PM Roach SM
Administrative Appeals Tribunal
P.M. Roach (Senior Member)
These applications relate to the affairs of a company which I shall refer to as MORE-CO. They arise out of an investigation into the affairs of the company conducted as long ago as 1980. Among other things, as its principal activity the company carried on business as ``air conditioning manufacturers''. It presented its returns of income to the Commissioner annually and was assessed upon its returns as lodged. The assessment for the year of income ended 30 June 1979 issued on 12 February 1980. The investigation into the affairs of the company was carried out subsequently. Then
ATC 882on 10 June 1981 the Commissioner issued further assessments (including an original assessment as appropriate) for the years of income ended 30 June 1976 to 1979 (inclusive) and, at the same time, also issued notices of assessment of Div. 7 tax in relation to years of income ended 30 June 1976 and 1977.
2. In its returns of income MORE-CO had claimed (inter alia) deductions as follows:
Year ended 30 June 1976 1977 1978 1979 Total $ $ $ $ $ Research and development 32,600 77,094 10,841 - 120,535 Purchases 209,323 94,974 106,019 218,469 628,785 Sub-contractors 3,335 5,261 6,997 16,434 32,027 Travelling and Entertainment 6,085 10,179 10,720 8,328 35,312 Insurance 4,156 8,774 5,832 4,287 23,049 Motor Vehicle Expenses 10,899 15,306 15,939 15,617 57,761
WHEN THE COMMISSIONER ISSUED THE INCREASE TAXABLE INCOME AS FOLLOWS: ASSESSMENTS OF JUNE 1981 THE EFFECT WAS TO
Previously Assessed 19,772 5,060 (18,158) 9,665 16,339 INCREASE 33,643 82,464 20,749 31,698 168,554 ------- ------- ------ ------- -------- Increased Assessments $53,415 $87,524 $2,591 $41,363 $184,893
3. SOME ADJUSTMENTS WERE NOT DISPUTED. THEY WERE:
1978 1979 $ $ INSURANCE 573 - MOTOR VEHICLE EXPENSES 2,731 2,901 REPAIRS (NET) - * 590
*AN ALARM SYSTEM INSTALLED AT A COST OF $621 WAS CLAIMED AS REPAIRS BUT DISALLOWED AS CAPITAL EXPENDITURE. DEPRECIATION OF $31 WAS ALLOWED.
4. ON THE OTHER HAND THE DEDUCTIONS CLAIMED FOR ``RESEARCH AND DEVELOPMENT'' UNDER THAT TITLE WERE WHOLLY DISALLOWED. THEY ARE COMPLETELY IN DISPUTE. THEY ARE AS FOLLOWS:
1976 1977 1978 1979 TOTAL $ $ $ $ $ RESEARCH AND DEVELOPMENT 32,600 77,094 10,841 - 120,535
5. OF THE CLAIMS AS ``PURCHASES'', THE (IN A MANNER YET TO BE EXPLAINED) AS FOLLOWS: COMMISSIONER DISALLOWED AMOUNTS MADE UP
1976 1977 1978 1979 TOTAL $ $ $ $ $ PURCHASES: D-2 - * 1,913 1,499 5,539 8,951 D-3 - - 624 1,819
2,443 1976 1977 1978 1979 TOTAL $ $ $ $ $ OTHERS - - - 431 431 ABANDONED - - ** 22 - 22 ------ ------ ------ ------ ------- $1,913 $2,145 $7,789 $11,847
*CONCEDED BY THE COMMISSIONER AT THE HEARING TO THE EXTENT OF $180.
**THIS CLAIM WAS ABANDONED BY THE APPLICANT AT THE HEARING.
6. SIMILARLY, CLAIMS TO ``TRAVEL AND WERE DISALLOWED TO THE EXTENT ENTERTAINMENT'' (DESCRIBED IN A MANNER YET TO BE EXPLAINED) SHOWN BELOW:
TRAVEL AND 1976 1977 1978 1979 TOTAL ENTERTAINMENT $ $ $ $ $ D-1 1,043 3,278 995 238 5,554 D-2 - - 3,463 50 3,513 D-3 - - - 536 536 OTHER - * 179 - * 199 378 ------ ------ ------ ------ ------ $1,043 $3,457 $4,458 $1,023 $9,981
*THESE CLAIMS WERE ABANDONED BY THE APPLICANT AT THE HEARING.
