ALLEN & ANOR (AS TRUSTEES FOR THE ALLEN’S ASPHALT STAFF SUPERANNUATION FUND) v FC of T

Judges:
Keane CJ
Greenwood J
Middleton J

Court:
Full Federal Court, Brisbane

MEDIA NEUTRAL CITATION: [2011] FCAFC 118

Judgment date: 7 September 2011

Keane CJ, Greenwood and Middleton JJ

Introduction

1. During the 2003 income year the Allen's Asphalt Staff Superannuation Fund (the Super Fund) received a distribution of $2,500,005 as beneficiary of the Allen's Asphalt Fixed Trust (the Fixed Trust) by virtue of the Super Fund's fixed entitlement to 100% of the income of the Fixed Trust. The Fixed Trust itself had received this sum by way of a distribution from the Allen's Asphalt Hybrid Fixed Trust (the Hybrid Trust), the sum of $2,500,005 being a capital gain realised on the sale of an asset of the Hybrid Trust.

2. On 9 November 2006 the Commissioner of Taxation (the Commissioner) issued a notice of amended assessment to Mr and Mrs Allen (the taxpayers) who are now the trustees of the Super Fund. The amended assessment was made on the basis that the distribution was "special income" of the Super Fund within s 273(7) of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936). Accordingly, the sum fell to be taxed at the rate of 47% rather than 15%. Subsequently, a penalty assessment was issued by the Commissioner at the rate of 25% pursuant to s 284-75 of the Taxation Administration Act 1953 (Cth) (TAA).

3. The taxpayers objected to the amended assessment and that objection was disallowed by the Commissioner. The taxpayers then brought proceedings in the Federal Court of Australia pursuant to s 14ZZ of the TAA by way of appeal against a decision by the Commissioner to disallow their objection to the amended assessment.

4. The learned primary judge dismissed the taxpayers' appeal, holding that the sum received by the Super Fund from the Fixed Trust was "special income" of the Super Fund:
Allen (Trustee), in the matter of Allen's Asphalt Staff Superannuation Fund v Commissioner of Taxation 2010 ATC 20-225; [2010] FCA 1276 (Reasons). Her Honour also dismissed the taxpayers' appeal against the penalty assessment on the basis that the taxpayers' failure to acknowledge in their income tax return that the distribution was special income was not a reasonably arguable position. The taxpayers now appeal to this Court.

5. The following issues arise on appeal:

6. The arguments which arise in relation to these issues are principally concerned with the construction of the legislation. The primary facts are not in dispute. It is convenient to begin by setting out the principal pieces of the legislative scheme on which the questions of construction turn. Before we address those questions of construction, we will briefly summarise the facts of the case and the reasons of the primary judge.

The legislation

7. The principal provision applicable to the facts of this case is s 273 of the ITAA 1936 as it was at 1 July 2003. It should be noted that s 273 of the ITAA 1936 has since been replaced by s 295-550 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997), which was evidently enacted to put paid to the arguments advanced by the taxpayers in this case.

8. It is common ground that the Super Fund is an eligible entity and a complying superannuation fund for the purposes of Part IX of the ITAA 1936.

9. Section 272 of the ITAA 1936 provides relevantly:

"The taxable income of an eligible entity shall be calculated as if the trustee were a taxpayer and;

  • …
  • (b) … a resident."

10. In
Commissioner of Taxation v Commercial Nominees of Australia Ltd 2001 ATC 4336; (2001) 179 ALR 655 at [11] (Commercial Nominees) Gleeson CJ, Gaudron, McHugh, Kirby and Crennan JJ explained that:

"[T]he expression 'as if', in s 272, shows that the calculation of taxable income is upon a hypothetical basis. Taxable income is, relevantly, assessable income minus allowable deductions (ITAA 1936, ss 6 and 48). The hypothesis includes the concept that the trustee for the time being of an eligible entity, in this case a complying superannuation fund, derives income, and incurs allowable deductions, not in its own right, but in virtue of its office. …"

11. Section 273 of the ITAA 1936 was amended by the enactment of the Superannuation Legislation Amendment Bill (No 2) 1999 to add subss (6), (7) and (8). After the amendment, the section provided:

12. Section 278 of the ITAA 1936 relevantly provides:

13. Section 284 of the ITAA 1936 provides:

"The special component of the taxable income of a complying superannuation fund is the amount (if any) remaining after deducting from the special income:

  • (a) any allowable deductions that relate exclusively to the special income; and
  • (b) so much of any other allowable deductions as, in the opinion of the Commissioner, may appropriately be related to the special income."

14. Section 285 of the ITAA 1936 provides:

"The standard component of the taxable income of a complying superannuation fund is the amount (if any) remaining after deducting the special component from the taxable income."

15. Different rates of tax apply in respect of the special component and standard component of taxable income. Section 26 of the Income Tax Rates Act 1986 (Cth) sets out of the rates of tax imposed upon special income as follows:

  • " 26 Rates of tax payable by trustees of superannuation funds
    • (1) The rates of tax payable by a trustee of a complying superannuation fund in respect of the taxable income of the fund are:
      • (a) in respect of the standard component - 15%; and
      • (b) in respect of the special component - 47%.
    • (2) The rate of tax payable by a trustee of a non-complying superannuation fund in respect of the taxable income of the fund is 47%."

16. Div 284 of the TAA sets out the circumstances in which administrative penalties may apply and the amounts of those penalties. The tax shortfall penalty was imposed pursuant to s 284-75, which provides:

  • 284-75 Liability to penalty
    • (1) You are liable to an administrative penalty if:
      • (a) you or your agent makes a statement to the Commissioner or to an entity that is exercising powers or performing functions under a *taxation law; and
      • (b) the statement is false or misleading in a material particular, whether because of things in it or omitted from it; and
      • (c) you have a *shortfall amount as a result of the statement.

        Note: Subsection 2(2) specifies laws that are not taxation laws for the purposes of this Subdivision.

