TAYLOR & ANOR v FC of T

Members:
A Sweidan SM

Tribunal:
Administrative Appeals Tribunal

MEDIA NEUTRAL CITATION: [2006] AATA 1120

Decision date: 22 December 2006

A Sweidan (Senior Member)

1. The applicants, Mr Athans and Mr Taylor both Chartered Accountants who practice in partnership, claim to be entitled to income tax deductions in the year ending 30 June 1997 for expenses they claim to have incurred as "master franchisees" of Fishing Information Line Australia Pty Ltd, as follows: -

2. In relation to both applicants:

and the applicants have sought a review by the Tribunal of such disallowance.

3. The respondent contends: -

Evidence

4. The applicants both gave evidence and other witnesses to whose evidence reference is made below also testified. The applicants produced the following copy documents (which were received as exhibits and marked as shown) in support of their entry into the arrangements which they allege gave rise to the claimed deductions:

5. The Tribunal also had before it the generic and individual "T" documents tendered by the respondent.

6. The applicants produced no copies of the Master Licence Agreement or the Management and Marketing Agreement or the Loan Agreement referred to in the Master Licence Execution Sheets. They did not offer any explanation as to why they were described in all subsequent documents as Master Franchisees.

7. Instead, the applicants relied on sample documents contained at V2/305-368 of the T documents as containing the terms of the arrangements they entered into. Those sample documents are: -

8. On the evidence before the Tribunal the applicants have established that they were Master Franchisees of Fishing Information Line Australia Pty Ltd, as Franchisor, but not the terms of the arrangement they had with the Franchisor. Although the applicants, by the Master Licence Execution Sheets purported to enter into and be bound by a Master Licence Agreement and a Marketing and Management Agreement they rely on the sample documents and accordingly the Tribunal's view is that they are to be treated as Master Franchisees pursuant to the terms of the sample Master Franchise

ATC 2004

Agreement, T90, V2/325, as contended by the respondent.

9. The applicants have established on the evidence that, in respect of each Master Franchise, they paid a total of $10,125 (being an initial $5,000 plus a total of $5,125 by way of principal and interest under the Short Term Loan Agreement). As pointed out by the respondent this is consistent with the sample Loan Agreement T91, V2/339 which contemplates an advance of $31,000 to be applied in payment to the Franchisor of the Franchise Fees (as defined in the Master Franchise Agreement).

Section 51(1): relevant legal principles

10. The witness statements and oral evidence of the applicants and their witnesses reflect their enthusiasm for the Fishing Information Line business concept. However, this is of little assistance to the Tribunal in determining the issues raised by the respondent and outlined at paragraph 3 above. The applicants both claimed that tax considerations were not an important factor in deciding to enter the project.

11. The respondent contends and the Tribunal agrees that in determining the issues arising under section 51(1), the following principles of law apply.

Sham

12. The case law shows that sham arises where there is a "common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating":
Snook v London & West Riding Investments Ltd (1967) 2 Q.B. 786 at 802.

13. "A "sham" is therefore for the purposes of Australian law, something that is intended to be mistaken for something else or that is not really what it purports to be. It is a spurious imitation, a counterfeit, a disguise or a false front. It is not genuine or true, but something made in imitation of something else or made to appear to be something which it is not. It is something which is false or deceptive: "
Sharrment v Official Trustee in Bankruptcy (1988) 18 FCT 449 per Lockhart, J. at 454. Critical to characterizing a transaction as a sham is that the parties do not intend to give effect to the ostensible transaction:
Scott v Commissioner of Taxation (No. 2) (1966) 40 ALJR 265 at 279. And see
Albion Hotel Pty Ltd v FCT (1965) 115 CLR 78 at 90, 92. Business - second limb of section 51(1)".

14. There are a number of factors to consider in order to determine whether or not a taxpayer is carrying on a business. They are:

First limb of section 51(1)

15. The determination of whether outgoings are deductible for the purposes of section 51(1) is a matter of characterization by reference to the advantage the outgoings seek to achieve. The outgoing must be incidental and relevant to gaining or producing assessable income. Put another way, the production of assessable income is the occasion of the outgoing:
Amalgamated Zinc (de Bavay's) Ltd v FCT (1935) 54 CLR 295 at 309 and
Ronpibon Tin NL v FCT (1949) 78 CLR 47.

16. The relationship between the outgoing and the assessable income must be such as to impart to the outgoing a character of an outgoing of the relevant kind. Where there is a disproportion between the outgoings incurred and the amount of assessable income, the question of the character of the outgoings must be answered by:

"a common sense appreciation of the overall factual context in which the outgoings were incurred. It necessarily involves a consideration of the contents and implications of the overall contractual arrangements … pursuant to which the outgoings … became payable. … it also encompasses a consideration of the purpose which the members of the partnership … had in incurring the outgoings."


Fletcher v FCT 91 ATC 4950; (1991) 173 CLR 1 at 20-21.

17. 

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For amounts to be deductible, this "commonsense" or "practical" weighing of all the factors ought to indicate that the relationship between the whole of the expenditure and the production of assessable income is "genuine and not colourable". See Fletcher at 17.1-18.2, 18.7-19.4 and
Ure v FCT 81 ATC 4100; (1981) 34 ALR 237 per Brennan, J at 241, lines 20-31 and per Deane and Sheppard, JJ at 248-249, line 25 and 249, line 35 -250.

18. The occasion of the loss or outgoing is not the earning of assessable income where the circumstances point to another purpose. See
Fletcher v FCT 91 ATC 4950; (1991) 173 CLR 1 at 17-18.

