Case V3
Members:CJ Bannon QC
BJ McMahon SM
Tribunal:
Administrative Appeals Tribunal
C.J. Bannon Q.C. (Deputy President)
These applications are heard together by consent and relate to the years of income ended 30 June 1982 to 30 June 1985 inclusive. For convenience the taxpayers will be referred to as Mr and Mrs Goodyear and Mr and Mrs Archer. Mr Goodyear's applications relate to the taxation years ending in 1982, 1983 and 1985. Mrs Goodyear's applications relate to the years ending 1982 to 1985 inclusive. Mr Archer's applications relate to the taxation years ending 1982, 1984 and 1985, while Mrs Archer's relate to the years 1982 to 1985 inclusive. The Tribunal documents became Exhibits A to D inclusive (Transcript pp. 4 and 51).
The Tribunal as originally constituted consisted of the present Members as well as Mr G. Nicholls. When Mr Nicholls became a Senior Member, the Tribunal was reconstituted by consent to substitute Mr Nicholls in his new role instead of in his former role as an ordinary Member. Later, when Mr Nicholls became unavailable, the parties agreed that the hearing be continued pursuant to sec. 23 of the Administrative Appeals Tribunal Act 1975, by the remaining Members.
Mr and Mrs Goodyear and Mr and Mrs Archer were in partnership together in subdividing and selling land at Killarney Vale in New South Wales. The men were both builders and some lots were sold with houses already built on them. The families had a common accountant. In the proceedings before us neither Mrs Goodyear nor Mrs Archer gave evidence and it would appear that business decisions were left to their husbands. Mrs Goodyear is seriously incapacitated and Mr Goodyear advanced her condition as one reason why he was interested in an annuity scheme (Transcript pp. 116 and 117).
According to Mr Goodyear, the accountant, in late May or June 1982, suggested a meeting with himself and Mr Archer. The accountant showed them a brochure, a copy of which is Exhibit E, concerning a superannuation investment, conducted by ``A Pty. Ltd.''. He said the accountant spent some time explaining the brochure and Mr Goodyear then took it home and explained it to his wife (Transcript p. 95). The accountant told him there were income tax benefits available with the scheme (Transcript pp. 74 and 82 - denied Transcript p. 83 but admitted again Transcript pp. 93 and 95).
Mr Goodyear maintained that while the scheme offered a tax benefit in later years, that was simply a bonus. He said he entered into it purely for the superannuation benefit (Transcript pp. 74 and 93). It was discussed that it was desirable to enter into the superannuation scheme before 30 June 1982, because the scheme finished then (Transcript p. 93). Mr Goodyear denied that entry into the scheme before 30 June 1982 was to minimise tax on profits realised from the subdivision although he admitted that 15 lots had been sold in that year at a gross price of something in the order of $450,000 (Transcript p. 95) but he maintained, albeit at least mistakenly, that no profit would be available in that year because of the need to repay advances made to the building partnership by Australian General Credits. This view runs counter to traditional accountancy methods of apportioning profits, realisations and debts over the term of a subdivision realisation.
In June 1982 Mr Goodyear secured an advance of $30,000 from AGC repayable over 10 years at 21% interest reducible. He and his wife signed the application form for partnership units which is attached to Exhibit E and left it with the accountant, together with a bank cheque for $25,000 made out to ``A Pty. Ltd.''.
Mr Archer gave evidence that for quite a number of years the accountant had been telling him he ought to have some superannuation (Transcript p. 128). Some time early in 1982 the accountant said to him that he had an annuity fund he might be interested in and showed him a brochure (Exhibit E). The accountant said (Transcript p. 129):
``... that it was a very good superannuation type annuity or annuity, superannuation, wherein the latter years - I think, 10 or 11 to 15, is very beneficial to you and at the start of it there is a tax deduction which is sort of like the icing on the cake sort of thing.''
Mr Archer took the brochure home and he and his wife read it. The Archers borrowed $35,000 from AGC and signed the application form for partnership units attached to Exhibit E and left a bank cheque for $25,000 made out to ``A Pty. Ltd.'' together with the application form for partnership units with the accountant.
