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TAYLOR & ANOR v FC of T

Members:
A Sweidan SM

Tribunal:
Administrative Appeals Tribunal

MEDIA NEUTRAL CITATION: [2006] AATA 1120

Decision date: 22 December 2006

A Sweidan (Senior Member)

1. The applicants, Mr Athans and Mr Taylor both Chartered Accountants who practice in partnership, claim to be entitled to income tax deductions in the year ending 30 June 1997 for expenses they claim to have incurred as "master franchisees" of Fishing Information Line Australia Pty Ltd, as follows: -

  • (a) Mr Taylor, $60,000 being: -
    • (i) $40,000 claimed in respect of the acquisition by him of a "master franchise";
    • (ii) $20,000 claimed in respect of his acquisition of another master franchise with the other applicant Mr Athans;
  • (b) Mr Athans, $20,000 claimed in respect of his acquisition of a half interest in a master franchise with the other applicant, Mr Taylor.

2. In relation to both applicants:

  • (a) On 28 February 2001 the respondent made a determination under s 177F of the Income Tax Assessment Act 1936 ("the Act") that the deductions claimed by the applicants as set out above should not be allowable in relation to the year of income ended 30 June 1997;
  • (b) Amended assessments disallowing the claimed deductions issued on 13 March 2001; and
  • (c) On 18 May 2004 the respondent disallowed the applicants' objections dated 3 April 2001 against the amended assessments.

and the applicants have sought a review by the Tribunal of such disallowance.

3. The respondent contends: -

  • (a) the claimed expenses are not allowable under section 51(1) of the Act because: -
    • (i) the arrangements which the applicants allege gave rise to them were shams;
    • (ii) the claimed expenses were not necessarily incurred by the applicants in the course of conducting a business for the purpose of earning assessable income;
    • (iii) the claimed expenses were not otherwise incurred for the purpose of gaining or producing assessable income;
    • (iv) alternatively, the expenses were of a capital and not a revenue nature; alternatively
  • (b) if the claimed deductions were allowable under section 51(1), Part IVA of the Act applies and the Commissioner was entitled to make determinations disallowing them pursuant to section 177F of the Act.

Evidence

4. The applicants both gave evidence and other witnesses to whose evidence reference is made below also testified. The applicants produced the following copy documents (which were received as exhibits and marked as shown) in support of their entry into the arrangements which they allege gave rise to the claimed deductions:

  • (a) A18: letter dated 18 August, 1997 to Mr Taylor from Fishing Info-Line enclosing

    ATC 2003

    Master Franchise certificate and an allocation of Australia Post postcodes.
  • (b) A21: Fishing Info Line Master Execution Sheet bearing commencement date 27 June, 1997 and signed by Mr Taylor as Master Licensee and a Mr Heinze for Fishing Information Line Australia Pty Ltd, Fishing Information Line Management Pty Ltd, Fishing Information Line Finance Pty Ltd and Fishing Information Services Pty Ltd. By the Execution Sheet, Mr Taylor agreed to be bound by the terms of: -
    • (i) the Fishing Information Line Master Licence Agreement with the Master Licensee, Fishing Infoline Australia Pty Ltd and Fishing Information Services Pty Ltd;
    • (ii) the Fishing Information Line Management and Marketing Agreement with Fishing Information Line Management Pty Ltd (" the Manager ");
    • (iii) the Fishing Information Line Loan Agreement with Fishing Information Line Finance Pty Ltd (" the Lender ").
  • (c) A23: undated Fishing Information Line Short Term Loan Agreement signed by Mr Taylor by which Mr Taylor, as Master Licensee: -
    • (i) borrowed from Fishing Information Line Finance Pty Ltd the sum of $5,000 (" advance "), to be paid by the Lender to the Manager to be paid and applied in accordance with the Management and Marketing Agreement;
    • (ii) agreed to repay the advance and interest thereon by five consecutive monthly payments of $1,025 commencing one month after the Commencement Date (27 June, 1997);
    • (iii) agreed to pay stamp duty.
  • (d) A24, A25: undated Fishing Information Line Master Licence Execution Sheet signed by Mr Athans and Mr Taylor and undated Short Term Loan Agreement signed by Mr Athans and Mr Taylor, both in the same terms as A21 and A23.
  • (e) A26: letter to Mr Taylor from Fishing Info-Line dated 15 May, 1998 enclosing face sheets from our Data Base.
  • (g) A29-A37: correspondence enclosing revenue statements: -
    • (i) for Mr Taylor, for the periods to 30/6/98, 1/7/1998 to 30/6/1999 and 1/7/1999 to 31/12/1999;
    • (ii) for Athans & Taylor, for the period 1/7/1999 to 31/12/1999.
  • (h) A1-A17: cheque butts and bank statements supporting payment of an initial amount of $5,000 in respect of each franchise and repayment of the Short Term Loan over the period October 1997 to December 1997.

5. The Tribunal also had before it the generic and individual "T" documents tendered by the respondent.

6. The applicants produced no copies of the Master Licence Agreement or the Management and Marketing Agreement or the Loan Agreement referred to in the Master Licence Execution Sheets. They did not offer any explanation as to why they were described in all subsequent documents as Master Franchisees.

7. Instead, the applicants relied on sample documents contained at V2/305-368 of the T documents as containing the terms of the arrangements they entered into. Those sample documents are: -

  • (a) T89, V2/305: Fishing Info-Line Information Memorandum, Master Franchise Offer;
  • (b) T90, V2/325: Fishing Info-Line Master Franchise Agreement;
  • (c) T91, V2/339: Fishing Info-Line Loan Agreement;
  • (d) T93, V2/349: Fishing Info-Line Tax Opinion;
  • (e) T94, V2/363: Fishing Info-Line Cash Flow Projections.

8. On the evidence before the Tribunal the applicants have established that they were Master Franchisees of Fishing Information Line Australia Pty Ltd, as Franchisor, but not the terms of the arrangement they had with the Franchisor. Although the applicants, by the Master Licence Execution Sheets purported to enter into and be bound by a Master Licence Agreement and a Marketing and Management Agreement they rely on the sample documents and accordingly the Tribunal's view is that they are to be treated as Master Franchisees pursuant to the terms of the sample Master Franchise

ATC 2004

Agreement, T90, V2/325, as contended by the respondent.

9. The applicants have established on the evidence that, in respect of each Master Franchise, they paid a total of $10,125 (being an initial $5,000 plus a total of $5,125 by way of principal and interest under the Short Term Loan Agreement). As pointed out by the respondent this is consistent with the sample Loan Agreement T91, V2/339 which contemplates an advance of $31,000 to be applied in payment to the Franchisor of the Franchise Fees (as defined in the Master Franchise Agreement).

Section 51(1): relevant legal principles

10. The witness statements and oral evidence of the applicants and their witnesses reflect their enthusiasm for the Fishing Information Line business concept. However, this is of little assistance to the Tribunal in determining the issues raised by the respondent and outlined at paragraph 3 above. The applicants both claimed that tax considerations were not an important factor in deciding to enter the project.

11. The respondent contends and the Tribunal agrees that in determining the issues arising under section 51(1), the following principles of law apply.

Sham

12. The case law shows that sham arises where there is a "common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating":
Snook v London & West Riding Investments Ltd (1967) 2 Q.B. 786 at 802.

13. "A "sham" is therefore for the purposes of Australian law, something that is intended to be mistaken for something else or that is not really what it purports to be. It is a spurious imitation, a counterfeit, a disguise or a false front. It is not genuine or true, but something made in imitation of something else or made to appear to be something which it is not. It is something which is false or deceptive: "
Sharrment v Official Trustee in Bankruptcy (1988) 18 FCT 449 per Lockhart, J. at 454. Critical to characterizing a transaction as a sham is that the parties do not intend to give effect to the ostensible transaction:
Scott v Commissioner of Taxation (No. 2) (1966) 40 ALJR 265 at 279. And see
Albion Hotel Pty Ltd v FCT (1965) 115 CLR 78 at 90, 92. Business - second limb of section 51(1)".

14. There are a number of factors to consider in order to determine whether or not a taxpayer is carrying on a business. They are:

  • (a) the activities undertaken by the taxpayer;
  • (b) the repetition and regularity of those activities;
  • (c) whether the activities are organized in a business-like manner;
  • (d) the structure through which the activities are conducted;
  • (e) whether the activities are carried out for a profit-making purpose.

  • See
    Ferguson v FCT 79 ATC 4001; (1979) 26 ALR 307 at 311;
    Hope v The Council of the City of Bathurst (1980) 144 CLR 1.

First limb of section 51(1)

15. The determination of whether outgoings are deductible for the purposes of section 51(1) is a matter of characterization by reference to the advantage the outgoings seek to achieve. The outgoing must be incidental and relevant to gaining or producing assessable income. Put another way, the production of assessable income is the occasion of the outgoing:
Amalgamated Zinc (de Bavay's) Ltd v FCT (1935) 54 CLR 295 at 309 and
Ronpibon Tin NL v FCT (1949) 78 CLR 47.

16. The relationship between the outgoing and the assessable income must be such as to impart to the outgoing a character of an outgoing of the relevant kind. Where there is a disproportion between the outgoings incurred and the amount of assessable income, the question of the character of the outgoings must be answered by:

"a common sense appreciation of the overall factual context in which the outgoings were incurred. It necessarily involves a consideration of the contents and implications of the overall contractual arrangements … pursuant to which the outgoings … became payable. … it also encompasses a consideration of the purpose which the members of the partnership … had in incurring the outgoings."


Fletcher v FCT 91 ATC 4950; (1991) 173 CLR 1 at 20-21.

17. 

ATC 2005

For amounts to be deductible, this "commonsense" or "practical" weighing of all the factors ought to indicate that the relationship between the whole of the expenditure and the production of assessable income is "genuine and not colourable". See Fletcher at 17.1-18.2, 18.7-19.4 and
Ure v FCT 81 ATC 4100; (1981) 34 ALR 237 per Brennan, J at 241, lines 20-31 and per Deane and Sheppard, JJ at 248-249, line 25 and 249, line 35 -250.

18. The occasion of the loss or outgoing is not the earning of assessable income where the circumstances point to another purpose. See
Fletcher v FCT 91 ATC 4950; (1991) 173 CLR 1 at 17-18.

Capital

19. In resolving the issue whether outgoings are on revenue or capital account it is incumbent upon the Tribunal to analyse all the rights and obligations of the applicant in asking what the outgoings are really for, rather than rely on the way the outgoings were styled:
Vincent v FCT 2002 ATC 4742; (2002) 124 FCR 350 at [64], [65] and [67]. A casual investment of capital to yield an enlargement at the end of a period of time but without forming any business system or practice by the taxpayer, is passive investment and the outgoings are on capital account: of
Clowes v FCT (1954) 91 CLR 209 at 218;
Milne v FCT 76 ATC 4001; (1976) 133 CLR 526 at 535; and
Enviro Systems Renewable Resources Pty Ltd v ASIC (2001) 80 SASR 1 at [36], [43], [44].

Table analysing the Master Franchise Agreement

20. In the following table submitted by the respondent the requirements of the sample Master Franchise Agreement are analysed against the evidence, the conduct of the parties and the legal principles set out above with respect to section 51(1). The table also sets out the respondent's comments.

