Ferris v. Federal Commissioner of Taxation

Judges:
Davies J

Court:
Federal Court

Judgment date: Judgment handed down 16 September 1988.

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Davies J.

This appeal arises from the partial disallowance of an objection lodged by the applicant, William Duncan Ferris, with respect to an amended assessment issued with respect to his income for the year ended 30 June 1984. The notice of amended assessment, issued on 30 May 1985, exercised the discretion conferred by sec. 109 of the Income Tax Assessment Act (Cth) (``the Act'') and included in Mr Ferris's assessable income the whole of a retiring allowance of $270,000, paid to him by his employer International Venture Corporation Ltd. (``IVC''). A further amended assessment, which issued on 6 March 1986, also exercised the discretion conferred by sec. 109 and treated $78,000 of the $270,000 as a retiring allowance assessable under sec. 27C of the Act and the balance as a dividend assessable under sec. 44(1) of the Act.

Section 109 of the Act, prior to amendment by Act No. 108 of 1987, read:

``So much of a sum paid or credited by a private company to a person who is or has been a shareholder or director of the company or a relative of a shareholder or director, being, or purporting to be -

• (a) remuneration for services rendered by that person; or
• (b) an allowance, gratuity or compensation in consequence of the retirement of that person from an office or employment held by him in that company, or upon the termination of any such office or employment.

as exceeds an amount which, in the opinion of the Commissioner, is reasonable, shall not be an allowable deduction and shall, for the purposes of this Act other than the purposes of Division 11A of Part III and Division 4 of Part VI, be deemed to be a dividend paid by the company on the last day of the year of income of the company in which the sum is paid or credited.''

This provision, in a slightly different form, was introduced into the previous Act to apply to income derived during the year ended 30 June 1934 and thereafter. It was introduced at a time when income from personal exertion was taxed at a lesser rate than income from property and also at a time when taxation authorities were concerned to ensure that a deduction was not obtained by a company for a payment that was, in reality, a payment made out of profits. In
Moreau v. F.C. of T. (1926) R. & McG. 84, Isaacs J. had held that a bonus paid by a company to its governing director, who was also the controlling shareholder, was a distribution made by the company out of its profits to its preponderating shareholder who had the power to demand and to obtain and was therefore a dividend. In
Aspro Limited v. Commr of Taxes (N.Z.) (1932) A.C. 683, the Judicial Committee had held that an assessment disallowing as a deduction for past remuneration a part of the sum paid by a company to its directors who were also the sole shareholders had not been incorrect. In
Overy v. Ashford Dunn & Co. Ltd. (1933) 17 T.C. 497, three directors of a company who owned all the shares in the company had sold those shares to another entity and had vacated their offices as directors. Immediately prior to the sale of the shares the company had resolved to repay the retiring directors compensation for loss of office, which compensation, together with remuneration to be paid to them, absorbed the whole of the profits of the company and up to the date of the sale. It was held that the payment was a distribution of the company's profits. In
Robert G. Nall Ltd. v. F.C. of T. (1936-1937) 57 C.L.R. 695, an appeal failed against the allowance by the Commissioner as a deduction of part only of the remuneration paid to the governing director of the company, all the shares of which were allotted to members of his family.

It was with such considerations in mind that sec. 109 and its concomitant sec. 108 found their place in Div. 7 of Pt III, a division dealing with the distributable income of a company and with its dividends. As Fisher J. said in
F.C. of T. v. Comber 86 ATC 4171 at p. 4176:

``As previously mentioned, sec. 109 appears in Div. 7 of Pt III of the Act, a Division which applies exclusively to private companies. The purpose of the provisions in the Division is to place additional obligations on private companies. These obligations, and in particular the flat rate of tax imposed by subsec. 104(1), discourage private companies from refraining from distributing income which if received by an individual shareholder would be assessable to tax at his or her personal rate. If such provisions were not included in the Act a taxpayer could transfer his

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ATC 4758

business or his investments to a private company, which company would only be liable to primary tax on its taxable income. The shareholders would be taxable, if at all, only on such of the profits of the company as the directors considered appropriate to distribute by way of dividends. To counter this method of tax minimisation the legislature imposed a flat rate of tax (50c in the dollar) on the undistributed profits of private companies, thereby encouraging if not compelling them to make what was determined to be a sufficient distribution of their profits to their shareholders.

This being the purpose and effect of Div. 7 of Part III of the Act, it provides the context in which it is proper to construe sec. 109.

