FC of T v HART & ANOR
Members: Gleeson CJMcHugh J
Gummow J
Hayne J
Callinan J
Tribunal:
High Court of Australia
MEDIA NEUTRAL CITATION:
[2004] HCA 26
Callinan J
75. The Court has before it an appeal and an application for special leave to appeal by the appellant. The former raises questions as to the nature of a scheme under the Income Tax Assessment Act 1936 (Cth) (``the Act'') and the identification of the dominant purpose of it. The latter relates to the basis of an assessment of a taxation benefit claimed in respect of compound interest. If the appellant succeeds on his appeal, the issue sought to be resolved by the application for special leave to appeal need not be.
Facts
76. The respondents owned a residential property at Jerrabomberra that was mortgaged to the ANZ Banking Group Ltd (``ANZ''). They decided to buy another residence at Fadden and to make their current residence available for rent. On 21 August 1996 the respondents paid a holding deposit on the Fadden residence. Only then did they explore ways and means of financing the purchase. They obtained a brochure from a mortgage broker, Austral Mortgage Corporation Pty Ltd (``Austral'') which promoted a particular arrangement of lending and repayment which it described as a ``Wealth Optimiser''. The inescapable purpose of the Wealth Optimiser was, as will appear, to facilitate the repayment of a loan to be used not exclusively for the derivation of income but so as to derive the maximum tax benefits possible.
77. The accurate description by the broker of the arrangements and terms of a Wealth Optimiser in this way, which it provided in its promotional material, almost alone establishes this:
```Lets you better manage your after tax dollars'
...
Under the Wealth Optimiser way, your loan is split into two portions, a home loan portion and an investment loan portion. You
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have the choice of allocating the repayments to either the home loan portion, the investment loan portion, or both. By choosing to allocate all of your repayments to your home loan portion, the home loan portion is paid off quickly, usually in around 5 or 6 years instead of 15 to 25 years. During this period, interest continues to accrue and is capitalised monthly on your investment loan portion....
Once your home loan portion is paid off, all of your repayments are allocated to paying off your investment loan portion. Your home remains as security for your investment loan portion. The size of your repayments remains the same throughout the loan (unless you wish to increase them, or interest rates vary).
...
HOW DOES WEALTH OPTIMISER WORK?
The home loan portion needs to be used for financing residential real estate, which will be security for both loan portions. The investment loan portion can be used for investment in shares, managed funds, etc. However for Wealth Optimiser to work most effectively, you need to be paying off a home loan and also a loan used to finance an income producing investment.''
78. On 23 August 1996 the respondents were provided with a schedule of the benefits of a Wealth Optimiser compared with a standard loan. It showed that the financing of a borrowing for the purchase of a residence of $145,023, and a loan of $120,592 to finance the purchase of an investment property over 25 years would generate for the borrower $169,470 in increased income tax deductions above those that the borrower would have been entitled to receive under a conventional borrowing if the loan were to extend to its full term. It showed that the amount of interest paid under a Wealth Optimiser and under a conventional loan was the same. It also showed that, after eight years, the amount owing in respect of the property bought for the derivation of income would have increased from $120,592 to $233,085. A likely consequence would be that the amount outstanding in respect of the investment property would come to exceed its value.
79. The respondents were offered a Wealth Optimiser loan of $298,000. Approximately $95,000 and $203,000 were to be respectively utilized to discharge the mortgage on the respondents' current residence which was then to be let and in purchasing the respondents' proposed replacement of it. Permanent Custodians Limited (``the lender'') was a legal personality quite separate from Austral. Principal and interest were to be repayable in full 25 years from the date of settlement. Interest would be payable at a variable rate. It was then 9.15%, a slightly, but not significantly higher rate than the respondents had been paying on their current loan by ANZ (8.69%). The respondents were informed that:
``If you ask us to, we will split this amount into a maximum of 2 separate loan accounts. We will calculate interest on each loan account separately and give you a separate statement for each loan account.''
