Allsene Pty. Limited v. Federal Commissioner of TaxationJudges:
Full Federal Court
Lockhart, Beaumont and Einfeld JJ.
Allsene Pty. Limited (``the taxpayer'') appeals from a decision of the Administrative Appeals Tribunal (``the Tribunal'') affirming several decisions of the Commissioner of Taxation (``the Commissioner'') disallowing objections by the taxpayer to assessments of income tax, and, consequentially, Div. 7 tax and additional tax in six years of income (30 June 1976 to 30 June 1981) pursuant to the provisions of the Income Tax Assessment Act 1936 (``the Assessment Act''). It will be convenient to consider first the assessment made in respect of the 1976 year.
The 1976 assessment
In its 1976 income tax return, the taxpayer disclosed a loss of $203.81 made up as follows:
Fees received $61,868.21 Expenses Fees paid $58,675.00 Bank fees 27.02 Petty and office expenses 250.00 Postages 420.00 Audit fees 200.00 Rent 2,500.00 62,072.02 --------- --------- Net loss: $203.81
The only items in dispute are the amounts of $61,868.21 and $58,675 described as ``Fees received'' and ``Fees paid'' respectively. The Commissioner's notice of assessment amended the taxable income returned by the taxpayer to the amount of $88,600 made up as follows:
$ Taxable income returned (204) Add Omitted gross fees receivable 30,129 Deduction for franchise fees payable disallowed 58,675 ------- Amended taxable income $88,600
Thus, the Commissioner first increased the taxpayer's assessable income by $30,129 by including as ``gross fees receivable'' certain franchise fees which had been earned but not yet received from several Australian companies; and secondly, disallowed the taxpayer's claim to deduct certain other franchise fees paid or payable to an English company in circumstances to be described below.
By its notice of objection, the taxpayer objected against the assessment, claiming that it should be set aside or, alternatively, reduced by the ``excision'' of the amount of $30,129, which the Commissioner had included in the taxpayer's assessable income; or, alternatively, reduced by allowance of a deduction in the sum of $58,675. The principal grounds of the objection were: (1) The amount of $30,129 was not assessable income. (2) The sum of $58,675 was a deduction allowable under sec. 51(1) of the Assessment Act. (3) The ``cash'' or ``receipts'' basis was the appropriate basis for the income derived by the taxpayer. (4) Even if an ``earnings'' or ``accruals'' basis were appropriate (a) the amount of $30,129 did not constitute assessable income; (b) the sum of $58,675 was an allowable deduction. (5) The assessment was not authorised by sec. 260 of the Act.
The Commissioner having disallowed the objection, the taxpayer requested that the Commissioner's decision be referred to a board of review (that is to say, the Tribunal) for review.
The other assessments
Returns were made and assessments issued in respect of the other five years of income which raised for determination the same questions, in principle, as were raised in the objection lodged in respect of the 1976 year. In the circumstances, it will not be necessary to refer to the detail of the assessments for the other years.
The taxpayer's case, as opened to the Tribunal by its counsel
At the commencement of the hearing before the Tribunal, senior counsel for the taxpayer opened the taxpayer's case as follows:
``[Senior council]... [A] Mr D.M. Tooley... was the beneficial owner of the issued capital of a number of companies carrying on a business in Australia. The companies taught typing, secretarial and receptionist skills and things of that nature. In the second half of 1975 those companies were operating centres [`the centres']... at four places in New South Wales... They were being operated by a company called the Typing Centre of New South Wales Pty. Limited. A Mr and Mrs Scurrah held all the shares in that company on trust for Mr Tooley and Mr and Mrs Scurrah were the directors... There were also centres in the cities of Adelaide and Brisbane. They were being conducted by a company called Television Typing Centre Pty. Limited, that being a company incorporated in Queensland. Again, Mr and Mrs Scurrah held the issued shares for Mr Tooley and they were the directors. There was a centre in Melbourne operated by another company with the same name, the Television Typing Centre Pty. Limited, that one being incorporated in Victoria. There was also a centre in Perth... Mr and Mrs Scurrah
ATC 5336owned all the shares in all of these companies... on trust for Mr Tooley and they were the directors of all [of] them. The Perth centre was operated by the Typing Centre of Perth Pty. Limited and the Canberra place was occupied by Television Typing Centre Pty. Limited, this one being incorporated in the Australian Capital Territory and there was the possibility of... opening more centres in other places. Now Mr Tooley had, in 1975, been introduced by a Mr John De Monte, a person he had known for a long while, to a gentleman named Mr Gartland,... of Irish birth and residence... Mr Gartland had evolved, or more accurately, initially was in the course of evolving what he described as a new and improved method of teaching typing. I am not going to describe it. Mr Tooley will. All I can really say that I understand about it is that it involved the use of television tapes and television screens that people could sit and look at something and be instructed as to what they should be doing. I assume there is a bit more involved than that but that is, I gather, the essence of it. Mr Tooley became interested in it and a company which he conducted in New Zealand, carrying on a similar type of business, was given the use of it for a period to experiment with it to see if it was indeed an improved teaching method. It came to the conclusion, no doubt with the assistance of the Scurrahs, that it was and negotiations then proceeded, in fact in London, for a franchise arrangement. The negotiations were conducted by Mr Grant,... solicitor, on behalf of Mr Tooley and the companies, with a firm of solicitors in London and they resulted in agreement as to the terms and conditions of the grant. An application was then made to the Reserve Bank of Australia for its approval to enter into an arrangement, that being necessary under the foreign exchange regulations as [they] then were. The Reserve Bank gave its approval, by a letter of 18 November 1975... [the letter was later tendered]. The actual agreement executed by both parties bears date 9 December 1975.... it was executed here by the Scurrahs and sent over to [be] execute[d] in London. It came back executed by the grantor... being a United Kingdom company called Dalem... Limited...''
Senior counsel for the taxpayer then sought to tender, in his opening, the agreement dated 9 December 1975. Senior counsel for the Commissioner objected to the tender at that stage because, he said, the document was controversial and there were ``issues of sham and so on''. The document was, in fact, tendered later when Mr Tooley was called to give evidence. It is convenient to describe it now.
