Cooper Brookes (Wollongong) Pty Ltd v Federal Commissioner of Taxation

REASONS FOR JUDGMENT HILL AND SACKVILLE JJ: THE PROCEEDINGS This is an appeal and cross-appeal from orders made by a Judge of this Court on objections made by the respondent/cross respondent ("Prestige") to assessments issued by the appellant/cross respondent ("the Commissioner"). The assessments were issued in respect of the tax years from 1979 to 1992. Each was based on the application of s 100A of the Income Tax Assessment Act 1936 (the "ITAA") to certain transactions involving Prestige and the Prestige Unit Trust (the "Trust"). The primary Judge identified three separate transactions or series of transactions, each of which is said by the Commissioner to justify the application of s 100A of the ITAA. The three transactions have been described as · the "RLAV transaction"; · the "1981 NMLA transaction"; and · the "1984 NMLA transaction". The RLAV transaction involved the sale by Prestige of a profitable business to the then trustee of the Trust (the "Trust") and the issue of 93 per cent of units in the Trust to a company known as Ronald Lyons Australia (Vic) Pty Ltd ("RLAV"). RLAV had substantial tax losses and, prior to the allotment of units, effectively became subject to the control of the same persons who controlled Prestige. Prestige later became the trustee of the trust. In essence the Commissioner's case is that the arrangement pursuant to which this transaction took place was made for the purpose of avoiding tax. The purpose was to be achieved by diverting income from Prestige to RLAV, thereby enabling the latter to offset the income against its tax losses and to pay interest to an offshore company controlled by the same interests as controlled Prestige. The Commissioner says that the arrangement constitutes a "reimbursement agreement" for the purposes of s 100A of the ITAA and that the income distributed to RLAV is deemed by s 100A(1) to be income to which no beneficiary is presently entitled. The consequence is said to be that the trustee of the Trust (which is Prestige itself) is assessable to income tax at the special rate declared for the purposes of s 99A of the ITAA. That rate is set at the highest marginal rate for individual taxpayers and was 61.5 per cent in the first of the tax years in question and 48 per cent in the last. The NMLA transactions each involved the issue of units in the Trust to National Mutual Life Association Ltd (NMLA), a life assurance company. Pursuant to s 112A of the ITAA, NMLA's assessable income included income derived from assets in its statutory fund. The Commissioner's position is that the agreements pursuant to which these transactions were undertaken had a tax avoidance purpose, namely the diversion of income from RLAV (after its tax losses had been "used up") to the tax exempt NMLA. The Commissioner says that the agreements are reimbursement agreements for the purposes of s 100A of the ITAA and that the trustee of the Trust is assessable at the special rate provided for in s 99A in respect of the income distributed to NMLA. The primary Judge found in favour of Prestige in relation to the RLAV transaction. His Honour did so on the ground that s 100A, as a matter of construction, applied only to reimbursement agreements entered into in relation to an existing trust estate, and not to agreements which involve the creation of the trust estate. However, his Honour found in favour of the Commissioner in relation to the NMLA transactions. The Commissioner appeals against the decision in favour of Prestige in relation to the RLAV transaction, while Prestige cross appeals against the decision in favour of the Commissioner in relation to the NMLA transactions. Prestige has filed a notice of contention by which it seeks to support the primary Judge's decision in relation to the RLAV transaction on grounds either rejected or not considered by his Honour. THE STATUTORY SCHEME The statutory scheme set out in this part of the judgment is that which was in force during the relevant period. Section 100A forms part of Division 6 of Part 3 of the ITAA, which is headed "Trust Income". Section 96 states that, except as provided in the ITAA, a trustee "shall not be liable as trustee to pay income tax upon the income of the trust estate". Under s 97, where a resident beneficiary of a trust estate who is not under any legal disability is presently entitled to a share of the income of the trust estate, the assessable income of the beneficiary is to include that share of the net income of the trust estate. Section 98 provides that, where a resident beneficiary of a trust estate who is under a legal disability is presently entitled to a share of the trust income, the trustee is assessable to tax in respect of that share of the income as if it were the individual. Section 99A provides for certain trust income to be taxed at a special rate. In particular, s 99A(4) provides that where there is no part of the net income of a resident trust estate that is · included in the assessable income of a beneficiary pursuant to s 97; · in respect of which the trustee is liable to pay tax pursuant to s 98; or · is income attributable to sources outside Australia and represents income to which a non-resident beneficiary is entitled, the trustee is to be assessed and liable to pay tax on the net income of the trust estate at the rate declared by Parliament for the purposes of the section. As we have mentioned, during