CASE 11/99

Members:
J Block SM

Tribunal:
Administrative Appeals Tribunal

MEDIA NEUTRAL CITATION: [1999] AATA 649

Decision date: 31 August 1999

J Block (Senior Member) (a) There are four objection decisions which, by agreement between the parties, were heard together by the Tribunal; there were originally five but the fifth objection decision (which related to an objection by a director of and shareholder in the Company against an assessment under section 108 of the Income Tax Assessment Act 1936 (``Tax Act'')) was settled.

(b) (1) Matter No. NT98/41 relates to the disallowance by the Respondent by notice dated 19 December 1997 of an objection dated 24 February 1997 against an amended assessment issued on 27 November 1996 in respect of the year ending June 1995 (``relevant year''); that decision is referred to as the Income Tax decision.

Document T10 at page 55 of the Income Tax T Documents (and which is a page in the Reasons for Decision pursuant to which the objection was disallowed) indicates that the relevant questions in respect of the Income Tax decision were as follows:

``1. Whether or not the following amounts being private portions of borrowing expenses are allowable deductions under subsection 67(1) of the Income Tax Assessment Act 1936 (`the Act'):

For the year ended 30/6/94 - $1,283.

For the year ended 30/6/95 - $2,018.

2. Whether or not the additional tax for understatement... should be remitted under subsection 227(3) and 170AA(11) respectively of the Act?''

(2) Document T4 at pages 15 and 16 of the Income Tax T Documents indicate that in respect of each of the years ending June 1994 and the succeeding year (which is the relevant year), the Respondent issued adjustment sheets and pursuant to which, in respect of the first of such years, there were add-backs in respect of ``private portion of borrowing expenses disallowed'' and in addition a correction in respect of ``sales increased to correct wrong postings to shareholder's loan account'' and in the relevant year there were add-backs of $2,018 in respect of ``private portion of borrowing expenses disallowed'' and in addition $7,140 for ``sales increased in respect of hay''. Page 16 bears a handwritten notation in respect of the first of those years reading: ``See corrected adj sheet''.

(3) The Tribunal notes that its decision in relation to the Income Tax decision relates only to the questions referred to at page 55 of T10 of the Income Tax T Documents (supra) and in particular the disallowance of borrowing costs for the two years in question and the penalty imposed in consequence of that disallowance. The Tribunal is not clear, having regard to the amended assessment (T6, pp. 20-21 of the Income Tax T Documents) whether that assessment relates to the questions previously referred to and also the other add-backs; this decision does not relate (if relevant) to any other add-backs.

(4) The Tribunal notes that the hearings in this matter tended to concentrate on the fringe benefits tax objection decisions (and in particular the amounts assessed as loan fringe benefits) to a very considerable extent, and so that the Income Tax decision was dealt with in the main in closing argument.

(c) NT98/43, 47 and 48 relate to assessments of fringe benefits tax (``FBT'')(and penalties referable thereto) in respect of the FBT years ending 31 March 1994, 31 March 1995 and 31 March 1996 respectively; those years are referred to collectively as the ``FBT years'' and each is an ``FBT year''. In respect of each FBT year, the Respondent by notice dated 17 December 1997 disallowed the Applicant's objection dated 24 February 1997 against an amended FBT assessment issued on 13 November 1996. The objection decisions referred to in this subclause (c) are referred to collectively as the ``FBT decisions'' and each is an ``FBT decision''.

2. The Applicant was represented by Mr John Eager, a consultant solicitor, while the Respondent was represented by Ms Barbara Zakos and Mr Ian Marriott, both of whom are officers of the Respondent. The Tribunal had before it, in respect of each of the Income Tax decision and also the FBT decisions, T Documents (and also supplementary T Documents) lodged pursuant to section 37 of

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the Administrative Appeals Tribunal Act 1975. The T Documents are referred to, as relevant, as the Income Tax T Documents, and the FBT T Documents. The Tribunal also accepted into evidence exhibits as follows:

• Exhibits A1 to A35 inclusive (distinguished by their tab numbers) are exhibits tendered by the Applicant and which are referred to in each of the two witness statements, which are Exhibits A36 and A37 respectively.
• Exhibit A36 is a witness statement dated 26 February 1999 by a man who will be referred to as ``Wilson''; these matters were heard in private, however, and to make these Reasons more readable, I have allotted pseudonyms to the two witnesses who gave evidence before me and to certain other persons and places who or which are relevant.
• Exhibit A37 is a witness statement dated 26 February 1999 by an accountant who will be referred to as ``French''.
• Exhibit A38 is an annexure to the document styled ``Outline of Applicant's Contentions'' referable to the FBT decisions; that annexure was prepared by the Applicant, on the assumption that certain loan benefits are loan fringe benefits and sets out the Applicant's calculations of the FBT (exclusive of penalty) in respect of the FBT years; it is unnecessary for me to reproduce Exhibit A38 in full; suffice it to say that the Respondent accepted that it was correct. Therefore, and pursuant to Exhibit A38, the FBT (exclusive of penalty) in respect of each of the three FBT years payable by the Applicant (assuming a finding in favour of the Respondent) is as follows:

``1994 - $7,868;

1995 - $11,674;

1996 - $3,623.''

3. The issues in these matters fall within a relatively narrow compass; the relevant facts will be outlined later in these Reasons. Nevertheless these matters have generated a surprisingly large quantity of paper and were heard over three days in April, May and August 1999 respectively. In addition to those hearing days (and when the objection decisions proper were heard), the Applicant had previously made two interlocutory applications both of which were fully argued. In respect of those interlocutory applications the Applicant first sought an order under section 42D of the Administrative Appeals Tribunal Act 1975, that the matters be remitted to the Respondent for reconsideration of the objection decisions. The Tribunal, having considered all of the documents then before it, and having regard to a decision by Deputy President Forgie of this Tribunal (which was referred to at length in the Tribunal's decision to dismiss), dismissed that application. At a subsequent directions hearing, the Respondent agreed to furnish further documentation; a considerable quantity of further documentation was furnished, and the T Documents were supplemented accordingly. The Applicant nevertheless made a further substantive application for an order requiring the Respondent to furnish yet further documentation; that application was also, after argument, dismissed. In respect of each of those applications, a formal decision was issued.

4. (a) The other pseudonyms selected for the purposes of these Reasons are as follows:

• ``Downford'' refers to a town in New South Wales; the property which is relevant to these proceedings is situated near Downford;
• ``Company'' refers to the company which is the Applicant in these proceedings;
• ``Wilson'' and his wife (referred to as ``Mrs Wilson'' although she prefers in fact to use her maiden name) are the only shareholders in and also the only directors of the Company; ``Mr & Mrs Wilson'' and the ``Wilsons'' have corresponding meanings;
• ``Douglas'' refers to a solicitor in Downford who was involved in the negotiations which preceded the purchase of the property;
• ``Mr & Mrs Oliver'' refer respectively to the married couple who previously owned the property; their company, which previously owned the nursery business which was conducted on the property, is referred to as ``Alban''. Mr & Mrs Oliver are also referred to as the ``Olivers''.

(b) The relevant property was referred to in the T Documents and the proceedings by its name. I intend to refer to it simply as the ``property''. The area of the property is approximately 12.99 hectares or 32.1 acres.

