The Concept of "Sham"
46 As Lockhart J observed in Sharrment Pty Ltd & Ors v Official Trustee in Bankruptcy (1988) 18 FCR 449 at 453, "sham" is a word which, although not infrequently having attracted the attention of the courts, usually hovers on the periphery of cases. As in Sharrment, here it lies at the heart of the case. The principal basis upon which the Commissioner seeks to defend the assessments he has issued to the applicants, both in this Court and in the Tribunal, is that the payments contended by the applicants to be loans from entities overseas to entities in Australia, and the instruments, if any, said to evidence the terms on which these payments were made, are sham transactions and documents, a disguise or pretence for something else; that something else is identified as the bringing into Australia of funds held for Mr Townsing and/or entities association with him, with no obligation on the recipient to repay. Apart from Mr Townsing, the Commissioner does not identify the associated entity or entities for which the funds are held, nor the entity or entities holding them; rather, in the absence of the payments being found to be loans to and borrowings by the Australian entities, he puts the applicants to proof that the assessments are excessive, and contends that the applicants have not discharged the onus each carries: s 14ZZO(b) of the TAA.
47 In Sharrment, Lockhart J at 453 noted that the term "sham" is ambiguous and that ambiguity and uncertainty surrounds its meaning and application, a view which found resonance with the plurality in Raftland Pty Ltd v Commissioner of Taxation of the Commonwealth of Australia (2008) 238 CLR 516 at [35], who, because a finding of sham requires a finding of an intent to deceive, suggested the need for caution in adoption of the description "sham" (at [36]); a court will not find that a transaction is a sham if another inference is at least equally open: Sharrment at 461; see too Lewis v Condon (2013) 85 NSWLR 99 at [63] where Leeming JA, with whom McColl JA and Sackville AJA agreed, referred to the observations of Neuberger J in National Westminster Bank Plc v Jones [2001] BCLC 98 at [59] that there is a "strong and natural presumption against holding a provision or a document a sham". To like effect, see Coshott v Prentice (2014) 221 FCR 450 at [64].
48 At the outset, there is a need to distinguish the way in which the courts in this country, and in the United Kingdom and Canada, have construed and applied the concept of "sham" to transactions and documents, and not confuse it, with the formulation and application of the sham doctrine in the United States, which grew out of the landmark decision of the United States Supreme Court in Gregory v Helvering 293 US 465 (1935). In delivering the judgment of the Court, Justice Sutherland at 469,470 said:
Putting aside, then, the question of motive in respect of taxation altogether, and fixing the character of the proceeding by what actually occurred, what do we find? Simply an operation having no business or corporate purpose - a mere device which put on the form of a corporate reorganization as a disguise for concealing its real character, and the sole object and accomplishment of which was the consummation of a preconceived plan, not to reorganize a business or any part of a business, but to transfer a parcel of corporate shares to the petitioner. No doubt, a new and valid corporation was created. But that corporation was nothing more than a contrivance to the end last described. It was brought into existence for no other purpose; it performed, as it was intended from the beginning it should perform, no other function. When that limited function had been exercised, it immediately was put to death.
In these circumstances, the facts speak for themselves and are susceptible of but one interpretation. The whole undertaking, though conducted according to the terms of subdivision (B), was in fact an elaborate and devious form of conveyance masquerading as a corporate reorganization, and nothing else. The rule which excludes from consideration the motive of tax avoidance is not pertinent to the situation, because the transaction upon its face lies outside the plain intent of the statute. To hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose.
49 It has been suggested, see Postlewaite, Philip F, "The Status of the Judicial Sham Doctrine in the United States" (2005) 15(1) Revenue Law Journal 140, following the Fifth Circuit's decision in Compaq Computer Corp v Commissioner of Internal Revenue 277 F 3d 778 (5th Cir 2001) overturning the Tax Court's conclusion that the transaction in that case lacked both a business purpose and a pre-tax profit potential (113 TC 214 (1991)), as well as other recent cases, including that of the United States Supreme Court in Gitlitz v Commissioner of Internal Revenue 531 US 206 (2001), that the judicial sham doctrine in the United States may be on the wane, necessitating greater reliance on Congress to assume responsibility for preventing "excessive taxpayer behaviour". Whether or not this is so, may be put to one side, save to say that that doctrine has nothing to do with concept of "sham" in this country; nor in the United Kingdom or Canada.
