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Case X90

Members:
IR Thompson DP

Tribunal:
Administrative Appeals Tribunal

Decision date: 2 November 1990.

I.R. Thompson (Deputy President)

The application in these proceedings is for review of a decision made by the respondent in August 1989 in respect of four objections made by the taxpayer under sec. 185 of the Income Tax Assessment Act 1936 (``the Act'') against amended assessments issued under sec. 170 of the Act in respect of the 1984-1987 taxation years. At the request of the applicant those objection decisions were referred to the Administrative Appeals Tribunal under sec. 189 of the Act; by virtue of subsec. (2) of that section the referral is deemed to be an application to the Tribunal for review of the objection decisions.

2. At the hearing of the deemed application the taxpayer was represented by Mr A.J. Kelly, of counsel, and the respondent by Mr P.J. Cosgrave, of counsel. Numerous documents were tendered in evidence. In addition the taxpayer and D, who was the general manager of a company, Z Co., for whom draughting work was done by the taxpayer in each of the taxation years, gave oral evidence.

3. In each of the four years the taxpayer performed the work but payment for it was made by Z Co., to a company, A Co., which was trustee of the taxpayer's family trust. Apart from a very small amount, less than $10, the moneys paid for the work done by the taxpayer constituted the whole of the income of the trust in each of the years. After deduction of an amount said to represent the amount of general expenses of the trust, the trustee distributed the whole of its net income each year to the taxpayer, his wife and his three children. In his income tax return for each of the years the taxpayer stated no income from salary or wages but inserted the amount of income distributed to him by the trust in the box appropriate to show income received as a beneficiary under an instrument of trust. Assessments were issued in accordance with his returns.

4. However, in February 1989 amended assessments were issued in respect of all four years; they treated as the taxpayer's personal income the whole of the amount paid by Z Co. for the draughting work he performed. In the

ATC 650

statement of the respondent's reasons for his objection decisions he said that the assessments were amended because the respondent decided to cancel, pursuant to sec. 177F(1) of the Act, what he regarded as a ``tax benefit''; that section is included in Pt IVA of the Act and the meaning of ``tax benefit'' is to be ascertained by reference to sec. 177C. However, in the statement the respondent asserted also that there was a scheme which was struck down by sec. 260(1) of the Act. At the hearing of the application Mr Cosgrave argued in the alternative that either there was a ``scheme'', as defined in sec. 177A, to which sec. 177D applied or that there was an arrangement which sec. 260 rendered void against the respondent. The reason why the submission was made in the alternative was because of the dates on which various events had occurred. Section 260 does not apply to an arrangement made or entered into after 27 May 1981; by virtue of sec. 177D, Pt IVA applies only to schemes entered into after that date.

5. The taxpayer gave evidence of his qualifications as a draughtsman and of the circumstances in which he performed work as such from the time when he started as a trainee at the age of 19. From his evidence I am satisfied of the following facts. Immediately after completing his training the applicant was employed by Y Co. as a detail draughtsman for four years. At the end of that time he continued to be employed by that company but as a design draughtsman; that was a promotion. He prepared designs of industrial equipment. In 1969 and 1970 he took one year's working holiday away from Y Co. but at the end of that period he returned to his employment with it. He remained as an employee until September 1976, by which time he had become a leading design draughtsman; in that capacity he supervised the work of other draughtsmen as well as doing draughting work himself. At some time before 1976 Y Co. was taken over by another group of companies. Both before and after the take-over Y Co. had eight to ten draughtsmen working for it; about half were employees of Y Co. and the others performed their work as independent contractors. In 1976, after consulting his accountant, B, the taxpayer formed a business partnership with his wife, registered a business name for the business of the partnership, opened a bank account in the name of the partnership and arranged with Y Co. that he should forthwith cease to be an employee and work instead as an independent contractor on behalf of the partnership, from the following day onward.

6. The taxpayer's work remained as it had been before. He still did such work as the chief draughtsman allocated to him; but he no longer enjoyed the benefits of being an employee, such as paid leave. The amount of money paid to the partnership for his services was greater than the amount of the salary which had been paid to him as an employee. The only business carried on by the partnership was the provision of draughting services; all the draughting work was done by the taxpayer, as his wife was not a trained draughtsman and the partnership did not employ any other person to do draughting work. Neither the taxpayer nor the partnership was required to find another person to do his work when he was not available. The taxpayer rendered invoices to Y Co. in the name of the partnership. A book was maintained in which cash receipts of the partnership were entered. In 1977 the company which had taken over the business of Y Co. was merged with another company; thereafter the business formerly carried on by Y Co. was carried on by the new company in its own name. Consequently, from April 1977 until April 1978 the invoices were addressed to that company. In 1978 that company ceased to operate in Melbourne; some months before doing so it informed the taxpayer that no further work was available to the partnership.

