Re Verma; Ex parte Deputy Federal Commissioner of Taxation.
Judges:Beaumont J
Court:
Federal Court
Beaumont J.
By his petition in bankruptcy seeking to sequestrate the estate of the debtor, the Deputy Commissioner of Taxation relies on an act of bankruptcy arising from failure to comply with a bankruptcy notice based upon a default judgment obtained in the Supreme Court of New South Wales in the sum of $331,793.67. The judgment was obtained on assessments for income tax for the years ended 30 June 1979 (assessment issued 2 July 1980) and 30 June 1980 (assessment issued 3 December 1981) and additional tax for late payment. The default judgment was obtained on 2 August 1983 despite the fact that objections to the assessments had been referred to the Taxation Board of Review in March 1983 and were awaiting a hearing.
The bankruptcy notice was served on 23 October 1983. In November 1983, the debtor applied to the Court for orders setting aside the bankruptcy notice or, alternatively, extending time for compliance with it. The application, which was contested, was heard by Neaves J. On 22 December 1983, for reasons he then gave, his Honour declined to set aside the notice. Reference will be made to these reasons later. However, to give the applicant a last opportunity to comply with the bankruptcy notice, the learned Judge extended time for compliance with the notice up to and including 13 January 1984. The opportunity was declined, the debtor adopting the stance, which he maintains, that the assessments grounding the default judgment are wrong and should be set aside.
The petition was served on 27 February 1984. It alleges that the debtor is indebted to the Deputy Commissioner in the sum of
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$632,692.23, being not only the judgment debt but also income tax and additional tax in respect of the years ended 30 June 1981 and 30 June 1982. By his notice of intention to oppose the petition, the debtor relies upon the following grounds:``1. That the debtor does not owe the Petitioner the amount claimed in the Petition herein or any amount.
2. That the Petitioner has wrongfully refused to allow deductions in the assessment of the debtor's taxable income which would have the effect of reducing the tax payable by the debtor to nil.
3. That the Court should exercise its discretion not to make a sequestration order against the debtor.
4. That the debtor has sought referral of the Petitioner's decisions to disallow the debtor's objections to the Petitioner's assessments, to a Board of Review and that such Board has not heard the said referrals.''
The tax dispute between the parties arises out of two categories of claims for deductions disallowed by the Deputy Commissioner which, the debtor claims, should be deducted from his assessable income in the form of his earnings as a medical practitioner. First, the debtor claimed, and the Deputy Commissioner disallowed, a deduction under Div. 10B of Pt. III of the Income Tax Assessment Act 1936 in respect of an alleged investment of the sum of $140,000 made in each of the 1979 and 1980 years of income in connection with the production of a film entitled Progress for Two Nations. Secondly, the debtor claimed, and the Deputy Commissioner disallowed, a deduction in each of the 1981 and 1982 years of income in the sum of $500,000 being his share of an alleged loss suffered by a partnership of which the debtor was a member. The debtor alleges that the partnership purchased an annuity in the sum of $23,500,000 and borrowed the amount of the purchase price. The partnership claimed to have included as an allowable deduction the interest cost incurred of servicing the borrowing.
Notwithstanding the size of the deductions claimed, on the hearing of the petition, the debtor made no attempt to develop, in terms of specific evidence, the basis upon which he proposed to challenge the assessments. The debtor was content to allow the matter to rest merely in the assertions made by his accountants on his behalf in the form of the notices of objections lodged. As a consequence, it is no easy task to discern the taxpayer's prospects upon the hearing of his objections by the Board of Review.
For instance, in the case of the film scheme, apart from denying the application of any of the relevant statutory tax avoidance provisions, reliance is placed by the debtor upon the following assertions in his notice of objection in respect of the year ended 30 June 1980:
``1. The taxable income of $140,531 as assessed should be reduced to NIL as returned by the allowance of a $140,000 deduction for a capital investment in the copyright of the film `Progress for Two Nations'.
2. The said deduction of $140,000 for the part investment in the copyright of the film `Progress for Two Nations' is an allowable deduction pursuant to the provisions of sec. 124M of the Australian Income Tax Assessment Act 1936, and in particular to Subdivision 1 of the said section.
3. The stated copyright to the picture `Progress for Two Nations' is a unit of industrial property as defined by sec. 124UA of the Australian Income Tax Assessment Act 1936.