21. The respondent contends that even without the analysis provided in the table the applicants evidence supports the conclusions at sub-paragraphs 3(a)(ii) and (iv) above (namely that the applicants were not in a business and/or that the expenses incurred were capital expenses). The respondent contends that they incurred outgoings without regard to the nature of the arrangements they entered into. As Mr Paikos one of the applicants' witnesses put it, this was an investment that was a 'franchise arrangement". That is, it was called a franchise but the evidence shows that no regard was had to the nature of a franchise or the rights and obligations a franchise implies ie:-

  • (a) The applicants incurred amounts for the purpose of securing a share of the revenues of the Fishing Information Line business according to an analysis of postcodes:-
    • (i) Mr Athans said: "essentially I invested in Fishing Information Line with a view to making money. I believed it was a successful business - I would have a share of the business from the postcodes allocated to me - the organisers make the calls";
    • (ii) Mr Taylor said: "they promoted the concept - if there was revenue from my postcodes I got that revenue. I was not promoting I was paying for that promotion";
  • (b) The evidence shows that the; applicants approached the Fishing Information Line arrangements and thought of them in the same way as they did any other investment:-
    • (i) they looked at the likely success of Fishing Information Line's business concept and not the likely success of marketing it in an allocated geographical location as appeared to be the concept for the franchised businesses. Mr Athans said: "I believe very firmly in the internet. I have a passion for internet based activity. Fishing is the world's largest pastime - marrying the two together was something worth taking a risk on".
    • (ii) they assessed the investment on the potential size of the market for Fishing Information Line's products and assessed Fishing Information Line's proposed overall market penetration. Mr Taylor said of the projections that he "did not need to do market analysis as they only needed 2% of the market" and "the projections looked reasonable, it was a large market";
  • (c) It appears that otherwise the applicants had no regard to what the amounts they purportedly incurred were being paid for.

    ATC 2006

  • (d) The applicants clearly did not think of or approach the arrangements as being arrangements by which they entered into a business. They had no intention of carrying on a business themselves. They did not intend anyone to do so on their behalf. They left it all to the "organisers" as Mr Athans described those he had entered into the arrangements with.

22. The respondent contends that the analysis in the following table of the rights and obligations purportedly established by the Master Franchise Agreement supports the conclusion that: -

  • (a) the franchise arrangements were a sham;
  • (b) alternatively, the applicants were not in a business: -
    • (i) the activities of the purported business were insufficiently organized and defined as to be capable of being carried out in a business-like manner;
    • (ii) the applicants' conduct is not consistent with a profit-making purpose or an intention to carry on business;
    • (iii) significantly, beyond the execution of the Master Licence Execution Sheets and the Short Term Loan Agreements, the applicants engaged in no business activity;
  • (c) the applicants' conduct indicates that their purpose in incurring the outgoings associated with entry into Master Franchise Agreements was not otherwise the gaining or producing of assessable income;
  • (d) alternatively, the expenses the applicants incurred were capital and not revenue expenses. The applicants were passive investors. The outgoings were incurred in order that they might obtain a share of the revenue of the Fishing Information Line business.

  • (Note, IM, where used in the following table, means the Fishing Info-Line Information Memorandum - T89, V2/305.)


    "REQUIREMENTS OF THE SAMPLE MASTER FRANCHISE AGREEMENT T90 V2/325-338 RESPONDENT'S COMMENTS
    Recital C: The Master Franchisee has requested the Franchisor to licence to the Master Franchisee the right to use the Fishing Info-Line System and to use the Fishing Info-Line Image for the sole purpose of conducting the Franchised Business  
    Fishing Info-Line System, defined, clause 1.1: information comprised in any one or more of the marketing plans, business formats, systems, methods, procedures, policies, operations and standards relating to and controls upon the conduct of a business supplying the Fishing Info-Line Products using any part of the Fishing Info-Line Image under licence from the Franchisor, as may be specified by the Franchisor from time to time in the Manual or otherwise in writing. There is no evidence that a Manual existed or that there were any marketing plans, business formats or the like according to which the Franchised Business was to be conducted or which might be provided to the franchisee to assist with the conduct of his business.

    ATC 2007

    Fishing Info-Line Image, defined, clause 1.1: means the Trade Marks, and the names "Fishing Info-Line" and "Fishing Info-Line Australia" and other related ancillary trade marks, trade names, copyrights, emblems, designs, logos, labels, signs, symbols and indicia devised or employed by the Franchisor to identify and distinguish Fishing Info-Line Products and Fishing Info-Line Outlets exploiting the Fishing Info-Line System, as may be prescribed, excluded, added to, changed or modified by the Franchisor from time to time. Save for a "TRADE MARKS SCHEDULE" which appears at the end of the Agreement (V2/337) the Fishing Info-Line Image is not further defined. This Schedule contains no more than the typed names "Fishing Info-Line" and "Fishing Information Line".
    This is to be contrasted with the names "Fishing Info-Line" and "Fishing Info-Line Australia" referred to in the definition clause.
    It is also to be contrasted with the logo appearing at the top of each page of the IM. The Master Franchise Agreement does not include that logo in the Fishing Info-Line Image.
    In the end, there appears to be no Fishing Info-Line Image.
      SHAM
      • Applicants intending to carry out the Franchise Agreement would not have paid for the use of a System and Image which did not exist;
      • The Franchisor, genuinely intending to attract franchisees, would clearly define and make available for consideration its System and Image and require the conduct of business in conformity with them.
      BUSINESS
      • Requires a profit-making purpose. The applicants were indifferent to whether the System and Image existed even though they were to pay fees for their use.
    Franchised Business  
    Definition, clause 1.1: the sales agency business, the operation of which is permitted by virtue of the rights and benefits granted by the Franchisor to the Master Franchisee pursuant to this Agreement The IM at V2/312 [3.1] describes the franchisee's business slightly differently, as a business of developing, promoting and marketing Fishing Information Line Products and Services …
    Clause 2.1: contemplated the conduct of one (1) Fishing Info-Line Outlet supplying (as the exclusive agent of the Franchisor) the Fishing Info-Line Products within the Territory during the Term…"  
    Fishing Info-Line Outlet, definition, clause 1.1: business, conducted under a franchise granted by the Franchisor of supplying any, some or all of the Fishing Info-Line Products, as an exclusive agent of the Franchisor.  

    ATC 2008

    The business to be conducted is further defined by the Franchisor's Obligations in clause 5.5 and the Duties of the Master Franchisee in clause 6. These obligations and duties are directed to the supply of goods by franchisees to customers in their territory. For example, they require the Franchisor to supply products to the franchisee (clause 5.5), and the franchisee to promptly submit product orders on the required form (clause 6(f)) and maintain product supply (clause 6(g)). The nature of the goods and/or services to be supplied is outlined in the IM
    At V2/312 [3.2]
    These include the use of the fishing Info Line telephone and fax service, the internet, sale of Fishing Infoline Membership cards and advertising or sponsorship from participants in the fishing industry within the territory.
    Fishing Info-Line Products, definition, clause 1.1: goods and/or services authorized by the Franchisor from time to time for supplying through a Fishing Info-Line Outlet. At V2/315-319 [6.3.1]-[6.4.7] further detail is given regarding the Fishing Info Line, advertising, assistance to Government, the Internet, travel, Fishing Info Cards, an annual National Fishing Competition and multi media involvement.
    The IM is vague about whether or how the products and services outlined are to be supplied, promoted or marketed by franchisees. In this respect, the Cash Flow Projections T94, V2/363 include revenue to franchisees only from Subscription advertising, Telephone revenue and Card membership sales.
    Clearly, many of the products and services could not be supplied directly by the franchisee, as the sample Franchise Agreement contemplated. Accordingly, it appears that, at best, the franchisee's business was confined to marketing and promotional activities.
      Ultimately:
      • the Franchised Business defined by the sample Franchise Agreement is at odds with the nature of the goods and services contemplated by the IM, particularly the telephone service, the internet and the travel service. These services might be promoted by the franchisee, as the IM suggests, but not supplied by him, as the sample Franchise Agreement seems to require.
      • it is not clear which products and services were to be marketed and promoted by the franchisee and which by the Franchisor or, indeed, whether they might duplicate each other's activities.
    This confusion is compounded by the substantial Marketing Fee which comprised more than half the Franchise Fees payable by the franchisee to the Franchisor.

    ATC 2009

      • the IM is confused concerning whether or how the products and services outlined were to be supplied, marketed or promoted by franchisees at all. At V2/311 [2.0] it states: Master Franchises are now being offered for a limited number of territories which entitle the owner to participate in the proceeds from the distribution of Fishing Information Services' Products and Services.
    Consistently with this statement, it appears from the IM at V2/317 [6.4.2] that the Franchisor, itself, intended to market for advertising subscriptions.
    More importantly, the terms of the sample Franchise Agreement provided for revenue sourced in the franchisee's Territory to be distributed to the franchisee without regard to whether it was obtained by the franchisee's efforts (clause 1.1, definitions of Commission and Gross Receipts, discussed below).
    Again, the Marketing Fee payable to the Franchisor as part of the Franchise Fees adds to the confusion if not pointing to a business model by which franchisees, in fact, invest in the Franchisor's business in return for a share of its revenue.
       
      SHAM
      • In the end result, the business model is, at best, ill-defined, and, at worst, hopelessly flawed. There was no Manual, System or Image and poor definition by the IM of the business trading activity by which profits were to be generated.
      • The business presented by the IM was, in any event, inconsistent with the requirements of the sample Master Franchise Agreement which purportedly governed the parties' business relationship.
      Having regard to the actual Fishing Info-Line business, neither party to the sample Master Franchise Agreement could have intended that it be carried out according to its tenor.
       
      BUSINESS
      • The activities of the Franchised Business were not defined in a business-like manner.

    ATC 2010

      • The structure by which the activities were to be conducted was unclear, particularly in the division of activity as between the Franchisor and the franchisees.
      • The uncertainty as to precisely what the business was and what was necessary to its conduct indicates that the applicants did not intend to carry out a business.
      • The applicants were indifferent to whether they profited from their investment. They made no inquiry about the Cash Flow Projections T94, V2/363 which showed revenue to franchisees from a comparatively limited range of activities.
      • In any event, the assumptions on which the Cash Flow Projections were based are not stated. Accordingly, the applicants had no means of assessing their strength. They made no inquiries about them.
    In this respect, the IM is of little assistance. With respect to the Fishing Info Line, for example, it states at V2/316: Since the commencement of our telephone service in August 1996 calls have increased and by December 1997 we expect that this number will increase to 8000 per month. No basis for the expectation is given. The statement carefully avoids stating the current number of calls per month.
      Had the applicants made inquiries and entered into the Franchise Agreement nevertheless, the same indifference would be demonstrated.
      • Inquiry would have revealed that the company had been in business for less than a year during the course of which it had incurred substantial losses and substantial debts to third parties: see the Langridge report at page 28.
      • Moreover, inquiry would have indicated the expectation of 8000 calls per month to the Fishing Info Line by December 1997 to be unrealistic. Records kept by CITEC, the provider of the telephone service, indicate that calls over the 12 month period after the commencement of the business in August 1996 averaged 459 calls per month (T241 at V3/828 and see Mr Langridge's report at page 35 [5.2.2].