7. IN FACE OF THOSE ADJUSTMENTS THE COMMISSIONER DETERMINED THAT THE APPLICANT WAS LIABLE TO ADDITIONAL TAX FOR INCORRECT RETURNS. HAVING SO DETERMINED, HE FURTHER EXERCISED HIS DISCRETION AS TO THE REMISSION OF ADDITIONAL TAX AND FIXED UPON ADDITIONAL TAX TO BE LEVIED AT 50% OF TAX AVOIDED. THE AMOUNTS SO LEVIED WERE:
1976 1977 1978 1979 TOTAL $ $ $ $ $ ADDITIONAL TAX 7,149 18,966 595 3,114 29,824
8. WHEN THE FIRST ASSESSMENTS HAD ISSUED THE COMMISSIONER HAD GIVEN NOTICE IN RELATION TO THE YEARS OF INCOME ENDED 30 JUNE 1976 AND 1977 OF THE AMOUNTS NECESSARY TO BE DISTRIBUTED BY WAY OF DIVIDEND TO CONSTITUTE A SUFFICIENT DISTRIBUTION FOR THE PURPOSES OF DIV. 7 OF THE INCOME TAX ASSESSMENT ACT 1936 (``THE ACT''). BY THAT STANDARD SUFFICIENT DISTRIBUTIONS WERE EFFECTED BY MORE-CO. HOWEVER, HAVING ISSUED THE AMENDED ASSESSMENTS OF JUNE 1981 THE COMMISSIONER ALSO GAVE NOTICE OF ASSESSMENT OF DIV. 7 TAX IN WHICH HE FIXED UPON TAXABLE AMOUNTS OF $4,878 AND $8,158 AND UPON TAX OF $2,439 AND $4,079 FOR THE YEARS OF INCOME ENDED 30 JUNE 1976 AND 1977 RESPECTIVELY.
9. TO THE EXTENT PREVIOUSLY INDICATED ALL ASSESSMENTS OF JUNE 1981 WERE OBJECTED TO IN AUGUST OF THAT YEAR. FOLLOWING DISALLOWANCE OF THE OBJECTIONS, REQUESTS FOR REFERENCE FOR INDEPENDENT REVIEW WERE MADE ON 30 OCTOBER 1981. THE COMMISSIONER REFERRED THE MATTERS FOR INDEPENDENT REVIEW IN OCTOBER 1986.
10. I AM SATISFIED THAT AT ALL MATERIAL TIMES MORE-CO WAS DOMINATED BY THE PERSON TO WHOM I HAVE REFERRED TO AS D-1. IN HIS OWN RIGHT AND BY REASON OF CONTROL OF A CORPORATE SHAREHOLDER IN MORE-CO, AT ALL MATERIAL TIMES HE CONTROLLED 80% OF THE CAPITAL OF THE COMPANY. I FIND THAT HE WAS AT ALL MATERIAL TIMES A DIRECTOR OF THE COMPANY BUT THAT AT NO MATERIAL TIME DID HE RECEIVE ANY DIRECTOR'S FEE OR SALARY AS AN OFFICER OF MORE-CO. I ALSO FIND THAT THE PERSON WHOM I HAVE REFERRED TO AS D-2 WAS AT ALL MATERIAL TIMES A DIRECTOR OF THE COMPANY AND HOLDER OF 10% (LATER 15%) OF ITS ISSUED CAPITAL. DURING THE RELEVANT YEARS OF INCOME HE WAS REMUNERATED AS A DIRECTOR ($760 IN THE FIRST YEAR AND $960 IN EACH OF THE YEARS FOLLOWING) AND AS AN EMPLOYEE ($10,444; $9,810; $11,166; AND $12,100). ACCORDING TO THE COMPANY'S STATUTORY RECORDS, D-3 BECAME A DIRECTOR OF THE COMPANY DURING THE 1978 YEAR BUT HE IS NOT RECORDED IN THE INCOME TAX RETURNS OF THE COMPANY AS EVER HAVING RECEIVED DIRECTOR'S FEES. FOR A PERIOD HE HELD 5% OF THE ISSUED CAPITAL OF THE COMPANY. IN THAT PERIOD THE PERCENTAGE OF CAPITAL HELD BY D-2 WAS INCREASED TO 15%.
