RIPPON v FC of TJudges:
This appeal from the Administrative Appeals Tribunal constituted by Professor YFR Grbich Senior Member concerns the application of s. 260 of the Income Tax Assessment Act 1936. The taxpayer is a consulting engineer. The Tribunal held that a corporate and trust structure by which his professional practice was carried on was struck down by s. 260 with the consequence that he was liable for tax as though the income were received in his own hands.
It would seem there was little dispute before the Tribunal as to the primary facts. The taxpayer graduated from the University of Newcastle in 1970 and worked for a succession of employers as an engineer up until 1974 when he joined the Coal Division of the Gollin Group. When the group collapsed the taxpayer was engaged by its Receiver in connection with a coal loader project. When that project was completed in October 1976 he decided to go into business on his own as a project
ATC 4188management consultant. He had received a lump sum termination payment of $20,000 and this amount provided the capital for the new venture.
He consulted a solicitor and, as he put it, ``I spoke to him about setting up a structure to be able to continue in my own right and to cater for my business and my family's interests in the most appropriate way''. The following structure was established. A shelf company was acquired, and its name changed to John T Rippon Pty Ltd (the company). That company was made the trustee of a unit trust called the John T Rippon Unit Trust. All the units in the trust were held by another company called John T Rippon Holdings Pty Ltd on a discretionary trust, the beneficiaries of which were the wife and children of the taxpayer. There were three children at the time, boys aged six, four and one. Another boy was born some 12 months later.
The date on which these various structures were established seems to have been 3 December 1976. There was understandably some haziness in the recollection of the taxpayer as to the precise date on which business commenced and whether it commenced before the structures were established. He said in his evidence that ``if there was a gap it would be a very short gap''. Counsel for the Commissioner endeavoured to establish that there was a gap of sufficient length to be legally significant but the Tribunal found as a fact that the unit trust structure was formed on or about the time when the taxpayer left his employer and commenced a new consulting business. This finding was accepted in the hearing before me.
The company commenced to carry on business as a consulting engineer. It occupied furnished serviced office premises in North Sydney. Secretarial services were available and charged according to use. The company canvassed work and sent out letters to potential clients. As a consequence the company obtained various professional engagements. It was retained by the Newcastle City Council in relation to an abattoir project and also to advise on the engagement of a general manager. It provided other reports for local government and private clients. At a fairly early stage in the business the company engaged consultants to assist in the work it provided for clients. These were engaged on a sub-contract basis, that is to say the company paid the consultant itself. After a while the company also engaged as a full time secretary a lady who had initially done work for the company at the serviced offices. On 2 December 1977 the business name John T. Rippon and Associates was registered with the company as proprietor.
The amount of the taxpayer's salary was fixed by reference to his previous rate of pay. After discussions with his solicitor, the amount of $18,000 was agreed on as being comparable with the salary he had received from Gollin.
However that level of salary was not maintained beyond the first few years because of a quite fortuitous circumstance. The company and the taxpayer became involved in a venture with a company called Kordiak Bars Pty Ltd which fitted bull bars to motor vehicles. This connection proved to be disastrous and ultimately led to the taxpayer becoming bankrupt in 1982.
The following table shows for relevant tax years the amount received by the company as gross fees, the salaries paid, the amounts paid to consultants and distributions through the discretionary trust.
----------------- Gross Fees Salaries Consultants Distribution $ $ $ $ 1977 39,720 6,032 6,579 11,922 (part) 1978 N/A 18,096 N/A nil 1979 35,402 16,684* 7,560 nil 1980 42,186 3,016 12,612 nil 1981 49,893 5,998 13,655 5,988 1982 70,682 4,190 9,621 24,550 1983 73,492 4,400 (1,340) 5,207 *include secretary's salary 4,622 -----------------
The Tribunal's decision
After referring to the authorities and in particular
Newton & Ors v FC of T (1958) 11 ATD 442; (1958) 98 CLR 2,
FC of T v Gulland 85 ATC 4765; (1985) 160 CLR 55,
Tupicoff v FC of T 84 ATC 4851; (1984) 4 FCR 505 and
Bunting v FC of T 89 ATC 5245; (1989) 24 FCR 283 the Tribunal said:
``In my opinion there is no general reason why a professional, such as the engineer in this case, should not in appropriate circumstances use a trust structure to conduct his consultancy business without risking the s. 260 sword of Damocles. In any event, if such behaviour is to be proscribed it properly falls within the function of Parliament rather than a Tribunal such as this. There is no reason why tax considerations should not enter into that decision. Nor, in appropriate cases, is there any reason why a professional should not move to such a structure after some period of deriving income on his own account. Nor is the fact that the personal exertion and expertise of a particular entrepreneur is the main productive asset and dominant income- generating force in a trust or company conclusive evidence that the structure was formed to avoid the Act. Nor does the lack of any goodwill or property held by the trust, in itself and taken alone, lead to that conclusion (though it would be one factor to be weighed in the balance).