4. The said effective life in relation to the Australian picture `Progress for Two Nations' is specifically defined in sec. 124UA(1) of the Australian Income Tax Assessment Act 1936.
5. The said effective life of the Australian picture `Progress for Two Nations' is taken pursuant to provisions of sec. 124UA of the Australian Income Tax Assessment Act 1936 as two years.
6. The stated Australian picture `Progress for Two Nations' is an Australian film as defined in sec. 124K of the Australian Income Tax Assessment Act 1936-1979 as amended, and is so defined by the Minister for Home Affairs and certificated.
7. For the year ended 30 June 1979 I did incur a liability in the copyright of the picture `Progress for Two Nations' of $280,000.
8. In accordance with the formula as specified in sec. 124K of the Australian
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Income Tax Assessment Act 1936 the said deduction allowable for the year ended 30 June 1979 and for the year ended 30 June 1980 is $140,000 with respect to each year.9. The rights or the film to which they relate were first used for producing income during the year ended 30 June 1979....''
In the case of the claim in connection with the annuity, the material relied on by the taxpayer is even more cryptic. The notice of objection for the year ended 30 June 1981 reads, so far as material as follows:
``The taxpayer is a member of the Tinsteer Partnership No. 58.
In the course of the business of the partnership, the partnership purchased an Annuity for the sum of $23,500,000. In order to finance the purchase of this Annuity the partnership borrowed the sum of $23,500,000 from an independent finance company.
For the year ended 30th June 1981 the partnership received income from the Annuity of $2,949,250 from which it is entitled to deduct, under Section 26AA(2), an amount of $2,937,500 representing one eighth of the purchase price of the Annuity. This leaves the partnership with assessable income, under Section 26AA, of an amount of $11,750.
It is further claimed that the partnership is entitled to a tax deduction of an amount of $2,937,500 representing interest at the rate of 12.5% p.a., as per the executed Loan Agreement, on the borrowing of $23,500,000.
It is claimed that the whole of this interest is deductible as it was incurred in gaining or producing assessable income.
However, if the whole of this interest is not deductible (which is not admitted) then part of this interest is deductible and it is claimed that this amount represents 44.86% of the total interest paid as this is the proportion expended to produce assessable income over the terms of the Annuity Contract.
It is claimed that the deduction allowed to the partnership should be calculated in the following manner:
Based on an Annuity cost of $23,500,000 for a period of 8 (eight) years, and a loan of $23,500,000 carrying interest at the rate of 12.5% p.a.
$ Annuity income 2,949,250 Less sec. 26AA(2) Deduction 2,937,500 --------- Assessable income - sec. 26AA 11,750 Interest paid - 12.5% on $23,500,000 2,937,500 ---------- Net loss for year $2,925,750 ----------The taxpayer's share of the loss in the Tinsteer Partnership No. 58 was allocated as per Partnership Minutes and the Partnership Agreement as being $500,000 and this is the amount which should be allowed to the taxpayer as a deduction in the 1981 return of income...''
As has been said, the objections to the assessments in respect of the years ended 30 June 1979 and 30 June 1980 were referred to the Taxation Board of Review in March 1983. The objections in respect of the subsequent years were referred to the Board at a later date. It appears that the volume of objections awaiting a hearing before the Board is so great that a hearing of the debtor's objections cannot take place until 1985. Indeed, despite the urgency of the matter arising from the pendency of this petition in bankruptcy, the pressure of work of the Board is such that it is not yet able to fix a hearing date which will not take place until well into next year.
In the circumstances, the debtor seeks an adjournment of the petition until the ultimate fate of his objections is known. This would involve adjourning the petition until the matter has been finally determined either by the Board or, on appeal, by the Supreme Court or this Court, or, by leave, the High Court. Alternatively, the debtor contends that the Court should exercise the discretion vested in it by sec. 52(2)(b) of the Bankruptcy Act 1966 in his favour and dismiss the petition.
Both applications are opposed by the Deputy Commissioner, who calls in aid, in particular, sec. 201 of the Income Tax Assessment Act. It provides:
``The fact that an appeal or reference is pending shall not in the meantime interfere with or affect the assessment the subject of
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the appeal or reference; and income tax may be recovered on the assessment as if no appeal or reference were pending.''