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That area is divisible (for the purposes of these Reasons) into three distinct areas as follows:

(1) There is a private residence (and tennis court) which occupies an area which was sometimes referred to as encompassing an acre and sometimes a hectare of the entire property. It may be that with surrounding curtilage, the area involved is a hectare but, as will be seen, nothing very much turns on the precise size of the private residence.
(2) About 7.66 acres is used in respect of a nursery (and related business) display area; the nursery and related businesses are collectively referred to as ``the business''.
(3) The remainder of 23.5 acres is used for farming activities which were associated with the business.

The term ``property'' refers to the property, excluding the dwelling in which the Wilson family reside. The term ``whole property'' refers to the property and the dwelling. The whole property was (and presumably still is) held under one title; there was evidence by Wilson that subdivision was not permissible under Downford regulations.

(c) The FBT decisions relate to certain benefits, and which, so the Respondent contends, were fringe benefits in respect of each FBT year. Those benefits are of two types, and being loan benefits and expense payment benefits.

5. The facts, about which there is little real dispute, are as follows:

(a) In 1993 the Company was engaged in the conduct of a business (not the business which figures in these Reasons) in Downford. Mr & Mrs Wilson became aware of the fact that the Olivers wished to sell the property and the business. It is relevant to note that the Olivers were the owners of the property, whereas their company, Alban, owned the business.
(b) It was originally intended that the Company would purchase both the property and the business; indeed Exhibit A1 is a lengthy loan proposal prepared in respect of the Company for submission to a bank in Downford (the ``Bank'') in which finance in an amount of $300,000 was sought. Exhibit A1 indicates that of the total price of $500,000 for the business and property, $100,000 would be provided by Mr & Mrs Wilson, $100,000 would be provided by the Olivers by way of vendor finance (secured by a second mortgage over the whole property) and accordingly the Bank was asked to provide finance of $300,000 to the Company. Exhibit A1 consists of a considerable number of documents; in particular it includes a business resume in respect of Wilson; in addition it includes an extract from figures furnished by French, who was also the accountant to the Olivers, referable to the business and which indicates that for the period of 6 months from 1 July 1992 to 31 December 1992 the net profit was $68,757 but that that amount increased by $16,854 to $85,611 (or $171,222 on an annualised basis) if rent, depreciation, and interest were added back.
The business resume in respect of Wilson indicated that he had enjoyed a considerable degree of business success. He had, inter alia, worked for a bank for a period of three years, he had been the manager of various business undertakings, and in addition he had been the president of the Chamber of Commerce of another town in New South Wales.
(c) Subsequently numbered exhibits indicate that the Bank approved the grant of finance to the Company; see in particular Exhibits A2 and A3. The security required by the Bank was broadly that offered under Exhibit A1 and being a registered first mortgage over the property, a debenture in respect of the Company's assets and guarantees by Mr & Mrs Wilson. Exhibit A3 indicates that the second of the securities required was a registered mortgage over the property and the fourth was a letter of priority in relation to a second mortgage in favour of the Olivers.
(d) The evidence is that subsequently a meeting took place with French (who was the accountant to both the Wilsons and the Olivers) and the solicitor, Douglas, who also acted for both parties. At that meeting a discussion took place; Wilson remembered very little of what had been discussed at that meeting, but after some hesitation agreed that capital gains tax had been raised. In fact, French confirmed, when he gave evidence, that capital gains tax was very much an issue raised at that meeting; if the Company had purchased the property as was originally intended, there would have been

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two adverse tax consequences; in the first place the Company could not have enjoyed the principal private residence exemption allowed to natural persons under the Tax Act and, in the second place, if the Company had resold the property at some later date at a profit, its capital gain would have been reduced by indexation of its cost base but the benefit of that indexation factor would have been lost if that profit were distributed in full, since the indexation portion would have given rise to an unfranked dividend.
(e) For these reasons, it was decided that the transactions should be restructured in such manner that the Wilsons purchased the property from the Olivers while the Company purchased the business from Alban. Accordingly:
- (1) Exhibit A5 is an Agreement for Sale of Business (in respect of the business) between Alban as seller and the Company as purchaser for an amount of $63,000;
- (2) Exhibit A6 is a Contract for the Sale of the Property (in respect of the whole property) by the Olivers to the Wilsons (as joint tenants) for a price of $437,000. It is relevant to note that condition 12 of the annexure to that document specifies that of the total amount, $80,000 was apportioned to ``house and one hectare''.
(f) The Bank was, of course, advised of this change of plan; it agreed nevertheless to lend $300,000 to the Company on the basis that a real property mortgage would be granted in respect of the whole property by the Wilsons as guarantors on behalf of the Company.

6. (a) Mr Wilson gave evidence before the Tribunal. His evidence overall indicated a distinct lack of knowledge of basic accounting principles. Some of his evidence as to the meeting previously referred to is set out at pages 17-20 of the transcript for 26 May 1999 as follows (edited to preserve confidentiality, and as will be done in respect of all excerpts from the transcript):

``MS ZAKOS: You have a loan proposal prepared for [the Company] by a person named [] from []? - That is correct.

I refer the Tribunal to A(1). On page 3 of the proposal, it gives a profile of your background and your success in businesses. You have been quite successful, haven't you, turning businesses over, I understand carrying business over from a profit of $25,000 per annum to $69,000 per annum. Then from March '81 to April '86, in respect of the [], you increased turnover from $250,000 to 1.8 million, is that correct? - That is correct.

Then as a manager of [], you increased stock run from 3.3 million to 5.7 and you turned the company around from a major trading loss to a major trading profit, is that correct? - That is correct.

Once again, your timber logs and latest business was quite successful? - It was difficult to start up.

Generally you have been a very successful businessman, as such?

MR MARRIOTT: I think we - could I just ask you to answer these questions, a no[d] doesn't show up as anything on transcript? - Sorry.

So yes or no.

MS ZAKOS: Mr [French] has always been your accountant in respect of the activities conducted by [the Company]? - Yes, he has.

MR BLOCK: The loan proposal was prepared by []. Is Mr [French] connected with [] somehow or other?

MS ZAKOS: I don't know whether they are connected. All I do know is they are two separate individuals. I think and I stand to be corrected, I think [] is a financial advisor? - That is correct.

That is correct. Mr [French], is he accountant for both, I understand, [the Company] and Mr [Wilson] and Mrs [ Wilson], is that correct? - That is correct.

Mr [French] has always prepared your accounting records for [the Company]? - Yes, he has.

He has prepared your income tax for yourself and your wife? - Yes, he has.

Since when? - Since we started [the Company].

What [sic] was approximately 1989? - 1991, I think, wasn't it.

1991? - Yes.

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In respect of the years ended 30 June 1993 and following, what did you give Mr [ French] by way of information for him to prepare your income tax returns and financial statements? - It would have been cheque books and deposit books, bank statements.

Did you provide him with any receipts or any invoices? - If he would have requested at the time, yes, certainly.

Does he request them? - From time to time, yes, he does.

What about in the years ended 30 June 1993, 1994 and 1995? - I don't recall but I would, you know, I am sure that there would have been something that he would have wanted further information on or clarification of at the time.

In other words, you provided him with your cheque books, deposit books, bank statements and possibly invoices or receipts as requested by Mr [French]? - Yes.

Did you keep all your invoices and receipts? - Yes.

So at any time they could have been asked for? - Yes.

You could have been in a position to provide them? - That is correct.

Did you discuss the purchase of the property with Mr [French]? - Yes, we did.

Could you tell me when you discussed that? - It was prior to the purchase of that. It would have been around March, April '93.

