PM Roach SM
Administrative Appeals Tribunal
P.M. Roach (Senior Member)
The applicant, who was born in England in 1949 and who had married there in 1972, migrated to Australia. He arrived in this country on 27 March 1980. Prior to migrating he had pursued a career in the computer industry. Over a period of nearly a decade he had been employed by a succession of companies as a computer programmer and later as a computer systems analyst. When he arrived in Australia he was in the condition of many who have migrated to this country. He was unemployed.
2. He set about securing employment in the computer industry and an agent directed his attention to possible opportunities. One project which came under notice in which his services could be utilised involved the development of a specific program for a finance company (Fin-Co). As is common in the computer industry, quite often the services of computer specialists are only required for the duration of particular projects. His introduction to that project came through a computer company (Consultants) which had the responsibility for the development of the program required by Fin-Co. Consultants referred the applicant to Sydney solicitors who arranged for the incorporation of a company (Alpha) and for Alpha to act as trustee pursuant to the provisions of a deed of trust. Alpha contracted with Consultants to make available the services of the applicant to work on the Fin-Co project commencing 14 April 1980. From that date the applicant became an employee of Alpha. The terms of the applicant's employment with Alpha were not formally documented.
3. The only two issued shares in capital of Alpha were held by the wife of the applicant and a long-term friend. The share of the friend was held in trust for the applicant's wife. Alpha carried on no activities otherwise than as trustee of the discretionary trust. The discretionary trust provided that, at the discretion of the trustee, ``the eligible beneficiaries'' might be the wife, children, grandchildren and great-grandchildren of the applicant; the spouses of all the children of the applicant; any future wife or wives of the applicant; and such other persons as the trustee ``shall by notation before the Perpetuity Date appoint to be eligible beneficiaries'' provided however that (inter alia) the applicant could not be appointed an eligible beneficiary. The power of removal and appointment of trustees was vested in the wife of the applicant.
4. On 29 May 1981 Alpha established a superannuation scheme for the benefit of its only employee, the applicant.
5. Then, when Consultants no longer had need for the services of the applicant in relation to the Fin-Co project, the contract between Alpha and Consultants came to an end. At that point the applicant was able to continue in the employment of Alpha because Alpha was able to arrange for the services of the applicant to be utilised in another computer project with a State Government Authority. In that connection Alpha arranged with an intermediary company (Mid-Co) to make the services of the applicant available to Mid-Co. In turn, Mid-Co made his services available to the State Government Authority. From that point the applicant rendered service in the offices of the State Government Authority. That arrangement continued until that project too came to an end. That was after the close of the period under consideration upon these references. Throughout the relevant period Alpha was remunerated first by Consultants and later by Mid-Co on an hourly rate for the hours worked by the applicant. The rate increased from time to time.
6. The relevant figures are not in dispute and, in that regard, the evidence shows the following:
Year ended Fees to Other income Salary to Other expenses 30 June Alpha Alpha applicant Alpha $ $ $ $ 1980 5,290 - 2,884 10 1981 28,259 65 15,194 5,886 1982 34,201 480* 15,841 4,806 1983 39,263 2,208 18,492 10,828
*(less set-off of loss and share options of $240)
7. What distinguishes these arrangements from the employments the applicant had known in the United Kingdom were the circumstances that:
- (a) the applicant had been instrumental in bringing into existence both the contracts for services between Alpha and first Consultants and later Mid-Co; and the contract of services between himself and Alpha; and
- (b) although he was neither a beneficiary of the trust nor a shareholder in Alpha, the beneficiaries who actually derived income from the trust were limited to the wife and child of the applicant.
8. On the other hand, just as in his prior employments the ``profit'' from his labour passed to his employer and through it to persons who were distinct legal entities from himself. In those circumstances so much remuneration as the applicant received from his employer constituted assessable income in his hands and so much as constituted the profit from his labour which remained with his employer was assessable to tax against the employer. However, in this instance the applicant contends for a different result.
9. In determining whether the Commissioner is correct in his contentions it is appropriate to commence by recognising that basically income tax is levied against taxpayers on the basis of what they have done: not on a basis as to what they might have done and not on a basis of what others have done. That principle found expression in another context in the unanimous joint judgment of a Full Bench of the High Court of Australia in
Ronpibon Tin N.L. and Tongkah Compound N.L. v. F.C. of T. (1949) 78 C.L.R. 47 at p. 60 when, in the course of considering a claim to deductions by a company, the Court said:
``It is important not to confuse the question how much of the actual expenditure of the taxpayer is attributable to the gaining of assessable income with the question how much would a prudent investor have expended in gaining the assessable income. The actual expenditure in gaining the assessable income, if and when ascertained, must be accepted. The problem (in this case) is to ascertain it by an apportionment. It is not for the Court or the Commissioner to say how much a taxpayer ought to spend in obtaining his income, but only how much he has spent...''
