GROLLO NOMINEES PTY LTD & ORS v FC of T

Judges:
Sheppard J
Foster J
Whitlam J

Court:
Full Federal Court

Judgment date: 26 March and 18 April 1997

Sheppard, Foster and Whitlam JJ

The appeals to be considered in these reasons for judgment are appeals from decisions of the Administrative Appeals Tribunal (Olney J, Deputy President). Appeals have been brought by both the taxpayers and the Commissioner. They give rise to a large number of complex issues. Additionally, there is an appeal by some of the taxpayers from the judgment of Olney J, sitting as a judge of this Court, in a connected matter. That appeal is No. VG 460 of 1994. It is dealt with in separate reasons for judgment published at the same time as these reasons. The appeals from the Tribunal lie only upon a question of law. No appeal lies on any question of fact; s. 44 of the Administrative Appeals Tribunal Act 1975.

Background

Two of the parties to the appeals are Grollo Nominees Pty Limited and Grofam Pty Limited. They are members of what is referred to as the Grollo Group of companies. The driving force behind this Group is two brothers, Bruno and Rino Grollo. Their father, Luigi Grollo, commenced a concrete paving business in 1948. He employed workers, many of whom were relatives or family friends. Most remained as employees for many years. In the early 1960s Luigi Grollo's firm, L. Grollo & Co., commenced contracting for the construction of both private and public swimming pools and for concrete construction work on large projects. By the late 1960s the firm regularly subcontracted to a number of major building companies, and by the early 1970s it was working on a number of shopping centres and large commercial buildings in and near the City of Melbourne. In each case it acted as subcontractor for the concrete structure. This meant that, with the technological changes occurring in the building industry, the firm was doing the major part of the work on those projects. The success of the Grollo business depended upon a loyal labour force and a reliable and reasonably priced supply of concrete. In 1970 there was a serious strike in the concrete industry. By that time the structure of the business had been changed into a group of companies. The Group bought its own trucks and set up a concrete plant which was later replaced by a permanent plant. It was then, and has since been, in a position to guarantee regular supplies of concrete and to control the price at which it could obtain and supply concrete.

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What we have so far said about the history of the Grollo Group and also what follows, have been largely taken from his Honour's reasons for decision. With respect, we are indebted to his Honour for the concise, yet comprehensive, account of the background of the case which is to be found in his reasons.

The next development undertaken by the Group was the building of properties to be held by the Grollo interests as long term investments. His Honour said that, having the capacity to build cheaply and quickly, the Group was able to generate immediate equity in its projects, the equity being the difference between the cost of construction and the value of the building after completion. The Grollo family's objective was to accumulate a substantial portfolio of commercial properties which would provide a secure income with capital growth. The equity thus generated provided a capital base from which to borrow funds to commence new projects.

At different times the business was carried on through various companies within the Group. It was common practice for a new company or trust structure to be the owner of each new project. On occasions a development was carried out by a Grollo company with a joint venture partner. A company, Grofam Pty Limited, was one of the companies that acted as builder for these projects. The minutes of a meeting of Grofam's directors held on 30 October 1980 reveal that Rino Grollo informed the meeting that all construction contracts of the Grollo Group were being undertaken by Grofam. Apart from its own plant and equipment, Grofam had access to the labour force and other skills, equipment and material available from other companies within the Group. None of the companies within the Group made any profit from supplying labour, plant, equipment, concrete or other materials to other Grollo companies. Within the Group, everything was provided at cost.

By mid-1980 the Grollo Group, or rather companies within it, had an option over land on the western side of King Street and land on the north-eastern corner of Collins and King Streets in Melbourne. Land on the south-eastern corner of Collins and King Streets belonged to the National Mutual Life Association which, in late 1980, made it known that it wanted to sell this land. It was obvious that a large development on the National Mutual land could overshadow the nearby sites owned by the Grollo Group and thus detract from their value as sites for major developments. Various proposals were explored between the Grollos and National Mutual. Ultimately, on 24 December 1980, the Group acquired an option to purchase the National Mutual site. The option was extended, by a series of extensions, to 4 December 1981.

The Grollos had the capacity to develop the National Mutual site but could not do so ``without a strong financial partner.'' On 4 December 1981 a company, Porkellis Australia Pty Ltd (``Porkellis''), and Grollo Australia Pty Limited (``Grollo Australia'') executed a document entitled ``Partnership Deed for Rialto Joint Venture'' whereby they agreed to associate themselves in a joint venture to be known as the Rialto Project. Involved was the acquisition, development and holding as an investment of certain properties in Melbourne. The development envisaged the construction of a multi-storey office and hotel complex and the renovation of three historic buildings. The joint venturers agreed to contribute to the cost of the project in equal shares. A company then named Walktrek Limited, which was associated with Porkellis, agreed to finance 75 per cent of the contribution of each joint venturer. During the course of the project Porkellis changed its name to St Martins Victoria Pty Ltd (``St Martins''). Walktrek Limited changed its name to Porkellis Finance UK Ltd.

Grollo Australia was a company incorporated or acquired for the project. It had not previously engaged in any building or construction activities for the Grollo interests. Its only activity was the Rialto Project.

The joint venture deed provided for Grofam to be engaged as the project builder and for the work to be executed by it under contracts which provided for the payment of a fixed lump sum with no rise and fall provision. The sum included an agreed amount for preliminaries, overheads and profit.

By contract dated 2 April 1982, Grofam agreed with the joint venturers to undertake bulk excavation and other works in relation to the project. Subsequently, by a series of letters of instruction dated between 5 August 1982 and 16 May 1983, it was engaged to undertake other aspects of the construction work. His Honour said that progress payments were made to Grofam from the joint venture bank account into which equal contributions had first been

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made by or on behalf of the joint venturers. As a general statement, that is true, but it will later be seen that the route by which payments were made to Grofam and the route by which payments were made by it to Grollo Australia and to St Martins were somewhat more circuitous than his Honour's statement suggests.

Each round of contributions involved Porkellis Finance UK paying into the joint venture bank account 75 per cent of the progress payment being 37.5 per cent of the payment on behalf of each of the joint venturers. Each joint venturer was obliged to pay 12.5 per cent of the amount required. That statement also requires qualification. It was the expectation of the Grollo brothers that it would not be necessary for any Grollo company actually to pay Grollo Australia's 12.5 per cent share. The Grollos believed that the costs of construction would be such that the amount of Grollo Australia's share would come from the excess of amounts received over the cost of building and that Grollo Australia's obligation to contribute 12.5 per cent of the amount would be satisfied in this way.

On 27 October 1983 the joint venturers entered into a deed entitled, ``Deed of Variation of the Partnership Deed for the Rialto Joint Venture'', whereby the provisions of the joint venture deed relating to the engagement of Grofam as the project builder were replaced by provisions whereby the joint venturers acknowledged that they would engage either Grollo Australia or Grofam as the project builder. On the same day a series of building contracts were entered into. Two contracts were executed between the joint venturers and Grofam. The first related to preliminary works for the hotel and the second to preliminary works for the car parks and offices. The joint venturers also entered into two contracts with Grollo Australia, the first for the hotel structure and the second for the car park and office structure. Under each of the latter contracts Grollo Australia was obliged to cause Grofam to carry out the preliminaries for, and the structure of, the relevant works and to cause Grofam to sub-let the balance of the works.

At the time the building contracts were executed, Grofam had in fact completed the preliminary works covered by the two contracts which it executed and some work had been done by it in respect of the work contracted to be done by Grollo Australia.

On 27 October 1983 Grofam and Grollo Australia each executed under their respective common seals a document addressed to St Martins (formerly Porkellis) in which they purported to confirm that whatever contracts had theretofore been entered into by Grofam in respect of the Rialto Project, those contracts had been entered into at the request and direction of Grollo Australia and all moneys paid to Grofam pursuant to such contracts had been paid at Grollo Australia's direction and received by Grofam on Grollo Australia's behalf. After 27 October 1983, Grollo Australia appointed Grofam as its subcontractor and progress payments were thereafter made by the joint venturers to Grollo Australia. Grollo Australia paid Grofam the cost of executing the works.

The project was completed in August 1988. The total amount paid from the joint venture bank account to Grofam and Grollo Australia for construction work on the project exceeded the actual building costs by an amount in excess of $50 million. His Honour referred to this as ``the building surplus''. The appeals relate primarily to income tax liabilities said to arise as a consequence of the building surplus derived from the construction of the Rialto Project. Until 27 October 1983 the project builder was, at least to outward appearances, Grofam; thereafter it was Grollo Australia. His Honour said that, at all relevant times, Grofam acted in the capacity as trustee of the Grofam Unit Trust and Grollo Australia acted as trustee of the Rialto Unit Trust.

The issues

It is the Commissioner's case that the Rialto construction receipts paid to Grofam by the joint venturers for work executed before 27 October 1983 were part of Grofam's assessable income in the respective years of income in which they were received and that the agreements executed on 27 October 1983 and the course of conduct of Grofam and Grollo Australia after that date were a scheme within the meaning of Part IVA of the Income Tax Assessment Act 1936 (``the Act''). His Honour said that the Commissioner had determined, pursuant to subsec. 177F(1) of the Act, that the Rialto construction receipts paid to Grollo Australia after 27 October 1983 were to be included in the assessable income of Grofam for the respective years of income in which they were received. The assessments issued by the Commissioner have been issued on this basis.

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The Commissioner also issued assessments on an alternative basis, namely, that the Rialto construction payments received by Grollo Australia after 27 October 1983 were assessable income derived by Grollo Australia.

Hereafter we refer to the Grollo Group of companies or to the Grollo interests, when referring to them collectively, as ``the appellants''. We shall do this whether we are dealing with the Grollo appeals or the Commissioner's appeals. We refer to the Commissioner of Taxation as ``the Commissioner''.

The appellants contend that no part of the Rialto building surplus formed part of the net income of either Grofam or Grollo Australia. They say that, prior to 27 October 1983, Grofam had an arrangement with Grollo Australia whereby any building surplus belonged to Grollo Australia. It was said that Grofam was building at cost for that company. In the alternative, the appellants rely upon the notice given on 27 October 1983 under the common seals of Grofam and Grollo Australia to St Martins as establishing an agency between Grofam and Grollo Australia. The appellants also say that in 1983 it was too early in the project for any profit to have emerged. Insofar as Grollo Australia might have become entitled to any of the building surplus, the appellants say that such surplus was not income because it was not income according to the ordinary concepts and usages of mankind but rather represented a reduction in the cost to Grollo Australia of its equity in the Rialto Project. The appellants also say that the Commissioner's determinations pursuant to subsec. 177F(1) of the Act are not maintainable. There are also issues about additional tax and the validity of an amended assessment issued to one of the Grollo family, Leanne Grollo.

The Federal Court appeal - background

Before we make a more precise statement concerning the issues between the parties in the appeals from the Tribunal, it is necessary to say something of the appeal in matter No. VG 460 of 1994, i.e. the Federal Court matter. Again, the account of those proceedings which we are about to give comes from his Honour's reasons for judgment. During the period 1989 to 1992 the Commissioner conducted an audit of the income tax affairs of the Grollo companies in the course of which disputes arose as to whether any, and if so what, taxable profit or income was derived by any, and if so which, of those companies from the construction of the Rialto building in Melbourne. There were also issues arising out of other transactions and in consequence of the nature of the financial affairs of the various companies and individuals.

In 1992 there were negotiations between the parties with a view to resolving these disputes. On 30 June 1993 some of the Grollo parties instituted proceedings in the Federal Court seeking a declaration that the Commissioner and the Grollo companies had concluded an enforceable settlement of the disputes. This assertion was denied by the Commissioner. But on 22 September 1993, prior to the hearing of the 1993 proceedings, the appellants and the Commissioner executed an agreement described as terms of settlement in respect of the 1993 proceedings and the disputes.

By the terms of settlement the parties agreed that, in full settlement of all issues other than the Rialto issues and another immaterial issue, the appellants would pay to the Commissioner $27.5 million, that the Commissioner would issue assessments in respect of the non-Rialto issues for a total amount not exceeding $27.5 million, that the payment by the appellants of the $27.5 million would be in full and final discharge of all liability under the non-Rialto assessments. The appellants were to forego certain carried forward losses specified in the terms of settlement.

It was also agreed that the Commissioner would issue and serve assessments in respect of the Rialto issues for a total sum (including additional tax and other penalties) not exceeding $39 million, being $19 million primary tax and $20 million penalties. It was agreed that the Commissioner could issue and serve alternative assessments and that, except as expressly provided to the contrary in the terms of settlement, all such assessments, i.e. the Rialto assessments, would be raised in accordance with the provisions of the Act and be subject to the ordinary objection and referral or appeal provisions of Part IVC of the Taxation Administration Act 1953.

We deal with the questions which arise for decision in the Federal Court appeal (No. VG 460 of 1994) in the separate reasons published in that matter. We mention the matter at this stage because it forms part of the background to the appeals from the Tribunal.

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The assessments in question

On 27 September 1993, the Commissioner, purporting to act pursuant to the terms of settlement, issued two sets of assessments. The first set comprised 17 assessments. They were described in argument as the ``Grollo Australia assessments''. The second set of assessments comprised 282 assessments in respect of the period from 1 July 1982 to 30 June 1988. These were referred to in argument as the ``Grofam assessments''. We shall refer to them similarly.

Under the Grofam assessments, the Commissioner included in the net income of the Grofam Unit Trust amounts of profits said to have been derived by Grofam as trustee of the Grofam Unit Trust from the construction of the Rialto building for the period 1 July 1982 to 27 October 1983. In addition, the Commissioner, as mentioned, made determinations under subsec. 177F(1) of the Act that specified amounts that were referable to tax benefits said to have been obtained by Grofam in connection with a scheme within the meaning of Part IVA of the Act relating to the construction of the Rialto building. The determinations were, in substance, that the amounts be included in the assessable income of Grofam for the period 27 October 1983 to 30 June 1984 and for each of the years ended 30 June 1985 to 30 June 1988 inclusive. Consequential adjustments and certain other adjustments were made to the income and losses of the beneficiaries of the Grofam Unit Trust and its successive trusts and beneficiaries. The Grofam assessments comprised 140 assessments in respect of the year ended 30 June 1983. These were issued pursuant to s. 98 of the Act against Grollo Nominees Pty Limited in its capacity as trustee of the Bruno Grollo Nos 11-30 Trusts and the Rino Grollo Nos 11-30 Trusts on account of each of the infant beneficiaries of each of those trusts. A further 140 assessments were issued in respect of the year ended 30 June 1984. These were issued pursuant to s. 98 of the Act against Grollo Nominees Pty Limited in its capacity as trustee of the Bruno Grollo Nos 11-30 Trusts and the Rino Grollo Nos 11-30 Trusts on account of each of the infant beneficiaries of each of those trusts. Additionally, assessments were issued against two companies, Grollo Finance Pty Limited and Collins Street Constructions Pty Limited, in respect of the year ended 30 June 1988. Although determinations were made under subsec. 177F(1) of the Act for the 1985, 1986 and 1987 years of income, no Grofam assessments were issued for those years because, by reason of losses incurred in relation to matters other than the construction of the Rialto building, no taxable income was derived by the relevant trusts or companies in those years of income.

The taxpayers under these various assessments, i.e. for the most part the beneficiaries under the Trusts, applied to the Tribunal for review of the Commissioner's decisions to disallow objections lodged in respect of the assessments.

The issues - a more precise statement

Counsel for the appellants stated the issues arising in relation to the Grofam assessments as follows:

(a) whether Grofam in its capacity as trustee of the Grofam Unit Trust derived income or profit from the construction of the Rialto building during the year ended 30 June 1983 and during the period from 1 July 1983 to 27 October 1983;
(b) whether the assessments that were issued pursuant to Part IVA of the Act were excessive. In particular were the determinations under subsec. 177F(1) validly made in respect of the period from 27 October 1983 to 30 June 1984 and for each of the years ended 30 June 1985 to 1988 inclusive;
(c) whether liability to additional tax was imposed under s. 226 of the Act for the year ended 30 June 1983, s. 223 of the Act for the year ended 30 June 1984 and s. 226 in respect of the assessments made under Part IVA. If so, were decisions to remit part of the additional tax correctly made;
(d) whether the amounts of primary tax under the assessments for the 1983 and 1984 years of income were correctly calculated in accordance with Schedules 6 and 12 of the Income Tax (Rates) Act 1982 (``the Rates Act'');
(e) whether the Commissioner in making the assessments was entitled under the terms of settlement to make adjustments to income and losses returned by members of the Grollo Group of companies in respect of issues other than the issue as to whether any and, if so, what income or profit was derived by any and, if so, which member of the Grollo Group from the construction of the

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Rialto building. If the Commissioner was so entitled, there is the further question whether the taxpayers were entitled to object against any such assessments.

The principal contentions of the appellants were stated to be as follows:

(a) The Tribunal erred in law in finding that Grofam derived an excess of assessable income over deductible outgoings from the construction of the Rialto building during the year ended 30 June 1983 and during the period from 1 July 1983 to 27 October 1983. This contention was said to relate to appeals Nos VG 209, 269 and 409 of 1995.
(b) The Tribunal erred in law in holding that determinations were validly made under subsec. 177F(1) of the Act in respect of the period from 27 October 1983 to 30 June 1984 and each of the years ended 30 June 1985 to 1988 inclusive and that the assessments for the years ended 30 June 1984 and 30 June 1988 that were based upon those determinations were excessive. This matter arises in appeals Nos. VG 409 and 489 of 1995.
(c) The Tribunal erred in law in finding that the primary tax was correctly calculated under Schedule 12 of the Rates Act for the 1984 year of income. This contention arises in appeal No. VG 409 of 1995.
(d) The Tribunal erred in law in confirming the amounts of additional tax assessed under the assessments in respect of taxable income arising during the year ended 30 June 1983 and the period 1 July 1983 to 27 October 1983. This contention was said to arise in all appeals.

The period up to 27 October 1983

We propose to proceed by first considering the matters in para. (a) of these contentions. We shall then deal successively with the other contentions. Sometimes the appeals brought by the Commissioner raise matters connected with matters arising in the appellants' appeals. In such cases we shall deal with all questions in relation to that particular aspect of the matter. As necessary we shall deal with the Commissioner's appeals after we have completed our consideration of the appellants' appeals.

The first matter to be dealt with is whether Grofam derived an excess of assessable income over deductible outgoings from the construction of the Rialto building during the year ended 30 June 1983 and the period 1 July 1983 to 27 October 1983. His Honour concluded that it did. In order to resolve this issue, a number of particular questions need to be considered. These are:

(a) Whether the Tribunal erred in law in holding that on the findings of fact it made there was no at-cost arrangement between Grofam and Grollo Australia in respect of the construction work carried out prior to 27 October 1983.
(b) Whether the Tribunal made an error of law in construing the notice and the Grollo Australia contracts that were executed on 27 October 1983. This raises the question whether the Tribunal was correct in deciding that the notice given on 27 October 1983 could not affect the incidence of taxation.
(c) Whether the Tribunal erred in law in holding that it was not too early for Grofam to have derived income or a profit from the construction work in the year ended 30 June 1983. Wrapped up in this question is whether the Tribunal was correct in approaching the matter by applying what was described in the evidence as the basic method of accounting rather than another method of accounting described in argument as the emerging profit basis. We shall explain these expressions, and also the expression ``estimated profits basis'', when we come to deal with this question.
(d) Assuming questions (a), (b) and (c) are answered favourably to the Commissioner, whether the Tribunal erred in law in holding that Grofam, in the year ended 30 June 1984, was not entitled to claim as deductions amounts equal to the income or profit derived by it from the construction work prior to 27 October 1983.

In order to deal with these matters, it is necessary to refer to some evidence and to consider the conclusions reached by his Honour in relation to the various matters. The account of the evidence comes substantially from his Honour's reasons. The starting point for their consideration is the deed, described as the Joint Venture deed, which was executed on 4 December 1981. The parties to the deed were Porkellis, Grollo Australia and Messrs Luigi, Bruno and Rino Grollo and their respective wives. The last six parties were guarantors.

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In substance the joint venture deed provided for the joint venture partners, Porkellis and Grollo Australia, to contribute equally to the cost of the acquisition of the Rialto site and of the development of that site by constructing two tower buildings, a carpark, plaza and ancillary facilities as well as renovating and ``recycling'' three historic buildings. The business of the joint venture was confined to the implementation of that project. The deed provided for ``all proper expenditures, costs and expenses of whatever nature relating to the project'' to be shared equally by the joint venturers and for each joint venturer to pay to the joint venture bank account its share of all amounts required. As his Honour said, the joint venturers agreed to engage Grofam as project builder.

In his reasons, his Honour set out Clause 7 of the deed prior to its being varied by a later deed dated 27 October 1983 the same day as the notice earlier referred to. We shall refer to the variation in a moment but it would seem that it did not have any effect on the relationship between the parties up to 27 October 1983 when it was signed. Significantly cl. 7 provided that separate and individual building contracts should be prepared and executed for each of seven stages of the project, namely, bulk excavation, structure and protection of certain factory buildings which apparently adjoined the site, foundations, carpark and plaza slab, towers and plaza finishes, hotel and the factory tavern fitout. Each building contract was to be in the form of an appropriate agreement and conditions of building agreement but to take the form of a deed amended as necessary to make it consistent with and to give effect to an agreement earlier reached between the joint venturers specified in subparas (c) to (f) of Clause 7.1 of the joint venture deed. Clause 7.1(c) was as follows:

``Grofam shall under each Building Contract itself provide and perform the Preliminaries for a fixed lump sum (which shall include a fixed amount for overheads and profit) with no rise and fall as hereafter provided and there shall be no rise or fall provision relating thereto.''

With para. (c) needs to be read para. (d) which was as follows:

``Grofam shall under each Building Contract itself provide, and perform the works in relation to, the Structures for a fixed lump sum (which shall include a fixed amount for overheads and profit) with no rise and fall, such fixed lump sum to be in accordance with the following provisions...''

The emphasis is added.

There then followed a number of paragraphs. Amongst other things it was provided that in the first instance tenders should only be called from Grofam. If such tender for a stage by Grofam was, in the reasonable opinion of the Project and Property Manager in accordance with the budget, the joint venturers would accept such tender and Grollo Australia would procure Grofam to enter into a building contract with the joint venturers in accordance with the provisions of the joint venture deed in respect of such tender for such stage. There was a provision which applied in the event that the Project and Property Manager thought that the tender by Grofam was not reasonable in which case tenders could be invited from other builders.

Clause 7.1(f) contained a number of provisions dealing with the contents of building contracts entered into by Grofam. Amongst these provisions it was provided in subpara. (iv) that the contract should make provision that there should be no ``mark up'' or additional margin or profit to Grofam on any variations including any variation to subcontracts on any administrative charges.

Clause 7.2 provided for the consequences of default by Grollo Australia under certain subparagraphs of Clause 4. It is unnecessary to refer to the detail of these. However, it is relevant to refer to other parts of Clause 4. Clause 4.1 provided that all proper expenditures, costs and expenses of whatsoever nature relating to the project should be shared equally by the joint venturers. Clause 4.2 provided that all income derived by the joint venture should belong to the joint venturers in equal parts.

Clause 2 defined the project. It comprised a number of elements the principal of which were:

(a) Grollo Australia and Porkellis would enter into a contract with National Mutual under which they would be purchasers as tenants in common in equal shares of the National Mutual land.
(b) The joint venturers would enter into a contract for the acquisition of that land and

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certain other land referred to in the clause and each contribute 50 per cent of the moneys payable under each contract.
(c) The joint venturers would construct on the land so acquired certain buildings comprising two tower buildings, a carpark, plaza and ancillary facilities and would renovate and ``recycle'' three historic buildings situated on the land.
(d) The buildings were to be constructed generally in accordance with certain drawings with specifications, copies of which had been signed by the joint venturers.
(e) The construction was to proceed generally in accordance with a program outlined in the feasibility study which was identified by the parties.