What discussions took place? - The discussions took place on the basis of how can we get the finance for it. Could we get the finance for it and how should we structure the purchase of the land and the business.

How did you decide to structure the purchase of the land? - From my recollection we had a meeting with [ Douglas], who was our solicitor and [ French] in [Douglas's] office.

MR BLOCK: What was the name of that solicitor? - [Douglas] of [Douglas] and Sons.

You had a discussion with? - [Douglas] from [Douglas] and Sons, Solicitors in [ Downford] and [French] from [French] & Co in [Downford]. From my recollection the discussions were based on the best possible situation for myself and Mrs [Wilson] to purchase the company of which a decision was made that myself and Mrs [Wilson] purchase a house and one acre and the balance of the land would be purchased for the income or the deriving of the business or the income.

You said purchase the company. You don't mean that? - No, the company, [the Company] buy the land.

So your original idea was? - Myself and Mrs [Wilson] -

You and your wife purchased just the house on an acre? - Yes.

And [the Company] purchases the rest? - That is as I understood it.

So a rental proposal, but it altered, didn't it? - Yes, I don't totally understand a lot of this and I am basically relying on [Douglas] who is the solicitor and [French] our accountant to advise us on what was set up. That is my basic understanding of it.

MS ZAKOS: I will come back to that discussion in a moment, so we will hold that for a moment. I just want to take you back to the records provided for Mr [French]. Can you remember giving Mr [French] your telephone bills? - No, I can't.

Can you remember giving Mr [French] your rates notices? - Yes, I think there was - yes, because the property has just one, like there is not two rate bills or whatever.

So you actually gave him the rate notices? - Yes.

You say you can't remember giving [ French] the telephone bills but you do remember giving him the rates notices? - Well, the telephone - yes, because it would have come up as to what rates we would have paid.

What about the electricity bill? - No, I couldn't say on that. I don't know.

In respect of the interest, would you have given him your bank statements? - Yes.

In respect of the loan accounts as well? - Yes.''

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(b) Wilson subsequently agreed that capital gains tax was a relevant consideration.

(c) In respect of the whole property, the Company paid expenses referable to the dwelling and in particular electricity (and there was one meter only for the whole property), telephone bills (and there were separate telephones and thus separate telephone accounts for the dwelling and the business) and rates, and also interest in respect of the vendor finance which was provided by the Olivers; see in this context the following extract from pages 24-26 of the transcript for 26 May 1999 as follows:

``In respect of the telephone, you have a separate telephone at your home? - That's right.

As opposed to that in the nursery business? - Yes.

You have two separate phone bills? -Yes.

And they were both paid by the company, weren't they? - Yes.

In respect of the electricity -? -

MR BLOCK: Sorry, separate telephone bills both paid by the company? - Yes.

...

MS ZAKOS: I think we were talking about the electricity? - Yes, there was only one account.

It's only one account? Can you explain why it's only one account? - Because there is only one meter that the council read on the property.

Did you take into account the private reporting of electricity at that time which related to your home? - Not at that time.

So effectively we have the situation that a company paid for your private telephone expenses? - That was correct.

We also have the situation where the company also paid for the private proportion of electricity in respect of your residential home? - It was paid as per the account, yes.

You kept a separate check account as Mr [ Wilson] and Mrs [Wilson] as opposed to that of [the Company]? - Yes we did.

You didn't write a cheque out to pay for a private proportion of this electricity bill did you? - No.

The company paid the full hundred percent? - Yes, that is correct.

Did you tell Mr [French] that the company had paid for these extensions on your behalf? - No.

Is there a reason for that? - I didn't even consider it.

Didn't consider it. You maintain that if there was a benefit in your statement, you maintain that if there was a benefit that was owed to you by way of a loan benefit, you believe -''

(d) Wilson's evidence as to his lack of knowledge is, in the view of the Tribunal, surprising when one considers his previous work experience and the positions held by him. Overall there is some doubt in the mind of the Tribunal as to whether he was as naive as he sought to suggest.

(e) Wilson made it clear that it was never contemplated that the Company would pay rent for the property; page 51 of the transcript for 26 May 1999 indicates that for the first 12 or 18 months, the Company did not derive a profit and that Mr & Mrs Wilson received minimal wages. In general terms the business endured a difficult passage through a period of some years after it acquired the business; its problems were compounded by the fact that the Company thought that one of the assets (of the business) it was acquiring was a bobcat but that, so it transpired, that bobcat was under lease; it thus became necessary for the Company to pay rental for a bobcat. The Applicant did not seek a reduction in the price paid for the business in consequence of the fact that it had to pay unanticipated bobcat rentals.

(f) Mr Wilson was shown the accounts for the Company for the year ending June 1993; those accounts were incorrect because the property was reflected as an asset of the Company when, of course, it was not. See page 37 of the transcript for 26 May 1999 and the following exchange:

``MS ZAKOS: Thank you. Do you agree that is a balance sheet for [the Company] for the year ended 30 June 1993? - That's correct.

Do you also agree, under fixed assets, the property is shown as an asset of [the Company]? - That's fixed assets freehold land at cost? Is that the one?

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That's correct? - Yes, that is there.

But that's not right, is it? - I don't know what you are getting at, I'm sorry.

[The Company] doesn't own the property, does it? Yourself and your wife own the property? - Right, that's it.

MR BLOCK: Sorry, I think you said `Right, that's it'. Is that what you answered? - It was a question if the freehold -

MR BLOCK: The question is quite simple. Is that statement in the balance sheet right or wrong? Is it right or wrong that [the Company] owns freehold land at cost? What do you think? - I don't know. I honestly don't know. If that's what it says there, obviously that's what you are getting at. If that's what it says on that piece of paper.

MS ZAKOS: That's not right, is it? - I don't know. Is it?

You should know Mr [Wilson]. Who purchased the property? -''

7. It should be noted at this juncture that the Respondent accepted that the dwelling was separately paid for by the Wilsons out of their own moneys. There was some discussion as to this aspect; however, the Tribunal is prepared, the Respondent having made this concession, to accept that this is so, and accordingly the property, with which the Tribunal is concerned for the purpose of these objection decisions is, for the most part, the property as previously defined and thus excluding the dwelling.

8. It follows, of course, from the fact that the Company was the borrower from the Bank whereas the Wilsons purchased the property that the Company (having obtained the finance from the Bank) must be taken to have on-lent a part of the relevant moneys to the Wilsons to enable them to complete the purchase of the property; the amount on-lent was (as appears from page 72 of the FBT T Documents) $243,300. The loan so arising did not bear interest, and gave rise, so the Respondent contends, to loan fringe benefits.

9. (a) Oral evidence was also given by French. It will be recalled that he was also the accountant for the Olivers. It was he who furnished the detailed capital gains tax evidence previously referred to. It was also he who prepared the 1993 accounts for the Company which erroneously reflected the property as belonging to the Company. That erroneous error had the inevitable effect that the entries as regards loan accounts referable to the Wilsons were equally inaccurate. Similarly and for the same reason, those accounts were incorrect in that they reflected the vendor finance provided by the Olivers as a liability of the company.

(b) French said in evidence that he was unaware of the fact that the whole property was held under one title; the Tribunal doubts whether this can be correct.

(c) But perhaps even more surprising is the fact that French, having become aware of the true position, nevertheless drew the Company's accounts for the years ended June 1994 and June 1995 in exactly the same way and containing exactly the same errors. He sought to explain this aspect firstly on the basis that the accounts were expressed to be unaudited, and secondly that they were not produced to the Respondent, who received abridged information only.

