-
The impact of this case on ATO policy is discussed in Decision Impact Statement: O'Brien v Commissioner of Taxation (Published 8 July 2008).
O’BRIEN v FC of T
Members:SC Fisher M
Tribunal:
Administrative Appeals Tribunal, Brisbane
MEDIA NEUTRAL CITATION:
[2008] AATA 86
SC Fisher (Member)
Introduction
1. Mr Denis Ronald O'Brien (the Applicant) is a Chartered Accountant by profession.
2. For the fiscal years ended 30 June 1997, 30 June 1998 and 30 June 1999, the Commissioner of Taxation (the Respondent) disallowed objections by the Applicant against the Respondent's decision to make Part IVA determinations varying the assessable income of the Applicant.
3. The decisions under review before the Tribunal are decisions made by the Respondent on 14 October 2005 and 27 October 2005 which disallowed, in part, the Applicant's objections against assessments in relation to the fiscal
ATC 2014
years ended 30 June 1997, 30 June 1998 and 30 June 1999. These objections were made on behalf of the Applicant on or about 6 August 2001.4. These applications are governed by the Income Tax Assessment Act 1936 ("ITAA 1936"), in particular Part IVA.
Background
5. The Applicant lodged income tax returns for the financial years ended 30 June 1997 on 24 April 1998, 30 June 1998 on 23 April 1999 and 30 June 1999 on 17 May 2000. The Applicant was issued with Notices of Assessment on 1 May 1998 (1997 fiscal year), on 6 May 1999 (1998 fiscal year) and on 25 May 2000 (1999 fiscal year).
6. The Respondent issued Amended Assessments on 13 June 2001 and 18 July 2001 disallowing deductions claimed in the earlier income tax returns. On 24 April 2001 and 27 April 2001 the Respondent made determinations pursuant to s177F of the ITAA 1936 in respect of the Applicant.
7. On or about 6 August 2001 the Applicant submitted Notices of Objection against the Amended Assessments.
8. On 14 October 2005 and 27 October 2005 the Respondent disallowed the objections of the Applicant.
9. The Applicant then commenced these proceedings in this Tribunal.
Transactional history
10. The underlying facts to this application are not in dispute.
11. The Barkworth Olive Groves Project was promoted by the companies associated with the Barkworth Group, including Barkworth Management Ltd and Barkworth Olive Groves Ltd in March 1997. The object behind the Barkworth Olive Groves Project was to establish olive groves on a commercial scale in Australia.
12. The promoters of the Barkworth Olive Groves Project sought to raise capital by issuing shares to interested investors. Shares were issued by Barkworth Olive Groves Ltd, which appointed Barkworth Management Ltd to manage the land, trees and harvesting and marketing for members/growers.
13. Attached to the shares on Barkworth Olive Groves Ltd were rights to occupy and farm a defined portion of land which effectively made the shareholder a grower. By purchasing shares in Barkworth Olive Groves Ltd, members could acquire an interest in property owned by the relevant companies.
14. If a shareholder exercised a right to occupy land owned or managed by the Barkworth Olive Groves Project companies, a Management Agreement was entered into between the shareholder, Barkworth Management Ltd, the Australian Rural Group Ltd (the trustee company), and Barkworth Olive Groves Ltd. The Management Agreement committed the shareholder to paying management fees and the purchase price for the supply of various agricultural items. If required, a subscriber could obtain finance from Barkworth Finance Pty Ltd by means of a Loan Agreement, supported when necessary by a Loan Indemnity Agreement. These payments would be made to meet other financial commitments subscribers owed under the investment proposal.
15. Another similar agricultural finance venture was promoted by the Barkworth Olive Groves Project group of companies in March 1998. Broadly speaking, its features are similar to the March 1997 project. It is not necessary for the details of this project to be recited in any detail in this decision.
Issue
16. The central issue in this matter is whether the Respondent was correct to cancel a tax benefit in the nature of deductions for expenditure made or incurred by the Applicant and raise amended notice of assessments under Part IVA. The Respondent accepted that cash payments made by the Applicant were properly deductible[1]
Part IVA determinations
Barkworth Olive Groves Project Number 1
17. Fiscal year ended 30 June 1997: $33,802 being a tax benefit that is referable to a deduction is not allowed. This determination was made on 24 April 2001. Fiscal year ended 30 June 1998: $32,446 being a tax benefit that is referable to a deduction is not allowed. This
ATC 2015
determination was made on 24 April 2001. Fiscal year ended 30 June 1999: $26,608 being a tax benefit that is referable to a deduction is not allowed. This determination was made on 24 April 2001.
Barkworth Olive Groves Project Number 2
18. Fiscal year ended 30 June 1997: $10,857 being a tax benefit that is referable to a deduction is not allowed. This determination was made on 27 April 2001. Fiscal year ended 30 June 1998: $7,005 being a tax benefit that is referable to a deduction is not allowed. This determination was made on 27 April 2001. Fiscal year ended 30 June 1999: $10,857 being a tax benefit that is referable to a deduction of the Applicant is not allowed. This determination was made on 27 April 2001.
Evidence on behalf of the Applicant
The Applicant prepared the Estate Succession Planning Blueprint (ESPB) Synopsis[2]
19. In cross-examination, the Applicant said that he recommended the project of March 1997 to five of his clients who ultimately became investors. Thirty of his clients became investors in the March 1998 project.
20. Mr Douglas Pollard[3]
21. Mr Pollard described the contents of the seven prospectuses issued by the Barkworth Group of companies as follows:
- (a) Fixed operating costs per farm to operate for two to three years with approximately 50% paid by a member/grower and 50% from a mix of cash, five year loans, indemnity money, and other loans.
- (b) Member/grower given the option to pay 100% of the operating costs of the farm.
- (c) Finance offered in the following ways:
- • Five years for all prospectuses.
- • With the 1997 and 1998 (Project 1- A -2), a finance option was in the form of a special cost to receive an indemnity that, should the sale of produce be insufficient to repay the loan over the life of the right to farm (20 years), any balance owing would be met by the manager.
- • With 1999 (Project 3), while no indemnity was offered, the member/grower had the option to rely on the sale of produce to repay the loan with any remaining debt to be repaid in year 20 or upon ceasing to carry on a business, whichever is the earlier.
- (d) With grower costs and processor costs being variables and subject to risks of farming, provision was made to quarantine the grower from these costs by entering into a Management Agreement. Here, such costs were to be incurred by the management company in exchange for a percentage of the crop.
- (e) Advice that the group was in the process of expanding by way of settlement of the first property, purchase of other properties, and establishing equity in processing factories in order to expand to a size sufficient to establish economies of scale.
22. The majority of members/growers took advantage of the offers in Prospectus 1-A-2, 3. Subsequent to Prospectus 3 the limit to loans was five years, as financed by Barkworth Finance Pty Ltd.
23. For Prospectus 1-A-2 and 3, the Boards considered that with a reasonable mix of applications for cash, five year loans, and indemnity money and with a reasonable number of applications there would be sufficient cash flow to finance the development responsibilities until cash was generated from crops.
