Federal Commissioner of Taxation v. Gulland.

Members: Gibbs CJ
Wilson J
Brennan J
Deane J

Dawson J

Tribunal:
Full High Court

Decision date: Judgment handed down 18 December 1985.

Dawson J.

F.C. of T. v. Gulland

Section 260 of the Income Tax Assessment Act 1936 (Cth) has been amended to apply only to contracts, agreements or arrangements made or entered into on or before 27 May 1981: see subsec. (2). Part IVA of the Act has been added to take the place of sec. 260 in relation to schemes entered into after 27 May 1981, but there remains a number of cases, of which this is one, which fall to be determined under the older provision.

It may be as well to recall at the outset the terms of sec. 260(1), which provide that:

``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.''

Many words have been spoken and much ink has been spilt over the meaning of sec. 260 without providing any complete resolution of the problems which it has thrown up. No doubt that is why it has been replaced. Nevertheless the problems which arise in this case may, I think, be decided by principles which can be extracted from those cases which have grappled with the section.

In 1979 the respondent taxpayer, Dr Gulland, chose to reorganize his affairs with the provisions of the Income Tax Assessment Act in mind and it is the ``purpose or effect'' of the arrangement which he adopted which is crucial to the determination of this case. There is no question that there was an arrangement within the meaning of sec. 260 since an arrangement within the meaning of the section embraces a planned course of action, at least where the plan is between two or more persons, and includes the steps by which the plan is put into effect:
Bell v. F.C. of T. (1953) 87 C.L.R. 548 at p. 573 ;
Newton v. F.C. of T. (1958) 98 C.L.R. 1 at pp. 7-8; (1958) A.C. 450 at p. 465 . The question is whether the purpose or effect of the arrangement was to provide an escape for the taxpayer from the payment of tax in a manner precluded by sec. 260.

Dr Gulland is a medical practitioner who practised on his own in Maylands in Western Australia. By a deed of settlement dated 8 April 1977, he had created a trust (``the family trust'') of a type which has come to be known as a service trust. It was called the ``Dr I. Gulland Family Trust''. The settlor was Dr Gulland's mother and the trustee was a Dr Brindal who was formerly in partnership with Dr Gulland in a medical practice. Under the terms of the family trust, the trustee had a discretion to distribute the income among beneficiaries which included Dr Gulland, his wife and children. In default of the exercise of the trustee's discretion, the income was divisible among the children.

Dr Gulland's declared purpose in establishing the family trust was to ensure that members of his family had their own income and also to achieve some splitting of his income. The services provided by the trust were the employment of staff, the payment of salaries and pay-roll tax, the provision of office supplies, the issue, collection and banking of accounts, the provision of all necessary drugs and dressings, the arrangement of pathology tests and all other management and office services agreed on from time to time. Dr Gulland agreed to pay for the cost of these services plus an added charge of 30% of their cost. The family trust purchased certain plant from Dr Gulland for the sum of $1,643 and leased it back to him at a monthly rental of $45.18.

ATC 4792

Between 1977 and 1979, Dr Gulland had discussions with his accountant, Mr Osborne, about the creation of a superannuation fund. The attraction of a superannuation fund was that it was a form of compulsory saving, allowing a fund to be built up to provide for Dr Gulland's retirement or death. It was important that contributions to the fund should constitute tax deductions and that Dr Gulland should have some control over the investment of the fund. Mr Osborne suggested the creation of a medical unit trust and advised the respondent to approach another medical practitioner to join Dr Gulland as a co-trustee of the unit trust. Clearly it was regarded as necessary for the trustees to be medical practitioners because the trust was to be carrying on a medical practice. It would employ Dr Gulland in the practice and establish a superannuation fund for his benefit.

A Dr Burke, who carried on a general practice near Dr Gulland's surgery, agreed to act as a co-trustee. A deed of trust dated 1 March 1979 was made between Mr Osborne as ``Founder'' and Dr Gulland and Dr Burke as ``Trustees''. The deed established a unit trust known as ``The Gulland Medical Clinic Unit Trust'' (``the unit trust'') which comprised ten units. These units were held by Dr Brindal as trustee of the family trust. The trustees under the unit trust were given various powers, including a power to invest its funds in carrying on the business of providing medical services, to employ a medical practitioner or other employees and to enter into or maintain any superannuation fund for the benefit of any employee.

To complete the scheme, a sale agreement, an employment agreement and a service agreement were executed. Under the sale agreement, Dr Gulland offered to sell to the trustees of the unit trust the whole of his medical practice and all estate, title and interest therein including goodwill, plant, equipment and supplies. The price was to be $6,304. It was resolved at a meeting of the trustees of the unit trust on 5 April 1979 to purchase Dr Gulland's practice but the purchase price has never been paid and remains in the books of the unit trust as a loan from Dr Gulland. It was further resolved to engage Dr Gulland as a medical practitioner at an annual salary of $20,000. The employment agreement was made between Dr Gulland and Dr Burke as trustees of the unit trust called ``the Employer'' of the one part and Dr Gulland called ``the Doctor'' of the other part. There was no reference to superannuation in the employment agreement.

The trustees of the unit trust resolved to enter into a management services agreement with Dr Brindal as trustee of the family trust for the provision of certain services to the unit trust. The existing service agreement between Dr Gulland and the family trust was terminated and a new service agreement was concluded between Dr Brindal as trustee of the family trust and Dr Gulland and Dr Burke as trustees of the unit trust. Under that agreement, the family trust was engaged to provide management and administrative services to facilitate the operation of the medical practice carried on by the trustees of the unit trust. In particular, the family trust was to be responsible for providing all staff, premises, surgeries, consulting rooms, plant and equipment for the purposes of the practice.

Dr Gulland's taxable income was stated in his income tax return for the year ended 30 June 1979 to be $19,405. By notice of assessment dated 30 April 1980, the Deputy Commissioner of Taxation assessed income tax on a taxable income of $16,296. The difference of $3,109 was a loss made by the unit trust which the Deputy Commissioner, in reliance upon sec. 260, treated as a loss incurred by Dr Gulland.

Counsel for the Commissioner indicated during the hearing before us that appropriate calculations are as follows: 

                                                 $

      Taxable income returned                  19,405

      Less 
"
salary
"
                             5,001

                                               ------

                                               14,404

      Add net income purportedly

      derived by Unit Trust                     1,892

                                               ------

                                               16,296

                                               ------

The figure of $1,892 was calculated as follows:

                                                 $

      Gross fees                               12,130

      Less:                         $

      deductions claimed          17,239

      Less:

      disallowed wages             5,001

      superannuation               2,000

                                   -----       10,238

                                               ------

                                                1,892

                                               ------

ATC 4793

Dr Gulland gave notice of objection against the assessment and the objection was disallowed. He requested that it be treated as an appeal to the Supreme Court of Western Australia [reported at 83 ATC 4352]. The appeal was dismissed and Dr Gulland further appealed to the Full Court of the Federal Court [reported at 84 ATC 4587]. That appeal was allowed and it is from the judgment of the Federal Court that this appeal is now brought.

