PM Roach SM
Administrative Appeals Tribunal
P.M. Roach (Senior Member)
These applications for review relate to the affairs of a taxpayer in relation to the years of income ended 30 June 1985 and 1986. They arise out of amended assessments of income tax which issued to the taxpayer, whom I shall refer to as
ATC 900Nigel, on 8 July 1987. The objections lodged to the amended assessments were disallowed on 9 August 1988 and the requests made by the taxpayer for an independent review resulted in the relevant documents being forwarded to this Tribunal in March 1989. At the same time the Commissioner was seeking to enforce a judgment entered in his favour against the applicant. Upon the application of the applicant and with the co-operation of the Commissioner, the Tribunal was able to bring the matter to hearing in May 1989.
2. Nigel was a gifted photographer specialising in service to the commercial world through the medium of the advertising industry. From 1 July 1978 the business was carried on by a company (Lens-co). With effect from 1 July 1984 the business was carried on by another company (Print-co). The issues for determination arise out of the relationship between Nigel and Lens-co. They also involve a consideration of the operations of Lens-co and the circumstances attending the sale of its assets to Print-co with effect from 1 July 1984. Both companies were wholly controlled by Nigel and his wife. I am satisfied that Nigel alone exercised that control.
3. The sale of the business of Lens-co to Print-co was explained on the basis that Nigel had been harassed over a long period by a former spouse who made financial and other claims upon him. It was contended that, although she had had no proprietary interest in Lens-co, Nigel feared that his control of that company might be imperilled. It was suggested that the transfer of assets to Print-co could avoid any problems from that direction. I reject the explanation. It was not even as if there was to be any attempt to conceal the transfer of business. The names of both companies were distinguished only by the incorporation into the name of Print-co of one further word. The shareholders of both companies were Nigel and his wife. (Her interest in Print-co came to be a 50% interest instead of her holding one only of the 101 allotted shares in Lens-co.) Further, the premises in which the business was to be conducted by Print-co continued to be the same - being premises owned by Nigel.
4. At the hearing evidence was first given by an accountant in private practice. His role for most of the period under consideration was to take the accounting records presented to him by Lens-co and other information supplied by or on Nigel's behalf relating to the preparation of income tax returns; to prepare a general ledger, a journal, a trial balance, a profit and loss account and a balance sheet; and to prepare and present income tax returns. I am satisfied that he did so diligently and skilfully and with a concern to ensure that available deductions were claimed for income tax purposes as soon as possible. (I note in passing that one deduction to be hereafter mentioned for $13,000 was claimed as a deduction in the year of income ended 30 June 1981 although the cheque in payment was not drawn until 1 July of that year. In making the observation I merely note that there was an awareness of, and an alertness to take advantage of, the benefits to be had by depressing taxable income in a current year, even at the price of allowing a later increase in tax liability). Unfortunately, the hearing and the presentation of evidence was made confusing, just as the task of the Commissioner's investigators in the past had been made more difficult, by errors made in the presentation of accounting documents. It happened that neither a profit and loss appropriation account nor a balance sheet for the period ending 30 June 1984 - a critical date - as presented to the Commissioner were the final statement of those accounts for that year. They were incomplete drafts which had been brought into existence before all relevant entries to be provided for by journal had been incorporated and the resulting accounts adopted.
5. It is also to be observed that the direct evidence of the accountant was very limited. Understandably he had assumed the accuracy of the information presented to him and processed it in accordance with relevant accounting standards. He gave credit to cheque butt records but of itself that did not establish the accuracy of those cheque butt records (cf. the reasons for decision in Case V38, 88 ATC 325). In particular, in relation to the transaction which in the eyes of the Commissioner is to be characterised as a ``scheme'', he had no knowledge of the particular arrangements but merely incorporated in the returns accounting particulars in accordance with directions given him on behalf of Lens-co.
6. The only other witness for the applicant was the applicant himself. Witnesses who had advised Nigel professionally and who had acted
ATC 901in the implementation of the arrangement and generally in relation to it were not called to explain what they knew, or their advice, or to give details of what they had done in the course of the service of Nigel or the company. Further, the person who had introduced Lens-co and Nigel to the ``scheme'' was not called as he was dead.
7. None the less Nigel presented himself in the witness box and there asserted the accuracy of the accounting records maintained under his direction over many years. While his evidence was in many respects vague, with particulars often being incomplete and his understanding of events limited - but not so limited as he would have had me believe - taking into account the limited challenge to the accuracy of those records, and the circumstance that there had been an extensive investigation of the affairs of Lens-co, I accept his evidence and that of the accountant as being more probably than not accurate, except in so far as I shall hereafter otherwise indicate.