24. The funds owing would be by way of a debt owed by members/growers to Barkworth Finance Pty Ltd. The debt represents profit to the management and the Board. It is not unreasonable to defer payment of the debt until the sale of crops from the Barkworth farms. The cash flow from the book profit was subject to the performance of management, as per the Management Agreement with running costs assessment by management after three years in exchange for a percentage of the crop.
25.
ATC 2016
The Business Plan in the prospectus showed promise in its projections and expert opinion gave support to the key aspects of the Business Plan. The promoters considered that it was not unreasonable to offer:- (a) Management Agreement terms to isolate growers from farming costs;
- (b) Offer indemnity on the loan for a fee;
- (c) Loan funds the recovery of which was subject to cash flows from crops and profits from processing own and crops purchased from non-Barkworth growers, eg Australian Olive Company.
26. The Boards' immediate and long-term plans to make profit from the larger picture of three properties over three different geographic areas with processing facilities and marketing arrangements servicing some 500,000 olive trees.
27. Mr Pollard commented as follows in his evidence on some documentation provided by the Applicant:
"I have read the Strategy for Appeal as prepared by Denis Ronald O'Brien.
His methods of identification of low to non-risk versus risk through the use of the ESPB clearly identifies the shift of the risk and reflects a key element which we were attempting to portray with the use of the Management Agreement and Indemnity Agreement and structuring generally.
The Business Plan was based on independent authoritative opinions and well supported by experts as is depicted in each Prospectus. The structuring and supporting agreement as adopted were as recommended to us by experts and appropriate for the status of the Business Plan. At no time was there to be any artificial loss producing exercise to pass on to growers.
The dominant purpose at all times was to establish a leading position in Australia in the growing, processing and marketing of olives and to maintain that leading position. The time element was considered to be related to the time it took to:
establish at least five hundred thousand (500,000) trees over three (3) farms positioned to survive adverse climatic conditions;
processing factories;
marketing
and that with satisfactory structuring for management to control the group and reap the appropriate rewards through performance.
At no time has there been any dominant intention to establish a tax benefit for myself nor the promoters nor growers."
28. Mr Pollard's evidence in chief continued:
"The use of an 'Indemnity Agreement' other than the cost of some $300 for each farm of 20 trees did not establish any additional tax deduction to the grower. Its major purpose was to send the message of 'management' confidence in the Business Plan such that 'management' in exchange for #00 would assume responsibility for their debt after growers paid fixed costs for three years. With project 1 (1997) the investor was a grower only and needed to be aware of 'management' confidence in the absence of any profit from processing. Such 'indemnity' would not be called upon should the Business Plan come to pass. The Business Plan projections provided for repayment of the loan after distribution of 50% of the net profit after management's share of any crop going to the grower after fourteen years with the remaining six years providing substantial cash flow for the investor.
The 'indemnity' was an appropriate strategy by the promoters in light of the favourable Business Plan and the venture into the industry on the scale proposed not having been done prior to 1997 and it being the inaugural year.
Some 27% of investors did not take up the 'indemnity' and it may be they did not take up the offer as they did not consider it worth $300 for 20 trees in view of the Business Plan. Further still some of the 27% may have considered it unnecessary.
With Project 3 in 1999 7,400 farms were taken up in the absence of any offer of any
ATC 2017
indemnity and for Projects 1 - A - 2 there were some 7,623 farms taken up of which 27% of the investors did not take up any indemnity."
Evidence for the Respondent
29. The Respondent relied on evidence from Mr Trevor Wenzel, Senior Compliance Officer, Australia Taxation Office[4]
30. Mr Wenzel gave evidence that:
"The general investors in Barkworth Olive Grove Project No 1 (BOGP) and Barkworth Olive Grove Project No 2 (BOGP2) would not and could not have known about the information and documents that I had access to and was able to consider.
Additional entities involved in BOGP2 were Rural Services & Marketing Pty Ltd and Rural Services & Marketing Pty Ltd as trustee for the RSM Trust, for which financial statements are not publicly available. Investors in BOGP2 would not have been aware of the involvement of these additional entities.
Additionally, investors would not have been aware of the Contractor Agreement and the Delegation Agreement.
The use of non-public companies meant that the financial transactions entered into within the Barkworth Group would not have been known to the general investors.
The round robin set of transactions from the records of the respective companies would not have been known to investors as a non public company interposed between the public companies was one of the entities used for the round robin flow of funds.
The round robin transactions used cleared funds through the use of an overdraft facility with the Bank of New Zealand, which appears to have been available from 26 June 1998 and closed on 1 July 1998.
The overdraft facility funds were used as the source of funds for loans to investors. The overdraft facility only lasted for a matter of days. The financial statements of the entities in Barkworth do not disclose any alternative funding.
The report and attachments indicate the contrived nature of aspects of the arrangements entered into by investors with Barkworth entities, and who took up the financing option under the prospectus in BOGP2."
Discussion of the evidence and task of the Tribunal
Applicant's submissions
31. The Applicant's contentions are identified below.
32. The Applicant relies on the following conduct:
- (a) Attending seminar
- (b) Attending analysis of Prospectus to evaluate investment, particularly risk
- (c) Satisfied as to integrity of the Business Plan structuring.
- (d) Satisfied that the structuring provided for promoters to defer receipt of any profit element of their fee to carry out their contractual obligations until they fulfilled those obligations by way of crop and processing.
- (e) Satisfied that further Prospectuses would issue with consistent costing.
- (f) Invested in 1 - A - 2 -3 and taken up 2:1 rights issue (no tax deduction) in 2001 and additional AB Class shares (no tax deduction) in 2004.
33. The Applicant's understanding of the Barkworth Group position includes the following:
- (a) A sound Business Plan.
- (b) The integrity of the Business Plan was evident in the structuring in that there were sufficient profits to support the structure.
- (c) The Business Plan satisfied the essential element for risk ventures by giving the option to investors to trigger deferment of the cash flow of most of the promoters profit until the crops were able to be processed and sold.
- (d) They did not offer any more tax deduction to IGP's in their offer for the indemnity than was offered if no indemnity was taken up by option.
- (e) They showed their confidence in their projections by putting the equivalent of their profit element into the indemnity thus quarantining IGP's from risk at a reasonable cost to IGP's.
ATC 2018
34. The Applicant's understanding of the structure of the Barkworth Group:
- (a) The Barkworth Group established a Business Plan beyond a ten year period which was based on third party expert opinions.
- (b) Doug Pollard, the CEO of the Barkworth Group, graduated as an engineer from the University of Queensland. He has spent considerable time in irrigation. He had not been part of any promotion to the public of any project.
- (c) The Business Plan was viable. The Business Plan passed the satisfactory test.
- (d) The Barkwroth Group, following consultation with financial advisers, resolved a form of structuring appropriate to accommodate
- (i) The recommended source of subscriber funds ie., the type of subscriber
- (ii) Permit normal tax deductions to subscribers as provided in the Income Tax Assessment Act 1936 as amended in their capacity of farmers and processors
- (iii) Preserve the integrity in the business plan in the structuring.
- (e) The Barkworth Group established a costing for the subscriber market such that consistency would apply on a year to year basis.
