CASE 23/94

Members:
BA Barbour SM

Tribunal:
Administrative Appeals Tribunal

Decision date: 17 May 1994

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BA Barbour (Senior Member)

These applications, lodged with the Tribunal on 20 September 1993, seek review of objection decisions of the respondent dated 21 July 1993 disallowing the applicant's objections of 15 May 1992. The applications relate to assessments for the years ending 30 June 1988, 1989, and 1990.

2. The Tribunal had before it documents (T documents) lodged pursuant to section 37 of the Administrative Appeals Tribunal Act 1975 (AAT Act), and a file of documents lodged by the taxpayer. The applicant company was represented by Mr Geerson, and the respondent Commissioner by Mr Dalby. Mrs P, a director and shareholder of the applicant company, was unable to attend the hearing of this matter, and a medical certificate was produced to explain her absence. Following her agreement, and the agreement of all the parties and the Tribunal, Mrs P gave evidence to the Tribunal over the telephone. Mr P, the husband of Mrs P, and a director and shareholder of the applicant company, gave oral evidence in person.

3. Prior to the hearing of this matter, the parties had reached agreement in relation to many of the matters in dispute before the Tribunal, and sought a decision in the agreed terms pursuant to section 42C(3) of the AAT Act. The Tribunal is satisfied that such matters

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as have been agreed upon are within its jurisdiction, and believes it appropriate to give effect to the terms of that agreement. Those orders are set out at the end of these reasons.

4. The single issue to be decided by the Tribunal is whether the sum of $6900 paid to Mrs P as remuneration for her services in the year ending June 1988, as a director of the applicant was in excess of what was reasonable, pursuant to section 109 of the Income Tax Assessment Act 1936 (Tax Act). The applicant company said that those services were properly valued at $6900, while the respondent contended that the proper value of Mrs P's services as director was nil.

5. Section 109 of the Tax Act provides:

``109(1) If a private company pays or credits to an associated person an amount (in this subsection called the `excessive amount' ) that is, or purports to be:

• (a) remuneration for services rendered by the associated person; or
• (b) an allowance, gratuity or compensation in consequence of the retirement of the associated person from an office or employment held by the associated person in the company, or upon the termination of any such office or employment;

so much (if any) of the excessive amount as exceeds an amount that, in the opinion of the Commissioner, is reasonable:

• (c) is not an allowable deduction; and
• (d) shall, for the purposes of this Act other than Division 11A of Part III and Division 4 of Part VI, be deemed to be a dividend paid by the company:
  • (i) to the associated person as a shareholder in the company;
  • (ii) out of profits derived by the company; and
  • (iii) on the last day of the year of income of the company in which the excessive payment or credit is made.''

6. There is no issue between the parties that the applicant is an associated person, she being a shareholder and director of the company at the relevant time (Section 109(3), since repealed, and Section 26AAB(14) Tax Act).

7. The facts, as summarised but not fully stated by the Tribunal, are that the applicant is a small family company, of which Mr and Mrs P are the only shareholders and directors. Prior to the 1988 tax year, Mr P gave evidence that the applicant company had variously engaged in the operation of an oil depot and a milk run, and since 1983 had carried on a business transporting concrete under contract for Boral Limited. Mr and Mrs P had both worked for the company in all these ventures, and had both been paid wages by the applicant company.

8. Mr and Mrs P operated the concrete carting business together in the 1988 tax year, the husband driving the truck, and the wife, among other duties, keeping the books of the business, ensuring the company office (which was located at the home of Mr and Mrs P) was attended at least three hours every business day, and collecting and delivering spare parts to Mr P while he was on site. As was agreed between the parties, and as the Tribunal has found appropriate, the value of Mrs P's services as an employee of the applicant company for the 1988 tax year was $4250.

9. Mr and Mrs P also gave evidence that decisions in relation to the continuing direction of the applicant company were made jointly by them, and Mr P's evidence was that without the assistance of Mrs P the company would not have succeeded. Both Mr and Mrs P were guarantors for loans made to the company by financial institutions. Although formal meetings were not held by the company, Mrs and Mr P would discuss matters relating to the applicant company's business future at any time that this was necessary.

10. Mrs P was asked questions in relation to her responsibilities as a director of the applicant company, and her response was to the effect that she had to look after everything, ensure that tax was paid, and that the applicant obeyed company laws, although she was unable to point to specific statutory requirements. Mrs P also gave evidence in relation to her understanding of the company's superannuation and taxation obligations. Mrs P was unable to identify legislation that dealt with her corporate law responsibilities. No oral evidence was taken in relation to Mrs P's duties as secretary of the applicant company.

11. The original tax return filed by the applicant recorded Mrs P's wages as $12500 (see T3, page 11), but the applicant's objection to assessment broke up that remuneration to

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include $5600 as wages and $6900 as director's fees.

12. Mrs P was unable to indicate to the Tribunal the way in which the remuneration for directors' services was calculated, although her evidence suggested that it was related to the success or otherwise of the business.

