SPOTLESS SERVICES LIMITED & ANOR v FC of TJudges:
These are four appeals, being heard together by consent, from decisions of the respondent, the Commissioner of Taxation (``the Commissioner''), disallowing objections of the applicants, Spotless Services Limited (``Spotless Services'') and Spotless Finance Pty Limited (``Spotless Finance''), against assessments to income tax in respect of the year of income ended 30 June 1987 (``the year of income'').
Spotless Services is the applicant in two of the appeals (VG 108 and VG 109 of 1991) and Spotless Finance is the applicant in the other two appeals (VG 110 and VG 111 of 1991).
The return of income of Spotless Services for the year of income claimed chat interest of $2,670,663 (throughout the judgment references to currency are in Australian dollars) was received by Spotless Services from European Pacific Banking Company Limited (``EPBCL'') in the Cook Islands, being interest derived from a deposit of $40m made by Spotless Services and Spotless Finance with EPBCL in the Cook Islands.
The $40m was derived from the successful public flotation of shares in Spotless Services in about September 1986. The Spotless Group (I use that expression for convenience) had approximately $40m of surplus funds during the year of income but they were required in the following year for investment purposes. It was decided to place the surplus monies on deposit with EPBCL in the Cook Islands.
Spotless Services claimed the interest to be exempt from income tax pursuant to s. 23(q) of the Income Tax Assessment Act 1936 (``the Act'') on the basis that it had been derived from a source outside Australia and Papua New Guinea, namely, the Cook Islands and that withholding tax of $103,230 had been paid on the interest in the Cook Islands. The return of income of Spotless Finance for the year of income similarly claimed that it had received interest of $295,688 from EPBCL in the Cook Islands. It claimed the interest to be exempt from income tax pursuant to s. 23(q) on the basis that it had been derived in the Cook Islands and that withholding tax of $11,469 had been paid on the interest in the Cook Islands.
The Commissioner issued a notice of assessment to Spotless Services dated 16 February 1988, which he amended by notice of amended assessment dated 3 August 1989 increasing the taxable income of Spotless Services from $4,137,995 to $6,808,658, an increase of $2,670,663. The Commissioner asserted that the sum of $2,670,663 represented interest on the deposit of $40m which was derived from a source within Australia. Spotless Services objected to the inclusion of the amount of $2,670,663 in its assessable income. The Commissioner disallowed the objection and that decision is the basis of appeal VG 108 of 1991.
Appeal VG 110 of 1991 raises with respect to Spotless Finance the same question in principle as appeal VG 108 of 1991 raises with respect to Spotless Services, the difference being the amount of the interest derived by Spotless Finance on the deposit, namely, $295,688.
In each case the Commissioner imposed additional tax: in the case of Spotless Services $194,610.87 and in the case of Spotless Finance $12,805.56.
The Commissioner issued to Spotless Services a further notice of amended assessment on 15 February 1991 accompanied by an adjustment sheet in which he sought to rely upon an alternative basis for bringing to tax the sum of $2,670,663, namely, that the Commissioner made a determination pursuant to s. 177F(1)(a) of the Act to include that sum in the assessable income of Spotless Services. The Commissioner asserted that Spotless Services obtained a tax benefit in connection with a scheme to which Part IVA of the Act applies, namely, that he sum of $2,670,663 is an amount which would have been included or might reasonably be expected to have been included in the assessable income of Spotless Services if the scheme had not been entered into or carried out. This amended assessment is the
ATC 4400subject of the appeal by Spotless Services VG 109 of 1991.
The Commissioner issued a further notice of amended assessment to Spotless Finance dated 15 February 1991 also based on Part IVA of the Act in respect of the sum of $295,688. This amended assessment is the subject of the appeal by Spotless Finance VG 111 of 1991.
Two of the appeals by Spotless Services and Spotless Finance (VG 108 and VG 110 of 1991) raise the question whether the source of the payments of interest derived by them from EPBCL was the Cook Islands or Australia. The other two appeals (VG 109 and VG 111 of 1991) assume that the source of the payments of interest is the Cook Islands, not Australia; they raise the question whether Part IVA of the Act operates to deem the amounts of interest to be included in the assessable income of Spotless Services and Spotless Finance for the year of income.
The evidence is primarily documentary, consisting of affidavits filed on behalf of both taxpayers and the Commissioner and numerous exhibits thereto, together with a few additional exhibits.
Three witnesses were called by counsel for the applicants (all of whom swore affidavits which were read), namely:-
• Neil Leonard Williams, the Executive Director, Finance of the Spotless group of companies (of which the two taxpayers are members) and the Senior Financial Officer of Spotless Finance;
• Peter John Levy, a corporate solicitor with the Spotless Group;
• Richard C Kuegler who is an accountant and management consultant. During the period from June 1986 to April 1987 he was employed in the Cook Islands as the Finance and Administration Manager of European Pacific Banking Corporation (``EPBC''). EPBCL is a wholly owned subsidiary of EPBC. From July 1986 to April 1987 Mr Kuegler also was employed in the Cook Islands as a Finance and Administration Manager of EPBCL, so that the periods of his engagement by both corporations substantially overlapped.
Four witnesses (all officers of the Commissioner) were called by counsel for the Commissioner (all of whom swore affidavits which were read), namely:-
• Mark James Lyburn;
• Fergus Farrow;
• Graham Reginald Whyte; and
• John David Thorburn.
All witnesses were cross-examined.
Most of the facts are not in dispute and little turns on credibility of the witnesses.
I shall state my findings of fact in considerable detail. This is necessary because the submissions of counsel, especially with reference to s. 23(q), attached considerable importance to particular events and the dates on which they occurred.
EPBCL was incorporated in the Cook Islands under the Companies Act 1970-71 (Cook Islands). EPBC was incorporated on 29 August 1985 under the International Companies Act 1981-2 (Cook Islands). At all relevant times EPBC was registered pursuant to s. 28 of the Development Investment Act 1977 (Cook Islands) in respect of off-shore banking business to be conducted, inter alia, with EPBCL. During the period of Mr Kuegler's employment EPBCL maintained an Australian dollar account with EPBC.
During the year of income EPBCL was the largest retail bank in the Cook Islands. It employed about 40 full-time staff and maintained over 5,000 savings accounts and several thousand cheque accounts.
During the year of income EPBCL was wholly owned by EPBC which in turn was owned by European Pacific Investments SA, a Luxembourg publicly listed company. The shares in European Pacific Investments SA were principally owned by the Bank of New Zealand, Fay Richwhite & Co Limited and Brierley Investments Limited. The shares were listed in both Luxembourg and New Zealand. Approximately 16% of the issued capital was publicly owned.
During Mr Kuegler's employment with EPBCL it was the holder of a domestic banking licence issued pursuant to s. 4 of the Banking Act 1969 (Cook Islands). It did not carry on business outside the Cook Islands and was not authorized to do so. Neither EPBCL nor EPBC has a licence to carry on banking business in Australia under the Australian banking legislation.
Pursuant to s. 19 of the Development Investment Act 1977 (Cook Islands), concessions as to the deduction of withholding tax under the Income Tax Act 1972 (Cook Islands) were granted to EPBCL.
In mid 1986 Mr Williams (the Executive Director, Finance of the Spotless group and Senior Financial Officer of Spotless Finance) spoke to Bankers Trust Australia Limited (``BTA'') and other companies about the investment of funds of the Spotless group. BTA was marketing a s. 23(q) investment proposal for EPBCL in the Cook Islands.
On 10 September 1986 a telex was sent by Mr P C Clarke, a director of EPBCL, from the Cook Islands to Mr Williams in Australia, setting out the terms and conditions of the s. 23(q) investment proposal. The telex stated that EPBCL was ``pleased to present terms and conditions of the certificates of deposit now on offer by European Pacific Banking Company Limited, a wholly owned subsidiary of European Pacific Banking Corporation''. The minimum deposits were stated to be $10m with an interest rate of 1.2% per annum below the Australian bank bill buying rate; interest was subject to Cook Islands withholding tax at a rate of 5% of the amount of interest; the interest was payable by cheque deliverable to the attorney of ``Spotless Limited'' at the offices of EPBC in the Cook Islands on settlement day; the term of the deposit was 90, 180 or 360 days as negotiated; and the deposit was secured by a letter of credit issued by Midland Bank plc. Midland Bank is the bank which was offered to the taxpayers by EPBCL (also, of course, EPBC) as the bank which would guarantee to investors the security of their investment by way of deposit with EPBCL. The bank's name appears frequently in the evidence, for example as Midland Bank plc (Singapore) or Midland Bank, London. Nothing turns on the particular corporate form of the bank, so for convenience I shall generally refer to it as ``Midland''. The telex stated that ``Further deposit details are included in the memorandum currently being forwarded to you''.
