LYMAN v FC of T

Members:
DW Muller DP

Tribunal:
Administrative Appeals Tribunal

MEDIA NEUTRAL CITATION: [2004] AATA 928

Decision date: 3 September 2004

DW Muller (Deputy President)

This review relates to objection decisions covering income tax years ending 30 June 1998, AAT file number QT2003/143; 30 June 1999, AAT file number QT2003/144 and 30 June 2000, AAT file number QT2003/145. In each of the three tax years Geoffrey John Lyman claimed as a deduction an amount of $32,692.00 representing amortisation of $326,923.00 claimed to be the cost of his share of a copyright, over the remaining years of the copyright.

2. The claims for deductions were rejected on the grounds that the true value of the patent to Mr. Lyman was significantly less than $326,923.00.

3. At the hearing Mr. Lyman was represented by his accountant, William Schoch. The Respondent was represented by Mr. Hack SC and Mr. McQuade.

4. Mr. Lyman, in common with many other applicants for review at the AAT was a participant in an arrangement, devised and promoted by Mr. Schoch, that sought to take advantage of Division 10B of the Income Tax Assessment Act 1936 (the 1936 Act) and, with effect from the 1999 income year, Division 373 of the Income Tax Assessment Act 1997 (the 1997 Act). Broadly, those provisions permit accelerated deduction of capital expenditure on industrial property.

5. It is not necessary for present purposes to consider separately Division 373 of the 1997 Act, the elements of that Division being relevantly identical to those that operate in Division 10B of the 1936 Act.

6. The operative part of Division 10B is s. 124M. It permits the owner of a ``unit of industrial property to which this Division applies'' to deduct annually an amount based upon the amortised value of the property. The term ``unit of industrial property'' is defined by s. 124K(1) as meaning, relevantly,

``(a) rights possessed by a person under a law of Australia as:

  • (i) the grantee or proprietor of a patent for an invention; or
  • ...
  • (iv) a licensee under such a patent...

and includes equitable rights in respect of such a patent... or in respect of a licence under such a patent...''

The Division applies, relevantly, by virtue of s. 124L(1)(b) to the owner of a unit of industrial property who ``incurred expenditure of a capital nature on the purchase of the unit of industrial property''.

7. It is important, in the context of this case, to note s. 124R which governs the manner in which the cost to the owner of the unit of industrial property is to be determined. Sub- section 124R(1)(b) has the effect that whilst, ordinarily, the cost is the expenditure referred to in s. 124L(1)(b), that does not apply in the circumstances set out in s. 124R(3). That sub- section provides:

``(3) Where, in the case of an owner referred to in paragraph 124L(1)(b):

  • (a) the Commissioner is satisfied, having regard to any connection between the owner and the person from whom the unit of industrial property concerned was purchased or to any other relevant circumstances, that the owner and that person were not dealing with each other at arm's length in relation to the purchase; and

    ATC 2271

  • (b) the expenditure of a capital nature incurred by the owner on the purchase of the unit of industrial property:
    • (i) exceeds the amount that was the cost of the unit to the last preceding owner of the unit; or
    • (ii) does not exceed the amount that was the cost of the unit to the last preceding owner of the unit but exceeds the value of the unit at the time of the purchase;

the cost of the unit to the owner for the purposes of this Division shall be taken to be the cost of the unit to the last preceding owner of the unit or the value of the unit at the time of the purchase, which ever is the less.''

8. The steps in the scheme devised by Mr. Schoch were as follows:

  • i. Ralph McKay had invented a computer program called the ``Universal Risk Machine'' for use in assessing risk exposure for transactions in financial markets.
  • ii. Mr. McKay invented Universal Risk Machine in about 1988 but he had been having trouble exploiting it commercially. A company of which Mr. McKay was a director was issued with a copyright for the computer program for the Universal Risk Machine in the early 1990s.
  • iii. Mr. Schoch devised a scheme whereby it was to appear that 52 investors would each buy a 1/52 share in the patent owned by Mr. McKay's company.
  • iv. Each investor paid $27,500 to Mr. Schoch. That is, a total of $1,430,000.
  • v. Mr. McKay's company purported to transfer 1/52 of the right to its copyright to each of the 52 investors for 10 years by means of a number of complicated transactions from company to company.
  • vi. During the course of one of the transactions, Mr. Schoch assigned a total value of $17M to the copyright.
  • vii. Each investor therefore became the proud owner of 1/52 of a copyright said to be worth $17M. That is, $326,923.00 each.
  • viii. There was also a final contract in which each investor agreed to sell the 1/52 share, ``worth'' $326,923, back to Mr. McKay at any time within four years for $27,500, and thereafter for a slightly higher price.

9. Mr. Lyman was one of the investors.

10. The attraction of the scheme from the point of view of the investors was that for an outlay of $27,500 they could claim a deduction of about $32,692.00 per year for ten years, representing amortisation of the $326,923 over the ten year period.

11. The attraction for Mr. McKay was that he received funds to manufacture and market his invention, and he could buy it back any time he liked for or near the original price of $27,500.

12. The attraction for Mr. Schoch was the fee for providing the service.

13. The claims for deductions for the years 1998, 1999 and 2000 were eventually investigated and disallowed. An understatement penalty of 50% was initially imposed on Mr. Lyman, and the other investors, later reduced to 10% in the case of Mr. Lyman and most of the other investors.

14. The Tribunal heard several days of evidence, followed by extensive written submissions by Mr. Hack.

15. Mr. Schoch was called upon to respond to Mr. Hack's submissions. He thereupon conceded on behalf of Mr. Lyman that the transactions had been a sham.

16. Mr. Schoch went on to submit that the Tribunal should reduce the 10% penalty. He said that he had sought from the Commissioner on behalf of the investors a private ruling. This had been refused. He said that if he had received a ruling that his scheme was not approved he would never have embarked upon it.

17. The material shows that the Commissioner not only refused to give a private ruling but also pointed out that the ``valuations'' were not accepted, and that more information was needed about the parties to the contracts.

18. The Tribunal takes the view that the Commissioner's reply could in no way amount to encouragement to embark on the scheme.

19. The Tribunal also takes the view that an investor would have to be highly suspicious of a scheme in which for a one-off outlay of $27,500, a deduction of $32,692.00 could be claimed each year for the next ten years.

20. The Respondent ultimately imposed understatement penalty pursuant to Part VII of


ATC 2272

the 1936 Act at the rate of 10%. By way of comparison,
  • • S. 226F, ``lack of reasonable care'' imposes a penalty of 25%;
  • • S. 226H, ``recklessness'' imposes a penalty of 50%.

21. The Tribunal takes the view that the Respondent has been extremely generous on the question of penalty.

22. The Tribunal affirms the objection decision in relation to the tax years ending in 1998, 1999 and 2000, including the understatement penalty rate of 10%.


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