P Gerber DP
CJ Stevens M
GR Taylor M
Administrative Appeals Tribunal
Dr P. Gerber (Deputy President), C.J. Stevens, G.R. Taylor (Members)
These 14 matters were heard at first instance before an Administrative Appeals Tribunal constituted by Deputy President Bannon Q.C., Senior Member McMahon (as he then was) and Senior Member Nicholls. All matters were, by consent, heard together, raising the same issues common to all applicants. In the result, Messrs Bannon and McMahon (Mr Nicholls having died before the decision issued) disallowed the objections, albeit for reasons not wholly congruent. The applicants appealed the Tribunal's decision to the Federal Court, which allowed the appeal for reasons which will be dealt with shortly. The Court ordered that the Tribunal's decision be set aside and the case be remitted to the Tribunal for further hearing. In the result (a special leave application to the High Court having been refused) the
ATC 924applications were relisted for further hearing by the Tribunal on 12/13 October 1989.
2. Because one of the complaints against the original decision was that the applicants had been denied natural justice, it was decided to reconstitute the Tribunal. The parties were informed of this decision at a directions hearing on 16 August 1989 and both expressed their complete concurrence. In the result, the further hearing proceeded without either party adducing any evidence and, after brief argument by both counsel, the matter concluded before the luncheon adjournment on the first day.
3. In these circumstances, the Tribunal is compelled to make its findings of fact and conclusions in law from what emerges from counsels' addresses, the transcript of the earlier proceedings, the previous decision of the Tribunal and the exegesis thereon in the joint judgment of the Federal Court on appeal, a task which can be likened to reconstructing the Old Testament from the Dead Sea scrolls.
4. We commence this ``reconstruction'' by repeating gratefully what their Honours of the Federal Court, in their joint judgment, adopted as the material facts for purposes of their decision (88 ATC 4834 at pp. 4836-4839).
``The relevant facts commence in mid-1982. The four applicants were partners in the business of subdividing and selling land at Killarney Vale on the central coast of New South Wales. Mr Fletcher and Mr Dunlop were both builders and some lots were sold by the partnership with houses already constructed upon them. The four applicants shared the services of Mr B.F. McGrath, a public accountant then practising in The Entrance as B.F. McGrath & Co. Some time late in May or early in June 1982 Mr McGrath had a meeting with Mr Fletcher and Mr Dunlop at which he showed them a brochure put out by a company named Annuity Investments Pty. Limited. The brochure advertised the availability of what it called `Future Cash Benefits'. Three different investment plans were offered, spanning terms of 15 years, 20 years and 25 years respectively. Features common to all three plans were that income tax deductions were said to be available in each of the first five years and that moneys were to be received by the investor only during the last five years of the plan. Mr McGrath explained the brochure, pointing out to the two men that tax benefits were available.
After discussion, the four applicants decided to make an investment in the annuity scheme. Each applicant borrowed some money from an independent financier. On 23 June 1982 each couple completed an application to invest $25,000 in the scheme. The total investment of the four taxpayers therefore amounted to $50,000. Each of the applications related to the 15 year plan. These applications were addressed to `The Managing Partner, Annuity Investments' at an address in Sydney. Apparently the applications, and bank cheques for the subscription moneys, were sent to that address by Mr McGrath. The address was the office of a firm called Crennan & Co., which carried on business as `financial and taxation consultants'.
Evidence was given before the Tribunal by Mr Malcolm Tucker, an acountant carrying on practice in Wagga Wagga in the firm J.A. Crowl and Associates. He said that this firm, after taking actuarial and legal advice, had created a series of pro forma documents available to be used as needed in particular cases. Upon receipt of the loan applications signed by the applicants, Mr Robert Watson of Crennan & Co. contacted J.A. Crowl and Associates. That firm then prepared the documents for use in this case. The documents included a partnership agreement, two loan agreements and an annuity agreement. The partnership agreement was sent to the applicants, through Mr McGrath, for execution. The other documents were retained by J.A. Crowl and Associates
The partnership agreement was in the form of a deed. It was dated 30 June 1982, although it was apparently signed by the applicants a few days before that date. The deed constituted a partnership known as `Annuity Investments Partnership No. 18', consisting of the four applicants and a company named Jimal Nominees Pty. Limited. The capital of the partnership was stated to be $50,001; $50,000 contributed by the applicants - and in return for which they were each allocated 5,000 `ordinary unit' - and $1 subscribed by Jimal in
ATC 925return for which it took one `special unit'. Subject to a preferential payment out of profits of $1 per annum to Jimal, the four applicants were to bear the profits and losses of the partnership. The deed made provision for the disposal of units and for the management of the partnership. It included a provision, cl. 21, appointing Jimal as the first managing partner of the partnership. Clause 23(1) provided that, subject to any direction of a general meeting of the partners or a regulation of the committee of management, the managing partner `shall have control of the policy and management of the business of the partnership'. By cl. 23(3) the managing partner was `empowered to enter into and sign contracts, arrangements and agreements of any nature whatsoever in connection with and incidental to the business of the partnership'. In particular, by cl. 23(4), the managing partner was empowered to borrow money for the purpose of carrying on the partnership business and to pledge the partnership assets by way of security.
The first of the loan agreements was made by Jimal, on behalf of the partnership and pursuant to the powers conferred upon it by the deed of partnership, with a company known as Doowarf Nominees Pty. Limited. By that deed Doowarf covenanted to lend to the partnership the sum of $2,000,000. Interest at the rate of 18% per annum was payable annually in advance. The capital was to be repaid, along with interest for each of the then current years, by three instalments due respectively on 30 June 1994, 30 June 1995 and 30 June 1996. The agreement was unusual in that it absolved the borrowers from any personal liability for payment of either the principal sum or interest thereon. Clause 5 relevantly provided:
- `5(a) In order to secure to the Lender performance by the Borrower of his obligations under this Agreement, the Borrower hereby agrees to execute and enter into in favour of the Lender, upon the Lender's request and at the cost of the Lender, a charge and/or other security (as the Lender may require) over any property or interest in any property acquired by the Borrower with the principal sum or any part thereof, to secure repayment of the principal sum and interest provided for pursuant to this Agreement.
- (d) The Lender hereby agrees that in the event of default by the Borrower any claim under this Agreement for either principal or interest repayments shall be limited to the value of the security taken under this Clause and the Lender shall have no further recourse against the Borrower in the event of any deficiency in the security.'
The effect of this agreement was to create an obligation to pay to Doowarf interest, in each of the first 12 years, of $360,000. The interest liability was to reduce in subsequent years as repayments of principal were made. But it was not intended that the partners should themselves find the money required for payments of interest. That was to come from two other sources: the second loan agreement and an annuity agreement.
The second loan agreement was also made by Jimal on behalf of the partnership. In this case the lender was a company called Eromdim Nominees Pty. Limited. The Eromdim loan agreement provided for that company to advance to the partnership at 30 June in each of the years 1982 to 1986 inclusive the sum of $190,000 together with the amount of the interest payable to Eromdim under this agreement; that interest being calculated at the rate of 18% per annum and payable in advance. The whole of the principal, together with interest for the then current years, was repayable by instalments due on 30 June in each of the years 1992, 1993 and 1994. Once again, there was a clause - in the same terms as that in the Doowarf agreement - confining the rights of the lender to the security.
The annuity agreement was made between Jimal, on behalf of the partnership, and Annuity Investments Pty. Limited. It was a simple document whereby, in consideration of the payment to it of $2,020,000, Annuity Investments agreed to pay to the partnership the sum of $170,000 in each of the first five years following the agreement, the sum of $600,000 in each of years six to 10 and the sum of $1,119,000 in years 11 to 15; all inclusive. The agreement contained an
ATC 926undertaking by Annuity Investments to redeem the annuity in whole or in part at any time after the expiration of 23 months from the date of the agreement; such redemption to be made within 21 days from the receipt of a notice of redemption given by the partnership. The redemption price was set out in an appendix to the agreement, being $24,000 at the end of year 2 and rising by specified steps to $80,000 at the end of year 10.