8. Before setting out the financial history of these matters in some detail it is appropriate to acknowledge that it will be necessary from time to time to make a distinction between accounts maintained in a form appropriate to the fiscal purposes of the Commissioner (``tax accounts'') and accounts maintained with a view to providing an accurate statement of financial activities and the financial status of a company in accordance with ordinary commercial and accounting principles (``commercial accounts''). Lens-co, in common with a large number of other companies, followed a practice of only maintaining one set of accounts presented in a form contended to be sufficient to satisfy the requirements of tax accounts. That being so, when considering the position of the company by reference to the standards of ``commercial accounts'', it is necessary to recognise that some items relevant to tax accounts (e.g. investment allowance) are not appropriate to be taken into account as such in commercial accounts - such items tend to produce a taxable profit less than the commercial profit. On the other hand, items properly brought to account to assess commercial profit (e.g. entertaining expenses) may be excluded from account in fixing taxable profit. The result is that what might be determined to be profits available for distribution by the standards of the Companies Code (sec. 565 - cf.
Industrial Equity Ltd. v. Blackburn (1977) 137 C.L.R. 567) may be a figure less than the ``taxable income'' of the same company as determined by tax accounts. In particular, it must be recognised that in assessing the ``profitability'' of a company's operations regard must be had to income tax as a present or contingent liability which from the nature of things is not a consideration to be taken into account in determining ``taxable income''. (
The Commonwealth v. O'Reilly (1984) 2 ACLC 190; (1984) 8 A.C.L.R. 804.)
9. Nigel conducted and controlled a successful business. I accept that his working hours were substantial and his skills considerable. I also accept that his wife played a substantial part in the conduct of the business. There is no suggestion on the part of the Commissioner that the provision made by Lens-co for their immediate and long-term remuneration was in any respect unreasonable. Indications of the overall growing success of operations may be had in considering the figures for gross sales and also the figures for remuneration. In the following table I have incorporated the 1985 figures relating to Print-co as operator of the business in succession to Lens-co.
Year ended 30 June 1980 1981 1982 1983 1984 1985 $ $ $ $ $ $ Gross Sales 125,931 233,137 184,008 220,851 232,824 204,423 Salary & Wages Husband 20,020 19,950 31,800 31,200 43,754 44,531 Wife 17,004 15,656 23,850 23,400 35,626 35,572 Director's Fees 4,500 -- -- -- -- -- ------ ------ ------ ------ ------ ------ 41,524 35,606 55,650 54,600
79,380 80,103 Year ended 30 June 1980 1981 1982 1983 1984 1985 $ $ $ $ $ $ Superannuation 18,743 28,414 17,563 169 25,927 25,742 ------ ------ ------ ------ ------- ------- 60,267 64,020 73,213 54,769 105,307 105,845
Operations commenced during 1979. Gross sales to 30 June 1979 amounted to $7,241. No provision was made for remuneration to that date.
10. Although Nigel and his wife may have been well rewarded by their remuneration packages, the profitability of Lens-co, in its own right and according to the accounts of Lens-co, was substantially less.
Year ended 30 June 1979 1980 1981 1982 1983 1984 1985* $ $ $ $ $ $ $ Profit (Loss) ** (33) (27) (30,285) 32,061 1,585 37,539 22,218 * The figure is for Print-co. ** Losses carried forward and other tax adjustments have been excluded.
However, the Commissioner took a different view of that. He contended that the figures so presented by the company gave neither a true reflex of the taxable income of the company nor of its profitability according to commercial concepts. In particular, he pointed to a ``scheme'' which he contended broadly had the effect of creating ``artificial'' losses. I use the term ``scheme'' in a non-perjorative sense to represent something which the Commissioner considers to have been planned and implemented with a view to income tax advantages. Use of the term is not intended to suggest that the plan was either effective or ineffective for such purposes. In consequence the Commissioner contended for the following figures for taxable income:
Year ended 30 June 1981 1982 1983 1984 $ $ $ $ Previously assessed (or returned)* (31,316) 745 739 36,247 Add: Omitted Intere 5,489 Interest disallowed 100,750 90,000 91,491 Fees disallowed 13,000 1,000 Carry forward loss 31,316 ------- 123,061 Less: Interest Income 101,400 ------- ------- ------ ------ 82,434 21,661 92,230 41,736 *The figures differ from those for "Profit (Loss)" (ante) by reason of factors such as carry-forward losses and Investment Allowance.
Nigel does not accept that the Commissioner was ever entitled to so assess Lens-co.