His Honour said that, because the project had not been completely defined and building contracts had not been prepared at the time the joint venture deed was executed, it was necessary initially for works to be authorised less formally than the joint venture deed envisaged. Excavation of the site commenced in April 1982 pursuant to the contract signed on 2 April 1982 known as the ``Bulk Excavation Contract''. The parties to the bulk excavation contract were the joint venturers and Grofam.

Although it is clear enough from what has been said, it needs to be emphasised here that Grofam was not a party to the joint venture agreement. But under the joint venture agreement Grollo Australia was obliged to procure Grofam to carry out the building work on the project. As earlier mentioned, Grollo Australia was a new company within the Grollo Group. It was the corporate vehicle which the Grollos employed to undertake the project. Grofam, on the other hand, had undertaken a number of projects some of which appear to have been still in the course of completion at the time Grofam undertook the Rialto Project.

A further matter that needs to be noticed at this point is that the Grollo Group at all times included a company which acted as banker for the Group. This company was known at various times as L. Grollo Nominees Pty Limited or L. Grollo Sales Pty Limited. All moneys passing from one company in the Group to another were channelled through the banker. Thus surplus moneys earned by Grofam intended for Grollo Australia were paid first of all to the banker which in turn passed them on to Grollo Australia. That was a comparatively simple transaction at least in the 1983 year of income when a sum of $3.5 million earmarked for Grollo Australia flowed directly through the banker to that company. It is not necessary to go into the matter in depth, but an examination of the transactions between the companies would, we think, reveal a complex situation of moneys passing to companies engaged in building work so that expenses incurred by them could be paid and moneys flowing to the banker from such companies which were surplus to needs. In some cases the moneys remained with the banker; in others they were passed on to yet other companies in the Group.

In the period between the execution of the joint venture deed on 4 December 1981 and the execution of the variation deed on 27 October 1983, the bulk excavation contract was the only formal contract entered into between the joint venturers and Grofam. Work was, however, carried out pursuant to a series of letters of appointment addressed by the joint venturers to Grofam and accepted by it. The first two such letters were dated 5 August 1982. In one case the letter expressed acceptance of Grofam's tender for the supply of necessary plant, equipment, material and labour to install caissons according to certain drawings for a fixed contract sum of approximately $4 million. The second letter related to two other aspects of the project involving fixed price contract sums of approximately $160,000 and $385,000 respectively. A further such letter dated 13 September 1982 dealt with the acceptance of a tender relating to part of the hotel structure for a fixed price of $2.9 million. A similar letter instructed Grofam to proceed with certain work on the carpark structure for a fixed sum of $1.75 million. Letters written in relation to part of the hotel structure and the carpark each contained a statement to the effect that, when the terms of the head contract had been agreed, the work included in the letters would be incorporated into the hotel contract. Obviously enough, the understanding in relation to the earlier letters of appointment was the same. There were further letters of this kind to the detail of which we do not refer.

Building contracts were finally entered into between the joint venturers and Grofam on 27 October 1983. By that time all the work covered by the two contracts executed by

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Grofam on that day had been completed. On the same day two further contracts were executed by the joint venturers and Grollo Australia. Some of the work encompassed by the latter contracts had already been done by Grofam pursuant to the various letters of instruction. His Honour said that the exact extent of the work completed by Grofam before 27 October 1983 was not precisely identified in the evidence nor was the amount of money paid or payable to Grofam for work done before that date specifically referred to, but a schedule of cash payments was prepared by a Mr James, who had been employed by a firm of accountants, Touche Ross & Co., as a senior tax consultant between 1982 and 1985. He became a partner in 1985 but resigned from the firm in 1992. His involvement with the Rialto Project commenced in 1982. His Honour said that the schedule prepared by Mr James provided some insight into the state of affairs as at 27 October 1983. According to the schedule, a total of $57.5 million was paid to Grofam from the joint venture bank account in the period between 21 May 1982 and 11 November 1983. In the period between 14 December 1983 and 16 November 1987 the joint venturers paid Grollo Australia $191.5 million. The total of all amounts paid to Grofam and Grollo Australia from the joint venture account was approximately $249 million.

The building contracts executed on 27 October 1983 by Grofam were for preliminary works on the hotel and carpark and offices. The total amount involved was $8.5 million. This work, if not then complete, was almost so. The purpose of Grofam's executing these contracts seems to have been designed to attempt to bring a measure of formality and consistency into the building arrangements which had been lacking up to that time. The building contracts executed by Grollo Australia were for the hotel structure ($39 million) and carpark and offices structure ($198 million) a total of $237 million. It would appear that this was work which, for the most part, was still to be done.

His Honour said that none of the building contracts executed on 27 October 1983 covered the work provided for in the bulk excavation contract. His Honour said that he was unable to say whether or not any other work actually done by Grofam before 27 October 1983 was covered by one or other of the four contracts. He said that the total of all amounts payable to Grofam and Grollo Australia by the joint venture for work covered by the four building contracts was $245.5 million.

His Honour then drew some conclusions about amounts which had been received by Grofam and Grollo Australia and about the difference between the overpayment to Grofam which he found to have been made and an underpayment to Grollo Australia which he also found to have occurred. From these conclusions his Honour inferred that Grofam carried out work to the value of $3.5 million which was not covered by any of the four building contracts executed on 27 October 1983 and, further, that prior to 27 October 1983, Grofam carried out work to the value of $45.5 million which was subsequently included in the contracts signed by Grollo Australia on 27 October 1983.

In addition to the building contracts executed on 27 October 1983 to which reference has been made, two other contracts were executed. The first of these was a variation deed which had the effect of making some variations to the joint venture agreement. Significantly, Clause 7.1, as varied, opened with the words:

``The Joint Venturers acknowledge that they will engage either Grollo or Grofam as project builder (Grollo or Grofam as the case may be being herein referred to as the `Project Builder') on terms and conditions to be agreed with the Project Builder but including the following...''

The balance of the subparagraph was substantially in the same form as the corresponding provision in the original joint venture deed.

Also on 27 October 1983 there was executed under the common seals of Grollo Australia and Grofam the notice to St Martins to which reference was earlier made. The document is as follows:

            
``TO: ST. MARTINS VICTORIA PTY. LIMITED

RE: Rialto Project
    --------------

Grollo Australia Pty. Ltd. (`Grollo') and Grofam Pty.
Ltd. (`Grofam') hereby confirm the following:

1. Whatever contracts have heretofore been entered
into in respect of the above Project by Grofam
have been so entered into at the request and
direction of Grollo; and

2. All moneys paid pursuant to the contracts
mentioned in 1 above to Grofam have been so paid
on Grollo's direction and received by Grofam on
Grollo's behalf.

THE COMMON SEAL OF GROLLO)
AUSTRALIA PTY. LTD. was           )
hereunto affixed in accordance    )   L.S.
with its Articles of)
Association in the presence       )
of:

 Bruno Grollo Director
 R. Grollo Secretary

THE COMMON SEAL of GROFAM)
-------------------------
PTY. LTD. was hereunto            )
---------
affixed in accordance with        )   L.S.
its Articles of Association       )
in the presence of:               )

 Bruno Grollo Director
 R. Grollo Secretary''

In due course it will be necessary to consider questions arising in relation to this notice. There are questions concerning its meaning and intended operation and also its effect, particularly its effect, if any, upon the operation of the Act.

In December 1983 agreements were prepared which were intended to effect the appointment by Grollo Australia of Grofam as ``sub-builder for the Project''. The documents are undated but they were executed by both Grollo Australia and Grofam. Mr Bruno Grollo said that he believed that the documents were signed in December 1983. They were recorded in the minutes of the two companies on 17 April 1984. As his Honour said, nothing turned upon the exact date when the documents were executed. Each agreement referred to the separate building contracts entered into by Grollo Australia on 27 October 1983. Each recited that, until 27 October 1983, which was described as the ``Changeover Date'', Grofam was engaged by Grollo Australia and St Martins (previously Porkellis) as the builder of the hotel structure known as the Rialto Project and that on and from the changeover date the joint venturers had appointed Grollo Australia as builder in substitution for Grofam in accordance with the terms and conditions of a head contract dated 17 October 1983. The agreement provided that, with effect from the changeover date, Grollo Australia appointed Grofam as sub- builder in relation to the work on terms generally in accordance with the relevant terms and conditions of the head contract and upon such other terms agreed upon between Grollo and Grofam. The agreements were executed under the common seals of the two companies.

Agreement or common understanding that Grofam would carry out work at cost

Against that background it is now possible to come to the question whether the Commissioner was correct in assessing Grofam for the income earned on the Project up to 27 October 1983 i.e. during the year of income ended 30 June 1983 and during the period 1 July to 27 October 1983 which fell within the income tax year ended 30 June 1984. His Honour said that, in the submission of counsel for the appellants, the arrangement between Grollo Australia and

ATC 4598

Grofam was evidenced by a number of matters, namely:

(a) The invariable practice of the Grollo Group as at 4 December 1981 when the joint venture deed was executed was that entities within the Group building for other Grollo entities did so at cost. Reliance was placed upon the evidence of Mr Bruno and Mr Rino Grollo and also the accountant Mr Dowding as to past practice in respect of other property developments in which the Group had been involved.
(b) A conversation between Bruno and Rino Grollo shortly prior to 4 December 1981 in which, in the context of a discussion as to how the construction of the Rialto Project would be carried out, Bruno Grollo said words to the effect that it would be done in the way it had always been done within the Group, namely at cost; to this Rino Grollo agreed.
(c) At a meeting on 14 September 1982 attended by the two Grollos, Mr Dowding and a Mr Sankey, when the question of Grofam's potential profit arising from the Rialto contract was raised, Bruno Grollo expressed the view that there was no profit as all they were doing was putting up a building for a much lower cost than would otherwise be the case. Mr Sankey was the finance director of the Grollo Group from March 1982. Previously he had been a bank manager.
(d) A statement made in August 1983 in an application by Grofam as trustee for the Grofam Unit Trust for a PPS deduction exemption certificate. The abbreviation PPS stands for prescribed payments system. The statement said that, from 1 July 1983, the trustee, i.e. Grofam, had ceased to carry on construction work for the public. Instead it had confined its activities to construction on behalf of entities having, or at least partly having, ownership. Work in respect of all projects commenced from 1 July 1983 would therefore be provided at cost. The letter said that it was submitted that for the income year ending 30 June 1984 and for subsequent years, the trust estate would derive no net income. The changed role of the trustee was such that there would be no profit making purpose. It was said that it was ``now a `non-profit' organisation''.
(e) A statement made by Mr Rino Grollo to Mr Nelson, a solicitor, on 5 August 1983 to the effect that Grofam was not making a profit.
(f) Evidence of the two Grollos to the effect that they regarded the building work carried out by Grofam as being the means whereby Grollo Australia would meet its joint venture equity obligations. It was said that the view held by the Grollos was inconsistent with there being an intention that Grofam would carry out the construction for a profit at the expense of Grollo Australia.
(g) There was a cash flow generated by the construction work that was used by Grollo Australia to meet its obligations to pay cash into the joint venture account.
(h) The provision to Grofam at cost of the building and other resources of other entities within the Grollo Group.
(i) The asserted implausibility of the notion that Bruno and Rino Grollo would intend that Grofam derive a profit from Grollo Australia.
(j) The readiness of the Grollos to execute the 27 October 1983 notice which was said to give formal expression to what they regarded as the substance and truth of the position.

Not all these matters were relied upon before us in these appeals. We mention them as background to what his Honour eventually said about them. This has a bearing on his Honour's view of the credibility of the witnesses called in the appellants' case.

His Honour said that, to a large extent, proof of the applicants', i.e. appellants' assertion that in the period to 27 October 1983 Grofam was building at cost for Grollo Australia was dependent upon the credit of the two Grollos and Mr Dowding. His Honour said, ``To the extent that the evidence of those 3 witnesses is relied upon in support of the applicants' proposition I reject it as lacking credit.'' His Honour then set out his reasons for that conclusion.

We do not find it necessary to go to his Honour's reasons. There could be no challenge to a conclusion such as his Honour reached in an appeal which is restricted to an appeal on questions of law. The important fact is that, to the extent that the matters relied upon depended upon the evidence of the Grollos and Mr

ATC 4599

Dowding, his Honour rejected it because he did not believe it.

It is important, however, to note that, not only, as his Honour said, was there no mention made of an at cost arrangement between the two parties; the evidence established that the Grollos and Mr Dowding anticipated that, if the form of the documentation caused a tax problem, steps (not then identified) would have to be taken to resolve the problem. As his Honour said, the Rialto Project was not just another project in which one Grollo company would be building at cost for another. Mr Dowding was aware that there was a possibility that Grofam could derive a cash surplus. This was because the joint venture agreement provided for fixed price contracts, something that was not a feature in other projects undertaken by the Grollo Group either on their own behalf or as a joint venture partner.

At this point it is necessary to mention two letters written by Touche Ross & Co. The first was dated 30 March 1983 and was addressed to a Mr Crawford of St Martins. The letter appears to have been intended to be an indication to St Martins that changes in the arrangement which then existed were wanted and to assure him that there would be no disadvantage to the St Martins' interests as a consequence of what was proposed. The letter referred to previous discussions regarding the tax effect on the Grollo Group of the existing joint venture arrangements. After some preliminary remarks, there was set out a proposal for the restructuring of the arrangements which was said to achieve the ``desired objectives'' for the Grollo Group without in any way affecting the interests of Porkellis (i.e. St Martins) or its associated companies. The proposed arrangement involved the joint venture parties and Grofam agreeing that Grollo Australia be appointed project building manager; Grollo Australia was to manage and control the construction undertaken by Grofam as its builder; Porkellis (St Martins) would pay Grollo Australia one half of the agreed construction costs; and Grollo Australia would pay to Grofam the cost of constructing the building. It was said that the essential difference between this arrangement and the existing arrangement was that Grollo Australia did not pay Grofam the profit Grofam would be entitled to under the existing arrangement. The letter said that the proposed variation related only to the uncompleted work on the hotel and office contracts. Work already completed would not be affected. The existing contracts between the joint venturers and Grofam, so far as they related to uncompleted work, would be assigned by the joint venturers to Grollo Australia and the joint venture agreement would be amended. St Martins was asked to consider the proposition put to it in the letter.

The second letter was dated 19 August 1983. It was signed by Mr Dowding and addressed to Mr Rino Grollo. The letter opened with the setting out of two alternative proposals whereby a retention arrangement was to be incorporated into the payments made by Grofam to the joint venture. It was said that the purpose of such an arrangement was to postpone the derivation of the taxable profit Grofam was to receive in relation to the construction of the Rialto Project. Mr Dowding said, ``It should be pointed out that the proposal is not designed to diminish Grofam's tax, but merely to postpone the derivation of the agreed profit figure.'' Later the letter said, ``Currently, the agreements provide that Grofam is to be reimbursed its expenses and agreed profit, on production of architect's certificate. As such, Grofam will be liable to tax on the agreed profit on a profit emerging basis, as and when the payments are made.'' The emphasis is added.

The letter went on to discuss the two alternative suggestions made to achieve the goal mentioned at the beginning of the letter. It expressed an opinion in favour of one rather than the other. None of this is important for present purposes. What is important is that in August 1983, Mr Dowding, who was the close adviser to the Grollo Group on tax and other matters, was expressing to Mr Rino Grollo his view - not suggested by Mr Grollo to be at all contentious - that Grofam was to receive the profit and an acknowledgment that the agreements as they then were provided that Grofam was to be reimbursed its expenses and agreed profit on the production of an architect's certificate. The statement further acknowledged that Grofam would be liable to tax on the agreed profit although on a profit emerging basis. It will be necessary in due course, when considering other submissions, to identify what is meant by the expression ``profit emerging basis'' and to determine whether or not Mr Dowding was correct in the view he there expressed in relation to it. But that is by the way at the moment.

ATC 4600

This is not an appeal on a question of fact. We have mentioned the letters only to emphasise that, within the Grollo camp, as late as August 1983, i.e. two months before the changes brought about by the documents executed on 27 October 1983, it was recognised that Grofam was liable for tax on the income it had earned and was earning up to that time.

Subject to one further matter with which it is necessary to deal in relation to this aspect of the case, we would reject the submissions which were made by counsel for the appellants that his Honour was in error in not upholding the submission that there was an arrangement between Grollo Australia and Grofam that in fact Grofam would build at cost and not itself be entitled to any profit.

The way that the matter was put in written submissions lodged on behalf of the appellants was to say that, at material times, there was an arrangement that operated between Grollo Australia and Grofam that Grofam would perform the Rialto building works at cost and that any surplus from the joint venture payments would belong to Grollo Australia. Particular matters which were relied upon were as follows:

(a) The Tribunal misdirected itself as to the legal effect of the documents that were executed on 4 December 1981, including the joint venture deed, to Clause 7 of which detailed reference has been made, and failed to take into account as relevant considerations the conduct of St Martins, Grollo Australia and Grofam in respect of the agreements embodied in those documents and the negotiations and other agreements that were entered into after 4 December 1981 up to and including 27 October 1983.
(b) The Tribunal misdirected itself as to the legal effect of the common intention of those who controlled Grofam and Grollo Australia, i.e. Messrs Bruno and Rino Grollo, concerning the relationship between those companies in relation to the construction of the Rialto building, and/or failed to take into account as a relevant consideration that common intention.
(c) The Tribunal failed to accept that the common assumption that Grollo Australia and Grofam that as between them the state of affairs was that Grofam was building for Grollo Australia at cost, if acted on by them both, could give rise to legal relations between them defined by that common assumption.

We shall deal separately with the submission based on there having been a common assumption.

In para. 75 of its decision, the Tribunal said that neither the records of Grollo Australia nor those of Grofam disclosed any decision, agreement or arrangement made by or between the companies to the effect of the at cost arrangement asserted by the appellants in relation to the Rialto Project. Nor was there any contemporary record of any kind evidencing or referring to such an agreement or arrangement. The Tribunal went on to refer to the assumption upon which the appellants place separate reliance. As we say we shall come to this in a moment.

Having looked at the various documents and undertaken a general consideration of the relevant evidence, we can only say that we do not find any error in the conclusion reached by the Tribunal in that part of para. 75 of its decision to which we have referred. Furthermore, the joint venture deed executed on 4 December 1981 plainly provided for profit to be received by Grofam. For instance, Clause 7.1(c) provided that Grofam should, under each building contract, itself provide and perform the ``Preliminaries'' for a fixed lump sum which was to include a fixed amount for overheads and for profit. Clause 7.1(d) was expressed in similar language as was Clause 7.1(d)(i). Reference may also be made to Clause 7.1(f)(iv) which provided that each building contract should make provision that there should be ``no mark up or additional margin of profit'' to Grofam on any variations.

To the extent that there is any evidence of any such arrangement as that contended for by counsel for the appellants, it depends, directly or indirectly, on the acceptance of the evidence of the Messrs Grollo. In para. 65 of its decision the Tribunal said, in relation to their evidence and also the evidence of Mr Dowding, that, to the extent that the evidence of those three witnesses was relied upon in support of the appellants' proposition, the evidence was rejected as lacking credit. As we have said, on this appeal there could be no challenge to that conclusion because it does not give rise to a question of law. That aside, however, it is our opinion that the Tribunal's decision on this

ATC 4601

aspect of the case reflects no error whether of fact or law.

Furthermore, there has to be weighed on the other side of the scales the effect of the two letters earlier referred to written by Touche Ross to St Martins and Mr Rino Grollo on 30 March 1983 and 19 August 1983 respectively. We do not refer to the detail of these again but, particularly the second of them, establishes that Mr Dowding only two months before the execution of the documents on 27 October 1983 was of opinion - an opinion he conveyed to Mr Rino Grollo without demur from him - that income from the project earned up to that stage was the income of Grofam; in other words it and not Grollo Australia was the company which had made any profit.

A further submission relied upon by counsel for the appellants was that in material respects the terms of the joint venture deed executed on 4 December 1981 were incomplete. The making and execution of further agreements was required before the joint venture deed could operate as a complete agreement. Thus, so counsel submitted, there was no agreement as to the amount for preliminaries, which was a matter that was critical to the future of the joint venture, and there was no provision in the documentation for fixing the preliminaries in the event that an amount could not later be agreed. And the terms of the property and project management agreement were still to be negotiated - reference was made to Clause 8 of the joint venture deed. Moreover, Grofam was not a party to and was not bound by the terms of that deed. Further matters of a similar kind were relied on.

None of those matters changes the basic structure of what was contemplated by the joint venture deed executed on 4 December 1981. Although Grofam was not a party to that deed, Grollo Australia and St Martins acknowledged to each other that they would engage Grofam as project builder. True Clause 7.1 of the deed provided that the engagement would be on terms and conditions to be agreed with Grofam, but the particular matters which followed and which included the references to profit earlier mentioned, were matters which were to be included in the agreement. It may have contained provisions of various kinds to adapt it to the nature of the contract which was to be entered into but, so far as the terms and conditions provided for in Clause 7.1, they were to be included, they were certain and they made it clear that Grofam was to receive the profit, not Grollo Australia.

Further matters relied upon stemmed from conversations deposed to by the two Grollos. So far as these are concerned it is enough to mention again the adverse view the Tribunal formed of the evidence of those witnesses.

For these various reasons, we reject the submissions with which we have so far dealt.

The common assumption argument

That then brings us to what may be called the common assumption argument. In counsel's submission the Tribunal was in error in failing to accept that the common assumption of Grollo Australia and Grofam that as between them the state of affairs was that Grofam was building for Grollo Australia at cost, if acted on by them both, could give rise to legal relations between them defined by their common assumption.

The common assumption argument stems from remarks made by the Tribunal in the latter part of para. 75 of its decision. His Honour said that, at its highest, the appellants' case was based upon what was said to be the assumption of the Grollo brothers that Grofam would build at cost for Grollo Australia. The Tribunal continued:

``For reasons already exposed I am of the view that this was an ill-founded assumption. In my opinion the joint venture deed expressed both the form and the substance of the relationship between the joint venturers inter se and the proposed relationship between the joint venturers and Grofam. The conduct of the 3 parties subsequent to the existence of the joint venture deed was entirely consistent with the carrying into effect of its terms and nothing has been proved to establish that any other relationship existed between Grollo Australia and Grofam apart from that contemplated by the joint venture deed.''

As we understand the submissions made by counsel for the appellants on this aspect of the case, they involve the placing of reliance upon a finding by his Honour that there was indeed a common assumption of fact such as that to which the Tribunal refers in para. 75. But, in order to understand the Tribunal's approach, it is necessary to have regard to earlier paragraphs of its decision. In para. 73 it said that, assuming for present purposes that all the assertions of

ATC 4602

fact relied upon by the appellants were accurate, the arguments advanced lacked cogency for the reason that they relied on an assumption which was made at the outset of the project that the ``Grollo builder'' (whoever it might be) would be able to execute the building works for an amount sufficiently less than the agreed fixed price to enable the 12.5 per cent equity required to be contributed by Grollo Australia to be financed from the funds coming from the joint venturers. The Tribunal said that this said nothing about the arrangement between the various Grollo entities inter se. It was not a case of Grofam making a profit from Grollo Australia but rather it was a case of Grofam making a profit from the joint venturers.

In order to understand the Tribunal's approach, one must give full weight to the introductory words in the passage from para. 73 of its decision to which we have referred, ``Assuming for present purposes...''. In our opinion, the way to read para. 73, and also paras 74 and 75, is to read them on the basis that what the Tribunal was doing was assuming, rather than finding, a common assumption and then saying that, even if such an assumption existed, it would not help the appellants' case. But the assumption itself is flawed. It is flawed because of his Honour's rejection of the Grollo evidence and also that of Mr Dowding. And it is also flawed by the terms of the Touche Ross letters, particularly that of 19 August 1983. If there were any such assumption as is relied upon by counsel for the appellants, it would be most unlikely that Mr Dowding, who was closely familiar with the Grollo affairs, would have written a letter to Mr Rino Grollo in those terms. If he had, one might have expected Mr Grollo to have replied pointing out to Mr Dowding that he was acting under a misapprehension. There is no such evidence. All these matters relate, of course, to questions of fact. We mention them only to show that his Honour ought not to be taken to have found any common assumption by the parties such as is referred to in para. 75 of his reasons. We take him to have been doing no more than rejecting an argument already rejected because of his findings of fact on an additional and independent ground.

