Federal Commissioner of Taxation v. Bunting

Judges:
Lockhart J

Court:
Federal Court

Judgment date: Judgment handed down 7 April 1989.

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Lockhart J.

These four appeals from decisions of the Administrative Appeals Tribunal (Taxation Appeals Division) concern sec. 260 of the Income Tax Assessment Act 1936 (``the Act'') [reported as Case V62,
88 ATC 467]. They relate to the income years 1980 to 1983. The same question of law arises in each appeal. Although there are technically four appeals, only one notice of appeal was in fact filed and it was in respect of all four years of income.

The respondent, Mr Bunting, was born in England in 1949 and married there in 1972. He migrated to Australia, arriving here on 27 March 1980. Before then he had been employed for about a decade in England by various companies as a computer programmer and later as a computer systems analyst.

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ATC 4360

Upon arrival in Australia he sought employment in the computer industry. He approached several agencies and was interviewed for various positions. One of the companies in the computer industry which interested him was a company called Computations Pty. Limited (``Computations''). In early April 1980 he spoke to Mr Halliday, an officer of Computations, who said that Computations was looking for a consultant to take over a particular project involving the development of a specific program for it. It was suggested to Mr Bunting that, if he were to be involved, he may need to perform the task through the agency of a company with limited indemnity. It is common in the computer industry for the services of computer specialists to be required only for the duration of particular projects and for those services to be provided through companies which may be controlled by the computer specialists. In this case Computations required a specific program to be developed for one of its clients, a finance company. The project was described in the evidence as the Fin-Co project.

Computations suggested to Mr Bunting that he speak to a solicitor to discuss the formation of an appropriate corporate entity. Mr Bunting did this and consequently decided to adopt the structure which is the subject of this appeal.

This structure involved the incorporation of a company, Manting Pty. Limited (``Manting''), which was effected on 9 April 1980 under the Companies Act 1961 (N.S.W.). Its objects are manifold and include the establishment and support of trusts for the benefit of dependants of employees or directors of the company.

The two subscribers to Manting's memorandum were Mr Bunting's solicitor and a friend of Mr Bunting, a Mr Brown. Manting issued two shares in its capital, one of which was held by Mr Bunting's wife and the other by Mr Brown. Mr Brown's share was held upon trust for Mrs Bunting.

A deed of trust dated 14 April 1980 was executed between a Mr O'Reilly as settlor and Manting as trustee. It was a discretionary trust. ``The eligible beneficiaries'' is an expression defined by the deed as meaning Mrs Bunting, Mr Bunting's children, grandchildren and great-grandchildren, spouses of the children of Mr Bunting and any future wife or wives of Mr Bunting and such other persons as the trustee (Manting) may appoint (cl. 1(b)). The class of eligible beneficiaries was so expressed as to exclude Mr Bunting himself. The power of removal and appointment of trustees was vested in Mrs Bunting.

The only activities carried on by Manting were as trustee of the Bunting family trust.

The Tribunal, constituted by Mr P.M. Roach (Senior Member), found that Manting contracted with Computations to make Mr Bunting's services available from 14 April 1980 as a computer consultant to work on the Fin-Co project. From that date Mr Bunting became an employee of Manting. The Tribunal found that the terms of Mr Bunting's employment by Manting were not ``formally documented''. A meeting of the directors of Manting was held on 14 April 1980 at which were present Mr Bunting's solicitor and a Mr Burns, a friend of Mr Bunting. Mr Bunting was himself in attendance at the meeting. Minutes of the meeting record that Mr Burns was appointed chairman of the meeting. It was resolved that Manting:

``establish itself in the computer industry by the employment of Mr R.J. Bunting, an expert in the field of computer systems design and implementation. Mr Bunting having consented to be so employed, it was agreed that he be paid a salary of $15,000 per annum until otherwise resolved by the company.''

The minutes of that meeting also record the following:

``Mr Bunting advised that Computations Pty. Limited, a computer company based at 1 York Street, Sydney had expressed to him an interest in engaging the company as a consultant to its operations. It was resolved that Mr Bunting write to Computations Pty. Limited setting out the services that the company was capable of providing and the applicable rates of charge.''

Under ``Further Business'' the minutes record that:

``It was resolved that the Company having employed Mr Bunting all attempts should be made to procure such further computer consultancy business as may be available.

It was further resolved that consideration be given to the employment of such additional persons as may be required to satisfy any

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ATC 4361

additional assignments that become available to the company.''

