PEABODY v FC of TJudges:
In respect of the year of income ended 30 June 1986, the appellant, Mary Genevieve Peabody, was assessed, as a result of an amended assessment, to income tax on an additional amount of $888,005. The respondent, the Commissioner of Taxation, has supported the amended assessment by claiming that the taxpayer obtained, or would, but for the operation of s. 177F of the Income Tax Assessment Act 1936 (``the Act''), have obtained a tax benefit in connection with a scheme to which Part IVA of that Act applied.
The taxpayer objected, arguing that there was no such scheme or, alternatively, that if there was, the scheme was explainable on grounds of finance and commerce. A further ground of
ATC 4587objection claimed that, in any event, no tax benefit had been obtained by the taxpayer. Finally, the taxpayer challenged the Commissioner's calculations of the amount of the alleged tax benefit and the quantum of penalty tax imposed by operation of s. 226 of the Act.
The Commissioner, by notice dated 20 June 1990, advised the taxpayer that her Notice of Objection had been considered but had been disallowed. The taxpayer responded by lodging with the Commissioner, within the time prescribed by the former s. 187 of the Act, a request that his decision be referred to this Court. That has been done and thereby constituted the instituting by the taxpayer of an appeal to this Court against the Commissioner's decision. The nature of an appeal to this Court that involves the likely operation of s. 177F of the Act has been explained by Hill J. (with whom Burchett and von Doussa JJ. agreed) in
FC of T v Jackson 90 ATC 4990; his Honour said at p. 5000:
``Thereafter the taxpayer is given a choice, if dissatisfied with the Commissioner's objection decision, either to request the Commissioner to refer the decision for review by the Administrative Appeals Tribunal or to request him to refer it to this Court: sec. 187. That choice may, in a particular case, be of the utmost significance, for while the Administrative Appeals Tribunal is empowered to make a full administrative review of the decision, and in so doing may exercise afresh the powers and the discretions of the Commissioner, this Court has no such power. Thus, in a case where the exercise of discretion by the Commissioner may have been involved, this Court cannot stand in the shoes of the Commissioner and do again that which he has done, but is limited to the ordinary grounds of judicial review, namely to ensuring that the Commissioner has addressed himself to the right issue, that his decision is not affected by an error of law, that he has not taken some extraneous factor into consideration nor failed to take some relevant factor into consideration:
Avon Downs Pty. Ltd. v. F.C. of T. (1949) 78 C.L.R. 353 at p. 360. Thus, by way of example, it could not be doubted that, if a case involving the exercise of the discretion to make a determination under sec. 177F were to come before this Court, the Court's power to review the discretion would be limited as set out above. In particular, the Court could not itself exercise the discretion.''
Guided by those remarks, I turn to the relevant facts which, in the summary that follows, constitutes my findings.
In 1963, Terrence Elmore Peabody, (``Mr. Peabody'') the husband of the taxpayer, established with his father and another partner a fly ash business. In his affidavit sworn on 27 February 1991, Mr. Peabody described fly ash in these terms:
``Fly ash is a light powdery material known as a pozzolan which is obtained as a by product of coal burnt in power stations, where it is collected by electrostatic precipitation of flue gases. When blended with cement, fly ash adds strength and durability to concrete and reduces its cost. At the time we commenced to carry on business, fly ash was mainly used in mass concrete, e.g. road material and grouting, and we subsequently developed a derivative process for use in structural concrete, which is now its principal use.''
The business flourished and by 1985 the shareholdings in the corporate structure that operated it were owned, as to 62% or thereabouts by the Peabody interests with the balance of 38% being held by a business friend and associate, Mr. Ray Kleinschmidt; de facto control of the Peabody interests was, at all times material to these proceedings, exercised by Mr. Peabody. Although there were numerous companies involved in the operation of the business, it will be sufficient to name four of them: Pozzolanic Enterprises Pty. Ltd., Pozzolanic (Queensland) Pty. Ltd., Pozzolanic Bulk Carriers (Queensland) Pty. Ltd. and Coastal Bulk Haulage Pty. Ltd.; all other companies were subsidiaries of one or other of those four companies.
In 1985, all the shares in the four Pozzolanic companies that were owned by the Peabody interests were either registered in the name of T.E.P. Holdings Pty. Ltd. in its capacity as the trustee of a trust known as the ``Peabody Family Trust'' or in Mr. Peabody's name; however, his holdings were minimal and, for practical purposes, may be ignored. Mr. Peabody and his wife were the only directors and shareholders of T.E.P. Holdings Pty. Ltd.;
ATC 4588that company did not carry on any business in its own right nor did it act as a trustee of any other trust.
Mr. Peabody deposed in his affidavit, and reaffirmed in evidence, that for some time prior to 1985 he had been considering the possibility of making a public float of the Pozzolanic Group. During the course of the trial, an amount of time was devoted to the discussions that took place between Mr. Peabody and Mr. Kleinschmidt concerning this subject; in particular, there was a debate concerning Mr. Kleinschmidt's willingness to participate in the float. It was Mr. Peabody's evidence that his plan was to achieve a public float with his interests retaining 50% control; he did not think that he could achieve this objective if Mr. Kleinschmidt remained such a large shareholder. I do not consider that it is necessary to examine that evidence in any detail; it is sufficient to state that the two men met on 14 October 1985 and ultimately struck a bargain whereby Mr. Kleinschmidt agreed to sell the whole of his interest in the group to the Peabody interests.