The Dalem agreement
The agreement, bearing date 9 December 1975, was made between Dalem Limited (``Dalem''), a company incorporated in the United Kingdom and the taxpayer, a company incorporated in New South Wales (``the Dalem agreement''). In the Dalem agreement, it was, first, recited (recital (A)) that Dalem had the right to license or franchise the use of the ``teaching methods, courses, programmes and systems'' described in the first schedule to the Dalem agreement (``the teaching system'') for the ``teaching of shorthand and touch typing'', inter alia, within Australia. The teaching system was described in the first schedule as follows:
``(1) A phonetic system of shorthand the symbols and codes of which are on seven one-hour video recording tapes, together with instruction book to be used in conjunction therewith.
(2) An improved system of teaching touch typing contained in six sterio [sic] cassette recorded tapes.''
Secondly, it was recited (recital (B)), that the parties had agreed that Dalem would enfranchise the taxpayer to operate and use the teaching system within Australia on the terms contained in the Dalem agreement (as follows).
In consideration of the payments agreed to be paid by the taxpayer in cl. 7 and 8, Dalem granted to the taxpayer the licence or franchise to use the teaching system within the geographic areas mentioned in the second schedule (``the territory'') and agreed to supply the teaching system to the taxpayer upon the terms of the Dalem agreement (cl. 1(1)). The territory was described in the second schedule as follows:
``(1) The geographic areas within a three mile radius of the G.P.O.s of Sydney, Melbourne, Canberra, Brisbane, Adelaide and Perth, within the Commonwealth of Australia.
(2) The geographic areas within a three mile radius of the G.P.O.s of Parramatta, Chatswood and Bankstown within the State of New South Wales.
(3) Such other geographic areas as shall be agreed in writing between the parties to be geographic areas included in this Schedule.''
The taxpayer agreed to use its best endeavours commercially to exploit the teaching system to its maximum throughout the territory (cl. 1(2)). Copyright remained in Dalem (cl. 1(3)). Subject to Dalem's approval, the taxpayer had the right to sub-license or sub-franchise all its rights under the Dalem agreement (cl. 2(1)). The terms of any sub-license or sub-franchise were stipulated (cl. 2(2)). The taxpayer remained responsible to Dalem for the compliance with the terms of any sub-licence or sub-franchise (cl. 2(3)). Dalem agreed not to withhold unreasonably its approval to the exercise by the taxpayer of its right to sub-license or sub-franchise (cl. 2(4)). Dalem agreed generally to assist the taxpayer in the operation of the teaching system and, in particular, would (cl. 3(1)):
``(a) supply and provide to the operator sufficient quantities of the items referred to in the First Schedule to operate up to twelve centres
(b) provide instruction for the operator and its staff in the operation of the teaching system
(c) supply the operator with plans and precedents of class time-tables programmes schedules examinations procedures and projects
(d) provide instruction and assistance for the operator and its staff in the layout and selection of classrooms typewriters and equipment and in the size and composition of classes
(e) arrange lectures and staff training courses for persons employed by the operator
(f) arrange demonstration classes for student lecturers and/or staff of the operator
(g) provide assistance for the operator in the selection and recruitment of staff to be engaged in the operation of the teaching system
(h) supply a student manual for the purposes of causing reproductions to be made for distribution to students
(i) make available a trained employee in Australia and maintain him there for a period of not less than one month for the purpose of implementing the matters herein referred to and will supply these services as may from time to time be required.''
If requested by the taxpayer, Dalem would also provide services for any sub-licensee or sub-franchisee (cl. 3(3)). The assistance provided by Dalem under cl. 3(1) or (3) was to be free of charge to the taxpayer, except where skilled personnel were used in Australia, in which case, the taxpayer was to reimburse Dalem the reasonable salary of such personnel (cl. 3(2)). The taxpayer was to provide, at its own expense, suitable equipment, premises and staff (cl. 4). Provision was made for the replacement by Dalem of tapes and materials (cl. 5).
Subject to prior determination under cl. 10, the term of the Dalem agreement was a period of three years from 1 January 1976 (cl. 6(1)). The taxpayer had the option to extend the Dalem agreement for a further period of one year, and if exercised, for another period of one year (cl. 6(2)) by three months' written notice (cl. 6(3)).
Subject to cl. 8, the taxpayer was to pay Dalem by way of royalty such sum as would represent 15 per cent of the aggregate gross receipts by way of fees from students enrolled by the taxpayer or any sub-licensee or sub-franchisee (cl. 7). The taxpayer was, in any event, to make the following minimum payments to Dalem: (a) year 1 - (U.S.) $65,000; (b) year 2 - (U.S.) $80,000; (c) year 3 - (U.S.) $95,000; (d) year 4 - (U.S.) $110,000; (e) year 5 - (U.S.) $125,000 (cl. 8(1)). The minimum payments were to be made by monthly instalments (cl. 8(2)). As soon as practicable after 30 June in each year, the taxpayer was to provide Dalem with a certificate by the taxpayer's auditor as to the
ATC 5338taxpayer's gross receipts during the period ending 30 June and the amount of royalty payable converted into U.S. dollars (cl. 8(3)). The taxpayer was to maintain appropriate accounting records (cl. 9(1)).
Dalem might, without notice, determine the Dalem agreement if the taxpayer was wound up or in breach of the Dalem agreement (cl. 10).
The taxpayer agreed not to (i) teach the teaching system outside the territory; (ii) disclose the teaching system except as might be necessary for the instruction of personnel and for use in courses (cl. 11(1)).
Dalem agreed that, during the period of the Dalem agreement, it would not, by itself, or by any licensee or franchisee, teach the teaching system in the territory (cl. 12). The contract was governed by English law and any proceedings were to be brought in English courts (cl. 13). The Dalem agreement was conditional upon the consents of the Bank of England and the Reserve Bank of Australia (cl. 14).
The copy of the Dalem agreement which was later tendered was executed under their common seals. The affixation of Dalem's seal was witnessed by Mr Gartland as a director, and by Cyril Kanter, as secretary. The affixation of the taxpayer's seal was witnessed by Mr Scurrah, as a director, and by Mrs Scurrah, as secretary.
