Tupicoff v. Federal Commissioner of Taxation.Judges:
Supreme Court of Queensland
Gary Tupicoff (``the taxpayer'') has appealed to this Court pursuant to sec. 187(2) of the Income Tax Assessment Act 1936. The appeal is against the assessment of the taxpayer's income tax for the year ended 30 June 1980. The taxpayer in his return for that year had disclosed a taxable of $8,060 including salary and wages of $7,800 earned as
ATC 4368an employee of Gary Tupicoff (Insurances Nominees) Pty. Ltd.
By his assessment issued on 4 August 1981, the Commissioner assessed the taxpayer to income tax on a taxable income of $18,569. He arrived at this figure by making adjustments as shown in the adjustment sheet accompanying the assessment. The Commissioner included as income the sum of $18,292 being $10,492, the net income of the Gary Tupicoff Family Trust plus the salary of $7,800 shown in the taxpayer's return.
The sole ground of objection argued was that the assessment should be reduced by excising from the assessable income the sum of $10,492 or alternatively such other sum as is found to be appropriate.
By a document dated 3 July 1970, called a Letter of Appointment, the National Mutual Life Association of Australasia Limited (``NML'') appointed the taxpayer an agent ``to obtain New Business for the Association''. On the same day the taxpayer agreed in writing to accept the appointment. The Letter of Appointment expressly provided that either party might terminate the appointment by giving to the other one week's notice in writing and that in certain events NML might terminate it without notice. Clause 15 of the letter provided:
``15. This appointment is personal to you and it or any benefit arising to you therefrom shall not be assignable and you shall not grant any licence or admit any person to partnership with you thereunder. In the event of your bankruptcy or if you enter into any arrangement or composition with your creditors, this appointment shall forthwith and ipso facto terminate and all moneys payable to you hereunder shall be absolutely forfeited to the Association.''
Suffice to say at this stage, that in terms of the letter of appointment and the schedules thereto the taxpayer, as a field representative of NML, became eligible to participate in named benefit plans including a superannuation plan as well as becoming entitled to bonus commission calculated in accordance with specified scales and formulae.
The taxpayer, thereafter and until 1 June 1978 worked as an agent for NML. Initially he worked for some months from NML's office at 293 Queen Street, Brisbane but later moved to 54 Jephson Street, Brisbane but later moved 54 Jephson Street, Toowong where, to use the taxpayer's words he ``worked out of'' those premises until 1980. NML occupied the whole ground floor of 54 Jephson Street. When the taxpayer first moved there he had no office - he had a telephone and temporary use of a table. Later he had an office which he rented from NML. He said there were about 20 agents operating from NML's Toowong premises and about six of these had rented offices.
In evidence before me the taxpayer, when asked what he did as an insurance agent, said:
``Approaching prospective clients as to whether they wished to talk to me about their insurance; arranging the insurance - advertising the fact that - among contacts and friends and acquaintances and centres of insurance that I was in the insurance business; as I say writing the business making sure that the clients were accepted because many clients do not have the health that is required for insurance and making sure that the premiums were paid; letters to policy holders regarding the type of insurance they had purchased; also looking after, you might say - the terminology of `orphan policy holders' where the insurance company had asked me to contact these people as the agent who had originally arranged the insurance business was no longer at any agency with them; so I would contact these people and try to get an appointment to talk to them about their insurance and if not perhaps be of some sort of service so ultimately at some stage in the future they might consider me as their insurance agent.''
Prior to 1 June 1978 the taxpayer, in conjunction with another NML agent employed a part-time secretary. They had a number of part-time secretaries the longest serving being a Miss Wallis. The taxpayer and another agent named Thomson were registered with the Australian Taxation Office as a group employer - as from 6 February 1978.
On 15 August 1970 the taxpayer had married. Two children were born - Vanessa on 22 December 1971 and Cynthia on 11 August 1973. After marriage the taxpayer's wife assisted in the conduct of the taxpayer's wife assisted in the conduct of the taxpayer's agency business. The taxpayer said he paid his wife $50 per week for the work she did in his insurance business. In 1974 the taxpayer's wife acquired
ATC 4369an agency from National Mutual Fire Insurance Company which appears to have been a subsidiary of NML. She operated it until 1978.
On 1 June 1978 Gary Tupicoff (Insurances Nominees) Pty. Ltd. was incorporated as a proprietary company under the Companies Act 1961-1975. The first directors of that company were the taxpayer and his wife June Thelma Tupicoff.
The first meeting of directors of that company (whom I shall hereafter call ``the company'') was held on 1 June 1978. The two subscriber's shares, held by solicitors, were transferred to the taxpayer and his wife and a further ordinary share was allotted to NML at par for cash in accordance with its application for that share.
By a document styled ``Deed of Trust'' dated 1 June 1978, made between Lenard Tupicoff as settlor and the company as trustee, ``The Gary Tupicoff Family Trust'' was created. This trust was a discretionary trust and there were four classes of beneficiary:
- (a) The primary beneficiary who was the taxpayer;
- (b) The primary beneficiaries who were the primary beneficiary, the taxpayer's wife and any child or adopted child of the primary beneficiary and/or his wife;
- (c) The secondary beneficiaries therein described; and
- (d) The tertiary beneficiaries therein described.