ATC 115
The accountant sent both partnership unit application forms (Exhibit J) signed by the Goodyears and Archers together with their separate bank cheques for $25,000 per family (Exhibit K) to the firm of ``taxation consultants'' in Sydney which had sent him the brochures (Transcript p. 46). A person reading the brochures, Exhibit E, and the application forms, Exhibit J, could be pardoned for believing that what was being offered to subscribers was a ``prescribed interest'' within the meaning of sec. 5(1) and sec. 170 of the uniform Companies Code 1981 and would have been open to objection if issued to the public. Furthermore it was, to say the least, misleading in that it gave the impression that the units were issued by the company itself. Further documents were then sent by the Sydney ``taxation consultants'' to the accountant under cover of a letter dated 30 August 1982 (Exhibit G). The letter forwarded with it four certificates headed ``A Pty. Ltd.'' which, on inspection, turn out to be certificates for 5,000 units each in ``A Pty. Ltd.'' one for each of Mr and Mrs Goodyear and for Mr and Mrs Archer. Also enclosed was a copy document headed Annuity Agreement executed under the common seals of ``A Pty. Ltd.'' and a company called ``J'' as managing partner for ``A Pty. Ltd.'' made on 30 June 1982, pursuant to which in consideration of the sum of $2,020,000, ``A Pty. Ltd.'' grants to ``J'' an annuity for the period and in the amounts specified in the schedule, namely:
``Years one to five inclusive $170,000 Years six to ten $600,000 Years eleven to fifteen inclusive $1,119,000The Due Date for payment shall be the thirtieth day of June in each and every year commencing on the thirtieth day of June, 1982.''
The deed contains a covenant to redeem the annuity in whole or in part in accordance with a schedule (``Appendix `A''').
Another document enclosed is a copy of a loan agreement made on 30 June 1982, whereby a company called ``D'' lends the sum of $2,000,000 to ``A Pty. Ltd.'' with interest at 18%, with interest of $360,000 payable on 30 June each year for the first 12 years, and instalments of principal and interest repayable as follows:
30 June 1994 $661,400
30 June 1995 $1,084,920
30 June 1996 $1,084,920
The next document enclosed was a copy of a loan agreement made on 30 June 1982 whereby a company called ``E'' makes a loan to ``A Pty. Ltd.'' as follows:
``THE PRINCIPAL SUMS to be advanced plus accrued interest calculated at the rate of 18% (eighteen per centum) per annum payable annually in advance are:
30 June 1982 $190,000 30 June 1983 $190,000 30 June 1984 $190,000 30 June 1985 $190,000 30 June 1986 $190,000THE PRINCIPAL AND INTEREST is to be repaid annually in advance on the thirtieth day of June in each year as follows:
1992 $724,920 1993 $724,920 1994 $423,524''
The last document enclosed with the letter was a copy of a partnership agreement (Exhibit H) for ``A Pty. Ltd.''. This turned out to be each of the Goodyears and Archers as the holders of $12,500 each in ``Ordinary Units'' and ``J'' as the holder of $1 - in ``Special Units''. ``J'' was the managing partner and by cl. 23 had the control of the policy and management of the business of the partnership, power to enter into contracts and agreements and to borrow money for the purposes of carrying on the business of the partnership. The accountant procured the execution of this document by the Goodyears and Archers. It was executed by ``J''. It is plain from the evidence of the accountant and that of Goodyear and Archer that the accountant never explained the loan agreements, or the Annuity Agreement, the partnership certificates or even the partnership agreement to his clients (accountant's evidence generally Transcript pp. 53b-59), although the accountant claimed he discussed the legal opinion and Details for Professional Advisers Exhibits F1 and F2 with his clients (Transcript p. 57). It was plain from the evidence of Goodyear (Transcript p. 121) and Archer (Transcript p. 170) that they were never informed (nor were their wives) of the extent of the borrowings by ``J'' on behalf of ``A Pty. Ltd.'' nor of the elaborate annuity and
ATC 116
loan arrangements made for the purpose of carrying out the scheme offered to them in accordance with the brochure Exhibit E.The application form in Exhibit E (brochure) contains a provision requesting ``A Pty. Ltd.'' to contact the applicant's accountant ``and make available complete details of the `A Pty. Ltd.' Future Cash Benefits plan to which I am contemplating participation. He/they are to examine the plan's implications in relation to my own affairs in order to confirm to me upon subsequent consultation the benefits thereby gained by my participation''. Needless to say the accountant is not a party to this document. It may be presumed that the documents sent to the accountant by the ``taxation consultants'' (Exhibits G and H), were sent to him on behalf of ``A Pty. Ltd.''. Although a director of that company gave evidence that he signed the Annuity Agreement, part of Exhibit G, on behalf of ``A Pty. Ltd.'' (Transcript p. 323), which was returned to the accountant per medium of the Sydney ``taxation consultants'', and regarded the company as bound by it, he knew nothing about the source of the sum of $2,020,000 (Transcript p. 324). He supposed the ``taxation consultants'' were agents of the company (Transcript p. 325).
