Fowler v Commissioner of Taxation

The Legislation 10 In the following discussion, references to Parts and to sections are references to the Act, as it existed at the relevant time. 11 Part 1-3 is headed "Core provisions". Within that Part, s 4-1 provides that "[i]ncome tax is payable by each individual and company, and by some other entities". Division 9, starting at s 9-1, lists the entities that must pay income tax. Section 960-100 of the Act defines "entity". It suffices to say that "entity" means, inter alia, an individual such as Mr Fowler and a body corporate such as the Company. 12 Section 4-5 provides that where a provision of the Act uses the expression "you", "it applies to entities generally, unless its application is expressly limited". Note 1 to s 4-5 states that the expression "you" is in fact not used in provisions that apply only to entities that are not individuals. Accordingly, the note foreshadows that the word "you" will be found to refer to an individual either alone or with others. 13 Section 4-10(2) provides that income tax is worked out by reference to a person's "taxable income" for the "income year". Section 4-10 also provides that an "income year", generally speaking, refers to each year ending on 30 June, called the "financial year". Section 4-15 provides that "taxable income" is "assessable income" minus deductions. The present case is concerned with "assessable income". 14 Division 6 within Pt 1-3 is headed "Assessable income and exempt income". Section 6-5(1) provides: "Your assessable income includes income according to ordinary concepts, which is called ordinary income". Section 6-5 also includes in subss (2) and (3) respectively, provisions covering the situations in which an entity is and is not an Australian resident. Those two subsections used the word "derived". Section 6-5(4) provides that in working out whether and when ordinary income is derived, "you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct". 15 In the present case, the Company received the amounts in question, which were its ordinary income, so there is no issue as to whether and when the Company derived it. 16 Section 6-10(1) provides that an entity's assessable income also includes some amounts that are not ordinary income. Section 6-10(2) states: Amounts that are not ordinary income but are included in your assessable income by provisions about assessable income, are called statutory income. (Footnote omitted.) If the amounts in question are indeed included in Mr Fowler's assessable income by operation of the Act, they must be so included as statutory income, because they are not his ordinary income. 17 Section 6-10(3) provides: If an amount would be statutory income apart from the fact that you have not received it, it becomes statutory income as soon as it is applied or dealt with in any way on your behalf or as you direct. (Footnote omitted.) Subsections (4) and (5) of s 6-10 deal, respectively, with the situations in which the assessable income of an entity that is, and is not, an Australian resident includes statutory income. 18 The word "derived" is absent from s 6-10. Mr Fowler relies on s 6-10(3) to suggest that in the present case, in order for the amounts in question to be part of his statutory income, since they were not received by him, they would have had to be applied or dealt with on his behalf or as he directed. I reject this submission below. 19 Part 1-4 is headed "Checklists of what is covered by concepts used in the core provisions". Only one provision within that Part need be noted, namely s 10-5. Relevantly, that section sets out in a table, as a guide, provisions of the Act that include in assessable income amounts that are not ordinary income. The table includes the following: alienated personal services income .................................................................................................. 86-15 Section 10-5 tells us that we can expect to find that s 86-15 will include "alienated personal services income" that is not an entity's ordinary income into the entity's assessable income. As will be seen below, in my opinion s 86-15 does have that effect, and did so in the case of Mr Fowler. 20 I turn now to Pt 2-42 of the Act which is headed "Personal services income". Section 84-1 provides a guide to Pt 2-42. The section states: This Part is about 2 issues relating to personal services income. Division 85 limits the entitlements of individuals to deductions relating to their personal services income. Division 86 sets out the tax consequences of individuals' personal services income being diverted to other entities (often called alienation of the income). These Divisions do not affect individuals or other entities that conduct personal services businesses. Division 87 defines personal services businesses. 21 I will not need to discuss in detail the definition of a "personal services business" in Div 87, but s 87-10, which states the object of Div 87, is illuminating in this respect. That section refers to "genuine business but not situations that are merely arrangements for dealing with the personal services income of individuals" (footnote omitted). Section 87-15 sets down the circumstances in which a "personal services entity" conducts a "personal services business". Although the Company was a personal services entity (see s 86-15(2) set out below), it is common ground that it was not conducting a personal services business because the criteria of s 87-15 were not met. 22 I turn now to Divs 84 and 86. 23 Section 84-5 provides: (1) Your ordinary income or statutory income, or the ordinary income or statutory income of any other entity, is your personal services income if the income is mainly a reward for your personal efforts or skills (or would mainly be such a reward if it was your income). .... (2) Only individuals can have personal services income. (3) This section applies whether the income is for doing work or is for producing a result. (4) The fact that the income is payable under a contract does not stop the income being mainly a reward for your personal efforts or skills. The amounts in question that were received by the Company, were the personal services income of Mr Fowler, even though, according to ordinary concepts, they were the income of the Company. 24 Three examples appear below subs (1) in s 84-5, of which the first is as follows: Example 1: NewIT Pty. Ltd. provides computer programming services, but Ron does all the work involved in providing those services. Ron uses the clients' equipment and software to do the work. NewIT's ordinary income from providing the services is Ron's personal services income because it is a reward for his personal efforts or skills. The similarity of this example to the facts of the present case is obvious. 25 Division 86 is headed "Alienation of personal services income". Section 86-1 provides: Income from the rendering of your personal services is treated as your assessable income if it is the income of another entity and is not promptly paid to you as salary. However, this does not apply if the other entity is conducting a personal services business. There are limits to the other entity's entitlement to deductions to offset against the amount treated as your income. This provision presupposes that the income from the rendering of the individual's services is "the income of another entity", and not of the individual. Section 84-5(1) (set out above) contemplates the same possibility. 26 Section 86-10 provides that the object of Div 86 is "to ensure that individuals cannot reduce or defer their income tax (and other liabilities) by alienating their personal services income through companies, partnerships or trusts that are not conducting personal services businesses" (footnotes omitted). 27 Section 86-15, which is central in the present case, provides in subss (1)-(3) as follows: (1) Your assessable income includes an amount of ordinary income or statutory income of a personal services entity that is your personal services income. … (2) A personal services entityis a company, partnership or trust whose ordinary income or statutory income includes the personal services income of one or more individuals. … (3) This section does not apply if that amount is income from the personal services entity conducting a personal services business. (Footnotes omitted.) The Company was a personal services entity because its ordinary income included the personal services income of Mr Fowler. 28 Subsection (4) of s 86-15 has the effect that s 86-15 does not apply to the extent that the personal services entity promptly pays the amount to the individual as an employee, as salary or wages. In the present case the Company did not promptly pay the amounts in question to Mr Fowler as salary or wages. It did not pay them to him at all. 29 Section 86-30 prevents double taxation. It provides that ordinary income or statutory income of the personal services entity is neither assessable income nor exempt income of that entity, to the extent that it is personal services income included in the individual's assessable income under s 86-15. Accordingly, if, as the Commissioner contends, s 86-15 operated to include the amounts in question in Mr Fowler's assessable income, they are not assessable income of the Company.