Mr Tucker was, at the relevant time, a director in each of Jimal, Doowarf and Eromdim. Following its incorporation in April 1982 he had, for a short time, been also a director of Annuity Investments. The person acting as secretary of each of these companies, Mr Trevor Hattersley, was an employee of J.A. Crowl and Associates. The annuity agreement and the two loan agreements were each partially executed in Wagga Wagga before 30 June 1982. On that day Mr Tucker drove to Canberra with Mr James Crowl, of his firm. He there completed the execution of the documents mentioned above. He also signed three bills of exchange which are relevant to this case.
The first bill was drawn on Doowarf by the partnership in the sum of $2,000,000. This was intended to be a payment in satisfaction of the loan agreement between those parties. Doowarf accepted this bill. On behalf of the partnership, Mr Tucker then endorsed the bill to Annuity Investments; thus paying the bulk of the annuity purchase price. Annuity Investments then endorsed the bill back to Doowarf, in satisfaction of an arrangement between those two companies whereby Annuity Investments had agreed to lend Doowarf $2,000,000 for 15 years at 18% interest.
The second bill was for $190,000. It was drawn by the partnership on Eromdim, being for the first payment of loan moneys under the agreement between those parties. Eromdim accepted the bill and Mr Tucker, on behalf of the partnership, then endorsed the bill to Doowarf, by way of payment of the first year's interest due to that company. Doowarf endorsed the bill to Eromdim.
The third bill had a value of $170,000. It was drawn by the partnership on Annuity Investments, being the first year's annuity payment. This bill was accepted by Mr Tucker on behalf of that company and endorsed to Doowarf. In turn Doowarf endorsed the bill back to Annuity Investments.
The net result of all this activity was, therefore, that all three bills ended up in the hands of the original drawee, so that no payment actually passed under the bills.
The only money which did pass at the end of June 1982 was the $50,000 paid by the applicants. Their cheques were paid into the bank account of Jimal. Almost immediately thereafter that company paid out the same sum to a company called TransCity Holdings Limited, a `money market manager', where it was held to the account of Annuity Investments. The Tribunal found that $30,000 was retained by Annuity Investments as an `Establishment Cost'; leaving a balance of $20,000 available for actual investment. This $20,000 constituted the balance of the sum of $2,020,000 payable by the partnership to Annuity Investments as consideration for the grant of the annuity.
Mr Tucker gave evidence that, on 30 June in each of the years 1983, 1984 and 1985, he carried out similar `round robins' with bills of exchange, in order to effect the payments required by the two loan agreements and the annuity agreement. The evidence includes a document summarising the effect, in cash terms, of these transactions. That document is attached to these reasons as Annexure A. It will be seen that, apart from the $1 contributed by Jimal in 1982, the scheme provided for inwards and outwards funds to tally precisely in each year until 1992. During each of the final five years funds of about $34,000 would accrue to the partners.
The taxation ramifications of the arrangements are set out in a further document tendered to the Tribunal, Annexure B to these reasons. [Annexures A and B reproduced on pp. 4840-4841.] The abbreviation `UPP' in the second line is `undeducted purchase price'; the draftsman having in mind, we are told, sec. 26AAA of the Income Tax Assessment Act 1936. The interest deduction is claimed at 78.61% of the actual interest charges. It will be seen
ATC 927that the document envisages substantial taxation deductions for each of the four applicants during the first five years, small deductions during the following five years and very large taxable receipts over the last five years. The taxable receipts range from approximately four to seven times the amount of the available cash income. From a practical point of view, having regard to the incidence of taxation, it will clearly be advantageous to the applicants to terminate the arrangement prior to 1992.
Evidence was given by Mr C.J.R. Latham, the consulting actuary who advised in connection with the scheme, that a sum of $20,000 invested free of tax at the rate of 14% per annum for a period of 15 years would provide sufficient income to permit a payment out of the fund of $18,945 in each of the final five years. An investment of $50,000, upon the same assumptions, would therefore yield payments of $47,362.50 in each of those years.
Annuity Investments Partnership No. 18 submitted an income tax return for the year ended 30 June 1982. That return showed income of $170,000, being the annuity received, and expenditure of $494,667, being interest paid of $360,000 and undeducted purchase price of $134,667. The result was a net loss of $324,667. In their personal returns each of the applicants claimed, as a deduction, one quarter of this amount. In each case these claims were rejected. In each case objections were lodged but disallowed. Although the relevant monetary sums differed a little, the same course of events occurred in the subsequent relevant years; thus giving rise to the 14 appeals to the Tribunal.''
5. It is now necessary to set out the reasons of Deputy President Bannon Q.C. and Senior Member McMahon (as he then was), if only to put this epic in historic context.
6. The learned Deputy President, after reviewing the evidence, concluded that the eminences grise behind the instant scheme were Messrs Tucker and McGrath. He concluded that, whatever may have been the intention of the taxpayers, Tucker's highly artificial scheme was expressly designed to achieve large tax deductions in the first five years by means of an elaborate ``round robin'' scheme of bills of exchange and associated annuity partnerships and loan agreements. The learned Deputy President went on to observe that, in relation to Pt IVA, ``this appears to be a case in which the taxpayers entered into the annuity schemes with the dominant purpose within the meaning of sec. 177A(5) of the Act, for the purpose of obtaining a tax benefit...''. This latter conclusion was destined to set in train the lengthy odyssey upon which this case embarked before returning ``home'', if only because Pt IVA had not been relied on at the hearing and no argument was advanced, either for or against its application, by either party. Mr McMahon agreed with Mr Bannon's conclusion as well as his decision, but omitted to refer to Mr Bannon's reasons. Mr McMahon gave additional reasons of his own.
7. On appeal, Lockhart, Wilcox and Burchett JJ. concluded:
- (i) that the Tribunal had failed to make the necessary factual finding, both under sec. 82KH(1F) and 82KL, to support its conclusion based on Subdiv. D of Div. 3; and
- (ii) that the applicants had been denied the opportunity to address the issue of Pt IVA.
In the result, as already pointed out, the appeal was allowed, the decision set aside and the case remitted to the Tribunal for further hearing. The Court adding that ``if the case is remitted to the Tribunal, this (i.e. the questions in relation to sec. 82KH(1F) and 82KL) is a matter which may be further addressed and the requisite findings made... It is not obvious to us that any useful further evidence would be available, but this impression may be erroneous. Particularly if any additional evidence is relevant to Pt IVA, it would seem appropriate to permit it to be adduced''.
8. Turning to the evidence before the Tribunal as originally constituted, exhibit ``F 1'' is headed ``DETAILS FOR PROFESSIONAL ADVISORS [sic]''. This document, which is set out below, amply supports the first Tribunal's conclusion that tax deductions loomed large in the minds of the ``advisors'' who led the ``annuitants'' into this arrangement.
``Under the FCB (`Future Cash Benefits') plan, an investor will contribute capital to a partnership which will purchase an annuity
ATC 928out of capital and borrowed funds. The investor - via a partnership structure - will include only part of the annuity income received as assessable income and will claim a deduction for that part of the interest which was incurred in financing the purchase of assessable income.
In its simplistic form, an annuity is a yearly payment of a stated sum of money either for life or for a term of years. A more complete definition is to be found under Article 14(2) of the U.K. double tax agreement which states:
- The term `annuity' means a stated sum payable periodically at stated times during life or during a specified or ascertainable period of time under no obligation to make the payments in return for adequate and full consideration in money or money's worth.'
In analysing the taxation aspects of the FCB plan, secs. 26AA and 51(1) are the relevant sections of the Income Tax Assessment Act to be considered.
Section 26AA(1) provides:
- `The assessable income of a taxpayer shall include the amount of any annuity, excluding, in the case of an annuity which has been purchased, that part of the amount of the annuity which represents the undeducted purchase price.'
In the case of an annuity for a known term of years, the amount to be excluded from the investor's assessable income is equal to the total undeducted purchase price divided by the number of years in the term.
`All losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital or of a capital, private or domestic nature...'
Section 6(1) provides that:
- ``exempt income' means income which is exempt from income tax and includes income which is not assessable income.'
