Federal Commissioner of Taxation v. Kareena Hospital Pty. Limited.
Judges: Bowen CJBrennan J
Lockhart J
Court:
Federal Court of Australia
Lockhart J: These are four appeals by the Commissioner of Taxation from orders of the Supreme Court of New South Wales in its administrative law division upholding objections by the taxpayer against amended assessments to income tax and assessments to Div. 7 tax for the years of income ended 30 June 1973 and 30 June 1974.
The appeals concern the construction, operation and effect of sec. 260 of the Income Tax Assessment Act 1936 (``the Act'').
The learned trial judge held that the taxpayer entered into an arrangement with others which had the effect of reducing the liability of the taxpayer to pay income tax so
ATC 4674
that the arrangement was avoided by the section; but his Honour went on to find that although that section had annihilated the relevant arrangement, all that was left in the hands of the taxpayer was a capital sum equivalent to the amount of income which it would have derived had the arrangement not been entered into, so that the money it received could not properly be treated as assessable income in its hands. Hence his Honour allowed the taxpayer's appeals.It was contended before the learned trial judge that the relevant transactions were not intended to be genuine and were shams. His Honour rejected this contention. The Commissioner did not challenge in this Court his Honour's findings on this question.
I shall state the principal facts.
International Clearing House Pty. Limited (in liq.) (``International'') was incorporated on 23 March 1937. It was wound up as a creditor's voluntary winding up. At the date of its winding up it had accumulated losses due to unfavourable trading. Its liquidator sought to dispose of the company as what is commonly regarded as a ``tax loss'' company for the purpose of obtaining some moneys with which to make payments to creditors.
On 23 October 1972 the Supreme Court of New South Wales in its Equity Division approved a scheme of arrangement between International and its creditors. On the same day the Court made an order pursuant to sec. 243 of the Companies Act 1961 (N.S.W.) staying all proceedings in relation to the winding up altogether and unconditionally.
Dr. and Mrs. Segal are the sole shareholders of Kareena Holdings Pty. Limited (``Holdings'') and of the taxpayer. They sought to take advantage of International's tax losses. What was proposed was that a highly profitable business carried on by the taxpayer should, until the losses of International were absorbed, be carried on by International.
The proposal did not involve any change in the shareholding of International. The shareholders were at all times to remain the same as they were before the winding up. That overcame any problem that might otherwise have arisen by reason of the provisions of sec. 80A of the Act. For the period during which International was to carry on the business, the directors of International were to be Dr. and Mrs. Segal. As the income from the business previously carried on by the taxpayer would be received by International it was essential that it be balanced by an indebtedness of International to the taxpayer, to be secured by an equitable mortgage over the assets of International, the control of the taxpayer being in the hands of Dr. and Mrs. Segal.
The Commissioner, before both the learned trial judge and this Court, contended that the matters referred to in the following paragraphs (a) to (f) inclusive, and the agreements and understandings which gave rise to them, constituted the relevant arrangement. The learned trial judge upheld that contention. The taxpayer, although challenging his Honour's findings as to there being an arrangement within sec. 260, does not dispute that the following events occurred:
- (a) On 31 January 1973 Holdings granted a lease of the premises upon which the hospital business was carried on to International. Previously the taxpayer had surrendered a lease of the premises which it had from Holdings. The lease provided that International was to hold as tenant for a term of one year commencing on 1 February 1973 at a monthly rental of $1,200.00, payable in advance. The lease also provided, by cl.3(b) that International would pay to Holdings a sum of money on the date of execution of the lease
- ``which is the consideration payable in one amount in the nature of a premium for the granting of this lease and is apart from the amount hereinbefore provided and does not include any payment for goodwill or for a licence.''
- As originally typed, the amount provided for was $120,000.00. That figure has been scored through and the figure $113,000.00 substituted. Dr. and Mrs. Segal executed the lease as director and secretary respectively both of Holdings and International. Their signatures appear beside the alteration to the amount of the premium which was made. They also appear beside a clause in which reference is made to the premium of $120,000.00 (cl.9) but the clause has not been altered.
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- (b) On 31 January 1973 the taxpayer lent the amount of premium as originally provided for, namely $120,000.00, to International. It paid a cheque to International for that sum on that day. On the same day, International paid the premium to Holdings by cheque, and Holdings paid a cheque to the taxpayer for the same amount. The transaction was treated by the taxpayer in its books as a reduction of an indebtedness owed by Holdings to it. In the result there was a ``round robin'' of cheques which left each company in precisely the same position as to money or cash as it was before any cheque was drawn and paid. His Honour held that, notwithstanding such circumstance, the paying and receiving of the cheque did create rights and obligations different from those which previously existed. The assets and liabilities both of International and Holdings after the transaction were different from what they had been before.
- (c) Prior to the drawing of the cheques two bank accounts were opened in the name of International. On and from 1 February 1973 International purported to carry on the business formerly carried on by the taxpayer. All receipts were deposited to the credit of one of the bank accounts, and all monthly and major payments for the purposes of the business were paid out of that account. Sundry day to day accounts and amounts were from time to time transferred from the first account to the second account to enable these payments to be made. The taxpayer had, prior to 1 February 1973 operated its two bank accounts in much the same way. Its accounts remained open during the period 31 January 1973 to 31 July 1973 but were largely dormant during that time.
- (d) Early in February 1973, International became registered as an employer for the purposes of the Pay-roll Tax Act, 1971 (N.S.W.) and as a group employer for the purposes of the Act. All persons, other than Dr. and Mrs. Segal, previously employed by the taxpayer in the business of running the hospital ceased, as from 31 January 1973, to be employed by it and became employed by International. Their wages and salaries were paid by International. International paid all other outgoings in relation to the operation of the business including the rental which fell due under the lease.