The questions of law raised by the notice of appeal 30 The Notice of Appeal raises the following questions of law: (a) Whether section 86-15 and section 84-5 of the Income Tax Assessment Act 1997 (Cth) are capable of including an amount in the assessable income of an individual if the amount is not "your income", or "income", or beneficially owned or derived by, or income on ordinary concepts of the individual, under Division 6? (b) Whether section 86-15 of the Income Tax Assessment Act 1997 (Cth) operates by its own force to include an amount in the assessable income of an individual or whether section 86-15 needs to be read in conjunction with the jurisdiction, source, derivation and timing rules contained in section [sic] 6-10(3) and 6-10(4) of the Act? (c) Whether under section 6-10(4) of the Income Tax Assessment Act 1997 (Cth) the statutory income to be included in the assessable income of a year of income of an individual can include an amount that is deemed personal services income under section 86-15 but which is not from a source or any source other than the statutory construct in section 86-15? (d) Whether under section 6-10(3) of the Income Tax Assessment Act 1997 (Cth) the statutory income to be included in the assessable income for a year of income can include amounts that are not received or applied or dealt with on the Applicants[sic] behalf or as directed in that year of income? The following grounds of the appeal were pressed: (a) The Tribunal erred in law by treating section 86-15 of the Income Tax Assessment Act 1977 (Cth) as an assessing provision divorced from Division 6 of the Income Tax Assessment Act 1977 (Cth). (b) The Tribunal erred in law by accepting that there was no doctrine of law which would require that the taxation of income depends on ownership of that income. (c) The Tribunal erred in law by failing to consider whether the Applicant derived ordinary income as prescribed in section 6-5 of the Income Tax Assessment Act 1997 (Cth). (d) The Tribunal erred in law by treating an amount deemed under section 86-15 of the Income Tax Assessment Act 1997 (Cth) as the source of statutory income of the Applicant under section 6-10(4) of the Income Tax Assessment Act 1997 (Cth).