80. Interest was to be calculated daily on the unpaid balance of the loan (``or if applicable on the unpaid balance of each loan account'') and was to be debited monthly in arrears. Repayments would be $2533 per month, subject to variations of interest rates. On 2 October 1996, the respondents confirmed that they wished to accept the offer. On 4 September 1996 they had entered into a contract to purchase the Fadden property. On 7 October 1996 the respondents made a request to Austral to split the loan into two accounts, one for $202,888 (to be applied to the purchase of the new residential property) (``loan account 1'') and the other for $95,112 (to be applied to the refinancing of the investment property) (``loan account 2'') with payments to be allocated to loan account 1 (until the balance in that account was paid off). The terms providing for the splitting of the loan into separate loan accounts and the capitalization of all interest accruing on the loan balance were cll 4.3 and 8.6.
``4.3 Loan Accounts
If you ask us to, we will:
- (a) split the Loan Balance into a maximum of four separate Loan Accounts; and
- (b) allocate the Loan Balance between those Loan Accounts in accordance with your request.
...
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8.6 Capitalisation of Interest
On each Payment Date, we will capitalise all interest accrued on the Loan Balance during the immediately preceding Interest Period by debiting your Loan Accounts. Capitalising interest means that interest is added to the amount on which the interest is accruing, and interest then accrues on the total amount.''
81. Because the respondents had nominated that the whole of their repayments should be allocated to loan account 1, all payments of principal and interest were applied in reduction of that account, while interest on the amount owing on loan account 2 was capitalized, and compound interest was debited. The consequence was that, as no reductions of the principal outstanding on loan account 2 occurred in the 1997 or 1998 financial years, interest accrued on the whole of the amount of that account. Nor were any payments of interest made in respect of loan account 2 in those years. Compound interest accordingly accrued. The respondents claimed deductions for the whole of the unpaid interest accruing in loan account 2. The appellant was of the opinion that the compound interest was not deductible on any view and disallowed it. He also made determinations under Pt IVA of the Act disallowing as a deduction the interest which would not have accrued on loan account 2 had the agreed periodical payments made by the respondents been allocated proportionally to the two accounts.
First instance in the Federal Court
82. The respondents objected. The appellant rejected their objections. The respondents appealed pursuant to Pt IVC of the
Taxation Administration Act
1953 (Cth) to the Federal Court. There, the appellant contended that on any view there was a scheme in place and that it was possible to characterize it as such, either broadly or narrowly. The primary judge (Gyles J) summarized the appellant's contentions which are maintained in this Court in these ways:
[56]
``The [ appellant] contends that the scheme is all the steps leading to and the entering into and the implementation of the loan arrangements between Austral and the [ respondents], including:
- (a) the marketing of the `Wealth Optimiser Loan' to the [ respondents];
- (b) the splitting of the loan into the home loan portion and the investment loan portion;
- (c) the acceptance by Austral of capitalisation of interest on the investment loan portion, on the basis that it receives another predetermined amount in reduction of the home loan portion;
- (d) the election by the [ respondents] to allocate the whole of the repayments to the home loan portion until that portion of the loan has been paid; and
- (e) the consequential incurring of an amount of additional interest and further interest on the investment loan portion.
Alternatively, the scheme is said to be the provision in the loan for the division into two portions and the direction of the repayments to one or other portion and the direction by the [ respondents] of the repayments to the home loan portion. The parties to the scheme are alleged to be the [ respondents], and/or Austral and/or its directors, and/or [ the lender] and/or its directors.
The [ appellant] contends that the tax benefit is either of the following:
- (a) if all the interest on the investment loan portion is deductible (including the additional interest and the further interest), the tax benefit is the difference between:
- (i) the interest incurred on the investment loan portion; and
- (ii) the interest that would have been incurred on the investment loan portion if the [ respondents] had allocated the total minimum payment proportionally across both accounts.
Under this scenario, the tax benefit for each of the [ respondents] would be $96 for the 1997 year and $365 for the 1998 year;
- (b) if the additional interest is not deductible but the further interest is deductible, the tax benefit is the difference between:
- (i) the interest the [ respondents] would have incurred on the investment loan portion if the [ respondents] had a conventional interest only investment loan; and
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- (ii) the interest the [ respondents] would have incurred on the investment loan portion if the [ respondents] had operated the accounts as separate conventional principal and interest loans.
Under this scenario the tax benefit for each of the [ respondents] would be $29 for the 1997 year and $50 for the 1998 year.''