50 In 1984, the Canadian Supreme Court, in Stubart Investments Limited v R [1984] 1 SCR 536, expressly rejected the proposition that a transaction may be disregarded for tax purposes solely on the basis that it was entered into by a taxpayer without an independent or bona fide business purpose (at [55]). In the course of delivering the principal judgment of the Court (concurred in by Beetz and McIntyre JJ; Wilson J agreeing, concurred in by Ritchie J), Estey J embraced the concept of sham as articulated by Diplock LJ in Snook v London & West Riding Investments Ltd [1967] 2 QB 786 at 802 (see [53] below) which he said had been "adopted by this Court" in MNR v Cameron, [1974] SCR 1062. At [28] Estey J noted that in the United Kingdom there was evidence that the courts were moving from the principles enunciated in the older cases to "something approaching the United States bona fide business purpose rule". This was a reference to the then recent decisions of the House of Lords in W T Ramsay Ltd v Inland Revenue Commissioners [1982] AC 300; CIR v Burmah Oil Co Ltd [1982] STC 30 and Furniss (Inspector of Taxes) v Dawson [1984] AC 474, a move which was applauded in the writings of some at the time: see Peter Millet QC, as his Lordship then was, in (1986) British Tax Review (Pt 6) 327-339, where the learned author concluded:
So, after a journey that has taken 50 years, we have at last found a solution to the problem of artificial tax avoidance; and it turns out to be remarkably similar to that expounded by Learned Hand J. in 1934. It is not based merely on rhetoric or prejudice against the tax-avoider, but on sound logic and legal reasoning. It is in accordance with ordinary legal principles; and indeed restores the role of ordinary legal reasoning to tax cases, from which it had effectively been excluded. Above all, it makes the law accord with common sense; for it really would offend common sense if the taxpayer had won in Ramsay or Eilbeck v. Rawling, Helvering v. Gregory or Furniss v. Dawson. None of those taxpayers has any real cause for complaint. When he was first told of the scheme and that it would save tax, he must have been incredulous: it was too good to be true. It is only fitting that the answer given by the courts is: "Indeed, it is too good to be true.".
51 With the benefit of hindsight, it is easy to say that the applause was somewhat premature; subsequent decisions of the House of Lords cast such doubt on the efficacy of the so-called solution that recourse eventually had to be had to a statutory anti-abuse provision (Part 5 (ss 206-215) of the Finance Act 2013 (UK)) in the fight against artificial tax avoidance. But that too can be put to one side, because what is relevant for present purposes is that the concept of "sham" in the United Kingdom remains today, as it has always done, in the restated articulation that fell from Diplock LJ in London and West Riding Investments (see [53] below).
52 Prior to what fell from Diplock LJ in London and West Riding Investments, Windeyer J had occasion to consider the concept of sham in two different factual contexts. First, in Albion Hotel Pty Limited v The Commissioner of Taxation of the Commonwealth of Australia (1964-1965) 115 CLR 78, his Honour held that a written instrument, brought into existence some two years after a parent company started making advances to its wholly owned subsidiary, but back-dated to around the commencement of those advances, requiring the subsidiary to pay interest on the advances, in circumstances where no interest was paid or asked to be paid, was a sham and the claims for deductions disallowed, even though the moneys advanced by the parent to the subsidiary, and payments by the subsidiary to the parent, were to be treated as loans and repayments thereof respectively. Second, in Scott v Commissioner of Taxation of the Commonwealth (No 2) (1966) 40 ALJR 265, his Honour had occasion to consider whether a superannuation fund was established for the benefit of employees; he concluded that it was not, but if it was, his Honour concluded that it was not applied at any time for the purposes for which it was established. In the course of his reasons, his Honour said (at 279):
The difficult and debatable philosophic questions of the meaning and relationship of reality, substance and form are for the purposes of our law generally resolved by asking did the parties who entered into the ostensible transaction mean it to be in truth their transaction, or did they mean it to be, and in fact use it as, merely a disguise, a façade, a sham, a false front - all these words have been metaphorically used - concealing their real transaction: see the cases referred to by Jordan C.J. in Perpetual Trustee Co. v. Bligh (1940), 41 S.R. (N.S.W.) 33, at p. 39, and Hawke v. Edwards (1947), 48 S.R. (N.S.W.) 21, at p. 23, and Collis v. Margroarty and O'Sullivan, [1913] S.R.Qd. 25, affirmed 15 C.L.R. 692.
