Case X58

Members:
CJ Bannon QC

Tribunal:
Administrative Appeals Tribunal

Decision date: 6 July 1990.

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C.J. Bannon Q.C. (Deputy President)

The taxpayer is a family-controlled proprietary company (``Alpha'') and seeks review of a decision of the Commissioner of Taxation (``the respondent'') on the Alpha company's objection to an assessment of income tax for the financial year ended 30 June 1980. In the Alpha income tax return for the financial year in question (ex. A), Sch. 16 discloses the sale of a share in another proprietary company (``the trustee company'') for over half a million dollars, but makes the claim that such moneys are a capital receipt of moneys for the share which, it is asserted, ``was not acquired for speculative or profit-making purposes''. The trustee company had two shareholders, each a proprietary company, holding one share each paid up to $1 - those shares having been acquired in 1976 (ex. C, para. 11).

At all relevant times, certain medical services were provided through a business conducted by a proprietary company (``MPS'') as trustee of a unit trust (``MPSUT'') (see affidavit of the medical practitioner, hereinafter called ``the parent'', ex. C, para. 14). The business conducted by MPS generated substantial income, and in the financial year 1980 it was decided on 27 June 1980 to distribute approximately $1,250,000 of that income to the trustee company, which was the holder of all the units in MPSUT. So far, it seems clear that the distribution rendered the trustee company liable to pay income tax under Pt III Div. 6 of the Income Tax Assessment Act 1936 (Cth) (``the Act'') if no beneficiary was presently entitled to the income. According to the affidavit of the parent, para. 15 (ex. C), all the income of MPSUT was distributed to the trustee company as trustee of another trust ``MD Trust''.

The two shareholders of the trustee company, designated as the Alpha and Beta companies, at all relevant times were family companies, with the parent as chairman of directors (ex. C, para. 3 and 5). Alpha and Beta were also eligible beneficiaries within the meaning of cl. 1(f) of the MD Trust (ex. D). It therefore seems correct that if the trustee company had distributed the income received by it from MPS as trustee of MPSUT, to Alpha and Beta as eligible beneficiaries of the MD Trust, Alpha and Beta would have been liable to pay income tax on their respective shares of the income.

The fact is that approximately one-half of the income received by the trustee company from MPS as trustee of MPSUT eventually was received by each of the Alpha and Beta companies, in both of which the parent was chairman of directors. However, the way it got there was by a path which will now be outlined.

Tax scheme

Instead of appointing the income of the MD Trust to one or more of the eligible beneficiaries set out in Sch. 1 to the trust deed (ex. D), on 29 June 1980 the parent removed himself as the person having the power to appoint and remove trustees of the MD Trust, and appointed the trustee company to exercise such powers (ex. C, annexure C). At the same time, the parent, purporting to act in pursuance of para. 14 of Sch. 1 of the trust deed of the MD Trust, appointed a proprietary company ``L'' as an eligible beneficiary under the MD Trust (ex. C, annexure D). On the same day, a meeting of the directors of the trustee company was held, at which it was resolved that the whole of the income and capital of the MD Trust was irrevocably appointed to L (ex. C, annexure E).

On 30 June 1980, the two companies Alpha and Beta resolved to sell their shares in the trustee company to a further proprietary

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company ``S. Pty. Ltd.'' (ex. C, annexure F). The sale was the subject of an agreement between S. Pty. Ltd. and Alpha and Beta (ex. C, annexure G, as explained in para. 28 of the affidavit ex. C). To complete the circulation of money, a series of directions were given (annexures J to N inclusive, ex. C). On one view, these had the total effect that the moneys due from S. Pty. Ltd. for the purchase of the shares of Alpha and Beta in the trustee company, passed half each to Alpha and Beta and then through them to the parent, and from him back to the trustee company, but as appears from ex. 1, item G, the real steps of money circulation taken were through another company which sent the money to S. Ltd. as an alleged loan. At that stage, $30,000 commission was syphoned off to the ``consultant'', a person I hasten to add who was not a member of the legal profession. The balance was then transferred as to half each to Alpha and Beta. It is this half payment which is the money disclosed in the income tax return (ex. A, Sch. 16).