83. His Honour held that compound interest was deductible under s 51(1) of the Act (for the 1997 year) and under s 8-1 of the
Income Tax Assessment Act
1997 (Cth) for the 1998 year,
[57]
The appeal to the Full Court of the Federal Court
84. On appeal, the Full Court of the Federal Court (Hill, Hely and Conti JJ) affirmed the decision of the primary judge as to the deductibility of the compound interest under s 51(1) and s 8-1, but held that the provisions of Pt IVA did not apply to disallow the deductions for either the compound interest or the further interest. Its opinion was that the narrower scheme was not a scheme for the purposes of Pt IVA, and that the scheme had to be the wider one, if any. Their Honours held that the wider ``scheme
[
as suggested by the appellant] was directed to a commercial end, the borrowing of money for use in financing and refinancing the two properties'' and ``
[
t]hat is what a reasonable person would conclude was the ruling, prevailing or most influential purpose of the
[
respondents] in entering into or carrying out the scheme''.
[59]
The appeal to this Court
85. In almost every respect the language of the legislature is expressed in the widest possible terms. The sections with which the Court is particularly concerned are:
``177A Interpretation
(1) In this Part, unless the contrary intention appears:
...
`scheme' means:
- (a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and
- (b) any scheme, plan, proposal, action, course of action or course of conduct.
...
(3) The reference in the definition of `scheme' in subsection (1) to a scheme, plan, proposal, action, course of action or course of conduct shall be read as including a reference to a unilateral scheme, plan, proposal, action, course of action or course of conduct, as the case may be.
(4) A reference in this Part to the carrying out of a scheme by a person shall be read as including a reference to the carrying out of a scheme by a person together with another person or other persons.
(5) A reference in this Part to a scheme or a part of a scheme being entered into or carried out by a person for a particular purpose shall be read as including a reference to the scheme or the part of the scheme being entered into or carried out by the person for 2 or more purposes of which that particular purpose is the dominant purpose.
...
177C Tax benefits
(1) Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to:
- (a) an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out; or
- (b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out;
- ...
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and, for the purposes of this Part, the amount of the tax benefit shall be taken to be:
- (c) in a case to which paragraph (a) applies - the amount referred to in that paragraph; and
- (d) in a case to which paragraph (b) applies - the amount of the whole of the deduction or of the part of the deduction, as the case may be, referred to in that paragraph.
...
177D Schemes to which Part applies
This Part applies to any scheme that has been or is entered into after 27 May 1981, and to any scheme that has been or is carried out or commenced to be carried out after that date (other than a scheme that was entered into on or before that date), whether the scheme has been or is entered into or carried out in Australia or outside Australia or partly in Australia and partly outside Australia, where:
- (a) a taxpayer (in this section referred to as the `relevant taxpayer' ) has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and
- (b) having regard to:
- (i) the manner in which the scheme was entered into or carried out;
- (ii) the form and substance of the scheme;
- (iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;
- (iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;
- (v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;
- (vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;
- (vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and
- (viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi);
it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers).
...
177F Cancellation of tax benefits etc.
(1) Where a tax benefit has been obtained, or would but for this section be obtained, by a taxpayer in connection with a scheme to which this Part applies, the Commissioner may:
- (a) in the case of a tax benefit that is referable to an amount not being included in the assessable income of the taxpayer of a year of income - determine that the whole or a part of that amount shall be included in the assessable income of the taxpayer of that year of income; or
- (b) in the case of a tax benefit that is referable to a deduction or a part of a deduction being allowable to the taxpayer in relation to a year of income - determine that the whole or a part of the deduction or of the part of the deduction, as the case may be, shall not be allowable to the taxpayer in relation to that year of income;
- ...
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and, where the Commissioner makes such a determination, he shall take such action as he considers necessary to give effect to that determination.
(2) Where the Commissioner determines under paragraph (1)(a) that an amount is to be included in the assessable income of a taxpayer of a year of income, that amount shall be deemed to be included in that assessable income by virtue of such provision of this Act as the Commissioner determines.
...
(2C) Notice of the determination must be given to the taxpayer and... to the person who paid the amount.
(2D) More than one determination may be included in the same notice.
(2E) A failure to comply with subsection (2C) does not affect the validity of a determination.
...