7. The taxpayer was then approached by D, who had previously been an employee of Y Co. and had left it in order to set up his own business. He had established a company, Z Co., to operate the business. D invited the taxpayer to perform work for Z Co. on behalf of the partnership. Consequently, immediately after ceasing to do work for the successor of Y Co., he began to do work for Z Co. As he had done with Y Co. and its successors, he issued invoices in the name of the partnership regularly and payments were made by Z Co. to the partnership. That continued until March 1981. Throughout the time that the payments were made to the partnership by Y Co. and its successors and by Z Co., those payments were for all practical purposes the only income of the partnership. The net income of the partnership each year was divided equally between the taxpayer and his wife and each declared the

ATC 651

amount of that half-share of the net income in his or her income tax returns and was assessed accordingly.

8. In March 1981, after obtaining further advice from his accountant, B, the taxpayer decided that a family company should be incorporated and a discretionary family trust created. After he had discussed the matter with his wife that was done. He then informed D that in future his services as a draughtsman would be provided to Z Co. by A Co. and not by the partnership. Invoices were issued in the name of A Co. and were treated by A Co. as income of the family trust. At the end of each taxation year the accounts of the trust were prepared by the accountant, B, from the books of A Co. B also advised the applicant and his wife on what he considered should be the amount distributed by the trustee to each of them and to each of their three children. Although minutes were prepared recording that the directors of A Co. had resolved to distribute the net income of the trust in accordance with what B recommended, no meetings were in fact held and neither the taxpayer nor his wife knew on what basis B had recommended distribution of particular amounts to particular beneficiaries; they simply accepted his recommendations. Further, the amounts shown in the trust accounts as having been distributed to beneficiaries in accordance with the minutes of the meetings were not actually paid to them. Nor were cash payments made to the taxpayer and his wife of the precise amounts shown in the trust accounts; rather, as directors of A Co., the trustee, they used the trust moneys as required from time to time to meet household and other expenses of the family's daily living. There was no written agreement between the taxpayer and A Co. for A Co. to employ him. He was not paid a salary but, as stated in his income tax returns, simply received a distribution of the income of the trust.

9. Neither the partnership nor A Co. acquired any substantial assets other than a very few items of equipment used by the taxpayer for performing his draughting work, such as a draughting board, pens and a calculator, and a motor car which he used to travel from home to the premises of the company for whom the draughting work was done and in which he travelled also occasionally to visit clients of those companies when that was required. Apart from those occasional visits to clients, his work was performed at the premises of Y Co., its successors and Z Co. The taxpayer, the partnership and the family company did not pay any rent to any of those companies either for the premises in which the work was done or for equipment provided by them for use in doing the draughting work. Apart from the fact that there was slightly greater flexibility in his working hours, the companies' requirements in respect of the performance of the draughting work were similar to what they required of their employees.

10. In July 1981 Z Co. was acquired by a large public company and a subsidiary of that company was made responsible by it for operating the business which Z Co. had operated. Subsequently, another subsidiary took over that role. The taxpayer continued to do work for those companies; any reference to his doing work for Z Co. is intended to included reference to his working for those successors of Z Co.

11. In April 1983 the subsidiary which was running the business insisted that all persons doing draughting work for it should work as its employees and not as independent contractors. One of the persons who had been doing draughting work as a contractor declined to become an employee and left. However, the taxpayer decided to remain and to work as an employee. He did so until September 1983. However, he was not happy at the change; although as an employee he was entitled to the benefits of employment such as paid leave and a leave loading, the amount of cash paid to him as his salary was considerably less than the amount which had been paid to A Co. for the work when he had done it as a contractor. He, therefore, looked for opportunities to work elsewhere. By then his ability and experience as a draughtsman were recognised by D as above average; it seems that they were also so recognised by the principal competitor of Z Co., which offered the taxpayer employment at a salary considerably higher than that which was being paid to him by Z Co. He, therefore, gave notice to D of his resignation.