The parties' submissions 31 In his counsel's written submissions, Mr Fowler concedes (para 5): ... that the factual circumstances are within the intended ambit of the recently enacted personal services income rules… in Part 2.42 [sic] of the Income Tax Assessment Act 1997…. The question is, of course, whether that intended scope has manifested itself properly within the words of section 86-15 read in the context of section [sic] 84-5 and 86-30 of that Act. This concession was correctly made. It is difficult to conceive of circumstances that fall more clearly within Div 86 in Pt 2-42. Mr Fowler's submission is that the provisions fail to achieve the object that the legislature intended them to achieve. 32 Mr Fowler submits, firstly, that the Tribunal erred in its unqualified acceptance of para 32 of the Commissioner's submission that there is no doctrine of law which would suggest that the taxation of income depends on ownership: see Re Fowler and Commissioner of Taxation [2006] AATA 808; (2006) 64 ATR 1113 at [32]. Mr Fowler elaborates on this submission by referring to the following cases in support of the proposition that income that is derived by a taxpayer beneficially is included in the taxpayer's assessable income: Countess of Bective v Federal Commissioner of Taxation (1932) 47 CLR 417 at 424; MacFarlane v Commissioner of Taxation (1986) 13 FCR 356 at 367; Windshuttle v Commissioner of Taxation (1993) 46 FCR 235; 93 ATC 4992 at 5000; Zobory v Commissioner of Taxation (1995) 64 FCR 86 at 89; Reiter v Commissioner of Taxation (2001) 113 FCR 492 at [24]; Service v Commissioner of Taxation (2000) 97 FCR 265 at [73]; Case 1/2006 [2005] AATA 1251;2006 ATC 101; ABB Australia Pty Ltd v Federal Commissioner of Taxation (2007)162 FCR 189 at [64]. In the present case, it was the Company, not Mr Fowler, that derived and became the beneficial owner of the amounts in question. 33 Secondly, Mr Fowler submits that s 84-5(1) is to be construed as referring to income that is beneficially derived by the individual. Similarly, he submits that the opening words of s 86-15(1), "Your assessable income", refer to income derived by the individual beneficially. 34 Mr Fowler contends that the drafting of ss 84-5 and 86-15 "has fundamentally miscarried" because the drafter, like the Tribunal, has overlooked the import of the authorities, which insist that assessable income be income derived by a taxpayer beneficially - that is to say, be income of which the taxpayer becomes the beneficial owner. Mr Fowler submits that "the defect in the drafting of sections 84-5 and 86-15 is so fundamental that it is not open to a Court to cure by, as it were creative construction" . 35 Thirdly, Mr Fowler submits that there are fundamental problems concerned with the source and timing of the derivation of the income, if the construction supported by the Commissioner and accepted by the Tribunal is correct. Mr Fowler submits that the question of timing is dealt with in s 6-10(3) and that of source in subss 6-10(4) and (5) (both set out above). In substance, he submits that these provisions cannot work if there is an automatic attribution of income of the kind that the Tribunal accepted Pt 2-42 brings about. 36 For his part, the Commissioner submits that, subject to any constitutional constraints, it is open to the legislature to tax as a person's assessable income any amounts it may choose to identify, and that it has unambiguously specified the amounts in question in the present case as included in the statutory income of Mr Fowler. 37 The Commissioner relies on R v Barger (1908) 6 CLR 41 at 114, adopted in Fairfax v Federal Commissioner of Taxation (1965) 114 CLR 1 at 12-13, for the proposition that subject only to the limitations expressed in the Constitution, the Parliament's power to levy taxation: was plenary and absolute; unlimited as to amount, as to subjects, as to objects, as to conditions, as to machinery… with the result that: the Parliament has, prima facie, power to tax whom it chooses, power to exempt whom it chooses, [and] power to impose such conditions as to liability or as to exemption as it chooses. The Commissioner submits that on the assumption that there was a general principle contended for by Mr Fowler, it has been overtaken by the introduction of the Act, which evinces a clear intention to include in a person's assessable income, in the circumstances identified in the Act, amounts of income that the individual did not beneficially derive. 38 The Commissioner submits that ss 84-5 and 86-15 work satisfactorily together, and, in response to Mr Fowler's submissions concerning timing and source, that there is no difficulty in these respects.