- (e) It was realised after a time that the accumulated losses of International were of the order of $113,000.00 rather than $120,000.00. Accordingly it was decided to reduce the amount of the premium by $7,000.00. That sum was adjusted on 9 April 1973 by a further ``round robin'' of cheques having the effect of reducing by $7,000.00 the amount of the premium paid by International for the lease, its indebtedness to the taxpayer and the amount by which the loan by Holdings to the taxpayer had been reduced. His Honour held that that was the reason why the alteration to cl. 3(b) of the lease was made, and that it must have been intended to make a similar alteration to cl. 9, but that this was overlooked.
- (f) By the end of June 1973 the losses had been exhausted; but International had incurred obligations to the taxpayer in respect of moneys collected by it from debtors of the taxpayer as to debts incurred by them on or prior to 31 January 1973, the rental of certain equipment, a service fee and rental of a car park. These amounts totalled a sum in the order of $30,000.00. By the end of July 1973, the net income of the business had overtaken that figure as well. It was then decided that the business should revert to the taxpayer notwithstanding that the lease had a further six months to run. His Honour said:
- ``there is a question as to how it was that the lease was determined. In the affidavit of Hospital's (i.e. the taxpayers') accountant, Mr. Millar, it is said that it was determined for non-payment of rent, but no rent up to 31 July 1973 remained unpaid at that date. When this was put to Mr. Millar he said that the lease was determined because International had said that it would not pay rent in the future. I am not satisfied that this was so, but I do not regard the matter as being of any consequence because it is clear that the lease was determined by mutual
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consent and by the giving up by International of possession of the premises.''
- (g) As from 1 August 1973 the taxpayer again carried on the hospital business. All staff were re-employed by it. It continued to operate as it had done prior to 1 February 1973.
It is convenient if I refer to certain other facts which, although not the subject of specific findings by his Honour, are relevant to the questions for determination. Those facts are as follows: -
- (h) By deed of charge dated 10 March 1973 and registered on 23 March 1973, between International and the taxpayer, International charged all its undertaking and assets (as to some by fixed charge and as to others by floating charge) with the payment to the taxpayer of all moneys then or thereafter to become due owing or payable by International to the taxpayer. The evidence is silent as to whether the charge was ever discharged.
- (i) A document described in the evidence both as ``a summary of accounts'' as between the taxpayer and International from 2 February 1973 to 30 June 1974 and as a ``copy of statement of loan account'' of the taxpayer from the records of International, records the financial transactions between the two companies, commencing with a credit in favour of the taxpayer of the advance of $120,000.00 made by the taxpayer to International on 2 February 1973 and concluding with journal entries apparently made as at 30 June 1974 reflecting a nil balance. The document shows a credit balance in favour of the taxpayer as at 30 June 1973 of $30,001.95.
- (j) The indebtedness of International to the taxpayer secured by the charge was repaid from time to time, as moneys were available, out of the profits of the business being carried on by International, the intention of the parties being that as the repayment was of the secured debt it would be a capital receipt in the hands of the taxpayer.
International returned as assessable income the income which it had earned in carrying on the business during the years of income ended 30 June 1973 and 30 June 1974. It claimed in its returns as deductions the losses which it had accumulated prior to commencing the carrying on of the business. The Commissioner assessed International for income tax in respect of the comparatively small sum of taxable income which was returned.
The income tax payable was paid in fact by Dr Segal.
The taxpayer lodged returns in respect of the same years, omitting the income earned during the relevant period in which the hospital business was carried on by International. The Commissioner issued assessment in accordance with the returns; but later, having investigated the matter, issued amended assessments which included in the taxpayer's assessable income the entirety of the net income earned by the hospital business during the periods 1 February to 30 June 1973 and 1 July to 31 July 1973. He also issued amended assessments pursuant to Div. 7 of Part III of the Act in respect of undistributed profits of the taxpayer. The taxpayer's appeals are against those amended assessments and Div. 7 assessments.
The Commissioner accepts the finding of the learned trial judge that there was an arrangement which had the effect of reducing the liability of the taxpayer to pay income tax, and that such arrangement was avoided by the section; but he challenged his Honour's finding that after the section had done its work of annihilation, all that was left exposed was the receipt by the taxpayer of a sum, equivalent to the amount of income it would have earned had the arrangement not been entered into, which in all the circumstances was properly characterised as capital.
The taxpayer, whilst accepting his Honour's finding that the receipt by the taxpayer was of a capital nature, challenged the anterior findings of his Honour to which I have referred.
It is convenient if I consider first the question whether there was an arrangement which had the effect of reducing the taxpayer's liability to pay income tax, and whether sec. 260 operates to avoid it, notwithstanding that there may be nothing in the taxpayer's hands in the nature of income after the section has destroyed the arrangement.
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In considering the application of sec. 260:
- ``the first step must be to ascertain what is the `contract agreement or arrangement' which is said to have the `purpose or effect' specified in para. (a) to (d) and to ascertain which of those paragraphs is said to apply'': -
per
Aickin
J. in
Slutzkin
&
Ors.
v.
F.C. of T.
77 ATC 4076
;
(1977) 51 A.L.J.R. 322
at p. 4082; 326
.
This preliminary question is not without some difficulty in the present case. As I have said, the Commissioner contends that the matters referred to in the lettered paragraphs (a) to (f) alone and the agreements and understandings which gave rise to them constituted the relevant arrangement. Those paragraphs comprise a conglomeration of matters without differentiation between the terms of the alleged arrangement, its purpose or effect.