Capital

19. In resolving the issue whether outgoings are on revenue or capital account it is incumbent upon the Tribunal to analyse all the rights and obligations of the applicant in asking what the outgoings are really for, rather than rely on the way the outgoings were styled:
Vincent v FCT 2002 ATC 4742; (2002) 124 FCR 350 at [64], [65] and [67]. A casual investment of capital to yield an enlargement at the end of a period of time but without forming any business system or practice by the taxpayer, is passive investment and the outgoings are on capital account: of
Clowes v FCT (1954) 91 CLR 209 at 218;
Milne v FCT 76 ATC 4001; (1976) 133 CLR 526 at 535; and
Enviro Systems Renewable Resources Pty Ltd v ASIC (2001) 80 SASR 1 at [36], [43], [44].

Table analysing the Master Franchise Agreement

20. In the following table submitted by the respondent the requirements of the sample Master Franchise Agreement are analysed against the evidence, the conduct of the parties and the legal principles set out above with respect to section 51(1). The table also sets out the respondent's comments.

21. The respondent contends that even without the analysis provided in the table the applicants evidence supports the conclusions at sub-paragraphs 3(a)(ii) and (iv) above (namely that the applicants were not in a business and/or that the expenses incurred were capital expenses). The respondent contends that they incurred outgoings without regard to the nature of the arrangements they entered into. As Mr Paikos one of the applicants' witnesses put it, this was an investment that was a 'franchise arrangement". That is, it was called a franchise but the evidence shows that no regard was had to the nature of a franchise or the rights and obligations a franchise implies ie:-

22. The respondent contends that the analysis in the following table of the rights and obligations purportedly established by the Master Franchise Agreement supports the conclusion that: -

Tax benefits

23. The respondent asserts that as a result of entering into Master Franchise Agreements and Loan Agreements, the applicants obtained significant tax benefits, as the report of Mr Langridge the respondent's expert witness explains. Mr Taylor's overall net cash position was improved by $2,450.01 (Langridge report, page 47 at 8.2.4) in the two years to the end of 30 June, 1998. Mr Athans' overall net cash position was improved by $4,573.46 (Langridge report, page 50 at 8.3.4).

24. The IM promoted this benefit and explained how it was to be derived, as follows:

25. The respondent contends that conversely, the analysis in the table establishes that the Master Franchise Agreements which purportedly governed the arrangements between the applicants and the Franchisor were, at best, unworkable. From a practical viewpoint Mr Corriea (a witness called by the applicants) explained in his evidence the unworkability which the analysis demonstrates. Based on his experience with a similar business he said he could have run the Fishing Information Line business nationally with 3 people. It did not require the involvement of 220 other people except as investors.

26. The respondent contends further that the analysis in the table establishes that:-

Sham

27. On the basis of the above analysis, the respondent contends that it ought to be concluded that the Franchise Agreements and the loans taken out to fund franchise fees were a sham. They could not be carried out according to their terms. Neither party sought to do so.

28. The respondent further contends that the Master Franchise Agreements apparently entered into were a façade: -

29. The Tribunal's finding on this issue is that, while the respondent's contentions have substantial force it nevertheless appears that the parties clearly intended to create some form of binding legal relationship, albeit that due to the deficiencies in the documentation as set out in the respondent's detailed analysis, it is unclear exactly what the nature of that relationship was. On balance, the Tribunal is of the view that the agreements cannot be characterised as a sham although the relationship that was created was not what was purported.

No business

30. The respondent further contends that if the arrangements were not a sham, the analysis in the table indicates that the applicants did not incur the claimed deductions in the course of a business for the purposes of gaining or producing assessable income because: -

31. 

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The Tribunal finds that the respondent's assertions are justified and that applicants have failed to show that they were carrying on a business within the meaning of the second limb of section 51(1) of the Act.

Section 51(1) - first limb

32. The respondent contends that the tax benefits obtained by the applicants are material to the Tribunal's consideration of the first limb of section 51(1) of the Act. If the Tribunal finds, as it has done, that the applicants were not in a business, it must, nevertheless, consider whether their claimed outgoings were incurred for the purpose of gaining or producing assessable income.

33. The respondent contends and the Tribunal agrees that because of the disproportion between the applicants' outgoings and the assessable income earned from their investments, it is necessary to examine "the whole set of circumstances" in order to determine whether the disproportion between the outgoings and the assessable income is to be explained by reference to the independent pursuit of some objective other than the gaining of assessable income: see Fletcher
91 ATC 4950; (1991) 173 CLR 1 at 18-19.

34. The Tribunal is of the view that as contended by the respondent in this case, the occasion of the outgoings is to be explained by reference to the independent pursuit of an objective of obtaining a tax benefit. Based on the conduct of the applicants and the terms of the arrangements, analysed in the above table the Tribunal does not accept that the applicants' entry into the Master Franchise Agreement and the Loan Agreement was primarily for the purpose of deriving assessable income and the applicants have failed to discharge the onus which they bear in this regard. In the Tribunal's view although this may have been a secondary, hoped for, objective the considerable tax advantages they derived as a result of their investment provide a more likely explanation of the applicants' dominant motive for entry into the arrangements. The Tribunal accordingly finds that the claimed outgoings were not incurred for the purpose of gaining or producing assessable income and hence are not deductible under the first limb of s 1(1).

Capital

35. As the analysis in the respondent's table shows: -

36. In the Tribunal's view from the documentation before the Tribunal the only fundamental obligation which emerges is that of the Franchisor to pay the applicants' commission. It was bound to do so and did, regardless of whether they formed any business system or practice themselves. According to the sample Master Franchise Agreement (clause 1.1) commission was payable by reference to the aggregate of all purchase moneys received by or on behalf of the Franchisor from the sale of Fishing Info-Line Products in the Territory allocated to the Franchise. Any efforts of the applicants or the forming of any business system or practice by them was immaterial to their right to receive returns. In the Tribunal's view their evidence shows that they well understood this.

