Federal Commissioner of Taxation v. P. Iori & Sons Pty. Limited.

Judges: Fox J
Lockhart J

Beaumont J

Court:
Full Federal Court

Judgment date: Judgment handed down 4 September 1987.

Beaumont J.

The question in these appeals is whether the respondent, P. Iori & Sons Pty. Limited, may in the years of income ended 30 June 1976 to 1979 deduct certain amounts pursuant to the provisions of sec. 82AAC of the Income Tax Assessment Act 1936 as follows:

"82AAC Where a taxpayer, for the purpose of making provision for superannuation benefits for... an eligible employee sets apart or pays in the year of income an amount or amounts as or to a fund ... from which the benefits are to be provided, and the right of the employee... to receive the benefits is fully secured, the amount or the sum of the amounts is... an allowable deduction."

(Emphasis added.)

The primary facts are not in dispute. In the years of income, the respondent was a family company carrying on the business of poultry farming. By deed dated 9 May 1975 made between it and two of its directors, Mr John Iori and Mr Edo Iori as trustees, it established a superannuation fund for the purpose of providing benefits for certain of its employees. To become a member of the fund, an employee had first to be invited by the respondent (cl. 1). The moneys comprising the fund were to be invested, inter alia, "with or to the [respondent] so long as the [respondent] shall execute a charge acceptable to the trustees over an asset or assets real or personal acceptable to the trustees" (cl. 2(a)). It is common ground that no such charge was ever executed. The trustees were also authorised to invest the fund in policies of assurance on the life of a member (cl. 2(a)). The respondent was to contribute to the fund "at such rate and [sc. as] the [respondent] shall determine" and notify to the member (cl. 2(b)). The trustees were required:

"to ensure the stability of the fund and to secure the rights of the members and the benefits and beneficiaries PROVIDED THAT the contribution of the company shall include the total cost of providing any life assurance cover held by or effected by the trustees pursuant to clause 5A hereof."

(Cl. 2(b).)

The contribution of a member shall be such sum as the trustees shall notify to such member on his admission subject to the proviso that the trustees may vary such contribution in their absolute discretion so long as such contribution shall not at any time exceed the proportion of such member's salary or wage which such member's contribution bore to his salary or wage at the date of his admission (cl. 4(a)). The amount of a member's benefit shall be paid to him in the events of retirement or ceasing to be in employment or death in the circumstances specified in the deed (cl. 5). If while in the service of the respondent a member dies or leaves its service because of "permanent total disablement", the trustees are empowered, for the purpose of securing the benefits then payable, to accept or effect any policy or policies of assurance (cl. 5A). If the member is dismissed for misconduct, the trustees shall refund to the member his contributions and the balance standing to the credit of his account shall be forfeited (cl. 6). The trustees may from time to time determine the value of the fund. In making that determination, the trustees shall not take into account the value of any policies of assurance held on the lives of members (cl. 8(i)). For the purpose of making a payment under cl. 6 the sum payable as the amount of the benefit of a member shall be that portion of the value of the fund as last determined by the trustees which the benefit of that member bears to the aggregate of the benefits of all members together with the benefit of any policy of assurance on the member's life (cl. 8(ii)). The other provisions of the deed are not material for our purposes.

The only members of the fund are Mr Pellegrino Iori, Mr Edo Iori and Mr John Iori. The respondent claims that in respect of the income years ended 30 June 1976 to 1979, it contributed to the fund the sums of $10,100, $38,300, $31,300 and $31,300 respectively. In the main, the contributions were made by, but at the same time lent back to, the respondent by the following journal entries: 

       "Superannuation                               $8,000

       Loan P. Iori Superannuation Fund                              $8,000

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      Being superannuation paid on the lives of Pellegrino

      Iori $4,000 Edo $2,000 John $2,000"
        
      "Superannuation                              $35,000

       Loan P. Iori Superannuation Fund                             $35,000



      Being superannuation paid on the lives of Pellegrino

      $25,000 Edo $5,000 Jack $5,000"
        