Section 201 apart, it is the general practice of the Bankruptcy Court not to proceed to sequestrate the estate of a judgment debtor where an appeal is pending against the judgment relied on, provided that the appeal is based on genuine, arguable grounds. In
Ex parte Heyworth; In re Rhodes (1884) 14 Q.B.D. 49, the Registrar adjourned the hearing of a bankruptcy petition under sec. 7(4) of the Bankruptcy Act 1883 (U.K.). It provided that:
``[W]hen the act of bankruptcy relied is non-compliance with a bankruptcy notice to pay, secure, or compound for a judgment debt, the Court may, if it thinks fit, stay or dismiss the petition on the ground that an appeal is pending from the judgment.''
The Court of Appeal held that if the appeal appears to be a bona fide one, the hearing of the bankruptcy petition ought to be adjourned. On the other hand, if the appeal is evidently frivolous, a receiving order ought to be made notwithstanding its pendency. Bowen L.J. said (at p. 52):
``It cannot, of course, be said that the mere fact that an appeal is pending from the judgment, gives the debtor an absolute right to a stay of proceedings, or to have the petition dismissed. But, under subsec. (4) of sec. 7, the registrar is clothed with a discretion; he has an absolute discretion to consider what is the best thing to be done under the circumstances. And it would be impossible for this Court to interfere with the exercise of his discretion unless we were satisfied that the registrar could not have been right. If it could be shewn that the appeal from the judgment must be a frivolous one, we might reasonably have come to the conclusion that there was a reasonable ground of appeal, it would be a monstrous thing that a receiving order should be made while the appeal is pending.''
Although there is no precise counterpart of sec. 7(4) of the United Kingdom statute in the Australian Act, the general discretion given to the Court by sec. 52(2)(b) of the local Bankruptcy Act, in particular sec. 52(2)(b), is sufficiently open-ended to entitle the Court, in a proper case, to adjourn or dismiss a petition in the exercise of its discretion when an appeal against the judgment or order relied on is pending. But by what criteria is a ``proper case'' to be judged for this purpose?
In
Bayne v. Baillieu (1907) 5 C.L.R. 64, a firm of solicitors obtained a judgment for costs in proceedings unsuccessfully brought against them for alleged breaches of trust. After notice of appeal to the High Court from judgment had been filed, the solicitors, having in a subsequent action recovered judgment for the costs, presented a petition for sequestration of the plaintiff's estate. The act of bankruptcy relied on was the plaintiff's failure to comply with a debtor's summons founded on the judgment and to satisfy a writ issued upon it. It was not suggested that the debtor had any estate or that the solicitors would obtain any advantage from the sequestration other than putting difficulties in the way of prosecuting the appeal. However, an order absolute for sequestration having been made in the Supreme Court before the appeal to the High Court was heard, the plaintiff appealed to the High Court against the making of the sequestration order.
It was held by Griffith C.J., Barton and O'Connor JJ. that an order of sequestration ought not to have been made but that the petition should have been either adjourned until after the hearing of the appeal or dismissed. Griffith C.J. said (at p. 67):
``Without saying that under all circumstances proceedings for sequestration founded upon a judgment, from which notice of appeal to this Court has been given, must fail, it is sufficient in this case to say that, in the absence of any evidence that the appellant had an estate which the respondents desired to have administered in the Insolvency Court, they must fail.''
In the present case, the taxpayer personally seems to possess few assets of any substantial worth. In any event, if this petition is adjourned more or less indefinitely as he seeks, he is prepared to offer to the Court an undertaking that he will not dispose of his assets except in the ordinary course of his ordinary business.
Guidance for present purposes can, I think, be found in the approach taken to the similar question which arises when the Supreme Court's jurisdiction to wind up companies is invoked by the Deputy Commissioner notwithstanding that the assessment underlying
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the judgment debt is the subject of an unresolved challenge. The authorities in this area were fully considered in a recent decision of Needham J. inD.F.C. of T. v. Glastonbury Steel Fabrications Pty. Limited 84 ATC 4639. The Deputy Commissioner applied to the Court for the winding up of the taxpayer company. It sought to stay the proceedings until after its appeal against an assessment had been determined. During the hearing, the Deputy Commissioner challenged the admissibility of evidence sought to be tendered by the taxpayer company to show that there was substance in its appeal against the assessment. After referring to the decision of the Court of Appeal of the Supreme Court of New South Wales in
D.F.C. of T. v. Mackey 82 ATC 4571, Needham J. said (at 84 ATC p. 4640) that the question to be resolved was whether, on an application for such a stay, the grounds of the appeal could be considered in order to determine whether the grounds relied upon by the taxpayer company were substantial. Needham J. held that there was nothing in the decision in Mackey, supra, which precluded him from including in the material relevant to the exercise of his discretion evidence as to the substantive nature of the grounds of the appeal. Accordingly, the learned Judge admitted evidence directed to the establishment of, not the grounds of appeal themselves, but the substantive nature of such grounds. In my view, a similar approach is open in the present case.
