Cranstoun v. Federal Commissioner of Taxation.
Judges:Carter J
Court:
Supreme Court of Queensland
Carter J.
The appellant during the year ended 30 June 1980 was an employed geologist. From that employment he earned the gross sum of $22,887. His only other income in that financial year was $2,017 being income from a trust and interest totalling $2,390. Included in the latter sum is the sum of $180 shown as received from A. & B. Management (No. 60) Pty. Ltd. His return for that income tax year claims a deduction in the sum of $20,446 made up as to $20,430 said to be interest on borrowed money used to produce investment and property income and as to $16 for bank charges. His taxable income was claimed to be $6,842.
The appellant's brother, David John Cranstoun, an accountant, prepared the relevant income tax return. He was an employed accountant and his employer had some kind of undefined contractual relationship with the accountancy firm Ahern Betar and Dunn. The principals of the latter firm included John Waymouth Ahern and Christopher John Betar. The firm's trust account is entitled Ahern Betar and Dunn Trust Account (``A. B. & D. Trust Account''). Messrs. Ahern and Betar were the directors of A. & B. Management (No. 40) Pty. Ltd. (``A. & B. 40'') and of A. & B. Management (No. 60) Pty. Ltd. (``A. & B. 60''). A. & B. 40 was a trustee of the Rocklea Trading Trust and on 30 June 1980 income was distributed from that source to the Ahern Investment Trust and the Betar Investment Trust. Messrs. Ahern and Betar were also the directors of Tarbet Investments Pty. Ltd. (``Tarbet'') and Betar was its secretary. The shareholders of each of these companies did not include any persons unrelated to Messrs. Ahern and Betar.
The respondent disallowed the claimed deduction of $20,430 for interest and dismissed the taxpayer's objection. He now appeals against that decision.
Before I recite the relevant facts in this appeal I should add that the evidence establishes that the series of transactions said to support the result for which the appellant contends were not unique or peculiar to him because he was only one of a large number of other persons who also sought to derive a benefit in the form of a reduced liability to pay income tax by reference to a series of transactions in the same form. In short the appellant was only one participant in a scheme which was promoted, executed and supervised by Messrs. Ahern and Betar and the employees of their accountancy firm, the sole purpose of which was to permit participants in it to obtain an income tax deduction for interest on moneys said to have been borrowed in order to produce investment and property income. It is not entirely correct to say that that was the sole purpose of the scheme. As will appear, such money as was paid by participants in the course of the operation of the scheme found its way into A. & B. 40 from whence it was distributed to the Ahern Investment Trust and the Betar Investment Trust. In that sense Messrs. Ahern and Betar were remunerated for their services. I turn now to the relevant facts.
On 24 June 1980 a cheque was drawn by A. & B. 40 (Rocklea Trading Trust) for $180,000. That cheque was signed by Ahern and was drawn in favour of A. B. & D. Trust Account. This was said to be a loan from A. & B. 40 to the appellant. The appropriate entry was made in the trust account books including the ledger account of the appellant in those books. On the same day that cheque was deposited at the National Bank of Australia Limited, Central Branch where all relevant bank accounts were kept and the appropriate debit and credit entries made. Also on the same day a cheque for $180,000 was drawn on A. B. & D. Trust Account for the same amount, namely $180,000 in favour of A. & B. 60. That cheque was likewise signed by Ahern and was said to be a loan from the appellant to A. & B. 60. That cheque was likewise deposited at the same bank and the appropriate debit and credit entries made. Again on the same day another cheque for $180,000 was drawn on the account of A. & B. 60 in favour of A. & B. 40. It likewise was signed by Ahern and again on that same date was deposited at the bank and the relevant entries made in the bank's books. I should also have mentioned that appropriate bookkeeping entries were also made in the books of A. B. & D. Trust Account, A. & B. 40 and A. & B. 60.