The brochure, Exhibit E, alleges on p. 2:
``The finance company lending the funds will take a charge over the annuity as its security and as the annuity value will always exceed any loan value for the entire term there cannot be any further recourse on an investor for further payments.''
Leaving aside for the moment any question of sham, the partnership agreement outlined and the various consequential loans and the Annuity Agreement may all be open to be set aside in a court of equity. The clause regarding lack of recourse to investors depends in no small part upon the loans and borrowings made by ``J''. The lack of recourse depends on the terms of those documents. It may well be that the Goodyears and Archers could seek to avoid the agreements, but they have not done so. The Tribunal faces the documents as they are. It does not enjoy any power to set them aside. Furthermore, sec. 260 of the Act does not apply to transactions entered into after 27 May 1981.
As regards sham it is difficult to see how that argument could succeed. In order for an agreement to be a sham, it must be a facade, a disguise concealing the real transaction.
Clyne
v.
F.C. of T.
83 ATC 4508
at p. 4515
per
Yeldham
J. It is difficult to reach that conclusion in view of the evidence of the director of ``A Pty. Ltd.''. Both parties must be parties to the facade in order for an agreement to be a sham. That argument is not upheld.
Similar problems face an argument based on mistake. The taxpayers do not assert any lack of consent or mistake on their part in execution of the agreements even if steps taken thereunder were not foreseen. (See
Saunders v. Anglia Building Society
(sub. nom.
Gallie
v.
Lee)
(1971) A.C. 1004
at p. 1035
.)
Having analysed to some extent the paper documents, reference will now be made to the activities of the moving spirit behind the annuity activities of ``A Pty. Ltd.''. In a provincial New South Wales town an accountant, a director of the company ``A Pty. Ltd.'', sought the advice of an actuary concerning calculations to structure annuity and loan repayments for the plans to which the Goodyears and Archers subscribed (Transcript p. 265). It is clear from the evidence of an actuary, Mr L, that the accountant was postulating the making of a loan by a finance company to an annuitant to purchase the annuity (Transcript p. 264), with provision for an ability to surrender the annuity and repay the loan after say 10 years (Transcript p. 264). Mr L gave the following evidence concerning the provision of a facility to surrender the annuity and his conversation with the provincial accountant at Transcript pp. 264 and 265:
``As far as I can recall there seemed to be some tax implications involved but I never understood them.
No, but from what he told you were the tax implications that for the first 10 years the annuitant was not going to be getting anything in cold hard cash? - Yes.
But for at least part of the first 10 years the annuitant was going to be getting a tax benefit? - Yes.
But after the 10 years things would change and the annuitant would then be in receipt of cold hard cash? - Yes.
And the tax benefits would be much less in those circumstances? - Yes.
ATC 117
So that it was in that context, I take it, that the accountant was discussing with you the ability to renegotiate the facility after, say, 10 years? - That was my understanding, yes.
So as you understood it an annuitant who had the benefit of the tax deduction, say, for the first 10 years could then bail out after 10 years? - That seemed to be the intention, yes.
That was the intention you gleaned from the accountant, was it not? - Yes.
Then your letter goes on, `Clearly there are innumerable ways in which any annuity and loan repayment can be structured, however you have advised various requirements which will constrain the structure'? - Yes.