The history of the matter after the execution of the Dalem agreement, as opened by senior counsel for the taxpayer
Senior counsel said:
``That document having been executed, the taxpayer... proceeded to execute sub-licence agreements with each of the five companies named... They are all in the same terms except obviously as to the identity of the grantee, as to the geographical area and as to the royalty to be paid. The document apart from those matters follows exactly the terms of the head agreement. Each of the sub-agreements provided for a payment of 15½ per cent - the half per cent obviously being intended to cover the operating costs of Allsene - of the aggregate gross fees by way of fees from students enrolled again by the operator and sub-licensee, tendering courses using the system. Each of these agreements has a separate minimum payment clause. They differ somewhat. They are expressed to be in Australian dollars, but I do not think anything is going to turn on it...
Now, the accounts were prepared for the relevant companies which formed part of the tax returns. All seemed to have been prepared on the basis that the appropriate method of accounting was the cash received method. Allsene was accounted for what it actually got in its year of income from the sub-licensees, and the amounts it actually paid to Dalem.
So, it had not received from the sub-franchisees in that year the total of its entitlement. Indeed if one goes back to the head agreement, which perhaps would refer to this clause, the head agreement in clause 8.3 provided certification of the amount payable after 30 June each year, and that clause found its way in exactly the same terms except to reference to US dollars, in all the sub-agreements.
The consequence of accounting on that basis can be seen from the tax returns for each year. There is not very much in any of them that is particularly significant... but dealing with it year by year, the year ended 30 June 1976, which effectively was only a half-year for Allsene, it showed fees received of $61,868.21.
I should have said its sole business activities throughout the whole of the years in question was the sub-licensing. It did nothing else. It had some expenses of a routine and non-controversial nature and it paid during the year $58,675 to Dalem. The consequence was that it showed a loss for the year of $203.81. The assessment which did not issue until June 1984, and... from the adjustment sheet... [w]hat the Commissioner did was in effect to say it was not appropriate for this company to account on a cash received basis. It should have accounted for its entitlement on an accrual basis, and the Commissioner has said that the admitted income was $30,129 which, if correct, would bring the income up from $61,000-odd to $91,997.21... I am not going to argue that the cash basis was the right basis, or the accrual basis is the wrong basis, nor am I going to take time
ATC 5339arguing as to whether an $30,129 was the right amount to add or whether it should have been 31 or 29. It is not going to make any difference. I am prepared to concede that the adjustment for the purpose of this appeal is correct. However, having said that under the sub-franchise agreement Allsene was entitled to receive not $61,000 but $91,000 from the operating company, the Commissioner chose to disallow the entire amount which had, in fact, been paid to Dalem. Now, on the basis that the Commissioner is correct in saying the income entitlement in this year was $91,997.21, fees received from the various sub-franchisees, it follows necessarily if that was 15½ per cent of the gross that Dalem was entitled to that amount multiplied by 15 divided by 15.5. That arithmetic would indicate that the allowable deduction on the basis of converting the accounting treatment from cash to accruals would have been $89,029.56, but the Commissioner has allowed nothing. So he has, in respect of a company that showed in fact on a cash basis a loss for the year of $203.81 assessed it on the basis that it derived taxable income of $88,600. He has calculated the tax to be $37,655 and imposed a penalty of $43,937. And then on top of that was a Division 7 assessment.''
The evidence tendered to the Tribunal
The taxpayer called Mr Tooley and Mr Grant. Both were cross-examined by senior counsel for the Commissioner. In addition to the Dalem agreement and the Reserve Bank letter, the taxpayer tendered the agreements with the sub-licensees, together with purported notices of extension of the term of (i) the Dalem agreement and (ii) the sub-licence agreements. The taxpayer's cheque book was also tendered. It was common ground, first, that the taxpayer paid Dalem the amounts claimed as deductions in its returns, and secondly, that the taxpayer received from the sub-licensees (``the centres'') the amounts disclosed in its returns as income.
The Commissioner called Mr B.R. Woolford, senior investigation officer, Australian Taxation Office and Mr B.M. Neligan, senior advising Officer, Australian Taxation Office. Both officers gave evidence of their investigations. The Commissioner also tendered several documents providing evidence of the transactions now in dispute and of certain transactions entered into by Dalem and its predecessors in title to which reference will be made later.
The cases sought to be made by the parties before the Tribunal
The submission put to the Tribunal on behalf of the taxpayer was, in essence, that the Commissioner could not both approbate the sub-licences but, at the same time, reprobate the head licence, i.e., the Dalem agreement. It was said that the Commissioner could not disallow the taxpayer a deduction in respect of what was paid as the price for the head licence and, at the same time, assess the taxpayer for income in the form of licence fees received from sub-licensees.
On behalf of the Commissioner, it was submitted that the Dalem agreement was a sham because it was not intended by the parties to be performed or binding according to its terms. The Commissioner relied on the following: (a) The agreement was not in fact performed according to its terms. (b) The ``benefits'' purportedly conferred on the taxpayer by the agreement were not needed by the taxpayer, because the taxpayer already had what the agreement purported to give. (c) The parties to the agreement were under common control and were not dealing at arm's length. (d) Mr Tooley's evidence, so far as he asserted that the agreement was genuine, should not be accepted. It was argued that the amounts paid by the taxpayer were not expenditure incurred at all. Alternatively, it was contended that the sole or dominant purpose of the payments by the taxpayer was the obtaining of a tax benefit and not the acquisition of an income-producing benefit. Other matters were relied on, including sec. 260 and the ``fiscal nullity'' doctrine.
The Tribunal's decision
The Tribunal gave lengthy reasons for its decision. Since the facts were complicated, it is necessary to read the whole of the reasons in order to understand why it was decided to affirm the decisions under review. In order to reduce these reasons to manageable proportions, the Tribunal's process of reasoning may, I think, be summarised as follows.
(1) The issues for determination as perceived by the Tribunal
The Tribunal said that the primary issue for determination was whether the taxpayer was entitled to deduct the franchise fees from its income. A secondary issue, which, in the circumstances, the Tribunal did not have to deal with, was whether, if any deduction were allowable, it should be limited to the fees actually paid, as distinct from an accrual basis of deductibility.