(3) Where the Commissioner has made a determination under subsection (1)... in respect of a taxpayer in relation to a scheme to which this Part applies, the Commissioner may, in relation to any taxpayer (in this subsection referred to as the `relevant taxpayer' ):
- (a) if, in the opinion of the Commissioner:
- (i) there has been included, or would but for this subsection be included, in the assessable income of the relevant taxpayer of a year of income an amount that would not have been included or would not be included, as the case may be, in the assessable income of the relevant taxpayer of that year of income if the scheme had not been entered into or carried out; and
- (ii) it is fair and reasonable that that amount or a part of that amount should not be included in the assessable income of the relevant taxpayer of that year of income;
determine that that amount or that part of that amount, as the case may be, should not have been included or shall not be included, as the case may be, in the assessable income of the relevant taxpayer of that year of income; or
- (b) if, in the opinion of the Commissioner:
- (i) an amount would have been allowed or would be allowable to the relevant taxpayer as a deduction in relation to a year of income if the scheme had not been entered into or carried out, being an amount that was not allowed or would not, but for this subsection, be allowable, as the case may be, as a deduction to the relevant taxpayer in relation to that year of income; and
- (ii) it is fair and reasonable that that amount or a part of that amount should be allowable as a deduction to the relevant taxpayer in relation to that year of income;
determine that that amount or that part, as the case may be, should have been allowed or shall be allowable, as the case may be, as a deduction to the relevant taxpayer in relation to that year of income;
- ...
and the Commissioner shall take such action as he considers necessary to give effect to any such determination.
(4) Where the Commissioner makes a determination under subsection (3) by virtue of which an amount is allowed as a deduction to a taxpayer in relation to a year of income, that amount shall be deemed to be so allowed as a deduction by virtue of such provision of this Act as the Commissioner determines.
(5) Where, at any time, a taxpayer considers that the Commissioner ought to make a determination under subsection (3) in relation to the taxpayer in relation to a year of income, the taxpayer may post to or lodge with the Commissioner a request in writing for the making by the Commissioner of a determination under that subsection.
(6) The Commissioner shall consider the request and serve on the taxpayer, by post or otherwise, a written notice of his decision on the request.
(7) If the taxpayer is dissatisfied with the Commissioner's decision on the request, the
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taxpayer may object against it in the manner set out in Part IVC of the Taxation Administration Act 1953 .''
86. In the Explanatory Memorandum to the Income Tax Laws Amendment Bill (No 2) 1981 (Cth) which introduced Pt IVA (in which the relevant sections appear) into the Act, the Treasurer said this:
[60]
``The proposed new Part IVA, which this Bill will insert into the Principal Act, is designed to overcome [ limitations on the scope of s 260, as exposed by judicial decisions] and provide - with paramount force in the income tax law - an effective general measure against those tax avoidance arrangements that - inexact though the words be in legal terms - are blatant, artificial or contrived. In other words, the new provisions are designed to apply where, on an objective view of the particular arrangement and its surrounding circumstances, it would be concluded that the arrangement was entered into for the sole or dominant purpose of obtaining a tax deduction or having an amount left out of assessable income.
That test for application of the new provisions is intended to have the effect that arrangements of a normal business or family kind, including those of a tax planning nature, will be beyond the scope of Part IVA.
In this respect, Part IVA may be seen as effectuating in general anti-avoidance provisions of the income tax law a position akin to that which appears to emerge from the decision of the Privy Council in
Newton v FC of T (1958) 98 CLR 1 . The essence of the views expressed in that case was that a tax avoidance situation covered by section 260 exists only if it can be predicated from looking at an arrangement that it was implemented in that particular way so as to avoid tax.In coming to a conclusion about the application of Part IVA in particular situations, it will be necessary to examine all relevant external evidence of the purposes for which a person entered into an arrangement and carried it out in the way it was carried out. The manner in which the scheme was entered into, its form and substance, timing aspects, its practical results, including changes in the financial positions of the taxpayer and connected persons and the nature of those connections (eg, business, family) are all to be considered.
It will be necessary, if Part IVA is to apply, that a taxpayer has obtained a `tax benefit'. A tax benefit will have been obtained by a taxpayer in connection with a scheme if, after applying the other provisions of the Principal Act to the taxpayer, either an amount is not included in assessable income of the taxpayer that might reasonably be expected to have been included if the scheme had not been entered into, or a deduction is allowable to the taxpayer the whole or a part of which might reasonably be expected not to have been allowable if the scheme had not been entered into.