The question of solvency
11. The contrast between the two positions can be seen by comparing the figures in the tables following. The first table traces the development of the profit and loss appropriation account maintained by Lens-co:
Year ended 30 June 1981 1982 1983 1984 1985 $ $ $ $ $ Retained Profits b/f (60) (30,345) 1,272 2,113 18,799 Net Profit before tax (30,285) 32,061 1,585 37,539 (813) -------- ------ ----- ------ ------ Profits b/f (30,345) 1,716 2,857 39,652 17,986 Less: Tax 343 340 16,555 119 Provision for Dividend 101 101 258 17,867 Dividends paid 303 4,040 Retained profits (30,345) 1,272 2,113 18,799
The second table is a table prepared by one of the Commissioner's investigators. It shows the following:
Year ended 30 June 1981 1982 1983 1984 1985 $ $ $ $ $ Opening Balance (60) 82,373 103,692 195,178 220,139 Amended Taxable Profit 82,433 21,661 92,230 41,736 (813) ------ ------- ------- ------- ------- 82,373 104,034 195,922 236,914 219,326 Tax paid 342 340 16,674 Dividends paid 404 101 21,908 ------ ------- ------- ------- ------- Closing balance 82,373 103,692 195,178 220,139 197,418 ------ ------- ------- ------- -------
In a further table the Commissioner's investigators sought to bring to account ``tax accrued'' as an obligation which, in his contention, would have arisen upon giving effect to, or providing for, the disallowance of the ``scheme''.
Year ended 30 June 1981 1982 1983 1984 1985 $ $ $ $ $ Opening balance (60) 44,454 56,151 105,551 127,987 Amended taxable profit 82,433 21,661 92,230 41,736 (813) ------ ------ ------- ------- ------- 82,373 66,115 148,381 147,287 127,174 Tax paid 342 340 16,674 Dividends paid 404 101 21,908 Tax accrued 37,919 9,622 42,086 2,525 ------ ------ ------- ------- ------- Closing balance 44,454 56,151 105,551 127,987 105,266 ------ ------ ------- ------- -------
12. There are two other aspects of arrangements which should be mentioned at this point. The first is that at all material times Lens-co carried on business from premises owned by Nigel which it occupied rent free. Secondly, as is also commonplace in similar circumstances, a loan account was maintained between the company and Nigel as its principal shareholder. The balance fluctuated from time to time. I find that when the account was opened it acknowledged Nigel as a substantial creditor by crediting to him the sum of $40,277 as the price of the assets which he had transferred to Lens-co. With the passage of the years roles reversed and Nigel came to be recorded as a debtor on loan account to Lens-co.
13. It follows from the competing contentions that:
- (a) if the company had no greater tax liability than it acknowledged, its assets
ATC 904exceeded its liabilities and it had a capacity to distribute substantial sums to Nigel by way of dividends; but
- (b) if the company had a liability in tax such as was to be contended for by the Commissioner, it could not lawfully have distributed substantial dividends and it could not have released Nigel from liability on loan account without rendering itself insolvent and incapable of meeting its tax liabilities.
14. The balance sheets for Lens-co as presented by Lens-co over the July 1979 to June 1985 period had presented the following information:
Year ended 30 June 1980 1981 1982 1983 1984 1985 $ $ $ $ $ $ Issued Capital Shares 101 101 101 101 101 101 General Holding Reserve 23,943 Capital Realisation Account 95,000 Debt Forgone Account (104,282) Unappropriated Profits (60) (30,345) 1,271 2,113 39,395 ------ -------- ----- ----- ------ ------- 41 (30,244) 1,372 2,214 39,496 14,762 ------ -------- ----- ----- ------ ------- Fixed Assets Plant & Equip. 15,275 30,438 47,852 46,023 67,053 Goodwill 15,000 15,000 15,000 15,000 15,000 15,000 *Investment 650,000 650,000 Current Assets Debtors 17,925 28,472 22,392 12,444 40,387 Nigel -- Loan 17,398 45,937 78,035 92,674 *K Investment P/L 650,000 Bank 4,237 19,091 57,663 3,134 *Tri P/L 812,594 Less Current Liabilities Creditors 479 776 3,230 5,700 3,610 Nigel 2,336 Mrs Nigel 2,426 Bank 42,917 20,886 85,469 175,142 238 ------ Super. Fund 21,840 34,340 34,340 *H. Finance P/L 650,000 *L Investments P/L 100,750 *T Investments P/L 90,000 Provision Income Tax 342 340 Provision Dividend 101 101 Less Long-Term Liabilities Mrs Nigel 2,426 3 *T Investment 650,000 731,000 812,594 ------ ------- ------- ------- ------- ------ Net Assets 41 (30,244) 1,372 2,214 39,496 14,762 ------ ------- ------- ------- ------- ------
In that table the items marked with an asterisk are the principal assets and liabilities relating to the alleged ``scheme''.