An ``information memorandum'' was sent by EPBC or EPBCL to Spotless Services in September 1986. It purports to be issued by EPBC and states that it is furnished:
``for purposes of analysis pending further discussions with you and does not constitute, nor is it intended to constitute, an offer to the public of securities or an invitation to the public for subscription of or purchase of any interest or deposit of any monies in terms of the Companies Code.''
Under the heading ``Issue Details'' it is stated that the ``deposit taker'' is EPBCL, a 100% owned subsidiary of EPBC, incorporated in the Cook Islands; the ``security'' is said to be ``certificates of deposit supported by letters of credit, issued by Midland Bank plc, Singapore branch''. The minimum deposits are said to be ``AUD 10 million'', terms of deposits are 90, 180 or 360 days with longer terms negotiable. The interest rate is stated as being one which will reflect market conditions at a margin under the bank bill rate for all the term of the investment; and it is stated that all interest will be subject to 5% Cook Islands withholding tax on the interest amount. The interest is said to be paid on a discounted basis on issue date. The purpose of the issue is said to be ``to expand the bank's deposit base. In all circumstances funds raised by the issue of these Certificates of Deposit will be applied to the bank's activities outside Australia''.
Under the heading ``Nature of Investment'' the following appears:
``The interest on this investment is subject to withholding tax at its source in the Cook Islands and as no international tax treaty exists between the Cook Islands and Australia, the interest derived from the deposit should be exempt income for tax purposes in accordance with section 23(q) of the Income Tax Assessment Act.
Attached as Appendix A, is a legal opinion from Stephen Jaques Stone James confirming that investment in the certificates of deposit by Australian residents produces exempt income. However, the advice in this opinion has been provided for the benefit of European Pacific Banking Corporation only and in tending investors should seek independent legal advice upon their own particular circumstances.''
Under the heading ``European Pacific Banking Corporation - Bank Profile'' it is stated that EPBC is the parent company of the deposit taker, EPBCL. EPBC is a bank formed in the Cook Islands early in 1986 and is jointly owned by Brierley Investments Limited and Capital Markets Limited, both publicly listed companies in New Zealand. EPBC is the first
ATC 4402bank to be issued with a Class A banking licence in the Cook Islands and conducts a full range of banking services. The Board of Directors is said to consist of:
• Mr D M Richwhite (Chairman), principal of Fay, Richwhite & Co Limited and joint Chief Executive and director of Capital Markets Limited;
• Mr D W Lloyd (Deputy Chairman and Chief Executive), Chairman of Cook Islands Trust Corporation Limited;
• Mr P D Collins (Chief Executive and Director of Brierley Investments Limited); and
• Mr T C Clarke, solicitor, and director of Cook Islands Trust Corporation Limited.
The head office is stated as being at Raratonga, Cook Islands.
Mr Williams gave evidence that the Spotless group received both the information memorandum and the ``legal opinion''. The ``legal opinion'' was from Messrs Stephen Jaques Stone James and is in the form of a letter from that firm to Mr Clarke of EPBC addressed to him in the Cook Islands. It states that the instructions received by the solicitors are to advise EPBC on ``the taxation consequences of a proposed transaction involving the Cook Islands''. The letter proceeds:
``We understand that it is intended that an Australian resident corporation should arrange for funds to be placed on deposit with EPBCL in the Cook Islands, a subsidiary of EPBC.''
It then sets out under the heading ``Background'' what the letter states to be the writer's understanding ``that the following series of transactions will take place'':
``1. An Australian resident investor will be approached by EPBCL from the Cook Islands to suggest the placement of a deposit with EPBCL.
2. The investor will open an account with Midland Bank plc in Singapore and another account with EPBC in the Cook Islands.
3. The investor will appoint an attorney in the Cook Islands with power to draw funds or cheques upon the investor's account with EPBC in the Cook Islands.
4. The investor will place his account with Midland Bank plc in Singapore in funds.
5. The investor will then instruct that a transfer of funds from the Singapore account to the Cook Islands account take place.
6. EPBC will instruct Midland Bank plc to issue to the investor a letter of credit both with respect to the account with EPBC and any subsequent deposit with EPBCL.
7. The attorney in the Cook Islands will draw a cheque on the EPBC account in favour of EPBCL.
8. EPBCL will issue a certificate of deposit to the attorney and will in turn draw a cheque on its account with EPBC representing interest upon the deposit and hand the cheque for interest to the attorney. EPBC will deduct the appropriate amount of Cook Islands withholding tax from this interest. The attorney will hold the certificate of deposit in the Cook Islands.
9. The attorney will advise the investor of receipt of the certificate of deposit and receipt of the cheque for interest. The cheque for interest will be deposited with the investor's account with EPBC with instructions that a transfer be made to the investor's account in Singapore with Midlands Bank plc.
10. EPBC as parent of the subsidiary will undertake to ensure the payment of withholding tax to the Cook Islands Government is included in the monthly return of EPBCL and receipt for the payment of the tax is forwarded to the investor in due course.
11. On maturity the Cook Islands attorney will surrender the certificate of deposit and receive back its face value. Proceeds will be banked in the EPBC account of the investor, with instructions to transfer to investor's Singapore account with Midland Bank plc.''
The letter then proceeds to examine the question whether ``Australian resident investors'' will be subject to Australian tax on interest income they derive from the deposit. It analyses s. 23(q); and, after stating that no single case establishes what principles govern the determination of the source of interest income, it says that some indication of its source can be determined from six circumstances (which it is unnecessary to recite). The letter says that these factors or circumstances indicate that the source of the
ATC 4403interest income in question is in the Cook Islands. It then proceeds:
- (i) The agreement for the deposit is concluded in the Cook Islands when the deposit with EPBC is actually made by the Attorney on behalf of the Australian resident. It should of course be ensured that no agreement is concluded prior to this time in Australia;
- (ii) The moneys are deposited with EPBCL by the Australian resident's Cook Islands attorney in the Cook Islands. We strongly recommend that, if any agreement is concluded between the Australian resident (by his attorney) and EPBCL, before the deposit is made, it state that the deposit must be made in the Cook Islands;
- (iii) The moneys are drawn by the Australian resident's Cook Island attorney from a bank account with EPBC in the Cook Islands for the purpose of making the deposit;
- (iv) We are instructed that both EPBC and EPBCL are resident in the Cook Islands and are not resident in Australia. It would be preferable for the certificate of deposit to be retained in the Cook Islands;
- (v) The interest is payable by EPBCL in the Cook Islands. We would strongly recommend that any agreement entered into between EPBCL and the Australian resident specifically state where the interest is payable.''
The letter examines the tax position in the Cook Islands with respect to the transaction under contemplation, turns to Part IVA of the Act and says:
``In considering the income tax position of the investor, regard must always be had to the anti-avoidance provisions contained in Part IVA of the Act.''
It then examines certain of those provisions and concludes:
``Although the circumstances of each investor must be examined individually, it will generally be correct to say that the dominant purpose of the investor when it enters into the proposed transaction is not to obtain a tax benefit by no longer deriving assessable income upon its current investments, but to seek a greater return upon investment by deriving income which, by virtue of the provisions of the Act, is exempt income. It is our view that, although there has yet to be a judicial consideration of the provisions of Part IVA, such an argument would be likely to succeed. Therefore, the entry by the investor into the transaction outlined above should not, we believe, attract the operation of Part IVA of the Act.
This advice is provided only for the benefit of European Pacific Banking Corporation and may not be relied upon by any other party including those contemplating entering into the transactions discussed herein. Such parties should seek independent advice referable to their own particular circumstances.''
Also included with the documents sent by EPBCL to the Spotless companies were a ``sample copy of certificate of deposit'', a ``form of letter of credit'' and a memorandum outlining ``settlement procedures''.
The form of certificate of deposit purports to be issued by EPBCL from the Cook Islands and certifies, amongst other things, that there has been deposited with EPBCL at its head office the principal amount of Australian dollars to be payable to the investor, that the interest amount on the deposit shall be paid in Australian dollars upon presentation of the certificate to EPBCL and that payments will be made subject to Cook Island tax.
The form of letter of credit is addressed to the beneficiary and purports to be issued by Midland as an irrevocable, non-transferable, standby letter of credit on account of EPBCL and to be issued in connection with the certificate of deposit issued by EPBCL to the beneficiary with a stated face value, maturity date and amount.