The application of sec. 201 of the Income Tax Assessment Act has been considered in a number of related contexts. In
Clyne v. D.F.C. of T. 82 ATC 4510; (1982) 43 A.L.R. 342, Mason A.C.J. spoke (at ATC pp. 4511-4512; A.L.R. p. 344) of the possible oppression and unfairness to a taxpayer arising from the reliance by the Deputy Commissioner upon a notice of assessment under challenge. After a consideration of the prospects of success in an appeal to the High Court, the automatic stay of proceedings in that case was removed.
In subsequent litigation between the same parties (see 82 ATC 4690; (1982) 45 A.L.R. 323), the debtor failed in an attempt to set aside a bankruptcy notice on the ground that the assessment referred to by Mason A.C.J. was under challenge by reference to the Board of Review. The Full Court of this Court (Bowen C.J., McGregor and Fisher JJ.) said (at ATC p. 4693; A.L.R. p. 328):
``In our view the Commissioner is entitled to avail himself of the provisions of the Bankruptcy Act in his capacity of a judgment creditor. In the same capacity he is entitled to levy execution. He does not use the special position conferred upon him by sec. 201 in doing so nor does he need any assistance from that section. It is true that sec. 201 entitles him to obtain the judgment for disputed tax. If the Commissioner takes this course and obtains a judgment he has thereafter the rights of a judgment creditor. Mr. Clyne's contention that sec. 201 does not apply to bankruptcy proceedings and that the bankruptcy notice should therefore be set aside is misconceived. That is not to say that if a petition is subsequently presented, the fact that the amount payable by the taxpayer is still genuinely in dispute or that the taxpayer may have a counter-claim against the Commissioner are not relevant considerations for a court to take into account in the exercise of its discretion under sec. 52(2) of the Bankruptcy Act.''
(Emphasis added.)
It follows that, provided there is a genuine dispute as to the liability for tax it is open to the Court to adjourn the petition or to order its dismissal under sec. 52(2). But, has the present debtor demonstrated the existence of a genuine contest?
In refusing to set aside the bankruptcy notice in the present matter, Neaves J. followed the decision of Lockhart J. in Clyne v. D.F.C. of T. (82 ATC 4484 at p. 4487) and said (at pp. 7-8 [of the transcript]):
``The applicant in the present case has put no material before the Court to show that there is a dispute `genuinely based on substantial grounds'. Nor has any argument been presented identifying the issues that are said to arise and upon which the Court might form some impression of the likelihood of the applicant succeeding before the Board of Review. The applicant has relied solely upon the assertions contained in the notices of objection and the period of delay between the being lodged and the applicant being notified that the objections had been disallowed. While the period of delay is substantial it provides, of itself, no sufficient basis for concluding that there are serious questions based on substantial grounds for resolution between the applicant and the respondent.
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The applicant has taken no steps to seek a stay of execution of the judgment on which the bankruptcy notice is based. It is of course, open to him to do so. Further, he may, without payment of the amount of the judgment debt, secure payment thereof to the satisfaction of this Court or the respondent. He has taken no steps in that regard.
I should also add that the applicant did not seek to rely on the ground of hardship and put no material before the Court on that issue.''
The debtor was thus fully alerted to the need, in this proceeding, to adduce evidence to indicate the substantive nature of the grounds upon which he proposes to challenge the assessments. Despite the warning given by Neaves J., no more than a token effort is made by the debtor even to sketch out the framework of the attack he says he will make upon the assessment. For instance, no attempt is made to establish, even by secondary evidence, the terms of the documentation relied upon to justify the deductions and losses claimed. Instead, the debtor is content to allow the matter to rest in little more than assertion of the position as he sees it: the evidence relied on by him consists of no more than the tender of the notices of objection against the assessments. The submission put on behalf of the debtor is that once the Bankruptcy Court is made aware of the fact that an objection to an assessment has been referred to the Board, the Court should adjourn the petition until the tax dispute is resolved in the Board or in the Courts.
