Analysis
104 There is much force in BARM's contention that alternative (1) does not involve taxation by reference to economic equivalence. Generally speaking, that doctrine has been relied on to seek re-characterisation of a receipt or outgoing where there is more than one way to achieve the desired economic result and the taxpayer chooses the way which is the most tax effective. Anti-avoidance provisions aside, the courts have consistently rejected the doctrine of taxation by reference to economic equivalence, that is, by reference to the ways in which the transaction could or might have been done, as an aid to characterisation. As was said in the joint judgment of Gaudron, McHugh, Kirby and Hayne JJ in Federal Commissioner of Taxation v Orica Ltd (1998) 194 CLR 500 at [70]:
'[L]ittle or no guidance is offered by considering what other transactions the taxpayer might have made to achieve a commercial result substantially the same as the commercial result said to flow from the making of the Principal Assumption Agreement. No doubt the taxpayer mighthave taken the amount of $62,309.546 which it paid to MMBW and instead of paying it to MMBW under the Principal Assumption Agreement have invested it in Commonwealth Bonds maturing at or about the same time as its debentures were to mature. If it had done that it would have derived income which it might then have applied in satisfaction of most, if not all, of its liabilities to debenture holders. Similarly, it might have invested the same amount as it paid to MMBW on more speculative investments and it might then have obtained returns greater than the amount necessary to pay the debenture holders. Examination of those other transactions does not reveal whether or when the taxpayer derived income as a result of the making of the Principal Assumption Agreement. In particular, the characterisation of the gains or receipts obtained in accordance with hypothetical transactions of the kind described is of little, if any, assistance in characterising the nature of the benefits identified as flowing from the making of the Principal Assumption Agreement.'
In many ways, this is no more than an echo of what was said over twenty years before by Sir Nigel Bowen in Federal Coke Co Pty Ltd v F C of T (1977) 34 FLR 375 at 386 - 387:
'His Honour appears to have considered that he could approach the characterisation of the receipts in the hands of the taxpayer by treating them as if they were received by Bellambi or the Bellambi group. On the other hand, if they were treated as received by Federal, his Honour thought that they were received by Federal just as much as compensation for the contraction of the contract to supply coke as if the payee had been the parent rather than the subsidiary. One may have some sympathy with an approach of this kind. However, in taxation matters, the court is obliged to have regard to the actual facts and not to their equivalents. In cases where it is appropriate the court may apply a statutory provision such as s 260 to get rid of a contract, agreement or arrangement and deal with the case in disregard of that element, but, where there is no statutory warrant for doing so, the court cannot disregard certain of the facts or re-arrange the facts or decide the case according to its view of the substance of the matter. It is not legitimate to disregard the separateness of different corporate entities or to decide liability to tax upon the basis of the substantial economic or business character of what was done.'
105 On the other hand, contrary to the submission in [73] and [74] above, BARM's alternative (1) does require a disregard of the legal relationships created by the relevant instruments; it requires a conflation of separate transactions, albeit financially dependent separate transactions, and taxation by reference to the end economic result of that conflation. That is equally impermissible. While not directly in point, it has a resonance with the alternative argument that was put to the High Court in Investment Merchant Finance Corporation Ltd v Federal Commissioner of Taxation (1971) 125 CLR 249 where the assessment in question was sought to be upheld on the footing that the transaction, as a whole, was the carrying out of a profit-making scheme for the purposes of s 26(a) of the ITAA 1936, and that, in determining the profit derived from the scheme, the dividend received should be brought into account rather than being treated as itself, assessable income in accordance with s 44 of the ITAA 1936: in particular, see Menzies J at 262. That alternative argument was rejected by all members of the Court.
106 Of course, there will be cases where the Parliament mandates such treatment. The example that comes most readily to mind is the consolidation regime in Part III - 90 of the ITAA 1997.
107 Alternative (1), rather than avoiding a 'blinkered' view of the transaction as submitted by BARM, does just that by requiring a 'closing of the eyes' to the separate transactions that took place. Contentions that alternative (1) recognises the reality of the transaction, as a whole, elides what that involves - conflation of separate, albeit financially dependent, transactions, and taxation by reference to the end economic result. Like taxation by reference to economic equivalence, it must be rejected.