The memorandum outlining ``settlement procedures'' reads as follows:
``1. Investor opens bank account with Midland Bank PLC, Singapore branch and European Pacific Banking Corporation (`EPBC') in the Cook Islands.
2. Investor places his Midland Bank PLC, Singapore branch account in funds one business day prior to settlement to facilitate prompt funds flow on settlement day.
3. Investor appoints an attorney with power to draw funds upon Investor's account with EPBC.
4. On settlement day in the Cook Islands:
- (i) Attorney draws a cheque on Investor's bank account maintained with EPBC made in favour of European Pacific Banking Company Limited (`EPBCL') for the face value of the Certificate of Deposit (`C.D.').
- (ii) EPBCL issues the C.D. to the attorney and draws a cheque on its account with EPBC in favour of Investor for an amount of the interest, net of Cook Island withholding tax.
- (iii) Attorney deposits the interest cheque with Investor's bank account maintained with EPBC, together with instructions to transfer funds for same day value to the Investor's bank account maintained with Midland Bank PLC, Singapore branch.
- (iv) Attorney will communicate completion of settlement to Investor in Sydney.
- (v) Attorney will hold the C.D. in safe custody in the Cook Islands until maturity date.
5. On settlement day in Sydney:
- (i) Midland Australia shall present Investor with the Letter of Credit in support of the C.D. issued in the Cook Islands.
- (ii) Investor shall give irrevocable instructions to Midland Australia to transfer funds from Investor's account maintained with Midland Bank PLC, Singapore branch to Investor's account maintained with EPBC in the Cook Islands.
- (iii) Midland Australia shall confirm transfer of the interest amount to Investor's account maintained with Midland Bank PLC, Singapore branch.
6. On maturity day in the Cook Islands, the Attorney shall surrender the C.D. to EPBCL, and receive payment for the face value of the C.D. from EPBCL. The Attorney will then deposit funds in Investor's account maintained with EPBC together with instructions to transfer funds to Investor's account maintained with Midland Bank PLC, Singapore Branch.''
On 23 September 1986 certain agreements were signed by or on behalf of EPBC, EPBCL and Midland which established a letter of credit facility for EPBC and EPBCL with Midland. Under the agreement Midland agreed to arrange for irrevocable standby letters of credit to be opened for the account of EPBCL in favour of investors making deposits with EPBCL from time to time as security for the obligations of EPBCL in respect of the deposits. A form of ``charge over deposits'' was executed by EPBC in favour of Midland whereby EPBC granted a charge in favour of the Midland Bank over each deposit to be taken.
At some time before 4 December 1986 Mr Kuegler of EPBCL received instructions from Fay Richwhite in Melbourne to send to Spotless Services in Melbourne a telex containing amended terms of the offer. On the same day (4 December) Mr Kuegler sent a telex to Mr Williams of Spotless Services setting out details and terms and conditions of the certificate of deposit being offered. It provided that an interest rate of 13.3% was to be paid in arrears and that the deposit was to be secured by a letter of credit issued by Midland. It also stated that the offer may be accepted by delivery of a cheque for $40m to EPBCL at the offices of EPBC in the Cook Islands.
On 5 December 1986 Mr Williams telephoned Mr Clarke of EPBCL about ``completing proposals'' that Spotless Services ``were looking at what offered a higher after tax yield''. Mr Williams gave evidence that the ``major reason why I contacted Mr Clarke was to see if I could negotiate a higher rate than that which is on offer here''. Mr Williams succeeded ``in increasing the rate of return''.
By telex dated 5 December 1986 Mr Kuegler of EPBCL stated to Mr Ian Auld of Midland, Sydney:
``Please be advised that a letter of credit will be required for settlement Wednesday, 10 December (Sydney time) with details as follows...''
The details that followed stated that the required face value was $40m with an expiry date of 23 June 1987 on account of EPBCL, the investor being Spotless Services, the advising bank being Westpac Banking Corporation (``Westpac'') and the issue date of the letter of credit 10 December 1986.
On 7 December 1986 Mr Kuegler sent a further telex to Mr Auld informing him that a letter of credit would be required for settlement on Wednesday, 10 December (Sydney time) with certain adjusted details.
On 8 December 1986 (a Monday) Mr Williams received a telex dated 5 December from Mr Kuegler confirming the terms and conditions of the deposit that had been negotiated with Mr Clarke in the Cook Islands. Following Mr Williams' discussion on 5 December with Mr Kuegler, steps were taken to prepare documents for use in the Cook Islands to give effect to the proposed investment in the Cook Islands. Mr Williams also instructed Mr Levy to prepare to depart for the Cook Islands to implement the proposals.
On 8 December 1986 a document described as a joint venture agreement was executed in Australia by Spotless Services and Spotless Finance whereby they agreed to ``associate themselves as Joint Venturers'' for the business or object of investing funds in the Cook Islands and ``for the sake of convenience the investments were to be made in the name of Spotless Services''. The joint venture was to subsist until the redemption of the investment, and any interest accruing thereon, and the joint venture was to be restricted to the carrying out of the investment in the Cook Islands. It was agreed that a bank account of the joint venture was to be established with EPBCL in the Cook Islands in the name of Spotless Services. The management and control of the joint venture was to be vested in the Board of Directors of Spotless Services. On the maturity of the investment the parties would receive the return of capital contributed, together with earned income, after allowance for all expenses of the joint venture, and the return was to be made pro rata in proportion to capital contribution.
The deposit of $40m was to be made by Spotless Services on behalf of itself and Spotless Finance pursuant to the terms of the joint venture agreement. The two companies contributed to the total investment of $40m in the following proportions: Spotless Services $36m - 90%; Spotless Finance $4m - 10%.
Other documents were executed by Spotless Services on 8 December that Mr Levy was to take with him to the Cook Islands including a power of attorney from Spotless Services to him appointing him as the attorney of Spotless Services to perform and carry out in the Cook Islands certain acts specified in Schedule E to the power which in essence were:-
• To draw a cheque on the bank account of Spotless Services with EPBC in the Cook Islands in the sum of $40m in favour of EPBCL;
• To deposit that cheque with EPBCL in the Cook Islands for the credit of Spotless Services;
• To receive a certificate of deposit issued by EPBCL to the face value of $40m;
• To hold the certificate of deposit in safe custody for Spotless Services in the Cook Islands and to send a copy of it by facsimile transmission to Spotless Services;
• To surrender the certificate of deposit to EPBCL at the offices of EPBCL in Raratonga, Cook Islands;
• To receive upon surrender of the certificate of deposit a cheque drawn by EPBCL upon the account it maintained with EPBC in the sum of $40m plus interest in favour of Spotless Services; and
• To deposit the cheque just mentioned in the account and at the same time to deliver instructions to EPBC to transfer funds equal to the same day value of the amount of the cheque from the account to Spotless Services for the credit of Spotless Services or as it may direct.
Another document executed in Australia by Spotless Services before Mr Levy left for the Cook Islands and which he took with him to the Islands was a mandate from Spotless Services authorizing EPBCL to open a bank account in the name of Spotless Services with EPBCL at Raratonga.
On 8 December Mr Levy travelled from Australia to the Cook Islands arriving there on 9 December (Cook Islands time: ``CI time'') (8 December Australian Eastern Summer time: ``AES time''). Mr Levy carried with him the documents requisite to the tasks which he was to perform' in the Cook Islands.
On 8 December 1986 Mr J V Corser of Midland requested Midland London to issue by telex to Westpac in Melbourne an unconfirmed letter of credit on Midland's facility for $40m in favour of Spotless Services. The client is described as EPBCL.
On 9 December 1986 Westpac Melbourne received a telexed unconfirmed letter of credit
ATC 4406for $40m drawn on Midland in favour of Spotless Services which stated that it was issued on account of EPBCL and related to the certificate of deposit issued by EPBCL to Spotless Services.
On 9 December 1986 Mr Ian Auld of Midland sent a telex to Midland, Singapore, stating that it was to receive instructions from the Cook Islands to disburse approximately $39,680,481 to the account of Bankers Trust Asia Limited, Sydney and $118,869 to the account of Midland at Westpac, Sydney. It was said that this transaction would take place on 10 December 1986 in Sydney only upon deposit of cleared funds paid into Midland's account with Westpac, Sydney. It asked for Midland to confirm this event. It also asked that Midland be notified when the transfer instructions were given by Midland to Westpac.
