CASE 13/95

Members:
BJ McMahon DP

Tribunal:
Administrative Appeals Tribunal

Decision date: 13 March 1995

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BJ McMahon (Deputy President)

The 4 applicants were wives of members of a professional partnership of 7 men. Together with 2 other wives to whom reference will later be made, they were lessees of premises occupied by the professional partnership under sub-lease from the applicants. The seventh professional partner was not married. The lease was, on its face, last executed on 27 November 1985. The building of which the premises forms part was sold in the financial year ended 30 June 1988. In order to obtain vacant possession, the purchaser paid a sum of money to the lessees in consideration of their entering into a deed and instrument of release.

2. A total of $750,000 was paid. Of this amount $125,000 was received by each of the 4 applicants in her own right. The fifth wife held her interest in the lease on trust for the 4 applicants, pursuant to an agreement manifested and implemented by a declaration of trust executed on 22 December 1987. As a result of that, each of the applicants received a further sum of $31,250. One of the applicants has recognised capital losses which may be offset against this sum.

3. In both cases, it was agreed that there was no cost base. Accordingly the question for consideration is whether the sum of $125,000 is taxable as a capital gain in the hands of each of the 4 applicants by virtue of the provisions of Part IIIA of the Income Tax Assessment Act. The fact that no cost base can be pointed to under s 160ZH of that Act would have the result of including the whole of the $125,000 as a sum taxable under the provisions of that Part in the hands of each of the applicants. It is conceded by all the applicants and by the respondent that the additional sum of $31,250, which each of the 4 applicants received, constituted a capital gain without a cost base.

4. The sixth lessee received consideration from the purchaser, but following litigation, it is conceded that no part of the consideration received by her was attributable to the applicants.

5. All 4 applicants denied liability on the basis that the asset disposed of was either acquired prior to 20 September 1985 (s 160L), or that the asset disposed of was acquired under a contract which was entered into prior to 20 September 1985 (s 160U(3)). A great deal of detailed evidence and submissions was put forward on behalf of the applicants. Some of the material related to issues that were conceded prior to the hearing so that it will not be necessary to canvas it in detail. Notwithstanding the complexity of the presentation, the essential facts and the applicable law can be stated rather more simply.

6. In or about October 1984 it was agreed by the partners of 3 professional practices that they would merge. It was further agreed that following the merger, the new practice should be carried on at premises occupied by one of the merging firms, enlarged by the addition of more office space in the same building. One of the members of the firm that was already located in the building, Mr B, was appointed by all 3 firms to represent them in negotiations to obtain a long term tenancy of sufficient space in that building.

7. In February 1985 the 4 applicants, together with the 2 other wives to whom I have referred, registered changes in particulars of their business name under which they carried on a business of providing secretarial services. All the wives of course signed the application for registration and particulars of the change. The changes consisted of the introduction of wives of the incoming partners as additional parties. For taxation purposes, the wives constituted a partnership because they were in joint receipt of an income. Whether their association amounted to a partnership as understood under the Partnership Act, it will not become necessary to decide. There was at no time any written agreement between the women setting out the

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terms of their arrangement. It is clear, however, that they purported to carry on business under a business name, to which I will refer as Secretarial Services, and that profits from this business were distributed to members of Secretarial Services on a regular basis. As will be seen, Secretarial Services had been in existence for some time prior to the merger. It later took a more active role in the financial affairs of the non professional side of the partnership as a result of decisions to which reference will be made.

8. From and including the payment made in April 1985, up until and including the last payment of rent in 1988 when vacant possession was given to the purchaser, Secretarial Services paid all rent to the landlord for the existing suites and for the additional suites as they became vacant. All rent was paid by Secretarial Services by cheque drawn on its current account and signed by a signatory previously authorised by all the members of Secretarial Services in instructions to their bank.

9. Mr B carried out considerable negotiations with the lessor in the first half of 1985. It was intended that the new professional partnership should commence from 1 July 1985 and it was desirable that all matters in relation to the refurbishment and alteration of the premises be completed by then. The physical works were in fact carried out and the incoming partners took up joint occupation over the weekend of 30 June 1985.

10. On 5 February 1985 one of the professional partners (who happened to be the unmarried partner) prepared a memorandum addressed to his partners outlining various aspects of the amalgamation needing to be addressed, including the proposed income tax structure of the partnership. Included amongst his recommendations was one that the Secretarial Services, which had previously been used to service one of the original partnerships, should be reinstated, that the new wives should be brought in as members of that organisation and that the premises should be sub-leased by Secretarial Services to the professional partnership at a mark up of 10 per cent per annum. It was also recommended that Secretarial Services should provide the non- professional staff at a mark up of 30 per cent on their gross wages including pay-roll tax. These recommendations were discussed at a meeting of the professional partners on 11 February 1985 and were adopted.