There are some observations which can be made about sec. 260 in a preliminary way. The purpose or effect of the arrangement must be seen from the terms of the arrangement itself or from the acts by which it was implemented. The purpose of the arrangement is not the same thing as the motivation of the taxpayer to reduce the income tax for which he would otherwise be liable in the future. See
F.C. of T. v. Lutovi Investments Pty. Ltd. 78 ATC 4708 at p. 4726; (1978) 140 C.L.R. 434 at p. 466 . The purpose of an arrangement is the result aimed at and its effect is the result achieved. See Newton v. F.C. of T. at C.L.R. p. 8; A.C. p. 465. Ordinarily the two terms do not require separate consideration because the effect of an arrangement will coincide with its purpose and it is hardly likely that the Commissioner would pursue under sec. 260 an arrangement which failed to achieve its purpose. It is unnecessary to draw any distinction in this case between the purported purpose or effect of the arrangement and its actual purpose or effect if, indeed, such a distinction can, practically speaking, ever have any significance. See
F.C. of T. v. Newton (1957) 96 C.L.R. 577 at pp. 598 and 647.

An arrangement which comprises measures not intended to operate as they purport to, will be a sham and will be deprived of legal effect because it has no reality in law. But it will be deprived of effect because of its fictitious nature and not because of the application of sec. 260. Thus, if the whole arrangement in this case were a sham there would be no need to resort to sec. 260. See
Hancock v. F.C. of T. (1961) 108 C.L.R. 258 at p. 301 per Windeyer J. But in the Supreme Court, where the matter was heard initially, the learned primary Judge ( Kennedy J.) found that, although many of the steps taken to implement the arrangement were artificial and carelessly executed, the arrangement was intended to operate according to its tenor and to create enforceable rights and obligations. Moreover, he found that it was effective in fact and in law to produce the results intended, in particular the sale of the goodwill of Dr Gulland's practice to the trustees of the unit trust and his employment by those trustees who were, of course, himself and Dr Burke. No attack was made upon these findings before us and they may, therefore, be accepted.

It is unnecessary for the purpose or effect of an arrangement to fall within sec. 260 that it be the sole or, it would seem, even the dominant purpose. This flows from the terms of the section itself which is expressed to operate only so far as the purpose of the arrangement falls within one or other of the descriptions which it contains, thus recognizing the possibility of other purposes to which the section has no application. See F.C. of T. v. Newton at 96 C.L.R. pp. 597 and 634-635; Newton v. F.C. of T. at C.L.R. p. 10; A.C. p. 467;
Hollyock v. F.C. of T. 71 ATC 4202 at p. 4205; (1971) 125 C.L.R. 647 at p. 657 . Cf.
Europa Oil (N.Z.) Ltd. (No. 2) v. Commr of I.R. (N.Z.) 76 ATC 6001 ; (1976) 1 N.Z.L.R. 546 at p. 556 .

All of this, however, leaves untouched the problem which is central to the application of sec. 260. That problem arises because sec. 260, on the one hand, clearly seeks to reduce the opportunities which a taxpayer has to avoid the payment of income tax whereas, on the other hand, those very opportunities may be provided by other provisions of the Income Tax Assessment Act which contemplate means by which a taxpayer may organize his affairs so as to incur a greater or lesser tax liability according to the decision which he makes. The reconciliation of sec. 260 with those other provisions of the Act which provide the taxpayer with a choice may be traced through the cases.

In
D.F.C. of T. v. Purcell (1921) 29 C.L.R. 464 , the respondent was the owner of pastoral holdings in Queensland and he declared himself a trustee of them for himself, his wife and daughter equally. He reserved to himself wide powers of management, control and investment. The effect was to reduce the income of the respondent and hence his liability for tax. It was held that sec. 53 of the Income Tax Assessment Act 1915-1916 (Cth), the equivalent of the present sec. 260, did not operate to avoid the settlement. The case may, perhaps, be explained upon the basis that there was no contract, agreement or arrangement of

ATC 4794

which the disposition of property formed part, but at p. 473 Gavan Duffy and Starke JJ., in pointing out that sec. 53 did not prohibit the disposition of property, also said:

``Its office is to avoid contracts, & c., which place the incidence of the tax or the burden of tax upon some person or body other than the 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. But any agreement which directly or indirectly throws the burden of the tax upon a person who is not liable to pay it, is within the ambit of sec. 53.''

This approach was subsequently reflected in the decision in
W.P. Keighery Pty. Ltd. v. F.C. of T. (1957) 100 C.L.R. 66 . In that case the appellant company was brought into being as a non-private company by the allotment of redeemable preference shares in order that it might receive dividends as a shareholder in a private company upon which tax would otherwise have been imposed under Div. 7 of Pt III of the Income Tax and Social Services Contribution Assessment Act 1936-1952 (Cth). It was held that this was a course which was open under the provisions of the Act, Dixon C.J., Kitto and Taylor JJ., at pp. 93-94, pointing out that:

``Because this is so, an attempt by the Commissioner to rely upon sec. 260 in the present case in order to avoid only the applications for and allotments of the redeemable preference shares would be an attempt to deny to the appellant company the benefit arising from an exercise which was made of a choice offered by the Act itself. The very purpose or policy of Div. 7 is to present the choice to a company between incurring the liability it provides and taking measures to enlarge the number capable of controlling its affairs. To choose the latter course cannot be to defeat evade or avoid a liability imposed on any person by the Act or to prevent the operation of the Act. For that simple reason the attempt must fail, and the Commissioner cannot rely upon sec. 260 in order to treat as void any more extensive set of facts, for an attempt to do so could not stop short of including the incorporation of the appellant company itself.''

A similar approach is to be seen in
F.C. of T. v. Casuarina Pty. Ltd. 71 ATC 4068 ; (1971) 127 C.L.R. 62 ;
Mullens & Ors v. F.C. of T. 76 ATC 4288; (1976) 135 C.L.R. 290 ;
Slutzkin & Ors v. F.C. of T. 77 ATC 4076 ; (1977) 140 C.L.R. 314 and
Cridland v. F.C. of T. 77 ATC 4538 ; (1977) 140 C.L.R. 330 . In the last of these four cases, Mason J., with whom the remainder of the Court agreed, said at ATC p. 4541; C.L.R. p. 339, of the principle underlying the Keighery case, that:

``... is not confined to cases in which the Act offers two alternative bases of taxation; 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.''