By telex sent on 8 December (CI time) by Mr Kuegler of EPBC to Midland it was stated that upon payment of $A40m into the account of EPBC on 10 December (Singapore time) there would be disbursed $39,680,481 to Bankers Trust Asia Limited's account with Westpac, Sydney and $118,549.54 to Midland's account with Westpac, Sydney, the balance of the funds to be placed on a seven day rollover deposit.
On 9 December (Singapore and AES time; but 8 December CI time) Midland instructed Westpac Sydney to disburse $40m on 10 December (AAS time and Singapore time; but 9 December CI time) to Bankers Trust Hong Kong.
On 10 December 1986 Midland sent a telex to the attention of Mr Auld stating that it had instructed Westpac, Sydney to debit the account in the sum of $39,799,030.54.
On 10 December (AES and Singapore time) Midland instructed Westpac that, upon receipt of $40m on 10 December, Westpac was to credit to Bankers Trust Hong Kong's account and Bankers Trust Asia's account with Westpac in Sydney the sum of $40m.
By facsimile transmission of 9 December 1986 from Mr Kuegler of EPBC to Midland for the attention of Mr Auld, Mr Kuegler sent Mr Auld a copy of the banking instruction telexed to Midland, a copy of the notice of deposit and deposit taker and a copy of the notification to the deposit taker of the charge of deposit agreement.
On 9 December 1986 there was a meeting of the ``Finance and Development Committee'' of Spotless Services in Brunswick, Victoria in which amongst other things consideration was given to the letter of credit that had been proposed. It was noted that this document secured the interest of the Spotless companies and that it was the responsibility of Westpac to confirm the bona fides of the letter of credit provided by Midland. It is clear that the directors of the Spotless group were concerned about the need to confirm the adequacy of the letter of credit securing the investment and it was decided that the principals of the legal advisers of the Spotless group should be requested to attend settlement to confirm the adequacy of the form of the letter of credit. The committee authorized settlement to take place in the Cook Islands at 11.30am on Wednesday, 10 December 1986 (AES time) ``provided that all security arrangements are in place and to our satisfaction''. At the request of Spotless Services a number of amendments was made to the letter of credit and some of these changes were finalized between Mr David Lowe of Fay Richwhite and Mr Auld. Bankers Trust Australia Limited required a further amendment to be made to the letter of credit to ensure that the amount secured was the principal and interest less any withholding tax legally payable in the Cook Islands.
Midland issued an amendment advice to its original letter of credit which contained the necessary amendments to give effect to the request of Bankers Trust Australia Limited and to meet the requirements of the Finance and Development Committee of Spotless. An additional amendment was made to have the security payable in Australia rather than the United Kingdom. The effective date for the letter of credit was also changed from 10 December to 11 December and the certificate of deposit's maturity date from 23 to 24 June 1987.
On 10 December 1986 Mr Auld of Midland Sydney sent a Swift Message to Midland Singapore stating that it should receive instructions from EPBC amending its prior disbursement advices to Westpac whereby payment of $39,680,481 was to be paid to Bankers Trust, Hong Kong in lieu of Bankers Trust Asia Limited. The message said to advise Westpac by Swift Message to enable settlement to be effected on 10 December (AES time).
Mr Kuegler of EPBCL sent a telex to Midland Singapore on 9 December (CI time) stating that the settlement date had been amended from 10 to 11 December and that the disbursement of $39,680,481 should be credited to the account of Bankers Trust Hong Kong. The instructions were said to be irrevocable. Midland Singapore sent a telex to Westpac Sydney repeating the amended instructions of EPBCL in relation to the Midland account with Westpac Sydney.
On 10 December 1986 Mr Auld of Midland Sydney sent a facsimile transmission to Mr Kuegler of EPBC in the Cook Islands confirming nomination of Bankers Trust Hong Kong as the Deposit Taker for the deposit of $39,680,481 subject to EPBC's acknowledgment of the charge in favour of Midland over the deposit. On the same day Mr Kuegler sent a facsimile transmission to Mr Auld enclosing a copy of the banking instructions telexed to Midland together with a copy of the notification to Deposit Taker (Bankers Trust Hong Kong) of Midland's charge over the EPBC deposit.
On 10 December (AES time) Westpac paid out $40m on account of Midland to Bankers Trust in accordance with the irrevocable instructions given to Midland on 8 December. Also on 10 December (AES time) EPBC granted a charge over the EPBC deposit to Midland.
On 10 December (9 December CI time) Mr Levy telephoned Mr Kuegler and arranged a time for settlement at 3.00 p.m. C.I. time. At 3.00 p.m. Mr Levy attended the offices of EPBC for settlement. EPBC was represented by Mr Kuegler. Mr Levy exhibited the power of attorney and mandate to Mr Kuegler. Mr Kuegler perused the power of attorney and made a photocopy of it. Mr Kuegler gave Mr Levy an unsigned cheque in the sum of $40m in favour of EPBCL to be drawn on the account of Spotless Services with EPBC. On 9 December 1986 (CI time) there was to have been credited $40m to the account of Spotless Services maintained with EPBC. At this time Mr Kuegler received a telephone call from Australia. Mr Kuegler informed Mr Levy that there was a problem with the telegraphic transfer of funds from Australia. Mr Kuegler said that he should wait for a second telephone call to see if the transaction could proceed. About 15 minutes later Mr Kuegler received a second telephone call from Australia. Mr Kuegler told Mr Levy that the problem in Australia had not been resolved and that settlement could not proceed. Mr Kuegler and Mr Levy rescheduled their appointment for 3pm the following day, 11 December (10 December CI time). The cheque made out for $40m in favour of EPBCL dated 9 December 1986 was torn up and disposed of.
On 10 December Spotless Services reinvested the $40m on the overnight money market.
On 11 December (10.30 am AES time) Mr Williams picked up in Melbourne a bank cheque for $40m payable to Midland. He went to the offices of Bankers Trust in Collins Street. The letter of credit issued by Midland was inspected by the legal advisers of Spotless Services and handed to Mr Williams, who then handed over the bank cheque for $40m together with a letter of authorization from Spotless Services to Midland to credit the $40m to the account of Spotless Services with EPBCL in the Cook Islands.
On 11 December (AES time) (3.00pm on 10 December CI time) Mr Levy attended EPBCL and met Mr Kuegler once again. Mr Kuegler received a telephone call from Australia and he told Mr Levy that the telephone call confirmed that the transfer of funds could proceed. At that time Mr Levy signed a cheque dated 10 December 1986 for the sum of $40m drawn on the account of Spotless Services with EPBC. He handed the cheque to Mr Kuegler. In return Mr Kuegler handed Mr Levy a pre-prepared non- negotiable certificate of deposit dated 10 December (CI time) with a maturity date of 23 June 1987 (CI time) together with an undertaking signed by Mr Kuegler on behalf of EPBCL. Mr Levy returned to Australia on 12 December (AES time) with the original of the certificate of deposit in his possession.
On 11 December (AES time) Midland paid the $40m received from Spotless Services into Midland's account with Westpac thus rectifying an overdraft which had been created by payment out to Bankers Trust on 10 December. The Midland money market account with Westpac was overdrawn due to the one day delay in settlement.
On 11 December (AES time) EPBC gave notice to Midland that on 11 December the $40m had been disbursed to Bankers Trust
ATC 4408Hong Kong and was the subject of the charge previously given to Midland.
On 5 June 1987 Mr Auld of Midland sent to Mr Lowe of Fay Richwhite & Co, Sydney a letter requesting him to obtain instructions from ``the beneficiaries'' (i.e. Spotless Services) as to the disposal of the funds at the maturity of the investment.
On 19 June 1987 Mr Auld sent to Mr Clarke of EPBC by facsimile transmission a request to instruct Bankers Trust Asia Limited, Hong Kong to remit the proceeds of the deposit to the account of Midland with Westpac, George Street, Sydney. He also contacted Mr Rice of Bankers Trust Asia Limited, Hong Kong informing him that upon direction from EPBC the proceeds of the Spotless Services' deposit were to be remitted to the account of Midland with Westpac, George Street, Sydney.
On 22 June 1987 Mr Levy, the Corporate Treasurer of Spotless Services, sent a facsimile transmission to Mr R Python of EPBCL requesting that upon maturity of the investment the principal and interest be paid to an account of Spotless with Westpac, Queen Street, Brisbane. Mr Python of EPBC sent a telex to Midland instructing it upon receipt of $42,966,350.97 from Bankers Trust Asia Limited, Hong Kong (being the maturity of the deposit on behalf of Spotless Services) to disburse the funds as follows: $42,842,192 to the account of Spotless Services with Westpac, Queen Street, Brisbane and $124,158.97 to the account of EPBC with Midland.