The Commissioner did not contend before the learned trial judge that the facts referred to in my lettered paragraphs (h) and (j) were part of the arrangement struck down by the section. Nor were they included in the particulars furnished by the Commissioner to the taxpayer of the arrangement relied upon by him as falling within the section. This is not without importance because the Commissioner has presented his case on the footing that the moneys received by the taxpayer from International, being substantially the proceeds of the business which International purported to carry on, are the very moneys which one finds in the hands of the taxpayer after the section has annihilated the relevant arrangement, and are said to constitute income in the hands of the taxpayer.
If the indebtedness of International to the taxpayer and the charge securing its repayment remain after the section has done its work of annihilation, then all that has been received by the taxpayer is a series of payments of money in reduction of a debt, repayment of which is secured by a charge over the assets of International. On any view of the facts in this case, those moneys would necessarily have the character of capital in the hands of the taxpayer, and the Commissioner would fail.
The Commissioner asserted before this Court that the finding of his Honour in para. (b) above relating to the sum of $120,000.00 and the events of 31 January 1973 and, in particular the finding by his Honour that the payment of $120,000.00 was treated by the taxpayer in its books as a reduction of the indebtedness owed by Holdings to it, was a recognition by his Honour of the existence of the indebtedness of International to the taxpayer and the charge securing its repayment. In my opinion these findings of his Honour do not support this assertion by the Commissioner.
One finds nowhere in the contentions of the Commissioner as summarised by his Honour in his reasons for judgment, nor in the particulars of sec. 260 provided by the Commissioner to the taxpayer, any reference to the moneys paid by International to the taxpayer out of the profits of the business carried on by International as being the moneys left exposed in the hands of the taxpayer after sec. 260 is said to have completed its work. Yet it is those very moneys which the Commissioner contends constitute the assessable income in the hands of the taxpayer. Not surprisingly in these circumstances one sees no reference to these matters in his Honour's reasons for judgment. The only moneys which found their way into the taxpayer's hands referred to in his Honour's reasons for judgment are the payments of $120,000.00 on 31 January 1973 and $7,000.00 on 9 April 1973, in each case by Holdings to the taxpayer, that is the two cheques ending up with the taxpayer after the two ``round robins'' had been completed.
Although I think the position is not very satisfactory, I am prepared to assume, for the purpose of resolving the question before this court, that the arrangement alleged to be caught by sec. 260, if it exists at all on the facts of the case, includes the facts set out in (h) and (j) above as well as those mentioned in (a) to (f) together with the agreements and understandings which gave rise to them.
Counsel for the Commissioner, who was counsel for the Commissioner at the hearing before the learned trial judge, informed this Court that, before the learned trial judge it was, and before this Court it is, the Commissioner's case that the money which is left exposed with the character of income, after the section had completed its work of annihilation, is the money in the hands of the taxpayer paid to it at various times by
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International in reduction of the indebtedness of International to the taxpayer.It seems clear that the Commissioner has assessed the taxpayer on this basis as the adjustment sheet accompanying the notice of amended assessment of the taxpayer to income tax for the year ended 30 June 1973 describes the taxable income assessed as ``net business income for the period 1 February 1973 to 31 July 1973 not included...''. That period falls within the two tax years ended 30 June 1973 and 30 June 1974 respectively, and is thus explicable on the basis that it is the moneys paid by International to the taxpayer that the Commissioner asserts is included in the taxpayer's assessable income.
It was not suggested by counsel who appeared for the taxpayer, that if there was an arrangement, otherwise falling within sec. 260, it could be characterised as one explicable as ordinary business or family dealing: see
Newton's case
(1958) A.C. 450 per Lord
Denning
at p. 466. However, it is as well to bear in mind the following passage from the judgment of
Mason
J. at p. 360, with whom the other members of the High Court agreed, in
Cridland
v.
F.C. of T.
77 ATC 4538
at p. 4542;
(1978) 52 A.L.J.R. 96
at p. 98;
16 A.L.R. 355
at p. 360
:
``The distinction drawn by Lord Denning in Newton v. F.C. of T. (1958) 98 C.L.R. 1 at p. 8 between arrangements implemented in a particular way so as to avoid tax and transactions capable of explanation by reference to ordinary business or family dealing has not been regarded as the expression of a universal or exclusive criterion of operation of sec. 260. Lord Denning's observations were applied neither in the Mullens case nor in the subsequent case of Slutzkin v. F.C. of T. 77 ATC 4076; (1977) 51 A.L.J.R. 322.''
Counsel for the taxpayer contended that sec. 260 did not apply in the present case and supported his contention on a number of alternative bases. He contended that the taxpayer had chosen to bring itself within one, rather than another, provision in the Act and thus had exercised a choice which the Act offered him. This is what is sometimes described as the ``choice principle'' which has been applied in a number of decisions including
W.P. Keighery Pty. Limited
v.
F.C. of T.
(1957) 100 C.L.R. 66
and
F.C. of T.
v.
Casuarina Pty. Limited
71 ATC 4068
;
(1971-1972) 127 C.L.R. 62
.
In Keighery's case a company was structured so that it would be a public company for tax purposes. This enabled it to take advantage of the specific provisions of the Act which exempted public companies from liability to tax under Div. 7 of the Act. The High Court held that the Act itself afforded the taxpayer a choice between being public and being private, and that sec. 260 could not operate to strike down the exercise of the very choice which the Act itself afforded.
Counsel for the taxpayer contended that this principle applied in the present case as the taxpayer had chosen to bring itself within one rather than another provision in the Act; namely it had chosen not to derive assessable income under sec. 25 or any other section of the Act, but had resorted to the provisions of sec. 80, relating to the carrying forward of previous years' losses as allowable deductions. Reliance was placed on the decision of the High Court in
Hooker-Rex Limited
v.
F.C. of T.
70 ATC 4033
;
(1970) 123 C.L.R. 71
.
In my opinion this contention fails.