    ATC 2011

    Franchisee's remuneration  
    Clause 10: Franchisor shall pay or allow to be paid to the Master Franchisee the Commission (less the Franchise Fees, Loan Repayment (if any) and Approved Sales Agents Fees (if any) in accordance with the provisions of this Clause 10.
    Clause 10 further provides that Commission is to be calculated and paid for each 3 month period (Accounting Period, Payment Date).    		 The applicants have produced the following revenue statements (A29-A37): -
      • For Master Franchise No. 073 (Mr Taylor) to 30/6/98, 1/7/98 to 30/6/99 and 1/7/99 to 31/12/99;
      • For Master Franchise No. 072 (Athans & Taylor) for the period 1/7/99 to 31/12/99.
    Clause 1.1, definition: Commission means an amount equal to the Gross Receipts less:
    (a) the cost of Fishing Info-Line Products sold in the Territory or 25% of the Gross Receipts (whichever is the greater amount); and
    (b) the cost of freight and packaging and taxes and duties in respect of Fishing Info-Line Products sold in the Territory.    		 The applicants accepted the calculations of revenue without question although they make no reference to the customers in their territories from whom the business came.
    Neither the Master Franchise Agreement nor the Cash Flow Projections (V1/363) not the above revenue statements provided any basis upon which the Gross Revenues shown were derived.
    Clause 1.1, definition: Gross Receipts means the aggregate of the purchase moneys received by or on behalf of the Franchisor from the sale of Fishing Info-Line Products in the Territory … SHAM
    None of the parties conducted themselves in accordance with the terms of the sample Franchise Agreement.
    The applicants were indifferent to whether or how the business they had purportedly entered into derived revenue and how that revenue and their commission was recorded and accounted for.
    The Franchisor made no attempt to comply with the Franchise Agreement's requirements regarding the calculation and payment of revenue.
       
      BUSINESS
      • The applicants' activities as franchisees were not organized in a businesslike manner: -
        • records of the purported business were vague and irregular;

    ATC 2012

        • the production of only one revenue statement for Athans & Taylor further illustrates failure to retain even the most basic records of their business. In this respect, it might be noted that Athans & Taylor have produced no Master Franchise Certificate or allocation of postcodes for Master Franchise No. 072.
        • The applicants were indifferent to the basis upon which the revenues of the business were calculated or allocated.
        • The applicants were indifferent to the failure of their purported business to derive a commercial profit and to derive a profit even remotely in the realm predicted by the Cash Flow Projections ($3,520 for 1998 and $4,514 for 1999).
      The effect of the definitions of Commission and Gross Receipts is that the franchisee was entitled to be paid Commission whether or not he conducted any business activity in the Territory. The Franchisor was to provide the products and services and derive revenue which it promised to distribute amongst franchisees. And see the terms of A18: letter dated 18/8/97 from Fishing Info-Line.
      As noted earlier: -
      • as appears from the IM and the Cash Flow Projections, many of the business activities described were to be undertaken by the Franchisor in any event;
      • the Franchisor was to, itself, engage in marketing and promotional activities for the purpose of securing business, including advertising subscriptions. In this respect, more than half of the Franchise Fees comprised a Marketing Fee.

    ATC 2013

       
      CAPITAL
      In the end result, even if the applicants' intention was to derive assessable income, their outgoings were outgoings of capital. There was little incentive to the franchisee to undertake marketing or promotional activities. In substance, the applicants' outgoings, however styled, were simply provided by way of funding the Franchisor's own business activities in return for a share of its revenue.
    Clause 13: If an inspection or audit of the books and records of the Franchised Business reveals any understatement of the Gross Receipts….. More importantly, the terms of the sample Master Franchise Agreement provided for revenue sourced in the franchisee's territory to be distributed to the franchisee without regard to whether it was obtained by the franchisee's efforts: [clause 1.1 definitions of Commission and Gross Receipts.]
      This clause is at odds with a business which receives revenue only as distributed by the Franchisor.
    Territory, definition, clause 1.1: geographic area within the Country [Australia] allocated to the Master Franchisee upon execution of this Agreement and notified to the Master Franchisee in writing (which notice is deemed to be incorporated in to this Agreement). Nature of the Territory is outlined in the IM (T89 V2/at 312) Each Master Franchisee territory consists of an exclusive area comprising an allocation of specifically nominated Australia Post post code areas. Each territory contains approximately 81,500 population.
    This "random" allocation of franchise territory is to be contrasted with the Information Memorandum (T89 V2/305 at 316) where potential franchisees were advised: we have identified and compiled into a data base more than 18000 business [sic] which are potential subscriber advertisers. These potential customers were, however, not to be allocated to franchisees for the benefit of their sales agency businesses.
    Similarly, for the purposes of the telephone and fax service (IM at V2/315 [6.3.1]) Fishing Info Line has divided Australia into some 210 regions containing 1400 separate localities for its reporting services network. Yet franchise territories were not allocated to align with the regions to be served by the Fishing Info Line.
       
      SHAM
      The nature of the Territory is unworkable. It indicates that the parties had no intention of carrying out any franchise arrangement.
      Applicants were asked and, apparently, content to enter into a business without: -

    ATC 2014

      • having any choice as to where it was to be conducted;
      • knowing where it was to be conducted;
      • consideration being given to defining the franchisee's agency in a way that was consistent with the way the Franchisor intended to run the underlying business;
      • any indication as to the means by which revenue received by the Franchisor was to be identified as sourced from franchisees' territories.
      A20, MASTER FRANCHISE INVESTMENT, Master Franchise No 073, Schedule of exclusive Post Codes Allocated to this Territory, being Mr Taylor's.
    The allocated postcode areas were principally in Tasmania and South Australia and not in Western Australia where the applicant Taylor resided. Despite his extensive interest in and knowledge of fishing in Western Australia, Mr Taylor made no complaint.
    Indeed, he made no investigation of the location or the "fishing demographic" of the allocated areas e.g. as to: -
      • businesses of the kind listed in the IM, at V2/316;
      • fishing grounds in the allocated areas.
      Further, the applicants made no investigation of the means by which revenue received by the Franchisor was to be identified as sourced from their territories.
       
      BUSINESS
      The structure and organization of the Franchised Business was not business-like and, apparently, calculated against rather than in favour of the success of the Franchised Business.
      The applicants lacked a profit making purpose in agreeing to an unworkable basis for the operation of their purported business.
      Their indifference to making a profit is further illustrated by their failure to ascertain how revenue received by the Franchisor was to be identified and allocated to them.

    ATC 2015

    Monies payable by the franchisee  
    Clause 2.1 and definitions, clause 1.1: includes an Establishment Fee as described in the Franchisee Fees Table, being $1,000 for processing the Master Franchisee's application, preparation of documentation and initial administrative costs of the Franchisor in establishing the Master Franchisee's franchise.
    Clause 4: Master Franchisee shall pay to the Franchisor the Franchise Fees on the dates and in the manner set out in the Franchise Fees Table.    		  
    Franchise Fees Table
    Annual Franchise Fee
    First Year: $7,500 paid in advance…
    Each Subsequent Year: 1.0% of the Commission during each Year after the first Year…    		 The applicants were, apparently, content to pay $7,500 for the use of an Image and System without being satisfied as to what they were or whether they existed.
    The Annual Franchise Fee is the annual fee for the use of the Fishing Info-Line Image and Fishing Info-Line System. Further, the sample Franchise Agreement provides that the Franchised Business is no more than a sales agency business conducted by the franchisee as an exclusive agent of the Franchisor.
    The Franchisor receives all revenue from the sale of Fishing Info-Line Products and, consistently with the notion of a sales agency, pays the sales agent an amount by way of commission.
    Although the grant of the sales agency might involve a licence to the sales agent to use an image and/or a requirement to sell according to a certain system, it is odd that the sales agent should be charged such a substantial sum for the use of the image and system which is, ultimately, to secure sales for the benefit of the "franchisor's" business.
    Moreover, the franchisee was to receive a share of revenue sourced from the Territory whether or not he made use of the System or Image.
    Annual Service Fee
    First Year: $7,175 paid in advance…
    Each Subsequent Year: 1.0% of the Commission during each Year after the first Year…
    The Annual Services Fee is the annual fee for the administrative and accounting services provided by the Franchisor under this Agreement.    		 The confusion between the Franchise Fees Table and the terms of the sample Franchise Agreement itself mean one cannot be sure what this amount of $7,175 is to be paid for. Nevertheless, the applicants paid it without question.

    ATC 2016

    Clause 5.1 contemplates services of a different kind
    (a) the services of management guidance and operations review in respect of the Fishing Info-Line System;
    (b) relevant data and information as may be necessary to ensure that the Master Franchisee has the benefits of the exploitation and use of the Franchised Business of the Fishing Info-Line System.    		  
    Annual Marketing Fee
    First Year: $20,025 paid in advance……
    Each Subsequent Year: 3.0% of the Commission during each Year after the first Year…
    The Annual Marketing Fee is the annual fee for the advertising, marketing and promotional services to be provided by the Franchisor to the Master Franchisee under this Agreement.    		 More than half the first year Franchise Fees comprised a marketing fee.
    The existence of such a large fee is difficult to reconcile with the business the franchisees were to conduct which was, apparently, the marketing of the Fishing Info-Line Products.
    If the Franchisor was, itself, to engage in promotional and marketing activities, the degree to which the franchisee was to conduct any marketing business independent of the Franchisor is very unclear.
    Clause 5.3: The Franchisor shall during the First Year and each subsequent Year:
    (a) advertise the Fishing Info-Line Image;
    (b) advertise the Fishing Info-Line Products; and
    (c) arrange for special events, promotional activities, incentives and offers for the marketing of the Fishing Info-Line Image and Fishing Info-Line Products.    		 The Franchisor provided no detailed marketing plan, beyond the broad statement made by clause 5.3, by which the applicants might assess the appropriateness of the fee or, indeed, the scope of the Franchisor's marketing activities. The proposed scope of the franchisee's business activities was, as a result, even more unclear.
    Nevertheless, the applicants agreed to the Marketing Fee without question.
    The applicants did not intend to be trained. Both decided to invest, in part, because participation was passive (Taylor, witness statement, [6]; Athans, witness statement, [4]).
    Training Fee
    $3,750 paid in advance…
    The Training Fee is for the Franchisor's training services to be supplied within 12 months of the Commencement Date (after allocation of the Territory and commencement of the Franchised Business)    		 There was no basis for assessment of the reasonableness of the training fee. It was charged for unspecified training at the discretion of the Franchisor.
    Nevertheless, the applicants paid it without question. In Mr Taylor's case, he paid it twice. Presumably, he or his agents could only be trained once.
    Clause 5.2 The Franchisor will provide training for the Master Franchisee and the Master Franchisee's employees, agents and contractors in the Fishing Info-Line System as may in the opinion of the Franchisor be necessary… SHAM
    The applicants agreed to pay fees which made no commercial sense.
    The Franchisor charged fees which made no commercial sense.

