CASE Y13

Members:
YFR Grbich

Tribunal:
Administrative Appeals Tribunal

Decision date: 5 February 1991

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Dr YFR Grbich (Senior Member)

The applicant is a mechanical engineer employed by a large engineering company in Gladstone. This case concerns approximately $500,000 income, generated by the applicant in his spare time for consulting work. In particular, the case deals with the effectiveness of a discretionary trust used as a vehicle for receiving consulting income and splitting it amongst the applicant's family. The Commissioner purports to annihilate the transaction with the ``new'' general anti-avoidance provisions in Part IVA. This case raises basic questions about the effectiveness and reach of this second generation anti-avoidance provision.

2. This reference to the Tribunal deals with four tax years, from the year ended 30 June 1982 to the year ended 30 June 1985. It involves assessments on the applicant, the main income generating and moving force behind the trust, and assessments on the objects of the discretionary trust, his wife and her three children. The assessable income assessed to the applicant is $42,215 for the 1982 tax year, $68,400 for 1983, $153,930 for 1984 and $126,543 for 1985. There are also claims for deductions of under $50,000. These are dealt with later in the decision.

3. The applicant is a qualified mechanical engineer. At the relevant times he had worked at a senior level for a large public engineering company for 15 years. His work at the relevant time largely involved supervision and management. According to his evidence, the applicant was approached by members of the engineering industry to undertake specific work in his nights and evenings. The work consisted of consulting on the preparation of large scale tenders by the clients, including quantity surveying, determining charging rates for units of work, evaluating engineering risks and so on. His evidence was that the clients advised him to see an accountant with a view to getting advice and, ultimately, to form a trust as the vehicle to enter into the contracts.

4. According to the applicant, this trust arrangement was used to avoid a conflict of interest with his regular job. In his evidence he said that by using a separate vehicle he could avoid the appearance of such conflict. This reasoning was strenuously tested in cross-examination. Applicant's counsel advanced the argument that the Tribunal should concentrate on the applicant's perception that the separate entity would give some sort of protection from the dangers of a conflict of interest.

5. The applicant went to his accountant and a ``grandad'' discretionary trust was formed. We will call it the ``Taxpayer Family Trust''. It had a corporate trustee. We shall call it ``Blackrock Pty. Ltd.''. This was a shelf company purchased in March 1982. The applicant and

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his wife were the only shareholders in the company. The trust was formed with a settlement of $100 by ``grandad''. The objects of this discretionary trust included the applicant, his wife, the wife's children, other children and grandchildren of the applicant and his wife, with the usual provision for companies, charities and so forth. The objects also included persons added by the appointers, excluding only the ``grandad'' settlor. The trustee had an absolute discretion to pay capital or income to the objects of the trust. There was power to set aside funds for appointed objects on separate trusts. There was power to accumulate income. It was a non-exhaustive discretionary trust to wide class of objects.

6. A large majority of the consulting work (approximately 80%) was done for one client and the rest for one other. The consultation work involved preparation of tenders for large engineering contracts around Australia. Payment was based on an hourly rate in some cases. In other cases it was based on a percentage of contract price, with no payment if tenders did not succeed. The applicant worked after hours, during the weekends and holidays. The trust paid him no salary. In the first two years he received no distributions. In the 1984 tax year he was distributed an unspecified balance of the trust income, after most of it was distributed to the wife and children.

7. The applicant's wife received a salary ranging from approximately $4,000 to over $5,000 for the relevant years. This was for clerical, typing and occasional telephone answering. The bulk of the income generated by the trust was split among the children, as objects of the trust.

8. In cross-examination the respondent attacked the applicant's version of the facts in three ways. First, by emphasising that the clients sought out the skills of the applicant and that it was his personal services they were buying. Second, by attacking the applicant's claim that by doing the work through a trust vehicle, the applicant avoided a conflict of interest with his normal job. Third, by attacking the applicant's insistence that tax considerations did not play a significant part in his decision to use the trust structure.