Both sec. 108 and 109 are provisions protective of the purpose and effect of Pt III and in each of them the statutory fiction of a deemed dividend is employed to implement that purpose and that effect. Each, in general terms, seeks to ensure that the profits of private companies are not reduced by loans or payments of excessive remuneration or retiring allowances to shareholders, directors or others close to these persons...''

Section 109 first provided that so much of the remuneration or payment on retirement as exceeded an amount which in the opinion of the Commissioner was reasonable should not be an allowable deduction and that the excess should be deemed to be a dividend paid out of profits derived by the company to the recipient and received by him as a shareholder of the company. Section 109 was amended by sec. 17 of Act No. 90 of 1952 so as to apply to a payment to a person ``who is or has been a shareholder or director of the company or a relative of the shareholder or director''. The section deemed the excess to be a dividend paid by the company on the last day of the year of income of the company in which the sum was paid or credited. Perhaps inadvertently, the new provision omitted the provision that the payment be deemed to have been ``received by him as a shareholder of the company'', an omission leading to the decision in F.C. of T. v. Comber, cited above, in which it was held that a payment to which sec. 109 applied which was made to a person who was not a shareholder of the company was not assessable in his hands as a dividend as only a dividend paid to a shareholder was so assessable.

Because of the mischief with which sec. 109 was designed to deal and the context in which it appears in the Act, review tribunals have been less inclined to disallow a payment made by a company which had a board of directors independent of the recipient and in the circumstance that the recipient has no significant shareholding or shareholding control than has been the case where the directors and the recipient have had the same or related interests. I need mention only three cases of the former character. In Case 95,
10 C.T.B.R. (O.S.) 611, a Board allowed the full amount paid to a managing director and to the chairman of directors, both of whom had negotiated certain remuneration and who were at arm's length from the shareholders and unable to assert any claim by virtue of shareholding interests. At p. 613 the Board said:

``In view of the Aspro case the purpose of s. 109 is fairly obvious. Where, as in that case, the source, method and destination of a payment by a private company to its shareholders is the same whether the payment is remuneration or a dividend, and the sole consequence of its being remuneration is a reduction of the liabilities of the company and the shareholders to income tax, there must always be an incentive to pay dividends in the disguise of remuneration. The revenue being the only potential sufferer from the differentiation (for as the Aspro case shows, the creation of the prima facie constitutive facts is in the hands of the shareholders concerned), it was only natural for the legislature to enact that the amount to be treated as remuneration in any such case should be left to the opinion of the Commissioner. Although the application of s. 109 extends beyond the extreme case (such as Aspro's) it is nevertheless limited to cases in which some or all of the potentialities of that case are capable of realization.''

In Case 89,
12 C.T.B.R. (O.S.) 635, a Board of Review upheld a company's claim to a deduction of the full remuneration paid. The Board said at p. 640:

``32. As the Board has pointed out on many occasions, the question of what is reasonable remuneration must primarily

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ATC 4759

depend on the value (to the company concerned) of the services rendered. In arriving at an opinion on this matter for the purposes of s. 109, considerable difficulty is sometimes experienced because directors are not infrequently the largest shareholders. But where, as in this case, the value of the directors' services is determined by an independent controlling body of shareholders residing abroad, it would require strong evidence to convince us that they were not the best judges of what should be paid, and we should find it exceedingly hard to believe that they agreed to pay more than they thought the services were worth.''

More recently, in Case T43,
86 ATC 356, a majority of a Board of Review upheld the deduction of the full amount of a retiring allowance paid. At pp. 364-365, Mr P.M. Roach said:

``9. Although those decisions established that the policy of the Division has been less effectively enacted than it might have been, in my view the decisions do not alter the policy objective of the Parliament whereby sec. 109 was intended to prevent a company from unreasonably reducing its taxable income by making excessive payments to members and related persons in the guise of remuneration for services or retiring allowances.

...

11. Despite that recognition of an `infinite variety of circumstances', none the less in this particular instance the Commissioner disallowed the claim as a result of calculations directly applying the guidelines and without having regard to other relevant matters such as the statutory definition call for. I am of opinion that that approach was too narrow. It ignored the following facts which I find (a) that all of the directors who were party to the decision-making (that is excluding the Australian manager) including, in particular, the directors from the United Kingdom acting with the authority of the board of the holding company thought that it was reasonable to pay $100,000 to the Australian manager upon his retirement in recognition of his past services; (b) that the Australian manager had no influence on that decision; (c) that the Australian manager had no material capacity to influence that decision; (d) that the amount was not paid, nor was its quantum influenced by, the circumstance that the Australian manager was a minor shareholder in the holding company; (e) that the payment was not influenced by any desire on the part of the company to `distribute profits' to a member otherwise than by way of dividend; (f) that the retiring allowance was no greater or less than it would have been had the Australian manager served the company without having been formally appointed a director of the Australian company; (g) that the amount of the retiring allowance was no greater and no less than it would have been had the Australian manager not been a shareholder in the holding company.