In paragraph 25 of his affidavit, Mr. Peabody said:
``There were three main things agreed at the meeting: that we didn't want any further disagreement; that he would sell the shares at fair market value based on a valuation of the company; and that the sale price would not be publicly disclosed. We shook hands upon the agreement.''
Mr. Kleinschmidt's version of the meeting on 14 October 1985 was set out in paragraph 10 of his affidavit of 22 February 1991. He said:
``We agreed upon the method for determining the price. We did not actually work out the final figure at this meeting - that was worked out later. I knew that my percentage was roughly 40% - it might have been a little more or a little less. We came up with a figure based on $24 million and we agreed to deduct a percentage for the expenses. The costs which were to be taken off were a percentage of what the float was going to cost and a percentage of the interest between when I got paid and when the company was supposed to float. I asked Terry Peabody not to publicly disclose how much money I was to get for my shares, as I didn't want anyone to know. I still don't. We shook hands on the deal before we left. I dropped him back at his office after the meeting. I knew that once we have made the deal he would honour it and he knew that I would front up.''
The two men were not concerned to hammer out details at their meeting; each trusted the other and, having overcome minor set-backs with respect to Mr. Kleinschmidt's participation in the public float and the role of his son as a director of the Pozzolanic group, a harmonious status quo had been restored.
On 17 October 1985 an important meeting took place between Mr. Peabody and the stockbrokers who were then advising on the proposed public float. According to Mr. Peabody he was advised by his brokers that:
``... a difference between the purchase price for Ray Kleinschmidt's shares and the issue price to the public would cause a problem in the marketing of the issue, as the public would view a lesser purchase price paid for his shares as indicating a possible lesser true value for their shares, but would also question the fact if a higher price was paid for his shares.''
Mr. Peabody then proceeded to state his perception of the vagaries of the stock market in these terms:
``At this point I was seeking to pay Ray Kleinschmidt a fair market value for his shares which did not have to be publicly disclosed, as requested by him. Also non- disclosure gave me the option to go public at an issue price that was not tied to the Ray Kleinschmidt purchase price. I considered that this was a commercial necessity given the fluctuating stock market. There was no certainty that the float would proceed, nor was it possible to predict, if it did proceed, the final issue price until the underwriting agreement was completed. This would not happen until a short time before the initial float.''
Unfortunately, neither of the brokers who were present at that meeting, a Mr. Milne-Pott and a Mr. Cox, gave evidence in support of what Mr. Peabody had said. However, Mr. Wruck, a chartered accountant, who was one of Mr. Peabody's financial advisers, was present at that meeting. His recollection of the events, as set out in paragraph 14 of his affidavit of 22 February 1991, was as follows:
``One major difficulty discussed at the meeting revolved around the fact that if an agreement was reached with Kleinschmidt that he should sell his shares to Terry Peabody (or nominee) and if there was a subsequent public float of the company in which the Kleinschmidt shares were involved then full disclosure would need to be made of the Kleinschmidt share purchase. Cox and Milne-Pott were of the view that it would not be advisable to have to make disclosure in the prospectus as it would very likely involve disclosing a purchase of shares at a price different from that which would be offered to the public in the prospectus.''
Mr. Dutney, the solicitor for the Peabody interests, who also attended the October 17 meeting, made no mention of the subject of disclosure in his notes or in his affidavit. Mr. Dutney is a proficient shorthand writer and it was his practice to make contemporaneous shorthand notes of the more important aspects of a conference. However, the fact that he did not make a note on the subject of disclosure is not conclusive one way or the other; in particular, it does not mean that the subject of disclosure was not raised at the meeting of 17 October 1985. Indeed, Mr. Dutney has a note that the subject was discussed by him on the following day with Mr. Wruck and Mr. Wruck's partner, Mr. Thurecht. Furthermore, a decision was made to obtain the advice of Queen's Counsel on whether there was a need to make any, and if so what, disclosure in a prospectus of the purchase of Mr. Kleinschmidt's shares.
The conclusion that I have drawn is that in October 1985 Mr. Peabody and his advisers then had - at the least - a hope or an expectation that the public float would be capitalised at a figure well in excess of the base figure of $24M that Mr. Peabody and Mr. Kleinschmidt had used as a starting point to reach their bargain. I further find that Mr. Peabody and his advisers foresaw the possibility of commercial difficulties if it was thought necessary to disclose in the prospectus that within a short time prior to the float there had been a sale of a substantial parcel of shares in the group at a substantially different figure. It may well have been that Mr. Kleinschmidt, during his negotiations with Mr. Peabody, expressed the wish that the price obtained by him for his shares be kept confidential; I have no cause to doubt his evidence on this subject. However, in my opinion, it was not the wish of Mr. Kleinschmidt that was the determining factor: that was merely a coincidence. The dominant reason for investigating the question of non-disclosure was to avoid, hopefully, the need to explain in the prospectus that the price offered to the public was in excess of Mr. Kleinschmidt's price.
The written opinion of Queen's Counsel was obtained on or about 25 October 1985. With some qualifications, it advised that disclosure would not be necessary. The accuracy of that advice is not in issue in these proceedings; what is of significance is the manner in which Mr. Peabody and his advisers reacted to that advice. In his affidavit Mr. Peabody described it as ``a typical barrister's opinion, going each way''. He claimed that it ``certainly left doubt as to whether we would have to (make disclosure)''. He claimed that the brokers told him that ``we had better find a better way''. Mr. Dutney did not state his views about the advice of counsel but Mr. Wruck's reaction is set out in paragraph 17 of his affidavit. He said:
``At about 10.30 a.m. on 25 October 1985, Peter Thurecht and I met with Terry Peabody at his office at Expo House to consider the various problems which arose in conjunction with the proposed float. The advice of Andrew Neil Dutney (who was not present at this meeting), Peter Thurecht and myself conveyed to Terry Peabody was that it would be imprudent to accept the opinion of Counsel with such heavy provisos. We rang Ross Milne-Pott from Terry Peabody's office to discuss this problem and arising out of that conversation emerged the idea of converting the shares purchased to redeemable preference shares. I am not sure who initiated the suggestion as it arose from a `think tank' type of discussion as a solution to the disclosure problem.''