(2) The history of the matter, as described by the Tribunal
(a) The franchising arrangements
The corporate structure of the taxpayer and the entry into the Dalem agreement was described. Mention was made of Mr Tooley's evidence that in the description of the teaching system in the schedule to the Dalem agreement, an error had been made, and that it should have read as follows: ``An improved system of teaching touch-typing contained in six video tapes and six stereo cassette recorded tapes.''
Reference was then made to an agreement made on 5 November 1975 between Dalem and a Danish company, ``I. Jacobsen A.S.'', now ``Finansieringsseelskabet at 5 November 1975 Aps. of Copenhagen'' (``the Danish company''), whereby the Danish company granted to Dalem the exclusive right to use a system (``the system'') for teaching shorthand and touch-typing in all countries other than Great Britain (``the Danish agreement''). The system was described in that agreement as: ``(1) A phonetic system of shorthand the symbols and codes of which are on seven one-hour video recording tapes, together with instruction book to be used in conjunction therewith. (2) An improved system of teaching touch typing contained in six stereo cassette recorded tapes.'' Subject to prior determination for cause, the Danish agreement was to be in force for 10 years from 1 November 1975. Dalem was liable for a royalty of 95 per cent of Dalem's gross receipts from sub-licensees, but if the gross receipts exceeded $300,000 in any calendar year, a royalty of 99 per cent of that excess was payable. In other respects, the Danish agreement was similar to the Dalem agreement.
Mention was next made to another agreement (``the Liechtenstein agreement'') made on or about 5 November 1975 between the Danish company and a Liechtenstein company (``the Anstalt''), which was not tendered in evidence, but was said to be similar to the Danish agreement, providing for ``the payment by the Danish company to the Anstalt of franchise fees received from [Dalem]''.
(b) Mr Tooley's evidence
The evidence given by Mr Tooley was then summarised. Reference was made to the early negotiations with Mr De Monte and the discussions in London in August 1975 with Mr Gartland, when Mr Grant was present. According to Mr Tooley, Mr Grant then suggested that ``in order to make the agreement workable and to save expense the taxpayer, which was a shelf company, should take the franchise for Australia''. Mr Tooley said that upon the signing of the Dalem agreement, he brought to Australia the video and cassette tapes for use by the centres. Subsequently, materials were received from Dalem on a ``six monthly basis''. When the Dalem agreement expired, the tapes were returned to Dalem. The centres ``still carried on teaching the same system, the only difference being that the video tapes were made with a different process which [Mr Tooley] regarded as his own''.
(c) Mr Grant's evidence, as summarised by the Tribunal
According to Mr Grant's evidence, in November 1975, he was shown the Liechtenstein agreement and the Danish agreement so that he could ``verify the proprietorship of the copyright that was being licensed''. At this time, the final documentation of the Dalem agreement was settled in discussions Mr Grant had with the English solicitors acting for Dalem.
(d) The relationship between Dalem and the Danish company as described by the Tribunal
Dalem was incorporated in October 1975. Its directors and shareholders were Mr Kanter and Mr H.K. Gordon, who were partners in a London firm of accountants. Upon the death of Mr De Monte in November 1975, his shares in a company which carried on a typing and shorthand school in London, referred to as the ``London centre'', were transferred to Dalem. It appeared that, originally, the shareholders of the London centre were Mr De Monte, as nominee of the Anstalt, and C. Jensen. In June
ATC 53411978, Jensen's share was transferred to Mr Kanter's wife. In the result, the shares in the London centre were held by Dalem and Mrs Kanter as nominees of the Anstalt. In 1977, it was agreed between the Danish company and the London centre that the Danish company would franchise the London centre to operate its teaching system. From that time, royalties were paid by the London centre to the Danish company.
(3) The Tribunal's reasoning to support its conclusion ``that the [Dalem agreement] was a sham and that there was no liability on the part of the taxpayer to pay royalties to Dalem''
The Tribunal referred to the observations of Windeyer J. in
Scott v. F.C. of T. (No. 2) (1966) 40 A.L.J.R. 265 at p. 279 that the question to be determined was whether the parties who entered into ``the ostensible transaction mean it to be in truth their transaction, or did they mean it to be, and in fact use it as, merely a disguise, a facade, a sham, a false front... concealing their real transaction''. The Tribunal also cited the well-known statement of Diplock L.J. in
Snook v. London and West Riding Investments Limited (1967) 2 Q.B. 786 at p. 802 that ``for acts or documents to be a `sham'..., all the parties thereto must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating''. Mention was also made of several local decisions (
Coppleson v. F.C. of T. 81 ATC 4019 at pp. 4021-4022;
Clyne v. F.C. of T. 83 ATC 4508 at pp. 4515-4516 and
Sharrment Pty. Ltd. v. Federal Trustee in Bankruptcy (1988) 82 A.L.R. 530 at pp. 536-537).
The Tribunal said that ``[i]n determining whether the parties intended that the said agreement should take effect according to its tenor, all the facts and circumstances should be taken into consideration, and in particular the events which occurred subsequent to the agreement''. [Emphasis added]
In concluding that the Dalem agreement should be regarded as a sham, the Tribunal relied upon the following: The absence of minutes of meetings of the directors of the taxpayer dealing with the agreement or the tapes; (with the exception of the letters extending the period of the agreement), the absence of correspondence between the parties; the failure of the centres and of the taxpayer to pay royalties in accordance with the terms of the sub-licences and the Dalem agreement respectively; the lateness of the exercise of the options to extend the agreement; the omission from the first schedule to the agreement of the six video tapes, which were ``the most important ingredient in the teaching systems''; the lack of profitability of the operations conducted by the centres during the period of operation of the agreements as contrasted with the centres' profitability before the agreements; the extensions of the periods of the agreements notwithstanding the lack of profits; the small amount ($1,200) for which the tapes were insured; the substantial size of the royalties paid by the centres to the taxpayer being lent to Mr Tooley; the fact that, after the taxpayer ceased using the tapes provided by Dalem it continued using the same system without payment of any royalty - the only difference was in the method of producing the tapes; the facts (i) that Dalem was ``run'' by an accountant, Mr Kanter; (ii) that it had no staff and apart from minor items, no expenses; (iii) that, save for the franchise fees, it had no receipts; (iv) that Mr Tooley was closely associated with the Anstalt; (v) that Mr Tooley had had dealings with Mr D. Hunt, an associate of Mr Gartland, in 1981; (vi) that it appeared that Mr Hunt had ``taken over'' the London centre; (vii) that the dealings between Mr Tooley and Mr Hunt in 1981 suggested that a purported option transaction between them was being used as ``a way of returning the franchise fees, or a substantial part of them''; (viii) the fact that, in 1978, Mr Tooley had informed a bank officer that he was the ``overall beneficiary'' of the several typing centres in Australia and that the Sydney centre had ``achieved a line-ball situation as the franchise expenses accruing to [Mr Tooley] were directly related to the profitability of [that centre]''. The Tribunal said that, in his evidence, Mr Tooley denied this and also disputed that ``moneys passing backward and forward between the New South Wales centre and him represented the royalties being contra-entered against the amounts owing''. The Tribunal said that Mr Tooley's recollection of a number of matters was ``faulty''; and that other witnesses, who ``might well'' have been able to explain a number of matters, were not called. On the other hand, the Tribunal found Mr Grant's evidence to be ``totally acceptable''.