The Court might as well have said:
``It is not for the Court or the Commissioner to say how much a taxpayer ought to earn as a result of his efforts, but only how much he has earned;''
``It is not for the Court or the Commissioner to say which taxpayer ought to have earned any particular assessable income but only how much assessable income has been earned by each taxpayer.''
10. In short, the fiscal system does not ordinarily direct or determine what people may or may not do. Laws other than tax laws determine the limits of permitted conduct and the norms by which society conducts its affairs. Tax laws accept that, and that it is what people do (or omit to do) which determines their liability in tax. That extends to the point of recognising unlawful and even criminal conduct as conduct generating a liability to tax.
11. So it is that the Income Tax Assessment Act 1936 (``the Act'') recognises both natural persons and legal fictions (such as registered companies) as taxpayers (sec. 6: ``... person includes a company''). It recognises partnerships (``an association of persons carrying on business as partners or in receipt of income jointly...'' (sec. 6.)) as deriving income
ATC 470(sec. 91): but provides for the assessment of partners (Div. 5). Similarly, it recognises trustees as deriving income but, depending upon circumstances, provides for the imposition of tax against either the trustee or the beneficiaries (Div. 6). In that way then the Act recognises and allows persons to organise their affairs as they please, provided that they accept the tax consequences appropriate to the organisation they have implemented.
12. As a result, the determination of taxable income for each person in the community ordinarily requires that the assessable income of the taxpayer (company, partnership, trust or individual) be determined by identifying what has been ``derived'' as assessable income by that taxpayer. Against the sum so determined all deductions permitted by the Act which have been ``incurred'' during the relevant year of income are allowed. Thereby the taxable income of that taxpayer for that year is determined (sec. 48). The taxpayer is assessed to tax on the basis of what it was that he derived in the year of income less such allowable deductions as were incurred during the same year of income. He is not to be assessed on the basis of what might have been, whether by reason of the timing of the derivation of income or of the date on which a loss or outgoing was incurred or by reason of the possibility that he might have derived a greater sum than was in fact derived.
13. That being so, in my view there is no doubt that if the income sought to be attributed by the Commissioner to this applicant was derived by the applicant, then it is assessable against him and that, if it was derived by the company, it would be assessable against the company rather than against the applicant, unless sec. 260 of the Act intervenes.
14. Whether the income was derived by the company or the applicant is a proper question to be considered. What finding will be appropriate in that regard will depend upon the evidence in each case. As the facts are presented before me, in the simplest sense of ``derivation'', I am satisfied that the assessable income in question was ``received'' by the company - not by the applicant - and in that sense ``derived'' by the company.
15. It has sometimes been contended for the Commissioner that there is a general proposition of taxation law that income generated by personal exertion cannot be alienated in any way and that any attempt to do so on the part of the person effecting the personal exertion is simply ineffectual. In
F.C. of T. v. Gulland; Watson v. F.C. of T.; Pincus v. F.C. of T. 85 ATC 4765 at p. 4773 Gibbs C.J. said:
``it is simply not right to say that the Act allows a taxpayer the opportunity to have his own income from personal exertion taxed as though it were income derived by a trust and held for the benefit of a number of beneficiaries.''
There are said to be other existing authorities to similar effect. That that is so was acknowledged by four Judges of the High Court of Australia in
F.C. of T. v. Everett 80 ATC 4076, when they said (at p. 4082):
``The (Commissioner's) proposition is that income from personal exertion cannot be assigned so that it is not first received as income by the assignor. The (Commissioner) relies on the remarks of Henry J. in
Spratt v. Commr of I.R. (N.Z.) (1964)N.Z.L.R. 272 at p. 277:
- `No taxpayer can, by way of assignment, escape assessment of tax on income resulting from his personal activities - such income always remains truly his income and is derived by him irrespective of the method he may adopt to dispose of it.'
He also relies on the observation of Menzies J. in
Peate v. F.C. of T. (1964) 111 C.L.R. 443 at p. 446, that it is established that `a family man... cannot achieve taxation immunity by the simple expedient of assigning his earnings to his wife and family'. See also
Parkins v. Warwick (1943) 25 T.C. 419 at p. 424; Kelly at p. 384.''
(A reference to
Kelly v. I.R.C. (N.Z.) 1 A.T.R. 380).