Although it is not possible to identify the originator of the idea concerning the conversion of the shares, it does not really matter. The idea can be simply expressed without descending to the plethora of detail that was necessary to carry it out. The emphasis was upon the concept of converting the shares to a class so that they were virtually worthless; however, as will become apparent, it was not necessary that they
ATC 4590be converted to redeemable preference shares. The conversion of the shares was implemented by the Peabody interests using a ``shelf company'' Loftway Pty. Ltd. to buy all the Kleinschmidt shares in the four Pozzolanic companies; the shares in Loftway were wholly owned by T.E.P. Holdings Pty. Ltd., as the trustee of the ``Peabody Family Trust''. The purchase price was agreed by Mr. Peabody and Mr. Kleinschmidt on or shortly prior to 6 November 1985 at $8,656,177.00 and this sum was paid at settlement on 13 December 1985 with the assistance of finance provided by the group's banker. Thereafter, each of the four companies in the Pozzolanic group, with the consent of Loftway - it being then the sole shareholder in each company - passed appropriate special resolutions that had the effect of devaluing the Kleinschmidt shares to their par value or even less. Save for variations to accommodate the actual number and original class or classes of shares, the special resolution that was passed at a meeting of members of Pozzolanic Enterprises Pty. Ltd. on 20 December 1985 typifies the special resolutions that each of the other three companies passed.
``(1) That the articles of association of the company be amended by inserting at the end of regulation 6 the following provisions:
`Z' CLASS PREFERENCE SHARES
The company may issue as Z class preference shares of $1.00 each or may with the consent of the holder or holders thereof convert already issued shares of the company to Z class preference shares of $1.00 each which shall have and be subject to the following rights privileges and conditions:
- (i) the right to a fixed non-cumulative preferential dividend at the rate of 1% per annum on the capital for the time being paid up thereon or deemed to be paid up thereon in priority to all the other shares in the capital of the company;
- (ii) the right to such further preferential dividend on the capital for the time being paid up thereon or deemed to be paid up thereon in priority to all the other shares in the capital of the company as may from time to time be declared by the company on the recommendation of the directors;
- (iii) the right on a winding-up to be paid the full amount of the capital for the time being paid up thereon or deemed to be paid up thereon before payment of any amount to the holders of the remaining issued shares but no right to participate in a winding-up for any amount in excess of the paid up capital;
- (iv) the Z class preference shares shall not confer any voting rights whatever on the holders thereof.
(2) That the issued shares of the company held by Loftway Pty. Ltd. (being 380 ordinary shares and 25 A shares of $1.00 each) are hereby (with the consent of Loftway Pty. Ltd.) converted to Z class preference shares of $1.00 each.''
The Kleinschmidt shares, which previously had a value in excess of $8. 6M, became Z class preference shares with a total value of less than $500.00 and the holding of the ``Peabody Family Trust'', previously worth 62% of the net worth of the group, was then worth, 100%; save for $500 or thereabouts, the value of the Kleinschmidt shares had been switched over or added to the value of the Trust's shares but without any change to the Trust's numerical shareholdings.
However, it is timely to return to 28 October 1985 and to set out Mr. Dutney's notes of the telephone conversation that he had that day with Messrs Wruck and Thurecht about the public float:
``If we have a new entity formed by the Peabody interests that acquired K's shares
We have the purchase of this group for $8.5 million
Because it is an unrelated sale and purchase we should not have to put in valuations of shares
Having acquired those shares the shares are converted into say 10% preference shares by resolutions of the various companies and changes in articles
The fact is that the remaining equity shares that are already owned by Peabody effectively become 100 equity ownership shares
Then Terry can sell off his shares being the shares he has owned all the time to the new
ATC 4591public company for whatever the capitalised sum is
It has the effect of not having to contend with 26AAA
It means that the entity which Peabody uses to acquire the shares will buy for $8.5 million and have them taken up by the public company for $10 or whatever and that entity would be funded by a loan from Terry and we can have that wound up
The loss not being effectively able to be used.
It bumps up the values of Terry's own ordinary shares by the sum paid out to Kleinschmidt.''
In my view, it is most significant that nowhere in that note is there a reference to the subject of disclosure. On the other hand, it is highly significant to note the reference to ``26AAA'', a subject that appears in Mr. Dutney's notes of further telephone conversations with Mr. Wruck on 5 and 7 November 1985. That, of course, is a reference to s. 26AAA of the Act which provided for the inclusion, as assessable income of a taxpayer, of any profit arising from the sale of property purchased within the preceding twelve months. Mr. Peabody's advisers were alert to the fact that his group would be purchasing Mr. Kleinschmidt's shares and would be potentially on-selling them to the public company at a capital gain. In fact, calculations suggest that if that on-sale had taken place, the capital gain of the purchaser of the Kleinschmidt shares would have been, without making any allowance for buying and selling expenses, $2,694,444.