15. What result would emerge for Nigel as holder of all but one of the 101 shares in Lens-co would depend upon two things: whether the realisable value of assets had been understated; and whether liabilities had been fully and accurately stated.
16. As to that, I am satisfied that it was reasonable for those concerned to consider those possibilities. I am satisfied that, as at 1 July 1984, the plant and equipment of Lens-co had a value at least equal to its depreciated value in the tax accounts and that the ``goodwill'' of the business had a value substantially greater than the $15,000 attributed to it in the accounts - that being merely the historic figure brought forward when goodwill was acquired from Nigel by Lens-co at the point of commencing business. I am so satisfied on having regard to the circumstance that to ``owners/operators'' such as Nigel and his wife, the company had a demonstrated capacity for providing such owners with substantial rewards by way of salary and wages and by superannuation, even if not always substantially by way of dividends. Further, I am so satisfied notwithstanding that it happens that the total figure for which goodwill, plant and equipment was to come to be sold to Print-co happens to conveniently equal a sum sufficient to enable the loan account to be dealt with as it was. I am not persuaded that the equality of figures was either accidental or co-incidental, but I draw no inference adverse to either Lens-co or Nigel as a result of that. But, I also find that, having so disposed of goodwill on the sale of the business there was no basis for retaining goodwill as a balance sheet item (cf. post).
17. As the case was presented, neither side sought to develop fully the argument for or against the ``scheme'', or the evidence in relation to the ``scheme''; certainly not in such a way as would have been expected had the issue on the reference been a question of determining whether or not any assessments or purported assessments of Lens-co were excessive. The evidence of Nigel in relation to the ``scheme'' was very vague and imprecise. It was not wholly persuasive. His contention simply was that a man (now deceased) had persuaded him that money was to be had by borrowing large amounts of money at one rate of interest and on-lending it at a higher rate of interest. He professed that no one had mentioned to him any prospect of tax advantages in implementing such an arrangement. I do not accept that. When asked what he knew of other parties to the transactions giving rise to the ``scheme'', he said he knew nothing of them. He expressed a firm belief that money had been made out of the project by Lens-co. When asked how it was that anyone might be willing to lend $650,000 to Lens-co his explanation was simply that he had understood that the investment arising by on-lending would itself provide security for the borrowing. Presumably it was that thinking which not only explained why a third party would lend to Lens-co but also why Lens-co does not seem to have been in fear of default by any person to whom it might lend the money.
18. An investigator of the Commissioner presented a table in which he purported to set out all relevant money movements. The table disclosed the following:
LENS-CO ------- BANKING LEDGER -------------- Receipts Payments A 29/6/81 29/6/81 ... Finance (Loan) $650,000 Chq. 025326 $650,000 "... Investments"
(Loan) Receipts Payments A 30/6/81 30/6/81 ... Investments (Loan) $100,750 Chq. 025335 $100,750 "... Finance" (Interest) 1/7/81 Chq. 025327 $13,000 (dated 29/6/81) "... Consultants" (Fee) 14/7/81 14/7/81 ... Investments $101,400 Chq. 088516 $101,412.46 (dated 13/7/81) "... Investments" (Repay loan and interest) 1 18/12/81 18/12/81 ... Pty. Ltd. (Via ... $650,000 presumed to be loan Nominees Pty. Ltd.) (Loan) repayment to ... Finance 2 23/12/82 6/1/83 ... Pty. Ltd. $80,516.41 Chq. 027086 $90,000 (dated 23/11/82) "... Pty. Ltd." (interest) 3 6/10/83 13/10/83 ... Pty. Ltd. $81,954 Chq. 553320 $91,491 (Loan 2 & 3 = $162,470.41) (dated 30/6/83) (Loan 1, 2 & 3 = $812,470) "... Pty. Ltd." (Interest) Sale of Business -- $95,000 Minute: 1/5/84 Plant & Equipment -- $67,000 Date of Sale: 1/7/84 -------- $162,000 N/A -------- Purported Loan Repayments to ... P/L 12/6/85 13/6/85 ... Nominees $650,000 Chq. 194051 $650,000 Ex- ... Pty. Ltd. (dated 15/6/84) per Lens-co Pty. Ltd. "... Pty. Ltd." Chq. No. 194051 endorsed to Lens-co Pty. Ltd. 25/6/85 26/6/85 ... Finance $162,000 Chq. 194052 $162,594 (Loan) (dated 15/6/84) "... Pty. Ltd." -------- Total $812,594 (as per B/S in 1984) (income tax return)
The facts asserted are undisputed. But it should be observed that they do not clearly and precisely account for the adjustments later made when assessments issued.