37. Further, in the Tribunal's opinion the evidence including that of the applicants' witnesses shows that the outgoings, although styled as franchise fees, service fees, marketing fees and training fees were in fact for nothing more than the purchase of a passive investment and hence were in the Tribunal's view capital in nature and not deductible under section 51(1).

Part IVA: relevant legal principles

38. While the Tribunal has, for the reasons set out above come to the conclusion that the applicants are not entitled to a deduction for their outgoings under section 51(1) the Tribunal will nevertheless for the sake of completeness and in the event that the Tribunal's conclusion as to deductibility under section 51(1) is incorrect, proceed to consider the Part IV A question.

39. 

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Section 177F provides, inter alia, for the disallowance of tax benefits in the form of deductions claimed by taxpayers in connection with a scheme to which Part IVA applies.

40. Section 177C of the 1936 Act relevantly defines "tax benefit" in the following terms:

"Subject to this section, a reference in this Part to the obtaining by the taxpayer of a tax benefit in connection with a scheme shall be read as a reference to -

  • …

  • (b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out;

  • …

  • and, for the purposes of this Part, the amount of the tax benefit shall be taken to be -

  • …

  • (d) in a case to which paragraph (b) applies - the amount of the whole of the deduction or the part of the deduction, as the case may be, referred to in that paragraph. …"

41. Section 177D is the key provision in Part IVA. It provides that the scheme must be entered into or carried out by a person for a purpose of the kind identified in section 177D(b): see
FC of T v Hart 2004 ATC 4599; (2004) 217 CLR 216 per Gleeson CJ and McHugh J at [16], per Gummow and Hayne JJ [34], [37], [50], [56] and per Callinan [92]. It provides:

"This Part applies to any scheme that has been or is entered into after 27 May 1981, and to any scheme that has been or is carried out or commenced to be carried out after that date … 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 -

  • the manner in which the scheme was entered into or carried out;

  • the form and substance of the scheme;

  • the time at which the scheme was entered into and the length of the period during which the scheme was carried out;

  • the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;

  • 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;

  • 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;

  • any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and

  • the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (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 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)."

42. According to section 177A(5), the "purpose" for which a person entered into or carried out a "scheme" may be the sole purpose or the dominant purpose of doing so.

43. 

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Finally, "scheme" for the purposes of Part IVA is defined in section 177A(1) of the 1936 Act as follows:

" 'scheme' means -

  • (a) 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
  • (b) any scheme, plan, proposal, action, course of action or course of conduct …".

44. As has frequently been observed by both the Federal Court and the High Court, the definition of "scheme" in section 177A(1) is very broad. See, for example,
Federal Commissioner of Taxation v Spotless Services Ltd 96 ATC 5201; (1996) 186 CLR 404 at 425 per McHugh J;
Federal Commissioner of Taxation v Peabody 94 ATC 4663; (1994) 181 CLR 359 at 383; see further
Commissioner of Taxation v Hart 2004 ATC 4599; (2004) 78 ALJR 875 at 878 [9] per Gleeson CJ and McHugh J; 885 [43] per Gummow and Hayne JJ; 893 [85], 899 [87] per Callinan J;
Eastern Nitrogen Ltd v Commissioner of Taxation 2001 ATC 4164; (2001) 108 FCR 27 at 43 [71].

Scheme

45. The Tribunal finds that In each application the scheme, within the meaning of section 177A(1), was the making and the implementation of the Fishing Info-Line Information Memorandum, the Fishing Information Line Master Execution Sheet, the Short Term Loan Agreement, the Master Franchise Agreement, and the Loan Agreement.

46. Apart from the Loan Agreements, relevant features of the above documents have been set out in the table above and, in the case of the Master Execution Sheet and the Short Term Loan Agreement, in paragraph 4 above.

47. By the sample Loan Agreement [T91, V2/339-343] the Lender agreed to lend $31,000 to the Master Franchisee. The terms of the Loan Agreement included the following:-

Parties to the scheme

48. The Tribunal finds that the parties to the schemes included each applicant, the partners John Athans and Leonard Taylor, Fishing Information Services Pty Ltd, Fishing Information Line Australia Pty Ltd Unit Trust, Fishing Information Line Finance Pty Ltd, Fred Heinze, Kahl Heinze, the principals of the Fishing Information Line companies and Equitable Funds Management Ltd, a creditor and architect of the franchise arrangement.

Tax benefit

49. The tax benefits are the following deductions claimed by the applicants for the 1997 income year -

Each $40,000 was described as comprising:-


Annual franchise fee $ 7,500
Training fee $ 3,750
Annual service fee $ 7,175
Marketing fees $20,025
Interest $ 1,550
  $40,000

[V2/312, 314 (IM), 338 (Master Franchise Agreement), 341 (Loan Agreement)]

50. The Tribunal finds that if the scheme had not been entered into or carried out these deductions would not have been available to the applicants.

Section 177D(b) factors

51. There is overwhelming authority that the test posited by section 177D is an objective one:
Federal Commissioner of Taxation v Spotless Services Ltd 96 ATC 5201; (1996) 186 CLR 404 at 421-423, 424;
Federal Commissioner of Taxation v Consolidated Press Holdings 2001 ATC 4343; (2001) 207 CLR 235 [95];
Eastern Nitrogen Ltd v Commissioner of Taxation 2001 ATC 4164; (2001) 108 FCR 27 per Carr, J. at [80]-[84];
Commissioner of Taxation v Sleight 2004 ATC 4477; (2004) 136 FCR 211 per Hill J (Hely J agreeing) at [67] and per Carr, J. at [205];
Calder v FCT 2005 ATC 4760; (2005) 61 ATR 267 at [91];
Commissioner of Taxation v Cooke 2004 ATC 4268; (2004) 55 ATR 183 at [88]. As stated by the High Court it does not require, or even permit, any inquiry into the subjective motives of the relevant taxpayers or others who entered in to or carried out the scheme or any part of it:
FC of T v Hart 2004 ATC 4599; (2004) 217 CLR 216 at [65]. Accordingly, the subjective knowledge, understanding or intention of the applicants (or anyone else) with respect to the financial structuring of the scheme, its conduct or perceived returns from the scheme is irrelevant, and their evidence in this regard is not to be given any weight by the Tribunal.