Until the arrival of the vesting day defined in the deed the trustee (subject to a power to accumulate income) had power in its absolute discretion in any financial year ending on 30 June to decide before 30 June in that year in what shares and proportions the income of that year or part thereof should be divided among some or all of the beneficiaries. The trust deed contained provisions to take effect on failure by the trustee to exercise that discretion before 30 June. I should here add that in evidence before me the taxpayer conceded that he structured the shares in the company so that he could effectively control the company.
By a document dated 6 June 1978 and addressed to NML the taxpayer referred to his letter of appointment dated 3 July 1970 and tendered his resignation thereunder with effect from 1 June 1978. The document (omitting formal parts) reads:
``1. I refer to my Letter of Appointment dated 3rd July 1970 and wish to tender my resignation thereunder with effect from 1st June 1978.
As you are aware, Gary Tupicoff (Insurances Nominees) Pty. Ltd. will apply for an appointment as representative of the Association from that date in terms of the current Letter of Appointment applicable to companies.
2. I do hereby declare and irrevocably agree that in the event of my Company being appointed as aforesaid I shall at all times hereafter personally indemnify and keep indemnified the Association against all actions, proceedings, claims and demands of any person or persons, company or companies resulting from the incorporation of my Company and from the appointment of my Company as representative of the Association and by reason of its acting as such representative under the Letter of Appointment issued by the Association and also against all costs, damages and expenses which the Association may incur or sustain by reason, or as a result of such incorporation and appointment of my Company and of its acting as aforesaid.''
By another document dated 1 June 1978, described as a ``Letter of Appointment'' and addressed to the directors of the company, NML, by its then manager for Queensland, advised that the company was thereby appointed to obtain new business for NML subject to the company's acceptance of the terms and conditions set out in the letter of appointment. This letter was quite a lengthy document. Condition 1 thereof read:
``1. (a) The Company shall appoint at least one employee and may appoint another or other employees to assist or enable it to conduct its business
Provided Always -
- (i) that no such appointment shall be made unless that person shall have been previously approved by the Association in writing.
- (ii) that that employee or those employees shall be and be deemed to be exclusively employed by the Company
- (iii) that in this Letter of Appointment where any provision requires the
ATC 4370Company to do or to refrain from doing any act matter or thing such provision where the context permits shall also be deemed to apply to every employee (including the Company's accredited representative hereinafter mentioned) or other person whatsoever acting on its behalf in relation to this Letter of Appointment (whether he or they are acting within the scope of his or their employment or not) as if each and everyone of such persons had been additionally mentioned in such provision and the Company shall accept and be deemed to have accepted in respect of all such acts matters and things absolute liability for any loss or damage suffered by the Association in relation thereto.
(b) The Company shall nominate one of those employees to obtain New Business for the purposes of this Letter of Appointment and advise the Association in writing accordingly. Upon the Association giving to the Company written notice of the Association's approval of the nomination of that employee for the purposes aforesaid that employee shall thereafter be and subject as hereinafter mentioned continue to be the Company's accredited representative for the purpose of this Letter of Appointment. The Association may at any time thereafter in the exercise of its discretion by written notice to the Company withdraw the Association's recognition of the Company's accredited representative for the purpose of this Letter of Appointment in which event that employee shall forthwith cease to be the Company's accredited representative as aforesaid.''
On 6 June 1978 the company, under its common seal and the signature of the taxpayer agreed to accept the appointment to obtain new business for NML on the terms and conditions set out in the Letter of Appointment dated 1 June 1978.
On 6 June 1978 the company, under its common seal, executed a document addressed to NML. By that document the company notified NML that it had resolved in effect to authorise the taxpayer to be its accredited representative. This document (omitting formal parts) reads:
``1. This Company, at a meeting of its Board of Directors on 2/6/78, has resolved to authorise the persons named below or any one or more of them to enter into and sign on its behalf, contracts and any other documents to be completed by the Company in connection with its dealings with The National Mutual Life Association of Australasia Limited (the Association) or any of its subsidiaries or associated companies including but without limiting the generality of the foregoing:
- (a) any contract for the Company's appointment as a representative of the Association or of National Mutual Fire Insurance Company Limited and any acknowledgement of an appointment as a representative as above;
- (b) any contract or other document relating directly or indirectly to the Company in its capacity as a representative as stated herein or to its operations as a representative.
2. The names of the persons, any one or more of whom is authorised to sign on behalf of the Company, and the specimens of their signatures are as follows:
By another document (undated) and addressed to NML, the company, under the hand of the taxpayer notified NML that the company, at a meeting of its Board of Directors held on 2 June 1978, had resolved to submit to NML the name of the taxpayer as ``accredited representative'' as referred to in Letter of Appointment dated 1 June 1978. This letter included the following request:
``The company requests that any amounts which have been and shall hereafter be debited against the commission account of Mr. Gary Tupicoff are to be debited against the company's commission account as from the date of its appointment as representative of the Association and in consideration of the Association's appointing the company its representative, the company irrevocably accepts responsibility for repaying to the Association any advances, credits or loans which have been or will be made or granted to Mr. Gary Tupicoff and remain outstanding.''
