• The impact of this case on ATO policy is discussed in Decision Impact Statement: Aitken & Langford and Commissioner of Taxation (Published 4 August 2009).

AITKEN & ANOR v FC of T

Members:
BJ McCabe SM

Tribunal:
Administrative Appeals Tribunal, Brisbane

MEDIA NEUTRAL CITATION: [2009] AATA 83

Decision date: 10 February 2009

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BJ McCabe (Senior Member)

1. Raymond Aitken and Ronald Langford ("the taxpayers") were formerly officers and shareholders in Pactim Resources (PNG) Pty Ltd ("Pactim"), a company involved in the timber industry in Papua New Guinea ("PNG"). In 1995, Pactim agreed to sell its interest in another company. The shares in that other company were held by Messrs Aitken and Langford on behalf of Pactim. The sale agreement provided that the consideration for the sale be paid directly to Messrs Aitken and Langford, the applicants in these proceedings. The Commissioner says those payments to the

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applicants (or payments to persons nominated by the applicants) were effectively distributions by Pactim to its shareholders. The Commissioner says those dividends were assessable income in the hands of the applicants. Messrs Aitken and Langford dispute the amount of money that was paid under the sale agreement. They also argue the Commissioner's characterisation of the payment to them is wrong. They have asked the Tribunal to reconsider the Commissioner's objection decision.

2. The Commissioner's case changed during the course of the proceedings as more information came to hand. It was initially argued that Pactim was a controlled foreign corporation and that Mr Langford was not an Australian resident at the relevant time. The Commissioner has accepted those assumptions are incorrect. The dispute now revolves around the question of whether monies paid to Messrs Aitken and Langford during the 1995 year of income under the terms of the contract of sale are dividends assessable under s 44(1)(a) of the Income Tax Assessment Act 1936 ("ITAA36").

The facts

3. The story begins in 1989 when Mr Langford incorporated Pactim. The company was formed to exploit opportunities in the timber industry in PNG. Mr Langford was initially the sole director and shareholder. Later that year, Mr Aitken took a 48% interest in the company and joined the board. He explained at the hearing that he was brought in to oversee the company's finances. He said he only visited PNG about once a month in the period that followed. Mr Langford managed the day-to-day operations of the company in PNG. The pair remained in control of Pactim at all relevant times.

4. The account that follows was drawn from Mr Aitken's evidence. Although the events described occurred nearly 15 years ago, Mr Aitken exhibited an impressive recall of events and transactions. He gave his evidence in a forthright way. Mr Aftanas, for the Commissioner, submitted that Mr Aitken's oral evidence should be discounted because it was prompted by leading questions from his representative. While I acknowledge there were a number of leading questions, Mr Aitken did not strike me as a witness who was easily led. I accept he was a witness of truth and that he did his best to assist the Tribunal. For the sake of completeness, I note I have no reason to doubt the veracity of Mr Langford's evidence although his recollection of events was not as clear as that of Mr Aitken. I accept in any event that Mr Aitken's professional expertise and his responsibility for the management of the company's financial affairs makes his evidence more useful.

5. Mr Aitken referred to commercial disputes that prevented the company from realising opportunities in the timber industry in its early days. He described a frontier-like commercial environment in which government officials and local personalities in PNG (including some members of the clergy) played an unpredictable role. In 1991, Pactim entered into an arrangement with McDui Developments Pty Ltd ("McDui"). McDui carried on a logging business. It held a timber logging licence and owned a number of other assets, including plant and equipment, houses and a hotel. McDui was in trouble at the time: its equipment was old, it did not have experienced managers and it was struggling to repay it debts. Under the terms of the agreement with McDui, the shares in McDui were sold to Pactim, McDui's timber licence was assigned to Pactim and Pactim agreed to guarantee McDui's debts: exhibit 3 at pp 8-19, 20-37. Mr Aitken said he understood the assets of the company would eventually be assigned to Pactim when the debts were repaid. He explained in cross-examination that he recalled the arrangement required that the McDui liabilities be discharged out of the cash flows generated from the McDui assets. Mr Aitken also said he and Mr Langford extended personal guarantees to the former directors of McDui.

6. After completing the McDui transaction, Pactim was in the timber business. But Mr Aitken said it soon became apparent that Pactim was not big enough to effectively exploit the opportunity. The company had limited funding available to it and experienced cash flow problems. Mr Aitken said the taxpayers did not accept directors' fees because that would have made the financial situation worse.

7.