The Hooker-Rex case decided that a taxpayer could invoke the ``choice principle'' notwithstanding the circumstance that it was a subsidiary of the taxpayer rather than the taxpayer itself who resorted to the provisions of sec. 80 the subsidiary being a ``loss company''. The taxpayer was a member of a group of companies, another member of which being a ``loss company'' and a subsidiary of the taxpayer, was selected by those who controlled the group as the appropriate vehicle to derive income so that the accumulated losses could be claimed as deductions.
In the present case it was International, not the taxpayer, who sought to bring itself within sec. 80 and related sections. The shareholders of International remained at all material times as they were before the winding up commenced. International never became a subsidiary of the taxpayer. It was vital to the success of the whole operation embarked upon by the taxpayer and others
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that the requirements of sec. 80A, which required substantial continuity of beneficial ownership of the relevant shares in the ``loss company'' (International), so that losses of previous years might be taken into account during the subsequent relevant years of income, were fulfilled. Although Dr. and Mrs. Segal were the directors of International during the period it carried on the hospital business, they were not appointed directors by the taxpayer. The charge over the assets of International held by the taxpayer was the key to the operation as it was the damoclean sword hovering above International and its shareholders, whilst income was received by International, ready to descend on International, should the shareholders of International develop an appetite for that income.The taxpayer ceased to carry on its business and surrendered to Holdings its lease of the premises on which the business was carried on. It advanced money to International and secured its repayment by the charge. The taxpayer ceased to employ all persons, other than Dr. and Mrs. Segal, previously employed by it in carrying on the business of running the hospital. But none of those actions by the taxpayer answer the description of the exercise of a choice by the taxpayer to bring itself within one rather than another provision in the Act. All the taxpayer relevantly did was to choose to cease deriving income. In my opinion that is not the exercise of a choice by the taxpayer of two alternatives provided by the Act.
I am supported in my view by the observations of
Walsh
J. in
F.C. of T.
v.
Ellers Motors Sales Pty. Ltd.
72 ATC 4033
;
(1972-1973) 128 C.L.R. 602
at pp. 4042-4043; pp. 620-622
, in whose reasons for judgment
Windeyer
and
Gibbs
JJ. concurred.
Counsel for the taxpayer next contended that what he described was the ``extended choice'' exception so sec. 260 applied to the present case.
It is clear from the judgments of
Barwick
C.J. and
Stephen
J. in
Mullens
&
Ors.
v.
F.C. of T.
76 ATC 4288
;
(1975-1976) 135 C.L.R. 290
at p. 4292; p. 298 and p. 4303; p. 318
respectively that the principles underlying the decision in
Keighery's case
are not confined to the case where the Act itself offers a choice between two or more specific alternatives.
In Cridland's case 77 ATC 4538 at p. 4542 Mason J., with whose reasons for judgment Barwick C.J., Stephen, Jacobs and Aickin JJ. agreed, said:
``The decision in the Mullens case and the passages from the judgments to which I have referred show that the principle which underlies the Keighery case is not as narrow as the primary judge supposed it to be. It is not confined to cases in which the Act offers two alternative bases of taxation; it proceeds on the footing that the taxpayer is entitled to create a situation by entry into a transaction which will attract tax consequences for which the Act makes specific provision and that the validity of the transaction is not affected by sec. 260 merely because the tax consequences which it attracts are advantageous to the taxpayer and he enters into the transaction deliberately with a view to gaining that advantage.''
Keighery's case, as explained in Mullens' case and Cridland's case, proceeds on the basis that it is the taxpayer who enters into a transaction which will attract advantageous tax consequences for which the Act makes specific provision.
There is in my opinion, an inherent difficulty in applying Mullens' case and Cridland's case to the present case in that the taxpayer has resorted to no particular provision of the Act to obtain an advantage.
All the taxpayer relevantly did was to choose not to derive income between 31 January 1973 and 31 July 1973. It is true that, by not deriving assessable income, the taxpayer enjoyed the benefit of not being liable to tax; but this is not the adoption by the taxpayer of a particular course of conduct which attracts a tax advantage for which the Act makes specific provision.
I turn to the contention of counsel for the taxpayer that sec. 260 does not strike at new sources of income or restrict the taxpayer's liability to deal with his affairs in a manner likely to reduce his liability to income tax.
In
Europa Oil (N.Z.) Limited (No. 2)
v.
Commr. of I.R. (N.Z.)
76 ATC 6001
;
(1976) 1 W.L.R. 464
, Lord
Diplock,
in delivering the opinion of the majority of the Board comprising Viscount
Dilhorne,
Lord
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Diplock, Lord Edmund Davies and Sir Garfield Barwick (Lord Wilberforce giving a dissenting opinion) said at p. 6009; 475:``Secondly, the description of the contracts, agreements and arrangements which are liable to avoidance presupposes the continued receipt by the taxpayer of income from an existing source in respect of which his liability to pay tax would be altered or relieved if legal effect were given to the contract, agreement or arrangement sought to be avoided as against the Commissioner. The section does not strike at new sources of income or restrict the right of the taxpayer to arrange his affairs in relation to income from a new source in such a way as to attract the least possible liability to tax. Nor does it prevent the taxpayer from parting with a source of income.''
In Slutzkin & Ors. v. F.C. of T. 77 ATC 4076; (1977) 51 A.L.J.R. 322 Barwick C.J. said at p. 4079; 324:
``But the choice of the form of transaction by which a taxpayer obtains the benefit of his assets is a matter for him: he is quite entitled to choose that form of transaction which will not subject him to tax, or subject him only to less tax than some other form of transaction might do.
