Decision impact statement

Commissioner of Taxation v Trail Bros Steel & Plastics Pty Ltd

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Court citation:
[2010] FCAFC 94
2010 ATC 20-198
79 ATR 780
(2010) 186 FCR 410
(2010) 272 ALR 40

Venue: Federal Court of Australia
Venue Reference No: QUD 275 of 2009
Judge Name: Dowsett, Edmonds and Gordon JJ
Judgment date: 29 July 2010, corrigendum 2 August 2010
Appeals on foot: No
Decision Outcome: Partly Adverse

Impacted Advice

Impacted Practice Statements:

• PS LA 2005/24

Précis

Outlines the ATO view of this case which concerned whether Part IVA of the Income Tax Assessment Act 1936 applied to a scheme to overcome law changes that limited employer deductibility for superannuation contributions for employees to age-based limits.

Brief summary of facts

The taxpayer employed Mark Trail and Allan Trail under written employment contracts.

Each employment contract required the taxpayer, in addition to cash remuneration, to make superannuation contributions to the Trail Bros Superannuation Fund (the Fund) totalling $297,000 during the first four years of trading. $120,000 was paid by the taxpayer to the Fund in the year ended 30 June 1996, representing a $60,000 payment for each employee.

In the year ended 30 June 1997 (the 1997 year), legislative amendments had the effect of limiting deductibility for superannuation contributions under the employment contracts to annual age-based deduction limits for each employee: $27,170 for Mark Trail and $9,782 for Allan Trail in the 1997 year and $28,420 for Mark Trail and $10,232 for Allan Trail in the year ended 30 June 1998 (the 1998 year).

In response, the taxpayer and the two employees orally agreed to vary the employment contracts so that instead of making superannuation contributions to the Fund, the Taxpayer would make payments to the Trail Bros Pty Ltd Employee Welfare Fund (the Welfare Fund). The Welfare Fund was established by a deed of trust dated 19 June 1997. In both the 1997 year and the 1998 year, the taxpayer paid $210,000 to the Welfare Fund. The taxpayer claimed a deduction for each payment. The Commissioner disallowed the deductions on the basis that the amounts were not deductible or, if they were, that Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) operated to disallow the deductions.

The Administrative Appeals Tribunal (the AAT) found the payments to the Welfare Fund were deductible under s 51(1) of the ITAA 1936 for the 1997 year and under s 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for the 1998 year. The AAT also found that although there was a scheme within the meaning of s 177A(1) of the ITAA 1936, Part IVA of the ITAA 1936 did not apply because the taxpayer had not obtained a tax benefit in connection with a scheme within the meaning of s 177C of the ITAA 1936. The AAT did not consider the application of s 177D (b) of the ITAA 1936.

The Commissioner appealed to the Federal Court pursuant to s 44 of the Administrative Appeals Tribunal Act 1975 (the AAT Act). That appeal was limited to the AAT's treatment of Part IVA of the ITAA 1936.

The trial judge (Greenwood J) found that the taxpayer had obtained a tax benefit in each year but, contrary to the Commissioner's submission, found that the tax benefit was not the $210,000 paid to the Welfare Fund in each of the 1997 year and the 1998 year, but the difference between the $210,000 and the superannuation age-based deduction limits for each employee (the differential). His Honour set aside the decision of the AAT and remitted the matter to the AAT.

The Commissioner appealed to the Full Federal Court concerning the amount of the tax benefits found by the trial judge, contending the taxpayer obtained tax benefits in connection with the scheme of the full amount of the deductions allowable under the scheme.

The taxpayer cross-appealed, contending that:

(a)

the Commissioner's appeal to the Federal Court from the AAT's decision was not 'on a question of law' as required by s 44 of the AAT Act; and

(b)

the trial judge, having determined that the tax benefit the taxpayer had obtained in connection with the scheme in each year was not $210,000, but the differential, should have found that the Commissioner's power to make a determination under s 177F of the ITAA 1936 was never enlivened and so should have dismissed the Commissioner's appeal on the basis that the taxpayer had established that the Commissioner's assessment was excessive.

Issues decided by the court

The Full Federal Court (Dowsett & Gordon JJ, with whom Edmonds J agreed) unanimously dismissed both the Commissioner's appeal and the taxpayer's cross appeal, thereby remitting the matter to the AAT to complete its analysis of the application of s 177D(b) of the ITAA 1936.