19. It was contended for Nigel that the exposition by the investigator was incomplete in that it failed to take into account the circumstance that Print-co had given security to
ATC 907one of the other parties. It may be that it did. But since no evidence was presented to indicate just what the security was, or the extent of the liability of Print-co under the security, or as to the circumstances giving rise to it, I find the evidence which was presented completely unhelpful. Another matter to be noted is that, although the deductions for interest outgoings were claimed in sums of $90,000 and $91,491 by Lens-co for the years of income ended 30 June 1982 and 1983 the payments were not made until December 1982 and October 1983 respectively. Further, the only interest income ever acknowledged to have been derived by Lens-co ($101,400) was brought to account by Lens-co in the year of income ended 30 June 1982 (but excluded by the Commissioner on assessment). That may explain why it was that this otherwise successful company should have later fallen on such hard times as to cause Nigel to engage upon a realisation of other substantial personal assets in order to meet outstanding obligations. It may be - it certainly seems to be consistent with the adjustments made by the Commissioner - that Lens-co had to face the outgoings but that the expected income did not come in full measure.
20. As the evidence stands before me I am not persuaded that the assessments later made, or purporting to have been made, against Lens-co were excessive.
The sale of the business
21. I am satisfied that towards 30 June 1984 decisions were taken which were to result in the transfer of the assets of the business of Lens-co to Print-co; in Lens-co deciding to forgo the indebtedness to it of Nigel; and in the placement of Lens-co in liquidation, as a company stripped of assets and liabilities.
22. The starting point to those ends was an agreement which, so far as Lens-co is concerned, was recorded in a minute of a meeting of directors of Lens-co of 1 May 1984 which provided:
``It was resolved that the goodwill of the business operated by the company including all clients and contracts be sold for $95,000.
It was further resolved that the plant and equipment be sold for $67,000.
The sale of the business is to be effective as of 1 July 1984.''
I accept that the arrangement was implemented and that the prices were not excessive.
The winding up
23. Decisions were taken on 1 May 1985 which resulted in what counsel for the Commissioner referred to as the ``de facto'' winding up of Lens-co. That day the directors resolved:
It was recommended that the unappropriated profits of the company be distributed in total to current shareholders.''
On the same day it was resolved at an extraordinary General Meeting of shareholders:
It was resolved that all unappropriated profits from the company be declared as dividends to the shareholders in anticipation of putting the company into liquidation.
It was further resolved that the dividends would be credited to the shareholders current accounts prior to completion of the financial year.''
In due course entries were made in the account of Lens-co to give effect to those resolutions.
The assessments of Lens-co
24. I mentioned earlier that some of the confusion in the presentation of the issues were sourced in the presentation of some accounts in draft form rather than in final form. But the respondent too contributed to the confusion attending this case. On 15 August 1986 the Commissioner advised the liquidator:
``On the basis of the return and/or information furnished there is no income tax owing in respect to income derived by the company up to the date of liquidation.
Provided sufficient funds are retained to meet income tax payable on any taxable income derived during the course of winding-up, action may proceed to distribute the assets of the company and finalise the liquidation.''
I note immediately that, as all the events material to the assessment of the applicant had occurred long before that date, there can be no suggestion that in that advice there is any
ATC 908factual foundation for an estoppel argument, even if such an argument could be availed of by a taxpayer (
F.C. of T. v. Wade (1951) 84 C.L.R. 105).
25. Having received that notice of advice on 9 October 1986 the liquidator proceeded to hold the final meeting of the company.
26. By letter of 8 January 1987, addressed to the liquidator of Lens-co, the Commissioner then advised that his letter of 15 August 1986
``was issued in error and is herewith retracted.''
``no clearance can be granted to finalise the liquidation at this stage''
because Lens-co was under investigation. The liquidator responded immediately, contending that the liquidation had been finalised. The Commissioner thereon made application to the Supreme Court of Victoria and on 15 January 1987 on an ex parte application procured an Order (inter alia) that sec. 411(5) of the Code did not apply in relation to (Lens-co). The effect of the Order was to stay the liquidation process. As there is no evidence before me that a final meeting was duly held or a return duly lodged with the Commissioner, as required by sec. 411 of the Code, I find that the dissolution provided for by sec. 411(5) had not occurred before the Order of the Court was made. There was nothing in the evidence to suggest that there had been any further Order of the Court.