The process just outlined is the foundation for the appellant's case which is that on 24 June 1980 he borrowed $180,000 from A. & B. 40 and then immediately on lent that sum to A. & B. 60. The interest said to have been received and paid by the appellant as a result of those loans is included among the items of income and expenditure which the appellant returned to the respondent. The sum of $180 is the amount referred to earlier as being income received by
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way of interest from A. & B. 60. The claimed deduction includes the sum of $20,430 said to have been paid by way of interest to A. & B. 40 in respect of the loan of $180,000 made by the latter to the appellant so that the latter could on lend that sum to A. & B. 60 in order to produce the investment income, namely $180. It is hardly necessary for me to emphasise the circular nature of the process which is said to involve the movement of $180,000 between the parties supported as it is by the documentation created in the office of Ahern Betar and Dunn and at the National Bank of Australia Limited.On the same date, 24 June 1980, the appellant and A. & B. 40 executed a document which is described as the loan agreement relating to the borrowing by the appellant of $180,000 from A. & B. 40. I will refer to this and related documents later. It is sufficient to mention at this stage that the terms of the agreement gave to the borrower the right at his option to pay to the lender the interest in advance with a provision for a sliding interest rate depending upon when the interest was paid, e.g. if the interest was paid ``on or before the date'' of the agreement the rate was 10%; if it was paid on or before 30 June 1980 the rate was 12%. The whole of the interest payable by the appellant to A. & B. 40 was calculated to be the sum of $20,430. That is, the sum claimed by the appellant as a deduction. It is said that it was paid by the appellant to A. & B. 40 on 26 June 1980. I turn then to the process involved in the payment of this sum which is said to be the relevant interest payment.
On 26 June 1980 the appellant paid to Ahern Betar and Dunn from his own funds the sum of $2,250. That was credited to him in his account in the A. B. & D. Trust Account. Betar's evidence was that this sum was paid ``to fund the interest'' payable to A. & B. 40. On the same date Tarbet lent to the appellant the sum of $18,180. It will be recalled that Tarbet was another Ahern and Betar company and Betar was its secretary. The addition of the two sums mentioned is the sum of $20,430, the amount payable to A. & B. 40. I pause to mention that the $2,250 contributed by the appellant was the sole cash contribution to the scheme by any of the participants in it. It was paid by the appellant's own cheque drawn on his account at the Bank of New South Wales, Fortitude Valley. Both cheques, i.e. the appellant's cheque and the cheque drawn by Tarbet on its account at the National Bank of Australia Limited were on 26 June 1980 by the same deposit, credited to the account of A. B. & D. Trust Account. On the same day a cheque for $20,430 was drawn on A. B. & D. Trust Account in favour of A. & B. 40, that being the amount of prepaid interest and on that same day it was deposited to the credit of A. & B. 40 at the National Bank. Again on 26 June 1980 a cheque was drawn by A. & B. 40 in favour of Tarbet and on the next day, 27 June 1980, that cheque was deposited to the credit of Tarbet at the bank. Again in the case of each transaction appropriate entries were made in the various books of account and at the bank. The result of the last transaction was that the sum of $18,180 had also moved in a circular fashion but the balance amount, namely $2,250 had been left in the account of A. & B. 40, the trustee of the Rocklea Trading Trust. That amount, along with others, was on 30 June 1980 then distributed to those beneficially entitled to it including the Ahern and Betar Investment Trusts.
Finally, there remains to be seen the process whereby the appellant repaid to Tarbet the sum of $18,180 said to have been borrowed by the appellant to enable the prepayment of the interest to A. & B. 40. I pause also to mention that that loan from Tarbet to the appellant was interest free.