In this particular case, my characterisation decision is not self-evident but turns on a weighing of all the circumstances and turns largely on the objective steps in the transaction. This case is on the borderline. I find, on balance, that this transaction satisfies Lord Denning's critical fourth test [see Newton, supra] and that the transaction is annihilated by s. 260. The following factors moved the balance in favour of this view. First, there was the complexity of the structure. Whilst a company trustee of a unit trust and a separate discretionary sub-trust might be justified for a large and complex professional practice, the use of such complexity seems difficult to explain satisfactorily in this case without predicating that the structure was implemented in the way it was to escape the burden of the normal operation of the progressive tax system on the taxpayer. Second, the taxpayer's use of a registered business name rather than the company and the general inference from all the facts that the taxpayer projected himself personally and acted as if he were running his own business. Third, the limited scope of the taxpayer's consulting business and the `uncomfortable' means and ends relationship between the nature of that consulting, the limited organisation, minimal staff and office space, and the elaborate legal structure adopted to give practical expression to `these' objectives. Fourth, the minimal payments of salary to the taxpayer during the relevant period from 1980 to 1983 bear no relation to his work for the trust in later years. The mere fact that such a small salary might be explained, at least over part of the time, as a means of escaping other creditors does not legitimise the structure as being for commercial or family purposes, so far as this particular `creditor' (the Commissioner) is concerned. In my view such disproportionality is not repaired by vague assertions that the business structure was being established for all future eventualities.''
The Tribunal discussed the antecedent transaction doctrine which had been relied on by counsel for the taxpayer. The Tribunal concluded:
``The lack of an antecedent transaction does not and, in my respectful opinion, cannot, on a balanced consideration of the language of s. 260 in the context of its policy objectives, support the inference that s. 260 cannot operate. If that inference were correct, the most blatant and artificial tax avoidance scheme would escape s. 260, provided only that it was constructed to give legal form to a new set of circumstances.''
In the context of the discussion it seemed clear enough that the Tribunal intended to refer to antecedent situations as well as transactions.
Factors relied on by the Tribunal
In my opinion, the four factors adverted to by the Tribunal do not lead to a conclusion that s. 260 applies.
First, the complexity of the structure is only of relevance insofar as that complexity in itself predicates that the structure was established for the purpose of tax avoidance. What is important for the purpose of s. 260 is not so much complexity as artificiality. If the structure
ATC 4190adopted is explicable by reference to ordinary business and family arrangements, then complexity as such does not attract the operation of s. 260.
Counsel for the Commissioner could not suggest any tax-related reason which explained the use of two trusts rather than one. One obvious non-tax reason which springs to mind is that the unit trust would be convenient in the future were the taxpayer to take a partner into the business. Units could be allotted to the new partner who could then make such personal trust arrangements as suited his or her own circumstances. As the taxpayer said in evidence, the business was very new, and he was concerned to provide ``the maximum flexibility for whatever might occur in the future years''.
Secondly, the use of the business name and the prominence of the taxpayer's identity in the conduct of the business are consistent with the fact that the personal skill and reputation of the taxpayer were likely to be of critical importance to a professional practice such as this. If the company had the right to use the services of the taxpayer and his personal qualities as an engineer might be likely to attract business, there was a very practical reason, quite unconnected with tax, to put his name at the forefront of the company's activities.
