Commissioner of Taxation (Cth) v Peabody

High Court of Australia|1986-06-30|Before: McHugh JJ, O'Loughlin J, Cooper JJ, Mason J

High Court of Australia Mason C.J. Brennan, Deane, Dawson, Toohey, Gaudron and McHugh JJ. Commissioner of Taxation (Cth) v Peabody [1994] HCA 43

The Court delivered the following written judgment: -

1994, Sept. 28 Mason C.J.,Brennan, Deane, Dawson, Toohey, Gaudron and McHugh JJ.

See Cridland v Federal Commissioner of Taxation (1977), 140 C.L.R. 330, at pp. 337-338, per Mason J. 2. (1992) 24 A.T.R. 58; 92 A.T.C. 4,585. 3. (1993) 40 F.C.R. 531.

Mrs. Peabody's husband, Terrence Elmore Peabody, had established in 1963 with his father and another partner a fly ash business. Fly ash is a light, powdery substance, also known as pozzolan, which is a by-product of coal burnt in power stations. When blended with cement, fly ash adds strength and durability to concrete and reduces its cost. The business successfully developed the process for the use of fly ash in structural concrete and in 1985 was owned as to 62 per cent by the Peabody interests and as to 38 per cent by a Mr. Ray Kleinschmidt or interests associated with him. The business comprised four main companies: Pozzolanic Enterprises Pty Ltd, Pozzolanic (Queensland) Pty Ltd, Pozzolanic Bulk Carriers (Queensland) Pty Ltd and Coastal Bulk Haulage Pty Ltd There were other companies but they were all subsidiaries of one or other of these companies which may be referred to as the Pozzolanic Group.

The shares in the Pozzolanic Group which were owned by the Peabody interests were held in the name of TEP Holdings Pty Ltd ("TEP Holdings"). That company held the shares as trustee of a discretionary trust known as the Peabody Family Trust. Mrs. Peabody and her two children were the beneficiaries under the trust and she and her husband were the only directors of TEP Holdings.

In 1985 Mr. Peabody formulated a plan, which he had been considering for some time, whereby TEP Holdings would acquire Mr. Kleinschmidt's interest in the Pozzolanic Group, publicly float 50 per cent of that group and retain control of the remaining 50 per cent. Mr. Peabody and Mr. Kleinschmidt reached an agreement that the latter would sell the whole of his interest in the group to the Peabody interests. Mr. Kleinschmidt did not want the price of his shares - which was some $8.6 million - to be disclosed publicly and Mr. Peabody agreed that there should be no public disclosure.

There was an expectation that the public float would be capitalized at a figure well in excess of the $24 million which was the basis of the price agreed for the purchase of the Kleinschmidt shares. It was anticipated that difficulties might arise if it became necessary to disclose in the prospectus for the float that the shares acquired by the Peabody interests from Mr. Kleinschmidt had been acquired a short time before at a figure substantially less than that for which they were offered to the public. Advice was obtained from senior counsel that disclosure was not required, but the advice was qualified.

Discussion between Mr. Peabody and his advisers revealed the possibility of the Peabody interests acquiring the Kleinschmidt shares and converting them to a different class with restricted rights which would render them almost worthless. The consequence of that would be that the shares held by TEP Holdings would increase in value by the amount shed by the Kleinschmidt shares. Mr. Peabody's solicitor pointed out that TEP Holdings could then sell the shares it had always owned to a public company formed for the purpose of the float for a price which reflected the increased value and so avoid the application of s. 26AAA of the Act which at that time included as assessable income any profit arising from the sale of property acquired within twelve months of the sale. No decision was made initially whether TEP Holdings or a separate company would be the purchaser of the Kleinschmidt shares.