11. D-2 WAS THE ONLY PERSON TO GIVE EVIDENCE. D-3 HAD SEVERED HIS ASSOCIATION WITH THE COMPANY IN CIRCUMSTANCES WHICH MADE MORE-CO UNWILLING TO SEEK HIS ATTENDANCE AS A WITNESS AND D-1 HAD LONG SINCE COME TO RESIDE IN THE UNITED KINGDOM. (AS D-1 WAS ABSENT FROM THE HEARING, IT WAS AGREED THAT THE MONEYS IN DISPUTE HAD BEEN EXPENDED BY MORE-CO AND APPLIED FOR THE PURPOSES MENTIONED IN THESE REASONS.) DESPITE HIS RESIDENCE THERE I AM SATISFIED THAT HE EXERCISED COMPLETE AND EFFECTIVE CONTROL OVER THE COMPANY, EFFECTED PARTLY BY VISITS TO AUSTRALIA.
12. D-2 JOINED THE COMPANY AS AN EMPLOYEE AND DIRECTOR IN ABOUT 1973. SINCE ABOUT 1982 HE HAS BEEN MANAGING DIRECTOR OF MORE-CO. THE ASSOCIATION OF D-1 WITH THE COMPANY EXTENDED BACK TO THE LATE 1960S. D-2 WAS THE MAN RESPONSIBLE FOR THE PRINCIPAL ACTIVITIES OF THE COMPANY AS AIR CONDITIONING MANUFACTURERS. BUT IT SEEMS THAT D-1 HAD ADDITIONAL TALENTS AND, IN PARTICULAR, A FLAIR FOR ENGINEERING DESIGN. HE DEVELOPED A CONTINUOUS READING EMISSION SPECTROMETER. THE PLANNED PURPOSE OF THE DESIGN WAS TO PROVIDE A MEANS OF SWIFTLY, ECONOMICALLY AND CHEAPLY CONDUCTING AN INITIAL ASSESSMENT OF THE GEOLOGICAL CHARACTERISTICS OF LARGE AREAS OF LAND AS A PRELIMINARY TO UNDERTAKING SEISMIC SURVEYS AS AN AID TO PETROLEUM EXPLORATION. THE PROPOSED USE OF THE SPECTROMETER WAS TO ANALYSE AIR-BORNE PARTICLES IN THE COURSE OF AERIAL PROSPECTING FROM AIRCRAFT. APPLICATION FOR A PATENT WAS REGISTERED IN THE NAME OF D-1. DEVELOPMENT OF THE SPECTROMETER WAS AN EXPENSIVE MATTER. IN ITS RETURNS MORE-CO CLAIMED TO HAVE EXPENDED IN ALL $120,535 IN RESEARCH AND DEVELOPMENT EXPENSES DURING THE YEARS OF INCOME ENDED 30 JUNE 1976 TO 1978 (INCLUSIVE). WHAT WAS FOUND BY THE COMMISSIONER'S OFFICER IN THE COURSE OF HIS INVESTIGATION WAS THAT THE SUM OF $32,600 CLAIMED AS HAVING BEEN EXPENDED ON RESEARCH AND DEVELOPMENT IN THE YEAR OF INCOME ENDED 30 JUNE 1976 WAS REPRESENTED BY AMOUNTS APPROPRIATED TO THE PROFIT AND LOSS ACCOUNT FROM THE LOAN ACCOUNT OF D-1 ($26,000) AND ``SUNDRY CREDITORS'' ($6,600). AT THE HEARING IT WAS PROPOSED ON BEHALF OF THE APPLICANT, AND ACCEPTED ON BEHALF OF THE COMMISSIONER, THAT THE SUM OF $32,600 (INCLUDING $26,000 REPRESENTED AS CASH REMITTED TO D-1 OVERSEAS) WAS MADE UP AS FOLLOWS:
$ 18/12/75 (DEVELOPMENT REMOTE SENSOR)............ 5,000 13/4/76 (DEVELOPMENT REMOTE SENSOR)............ 20,000 21/5/76 UNSPECIFIED ........................... 1,000 ------- 26,000 SUNDRY CREDITORS ...................... 6,600 ------- $32,600 -------
13. FOR THE YEAR OF INCOME ENDED 30 JUNE 1977 IT IS SUFFICIENT FOR PRESENT PURPOSES TO SAY THAT THE AMOUNT OF $77,094 CLAIMED FELL INTO THREE PARTS:
$ AIRCRAFT PURCHASE 23 MARCH 1977 .................................... 15,521 AIRCRAFT OPERATING EXPENSES AND MAINTENANCE ........................