108 The argument underlying alternative (2) involves the deferral of derivation of income represented by the management fees to the time BARM receives payments of interest and repayments of principal on the deposit with PGF. For an accruals basis taxpayer, the point of derivation of such income would normally be, as the Commissioner contended, when the management fees fell due, subject of course to the principle that comes out of Arthur Murray that, even if received, there will be no derivation until the receipt is earned. As indicated in [95] above, that latter principle was observed in the way in which BARM returned the income represented by the management fees.
109 The argument for deferral to the time BARM receives payments of interest and repayments of principal on the deposit with PGF is said to '… look to realities' to use the words of Rich J in Prior at 13. What it effectively asserts is that BARM should be treated as a cash basis taxpayer in respect of such income and then only for the amount of money received. Reliance for this argument is placed on the process of reasoning in Arthur Murray, albeit for a very different principle, Prior and Barratt. I deal with each of these cases below.
110 What this argument ignores is that BARM received the consideration for its management services when the bills of exchange were delivered to it. In other words, if it is to be treated as a cash basis taxpayer in respect of such income, it is the time of delivery of the bills of exchange that is the point of derivation. In this regard, subs 21(1) of the ITAA 1936 provides:
'Where, upon any transaction, any consideration is paid or give otherwise than in cash, the money value of that consideration shall, for the purposes of this Act, be deemed to have been paid or given.'
There was evidence before me going to the financially dependent nature of the bill transactions which might lead one to accept that the money value of the bills was less than their face amounts. But there was no such valuation in evidence. Equally, there was evidence before me going to the quantum of funds held by the accommodation party at the time of each bill transaction which might lead one to accept that the value of the bills was equal to their face amounts. But again, there was no such valuation in evidence. BARM carries the onus of proving that the assessments are excessive: s 14ZZO of the Taxation Administration Act. On the issue of the money value of the bills at the relevant times, it has not discharged that onus. It is not for me, particularly in the face of the competing evidence outlined above, to speculate what that value might be.
111 However, I am not persuaded that BARM should be treated as a cash basis taxpayer in respect of such income; certainly not by reference to the authorities upon which BARM relied. It is to those authorities that I now turn.
112 Whatever else it might support, nothing was said in Arthur Murray which supports the argument underlying alternative (2). Arthur Murray was a case stated by Barwick CJ in five pending appeals from decisions of the Board of Review. The facts relevant to the only question that had to be formally answered were few and simple. They are recited in the judgment of the Court in the following terms at 316:
'In the relevant years the company carried on a business of giving courses of tuition in dancing for fees of varying amounts per hour. What the case describes as basic courses of tuition available consisted of 5, 15 or 30 hours of private tuition to be taken by appointment within a year, though some students contracted for a course of 1,200 hours' tuition to be taken at any time during the student's lifetime. Payment for a course of lessons was often made in advance, either in the form of a lump sum or by instalments, a variable discount being allowed for immediate payment. For example, the fee for a lifetime course of 1,200 hours was Ł3,300, reducible to Ł3,000 for immediate payment. The student was given no contractual right to a refund in the event of his not completing the course - indeed the form of contract in general use denied any such right - though in practice refunds were sometimes given. In the company's books, fees were credited immediately upon their being received to an account styled "Unearned deposits - Untaught Lessons Account", and from that account amounts corresponding with lessons taught were periodically transferred to the credit of an account styled "Earned Tuition Account". The company made up its income tax returns on the footing that fees received in advance of tuition formed no part of its assessable income at the moment of receipt, but became such as and when earned by the giving of the lessons. The Commissioner, on the other hand, made the relevant assessments upon the view that fees received in advance of tuition possessed the character of assessable income in the company's hands from the moment of receipt, so that in respect of a given year of income there was no need to distinguish between fees for which lessons had been given during the year and fees for which at the end of the year the lessons still remained to be given. The question to be decided is, in effect, whether on the facts as stated it is open to the Justice hearing the appeals to uphold the Commissioner's view.'
113 The Court answered that question 'no' by declaring that on the facts appearing in the case stated the conclusion is not open that a receipt of fees for a specified number of dancing lessons to be given over a period subsequent to the receipt is a derivation of assessable income. In the course of their reasons, the Court said at 320:
'Nothing in the Act is contradicted or ignored when a receipt of money as a prepayment under a contract for future services is said not to constitute by itself a derivation of assessable income. On the contrary, if the statement accords with ordinary business concepts in the community - and we are bound by the case stated to accept that it does - it applies the provisions of the Act according to their true meaning.'