We do not gainsay that, if such a common assumption had been established, there may have been a question of law which may have needed to be decided. The matter was put a number of ways by counsel but their preferred way was based upon the decision of the High Court in
The Commonwealth of Australia v Verwayen (1990) Aust Torts Reports ¶81-036; (1990) 170 CLR 394. Extensive reference was made to the judgments in that case. In the view we take of the matter, the case has no bearing on the outcome of the present one and we do not, for that reason, refer to the detailed argument which was presented based upon it.

In the result we reject the submissions based upon a supposed common assumption.

The effect of the 27 October 1983 notice

There is then the effect of the notice dated 27 October 1983 to St Martins executed under the common seals of Grollo Australia and Grofam. By it the two Grollo companies ``confirmed'':

``1. Whatever contracts have heretofore been entered into in respect of the above Project by Grofam have been so entered into at the request and direction of Grollo [Grollo Australia]; and

2. All moneys paid pursuant to the contracts mentioned in 1 above to Grofam have been so paid on Grollo's direction and received by Grofam on Grollo's behalf.''

The questions to which the execution of the notice gives rise must be approached upon the basis of the conclusions so far reached. In other words there was no arrangement whereby the profit earned on the Project was to be treated as received by Grollo Australia and there was no common assumption that that was the case. All this points to the position being one under which any profit was earned by Grofam and not Grollo Australia. Upon the basis of those conclusions, the question is whether the notice can have any effect in this case. In our opinion it cannot. An over simplified way of putting the matter is to say that the notice cannot bind the Commissioner. But the real reason it cannot is because the Act operated upon the moneys which were received by Grofam in relation to the project. In particular the amounts which were received were assessable income, i.e. income according to ordinary concepts, under s. 25 of the Act. To ascertain the taxable income of Grofam (s. 6) it was necessary for allowable deductions under s. 51 and perhaps other sections of the Act to be taken into account. It is perfectly true that there are questions concerning the determination whether there was any assessable income for the year ending 30

ATC 4603

June 1983 or the period 1 July 1983 to 27 October 1983. Those matters need to be dealt with separately. In our opinion they raise difficult questions for consideration. All we are saying at the moment is that, if it be correct to say that profit was earned as a consequence of the building operations which were being undertaken by Grofam during those two periods, the profit was Grofam's profit and not that of Grollo Australia. Whatever the meaning and effect of the notice of 27 October 1983 may have been intended to be, it could not change that situation as against the Commissioner because the Act had operated upon the situation before the notice came into effect. The notice purports to have a retrospective effect. As between the parties it may have had that effect. That is not the point. The question is whether it could affect the rights and obligations of Grofam and Grollo Australia under the Act. In our opinion it could not. The income or profit received by Grofam during the period vested in it. That is what the Act operated on. Furthermore, the income year ended 30 June 1983 was over before the notice was executed as indeed it was when Mr Dowding wrote his letter of 19 August 1983.

A number of arguments were put in relation to the notice. Questions of its proper interpretation were raised. There was also a question concerning its purpose. It was suggested by counsel for the Commissioner that its real purpose was as a reassurance to St Martins that the new arrangement, i.e. the arrangement whereby on and from 27 October 1983 Grollo Australia was to become the builder in place of Grofam, would not involve St Martins in any double payments. When one looks at the other documents which were executed on 27 October 1983, one gains the impression that, if the notice of 27 October 1983 were given the meaning and effect contended for by counsel for the appellants, there would be an inconsistency between the notice, on the one hand, and a number of the other documents on the other. This consideration would tend to support the submission made by counsel for the Commissioner that the purpose and effect of the notice of 27 October 1983 was not that contended for by counsel for the appellants but rather that it was intended as a reassurance to St Martins that there would be no double payment involved in its agreeing to the new arrangement.

This matter was referred to by his Honour in para. 58 of his reasons. He there referred to the evidence of St Martins' solicitor, Mr Gibb, who said that the purpose of the notice was to ensure that the change of arrangements would not involve St Martins in a double payment. Whilst his Honour thought this a reasonable precaution, he also said that, if that were the intention of the document, it was ``singularly unsuccessful in conveying that meaning''. In our opinion the critical part of the notice for present purposes is the latter portion of para. 2 in which it is said that all moneys paid pursuant to the contracts mentioned in para. 1 were received by Grofam on Grollo's behalf. In fairness to the submissions made on behalf of the appellants, we think it difficult to escape the conclusion that these words were intended to affect retrospectively what had gone before. It is true that the notice is addressed to St Martins. It is not itself an agreement between Grollo Australia and Grofam. A better view may be that its purpose was to inform St Martins of what the two companies had subsequently agreed. For the various reasons earlier given, it cannot reflect a common assumption or understanding which existed all along. That would be inconsistent with the joint venture agreement and with the letters of 30 March and 19 August 1983 earlier referred to.

In our opinion, his Honour was correct in his view that the notice of 27 October 1983 did not affect the previously existing position. But we think that the most satisfactory reason why that is so is because the income in question had already vested in Grofam. It was free to make such arrangements about it as it wished and to enter into such agreement with Grollo Australia as it deemed appropriate even if the agreement purported to affect what had gone before. But none of those acts could have any bearing on the fact that the income, if income there was, was received by Grofam with the consequence that it was bound to include it in its assessable income.

Basic approach and emerging profit and estimated profits bases

The next matter to be considered is the question of how one approaches the task of ascertaining whether any profit was indeed made by Grofam in carrying out the work on the project in the period 1 July 1982 to 27 October 1983. It was suggested that there were three possible ways in which this problem could

ATC 4604

be approached. The first was in accordance with what was described as the basic approach, the second in accordance with the estimated profits basis, and the third in accordance with the emerging profit basis. We shall endeavour to explain each of these expressions.

The starting point for that exercise is reference to an income tax ruling number IT 2450 entitled ``Income Tax: Recognition of Income from Long-Term Construction Contracts''. The ruling is dated 1 October 1987, i.e. after the income periods in question here. Provisions of the Act which were considered in relation to the making of the ruling were ss. 25, 51, 28-31, 170(9), 223, 227(3), 263 and 264.

In the CCH volume of Income Tax Rulings for the year 1987 it is noted (at 12,022) that, according to the CCH Digest, the ruling states the principles and practices which are to apply in bringing to account for income tax purposes income derived from long-term construction contracts. Two methods were said to be acceptable for accounting for long-term construction contracts provided that whichever one was chosen was used consistently in relation to all years during which the particular contract ran and to all similar contracts entered into by the taxpayer. The two methods were the basic approach and the estimated profits basis. The basic approach was one pursuant to which all progress and final payments received in a year (including amounts billed or entitled to be billed in that year) were to be included in assessable income and income tax deductions were allowed for losses and outgoings to the extent permitted by the income tax law.

The estimated profits basis permitted a taxpayer to spread the ultimate profit or loss on a long-term construction project over the years taken to complete the contract provided the basis was reasonable and was in accordance with accepted accountancy practices. The ultimate profit or loss was in effect notional taxable income expected to arise under a particular contract. This could be spread over the years taken to complete the contract. The amount could be adjusted from year to year to reflect changes caused by increases in material and labour costs, industrial problems, delays and so forth. The note says that the Commissioner did not accept what was described as ``the completed contract basis'' of accounting, i.e. the bringing of profits and losses to account only on completion of a contract. This is the emerging profit basis for which the appellants here contend.

The ruling is not binding on the parties or the Court. It is an indication of the Commissioner's approach to this problem. Taxpayers are free to apply it or, if not satisfied with it, to object to assessments based on it and to invoke the appropriate appeal process to have the matter tested. In a moment we shall refer to some authorities which provide guidance as to the principles to be applied generally to a problem of this kind. Although the cases are helpful, they do not deal with this particular problem. They do say that the question is a question of law and not a question of fact. Nevertheless, they also say that it is relevant to take into account accountancy practices which are relevant to the problem and which may provide guidance to the Court in reaching its conclusion.

In its introductory remarks, the ruling says that little had issued out of National Office by way of statement of principle on the basis of returning income from long term construction projects. Income Tax Order No. 128 dated 11 December 1915 had said that, in the matter of uncompleted contracts, where progress payments were made, it had been decided to levy tax in the same manner as was adopted in the State Department in Victoria, i.e. on the actual estimated profits or income made in the specific year in which tax was based without regard to the amount of progress payments made. In other cases where several contracts might be in varying stages of advancement and progress payments were made in each, a fair estimate was thought to be possible of the profits made at a definite date. Even if this estimate for the 12 months were a rough one, the balance of profits would come into the taxpayer's income in the year in which the contract was completed. It was said in the ruling that it was apparent that the current Act proceeded on the basis that, in relation to contracts extending over more than one year of income, assessable income could include estimated amounts of profits and that estimated losses could be allowed as income deductions. This was said to appear from subsec. 170(9) of the Act.

Subsection 170(9) provides:

``Notwithstanding anything contained in this section, when the assessment of the taxable income of any year includes an estimated

ATC 4605
amount of income, or of profits or gains of a capital nature, derived by the taxpayer in that year from an operation or series of operations the profit or loss on which was not ascertainable at the end of that year owing to the fact that the operation or series of operations extended over more than one or parts of more than one year, the Commissioner may at any time within 3 years after ascertaining the total profit or loss actually derived or arising from the operation or series of operations, amend the assessment so as to ensure its completeness and accuracy on the basis of the profit or loss so ascertained.''

Section 170 is, of course, the section which deals generally with the amendment of assessments. It may be observed in passing that subsec. 170(9) uses the expression ``estimated amount of income''.

Of this subsection the income tax ruling said that it authorised amendment of assessments to ensure that income tax liability arising from contracts extending beyond one year of income was restricted to the ultimate profit or loss on the contracts and that estimated amounts of income upon which tax had been paid in relevant years fairly represented profits and/or losses attributable to the relevant years. The ruling then referred to Canberra Income Tax Circular Memorandum No. 639 (CM 639) which was issued in 1951. It stated three propositions. Firstly, in contracts which extended for more than one year of income, it was not permissible to defer the bringing of profits or losses into account until the contract was completed; secondly, the income tax law required all progress and final payments received in a year to be included in assessable income and income tax deductions allowed for losses and outgoings to the extent permitted by the income tax law; and thirdly, notwithstanding that that was so, any method of accounting which had the effect of allocating, on a reasonable basis, the ultimate profit or loss on a contract over the years taken to complete the contract would be acceptable.

The ruling said that it had been suggested from time to time that the approach outlined in the third point made above should be discontinued on the basis that it was not strictly in accordance with the requirements of the Act. This was not a matter which had been the subject of judicial consideration in Australia but the High Court of New Zealand had occasion to consider the basis of assessing profits from a contract extending over a number of years in
H.W. Coyle Limited v Commissioner of Inland Revenue (NZ) 80 ATC 6012 decided by Holland J.

The ruling summarised the findings of the Court. Part of the summary was to the following effect:

(a) Although there were alternative methods of accounting, each of which was based on proper accounting principles and resulted in profit being declared in different years, where the total profit of a long-term contract will be the same, nevertheless that cannot be the situation in determining what is assessable income.
(b) Each case must depend upon the terms of the contract and the provisions for payment in order to ascertain whether a profit, i.e. assessable income, had been derived at any particular stage.
(c) The contract provided the circumstances in which progress payments were to be made. If they were due then the profit in respect of the events had been derived.
(d) Finally, moneys which were entitled to be retained by the proprietor were not derived or earned and should not be included in assessable income until they were payable.

Coyle's case and the summary dealt with matters additional to the ones to which we have referred but they are not relevant to the circumstances of the present case. The summary appears to be an accurate summary of the conclusions of the Court in that case but, for completeness, we refer to some other remarks made by Holland J who said (at 6019-6020):

``The contractor, be he an individual, a partnership or a limited liability company, is no doubt concerned to know how he is progressing by way of profit or loss in respect of a long term contract. The Land and Income Tax Act, however, is concerned with assessing liability for tax on income derived during the fiscal year and as defined in the legislation. The results may well be different.

There is at present some difference of opinion in the accountancy profession as to whether in the case of long term contracts, the percentage of completion method is the

ATC 4606
appropriate method or whether the completed contract method is appropriate. I am satisfied from the evidence that the choice of method will vary according to the contract and that in many cases where there can be no accurate forecast as to whether an ultimate profit or loss will be incurred on the completed contract, it may be desirable to prepare accounts according to the completed contract method at least until the stage has been reached where the future end result of the contract can be reasonably accurately forecast. Where there is no reason to doubt that the contract is going according to plan and budget, there are considerable advantages in the adoption of the percentage of completion method as a means of accurately recording the financial position of the contractor at the end of each year.

I am satisfied that a large number of substantial contracting companies are adopting the percentage of completion method in presenting their accounts in relation to long term contracts, but in the end I find that I fortunately do not have to resolve any differences of opinion between the eminent chartered accountants and Professor of Accountancy who gave evidence before me on principles of accounting. My task is to apply the statutory provisions of the Land and Income Tax Act 1954, now the Income Tax Act 1976, to the Objector concerned and the particular contract.''

In para. 10 of the ruling it is said that, notwithstanding Coyle's case, the Act proceeds on the basis that the assessable income of taxpayers engaged in long-term construction projects may reflect estimated amounts of profits and losses and that the Act has been administered in this way since its inception. It was therefore not proposed to say that an approach which involved a different method of accounting which had the effect of allocating, on a reasonable basis, the ultimate profit or loss on a contract over the years taken to complete the contract was not necessarily acceptable. The ruling continued, ``What must be said, however, is that if this approach based on estimated amounts is to be accepted, attitudes of fairness and reasonableness must be adopted by both the Australian Taxation Office and taxpayers.''

The sentence quoted suggests that the ruling is somewhat narrower than at first sight it appeared to be. It seems that the only two bases which the Commissioner regards as available to taxpayers are the basic approach and the estimated profits basis. The matter, at least in the Commissioner's view, is not at large.

There were then set out the detailed provisions of the ruling. Amongst other things it was said that, as stated in CM 639, the basic approach was that all progress and final payments received in a year should be included in assessable income and income tax deductions allowed for losses and outgoings to the extent permitted by the income tax law. The ruling said that this approach seeks to treat taxpayers engaged in the long-term construction industry in the same manner as any other taxpayer in business. Reference was made to Henderson's case (
Henderson v FC of T 69 ATC 4049; 70 ATC 4016; (1968-1970) 119 CLR 612). The ruling said that, normally, progress payments under long-term construction contracts were made at specified times or stages of construction. It was not unusual, however, for an up-front payment of part of the contract price to be made to a contractor at the time of, or prior to, the beginning of the work. The reason why such a payment might be made was discussed and it was then said that, for taxpayers who use the basic approach in determining taxable income, up-front payments of the contract price or advance progress payments were assessable income in the same way as progress and final payments. The particular question with them was whether they could be said to be derived at the point of receipt or whether they should be regarded as unearned income in terms of the decision in
Arthur Murray (NSW) Pty Limited v FC of T (1965) 14 ATD 98; (1965) 114 CLR 314 and brought to account as and when work progressed.

There was then reference to retention sums. We do not trouble about that matter. Certain other matters were also dealt with and the ruling turned to the estimated profits basis which was said to permit a taxpayer to spread the ultimate profit or loss on a long-term construction project over the years taken to complete the contract provided the basis was reasonable and was in accordance with accepted accountancy practices. It was said that it was important in this context to understand what was meant by

ATC 4607

the expression ``ultimate profit or loss''. In one sense profit or loss was simply the result of the comparison between receipts and expenditure. In another sense it was a figure determined by the application of accountancy principles. The ruling made it clear that the expression was not used in either of these senses. Rather it was intended to refer to the overall taxable income expected to arise from a particular contract - it required the total receipts expected to be received under the contract to be regarded as assessable income and income tax deductions to be allowed for expected losses and outgoings to the extent permitted by the income tax law on the assumption that the losses and outgoings would actually be incurred over the period of the contract. The ruling continued, ``Ultimate profit or loss is in effect notional taxable income expected to arise under a particular contract and it is the notional taxable income which may be spread over the years taken to complete the contract. Another way of determining notional taxable income is to begin with the expected overall net profit or loss for accounting purposes and make appropriate adjustments for income tax purposes.''

It was said that a taxpayer deriving income from long-term construction projects was not irrevocably bound to the figure for profit or loss initially expected. It was something which could be adjusted from year to year, i.e. in each year of the contract the amount of notional taxable income might be determined according to expectations existing at the close of each year. It was said that there were a number of acceptable methods of allocating notional taxable income over the years taken to complete a long-term construction contract. Each sought to recognise notional taxable income in a manner that reflected progress of a contract. The particular method used would depend upon the nature of a contract. In a cost plus contract, i.e. a contract where the contractor was to be paid for agreed cost plus a percentage or fixed fee, the amount of notional taxable income to be included in assessable income in each year would be determined by ascertaining the percentage that notional taxable income bore to agreed cost in applying the percentage to costs incurred in a year. In fixed price contracts it would be a matter of determining the notional taxable income year by year and including an appropriate amount of the notional taxable income in assessable income of each year. Reference was made to Accounting Standard AAS11 (later to be referred to) which, in para. 11, suggested three alternative methods by which this might be achieved. Each was said to be acceptable to the Tax Office.

The ruling emphasised that it was a basic principle of the income tax law that liability to income tax was an annual event and, if it appeared at the end of a year of income that there was a profit element in the long-term construction contract regardless of the stage reached, the law operated so that an appropriate amount of the profit converted to notional taxable income must be brought to account. At the same time, so the ruling said, it was recognised that, in the very early stages of a long-term construction contract, it might not be apparent that the profits had been derived. The ruling continued, ``Even so, it is not accepted that, as a general proposition, there should be a threshold stage before which assessable income would be derived under long-term construction contracts.''

Reference was then made to CM 639 in which it was stated that the completed contracts basis was not an acceptable method for determining taxable income from long-term construction contracts. The ruling said that this was still the case. The reason that it was not acceptable was that liability to income tax had to be determined annually. In the case of long- term construction projects it was the position at the end of each year that had to be taken into account. Subsection 170(9), so the ruling said, was the mechanism provided in the income tax law to ensure that in the end result there was not an over-assessment of income tax liability. The ruling then discussed the detail of subsec. 170(9). It went on to deal with additional tax, particularly in the context of current tax audits and small businesses. We do not need to refer to the detail of the ruling in relation to these matters.

We next refer to the relevant accounting standard, AAS11. The Standard was expressed to have been issued in March 1983 and to have been re-issued in August 1987. So far as we can tell, there was no significant amendment of the Standard in the period between the original issue and the re-issue.

The Standard is issued by the Australian Society of Accountants and the Institute of Chartered Accountants in Australia. It is described as ``Accounting for construction

ATC 4608

contracts''. Clause 2 of the Standard contains a number of definitions. ``Construction contract'' means, inter alia, a contract relating to construction work and includes contracts to design, build, construct or produce. A ``Fixed price contract'' means a construction contract where the contractor agrees to a fixed total contract price or to a fixed charge per unit of work, whether or not the contract includes a rise and fall clause. ``Percentage of completion method'' means the method of profit recognition whereby profit is brought to account in proportion to work performed on a construction contract for each accounting period in which construction occurs.

In Clause 3 it is said that a major issue in accounting for construction contracts is the proper recognition of profit or surplus (total contract revenue less related costs) in each of the accounting periods over the period from the date at which the contract activity is commenced to the date when the contract activity is completed. In Clause 4 it is said that, in considering when profit should be recognised, two competing objectives needed to be reconciled. These were that profit ought to be recognised in a manner that reflects periodic accomplishment; and that profit ought not to be recognised until its existence is reasonably assured. Clause 5 says that the two methods commonly used to recognise profit from construction contracts are the percentage of completion method and the completed contract method. Under the percentage of completion method, profit is recognised in proportion to the progress on a contract for each period in which construction occurs. Under the completed contract method, profit is recognised when the project is substantially complete and remaining known costs and potential risks are insignificant in amount. Clause 6 follows this up by saying that, because of the uncertainty inherent in estimating costs to complete a project, especially during the early stages of the work on the contract, it is common practice for entities to carry the project at cost and to employ the percentage of completion method only after the contract has reached a given percentage of completion. Amongst other things, Clause 8 says that, in the case of fixed price contracts, the percentage of completion method is to be applied when all of a number of conditions are satisfied. These include the ability reliably to estimate total contract revenue to be received, the ability reliably to estimate the costs to complete the contract, and the capacity reliably to determine the stage of contract completion.

The provisions are emphasised in a section of the Standard under the heading, ``Method of Profit Recognition''. The relevant paragraphs are 36, 37 and 38. Paragraph 36 says that the amount of profit on fixed price contracts shall be recognised in accordance with the percentage of completion method when all of a number of conditions are satisfied. The conditions are:

(a) total contract revenues to be received can be reliably estimated;
(b) the costs to complete the contract can be reliably estimated;
(c) the stage of contract completion can be reliably determined; and
(d) the costs attributable to the contract to date can be clearly identified and can be compared with prior estimates.

Paragraph 37 deals with cost plus contracts and is not relevant for present purposes. Paragraph 38 provides that, if the conditions specified in para. 36 are not satisfied, either at the inception of a construction contract or during the course of it, no profit shall be recognised until they are so satisfied.

It is plain enough, upon the basis of what is to be found in paras 8, 36 and 38, that the Standard advocates the emerging profit basis. But it must be remembered that the Standard is concerned with accounting standards. It is not concerned with the requirements of the Act. The ultimate purpose of the Standard is to endeavour to ensure that the accounts of the body in question will accurately reflect the state of the body's affairs.

Sometimes the requirements of proper practice in relation to accounting will coincide with, or at least give guidance in relation to, the approach which should be undertaken in ascertaining assessable income, allowable deductions and taxable income. A reference to authorities later to be mentioned establishes that this is often the case. Nevertheless, a note of caution has to be sounded. In a CCH publication, ``Guidebook to Australian Accounting Standards'' (1991) said to be endorsed by the Australian Society of Certified Practising Accountants for use by its members in practice, it is said that the provisions of

ATC 4609

Australian Accounting Standard AAS3, ``Accounting for Income Tax (Tax-effect Accounting)'' may need to be considered in applying AAS11 having regard to Taxation Ruling IT 2450, ``as the completed contract method is deemed unsuitable for taxation purposes''. What has to be remembered is, as the ruling emphasises, that the ascertainment of assessable income and allowable deductions for income tax purposes is required by the Act to be approached on an annual basis. An attempt has to be made each year to make an assessment of assessable income and allowable deductions with a view to determining whether or not there is taxable income.

In
FC of T v Dunn 89 ATC 4141; (1989) 85 ALR 244, Davies J said (at ATC 4148; ALR 252) that, although ordinary accounting principles and practice are not determinative of the issue, they are relevant and may be influential. His Honour referred to Carden's case (
The Commissioner of Taxes (South Australia) v Executor, Trustee and Agency Company of South Australia Limited (1938) 5 ATD 98; (1938) 63 CLR 108), later to be referred to, and to Arthur Murray. However, he also said that there were instances where the law had adopted a view different from that of accounting practice. In this respect he referred, inter alia, to Henderson's case. Reference may also be made to the judgment of Gummow J in
Barratt & Ors v FC of T 92 ATC 4275 at 4277; (1992) 36 FCR 222 at 224 and to the judgment of Hill J in
FC of T v Citibank Limited & Ors 93 ATC 4691 at 4698-4702.

Counsel for the appellants referred to evidence given by accountants. The witnesses were Mr Talbot, Mr Thomson and Mr Douglas. Mr Talbot was called in the appellants' case. He is a member of the accounting firm of Price Waterhouse. Amongst other things, Mr Talbot said there was no accounting standard in force until the end of 1983. He said there were a number of alternative methods ``about''. According to his evidence, the most usual methods would have been either the percentage of completion or the completed contract method, both of which were common at the time. But he said that he understood that the basic approach was also used on occasions and he thought that there were variants in between those two approaches and possibly even other methods.