35. The Applicant's understanding of the sources of Barkworth Group profit is that it is sourced from three areas. The first source from the economies of scale that would arise where a large number of farms could be established. There are certain fixed costs such that where a small number of farms had to be developed that budget cost may be exceeded. As the number of farms increases the cost per tree should reduce substantially and so a profit may emerge available to the Barkworth Group through one or more members of the Group according to the duties it had to perform. Any surplus from the establishment of the farms may be needed to finance the Barkworth Group obligations under the share farming agreements and share processing agreements.
36. These agreements provide for the available crops and the processing of same and processing of buy in crops to be made available to the Barkworth Group to produce a second source of profit. Again economies of scale arise. The business Plan expert opinions supported sufficient yield from farm crops and buy in crops and the processing of both to produce a profit to the Barkworth Group.
37. The third source of profit would arise from the control of BOGL by the Barkworth Group. The prospectuses do not specifically provide for a Barkwroth Group profit. Their profit, if any, is appropriate for their risk. Their profit comes from the three sources and is subject to their performance.
38. The Barkworth Group profit, if any, could thus be said to arise upon from the group's ability to attract investors and provide finance where appropriate, develop the farms efficiently, produce crops and buy and process crops, manage BOGL.
39. The Barkworth Group has developed and maintained three farming properties with some 375,000 trees and invested in two factories and promoted the Viva Olive Oil Brand from the funds provided by investors - growers - processors and their own funds. There are no other debts. At $457 per tree for some 375,000 trees there were total subscriptions by cash or debt of some $171,375,000. The profit to the Barkworth Group is that figure less all costs at any one time.
40. Some of the Barkworth Group's profit may have arisen from the cash contribution by investors - growers - processors (IGP) to date. The balance of any profit would be subject to the quantum of crop from the farms and/or brought in and the processing of both and how soon it is done.
41. The Barkworth Group profit is on paper, part cash and balance on performance. The Barkworth Group has deferred most of their profit cash flow until they and the industry come up to the performance expectations they promoted. The performance expectations were based on the business plan which was considered as appropriate. The promoters are entitled to a profit of generous proportion where they take such risks but only if they succeed.
42.
ATC 2019
In regards to the net tax position, the evidence of Trevor Wenzel was not part of relevant facts. A very high percentage of the $171,375,000 was tax deductible. At the same time BML and BOML did include such amounts as assessable income. From the evidence of Trevor Wenzel, BML and BOML contracted out the bulk of the work and recorded an expense in doing so and claimed a deduction for that expense. This process is separate and distinct and not part of the process of issuing prospectuses for the development of olive farms for IGP's. It should not influence the outcome of dominant intention as it pays no part.43. IGP's in the prospectuses for 1 + A + 2 would have been concerned with:
- (a) absence of any track record from the Barkworth Group members;
- (b) absence of any large developments in the olive oil industry in Australia and resulting statistics;
- (c) risks associated with being an IGP;
- (d) the risks associated with agricultural pursuits;
- (e) motivation for the Barkworth Group through BML to ensure that processing came on line as fast as appropriate as IGP income depended upon not only crop produced and processed internally but also the buy in of outsider crops and processing which together gave processing equivalent at 75 kgm per tree ie., 1.5 tonne per farm of 20 trees. The prospectus did show profit and cash flow available;
- (f) where the IGP paid cash in less than 5 years to the promoter the promoter could be distracted form the course of (e) as he would have already received a substantial cash flow. The result would of course be less cash available as return on investment than as projected to the IGP;
- (g) where the IGP took out a loan and exercised the conditional option for an indemnity then the Barkworth Group through BML would treat as a priority the need for 'cash in flow' from produce and processing whether the olives processed were from the farm of 20 trees or purchased from outside growers. The Barkworth Group would ensure that processing at the equivalent rate of 75 kgm per tree would be a priority to ensure sufficient cash flow to provide for:
- (i) repayment of any Barkworth Group cash advances over and above that cash as contributed by the IGP to develop and sharefarm the operations;
- (ii) payment of Barkworth Group profit outstanding being that part of BFPL internal loan to BML;
- (iii) paying interest on development loan and applying the profit as to 50% to reduce loan from BFPL and 50% distribution to IGP.
- (h) Promoters cash flow limited to risk capital (ie., direct costs and excluding Barkworth Group profit element) until they fulfil the business plan projections.
44. The Barkworth Group was well aware of what the IGP'S would consider as key concerns. Any structuring to alleviate those concerns and at the same time maintain the integrity of the business plan would be of utmost importance to attract IGP's. Further still that IGP's would be no different from any other investor placing their money with a promoter of an agriculture pursuit in as much as the structuring should provide that promoters should only make their profit from the successes of the promotion and in the meantime remuneration should be of modest proportion until they had a track record of successes. Further still again that the prospectuses were to be over a number of years, as provided in the Business Plan, and that costing must be kept consistent. To do otherwise would breed discontent in the existing investors and establish a resistance to apply under subsequent prospectuses for additional farms and/or for shares alone.
45. With the Barkworth Group's awareness of IGP issues the Barkworth Group chose to adopt the strategy of extending the quarantining of risk through the use of sharefarming and processing agreements to the development area of the farm. The Barkworth Group did offer at $300 per 20 trees an insurance or indemnity that BML would take over the risk should the IGP put the loan in a more acceptable state to support the offer. The Barkworth Group already
ATC 2020
controlled the future cash from the crops and their processing and that BFPL would have no difficulty in the administration of such an offer.46. All other applications were paid by IGP's in less than five years. The cash funds from this source and from cash contributions by IGP's who had loans and indemnities was used to purchase, develop and sharefarm all applications. Any shortfall of cash was provided by the Barkworth Group on a continuing basis subject to cash inwards from crops and processing. The only unpaid debt was that owing to the Barkworth Group. The quantum of Barkworth Group profit was subject to its performance as outlined more particularly at (5) above.
47. In essence where full control rested within the Barkworth Group the loan and its indemnity is a quantifiable amount based on fair and reasonable costing. The indemnified loan in essence represents part of the profit entitlement of the Barkworth Group which is subject to their ability to perform and is considered fair and reasonable under all the circumstances and fully capable of repayment over 14 years of the 20 year farming and processing agreements.
48. The dominant intention to carry on a business for the purpose of profit to IGP and the Barkwroth Group and not for purpose of establishing a tax benefit. The ATO has disallowed any tax deduction to the extent of that loan upon the basis as shown in A above where reference is made to the Respondent's Case.
49. The indemnity did not create any additional tax deduction resulting from the application under the prospectus. The cost of $300 per twenty trees for the indemnity has been allowed as a tax deduction.
50. The indemnity did establish:
- (a) a shift of risk from IGP's to the promoter group as depicted on the ESPB as included in A(2) above;
- (b) a more pressing need on the Barkworth Group to indentify with the processing capacity of 75 kgm per tree and perform along the lines above in order to produce cash to reduce the indemnified loan and make distributions to IGP's.
51. There is sufficient evidence to support a case that the dominant intention was not to provide a tax benefit but rather to place the IGP's in a less risk position whilst the Barkworth Group performed and recoupled the indemnified loan monies through their performance.