114 Earlier in their reasons, the Court had said at 318:
'As Dixon J. observed in Carden's Case: "Speaking generally, in the assessment of income the object is to discover what gains have during the period of account come home to the taxpayer in a realized or immediately realizable form". The word "gains" is not here used in the sense of the net profits of the business, for the topic under discussion is assessable income, that is to say gross income. But neither is it synonymous with "receipts". It refers to amounts which have not only been received but have "come home" to the taxpayer; and that must surely involve, if the word "income" is to convey the notion it expresses in the practical affairs of business life, not only that the amounts received are unaffected by legal restrictions, as by reason of a trust or charge in favour of the payer - not only that they have been received beneficially - but that the situation has been reached in which they may properly be counted as gains completely made, so that there is neither legal nor business unsoundness in regarding them without qualification as income derived.'
115 The Court went on, by way of clarification and elaboration, as follows at 319:
'Likewise, as it seems to us, in determining whether actual earning has to be added to receipt in order to find income, the answer must be given in the light of the necessity for earning which is inherent in the circumstances of the receipt. It is true that in a case like the present the circumstances of the receipt do not prevent the amount received from becoming immediately the beneficial property of the company; for the fact that it has been paid in advance is not enough to affect it with any trust or charge, or to place any legal impediment in the way of the recipient's dealing with it as he will. But those circumstances nevertheless make it surely necessary, as a matter of business good sense, that the recipient should treat each amount of fees received but not yet earned as subject to the contingency that the whole or some part of it may have in effect to be paid back, even if only as damages, should the agreed quid pro quo not be rendered in due course. The possibility of having to make such a payment back (we speak, of course, in practical terms) is an inherent characteristic of the receipt itself. In our opinion it would be out of accord with the realities of the situation to hold, while the possibility remains, that the amount received has the quality of income derived by the company.' (Emphasis added)
116 In the present case, accepting that the delivery of the bill of exchange to BARM is the equivalent of a receipt of money, there is nothing further that BARM has to do to earn the amount for which the bill is payable; there is no circumstance which could arise under which BARM would have to return the bill to PGF as the drawer such as to make it 'an inherent characteristic of the receipt itself'; and while the transaction for which the bill is delivered to BARM, namely, the discharge of the payment obligation of the participant in respect of the management fees, is financially dependent on the next transaction for which the bill is endorsed to PGF as the borrower, namely, the making of the deposit by BARM with PGF, there is no 'legal impediment in the way of the recipient's [BARM's] dealing with it as he [it] will'.
117 In my view, there is no process of reasoning in, or principle coming out of, Arthur Murray which supports the argument underlying alternative (2). And this would be the case whether BARM is an accruals basis or cash basis taxpayer, assuming of course that the principle coming out of Arthur Murray applies equally to both. While Arthur Murray concerned an accruals basis taxpayer, there seems to be no reason why the principle does not equally apply to a cash basis taxpayer.
118 Prior concerned a cash basis taxpayer who, during his lifetime, was a member of a partnership which was dissolved by a deed. His sole co-partner had borrowed money from him on his private account and the deceased had lent money to the partnership. An account was made up of the dealings between them on the dissolution and the result was shown as leaving the co-partner indebted to the deceased in the sum of Ł8,388, which included a sum of Ł2,535 made up of two amounts:
(1) Ł1,462 interest, said to be owing at 13 August 1932 by the co-partner on his personal account.
(2) Ł1,073 interest, said to be the deceased's half share of the interest owing to him by the partnership at the time.
By the deed, he undertook a personal liability to the deceased for the amount and secured it over a certain property already mortgaged, for part of the sum. The property was actually worth only Ł3,295 and by reason of his financial position the co-partner was unable to pay even the arrears of interest included in the sum and no payment had ever been made in respect of the sum.
119 The Commissioner contended that the interest referred to represented interest derived by the deceased during the account period ended 30 June 1932 but capitalised by means of the deed dated the 13 August 1932 affecting the dissolution of the partnership. Under the deed, the interest had been carried to the capital account.
120 The question before the court was whether the taxable income of the deceased for the year ended 30 June 1933 included an amount of Ł2,097 or any part, and if so, what part of that sum.