I.R. Commrs. v. Duke of Westminster (1936) A.C. 1 , too easily forgotten, is still basic in this area of the law. There is no room in that area for any doctrine of economic equivalence. To the legal form and consequence of the taxpayer's transaction, which in fact has taken place, effect must be given: See
Commr. of I.R. v. Europa Oil (N.Z.) Ltd. 70 ATC 6012 ; (1971) A.C. 760 . A passage from this decision at ATC p. 6018; A.C. p. 771 of the report warrants emphasis:
- `The question for decision is not to be answered by describing the benefit derived by Europa through Pan Eastern as in substance a discount or, more ambiguously, as a price concession. No doubt it was a concession obtained from Gulf, in the course of a discussion about prices, but in a matter of taxation it is necessary to consider and respect the legal form in which the concession was embodied. Their Lordships have no need to restate the principle laid down in such cases as I.R. Commrs. v. Duke of Westminster (1936) A.C. 1...'.''
In the Duke of Westminster case Lord Tomlin said at p. 19:
``Every man is entitled if he can to order his affairs so as that the tax attaching under the appropriate Acts is less than it otherwise would be.''
In my opinion the principles enunciated by the Judicial Committee in Europa Oil (N.Z.) Limited (No. 2) govern the present case, notwithstanding that it concerned sec. 108 of the Land and Income Tax Act 1954 (New Zealand). That section is for present purposes similar to sec. 260 of the Act. The taxpayer chose to arrange its affairs by not deriving assessable income during a period of some six months. In one sense it may be said to have parted with a source of income on 31 January 1973 in favour of International. For my part I prefer to say that the taxpayer chose to so arrange its affairs as not to derive income during this period, and thus not attract a liability to tax.
I approach this case on the footing that the opinion of the Judicial Committee in Europa Oil (N.Z.) Limited (No. 2) and the decision of the High Court in Cridland's case are not in conflict with each other. The reasons of Barwick C.J. in Slutzkin's case (supra) at 77 ATC at p. 4079; and in Mullens' case (supra) 76 ATC at p. 4292; (and his Honour was a member of the board which decided Europa Oil (N.Z.) Limited (No. 2)) proceed on the basis that there is no such conflict; as to the observations of Aickin J. in Slutzkin's case 77 ATC at pp. 4083-4084; and those of Mason J. (with whose reasons the other members of the Court agreed) in Cridland's case 77 ATC at p. 4542; 16 A.L.R. at pp. 360-361.
Whether the Duke of Westminster case and Europa Oil (N.Z.) Limited (No. 2) represent a wider principle of which cases such as Keighery, Casuarina, Mullens, Slutzkin and Cridland are but particular applications, or whether they are two separate streams of authority co-existing in harmony with each other, it is neither necessary nor appropriate for me to decide.
However, it is not without interest to observe that the principles enunciated by the Judicial Committee in the Europa case are
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reflected in earlier decisions of the High Court. In the joint judgment of Rich, Dixon and Evatt JJ. inClarke v. F.C. of T. (1932) 48 C.L.R. 56 decided in 1932 their Honours said at p. 77:
``Where circumstances are such that a choice is presented to a prospective taxpayer between two courses of which one will, and the other will not, expose him to liability to taxation, his deliberate choice of the second course cannot readily be made a ground of the application of the provision. In such a case it cannot be said that, but for the contract, agreement or arrangement impeached, a liability under the Act would exist. To invalidate the transaction into which the prospective taxpayer in fact entered is not enough to impose upon him a liability which could only arise out of another transaction into which he might have entered but in fact did not enter. Where, however, the annihilation of an agreement or arrangement so far as it has the purpose or effect of avoiding liability to income tax leaves exposed a set of actual facts from which that liability does arise the provision effectively operates to remove the obstacle from the path of the Commissioner and to enable him to enforce the liability.''
In
War Assets Pty. Limited
v.
F.C. of T.
(1952-1954) 91 C.L.R. 53
Dixon
C.J.,
Williams
and
Kitto
JJ. said at p. 98:
``The present case is simply one of a choice being presented to the appellant and Baker as prospective taxpayers between two courses one of which would, and the other would not, expose them to liability. As was said in Clarke's case (1932) 48 C.L.R. 56 the deliberate choice of the second course cannot readily be made a ground of the application of sec. 260.''
Although I have reached the conclusion that there is no room for the application of sec. 260 to the present case, I shall consider the question as to the effect of applying the section, if it were otherwise applicable, because that is the primary question to which the Commissioner's contentions have been directed, he having the benefit of the learned trial Judge's finding that there was an arrangement which was avoided by the section.
Section 260 is an annihilating provision only. The contracts, agreements or arrangements which it avoids are avoided as against the Commissioner only. It does not itself impose tax. It does no more than avoid or annihilate a transaction. It does no work by way of reconstruction. After annihilation, there must be facts which still justify the assessment of the Commissioner: see
Bell's case
(1953) 87 C.L.R. 548
;
Bayly's case
77 ATC 4045
;
Slutzkin's case (supra); Mullens case (supra)
especially per
Barwick
C.J. 76 ATC at p. 4295; 135 C.L.R. at p. 303.
The Commissioner contends that after sec. 260 has done its work of annihilation there is left, in the hands of the taxpayer, money received by it impressed with the character of income. He relies on the fact that before 31 January 1973 and after 31 July 1973 the taxpayer carried on the hospital business, and then asserts that, after the section has destroyed the relevant arrangement, there is left in the taxpayer's hands money being the income of the hospital business the sources of which are moneys paid by patients and others to whom services were provided in the course of carrying on the hospital business. The Commissioner treats the banking accounts of International, into which those moneys were paid by patients and others, and out of which moneys were paid to the taxpayer, merely as conduits of convenience for the taxpayer.
The Commissioner's contentions were founded on two assumptions; first, that the carrying on of the hospital business between 31 January and 31 July 1973 was a continuation of the business previously carried on by the taxpayer; and secondly, that the moneys received by the taxpayer can be identified and are truly characterised as the receipts of that business.
