Heerey J

Merkel J
Finkelstein J

Full Federal Court


Judgment date: 3 March 2000

Heerey, Merkel and Finkelstein JJ


1. This appeal is concerned with the circumstances in which a corporate trustee of a unit trust is liable to pay fringe benefits tax (``FBT'') under the Fringe Benefits Tax Assessment Act 1986 (Cth) (``the Act'') on interest free loans made to its directors who, together with members of their families, are the persons for whose ultimate benefit the trust was established.

2. By amended assessments issued for the period 1 July 1986 to 31 March 1987 and the years ending 31 March 1988 and 31 March 1989 the respondent (``the Commissioner'') assessed the appellant to FBT in respect of interest free loans made at the request of its directors and for their benefit. The Commissioner disallowed objections to those assessments and the appellant unsuccessfully applied to the Administrative Appeals Tribunal (``the AAT'') to review the Commissioner's decision [reported at 98 ATC 2205]. The appellant then brought an appeal to a single Judge of the Federal Court against the decision of the AAT [reported at 99 ATC 4788]. That appeal was dismissed and it is the appeal from that decision which is now before the Court.

Background Facts

3. The material facts are not in dispute. In 1976 the appellant was appointed as trustee of the Knowles Investment Unit Trust. The trust had been established to conduct the business of constructing, selling and managing retirement villages. The directors of the appellant are Graham Knowles, John Knowles, Russell Knowles and Ian Ball. The beneficial interest in the trust fund is divided into units. Each director established a discretionary trust in which he and his family are beneficiaries. The trustee of each family trust holds 25 per cent of the units in the unit trust.

4. During the period to which the assessments relate, each director was paid a salary. The salary was paid at the rate of $31,588 per annum except for the twelve months ending 30 June 1981 when it was increased to $32,756, except in the case of John Knowles who was paid $31,557.

5. The appellant maintained a chequing account. Each director was authorised to operate that account. Certain of the funds in that account, including funds provided on overdraft, were used by the directors to meet their, or their family's, private expenses. A director would either draw a cheque for a particular expense or he would give the account for that item to the accounting staff who would arrange for a cheque to be drawn, signed by one of the directors, not necessarily the director who had requested that the cheque be drawn, and delivered to the payee.

6. The appellant employed a full-time accountant, Mr Saul. One of his responsibilities was to ensure that money paid to meet the

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directors' expenses was properly accounted for. Initially all payments were recorded in a purchase analysis report. At the end of each annual accounting period the amounts paid at the request of a particular director were debited to the loan account of the trustee of that director's family trust. Mr Saul said that in the books of account of the unitholder, the money would be shown as having been lent to the director.

7. There was no relationship between the amount of money each director requested be paid and the personal effort involved in working as a director. Nor was there any relationship between the amount paid at the request of one director and the amount paid at the request of the others. The following table, which sets out the balance of the loan accounts due on various dates, demonstrates this:

                           30.6.86     30.6.87     30.6.88     31.7.88
J Knowles Family Trust     $767,426    $772,726  $1,243,472  $1,446,594
G Knowles Family Trust     $467,310    $519,372  $1,494,783  $1,569,845
R Knowles Family Trust     ($72,195)    $37,980    $558,285    $614,312
I Ball Family Trust         $35,025     $83,358    $369,171    $384,763
                         ----------  ----------  ----------  ----------
                         $1,197,566  $1,413,436  $3,655,711  $4,015,514

8. The amended assessments included the taxable values of the loans calculated in accordance with the Act. Those values and the FBT payable are shown in the following table:

Period                 Loan Benefit        FBT      Additional Tax
1/7/1986 - 31/3/1987     $152,548      $70,172.08     $35,220.62
1/4/1987 - 31/3/1988     $320,362     $156,977.38     $47,308.25
1/4/1988 - 31/3/1989     $150,972      $73,976.28      $7,498.97

The Act

9. Section 66(1) provides that, subject to the Act, ``tax imposed in respect of the fringe benefits taxable amount of an employer of a year of tax is payable by the employer.'' When the loans were made the expression ``fringe benefits taxable amount'' was defined in s 136(1) as ``the sum of the taxable values, in relation to the year of tax, of all the fringe benefits in relation to the employer in relation to the year of tax.''