      "Superannuation                              $30,000

      Loan P. Iori 
&
 Sons Superannuation Fund                       $30,000



      Being superannuation paid on the lives of P. Iori

      $20,000 E. Iori $5,000 and J. Iori $5,000"
        
      "Superannuation                              $30,000

      Loan P. Iori 
&
 Sons Superannuation Fund                       $30,000



      Being superannuation paid on the lives of P. Iori

      $20,000 E. Iori $5,000 and J. Iori $5,000"

It is common ground that no interest was charged in respect of these loans until 1979. Folio 82 of the journal which, as has been noted, bears the date 30 June 1979, records the following item: 

      "Interest Paid                              $6,020.34

      Loan P. Iori 
&
 Sons Super Fund                               $6,020.34



      Being interest paid at 6% p.a. on outstanding

      balance."

It appears that, in addition to the amounts claimed to have been the subject of the entries in its journal, the respondent paid an insurance company the sum of $1,299.96 in each of the years ended 30 June 1978 and 1979. The Commissioner has allowed a deduction for these amounts. In issue are the amounts of $8,000, $35,000, $30,000 and $30,000 respectively.

Mr John Iori explained the origins of these transactions in his affidavit:

"3. In or about 1975 I had a conversation with a Mr F.T.C. Wenham who is a chartered accountant carrying on practice in the firm name of Nelson Wheeler and Co. I am unable to recall the precise words spoken during this conversation. The substance and effect of the conversation was that I instructed Mr Wenham to establish a superannuation fund (to which I shall refer to as the Fund) to provide retirement benefits for my brother Edo and myself. I left the detailed work of establishing and administering the superannuation fund in the hands of Mr Wenham. Exhibited hereto and marked with the letters `JII' is a true copy of the Deed of Trust establishing the superannuation fund.

4. On or about the 9th May, 1975 I gave instructions to Mr Wenham in my capacity as a trustee of the fund to carry out the necessary accounting work for the fund and to prepare and lodge the relevant annual returns of income with the Deputy Commissioner of Taxation.

5. I recall that in or about April of 1976, 1977, 1978 and 1979 a directors' meeting of the company was held at which a dividend was declared. This meeting was held at the offices of Mr R.W. Franks, who is a partner in a firm of chartered accountants who act for the company. I am unable to recall the precise words which I said to Mr Franks but the substance of what I said was that `the company was to contribute to the superannuation fund as much as it was allowed to do so by the Commissioner of Taxation and that it could afford'. I recall

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that the amount of the contributions in respect of my father Pellegrino Iori, my brother Edo Iori and myself were also discussed with Mr Franks at this meeting.

6. I am also unable to recall the precise words said by Mr Franks on each of these occasions in April 1976, 1977, 1978 and 1979. However, the substance of what he said to me was that he told me of the profit the company was likely to earn in the current year. He said to me, that the company should make the same or about the same contribution to the superannuation fund as it had made for the previous year. I accepted his advice both as a director of the company and as trustee of the superannuation fund.

7. I say that I did not open a bank account for the superannuation fund until about June, 1981 when I caused an account to be opened at the Commonwealth Trading Bank, Parramatta on Mr Wenham's instructions. Up to and for some time after this date, all cash receipts and cash payments relating to the affairs of the superannuation fund were made on behalf of the trustees by the company or associated companies of which I was a director. I say that this was simply done as a matter of convenience."

Mr Franks, an accountant with the firm H.W. Rowan, Miller & Co., was also retained by the respondent. His evidence was as follows:

"Q. Your firm did not, as I understand the situation, undertake any accountancy work in connection with the superannuation fund? - A. No, that was undertaken by a firm by the name of Nelson Wheeler.

Q. Did you from time to time, in the period from 1975 to 1980, at least, have any conversations with any person at Nelson Wheeler & Co. in relation to the superannuation fund, and, if so, can you name that person? - A. With a Mr Bill Scott of that firm.