27. None the less, on 22 January 1987 the liquidator advised the Commissioner, then represented by the Australian Government solicitor, that:
``I ceased to be the liquidator on 9 October 1986 and therefore have no standing in this matter. It is my opinion that if there are to be any appearances or opposition to the application it should be by the former directors of the company. I note it is your intention to forward by post to the registered office of the company a copy of the Order. I presume you mean the last address of the registered office as since the the [sic] date of liquidation the company would not now have a registered office.''
28. Notices of assessment against Lens-co were prepared under date 6 April 1987 and also under date 8 April 1987. Only the Commissioner's file copies of the later documents were exhibited before me. None the less I am satisfied that, apart from differences in date and, possibly, the address to which they were directed, they were identical sets. There were four assessments in each set. They were for the years of income ended 30 June 1981 to 1984 inclusive.
29. By letter of 8 April 1987 all notices were posted to Lens-co, care of the liquidator. The covering letter said:
``Reference is made to the notices of assessment for years 1981-1984 that issued to you on 6 April 1987. You are advised that these [sic] notices were issued to you in error and may be disregarded.
Any inconvenience that this has caused you is regretted.''
30. By communications addressed to the solicitors for the applicant on the eve of hearing the liquidator asserted that three assessments dated 6 April 1987 and three assessments dated 8 April 1987 had been received by him under cover of the letter of 8 April 1987. He confirmed to the solicitors to the applicant the view previously expressed that he had no standing in the matter. Later he advised them that, to the eve of hearing, he had not received any advice or notice from the Commissioner of Taxation or the Commissioner of Corporate Affairs that the company had not been dissolved. It may be so, but that alone does not persuade me that Lens-co has been dissolved.
31. The assessments referred to on the face of them had the effect of increasing taxable income previously assessed (or returned) for Lens-co as follows:
Year ended 30 June 1981 1982 1983 1984 $ $ $ $ Previously ass'd (ret'd) (31,316) 745 739 36,247 Add: Interest 100,750 90,000 91,491
5,489 Year ended 30 June 1981 1982 1983 1984 $ $ $ $ Fees 13,000 Carry forward loss 31,316 ------ ------- ------ ------ Deduct: Interest (101,400) ------ ------- ------ ------ Assessed at 82,434 21,661 92,230 41,736
The assessment of Nigel
32. Then on 8 July 1987 the Commissioner issued to the applicant the amended assessments which are the subject of challenge in these proceedings. Those amended assessments increased taxable income previously assessed as follows:
Year of income ended 30 June 1985 1986 $ $ Taxable income as previously assessed 69,124 48,759 Loans/Advances from (Lens-co) considered to be dividends 110,174 -- Value of benefits derived from employment (use of company cars for private purposes) included in assessable income 1,800 1,720 Omitted interest from income included in assessable income 208* -- Profit from the sale of shares derived at the 1986 income year excised from assessable income (1,210) Profit from the sale of shares included in the assessable income 1,238** ------- ------ Taxable income as shown in attached notice 180,096 51,717 * By, agreement the objection is to be allowed in $195. ** The adjustment was not objected to.
The loan account issue
33. The key issue in these references is that relating to the sum of $110,174 identified in the adjustment sheet as:
``Loans/Advances from (Lens-co) considered to be dividends.''
The issue relates to the loan account maintained by Nigel with the company.
34. According to the accounts of Lens-co the indebtedness of Nigel to the company was as it appears in the table following. The change from the previous year is recorded in the fourth column.
Year ended 30 June 1979 ($40,277) Change ($40,277) 30 June 1980 ($2,336) Change $37,941 30 June 1981 $17,398 Change
$19,734 Year ended 30 June 1982 $45,937 Change $28,539 30 June 1983 $78,036 Change $32,099 30 June 1984 $92,674 Change $14,638 30 June 1985 Nil Change ($92,674)
The transactions and events giving rise to a ``Nil'' balance at 30 June 1985 constitute the main issues upon this reference. They will be considered in detail in due course.
35. I am satisfied that the change in the loan account balance in any one year was a reflex of both debits and credits to the loan account made in relation to that year of income. I am also satisfied that in relation to all advances made to at least 30 June 1984, by which date net indebtedness stood at $92,674, that at the time any advance contributing to that liability was made it was not intended that the moneys advanced should never be repaid.
36. I find that, during the year of income ended 30 June 1985, the balance due and owing by Nigel to Lens-co on loan account moved in accordance with the following table:
Nigels' Loan Account Debit Credit Dr. Balance $ $ $ 1/7/84 Opening Balance 92,673.58 30/6/85 Journal 8503 3,361 96,034.58 Journal 8503 10,000 106,034.58 Journal 8503 6,000 112,034.58 Journal 8503 15,000 127,034.58 Journal 8504 17,000 110,034.58 Journal 8506 23,942.75 86,091.83 Journal 8512 4,040 82,051.83 Journal 8517 80,339 1,712.83 Journal 8513 1,712.83 --
37. The figure brought to account by the Commissioner was not the $110,034 appearing in the last table but $110,174. The difference is to be explained by an adjustment to the figures for ``Advances'' (cf. below).