The relevant purpose, already referred to, that is to be enquired into is a purpose of obtaining a tax benefit, in the sense just mentioned. Specification of what constitutes a tax benefit and that the relevant purpose is one of obtaining such a benefit is designed to eliminate the uncertainties associated with the use in section 260 of less precise expressions, eg, `altering the incidence of any income tax' and `defeating, evading or avoiding any duty or liability imposed on any person by this Act' and which appear to be at the root of the development by the courts of the `choice principle'...
Section 177A: Interpretation
This section contains a number of provisions of a definitional nature.
By sub-section (1), `scheme' is to be defined in a way that covers the various forms in which tax avoidance arrangements may be found. It is to mean any agreement, arrangement, understanding, promise or undertaking whether it is express or implied and whether or not legally enforceable. Any scheme, plan, proposal, action, course of action or course of conduct is also to be treated as a `scheme'. Under sub-section 177A(3) `scheme' in the sense just referred to is to include such arrangements when they are of a unilateral kind.
...
Proposed sub-section (4) is addressed to the fact that schemes of the kind to which Part
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IVA is directed usually involve a number of parties. Accordingly, references to the carrying out of a scheme by a person are to be taken as including references to the carrying out of a scheme by a person together with others.Sub-section (5) is a provision of some consequence and is designed as part of the measures necessary to give effect to the intention that the relevant tax-motivated purpose that may bring Part IVA into operation is a sole or dominant purpose. Sub-section (5) relates principally to the words at the end of proposed section 177D which refer to a person having acted for `the purpose' of enabling a taxpayer to obtain a tax benefit. That language refers to a person's sole purpose but, by reason of sub- section 177A(5) the expression is in the case of a scheme with more than one purpose to include also a dominant purpose, ie, a purpose that outweighs all other purposes put together.
...
Section 177C: Tax benefits
The significance of the term `tax benefit', which this section defines, is that it represents the kind of tax consequence which a person must have the sole or dominant purpose to achieve, and which must have been achieved, if Part IVA is to apply by reason of section 177D. In brief, a `tax benefit' represents the non-inclusion in assessable income of an amount that, but for the scheme, might reasonably be expected to have been included and a deduction being allowable that, but for the scheme, might reasonably be expected not to have been allowable.
A tax consequence other than non-inclusion of an amount in assessable income or allowance of a deduction will not be a `tax benefit', and will thus be outside the scope of Part IVA. In other words, Part IVA applies only in relation to things that go to make up a person's taxable income, and not to rebates of or credits against the tax on a person's taxable income. Withholding taxes, being taxes that are not based on the difference between assessable income and allowable deductions will also be outside the scope of Part IVA.
The main part of section 177C is in sub- section (1). Taking assessable income and allowable deduction items separately, the sub-section is designed as follows.
First, a `scheme' (see sub-section 177A(1)) must be identified. Then, it has to be found that an amount would have been included, or might reasonably be expected to have been included, in assessable income of a taxpayer but for the scheme. For the purposes of answering the twin questions posed by section 177D, viz, whether a tax benefit has been obtained, and whether a person has a purpose of obtaining a tax benefit, that amount, to the extent that it is not, or is not to be, included in assessable income, is to represent a tax benefit in relation to the taxpayer concerned.
It follows that if there is a scheme designed so that an amount is not included in assessable income and another provision of the Principal Act operates to counter that scheme by requiring that it be so included, the amount cannot be a tax benefit obtained by the taxpayer concerned, and Part IVA will be inapplicable. In other words, Part IVA is a `last resort' measure.
...
Section 177D: Schemes to which Part applies
This section will identify schemes to which Part IVA is to apply. Supplemented by section 177E in the particular area of the stripping of company profits it will provide the basis on which action is to be taken under section 177F to cancel the relevant tax benefit.
In brief, section 177D makes Part IVA applicable as a matter of law to a scheme if a taxpayer has obtained a tax benefit under it and, on the basis of an objective view of features of the scheme and its surrounding circumstances, it would be concluded that the scheme was, in tax terms, a `blatant' one, that is, it was entered into by a person for the sole or dominant purpose of enabling the taxpayer to obtain a tax benefit.