As to the first assumption, it is true that before 31 January 1973 the taxpayer derived income from the carrying on of the hospital business; but the decision was then taken by the taxpayer that it should cease to carry on that business. It carried this decision into effect and ceased to do anything that could constitute the derivation of income until after 31 July 1973.
The granting by Holdings to International of the lease of the premises upon which the hospital business was carried on; the loan of
ATC 4682
$120,000.00 later reduced to $113,000.00, by the taxpayer to International; the employment by International of the employees previously employed by the taxpayer; the determination of the said lease, even if struck down by sec. 260, along with the other transactions referred to in (a) to (f) and (h) and (j) above, does not leave exposed a situation where the taxpayer was carrying on the hospital business during the period 31 January to 31 July 1973. To achieve that result necessarily involves a process of reconstruction. The income received by the taxpayer from carrying on the hospital business before 31 January 1973 was different income, derived during a different accounting period and by a different person from the income which was derived later. The taxpayer did nothing answering the description of derivation of income; nor did it carry on or hold itself out as carrying on any of the hospital business during the relevant period.As to the second assumption, one normally characterises the receipt of money by a person with reference to the relationship that exists between himself as payee and the payer. In the present case, for sec. 260 to operate, one must be able to find on the evidence, after the section has done its work of annihilation, that the payments made by International to the taxpayer have the character of income in the hands of the taxpayer. This in turn requires that one can identify payments made by patients and others for the services they received from the carrying on of the hospital business with the moneys paid to the taxpayer.
It is true that moneys paid to International during the relevant period were from patients and others relating to the carrying on of the hospital business; but payments made by International to the taxpayer included the following:
- (i) $15,000.00 paid during the period 31 January 1973 to 30 June 1973 as a service fee payable at the rate of $3,000.00 per month by International to the taxpayer for the services rendered by Dr. Segal and others, who remained in the employ of the taxpayer during the relevant period, in relation to the conduct of the affairs of International;
- (ii) $3,000.00 paid as a service fee during the month of July 1973;
- (iii) $825.00 paid by International to the taxpayer being rental of hospital equipment paid during the period 31 January 1973 to 30 June 1973;
- (iv) $165.00 paid for the month of July 1973 by International to the taxpayer also being rental of hospital equipment;
- (v) $1,875.00 being rental paid during the period 31 January 1973 to 30 June 1973 for use of a car park; and
- (vi) $375.00 also paid as rental for the car park during July 1973.
It is the section which operates to avoid the relevant contract, agreement or arrangement, not the act or decision of the Commissioner. ``He'' (i.e. the Commissioner) ``cannot treat some of the arrangements which come within sec. 260 as void and others as not. He is given no option'': see
Peate
v.
F.C. of T.
(1966) 116 C.L.R. 38
at p. 44
.
In F.C. of T. v. Casuarina (supra) Windeyer J. said, 70 ATC at pp. 4077-4078; 127 C.L.R. at p. 75:
``And as I understand the authorities it operates to render void as against the Commissioner the entirety of any arrangement or scheme to which it applies. It does not, I think enable the Commissioner to select part of a scheme - in this instance the allotment of shares in Casuarina to Forum - and treat that as a nullity while allowing other parts of the scheme - in this instance the receipt by Casuarina of dividends from Len Sternberg Motors - to stand and exact tax upon that basis.''
Accordingly the process of annihilation necessarily involves the destruction of the character of the moneys mentioned above as service fees, rental of hospital equipment and rental for use of the car park (see para. (f) above).
In my opinion none of the payments which I have specified above made by International to the taxpayer during the relevant period can be identified with any of the moneys paid by patients and others who received services arising out of the carrying on of the hospital business.
Nor am I satisfied that any of the other moneys paid by International to the taxpayer can be similarly identified.
ATC 4683
This analysis shows that the requisite identification of moneys in the taxpayer's hands with the receipt of the hospital business or otherwise as income cannot be established.
It is not a permissible approach to say that as all moneys received by International from patients and others were paid into its banking accounts, and thereafter some of them found their way into the taxpayer's banking accounts, therefore the moneys received by the taxpayer were in truth the moneys paid by the patients and others. One must characterise the moneys in the hands of the taxpayer with reference to the circumstances surrounding each payment to it, for it is those moneys, not the moneys received by International, that the Commissioner asserts are left stamped with the character of income after the section has completed its work of destruction.
However, the Commissioner's case is seen at its highest if one regards the moneys paid to International by patients and others as passing through its banking accounts into the banking accounts of the taxpayer, the role of International being merely as a conduit or automaton (see Clarke's case (supra) at p. 79), so that after the section has struck down the relevant arrangement, one is left with those moneys in the taxpayer's hands.
The role of International as a conduit or automaton to my mind necessarily presupposes that the taxpayer intended International to perform that role. Short of a process of reconstruction such intent cannot be imputed to the taxpayer. Quite the contrary.
The taxpayer intended to cease carrying on business after 31 January 1973 and acted consistently with that intention and that alone. If International was the automaton of anybody, it was the automaton of Dr. and Mrs. Segal.
No process of annihilation can strike down the incorporation or existence of International. It was incorporated in 1937 before any arrangement was contemplated. Nor can the fact that International received the moneys be struck down. The process of annihilation can destroy the legal relationship which characterises the payment and receipt of moneys but not the very flow of the funds themselves.
In order to establish the role of International as intermediary or automaton, its role must be characterised independently of any intention on the part of the taxpayer. Hence one is left in the realm of constructive trust which arises by operation of law without reference to the intention of the parties concerned.