10. To understand what was meant by the phrase ``fringe benefits taxable amount'' the following definitions found in s 136(1) must be taken into account:

  • • ``fringe benefit'' which is defined to include ``a benefit provided... to the employee or to an associate of the employee... by... the employer... in respect of the employment of the employee...'';
  • • ``benefit'' which is defined to include ``any right, privilege, service or facility'';
  • • ``employee'' which is defined to include ``an employee within the meaning of Division 2 of Part VI of the Income Tax Assessment Act 1936 (Cth)''. In s 221A of the Income Tax Assessment Act ``employee'' is defined as ``a person who receives or is entitled to receive salary or wages which include payments made by company by way of remuneration to a director.'';
  • • ``employment'' which is defined to include ``the holding of any office or appointment, the performance of any functions or duties, [and] the engaging in of any work.''

11. Accordingly, subject to certain immaterial exceptions, the taxable value of a fringe benefit provided by a company to its director or to an associate of that director was taxable if the benefit was provided ``in respect of the employment of'' the director. By s 136(1) the phrase ``in respect of, in relation to the employment of an employee include[d] by

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reason of, by virtue of, or for or in relation directly or indirectly to, that employment''.

12. A loan can be a benefit for the purposes of the Act. Section 16(1) provided:

``Where a person (in this subsection referred to as the `provider' ) makes a loan to another person (in this subsection referred to as the `recipient' ), the making of the loan shall be taken to constitute a benefit provided by the provider to the recipient and that benefit shall be taken to be provided in respect of each year of tax during the whole or a part of which the recipient is under an obligation to repay the whole or any part of the loan.''

13. The value of the loan for the purpose of the assessment of FBT is ``the amount (if any) by which the notional amount of interest in relation to the loan in respect of the year of tax exceeds the amount of interest that has accrued on the loan in respect of the year of tax'': see s 18. The ``notional amount of interest'' is defined in s 136(1). It is not necessary to set out that definition.

14. As regards the provision of benefits, s 148(1) provided:

``A reference in this Act to the provision of a benefit to a person in respect of the employment of an employee is a reference to the provision of such a benefit:

  • (a) whether or not the benefit is also provided in respect of, by reason of, by virtue of, or for or in relation directly or indirectly to any other matter or thing;
  • ...
  • (h) whether or not the benefit is provided as a reward for services rendered, or to be rendered, by the employee.''

15. FBT is payable when the benefit is paid to the director or his associate. ``Associate'' is given the same meaning in relation to a person as that expression has in s 26AAB of the Income Tax Assessment Act: see the definition of associate in s 136(1). By s 148(2) where a benefit is provided to a person, other than the employee or an associate of the employee, under an agreement between the provider and the employee, the recipient shall be deemed an associate. It follows that if the loans made in this case were benefits payable ``in respect of'' the employment of each director, on the facts each unitholder was an associate of a director.

The decision of the AAT

16. The AAT considered that the single issue for its determination was whether the loans were benefits ``in respect of the employment'' of the directors. It said that the words ``in respect of the employment of the employee'' required ``a nexus, some discernible and rational link, between the benefit and employment.'' It concluded that employment of the directors was the ``principal connecting reason'' for the provision of the loans. The Tribunal gave the following reasons [at 98 ATC 2213]:

``... [T]here is a clear nexus, causal relationship between the advances or loans and employment of the four directors. It was in that capacity as a director that each was able and permitted to make `drawings' from [ the unit trust]. The structure of the group was established in such a way that the directors were not owners. In my view, this is a case where the directors have to accept the consequences of that structure. It was in their capacity as directors and directors only that they borrowed money from the company of which they were directors.... [ The drawings] were clearly a benefit and employment was the princip[le] connecting reason for such benefits so as to render the benefit as provided in respect of the employment. Employment was the discernible link with the benefit and while the Act does not require this link to be the sole or even dominant one, there was no other formal or enforceable entitlement which gave rise to the benefit.''