Thirdly, if by ``scope'' the Tribunal meant the size in terms of turnover of the company's business when the structure was established, then no doubt the scope was small and the physical assets modest. But many of the largest organisations in engineering, as well as law, accountancy and other professions and businesses in this country, had humble beginnings. The adoption at the outset of a structure which would be appropriate for hoped for growth is no indicia of tax avoidance.
Fourthly, the salary which the taxpayer received in the earlier years under review was fixed by reference to his previous experience as an employee. Such salary therefore reflected a proper commercial value of the personal service he was to render to the company - which of course was to earn income by the use of other resources, such as the capital injected by the taxpayer and services provided by consultants. The fact that much less salary was earned in 1980 to 1983 is explicable by the Kordiak problems. The point at issue is the proper characterisation of the arrangements in 1976. Future events are only relevant insofar as they cast light upon the purpose and effect of those arrangements. Absent the Kordiak problems, the reasonable inference is that the taxpayer's salary would have continued without substantial reduction. I do not see that the salary reduction which in fact took place assists the Commissioner's case.
Ordinary business or family dealing
A frequently adopted ``practical test for deciding whether an arrangement is one to which the section applies'' (Gulland 85 ATC at 4771; 160 CLR at 66 per Gibbs CJ) is to be found in the advice of the Privy Council in Newton 11 ATD at 445; 98 CLR at 8.
``In order to bring the arrangement within the section you must be able to predicate - by looking at the overt acts by which it was implemented - that it was implemented in that particular way so as to avoid tax. If you cannot so predicate, but have to acknowledge that the transactions are capable of explanation by reference to ordinary business or family dealing, without necessarily being labelled as a means to avoid tax, then the arrangement does not come within the section.''
The question to be asked is whether the arrangement bears on its face the stamp of tax- avoidance:
Peate v FC of T (1964) 13 ATD 346 at 348-349; (1962-1964) 111 CLR 443 at 469 per Kitto J.
For a young professional man with a dependent family leaving the security of salaried employment for the hazards, risks and potential rewards of the marketplace, the adoption of a corporate structure has many advantages. Limited liability is one. Also if the practice prospers there will be a vehicle in which the goodwill can accrue and new partners acquire interests. The business will have a continuing entity separate from its changing proprietors. By adopting a corporate structure for his new venture the applicant was only doing what countless business people and, more recently professionals, have done since
Salomon v Salomon & Co. Ltd (1897) AC 22.
Turning to the discretionary trust aspect, I note that the Tribunal said:
``It is clear that taxpayers with income from property or a business can transfer income- producing property to other persons or entities. It is typical to use companies or
ATC 4191trusts as a vehicle for the business. Why should a general prohibition operate on taxpayers who wish to organise the provision of professional services in a similar manner? The answer is that no such prohibition should, or in my opinion currently does exist.''
Counsel for the Commissioner did not dispute this general proposition. In my view, it is plainly correct.
A person with a family who establishes a business will often want to use a legal structure to achieve the result that some or all of the financial benefits which, hopefully, the business will generate will go to family members. Both legal obligation and natural love and affection encourage such an objective. The adoption of a structure that will achieve it is, to my mind, an ordinary family dealing. It is comparable to one of the examples of ordinary business or family dealings given by the Privy Council in Newton immediately following the passage quoted in this judgment, viz a declaration of trust made by a father in favour of his wife and daughter: see 11 ATD at 445; 98 CLR at 9. Whether the structure actually chosen is a company with different classes of shares or a discretionary trust or a combination of both, such an arrangement does not necessarily bear the stamp of tax avoidance, notwithstanding that the person establishing the structure may be better off in terms of his personal tax liability compared with his position were he to embark on the new venture as a sole trader on his own account.
Antecedent transaction or situation
These concepts have been firmly entrenched in the jurisprudence of s. 260: see e.g. Gulland 85 ATC 4765 at 4774-4775; 160 CLR at 73 per Gibbs CJ, Bunting 89 ATC 5245 at 5251; 24 FCR at 288 per Beaumont J. They grow from pars (a) and (c) of s. 260.