In more detail, for a scheme to be one to which Part IVA applies by reason of section 177D it must be a scheme entered into after the date of introduction of the Bill or a scheme that technically is not `entered into'
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(eg, one constituted by a unilateral course of action) but is carried out or commenced to be carried out after that date....Under paragraph (a) it is a condition for the application of Part IVA that a taxpayer has obtained, or would otherwise obtain, a `tax benefit' (section 177C) in connection with the scheme concerned.
Paragraph (b) sets out the range of matters to which regard is to be had in coming to a conclusion whether a relevant person had the degree of taxation purpose that must exist if section 177D is to make Part IVA apply.
These are -
- • the manner in which the scheme was entered into or carried out;
- • its form and substance;
- • the particular time at which the scheme was entered into and the period during which it was carried out;
- • the tax result that, but for Part IVA, would be achieved by the scheme;
- • any change resulting from the scheme in the financial position of the taxpayer;
- • any such change in the financial position of a person with whom the taxpayer has business, family or other connections;
- • any other consequence of the scheme for the taxpayer or a connected person;
- • the nature of any connections between the taxpayer and a connected person whose financial position changes as a result of the scheme.
Against this background, the remaining provisions of sub-paragraph (b) of section 177D operate so that Part IVA will effectively strike down a scheme that on its face, and considered in the light of the designated surrounding circumstances just outlined, is one of which it is appropriate to say that it must have been engaged in for tax purposes.
In more detail, if on the basis of the matters to which regard is to be had it would be concluded that the person or one of the persons who entered into or carried out the scheme, or any part of it, did so for the sole or (by reason of sub-section 177A(5)) dominant purpose of enabling the taxpayer or any taxpayer concerned to obtain a tax benefit then (the other tests of section 177D having been satisfied), Part IVA will apply.
...
Section 177F: Cancellation of tax benefits, etc.
Section 177F is the `reconstruction' provision of Part IVA and will come into play once section 177D, together with section 177C (for the general run of cases), or section 177E (for dividend stripping and similar schemes) has done its work of both exposing for annihilation a sought-for `non- taxable' position and quantifying the amount of the `tax benefit' that stands to be cancelled. The essential function of section 177F is to enable the Commissioner of Taxation, against the background of the other sections mentioned, to determine precisely what tax adjustments should be made in the assessments of the taxpayer concerned and of other taxpayers affected by the scheme.
Sub-section (1) effectively calls on the Commissioner to make a formal determination as to how much of the amount of the identified tax benefit is to be cancelled and directs him, where he has made such a determination, to take such assessing and other action as he considers necessary to give effect to it. There are two kinds of determination possible - under paragraph (a), that the whole or a part of an amount that is not otherwise included in assessable income be so included and, under paragraph (b), that the whole or a part of a deduction or of a part of a deduction that is otherwise allowable be not allowable.
By sub-section (2), the Commissioner is required, where a determination has been made under paragraph (1)(a), to further determine the appropriate provision of the Principal Act under which the amount in question is to be included in assessable income. A corresponding provision is not called for in relation to a determination that is made under paragraph (1)(b) because the process of cancelling a tax benefit (by disallowing a deduction) under the latter paragraph does not involve the same degree of positive reconstruction to a taxable position as will be necessary where, under a
ATC 4624
scheme, an amount has not been included in assessable income.An example of where a determination of the provision under which an amount is to be included in assessable income would be relevant is where there is a question of whether or not an amount to be included in the assessable income of a company has the character of a dividend on which the rebate of tax on intercorporate dividends (section 46) is allowable.
Where the Commissioner has made a determination under sub-section (1), he is also authorised, by sub-section (3), to make a compensating adjustment in favour of either the taxpayer against whom the determination has been made, or any other taxpayer, if he is of the opinion that the person concerned has suffered a taxation disadvantage as a result of the scheme and that it is fair and reasonable that the adjustment be made. The Commissioner again is empowered to take whatever action is necessary to give full and proper reconstructive effect to the determination.