the relevant years of income the declared rate varied, but was as high as 61.5 per cent. Section 100A was inserted into the ITAA by the Income Tax Assessment Amendment Act 1979 (the "1979 Act"), which also substituted new ss 97, 98 and 99A(4) for earlier versions of those provisions. The legislation was introduced into the Parliament as the Income Tax Assessment Amendment Bill (No 5) 1978, following a statement by the then Treasurer on 11 June 1978. Because the taxpayer placed considerable reliance on the extrinsic materials, it is convenient to refer here to passages in the Treasurer's statement and the Explanatory Memorandum accompanying the Bill. In the 11 June 1978 statement, the Treasurer announced the Government's intention to legislate to overturn schemes which had the "broad purpose of allowing income derived by trusts to be passed on to beneficiaries in a tax free form". The statement continued as follows: "A feature of several of the schemes is a very wide power given to the trustee under the terms of the trust instrument as to the distribution or application of trust income. In reliance on this power, the trustee agrees with promoters of tax schemes and other compliant parties to distribute or apply the bulk of the trust income - either directly or through an interposed trust - for the apparent benefit of specially introduced beneficiaries who do not pay any, or any substantial, amount of tax on the amount distributed or applied. In some cases the nominal beneficiary selected is a tax-exempt body, such as a charitable institution or sporting association. In other cases, it is a company, set up for the purpose by the promoters of the scheme, that by one means or another escapes payment of tax on the income. One technique is to set artificially-created paper 'losses' off against the income received from the trust. Another technique is to strip assets from the recipient company so that tax assessed on the income cannot be collected. Yet again, the income may be distributed to non-resident individuals each of whom does not have enough Australian taxable income to be liable to tax, but who will account for the income to the Australian family concerned. The essential element common to the schemes is that, while the income concerned is effectively freed from tax in the hands of the nominal beneficiary, the terms of the underlying arrangement ensure that the beneficiary does not enjoy anything like the full use or benefit of the income. Instead, the arrangement, requires a broadly equivalent capital sum - but reduced by the promoter's fee and a modest reward for the services of any participating exempt body - to be directed to persons intended all along as the real beneficiaries of the trust. The arrangements are often very complex and the party responsible for putting the real beneficiaries in funds may be an associate of the nominal beneficiary. The return of the funds may be achieved by a settlement on another trust established for the benefit of the real beneficiaries of the main trust or their families, by the making to them of what is known colloquially as a 'collapsible loan', i.e. a loan that effectively does not have to be repaid, or through the nominal beneficiary having acquired the right to the income by payment to the real beneficiaries of a broadly equivalent sum. ... The legislation to counter tax avoidance through trust stripping schemes will broadly be on the lines that any distribution or application of income by a trustee, pursuant to a relevant contract, arrangement or understanding, will be treated as not having been made. This means that the trustee will be liable to be assessed and pay tax at the rate of 60 per cent on the amount involved as if it had been accumulated in the trust. In broad terms, a relevant contract, arrangement or understanding will be one the terms of which contemplate conferring on a particular beneficiary a 'present entitlement' to income of a trust, and under which the beneficiary or an associated party is to provide funds or benefits in money's worth for another person, company or trust." The Explanatory Memorandum accompanying the Bill explained the operation of the proposed s 100A as follows: "The arrangements generally turn on the operation of section 97 which, as described earlier in this memorandum, provides for a beneficiary to be subject to tax where the beneficiary is presently entitled to a share of the income of a trust estate and is not under any legal disability. In those circumstances, the beneficiary's share of the trust net income is included in his assessable income and the trustee is not required to pay tax on the income. Where the trustee has a discretion to pay or apply income for the benefit of one or more specified beneficiaries and the trustee exercises the discretion in favour of a beneficiary, section 101 deems the beneficiary to be presently entitled to the amount paid or applied. Such an amount thus also falls to be taxed to the beneficiary under section 97. A common feature of the tax avoidance arrangements at which the proposed section is directed is for a specially introduced beneficiary to be made presently entitled to income of the trust estate, so that the trustee is relieved of any tax liability on the income. Under the arrangements, the beneficiary also does not pay tax, e.g., because of a peculiar tax status. For example, the beneficiary may be a body or organisation that qualifies for exemption