Mr Talbot was shown Grofam's income tax return for the year ended 30 June 1982. Mr Talbot accepted that the fees shown as received in that return included fees in respect of the Rialto Project which amounted to $57,000. All the fees, including those received in respect of the Rialto Project, were included in the return and all of the expenses for the relevant year were returned under ``expenses''. Mr Talbot agreed that that was an application of the basic approach. He agreed that the method was acceptable. However, it is plain on the face of Mr Talbot's evidence that he was not comfortable with that approach. He said that he would defer recognising some of the income until sufficient percentage completion had occurred or the contract had been completed. He would make a note on the accounts describing the accounting method which had been used.

The income tax return of Grofam for the year ended 30 June 1983 shows that it received $31.3 million in fees. There was some other income which brought its total income to $31.4 million. Expenses were $31.37 million leaving an operating profit of approximately $59,000. Mr Talbot's cross-examination proceeded upon the assumption that the fees paid to Grofam in respect of the Rialto Project during the 1983 year were included in the fees shown in the income tax return. Accordingly, Grofam had returned its income for that year in accordance with the basic approach. Mr Talbot was asked whether, in the light of the fact that Grofam had accounted in accordance with the basic approach during the 1982 and 1983 years, it would be proper accounting in years subsequent to 1983 to adopt a basis other than the basic approach. Mr Talbot said that it was always better to change to a preferable accounting method. He said the Standard was not in force at the relevant time but it was a better method and known to be such. Mr Talbot agreed that the basic approach, although not his preferred approach during the years 1982 and 1983, was ``a legitimate or acceptable accounting method to use''.

Mr Thomson is another member of Price Waterhouse also called by the appellants. In his statement he said that it was not acceptable accounting practice, either before or after the introduction of AAS11, to account for profit progressively upon a cash basis. His statement was made in the context of long term

ATC 4610

construction contracts. Mr Thomson would not accept that an appropriate form of accounting by Grofam for the 1982 and 1983 years was to return the payments that it had received and the expenses that it had paid in each of those years. He said that ``accrual accounting'' was a generally accepted accounting principle. He said that there were other accounting standards in other jurisdictions and that there was other material in which the question was discussed all of which indicated that the preferable accounting treatment was either percentage completion or completed contract. He said the basic approach, which he described as the cash basis of accounting, was not a generally accepted basis of accounting in preparing corporate accounts for accounting purposes.

Mr Douglas is also an accountant. He is a partner in Deloitte Touche Tohmatsu who practise as chartered accountants. In his statement he said that he had been asked to assume, amongst other things, that the accounting policy employed by Grofam as at 30 June 1983 was to account for uncompleted construction contracts in the profit and loss account by bringing to account progress claims and construction costs on those contracts as revenue and expenses in the year of income during which they were either claimed or incurred. Mr Douglas was called in the Commissioner's case. He said that, on the basis of the assumptions he had been asked to make, there was no basis whatever, in accounting theory or practice, on which Grofam could have failed to account, in its accounts for the year ended 30 June 1983, for profit derived by it from the Rialto Project in that year. He said that any profit earned by Grofam on those contracts should have been brought to account in the profit and loss account of the Grofam Unit Trust for that year by the inclusion of the progress payments as income and the building costs as expenses. In the course of his cross- examination, Mr Douglas agreed with counsel for the appellants that, if he had been asked about a company engaged in long term construction contracts which had been using the method of accounting assumed by him in his statement, he would have recommended that the company change that method. He agreed that, if he had been the accountant involved in the matter, he would not have continued to use the method involved, i.e. on the assumptions which had been put to him.

We have referred to this evidence because it is referred to in the written submissions made on behalf of the appellants. It is to be observed, however, that there is no mention made in the course of either Mr Hayes' (senior counsel for the Commissioner) cross-examination of Mr Talbot and Mr Thomson on the one hand nor in the cross-examination of Mr Shaw (senior counsel for the appellants) of Mr Douglas of there being any problem of applying the method which was advocated by counsel for the appellants and agreed as appropriate by each of the accountants in the context of the return of income in an income tax return. In other words, the distinction made by Davies J in Dunn's case was not adverted to nor was the opinion of any accountant sought in relation to that matter.

It is necessary next to refer to three decisions of the High Court. The first of these is Carden's case (supra). In the course of his judgment Dixon J (as he then was) said (at ATD 129-130; CLR 151-152):

``The question whether one method of accounting or another should be employed in assessing taxable income derived from a given pursuit is one the decision of which falls within the province of courts of law possessing jurisdiction to hear appeals from assessments. It is, moreover, a question which must be decided according to legal principles. In the dichotomy between questions of fact and of law upon which courts so continually insist in dealing with the problems of income tax they are called upon to solve, there are thus grounds enough for placing it under the category of questions of law. But it is, I think, a mistake to treat such a question as depending upon a search for an answer in the provisions of the legislation, a search for some expression of direct intention to be extracted from the text, however much it may be hidden or obscured by the form of the enactment.

Income, profits and gains are conceptions of the world of affairs and particularly of business. They are conceptions which cover an almost infinite variety of activities. It may be said that every recurrent accrual of advantages capable of expression in terms of money is susceptible of inclusion under these conceptions. No single formula could be devised which would effectually reduce to the just expression of a net money sum the annual result of every kind of pursuit or

ATC 4611
activity by which the members of a community seek livelihood or wealth. But in nearly every department of enterprise and employment the course of affairs and the practice of business have developed methods of estimating or computing in terms of money the result over an interval of time produced by the operations of business, by the work of the individual, or by the use of capital. The practice of these methods of computation and the general recognition of the principles upon which they proceed are responsible in a great measure for the conceptions of income, profit and gain and, therefore, may be said to enter into the determination or definition of the subject which the legislature has undertaken to tax. The courts have always regarded the ascertainment of income as governed by the principles recognised or followed in business and commerce, unless the legislature has itself made some specific provision affecting a particular matter or question.''

Later his Honour said (at ATD 130-132; CLR 153-155):

``It is, perhaps, true that with the growth of experience in the taxation of income and the widening of the area and increase in the weight of liability, the legislative tendency has been to add to the number of specific provisions governing the ascertainment of taxable income. But it is worth noticing that the British Income Tax Codification Committee decided that, in dealing with the computation of profits from businesses, their draft code should first contain a statement that the computation is to be made on ordinary commercial principles and should then set out a list of specific matters allowed or disallowed in computing profits for income tax purposes; (1936) Cmd. 5131, p. 49.

The tendency of judicial decision has been to place increasing reliance upon the conceptions of business and the principles and practices of commercial accountancy. In the case cited [
Sun Insurance Office v Clark [1912] A.C. 443], Lord Loreburn (at p 454) went even further than Lord Haldane at 455]. He said:- `There is no rule of law as to the proper way of making an estimate. There is no way of estimating which is right or wrong in itself. It is a question of fact and figures whether the way of making the estimate in any case is the best way for that case.'

But the process by which the principles and practices evolved in business or general affairs are drawn upon for the solution of questions presented to courts of law almost inevitably leads to a development in the law itself. For, under our system of precedent, a decision adopting or resorting to any given accounting principle or application of principle is almost bound to settle for the future the rule to be observed and the rule thus comes to look very like a proposition of law. But in some matters, particularly in the attribution of expenditure between capital and income, the courts have found it impossible to formulate a principle as an induction from commercial practice and have left the matter almost as much as ever in the realm of fact or discretionary judgment. Thus, in
Lothian Chemical Co. Ltd v Rogers (1926) 11 Tax Cas., at pp. 520-521 Lord Clyde says:- `It has been said times without number - it has been said repeatedly in this Court - that in considering what is the true balance of profits and gains in the Income Tax Acts - and it is not less true of the Act of 1918 than of its predecessors - you deal in the main with ordinary principles of commercial accounting. They do expressly exclude a number of deductions and allowances, some of which according to the ordinary principles of commercial accounting might be allowable. But where these ordinary principles are not invaded by statute they must be allowed to prevail. It is according to the legitimate principles of commercial practice to draw distinctions, and sharp distinctions, between capital and revenue expenditure, and it is no use criticising these, as it is easy to do, upon the ground that if you apply logic to them they become more or less indefensible. They are matters of practical convenience, but practical convenience which is undoubtedly embodied in the generally understood principles of commercial accounting.'

In the present case we are concerned with rival methods of accounting directed to the same purpose, namely, the purpose of ascertaining the true income. Unless in the statute itself some definite direction is

ATC 4612
discoverable, I think that the admissibility of the method which in fact has been pursued must depend upon its actual appropriateness. In other words, the inquiry should be whether in the circumstances of the case it is calculated to give a substantially correct reflex of the taxpayer's true income. We are so accustomed to commercial accounts of manufacturing or trading operations, where the object is to show the gain upon a comparison of the respective positions at the beginning and end of a period of production or trading, that it is easy to forget the reasons which underlie the application of such a method of accounting to the purpose of ascertaining taxable income. Although the field of profit-making which it covers in practice is probably much greater than any other among the manifold forms of income or revenue, it is a system of accounting which does not represent the primary or basal position from which an investigation of income for taxation purposes begins. Speaking generally, in the assessment of income the object is to discover what gains have during the period of account come home to the taxpayer in a realised or immediately realisable form.''

The second decision of the High Court to which reference needs to be made is that in
XCO Pty Ltd v FC of T 71 ATC 4152; (1971) 124 CLR 343, a decision of Gibbs J (as he then was). In the course of his judgment Gibbs J said (at ATC 4156; CLR 351) that, in the absence of some definite direction in the Act, the Commissioner should in an assessment of income, adopt the method of accounting which is in fact appropriate to the circumstances of the case, or which in other words ``is calculated to give a substantially correct reflex of the taxpayer's true income''. Reference was made to Carden's case at ATD 131; CLR 154. Gibbs J went on to say that, where the carrying out of a profit-making scheme extends over more than one year, the difference between receipts and disbursements in any one year may not give a true reflection of the profit arising or loss sustained in that year and the assessment of profit on an ``emerging basis'' might be appropriate. The emphasis is supplied.

Finally, reference should be made to the decision of the High Court in
Brent v FC of T 71 ATC 4195; (1971) 125 CLR 418, another decision of Gibbs J. Gibbs J again referred (at ATC 4200; CLR 428) to Carden's case. He continued (at ATC 4200; CLR 428) by saying that the Court in that case was concerned with the question whether an accounting on an earnings basis appropriately reflected the professional income of a medical practitioner as regards each year which had ended before the death. It was held in respect of those years that his professional income was properly assessed upon actual receipts. Dixon J had said (5 ATD at 132; 63 CLR at 155) that, speaking generally, in the assessment of income the object was to discover what gains had, during the period of account, come home to the taxpayer in a realised or immediately realisable form.

The authorities to which we have referred have been dealt with in a number of later cases. We do not find it necessary to refer to these except to say that, in Henderson's case, reference is made by Windeyer J at first instance (at 69 ATC 4050; CLR 619) to both Carden's case and the Arthur Murray case. Barwick CJ, who wrote the principal judgment of the Full Court, referred to Carden's case at 70 ATC 4018; CLR 646 and 647. None of these references affects the principles for which the case is authority. It is well known and it has been applied in a number of contexts. The only other matter which we mention at this point in relation to the authorities is that none deals with a problem of this kind; in other words none deals with the ascertainment of the income of a taxpayer engaged in the building industry which undertakes long term building contracts. Carden's case provides general guidance in a matter such as this, but that is as far as it goes.

Counsel for the appellants submitted that the emerging profits method of accounting, rather than the basic approach method, was calculated to give a substantially correct reflex of the taxpayer's true income, thus adopting the language of Dixon J in Carden's case. A number of matters were said to support that conclusion. These were:

(a) In circumstances where income is to be derived from construction work that is to be carried out over a number of years, the difference between receipts and disbursements in any one year may produce a result that is quite different from the true profit (or loss) that will be derived from the whole of the work. To treat receipts and expenses as income derived and outgoings incurred in each year in which they occur

ATC 4613
may well be a distortion of the true income (or loss) derived from the whole of the construction work. Reference was made to subsec. 170(9) of the Act which has been earlier quoted. It was said that assessments made by adopting the profit emerging basis might be amended once the construction work was completed, if necessary, to reflect the actual income or loss. It will be recalled that the subsection uses the expression ``an estimated amount of income derived by the taxpayer''. It does not use the expression ``the profit emerging basis'' or any similar expression. It may be that counsel intended that the expression ``profit emerging basis'' should be given the same meaning as the meaning to be attached to the expression ``estimated amount of income'' in subsec. 170(9). But we find it difficult to perceive what assistance the appellants' case can derive from the subsection.
(b) The application of a profit emerging method of accounting in the circumstances of this case accords with proper accounting principles. Reference was made to the accounting standard, particularly to paras 36 and 38 thereof earlier mentioned and to the accounting evidence to which we have referred. It was submitted that, although accounting principles and practice were not determinative of the outcome, they were relevant and could be influential.
(c) Reliance was placed on the evidence of a Mr Tasker, who was the cost consultant and quantity surveyor for the Rialto Project. He had the responsibility for the care and conduct of the work undertaken by the firm in which he was a member, Rider Hunt & Partners, on behalf of the joint venture. Mr Tasker referred to the fact that risks associated with the construction of the Rialto Project were extremely high. Accordingly, in his opinion, the costs to complete the construction could not be reliably estimated by the builder until the project was approximately 90 per cent complete, which occurred early in 1986. Counsel said that the high risks associated with the project and the inability reliably to estimate the costs to complete the construction until the project was approximately 90 per cent complete provided cogent support for the submission that the emerging profits method of accounting rather than the basic approach gave the correct reflex of the income derived from the construction of the Rialto building. Counsel said that, at the very least, these were relevant matters to which the Tribunal failed to give any consideration.

In its treatment of the matter the Tribunal referred to the decisions in XCO and Brent. As his Honour said, whilst the principles are clear enough, their application in any given context is not necessarily straightforward.

His Honour summarised the facts which he thought relevant to the question of what method of accounting was appropriate to the circumstances of the case. The matters upon which his Honour relied follow. We have added some remarks of our own. These appear in parenthesis.

(a) In 1979 the Commissioner requested one of the Grollo companies, L. Grollo & Co Pty Limited, to supply details of the manner of treatment of progress claims received in relation to uncompleted contracts. Touche Ross replied on 10 September 1979 on behalf of the company. Amongst other things the letter said that progress claims received by the company on uncompleted contracts had been brought to account as assessable income in the year of income during which they were claimed. They were generally brought to account as income in the year of receipt. Two exceptions were mentioned, they being sums claimed in one income tax year but not received until the following year, and retentions.
(b) In the 1960s and 1970s the Grollo Group had undertaken many large construction jobs including large commercial buildings in the City of Melbourne, sewerage and other water works, bridges, canals and airstrips. Mr Rino Grollo agreed that the invariable practice of the Grollo companies prior to 1983 was to return payments received and to claim as deductions expenses paid in the year in which those payments were received or expenses incurred regardless of whether the contracts were completed or not. (That is borne out by Grofam's 1982 and 1983 returns.)
(c) No separate records were maintained within the accounts of Grofam for the Rialto Project.

ATC 4614
(d) Grofam's 1982 and 1983 accounts were prepared using the basic approach. (There can be no issue about this.)
(e) In its 1983 income tax return Grofam disclosed fees received of $31.3 million and expenses of $31.3 million. We have earlier referred to this. The accounts were finalised by Mr Dowding. He suggested one adjustment. That was the sum of $3.5 million which Mr Dowding estimated as the surplus from the Rialto Project. This sum was transferred by journal entry to Grollo Australia. It is shown in Grofam's journal as ``est. profit on Rialto contract to 30/6/83 - agreement with G.Aust''. (The entry was made by a Mr Vine who was an accountant employed by one of the Grollo companies. Mr Vine's evidence was that the terms of the entry were given him by Mr Dowding.)
(f) Grofam had undertaken a series of fixed sum contracts for the joint venturers. No single contract was of any great magnitude in terms of the overall project.
(g) Grofam's 1983 income tax return was dated 23 December 1983. By that time Grofam had ceased to be the project builder. The notice to St Martins of 27 October 1983 had been executed. Grofam continued on as builder but under a contract with Grollo Australia rather than with that company and St Martins as joint venturers.

Upon the basis of these conclusions, his Honour said that, on the facts of the case, it was entirely appropriate that, for the year ending 30 June 1983, Grofam's accounting treatment of the Rialto receipts and expenditure should be in accordance with the basic approach. His Honour further said that, in his opinion, it was not too early for Grofam to have returned a profit from the Rialto Project in the year ending 30 June 1983.

Despite the assertion of counsel for the appellants that Carden's case is authority for the proposition that the question here to be resolved is a question of law, we have some reservations whether this is truly the case. Dixon J said in Carden's case that a question such as this is a question of law. But his Honour said what he did in the context of his substantial treatment of the approach that was to be followed in dealing with a submission such as this. Of course he was not concerned with a submission made in a case of this kind. The case before him was concerned with a different area of activity. He was not concerned with income or profit arising as a consequence of the carrying out of a long term building contract. Nevertheless, what his Honour said has provided general guidance to courts dealing with difficult problems relating to the ascertainment of assessable income in a variety of contexts. The important matter to notice about what his Honour said is that he did not shut out reference to accounting principles or to the opinions and practices of accountants in a context relevant to the particular problem in hand. In the view we take of the matter, we do not need to decide whether or not there is here involved a question of law. That is because we have reached the conclusion that the appeal in relation to this aspect of the case must fail whether or not it is on a question of law.

There are a number of reasons for this. The accounting evidence to which reference has been made shows that the basic approach is an acceptable method of accounting although it may not, in a variety of cases, provide as true a reflection of whether there has been a profit or a loss in the early stages of a long term building contract. What is important in this case is that the basic approach was the approach invariably followed by companies in the Grollo Group over the years. We say ``invariably'' mindful of the fact that the evidence does not disclose the practices of the Group in every case for every year of income. But the accounting and other evidence suggests that what we have said was the case.

In some circumstances it may not be helpful to say that a company should know its own business best. But here the Grollos were always advised by accountants. The picture of their affairs we have is that they were not loosely arranged. Every project that was undertaken was undertaken with due regard to its financial consequences including its taxation consequences. Nothing seems to have been done without taking advice. It was the practice of the Grollo Group to account for tax purposes in accordance with the basic approach. That appears clearly from the terms of the Grofam returns for the 1982 and 1983 years. The question we have asked ourselves is, why, that being the case, there is any reason to depart from the accounting method adopted by the Grollos themselves which, as we say, is an acceptable accounting method.

ATC 4615

Then one must be careful to bear in mind the nature of the exercise which is involved. It is the ascertainment of the amount of the taxpayer's taxable income. This is to be arrived at by ascertaining the amount of the assessable income and then the amount to be deducted from it in respect of deductions and losses allowable under the Act. This is a matter that is emphasised in the Commissioner's Taxation Ruling IT 2450. In our view, it was right that it should be emphasised. As Holland J said in Coyle's case in the passage quoted from his judgment, the court's task is to apply the applicable provisions of the relevant income tax statute to the taxpayer and the particular contract. The fact that this is so may, as we have earlier indicated, on occasions lead to an income tax return being prepared in accordance with different rules and principles from those which would be applied in reporting accurately on a company's financial position either at a given date or during a particular accounting period in its balance sheet, profit and loss account and other financial statements.

The Commissioner saw the need for some relaxation of a strict application of the basic approach. He indicated in his ruling that in some circumstances he would accept another method, namely the estimated profits basis. That would allow a taxpayer engaged in carrying out a long term contract to make an estimate of the expected profit from a contract and to apportion this over the period the contract was expected to run. Estimates could be revised from time to time to allow for changes in the outlook which occurred after the original estimates were made. Subsection 170(9) of the Act permitted this course.

But the estimated profits basis is not the method for which the appellants here contend. Nor, upon analysis, is it the method provided for in the relevant accounting standard, AAS11; see particularly paras 36 and 38 thereof earlier referred to. These paragraphs, notwithstanding their language, advocate, not the estimated profits basis but the emerging profit basis. The accounting evidence is in accordance with this approach. That method involves a wait and see approach. Only when it is fairly clear that the outcome of the contract is likely to be profitable is any element of profit or gain brought to account. That approach is readily understandable in an industry as volatile and uncertain as the building industry is. It is no doubt a sensible basis from the point of view of the company itself, its shareholders and its creditors. Nevertheless, we think it difficult to discern anything in the income tax legislation which allows such a method to be used in returning income for tax purposes, an exercise that has to be done each year. Subsection 170(9) of the Act will not help because the most that it contemplates is the inclusion of an estimated amount of income derived by the taxpayer in the relevant year from an operation, or series of operations, the profit or loss in which was not ascertainable at the end of the year owing to the fact that the operation, or series of operations, extended over more than one year.

It is to be noted that the estimate is not of profit but of income. That is in accordance with the overall approach of the Act which is to ascertain assessable income and allowable deductions and thus the resultant taxable income. If a company engaged in the carrying out of a long term building contract receives an excess of what is apparently assessable income for the year of income in question over the amount of allowable deductions, the result the Act calls for is for the excess to be treated as taxable income. It is true that this statement may represent an oversimplification of the matter. There may be reasons even under the legislation why particular moneys received by a taxpayer ought not to be treated as received as income in a particular year. We do not need to go into this, but payments may be made in advance, they may represent retention sums, or they may be earmarked for further expenditure or application to take place or to be made in subsequent years. And, on the other side of the account, there may be provisions for various contingencies which will properly be allowed as deductions. We mention these matters only to show that we are conscious that the statement which we have expressed in absolute terms may need some qualification. The point we make is that, subject to those matters, the Act requires the account to be made on an annual basis so that taxable income may be brought to tax for each of the tax years in question.

A further and independent matter that needs to be addressed is that the appellants have not in this case really made the case they purport to espouse. There was no submission put to the Court which purported to demonstrate how, in this case, the emerging profit basis was to be

ATC 4616

applied. Unless one had some means of understanding how the matter was to be approached in detail, as distinct from generally, one could not reach a conclusion on whether it would provide a true reflection of the assessable income earned by Grofam in the periods in question. The submission relied on more general grounds saying that the basic approach was an entirely inappropriate method to apply. This, coupled with the fact that it was far too early in the history of the contract to reach any conclusion on the question whether the contract would ultimately prove profitable, was said to justify the upholding of the objection. That, in our opinion, cannot be correct. That is because the appellants' submissions do not come to grips with the particular circumstances of this case.

That is enough to lead to the conclusion, already foreshadowed, that the appellants' case fails on this aspect of the matter. But there is another and really more compelling factor which applies in relation to the 1983 year of income. It is the transfer by journal entry of the sum of $3.5 million from Grofam to Grollo Australia. This may have been done in order to give effect to the arrangement which was thought to exist or to have been brought about by the notice given to St Martins on 27 October 1983. There is no finding about this matter. Whatever the reason may have been, it is clear in our opinion, that the amount was transferred because it was surplus to needs. Plainly it represented an excess of assessable income over allowable deductions. There is no other view reasonably open. His Honour concluded that the taxable income of Grofam for the 1983 year was $3.5 million. Subject to one further submission which needs to be dealt with, we are unable to detect any error in his Honour's conclusion. Certainly we can detect no error of law.

There is one final matter to be mentioned. It is not surprising that a sum of $3.5 million should find its way from Grofam to Grollo Australia in the circumstances which existed. It will be recalled from the early part of these reasons that it was the practice of the Grollo Group to build at a cost which was usually less than the contract price. In more recent years, the Grollos developed an interest in investing in property and of undertaking building work wholly or partly on their own behalf. In the present case they intended, if they could, to provide the contribution which Grollo Australia was bound to make available under the Joint Venture Deed from excesses of progress payments over expenses, the idea being that their 12.5 per cent share would be paid in this way rather than by an actual contribution made by one or other of the Grollo companies. That again suggests that all along they intended to achieve a situation in which there would be, so far as possible, a substantial surplus of payments or income over expenses. Such a situation called, in our opinion, for the adoption of the basic method of accounting which is advocated by the Commissioner in this case and is indeed the method which the Grollos themselves applied.