The Tribunal then expressed its conclusion as follows:
``On the whole of the evidence therefore we are of the opinion that the said agreement of 9 December 1975 was a sham. At the very least, we are not able to conclude, on the balance of probabilities, that the said agreement expressed the real and genuine intention of the parties. It was instead a cloak which was intended to facilitate the transfer of money in the form of franchise fees from this country to the United Kingdom and ultimately to Liechtenstein. The purported deduction of those fees from the income of the taxpayer was, we think, ineffective.''
The Tribunal's decision that even if the Dalem agreement were not a sham, the franchise fees were not deductible under sec. 51(1) because the expenditure was incurred to obtain a tax advantage
Proceeding on the assumption, for the sake of the argument, that the Dalem agreement was not a sham, the Tribunal further held that the licence fees should not be allowed as a deduction for these reasons:
``We are of the opinion that the outgoings in question are not deductible under sec. 51(1) of the Act. We do not think that they should be regarded as the cost of a step taken in the process of gaining or reducing the taxpayer's assessable income;... They were the subject of a process, the purpose and end of which was the transfer of franchise fees from Australia without paying any tax on them. In the circumstances they should not be regarded as a business expense, or as an expense otherwise incurred in gaining or producing the franchise fees received by the taxpayer from the centres.''
The taxpayer's attack on the Tribunal's finding that the Dalem agreement was a sham
The taxpayer now argues that the Tribunal's finding was not justified for the following reasons:
- (1) What the Tribunal was really doing was applying the doctrine of ``fiscal nullity'' in an unacceptable, ``back-door'' way.
- (2) The rejection by the High Court in
John v. F.C. of T. 89 ATC 4101; (1989) 63 A.L.J.R. 166 of the supposed doctrine of ``fiscal nullity'' does not permit the application in Australia of such a principle in any form.
- (3) The Tribunal was not entitled to use the concept of sham for that purpose.
- (4) The Tribunal misunderstood and did not correctly apply the onus of proof in relation to sham.
- (5) The Tribunal made no positive finding of the factual matters necessary to support a conclusion of sham.
- (6) No reasonable Tribunal could, on the evidence, have concluded that the relevant agreement was a sham.
- (7) The only facts which were relevant, and to which the Tribunal should have had regard, were as follows:
- (i) On 8 October 1975, the taxpayer was incorporated.
- (ii) On 13 October 1975, Dalem was incorporated in the United Kingdom.
- (iii) In November 1975 a franchise agreement was entered into between the Anstalt and the Danish company permitting the use of a typing system (``the system'') throughout the world.
- (iv) On 5 November 1975 an agreement was entered into between the Danish company and Dalem permitting use of the system in the whole of the world except the United Kingdom.
- (v) On 18 November 1975 approval was given by the Reserve Bank to entry by the taxpayer into a franchise agreement with Dalem.
- (vi) On 9 December 1975, a franchise agreement permitting the use of the system in Australia was entered into by the taxpayer with Dalem (it was this agreement only that was held to be a sham).
- (vii) In December 1975, by several written agreements the taxpayer granted sub-franchises to several typing centre operators in Australia.
- (viii) In December 1975, Mr Tooley brought from the United Kingdom to Australia the video and cassette tapes for
ATC 5343use in the system the subject of the franchise and sub-franchise agreements.
- (ix) In January 1976, the Australian typing centre operators began to use the system.
- (x) The sole activity of the taxpayer was the licensing of the system from Dalem and the sub-franchising of the system to the Australian typing centres; and the only income of the appellant consisted of franchise fees from the Australian typing centres. The composite transaction or series of transactions evidenced by the above facts was set out in diagrammatical form handed up by counsel as follows:
|---------------------------| | SYSTEM VERLEIH ANSTALT | | (LIECHTENSTEIN ANSTALT) | |___________________________| | \|/ franchise | |-------------------------------| | FINANSIERINGSSEELSKABET AF 5. | | NOVEMBER 1975 Aps. | | (DANISH COMPANY) | |_______________________________| | \|/ sub-franchise | |-------------------------------| | DALEM LIMITED (U.K. COMPANY) | |_______________________________| | \|/ sub-franchise | |---------------------| | ALLSENE PTY. LIMITED| |_____________________| | \|/ | |--------------------------------| | THE TYPING CENTRE OF N.S.W. | | PTY. LIMITED | | THE TELEVISION TYPING CENTRE | | PTY. LIMITED | | (Incorporated in Victoria) | | THE TELEVISION TYPING CENTRE | | PTY. LIMITED | | (Incorporated in Queensland) | | THE TELEVISION TYPING CENTRE | | PTY. LIMITED | | (Incorporated in A.C.T.) | | THE TYPING CENTRE OF PERTH | | PTY. LIMITED | |________________________________|
- (8) The Tribunal's conclusion that the agreement of 9 December 1975 should be regarded as a sham is based on facts which, the taxpayer says, are largely irrelevant to that issue and, in any event, are not limited to that one agreement as opposed to the composite transaction of which it was a part. The effect of this ``selective'' approach is, ``somewhat conveniently'', to leave the taxpayer deriving income from its sub-franchisees which, but for the entire arrangement, it would not have derived whilst, at the same time, denying the taxpayer the deduction for the cost to it of that franchise.