    ATC 2017

      BUSINESS
    TOTAL OF FRANCHISE FEES
    First Year: $39,450 paid in advance…..
    Each Subsequent Year: 5.0% of the Commission…….    		 The applicants agreed to pay fees which made no commercial sense or, at least, without consideration of the commercial advantage the fees secured for them.
    Conduct of the business by the franchisee
    Clause 3.1: prohibits the Master Franchisee, inter alia appointing any sub-agent or sub-distributor or sub-contracting the supply of Fishing Info-Line Products without the prior written consent of the Franchisor.
    Clause 3.3: Where the Master Franchisee appoints an Approved Sales Agent or Trained Personnel, the Master Franchisee shall at all times monitor, and shall retain the authority to direct and control, their sales and distribution activities.    		 The IM at V2/313 [3.6] refers to the possible appointment of Approved Sales Agent(s) to assist the master franchisee to conduct sales activities…remunerated from gross revenue.
    Master Franchisees may elect to conduct their Fishing Infoline Franchise exclusively or may elect to appoint one or more approved sales agents (non exclusively) to assist with this activity…
    At V2/313 [4.1] in respect of projected cash flows, the IM notes: the projections include an allowance of up to 20% of gross revenue to an approved Sales Agent.
    Clause 9: The Master Franchisee shall at all times personally manage and control the Franchised Business.
    Clause 10: contemplates the payment of Approved Sales Agents Fees from Commission.
    "Approved Sales Agents" is not defined.    		 No information is given about who Approved Sales Agents are, how they might be appointed or on what terms.
    Although the Approved Sales Agent is, ostensibly, the franchisee's agent, it is to be paid out of gross revenue and, accordingly, by the Franchisor.
    Neither applicant appointed an Approved Sales Agent.
    Even were an Approved Sales Agent appointed, the IM contemplates that the agent will assist the franchisee. Obviously, because the franchisee is in a marketing business, the activities of the approved sales agent would have to be defined and monitored, particularly in light of the franchisee's obligation to manage and control the Franchised Business.
    The applicants did not intend to, themselves, conduct the business. Both decided to invest, in part, because participation was passive (Taylor, witness statement, [6]; Athans, witness statement, [4]).
    Clause 12: The Master Franchisee shall at all times keep full and proper books of account and records….showing clearly all transactions of the Franchised Business and separate from any other business of the Master Franchisee. As the applicants never started or engaged in a business: -
      • they kept no records of any Franchised Business. Such revenue statements as were provided to them by the Franchisor did not show all transactions by which revenue was earned;

    ATC 2018

    Clause 14: The Master Franchisee shall supply to the Franchisor in a form provided or specified by the Franchisor operational reports as set out in the Manual. • they never provided reports. Indeed, they could not do so as there appeared to be no Manual from which the form of the report could be established;
      • they were paid Commission anyway. In the circumstances, such revenue as they were paid was, necessarily, revenue earned by the Franchisor in the conduct of its own business.
       
      SHAM
      The applicants never conducted a Franchised Business.
    The Franchisor made no complaint and paid them Commission revenue anyway.
       
      BUSINESS
      The applicants never started any business. They carried out no activity themselves beyond execution of the Master Execution Sheet and making payments of cash between June, 1997 and December, 1997.
    They did not appoint any Approved Sales Agent to do so.
    Approved Sales Agents were not defined. Neither was their role or the terms upon which it would be carried out. Accordingly, in this respect also, the proposed activities and structure of the franchise was not businesslike.
       
      CAPITAL
      The applicants conducted no business activity either themselves or through an Approved Sales Agent. They were paid Commission anyway. In the circumstances, such revenue as they were paid was, necessarily, no more than a share of revenue earned by the Franchisor in the conduct of its own business.

Tax benefits

23. The respondent asserts that as a result of entering into Master Franchise Agreements and Loan Agreements, the applicants obtained significant tax benefits, as the report of Mr Langridge the respondent's expert witness explains. Mr Taylor's overall net cash position was improved by $2,450.01 (Langridge report, page 47 at 8.2.4) in the two years to the end of 30 June, 1998. Mr Athans' overall net cash position was improved by $4,573.46 (Langridge report, page 50 at 8.3.4).

24. The IM promoted this benefit and explained how it was to be derived, as follows:

  • (a) At T89, 2/311-312

    Benefits of a Master Franchise include:

    • • A low initial cash outlay of $10,000
    • • A possible tax deduction of $40,000

      ATC 2019

    • • A possible tax saving of: $19,480 at 48.7% tax rate $14,400 at 36% tax rate
    • … … … ….
    • • Ability to borrow on a limited recourse basis, funds to cover a part of the initial investment and operating costs. That is a loan of $31,000 repayable only from the proceeds of the franchise business.
    • … … … … …..
    • • By making an initial cash outlay of $10,000 and borrowing $31,000 from Fishing Information Line Finance Trust on a limited recourse loan basis, Master Franchisees may be entitled to claim an immediate tax deduction of up to $40,000 and benefit from a tax saving or refund of up to $19,480 ……………

  • (b) At T89, 2/312

    Master Franchisees, by making an initial cash outlay of $10,000, should be able to claim an immediate tax deduction of $40,000, as detailed below…..

  • (c) At T89, 2/313 [4.0]

    Master Franchisees will be able to access a Limited Recourse Loan of $31,000 per Master Franchise to assist in the financing of the initial fees and costs.

    Repayments on this loan are from the Master Franchisee's share of gross revenue or the sale of the Franchise business only, therefore because the Limited Recourse Loan is only serviced from future revenues. There are no further out of pocket payments of any kind whatsoever.

  • (d) At T89, 2/314: Summary of Pre-Payments

25. The respondent contends that conversely, the analysis in the table establishes that the Master Franchise Agreements which purportedly governed the arrangements between the applicants and the Franchisor were, at best, unworkable. From a practical viewpoint Mr Corriea (a witness called by the applicants) explained in his evidence the unworkability which the analysis demonstrates. Based on his experience with a similar business he said he could have run the Fishing Information Line business nationally with 3 people. It did not require the involvement of 220 other people except as investors.

26. The respondent contends further that the analysis in the table establishes that:-

  • (a) the Master Franchise Agreement lacked the features of a system which was to be exploited in a businesslike way: -
    • (i) the Franchised Business and the activities to be conducted in its pursuit were inadequately or inconsistently defined. It is not clear what the Fishing Info-Line Products were, whether and how some or all of them were to be dealt with by Franchisees or on what basis;
    • (ii) to the extent that activities were defined, there appeared to be duplication between the Franchisor and franchisees. This is particularly apparent with respect to the Marketing Fee. Franchisees were, apparently, to conduct a business marketing and selling Fishing Info-Line Products yet paid most of their fees for marketing by the Franchisor;
    • (iii) other services to be provided by the Franchisor in return for fees were inconsistently defined (Annual Services), to be provided at the discretion of the Franchisor (training) or non-existent (Image and System). In the end, the charging of fees at all was inconsistent with the sample Master Franchise Agreement's characterization of franchisees as sales agents to whom commission was payable;
    • (iv) the Territory in which the Franchised Businesses were to be conducted was randomly allocated, in another State, and not aligned with the Franchisor's own identification of how the business might best be conducted;
    • (v) franchisees were permitted to appoint Approved Sales Agents, yet there was no indication as to who they might appoint, how or on what terms;
    • (vi) franchisees were to be paid commission according to sales made in their Territories regardless of their efforts whilst there was no indication as to how

      ATC 2020

      income sourced in their Territories could be identified and applied to them;
  • (b) the only activity the applicants undertook was to execute a Master Execution Sheet and make cash payments between June, 1997 and December, 1997. Clearly these activities were not carried out for the purpose of making a profit. The applicants purportedly incurred fees to conduct a business which they, in fact, never conducted. They neither carried on a Franchised Business nor appointed an Approved Sales Agent to do so. It is not to the point for the applicants to say they thought they had appointed a manager. The nature of the marketing business into which they purportedly entered called for direction and control of the activities of any manager or agent as clause 3.3 of the Master Franchisee Agreement recognised;
  • (c) the applicants were indifferent to the performance or potential performance of their purported businesses: -
    • (i) they made no inquiries to clarify any of the features of the purported businesses;
    • (ii) they incurred fees for poorly defined services without question;
    • (iii) they made no complaint that their income from the purported businesses fell far short of the income projected in the Projected Cash Flows;
    • (iv) they required no accounting from the Franchisor in respect of the source of revenue attributed to their businesses or the basis of its calculation which had not been set out in the IM, in the Projected Cash Flows (V1/363) or anywhere else.
  • (d) the applicants received income from the purported businesses without question although they had taken no steps to conduct them.

Sham

27. On the basis of the above analysis, the respondent contends that it ought to be concluded that the Franchise Agreements and the loans taken out to fund franchise fees were a sham. They could not be carried out according to their terms. Neither party sought to do so.

28. The respondent further contends that the Master Franchise Agreements apparently entered into were a façade: -

  • (a) presented by the applicants in order to disguise the true purpose of the transactions, namely securing tax advantages, which were clearly outlined and identifiable;
  • (b) by which the purported Franchisor sought to attract funds, not for the conduct of a franchise operation but in order to satisfy debts owed to third parties. See section 3.2 of Mr Langridge's report.

29. The Tribunal's finding on this issue is that, while the respondent's contentions have substantial force it nevertheless appears that the parties clearly intended to create some form of binding legal relationship, albeit that due to the deficiencies in the documentation as set out in the respondent's detailed analysis, it is unclear exactly what the nature of that relationship was. On balance, the Tribunal is of the view that the agreements cannot be characterised as a sham although the relationship that was created was not what was purported.

No business

30. The respondent further contends that if the arrangements were not a sham, the analysis in the table indicates that the applicants did not incur the claimed deductions in the course of a business for the purposes of gaining or producing assessable income because: -

  • (a) the Master Franchise Agreements which purportedly governed the arrangements between the applicants and the Franchisor were, at best, unworkable. They lacked the features of a system which was to be exploited in a businesslike way;
  • (b) the only activity the applicants undertook was to execute a Master Execution Sheet and make cash payments between June, 1997 and December, 1997. Clearly these activities were not carried out for the purpose of making a profit. The applicants purportedly incurred fees to conduct a business which they, in fact, never conducted. They neither carried on a Franchised Business nor appointed an Approved Sales Agent to do so;
  • (c) the applicants were indifferent to the performance or potential performance of their purported businesses.

31. 

ATC 2021

The Tribunal finds that the respondent's assertions are justified and that applicants have failed to show that they were carrying on a business within the meaning of the second limb of section 51(1) of the Act.

Section 51(1) - first limb

32. The respondent contends that the tax benefits obtained by the applicants are material to the Tribunal's consideration of the first limb of section 51(1) of the Act. If the Tribunal finds, as it has done, that the applicants were not in a business, it must, nevertheless, consider whether their claimed outgoings were incurred for the purpose of gaining or producing assessable income.

33. The respondent contends and the Tribunal agrees that because of the disproportion between the applicants' outgoings and the assessable income earned from their investments, it is necessary to examine "the whole set of circumstances" in order to determine whether the disproportion between the outgoings and the assessable income is to be explained by reference to the independent pursuit of some objective other than the gaining of assessable income: see Fletcher
91 ATC 4950; (1991) 173 CLR 1 at 18-19.

34. The Tribunal is of the view that as contended by the respondent in this case, the occasion of the outgoings is to be explained by reference to the independent pursuit of an objective of obtaining a tax benefit. Based on the conduct of the applicants and the terms of the arrangements, analysed in the above table the Tribunal does not accept that the applicants' entry into the Master Franchise Agreement and the Loan Agreement was primarily for the purpose of deriving assessable income and the applicants have failed to discharge the onus which they bear in this regard. In the Tribunal's view although this may have been a secondary, hoped for, objective the considerable tax advantages they derived as a result of their investment provide a more likely explanation of the applicants' dominant motive for entry into the arrangements. The Tribunal accordingly finds that the claimed outgoings were not incurred for the purpose of gaining or producing assessable income and hence are not deductible under the first limb of s 1(1).