Prima facie, the amount of the annuity which is excluded by the operation of sec. 26AA(2) is `exempt income' within the sec. 6(1) definition. Therefore, to the extent to which it may be argued that that proportion of the interest is incurred in gaining `exempt' income, the total interest paid may not be deductible.
The method of apportioning the interest for the purposes of determining the deduction available under sec. 51(1) would be:Total Assessable Interest Expenditure Income x ---------------------- for the Year Total Annuity Income
The total assessable income would be the total annuity income less the purchase cost of the annuity.
Assume that an investor selects a 20 year FCB plan which is to service his future cash needs. Out of an investment - $25,000 - and borrowed funds - $990,000 - an investor acquires a $1,000,000 annuity which will return the investor $6,398,500 over the twenty year term. Assume further that the investor's first year annuity receipt will be $85,000 and his interest payment will be $180,000.
In flow chart form, the investor's position will be as follows:
STEP 1: +-------------+ + ------------+ | | / Loans $990,000 (1) | | | INVESTOR |--------------------------------| FINANCIER | | | \ | | +-------------+ + ------------+ | | Purchases (2) | $1,000,000 | Annuity \|/ +-------------+ | ANNUITY | | INVESTMENTS | +-------------+ STEP 2: +-------------+ +-------------+ | | Pays Interest $180,000 (4) \ | | | INVESTOR |--------------------------------| FINANCIER | | | / | | +-------------+ +-------------+ /|\ | Pays (3) | $85,000 | Annuity | +-------------+ | ANNUITY | | INVESTMENTS | +-------------+ YEAR 1 INVESTOR'S POSITION: Income: Total Annuity Income $ 85,000 Deduct: S. 26AA `exclusion' -- refer below 50,000 -------- $ 35,000 ======== Expenditure: Interest Paid $180,000 Deduct: `Exempt' Proportion (15.63%) 28,134 -------- $151,866 ======== $116,866 ======== Net Deduction: Calculation S. 26AA Exclusion -- Purchase Price of Annuity $1,000,000 Annuity Term 20 Years Section 26AA `exclusion' = $1,000,000 divide 20 = $50,000 ======= Calculation `Exempt' Proportion Purchase Price of Annuity $1,000,000 Total Annuity Income $6,398,500 Exempt proportion = $1,000,000 x 100 ---------- $6,398,500 = 15.63%" =======''
9. We are satisfied from the above that the promoters viewed the success of this scheme as depending on the interest payments being tax deductible and the undeducted purchase price qualifying for exclusion from assessable income. To ensure that this aspect was clearly understood by prospective investors in Annuity Investments Pty. Ltd. (henceforth referred to as ``Annuity'') and their advisers, an opinion was sought from counsel, who was asked to answer a number of specific questions and to advise generally. It is clear that counsel's opinion (which was attached to the circulated material) was mainly concerned with the tax consequences of the proposed scheme. Since this Tribunal is compelled to reach its conclusion, reasons and decision on the evidence before the Tribunal as originally constituted, we propose to set out counsel's advice and the answers to the specific question put to him in full:
``Re: Purchase of an annuity
In this matter I am asked to advise on a proposal involving the purchase of an annuity.
It is intended that the annuity instalments will be of fixed variable amounts payable over a period of 20 years and that the overall yield will be 18.5%.
I am instructed that the annuity will be purchased from the funds borrowed from an independent finance company. The term of the loan will be 20 years. During the first 10 years, interest only will be paid at the rate of 18% per annum (reducible). For the following 10 years, an interest rate of not more than 18% will be negotiated and during this period instalments of principal will be paid by the borrower so that the loan will be repaid after 20 years.
I am also instructed that during the first five years of the period of the loan, a second independent finance company will loan sufficient amounts to the purchaser of the annuity to finance the difference between the annuity receipts and interest payments under the first mentioned loan.
The finance company or companies will, I am advised, take a charge over the annuity to secure the repayment of the loan.
The annuity company will be a dealer in annuities and will carry on the business of issuing annuities and paying annual sums to the various annuitants. The following are the questions on which I am asked to advise and my answers thereto:
Would the annuity be an annuity so called in view of the fact that an equal annual payment is not paid in each year and would it be income in the hands of the taxpayer or a return of capital?
This first question requires a determination of whether each proposed annuity will be an annuity for the purposes of sec. 26AA(1) of the Income Tax Assessment Act which is in the following form:
- `The assessable income of a taxpayer shall include the amount of any annuity, excluding, in the case of an annuity which has been purchased, that part of the amount of the annuity which represents the undeducted purchase price.'
The Act does not contain a definition of an annuity and it is therefore necessary to determine whether the proposed payments will, in fact, amount to an annuity by reference to general legal principles.
The mere description of a payment as an annuity is not decisive in determining its
ATC 931real character and it is therefore necessary to determine the substance and nature of the payments -
Perrin v. Dickson (1929) 14 T.C. 608. In that case, whilst the payment was described in the documentation as an annuity, it was held not to be on the grounds that the payments were in reality repayments of the principal sum.
The general principle at law is that where annual payments are made in liquidation of a principal sum, the payments would not constitute annuities for the purposes of sec. 26AA. On the other hand, if there is no fixed sum or debt being liquidated, the annual payments would constitute annuities for the purposes of sec. 26AA. This distinction is vital in the circumstances presently under consideration, as an important element is that the payments do fall within 26AA, so that a deduction is obtained for the undeducted purchase price of the annuity. The undeducted purchase price is defined in subsec. 4 of sec. 26AA as meaning so much of the purchase price of the annuity paid by the taxpayer as has not been allowed and is not allowable as a deduction and in respect of which a rebate has not be allowed and is not allowable.
To determine whether the proposed payments would constitute an annuity, it is necessary to refer to some of the decided cases on this subject. In
Scoble v. Secretary of State for India (1903) 1 K.B. 494, Vaughan Williams L.J., whose judgment was approved in the subsequent appeal to the House of Lords said (at p. 501):
- `It could not be said that every annual sum payable on a contract was necessarily an annuity within the Income Tax Acts. It had to be admitted that in any case in which it appeared on the face of the contract that there was a debt existing of such a nature that it could be said that the contract was not to purchase an annuity, but a contract under which a debt was made payable by instalments, in such a case the Income Tax Acts would not apply to the whole sum payable by such annual instalments.'
In the subsequent case of
Chadwick v. Pearl Life Insurance Company (1905) 2 K.B. 507, Walton J. said (at p. 514):
- `It is obvious that there will be cases in which it will be very difficult to distinguish between an agreement to pay a debt by instalments and an agreement for good consideration to make certain annual payments for a fixed number of years. In the one case there is an agreement for good consideration to pay a fixed gross amount and to pay it by instalments: In the other there is an agreement for good consideration not to pay any fixed gross amount, but to make a certain, or it may be uncertain, number of annual payments. The distinction is a fine one and seems to depend on whether the agreement between the parties involves an obligation to pay a fixed gross sum.'
Southern-Smith v. Clancy (1941) 1 K.B. 276, the taxpayer had entered into a contract with a life insurance company. He paid a lump sum in consideration of which the company agreed to pay him an annuity during his life and if at his death, the aggregate payments did not equal the amount he had paid, then to pay the annuity to his wife or sister until they did so. The English Court of Appeal held that what the taxpayer was paid was subject to tax as an annuity. Green M.R. said at p. 286:
- `It seems to me that the capital sum did cease to exist when once it was paid and that the so called guarantee was an undertaking not to refund a capital sum or any part of a capital sum but to continue annual payments for an ascertainable period.'
Clauson L.J. said at p. 291:
- `The only continuing relation between the annuity and the vanished capital fund is that the amount of the vanished capital sum is arbitrarily taken to measure the minimum period for which the annuity is to run.'
These cases were cited with approval by the High Court in the leading Australian case on annuities -
Atkinson v. F.C. of T. (1950-1951) 84 C.L.R. 298.
In applying the principles established in these cases to the circumstances presently under consideration, I am of the opinion that the contract between the parties will not
ATC 932involve an obligation to pay a fixed gross sum (Chadwick's case) nor is it an arrangement which involves the refund of the capital sum paid by the taxpayer to the annuity company.