(d) French said that he also prepared tax returns for the Wilsons in accordance with information they provided.

(e) And there were other accounting errors:

(1) Clause 7.7 of French's witness statement (which is Exhibit A37) reads as follows:
- `` Hay sales banked to Mr [Wilson's] own savings account . Mr [P] had discussed this with Mr [Wilson] while I was in [] and I had checked it after talking to Mr [Wilson] about the issue. I agreed with Mr [P] that the $7,140 had not been included in [the Company's] sales for 1994-95 and would need to be added to assessable income.''
It will be noted that the amount in respect of hay sales banked to Wilson's own account was by no means insignificant.
(2) Clause 7.6 of the Applicant's statement reads as follows:
- `` The loan account of the [Wilsons] with [the Company] . Mr [P] asked for information about a number of credit entries to the loan account for the 1993-94 year. He accepted an amount introduced as capital by Mrs [Wilson]. I agreed that my office had made computer keying errors which credited $18,936.16 to the loan account instead of crediting it to sales. I agreed that the error should be adjusted....''
  
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(3) French, although he practices a long way from Downford, saw fit in his witness statement to seek to value the occupancy rights of the property; it is doubtful whether he was qualified to do so.
(4) French's witness statement contains a clause to the effect that he advised the Company that it was under no obligation to furnish FBT returns.
(5) All in all, and putting it at its altogether kindest, the explanation by French as to the fact that the accounts were wrong was ingenuous.

10. It is fair to say that the Wilsons apparently treated the Company as if they and the Company were a single entity. In economic terms this was not a surprising approach; they were, after all, the only shareholders in and directors of the Company. This said, it does not excuse the fact that records were incorrectly or inadequately maintained, that the Company claimed for expenses which were expenses of the Wilsons, and that sales proceeds were banked to Wilson's own account instead of that of the Company. However, that they did not contemplate charging the Company rent and also the fact that their wages in the first years were minimal is not surprising having regard to the financial position of the Company at the time. In the first year after the business was acquired, they received $20,000 in aggregate as salary and the aggregate amount received in the second year was not much more.

11. (a) The Tribunal turns now to deal specifically with the Income Tax decision.

(b) Section 67(1) of the Tax Act reads as follows:

``Subject to this section, so much of the expenditure incurred by the taxpayer in borrowing money used by him for the purpose of producing assessable income as bears to the whole of that expenditure the same proportion as the part of the period for which the money was borrowed that is in the year income bears to the whole of that period shall be an allowable deduction.''

(c) Ms Zakos referred the Tribunal in particular to
Ure v FC of T 81 ATC 4100; (1981) 50 FLR 219. She urged the Tribunal, having regard to that decision, to have regard in this context to the use to which the moneys borrowed by the Applicant were put by the Applicant.

(d) Mr Eager by contrast urged the Tribunal to have regard to the decision in
FC of T v Total Holdings (Aust) Pty Limited 79 ATC 4279; (1979) 43 FLR 217. He referred the Tribunal in particular to Income Taxation in Australia and comments therein of the author, the learned Professor R. Parsons. At paragraphs 6.105 and 6.106, which are set out below in these Reasons, Professor Parsons refers to the decision in Total Holdings in the following terms:

``[6.105] Total Holdings was concerned with the deductibility of interest on borrowings from the French holding company, so far as those borrowings were to be traced into loans made to TAL without interest, and which continued to be loans without interest. A purpose to borrow and lend at no interest does not show on its face a connection between the payment of the interest on the borrowing and a process of income derivation. The finding of a purpose which will connect the payment of interest with a process of income derivation, requires that one go beyond the making of the loan. Lockhart J. (with whose judgment the other members of the Federal Court agreed), in going beyond the loan, relied on evidence given by a witness who was a director of TAL and of the French holding company. The witness gave evidence as to his own state of mind, and of conversations with a director of the taxpayer going to the latter's state of mind. This reliance might suggest that the purpose of an outgoing by way of interest, which `follows accessorily the purpose of the principal sum' (Isaacs J. in Munro (1926) 38 C.L.R. 153 at 198), is a matter of subjective purpose and that the general principle in regard to deductibility - that it is the objective purpose that governs ([6.2]-[6.16] above) - is subject to an exception in this context. The investigation of subjective purpose in Total Holdings influenced Sheppard J. in Magna Alloys & Research Pty Ltd (1980) 80 A.T.C. 4542 to take a subjective approach to the determination of purpose in a context other than the deductibility of interest. It has been seen that the subjective approach in the context of the facts in Magna Alloys was rejected, albeit in a somewhat equivocal way, in the Federal Court in Ure (1981) 81 A.T.C. 4100 as requiring an objective

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approach where the question is the purpose of outgoings by way of interest (per Brennan J. at 4104). But Lockhart J. in Total Holdings is not expressly rejected.

[6.106] In Total Holdings (Australia) Pty Ltd (1979) 79 A.T.C. 4279 at 4286, Lockhart J. held that the activities of the taxpayer `were designed to render TAL profitable as soon as commercially feasible and to promote the generation of income by TAL and its subsequent derivation by the taxpayer and thence [the French holding company]'. He rejected any inference that `it was the dominant or, for that matter, any purpose of the taxpayer in making interest fee loans to TAL that once TAL became profitable, a substantial portion of shares held by the taxpayer in TAL would be disposed of to some outsider for capital profit'. He went on to assert that `even if the evidence did warrant the drawing of [the] inference [of purpose to make a capital gain], I am far from satisfied that it would operate to deny a business or income producing character to the interest-free loans over such a long period of time'. No reasons for this want of satisfaction are given, except in the reference to `a long period of time'. There must be circumstances where lending interest free to a company in which one holds shares, or, equally, subscribing for shares, reflects a purpose, not to derive income, but to generate a capital gain. It is not easy to appreciate why the Commissioner in Total Holdings made the admission he did in regard to the subscription for shares, while making the argument that there was no income producing purpose in the lending interest free. To the extent that a purpose to obtain a capital gain is to be inferred, the payments of interest should be denied deduction.''

(e) Mr Eager contended that the Tribunal should not adopt a blinkered approach as referred to by Professor Parsons in succeeding paragraphs of Income Taxation in Australia, but rather should have regard to the purpose for which the Company borrowed the money. He urged the Tribunal to find, in accordance with Total Holdings, that the moneys were on-lent for an overall purpose of income derivation.

(f) The Tribunal notes, with some surprise, that the Respondent had allowed all of the interest incurred in all relevant periods. Accordingly to disallow a part of the borrowing costs would appear to be inconsistent.

(g) Curiously enough both parties argued the Income Tax decision as if it fell to be determined under section 51(1) of the Tax Act; that section reads (in part) as follows:

``All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions...''

Total Holdings is an interest deduction case. Ure is generally quoted as authority for the proposition that where one borrows at a higher rate and lends out at a lower or nominal rate to an associate, the allowable interest deduction is confined to the lower or nominal rate obtained.