52. Should the Business Plan have been based upon a less promising industry eg., growing pineapples at the bottom of the Pacific Ocean, then the structuring as adopted in the prospectus would not have taken on board the integrity of the Business Plan and the allegation by the ATO of the dominant intention may have been much closer to the truth.
53. The Commissioner of Taxation in his submission of 29/09/06 at Clause 56 claims that the Produce Ruling as provided by him on subsequent projects can have no bearing on Projects 1 - A - 2 being the matter before the AAT. The purpose of reference to those product rulings is to, by comparison, bring into focus the reality of 'loans' based on the same costings.
54. The Commissioner claims in his submission that all that remains to be determined is the quantum of the loan to be deductible plus what are the specific costs for the first three years.
55. The applicant's submission is that the 'loans' which were indemnified were real and were maintained and were capable of repayment under the contractual control of the Barkworth Group over all or part of 20 years.
56. The applicant's further submission is that the 'loan' established payment to the Barkworth Group which they would have included as assessable income as and when the 'loan' was made."
Respondent's submissions
57. In general, the Respondent conducted a bifurcated case. The Respondent accepted that cash payments made by the Applicant were properly deductible, but it was the financed payments which were not.
58. In this matter there were two primary schemes, one for each project, the Barkworth Olive Groves Project ("BOGP") and Barkworth Olive Groves Project No. 2 ("BPGP2), and further schemes for each
ATC 2021
additional income year that each respective project covers. Put another way, there was a scheme within the meaning of Part IVA for each application before the Tribunal.
Barkworth Olive Groves Project (1997-1999) ("BOGP")
59. In relation to the Barkworth Olive Groves Project, the first primary scheme, the Commissioner says the respective schemes for the income years ended 30 June 1997 to 1999 were as follows:
Income year ended 30 June 1997
60. The completion of the Application and Power of Attorney form contained in the Barkworth Olive Groves Limited ("BOGL") and Barkworth Management Limited Prospectus ("BML"), subscribing for 2,000 "A" class shares.
61. The completion of the "Option Form" and the selection of and entry into:
- • The management Agreement by BOGL as agent with BML;
- • The selection and exercise of the 'Loan option' to borrow a total of $35,000 which was to be used to pay for Year 1 Management Fees, fees for Drainage and Soil Erosion Control Works and fees in respect of the Irrigation System ("the finance payments") as itemised I paragraph 7.4 below; and
- • The selection of the option and entry into an Indemnity Agreement with BOGL acting as agent.
62. The payment by the Applicant of the following fees:
| Olive Tree Purchases | $ 160 |
| Management Fee | $ 660 |
| Farm Administration Fee | $ 700 |
| Interest | $4,376 |
| Loan Indemnity Fee | $1,200 |
| Total | $7,096 |
63. The payment by the Applicant of the following amounts ("the financed payments") through the use of the finance option contained in the prospectus:
| Irrigation System | $ 4,066 (total for 4 farm units) |
| Erosion Protection Works | $11,460 (total for 4 farm units) |
| Year 1 Management Fee` | $11,340 (total for 4 farm units) |
| Total | $26,866 |
64. The claiming of all the amounts referred to above as deductions in the income year ended 30 June 1997.
Income year ended 30 June 1998
65. All the previous steps for the year ended 30 June 1997 and the further steps outlined below:
The payment by the Applicant of the following fees:
| Year 2 management Fee | $ 7,000 |
| Farm Administration Fee | $ 600 |
| Interest | $ 2,900 |
| Principal Repayment | $ 6,000 |
| Total | $16,500 |
66. In addition to the above amounts paid by the Applicant and pursuant to Prospectus "A", the Applicant also paid the amount of $14,840 for processing capacity in the factory owned and operated by a member of the Barkworth Group of companies (Inglewood Processing Pty Ltd).
67. The payment by the Applicant of the following amounts ("the financed payments") through the use of the finance option contained in the prospectus:
| Irrigation System | $ 4,066 |
| Total | $ 4,066 |
68. The claiming of all these amounts referred to above as deductions in the income year ended 30 June 1998.
ATC 2022
Income year ended 30 June 1999
69. All the previous steps for the year ended 30 June 1997 and 1998 and the further steps outlined below:
70. The payment by the Applicant of the following fees:
| Year 3 Management Fee | $ 5,000 |
| Farm Administration Fee | $ 400 |
| Interest | $ 2,320 |
| Total | $ 7,720 |
71. The payment by the Applicant of the following amounts ("the financed payments") through the use of the finance option contained in the prospectus:
| Irrigation System | $ 4,068 |
| Total | $ 4,068 |
72. The claiming of all these of these amounts as deductions in the income year ended 30 June 1999.
Barkworth Olive Groves Project No. 2 (1998-2000): "BOGP2"
73. In relation to the Barkworth Olive Groves Project No. 2, the second of the two primary schemes, the Commissioner says the respective schemes for the income years ended 30 June 1997 to 1999 were as follows:
Income Year ended 30 June 1998
74. The completion of the Application and Power of Attorney form contained in the Barkworth Olive Groves Limited ("BOGL") & Barkworth Management Limited ("BML") Prospectus, subscribing for 500 "B" class shares.
75. The completion of the "Option Form" and the selection of and entry into:
- • the Management Agreement by BOGL as agent with BML;
- • the exercise of the 'Loan option' to borrow a total of $17,590 from BFPL which was to be used to pay Year 1 Management Fees, fees for Drainage and Soil Erosion Control Works and fees in respect of the Irrigation System; and
- • the selection of the option and the entry into an Indemnity Agreement with BOGL acting as agent.
76. The payment by the Applicant of the following fees:
| Olive Trees | $ 40 |
| Total | $ 40 |
77. The payment by the Applicant of the following amounts ("the financed payments") through the use of the finance option contained in the prospectus:
| Management/Processing etc | $ 5,350 |
| Factory Access Fee | $ 450 |
| Brand Licence Fee | $ 1,000 |
| Farm Administration Fee | $ 175 |
| Irrigation System | $ 1,017 |
| Erosion Protection Works | $ 2,865 |
| Total | $ 10,875 |
78. The claiming of all these of these amounts as deductions in the income year ended 30 June 1998.
Income year ended 30 June 1999
79. All the previous steps for the year ended 30 June 1998 and the further steps outlined below:
80. The payment by the Applicant of the following fees:
| Share Call | $ 450 |
| Loan Indemnity Fee | $ 400 |
| Principal Repayment | $ 3,250 |
| Interest | $ 888 |
| Total | $ 4,988 |
81. The payment by the Applicant of the following amounts ("the financed payments") through the use of the finance option contained in the prospectus:
