Alloyweld Pty. Ltd. v. Federal Commission of Taxation.

Judges:
Derrington J

Court:
Supreme Court of Queensland

Judgment date: Judgment handed down 15 May 1984.

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Derrington J.

The appellant taxpayer is a proprietary company of whom the directors and shareholders are Mr. and Mrs. Marl, the former being the managing director and agent and no doubt the mind of the company for all relevant purposes.

On 13 April 1978 after a conversation with the appellant's accountant, Mr. Habermann, Mr. Marl went to the latter's office for a discussion with a Mr. John Shaw of Rockhampton who was an entrepreneur of tax-avoidance schemes. It is admitted that the discussion was designed to set up such a scheme. In evidence Mr. Marl suggested that at one stage in the discussion he believed that the scheme would provide a loan to the appellant, which would have been useful for its business, but he admitted that his mind was disabused of this misconception by the time he signed the relevant cheques at the bank in the course of executing the arrangement. That was the only suggested qualification to the proposition that the scheme was purely for the purpose of tax avoidance.

Commonly known as the ``pre-paid interest scheme'', it worked in this way:

• 1. Mr. Shaw's company, Rangeland Credits Pty. Ltd. (``Rangeland''), agreed to lend to the appellant the sum of $40,000 repayable 30 years later, and unsecured.
• 2. Interest was generally set at 14% per annum payable quarterly in advance, but subject to a number of options. Those options were to be exercised within 24 hours of the signing of the loan agreement. The option adopted by the appellant by pre-arrangement was the payment of five years interest in advance at the rate of 14% whereupon the interest for the balance of the term would be 4% per annum payable quarterly in advance.
• 3. Immediately thereafter, for $14,520 Rangeland executed an assignment of the debt to Mr. Marl who gave notice of the assignment to the appellant.
• 4. The form of application for a loan, particulars of the proposed loan, loan agreement, notification of election to pre-pay interest, deed of assignment of the debt and notice of the assignment were all executed at the same time by the respective parties at the same time by the respective parties at the accountant's office before they went to the appellant's bank where the passing of funds then occurred.
• 5. By prearrangement with the appellant's bank as part of an express tax-avoidance scheme, the following arrangements took place at that bank:
  • (a) Although the appellant had a fully drawn loan account of $25,000 and a working account which was in overdraft for about $8,400 (``the No. 1 Account''), a fresh account was opened (``the No. 2 Account'') in which was deposited the $40,000 provided by Rangeland.
  • (b) At the same time, the bank provided the appellant with $28,100 against a bridging loan account, and a bank cheque for that sum was immediately handed to Mr. Shaw. Under the scheme this was to represent the prepayment of interest.

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    ATC 4330

  • (c) At the same time the bank advanced Mr. Marl the sum of $14,520 against a personal bridging loan account, and a bank cheque for that sum was also immediately handed to Mr. Shaw. Under the scheme this was to represent the payment of the purchase price for the assignment of the loan.
• 6. The No. 2 Account was thereafter used by the appellant as a running business account for the payment of business expenses, but no deposits were made in that account. Rather they were made into the No. 1 Account which permitted a build up of credit in that account. By 20 June 1978, the No. 2 Account was in debt to the extent of $2,883.46.
• 7. On 7 June 1978, on being supplemented by $10,000 from a personal savings bank investment account of Mr. and Mrs. Marl, the No. 1 Account of the appellant provided $28,100 in payment out of the appellant's bridging loan account. No interest or bank charges appear to have been made against the bridging loan account by the bank.
• 8. On 4 July 1978 the No. 1 Account also paid the sum of $14,607.60 in full payment of the bridging loan account of Mr. Marl with the bank. In that latter account, the overdraft application fee was charged against the ordinary general account of the appellant, and there were no other bank or interest charges against the bridging loan account.
• 9. On 4 July 1978 the No. 1 Account by transfer of funds also liquidated the debit of $2,883.46 in the No. 2 Account. The only bank charges against that latter account were two reference charges of $2 each and a small amount of interest, presumably on the overdrawn sum.
• 10. Although the loan from Mr. Marl was shown in the balance sheet of the appellant for the year ending 30 June 1978, and although more than five years have passed since the prepayment of the first five years' interest, no dealings have occurred in connection with the loan, and more particularly no further interest has been paid or demanded.