Q. Can I take you back to the time when you made the first, if I can call it, superannuation entry in respect of the 30 June 1975 year. I take you to the entry which bears date 30 June 1975 on folio 65 (ex. H) which refers to transfer of superannuation fund and so on. I think there are two entries, one on 64 and one on 65. Before you made those entries in respect of the year ended 30 June 1975, do you recall having a conversation with Mr Scott? - A. Before we made the entries?

Q. Yes? - A. Before the actual entries went into the book conversations were always held with Mr Scott.

Q. Take for instance that particular year, 30 June 1975. Can you recall approximately when it was that you had the conversation with Mr Scott? - A. Usually they were in the period sort of October to November after the 75 - the actual conversations with Mr Scott were had...

Q. Can you remember what you said to him at all, recapturing as best you can the conversation in narrative form? (objected to: allowed subject to objection) Can you remember, just recapturing as best you can - and obviously enough as best you can - in dialogue form what questions you asked of him or he asked of you and what answer you gave to him or he gave to you without mentioning specific figures, just use the word X dollars or Y dollars? - A. This is with Mr Scott?

Q. That is so? - A. I used to go to the firm in Sydney...

Q. That is Nelson? - A. That is Nelson Wheeler, where Mr Scott was I think an employee and later a partner, and going down there, knowing the figure we were looking at for superannuation... (objected to).

His Honour: You are just asked the conversation? - A. We would sit and just discuss the superannuation fund books.

Q. Please, I know it was a long while ago, but just try and give as best you can `he said and I said'? - A. If you want me to shorten it down, we would come down to the actual figures and ensure that the figures... (objected to: rejected).

Mr Conti: Q. It must be, unfortunately, `I said to Mr Scott `Bill, it is X dollars or Y dollars' and he said such and such', can you try and put it in that sort of narrative form? - A. Well, I would say to Mr Scott `The figure for superannuation is X, you will have to take up the journal entry within

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the superannuation fund to agree with what we have made the contribution from the company' and then he would take his notes and...

Q. Did he say anything, `Yes'? - A. `That's fine', or `Yes, we will have to' and he would take his notes on what the figure was..."

There was no evidence to suggest that at any meeting of directors of the respondent it was resolved that the respondent contribute to, or set aside moneys for, the fund. No cheques were drawn to effect the transactions. Apart from the book entries already mentioned, the only documents evidencing these dealings were the respondent's annual accounts. The profit and loss account for the year ended 30 June 1976 recorded $10,099.96 as "superannuation". The balance sheet disclosed a liability to the fund on a loan account of $35,339. The accounts were approved by directors and shareholders on 9 December 1976 and 30 December 1976 respectively. The profit and loss account for the year ended 30 June 1977 showed "Superannuation" in the sum of $38,299.96. The balance sheet disclosed a loan account for the fund of $70,339. The accounts were approved by directors and shareholders on 9 December 1977 and 30 December 1977 respectively. The profit and loss account for the year ended 30 June 1978 recorded "Superannuation" in the sum of $31,299.96. The balance sheet showed the fund's loan account at $100,339. The accounts were approved by directors and shareholders on 14 November and 5 December 1978 respectively. The profit and loss account for the year ended 30 June 1979 showed "Superannuation" of $31,299.96. The balance sheet stated the fund's loan account at $136,359.34. The accounts were approved by directors and shareholders on 8 December and 28 December 1979 respectively.

In the Supreme Court, the Commissioner argued that the respondent had failed to meet the requirements of sec. 82AAC in two respects: (1) no moneys had been set apart or paid in the year of income; (2) the rights of employees were not fully secured.

It is convenient to consider these objections in turn.

In the Supreme Court, it was submitted on behalf of the respondent that the relevant provisions of sec. 82AAC had been complied with for a number of reasons: (a) there was contemporaneously a set-off for identical sums representing the loan back transactions; (b) there was a setting aside, either because of the matters in (a) or because the respondent's signed balance sheets acknowledged the debt owed the fund; (c) the parties, by their conventional conduct, treated these transactions as having full legal effect and the Commissioner, albeit a third party, is bound by the parties' conventional conduct.

It was argued for the Commissioner that the mere making of journal entries did not constitute either a payment or a setting apart for present purposes.