It is appropriate that I here state that although the Memorandum and Articles of Association of the company and the trust deed were prepared
ATC 4371by the taxpayer's solicitors Messrs. McCullough and Robertson I am satisfied after hearing Mr. Webb, the Queensland manager for NML, that NML was involved in the settling of the forms of those documents. I find NML required certain amendments to be made to those documents and that the taxpayer became the accredited agent of the company only with NML's approval.
After this series of dealings was completed the taxpayer continued selling life assurance for NML. He operated from the premises at 54 Jephson Street and later from the city office of NML in Edward Street, Brisbane. I am satisfied the name of the company appeared at the premises he used. For business correspondence the taxpayer used a letterhead on which the name of NML was prominent. Prior to the company's incorporation this letterhead showed the taxpayer as the representative. After incorporation the letterhead showed the company's name and the accredited representative to be the taxpayer. On 5 July 1978 NML had supplied the taxpayer with different styles of its letterhead which might be adapted for use by the company.
On 2 June 1978 the company opened a current account with the Commercial Banking Company of Sydney Limited at Toowong. Following a merger of banks the company continued the account with the National Australia Bank Limited.
As from 30 June 1978 the company became the registered group employer with the Australian Taxation Office.
From NML's side, in June 1978, it commenced a commission account in the name of the company. It continued this account thereafter. Such account disclosed details of commissions paid or credited to the company.
During October and November 1978 National Mutual Fire Insurance Company Limited kept commission accounts in the taxpayer's name. From December 1978 National Mutual Fire Insurance Company Limited commenced to keep commission accounts in the name of the company.
After the company came into existence the taxpayer, while engaged in selling insurance, used a business card provided by NML. This card showed the name of the company but was so designed that the name of the taxpayer and his office of managing director were to the fore.
The company, as trustee for the Gary Tupicoff Family Trust, lodged an income tax return for the year ended 30 June 1980. The return was prepared by Messrs. Munro and Dear, accountants who acted for the taxpayer and the company. The profit and loss statement of the company (as trustee) for that year showed a net profit before tax of $10,492.45. The return disclosed that the sum of $10,492 had been distributed as follows:
$ To Vanessa 1,040 To Cynthia 1,040 To the taxpayer's wife 8,412
This distribution accorded with a resolution of the directors of the company passed on 29 June 1980.
The gross profit for the company in that year was $35,003.88 derived from the following commissions received:
$ From NML 33,820.71 From National Mutual Fire 1,183.17 ---------- $35,003.88 ----------
Of the expenses claimed, wages totalled $15,723.53.
The balance sheet for the company as at 30 June 1980 showed among current assets an amount of $11,593.33 described as ``loan - G. Tupicoff''. Comparative figures for the 1979 balance sheet showed a nil balance against this item.
The taxpayer gave evidence that this $11,593.33 was the total of certain payments (other than salary) made by the company to him or on his behalf and treated as loans to him. The effect of these dealings was to raise a debit against the taxpayer for this sum. I am satisfied that to get rid of this liability it was the practice of the directors of the company, at least in the 1979 and 1981 financial years, to resolve to pay the taxpayer a management fee for his services to the company and further, that the amount of that management fee be credited to his loan account with the company. On 29 June 1981, at an extraordinary general meeting of members of the company it was resolved that the taxpayer be paid a management fee of $12,500 for his services to the company, during the year ended 30 June 1981 to be credited to his loan account on 29 June 1981.
The above recital of facts having been made I can now turn to matters raised in argument.
For the Commissioner, Mr. Cooper Q.C. made two basic submissions. First he said the transactions entered into by the taxpayer, the company and NML in June 1978 were all a sham and that in reality what occurred was an attempt by the taxpayer to alienate his future income, i.e. income actually derived by the taxpayer from his personal exertion as an insurance salesman. Next, Mr. Cooper submitted that sec. 260 of the Income Tax Assessment Act 1936 operated on the arrangements in such a way that the assessment should be upheld.
I propose to deal with the sec. 260 argument first. Menzies J. in
Peate v. F.C. of T. (1962) 12 A.T.D. 507; (1964) 111 C.L.R. 443 at A.T.D. p. 517; C.L.R. pp. 458-459 said:
``... I see no point in attempting to decide this matter independently of sec. 260 if the case falls within its scope, for in that event that section, without the Commissioner or Court `invoking' its operation, is part of the law that has to be applied and, so far as the Commissioner is concerned and in these proceedings, its operation would require some things that were done to be disregarded notwithstanding that for other purposes their legal effect would remain unimpaired.''
Section 260 provided:
``260 Every contract, agreement, or arrangement made or entered into, orally or in writing, whether before or after the commencement of this Act, shall so far as it has or purports to have the purpose or effect of in any way, directly or indirectly -
- (a) altering the incidence of any income tax;
- (b) relieving any person from liability to pay any income tax or make any return;
- (c) defeating, evading, or avoiding any duty or liability imposed on any person by this Act; or
- (d) preventing the operation of this Act in any respect,
be absolutely void, as against the Commissioner, or in regard to any proceeding under this Act, but without prejudice to such validity as it may have in any other respect or for any other purpose.''