The Commissioner asserts that after the process of destruction has been completed there is a sum of money in International's hands which it is bound to account to the taxpayer. On this hypothesis, International is neither a lessee, nor an employer, nor the owner of a goodwill of a business, nor is it carrying on the business. Nor is it indebted to the taxpayer and no charge exists therefore over the assets of International. In my opinion, no constructive trust could arise in those circumstances. The exposed facts would not give rise to any equitable obligation of International to account to the taxpayer as the person truly entitled to the moneys held by International. That would necessarily involve a process of reconstruction.
In other words, once the section has annihilated all parts of the relevant arrangement and one finds International holding moneys in its banking accounts which it in fact passes across to the taxpayer, leaving aside any problem of identification to which I have already referred, there is nothing to be found from the residual or exposed facts from which one could deduce equitable obligations attaching to the conscience of International requiring it to account to the taxpayer as the true owner of the moneys. One must then build or construct facts out of which the equitable obligation could be said to arise. If one could adopt this course then it would not be a difficult step to take to say that the moneys paid by International to the taxpayer were paid pursuant to that obligation, thus leaving the moneys in the hands of the taxpayer impressed with the same character as they bore in the hands of International, namely the proceeds of the carrying on of a business and therefore constitute assessable income in the hands of the taxpayer. In my opinion such a course is impermissible.
The Commissioner relied in support of his contentions upon the decision of both the High Court and the Privy Council in
Peate v.
ATC 4684
Westbank replaced the partnership. The doctors who had been partners became directors of that company. The fees earned as a result of their carrying on the practice of medicine were paid in Westbank's account instead of into the partnership account; and after deduction of expenses, including the cost of employment of the other doctors and £ 5,000 to be kept each year by Westbank for the payment of taxes and dividends, the balance was paid to each of the family companies as service fees. Each family company received the same percentage of the net income as each doctor previously received from the profits of the partnership, less the £ 5,000. Each family company received the same percentage share of any dividends declared by Westbank out of the £ 5,000 retained; and each of the eight doctors received a salary from his own family company.
Counsel for the Commissioner submitted that, whilst not a wholly perfect analogy, Peate's case provided a very close analogy to the present case. He submitted that, just as Westbank replaced the partnership, so here International replaced the taxpayer; secondly, that the doctors who had been members of the partnership became directors of Westbank, and in the present case the employees of the taxpayer, with the exception of Dr. and Mrs. Segal, became employees of International; thirdly, that fees earned were paid to Westbank rather than to the partnership, just as here fees earned were paid to International, or at least through International to the taxpayer; fourthly, that payment to the family companies from which each doctor received a salary could be equated here to a payment to the taxpayer of the fees earned by International in discharge of its debt.
In my opinion, Peate's case is clearly distinguishable from the present case. First, a fundamental distinction between Peate's case and the present is that only a qualified medical practitioner, being a natural person, could carry on the profession of medicine under the Medical Practitioner's Act of New South Wales, so that at all times the carrying on of the medical practice necessarily involved the activities of Dr. Peate and his fellow practitioners. In the present case, the carrying on of a hospital business is an activity which may be legitimately engaged in by corporations as well as by natural persons and the taxpayer, not only did not carry on that business during the relevant period, but took positive steps to bring its previous business activities to an end.
Secondly, Peate's case is an example of an attempt by a taxpayer to assign his future gross income ``upon condition that the assignee, after paying the appellant's share of working expenses, should then pay to the appellant such part of the net amount as he should direct and, thereafter, expend the balance in a specified manner for the benefit of the appellant's wife and children'': per Taylor J. at p. 475 and per Windeyer J. at pp. 480-481. Kitto J. expressed himself in different language but to much the same effect at pp. 471-472.
The Judicial Committee adopted a similar approach as appears from (1966) 116 C.L.R. at p. 43.
In the present case, there could be no suggestion that there was any attempt by the taxpayer to assign income to any person.
Counsel for the Commissioner also relied upon the decision of the High Court in Clarke's case (supra) .
In Clarke's case the appellant was the owner of licensed premises which he proposed to lease to a tenant. It was intended that there would be a payment by the tenant of a substantial premium for the granting of the lease which, had it been paid to the taxpayer, would have constituted assessable income in his hands. Instead of the lease being granted directly to the taxpayer he agreed that he would grant the lease to the company of which he was sole beneficial shareholder and governing director and that
ATC 4685
in consideration of the payment to the company of the appropriate premium, the company would transfer the whole of its interest in the lease to the tenant. The lease was granted to the company, the premium was paid and the company assigned the lease to the tenant. In fact, the premium was paid into the hands of the taxpayer himself and was paid by him into his own banking account. This payment was treated by the company in its books as a payment to it.The Court consisting of Rich, Dixon and Evatt JJ. in a joint judgment, held that the case fell within sec. 93 of the Income Tax Assessment Act 1922-1952, corresponding in all relevant respects to the present sec. 260.
At pp. 79 and 80 their Honours said -
``The purpose, therefore, clearly appears of avoiding the liability which was imposed by the requirement of sec. 16(d) that assessable income shall include consideration in the nature of a premium demanded and given in connection with leaseholds. McDonough definitely sought and obtained a leasehold interest in the Burwood Hotel, which the taxpayer granted to satisfy that very purpose. He gave, as a consideration for that leasehold interest, a premium. He paid the premium directly into the taxpayer's hands and the taxpayer retained the money. But to avoid the application of sec. 16(d) which these facts would otherwise require, the taxpayer interposed his Company as a conduit for the assurance of the leasehold interest and as an imputed recipient of the premium. The grant of the lease to the Company, his automaton, and its immediate assignment to the intending lessee, and the subsequent liquidation of the Company, and the entries in the books of the Company narrating the taxpayer's accountability to it for the money and the accountability of himself as the Company's liquidator in a like sum, all amount to an arrangement adopted for the sole purpose of intercepting the liability to income tax which would otherwise flow from the payment to him of a consideration actually demanded and actually given in connection with the leasehold. For these reasons the sum of £ 8,561 formed part of the taxpayer's assessable income.''