There was further discussion about the method of financing the purchase of the Kleinschmidt shares. It became apparent that there were advantages if a financier, rather than simply lending the necessary money, were to subscribe for redeemable preference shares in the company which was to purchase the shares. By this method, the cost of the finance would be considerably reduced. The financier would receive dividends on the preference shares equal to the interest which it would have received under a conventional arrangement but less the tax which it would have paid on that interest. The financier would receive under s. 46 of the Act, as it then was, a rebate of 100 per cent of tax in respect of the dividends. Thus the financier would effectively receive a tax-free dividend equivalent to the after-tax interest. Once the dividends had been declared, the preference shares would be redeemed so that the financier would receive back an amount which would be the equivalent of the principal of a loan.

It was decided that TEP Holdings should acquire a shelf company, Loftway Pty Ltd ("Loftway"), to purchase the Kleinschmidt shares in the Pozzolanic Group. This was done and the shares in Loftway were held by TEP Holdings in its capacity as trustee of the Peabody Family Trust. Westpac Banking Corporation ("Westpac") became the financier. Loftway purchased the Kleinschmidt shares for the sum of $8,656,177. The money to pay for these shares was provided by Westpac subscribing for redeemable preference shares in Loftway. After the Kleinschmidt shares in the Pozzolanic Group had been acquired by Loftway, the four Pozzolanic companies each declared dividends which were paid to Loftway. With this money Loftway in turn declared the appropriate dividend to be paid to Westpac.

Each of the four companies in the Pozzolanic Group, with the consent of Loftway, passed special resolutions converting the shares which Loftway had purchased in them into "Z" class preference shares which carried restricted rights reducing their value from some $8.6 million to something less than $500. As a consequence, the shares in the Pozzolanic Group held by TEP Holdings, which previously represented only 62 per cent of the equity in the group, came to represent virtually 100 per cent of that equity. Thereafter, TEP Holdings (and Mr. Peabody in respect of a small number of shares in his name) agreed to sell the whole of the ordinary shares in the Pozzolanic Group to a company which eventually became Pozzolanic Industries Ltd. ("Pozzolanic Industries") for $30 million. The purchase price was payable partly in cash and partly in shares in Pozzolanic Industries with the result that TEP Holdings eventually held 50 per cent of the shares in Pozzolanic Industries. The remaining 50 per cent of the shares in Pozzolanic Industries were floated to the public. No mention was made in the prospectus for the float of the price paid for the purchase of the Kleinschmidt shares.

With money raised by the sale, TEP Holdings lent an amount to Loftway which enabled it to redeem the preference shares held by Westpac. It appears that eventually Loftway transferred the "Z" class shares in the Pozzolanic Group to TEP Holdings which then transferred them to Pozzolanic Industries either by way of gift or at par value. TEP Holdings forgave Loftway the debt arising out of the above-mentioned loan by TEP Holdings to Loftway.

The determination made by the Commissioner under s. 177F of the Act was that the sum of $888,005 should be included in the assessable income of Mrs. Peabody for the year ended 30 June 1986. This was done pursuant to s. 97 of the Act upon the basis that Mrs. Peabody was a beneficiary of a trust estate presently entitled to a share of the income of the trust estate. That figure represented one-third of the profit for the purposes of s. 26AAA which the Commissioner claims TEP Holdings would have realized if it had bought the Kleinschmidt shares and sold them within twelve months of their acquisition.

The trustees of the Peabody Family Trust had resolved to distribute the whole of the income of the trust estate (including specifically any amounts which the Commissioner should add as a result of amended assessments) equally among the three beneficiaries of whom Mrs. Peabody was one. As a result Mrs. Peabody was said by the Commissioner to have derived, by the application of s. 97, assessable income in the sum of $888,005.

The Commissioner's discretion to cancel a tax benefit under s. 177F is dependent upon a tax benefit having been obtained by a taxpayer in connexion with a scheme to which Pt IVA applies. "Scheme" is defined broadly in s. 177A(1) as meaning:

(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

(b) any scheme, plan, proposal, action, course of action or course of conduct.