13. Mr P's evidence confirmed the link of the payment to the profitability of the business. He explained that if there was something that Mr and Mrs P wanted, be it for business or private use, and the applicant company could afford it, then company funds would be used to purchase that object. For example, if Mr and Mrs P needed a new television, and did not have sufficient funds to purchase it, then the money would come from the company. It was recorded on the cheque butt that the money was for private use, and this sum was later attributed to directors' fees. The amount of directors' fees was the amount of business funds used to buy personal things. At no time did Mr and Mrs P sit down and decide what was an appropriate recompense for directors' services, and pay that to Mrs P. Mr P also stated that this was the first time that the company had made sufficient funds for the directors to be paid a fee for their services.

14. I have had regard to all the other material placed before the Tribunal. Before proceeding to the various submissions, I consider both Mr and Mrs P to have been truthful and honest witnesses, who gave their evidence in a frank and forthright manner. I find the facts as stated above to be true. There are two matters that I wish to comment on further in relation to other material before me.

15. The applicant's tax return for 1989 indicates that an amount of $12000 was paid to her as director of the applicant company. This amount was not disallowed by the Commissioner in the amended assessment, and Mr Dalby explained that this was due to an oversight on the respondent's part, and would probably be reconsidered following the Tribunal's decision in this matter. Hence, there was no objection by the applicant to the Commissioner's amended assessment for that year in respect of that amount.

16. This deduction for director's fees is not before the Tribunal: see section 14ZV Taxation Administration Act 1953. Given that both the 1989 and 1990 tax years are before the Tribunal on these applications, it would seem to me that the more appropriate course would have been for disputes in relation to remuneration for services by Mr and Mrs P in those later years to have been before the Tribunal on this occasion.

17. I also commented at the hearing of this matter that evidence was not led by the applicant in relation to the remuneration to Mr P for his services as director in the 1988 tax year. While the tax return of the applicant company indicates that an amount of $13500 was paid to Mr P in that year as wages, and no money for his service as director (see T3, page 13), the figure may well represent both wages and a director's fee, as it did for Mrs P. Mr Geerson was unable to provide the Tribunal with a breakdown of that amount. This material would have been highly relevant to the Tribunal's present inquiry.

18. I wish first to deal with the submission of the respondent that the applicant company had not shown that it had incurred an expense, and therefore the fees paid were not deductible pursuant to section 51(1) of the Tax Act. The respondent sought leave to put this in issue in a letter addressed to the applicant's Mr Geerson and faxed to the Tribunal on 2 May 1994. It was not argued at any length before me, and the respondent did not indicate the grounds upon which the submission was based.

19. The question of deductibility under subsection 51(1) of the Tax Act is a separate inquiry to that undertaken when deciding if remuneration paid to an associated person is reasonable, the question being whether the amount paid by the business is an allowable expense; see e.g.
W.J. & F. Barnes Pty Ltd v FC of T (1957) 11 ATD 170; (1957) 96 CLR 294.

20. In Case K54
(1959) 10 TBRD 283, Mr Burke, the Chairman of the Board of Review No. 1, stated that:

``It seems clear from a reading of Barnes Case that the exercise or purported exercise of discretion by the Commissioner under s. 109 presupposes that the payment being dealt with by the Commissioner is of such a description that it would, apart from s. 109, constitute an allowable deduction... The question of the allowability of a payment as a deduction is one question, and... The question whether an otherwise allowable deduction should be reduced because it is unreasonable in amount is another question. It is a distinct and different question...''

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21. The applicant claimed as an outgoing, an amount of $12500 that had been paid to Mrs P, initially because it was said that this sum represented wages to her (see T3, page 13), and later because it was said that this sum represented wages ($5600) and director's fees ($6900). In oral evidence, Mr P stated that he came to an amount of director's fees by totalling the money spent out of company funds on private requirements; it was not clear to me if this exercise was used to calculate the 1988 director's fee to Mrs P. It was not submitted by the respondent that Mrs P did not receive the fees that are claimed by the applicant company as a deduction. I was not directed to any evidence that put in issue the payment of this sum, for whatever reason, to Mrs P.

22. I find, therefore, that the amount of $12500 paid to Mrs P was an outgoing incurred by the applicant company for her services as a director and employee of the applicant company. It is an allowable deduction pursuant to subsection 51(1), but only to the extent that it represents a reasonable remuneration pursuant to section 109 of the Tax Act. I turn then to the question of whether that deduction should be reduced because it is an unreasonable amount.

23. The applicant submitted that Mrs P was properly paid $6900 for her services as a director of the applicant company. It was submitted that when all matters are taken into consideration, for example, the onerous responsibilities of a company director and potential liabilities to which Mrs P exposed herself, the past services of Mrs P to the company, the ability of the company to pay Mrs P director's fees, and the cost of directors' indemnity insurance, an amount of $6900 was reasonable remuneration for the services rendered by Mrs P as a director of the applicant company. The applicant referred the Tribunal particularly to
Ferris v FC of T 88 ATC 4755.

24. Ferris's case dealt with section 109 of the Tax Act prior to its amendment in 1987, that section being substantially similar to the current section 109 (above). As cited in that case [at p 4758], Fisher J in
FC of T v Comber 86 ATC 4171 [at p 4176] stated that, in general terms, ``... [Section 109] seeks to ensure that the profits of private companies are not reduced by loans or payments of excessive remuneration or retiring allowances to shareholders, directors or others close to these persons...''