Paragraph (a) deals with a disadvantage in the form of an amount having been included in a person's assessable income that would not have been included if the scheme had not been entered into. The Commissioner is empowered, if it is fair and reasonable to do so, to determine that the amount or part of the amount should not be included in the taxpayer's assessable income. Correspondingly, under paragraph (b) the Commissioner is empowered, if it is fair and reasonable to do so, to make a determination to reverse either wholly or partially a disadvantage in the form of a deduction not having been allowed to a taxpayer that would have been allowable if the scheme had not been entered into.
Where the Commissioner is to make an adjustment in favour of a person under paragraph (3)(b) by allowing a deduction not otherwise allowable, sub-section (4) will have the effect that the reconstruction of the taxpayer's taxation position is to be effected by allowing a deduction under such provision of the Principal Act as the Commissioner determines.
This serves a purpose corresponding with that served by sub-section (2) in the reconstruction process accompanying the cancellation of a tax benefit attributable to the exclusion of an amount of assessable income.
The next four sub-sections (5) to (8), are designed to extend the benefit of the ordinary objection and appeal provisions to a taxpayer who is dissatisfied with any decision of the Commissioner to not make a determination under sub-section (3) in favour of the taxpayer.
As background, any assessment action by the Commissioner in reliance on section 177F - whether adverse to or in favour of the taxpayer - will be subject to the usual rights of objection, review by an independent Taxation Board of Review and appeal to a Court. These procedures include the power of a Board of Review to substitute its determinations and decisions for those of the Commissioner. However, these procedures may not be available to a taxpayer in a situation where Part IVA has been applied against another taxpayer and the Commissioner considers that the case is not one calling for him to make a compensating adjustment under sub-section (3) in favour of the first taxpayer, ie, an adjustment which that taxpayer considers should be made.
Under proposed sub-section (5) such a taxpayer may ask the Commissioner to make a determination under sub-section (3). By sub-section (6) the Commissioner is to consider the request and give written notice of his decision. If the taxpayer is dissatisfied with the decision he may, under sub-section (7), and within 60 days, lodge a formal objection with the Commissioner. By sub- section (8) the objection, review and appeal provisions of the Principal Act are to apply in relation to such an objection.''
87. Read literally, the definition of a scheme is easily wide enough to include something much less than an agreement or arrangement: indeed to include an ``action'', or ``course of action'', or a promise made pursuant to, or as part of an agreement or arrangement, or of a scheme. A scheme, however it is to be described, must nonetheless be something which is, or can be the object of a particular, that is to say, a dominant purpose as required by s 177A(5). Further requirements are that what is
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sought to be identified as a scheme, must be something to which the matters referred to in s 177D(b) can or may be relevant.88. Those matters, especially those of relevance here, do not operate, however, to narrow the meaning of a scheme. The reference in s 177D(b)(ii) to the ``substance of the scheme'' invites attention to what in fact the taxpayer may achieve by carrying it out, that is to matters whether forming part of, or not to be found within the four corners of an agreement or an arrangement. They also require that substance rather than form be the focus. And s 177D(b)(v) requires reference to the financial position, actual or prospective, of the taxpayer before and after the scheme.
89. The first step is to ascertain whether the transactions, or any action taken in relation to, or as part of them, are capable of constituting a scheme within the meaning of s 177A(1). In my opinion there is no doubt that there was a scheme here within that meaning, and that there is more than one way in which what passed between the respondents, Austral and the lender, can be seen to answer the statutory definition of a scheme. The arrangement that the respondents might elect to have interest debited exclusively to one account was each of, an ``agreement'', ``understanding'', ``promise'' or ``undertaking'', and although the definition does not require as an element of it, legal enforceability, each was legally enforceable as such. The election as to the application of the payments also answers the description of an ``action'' or ``course of action'' within the meaning of those words in s 177A(1)(b). This was so despite that the Court said in
FC of T v Peabody
,
[61]
90. The respondents sought to emphasize, in attacking the appellant's submissions, that the election by them, or their splitting of the loan in the way in which they did could constitute a scheme, a statement of the Court in
Peabody
[63]
91. Nor is there any doubt that the respondents obtained a tax benefit under s 177C `` in connection with a scheme ''. The use of the word ``connection'' is significant. It is a word of wider import than, for example, ``result''. The benefit is obvious: a deduction from each respondent's taxable income of the whole of the interest payable in respect of a loan to finance not just the acquisition or holding of an investment property but of both it and a residence, the interest on the financing of which is not tax deductible.