I am of the view that once the capital sum is paid to the annuity company the principal sum has disappeared and the annual payments payable to the taxpayer do, I think, constitute an annuity with the result that the average annual amount of the undeducted purchase price will be deducted from each annuity payment for tax purposes. The payments are not therefore, in my view, in the nature of the repayment of a debt by instalments.
The question arises as to whether the fact that the annual payments will be of fixed variable amounts has any influence on whether the arrangement is an annuity. In the dozens of cases that have been decided on annuities, I have not been able to find one where the annuity was of a variable amount. However, in
Just v. F.C. of T. (1949) 8 A.T.D. 419, it was held by the High Court that a contract for the payment of 90% of the rent from a particular property to a particular individual was a rent-charge on that property. A rent-charge is in the nature of an annuity the difference being that a rent-charge is charged against specific property. One can therefore draw an analogy between that case and the payment of an annuity by the variable amounts.
I have reached the conclusion that there is no reason why an annuity could not be arranged on the basis that the payments are of fixed variable amounts. A person could, by will, create an annuity in favour of a child whereby the payments, for the period whilst the child is being educated, are greater than the amounts payable on completion of his or her education. Such an arrangement, in my view, would still be an annuity for the purposes of sec. 26AA of the Income Tax Assessment Act.
It is interesting to note that in sec. 44(3) of the English Finance Act of 1940, an annuity is defined as including any series of payments, whether interconnected or not, and whether of the same or of varying amounts.
The conclusion I have reached is, in my opinion, in accord with the definition of annuity in the old case of
Bignold v. Giles (1859) 4 Drew. 343 which is to the following effect:
- `An annuity is a right to receive de anno in annum a certain sum that may be given for life or for a series of years: It may be given during any particular period or in perpetuity.'
Would the payments to the Lender be an allowable deduction under sec. 51(1) and if so would the deduction be allowed in whole or in part and if in part how would that part of the deduction be calculated?
Section 51(1) in effect provides that all outgoings to the extent to which they are incurred in gaining or producing assessable income are allowable deductions except to the extent that they are incurred in gaining exempt income.
Outgoings incurred in order to derive income in future years are allowable deduction -
A.G.C. (Advances) Ltd. v. F.C. of T. (1975) 132 C.L.R. 175 and
F.C. of T. v. Total Holdings (Aust.) Pty. Ltd. 79 ATC 4279.
If monies are outlayed partly for the purpose of earning assessable income and partly for other purposes, they must be apportioned for the purpose of determining how much of the outgoing is deductible under sec. 51(1) -
Ronpibon Tin N.L. v. F.C. of T. (1949) 78 C.L.R. 47 and
Ure v. F.C. of T. 81 ATC 4001. The effect of these principles in this instance is that the interest incurred to the finance companies must be apportioned in respect of the whole of the future anticipated assessable income under the contractual arrangement that is entered into. The total assessable income will, in my view, be the annual annuity payments less the annual amounts which represent the undeducted purchase price.
The appropriate method of apportioning the interest for the purposes of determining the deduction available under sec. 51(1) would, in my view, be -
total assessable Interest expenditure income x ---------------------- for the year anticipated assessable income
An alternative view is that the apportionment in each year should be based solely upon the assessable income in proportion to the total income in the particular year in question. In light of the decisions referred to above in A.G.C. and Total, this is not a proper method of apportionment and, in my view, the one set out above is the correct one.
I am also asked to advise on the effect of sec. 82KJ, 82KK and 82KL on the proposal.
Section 82KJ in effect provides that if:
- (a) a deduction is sought in respect of a tax avoidance agreement, and
- (b) having regard to the benefit obtained, it is excessive, and
- (c) property is obtained, and
- (d) the consideration paid for the property is inadequate,
the deduction sought is not allowable.
In my opinion, sec. 82KJ will not apply to the proposed arrangement as the rate of interest of 18% is, in my view, not excessive in the present climate. Secondly, the consideration being paid for the property obtained (i.e. the annuity) cannot be inadequate if it is actuarily calculated as being full and proper consideration for the annuity received.
Section 82KK will not, in my opinion, apply to the circumstances presently under consideration as the interest is not being incurred to an associate, the finance companies being at arm's length from the annuitant.
Section 82KL provides that where the tax saving plus the value of an additional benefit obtained by the tax payer is equal to or greater than the amount of the expenditure, the expenditure is not deductible.
Additional benefit is defined in sec. 82KH(1F)(b) as meaning a benefit obtained as a result of a tax avoidance agreement which is additional to the benefit for which the expenditure is incurred.
Section 82KL cannot, in my opinion, be applied to this proposal as no benefit is being obtained additional to the annuity being purchased at arm's length for proper consideration.
There is, however, one particular aspect of sec. 82KL which requires particular consideration. Section 82KH(1J) provides that for the purposes of sec. 82KL an additional benefit will be obtained if a debt is owing by a taxpayer and it may reasonably be expected that the debt will at some time in the future be released or abandoned or that the creditor will fail to demand repayment. In these circumstances, there is deemed to be an additional benefit for the purpose of sec. 82KL which is equal to the indebtedness that it is expected will be forgiven.
If, therefore, the annuitant wishes to realise his interest in the annuity at any time in the future, it is important that it should not be intended that the debt will be forgiven. At that time the annuity should either be surrendered or sold and the debt repaid.
Would Counsel confirm that if the annuity company carried out at least 25 to 30 transactions that it would be assessable on the capital sum in the year of receipt and would then be eligible to deduct all annuity payments in future years?
Arthur Murray (N.S.W.) v. F.C. of T. (1965) 114 C.L.R. 314 it was held that the proper basis of accounting for assessable income where income relates partly to services to be provided in future years is that the income is assessable in the year that the relevant services are provided. See the decision in
Commercial Union Assurance Co. of Aust. Ltd. v. F.C. of T. 77 ATC 4186 to similar effect in relation to provision to be made out of premium income for future claims.
As a result of the decision in these cases, I am of the opinion that the proper method of accounting for the assessable income of the annuity company is for provision to be made
ATC 934in the year in which the consideration is received for the future annuity instalments. The provision so made will need to be brought in as assessable income in the year in which the relevant instalments are paid.
In my opinion, the company will continue over the period of the annuities to be in the business of paying annuities even if there is only one year in which the company issues annuities providing there are sufficient transactions for the company to be deemed to be in the business of paying annuities.
Alternatively, the company could bring in the whole of the considerations received as assessable income in the year in which they are received and deduct the annuity payments in future years. In light of the decisions referred to above it is, in my view, open to the Commissioner to assess the income and the expenditure in the form of the annuity payments on a different basis and I am of the opinion that the principles established in the cases referred to above should be followed.
The finance companies involved are all registered in the A.C.T., so they will not require registration, but would Counsel advise whether he considered registration would be required under any other Act, for example, the Life Insurance Act 1945 (Cth), bearing in mind that no life policy, as defined, is involved?
Could Counsel advise whether in his opinion if a member of the partnership sold his interest in the partnership would the purchaser of the outgoing partner's interest be entitled to a full deduction for any partnership loss including his proportionate share of the $50,000 deduction allowed under sec. 26AA(2)?
The effect of sec. 90 of the Income Tax Assessment Act is the assessable income of a partnership is calculated as if the partnership were a resident taxpayer. If there is a change in the partners through a partner selling his interest to another, a new partnership is thereupon constituted for the purposes of the Income Tax Assessment Act. Assuming that the new partnership acquires the assets and assumes the responsibilities and liabilities of the old partnership the new partnership will, in my view, be entitled to a deduction for the interest incurred in gaining assessable income of the partnership.
Section 26AA on the other hand poses a problem in so far as the assessable income of a taxpayer in respect of an annuity is reduced by the undeducted purchase price paid by that taxpayer. Because the new partnership is deemed to be a taxpayer for the purposes of the Act, the new partnership will not be entitled to have the undeducted purchase price excluded from its assessable income as it was not the taxpayer that paid the consideration for the annuity in the first place.