25,925 $ REIMBURSEMENTS TO D-1 ........................................... 41,264 SUNDRY CREDITORS ................................................ 983 ------- 83,694 LESS SUNDRY CREDITORS 30 JUNE 1976 .............................. 6,600 ------- $77,094 -------
14. IN THE FOLLOWING YEAR THE AMOUNT CLAIMED OF $10,840 WAS MADE UP:
$ AIRCRAFT MAINTENANCE AND OPERATION EXPENSES AND MISCELLANEOUS .. 7,425 PATENT APPLICATION ............................................. 4,399 ------- TOTAL .......................................................... 11,824 LESS SUNDRY CREDITORS 30 JUNE 1977 ............................. 983 ------- $10,841 -------
15. HOWEVER, THE COST OF ``RESEARCH AND DEVELOPMENT'' DID NOT END AT $120,535. UNDER THE CLASSIFICATION ``TRAVEL AND ENTERTAINMENT'' MORE-CO HAD CLAIMED DEDUCTIONS FOR $1,043; $3,278; $995 AND $238 (IN ALL $5,554) IN MEETING EXPENSES INCURRED BY D-1 IN TRAVEL AND ENTERTAINMENT. I AM NOT PERSUADED THAT THE EXPENSES SO INCURRED BY THE COMPANY WERE INCURRED OTHERWISE THAN IN RESPECT TO THE RESEARCH AND DEVELOPMENT PROJECT. IN THE 1978 YEAR, UNDER THE SAME HEADING, A CLAIM WAS MADE TO DEDUCT THE EXPENSES OF $3,463 BY REASON OF D-2 TRAVELLING TO ENGLAND IN RELATION TO THE RESEARCH PROJECT. I AM NOT PERSUADED THAT THAT EXPENSE RELATES TO ANYTHING ELSE.
16. THAT BEING SO THE FIRST ISSUE TO BE DETERMINED IS THE COMPANY'S CLAIMS TO DEDUCTIONS IN RELATION TO THE ``RESEARCH AND DEVELOPMENT'' PROJECT IN SUMS OF $33,643; $80,372; $15,299 AND $238 IN THE YEARS OF INCOME ENDED 30 JUNE 1976 TO 1979 RESPECTIVELY.
17. A SECOND ISSUE RELATES TO AMOUNTS EXPENDED BY MORE-CO IN THE INTERESTS OF D-2 AND D-3 AND CLAIMED AS DEDUCTIONS WHICH WERE REPRESENTED TO HAVE BEEN AS FOLLOWS:
1977 1978 1979 $ $ $ PURCHASES D-2 1,913 1,499 5,539 D-3 - 624 1,819 TRAVEL AND ENTERTAINMENT D-2 - - 50 D-3 - - 536 ------ ------ ------ $1,913 $2,123 $7,944 ------ ------ ------
18. THE CLAIMS SO MADE RELATEd to matters as diverse as paying the accounts of employees with organisations such as ``Mr Wallpaper'', ``Grace Bros.'' and ``Mad Barry's'' and, on the other hand, paying the air-fare for D-3 and family to Tasmania and return. The issue to be determined is whether the outlays of the company in that regard are allowable pursuant to sec. 51 of the Act, or whether the sums are to be disallowed pursuant to the provisions of sec. 108 of the Act.
19. A third area of dispute relates to a claim made under the heading ``purchases'' ($431 in 1979 in relation to persons other than the directors); and a claim made for a payment to sub-contractors ($1,236 in 1979). The question in each case is whether the claims should be allowed as sec. 51 deductions.
20. The next question to be determined is whether the Commissioner had power to impose any penalties for incorrect returns and, should that question be answered affirmatively,
ATC 886whether the penalties imposed should be reduced.
21. The final claim to be decided will be largely resolved consequentially upon a determination of the foregoing issues. Determination of those matters will decide to what extent the assessments of Div. 7 tax are excessive.