On 1 July 1980 a cheque was drawn on A. B. & D. Trust Account in favour of Tarbet for $18,180. The appellant's ledger account was debited with that sum which is said to be the repayment by the appellant to Tarbet of the amount borrowed interest free to permit prepayment by the appellant of the interest due to A. & B. 40. In theory it would mean that such a payment would result in his account in the A. B. & D. Trust Account being overdrawn. However, that consequence was avoided by reason of what is said to be a payment, on the same day by A. & B. 60, to the appellant of interest in respect of the borrowing by A. & B. 60 of the sum of $180,000 from the appellant. It will be recalled that on 30 June 1980 the appellant's ledger account had been credited with the receipt of $180 being interest on the loan received in that year. The sum of $18,000 said to have been paid by A. & B. 60 on 1 July 1980 supplemented the earlier receipt thereby permitting the payment to Tarbet. I should add that the evidence discloses that the payment on 1
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July 1980 by A. & B. 60 to A. B. & D. Trust Account was not for $18,000 only. The cheque in question is for the sum of $487,000 of which the $18,000 in question is said to be a part. The larger amount was a lump sum payment to cover similar payments in respect of some of the other participants in the scheme. There only remains to observe the process whereby A. & B. 60 was reimbursed for the payment of $18,000 interest to the appellant (and to many others).Also on 1 July 1980 there was paid to the credit of A. B. & D. Trust Account a cheque drawn by A. & B. 60 for $4,870. Betar's evidence is that that probably relates to ``another client who was just omitted from the bulk cheque''. On the same day also, a cheque for $491,870 (the sum of $487,000 and $4,870) was drawn on the account of Tarbet in favour of A. & B. 60 and deposited to its credit thereby completing again the circular process and insuring that all relevant accounts were balanced.
Certain features of the whole process can now be summarised.
- 1. All of the corporate participants in the process described above had the same directors, namely Messrs. Ahern and Betar.
- 2. These same persons maintained and operated the A. B. & D. Trust Account.
- 3. As a result of the series of circular transactions in which it is said that money was lent and repaid, none of the corporate participants were in the end advantaged or disadvantaged except that there was a resultant surplus in A. & B. 40 of $2,250 that being the same amount and the only amount contributed by any person to the scheme other than the Ahern and Betar companies. A. & B. 40 was the trustee of the Rocklea Trading Trust and included among those beneficiaries entitled under that trust was the Ahern Investment Trust and the Betar Investment Trust.
- 4. There was nothing before me which evidences any contractual arrangements between A. & B. 40 and A. & B. 60 as to the movement of $180,000 from the latter to the former nor in relation to the movement of $18,180 from A. & B. 40 to Tarbet on 26 June 1980 nor in relation to the movement on 1 July 1980 of $491,870 from Tarbet to A. & B. 60.
- 5. The only person who suffered any immediate financial disadvantage was the appellant who had contributed to the scheme $2,250 from his own funds but at the end of the process there is said to have accrued in his favour a tax deduction in the sum of $20,430.
Before I pass to the so-called loan agreements I should state my finding that the sum of $2,250 was paid by the appellant as a fee for services rendered by the firm Ahern Betar and Dunn and that that amount went to swell the funds available for distribution on 30 June 1980 to those beneficially entitled under the Rocklea Trading Trust of which A. & B. 40 was the trustee.
I should have indicated earlier that moneys said to have been paid or received on behalf of the appellant by or into the A. B. & D. Trust Account were supported by written authorities signed by the appellant and dated 24, 26 and 30 June 1980 respectively.
The agreement which is dated 24 June 1980 and which is said to evidence the loan of $180,000 from A. & B. 40 to the appellant (exhibit 36) provides for a term of 50 years. I have referred already to the varying rates of interest available if interest is paid in advance. I will set out in full the terms of clauses 4.5 and 4.6:
``4.5 Where the Borrower invests the Principal Sum by lending it whether at interest or otherwise then the Principal Sum shall only be repayable by the Borrower to the Lender if and when the Borrower receives repayment on account of the said investment and the Lender shall not be entitled to enforce its right of repayment of the Principal Sum until that event has occurred and then only to the extent of the money received by the Borrower and the Lender's right to sue upon the personal covenant of the Borrower to repay the Principal Sum is limited accordingly.
4.6 Where the Borrower invests the Principal Sum by lending it to a third party whether at interest or otherwise and that third party thereafter defaults in payment of any interest due to the Borrower theron then from the time of such default by the third party the Borrower shall not be bound to pay to the Lender interest due to the Lender hereunder and the Lender shall not be
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entitled to enforce any of its rights under this Agreement with respect to the repayment of the Principal Sum or payment of interest hereunder except to the extent of interest received by the Borrower from the third party on account of the aforesaid investment of the Principal Sum lent by the Borrower to the third party and the Lender's rights to sue on the personal covenant of the Borrower to repay the Principal Sum and pay interest thereon is limited accordingly.''