    • (2) You are liable to an administrative penalty if:
      • (a) you or your agent makes a statement to the Commissioner or to an entity that is exercising powers or performing functions under an *income tax law; and
      • (b) in the statement, you or your agent treated an *income tax law as applying to a matter or identical matters in a particular way that was not *reasonably arguable; and
      • (c) you have a *shortfall amount as a result of the statement; and
      • (d) item 4, 5 or 6 of the table in subsection 284-90(1) applies to you.
      • …

17. The term "shortfall amounts" is defined in s 284-80 of the TAA.

Factual background

18. The Super Fund was established on 28 June 1993. Allen's Asphalt Pty Ltd, a company of which the taxpayers were directors, was appointed trustee of the Super Fund at its inception. On 1 January 2003 Allen's Asphalt Pty Ltd retired as trustee and the taxpayers became the trustees of the Super Fund in its place.

19. Mr Allen was also a director of Astonglen Pty Ltd, which executed the declaration of trust which created the Fixed Trust on 28 June 2002. The schedule to the trust deed nominated Allen's Asphalt Pty Ltd, in its capacity as trustee of the Super Fund, as the "absolute beneficiary" of the Fixed Trust with a 100% vested and indefeasible interest in the income of the trust estate of the Fixed Trust. The minutes of meeting of the directors of Astonglen for 30 June 2003 record that the trustee of the Super Fund was presently entitled to the net income of the Fixed Trust.

20. The Hybrid Trust was created on 28 June 2001. Allen's Asphalt Pty Ltd, as trustee of the Super Trust, was designated as the "absolute beneficiary" of the Hybrid Trust. The trustee of the Hybrid Trust was a corporation of which Mr Allen was the sole director. By deed of variation signed by Mr Allen on 28 June 2002, a new class of "discretionary beneficiaries" was added to the Hybrid Trust. These discretionary beneficiaries included the Fixed Trust.

21. The establishment of the trust structures and flow of funds through these trust structures to the Super Fund occurred pursuant to legal advice obtained by the taxpayers.

22. The Super Fund's 2003 income tax return was lodged in March 2004. On 5 March 2004 the Hybrid Trust's income tax return was lodged showing a distribution of $2,500,000 to the Super Fund; but the Commissioner was subsequently told that the trust distribution was in fact received by the Super Fund from the Fixed Trust and not the Hybrid Trust. A request was made to amend the income tax return accordingly, and this request was accepted by the Commissioner.

23. By a Notice of Amended Assessment issued on 9 November 2006, the Commissioner assessed the Super Fund's distribution from the Fixed Trust as "special income".

24. On 15 November 2006, a tax shortfall penalty of $169,226.70 was imposed on the taxpayers by the Commissioner pursuant to s 284-75 of the TAA in addition to a general interest charge of $301,335.29 from the Super Fund.

25. The taxpayers, as trustees of the Super Fund, lodged a notice of objection to the amended assessments on 16 March 2007. This notice of objection was disallowed in a decision by the Commissioner on 26 February 2008. On 23 April 2008 the taxpayers, as trustees of the Super Fund, brought their appeal against the Commissioner's decision to the Federal Court.

The reasons of the primary judge

26. The primary judge accepted at [30] the Commissioner's submission that the term "income" used in s 273 is apt to encompass receipts which are assessable income by virtue of the income tax legislation. Her Honour was persuaded that the term "income" in s 273(7) referred to assessable income. It is this conclusion which is the principal focus of argument in this Court. We will discuss these arguments in due course.

27. As to the other requirements of s 273(7), the primary judge described the "arrangement" in question at [64] of her Honour's Reasons:

"… The Commissioner submits that the trustee of the Super Fund acquired the fixed entitlement to income of the Fixed Trust estate under an arrangement, or derived that net income under that arrangement, which arrangement comprised the following steps:

  • • the establishment of the Fixed Trust providing for a fixed entitlement to the trustee of the Super Fund to 100% of the net income of the Fixed Trust;
  • • the amendment of the Hybrid Trust deed to include the newly created Fixed Trust as a beneficiary;
  • • the amendment of the Super Fund trust deed;
  • • the preparation of a trustee resolution for the distribution of income from the Hybrid Trust to the Fixed Trust;
  • • the distribution of income from the Hybrid Trust to the Fixed Trust and the acceptance of the distribution by the Fixed Trust;
  • • the preparation of a trustee resolution for the distribution of income from the Fixed Trust to the Super Fund;
  • • the distribution of income from the Fixed Trust to the Super Fund and the acceptance of the distribution by the trustee of the Super Fund;

(I note that it is not in dispute that these events occurred - the applicant's objection relates to whether they all formed part of 'the arrangement')."

28. As to whether the trustee of the Super Fund "acquired" the fixed entitlement, her Honour at [58] interpreted the term "acquire" as apt to include obtaining an entitlement to a distribution under a declaration of trust. The primary judge accepted at [69] that an "arrangement" could "involve a series of interrelated steps beyond the formal declaration of trust" and proceeded on the basis that "steps taken by the parties beyond those focused on the formalities of the trust relationship … can properly constitute aspects of an 'arrangement'" (at [70]). Her Honour said at [74]:

"…the overall plan carried out by Mr Allen in conjunction with the relevant trustee companies, as evidenced in the background facts set out earlier in this judgment, and which plan culminated in the distribution of income from the Hybrid Trust through the Fixed Trust to the Super Fund, should be regarded as the 'arrangement'."

29. As to "dealing", the primary judge regarded the term as "being referable to [the] conduct of oneself to persons"; it "can be both active and passive" (at [82]) so that the Super Fund was "'dealing' with another party [to the arrangement] simply by receiving pre-tax income of a trust" (at [84]). Her Honour said (at [86]):

"… the arrangement under which the Super Fund acquired the fixed entitlement to the income and actually derived the income was not merely the formal creation of the Fixed Trust in June 2002, but was a series of interrelated steps culminating in the Super Fund's acquisition of the fixed entitlement and the derivation of income. To that extent the Super Fund 'dealt' with the other parties to the arrangement."

30. Her Honour concluded at [91] that the dealings in question were not at arm's length in that:

  • "• … all acts of the trusts were performed under the effective direction of Mr Allen.
  • • The effect of the arrangement was to provide for the distribution of income of the Hybrid Trust, through the Fixed Trust, to the Super Fund in the 2003 financial year. The arrangement diverted the distribution of income that might have been expected to have been distributed to the beneficiaries of the Hybrid Trust, including individual beneficiaries.
  • • No consideration was provided by the Super Fund in respect of the distribution of income from the Fixed Trust.
  • • There appeared to be no commercial justification for the distribution of income from the Hybrid Trust to the Fixed Trust and thence to the Super Fund."