12. D was extremely concerned at the prospect of losing the taxpayer's services, particularly as he would be providing them to the competitor. With considerable difficulty he managed to persuade the parent company to agree to his offering the taxpayer an

ATC 652

opportunity to continue to work for Z Co. not as an employee but through his family company as an independent contractor. The taxpayer agreed to continue to work for Z Co. on that basis. Thereafter he continued to do draughting work for Z Co. under the same arrangements as had existed before he had been obliged in April 1983 to become an employee. That situation ended, however, in July 1988, when he was offered and accepted employment by another company in what he described as ``a staff position''. In that employment he was provided with a motor vehicle by his employer and was able to participate in the employer's superannuation scheme. In addition, he was paid an attractive salary and, of course, was entitled to the usual benefits of employment such as paid leave and payment of a leave loading. He regarded the remuneration package as more advantageous than the payment of A Co. of the amount that was previously being paid to it by Z Co.

13. The taxpayer gave evidence of the reasons why he and his wife established the partnership in 1976. He said that his wife was no longer working; she had previously been doing so but had recently had a child. The taxpayer said that he felt that, if the partnership were established, they might be more secure and that it would be better for them as a family unit. He said that the partnership business was intended to ``further my career''. There was no need for any substantial capital as very few assets were needed for the business. When the circumstances in which the partnership was established are viewed objectively, there can, in my view, be no doubt that the purpose of establishing it was to enable the taxpayer to obtain for his work payment in cash of the equivalent of his former salary and the employee benefits and then to split that total income between himself and his wife so as to reduce the amount of income tax payable from what it was when he was an employee. In coming to that conclusion I regard it as significant that his wife had only recently ceased to earn income herself, that the work done by the taxpayer remained substantially the same as before its establishment and that no attempt was made to expand the business in any way; the creation of the partnership did nothing to ``further his career''.

14. The taxpayer gave evidence also of the reasons why A Co. was incorporated and the trust established. Giving evidence-in-chief he said that he felt that to establish the company would lead to expansion of the business by giving the business a higher profile. It was incorporated after he had sought B's advice; as a result of that advice he understood that there would be some tax benefit but, he said, he thought that it would not be significant. He said that he anticipated that the company would be a vehicle to provide for estate planning and to ``better order affairs of the family in the long term as to assets and business''. He said that he had learned of trusts from other persons who were working on contract.

15. When cross-examined, he said that he could not recall what B had said were the advantages of incorporating the company and establishing the trust. He said that he had been nervous of the legal liability of the partnership for negligence and that he thought that, if the business was to succeed, it could do so better if there were a company. He said that he wanted capacity to expand the business; however, he acknowledged that he had had no problems operating through the partnership. He said that D had not required the incorporation of a company or the establishment of a trust. He admitted that initially the main benefit of establishing the trust was the advantage which it gave for distributing income to his children. Finally, when asked in cross-examination what had been the main reason for incorporating the company, he said that it had been to benefit the whole family and to give an opportunity to his children to be employed by it.

16. Again, when the evidence is examined objectively, there can be no doubt, in my opinion, that the dominant purpose for incorporating A Co. and establishing the trust was to reduce still further the income tax which was payable in respect of money paid for the taxpayer's services, already substantially reduced by the earlier formation of the partnership and the arrangements for the work to be performed on its behalf. It enabled the income from the work done by the taxpayer to be distributed between himself, his wife and his three children instead of being divided only between himself and his wife.

17. Under cross-examination the taxpayer gave evidence that, when he ceased to work as an employee for Z Co. and again provided his services under contract through A Co., he

ATC 653

maintained the ``family trust structure which was designed to benefit my family''. He acknowledged that up to that time and subsequently neither he nor A Co. had sought opportunities to expand the business. When the circumstances of his again providing his services on contract are viewed objectively, there is no doubt, in my view, that the dominant purpose of his doing so through A Co. as trustee of the discretionary family trust was to reduce the amount of tax which he had been liable to pay in respect of his income from his salary as an employee, and to do so by being able to distribute the income between himself, his wife and his children for taxation purposes. I regard it as significant that he had had an opportunity to work for another company as an employee at a higher salary than that which Z Co. had been paying him and that he adduced no evidence that the total pre-tax value of the salary offered by that company and of the usual employee benefits that he would have enjoyed if he had taken up that employment was less than the amount which Z Co. paid for his services from September 1983 onwards when he did his work for it on a contract basis.

