Fletcher v Commissioner of Taxation - [1991] HCA 42 - HCA 1990 case summary — Zoe

CTHHCA

Fletcher v Commissioner of Taxation

[1991] HCA 42

High Court of Australia|1990-06-28|Before: McHugh JJ, Burchett JJ, Lee JJ

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Source facts

Court

High Court of Australia

Decision date

1990-06-28

Before

McHugh JJ, Burchett JJ, Lee JJ

Source

Original judgment source is linked above.

Judgment (42 paragraphs)

[1]

These proceedings involve a challenge to the correctness of fourteen income tax assessments issued by the respondent Commissioner of Taxation ("the Commissioner") to one or other of the four appellants ("the taxpayers") in respect of tax years within the period 1982-1985 ("the tax years"). In each of the returns giving rise to the assessments, the particular taxpayer claimed a deduction for his or her share of the net loss allegedly sustained in the relevant tax year by a partnership called "Annuity Investments Partnership No. 18" ("the partnership"). In each assessment, the Commissioner disallowed the claimed deduction. Objections by the taxpayers against the assessments were all disallowed by the Commissioner. The taxpayers appealed to the Administrative Appeals Tribunal. The Tribunal ("the First Tribunal") affirmed the Commissioner's decision in relation to each objection on the ground that the claim to the deduction should be disallowed pursuant to the general anti-avoidance provisions of Pt IVA of the Income Tax Assessment Act 1936 Cth ("the Act"). An appeal by the taxpayers to the Full Court of the Federal Court (Lockhart, Wilcox and Burchett JJ.) was upheld on the ground that Pt IVA had been neither relied upon by the Commissioner in making the assessments or disallowing the objections nor raised in the course of the hearing before the First Tribunal [1] . The consequence was that the decision of the First Tribunal was vitiated by a denial of procedural fairness. The Full Court ("the First Full Court") ordered that the matter be remitted to the Tribunal for further hearing. An application to this Court for special leave to appeal from the decision of the First Full Court was refused.

[2]

[26]

All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income (emphasis added). Two introductory points should be made about s. 51(1). The first is that, as the words "to the extent to which" make plain, the sub-section contemplates apportionment. In their joint judgment in Ronpibon Tin N.L. and Tongkah Compound N.L. v. Federal Commissioner of Taxation [6] , Latham C.J., Rich, Dixon, McTiernan and Webb JJ. pointed out that there are at least two kinds of outgoings which require apportionment for the purposes of the sub-section: One kind consists in undivided items of expenditure in respect of things or services of which distinct and severable parts are devoted to gaining or producing assessable income and distinct and severable parts to some other cause. In such cases it may be possible to divide the expenditure in accordance with the applications which have been made of the things or services. The other kind of apportionable items consists in those involving a single outlay or charge which serves both objects indifferently. As their Honours also pointed out [6] , what represents the appropriate apportionment in the case of such items of expenditure is essentially a question of fact. The second introductory point to be made about s. 51(1) is that the reference in it to " the assessable income" is not to be read as confined to assessable income actually derived in the particular tax year. It is to be construed as an abstract phrase which refers not only to assessable income derived in that or in some other tax year but also to assessable income which the relevant outgoing "would be expected to produce" [7] . 1. (1949) 78 C.L.R. 47, at p. 59. 2. (1949) 78 C.L.R. 47, at p. 59. 3. ibid., at p. 57; see also A.G.C. (Advances) Ltd. v. Federal Commissioner of Taxation (1975), 132 C.L.R. 175, at pp. 196-197; Federal Commissioner of Taxation v. Riverside Road Lodge Pty. Ltd. (In liq.) (1990), 23 F.C.R. 305, at pp. 311-312; John v. Federal Commissioner of Taxation (1989), 166 C.L.R. 417, at p. 426.