Section 26AA does not seem to require, however, that the taxpayer must have paid the purchase price to the annuity company. It would appear to be sufficient for the purposes of that section if the new partnership reimbursed the old partnership for the consideration which relates to annuity instalments still outstanding at the date of the constitution of the new partnership. If that were done, there is a possibility that the new partnership would be able to reduce its assessable income by the amount so reimbursed to the old partnership on the basis that it is the purchase price paid by that taxpayer, namely the new partnership.
If it was not practicable to follow that course, the new partnership would, in my opinion, obtain a deduction for the whole of the interest payments as the whole of the annuity payments would be assessable income.
If the annuitant was an individual or a company as distinct from a partnership, it would, of course, be possible for the annuitant to surrender his annuity rather than having to sell his interest to somebody else. In these circumstances, the amount received by the annuitant as the surrender value would, in my view, be a capital receipt.
In view of the favourable terms under which the annuity is issued to the taxpayer,
ATC 935including the annual capital gain, and the overall resulting income, does Counsel consider that any taxpayer entering into the arrangement would be able to convince a Court that the tax advantage was not his dominant purpose for entering into the arrangement?
This question involves a consideration of whether Pt IVA of the Income Tax Act could be applied by the Commissioner of Taxation to this proposal. Pt IVA is the much publicised provision which replaces the old sec. 260 of the Act. The effect of it is that if an amount is excluded from a taxpayer's assessable income that might reasonably be expected to have been included if a scheme had not been entered into, the Commissioner of Taxation may include that amount in that taxpayer's income - sec. 177C(1) and 177F(1). A `scheme' is widely defined as any arrangement, plan, course of action, etc. entered into after 27 May 1981, the dominant purpose of which is to bring about a reduction in assessable income - sec. 177A(1), 177A(5), 177C(1) and 177D.
The test of whether a scheme has been carried out is an objective one and is determined, in my opinion, not by the purpose in the mind of the taxpayer but rather is determined by what an objective onlooker would regard as being the main purpose behind the transaction, having regard to the manner in which it is carried out.
If, therefore, an objective onlooker would regard the dominant purpose behind a taxpayer entering into this particular transaction as being to obtain the tax benefit, then the Commissioner can apply Pt IVA to add the relevant amount back to the income of the taxpayer and to add penalty tax.
If, however, the entering into the arrangement by the taxpayer is for a commercial purpose and that purpose is determined by the objective onlooker as being the main purpose, having regard to the matters listed in sec. 177D, then Pt IVA does not apply to enable the Commissioner to disallow the deduction obtained from purchasing the annuity.
Having considered the matters listed in sec. 177D, in the context of this proposal, I am of the opinion that as a result of the overall yield of 18.5% available to each participant, it would be reasonable for an objective onlooker to regard the dominant purpose behind the purchase of the annuity as being a commercial one, with the result that Pt IVA would not apply to it.
In any event, I think it is highly questionable whether the reduction in assessable income brought about by the undeducted purchase price of the annuity is a `tax benefit' as defined in sec. 177C.
If the partnership was a Queensland Limited partnership and the taxpayer could only lose his initial capital, say $100, would this jeopardise any tax loss that the taxpayer may claim each year?
I am of the opinion that the taxpayer's position is not in any way varied by the partnership being a limited liability partnership as distinct from an ordinary partnership.
Finally, I am asked to advise generally in respect of this arrangement.
Firstly, I am of the view that the Crimes (Taxation Offences) Act cannot apply to this proposal and therefore a person entering into it will not have committed an offence under that Act.
Secondly, whilst no doubt the annuitant will generally be a partnership, it would also be appropriate, in my view, for the annuitant to be an individual or a company. Traditionally, annuities have been issued to an individual or individuals and issuing it in that manner would be in line with the traditional approach. An individual or a company that is an annuitant will, in practical terms, be able to dispose of his interest in the annuity readily by being able to surrender it.
Thirdly, it is important, in my opinion, from a taxation point of view that the taxpayer pay some of the purchase price of the annuity out of his own funds so that it cannot be said that the whole of the
ATC 936purchase price has been provided out of borrowed funds.
Finally, it is important to note that an annuity can only be created inter vivos by deed -
Re Locke (1823) 2 Dow. and Ry. K.B. 603. Unless there is specific provision for redemption in the deed granting the annuity, the annuity granted by deed is not redeemable -
Coverley v. Burrell (1821) 5 B. and Ald. 257.
Despite the opinion expressed above, the possibility of retrospective legislation (a somewhat prophetic observation, our comment) or of a purposive legal interpretation by a Court or that I have overlooked something should be borne in mind by the persons associated with this proposal.''
10. The above opinion is clear and self-explanatory. We are satisfied from the transcript of McGrath's evidence, that he had read the relevant material (including the above opinion) supplied by Annuity and acted on the view - central to this scheme - that the annuitants were entitled to deduct the interest payments incurred from their taxable income. Thus, McGrath conceded that he had conveyed the relevant contents of the brochure, the ``Details for Professional Advisors'' [sic] as well as counsel's opinion (ex. ``E'', ``F1'' and ``F2'') to these clients. Thus, the following took place in cross-examination:
``Just dealing with the opinion and the Notes to the Professional Advisers, did you read those yourself? - Yes.
Did you show them to your clients? - Not that I recall.
Did you discuss them with your clients? - Yes.
And what you said (was that) you had them and you had read them? - Yes.
And you were satisfied about them? - Yes.
Well, what did you say to them? - Well, I just said that I had read them and that it appeared to be a good annuity, and according to opinion that I had received, it satisfied all sections of the Taxation Act.''
11. On the whole of the evidence as it emerges from the transcript, we are satisfied that when the extreme artificiality of this financial scheme is examined, involving as it does bills of exchange for millions of dollars going on a merry-go-round and finishing up, as clearly intended, back in the hands of the drawee, the conclusion is overwhelming, viz. that this whole exercise had, as far as the accountants were concerned, the dominant purpose of reducing the taxable income of their clients. Taking the 1982 tax year as an example, the only ``real'' money consisted of some $50,000, 60% of which was paid to Annuity as its share of this bonanza, leaving only some 40% ($20,000) for actual investment, being the balance of the sum of $2,020,000 payable by the partnership to Annuity as consideration for the grant of the annuity. This same exercise was repeated in 1983, 1984 and 1985. Our conclusion becomes further reinforced when regard is had to Tucker's evidence. The following is taken from his cross-examination:
``Annuity never handed over either a cheque or cash to the value of $2,000,000 to Doowarf Nominees Pty. Ltd. conformably with that loan agreement, did it? - It did not hand a cheque nor cash...
In respect of the loan by Annuity to Eromdim Nominees Pty. Ltd. did Annuity hand over cash to the extent of $950,000? - It did not hand over cash to the extent of $950,000.
Or a cheque drawn on a bank? - No, it did not.
But in any event the situation was, I take it, that it was intended that these loan agreements should have some effect? - Certainly.
Namely the effect of making on the one hand Doowarf Nominees Pty. Ltd. indebted to Annuity in the sum of $2,000,000 plus interest? - Yes.
And the effect of making Eromdim Nominees Pty. Ltd. liable to Annuity in the sum of $950,000 plus unpaid interest? - Yes.
Thus by the agreements to bring about, in effect, the ability to have a round robin of bills of exchange? - That is right.
Deputy President Bannon: I suppose they generate payments of interest if anyone has got the money to pay it?
Mr Rolfe: Well, they generate payments of interest but they are also dealt with by bills of exchange, are they not, Mr Tucker? - Yes, sir.
And round robins of bills of exchange, that is the way it is done, is it not? - Yes, sir.
There was never any intention in any of the documentation which you have been shown by my learned friend, Mr Hill, or which I have just shown you that either cash or cheques should get outside the system? - That is right.
There was just going to be a passing of bills of exchange to bring about the results of these various agreements? - That is right.''
Later, the following emerged in cross-examination.
``You see, I suggest to you, Mr Tucker, that you knew full well when these documents were executed that certainly for the first ten years no money was ever going to have to change hands? - It depended on whether there was a profit or a loss.