Mr. Wruck's recollection of his conversation with Mr. Dutney on 28 October 1985 is recorded at paragraph 18 of his affidavit. It does not match Mr. Dutney's notes in all respects and, in particular it makes no reference to s. 26AAA of the Act. But, like Mr. Dutney's notes, it is also silent on the issue of disclosure.
However the subject of disclosure surfaced once more on 4 November 1985. In paragraph 28 of his affidavit, Mr. Dutney summarised the substance of a telephone conversation that he had that day with Mr. Wruck. According to Mr. Dutney, Mr. Wruck-
``... suggested that disclosure in the prospectus would not be necessary if the shares acquired from Kleinschmidt were converted to redeemable preference shares and not sold to the public company until some later time for $5.00 or some other nominal sum.''
Mr. Wruck did not refer to that conversation in his evidence.
The next matter of significance occurred at a meeting on 13 November 1985 between Mr. Wruck and the representatives of a business house that was interested in acting as financier for the purchase of the Kleinschmidt shares. According to Mr. Wruck, the original intention was to have T.E.P. Holdings Pty. Ltd. purchase the Kleinschmidt shares on behalf of the Trust. If that had occurred, it would have meant that the ``Peabody Family Trust'' then owned the whole of the issued capital of the Pozzolanic group save for the few shares registered in Mr. Peabody's name. However, Mr. Wruck said that the financier's representatives had recommended that the purchaser of the Kleinschmidt shares should be:-
``... a separate corporate entity distinct from the Peabody Family Trust so that the finance could be provided by way of redeemable preference shares...''
This scheme, which evolved as a result of a different meeting with different people (and is not to be confused with the scheme to convert the shares to Z class shares) was used to finance the purchase of the Kleinschmidt shares but, as events transpired, it was the group's banker who made the advance. Instead of lending the required sum to Loftway Pty. Ltd. at a conventional interest rate (which was then in the vicinity of 20%), the bank subscribed the same amount for redeemable preference shares in Loftway and received dividends on those shares of amounts equal to the after-tax amounts that would have been retained by the bank in a conventional lending exercise. The banker, being a public company, was then able to receive the dividends and hold them wholly rebatable from income tax under the provisions of s. 46 of the Act. Following the successful public float, the ``Peabody Family Trust'' was heavily cashed-up; it was able to advance sufficient money to Loftway so that it could redeem the bank's shares. Subsequently, repayment of that advance was waived by the Trust.
Mr. Dutney lodged a draft prospectus for the proposed public issue by the new public company, Pozzolanic Industries Ltd, on 23
ATC 4592December 1985; it made no mention of the price paid for the Kleinschmidt shares. On the same day he also lodged a copy of the draft agreement under which T.E.P. Holdings Pty. Ltd. and Mr. Peabody agreed to sell to Pozzolanic Industries Ltd for $30M the shares in the four Pozzolanic companies that were specified in the agreement. Those shares were the whole of the issued shares other than the Kleinschmidt shares which had, by then, been classified as Z class preference shares.
The prospectus had this to say about the Z class shares:
``Thus Pozzolanic Industries Limited holds directly or indirectly all the shares in the four companies shown on the second line of the diagram on page 7 namely Coastal Bulk Haulage Pty. Limited, Pozzolanic (Queensland) Pty. Limited, Pozzolanic Enterprises Pty. Ltd. and Pozzolanic Bulk Carriers (Queensland) Pty. Ltd. except for a number of Z class preference shares held by third parties in these four companies. These Z class preference shares are entitled to a 1% noncumulative preferential dividend and return of capital only on winding up and have no voting rights.''
The float was successful and the position, after the float, was as forecast in the prospectus:
``Over recent years, Terry Peabody (Chairman and Managing Director) has moved to a position where he now controls, directly or indirectly 100% of the issued shares in the Pozzolanic group of companies. The company will use the money raised by the issue in payment of money owing in respect of property acquired by the company pursuant to the agreement referred to in paragraph 10, page 34. This involves the payment of $15 million to Mr Peabody.
On the successful completion of the issue Mr Peabody will own directly or indirectly a 50% interest in the Pozzolanic group and the public will own the other 50%.''
Much later, in 1987, Loftway transferred some - and perhaps all - of the Z class shares in the four Pozzolanic companies to T.E.P. Holdings Ltd. Mr. Vitulano, a senior officer in the Audit section of the Tax office, exhibited to his affidavit of 5 June 1992 copies of transfers from T.E.P. Holdings Pty. Ltd. in favour of the publicly listed company, Pozzolanic Industries Ltd. of the Z class 1% non-cumulative, non- voting preference shares in two of the four companies. Those two transfers were dated 4 November 1987 and stated that the consideration was ``Nil''. It is not clear whether the Z class shares in the other two companies were likewise transferred but in my view, nothing turns on this issue.
I consider the issue of not disclosing the purchase price of the Kleinschmidt shares in the prospectus as a ``red herring''. I have come to that conclusion for the following reasons: if it be accepted that there was genuine concern to keep secret the amount paid to Mr. Kleinschmidt for his shares, neither the evidence nor counsel's submissions have explained how the conversion of the shares to Z class shares allowed or permitted or authorised or justified the non-disclosure. Expressed another way, if there was any obligation to make such a disclosure in the prospectus, the devaluation of the shares subsequent to their purchase by Loftway would not have removed the requirement to disclose. I am not rejecting the evidence that Mr. Kleinschmidt wished to keep secret the price that was paid for his shares - I am merely expressing my finding that his wish played no part whatsoever in the decision to engage in the exercise of devaluing his shares. However, there is a further obstacle in the path of the taxpayer. There was no need to use a limited liability company to implement the conversion scheme; the act of converting the Kleinschmidt shares was the separate act of each of the four Pozzolanic companies. The act of conversion required the consent of the owner of the shares, but the owner could have been the Trust; it did not have to be a company such as Loftway. Even without recourse to Mr. Dutney's notes, it is abundantly clear that the conversion exercise and the devaluation of the Kleinschmidt shares was implemented to avoid the provisions of s. 26AAA of the Act; Mr. Dutney's notes merely corroborate that which was already obvious.