31. Her Honour went on (at [98]) to say:

"… steps were taken, in non-arm's length dealings and in pursuance of the arrangement, to cause a distribution of income to the Super Fund to allow taxation of the income at only 15% rather than at the marginal tax rate applicable. There does not appear to have been any other justification for the arrangement except this ultimate goal."

32. Her Honour concluded that "the amount of relevant income received by the Super Fund was greater than might have been expected to have been received if the parties had been dealing with each other at arm's length" (at [99]).

33. On the question of penalty, her Honour referred to the reasons of Hill J in
Walstern v Commissioner of Taxation 2003 ATC 5076; [2003] 138 FCR 1 at [108] (Walstern) and said (at [112]):

  • "• As Hill J observed in Walstern, the test of whether a statement is 'reasonably arguable' is objective, not subjective. If objectively the statement is not reasonably arguable, the belief of the taxpayer in advice provided by professional advisers does not make its position reasonably arguable.
  • • Although there are no authorities considering s 273, there are many authorities considering concepts of 'income', 'derived', 'dealing', 'arrangement', 'parties', and 'arm's length'. Those authorities support the position taken by the Commissioner in these proceedings rather than the applicant, as does the Explanatory Memorandum."

34. In addressing the matters adverted to by Hill J, her Honour gave particular consideration to "whether the [appellant] had taken reasonable care in making statements which were false or misleading in these proceedings" (at [108]). In this regard, the taxpayers adduced evidence that they had received written legal advice regarding the taxation implications of the distribution from the Fixed Trust to the Super Fund. The advice was supported by the written opinion of Senior Counsel.

35. Notwithstanding the care which her Honour accepted had been exercised by the taxpayers, her Honour was unable to find that their position was "reasonably arguable", there being no basis for holding that "what the [appellant] argued is as likely to be correct as incorrect, or is more likely to be correct than incorrect" (at [113]).

The taxpayers' arguments in this court

36. The taxpayers argue that "income" has the same meaning in s 273(1) and (7) and that it does not include assessable income but is restricted to income according to ordinary concepts. To put it another way, they say that "income", a non-defined term, does not include "assessable income", a defined term. Further, the taxpayers submit that the omission of such a significant word as "assessable" should not be glossed over as a form of 'shorthand' reference to the term "assessable income".

37. The taxpayers also contend that the collocation of "derived" and "income" in s 273 points towards the ordinary usage of the word income and away from the conclusion that it encompasses assessable income resulting from the passive receipt of a distribution of a capital gain to a beneficiary of a trust estate.

38. If the word "income" includes assessable income, then for the distribution to the Super Fund to be "special income", other requirements of s 273(7) must be met. The taxpayers argue that these elements are not present here. The taxpayers accept that given the wide definition of "arrangement" in s 273(8), an arrangement of some kind existed. It is said, however, that Mr Allen engaged in a series of unilateral acts so that there was no understanding, promise or undertaking between any of the entities involved in the distributions from the Hybrid Trust to the Fixed Trust to the Super Fund.

39. As to whether the Super Fund "acquired" its fixed entitlement to a distribution of all the income of the Fixed Trust under an arrangement, the appellants submit the acquisition by the Super Fund was entirely passive, it having been accepted by the primary judge at [50] that the Super Fund did nothing to obtain the entitlement.

40. The taxpayers also argue that no active step to receive the distribution was undertaken by the Super Fund. For that reason, the taxpayers argue that there was no dealing between the parties to the arrangement. They say that there must be some transactional activity by the Super Fund to constitute a "dealing". The taxpayers argue that as all actions were unilateral on the part of Mr Allen, there was no dealing (at arm's length or otherwise) involved in the Super Fund obtaining its fixed entitlement or in its receiving the distribution.

41. Finally, the taxpayers argue that, even if they fail on their substantive challenge to the amended assessment, the imposition of a shortfall penalty and interest on that penalty, was not warranted as the appellants' position was reasonably arguable within the meaning of s 284-75 of the TAA. Accordingly, if the amended assessments stand, the appellants seek orders setting aside the penalty assessment of 15 November 2006, and an order requiring the Commissioner to recalculate the general interest charge.

Consideration

Income in s 273(7)

42. The term "income" is not defined in the legislation. The protean quality of the term "income" in tax legislation has long been recognised. In
Resch v Federal Commissioner of Taxation (1942) 66 CLR 198 at 210-211, Rich J said of the predecessor to the ITAA 1936:

"It is maintained that the Act does not confine itself to one subject of income but extends to another subject of taxation, namely, capital profits. The subject is profits or gains, and the distinction between gains of an income nature and gains of a capital nature is neither instituted nor maintained by the assessment Act. …The word 'income' is comprehensive enough to include the subjects dealt with in the Act, and its use in this connection is in accordance with common understanding, which is one main clue to the meaning of the legislature: Cf. Bank of Toronto v. Lambe.

[Footnote omitted]."

43. In the same case, Dixon J said at 224-225:

"The subject of the income tax has not been regarded as income in the restricted sense which contrasts gains of the nature of income with capital gains, or actual receipts with increases of assets or wealth. The subject has rather been regarded as the substantial gains of persons or enterprises considered over intervals of time and ascertained or estimated by standards appearing sufficiently just, but nevertheless practical and sometimes concerned with avoidance or evasion more than with accuracy or precision of estimation.

…

The distinction between profits of a capital nature and profits in the nature of income in the strict sense is not one which the Act maintains. Nor is it a discrimination which the legislature is bound to regard. Indeed, in the United States, under the 16th Amendment which speaks of 'income,' the term is considered to include all profits whether on account of capital or on account of income in the strict sense. In United States v. Stewart Douglas J. says: '"Income" is a generic term amply broad to include capital gains for purposes of income tax,' citing Merchants' Loan & Trust Co. v. Smietanka …

[Footnotes omitted]."

44. Whether the word "income" in s 273(7) refers only to income according to ordinary concepts or to assessable income is a question which must be addressed having regard to the context and the mischief at which the section is aimed.

