Federal Commissioner of Taxation v. Gulland.

Judges: Gibbs CJ
Wilson J

Brennan J
Deane J
Dawson J

Court:
Full High Court

Judgment date: Judgment handed down 18 December 1985.

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Brennan J.

F.C. of T. v. Gulland; Watson v. F.C. of T.; Pincus v. F.C. of T.

I have had the advantage of reading in draft the judgments of Dawson J. in these matters. I agree with his Honour's conclusions and, subject to what follows, with his reasons for reaching them. I can therefore state briefly the operation which I would attribute to sec. 260 of the Income Tax Assessment Act 1936 (Cth). That section is expressed to operate upon contracts, agreements or arrangements (hereafter indifferently described as arrangements) which have or purport to have any of the purposes or effects specified in para. (a) to (d) of that section. Conveniently, though not exhaustively or precisely, the purposes or effects specified in para. (a) to (d) may be described as tax avoidance. In terms, sec. 260 avoids as against the Commissioner any arrangement which has the effect of avoiding tax, whether or not tax avoidance is a purpose of the arrangement and irrespective of the means by which tax is avoided. The true scope of the section is more limited, but the limitations to be placed on the words used in sec. 260 and the principles which justify the placing of limitations on its words are problems of continuing difficulty.

One of the limitations to be placed on sec. 260 is justified by a familiar rule of statutory construction: generalia specialibus non derogant
Reg. v. Kelly ; Ex parte The Victorian Chamber of Manufactures (1953) 88 C.L.R. 285 at p. 319 ). The Act contains a great number of specific and particular provisions which affect taxable income (as defined in sec. 6(1)) and a taxpayer's consequential liability for tax. The intention of the legislature in enacting specific and particular provisions which affect assessable income or add to or increase allowable deductions is that those provisions should have effect according to their tenor, so that a taxpayer who brings himself within a specific and particular provision which purports to confer a tax benefit should be

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entitled to have that benefit. That intention would fail if sec. 260 were to operate according to its literal terms, for sec. 260 would avoid any arrangement which brought the taxpayer within a specific and particular provision of the Act which conferred a tax benefit. It could not have been intended by the legislature that sec. 260 should prevail over the specific and particular provisions and destroy the tax benefits they were intended to confer. It is necessary therefore to read down sec. 260, a general provision, in order to provide for the operation of the specific and particular provisions of the Act. This approach to the construction of sec. 260 was taken by Stephen J. in
Mullens & Ors v. F.C. of T. 76 ATC 4288 at pp. 4303-4304; (1976) 135 C.L.R. 290 at p. 319 :

``Section 260 of the Act, in performing its task of `protecting the general provisions of the Act', cannot be allowed to negative the Act's specific and particular provisions, of which sec. 77A is one. To so understand sec. 260 would be wholly out of accord with general principles of statutory interpretation. Menzies J. recognized this when he remarked, in
Ellers Motor Sales Pty. Ltd. v. F.C. of T. 70 ATC 4008 at p. 4015; (1969) 121 C.L.R. 665 at p. 677 , that it was not to be thought that the specific provision of which the taxpayer had there taken advantage `was given merely to be taken away by the operation of sec. 260', and see F.C. of T. v. Casuarina Pty. Ltd. especially per Gibbs J. at ATC p. 4081 and C.L.R. p. 105.''

As a taxpayer may choose to organize his affairs in such a way as to take advantage of tax benefits provided by the ``specific and particular'' provisions of the Act, a principle - the ``choice principle'' - gives expression to the scope of sec. 260, Mason J. in
Cridland v. F.C. of T. 77 ATC 4538 at p. 4542; (1977) 140 C.L.R. 330 at p. 339 , stated the principle in these terms:

``... [it]... proceeds on the footing that the taxpayer is entitled to create a situation by entry into a transaction which will attract tax consequences for which the Act makes specific provision and that the validity of the transaction is not affected by sec. 260 merely because the tax consequences which it attracts are advantageous to the taxpayer and he enters into the transaction deliberately with a view to gaining that advantage.''

As this enunciation of the principle recognizes, the choice principle operates only to the extent necessary to give effect to a ``specific provision'' of the Act. The choice principle gives expression to the scope of sec. 260 ascertained by reading down the words of the section in order to allow other and specific provisions of the Act to have their intended operation. The choice principle is inapplicable when the arrangement does not attract a tax benefit conferred by a specific provision but is an arrangement which, as in the present cases, seeks to divert income from one taxpayer to another. Having ascertained the scope of sec. 260 it is necessary to consider what is the condition of its operation on cases which do not depend on a specific provision of the Act.