...

13. What sec. 109 does is to rank as unreasonable any amount paid by way of a retiring allowance if in the opinion of the Commissioner it exceeds a reasonable retiring allowance, the consequence being that then to the extent of the excess it is like to a distribution of accumulated earnings. When one takes into account all of the circumstances operating here and recognising (as I have found) that the amount paid to the Australian manager was not influenced by his status at any time as a director of the Australian company or as a member of the English company then I am satisfied that what was spent was reasonably spent and that no part of the amount so spent `exceeds an amount which, in the opinion of the (Board), is reasonable...'.''

The provisions of the Act which provide for a deduction with respect to retiring allowances paid to officers and employees, sec. 51(1) and 78(1)(c) do not prescribe as a criterion for deductibility that the sum paid should be a sum which in the opinion of the Commissioner is reasonable. The test laid down by sec. 78(1)(c), the relevant provision in this case, is that the sum be ``in the opinion of the Commissioner... paid in good faith in consideration of the past services of the employee in any business operations which were carried on by the taxpayer for the purpose of gaining or producing assessable income''. Section 109 applies in relation to a payment by way of remuneration or retiring allowance inter alia to a person who is or has been a director and

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ATC 4760

authorises the Commissioner to disallow any part of the sum ``as exceeds an amount which, in the opinion of the Commissioner, is reasonable''. This provision must be construed and applied having regard to the context in which it appears.

Section 109 is concerned with the payment of sums which are so high as to amount to a diversion to remuneration or retiring allowance of profits that ought to have been retained by a company and taxed as such or distributed and taxed on their distribution as dividends. Necessarily, the mischief which the section is designed to prevent is most clearly seen in those instances where the recipient of the payment is a shareholder or is related to a shareholder, particularly in those cases where the recipient of the payment has sufficient influence by virtue of his shareholding or of the shareholding of a related person to influence or direct the destination to which profits of the company will be put.

Section 109 requires for its operation a decision by the Commissioner that a sum paid or a part of a sum paid was unreasonable in amount. In a simple case where a sum is paid by a company to directors who are also the shareholders in the company or are closely associated to shareholders in the company, the Commissioner may readily form his own view as to whether the sum paid was a fair payment by way of remuneration or retiring allowance, for if the sum were not paid as remuneration or retiring allowance it would nevertheless enure to the benefit of the directors or their associated shareholders by virtue of being retained or distributed as profits of the company. However, when remuneration is paid to a director who has no or no significant shareholding in the company and the payment is made in good faith by directors who are independent of the recipient, on what basis is the Commissioner to decide that the sum paid is unreasonable? Clearly, if the sum is paid, it must be paid by way of remuneration or retiring allowance for the director has no shareholding interest which would justify it. A decision that the sum paid was unreasonable may involve a view that the recipient ought not to have received the sum in any form from the company.

This point highlights the difference between the Commissioner's function under sec. 23F of the Act, particularly his function under sec. 23F(2)(h), and his function under sec. 109. A superannuation fund to which sec. 23F applies is a fund which is subject to the many detailed controls provided by the section including the discretion conferred upon the Commissioner by sec. 23F(2)(h) which, in the year with which we are concerned, read:

``(2) Subject to the succeeding provisions of this section, this section applies, in relation to a year of income, to a superannuation fund, not being a fund of a kind referred to in paragraph 23(jaa) if -

• ...
• (h) the benefits that any employee has, or the dependants of any employee have, the right to receive from the fund are not excessive in amount having regard to -
  • (i) the remuneration paid to the employee for services rendered by him to his employer;
  • (ii) the period of the service rendered by the employee to his employer;
  • (iii) the benefits, pensions and allowances that have been, are being or may be provided for the employee or his dependants from any other fund to which this section applies in relation to the year of income or has applied in relation to a previous year of income; and
  • (iv) any other matters that the Commissioner considers relevant;
  • ...''

A sec. 23F fund must be ``an indefinitely continuing fund'' established to provide superannuation and other approved benefits to employees. The income of a fund which meets the criteria of sec. 23F has a special exemption from taxation. See sec. 23F(12).