[36]

The material before the Court does not disclose the precise chain of reasoning underlying the Commissioner's disallowance of the claim by each of the taxpayers to a deduction in respect of the alleged partnership loss in each of the tax years. Notwithstanding the rejection by the First Full Court of the arguments based on sham and fiscal nullity, the Commissioner apparently did not contend before either the Second Tribunal or the Second Full Court that there should be included in the assessable income of any of the taxpayers in respect of any of the tax years an amount representing a share of net income of the partnership in respect of that tax year. Nor did either the Second Tribunal or the Second Full Court indicate a view that any such amount should properly have been included in the assessable income of any of the taxpayers. In a context where the rejection of arguments of sham and fiscal nullity would appear to leave the partnership in receipt of assessable income (i.e. the adjusted receipts under the annuity agreement) and where there were no outgoings other than interest, it arguably follows that there is implicit in the decision of both the Second Tribunal and the Second Full Court the view that, in the assessment of the net income or loss of the partnership in each of the tax years, a deduction in respect of interest should be allowed to the extent of the amount of assessable income derived by the partnership in that tax year. Be that as it may, that is the approach which was adopted on behalf of the Commissioner in this Court where it was conceded that a deduction for interest outgoings should be made in the calculation of the net income or loss of the partnership to the extent necessary to produce a nil result. That concession was, in our view, properly made. As has been seen, the outgoings of interest represented the cost of the partnership's borrowing for the purchase of the rights under the annuity agreement. To the extent that the partnership's outgoings of interest in a particular tax year did not exceed assessable income actually derived by the partnership under the annuity agreement in that tax year, they are properly to be characterized as incurred in gaining or producing that assessable income and were therefore deductible (pursuant to s. 51(1)) in the calculation of the net income or loss of the partnership for tax purposes. Beyond that point, the mere relationship between outgoings actually incurred and the much smaller amounts of assessable income actually derived does not suffice, without more, to answer the question whether, and if so to what extent, the adjusted outgoings of interest are properly to be characterized as incurred in gaining or producing assessable income. That question must be answered by reference to a common sense appreciation of the overall factual context in which the outgoings were incurred. It necessarily involves a consideration of the contents and implications of the overall contractual arrangements to which the partnership became a party and pursuant to which the outgoings of interest became payable. As will be seen, it also encompasses a consideration of the purpose which the members of the partnership, and those who advised them or acted on their behalf, had in view in incurring the outgoings.

[38]

In that context, it is not surprising that the agreements provided a mechanism whereby the adverse consequences to the taxpayers of the last five years of the "plan" could be avoided. As has been seen, in the event of default on the part of the partnership under the loan agreements at any time in the first ten years, the partnership would be under no liability to actually repay outstanding principal or to pay further interest. The entitlement of Doowarf and Eromdim would be limited by the express provisions of the loan agreements to recourse against "any property or interest in any property acquired [by the partnership] with the principal sum or any part thereof" of the relevant loan. The only property or interest in property which would answer that description would be the partnership's interest under the annuity agreement. In these circumstances, as the members of the First Full Court pointed out, it would "clearly be advantageous" to the taxpayers to ensure that the annuity and loan agreements did not run their full course. Indeed, it is difficult to avoid the impression that the whole structure of the "investment plan" was predicated upon an assumption that the various agreements would be effectively terminated at some time before the commencement of the last five years. In that regard, it is relevant to note that the evidence did not disclose how the $20,000 balance (being the result of the deduction of Annuity Investment's $30,000 fee from the amount actually invested by the taxpayers) could be expected to generate the projected surplus of about $34,080 of annuity receipts over all partnership outgoings which the partnership would theoretically be entitled to receive in cash in each of the last five years if the annuity agreement were to be permitted to run its full fifteen-year course. So to say is not to question the decision of the First Tribunal, confirmed by the First Full Court, that the agreements cannot be disregarded as shams. It is simply to recognize that the agreements were so framed that it lay within the control of the partnership effectively to terminate them prematurely and that it was clearly in the interests of the taxpayers to insist that the agreements in fact be terminated before the commencement of the eleventh year of the "plan".

