Case T81

Members:
P Gerber SM
KL Beddoe SM

Tribunal:
Administrative Appeals Tribunal

Decision date: 3 November 1986.

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Dr. P. Gerber and K.L. Beddoe (Senior Members)

The applicant in this case is a company manager, his wife is solely engaged in domestic duties. In order to give the wife a greater sense of independence and security, the couple decided that they would enter into an arrangement whereby they would invest in income-earning properties as joint tenants. An oral agreement was reached and reduced to writing.

``RECORD OF DISCUSSION held this Fourteenth day of February, 1977 between (husband), Company Manager, and (wife) his wife, both of Tax Avenue, Fiscal Creek.

Concern was expressed by the said (wife) that, having committed herself entirely to the welfare and upbringing of a family, she was not in receipt of any regular separate income and in the event of the untimely death or accident induced disability of her husband, the said (husband) who was the sole income earner of the family, both she and the family may find themselves in difficult circumstances.

It was therefore decided that investment in income producing property should take place on the following basis:

• 1. Requisite funds were to be borrowed from existing bankers or any other recognised avenue of finance.
• 2. Properties were to be purchased in the names of both parties as joint tenants.
• 3. The present joint bank accounts conducted at Bank of New Zealand were to be used for the purpose of recording the incoming and outgoing of funds.
• 4. Separate accounting records were to be kept of the income and expenditure incurred in respect of the ownership of such properties.

As soon as practicable after the 30th June each year, a summary of the year's activities was to be prepared, showing the total receipts and total expenditure.

In the event of a net profit, that is, income exceeding expenses, in any one year, it was to be apportioned

• 75% to (wife)
• 25% to (husband)

and the amounts so calculated withdrawn from the joint bank accounts and paid to the individuals concerned. (Wife) was also given the ability to withdraw at any time, such sums as were estimated to be equivalent to her share of the profits up to the date of withdrawal with a balancing adjustment to her share, if found necessary, at year end.

In the event of a net loss, that is, expenses exceeding income, in any one year, the whole of the loss was to be absorbed by (husband).

In witness hereof, the two parties concerned have prepared this record of their discussions as to their intentions and have appended their signatures hereto, this twenty first day of February, 1977.

(Sgd) (Wife)

(Husband)''

2. In the result, the parties purchased several properties as joint tenants. The properties were let and, as predicted, there was a loss in the first year (1978), in the second year the parties broke even and have shown a profit ever since. These properties are still held by them. The rent was paid by cheque made out to the husband and wife. In substance, what the parties sought to achieve, and did achieve, was that the applicant would receive 25% of any surplus, the wife 75%; in the event of any

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ATC 1111

losses, these would be borne wholly by the applicant.

3. The respondent Commissioner of Taxation adopted the view that there was an equal partnership and allowed the applicant only half the loss incurred in the 1978 tax year ($971) as opposed to the full amount as claimed.

4. A number of submissions were relied upon. Firstly, it was said, the effect of sec. 92 of the Income Tax Assessment Act 1936 was that no greater amount than $971 was allowable as a deduction to the applicant, constituting his interest in the partnership loss incurred by the partnership, being income received jointly from properties held as joint tenants. Secondly, it was argued that the purported transfer by the taxpayer of a right to receive income from property for a period that will or may terminate before the expiration of seven years from the date of the purported transfer is ineffective by virtue of sec. 102B of the Act; alternatively, no greater deduction than $971 is allowable to the taxpayer under sec. 92(2) of the Act for his purported interest in the partnership loss of $1,941, calculated pursuant to the terms of the agreement dated 21 February 1977 because:

• (a) the transactions which give rise to the taxpayer's purported interest in the partnership loss are shams and do not have the legal effect contended for by the taxpayer;
• (b) such transaction constitutes a contract, agreement or arrangement within the meaning of sec. 260 of the Act and is void as against the Commissioner;
• (c) such transaction should be disregarded as being a fiscal nullity for purposes of the Act.