On 23 June 1987 Midland sent a telex to Mr Auld of Midland informing him that EPBC had directed it to transfer $42,842,192 to Spotless Services. Midland requested Mr Auld to confirm this amount. On the same day Mr Auld confirmed the amount by telex.
Mr Levy of Spotless Services sent the certificate of deposit to EPBCL and acknowledged that the principal and interest of $42,842,192 had been paid and requested a receipt for the payment of the withholding tax in the Cook Islands. Mr G R Stewart of EPBCL sent a receipt as requested for the payment of the withholding tax to Mr Williams of Spotless Services on 4 August 1987.
Although the events with which these appeals are concerned have been recited in detail, they are basically straightforward. It is convenient to summarize them before turning to the questions of law that arise, so that the broad picture is kept in mind. In late 1986 Spotless Services and Spotless Finance had available $40m as a result of a successful company public flotation. They did not need to apply their funds for their current business needs during the year of income, so they sought a suitable short term investment in which to place the funds. They had been approached by Bankers Trust about the investment of funds in the Cook Islands and the tax benefits to be gained therefrom. A letter of offer had been received by the Spotless group from EPBCL which was considered by Spotless Services and Spotless Finance. They decided to place the $40m on deposit with EPBCL in the Cook Islands. Mr Levy of Spotless Services was authorized to travel to the Cook Islands and attend to the investment. Mr Levy travelled to the Cook Islands and he attended at the appointed place for settlement on 10 December 1986 (AES time, being 9 December CI time). The transaction could not proceed that day because the investment was to be made by depositing funds against the certificate of deposit to be issued by EPBCL. That deposit was to be secured, in the interests of the Spotless companies, by a letter of credit from Midland.
On 10 December (AES time) the letter of credit was not in a form satisfactory to the Spotless companies so settlement did not proceed that day. Midland agreed to make suitable amendments to the letter of credit and on 11 December the transaction proceeded. The two Spotless companies provided funds which were placed to the credit of Spotless Services under the joint venture agreement with EPBC. Midland provided a letter of credit which would be invoked in the event that there was default by EPBCL on its certificate of deposit. Mr Levy drew a cheque for $40m against the funds held on behalf of Spotless Services and Spotless Finance and that was applied by making a deposit against the certificate of deposit issued by EPBCL. After the funds had been deposited the transaction was completed on 11 December (AES time). On maturity in 1987 Spotless Services and Spotless Finance received back the principal together with interest less Cook Islands' withholding tax.
The case involves the determination of the question whether the source of the interest was
ATC 4409derived by the taxpayers from Australia and Papua New Guinea or the Cook Islands.
The taxpayers claim that the interest represented money derived by them in the Cook Islands and was exempt income under s. 23(q) of the Act. The Commissioner seeks to attribute an Australian source to that sum.
Section 23(q) provided at the relevant time that income derived by a resident from sources out of Australia and Papua New Guinea is exempt income where it is not exempt from tax in the country where the income is derived provided that there is a liability for tax in the country where that income is derived and the Commissioner is satisfied that the tax has been or will be paid.
Section 23(q) was omitted from the Act by Act No. 51 of 1986. The last year of income to which s. 23(q) applied was the year of income with which this case is concerned, namely, the year of income ending 30 June 1987.
The word ``source'' is not defined in the Act but its meaning and application have been frequently considered by Australian courts in various contexts.
Nathan v FC of T (1918) 25 CLR 183 Isaacs J. said at 189-190 with reference to ss. 10 and 14(b) of the Income Tax Assessment Act 1915 (Cth) as to the source of dividends:
``The Legislature in using the word `source' meant, not a legal concept, but something which a practical man would regard as a real source of income. Legal concepts must, of course, enter into the question when we have to consider to whom a given source belongs. But the ascertainment of the actual source of a given income is a practical, hard matter of fact.''
This passage has been cited and approved in a number of cases including judgments of the High Court in
Studebaker Corporation of Australasia Ltd v Commr of Taxation (NSW) (1921) 29 CLR 225 at 233;
FC of T v Robert Mitchum (1965) 13 ATD 497; (1965) 113 CLR 401 per Barwick C.J. at ATD 501; CLR 406; and
Esquire Nominees Ltd v FC of T 72 ATC 4076; (1971-1973) 129 CLR 177 per Gibbs J. at ATC 4086; CLR 192. The passage was considered by this Court in
Thorpe Nominees Pty Limited v FC of T 88 ATC 4886 (per Lockhart J. at 4892-4893, Sheppard J. at 4894-4895 and Burchett J. at 4896-4897). In Thorpe I said at 4893:
``The phrase `practical, hard matter of fact' appears in many of the reported cases where the meaning of the word `source' was discussed including cases earlier than Nathan's case. The use of the word `hard' renders the meaning of the phrase a little opaque, a difficulty adverted to in some of the cases including C. of T. (N.S.W.) v. Freeman (1956) 30 A.L.J.R. 42 at p. 48.''
What emerges from the authorities is plainly enough that the test to be applied in determining the source of income for the purposes of the Act is to search for ``the real source'' and to judge the question in a practical way: see Mitchum per Barwick C.J. at ATD 501; CLR 406;
FC of T v Efstathakis 79 ATC 4256; (1979) 38 FLR 276;
FC of T v French (1957) 11 ATD 288 at 296-297, 298 and 300; (1957) 98 CLR 398 at 415, 418 and 421.
I agree with the following passage from the judgment of Burchett J. in Thorpe at 4896-4897:
``Practical reality is not a test so much as an attitude of mind in which the Court should approach the task of judgment. Reality, like beauty, is often in the eye of the beholder. (Cf. the comments made by J. D. Jackson in an article in 51 Mod. L.R. 549 at p. 557 et seq.) What the cases require is that the truth of the matter be sought with an eye focused on practical business affairs, rather than on nice distinctions of the law. For the word `source', in this context, has no precise or technical reference. It expresses only a general conception of origin, leading the mind broadly, by analogy. The true meaning of the word evokes springs in grottos at Delphi, sooner than the incidence of taxes. So the exactness which the lawyer is prone to seek must be consciously set aside; indeed, with respect to a choice between various contributing factors, it cannot be attained. The substance of the matter, metaphorically conveyed when we speak of the source of income, is a large view of the origin of the income - where it came from - as a businessman would perceive it.''
The cases demonstrate that there is no universal or absolute rule which can be applied to determine the source of income. It is a matter of judgment and relative weight in each case to determine the various factors to be taken into account in reaching the conclusion as to source
ATC 4410of income. As Bowen C.J. said in Efstathakis at ATC 4259; FLR 280:
``the answer is not to be found in the cases, but in the weighing of the relative importance of the various factors which the cases have shown to be relevant.''
Commr of Inland Revenue (NZ) v N V Philips Gloeilampenfabrieken (1954) 10 ATD 435;
Grainger & Son v Gough  AC 325;
FC of T v United Aircraft Corporation (1943) 7 ATD 318; (1943) 68 CLR 525 and
Commr of Inland Revenue v Hang Seng Bank Limited  1 AC 306.
Cliffs International, Inc v FC of T 85 ATC 4374 Kennedy J. observed at 4390 that the place where the relevant contract was made from which the income was derived was held to be of no particular significance in
Commr of Taxation (NSW) v Meeks (1915) 19 CLR 568; but in
Premier Automatic Ticket Issuers Ltd v FC of T (1933) 2 ATD 383; (1933) 50 CLR 268 and in
Tariff Reinsurances Ltd v Commr of Taxes (Vic) (1938) 4 ATD 498; (1938) 59 CLR 194 the place where the relevant contract was made was held to be of considerable significance. Similarly with respect to the place where the income is received: see Tariff Reinsurers per Dixon J. at ATD 510; CLR 217.
The researches of counsel and my own researches have not revealed any case directly in point to the present appeals. In my opinion where the source of interest payable under a contract of loan lies at the heart of the judicial inquiry the place or places where the contract was made and the money lent are of considerable importance; but it goes too far to say that the source of the interest in the present case is necessarily determined solely by reference to the place where the contract of loan was made and the money in fact lent.
Counsel for the Commissioner argued that the contract of loan was made in Australia, whereas counsel for the taxpayers argued that it was made in the Cook Islands. Counsel for the Commissioner argued, in the alternative, that if the contract of loan was made in the Cook Islands nevertheless the other relevant facts and circumstances support the conclusion that the true source of the income was Australia, not the Cook Islands.
