Decision impact statement
Forrest v Commissioner of Taxation
Court Citation(s):
[2010] FCAFC 6
2010 ATC 20-163
78 ATR 417
Venue: Federal Court of Australia
Venue Reference No: WAD 101 of 2008
Judge Name: Spender, Sundberg and McKerracher JJ
Judgment date: 5 February 2010
Appeals on foot:
No.
Impacted Advice
Relevant Rulings/Determinations:
Subject References:
Interest Expense
Hybrid Trust
Eligible Termination Payment
Gift
Penalties
Précis
Outlines the ATO's response to this case, which concerned the deductibility of interest on money borrowed to acquire units in a hybrid trust, and the assessability, as an eligible termination payment, of a payment made to a charity on the resignation of the taxpayer from his employment.
Decision Outcome:
Partially Allowed
Brief summary of facts
Forrest was a shareholder and Chief Executive Officer of Anaconda Nickel Ltd, an ASX listed company ("Anaconda"). He was also a unit holder in the Minderoo Trust ("the Trust") that held a large number of shares in Anaconda. He had borrowed money to acquire the units and claimed interest expenses in relation to the loans.
The Trust was a 'hybrid' trust in that it was to be in receipt of revenue income that was to be distributed to the unit holders and also capital gains that were to be distributed to the discretionary beneficiaries at the discretion of the trustee. However, one of the provisions of the deed indicated the trustee could treat any income as income of any type. It appeared that it could treat fixed income as discretionary income and vice versa.
Forrest and his family owned 8% of Anaconda and the other large shareholders were Anglo American plc ("Anglo") which owned 25%, Glencore International AG ("Glencore") which owned 22% and Sherritt International Corporation ("Sherritt") which owned 9%. On 4/4/01 Anglo requisitioned an extraordinary general meeting to be held on 31/5/01. Anglo's purpose in calling this meeting was to wrest control of the board of Anaconda from Mr Forrest and those who supported him. Glencore was aligned with Anglo and on the morning of 31/5/01, Forrest was advised that Sherritt had given its proxy to Glencore.
When Forrest became aware of this he realised that he would be defeated and he commenced negotiations with Sherritt and Glencore in the belief that Glencore would make concessions to avoid a public vote. It was agreed amongst other things that:
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- Forrest would stay on as CEO of Anaconda until the earlier of 18/11/01 or the appointment of a replacement CEO.
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- Anaconda would make a donation of $3.5m to a charity ("the Charity") that Forrest was going to establish. (Glencore also agreed to contribute $3.5m and Anglo agreed in principle to consider making a donation).
Forrest resigned as CEO on 16/11/01 and Anaconda paid $3.5m into a trust account pending requirements which had to be met relating to the creation of the charity. On 31/12/01, the $3.5m was deposited into the account of the charity and then on 15/1/02 the $3.5m was withdrawn from the charity's account and deposited into the account of Forrest. The money was paid in an off market transaction to Forrest and related parties for the acquisition of 4,117,643 Anaconda shares. For the purposes of the transaction, the shares were valued at 85 cents each, while on that day the ASX closing price for such shares was 74 cents.
The Commissioner disallowed the interest costs claimed in relation to the purchase of the units in the Trust and assessed Forrest on an ETP of $3.5m in the year ended 30 June 2002.
The Commissioner considered the Trust was a discretionary trust and there was no certainty that any income derived by the Trust would be directed to Mr Forrest. Accordingly it was considered that there was not sufficient nexus to the gaining of income for the interest expenses to be deductible.
It was also considered that the payment of the $3.5m to the charity was made in consequence of the termination of employment by Forrest and the amount was assessable to him as an ETP.
Penalties were imposed at a rate of 25% in respect of the interest expenses as Forrest or his agent were considered to be careless. A penalty of 50% was imposed in relation to the ETP as it was considered that Forrest or his agent had been reckless.
Forrest claimed that the Trust was a fixed trust and that he was entitled to the income of the trust in proportion to the units that he held. He also claimed that, even if it were found that the trust was discretionary, it was the intention of the trustees to distribute the income to him and therefore the interest expenses were deductible.
Forrest also claimed that the payment of $3.5m was not made in consequence of the termination of his employment. He claimed that it was made in consequence of settlement of a dispute between shareholders over control of Anaconda and accordingly it was not assessable to him as it was paid to the Charity.
He further claimed that, if the payment was considered to be an assessable ETP, he was entitled to a deduction for that amount as a donation to an approved charity.
The matter went before the Administrative Appeals Tribunal In a decision reported as The Taxpayer and Commissioner of Taxation [2008] AATA 325, Deputy President Nicholson found that:
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- The trust was a discretionary trust;
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- There was insufficient nexus between the interest expenses and the gaining of assessable income for the expenses to be deductible;
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- The penalty imposed in respect of claiming the interest expenses as a deduction was remitted in full;
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- The payment of $3.5m was assessable as an ETP;
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- Forrest was not entitled to any deduction for a donation; and
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- The penalty imposed for failing to return the ETP was appropriate.
Forrest appealed against this decision to the Federal Court. The Court decided that it was appropriate for the matter to be heard by a Full Court.