17. The appellant's principal contention had been that the loans were made because the directors, through their respective family discretionary trusts, were the ``effective owners'' of the trust fund. Accordingly, so it was argued, the loans should be exempt from FBT in accordance with Taxation Ruling MT 2019 which was concerned with FBT on benefits provided to shareholder employees of private family companies. Paragraph 19 of that Ruling reads:

``As a general rule, where there are no facts or circumstances which positively indicate that a loan to a shareholder/employee is associated with that person's employment and the loan is consistent with his or her status as a shareholder, it would ordinarily be inferred that the loan was made by virtue

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of the shareholding. This approach recognises that major shareholders of a family company may obtain loans from the company on a view that these are merely as a return of their own money rather than a reward for any services rendered to the company....''

The AAT rejected this argument, giving two reasons [at 98 ATC 2211]:

``... Firstly, the directors are not shareholders or unit holders. They may be regarded as controllers of [the unit trust] but that control stems from their role as directors of [the trustee of the unit trust], presumably as directors of the corporate trustees of the family trusts and, to a degree, as appointors in each of the family trusts. However they were not, themselves, owners. Secondly, if the loans were to be regarded as consistent with a status of owners, it would be expected that the loans would be in proportion to the ownership share. They were not, given the lack of pattern, consistency or cumulative amounts of the loans.''

Further, the AAT doubted the appellant's capacity to provide the loans out of surplus funds in the long term. Consequently, the AAT was not prepared to treat the loans as a ``return'' of the director's money. The AAT said:

``... The simple facts are that the four directors were not owners of the business and had no vested interest in or entitlement to income, profits or capital of the business. Each was a contingent beneficiary as to income of a family trust with entitlements to income only if [the unit trust] had a net income and the trustee of the relevant family trust resolved in its absolute discretion to distribute part or all of the trust's share of that net income to the director.''

The decision of the trial judge

18. On the question of whether the AAT had erred in law, the trial judge first considered what was meant by a benefit provided ``in respect of the employment of an employee''. His Honour said [at 99 ATC 4794]:

``13. Because the meaning of `in respect of the employment' depends upon the context, it is important to observe that a benefit is provided in respect of employment `whether or not it is provided as a reward for services': s 148(1)(h), and whether or not it is also provided in respect of some other matter or thing: s 148(1)(a). Thus the reward argument that was rejected in Smith must a fortiori be rejected here. A benefit is provided to an employee `in respect of the employment of the employee' for the purposes of the definition of `fringe benefit' if it is granted as a consequence of the existence of the employment relationship, or if the relationship is a reason why the benefit is provided, or is a cause of its provision. It does not matter that there is as well some other reason or cause for the grant, or that the grant is a consequence not only of the employment but of something else. The benefit does not have to be a reward for services rendered.

14. The Tribunal asked whether there was a `causal relationship' between the advances and the employment of the directors, and whether the employment was a `causal factor in the benefit'. On another occasion it asked whether there was a `discernible and rational link between the benefit and the employment'. Although the Tribunal did not refer to
Technical Products Pty Ltd v State Government Insurance Office (Q) (1989) Aust Torts Reports ¶80-245; (1989) 167 CLR 45, that case, which concerned the words `damages in respect of such motor vehicle', is doubtless the source of the expression `discernible and rational link'. See at Aust Torts Reports 68,622; CLR 47, 48. The language the Tribunal used to describe the required relationship between the loans and the employment does not involve any misconstruction of the words `in respect of the employment'.''

19. The trial judge then summarised the findings of the AAT [at 99 ATC 4795-4796]:

  • ``• The directors were not the owners of the applicant's business (Saul 450).
  • • They had no vested interest in or entitlement to income, profits or capital of the business (Saul 496; Unit Trust Deed 29, Family Trust Deeds 760, 791, 821).
  • • The loans were made to meet the directors' private expenses (J Knowles 466; Ball 479).
  • • Each director was a `sole cheque signatory' to the applicant's account (J Knowles 465; Saul 500).