18. It is unnecessary to set out here the provisions of sec. 260 of the Act; they have been considered by the courts on many occasions. What has to be stressed, however, is that the section does not apply to ``any contract, agreement or arrangement made or entered into after 27 May 1981''. In light of decisions of the High Court of Australia and the Federal Court, notably
Tupicoff v. F.C. of T. 84 ATC 4851; (1984) 56 A.L.R. 151 and
F.C. of T. v. Gulland 85 ATC 4765; (1985) 62 A.L.R. 545, there can be no doubt that, on the basis of the facts which I have found, if the arrangement which resulted in the payment for the taxpayer's work in the 1984, 1985, 1986 and 1987 taxation years being made to A Co. as trustee of his discretionary family trust was made or entered into before 28 May 1981, sec. 260 is applicable to it. The arrangement cannot be explained as ordinary business or family dealings. Its purpose and effect was to alter the incidence of income tax payable on income derived from personal exertions. The ``choice principle'' is inapplicable because the arrangement did not of itself grant a tax benefit by reason of a specific provision of the Act but merely attempted to divert income from the taxpayer to others.

19. However, although in September 1983 the taxpayer made use of A Co. and the discretionary family trust when he ceased to work as an employee and began to work again on a contract basis, the opportunity to do so arose only at that time. Section 260 had no doubt been applicable to avoid as against the respondent the arrangements which led to the splitting of the income from the taxpayer's personal exertions in the years from 1977 to 1983, even though the respondent failed to take action to avoid them. But in September 1983, although the taxpayer took advantage of action taken in earlier years which had formed part of the arrangement to which sec. 260 applied, the new opportunity to use them led to the commencement of a new scheme at that time. Consequently, in my view, sec. 260 is not applicable to that new arrangement.

20. It is, therefore, necessary to consider whether the provisions of Pt IVA of the Act are applicable, that is to say whether the taxpayer obtained a tax benefit in connection with a scheme and, if he did, whether it was a scheme to which that part applied so as to entitle the respondent to determine that the income received by A Co. for the work done by the taxpayer for Z Co. is to be included in the taxpayer's assessable income.

21. ``Scheme'' is defined in sec. 177A(1) as meaning, inter alia, a course of action or a course of conduct. In the present case the course of action or course of conduct was the change from the status of employee with Z Co., the rejection of the offer of employment by the other company at a higher salary and the continuation of work for Z Co. on a contract basis through A Co. as trustee of the discretionary family trust.

22. So far as is relevant in these proceedings, sec. 177C(1) is as follows:

``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

    ATC 654

    assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out; or
  • ...

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
  • ...''

23. Mr Kelly submitted that the taxpayer had not obtained a tax benefit in connection with the scheme in the present case because, if D had not offered him the opportunity to work on that contract basis, he would not have continued to do work for Z Co. No amount would have been paid by Z Co. to A Co. Consequently the amount actually paid would not have been included, and could not reasonably have been expected to have been included, in the taxpayer's assessable income if the scheme had not been carried out. However, cases such as
Bunting v. F.C. of T. 89 ATC 5245 and
Daniels v. F.C. of T. 89 ATC 4830, both cases in which stress was laid on the general rule that income from personal exertions is assessable in the hands of the person who earned it by those personal exertions, make it clear that regard has to be had to the whole of the circumstances which existed before the particular course of action was embarked on and not merely the situation which existed at the time when the taxpayer began to embark on it. I have no doubt that the taxpayer obtained a tax benefit in the present case in connection with the scheme and that the tax benefit was that more than half of the amount which was paid by Z co. to A Co. for the taxpayer's work was not included in his assessable income.

24. Section 177D specifies the circumstances in which Pt IVA applies to a scheme. It is as follows:

``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 sub-paragraph (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 sub-paragraph (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 of other taxpayers each

    ATC 655

    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).''

25. The requirement of para. (a) of sec. 177D is met in this case, as the taxpayer obtained a benefit in connection with the scheme. I have already made findings of fact as to the manner in which the scheme was entered into and as to its form and substance. There is no doubt that, but for Pt IVA, the scheme would have achieved the result that the income from the personal exertions of the taxpayer in doing work for Z Co. would not have been his assessable income but would have been the assessable income of A Co. as trustee of the discretionary family trust; as a result of resolutions passed by the taxpayer and his wife as directors of A Co., the income would have been distributed to the taxpayer, his wife and their children so that the total amount of the tax payable in respect of it would have been considerably less than the tax for which the taxpayer would have been liable if it had been his assessable income. The scheme changed the financial position of the taxpayer so that he did not receive the money paid by Z Co. for his work as his own assessable income. When all those matters are viewed objectively, I am satisfied that it must be concluded that the taxpayer entered into and carried out the scheme for the purpose of enabling him to obtain the tax benefit in connection with it.

