• The impact of this case on ATO policy is discussed in Decision Impact Statement: Fitzroy Services Pty Limited v Commissioner of Taxation (Published 22 November 2013).

FITZROY SERVICES PTY LTD v FC of T

Members:
Edmonds J

Tribunal:
Federal Court, Sydney

MEDIA NEUTRAL CITATION: [2013] FCA 471

Decision date: 20 May 2013

---

Edmonds J

INTRODUCTION

1. The applicant appeals against the respondent's ("Commissioner's") objection decision dated 22 December 2011 disallowing the applicant's objections, dated 22 August 2011 and 22 November 2011, to the following assessments:

	Tax	Year ended 30 June	Issue Date	Original/Amended
1	Income tax	1999	1 July 2011	Amended
2	Income tax	2000	1 July 2011	Amended
3	Income tax	2001	1 July 2011	Amended
4	Income tax	2002	1 July 2011	Amended
5	Income tax	2003	1 July 2011	Amended
6	Income tax	2005	1 July 2011	Amended
7	Income tax	2006	4 July 2011	Amended
8	Income tax	2007	4 July 2011	Amended
9	Income tax	2008	4 July 2011	Amended
10	Income tax	2009	4 July 2011	Amended
11	Shortfall penalty	1999	15 Nov 2011	Original
12	Shortfall penalty	2000	15 Nov 2011	Original
13	Shortfall penalty	2001	1 July 2011	Original
14	Shortfall penalty	2002	1 July 2011	Original
15	Shortfall penalty	2003	1 July 2011	Original
16	Shortfall penalty	2005	1 July 2011	Original
17	Shortfall penalty	2006	5 July 2011	Original
18	Shortfall penalty	2007	5 July 2011	Original
19	Shortfall penalty	2008	5 July 2011	Original
20	Shortfall penalty	2009	1 July 2011	Original

2. The amended assessments of income tax arose as a result of the Commissioner's disallowance of the applicant's claims for allowable deductions for outgoings said to be incurred by the applicant in respect of the following items:

• (1) Management fees - being the amounts referred to in the table below set opposite the relevant years of income, paid by the applicant to associated companies.
  

  Income Year	Amount $
  1999	8,000
  2000	23,000
  2001	5,000
  2004	197,016
  2005	67,500
  2008	50,000

  The disallowance of the claim in respect of the 2004 income year did not give rise to a taxable income in that year; which explains the absence of any amended assessment in respect of that year. Nevertheless, the disallowance of that claim gives rise to a live issue insofar as it reduces carry forward losses allowable as deductions in subsequent years of income.

• (2) Interest and Bank fees - being the amounts referred to in the table below set opposite the relevant years of income, paid by the applicant to an entity incorporated in Western Samoa and called the Hua Wang Bank Berhad ("Hua Wang Bank").
  

  Income Year	Interest $	Bank fees $	Total $
  2005	257,656	5,445	263,101
  2006	308,203	11,995	320,198
  2007	358,346	5,295	363,641
  2008	431,753	5,458	437,211
  2009	410,119	7,183	417,302

3. The applicant's claims for allowable deductions for the management fees were made in reliance on s 8-1 of the Income Tax Assessment Act 1997 (Cth) ("1997 Act"). In the alternative, entitlement to allowable deductions for the management fees was placed on s 25-25 or s 40-880 of the 1997 Act.

4. The applicant's claims for allowable deductions for the interest and bank fees were made in reliance of s 8-1 or, in the alternative, s 25-25.

5. In addition to the substantive issues in [2] above, the applicant, in its objections to the amended assessments of income tax and assessments of shortfall penalty, put in issue the following collateral matters:

• (1) The power of the Commissioner to issue the amended assessments of income tax.

  On the hearing, the only year of income that was pressed in respect of this issue was the year of income ended 30 June 2005 where, due to the effluxion of time, the Commissioner had no alternative but to source his power to amend in his opinion that there had been fraud or evasion: Item 5 of s 170(1) of the Income Tax Assessment Act 1936 (Cth) ("1936 Act"). This issue is dealt with at [51] to [54] below.

• (2) Whether the Commissioner was correct to impose penalties in relation to tax shortfalls in the years of income ended 30 June 1999 and 2000 pursuant to ss 222A to 226ZB of the 1936 Act and administrative penalties in the years of income ended 30 June 2001 to 2003 inclusive and 30 June 2005 to 2009 inclusive pursuant to Div 284 of Sch 1 to the Taxation Administration Act 1953 (Cth) ("TAA").

  The imposition of penalties and the applicability of the base penalty amount under former s 226J of the 1936 Act and under s 284-90(1) of Sch 1 of the TAA, "intentional disregard of a taxation law" (Item 1 of the table) relied on by the Commissioner was not pressed in oral argument although it was the subject of written submissions. It is dealt with at [57] below.

• (3) Whether the Commissioner was correct not to remit the penalties imposed in the years of income ended 30 June 1999 and 2000 pursuant to s 227(3) of the 1936 Act and in the years of income ended 30 June 2001 to 2003 inclusive and 30 June 2005 to 2009 inclusive pursuant to s 298-20(1) of Sch 1 to the TAA.

  Again, this issue was not pressed in oral argument. It was touched upon (it cannot be put higher than that) in written submissions by contending that the same considerations referred to in relation to the issue in (2) above should inform the Court's review of the discretion to remit penalties. As such, it is not necessary to say anything more on this issue than is said in [59] below.

• (4) Whether the Commissioner was correct to impose interest in the year of income ended 30 June 1999 and general interest charge in the year of income ended 30 June 2000 pursuant to s 170AA of the 1936 Act, general interest charge in the years of income ended 30 June 2001 to 2003 inclusive pursuant to s 204 of the 1936 Act and shortfall interest charge in the years of income ended 30 June 2005 to 2009 inclusive pursuant to s 280-100 of Sch 1 to the TAA.

  This issue was not pressed in oral argument; nor was it the subject of written submissions. In those circumstances, its resolution follows the outcome of the substantive issues.