Issues decided by the court
The Court found that whether the interest expenses are deductible depended on a proper construction of the trust deed. In the opinion of the Court, the power conferred by clause 12 of the deed could not be exercised by the trustee wrongly to classify a receipt as a capital gain, when the receipt was, in truth, income. The clause is not an unlimited power to be exercised in the trustee's unconfined discretion. In the Court's judgment, the terms of the deed demonstrate the settlor's and trustee's objective intention that the income other than capital gains was to be held on a fixed trust for the Unit Holders and capital gains were to be held on a discretionary trust.
The Court agreed with Forrest's submissions that the interest expenses were incurred for the purpose of furthering his present or future income. To be deductible under s8-1, an expense must be incurred 'in the course of' gaining or producing assessable income. It is both sufficient and necessary that the occasion for the loss be found in whatever would be expected to produce income though income need not in fact be produced.
The Court found that the income of the Trust, other than realised and unrealised capital gains, was held on a fixed trust for the Unit Holders and it followed that the interest payments are deductible.
The Commissioner submitted that, if Forrest was successful in his appeal on the deductibility of interest, the matter should be remitted to the Tribunal to consider the question of apportionment. The Court decided that the right to appeal against an AAT decision is only on a question of law and as the Commissioner had not raised this issue before the Tribunal, it could not now be raised. The Court did not consider whether there was any merit in the apportionment contention.
The Court held that the finding on the facts by the Tribunal that the payment by Anaconda to the Charity was an ETP could disclose a question of law only if the only finding open to the Tribunal was that the payment by Anaconda was not in consequence of the termination of Forrest's employment. The Court considered the factors stated in the judgment of the Tribunal and concluded that it was open to the Tribunal to conclude that the payment was made in consequence of the termination of Forrest's employment as CEO of Anaconda. Therefore, Forrest's appeal disclosed no error of law in the Tribunal's decision.
The parties agreed that, if it was found that the $3.5m payment was part of Forrest's assessable income, then he would be entitled to a deduction for this amount under Division 30 of the Income Tax Assessment Act 1997 unless s78A of the Income Tax Assessment Act 1936 operated to disallow the deduction.
The Court considered the circumstances of the donation and sale of shares to the Charity. The Court said that these circumstances, including the fact that the amount the Charity paid for the shares was more than their market value at the time, led to the deduction being denied under paragraphs 78A(2)(a), (c) and (d).
The Court also considered the penalty imposed on Forrest for failing to return his ETP. The Commissioner had imposed a penalty of 50% as it was considered that Forrest had been reckless. The Court commented that the test for recklessness required gross carelessness rather than mere negligence. The Court concluded that it could not be reasonably argued that Forrest or his accountant were guilty of gross carelessness. The penalty was reduced to nil.
ATO view of Decision
The ATO accepts the finding of the Court that, having regard to the settlor's objective intention ascertained from all the provisions of the deed, the clause which appeared to confer upon the trustee an unfettered discretion to determine whether a receipt was capital or income was in fact no more than an administrative power to honestly classify receipts according to law.
Relevantly, the Court was of the view that the settlor's intention of creating a fixed trust of income other than capital gains would have been defeated if the power had been construed as a discretionary power of re-characterisation. There may be other cases in which such a power would not be inconsistent with the settlor's objective intention.
For procedural reasons, the Court did not consider whether the Commissioner was correct to contend that the interest expenses should be apportioned between their income producing and non-income producing purposes, as countenanced in Taxation Determination TD 2009/17. The Court's decision therefore does not require a review of the position stated in that Determination.
The ATO agrees with the decision in relation to the eligible termination payment and the gift issues.
The ATO accepts that the decision to reduce the penalty to nil was open to the Court on the facts.
Administrative Treatment
List of Rulings and Determinations Affected
None
Implications on current Public Rulings & Determinations
None
Implications on Law Administration Practice Statements
None
Legislative References:
Administrative Appeals Tribunal Act
44
Income Tax Assessment Act 1936
27A
78(2)
97
Income Tax Assessment Act 1997
8-1
Div 30
Taxation Administration Act 1953
284-90
Case References:
Colby Corporation Pty Ltd v FCT
[2008] FCAFC 10
(2008) 165 FCR 133
71 ATR 62
FCT v R & D Holdings Pty Ltd
[2007] FCAFC 107
(2007) 160 FCR 248
2007 ATC 4731
67 ATR 790
In re Baillie; Whiting v Cavendish
[1928] VLR 171
(1928) 34 ALR 12
Le Grand v Commissioner of Taxation
[2002] FCA 1258
(2002) 124 FCR 53
2002 ATC 4907
(2002) 195 ALR 194
(2002) 51 ATR 139
McIntosh v FCT
(1979) 25 ALR 557
(1979) 10 ATR 13
(1979) 79 ATC 4325
Orr v Wendt
[2005] WASCA 199
Re Wynn (decd); Public Trustee v Newborough
[1952] 1 Ch 271
Reseck v FCT
[1975] HCA 38
(1975) 133 CLR 45
5 ATR 538
75 ATC 4213
Salomon v A Saloman & Co Ltd
[1897] AC 22
Wendt v Orr
[2004] WASC 28