11. It is clear that from that day, Mr B knew that his negotiations with the lessor were on behalf of Secretarial Services and not on behalf of the professional partnership. I am also satisfied that a sufficient nexus was established between the wives and Mr B, authorising him to act on their behalf in these negotiations through their bank authorisation, through general discussions which they had with their respective husbands, and through general discussions which they had with each other at a dinner held at The Rocks upon the inauguration of the new professional partnership. Their authority to Mr B was later to be evidenced in other ways. I find therefore that from 11 February 1985 (at the latest) Mr B knew that he was representing the wives who constituted Secretarial Services in his negotiations concerning the premises, and those wives knew that Mr B was representing them and had authority to bind them in matters relating to the premises.

12. Rent continued to be paid by Secretarial Services and to be accepted by the lessor from that firm from February 1985. These payments are substantiated by banking records, which were tendered in evidence. Rent was charged by Secretarial Services to the professional partnership computed on the basis of the actual rent paid plus a mark up of 10 per cent, but reduced by any rent received on several sub- lettings to third parties of premises which were temporarily surplus to the requirements of the professional partnership. Secretarial Services also made certain charges for the provision of staff and for telex transmissions and telephone calls.

13. News of the intended sale of the building was received by Mr B in August 1985. By that time although negotiations had been continuing, no formal lease documentation had been entered into. It is clear from the material put before me, however, that the lessor considered that the interests of Secretarial Services should be made known to the proposed purchaser and that steps should be taken towards formalising the arrangements with that firm. That the lessor notified the interest of Secretarial Services to the intending purchaser is, to my mind, another piece of evidence that arrangements were sufficiently advanced, in the contractual sense, to compel the lessor to make a disclosure against its interest. It is conceivable that if the

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interests of Secretarial Services had not been disclosed, the amount required to obtain a surrender of any leasehold interest might have been reduced and the purchase price which the lessor might reasonably have expected to receive may have been increased. In August 1985 there was no indication on the title, or in any other public way, of the interest of Secretarial Services which could have put the purchaser on notice.

14. By 22 August 1985, it was settled that the lease should be in the names of the wives as lessees and the husbands as guarantors. This arrangement was evidenced by 2 telexes sent by Mr B to the property officer of the lessor and was evidenced by certain conversations with that officer, of which he gave evidence. The proposed lease had reached the stage of agreement on all other principal terms, a subject to which I will later return.

15. On 18 September 1985 the lessor wrote to its solicitors with a lease summary to enable them to prepare the lease in favour of Secretarial Services. The solicitors were instructed to return the completed lease to the lessor which was then to obtain the lessees' signatures and was to return the document to the solicitors after execution by the lessor.

16. Objection was taken by counsel for the respondent to any use being made of this letter. I agree that it is not correspondence between the contracting parties. I also agree that its provenance was not strictly accounted for. I have formed the view, however, that there is nothing apparent on the face of the document to indicate that it is other than what it purports to be and there is no evidence contradicting the terms of the letter or indicating that any limitation should be put on its language. It is in my view another tile in the mosaic, tending to indicate that agreement had been reached between the lessor and Secretarial Services as to the principal matters to be covered in the proposed lease.

17. This turned out to be the case. When the formal lease was received by Mr B he arranged for the wives to execute it. The date on which it was said to have been signed by them was 25 October 1985. Three very minor alterations were made but otherwise the document as prepared was accepted.

18. Signed copies of the lease were sent to the lessor on the same day. They were later executed by the lessor on a day said to be 27 November 1985. The lease was subsequently registered at the Land Titles Office. An endorsement by the Registrar General on the copy tendered in evidence indicates that registration took place on 7 March 1986.

19. The disposal giving rise to the alleged capital gain was constituted primarily by a deed of release dated 30 December 1987. In that document the lessees covenanted that not later than 12 noon on 30 June 1988, or such earlier date as the lessees should vacate the premises, they would ``surrender to the lessor all the estate title right and interest of the lessee in to and under the lease and the whole of the demised premises and all the hereditaments and premises comprised in and demised by the lease to the intent that the residue of the term of the lease unexpired as at the surrender date shall as from the surrender date merge and be absolutely extinguished''.

20. This document was followed by an instrument of release dated 20 June 1988. What was disposed of, therefore, was the legal estate of the applicants (and 2 others) in a registered lease which was expressed to be for a term of 6 years, commencing on 1 August 1985 and to terminate on 31 July 1991, together with an option for renewal as therein set out.