Mr Bunting worked on the Fin-Co project, and, when it was completed, the contract between Computations and Manting came to an end. Mr Bunting continued in the employment of Manting because it was able to arrange for his services to be used in another computer project with a State government authority. Manting arranged with a company, Parity People Pty. Limited (``Parity People''), to make the services of Mr Bunting available to it. In turn Parity People made Mr Bunting's services available to the relevant government authority. Mr Bunting worked on that computer project in the offices of the government authority. This arrangement continued until the project came to an end which was after the close of the period covered by the references to the Administrative Appeals Tribunal.

Throughout the relevant period Manting was remunerated, first by Computations and later by Parity People, on the basis of an hourly rate for the hours worked by Mr Bunting. The rates increased from time to time. Manting, in turn, paid a salary to Mr Bunting.

On 29 May 1981 Manting established a superannuation scheme for the benefit of its only employee, Mr Bunting.

The profit and loss statement of the Manting Trust for the year ended 30 June 1981 is a fair sample of the other years with which these appeals are concerned (years ended 30 June 1980, 1982 and 1983). It states that the income was constituted by consultancy fees of $28,259 and interest received of $65, a total of $28,324. The interest component represents interest on moneys deposited or otherwise invested, presumably on a short-term basis, by Manting being the income received by it from Computations and Parity People. The expenses claimed by the Manting Trust represent accountancy fees, bank fees, electricity, entertainment, insurance, legal costs, certain motor vehicle expenses and licences and lodgment fees, stationery, printing, postage, salaries and wages, superannuation, technical books and papers, telephone and depreciation. The total expenses of Manting are $21,080 of which the two principal components are the salary paid to Mr Bunting of $15,194 and superannuation of $3,525 in respect of Mr Bunting.

Paragraph 6 of the Tribunal's findings states that the relevant figures, and they are not in dispute, are as follows [ATC p. 469]:

Year ended    Fees paid           Other income  Salary paid     Other expenses
 30 June     to Manting*           of Manting   to Mr Bunting    of Manting
                $                     $               $               $
1980          5,290                   -             2,884              10
1981         28,259                   65           15,194           5,886
1982         34,201                  480 **        15,841           4,806
1983         39,263                2,208           18,492          10,828
      

^*(by Computations and later by Parity People)

^**(less set-off of loss and share options of $240)

The Commissioner assessed Mr Bunting on the basis that he was the recipient of the income which had been returned by the Manting Trust, but allowed him as deductions the deductions claimed by the trust itself excluding salaries and superannuation.

The Tribunal rejected the Commissioner's argument that a sham transaction was involved. The application of sec. 260 to the facts of the case was the primary matter raised before the Tribunal which held that it was satisfied that there was no scope on the facts of the case for the application of the section. It reached that conclusion having regard to the Tribunal's understanding of the reasoning of the High Court in
F.C. of T. v. Gulland 85 ATC 4765; (1985) 160 C.L.R. 55 and the decision of a Full Court of this Court in
Tupicoff v. F.C. of T. 84 ATC 4367; 84 ATC 4851; (1984) 4 F.C.R. 505. The primary ground of the Tribunal's reasoning was that there was no transaction or situation which preceded the derivation of income by the trust upon which sec. 260 could operate. The Tribunal held that, although sec. 260 may operate when an existing stream of income is rechannelled, it says nothing about how a new stream of income should flow and

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ATC 4362

that in this case there was no existing stream of income which could be or was rechannelled.

The Tribunal rejected the argument that the arrangements put in place after Mr Bunting's arrival in Australia, which led to the trust deriving the income from Mr Bunting's exertion, were simply in substitution for the earlier derivation of income in the United Kingdom by Mr Bunting. The Tribunal did not regard the earlier derivation of income as constituting an antecedent situation for the purposes of sec. 260. The features which were held to distinguish the arrangements in question in these proceedings from the various forms of employment of Mr Bunting in the United Kingdom were that Mr Bunting had been instrumental in bringing into existence the contracts for services between Manting and Computations and later Parity People and the contract of service between himself and Manting; and that, though Mr Bunting was neither a beneficiary of the trust nor a shareholder in Manting, the beneficiaries who actually derived income from the trust were limited to his wife and child.

The Tribunal upheld the objections of Mr Bunting and varied the decisions of the Commissioner upon the objections by reducing the taxable income of Mr Bunting accordingly.

The Commissioner's grounds of appeal to this Court were confined to sec. 260, so no question of sham arises.

Subject to the choice principle, sec. 260 will operate on arrangements which are implemented in a particular way for the purpose or effect of avoiding tax: F.C. of T. v. Gulland (supra) per Gibbs C.J. at ATC p. 4771; C.L.R. p. 66. For sec. 260 to apply the purpose or effect of the arrangement must be seen from its terms or the acts by which it was implemented:
Newton v. F.C. of T. (1958) 98 C.L.R. 1; Gulland per Gibbs C.J. at ATC p. 4771; C.L.R. p. 66 and Dawson J. at ATC pp. 4792-4793; C.L.R. p. 104.