Submissions

The respondent submits that the arrangements outlined in the paragraphs under the heading ``Tax Scheme'' were artificial arrangements void as against the respondent pursuant to sec. 260 of the Act. On behalf of Alpha, Mr A. Slater of counsel agreed they were artificial arrangements designed to avoid the incidence of income tax, but said the respondent acted under a misconception in assessing Alpha when he should have assessed the trustee company or MPS under sec. 100A of the Act. He submitted that sec. 260 cannot be relied upon to reconstruct a tax liability in Alpha if such liability does not arise from the circumstances revealed by its operation.
John v. F.C. of T. 89 ATC 4101 at p. 4108.

Apart from any effect of sec. 260 of the Act, the decision of the parent to appoint L company as an eligible beneficiary of the MD Trust, and the decision of the trustee company as the then trustee of the MD Trust to appoint the whole of the capital and income of the MD Trust to the L company, are both open to doubt. The MD Trust was established, it would seem, primarily for the benefit of the wife and family of the parent and his family companies, being the persons mentioned in Sch. 1 to ex. D. L company appears to have been a vehicle employed in the income-stripping schemes of the consultant. In my opinion, it was an excess of power, and a breach of trust, for the trustee company to appoint the capital and income of the MD Trust to the L company.
Re Ball's Settlement Trusts (1968) 1 W.L.R. 899 at p. 905; In
re Holt's Settlement (1969) 1 Ch. 100 at pp. 116-117; In
re Pilkington's Will Trusts (1964) A.C. 612 at p. 629 per Lord Reid and at p. 641 per Viscount Radcliffe. What was done was not believed to be for the benefit of the beneficiaries, but for the benefit of a tax scheme. It attempted to change the whole substratum of the trust. The price paid for the shares in the trustee company is not predicated on their real value of $1 each, but is based on the breach of duty by the trustee company, and the value of the income wrongly stripped from that company and passed on by various means to the Alpha and Beta companies.

Leaving aside the effect of sec. 260, the Commissioner may still be in a position to assess the trustee company to tax, and for a liquidator to trace the moneys paid to the Alpha and Beta companies or their beneficiaries, so as to obtain payment of the tax from the trustee company. The income of the MD Trust was not formally appointed to the Alpha and Beta companies. It never was, and they had no present entitlement to that income under the terms of the MD Trust in default of the appointment to the L company. The rule in
Saunders v. Vautier (1841) 4 Beav. 115; 49 E.R. 282 cannot be applied, because the determination of the ultimate beneficiaries as to capital had not then taken place, and the resolution of the directors of the trustee company fixing the closing date of the MD Trust (ex. C, annexure E) fixed it at 1 July 1980. In my opinion, cl. 4.1(iii) of the MD Trust Deed (ex. D) cannot therefore be prayed in aid to give sec. 100A of the Act any operation.

What then is left exposed after the annihilating effect of sec. 260 of the Act is applied? The answer appears to be that MPSUT distributed income to the trustee company, being the trustee at the relevant time of the MD Trust. Further, by various means, that income of the MD Trust (subject to minor exceptions) was distributed to Alpha and Beta, two of the eligible beneficiaries of income under the MD Trust, although without the benefit of a formal appointment to them. Once the scheme is

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struck down, the characterisation of the money received by Alpha as a capital receipt also disappears as against the respondent.

Mr G.K. Downes Q.C. for the respondent pressed the Tribunal with the analogy of
F.C. of T. v. Gregrhon Investments Pty. Ltd. & Ors 87 ATC 4988. Mr Slater pointed out that Gregrhon was concerned not with trust income, but with Div. 7 tax, on dividends of a private company and was not concerned with sec. 44 of the Act. However, in my opinion, the words of Lockhart J. in Gregrhon at p. 5007 are applicable to this case:

``Viewed objectively, to my mind it is plain that there was but one transaction involving a series of integrated and mutually dependent steps including the sale and transfer of shares by the respondents to the Shareholder interests and an interlocking flow of funds.''