Now, what is your recollection now of the various requirements advised by the accountant which would constrain the structure? - He nominated the amounts of annuity that it was intended to pay within the first 5 years and in the second 5 years and third 5 years and therefore it was not up to me to vary those amounts of annuity, it was up to me to decide what amounts of annuity we merge in the final 5 years, but I had no say in the structure of the first 10, 15 years, depending on the term of the annuity.
Just so I might understand that, when you say he nominated, you mean he specified a figure? - Yes.
Of the annuity for the first 5 years? - Yes, and then the second 5 years at a different amount.''
Concerning the instructions given him by the accountant, which are referred to in the actuaries' letters to the accountant dated 15 January 1982, 22 March 1982 and 5 April 1982 (Exhibit Z), Mr L made it clear that his calculations did not depend on the initial investment by the taxpayers; the amounts of the annuity payments and the loans being matched at rates of interest to achieve the requested results on paper. Mr L also indicated at Transcript p. 254 that no liability to tax was considered in his calculations. Mr L's letter of 5 April 1982 makes it clear that he is considering returns upon real investments. Mr L also produced further calculations (Exhibit R) based upon the partnership agreement (Exhibit H), the loan agreements between ``D'' and ``A Pty. Ltd.'' (part Exhibit G), the loan agreement between ``E'' and ``A Pty. Ltd.'' (part Exhibit G) and the annuity agreement between ``A Pty. Ltd.'' and ``J'' (part Exhibit G) (Transcript p. 185). Mr L corrected the calculations in evidence at Transcript pp. 252 and 253.
Having set in place the paper calculations for the annuity cashflows, and having achieved execution of various agreements, the mechanism of the scheme was now implemented in a manner which was not known to the Goodyears and Archers (Transcript pp. 121, 170-174 and 315) and would have left them gasping, if known. Working closely with the accountant was another accountant, Mr T. Mr T held the multiple roles of being a director or secretary of ``A Pty. Ltd.'' at all material times (Transcript p. 228). He is at present its secretary (Transcript p. 201). Mr T was also a director of ``D'', of ``E'' and of ``J'' (Transcript p. 201). Moving blithely from the duties of one office to those of another, Mr T signed various documents in Canberra in the Australian Capital Territory (Transcript pp. 210, 211, 214, 216 and 217). Mr T signed bills of exchange for various large sums of money passing on paper between ``A Pty. Ltd.'', ``E'', ``A Pty. Ltd.'' and ``D'', by way of orders, acceptances and endorsements of the bills. Mr T admitted the following:
``Yes, I will just take you back a step. You have agreed the bills of exchange were not supported by any cash? - Correct.
And in so far as the bills were endorsed by `A Pty. Ltd.' to `E' that was merely building up a paper entry by way of a debit in the books of `A Pty. Ltd.', was it not? - Yes, it replaced a book entry.
Well, that was all it was, a book entry? - That is correct.
And creating a book entry in the book of `E'? - Yes.
By way of a credit? - Yes.
But without any money to support either the debit or the credit? - Yes.
The same was the situation in so far as `A Pty. Ltd.' endorsed bills of exchange to `D', was is not? - Yes.
Now, you were aware, of course, that `A Pty. Ltd.' had agreed to lend money to `D' in the sum of $2,000,000, were you not? - Yes.
ATC 118
That was brought in as part of the arrangement, was it? - Yes.
So that ultimately the bills of exchange could go around in a circle? - Yes.
Similarly you were aware that `A Pty. Ltd.' had agreed to lend money to `E'? - Yes.
That was part of the scheme? - Yes, it was.
And also so the bills of exchange could go around in a circle? - Yes.
And the circle could never be broken, so that none of the parties if they turned difficult would start making a demand on the bills? - Yes, that is correct.
It was your understanding at all times that these so-called payments would be made by way of these round robins of bills of exchange? - Yes.
And that would be done basically under your control as an officer of one of the relevant companies? - Yes.
And without reference to any of the other partners in `A Pty. Ltd.'? - Yes.''
(Transcript pp. 295-297.)
It was clear on the evidence that Mr L's calculations did not take into account any contribution from the taxpayers (Transcript p. 283) and that by setting the interest rates, loan repayments and annuity repayments at pre-ordained figures, a perfect round robin of paper transactions was achievable. At Transcript p. 271, Mr L said:
``Well, the artificiality was in setting the annuity income at specified amounts in the first fifteen years.''