In the context, the Commissioner has an ongoing function to ensure that the overall level of a sec. 23F fund is not excessive having regard to the aim of the fund to provide proper superannuation and other approved benefits to employees and that a payment made out of the fund to any one employee or former employee is likewise not excessive. It is the propriety of the fund as a fund providing proper superannuation and like benefits to employees that is the rationale for the exemption from the ordinary taxation provisions.

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ATC 4761

In this context, the development by the Commissioner of the standard set out in Taxation Ruling IT 2026, to which I shall later refer in more detail, is clearly appropriate for the Ruling establishes levels of benefits which are fair and proper to employees generally. The Ruling provides a guideline which employers, trustees of superannuation funds and officers of the Taxation Office may follow in their administration of matters relating to sec. 23F funds. See the remarks of Brennan J. in
Re Drake and Minister for Immigration and Ethnic Affairs (No. 2) (1979) 2 A.L.D. 634 at p. 639 and Discretionary Powers by D.J. Galligan at p. 147.

In making a decision under sec. 109, the Commissioner may in an appropriate case take into account the standard he has enunciated in Taxation Ruling IT 2026. Particularly will that be the case where the payment would have enured to the benefit of or would have gone to the recipients in any event and the sole question is whether it ought to have gone by way of remuneration or retiring allowance on the one hand or by way of profits on the other. But Taxation Ruling IT 2026 will not necessarily be relevant to or, if relevant, will not necessarily carry weight in a sec. 109 determination. The question in sec. 109 is not whether a payment or the amount thereof was excessive having regard to standards laid down by the Commissioner for the administration of sec. 23F superannuation funds but whether in the particular circumstances of the case, the payment by the company to the recipient or its amount was unreasonable. In a case where the payment, if made, should only have been made as remuneration or retiring allowance, then, a decision that the payment or that the amount of the payment was unreasonable may involve a view that the payment or a payment of that amount ought not to have been made by the company to the recipient at all.

The discretion conferred by sec. 109 involves a decision in each particular case as to whether or not a payment or the amount of a payment was in the circumstances of the case reasonable. As the very many reported decisions of Boards of Review and of the Administrative Appeals Tribunal show, the circumstances which come up for consideration are infinitely variable. No standard has been developed specifically for sec. 109 by the very reason of the diversity in the nature and circumstance of payments which may be subject to sec. 109. In such a diversity of circumstances, the development of a standard is scarcely appropriate. When circumstances differ widely, the application of a standard may lead to a failure on the part of the decision maker to make the decision having regard to the facts of the particular case.

I turn now to consider the information that was before officers of the Taxation Office when the subject decisions were taken. Most of this information is described in the affidavit and oral evidence of Miss Chin Wong, who was an assessor in the company's Assessing Section of the Taxation Office. Miss Wong specialised in determinations under sec. 109 of the Act and was the officer who dealt with the objection lodged on Mr Ferris's behalf.

Miss Wong was aware that Mr Ferris and certain other persons had been instrumental in establishing IVC in 1970. This company had been set up to provide capital for new commercial ventures. Mr Ferris became managing director of IVC. The Court was informed that Mr Ferris personally held 26 shares, a negligible number, and that a private company with which he was associated also held some shares. Miss Wong did not refer in her evidence to the shareholding and it may be assumed that she inferred, and I take it correctly inferred, that these shareholdings played no part in the events to be considered.

In 1977, IVC made a major investment in a company known as Barlow Marine Ltd., which specialised in the production of marine winches. Shortly afterwards, this company had financial difficulties and Mr Ferris, although he continued to be remunerated by IVC, spent much of his time attending to its management. During his management, the export business of Barlow Marine and its overall turnover increased markedly. It took over another business in the United Kingdom and developed in that country also. It did the like in the United States of America. Mr Ferris had to live for some time with his family in the United Kingdom developing the interests there and had then moved to the United States to develop the interests in that country before returning with his family to Australia. In 1984, the financial difficulties of Barlow Marine had been overcome and it had developed into a world-wide enterprise. In 1984, Barlow Marine was taken over by a New Zealand company.

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ATC 4762

Mr Ferris's services with IVC were terminated so that he could join the New Zealand company. IVC itself ceased to carry on business as a provider of venture capital. Mr Ferris had had an entitlement under a superannuation fund established by IVC but it appears that there was to be no payment out of that fund as it was worthless.