Mr Downes also referred me to the observations of the High Court in
F.C. of T. v. The Myer Emporium Ltd. 87 ATC 4363 at pp. 4366-4367; (1987) 163 C.L.R. 199 at pp. 209-210 concerning gains from isolated business transactions being regarded as income. In my opinion, there is some difficulty in applying that judgment once the Commissioner relies successfully, as he does here, on sec. 260 of the Act to strike down the mechanism for the acquisition of the money by Alpha.

Before proceeding further, it is incumbent upon me to make a finding as to the parties to the arrangement, affected by sec. 260. In my opinion, the evidence from the affidavit (ex. C), ex. No. 1 and 2, and the admissions made, establish that those parties are the person referred to as the parent, the trustee company, the companies Alpha and Beta, and L company and S. Pty. Ltd. The proper inference from the evidence is that the arrangement was to transfer the income derived by the trustee from the MD Trust to Alpha and Beta, two of the eligible beneficiaries under that trust, without formally appointing the income to them, by the strategem of appointing the L company as a new eligible beneficiary under the MD Trust and utilising the money payable to the L company to fund the sale by Alpha and Beta of the two shares in the trustee company each for a sum roughly equivalent to half the income of the MD Trust so characterising the receipt as capital rather than income.

On behalf of Alpha it was submitted as follows:

``4. That there was a scheme to avoid tax cannot be disputed. However, the tax avoided was not tax which would have fallen on the applicant, and sec. 260 cannot be used to support an assessment upon the applicant.
Rowdell Pty. Ltd. v. F.C. of T. (1962) 111 C.L.R. 106 at pp. 125, 117, 135;
Stamp v. F.C. of T. 88 ATC 4803 at p. 4805.

5. Moreover, sec. 260 cannot be used to erect or `reconstruct' a tax liability in a taxpayer if such liability does not arise from the circumstances revealed by its operation: John v. F.C. of T. 89 ATC 4101 at p. 4108. Here if the steps in the scheme identified by the Commissioner are taken away nothing is revealed which would impose a liability on the applicant. It is treated as if it had not sold its shares at all; it is certainly not assessable on any profit arising on sale.''

I do not accept the second sentence of the first of those submissions. I consider the tax would have fallen on Alpha as the ultimate recipient of income of the MD Trust. As to the second submission, I agree with it, but believe it is answered by the finding of fact which I have made, and my acceptance of the words of Lockhart J. as applicable to this case. I consider the moneys received by Alpha, when the offending transactions are struck down, is revealed to be an income receipt, and not a capital receipt, from the sale of shares as claimed.

Submissions were also made to me on behalf of the respondent as to whether the moneys in question were liable to be taxed pursuant to sec. 25(1), 26(a), 97, 99B, 26(b), 44 or 47 in that order of preference. The respondent, in the course of argument, was uncertain as to which provision would be applicable. As to those provisions, I agree with the submissions of counsel for Alpha set out below:

``2. The first limb of sec. 26(a) has no application. For the first limb to apply, the property in question must have been acquired with a dominant purpose of resale at a profit:
Burnside v. F.C. of T. 77 ATC 4588 at pp. 4595, 4593-4594; (1977) 138 C.L.R. 23 at pp. 28, 35.

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3. The second limb of sec. 26(a) is also inapplicable. For the second limb to apply in respect of an asset not acquired for resale at a profit there must be a scheme to employ that asset to profit-making advantage. Where the asset is not committed to a scheme or undertaking, but is simply sold, sec. 26(a) has no application. Burnside v. F.C. of T. ATC at pp. 4590-4591, 4594-4595, 4603, 4604, 4595; C.L.R. at pp. 27, 37, 49, 50, 28;
White v. F.C. of T. (1970) 120 C.L.R. 191 at pp. 219, 217;
F.C. of T. v. Williams 72 ATC 4188 at pp. 4192-4193, 4194-4195; (1972) 127 C.L.R. 226 at pp. 245-246, 249;
McGuiness v. F.C. of T. 72 ATC 4023 at pp. 4027-4028.''

However, I do not accept counsel's submission based on sec. 25, predicated on treating the moneys received by Alpha as being the receipt of profits on the sale of a share in the trustee company. Considering all the other sections nominated, I have formed the view that the moneys in question are liable to assessment either under sec. 99B or 25 or both.

Accordingly, I have come to the conclusion that the objection decision under review should be affirmed.