Supplementary to this catalogue, a few added words of explanation are necessary. First, although Rangeland provided $40,000, it immediately received back $28,100 representing the prepayment of interest, and $14,520 representing the purchase price for the assignment of the land. The total figure of $42,620 represents an increase of $2,620 which is acknowledged by Mr. Marl to be Mr. Shaw's fee for arranging the scheme. Secondly, recognising that both Mr. Marl and the bank lent themselves to the scheme, there was in reality nothing more than the shuffling of the same money through various accounts after the $40,000 was paid in by Rangeland and immediately paid back out to it. Thirdly, there are two loose ends. The debt and some interest are still theoretically due by the appellant to Mr. Marl, and there is the question of the nature of the payment of $14,607.60 by the appellant in liquidation of Mr. Marl's bridging loan on 4 July 1978. It may be that they were intended to cancel each other out but that the formalities were not complied with; but it is of little importance.

I find that there was no real substance behind the transactions constituting this contrivance. Rangeland merely provided the initial funds exclusively for the purposes of a tax-avoidance scheme, expecting that it would immediately be refunded the sum provided by way of bank cheques which included an added sum by way of fees for setting up the transaction. The arrangements with the bank were expressly made to promote a tax-avoidance scheme and the bank's position was de facto, completely unaltered by the arrangement. Mr. Marl who, with his wife, was the owner of the company and manipulated their respective funds freely, regarded the arrangement as not really being a loan at all and did not consider the company to be under any obligation other than to complete the circularity of the transaction in time. This it did by liquidating his bridging loan shortly after the end of that financial year. Subject to that, he had no real intention or expectation of entering into the relationship of lender/borrower with the appellant save to the extent of presenting that appearance for the scheme and having that appearance dutifully recorded in the appellant's accounts for presentation in support of the claim for a deduction. Had there been any durable paper result in the financial relationship between Mr. Marl and the company, which I doubt, that had no real consequence for either of them. Having said that, I would add that Mr. Marl was for the most part open and credible and was

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ATC 4331

obviously led, though not unwillingly, into this arrangement.

To the extent necessary, I find that there was a sham and in doing so apply the test enunciated by Diplock L.J. in
Snook v. London & West Riding Investments Ltd. (1967) 2 Q.B. 786 at p. 802, approved by Lord Fraser of Tullybelton in
W.T. Ramsay Ltd. v. I.R. Commrs. (1982) A.C. 300 at p. 337:

``It means acts done or documents executed by the parties to the `sham' which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create.''

Further, if necessary I have no hesitation in finding that the arrangement with the bank was a sham to avoid the position where the payment would be made out of the same account that received the moneys from Rangeland. But it is probably unnecessary to go that far for in circumstances such as these it is legitimate on this question to look at the appellant's funds in that bank as a whole and perhaps even the funds in his hands, wherever they may be, as a whole. Any failure on my part to refer to funds which he knows to be available to him under such an artifical scheme does not imply that they are excluded from this principle, nor does
Rabinov's case [83 ATC 4437] say so.

Pursuant to authority elsewhere, the appellant has abandoned its appeal against the disallowance by the Commissioner of the claim for prepaid interest. The appeal is now limited to the imposition by the Commissioner of an additional tax of one-half of the tax payable in respect of the deduction which was disallowed. The appeal goes not to quantum, for the Commissioner in his discretion could have charged twice the amount of taxation involved, but to his power to charge the additional tax at all. In its state at the relevant time, sec. 226(2) read, in part:

``Any taxpayer who... includes in his return as a deduction for... expenditure incurred by him an amount in excess of the expenditure actually incurred by him, shall be liable to pay as additional tax an amount equal to double the difference between the tax properly payable by him and the tax that would be payable if it were assessed upon the basis of the return furnished by him...''