In 1984, the directors of IVC other than Mr Ferris were Mr B.N. Kelman, who was the general manager and a director of C.S.R. Ltd., Mr David Clarke, who had been the chief executive of the Hill Samuel Group and was with the Macquarie Bank, Mr Ted Vogt, who represented the interests of an American shareholder, Textron Inc., and Mr Rodney O'Neill, who was the chairman of the Hy-Mix concrete and trucking organisation. Those directors thought it proper to make an ex gratia payment to Mr Ferris for his past services. They sought the advice of IVC's solicitors and of Mr D.A. Staff Q.C. A figure of $270,000 was adopted. The basis, if any, for its calculation has not been made clear, the case being put to the Commissioner on the footing that it was a sum determined by a group of experienced directors who were independent of Mr Ferris and well qualified to judge what was reasonable.

Miss Wong adopted the following remuneration for the last three years of Mr Ferris's service:

      1982           $31,280
      1983            41,273
      1984            43,444(projected)
      

which yielded an average salary of $38,665.

In forming her view, Miss Wong had before her a letter from Mr Kelman which contained the following information inter alia:

``2. In determining the retirement benefit of $270,000 the board of directors made reference to various factors as follows:

• (a) The company was entering a voluntary liquidation and Mr Ferris's services had therefore to be terminated prematurely and without reasonable notice.
• (b) Mr Ferris had served as founder of the company and managing director uninterrupted from 7th August 1970 until termination, about 14 years later. In this period, he had pioneered the venture capital investment technique in Australia designed to assist small and developing companies expand by access to risk capital. As events transpired, this proved to be a very difficult investment process, but Mr Ferris stayed with the task to the end.
• (c) The board was aware that the IVC Superannuation Fund was most unlikely to produce any retirement benefit whatsoever for Mr Ferris, for the reasons referred to earlier in this letter.
• (d) The company's largest investment was in Barlow Marine Limited which found itself in severe financial and operating difficulties early in 1977. Mr Ferris, while remaining the managing director of IVC, was seconded to Barlow to try and save it from bankruptcy and hence to salvage IVC's important investment therein.

During Mr Ferris's term with Barlow it was necessary for him and his family to relocate once to the U.K. and once to the U.S.A. This involved considerable hardship on his family (with schooling and other related challenges); Barlow now derives 90% of its revenues from outside Australia; and under Mr Ferris's leadership won the Small Business Award in 1980, the Prince Philip Design Award in 1981, and the National Export Award in 1984.

These efforts by Mr Ferris helped recover IVC's original investment and then greatly enhanced it. Ultimately IVC was able to sell the majority of its holding in Barlow at a very satisfactory price in 1984. The board was mindful of Mr Ferris's performance in determining what it considered a fair and reasonable retiring allowance.

• (e) The Deputy Commissioner's letter of 2nd May 1979 (copy attached) had determined the `reasonable superannuation benefit' at a figure of $270,300. This letter was not qualified in any way.
• (f) The board of IVC was at all times a completely independent group of directors. In addition to Mr Ferris, the board was comprised of myself as Chairman (I am General Manager and a Director of CSR Limited), Mr David

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  ATC 4763

  Clarke (Chief Executive of the Hill Samuel Group - now Macquarie Bank), Mr Ted Vogt (representing the interests of the USA shareholder Textron Inc), Mr Rodney O'Neill (Chairman of the Hy-mix concrete and trucking organisation).

This board was mindful that it represented a diversity of public company shareholders (such as the MLC and Hill Samuel) and private companies and individuals. It was anxious to be correct, and to be seen to be correct, in any retirement determination in respect of Mr Ferris. The board therefore sought the legal counsel of its solicitors and of Mr Doug Staff Q.C. before settling the term and amount of the retirement payment of $270,000.

3. I confirm my comment to you that at all times the board of IVC held the view that Mr Ferris was properly and commercially remunerated.''

The reference in point (e) of the above to a letter from the Deputy Commissioner dated 2 May 1977 was a reference to a figure calculated by the Commissioner for the purposes of the superannuation fund and of sec. 23F of the Act. Miss Wong did not take this figure into account and it appears to be irrelevant.

There was also before Miss Wong a memo of an interview between Mr T. Akhurst, ADC (Assessing) on the one hand and Mr Kelman and Mr Roxburgh, accountant on the other. The following information was set out therein:

``According to Mr Kelman, the amount of the payment was determined by D Staff QC whose decision was said to have been based on such factors as the size of the company, the sale price of its investment in Barlow Marine and amounts paid to Mr Ferris in earlier years....

In seeking a deduction for the retiring gratuity paid, Mr Roxburgh stressed that although IVC was a private company, the shareholders were totally independent of Mr Ferris and there could be no suggestion that the transaction was not at arm's length.''

