Decision impact statement
Darrelen Pty Ltd, Trustee of the Henfam Superannuation Fund v The Commissioner of Taxation
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Court Citation(s):
[2010] FCAFC 35
(2010) 183 FCR 237
2010 ATC 20-180
78 ATR 916
Venue: Federal Court of Australia
Venue Reference No: NSD 1079 of 2009
Judge Name: Stone, Edmonds and Jagot JJ.
Judgment date: 30 April 2010
Appeals on foot:
No.
Impacted Advice
Relevant Rulings/Determinations:
Subject References:
Special income
Complying superannuation fund
Concessional taxation
Précis
This matter concerned the construction of former section 273(2) of the Income Tax Assessment Act 1936, which treated private company dividends received by a complying superannuation fund as 'special income', and therefore taxed at the top marginal rate, unless the Commissioner, having regard to the factors specified in paragraphs (a) to (f) of that subsection, considered it reasonable to not do so.
The essence of the dispute was whether, in exercising his discretion under section 273(2), the Commissioner is entitled to have regard to the price paid for the shares, in particular, a disparity between the cost and the market value at the time of acquisition, or whether the inquiry required under section 273(2) is limited to whether the dividends themselves were paid on a non-arm's length basis.
Decision Outcome
Favourable / Appeal dismissed.
Brief summary of facts
The material facts, as recorded by the judgment, include the following:
"On 10 October 1995 the trustee of the Fund acquired from an existing shareholder four shares (of the 100 on issue) in Vercot [Pty Ltd ('Vercot')] for $51,218. Vercot was a passive holding company that held 25,609,320 shares in Abigroup Limited ('Abigroup'), a listed public company. The listed market value of each Abigroup share was $0.58 per share."
"The acquisition had the effect that the Fund obtained an indirect interest in 1,024,373 shares in Abigroup, the market value of which on the date of acquisition was $594,136. The result was that the market value of the Fund's shareholding in Vercot, both when it was acquired and thereafter (and during the relevant years of income), was far in excess of the amount paid for it; the price was about 10% of the market value and between 1/10th and 1/6th of the true value."
"Abigroup paid substantial dividends to Vercot, which in turn paid dividends to its shareholders including the trustee of the Fund; the dividends in each of the relevant years of income were far in excess of the purchase price which the trustee of the Fund had paid for the shares. In this regard, against an acquisition cost of $51,218 (paid in October 1995), the trustee of the Fund received dividends as follows:" ... "in 2000 - $143,720; in 2001 - $143,720; in 2002 - $86,320 and in 2003 - $76,640."
And, "all dividends paid by Vercot on its shares in each of the relevant years of income were paid pari passu at the same rate, so that each shareholder (including the trustee of the Fund) received dividends in amounts equal to the proportion that the number of shares held bore to the total number of issued shares in Vercot."
Issues decided by the court
The underlying policy intent of section 273(2)
The court held that the underlying policy intent of section 273(2) "is to enable the Commissioner to deny the concessional taxation of income which has been diverted from taxpayers not enjoying that status".
The proper inquiry under section 273(2)
The court rejected the applicant's argument that the proper inquiry under section 273(2) is whether the dividend income was derived on a non-arm's length basis. The court explained that the applicant's argument was that what mattered was what happened in the year or years in which the dividend income was derived, not what happened in the year of acquisition. In that regard, the applicant argued that because all dividends paid in respect of the shares were paid pari passu there was no non-arm's length payment of dividends and the discretion should be exercised in the applicant's favour.
The court held that the argument is not supported by the text of section 273(2), and that it is inconsistent with the underlying policy intent of section 273(2), in that it "seems to adopt the position that the only way in which this can occur ... is where differential dividend rates are paid on such shares so that dividends paid on shares held by the concessional taxpayer are greater than the dividends paid on shares held by non-concessional taxpayer. But that is not the only way such income diversion can occur, as the facts of the present case illustrate."
Relevantly, the court observed, at paragraph 34, that:
"[i]f the price at which the four shares in Vercot were sold to the Fund had been set at their market value, the price at which they were sold would not have secured the sale of even one share; the dividends on those four shares would have continued to accrue to the transferor, a non-concessional taxpayer. So understood, the income diversion has occurred by recourse to a non-arm's length transaction on the acquisition of the shares."
The 'rate of return' or 'yield'
The Tribunal held that the rate of return on the dividends was "unquestionably enormous". In that regard, the court held that paragraph (c), which refers to the "rate of the dividend paid", does not also permit reference to the 'rate of return' or 'yield' on a dividend. However, the court held that the Commissioner may nonetheless have regard to the rate of return on the investment under paragraph (f).
The market value of the shares at the time of acquisition
The court disagreed with the Tribunal's reasoning that as a result of historical considerations the word 'value' in paragraph (a) means 'paid-up value' or 'par value'. The court held that "[h]istorical considerations of the kind referred to by the Tribunal do not persuade us that the word 'value' used in para (a), and in juxtaposition to the word 'cost' in para (b), means anything other than market value".
The court also held that the market value of the shares at the time of acquisition can be taken into "account under the heads of either paras (b) or (f), or in combination with each other".
Should the discretion have been exercised in the applicant's favour?
The court held that the Tribunal did not err in deciding that the discretion in section 273(2) should not be exercised.
Tax Office view of Decision
The judgment is generally consistent with the Commissioner's view, as outlined in Taxation Ruling TR 2006/7.
The Court found (contrary to the Commissioner's view in TR 2006/7, paragraphs 38 and 39) that s 273(2)(c) (the "rate of the dividend paid") does not permit consideration of the rate of return on the investment, or yield. However, the court also held that such a consideration was permissible under paragraph (f) (any other matters the Commissioner considers relevant). The Commissioner accepts the court's view on this issue.
Administrative Treatment
List of Rulings and Determinations Affected
Taxation Ruling TR 2006/7
Implications on current Public Rulings & Determinations
Taxation Ruling TR 2006/7
Section 273 has been repealed. However, section 295-550 of the Income Tax Assessment Act 1997 was enacted, which contains the same factors, but does not impose a discretion on the Commissioner. Rather, it has an objective test requiring the amount received to be consistent with an arm's length dealing.
Taxation Ruling TR 2006/7 is being reviewed to reflect the fact that section 273 has been repealed and section 295-550 of the Income Tax Assessment Act 1997 enacted. The judgment, and what bearing it may have on the construction of section 295-550, will be taken into account as part of that review
Implications on Law Administration Practice Statements
None
Legislative References:
Income Tax Assessment Act 1936
Section 273(2)(repealed by Act No. 15 of 2007)