At Transcript p. 275 he said the annuitant does get the rate of return nominated by the contract. It is clear from Mr L's evidence and especially from his flow chart, Exhibit R, that the money arrangements were artificially contrived so as to provide for expenditure on interest payments to exceed income in the first five years of operation. This accords with the statement appearing on the fourth page of the brochure Exhibit E that persons such as the taxpayers, entering into an 11-year plan as they did, achieved tax deductions in the first five years. When asked if annuities of about $17,000 for five years could be achieved by a straight out investment of $20,000 free of tax for 11 years Mr L agreed this was the case if the investment was at 14% per annum (Transcript pp. 255-256). The question then remains, what was the elaborate round robin scheme of bills of exchange and associated annuity, partnership and loan agreements, intended to achieve which an ordinary investment with a bank would not achieve, apart from some far off possibilities in capital accumulation which were not fully revealed to the taxpayers. The obvious answer is tax deductions for the first five years.
While the round robin mechanism was not revealed to the taxpayers, the brochure Exhibit E on p. 3 made it plain that by entering into the scheme, large deductions from taxable income were obtainable. The scheme worked in accordance with the diagram on p. 119 (part of Exhibit R).
While it is clear that the country accountant's highly artificial scheme was expressly designed to achieve large tax deductions in the first five years, it does not necessarily follow that this was also the purpose of the taxpayers. The way the case has been presented to the Tribunal is that the taxpayers' principal purpose in entering into the annuity scheme was to gain the benefit of the annuities, the tax deductions being noticed by being simply incidental, or ``icing on the cake''.
The reward for ``A Pty. Ltd.'' lay in the Establishment Cost which it charged (see Exhibit E), being $30,000 out of the total investment of $50,000 by the Goodyears and Archers, plus any incidental profits if unit holders surrendered annuity entitlements.
It was submitted that the taxpayers were not entitled to deductions pursuant to sec. 51 of the Income Tax Assessment Act 1936 (Cth) (``the Act'') because of the provisions of Subdiv. D of Div. 3 of the Act. The definition of ``relevant expenditure'' in sec. 82KH(1) includes expenditures coming within sec. 51 and it would seem sec. 82KH(1)(d) would specifically apply, and in any event, sec. 82KH(1)(w) would bring the deductions claimed within the definition. Again the scheme for the annuities agreement clearly falls within the definition of ``tax avoidance agreement'' in sec. 82KH(1). Learned counsel then argued that an additional benefit pursuant to sec. 82KH(1F)(b) of the Act arose by reason of sec. 82KH(1J) in that interest was payable under a tax avoidance agreement satisfying para. (a)
Assessable income
Allowable deductions
Annuities Investment Partnership No. 18.
Partnership Net Income and Loss for Income Tax 1982-1996
ATC 120
thereof, a debt became owing by the taxpayers within the terms of para. (b)(i) thereof and that para. (c) was satisfied because it may reasonably be expected that either by reason of or as part of the tax avoidance agreement ``D'' and/or ``E'' would release the partnership from the debt and/or debts. Further it was said that on any view of the evidence the taxpayers never contemplated having to repay such debts, or having to include in their assessable income such large amounts as the scheme projected for its later years.This appears to be correct. Although partners are liable for the debts incurred by each other in the partnership business, the members of ``A Pty. Ltd.'' had been assured in the brochure, Exhibit E, that ``as the annuity value will always exceed any loan value for the entire term, there cannot be any further recourse on an investor for further payments''. The round robin nature of the scheme with its creation of periods of partnership loss and partnership profits through paper transactions appears to indicate that the profits at the end of the rainbow are a mirage, together with the paper debts. There is no indication on the evidence of any fund provided by ``A Pty. Ltd.'' to meet the projected profits.