Under s. 177A(3) the scheme, plan, proposal, action, course of action or course of conduct may be unilateral. Section 177A(5) provides: A reference in this Part to a scheme or a part of a scheme being entered into or carried out by a person for a particular purpose shall be read as including a reference to the scheme or the part of the scheme being entered into or carried out by the person for 2 or more purposes of which that particular purpose is the dominant purpose.

Under s. 177C(1)(a) a reference in Pt IVA to the obtaining of a tax benefit in connexion with a scheme is to be read relevantly as a reference to:

an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out.

Section 177D, so far as is relevant, provides that Pt IVA shall apply to a scheme, where:

(a) a taxpayer (in this section referred to as the "relevant taxpayer") has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and

(i) the manner in which the scheme was entered into or carried out;

(iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;

(iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;

(v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;

(vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;

(vii) any other consequence for the relevant taxpayer, or for any person referred to in sub-paragraph (vi), of the scheme having been entered into or carried out; and

(viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in sub-paragraph (vi),

it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers).

Where a tax benefit has been obtained, or would but for s. 177F be obtained, by a taxpayer in connexion with a scheme to which Pt IVA applies, the Commissioner may under s. 177F(1)(a) - "in the case of a tax benefit that is referable to an amount not being included in the assessable income of the taxpayer of a year of income - determine that the whole or a part of that amount shall be included in the assessable income of the taxpayer of that year of income". The amount so determined shall, under s. 177F(2), be deemed to be included in the assessable income by virtue of such provision of the Act as the Commissioner determines.

The scheme in this case as originally identified by the Commissioner extended "to the conversion of the [Kleinschmidt shares] to "Z" class shares, with the result being that same were not subsequently sold to the newly-formed public company Pozzolanic Industries Ltd.". Subsequently, in the Federal Court proceedings, the Commissioner particularized the scheme as including the following steps:

(1) The purchase of all the shares of [the Pozzolanic Group] which were owned by R.T. Kleinschmidt by [Loftway];

(2) The issue of preference shares by [Loftway] to [Westpac];

(3) The conversion of shares in the [Pozzolanic Group] to "Z" class preference shares;

(4) The reduction in the considered value of the [Pozzolanic Group] shares by [Loftway];

(5) The special resolution by the [Pozzolanic Group] to remove the right of "Z" class preference shareholders to receive preferential dividends;

(6) The loan made by [TEP Holdings] which was the trustee of the Peabody Family Trust to [Loftway] and the terms and conditions of that loan;

(7) The public float of Pozzolanic Industries Ltd. which float excluded the "Z" class shares;

(8) The redemption of its preference shares in the target entities by [Loftway] from [Westpac];

(9) The sale of the [Pozzolanic Group] "Z" class shares by Loftway to [TEP Holdings] for a consideration of $476.00;

(10) The transfer of the shares by [TEP Holdings] as a gift or at par value to Pozzolanic Industries Ltd.

At first instance in the Federal Court, O'Loughlin J. took the view that Mr. Kleinschmidt's wish to keep confidential the price which was paid for his shares played no part in the decision to convert those shares into "Z" class shares. That conversion, he said, was implemented to avoid the provisions of s. 26AAA and was to be considered separately from the method adopted to finance the purchase of the Kleinschmidt shares, the purpose of which was plainly commercial. The relevant scheme might, O'Loughlin J. concluded, be confined to the conversion of the Kleinschmidt shares to "Z" class shares, but he was of the view that even if it extended to the issue of redeemable preference shares by Loftway as a means of obtaining cheap finance, the dominant purpose was still to avoid the application of s. 26AAA and so obtain a tax benefit.

The Full Court of the Federal Court took a different view. They pointed out that the scheme identified by the Commissioner comprised a series of steps, of which the conversion of the Kleinschmidt shares to "Z" class shares was only one. In their view it was not open to the Court to take one step and classify it as a scheme in itself. The discretion vested in the Commissioner to make a determination under s. 177F(1) was, the Full Court said, dependent upon the existence of a scheme to which Pt IVA applied in connexion with which a taxpayer obtained a tax benefit and it was not possible to substitute some other scheme for the scheme upon which the Commissioner exercised his discretion under that section. That discretion was exercisable by the Commissioner and not by the Court so that, in the view of the Full Court, it was not possible to support the validity of its exercise upon a basis other than that adopted by the Commissioner - that is to say, to do so by reference to a scheme other than that identified by the Commissioner.

