Case D45

Judges:
AM Donovan Ch
GR Thompson M
RK Todd M

Court:
No. 2 Board of Review

Judgment date: 25 August 1972.

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A.M. Donovan (Chairman) G.R. Thompson and R.K. Todd (Members): A convenient course was followed by hearing these three references together for between them they require consideration of but two aspects of a single issue. The reference of A Pty. Ltd., which we will refer to as ``the company'', resulted from the disallowance of deductions claimed in respect of two payments each of $4,000 made to Mrs. M and Mr. L during the year ended 30 June 1969, and described as retiring allowances. The references of the two recipients resulted from the assessment in full of the amounts so received, it being contended on their behalf that sec.26(d) of the Act operated to render as assessable income only 5% of those amounts.

2. The company was incorporated in 1958 and took over a business commenced by Mrs. M in 1951. Its activities were conducted from Mrs. M's home and consisted mainly of acting as agent for an interstate principal in the sale of

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merchandise. In 1968 the principal acquired the company's main competitor, and it seems to have been assumed that the agency on which such a large part of its business depended would be transferred from it to that competitor. In these circumstances, Mrs. M and Mr. L, who were then the company's only directors and shareholders, offered to sell their shares in it to the interestate principal for a total of $1,500 and their offer was accepted. These negotiations were conducted verbally. It was not until February 1970, however, that the sale was finally effected and it was concluded then as a result of a formal written offer, obviously prepared by the purchaser's solicitors, which incorporated all the terms and conditions of sale and the undertakings given by Mrs. M and Mr. L. The formal contract was on the basis that all the company's debts had been satisfied and that it had been denuded of all its assets. Although it was not so stated in evidence, it can be assumed that this contract embodied the express or implied terms of the former oral agreement. No doubt it was as a result of this understanding that upon conclusion of the verbal agreement in November 1968, the company's business was allowed to run down. All trading ceased in the following month, and thereafter all that was done was to introduce a representative of the interstate principal to customers, collect and settle outstanding accounts and strip the company of its assets.

3. At all material times the issued capital of the company consisted of 200 shares each of $2. One parcel of 100 shares was held by Mrs. M. The remaining shares were originally held by Mr. M but, upon his death in 1960, they passed to the trustee of his estate from whom they were acquired by Mr. L for the sum of $2,000, probably in 1965.

4. Mrs. M became a director of the company at the time of its incorporation and Mr. L joined the board when he acquired his shares. Both discharged duties other than those associated with the office of director. Mrs. M originally did the secretarial and clerical work and helped her husband with selling merchandise. Upon his death she became the company's sole operative, subject to limited assistance from ``a casual girl'' About the time he acquired his shares, Mr. L commenced part-time work with the company doing clerical and accounting work as well as attending to delivery of merchandise, and he continued to perform these duties until the end of 1966. Mrs. M's estimate of the time thus taken was two of three days per week, while his was 30 to 35 hours per week. Relieved of the duties assumed by Mr. L, Mrs. M appears to have devoted her activities solely to selling until, in December 1966 while on company business, she sustained very severe injuries in a motor vehicle accident. Thereafter she seems to have been able to do little more than attend to the telephone and act in an advisory capacity. Upon this change in circumstances, Mr. L added the selling duties to those he was then discharging and was so occupied on a full-time basis until December 1968 when the company's business ceased.

5. Whilst ensuring that the company's small amount of capital was adequately rewarded, the directors appear to have adopted the practice of taking the remainder of the profits by way of remuneration. This end was achieved by voting relatively large amounts as ``directors' fees''. No doubt this represented an easy way of achieving the desired end, but it is reasonable to suppose that virtually all the remuneration related to the performance of duties other than those associated with the office of director as such, which seem to have been no more than of a purely formal nature. It is not possible to say how Mrs. M and Mr. L assessed their relative worth to the company for part-time service. It seems, however, that full-time service by either was regarded as commanding remuneration of approximately $4,000 per annum. The Commissioner appears to have shared this view, for as far as is known he allowed all deductions claimed for the amounts so paid.

6. The payments claimed as retiring allowances were made during the year ended 30 June 1969, pursuant to a resolution of directors dated 29 May of that year in the following terms -

``In view of the imminent retirement of

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(Mrs. M.) and (Mr. L) it was resolved that each be paid a retirement allowance of $4,000.

It was further resolved to direct the trustees of the superannuation fund to pay (Mrs. M) and (Mr. L) their full entitlements from the fund.''

