Considerations
43 The position in relation to the resolution of the present application seems to me to be this.
44 Some time prior to 30 June 1997 the taxpayer and Mr Mark Trail and Mr Allan Trail entered into and carried into effect a scheme to vary the contracts of employment of 1 April 1996 so as to provide that the payments due to the brothers under the contracts would be made and the taxpayer's contractual obligations discharged, by making the payments to the trustees of the Employee Welfare Fund on the terms of the trust instrument. The trust had been brought into existence expressly for that purpose as part of the scheme. Having regard to the character of the contractual promise that underlay the payments, they were deductible from the assessable income of the taxpayer in the 1997 and 1998 tax years: [11], [12], [13], [14], [19], [20], [23] and [24] of the Tribunal's reasons.
45 Although the Employee Welfare Fund's constitutional instrument contemplates a fund established for the benefit of the employees of the taxpayer, Mr Mark Trail's evidence of the practice of the taxpayer in helping employees was found by the Tribunal to be hyperbole. His motivation in establishing the fund was called into question by the Tribunal and the fund was described as a "mechanism" by which the taxpayer could continue to make the payments to the two brothers that it was obliged to make under the contracts: [13] of the Tribunal's reasons.
46 Accordingly, the scheme consisting of the variation of the contracts; the incorporation of the Employee Welfare Fund to receive the payments under the mechanism of a fund for the benefit of the taxpayer's cohort of employees but which was a new vehicle for the payment to the brothers of the monies they would have received under the contracts; and the payments to the Fund, are to be set aside, notionally.
47 The pre‑scheme arrangements involved circumstances in which the taxpayer was contractually obliged to pay each brother a contribution to a superannuation fund of $237,000.00 within the 1997, 1998 and 1999 tax years, $60,000.00 having been paid to each brother in the 1996 tax year. These future payments in the 1997, 1998 and 1999 tax years were contractual obligations of the taxpayer notwithstanding that age‑based limits on the deductible amount of contributions to an employee superannuation scheme, from the taxpayer's assessable income, had been imposed by amendments to the Act.
48 The Tribunal examined a question it perceived to be the question required to be asked by s 177C(1)(b) of the Act of whether an hypothesis could be identified of what might reasonably have been expected to have happened had the scheme not been entered into. The Tribunal recognised that an alternate postulate to the scheme that involved a sufficiently reliable prediction as to the events that might have occurred, so as to be regarded as a reasonable alternate postulate, was the focus of the statutory enquiry.
49 In that sense, the Tribunal did not formulate an incorrect test to be applied in deciding whether the kind of deduction claimed under the scheme would not have been allowable or might reasonably be expected not to have been allowable to the taxpayer, absent the scheme. That test however necessarily involves an examination of the particular activity the taxpayer would have undertaken or might reasonably be expected to have undertaken in lieu of the scheme and whether the activity would or might reasonably be expected to have resulted in an allowable deduction of the same kind as that claimed by the taxpayer in the two tax years, under the scheme: Federal Commissioner of Taxation v Lenzo per Sackville J at [128] and Heerey J at [38] to [41].
50 There was however no evidence before the Tribunal of that activity. What would or might the taxpayer have reasonably done absent the scheme? Would the taxpayer have paid all the amounts due under the contracts to the two brothers by making the contributions to the superannuation fund? The Tribunal thought not, because the characterisation of the payments involved fully deductible employment contributions by the taxpayer and the taxpayer had implemented the scheme, together with the Trail brothers, so as to enable the contractual payments to be varied and paid to the new Employee Welfare Fund to preserve the fully deductible character of those payments. It followed, in the Tribunal's view, that it was contrary to the interests of the taxpayer and each brother to engage in any activity that "did not allow for complete deductibility of all payments". It necessarily follows, having regard to that finding, that the taxpayer would not have made the pre‑scheme contractual payments to the Employee Superannuation Scheme except to the extent of the age‑limited deductible contributions.