An extreme view of the principle laid down by these cases would, however, tend to deprive sec. 260 of any practical effect. On the other hand, to apply the words of the section literally would give it an operation which the rest of the Act shows it was not intended to have. It was this dilemma which led Fullagar J. to remark in F.C. of T. v. Newton, at p. 646, that sec. 260 has been regarded as a difficult section. But the problem is, as I have already remarked, one of reconciling sec. 260 with the rest of the Act and so is a problem of construction. It is a matter of construing the Act as a whole to determine where the incidence of tax was intended to fall. Only by this means might it be discovered whether or not a particular transaction falls within sec. 260.

That, I think, is the basis of the decision of the Privy Council in Newton v. F.C. of T. and, viewed as a decision upon the construction of the Act, it throws light upon the proper operation of sec. 260. In that case a series of transactions took place designed to enable private companies to distribute profits so as to avoid Div. 7 tax but in such a way as to allow money to be reinvested in the companies and to

ATC 4795

enable shareholders to receive non-taxable payments by way of capital. The arrangement in question was held to be caught by sec. 260 by the application of a test which was expressed at C.L.R. pp. 8-9; A.C. p. 466 as follows:

``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. Thus, no one, by looking at a transfer of shares cum dividend, can predicate that the transfer was made to avoid tax. Nor can anyone, by seeing a private company turned into a non-private company, predicate that it was done to avoid Div. 7 tax, see W.P. Keighery Pty. Ltd. v. F.C. of T. Nor could anyone, on seeing a declaration of trust made by a father in favour of his wife and daughter, predicate that it was done to avoid tax, see D.F.C. of T. v. Purcell. But when one looks at the way the transactions were effected in
Jaques v. F.C. of T. (1924) 34 C.L.R. 328 ;
Clarke v. F.C. of T. (1932) 48 C.L.R. 56 , and Bell v. F.C. of T. - the way cheques were exchanged for like amounts and so forth - there can be no doubt at all that the purpose and effect of that way of doing things was to avoid tax.''

This passage is not without its difficulty. The reference to ordinary business or family dealing is a reference by way of example to transactions capable of reasonable explanation by reference to considerations other than avoidance of tax. See Hancock's case, at p. 283. In the three cases last cited in the passage, it is true to say that the purpose and effect of the arrangement in each of them was to avoid tax. But the same can at least be said of the transaction in W.P. Keighery Pty. Ltd. v. F.C. of T. and such a consideration hardly affords a ground of distinction between that case and the three cases referred to. Before turning to the true basis upon which a distinction can be drawn, I should refer to the later case of
Peate v. F.C. of T. (1966) 116 C.L.R. 38 ; (1967) 1 A.C. 308 , particularly as it is possible to point to resemblances between that case and the present case.

In Peate's case a number of medical practitioners who carried on practice as partners dissolved the partnership. Each formed a separate family company and together they formed one central company which carried on the business of providing medical services. Each practitioner was employed by his family company which in turn supplied his services to the central company. After certain deductions, the net income of the central company was paid to each of the family companies as service fees or dividends in the same proportions as the practitioners had previously shared in the profits of the partnership. Each of the practitioners was paid a salary by his family company. This arrangement was held both by this Court and on appeal to the Privy Council to have the purpose and effect of avoiding a liability imposed upon each practitioner by the Income Tax Assessment Act.

The Privy Council expressed the basis upon which it formed its view, C.L.R. p. 43; A.C. p. 330, as follows:

``Before these arrangements were made in 1956 the appellant received 14 per cent of the net profits of the partnership and was assessed accordingly. After they were made, the doctors who had been partners treated patients in the same way as they had before but as a result of these arrangements, their incomes from the practice of their profession were reduced to the salaries received from the `family' companies who received either by way of service fees or dividends the same percentage of the net profits of Westbank as the doctors had been entitled to under the partnership agreement.''

This passage emphasizes, I think, the artificial character of the arrangement as being the circumstance which brought it within the ambit of sec. 260. Its very complexity pointed to its contrived nature and took it beyond the range of transactions ordinarily encountered in the organization of affairs for business or personal reasons. It was, to use the phraseology of Isaacs J. in Jaques' case, at pp. 359-360, a situation which was manufactured and did not represent a true business operation or reorganization of the taxpayer's affairs for

ATC 4796

personal reasons. With it might be contrasted the arrangement in Keighery's case which, whilst its purpose was no less than in Peate's case to avoid paying more tax than was necessary, did not need to be contrived but represented the mere exercise of a choice offered by the Act.

It is, I think, a notion of this kind that Kitto J. had in mind in Peate's case (1964) 111 C.L.R. 443 at p. 469, when he said:

``The arrangement bears ex facie the stamp of tax-avoidance. An understandable purpose of providing for the doctors' families, and doing so quite honestly, is perfectly evident; but what is equally evident is a purpose of doing so by a method which will divert income away from the participating doctors to or for the benefit of their families, to the end that a substantial part of the tax might be avoided which would have been incurred if the income had first been derived by the doctors and then applied by them for the benefit of their families.''

Section 260 is not explicitly directed at contrived arrangements or arrangements which are out of the ordinary, but the fact that an arrangement is of that nature is a circumstance which, when the purpose or effect of the arrangement is to do any of those things which are referred to in para. (a) to (d), may indicate that as a matter of construction the arrangement is one for the avoidance of tax to which sec. 260 is intended to apply. It may indicate that the choice or choices made by the taxpayer are not available by reason of the presence of sec. 260 in the Act, however much they may have been available in the absence of that section. It is in the end a matter of construction whether the section applies in a particular case. It must be conceded that to say as much is not to lay down a test of any great precision, but the reconciliation of sec. 260 with the other provisions of the Income Tax Assessment Act is of its very nature an exercise which may have to be performed whenever a contract, agreement or arrangement is impugned by reference to it. The result is to preclude the formation in advance of rules with any more exact application.