The avoidance of tax need not be the sole purpose of the arrangement. As Gibbs C.J. said in Gulland at ATC p. 4772; C.L.R. p. 68:

``If tax avoidance is one of the main purposes of the arrangement in the sense that it is not inessential or merely incidental, that is enough.''

There could be no business or family purpose served by the arrangement in question other than to provide Mr Bunting with superannuation benefits and to adopt a corporate vehicle for provision of his services, as appears to have been a common practice in the computer industry at the relevant time. However, the structure which was created was more than was necessary to provide those benefits. No business or family purpose can be found for the creation of the family trust. The trust is a discretionary trust from which Mr Bunting is expressly excluded as a beneficiary. This provides a strong indication that the primary purpose of the transaction was to split Mr Bunting's income between himself and members of his family.

Looking at the arrangement as a whole in this case it is plain that its purpose and effect was to alter the incidence of income tax and relieve Mr Bunting from a liability to pay the tax which would otherwise have been imposed upon him.

The proposition that Mr Bunting was entitled to bring himself within the choice principle as explained by Mason J. in
Cridland v. F.C. of T. 77 ATC 4538 at pp. 4541-4542; (1977) 140 C.L.R. 330 at p. 339 and in
Gulland and John v. F.C. of T. 89 ATC 4101; 83 A.L.R. 606 is fallacious. The principles enunciated in those cases do not apply to a case like the present where the so-called choice is as to the manner in which Mr Bunting conducted his income-earning activity, the choice being to work as an employee of the trustee company (Manting) rather than for the computer agency company. A similar proposition was considered by Fisher J. in Tupicoff at ATC p. 4853; F.C.R. p. 509 where his Honour adopted the following passage from the judgment of Bowen C.J. in
Gulland v. F.C. of T. 84 ATC 4587 at pp. 4589-4590; (1984) 3 F.C.R. 354 at pp. 357-358. Bowen C.J. said:

``The arrangement here goes beyond mere entry into a transaction such as a university student buying units in a trust. Here, with a purpose of altering the incidence of taxation in which his income from his practice was taxable in his hands, the taxpayer set about creating an entirely different situation whereby by means of a number of agreements entered into by a trust which he set up for this purpose the income would

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ATC 4363

eventually end up in the hands of a family trust rather than his own.''

As in Tupicoff the choice principle does not apply here so as to oust sec. 260.

The critical question on which this case ultimately turns is whether there was an antecedent transaction or situation in the sense in which those expressions are used in the authorities.

It is generally accepted that sec. 260 does not apply where there was no antecedent transaction or situation whereby income was derived. This principle is based on the ground that the operation of sec. 260 has been said to be dependent upon an alteration in the incidence of tax or in some existing liability to pay tax.
Europa Oil (N.Z.) Limited v. Commr of I.R. 76 ATC 6001; (1976) 1 W.L.R. 464 at p. 475;
Mullens v. F.C. of T. 76 ATC 4288; (1976) 135 C.L.R. 290 per Barwick C.J. at ATC pp. 4294-4295; C.L.R. pp. 302-303;
F.C. of T. v. Patcorp Investments Limited 76 ATC 4225; (1976) 140 C.L.R. 247 per Gibbs J. at ATC p. 4236; C.L.R. pp. 298-299 and
Slutzkin v. F.C. of T. 77 ATC 4076; (1977) 140 C.L.R. 314 per Barwick C.J. at ATC p. 4080; C.L.R. p. 320.

The cases do not draw precise distinctions between antecedent transactions or situations; but, as Gibbs C.J. said in Gulland at ATC p. 4775; C.L.R. p. 73:

``there is nothing in sec. 260 that supports the view that that section can apply only when there has been an antecedent transaction between parties. An arrangement will, for example, be within the section if it alters the incidence of income tax in a case in which the only relevant antecedent circumstance is that the taxpayer is in receipt of income.''

His Honour thus emphasised the distinction between an antecedent transaction and an antecedent situation or circumstance, a distinction which other members of the Court in Gulland also recognised. As Dawson J. observed at ATC p. 4796; C.L.R. p. 111:

``It should also be pointed out that the authorities draw a distinction between an arrangement which modifies an antecedent transaction or situation and one which merely orders a taxpayer's affairs in relation to income from a new source... In the former case, but not the latter, sec. 260 may have an application for there may be an alteration of the incidence of income tax... But the distinction can be of no assistance in this case where, if there was no antecedent transaction, there was an antecedent situation consisting of the taxpayer's practice of his profession in a particular manner. The arrangement changed that situation and did so in order to alter the incidence of income tax. The change however gave rise to no new source of income...''