16. However, as their Honours said of that argument:
``The appellant's argument did not succeed in identifying the origin of the proposition or, indeed, the precise area of its operation.''
With great respect to all of the Judges whose observations in this regard have been referred to, I find the expressions used in support of the
ATC 471proposition quite unhelpful if they are to be understood as statements supporting the general proposition earlier referred to. One can agree that a person who has derived income cannot so organise his affairs as to no longer derive what he has derived. But if he suffers or allows another person to derive the income in question as the income of that person, the income in question is then derived by that other person. The contention begs the questions ``what constitutes the income in question?''; and ``who derived that income?''.
17. In the circumstances of this case, in order to secure the benefit of the applicant's services, Alpha was paid by the customer pursuant to a contractual arrangement made with Alpha. All of the amounts of income in question before me were paid to Alpha as the party directly entitled. Alpha received the moneys and, in my view, it ``derived'' them. The circumstance that the payments were made to Alpha by Consultants in order to secure the services of the applicant do not alter that fact as to derivation. I am satisfied in all respects that Alpha ``derived'' the assessable income in question.
18. In this context it is also appropriate to consider whether what was done constituted ``a sham transaction (which) is inherently worthless and needs no enactment to nullify it'' [Isaacs J. in
Jaques v. F.C. of T. (1923-1924) 34 C.L.R. 328 at p. 358]. In my view, it was not. I accept that what was done was deliberately done intending that it should have the effects provided for by law. In my view, it was intended that Alpha would be entitled to the amounts it received and that the entitlements of the applicant would only be to a salary and superannuation benefits as provided for. I am also satisfied that it was intended that the ``profit'' which the company so gained from the exertions of the applicant would beneficially held by the company to the advantage of the shareholders in the company. It was not a sham.
19. Thus the question which remains for determination is whether sec. 260 of the Act applies. Although frequently referred to and often quoted I sometimes suspect that it is less frequently read. So far as is material, it provides as follows:
``260(1) Every... arrangement... entered into,... shall so far as it has or purports to have the purpose or effect of...
- (a)altering the incidence of any income tax;
- (b) relieving any person from liability to pay any income tax or make any return;
- (c) defeating, evading, or avoiding any duty or liability imposed on any person by this Act; or
- (d) preventing the operation of this Act in any respect,
be absolutely void, as against the Commissioner,... but without prejudice to such validity as it may have in any other respect or for any other purpose.
(2) This section does not apply to any contract, agreement or arrangement made or entered into after 27 May 1981.''
20. I doubt that there would be anyone who would contend that the legal system has served the community well in its attempts to define and give effect to a clear interpretation of the section. Recent history indicates that: particularly when it is borne in mind that it is now more than a decade since Mason C.J. (as a Judge of the High Court of Australia) said in
Cridland v. F.C. of T. 77 ATC 4538 at p. 4541; (1977) 140 C.L.R. 330 at p. 337:
``Although the very restricted operation conceded to sec. 260 by the course of judicial decision and the generality of the language in which the section is expressed stand in high contrast, the construction of the section is now settled. It is therefore a source of some surprise that it continues to be relied upon when its defects and deficiencies have been apparent for so long. More than twenty years ago Kitto J. said in
F.C. of T. v. Newton (1957) 96 C.L.R. 577 at p. 596: `Section 260 is a difficult provision, inherited from earlier legislation, and long overdue for reform by someone who will take the trouble to analyse his ideas and define his intentions with precision before putting pen to paper.' This message, despite its clarity, seems not to have reached its intended destination.''
[It must now be acknowledged that sec. 260 has since been repealed and other provisions substituted for it.]
21. Section 260 is a section which has been successfully relied on by the Commissioner in attributing to a taxpayer as assessable income:
- (a) moneys coming into his hands in the guise of capital [``the converted income cases'' Jaques (1923-1924) 34 C.L.R. 328;
Clarke (1932) 48 C.L.R. 56;
Bell (1951-1953) 87 C.L.R. 548; Newton (1958) 98 C.L.R. 1;
Hancock (1959-1961) 108 C.L.R. 258;
Mayfield (No. 1) (1961) 108 C.L.R. 303;
Mayfield (No. 2) (1961) 108 C.L.R. 323; and
Ellers Motors Sales Pty. Ltd. 72 ATC 4033]; and
- (b) moneys received by an associated person or entity as if they were assessable income of that entity [``the derivation cases''
Millard (1962) 108 C.L.R. 336;
Arbuckle (1964) 13 A.T.D. 378 Peate (1966) 116 C.L.R. 38;
Hollyock 71 ATC 4202; Gulland 85 ATC 4765; Watson (ibid.); Pincus (ibid.) and Tupicoff 84 ATC 4851].