• (5) Whether the Commissioner was correct not to remit the interest imposed in the year of income ended 30 June 1999 pursuant to subs 170AA(11) of the 1936 Act, the general interest charge imposed in the years of income ended 30 June 2000 to 2003 inclusive pursuant to s 8AAG of the TAA and the shortfall interest charge imposed in the years of income ended 30 June 2005 to 2009 pursuant to s 280-160 of Sch 1 to the TAA.

  This issue was not pressed in oral argument; nor was it the subject of written submissions. Its resolution stands or falls akin to the issue in (4) above.

6. The applicant was incorporated in 1982. It was originally called Heasman Shock Absorbers Pty Ltd. At all relevant times, the applicant was owned and controlled by Mr Allan Heasman and his brother, Mr Douglas Heasman; it was one of a number of companies, owned and controlled by Mr Allan Heasman and his brother, involved in a business of providing auto-repair services as well as retailing shock absorbers and pneumatic air devices carried on from Sydenham, New South Wales, during this period. While these companies (including the applicant) were associated by their common ownership and control, they did not form a group for corporation law purposes - none was a subsidiary or parent of the other.

THE EVIDENCE

7. This case was notable for the lack of issue-specific evidence called on behalf of the applicant. In particular, the evidence in chief was lacking in any degree of particularity and, at times, descended into unhelpful generalisation. This was not assisted by the upholding of a number of objections to paragraphs of affidavits relied on by the applicant, but even if the paragraphs in question had gone into evidence, the same difficulty would be present. Messrs Allan and Douglas Heasman gave evidence on behalf of the applicant, but by their own admission, Mr Douglas Heasman has taken little interest in the financial and taxation affairs of the business and while Mr Allan Heasman has taken almost all responsibility for looking after those affairs, he has always relied on professional advice. There were a number of important matters where Mr Allan Heasman was not able to provide the Court with any assistance to enable it to make findings critical to the outcome of the issues in dispute. I deal with these below.

8. A Ms Sytara Anekamai, a chartered accountant who has worked in the accounting firm of Gould Ralph since 2001, was called on behalf of the applicant. Her evidence was that for the entirety of her time with Gould Ralph, she has worked under the supervision of Mr Vanda Gould and has been responsible for preparing the accounts and tax returns of companies owned and controlled by Messrs Allan and Douglas Heasman (including the applicant) as well as their personal tax returns. Her evidence on one important matter was that she did what she did because she was instructed to by Mr Gould, but Mr Gould was not called.

9. A Mr Bede Carran, a Chartered Accountant from New Zealand, was called on behalf of the applicant. Between February 2000 and December 2002, Mr Curran was employed by Asiaciti Trust Samoa Limited ("Asiaciti Trust") as its General Manager and, in that role, was appointed a director of a number of Samoan corporations, including the Hua Wang Bank. Mr Carran's evidence was that Mr Gould was the person he principally took instructions from in relation to transactions that the Hua Wang Bank entered into with its clients; but as noted above, Mr Gould was not called. Mr Carran had left the employ of Asiaciti Trust and resigned as a director of the Hua Wang Bank well before the years of income in which the Commissioner disallowed the applicant's claims for allowable deductions in respect of interest and bank fees (see [2(2)] above).

10. Because of the lack of issue-specific evidence called on behalf of the applicant, it is not possible to make precise findings of fact of the kind one would hope and expect to be able to make in a case such as this. One is impelled to draw inferences, favourable or adverse, from the evidence given and the Court's task is not assisted by the fact that the factual context has its genesis back in 1994, nearly 20 years ago. In the face of the provisions of s 14ZZK(b) of the TAA, the applicant has to wear any adverse consequences flowing from these evidentiary difficulties and inadequacies.

BACKGROUND

11. In or about May 1994 Messrs Allan and Douglas Heasman received advice from Mr Vanda Gould that foreign superannuation funds provided certain advantages over Australian-based superannuation funds; in particular, freedom from the constraints of the "in-house asset" rules thus facilitating the ability of the foreign fund to make moneys, contributed to it by an employer entity for the benefit of employees, available to that employer entity to finance working capital requirements.

12. Mr Allan Heasman instructed Mr Gould to set up such a fund and to this end the "Automotive Engineers Superannuation Fund" ("the Fund") was established in Western Samoa. Allan J Heasman (Sales) Pty Ltd ("Heasman Sales"), one of the companies owned and controlled by Messrs Allan and Douglas Heasman, made two initial contributions to the Fund in the sum of $250,000 in June 1994, a total of $500,000. This was the first of a stream of outbound and inbound remittances over the years which gave rise to claims by companies associated with Messrs Allan and Douglas Heasman (including the applicant) for deductions for interest and bank fees.

13. The funds initially contributed to the Fund by Heasman Sales were made available to the Hua Wang Bank. In
Deputy Commissioner of Taxation v Hua Wang Bank Berhad [2010] FCA 1014 at [43], Kenny J found that Mr Vanda Gould was responsible for setting up the Hua Wang Bank. It was incorporated in January 1994. There was no evidence as to how the funds got from the Fund to the Hua Wang Bank; whether it was by way of gift, loan, deposit or otherwise, nor on what terms and conditions.

14. In June 1994 Heasman Sales entered into a "loan agreement" with the Hua Wang Bank and Messrs Allan and Douglas Heasman entered into a deed with the Hua Wang Bank under which they guaranteed the obligations of Heasman Sales to the Hua Wang Bank. The funds made available to the Hua Wang Bank by the Fund were then remitted to a bank account in Australia "by way of loan" from the Hua Wang Bank to Heasman Sales.

15. What followed in the ensuing years is summarily described by Mr Allan Heasman in his affidavit of 1 June 2013 (Ex 3):

• 28. From 1994 onwards we made annual payments of interest to the Hua Wang Bank by telegraphic transfer in accordance with the loan agreement, and paid interest withholding tax on these amounts. I'm no longer sure of which of our companies paid the interest in each specific year. I liaised with our accountants at Gould Ralph in connection with these payments.
• 29. Each interest payment was then borrowed back from the Hua Wang Bank with money being remitted to Australia and then later interest payments were calculated on the basis of the enlarged principal debt.
• 30. In 1999, [Heasman Sales] applied for an extension of the loan. …
• 31. In 1999 [Heasman Sales] executed a document that extended the loan facility provided by the Bank, and renewed the personal guarantees. …
• 32. After some years had passed the making of the annual interest payment to the Hua Wang Bank in order to secure a roll-over of the debt had become quite a notable event for our business. In order to meet the annual payment it was often necessary to pool the money from all our other entities so that sufficient funds were available for the interest instalment.
• …
• 34. Where [Heasman Sales] distributed funds from the rollover of the Hua Wang Bank loan to other Heasman group entities, there was no regular interest charged on these funds.
• 35. I am aware that the financial statements for [Heasman Sales] for the years up until the end of the 2004 income year show amounts owing to this company from the other Heasman entities. There were never any formal loan agreements under which [Heasman Sales] provided funds to the other Heasman entities. I used to pay funds out of [Heasman Sales] to the other entities purely on the basis of the operational needs of those entities.