The whole of the circumstances must be considered in each case and often there will be special features which will point to the proper conclusion. For example, it will be significant in cases such as Peate's case and the present case that the arrangement in question does not facilitate the practice of the profession which it governs. It will be all the more significant if the method adopted fails to meet the requirements of the law or of professional standards. Although he found no need to elaborate upon the matter, Taylor J., in finding that sec. 260 applied in
Millard v. F.C. of T. (1962) 108 C.L.R. 336 , no doubt attached importance to the fact that the company said to carry on the appellant's business as a bookmaker could not obtain registration as a bookmaker. And in Hollyock v. F.C. of T., where the taxpayer was a pharmaceutical chemist who sold his wife a half share in his business and declared himself to be a trustee of the business for himself and his wife, Gibbs J. considered it important in reaching his conclusion that sec. 260 applied that the business could only lawfully be carried on by a pharmaceutical chemist. Cf.
Bayly v. F.C. of T. 77 ATC 4045 ; (1977) 15 S.A.S.R. 446 ;
Jones v. F.C. of T. 77 ATC 4058 ; (1977) 15 S.A.S.R. 462 and
Peacock v. F.C. of T. 76 ATC 4375 ; (1976) 28 F.L.R. 355 . The inability of the central company in Peate's case to sue for medical fees was a relevant, although not conclusive, consideration. See 111 C.L.R. at p. 460 per Menzies J.

It should also be pointed out that the authorities draw a distinction between an arrangement which modifies an antecedent transaction or situation and one which merely orders a taxpayer's affairs in relation to income from a new source or in relation to a deduction from which the previous transaction or situation did not preclude him. In the former case, but not the latter, sec. 260 may have an application for there may be an alteration of the incidence of income tax, etc. See Mullens's case at ATC p. 4294; C.L.R. p. 302 per Barwick C.J. and Cridland's case at ATC pp. 4541-4542; C.L.R. pp. 338-339 per Mason J. But the distinction can be of no assistance in this case where, if there was no antecedent transaction, there was an antecedent situation consisting of the taxpayer's practice of his profession in a particular manner. The arrangement changed that situation and did so in order to alter the incidence of income tax. The change, however, gave rise to no new source of income nor did it give rise to any deduction from which the very nature of the previous situation did not preclude the taxpayer. Cf. Europa Oil (N.Z.) Ltd. (No. 2) v. Commr of I.R. (N.Z.) at p. 556.

ATC 4797

Turning to the circumstances of this case, it is necessary first to observe that if the Commissioner of Taxation succeeds in his argument, there will be a decrease rather than an increase in the taxpayer's liability for tax in the year of income in question. That is because of the loss made by the unit trust in that year because of a holiday taken by Dr Gulland. During the period of the holiday Dr Gulland was not replaced by a locum and no income was derived by the unit trust. It was not suggested that this situation is likely to be repeated in future years, nor was it suggested that in future years the creation of the unit trust will not have the effect of further splitting the taxpayer's income. No great weight can, in my view, be placed upon the loss in the year in question.

It also needs to be noted that the Commissioner was prepared to accept the payment of service fees to the family trust as an outgoing incurred by Dr Gulland in producing assessable income and no attempt was made to invoke sec. 260 before the arrangement in question was put into effect. The existence of the family trust, however, provided the vehicle for the taxpayer to split his income further by means of the management services agreement made between the unit trust and the family trust.

The arrangement relied upon by the Commissioner was particularized by him as follows:

Individually, the steps revealed by these particulars may not give rise to any question of tax avoidance. Of itself and without more, the establishment and operation of a superannuation fund, notwithstanding the opportunity it offers to deduct from assessable income contributions to the fund on behalf of an employee, will not attract sec. 260. And it was the establishment and operation of such a fund by the unit trust for the benefit of himself which Dr Gulland gave as the principal reason for the arrangement which was made, although he agreed that income splitting was a minor part of its attraction. However, when the arrangement is viewed objectively, as it must be, it was critical to the plan that there should have been a diversion of income which would otherwise have been derived by Dr Gulland, both for the purpose of relieving him from liability for income tax and for the purpose of making funds available to the unit trust so that it might, as Dr Gulland's employer, make deductible contributions to a superannuation fund for his benefit. The making of contributions would reduce the assessable income of the unit trust and thus reduce in turn the amount available for payment to the family trust and ultimately for distribution to the members of Dr Gulland's family or himself. To the extent that the income of the unit trust was not required for contributions to a superannuation fund, it remained diverted from Dr Gulland, being payable to the family trust.

Looking at the arrangement as a whole, it cannot be doubted that its purpose and effect was to alter the incidence of income tax and relieve Dr Gulland from a liability to pay income tax which would otherwise have been imposed upon him. There could be no business or family purpose served by the arrangement other than to provide Dr Gulland with superannuation benefits and, even then, the structure which was erected was more than was necessary to provide those benefits. The only possible explanation for making the family trust and not Dr Gulland the beneficiary of the unit trust was to reduce his income and consequently his income tax liability. Even the separation between employer and employee

ATC 4798

was contrived rather than dictated by any considerations flowing from the nature of the medical practice or the way in which it had been conducted. It was, to use the words of Menzies J. in Peate's case , 111 C.L.R. at p. 446, a legal rather than an economic separation.

As the primary Judge found, so far as Dr Gulland's patients were concerned, his practice continued on as before, notwithstanding the making of the arrangement. His co-trustee in the unit trust, Dr Burke, was in the position of a competitor and she did not concern herself in the practice. No patient would have known of her involvement. There was not even a possible business purpose as there was in Peate's case; there was no limitation of liability and the provision of medical services was not facilitated in any way. A trust with medically qualified trustees was necessary in order that a medical practice might be carried on under the new arrangement, but that was dictated by tax considerations rather than any other benefit to be derived from carrying on a practice in that form. The whole arrangement was artificial and avoidance of income tax was found by the trial Judge, correctly in my view, to be its main purpose.

For these reasons, this is a case in which sec. 260 was intended to apply and the arrangement is, in my view, void as against the Commissioner. The result is not attended by the sort of difficulties pointed out by Lord Donovan in his dissenting judgment in Peate's case. The Commissioner is entitled to disregard the sale of Dr Gulland's practice to the unit trust and the employment agreement made between that trust and himself. That being done, the income earned by Dr Gulland in the practice was derived by him and his taxable income during the year in question is to be arrived at by allowing the deductions made by the unit trust in so far as those deductions are available to Dr Gulland as a sole practitioner on his own account. No reconstruction is necessary. Upon this basis, there can be no contest about the calculations which I have set out above showing a taxable income of $16,296.

I would allow the appeal.

Dawson J.:

Watson v. F.C. of T.

This appeal, which concerns the application of sec. 260 of the Income Tax Assessment Act 1936 (Cth) to an arrangement for the conduct of a medical practice, was heard together with the appeals in
F.C. of T. v. Gulland and Pincus v. F.C. of T. 85 ATC 4765 because of the similar questions involved. The appellant in this case, Mr Watson, was unsuccessful before the primary Judge ( Kennedy J.), who heard the matter separately [reported at 83 ATC 4336]. Mr Watson appealed unsuccessfully to the Full Court of the Federal Court [reported at 84 ATC 4606], from which he brings this appeal.