In a statement furnished to the appellant's solicitors prior to the hearing of the appeal the Commissioner advised those solicitors that the statutory provisions on which he relied were sec. 19, 25 and 260 of the Income Tax Assessment Act and that the material facts relied on by him were:
``(i) that at all material times prior to 6th June 1978, all income derived by Mr. Tupicoff from his occupation as a National Mutual Insurance Agent was derived by his personal exertion;
(ii) that the following transactions, namely -
- 1. the purported resignation of Mr. Tupicoff as a National Mutual Insurance Agent; and
- 2. the purported appointment of Gary Tupicoff (Insurances Nominees) Pty. Ltd. as trustee of the Gary Tupicoff Family Trust, as a National Mutual Insurance Agent in lieu of Mr. Tupicoff
were transactions which were entered into for the purpose of giving the appearance that Gary Tupicoff (Insurances Nominees) Pty. Ltd. had been appointed as National Mutual Insurance Agent in lieu of Mr. Tupicoff but without an intention of supplanting the relationship that had existed between Mr. Tupicoff and National Mutual at all material times prior to 6 June 1978;
(iii) Alternatively, that the said transactions and the documents executed to effect the same were entered into and executed for the purpose or effect of altering the incidence of income tax in respect of income derived by Mr. Tupicoff from his occupation as a National Mutual Insurance Agent by his personal exertion.
(iv) Alternatively, that the said transactions and documents had effect only as creating a tripartite relationship between National Mutual, Mr. Tupicoff and Gary Tupicoff (Insurances Nominees) Pty. Ltd. whereby Mr. Tupicoff continued thereafter to derive income as a National Mutual Insurance Agent by his personal exertion which income was, by agreement of the parties, paid to Gary Tupicoff (Insurances Nominees) Pty. Ltd.''
Newton v. F.C. of T. (1958) 11 A.T.D. 442; (1958) A.C. 450 the Judicial Committee in
ATC 4373speaking of the word ``arrangement'' in sec. 260 said (at A.T.D. p. 445; A.C. p. 465):
``Their Lordships are of opinion that the word `arrangement' is apt to describe something less than a binding contract or agreement, something in the nature of an understanding between two or more persons - a plan arranged between them which may not be enforceable at law. But it must in this section comprehend not only the initial plan, but also all the transactions by which it is carried into effect - all the transactions, that is, which have the effect of avoiding taxation, be they conveyances, transfers or anything else.''
That view has been consistently followed in Australia (see
Hollyock v. F.C. of T. 71 ATC 4202 at p. 4205; (1971) 125 C.L.R. 647 at p. 655; Peate's case (supra) at (1964) 13 A.T.D. 349; C.L.R. p. 469).
I have no doubt on the evidence before me that the formation of the company, the creation of the trust and the various dealings involving the taxpayer, NML and the company which resulted in the taxpayer resigning as a new business agent of NML and becoming an accredited person employed by the company and still doing the same work as he did before his resignation, constituted an arrangement within sec. 260.
I should at this stage deal with other evidence before me which clearly shows that the arrangement was not something which came into existence suddenly and without due consideration.
The taxpayer's business as an agent of NML prospered from the time of its commencement save for a slump during 1974-1975. I find that by 1977 the business was flourishing and that the taxpayer was earning a gross income of about $27,000 to $30,000 per annum. His income was, I find, approaching a level where a higher tax rate would be imposed and it was a matter of concern to the taxpayer that if his business continued to prosper he would ultimately get to a higher tax level.
The taxpayer gave evidence of other matters which he said influenced his decision to enter into the arrangements of June 1978 and I shall say more of these shortly.
As far back as 1969 NML had considered the aspect of tax relief for certain of its agents. Mr. Webb, who as I have said is the present Queensland manager of NML and who gave evidence for the taxpayer, agreed that in those years NML was getting some pressure from its agents to allow incorporation. Prior thereto incorporation was not permitted by NML. This pressure was, I find, to gain some tax relief through incorporation. NML approached the Commissioner of Taxation in Canberra and from 1971 NML permitted incorporation of certain of its agents.
In a lengthy letter from NML's head office to the then Queensland manager (dated 28 April 1976) the matter of formation of trusts by NML's representatives was discussed. This letter commenced:
``In order to assist our representatives in legitimate tax saving aims, the Association has, since 1971, agreed to the incorporation of agencies by selected representatives. The income tax advantages from incorporation result from the fact that the total distributable income of the company can be divided among the shareholders (representatives and family members) in proportion to their entitlements with a reduction in personal tax otherwise payable by the representative. However, because of the present system of company taxation, including a higher primary tax of 42½% plus an undistributed profits tax of 50% plus personal tax on dividends and salaries plus gift duty problems in South Australia and Victoria and difficulties of company administration, companies have lost much of their popularity as tax saving devices. Instead, the family discretionary trust has become the basis of modern tax and estate planning...''
This letter discussed procedures to be followed by representatives who had not then incorporated and who wished to form a trust. The letter advised formation of a proprietary limited company to act as trustee of the settlement creating the trust.