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On 4 June 1991 Pactim decided to enter into an agreement with Mr Chong Chee Yan ("Mr Chong"), a businessman with extensive interests in the logging industry in Malaysia. Mr Chong had access to machinery and other contacts that would be useful in the business. Under the terms of the agreement with Mr Chong, Pactim received a payment of $US1.2 million. In return it agreed to back the McDui assets (including the right to exploit the timber concession) and liabilities into a joint venture vehicle called Landwell Resources Pty Ltd ("Landwell Resources"): exhibit 3 at pp 38-55, 56-68. Mr Chong held 51% of the shares in Landwell Resources. Messrs Aitken and Langford held 40% of the shares in their own name, although the taxpayers say those shares were held beneficially for Pactim. Mr Aitken explained that Mr Chong preferred it that way: he wanted to deal with individuals, not a company. The balance of the shares was held by two other businessmen. One of the businessmen, Mr Lim, was a Singaporean who had introduced Mr Chong to Pactim and the taxpayers.

8. Mr Aitken said he had a good relationship with Mr Chong but that did not stop Mr Chong from commencing proceedings in a Singaporean court against him and Mr Langford. Pactim, Mr Crowder and Mr Lim, the other shareholders in Landwell Resources, were also sued. The proceedings related to an earlier proposal involving another joint venture company, Landwell Forestry Pty Ltd. That venture had not proceeded. Mr Aitken said the issue of proceedings was Mr Chong's way of saying he wanted to resolve the commercial relationship by buying Pactim and the other businessmen out of the operation in PNG. Mr Chong was effectively using the proceedings as leverage. Mr Aitken said Mr Chong wanted to privatise Landwell Resources in Malaysia. Mr Aitken said he first learned of the court action while meeting with Mr Chong in Singapore. He said he was startled at the time but accepted that it was the way business was done.

9. Messrs Aitken and Langford decided to negotiate an exit from the Landwell Resources business as part of a settlement of all outstanding matters between Pactim and Mr Chong. The sale agreement was executed on 23 March 1995: exhibit 3 at pp 98-110. The document is described as a settlement agreement because, as Mr Aitken explained, that is what it was: the sale was executed in order to settle the legal proceedings in Singapore. The recitals to the agreement confirm that to be the case: exhibit 3 at p 100. I note Pactim and the individual shareholders were all parties to the agreement.

10. The settlement agreement provides for the minority shareholders to sell their interests in Landwell Resources to Mr Chong for a total consideration of $US1.55 million. The sale price was apportioned between each of the shareholders: exhibit 3 at p 101 at [3]. Messrs Aitken and Langford were said to be entitled to $US632,653 each in return for their shares. Each of them held 100,000 shares in their own names. Interestingly, the agreement does not suggest the shares were held by the taxpayers on behalf of Pactim or anyone else. The purchase price was to be paid by instalments into the trust account of the taxpayers' Singaporean solicitors: see exhibit 3 at pp 103-104. If the original agreement had been carried out, Mr Chong would have paid $US227,445.64 to each of Messrs Aitken and Langford during the year of income ending on 30 June 1995.

11. The agreement also provided for the payment of outstanding directors' fees to the taxpayers, and for the set-off of debts the taxpayers and Pactim owed to Landwell Resources: exhibit 3 at p 105 at [17]-[18]. Mr Aitken explained in his testimony that he and Mr Langford did not draw directors' fees from Landwell Resources. Under cross-examination, he explained the directors' fees were credited to him and Mr Langford in the books of the company but those fees were regarded as an asset of Pactim. When the time came to settle the intercompany debts between Landwell Resoures and Pactim, the amount of the unpaid directors' fees was offset against Pactim's liability. Mr Aitken insists the taxpayers did not benefit from the transaction. That explanation suggests the settlement agreement does not accurately or fully reflect the reality of the agreement. Other evidence tends to confirm that conclusion.

12.

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I accept Mr Aitken's explanation that he and Mr Langford held the shares in Landwell Resources on trust for Pactim. He says he and Mr Langford agreed to take the shares in their own names in the first place because of Mr Chong's preference for dealing with individuals. I have already indicated I was impressed with Mr Aitken's testimony: he appeared to be an intelligent and forthright witness who was doing his best to assist the Tribunal. The explanation also makes sense given the picture Mr Aitken painted of a business culture where the law and legal agreements were less important than personal relationships. The two men were operating in a business culture that was quite different from that which prevails in Australia. Mr Aitken's evidence is also consistent with the testimony of Mr Langford who was able to refer me to a declaration of trust in respect of the shares: exhibit 1 at pp 22-23. There is no reason to believe the two taxpayers had different arrangements. In any event, Mr Aftanas, for the Commissioner, conceded in his submissions that the taxpayers held their shares on trust for Pactim. In all the circumstances, I accept the settlement agreement does not accurately reflect (or it is silent with respect to) the reality of the relationships between the individuals and their entitlements.