The appellant is a surgeon specializing in urology. Until 1979 he practised in partnership with four other urologists in Perth, Western Australia. During 1979, the partnership was dissolved and, upon the advice of accountants, an arrangement was made between the former partners whereby the practice previously carried on by them was sold to a trust of which Mr Watson and his four partners were the trustees. It was called the W.E.L.M.T. Urological Unit Trust (``the W.E.L.M.T. Trust''), the name being formed by the initial letter of the surname of each of the partners.

The arrangement involved a plan to provide superannuation to the former partners as employees of a trust. The trust would make contributions, which would be deductible from its assessable income, to a superannuation fund to provide for the death or retirement of its employees. Although Mr Watson's evidence was that his object in entering into the arrangement was ``predominantly superannuation'', he accepted, and the learned primary Judge found, that income splitting was also an object.

In addition to the W.E.L.M.T. Trust, there were created a service trust called the Urological Service Unit Trust (``the service trust'') and, in the case of Mr Watson, a family trust called the S.H. Watson Family Trust (``the family trust'').

The trustees of the family trust were Mr Watson and his wife. There were four classes of beneficiaries: A class beneficiaries (Mr Watson and his wife); B class beneficiaries (the children, grandchildren and remoter issue of Mr Watson and his wife); C class beneficiaries (persons or entities connected with B class beneficiaries); and D class beneficiaries

ATC 4799

(charities nominated by the trustees). Discretionary powers were given to the trustees of the family trust to pay or apply the income amongst the beneficiaries and Dr Watson was specifically empowered during his lifetime to remove existing trustees and to appoint new trustees.

The trustee of the service trust was Beates Nominees Pty. Ltd., a company controlled by the five partners. Each unit holder in the service trust was entitled to a beneficial interest in the trust fund and to share in its income in the proportion which the units held bore to the total number of units issued. Mr Watson and his wife, as trustees of the family trust, were described as the first beneficiaries, holding fifty units.

The trustees of the W.E.L.M.T. Trust were, as I have said, the five partners. There were fifty units in the trust divided amongst five unit holders. Mr Watson and his wife held ten units as trustees of the family trust. There was a similar arrangement in the case of each of the other partners. The rights of unit holders were similar to those of unit holders in the service trust. Each trustee was required at all times to be a medical practitioner and an employee of the trust. The trustees were empowered to carry on any business or business activity and although it was somewhat curiously provided that the trust should not practise medicine or surgery, it was, as the learned primary Judge found, the whole object of the arrangement that the trustees should do so.

Although formal agreements were subsequently prepared, it was found by the primary Judge that each doctor was employed pursuant to an oral agreement by the W.E.L.M.T. Trust as a salaried employee commencing on 1 June 1979. When the terms of the agreement were finally settled, in the case of Mr Watson there was to be paid an initial salary of $19,800 per annum together with an amount of $5,200 for motor vehicle expenses. The agreement also provided that the trust, as employer, would make contributions on behalf of the doctor to a superannuation scheme, such contributions not to exceed the maximum non-contributory amount determined from time to time by the Commissioner of Taxation.

A management services agreement was made between the trustees of the W.E.L.M.T. Trust and Beates Nominees Pty. Ltd. on behalf of the service trust. Under the agreement, the latter was to make available various services including the provision of staff, surgeries, consulting rooms, medical supplies, equipment and all other management and office services required by the trustees of the W.E.L.M.T. Trust. The fee for the provision of these services was to be such monthly amount as was agreed from time to time.

The medical practice carried on by the five doctors in partnership was sold by them, referred to as ``the Vendor'', to the trustees of the W.E.L.M.T. Trust, referred to as ``the Purchaser'', the goodwill being valued at $30,000. The premises upon which the practice was carried on were leased by the trustees of the W.E.L.M.T. Trust.

Whilst the arrangement was effected in a somewhat haphazard fashion, involving the use of fictitious minutes, pre-dated documents and the substitution in some instances of formal written documents for oral agreements which were already in operation, the primary Judge found that it was not a sham and that the legal changes which it purported to make were intended to be and were effective.

Nevertheless, the artificiality of the arrangement could hardly be disguised. Although rubber stamps were prepared for use upon accounts and receipts stating that cheques were to be made payable to the W.E.L.M.T. Trust and the trustees of the W.E.L.M.T. Trust, they were nevertheless sent out under Mr Watson's name and it is not clear, as the trial Judge found, that patients would be aware of any change. In any event, old stationery used when the partnership was on foot continued to be used for some time after the creation of the W.E.L.M.T. Trust. Some insurance policies were transferred to the W.E.L.M.T. Trust but each doctor obtained his own professional indemnity insurance cover. It was, however, said that the trust should be introduced as a co-insured.

In Mr Watson's income tax return for the year ended 30 June 1979, the sum of $1,683 was said to have been received from the W.E.L.M.T. Trust from 1 June 1979 to 30 June 1979. Mr Watson derived income while employed by the Sir Charles Gairdner Hospital from 1 July 1978 to 30 June 1979 but this income was returned as income of the

ATC 4800

partnership. The partnership return for the year ended 30 June 1979 shows a net income of $350,281. It contains a note under the heading ``Sale of Business'' that on 1 June 1979 the partners' medical practice was sold to the W.E.L.M.T. Trust for $51,450, being $7,125 for equipment, furniture and fittings, $14,325 for leasehold improvements and $30,000 for goodwill of the practice. The return of the W.E.L.M.T. Trust for the period 29 May 1979 to 30 June 1979 shows a loss of $3,532, salaries being $9,167 and superannuation contributions $23,471.

An amended assessment added $5,484 to Mr Watson's taxable income as ``Income adjusted as a result of variation in partnership distribution''. This sum reflects the addition to the partnership income of the superannuation contributions for the five partners less the net loss shown in the W.E.L.M.T. Trust accounts. In making the amended assessment, the Commissioner relied upon sec. 260 of the Income Tax Assessment Act.

It appears from counsel for the Commissioner that the correct calculation requires the addition of $29,106 to the net income of the partnership, the further adjustment being necessary to take into account the salaries paid to the doctors in addition to their superannuation. The sum of $29,106 is calculated as follows: 

                                                  $

      Gross fees                                33,905

      Salaries                                   3,120

                                                ------

                                                37,025

      Less:                            $

         deductions claimed          40,557

         Less:

            disallowed salaries       9,167

            superannuation           23,471      7,919

                                     ------     ------

                                                29,106

                                                ------

There is, in my view, no distinction of any significance to be drawn between the arrangement in this case and the arrangement in Gulland's case in the application of sec. 260. True it is that in Gulland's case the taxpayer was engaged in practice as a sole practitioner before entering into the arrangement whereas in this case he was in partnership. That, however, means no more than that the arrangement made effected changes to a pre-existing situation of a different kind. It was a situation with consequences relating to the incidence of liability for income tax which the arrangement sought to alter. As in Gulland's case, the provision of a superannuation fund to which deductible contributions could be made was an important factor in the making of the arrangement but the plan adopted went beyond what was necessary for the provision of superannuation benefits, even benefits funded by deductible contributions.