For these various reasons, we are satisfied that the submissions made by counsel for the appellants that there was no taxable income earned by Grofam in the 1983 year of income nor during the period 1 July 1983 to 27 October 1983 should be rejected.

Deliberate understatement of income

There is a question whether or not the understatement of income which we have found established was made deliberately. There are written submissions about this subject which we have considered. In the circumstances we do not think there can be any doubt about the answer to the question. Plainly the failure to disclose the surplus income in the two periods was done deliberately. That, however, is a conclusion of fact, not of law. No question of law is involved in relation to this aspect of the case. His Honour's findings were clearly open to him on the evidence which was before him.

There are some consequential questions to be dealt with arising from the terms of the relevant legislation. We deal with these later on under the heading ``Additional Tax''.

Deduction of amounts paid by Grofam to Grollo Australia

The appellants submitted that, if it were found that Grofam did derive income or profit from the construction of the Rialto Project in the two periods in question, it should be entitled to claim the amounts of those profits or income as deductions under s. 51 of the Act, not in the 1983 year of income but in the 1984 year of income. That, so it was submitted, was because, by reason of the notice of 27 October 1983 and the four building contracts that were executed on that date, Grofam was obliged to account to

ATC 4617

Grollo Australia for any moneys not spent by it on the construction work. It was submitted that that obligation followed as a matter of law from the fact that the moneys received by Grofam from the work carried out on the construction of the Rialto building up to 27 October 1983 were received by it on behalf of Grollo Australia.

The submission really relies for its validity upon the true meaning and legal effect of the notice of 27 October 1983. Those indeed are the words of the submission. That takes one back to the considerations which were discussed when the legal effect of the notice of 27 October 1983 was being considered. For similar reasons given in relation to that aspect of the case, we would reject the submissions made about the deductibility of the payments made by Grofam to Grollo Australia in the 1984 year of income.

That then completes the treatment of the matters which arise for decision in relation to the period prior to 27 October 1983. Each of the submissions made on behalf of the appellants is rejected.

The years after 27 October 1983

We turn next to the period after 27 October 1983. A principal question which arises for decision is whether his Honour was correct in upholding the Commissioner's case that he was entitled to invoke the provisions of Part IVA of the Act because there was a scheme to which that Part of the Act applied. But the appeals both by the appellants and the Commissioner raise other questions. The Commissioner took the view that he was entitled to assess the income tax which he contended was due either to Grollo Australia or Grofam or, more correctly, to the trusts or beneficiaries either of the Grofam Family Trust or the Rialto Family Trust. Alternative notices of assessment were issued. The Commissioner submitted that it was open to him to elect which of the assessments would be enforced. For this purpose he relied on the decision of the High Court in
DFC of T v Richard Walter Pty Ltd 95 ATC 4067; (1995) 183 CLR 168 where it was held that the Commissioner may issue assessments on an alternative basis to different taxpayers in respect of the same income. The fact that the taxpayer and another person received assessments relating to the same amount of income did not evidence bad faith or improper purpose on the part of the Commissioner or mean that the taxpayer's assessment was tentative and not definitive. The parties accepted that the decision in Richard Walter authorised the course which the Commissioner had taken. It was a course contemplated in the terms of settlement earlier referred to.

Richard Walter was considered by the Full Court of this Court in
FC of T v Stokes 97 ATC 4001; (1996) 141 ALR 653. It was distinguished in that case upon the basis that the alternative assessments issued in Stokes were issued, not to different taxpayers, but to the same taxpayer. The case is accordingly of no relevance in the present circumstances.

As mentioned, his Honour upheld the Commissioner's submissions in relation to Part IVA of the Act but did not uphold them, at least fully, in relation to the assessment issued against Grollo Australia. His Honour concluded that the Commissioner was in error in including the totality of the income in the Grollo Australia assessments and said that the amounts to be included in those assessments were one-half of the moneys which were received. Essentially his Honour's reasons for that conclusion were that, Grollo Australia, being both owner and builder, could not be said to have derived income from the receipt of money which represented in effect the half of the construction payments contributed by itself. Counsel for the Commissioner challenged his Honour's conclusion in this regard. In their submission, the assessments issued against Grollo Australia were correct and should not have been reduced. On the other hand, counsel for the appellants submitted that no moneys received by Grollo Australia in respect of the project after 27 October 1983 were on revenue account. In their submission all amounts received were received on capital account. It follows that the matters to be dealt with in relation to this aspect of the case are:

(a) whether his Honour was in error in applying the provisions of Part IVA of the Act to Grofam;
(b) whether his Honour was correct in concluding that only one-half of the amount received by Grollo Australia after 27 October 1983 was income in its hands;
(c) if not, whether the entirety of the amount received by it after 27 October 1983 was received as capital and not as income.

We propose to deal with these questions in the order in which we have set them out. Before we do so, we make some general comments.

ATC 4618

In questions (b) and (c) we have referred to the amount received by Grollo Australia. This needs some explanation. The various questions arise in the context of the building of the Rialto Project by two joint venturers, St Martins and Grollo Australia, which each had a half interest in the project and which were each required to contribute one-half of the cost of the project. The funds for it were to come from borrowed money and from contributions by each joint venturer of what was described as ``equity''. Seventy-five per cent of the total funds required were borrowed from Porkellis Finance. Each joint venturer was responsible for half the borrowed amount. Each was also obliged to provide one-half of the remaining 25 per cent. At the conclusion of the building work, the joint venturers would own the Rialto buildings in equal shares. Each could retain its share as an investment or sell it as it deemed appropriate.

So far as the evidence discloses, St Martins did provide its 12.5 per cent share of equity and Porkellis Finance did advance 75 per cent of the contract price. Grollo Australia did not, however, provide its share of the equity in money. That was because it was envisaged all along that it would attempt to carry out the building work (in the period up to 27 October 1983 procure Grofam to carry out the building work) for no more than the moneys provided by St Martins and Porkellis Finance. Its unborrowed share of the equity, 12.5 per cent of the contract price, would be provided in this way. So far as one can tell, that is what occurred. At least that is the assumption upon which the case was argued in the Tribunal and before us. However, it would be surprising if the reality of what occurred was as we have said.

Reference has earlier been made to the role of L. Grollo Nominees as the Group's banker. All payments were apparently received by it and all disbursements were met by it. They were not necessarily met directly. In some cases they were met by the company which had incurred the expenditure with moneys provided to it by L. Grollo Nominees. The Group consisted of a large number of companies. Through one or another of these the Group employed labour. It had at its disposal construction equipment of all kinds. Some of this was quite elaborate and extremely expensive. Not all the equipment was owned; some may have been hired or leased from outside sources. Everything was done at cost. No Grollo company made any profit (or we imagine loss) in any dealing it had with any other member of the Group. Such accounts as we have seen appear to have been designed to show either a break-even situation or small profits as in the case of Grofam's accounts earlier referred to. Behind all this was the strategy of constructing buildings which would, once completed, be owned wholly or partly by the Grollos. The policy was to turn everything into capital.

As we understand the case made by Grollo Australia here, it is that, despite its obligation to contribute to the joint venture by providing 12.5 per cent of the required cost of the venture, it in fact paid nothing by way of money except its half share of the money borrowed from Porkellis Finance. It discharged its obligation by producing the buildings which made up the project upon completion of the building work. St Martins and Grollo Australia owned the land as tenants in common. At the conclusion of the contract the value of the land had substantially increased because of the buildings which then stood upon it.

So the appellants' case, in respect of the years of income after 27 October 1983, was that the Commissioner was in error in purporting to apply the provisions of Part IVA of the Act to Grofam and in error in including in the assessable income of Grollo Australia moneys received by it to enable the building project to be completed because all such moneys were received on capital account. Undoubtedly after 27 October 1983 Grollo Australia received moneys for the purpose of the contract, namely, the moneys which were borrowed from Porkellis Finance and the moneys which were provided by St Martins. It provided half the borrowed moneys as a consequence of its commitment to Porkellis Finance and notionally provided 12.5 per cent of the cost by completing the building for 87.5 per cent of the contract price.

We have said what we have in order to indicate that there is a degree of over- simplification in the way in which the matter has been so far approached. We do not think anything turns on this because the parties proceeded on the assumption that the matter could be looked at simply. It was to be treated as one in which St Martins provided half the cost made up of half the borrowed moneys and

ATC 4619

its 12.5 per cent equity contribution, and Grollo Australia provided half the moneys by providing half the borrowed moneys and its share of the equity, although this was provided in a sense notionally because of the manner in which the contract was carried out and the transaction proceeded. We propose to proceed upon this basis. Whether there are questions lurking in the background concerning what actually happened having regard to the complex nature of the way in which the Grollo affairs were carried on is not a matter that we have considered. The available material and the submissions made by the parties would not enable that to be done.

Part IVA of the Income Tax Assessment Act 1936

We turn then to the issues which arise under Part IVA of the Act. The central provision of Part IVA of the Act is to be found in s. 177F. That section, so far as material, provides that where a tax benefit has been obtained, or would but for the section be obtained, by a taxpayer in connection with a scheme to which the Part applies, the Commissioner may, in the case of a tax benefit that is referable to an amount not being included in the assessable income of the taxpayer of the 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. The expressions ``scheme'' and ``taxpayer'' are defined in s. 177A. ``Tax benefits'' are dealt with in s. 177C. It is also necessary to consider the provisions of s. 177D which deals with schemes to which Part IVA applies.

Subsection 177A(1) provides that in Part IVA, unless the contrary intention appears, ``scheme'' means 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 any scheme, plan, proposal, action, course of action or course of conduct. ``Taxpayer'' includes a taxpayer in the capacity of a trustee but, by subsec. 177A(2), this definition is not to be taken to affect in any way the interpretation of that expression ``where it is used in this Act other than this Part'', i.e. Part IVA. ``Taxpayer'' is defined in s. 6 to mean a person deriving income. It may be observed that the expression is thus apt to include a person who derives income but for one reason or another is not obliged to pay income tax. It seems that ``taxpayer'', where used in Part IVA, has the meaning ascribed to it in s. 6 and that, in the application of Part IVA, has additionally the extended meaning provided for in s. 177A. The provision is open to the construction that it excludes the application of the s. 6 definition to Part IVA but we think that the better view is that which we have stated. It may be observed that the definition of ``taxpayer'' in s. 6 is exhaustive; that contained in Part IVA is not.

Subsection 177A(3) provides that the reference in the definition of ``scheme'' in subsec. (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. Subsection 177A(4) provides that a reference to the carrying out of a scheme by a person is to be read as including a reference to the carrying out of a scheme by a person together with another person or other persons. Subsection 177A(5) provides that a reference in Part IVA 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 a scheme being entered into or carried out for two or more purposes of which that particular purpose is the dominant purpose.

The relevant provisions of subsec. 177C(1) are as follows:

``(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

...''

In a case to which para. (1)(a) applies the amount of the tax benefit shall be taken to be the amount referred to in that paragraph.

Subsection 177C(2) is relevantly as follows:

``(2) A reference in this Part to the obtaining by a taxpayer of a tax benefit in connection

ATC 4620
with a scheme shall be read as not including a reference to-

(a) the assessable income of the taxpayer of a year of income not including an amount that 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 where-

(i) the non-inclusion of the amount in the assessable income of the taxpayer is attributable to the making of a declaration, election or selection, the giving of a notice or the exercise of an option by any person, being a declaration, election, selection, notice or option expressly provided for by this Act; and

(ii) the scheme was not entered into or carried out by any person for the purpose of creating any circumstance or state of affairs the existence of which is necessary to enable the declaration, election, selection, notice or option to be made, given or exercised, as the case may be; or

...''

Section 177D provides that Part IVA 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 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 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).''

We should also mention s. 177G which provides that nothing in s. 170 prevents the amendment of an assessment at any time before the expiration of six years after the date on which tax became due and payable under the assessment if the amendment is for the purpose of giving effect to subsec. 177F(1).

In his reasons for decision, Olney J said that, having regard to the contractual arrangements existing between Grollo Australia and Grofam prior to 27 October 1983 and in particular the income tax consequences of those arrangements, he was satisfied that the agreements and course of conduct whereby:

(a) Grollo Australia and St Martins Victoria varied the joint venture deed so as to facilitate the engagement of Grollo Australia as the project builder for the Rialto Project but retain Grofam as the actual builder;
(b) Grollo Australia and St Martins entered into building contracts with Grollo Australia to cause Grofam to execute construction

ATC 4621
work in relation to the Rialto Project which, but for the variation of the joint venture deed, it would have been entitled to execute in its own right;
(c) Grollo Australia and Grofam executed the notice on 27 October 1983;
(d) Grollo Australia and Grofam executed the undated agreements whereby Grollo Australia appointed Grofam as its ``sub- builder'' for the Rialto Project; and
(e) after 27 October 1983 Grofam carried out the construction work on the Rialto Project at cost and Grollo Australia received the whole of the Rialto construction payments;

constituted a scheme within the meaning of subsec. 177A(1) which was entered into and carried out after 27 May 1981, that being the date when Part IVA took effect.

His Honour said that, if the scheme had not been entered into and carried out, the assessable income of Grofam for each of the years of income ``ending subsequent to 27 October 1983'' during the currency of the construction of the Rialto Project would have included, or might reasonably be expected to have included, the full amount of contract payments made to Grollo Australia during those years pursuant to the building contracts entered into between the joint venturers and Grollo Australia on 27 October 1983. His Honour said that, for the purposes of Part IVA, Grofam obtained, or would but for s. 177F of the Act have obtained, a tax benefit in connection with the scheme equivalent to the total of the amounts paid under the contracts.

Paragraph 113 of his Honour's reasons is as follows:

``Having regard to the provisions of s. 177D(b) and to the following facts-

(i) that the scheme was carried out by way of an agreement between the joint venturers to amend the joint venture agreement and to enter into building contracts with Grollo Australia rather than with Grofam;

(ii) that the form of the scheme was to facilitate the appointment of Grollo Australia as the project builder but the substance was for Grofam to continue to carry out the construction work in circumstances in which Grofam was paid only the cost of construction and Grollo Australia was to retain any surplus;

(iii) that the scheme was entered into after the commencement of construction at a time when it had become apparent that Grofam would be liable to pay income tax on the profit derived from the construction work, and was carried out over the balance of the period the project was under construction;

(iv) that the result achieved by the scheme in relation to the operation of the Act was that but for Part IVA, Grofam ceased to derive any profit from the construction of the project whereas such profit was derived by Grollo Australia in circumstances in which it was believed by Grofam and by Grollo Australia that same, or alternatively part of same, would not be taxable;

(v) that the financial position of Grofam was changed to the extent that it ceased to derive a taxable profit from the Rialto Project;

(vi) that the financial position of Grollo Australia was changed by the scheme in that it became entitled to the profits from the construction work in circumstances in which it believed that same were not taxable in its hands;

(vii) that there were no other consequences of the scheme for Grollo Australia or Grofam; and

(viii) that Grollo Australia and Grofam have common shareholders, namely Bruno Grollo and Rino Grollo, who are directors of both companies, and that the two companies are members of the Grollo Group of companies and in all respects are controlled by Bruno and Rino Grollo;

it would be concluded that Grollo Australia and Grofam, being parties to the scheme, entered into and carried out the scheme for the purpose of enabling Grofam to obtain the tax benefit referred to above.''

In relation to subpara. 113(iv) counsel for the Commissioner said that so much of the paragraph as contained the words, ``in circumstances in which it was believed by Grofam and by Grollo Australia that same, or alternatively part of same, would not be taxable'' might reveal a subjective approach.

ATC 4622

But counsel said that these words could be omitted and that the omission of them from the paragraph would make no difference to the point which was made in it. That would leave the statements made in the subparagraph as objective statements about which there could be no issue.

His Honour said that, by reason of the facts and circumstances recounted in para. 113, the scheme was a scheme to which Part IVA applied. He said that the Commissioner was entitled to determine pursuant to s. 177F that the whole of the benefit which Grofam obtained, or would but for s. 177F have obtained, in connection with the scheme be included in the assessable income of Grofam in the relevant years of income and that those amounts were properly to be deemed to be included in the assessable income of Grofam for each of the respective years of income ending after 27 October 1983 in which Grollo Australia received Rialto construction payments. His Honour also said that the assessments in question, which were based upon a determination made pursuant to subsec. 177F(1), took into account ``compensating adjustments'' made by the Commissioner pursuant to subsec. 177F(3). He said that he did not understand the quantum of such adjustments to be such an issue. We do not find it necessary to refer to the detail of subsec. 177F(3).

In their written submissions, counsel for the appellants referred to paras 110 and 111 of his Honour's reasons pointing to his Honour's identification of the scheme in para. 110 earlier referred to and to his Honour's conclusion in para. 111 that, if the scheme had not been entered into and carried out, the assessable income of Grofam for each of the years of income ending subsequent to 27 October 1983 during the currency of the contracts would have included, or might reasonably be expected to have included, the full amount of contract payments made to Grollo Australia during those years. Reference was also made to para. 113 of his Honour's reasons in which he said that it would be concluded that Grollo Australia and Grofam, being parties to the scheme, entered into and carried out the scheme for the purpose of enabling Grofam to obtain the tax benefit referred to in para. 111. It was submitted that the Tribunal erred in law in a number of respects in making the findings referred to.

The significance (if any) of Grofam being a trustee

Grofam was assessed as a trustee, it being the trustee of a family trust. In the submission of counsel for Grofam, a trustee cannot be caught by Part IVA of the Act at least unless the trustee is properly to be regarded as a taxpayer in respect of the trust income. In order to understand the submission it is necessary to have regard to some of the provisions of Division 6 of Part III of the Act which deals with liability to taxation. Division 6 is entitled ``Trust Income''. Section 95 of the Act, which is to be found in that Division, contains two definitions. One of these is of ``net income'' which is defined to mean, in relation to a trust estate, the total assessable income of the trust estate calculated under the Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions except certain concessional deductions and deductions mentioned in the section.

Section 96 provides that, except as provided in the Act, a trustee shall not be liable as trustee to pay income tax upon the income of the trust estate. Section 97 deals with the position of a beneficiary not under any legal disability who is presently entitled to a share of the income of the trust estate. The section provides that the assessable income of such a beneficiary shall include so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was a resident and so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was not a resident and is also attributable to sources in Australia. The section goes on to deal with exempt income. We do not need to refer to these provisions.

Section 98 provides that, where a beneficiary of the trust estate who is under a legal disability is presently entitled to a share of the income of a trust estate, the trustee of the trust estate shall be assessed and liable to pay tax in respect of so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was a resident and so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was not a resident and is also attributable to sources in Australia ``as if it were the income of an individual'' and were not subject to any deduction other than the concessional deductions (if any) that would have been

ATC 4623

allowable to the beneficiary if the beneficiary had been assessed in respect of the amount or the sum of the amounts applicable by virtue of the provisions of the section.

As we understand the evidence in the present case, the beneficiaries of the Grofam family trust are themselves family trusts. The correct view would therefore appear to be that none of the beneficiaries is under a disability so that the provisions of ss. 96 and 97 would operate to make the beneficiaries of the trust and not the trustee, i.e. Grofam, liable to pay income tax upon the income earned by the trust.

Earlier we referred to s. 177F of the Act as the central provision of Part IVA. Its opening words provide that, where a tax benefit has been obtained, or would but for the section be obtained, by a taxpayer in connection with a scheme to which the Part applies, the Commissioner may, in the case of a tax benefit that is referable to an amount not being included in the assessable income of the taxpayer of the 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. In counsel's submission the relevant taxpayer, Grofam, received no tax benefit because it was not itself liable to pay any income tax.

An initial difficulty we have with the submission arises from the terms of the definition of ``taxpayer'' in s. 177A. As mentioned, ``taxpayer'' includes a taxpayer in the capacity of a trustee. So, when one considers the words of subsec. 177F(1) to which we have referred, one needs to read ``taxpayer'' therein as including a taxpayer in the capacity of a trustee. It is tempting, as indeed counsel for the Commissioner urged us to do, to take the view that is sufficient to conclude the argument against Grofam. But closer analysis of the provision reveals that difficulties lie in the path of such an approach.

Counsel for the appellants referred to the explanatory memorandum circulated at the time the Bill for the Income Tax Laws Amendment Act (No. 2) 1981, in which Part IVA was enacted, was introduced into Parliament. It was there said (p. 8) that the definition of ``taxpayer'' in subsec. 177A(1) as including the taxpayer in a trustee capacity, was designed to refer to those situations where a trustee was, for example under ss. 99 or 99A (which deal with certain trust income being taxed as the income of an individual) of the principal Act, subject to tax in respect of some or all of the net income of the trust estate. The memorandum added, ``The definition will make it clear that Part IVA can be applied in such a case.'' This statement suggests that Parliament did not intend the definition of ``taxpayer'' in subsec. 177A(1) to apply in cases affected by s. 97. We are less certain about s. 98. That was the strong submission of counsel for the appellants.

Originally we thought this view of the matter was plainly incorrect. But on reflection we think that the position is not as clear-cut. Our problem arises because of the terms of the definition of ``taxpayer'' not in Part IVA but in s. 6. We have earlier indicated why we think that definition applies to the provisions of Part IVA. Section 96 and s. 97, if it be the applicable provision, operate to avoid a trustee being personally liable for income tax or income earned by the trust. It is true, as we have noted, that the definition of ``taxpayer'' in s. 6 refers to a taxpayer as a person deriving income so that it will apply even though the person described as a taxpayer pays no income tax. But there is a question whether the definition was intended to apply to a person such as a trustee who, although he or she derives income - see the definition of ``net income'' in s. 95 - does so not in any personal capacity but in the capacity of a trustee.

If the definition does apply, the statement in the explanatory memorandum will be found to be incorrect. But that is of no consequence if the language of the statute, although ambiguous, requires a different construction.

It needs to be said that the acceptance of the submissions made on behalf of Grofam would lead to an extraordinary result. We would not ourselves lightly take the view that, when Part IVA was enacted, the legislature intended to bring about a situation under which the interposition of a trustee would, at least in cases which were governed by s. 97, invariably mean that Part IVA had no application, no matter that there was plainly a scheme to which Part IVA applied, a consequent tax benefit to the beneficiaries and the presence of the other conditions which must exist before Part IVA will apply. That must be the necessary consequence of the acceptance of the appellants' submission because the word ``taxpayer'' plays a critical role in the operation of ss. 177C, 177D and 177F. If the trustee is not

ATC 4624

a taxpayer for the purposes of these provisions, there can be no tax benefit, no occasion for the carrying out of the exercise required by s. 177D if there be a tax benefit, and no work for s. 177F to do.

Reference was made during argument to the decision of the High Court in
Union-Fidelity Trustee Company of Australia Limited & Anor v FC of T 69 ATC 4084; (1969) 119 CLR 177. There Barwick CJ said (at ATC 4086; CLR 181):

``The effect of the definition of the net income of the trust estate in sec 95 is that the provisions of the Act are to be applied to the actual income of the trust estate as if it were the income of an individual deriving it. From the actual income of the trust estate there are abstracted all sums which can be seen to be assessable income. For the purpose of this abstraction or computation the only fact which is relevantly known is that the trustee, as a taxpayer, has derived the income.''

Kitto J said (at ATC 4090; CLR 187):

``In the light of the definition of `taxpayer' the expression `calculated under this Act as if the trustee were a taxpayer in respect of that income' may be expanded to read `calculated under this Act as if the trustee were a person deriving that income'. But the `as if' shows beyond question that the basis of the calculation is to be a hypothesis different from the actual fact. Since the fact is that the trustee derived the income, the hypothesis that it was derived by `a person' must be that it was derived not by the trustee but by a hypothetical person as to whom none of the facts is postulated which would make him a `resident' within the definition of that word in sec 6(1).''

Reference may also be made to the judgment of Menzies J (at ATC 4091; CLR 189).