Research and development
22. Section 73A of the Act provides:
``(1) The following payments made, and expenditure incurred, during the year of income (other than any amount which is allowable as a deduction under any other section of this Act) by a person carrying on a business for the purpose of gaining or producing assessable income shall be allowable deductions:
- (a) Payments to -
- (i) an approved research institute for scientific research related to that business; or
- (ii) an approved research institute, the object of which is the undertaking of scientific research related to the class of business to which that business belongs; and
- (b) Expenditure of a capital nature on scientific research related to that business (except to the extent that it is expenditure on plant, machinery, land or buildings or on alterations, additions or extensions to buildings or in the acquisition of rights in or arising out of scientific research).
(3) Where any expenditure or payment to which this section refers is incurred or made outside Australia and the business in relation to which it is so incurred or made is carried on partly in and partly out of Australia, the deduction allowable under this section shall be such part of the amount which would otherwise be allowable as the Commissioner considers reasonable in the circumstances.
(5) Notwithstanding anything contained in Section 55, the annual depreciation per centum in respect of plant used by the taxpayer for the purposes of scientific research only, being plant in respect of which depreciation is allowable under section 54, shall be deemed to have been fixed under section 55 as 331/3.
(6) In this section -
`Scientific research' means any activities in the fields of natural or applied science for the extension of knowledge.
(8) In this section, any reference to scientific research related to a business or class of business shall be read as including a reference to -
- (i) any scientific research which may lead to or facilitate an extension, or an improvement in the technical efficiency, of that business, or, as the case may be, of businesses of that class; and
- (ii) any scientific research of a medical nature which is of special relation to the welfare of workers employed in that business or, as the case may be, in businesses of that class.''
23. As there was no suggestion that in the circumstances there had been payment to any ``approved research institute'' it is only necessary to consider the claim for deductibility as based upon sec. 73A(1)(b). It can be immediately observed that:
- (a) section 73A is directed to making allowable as deductions amounts not otherwise allowable under other provisions of the Act. Accordingly, claims allowable pursuant to sec. 51 of the Act are not allowable pursuant to sec. 73A of the Act. On the other hand, a claim which would not satisfy some of the tests under sec. 73A of the Act does not necessarily fail to qualify for deductibility under sec. 51:
- (b) deductions under sec. 73A of the Act are only allowable to ``a person carrying on a business for the purpose of gaining or producing assessable income''. It is not disputed that MORE-CO was such a person:
- (c) to be allowable pursuant to sec. 73A of the Act the expenditure must be:
- - of a capital nature;
- - on scientific research;
- - ``related to that business'', that is to the business being carried on for the purpose of gaining or producing assessable income; and
- - must not be ``expenditure on plant, machinery,... or in the acquisition of rights in or arising out of scientific research.''
24. As the solicitor for MORE-CO recognised the possibility that the aircraft purchased constituted ``plant'', he advanced an alternative claim in relation to that expenditure. It was that an allowance for depreciation should be made pursuant to sec. 73A(5). His first claim so made was that, by force of that subsection, one-third of the cost of the aircraft should be allowed as a deduction in the year of purchase, the year ended 30 June 1977; and that, by reasons of considerations advanced in Case V102,
88 ATC 657, the failure on the part of the applicant to have explicitly claimed that relief in the grounds of objection lodged for that year should not bar the Tribunal from upholding the taxpayer's objection in that regard (cf. sec. 190 as amended). His further argument was that, having accepted the claim for depreciation in relation to the 1977 year, it followed that the claim could have been allowed in following years and that, therefore, such relief should be granted.
25. I am satisfied that if, in relation to the 1977 year, the only reason for disallowing the claim to depreciation had been that the aircraft constituted ``plant'' it would be proper to allow the deduction in that year (cf. the reasons for decision in Case V102 ante). However, I am not so persuaded in relation to the later years. To grant that relief in those later years would raise issues which would not have been available for consideration at all if the only year in relation to which objection had been made had been the 1977 year. In my view, there are still many circumstances in which a failure to raise a matter in an objection may result in an applicant being denied relief to which he might otherwise have been entitled (cf. Case V49,