45. In this regard, authoritative guidance as to the proper approach to the construction of tax legislation is afforded by the reasons of Hayne, Heydon, Crennan and Kiefel JJ in
Alcan (NT) Alumina Pty Ltd v Commissioner of Territory Revenue (Northern Territory) 2009 ATC 20-134(2009) 239 CLR 27 at [47] where their Honours said:

"This Court has stated on many occasions that the task of statutory construction must begin with a consideration of the text itself. Historical considerations and extrinsic materials cannot be relied on to displace the clear meaning of the text. The language which has actually been employed in the text of legislation is the surest guide to legislative intention. The meaning of the text may require consideration of the context, which includes the general purpose and policy of a provision, in particular the mischief it is seeking to remedy.

[Footnotes omitted]."

46. Their Honours went on to say at [57]:

"… [T]ax statutes do not form a class of their own to which different rules of construction apply; … [T]he fact that a statute is a taxing Act, or contains penal provisions, is part of the context and is therefore relevant to the task of construing the Act …"

Context

47. A study of the context in which s 273(7) operates suggests that special income was intended to refer to assessable income. By virtue of s 272 of the ITAA 1936, the taxable income of the Super Fund is to be calculated as if the trustees were a taxpayer. As the trustees of the Super Fund were, in that capacity, beneficiaries of the Fixed Trust, their assessable income as trustees of the Super Fund fell to be calculated in accordance with Division 6 of Part III of the ITAA 1936.

48. It was not suggested in argument for the taxpayers that reference to the provisions of Div 6 of Part III of the ITAA 1936 was not permissible. Although, the High Court in
Commissioner of Taxation v Commercial Nominees of Australia Limited 2001 ATC 4336(2001) HCA 33; (2001) 75 ALJR 1172 at [5], recognised that Part IX of the ITAA 1936, which includes s 273, was "described in the Treasurer's Explanatory Memorandum as 'an exclusive legislative regime for determining the taxable income of complying and non-complying superannuation funds'", their Honours further explained at [12] that "Part IX is not completely self-contained. Other provisions of the ITAA 1936 are also material".

49. It is necessary here to refer to ss 95 and 97 of the ITAA 1936. At the relevant time, they were in the following terms:

  • " 95 Interpretation
    • (1) [Definitions] In this Division:

      …

      net income , in relation to a trust estate, means the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions, except deductions under Division 16 or Schedule 2G and except also, in respect of any beneficiary who has no beneficial interest in the corpus of the trust estate, or in respect of any life tenant, the deductions allowable under Division 36 of the Income Tax Assessment Act 1997 in respect of such of the tax losses of previous years as are required to be met out of corpus.

      …

  • 97 Beneficiary not under any legal disability
    • (1) [Assessable income; exempt income] Subject to Division 6D, where a beneficiary of a trust estate who is not under any legal disability is presently entitled to a share of the income of the trust estate:
      • (a) the assessable income of the beneficiary shall include:
        • (i) so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was a resident; and
        • (ii) so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was not a resident and is also attributable to sources in Australia;

      …

      "

50. Section 6-5 of the ITAA 1997 also forms part of the statutory context. Sections 6-5 and 6-10 show that assessable income includes ordinary income and statutory income. The general scheme of the legislation is that income tax is imposed on taxable income, being the assessable income less allowable deductions. Section 6-5 provides:

  • " 6-5 Income according to ordinary concepts ( ordinary income )
    • (1) Your assessable income includes income according to ordinary concepts, which is called ordinary income .

      Note: Some of the provisions about assessable income listed in section 10 5 may affect the treatment of ordinary income.

    • (2) If you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

      …

    • (4) In working out whether you have derived an amount of ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct."

51. Section 6-10 of the ITAA 1997 provides:

  • " 6-10 Other assessable income (statutory income)
    • (1) Your assessable income also includes some amounts that are not ordinary income.

      Note: These are included by provisions about assessable income.

      For a summary list of these provisions, see section 10-5.

    • (2) Amounts that are not ordinary income, but are included in your assessable income by provisions about assessable income, are called statutory income.

      Note 1: Many provisions in the summary list in section 10-5 contain rules about ordinary income. These rules do not change its character as ordinary income.

      …

    • (4) If you are an Australian resident, your assessable income includes your statutory income from all sources, whether in or out of Australia.

      …

      "

52. Pursuant to s 97(1)(a) of the ITAA 1936, the income of the taxpayers as trustees of the Super Fund and beneficiaries of the Fixed Trust includes their share or proportion of the net income of that trust estate in accordance with s 95 of the ITAA 1936. By virtue of s 6-10 of the ITAA 1997 that share or proportion is assessable income of the taxpayers. In this way, if it is assumed that the trustees of the Super Fund are themselves the beneficiaries of a trust, any income which comes home to them will be assessable income by reasons of ss 95 and 97(1)(a) of the ITAA 1936. This assumption may properly be made in this case because s 273(7) of the ITAA 1936 is expressly predicated upon a state of affairs in which the trustee of the complying superannuation fund (CSF) receives the putative income by virtue of a fixed entitlement, that is to say a situation in which s 97(1)(a) operates. Thus, the sum of $2,500,205 distributed to the Super Fund in this case was the Super Fund's share of the net income of the Fixed Trust in accordance with s 95.

53. The assumption to which we have referred is reinforced by the consideration that s 273 does not itself impose a liability to pay tax, but assumes that the income to which it applies is liable to tax as imposed by s 278 of the ITAA 1936. Section 273 attaches a particular consequence in terms of the rate of tax to that taxable income which is identified as special income. The provisions of particular relevance here are ss 284 and 285. In this regard, s 284 contemplates that the "special component" of special income to which it refers is taxable income which is calculated by deducting allowable deductions from "special income". As noted above, the general scheme of the legislation is to impose tax on taxable income ascertained by deducting allowable deductions from assessable income.

54. The taxpayers emphasise that in s 273, "income" is not used alone but as part of the expression "income derived", arguing that the collocation of "income" with "derived" is not apt to encompass the distribution of a capital gain because a capital gain is not derived from income earning activity, and to receive a distribution is not to derive income. But ss 273(6) and (7) of the ITAA 1936 postulate that an entity, which is the beneficiary of a trust estate, may indeed derive income as a beneficiary of a trust estate. And as has been seen, the income of a CSF which is the beneficiary of a trust estate, will include gains of a capital nature which are deemed to be income.