38. I am satisfied that four advances ($3,500, $10,000, $6,000 and $15,000) were made. I also find that the account in that regard is not inaccurate by reason of the circumstance that, in bringing to account $3,361, the accountant set off $139 against a cheque drawn for $3,500 by reason of a credit due to Nigel in respect of a cheque for $139 previously debited to his account. I accept that the opening balance had been overstated by $139 and that the effect of the set-off was to correct that overstatement.
39. As to the sum of $17,000 that was recorded in the journal by the accountant as being ``summary of cash received for the year'', and also identified as ``loan directors'', Nigel could not say what it was, and the accountant could not say what it was, but it was something acknowledged by Lens-co - albeit a puppet controlled by Nigel - to reduce Nigel's indebtedness to Lens-co. I accept that Nigel was entitled to the credit, but I am not persuaded why. It may even have had the character of income in Nigel's hands, but as the $17,000 forms no part of the $110,034 said to constitute income, I make no finding in that regard.
40. The sum of $23,942.75 was not the subject of any clear explanation either.
ATC 911However, it was the assertion of the accountant - not controverted at all by Nigel - that the moneys had come to the hands of Lens-co from a client who had twice paid. The accountant was sure that, as between the client and Lens-co, the money was not due to Lens-co. He believed that there had been some exchange of correspondence between Lens-co and the client about it but none the less, in face of that rather extraordinary situation, he first processed the transaction by a journal entry in the following form:
30/6/85 Income Dr.$23,942.75 Loan -- Nigel Cr.$23,942.75 Being amount received from advertising department twice which has been set aside to shareholders in the event of pending recovery. Later there were two other journal entries as follows: 30/6/85 Loan -- Nigel Dr.$23,942.75 General holding reserve Cr.$23,942.75 Being adjustment to Journal 8506 for amount received from advertising department 30/6/85 Debt forgone account Dr.$23,942.75 Shareholders Loan Account Cr.$23,942.75 Being remaining balance of debt forgone as per Journal 8517.
41. I find that the $23,943 received by Lens-co constituted assessable income of the company. It was paid to it for services rendered. It may have been paid in error. It may have been that it should have been refunded to the client. It may have been retained dishonestly. But it still constituted assessable income in the hands of the company. As Rich J. sand in
Permanent Trustees Co. (N.S.W.) v. F.C. of T. (1940) 6 A.T.D. 5:
``A windfall on account of revenue may quite well be income.''
By treating the receipt in the course of trade as it was treated, the result was that the assessable income of Lens-co came to be understated. But inasmuch as that portion of the profits of Lens-co was credited to Nigel, the taxable income of Lens-co may not have been affected. Although the payment to Nigel was a ``windfall'', it constituted assessable income in his hands - whether it came to him as a dividend, or deemed dividend, or as a reward for services.
The $4,040 and $1,712
42. I accept that the credit of $4,040 was a credit of a dividend which had been provided for in the accounts to 30 June 1984. I find that the $1,712.83 also represented a dividend distribution as provided for in Journal entry 8513 as
``Being to distribute the remaining unappropriated profits to the shareholders on closure of the business as dividends.''
The amounts so credited to the loan account were in fact included in the figure returned by the applicant as dividends derived. In consequence, to that extent there has been a double-counting.
43. I am satisfied that the results of trading as Lens-co until 30 June 1984 generated, according to its own records, a substantial net profit for Lens-co such as would call for the payment of a substantial amount of income tax and also for the need, if Div. 7 liabilities were to be avoided, for a substantial dividend distribution in the year following.
44. The proposed final act to close off the operations of Lens-co was the action taken by Lens-co to implement a resolution of directors of Lens-co of 30 June 1985 recorded in the following terms:
It was resolved that the loan by the shareholders from the company be forgiven in view of the fact the company no longer was trading and that it holds sufficient reserves to absorb cancellation of the debt and has no material effect on the closure of the company prior to liquidation.
It was further resolved that the debt be written off to a debt forgone account.''
I propose to consider in detail the significance of what was done in consequence of that resolution.
45. That resolution was given effect to by a further journal entry:
"Debt Forgone Account Dr.$80,339 Shareholders Current Account Cr.$80,339 Being a transfer Balance out of Shareholder's account upon forgiveness of the debt"
46. On these things being done the balance sheet of Lens-co to 30 June 1985 was as previously set out. It was stripped of both assets and acknowledged liabilities and was therefore understood to be in a condition to persuade a liquidator to assume responsibility for the formal winding up.