A reading of these clauses immediately excites, I believe, the justifiable comment that their content is extraordinary even giving full reign to the right of parties to contract as they will. The sum lent to the appellant by A. & B. 40 was $180,000, a not inconsiderable sum of money. If the appellant on lent that sum to another then the principal sum was only repayable by the appellant and indeed only recoverable by A. & B. 40 if and when and only to the extent that the loan to the third party was repaid to the appellant. That is the effect of cl. 4.5. Clause 4.6 in effect means that if the sum of $180,000 is lent to a third party and the latter defaults in the payment of interest, then from the time of that default the appellant is relived of his obligation to pay interest to A. & B. 40 and the latter is prohibited from enforcing any of its rights under the agreement with respect to repayment of the principal sum or of interest.
The second agreement which is also dated 24 June 1980 is said to evidence the loan by the appellant to A. & B. 60 of the sum of $180,000. It is, for all practical purposes, an agreement of the same kind. The third agreement is dated 24 June 1980 (exhibit 62) and is made between Tarbet and the appellant. The principal sum is said to be $18,180 which, it will be recalled, was the part of the amount of interest payable to A. & B. 40 and which, together with the appellant's contribution of $2,250 is the amount of the claimed deduction. By the agreement Tarbet agreed to lend the appellant that sum on or before 30 June 1980. It was an interest free loan and was repayable on 1 July 1980. Clause 4.4 is in the following terms:
``4.4 The parties hereto acknowledge that the Borrower has entered into a loan agreement with A. & B. Management (No. 60) Pty. Ltd. dated 24th June, 1980 and the parties agree that the Borrower shall only be liable to make the payment referred to in clause 4.2 above out of the interest paid to the Borrower by A. & B. Management (No. 60) Pty. Ltd. under the aforesaid loan agreement on 1st July, 1980 AND the Lender shall not be entitled to treat a failure on the part of the Borrower to make in full or in part the instalment due as a default entitling the Lender to enforce its right of repayment of the Principal Sum under this Agreement and the Lender's right to sue upon the personal covenant of the Borrower to repay the Principal Sum is limited accordingly.''
The first and second agreements referred to above are made more intelligible by evidence given by Betar in cross-examination. The evidence elicited from him was that the agreements were all pre-prepared, having been prepared by a solicitor who was not the appellant's solicitor, but more importantly cross-examination on the agreements elicited the following:
``Did it occur to you that the proposed lender of money here, A. & B. Management (No. 40), was running a great risk of never being able to recover money as principal or as interest? - Well, that's not necessarily correct, is it?
Is it not? - That presumes A. & B. (No. 60) wasn't able to repay its loans.
No, it does not say that. It doesn't say...? - Paragraph 4.5?
In paragraph 4.5, where does it say - I don't see it mention A. B. 60 there? - No but that's the entity that borrowed the money from the borrower.
But somebody executing this agreement might have lent the money to anybody, the first man he met in the street. He could have done whatever he liked with it. This does not oblige him to lend it to A. B. 60? - No, it does not.
Was that the understanding, that really that is to whom he had to lend it? - Yes.
So, although not recorded here, it was part of the agreement that he must lend the money to A. B.? - He would not have been able to borrow the money from A. B. 40 if he didn't lend it to A. B. 60.''