88 ATC 381).
26. Upon the evidence which has been placed before me I am satisfied that the development of the spectrometer formed no part of the air conditioning business of MORE-CO. It was an entirely new project given over to the development of new equipment which in future - as considered at the time development was being undertaken - might be put to income-producing purposes. I find that by 30 June 1978 the project had been sufficiently developed, particularly through the personal efforts of D-1, to the point at which negotiations were proceeding overseas with others who might take over the project. I find that that was necessary because the capacity of MORE-CO to continue funding development had nearly reached the point of exhaustion. By 30 June 1978 it had expended nearly $130,000 on development. Shareholders' funds then stood at only $7,126. Liabilities (including shareholders' loans outstanding) stood at $99,528. I find that it was then that D-2 travelled to England (at a cost of $3,463) to participate in negotiations and that those negotiations ultimately resulted in an agreement being reached in December 1981 with North American interests. Those were then interests willing to rent the spectrometer for two years at an annual rental of $A5,000 with an ill-defined option to purchase at the end of 1983:
``at a price in terms to be agreed, but in any event not less than the equivalent of $A100,000.''
The amounts of rental were duly paid and returned as assessable income by MORE-CO.
27. It was suggested by the Commissioner's representative in the course of his closing address that, as had been canvassed in cross-examination, the research and development project was really the personal project of D-1 rather than that of MORE-CO. However, in his closing address, he also went on to suggest that, had it not been for the issue of amended assessments in June 1981, there might have been no later direction of assessable income to MORE-CO. I reject the suggestion. If any such submission was to be made, as a matter of simple fairness the issue should have been put to D-2 in the course of his evidence.
28. As to the former submission, having regard to the evidence as presented before me, I am satisfied that D-1 was the dominant influence in the affairs of MORE-CO and that he used that influence to cause MORE-CO to undertake the research and development project and bear the expense of undertaking it. I find that D-1 used his influence in order to nominate to MORE-CO the amounts to be paid on his account or reimbursed to him; and that he alone
ATC 888had effective control over the cost of research and development. But having said that I find that the research and development project was none the less the project of MORE-CO and that, even though the patent application was registered in the name of D-1, beneficial ownership in that intellectual property lay with MORE-CO. Further, I find that during the development phase it was the intention of MORE-CO that it should apply the project to income-producing purposes and that in due course it did so when it earned the revenues from North America. Subsequently nothing further came of the matter and the project died but that, in the circumstances of this case, is not a matter of any consequence.
29. Having held that all of the expenditure incurred constituted capital expenditure upon a research project which was not a project carried on in the course of conducting the air conditioning business of the applicant, it follows that nothing is deductible pursuant to sec. 73A(1). Further, in so far as the aircraft constituted ``plant'', as I find it did, it is to be observed that entitlement to a deduction for depreciation is not generated by sec. 73A(5), but by sec. 54 of the Act. The function of sec. 73A(5) is only to fix the rate of depreciation by substituting a rate of ``331/3%'' for the rate of depreciation which would otherwise be determined by the application of sec. 55 of the Act.
30. Before concluding my observations as to sec. 73A it is appropriate to make two further observations. The first is that I have considered whether the expenditure of $3,463 arising out of the visit of D-2 to the United Kingdom during the 1978 year of income should stand on any special footing. In my view, the answer is ``no''. In so far as it was related, or claimed to be related, to the expectation of derivation of future revenue such as was generated by the letting out or other exploitation of the spectrometer, it is not to be distinguished from any other item of expense so incurred. I so find notwithstanding that the visit was said to be related to negotiations which did later generate a flow of income. Secondly, I observe that, in view of the findings I have made as to sec. 73A, it is unnecessary to comment on the submission made for the Commissioner that I should have found that some part - perhaps a very substantial part - of the expenditure in question was ``incurred or made outside Australia'' so as only to make allowable such portion of the total expenditure as the Commissioner considers reasonable (cf. sec. 73A(3)).
31. Against that background one further question which has to be determined is whether the expenses of research and development not allowable pursuant to sec. 73A of the Act were allowable pursuant to sec. 51(1) of the Act as expenses incurred in the course of deriving assessable income. Another is whether any deductions are to be allowed pursuant to sec. 54 in relation to the aircraft purchased in the 1977 year.