No! I suggest to you that irrespective of whether there was a profit or a loss, you knew full well that no money was ever going to change hands, that is, be paid by Annuity to the annuitant? - Correct.
And that was because any amount payable was going to be offset by interest for those first ten years? - Yes.
During those first ten years you were aware that the annuitants were going to receive, if everything went well, substantial income tax benefit? - In the first couple of years?
The first ten years I said? - No, the first five years.
So the first five years they were going to receive substantial income tax benefits? - Yes. That was my understanding of it.
Which would make this type of scheme, as you understood it, attractive? - Yes.
Of course, after the first ten years, as you understood it, the annuitants were going to receive quite considerable amounts of money, were they not? - That was the way the plan was put to me, yes.
If it be the fact that an annuity subject to certain deductions becomes part of assessable income, then the annuitants were going to be liable, unless they could wipe it out in some other way, for income tax on the annuity? - That was my understanding of it...
The thing about this particular arrangement was that for the first ten years there was no tax liability of any consequence? - Yes, that is correct.
Indeed there were positive tax advantages, certainly in the first five years? - Yes.
But in years 11 to 15 there was a positive tax detriment, was there not? - According to those figures, yes.
What I want to suggest to you is that that was a matter well-known to you, as a director of Jimal, back in 1982? - Not really, because I relied on assurances that from the actuary's point of view and Mr Crowl's point of view that everything would be right.
But when you say `everything would be right', do you mean by that that in 1996, a net income of $818,836 would be paid to the taxpayers? (cf. Annexure `A', 88 ATC 4840) - He assured me - I have no knowledge of the calculations, the method of calculation, I have never professed to be a mathematician, I relied on his judgement entirely.
Yes, but one of the matters put forward in support of this scheme was that it offered positive tax advantages in the first years, was it not? - I believe it did, yes.
What I am suggesting to you is that in the latter five years it offered positive tax disadvantages? - Yes.
That was a matter of which you were well aware back in 1982? - I knew that there was income coming in the latter part of the annuity.
And certainly income far in excess of $17,000 odd; you knew that, did you not? - Yes.
Per annum? - Yes.
Well, did you ever communicate with the partners and say - or their accountant - `The level of income in the last five years will be quite high'? - No, I did not.
Have you ever seen any documentation which would indicate that the level of income in the last five years would be far in excess of the $17,039 set out in the brochure, Exhibit `E'... the grey brochure, do you remember, the one that you had not seen until just the other...? - Yes. Well, I cannot comment on the grey brochure because I had not seen it before.
No, but you are now aware that it shows an annuity of $17,039 per annum for the last five years, are you not? - Well, I recalled figures of that when I saw it yesterday, yes.
But you were aware back in 1982 that the figures were going to be far in excess of that, were you not? - I was aware.
That the figures were going to be far in excess of that? - Yes.
What I want to suggest to you, Mr Tucker, is that you were also aware that the intention of the parties was to get out of this scheme after ten years? - Well, I do not know what their intention was.
Well, so far as you were entering into agreements as a director of the managing partner you appreciated that from the partnership's point of view it would be deriving substantial income in the last five years, did you not? - Yes.
I suggest to you that it was your intention as managing partner to terminate this arrangement after the first ten years? - That is not right.
And that when you said yesterday that it was your intention that these various agreements should be binding agreements that it certainly was not your intention that these agreements should remain on foot after year 10? - That is not right.
You see, I suggest to you that the purpose of this arrangement was to provide a method for taxpayers to minimise their income tax over the first ten years of its operation? - That was one of the intentions.
And that thereafter the arrangement had little attraction to them? - Well, that was not in my mind.
I suggest to you it was, and that the reason it had little attraction to them was that it would hoist upon them large amounts of net income? - It was not in my mind, Mr Rolfe.
You were acting on behalf of the partnership? - Yes.
And I think you have agreed with me that the only advantage in the first ten years was to - well, do you agree with me that the only advantage in the first ten years was the tax deduction advantage? - Yes.
The fact of the matter is that of the $50,000 paid over by the taxpayers, $30,000 went by way of commission or fees, did it not? - Yes.
To whom was that paid? - To Crennan and Company and to a trust administered by Mr Crowl.
Well, the taxpayers got no further benefit out of that money? - That is correct.
As to the $20,000 that was paid in the first instance into the account of Jimal Pty. Ltd.? - Yes.
Thereafter you say it was transferred to a financier to earn interest? - Correct.
You were aware of redemption figures for various years after 23 months and up to ten years, were you not? - Yes.
Which provided an attractive return on that investment, leaving aside for the moment any question of annuity, if there be redemption? - You mean if the tax deduction was allowed?
Well firstly, if the tax deduction was allowed. Do you agree with that? - Yes.
And secondly, if the money was redeemed at the figures offered? - I cannot recall the exact figures that it would produce but could I have a look at the...
Well, yes, I think it is - certainly. - Well, according to Appendix `A' for a $50,000 initial investment the buy-back price is $24,000 at the end of year 2.
Yes, I am really looking at the end of year 10... Well, firstly, was it a return on $50,000 or $25,000? - According to my figures on $50,000 - according to my assessment.
Well, I suggest to you - the figure shown in the Appendix to the Annuity Agreement
ATC 939is $80,000 return on $50,000 after ten years? - Yes.
If you would be so kind as to go the first table (in ex. `E') under `Invest $25,000 now'. I appreciate you have not seen that document until recently, but there is something like $85,000 payable over the last five years, is there not? - Yes.
In respect of an investment of 25,000? - Right.
Do you know how the redemption figures were worked out? - No, I do not.
Was that a matter within the knowledge of Mr Crowl? - Yes.
Now, in addition to the income tax problems which would have confronted the taxpayers in the last five years in order to obtain the annuity, it would have been necessary for them to have paid out various loans, would it not? - Loans to the finance company?
Well, loans to Doowarf Nominees Pty. Ltd?
$2,000,000 had to be repaid to it? - Right.
And so far as Eromdim Nominees was concerned, $950,000 had to be paid to it?
So that there was some $2,950,000 (that) had to be repaid? - Yes.
If, as you say, these were genuine transactions? - Yes.
Well, it was a singularly uninviting five years for these taxpayers, was it not, if they were going to keep this scheme on foot from a financial point of view? - I cannot comment on that because it is something that was given to me to do and I accepted the advice and information from Mr Crowl on the condition that he said everything will be fine.
I just want you to assume that these taxpayers were builders and land developers in a not terribly big way, a reasonable way, on the mid-north coast of New South Wales. If they remained in this scheme from years 11 to 15, they received a net income of the order to which I have put to you? - Yes.
And they were obliged, in order to receive that net income, to pay out something in the order of $2.95 million? - Right.
I suggest to you, to anybody, that is not a very attractive financial situation? - I cannot change my answer. I am only acting on advice.
Deputy President Bannon: No, but you are being asked: do you think that is an attractive investment? - Well, if all the taxation implications are taken into account I was led to believe that...
I am not asking you what you were led to believe; what do you say now; what is your view now? - I have heard that many figures, I would presume no.
Mr. Rolfe: And those reasons, I suggest to you, would be very good reasons for a person bailing out after year 10 when the tax benefits had been obtained and before these various liabilities accrue? - That was never my intention. It was never put to me to do so...
Deputy President Bannon: Mr Tucker, it appears from what you have told us that Annuity was to gain an advantage from this scheme by receiving the establishment cost? - A portion of the establishment cost, yes.
And it appears from what you have told us, that the investors, the annuitants, stood to gain tax advantages? - Yes.
Are you able to tell us if you saw any other advantage to the investors in entering into this scheme? - I do not know what their thoughts were. I presume that taxation was probably foremost in their minds.
Yes, thank you.
Mr Hill: Mr Deputy President, I did not intend to ask this but in response to a question from you, the witness - the question was: did he see any other advantage to investors? He responded, I think, in a way which really was unresponsive, but leaving that aside, we would submit that ought to be struck from the record because he cannot indicate, as his answer sought to do, what was in their mind. His answer was, as I took it down, that he assumed - firstly, his assumption is not good - but he assumes the tax was their first consideration - (a) it was not responsive, and secondly, if it was responsive to anything, it was - his
ATC 940assumption was hardly or of any great significance.
