Cajkusic v Commissioner of Taxation

Federal Court of Australia (Full Court)|2006-11-24|Before: Howard Olney AM, Edmonds JJ, Olney AM

REASONS FOR JUDGMENT THE COURT: 1 This is an appeal from a decision of the Administrative Appeals Tribunal (constituted by the Honourable Howard Olney AM QC, Deputy President) in respect of applications, by each of the applicants, to review objection decisions made by the respondent on each of the applicants' objections to amended income tax assessments for the years ended 30 June 1997 and 1998.

Background 2 The applicants, Milivoj Cajkusic and Branka Cajkusic are husband and wife and are the parents of the third applicant, Daniel Cajkusic. The applicants were at all relevant times the principal beneficiaries of the Cajkusic Family Trust ('the Trust') and each was an employee of the trustee of the Trust, Intex Coatings Pty Ltd ('Intex'), which carried on business in that capacity. 3 In April 2003 the respondent issued amended assessments of income tax to each applicant for the years ended 30 June 1997 and 1998. In the case of the 1997 year, the taxable income of each applicant was increased by $205,425 and for the 1998 year the taxable income of each applicant was increased by $191,125. 4 The circumstance which gave rise to the issuing of the amended assessments was the disallowance by the respondent of deductions claimed by Intex in each of the 1997 and 1998 years for contributions made, and implementation costs incurred, in relation to an employee benefit trust arrangement entered into on 30 June 1997. The Trust's 1997 accounts include, as expenditure against gross profit from trading, the sum of $198,000 said to have been paid as 'Employee Share Unit Trust contributions' together with $7,425 described as 'Employee Share Unit Trust costs' (these sums totalling $205,425). For the 1998 year similar expenditure of $190,000 and $7,125 (totalling $197,125) was included in the Trust's accounts. 5 The amended assessments, in addition to disallowing deductions for this expenditure, gave effect to determinations made by the respondent under s 177F(1)(b) of the Income Tax Assessment Act 1936 (Cth) ('the 1936 Act') cancelling any tax benefit that might otherwise be obtained in respect of such expenditure and to determinations made by the respondent under ss 177F(1)(a) and 177(2) that the amounts in question (i.e. $205,425 for 1997 and $197,125 for 1998) be included in the assessable income of each of the applicants by virtue of s 97 of the 1936 Act. 6 On 13 June 2001, prior to the issue of the amended assessments to the applicants, the respondent issued Intex with a fringe benefit tax ('FBT') assessment for the FBT year ended 31 March 1998 which was based on the assertion that Intex provided its employees with a property fringe benefit with a net taxable value of $198,000. Subsequently, on 20 October 2002, but again prior to the issue of the amended assessments to the applicants, the respondent issued an amended FBT assessment to Intex for the year ended 31 March 1998 in respect of a property fringe benefit provided to the employees with a net taxable value of $388,000 - the sum of the two contributions referred to above. Intex has not lodged any objections against the two FBT assessments. It is common ground that the respondent has lodged a proof of debt in the winding up of Intex in relation to the latter FBT assessment and that no distribution has been made in favour of the respondent in relation to that debt.