However, in order to come within sec. 82KH(1F) of the Act it is necessary for the taxpayer to obtain a benefit or benefits under sec. 82KH(1F)(b)(i) which is in addition to the benefit in respect of which the relevant expenditure was incurred. If counsel's argument is correct, neither the debt would be enforced, nor would the annuity be paid, therefore there would be no ostensible benefit, i.e. annuity payments, in respect of which the relevant expenditure was incurred to which the tax benefits would be additional. Under sec. 82KH(1F)(b)(ii) it does not seem possible to predicate that the first five years of interest deductions would have been available if the relevant expenditure had been incurred otherwise than by reason of, as a result of or as part of a tax avoidance agreement. The note at ¶ 23-010, p. 14,504 of Vol. 3 Australian Federal Tax Reporter (CCH) appears to be correct where it says:
``Subdivision D of Div. 3 (sec. 82KH to 82KL) also contains provisions which may operate to deny deductions otherwise allowable under sec. 51. That Subdivision applies to deny a deduction where the loss or outgoing in question has been incurred under tax avoidance schemes designed to gain the benefit of the deduction without actually incurring any real detriment in terms of expenditure incurred.''
In the present cases the taxpayers did incur real detriment in terms of expenditure incurred. They paid out $50,000. Therefore it appears that they do not come within Subdiv. D of Div. 3 of the Act.
Turning now to the provisions of Pt IVA of the Act, this appears to be a case in which the taxpayers entered into the annuity schemes with the dominant purpose within the meaning of sec. 177A(5) of the Act, for the purpose of obtaining a tax benefit in connection with the scheme and that the scheme falls within sec. 177D of the Act.
The taxpayers' accountant at Transcript p. 47 said of the taxpayers:
``From memory they were not particularly wrapped in insurance company schemes.''
He said he knew nothing about the capital of ``A Pty. Ltd.'' except what was in the brochure, Exhibit E (and it said nothing). Mr Goodyear's account at Transcript p. 93 that the Goodyears were only interested in the superannuation cannot be accepted in the light of his knowledge of the tax benefits (Transcript p. 95) and his failure to inquire about ``A Pty. Ltd.'' and his claimed dislike of insurance-type superannuation (Transcript p. 92) does not bear examination. He had been subdividing and selling land and it seems hard to accept that he was unaware of a possible tax liability. A similar position obtains with Mr Archer (Transcript p. 148). The speed with which the agreements were negotiated to fall within the financial year ended 30 June 1982 (Transcript p. 151) and the coincidence of land sales having occurred, suggest the real reason was a tax reason.
It is not acceptable that two builders who had moved into land development, and their accountant, would not concern themselves with the financial viability of an unknown company, as against the safety of investing with a large life assurance company, if superannuation was the real motivation.
Not only does it seem that the dominant purpose of the taxpayers was to obtain the deductions for interest payments, but it seems
ATC 121
perfectly clear that this was the principal purpose involved in ``A Pty. Ltd.'' propounding the scheme. This is apparent from the way the annuity scheme is structured and from the instructions given by the accountant to Mr L. Section 177D takes into account not only the purposes of the taxpayers, but also the purpose of a person referred to in sec. 177D(b)(vi), or of persons who enter into or carry out the scheme. The accountant's intentions can be predicated to ``A Pty. Ltd.'' of which he was a director taking an active role in management. Having regard to each of the matters set out in sec. 177D(b), the conclusion should be drawn that the annuity scheme falls within the section. There appears to be no reason why the whole of the tax benefit obtained should not be treated as cancelled pursuant to sec. 177F(1) of the Act.It appears the proper answer to the taxpayers' objections is that the agreements with ``A Pty. Ltd.'' and the other agreements to implement the scheme, and the annuity scheme itself, were carried out with the dominant purpose of enabling the taxpayers to obtain tax benefits within the meaning of sec. 177D of the Act. In any event, the taxpayers have failed to overcome the onus of showing the assessments are incorrect.
On behalf of the Commissioner, it was also submitted that the arrangements amounted to a fiscal nullity and that the decision in
Oakey Abattoir Pty. Ltd.
v.
F.C. of T.
84 ATC 4718
is erroneous. I merely note the submission.
In my opinion, the objections to the tax assessments should be disallowed.
| Date: | Version: | Change: | |
| You are here | 1 January 1001 | Identified |
This information is provided by CCH Australia Limited Link opens in new window. View the disclaimer and notice of copyright.