9. While there is no reason to doubt the applicant's belief in the truth of his testimony, the inference to be drawn from the evidence must be located in the context of the objective facts. Under the old general anti-avoidance provisions in s 260, the test of tax avoidance was based largely, if not wholly, on inferences drawn from the objective aspects of a transaction. In his classic test, Lord Denning in
Newton v FC of T (1958) 98 CLR 1, 8 said:

``the section [260] is not concerned with the motives of individuals. It is not concerned with their desire to avoid tax, but only with the means which they employ to do it.... In applying the section you must, by the very words of it, look at the arrangement itself and see which is its effect - which it does - irrespective of the motives of the persons who made it.''

While I would have preferred the words ``minimise tax'' to ``avoid tax'', this test is as important today as it was back in 1958.

10. It was clear from the testimony that the applicant did not properly understand the impact of the trust, that he was hazy on precisely what tax factors were relevant to the decision (other than the fact that a trust gave more opportunities for deductions), and that he delegated much of the decision-making to his accountant and acted on that advice. For this reason, the evidence must be carefully tested against inferences drawn from the objective steps in the transaction.

11. Having weighed the evidence of the applicant and all the objective circumstances I find, on a balance of probabilities, that the formation of the corporate trustee structure to separate the consulting operation from the applicant's normal job was a moving factor in the arrangements. If I had to put a figure on it, I would weight it at 20%. But I do not find it plausible on the basis of an inference from the evidence and incomplete facts before the Tribunal that the structuring of the arrangements was not moved, to a significant degree, by tax considerations. If I had to put a figure on it, I would say 80%. Whether this was moved in part by the bush tax knowledge of the applicant or by his accountant, into whose hands, it is clear from cross-examination, he delegated much of the business decision making, is not clear. The accountant did not give evidence. But the use of the discretionary trust and nominee company does not support the inference that tax considerations did not

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play a significant part in moving his arrangements. Of course, and this should be clearly understood, to assert that tax arrangements play a significant part in the structuring of a taxpayer's affairs is not the same as asserting that Part IVA applies. A discussion of the precise criteria for its application will follow shortly.

12. The applicant's main argument was that the Commissioner's attempt to annihilate this transaction failed at the threshold. In order for a scheme to be annihilated under s 177D the taxpayer must ``obtain a tax benefit in connection with the scheme''. Section 177C(1) reads as follows:

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

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

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

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

The applicant's argument was a variant of the old antecedent transaction doctrine. In order to qualify as a tax benefit under s 177C(1)(a), it was argued, the Commissioner must show that ``an amount not... included in the assessable income of the taxpayer... might reasonably be expected to have been included... if the scheme had not been... carried out''. The argument was that ``scheme'', having a very wide definition in s 177A, would include all the steps in this transaction. This would include the formation of the trust, trustee company, distributions etc. In the absence of such a scheme, no money would have been earned. Since there was no stream of income before the present arrangements were put into effect, there was no tax benefit.

13. This argument is based on an excessively narrow reading of s 177C. The definition of ``tax benefit'' has a clear purpose in the framework of the general anti-avoidance provisions. Attempts to dissect its words and take them out of context would undermine the clear rule being communicated by the legislation. The section works by comparing the actual tax result obtained from the steps in the scheme under review with the steps which might have been expected had the various tax avoidance steps not been undertaken. It involves an attempt to predict, based on all the evidence, what might reasonably have been done had tax considerations not been present. In the case before us we treat the trust and corporate trustee, conditionally and for the purposes of argument, as an offending part of the scheme. Had it not been carried out, the question is whether the consulting work would have been performed by the taxpayer personally and, if so, what the tax bill would be. The Tribunal is required to predict what steps would have been taken but for the tax avoidance purposes. In this case, I find on a balance of probabilities from all the facts that the consulting work, payments for business expenses would have been made had the scheme in question not been put into effect. The test does not require certainty. The relevant test is ``reasonably to be expected''. This is based on a balance of probabilities or, on the basis of authority from another context, on something less (see Sheppard J on a similar formula from the Freedom of Information Act 1982 in
AG & Anor v Cockcroft (1986) 64 ALR 97, 109 and UK tax cases cited).