The Union-Fidelity case is authority for the proposition that income of a trust estate received from sources outside Australia by a trustee resident in Australia to which there is no beneficiary presently entitled is not assessable or liable to be taxed in the hands of the trustee under s. 99 of the Act. The present case is not concerned with that problem. The relevance of the Union-Fidelity case is in the statements of general principle which we have cited from the judgments of Barwick CJ and Kitto J. Both judges refer to the trustee deriving the income. They do so because the provisions of s. 95 which define ``net income'' use the expression ``taxpayer'' thus directing one to the definition of that word in s. 6. The two judges have said what they have in the context of the case which they had to decide. But their statement serves to emphasise the fact that s. 95 itself treats a trustee of trust income as if he or she were a taxpayer in respect of that income.

It may be noted at this point that the judges who wrote the principal judgment of the High Court in
FC of T v Spotless Services Limited & Anor 96 ATC 5201; (1996) 141 ALR 92 said (at ATC 5205; ALR 96) that Part IVA is as much a part of the statute under which liability to income tax is assessed as any other provision thereof.

We have reached the conclusion that the submissions made on behalf of the appellants should be rejected. We appreciate that in doing so we may be departing from the apparent approach adopted in the explanatory memorandum to which we have referred. But for the reasons given, we think that course is required in the present case. The explanatory memorandum cannot be allowed to override what, upon analysis, is the clear intention of Parliament as ascertained from the language which it has used in the statute. Furthermore, although one needs to give effect to the definition of ``taxpayer'' in s. 6, one must not lose sight of the extended definition of ``taxpayer'' in Part IVA itself which, although expressed in inclusive terms, tends to confirm one in the view that Part IVA was intended to apply to trusts and trustees in all circumstances. We find it difficult to think that Parliament itself did not intend that that definition was to apply in the construction of the important provisions to be found in ss. 177C, 177D and 177F.

In the course of their submissions, counsel for the appellants pointed to the fact that in the definition of ``net income'' in subsec. 95(1) of the Act, it was the net income of the trust and not of the trustee which was calculated by reference to the various provisions of the Act which relate to assessable income and allowable deductions on the hypothesis that the trustee was the taxpayer in respect of the income. We think this gives too much emphasis to the use in the definition of ``net income'' in s. 95 of the words ``trust estate''. The definition has to be

ATC 4625

read as a whole. It goes on to say ``as if the trustee were a taxpayer in respect of that income''. Subsection 177C(1) refers to the obtaining by a taxpayer of a tax benefit. The assumption upon which the definition of ``net income'' in s. 95 proceeds is that the trustee is a taxpayer. We are of opinion that the language of s. 177C will operate to pick up the provisions of the definition of ``net income'' in s. 95 because one has to approach the problem upon the basis that the trustee is a taxpayer. We therefore reject the submission.

In the result we reject the submissions made on behalf of Grofam based on the provisions of Division 6 of Part III of the Act.

The further suggested errors of law

We propose now to deal with each of the remaining errors of law identified by the appellants in their submissions. The first such error is claimed to be the misconstruction by the Tribunal of the documents that were executed on 4 December 1981 and the Tribunal's failure to have regard to the conduct of St Martins, Grollo Australia and Grofam in respect of the agreements embodied in those documents and the negotiations and agreements that were entered into after 4 December 1981 up to and including 27 October 1983. It was said that the Tribunal had misdirected itself as to the rights and obligations of Grofam ``vis a vis the joint venturers'' in respect of the construction of the building. It was also said that the Tribunal failed to recognise that immediately prior to 27 October 1983, Grofam was not a party to and was not obliged to enter into any building contract with the joint venturers. It was said that the error made by the Tribunal in this respect materially affected its findings as to the application of s. 177C of the Act, which deals with tax benefits, to the facts of the case.

Reference was then made to para. 177C(1)(a) and to the words used in that paragraph requiring a reference to a tax benefit to be read as a reference to an amount not being included in the assessable income of the taxpayer in 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. Reference was made to
FC of T v Peabody 94 ATC 4663; (1994) 181 CLR 359 where the High Court said (at ATC 4671; CLR 385) that a reasonable expectation requires more than a possibility. It involves a prediction as to events which would have taken place if the relevant scheme had not been entered into or carried out. The prediction must be sufficiently reliable for it to be regarded as reasonable. Reference was made to
Dunn v Shapowloff (1977-1978) CLC ¶ 40-451 at 30,151-30,152; [1978] 2 NSWLR 235 at 249 per Mahoney JA.

The decision of the High Court in FC of T v Spotless Services Limited (supra) was delivered on 3 December last, well after our decision in this matter was reserved. The case is relevant to a consideration of the questions which arise for decision here. We do not propose to make an analysis of it at this point but, as necessary, we shall refer to it at later stages of the judgment when it is relevant to do so. It should be mentioned that counsel for the Commissioner made further written submissions after the decision was given. We have taken these into account in resolving the various questions which arise for determination. No submissions in reply have been received from counsel for the appellants but we have assumed that they would dispute the general thrust of the further submissions made on behalf of the Commissioner.

The appellants' original submissions referred to para. 107 of the reasons of the Tribunal where it was said that, but for the variation deed, Grofam would have become entitled to contract payments from the joint venturers substantially in excess of the cost to it of executing the work which it in fact executed.

The essence of the submission made by counsel for the appellants on this branch of the case is that that finding proceeded on the erroneous assumption that Grofam was a party to or was obliged to enter into building contracts with the joint venturers under which it would be entitled to payments in excess of the costs to it of executing the work. As a result, so it was submitted, the Tribunal did not embark upon the exercise of predicting what might have taken place if the scheme as found by it had not been entered into and carried out. That exercise, so it was contended, required a consideration of the material circumstances that existed immediately prior to 27 October 1983 including the fact that the Grollos regarded the construction work as forming part of Grollo Australia's contribution to the equity of the joint venture and the fact that at that time Bruno Grollo and Rino Grollo intended that Grofam

ATC 4626

should not enter into a building contract with the joint venturers pursuant to which it would receive as income amounts in excess of the costs to it of constructing the building. It was submitted, having regard to all the circumstances, that it could not be reasonably predicted that Grofam would have entered into building contracts under which it would have been entitled to receive an assessable profit had the scheme identified by the Tribunal not been entered into. It was finally said that, whether this was the fact or not, the Tribunal erred in law in failing to give any consideration to the issue.

The reply made by counsel for the Commissioner to these various submissions relied on the following matters:

(a) It was intended that Grofam be the builder. It was the builder up to 27 October 1983.
(b) Grofam entered into the bulk excavation contract as well as the contracts arising from the letters of appointment earlier referred to. The work provided for in the bulk excavation contract and in those letters of appointment was largely complete by 27 October 1983.
(c) Grofam had completed and been paid for work to which the contracts between the joint venturers and Grollo Australia of 27 October 1983 related. The Tribunal inferred that Grofam had been paid $45.5 million for this work. Reference was made to para. 53 of the Tribunal's reasons where this finding was made. Reference may also be made to para. 52. There was no challenge to the findings made by the Tribunal in those paragraphs.
(d) The contracts in relation to the work to be done after 27 October 1983 were entered into between Grollo Australia and Grofam. Grofam thus continued to be the builder. Reference was made to para. 107 of the reasons in which, as mentioned, his Honour found that, but for the variation deed, Grofam would have become entitled to contract payments from the joint venturers substantially in excess of the cost to it of executing the work which it in fact executed. It was the fact that payment for construction work executed after 27 October 1983 was made to Grollo Australia rather than to Grofam. But his Honour's point was that that would not have been the case if it had not been seen to be necessary to alter the arrangement in order to make Grollo Australia the builder rather than Grofam itself.

In the submissions relied upon by the Commissioner it is said that, whether or not the Grollos regarded the construction work as forming part of Grollo Australia's contribution ``to the equity of the joint venture'' was irrelevant; the question was whether an amount that would, or might reasonably be expected to have been, included in the assessable income of Grofam had not been included in that income. Thus the issue was what would Grofam's assessable income reasonably have been expected to have been and not how Grofam would spend or channel its surpluses. Grollo Australia entered into the joint venture agreement knowing that Grofam was to be the builder and would earn the Rialto Construction profits which Grollo Australia would use to fund, directly or indirectly, its contribution to its share of the equity.

In our opinion the submissions made by the appellants should be rejected. As we have reflected on this matter, we have wondered whether there really is a question of law involved in the submission which is under consideration. Counsel for the Commissioner submitted that there was not. The various matters relied upon by the appellants are intended to persuade this Court that his Honour's conclusion expressed in para. 107 of his reasons that, but for the variation deed, Grofam would have become entitled to contract payments from the joint venturers substantially in excess of the costs to it of executing the work which it in fact executed, was erroneous. We find it difficult to understand how that can give rise to a question of law.

That matter aside, we are of opinion that the facts of the matter to which we have referred establish that the reason that the change in the arrangement was brought about was because of an apprehension that Grofam would be found to have received taxable income in the course of carrying out the work. This was plainly Mr Dowding's concern. Expression of his concern is found in the letter of 19 August 1983 earlier referred to. Furthermore, it is plain on the face of the evidence that it was never intended that the actual builder should be other than Grofam itself. It was in fact the builder from the commencement of the work until completion. It

ATC 4627

is true that it contracted with Grollo Australia to do the work after 27 October 1983, Grollo Australia being responsible to the joint venture for the building work. But it was Grofam which physically carried out the work albeit that, after 27 October 1983, it did so at cost with no profit to it.

The only other matter which needs to be mentioned is the reliance placed by counsel for the appellants on the fact that Grofam was not a party to the joint venture deed. But it was part of the Grollo Group and it was controlled within that group. It was the company which, at the relevant time, carried out the building work of the Group. That was why it was selected. Grollo Australia agreed with St Martins that it would procure Grofam to carry out the work and it is clear that the expectation of all parties, including Grofam itself, was that it would be the builder for the project throughout. Accordingly, we do not regard the fact that Grofam was not a party to the joint venture deed as of any relevance.

What the appellants may be asserting is that, because Grofam was not a party to the joint venture deed, it was not a party to the scheme relied upon by the Commissioner. But the definition of ``scheme'' in subsec. 177A(1) provides that ``scheme'' means, inter alia, an arrangement or an understanding. Furthermore, arrangements and understandings, as well as other transactions referred to in the subsection, will be caught whether express or implied and whether or not enforceable by legal proceedings. Furthermore, the definition of ``scheme'' does not mention the parties to a scheme. It does not identify any particular persons as parties to the agreement, arrangement, understanding, promise or undertaking referred to. And subsec. 177A(3) provides that the reference in the definition of ``scheme'' in subsec. (1) to a scheme, plan, proposal, action, course of action or course of conduct is to be read as including a reference to a unilateral scheme, plan, proposal, action, course of action, or course of conduct. Then it is to be observed that the opening words of subsec. 177C(1) dealing with tax benefits do not tie the taxpayer that is mentioned and who obtains a tax benefit in connection with a scheme to the scheme itself otherwise than by providing that the benefit is obtained by a taxpayer in connection with a scheme.

Section 177D applies to any scheme which has been entered into after 27 May 1981 where certain conditions apply. The first is provided for in para. (a) of the section which requires a taxpayer (referred to in the section as the ``relevant taxpayer'') to have obtained, or, to be in a situation where, but for s. 177F, it would have obtained, a tax benefit in connection with the scheme. Regard is then had to the various matters provided for in para. (b). That having been done, the question is whether, upon the basis of those various matters, 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 (that is the taxpayer who obtains the tax benefit in connection with the scheme) 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. There follow words which are in parentheses, namely, ``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''.

Grofam was part of the Grollo Group. It was under the control of the Grollo brothers. The evidence establishes that it was party to the scheme in question. It must have been aware of and complicit in what was transpiring. It must have been aware that the changes brought about by the alterations to the arrangements between the joint venturers on 27 October 1983 would mean that it would no longer receive the moneys from the joint venture but would enter into a building contract with Grollo Australia which would become responsible for the payments due to it. It must have been aware of this and complicit in it. Otherwise it would have allowed a situation to develop where a most profitable contract was, against its will, turned into one which was valueless. This is contrary to the commercial reality of the situation and indeed commonsense. In our opinion, his Honour's conclusion that it would be concluded that Grollo Australia, being the person or one of the persons which entered into or carried out the scheme, did so for the purpose of enabling the relevant taxpayer, i.e. Grofam, to obtain a tax benefit in connection with the scheme was plainly correct. In the result, the submissions made on behalf of the appellants are rejected.

ATC 4628

The next submission made by counsel for the appellants was that the Tribunal erred in finding that, having regard to the matters referred to in para. 177D(b), it would be concluded that Grollo Australia and Grofam entered into and carried out the scheme as found by the Tribunal to obtain a tax benefit. Counsel submitted that, in making this finding, the Tribunal erred:

(i) by misconstruing the documents that were executed on 4 December 1981 and by failing to take into account the fact that further agreements were required to be negotiated and executed before the joint venture structure could be finalised;
(ii) by failing to take into account the fact that between 4 December 1981 and 27 October 1983 negotiations and agreements were entered into that related to all aspects of the joint venture, including in particular the construction of the Rialto building;
(iii) by failing to take into account the fact that the agreements that were executed on 27 October 1983 added to, varied and, in some instances replaced, the agreements that were executed on 4 December 1981;
(iv) by failing to take into account the fact that immediately prior to 27 October 1983 Grofam was not a party and was not obliged to enter into any building contract with the joint venturers pursuant to which it would be entitled to receive income in excess of the costs to it of constructing the building; and
(v) by failing to take into account the objective commercial reasons for the building contracts and the notice and the form in which they were executed on 27 October 1983.

It was submitted that the various matters referred to by the Tribunal in para. 113 of its reasons, which has been earlier set out, proceeded on the erroneous assumption that, but for the scheme, Grofam would have executed the building contracts on 27 October 1983 in its own name. But, so the submission runs, Grofam was not obliged to enter into those agreements and the Tribunal did not consider the question whether it would have done so had the scheme not been entered into. In fact, so it was submitted, the evidence referred to by the Tribunal suggested that Grofam would not have executed the building contracts in the form they took on 27 October 1983. That submission was said to be supported by evidence from the Grollos. The first piece of evidence relied upon is evidence given by Mr Bruno Grollo to the effect that he wanted ``a simple stroke of the pen'' to get rid of the problem because in his view there was no profit in that all they were doing was putting up a building for a much lower cost than would otherwise be the case. Secondly, reference was made to attempts made by the Grollos and their advisers to negotiate building contracts in the name of Grollo Australia and later attempts by Mr Bruno Grollo and his advisers to negotiate a building contract in the name of Grofam containing retention provisions. Reference was also made to the request by Mr Bruno Grollo and Mr Rino Grollo made to St Martins on 25 October 1983 that Grollo Australia be party to the building contracts after the Grollo interests had failed to execute documentation executed by St Martins on 28 September 1983.

These various submissions require reference to further paragraphs of his Honour's reasons. In para. 97, his Honour said that, on 14 September 1982, Mr Dowding met with the Grollo brothers and Mr Sankey. He referred to a minute of a meeting made by Mr Dowding in which it was recorded that the question of Grofam's potential profit arising out of the Rialto contract was discussed along with the various means available to offset those profits against other deductions. The note said that, whilst Mr Bruno Grollo wanted a simple stroke of the pen to get rid of the problem, because in his view there was no profit in that all that they were doing was putting up a building for a much lower cost than would otherwise be the case, the ``technical difficulty'' was that to the joint venture partner the cost was a greater sum and the cost to the Grollos was purportedly a greater sum. Mr Dowding suggested that the best means of approach would be for substantial retentions to be inserted into the head construction contract so that these could be offset by a loan agreement between the joint venturers and Grollo Australia or a Grollo entity, preferably not the contracting party, giving rise to advances of say 90 per cent or thereabouts of the retention sums as they accumulated. In this way the Grollo Group would receive the cash but not be taxed on it until the retention period expired. It was agreed that this should be pursued but Mr Bruno Grollo asked that ``we made completely sure'' that there was no better way around the problem.

ATC 4629

His Honour accepted that Mr Dowding's record accurately reflected the thrust, if not the exact detail, of the conversation. Having considered Mr Dowding's note and what his Honour said about it, we are at a loss to understand how its contents assist the appellants' case.

Much of the ground covered by this submission has already been dealt with. Again, there is the problem whether any question of law arises for decision. But counsel for the appellants submitted that each of the matters referred to in subparas (i) to (vii) of para. 113 of the Tribunal's reasons failed to take into account the objective commercial reasons for the scheme as found by the Tribunal. It was said that Grollo Australia was the Grollo company that had the equity in the building and the interests in the joint venture. The two Grollo brothers and St Martins regarded the construction work as forming part of Grollo Australia's equity contribution to the joint venture. Prior to the execution of the formal building contracts, the excess of receipts over payments in respect of the building work was channelled from Grofam through the group's banker, L. Grollo Nominees Pty Ltd, to Grollo Australia. Grofam itself retained no part of the excess of payments over receipts for its own benefit or use. It was merely the conduit through which the various building resources of the whole Grollo Group of companies were channelled for the construction of the buildings. It had no employees and, although it owned some plant and equipment, it did not have all plant and equipment necessary for the project. The labour force, the concrete and other materials, and much of the plant and equipment were provided to and channelled through Grofam by other members of the Grollo Group of companies at cost. Thus the building resources of the whole of the Grollo Group of companies were committed to the project at cost and the benefit of the excess of construction receipts over construction costs was used by Grollo Australia as part of its equity contribution to the joint venture account. The agreements that were entered into on 27 October 1983 properly reflected, so far as the Grollo interests were concerned, the actual and intended commercial interests of Grollo Australia and Grofam in relation to the joint venture and the construction work. In summary it was submitted that, in making its finding in relation to the application of para. 177D(b) of the Act, the Tribunal failed to consider any of the matters that related to the objective commercial reasons for entering into the scheme as found.

It was further submitted that the object and purpose of the notice of 27 October 1983 was to protect St Martins in relation to existing and future obligations under the building contracts. That conclusion followed from the evidence accepted by the Tribunal as to the manner in which and the purpose for which the notice came into existence and from a construction of the true meaning and effect of the notice.

It was submitted that the proper application of para. 177D(b) of the Act to the facts was that the scheme was entered into as part of a commercial transaction that involved the execution of documents that had been negotiated at arms length with a joint venture partner in respect of a joint commercial venture in which part of the documentation had embodied the joint venture structure. The scheme was carried out by acting pursuant to those agreements. It was said that the form and substance of the scheme, so far as Grollo Australia was concerned, was to reflect correctly the actual and intended commercial interests of Grollo Australia and Grofam in the joint venture and in the construction work. It was contended that the scheme was entered into after almost two years of negotiations relating to the variation, substitution and completion of the documentation that was executed on 4 December 1981 and formed part of the documentation that finalised what up until 27 October 1983 had been an incomplete joint venture structure. The scheme continued until the construction was completed.

There are further submissions to be mentioned, but it is convenient to pause here to deal with what has so far been stated. We have had difficulty in understanding the relevance of many of the submissions which were made. Furthermore, the submissions overlook the anxiety of those advising the Grollo Group of companies and the Grollos themselves, about the fact that Grofam was facing a substantial tax liability. For all sorts of reasons earlier dealt with it was suggested that it had no tax liability. We have decided that the submissions made in this respect should be rejected. It did have a tax liability. What was done was done in order to change the way in which the project was

ATC 4630

structured. It is plain to us, as it was to his Honour, that a significant reason why this was done was to relieve Grofam of further tax liability. That is the only objective conclusion that could reasonably be drawn from the totality of the facts and circumstances of the case.

No doubt it was hoped that submissions that Grollo Australia itself would not be liable to any income tax in respect of the project because of the argument, yet to be dealt with, that Grollo Australia received the moneys on capital account, would prevail. We do not gainsay that there may have been commercial reasons for what was done in addition to those which seem to have been the primary reasons why the structure was changed as a consequence of the execution of the documents on 27 October 1983. The question becomes, assuming there to be more than one purpose, what was the dominant purpose. That is what subsec. 177A(5) requires to be considered.

The judges who wrote the principal judgment in the High Court in Spotless emphasised (at ATC 5205; ALR 96) that Part IVA of the Act was to be construed and applied according to its terms, not under the influence of ``muffled echoes of old arguments'' concerning other legislation. As mentioned, the judges said that Part IVA was as much a part of the statute under which liability to income tax was assessed as any other provision thereof. In circumstances where s. 177D applied, regard was to be had to both form and substance. Reference was made to subpara. 177D(b)(ii).

Later their Honours referred (at ATC 5205-5206; ALR 97) to a phrase ``rational commercial judgment'' which had been used by Cooper J, a member of the Full Court of this Court from whose decision the appeal to the High Court was brought 95 ATC 4775 at 4811; (1995) 62 FCR 244 at 287-288. His Honour had used the phrase ``a rational commercial decision''. It had been contrasted with another one, namely, the obtaining of a tax benefit as ``the dominant purpose of the taxpayers in making the investment''. The judges of the High Court said that this suggested the acceptance of a false dichotomy. They referred to the definition of ``scheme'' in subsec. 177A(1) and said (at ATC 5206; ALR 97) that a person may enter into or carry out a scheme within the meaning of Part IVA for the dominant purpose of enabling the relevant taxpayer to obtain a tax benefit where that dominant purpose is consistent with the pursuit of commercial gain in the course of carrying on a business.

Later their Honours said (at ATC 5206; ALR 97-98) that a taxpayer ``within the meaning of the Act'' may have a particular objective or requirement which is to be met or pursued by what, in general terms, would be called a transaction. The ``shape'' of that transaction need not necessarily take only one form. The adoption of one particular form over another might be influenced by revenue considerations. This was only to be expected. Thus, a particular course of action might be, to use a phrase found in the judgment of the Full Court of this Court, both ``tax driven'' and bear the character of a rational commercial decision. Importantly their Honours said that the presence of the latter characteristic did not determine the answer to the question whether, within the meaning of Part IVA, a person entered into or carried out a ``scheme'' for the ``dominant purpose'' of enabling the taxpayer to obtain a ``tax benefit''.

Their Honours continued (at ATC 5206; ALR 98):

``Much turns upon the identification, among various purposes, of that which is `dominant'. In its ordinary meaning, dominant indicates that purpose which was the ruling, prevailing, or most influential purpose. In the present case, if the taxpayers took steps which maximised their after-tax return and they did so in a manner indicating the presence of the `dominant purpose' to obtain a `tax benefit', then the criteria which were to be met before the Commissioner might make determinations under s. 177F were satisfied. That is, those criteria would be met if the dominant purpose was to achieve a result whereby there was not included in the assessable income an amount that might reasonably be expected to have been included if the scheme was not entered into or carried out.''

Their Honours went on to refer to some of the evidence in the case before them (at ATC 5206; ALR 98). They then set out the eight criteria appearing in para. (b) of s. 177D. The section was set out in full (at ATC 5208; ALR 98-99). Their Honours commented (at ATC 5207; ALR 99) that it was to be noted that the relevant purpose was that of the person or one of the persons who entered into or carried out the scheme or any part thereof. They contrasted

ATC 4631

the provisions of s. 260 (since repealed) which spoke of the purpose of the contract, agreement or arrangement which was rendered ``absolutely void as against the Commissioner''.

There followed a detailed discussion of the evidence, a reference to what was said by the Full Court and a reference to the taxpayers' submissions. Their Honours then said (at ATC 5211; ALR 103-104):

``In our view, the amount to which para (a) [ of subsec. 177C(1)] refers as not being included in the assessable income of the taxpayer is identified more generally than the taxpayers would have it. The paragraph speaks of the amount produced from a particular source or activity. In the present case, this was the investment of $40 million and its employment to generate a return to the taxpayers. It is sufficient that at least the amount in question might reasonably have been included in the assessable income had the scheme not been entered into or carried out.

Section 177D presents the question whether, having regard to the eight categories of matter identified in par (b), posited as objective facts, in the present case a reasonable person would conclude that the taxpayers entered into the scheme for the dominant purpose of enabling each to obtain a `tax benefit' in the necessary sense. A particular application of the definition provision of `tax benefit' in s 177C(1) thus involves consideration of the particular materials answering the various categories in par (b) of s 177D.