121 The Ł2,097 was arrived at by deducting from the total of the amounts shown above, Ł2,535, a sum of Ł438 that the taxpayer had returned as income in previous years.
122 All members of the Court held that the Ł2,097 was not income within the meaning of the ITAA 1936 for the year in question. In the course of his reasons, Rich J said at 12 - 13:
'If when the deceased entered into the deed of dissolution of partnership he had obtained an investment for the moneys due to him including interest adequate to cover it providing him with the equivalent in a capital form of everything due to him the case might not have been very different from that of a man who obtains a cheque for interest from the debtor and hands it back to him as part of a new investment on fixed mortgage on adequate security. But here the facts show that the deceased got nothing except a new obligation to pay in exchange for an existing obligation to pay. He was no nearer getting his money or of transferring it into anything of any value. His debtor could neither pay nor secure payment of the debt to him except by charging it on property already heavily mortgaged and quite incapable of producing a surplus out of which the amount representing interest could be paid. To see whether income has been derived one must look to realities. Usually payment of interest by cheque involves a receipt of income but payment by a valueless cheque does not. "For income tax purposes receivability without receipt is nothing." Law of Income Tax (Sir Houldsworth Shaw & Baker), p 111. You do not transform interest into an accretion of capital by writing out words on a piece of paper. There must be some reality behind them. Some accretion of value to corpus. The facts in this case show that there was not "an actually realised or realisable profit": Cross v. London & Provincial Trust Ltd [[1938] 1 KB 792 at 798. All that happened in this case was to change a forlorn hope of interest into a still more forlorn hope of capital. In my opinion income was not derived even if the sums for interest included in the Commissioner's Ł2,097 were really due and not as the taxpayers claim only in part due owing to error.'
123 Nothing that was said there supports the argument underlying alternative (2).
124 Barratt was concerned with whether an accruals basis of tax accounting was appropriate for a partnership of medical practitioners carrying on a pathology practice where the partnership required the use of large and expensive equipment and laboratory, courier and clerical services which were provided by service entities associated with the partners. A Full Court of this Court held that it was and dismissed the taxpayer's appeal. The principal judgment was given by Gummow J with whom Northrop and Drummond JJ agreed but, with respect, it does not shine any light on the appropriateness of the principle put forward by BARM that is alternative (2).
125 Expert accounting evidence was called by BARM in support of the argument underlying alternative (2) from Professor Robert Walker, the Professor of Accounting in the Faculty of Economics and Business at the University of Sydney. The Commissioner relied on expert accounting evidence from Mr Wayne Lonergan to deny the appropriateness of any financial accounting treatment consistent with the argument underlying alternative (2). With respect to both experts, I did not find their evidence provided me with any constructive assistance in resolving the issues raised by BARM's arguments. In any event, as Davies J observed in Commissioner of Taxation v Dunn (1989) 85 ALR 244 at 252:
'… ordinary accounting principles and practices are not determinative of the issue, they are relevant and may be influential, as Dixon J in Carden's case (at 152) and Barwick CJ, Kitto and Taylor JJ in Arthur Murray (at 318) pointed out …'
126 In conclusion, my view is that, consistent with BARM being an accruals basis taxpayer, the income represented by the management fees was derived by BARM when those fees fell due; or, in the case of fees which related to the provision of services in a year of income after the year in which the fees fell due, consistent with the principle that comes out of Arthur Murray, in the year of income in which those services were provided. That is, as I understand the evidence, how BARM returned the income represented by the management fees. Even if BARM were to be taxed on the management fee income as a cash basis taxpayer, and as indicated in [111] above, I do not think such a basis is appropriate, that would only defer derivation to the date of delivery of the bills of exchange or, in the case of fees which related to the provision of services in a year of income after the year in which the fees were received, consistent with the principle that comes out of Arthur Murray, in the year of income in which these services were provided.
127 Moreover, in the absence of evidence that the money value of the bills at the time of delivery to BARM was less than their face value, no deferral would also result in a reduction in the quantum of the amount derived.
128 BARM's position in relation to Issue 1 cannot be sustained; and it follows that its position in relation to Issue 2 must also fail.
129 The application must be dismissed with the costs.
I certify that the preceding one hundred and twenty-nine (129) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Edmonds.