14. It is said that those who fail to learn the lessons of history are doomed to repeat them. One would have expected that the ungainly antecedent transaction doctrine was finally laid

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to rest by Gibbs CJ in
FC of T v Gulland 85 ATC 4765, 4775; (1985) 160 CLR 55, 73 when he said:

``there is nothing in sec. 260 that supports the view that that section can apply only when there has been an antecedent transaction...''

Happily the ``resconstruction'' provisions in s 177F now make the doctrine irrelevant on the issue of liability after annihilation of transactions. The doctrine was resurrected in
Europa Oil (NZ) Ltd. v IRC (NZ) (No. 2) 76 ATC 6001, 6008-6009; (1976) 5 ATR 744, 753 and has been mobilized as the basis for an articifical attack on the main annihilation provisions themselves. The argument that you need on antecedent transactions to avoid tax are adequately rebutted by Gummow J in
Bunting v FC of T 89 ATC 5245, 5254 and the authority to which he refers in the context of s 260. In essence, the argument is that it is ``difficult to find a basis in Australian legislation'' for the proposition that the general anti-avoidance provisions strike only at income from an existing source where a liability is relieved. To quote
Taylor J ((1956) 96 CLR 577, 665) ``the real work of the section is intended to be done in cases... before income has been derived''. We need not go through a full rerun of this argument in the context of the new general anti-avoidance provisions. It diverts our attention from more significant issues about the proper meaning and limits of the general anti-avoidance provisions at the core of s 177D.

15. Another variant of this argument was advanced by Deputy President Todd in Case V160,
88 ATC 1058, 1070. The learned Deputy President said:

``This provision does not in my opinion apply at all comfortably in a trust situation, especially where there are numerous beneficiaries who might take. Depending on the terms of the decision made by the trustee about distribution, various consequences might flow. In this case, who is in terms of sec. 177C the taxpayer who would have had the assessable income included as part of that taxpayer's assessable income? The answer to this would depend on the decision made by the trustee. The crucial questions here... are whether the applicant, as the taxpayer, had a benefit in connection with the scheme, and whether he would have obtained such a benefit but for the annihilating effect of sec. 177F. In this case, I do not see how the conclusion can be drawn under sec. 177D that the scheme here entered into was entered into for the purpose of enabling the applicant to obtain a tax benefit. Who was to benefit could not be supposed, although it is clear enough that some person or persons was to benefit. The failure of the scheme has left the applicant presently entitled by default, but it does not flow from that that he was the taxpayer who was to obtain the tax benefit.''

The answer, with the utmost respect lies, assuming the discretionary trust is annihilated, in the amount that might reasonably have been expected to have been earned by the relevant taxpayer in the absence of the trust. This is reinforced by the wide range of criteria taken into account under s 177D, including the substance of the scheme, the change in financial position of connected persons and any change in the financial position of the taxpayer.

The answer in the present case, it seems to me, is that the assessable income and hence the tax benefit to the applicant in this case was reasonably to be expected had the scheme not been implemented. He Probably would have earned the consulting fee in his own right. The legislative purpose is clear and it is the objective of this Tribunal, so far as the language of the statute reasonably allows it, to give full effect to this purpose.

As Mason and Wilson JJ put it on the leading High Court decision in
Cooper Brookes (Wollongong) Pty. Ltd. v FC of T 81 ATC 4292, 4307:

``The courts are as much concerned in the interpretation of revenue statutes as in the case of other statutes to ascertain the legislative intention from the terms of the instrument viewed as a whole.''

16. The applicant advanced an allied but distinct argument on the application of s 177C. That argument was that definition of ``scheme'' in s 177A(1) is wide and that all the same steps must be disregarded in the comparison demanded by s 177C(1) between the steps actually used in the transaction and those which might reasonably be expected to have been put into effect but for the scheme. Under the new general anti-avoidance provisions in Part IVA, such questions are no longer relevant in determining tax liability after annihilation.