51 What would the taxpayer have otherwise done or might reasonably be expected to have done in the circumstances absent the scheme? Might it have varied the agreements to negotiate new employment contracts containing particular terms which might have given rise to an allowable deduction of the kind claimed in the full amount claimed, and, if so, on what basis or by reference to what steps? The Commissioner says that it is not part of the s 177C(1)(b) test nor is it therefore relevant to consider the tax implications of the alternate postulate as this simply invites the substitution of a new "scheme" for the one required to be stripped away. The Commissioner also says that since the variation of the agreements is part of the scheme that must be stripped away in its entirety, it is not part of the test under s 177C(1)(b) nor is it relevant, to bring within any formulation of an alternate postulate, any variation of the agreements.
52 The question asked by s 177C(1)(b) of the Act however is what activity would the taxpayer have undertaken or might reasonably be expected to have undertaken absent the scheme? Since the deductibility of the payments had been substantially eliminated by the amendments to the Act, it is not unlikely that the employer and the two brothers would have engaged in an activity of seeking to negotiate new employment terms. The new terms may have resulted in steps, events, actions or activities being undertaken by the taxpayer in furtherance of its commercial undertaking that would have given rise to, or might reasonably be expected to have given rise to, a deduction in the hands of the taxpayer of the kind it claimed under the scheme. However, it may not have given rise to such a deduction. The deduction claimed under the scheme must be characterised and a comparison made with the character of the activity said to give rise to, or reasonably expected to give rise to, a deduction of the same kind. In considering that question, it is relevant to have regard to a contended variation to the agreements if that variation is said to form an element of the proposed activity giving rise to the alternate postulate. It is also relevant to have regard to whether that activity would give rise to or might reasonably be expected to have given rise to a deduction of the kind claimed under the scheme. That is not to say that an activity which simply involves a variation to employment contracts so as to substitute one contrived mechanism or colourable structure to clothe non‑deductible payments with deductibility, with another, forms a part of the relevant hypothesis as such a payment would not give rise to an allowable deduction of the kind removed by the scheme.
53 The first step is to isolate with clarity the particular activity that would or might reasonably be expected to have occurred. In undertaking that step it is relevant to have regard to the evidence of the taxpayer as to the steps it says it would have undertaken or would have been likely to undertake in the absence of the scheme: Federal Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404 at pp 423 and 424 per Brennan CJ, Dawson, Toohey, Gaudron, Gummow and Kirby JJ. That subjective evidence of the individuals informing the guiding mind of the taxpayer is, of course, not in any sense determinative of the alternate postulate. However, that evidence, against the background of all the evidence, might assist in framing the nature of the activity the taxpayer would have undertaken or might reasonably be expected to have undertaken. Ultimately, the hypothesis is a prediction as to future events that would or might reasonably be expected to have been undertaken, and the Court, or the administrative decision‑maker, must form its own objective view of that hypothesis and whether, against the background of all the evidence, a sufficiently reliable counterfactual can be identified for it to be regarded as reasonable.
54 The difficulty however is that although the Tribunal formulated the correct test, it applied a different test. The Tribunal did not have before it evidence from the taxpayer of the activity it would have undertaken or might reasonably be expected to have undertaken and was thus not in a position to identify as a sufficiently reliable comparative alternate postulate, an hypothesis that the taxpayer would have discharged its obligations to each brother in a way that was fully deductible. That finding or conclusion was not supported by any evidence of activity on the part of the taxpayer that might have brought about that result. Accordingly, it seems to me that the application of the test, properly identified, miscarried by applying a test that did not investigate the strength of the evidence of the alternate postulate to test whether such an hypothesis was just a possibility or unsupported speculation or, alternatively, sufficiently reliable so as to be regarded as reasonable.
55 There was simply no evidence of the counterfactual as found.
56 In that sense, I am satisfied that there was an error of law in the application of the test required by s 177C(1)(b) and an error of law in that there was no evidence to support the alternate postulate that "a way" would have been found by the taxpayer to make the payments to the two brothers that would or might reasonably be expected to have resulted in an allowable deduction of the same kind as that claimed. The content of the activity giving rise to the way, is critical and the manner of its being undertaken, resulting in a payment that is said to be or might reasonably be expected to be deductible, is also critical. The Tribunal has adopted an exclusionary or reductionist approach in isolating an hypothesis as reasonable, by finding that whatever unidentified activity may have been undertaken, it would have resulted in an allowable deduction to the taxpayer of the kind claimed under the scheme.