Deputy President Bannon: I do not know, Mr Hill. I agree it was not completely responsive. It was partially responsive. What I was seeking to do was to gain the advantage of his understanding as an accountant of what was involved in it. I think to that extent his answers may be of some value. I think it ought to be allowed to stand, but I will leave it open to you to argue whether or not it is relevant.''
12. To the extent that the witness implied that the answer to some of the questions put to him would be better put to Mr Crowl, we can only note that that gentleman was not called as a witness. It is therefore open to this Tribunal to conclude that the unexplained failure to call Mr Crowl, who might reasonably have been expected to be called by the applicants, is because his evidence would not have assisted the argument sought to be advanced on their behalf; cf.
Jones v. Dunkel (1959) 101 C.L.R. 298.
13. The bare bones of the transcript make it difficult for us to determine to what extent - if any - the taxpayers, or which, if any of them, genuinely believed that they were embarking upon a superannuation scheme which had, ``by way of bonus'', some incidental tax benefits. Mr Dunlop claimed that one reason for entering into what he regarded as a form of ``superannuation'' was the fact that his wife was suffering from multiple sclerosis. The witness was somewhat vague as to the taxable income he had derived from the Dunlop and Fletcher partnership in the 1982 tax year. His stock answer to questions put to him in that regard was ``I do not recall''. In fact, his taxable income as returned from the sale of blocks of land from the subdivision was in excess of $73,000. His assertion that the tax saving provided by this ``superannuation'' was a mere ``fringe benefit'' is therefore less than convincing. When asked by his counsel whether McGrath had ``mentioned anything about income tax'', he first replied: ``No'', then qualified his answer by adding: ``Sorry, there was a fringe benefit or a benefit from the annuity that was - that was - was not actually our interest at the time, but there was a benefit with taking on the annuity investment''. The witness could not recall the conversation with McGrath. It is fair to say that Mr Dunlop did not fare well in his evidence. Thus he was asked by Deputy President Bannon what was the urgency in obtaining superannuation before June 1982. The witness replied:
``Because we had no superannuation, but my wife's health is not...
Mr Rolfe: In any event, there was no reference made to a tax benefit? - No reference made to a tax benefit.
After that meeting, was there any reference made to a tax benefit arising out of this arrangement by Mr McGrath to you? - No.
So tax benefits were never discussed between you and Mr McGrath in relation to this arrangement; is that the position? - That is correct.''
The witness fared worse the following day, as this extract of the cross-examination will demonstrate:
``When you went in to see Mr McGrath, did he produce to you the brochure which has become exhibit `E' in these proceedings, the grey brochure? - We had seen that brochure in Mr McGrath's office. That is correct.
And did you see it at this meeting in late May or early June of 1982? - I am not sure about this particular meeting. There were two meetings, may I add - there were two meetings. One of which there was information that Mr McGrath had by letter or by mail about this superannuation.
Was that before the meeting of late May or early June, or after it? - This was approximately around about late May.
Yes. Mr McGrath showed you the brochure, did he not? - He showed us the brochure.
And he said to you that the annuity fund, or investment which the brochure provided, was suitable for later years so far as you and Mr Fletcher were concerned? - There was an explanation with the superannuation and investment that there was a tax benefit for later years, but this was - the investment that we were doing was purely for superannuation. That was a bonus.
Yes. I though yesterday you said in answering some questions from my learned
ATC 941friend Mr Hill, that Mr McGrath had made reference to a tax benefit arising out of this arrangement? - About this superannuation investment?
Yes? - There was a tax benefit with it, yes. That is right, for the oncoming years.
Yes? - Not presently. It was for the years in the future.
Yes. Did he not tell you that the tax benefit would take effect as soon as you entered into the arrangement? - I cannot recall that.
I take it there was some discussion that it would be desirable to enter into this arrangement prior to 30 June 1982? - We were only interested in the superannuation. The benefit...
Well, could you answer my question? Was there some discussion as to whether it would be desirable to enter into the arrangement prior to 30 June 1982? - Only reason being that the superannuation finished in the - at 30 June.
So there was discussion that it would be desirable to enter into it by - or before 30 June 1982? - It was available to us, but it was not desirable for us to do it.
It was not desirable? - It was not desirable for us to do it.
There was no particular need for you to do it in that financial year? - No particular need for us to do it.
And did Mr McGrath say that to you? That there was no particular need to do it? - Not in those words. I cannot recall.
Did you say to Mr McGrath there was no particular need to do it? - There was no particular - in my own mind whether I had said to Mr McGrath or not, I know there was...
That is not what I am asking you, not what was in your own mind. I am asking what you said to Mr McGrath. Did you say to Mr McGrath, `There is no need to do it in this financial year'. - I cannot recall that.
But in any event, so far as you were concerned, there was no need to do it in that particular financial year? - That is correct.
There was never any question or discussion about if you did it in that financial year you would bring the annuity payments forward a year at the other end, was there? - No.
No. Well now, what you were told there was, by Mr McGrath at this meeting, that there was a benefit, as well as the superannuation benefit? - When we went through the whole brochure this was explained to us.
Yes. Well, do you say Mr McGrath took you through the whole brochure? - I can recall him explaining roughly how it worked. I cannot explain exactly now, this was some years ago.
Well, he certainly just did not give you the brochure and send you away to read it for yourself and make up your own mind, did he? - No.
He spent some time explaining the brochure to you? - He explained the brochure to us and I virtually took it home and explained it to my wife.
He explained to you that in addition to the annuity, which was some 11 years down the track, there were tax benefits in the meantime? - As a bonus on the side, this is correct.
Is that the way he described it, that the tax benefits were a bonus on the side? - Not in those words, I am not sure what words he used but along those lines, that is correct.
Even if the tax benefit was only a bonus on the side I suppose that held some attraction for you? - The investment held some attraction for us basically.
Well, did the tax benefit hold any attraction to you? - Well, that would be a bonus, yes, for sure.
Did it hold attraction for you? - It did hold an attraction.
During the financial year ended 30 June 1982 you apparently have sold 15 lots from the subdivision? - As I find this is correct.
At a gross price of something in the order of $450,000? - I have not added those figures up but obviously this is correct.
You were aware, were you not, that tax would have to be paid on so much of that money as was assessable income? - I was not aware of this.''
14. The evidence of Mr Fletcher, as it emerges from the transcript, did little to shed further light on the intentions of these taxpayers.
15. Turning to the law, we are satisfied that the appropriate test to be applied is not to look for the subjective intention of the taxpayers but to ask: what was the impugned expenditure intended to achieve? When the question is posed in that way, what the Fletchers and Dunlops intended or believed becomes irrelevant once it is found that the clear purpose of the expenditure, as revealed by the evidence, was to obtain a tax deduction. In a case such as this, the acts (and intentions) of the agents must be imputed to the principals; the maxim qui facit per alium facit per se applies alike in the field of income tax as it does in other areas of the law of agency. At the same time, we feel bound to add that the bare bones of the transcript do not inspire us with any degree of confidence that Messrs Dunlop and Fletcher were as naive as they gave the appearance - sight unseen - in the witness box. In short, we are highly sceptical of their assertion that their primary concern was to protect their future by way of ``superannuation'' or ``annuities''.
16. Applying the test we have outlined above, it follows that once we have concluded that this scheme was just another vehicle promoted for the dominant purpose of reducing taxable income, it follows that the interest payments do not constitute outgoings which were incurred in gaining or producing assessable income of these taxpayers. This test receives support from the views expressed by their Honours of the High Court (albeit in a different context) in
John v. F.C. of T. 89 ATC 4101 at p. 4105:
``In Ronpibon Tin N.L. and Tongkah Compound N.L. v. F.C. of T. (1948-1949) 78 C.L.R. 47 it was stated by the Court (at p. 56) that `For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end'. In
F.C. of T. v. Llbery 81 ATC 4661; (1981) 38 A.L.R. 172; 58 F.L.R. 191, Toohey J. said (at ATC pp. 4666-4668; A.L.R. pp. 179-180; F.L.R. p. 200) by reference to the above statement from Ronpibon Tin that `that was not to exclude the notion of purpose'. His Honour added that `purpose may stamp the outgoing as one having no relevant connection with the gaining or producing of assessable income'.
