How to turn a $30 domestic refrigerator into a tax-depreciable plant item worth $100,000, using fancy paperwork.[
By mid-1979, another form of the practice of attempting to secure tax deductions by creating a price that was, by virtue of side arrangements, well in excess of the real price, had been discovered.
This form of creation of paper losses concerned the income tax deduction for depreciation of plant used in a business to produce assessable income.
The matter was referred to Treasurer Howard by the ATO, and subsequently considered by Cabinet.116 At 11.59pm on 12 June 1979 the Treasurer released a statement outlining the government's decisions. There were existing provisions that limited allowable depreciation for purchased plant, but these applied only when depreciation had previously been allowable in respect of the plant.
Howard said:
A scheme exploiting this weakness in the law operates essentially along the following lines. A scheme promoter has an item of plant that has not previously attracted depreciation allowances and is worth, say, $5,000. The promoter lends a taxpayer an amount several times greater than the worth of the plant, with the terms and conditions of the loan being so arranged that its present value is nominal, (e.g., it is for 50 years, interest free). The taxpayer then uses the loaned moneys to buy the plant, at an excessive price, from the promoter, and produces assessable income from use of the plant by hiring it back to the promoter for a short period. This is designed to give the taxpayer an entitlement to a depreciation deduction based on the inflated cost price. In practice, the plant may never leave the possession of the promoter. The taxpayer then sells the plant at its true value of $5,000 (perhaps back to the promoter), thereby generating a depreciation deduction, mainly by way of a balancing adjustment, of the difference between the inflated cost price and $5,000. The promoter assigns his rights under the loan to an associate of the taxpayer for its nominal present value, with the result that for a payment of that amount the taxpayer effectively does not have to repay the loan.
The remedy he foreshadowed for this involved amending the law so that for purposes of the depreciation provisions 'cost' could not exceed the true value of the plant.
Howard went on to describe a second type of depreciation scheme:
A second type of depreciation scheme is more complex and exploits a feature of a special provision that deems a disposal of plant to occur where plant is transferred on the formation or dissolution of a partnership or on a change in partners or in partners' interests in a partnership. In these circumstances, the law permits the parties to specify a disposal value in the agreement giving rise to the change and, if this is done, that value must be accepted by the Commissioner of Taxation.
Relying upon this provision, a partnership might purchase plant for $600,000 of which $5,000 is provided from partnership capital and $595,000 by a loan from the promoter. As with the first scheme, the plant is hired out by the partnership (usually back to the vendor) for a short period to qualify the partnership for depreciation. The partnership is then reconstituted to admit as a partner a company controlled by the promoter. The new partnership agreement specifies $6,000 as the take-over value of the plant, ostensibly reflecting the fact that the plant is subject to a charge as security for the loan from the promoter, and because this value must be accepted by the Commissioner, the old partnership claims a depreciation deduction by way of a balancing adjustment of $594,000 to be shared by the partners. The new partnership then transfers the plant for a nominal amount to the introduced partner (the promoter's company) which in turn sells the plant back to the original owner for the original price of $600,000, and uses the proceeds to repay the loan of $595,000. The promoter's company does not use the plant for business purposes prior to the sale back to the original owner and that person, on the basis of a view that the limiting provisions referred to earlier do not apply, seeks on re-acquisition to claim depreciation on the cost of $600,000.
In some cases, the same plant is, in reliance on this view, used in successive schemes to create similar deductions for other taxpayers, despite the fact that the plant may never leave the possession of the original owner. In other cases, as an alternative to the final sale back to the original owner, the plant may be sold for actual and continuing use to a purchaser who has been a member of the partnership. In this case, the purchaser would claim to be entitled to normal depreciation in respect of plant for which he or she had already shared a balancing adjustment deduction for almost the full cost.
The legislative remedy in this case was that should the parties specify a value that is less than both the true value and the depreciated value of the plant, the lower of the true and depreciated values would be adopted in calculating balancing adjustments.
Exploitation through varying the second type of scheme was foreseen. For example, instead of the old partnership being reconstituted, it might simply sell the plant to the promoter's company for $5,000, with the existing law allowing deductions based on the actual (but nominal) sale price.
The government's remedial measures were made to apply to plant acquisitions, transfers of interest and sales after 12 June 1979. Legislation to this effect was introduced into parliament on 25 October 1979, by the Income Tax Laws Amendment Bill 1979.
The newly-announced policy of banning deduction of carry forward tax avoidance losses117 was also made to apply in relation to depreciation scheme losses.
An actual case
After hearings in the Administrative Appeals Tribunal and the Federal Court, the latter on 10 August 1988 handed down a decision on a depreciation scheme that had been entered into in April 1979, just before the amendments had effect. The case, F & C Donebus Pty Limited v. Federal Commissioner of Taxation,118 concerned a rural painting contractor, illustrating that scheme participation was not limited to people in the city.
The law report summarises the case this way:
The directors and major shareholders of the taxpayer company were a husband and wife. Early in 1979 the husband became concerned at the potential tax liability on that year's earnings which were in excess of $500,000. On 23 April 1979, on the advice of its accountant and for the avowed purpose of tax minimisation, the taxpayer purchased from the wife for $100,000 a domestic refrigerator worth $30. The purchase price was immediately loaned back to the taxpayer for an interest free term of 32 years. These transactions were evidenced by an invoice, a loan agreement and a bill of exchange endorsed by the wife in favour of the taxpayer. The next day, the taxpayer purported to lease or bail the refrigerator to another company associated with its accountant for an annual rental of $10. However, the refrigerator at no stage left the taxpayer's possession and was used by the taxpayer's employees to store their lunches. On 25 June 1979 the taxpayer sold the refrigerator to the husband for $100 and the next day received the first instalment of rental from the accountant's company.
By majority, the Federal Court upheld the Commissioner's disallowance of the taxpayer's claim for a depreciation deduction of $99,900. It did so in reliance on section 260, which was then, as Justice Wilcox described it, 'in its twilight phase'.
The transition from the apparent ineffectiveness of section 260, outlined in Chapter 5, to its partial resurrection (illustrated by the Donebus decision) is presented more fully in Chapter 51.
Sections within Chapters 31-40
Last Modified: Wednesday, 16 June 2010