16. In the years ended 30 June 1996 to 1998 inclusive, Heasman Sales claimed deductions for "interest expenses" paid to the Hua Wang Bank (gross of withholding tax) in those years. In its income tax returns for the years ended 30 June 1999 and 2000, Allan J Heasman (Holdings) Pty Ltd ("Heasman Holdings"), another associated company, claimed deductions for "interest expenses" paid to the Hua Wang Bank (gross of withholding tax) in those years. The claims by Heasman Holdings were the subject of proceedings in this Court in NSD 2077 of 2005, but Heasman Sales did not challenge the Commissioner's disallowance of objections to the disallowance of its claims for the years ended 30 June 1996 to 1998 inclusive. It is not clear why Heasman Holdings, and not Heasman Sales, claimed the allowable deductions for "interest expenses" paid to the Hua Wang Bank in the 1999 and 2000 years of income because it seemed to be accepted that, at least until 30 June 2004, it was Heasman Sales that was the "borrower" from the Hua Wang Bank and not Heasman Holdings. On the other hand, that may explain why Heasman Holdings settled its dispute with the Commissioner on 12 April 2006 on the terms that it did, including the agreement of the parties that:

Neither [Heasman Holdings], [Heasman Sales] nor any entity which is an associate of them (as defined in s 26AAB(14) of the Income Tax Assessment Act 1936) will claim a deduction for interest paid to Hua Wang Bank Berhad or to any other entity to which Hua Wang Bank Berhad may assign its loan.

17. It is not in dispute that the applicant is an associate of both Heasman Sales and Heasman Holdings.

FACTUAL CONTEXT TO PRESENT DISPUTE

18. Towards the end of the 2004 year of income there was a change in the entity which paid "interest" to the Hua Wang Bank on the moneys "borrowed" by Heasman Sales from that bank since 1994. The change and why it came about are summarily described by Mr Allan Heasman in Ex 3 in the following way:

• 53. [I]n about May 2004 I asked Gould Ralph to organise for the obligations under the Hua Wang Bank loan to be transferred to Fitzroy Services. The main reason for this was that [Heasman Sales] was insolvent and would ultimately go into liquidation.
• …
• 55. In 2005 Fitzroy Services executed a fixed and floating charge in favour of the Hua Wang Bank. …
• 56. For the remainder of the period in dispute, which was up until the end of the 2009 income year, Fitzroy Services continued to pay interest to the Hua Wang Bank and/or a separate entity called Hua Wang Finance, in accordance with our obligations under the loan agreement and claimed deductions. These amounts were borrowed back and capitalised into the loan.
• 57. In July 2009 Fitzroy Services applied for and was granted an extension of its loan from the Bank. …

MANAGEMENT FEES

19. The Commissioner did not dispute that the applicant made payments of the claimed amounts in the relevant years of income, but otherwise there was a complete dearth of evidence as to:

• (1) The identity of the party to which the payment was made;
• (2) the nature of the service provided to the applicant in return for the payment;
• (3) the identity of the party providing the service and how it was provided;
• (4) how often the service was provided and over what period of time;
• (5) the relevance of the service to the applicant's business or its income producing activities; and
• (6) an explanation of the diversity in the amounts paid each year by reference to the services provided in that year.

Indeed, Ex 3 did not even refer to the payments in the 2004 year of income, in the sum of $197,016, the largest of the amounts claimed in any of the relevant years. Mr Allan Heasman could not explain that omission.

20. In the applicant's written submissions on the issue of the deductibility of the management fees, it was contended that "at any given point", there was a single entity in the Heasman "group" that held the "group's" business premises; a single entity that paid the salaries of the "group" management team; and the "group's" workshop staff were employed by a single entity. That may be so, but on a year-to-year basis, there was a dearth of evidence going to such matters; moreover, there is no evidence or documentation going to any of the matters referred to in [19] above to enable the Court to make any finding as to which entity provided a service to the applicant, the nature of the service provided by that entity and its relevance to the applicant's business. The evidence available is unsatisfactory, generalised and unsupported by primary records.

21. In her evidence, Ms Anekamai was unable to shed any light on what the management fees related to in terms of the particular services provided. She said that if any amount was recorded as management fees in a primary accounting record, such as a book entry or cheque butt, she would put it through into the financial statements as management fees. In re-examination, she was able to identify the party to which the payments were made in respect of some of the years - the $5,000 in the 2001 year to Heasman Sales; the $67,500 in the 2005 year, $2,500 to Sydney Shock Absorbers Pty Ltd and $65,000 to Heasman Holdings; and the $50,000 in the 2008 year to Allan J Heasman Pty Ltd. She was not able to offer any explanation as to why the payments were made to different companies in the different years.

22. However, in the course of his cross-examination, Mr Allan Heasman gave evidence which might well explain, on a year-to-year basis, the diversity in amounts of the management fees and of their recipients. His evidence was to the effect that as part of the process of assembling funds necessary to meet interest commitments to the Hua Wang Bank in Western Samoa, as and when the time for meeting commitments approached, surplus funds from within the "Heasman Group" of companies would be "pooled" and that the transfers by way of pooling were "booked" as management fees in the primary records of the relevant companies. At one stage on the third day of the hearing, I asked him some questions about this and the transcript (T 184/46 to 185/30) reads:

HIS HONOUR: Excuse me. I'm sorry. I don't want to get confused. I understood your evidence yesterday and up till now to be that the moneys that were pooled up before moneys went out to the bank in Samoa, the moneys that were pooled into - for example, into the applicant's bank account came up by what you call management fees?---Yes. Yes. That's what I call them

They came into the pooling. Before they went out to the bank in Samoa- - -?---Yes.