The next issue that must be addressed is the use of Loftway and the method by which the purchase of the Kleinschmidt shares was financed. Is that of material significance in this case? Arguably, the bank might have benefited by receiving ``tax-free'' dividends instead of assessable income in the form of interest payments; however that is not a live issue in these proceedings. It may be inferred that the
ATC 4593Peabody interests benefited by this form of financing; the dividends payable on the redeemable preference shares were less than the interest that would have been otherwise payable on conventional borrowings; but this particular benefit was achieved by them without cost or loss to the revenue and counsel for the Commission made it clear that this aspect of the transaction was not the subject of attack or adverse comment.
It is true that the method of financing the purchase of the Kleinschmidt shares (involving the issue of redeemable preference shares) was only available to a company such as Loftway; neither a natural person nor a trust could initiate such a scheme. But such importance as might attach to that observation must be weighed against the fact that the decision to convert the Kleinschmidt shares to Z class shares preceded, and was independent of, the decision to finance the purchase by issuing redeemable preference shares to the banker; the former decision was made, at the latest, by 28 October (see Mr. Dutney's notes of his telephone conversation with Messrs Wruck and Thurecht on that day) whilst the latter decision was made at the earliest on 13 November when Mr. Wruck discussed proposals for financing the share purchase with a potential lender. For the purpose of considering the taxpayer's challenge to the amended assessment, I have come to the conclusion that the method of financing the purchase of the shares, despite its commercial importance, can be put to one side.
The transaction that warrants closest examination is that whereby the Kleinschmidt shares were converted to Z class shares. That transaction and the consequences that flowed from that transaction are the matters of importance in this case. When the issue is so reduced, it becomes apparent, and I so find, that the decision to convert the shares to Z class was made so that the provisions of s. 26AAA of the Act could be avoided. The Peabody interests had negotiated the purchase of a large parcel of shares in the group based on the group having a net worth of about $24M. Within a period of 12 months of that purchase there was to be a public float based on the group having a net worth of $30M. Somebody, (the particular taxpayer or taxpayers within the Peabody family who would purchase the Kleinschmidt shares) stood to make a capital gain that was equivalent to about 38% of $6M. However that taxpayer or those taxpayers would be liable to tax on that capital gain unless some lawful avoidance measure could be implemented.
It now becomes necessary to consider the provisions of Part IVA of the Act for the purpose of determining whether the taxpayer, Mrs. Peabody, obtained a tax benefit and, if so, whether the Commissioner's determination to cancel it under the provisions of s. 177F can be challenged.
Counsel for the taxpayer submitted that I should have regard to the Treasurer's second reading speech and the explanatory memorandum relating to the Bill that introduced Part IVA into the Act. He submitted that reference to this extrinsic material was necessary because it was, in the terms of s. 15AB of the Acts Interpretation Act 1901 (Cth) ``capable of assisting in the ascertainment of the meaning of the provision (of the Act...'' Such a submission inappropriately assumes that there is, or might be, some difficulty in ascertaining the meaning of the relevant provision; that is not the correct approach because s. 15AB is not to be called in aid unless and until there is a perceived need for assistance. As Hartigan J. said in Case W58,
89 ATC 524 at 533-534 when considering a similar submission in respect of the provisions of Part IVA of the Act:
``I am of the view that the primary source is the statute itself. The words of the statute are plain. I cannot use the Minister's words to displace the plain language of Parliament.''
His Honour was also comforted by his conclusion that in any event his perusal of the extrinsic material confirmed:
``... that the meaning of the provisions in question is the ordinary meaning conveyed by the text of the provision taking into account its context in the Act and the purpose or object underlying the Act.''
Although it was not necessary for Hartigan J. to take this extra step in light of his earlier finding that the ``words of the statute are plain'', I respectfully agree with his Honour's conclusion; I decline therefore to examine the extrinsic material.
Part IVA, comprising ss. 177A-177G was inserted in the Act by No. 110 of 1981. Section 177D, which is set out in full hereunder, provides that the Part applies to any scheme that
ATC 4594is entered into after a certain date where the relevant taxpayer obtains a tax benefit and, after having regard to the eight subject matters that are identified in paragraph 177D(b), it would be concluded that the person who entered into or carried out the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit.
If the qualifying circumstances of s. 177D are found to exist, then it is open to the Commissioner to invoke the powers contained in s. 177F. For example, in the case of a tax benefit that is referable to an amount not being included in the assessable income of a taxpayer, the Commissioner may:
``... determine that the whole or a part of that amount shall be included in the assessable income of the taxpayer of that year of income;''
The application of Part IVA of the Act to the affairs of a particular taxpayer will be based upon the existence of seven main features; it is now necessary to identify them and to assess the extent to which, if at all, they may properly be said to apply to the affairs of Mrs. Peabody.
1. Is there a scheme?
Section 177A defines ``scheme'' extensively. It means-
``(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and
(b) any scheme, plan, proposal, action, course of action or course of conduct;''
it also extends to a unilateral scheme, plan, proposal, action, course of action or course of conduct: (paragraph 177A(3)).