(h) Ure's case, of course, fell to be decided under both section 51(1) and section 67 of the Tax Act. As Professor Parsons notes, there are problems of correlation. See in this context paragraphs 10.219, 10.220 and 10.221 of Income Taxation in Australia as follows:

``[10.219] If costs of obtaining a borrowing are deductible in any circumstances under s. 51(1), there will be problems of correlating the operation of s. 51(1) and the operation of s. 67. All judges in the Federal Court in Ure (1981) 81 A.T.C. 4100 were able to avoid any such problems. Deane and Sheppard JJ. held that none of the costs - valuation fees, legal costs and guarantee fees - that fell to be considered in relation to s. 67 were working expenses, and all were in fact deductible in the manner allowed by s. 67. Brennan J. held that the guarantee fees, which were payable over the period of the loan, were working expenses - expenses of maintaining or servicing the borrowing - and were deductible under s. 51(1). He held that they were not deductible under s. 67, because they were not expenditure incurred in borrowing money.

[10.220] Where s. 51(1) and s. 67 are both prima facie applicable, s. 67 will, presumably, prevail as the more specific provision. If the costs are seen as outlays in obtaining the accommodation comparable with costs of revenue assets and not deductible under s. 51(1), they will be deductible under s. 67 and, in the operation

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of s. 82(2), will not be subtractable in determining any profit or loss that is income or deductible on the discharge of the liability.

[10.221] If the interpretation of the word `used' in s. 67 adopted by the Federal Court in Ure (1981) 81 A.T.C. 4100 is accepted, it will follow that no apportionment is possible under s. 67 so as to deny part of the cost of the borrowing in circumstances like those in Ure, notwithstanding the addition in 1984 of subs. (4) of s. 67. And if s. 67 is a code there will be no possibility of an apportionment under s. 51(1). Section 67(4) will not make an apportionment possible because it operates only where the taxpayer had borrowed money `used by' him only partly for the purpose of producing assessable income. The interpretation given to `used' in Ure requires a conclusion that, in the circumstances of that case, the money has been wholly used for the purpose of producing assessable income. Subsection (4) will be confined to an operation in circumstances where some part of the money borrowed has not been on-lent, or is not in the year of income on-lent, at interest.''

(i) It is of interest to note that in Ure's case borrowing costs were found to be deductible in full even though the section 51(1) interest deduction was confined to the interest derived. In fact, of course, the tests are different; section 67(1) adopts a purposive test. See in this context the CCH [Australian Federal Tax] Reporter at page 21,245 which states:

``Expenditure incurred in borrowing money is normally of a capital nature (
Texas Land and Mortgage Co v Holtam (1894) 3 TC 255) and would not therefore, apart from specific statutory provision, be an allowable deduction.

Section 67 provides statutory authority for the deduction of expenditure incurred in borrowing money where the money is used by the taxpayer for the purpose of producing assessable income. The section does not seem to require that assessable income should be produced in the same year as that in which a deduction is claimed (the words `incurred in gaining or producing the assessable income' used in sec 51(1)).''

(j) In the Tribunal's opinion, the proper construction of the transaction regarded as a whole is that the Company, having borrowed $243,4000 from the Bank, must be taken to have on-lent that amount free of interest to the Wilsons but on the basis that it obtained a right to use the land. The Company could not, and would not, have acquired the business if it did not also obtain the right to use the land. The Tribunal appreciates, of course, that the on- lending by the Company to the Wilsons occurred (as a matter of accounting necessity) in consequence of the manner in which the restructuring of the transaction was effected. Of course the Company cannot be heard to argue that the manner in which the transaction was structured should be ignored; there is no suggestion that it was a sham. It had legal effects and to which the Tribunal must have due regard.

(k) Since the on-lending to the Wilsons was made in order (albeit indirectly) to obtain the use of the property (and without which the business would not have been acquired), the purposive test required by section 67 of the Tax Act is satisfied, and the Income Tax decision must therefore be set aside.

12. (a) This brings the Tribunal then to the FBT decisions. There were, according to the FBT T Documents, two relevant fringe benefits and being expense payment fringe benefits (and there is no dispute between the parties as to quantum in respect of the expense payment fringe benefits) and loan fringe benefits; in the latter context the Respondent assessed by reference to the amount of $243,300 on- lent; the Respondent has accepted that, having regard to Exhibits A14 and A38, FBT must be calculated having regard to loan account movements as reconstructed, and thus by reference to the lower amounts set out in Exhibit A14. Put in other words, the Respondent must allow credits or set-offs for the original credit balances in favour of the Wilsons in the books of the Company and moneys introduced thereafter; the Tribunal need not detail the sources of those introduced moneys or the original credits.

(b) There will, of course, be fringe benefits which attract FBT only if the benefits in question were in fact fringe benefits as defined in the Fringe Benefits Tax Assessment Act 1986 (``FBTAA'').

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(c) The relevant sections for this purpose are the definition of ``fringe benefit'' in section 136(1) as expanded by section 148(1) both of which provisions are set out in full as follows:

``136(1) [Definitions] ...

...

`fringe benefit' , in relation to an employee, in relation to the employer of the employee, in relation to a year of tax, means a benefit:

(a) provided at any time during the year of tax; or

(b) provided in respect of the year of tax;

being a benefit provided to the employee or to an associate of the employee by:

(c) the employer;

(d) an associate of the employer; or

(e) a person (in this paragraph referred to as the `arranger' ) other than the employer or an associate of the employer under an arrangement between:

(i) the employer or an associate of the employer; and

(ii) the arranger or another person;

in respect of the employment of the employee, but does not include:

...

148(1) [Meaning of provision of benefit to person] A reference in this Act to the provision of a benefit to a person in respect of the employment of an employee is a reference to the provision of such a benefit:

(a) whether or not the benefit is also provided in respect of, by reason of, by virtue of, or for or in relation directly or indirectly to, any other matter or thing;

(b) whether the employment will occur, is occurring, or has occurred;

(c) whether or not the benefit is surplus to the needs or wants of the recipient;

(d) whether or not the benefit is also provided to another person;

(e) whether or not the benefit is, to any extent, offset by any inconvenience or disadvantage;

(f) whether or not the benefit is provided or used, or required to be provided or used, in connection with that employment;

(g) whether or not the provision of the benefit is, or is in the nature of, income; and

(h) whether or not the benefit is provided as a reward for services rendered, or to be rendered, by the employee.''

(d) The Tribunal respectfully agrees with the decision of Senior Member Pascoe in
J & G Knowles & Associates Pty Ltd v FC of T 98 ATC 2205 [at 2211-2212]; clauses 10, 11 and 12 of his decision in that matter are as follows:

``10. It was not in dispute that the four directors were `employees' for the purposes of the Act and there was no dispute as to the calculations of the taxable value of the alleged loan fringe benefits. In addition, there was no dispute that the family trusts were associates of the employer and the wives of the directors were associates of the director/employees. The sole issue in this case was whether it could be said that the loans were made `in respect of the employment of the employee'. In a passage from the judgment of the Supreme Court of Canada in
Nowegijick v R (1983) 144 DLR (3d) 193 at page 200, which was subsequently adopted by Toohey J of the High Court in
Smith v FC of T 87 ATC 4883 at page 4894; (1987) 164 CLR 513 at page 533, Dickson J said:

`The words ``in respect of'' are, in my opinion, words of the widest possible scope. They import such meanings as ``in relation to'', ``with reference to'' or ``in connection with''. The phrase ``in respect of'' is probably the widest of any expression intended to convey some connection between two related subject- matters.'