Approaching the present case I bear in mind the following passage from the judgment of Dawson J in Gulland, which was also a case concerning professional income from personal exertion. His Honour said (85 ATC at 4796; 160 CLR at 110):
``The whole of the circumstances must be considered in each case and often there will be special features which will point to the proper conclusion. For example, it will be significant in cases such as Peate's case and the present case that the arrangement in question does not facilitate the practice of the profession which it governs. It will be all the more significant if the method adopted fails to meet the requirements of the law or of professional standards. Although he found no need to elaborate upon the matter, Taylor J., in finding that sec. 260 applied in
Millard v. F.C. of T. (1962) 108 C.L.R. 336, no doubt attached importance to the fact that the company said to carry on the appellant's business as a bookmaker could not obtain registration as a bookmaker. And in Hollyock v. F.C. of T., where the taxpayer was a pharmaceutical chemist who sold his wife a half share in his business and declared himself to be a trustee of the business for himself and his wife, Gibbs J. considered it important in reaching his conclusion that sec. 260 applied that the business could only lawfully be carried on by a pharmaceutical chemist: cf.
Bayly v. F.C. of T. 77 ATC 4045; (1977) 15 S.A.S.R. 446;
Jones v. F.C. of T. 77 ATC 4058; (1977) 15 S.A.S.R. 462 and
Peacock v. F.C. of T. 76 ATC 4375; (1976) 28 F.L.R. 355. The inability of the central company in Peate's case to sue for medical fees was a relevant, although not conclusive, consideration. See 111 C.L.R. at p. 460 per Menzies J.
It should also be pointed out that the authorities draw a distinction between an arrangement which modifies an antecedent transaction or situation and one which merely orders a taxpayer's affairs in relation to income from a new source or in relation to a deduction from which the previous transaction or situation did not preclude him. In the former case, but not the latter, sec. 260 may have an application for there may be an alteration of the incidence of income tax, etc. See Mullens' case at ATC p. 4294; C.L.R. p. 302 per Barwick C.J. and Cridland's case at ATC pp. 4541-4542; C.L.R. pp. 338-339 per Mason J. But the distinction can be of no assistance in this case where, if there was no antecedent transaction, there was an antecedent situation consisting of the taxpayer's practice of his profession in a particular manner. The arrangement changed that situation and did so in order to alter the incidence of income tax. The change, however, gave rise to no new source of
ATC 4192income nor did it give rise to any deduction from which the very nature of the previous situation did not preclude the taxpayer. Cf. Europa Oil (N.Z.) Ltd. (No. 2) v. Commr of I.R. (N.Z.) at p. 5566.''
Later, in dealing with the case of another appellant, his Honour said (85 ATC at 4805; 160 CLR at 126):
``The argument, however, ignores the reality of the situation in that both before and after the dissolution of the partnership and the application of sec. 260, Dr Pincus was without interruption carrying on the practice of his profession in a manner which was essentially the same, however much the income which he derived thereby might flow through different channels. The source of income was the same and the effect of sec. 260 was to preclude Dr Pincus from the choices which he might have had were he to have been setting up practice afresh or for the first time.''
To say that the taxpayer received periodical remuneration for working as a professional engineer both before and after the impugned arrangement is true enough. But to extract that fact in isolation and expose it to s. 260 is to ignore the clear mandate of authority. There was here a matrix of circumstances which to the hypothetical observer (cf Newton, 11 ATD at 445-446; 98 CLR at 8-9) give the arrangements sense and meaning unconnected with tax avoidance. Some of these business and family circumstances I have already mentioned. One other should be noted, viz the fact that there was, as far as I was informed, no legal impediment to a non-qualified person carrying on the business of a professional engineer: cf Gulland 85 ATC at 4796; 160 CLR 111 per Dawson J.
I think this case differs from Bunting because there was a new enterprise involving, amongst other things, the injection of capital and the contemplation that the efforts of persons other than the taxpayer would be harnessed for the purposes of the business. Still more is it different from cases like Peate, Gulland and Tupicoff where an artificial structure was introduced into existing professional practices and employment arrangements.
The appeal is allowed with costs, including reserved costs. The decision of the Tribunal dated 13 June 1991 is set aside. It is ordered that the taxpayer's objection to the assessment of income tax for the years ended 30 June 1980 to 1983 (both inclusive) be allowed.