The diversion of income, with a consequent alteration in the incidence of income tax liability, was an essential part of the arrangement. There was no other explanation why Mr Watson held units in the W.E.L.M.T. Trust and in the service trust, not on his own behalf but on behalf of the family trust. And the establishment of the superannuation fund in the circumstances of this case involved the diversion of income from Mr Watson. It is unnecessary, as it was unnecessary in Gulland's case, to say whether that by itself would be sufficient to attract sec. 260. It is enough to say that it is a circumstance which must be considered as part of the arrangement as a whole in determining its purpose or effect.

The arrangement in this case was, as in Gulland's case, artificial and contrived. It served no personal, business or professional purpose, except to the extent that the provision of superannuation benefits could be said to constitute any such purpose. And, as I have said, the provision of superannuation benefits provides no sufficient explanation of the arrangement. The practice which had formerly been the practice of the partnership continued to operate as it had previously. As the primary Judge found, the only indication to patients of the existence of a trust was to be found in the account and receipt forms but even when these were received by patients it was long after the services to which they related had been provided. No limitation of liability was achieved. The employment of the doctors by themselves, albeit as trustees, could hardly be said to have wrought any discernible changes in the manner in which the practice was carried on or in the practical relationship of the doctors amongst themselves.

It is, I think, unnecessary to repeat the examination of the principles governing the application of sec. 260 which I made in Gulland's case. It is sufficient to say that in my view the arrangement in this case had the

ATC 4801

purpose and effect of altering the incidence of income tax and of relieving Mr Watson from liability to pay income tax and that it is a case to which sec. 260 was intended to apply.

The effect of the application of sec. 260 is to strike down the arrangement and the arrangement in this case includes, unlike Gulland's case, the setting up of the service trust as well as the other trusts. As has been repeatedly pointed out, sec. 260 operates only to destroy and not to re-create and it may be possible to argue that the partnership was dissolved and cannot now be revived. Such an argument would be inconsistent with the view taken by the majority in the Privy Council in
Peate v. F.C. of T. (1966) 116 C.L.R. 38 ; (1967) 1 A.C. 308 (cf. Lord Donovan in dissent) which saw the dissolution of the partnership as part of the arrangement which was void against the Commissioner. However, it is not necessary in this case to pursue this aspect of the matter. When the arrangement is disregarded, even if the dissolution of partnership is included in it, the five doctors continued to practise together and to be in receipt of income jointly. There was, therefore, a partnership within the definition of that term in sec. 6(1) of the Income Tax Assessment Act and the Commissioner was entitled to view the income of the W.E.L.M.T. Trust as the assessable income of that partnership. Even if the original partnership were to be regarded as having been dissolved, it is possible to adopt the approach which was taken by this Court in
Peate's case (1964) 111 C.L.R. 443 and which was expressed by Menzies J., at p. 461, as follows:

``What is left then 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.''

Upon either view, the Commissioner was entitled to arrive at the conclusion which he did and to make the assessment upon the basis which he did.

I would dismiss the appeal.

Dawson J.:

Pincus v. F.C. of T.

This appeal was heard together with the appeals in
F.C. of T. v. Gulland and Watson v. F.C. of T. ( 85 ATC 4765 ) . It also concerns the application of sec. 260 of the Income Tax Assessment Act 1936 (Cth) to an arrangement for the conduct of a medical practice.

The appellant, Dr Pincus, is a medical practitioner who practised as a sole practitioner in general practice at Stafford Road, Stafford in Queensland and later established an additional surgery at Stafford Heights. In 1965, he entered into a partnership with another medical practitioner, Dr Backstrom. In 1971 and 1975 respectively, Dr Richardson and Dr Seet joined the partnership. Dr Pincus and Dr Richardson worked at Stafford Road, Dr Backstrom worked at Stafford Heights and Dr Seet worked at both places.

Early in 1978, Dr Pincus became dissatisfied with the way in which the partnership was operating. The dissatisfaction sprang, it appears, from the fact that not all of the partners were putting equal effort into the practice. Dr Pincus discussed with his brother, a barrister, and with Mr Lee, a solicitor, a change in the practice involving the creation of trusts. It was explained to Dr Pincus that a trust scheme might be created which would provide superannuation benefits for himself and enable income to reach members of his family as beneficiaries of a trust. The matter was considered by the partners who agreed at a meeting held on 18 June 1978 to implement the proposed scheme. On 14 August 1978, the following documents were executed:

The following steps were taken with regard to the practice at Stafford Road. A bank account in the name of ``Dr Backstrom Trust Account'' was opened. The staff formerly employed by the partnership became employed, as were Dr Pincus and Dr Richardson, by Dr Backstrom as trustee of the Stafford Road Medical Centre Trust. A notice was placed in the surgery at Stafford Road informing patients that the practice there would be conducted by the Stafford Road Medical Centre Trust and that Dr Pincus, Dr Richardson and Dr Seet would be in attendance. The name ``Stafford Road Medical Practice'' was registered as a business name, the name Stafford Road Medical Centre being unavailable, and the plates outside the surgery were changed. The letter-head used and the heading upon the accounts were altered to refer to the Stafford Road Medical Practice. Suppliers were asked to render accounts to the Stafford Road Medical Practice. The lease to the premises at Stafford Road previously occupied by the partnership was transferred to Dr Backstrom.

On 27 April 1979, the Stafford Road Medical Practice as employer, and Dr Pincus and his wife as trustees, entered into a trust deed to establish a superannuation plan known as the Stafford Road Medical Practice Superannuation Plan.

On 24 October 1978, cheques for $10,792 and $10,761 were deposited to the credit of the partnership bank account as payment for the goodwill of the practice carried on at Stafford Road and Stafford Heights and other property. Dr Pincus' share of the money deposited was $5,338. Also on 24 October 1978, Dr Pincus paid $5,400 to the Pincus Children Trust of which he was the trustee and his children were beneficiaries. This trust had been established some years before. $5,399 of the $5,400 deposited was used to purchase 5,399 units in the Stafford Road Medical Centre Trust. A similar number of units was purchased by the R.G. Richardson Family Trust.