The taxpayers were determined to place the $40 million in short-term investment for the balance of the then current financial year. The reasonable expectation is that, in the absence of any other acceptable alternative proposal for `offshore' investment at interest, the taxpayers would have invested the funds, for the balance of the financial year, in Australia. The amount derived from that investment then would have been included in the assessable income of the taxpayers. The interest rate in the Cook Islands was 4.5 per cent below applicable bank rates in Australia. It reasonably could be concluded that the amount the taxpayers would have received on the Australian investment would have been not less than the amount of interest in fact received from the investment with EPBCL. Accordingly, there is no error adverse to the taxpayers in identifying the amount of the `tax benefit' as an amount equal to the interest less the Cook Islands withholding tax.''

The facts of the present case have been referred to. We do not need to repeat them. In our opinion his Honour's conclusion that the dominant purpose was to gain a tax benefit is unimpeachable. Whether one looks at the matter as a question of law or fact, there can be no question but that the dominant purpose here was to achieve a situation under which Grofam would not, after 27 October 1983, continue to be liable for income tax.

Accordingly, the submission under consideration is rejected. As earlier indicated, we think that the submission, at least in many places, lacks reality and ignores the evidence. It builds a case which was really not found to have been made out.

There were some other submissions relied upon by the appellants which can be disposed of briefly. A number of these are consequential upon submissions which we have rejected. We have taken them generally into account but we do not think that they take the matter further and we would reject them. Another of the submissions again raises the question of the applicability to the circumstances of this case of the emerging profits method or basis of ascertaining assessable income. This has been dealt with in relation to the income earned by Grofam prior to 27 October 1983. Similar considerations apply in respect of the subsequent period. The submission is therefore rejected.

One further matter remains to be considered. It was submitted that the determinations made by the Commissioner were not authorised by subsec. 177F(1) of the Act because preconditions for making a determination, namely that a tax benefit had been obtained, or would but for the section be obtained, by a taxpayer in connection with the scheme to which the Part applied were not satisfied. We have already reached the conclusion that that submission should be rejected. But it was also submitted that, having made the determinations, the Commissioner did not take action to give effect to the determination as required by subsec. 177F(1). The Commissioner determined

ATC 4632

that the whole of the amounts of the tax benefits should be included in the assessable income of Grofam. As the submission emphasises, no assessments were issued against Grofam; no amount was included in its assessable income. The amounts in question were included in the net income of the trust estate and assessed as assessable incomes of the ultimate beneficiaries. Thus, so the submission runs, the assessments that issued did not give effect to the determinations that were made and were thus not authorised by para. 177F(1)(a).

We accept the submissions made on behalf of the Commissioner in answer to that proposition. In the submission of counsel for the Commissioner, s. 177F does not require the issue of an assessment to the taxpayer who obtains the tax benefit. What it requires is that the Commissioner take such action as he shall consider necessary to give effect to the determination. Hence, so it was submitted, the section permits the Commissioner to give effect to his determination that the tax benefit obtained by Grofam be included in its assessable income by issuing assessments to the taxpayers who, through interposed trusts, were assessable in respect of that income under Division 6 of Part III of the Act. We agree with these submissions and reject those of the appellants.

That completes our treatment of the issues arising under Part IVA of the Act. The next matters to be considered are those which concern the amounts of income (if any) earned by Grollo Australia.

The income (if any) of Grollo Australia after 27 October 1983

As his Honour said, it is a matter of contention as to whether Grollo Australia derived taxable income from the Rialto Project out of the two building contracts which it entered into on 27 October 1983. Three alternative propositions were advanced. The Commissioner contended that all Rialto construction payments received by Grollo Australia from the joint venture account were assessable income in Grollo Australia's hands and that the actual cost of construction was deductible expenditure. On the contrary, the appellants submitted that no part of the construction payments were assessable income. The third alternative was that half of the construction payments were assessable income and half of the cost of construction was deductible for taxation purposes. His Honour concluded that the third alternative should be adopted. He said that, in his opinion, Grollo Australia should have returned Rialto construction payments as assessable income and claimed half the construction costs as deductions. As to the other half, he thought that Grollo Australia, being both the owner and builder, could not be said to have derived income from the receipt of money which represented in effect the half of the construction payments contributed by itself.

This Court is faced with the same alternatives as confronted his Honour. The primary submission of counsel for the appellants was that no part of the construction surplus was taxable in the hands of Grollo Australia. The primary submission of the Commissioner was that the whole was taxable. As a fall-back position, both parties supported the third alternative, namely, that one-half the construction surplus was assessable income and one-half the construction costs were allowable deductions. The question is which one of these alternatives is correct.

In their submissions in support at this part of their case, counsel for the appellants said that, applying ``a business conception'' to the facts of the case and having regard to the realities of what had occurred, the excess of the payments from Grollo Australia and St Martins to Grollo Australia over the costs of construction was a reduction in the cost of Grollo Australia's equity contribution to the project. Accordingly, the surplus was of a capital nature and not taxable as income. It was contended that, in all the circumstances, Grollo Australia's objective was primarily to acquire a major long-term interest in the completed building and the construction was a means to achieve that end. It was not appropriate to recognise a profit or loss on construction separately from any profit or loss on the sale of Grollo Australia's interests in the property. It followed that the excess of the payments by Grollo Australia and St Martins to Grollo Australia over the cost of construction formed part of the net costs of Grollo Australia acquiring its interest in the building.

It was also submitted that, on an objective assessment of all the circumstances, Grollo Australia did not build the Rialto buildings for the sake of the profits it might earn by its efforts as builder but in order to own the buildings when they were completed. It was in reality an

ATC 4633

owner-builder building, not for sale or pursuant to a commission, but for retention as an investment. Objectively speaking that is true so far as Grollo Australia's own interest is concerned. It is not correct in relation to the half of the project which belonged to St Martins. If one is to apply the analogy relied upon by counsel, Grollo Australia was building for St Martins pursuant to the obligations contained in the various contractual documents. That is, we emphasise, in relation to the St Martins' interest in the project. But unquestionably Grollo Australia intended all along to discharge its obligation to contribute equity to the project by using only the moneys borrowed from Porkellis Finance (of which it was obliged to repay one- half) and from the moneys provided by St Martins.

The solution to the problem lies in the correct characterisation of the moneys which came to Grollo Australia's credit to enable it to carry out the building work. This overlooks for the moment the question of the characterisation and treatment of the moneys notionally contributed by Grollo Australia for its share of the equity contribution to be provided by the two joint venturers. It also masks another problem, namely, the characterisation of so much of the moneys received from Porkellis Finance pursuant to the mortgage as represented the half share of the borrowed moneys for which Grollo Australia was responsible. There may be no point of distinction between the way in which these moneys should be treated and the way in which the moneys representing Grollo Australia's contribution to the equity should be treated.

In
GP International Pipecoaters Pty Ltd v FC of T 90 ATC 4413; (1989-1990) 170 CLR 124, the High Court said (at ATC 4419; CLR 136-137):

``... The relevant question is not the character of the expenditure by [The State Energy Commission]. A receipt may be income in the hands of a payee whether or not it is expenditure of a capital nature by the payer. Nor is the relevant question the nature of the expenditure made by the taxpayer in the construction of the plant. A taxpayer may apply income in the acquisition of a capital asset or, conversely, apply a capital receipt to discharge a liability of a non-capital nature. As Cozens-Hardy M.R. observed in
Hudson's Bay Co. v Stevens (1909) 5 T.C. 424 at p. 436:

`... if the money is otherwise liable to income tax it cannot escape taxation by reason of its being applied to a capital purpose.'

And thus a receipt may be income although the recipient is bound to apply it for the purpose of discharging a capital liability:
Mersey Docks v. Lucas (1883) 8 App. Cas. 891 at pp. 904, 909-910;
Commrs of IR v. Corporation of London (as Conservators of Epping Forest) (1953) 34 TC 293 at p 329; (1953) 1 W.L.R. 652 at p. 670; (1953) 1 All ER 1075 at pp 1089-1090. The Commissioner and the taxpayer both treated the cost of constructing the plant as capital expenditure, but the question is not whether that was an expenditure of capital nor whether the plant was used for the purpose of producing assessable income so that depreciation of the plant was deductible under sec 54 of the Act. The relevant question is whether the receipt of the establishment costs was income in the taxpayer's hands. It is necessary to keep that question steadily in mind and not to confuse the character of the receipt with the nature of the asset acquired by application of the moneys received.''

The Court said that the appellant's submissions were to the effect that the plant in question was a capital asset, that the moneys expended in its construction were an expenditure of a capital nature by the taxpayer, and that, as those moneys were received for the purpose of expenditure on the construction of the plant, their receipt was a receipt of capital. The Court said that the first two steps might be accepted but the final step assumed that, when money is received for the purpose of its being expended by the recipient, the character of the receipt is necessarily determined by the character of its proposed expenditure by the recipient. The Court continued (at ATC 4419; CLR 137):

``... That assumption is erroneous and, even if the establishment costs were received for the purpose of expenditure on the construction of the plant, it does not necessarily follow that their receipt was a receipt of capital. Before turning to the character of the receipt, it is desirable first to

ATC 4634
consider the means by which the character of expenditure may be determined.

The character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by the making of the expenditure, for the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid:...''

The Court made reference to a number of authorities including
Associated Newspapers Ltd v FC of T; Sun Newspapers Limited v FC of T (1938) 5 ATD 87 at 96; (1938) 61 CLR 337 at 363 and
Cliffs International Inc v FC of T 79 ATC 4059; (1979) 142 CLR 140.

Later the Court said (at ATC 4420; CLR 138):

``... To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business. The factors relevant to the ascertainment of the character of a receipt of money are not necessarily the same as the factors relevant to the ascertainment of the character of its payment.''

The Court went on (at ATC 4420; CLR 138) to refer to its decision in
FC of T v The Myer Emporium Ltd 87 ATC 4363; (1987) 163 CLR 199, introducing its citation from that case by saying that the importance of ascertaining the scope of the business and a recipient's purpose in engaging in it as a means of determining the character of a receipt appeared from the passage which was then quoted. The Court in Myer had said (at ATC 4366-4367; CLR 209-210):

``Although it is well settled that a profit or gain made in the ordinary course of carrying on a business constitutes income, it does not follow that a profit or gain made in a transaction entered into otherwise than in the ordinary course of carrying on the taxpayer's business is not income. Because a business is carried on with a view to profit, a gain made in the ordinary course of carrying on the business is invested with the profit- making purpose, thereby stamping the profit with the character of income. But a gain made otherwise than in the ordinary course of carrying on the business which nevertheless arises from a transaction entered into by the taxpayer with the intention or purpose of making a profit or gain may well constitute income. Whether it does depends very much on the circumstances of the case. Generally speaking, however, it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business. Nor does the fact that a profit or gain is made as the result of an isolated venture or a `one-off' transaction preclude it from being properly characterized as income (
FC of T v Whitfords Beach Pty Ltd 82 ATC 4031 at pp 4036-4037, 4042; (1982) 150 CLR 355 at pp. 366-367, 376).''

We have not discussed the facts in Pipecoaters because the facts of each case must be considered in the light of the applicable principles. It is helpful, however, to refer to one further passage from the Court's judgment in that case. It said (at ATC 4422; CLR 142):

``... it is necessary to consider the taxpayer's submission that the cases show that a receipt of moneys intended by payer and payee to recoup a recipient's capital expenditure is a receipt of a capital nature. That proposition can be accepted when the amount is received by way of gift or subsidy to replenish or augment the payee's capital, for in such a case the receipt cannot fairly be said to be a product or incident of the payee's income-producing activity... But it cannot be accepted that an intention on the part of a payer and a payee or either of them that a receipt be applied to recoup capital expenditure by the payee determines the character of a receipt when the circumstances show that the payment is received in consideration of the performance of a contract, the performance of which is the business of the recipient or which is

ATC 4635
performed in the ordinary course of the business of the recipient.''

The starting point for a consideration of the problem here is the fact that Grollo Australia was one of the Grollo Group of companies. The Group carried on business as substantial builders of commercial and industrial buildings. Over the years it had also engaged in construction work for public authorities. It had been in business for over ten years, that is at the time these transactions were entered into. Grollo Australia was a new member of the Group. It was the vehicle which was used for this project. It was the joint venturer for the Grollo interests and it entered into the arrangements with the other joint venturer, St Martins. Originally, it was not intended to be the builder; the builder was to be Grofam. It was only when problems were encountered as a consequence of that being the case that the structure of the arrangement was changed so that Grollo Australia became, at least nominally, the builder employing Grofam as a sub-builder to carry out the building work involved in the project.

After 27 October 1983, payments made by Porkellis Finance and St Martins which were used to fund the project, were paid on Grollo Australia's behalf. We say that because it is not clear whether moneys were actually paid to Grollo Australia or whether the moneys which were due were paid to the Group's banker, L. Grollo Nominees, and disbursed by it for the cost of building the project whether to Grofam, to other companies in the Grollo Group or to outside contractors. The detail of this is not important. The moneys were paid, at least notionally, to Grollo Australia and disbursed by it or at its direction for the purposes of the project.

Grollo Australia, at least up to the stage of this project, had not been engaged in the building industry in the sense of having carried out other building projects as had Grofam. But it would not be correct to treat its activities in isolation of those of the remainder of the Group. It was part of a group which was regularly carrying out building projects, whether for the Grollos themselves or for other persons. It is true that the project in question was very large and was probably the largest project which the Group had on hand during the years of construction which began in 1981. But it was, nevertheless, but one more project.

The Court in Pipecoaters emphasised the importance of ascertaining the scope of the business and a recipient's purpose in engaging in it as a means of determining the character of a receipt. That was the reason why reference to the Myer case was made in the judgment. But it may be thought that this case is a clearer one than Myer and that the reference to it is unnecessary in the present circumstances.

A further factor to be taken into account is that the building work was being done, not only for Grollo Australia itself, but also for St Martins which was unconnected with the Group. Its only relationship with the Group was the joint venture in which it engaged with Grollo Australia.

All these factors lead, in our opinion, to the conclusion that the character of the receipt of the moneys paid by Porkellis Finance and St Martins pursuant to the joint venture agreement received by Grollo Australia, whether actually or notionally, was as income and not as capital. The position may have been different, so far as Grollo Australia was concerned, if Grofam had continued to be employed as the builder by the two joint venturers and had transferred surpluses to Grollo Australia; but that arrangement was terminated and replaced by one whereby Grofam became responsible for the building work to Grollo Australia rather than the joint venturer. It was Grollo Australia which undertook the responsibility for the construction work on behalf of the joint venture.

In our opinion the various factors to which we have referred, lead to the conclusion that the moneys received by Grollo Australia were received by it on revenue and not on capital account. The fact that Grollo Australia was one of the joint venturers and thus responsible for the repayment of one-half of the borrowed moneys to Porkellis Finance as well as for its contribution of equity are complicating factors which require separate attention. But subject to the problems which arise because of those matters, we are satisfied that the moneys received by Grollo Australia are properly characterised as income and not as capital. We therefore reject the submission that Grollo Australia earned no assessable income as a consequence of receiving the moneys from St Martins and the mortgagee.

The next question is whether Grollo Australia received as assessable income the whole of the

ATC 4636

amounts paid, including amounts notionally paid by it for its contribution to the joint venture. As mentioned, his Honour concluded that it did not because it was both owner and builder and could not be said to have derived income from the receipt of money which represented in effect the half of the construction payments contributed by itself, i.e. the 12.5 per cent equity in the project which the joint venture agreement obliged it to contribute together with its half share of the money which was borrowed.

Counsel for the Commissioner submitted that, because Grollo Australia was the builder under the contract, it received all moneys, including those notionally received in respect of its own share, as income. Reliance was placed on the decision of the High Court in
Leonard v The Federal Commissioner of Taxation (1919) 26 CLR 175. There the appellant had lent a sum of money at interest to a partnership of which he was a member. During the relevant tax year the appellant was credited by his bankers with the amount of interest payable for that year on the loan. During the same year the partnership made a loss. The appellant's share of the loss included his share of the interest so credited. The High Court held that the whole of the interest credited to the appellant was properly included in the assessment of the appellant for the year in question.

The judgment of the High Court was delivered by Isaacs J who referred to the relevant provisions of the Income Tax Assessment Act 1915-1916 which was then in force. He referred (at 178) to the fact that the relevant section operated so that the firm, although composed of two partners, had, for the purposes of the applicable Act, a single personality.

His Honour said (at 178):

``If, for instance, the firm of Leonard & Cameron had borrowed the £22,000 from another firm, consisting of (say) Leonard and Smith, it would be perfectly clear that Leonard & Smith as a single entity would have received the £1,100 from Leonard & Cameron, and that Leonard as a member of the firm of Leonard & Smith would then have been taxable for it in respect of the income of Leonard & Smith. But it would be indisputable that that income would have been received by the firm of Leonard & Smith quite independently of Leonard's interest in the firm of Leonard & Cameron. Leonard received the £1,100 as an individual, and he received it in the same way; it does not affect the principle at all.''

But, significantly for present purposes, his Honour added (at 179) that on the facts of the case it was clear that, if the section had not been enacted, the general principles of law would have rendered the appellant liable in the same way. The court would have arrived at the same conclusion independently of the section on the facts as they were.

As counsel for the appellants submitted, whatever the position was under the 1915 Act, the position is now different. This is made clear by the decision of this Court in
Rowe (B and HG) v FC of T 82 ATC 4243; (1982) 60 FLR 475 where the Full Court of this Court said (at ATC 4243-4244; FLR 476) that there was nothing in the Act which denied or altered the basic legal principle that the profits or net income of a partnership were the profits or net income of those who constituted it. That statement was approved by Mason and Wilson JJ in
FC of T v Galland 86 ATC 4885 at 4887; (1986) 162 CLR 408 at 414.

Nevertheless, counsel for the appellants acknowledged that they had to deal with the statement in the judgment of Isaacs J in Leonard's case that, on the facts of that case, it was clear that, if the section had not been enacted (i.e. the section in the 1915 Act) the general principles of law would have rendered the appellant liable in the same way. Reference was made to
The Bohemians Club v The Acting Federal Commissioner of Taxation (1918) 24 CLR 334 where Griffith CJ said (at 337-338):

``A man's income consists of moneys derived from sources outside of himself. Contributions made by a person for expenditure in his business or otherwise for his own benefit cannot be regarded as his income, unless the Legislature expressly so declares. This Act does not contain any such declaration either express or implied.''

The Bohemian's Club case concerned a club and not a partnership but in our opinion the statement made by Griffith CJ is of more relevance to the present problem than the decision in Leonard's case which depended upon its own facts.

The principle expounded by Griffith CJ is, in essence, that which was applied by his Honour

ATC 4637

in reaching the conclusion which he did. His view was that so much of the moneys borrowed from Porkellis Finance as represented the half of the liability for which Grollo Australia was responsible and, if it be the correct way of looking at it, the notional amount received by Grollo Australia from the construction surplus which resulted in its not having to contribute in cash its share of the equity contribution which it was bound to provide, were not moneys which constituted assessable income because the moneys came from Grollo Australia itself partly by reason of its obligation to repay the amount borrowed on mortgage and partly because of the way in which its half share of the equity contribution by the two joint venturers was funded.

In those circumstances, we have reached the conclusion that his Honour was correct in the view which he took. The contribution made by St Martins pursuant to its obligation in the joint venture agreement coupled with its contribution of the moneys borrowed were assessable income. The other half of those moneys was not.

Additional tax

We have earlier dealt with factual questions concerning additional tax in respect of tax payable on income earned prior to 27 October 1983. Questions also arise in relation to additional tax remitted by the Commissioner in respect of income earned after that date. It will be seen in a moment that the way in which the Act operates is to impose additional tax in a variety of circumstances but to confer on the Commissioner a discretion to remit the additional tax in whole or in part if he considers the circumstances warrant it. In order to provide guidance both to the Commissioner's staff and to taxpayers and their advisers, the Commissioner has issued certain rulings containing guidelines as to the way the Commissioner's discretion will usually be exercised in certain classes of case. Relevant rulings are Taxation Ruling IT 2517, which deals with the remission of additional tax generally, and Taxation Ruling IT 2564 dealing with the remission of additional tax imposed in tax avoidance cases under Part IVA of the Act. Also relevant are earlier rulings which these rulings replaced.

We have taken these rulings generally into account, but the rulings do not bind the Tribunal. Nor do they bind the Court. Nevertheless, a reading of his Honour's reasons discloses that he has paid close attention to them. In some places he has used terms and expressions which come from the rulings.

Mr L.P. Maddern is an income tax auditor in the Australian Tax Office. He gave evidence in the proceedings before the Tribunal. His Honour said that the basis of the various decisions made by the Commissioner relating to the ``remission of additional tax'' was explained in a document prepared by Mr Maddern. The document is set out in his Honour's reasons. The first paragraph would appear to deal with the position before 27 October 1983. We do not refer to it for that reason. Mr Maddern said that, because of determinations to be made under s. 177F, the amount of tax payable would exceed the amount that would have been payable if the determinations were not made. The general assertion was made that taxpayers in the Grollo Group had made statements which were false or misleading in a material particular or had omitted from statements ``any matter or thing without which the statement was misleading in a material particular, and less tax would be payable if an assessment were made on the basis that the statement was not false or misleading. The false or misleading statements include assessable income omitted from returns of income of taxpayers (including trust estates) whose present entitlement to that income arises because of the applicability of trustees' resolutions and/or the default clauses of trust deeds.''

The document then referred to the settlement of the matter which has been previously explained. It was said that it had been agreed with representatives of the Grollo Group that in order to accommodate the various arguments that the Commissioner might wish to present to the Tribunal or to the Court, assessments would issue assessing all the Rialto construction profit; firstly, to Grofam as trustee for the Grofam Unit Trust and secondly to Grollo Australia as trustee for the Rialto Unit Trust. Mr Maddern said that, in imposing the additional ``penalty'' tax, regard was had to guidelines contained in income tax rulings which were referred to. He said that the rulings provided for both the basic (flat) component of the additional (penalty) tax and also ``for a per annum component''. He said that it was considered that a culpability factor applicable to deliberate evasion was

ATC 4638

appropriate. This was 45 per cent which was derived from Taxation Ruling IT 2517. In the interests of consistency it was considered appropriate to use that rate in all years. Use of the basic rate in conjunction with the standard per annum component would have resulted in the imposition of additional tax in the vicinity of $30 million. Mr Maddern continued:

``To achieve the global settlement of the other issues in dispute, it was finally decided to make a concession on the per annum component of the additional (penalty) tax applicable to the Rialto construction profits, notwithstanding that the Rialto construction profits issue was to be litigated rather than settled. Accordingly, it was decided to limit the additional (penalty) tax to $20 million.''

Mr Maddern said that, to give effect to the agreement, the ``per annum component'' was reduced in accordance with a table which was contained in the document which he prepared. This was introduced by the words, ``In respect of the assessments that issued as a consequence to assessing the Rialto construction profit to Grofam Pty Ltd...'' and there were then stated percentages for the 1983, 1984 and 1988 years. Each of these percentages was well below 20 per cent. The significance of that matter will appear in a moment. The 1983 year is not relevant for present purposes because, as already stated, we are of opinion that his Honour's factual conclusions in relation to the income for that year ought not to be disturbed. There is no reference to the 1985, 1986 or 1987 years because, despite the Commissioner's determination under s. 177F of the Act, no taxable income was earned by Grofam during those years. There is a second table dealing with the assessments issued to Grollo Australia for the 1984, 1986 and 1988 years. Again, the amount of the penalty is substantially less than 20 per cent of the income tax which was considered by the Commissioner to be payable.

We next refer to the relevant legislation. The references are to the various legislative provisions in force at the relevant times. Most of them have since undergone amendment. The additional tax in most cases was imposed pursuant to s. 223 of the Act which, in the circumstances, with which it dealt, imposed a penalty of double the tax avoided. That statement is a little elliptical but it is sufficient for present purposes. Cases under Part IVA were dealt with, not under s. 223, but under s. 226. But again the additional tax which was imposed was double the tax avoided. Section 227 of the Act dealt with the remission of additional tax. It applied both to cases under s. 223 and to those under s. 226. It provided that the Commissioner should make an assessment of the additional tax payable by a person under a provision of Part VII which is the Part of the Act dealing with penalty tax. Subsection 227(3) provided that the Commissioner might, in the Commissioner's discretion, remit the whole or any part of the additional tax payable by a person under a provision of Part VII.

