Decision impact statement

Commissioner of Taxation v White; Commissioner of Taxation v White (No 2)

Court Citation(s):
[2010] FCA 730
2010 ATC 20-195
(2010) 79 ATR 49
[2010] FCA 942
2010 ATC 20-205
80 ATR 373

Venue: Federal Court of Australia
Venue Reference No: VID 889 of 2009
Judge Name: Gordon J
Judgment date: 14 July 2010; 31 August 2010
Appeals on foot:
No.

Impacted Advice

Relevant Rulings/Determinations:

• N/A

Subject References:
Assessable income
Employee benefits
Deemed dividends
Administrative penalty

Précis

Outlines the ATO's response to this case which concerned whether amounts paid to an employee incentive trust were assessable to a shareholder/director of the employer company, and whether an administrative penalty of 50% for recklessness was excessive.

Brief summary of facts

The taxpayer, an engineer, was the sole director and a shareholder of Troy White Engineering Pty Ltd (TWE), a company carrying on a tooling engineering business during the 1999 and 2000 income years. The taxpayer was also an employee of TWE.

As part of what was purported to be an employee incentive trust plan for TWE, a new company, Kalix Investments Pty Ltd (Kalix), was incorporated on 30 June 1999, and the taxpayer became its employee. It was intended that the taxpayer would become a consultant to TWE, and that Kalix would be paid management fees from TWE for the taxpayer's services. The taxpayer was the sole director of Kalix.

A trust was also established on or about 30 June 1999 for the purported purpose of providing long term incentives to the taxpayer and two important employees of TWE. The taxpayer was a director of the trustee of the trust.

On 30 June 1999, TWE made a payment of $120,120 (for the two employees) to the trustee of the trust. The plan had also been for TWE to make a management fee payment of $22,000 to Kalix, and for Kalix to make a payment of $22,000 to the trustee for the taxpayer. However, TWE made the payment of $22,000 directly to the trustee on 30 June 1999.

In the 2000 income year, one of the other employees of TWE also became an employee of Kalix and a consultant to TWE. A remuneration report recommended that a particular level of incentive payments be made by Kalix to the trustee of the trust for the taxpayer and the other employee. However, the recommendation was not followed, and considerably more was paid by TWE to Kalix as a management fee for the taxpayer ($399,000), and then paid by Kalix to the trustee for the taxpayer.

The Commissioner assessed the amounts of $22,000 and $399,000 to the taxpayer for the 1999 and 2000 years, respectively, as ordinary income from dividends or services rendered, or as deemed dividends under section 109 of the Income Tax Assessment Act 1936 (ITAA 1936). The Commissioner also assessed a penalty of 40% (50% for a tax shortfall caused by recklessness, reduced by 20% for voluntary disclosure made after the start of the tax audit).

The AAT found that the taxpayer used the incentive plan as a means of extracting profits from TWE. In relation to the 1999 year, the AAT found that it would be fanciful to suggest that the taxpayer provided any services to TWE in his capacity as an employee of Kalix. Rather, the payment of $22,000 to the trustee was made by TWE in return for services rendered by the taxpayer as an employee of TWE. The payment was in the nature of ordinary income, which the taxpayer directed be paid to the trustee.

In relation to the 2000 year, the AAT found that the payment of $399,000 from TWE to Kalix was also made for services rendered by the taxpayer to TWE. However, the AAT was satisfied that only $135,000 of the $399,000 was assessable to the taxpayer as either ordinary income, or excessive remuneration under section 109 of the ITAA 1936.

The AAT also found that the penalty imposed for both years should be 20% (25% for a tax shortfall caused by lack of reasonable care, reduced by 20% for voluntary disclosure).

The Commissioner appealed to the Federal Court on the basis that the AAT had erred in not finding that the amount of $264,000 was also assessable to the taxpayer in the 2000 year, and in not finding that the taxpayer was liable to penalty tax at a base amount of 50% (subject to a reduction of 20%) because the tax shortfall was caused by the recklessness of the taxpayer's tax agent. The taxpayer cross-appealed against the AAT's findings that the amounts of $22,000 and $135,000 were assessable to the taxpayer.

Issues decided by the court

In its first decision, the Federal Court (Gordon J) found that, as the AAT had found that the payment of $399,000 from TWE to Kalix was a payment made for services rendered by the taxpayer, the AAT should have found that the amount of $264,000 paid by Kalix to the trustee in the 2000 income year was also derived as ordinary income by the taxpayer (paragraphs 20 to 29). The Court also rejected the taxpayer's cross-appeal that the amount of $22,000 paid to the trustee was not derived as ordinary income in the 1999 year (paragraphs 41 to 44).

In its second decision, on penalty, the Federal Court held that the AAT had failed to address the former section 226H of the ITAA 1936, and that the taxpayer had not discharged the onus of proving that his tax agent was not reckless in filing the taxpayer's tax returns for the 1999 and 2000 income years. Her Honour noted that the conclusion that a 50% penalty applied to the tax shortfall was not inconsistent with any finding by the AAT (paragraphs 17 to 20).

ATO view of Decision

The Federal Court recognised that, based on the findings of fact made by the AAT, the payments made to the trustee of the incentive trust on behalf of the taxpayer were ordinary income derived by him from the provision of his services.

The Court also recognised that the taxpayer was liable to a penalty under the former section 226H of the ITAA 1936.

Administrative Treatment

Implications on current Public Rulings & Determinations

None

Implications on Law Administration Practice Statements

None

Legislative References:
Income Tax Assessment Act 1936
26(e)
44(1)
109
226H
226L

Income Tax Assessment Act 1997
6-5(1)
6-5(4)
6-10(3)

Taxation Administration Act 1953
14ZZK

Administrative Appeals Tribunal Act 1975
44

Case References:
FCT v Stone
(2005) 222 CLR 289
2005 ATC 4234
59 ATR 50

FCT v McNeil
(2007) 229 CLR 656
2007 ATC 4223
64 ATR 431

FCT v Montgomery
(1999) 198 CLR 639
99 ATC 4749
42 ATR 475

FCT v Zoffanies Pty Ltd
(2003) 132 FCR 523
2003 ATC 4942
54 ATR 280

FCT v Starr
(2007) 164 FCR 436
2007 ATC 5447
67 ATR 923

BRK (Bris)Pty Ltd v FCT
2001 ATC 4111
[2001] FCA 164
46 ATR 347