Decision impact statement

Lawrence v Commissioner of Taxation

Court Citation(s):
[2008] FCA 1497
2008 ATC 20-052
70 ATR 376

Venue: Federal Court of Australia
Venue Reference No: VID 882 of 2008
Judge Name: Jessup J
Judgment date: 10 October 2008
Appeals on foot:
No.

Impacted Advice

Relevant Rulings/Determinations:

• MT 2008/2
• MT 2008/3

Subject References:
Dividend stripping scheme
Scheme benefit
Scheme penalty
Reasonably arguable position
Voluntary disclosure
Tax audit

Précis

Outlines the ATO's response to that part of the case which concerns the application of the administrative penalty provisions in Schedule 1 to the Taxation Administration Act 1953 (TAA).

Decision Outcome

Partly adverse

Brief summary of facts

During the 2003 income year, 2 companies controlled by the taxpayer ("the target companies"), with past, current, and anticipated future year profits, entered into a Distributable Surplus Arrangement ("DSA") promoted by Cleary Hoare. The objective of each DSA was to provide for the effective payment or transfer of profits of the companies in a manner that would not give rise to a deemed dividend. In summary, the "target companies" used promissory notes to purchase "B" class shares in a newly formed private company whose only other shares (2 "A" class shares) were held by a trustee company associated with the taxpayer. Almost immediately, the "B" class shares were rendered worthless and their value shifted to the "A" class shares in a pre-ordained series of steps. Pending liquidation, the newly formed company recorded a loan to the trustee company by way of delivery of a promissory note. Funds were then made available from the trust in non-taxable capital form to the taxpayer to repay debts to the target companies.

The schemes did not feature vendor shareholders selling their shares cum-dividend, with the purchaser receiving a dividend, getting a dividend rebate, selling the shares ex-dividend at a loss, and obtaining a revenue loss on the sale. As a result of the schemes, all of the profits and anticipated profits of the target companies were transferred to other entities controlled by the taxpayer for his benefit.

The Commissioner took the view that each DSA was a scheme by way of, or in the nature of, dividend stripping (subparagraph 177E(1)(a)(i) of the Income Tax Assessment Act 1936 (ITAA)), or a scheme having substantially the effect of such a scheme (subparagraph 177E(1)(a)(ii)). He viewed the diminution in the value of the 'B' class shares as a result of each scheme as being a disposal of property by the target companies, and formed the opinion that that disposal represented a distribution of the profits of those companies (paragraph 177E(1)(b)). He also took the view that, if the target companies had paid a dividend out of profits equal to an amount represented by the diminution in value of the 'B' class shares, the amount of that distribution might reasonably be expected to have been included in the taxpayer's assessable income (paragraph 177E(1)(c)). As a result of section 177E applying to each DSA, the taxpayer was assessed under section 177F on a tax benefit equal to the amount identified under paragraph 177E(1)(c).

Accompanied by a letter of 3 May 2005, the Commissioner had sent a notice under section 264 of the ITAA to the taxpayer to attend and give evidence concerning his income, and the income of numerous related entities, for the 1996 to 2004 years. It was accepted that the applicant made a voluntary disclosure of the details of each DSA by letter dated 12 May 2005. The Commissioner assessed the taxpayer to penalty of 40% of a scheme shortfall amount (50% base penalty under subparagraph 284-160(1)(a)(i) of Schedule 1 to the TAA, with a reduction of 20% under subsection 284-225(1) for a voluntary disclosure made after notification of an audit).

Issues decided by the court

In relation to section 177E, the main issue was whether either of subparagraphs 177E(1)(a)(i) or (ii) applied to each DSA. Jessup J concluded that each scheme was not covered by subparagraph (i) (see paragraph 74), but was a scheme covered by subparagraph (ii) (see paragraph 84).

In relation to penalty, although his Honour accepted the taxpayer's contention that, for the purposes of subparagraph 284-145(b)(i), the Full Federal Court decision in FCT v Starr (2007) 164 FCR 436 required consideration of the subjective, rather than objective, purpose of an entity that entered into a scheme (paragraph 104), he found that it was reasonable to conclude from the circumstances surrounding the taxpayer's involvement in each DSA, that the taxpayer entered into, and carried out, the schemes with the dominant purpose of getting a scheme benefit from them (paragraph 105).