In spite of the description adopted, it is impossible to escape the conclusion that the payments represented, at least in part, a step in reducing the company to its corporate shell. It is, we think, no mere coincidence that the charging of these amounts to the profit and loss account of the year ended 30 June 1969, gave rise to a loss of $7,545, which was almost sufficient to offset the credit in the appropriation account of $7,477 at the end of the preceding year. One of the directors, probably both, recognised the taxation advantages from absorbing that credit balance in this fashion rather than using it for the declaration of dividends. This view is reinforced by the fact that the payments were of equal amount, that is to say in proportion to shareholding, and were not calculated by reference to the length or total value of the services rendered to the company by the recipients. For her part Mrs. M said of the equal payments that she did not wish to be ``greedy'', and her attitude also seems to have been influenced by the fact that the shares for which Mr. L had paid $2,000 were being sold by him for $750.

7. In the minute of the directors' resolution quoted above, reference was made to payment to Mrs. M and Mr. L from a superannuation fund. This fund had been established by the company and its two directors were its only members. From the date of their admission to the fund, the company had contributed the same amount for each annually. The individual members appear to have themselves contributed each year such amounts as would entitle them to claim the maximum deduction under sec.82H of the Act. From the fund Mrs. M received $13,317 and Mr. L $5,807.

8. In the objection lodged on behalf of the company it was contended that the retirement allowances were deductible pursuant to sec.51. At the hearing, however, the solicitor who appeared for the taxpayers addressed no argument on this ground, although he did not formally abandon it. In these circumstances, we content ourselves with saying that the facts do not support a conclusion that the payments were outgoings ``necessarily incurred in carrying on a business'' by the taxpayer. In our view they are not deductible under sec.51.

9. An alternative argument was rested on the provisions of sec.78(1)(c) which, as far as material, permit the deduction of ``sums... paid... as... retiring allowances to persons who are or have been employees... to the extent to which in the opinion of the extent to which in the opinion of the Commissioner those sums are paid in good faith in consideration of past services''. The first point to be noticed is that the paragraph refers to employees and, unlike other provisions in the Act, there is no expanded definition to comprehend directors. Nevertheless, as we have already observed, the services of Mrs. M and Mr. L went far beyond those associated with the office of director. They can fairly be regarded as acting for the company in a dual capacity and as falling within the description ``employee''. Next, in terms, the paragraph contemplates the receipt of a retiring allowance while the relationship of employer-employee still subsists and appears to comprehend a payment genuinely made as a retiring allowance, although made in fact prior to the employee's cessation of duty. In the circumstances of this case, there was no formal resignation from the office of director until March 1970, that is until the next succeeding financial year, but that delay arose in the somewhat extraordinary circumstances described. As mentioned above, the oral agreement to sell the shares was concluded in November 1968, the company's business was brought to an end almost immediately and with it all the duties of Mrs. M and Mr. L in their capacity of employees ceased. They could not very well formally retire from the bare office of director until the sale of the shares was completed - a matter which was outside their control and which depended upon the purchaser. In these circumstances, we have no great difficulty in deciding that the

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payments in question are capable of being described as ``retiring allowances'' for the purposes of the section.

10. The third point to be noted about the provision is the requirement that sums are deductible only to the extent that ``in the opinion of the Commissioner those sums are paid in good faith in consideration of part services''. Because of one of the submissions made to the Board, we pause to observe that these words exclude the possibility of taking into account anything in the nature of compensation for loss of office or employment. We do not here stay to consider their meaning, for in the circumstances of this case any amounts which satisfy sec.78(1)(c) have also to survive the application of sec.109, to which we now turn.

11. To the extent to which it is material, that section provides -

``So much of a sum paid... by a private company to a person who is... a shareholder... being...

(b) An allowance... in consequence of the retirement of that person... as exceeds an amount which, in the opinion of the Commissioner, is reasonable, shall not be an allowable deduction...''

In a reference it is of course for the Board to substitute its opinion for the opinion of the Commissioner, and the taxpayers' solicitor submitted that in considering the reasonableness of the payments for the purposes of this section the amounts paid out from the superannuation fund should be ignored. On the other hand, the Commissioner's representative argued that they should be taken into account. He argued further that the reasonableness of the sums should be tested by comparing the total of the retiring allowances and the payments from the superannuation fund with the amount determined according to the formula referred to in Public Information Bulletin issued by the Commissioner in May 1965 in relation to sec.23F. That section exempts from tax the income of certain superannuation funds subject to conditions which include the requirement that the benefits provided by the fund should not be excessive. In the Bulletin mentioned, the Commissioner announced that he would not regard as excessive an allowance of up to seven times the average salary over the last three years of employment after twenty years service with pro rata reduction for service of shorter duration. His representative submitted that on this approach the benefits provided for Mrs. M and Mr. L from the fund alone were excessive and for this reason the retiring allowances paid directly to them must be treated as being unreasonable in amount.