Capital

35. As the analysis in the respondent's table shows: -

  • (a) the applicants ostensibly incurred fees to commence a business;
  • (b) the fees incurred were for inadequately defined services;
  • (c) the business structure purportedly established by the Master Franchise Agreement lacked the features of a system which could be exploited in a businesslike way;
  • (d) the applicants never did start a business;
  • (e) the applicants received revenue anyway.

36. In the Tribunal's view from the documentation before the Tribunal the only fundamental obligation which emerges is that of the Franchisor to pay the applicants' commission. It was bound to do so and did, regardless of whether they formed any business system or practice themselves. According to the sample Master Franchise Agreement (clause 1.1) commission was payable by reference to the aggregate of all purchase moneys received by or on behalf of the Franchisor from the sale of Fishing Info-Line Products in the Territory allocated to the Franchise. Any efforts of the applicants or the forming of any business system or practice by them was immaterial to their right to receive returns. In the Tribunal's view their evidence shows that they well understood this.

37. Further, in the Tribunal's opinion the evidence including that of the applicants' witnesses shows that the outgoings, although styled as franchise fees, service fees, marketing fees and training fees were in fact for nothing more than the purchase of a passive investment and hence were in the Tribunal's view capital in nature and not deductible under section 51(1).

Part IVA: relevant legal principles

38. While the Tribunal has, for the reasons set out above come to the conclusion that the applicants are not entitled to a deduction for their outgoings under section 51(1) the Tribunal will nevertheless for the sake of completeness and in the event that the Tribunal's conclusion as to deductibility under section 51(1) is incorrect, proceed to consider the Part IV A question.

39. 

ATC 2022

Section 177F provides, inter alia, for the disallowance of tax benefits in the form of deductions claimed by taxpayers in connection with a scheme to which Part IVA applies.

40. Section 177C of the 1936 Act relevantly defines "tax benefit" in the following terms:

"Subject to this section, a reference in this Part to the obtaining by the taxpayer of a tax benefit in connection with a scheme shall be read as a reference to -

  • …

  • (b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out;

  • …

  • and, for the purposes of this Part, the amount of the tax benefit shall be taken to be -

  • …

  • (d) in a case to which paragraph (b) applies - the amount of the whole of the deduction or the part of the deduction, as the case may be, referred to in that paragraph. …"

41. Section 177D is the key provision in Part IVA. It provides that the scheme must be entered into or carried out by a person for a purpose of the kind identified in section 177D(b): see
FC of T v Hart 2004 ATC 4599; (2004) 217 CLR 216 per Gleeson CJ and McHugh J at [16], per Gummow and Hayne JJ [34], [37], [50], [56] and per Callinan [92]. It provides:

"This Part applies to any scheme that has been or is entered into after 27 May 1981, and to any scheme that has been or is carried out or commenced to be carried out after that date … where -

  • (a) a taxpayer (in this section referred to as the 'relevant taxpayer' ) has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and
  • (b) having regard to -

  • the manner in which the scheme was entered into or carried out;

  • the form and substance of the scheme;

  • the time at which the scheme was entered into and the length of the period during which the scheme was carried out;

  • the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;

  • any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;

  • any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;

  • any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and

  • the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi),

  • it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers)."

42. According to section 177A(5), the "purpose" for which a person entered into or carried out a "scheme" may be the sole purpose or the dominant purpose of doing so.

43. 

ATC 2023

Finally, "scheme" for the purposes of Part IVA is defined in section 177A(1) of the 1936 Act as follows:

" 'scheme' means -

  • (a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and
  • (b) any scheme, plan, proposal, action, course of action or course of conduct …".

44. As has frequently been observed by both the Federal Court and the High Court, the definition of "scheme" in section 177A(1) is very broad. See, for example,
Federal Commissioner of Taxation v Spotless Services Ltd 96 ATC 5201; (1996) 186 CLR 404 at 425 per McHugh J;
Federal Commissioner of Taxation v Peabody 94 ATC 4663; (1994) 181 CLR 359 at 383; see further
Commissioner of Taxation v Hart 2004 ATC 4599; (2004) 78 ALJR 875 at 878 [9] per Gleeson CJ and McHugh J; 885 [43] per Gummow and Hayne JJ; 893 [85], 899 [87] per Callinan J;
Eastern Nitrogen Ltd v Commissioner of Taxation 2001 ATC 4164; (2001) 108 FCR 27 at 43 [71].

Scheme

45. The Tribunal finds that In each application the scheme, within the meaning of section 177A(1), was the making and the implementation of the Fishing Info-Line Information Memorandum, the Fishing Information Line Master Execution Sheet, the Short Term Loan Agreement, the Master Franchise Agreement, and the Loan Agreement.

46. Apart from the Loan Agreements, relevant features of the above documents have been set out in the table above and, in the case of the Master Execution Sheet and the Short Term Loan Agreement, in paragraph 4 above.

47. By the sample Loan Agreement [T91, V2/339-343] the Lender agreed to lend $31,000 to the Master Franchisee. The terms of the Loan Agreement included the following:-

  • (a) by clause 2 the $31,000 ("the Advance") was to be lent to the Master Franchisee and the Master Franchisee irrevocably authorized and directed the Lender to apply the advance in payment of the franchise fees;
  • (b) by clause 4 the Master Franchisee would pay interest on the Advance: -
    • (i) for the period from 30 June 1997 to 30 June 1998 (the first year) at the rate of 6% per annum (calculated monthly) discounted to the amount of $1,550;
    • (ii) then at the rate of 6% per annum or an amount equal to the Loan Repayment (defined as 65% of the Commission), whichever was the lesser amount;
  • (c) by clause 3.1(a) the Advance and the interest thereon were to be repaid by paying the Lender each Loan Repayment on each payment date. Payment date is not defined in the Loan Agreement but is given meaning in the sample Master Franchise Agreement as the last day of each 3 consecutive months following the date of execution of the Master Franchise Agreement;
    • (i) by clause 3.2 the Master Franchisee was not required to repay in any other way;
    • (ii) by clause 5 the Master Franchisee agreed that the Lender was entitled to receive the Loan Repayment out of the Commission before payment of the Commission to the Master Franchisee and irrevocably authorised the Lender to direct the Franchisor to deduct and pay in that way;
  • (d) by clause 7.2 the Lender was not entitled to have resort for the payment of the Advance or interest thereon to any asset or property of the Master Franchisee except the "Franchised Business".

Parties to the scheme

48. The Tribunal finds that the parties to the schemes included each applicant, the partners John Athans and Leonard Taylor, Fishing Information Services Pty Ltd, Fishing Information Line Australia Pty Ltd Unit Trust, Fishing Information Line Finance Pty Ltd, Fred Heinze, Kahl Heinze, the principals of the Fishing Information Line companies and Equitable Funds Management Ltd, a creditor and architect of the franchise arrangement.

Tax benefit

49. The tax benefits are the following deductions claimed by the applicants for the 1997 income year -

  • ATC 2024

    (a) $40,000 claimed by Mr Taylor in respect of the acquisition by him of a master franchise;
  • (b) $20,000 claimed by each of Messrs Taylor and Athans in respect of their acquisition of a master franchise in partnership.

Each $40,000 was described as comprising:-


Annual franchise fee $ 7,500
Training fee $ 3,750
Annual service fee $ 7,175
Marketing fees $20,025
Interest $ 1,550
  $40,000

[V2/312, 314 (IM), 338 (Master Franchise Agreement), 341 (Loan Agreement)]

50. The Tribunal finds that if the scheme had not been entered into or carried out these deductions would not have been available to the applicants.

Section 177D(b) factors

51. There is overwhelming authority that the test posited by section 177D is an objective one:
Federal Commissioner of Taxation v Spotless Services Ltd 96 ATC 5201; (1996) 186 CLR 404 at 421-423, 424;
Federal Commissioner of Taxation v Consolidated Press Holdings 2001 ATC 4343; (2001) 207 CLR 235 [95];
Eastern Nitrogen Ltd v Commissioner of Taxation 2001 ATC 4164; (2001) 108 FCR 27 per Carr, J. at [80]-[84];
Commissioner of Taxation v Sleight 2004 ATC 4477; (2004) 136 FCR 211 per Hill J (Hely J agreeing) at [67] and per Carr, J. at [205];
Calder v FCT 2005 ATC 4760; (2005) 61 ATR 267 at [91];
Commissioner of Taxation v Cooke 2004 ATC 4268; (2004) 55 ATR 183 at [88]. As stated by the High Court it does not require, or even permit, any inquiry into the subjective motives of the relevant taxpayers or others who entered in to or carried out the scheme or any part of it:
FC of T v Hart 2004 ATC 4599; (2004) 217 CLR 216 at [65]. Accordingly, the subjective knowledge, understanding or intention of the applicants (or anyone else) with respect to the financial structuring of the scheme, its conduct or perceived returns from the scheme is irrelevant, and their evidence in this regard is not to be given any weight by the Tribunal.

52. In this respect, see
Vincent v Commissioner of Taxation 2002 ATC 4490 (at first instance) at [133] and [142]. There, French, J. found, for the purposes of section 51(1) of the Act that Ms Vincent's purpose was to obtain investment returns from the project under consideration. In the context of Part IVA, however, her subjective purpose was not material. On the basis of the financial structuring and operations of the project entities his Honour found that, notwithstanding Ms Vincent's subjective intentions, it would be concluded that the dominant purpose of Ms Vincent in entering into the project was to obtain the relevant tax benefits. Further, a taxpayer's unawareness of round robin transactions was, specifically, held to be immaterial in
Calder v FCT 2005 ATC 4760; (2005) 61 ATR 267 at [114].

53. Further, as the terms of section 177D make clear, the reference in that section to "purpose", objectively determined, includes not only the applicants' respective purposes in entering the scheme, but the purpose of the scheme's promoters in enabling the applicants and other investors who subscribed to the project to obtain tax benefits in connection with the scheme. In this respect, see
Vincent v Commissioner of Taxation 2002 ATC 4490; (2002) 124 FCR 350 at [100];
Puzey v Federal Commissioner of Taxation 2002 ATC 4853; (2002) 194 ALR 615 per Lee, J. [105];
Commissioner of Taxation v Sleight 2004 ATC 4477; (2004) 136 FCR 211 per Hill, J. (Hely, J. agreeing) at [65]-[66], [67.3], [96] and per Carr, J. at [239]-[240].

54. Each of the eight factors set out in section 177D (b) must be considered. However as Hill J pointed out in
Peabody v Commissioner of Taxation 93 ATC 4104; (1993) 40 FCR 531 at 543:

"This does not mean that each of those matters must point to the necessary purpose referred to in s 177D (b). Some of the matters may point in one direction and others may point in another direction. It is the evaluation of these matters, alone or in combination, some for, some against, that s 177D requires in order to reach the conclusion to which s 177D refers."

ATC 2025

See also
Commissioner of Taxation v Sleight 2004 ATC 4477; (2004) 136 FCR 211 per Hill, J. at [67].