of its income under specific provisions, or it may be another trust that has sufficient deductible losses to absorb its share of income as a beneficiary of the first trust estate. Invariably, the arrangements require this introduced beneficiary to retain only a minor portion of the trust income and to ensure that some other person - the one actually intended to take the benefit - effectively secures enjoyment of the major portion of the trust income but in tax-free form (e.g., by the settlement of a capital sum in another trust estate for the benefit of that person). The proposed section 100A will look to the existence of an agreement or arrangement that is entered into otherwise than in the course of ordinary family or commercial dealing and under, or as a result of which, present entitlement to a share of trust income is conferred on a beneficiary in return for the payment of money or the provision of valuable benefits to some other person, company or trust. In those circumstances, the section will require the income of the trust that is dealt with under the 'reimbursement agreement' to be treated as having been accumulated by the trustee as income to which no beneficiary is presently entitled. This will result in the trustee being liable to pay tax on the income under section 99A at the prescribed tax rate, 61.5 per cent for 1978-79. The new section is to apply to reimbursement arrangements giving present entitlement to an introduced beneficiary where the relevant trust income is paid to or applied for the benefit of the beneficiary after 11 June 1978, the day on which the Government announced its intention to introduce legislation to overcome these arrangements." Section 100A(1) provides as follows: "(1) Where - (a) apart from this section, a beneficiary of a trust estate who is not under any legal disability is presently entitled to a share of the income of the trust estate; and (b) the present entitlement of the beneficiary to that share or to a part of that share of the income of the trust estate (which share or part, as the case may be, is in this sub-section referred to as the 'relevant trust income') arose out of a reimbursement agreement or arose by reason of any act, transaction or circumstance that occurred in connection with, or as a result of, a reimbursement agreement, the beneficiary shall, for the purposes of this Act, be deemed not to be, and never to have been, presently entitled to the relevant trust income." If s 100A(1) applies to a beneficiary, the effect is that the beneficiary is deemed not to be presently entitled to income, thereby rendering the trustee assessable at the special rate determined pursuant to s 99A of the ITAA. Section 100A(5) provides as follows: "For the purposes of sub-section (1), but without limiting the generality of that sub-section, where - (a) a reimbursement agreement was entered into at or after the time when a person became a beneficiary of a trust estate (whether the person became a beneficiary of the trust estate before or after the commencement of this action); and (b) the amount (in this sub-section referred to as the 'increased amount') of the share of the income of the trust estate to which the beneficiary is presently entitled exceeds the amount (in this sub-section referred to as the 'original amount') of the income of the trust estate to which the beneficiary would have been, or could reasonably be expected to have been, presently entitled if the reimbursement agreement had not been entered into or if an act, transaction or circumstance that occurred in connection with, or as a result of, the reimbursement agreement had not occurred, the present entitlement of the beneficiary to so much of the increased amount as exceeds the original amount shall be taken to have arisen out of the reimbursement agreement." Subsections 100A(7), (8) and (9) define "reimbursement agreement" for the purposes of s 100A: "100A(7) Subject to sub-section (8), a reference in this section, in relation to a beneficiary of a trust estate, to a reimbursement agreement shall be read as a reference to an agreement, whether entered into before or after the commencement of this section, that provides for the payment of money or the transfer of property to, or the provision of services or other benefits for, a person or persons other than the beneficiary or the beneficiary and another person or other persons. 100A(8) A reference in sub-section (7) to an agreement shall be read as not including a reference to an agreement that was not entered into for the purpose, or for purposes that included the purpose, of securing that a person who, if the agreement had not been entered into, would have been liable to pay income tax in respect of a year of income would not be liable to pay income tax in respect of that year of income than that person would have been liable to pay if the agreement had not been entered into. 100A(9) For the purposes of subsection (8), an agreement shall be taken to have been entered into for a particular purpose, or for purposes that included a particular purpose, if any of the parties to that agreement entered into the agreement for that purpose, or for purposes that included that purpose, as the case may be." Subsections (10) and (11) provide as follows: "100A(10) A reference in subsection (7) to the payment of money to a person or persons shall be read as including a reference to the payment of money to a person or persons by way of loan. 