13. The fluid nature of the documentation was also evidenced by the fact the settlement agreement was varied on several occasions in supplementary agreements that are set out in exhibit 3 at pp 111-132. The total purchase price was reduced to $US1,445,102 in the first supplementary agreement, after Mr Crowder's estate was excluded from the arrangements: exhibit 3 at p 113. The other agreements made changes to clauses [7] and [10] of the original agreement. Clause [7] dealt with the progressive transfer of the shares to Mr Chong's nominees while clause [10] dealt with the timing and quantum of the instalment payments to the shareholders. Pactim is a party to all of the supplementary agreements. Messrs Aitken, Langford and Lim are also parties.

14. Mr Aitken said the third and fourth supplementary agreements in particular became necessary because Mr Chong had not discharged his obligations under the original agreement. In the third supplementary agreement (exhibit 3 at p 122), Mr Chong agreed to pay an amount in respect of interest on outstanding amounts. He also agreed to pay a lump sum of $US232,500 to Mr Lim that would be distributed between Mr Lim, Mr Aitken and Mr Langford. That amount was to be paid on the execution of the third supplementary agreement, which is dated 1 June 1995. Mr Chong undertook to pay a further $US135,625 to each of the shareholders in three monthly instalments with a final payment of $US660,727 to be distributed amongst the three shareholders in proportion to their respective shareholdings in Landwell Resources on or before 23 September 1995.

15. In the fourth supplementary agreement dated 12 February 1996 (exhibit 3 at pp 126ff), the parties varied the terms of the settlement again to reflect the fact that Mr Chong had not made all of the payments that had previously been agreed. The agreement acknowledged that Mr Chong remained indebted to Messrs Aitken, Langford and Lim in the amount of $US727,601.60 as at 7 February 1996, which included a $US50,000 amount as compensation for the delay in making payments under the original agreement. The fourth supplementary agreement went on to record a confusing range of other payments that were to be made in a variety of currencies.

16. The Commissioner says the agreements suggest the taxpayers did receive three payments in the financial year ending 30 June 1995. Specifically, the Commissioner says the original agreement as amended by the third supplementary agreement provided for the following payments to be made to each of the taxpayers:

• • $US67,391.30 on 23 March 1995
• • $US101,086.95 on 1 June 1995 and
• • $US58,967.39 on 23 June 1995

17. The Commissioner says the recitals to the fourth supplementary agreement appear to acknowledge these payments were made. In those circumstances, the Commissioner says it is reasonable to infer the payments were in fact made to the taxpayers.

18. The position of the taxpayers is complicated because they are unable to confirm precisely how much, when, and to whom payments were made under the agreements. Mr

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Aitken says Mr Chong made a number of payments directly to Pactim's creditors in PNG. Some of the money owed to the shareholders (and therefore Pactim, the beneficial owners of the shares) was offset against debts owed by Pactim to Landwell Resources. Some of the money was paid in Ringgit, some in Dollars, and some in Kina. Mr Aitken said the movement between currencies resulted in losses on exchange rates. He acknowledged that a large amount of money was paid into his Singaporean bank account. He said it was disbursed from there to various creditors of Pactim, including Mr Lim. Mr Aitken said the cheques from Mr Chong were paid into a personal account because banking regulations in Singapore at the time made it difficult for Pactim to establish an account in its own name. I have no reason to doubt Mr Aitken's explanation as to why money was paid into his personal account. It is logical and consistent with the objective facts. I accept it.

19. Mr Aitken was asked about an amount of around $40,000 that he used to pay down his overdraft from the National Australia Bank. The payment was discussed in correspondence between the bank and Mr Aitken in late 1995. The correspondence was tendered in evidence at exhibit 13. Under cross-examination, Mr Aitken said he recalled the payment was made by Pactim in settlement of an outstanding debt that Pactim owed to Mr Aitken. (Mr Sneddon pointed out in his final submissions that Pactim's books disclosed that the company owed around 480,000 Kina to the taxpayers, so this is certainly possible). When asked during re-examination to talk about the payment, he re-visited his earlier answers although not in a way that suggested he was being untruthful. He seemed less certain that the money was a repayment; he agreed it might have been an amount he retained in his account from the sale proceeds. He insisted in any event that the amount was reported in his income tax return. Mr Sneddon argued in his closing submissions that a payment of around $68,000 from Pactim was declared in the 1996 year of income. The correspondence in exhibit 13 tends to confirm the payment was not made until after the 1995 year of income, however it is to be characterised. Given Mr Aftanas did not make anything of this evidence in his final submissions, I accept the money used to reduce Mr Aitken's overdraft was not derived during the 1995 year of income, and is therefore irrelevant for present purposes.