    ATC 4156

  • • Each was authorised as a director to withdraw funds at any time for private needs without approval from the other directors (J Knowles 466; Ball 476; G Knowles 484, 485; Saul 500).
  • • The amounts withdrawn were determined entirely by the directors' individual needs and not by the needs of unitholders (Saul 451).
  • • The directors could not obtain access to the applicant's money as shareholders or as beneficiaries of the unit trust (Ball 479).
  • • The only way they could obtain money in the way they did was in their capacity as directors (Ball 476-477, 479, 480).
  • • At the time the loans were made the applicant had insufficient funds to make returns of capital (Saul 447-449, 452; Wardle 460; J Knowles 472).
  • • The capital distributed occurred well after the funds were borrowed (J Knowles 467, 737; Saul 502).
  • • The loans were not made in proportion to any ownership share (Saul 500, 510).
  • • There was no formal or enforceable entitlement to the loans other than the employment relationship.''

The trial judge concluded that, on those facts, it was open to the AAT to determine that there was a causal relationship, or a discernible and rational link, between the loans and each director's employment and that no error of law had been demonstrated. In arriving at this conclusion his Honour rejected the appellant's submission that the AAT had misunderstood its ``ownership'' contention.

Contentions on the Appeal

20. The primary argument of the appellant was that the loans made to the directors were not ``in respect of [their] employment''. Following the argument that had been put below, it was said that the loans were to be explained by the ultimate beneficial ownership of the trust fund by the directors and their families, an ``ownership'' that could be traced through their respective family discretionary trusts. It was conceded by the appellant that the ability of the directors to sign cheques enabled the loans to be made and there was therefore a causal link between their holding of office and the provision of the loans. But it said that the link was not a sufficient or relevant link for the purposes of the Act. Accordingly, it was argued that the trial judge had erred in both the construction of the Act and in its application to the facts of the case.

21. The Commissioner argued that on the facts found by the AAT it was bound to conclude that the requisite connection between the loans and the employment of the directors had been established. In particular, the Commissioner contended that the directors' control of the unit trust, rather than their misconceived notion of their ownership of its assets, enabled the directors to obtain the loans. In substance, the Commissioner contended that it was only as a result of their employment as directors that they were able to, and did, withdraw the funds that made up the relevant loans and that the directors had no right or authority to do so in any other capacity. In those circumstances, so the argument went, the only conclusion that was open was that the loans were made as a consequence of the employment and were a product or an incident of that employment.

``In respect of the employment''

22. The words ``in respect of'' have no fixed meaning. They are capable of having a very wide meaning denoting a relationship or connection between two things or subject matters. However the words must, as with any other statutory expression, be given a meaning that depends on the context in which the words are found:
State Government Insurance Office (Qld) v Rees & Anor (Liquidators of KD Morris & Sons Pty Ltd) (1979) CLC ¶40-586 at 32,574 and 32,578; (1979) 144 CLR 549 at 553-554 and 560-561;
Technical Products Pty Ltd v State Government Insurance Office (1989) Aust Torts Reports ¶80-245 at 68,622, 68,624 and 68,626; (1989) 167 CLR 45 at 47, 51 and 54;
Construction Industry Long Service Leave Board v Irving (1997) 15 ACLC 824 at 831; (1997) 74 FCR 587 at 595 and
FC of T v Scully 2000 ATC 4111 at 4121 [39] and [40]; [2000] HCA 6 at [39] and [40].

23. The AAT was correct in stating that the phrase requires a ``nexus, some discernible and rational link, between the benefit and employment''. That, however, does not take the matter far enough. For what is required is a sufficient link for the purposes of the particular legislation: see Scully at ATC 4121 [38] to [40]; HCA [38] to [40]. It cannot be said that any causal relationship between the benefit and the

ATC 4157

employment is a sufficient link so as to result in a taxable transaction. For example, a discretionary trust with a corporate trustee might be established to purchase a family home for the benefit of its directors and their family. It does not follow that the rent free occupation of that home on the authority of the directors is a benefit provided ``in respect of'' their employment for the purposes of the Act. While there is a causal relationship between the provision of the benefit and the employment it is not a sufficient or material relationship. The rent free occupancy arises because the trust was established for that purpose; a reason extraneous to the employment of the directors.