The relevant contract of loan was made between each of the taxpayers on the one hand and EPBCL on the other hand. The issue is whether the contract was concluded by the time of the meeting in Melbourne on 11 December (AES time) when Mr Williams handed over the bank cheque for $40m or at the meeting in the Cook Islands on 11 December (AES time and 10 December CI time) when Mr Levy handed the cheque for $40m to Mr Kuegler.
Counsel for the Commissioner argued that at least by the time of the meeting in Melbourne on the morning of 11 December a contract had been made so that thereafter the taxpayers were bound by it. Counsel for the Commission argued that the taxpayers became bound on 11 December by the acts of handing the bank cheque for $40m to the representative of Midland together with instructions to place the money to the credit of the account of Spotless Services with EPBC or EPBCL. The actions of Mr Levy in the Cook Islands on 11 December (AES time) were simply, so it was argued by counsel for the Commission, in consummation of the settlement that necessarily followed from the making of the agreement already made.
The telex of 5 December 1986 from Mr Kuegler was received by Mr Williams on the morning of 8 December 1986 and that telex confirmed the terms and conditions of the deposit that had been negotiated with Mr Clarke in the Cook Islands. It is clear on the face of that document that it is an offer made to the taxpayers which was available for acceptance by them by delivery of a cheque for $40m to EPBCL at the offices of EPBC in the Cook Islands. It is true that EPBCL extended its offer for one further day beyond the time specified in the telex of 5 December; but that was because of the problem that arose with respect to the letter of credit requiring the extension of time. On 10 December (CI time) the cheque for $40m was delivered to the place of business of the offerer, namely EPBCL, specified in the telex. It was delivered by Mr Levy on behalf of the taxpayers, who received in return the certificate of deposit. The contract was made in the Cook Islands.
The taxpayers took very seriously the terms on which the letter of credit was to be issued by Midland. That was to provide their security after the deposit had been made in the Cook Islands; and it represented a very large sum of money, being the greater part of the capital recently raised in the public flotation. The letter of credit is itself an important document, but one which cannot play a determinative role in
ATC 4411ascertaining the source of the income. It is true that the letter of credit was the security to the taxpayers for the loan, but it only took effect upon the issue of the certificate of deposit in the Cook Islands. Until the cheque was handed over by Spotless Services in the Cook Islands the taxpayers were not bound by any contract. Similarly, the taxpayers were not protected by the letter of credit until they themselves became bound to make the loan. The letter of credit itself was made on the application of EPBCL and is directed to the Secretary of Spotless Services. Two events are stated as preconditions entitling Spotless Services to call on the letter of credit and they are set out in paragraph 1(d) of the letter and require as a precondition that the certificate of deposit must have issued. Spotless Services did not acquire any rights under the letter of credit until it received the certificate of deposit. The letter of credit was provided as collateral security to the taxpayers.
The event which concluded the contract and bound the parties was the delivery of the cheque in the Cook Islands on behalf of the Spotless companies to EPBCL and the receipt of the certificate of deposit by them through their agent, Mr Levy. The certificate of deposit is the critical document for the purposes of the contract between the parties. It is that document which gave rise to rights vested in the taxpayers against EPBCL and it was only in default of that certificate being honoured that Spotless Services was entitled to call on the letter of credit which it had received.
The contract of loan is between the two Spotless companies on the one hand and EPBCL on the other. It was not an agreement which the taxpayers had with Midland. The contract was in fact one constituted by the telexed offer of 5 December and was accepted by conduct in the Cook Islands.
The taxpayers were not contractually bound to EPBCL on 11 December when Mr Williams picked up the bank cheque for $40m payable to Midland and went to the offices of Bankers Trust in Collins Street, Melbourne and did the various other things to which reference has already been made, including in particular, the handing over of the cheque for $40m with the letter of authorization. What was done in Melbourne on 11 December was certainly preparatory to the making of the contract. The taxpayers had available the bank cheque for $40m payable to Midland which was handed by their representative to Midland with instructions as to what should be done with it. Midland was acting as a conduit for the transmission of funds to the Cook Islands where they would be held on account of the taxpayers. What happened in Melbourne simply put the taxpayers in a position to conclude an agreement in the Cook Islands. The events in Melbourne on 11 December indicated that the taxpayers fully intended to go ahead with the making of the loan; but there was no contract that bound them to EPBCL until a cheque was drawn against the funds lodged in Melbourne and a cheque given by Mr Levy on their behalf to EPBCL in the Cook Islands and for which they received in return a certificate of deposit. Until those events occurred there was no binding contract of loan between the taxpayers and EPBCL. The contract was entered into in the Cook Islands not in Melbourne. The contract is between each of the taxpayers on the one hand and EPBCL on the other. It was concluded at the meeting in the Cook Islands on 10 December (CI time) when Mr Levy handed the cheque for $40m to Mr Kuegler and Mr Kuegler handed Mr Levy in return the certificate of deposit.
There are other facts and circumstances that in my view point strongly in the direction of the conclusions that the interest was derived by the taxpayers in the Cook Islands. The borrower, EPBCL, was incorporated in the Cook Islands and carried on business there. It did not carry on business in Australia. The deposit was repaid, together with interest, less withholding tax, from the Cook Islands. It is impossible to ignore the legal effect of the arrangements entered into by the parties with respect to the lending of the money. Until the cheque for $40m was handed over on 11 December in the Cook Islands (10 December CI time) and the certificate of deposit received in return there was no contract between the lender (the taxpayers) and the borrower (EPBCL). If EPBCL failed to honour the certificate of deposit on the due date the taxpayers could have sued on the certificate and there would have been no answer in law to their right to judgment.
The source of the interest derived by the taxpayers from the making of the loan was the Cook Islands.
Part IVA of the Act was introduced by the Income Tax Laws Amendment Act (No 2), No 111 of 1981, and applied to a ``scheme'' entered into after 27 May 1981. The legislative purpose of Part IVA was to replace s. 260, the anti-avoidance provision which in 1981 was regarded as having only limited operation. As was pointed out by this Court in
Jackson v FC of T 89 ATC 4429 (Gummow J. at first instance) and on appeal to a Full Court of the Court
FC of T v Jackson 90 ATC 4990; and in
Peabody v FC of T 93 ATC 4104 by a Full Court of the Court differently constituted, though with Hill J. delivering the principal judgment in each case. Unlike s. 260, Part IVA does not operate of its own force. It is predicated upon the making of a determination by the Commissioner pursuant to s. 177F(1), which so far as presently relevant provides as follows:
``177F(1) Where a tax benefit has been obtained, or would but for this section be obtained, by a taxpayer in connection with a scheme to which this Part applies, the Commissioner may-
- (a) in the case of a tax benefit that is referable to an amount not being included in the assessable income of the taxpayer of a year of income - 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; or
- (b) in the case of a tax benefit that is referable to a deduction or a part of a deduction being allowable to the taxpayer in relation to a year of income - determine that the whole or a part of the deduction or of the part of the deduction, as the case may be, shall not be allowable to the taxpayer in relation to that year of income;
and, where the Commissioner makes such a determination, he shall take such action as he considers necessary to give effect to that determination.''
The prerequisites for making a determination under s. 177F(1) are first that there is in existence a ``scheme'' to which Part IVA applies and second that the taxpayer has obtained a ``tax benefit'' in connection with that scheme or would but for the operation of s. 177F(1) have obtained such tax benefit.
The word ``scheme'' is defined in s. 177A as meaning:
``(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 is thus cast in very wide terms.
The ``scheme'' in order to attract the operation of Part IVA must have been entered into or carried out having regard to the matters set out in s 177D(b) (including the manner in which the scheme was entered into or carried out and the form and substance of the scheme - to mention but two of the eight integers specified in s. 177D(b)) - and where having regard to those matters:
``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 purpose to which s. 177D refers 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 or two or more persons of which that particular purpose is the dominant purpose (s. 177A(5)).
A ``tax benefit'' is defined in s. 177C as relating to assessable income in these terms:
``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
ATC 4413assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out;...''