Thirdly, it was submitted that the arrangement by which the applicant bore the whole of any loss constituted a sham.

5. When the Tribunal pointed out to the Commissioner's representative that he had not cross-examined the applicant on the issue of ``sham'' - an allegation tantamount to fraud - and that the issue of ``fiscal nullity'' had been held in
Oakey Abattoir Pty. Ltd. v. F.C. of T. 84 ATC 4718 not to apply in this country, the submissions both with respect to ``sham'' and ``fiscal nullity'' were abandoned.

6. In the end the only authority relied on by the Commissioner in support of his decision on objection was Case Q35, 83 ATC 154. The facts, taken from the headnote at p. 154, read as follows:

``The taxpayer and his wife rented out a house which they owned as joint tenants. The rent was paid into a joint account and expenses relating to the property were paid out of the same account. Each year expenses exceeded the rental income and a loss resulted.

The taxpayer claimed that as he was the sole income earner in the family and had in fact paid the expenses, he was entitled to deduct the full amount of the losses. The Commissioner took the view that a partnership existed between the taxpayer and his wife and that they were entitled to share the partnership losses equally. He therefore allowed the taxpayer a deduction for only 50% of the losses. The taxpayer objected against the assessment.''

In their decision, Messrs K.P. Brady (Chairman) and J.E. Stewart (Member) stated at p. 155:

``Unfortunately for the taxpayer, the legal consequences which flow from owning the residence jointly with his wife are not affected by their private arrangement for claiming deduction of its operating losses. Each of them is as much entitled to any part of the house property as the other. Neither of them can point to any part of the property as his or her own to the exclusion of the other. Similarly, either one of them cannot take the whole of the profits (or losses) to the exclusion of the other. (See Megarry and Wade, The Law of Real Property 2nd ed., pp. 392 and 393, p. 405 3rd ed.) In the instant case we have seen that the couple owned their residence jointly and thus they were in receipt of the rental income jointly. The taxpayer did not seek to contend that his wife in any way alienated her right to receive her share of the income from the property.''

If the above statement is intended to convey that it is not competent for partners to vary the distribution of their profits and losses, or that, whilst profits may be shared rateably, all losses may be borne by one of them exclusively, we respectfully disagree with that view. We hold

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that it is always open to one partner to agree to indemnify the other(s) against loss without removing from the agreement its character as a contract of partnership. The question in this case is: Have the parties achieved the desired result, and, if so, is it void as against the Commissioner by virtue of sec. 260 of the Income Tax Assessment Act.

7. As to the first proposition, it seems to us that the agreement, although inelegantly drafted, none the less clearly records the intention of the parties - the applicant was to ``absorb'' all losses incurred by the partnership.

8. In view of the fact that this was an informal arrangement, we think it would be wrong to demand too great a formalism and to search in the agreement for such phrases as ``the party of the first part hereby undertakes to indemnify the party of the second part against all losses that may be incurred by the partnership''. We therefore find that the agreement is adequate to achieve its desired object.

9. It remains to consider whether the arrangement is struck down against the Commissioner by recourse to sec. 260. We are mindful that this section has recently been given a new lease as a result of the decisions of the High Court in F.C. of T. v. Gulland; Watson v. F.C. of T. and
Pincus v. F.C. of T. 85 ATC 4765. Nevertheless, we are not prepared to apply this section in a case where the respondent made no attempt to argue its applicability or, indeed, directed a single question to the principal witness in cross-examination in an endeavour to demolish the case that the arrangement was capable of an innocent explanation by reference to ordinary family dealings between husband and wife, and/or that tax avoidance was one of the main purposes of the agreement, as distinct from merely being incidental to it. This achieves added weight when it is borne in mind that it was deposed that the whole purpose of the arrangement was to give the wife greater financial independence. The agreement, on the face of it, is certainly not one that we feel we are bound to construe contra proferentem.

10. In the result, we would set aside the decision under review and uphold the objection.

Claim allowed