32. My view of all the expenditure I have identified as expenditure on ``research and development'' is that no part of that expenditure was incurred within the meaning of sec. 51(1) of the Act. The expenditure had no other relationship to the business of air conditioning manufacturers or the income generated from that business than that that business activity provided a source of funds to finance the research and development. The research and development project was conceptually distinct from that business of air conditioning manufacturers. Ultimately, the research and development project did generate assessable income in the hands of MORE-CO but, relative to that income and that source of income, the development of the spectrometer was the development of the ``profit-yielding subject'' which was to generate that income (
Sun Newspapers Ltd.; Associated Newspapers Ltd. v. F.C. of T. (1938) 61 C.L.R. 337). The research and development project was concerned about the development of a capital asset. It was not about putting any existing capital asset to any income-generating use so that it could then be said that expenses were incurred ``in the course of'' income-generating activity. Accordingly, the claim pursuant to sec. 51(1) of the Act fails. Similarly, since sec. 54(1) only provides for depreciation on ``plant or articles owned by a taxpayer and used by him during that year for the purpose of producing assessable income'', it follows that the claim to depreciation in relation to the aircraft must also fail. It was not put to any income-producing activity.
Section 108 distributions
33. During the period of three years ended 30 June 1979 the company paid in all $8,951 to
ATC 889the use of D-2 and claimed a deduction for the amount so expended as ``purchases''. In the latter year it also paid $50 to his use and claimed a deduction as ``travel and entertainment''. In a similar way, in the two years to 30 June 1979, the company paid $2,443 to the use of D-3, claiming the deduction as ``purchases''; and $536 in the year of income ended 30 June 1979, claiming the deduction as ``travel and entertainment''. The Commissioner contends that the company is not entitled to any deduction in relation to the moneys so paid because sec. 108(1) (as it was) deems the transactions to constitute dividends. Section 108 provided, so far as is material:
``If... payments are made by (a private) company... for the individual benefit of, any of its shareholders, so much, if any, of the amount... of those... payments, as, in the opinion of the Commissioner, represents distributions of income shall, for the purposes of this Act..., be deemed to be dividends paid by the company on the last day of the year of income of the company in which the payment or distribution is made.''
In doing so, it was argued for the Commissioner that the basis for the payments was status as shareholders rather than as employees - that the distributions were of the profits of the company rather than expenditure necessary to be taken into account in determining the profits of the company.
34. In the circumstances of this case I am not persuaded that it was so. Neither D-2 nor D-3 was a major shareholder in the company. Neither controlled any substantial shareholding in the company. Neither was in common interest with the dominant shareholder in the company. I accept that D-2 and D-3 sought to benefit themselves at the expense of the revenue and that it was in the capacity of D-2 to achieve that. But that alone is not sufficient to constitute such a distribution as sec. 108 contemplates. Accordingly, I am persuaded that the outlays in question were not touched by the provisions of sec. 108 and that the expenditure did constitute a ``loss or outgoing'' incurred by MORE-CO in the course of carrying on its business as an air conditioning manufacturer. Further, there was no suggestion that sec. 109 of the Act applied to disallow so much of the expenditure as might have been thought to be excessive and, therefore, unreasonable. That being so I am satisfied that the expenses were all losses in outgoings incurred in carrying on that business and are all allowable as deductions to the company. It is unnecessary to express any view as to the tax consequences of that finding for either D-2 or D-3.
Other sec. 51 claims
35. I accept the evidence of D-2 that the remaining disputed item under the classification ``purchases'' ($431 in 1979) and the claim in relation to payments to sub-contractors ($1,236 in 1979) did constitute losses or outgoings allowable pursuant to the provisions of sec. 51. The representative for the Commissioner did not really contend otherwise. Rather he asserted that the Commissioner's conduct in disallowing the claims at the time of the investigation had been reasonable in that the matters were not then adequately vouched. It may be that that is so but, as was pointed out during the hearing, if taxpayers withhold information from the Commissioner and only present information in support of their claims at a hearing before this Tribunal, they will have had to pay a natural penalty: the costs incurred in the prosecution of a claim before the Tribunal.
36. In considering the question of additional tax, it is clear from the decision of a Full Bench of the Federal Court in
F.C. of T. v. Rabinov 83 ATC 4437 that, so long as the expenditure for which the claim was made constituted ``expenditure actually incurred'', then under the provisions of sec. 226 (as they then stood), there can be no imposition of additional tax for incorrect return. Clearly then, since I have accepted that the expenditure on the major item: research and development, was incurred, it follows that there can be no imposition of additional tax in that regard. In that context I have found that the expenditure was incurred and have found that it was fairly and accurately described for what it was, even though the description was far from full and complete, and even though the claim to deductions pursuant to sec. 73A was entirely unsound. As to all other claims which have been allowed pursuant to sec. 51, the same conclusion applies. The moneys were expended and the liabilities were incurred. That being so, in so far as penalties have been imposed for incorrect return, they must be set aside.