- - -they came up by what you said were payment of management fees?---Yes.

Right. And when they came back, they came back to the applicant?---Correct.

And then they went back down on a needs basis to the companies that had provided it or to other companies within the group that needed it?---Yes.

And they went down by way of interest free loans?- - -That's- - -

Is that your evidence, because that's my understanding of the evidence- - -?---Yes. I- - -

- - - you've given today?---How that is recorded with - yes, I would understand that to be the case.

So- - -?---Yes.

Right.

MR McGOVERN: But the transfers were styled management fees, weren't they?---Certainly the pooling of the funds I call management fees. The funds going the other way would be better described as - as loans, and perhaps they are in the financial records as loans, because I describe them as "Funds return," "Funds return" and "Funds transfer part back."

23. Mr Heasman's reference to a "pooling" of funds into the applicant's bank account is obviously a reference to the situation post the 2004 income year when the applicant was paying the "interest" to the Hua Wang Bank. Prior to the 2005 income year the "pooling" had taken place into Heasman Sales' bank account with transfers out of other companies' accounts (including the applicant's) being booked as management fees. So much is evident from Mr Heasman's evidence which followed (T 185/41 to 187/22):

And you say that Fitzroy Services is asserting deductions for the following expenditure during the 1999 to 2009 years. Now, that figure of $8000 in 1999, are you asserting that that's management fees or are you asserting that it's something else, or don't you know?---This is - these sums are unrelated, I think. Well, I - looking at them, I'm only surmising what they are. I - I would need a label and - or something to know exactly what they were. So, based on my surmising, Heasman Shock Absorbers [the applicant's previous name] at the time, 1999, wasn't servicing the overseas debt, so it certainly was nothing to do with what you are talking about. In the course of retailing Bilstein Shock Absorbers, which, at the time, there was the sales tax, 22 per cent reason for having that company, it would slowly accrue a little bit of profit and because, at that time, was not employing anybody, it's possible that it paid a bill amounting to $8000. It - it could have been a contribution for rent or an advertising bill, because it simply had accumulated a little bit of money. It wasn't a major working account at that time.

So if it had accumulated some money you would think of some expense to- - -?---Yes. Yes.

- - -offset against that amount?---Yes.

Is that right?---Well, we would spend it out. Yes.

Right. And you would make a claim for some offset expense. Is that right?---Yes.

And then the same is true with all of these other figures for 2000 through to 2008 referred to at paragraph ---?---Yes. When ---

--- 67. Sorry. Just ---?---Sorry.

We've been doing a lot - maybe I'm at fault as well, but we've both talked over each other this morning. But in relation to paragraph 67, those other amounts of expenditure, they are to be understood in the same sense - that is to say that in respect of each of those years where a little bit of profit was accumulated you looked to try to find some expense to offset it against. Is that correct?---Well, I don't know what you mean by "offset." If it's a loan we would pay some back, if it's an invoice we would pay it. So I'm not sure what you mean by "offset."

Well, the figure of $23,000 for the 2000 income tax year ---?---Yes.

--- have you got any idea whatsoever as to what that is for?---Again, this was the time before Heasman Shock Absorbers was servicing this loan, so there's no large amounts of money going in and out of that account so - there might have been a gradual accumulation of some gross profit that it possibly - there was even a payment to - to - there was a - it could be a defunct welfare fund, because we created a welfare fund at one stage, a bank account. Whether or not it was treated as that when the books were finalised or just we had to add it to our personal income to cover it - it's possible that the $8000 could have been a contribution to - to that welfare fund account.

And what about the $5000 in 2001? It would just be speculation as to what that was for, wouldn't it?---Yes. It's not a large amount of money and - and at that time that account was - I mean Gould Ralph's office asked why are we persisting with that account now that - that the GST or sales tax is on the end amount no matter what. There was no real effective reason to still have that company, but we just got used to having that retail front as opposed to trading as Sydney Shock Absorbers to retail inquiries.

Well, the 67,500 figure, again that's in the same category. You are not able to shed any light on what that payment was for. Is that correct?---I - I'm not - it could be - at that time we had a Westpac loan for the building next door.

Well, don't speculate? Okay. If I'm not allowed to speculate or guess, I can't identify it. I - I don't know. I mean ---

And the same is also true ---?--- --- it's something. I don't dispute that it was there, but I just simply don't know what it's for.

And in terms of the person most close to the action who would know anything about these figures, in the first instance it has to be you, doesn't it?---In the first instance, yes.

And then, in terms of any explanation that might be offered to Gould Ralph, that would be an explanation that would come from you. Is that right?---To - to - if requested, if it wasn't self-explanatory on the cheque butt or - or bank statement.

Right.

CONCLUSION ON MANAGEMENT FEES

24. On the evidence, the Court is not in a position to conclude that the outgoings incurred by the applicant in the relevant years of income and described as "management fees" (see [2(1)] above) were allowable deductions in those years under s 8-1 of the 1997 Act. While the alternative claims in reliance on s 25-25 or s 40-880 were not pressed orally, on the evidence, the Court is in no better position to adjudicate on those claims.

25. It follows that this issue in the applicant's appeal must fail.

INTEREST AND BANK FEES

26. The Commissioner assailed the applicant's entitlement to deductions for the interest and bank fees it paid to the Hua Wang Bank in the relevant years of income in the table in [2(2)] above on one or more of three bases:

• 1. The alleged loan or loans from the Hua Wang Bank to Heasman Sales which were assumed by the applicant and the loan or loans to the applicant following that assumption is an arrangement or arrangements which is a sham "to disguise the fact that the applicant expatriated funds to the Hua Wang Bank from Australia to avoid scrutiny and support false deductions for interest payments and bank fees" (Commissioner's amended appeal statement at [112])/"to disguise transfers of money made to support the deductions which were falsely claimed" (Commissioner's outline of opening submissions at [42]).
• 2. Insofar as the applicant is alleged to have assumed the obligations of Heasman Sales to the Hua Wang Bank as at 30 June 2004, that there was in law no such assumption and to the extent that the interest claimed as deductions were, in the relevant years of income, referrable to a debt alleged to be so assumed, it was not interest but a voluntary payment and not deductible.
• 3. That, in any event, the interest and bank fees were not deductible under s 8-1 or, in the alternative, s 25-25 of the 1997 Act because the requirements under those provisions for outgoings to be allowable deductions from assessable income were not satisfied.