| Management/Processing etc | $ 4,100 |
| Factory Access Fee | $ 450 |
| Farm Administration Fee | $ 150 |
| Irrigation System | $ 1,017 |
| Total | $ 5,717 |
82. The claiming of all these sums amend as per above as deductions in the income year ended 30 June 1999.
83. The Commissioner considered that it was not reasonably arguable that Part IVA did not
ATC 2023
apply so that 50% is the appropriate level of penalty. The Commissioner reduced this level of penalty to 10% in accordance with section 226E ITAA36 because it was accepted that the Applicant made a voluntary disclosure. The Commissioner does not consider that any remission of the whole or part of the penalty should be remitted under subsection 227(3) ITAA 1936.84. All the previous steps for the year ended 30 June 1997 and 1998 and the further steps outlined below:
85. The payment by the Applicant of the following fees:
| Year 3 Management Fee | $ 5,000 |
| Farm Administration Fee | $ 400 |
| Interest | $ 2,320 |
| Total | $ 7,720 |
86. The payment by the Applicant of the following amounrs ("the financed payments") through the use of the finance option contained in the prospectus:
| Irrigation System | $ 4,068 |
| Total | $ 4,068 |
87. The claiming of all these amounts as deductions in the income year ended 30 June 1999.
Barkworth Olive Groves Project No. 2 (1998-2000): "BOGP2"
88. In relation to the Barkworth Olive Groves Project No. 2, the second of the two primary schemes, the Commissioner says the respective schemes for the income years ended 30 June 1997 to 1999 were as follows:
Income Year ended 30 June 1998
89. The completion of the Application and Power of Attorney form contained in the Barkworth Olive Groves Limited ("BOGL") & Barkworth Management Limited ("BML") Prospectus, subscribing for 500 "B" class shares.
90. The completion of the 'Option Form' and the selection of and entry into:
- • The management Agreement by BOGL as agent with BML;
- • The exercise of the 'Loan option' to borrow a total of $17,590 from BFPL which was to be used to pay Year 1 management Fees, fees for Draining and Soil Erosion Control Works and fees in respect of the Irrigation System; and
- • The selection of the option and the entry into an Indemnity Agreement with BOGL acting as agent.
91. The payment by the Applicant of the following fees:
| Olive Trees | $ 40 |
| Total | $ 40 |
92. The payment by the Applicant of the following amounts ("the financed payments") through the use of the finance option contained in the prospectus:
| Management/Processing etc | $5,350 |
Legislation
Tax benefit - section 177C of ITAA 1936
93. Part IVA cannot apply unless a taxpayer has obtained, or would but for s177F of ITAA36 obtain, a tax benefit in connection with a scheme. Subsection 177C(1) defines four kinds of tax benefit, of which the second is relevant for present purposes. Paragraph 177C(1)(b) provides that the obtaining of a 'tax benefit' by a taxpayer in connection with a scheme shall be read as a reference to:
"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".
94. Subsection 177C(1) allows two ways of determining whether a tax benefit has been obtained in connection with a scheme. The first is that the relevant tax benefit would not have been obtained if the scheme had not been entered into or carried out. The second is that the relevant tax benefit might reasonably be expected not to have been obtained if the scheme had not been entered into or carried out. If it is possible to say that a tax benefit would
ATC 2024
not have been obtained but for the scheme, it is not necessary to refer to the reasonable expectation test.95. The identification of a tax benefit necessarily requires consideration of the income tax consequences, but for the operation of Part IVA, of an 'alternative hypothesis' or an 'alternative postulate'. This is what would have happened or might reasonably be expected to have happened if the particular scheme had not been entered into or carried out.
96. A reasonable expectation requires more than a possibility. In
Federal Commissioner of Taxation v Peabody 94 ATC 4663; (1994) 181 CLR 359 it was stated (at 385) that:
"A reasonable expectation requires more than a possibility. It involves a prediction as to events which would have taken place if the relevant scheme had not been entered into or carried out and the prediction must be sufficiently reliable for it to be regarded as reasonable."
97. The tax benefits identified in the Part IVA determinations are set out below. These figures represent the total of the claimed deductions for each income year, namely cash payments and financed payments. As the cash payments have subsequently been allowed the tax benefit for each income year has been adjusted by subtracting the cash payments from the total payments for each income year:
| Tax Benefit Cash Payments allowed | Difference (adjusted Tax Benefit) | ||
| 1997 | $33,802 | $7,096 | $26,704 |
| 1998 | $32,446 | $31,340 | $1,108 |
| 1999 | $26,608 | $7,720 | $18,988 |
| Barkworth Olive Groves Project No.2 | |||
| 1998 | $10,857 | $40 | $10,817 |
| 1999 | $7,005 | $4,538 | $2,467 |
98. The Commissioner considered that the tax benefit in connection with each scheme is the amount in the column headed 'Difference (Adjusted Tax Benefit)'. These amounts represent the financed payments in each income year.
99. The Commissioner submitted that the tax benefit would not have been obtained if the scheme had not been entered into.
'OBJECTIVE PURPOSE' - SECTION 177D
100. Section 177D provides that Part IVA applies to a scheme in connection with which the taxpayer has obtained a tax benefit if, after having regard to eight specified factors, it would be concluded that a person who entered into or carried out the scheme, or any part of it, did so for the purpose of enabling the taxpayer to obtain the tax benefit.
101. Section 177D refers to 'the purpose' of the person who entered into or carried out the scheme or any part of the scheme. The person need not be the taxpayer. Subsection 177A(5) clarifies that the 'purpose' includes the dominant purpose where there are two or more purposes.
102. The dominant of two or more purposes is the ruling, prevailing or most influential purpose[5]
103. It is possible for Part IVA to apply notwithstanding that the dominant purpose of obtaining the tax benefit was consistent with the pursuit of commercial gain[6]
104. It may be relevant in determining what objectively was the purpose of any person entering into or carrying out the scheme, or any part of the scheme, to have regard to the purposes of the advisers or other agents of any of those persons. This, of course, will be appropriate only where a person acts on professional advice and what was done on professional advice is relevant to considering the eight matters required to be considered in applying the purpose test in paragraph 177D(b) ITAA36.
105. The section requires the Commissioner to have regard to each of the eight matters in paragraph 177D(b) in reaching an objective conclusion about purpose. However, not all of the matters will be equally relevant in every case. The eight matters in paragraph 177D(b) are to be each individually taken into account for the scheme having regard to all the relevant
ATC 2025
evidence, and then weighed together, in arriving at the conclusion as to dominant purpose. Provided the eight matters identified in paragraph 177D(b) are each taken into account, it is possible to arrive at the conclusion as to purpose by making a global assessment of purpose.106. Consideration of the eight factors involves comparison of the scheme with the 'alternative hypothesis'. In other words, the conclusion about the dominant purpose of a person entering into or carrying out the scheme, or any part of it, necessarily requires consideration of what may otherwise have occurred.
Paragraph 177D(b)(i) ITAA36 The manner in which the scheme was entered into or carried out.
107. Both BOGP and BOGP2 were set up and promoted by Barkworth Olive Groves Limited in conjunction with other entities of the Barkworth Group of companies. The purpose of the prospectuses was to raise funds for the aims identified in the prospectuses.
108. The manner in which this was affected was to put forward an option to potential subscribers that provided large up front deductions due to the favourable tax consequences structured into the option. This option (the use of finance and the indemnity) maximised the tax deductions that might be claimed by subscribers.
109. The finance and indemnity option was taken up by the vast majority of investors under both projects.
110. The following are features of the schemes:
- (a) Where an indemnity was entered into the loan finance provided was limited recourse in that for BOGP a subscriber did not have to repay the loan after 3 years and after two years for BOGP2.