47. To appreciate the significance of the resolution to ``forgo'', it is appropriate to compare in financial terms the decisions respectfully contended for by the parties after giving effect to all other financial transactions. In doing so, in the following tables I have taken into account:
- (a) the liability of Nigel to Lens-co at $80,339;
- (b) the circumstance that after the sale of the business it was inappropriate to retain ``goodwill'' as an item of value in the balance sheet;
- (c) the financial position contended for by the applicant; and
- (d) the financial position contended for by the Commissioner.
48. In the comparative tables following the objective is to express the financial position of the company in balance sheet terms according to the respective contentions of the parties immediately prior to the passage of the resolution to forgo.
49. BALANCE SHEET OF LENS-CO (Immediately prior to resolution to "forgo") Figures according to: Taxpayer Commissioner SHAREHOLDERS FUNDS Ordinary Shares $101 $101 Capital Realisation Reserve $95,000 $95,000 Goodwill ($15,000) ($15,000) Unappropriated Profits Reserve ($92,152) ------- --------- $80,101 ($12,051) ------- --------- ASSETS Shareholder's Loan $80,339 $80,339
$80,339 $80,339 Figures according to: Taxpayer Commissioner LIABILITIES Bank $238 $238 Tax $92,152 ------- --------- $80,101 ($12,051) ------- ---------
50. Upon the evidence presented before me the resolution to ``forgo'' and the action taken on the part of Lens-co in writing up its books of account to give effect to that resolution constituted nothing more than a unilateral act on the part of Lens-co whereby the company declared its intention to remit the debt due to it by Nigel and adopted accounts intended to reflect that decision. On the face of it, although that was done when Lens-co was substantially controlled by Nigel, it was not done in such a way as to confer any right upon Nigel against the company such as would have entitled him to resist a claim for payment of the debt. There is no basis in the evidence before me for Nigel to contend that he was released, whether by deed under seal or by any agreement for which consideration was given, or that he so acted in consequence of the company's representations as to be entitled to allege an estoppel. Once that is recognised, it follows that nothing has passed to Nigel. His liability to the company remains as it was. He may cease to be liable to pay the company by force of law by reason of the effluxion of time, but he was not so released by reason of either the passage of resolution or the action taken by the company in writing up its books of account.
51. The situation is therefore quite unlike the situation considered by the Supreme Court of New Zealand in
Campbell & Anor v. Commr of Inland Revenue (N.Z.) (1967) 14 A.T.D. 551 where debts of shareholders were forgiven by deeds of forgiveness. In those circumstances the execution and delivery of the deeds conferred an immediate financial benefit upon the persons in whose favour the deeds were executed. But no such advantage was conferred here. If any advantage is to come to the applicant it seems likely that it will come in consequence of the belated decisions of the Commissioner to raise assessments against the company and advance his claims to be a creditor of the company.
Motor vehicle expenses
52. The issue relates to the use for private and personal purposes by Nigel of a four-wheel drive vehicle owned and operated at the expense of the company. The vehicle was presented for inspection and was seen to be what the evidence said it was: a work vehicle. Even so the applicant made some use of it for private purposes. I am satisfied that that use was slight and that the increased costs of operating the vehicle occasioned by that use were small. On the other hand the advantage to the applicant was quite substantial, if considered in comparison with the costs he would have incurred to obtain substitute transport. The issue was to be resolved by an exercise of judgment and on that basis I think some reduction is appropriate. I would reduce the amounts assessed from $1,800 to $1,350 and from $1,720 to $1,300 in the years of income ended 30 June 1985 and 1986 respectively.
Omitted interest - $208
53. As it was so agreed by the parties, taxable income for the year of income ended 30 June 1985 will be reduced by $195 on account of this item.
54. Additional tax was levied in the sum of $46,194 and $536 in the years of income ended 30 June 1985 and 1986 respectively. No evidence or argument was addressed on the question of remissions. That being so, the only further remissions which will be allowed will be those flowing from the reductions in taxable income; and from a reduction in the ``compensatory rate'' from 20% p.a. to 14.026% p.a.
55. On the principal issue, taxable income was excessive to the extent of $86,231 ($110,174 - $23,943). That being so, the determination of the Tribunal is that for the years of income ended 30 June 1985 and 1986
ATC 914respectively taxable income shall be reduced by the sums of $86,876 and $420 and additional tax for incorrect returns by sums to be determined upon receipt from the parties of details as to the calculations of additional tax as levied together with such submissions as they care to make within 14 days of the date hereof.