Decision impact statement
Commissioner of Taxation v H
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Court Citation(s):
[2010] FCAFC 128
2010 ATC 20-218
85 ATR 357
(2010) 188 FCR 440
(2010) 274 ALR 1
Venue: Federal Court of Australia
Venue Reference No: NSD 211 of 2010
Judge Name: Downes, Edmonds and Greenwood JJ
Judgment date: 20 October 2010
Appeals on foot:
No.
Impacted Advice
Relevant Rulings/Determinations:
Subject References:
Distributable surplus
Division 7A
General Interest Charge
Net assets
Present legal obligation
Précis for the web page index:
Outlines the ATO response to the decision of the Full Federal Court in relation to when income tax and general interest charge assessed by an amended assessment are 'present legal obligations' for the purposes of calculating a company's net assets and distributable surplus.
Decision Outcome
Commissioner's appeal dismissed
Brief summary of facts
The taxpayer was a director and shareholder of a company, Waffles Pty Ltd ('Waffles'). Between 1999 and 2001, Waffles had an arrangement with an overseas company in which Waffles paid the overseas company amounts described as 'marketing expenses' and the overseas company remitted approximately 90% of those amounts back (directly or indirectly) to the taxpayer's bank account. Waffles claimed deductions for the 'marketing expenses'.
In 2007 the Commissioner disallowed the deductions Waffles had claimed for the marketing expenses in the 1999 to 2001 income years, and made amended assessments increasing Waffles' taxable income and tax payable, and imposed general interest charge ('GIC') under s 204 of the Income Tax Assessment Act 1936 ('ITAA 1936').
In 2007 the Commissioner issued amended assessments to the taxpayer, assessing him pursuant to Division 7A on his share of the amounts deposited into the bank account, as payments treated as dividends pursuant to s 109C of the ITAA 1936.
In calculating Waffles' distributable surplus under s 109Y for the purposes of Division 7A as at 30 June 1999, 2000 and 2001, the Commissioner did not subtract any amount of tax payable by Waffles under the amended assessments made in 2007 from its net assets, as the tax payable under the amended assessments was not considered to be a present legal obligation of Waffles as at the end of the relevant income years. Similarly, the Commissioner did not subtract any amount of GIC in calculating the company's net assets.
The taxpayer objected to the amended assessments; the objection was disallowed, and he subsequently applied to the AAT for review of the objection decision.
The AAT held that income tax, having been imposed by the Income Tax Act 1986 to be payable for each year, was a present legal obligation of the company as at the end of each income year. The obligation was to pay tax at the amount subsequently properly ascertained, assessed and determined. The amounts of tax payable under the amended assessments made in 2007 in respect of the 1999, 2000 and 2001 income years should have been subtracted from the company's net assets in calculating its distributable surplus as at 30 June in the income years 1999, 2000 and 2001.
The AAT also held that as s 204 of the ITAA 1936 provides that GIC accrues daily while tax is unpaid after the due date, the GIC also was a present legal obligation as at 30 June of the 1999 to 2001 income years for the purposes of the s 109Y distributable surplus calculation.
The Commissioner appealed to the Full Federal Court.
Issues decided by the court
Income Tax
The Court considered the legislative context of s 109Y and the explanatory memorandum to the Bill introducing Division 7A, and found that the purpose of s 109Y was to provide a 'cap' or limit on the amount to be treated as assessable dividends, namely, up to but not exceeding the realised and unrealised profits in the company, and the meaning of 'present legal obligation' and 'distributable surplus' should be interpreted in that context
The Court observed that the profits of a company available for distribution are 'after-tax' profits, and considered that a construction of s 109Y which promotes that result is to be preferred to one that does not.
The Court considered that the term 'obligation' embraces situations outside of a creditor/debtor relationship, and concluded that prior to an assessment, the company had an obligation to pay income tax arising from the operation of the Income Tax Act 1986. That obligation came into existence on 30 June of the year of income in which the income was derived. At worst that obligation might be a contingent obligation (contingent on an assessment being made), but that does not disqualify it as a present legal obligation in the sense that it exists as at 30 June, though the obligation is to do something at a future date.