It is next necessary to refer to certain provisions of the Taxation Administration Act 1953 (``the Administration Act'') dealing with taxation objections, reviews and appeals. The starting point is s. 14ZZA which provides that the Administrative Appeals Tribunal Act 1975 applies in relation, inter alia, to the review of ``reviewable objection decisions''. A ``reviewable objection decision'' means, inter alia, an objection decision that is not ``an ineligible income tax remission decision''. ``An ineligible income tax remission decision'' has the meaning given it by s. 14ZS. Pursuant to that section, an objection decision is an ineligible income tax remission decision if subsec. (2) of the section applies.

Before coming to the detail of the provisions of that subsection, it should be explained that the Administration Act has undergone a number of amendments in recent years. Two of these are of particular relevance. The first is to be found in the Taxation Laws Amendment (Self Assessment) Act 1992 (``the 1992 Amendment Act''). That Act dealt, inter alia, with a number of amendments to be made to the Administration Act. Amongst these were amendments to s. 14ZS. Section 14 of the 1992 Amendment Act provided that, despite the amendments made by s. 6 of that Act to the Administration Act, s. 14ZS of the Administration Act, as in force immediately before the commencement of the 1992 Amendment Act, continued to apply to objection decisions that related to the remission of additional tax payable by a taxpayer under, inter alia, s. 223 and s. 226 of the Assessment Act.

The previous form of s. 14ZS was provided for in the Taxation Laws Amendment (No. 3) Act 1991. So far as relevant subsec. 14ZS(2) then provided that an objection decision was an

ATC 4639

ineligible income tax remission decision if it related to the remission of additional tax payable by a taxpayer under the Assessment Act and its amount, after the decision was made, did not exceed, relevantly, in the case of additional tax payable under s. 223 and s. 226 of that Act, 20 per cent of the amount of ``relevant affected tax'' in relation to the taxpayer in relation to the year of income. Subsection 14ZS(2) also provided for cases falling under s. 223 which related to two or more years of income. In those cases there was to be no review unless the amount of the additional tax exceeded 20 per cent per year of the amount of ``relevant affected tax''. That is the form of subsec. 14ZS(2) applicable here. The amounts of additional tax imposed by the Commissioner in these matters did not exceed 20 per cent of the relevant affected tax in any case.

Against that background, we come to the way in which the matter was dealt with by his Honour. After referring to Mr Maddern's document, his Honour said that he did not intend to enter upon a detailed examination of the legislative framework which had applied at relevant times to the imposition and remission of additional tax. Rather, he proposed to address two factual matters which ``may be adequate to dispose of the competing arguments in relation to the general issue of additional tax''. His Honour said that the evidence established to his satisfaction that in the 1983 year of income and in the 1984 year in respect of the period ending 27 October 1983, the assessable income of Grofam was deliberately understated for the purpose of concealing the profits derived from the Rialto Project. This is a matter with which we have already dealt. It is unnecessary to refer to the detail of the discussion which follows in his Honour's reasons. At the conclusion of his discussion of this matter, his Honour said that it had been convenient to canvass the facts in relation to the period before 27 October 1983 to provide a basis of comparison with the facts after that date.

His Honour next referred to a letter dated 9 November 1983 written to the Commissioner by Touche Ross (subsequently Peat Marwick) on behalf of Grollo Australia. The letter contained an application for a deduction exemption certificate in relation to Grollo Australia. This was a certificate known as a PPS Exemption Certificate. The application was made for the purpose of obtaining an exemption from the prescribed payments system which would otherwise have applied. The letter referred to the fact that Grollo Australia was the trustee of the Rialto Unit Trust. The Trust was said to be an equal partner in the Rialto joint venture which was described as a project involving the construction of a building complex costing $280 million. It was said that the joint venture agreements provided for Grollo Australia to act as head contract builder of the project. Any difference between the cost of construction ``and the agreed arms length construction price'' effectively formed part of Grollo Australia's equity in the joint venture. An exemption certificate was requested pursuant to s. 221YHQ of the Act. Alternatively, a ruling was requested that, as Grollo Australia was constructing the building for a joint venture in which it held a 50 per cent interest, payments from the joint venture account to it were not within the prescribed payments system. It was also said that the Deputy Commissioner had previously advised that the ``interests costs'' accrued during the course of the construction of the project would be deductible. As a result the Trust had considerable ``carry forward tax losses''.

The deduction exemption certificate was issued on 25 November 1983. No response was made to the request for an income tax ruling. His Honour said that, as a condition precedent to the issuing of the deduction exemption certificate, it was necessary for the Commissioner to be satisfied that there was ``no reasonable likelihood that tax will be payable by the applicant, i.e. Grollo Australia.'' Reference was made to the then form of subsec. 221YHQ of the Act. His Honour said that, presumably the Commissioner was so satisfied and presumably he acted on the assumption that the letter of 9 November 1983 accurately stated the relevant facts.

His Honour said that it was a necessary inference from the evidence that it was the intention of the Grollo companies after 27 October 1983 that Grofam would perform its role as subcontractor on an at cost basis. It was beyond question, so his Honour said, that it did so for the balance of the project. His Honour added that the statement in the letter written by Touche Ross to the Commissioner that any difference between the cost of construction and

ATC 4640

the agreed construction price effectively formed part of Grollo Australia's equity in the joint venture, expressed the view then adopted by the Grollo advisers. His Honour continued, ``as it happens, it is a view which we have found to be erroneous but it is certainly one which some experts support. Right or wrong, it is clear that the issue was raised with the Commissioner, albeit in general terms, and it discloses a state of affairs quite different from that which had been discussed... in 1981.''

His Honour added:

``In my opinion, it is of no comfort to the Commissioner that the letter of 9 November 1983 was written in support of a PPS exemption application. It was addressed to the Deputy Commissioner and it made assertions about Grollo Australia's liability to tax on the Rialto construction surplus; it not only contained a reference to the matter which had been discussed with Bohan [a member of the Commissioner's staff] in 1981, but also sought a ruling as to whether the joint venture payments received by Grollo Australia were within the PPS. There is no evidence that the Commissioner ever replied to the request for a ruling despite the fact that a similar request was contained in a letter written on 27 June 1984.''

His Honour referred to a submission which had been made to him that the PPS scheme was administered by a separate branch of the Tax Office and that there was no liaison between that branch and other relevant branches of the office. His Honour said that this was a matter of ``logistics'' within the office and added that a disclosure made to the Commissioner was nonetheless made to the Commissioner whatever the primary purpose of the disclosure. The Commissioner must be taken to have had notice of the contents of the letter of 9 November 1983 and other similar letters written on Grollo Australia's behalf and must also be taken to have been aware of the outline of the Rialto Project given to one of his officers in 1981. He concluded that, on any view of the facts, the Commissioner was aware of the position Grollo Australia adopted. By continuing to issue exemption certificates to Grollo Australia the Commissioner had apparently accepted the position.

His Honour added that the failure to return any of the Rialto profits derived after 27 October 1983 was consistent both with the view of the Grollo advisers that they were not taxable and with the apparent acceptance of that position by the Commissioner. His Honour continued:

``The evidence does not support a finding that the failure to return the Rialto construction surplus as income after 27 October 1983 was done fraudulently or with the intention of evading tax. The Commissioner's decision to apply a common `culpability component' in his assessment of additional (penalty) tax was based upon an erroneous assumption that the evasion which occurred in relation to the pre-27 October 1983 income tainted the applicants' conduct in subsequent years.''

His Honour said that it remained to consider whether it could be said that deliberate steps were taken, either before or after the commencement of official enquiries, to conceal the avoidance of tax. He referred to a letter and an accompanying submission written by KPMG Peat Marwick to Mr Lloyd of the Tax Office on 25 March 1992. We do not refer to the detail of these documents.

His Honour said that the submission contained a number of factual errors. Furthermore, it had advocated treatment of the Rialto surplus in a manner contrary to what had been found by the Tribunal to be appropriate. His Honour continued:

``However, despite the fact that it was sent to the ATO in March 1992, it is not specifically referred to, or relied upon in the document prepared by Maddern quoted in paragraph 141 [the reference is to the document prepared by Mr Maddern referred to at the outset of this discussion]. Indeed, nowhere in that document is the assessment of the `culpability component' of the additional tax assessed by the Commissioner said to have been affected by any deliberate steps taken, either before or after commencement of the Commissioner's enquiries, to conceal the avoidance of tax.

The cross-examination of both Maddern (T 1890-1) and Lloyd (T 1912) revealed that at the time the assessments were issued the ATO officers believed that the 27 October notice was a document prepared by Grollo to further what was regarded as a fraud on the revenue. Both officers conceded that this

ATC 4641
belief has since been shown to be erroneous.''

His Honour concluded:

``There is no evidence that the letter of 25 March 1992 was written with any fraudulent intent. Indeed, by the time it was written the ATO audit had been in progress for nearly 3½ years. The ATO was in possession of all relevant documents and to the extent that the letter may have contained statements which were inaccurate, the truth of the situation must have been well known to the ATO by then. I do not think that the advocacy of a particular point of view, however erroneous, should be treated as fraudulent.

To the extent that the Tribunal's view on the question of culpability is relevant it is my opinion that Grollo Australia's failure to return any income from the Rialto project should be classed as an honest mistake in respect of a contentious item.''

Despite submissions to the contrary by counsel for the Commissioner, we find it difficult to understand how this Court could interfere with such a finding in a situation where the appeal lies only on a question of law. His Honour saw the witnesses and made a finding concerning the credibility of witnesses. He thought that the failure to return any income from the Rialto Project after 27 October 1983 should be classed as an honest mistake in respect of a contentious item. Just how contentious the items in question were can be judged by the submissions which were made about the various matters which have been dealt with and the reasons given for the conclusions which have been reached.

The matter is a complex one. In relation to Part IVA, the position has, in our respectful opinion, become clearer than it was when the matter was argued or when the matter was decided by his Honour. That is because of the decision of the High Court in Spotless. It is true that that decision gave effect to the Commissioner's approach to the section in argument both before the Tribunal and before this Court, but the decision of the Full Court of this Court in Spotless had not been given at the time that the argument was concluded before us. By majority, the Full Court took a different view from that which ultimately prevailed in the High Court. If we had been left to decide the matter upon the basis of the law as expounded by the majority in the Spotless decision in the Full Court of this Court, our decision may have been to a different effect. We express no view about this; we mention the matter only to show that what his Honour said about the matter being contentious was clearly correct.

In the case of Grollo Australia, the Commissioner's view was that the whole of the moneys received by it, including its share of the borrowed moneys and those notionally received in respect of its share of the equity, were assessable income. That is a view which has not prevailed. The amount of income tax actually payable by Grollo Australia will therefore be substantially reduced. Furthermore, there was a real question concerning whether the moneys provided by St Martins by way of its share of the borrowings and its equity contribution led to there being any taxable income. That was because, in the way the matter was looked at by Grollo Australia and its advisers, the excess of assessable income over allowable deductions represented capital in Grollo Australia's hands. That submission has been rejected but that does not mean that the submission was untenable.

In order to endeavour to overcome the problems confronting the Commissioner because of the limited nature of the appeal to this Court, counsel attacked his Honour's reliance on the circumstances surrounding the issue of the PPS certificate earlier referred to. In their submission, his Honour's reliance on it was misplaced, not only because the application for it was dealt with by a different department or section of the Tax Office, but also because it was not open to his Honour to rely on the certificate as an indication of full disclosure. We see the force of this submission. But we find it difficult to conclude that his Honour's reliance on it revealed an error of law. It may be that, if this appeal lay on a question of fact, the view might have been taken that his Honour placed excessive weight or reliance on the evidence about the certificate. But that is not a course which is open to us. Unless error of law is revealed, we may not interfere.

In any event it is clear from a reading of the whole of his Honour's reasons that he took into account a number of matters in reaching his conclusion of which the circumstances surrounding the issue of the PPS certificate were only one. In their submissions, counsel for

ATC 4642

the Commissioner advanced reasons why his Honour's judgment on this aspect of the case revealed error. A number of matters were referred to. We do not deal with the detail of these because, whether one has regard to them individually or cumulatively, they are all matters which might be relied upon if his Honour's factual conclusions were being challenged in an appeal in which that course was open. Here it is not.

Two further matters remain to be dealt with. They do raise questions of law. The first dealt with the application of s. 14ZS of the Administration Act. In the submission of counsel for the Commissioner, there was no appeal to the Tribunal permitted because the 20 per cent limit imposed by s. 14ZS of the Administration Act was not exceeded. In the submission of counsel for the appellants, the provisions of s. 14ZS of the Administration Act did not preclude the review of the Commissioner's decision because the relevant objection decisions that were before the Tribunal related to the correctness of the whole of the assessments, not just the correctness of the remission of additional tax. In the appellants' submissions, the effect of s. 14ZS was not to exclude a review of an objection decision which related in some part only to remission of additional tax. It only excluded review of an objection decision which related wholly to the remission of additional tax. That, so counsel submitted, was not the case here.

We think that the question of construction which counsel's submission presents for decision is not without difficulty. The relevant words of subsec. 14ZS(2) are ``An objection decision is an ineligible income tax remission decision if it relates to the remission of additional tax payable by a taxpayer...''. The expression ``it relates to'' is an expression of wide import. It is capable of applying to the words which are used even though the remission decision is only part of what is involved in the totality of the decision. On the other hand, it would seem an odd thing if there were, as here there is, an appeal to the Tribunal on the question of the amount of income tax payable which did not carry with it the right to question any consequential imposition of additional tax. In other words, if as indeed happened, the Commissioner assessed a taxpayer on the basis that the whole of a particular sum of money was assessable income in its hands and it was found by the Tribunal that only half the amount was income, it would seem wrong to leave in place penalties imposed by the Commissioner on the basis that the whole amount was assessable income. It is that feature of the matter which has persuaded us that effect should be given to the submissions of the appellants.

It may be that the appropriate course is that referred to by Jenkinson J in
Stevenson v FC of T 91 ATC 4476 at 4490; (1991) 29 FCR 282 at 299; see also the decision of the Full Court of this Court in
Fletcher & Ors v FC of T 88 ATC 4834; (1988) 19 FCR 442. The circumstances of the case before Jenkinson J differed from those in question here. But his Honour said (at ATC 4490; FCR 299):

``In my opinion the reasoning of the Full Court in Fletcher's case strongly supports, if it does not require, the conclusion I reach that the Tribunal did not lack power to give effect to its conclusion that the taxable income of the applicant, and so the tax due, in respect of the year of income ended 30 June 1981 were amounts greater than the respective amounts specified in the amended assessment, objection against which had been wholly disallowed by the respondent. The means available to the Tribunal to give effect to that conclusion was in my opinion to make decisions, first, that the respondent's decision under review be varied by adding thereto a decision that the taxable income of the applicant and the tax payable thereon in respect of the year of income were respectively the amounts determined by the Tribunal and second, that the matter be remitted to the respondent with a direction that he further amend the assessment accordingly. Such decisions could in my opinion involve no contravention of the letter or the spirit of any provision of s. 170. Contravention of the letter of s. 170 is not possible, because no command is addressed to the Tribunal, or authority conferred on the Tribunal, by any provision of that section; the Tribunal does not, and cannot, amend an assessment. Contravention of the spirit of the section is not effected by such decisions because s. 170(7) manifests a clear legislative intention that the time which elapses between a decision by the Commissioner on an objection against an assessment and the

ATC 4643
amendment of that assessment `in order to give effect to the decision upon any review' is not to be included in the measurement of the periods ordained by other provisions of that section.''

Subsection 170(7) provided that nothing in s. 170 should prevent the amendment of any assessment in order to give effect to the decision upon any appeal or review, or its amendment by way of reduction in pursuance of an objection made by the taxpayer or pending any appeal or review. Section 170 has been earlier referred to. It is the general provision in the Act dealing with the amendment of assessments.

During the argument, it was agreed that it would not be appropriate to make orders without giving the parties an opportunity of considering the Court's reasons and then bringing in short minutes of order to give effect to its decision. This is one of the matters - there are no doubt others - that will need a degree of care in the formulation of appropriate orders.

The second question of law concerns the construction and application of the provisions of subsec. 223(4) of the Act. The additional tax payable by Grofam in respect of the year ended 30 June 1984, which related to false statements of assessable income made or having effect during the period 1 July 1983 to 27 October 1983, was imposed upon Grollo Nominees Pty Limited, not Grofam. Grollo Nominees is the beneficiary under the Grofam Unit Trust. Counsel for the appellants contended that the provisions of subsec. 223(4) were such as to prevent the Commissioner, in the circumstances of this case, assessing a beneficiary under a trust for additional tax.

Subsection 223(4) is as follows:

``(4) Where-

(a) a trustee of a trust estate-

(i) makes a statement to a taxation officer, or to a person other than a taxation officer for a purpose in connection with the operation of this Act or the regulations, that is false or misleading in a material particular; or

(ii) omits from a statement made to a taxation officer, or to a person other than a taxation officer for a purpose in connection with the operation of this Act or the regulations, any matter or thing without which the statement is misleading in a material particular,

being a statement relating to, or to the affairs of, the trust estate; and

(b) the tax properly payable by a person who is or has been a beneficiary of the trust estate exceeds the tax that would have been payable by a last-mentioned person if it were assessed on the basis that the statement were not false or misleading, as the case may be,

the trustee is personally liable to pay, by way of penalty, additional tax equal to double the amount of the excess.''

Subsection 223(4) is found in the legislation as it was after 14 December 1984. It was then that amendments to the Act made by the Taxation Laws Amendment Act 1984 came into operation. Notwithstanding that it was not in force at any time up to 27 October 1983, the provision appears to be applicable because the relevant income tax returns were lodged after 14 December 1984 when the amendments came into force. That was the assumption upon which the matter was argued.

In the submission of counsel for the appellants, on the proper construction of subsec. 223(4), where a trustee wrongly omits income from the return of the trust estate, additional tax is imposed on the trustee under the subsection. Counsel submitted that additional tax was not also imposed on the beficiaries of the trust by reason of their failure to return their share of the net income of the trust estate which, ex hypothesi, the trustee had not properly calculated or returned. Counsel said that to read the Act in such a way as to impose additional tax on the beneficiaries would be to read it as imposing additional tax more than once by reason of what was in substance the same omission. Accordingly, in respect of the year ended 30 June 1984, Grollo Nominees was not liable to pay additional tax under s. 223 of the Act by reason of any omission of Grofam to return income of the Grofam Unit Trust.

The submission is an attractive one. Counsel for the Commissioner dealt with it in their oral submissions rather than in their written submissions. They said that the submission was misconceived because the basis of the additional tax that had been assessed was an omission from the tax return of Grollo Nominees as trustee for Monica Grollo and not

ATC 4644

Grollo Nominees in respect of some omission or mistake by Grofam. What counsel described as the ``fundamental premise of the argument'' was flawed with the consequence that it failed.

After counsel for the Commissioner had said what they did, there was a discussion with the Court about the matter. Counsel was asked whether the argument mattered when one took into account the amount which was to be paid in the light of the Court's decision about remission. Counsel for the Commissioner said that it did not matter. Someone was liable for the additional tax, even if the wrong person had been chosen. The same principles as to remission were relevant. What counsel was saying was that counsel for the appellants had proceeded on a misconception as to whose omission the assessment was based upon.

At that point it seemed to us that the whole exercise had become quite unsatisfactory. We were not referred to sufficient of the evidence to be able to deal with the point adequately; perhaps the evidence was not led. And there seems to be something to be said for the view that, in any event, the exercise was hypothetical. Accordingly, we do not propose to decide the outcome of the appellants' submission on this matter at this stage. If, after our judgment has been considered by the parties and by their legal advisers, it is necessary to decide the point, we shall consider the matter further in the light of such submissions as then exist. We mention that the matter is discussed by counsel for the Commissioner at pp. 239-242 and by counsel for the appellants at pp. 287-288 of the appeal transcript.

In the result, therefore, we have reached the conclusion that the matters relied upon by the Commissioner in relation to additional tax on income earned after the period ending 27 October 1983 should not persuade the Court to adopt a view different from that of his Honour. We leave open the question which concerns the construction and application of subsec. 223(4) of the Act.

Leanne Grollo

The Commissioner issued an assessment in respect of Ms Leanne Grollo's income for the year ending 30 June 1986 on 21 April 1987. Under it tax was payable on 20 May 1987. In an amended assessment issued on 27 September 1993 the Commissioner increased Ms Grollo's taxable income by $1,357,386. It was submitted to his Honour that, if the amended assessment were not set aside for other reasons, it should be set aside as having been made beyond the time limit prescribed by subsec. 170(2) of the Act.

Subsection 170(2) deals with the amendment of assessments by the Commissioner where there has not been a full and true disclosure of all the material facts necessary for the assessment and there has been an avoidance of tax. The assessment may be amended at any time if the Commissioner is of opinion that the avoidance of tax was due to fraud or evasion. Otherwise any amendment must be made within a period of six years. The amendment in the present case was made more than six years after the date upon which the tax became due and payable under the original assessment. So the amendment was invalid unless there was an avoidance of tax due to fraud or evasion. In the light of his findings, his Honour thought that there was no basis for the conclusion that there had been a fraudulent evasion of tax on the part of Ms Grollo in respect of the relevant year of income. Since we take the view that the submissions made concerning additional tax on income earned after 27 October 1983 should be rejected, we reach the same conclusion as his Honour in relation to Ms Grollo.

Nevertheless, we should briefly indicate that there were some matters of contention which would have had to be resolved had there been a different conclusion in relation to the additional tax. In the submission of the Commissioner there were two questions. The first was whether the omission of any Rialto construction profit from the net income of Grollo Australia as trustee of that trust amounted to fraud or evasion under the section. We have resolved that issue adversely to the Commissioner. The consequence is that we are of opinion that his submissions must fail. But the second question posed by the Commissioner was whether, assuming fraud or evasion by companies in the Grollo Group and their officers, could that fraud or evasion be imputed to Ms Grollo for the purposes of the section. There was no suggestion that Ms Grollo herself was personally involved in any fraudulent conduct. Counsel for the Commissioner developed submissions intended to persuade the Court that Ms Grollo was responsible in law for the fraud or evasion of the companies and the officers referred to. In their submissions, counsel for Ms Grollo disputed that proposition. In essence they submitted that in no sense could it be said

ATC 4645

that the conduct of Grollo Australia and its directors, in making and lodging the 1986 return of the Rialto Unit Trust, was conduct on behalf of or to be imputed to Ms Grollo. Counsel said that Grollo Australia was not the agent or delegate of Ms Grollo. She did not have the power to direct them as to the way in which they should carry out their duties as trustees.

In the view that we take of the matter, it is unnecessary to decide the question which the Commissioner's submissions pose. For that reason we do not express a view about it. The problem can await a case in which it more directly arises for decision.

The question arising under the Income Tax (Rates) Act 1982 ``the Rates Act''

This issue related to the assessment for the year ended 30 June 1984 of Grollo Nominees Pty Ltd as trustee for the Rino Grollo No. 11 Trust on account of Monica Grollo. At the relevant time she was an infant. This aspect of the case was settled during the hearing of the appeals. Accordingly, we say nothing further about it.

Conclusion

That completes the treatment of all matters which arose for consideration during the appeals except that concerning the construction of the terms of settlement. We have dealt with that matter in a separate judgment which will be published at the same time as these reasons are published.

The matter will be stood over for a short time to enable the parties and their legal representatives to consider what we have said. When the matter is again in the list, counsel are directed to bring in short minutes of order to give effect to our various conclusions. If there are any outstanding matters upon which they wish to make submissions, those submissions should be delivered in writing before the next hearing. Written submissions should not exceed 12 A4 pages in length.

THE COURT ORDERS THAT:

1. The appeals and cross-appeals be dismissed.

2. No order as to costs.

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