In summary the letter stated its conclusions and the effect of these was:
- (a) NML did not object to the formation of trusts by representatives who had either already incorporated their business or who qualified for incorporation, but did not encourage them to do so;
- (b) Incorporation was not a matter of course but was subject to the approval of NML, the
ATC 4374initial screening of applications and documents to be done as far as possible by branches concerned. Copies of all papers in relation to every incorporation with or without a trust were to be forwarded to NML's head office;
- (c) The matter of the Trade Practices Act and its possible effect on what are called ``Corporate Letters of Appointment'' were adverted to but no final decision was expressed;
- (d) Representatives contemplating incorporation must first consult the branch concerned to ascertain NML's conditions and requirements. It was said that if a representative incorporated (with or without a trust) he must note that the sole purpose of his company or trust was the incorporation of his business with NML and not the conduct of other trading activities.
Attached to this letter were draft letters to representatives who had then already incorporated and those who had not but who qualified for conversion to incorporation and/or a trust.
It is clear from this document that NML, while advising agents of its attitude to incorporation and/or creation of trusts, was expressly disclaiming any liability to the agent and warning the agent of pitfalls including the uncertainty as to levying of income tax. Section 260 was specifically mentioned.
This letter also set out NML's criteria for agents who were to be allowed incorporation and/or creation of a trust. The representative should already have had an appointment for at least three years and the appointment conducted to the satisfaction of the Association; his life assurance commission earnings from good quality business should be at least $25,000 or $30,000 per annum with a good indication that future earnings would remain at or go above this level. These conditions were I find not inflexible and the taxpayer met them.
On 3 October 1977 NML's head office wrote to NML's various State offices a letter dealing with incorporation of agents. This letter followed the 1977 Commonwealth Budget and included the following statement:
``As far as National Mutual Representatives who seek to form trading trusts are concerned, they should not only qualify under our guidelines but they should also be told of the current uncertainty in respect of trusts and their possible limited use. More than before will it be necessary to ask representatives who want to convert their agencies to seek proper professional accounting and legal advice as to the general usefulness and prudence of such a step at this stage.''
The taxpayer admitted that prior to incorporation of the company he had seen a copy of that letter. I find that during 1977 the taxpayer approached NML about his prospects of becoming an incorporated agent.
Early in February 1978, and prior to the taxpayer taking any steps to incorporate the company, the taxpayer received from Mr. Howard Tidd, NML's sale support officer, a memo dated 2 February 1978 dealing with ``conversion to Company and/or Trust''. Attached to the memo was a number of documents including a confidential letter dated 2 February 1978 from the Queensland manager of NML to the taxpayer. This letter commenced:
``It is the Association's policy that selected representatives may conduct their business with the Association through proprietary limited companies upon such terms and conditions as the Association shall approve. In addition, the Association does not object in principle to the formation of a trust in the context of your appointment and you will have to decide whether you intend to incorporate with or without a trust and whether you wish to continue as an individual representative as at present.''
It was made clear that the letter was not to be regarded as an invitation to form a trust. It gave advice to the taxpayer and included the following statement:
``For the sole purpose of enabling the Association to provide superannuation benefits for the accredited representative under the Field Staff Superannuation Fund it will be necessary for the Association to hold at least one share in your proposed company. The Articles of Association of the company to be formed must give the directors of the company power to decline to register any transfer of shares without the necessity to give any reasons for the refusal.''
The letter warned the taxpayer of the possibility of legislative or judicial intervention
ATC 4375and specifically that it was uncertain whether and to what extent the Commissioner of Taxation would try to apply sec. 260 of the Income Tax Assessment Act to such trusts.
The letter concluded with the following statement:
``You, personally, will be required to indemnify the Association against any costs, expenses or losses, etc., which it may incur by reason of the incorporation of your company or the formation of a trust which may arise from or in the course of the appointment of the company under its Letter of Appointment with the Association.''
Armed with this information the taxpayer spoke to his accountants Messrs. Munro and Dear who referred him to Messrs. McCullough and Robertson. These solicitors thereafter acted for the taxpayer in respect of the transactions forming part of the above arrangement.
The taxpayer, in evidence before me spoke of a number of advantages which he said he saw would be gained by incorporation. They were in summary:
- (a) To protect and provide family assets;
- (b) To provide his wife with the prospect of earning a greater income through favourable exercise by the trustee of the discretion under the proposed trust deed;
- (c) To provide a more advantageous business structure in that his status and prestige would be enhanced, there would be greater flexibility in employment of others to assist in gaining income and greater flexibility in the types of insurance business in which the company could engage;
- (d) To facilitate any possible sale of the business; and
- (e) To obtain advantages of limited liability.
The taxpayer conceded that at the time he entered into the arrangements he was aware of the prospect of tax advantages for him but said that any such advantages were not a principal object of the incorporation of the company, the setting up of the trust, his resignation and his appointment as an accredited agent of NML.
I accept that the taxpayer did hope to provide his wife with a greater income and that he did expect business advantages of the type mentioned in (c) above. The taxpayer was unconvincing when attempting to explain his belief that incorporation of the company with limited liability would protect him from exposure to any possible actions for negligent misstatement and thereby place his personal assets including his home at risk. Although he said that his possible personal liability when employed by the company was explained to him by his solicitors I find it impossible to believe that he was not told that if he made a negligent misstatement he would be exposed to personal liability and the company might well be too. In the circumstances of this case I am unable to see how incorporation would protect the taxpayer himself from any such liability bearing in mind that he was the sole employee of the company engaged in selling insurance.