55. As to whether the income can be said to have been "derived", in
Federal Commissioner of Taxation v Sun Alliance Investments Pty Ltd 2005 ATC 4955; (2005) 225 CLR 488 at [42] the High Court stated that the first step in ascertaining the meaning of "derived" is to refer to the thing that is said to be derived. In this case the distribution was received by the Super Fund by virtue of its 100% entitlement to the income of the Fixed Trust. Pursuant to s 97 of the ITAA 1936, the beneficiary of a trust estate is treated as having derived income equivalent to its share of the s 95 net income. As we have seen, this share will include an amount attributable to a net capital gain which is included in the assessable income.

56. The taxpayers argue that a beneficiary of a trust subject to tax as a consequence of s 97 of the ITAA 1936 does not derive income. Rather, the taxpayers say, the income is derived by the trust and then attributed to the beneficiary. But this is to make a distinction without a difference. Whether one speaks of the income being attributed or imputed to the beneficiary, it is clear that the statutory attribution or imputation is the functional equivalent of derivation. Professor Parsons explains the point in Income Taxation in Australia (The Law Book Company Limited, 1985) at 249:

"Sections 97 and 98 substitute 'present entitlement' and 'vested and indefeasible interest' as the tests of derivation. And s 101 deems a present entitlement when a trustee exercises his discretion 'to pay or apply income…for the benefit of' a beneficiary. These tests of derivation operate in a special fashion. They are strictly tests of derivation of trust law income by the beneficiary. From that derivation a derivation of income for purposes of the income tax is imputed. The derivation imputed is a derivation of a share of the income for purposes of the income tax, derived by the hypothetical taxpayer referred to in s 95 - the share being the same as the beneficiary's share of trust law income."

57. Section 273(7) of the ITAA 1936 can have no operation at all if the expression "income derived" excludes the receipt of trust distributions. The provision should not be interpreted as self-stultifying. The Court must seek to interpret the provision in a way which reconciles seeming inconsistency and gives the provision some operation. Section 273(6) of the ITAA 1936 discloses an unmistakable legislative intention to deal comprehensively with trust income, including amounts included in assessable income otherwise than by derivation from an income earning activity. If the "income derived" by the CSF as a beneficiary of a trust estate did not include trust distributions, s 273(6) could have no operation at all. The Court should shrink from a construction which would deprive a statutory provision of all operation. And there can be no doubt that the phrase "income derived" has the same operation in s 273(6) and 273(7).

58. It is convenient here to advert to one of the arguments advanced on behalf of the taxpayers in relation to s 273(7)(b) but which bears as well on the mischief at which s 273(7) is directed. It is said that in this case it is not possible to say that "the amount of income is greater than might have been expected to have been derived by the entity if [the parties to the arrangement] had been dealing with each other at arm's length in relation to the arrangement" (Reasons at [3]). The taxpayers argue that s 273(7)(b) could not be satisfied because the requirement to determine what the arm's length consequence would have been is an impossible comparison because any dealing in this case was plainly and avowedly not at arm's length. But the statute cannot be stultified because of the very conduct at which it is aimed. The comparison required by s 273(7)(b) postulates a hypothetical arm's length dealing which may be compared with what actually occurred: that there was not, in fact, an arm's length dealing does not make the comparison impossible.

59. Section 273(7)(b) is speaking of a hypothetical situation that "might have been expected to apply" if the parties to the arrangement had been dealing at arm's length. It requires little imagination to see that if the parties to the movement of funds in this case had been at arm's length, there would have been no distribution at all to the Super Fund. The usual expectation of humankind is that one gets what one pays for, and the Hybrid Trust and the Fixed Trust got nothing in relation to the payments which they made; and there was no purpose to the plan which informed the flow of funds other than the attraction of the favourable tax rate applicable to the income of a CSF.

The mischief

60. We turn now to consider the Explanatory Memorandum to Superannuation Legislation Amendment Bill (No 2) 1999. The Explanatory Memorandum expressly indicates in cll 2.12 and 2.17 an intention that the new provisions should apply in relation to assessable income. It also identifies at cll 2.1 and 2.13-2.15 the mischief at which s 273(6) and (7) were aimed, namely to prevent income being diverted through a superannuation fund to avoid the tax rates ordinarily applicable. The relevant passages from the Explanatory Memorandum are:

" Overview

  • 2.1 Schedule 2 to the Bill will amend section 273 of the Income Tax Assessment Act 1936 (ITAA 1936) so that the special income of a complying superannuation fund, approved deposit fund (ADF) or pooled superannuation trust (PST) will include:
    • • distributions from all trusts other than where the superannuation fund, ADF or PST has a fixed entitlement to income from that trust; and
    • • non arm's length trust distributions of income where the superannuation fund, ADF or PST has a fixed entitlement to income from that trust.
  • …

Purpose of the amendments

  • 2.2 To tighten section 273, an existing anti-avoidance measure, to close a loophole which allows certain distributions of trust income to superannuation funds made under non-arm's length arrangements to be taxed at the concessional rate of 15%.
  • …

Background to the legislation

  • 2.11 The taxation treatment of the income of a superannuation entity is governed by Part IX of the ITAA 1936. In general terms the trustee of a superannuation entity is taxed on the taxable income of the entity at the concessional rate of 15% where there is no 'special component' of the taxable income.
  • 2.12 Where a superannuation entity derives assessable income that is included in the 'special component' of the taxable income of the entity, the trustee of the entity is taxed on that income at the rate of 47%. The assessable income that is included in the special component is termed special income and is income derived from certain types of non-arm's length transactions (including the payment of certain private company dividends) that fall within the provisions of section 273 of the ITAA 1936.
  • 2.13 Section 273 is designed to prevent income from being unduly diverted into superannuation entities as a means of sheltering that income from the normal rates of tax applying to other entities, particularly the marginal rates applying to individual taxpayers.
  • 2.14 The ATO has become aware of arrangements which circumvent section 273. Under the arrangements, pre-tax income of a trust (usually a discretionary trust) is distributed to a complying superannuation fund set up for the benefit of the beneficiaries of that trust rather than to the beneficiaries themselves. The effect of the arrangements is that the income is taxed at only 15% as income of the superannuation fund rather than at the marginal rate of tax applicable to other beneficiaries.
  • 2.15 It is doubtful whether subsection 273(4) of the ITAA 1936, which seeks to tax income derived by a superannuation entity from a non-arm's length transaction at the non-concessional rate of 47%, would catch these discretionary trust distributions.
  • …

What trust distributions will be treated as special income?