The Court agreed with the AAT that the obligation to pay income tax arises by operation of the Income Tax Act 1986 itself, and not by the issue of a notice of assessment. On the making of an assessment, the present legal obligation arising from the Income Tax Act 1986 matures into an enforceable debt that becomes due and payable.
Accordingly, the Court found that the obligation to pay tax at the amount subsequently properly ascertained, assessed and determined was a 'present legal obligation', for the purposes of s 109Y, as at the end of the financial year in respect of which the income is derived.
GIC
The Court agreed with the AAT's observations that a person's liability to the GIC accrues on a daily basis as a direct consequence of the fact that tax remains unpaid after the due date. As a consequence, GIC becomes a present legal obligation on each day on which tax that should have been paid remains unpaid.
The fact that the Commissioner can remit GIC does not alter this position. Unless and until remitted, GIC remains a 'present legal obligation' on each day on which the tax that should have been paid remains unpaid.
Tax Office view of Decision
The decision applied the following principles in calculating the distributable surplus for the purposes of s 109Y(2) of the ITAA 1936.
Income Tax
The obligation to pay income tax for a particular year of income is a present legal obligation of a company at the end of that year of income. That obligation is to pay tax that is subsequently properly assessed.
If an amended assessment is made in relation to a particular year of income, the calculation of distributable surplus (where relevant) in relation to that year is similarly amended to reflect the tax payable on the amended assessment. That is, an amended assessment is a present legal obligation of the year to which it relates, rather than the year in which it is made.
While the Full Federal Court referred specifically to years of income ending on 30 June, the decision will also apply to companies which have a substituted accounting period.
GIC and SIC
The Court and the Tribunal considered that because liability to GIC accrues on a daily basis as a direct consequence of the fact that tax remains unpaid after the due date, GIC is considered to be a present legal obligation on each day the amount remained unpaid.
GIC payable due to an amended assessment is treated as a present legal obligation in the year in which it accrues (unless it is subsequently remitted).
The Commissioner notes that the assessments before the Court were for the years ended 30 June 1999 to 30 June 2003 (inclusive), and that amendments were made to the GIC regime by the Income Tax Amendment (Improvements to Self Assessment) Act (No. 1) 2005. Those amendments revised the due date for tax payable under amended assessments, and introduced the Shortfall Interest Charge (SIC).
Tax shortfall penalty
The Tribunal's decision on tax shortfall penalty was not appealed to the Federal Court and it accordingly stands. Tax shortfall penalty is not a present legal obligation of a company until an assessment of shortfall penalty is made.
Administrative Treatment
The ATO has reviewed TD 2007/28 and TD 2012/10 (which replaced TD 2008/28) following the decision of the AAT in this matter. The view expressed in the TD's reflected the decision of the Full Federal Court in Commissioner of Taxation v H [2010] FCAFC 128. This matter did not espouse any new principle and simply applied the decision in H. As such no further amendments were required to be made to any ATO precedential documents.
Implications on current Public Rulings & Determinations
The ATO is reviewing TD 2007/28 and TD 2008/28 to accord with the decision of the Full Federal Court.
Implications on Law Administration Practice Statements
None
Amendment history
| Date of amendment | Part | Comment |
|---|---|---|
| 9 April 2014 | Administrative treatment | Updated to reflect that all administrative treatment has been finalised and no further amendments required. |
Legislative References:
Income Tax Assessment Act 1936
109Y(2)
204
Income Tax Act 1986
The Act
Case References:
Clyne v Deputy Commissioner of Taxation
(1981) 150 CLR 1
12 ATR 173
81 ATC 4429
Commissioner of Taxation v Jones
(1999) 86 FCR 282
41 ATR 460
166 ALR 650
99 ATC 4373
Commissioner of Taxation v Kavich
(1996) 68 FCR 519
33 ATR 273
96 ATC 4752