- (b) There was no real security for the loan provided by the subscribers. Where an indemnity agreement was also entered into the only security for the loan that was provided to the financier was the future interest in the income of the respective projects.
- (c) If the future income was insufficient then the indemnity agreement took effect to capitalise any outstanding amounts and upon termination date the indemnifier was required to make good the payments owing.
- (d) The underlying project (i.e. the commercial growing of olive trees, and additionally in BOGP2 the processing and marketing of the olive products) was funded from the cash contributions made by subscribers. The option that provided finance and the taxation benefits was not necessary for the underlying project evidenced by the fact that the actual funds that were available for the development of the olive groves did not include the 'financed payments'. The 'financed payments' were not necessary for the development of the olive groves. They were only necessary in order to provide taxation benefits.
- (e) The finance that was provided to investors in BOGP (some $3.6 million) existed within the Barkworth entities as a result of a series of round robin transactions. The amount that was lent significantly exceeded the total equity within the Barkworth group of entities.
- (f) The finance that was provided to investors in BOGP2 was available within the Barkworth Group as a result of contrived and non-commercial round robin transactions. The amount lent to investors exceeded the total equity of the Group by some $30 million. This amount was 'provided' with the use of 'cleared funds' by virtue of an overdraft facility arranged with the Bank of New Zealand for the sum of $36.5million commencing 26 June 1998 and finishing 1 July 1998.
- (g) The amount of funds available to develop and run both BOGP and BOGP2 projects was limited to the cash contributions of investors. The amounts that were borrowed and used to prepay specified expenses ('the financed payments') did not result in cash available to be used by the companies but were merely paper transactions at best.
- (h) The expected returns for investors in BOGP (as per the prospectus) from the project were non-existent in the early years. Further, from year 4 additional fees are payable to the manager as fees for performing the harvesting work either by way of cash to be paid by the investor or by paying a percentage of the income derived from the harvesting and processing of the olives,
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| BOGP | Return on Investment | % of income to be paid as fees |
| Year 0 | 0% | |
| Year 1 | 0% | |
| Year 2 | 0% | |
| Year 3 | 0% | |
| Year 4 | 0% | 90% |
| Year 5 | 0% | 90% |
| Year 6 | 0% | 60% |
| Year 7 | 2.2% | 50% |
| Year 8 | 6.5% | 40% (yr 8-20) |
111. The figures for BOGP2 are:
| BOGP | Return on Investment | % of income to be paid as fees |
| Year 0 | 0% | |
| Year 1 | 0% | |
| Year 2 | 0% | |
| Year 3 | 0% | |
| Year 4 | 2.5% | 90% |
| Year 5 | 4.6% | 90% |
| Year 6 | 10% | 60% |
| Year 7 | 15.1% | 50% |
| Year 8 | 21.9% | 40% (yr 8-20) |
Paragraph 177D(b)(ii) The form and substance of the scheme
112. The second factor, which examines 'the form and substance of the scheme', requires that substance, rather than form, be the subject of inquiry. Put simply the factor directs attention to whether there is a discrepancy between the form of the scheme and its substance, meaning its commercial and economic substance. A discrepancy between the business and practical effect of a scheme on the one hand, and its legal form on the other, may well indicate the scheme has been implemented in a particular form as the means to obtain a tax benefit if the substance of the scheme may be achieved or available by some other more straightforward or commercial transaction or dealing.
113. In considering the second factor in relation to the tea tree oil scheme in
Federal Commissioner of Taxation v Sleight 2004 ATC 4477; (2004) 206 ALR 511 Hill J (with whom Hely J agreed) stated (at 532):
"There is a difference between the form and the substance of the present scheme. In form there is an option whether to farm alone or to employ the management company. There is a management agreement and financing and interest payments. The form, involving pre-payment of management fee and interest is, it may be concluded readily, designed to increase the taxation deductions available to an investor. The substance is, however, quite different. As senior counsel for the Commissioner put it, in substance the investor is a mere passive investor in what, once the tax features are removed, is a managed fund where no deduction would be available, or perhaps an alternative characterisation of the substance of the scheme is an investment in shares in the land company which at the expiration of 15 years is to own the tea tree plantation.
With respect to the learned primary judge it is not correct to say that form and substance are the same. Rather the particular shape the investment took was clearly fashioned in a way that would maximise 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."
114. The Respondent submitted that the comments of Mr Justice Hill are equally applicable to the present case. The finance option in both BOGP and BOGP2 took its particular shape and was clearly structured in a way that would maximise the tax deductions for investors. But for the tax deductions the form the investment might have been expected to take would clearly relate more to the substance of what happened i.e. the amount available for
ATC 2027
the respective projects being the amount that was paid in cash.115. The form of the schemes differs substantially from the substance. The form of the schemes was that a subscriber borrowed money from a lender in order to fund investment in the respective projects as represented by the two prospectuses. In form the investors were in the business of growing olives. In substance the investors were mere passive investors who made cash contributions and obtained deductions for these and for amounts 'lent' to them.
116. In form the amount of money available to be used in the growing of olives included the cash contributions and the amounts paid by investors using the borrowed funds. In substance, due to the round robin arrangement, none of the purported loan moneys were available to the project manager to be expended on operations. The only moneys available were the cash contributions of subscribers. In substance the amount of the fees paid using the borrowed funds cannot have been required to fund the operations of the projects.
Paragraph 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.
117. Subscribers made payments to BOGP and BOGP2 at a time to maximise the availability of taxation benefits (i.e. the prospectuses were issued in March of the respective income years ending 30 June). That is, small cash outlays were required while large up-front deductions were available.
118. The BOGP prospectus (dated 18 March 1997) provided:
"Directors have formed the opinion that the project is viable if subscriptions for at least 400,000 shares are received. If this minimum level is not achieved within four months of the date of this Prospectus , shares will not be allotted and all application moneys will be returned within 7 days of that date." (emphasis added)
119. The BOGP2 prospectus (dated 7 March 1998) provided:
"If this minimum subscription level is not achieved within four months of the date of this Prospectus , shares will not be allotted and all application moneys will be returned within 7 days of that date." (emphasis added)
120. While the period of time over which investors could invest in the respective projects cannot be compared to the flurry of activity that has been associated with entry into other tax avoidance arrangements, the end of the financial year was still a clear consideration.
Paragraph 177D(b)(iv) The result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme
121. The result achieved by the schemes, but for Part IVA, was that the taxable income of subscribers was reduced by the large up-front deductions that were claimed in respect of the expenses paid for with the finance provided. [referred to above under 177D(b)(i)]
Paragraph 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
122. By reducing the assessable income of subscribers through the claiming of the large up-front deductions, the financial position of the subscribers (including the Applicant) was changed by reason of the avoidance of the payment of tax on an amount of assessable income that was not reduced by the large up-front deductions. The use and enjoyment of the income, or part of the income, was retained by the subscribers (including the Applicant).
123. The applicant obtained the tax benefits identified above.
Paragraph 177D(b)(vi) 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
124. The Barkworth Group's financial position was changed in that a greater number of subscribers took up the offer in the respective prospectuses than would otherwise have been the case. Further the amounts paid by investors using the borrowed funds contributed to the income derived by the recipients of these funds.