Division 7 assessments
37. In consequence of the Commissioner taking the view he did of the matters to be taken into account in determining the taxable income of the company and in imposing on the company liability to pay additional tax, the Commissioner determined that there had been an insufficient distribution for the purposes of Div. 7 of the Act and he accordingly assessed Div. 7 tax as being payable in relation to the years of income ended 30 June 1976 and 1977 in sums of $2,439 and $4,079 respectively. Those assessments were challenged by MORE-CO.
38. In relation to the year of income ended 30 June 1976 the challenge was successful only in that it resulted in the imposition of additional tax being set aside. Had that result been achieved independently of the review process, it would have been open to the Commissioner to give effect to Div. 7 in light of the assessments as now reviewed as follows:
Year ended 30 June 1976 For review As reviewed $ $ Taxable income 53,415 53,415 LESS: Income tax 22,701 22,701 Additional tax 7,149 - ------ ------ Balance 23,564 [sic] 30,714 LESS: Retention allowance 14,139 18,428 ------ ------ Sufficient distribution 9,425 12,286 LESS: Distributed 4,547 4,547 Section 108 distributions - - ------ ------ Insufficiency of distribution 4,878 7,739 ------ ------ Division 7 tax $2,439 $3,869 ------ ------
To give effect to that now would be to increase the tax liability of MORE-CO for the year of income ended 30 June 1976 by $1,430
39. In relation to the year of income ended 30 June 1977 the situation is slightly more complicated in three respects. Firstly, the company returned interest income in the sum of $7,500; secondly, in that the Tribunal has held the assessment of taxable income to be excessive and has reduced the personal exertion component by $1,913 and, in consequence of that, it is necessary to exclude from account in Div. 7 calculations the sum of $1,913 as a sec. 108 distribution. In addition, in common with the previous year, the imposition of additional tax has been wholly set aside. That being so, had the Commissioner allowed the objections of MORE-CO in accordance with the findings upon this review, it would have been open to the Commissioner to have issued an amended assessment of Div. 7 tax in accordance with the following table:
1977 Personal Personal Property Exertion Total Property Exertion Total $ $ $ $ $ $ Taxable income 7,500 80,024 87,524 7,500 78,111 85,611 LESS: Income tax 3,450 36,811 40,261 3,450 35,931 39,381 Additional tax 1,626 17,341 18,967 - - - ----- ------ ------ ------ ------ ------ Balance 2,424 25,872 28,296 4,050 42,180
46,230 1977 Personal Personal Property Exertion Total Property Exertion Total $ $ $ $ $ $ LESS: Retention allowance 243 15,524 15,767 405 25,308 25,713 ------ ------ LESS: Sufficient distribution 15,529 20,517 LESS: Distributed 2,458 2,458 Section 108 distributions 1,913 - ------ ------ Insufficiency of distribution 8,158 18,059 ------ ------ Divisional tax $4,079 $9,029 ------ ------
The result would have been to increase the tax liability of the company by $4,950.
40. The questions which in consequence arise for consideration are:
- (a) whether the calculations are accurate; and
- (b) whether the Tribunal should direct increased assessments to issue in accordance with such calculations correctly made.
As to the latter point it is to be observed that, had it not been for the circumstance that the applicant objected to the Div. 7 assessments in addition to the primary assessments and, upon those objections being disallowed, requested an independent review of the Commissioner's determinations, it would not have been possible for the Tribunal to consider authorising or directing any increased Div. 7 assessments. On the other hand, it can be argued that it is the case for the applicant as presented before the Tribunal which logically carries with it, not only a reduction in liability to primary tax and additional tax for incorrect return, but, by extension, liability to an increased amount of Div. 7 tax.
41. As these possibilities were not adverted to during the hearing and as the parties have not had an opportunity to consider the accuracy of the calculations presented in these reasons I shall direct the matter to be re-listed so that further argument may be heard on those issues in the event that the parties are unable to reach agreement as to the terms of the order to be made.