His Honour then concluded that the base penalty amount applying to the taxpayer was 25% of the scheme shortfall amounts under subparagraph 284-160(1)(a)(ii), based on the finding that it was reasonably arguable that section 177E did not apply. Though with some reservations, his Honour accepted that the views expressed in Walstern P/L v FCT (2003) 138 FCR 1 about an earlier version of the reasonably arguable test in subsection 284-15(1) should apply to the interpretation of that provision. He found that the taxpayer's arguments about section 177E not applying to each DSA were, on balance, ones that had a rational basis in the Explanatory Memorandum to the Bill that introduced section 177E and in the decision in FCT v Consolidated Press Holdings Ltd (2001) 207 CLR 235 (paragraphs 105-6).

Finally, his Honour held that the base penalty amount should be reduced by 80% under subsections 284-225(2) and (4) (paragraph 111). His Honour found that the letter of 3 May 2005, and the accompanying section 264 notice, did not clearly "tell" the taxpayer that an examination by the Commissioner of his financial affairs for the purposes of the income tax laws for the 2003 income year was to be conducted.

The taxpayer appealed to the Full Federal Court in relation to the operation of section 177E. The Commissioner did not appeal in relation to the decision on penalty, nor did he lodge any notice of contention against the finding that each DSA was not covered by subparagraph 177E(1)(a)(i) .

On 20 March 2009, the Full Federal Court confirmed the decision of Jessup J in relation to the operation of section 177E. On 4 September 2009, the High Court refused to grant the taxpayer special leave to appeal.

ATO view of Decision

Jessup J has recognized that each DSA was not a scheme by way of, or in the nature of, dividend stripping, for the purposes of subparagraph 177E(1)(a)(i). However, the ATO notes that the Full Federal Court has recognized that each DSA is a paradigm example of the type of scheme to which subparagraph 177E(1)(a)(ii) was intended to apply.

In relation to the views of Jessup J about the interpretation of the purpose test in subparagraph 284-145(1)(b)(i), the ATO notes that, while the Full Federal Court in FCT v Star City P/L (No 2) [2009] FCAFC 122 recognised that its earlier decision in Starr was authority for the proposition that the former section 226L of the ITAA contained a subjective purpose test, Dowsett J in that decision made it clear that Starr was only a decision about section 226L, and did not consider the operation of subparagraph 284-145(1)(b)(i). His Honour noted that the language of section 226L is different to that used in section 284-145, and was apposite to refer to a reasonably drawn inference about whether the relevant entity had the identified purpose, and not to what was that entity's actual purpose. The ATO considers that the views of Dowsett J in Star City accurately reflects what was decided in Starr, and will follow his Honour's views about how the purpose test in subparagraph 284-145(1)(b)(i) applies instead of the views of Jessup J on that issue in this decision.

The ATO accepts that it was open to Jessup J to find that it was reasonably arguable that section 177E did not apply to each DSA in the way that he found. The ATO also accepts that, based on the particular terms of the letter of 3 May 2005, and the accompanying section 264 notice, it was open to his Honour to find that the taxpayer had not been 'told' that an income tax audit was to be conducted of his financial affairs for the 2003 income year before he made a voluntary disclosure of the details of each DSA on 12 May 2005.

Administrative Treatment

Implications on current Public Rulings & Determinations

None

Implications on Law Administration Practice Statements

None

Implications for general administration

For cases before the Administrative Appeals Tribunal or the Federal Court dealing with the application of subparagraph 284-145(1)(b)(i), the ATO will apply the views of Dowsett J in Star City that the words of the provision are apposite to refer to a reasonably drawn inference about whether a relevant entity had the identified purpose, and not to what was that entity's actual purpose.

Legislative References:
Income Tax Assessment Act 1936
177E

Taxation Administration Act 1953
284-15
284-145
284-150
284-160
284-225

Case References:
Commissioner of Taxation v Consolidated Press Holdings Ltd
207 CLR 235
2001 ATC 4343
47 ATR 229

Walstern Pty Ltd v Commissioner of Taxation
138 FCR 1
54 ATR 423
2003 ATC 5076

Federal Commissioner of Taxation v Starr
164 FCR 436
2007 ATC 5447
67 ATR 923

Lawrence v Commissioner of Taxation
[2009] FCAFC 29
2009 ATC 20-096

Commissioner of Taxation v Star City Pty Ltd (No 2)
[2009] FCAFC 122
2009 ATC 20-129