgoing in this case (which the employees would not be able to deduct) would be the cost of travelling from the employees’ individual residences to Perth airport, but that the employees’ arrival at Perth airport was equivalent to the arrival of Mr Lunney at the office of his employer at No. 11 Darling Harbour. In other words that arrival by the employees at Perth airport was the employees’ arrival at work from which they then travelled to Geraldton to undertake other tasks. The employees were submitted to be “in” their employment from the moment of their arrival at Perth airport and were not travelling “to” their employment at Geraldton. In contrast, the Commissioner contended that the employees were employed, and paid, to undertake activities at Geraldton and that their employment did not include their travel from Perth airport to Geraldton."  (p 53)

"Travelling from Perth airport to Geraldton was part of the employment of those employees. Each of the employees commenced their “rostered on” duties on arrival at Perth airport and took the flights because they were directed to do so and were required to do so as part of their employment obligations. The terms of employment of the “workforce” employees provided that the employees commenced their “rostered on” employment duties from their time of arrival at Perth airport."  (p 58)

"In my view, there is no reason why Perth Airport should not be a point at which the employees duties and remuneration for performance of those duties both commences and ceases. The contract of employment so provides. The fact that Perth Airport is not an area or premises owned or leased by John Holland, is irrelevant. In this respect, there is no difference between Perth Airport and No 11 Darling Harbour."  (p 44)

"From the time the John Holland employees, both Workforce and Staff, checked in at Perth Airport they were travelling in the course of their employment, subject to the directions of John Holland and being paid for it. That situation subsisted until they disembarked the plane at Perth Airport at the end of their rostered-on work time. At no time during that period were they travelling to work; they were travelling on work and the cost of doing so under the statutory hypothesis in s 52(1) FBTAA would be an allowable deduction to them under s 81 of the ITAA 1997."  (p 45)

"The case under consideration in Lunney was of “ordinary people” paying fares “to enable them to go day by day to their regular place of employment or business and back to their homes”; it was not about the specific demands occasioned by employment that required, as part of the employment, travel to a remote place. The employees in this case are required to travel as part of their employment to a remote location. Accordingly, the appeal should be allowed."  (p 64)

http://www.austlii.edu.au/au/cases/cth/FCAFC/2015/82.html

Falk vs Commissioner of Taxation

In this case the tribunal ruled that the character of a transaction is more important than any particular name it happens to be given when determining its nature under the income tax assessment act(s).

The Australian Capital Territory (ACT) government labelled a payment given to an employee in respect of legal costs incurred during a dispute between himself and the government as an 'act of grace' payment, but the tribunal ruled that the transaction was clearly made on the condition of Mr Falk dropping all claims against the ACT government in regard to those costs.  A payment made on such conditions is difficult be construed as an 'act of grace'.  A payment made in compensation of legal costs can only be considered 'ex gratia' (an act of grace) if there is no legal liability on behalf of the payee to make the payment - whereas the key distinction in this case was that the taxpayer dropped current legal proceedings against the ACT government in return for the payment.

The case rested upon the definition of the word 'indemnity', and also, what particular characteristics of a payment constitute the label 'ex gratia'.  The tribunal held that payments of indemnification are made in respect of losses that have already occurred (as opposed to losses that 'may' occur).  In regard to ex gratia payments, the tribunal suggested that compensation for legal costs offered after legal proceedings have commenced do not bear the character of an 'act of grace'.

The ruling drew upon a long debate about the word "indemnify".