In the year of income in question, which ended 30 June 1979, Dr Pincus, in an amended income tax return dated 23 November 1979, disclosed an assessable income which included $23,000 being gross salary paid by the Stafford Road Medical Practice, and $9,817 being Dr Pincus' share of the partnership profits. By an assessment issued on 21 May 1980, Dr Pincus was assessed to income tax based upon a taxable income of $28,045 for the year ended 30 June 1979.

The net income of the Stafford Road Medical Centre Trust for the year ended 30 June 1979 was $28,808. Half of this amount, namely $14,404, was distributed to Dr Pincus' children as beneficiaries of the Pincus Children Trust.

On 11 March 1983, an amended assessment was issued to Dr Pincus. By an adjustment sheet which accompanied the amended assessment, the alteration which was made was identified as follows: 

      Taxable income previously                $

        assessed                             28,045

      Add:

      Share of net income - Stafford

      Road Medical Practice                  14,404

                                            -------

      Taxable income as shown in

      attached notice of assessment         $42,449

                                            -------

It is apparent that the alteration was made in reliance upon sec. 260 of the Income Tax Assessment Act.

Dr Pincus objected to the amended assessment but his objection was disallowed and he requested that it be treated as an appeal to the Supreme Court of Queensland.

The learned primary Judge ( Kelly J.) made a number of findings. In particular, he found that a substantial purpose of the arrangement made by Dr Pincus was to minimize his income tax. The trial Judge said [84 ATC 4187 at p. 4191]:

``The realities of the situation appear to me to be that the practice at Stafford Road was carried on in essentially the same way after the arrangements came into force as it had been carried on prior to their doing so. There was certainly a change in the legal

ATC 4803

structure but I have no doubt that Dr Backstrom, although in law the employer of the appellant and the other doctors who worked at Stafford Road, exercised no real control over the way in which the practice was conducted. In the result the appellant continued to earn income in much the same way as he had previously done but with a change in the structure in which that income was being earned.''

Upon this basis the primary Judge held that sec. 260 applied but held that Dr Pincus had made a full and true disclosure of all the material facts necessary for his assessment so that the amendment of his assessment was not authorized under sec. 170 of the Act. The Commissioner successfully appealed to the Full Court of the Federal Court which also dismissed a cross-appeal by Dr Pincus in relation to the primary Judge's finding under sec. 260. It is against that aspect of the Federal Court's judgment that Dr Pincus brings his appeal to this Court.

The primary Judge reached his conclusion that sec. 260 applied to the arrangement in this case upon the basis of the reasoning in
Peate v. F.C. of T. (1964) 111 C.L.R. 443 , on appeal (1966) 116 C.L.R. 38 ; (1967) 1 A.C. 308 . Before us, as before the Federal Court, the argument put on behalf of Dr Pincus in relation to sec. 260 was confined to a submission that Peate's case is no longer good law and, in any event, this case is distinguishable from Peate's case . An alternative submission was put that if the arrangement in question is struck down by the application of sec. 260, there is no identifiable income derived by the taxpayer upon which he would have been liable to tax if the arrangement avoided by the section had not been made; in particular, it is said that no partnership between Dr Pincus and Dr Richardson is exposed by the avoidance of the arrangement.

There is, I think, no reason why Peate's case should no longer be regarded as having been correctly decided. Whilst the interpretation of sec. 260 has undergone some vicissitudes during the twenty or so years since that case was decided, its authority has not been challenged. Nor does it seem to me the principles which were sought to be applied in that case are other than in accord with those principles which have been laid down in later cases. True it is that limits to the application of sec. 260 have been identified which may now be more apparent than they were at the time of the decision in Peate's case. Thus in
Cridland v. F.C. of T. 77 ATC 4538 at p. 4541; (1977) 140 C.L.R. 330 at p. 337 , Mason J. was able to refer to ``the very restricted operation conceded to sec. 260 by the course of judicial decision''. However, the restrictions are but a recognition of the fact that sec. 260 does not deny a taxpayer a choice which is offered by the Act itself unless there is something other than the making of such a choice to indicate that a contract, agreement or arrangement has the purpose or effect of avoiding tax in a way which is prohibited by the section. It is only by the adoption of such an approach that it has been possible to reconcile sec. 260 with the rest of the Act. That approach was, however, clearly laid down in
W.P. Keighery Pty. Ltd. v. F.C. of T. (1957) 100 C.L.R. 66 some time before the decision in Peate's case and there was no suggestion in the latter case of any divergence from it. Rather, the decision in that case is an example of a taxpayer seeking to avail himself of the choices offered by the Act by means of a contrived scheme which could only be explained upon the basis of tax avoidance. It was a scheme which did not aid the taxpayer in the practice of his profession or in the ordinary organization of his affairs and constituted a quite extraordinary arrangement when viewed apart from the provisions of the Income Tax Assessment Act. Because the arrangement went beyond the simple exercise of a choice offered by the Act in seeking to avoid tax, sec. 260 was held to apply and to deny to the taxpayer the choice which he would otherwise have had. It is that circumstance which distinguishes Peate's case from Keighery's case and the cases which followed it (see
F.C. of T. v. Casuarina Pty. Ltd. 71 ATC 4068 ; (1971) 127 C.L.R. 62 ;
Mullens & Ors v. F.C. of T. 76 ATC 4288 ; (1976) 135 C.L.R. 290 ;
Slutzkin & Ors v. F.C. of T. 77 ATC 4076 ; (1977) 140 C.L.R. 314 and Cridland v. F.C. of T. ) [77 ATC 4538]. There is no inconsistency and no reason to suppose that the decision in Peate's case is no longer good law.

An aspect of the submission that Peate's case should no longer be followed was the contention that, when it was decided, professional men were set apart from other taxpayers, and particularly from those whose personal exertion contributed little to their income, in a way which deprived them of tax

ATC 4804

advantages available to others. That, it was said, is no longer so. It is, of course, conceivable that the nature of professional practice may change in such a way that an arrangement of the type struck down in Peate's case will no longer be seen as an artificial contrivance for the purpose of tax avoidance but as the exercise of a choice in the ordinary course of things which brings with it a tax advantage. That would not, however, be to deny the principles laid down in Peate's case. It would merely be to require their application to changed circumstances. And, as I remarked in Gulland's case, the application of those principles may in each case require a separate consideration of the circumstances in which a contract, agreement or arrangement is impugned by reference to sec. 260.