55. Nevertheless, the relevant purpose may be so apparent on the evidence taken as a whole that consideration of the statutory factors adumbrated in section 177D (b) can be collapsed into a global assessment of purpose:
Federal Commissioner of Taxation v Consolidated Press Holdings 2001 ATC 4343; (2001) 207 CLR 235 at [94] and
Commissioner of Taxation v Sleight 2004 ATC 4477; (2004) 136 FCR 211, per Hill, J. at [67]. Echoing the statement in
FCT v Consolidated Press Holdings Ltd 2001 ATC 4343; (2001) 207 CLR 235 per the Court at [94], the Full Court in
Calder v FCT 2005 ATC 4760; (2005) 61 ATR 267, at [79]-[80] stated:- "It is important, however, to bear in mind that the ultimate judgment as to purpose under s 177D is holistic, albeit it requires that regard be paid to each of the eight factors listed in s 177D(b). Indeed it can be expressed as a global or overall judgment provided that it is apparent that those factors have been considered".

56. The authorities make it clear that, critically, the pursuit of a commercial objective is not inconsistent with the existence of a dominant purpose of enabling the taxpayer to obtain a tax benefit. This has been pointed out: -

  • (a) from the earliest authority,
    Federal Commissioner of Taxation v Spotless Services Ltd 96 ATC 5201; (1996) 186 CLR 404 at 415, 416 (and see
    Federal Commissioner of Taxation v Consolidated Press Holdings 2001 ATC 4343; (2001) 207 CLR 235 [96]) -
  • (b) through the authorities concerning agricultural investments:
    FCT v Sleight 2004 ATC 4477; (2004) 136 FCR 211 per Hill J at [67.6] (Hely, J. agreeing) and per Carr J [206];
    Calder v FCT 2005 ATC 4760; (2005) 61 ATR 267 at [92]; and
    FCT v Cooke 2004 ATC 4268; (2004) 55 ATR 183 at [93] -
  • (c) and, ultimately, confirmed by the High Court in
    Commissioner of Taxation v Hart 2004 ATC 4599; (2004) 217 CLR 216 per Gleeson CJ and McHugh J at [10]-[12], [16]-[18] per Gummow and Hayne JJ at [52], [68], [71]; and per Callinan, J. at [93]-[96].

In both Spotless and Hart, the High Court emphasized the shape or form taken by the scheme as pointing to its purpose.

57. There is in the Tribunal's view no scope for comparing the approaches in other cases to select a preferred approach. The Tribunal accepts that, as asserted by the respondent, to do this is to misconceive the task under Part IVA. As Gummow and Hayne JJ put it in Hart (2004) 217 CLR 216 at [52]: "Always the question must be whether the terms of the Act apply to the facts and circumstances of the particular case." And see Sleight per Hill and Carr JJ at [244] and [111].

58. Master Franchise Statements of Revenue and Fees in the applicants' documents indicate some distributions of income set off against franchise fees payable by participants were recorded. It is clear from the cases that to point to any such commercial outcome is, however, insufficient for the purposes of section 177D(b). In these cases, examination of the circumstances of the franchises and the implications of the agreements by which they were given effect, by reference to the factors identified in section 177D(b), reveals in the Tribunal's view that the dominant purpose of the arrangements was to secure a tax benefit for the applicants and other participants.

59. The Tribunal is of the view that as contended by the respondent the critical elements which emerge from the examination below of the 8 factors in section 177D(b) are as follows: -

  • (a) Participants in the project incurred obligations per franchise comprising: -
    Establishment fee $1,000
    Annual franchise fee $7,500
    Training fee $3,750
    Annual service fee $7,175
    Marketing fees $20,025
    Interest $ 1,550
      $41,000
  • (b) the taxable income of participants in the 1997 year was reduced by the amount of $40,000 of the obligations incurred per franchise;

    ATC 2026

  • (c) by entering into the limited recourse loan and the short term loan: -
    • (i) entry into a franchise could be obtained for a limited cash payment of $5,000;
    • (ii) otherwise, franchise payment obligations would be met from those loans;
    • (iii) cash repayments totalling $5,125 payable over the period July to December, 1997 under the terms of the short term loan were the only other cash payment required of participants and were fully funded by savings in income tax otherwise payable;
  • (d) as set out in the Langridge report the resulting tax savings were greater than the cash payments required.

60. In the event, the commercial performance of the franchises was not material. The tax savings were to cover the initial payment obligations. Further payments, in respect of the loan and franchise fees were to be met only from the proceeds of the Franchised Businesses. Accordingly, the applicants and other participants would keep the benefit of the tax savings without further risk and regardless of the outcome of the franchises;

61. Moreover, in the Tribunal's opinion the respondent is correct in asserting that the above features of the scheme served no apparent purpose except to create large tax deductions from which operations could be funded, without further demand being made on the "franchisee". They did not fund ongoing commercial conduct of the franchise and the underlying business operation of the promoter entities. The loans, made by entries in the books of the various entities were not supported by cash [as described in the Langridge report at pages 8-10, 13-15, 18 to 19]. In the result, the project could only be conducted using cash payments made by participants in respect of principal and interest on their loans. Ultimately, then, the large up-front fees had no apparent commercial function. No actual funds were advanced by the lender in respect of them. The only possible function of the high prepaid fees and the loan was to gear up the available tax deductions

62. In any event the evidence shows that from a commercial viewpoint, the predicted returns from the so-called Franchised Businesses were, on any view, uncertain. The Fishing Information Line was an innovative start-up business without a successful track record. Assumptions on which Projected Cash Flows (V2/363) were based were not stated. In any event the Franchised Businesses did not have a workable structure which could be successfully exploited by franchisees. and, were in any event, unsatisfactory as the Franchised Businesses relied on an underlying business which had little substance and did not have a workable structure capable of successful exploitation by franchisees.

Section 177D(b)(i) - the manner in which the scheme was entered into or carried out

Applicants

63. The Applicants: -

  • (a) signed Master Licence Execution Sheets [A21-22 and 24];
  • (b) signed Short Term Loan Agreements [A23 and 25];
  • (c) paid cash of $5,000 per franchise [A1-9 and 10-17];
  • (d) repaid the short term loans [A1-9 and 10-17];
  • (e) claimed tax deductions [Taylor T5/19 and T3/12-17] [Athans T5/20 and T3/12-17];
  • (f) received Franchise Certificates and allocation of postcodes [for Franchise 073 only, see A19-20];
  • (g) received irregular revenue statements [A29-A37].

64. The Applicants did nothing further. They took no steps to themselves conduct the Franchised Businesses which they had purportedly acquired. They did not appoint anyone else to do so. The revenue statements disclose no amount allocated to a manager or sales agent [A29-A37].

65. The terms of the sample Loan Agreement required nothing further of the applicants. All payments of principal and interest under the loan were payable only from the revenue of the Franchised Business [clause 5, T91, V2/339-343].

66. 

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As well, any further expenditure for franchise fees and, where appointed, Approved Sales Agent fees was to come out of future revenue of the Franchised Business [clauses 10 and 11 of the sample Master Franchise Agreement, T90, V332]. Accordingly, the carrying out of the Franchised Businesses required nothing more from franchisees beyond signing an application form and the initial cash payments. Franchisees obtained the benefit of the available tax deductions regardless of the outcome of the franchises.

Fishing Information Line Pty Ltd and those under its control

67. Establishing franchises for sale raised funds to satisfy debts owed to Equitable Funds Management Ltd by Fred and Kahl Heinze [Heads of Agreement T5, V1/40-45; Agreement T11, V1/84-94; Langridge report at pages 20-22 and 28]. The debt was to be satisfied by the offer of 220 franchises which would each return $10,000 cash funds to the Franchisor with franchise documentation to be provided by Equitable Funds Management Ltd.

68. The non-cash component of the proposed $42,000 was never available and not intended to be available to the Franchisor in the year ended 30 June, 1997. It was to be the subject of a Loan Agreement made by franchisees with a finance company, Fishing Information Line Finance Pty Ltd, under the same ownership and control as the Franchisor [Company reports - T223 and T224, V3/754-757 and IM - T89, V2/320].

69. Mr Langridge's report at 2.2.1.1 [pages 8-10] and 2.2.2.1 [pages 13-15] and 2.3 [pages 18-19] establishes that: -

  • (a) round robins were carried out for loans per franchise, but the round robins bore no relationship to the franchises sold. They were not reflected in the company accounts;
  • (b) loans of $31,000 in respect of franchises actually sold were effected by book entries made internally within the company accounts;
  • (c) the only funds which flowed into the promoter entities were the cash funds paid by investors.

Promotion of the franchises

70. The IM put the tax advantages of the scheme squarely to the fore, promoting this benefit and explaining how it was to be derived (at T89, V2/311-312, 312[3.2], 313 [4.0], 314 in the terms set out above.

71. The features of an immediate tax deduction, the limited recourse loan and the positive cash savings ("Tax Deduction 4:1"; "No Profit = No Loan Repayment"; "$10,000 ONCE ONLY OUTLAY with no more to pay") were promoted to accountants for their clients [Accountants Brief T28, V1/162-165] and used by sales agents generally [T30 and T31, V1/169-170 and T40, V1/181-183].

Allocation of territories

72. The IM offered a maximum number of 220 franchises [T89, V2/312]. The Master Franchise List suggests up to 300 franchises were sold [T311, SuppV/44-51] and see the ATO auditor's summary [T193, V3/616]. As a result, franchise territories said to comprise an allocation of postcodes covering a population of 81,500 [IM - T89, V2/312] were duplicated. This was demonstrated in an analysis of the postcodes allocated to franchises, undertaken by the ATO auditor [ATO Position Paper - T202, V3/696].

73. Allocation of franchise territories was random by postcode. Moreover, it was inconsistent with indications of how the Franchised Businesses might best be arranged:

  • (a) the IM indicated that 18,000 businesses had been compiled into a database of potential subscriber advertisers [See IM - T89, V2/316];
  • (b) the Fishing Info Line telephone and fax service used as a reporting services network comprised 210 regions and 1,400 localities. [See IM - T89, V2/315]

Approved Sales Agents

74. Franchisees could appoint an Approved Sales Agent. [IM - T89, V2/313]. The Generic T Documents include a form of sales agreement, evidently to be circulated to Master Franchisees on or about 25 August 1998. Accompanying correspondence stated: "Your sales agent has been appointed in accordance with the agreement and we would appreciate if you could sign and return same. We will then have them completed by the sales agents in bulk and returned to you." (our emphasis) [T107, V2/445-448].

75. 

ATC 2028

However, the form of sales agreement did not: -
  • (a) specify the agent, the franchisee, the territory or the remuneration to be paid to the agent;
  • (b) adequately define the activities to be conducted by the sales agent;
  • (c) define the means by which the agent's activities were to be monitored although, by the terms of the sample Master Franchise Agreement, the franchisee was charged with the obligation to personally manage and control the Franchised Business (V2/325, sample Master Franchise Agreement, clause 9).

76. It appears that there were, at best, 2 sales agents in the whole project whose activities related, respectively to eastern Australia and Western Australia [ATO promoter interview Q43-Q53 - T187, V2/591].

77. Ultimately, there is no evidence that any Master Franchisee appointed an Approved Sales Agent, and these applicants certainly did not do so.