The ground of appeal is that the sum claimed by way of prepayment of interest was expenditure actually incurred by the appellant and so its inclusion in his return does not come within the description of the occasion of liability to additional tax contained in the section. That, it is argued, is limited to the occasion when a deduction is claimed for a sum which has not actually been expended, and the section does not apply to the case where actual expenditure has been wrongly claimed or characterised as a deduction. The Commissioner's reply is that because there was, apart from Mr. Shaw's fee, no cost to the appellant at all in the transaction, and because the money was in fact paid out of a sum already received as part of the scheme, there was no expenditure at all incurred by the appellant. Further or alternatively, he argues that the arrangement is a sham or a fiscal nullity. Finally, he claims that even if the appellant had incurred the expenditure, the additional tax is payable under this section because it was wrongly claimed or characterised as a deduction in the return; but it is acknowledged that this argument is contrary to the decision in
F.C. of T. v. Rabinov & Anor. 83 ATC 4437, a decision of the Full Court of the Federal Court by which I am bound, and the argument is reserved for another place.

It is in respect of the second issue in Rabinov's case that the Commissioner claims to succeed here, i.e. whether the payment ``can be truly described as `expenditure actually incurred' by the taxpayer''. Although that question was answered in the affirmative in Rabinov's case and its predecessors, the Commissioner points to the reasons expressed in those cases and says that because the criteria relied on there are not present here, the reverse result should follow. It does not necessarily follow, but of course the absence of those criteria may well have considerable weight in the overall assessment of the point. The argument relies upon the facts that this is not said to be other than a tax-avoidance scheme, that Mr. Marl acknowledged to the taxation investigator that there was no real loan at all, and that the payment of what was referred to as prepaid interest was not paid from any separate fund or in advance of receipt of the moneys provided by Rangeland, but on the contrary was

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ATC 4332

in substance only paid out of moneys received in advance under the scheme.

In Rabinov's case, the artificiality of the contrived scheme was recognised, but in its joint judgment the Full Federal Court made the points that the taxpayer was not a party to nor at all relevant times aware of the transactions constituting the scheme, and that the payment made by the taxpayer pursuant to the scheme and which was claimed as a deduction, was made prior to the payment to him of a broadly equivalent sum. At p. 4441, the judgment reads:

``In our view, the agreement that each taxpayer made with Baldon, though part of an overall scheme that failed to achieve its purpose of making a tax free gift to the fund, cannot operate to destroy the effect of what otherwise was expenditure actually incurred by each taxpayer. As already pointed out, the taxpayers did not use the loan money in order to make payments to the fund. The money paid by Baldon into the account of each taxpayer was paid subsequent to the payment of money to the fund and, as acknowledged by the Commissioner, each loan is still outstanding.

Counsel for the Commissioner agreed that if the taxpayers had borrowed money from their bank to make the payments to the fund it could not be said that they had not actually incurred the expenditure in question. But, it was said, the agreement with Baldon somehow had that consequence. On what basis it could have that consequence was not satisfactorily explained, particularly when each taxpayer made payment of $25,000 to the fund before entering into the agreement with Baldon and, of course, before receiving the loan from the company.''

Whilst it is far from unknown that interest and other loan charges be paid immediately from loan funds received, in view of the fact which I find that this was nothing other than a contrived and artificial scheme to avoid taxation, there is considerable logical force in the proposition that, as the payment out by the appellant was made from funds which were advanced to it for that express purpose as part of the scheme, it could not be truly said that there was any expenditure by it at all. Further, by reason of the contrived nature of the arrangement, there is no substantial effect by reason of the difference of accounts in the same bank used for money received and that paid out. In each step of reasoning, it is wrong to read the particular facts out of their true context.

The payment by the appellant of an actual sum of money, as represented by the bank cheque, would ordinarily amount to expenditure, but when it is simply paid out as part of a scheme from a sum already received and not as a bona fide payment of what it purports to be, it is not entitled to that status. There was no use by the appellant of its own money as distinct from that already provided, nor any incurring of liability. The argument for the appellant that the bank cheque represented real money to the bank misses the point, for the bank did not pay the money on its own account but debited that sum against the appellant, having already received his deposit of a larger sum into another account as the result of prearrangement. In any case, it is not the bank's payment under its cheque which is relevant, but the expenditure claimed to have been made by the appellant from his resources. To this end it is not in point to say that the payment by the bank was not a sham, for the sham relates to the issue of expenditure by the taxpayer, and a real payment by the bank is equivocal in relation to that.