For his part, the Deputy Commissioner takes the stand that the onus rests on the debtor to establish the substantial nature of his grounds of challenge to the assessments. He submits that, since the debtor had failed to do this, he, the Deputy Commissioner, can properly decline to adduce specific evidence on the matters in contest under the assessments. In short, the Deputy Commissioner relies upon the debtor's failure to discharge the evidentiary onus of proof in an application of the kind now made for the adjournment or dismissal of the petition.
In the result, I am left without any real indication from either party as to what, if any, issues of fact or law will be litigated between them when the assessments come under scrutiny. On the one hand, the debtor points to his notices of objection and correspondence from his accountants to the Deputy Commissioner outlining the case to be made on his behalf in challenging the assessments. On the other hand, the Deputy Commissioner asserts that the deductions and losses claimed arise out of tax avoidance or tax minimisation schemes which, apart from the debtor's failure to discharge the onus of proof, are on their face ineffective in any event.
Because of the inability or unwillingness of the parties to crystallise the issues arising between them, it is extremely difficult, if not impossible to attempt an assessment of the likely fate of the debtor's objections, even on the limited basis that is appropriate in the present type of application. Looked at superficially, it seems that there may be some substance in the debtor's claim to a deduction in respect of his investment in the film production. The Deputy Commissioner has declined to advance any particular reason why this deduction should be denied. No specific challenge to the scheme seems to have been foreshadowed. It appears to be common ground that the film was in fact, made. Of course, the taxpayer must establish more than this to gain a deduction. Yet, given the limited perspective of the contest which was made available in this proceeding, it is not apparent what disqualifying circumstance is, or circumstances are, relied on by the Deputy Commissioner. Thus, even if in these matters the debtor bears the general onus of proof (see Income Tax Assessment Act, sec. 190(b)), and although the material relied on by him is far from satisfactory, nonetheless the debtor may well have adduced a scintilla of the evidence required to justify his claim to a deduction. However, in the light of the conclusion I have reached on another aspect of the case, it is unnecessary to express any concluded view on this difficult question.
In my opinion, whatever the status of the claim for a deduction on account of the film scheme, the claim for a deduction in respect of the interest liability incurred in connection with the annuity appears at least dubious on the flimsy material available. On its face, this transaction is extraordinary: it appears to be entirely artificial and without any commercial rationale. It seems to have been entered into for fiscal purposes only. On the basis that the sole purpose of the transaction was to gain a tax benefit, a deduction as claimed for the interest allegedly incurred would be extremely difficult,
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if not impossible, to sustain (cf.F.C. of T. v. Ilbery 81 ATC 4661; (1981) 38 A.L.R. 172).
In the result, in my opinion, even if the debtor could demonstrate a substantial ground of objection on the claim made in respect of the film scheme, he has failed to indicate any genuine substantive basis for the other objection. Since the amount involved in the latter objection ($500,000) even if taken alone is well in excess of the statutory amount required to present a petition (see Bankruptcy Act, sec. 44(1)(a)), it follows that the Deputy Commissioner is entitled to proceed on the petition in respect of at least part of the debt claimed by him.
In the circumstances, I decline to grant the debtor the adjournment sought. I further decline to exercise the discretion vested in the Court by sec. 52(2)(b) of the Bankruptcy Act. Since Neaves J. has already held that the bankruptcy notice should not be set aside, it follows that an act of bankruptcy was committed at the expiration of the extended time for compliance. I therefore propose to make a sequestration order but to stay all proceedings under the order for a period of 21 days in order to give the debtor a final opportunity to resolve the matter.
I am satisfied that the debtor has committed the act of bankruptcy alleged in the petition by reason of his failure to comply with the bankruptcy notice served on him. Although I am not satisfied that the debtor is indebted to the Deputy Commissioner for the whole amount claimed in the petition. I am satisfied that he is so indebted in an amount in excess of $1,000. I am satisfied with the proof of the other matters of which sec. 52(1) of the Bankruptcy Act requires proof. I note that Max Christopher Donnelly, a registered trustee, has consented to act as the trustee of the estate of the debtor.
THE COURT ORDERS THAT:
1. I make a sequestration order against the estate of the debtor.
2. I order that the costs of the Deputy Commissioner (including reserved costs) be taxed and paid according to the Bankruptcy Act.
3. I order that all proceedings under order 1 be stayed for a period of 21 days from this date.
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