I find that, as the company held no assets (other than those fixed assets acquired from the taxpayer's business after incorporation and as shown in the 1980 balance sheet) the company's structure in the circumstances of this case could not protect the taxpayer's personal assets such as his house. At the material time his house had not become a trust asset.
I have set these matters out in some detail because the Commissioner has submitted that the above arrangement was entered into and executed for the purpose or effect of altering the incidence of income tax in respect of income derived by the taxpayer by personal exertion in his occupation of an NML agent. The Commissioner relies on limb (a) of sec. 260.
In Newton's case (supra) at A.T.D. p. 445; A.C. p. 466, the Judicial Committee (in speaking of a case to which limb (c) of sec. 260 applied) said:
``In order to bring the arrangement within the section you must be able to predicate - by looking at the overt acts by which it was implemented - that it was implemented in that particular way so as to avoid tax. If you cannot so predicate, but have to acknowledge that the transactions are capable of explanation by reference to ordinary business or family dealing, without necessarily being labelled as a means to avoid tax, then the arrangement does not come within the section.''
And so, I have to consider objectively whether the transactions forming part of the arrangement can be classified as an ordinary business or family dealing. In my opinion they clearly cannot. Before the transactions the
ATC 4376taxpayer was an agent of NML selling life assurance on its behalf. The sales were made purely as a result of his selling ability. After the transactions the taxpayer sold life assurance on behalf of NML - as he had done before - save that he was then an accredited agent and an employee of the company. In the 1980 year all the gross earnings of the company were derived from the taxpayer's selling ability. The taxpayer, so far as dealings with clients and potential clients were concerned, operated in exactly the same way both before and after the transactions. There were admittedly minor differences - e.g. the business cards, the letterheads and NML paying commission to the company and the company acquiring certain assets. These differences do not, in my view, cause me to believe that from the clients' viewpoint there was any substantial change in the taxpayer's operations after the transactions were completed.
If I had had any doubts about whether or not the transactions were an ordinary business or family dealing (and I do not) those would have been dispelled by the way in which the taxpayer used moneys in the company bank account as his own by creating substantial loan accounts in his favour and subsequently liquidating or reducing them by the management fee credit device.
And so I move on to the aspect of the purpose of the arrangement which as stated in Newton's case has to be ascertained by looking at the arrangement itself (see also Hollyock (supra) at ATC p. 4205; C.L.R. p. 655).
Before me the taxpayer contended that before sec. 260 could apply I must be satisfied that the transactions had ``as their main purpose or one of their main purposes'' altering the incidence of income tax. His counsel, Mr. Byrne Q.C. relied heavily on what Lord Diplock had said in delivering the majority judgment of the Judicial Committee in
Europa Oil (N.Z.) Limited (No. 2) v. Commr. of I.R.(N.Z.) 76 ATC 6001; (1976) 1 W.L.R. 464 At ATC p. 6009; W.L.R. p. 475 Lord Diplock, in considering the New Zealand equivalent of sec. 260 and in speaking of several things to be noted in connection with the application of that section said:
``Fourthly, the section in any case does not strike down transaction which do not have as their main purpose or one of their main purposes tax avoidance. It does not strike down ordinary business or commercial transactions which incidentally result in some saving of tax. There may be different ways of carrying out such transactions. They will not be struck down if the method chosen for carrying them out involves the payment of less tax than would be payable if another method was followed. In such cases the avoidance of tax will be incidental to and not the main purpose of the transaction or transactions which will be the achievement of some business or commercial object:
Newton v. Commissioner of Taxation (1958) A.C. 450 at p. 465;
Mangin v. Commr. of I.R. 70 ATC 6001; (1971) A.C. 739;
Ashton v. Commr. of I.R. 75 ATC 6001; (1975) 3 All E.R. 225).''
Although Europa has been referred to in subsequent High Court decisions e.g.
Cridland v. F.C. of T. (77 ATC 4538; (1977) 140 C.L.R. 330) I have not found any High Court authority which expressly approves the above quoted passage.
Indeed, the High Court authorities seem to disagree with Lord Diplock. In Hollyock's case (supra), Gibbs J. (as he then was) reviewed earlier authorities on this point. At ATC pp. 4205-4206; C.L.R. pp. 655-657 he referred to Newton's case (supra);
Hancock v. F.C. of T. (1961) 12 A.T.D. 312 at p. 317 ((1961) 108 C.L.R. 258 at p. 283); Peate's case (supra) and Mangin v. Commr. of I.R. (N.Z.) 70 ATC 6001; (1971) A.C. 739 at p. 751. He distinguished the latter (a New Zealand case) and at ATC pp. 4205-4206; C.L.R. p. 657 said:
``To hold that tax avoidance should be the principal purpose of the arrangement would seem to me to be opposed to the reasoning on which those decisions rest, and would introduce into sec. 260 a refinement which is not suggested by the words of the section itself, and which would tend to increase, rather than remove, the difficulties to which the section gives rise, by requiring the courts to weigh one purpose against another and to decide which was predominant. An arrangement may, for example, be designed to secure both the avoidance of income tax and the avoidance of death duties - each purpose may be equally important - and in such a case the arrangement does not in my opinion escape from sec. 260 simply because it cannot be held that the avoidance of tax is
ATC 4377the principal purpose of the scheme. On the other hand, if tax avoidance is an inessential or incidental feature of the arrangement, that may well serve to show that the arrangement cannot necessarily be labelled as a means to avoid tax.''