Although the first limb of sec. 51(1) speaks of a loss or outgoing `incurred in gaining or producing the assessable income', a loss or outgoing may be so incurred notwithstanding that no income has been gained or produced in the period in which the loss or outgoing is claimed to be deductible. The test of deductibility under that limb, as laid down in Ronpibon Tin, is that `it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income' (at p. 57).
It is readily understandable that, if no income has been gained or produced and a question arises as to whether the occasion would be expected to produce assessable income, consideration of the purpose for which the expenditure was outlaid might not be wholly irrelevant. It may be too that even where income is produced `the purpose for which the advantage occasioning the loss or outgoing is sought may evidence a sufficient relationship with the income-earning process'.
Handley v. F.C. of T. 81 ATC 4165; (1981) 148 C.L.R. 182, per Stephen J. at ATC pp. 4168-4169; C.L.R. pp. 189-190. But the cost of a step taken in the process of gaining or producing income must be regarded as an outgoing or taken into account in calculating the loss (if any) incurred, whatever purpose or motive may have attended all or any of the steps involved.''
17. We consider it highly significant that the High Court referred to Toohey J.'s decision in Ilbery with approval (the other two members of the Court concurring). Elsewhere in his judgment, Toohey J. stated (81 ATC 4661 at p. 4667):
``As Brennan J. pointed out (in the
at p. 4547Magna Alloys case 80 ATC 4542 at p. 4547):
- `Though purpose is not the test of deductibility nor even a conception relevant to a loss involuntarily incurred, in cases where a connection between an outgoing and the taxpayer's undertaking or business is affected by the voluntary
ATC 943act of the taxpayer, the purpose of incurring that expenditure may constitute an element of its essential character, stamping it as expenditure of a business or income-earning kind.'
Conversely, I would add, purpose may stamp the outgoing as one having no relevant connection with the gaining or producing of assessable income.''
The above passage was, in turn, cited with approval by Wilcox J. in
Anderson v. F.C. of T. 89 ATC 4982 at pp. 4990-4991, a case which, like the present one, involved expenditures incurred by a partnership for no discernible purpose other than to derive a tax deduction.
18. In the result, we are satisfied on the authorities that once it has been shown - as in this case - that the purpose of the impugned outgoing was to obtain a tax deduction, that fact sufficiently colours the outgoing to take it out of sec. 51; cf. Case V104,
88 ATC 670 at p. 676.
19. The Crown argued in the alternative that, even if the losses were deductible pursuant to sec. 51, the claim would nevertheless fail, either because the outgoings were incurred pursuant to a ``tax avoidance scheme'' as defined in Subdiv. D of Div. 3; and/or that on the evidence, the Tribunal should conclude that the dominant aim of this scheme was to obtain a tax deduction, so that Pt IVA operates to include the amount sought to be deducted as part of the taxpayers' assessable income as though the arrangement had not been entered into; sec. 177C(1) and 177F(1). However, having concluded that the claimed deductions were not incurred in gaining the taxpayers' assessable income so that sec. 51 does not apply, no concluded opinion on sec. 82KH-82KL is required. This view finds ample support in the decision of the Federal Court on appeal, where their Honours noted [88 ATC 4834 at p. 4852]:
``If the payments are not deductible under sec. 51, that is the end of the matter. The taxpayers' appeals must fail. The possible application of Subdiv. D does not arise.''
Thus emboldened, Mr Rolfe invited us to uphold the earlier Tribunal's findings on Pt IVA, the more so since no further material was adduced in an attempt to qualify or negative the earlier Tribunal's findings under that head. For the sake of completeness, we include the Tribunal's findings in relation to Pt IVA [88 ATC 113 at pp. 120-121]:
``Turning now to the provisions of Pt IVA of the Act, this appears to be a case in which the taxpayers entered into the annuity schemes with the dominant purpose within the meaning of sec. 177A(5) of the Act, for the purpose of obtaining a tax benefit in connection with the scheme and that the scheme falls within sec. 177D of the Act.
The taxpayers' accountant at Transcript p. 47 said of the taxpayers:
- `From memory they were not particularly wrapped in insurance company schemes.'
He said he knew nothing about the capital of `A Pty. Ltd.' except what was in the brochure, Exhibit E (and it said nothing). Mr Goodyear's account at Transcript p. 93 that the Goodyears were only interested in the superannuation cannot be accepted in the light of his knowledge of the tax benefits (Transcript p. 95) and his failure to inquire about `A Pty. Ltd.' and his claimed dislike of insurance-type superannuation (Transcript p. 92) does not bear examination. He had been subdividing and selling land and it seems hard to accept that he was unaware of a possible tax liability. A similar position obtains with Mr Archer (Transcript p. 148). The speed with which the agreements were negotiated to fall within the financial year ended 30 June 1982 (Transcript p. 151) and the coincidence of land sales having occurred, suggest the real reason was a tax reason.
It is not acceptable that two builders who had moved into land development, and their accountant, would not concern themselves with the financial viability of an unknown company, as against the safety of investing with a large life assurance company, if superannuation was the real motivation.
Not only does it seem that the dominant purpose of the taxpayers was to obtain the deductions for interest payments, but it seems perfectly clear that this was the principal purpose involved in `A Pty. Ltd.' propounding the scheme. This is apparent from the way the annuity scheme is structured and from the instructions given
ATC 944by the accountant to Mr L. Section 177D takes into account not only the purposes of the taxpayers, but also the purpose of a person referred to in sec. 177D(b)(vi), or of persons who enter into or carry out the scheme. The accountant's intentions can be predicated to `A Pty. Ltd.' of which he was a director taking an active role in management. Having regard to each of the matters set out in sec. 177D(b), the conclusion should be drawn that the annuity scheme falls within the section. There appears to be no reason why the whole of the tax benefit obtained should not be treated as cancelled pursuant to sec. 177F(1) of the Act.
It appears the proper answer to the taxpayers' objections is that the agreements with `A Pty. Ltd.' and the other agreements to implement the scheme, and the annuity scheme itself, were carried out with the dominant purpose of enabling the taxpayers to obtain tax benefits within the meaning of sec. 177D of the Act. In any event, the taxpayers have failed to overcome the onus of showing the assessments are incorrect.''
20. We are therefore satisfied that there was ample evidence before the Tribunal at first instance on which it based its decision with respect to the application of Pt IVA. However, in the end - and hearing the matter de novo - we have decided that once we have reached the conclusion that sec. 51 does not apply - a conclusion which has the imprimatur of the Federal Court - an examination of the specific anti-avoidance provisions of Subdiv. D of Div. 3 becomes the kind of lumber an administrative tribunal can well do without. For much the same reason, we have concluded that in this case no decision on Pt IVA is required.
21. For the sake of completeness, we wish to add that at the conclusion of addresses we indicated to the parties that we were still uncertain how sec. 26AA applied to these payments, which we were not even convinced qualified as annuities as that term is generally understood, adding that payments do not become annuities merely because one party said they were and no one sought to question the assertion. However, it soon became clear that both Mr Rolfe and Mr Pape were taken by surprise and the matter was not pursued. In the circumstances, we do not propose to enlarge on that aspect in our decision, if only because, if one lesson emerges from this case, it is that superior courts - like equity - will not assist a volunteer. Indeed, to the extent that we have been solemnly invited by learned counsel to venture a pronouncement on Pt IVA and/or to define what constitutes a ``tax avoidance agreement'' for purposes of sec. 82KH(1), we have politely, but firmly, declined both invitations.
The Tribunal was asked to decide this matter upon the transcript in the earlier proceedings. Indeed, since nothing else of any consequence transpired at the further hearing, we had no alternative. Having carefully read the transcript of the proceedings in the previous hearing, we are satisfied, for the reasons outlined above, that the objection decisions under review must be affirmed.