A disposition of income-yielding property could not have been intended to be within the net of sec. 260 merely because the disposition has the effect of relieving the disponor of tax liability which would have been imposed on him had he continued to receive the income yielded by the property. In
D.F.C. of T. v. Purcell (1921) 29 C.L.R. 464 Gavan Duffy and Starke JJ. (at p. 473) said in respect of the corresponding provision to sec. 260 in the Income Tax Assessment Act 1915-1916 (Cth):

``The section... does not prohibit the disposition of property. Its office is to avoid contracts, & c., which place the incidence of the tax or the burden of tax upon some person or body contemplated by the Act. If a person actually disposed of income-producing property to another so as to reduce the burden of taxation, the Act contemplates that the new owner should pay the tax. The incidence of the tax and the burden of the tax fall precisely as the Act intends, namely, upon the new owner.''

Although a simple disposition of income-producing property does not attract the operation of sec. 260, a larger transaction of which a disposition of property forms a part may be caught: see
Hancock v. F.C. of T. (1961) 108 C.L.R. 258 at p. 283 . The distinction between arrangements upon which sec. 260 operates and those upon which sec. 260 does not operate when both classes of arrangements have the effect of avoiding tax is not easily gleaned from an examination of the

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text of that section. But it can be said that an arrangement which has the effect of avoiding tax is not within the section unless the avoidance of tax is a purpose for which the arrangement was made. Section 260 does not operate on an arrangement unless it has a purpose as well as the effect of avoiding tax. (We can put aside arrangements which have or purport to have a purpose of tax avoidance but which do not have or purport to have a corresponding effect, for the avoiding of such an arrangement would leave the position of the taxpayer vis- à -vis the Commissioner unaffected.) If it can be predicated of an arrangement that among the purposes for which it was made is the purpose of avoiding tax then, provided that purpose is a substantial, not merely incidental, purpose of the arrangement, it is an arrangement on which sec. 260 operates (
Hollyock v. F.C. of T. 71 ATC 4202 at p. 4205; (1971) 125 C.L.R. 647 at p. 657 ). To predicate of an arrangement that a purpose for which it was made is the avoidance of tax, something more is needed than a purpose to achieve what the arrangement is apt to effect if the arrangement is apt to effect a variety of consequences only one or some of which is the avoiding of tax. In
Newton v. F.C. of T. (1958) 98 C.L.R. 1 at p. 8 , Lord Denning delivering the judgment of the Privy Council 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.''

A purpose of avoiding tax is not taken to exist when the means adopted to carry the arrangement into effect are fairly referable to ordinary business or family dealing and the avoidance of tax is merely incidental. If a purpose of avoiding tax is found to exist, the arrangement is caught by sec. 260 even though the advancing of ordinary business or family interests is one of the purposes and one of the effects of the arrangement. After the passage which I have cited from Newton, their Lordships went on to give instances of cases where it was thought that nobody could predicate of the arrangement that it was made for the purpose of avoiding tax in the sense which their Lordships had stated. Some of those instances, notably
W.P. Keighery Pty. Ltd. v. F.C. of T. (1957) 100 C.L.R. 66 , were in truth examples of cases which fell outside the net of sec. 260 not because they did not answer the test of purpose but because the case was covered by a specific provision of the Act and sec. 260 was inapplicable on that account.

Confusion is inevitable if the rule which requires sec. 260 to be read down is invoked to determine its application after its true scope is ascertained. The choice principle should not be applied when there is no occasion to invoke the rule generalia specialibus non derogant on which it is founded. If the choice principle were applied to deny the operation of sec. 260 on arrangements which do not depend on a specific provision of the Act, the choice principle would annihilate sec. 260 itself. The true reconciliation between the choice principle and the Newton test of purpose is to limit the former to cases depending upon a specific provision of the Act. It is not necessary now to consider the boundary between the two classes, but in principle only those arrangements or parts of arrangements which depend upon specific provisions fall outside the scope of sec. 260.

In the present cases, the respective arrangements are made, in greater or less degree, for purposes other than tax avoidance. In the case of Dr Pincus, one of the chief purposes of the arrangement was to carry to completion the dissolution of the partnership of which he had been a member. Nevertheless in every case, the means of implementing the arrangement was artificial as Dawson J. has demonstrated. The means are not fairly referable to ordinary business or family dealing, and the proper inference is that each of the arrangements was made for a purpose of avoiding tax. None of the arrangements attracts a specific provision of the Act. It is immaterial that a purpose or effect of an arrangement is to obtain an allowable deduction under sec. 82AAC for the trustees of a unit trust who set apart or pay money to a fund for the superannuation of an employed doctor. Section 82AAC provides no tax benefit for the doctor. None of the arrangements purports to obtain a sec. 82AAC deduction for the doctor. It

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follows that as between the respective taxpayers and the Commissioner, the arrangements are void.