Sham

27. In his amended appeal statement, the Commissioner relied on the following factors as the basis of his contention of sham at [112]:

• (1) In each of the years in which the deductions were claimed, the applicant received an amount from the Hua Wang Bank approximately equal to the amounts remitted to the Hua Wang Bank purportedly on account of interest payments and bank fees;
• (2) there is no evidence of the application of loan funds from the Hua Wang Bank as working capital of the business of the applicant, or Heasman Sales, or any other related entity;
• (3) the alleged loan or loans was uncommercial in that the risks of recovery in the event of default by the borrower were very high having regard to the financial position from time to time of the applicant;
• (4) the loan facility or facilities was increased from time to time without the provision to the Hua Wang Bank of any adequate security by either Heasman Sales or the applicant, and without provision of any financial information about the borrower that might have supported a decision to increase the loan facility or facilities.
• (5) the security provided in support of the loan or loans, namely, the charges referred to above and personal guarantees from the directors, was grossly inadequate having regard to the stated loan balance from time to time;
• (6) the applicant did not provide financial statements to the Hua Wang Bank, on an annual basis, as required by the loan agreement;
• (7) the interest rate stipulated in the loan agreements was uncommercial in that it was highly volatile and not a typical interest rate for a retail loan;
• (8) the financial records of the Hua Wang Bank do not record the loan or loans as an asset;
• (9) The Hua Wang Bank assesses its credit risk in view of customer deposits being used as security for customer loans and advances.
• (10) no records have been produced which confirm that the amounts of interest purportedly paid reflect the interest rates in the loan agreements;
• (11) there are no written loan applications for the increases in the loan facility;
• (12) the former directors directed the flow of funds to the Hua Wang Bank via telegraphic transfer.

28. In his outline of opening submissions the Commissioner pointed to the following alleged anomalies as supportive of a finding that the loan arrangement or arrangements was a sham:

• (1) The flow of funds strongly suggests that the source of funds transferred to the applicant by the Hua Wang Bank were funds transferred to the Hua Wang Bank by the applicant;
• (2) the absence of evidence that the Hua Wang Bank took steps to satisfy itself that the applicant would be able to repay the alleged loan or loans;
• (3) the absence of evidence that the applicant would have been able to meet its alleged liability to the Hua Wang Bank if required;
• (4) the absence of adequate security for the alleged borrowings and the existence of security documents that do not appear to be referable to the alleged loans and on which stamp duty has been paid for amounts much less than the alleged borrowings;
• (5) the alleged assumption in May 2011 of a liability of $4.5 million or thereabouts to Hua Wang Bank Australia Pty Ltd by Heasman Suspensions Pty Ltd, a company having a capital of $2, in place of the applicant's liability to the Hua Wang Bank (T 76/13 - 77/2).

29. A number of the factors and alleged anomalies listed in [27] and [28] above, far from being indicia that the alleged loan or loans are shams, have no relevance at all to that issue; and the balance, neither alone nor collectively, point in that direction. In
Richard Walter Pty Ltd v Commissioner of Taxation (1996) 67 FCR 243, Hill J at 257-258 said that, without in any way derogating from the views expressed by Lockhart J in
Sharment Pty Ltd & Ors v Official Trustee in Bankruptcy (1988) 18 FCR 449 at 454, he would prefer to define a transaction as being a sham transaction where it involves:

A common intention between the parties to the apparent transaction that it be a disguise for some other and real transaction or for no transaction at all .

(Emphasis added.)

Consistent with that definition, his Honour said (at 258):

[I]n a case such as the present where there have been real payments made by bills of exchange in the form of cheques cleared through the banking accounts of the parties and recorded as loans in relevant books of account, the transactions involving the bills of exchange can clearly not be a disguise for something which is not a transaction at all. Rather, for there to be a sham there will need, in such a case, to be a common intention of both the apparent lender and the apparent borrower, that the transaction which they have purported to have entered into disguises some real transaction.

30. Unsurprisingly, the Commissioner in his oral submissions did not contend that the apparent loan transaction or transactions were a disguise for some other transaction which was the real transaction. Nor could he, because there was no evidence to support such a contention.

31. In my view, there is much to be said for the view expressed by Lehane J, albeit in dissent, in the same case at 267-268, and its applicability to the facts of the present case:

Moreover, it must be borne in mind that it is of the essence of a structure intended to be effective to minimise tax that it be created by means of real transactions, giving rise to real rights and obligations, however "artificial" they may be, in the sense of being incapable of rational explanation except on the basis of their tax consequences. It cannot be said, I think, that there is anything more artificial in the transactions with which we are concerned than there was in those which, in a somewhat different context, confronted the Court in
Sharment Pty Ltd v Official Trustee in Bankruptcy (1988) 18 FCR 449. One expects, in a case such as this, that transactions are intended to have their apparent legal effect because it is only if they do that they are efficacious to achieve the desired consequences. In this particular case, it is no longer suggested that any of the transactions involved in the 1981 "re-structure" had any legal effect other than their apparent effect; it is suggested only that the "loans" to the taxpayer were not really loans at all but payments which were gratuitous and which were not intended to be recoverable. That, for reasons which I have given, seems to me a conclusion so surprising that one would be reluctant to accept it in the absence of cogent evidence. However, there is nothing in the documentary evidence which supports that conclusion: indeed, the documentary evidence is to the contrary effect.

32. In
Raftland Pty Ltd v Commissioner of Taxation (2008) 238 CLR 516 at [56], the plurality observed that what Lehane J said in Richard Walter was "undoubtedly true" while at the same time pointing out that it did "not deny the possibility that, in a particular case, documents might not be intended by the parties to have legal effect according to their tenor". But that is not this case. The plurality's subsequent conclusion at [58] that it was open to the primary judge to find that an entitlement under a trust deed was not intended by the relevant parties "to have substantive, as opposed to apparent, legal effect", wherever it takes the doctrine of "sham" in this country, is a conclusion on the particular facts of that case.