92. The next question, which is of purpose, is whether under s 177D the scheme is one to which Pt IVA applies. This will, in my view, in most cases be the critical question. The answer to it, both as a matter of statutory interpretation and as the Explanatory Memorandum indicates, was intended to be the fulcrum upon which
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most Pt IVA cases will turn, because the definition of a scheme, being as wide as it is, will relatively easily be satisfied, and the presence or absence of a tax advantage will also usually be readily apparent. The Act requires that questions raised by s 177D be answered by reference to the indicia stated in the section. It is not necessary of course that every one of them be relevant to every scheme. Indeed the presence or overwhelming weight of one factor alone may of itself in an appropriate case be of such significance as to expose a relevant dominant purpose.93. The first of the indicia is ``the manner in which the scheme was entered into'' (s 177D(b)(i)). The [ wider] scheme was entered into by a transaction between arms length parties who were agreed that its manner of operation, by the making of the election, would lead to maximum tax deductibility. A narrower scheme was the election itself and payment in accordance with it, these being actions of the respondents.
94. The ``form and substance'' (s 177D(b)(ii)) of the scheme were to this end and effect: tax deductibility. It is also relevant that the scheme, however it is to be defined, was apparently tax neutral for the lender. And it was not suggested that the broker would be disadvantaged financially by the form it took. The contrary was probably the case but it is unnecessary to decide whether that is so. An aspect of the question to which s 177D(b)(ii) gives rise, is whether the substance of the transaction (tax implications apart) could more conveniently, or commercially, or frugally have been achieved by a different transaction or form of transaction. At least arguably it could have been. If it had, compound interest would have been avoided. Non-recourse by the lender to both (on default by the respondents), rather than to one of the properties only, may have been able to be negotiated. The absence of adversion by the respondents to such a consideration is itself some indication of the purpose to be inferred from the circumstances. The scheme was intended to endure for many years. Its duration had this significance. Although the debt in respect of the residence would be relatively quickly discharged, the mortgage on it would have to remain as security for the outstanding debt because of the very real chance that the sum of the principal owing on the investment property and the accumulating interest, would come to exceed the latter's value and would provide insufficient security for the debt. This, it may be observed, was a matter to which the Full Court did not have sufficient regard in identifying the respondents' dominant purpose. Each of ss 177D(b)(iii), (iv) and (vii) require that all of these matters be taken into account in determining whether Pt IVA applies.
95. From the matters to which I have referred it is easy to conclude, inevitable in fact that a court do so, that the respondents entered into a scheme for the [ dominant] purpose of obtaining a tax benefit. What other purpose or purposes could have made commercial or other sense? There was no material before the Court to show that the purchase of the investment property was in fact a good investment in the sense that even if it did not yield a rental sufficient to cover interest and other outgoings there was a reasonable chance that it would appreciate in value. Repayment of the principal owing in respect of the residence did not make it immune to recourse by the lender in the event of default or shortfall in payment or value of the investment property.
96. It may be that the respondents did wish to make an investment and to change their residence. These were entirely irreproachable and proper objectives. But the means adopted to achieve these results could readily, and should be objectively concluded to be a scheme for the [ dominant] purpose of enabling the respondents to obtain a tax benefit, and that is so no matter which of the alternative definitions as to the width of the schemes, within which what occurred here falls, is preferred.
97. I would allow the appellant's appeal. The appellant agreed that he should pay the respondents' costs in this Court in any event. The orders made by the Full Court of the Federal Court on 26 November 2002 should be set aside and the appeal to that Court be dismissed with costs.
98. Having reached this conclusion, it is unnecessary to resolve the questions which the appellant's application for special leave raises. That application should therefore be dismissed.
ORDER
1. Appellant's application for special leave to appeal on the ground set out in paragraph (2) in his draft notice of appeal filed with that application refused.
2. Appeal allowed.
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3. Set aside the orders made by the Full Court of the Federal Court of Australia on 26 November 2002 and, in their place, order that the appeal to that Court be dismissed with costs.
4. Appellant to pay respondents' costs in this Court.
Footnotes
[56][57]
[58]
[59]
[60]
[61]
[62]
[63]
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