24. It is instructive to consider
Smith v FC of T 87 ATC 4883; (1987) 164 CLR 513. Section 26(e) of the Income Tax Assessment Act provides that a taxpayer's assessable income shall include the value to the taxpayer of all ``allowances, gratuities, benefits, bonuses and premiums allowed, given or granted to him in respect of, or in relation directly or indirectly to, any employment of or services rendered by him...''. The appellant received $570 under an Encouragement to Study scheme that had been established by the Bank that employed him. The payment was made in accordance with the scale of allowances prescribed by general rules promulgated by the Bank for successfully completing an ``approved course of study''. The scheme, which was open to all of the Bank's staff, provided for reimbursement of costs and included special arrangements to facilitate study in accordance with the Bank's policy to encourage its employees to increase their knowledge in subjects relevant to banking. The question at issue was whether the $570 was caught by s 26(e).

25. Wilson, Brennan and Toohey JJ held that the receipt was assessable income because the benefit was provided as a consequence of the taxpayer's employment. Wilson J said (at ATC 4886; CLR 519) that a ``necessary relation'' to the employment of the taxpayer or a ``requisite relationship'' between the benefit received and the ``employment'' had to be established. In that connection his Honour said (at ATC 4886; CLR 519).

``... It is tempting to strive to identify criteria which will assist in the process of characterization. But, however helpful such criteria may be, it is unwise to expect any paraphrase to provide a final or overriding test. Ultimately, it is the words of the statute that must prevail. Toohey J. finds it helpful to ask whether the benefit allowed, given or granted is a consequence of the employment of the taxpayer. So do I. I also find it helpful to ask whether the benefit is a product or incident of the employment...''

(citations omitted)

Brennan J (at ATC 4889; CLR 525) stated that an allowance is paid in consequence of the employment ``... if the payment of the allowance is made because of some aspect of the employment...'' Accordingly, if some aspect of an employee's employment is a ``substantial reason'' for the allowance it cannot be said that the payment is made for reasons extraneous to the employment.

Toohey J said (at ATC 4894; CLR 533-534):

``... There was an evident connection between the appellant's employment and the sum he received. And in a very real sense the payment was a consequence of the existing relation of employer and employee. It was only as an employee that the appellant qualified for the benefits payable under the scheme.''

Gaudron J (at ATC 4896; CLR 536-537), with whom Deane J agreed, characterised the subject payment as recompense or reward for undertaking and completing an approved course of study which, although approved by the Bank, was required neither as a condition of the relation of employer and employee nor as a qualification necessary for the rendering of services in that relationship. Thus, her Honour concluded that the payment was not made in consequence of the relation of employer and employee.

26. The differences in approach in Smith show how difficult it is to state a test to determine whether the requisite relationship or connection exists. In the case of s 26(e) the question was said to be resolved by asking any one of the following questions:

  • • is the benefit a ``product or incident of the employment''? (Wilson J at ATC 4886; CLR 519);
  • • is some aspect of the employment a substantial reason for the benefit? (Brennan J at ATC 4890; CLR 526);
  • • is ``in a very real sense the payment... a consequence of the existing relationship of

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    employer and employee''? (Toohey J at ATC 4894; CLR 533); or
  • • is the employment one of the ``proximate causes'' of the payment? (Gaudron J at ATC 4896; CLR 537).

Whatever question is to be asked, it must be remembered that what must be established is whether there is a sufficient or material, rather than a, causal connection or relationship between the benefit and the employment. There is, in any event, a danger in placing too much emphasis on causation. As Lord Hoffman pointed out in
Environment Agency v Empress Car Co Ltd [1999] 2 AC 22 at 29, an answer to the question of whether A has caused B will differ according to the purpose for which the question is asked.

27. Here the question whether there is a sufficient or material connection or relationship between a benefit and employment is assisted by having regard to the purpose or object of imposing FBT on employers. That purpose was stated by the then Treasurer, Mr Keating, in the Second Reading Speech (2 May 1986, Hansard, House of Representatives) at 3020 to be to ``ensure that all forms of remuneration paid to employees bear a fair measure of tax...''

28. While the width of the definition of ``fringe benefit'' was designed to capture benefits that, in truth, were other than remuneration, the stated purpose suggests that asking whether the benefit is a product or incident of the employment will be helpful. If it is not then the benefit is likely to be extraneous to the employment and will not bear FBT, notwithstanding that the employment might have been a causal factor in the provision of the benefit. In particular, the fact that a benefit is provided to a director because it was authorised by that director will not, of itself, be sufficient to characterise the benefit as one which is ``in respect of'' the employment. Without more, it is not a product or incident of that office.