33. Finally, on this issue, one needs to recall what Richmond P said in
Re Securitibank Ltd (No 2) [1978] 2 NZLR 136 at 150 that there is no "middle slot or half-way house between sham and unassailable transaction". Richardson J echoed similar comments (at 170) in expressing his preference for the analysis and explanation of
Price v Parsons (1936) 54 CLR 332 by Jordan CJ in
Boydell v James (1936) 36 SR (NSW) 620 at 627-628, to the half-way house approach that commended itself to the primary judge in that case.

34. The loan or loans between the Hua Wang Bank and Heasman Sales, and subsequently the applicant, is not a sham; nor is it a nullity on some "half-way house" principle of not being a "genuine transaction" or being "non-commercial". It is therefore necessary to consider whether the applicant's entitlement to deductions for the interest and bank fees can be denied on one or both of the other bases upon which the Commissioner relies.

No Assumption of Debt by the Applicant as at 30 June 2004

35. The applicant contended that it contractually assumed an indebtedness to the Hua Wang Bank as at 30 June 2004 equal to the amount of the debt owing by Heasman Sales to the Hua Wang Bank as at that date as consideration for the extinguishment of that latter indebtedness. Under this alleged tripartite contract, the consideration for the applicant undertaking the assumption was the alleged assignment by Heasman Sales to the applicant of the receivables owed to Heasman Sales by the associated companies as at 30 June 2004.

36. The principal, but by no means the only, difficulty with this contention is that there is no evidence, either in writing or of oral statements at the time, from which one could find that there was a tripartite contract between the Hua Wang Bank, Heasman Sales and the applicant to effect such a novation. The extinguishment of Heasman Sales indebtedness incorporating the assumption by the applicant of an equivalent debt (not the same debt) could not be effected by assignment, only by a tripartite agreement of novation. The distinction between the two was concisely put by Windeyer J in
Olsson v Dyson (1969) 120 CLR 365 at 388:

The ultimate distinction, in juristic analysis, between a transfer of a debt by assignment and by novation is simple enough. Novation is the making of a new contract between a creditor and his debtor in consideration of the extinguishment of the obligations of the old contract: if the new contract is to be fully effective to give enforceable rights or obligations to a third person he, the third person, must be a party to the novated contract. The assignment of a debt, on the other hand, is not a transaction between the creditor and the debtor. It is a transaction between the creditor and the assignee to which the assent of the debtor is not needed. The debtor is given notice of it; for notice is necessary to complete an assignment pursuant to the statute or in the case of an equitable assignment to preserve priorities. But the debtor's assent is not required. He is not a party to the transaction.

37. Moreover, there is no evidence, either in writing or of oral statements at the time, from which one could find that there were assignments of the associated company receivables as at 30 June 2004 from Heasman Sales to the applicant.

38. The applicant contended that the Court should find that there was an express novation of Heasman Sales' indebtedness to the Hua Wang Bank incorporating an assumption by the applicant of an equivalent indebtedness to that bank, but I reject that contention, just as I reject any contention that there were assignments of the associated company receivables from Heasman Sales to the applicant. There is no evidence of either.

39. There is evidence of accounting entries which are intended to reflect that such novation, assumption and assignments occurred, but those accounting entries are certainly not evidence of the acts themselves. The financial accounts of Heasman Sales and the applicant as at 30 June 2004 were both in evidence and these recorded the following:

HEASMAN SALES: AS AT 30 JUNE 2004
CURRENT ASSETS	This YTD $	Last YTD $
Loans Unsecured (2)	-	1,978,529.12
Note:
2 Loans, unsecured
Allan J Heasman Pty Ltd	-	739,390.34
Allan J Heasman (Holdings) Pty Ltd	-	1,040,138.78
Heasman Shock Absorbers Pty Ltd	-	4,000.00
Sydney Shock Absorbers Ltd	-	195,000.00
		1,978,529.12
NON-CURRENT LIABILITIES
Hua Wang Bank Berhad	-	2,208,000.00
THE APPLICANT: AS AT 30 JUNE 2004
CURRENT ASSETS	This YTD $	Last YTD $
Loans, unsecured (2)	2,394,631.32	510.01
Note:
2 Loans, unsecured
Allen J Heasman Pty Ltd	1,031,854.04
Allen J Heasman (Holdings) Pty Ltd	1,008,366.95
Polyair Springs Pty Ltd	159,187.71
Sydney Shock Absorbers Pty Ltd	195,222.62
	2,394,631.32
NON-CURRENT LIABILITIES
Hua Wang Bank	2,643,600.00	-

40. Ms Sytara Anekamai gave evidence that she was responsible for producing the financial statements and preparing the income tax returns for the Heasman "group" of companies. During the course of cross-examination, Ms Anekamai's attention was drawn to the balance sheet of Heasman Sales for the year ended 30 June 2004. The transcript (at T 220/1 to 220/18) reads:

If you have a look at the balance sheet - - -?---Yes.

Can you that [sic] for the previous year under the heading Current Liabilities, there is an entry against name Hua Wang Bank Berhad for $2,208,000?---Yes.

For the year ended 30 June 2004, there is no amount?---Yes.

Can you say what documents you had available to you to prepare those entries for the balance sheet?---My supervisor instructed me to make entries to move the balance sheet items from Allan J Heasman Sales to another company.

Mr Gould instructed you?---Yes.

To move---?---To transfer balance sheet items from one company to another.

And that is how that balance sheet comes to appear in the way it does?---Yes.

And does the same apply to the unsecured loans listed under current assets?---Yes.

41. In the alternative, the applicant contended that there is evidence of a novation by conduct "incorporating not only entry by the Applicant into a new contract, but rescission of the original contract between the Bank and [Heasman Sales]" (Applicant's further submissions [25]). The applicant pointed to the following:

• (1) The applicant's payment of interest to the Hua Wang Bank in respect of the assumed debt.
• (2) The applicant's execution of a fixed and floating charge in favour of the Hua Wang Bank, as security for the indebtedness.
• (3) The payment of drawdowns on the loan facility into the applicant's bank account, and issuance of subsequent invoices to the applicant for annual payments on the loan.
• (4) The fact that the Hua Wang Bank did not prove for the debt owed to it by Heasman Sales when that company went into liquidation.
• (5) The Hua Wang Bank's auditor asked the applicant's directors to confirm in writing the applicant's indebtedness to it as at 30 June 2005, and the applicant's directors did so.