20. The taxpayers say they did not retain any of the sale proceeds from the sale of the shares in Landwell Resources in the 1995 year of income. They deny that any of the money was used to discharge any of their personal debts or obligations. They say all of the money which has not been accounted for was used for Pactim's purposes, most obviously to pay debts. They say they were assiduous in paying Pactim's debts because the business community in PNG was very small. They would have had no future as individual businessmen in that community if they had allowed a company which they managed to leave unpaid debts.

The legislation

21. Section 44(1) of ITAA36 says the assessable income of a taxpayer includes dividends paid to him by a company out of profits derived from any source. The definition of "dividend" in s 6 is very wide, and includes any distribution made by a company to any of its shareholders. Section 19 makes it clear that income or money will be deemed to have been derived by a person even though it is not actually paid over to him if it is dealt with on his behalf or at his direction.

22. The Commissioner also relies on s 14ZZK(b) of the Taxation Administration Act 1953 ("the TAA"). That section says the taxpayer has the burden of proving that an assessment is excessive or wrong. The section is conventionally justified on the basis that the taxpayer is usually in the best position to establish the facts; the Commissioner is often left to guess, and guessing is an inexact process: see
Trautwein v Federal Commissioner of Taxation (No 1) [1936] HCA 77; (1936) 56 CLR 63 at 87-88 per Latham CJ. As a practical matter, the taxpayers in this case must provide evidence that persuades me that the Commissioner's guess is wrong. But they must go further: they must persuade me of an alternative explanation or answer. It is not enough to throw up their hands and say no one can be sure of the true situation.

23.

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At first glance, the taxpayers face a difficult task in discharging their burden under s 14ZZK of the TAA. The events in question occurred a long time ago across several other jurisdictions. Memories have faded, although I have already commented favourably on the accuracy of the recollections of Mr Aitken in particular. Importantly, I have found the documents recording the formal agreements are unreliable guides to what occurred. As I have already explained, I accept the business environment in which the taxpayers operated was populated by people from different cultures who were more interested in personal relationships than formal legal documents. The documents purportedly recording the detail of transactions must therefore be treated with care, and must be seen in the context of the free-wheeling, frontier-style business environment in which they were created. I accept the evidence of Mr Aitken that Mr Chong adopted a flexible approach to the fulfilment of his obligations under the various agreements. Given the state of the documents and the plausible explanations offered by Mr Aitken in particular, I do not think it is safe to assume that a payment was made by Mr Chong simply because he agreed in a document that he had made the payment or that he would do so.

24. I think the most reliable guide to what transpired in 1995 is found in the oral evidence of Mr Aitken, although Mr Langford's evidence was also of some assistance. I note there were discrepancies between the accounts offered by the two men, but that is unsurprising given the passage of time. They insisted (a) they did not retain the sale proceeds for themselves, and (b) they did not direct Mr Chong or anyone else to deal with the sale proceeds on their behalf. Their explanation had the ring of truth about it. Mr Aitken in particular was an experienced businessman with financial expertise. He would undoubtedly have realised that blatantly appropriating the proceeds of the sale of a company asset would have been a serious breach of the law. He struck me as a careful businessman, albeit one who was operating in a free-wheeling business environment. While he was forced to accept sub-standard documentation of agreements with third parties, it seems unlikely that he would have made the obvious error of failing to arrange for the company to declare a dividend or otherwise legitimate the transfer of funds.

25. It is no longer possible to accurately determine how much money was paid to whom following the sale of the shares in Landwell Resources in 1995. I have already noted that the documents are of limited assistance, and that memories have faded. But it is not strictly necessary for me to make a finding on those matters in circumstances where I accept the taxpayers' evidence that they did not take the money themselves, or direct that any of it be applied for their purposes.

26. Notwithstanding the paucity of other evidence, I am satisfied the taxpayers have discharged their obligation under s 14ZZK TAA to show that the Commissioner's assessment is wrong. I am satisfied the taxpayers did not receive a dividend from Pactim within the meaning of s 44 of ITAA36 which should have been disclosed in their tax returns and which has not been disclosed. It is therefore unnecessary for me to address the other arguments of the parties over whether dividends were paid out of profits.

Conclusion

27. The objection decision under review is set aside. The Tribunal decides in substitution that the taxpayers have not failed to disclose the payment of dividends from Pactim Resources (PNG) Pty Ltd in their tax returns for the year ended 30 June 1995.