12. It has long been the policy of the Act to encourage the making of financial provision for the retirement of employed persons. This has been done by allowing deductions to an employee, inter alia for contributions to a superannuation fund, and to the employer not only in respect of contributions to such a fund but also in respect of retiring allowances and pensions paid directly to retiring or retired employees. The policy of encouragement extended to the exemption from taxation of the income of superannuation funds. Abuse of these provisions led to their review, as a result of which sweeping amendments were effected to the Act including the introduction of sec.23F. A fund to which sec.23F applies, and to which the Public Information Bulletin referred, may well be one to which both employer and employee contribute. The test of what constitutes excessive benefits from such a fund is not necessarily a satisfactory criterion for determining the reasonableness of payments made by the employer alone and we are disinclined to adopt the approach urged upon the Board by the Commissioner's representative. This is not to say that we think that the benefits from the fund resulting from the employer's own contributions should be ignored. On the contrary, in our view they should be taken into account. This is so because the very reason why sec.109 imports the test of reasonableness is to ensure that, so to speak, the cost of the payments to the public purse is not excessive. It seems as plain as it could be that there should be taken into account in considering the reasonableness of retiring allowances paid directly by the employer to the employee the amount of any retiring

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benefit provided indirectly by the employer for the same employee by means of deductible contributions to a superannuation fund, that is to say contributions which in the same sense have also been a cost to the public purse.

13. In forming the opinion under sec.109 of what constitutes a reasonable benefit upon retirement, regard has to be paid to a number of factors. A matter to be taken into consideration is the value of the employee's services to the employer. In this regard there is no reason to depart from what the company itself fixed as annual remuneration for full-time employment, i.e. approximately $4,000. Another matter to be taken into account, and one to which Boards have attached considerable significance, is the length of the employee's service, although they have not evolved a formula for universal application and have treated each case on its own merits.

14. This is the weakest feature of the present case, particularly in relation to the payment to Mr. L. When he received the amount in question his service with the company extended only over five years, of which approximately half was on a part-time basis only. The adoption of the most generous approach of boards in so far as duration of service is concerned gives as a reasonable payment less than the amount provided by the company through its contributions to the superannuation fund. For the reasons expressed above, we are of the view that this benefit should be taken into account and when that is done we are driven to the conclusion that no part of the retiring allowance directly paid to Mr. L can be considered reasonable. We come to this decision with the knowledge of what is so often said about a nil amount not constituting an amount at all.

15. Even if the period subsequent to Mrs. M's injury is taken into account and is regarded as full-time service with the company, her association with it on that basis extended only over 11 years. By taking this period into consideration and adopting the approach mentioned above, we reach the conclusion that a reasonable amount of retiring benefit exceeds by only about $500 the amount provided by the company through its contributions to the superannuation fund. Accordingly, of the amount of $4,000 paid directly to Mrs. M, only $500 should be treated as being a reasonable amount.

16. These conclusions, based as they are on sec.109, make any further detailed consideration of sec.78(1)(c) unnecessary. We earlier left on one side the question whether the sums in dispute were, in the words of the section, ``in the opinion of the Commissioner... paid in good faith in consideration of the past services''. It is sufficient now merely to observe that there is nothing in the evidence to suggest that of the total amount of $8,000 any lesser sum than $500 was so paid. In the light of our findings, the effect of sec.109 upon sec.78(1)(c) is to permit deduction of $500 of the amount in question. However, sec.79C operates to limit the deduction to the amount of the company's taxable income of the year, that is to say to the amount of $455.

17. The objections of the individual taxpayers assert that only 5% of the amounts received by them as retiring allowances is assessable income. This contention is based on the positive part of para. (d) of sec.26. However, the paragraph continues in these terms -

``Provided that this paragraph shall not apply in respect of any amount which under any provision of the Act is deemed to be a dividend...''

This proviso necessitates some further reference to sec.109 which, in addition to denying a deduction in the circumstances described earlier, provides that to the extent to which any sum on which it operates exceeds what in the opinion of the Commissioner (or, upon a reference, the Board) is a reasonable amount, the excess (subject to exceptions which are not material) shall be deemed to be a dividend paid by the company. In the result therefore, the objections of Mrs. M and Mr. L require no separate consideration for they turn on what has already been decided in relation to sec.109. The conclusion expressed above

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means that Mrs. M's objection succeeds only to a limited extent. Of the amount of $4,000 received by her, $3,500 is deemed to be a dividend and is assessable in full and $500 falls under the positive provision of sec.26(d) and is assessable to the exent of 5% only so that a total of $3,525 is assessable income. In the case of Mr. L, the whole payment of $4,000 is deemed to be a dividend and is therefore assessable in full with the result that his objection fails completely.

18. For the reasons expressed above, we would (a) uphold the company's objection to the extent of allowing a deduction of $455 sufficient to reduce its taxable income to nil; (b) uphold the objection of Mrs. M to the extent of reducing her assessable income by $475; and (c) uphold the Commissioner's decision on the objection of Mr. L and confirm the assessment in question.

Claim allowed in part.