Miss Wong based her calculations upon the method of calculation stated in Taxation Ruling IT 2026 which was operative on and after 1 July 1982 with respect to contributions to and payments out of superannuation funds. I need not go into the details of the calculation. It has been conceded that Miss Wong applied the method of calculation set out in the Taxation Ruling. The method of her calculation looked to matters such as length of service, amount of salary, age, interest rates and so on. Miss Wong's affidavit discloses her reasoning as follows:

``The calculation set out for the `Balance in Fund-Withdrawal, Lump Sum' method in the Commissioner's ruling IT 2026; a copy of extracts from that ruling are annexed hereto and marked `A'. That calculation yielded a reasonable benefit of $77,795.00 and took into account the following:

• (a) The applicant's year of birth - 1946.
• (b) The applicant's years of service with the company from its incorporation on 7 August 1970 until retirement in 1984 - 14 years.
• (c) The possible years of service had the applicant retired at 65 years - 41 years.
• (d) The applicant's salary from the company for his last three years of service:
  • (i) 1982 - $31,280.00
  • (ii) 1983 - $41,273.00
  • (iii) 1984 - $43,444.00 (projected), yielding an average salary of $38,665.00 per annum.
• (e) An interest rate of 9%.
• (f) A salary growth rate of 8%.

Annexed hereto and marked `B' is a copy of the calculation, which was made in April 1985, together with an endorsement subsequently made in November 1985 to the effect that the maximum reasonable benefit is $78,000.''

Miss Wong did not take into account any entitlement under the superannuation fund, a matter I have already discussed. She considered that Mr Ferris's remuneration had been adequate, as she was entitled to do having regard to Mr Kelman's letter. She disregarded the figure of $270,300 which had been stated in the Deputy Commissioner's letter of 2 May 1979. Miss Wong did not consider it to be relevant that the Board of Directors had taken legal advice before determining the amount paid. She considered the fact that the Board of Directors was completely independent of Mr

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ATC 4764

Ferris to be relevant only to the question of a deduction under sec. 78(1)(c) and that it was not a matter which justified ``any adjustment to the reasonable benefit calculated for the purposes of sec. 109''. She did not consider relevant the fact that Mr Barlow had managed the affairs of Barlow Marine as she had treated his period of service with IVC as continuous.

Miss Wong's decision that the maximum and reasonable benefit was $78,000 was subsequently approved by her senior assessor, Mr N. McIlraith, and was the basis upon which the amended assessment which implemented the decision on the objection issued.

As Mr Ferris was the holder of 26 shares in IVC, and therefore a shareholder, no argument was put to the Court that the excess determined, $192,000, was not brought in as assessable income by the operation of sec. 44(1)(a) of the Act. And no submission was put that the deemed dividend was not paid out of the profits of IVC. The sole issue raised was whether the discretion conferred by sec. 109 of the Act was correctly exercised.

In an appeal of this nature where what is in issue is the exercise of a discretion by the Commissioner, the Court's function is limited to determining whether there was an error such that, in judicial review proceedings before it, this Court would make an order of review with respect to the challenged decision. That issue is to be determined by reference to the material which was or ought to have been taken into account by the Commissioner when the challenged decision was made. See
Avon Downs Pty. Ltd. v. F.C. of T. (1949) 78 C.L.R. 353 and
Kolotex Hosiery (Australia) Pty. Ltd. v. F.C. of T. 75 ATC 4028; (1975) 132 C.L.R. 535.

Mr S.W. Gibb, counsel for the Commissioner, supported the amended assessment by reference to the decision of Hunt J. in
Henry Comber Pty. Ltd. v. F.C. of T. 85 ATC 4450. At pp. 4455-4456, his Honour distinguished between what he said were the subjective elements raised by sec. 78(1)(c), that is to say whether a payment was made in good faith, and the test of ``objective reasonableness'' required by sec. 109. His Honour was hearing an appeal from a decision of the Board of Review for which Dr Beck had written the principal reasons. At pp. 4459-4460, his Honour said:

``The company, then, must demonstrate in accordance with ordinary administrative law principles why the Board's decision in relation to sec. 109 should be interfered with. In my view, the basis for the decision of Dr Beck (which the parties have accepted as the basis for the Board's decision) was that the Commissioner should have taken into account those matters contemplated by sec. 23F(2)(h) plus the three additional factors which he identified as being relevant.

Section 23F(2)(h) requires the superannuation benefits to be paid to employees not to be excessive in amount having regard to:

• (i) the remuneration paid to the employee for service rendered by him to his employer;
• (ii) the period of the service rendered by the employee to his employer;
• (iii) the benefits, pensions and allowances that have been, are being or may be provided for the employee or his dependants from any other fund to which that section applies; and
• (iv) any other matters that the Commissioner considers relevant.
• ...