52. In this respect, see
Vincent v Commissioner of Taxation 2002 ATC 4490 (at first instance) at [133] and [142]. There, French, J. found, for the purposes of section 51(1) of the Act that Ms Vincent's purpose was to obtain investment returns from the project under consideration. In the context of Part IVA, however, her subjective purpose was not material. On the basis of the financial structuring and operations of the project entities his Honour found that, notwithstanding Ms Vincent's subjective intentions, it would be concluded that the dominant purpose of Ms Vincent in entering into the project was to obtain the relevant tax benefits. Further, a taxpayer's unawareness of round robin transactions was, specifically, held to be immaterial in
Calder v FCT 2005 ATC 4760; (2005) 61 ATR 267 at [114].

53. Further, as the terms of section 177D make clear, the reference in that section to "purpose", objectively determined, includes not only the applicants' respective purposes in entering the scheme, but the purpose of the scheme's promoters in enabling the applicants and other investors who subscribed to the project to obtain tax benefits in connection with the scheme. In this respect, see
Vincent v Commissioner of Taxation 2002 ATC 4490; (2002) 124 FCR 350 at [100];
Puzey v Federal Commissioner of Taxation 2002 ATC 4853; (2002) 194 ALR 615 per Lee, J. [105];
Commissioner of Taxation v Sleight 2004 ATC 4477; (2004) 136 FCR 211 per Hill, J. (Hely, J. agreeing) at [65]-[66], [67.3], [96] and per Carr, J. at [239]-[240].

54. Each of the eight factors set out in section 177D (b) must be considered. However as Hill J pointed out in
Peabody v Commissioner of Taxation 93 ATC 4104; (1993) 40 FCR 531 at 543:

"This does not mean that each of those matters must point to the necessary purpose referred to in s 177D (b). Some of the matters may point in one direction and others may point in another direction. It is the evaluation of these matters, alone or in combination, some for, some against, that s 177D requires in order to reach the conclusion to which s 177D refers."

ATC 2025

See also
Commissioner of Taxation v Sleight 2004 ATC 4477; (2004) 136 FCR 211 per Hill, J. at [67].

55. Nevertheless, the relevant purpose may be so apparent on the evidence taken as a whole that consideration of the statutory factors adumbrated in section 177D (b) can be collapsed into a global assessment of purpose:
Federal Commissioner of Taxation v Consolidated Press Holdings 2001 ATC 4343; (2001) 207 CLR 235 at [94] and
Commissioner of Taxation v Sleight 2004 ATC 4477; (2004) 136 FCR 211, per Hill, J. at [67]. Echoing the statement in
FCT v Consolidated Press Holdings Ltd 2001 ATC 4343; (2001) 207 CLR 235 per the Court at [94], the Full Court in
Calder v FCT 2005 ATC 4760; (2005) 61 ATR 267, at [79]-[80] stated:- "It is important, however, to bear in mind that the ultimate judgment as to purpose under s 177D is holistic, albeit it requires that regard be paid to each of the eight factors listed in s 177D(b). Indeed it can be expressed as a global or overall judgment provided that it is apparent that those factors have been considered".

56. The authorities make it clear that, critically, the pursuit of a commercial objective is not inconsistent with the existence of a dominant purpose of enabling the taxpayer to obtain a tax benefit. This has been pointed out: -

In both Spotless and Hart, the High Court emphasized the shape or form taken by the scheme as pointing to its purpose.

57. There is in the Tribunal's view no scope for comparing the approaches in other cases to select a preferred approach. The Tribunal accepts that, as asserted by the respondent, to do this is to misconceive the task under Part IVA. As Gummow and Hayne JJ put it in Hart (2004) 217 CLR 216 at [52]: "Always the question must be whether the terms of the Act apply to the facts and circumstances of the particular case." And see Sleight per Hill and Carr JJ at [244] and [111].

58. Master Franchise Statements of Revenue and Fees in the applicants' documents indicate some distributions of income set off against franchise fees payable by participants were recorded. It is clear from the cases that to point to any such commercial outcome is, however, insufficient for the purposes of section 177D(b). In these cases, examination of the circumstances of the franchises and the implications of the agreements by which they were given effect, by reference to the factors identified in section 177D(b), reveals in the Tribunal's view that the dominant purpose of the arrangements was to secure a tax benefit for the applicants and other participants.

59. The Tribunal is of the view that as contended by the respondent the critical elements which emerge from the examination below of the 8 factors in section 177D(b) are as follows: -

60. In the event, the commercial performance of the franchises was not material. The tax savings were to cover the initial payment obligations. Further payments, in respect of the loan and franchise fees were to be met only from the proceeds of the Franchised Businesses. Accordingly, the applicants and other participants would keep the benefit of the tax savings without further risk and regardless of the outcome of the franchises;

61. Moreover, in the Tribunal's opinion the respondent is correct in asserting that the above features of the scheme served no apparent purpose except to create large tax deductions from which operations could be funded, without further demand being made on the "franchisee". They did not fund ongoing commercial conduct of the franchise and the underlying business operation of the promoter entities. The loans, made by entries in the books of the various entities were not supported by cash [as described in the Langridge report at pages 8-10, 13-15, 18 to 19]. In the result, the project could only be conducted using cash payments made by participants in respect of principal and interest on their loans. Ultimately, then, the large up-front fees had no apparent commercial function. No actual funds were advanced by the lender in respect of them. The only possible function of the high prepaid fees and the loan was to gear up the available tax deductions

62. In any event the evidence shows that from a commercial viewpoint, the predicted returns from the so-called Franchised Businesses were, on any view, uncertain. The Fishing Information Line was an innovative start-up business without a successful track record. Assumptions on which Projected Cash Flows (V2/363) were based were not stated. In any event the Franchised Businesses did not have a workable structure which could be successfully exploited by franchisees. and, were in any event, unsatisfactory as the Franchised Businesses relied on an underlying business which had little substance and did not have a workable structure capable of successful exploitation by franchisees.