I find that the facts of this case constitute a scheme for the purposes of Part IVA of the Act. It was a unilateral scheme in the sense that it was a course of action that was implemented by Mr. Peabody: he and his advisers, Mr. Dutney, Mr. Wruck and others are properly to be counted as one; it was not a bilateral scheme because there was no other party at arms length who was involved in the scheme; the course of action that constituted the scheme was the decision to convert the Kleinschmidt shares to worthless Z class shares and certain consequential transactions that were implemented to give effect to that decision.
Whether the scheme should be classified as stopping with the conversion of the shares to Z class shares or whether it should be extended to include Loftway's issue of redeemable shares to fund their purchase is an interesting question, but it is one which it is not necessary to decide. Let it be assumed that the scheme did extend to the legitimate purpose of obtaining cheap finance through the issue of redeemable preference shares; that will not save the relevant taxpayer if some other proscribed purpose existed that can properly be classified as the dominant purpose of the plan: (sub-s. 177A(5)).
2. The relevant date
Part IVA of the Act only applies to schemes that have been entered into after 27 May 1981 (s. 177D). That condition has been met in this case.
3. The identity of the relevant taxpayer
Section 177D of the Act uses the expression ``relevant taxpayer'' to describe the person who has obtained the tax benefit. The provisions of that section are as follows:
``This Part applies to any scheme that has been or is entered into after 27 May 1981, and to any scheme that has been or is carried out or commenced to be carried out after that date (other than a scheme that was entered into on or before that date), whether the scheme has been or is entered into or carried out in Australia or outside Australia or partly in Australia and partly outside Australia, where-
- (a) a taxpayer (in this section referred to as the `relevant taxpayer') has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and
- (b) having regard to-
- (i) the manner in which the scheme was entered into or carried out;
- (ii) the forn and substance of the scheme;
- (iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;
- (iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;
- (v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;
- (vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;
- (vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and
- (viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi),
it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers).''
The section makes it quite clear that the ``relevant taxpayer'' need not be ``the person, or one of the persons, who entered into or carried out the scheme...''. They might be one and the same but they need not be. It is first necessary to identify the ``relevant taxpayer''; thereafter it will be necessary to identify a ``tax benefit'' and to connect it to the ``relevant taxpayer''. In seeking to apply the provisions of Part IVA to the circumstances of this case, the Commissioner identified the three beneficiaries of the ``Peabody Family Trust'', being the taxpayer and Mr. & Mrs. Peabody's two children as the ``relevant taxpayers''. The choice of the ``relevant taxpayers'' cannot be arbitrary; it is governed by the opening words of sub-s. 177C(1) and the contents of the first three paragraphs of that subsection; they explain what is meant by the obtaining by a taxpayer of a tax benefit. So far as it is applicable to the circumstances of this case, that section provides as follows:
``177C(1) Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to-
- (a) an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out; or
- (b)... (not material as it deals with deductions)
- (ba)... (not material as it deals with a s. 159TL rebate)
and, for the purposes of this Part, the amount of the tax benefit shall be taken to be-
- (c) in a case to which paragraph (a) applies - the amount referred to in that paragraph;
Thus the reference to ``the obtaining by a taxpayer of a tax benefit'' is not to be taken as permitting the Commissioner to target any person; on the contrary, in a consideration of the facts of this case, he is restricted by the terms of paragraph 177C(1)(a) as expounded by the provisions of s. 177D. This is so because ``the relevant taxpayer'' in that section must be one and the same as the person who is ``the taxpayer'' in s. 177C. It is not every taxpayer of whom it could be said that an ``amount would have been included, or might reasonably be expected to have been included'' in his or her assessable income; but it will be sufficient for the Commissioner if the decision maker could properly postulate that it ``might reasonably be expected'' that the capital gain of some $2.69M would have been divided equally such that a third of it would have been included in the assessable income of each of the three beneficiaries of the trust ``if the scheme had not been entered into or carried out''.
4. The tax benefit
A tax benefit may be one of three things; it could be the avoidance of an amount being included in assessable income - and that is the issue for determination in this case; or it could be the allowance of a deduction or of a rebate - but neither of those issues arise in these proceedings.
The argument advanced by the Commissioner was that, but for the scheme, the ``Peabody Family Trust'' would have been the purchaser of the Kleinschmidt shares and the Trust would have on-sold the shares to the public company at a profit within a period of 12 months. The accounts of the Trust for the relevant year of income having shown that the income for that year had been distributed equally between the three beneficiaries, it was therefore reasonable to assume that the capital gain on the sale of the shares would have been likewise distributed; thus, so the argument concluded, it was reasonable to assume that the taxpayer, Mrs. Peabody, benefited to the extent of one-third of the capital gain.
The language of paragraph 177C(1)(a) is not very demanding; it merely calls for a reasonable expectation. Thus a reference to a taxpayer obtaining a tax benefit shall be read as a reference to an amount not being included in the assessable income of a taxpayer ``... where that amount would have been included, or might reasonably be expected to have been included...'' if the scheme had not been entered into or carried out.