53 Diplock LJ described the "popular and pejorative word " sham in London and West Riding Investments at 802 in these terms:
I apprehend that, if it has any meaning in law, it means acts done or documents executed by the parties to the "sham" which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create. But one thing, I think, is clear in legal principle, morality and the authorities (see Yorkshire Railway Wagon Co. v. Maclure and Stoneleigh Finance Ltd. v. Phillips), that for acts or documents to be a "sham", with whatever legal consequences follow from this, all the parties thereto must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating. No unexpressed intentions of a "shammer" affect the rights of a party whom he deceived. There is an express finding in this case that the defendants were not parties to the alleged "sham." So this contention fails.
(Emphasis added)
54 In Miles v Bull (1969) 1 QB 258, Megarry J at 264 said:
[A] transaction is no sham merely because it is carried out with a particular purpose or object. If what is done is genuinely done, it does not remain undone merely because there was an ulterior purpose in doing it. … Mere circumstances of suspicion do not by themselves establish a transaction as a sham; it must be shown that the outward and visible form does not coincide with the inward and substantial truth.
So much was accepted as correct by Leeming JA in Lewis v Condon at [68] in reliance on the authorities and writings there referred to.
55 In Ramsay, Lord Wilberforce said at 323:
[T]o say that a document or transaction is a "sham" means that while professing to be one thing, it is in fact something different.
And Lord Fraser at 337, after referring with apparent approval to what Diplock LJ said at 802 in London and West Riding Investments said:
Thus an agreement which is really a hire purchase agreement but which masquerades as a lease would be a sham.
56 Sixteen years after Sharrment, and twenty two years after Ramsay, the High Court of Australia endorsed what Lockhart J said in the former case, in Equuscorp Pty Ltd v Glengallan Investments Pty Ltd (2004) 218 CLR 471, at [46] in the following way:
"Sham" is an expression which has a well understood legal meaning. It refers to steps which take the form of a legally effective transaction but which the parties intend should not have the apparent, or any, legal consequence.
57 In Equuscorp at [46]-[51], the High Court criticised the application of the notion of sham to transactions which were legally effective, but where their economic effect was put in issue. The Court made it clear that any general principle - "that there is no 'loan' unless there is 'real' money lent" - was wrong and should be over-ruled (at [47]). As Lockhart J pointed out in Sharrment at 454 by reference to Perpetual Trustee Co Ltd v Barnett (1969) 90 WN (Pt 1) (NSW) 637, the fact that the transaction involved a round robin of cheques does not necessarily establish that the transaction is a sham, even when no party has funds to meet the cheques.
58 Just because one person or the same group of persons may be behind two corporate entities that enter into a contract does not mean that the contract is not genuine; that is, it is a document the parties do not intend to have its apparent legal effect. Moreover, just because a document described as a contract is unsigned or is only signed by one party does not by itself indicate that it is a sham. An unsigned contract can record the terms of an agreement that has been reached between parties: R v Dickson (No 18) [2015] NSWSC 268 at [47].