26. In the respondent's delegate's statement of his findings on material questions of fact made under sec. 37 of the Administrative Appeals Tribunal Act 1975 he has stated that the amended assessment was made pursuant to sec. 177F(1) of the Act. Where a tax benefit has been obtained, that subsection empowers the respondent to determine that the whole or a part of the amount not included in the assessable income of the taxpayer is to be included in his assessable income. Having found that there was a scheme which was entered into after 27 May 1981, that the taxpayer obtained a tax benefit in connection with it and that it was a scheme to which Pt IVA applied, I am satisfied that the Commissioner had the power to determine pursuant to sec. 177F that the whole of the amount that had not been included in the taxpayer's assessable income for each of the four years was to be included in it and that in all the circumstances the making of that determination was the preferable decision. Consequently, although there is no formal statement in the sec. 37 statement and no document has been tendered in evidence which is formally expressed in terms of a determination having been made, the fact that the amended assessment was made ``pursuant to section 177F(1)'', when considered in light of the omnia praesumuntur rule, is, I am satisfied, evidence that a determination was made. In any event, if the determination was not made by the respondent the Tribunal now has power to make it (see
Fletcher & Ors v. F.C. of T. 90 ATC 4559) and in affirming the objection decisions the Tribunal does so. Accordingly, the amendment of the original assessments so as to include in the taxpayer's assessable income the whole amount that was paid by Z Co. to A Co. in respect of his work for Z Co. as a draughtsman in each of the years of income was correct.

27. Mr Kelly submitted that, when the Tribunal construed the provisions of Pt IVA, it should have regard to the Treasurer's speech in the House of Representatives on the second reading of the Income Tax Laws Amendment Bill (No. 2) 1981, which amended the Act by adding Pt IVA to it. Undoubtedly, the Tribunal has power, pursuant to sec. 15AB of the Acts Interpretation Act 1901, to give consideration to any material not forming part of the Act which is capable of assisting in the ascertainment of the meaning of any provision of it. It can do so either in order to confirm that the meaning of the provision is the ordinary meaning conveyed by the text or to determine the meaning of the provision when the provision is ambiguous or obscure or where the ordinary meaning conveyed by the text leads to a result which is manifestly absurd or unreasonable. However, that does not mean that it should necessarily do so whenever it has to construe a statutory provision.

28. I am satisfied that the provisions of Pt IVA which it has been necessary to consider in these proceedings are not ambiguous or obscure and that the ordinary meaning conveyed by the text does not lead to a result that is manifestly absurd or unreasonable. Therefore, if consideration is to be given to the Second Reading Speech, it is simply to confirm that the meaning of the provision is the ordinary

ATC 656

meaning conveyed by the text. In Case W58
89 ATC 524 the Tribunal, constituted by the late Hartigan J. as President, said at para. 53:

``I am of the view that the primary source is the statute itself. The words of the statute are plain. I cannot use the Minister's words to displace the plain language of Parliament. I refer to the words of Mason C.J., Wilson and Dawson JJ. in
Re Bolton, Ex parte Beane (1987) 162 C.L.R. 514 at p. 518:

  • `The words of a Minister must not be substituted for the text of the law.'''

29. The passages from the Second Reading Speech which Mr Kelly asked the Tribunal to take into consideration referred to the fact that Pt IVA was intended to ``strike down blatant, artificial or contrived arrangements'', that the husband and wife who chose to run a business as partners would need to have no fear of having their arrangements affected by Pt IVA and that there would be no question of the new provisions impeding a parent passing to a spouse or children the use and enjoyment of some income-producing assets. Although Mr Kelly referred to the taxpayer's skills as a draughtsman as an asset of A Co. as trustee for the discretionary family trust, and as having been an asset of the partnership before A Co. was incorporated, in my view neither of those assertions is correct, particularly when regard is had to the fact that there was never any formal contract between the taxpayer and either the partnership or A Co.

30. Having considered the passages from the Treasurer's Second Reading Speech to which Mr Kelly referred, I have come to the same conclusion as Hartigan J. reached in Case W58 that ``the words used in the sections that go to make up Pt IVA are not at odds with the text of the Second Reading Speech''; the speech confirms that the meaning of the provisions is the ordinary meaning conveyed by the text, taking into account its context in the Act and the purpose or object underlying the Act. I am satisfied that the scheme in this case can properly be described as contrived; it diverted to the beneficiaries of the trust income derived from the taxpayer's personal exertions.

31. Accordingly, the objection decisions under review must all be affirmed. As agreed by counsel, the liability of the taxpayer's wife and children will now have to be reassessed on the basis that they received no income from the trust in the years to which these proceedings relate.


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