The taxpayer withdrew its appeal on 28 February 2011 before the AAT completed its review and the case is now finalised.

Commissioner's appeals were on a question of law

The Court dismissed the taxpayer's argument that the questions raised by the Commissioner on his appeal from the AAT 'involved' a question of law but were not 'on' a question of law.

The Court concluded that each of the Commissioner's questions "was properly the subject of appeal under s 44 of the AAT Act" (para [15]), noting (at para [14]) that:

a question of law 'directing the Court's attention to the manner in which the Tribunal failed to discharge its obligations according to law' is a legitimate subject of an 'appeal' under s 44(1) of the AAT Act and nothing in the cases 'limits the reach of s 44 to questions of law divorced from the need to look at the facts'.

Taxpayer has onus of proving no tax benefit obtained in connection with a scheme

The Court held (at para [35]) that it is the taxpayer who bears the onus to establish they have not obtained a tax benefit in connection with a scheme for the purposes of s 177C of the ITAA 1936. In so doing, the Court rejected (at para [34]) the taxpayer's submission that:

the Commissioner, not the Taxpayer, had the burden of identifying the alternative postulate [what would have or might reasonably be expected to have taken place in the absence of the scheme] and that only when the Commissioner had established an alternative postulate did the burden shift to the taxpayer to show that the Commissioner's alternative postulate was only a 'possibility not a prediction sufficiently reliable for it to be regarded as reasonable'.

An element of the scheme may form part of the alternative postulate

At paragraphs [27] to [31], the Court considered a submission the Commissioner had made to the trial judge, but which formed no part of the Commissioner's submissions before the Full Court. That submission was that:

The question posed by s 177C (1) (b) is to be answered on the assumption that the entire scheme had not been entered into or carried out. It is not open to the taxpayer to point to what might reasonably be expected to have been done if only part of the scheme had not been entered into or carried out [citing FCT v Lenzo [2008] FCAFC 50; (2008) 167 FCR 255 at [121].]

That submission went on to argue that "[b]y taking into account the availability to the applicant and the directors of varying the contracts of employment the Tribunal had regard to an irrelevant or improper consideration" because "[v]ariation of the contracts of employment was one of the very components of the scheme in the present case which s 177C (1) requires to be taken not to have occurred [citing Lenzo at [121] and [130] ]".

The Court concluded that an element of the scheme may form part of the alternative postulate. In particular, the Court stated (at para [29]):

The particular activity or the events that would have, or might reasonably be expected to have, taken place in the absence of the scheme and which are identified as a result of the objective enquiry are not confined or defined by the scheme. Of course, it cannot be the same complete set of events giving rise to the scheme - that would be the scheme. But at the same time, the identification of the activity or the events does not necessarily preclude any element of the scheme.

Deduction under alternative postulate need not be of same kind as that under scheme

The Court concluded that the trial judge was wrong in approaching the question of the identification of the tax benefit obtained by the taxpayer in connection with the scheme by reference to whether under the alternative postulate there was an allowable deduction of the same kind as the deduction allowable under the scheme. The Court concluded (at paras [44] and [66]) that an allowable deduction identified in the alternative postulate need not be of the same kind as the deduction allowable under the scheme. In so doing, the Court arguably did not follow the decision of the differently constituted Full Federal Court in Lenzo. The observations at para [52] could be interpreted as regarding Lenzo as wrongly decided in that respect.

Instead, the Court held (see paras [30], [49] and [65]) that the amount of the tax benefit in the context of s 177C (1) (b) is simply any excess in the amount of the deduction allowable to the taxpayer in relation to a year of income under the scheme over the amount of the deduction allowable to the taxpayer in relation to that year of income under the alternative postulate. Edmonds J stated (at para [65]) that:

This does not mean that the taxpayer is at large in pointing to some

alternative allowable deduction having no relevance to the impugned scheme,...

Amount of tax benefit obtained by taxpayer in connection with scheme was the differential

The Court concluded (at paras [53] and [54]) that the trial judge was right to conclude that the taxpayer had obtained a tax benefit in connection with the scheme in each of the relevant years equal to the difference between the amount of the allowable deduction under the scheme for the employee welfare fund contributions and the amount of the allowable deduction under the alternative postulate (which was a deduction for superannuation contributions for the two employees up to their age-based limits).