Section 177D(b)(i) - the manner in which the scheme was entered into or carried out

Applicants

63. The Applicants: -

64. The Applicants did nothing further. They took no steps to themselves conduct the Franchised Businesses which they had purportedly acquired. They did not appoint anyone else to do so. The revenue statements disclose no amount allocated to a manager or sales agent [A29-A37].

65. The terms of the sample Loan Agreement required nothing further of the applicants. All payments of principal and interest under the loan were payable only from the revenue of the Franchised Business [clause 5, T91, V2/339-343].

66. 

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As well, any further expenditure for franchise fees and, where appointed, Approved Sales Agent fees was to come out of future revenue of the Franchised Business [clauses 10 and 11 of the sample Master Franchise Agreement, T90, V332]. Accordingly, the carrying out of the Franchised Businesses required nothing more from franchisees beyond signing an application form and the initial cash payments. Franchisees obtained the benefit of the available tax deductions regardless of the outcome of the franchises.

Fishing Information Line Pty Ltd and those under its control

67. Establishing franchises for sale raised funds to satisfy debts owed to Equitable Funds Management Ltd by Fred and Kahl Heinze [Heads of Agreement T5, V1/40-45; Agreement T11, V1/84-94; Langridge report at pages 20-22 and 28]. The debt was to be satisfied by the offer of 220 franchises which would each return $10,000 cash funds to the Franchisor with franchise documentation to be provided by Equitable Funds Management Ltd.

68. The non-cash component of the proposed $42,000 was never available and not intended to be available to the Franchisor in the year ended 30 June, 1997. It was to be the subject of a Loan Agreement made by franchisees with a finance company, Fishing Information Line Finance Pty Ltd, under the same ownership and control as the Franchisor [Company reports - T223 and T224, V3/754-757 and IM - T89, V2/320].

69. Mr Langridge's report at 2.2.1.1 [pages 8-10] and 2.2.2.1 [pages 13-15] and 2.3 [pages 18-19] establishes that: -

Promotion of the franchises

70. The IM put the tax advantages of the scheme squarely to the fore, promoting this benefit and explaining how it was to be derived (at T89, V2/311-312, 312[3.2], 313 [4.0], 314 in the terms set out above.

71. The features of an immediate tax deduction, the limited recourse loan and the positive cash savings ("Tax Deduction 4:1"; "No Profit = No Loan Repayment"; "$10,000 ONCE ONLY OUTLAY with no more to pay") were promoted to accountants for their clients [Accountants Brief T28, V1/162-165] and used by sales agents generally [T30 and T31, V1/169-170 and T40, V1/181-183].

Allocation of territories

72. The IM offered a maximum number of 220 franchises [T89, V2/312]. The Master Franchise List suggests up to 300 franchises were sold [T311, SuppV/44-51] and see the ATO auditor's summary [T193, V3/616]. As a result, franchise territories said to comprise an allocation of postcodes covering a population of 81,500 [IM - T89, V2/312] were duplicated. This was demonstrated in an analysis of the postcodes allocated to franchises, undertaken by the ATO auditor [ATO Position Paper - T202, V3/696].

73. Allocation of franchise territories was random by postcode. Moreover, it was inconsistent with indications of how the Franchised Businesses might best be arranged:

Approved Sales Agents

74. Franchisees could appoint an Approved Sales Agent. [IM - T89, V2/313]. The Generic T Documents include a form of sales agreement, evidently to be circulated to Master Franchisees on or about 25 August 1998. Accompanying correspondence stated: "Your sales agent has been appointed in accordance with the agreement and we would appreciate if you could sign and return same. We will then have them completed by the sales agents in bulk and returned to you." (our emphasis) [T107, V2/445-448].

75. 

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However, the form of sales agreement did not: -

76. It appears that there were, at best, 2 sales agents in the whole project whose activities related, respectively to eastern Australia and Western Australia [ATO promoter interview Q43-Q53 - T187, V2/591].

77. Ultimately, there is no evidence that any Master Franchisee appointed an Approved Sales Agent, and these applicants certainly did not do so.

Application of franchisees' funds

78. Cash payments received from the sales of the franchises funded the underlying business operations of the promoter entities and were paid to external parties:

79. Pursuant to the IM [T89, V2/313] and the Loan Agreements [definition of "Loan Repayment" in clause 1 and clause 3 - T91, V2/340], 65% of Commission due to Master Franchisees was to be paid by way of principal and interest. In fact, 100% of the franchisees' gross revenue was applied as the loan repayment, at least in the 1998 year: see A30 and the Langridge report at pages 19 and 30.

80. The franchise arrangements were carried out by three companies under the same ownership [Company reports - T223 and T224, V3/754-757 and IM - T89, V2/320]. The conduct of the arrangements by three separate but related entities created a complex structure with no apparent commercial purpose. It did, however, facilitate the ostensible making of loans to franchisees without the support of actual funds.

Section 177D(b)(ii) - the form and substance of the scheme

81. In form:-

82. In the Tribunal's view the evidence clearly shows that, the fees played no role in substance in the franchises except to generate tax savings: -

83. 