Application of franchisees' funds

78. Cash payments received from the sales of the franchises funded the underlying business operations of the promoter entities and were paid to external parties:

  • (a) by way of loan repayment to Equitable Funds Management Ltd;
  • (b) by way of distribution to ABC Investment Funds Management Pty Ltd a unit holder in the Fishing Information Line Australia Unit Trust (Franchisor).

  • After payment to these external parties only 24% of the funds received from the sale of the franchises were left and available for fulfilling the terms of the Franchisor's obligations to the Master Franchisees. Langridge report at page 28.

79. Pursuant to the IM [T89, V2/313] and the Loan Agreements [definition of "Loan Repayment" in clause 1 and clause 3 - T91, V2/340], 65% of Commission due to Master Franchisees was to be paid by way of principal and interest. In fact, 100% of the franchisees' gross revenue was applied as the loan repayment, at least in the 1998 year: see A30 and the Langridge report at pages 19 and 30.

80. The franchise arrangements were carried out by three companies under the same ownership [Company reports - T223 and T224, V3/754-757 and IM - T89, V2/320]. The conduct of the arrangements by three separate but related entities created a complex structure with no apparent commercial purpose. It did, however, facilitate the ostensible making of loans to franchisees without the support of actual funds.

Section 177D(b)(ii) - the form and substance of the scheme

81. In form:-

  • (a) the sample Franchise Agreement provided for a participant to establish a Franchised Business as Master Franchisees;
  • (b) participants could elect to engage a sales agent;
  • (c) participants incurred deductible franchising and marketing fees in respect of the operation of the Franchised Business [IM - T89, V2/311-313, Franchise Agreement - T90, V2/328, 329, 332, 338];
  • (d) payment of the deductible fees was by way of a loan agreement;
  • (e) participants were to pay $5,000 cash initially and a further $5,125 was paid under a short term loan agreement by five consecutive monthly payments of $1025 commencing 27 June 1997 [IM - T89, V2/311-312, Loan Agreement - T91, V2/339-343, Short term loan agreement - T97, V2/381].

82. In the Tribunal's view the evidence clearly shows that, the fees played no role in substance in the franchises except to generate tax savings: -

  • (a) the only funding available to the scheme came from the actual cash payments made by participants and not from the fees they were charged. The loans were not made for all practical purposes [Mr Langridge's report pages 18-19].
  • (b) the tax savings generated by the deductible fees charged created the funding for participants' actual cash payments;
  • (c) of the actual cash payments made by participants, a significant proportion was to be paid to third parties, Equitable Funds Management Ltd and ABC Investments Ltd [Mr Langridge's report pages 26-28].

83. 

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In substance, then, the franchise arrangements took a shape which was not necessary to its commercial outcomes. That shape was clearly to ensure deductions for franchise fees incurred but which, by the terms of the loan agreement, were never required to be met. The loan did not serve the commercial outcomes of the franchise arrangements as obligations in respect of the fees, although legally satisfied, were not actually paid.

84. The following passage from Hill, J.'s judgement in
Commissioner of Taxation v Sleight 2004 ATC 4477; (2004) 136 FCR 211 underlines the above point as well as articulating the relevant "alternative postulate" contemplated by Gummow and Hayne, JJ. in
Commissioner of Taxation v Hart (2004) 217 CLR 216 at [66]. At [82] of his judgement in Sleight, Hill, J. stated as follows: -

"… . the particular shape the investment took was clearly fashioned in a way that would maximize the tax deductions. They were geared up by the loan agreement with up front interest payments. But for the tax deductions the form the investment might be expected to take would clearly relate more to the substance of what happened. Rather than a loan with prepaid interest where the loan was to be repaid out of the investor's profit share without recourse … the substance is that the investor was to receive only a lesser share of profit over the term of the loan agreement. The loan allowed, also, the prepayment of the management fee and the deduction which emanated from that":

85. The Tribunal further refers to
Calder v FCT 2005 ATC 4760; (2005) 61 ATR 267 at [69] and [117]. Investors in those schemes and the franchisees here were, in substance, passive investors. That view is further borne out here by the franchisees' right to receive revenue regardless of the activities of their Franchised Business. By the definitions of Commission and Gross Revenue in clause 1.1 of the sample Master Franchise Agreement (V2/325), franchisees' share of revenue was based upon all sales made in their Territory not upon who made them, i.e irrespective of anything to be done by the applicants.

86. Moreover, as the respondent's analysis in the table summarized above demonstrates the scheme lacked substance from a commercial point of view.

87. It also appears that there was little substance in the underlying business, as Mr Langridge's report establishes: -

  • (a) the underlying business operations commenced in August, 1996;
  • (b) by June, 1997, substantial losses and debts to third parties had been incurred [Langridge report page 23];
  • (c) the represented expectations concerning calls to the Fishing Info Line were, at best, highly optimistic, given the history. The expectation of 8000 calls per month to the Fishing Info Line, by December 1997 was clearly unrealistic [IM - T89, V2/316]. Records kept by CITEC, the provider of the telephone service, indicate that over the 12 month period after the commencement of the business in August 1996 calls averaged 459 per month [T150, V2/533.6; T241 at V3/828, Langridge report at page 35 paragraph 5.2.2];
  • (d) the Cash Flow Projections [T94, V2/364] showed revenue to franchisees from a comparatively limited range of activities. The assumptions on which the Cash Flow Projections were based are not stated. Accordingly, participants had no means of assessing their validity. The applicants made no inquiries about them. Inquiry would have revealed that the company had been in business for less than a year during the course of which it had incurred substantial losses and substantial debts to third parties [Langridge report, page 28];

Section 177D(b)(iii) - the time at which the scheme was entered into and the length of the period during which the scheme was carried out

88. The Fishing Info-Line business commenced in August, 1996 [T204, V3/732; T2, V1/37].

89. The Heads of Agreement providing for the formation and implementation of the franchising arrangements was entered into in March, 1997 [T5, V1/40-45].

90. Thereafter the IM and franchise documents were prepared and marketed.

91. According to the applicant's statements, in or about April 1997 they received "an

ATC 2030

information package containing a franchise opportunity with Fishing Information Line" (paragraph 1 of each statement). The Applicants entered into the franchise arrangements, on 27 June 1997 for Mr Taylor - Number 073 [A5, A1, A21 and A18], and 30 June 1997 for Mr Athans and Mr Taylor - Number 072 [A14 and A10]. This timing is in the Tribunal's view indicative that entering into the scheme was tax driven.

92. The term of the franchise is not defined in the Master Franchise Agreement but is described in the IM and other documentation as 20 years: see [T89, V2/312 and A18 and A19 Master Franchise Certificate for 073].

93. It is not known and is in any event immaterial whether the underlying business operations of Fishing Information Line have ceased.

Section 177D(b)(iv) - the result in relation to the operation of the Act that, but for this Part, would be achieved by the scheme

94. But for Part IVA of the Act, the prima facie result of the scheme was that the applicants became entitled in the 1997 year, to deductions in respect of franchise, training and marketing fees and interest totalling $60,000 in the case of the applicant Mr Taylor and $20,000 in the case of the applicant Mr Athans.

Section 177D(b)(v) - any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme

95. As a result of entering into Master Franchise Agreements and Loan Agreements, the applicants generated tax deductions sufficient to recoup the cash contributions each made to the project and retain a surplus. Mr Langridge's report, relevantly, details the tax effect of investment in the project. Mr Taylor's improved cash surplus position in the two years to the end of June, 1998 was $2,450.01 [Langridge report, page 47 at 8.2.4 and page 53 at 8.5], and Mr Athans' was $4,573.46 [Langridge report, page 50 at 8.3.4 and page 53 at 8.5]. The report also details the hypothetical investor paying tax at the top marginal rate contemplated by the project prospectus [Langridge report, page 51 at 8.4 and page 53 at 8.5].

96. At the hearing evidence emerged from Mr Taylor as to Mr Athans' entry into another tax effective investment. The tax effect of other projects entered into is not material to the question of whether Part IVA applies in respect of the deductions claimed by them in respect of their participation in the project. The deductions from Fishing Information Line franchises were of considerable value, particularly if other deductions claimed were not allowable. See
Commissioner of Taxation v Sleight 2004 ATC 4477; (2004) 136 FCR 211 per Hill, J at [88] and Carr, J. at [225]. Moreover, as Carr, J. observed in Sleight, at [224]: "on a proper construction of s 177D(b) the assessment should be made, in respect of this factor … as at the time of entry into the scheme. A reasonable person would be entitled to draw his conclusion about dominant purpose on the basis that the respondent entered into three schemes at one time and that each of those schemes would result (but for Part IVA) in the allowance of the deductions claimed."

97. Actual returns as shown by revenue statements [A29-A37] were:

" Mr Taylor - Franchise Number 073:

30 June 1998 - revenue $2,388.25 was applied to the loan balance [A29, 30, 32].

30 June 1999 - revenue was $40.59 less fees of $12.19 and of the difference $18.47 was applied to the loan balance leaving a remittance to the franchisee of $9.94 [A31- 32].

31 December 1999 - revenue was $6.08 less fees of $3.04 and of the difference $1.98 was applied to the loan balance leaving a remittance to the franchisee of $1.06 [A33-34].

30 June 2000 - revenue was $9.37 less fees of $4.69 and of the difference $3.05 was applied to the loan balance leaving a remittance to the franchisee of $1.64 [A37].

Taylor & Athans partnership - Franchise Number 072

30 June 1998 - no statement was provided but see Mr Langridge's analysis [Langridge report page 49 at 8.3.3] from which he infers that a distribution of $361.85 was made.

31 December 1999 - revenue was $431.09 less fees of $215.54 and of the difference

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$140.10 was applied to the loan balance leaving a remittance to the franchisee of $75.44 [A35-36]."

98. As already noted beyond the required cash contributions, the applicants did not have to contribute any more money. All fees payable were to be recouped only from such gross income as the franchises might generate. Similarly, principal and interest repayments on the balance of the loans were payable only from future franchise income.

99. The franchises have not generated income sufficient to cover those costs to date. Accordingly, the Applicants' participation has not resulted in any change in their financial position beyond any surplus created by the claimed tax deductions.

100. In Commissioner of Taxation v Sleight the Court contrasted the availability of tax deductions with the uncertainty of the investment yields which the project there might realize: see (2004) 136 FCR 211 per Hill, J at [88], [93], [94] and per Carr, J. at [216], [226] - [227].

101. In this matter beyond the cash advantages afforded them by the tax savings, it could not be reasonably expected that there would be any material change in the financial position of the applicants and other participants as a result of their participation as franchisees.

102. As previously stated the evidence shows that the Franchised Businesses:

  • (a) were supported by an underlying business which had little substance. At best, it was a start-up business with an innovative product and, hence, inherently risky. See IM at 5.0 Caveat On Projections - T89, V2/314] ;
  • (b) did not have a workable structure capable of successful exploitation by intending franchisees.

This is clearly shown by the analysis in the table summarized at paragraph 22 above.

103. The Cash Flow Projections in the IM were unreliable. As Mr Langridge reports, the assumptions on which the projections were based are not stated. The main driver of the projections was gross revenue with other costs determined as a percentage of gross revenue. The base revenue was determined using 1998 figures that implied a significant increase on historic revenue, and the base figures were then projected using arbitrary compound growth percentages. Although there are references to deriving these figures from internal databases and market research, no such material has been provided [Langridge report at 5.2.2, page 32 and at 5.3, page 37.