Errors in Part IVA determination do not invalidate related assessment

The Court held (at paras [57] and [72]) that "it is not open to a taxpayer to challenge the validity of an assessment to give effect to a determination made under Part IVA [of the ITAA 1936] by showing some error in the making of the determination."

Further, the Court held (at para [57]) that "[t]he making of a determination under s 177F of the 1936 Act is not open to challenge in Pt IVC proceedings by showing some error in the making of the determination ...The making of a determination is procedural and does not go to substantive liability".

The Court noted (at para [57]) that, instead:

A determination having been made by the Commissioner, the issues of objective fact in a Pt IVC proceeding will be whether there was a scheme to which Pt IVA applied and if so, whether there was a tax benefit obtained in connection with that scheme ... The onus is on the taxpayer to show objectively that there was no scheme in connection with which the taxpayer obtained a tax benefit.

Consequently, the Court held (at para [57]) that "the erroneous identification by the Commissioner of the scheme, or the misconception by him as to the connection of a tax benefit with such a scheme, will not be fatal to the application of Pt IVA".

The Court therefore dismissed the taxpayer's cross-appeal as to the validity of the assessment, concluding (at paras [58] and [59]):

The assessment is not invalid. The making of the Commissioner's determination is procedural - it is not open to challenge. The taxpayer's submissions are contrary to the express words of the 1936 Act (ss 175, 175A and 177) and contrary to long established authority. ... The fact that the tax benefit, objectively determined, is the differential does not lead to the dismissal of the Commissioner's appeal.

Tax Office view of Decision

It is not clear whether the Full Federal Court's interpretation of s 177C(1) in Trail Bros Steel & Plastics Pty Ltd (Trail Bros) differs in some respects from that of the differently constituted Full Federal Court in the earlier case of Lenzo.

In Lenzo, Sackville J (with whom Heerey and Siopis JJ agreed, at paras [42] and [160] respectively) held (at para [128]) in relation to the interpretation of s 177C(1)(b) that:

in determining whether the particular deduction claimed by the taxpayer would or might reasonably have been allowable, the Court must consider, in the absence of the scheme, what activity the taxpayer would have undertaken. The taxpayer can satisfy the onus of showing that he or she has not obtained a tax benefit in connection with a scheme if:

•

he or she would have undertaken or might reasonably be expected to have undertaken a particular activity in lieu of the scheme; and

•

the activity would or might reasonably be expected to have resulted in an allowable deduction of the same kind as the deduction claimed by the taxpayer in consequence of the scheme . (Emphasis added)

Sackville J went on to say [at para 129] in rejecting the taxpayer's contention of a hypothetical contribution to a superannuation fund:

"...it would have been a deduction of quite a different character than that actually claimed...".

This suggests that the court may have intended that "the same kind" requirement meant "of the same character" not simply the same amount.

However, in Trail Bros, Dowsett and Gordon JJ (with whom Edmonds J agreed at para [62]) held (at para [44]) that:

we do not consider that on the proper construction of s 177C, the allowable deduction identified in the alternative postulate must be of the same kind as that claimed as a deduction under the scheme.

Further, their Honours went on (in para [52]) to hold in relation to s 177C(1)(b) that:

in the identification of the tax benefit, no part of the enquiry posed by s 177C enquires whether there was an allowable deduction of the same kind as that claimed under the scheme. Any suggestion to the contrary in earlier authorities (e.g. Lenzo 167 FCR 255 at [121] - [125] and [128]) may now be put to one side as explained in Spotless 186 CLR 404.

Interestingly, the Court based its reasoning on the High Court's decision in Federal Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404 which was an income benefit case involving paragraph 177C(1)(a). In that case, the High Court stated that "the paragraph speaks of the amount produced from a particular source or activity" (at 424) but did not specifically address the identification of a deduction tax benefit.

The Full Federal Court (Edmonds J, with whom Bennett and Middleton JJ agreed) in FCT v Ashwick (Qld) No 127 Pty Ltd [2011] FCAFC 49 has subsequently expressed the same view (at para [153, (14)]), as the Court in Trail Bros.

While a degree of uncertainty may still exist, it seems clear that the allowable deduction under the alternative postulate must have some reasonable factual basis to support it and that a taxpayer is not at large in pointing to an alternative allowable deduction having no relevance to the impugned scheme (see in particular Edmonds J at para 65).