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In substance, then, the franchise arrangements took a shape which was not necessary to its commercial outcomes. That shape was clearly to ensure deductions for franchise fees incurred but which, by the terms of the loan agreement, were never required to be met. The loan did not serve the commercial outcomes of the franchise arrangements as obligations in respect of the fees, although legally satisfied, were not actually paid.

84. The following passage from Hill, J.'s judgement in
Commissioner of Taxation v Sleight 2004 ATC 4477; (2004) 136 FCR 211 underlines the above point as well as articulating the relevant "alternative postulate" contemplated by Gummow and Hayne, JJ. in
Commissioner of Taxation v Hart (2004) 217 CLR 216 at [66]. At [82] of his judgement in Sleight, Hill, J. stated as follows: -

"… . the particular shape the investment took was clearly fashioned in a way that would maximize the tax deductions. They were geared up by the loan agreement with up front interest payments. But for the tax deductions the form the investment might be expected to take would clearly relate more to the substance of what happened. Rather than a loan with prepaid interest where the loan was to be repaid out of the investor's profit share without recourse … the substance is that the investor was to receive only a lesser share of profit over the term of the loan agreement. The loan allowed, also, the prepayment of the management fee and the deduction which emanated from that":

85. The Tribunal further refers to
Calder v FCT 2005 ATC 4760; (2005) 61 ATR 267 at [69] and [117]. Investors in those schemes and the franchisees here were, in substance, passive investors. That view is further borne out here by the franchisees' right to receive revenue regardless of the activities of their Franchised Business. By the definitions of Commission and Gross Revenue in clause 1.1 of the sample Master Franchise Agreement (V2/325), franchisees' share of revenue was based upon all sales made in their Territory not upon who made them, i.e irrespective of anything to be done by the applicants.

86. Moreover, as the respondent's analysis in the table summarized above demonstrates the scheme lacked substance from a commercial point of view.

87. It also appears that there was little substance in the underlying business, as Mr Langridge's report establishes: -

Section 177D(b)(iii) - the time at which the scheme was entered into and the length of the period during which the scheme was carried out

88. The Fishing Info-Line business commenced in August, 1996 [T204, V3/732; T2, V1/37].

89. The Heads of Agreement providing for the formation and implementation of the franchising arrangements was entered into in March, 1997 [T5, V1/40-45].

90. Thereafter the IM and franchise documents were prepared and marketed.

91. According to the applicant's statements, in or about April 1997 they received "an

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information package containing a franchise opportunity with Fishing Information Line" (paragraph 1 of each statement). The Applicants entered into the franchise arrangements, on 27 June 1997 for Mr Taylor - Number 073 [A5, A1, A21 and A18], and 30 June 1997 for Mr Athans and Mr Taylor - Number 072 [A14 and A10]. This timing is in the Tribunal's view indicative that entering into the scheme was tax driven.

92. The term of the franchise is not defined in the Master Franchise Agreement but is described in the IM and other documentation as 20 years: see [T89, V2/312 and A18 and A19 Master Franchise Certificate for 073].

93. It is not known and is in any event immaterial whether the underlying business operations of Fishing Information Line have ceased.

Section 177D(b)(iv) - the result in relation to the operation of the Act that, but for this Part, would be achieved by the scheme

94. But for Part IVA of the Act, the prima facie result of the scheme was that the applicants became entitled in the 1997 year, to deductions in respect of franchise, training and marketing fees and interest totalling $60,000 in the case of the applicant Mr Taylor and $20,000 in the case of the applicant Mr Athans.

Section 177D(b)(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

95. As a result of entering into Master Franchise Agreements and Loan Agreements, the applicants generated tax deductions sufficient to recoup the cash contributions each made to the project and retain a surplus. Mr Langridge's report, relevantly, details the tax effect of investment in the project. Mr Taylor's improved cash surplus position in the two years to the end of June, 1998 was $2,450.01 [Langridge report, page 47 at 8.2.4 and page 53 at 8.5], and Mr Athans' was $4,573.46 [Langridge report, page 50 at 8.3.4 and page 53 at 8.5]. The report also details the hypothetical investor paying tax at the top marginal rate contemplated by the project prospectus [Langridge report, page 51 at 8.4 and page 53 at 8.5].

96. At the hearing evidence emerged from Mr Taylor as to Mr Athans' entry into another tax effective investment. The tax effect of other projects entered into is not material to the question of whether Part IVA applies in respect of the deductions claimed by them in respect of their participation in the project. The deductions from Fishing Information Line franchises were of considerable value, particularly if other deductions claimed were not allowable. See
Commissioner of Taxation v Sleight 2004 ATC 4477; (2004) 136 FCR 211 per Hill, J at [88] and Carr, J. at [225]. Moreover, as Carr, J. observed in Sleight, at [224]: "on a proper construction of s 177D(b) the assessment should be made, in respect of this factor … as at the time of entry into the scheme. A reasonable person would be entitled to draw his conclusion about dominant purpose on the basis that the respondent entered into three schemes at one time and that each of those schemes would result (but for Part IVA) in the allowance of the deductions claimed."

97. Actual returns as shown by revenue statements [A29-A37] were:

" Mr Taylor - Franchise Number 073:

30 June 1998 - revenue $2,388.25 was applied to the loan balance [A29, 30, 32].

30 June 1999 - revenue was $40.59 less fees of $12.19 and of the difference $18.47 was applied to the loan balance leaving a remittance to the franchisee of $9.94 [A31- 32].

31 December 1999 - revenue was $6.08 less fees of $3.04 and of the difference $1.98 was applied to the loan balance leaving a remittance to the franchisee of $1.06 [A33-34].