The learned Judge held that the relevant provisions of sec. 82AAC were complied with. In his opinion [87 ATC 4058 at p. 4064]:

"... it is proper to treat the company as having paid the superannuation contributions, and also with having received a loan from the trustees of the superannuation fund; and that... the relevant journal entries (against the background of agreement upon the amount of contributions to be made by the plaintiff in respect of superannuation between Mr Iori senior and his two sons, the agreement between the two accountants, the fact that Mr John Iori was both a director of the taxpayer and a trustee of the superannuation fund, and the steps taken in relation to the financial accounts thereafter), constituted the making of agreements in respect of each relevant year, partly expressed and partly implied, and the instantaneous performance or effectuation of those agreements. The case is not one of the mere `making by the company of a journal entry in the books of account without reference to, or without the agreement of the person said to be the recipient of the money'... The only directors of the taxpayer were Mr Iori and his two sons. They were the only beneficiaries under the superannuation scheme."

In this Court, the Commissioner challenged the conclusion arrived at by the learned Judge that the journal entries "constituted making of agreements in... each... year, partly expressed and partly implied and the instantaneous performance... of those

ATC 4787

agreements". The Commissioner contended that there was no evidence or other material to support such a finding.

As has been said, there is no dispute about the primary facts. The matter of contention lies in the proper inferences to be drawn from those facts.

It will be remembered that the events in question assumed an established pattern which may be summarised thus:

It follows, in my view, that in respect of each year of income, the respondent, by its directors and corporators, committed itself to the amount to be contributed by the respondent in respect of each fund member. Two questions arise in this connection:

As has been said, in April of each of the years of income, the matter of superannuation contribution was largely put into the hands of the accountants. But this was not to say that they were given carte blanche. The dealings between the parties proceeded on the footing that, although the accountants were to have the carriage of the matter, the three members of the family retained the ultimate say, as directors and corporators of the respondent, on the questions whether, in respect of any particular plan of income, the respondent would make a contribution to the fund in respect of a member and, if so, the amount of any such contribution. The evidence discloses the existence of at least two considerations which influenced these decisions. To begin with, the amount to be contributed was governed to some extent by the size of the respondent's profits. Secondly, there was a reference to the limitation of the ceiling imposed by the Commissioner on the amount of such contributions for tax purposes. However, it appears that neither of these considerations was explored in detail. In short, whilst by 30 June in each year the respondent had committed itself in principle to make an appropriate contribution to the fund, it made no commitment in respect of any particular amount for any fund member until approximately six months later.

The respondent's argument, both in the Supreme Court and before us, proceeded on the assumption that the making of an agreement to the material effect, and its implementation, was the relevant criterion for present purposes. The language of the statute and the terms of the deed contemplate something more than a mere agreement to contribute. The Act requires that an amount be set apart or paid in the year of income. The deed speaks of a contribution, at any time, at such rate as the respondent shall determine and notify to the member and the trustees (cl. 2(b)). "Contribute" is, no doubt, used there with its ordinary meaning of "to give in common with others" (Macquarie Dictionary). Money is not expressly mentioned in cl. 2(b) but is clearly implicit in the obligation to give or contribute. As I understood the argument, the respondent accepts all of this but says that, by virtue of the agreement by the trustees to lend the amount of the respondent's contributions back to it immediately, there is a notional payment which satisfies both the Act and the deed.

What constitutes a "setting apart" for our purposes was considered by Owen J. in
Winchcombe Carson Ltd. v. C. of T. (N.S.W.) (1938) 5 A.T.D. 69 .

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The scheme of the taxpayer's superannuation deed was carried out by opening an account in the company's books in the name of each employee. To each account was credited the employee's contribution which was retained out of his salary. From time to time the taxpayer credited each account with an amount equal to that contributed by the employee and added thereto interest on the total amount credited. The amounts credited to each account by the taxpayer as its contribution and for interest were then by a series of book entries written off to the taxpayer's profit and loss account. Under the deed, on the happening of the stipulated events, the employee became entitled to receive the amount standing to his credit in the account in his name. Owen J. said (at pp. 73-74):

"As to the sum of £ 10,066/0/1, the company's claim is that this sum was `set apart or paid as or to a' pensions fund on September 30, 1935.