Whether or not a benefit will be included as a fringe benefit depends upon finding a connection or relationship between the benefit and employment. That connection, relationship, cause of the benefit need not be the dominant one as provided for in section 148 of the Act but it is necessary to find that employment is a causal factor in the benefit. The applicant submitted that, here, the relationship was one of ownership of the applicant with no element of employee and employer as a factor in the loans. The respondent submitted that there was no ownership by the directors per se and the

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only relationship which gave rise to the loans was that of director of the applicant company.

11. The applicant sought comfort in Taxation Ruling MT 2019 which discusses fringe benefits tax in relation to shareholder employees of family private companies and directors of corporate trustees. Paragraph 19 of the Ruling states:

`As a general rule, where there are no facts or circumstances which positively indicate that a loan to a shareholder/ employee is associated with that person's employment and the loan is consistent with his or her status as a shareholder, it would ordinarily be inferred that the loan was made by virtue of the shareholding. This approach recognises that major shareholders of a family company may obtain loans from the company on a view that these are merely as a return of their own money rather than a reward for any services rendered to the company.'

Comments in the Ruling relating to directors of corporate trustees are confined to provision of non-cash benefits such as free occupancy of a family home. I am unable to see how this Ruling provides much assistance to the applicant. Firstly, the directors are not shareholders or unit holders. They may be regarded as controllers of KIUT but that control stems from their role as directors of KIUT, presumably as directors of the corporate trustees of the family trusts and, to a degree, as appointers in each of the family trusts. However, they were not, themselves, owners. Secondly, if the loans were to be regarded as consistent with a status of owners, it would be expected that the loans would be in proportion to the ownership share. They were not, given the lack of pattern, consistency or cumulative amounts of the loans. Thirdly, the applicant was in no position to return money to its owners. The ability to make loans was said to be the result of surplus cash generated by the method of operation of the business. But this was relatively short term surplus cash. It was required to be paid to vendors at the end of an agreed period and, at all times during the relevant period, the group had substantial borrowings and the bank account was in overdraft. Further, the group and KIUT incurred a loss in the year ended 30 June 1987, made a profit in the year ended 30 June 1988 but not sufficient to offset prior year losses and incurred a further loss in the year ended 30 June 1989. It was said that the loans were equivalent to drawing out capital of the business and this was demonstrated by their extinguishment from the capital distribution on 1 August 1988. However, approximately 75% of this capital distribution was from unrealised profits and, while this proposition may have demonstrated an increase in asset value of KIUT, was not represented by any cash surplus or provided an ability to make cash distributions. The realised profit proportion of the capital distribution represented some 44% only of the loan balances immediately prior to the resolution and the journal entry for the capital distribution. It may well be that the applicant's advisers performed a disservice to the applicant and its directors in allowing them to believe that it was not unreasonable to borrow in excess of $4 million against funds held to satisfy future liabilities and from unrealised gains.

12. It is clear that a benefit does not become a fringe benefit solely because there exists a benefit and an employer-employee relationship. The words `in respect of the employment of the employee' in the definition of `fringe benefit' in subsection 136(1) require a nexus, some discernible and rational link, between the benefit and the employment. Here the applicant says there was no such nexus and the discernible link was between ownership and the benefits. The respondent says there is no other nexus because there was an employment relationship and no actual ownership relationship. In my view, this is one of those not unusual cases of four businessmen who obtain and accept advice as to an appropriate legal structure within which to own and operate the business but do not understand the legal ramification of the structure adopted and, in fact, ignore it in the day to day operations of the business. The simple facts are that the four directors were not owners of the business and had no vested interest in or entitlement to income, profits or capital of the business. Each was a contingent beneficiary as to income of a family trust with entitlements to income

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only if KIUT had a net income and the trustee of the relevant family trust resolved in its absolute discretion to distribute part or all of the trust's share of that net income to the director. Under the terms of each family trust the director was not a `primary beneficiary' and had an entitlement to capital of the trust only if, prior to the vesting day, the trustee by instrument in writing exercised a power of appointment in favour of such director. In a legal sense, each director had no greater interest in the income or capital of the family trust than any other `general beneficiary' which, in each case, included brothers, parents-in-law, children and spouses. True it was, that, on 1 August 1988, each of the directors were favoured by the trustee of each of the family trust with a distribution of 50% of 25% of the capital distribution, or $990,171. However, this was well after the funds were borrowed from KIUT. The decision and resolutions relating to the capital distributions had all the hallmarks of seeking to resolve a problem recognised by the advisers and there is no evidence that such potential distribution was in contemplation by anyone when funds for personal use were borrowed from KIUT.''

(e) In
Curtain World Pty Ltd v DFC of T 99 ATC 2020 Deputy President Barnett of this Tribunal noted that he agreed with Senior Member Pascoe's view (as set out in the Knowles case) that the mere existence of both a benefit and employment is not sufficient, and that there must be a nexus between the benefit and employment. The Curtain World case related to the provision by a company of luxury cars to its directors and where there was a partial business use of those cars. Clauses 16 and 17 [at 2024] of that decision are as follows:

``16. The Tribunal finds that the three directors were actually employed by the applicant during the fringe benefit tax years and that they actually used the vehicles for varying proportions of total usage for the purpose of that employment (see table of usage in the Statement of Agreed Facts). Clearly this falls within the words that the vehicles were provided `in relation directly or indirectly to that employment'.

17. If there was lingering doubt it is dispelled by reference to s. 148(1) which includes a benefit which `is also provided in respect of... etc any other matter...' such as ownership or family relationships. In relation to DHW if the vehicle was provided in respect of employment which has already occurred or as a reward for services rendered it would be caught by para (b) and (h).''

(f) Mention was made at the hearing of the Federal Court having recently upheld the decision of Senior Member Pascoe in Knowles' case. The Tribunal, after the conclusion of the hearing, obtained a copy of the judgment which was handed down on 6 August 1999 by Sundberg J (
J & G Knowles & Associates Pty Ltd v FC of T 99 ATC 4788 at 4795-4796; [ 1999] FCA 1060); clauses 19, 20 and 21 of that judgment are as follows:

``19. I have set out passages from the Tribunal's reasons in which various findings are made. I record below the more significant of them. The references in brackets that appear after a finding are to pages in the Appeal Books. The first six findings (some of mixed fact and law) were not in dispute.

• The directors were not the owners of the applicant's business (Saul 450).

• They had no vested interest in or entitlement to income, profits or capital of the business (Saul 496; Unit Trust Deed 29, Family Trust Deeds 760, 791, 821).

• The loans were made to meet the directors' private expenses (J Knowles 466; Ball 479).

• Each director was a `sole cheque signatory' to the applicant's account (J Knowles 465; Saul 500).

• Each was authorised as a director to withdraw funds at any time for private needs without approval from the other directors (J Knowles 466; Ball 476; G Knowles 484, 485; Saul 500).

• The amounts withdrawn were determined entirely by the directors' individual needs and not by the needs of unitholders (Saul 451).

• The directors could not obtain access to the applicant's money as shareholders or as beneficiaries of the unit trust (Ball 479).

• The only way they could obtain money in the way they did was in their capacity as

ATC 205
directors (Ball 476-477, 479, 480).

• At the time the loans were made the applicant had insufficient funds to make returns of capital (Saul 447-449, 452; Wardle 460; J Knowles 472).

• The capital distributed occurred well after the funds were borrowed (J Knowles 467, 737; Saul 502).

• The loans were not made in proportion to any ownership share (Saul 500, 510).

• There was no formal or enforceable entitlement to the loans other than the employment relationship.