In The Tribunal 7 Before the Tribunal the respondent conceded that the objection decision made by the respondent on each applicant's objection to his or her amended assessment for the year ended 30 June 1997 should be set aside and in lieu thereof the objection of each applicant should be wholly allowed. This concession was said to be made on the basis that in the 1997 year no distribution was made by the family trust in favour of the beneficiaries. The respondent also conceded that for the 1998 year, in accordance with the terms of the instrument pursuant to which the Trust was constituted, that the net income of the Trust should be assessed equally among each of the three principal beneficiaries. Accordingly, the respondent conceded that the objection decision made on each applicant's objection to his or her amended assessment for the year ended 30 June 1998 should be varied to reflect this position. 8 In the course of its reasons, the Tribunal said: '[5] For present purposes it is assumed that the payments said to have been made, namely a total of $205,425 in the 1997 year and $197,125 in 1998 were in fact made. Although the available evidence is inadequate to establish conclusively that the full amount of each of the contributions was in fact made, these amounts are shown as deductions in the accounts of the family trust. The 1997 accounts show a net loss for that year of $54,838 which has been carried forward into the 1998 accounts which show an accumulated loss at 30 June 1998 of $26,141. If the deductions of $205,425 in 1997 and $197,125 in 1998 were properly disallowed there would not have been any loss to carry forward into 1998 and hence the net profit for 1998 (shown as $28,679 in the Cajkusic Family Trust Trading, Profit and Loss Statement for the year ended 30 June 1998) would be increased by $197,125.' 9 The Tribunal assessed the evidence, particularly that of two witnesses called on behalf of the applicants, Mr Daniel Cajkusic, the third applicant, and Mr Luciano Colombo, the former accountant of Intex, in the following terms (at [8]): '…[Mr Daniel Cajkusic] did not demonstrate any real understanding of the manner in which the plan was to be implemented nor of the nature and extent of the benefits that would accrue from it. Mr Colombo was at the relevant time associated with the promoters of the plan but was of little assistance in identifying the process whereby the funds said to have been contributed by Intex were dealt with. It was entirely unhelpful that none of the relevant documents that would have explained the working of the plan were put before the Tribunal. Although Intex and indeed it appears the various companies involved in promoting the plan are now in liquidation no explanation was offered as to why relevant records and documents could not be made available. The clear inference from the available evidence is that whatever contributions Intex may have made pursuant to the plan, the amounts contributed were through a series of interest free loans or other transactions, returned in full. The conclusion gleaned from Daniel Cajkusic's evidence is that the money was ultimately distributed to the applicants as part of their remuneration as employees of Intex. There is nothing in Intex's accounts to suggest that amounts corresponding to the contributions were ever received by it either by way of loan or otherwise.' 10 Despite the state of the evidence, the respondent did not put in issue before the Tribunal that the alleged contributions to the employee benefit trust had never been incurred by Intex nor that the applicants had not discharged their onus in this regard. The Tribunal therefore proceeded to determine the applications before it on the basis set out in [9] of its reason: '[9] Despite the inconclusive nature of the evidence as to what amounts were in fact contributed by Intex pursuant to the employee benefit trusts it is appropriate for the purposes of the present applications to treat the amounts of $198,000 and $190,000 claimed as deductions in Intex's 1997 and 1998 accounts as having been paid pursuant to the plan described in Daniel Cajkusic's evidence. The applicants bear the onus of proving that the sums in question represent legitimate deductions for income tax purposes; and if they were legitimate deductions, the further question arises as to whether the amounts were paid pursuant to a scheme which would attract the operation of Part IVA of the 1936 Act.' 11 With respect, the reference to the further question in relation to Part IVA was effectively abandoned as an issue by the respondent with the concessions he made in [7] supra. 12 The Tribunal proceeded to deal with the deductibility issue and concluded that neither the contributions nor the administrative costs were deductible for the reasons given at [10] and [11]: '[10] … There is nothing in the evidence to support the proposition that the contributions made to the employee benefit trusts represented outgoings incurred in gaining or producing assessable income or that they were necessarily incurred in carrying on Intex's business for the purpose of gaining or producing such income. The contributions served no business purpose; they were clearly voluntary payments which in no way affected the capacity of Intex to derive income. Nor is there any material to suggest that the contributions were made to ensures the applicants' loyalty or productivity or as an incentive to continue in their employment. The only motivation for making the contributions was the tax savings the applicants sought to achieve. The requirements for deductibility have not been established. [11] The reasoning leading to the conclusion expressed in the preceding paragraph is equally applicable to the payments of $7,425 and $7,125 described in the evidence as administrative costs in implementing the arrangement which were respectively claimed as deductions in Intex's 1997 and 1998 accounts.' 13 The Tribunal then expressed its view as to the consequences of the disallowance of these outgoings as allowable deductions in calculating the s 95 'net income' of the Trust in the years ended 30 June 1997 and 1998, and in the following terms: '[12] As a consequence of the deductions claimed for the year ending 30 June 1997 not being allowable, there was no loss to carry forward from that year; and by reason of the deductions claimed for the year ending 30 June 1998 not being allowable the net income of the family trust for that year increases by $197,125. Intex, as trustee of the family trust, did not determine to exercise its discretion to distribute income of the trust estate for the year ending 30 June 1998 and accordingly, by virtue of the provisions of paragraph 3(a) of the Deed of Settlement, the applicants became entitled to the net income as tenants in common in equal shares. In these circumstances it is appropriate (as the respondent concedes) that the amended assessment of income tax issued to each applicant be varied to take account of an increase in taxable income equal to one third of the net income of the family trust for the year ended 30 June 1998.'