Might it therefore be reasonably expected that, but for the scheme, one-third of the capital gain arising from the sale of the Kleinschmidt shares to the public company would have been included in the assessable income of the taxpayer for the financial year ended 30 June 1986? In
FC of T v Arklay 89 ATC 4563 a Full Court of the Federal Court was concerned with the meaning to be given to the expression ``circumstances existed by reason of which it was reasonable to expect'' appearing in paragraph 82AAS(2)(a) of the Act. In a joint judgment the court concluded:
``We are of the opinion that the phrase with which we are concerned in the context of sec. 82AAS of the Act requires a determination whether or not circumstances exist by reason of which the decision-maker is able to expect on reasonable grounds that superannuation benefits would be provided as stipulated in the section. That test is an objective one. However, in applying the test the decision-maker, in considering the circumstances, should have regard to any relevant matters concerning the taxpayer personally. Put another way our understanding of the meaning of the expression is one which involves the application of an objective test, but, as one of the concomitant elements of that test, the subjective intentions of the taxpayer may be relevant.''
In arriving at its decision in Arklay's case, the Full Court gained assistance from the judgments of another Full Court of this Court in
Attorney-General's Department & Anor v Cockcroft (1986) 64 ALR 97. That case dealt with s. 43 of the Freedom of Information Act 1982 which exempted from disclosure a document the disclosure of which ``could reasonably be expected to prejudice the future supply of information to the Commonwealth...''. Bowen C.J. and Beaumont J. said:
``[I]n our opinion, in the present context, the words `could reasonably be expected to prejudice the future supply of information' were intended to receive their ordinary meaning. That is to say, they require a judgment to be made by the decision-maker as to whether it is reasonable, as distinct from something that is irrational, absurd or ridiculous, to expect that those who would otherwise supply information of the prescribed kind to the Commonwealth or any agency would decline to do so if the document in question were disclosed under the Act. It is undesirable to attempt any paraphrase of these words. In particular, it is undesirable to consider the operation of the provision in terms of probabilities or possibilities or the like. To construe s 43(1)(c)(ii) as depending in its application upon the occurrence of certain events in terms of any specific degree of likelihood or probability is, in our view, to place an unwarranted gloss upon the relatively plain words of the Act. It is preferable to confine the inquiry to whether the expectation claimed was reasonably based (see
Kioa v Minister for Immigration & Ethnic Affairs (1985) 62 ALR 321 per Gibbs CJ and Mason J).''
Viewed objectively, I am of the opinion that an expectation that Mrs. Peabody might have,
ATC 4597but for the scheme, received as assessable income one-third of the capital gain was reasonably based.
There was a suggestion during the course of argument that if Part IVA applied to any of the transactions dealing with the Kleinschmidt shares, the ``relevant taxpayer'' was Loftway - not the beneficiaries of the trust. There are two answers to this proposition; the first is the evidence of Mr. Wruck. He said that the trust was the intended purchaser until the alleged problem of disclosure was said to have been overcome by the decision to convert the shares to worthless Z class shares. I have already held that the conversion did not affect the question of disclosure and I have further held that, in any event, the scheme to convert the shares (as distinct from the method of financing their purchase) did not require the use of a limited liability company such as Loftway. The second answer throws up, once more, the concept of a reasonable expectation; the decision maker did not have to be satisfied that Mrs. Peabody would have been the relevant taxpayer; there need only be a reasonable expectation ``as distinct from something that is irrational, absurd or ridiculous''. The burden on the taxpayer of proving that the assessment is excessive is very onerous when all that is needed to verify it is a reasonable expectation that an amount might have been included in the assessable income of the taxpayer.
In this case I am of the opinion, for the following reasons, that the Commissioner was correct in identifying the beneficiaries of the Trust as the ``relevant taxpayers''. First, the Trust was, and had for some time past been, the vehicle that had been used by the Peabody family to hold its shares in the Pozzolanic group; in normal circumstances, it would have been the logical purchaser of the Kleinschmidt shares; that conclusion accords with Mr. Wruck's evidence. Conversely, the taxpayer led no evidence to suggest any other likely purchaser (other than Loftway of course). Secondly, the trustee of the ``Peabody Family Trust'' had, in the relevant year of income, resolved to distribute the income of the trust equally between the three beneficiaries; the Commissioner followed the same pattern. Thirdly, the Trust - and through it the three beneficiaries - were the parties who actually enjoyed the benefit of the $2.69M increase in the value of their shares; this enjoyment was achieved because the Trust's shareholding in the Pozzolanic group was inflated commensurately with the deflation in the value of the Kleinschmidt shares. Hence, if the trust had purchased the Kleinschmidt shares and on- sold them to the public company there would have been a capital gain of approximately $2.69M and that would have been assessed to tax, pursuant to the provisions of s. 26AAA of the Act, either in the hands of the trustee or in the hands of the beneficiaries who were entitled to it. Finally, the Trust, by releasing Loftway from its obligations to repay borrowed moneys, became, de facto, the party, who supplied the funds to purchase the Kleinschmidt shares.
The tax benefit has already been identified in general terms but specifically in relation to the taxpayer it was the sum of $888,005, being one- third of the sum ascertained by deducting certain purchasing and selling expenses from the capital gain that would have been enjoyed by the trust if it had purchased and on-sold the Kleinschmidt shares. The benefit that was derived by the taxpayer as a result of the scheme was her participation in the receipt by the Trust of a greater sum on the sale of its shares in the Pozzolanic group to the public company than would have otherwise been received.
5. The matters to which regard must be had
The structure of Part IVA of the Act is such that an identification of a tax benefit in the hands of the relevant taxpayer is not necessarily sufficient to attract the power that is vested in the Commissioner under s. 177F. In these proceedings, the Commissioner's right to call in aid the provisions of that section will depend, in the first instance, upon the transactions that have been identified in the findings of fact thus far (or some part or parts of them) amounting to a scheme to which Part IVA of the Act applies and pursuant to which a ``relevant taxpayer'' has obtained a ``tax benefit''. However, before the powers in s. 177F can be utilized, regard must be had to the eight matters that are set out in paragraph l77D(b). I do not consider that there must be a finding that is adverse to the taxpayer in each of eight inquiries; it will be enough if the presence of one is sufficient to bring about the conclusion that is contemplated in the last part of the section.
