Peate v FCT

(1964) 111 CLR 443
[1964] HCA 84
111 CLR 443
38 ALJR 164
[1965] ALR 352
13 ATD 346
9 AITR 355

---

(Judgment by: Kitto J.)

Peate
v Federal Commissioner of Taxation

Court:

Judges: Menzies J.
McTiernan

KittoTaylor
Windeyer
Owen

Subject References:
Income Tax (Cth)

Hearing date: September 4, 5, 6, 7, 10;
Judgment date: 12 December 1962

Sydney

---

Judgment by:
Kitto J.

KITTO J. The Court has before it three appeals against orders of Menzies J. made on the hearing of appeals against three assessments of income tax under the provisions of the Income Tax and Social Services Contribution Assessment Act 1936 (Cth) as amended. The assessments related to the income derived by the appellant in the years ended 30th June 1958, 1959 and 1960 respectively. His Honour remitted the assessments to the Commissioner for amendment in certain minor respects and otherwise dismissed the appeals.

2. The contest between the parties relates to certain amounts of an income nature which, though the appellant did not in fact derive them, have nevertheless been treated in the assessments as part of his assessable income. The ground of their inclusion is that s. 260 of the Act applies to the facts of the case with the result that the appellant must be considered as having derived those amounts. The section declares void as against the Commissioner inter alia every "arrangement" made or entered into, orally or in writing, so far as it has or purports to have the purpose or effect of in any way, directly or indirectly, avoiding any liability imposed on any person by the Act. A liability is imposed by s. 17 upon any person to pay tax at the rates declared by the Parliament upon the taxable income derived by him, that is to say (see s. 6) upon the amount remaining after deducting from his assessable income all allowable deductions. The assessments in the present case have been made on the footing that an arrangement into which the appellant entered had the purpose or effect of avoiding his liability under s. 17 in respect of the amounts abovementioned, by making what otherwise would have been a derivation by him a derivation by others, and that s. 260 makes the arrangement ineffectual to achieve that result.

3. The relevant facts as established before Menzies J. are fully stated in his Honour's judgment, and I shall not restate them in detail. It is sufficient to pick out here the salient features only of the case. The taxpayer is a doctor. For some years before the relevant years of income he practised in partnership with a number of other doctors, but the partnership was dissolved by mutual agreement on 31st August 1956. This was done in order to clear the ground for the adoption of a plan which the doctors were advised would serve several purposes, including the improvement of their tax position. By a series of concerted steps, including the formation of companies and the execution of agreements, a situation was brought about in which the doctors practised no longer in partnership with one another, but each of them attended to patients on behalf of a company called A. E. Westbank Pty. Limited, the formation of which had been part of the plan. I shall call the company Westbank. Each doctor bound himself by an agreement to which Westbank was a party to ensure that every patient should contract with Westbank that payment for treatment should be due to Westbank directly, even though the doctor might have rendered services in his own name. The doctor further bound himself, if he should fail to carry out the obligation just mentioned, to pay Westbank as liquidated damages an amount equivalent to the usual fees for the treatment; and he agreed that in satisfaction of such damages any moneys tendered or forwarded to him by any person in respect of fees should be the property of Westbank. What happened in fact was that some payments in respect of the doctors' services to patients were made to Westbank, while others were made to the doctors, but the doctors passed on the amounts they received to Westbank.

4. Westbank employed, in addition to the doctors referred to, some doctors who were outside the plan and some persons who were not doctors. The fees received by Westbank for medical services rendered, whether rendered by the doctors in the group or by doctors engaged from outside, were applied in accordance with decisions made from time to time by the participating doctors in their capacity of directors of Westbank. In particular, disbursements were made (1) in paying the salaries and wages of the doctors engaged from outside and of other employees, and in meeting the expenses of Westbank's business as a company supplying medical services to the public through the doctors who were in the plan; (2) in making contributions to a superannuation fund for employees; and (3) in paying what were called service fees. The recipients of the service fees were family companies which had been formed under the plan, one in respect of each of the participating doctors. The payment of the service fees was, in effect, the distribution of Westbank's net income among the family companies in proportions agreed upon between the doctor-directors from time to time. The proportions did not always correspond exactly with the proportions in which the profits of the partnership had been divided - not even while all the doctors who had been partners continued to participate in the carrying out of the plan; and from time to time changes in the personnel of the group took place. But at the beginning the appellant's share was the same as under the partnership, and it increased slightly later on.