The Appeal to this Court 14 The applicants' case on appeal to this Court involved arguments based on the proposition that for a beneficiary to be assessed in respect of any of the income of a trust estate, three requirements must be satisfied: (1) There must be income of the trust estate in the sense of a distributable net income. (2) A beneficiary must be presently entitled to a share of that income. (3) There must be net income of the trust estate within the meaning of s 95 of the 1936 Act - a requirement that was not in dispute. 15 The applicants' arguments on the first two requirements were that: (1) For the year ended 30 June 1998, there was no such income. (2) Intex's right of indemnity and exoneration as trustee precluded any beneficiary having any entitlement to any income of the Trust for the 1998 year. 16 At the commencement of the hearing of the appeal the respondent raised the question of whether the applicants' objections contained grounds sufficient to confer jurisdiction on the Tribunal to hear the applicants' case in reliance on s 97 of the 1936 Act, in particular the argument that there was no income of the Trust to which any of the applicants could be presently entitled. The applicants pointed to the provisions of par (5) of the notice of objection, which is in common form: 'Alternatively, the Adjusted Income Amount [$197,125.00] is incorrectly assessed by the Commissioner to the Taxpayer and, is accordingly, not authorised by s 97 of the 1936 Act.' and submitted that while it is expressed as a claim, rather than as a ground, it is sufficient to put the respondent on notice that his reliance on s 97, however the argument might be articulated, is put in issue. 17 Section 14ZU of the Taxation Administration Act 1953 (Cth) provides, inter alia, that a person making a taxation objection must state in it, fully and in detail, the grounds on which the person relies. In H. R. Lancey Shipping Co. Pty Ltd v Federal Commissioner of Taxation (1951) 9 ATD 267 at 273, Williams J said: 'The grounds of objection need not be stated in legal form, they can be expressed in ordinary language, but they should be sufficiently explicit to direct the attention of the respondent to the particular respects in which the taxpayer contends that the assessment is erroneous and his reasons for this contention. In each case the sufficiency of the grounds is a matter for the Court. Vague grounds such as that the assessment is excessive are not, in my opinion, a compliance with the Act.' In our view, the applicants' notices of objection lodged against the amended assessments for the year ended 30 June 1998, in particular the express reference in par (5) to s 97 of the 1936 Act, is sufficiently explicit to direct the attention of the respondent to the fact that his reliance on s 97 is considered to be erroneous, and is put in issue. It is not necessary, in our view, that the component arguments under s 97 of the 1936 Act be articulated at this stage. In this Court, if not in the Tribunal, the medium for that function comes later in the form of the respondent's appeal statement (O 52B r 5 of the Federal Court Rules) and the applicant's statement of facts, issues and contentions in response thereto.