21. The relevant asset is therefore the absolute interest of each of the applicants as a tenant in common in the leasehold estate. It is not to the point therefore to show that the applicants acquired an equitable interest as lessees prior to the registration of the lease. Whatever tenancy rights may have been held in the premises prior to registration of the lease, that tenancy was not the asset disposed of for the consideration now in issue. The leasehold estate disposed of was created by registration of the lease as the term exceeded 3 years. Until registration, there was only a lease for a year plus an agreement for more (
Chan & Anor v Cresdon Pty Ltd (1989) 168 CLR 242 at 248). Lengthy submissions were made to establish that the applicants in fact acquired ascertainable equitable interests in rem prior to 20 September 1985. It is not necessary to determine whether this was in fact the case as the asset disposed of and the asset to be considered in this application, was a legal interest that came into existence after the grant and registration of the lease.

22. It is also not helpful to consider examples of equitable estates arising by virtue of a claim

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to a right for specific performance. This right is simply a remedy afforded by the courts, where a specifically performable contract exists. If the contract exists, then the applicants will succeed by virtue of the provisions of s 160U(3). If the contract does not exist, it can not be brought into existence through a claim to a remedy.

23. Claims founded on an estoppel arising otherwise than from an agreement for the grant of the leasehold estate do not arise. If there is a contract, as the applicants allege, then it is not necessary to look further. If there is no such contract, then estoppel does not create one but merely precludes the lessor from denying its existence in any suit to secure delivery of the grant of the estate. Submissions were put by the applicants tending to show that they would have been entitled, vis-à-vis the lessor, to a grant by virtue of an estoppel arising either from deed or from conduct (
Waltons Stores (Interstate) Ltd v Maher & Anor (1987-1988) 164 CLR 387 at 414). Whether or not this is so, and whether or not such an inter partes relationship binds the Commissioner, does not fall for decision. The applicants can succeed only if they can show that the legal estate in the lease came into existence prior to 20 September 1985 (and patently this can not be demonstrated) or that the asset disposed of was acquired under a contract. An estoppel situation does not establish either proposition.

24. An argument was put on behalf of the applicants that s 160M(3)(d) had application to the present facts. In my view, however, the evidence does not support a proposition that the applicants had the use and enjoyment of an asset which was subsequently disposed of, which use and enjoyment was obtained for a period at the end of which title to the asset would or might pass to that person (to paraphrase the provisions). This paragraph is certainly not intended to cover the type of situation presently under consideration. What the applicants disposed of was not the premises, but a leasehold estate. They could not, and did not, have the use and enjoyment of the leasehold estate until it came into existence and this did not happen until registration after execution of the lease on 27 November 1985.

25. The only real issue, in my view, is whether s 160U(3) has application. The applicant must show that the leasehold estate was acquired ``under a contract'' prior to the relevant date. In Case 50/94,
94 ATC 440 at 447 Barry J ventured the opinion (obiter) that the use of the word ``contract'' in s 160U(3) should be interpreted as an ``enforceable contract''. He said: ``To read it in any other way would lead to astonishing results''. Counsel for the applicant suggested that such a reading itself would lead to confusion as enforceability under the equivalent State Acts derived from the original Statute of Frauds carried different requirements and tests. In my view this does not present any practical difficulty. I agree with His Honour that ``contract'' should be read to mean ``an enforceable contract'', that is to say a contract enforceable in accordance with the proper law of the contract. The section requires that the asset be acquired ``under a contract''. If the contract were unenforceable, it would not be the type of contract contemplated by the section as the fons et origo of the asset disposed of. An unenforceable contract will not ground specific performance. It may sometimes, however, be enforced indirectly in ways discussed by McHugh JA in
Paul v Pavey & Mathews Pty Ltd ((1985) 3 NSWLR 114 at 120 and following). Such an available procedure however would not, in my view, be sufficient to elevate a contract otherwise unenforceable at law to a contract that has a clear and direct relationship to the creation of the asset disposed of. In my view, s 160U(3) requires such a relationship to be demonstrated.

26. I consider, however, that the applicants have shown the existence of an enforceable contract prior to the relevant date and that the lease was acquired under that contract. It is true that there was no written contract. It is also true that there is no immediately identifiable offer and acceptance during the course of the negotiations. It is, however, possible to say quite comfortably that by 22 August 1985 agreement had been reached on all the essential terms of the lease namely, the parties, the premises, the rent, the commencement date and the term. Agreement on the mechanical clauses was assumed and is illustrated by the fact that no real amendment was made to the draft subsequently produced.