104. In light of the above deficiencies in the Cash Flow Projections, the analysis of them made by the applicants witness Mr Paikos, taking them at face value, is not realistic as Mr Langridge's report clearly demonstrates at pages 33-37.

105. On the face of the Cash Flow Projections in the IM the bulk of the commercial return shown by the projections is in the last 10 years of a 20 year projection with the inevitable decrease in reliability of looking that far into the future, as the applicants' witness Mr Correia indeed points out. Accordingly, the principal return to participants clearly lay in the tax savings/net cash position provided by the up-front tax deductions [Langridge Report at pages 52 and 41].

106. It appears to the Tribunal that in the end, participants in the franchise arrangements could not reasonably expect any material return beyond the early tax benefits their participation yielded. On the evidence the Franchised Business and the underlying business on which the franchises would rely were start up businesses providing an innovative service. There was no history or track record for the underlying business or for a franchise operation of this kind.

107. On the other hand, because of the early tax benefits they expected and the limited recourse terms of the loan, it appears that investors could participate in the project without any risk to their own funds. Accordingly, participants could take a chance on the commercial performance of the franchises. Actual performance was of limited concern. Any return which might ultimately be achieved was an additional benefit but by no means certain compared with the expected tax benefits.

108. In that context, the likely unsatisfactory commercial return from a Franchised Business is an additional factor pointing to the requisite taxation purpose for the purposes of section 177D(b). However, even if the Tribunal were to

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find that franchisees could expect a satisfactory commercial return, a contrary conclusion would not necessarily follow.

109. In the Tribunal's opinion, the comparison of different rates of return is immaterial. It is, therefore, inappropriate, for example, to compare rates of return indicated by the projections here with returns predicted for the project in
Commissioner of Taxation v Cooke 2004 ATC 4268; (2004) 55 ATR 183, at least without an understanding of the risks of the project there. In Cooke the Court's consideration of the commercial viability of the project was restricted to the prospectus without more: see (2004) 55 ATR 183 at [19], [72], [98] and [100]. As the evidence here shows, the predicted returns are not to be taken at face value.

110. It is significant that there are no other consequences to participants owing to the effects of the tax benefits and the non-recourse loan, as set out above, and see further below regarding the loan.

Section 177D(b)(vi) - any change in the financial position of any person who has, or has had, any connection (whether or a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme

111. Under the terms of the scheme documents the $10,000 cash payment received by the promoters from each of the participants was in effect funded by the Revenue through the tax savings and cash flow consequences of the deductions.

112. Under the terms of the Master Franchise Agreement and the Loan Agreement the promoters were to take most of the revenue derived from the business as follows: -

  • (a) under clauses 10, 11 and the definition of "Commission" in clause 1.1 of the sample Master Franchise Agreement - 25% of the Gross Receipts received by the Franchisor are retained by the Franchisor;
  • (b) under the definition of "Franchise Fees" in clause 1.1, clause 4 and the Franchise Fees Table of the sample Master Franchise Agreement - 5% of the balance would go to the Franchisor as ongoing fees;
  • (c) up to 20% of Gross Revenue was the allowance for the remuneration of an Approved Sales Agent [IM - T89, V2/313 at 3.6];
  • (d) then 65% of the remaining balance of the "Commission" was to go as loan repayments pursuant to the definition of "Loan Repayment" and clauses 3.1 and 5 of the Loan Agreement [IM - T89, V2/340-341]. In fact in the 1998 year 100% was taken not 65% [Langridge Report at page 19].

113. The evidence also shows that cash payments received from the sales of the franchises funded the underlying business operations of the promoter entities and were paid to external parties: by way of loan repayment to Equitable Funds Management Ltd and by way of distribution to ABC Investment Funds Management Pty Ltd a unit holder in the Fishing Information Line Australia Unit Trust (Franchisor): Langridge report at page 28.

114. Beyond the cash payments sourced from participants' tax savings, the financial position of the project entities did not change as a result of the scheme. Loan funds were not made available and were clearly not intended to be. [See the Langridge report at 3.4 pages 26-28 and at 2.3 pages 18-19].

115. As well, as previously noted the evidence shows that, the Lender had no substance. The Lender was incorporated in July, 1997 and had assets consisting of $2 of share capital [T22-, V3/75-]. Considered as a separate entity, which it purported to be, the Lender had little prospect of obtaining funds to make the loans it undertook, which were to its commercial disadvantage: -

  • (a) it proposed to make loans totalling $31,000 per franchise with repayment to depend upon the franchise yielding profits;
  • (b) franchisee fees were payable from the proceeds before interest and principal payable in respect of the loan [clause 11, sample Master Franchise Agreement T90, V2/332];
  • (c) interest was variable and could not exceed an amount equal to the amount repayable from the revenues of the Franchised Business [clause 4(b), sample Loan Agreement, T91 V2/339].

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  • (d) as already outlined, there was a real prospect that the income generated by the franchise would not be sufficient to ensure payments of interest and the balance of the principal of the loan.

Section 177D(b)(vii) - any other consequence for the relevant taxpayer, or for any person referred to in sub-paragraph (vi), of the scheme having been entered into or carried out.

116. In the opinion of the Tribunal it is significant that once the Master Licence Execution Sheets were signed and the cash payments made on application and pursuant to the terms of the short term loan agreements there were no other consequences financial or otherwise for the applicants in entering into and carrying out the scheme. Certainly nothing further was demanded from them.

Section 177D(b)(viii) - the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in sub-paragraph (vi).

117. There was a business connection between the applicants and the Fishing Information Line entities, albeit that as already stated the exact nature of the connection is unclear.

Section 177D(b) conclusion

118. The Tribunal concludes that the above consideration of the section 177D(b) factors reveals that the scheme "took such a form that there is a particular scheme in respect of which a conclusion of the kind described in s 177D is required, even though the particular scheme also advances a wider commercial objective":
FCT v Hart 2004 ATC 4599; (2004) 217 CLR 216 per Gleeson CJ and McHugh J at [16], and further as set out as above showing that in the consideration of each of the section 177D(b) factors, the following aspects of the scheme emerge as extraneous to the substance of an investment in a commercial franchise: -

  • (a) large up-front charges designed to be of a revenue character -
  • (b) funded by a loan -
  • (c) made on limited recourse terms; and
  • (d) ongoing franchise fees to be met only from the proceeds of the project.

119. In the event, the evidence shows that commercial performance of the franchises was not material. The tax savings covered the initial payment obligations. Further payments, in respect of the loan and franchise fees were to be met only from the proceeds of the Franchised Businesses. Accordingly, the applicants and other participants would keep the benefit of the tax savings without further risk and regardless of the outcome of the franchises.

120. On the basis of these matters alone, the Tribunal finds that the scheme was entered into or carried out with the dominant purpose of obtaining tax benefits. Even if the scheme could be said to have a commercial intention or satisfactory commercial outcome the above features by which participants risked none of their own funds, were its primary attraction in the Tribunal's opinion.

121. The Tribunal also notes the following additional features here:

The evidence is that the applicants were not likely to secure an acceptable commercial return. The Franchised Businesses:

  • (a) were supported by an underlying business which had little substance. At best, it was a start-up business with an innovative product and, hence, inherently risky. See IM at 5.0 Caveat On Projections - T89, V2/314];
  • (b) did not have a workable structure capable of successful exploitation by intending franchisees; and
  • (c) were supported by Projected Cash Flows (V2/363) which could not be adequately assessed because they contained no indication of the assumptions on which they were based.

122. Even if the Tribunal found to the contrary, a contrary conclusion as to purpose would not be warranted in its opinion. To focus on whether the predicted returns were satisfactory or likely to be achieved begs the question posed by section 177D(b), as Hart indicates. There, Mr and Mrs Hart borrowed funds for, inter alia, an investment property. There was no question that the funds were borrowed for a commercial purpose or that they would secure an acceptable commercial return.

123. Accordingly, even a likely commercial return to participants from their entry into the

ATC 2034

scheme ought not to outweigh the features referred to above. In this respect, it should be noted that the poor returns which the investors in Sleight and Calder might have expected, apart from the savings afforded by their tax deductions, sat with a series of other matters which founded the respective Courts' conclusions. See Sleight, per Hill, J. at [77] - [83], [88] and Carr, J. at [211] - [216] and [225] - [227] and Calder at [78].

124. Accordingly in the Tribunal's view, it would be concluded that the sole or dominant purpose of the applicants in undertaking the obligations incurred by them was to generate a large up-front tax deduction resulting in tax savings to them which were sufficient to fund the cash payments they were required to make in respect of their participation, whilst leaving them with improved cash surplus positions in the two years to the end of June, 1998, being $2,450.01 for Mr Taylor [Langridge report, page 47 at 8.2.4 and page 53 at 8.5]and $4,573.46 for Mr Athans $4,573.46 [Langridge report, page 50 at 8.3.4 and page 53 at 8.5].

125. Alternatively, it would in the opinion of the Tribunal be concluded that the sole or dominant purpose of Fishing Information Services Pty Ltd, Fishing Information Line Australia Pty Ltd Unit Trust, Fishing Information Line Finance Pty Ltd, Fred Heinze, Kahl Heinze and Equitable Funds Management Ltd, in entering into or carrying out the scheme, was to obtain a tax benefit for participants in the project, including the applicants. The case law makes it clear that it is not to the point that the overall commercial objective of the promoter entities was to make money. They achieved their commercial purpose by creating a structure to which the attractiveness of the tax advantages it secured was central. Obiter comments made in the Full Federal Court decisions in Vincent at [100] and Sleight at [95]-[96] must now be read in light of the High Court decision in Hart.

Conclusion with respect to Part IVA

126. It follows from the foregoing that, in respect of the 1997 year the respondent was authorised and entitled under section 177F(1)(b) of the Act to determine that the tax deductions claimed by each applicant in each of 1997 year were not allowable. The applicants have in the opinion of the Tribunal comprehensively failed to discharge the onus which rests on them to show that the relevant assessments were excessive.

Cash outlays

127. As the Tribunal has found that the payments made by the applicants are not deductible under section 51(1) there is no basis for the Tribunal to follow the reasoning in
Commissioner of Taxation v Sleight (2004) 136 FCR 211 per Hill J at [112]-[115] (Hely J agreeing) and per Carr J at [246]. There the Court took the view that in the exercise of discretion under section 177F(1)(b) of the Act cash payments made by the respondent were to be allowed as deductions, having decided that the deductions were otherwise allowable under section 51(1). That is not the case here.

Decision

128. The applicants have not discharged the onus which lies on them under Paragraph 14ZZK(1)(b) of the Taxation Administration Act 1953 which requires that for the purpose of ascertaining their true income tax liability, the Tribunal must review whether the respondent's assessment is excessive, in the sense of assessing an amount greater than the taxable income on which tax ought to have been levied. Paragraph 14ZZK(1)(b) places on the applicants the onus of satisfying the Tribunal that the amount assessed is wrong and is greater than their actual substantive liability under the terms of the Income Tax Assessment Act 1936. See
FCT v Dalco (1990) 168 CLR 614 at 621 and 625. The applicants have failed to do so.

129. The Tribunal accordingly affirms the decisions of the respondent under review in relation to both applicants.


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