Superannuation entity receives income from a discretionary trust .

  • 2.17 Assessable income that is derived by a superannuation entity, in the capacity of beneficiary of a trust estate, other than through the holding of a fixed entitlement to income, will be regarded as special income of the entity under new subsection 273(6) . That is, new subsection 273(6) will include as special income any assessable income derived by a superannuation entity in the capacity of beneficiary of a discretionary trust.

Example

A husband and wife are principals of a business. A discretionary trust is established to carry on the business, the beneficiaries of which are the principals, other family members and the superannuation fund. A superannuation fund is also established with the principals as the members of the fund. The trustees of both the discretionary trust and the superannuation fund are corporate trustees 100% owned by the principals. This ensures that the husband or wife has effective control over the activities of both the discretionary trust and the superannuation fund.

The trustee of the trust exercises its discretion to distribute an amount of trust income to the trustee of the superannuation fund in preference to the other beneficiaries who would otherwise be taxable on the income at their applicable marginal rate in accordance with Division 6 of Part III of the ITAA 1936. New subsection 273(6) would include any distribution made by the trustee to the superannuation fund as special income of the fund.

Superannuation entity receives income from a fixed trust under non-arm's length arrangements

  • 2.18 Assessable income that is derived by a superannuation entity in the capacity of beneficiary of a trust estate with a fixed entitlement to income will be regarded as special income of the entity under new subsection 273(7) if both of the following tests are satisfied:
    • • the entity acquired the fixed entitlement under an arrangement, or the income was derived under an arrangement, in relation to which some or all of the parties were not dealing with each other at arm's length [new paragraph 273(7)(a)] ; and
    • • the amount of that income is higher than might have been expected to have been derived by the entity if those parties had been dealing with each other at arm's length in relation to the arrangement [new paragraph 273(7)(b)] .
  • 2.19 New subsection 273(8) provides that for the purposes of new subsection 273(7) , the word arrangement means:
    • • any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and
    • • any scheme, plan, proposal, action, course of action or course of conduct."

61. The Explanatory Memorandum went on to give some examples of situations that would be covered by the new s 273(7):

Example One

At the beginning of the 1998-99 financial year, the trustee of a superannuation fund acquired 20 $1 units in a unit trust. The directors and shareholders of the trustee company of the unit trust are members of the superannuation fund. Each unit conferred a fixed entitlement to distributions of income from the unit trust.

There was a mutual understanding between the parties that subsequent to the acquisition of the units in the unit trust by the superannuation fund, $100,000 would be distributed each year to the unit trust from a discretionary trust of which the unit trust was a beneficiary. A distribution from the discretionary trust to the unit trust was made prior to the end of the financial year.

Units in the trust were purchased during the financial year by an arm's length party for $10,000 each.

At the end of the financial year the trustee of the unit trust resolves to distribute the income of the trust to unit holders.

In these circumstances, the purchase of the units, the subsequent injection of funds from the discretionary trust and the distributions of trust income to the superannuation fund, being within the contemplation of the trustee of the superannuation fund and the trustee of the unit trust (whether or not it is in the contemplation of the trustee of the discretionary trust), would fall within the definition of "arrangement" in new subsection 273(8) , being an arrangement that relates to the acquisition of a fixed entitlement to the income of the trust.

As the parties are not involved in real bargaining in relation to the arrangement, they are not dealing at arm's length with each other in relation to that arrangement. This would be demonstrated by the fact the trustee of the superannuation fund acquired the units in the unit trust for less than market value consideration. The first test in new paragraph 273(7)(a) would be satisfied.

The income of the unit trust has increased as a result of the distribution received from the discretionary trust under an arrangement some of the parties to which were not dealing at arm's length. As a result the unit trust has more income available to be distributed to unit holders. If the parties were dealing at arm's length no distribution to the unit trust from the discretionary trust could be expected and less income would have been available for distribution to unit holders.

Accordingly, the amount of income derived by the superannuation fund from the arrangement is greater than might have been expected to have been derived by the fund if the parties had been dealing with each other at arm's length. The test in new paragraph 273(7)(b) would be satisfied.

The income derived by the superannuation fund will be treated as special income.

Example Two

On 20 October 1992, the trustee of a superannuation fund acquired 20,000 $10 units in a unit trust. Each unit conferred a fixed entitlement to distributions of income from the unit trust. The members of the superannuation fund are the 100% owners of the corporate trustees of both the superannuation fund and the unit trust. The unit trust paid an arm's length distribution to the superannuation fund and other unit holders for the 1993-98 financial years.

During the 1998-99 financial year, the trustees of the superannuation fund, the unit trust and the ABC discretionary trust agree that before the end of the financial year the discretionary trust will distribute $100,000 to the unit trust. The trustee of the discretionary trust is also a corporate trustee 100% owned by the members of the superannuation fund. Also in that year, a private company which the members of the superannuation fund control lends $100,000 interest free to the unit trust. At the end of that financial year the trustee of the unit trust resolves to distribute the income of the trust to the unit holders.

The distribution received by the unit trust from the discretionary trust increases the income of the unit trust, which impacts on the amount available for distribution to unit holders. Therefore, the agreement between the trustee of the unit trust, the trustee of the superannuation fund and the trustee of the discretionary trust would be an arrangement that relates to the income derived by the superannuation fund within the meaning of new subsection 273(8) . As the parties are not involved in real bargaining in relation to the arrangement, they are not dealing at arm's length with each other in relation to that arrangement. The test in new paragraph 273(7)(a) would be satisfied.

As the trustee of the unit trust would not have to pay interest on the loan received from the private company the income of the unit trust would be increased, which would have an impact on the amount available for distribution to unit holders. Therefore the arrangement between the trustee of the unit trust and the private company would be an arrangement that relates to the income derived by the superannuation fund within the meaning of new subsection 273(8) . As the parties are not involved in real bargaining in relation to the arrangement, they are not dealing at arm's length with each other in relation to that arrangement. The test in new paragraph 273(7)(a) would be satisfied.