Although Hollyock's case is a decision of a single Justice of the High Court I am entitled to give it great weight. I am not bound by the Privy Council decision in Europa because the High Court's decisions in Hancock and Peate (by which I am bound) do not go as far as requiring that in this case, a sec. 260 arrangement have alteration of the incidence of income tax as its main purpose or as one of its main purposes.
It seems to me that the High Court cases referred to by Gibbs in Hollyock show that for sec. 260 to apply in the case before me, the arrangement must have as an essential feature (as opposed to an unessential or incidental feature) the purpose of altering the incidence of income tax.
In the view which I take of the matter and on all the evidence before me I find the transactions entered into and on which the Commissioner relies plainly had as their central feature the alteration of the incidence of tax on income earned by the taxpayer from his personal exertions as an insurance salesman. I did not believe the taxpayer when he said that tax advantages were not a principal object. Indeed, if Lord Diplock's test be correct I am satisfied that the transactions had as their main purpose and effect the splitting of the taxpayer's income between himself and his family. The results of the 1980 financial year show how successfully the taxpayer achieved his purpose.
Nevertheless, Mr. Byrne has submitted that if I did form the above view then, ignoring the annihilation effect, sec. 260 does not apply. The basis of this submission is that by entering into the transactions which he did, i.e. incorporating the company and causing the trust to be created, the taxpayer exercised a choice and did so in order to attract the taxing provisions of Div. 6 and 7 of Pt. III of the Income Tax Assessment Act. He relied heavily on Cridland's case (supra). That case is an extension of the principle of
W.P. Keighery Pty. Ltd. v. F.C. of T. (1957) 11 A.T.D. 149; (1957) 100 C.L.R. 66 which, as Mason J. pointed out (at ATC p. 4542; C.L.R. p. 339 of Cridland's case) decided ``that sec. 260 has no application to a case in which the Act offers to the taxpayer a choice of alternative tax consequences either of which he is free to choose...''.
In Cridland's case the taxpayer was an engineering student at a university. He applied for a unit of entitlement in two unit trusts. His sole purpose was to be able to average his income pursuant to Pt. III Div. 16 as a person who carried on a business of primary production. Mason J., delivering the leading judgment of the High Court said (at ATC p. 4542; C.L.R. p. 340):
``The transactions into which the appellant entered in the present case by acquiring income units in the trust funds in question were not, I should have thought, transactions ordinarily entered into by university students. Nor could they be accounted as ordinary family or business dealings. They were explicable only by reference to desire to attract the averaging provisions of the statute and the taxation advantage which they conferred. But these considerations cannot, in light of the recent authorities, prevail over the circumstance that the appellant has entered into transaction to which the specific provisions of the Act apply, thereby producing the legal consequences which they express.''
In my view, the present taxpayer's case is distinguishable from Cridland. No specific provisions of the Act apply to the transactions he entered into other than in a general way e.g. Div. 6 or 7 might apply.
I do not consider that this taxpayer can further extend the Keighery principle to fit his case simply by showing that his company might be taxed under Div. 7 and the trust might be taxed under Div. 6. I reject Mr. Byrne's submission on the ``choice'' aspect.
Next I come to the annihilating aspect of sec. 260. As Kitto J. in Peate's case, when speaking of sec. 260 said (at (1964) 13 A.T.D. p. 349; C.L.R. p. 470):
``The provision, it is true, operates only to destroy; it supplied nothing.''
In Newton's case (1958) 11 A.T.D. 442 at p. 447; (1958) A.C. 450 at p. 467 the Judicial Committee approved the following statement of Fullagar J. when the matter was before the High Court:
``Section 260 alters nothing that was done as between the parties. But for the purposes of income tax, it entitles the Commissioner to look at the end result and to ignore all the steps which were taken in pursuance of the avoided arrangement.''
The taxpayer does not dispute that these passages accurately state the law. However, his counsel submits that the fundamental principle is that after annihilation, there must be exposed facts justifying the levy of tax. Mr. Byrne relies on
Slutzkin v. F.C. of T. 77 ATC 4076; (1977) 140 C.L.R. 314 and in particular dicta of Barwick C.J. and Aickin J. At ATC p. 4080; C.L.R. p. 320 the former said:
``It is a complete misconception of the operation of sec. 260 to conclude that, because a transaction was entered into in the form in which it took in order not to subject its proceeds to tax in the hands of the recipient, sec. 260 is satisfied. Further, it is fundamental that the section is, as it has been said, no more than an annihilating section. It does not itself impose tax, nor does it construct or reconstruct any transaction. It does not more than avoid a transaction. The avoidance is of no consequence unless, if the transaction were swept aside, a factual situation involving the payment of tax is exposed.''
I will not quote the passage of Aickin J. relied on but it appears at ATC 4083; C.L.R. p. 326 of the report.