"There is no general principle that an amount received as compensation for, or reimbursement of, a deductible expense is assessable income. The proposition that a general principle of that kind exists was rejected by the High Court in Commissioner of Taxation v Rowe [1997] HCA 16."  (p 41)

"Finally, in relation to the ordinary meaning of ‘indemnity’ reaching to indemnification in respect of losses already incurred in the context of legal costs, we note the following statement of the High Court (Mason CJ, Brennan, Deane, Dawson and McHugh JJ) in Cachia v Hanes [1994] HCA 14; (1994) 179 CLR 403 at 410:

"It has not been doubted since 1278, when the Statute of Gloucester (6 Edw.I c.1.) introduced the notion of costs to the common law, that costs are awarded by way of indemnity (or, more accurately, partial indemnity) for professional legal costs actually incurred in the conduct of litigation.""  (p 54)

"For those reasons the Tribunal will proceed on the basis that the views of Walters J in Goldsbrough Mort correctly state the law. That however is the beginning of the required analysis, not its end. In Batchelor, Edmonds and Pagone JJ stated that it is the character of a receipt which determines whether what the taxpayer has received may relevantly bear the description as being ‘by way of insurance or indemnity’.[30] An ex gratia payment does not fit that language. In a passage the Tribunal adopts, their Honours said at [13]:

"It may be accepted that the words “by way of insurance or indemnity” are, and are intended to be, wide, but they must be applied as intended. Generally speaking a payment will not be regarded as an indemnity (whether the word is taken alone or in combination in the composite phrase “by way of insurance or indemnity”) unless the entitlement to its receipt precedes the event in respect of which it is paid. An ex gratia payment, for example, is not apt to be regarded as indemnification of a loss or outgoing notwithstanding that its receipt may be said, from the point of view of economic equivalence, to compensate the recipient for a loss which had been suffered or an outgoing which had been incurred. Similarly, a refund would not ordinarily be regarded as an indemnification notwithstanding that its receipt may be said to have rendered a taxpayer harmless, from an economic point of view, for an antecedent loss or outgoing.""  (p 55-56)

"The reasoning of the plurality in Batchelor therefore requires the Tribunal to determine the character of the receipt Dr Falk received. Neither its form nor its economic equivalence can be determinative of its character."  (p 58)

"(If if was found) that the device of an act of grace payment was required only to comply with ACT internal procedures. We would find that the payment was made (adopting the language of the Chief Solicitor) ‘in return for [Dr Falk] withdrawing his application to the AIRC for costs and providing a release of the Territory in relation to the AIRC and associated costs’."  (p 80)

"An ex gratia payment necessarily must be a payment made for reasons not compelled by law but that does not require its maker to be credulous or indifferent to his or her interests and a potential double recovery."  (p 84)

The case is here [2015] AATA 392:  http://www.austlii.edu.au/au/cases/cth/AATA/2015/392.html

Garrett vs Commissioner of Taxation

Harassing the Commissioner of Taxation

The federal court has dismissed the case of one Mr Garrett for the ninth time this year, this time for being a "vexatious litigant".  In his submission, the Commissioner of Taxation (the respondent) put forward 30 previous cases whereby Mr Garrett had lodged similarly passionate litigation, in support of a claim that Mr Garrett is abusing the court process to harass or cause delay for a wrongful purpose.

Mr Garrett has been issued with a bankruptcy notice (of which the Commissioner is presumably a party to) that is before other courts.

The judgement of Davies J contains some interesting remarks.

Referring to earlier dismissals of Mr Garrett's litigation:

"Pagone J ordered that Mr Garrett be prohibited from instituting in his own name...  in the institution of any proceedings in any registry of the Federal Court against the Commissioner, any second Commissioner of Taxation, any Deputy Commissioner of Taxation, any person who is or was employed in the Australian Taxation Office as an “APS employee” within the meaning of the Public Service Act 1999 (Cth) or any agent or advisor of the Commissioner, without the leave of the Court."  (p 9)

On the substance of earlier litigation:

"Beach J dismissed both applications, finding that Mr Garrett had not demonstrated any error in those decisions and there was no substance in any of the 48 proposed grounds of appeal in each matter, and that Mr Garrett had not shown that he would suffer any substantial injustice if leave were refused, even if the decisions were incorrect. "  (p 15)

On the claims from Mr Garrett in the present proceeding - demanding the Commissioner be refused his lawful ability to amend a return:

"Mr Garrett’s claim for an order that a notice of assessment “stand” is fundamentally misconceived. The notice of assessment in question is the notice of assessment of income tax issued to Mr Garrett for the year ended 30 June 2014 based on the income tax return that Mr Garrett lodged for that year. By seeking that order, Mr Garrett seeks to prevent the Commissioner from exercising his power of amendment under s 170 of the Income Tax Assessment Act 1936 Act (Cth)...  the Court would not interfere to prevent the Commissioner from performing his duty to reassess Mr Garrett’s liability in accordance with his duty to apply the law and to assess Mr Garrett to the correct amount of liability imposed by the Income Tax Assessment Acts...  "

On Mr Garrett's serious allegations of professional misconduct:

"Mr Garrett was previously criticised for making serious assertions without support. In Garrett v Macks [2006] FCA 601, Lander J said at [14]:

These claims in their bald form should never have been made. They make the most serious allegations against a number of people, three of whom are officers of this Court, two of whom are professional persons who act as liquidators and trustees and are, therefore, responsible in that manner to this Court, and one of whom, of course, is a senior public officer, being the Deputy Commissioner of Taxation. Mr Garrett has made no effort in any way to support the allegations made in the proceeding. It was put by Mr Evans, by way of evidence, but really by way of submission in paragraph 19 of his affidavit, that the allegations are scandalous. I agree."

On suing the Commissioner for not complying with the taxpayer charter:

"The pleading in the present case is yet another illustration of Mr Garrett’s practice to make serious allegations of impropriety against other persons in unsupported and bald form. The final order sought that the respondents are able to be sued under the provisions of the Taxpayers’ Charter is not relief that is available at law. Accordingly, the application is bound to fail."  (p 17)

The proceeding was dismissed.

The case [2015] FCA 485:  http://www.austlii.edu.au/au/cases/cth/FCA/2015/485.html

Coshott vs Commissioner of Taxation

In September 2014, the Administrative Appeals Tribunal held that a payment of $350,000 to Mrs Coshott as consideration to release Mr Vardas from all claims against him, was encapsulated by capital gain tax (CGT) event C2 - the disposal of an intangible asset.

If the tribunal found the existence of a CGT event, Mrs Coshott claimed that any arising gain should be offset by legal costs incurred during the dispute in question.  The tribunal refused to consider the intricate details of the CGT asset's cost base because in their view her record keeping was unsatisfactory, and hence could not be used to reduce a capital gain. 

In May 2015 the full federal court ruled that the tribunal failed to discharge its review function and that the matter should be remitted to the tribunal for a proper review of the cost base. 

Appealing from the tribunal to the federal court must be done so on a question of law, which in this case was:  "whether a failure to maintain adequate records in accordance with s 121-20 of the Income Tax Assessment Act 1997 (Cth) necessarily constitutes a failure to meet the onus of proof imposed on the taxpayer under s 14ZZK of the Taxation Administration Act 1953 (Cth)".

The question posed will provide an interesting debate in the tribunal when it is heard again later this year. 

Highlights from the judgment

"It may be that there was a degree of lack of clarity in the full identification of the costs by way of overlap and otherwise, but this did not relieve the Tribunal of a responsibility to examine and consider the material that had been put before it, and to deal with that matter in its reasons, including whether the material established at least a minimum figure for costs. "  (p 9)

"With the utmost respect to the Tribunal, on the basis of that material, we consider that there is a prima facie failure to discharge its review function in relation to the assessment of the incidental costs incurred by the taxpayer in the second element of the costs base of a CGT event, that is, in the determining a cost base."  (p 8)

"It is unnecessary to delay today’s matter by dealing with the propositions involved in Mr Lloyd’s submissions. There are other questions of law that could be posed, and the question as to whether that is a question of jurisdiction in the conditional sense, or a question of power, is a question for another day and another case. One could equally identify a question here as to whether, on the material placed before the Tribunal, and in the light of the reasons of the Tribunal, the Tribunal can be seen to have lawfully exercised its function of review."  (p 5)