The question is whether, on those facts, it was reasonably open to the Tribunal to conclude that there was a `nexus' or `causal relationship' or `discernible rational link' between the loans and the directors' employment. See Pozzolanic at 291 and Cowell at 10 per Hill J. In my view it was.

20. The applicant submitted that the Tribunal had misunderstood its `ownership' contention. It was said that the Tribunal had treated the contention as if it were that the directors were in fact the owners of the Group's business, whereas in truth what was asserted was that the explanation for the loans was not to be found in the fact that the directors were employees but in the fact that `they are, if not owners then pretty much like them'. While they were not owners of the business in law, and had `no vested interest in or entitlement to income, profits or capital of the business', they had `what one might refer to... as a vestible interest and therefore [were] to be regarded as being in a position where their dipping into the funds... flows from their position as people entitled to the benefit, and that's a bit like ownership'. It was not actual ownership in law, but it was `pretty close to it'. The Tribunal did not in my view treat the applicant as propounding an ownership in fact argument. What the Tribunal said was:

`It was said that the four directors regarded themselves as owners of the business and, although there was a formal legal structure of a unit trust in which the unit holders were the respective family trusts of the directors, the practical view of these non- professionals was that they were the owners.... It was said that the evidence showed that the monies borrowed were regarded as equivalent to drawing of the capital of the business by owners and the ultimate extinguishment by a capital distribution demonstrated this.

...

For the respondent, Mr Davies agreed that the four directors regarded themselves as owners of the business...'

21. In its later discussion of the competing arguments the Tribunal distinguished between the applicant's `ownership' contention as described in the above passage and the Commissioner's `ownership per se' or `actual ownership' contention. The Tribunal rejected the applicant's submission in a passage which demonstrates that it did not misunderstand it:

`In my view, this is one of those not unusual cases of four businessmen who obtain and accept advice as to an appropriate legal structure within which to own and operate the business but do not understand the legal ramifications of the structure adopted and, in fact, ignore it in the day to day operations of the business.

...

The structure of the group was established in such a way that the directors were not owners. In my view, this is a case where the directors have to accept the consequences of that structure.'

The Tribunal appreciated, but rejected, the applicant's `quasi-ownership' claim. What it regarded as important was the ownership position in fact and in law. The Tribunal did not misunderstand the applicant's argument.''

13. (a) It would seem then, having regard to the cases previously referred to, and also Taxation Ruling MT 2019, (referred to in the decision of Senior Member Pascoe in Knowles) that there is prima facie a distinction to be drawn between benefits paid to director/ employees who are also shareholders and director/employees who are not, and even if the latter have some form of quasi-ownership in relation to the company in question.

ATC 206

(b) In each of Curtain World and Knowles the director/employees were not the owners of the company in question; in Curtain World Deputy President Barnett nevertheless considered it relevant (and that a nexus was thereby provided) that the benefits were utilised in respect of the employment.

(c) The matters taken into account by Sundberg J in the appeal in Knowles indicate the types of matters which are or may be relevant in respect of a decision as to whether a benefit is relevantly connected.

(d) As set out previously, the evidence was that the Company was in difficult financial circumstances for some considerable time after it purchased the business. The Company presumably had little, if any, capacity to pay dividends or return capital.

(e) It is also, I think, critical to remember that the on-lending of so large an amount (in comparative terms) arose as a matter of accounting necessity. The accounts for 1993 incorrectly reflected the property as an asset of the Company. That erroneous method was continued in the accounts for the following two years. The Wilsons became debtors of the Company in consequence of the reversal of the property out of the Company's accounts. That occurred on a one-off basis, and it arose (notwithstanding that it was implemented much later in time) as a necessary consequence of the decision taken at the meeting with French and Douglas that the Wilson and not the Company should purchase the property from the Olivers, but that the Company would nevertheless remain the borrower from the Bank. In coming to that decision, the Wilsons might have acted as directors of the Company, but it is equally possible that it was taken by them as shareholders in or owners of the Company. The fact that the Company could not have contemplated a capital repayment or a distribution in respect of so large an amount may be relevant but not conclusive. It seems clear that the decision was taken without any real appreciation of the consequences of restructuring the transaction. The loan by the Company to the Wilsons arose not because the parties consciously agreed or even thought that such a loan should be provided, but because, and in relation to the accounts of the Company, the reversal out of the property led inevitably to a corresponding debit to the Wilsons. The loan is thus more aptly characterised as a ``deemed'' loan. (This too appears to be one of those situations, as referred to by Senior Member Pascoe in Knowles, where business people act on advice without appreciating the legal effect of acting in the manner advised). Indeed, it could (as occurred to me on reflection after the hearings) perhaps have been characterised also as an expense payment benefit; the Company paid an expense of the Wilsons, and being the balance of the purchase price of the property. That possibility was not canvassed at the hearings and it would be both unfair (and unnecessary) for me to canvass it further, more particularly as in my view it does not alter the result.

(f) It will be appreciated then that in respect of the benefits which have been assessed as loan fringe benefits, the Wilsons and the Company acted on advice the consequences of which were not considered in the required (or perhaps any) depth.

(g) But in respect of the benefits assessed as expense payment fringe benefits the position is altogether different. Whether or not French knew or ought to have known, and whether in particular the Wilsons actually furnished him with relevant information for this purpose, the evidence indicates that they regularly and on a systematic basis caused the Company to pay expenses which were properly payable by them, and not by the Company, and as if they were expenses of the Company. As is the case with many companies of this type, the conduct of its affairs was in the hands of its directors. (There was evidence before the Tribunal that the Company provided the Wilsons with a car, and that benefit was documented, so the Tribunal was informed, in board minutes.) Perhaps the most flagrant case is that of the dwelling telephone bills; so far as rates and electricity are concerned there should have been a proper apportionment, and it would not have been difficult to calculate. The vendor finance interest was of course also properly an expense of the Wilsons.

(h) It must be remembered also that the Wilsons in the relevant years were earning very little. Wilson in his evidence before the Tribunal did not explain why he and his wife as directors of the Company procured the payment by the Company of the expenses assessed as the expense payment fringe benefits, and their motives are a matter of conjecture. It is conceivable, and perhaps even likely, that the

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payments were made as a matter of economic necessity and bearing in mind that their combined earnings were so low. The payments in question were made on a regular basis and as if they were, in reality, expenses of the Company. Their very periodicity gives rise to an inference that they constituted a substitute for additional remuneration. It cannot be accepted that the Wilsons treated the Company for this purpose simply as if it was not a separate entity; the provision of a car by the Company to the Wilsons was (as set out in the preceding subclause) documented in board minutes, and appropriate and compensatory entries were effected in respect of the car. In fact the amount debited for the car altered when a different car was provided. This question can perhaps be tested by assuming hypothetically that the Wilsons were employees and shareholders but not directors of the Company. Would independent directors acting legally and properly (and, in other words, not in breach of their fiduciary duty) have made those payments as expenses of the Company? The answer is, of course, no. Certainly and in the event of a refusal by such directors to make the payments in question on this basis, the Wilsons could have exercised their voting power to remove the directors and to appoint themselves or other directors more amenable to their instructions in their stead. It is the fact that the Wilsons were the directors of the Company which enabled them to procure the payment by the Company of the relevant expenses as expenses of the Company. That fact, when considered in conjunction with the fact that the payments were made on a periodic basis, leads me to conclude that the capacity in which the benefits were received was that of employees and not as shareholders.