Therefore, those features of the agreement which prima facie can only be described as curious are thereby revealed as an integral part
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of the whole scheme. The documentation was obviously drawn in the terms in which it was to fit in with the process of circular transactions said to be evidenced by the drawing of the cheques and the consequential bookkeeping. In short, it was of the essence that it be made to appear that commercial transactions between parties at arm's length were underway but from the evidence of Betar it is plain that the execution of the agreements by the appellant was simply the means of providing the base to support the circular process, involving as it did the alleged transactions between the appellant, Ahern and Betar controlled companies and between the companies themselves. The fact that the agreements contain these unusual terms is in the final result of no moment because I find that there would never have arisen a situation which would have called for their operation. The borrowing from A. & B. 40, the on lending to A. & B. 60 and the borrowing of the interest component from Tarbet, which are all evidenced only by book entries and the use made of the banking system, could never have called for the application of the clauses referred to because it was integral to the scheme that there was never a prospect of default. The bookkeeping took care of that.The appellant himself did not give evidence although his availability was established. The only evidence of substance was that of Betar who was heavily involved in the scheme not only in so far as it related to the appellant but also to many others. Relevant evidence might have been given by the appellant but it was not. Evidence as to his intention in executing the agreements, whether the documents were intended by him to have any and if so what legal effect between himself and the various companies, the basis for his contribution of $2,250, his state of knowledge about the so-called loan transactions, the basis for the authorities signed by him involving the use of the A. B. & D. Trust Account, the nature and extent of his relationship with the firm Ahern Betar and Dunn, are only some of the matters about which he might have been asked. In summary, questioning of him might have elicited whether he was in truth entering into legally effective loan transactions for the purpose of gaining or producing assessable income or whether he merely signed documents as directed, and having paid into the trust account of Ahern Betar and Dunn a fee for services, then allowed others to do the bookwork which would ultimately entitle him to claim a tax deduction of $20,430. Findings of fact, to the extent that they have to be made, must be made in the absence of evidence from the person whose liability for income tax is in issue. He was the only person who could give direct evidence of relevant matters and ``[if he] prefers the well of the court to the witness box a court is entitled to be bold''. (Per Rich J. in
Insurance Commissioner v. Joyce (1948) 77 C.L.R. 39 at p. 49.)
I make the following findings:
- A. & B. 40, A. & B. 60 and Tarbet were companies controlled by Messrs. Ahern and Betar.
- 2. There was no outgoing incurred by the appellant in gaining or producing assessable income.
- 3. The payment of $2,250 by the appellant was a fee paid by the appellant to Ahern Betar and Dunn; firstly, for the right to participate in the scheme, secondly, for the right to have the use of Ahern and Betar controlled companies and thirdly, for the necessary bookkeeping required to support the scheme.
- 4. The sole purpose of the scheme was to avoid liability for income tax which was payable.
- 5. The process of circular transactions involving as it did the use of the banking system and the consequential bookkeeping, in its totality, did not have any element of commercial reality within it but was a mere use of the commercial fabric to contrive a result, namely, an alleged tax deduction the quantum of which could be made to suit the particular position of the client by adjusting the size of the alleged borrowings.
- 6. The written documents, including the agreements, authorites, minutes of meetings and books of account were not intended to evidence transactions between parties at arm's length having legal efficacy.
- 7. The so-called loan agreements, themselves supported as they were by the necessary domestic requirement of the scheme that the sum borrowed had to be seen to be on lent to another Ahern and Betar company, A. & B. 60, did not evidence and were not intended by the parties thereto to evidence in fact legally binding and
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enforceable contracts made between parties at arm's length and after negotiation on such matters as the rates of interest, the terms of the loan and the provisions for repayment, nor were they intended to create in fact a real legal relationship.
The first question is whether the alleged transactions were a sham. In
Snook v. London & West Riding Investments Ltd. (1967) 2 Q. B. 786 at p. 802 Diplock L.J. said:
``As regards the contention of the plaintiff that the transactions between himself, Auto Finance and the defendants were a `sham', it is, I think, necessary to consider what, if any, legal concept is involved in the use of this popular and pejorative word. I apprehend that, if it has any meaning in law, it means acts done or documents executed by the parties to the `sham' which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intended to create. But one thing, I think, is clear in legal principle, morality and authorities (see
Yorkshire Railway Wagon Co. v. Maclure (1882) 21 Ch. D. 309 and
Stoneleigh Finance Ltd. v. Philips (1965) 2 Q.B. 537), that for acts or documents to be a `sham', with whatever legal consequences follow from this, all the parties thereto must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating.''