- (9) It is accepted that, in England, the doctrine of ``fiscal nullity'' is used for this very purpose (cf.
Furniss v. Dawson (1984) 1 A.C. 474 at p. 527). But the doctrine has no application in Australia in that or any other form; in particular, the concept of sham cannot be selectively applied to achieve the same result.
- (10) In any event, the Tribunal misapplied the onus of proof by treating the question whether a transaction was a sham as one which the taxpayer ``bore the onus of disproving'' (but see
Metropolitan Discounts and Investments Co. Ltd. v. Bowra Radio & Electrics Co. Ltd. (1944) 18 A.L.J. 88 per Rich J. at p. 90).
- (11) It was not open, on the evidence, for the Tribunal to find - and indeed no such finding appears to have been made - that both parties to the Dalem agreement had a common intention that that document was not to create the legal rights and obligations which it gave the appearance of creating. Such a finding - as a positive finding - was necessary if there was to be a conclusion of sham.
The taxpayer's challenge to the Tribunal's [alternative] conclusion that no deduction was allowable under sec. 51(1) because the expenditure was incurred merely to obtain a tax advantage
On behalf of the taxpayer, it is submitted that, although the Tribunal referred to John's
ATC 5344case, it could not have correctly applied the principles established by that decision (cf.
F.C. of T. v. Patcorp Investments Ltd. 76 ATC 4225; (1977) 140 C.L.R. 247 per Gibbs J. at ATC p. 4223; C.L.R. p. 292). If the Dalem agreement was not a sham, the franchise fees could, on the facts, be nothing other than the cost to the taxpayer of the income earned from the sub-franchising arrangements.
Before turning to a consideration of the taxpayer's arguments, it is necessary to consider the competency and scope of the ``appeal''.
Competency and scope of the ``appeal''
Section 44(1) of the Administrative Appeals Tribunal Act 1977 (``the AAT Act'') restricts the proceedings in this Court, which are brought in its original, and not its appellate, jurisdiction, to an ``appeal'' which is ``on a question of law''. Thus the existence of a question of law is, first, a qualifying condition to ground an ``appeal'' and, secondly, if an ``appeal'' does lie, the question of law is the subject of the ``appeal'' itself and the ambit of the ``appeal'' is confined to that question (see
F.C. of T. v. Brixius 87 ATC 4963 at p. 4967;
TNT Skypak International (Aust.) Pty. Ltd. v. F.C. of T. 88 ATC 4279 at p. 4281;
Politis v. F.C. of T. 88 ATC 5029 at pp. 5032-5033).
Waterford v. The Commonwealth of Australia (1987) 163 C.L.R. 54, Brennan J. explained the operation of sec. 44(1) of the AAT Act as follows:
``The error of law which an appellant must rely on to succeed must arise on the facts as the A.A.T. has found them to be or it must vitiate the findings made or it must have led the A.A.T. to omit to make a finding it was legally required to make. There is no error of law simply in making a wrong finding of fact.''
At the same time, it is well established that the Tribunal ``will have made an error of law if there was no evidence to support a conclusion of fact, if the only true conclusion which the Tribunal, properly instructed as to law, could have reached is contrary to that it did reach, or if its decision otherwise was perverse'' (per Gummow J.,
F.C. of T. v. Raptis 89 ATC 4994 at p. 4996).
Did the Tribunal err in law in concluding that no deduction was allowable for the franchise fees paid or payable to Dalem?
It will be recalled that the Commissioner did not dispute that the amounts said to have been paid were, in fact, paid by and to the taxpayer as disclosed by the taxpayer in its returns. In the case of the return for the 1976 year, it was common ground that the taxpayer paid Dalem $58,675 and received $61,868.21 from the centres. What was in issue was the true legal character of these payments. The taxpayer claimed that the amounts were for franchise fees paid under a commercial arrangement. On the other hand, the Commissioner contended that the payments were merely a facade, intended to camouflage the movement of funds from Australia to Liechtenstein.
It is common ground that a deduction was allowable if the expenditure qualified under the terms of sec. 51(1) of the Assessment Act. By that provision, allowances and outgoings to the extent to which they are incurred in gaining or producing the assessable income (the first limb), or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income (the second limb), shall be allowable deductions, with certain exceptions not here material. To borrow the language of Lockhart J. in
Raymor (N.S.W.) Pty. Limited v. F.C. of T. 89 ATC 5173 at p. 5179, if, as a matter of fact, the payments were made in the course of the derivation by the taxpayer of its assessable income and were ``incidental'' and ``relevant'' to that end, they would fall within the first limb of sec. 51(1) (see, e.g.
Ronpibon Tin N.L. v. F.C. of T. (1949) 78 C.L.R. 47 at pp. 56-57); and if, as a matter of fact, the payments were ``appropriate'' or ``adapted'' for the purpose of ``earning'' such assessable income, they would fall within the second limb (see, e.g.,
F.C. of T. v. South Australian Battery Makers Proprietary Limited 78 ATC 4412 at p. 4416; (1978) 140 C.L.R. 645 at p. 653).
It will be recalled that, in his opening, senior counsel put the claim for the deduction squarely upon the ground that the Dalem agreement gave rise to a legal liability imposed upon the taxpayer to pay the franchise fees to Dalem. That is to say, the taxpayer's case before the Tribunal was based upon the existence of a legal liability to pay the fees, which liability
ATC 5345was said to have arisen from the terms of an express contract, namely the Dalem agreement. It was not the taxpayer's case that it was entitled to a deduction under sec. 51(1) because, for instance, its liability to Dalem arose otherwise than under the Dalem agreement (e.g., under an implied contract or under the law of restitution or ``unjust enrichment''); or because the amounts actually paid to Dalem, even if paid without any strict legal obligation to do so, none the less constituted expenditure which fell within the first limb of sec. 51(1) because the payments were made in the course of the derivation by the taxpayer of its assessable income and the payments were incidental and relevant to that end (see Ronpibon Tin (supra) at pp. 56-58). As has been said, the taxpayer's case was put solely upon the existence of a legal liability to pay the fees to Dalem pursuant to their express contract. But, as Lockhart J. pointed out in Raymor (supra) at p. 5179, the question on which a case such as this turns is the identification of the true legal character of the payments made by the taxpayer to Dalem, and in carrying out this exercise of characterisation, the Court must look at all the relevant circumstances surrounding the incurring of the expenditure including the Dalem agreement itself.