The Full Court concluded, therefore, that the only relevant scheme was that identified by the Commissioner. The scheme identified was a course of action or conduct by Mr. Peabody commencing with the purchase of the Kleinschmidt shares and ending with the transfer of those shares to Pozzolanic Industries. The dominant purpose of Mr. Peabody in entering into or carrying out that scheme was, in the view of the Full Court, commercial, namely, the acquisition of the Kleinschmidt shares and the flotation of a public company. It was not, so the Full Court said, to enable the taxpayer, Mrs. Peabody, to obtain a tax benefit in connexion with the scheme.

The Full Court also concluded that, in any event, it was not reasonable to expect that, if the scheme had not been entered into or carried out, the assessable income of Mrs. Peabody would have included the amount in question. Such an expectation could only be based upon the view that TEP Holdings would have purchased the Kleinschmidt shares and that, in the view of the Full Court, was not a reasonable expectation.

Accordingly, the Full Court allowed the appeal and upheld Mrs. Peabody's objection to the amended assessment of income tax in respect of the year of income ended 30 June 1986.

Under s. 177F(1), the Commissioner's discretion to cancel a tax benefit extends only to a tax benefit obtained in connexion with a scheme to which Pt IVA applies. The existence of the discretion is not made to depend upon the Commissioner's opinion or satisfaction that there is a tax benefit or that, if there is a tax benefit, it was obtained in connexion with a Pt IVA scheme. Those are posited as objective facts [3] . The erroneous identification by the Commissioner of a scheme as being one to which Pt IVA applies or a misconception on his part as to the connexion of a tax benefit with such a scheme will result in the wrongful exercise of the discretion conferred by s. 177F(1) only if in the event the tax benefit which the Commissioner purports to cancel is not a tax benefit within the meaning of Pt IVA. That is unlikely to be the case if the error goes to the mere detail of a scheme relied upon by the Commissioner. An error of a more fundamental kind, however, may have that result - where, for example, it leads to the identification of the wrong taxpayer as the recipient of the tax benefit. But the question in every case must be whether a tax benefit which the Commissioner has purported to cancel is in fact a tax benefit obtained in connexion with a Pt IVA scheme and so susceptible to cancellation at the discretion of the Commissioner.

See McAndrew v Federal Commissioner of Taxation (1956), 98 C.L.R. 263, at pp. 276-277, per Kitto J.; cf. Avon Downs Pty Ltd v Federal Commissioner of Taxation (1949), 78 C.L.R. 353, at p. 360, per Dixon J.

Of course, the Commissioner may be required to supply particulars of the scheme relied on [4] and in this case has supplied them in the form of the ten steps identified by the Commissioner. But the Commissioner is entitled to put his case in alternative ways. If, within a wider scheme which has been identified, the Commissioner seeks also to rely upon a narrower scheme as meeting the requirements of Pt IVA, then in our view there is no reason why the Commissioner should not be permitted to do so [5] , provided it causes no undue embarrassment or surprise to the other side. If it does, the situation may be cured by amendment, provided the interests of justice allow such a course [6] .

See Bailey v Federal Commissioner of Taxation (1977), 136 C.L.R. 214. 2. See XCO Pty Ltd v Federal Commissioner of Taxation (1971), 124 C.L.R. 343, at p. 349, per Gibbs J. 3. Bailey v Federal Commissioner of Taxation (1977), 136 C.L.R., at p. 219.