The amount of income derived by the superannuation fund from the arrangement is greater than might have been expected to have been derived by the fund if the parties had been dealing with each other at arm's length due to:

  • • the increase in income of the unit trust as a result of the distribution of income from the discretionary trust to the unit trust (if the parties were dealing at arm's length no distribution could be expected); and
  • • the increase in the income of the unit trust as a result of the trustee not having to pay interest on the loan from the private company.

The test in new paragraph 273(7)(b) would be satisfied.

The income derived by the superannuation fund will be treated as special income.

62. The mischief at which both s 273(6) and (7) ITAA 1936 were evidently aimed is the movement of assessable income, which would otherwise be taxed at the rate of 47% in the hands of the person who derived it, into a CSF by the mere exercise of a discretion (in the case of a discretionary trust) or by non-arm's length dealing in the case of a fixed trust entitlement. On the taxpayers' behalf it was suggested, by reference to the examples given in the Explanatory Memorandum, that the mischief targeted by s 273(7) was limited to the distribution of assets at an undervalue. But s 273(6) is clearly aimed at a wider target, and there is no reason to think that s 273(7) was more limited in its scope. And, of course, s 273(7) is not expressed in terms confined to the distribution of assets at an undervalue. It would be to attribute to the legislature an absurd inconsistency of intention in seeking to catch transfers of assets at modest undervalues while saying nothing about transfers for no value at all.

63. The taxpayers also argue that the Explanatory Memorandum does not assist the Commissioner's argument that assessable income is referred to in s 273(7). Rather, the taxpayers argue that the Explanatory Memorandum highlights that the legislature must have been aware of the difference between assessable income and income simpliciter, and chose not to use the expression "assessable income". The taxpayers thus try to make a virtue of necessity by arguing that cll 2.12 and 2.17 of the Explanatory Memorandum show that the Parliament must be taken to have advisedly decided that s 273(7) should not refer to "assessable income". That argument cannot be accepted.

64. Whatever use one may legitimately make of the Explanatory Memorandum in interpreting s 273(7), it cannot be treated as an indication that the legislature intended to exclude assessable income from the reach of the provision. To accept that view would be to attribute to the legislature an intention to confound the intention suggested by the Explanatory Memorandum. A more compelling explanation for the difference in language between the Explanatory Memorandum and s 273(7) is that the drafter of s 273(7) proceeded on the assumption that to speak of income in s 273(7) in the context of the existing legislative scheme was necessarily to speak of assessable income.

An arrangement

65. The taxpayers say that there was relevantly no arrangement for the purposes of s 237(7) because there was no arrangement involving more than one party. The taxpayers say that there was an arrangement of sorts but it was only a series of unilateral steps by Mr Allen. They argue, it seems, that it does not matter that, both at the time the trust structures that facilitated the making of the distribution were put in place, or at the time when Mr Allen caused the distribution to be effected from the Hybrid Trust to the Fixed Trust to the Super Fund, Mr Allen was acting as the director of the trustee of the Hybrid Trust, as director of the Fixed Trust, and as a trustee of the Super Fund. This is a remarkable submission; it cannot be accepted. It could be accepted only if one were to ignore the separate legal personality of the corporate trustees involved and treat as shams the carefully orchestrated series of trust structures and sequence of distributions. And that is a course which the taxpayers do not invite the Court to take.

66. The steps undertaken by Mr Allen in directing the trustee of the Hybrid Trust, the trustee of the Fixed Trust and the Super Fund, led to the results that the Super Fund received both a fixed interest in the trust estate of the Fixed Trust and the relevant distribution of income from that trust estate. Each result is readily seen to be the consequence of an "arrangement" to which the various trustees were parties. That is clearly so, given that the creation of the structure and flow of funds was orchestrated in conformity with the legal advice obtained by the taxpayers.

Acquisition of the fixed entitlement

67. Insofar as the Commissioner relied upon the acquisition of the Super Fund's fixed entitlement under the 28 June 2002 amendment to the trust deed of the Fixed Trust for the purpose of fulfilling s 273(7)(a), the taxpayers argue there was no acquisition by the Super Fund because its role was entirely passive.

68. The taxpayers' argument on this point cannot be accepted. Section 273(7)(a) is concerned with the acquisition of fixed entitlement to the income of a trust estate. In any case, where a beneficiary under a declaration of trust obtains an entitlement in respect of the trust estate, the beneficiary need not, and usually will not, play an active role in that acquisition.

Non arm's length dealing

69. The taxpayers' argument under this heading focuses upon only the last step in a series in which Mr Allen was acting as if that last step had to be a transaction involving the Super Fund. That focus is misdirected for a number of reasons. First, s 273(7)(a) ITAA 1936 does not require that "the dealing" consist of the actual derivation of the income in question by "the entity". There is no warrant in the language of s 273(7)(a) to view the steps which culminated in the receipt of the income by the Super Fund in the segmented way urged by the taxpayers. It would be a triumph of form over substance, and contrary to the evident intention of ss 237(7)(b) and 237(8), if regard was not had to the totality of the steps involving the three trusts which occurred at Mr Allen's instigation.

70. Secondly, the taxpayer's contentions that there was no dealing by the Super Fund in relation to the distribution to it because it did not interact with any other party, the Super Fund being merely the passive recipient of the distribution and that some form of transaction is necessary for there to be a dealing in relation to the arrangement, are inconsistent with the language of s 273(7)(a).

71. In this regard, s 273(7)(a) expressly applies to income derived by virtue of a fixed entitlement; where the derivation occurs by virtue of a fixed entitlement the recipient can be expected to "participate" only as a recipient. Further in this regard, in
Grimwade v Federal Commissioner of Taxation (1949) 78 CLR 199 at 220, Latham CJ and Webb J observed: "A transaction by a person must be with some other person". While a transaction requires mutual dealings between parties, s 237(7) refers to dealing, not to a transaction. Indeed, the use of "dealing" in s 273(7)(a) is to be contrasted with the use of "transaction" in s 273(4). In using "dealing" in s 273(7)(a) the Parliament must be taken to have intended to cast a wider net than is necessary to catch only those dealings which answer the description of transaction. And that broader approach is hardly surprising in a measure directed at arrangements where it was to be expected likely that there might be no quid pro quo moving from the recipient party to the others.