Jackson and Peabody are together authority for the following propositions, so far as presently relevant:-
- • Part IVA does not operate of its own force. It is predicated upon the making of a determination by the Commissioner pursuant to s. 177F(1);
- • in proceedings under Part V of the Act, where a determination under s. 177F has purportedly been made and relied upon by the Commissioner, it will be open to a taxpayer to challenge the existence of the conditions precedent to the making of the determination: for example, the existence of a scheme, whether there was a tax benefit, and whether the necessary conclusion as to purpose is to be arrived at, whether an invalid determination was made;
- • where, as a matter of fact, a scheme consists of a series of steps or a course of action, the Commissioner may not isolate out of that course of action one step and classify that as a scheme. Reference in Part IVA to ``part of a scheme'' suggests that where a series of steps constitutes a scheme, that whole series of steps is to be considered;
- • on a reference of an objection to a decision to the Court under Part V of the Act, it is the scheme identified by the Commissioner which is to be considered by the Court. In Peabody the scheme identified by the Commissioner included ten steps. It was held that it was that scheme involving those steps that was to be considered by the Court and that the learned trial Judge erred in holding that the scheme to be considered by the Court was merely one part of that scheme;
- • in determining whether the requisite tax benefit was obtained by the taxpayer in connection with the scheme it is necessary to determine what the expected outcome would be if the scheme adopted had not in fact been entered into or carried out;
- • Part IVA would seldom, if ever, operate to permit the Commissioner to make a determination where the overall transaction is in every way commercial, although containing some element which has been selected to reduce the tax payable.
Counsel for the Commissioner formally submitted that both Peabody and Jackson were wrongly decided; but I am sitting as a single judge of the Court and am therefore bound to apply both judgments. I shall proceed to determine this case by applying them.
The Commissioner formed the view that the provisions of Part IVA of the Act entitled him in the circumstances to make a determination pursuant to s. 177F to include in the assessable income of the taxpayers the interest received by them from the making of the loan to EPBCL. The making of the requisite determination under s. 177F of the Act was made in the following circumstances.
On 3 July 1989 the Commissioner delegated to the persons occupying and performing the office of Deputy Commissioner of Taxation his powers and functions under the Act mentioned in the schedule to the instrument. On 10 January 1991 the Commissioner directed Mr Highfield, a senior officer of the Commissioner, to perform the duties of the office of Deputy Commissioner and to exercise his powers and functions. Mr Highfield authorized senior officers, Grade B, to make determinations under Part IVA of the Act. Mr Farrow, an officer of the Commissioner who answered this last- mentioned description, made the relevant determination in this case in the name of Mr Highfield as Deputy Commissioner. No question of the validity of the determination arises in this case.
The first argument advanced by counsel for the taxpayers was that the Commissioner erred in his determination of the scheme in that he took a small piece of the relevant events, namely, the acts of Mr Levy in leaving Australia for the Cook Islands armed with authority to enter into the relevant transaction; travelling there and carrying out that transaction and determined that those events constituted the scheme. It was argued that the Commissioner isolated only a small part of what the taxpayers did and that this is precisely what Peabody says cannot be done by the Commissioner.
Counsel for the Commissioner argued that the Commissioner correctly, albeit narrowly, identified the scheme.
The scheme was determined by the Commissioner under s. 177F(1) to be as follows:-
``1. In the paragraphs below, consideration is given to the application of the provisions of Part IVA of the Income Tax Assessment Act 1936 (the Act) to the actions proposed, and carried out, by Spotless Services Ltd (the taxpayer) in the making, on or about 10 December, 1986, of a lending agreement with European Pacific Banking Corporation Ltd (EPBC) which was productive of $2,670,663 income for the taxpayer in the year of income ended 30 June, 1987.
2. That consideration is being made in circumstances in which, although I am of the opinion that the relevant amount of income was not exempt income pursuant to the provisions of section 23(q) of the Act, and thus was assessable income in the hands of the taxpayer, I am nevertheless having regard to the situation in which the sum of $2,670,663 did not form part of the assessable income of Spotless Services Ltd.
3. In considering, in the circumstances referred to in paragraph 2, the applicability of Part IVA in relation to the matters referred to in paragraph 1 above, it would appear necessary to establish:
- (a) whether there was, in the circumstances, a `scheme' as defined in section 177A(1); and
- (b) whether the scheme so identified is, pursuant to section 177D, a scheme to which Part IVA applies;
with the latter conclusion, if reached, requiring that there be a prior conclusion that a relevant person entered into the scheme for the purposes of enabling the present taxpayer to obtain a tax benefit in connection with the scheme.
4. In considering the question as to whether there was a scheme, it is noted that, although the relevant lending agreement was productive of the amount of $2,670,663 of income which is at issue, nevertheless the definition of `scheme' in section 177A(1) is such that the term does not apply solely to agreements, but rather the term may also apply to (non-contractual) courses of action which are carried out.
5. Thus, although there was a lending agreement between Spotless Services Ltd and EPBC which was productive of the relevant amount of $2,670,663 of income of the taxpayer, it is possible nevertheless to identify a range of particular plans, and courses of action, which the taxpayer conceived, and carried out, in relation to that lending agreement which could be characterised as `schemes' for the purposes of Part IVA.
6. The point made in the previous paragraph is illustrated by reference to the situation in which one corporate entity lends an amount of money to another, in circumstances where the terms of the lending agreement have been settled between the parties, and where there is no commercial advantage to the lender to have its authorised officer enter into the relevant agreement in any location other than the location in which he normally carries out his duties.
7. Thus, if it is indeed the case that there is no commercial advantage to be gained by a lender entering into a lending agreement at some location other than the location in which the relevant authorised officer of the lender normally carries out his duties - and it is difficult to conceive of any relevant advantage in so doing - then it follows that where there is a plan under which the authorized officer of the lender travels, in an exceptional manner, to some other location for the purpose of entering in to the relevant lending agreement, that plan is a plan which is conceptually distinct from, although related to, the lending agreement considered simply as a commercial agreement.
8. For the purposes of Part IVA, then, it is possible in the present case, by reference to the documents listed in paragraph 9 below, to isolate a scheme which consisted of the carrying out of a plan under which it was proposed that a lending agreement, which, ostensibly, was otherwise to be entered into on a commercial basis, should be made, not in the location in which it would be made on the basis of usual commercial considerations, but that it be made in a remote location, with that alternative location being chosen on the basis of considerations other than commercial considerations.
9. The documents referred to in the previous paragraph are:
- (a) an undated `Information Memorandum Relating to the Issue Of Certificates Of Deposit' published by EPBC;
- (b) memorandum of 26 November, 1986, to the Chairman and Directors of Spotless Services Ltd;
- (c) telex of 5 December 1986 from EPBC to Spotless Services Ltd;
- (d) grant of power of attorney by Spotless Services Ltd to Peter John Levy, dated 8 December, 1986;
- (e) a joint venture agreement of 8 December, 1986, between the taxpayer and Spotless Finance Pty Ltd;
- (f) minutes of meeting of the directors of Spotless Services Ltd, held on 9 December, 1986;
- (g) EPBC Certificate of Deposit, No. 156, of 10 December, 1986 issued to Spotless Services Ltd.
10. In the consideration of the application of Part IVA to the matters referred to above, it is necessary also to have regard to the matters referred to in section 177D(b) of the Act. Thus, regard will now be had to the matters referred to in section 177D(b) in connection with the question as to whether the taxpayer entered into or carried out the scheme, identified above, for the purpose of enabling the taxpayer to obtain a tax benefit, with each of the sub-paragraphs of section 177D(b) being considered in turn:
- (i) the scheme was contrived, in that there was no commercial reason for the taxpayer to perform the acts which constituted, on its part, its entry into the relevant agreement with EPBC;
- (ii) while the taxpayer may have been entering into an agreement with a profit- making commercial purpose, nevertheless the relevant scheme did not constitute part of any commerciality of the agreement as such, and the substance of the scheme, as distinct from substance of the lending agreement, was specifically non-commercial;
- (iii) the person given the power of attorney was acting under very specific instructions, and travelled outside of Australia for a single transaction only, and as such could not be said to be carrying on the business of the taxpayer outside of Australia during his brief period of absence from Australia;
- (iv) if section 23(q) is available to the taxpayer, then the result in relation to the operation of the Act that would be achieved by the scheme, but for the operation of Part IVA, would be that the amount of $2,670,663 would not form part of the assessable income of the taxpayer;
- (v) not applicable;
- (vi) not applicable;
- (vii) not applicable;
- (viii) not applicable.
11. It is thus possible to conclude that the taxpayer carried out the scheme for the purpose of enabling the taxpayer to obtain a tax benefit in relation to the scheme, namely the acquisition of a purported source outside of Australia for the amount of $2,670,663 of income, thus enabling that amount of income to become, by virtue of section 23(q), exempt income.
12. In that regard, it is further noted that, as the scheme (narrowly-conceived) had no commercial justification, then, the only conceivable purpose for the taxpayer in carrying out the scheme was to obtain the tax benefit referred to in paragraph 11 above. Accordingly, it follows, axiomatically, that it is not necessary to consider the application, to the facts of the present case, of the dominant purpose test provided in section 177D, when read in conjunction with section 177A(5).