100A(11) A reference in this section to a person shall be read as including a reference to a person in the capacity of a trustee." The expression "agreement" is defined in s 100A(13): "'agreement' means any agreement, arrangement or understanding, whether formal or informal, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings, but does not include an agreement, arrangement or understanding entered into in the course of ordinary family or commercial dealing." THE TRANSACTIONS The primary Judge summarised the three transactions. However, because his Honour held that s 100A could not apply to the distributions made in the course of the RLAV transaction, he did not need to deal with that transaction in detail. The following account of the RLAV and NMLA transactions is taken partly from his Honour's judgment, but also draws on an agreed statement of facts tendered in the proceedings. The RLAV Transaction For some years prior to 1979 Prestige carried on a successful business as a wholesaler and retailer of Toyota motor vehicles (the "Business"). The Business yielded substantial income. Prestige at this time was a member of the Perron group of companies, of which the chairman was Mr Lloyd Perron. Other members of the group included Century Finance Pty Ltd ("Century Finance") and Perron Investments Pty Ltd ("Perron Investments"). Mr Geoffrey Gadsdon was a director of Prestige at all material times and was primarily responsible within the group for the implementation of all three transactions. In late 1978 Ronald Lyons Australia (Vic) Pty Ltd ("RLAV") was a wholly owned subsidiary of Ronald Lyons Holdings Ltd (in Liquidation) ("RLH"), a United Kingdom company, and was unrelated to Prestige. RLAV at that time was insolvent and was under the administration of a receiver appointed by RLH's liquidator. RLAV's assets included tax losses of about $2.4 million and land in Melbourne with a market value of about $750,000. Its liabilities included a debt of about $8.2 million to Kaiser Ullman Ltd ("KUL"), secured by a mortgage over the land and about $950,000 due to RLH and other companies in the Lyons group. Between October 1978 and February 1979 negotiations were undertaken for the assignment to a company incorporated in Singapore, Cholmondeley Commercial and Equitable Estates (Singapore) Pty Ltd ("Cholmondeley"), of the rights of KUL and RLH in respect of the mortgage and of the indebtedness of RLAV. Mr Gadsdon gave evidence that, although the Perron group had no power to control the directors of Cholmondeley in the exercise of their voting rights, the directors of the Perron group companies hoped that the directors of Cholmondeley would act in accordance with the wishes of the Perron group from time to time. His Honour noted that there was no evidence that the hope was misplaced. On 25 January 1979, a deed of trust (the "Trust Deed") was executed, whereby the Trust was established as a unit trust, with LSP Pty Limited ("LSP") as Trustee. The sum of $100 was settled on the trustee. Under the Trust Deed, the trustee was empowered to issue 50 "A" class units and 2,000,200 "B" class units. On 23 February 1979, a series of documents was executed. These included the following: · a deed among KUL, Cholmondeley and RLH whereby KUL assigned its mortgage to RLH in consideration of $810,000 paid by RLH to KUL; · a deed between KUL and Cholmondeley whereby RLH assigned to Cholmondeley the debt due by RLAV for a nominal consideration; and · a mortgage by RLAV of its land to Century Finance to secure a loan of $1.3 million and an agreement for the postponement of the KUL mortgage (which had been assigned to RLH). His Honour found that as the result of these documents and actions taken pursuant to them, RLAV's only indebtedness was to Cholmondeley, in the sum of approximately $8 million, and to Century Finance, in the sum of $1.3 million. RLAV's only asset (other than tax losses) was the Melbourne land, which was mortgaged to secure its indebtedness to Cholmondeley and Century Finance. Between 26 and 28 February 1979, Mr Perron applied for all 50 "A" class units and RLAV applied for 1,866,850 (or 93.3 per cent) of the "B" class units. Other companies and persons, apparently all shareholders of Prestige, applied for the balance of the "B" class units. On 1 March 1979, the following events occurred: (i) Century Finance advanced to RLAV the sum of $1,866,850, on condition that sum be applied to subscribing for units in the Trust and the mortgage between RLAV and Century Finance was varied by increasing the sum secured by $1,866,850. (ii) LSP issued to unitholders the units for which they had applied and each unitholder paid $1.00 for each unit so issued. RLAV subscribed $1,856,850 for its units. (iii) LSP utilised the bulk of the moneys so paid to pay the taxpayer the agreed purchase price for the Business, namely, $1,915,383, and the purchase of the Business was completed. (iv) LSP, as had been intended, retired as trustee of the Trust and appointed the taxpayer as trustee in its place. The reason for LSP acting as trustee of the Trust for a short period was to avoid the difficulty of Prestige selling the Business as owner to itself as Trustee. The following distributions of income were made to RLAV by the taxpayer, as trustee of the Trust: "Year ended 30 April 1979 $ 149,348 Year ended 30 April 1980 $2,453,447 Year ended 30 April 1981 $3,492,522 Year ended 30 April 1982 $3,718,575 Year ended 30 April 1983 $NIL"