No particular change in circumstance was claimed to have occurred which would distinguish the way in which medical practices are now conducted from the way in which they were conducted at the time Peate's case was decided, unless it be the suggestion that it is now no longer necessary for a medical practitioner to sue for fees in his own name. It is, to say the least, arguable that this is not so in Queensland having regard to the provisions of sec. 48 of the Medical Act 1939 (Qld), but in any event it is hardly a sufficient ground upon which to deny the application of Peate's case. It was no more than a relevant circumstance in that case that the company providing medical services could not sue for fees. It was not decisive as a reason for concluding that the arrangement there was no ordinary business or professional transaction. See Peate's case, 111 C.L.R. at p. 460, per Menzies J.

Counsel for Dr Pincus sought, in any event, to distinguish Peate's case. He submitted that in this case the dissolution of the partnership formed no part of the arrangement subsequently made. Thus, he said, Dr Pincus' income from the partnership ceased upon its dissolution and the income which Dr Pincus received as a result of the arrangement was from a new source. The significance of this was said to be that sec. 260 presupposes the continued receipt of income from an existing source in respect of which the impugned arrangement seeks to alter the incidence of tax or to relieve the taxpayer from liability to pay tax. Dr Pincus was free, it was argued, to choose the way in which he received his income from a new source and sec. 260 had no application.

The basis of these submissions is to be found in the observations made from time to time that sec. 260 has no application where there has been no antecedent transaction or situation whereby income is derived because the operation of the section is dependent upon an alteration in some existing liability to pay tax. In
Europa Oil (N.Z.) Ltd. (No. 2) v. Commr of I.R. (N.Z.) 76 ATC 6001 at p. 6009; (1976) 1 N.Z.L.R. 546 at p. 556 , it was said of the New Zealand equivalent of sec. 260:

``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.''

In Mullens & Ors v. F.C. of T. at ATC pp. 4294-4295; C.L.R. pp. 302-303, Barwick C.J. added, after citing the foregoing passage:

``... it seems to me that by parity of reasoning, sec. 260 may be said not to be concerned with the right to a deduction which the only relevant transaction between the parties would produce in the future.

Again, it is otherwise if, by reason of an antecedent transaction or situation, the taxpayer was already subject to tax in respect of an income which that antecedent transaction or situation produced or would produce, or was not or would not be entitled to any deduction in the situation created by that antecedent transaction. In such a situation the avoidance of the impugned transaction, because it represented an endeavour to cast what had already been agreed into a form which avoided or lessened the amount of tax otherwise payable, would expose the antecedent situation which did not carry any right to a deduction. Just as there must be income, not derived from the impugned transaction but derived from the antecedent transaction between the parties which, when that transaction is struck down, is exposed as producing assessable income, so, in my opinion, in relation to a deduction, the avoidance of the impugned transaction must disclose a transaction or situation which did not entitle the taxpayer to a deduction.''

See also
F.C. of T. v. Patcorp Investments Ltd. (1976) 140 C.L.R. 247 at pp. 298-299 and Slutzkin & Ors v. F.C. of T. at ATC p. 4080; C.L.R. p. 320.

ATC 4805

Even if it be assumed that the partnership would have been dissolved in any event and forms no part of the arrangement under which Dr Pincus now carries on his professional activities, that fact does not, in my view, lead to the conclusion for which he contends. The new arrangement did not produce a new source of income in the sense in which the cases use that term. Dr Pincus' source of income whilst he was a sole practitioner, whilst he was practising in partnership, and now under the substituted arrangement, has been, and is, the same, namely the practise of his profession as a doctor. The form of arrangement under which he has practised from time to time has not altered the source of his income in any relevant sense. The source of his income tax has been his professional activities as a medical practitioner whether he has been a sole practitioner, a partner or an employee. It is from those activities that his income has derived and his liability to tax has arisen.

When speaking of the source of a taxpayer's income, the Privy Council, in Europa Oil (N.Z.) Ltd. (No. 2) v. Commr of I.R. (N.Z.), was, in the context, speaking of the real, or ultimate, source of income and not of the vehicle by which it was conveyed to the taxpayer. The legal structure within which an income may be derived by a taxpayer may vary but the source of that income may remain the same. So it was that in Gulland's case the taxpayer did not derive his income from a new source when he ceased to be a medical practitioner in practice on his own account and commenced to practise his profession as an employee. And in
Mangin v. Commr of I.R. (N.Z.) 70 ATC 6001 ; (1971) A.C. 739 , a farmer who leased his land to trustees who were to employ him to work it in the same way as he had done previously and to pay the income to beneficiaries, did not rid himself of the source of income constituted by his farming activities, however much the arrangement may have reduced the income derived by him from that source if the provisions of the arrangement were to be given effect.

The final argument put on behalf of Dr Pincus also proceeded upon the basis that the partnership was dissolved for reasons unconnected with tax and formed no part of any arrangement to which sec. 260 might be applied. Upon this basis it was said that to strike down the arrangement under sec. 260 would not be to affect the dissolution which must be accepted as having occurred. Thus, the argument continued, in the absence of the partnership which had been dissolved and of the impugned arrangement by reason of the application of the section, Dr Pincus derived no income in respect of which it could be said that there was any alteration of the incidence of income or the avoidance of tax by other means. The argument is one which seeks to rely upon the fact that sec. 260 is an annihilating provision which may strike down an arrangement but does not permit the reconstruction of a state of affairs which has ceased to exist as the basis upon which to charge tax. It is, however, little more than a variation of the previous argument that upon the dissolution of the partnership the taxpayer commenced to derive income from a new source and was free to choose the manner in which he did so without any constraint imposed by sec. 260. Upon this argument, the choice is one bestowed by the provisions of the Income Tax Assessment Act which is not inhibited by sec. 260 because that section is not concerned with new sources of income but with the alteration of antecedent transactions or situations with the specified purpose or effect.

The argument, however, ignores the reality of the situation in that both before and after the dissolution of the partnership and the application of sec. 260, Dr Pincus was without interruption carrying on the practice of his profession in a manner which was essentially the same, however much the income which he derived thereby might flow through different channels. The source of income was the same and the effect of sec. 260 was to preclude Dr Pincus from the choices which he might have had were he to have been setting up practice afresh or for the first time.

Accepting the dissolution of the partnership and disregarding the arrangement which took its place, Dr Pincus carried on practice at Stafford Road in association with Dr Richardson. As a result they were in receipt of income jointly and so were in partnership within the meaning of the definition of partnership contained in sec. 6(1) of the Income Tax Assessment Act. The expenses of the practice were paid by Dr Backstrom on behalf of Dr Pincus and Dr Richardson but were nevertheless, by reason of sec. 19 of the Act, met out of the income derived by them. Dr

ATC 4806

Pincus and Dr Richardson were in receipt of the net profits of the practice as partners and that portion of those profits which, under the arrangement, was received by Dr Pincus as trustee for the Pincus Children Trust is to be treated as income derived by him.

The appeal should be dismissed.

 

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