The cases are here:

Full Federal Court [2015] FCAFC 71:  http://www.austlii.edu.au/au/cases/cth/FCAFC/2015/71.html

Administrative Appeals Tribunal [2014] AATA 622:  http://www.austlii.edu.au/au/cases/cth/AATA/2014/622.html

Hii vs Federal Commissioner of Taxation

Even the judge admitted this 141 paragraph ruling was the product of a complex case. Mr Hii self-assessed as a Singaporean tax resident during years 2001-2009, an act which the Australian tax office (ATO) amounted to 'fraud or evasion' under Part IVA of the income tax assessment act (1936), because they thought he was a resident of Australia. Therefore, they amended the income tax returns in question.  (Note that income tax in Singapore is lower than Australia.)

At some point in the objection process, the ATO ceded to some arguments of the taxpayer, in turn, reducing his tax liability by amending his tax returns for a second time. However, the ATO maintained that the taxpayer was a resident of Australia and not Singapore - a point the taxpayer disputes and has taken to court, but before that proceeding commences, the taxpayer has a slightly more exotic objection. The objection is as follows; that when the Commissioner of taxation made the second amendments, he failed to reaffirm that the taxpayer had committed fraud or evasion, therefore the assessments are invalid.  (Yes, read it again, that is actually it)

The taxpayer had his work cut out for him considering that even if he was correct, s. 175 provides:

"The validity of any assessment shall not be affected by reason that any of the provisions of this Act have not been complied with."

The judge didn't make any surprising conclusions, ruling that the commissioner isn't required to reaffirm 'fraud or evasion' has occurred at every stage of amendment. The judge also ruled that s. 175 applies so that even if the Commissioner was required to reaffirm every point he makes in the act of amending, if his minions in the ATO forgot to perform that step, the assessment would still not be invalidated.  

The judge concluded that an assessment of the Commissioner can only be invalidated due to administrative error where public servants have acted in bad faith, and the only case he could name where such a conclusion was reached happened to be a federal court grilling of the ATO in Donoghue vs FCT earlier this year.

Highlights from the judgement

"In reviewing the first amended assessments in light of a taxpayer’s objection in order to determine if it was correct or should be allowed in whole or in part, it is not necessary for the Commissioner to redetermine, ab initio, all issues relevant to that decision. I accept the submission of the Commissioner that, in deciding the correctness of the original decision, it would be contrary to the concept of a “review” if every decision and consideration previously made by the Commissioner in relation to a taxpayer’s assessable income in any particular year was required to be discarded and made afresh. This absurdity is highlighted in the circumstance where an assessment is affirmed by the Commissioner, either wholly or in part. Certainly, the ITAA 36 does not specify that this procedure must be followed." (p 108)

"Mr Hii does not allege actual bad faith on the part of the Commissioner or his officers. His submission of conscious maladministration is referable only to Mr Hii’s claim that the Commissioner “took an unreasonable view of the law” by failing to form an opinion in relation to avoidance by Mr Hii due to evasion at the objection stage.

There is nothing before me to support such a finding as urged by Mr Hii. Even if the Commissioner took such a view of the law, at most on the material before me the view taken by the Commissioner would simply be wrong at law. I am not persuaded that the conduct of the Commissioner in this case can be described as conscious maladministration, which clearly contemplates bad faith." (p 101 & 102)

More to come

I doubt this is the last we will see of Mr Hii, a look at the case demonstrates he is in dispute with the ATO over sums upwards of $30 million.  He will now be left to argue that he was not a resident of Australia for the income years in question.

The case [2015] FCA 375:  http://www.austlii.edu.au/au/cases/cth/FCA/2015/375.html

Channel Pastoral Holdings vs Federal Commissioner of Taxation

Philosophical Underpinnings of Part IVA

Can the Commissioner rule that a consolidated group was formed as part of a tax avoidance scheme, then assess a subsidiary of the consolidated group as if the consolidated group was never created?