If two persons sign a document which on its face purports to be a loan agreement evidencing a loan from one to the other for $180,000 but it is agreed either expressly or impliedly that the document is intended to give the appearance only of a loan transaction then it is, in my view, a sham; it is something devised to delude, it is a trick or a hoax, an imposture, it is something that is intended to be mistaken for something else, it is not really what it purports to be, it is a spurious imitation or a counterfeit (The Oxford English Dictionary, Vol. IX, p. 615). However one defines it, it is in law nothing, nor, in my view, can it be elevated to be something which the law will recognise and enforce merely because documents which are drawn in legal language appear, a series of bookkeeping entries is made and extensive use made of the banking system involving debits and credits of the order of hundreds of thousands of dollars. No amount of professional ingenuity will make the agreement into what in fact it is not if the parties do not so intend. Parties who execute an agreement in such circumstances are, of course, always at risk if one person later seeks to abandon the earlier common intention. But there could be no such risk in this case. The appellant was anxious to maintain the appearance for his own financial benefit nor was there any likelihood that the directors of A. & B. 40, A. & B. 60 or Tarbet would take decisions adverse to the appellant because the terms of the agreements precluded that and in any event the success of the whole device required that there be no default and, as I observed earlier, the bookkeeping took care of that.
In my view the alleged loan transactions were shams as defined by Diplock L.J. in Snook's case.
It was argued that the scheme was fiscal nullity and therefore legally ineffective in providing the appellants with a permissible deduction under sec. 51(1):
W.T. Ramsay Ltd. v. I.R. Commrs. (1982) A.C. 300. There has been competing judicial points of view both in this country and elsewhere as to whether the principle is applicable to the Australian income tax legislation because of the provisions of sec. 260 of the Act. In view of the remarks of Gibbs J. in
F.C. of T. v. Patcorp Investments Ltd. 76 ATC 4225 at p. 4232; (1976) 140 C.L.R. 247 at p. 292 and of the Full Federal Court of Australia in
Oakey Abattoir Pty. Ltd. v. F.C. of T. 84 ATC 4718, I will deal no further with the point except to say that, were the concept of fiscal nullity part of Australian revenue law, I would be prepared to find that the above arrangement was a fiscal nullity.
That brings me to the submission that the scheme was an arrangement which, because of the provisions of sec. 260, is void as against the Commissioner. If I am wrong in my conclusion that the loan agreements were a sham I am nonetheless satisfied that the arrangement as outlined was one caught by the section and is therefore void against the Commissioner. The scheme as outlined bears ``the stamp of tax avoidance'': per Bowen C.J. in
Gulland v. F.C. of T. 84 ATC 4587 at p. 4590. In Oakey Abattoir Pty. Ltd. v. F.C. of T. at pp. 4729-4730 the Full Federal Court said of the scheme there in question:
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``But we think that the present case should be viewed with the wider perspective that the payment of interest was merely one step in a circuitous series of transactions which bore `ex facie the stamp of tax avoidance' (Gulland v. F.C. of T., 84 ATC 4587 per Bowen C.J.). To borrow the language of Bowen C.J. in Gulland (supra) this taxpayer did not merely, as in Cridland, `create a situation by entry into a transaction' to attract particular tax consequences. Given its complexity, its artificiality, its circular operation and its sole purpose of avoiding liability to tax, the arrangement in this case goes well beyond a mere entry into a transaction such as a university student buying units in a trust. In our view sec. 260(1)(c) is applicable to such an arrangement.''
In my view the case before me is of a like kind to that dealt with by the Full Federal Court in Oakey Abattoir Pty. Ltd. v. F.C. of T. and I am unable to distinguish it by reference to any material facts. Therefore, the remarks of the Full Court just cited are applicable to it. Following as I must the decision of the Full Federal Court I therefore hold that the arrangement described is caught by sec. 260 and that therefore the Commissioner was entitled to assess as he did.
In the result in my view the appeal should be dismissed with costs.
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