Reasoning 18 It is quite apparent from the extract of the Tribunal's reasons at [13] supra, that the Tribunal dealt with the consequences of the disallowance of the relevant outgoings as allowable deductions on the basis that it had the same effect on the Trust's distributable net income, by reference to which present entitlement is determined, as it did on the Trust's s 95 'net income', that is, in the year ended 30 June 1998 it had the consequences of increasing both the net distributable income and the s 95 net income by $197,125. There may be some circumstances where such consequences would follow. For example, where a provision of the relevant instrument pursuant to which a trust estate is constituted mandates that the distributable net income of a year shall be the amount that is the s 95 'net income' of that year (see Commissioner of Taxation v ANZ Savings Bank Ltd (1998) 194 CLR 328 at [29] infra), but there is no such provision in this case. It is appropriate, at this stage, to look at what the deed of settlement ('the deed'), pursuant to which the Trust was constituted, provides in this regard. 19 Clause 8(u) of the deed provides: '8. Without prejudice to the generality of the preceding Clause the Trustee shall have power: … (u) To determine what amount or amounts shall be treated as income of the Trust Fund and what amount or amounts shall be treated as capital and generally to determine the treatment and characterisation of all receipts and payments by the Fund; and in particular to determine that the income of the Fund for the purposes hereof is an amount equal to "the net income of the trust estate": within the meaning of Section 95 of the Income Tax Assessment Act or some other amount calculated by reference to considerations governing or affecting the incidence of taxation upon the receipts and outgoings of the Fund.' 20 As evidenced by the financial accounts of the Trust for year ended 30 June 1998 (incorporating the comparative financial accounts for the year ended 30 June 1997), Intex, consistently with the power vested in it by cl 8(u) of the deed, treated the outgoings in question as being on revenue account. By the same clause, it had the power to effectively deny the outgoings that characterisation by determining that the income of the Trust for the year ended 30 June 1998 shall be its s 95 'net income' for that year, but there is no evidence that it exercised that power. 21 The respondent submitted that '… what [is] income for trust law purposes, s 97 purposes, cannot be governed by what is said in the trust deed'. That, so the submission went, '… would be remarkable. You could just define your way out of what the Income Tax Assessment Act provides'. Reliance for this submission was placed on three cases: ANZ Savings Bank Ltd at [15] per Gleeson CJ; Thornley v Boyd (1925) 36 CLR 526 at 536 per Knox CJ; and McBride v Hudson (1961) 107 CLR 604 at 623 - 624 per Taylor J. The submission is flawed for a number of reasons. 22 First, it does not follow that, because the instrument pursuant to which a trust estate is constituted spells out that the trustee has an absolute discretion as to what receipts are treated as income and what outgoings are treated as outgoings against that income for the purposes of determining the income for s 97 purposes - the distributable net income - you can define your way out of the application of the 1936 Act. Liability for tax on the s 95 'net income' will fall where the 1936 Act intends it to fall. In other words, if there is no s 97 income - no distributable net income - to which any beneficiary is presently entitled, then liability for the tax on any s 95 'net income' will fall on the trustee under ss 99 or 99A of the 1936 Act. On the other hand, if there is any s 97 income to which beneficiaries are presently entitled, then any s 95 'net income', whether it is greater or smaller than the distributable net income, will fall to be taxed in the hands of those beneficiaries in proportion to their respective shares of the s 97 income: See Zeta Force Pty Ltd v FCT (1998) 84 FCR 70 and the cases there referred to. 23 Second, the passages from the second and third cases relied upon are dealing with something completely different from the subject matter of the passage relied upon in the first case. The submission not only seeks to conflate the two, but to discount earlier and later passages, in the second and third cases, going to the importance of the terms of the instrument pursuant to which the trust estate is constituted, be it an instrument inter vivos or a testamentary instrument. 24 In Thornley v Boyd, Knox CJ said (at 536): '… the duty of trustees empowered to manage and carry on a grazing business is to manage it according to the method which would be pursued by a prudent owner of the business, and to keep the accounts of the business in the manner usually adopted by such an owner. Accounts so kept should show at the end of each accounting period the sum which may properly be regarded as the distributable income of the business, and in the absence of special circumstances a person entitled to the income of the business should receive as such income this sum and no more.' His Honour is undoubtedly speaking of what should be properly regarded as the distributable income of the business carried on by the trustee, namely, the distributable net income or the s 97 income. However, this extract is preceded by the words : 'Subject to any specific directions given by a testator or settlor, …'. 