It was also argued by the company that it is wrong to apply any rule of thumb in the formation of an opinion under sec. 109; the Commissioner (and the Board) should, it is said, consider each case upon its own merits and without reference to the scale which is ex. 5. The matters to which sec. 23F(2)(h) is directed are, however, clearly relevant to the opinion to be formed under sec. 109. The inclusion of (iv) - `any other matters that the Commissioner considers relevant' - permits the flexibility which sec. 109 requires, provided of course that the amount identified in that scale (which is necessarily based only upon the matters enumerated in sec. 23F(2)(h) as (i), (ii) and (iii)) is increased or decreased according to the additional matters so considered to be relevant. Upon the basis that such adjustments are made, I see no error in the application of the sec. 23F(2)(h) scale to sec. 109.''

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ATC 4765

This part of his Honour's judgment was not the subject of the subsequent appeal in F.C. of T. v. Comber, cited above.

Mr Gibbs submitted that his Honour approved of the practice adopted in the Taxation Office in sec. 109 determination of applying the tests laid down in sec. 23F(2)(h) and Taxation Ruling IT 2026. However, what was before his Honour was a decision of a Board of Review which had not only taken into account the Commissioner's ruling with respect to sec. 23F funds but had also examined all the facts of the particular case. It appears from Case R103,
84 ATC 682 at p. 689, and Case R104,
84 ATC 692, that Dr G.W. Beck, with whose reasons Mr M.B. Hogan and Dr P. Gerber agreed, took into account ``... special factors I have recognised - the founding of the company, the bringing in of business from his previous employer and his unpaid director's duties''. His Honour found no error of law in the Board's approach.

I do not take his Honour as intending to state that the Commissioner has a power to set objective standards with which remuneration or a retiring allowance to which sec. 109 applies, must comply if it is not to be struck down. That is not what sec. 109 says or intends. Section 109 authorises the Commissioner to disallow a payment as a deduction in so far as it exceeds a reasonable sum. I agree with Hunt J. that the test of reasonableness is an objective one. But what is and what is not reasonable depends upon the circumstances of the particular case and upon commercial practice. Evidence as to what is done in the business world in the granting of retirement benefits is material which is relevant to a judgment as to whether or not a particular payment was reasonable.

The evidence that the directors of IVC were persons who held responsible posts in commerce, that they were experienced persons who could judge what was and was not a reasonable payment and that they were entirely independent of Mr Ferris and represented interests other than Mr Ferris's interests was therefore material relevant to the question of whether or not the payment itself was reasonable.

The fact that the payment was made on advice from solicitors and senior counsel was also evidence tending to show that it was a reasonable sum.

The range of payments laid down in sec. 233 of the Companies Code would also have been relevant to determine whether or not the payment was objectively reasonable. The particular payment was within the range that was not required by the Companies Code to be specifically approved by a general meeting of shareholders.

I am left with the impression that Miss Wong and her seniors simply applied the standard laid by Taxation Ruling IT 2026 which was established for the management of sec. 23F superannuation funds. Section 109 is not concerned with funds having a special exemption from income tax nor indeed with any form of superannuation fund. The proper exercise of the discretion conferred by sec. 109 demands an analysis of the facts of the particular case and a decision as to whether the payment in question exceeded the limits of reasonableness having regard to the circumstances in which it was paid.

I am left with the impression that Miss Wong and her seniors did not examine Mr Ferris's case in this light.

Indeed, in neither her affidavit nor her oral evidence did Miss Wong say that in her view the retiring allowance paid to Mr Ferris was unreasonable. Her affidavit referred to the calculation she had made and said ``that calculation yielded a reasonable benefit of $77,795''. She referred to an endorsement on the calculation ``to the effect that the maximum reasonable benefit is $78,000''. But the establishment of IVC and its engagement in venture finance had been a novel or at least an unusual undertaking. Mr Ferris had worked hard to achieve a respectable result in difficult circumstances. The undertaking was being brought to a close with his retirement. Why was it unreasonable for the other directors to resolve that Mr Ferris be paid a generous sum on his retirement? Was the sum so generous as to be beyond the limits of reasonableness? From whose point of view was the payment unreasonable? What had been the value of Mr Ferris's services to the enterprise? Had that value been fully reflected in the salary paid to him? Miss Wong's evidence scarcely deals with these questions.