Fullagar
J. referred to
Clarke's case
in
F.C. of T.
v.
Newton
(1956) 96 C.L.R. 578
at pp. 650 and 651
and said of it:
``It is, of course, a striking feature of this case that the instalment of the premium was in fact paid into the hands of the taxpayer himself, although on paper it would appear to have been payable to the company. One feels that there was some carelessness somewhere! At the same time, I find it impossible to think that the position would have been held to be different if the payment had been made to the company. The `arrangement' would have disguised the receipt, making it appear to be not an income receipt but a capital receipt. But, when the arrangement had been, so to speak, stripped away under sec. 93, it would have become manifest that a premium had really found its way (albeit a devious way) into the pocket of the taxpayer.''
Taylor J. referred to the case in similar terms at p. 668.
I have dealt already with the proposition that International was merely the automaton of the taxpayer. This is one ground of distinction between Clarke's case and the present case. This is not a case, unlike Clarke's case, of a taxpayer structuring a series of transactions after his liability to tax has arisen for the purpose of assigning or imputing that liability to another entity. The taxpayer ceased to carry on any relevant business activities between 31 January and 31 July 1973. In Clarke's case the Court treated it as one where the section, having annihilated the relevant arrangement, left a set of facts leading to the conclusion that the money included by the Commissioner in the taxpayer's assessable income, was in truth received by the taxpayer notwithstanding the elaborate series of steps that he took to prevent the assessable income becoming his. It was a case that turned very much upon its own facts.
The Commissioner also placed reliance on Bell's case (supra) . The facts are complicated and are fully set out in the joint judgment of the five justices of the High Court who heard them. See the full analysis of Bell's case in the judgments of Fullagar J. and Taylor J. in Newton's case (1956-1957) 96 C.L.R. 577 per Fullagar J. at pp. 649-654 and per Taylor J. at pp. 667-670.
ATC 4686
Much of what I have said about Clarke's case applies also to Bell's case . I see nothing in the reasons for judgment of the High Court in either case which operates to include in the taxpayer's assessable income the moneys paid to it by International. Both are cases depending on their own special facts.
The Commissioner relied also upon the decision of
Gibbs
J. in
Hollyock
v.
F.C. of T:
71 ATC 4202
;
(1971) 125 C.L.R. 647
. It was important that the relevant business, in that case being a pharmaceutical business, could be carried on lawfully only by a registered pharmaceutical chemist.
Gibbs
J. said at p. 4206; pp. 657-658:
``An important feature of the case is that the business which the appellant declared that he held in trust was one that could lawfully be carried on only by a pharmaceutical chemist, so that it remained necessary for the appellant to carry on the business and his wife could not lawfully join with him in carrying it on. As Menzies J. said in Peate v. F.C. of T. (1964) 111 C.L.R. at p. 460: `What, outside a profession, might be regarded as an ordinary business transaction may, within a profession, have an altogether different appearance.'''
Hollyock's case is similar to Peate's case in that material respect.
For these reasons, in my opinion even if there is an arrangement within sec. 260, and void as against the Commissioner, that would not leave in the hands of the taxpayer any assessable income. The facts which remain after annihilation do not leave the taxpayer as the recipient of the income of the business carried on by International. To hold otherwise would be, not to annihilate a transaction, but to impose on the taxpayer a liability which could only arise out of some other transaction into which it might have entered but did not.
The learned trial judge found that there was an arrangement caught by the section and avoided as against the Commissioner, but that, as the section merely annihilates, all that remained was capital in the hands of the taxpayer.
This appears to accord with the approach to the section adopted by Bray C.J. in Bayly v. F.C. of T. 77 ATC 4045 where his Honour said at pp. 4056 and 4057:
``Even if the arrangement is caught by the section and void as against the Commissioner that would not suffice to put the income notionally into the hands of the appellant so as to make him taxable upon it.
The effect of sec. 260 is simply to annihilate the arrangement as against the Commissioner. One looks then to see what would happen here if the arrangement was so annihilated.''
It is true that the section speaks of a contract agreement or arrangement having one of a number of purposes including the purpose of altering the incidence of income tax, and that purpose is different from effect. Logically, one may enter into an arrangement for a particular purpose but the purpose may not be achieved. Also, the effect of the arrangement may be quite different from the purpose.
For my part, I have difficulty understanding the relevance of the section unless, having found a contract, agreement or arrangement, one finds also that there is in fact a relevant purpose or effect including an alteration of the incidence of tax.
The section avoids the contract, agreement or arrangement only as against the Commissioner. What is the use to the Commissioner of an arrangement being avoided against him unless there is left exposed after the section has performed its work of annihilation, something answering the description of income in the hands of the taxpayer on which tax may be exacted?
In my opinion even if one were to find an arrangement with the purpose of altering the incidence of income tax the section would not avoid the arrangement as against the Commissioner unless the arrangement in fact altered the incidence of income tax.
The researches of counsel did not disclose any case where an arrangement was held to have been avoided yet there was in fact no alteration of the incidence of tax.
I am reinforced in the view I have taken by the following passage from the judgment of Barwick C.J. in Mullens' case (supra) at 76 ATC p. 4294; 135 C.L.R. p. 302:
``Though the section speaks of the purpose in entering into the transaction, it can have no relevance if, being effective,
ATC 4687
the transaction does not alter the incidence of tax, as that expression has come to be understood.''
In my opinion the appeals should be dismissed with costs.
ORDER:
1. The appeals be dismissed.
2. The appellant pay to the respondent it costs of the appeals.
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