25 Likewise, in McBride v Hudson at 623 - 624, Taylor J said: 'Consideration must be given to the nature of the relevant business activity and to the manner in which it is customarily carried on and, if in the course of carrying on a business pursuant to a direction to do so trustees adopt an appropriate and conventional method of accounting in order to determine the amount of profit to which a life tenant becomes entitled during any accounting period, no exception can be taken. No doubt it was for this reason that this court was prepared to accept as proper and usual the form of accounting disclosed by the facts in Thornley v Boyd …' 26 However, this extract from his Honour's reasons was immediately followed by the following: 'These observations must, of course, be understood subject to the qualification that if in any particular case it appears from the terms of the trust instrument that business profits are to be ascertained upon a cash basis only, or upon any other basis, those terms must prevail. But in the present case no such indication appears, and the testator, as a person conversant with the manner in which pastoral businesses are generally carried on, must be taken to have intended the profits of the business after his death to be ascertained by a process of accounting conventional and appropriate in that type of business.' 27 Once again, this case is concerned with the proper determination of the net distributable income - the s 97 income - and, in our view, it is made quite clear that in the determination of that amount, the terms of the trust instrument will prevail over any accounting principles that may otherwise be appropriate to the type of business being conducted. 28 The passage in the first case relied upon, ANZ Savings Bank, is concerned with a totally different matter. At [15] his Honour the Chief Justice said: 'For the reasons earlier given, the whole of the annuity amounts received by the trustee constituted income of the trust. The circumstance that the trust instrument, for the purpose of dealing with the entitlements of unitholders, treated the deductible amount as capital, did not alter what was described in Charles v Federal Commissioner of Taxation [(1954) 90 CLR 598 at 608] as "the character of those moneys in the hands of the trustees".' This observation has to be understood in the context of the facts which were before the Court. 29 At [13], his Honour had observed that the trust deed defined income - net distributable income - to mean the net income of the fund as defined in accordance with s 95 of the 1936 Act. Thus, the deductible amount (that part which was exempt income by virtue of the provisions of s 27H(1)(a) of the 1936 Act) was treated under the deed as capital and dealt with by a different clause of the trust deed than that which dealt with income as defined. So understood, the passage from the Chief Justice's judgment at [15] was dealing with what was income in the hands of the trustee in the calculation of the 'net income' of the trust estate for the purposes of s 95 of the 1936 Act. The point the Chief Justice was making was that it was not possible by the terms of the trust deed to bifurcate a receipt in the hands of the trustee which was income according to ordinary principles, and therefore income for the purposes of calculating the s 95 'net income', so that some part of that receipt was not income in calculating the s 95 'net income'. The Chief Justice was not, as the respondent's submission would have it, saying that a provision of the trust deed could not prescribe what was a receipt on revenue account and what was an outgoing on revenue account for the purpose of determining the s 97 income, that is, the distributable net income. 30 We are therefore of the view that the financial accounts of the Trust for the year ended 30 June 1998 properly disclose a distributable net income of $28,697 (before the carry forward of losses from previous years) on the basis that the relevant outgoings, disallowed for the purposes of determining the s 95 'net income' for that year, have nevertheless been properly applied against the income of the Trust for the purposes of determining its distributable net income on a stand alone basis for that year. The question which then arises is whether the loss from the 1997 year in the sum of $54,838 has to be made good before there can be net income from the Trust available for distribution to which beneficiaries of the Trust might be presently entitled pursuant to the default provisions of cl 3(a) of the deed. 31 The respondent, correctly in our view, conceded that if the distributable net income of the Trust for the year ended 30 June 1997 (a loss of $54,838) was properly determined as reflected in the financial accounts referred to, then, the rule in Upton v Browne (1884) 26 Ch D 588 (see too JD Heydon and MJ Leeming, Jacobs' Law of Trusts in Australia, Seventh Edition, 