ATC 2028
Paragraph 177D(b)(vii) Any other consequences for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out
125. Other consequences for the subscribers (including the Applicant) by virtue of the reduced taxable income, would be possible reductions in child support payments, eligibility for family allowance payments, reductions in Superannuation Surcharge and Termination Payments Surcharge, reductions in Medicare Levy Surcharge and possible eligibility for grants and other government payments based on taxable income.
Paragraph 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 subparagraph (vi)
126. The nature of the connection between the Applicant in this case and the Barkworth Group is only by virtue of the Applicant being a subscriber to the respective prospectuses.
Conclusion under section 177D ITAA36
127. A reasonable person would conclude that the dominant purpose of the promoters and/or subscribers in entering into the schemes was for the subscribers to obtain tax benefits.
128. There can be no dispute that in respect of each income year there was a scheme within the meaning of Part IVA and that a tax benefit would have been obtained by the applicant but for section 177F ITAA36. The evidence also supported the Commissioner's view that the promoters of the schemes carried out the schemes for the purpose of enabling investors, such as the applicant, to obtain a tax benefit. It is irrelevant to the operation of Part IVA that the applicant was unaware of the round robins and the fact that the finance arrangements were without substance. Accordingly, the Commissioner submitted that the provisions of Part IVA apply and the applications brought by Mr O'Brien should be dismissed. The Commissioner submitted that the objections decisions should be affirmed.
Penalties
129. Where Part IVA ITAA36 applies then penalties are imposed under section 226 ITAA36. The rates of penalty are 50% of the shortfall applicable to the Part IVA adjustment, or if it is reasonably arguable that Part IVA does not apply, 25% of the shortfall applicable to the Part IVA adjustment.
130. The Commissioner considered that it was not reasonably arguable that Part IVA did not apply so that 50% is the appropriate level of penalty. The Commissioner reduced this level of penalty to 10% in accordance with section 226E ITAA36 because it was accepted that the Applicant made a voluntary disclosure.
131. The Commissioner did not consider that any remission of the whole or part of the penalty should be made under subsection 227(3) ITAA36.
Tribunal's reasons
Outline of Part IVA
132. Part IVA applies when the following 5 sequential elements are satisfied:
- 1. There must be a "scheme" within the meaning of section 177A(1) entered into or carried out after 27 May 1981.
- 2. The taxpayer must obtain a "tax benefit" in connection with the section 177A scheme that has been identified. The tax benefit may relate to income amounts (section 177C(1)(a)), deductions (section 177C(1)(b)), capital losses (section 177C(1)(ba)), or foreign tax credits (section 177C(1)(bb)).
- 3. Having regard to the eight matters identified in par (b) of s 177D, it would be concluded that there was the necessary dominant purpose of enabling the taxpayer to obtain the tax benefit.
- 4. The Commissioner makes a determination that the whole or part of the amount of the tax benefit is to be included in the assessable income of the taxpayer (section 177F(1)(a): see
Federal Commissioner of Taxation v Spotless Services Limited 96 ATC 5201; (1996) 186 CLR 404 at 413; [1996] HCA 34 where A - D are set out). - 5. The Commissioner (and any other decision-maker but not the Federal Court) then "shall take such action as he considers necessary to give effect to that determination" (section 177F(1)).
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The jurisprudence of Part IVA
1. "Scheme" within Part IVA
133. The Respondent contended that the relevant Part IVA scheme in these appeals was as identified earlier in these Reasons for Decision. The Respondent contends that the finance payments fall under Part IVA. The Respondent accepted that the cash payments were properly deductible.
134. The Applicant did not dispute the characterisation of the "scheme" which the Respondent contended existed in this case. More particularly, these steps fit within the definition of "scheme" in section 177A(1) and that they constitute individually and together an agreement or arrangement which in turn fit into each of scheme, plan, proposal, action, course of action or course of conduct. The Tribunal is satisfied that, taken together, these steps identified by the Respondent as particularised in the preceding paragraph constitute a scheme for the purposes of Part IVA because if narrowed down they represent a plan or course of action ("scheme" is defined very broadly in section 177A).
2. "Tax benefit" within Part IVA
135. Whether tax benefits arose in the present cases was one of the critical issues in these appeals. The Respondent contended that the operation of the scheme has resulted in deductions which been made to reduce the otherwise assessable income of the Applicant. I
136. The Tribunal finds that the tax benefits are as follows. First, section 177C(1)(b) applies because the Applicant obtained deductions which were otherwise allowable but for the entry into the scheme in question, and secondly the tax benefits in each of the relevant fiscal years are as identified above of these Reasons for Decision. The Applicant did not dispute the identification and quantification of the tax benefit argued for by the Respondent.
137. The Tribunal noted the contention of the Applicant that he did not enter into the scheme for the purpose of obtaining a tax benefit. There was, however, no evidence before the Tribunal upon which it could act in order to determine what the Applicant would have done had the scheme not been entered into and carried out
3. The test prescribed by section 177D(b) - dominant purpose
138. The Tribunal considered each of the matters referred to in section 177D(b)(i)-(viii). It is well established within the jurisprudence on section 177D(b) that the eight nominated statutory factors constitute an exhaustive list of the matters to be considered by the relevant decision maker or adjudicator[7]
Section 177D(b)(i) the manner in which the scheme was entered into or carried out
139. The Applicant submitted that he entered into the scheme in order to succeed in olive oil production. The Applicant argued that his ESPB was geared around the business plan in the prospectus. The Applicant argued that his ESPB was designed to serve the needs of investors growers and other parties to the commercial transactions. The Applicant argued that he was an active investor and that he toured the facilities which the Barkworth Group managed. These considerations point of course to the subjective intention of the taxpayer. The law is that the subjective intentions of the taxpayer are not material: The Taxpayer and Commissioner of Taxation [2007] AATA 1279 at [225]. Instead, it is the objective elements which are decisive.
140. The Respondent pointed to the contrived and non-commercial round robin transactions associated with the Bank of New Zealand overdraft facility of $36.5 million commencing 26 June 1998 and finishing on 1 July 1998 which enabled investors such as the Applicant to borrow the funds necessary to engage in the so-called financing elements of the investment proposal (as distinct from the cash components, which were not ultimately in dispute). The Respondent relied also on the disjunction between the cash elements or contributions (which in practice were used to operate the relevant olive groves) and the finance elements which facilitated the funding necessary to ensure the non-cash borrowing elements were satisfied.
141. The Tribunal is of the opinion that the manner in which the scheme was entered into or carried out correctly separates the cash components from the finance components, leading to the finance elements pre-dominating in such a way as to bring forward and accelerate
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deductions for interest and fees well before income from the operation of the olive groves was received by the relevant entity in the Barkworth Group.Section 177D(b)(ii) the form and substance of the scheme
142. The Tribunal accepts the characterisation of the form and substance of the scheme in terms put by the Respondent. This was not gainsaid by the Applicant.