It is true that Mr Bunting derived no income in Australia until after he migrated here. But he arrived in this country on 27 March 1980 and very soon thereafter commenced looking for employment of the kind from which he had derived income in the United Kingdom. He commenced working here on 14 April 1980, less than three weeks after his arrival. He must have taken steps to put the income-splitting structure in place almost as soon as he arrived here because Manting was incorporated on 9 April 1980, less than two weeks after his arrival in this country, and the deed of trust was executed five days later, the same day as he commenced work as a computer consultant. In the United Kingdom Mr Bunting had been employed for about 10 years by various companies doing the same kind of work that he did here. There was no antecedent transaction, but there was an antecedent situation consisting of Mr Bunting's practice of his work in the computer industry as or akin to a computer consultant and as an employee. He was in receipt of income; and the fact that it was in the United Kingdom, not Australia, though relevant, is not in my opinion a circumstance which deprives the facts of their character as an antecedent situation within the sense in which that expression is used in the sec. 260 cases.

The arrangement changed that situation and did so for the purpose of altering the incidence of income tax. The change did not give rise to a new source of income. It was Mr Bunting's services before and after the arrangement that produced the income albeit through the intervention of a corporate structure under the arrangement. The moneys paid to Manting were directly related to and calculated by reference to Mr Bunting's services on the basis of an hourly rate. It is from Mr Bunting's activities as an employed computer consultant

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ATC 4364

that the income in question here was derived notwithstanding changes in the intricacies of Mr Bunting's employment details. The remarks of Fisher J. in Tupicoff v. F.C. of T. (supra) at ATC p. 4853; F.C.R. p. 509 are in point in this case:

``Here it is crucial to note that, although the taxpayer attempted to cease deriving income, he did not cease `the personal exertion' activities which heretofore had been the undoubted source of his income. Moreover sec. 260, on its application to dealings with income produced by personal exertion, operates in a manner markedly different from that when a disposition of income producing property is under consideration...

On a number of aspects of his argument counsel for the taxpayer placed reliance upon the decision of the Full Court of this Court in
F.C. of T. v. Kareena Private Hospital 79 ATC 4667; (1979) 41 F.L.R. 307. However, in my opinion he can gain no assistance from that case. There is a crucial fact difference in that the taxpayer company in Kareena ceases entirely, during the year of income under consideration, to carry on its income producing activities. It did not merely attempt, as in this matter, to divert the income of its activities into the hands of another...''

The notion of an antecedent situation is broad enough to encompass Mr Bunting's position. In the circumstances of the case, including the very short time lag between Mr Bunting's cessation of work in England and commencement of work in Australia, the fact that the previous employment was outside the jurisdiction does not materially affect the principle involved. Indeed, it would seem somewhat artificial to allow this fact to determine the application of sec. 260. This is a case where the arrangements in question were designed to alter the incidence of income taxation by splitting Mr Bunting's income amongst his family. Section 260 applies to invalidate the arrangement.

Section 260 is an annihilatory provision only. It effects a fictitious annihilation of contracts, agreements and arrangements. It does not permit the Commissioner to substitute new and fictitious sets of facts in their place or an alternative basis on which tax may be assessed: Newton; Gulland per Gibbs C.J. at ATC pp. 4771-4772; C.L.R. p. 67 and Dawson J. at ATC pp. 4800-4801; C.L.R. p. 118; John at ATC pp. 4108-4109; A.L.R. pp. 615-616.

Section 260 annihilates Manting and the trust. What is left exposed is the fact that Mr Bunting by his exertions earned the gross income attributed to the trust giving him the net income on which the Commissioner assessed, i.e. after allowing the deductions claimed by the trust excluding salaries and superannuation payments.

This Court's jurisdiction to hear appeals from the Administrative Appeals Tribunal arises from subsec. 44(1) of the Administrative Appeals Tribunal Act 1975. There must be an error of law to found that jurisdiction.
F.C. of T. v. Brixius 87 ATC 4963; (1987) 16 F.C.R. 359. In my opinion the Tribunal did err in law in its findings in that it did not correctly interpret sec. 260 as defined by the cases, in particular Gulland and Tupicoff, including the analysis in those cases of the principle of an antecedent transaction or situation and the rechannelling of streams of income. The Tribunal also, in my view, erred in its finding that the choice principle applied in this case to prevent the operation of sec. 260.

I would allow the appeals, set aside the decisions of the Tribunal and order Mr Bunting to pay the Commissioner's costs of the appeals.