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Under s 177F(1)(a) the Commissioner is given adequate basis so called ``reconstruction'' powers, to include avoided tax in assessable income through his own statutory powers. But the reconstruction issue raises its hydra-head again at this threshold level. The answer, again, is to be sought in the scheme of s 177C. To advance the proposition that the ``definition'' of scheme is very wide is not to concede the further proposition that all those same steps must be disregarded in the comparison demanded by s 177C. The relevant comparison is between the steps relevant to the ``amount not being included in the assessable income'' and the statutory predicate about what might reasonably have been included. This involves an active selection of those relevant steps and does not imply, any more than the old annihilation test in s 260 implied, complete obliteration of all the steps in the transaction. When coupled with the licence to ``reconstruct'' under the statutory predicate in s 177C, this argument imposes no obvious impediments to the effective operation of the provision in this case or, one would expect, in most other normal cases. Even if we disregard the discretionary trust and the corporate trustee, we can compare the reasonable expectation that the applicant would derive the income of the trust and, if necessary, could follow the cash flows into the hands of the wife and children, look at the work done by the applicant and find a constructive trust or implied agency.

17. The threshold condition of a tax benefit having been satisfied, the issue is whether the main annihilation provisions in s 177D apply. Section 177D reads:

``This Part applies to any scheme that has been or is entered into after 27 May 1981, and to any scheme that has been or is carried out or commenced to be carried out after that date (other than a scheme that was entered into on or before that date), whether the scheme has been or is entered into or carried out in Australia or outside Australia or partly in Australia and partly outside Australia, where -

• (a) a taxpayer (in this section referred to as the `relevant taxpayer') has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and
• (b) having regard to -
  • (i) the manner in which the scheme was entered into or carried out;
  • (ii) the form and substance of the scheme;
  • (iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;
  • (iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;
  • (v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;
  • (vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;
  • (vii) any other consequence for the relevant taxpayer, or for any person referred to in sub-paragraph (vi), of the scheme having been entered into or carried out; and
  • (viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in sub-paragraph (vi),

  it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers).''

The central issue is whether, on the facts before us, ``it would be concluded that one of

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the persons who... carried out the scheme or any part of [it] did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme''. In this enquiry, among other things, the Tribunal must have regard to ``the nature of any connection'' between the taxpayer and persons with family or business connections.

18. It is to be noted that under s 177D the transaction is annihilated where ``it would be concluded'', having regard to a very wide range of objective factors about the scheme, its substance and its context, that the person who carried it out did so for the purpose of obtaining a tax benefit. Whilst it does not exclude subjective factors, inferences from objective facts are the primary focus of the legislation.

19. It might have been expected that the precise limits of this predication test would be severely tested in a scheme such as this. It hardly involves blatant, contrived and artificial arrangements. This scheme used a well recognised income-splitting device which is freely available to taxpayers with income from property sources. Indeed, it was conceded by the respondent that the provision did not apply in the case of the interest income in this case. Section 177D still cannot operate where a taxpayer simply chooses between equally plausible and recognised business or property holding vehicles on the basis of tax consequences. The mere fact that tax considerations are present in the decision to structure business or property arrangements is not the evil at which s 177D is directed. The main focus is on the taxpayer's purpose of obtaining a tax benefit. The purpose under s 177A(5) is the dominant purpose. The overwhelming focus, to repeat, is on inferences drawn from the objective steps in the transaction and on the content and limits of the core test applied to it. While the thrust of the provision is clear, the test is not spelt out in detail by the legislation in this critical area. The critical choice is delegated to bureaucrats, Tribunal members and to judges. It is necessary to develop an orderly set of criteria for the application of this critical test and it is on this task that future authority is likely to focus. It is necessary to spell out the minimum threshold for such annihilation.