The Full Federal Court has ruled: Yes, the Commissioner can.  The key question was, who can the Commissioner assess, if anyone?

Can the Commissioner amend the assessment of the head entity to include a taxable capital gain (of the subsidiary) that would have existed if the consolidated group had never formed?  No:  The Federal Court ruled that the Commissioner can not assess the head entity of a consolidated group he is determining should never have been formed in the first place!  In their words this is an inconsistent conclusion.

Can the Commissioner issue an assessment to the subsidiary subject to this transaction, then attribute the taxable gain to the subsidiary's head entity in the consolidated group?  No:  The Federal Court dismissed this approach for the same reasons above.

Can the Commissioner issue an assessment to the subsidiary subject to this transaction, as if the consolidated group never formed?  The Federal Court said:  Yes. This is the preferred approach.

Highlights from the majority judgement

Background:

Head Entity:  CPH
Subsidiary:  CCC

The CGT event happened to CCC.  CPH was a dormant company until shares in CCC were transferred onto its books.

The logic behind assessing a subsidiary as if consolidation never occurred:
"In the present case, the application of Pt IVA proceeds on the basis that CCC is not a subsidiary member of the CPH consolidated group for part of the 2008 income year. The fact that CCC is not a member of the CPH consolidated group for part of the 2008 income year is the basis for the alternative determination. The Commissioner then is required to, and did, give effect to that determination by issuing the alternative assessment to CCC: s 177F(1)(a). The ability to issue an assessment to a subsidiary member of a consolidated group that was not a member for part of the income year is expressly provided for by s 701-30. That section does not ignore the single entity rule in Pt 3-90. It recognises, as was the fact, that there will be instances where a subsidiary member is not part of the consolidated group for the whole income year. Section 701-30 provides a method of working out how the entity core rules apply to the entity for periods in the income year when the entity is not part of the group. The method involves treating each period separately with no netting off between them. That is what occurred here. There is no basis for reliance on the default exception to the core rules in s 701-85." (p 109)

On the application of Part IVA to tax consolidated groups
"Thirdly, the tax benefit upon which a taxpayer is assessed in reliance on a determination made under s 177F(1)(a) is predicated on a postulate, which is a hypothesis as to what the taxpayer would have, or might reasonably be expected to have, done if he had not done what he did do. If that postulate is that the taxpayer would have, or might reasonably be expected to have, sold an asset as a stand-alone entity without having become a subsidiary member of a consolidated group, it does not seem to us that there is any reason to prevent the Commissioner from making a determination in those terms, and using an assessment to give effect to it."  (p 103)

On the intersection between s 177F (Part IVA) and pt 3-90 (Division 700 - tax consolidated groups)
"We accept that, at the time of issue of the assessment, CCC is part of CPH under the single entity rule in s 701-1, and that an assessment to CPH to give effect to the anterior determination to CCC can be said, in the context of the single entity rule viewed in isolation, to be consistent with that determination. But we cannot agree with that analysis when the single entity rule has to be viewed through the prism of its intersection with Pt IVA and the hierarchy afforded those latter provisions by s 177B(1). Arguably, this is best exemplified in our answer to reserved question 3 below (see [89] to [109]), and, in particular, our acceptance that s 177B(1) does not allow the single entity rule in s 701-1 to stand in the way of the Commissioner making a determination to include in the assessable income of CCC the amount that would have been included on the postulate upon which the determination to CCC was predicated, and issuing an assessment to CCC to give effect to that determination. Such an outcome leads to “harmonious goals”, to use the term that fell from the plurality in Project Blue Sky Inc v Australian Broadcasting Authority [1998] HCA 28; (1998) 194 CLR 355 (“Project Blue Sky”) at [70], in contrast to the conflicting outcome achieved by the issue of an assessment to CPH, said to give effect to an anterior determination to CCC only because CCC was a subsidiary member of the CPH consolidated group at the time of the issue of the assessment. Moreover, having regard to the objects of Pt 3-90, in particular that expressed in s 700-10(a) (see [67] above) – to prevent double taxation of the same economic gain realised by a consolidated group – it cannot be the case that the Commissioner is authorised to assess both CPH and CCC. In our view, the more harmonious outcome is the process underlying the issues raised by reserved question 3."  (p 82) *Emphasis added