59 In Sharrment, Lockhart J distinguished the characterisation of a transaction or document as artificial from a sham transaction or document and observed by reference to Coppleson v Commissioner of Taxation (1981) 52 FLR 95 at 100, that the complexity of a transaction does not in itself establish its character as a sham (at 454, 455). To like effect, Leeming JA in Lewis v Condon said (at [64]):
Sham … is to be distinguished from other transactions to which legal opprobrium attaches, such as transactions entered into for an improper purpose, which have long been the subject of statutory attention, such as voidable settlements or conveyances to defraud creditors. Sham is also to be distinguished from the body of law (which ultimately turns on questions of statutory construction) as to whether apparently artificial transactions attract taxation advantages: see Fletcher v Federal Commissioner of Taxation (1991) 173 CLR 1 at 19 and Tower MCashback LLP I v Revenue and Customs Commissioners [2011] UKSC 19; [2011] 2 AC 457…
60 Even if an agreement was entered into for the sole purpose of obtaining favourable tax treatment or a tax benefit, it does not necessarily follow that it was not genuinely intended by the parties to have legal affect. Indeed, as was pointed out by Lehane J, albeit in dissent, in Richard Walter Pty Ltd v Commissioner of Taxation (1996) 67 FCR 243 at 267-268:
Moreover, it must be borne in mind that it is of the essence of a structure intended to be effective to minimise tax that it be created by means of real transactions, giving rise to real rights and obligations, however "artificial" they may be, in the sense of being incapable of rational explanation except on the basis of their tax consequences. It cannot be said, I think, that there is anything more artificial in the transactions with which we are concerned than there was in those which, in a somewhat different context, confronted the Court in Sharrment Pty Ltd v Official Trustee in Bankruptcy (1988) 18 FCR 449. One expects, in a case such as this, that transactions are intended to have their apparent legal effect because it is only if they do that they are efficacious to achieve the desired consequences. In this particular case, it is no longer suggested that any of the transactions involved in the 1981 "re-structure" had any legal effect other than their apparent effect; it is suggested only that the "loans" to the taxpayer were not really loans at all but payments which were gratuitous and which were not intended to be recoverable. That, for reasons which I have given, seems to me a conclusion so surprising that one would be reluctant to accept it in the absence of cogent evidence. However, there is nothing in the documentary evidence which supports that conclusion: indeed, the documentary evidence is to the contrary effect.
In Raftland at [56] the plurality observed that what Lehane J said in Richard Walter was "undoubtedly true" while at the same time pointing out that it did "not deny the possibility that in a particular case, documents might not be intended by the parties to have legal effect according to their tenor". I shall return to Richard Walter at [65] below.
61 In Accent Management Limited v Commissioner of Inland Revenue [2007] NZCA 230 at [63], the New Zealand Court of Appeal echoed what Lehane J had said in Richard Walter:
Whether these transactions are shams depends primarily on the states of minds of Dr Muir and Mr Bradbury as to their genuineness. Given that it is not to their advantage that the transactions be shams, it might be thought a little perverse to attribute to them states of mind which are inconsistent with their best interests.
62 A finding that a term or terms of an instrument constituting a transaction is a pretence or sham is more likely to lead to a conclusion that the transaction so constituted is a sham than if the instrument merely evidences the transaction. But even where a court finds that a term of an instrument constituting a transaction is a sham, a court will not necessarily treat the underlying transaction as a sham. In Lewis v Condon, Leeming JA at [65] gave, as an example, the clause found by the House of Lords to be a sham in the otherwise valid lease in AG Securities v Vaughan [1990] 1 AC 417. To the same effect is the decision of the English Court of Appeal in Hitch v Stone (Inspector of Taxes) [2001] STC 214 at [86] where Arden LJ, with whom Kay LJ and Sir Martin Nourse agreed, concluded that cl 2 of the 1984 deed was capable of being a sham even if cl 1 of the same deed was valid and effective, and not a sham.
63 Such cases illustrate the point that it is possible for instruments to contain, in their terms, elements of pretence, but if those elements do not impugn the intentions of the parties to enter into a transaction of the kind asserted, for example, because the pretended terms do not touch the rights and obligations essential to or for a finding that the parties entered into a transaction of that kind, the transaction itself will not be a sham, even if the pretended terms are: see Accent Management at [54]-[64].
64 In Hitch, Arden LJ summarised the principles relevant to sham transactions in the following way (at 229-230, [63]-[69]):
[63] The particular type of sham transaction with which we are concerned is that described by Diplock LJ in Snook v. London & West Riding Investments Ltd [1967] 2 QB 786. It is of the essence of this type of sham transaction that the parties to a transaction intend to create one set of rights and obligations but do acts or enter into documents which they intend should give third parties, in this case the Revenue, or the court, the appearance of creating different rights and obligations. The passage from Diplock LJ's judgment set out above has been applied in many subsequent decisions and treated as encapsulating the legal concept of this type of sham. Mr Price referred us to Sharrment Pty Ltd v. Official Trustee in Bankruptcy (1988) 82 ALR 530 in which the Federal Court of Australia drew on Diplock LJ's formulation of sham in Snook's case.
[64] An inquiry as to whether an act or document is a sham requires careful analysis of the facts and the following points emerge from the authorities.