The appellant argues that the questions of sham and fiscal nullity are irrelevant and that the only question is whether there was an expenditure; and that the payment by it of real money in the form of a bank cheque means that it cannot be said that expenditure did not take place. Although an entrepreneur dresses it up with real money, a purported expenditure can still be a sham so that there is really no expenditure at all, particularly if it comes, in effect, from moneys supplied for that purpose. The Court is not expected to lend self-deception to the tax-avoidance industry. I deprecate the suggestion that the mere handing over of real moneys is necessarily expenditure.

Presumably this was implicitly recognised by the Full Court of the Federal Court in Rabinov's case as the foundation of its ratiocination. The point was made that though an artificial arrangement may have existed otherwise, the payment was a real payment and not a sham and it was expenditure. That Court did not decide that a payment of actual moneys could not also be a sham of an expenditure. Nor even did it decide that, if the payment of money were made by the taxpayer out of moneys received by it, all

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ATC 4333

as part of an artificial arrangement, it would necessitate a finding of sham before the term, expenditure, could be denied to the payment. By its very nature, a payment out of moneys received for that purpose, which is intended to form a payment merely for use in a tax-avoidance scheme, simply is not an expenditure. The appellant's contention that we are not concerned with the quality of the payment is wrong, for its quality goes to whether it was (a) expenditure and (b) real expenditure.

In coming to the conclusion that the purpose of the payment was only to set up a payment for a tax-avoidance scheme, I do not overlook that the legal form of the payment is as one for prepayment of interest. Nor do I neglect the principle in the Duke of
Westminister's case (1936) A.C. 1 (H.L.) that if the steps of a scheme are genuine the Court must accept their legal effect and not the scheme behind them. But I also take note of the statement of Lord Wilberforce in W.T. Ramsay v. I.R. Commrs. (1982) A.C. at pp. 323-324 where he said:

``Given that a document or transaction is genuine, the court cannot go behind it to some supposed underlying substance. This is the well-known principle of
I.R. Commrs. v. Duke of Westminster (1936) A.C. 1. This is a cardinal principle but it must not be overstated or overextended. While obliging the court to accept documents or transactions, found to be genuine, as such, it does not compel the court to look at a document or a transaction in blinkers, isolated from any context to which it properly belongs. If it can be seen that a document or transaction was intended to have effect as part of a nexus or series of transactions, or as an ingredient of a wider transaction intended as a whole, there is nothing in the doctrine to prevent form to substance, or substance to form. It is the task of the court to ascertain the legal nature of any transaction to which it is sought to attach a tax or a tax consequence and if that emerges from a series or combination of transactions, intended to operate as such, it is that series or combination which may be regarded. For this there is authority in the law relating to income tax and capital gains tax: see
Chinn v. Hochstrasser (1981) A.C. 533 and
I.R. Commrs. v. Plummer (1980) A.C. 896.''

When the classification of the payment as an expenditure or otherwise is undertaken, the real basis upon which the money is paid over must surely be a determining factor. The pursuit of the answer to this simple aspect of construction is not beset by the complexities of other routes. If the payment is made out of funds already received, in effect, and is made as part of an artificial arrangement for prepayment for interest but with the real intention of merely setting up a payment for tax avoidance, was it an expenditure? That is the question. The answer is that upon the proper construction of the expression, the facts indicate that it was not. And so, many facts such as the use of real money and the intervention into the transaction of the supposed stranger in the form of Mr. Marl to whom the debt is still allegedly due are of little or no relevance, after the above determination of fact.

Reference was also made by the appellant to
Cyprus Mines Corporation v. F.C. of T., 78 ATC 4468 which was relied upon by Jenkinson J. at first instance in Robinov's case. However, in the former, there was no question but that there was expenditure actually incurred and the issue was whether the additional tax could be levied because of the incorrect charcterisation by the taxpayer of the expenditure as a deductible item. Those references afford me no assistance either way on the present question.

I restrain myself from discussing the subject of fiscal nullity which it is now unnecessary to consider.

The appeal is dismissed with costs.