In this case, O'Loughlin J. at first instance took the view that the Commissioner had particularized the scheme too widely and that it should be confined to the devaluation of the Kleinschmidt shares and the subsequent disposal of them. He was not bound to accept the wider scheme advanced by the Commissioner before him and there was no unfairness to the taxpayer in his reaching the conclusion which he did, notwithstanding the apparent failure of the Commissioner to advance alternative schemes. The argument of the Commissioner plainly relied upon the devaluation of the Kleinschmidt shares as evidence of a dominant purpose on the part of Mr. Peabody to obtain a tax benefit, however widely the particulars were otherwise drawn. Before us the Commissioner sought to rely upon the narrower scheme identified by the judge at first instance and, in our view, he was entitled to do so.

However, the Full Court was of the view that the only scheme available to be considered in connexion with the tax benefit cancelled by the Commissioner was the whole scheme embraced by the particulars provided by the Commissioner. In relation to that scheme the Full Court concluded that the dominant purpose of Mr. Peabody - the only relevant person to enter into and carry out the scheme - was of a commercial nature and not to enable Mrs. Peabody to obtain a tax benefit. The Commissioner's answer to that was that the provisions of Pt IVA cover not only a scheme but any part of a scheme. That is to be seen, he said, in ss. 177D and 177A. In s. 177D it is contemplated that the person by reference to whose purpose the nature of the scheme is to be determined may be a person who enters into or carries out only part of the scheme. Section 177A(5) provides that it is the dominant purpose of a person entering into or carrying out part of a scheme which is relevant where that person has two or more purposes. The consequence, so the Commissioner argued, was that if Mr. Peabody's dominant purpose in carrying out that part of the scheme which consisted of the devaluation of the Kleinschmidt shares was to obtain a tax benefit, then any tax benefit obtained as a consequence was obtained in connexion with a scheme within the meaning of Pt IVA.

But Pt IVA does not provide that a scheme includes part of a scheme and it is possible, despite the very wide definition of a scheme, to conceive of a set of circumstances which constitutes only part of a scheme and not a scheme in itself. That will occur where the circumstances are incapable of standing on their own without being "robbed of all practical meaning" [7] . In that event, it is not possible in our view to say that those circumstances constitute a scheme rather than part of a scheme merely because of the provision made by ss. 177D and 177A. The fact that the relevant purpose under s. 177D may be the purpose or dominant purpose under s. 177A(5) of a person who carries out only part of the scheme is insufficient to enable part of a scheme to be regarded as a scheme on its own. That, of course, does not mean that if part of a scheme may be identified as a scheme in itself the Commissioner is precluded from relying upon it as well as the wider scheme.

See Inland Revenue Commissioners v Brebner , [1967] 2 A.C. 18, at p. 27.

The Commissioner also contested the alternative basis upon which the Full Court decided against him, namely, that any tax benefit was not obtained by Mrs. Peabody. He argued that, if the Kleinschmidt shares had not been converted to "Z" class preference shares, a proportion of the amount of profit which would have been derived from their sale, made necessary because of the float, might reasonably be expected to have been included in Mrs. Peabody's assessable income for the year ended 30 June 1986.

The difficulty faced by the Commissioner in making that submission was not in establishing that a tax benefit was obtained by reason of the conversion of the Kleinschmidt shares to "Z" class preference shares, but in establishing that the tax benefit was obtained by Mrs. Peabody in the relevant year of income. As O'Loughlin J. observed at first instance [8] :

The Peabody interests had negotiated the purchase of a large parcel of shares in the group based on the group having a net worth of about $24m. Within a period of twelve months of that purchase there was to be a public float based on the group having a net worth of $30m. Somebody (the particular taxpayer or taxpayers within the Peabody family who would purchase the Kleinschmidt shares) stood to make a capital gain that was equivalent to about 38 per cent of $6m. However that taxpayer or those taxpayers would be liable to tax on that capital gain unless some lawful avoidance measure could be implemented. 1. (1992) 24 A.T.R., at p. 67; 92 A.T.C., at p. 4,593.