The Commissioner's contention in this case is that the facts disclose a situation of the latter type.
22. In considering the two classes of case it is relevant to note that the former class involves an exercise directed to the preservation of the wealth of the taxpayer by avoiding liability to income tax whereas in the latter case the taxpayer chooses to accept a reduction in income in the future (with a corresponding reduction in income tax liability) by a course which he expects will increase the future taxable income of others, usually members of the taxpayer's family, attended by an appropriate increased liability in them to income tax: a circumstance which, in the absence of authority to the contrary, might be thought to suggest that under the new arrangement the incidence of tax will fall precisely as the Act contemplated.
23. In considering the application of sec. 260 in the circumstances of the present case it is necessary that I accept the guidance of the decision of the High Court of Australia in Gulland, Watson and Pincus 85 ATC 4765. In that trilogy of decisions it is the stated reasons of Dawson J. which must principally guide me. That reasoning had the unqualified support of Wilson J. (ibid., p. 4777); the support of Brennan J. except to the extent expressed in his Honour's reasons (ibid., p. 4777); and of his Honour, the then Chief Justice (ibid., p. 4769ff.); [Deane J. dissented (ibid., p. 4781)].
24. In approaching that task it should be borne in mind that even in relation to medical practitioners there is no decided case which supports a proposition that medical practitioners must be self-employed. They may be employed by corporations, companies, partnerships and individuals. If a medical practitioner employed by a company renders a professional service, the fee paid to the company in respect of that service is derived by the company. If a medical practitioner is in partnership, the fees generated by his personal services or the personal services of any of the partners or of any of their employees are derived by the partnership and not by the individual performing the service.
25. Further there is no support in the authorities for any rule of law which would provide that a medical practitioner may only be employed by companies or partnerships in relation to which he has no direct or indirect controlling influence or financial interest. Nor is there any support in the authorities for the proposition that a taxpayer cannot cease to be self-employed in a business and become an employee of the new entity operating that business, even if the taxpayer directly or indirectly controls the new entity conducting the business.
26. However, it is clear that sec. 260 does operate to make void for the purposes of the Act those arrangements which fall within its provisions with the result that ``annihilation'' may show that income derived by the efforts of the individuals concerned and in consequence deemed to have been derived by them. The ``purpose or effect'' of the arrangement must be seen from the terms of the arrangement itself or from the acts by which it was implemented (Dawson J. at p. 4793). What enables the Court to determine by the overt acts that the arrangement was implemented in that particular way so as to avoid tax may be the ``artificial character of the arrangement'' (ibid. p. 4795). As his Honour said in speaking of the Gulland arrangement:
``Its very complexity pointed to its contrived nature and took it (the arrangement) beyond the range of transactions ordinarily
ATC 473encountered in the organisation of affairs for business or personal reasons.''
Other considerations which influenced Dawson J. were:
``that the arrangement in question does not facilitate the practice of the profession which it governs... all the more significant if the method adopted fails to meet the requirements of the law or of professional standards''
(ibid., p. 4796).
It was also significant in the view of the Privy Council in Peate v. F.C. of T. [(1966) 116 C.L.R. 38 at p. 43] that in the circumstances of the case ``the doctors who had been partners treated patients in the same way as they had before...''. That is a matter of considerable significance.
27. It is nowhere suggested that sec. 260 only applies to members of the medical profession. Even before Peate's case it had been applied to accountants (Arbuckle) and bookmakers (Millard) and, since the Privy Council decision in Peate's case, it has been applied to chemists (Hollyock) and life assurance agents (Tupicoff - post). But it was a common characteristic of all those ``derivation cases'' other than Tupicoff that the income providers, be they patients of the doctor, purchasers from the chemist or punters dealing with the bookmaker were, or were likely to have been, unaware that they were dealing with a body corporate (or other newly introduced legal entity) in succession to natural persons.
28. Standing in the face of that view of the authorities, is the decision of the Full Bench of the Federal Court of Australia in
Tupicoff v. F.C. of T. 84 ATC 4851. (An application for special leave to appeal to the High Court of Australia was refused.) Tupicoff is exceptional in that there the payer who was the ``source'' of the income was a well-informed party to the rearrangement. In that sense it stood in complete contrast to the general body of patients of the doctor, customers of the chemist or patrons of the bookmaker.