29. To put the matter another way, although the process of characterising the benefit provided in a particular case can involve questions of fact and degree, it is not sufficient for the purposes of the Act merely to enquire whether there is some causal connection between the benefit and the employment: see
FC of T v Rowe 95 ATC 4691 at 4703 and 4710; (1995) 60 FCR 99 at 114 and 123. Although Brennan, Deane and Gaudron JJ observed in Technical Products (at Aust Torts Reports 68,622; CLR 47), that the requisite connection will not exist unless there is ``some discernible and rational link'' between the two subject matters which the statute requires to be linked, as was pointed out by Dawson J (at Aust Torts Reports 68,624; CLR 51), the connection must be ``material''.

Reasoning on the Appeal

30. The AAT said that the phrase ``in respect of the employment of the employee'' required ``a nexus, some discernible and rational link between the benefit and the employment''. It held that, on the facts found, there was ``a clear nexus, causal relationship between the advances or loans or employment of the four directors'' because it was in their capacity as directors that each director was ``able and permitted'' to make the relevant withdrawals from the bank account of the unit trust. In reality all that the AAT did was to establish that there was a causal relationship between the loans and the employment. The trial judge accepted that the AAT did not err in law in approaching the matter in that manner. In our view, however, the AAT failed to consider whether, notwithstanding that causal link, there was a sufficient or material relationship or connection between the loans and the employment.

31. By engaging in an inquiry that established that there was a causal relationship between the loans and the employment without inquiring whether there was a sufficient relationship between the two, the Tribunal erred in law. Accordingly, unless the facts found by the AAT obliged it to find in the Commissioner's favour in any event, the case must be remitted to the AAT for its reconsideration.

32. As matters presently stand, the evidence that was given by the directors was to the effect that the reason why the loans were provided was because the directors were, for all practical purposes, treating the assets of the unit trust as their own. The conclusion of the AAT, that the directors had no entitlement to the loans as ``owners'' of the trust fund did not resolve the matter.

33. Whether or not there is a sufficient connection between each director's employment and the loans to the unitholders to attract FBT was a question of fact for the Tribunal to determine. The material before the AAT pointed in two directions. The first was that the directors drew upon the assets of the

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unit trust because ultimately the trust was established, and its assets were to be held and applied, for their benefit and that of their families. The second is that it was agreed between the directors that, as an incident of their directorship, each of them were entitled to draw upon the appellant's funds by way of loans for their personal benefit. In the first case it is unlikely that there would be a sufficient connection with the employment, while in the second the loans are likely to be an incident or product of it.

34. Further, the AAT also found that while salaries paid to the directors were ``equal'' they were low and ``that the availability of interest free funds for personal use may well have been seen as additional and useful recompense for such modest salaries''. If in fact interest free funds were provided as ``additional... recompense for... modest salaries'' then that is likely to constitute a sufficient connection.

35. On a fair reading of the AAT's reasons it only decided that the employment of the directors was a cause of the loan. The fact that the four persons in question were directors of the appellant explains how, but not why, they were able to make the withdrawals. In those circumstances it was open to the AAT to conclude that the loans were not fringe benefits if it applied the correct legal test. Accordingly, it is appropriate to allow the appeal and to remit the matter back for further hearing before the AAT.


36. The appeal is to be allowed, the orders of the trial judge are to be set aside and, in lieu thereof, the decision of the AAT is to be set aside and the matter is to be remitted to it for its reconsideration in accordance with law. The appellant should have its costs of the appeal and the hearing below.


1. The appeal be allowed.

2. The orders made by the trial judge on 4 August 1999 be set aside and in lieu thereof it be ordered that:

  • (a) the decision of the Administrative Appeals Tribunal made on 21 May 1998 be set aside;
  • (b) the matter be remitted to the Administrative Appeals Tribunal to be determined in accordance with law.

3. The respondent pay the appellant's taxed costs of the appeal and the hearing below.

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