In this case ``the substance of the scheme'' (placitum (ii)) - that is, the conversion of the Kleinschmidt shares to worthless Z class shares -
ATC 4598and the advantageous ``change in (Mrs. Peabody's) financial position'' that resulted from the scheme (placitum (v)) were, without more sufficient to bring about that conclusion.
6. The person
I have already identified Mr. Peabody as ``the person'' who entered into or carried out the scheme. He was the negotiator; he was the decision maker; Loftway was merely his instrument for the implementation of the plan that had been proposed by his advisers and accepted by him.
7. The purpose
Section 177D stipulates that Part IVA only applies to a scheme where the several conditions in that section are met and ``it would be concluded that the person... who entered into or carried out the scheme... did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit...''. It need not be the exclusive purpose. Sub-section 177A(5) provides that:
``A reference in this Part to a scheme or a part of a scheme being entered into or carried out by a person for a particular purpose shall be read as including a reference to the scheme or the part of the scheme being entered into or carried out by the person for 2 or more purposes of which that particular purpose is the dominant purpose.''
In my opinion, Mr. Peabody carried out this scheme for the dominant purpose of enabling the three beneficiaries of the trust, of whom his wife, the taxpayer, was one, to obtain the tax benefit that has been identified.
In the particular circumstances of this case, I do not find it necessary to investigate the parameters that might apply to the word ``purpose''. Counsel referred to the presence of that word in s. 260 of the Act and to some of the High Court decisions on the meaning of the word in that section; e.g.
FC of T v Gulland; Watson v FC of T; Pincus v FC of T 85 ATC 4765; (1985-1986) 160 CLR 55 at ATC 4772; CLR 68 per Gibbs C.J., at ATC 4779; CLR 80 per Brennan J. and at ATC 4793 and 4796; CLR 105 and 110 per Dawson J. I think that some care should be taken before automatically applying decisions under s. 260 to the provisions of Part IVA. For example, there was no statutory interpretation in s. 260 of ``purpose'' such as is found in sub-s. 177A(5). Furthermore, s. 260 had a different effect upon a challenged arrangement; if the section applied, the arrangement was ``absolutely void, as against the Commissioner...''. But Part IVA does not strike down as void any scheme to which the Part applies; it merely empowers the Commissioner to ignore it and its consequences by permitting the Commissioner to determine that income will be included in or deductions or rebates will not be allowed against the assessable income of a taxpayer. In this case I am satisfied and so find that Mr. Peabody entered into the scheme in order to avoid the provisions of s. 26AAA of the Act and it was a direct and intended consequence of that avoidance that Mrs. Peabody and his children would obtain a tax benefit. It is therefore proper to say that Mr. Peabody's purpose of enabling his wife to obtain a tax benefit was his dominant purpose in entering into the scheme.
Counsel for the taxpayer argued that the language so frequently used in the old s. 260 cases applies to Part IVA in that it will only strike down those schemes that are blatant, artificial or contrived. I am not prepared to impose that restriction as it is unnecessary to do so in this case. However, and contrary to the submissions of counsel for the taxpayer I have no difficulty in labelling this scheme as blatant, artificial and contrived.
There remains only the question of the size of the tax benefit - that is, the amount of assessable income to be included in Mrs. Peabody's return. It was correctly submitted that s. 26AAA brings into assessable income any profit arising from the sale of an asset and that the profit is ascertained after deduction of costs of acquisition and sale (including all holdings costs such as interest on borrowed moneys). The hypothesis was advanced that if the ``Peabody Family Trust'' had purchased the Kleinschmidt shares and on-sold them, the financing would most likely have been by bank bill borrowing. There was evidence from Mr. Wruck to support this proposition and there was evidence that such costs would exceed $1M. However I am of the opinion that any such notional costs are not to be taken into consideration when considering the amount of the tax benefit. As I have already pointed out, the method of financing the purchase of the Kleinschmidt shares by the use of redeemable preference shares was a commercially
ATC 4599acceptable proposition. It was a transaction that was capable of being implemented independently of the transaction whereby the shares were converted to Z class shares; expressed another way, it did not owe its existence to the conversion scheme.
The conclusion that I have reached is that the conversion of the shares to Z class shares was the essential element of the scheme that gave rise to the tax benefit. That scheme was, of course, based upon and owed its existence to the purchase of the Kleinschmidt shares. But the scheme did not dictate the manner in which the purchase of the Kleinschmidt shares would be financed. The purchase could have been financed by a bank bill facility, by other conventional borrowing or, as the Peabody interests chose to do, by using a company and issuing redeemable preference shares to their financier. That choice of financing had nothing to do with the decision to convert the shares to Z class shares. It therefore had nothing to do with the obtaining of a tax benefit.
For the reasons set out above, the decision of the Commissioner to disallow the objection of the taxpayer to the relevant amended assessment is confirmed. The taxpayer is to pay the Commissioner's costs of the proceedings.
THE COURT ORDERS THAT:
1. The decision of the Commissioner to disallow the objection of the taxpayer to the amended assessment of income tax in respect of the year of income ended 30 June 1986 be confirmed.
2. The taxpayer pay the Commissioner's costs.