29. However, I observe that it was the view of the Federal Court that the transaction might well have been one of ``ordinary business dealing'' such as would be beyond the scope of sec. 260 had it not been for the circumstance that, in addition to a company controlled by the taxpayer succeeding to the business of the taxpayer as a sole trader, a family trust had also been introduced as part of the scheme. That aspect of the decision in Tupicoff finds express confirmation in Gulland et al. in that all of their Honours, constituting the majority of the Court, held that a mere transmission from being self-employed in business to being employed in the same business by a company directly or indirectly controlled by the taxpayer alone would not attract the operation of sec. 260. That being so, the further question which arises is whether a person employed by a stranger will attract the operation of sec. 260 if he terminates that employment to become employed by a company which he directly or indirectly controls and, in the course of employment of the latter company, renders the same services for his former employer as previously. I find no basis in that contention for distinguishing between employed persons and self-employed persons and know of no authority in support of any such distinction in that regard.
30. However, even if I should be incorrect about that, the application of sec. 260 further requires at least that the ``source of income'' be the same because ``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'' (
Europa Oil (N.Z.) Ltd. (No.2) v. Commr of I.R. (N.Z.) 76 ATC 6001 at p. 6009).
31. In this context ``source of income'' refers to ``the real, or ultimate source of income and not of the vehicle by which it was conveyed to the taxpayer. The legal structure within which an income may be derived by a taxpayer may vary but the source of that income may remain the same'' (Dawson J., Gulland, ante at p. 4805).
32. On the facts before him in relation to Dr Pincus, Dawson J. concluded:
``The new arrangement did not produce a new source of income in the sense in which the cases use that term. Dr Pincus' source of income whilst he was a sole practitioner, whilst he was practising in partnership, and now under the substituted arrangement, has been, and is, the same, namely the practice of his profession as a doctor. The form of arrangement under which he has practised from time to time has not altered the source
ATC 474of his income in any relevant sense. The source of his income tax [sic] has been his professional activities as a medical practitioner whether he has been a sole practitioner, a partner or an employee. It is from those activities that his income has derived and his liability to tax has arisen.''
(at p. 4805)
``The argument, however, ignores the reality of the situation in that both before and after the dissolution of the partnership and the application of sec. 260, Dr Pincus was without interruption carrying on the practice of his profession in a manner which was essentially the same, however much the income which he derived thereby might flow through different channels. The source of income was the same and the effect of sec. 260 was to preclude Dr Pincus from the choices which he might have had were he to have been setting up practice afresh or for the first time.''
33. Although there are phrases within the passages quoted which might suggest that it was sufficient for the application of sec. 260 that the taxpayer should have continued to earn income as a medical practitioner, the passage last quoted, in my view, clearly indicated that that is not so. ``Setting up practice afresh'' would have provided a ``new source of income'' and provided an opportunity ``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''. It follows that, although sec. 260 may operate when an existing stream of income is re-channelled, it says nothing about how a new stream of income should flow.
34. So it is that, in the circumstances of this case, even if it might be said in a meaningful sense that at all material times the taxpayer earned his income as a computer expert, that would not deny him the right to rearrange matters on establishing a ``new source of income'' within the calling of a computer expert.
35. But whatever may have been said in the cases of Gulland et al. and Tupicoff, the same cannot be said in this case. Prior to the commencement of this arrangement, there was no ``stream of income''. Like the draftsman in Case T4,
86 ATC 123, before the arrangement was set in place, the applicant was unemployed. By accepting employment with Alpha, the applicant was seeking to increase his income, accepting with it a liability which he had not previously had: an obligation to pay income tax. Unlike the doctors and Mr Tupicoff he was not seeking to reduce his personal tax contributions to the Revenue. It is true that by establishing the company and electing to work for it rather than working on his own account he was choosing to have some of the profit from his labour remain in the hands of the company with the consequence that his own liability to pay tax would be less than it might have been. But that was a course which he was entitled to follow: accepting a lower income for himself and with it a lesser liability in tax than might have been.
36. In all the circumstances having regard to:
- (a) the reasoning of the High Court of Australia in Gulland, Watson and Pincus (ante);
- (b) the observations of the Federal Court of Australia in Tupicoff (ante);
- (c) the fact that no stream of income existed which could be diverted;
- (d) the fact that the applicant was seeking an increase in his income and, correspondingly, an increase in his liability to income tax; and
- (e) the nature of income tax as a charge upon the activities actually undertaken by taxpayers exercising free choices between the courses of action available to them at law.
I am satisfied that there is no scope in the circumstances of this case for the application of sec. 260 of the Act.
37. Accordingly, the objections of the applicant will be upheld and the decisions of the Commissioner upon the objections will be varied by reducing the taxable income of the applicant to $2,884, $15,794, $15,841 and $18,492 for the years of income ended 30 June 1980, 1981, 1982 and 1983 respectively.