The purchase of the Kleinschmidt shares was necessary for the purposes of the float. The actual purchaser of those shares was Loftway and it is apparent that Loftway, or some other company performing the same role, was required to be the purchaser in order to obtain the cheaper finance for the purchase, regardless of the subsequent devaluation of the shares. It was not contested by the Commissioner that the decision to finance the purchase of the Kleinschmidt shares through Loftway was other than a rational, commercial decision. The scheme for cheaper finance required both the purchaser of the Kleinschmidt shares and the financier holding the redeemable preference shares in the purchaser to be entitled to a rebate under s. 46 of the Act in respect of dividends received by them. The Commissioner contended that the purchaser might reasonably be expected to have been TEP Holdings had there been no devaluation of the Kleinschmidt shares. A reasonable expectation requires more than a possibility. It involves a prediction as to events which would have taken place if the relevant scheme had not been entered into or carried out and the prediction must be sufficiently reliable for it to be regarded as reasonable [9] .

See Dunn v Shapowloff , [1978] 2 N.S.W.L.R. 235, at p. 249, per Mahoney J.A.

There were difficulties in the way of TEP Holdings itself financing the purchase of the Kleinschmidt shares, regardless of any subsequent devaluation. Even if it had been possible for that company to issue and pay dividends upon redeemable preference shares having regard to its status as a trustee, it is far from clear that it could have established any entitlement to a rebate in respect of the dividends paid on the Kleinschmidt shares acquired by it. In order to establish an entitlement to a rebate, it would have been necessary for TEP Holdings, a trustee, to acquire the Kleinschmidt shares beneficially so that it was entitled beneficially to the dividends. If the shares were acquired by TEP Holdings on behalf of the trust, the dividends would not have been included in its taxable income [10] and there would have been no rebate in respect of them (s. 46(2)). Since the purchase of the Kleinschmidt shares had to be financed whether or not they were subsequently devalued, any uncertainty as to the entitlement of TEP Holdings to a rebate in respect of dividends upon those shares made it unlikely that TEP Holdings would have been chosen as the purchaser of the shares. The Full Court was correct in its conclusion that there was no reasonable expectation that TEP Holdings would have acquired the Kleinschmidt shares as part of the exercise involved in the float. It may be added that, in any event, even if TEP Holdings had been able to acquire the Kleinschmidt shares in its own right and not as trustee, it would appear that there would have been no present entitlement on Mrs. Peabody's part to any proportion of any profit arising from the sale of those shares.

It necessarily follows that any profit obtained from the sale of those shares, had the devaluation not taken place, would have been obtained by Loftway so that any tax benefit in connexion with the devaluation and subsequent disposal of the Kleinschmidt shares was obtained by that company. There is no reason to suppose, and the Commissioner was unable to demonstrate, that, had the devaluation not taken place and had that profit been made by Loftway, it would have flowed, or could reasonably be expected to have flowed, to TEP Holdings and hence to Mrs. Peabody in the year ended 30 June 1986. In other words, and quite apart from any income tax which Loftway might have been liable to pay in respect of the profit, there was no reasonable expectation that Loftway would have declared dividends which would have reached the Peabody Family Trust in that year of income.

The Commissioner advanced examples in an effort to show that, even assuming that finance was raised by Loftway by the issue of preference shares, the acquisition and disposal of the Kleinschmidt shares might have taken place in a manner which would have resulted in Mrs. Peabody obtaining a tax benefit in the relevant year of income. But the method adopted by Loftway, apart from the devaluation of the Kleinschmidt shares, was found below to be entirely explicable upon a commercial basis and it could not be said of any of the examples advanced that, even if commercially possible, they would have been adopted in the absence of the devaluation as a matter of reasonable expectation.

For these reasons, it cannot be said that the amount which the Commissioner included in Mrs. Peabody's assessable income for the year ended 30 June 1986 was an amount which would have been included or might reasonably be expected to have been included in her assessable income for that year had the devaluation of the Kleinschmidt shares not taken place. Mrs. Peabody did not, therefore, obtain a tax benefit in connexion with a Pt IVA scheme and, accordingly, the appeal must be dismissed.

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