(i) My conclusion then is that the benefits referred to in subclauses (g) and (h) were indeed expense payment fringe benefits and properly assessed as such. And it is not necessary for me for this purpose to differentiate between expenses referable to the dwelling (electricity, rates and telephone) and expenses referable to the property (vendor finance interest).

(j) In conclusion as regards the expense payment fringe benefits, Mr Eager argued that the value should be reduced by the ``recipients contribution'' as defined in section 136(1) of FBTAA. The contribution, so he argued, is the market value of the right to use the property. Section 145 of FBTAA provides that consideration not in cash is to be accorded its market value. But one has only to consider the definition of ``recipients contribution'' in order to realise that such a contention is without foundation. Paragraph (b) of the definition, which uses the term ``paid'' applies to expense payment fringe benefits, whereas paragraph (a) of the definition which refers to ``consideration'' refers to other types of fringe benefits. As a matter of statutory interpretation paragraph (a) of the definition (but not paragraph (b)) attracts section 145 of FBTAA.

(k) Ms Zakos conceded that additional tax had been assessed under section 115 of FBTAA rather than correctly assessed pursuant to section 114 of FBTAA. The effect is the same. The circumstances (and the culpability) are such that I do not consider it appropriate to reduce the additional tax assessed. (It was only after an audit of the Company that the relevant assessments were made).

(l) Accordingly, the FBT decisions are, in relation to the amounts assessed as expense payment fringe benefits, affirmed.

14. (a) The Tribunal now turns to consider whether there was in fact a relevant connection between the employment and the benefits assessed as loan fringe benefits. It was suggested during the hearing that the loan benefits were provided by the Company to the Wilsons as landlords; in fact there was no lease. The evidence was that the Company could not afford to pay any consideration at all for its use of the property, and there was no evidence of any intention to charge rent in the future. It was suggested also, perhaps in passing, that the loan was made to them as guarantors or security providers; this contention must fail because they became guarantors or security providers in order to enable the Company to borrow from the Bank, and with the moneys so obtained to provide the benefit to the Wilsons; the borrowing from the Bank must have occurred in point of time first, even if all of the relevant transactions were completed at or about the same time.

(b) The Wilsons were of course the owners of all of the issued shares in the Company. This is in contrast to the position in Knowles and Curtain World where the director recipients of benefits were not the shareholders, even though they enjoyed (as set out previously) a form of

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quasi-ownership. I am inclined to view that this is a situation where the actions of the Wilsons, in obtaining the on-loan (or perhaps more aptly, the ``deemed on-loan''), are consistent with their ownership of the Company, even though the Company could not have provided the amount involved (or anything like it) by way of return of capital or distribution. This is so because (as set out previously) it occurred once only, and because it occurred as a matter of accounting necessity.

(c) In Curtain World Deputy President Barnett made a finding of nexus in consequence of the fact that the cars were provided to the directors who used them (partially) ``for the purpose of that employment''.

(d) In this matter, the Wilsons became the owners of the property; they made it available to the Company, without consideration, for use by the Company in its business. Indeed it was an integral aspect of the business; as set out previously the Company could not and would not have purchased the business unless it also obtained the use of the property. It is true that the Wilsons were employees of the Company and in fact the principal employees. They were also the only directors of the Company. But this said, it does not follow that the right to use the property was furnished in relation to their employment. The property would have been required by the Company for its business, regardless of the fact that the Wilsons were its directors and employees. Curtain World is distinguishable as to this aspect precisely because the benefits were luxury cars provided to the directors partially in order to perform their duties. It could perhaps be argued that the Wilsons could not have performed their duties in the business without the property, but that is not at all the same thing. There is a remote connection, but it does not seem to the Tribunal that that remote connection is sufficient to constitute the nexus required by the legislation. Indeed the fact that the cars provided to the Curtain World directors were utilised for both personal use and for business purposes, and in the performance of their employment duties, tends to reinforce my view that the provision of the property to the Company wholly for the purpose of its (the Company's) business did not constitute a nexus with their employment. The benefits in question were thus not loan fringe benefits, and the FBT decisions must, in respect of the amounts assessed as loan fringe benefits, be set aside.

15. (a) Having come to the conclusion that the on-lending did not result in loan fringe benefits, it is not necessary for me to consider the ``otherwise deductible'' rule. However it was argued at some length, and subclause (b) is included for the purpose of completeness only.

(b) Assuming that the loan benefits were loan fringe benefits (and the Tribunal has concluded that they were not), the Tribunal would have been obliged to consider the effect of sections 19(1)(a) and (b) of FBTAA (the ``otherwise deductible'' rule) which read as follows:

``19(1) [Interest on loan allowable deduction to employee] Where:

(a) the recipient of a loan fringe benefit in relation to an employer in relation to a year of tax is an employee of the employer;

(b) if the recipient had, on the last day of the period (in this subsection called the `loan period' ) during the year of tax when the recipient was under an obligation to repay the whole or any part of the loan, incurred and paid unreimbursed interest (in this subsection called the `gross interest' ), in respect of the loan, in respect of the loan period, equal to the notional amount of interest in relation to the loan in relation to the year of tax - both of the following conditions would have been satisfied:

(i) a once-only deduction (in this subsection called the `gross deduction' ), not being a foreign income deduction, would, or would but for section 82A, and Subdivisions F, GA and G of Division 3 of Part III, of the Income Tax Assessment Act 1936, and Divisions 28 and 900 of the Income Tax Assessment Act 1997, have been allowable to the recipient under either of those Acts in respect of the gross interest;

...''

The ``otherwise deductible'' rule requires the Tribunal to consider whether, assuming notionally that interest had been paid, that interest would have been deductible. There was, of course, in respect of the moneys deemed to have been on-lent an obligation to repay, even though there was little or no ability to do so. Mr

ATC 209

Eager urged the Tribunal to hold that it would have been deductible, by analogy with the decision in Total Holdings. In Total Holdings, a holding company was allowed a deduction for interest on moneys borrowed, which it lent interest-free to a wholly owned subsidiary. It may be (but the Tribunal expresses no opinion as to this aspect) that that decision would extend to any subsidiary (whether or not wholly owned) where the holding company has the power to compel dividend distributions.

Assume, by way of hypothesis, that the relevant moneys had been lent to the Company itself; it may be that an interest deduction would then be available by analogy with Total Holdings; assume next (again by way of hypothesis) that the moneys had been used to acquire shares in the Company (and this requires the further assumption that the necessary resolutions had been passed and other steps taken to sanction what would otherwise be the illegal provision of financial assistance by the Company in respect of the purchase of shares in itself); in these circumstances the interest would probably have been deductible. But in this matter there is an intervening step, and that is the acquisition of the property, and the provision of that property free of consideration to the Company. The Tribunal accepts that the Wilsons hoped that the Company would prosper. But that hope would not entitle them to a (notional) deduction for interest (notionally) incurred to purchase the property, the use of which is then provided free of any consideration to the Company. Ure's case is relevant; however and apart from Ure's case the connection is too remote. The interest does not have the necessary ``essential character'' (and see:
Ronpibon Tin NL & Tongkah Compound NL v FC of T (1949) 8 ATD 431; (1949) 78 CLR 47 and
Amalgamated Zinc (De Bavay's) Ltd v FC of T (1935) 3 ATD 288; (1935) 54 CLR 295) which would have entitled it to a deduction under section 51(1) of the Tax Act. This again is a legal consequence of the manner in which the transaction was restructured.

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