20. It might well be that the time is now ripe for attempts to articulate the limits of s 177D in cases such as the present. But as a vehicle for such a review, this case is not very instructive for a number of reasons. First, because the applicant did not put forward a serious argument on this point. Second, because the applicant received no salary and very little distributed income from the trust. Hence it is difficult to argue that the transaction was a bona fide structuring of commercial arrangements and that the dominant purpose of the transaction was not to obtain a tax benefit. Third, because in the recent decision of the Full Federal Court in Bunting v FC of T 89 ATC 5245 the Court applied the old general anti-avoidance provisions to a very similar situation. (See also Hartigan J in Case W58,
89 ATC 524, 536; Federal Court in
Tupicoff v FC of T 84 ATC 4851, 4853). The finding of Lockhart J, as reported without comment by Beaumont J (at 5250), was that a family trust structure created by a computer consultant, in circumstances similar to the present, ``was more than was necessary'' to provide the benefits of superannuation and a corporate vehicle for provision of services. Gummow J added that the limitation of personal liability was another reason for the trust. It was said

``No business or family purpose can be found for the creation of the family trust.''

A distinguishing feature of Bunting was that the taxpayer was expressly excluded as a beneficiary. This provided ``a strong indication that the primary purpose of the transaction was to `split' the [taxpayer's] income between himself and members of his family.'' Gummow J spelt it out by holding that (at 5253):

``what was done is not fairly explicable without an inference being drawn that a purpose, if not the primary purpose, was to effect a `split' of the income...''

The test from FC of T v Gulland 85 ATC 4765, 4772 is that if tax avoidance is one of the main purposes of the arrangement, in the sense that it is not inessential or merely incidental, the scheme is annihilated. I find that, on applying the terms of s 177D to the facts of this case, it would be concluded that the steps in setting up this particular discretionary trust were carried out to enable the taxpayer to obtain a tax benefit in connection with the scheme. I find this having regard to s 177D(b)(i), (ii), (iv), and (viii).

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21. It is clear from the evidence that the income of the trust was generated very largely from the skills, experience and effort of the applicant. His two major clients came to him personally after hearing about him through word of mouth. In one period of three months, on the basis of his evidence, he spent 862 hours on this work. Yet he received no salary. To apply the test of Gummow J in Bunting v FC of T 89 ATC 5245, 5253, ``what was done is not fairly explicable without an inference being drawn that a purpose, if not the primary purpose, was to effect a `split' of the income of the taxpayer between himself and the members of his family''. Gummow J (at 5253) affirmed the test of Gibbs CJ that it is enough for s 260 that ``tax avoidance is one of the main purposes of the arrangement in [the] sense that it is not inessential or merely incidental''. In my view a similar test must apply to s 177D. Since, as I have shown, mere diminution of tax cannot trigger s 177D, the test in the full context of Part IVA must involve inferences about attempts to avoid the provisions of the Act. The purpose of enabling the taxpayer to obtain a tax benefit through a scheme connotes that the dominant purpose of the steps designed to avoid tax, in the sense of circumventing the provisions of the Act.

22. For the relevant years the Commissioner disallowed the applicant's business expenses of $10,574 for the 1982 tax year, $13,840 for the 1983 tax year, $13,146 for the 1984 tax year and $9,582 for the 1985 tax year. These expenses covered accountancy fees, ``advertising and entertainment'', motor vehicle expenses, office and travel expenses and office salaries (mainly to the wife of the applicant). These expenses were disallowed to the trust by the Commissioner. My impression was that, in the event that the trust arrangement was annihilated, the Commissioner was prepared to allow the applicant to deduct these amounts. These issues were raised as an afterthought and little considered argument was directed to them.

23. This matter is remitted to the Commissioner with directions that the assess the income to the applicant in accordance with the terms of this decision and in accordance with
Jackson v FC of T 89 ATC 4429. Liberty is reserved for either party to apply further to the Tribunal if these matters of quantum cannot be settled by consent. The Tribunal can then complete this part of the decision with the benefit of considered argument from the parties.

24. For the reasons given, and subject to the settlement of outstanding matters of quantum, the decision under review is affirmed.