30 June 2000 - revenue was $9.37 less fees of $4.69 and of the difference $3.05 was applied to the loan balance leaving a remittance to the franchisee of $1.64 [A37].

Taylor & Athans partnership - Franchise Number 072

30 June 1998 - no statement was provided but see Mr Langridge's analysis [Langridge report page 49 at 8.3.3] from which he infers that a distribution of $361.85 was made.

31 December 1999 - revenue was $431.09 less fees of $215.54 and of the difference

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$140.10 was applied to the loan balance leaving a remittance to the franchisee of $75.44 [A35-36]."

98. As already noted beyond the required cash contributions, the applicants did not have to contribute any more money. All fees payable were to be recouped only from such gross income as the franchises might generate. Similarly, principal and interest repayments on the balance of the loans were payable only from future franchise income.

99. The franchises have not generated income sufficient to cover those costs to date. Accordingly, the Applicants' participation has not resulted in any change in their financial position beyond any surplus created by the claimed tax deductions.

100. In Commissioner of Taxation v Sleight the Court contrasted the availability of tax deductions with the uncertainty of the investment yields which the project there might realize: see (2004) 136 FCR 211 per Hill, J at [88], [93], [94] and per Carr, J. at [216], [226] - [227].

101. In this matter beyond the cash advantages afforded them by the tax savings, it could not be reasonably expected that there would be any material change in the financial position of the applicants and other participants as a result of their participation as franchisees.

102. As previously stated the evidence shows that the Franchised Businesses:

This is clearly shown by the analysis in the table summarized at paragraph 22 above.

103. The Cash Flow Projections in the IM were unreliable. As Mr Langridge reports, the assumptions on which the projections were based are not stated. The main driver of the projections was gross revenue with other costs determined as a percentage of gross revenue. The base revenue was determined using 1998 figures that implied a significant increase on historic revenue, and the base figures were then projected using arbitrary compound growth percentages. Although there are references to deriving these figures from internal databases and market research, no such material has been provided [Langridge report at 5.2.2, page 32 and at 5.3, page 37.

104. In light of the above deficiencies in the Cash Flow Projections, the analysis of them made by the applicants witness Mr Paikos, taking them at face value, is not realistic as Mr Langridge's report clearly demonstrates at pages 33-37.

105. On the face of the Cash Flow Projections in the IM the bulk of the commercial return shown by the projections is in the last 10 years of a 20 year projection with the inevitable decrease in reliability of looking that far into the future, as the applicants' witness Mr Correia indeed points out. Accordingly, the principal return to participants clearly lay in the tax savings/net cash position provided by the up-front tax deductions [Langridge Report at pages 52 and 41].

106. It appears to the Tribunal that in the end, participants in the franchise arrangements could not reasonably expect any material return beyond the early tax benefits their participation yielded. On the evidence the Franchised Business and the underlying business on which the franchises would rely were start up businesses providing an innovative service. There was no history or track record for the underlying business or for a franchise operation of this kind.

107. On the other hand, because of the early tax benefits they expected and the limited recourse terms of the loan, it appears that investors could participate in the project without any risk to their own funds. Accordingly, participants could take a chance on the commercial performance of the franchises. Actual performance was of limited concern. Any return which might ultimately be achieved was an additional benefit but by no means certain compared with the expected tax benefits.

108. In that context, the likely unsatisfactory commercial return from a Franchised Business is an additional factor pointing to the requisite taxation purpose for the purposes of section 177D(b). However, even if the Tribunal were to

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find that franchisees could expect a satisfactory commercial return, a contrary conclusion would not necessarily follow.

109. In the Tribunal's opinion, the comparison of different rates of return is immaterial. It is, therefore, inappropriate, for example, to compare rates of return indicated by the projections here with returns predicted for the project in
Commissioner of Taxation v Cooke 2004 ATC 4268; (2004) 55 ATR 183, at least without an understanding of the risks of the project there. In Cooke the Court's consideration of the commercial viability of the project was restricted to the prospectus without more: see (2004) 55 ATR 183 at [19], [72], [98] and [100]. As the evidence here shows, the predicted returns are not to be taken at face value.

110. It is significant that there are no other consequences to participants owing to the effects of the tax benefits and the non-recourse loan, as set out above, and see further below regarding the loan.

Section 177D(b)(vi) - any change in the financial position of any person who has, or has had, any connection (whether or 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

111. Under the terms of the scheme documents the $10,000 cash payment received by the promoters from each of the participants was in effect funded by the Revenue through the tax savings and cash flow consequences of the deductions.

112. Under the terms of the Master Franchise Agreement and the Loan Agreement the promoters were to take most of the revenue derived from the business as follows: -

113. The evidence also shows that cash payments received from the sales of the franchises funded the underlying business operations of the promoter entities and were paid to external parties: by way of loan repayment to Equitable Funds Management Ltd and by way of distribution to ABC Investment Funds Management Pty Ltd a unit holder in the Fishing Information Line Australia Unit Trust (Franchisor): Langridge report at page 28.

114. Beyond the cash payments sourced from participants' tax savings, the financial position of the project entities did not change as a result of the scheme. Loan funds were not made available and were clearly not intended to be. [See the Langridge report at 3.4 pages 26-28 and at 2.3 pages 18-19].

115. As well, as previously noted the evidence shows that, the Lender had no substance. The Lender was incorporated in July, 1997 and had assets consisting of $2 of share capital [T22-, V3/75-]. Considered as a separate entity, which it purported to be, the Lender had little prospect of obtaining funds to make the loans it undertook, which were to its commercial disadvantage: -

Section 177D(b)(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.

116. In the opinion of the Tribunal it is significant that once the Master Licence Execution Sheets were signed and the cash payments made on application and pursuant to the terms of the short term loan agreements there were no other consequences financial or otherwise for the applicants in entering into and carrying out the scheme. Certainly nothing further was demanded from them.