5. The issued shares in each family company (except two subscribers' shares in the case of the appellant's family company and possibly in the other cases also) were held by or in trust for members of the family of the doctor concerned. Each doctor had sold his practice, motor cars, etc., to his family company, and had entered into an agreement with it to serve it or its nominee at a salary. Westbank was the nominee of each of the family companies for this purpose. In the case of the appellant, the family company was W. Raleigh Pty. Limited, which I shall call Raleigh. From September 1956 Raleigh's directors were the appellant and his wife. He was the governing director with all the powers of the board, and one consequence was that it was in his power to depress his own salary as he chose, and so to regulate the portion of the service fees from Westbank that would be available for distribution to or for the benefit of his family. His wife was the secretary of Raleigh at a salary of 1,200 pounds at first, and later 1,300 pounds. Out of the service fees which Westbank paid to Raleigh there were paid the appellant's salary and his individual professional expenses, that is to say his expenses over and above the group expenses met by Westbank.

6. In accordance with the plan, the appellant and the other doctors who participated from time to time conducted as employees of Westbank the work of the practices that formerly they had carried on in partnership. The plan and all that was done under it plainly constituted an "arrangement" in the sense of s. 260; for Newton's Case [1958] AC 450 , at p 465; (1958) 98 CLR 1 , at pp 7, 8 establishes, as this Court had held in earlier cases, that the word "arrangement" in the section comprehends both a plan made between two or more persons and all the transactions by which it is carried into effect. Newton's Case [1958] AC 450 ; (1958) 98 CLR 1 makes clear also that the question whether an arrangement has or purports to have the purpose or effect of avoiding a liability to tax under the Act is a question as to the purposes or effects of the arrangement itself, rather than of the purposes in the minds of the parties. That is to say that it is a question whether, upon consideration of the overt acts which have been done in carrying out the plan, the arrangement is to be recognized as a means for the avoidance of a tax liability, whether or not it be a means to other ends also.

7. The arrangement in the present case, considered objectively as is thus required, may well seem to be characterized by several purposes and effects, some of them unconnected with taxation, including the protection of individual members of the group against liability for negligence; the making of superannuation provision for employees, including doctors employed to assist the group; the better organization of the group's activities and particularly its methods of accounting; and the making of provision for the doctors' families. (All of these purposes, indeed, the appellant swore were actually contemplated in the formation of the plan.) But the question remains, whether the overt acts that were done under the plan are fairly explicable without an inference being drawn that tax-avoidance is a purpose of the arrangement as a whole. Menzies J. thought they were not, and with respect I agree. The arrangement bears ex facie the stamp of tax-avoidance. An understandable purpose of providing for the doctors' families, and doing so quite honestly, is perfectly evident; but what is equally evident is a purpose of doing so by a method which will divert income away from the participating doctors to or for the benefit of their families, to the end that a substantial part of the tax might be avoided which would have been incurred if the income had first been derived by the doctors and then applied by them for the benefit of their families.

8. The case therefore falls, plainly as I venture to think, within the application of s. 260. The argument we have heard has been directed mainly to the consequences of this conclusion. In most of the cases which the Courts have decided under s. 260 the purpose and effect of the arrangements has been to avoid tax by converting what would have been a derivation of income into a derivation of capital. The work of the section being to invalidate such an arrangement "so far as it has or purports to have" that purpose or effect, the success of the arrangement as a means of achieving the conversion of income into capital has been denied. For the appellant in the present case an endeavour has been made to limit the operation of the section to arrangements of that kind. But the section must be given full operation according to its terms, and its terms apply to every arrangement which has the stated purpose or effect, whatever be the method by which it seeks to produce an avoidance of tax. The provision, it is true, operates only to destroy; it supplies nothing. But if a statutory denial of any of the legal consequences of the steps taken in carrying a concerted plan into effect will suffice to defeat a tax-avoidance for which the arrangement as a whole is a recognizable means, the section provides the denial, and by so doing enables an assessment to be made in disregard of those legal consequences.