42. The applicant contended that this evidence shows all three entities: the two parties to the original contract, as well as the debtor under the new contract, conducted their affairs over a five year period on the hypothesis that an effective novation occurred. The applicant contended it is difficult to conceive of a set of facts that more emphatically show a novation through conduct.

43. Finally, the applicant contended that it is not necessary for there to have been a rescission of the original loan agreement in order to establish that the applicant had obligations under a loan agreement; it would be enough if the applicant itself entered a contract with the Hua Wang Bank.

44. I am not convinced that this last proposition is correct, but there is a more fundamental problem with the applicants case on this particular issue. Even if there was an implied novation of the Heasman Sales debt to the Hua Wang Bank by conduct incorporating an assumption by the applicant of an equivalent indebtedness to the Hua Wang Bank, or in the alternative, as contended for in [43] above, just such an assumption, it does not follow that the interest on the assumed debt is an allowable deduction to the applicant under s 8-1. It will only be an allowable deduction if, as an outgoing, it is incurred in gaining or producing assessable income or in carrying on a business for that purpose. The two limbs each require the same nexus or connection between the outgoing and assessable income, and here there is no nexus or connection.

45. Even if there were assignments of the associated companies receivables from Heasman Sales to the applicant and, as I have already observed, apart from the entries made to the financial statements by Ms Anekamai at the direction of Mr Gould, there is no evidence that there were, by Mr Allan Heasman's own admission, these receivables were non-income producing in that no interest was charged on them. In short, the applicant's assumption of an interest-bearing debt or obligation to the Hua Wang Bank was financing its acquisition and retention of non-interest bearing receivables from associated companies. Any relevant nexus or connection necessary for entitlement to an allowable deduction for the interest and bank expenses on the assumed debt was non-existent.

46. It follows in my view, that insofar as the interest and bank expenses the applicant incurred to the Hua Wang Bank in the relevant years of income were referable to any assumption of indebtedness by the applicant to the Hua Wang Bank equivalent to Heasman Sales' indebtedness to the Hua Wang Bank as at 30 June 2004, such interest and bank expenses were not allowable deductions under s 8-1, nor under s 25-25.

The Outgoings for Interest and Bank Expenses were otherwise not Deductible

47. It remains to consider the entitlement of the applicant to allowable deductions for interest and bank expenses incurred in respect of loans made to it by the Hua Wang Bank after 30 June 2004. The proceeds of these loans were not retained by the applicant for its own working capital requirements; rather, immediately upon receipt, the proceeds were lent to associated companies on a needs basis by way of interest-free loans (see [22] above).

48. The applicant contended that this Court has repeatedly said that it is legitimate for a company to deduct expenditure it incurs in the course of business for the purpose of conferring benefits on related entities in anticipation of the revenue the company will derive because of its ongoing memberships of a corporate group. Reference was made to what was said by Lockhart J (with whom Northrop and Fisher JJ agreed) in
Federal Commissioner of Taxation v Total Holdings (Aust) Pty Ltd (1979) 43 FLR 217 at 228-229. Reliance was also placed on
Federal Commissioner of Taxation v E A Marr and Sons (Sales) Limited (1984) 2 FCR 326 as authority that a company can deduct the expense of leasing machinery to its related entities for nil consideration where the company derives revenue from those related entities by the provision of management and administrative services to those related entities. It was said that the Court regarded it as impermissible to isolate the non-profitable leasing activity from the intra-group services that did yield a profit. It was contended that, by parity of principle, it is not permissible in the present case, to isolate the applicant's non-profitable lending activity from the profitable provision of management services.

49. At least two things can be said in response to the applicant's reliance on these authorities. First, the Court's reasoning in each relied heavily on the prospect that the taxpayer company had for deriving dividend income from the subsidiary company or companies to which, in the case of Total Holdings, the interest-free loans were made and, in the case of E A Marr, the rental-free leasing was provided: see Total Holdings at 228-229; E A Marr at 331. In the present case, no such prospect existed because the applicant was not the holding or a sub-holding company of the associated companies to which the interest-free loans were made. Second, there was no evidence, as there was in E A Marr, that during the relevant years of income (2005 to 2009) the applicant provided management services to associated companies and derived income therefrom which was facilitated by the making of interest-free loans to those companies. As noted before, the management fees in earlier years had been so described as part of a pooling process before the remittance of interest commitments to the Hua Wang Bank. There is nothing in the evidence to suggest that the position was any different in later years of income (2005 to 2009). In my view, the facts of the present case are a long way from those which came before this Court in E A Marr. Indeed, as I indicated to counsel for the applicant during the course of argument, they have a greater affinity with those which came before this Court in
Associated Minerals Consolidated Ltd v Federal Commissioner of Taxation (1994) 53 FCR 115 involving, as it did, an interest-free loan by a company to its parent.

50. It follows, in my view, that insofar as the interest and bank expenses the applicant incurred to the Hua Wang Bank in the relevant years of income were referable to loans made to it by the Hua Wang Bank after 30 June 2004, such interest and bank expenses were not allowable deductions under s 8-1, nor under s 25-25.

2005 YEAR OF INCOME: FRAUD OR EVASION

51. As noted in [5(1)] above, due to the effluxion of time, the Commissioner had no alternative but to source his power to amend the applicant's assessment of income tax for the year ended 30 June 2005 in his opinion that there had been fraud or evasion: Item 5 of s 170(1) of the 1936 Act. In his written outline of opening submissions (at [47]), the Commissioner articulated his case on this issue as follows:

The facts before the Commissioner as confirmed by the evidence before the Court will support the conclusion that the applicant has not shown that the Commissioner's opinion was unreasonable, or legally erroneous.

In oral argument, this pithy statement was not elaborated upon by reference to the evidence before the Court or by way of further argument.