25. The applicant in that case was given an ex-gratia payment by a company that he had been instrumental in establishing, in consideration for his past services, and upon his leaving the employ of that company. The decision was made by directors of that company other than the applicant, and independent of him. Davies J, in remitting the matter to the respondent, noted [at p 4761] that:

``The discretion conferred by sec. 109 involves a decision in each particular case as to whether or not a payment or the amount of a payment was in the circumstances... reasonable... the circumstances which come up for consideration are infinitely variable.''

26. A similar approach was adopted in Case U64,
87 ATC 406, a case dealing with remuneration for services rendered in not dissimilar circumstances to the present matter, where Purvis J noted that ``... what is reasonable remuneration depends very largely on the value of the services rendered by the taxpayer to the relevant company...'', and that ``... what is reasonable must and can only be answered by a consideration of all the relevant circumstances in the evidence...''.

27. The respondent submitted that the question of what was reasonable remuneration for services depended on the value to the company of those services rendered. Having regard to her services as a director, as opposed to those as an employee, their value was properly nil. Even if the Tribunal found that Mrs P had minor duties as a director, the respondent contended that the applicant had not shown the number of hours Mrs P had devoted as director, nor the value of this, and hence had not shown that the assessment was excessive (as required by section 14 ZZK AAT Act).

28. I would qualify the respondent's suggested approach by noting that, while I am not compelled by the Tax Act to use a mathematical formula to arrive at an appropriate remuneration based on an hourly rate (see K54), I must be satisfied that the remuneration to Mrs P represents the value of the services rendered by her (see Case 70
(1944) 11 CTBR 145). That figure is only determinable by a consideration of all the circumstances. It is for the applicant to show that the figure claimed represents, in all the circumstances, a reasonable remuneration.

29. Duties of directors include ``... making decisions on marketing, management,

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accounting procedures, investment and development matters, cash flows, the company's performance...''; see Directors' Powers and Duties, JF Corkery, 1987. They are to be found in the articles of association, the common law and statute, and it is required that directors exercise ``... a reasonable degree of care and diligence...'' in the performance of their functions; see e.g., section 229(2) Companies Act 1981, and section 232(4) Corporations Law.

30. Mr Geerson submitted a folio of material containing a list of the responsibilities of directors, and outlining, in section 1, a list of the responsibilities of Mrs P as the company director and secretary. I have had regard to those matters, and note that there is substantial overlap between the duties of Mrs P as employee, and as director.

31. Additional duties or responsibilities peculiar to Mrs P as a director rather than an employee include her potential personal liability to creditors and others for failure to take reasonable care or comply with statutory duties, her participation in determining the future direction of the company, and her guaranteeing a loan made to the company. Mrs P. was always ``on call'' to help deal with problems of any nature that arose.

32. Mrs P's evidence indicated that she did not have an especially good grasp on the extent of her responsibilities as a company director (as opposed to those of employee), and the potential liabilities to which she was exposing herself. She was not an expert in the field of concrete transport, or of small business or office administration, which made up the bulk of her responsibilities as an employee.

33. The calculation of Mrs P's director's fees was most likely achieved by totalling the amount of company monies spent on private goods. The applicant company was therefore not in a position of being able to point to any resolution or other determinative process that illustrated an assessment had been made regarding the value of Mrs P's services as director.

34. Having regard to all the matters given in evidence, both oral and by submission, and regarding the figure paid to Mrs P as employee of the applicant company, I find that the sum of $6900 is excessive remuneration for the services of Mrs P as a director. I would regard a sum of approximately $50 per week to be a reasonable remuneration to Mrs P for her services as a director of the applicant company in the 1988 tax year. This is so having regard to her previous service to the company, her exposure to liability, her input into company decision making, and the ``on call'' nature of her responsibilities. While I accept that there is a degree of subjectivity in that figure, I am of the opinion that it accurately reflects the value of Mrs P's services to the company. This is in addition to, and for duties other than, those provided as employee to the company, for which Mrs P received approximately $80 per week.

35. For the 1988 tax year, I find that $2500 is reasonable remuneration for Mrs P's services as a director of the applicant company. The excessive amount of $4400 is therefore characterised as a dividend paid to Mrs P; see section 109(1)(d) of the Tax Act.

36. Because the parties have agreed to other matters before the Tribunal, I will vary the decisions under review, and decide that the applicant be allowed the following deductions:

• 1. $2500 for the year ending 30 June 1988, representing director's fees paid to Mrs P;
• 2. $4250 for the years ending 30 June 1988, 1989 and 1990, representing wages paid to Mrs P;
• 3. $437 for the year ending 30 June 1988, $567 for the year ending 30 June 1989, and $629 for the year ending 30 June 1990, representing telephone, light and power expenses;
• 4. $260 representing security expenses, $200 representing cleaning expenses, $62 representing printing expenses, and nil legal expenses for the year ending 30 June 1990.

37. The Tribunal otherwise affirms the objection decisions under review.