This Case Decision Summary illustrates the approach taken by the Commissioner of Taxation in applying Part IVA to a real fact situation. The facts have been simplified to focus on key practical issues.
To properly apply Part IVA, the law must be applied to all the relevant facts. In particular, an eight step test must be applied to determine whether, on the facts, a particular scheme objectively has the dominant purpose of obtaining a tax benefit not intended by the law. Where the scheme simply takes advantage of the intended operation of a structural feature of the law, Part IVA will not apply because the required dominant purpose will not exist.
In applying the dominant purpose test, regard must be had to the manner in which the scheme is carried out; that is, whether the scheme bears the stamp of tax avoidance. The Full Federal Court in Bellinz Pty Limited v Federal Commissioner of Taxation 98 ATC 4634 at 4647; 39 ATR 198 at 212 has noted the difficulty in applying Part IVA prior to the scheme being carried out, because the execution of the scheme may in fact be different to that originally proposed. Even where the scheme has been carried out, the Court has noted that a difficulty in coming to a view on the application of Part IVA is to ensure that all relevant facts are considered, including those concerning the manner in which the scheme is carried out.
This Case Decision Summary has been withdrawn.
ATO Case Decision
Case Decision Number:
CDS10283
Subject:
Can Part IVA (Income Tax Assessment Act 1936 (ITAA 1936)) apply to an arrangement under which income of a professional partnership is alienated for the benefit of the spouses and children of the partners by way of payments to a service trust?
Decision:
Yes. Part IVA (ITAA 1936) applies to the arrangement to include the assessable income avoided.
Facts:
The partners in a partnership of medical practitioners set up a unit trust (‘the Trust’) to provide administration and support staff to the partnership. The doctors were directors and office bearers of the company that was trustee of the Trust. The unit holders of this service Trust were family trusts. The beneficiaries of the family trusts were the spouses of the doctors and their children. All of the employed staff engaged in the work of the medical practice were employed by the Trust.
The fee paid by the partnership to the Trust for the services of the staff of the Trust included a mark up of 50% on the cost of those services to the Trust, that is, the wages of the staff of the Trust. The Trust also agreed to provide billing and collection services for which it was paid an additional fee of 10% of all amounts collected by the Trust on behalf of the partnership. Most collections were carried out immediately upon completion of the relevant consultation with the doctor. The Trust engaged a debt collection agency to recover hard core debts.
The service agreement between the partnership and the Trust specified that the doctors retained absolute control over the hiring and firing of staff of the Trust. The partnership owned the premises in which the doctors conducted the practice and also owned substantial assets that were utilised by the doctors during patient consultations. The staff of the Trust performed all of their services on those premises under the supervision of the doctors and in accordance with their directions, and used the assets of the partnership, including computers and other office materials and supplies, in performing the services. The staff enjoyed the use of amenities, such as a kitchen, provided by the partnership. The Trust did not provide the partnership with any premises, plant or other equipment.
Each doctor shared in the profits of the partnership according to the billings referable to their own personal exertion. The profits of the Trust were distributed to the unit holders (the doctors’ family trusts) in the same proportions as the partnership profits were shared by the respective doctors.
Neither the spouses nor their children performed any services for the Trust.
Reasons for Decision:
The arrangement could be distinguished from the facts of the Full Federal Court decision in FC of T v Phillips (Phillips’ case) 78 ATC 4361; (1978) 8 ATR 783. In Phillips’ case, a partnership firm of accountants rearranged their structure of operations from being entirely one unit by transferring their staff, furniture and all other plant to a trust. Staff employed by the trustee of the trust performed certain non-professional business activities of the firm. The furniture and plant was purchased by the trustee and leased back to the firm. The Full Federal Court rejected the Commissioner's argument that the expenditure was not or was not sufficiently connected with the business. The Court also rejected the Commissioner's alternative argument that an examination of the ends or purposes to be achieved by the expenditure established that it was not exclusively referable to the gaining of assessable income. There was no dispute that the charges paid by the firm to the trust were realistic and not in excess of commercial rates.
The Commissioner had sought to rely on section 260 (ITAA 1936) before the trial judge in the Supreme Court (FC of T v Phillips 77 ATC 4169; (1977) 7 ATR 345). However, in the Full Federal Court (78 ATC 4361; (1978) 8 ATR 783), the Commissioner abandoned relying on the provisions of section 260 (ITAA 1936).
Scheme
The scheme included all of the events and circumstances outlined in the above facts, including all the steps taken to set up the Trust with the family trusts as the unit holders entitled to certain fixed distributions.
Tax benefit
Each doctor obtained a tax benefit of the amount not included in the doctor’s assessable income which, but for its alienation through the Trust to the doctor’s family trust, would reasonably be expected to be included in the assessable income of the relevant doctor.
Purpose
A reasonable person would conclude that the dominant purpose of the doctors in entering into the scheme was to enable each doctor to obtain the tax benefit described above. Some of the factors relevant under paragraph 177D(b) (ITAA 1936) were:
(ii): form and substance: In form the arrangement provided for a separate entity, the Trust, to engage and supply staff to the partnership. In fact, the Trust had no assets, no premises and no overheads except the administrative cost of paying the wages of the Trust’s staff. The doctors controlled the activities of the staff and, therefore, the operations of the Trust as an indistinguishable part of the operations of the partnership practice. The Trust had no business structure and bore no administrative costs except the wages of the staff and the costs of paying them. The owners of the Trust, the family trusts, added no value. In the circumstances, the agreed fees appeared to be excessive and uncommercial. In addition, the fee for billing and collecting appeared to be partly in respect of the administrative and support services already covered by the fee for the staff’s services.
(iv), (v) and (vi): tax outcome and change in financial position of doctors and their families: The scheme had the effect of reducing the after-tax income of each of the doctors, but of increasing the after-tax income of each doctor’s immediate family by a greater amount. The overall change in each family’s financial position as a result of the scheme was positive. The alienation of income that brought about this financial change was not accompanied by an equivalent change in the responsibilities, duties or asset ownership of the members of the families.
Legislative References:
Income Tax Assessment Act 1936 subsection 51(1), Part IVA, paragraph 177D(b), section 260
Relevant Cases:
FC of T v Phillips 77 ATC 4169; (1977) 7 ATR 345
FC of T v Phillips 78 ATC 4361; (1978) 8 ATR 783
Keywords:
Beneficiaries
Family trusts
Income alienation
Part IVA
Partnership income
Partnerships
Personal services income
Schemes & shams
Service trusts
Tax avoidance
Tax benefits under tax avoidance schemes
Tax planning, avoidance & evasion
Trusts
Unit trusts
Date of decision:
3 June 1998
FOI Number:
I2000283