It has not been suggested that the payment to Mr Ferris was a cloak for any other transaction. Indeed, for sec. 109 to have been applied, it

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must have been accepted that the gratuity was properly paid as a retiring allowance in consideration of his past services. See
W.J. & F. Barnes Pty. Ltd. v. F.C. of T. (1957) 96 C.L.R. 294. This is not a case where a payment made to a person who had shareholding interests should be held to be unreasonable because the payment ought not to have been made by way of a retiring allowance but ought to have been made by way of a dividend. The subject payment, if unreasonable, ought not to have been made at all. The directors would have been in breach of the duty which they owed to IVC and its shareholders. See
Parke v. Daily News Ltd. (1962) 1 Ch.D. 927.

The evidence given by Miss Wong did not discuss her understanding of the nature of the discretion conferred by sec. 109. In such a circumstance, it can be difficult to determine whether or not an error of law was involved in the decision in the sense that the decision maker addressed the wrong question or adopted the wrong approach. In the present case, I have come to the view that the assessment proceeded on a wrong footing, that Miss Wong and her superior officers simply approached the issue as if the determination of a payment by a sec. 23F fund were involved and that they failed to construe and apply sec. 109 having regard to the context in which that section appears and the mischief which the section is designed to obviate. I come to this conclusion not only because the assessment and the amended assessment applied Taxation Ruling IT 2026, which was the standard devised for the management of sec. 23 funds but also because, apart from the calculation derived from that standard, there is no clear statement in Miss Wong's evidence that it was in her opinion unreasonable for IVC to make the payment to Mr Ferris and there is no explanation in her evidence, apart from the calculation based upon the standard, as to why it was unreasonable.

This is not a case where a payment went to Mr Ferris as a retiring allowance when the reasonable course was for it to be paid to him by way of dividend. The payment was made to Mr Ferris by the company in good faith in consideration of his past services. Of his value thereof to the company, the directors of IVC were the best judges.

I would accept Miss Wong's approach if the Ruling developed for sec. 23F funds had stated or established the community's perception of the upper limits of what is reasonable in the quantum of a retiring allowance or if there were some other reason to query the quantum thereof. But the Ruling merely establishes what in the Commissioner's view is excessive for the purposes of sec. 23F. So the question remains why and from whose point of view the payment made to Mr Ferris was unreasonable. Mr Ferris had been instrumental in establishing IVC and had seen it through difficult times. The company's venture had come to a close. In these circumstances, why should not the company grant to Mr Ferris a generous retiring allowance if the directors other than Mr Ferris thought it appropriate and why was the amount paid unreasonable? Miss Wong's evidence does not explain this.

Miss Wong and her superior officers considered irrelevant to a sec. 109 determination the fact that the payment was made by directors who were independent of Mr Ferris and well qualified to make a decision as to what was a reasonable and proper payment. In my opinion, the fact of the payment and the circumstances in which it was made was evidence that the amount paid was a reasonable sum and was a matter which ought to have been taken into account.

In these circumstances, I am of the view that there was an error in the amended assessment and in the further amended assessment and that there should be an order remitting the matter to the Commissioner for his reconsideration accordingly.

Mr D.A. Staff Q.C., with whom Mr K.E. Lindgren of counsel appeared for Mr Ferris, adduced evidence at the hearing additional to that which was before Miss Wong and her seniors when the decisions were made. Mr Staff submitted that the Court should set aside the assessment without remitting the matter for reconsideration and that on the evidence before the Court it should do so. Mr Staff referred to Kolotex Hosiery (Australia) Pty. Ltd. v. F.C. of T., cited above, and Henry Comber Pty. Ltd. v. F.C. of T., cited above. However, the Court would so act only if it were satisfied that the result contended for was the only one to which a decision maker, properly instructed and not acting unreasonably, could come. It is not for the Court itself to exercise the discretion which is conferred upon the Commissioner. The function of the Court is a function in the nature of judicial review. Unless the Court is satisfied

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that there is no room for the exercise of the subject discretion, the Court must remit the matter for reconsideration.

In the present case, I am not satisfied that the whole of the available material is before the Court. Although an extract from the minutes which authorised the payment of the retiring allowance to Mr Ferris is now in evidence, there is no direct evidence as to how the sum of $270,000 was calculated. There is no evidence as to the advice given by IVC's solicitor or senior counsel. There is no evidence as to the discussions which took place when the payment was considered. In brief, I am not satisfied that there is before the Court all the material that could be taken into account on a reconsideration of the matter and I am not satisfied that there is only one decision to which an administrator acting reasonably could come. The proper course is to remit the matter to the Commissioner for his reconsideration.

The order of the Court will be that the appeal will be allowed and the matter remitted to the Commissioner for his reconsideration of the exercise of the discretion conferred by sec. 109. The respondent should pay the costs of the appeal.