The contentions of the Commissioner are:

  • (a) That the setting apart or payment of the amount in question did not take place in the year of income but occurred in prior years when the company made the appropriate entries in its books crediting the employee and writing off to its profit and loss account the amounts so credited
  • ...

Dealing first with the sum of £ 10,066 0s. 1d. I have come to the conclusion that the Commissioner is correct in his contention that the `setting apart or payment' took place prior to the income year here in question.

Mr Hardie for the company has argued that a company cannot set apart or pay money merely by making book entries such as were made here. He says that to constitute a `setting apart' of money there must be either a payment to a particular person as a trustee or some specified portion of the company's assets must be allocated for the purpose of creating a benefit fund. In connection with this latter point, it must be remembered that the section speaks of the setting apart of a `sum' and not of `assets'.

I do not agree with Mr Hardie's contention. The section does not require the creation of a trust, although the fact that a scheme does not make such a provision is no doubt material in considering whether the benefits under it have been fully secured. If this argument is sound it is not altogether easy to imagine circumstances in which a `setting apart' of a sum of money, as opposed to a payment of it, would not create a trust, yet payment is not the only means of contribution contemplated by the section and, if the Legislature had thought it necessary to require that sums set aside should be vested in a trustee, it would have been very easy to say so.

I think that in ordinary business parlance it is not only usual but proper to describe what was done by the company year by year as the setting apart of money as or to a benefit fund."

A similar question arose in
F.C. of T. v. The Northern Timber and Hardware Co. Pty. Ltd. (1960) 103 C.L.R. 650 . The taxpayer claimed a deduction pursuant to sec. 66(1) of the Act, as it then stood. The taxpayer made a provision in its books of account to meet its prospective liabilities pursuant to long service leave legislation. The provision, which was to meet future liabilities and not an actual liability, was charged against the taxpayer's profits but there was no agreement or instrument which gave to any employee in respect of long service leave any right against or in respect of any asset or fund.

Fullagar, Kitto and Menzies JJ. said (at p. 657):

"... to make a book entry and no more does not come within the words `sets apart... a sum as or to a fund' from which pay for long service leave is to be provided. What the taxpayer did here had no legal effect whatever. The employer gave nothing and the employees gained nothing. There may in some cases be a question whether what an employer has done amounts to setting aside a sum as and to a fund, but such a question will only arise when the employer has done something that is binding and confers some benefit upon employees."

In my opinion, the amounts now in question were not "paid" to a fund within the meaning of sec. 82AAC. It is accepted by the respondent, correctly I think, that a payment could be established only if the journal entries relied upon were underpinned by a valid

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agreement to the effect that payment of its contributions be accepted by the trustees in a form other than by actual cash or by cheque (see
Whim Creek Consolidated N.L. v. F.C. of T. 77 ATC 4503 ; (1977) 17 A.L.R. 421 at p. 425 ). But, in my view, there was no valid agreement made in the present case. It is hardly necessary to add that it is not enough for the respondent to demonstrate its intention to make contributions to the fund. The respondent must go further and establish an actual agreement to the relevant effect: in a revenue context and otherwise, "the intention of a man cannot be considered as determining what it is that his acts amount to" (per Lord Buckmaster in
J. & R. O'Kane v. I.R. Commrs (1920) 12 T.C. 303 at p. 347 ).