As noted earlier, the Court in Trail Bros concluded that an element of the scheme may form part of an alternative postulate. On the other hand there are a number of passages in Lenzo that suggest a different view, that is, that an element of the scheme may not form part of an alternative postulate: see, for example, paragraphs [121], [130] and [136]. However, the Full Courts in Ashwick (at para [153] (4) & (6)) and AXA (at paras 131-133) have subsequently expressed the same view as the Court in Trail Bros.

Compensating Adjustments

The compensating adjustment provisions are an important part of the statutory scheme of Part IVA and, in the Commissioner's respectful opinion, bear on the proper construction of s 177C. However, they are not discussed in Trail Bros, Ashwick or Lenzo. Subsection 177F (3) authorises the Commissioner, among other things, to allow "any taxpayer" a deduction if two conditions are met. It is clear, we think, that "any taxpayer" includes the taxpayer in respect of whom the Commissioner has made a determination under s 177F(1) to cancel a tax benefit referable to a deduction, and does not mean "any other taxpayer". The two conditions are, first, that the Commissioner must be of the opinion that an amount would have been allowed or would be allowable to the relevant taxpayer as a deduction in relation to a year of income if the scheme had not been entered into or carried out, being an amount that was not allowed or would not, but for the compensating adjustment provisions, be allowable as a deduction to the relevant taxpayer in relation to that year of income; and second, that the Commissioner must also be of the opinion that it is fair and reasonable to allow that amount or a part of that amount as a deduction to the relevant taxpayer in relation to that year of income.

Prima facie, the compensating adjustment provision authorises the Commissioner to allow a compensating adjustment for a hypothetical alternative deduction, whether of the same or different kind to that actually obtained as a result of the scheme, with two provisos. First, the test requires that the Commissioner must be of the opinion that the taxpayer would have obtained a deduction, not merely that they might reasonably be expected to have obtained a deduction, if the scheme had not been entered into or carried out. That is, the standard required by the compensating adjustment provisions is higher than that for s 177C (1) (b). Second, and importantly, there is a requirement that it be fair and reasonable in the Commissioner's opinion to allow the compensating adjustment.

The approach taken by the Full Court in Trail Bros to the determination of the amount of a tax benefit in the context of s 177C(1)(b) produces the same result as a compensating adjustment by the Commissioner under s 177F(3)(b) in relation to the taxpayer in respect of whom the Commissioner has made a determination under s 177F(1)(b) where the deduction to be allowed as a compensating adjustment to that taxpayer in relation to a year of income would have been so allowable if the scheme had not been entered into or carried out.

However, the approach of the Full Court in Trail Bros produces a different result from the application of s 177F(3)(b) to such a taxpayer where an alternative postulate involves a hypothetical alternative deduction being allowable to the taxpayer in relation to the year of income, but the Commissioner is not of the opinion that:

•

such a deduction would have been so allowable (the taxpayer may have established only that such a deduction might reasonably be expected) if the scheme had not been entered into or carried out; or

•

it is fair and reasonable to allow such a deduction.

The way forward

It is well settled that the application of Part IVA will be sensitive to the particular facts of each case. The possible inconsistency in the Full Federal Court between Lenzo on the one hand and Trail Bros and Ashwick on the other as to whether the allowable deduction (if any) identified in the alternative postulate has to be of the same kind or character as that allowable (but for Part IVA) under the scheme creates some uncertainty for both taxpayers and the Commissioner.

The Commissioner will take all decisions of the High Court and Federal Court into account in applying Part IVA to the particular facts of cases. The Commissioner notes however the weight of authority now provided by the judgments in Trail Bros, Ashwick and AXA on the interpretation of s 177C (1).

Administrative Treatment

Implications for ATO precedential documents (Public Rulings & Determinations etc)

None

Implications for Law Administration Practice Statements

Law Administration Practice Statement PS LA 2005/24 Application of General Anti Avoidance Rules was updated on 16 September 2016 to reflect statements made by the Full Federal Court in relation to identifying the nature and amount of the a benefit under subsection 177C(1). The enactment of subsection 177CB(2) however, means that this issue will now be academic in many deduction cases after 16 November 2012. Refer to paragraphs 65-68 and 100 of the PS LA. See also paragraphs 99 and 116.