27. There was a binding agreement for a lease notwithstanding the fact that no note or memorandum, as required by the Conveyancing Act, came into existence. Instead, there was part performance constituted by the fact that Secretarial Services was let into possession with

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the knowledge of, and agreement of, the lessor. Counsel for the respondent pointed to the fact that physical occupation of the premises was at all relevant times solely that of the professional partners. In my view this is not relevant. Possession, rather than occupation, is the mark of part performance in these circumstances. Secretarial Services had a number of employees physically occupying space in the premises, but more importantly Secretarial Services had the use and enjoyment of the premises through the rental it received from the professional partnership and the profit it made over and above the rental it paid to the lessor, which was accepted regularly by the lessor from Secretarial Services. It is true that mere payment of money through the bank account of Secretarial Services is not part performance, nor does the description of those payments as rental necessarily characterise them as rental. However, taken in conjunction with all other related circumstances, that payment is additional evidence of an agreement on the part of the lessor to let the applicants into possession. How else were the payments to be characterised? Who else, as against Secretarial Services, was entitled to possession?

28. Counsel for the respondent argued that communications prior to 25 October 1985 were no more than negotiations toward terms which were not settled until the final form of lease was executed and furthermore that they were not conducted with the applicants or any agent authorised by them. For reasons which I have stated, I consider that proceedings had moved beyond the negotiation stage at the latest from 22 August 1985. Furthermore, I consider that all negotiations carried out by Mr B were, in his mind, as well as in the mind of the lessors (particularly after 22 August 1985) and at all times in the minds of the applicants, on behalf of Secretarial Services. Evidence that the lessor considered it was bound to Secretarial Services from August 1985 can also be seen by the fact that the lease as subsequently prepared provided for a term commencing on 1 August 1985. In submitting such a document, the lessor was acknowledging that at all times since that date, Secretarial Services had an entitlement to the grant of a registrable lease. There was never any issue between the parties as to the subsidiary terms of that lease. Once the arrangement had been formalised, the document was executed reasonably promptly.

29. So far as the 4 sums of $125,000 are concerned, therefore, the objection decisions will be set aside and the matters will be remitted to the respondent for reconsideration with the direction that the relevant asset was acquired under a contract entered into prior to 20 September 1985.

30. So far as the 4 sums of $31,250 are concerned, the objection decisions will be affirmed. The question then arises whether, and if so how much, additional taxation should be paid in respect of those elements of the assessments. There was no disclosure of the receipt, or of the facts leading to the receipt, of each of the sums in the return of income of any of the applicants. There was, however, evidence that genuine attempts had been made by them later to obtain legal advice from senior counsel as to the extent of their liability. They had also received prior legal advice from a well qualified firm of solicitors concerning the possibility of the imposition of capital gains tax. The terms of the advice, however, were such as to require the applicants to make certain decisions on facts known to them. In other words, the solicitors did not give unequivocal advice that the applicants would be liable to capital gains tax and that if they failed to disclose the circumstances, they would do so at their peril. The solicitors simply, and quite rightly, set out only the matters to be taken into consideration. On the advice that the applicants received, I do not consider it unreasonable that they took the course of action which they did. There was also evidence that negotiations continued for a considerable period during an audit with officers of the respondent and that there was no suggestion of any lack of cooperation during the audit on the part of any of the applicants or their representatives.

31. The assessment of additional tax contained a per annum component and a culpability component. Counsel for the applicants submitted that the per annum component should be remitted totally because the audit took so long and the consequent delay before the applicants paid the additional tax was caused not by their behaviour, but by the respondent's tardiness. In my view this argument can not succeed. A per annum component is simply to compensate the Commissioner for deprivation of the money to which he is entitled represented by the assessment, over a period between the raising of

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the assessment and the payment of the amount. The only circumstances considered as appropriate for remission of the per annum component are those set out in paragraph 81 of Income Tax Ruling 2517. None of those factors is apparent here.

32. On the other hand, a culpability component set at 35 per cent is, to my mind, unreasonably high. In paragraph 41 of the same Income Tax Ruling such a rate is said to be appropriate in circumstances of recklessness short of deliberate evasion. This is too harsh a view to take of the applicants' conduct. The fact that a considerable time elapsed before a firm view was formed by the Commissioner, the fact that it was necessary to obtain the opinion of Senior Counsel in a difficult and complex area of the law and the fact that full cooperation was extended to the respondent's officers indicate to me that a more appropriate heading under paragraph 41 is that of ``contentious item''. I would impose a culpability component of 5 per cent.

33. As to the additional tax on those sums of $31,250 received by each of the applicants, I would affirm that element representing the per annum component and reduce that element representing the culpability component from 35 per cent to 5 per cent.