The relevant circumstances would, of necessity, include the possibility that the Dalem agreement was a sham. The point is illustrated by South Australian Battery Makers (supra), where the question was whether certain rental payments were deductible. Gibbs A.C.J. said (at ATC p. 4416; C.L.R. p. 653):
``There can in my opinion be no doubt that the payments made by the taxpayer to the Trust under the lease were outgoings incurred in gaining or producing the assessable income, or alternatively were necessarily incurred in carrying on a business for the purposes of gaining or producing such income, within the meaning of sec. 51(1) of the Act. It is impossible to suggest that the lease was a sham. The taxpayer carried on its business in the factory on the leased land and the payments were those required by the lease to be made as the price for the right to possession of that land. The payments were made in the course of earning the assessable income and were incidental and relevant to that end:... They therefore fall within the first of the alternatives mentioned in the section. If the business had failed to produce income, and the payments were not within the first alternative, they would have been covered by the second alternative; they were necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, in the sense that they were clearly appropriate or adapted for the purpose of earning such income:... It would not be relevant, if it were the fact, that the taxpayer might have leased the same or other premises at a lower rental:
- `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.'
In other words, in the absence of any special circumstances (including the possibility that the Dalem agreement was a sham), it would appear that the franchise fees paid or payable to Dalem should be allowed as a deduction as the price paid for the use of the system over the term of the licence. The real question for the Tribunal was whether the Dalem agreement was a sham, that is to say, that the actual arrangement made by the parties to the Dalem agreement was different, in a substantial respect, from the purported statement of the arrangement which was set out in the terms of the Dalem agreement. If the surrounding facts disclosed that the parties went through the motions of drawing up and executing the Dalem agreement for the purpose of camouflaging a very different transaction, the Dalem agreement would be inoperative or illusory. The consequence would be that the purported payment of franchise fees under such an ``agreement'' would not be allowed as a deduction for franchise fees because the true legal character of the payment was substantially different from what it purported to be.
The Tribunal said, in the passage already cited, that in determining whether the parties intended that the Dalem agreement should take effect according to its tenor, all the facts and circumstances should be taken into consideration. In our opinion, this was a correct
ATC 5346statement of the relevant principle. Its application depended upon the particular facts and circumstances of this case. The Tribunal held, in the end, that the payments made by the taxpayer to Dalem were not, in truth, paid as franchise fees. Instead, the Tribunal found that the payments made were part of ``a cloak to facilitate the transfer of money... ultimately to Liechtenstein''. This conclusion, although one of inference or secondary fact, depended very much on the primary facts and, in particular, on the credibility of Mr Tooley's evidence. It is clear that the Tribunal did not accept the main thrust of Mr Tooley's version of what happened. That being so, it is difficult to see any footing for the taxpayer's contention that the Tribunal made an error of law in this respect. As has been said, the Tribunal correctly stated the relevant legal rule in this area. It must follow that an error of law, in this regard, could only have been made by the Tribunal if (a) there was no evidence to support its conclusion; or (b) the only true conclusion was to the contrary; or (c) its decision was otherwise ``perverse''. In our opinion, the Tribunal's conclusion that the Dalem agreement did not reflect the genuine intentions of the parties was reasonably open to it for the reasons it gave. Once the Tribunal declined to accept Mr Tooley's description of the relationships between the relevant parties, it was difficult to expect the Tribunal to believe that the parties intended that the franchising arrangements referred to in the documentation that was executed be operative in accordance with their tenor. True it is that the Tribunal accepted Mr Grant. However, Mr Grant's evidence was limited to his professional role as a solicitor. Far more significant was what were the real intentions of the clients, and in particular, Mr Tooley, as the principal actor.
The taxpayer accepted, before the Tribunal, and before us, that the real objective in the minds of the parties was to obtain a tax advantage. Once it is accepted first, that the arrangements had a fiscal, rather than a commercial objective, and, secondly, that Mr Tooley's version of events is rejected in important respects, it is difficult to perceive any relevant error of law on this branch of the case.
On behalf of the taxpayer, reliance was placed upon the reasoning in Sharrment's case but, in our opinion, that decision should be distinguished for our purposes. There, the architect of a series of transactions had died so that the only evidence of the parties' intentions consisted of the documentary material available. In those circumstances, it was not permissible for the Court to speculate whether the deceased's intentions were, in truth, in contradiction of the written agreements and transactions that had been formally entered into. In particular, it was not open to draw an inference of sham from the fact that the deceased controlled the corporate entities which were parties to the impugned transactions. In the present case, Mr Tooley was called but his version of the character of the dealings was not accepted. Moreover, the taxpayer failed to call other material witnesses without seeking to explain their absence.
The taxpayer also complained that, in finding that the Dalem agreement was a sham, the Tribunal was, in reality, applying the ``fiscal nullity'' doctrine by the ``back-door''. We do not think that this fairly reflects the Tribunal's process of reasoning. The Tribunal cited the passages from Scott's case and Snook's case which correctly stated the relevant principles. There is no reason to suppose that the Tribunal paid merely ``lip-service'' to these principles.
Nor, in our view, did the Tribunal reverse the relevant onus of proof in finding that the Dalem agreement was a sham. By sec. 190(b) of the Assessment Act, the taxpayer bore the general burden of proving that the assessment was excessive in this respect. The Tribunal held that it was not satisfied that the taxpayer had established that the expenditure qualified as an allowable deduction because it was a sham, being, in truth, a cloak which was intended to facilitate the transfer of money in the form of franchise fees from this country to the United Kingdom and ultimately to Liechtenstein. These conclusions were expressed as positive findings. In the face of findings so expressed, it is difficult to understand how the taxpayer could gain any comfort from the onus of proof. Whoever bore the onus on the sham argument, the Tribunal affirmatively found that the Dalem agreement was a sham.