An arrangement which, as between the taxpayer and the Commissioner, is avoided by sec. 260 nevertheless remains valid for other purposes. The arrangement has in law and in fact the effect which, as against the Commissioner, is annihilated. The situation that is left after sec. 260 has done its work is necessarily an hypothetical one having no existence in law or fact: it is the situation that would have existed had the arrangement not produced the specified effect. The difference between the situation which does exist in law and in fact and the hypothetical situation is the ``effect'' which attracts the operation of the section. Section 260 does not expressly prescribe what hypothesis is to be adopted for the purposes of the Act once an arrangement is avoided. One of the difficulties in the application of sec. 260 is ascertaining the hypothetical facts which, as between the taxpayer and the Commissioner must be taken to be the facts on which the determination of the taxpayer's taxable income depends.

When a taxpayer, prior to making an arrangement caught by sec. 260, has been in receipt of assessable income from a particular source and he would have continued to be in receipt of assessable income from that source but for the effect of the arrangement, the taxpayer is assessed to tax after the arrangement takes effect on the footing that he has continued in receipt of assessable income from that source. Thus in
Europa Oil (N.Z.) Ltd. (No. 2) v. Commr of I.R. (N.Z.) 76 ATC 6001 ; (1976) 1 W.L.R. 464 , Lord Diplock noted at ATC p. 6009; W.L.R. p. 475 ((1976) 1 All E.R. 503 at pp. 511-512) that, under the corresponding provision in the Land and Income Tax Act 1954 of New Zealand:

``... the description of the contracts, agreements and arrangements which are liable to avoidance presupposes the continued receipt by the taxpayer of income from an existing source in respect of which his liability to pay tax would be altered or relieved if legal effect were given to the contract, agreement or arrangement sought to be avoided as against the Commissioner. The section does not strike at new sources of income or restrict the right of the taxpayer to arrange his affairs in relation to income from a new source in such a way as to attract the least possible liability to tax. Nor does it prevent the taxpayer from parting with a source of income.''

Critical to a resolution of the present cases is an understanding of what is to be regarded as an existing source of income. When the source of income is not simply income-producing property, but a business carried on by the taxpayer personally, the business activity in which the taxpayer engages may be in reality the source of income. And if that be so, it is immaterial that the taxpayer disposes of the business by an arrangement which transforms him into an employee of the disponee. Of course, when the source of income of a business is the activity of the proprietor and he remains working in the business after he sells or otherwise disposes of it, the question whether the income remains his for the purposes of the Act or whether it is the income of the disponee depends on whether the sale or disposition was fairly referable to ordinary business or family dealing and the avoidance of tax was merely incidental. If the sale or disposition of the business is for the purpose, inter alia, of avoiding tax in the sense explained in Newton, the sale or disposition is avoided as against the Commissioner and the taxpayer is taken to continue to receive income from his business activity.

In the present cases, the respective taxpayers have continued to carry on their medical practices as they had before the respective arrangements were made. The medical services for which fees are paid are rendered by the individual doctor or doctors engaged in the practice and the gross fees received by the respective unit trusts must be treated as the assessable income of the doctor or doctors engaged in the practice. In
Peate v. F.C. of T. (1964) 111 C.L.R. 443 , where a group of doctors disposed of their practice to a company which they formed to employ them and to enter into agreements for medical services with patients, Menzies J. found (at p. 461):

``What is left then is a group of doctors practising together but without any formal agreement of partnership, using Westbank [the company which was formed in implementation of the arrangement] to receive all fees paid, to provide services for the group, to pay group expenses and to make distributions of what remained in

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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.''

Kitto J. agreed. He said (at p. 471):

``It means that s. 260 renders the arrangement void as against the Commissioner so far as it gave Westbank the beneficial property in fees collected and gave the quality of a resolution of a board of directors to the decisions of the doctors as to disbursement. What remains is the income produced by an association of doctors, received by them jointly, and subject to division in agreed proportions so that, in the language of s. 19, each doctor's distributable share was dealt with as he directed. It follows that each doctor must be considered to have derived his proportion of the income.''

Peate's case was followed by Gibbs J. in Hollyock v. F.C. of T. His Honour said (at ATC p. 4206; C.L.R. p. 658):

``... it is not possible to regard this case as one in which the appellant has simply disposed of income-producing property. It is true that a considerable quantity of trading stock was included in the assets of the business, but the income derived by the appellant was derived from carrying on the business, and the trading stock yielded income only because the business was carried on.

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Once the arrangement whose purpose was to avoid tax is annihilated, what clearly remains in the present case is that the appellant received the entire income from the pharmacy business.''

The doctors who were conducting the respective practices with which we are here concerned have continued to conduct them, though the ownership of each practice has passed to the trustees of a unit trust. The circumstances in which those transactions occurred are set out in the judgments of Dawson J. and I need not repeat them. The respective assessments to tax were made on the footing that the gross fees or an appropriate proportion of the gross fees earned in the respective practices are assessable income of the respective taxpayers. That was the correct footing for making the respective assessments.

The objections to the assessments were rightly dismissed. The Commissioner's appeal should be allowed; Dr Watson's appeal and Dr Pincus' appeal should be dismissed.