9. The Commissioner contends that the assessments are sustainable under the section without departure from this view of its operation. It is nothing to the point so far as the decision of the case is concerned that s. 260 was not mentioned either in the adjustment sheets which accompanied the notices of assessment or in contemporaneous letters in which the Commissioner offered the appellant an explanation of the steps taken in making the assessment. The adjustment sheets showed that what had been done was to reject so much of the appellant's return as treated his salary from Raleigh as an item in his assessable income, and instead to treat him as having derived a proportion of the net income of Westbank. The explanation in the letters was expressed in terms which went a little too far. It was considered, the letters said, that the gross income shown in Westbank's return was, "in fact and in law", derived by the partnership. This way of putting the matter has led the appellant to give prominence to a submission that s. 260 will not support the notional creation of a partnership where no partnership existed in fact. It is important to remember, however, that the word "partnership" is given by s. 6 an extended meaning. It includes inter alia an association of persons in receipt of income jointly. The adjustment sheets and the explanatory letters should be read with this in mind. The Commissioner was saying, in effect, that he ignored the separate corporate existence of Westbank, and consequently put out of account the contracts with Westbank, both of doctors and of patients, and the position of the participating doctors as directors of that company, and that the result was to find gross income produced by the work of the participating doctors and others who worked with them, pooled in an agreed bank account which was under the control of the participating doctors, drawn upon for the payment of the group expenses of producing that income, and (subject to that) made available for distribution in agreed proportions among the family companies. He was saying that there you have an association of doctors receiving income jointly, (i.e. into a common purse in the form of Westbank's bank account) and agreeing that the amount of that income which they considered available for distribution after providing for expenses should be divided, each doctor's share being paid to a company set up by him for the purpose.

10. Menzies J. took the same view of the application of s. 260 to the facts of the case. "What is left then", he said, "is a group of doctors practising together but without any formal agreement of partnership, using Westbank to receive all fees paid, to provide services for the group, to pay group expenses and to make distributions of what remained in agreed proportions and using their family companies to receive those distributions and to pay the individual expenses of practice. On this basis the assessable income of the doctors as a group was the total of gross fees earned" (1962) 111 CLR, at p 461

11. In my opinion this is correct. It means that s. 260 renders the arrangement void as against the Commissioner so far as it gave Westbank the beneficial property in fees collected and gave the quality of a resolution of a board of directors to the decisions of the doctors as to disbursement. What remains is the income produced by an association of doctors, received by them jointly, and subject to division in agreed proportions so that, in the language of s. 19, each doctor's distributable share was dealt with as he directed. It follows that each doctor must be considered to have derived his proportion of the income. It is nothing to the point that some of the income consisted of fees which had become due to Westbank and not to any individual doctor, or that some of it consisted of fees for the services of doctors employed from outside. Clearly s. 260 does not enable contracts that were made between patients and Westbank to be notionally replaced by contracts between patients and the individual doctors; but no such process is required for the upholding of the assessments. If all the patients' contracts be simply treated as void, so that all fees paid are regarded as having been paid gratuitously, it makes no difference. The fees are none the less income, brought into existence by the associated activities of the doctors and those who worked at their direction, and channelled into the common fund which bore the name of Westbank, there to be dealt with in the agreed manner.

12. We have not been asked to review so much of the orders of Menzies J. as remitted the assessments to the Commissioner for amendment in respect of certain matters of detail. Having reached the conclusion above stated on the substantial question in the case, I am of opinion that the appeals should be dismissed.