It may be possible to infer the making of an agreement between the trustees and the respondent that, in lieu of payment by cash or cheque, the amount of the respondent's contribution would be treated as if paid and as if lent back to the respondent by the trustees. Yet such an agreement would be in breach of trust. It will be remembered that the trust deed provided that the moneys comprising the fund were to be invested, inter alia, "with or to the [respondent] so long as the [respondent] shall execute a charge acceptable to the trustees" (cl. 2(a)). No charge was ever given nor, so far as the evidence goes, was it ever contemplated. No doubt the provision of security was drafted with a view to the requirement of sec. 82AAC that the rights of members be "fully secured" (see
Driclad Pty. Ltd. v. F.C. of T. (1966-1968) 121 C.L.R. 45 per Taylor J. at pp. 48-60). Whatever the rationale of cl. 2(a), its provisions were ignored here. As parties to the trust deed, the trustees and the respondent must be taken to be aware of its requirements. Nor does it assist the respondent to point to the circumstances that, as it happened, there was a community of interest between the corporators and directors of the respondent on the one hand and the trustees and beneficiaries on the other. Even if, under the rule in
Saunders v. Vautier [ (1841) 41 E.R. 482 ] , the beneficiaries could have combined to extinguish the trust, they had no power to modify the terms of the trust (see Jacobs' Law of Trusts in Australia, 5th ed. (R.P. Meagher and W.M. Gummow) at p. 648). It follows that, to the assumed, if not actual, knowledge of the trustees and the respondent, there was a breach of trust (see
Fouche v. The Superannuation Fund Board (1951-1952) 88 C.L.R. 609 at p. 637 ; Frank J. Finn and Peter A. Ziegler, Prudence and
Fiduciary Obligations in the Investment of Trust Funds (1987) 61 A.L.J. 329 at p. 333 ).

It appears that no argument was addressed to the Supreme Court that the subject transaction constituted a breach of trust. Yet the respondent bears the general onus and, in any event, the point is purely a legal one arising on accepted facts (see
Suttor v. Gundowda Pty. Ltd. (1950) 81 C.L.R. 418 ;
Bromley v. Muswellbrook Coal Co. Pty. Ltd. (1973) 129 C.L.R. 342 ).

Since the journal entries now relied on by the respondent were not supported by the substantiation of a valid agreement, it must also follow that, for the purposes of sec. 82AAC, there was no relevant payment.

There remains the possibility that, even if there was not payment, there was a "setting apart" of the amount of the contributions in question. This was the ground relied on by Owen J. in Winchcombe Carson, supra. However, as I understood the respondent's argument, this limb of sec. 82AAC was not strongly pressed before us. In my view, this requirement of sec. 82AAC was not satisfied here. In Winchcombe Carson, the employer bound itself to its employee by crediting an amount to his account in accordance with the provisions of the trust deed. But the transactions here relied on were carried out in breach of trust. As was pointed out in the Northern Timber case, supra, a "setting apart" will occur only when the employer has done something that is "binding and confers some benefit upon employees". Not only were the transactions in breach of trust and thus not binding, but it is also at least doubtful whether, taken as a whole, they conferred a benefit upon employees. The loans were unsecured and, until 1979, did not carry interest.

In the circumstances, I need not deal with the Commissioner's alternative submission that the payment, if any, took place after the year of income (see
Waddington v. O'Callaghan (1931) 16 T.C. 187 at p. 197 ; cf., in the different context of limitation of actions,
Stage Club Ltd. v. Millers Hotels Pty. Ltd. (1981) 150 C.L.R. 535 ). Nor need I deal with the Commissioner's contention that the rights of members were not "fully secured".

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On the question of additional tax, the Commissioner contends that, for the purposes of sec. 226 of the Act, no expenditure was incurred here. The respondent sought to rely upon
F.C. of T. v. Rabinov & Anor 83 ATC 4437 ; (1983) 50 A.L.R. 541 and
North Coast Grazing Pty. Limited v. F.C. of T. 87 ATC 4553 ; but, in my view, both cases can be distinguished. In Rabinov, there was no doubt that expenditure had been incurred; the only question was whether a deduction should, as a matter of law, be allowed. North Coast Grazing raised the question, different from that arising here, whether sec. 226 applied in respect of the disclosure of an amount as capital which should have been disclosed as income.

In my view, it was open to the Commissioner to impose additional tax.

I would allow the appeals.

THE COURT ORDERS:

1. Appeals allowed with costs.

2. Set aside orders made by the Supreme Court; in lieu thereof, order that the appeals to that Court be dismissed with costs.

 

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