52. In his reasons for decision accompanying his notice of objection decision dated 22 December 2011, the Commissioner gave his reasons for being of the opinion that there had been fraud or evasion as follows:

• 33. You claimed deductions for interest and bank fees and charges paid to Hua Wang Bank Berhad and Hua Wang Finance Limited. These amounts were transferred through the bank accounts of these entities and then repatriated to you under the cover of drawdowns on a loan. This arrangement is considered to be a sham.
• 34. The arrangement was structured in such a way that it hid the true nature of the transactions. There is no evidence that loan funds were received for working capital purposes.
• 35. The facts indicate that your directors controlled and implemented the arrangement and understood their actions. It is considered that your directors understood that structuring the arrangement in this way and using offshore entities would disguise their activities and provide a veil of legitimacy to the accounts.
• 36. You have not provided any evidence to substantiate the deductions for management fees. Further information in relation to the management fees was requested on 31 January 2011. In your response dated 1 March 2011 you advised that you do not have any invoices, contracts or agreements for these services. You advised that the fees were paid to associated companies in the Heasman Group and were calculated by reference to the actual Group costs incurred and related accounting costs. However, you have not provided any costing figures or worksheets to show how the management fees were determined.
• 37. During the audit it was determined that there was evidence of evasion based on the factors described in paragraphs 33 to 36 above. It is considered that there was sufficient basis for the Commissioner to form this opinion and the Commissioner was therefore able to amend your assessment for the 2004-05 financial year at any time.
• 38. In your objection you contend that you have not engaged in fraud or evasion. However, you have not provided any evidence or information in your objection to establish that evasion did not occur.

53. In the absence of further elaboration, I have no alternative but to assume that these matters alone found the basis of the Commissioner's opinion. In the face of my conclusion (at [34] above) that the loan or loans between the Hua Wang Bank and Heasman Sales, and subsequently the applicant, is not a sham and in the face of the Commissioner's concession that the applicant made the payments to associated companies of the amounts it claimed and described as "management fees", the whole foundation of the Commissioner's opinion, as outlined in [52] above, that there was fraud or evasion falls away. As Gleeson CJ said in
R v Meares 1997) 37 ATR 321 at [323]:

Although on occasion, it suits people for argumentative purposes, to blur the difference, or pretend that there is no difference, between tax avoidance and tax evasion, the difference between the two is simple and clear. Tax avoidance involves using, or attempting to use, lawful means to reduce tax obligations. Tax evasion involves using unlawful means to escape payment of tax. Tax avoidance is lawful and tax evasion is unlawful. Although some people may feel entitled to disregard that difference, no lawyer can treat it as unimportant or irrelevant. It is sometimes said that the difference may be difficult to recognise in practice. I would suggest that in most cases there is a simple practical test that can be applied. If the parties to a scheme believe that its possibility of success is entirely dependent upon the revenue authorities never finding out the true facts, it is likely to be a scheme of tax evasion, not tax avoidance.

54. What is here involved is tax avoidance, not tax evasion. In my view, the Commissioner's opinion that there is fraud or evasion in respect of the claims for deductions for management expenses and interest and bank fees is flawed and infected with legal error. In the absence of any other power enabling him to do so, the Commissioner had no power to issue the amended assessment in respect of the year of income ended 30 June 2005.

SHORTFALL PENALTIES

55. The objection decision in respect of the objection to the assessment of shortfall penalty for the year of income ended 30 June 2005 must be set aside and the objection allowed in full. On the basis that the Commissioner had no power to issue the amended assessment of income tax in respect of that year of income, there was no shortfall amount and, therefore, no base penalty amount in that year of income.

56. On the conclusions reached in [24], [46] and [50] above, there were shortfall amounts in each of the years of income ended 30 June 1999-2003 inclusive and 30 June 2006-2009 inclusive in the amounts assessed by the Commissioner and the only issues that remain are whether the base penalty amounts have been properly calculated, that is, by reference to the percentage applicable to the correct level of culpability, and whether an uplift factor of 20% has been properly imposed in each of those years of income other than the first.

57. The Commissioner assessed the base penalty amounts by reference to a culpability level of "intentional disregard of a taxation law" by the applicant or its agent: former s 226J of the 1936 Act and Item 1 of the Table in s 284-90(1) of the TAA. This conclusion was reached by reference to much the same factors set out in [52] above. For the reasons given in [53] above, it is flawed. On the other hand, there can be no argument that the shortfall amounts in each of the relevant years of income resulted from "recklessness" by the applicant or its agent (former s 226H of the 1936 Act and Item 2 of the Table in s 284-90(1) of the TAA) so that the appropriate base penalty amounts are 50% of the shortfall amounts in each year. The objection decision in respect of the objection to the assessments of shortfall penalties for the years of income ended 30 June 1999-2003 inclusive and 30 June 2006-2009 inclusive must be set aside and the objection allowed in part by the issue of amended assessments of shortfall penalties in respect of those years of income with base penalty amounts calculated at the rate of 50% of the shortfall amounts.

58. The applicant also put in issue the Commissioner's imposition of an uplift factor of 20% of the base penalty amount in respect of the years of income ended 30 June 2000 to 2003 inclusive and 30 June 2005 to 2009 inclusive in reliance on former s 226X of the 1936 Act and s 284-220(1)(c) of Sch 1 to the TAA. For the year ended 30 June 2005, this issue, for the reasons given above, has fallen away. Having regard to the terms of former s 226X(b) of the 1936 Act and s 284-220(1)(c) as it stood in Sch 1 to the TAA prior to its amendment (s 284-220(1) including para (c) thereof was amended by Act No. 56 of 2010, applicable in relation to things done on or after 4 June 2010), I, like Jessup J in
Gashi v Commissioner of Taxation [2012] FCA 638 at [57], am disposed to the view that it was open to the Commissioner to apply the uplift factor to the base penalty amounts in the remaining years of income.

REMISSION OF SHORTFALL PENALTIES

59. There is nothing to suggest that the Commissioner's failure or refusal to exercise his discretion, conferred by former s 227(3) of the 1936 Act or s 298-20(1) of Sch 1 to the TAA, to remit the shortfall penalties, miscarried by reference to the principles identified in
House v R (1936) 55 CLR 499 at 504-505.