57 As support for the notion that the taxpayer would have found a way to make the payments to each brother, the Tribunal embraced the submission of the taxpayer's counsel that the taxpayer could, for example, simply have paid the amount to the two directors (ie. the two brothers) or their wives or a third party and such payments would have attracted an allowable deduction. The taxpayer however did not identify any particular arrangement that might actually have been in contemplation or might reasonably have been adopted in the absence of the scheme. The taxpayer called no evidence providing a foundation for an objective assessment, on all the evidence, that the taxpayer would or might reasonably have been expected to take a particular course of action that would or might reasonably be expected to have given rise to an allowable deduction of the kind claimed under the scheme. No likely variation to the contracts was put in evidence nor the likely central terms of any potential variation. None of the other directors of the taxpayer were called to give evidence of the taxpayer's likely course of conduct had the scheme not been entered into having regard to the potential frustration of the employment contracts by the legislative changes. No other director of the taxpayer gave evidence that a common assumption upon which the contractual obligations rested had failed and, in consequence, in order to adjust the terms of the employment relationship, the taxpayer would have been likely to undertake particular steps for a particular reason giving rise to particular payments that would or might reasonably be expected to have given rise to an allowable deduction of the same kind as that claimed. Any payments to the two brothers either made to them or their wives or a third party would have been likely to result in assessable income in the hands of the brothers or fringe benefits tax being imposed upon the taxpayer. The taxpayer may have chosen to adopt a course of conduct which accepted such a liability but no evidence was available to demonstrate what might have occurred.
58 The alternative postulate that represents a reasonable prediction of future events absent the scheme is that the taxpayer would have made payments to the two brothers up to the age‑based limits provided for by the Act and would have sought to negotiate a variation to the contracts as to the balance payments which may have resulted in a new set of arrangements that may have given rise to an allowable deduction. However, in the absence of any real content or evidence of the relevant activity, it cannot be said that a deduction of the kind claimed under the scheme would have been allowable to the taxpayer or might reasonably be expected to have been allowable to the taxpayer absent the scheme, and thus the taxpayer has obtained a tax benefit in connection with the scheme in the amount of the allowable deductions in excess of the age‑based limits.
59 Accordingly, the decision of the Tribunal must be set aside.
60 The matter is to be remitted to the Tribunal to determine the questions before it by applying the test so as to determine whether there is evidence which supports an hypothesis that the taxpayer would have undertaken or might reasonably be expected to have undertaken a particular activity in lieu of the scheme and whether that activity would or might reasonably be expected to have resulted in an allowable deduction of the same kind as the deduction claimed by the taxpayer under the scheme consistently with the methodology identified in the authorities and in particular, Commissioner of Taxation v Peabody (1994) 181 CLR 359; Commissioner of Taxation v Hart (2004) 217 CLR 216; and Federal Commissioner of Taxation v Lenzo (2008) 167 FCR 255 at 278 [121] to [125] and [128]; Federal Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404.
61 If there is no evidence before the Tribunal that enables a sufficiently reliable prediction to be made of an alternate hypothesis that would or might reasonably be expected to have resulted in an allowable deduction of the kind claimed under the scheme, the hypothesis that represents a sufficiently reliable prediction of future events in the absence of the scheme, is that the taxpayer would have made payments to the Trail Bros Superannuation Fund of amounts equal to the age‑based limits under the Act on behalf of each brother, and no sufficiently reliable prediction can be made as to the course of conduct that would or might reasonably be expected to have been adopted as to the balance payments due under the contracts except that no payments beyond the age‑based limits would have been paid into the Trail Bros Superannuation Fund.
62 The respondent shall pay the costs of the applicant of and incidental to the application.
- I certify that the preceding sixty-two (62) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Greenwood.