2006 at [1945]) was applicable. That is, losses in one year must, in the absence of any contrary direction in the trust instrument, be made up out of profits of subsequent years and not out of capital so that there can be no profits properly distributable in cash until all past losses are paid. In the present case, therefore, the distributable net income of the Trust for the year ended 30 June 1998 was negative and none of the beneficiaries was presently entitled to anything. The consequence is, in our view, that the liability for tax on the s 95 'net income' falls wholly on Intex under s 99A of the 1936 Act. 32 In his written submissions the respondent submitted that because the contributions to the employment benefit trust ultimately finished up in the hands of some, if not all, of the beneficiaries, the provisions of s 101 of the 1936 Act were triggered and that such beneficiaries were deemed to be presently entitled to the amounts paid or applied for their benefit. This particular submission was not run below and was not, understandably, pressed during the hearing of the appeal. Underlying this submission is the predication that what was contributed to the employee benefit trust was paid out of gross income and that as this finished up, via the employee benefit trust, in the hands of some, if not all, of the beneficiaries, this was sufficient for the purposes of triggering the provisions of s 101. The predication is flawed. 33 Section 101 of the 1936 Act is in the following terms: 'For the purpose of this Act, where a trustee has a discretion to pay or apply income of a trust estate to or for the benefit of specified beneficiaries, a beneficiary in whose favour the trustee exercises his discretion shall be deemed to be presently entitled to the amount paid to him or applied for his benefit by the trustee in the exercise of that discretion.' 34 The reference to 'income of a trust estate' in this section is a reference to the distributable net income; that is, the same income to which s 97 refers. If, as in the present case, there is no distributable net income then, even where the trust instrument gives the trustee a discretion in terms of the section, there is nothing in respect of which it can be exercised. The only provision of the deed conferring on Intex a discretion in terms of s 101 is cl 3(a)(i), and all the references to 'income' is cl 3 of the deed are clearly references to the distributable net income. 35 This is not to say that in the case of a trust, where the trustee has no active duties to perform and incurs no outgoings in deriving the income of the trust, the payment by the trustee to a beneficiary during a year of income of a receipt which is income in the hands of the trustee will escape tax in the hands of the beneficiary. Clearly it will not. It will be included in the beneficiary's assessable income as ordinary income (s 6-5(1) of the Income Tax Assessment Act 1997 (Cth) ('the 1997 Act')) or statutory income (s 6-5(1) of the 1997 Act) by force of s 26(b) of the 1936 Act: See Union Fidelity Trustee Co. of Australia Ltd v FC of T (1969) 119 CLR 177 at 182 per Barwick CJ. 36 For the foregoing reasons, the applicants, as beneficiaries of the Trust, were not presently entitled to any part of the income of the Trust for the year ended 30 June 1998 because there was no distributable income to which they could be presently entitled. It follows that the s 95 'net income' of the Trust for the year ended 30 June 1998 is properly assessable to Intex under s 99A of the 1936 Act. 37 In the circumstances, it is not necessary to consider the second of the applicants' arguments at [15] supra, namely, that Intex's right of indemnity and exoneration as trustee precluded any beneficiary having any entitlement to any income of the Trust for the 1998 year. However, in passing we would merely observe that this submission, which appears to have its origin in what fell from the High Court in CPT Custodians Pty Ltd (previously t/as Sandhurst Nominees (Vic) Ltd (2005) 221 ALR 196 at [49] - [51], conflates two totally different concepts - present entitlement to an amount equal to the income of the fund (not to any particular asset vested in the trustee) on the one hand and the trustee's right to resort to such assets to meet liabilities on the other. This latter right of the trustee would not seem to impact on the beneficiary's present entitlement. 38 The appeal must be allowed and the order made by the Tribunal in respect of the year ended 30 June 1998 set aside. The objection decisions of the respondent on the applicants' objections to their amended assessments for the year ended 30 June 1998 must be set aside and the matter remitted to the respondent to decide the applicants' objections in accordance with these reasons. The respondent must pay the applicants' costs of the appeal. I certify that the preceding thirty-eight (38) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Court.

Associate: Dated: 24 November 2006 Counsel for the Applicants: Mr F O'Loughlin

Counsel for the Respondent: Mr J W de Wijn QC with Ms D M Harding

Solicitor for the Respondent: Australian Government Solicitor

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