Amendment history

Legislative References:
Administrative Appeals Tribunal Act 1975
44

Administrative Decisions (Judicial Review) Act 1977
The Act

Income Tax Assessment Act 1936
51(1)
Pt III, Div 3, Subdiv AA
82AAC
175
175A
177
Pt IVA
177A(1)
177C
177C(1)
177C(1)(b)
177D(b)
177F

Income Tax Assessment Act 1997
8-1

Taxation Administration Act 1953
Pt IVC
14ZZK
14ZZO

Superannuation Contributions and Termination Payments Taxes Legislation Amendment Act 1997
The Act

Superannuation Contributions Tax (Consequential Amendments) Act 1997
The Act

Taxation Laws Amendment Act (No 2) 1997
Sch 4

Case References:
Collector of Customs v Pozzolanic Enterprises Pty Ltd
(1993) 43 FCR 280

Collins v Administrative Appeals Tribunal
(2007) 163 FCR 35
[2007] FCAFC 111

Comcare v Etheridge
(2006) 149 FCR 522
[2006] FCAFC 27

Commissioner of Taxationv AXA Asia Pacific Holdings Ltd
[2010] FCAFC 134
2010 ATC 20-224

Commissioner of Taxation v Dalco
(1990) 168 CLR 614
[1990] HCA 3
90 ATC 4088
20 ATR 1370

Commissioner of Taxation v Futuris Corporation Ltd
(2008) 237 CLR 146
2008 ATC 20-039
69 ATR 41

Commissioner of Taxation v Hart
(2004) 217 CLR 216
2004 ATC 4599
55 ATR 712

Commissioner of Taxation v Jackson
(1990) 27 FCR 1
90 ATC 4990
21 ATR 1012

Commissioner of Taxation v Mochkin
(2003) 127 FCR 185
2003 ATC 4272
52 ATR 198

Commissioner of Taxation v Peabody
(1994) 181 CLR 359
94 ATC 4663
28 ATR 344

Commissioner of Taxation v Sleight
(2004) 136 FCR 211
2004 ATC 4477
55 ATR 555

Commissioner of Taxation v Spotless Services Ltd
(1996) 186 CLR 404
96 ATC 5201
34 ATR 183

Commissioner of Taxation v Swansea Services Pty Ltd
(2009) 72 ATR 120
[2009] FCA 402
2009 ATC 20-100

Commissioner of Taxation v Zoffanies Pty Ltd
(2003) 132 FCR 523
54 ATR 280
2003 ATC 4942

Deputy Commissioner of Taxation v Richard Walter Pty Limited
(1995) 183 CLR 168
29 ATR 644
95 ATC 4067

Epov v Federal Commissioner of Taxation
(2007) 65 ATR 399
2007 ATC 4092

Federal Commissioner of Taxation v Ashwick (Qld) No 127 Pty Ltd
[2011] FCAFC 49
2011 ATC 20-255

Federal Commissioner of Taxation v Cooper
(1991) 29 FCR 177
91 ATC 4396
21 ATR 1616

Federal Commissioner of Taxation v Lenzo
(2008) 167 FCR 255
2008 ATC 20-014
71 ATR 511

Gauci v Commissioner of Taxation
(1975) 135 CLR 81
75 ATC 4257
5 ATR 672

George v Federal Commissioner of Taxation
(1952) 86 CLR 183
[1952] HCA 21

McAndrew v Federal Commissioner of Taxation
(1956) 98 CLR 263
[1956] HCA 62

McCormack v Commissioner of Taxation
(1979) 143 CLR 284
79 ATC 4111
9 ATR 610

Minister for Immigration and Multicultural Affairs v Al Miahi
(2001) 65 ALD 141
[2001] FCA 744

Price Street Professional Centre Pty Ltd v Commissioner of Taxation
(2007) 243 ALR 728
2007 ATC 5044
67 ATR 544

Repatriation Commission v Hill
(2002) 69 ALD 581
[2002] FCAFC 192

Scicluna v New South Wales Land and Housing Corporation
(2008) 72 NSWLR 674
[2008] NSWCA 277

Tax Agents' Board v Bray
(2004) 58 ATR 118
2004 ATC 5088

TNT Skypak International (Aust) Pty Ltd v Federal Commissioner of Taxation
(1988) 19 ATR 1067
88 ATC 4279

WR Carpenter Holdings Pty Ltd v Federal Commissioner of Taxation
(2007) 161 FCR 1
66 ATR 336
2007 ATC 4679

WR Carpenter Holdings Pty Ltd v Commissioner of Taxation
(2008) 237 CLR 198
2008 ATC 20-040
69 ATR 29