In 1958 Australia's legislative attempt to pre-empt tax avoidance, contained in section 260, reached its highest point of achievement.
All countries must face the prospect that some taxpayers will seek by means that they hope or believe to be legal to escape tax that the country's tax law requires be paid.
Australia (like New Zealand) is one country that has long sought to tackle this problem by including in its statute law a general anti-avoidance provision. In other countries there may be special provisions for particular situations and the courts may have been persuaded to address the issue by development through the cases of general anti-abuse notions. In the UK, for example, the House of Lords developed a doctrine of fiscal nullity14 that was later supplemented by a disclosure regime for tax shelters.
A Commonwealth general anti-avoidance provision was contained in the 1922 Act (section 93) and by the 1970s was still in the form enacted in the 1936 Assessment Act. The section read:
Every contract, agreement, or arrangement made or entered into, orally or in writing, whether before or after the commencement of this Act, shall so far as it has or purports to have the purpose or effect of in any way, directly or indirectly:
a. altering the incidence of any income tax;
b. relieving any person from liability to pay any income tax or make any return;
c. defeating, evading, or avoiding any duty or liability imposed on any person by this Act; or
d. preventing the operation of this Act in any respect,
be absolutely void, as against the Commissioner, or in regard to any proceeding under this Act, but without prejudice to such validity as it may have in any other respect or for any other purpose.
Section 260 was relied on by the Commissioner over the years in making assessments. Some he maintained, others were lost, but the prospect of its application and the uncertainties it generated remained a 'policeman on the corner' to would-be tax avoiders, moderating their conduct.
However some limitations on its apparently wide scope had emerged, and the section was regarded as a difficult one. As far back as 1956, in Federal Commissioner of Taxation v. Newton, Justice Kitto in the initial hearing of the case in the High Court had this to say:
Section 260 is a difficult provision, inherited from earlier legislation, and long overdue for reform by someone who will take the trouble to analyse his ideas and define his intentions with precision before putting pen to paper. There have not been many cases in which the meaning of the section has been considered, but some points must now be taken as settled.15
It was in Newton that section 260, from the viewpoint of the Commissioner, reached its high-water mark. At first instance, Justice Kitto found that assessments raised by the Commissioner in reliance on section 260 could not be sustained. However, the Full High Court, in a four to one majority decision, upheld them.16
In those days it was possible for such matters to be taken on further appeal to the Privy Council in the UK, a right which the taxpayers in Newton exercised. Their leading counsel in the appeal was Sir Garfield Barwick QC, who had not represented the taxpayers before the High Court when the matter was there.
Shareholders in a group of private companies had found they had a significant tax problem. The companies had profits of some £1.764m which, if they did not distribute them as dividends, would attract under the operative undistributed profits tax an imposition of 15 shillings in the pound. If distributed as dividends to the shareholders (whom the Privy Council described as wealthy persons) they would have attracted tax in shareholders' hands at the same rate. The High Court noted that in the latter event the shareholders would have faced the need to pay 30 shillings in the pound when provisional tax was taken into account.
On advice, shareholders acted to get around the problem. On one day (a day before the end of the relevant tax period) a series of complex transactions and payments was implemented. This involved the introduction as a shareholder to receive special dividends of a vehicle company, Pactolus,17 owned by an accountant advising the shareholders. For the Privy Council, Lord Denning said:
Taking the transactions of all three companies together the result at the end of it all was that the motor companies distributed £1,661,772 in cash, of which they had invested £1,185,631 as capital in the companies and kept £476,091 in cash. The Pactolus company had received 161,213 shares which it was thenceforth entitled to a fixed dividend of five per cent. The Pactolus company had also retained £102,404 in cash.18
The Privy Council noted that if section 260 was found inapplicable the shareholders would have disposed of their shares for a capital payment of £1.661m and would not be liable for tax thereon. They observed also that avoidance of tax was not the sole purpose or effect of the arrangement - raising of new capital was an associated purpose.
But they concluded that section 260 did strike the arrangement down, leaving the shareholders to pay tax on the whole £1.764m, plus penalty tax of over £600,000.
This was the first and only section 260 case to reach the Privy Council. It dealt shortly with the arguments put before it, including two submissions by Sir Garfield that had not been put to the High Court. One of these, if accepted would have denied section 260 any effect; the other would have rendered it partially ineffective. With an eye to the difficulties of interpreting the provision, the Privy Council laid down some principles:
The answer to the problem seems to their Lordships to lie in the opening words of the section. They show that the section is not concerned with the motives of individuals. It is not concerned with their desire to avoid tax, but only with the means which they employ to do it. It affects every 'contract, agreement or arrangement' (which their Lordships will henceforward refer to compendiously as 'arrangement') which has the purpose or effect of avoiding tax. In applying the section you must, by the very words of it, look at the arrangement itself and see which is its effect -which it does- irrespective of the motives of the persons who made it. Williams J. put it well when he said 'The purpose of a contract, agreement or arrangement must be what it is intended to effect and that intention must be ascertained from its terms. These terms may be oral or written or may have to be inferred from the circumstances but, when they have been ascertained, their purpose must be what they effect'.19
Lord Denning continued:
In order to bring the arrangement within the section you must be able to predicate - by looking at the overt acts by which it was implemented - that it was implemented in that particular way so as to avoid tax. If you cannot so predicate, but have to acknowledge that the transactions are capable of explanation by reference to ordinary business or family dealing, without necessarily being labelled as a means to avoid tax, then the arrangement does not come within the section.20 Thus, no one, by looking at a transfer of shares cum dividend, can predicate that the transfer was made to avoid tax. Nor can anyone, by seeing a private company turned into a non-private company, predicate that it was done to avoid Div. 7 tax, see W.P. Keighery Pty. Ltd. v. Commissioner of Taxation. Nor could anyone, on seeing a declaration of trust made by a father in favour of his wife and daughter, predicate that it was done to avoid tax, see Deputy Federal Commissioner of Taxation v. Purcell. But when one looks at the way the transactions were effected in Jaques v. Federal Commissioner of Taxation; Clarke v. Federal Commissioner of Taxation, and Bell v. Federal Commissioner of Taxation - the way cheques were exchanged for like amounts and so forth - there can be no doubt at all that the purpose and effect of that way of doing things was to avoid tax.
In fitting its principles to earlier cases, the Privy Council mentioned with approval the decision in Keighery. This approval was to mean that in the hands of a future High Court bench the Newton decision carried seeds of its own destruction.
Sections within Chapters 1-10
Last Modified: Wednesday, 16 June 2010