Section 177D(b)(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).

117. There was a business connection between the applicants and the Fishing Information Line entities, albeit that as already stated the exact nature of the connection is unclear.

Section 177D(b) conclusion

118. The Tribunal concludes that the above consideration of the section 177D(b) factors reveals that the scheme "took such a form that there is a particular scheme in respect of which a conclusion of the kind described in s 177D is required, even though the particular scheme also advances a wider commercial objective":
FCT v Hart 2004 ATC 4599; (2004) 217 CLR 216 per Gleeson CJ and McHugh J at [16], and further as set out as above showing that in the consideration of each of the section 177D(b) factors, the following aspects of the scheme emerge as extraneous to the substance of an investment in a commercial franchise: -

119. In the event, the evidence shows that commercial performance of the franchises was not material. The tax savings covered the initial payment obligations. Further payments, in respect of the loan and franchise fees were to be met only from the proceeds of the Franchised Businesses. Accordingly, the applicants and other participants would keep the benefit of the tax savings without further risk and regardless of the outcome of the franchises.

120. On the basis of these matters alone, the Tribunal finds that the scheme was entered into or carried out with the dominant purpose of obtaining tax benefits. Even if the scheme could be said to have a commercial intention or satisfactory commercial outcome the above features by which participants risked none of their own funds, were its primary attraction in the Tribunal's opinion.

121. The Tribunal also notes the following additional features here:

The evidence is that the applicants were not likely to secure an acceptable commercial return. The Franchised Businesses:

  • (a) were supported by an underlying business which had little substance. At best, it was a start-up business with an innovative product and, hence, inherently risky. See IM at 5.0 Caveat On Projections - T89, V2/314];
  • (b) did not have a workable structure capable of successful exploitation by intending franchisees; and
  • (c) were supported by Projected Cash Flows (V2/363) which could not be adequately assessed because they contained no indication of the assumptions on which they were based.

122. Even if the Tribunal found to the contrary, a contrary conclusion as to purpose would not be warranted in its opinion. To focus on whether the predicted returns were satisfactory or likely to be achieved begs the question posed by section 177D(b), as Hart indicates. There, Mr and Mrs Hart borrowed funds for, inter alia, an investment property. There was no question that the funds were borrowed for a commercial purpose or that they would secure an acceptable commercial return.

123. Accordingly, even a likely commercial return to participants from their entry into the

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scheme ought not to outweigh the features referred to above. In this respect, it should be noted that the poor returns which the investors in Sleight and Calder might have expected, apart from the savings afforded by their tax deductions, sat with a series of other matters which founded the respective Courts' conclusions. See Sleight, per Hill, J. at [77] - [83], [88] and Carr, J. at [211] - [216] and [225] - [227] and Calder at [78].

124. Accordingly in the Tribunal's view, it would be concluded that the sole or dominant purpose of the applicants in undertaking the obligations incurred by them was to generate a large up-front tax deduction resulting in tax savings to them which were sufficient to fund the cash payments they were required to make in respect of their participation, whilst leaving them with improved cash surplus positions in the two years to the end of June, 1998, being $2,450.01 for Mr Taylor [Langridge report, page 47 at 8.2.4 and page 53 at 8.5]and $4,573.46 for Mr Athans $4,573.46 [Langridge report, page 50 at 8.3.4 and page 53 at 8.5].

125. Alternatively, it would in the opinion of the Tribunal be concluded that the sole or dominant purpose of Fishing Information Services Pty Ltd, Fishing Information Line Australia Pty Ltd Unit Trust, Fishing Information Line Finance Pty Ltd, Fred Heinze, Kahl Heinze and Equitable Funds Management Ltd, in entering into or carrying out the scheme, was to obtain a tax benefit for participants in the project, including the applicants. The case law makes it clear that it is not to the point that the overall commercial objective of the promoter entities was to make money. They achieved their commercial purpose by creating a structure to which the attractiveness of the tax advantages it secured was central. Obiter comments made in the Full Federal Court decisions in Vincent at [100] and Sleight at [95]-[96] must now be read in light of the High Court decision in Hart.

Conclusion with respect to Part IVA

126. It follows from the foregoing that, in respect of the 1997 year the respondent was authorised and entitled under section 177F(1)(b) of the Act to determine that the tax deductions claimed by each applicant in each of 1997 year were not allowable. The applicants have in the opinion of the Tribunal comprehensively failed to discharge the onus which rests on them to show that the relevant assessments were excessive.

Cash outlays

127. As the Tribunal has found that the payments made by the applicants are not deductible under section 51(1) there is no basis for the Tribunal to follow the reasoning in
Commissioner of Taxation v Sleight (2004) 136 FCR 211 per Hill J at [112]-[115] (Hely J agreeing) and per Carr J at [246]. There the Court took the view that in the exercise of discretion under section 177F(1)(b) of the Act cash payments made by the respondent were to be allowed as deductions, having decided that the deductions were otherwise allowable under section 51(1). That is not the case here.

Decision

128. The applicants have not discharged the onus which lies on them under Paragraph 14ZZK(1)(b) of the Taxation Administration Act 1953 which requires that for the purpose of ascertaining their true income tax liability, the Tribunal must review whether the respondent's assessment is excessive, in the sense of assessing an amount greater than the taxable income on which tax ought to have been levied. Paragraph 14ZZK(1)(b) places on the applicants the onus of satisfying the Tribunal that the amount assessed is wrong and is greater than their actual substantive liability under the terms of the Income Tax Assessment Act 1936. See
FCT v Dalco (1990) 168 CLR 614 at 621 and 625. The applicants have failed to do so.

129. The Tribunal accordingly affirms the decisions of the respondent under review in relation to both applicants.

 

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