[39]

If the adjusted outgoings of interest are, on a common sense appreciation of all the relevant facts, properly to be characterized on the basis that they were made pursuant to contractual arrangements which were expected to be fully performed in accordance with their terms with the result that the total of the projected annuity payments would actually be received by the partnership, the total assessable income which the partnership would be expected to derive would exceed the total of the adjusted outgoings of interest by more than $1. 7m (see Schedule B). On that basis, the adjusted outgoings of interest payable under the two loan agreements would properly be characterized as incurred in gaining or producing the totality of the assessable income payable under the annuity agreement over its purported fifteen-year term. So characterized, the adjusted outgoings of interest incurred in each of the tax years would be wholly deductible under the sub-section. On the other hand, if the reality of the situation be that the outgoings of interest were incurred on the basis that the three agreements would be effectively terminated at some time during the first ten years of the fifteen-year "plan", the total of the anticipated adjusted outgoings of interest would far exceed the total of the anticipated assessable income under the "plan". On that approach, the excess of the adjusted outgoings of interest over assessable income in each of the tax years could not be explained by reference to surplus assessable income which was expected to be derived in subsequent years. To the contrary, it would be necessary to look for some other explanation of the planned expenditure of outgoings of interest which exceeded assessable income by more than $2. 7m in the first ten years of the scheme. That explanation would obviously be found in the operation and anticipated consequences of the three agreements in the context of a planned termination of them all during the first ten years. In part, the explanation would lie in the provisions of the two loan agreements which enabled the partnership to participate in the overall "plan" without the individual partners being required to contribute more than the $20,000 (being the balance of the original $50,000) paid by the taxpayers and which enabled the partnership to walk away from the "plan" at any time without the individual partners being under a personal liability in relation to the payment of the principal (or interest) of the Doowarf or Eromdim loans. In part, it would be that found by the Second Tribunal and affirmed by the Second Full Court, namely, the very substantial personal income tax advantages which the taxpayers were expected to derive from the early years of the "plan". To the extent that the surplus of partnership outgoings of interest over annuity receipts in each of the tax years were to be so explained, the outgoings could not properly be characterized, for the purposes of s. 51(1), as incurred in gaining or producing assessable income or as not being "of a capital, private or domestic nature". It follows that, subject to the possible effect of Pt IVA and s. 82KL of the Act, the deductibility under s. 51(1) of the excess of the partnership's adjusted interest outgoings over the partnership's assessable income in each of the tax years turns upon whether those adjusted outgoings of interest are to be seen as payments made pursuant to a fifteen-year "plan" which could be expected to run its course or as payments made under a fifteen-year "plan" which was structured and expected to be terminated by the partnership before the commencement of its eleventh year.

[40]

The question whether the outgoings of interest were incurred on the basis or in the expectation that the fifteen-year plan would in fact run its full course is a question of fact. As such, the onus of proof in relation to it lay upon the taxpayers. In the circumstances of the present case, its determination involves consideration not only of the purposes of the taxpayers but also of the purposes of those who advised them and acted on their behalf and whose "acts (and intentions)" as agents must, as the Second Tribunal expressly pointed out, "be imputed to the principals". That question was clearly adverted to by both the Second Tribunal and the Second Full Court. There is however no express finding in relation to it in the reasons or judgment of either. It is arguable that a finding that the agreements would be prematurely terminated is implicit in some passages of the reasons of the Second Tribunal, in particular in the reference to the implications of the "unexplained failure to call Mr. Crowl" which immediately follows a lengthy extract from the evidence of Mr. Tucker (who executed the agreements and bills of exchange on behalf of the partnership) in the course of which, under cross-examination, he had acknowledged the taxation disadvantages of the last five years of the "scheme" and stated that he did not know whether "the intention of the parties" had been "to get out of this scheme after ten years". It may also be arguable that such a finding is implicit in the Second Tribunal's express statement that it was "satisfied that there was ample evidence" before the First Tribunal to found "its decision with respect to the application of Pt IVA" since the presiding member of the First Tribunal (Mr. Bannon Q.C.) had indicated the view that the projected "profits" of the last five years were a "mirage" and would never in fact be derived. Arguably, in a context where the overall effect of the fifteen-year plan would be, if it ran its full course, to yield a substantial surplus of assessable income over adjusted interest outgoings, such a finding was implicit in the statement of the Second Full Court to the effect that the Second Tribunal was "justified" in concluding that the "whole exercise had, as far as the accountants were concerned, the dominant purpose of reducing the taxable income of their clients". These aspects of the case were not, however, explored in argument in this Court where each side claimed to be entitled to succeed in any event. Nor was it suggested in argument that this Court should itself make any necessary further findings of fact.