Mr. Byrne submitted that if I treated the incorporation of the company, the creation of the family trust, the resignation, the fresh appointment of the company as NML's agent, the appointment of the taxpayer as the accredited agent of the company and the employment contract between the company and the taxpayer as all annihilated by sec. 260, nevertheless I should find no income exposed to taxation. He submits that what is left is income in the company's commission account, that this is not the taxpayer's income and therefore the taxpayer is not liable to be assessed to tax on it. I should here state that in my view the above recited transactions must all be treated as annihilated for the purposes of sec. 260.
Mr. Byrne has relied on a decision of the Full Court of the Federal Court of Australia -
F.C. of T. v. Kareena Private Hospital Pty. Ltd. 79 ATC 4667; (1979) 41 F.L.R. 307. The facts of that case as taken from the headnote are:
``The taxpayer respondent had been carrying on a profitable business conducting a private hospital. Its two shareholders and directors were a doctor and his wife. The taxpayer had leased its premises from a company (`Holdings') also owned and controlled by the doctor and his wife. Another company (`International') had accumulated losses which were thought to be $120,000 and which were deductible under sec. 80 of the Income Tax Assessment Act 1936. Arrangements were made whereby International carried on the private hospital business of the taxpayer until its losses were exhausted. These arrangements involved various steps. They included the following: (i) the taxpayer surrendered to Holdings its lease of the hospital; (ii) International was granted a twelve month lease of the hospital by Holdings; (iii) the taxpayer lent International $120,000; (iv) International paid Holdings a premium of $120,000 for the lease; (v) after a few months International made profits equal to its deductible losses and these were paid in varying amounts to the taxpayer to pay off International's debt to it and (vi) after the few months International ceased to carry on the hospital business and the taxpayer resumed control of the business.''
To that statement I would add that International engaged its own staff to operate the hospital.
In my opinion that case is clearly distinguishable from the present. For the period in question International operated the entire hospital business - Kareena had no control of or interest in the business. In the case before me the income derived by the company was the result of the taxpayer's personal activities. Without him the company earned nothing. The taxpayer's case is not one of income derived from property as was the situation in Kareena. Distinguishing Kareena, however, does not answer Mr. Byrne's submission. The Commissioner has relied on Peate's case as justifying my holding that moneys in the company's commission account are exposed as liable to tax in the taxpayer's hands.
Peate's case in the High Court and in the Privy Council has been the subject of later
ATC 4379comment but no High Court case has been cited showing that it is no longer good law. There eight doctors dissolved their partnership and agreed that fees owing to them should be collected by a company A.E. Westbank Proprietary Limited and accounted for by that company. It was held that as a result of the operation of sec. 260 each doctor's share of the fees received by Westbank was derived by him. Kitto J., when Peate's case was before the High Court, said (at 13 A.T.D. p. 350; C.L.R. p. 471):
``Menzies J. took the same view of the application of sec. 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'.
In my opinion this is correct. It means that sec. 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 sec. 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 sec. 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.''
When Peate's case went on appeal to the Privy Council the majority treated fees received by A.E. Westbank Proprietary Limited as income of the doctors.
Peate's case, insofar as it was held that fees received by Westbank were treated as received by the doctors personally, is indistinguishable from the facts in the instant case. The High Court had no trouble in applying sec. 260 to fees in the hands of Westbank. As Peate is binding I must treat the commission credited to the company as commission earned personally by the taxpayer.
I should add that Mr. Byrne did address an argument in respect of Peate's case based on Westbank's inability to sue for fees because it was not a registered medical practitioner. I do not understand the High Court to have based its decision primarily on this aspect of the matter. If I should be wrong then there is an analogy with the taxpayer's case. In the taxpayer's case National Mutual were as I find assiduous to ensure that the company's accredited agent should be the taxpayer. In effect, if the taxpayer was not that person, the company would not have been appointed agent in the first place and would not have received any commission. The taxpayer's position as accredited agent was, in my opinion, analogous to that of a registered medical practitioner.
Furthermore, once the annihilating effect occurs and the company is ignored who, one may ask, was the taxpayer's principal? The answer is there was no one. For whom was the taxpayer then working? The answer is - himself. Who was entitled to the commission which he earned? The answer must surely be ``the taxpayer''. To use the words of Wild C.J. in
Marx v. Commr. of I.R. (N.Z.) (1968) 15 A.T.D. 278 at p. 287; (1969) N.Z.L.R. 464 at p. 473 - ``That amount was earned entirely by the sweat of his own brow''.
Thus, for the above reasons I consider that sec. 260 applies.
However, Mr. Byrne submitted that because the evidence before me discloses that the taxpayer's wife had been assessed to tax on
ATC 4380$10,825 including the distribution to her under the family trust for the year ended 30 June 1980, there was therefore double taxation and her assessment is inconsistent with the Commissioner's assessment against the taxpayer. Mr. Byrne conceded that there can be no estoppel against the Commissioner of Taxation (
F.C. of T. v. Wade (1951) 9 A.T.D. 337 at p. 344; (1951) 84 C.L.R. 105 at p. 117) but went on to rely on sec. 177 of the Income Tax Assessment Act, the effect of which he submitted was to provide conclusive evidence of the correctness of the assessment against Mrs. Tupicoff. In my opinion this submission has no substance.
In the result I dismiss the appeal and confirm the assessment. I order the taxpayer to pay the Commissioner's costs of and incidental to the appeal to be taxed.
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