Technicalities of the Formalities

The five judges were split in their reasoning, with 3/5 affirming the position outlined above.  However, more accurately, all judges ruled in favor of the Commissioner for differing reasons.  I have quoted from the majority judgement of Edmonds and Gordon JJ, with whom Allsop CJ agreed with the conclusions of.

[2015] FCAFC 57

http://www.austlii.edu.au/au/cases/cth/FCAFC/2015/57.html

Devuba Pty Ltd vs Federal Commissioner of Taxation

This was a win for the taxpayer on small business CGT concessions in the Administrative Appeals Tribunal.  They ruled that ordinary shares are to be looked at before slightly more 'novelty' shares are considered, for the purpose of ownership tests outlined in the small business CGT concession division - 152.

When a company sells shares in a small business, if the owners of the company who sold the shares wish to claim small business capital gains concessions, the company must be 90% owned (directly or indirectly) by individuals who own at least 20% of the small business being sold (directly or indirectly).  It is a complex concept when viewed abstractly, but when the time comes to sell your own business, the dots are a lot easier to connect with entities you are familiar with (ie: your own companies and trusts).

The problem in this case was that the taxpayer's wife held a dividend access share (DAS) in the Devuba, allowing her access to dividends, only when the directors want to give her one.  The share carried with it no inherent rights or voting power.  The ATO concluded that because the DAS could be paid a dividend, even on occasions that ordinary shares were not paid anything, that the DAS could effectively over-ride an ordinary share. 

This is of importance because s 152-70 provides:

"An entity holds a direct small business participation percentage at the relevant time in an entity equal to the percentage of any distribution of capital that the company may make."

The ATO concluded that the husband "may" receive $0 because his wife owns a share that could over-ride him.  This is a interesting conclusion that could lead to the eventual conclusion that no one is entitled to anything in a company with two different types of shares that can be paid out on different occasions.  The end result in this case is that the taxpayer would not satisfy the requirements of s 152-70, because they failed to hold 90% of the company that sold the shares of the small business in question.  In fact, following the ATO logic they own 0%.

The Tribunal didn't side with the ATO on this occasion.  They ruled that ordinary shares should be used in these cases to test taxpayers according to s 152-70, with disregard to any novelty shares that may form part of the companies share capital (see the reasoning below).  After the test was applied at the level of ordinary shares, the taxpayer was demonstrated to be 90% owned by owners of the small business being sold and hence could claim the concessions.  Highlights from the judgement are below.

"In the view of the Respondent, the directors of the Applicant had discretion to pay a dividend on the DAS and could use their powers to pay a dividend on the DAS to the exclusion of all and any of the other classes of shares. Accordingly, the holders of the ordinary shares might obtain a zero distribution. As a result, for the purposes of the test contained in item 1 of the s 152-70, the "percentage of any dividend that the company (namely the Applicant) may pay" on the ordinary shares is nil. The consequence of such a finding would be that the SBPPs held by Mr Van der Vegt and the Trust in the Applicant would be zero and the Applicant would not be entitled to any relief under div 152.

The issue comes down to this - what is the effect of the words "the percentage of any dividend the company may pay" as those words are used in the Table in s 152-70(1) of the Act when read in the context of the DAS."  (p 51-52)

"When one looks at the terms of s 152 - 10 (2) it is readily apparent that the CGT stakeholder test that is the subject of that subsection needs to be satisfied "just before the CGT event". Similarly, in s 152 - 70 the direct SBPP is to be worked out "at the relevant time" which again is just before the CGT event. It would seem to follow from this that the rights of shareholders in the Applicant and for that matter in Primacy are to be assessed at the same time namely just before the CGT event.