13. For the above reasons, then, I am of the opinion that it would be appropriate to make, in relation to the scheme referred to in the foregoing paragraphs, a determination under section 177F(1) of the Act.''
The Commissioner supported this train of reasoning in the particulars of disallowance of the objections of the taxpayers furnished by him in the following terms:-
``Income Tax - Notice of Decision on Objection
Your objection, dated 11 April, 1991, against the amended assessment which issued on 15 February, 1991, in respect of
ATC 4416the year of income ended 30 June, 1987, has been considered and has been disallowed for the following reasons:
- (a) prior to the making of the determination in question, appropriate consideration was given to the matters referred to in section 177D(b);
- (b) a `scheme' for the purposes of Part IVA, namely the carefully considered and executed plan of action by the taxpayer under which it armed an officer of the company with authority to enter into a relevant loan agreement, and the sending of that officer to the Cook Islands in order to enter into that agreement, was properly identified;
- (c) that scheme was such that the taxpayer obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme, in that if the scheme had not been entered into the taxpayer would have entered into the relevant contract in Australia, and the interest income derived from the agreement would have been derived from Australia, and would thus have been assessable income in the hands of the taxpayer;
- (d) the sole purpose of the scheme was the obtaining of the relevant tax benefit, in that there was no commercial basis for the despatch of an officer of the company to the Cook Islands for the purpose of entering into the relevant loan agreement in that, for relevant commercial purposes, the agreement could as easily have been entered into in Australia;
- (e) on the basis of the above, it was a proper exercise of the Commissioner's discretion under the provisions of section 177F(1) to determine that the relevant benefit, in the amount of $2,670,663, should be included in the taxpayer's assessable income for the year of income ended 30 June, 1987;
- (f) accordingly, it was then appropriate, in accordance with the provisions of section 177F(2), to deem that the amount of $2,670,663 be included in the assessable income of the taxpayer for the year of income ended 30 June, 1987, by virtue of the provisions of section 25(1).''
A critical part, of the steps taken by the taxpayers to achieve their investment was the sending of Mr Levy to the Cook Islands and the entry by him there into the transactions on their behalf. This constituted the acceptance of the offer. But the offer cannot itself be ignored as part of the scheme and it is to be found in the telex of 5 December. The offer and the acceptance together with the intervening acts and probably the steps commencing with the receipt by the taxpayers of the information memorandum and other documents earlier than 5 December all constitute the relevant commercial transaction and the scheme. The Commissioner selected out of the relevant series of steps only some of them and classified that isolated segment as the scheme for the purposes of Part IVA. This he cannot do. In fairness to the Commissioner he did not have the benefit of the Full Court's judgment in Peabody when making his amended assessments in 1991. If he had, then he may have defined the scheme in different and wider terms.
The Commissioner's decisions on the objections of the taxpayers in respect of their respective assessments for the year of income must be set aside and the objections of the taxpayers to the amended assessments of income tax in respect of that year allowed.
I shall consider one other submission of counsel for the taxpayers as it was fully argued on both sides. Counsel argued that the Commissioner, having wrongly identified the scheme, fell into further error by wrongly carrying out his task under s. 177D. The section defines some eight things which, the Commissioner is required to take into account, followed by a balancing exercise in order to reach his conclusion as to whether the requisite purpose existed. It was argued that the Commissioner in fact took into account only those things that weighed against the taxpayers and not those which were in their favour. Reliance was placed upon the following passage from the judgment of Hill J. in Peabody at 4113-4114:
``In arriving at his conclusion, the Commissioner must have regard to each and every one of the matters referred to in s. 177D(b). This does not mean that each of those matters must point to the necessary purpose referred to in s. 177D. Some of the matters may point in one direction and
ATC 4417others may point in another direction. It is the evaluation of these matters, alone or in combination, some for, some against, that s. 177D requires in order to reach the conclusion to which s. 177D refers.''
In his determination the Commissioner said that sub-paragraphs (v), (vi), (vii) and (viii) of s. 177D(b) were ``inapplicable''. As mentioned earlier those sub-paragraphs read as follows:
``(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 was argued on behalf of the taxpayers that those were all relevant matters for consideration by the Commissioner, yet he failed to consider them and therefore erred, with the consequence that his determination is fundamentally flawed.
Counsel for the Commissioner argued that in reality what Mr Farrow did was to consider each of the matters mentioned in s. 177D(b) and came to a conclusion in respect of it. The fact that he concluded that certain of the subparagraphs were inapplicable does not mean that he did not consider them; it simply means that he considered them but, having done so, thought they were inapplicable. He may be right or wrong about that, but it does not follow that he did not consider the matters. The Act does not require that the Commissioner must be correct in respect of his consideration of each of those matters and give each of them appropriate weight, provided that he has considered them in good faith, which plainly he has.
Although the Commissioner said that he regarded subparagraphs (v), (vi), (vii) and (viii) of s. 177D(b) as ``inapplicable'', I do not regard the Commissioner as having thereby indicated that he ignored the matters referred to in those paragraphs. Had he done so then it is plain from Peabody that he would have fallen into error because he must have regard to each and every one of those matters before he performs his task of balancing or evaluation. By saying that they were regarded as inapplicable simply means, in my opinion, that the Commissioner, having had regard to the subparagraphs, saw nothing before him to assist in the conclusion whether or not the requisite purpose existed. This attack on the Commissioner's determination fails.
I shall not deal with the question of the purpose of the taxpayers in entering into the scheme. The Commissioner made a determination of the elements of the scheme too narrowly, and incorrectly (see Peabody); he thus approached the question of purpose on the basis that the elements of the scheme were as determined by him. It is unnecessary to analyze purpose when the basis on which the Commissioner approached the question is erroneous. Also, it is not appropriate to examine purpose of a scheme formulated on a wider basis than the formulation determined by the Commissioner.
Counsel referred in argument to s. 260 of the Act and its relationship to Part IVA. It is interesting to note that, if s. 260 had been operative at the relevant time the Commissioner would have been faced with the impossible task of saying that the section applied when the taxpayers would simply have taken advantage of a ``right of choice'' expressly given by the Act itself, namely, to invest money overseas and derive income from overseas sources, a right specifically granted by s. 23(q). The ``right of choice'' cases since Keighery's Case (
W.P. Keighery Pty Ltd v FC of T (1957) 11 ATD 359; (1956-1957) 100 CLR 66) would have led to that conclusion.
The former s. 260 and Part IVA bear interesting comparison. The word ``scheme'' as interpreted by the Courts with respect to s. 260 and its meaning as defined by s. 177A(1) are much the same. But Part IVA gives the Commissioner an express power of reconstruction, a power denied the Commissioner under s. 260. Section 260 related to the purpose of avoiding tax: see
Newton & Ors v FC of T (1958) 11 ATD 442; (1958) 98 CLR 1, which is an objective purpose. There are semantic differences between s. 177B of
ATC 4418Part IVA and from the language of judgments of courts in propounding the proper tests for the application of s. 260; but for Part IVA to apply it is necessary that a person enters into the scheme for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme (s. 177D). Of the eight circumstances listed in the section to which the Commissioner must have regard, none of them involves the subjective purpose or intent of a person to obtain a tax benefit; the circumstances predicate objective tests. Thus, there is some link between s. 260 and Part IVA.
Section 177C(2) and (3) exclude the operation of Part IVA where the tax benefit is derived from the making of a declaration, election, notice or option etc. expressly provided for by the Act. In my opinion, as presently advised, unless the exclusions of sub- s. (2) and (3) operate, the choice doctrine applicable by judicial decision to s. 260 is inapplicable to Part IVA. However, I have no concluded view on that question.
For these reasons I would order that the appeals be allowed and that it be ordered that the objection decisions in respect of the amended assessments of the taxpayers for the year of income ended 30 June 1986 be set aside and that the objections of the taxpayers to the amended assessments of income tax in respect of that year be allowed. I would order that the matters be remitted to the Commissioner for determination in accordance with law. The Commissioner must pay the costs of the taxpayers of the appeals.
THE COURT ORDERS THAT:
1. The four appeals be allowed.
2. The objection decisions in respect of the amended assessments of Spotless Services Limited and Spotless Finance Pty Limited for the year of income ended 30 June 1986 be set aside.
3. The objections of Spotless Services Limited and Spotless Finance Pty Limited to the amended assessments of income tax in respect of that year be allowed.
4. The matters be remitted to the Commissioner of Taxation for determination in accordance with law.
5. The Commissioner of Taxation pay the costs of Spotless Services Limited and Spotless Finance Pty Limited of the appeals.