Consideration 39 In my opinion, Mr Fowler has not exposed any error of law in the Tribunal's Reasons for Decision. 40 The terms of the Act are clear and leave no scope for a reading down of the kind for which Mr Fowler contends. 41 All of the integers of Mr Fowler's liability to tax are clear. It is not, and could not be, disputed: · that the amounts in question were personal services income of Mr Fowler; · that the amounts were ordinary income of the Company; · that the Company was a personal services entity; or · that the amounts were not income from the Company's conducting a personal services business. 42 I accept that the notion of derivation of income was important in the Income Tax Assessment Act 1936 (Cth): see, for example, ss 17, 19, 20, 21A, 25, 26. 43 I need not discuss the extent to which, under the Income Tax Assessment Act 1936 (Cth), there was any "doctrine of law" or "interpretative presumption" that that Act brought to account as assessable income only amounts of income that the taxpayer derived as "beneficial owner". I note, however, that with the exception of Case 1/2006 [2005] AATA 1251, which is not presently relevant, all of the authorities cited by Mr Fowler (see [32] above) relate to income according to ordinary concepts (called "ordinary income" in the Act). 44 Section 86-15 does not include in the individual's assessable income, income according to ordinary concepts that he or she derives. Income of that kind is the subject of s 6-5, noted earlier. If the amounts in question were income according to ordinary concepts derived by Mr Fowler, s 86-15 would be irrelevant to his circumstances. Part 2-42 must be construed in the light of its purpose. It would frustrate that purpose to insist that s 86-15 failed to reach income that was derived by the "alienee" (the Company in the present case) and of which the alienee became the beneficial owner 45 Mr Fowler's contention must be that there is a derivation/beneficial ownership principle that Pt 2-42 of the Act cannot be allowed to contradict. There is not. 46 I do not see any difficulty in the inter-relationship of ss 84-5 and 86-15. Section 84-5 had the effect that these items of the ordinary income of the Company were Mr Fowler's personal services income, because they would have been mainly a reward for his personal efforts or skills if in fact they had been his income rather than that of the Company. Subsection 86-15(1) then had the effect that Mr Fowler's assessable income included so much of the ordinary income of the Company as was Mr Fowler's personal services income, being, in fact, the whole of the amounts in question. 47 As noted earlier, within Div 6, s 6-10 had the effect that Mr Fowler's assessable income included amounts that were included in his assessable income "by provisions [of the Act] about assessable income", the latter being called statutory income. Section 10-5 correctly identifies s 86-15, dealing with "alienated personal services income", as one of those provisions about assessable income, because, as I have just held, that section is a provision that includes in an individual's assessable income certain income that is not his or her ordinary income. 48 Mr Fowler points out that, contrary to what was foreshadowed in the Explanatory Memorandum for the Bill for the Act, s 84-5(1) uses the word "income" alone and without a qualifier in two places. However, both of those instances clearly refer back to earlier uses of the word with qualifiers. 49 Mr Fowler's reliance on s 6-10(3) is misplaced. That provision applies only where receipt is a necessary element of an amount becoming statutory income of an entity. Examples are to be found in ss 15-3, 15-5, 15-10, 15-20, 15-25 and 15-30 of the Act, in all of which the word "receive" appears. However, receipt may be made such a necessary element without the use of that word or its derivatives. Section 86-15 does not require that Mr Fowler receive or derive the personal services income in question in order for that income to be included in his statutory income. Indeed, the section assumes that it will be received or derived by the alienee. Section 86-15 operates to include the amounts to which it refers in the statutory income of an individual without the necessity of his or her receiving them, and s 6-10(3) has no scope for operation. 50 I am also not persuaded to accept Mr Fowler's timing and source submissions. His submission seems to be that because there is an artificial attribution to the individual of amounts that constituted income of the personal services entity according to ordinary concepts, there is some complexity that would not otherwise exist in terms of identifying the time when the income becomes part of the individual's income and the source of the income. 51 In relation to timing, as noted above, s 6-10(3) has no application. By the operation of s 86-15(1), the individual's (Mr Fowler's in this case) personal services income becomes part of the individual's assessable income when it becomes part of the ordinary or statutory income of the personal services entity (the Company in this case). 52 Similarly, there is no difficulty as to the source of the items of statutory income in the present case. Mr Fowler was an Australian resident (see s 6-10(4)). Although it therefore does not matter, Mr Fowler's statutory income came from an Australian source, and the Company was incorporated in Australia, carried on business in Australia and supplied Mr Fowler's services to the labour hire firms within Australia. 53 Mr Fowler posed several hypothetical examples designed to show that Pt 2-42 might be thought to operate unjustly in particular sets of circumstances if the construction supported by the Commissioner were to find favour. I do not propose to say anything about them because, in my view, the statutory provisions in question clearly bear the construction that I have outlined above, and I do not find in the examples any reason to doubt the correctness of that construction. Certainly the circumstances of the present case provide a straightforward example of circumstances to which the legislature intended Pt 2-42 to apply, as Mr Fowler accepts. 54 The fact that Pt 2-42 would operate unjustly in circumstances that can be hypothesised may be a case for amendment, but it is no reason to defeat the legislative intention in the circumstances of the present case. If there has been any oversight by the drafter, it has been an oversight of the effect that the provisions might have in certain sets of circumstances, not of a fundamental principle that frustrates the drafter's intention (see [34] above).

Conclusion 55 For the above reasons, the appeal will be dismissed with costs. I certify that the preceding fifty-five (55) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Lindgren.

Counsel for the Applicant: Mr D B McGovern SC and Mr I S Young

Solicitor for the Applicant: Robert Richards & Associates

Counsel for the Respondent: Mr N J Williams SC and Mr D F C Thomas

Solicitor for the Respondent: Australian Government Solicitor