At that time being the moment just before 19 May 2010 logic would suggest that the only shares that carried any rights to dividends that may be paid in the Applicant were the ordinary shares. Those ordinary shares and no other shares at that time carried all the rights not only in respect of dividends but also in respect of voting and in respect of rights to distribution of surpluses on a winding up.

The consequence is that it cannot be said that at the relevant time (i.e. just before 19 May 2010), the DAS holder may be paid a dividend."  (p 61-63)
"The decision of the High Court in Casuarina would seem to suggest that it is more a case of testing a hypothetical dividend which may be paid by the company based on the facts as they exist just before 19 May 2010.
Consequently, the Tribunal concludes that in this case the relevant time to which the relevant provision takes us is just before 19 May 2010. It is at that time that the hypothetical needs to be posed - namely if a dividend were to be declared at that time the dividend would not and could not have been paid in favour of anyone other than the ordinary shareholders. At that time, Mr Van der Vegt had a direct SBPP in the Applicant of 50% and that is not diminished by the existence of discretionary entitlements in the DAS holder. The fact that at some hypothetical future time, a dividend could have been resolved and paid in favour of the DAS holder is, based on the reasoning of the High Court in Casuarina, not to the point and is largely irrelevant to the question at hand."  (p 76-77)

*Note:  This decision has been appealed*
*Was upheld in the initial appeal... (2016)


 [2015] AATA 255

http://www.austlii.edu.au/au/cases/cth/AATA/2015/255.html

WWXY vs Commissioner of Taxation [2015] AATA 130

In determining whether a property development business was being carried on, the tribunal concluded that acquiring development approval before selling land was a key determining factor.

The taxpayers purchased two blocks of land with the intention to substantially develop, but soon-after abandoned their plan to  perform substantial developments, and instead sold out of the project, but not before obtaining a few valuable development rights for the land that may have increased its value significantly.  The taxpayers compared themselves to Kratzmann in the High Court [1970]:

"It is, however, a matter for decision whether the difference between the purchase price and the selling price of the land—less the expenses of doing what the taxpayer did towards carrying out his scheme—is to be regarded as a profit from the carrying on or the carrying out of the taxpayer's scheme. What happened was that the taxpayer, for financial reasons, gave up the idea of developing the land as had been intended and sold it, so making a profit.

For the Commissioner it was argued that, because the purchase was part of a profit-making scheme, any profit arising from the purchase was a profit from the carrying on or carrying out of that scheme. It seems to me, however, that the profit here arose not from the purchase but from the sale and because the sale was not part of the profit-making scheme the profit did not arise ``from the carrying on or carrying out'' of that scheme. Indeed, the profit in question did not arise until the scheme had been abandoned."

Later cases on this issue include Myer [1987] and Westfield [1991], where the principle of acquiring an asset with the intention of making a profit was considered to be a determining factor in the question of whether or not a business was being undertaken.

The Commissioner's contention in the case was simple:

"The Commissioner says the taxpayer may have preferred to undertake a comprehensive development in company with other parties but the evidence in the email – and common sense – suggests from the outset that the taxpayer regarded the possibility of a profitable resale after obtaining relevant approvals as an acceptable outcome. On that view, the taxpayer was in the business of acquiring property for redevelopment but without a fixed view of how that redevelopment was to occur. "  (p 9)

That the taxpayer had a profit making intention.  Rather than abandoning this profit making scheme (as per Kratzmann), the taxpayer simply moved to "plan B", which was to make profit from the land in some other form.

The judge concluded:

"A range of successful outcomes must have been in contemplation. That range presumably included (and certainly did not exclude) the possibility of a profitable sale after obtaining a development approval. This case is different to the situation in Westfield, where a profitable resale of the land did not form any part of the taxpayer’s objective, even if the taxpayer knew that was one possible outcome of the transaction."  (p 22)



The case is here [2015] AATA 130:  http://www.austlii.edu.au/au/cases/cth/AATA/2015/130.html