In our opinion, it was reasonably open to the Tribunal to hold, as a conclusion of fact, that the Dalem agreement was a sham. It follows that the taxpayer has failed to demonstrate any error of law in this respect and that, to this extent, the appeal should be dismissed.
In the circumstances, it is not necessary to consider the alternative grounds relied upon by the Commissioner for not allowing the claim to deduct the amounts paid to Dalem.
Did the Tribunal err in law by holding that the ``franchise fees'' received by, or accrued due to, the taxpayer from the sub-franchisees were assessable income derived by the taxpayer?
There remains, however, the question whether the Tribunal erred in law in also affirming the decision of the Commissioner that the ``franchise fees'' received by, or accrued due to, the taxpayer from the sub-licensees should be treated as assessable income earned by the taxpayer. It is true that the Tribunal did not deal with this aspect of the matter in terms. However, by affirming the Commissioner's decision, the Tribunal must be taken to have held, by necessary implication, that the amounts received, or receivable, by the taxpayer constituted income in its hands.
It is common ground that the Dalem agreement on the one hand, and the series of agreements made between the taxpayer and its sub-licensees, on the other, constituted an entire arrangement. To put it differently, it is accepted by both parties that the Dalem arrangement, as the head agreement, and the arrangement made by the taxpayer with the centres, as the subsidiary agreements, were but parts of a single transaction. There was an entire transaction and it was intended to operate as a whole and not as a series of independent dealings. The Dalem agreement and the sub-licence arrangements with the centres were, in that sense, interdependent.
As has been said, the Tribunal held that the Dalem transaction was a sham. On the footing that the challenge to this finding fails, it should be accepted, for present purposes, that the Dalem arrangement was not what it purported to be, that is, the Dalem transaction should not be regarded as a franchising transaction but, rather, as a ``cloak to facilitate the transfer of money... ultimately to Liechtenstein''. As this finding indicates, part of the dealing involved in moving the money out of Australia consists of the payments, purporting to be ``franchise fees'' paid by the centres to the taxpayer. The payments made by the centres were the original sources of the funds that were ultimately ``moved'' to Liechtenstein. Also, the dealings between the centres and the taxpayer, and between the taxpayer and Dalem were interdependent.
Once it is concluded, as it must now be, that the Dalem dealings were a sham, it is difficult to resist taking the next logical step of concluding that the dealings between the centres and the taxpayer were also shams. Such a conclusion would be entirely consistent with the view taken by the Tribunal that what was really happening was that all the dealings, commencing with the payments made by the centres to the taxpayer and ending with the receipt of the funds by the Anstalt, were ``dressed up'' as fees paid for a franchise or licence arrangement which, in truth, the parties never intended to be operative. But it must then logically follow that the amounts received or receivable by the taxpayer from the centres did not have the character of assessable income. These amounts were not the franchise or licence fees they purported, on their face, to be. Their true character was, as the Tribunal found, part of the movement of funds out of Australia to Liechtenstein. It is not now suggested that these receipts could constitute assessable income of the taxpayer because, for some other reason, they had the character of income. On the contrary, the Commissioner's case, which was accepted by the Tribunal, has always been that the dealings now in question were no more than a facade intended to disguise the movement of funds from the centres to the Anstalt. If that be so, the amounts received by the taxpayer from the centres were received on account of capital and were not income.
It is submitted, on behalf of the Commissioner, that it is legally possible that a part of a transaction may be a sham but another part may be genuine and thus not a sham (see, e.g.
Esanda ltd. v. Burgess (1984) 2 N.S.W.L.R. 139 at pp. 153-154). This may be so, but the question is always what were the genuine intentions of the parties in the particular case at hand. Where, as here, it appears that no part of the arrangements are intended to operate according to its tenor, it must follow that every part of the purported transaction will be inoperative.
The question whether the Tribunal erred in affirming the Commissioner's decision by holding, at least by necessary implication, that the amounts received, or receivable, by the
ATC 5348taxpayer from the centres is not merely a question of fact. Rather, it is a case of an error of law because the only true conclusion, in this respect, which the Tribunal, properly instructed as to law, could have reached, is contrary to that it did reach.
We would propose to uphold the appeal to the limited extent that we would order that, in each year, the assessment of income tax be amended by omitting the amounts described as ``Fees received'' or ``gross fees receivable'' from the taxpayer's assessable income.
It is contended, on behalf of the Commissioner, that it is not open to the taxpayer to challenge the inclusion of the franchise fees in the assessment as part of the taxpayer's income. It is true that, by sec. 190(a) of the Assessment Act, unless the Tribunal or Court otherwise orders, a taxpayer is limited to the grounds stated in his objection. It is also true that the taxpayer disclosed the amounts actually received from the centres as its income in its returns but objected to the assessment in so far as it included the ``gross fees receivable'' from the centres. However, once the Commissioner contended, successfully, that the Dalem agreement was a sham, it logically followed that the sub-franchises were shams also. It is clear from counsel's opening address and submissions to the Tribunal, already referred to, that the taxpayer was complaining that the Commissioner could not both approbate and reprobate. In these circumstances, the interests of justice require that the taxpayer be granted leave to rely upon this ground of objection also. It would be unfair if the Commissioner could successfully contend that the deduction claimed should be disallowed because the underlying transaction was a sham if the taxpayer were unable to rely upon the same finding as extending to another aspect of an interdependent transaction. It may be that the point is covered by the grounds of objection on a liberal reading of them. However, for more abundant caution, we would propose that the taxpayer be granted leave to object to each of the assessments on the additional ground that the ``fees'' received or receivable by the taxpayer were not assessable income derived by it.
The taxpayer should be granted leave to object to each of the assessments on the additional ground that the ``fees'' received or receivable by the taxpayer were not assessable income derived by it. The appeal should be allowed in part but otherwise dismissed. The decision of the Tribunal should be set aside. In lieu thereof, it should be ordered that, in each year, the assessment of income tax be amended by omitting the amounts described as ``Fees received'' or ``gross fees receivable'' from the taxpayer's assessable income but that, in respect of the disallowance of the claim to deduct the franchise fees, the assessments, to that extent, should be confirmed. The assessments of Div. 7 tax and additional tax should be set aside as a consequence of the amendment of the assessments of income tax ordered above. Since each party has had partial success in the appeal, there should be no order for costs.