143. Much as was the case in
Federal Commissioner of Taxation v Hart 2004 ATC 4599; (2004) 217 CLR 216 at [9] per Gleeson CJ and McHugh J, the borrowing of funds by the Applicant in order to buy into the two projects over the relevant tax years was an indispensable element of the activities and transactions that produced the tax benefit. Without the financing element, the Applicant could not have acquired his shareholding and outlaid the funds necessary for the operation of the olive groves through the different entities in the Barkworth Group. This is not to say, of course, that funding investment subscriptions is antithetical to investing as a commercial activity. It is simply that in the context of Part IVA closer scrutiny attaches to funding mechanisms which provide upfront or accelerate deductions with the underlying income from the relevant investment project is delayed or deferred.
144. In the contentions of the Respondent on the form and substance element has been reproduced above. The nub of the argument of the Respondent was that the substance (or economic or commercial substance) did not require the collateral financing arrangements which the Applicant entered into with entities from the Barkworth Group. This was to be contrasted with the form of the legal arrangements which the Applicant entered into with the Barkworth Group which were quite remote from the practical activities of operating or managing the olive groves.
145. The Tribunal concludes that the form and substance of the scheme points towards a tax-driven investment proposal.
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
146. The Respondent argued that the Tribunal should take into account the four-month window between the issue of the relevant prospectuses (18 March 1997 and 7 March 1998) and the end of the fiscal years in which those prospectuses were issued. The Applicant did not dispute the contentions of the Respondent in that regard.
147. In the opinion of the Tribunal, this element does not have significant weight in this case. While the Tribunal agrees that the flurry of activity that has accompanied other tax-driven schemes was missing from this case, there is nothing in the four-month operational window which necessarily points to or against the tax attractiveness of the investment proposal which the Applicant subscribed to. The Applicant did not lead any evidence relating to the timing of the issue of the prospectuses, and the witness called from the Barkworth Group to give evidence on behalf of the Applicant did not give any evidence which touched on this matter in any significant respect.
Section 177D(b)(iv)-(viii)
148. The result accomplished by the scheme was that it resulted in up-front deductions associated with the finance elements which were available well before assessable income was received by the Applicant.
149. It is important to keep in mind what the High Court of Australia said in
Federal Commissioner of Taxation v Hart 2004 ATC 4599; (2004) 217 CLR 216 at [53] per Gummow and Hayne JJ that a taxpayer pays less tax if one particular form of transaction is adopted rather than another form does not demonstrate that Part IVA applies. The Tribunal accepts the characterisation of this element in terms put by the Respondent (refer to paragraph 125 above). This was not challenged by the Applicant.
150. This criterion focuses on financial position of people associated with the taxpayer from entry into and implementation of the relevant scheme. In the present case, this includes the Barkworth Group. There was no evidence of any other personal taxpayer associated with the Applicant personally (such as a trustee of a family trust, or beneficiaries of any family trust) who stood to gain from implementation of the relevant tax scheme. The
ATC 2031
Tribunal accepts the characterisation of the form and substance of the scheme in terms put by the Respondent (refer to paragraph 127 above). This was not countermanded by the Applicant.151. No evidence about this criterion was put before the Tribunal by either party. The Tribunal did take note of the contentions of the Respondent summarised in paragraph 128 above. The Tribunal gave this element comparatively little weight. It did not loom large in evidence or submissions.
152. The Respondent argued that the only relationship or connection between the Applicant and the Barkworth Group was his status as a subscriber (shareholder) of shares from the two relevant prospectuses (refer to paragraph 129). This in fact understates the relevant relationships. The Tribunal noted that besides the relevant capital subscription agreement which made the Applicant a shareholder of Barkworth Olive Groves Limited once the share subscription monies were paid and the relevant shares were issued, the Applicant entered also into a Loan Agreement with Barkworth Finance Pty Ltd and a Management Agreement between the Applicant, Barkworth Management Ltd and Australian Rural Group Ltd.
153. The Respondent did not argue that any of these agreements were a sham[8]
Section 177D(b)(ix) dominant purpose
154. This case, as indeed nearly all of the Part IVA cases, turns on the fulcrum of dominant purpose within section 177D(b).
155. As explained by the Tribunal in
Taxpayers and Commissioner of Taxation 2006 ATC 101; [2005] AATA 1251 at [52], the purpose referred to in section 177D(b) is the sole or dominant purpose. As the High Court explained in
Federal Commissioner of Taxation v Spotless Services Ltd[10]
"…a reasonable person would conclude that the taxpayers in entering into and carrying out the particular scheme had, as their most influential and prevailing or ruling purpose, and thus their dominant purpose, the obtaining thereby of a tax benefit, in the statutory sense."
156. The qualifier "dominant" comes about by dint of case law, not by the legislature itself. The purpose is that of a person (a taxpayer such as the Applicant), not the purpose of the scheme (as scheme not being a legal person[11]
157. The respective contentions of the parties on the dominant purpose criterion have been noted earlier in these Reasons for Decision. The Applicant argued that his objective purpose was that he was a genuine investor in an agricultural scheme who made agreed cash contributions and incurred financial liabilities in the shape of the financing elements which contributed to the deductions he claimed and received initially. With respect, this confuses subjective purpose with objective purpose. Objectively, the integers bearing on purpose in this case include (1) cash contributions whose tax deductibility was not in dispute in the ultimate sense, (2) borrowings used to fund financial contributions which became the subject of deduction claims did not result in additional funding for the individual olive grove projects but rather facilitated investing, (3) the lack of income in early years of the olive grove projects compared with accelerated or early deductions available for expenses incurred early in the life of the projects, and (4) some but not exclusive emphasis put on the promoters of the olive
ATC 2032
grove projects on the tax attractiveness of the projects.158. When all of these section 177D(b) factors are taken into account and given appropriate weight (both singly and collectively), the inexorable conclusion the Tribunal is led to is that the Applicant entered into the scheme and its associated transactions for the dominant purpose of ensuring he would receive a tax benefit in connection with the two olive grove projects. This is sufficient to attract the operation of section 177D(b) and in turn section 177F(1)(b).
Penalty tax
159. This leads to the question of penalty tax. The Respondent argued that the ultimate penalty imposed of 10% under section 226E should remain.[12]
160. The Tribunal considered that it was appropriate to remit the whole of the penalty tax. While the application of Part IVA has been sufficient to annihilate the tax benefit by dint of section 177F(1)(b), the evidence in this case does not indicate that the Applicant participated in the scheme with the avowed purpose of tax avoidance. Subjectively, the Applicant did wish to participate in an agricultural scheme that would harvest real products, albeit in a tax effective way. For this reason, the Tribunal considers that it is appropriate to remit the entirety of the penalty under section 227(3) of the ITAA 1936 (and cognate provisions such as section 284-215(1)(a) of Schedule 1 of the Taxation Administration Act 1953 ).
Tribunal's conclusion
161. For these reasons, the Tribunal concludes that the decisions of the Respondent under section 177F(1)(b) to cancel the tax benefits received by the Applicant by way of deduction relating to the two Barkworth Olive Grove Projects in the years of income in 1997 - 1999 was correct.
162. The Tribunal decides to remit the penalty tax imposed on the Applicant
Tribunal's order
163. The Tribunal decides to affirm the decisions under review in connection with the tax benefits, and to set aside the decision concerning the penalty tax.
Footnotes
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