72. Thirdly, it may be observed that s 237(7)(a) does not, in truth, require any of the parties actually to deal with each other at all. It is intended to catch distributions in which there has been some non arm's length dealing between the parties. It is not a condition of the operation that there should have been a dealing by the recipient of the distribution. In any event, there were active steps taken by the trustee of the Hybrid Trust and the trustee of the Fixed Trust to effect the flow of money through the trusts to the Super Fund.

73. And finally, the Super Fund's role was not entirely passive. It was the recipient of a distribution which it might have disclaimed; but it chose not to do so.

Reasonably arguable

74. The primary judge held that the position taken in the taxpayers' return was "not reasonably arguable", thus upholding the imposition of the penalty by the respondent. In this regard, the primary judge referred to the judgment of Hill J in Walstern at [108] where his Honour suggested the following approach to the application of s 226K of the ITAA 1936, a provision analogous to s 284-75 of the TAA:

"The following conclusions can be drawn as to the correct approach to penalty under s 226K:

  • 1. The test to be applied is objective, not subjective. This is clear from the use of the words 'it would be concluded' in para(1)(b) of the section;
  • 2. The decision-maker considering the penalty must first determine what the argument is which supports the taxpayer's claim;
  • 3. That person will already have formed the view that the claim is wrong, otherwise the issue of penalty could not have arisen. Hence the decision-maker at this point will need to compare the taxpayer's argument with the argument which is considered to be the correct argument;
  • 4. The decision-maker must then determine whether the taxpayer's argument, although considered wrong, is about as likely as not correct, when regard is had to 'the authorities';
  • 5. It is not necessary that the decision-maker form the view that the taxpayer's argument in an objective sense is more likely to be right than wrong. That this is so follows from the fact that tax has already been short paid, that is to say the premise against which the question is raised for decision is that the taxpayer's argument has already been found to be wrong. Nor can it be necessary that the decision-maker form the view that it is just as likely that the taxpayer's argument is correct as the argument which the decision-maker considers to be the correct argument for the decision-maker has already formed the view that the taxpayer's argument is wrong. The standard is not as high as that. The word 'about' indicates the need for balancing the two arguments, with the consequence that there must be room for it to be argued which of the two positions is correct so that on balance the taxpayer's argument can objectively be said to be one that while wrong could be argued on rational grounds to be right;
  • 6. An argument could not be as likely as not correct if there is a failure on the part of the taxpayer to take reasonable care. Hence the argument must clearly be one where, in making it, the taxpayer has exercised reasonable care. However, mere reasonable care will not be enough for the argument of the taxpayer must be such as, objectively, to be 'about as likely as not correct' when regard is to be had to the material constituting 'the authorities'; and
  • 7. Subject to what has been said the view advanced by the taxpayer must be one where objectively it would be concluded that having regard to the material included within the definition of 'authority' a reasoned argument can be made which argument when contrasted with the argument which is accepted as correct is about as likely as not correct. That is to say the two arguments, namely, that which is advanced by the taxpayer and that which reflects the correct view will be finely balanced. The case must thus be one where reasonable minds could differ as to which view, that of the taxpayer or that ultimately adopted by the Commissioner was correct. There must, in other words, be room for a real and rational difference of opinion between the two views such that while the taxpayer's view is ultimately seen to be wrong it is nevertheless 'about' as likely to be correct as the correct view. A question of judgment is involved."

75. In
Cameron Brae Pty Ltd v Federal Commissioner of Taxation 2007 ATC 4936 ; (2007) 161 FCR 468 at [70] (Cameron Brae) Stone and Perram JJ concluded that, even though they considered that the correct view was "clear", the question was "open to debate in the sense of being arguable". The approach taken by Stone and Perram JJ in Cameron Brae, with which we respectfully agree, is somewhat less strict than that suggested by Hill J in Walstern. On the approach in Cameron Brae, while a Court may come to a clear view on a question of statutory construction adverse to a taxpayer, that view is not decisive against the conclusion that the taxpayer's position was reasonably arguable.

76. Their Honours in Cameron Brae at [70] further treated as relevant the circumstance that "no authority squarely covered" the question of statutory construction on which the case turned and that the proper interpretation of the legislation in question depended upon "a full appreciation of the statutory history".

77. The present case, like Cameron Brae, and in contrast to Walstern, turns on questions of statutory construction. Walstern was a case where the erroneous position advanced in a taxpayer's return was founded upon an unreasonable view of, or a disregard for, the facts. See Walstern at [113].

78. In this case, as in Cameron Brae, the questions of statutory construction on which the case turns were free from authority squarely covering the point. And as our reasons on the substantive issues show, the taxpayers' position was debatable. There is another consideration which is relevant here.

79. It should, we think, be borne in mind is that the legislature itself considered that the taxpayers' position was sufficiently arguable to warrant the replacement of s 273(7) of the ITAA 1936 by subdivision 295H of the ITAA 1997. That the legislature considered it prudent to shore up the Commissioner's position in this way gives the Commissioner's insistence that the outcome of the present case was clear beyond rational argument a somewhat pharisaical quality.

80. This consideration was not adverted to by the primary judge. Together with the considerations referred to in Cameron Brae, it supports the conclusion that the position adopted by the taxpayers was reasonably arguable. In our respectful opinion, her Honour erred in failing to conclude that the position adopted by the taxpayers in their income tax returns was reasonably arguable.

81. We should make it clear that if the taxpayers' arguments had been confined to the arguments about arrangements, acquisition, dealings and undervalue, we would not have reached this view; but the resolution of the argument as to the scope of "income" in s 273(7) required a close examination of the statutory context in which the provision was to be interpreted. There was room for a real and rational difference of opinion on this question. Having regard to the heavily disadvantageous consequences for the taxpayers of supine acquiescence in the view that "income" in s 273(7) of the ITAA 1936 did indeed mean assessable income, and the availability of rational grounds for resisting those consequences, we are satisfied their position was reasonably arguable.

Conclusion and orders

82. We would allow the taxpayers' appeal on the question of penalty only. We would set aside the penalty assessment dated 15 November 2006.

83. Because interest was charged by the Commissioner on the amount of the penalty, we would also order the Commissioner to recalculate the general interest charge.

84. In order to recognise the balance of success on the appeal, we would order that the taxpayers pay three-quarters of the Commissioner's costs of the appeal to be taxed.

 

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