[65] First, in the case of a document, the court is not restricted to examining the four corners of the document. It may examine external evidence. This will include the parties' explanations and circumstantial evidence, such as evidence of the subsequent conduct of the parties.
[66] Second, as the passage from Snook makes clear, the test of intention is subjective. The parties must have intended to create different rights and obligations from those appearing from (say) the relevant document, and in addition they must have intended to give a false impression of those rights and obligations to third parties.
[67] Third, the fact that the act or document is uncommercial, or even artificial, does not mean that it is a sham. A distinction is to be drawn between the situation where parties make an agreement which is unfavourable to one of them, or artificial, and a situation where they intend some other arrangement to bind them. In the former situation, they intend the agreement to take effect according to its tenor. In the latter situation, the agreement is not to bind their relationship.
[68] Fourth, the fact that parties subsequently depart from an agreement does not necessarily mean that they never intended the agreement to be effective and binding. The proper conclusion to draw may be that they agreed to vary their agreement and that they have become bound by the agreement as varied (see for example Garnac Grain Co. Inc v H.M.F. Faure and Fairclough Ltd. [1966] 1 QB 650, 683-4 per Diplock LJ, which was cited by Mr Price).
[69] Fifth, the intention must be a common intention (see Snook).
65 Relevantly to the case at hand, one is drawn to the observations of the majority judgments in Richard Walter. At first instance (95 ATC 4,440) the primary judge found that loans claimed to have been made to the taxpayer by another company, the governing mind of both companies being a Dr Wenkart, were shams in the sense that it was never intended by the taxpayer and the lender that the taxpayer would repay the moneys which it received from the lender. On appeal to a Full Court, Lockhart J at 246, 247 said that there were two findings of the primary judge which were crucial to his Honour's conclusion. First, his Honour's rejection of the only witness (a Mr Holden), called to support the appellant's case that the payments were loans, as a credible witness and second, the failure to call other persons who could have contributed to the discussion on the true nature of the transactions, in particular Dr Wenkart, who the primary judge found to be "the governing mind of all relevant entities". Hill J made similar observations at 256, 257. After referring to the extract from Lord Diplock's judgment in London and West Riding Investments reproduced in [53] above, Hill J at 257, 258 said:
I have set out the quotation from Snook having regard to a submission made by counsel for Richard Walter that a transaction could not be a sham unless there was shown to be some other real transaction for which the sham transaction was a disguise. While that will ordinarily be the case it is not invariably so. A transaction may, as the passage cited from Snook recognises, be found to be a sham where there is no real underlying transaction at all. Without in any way derogating from the views expressed by Lockhart J in Sharrment, I would prefer to define a transaction as being a sham transaction where it involves:
A common intention between the parties to the apparent transaction that it be a disguise for some other and real transaction or for no transaction at all.
…
However, in a case such as the present where there have been real payments made by bills of exchange in the form of cheques cleared through the banking accounts of the parties and recorded as loans in relevant books of account, the transactions involving the bills of exchange can clearly not be a disguise for something which is not a transaction at all. Rather, for there to be a sham there will need, in such a case, to be a common intention of both the apparent lender and the apparent borrower, that the transaction which they have purported to have entered into disguises some real transaction.
Last, but by no means least, his Honour made the following observations in relation to the respective obligations of the taxpayer and the Commissioner in relation to onus (at 259):
Even if it had been necessary to determine whether the so-called loan transactions were shams, the onus could not have been on the Commissioner to show what the real transaction was, of which the payments formed part. Once sham is alleged by the Commissioner, he may then come under some factual obligation to identify the real transaction for which it is contended that the apparent transaction is but a disguise: Coppleson v Commissioner of Taxation (Cth) (1981) 52 FLR 95. But as that case itself illustrates, that is in the overall context of the statutory imposition of the burden of proof on the taxpayer and does not place upon the Commissioner an onus of satisfying the Court that there was a sham.
The onus not being upon the Commissioner to show a sham, so too the onus cannot be on the Commissioner to show what the genuine transaction was which is said to have been obscured by that sham.
As I have already sought to demonstrate, it was not necessary for his Honour to determine the matter by reference to sham in the sense of holding that the so-called loans were but a disguise for some other transaction. It was sufficient for his Honour to hold that the payments to Richard Walter were not loans. Once that finding had been made the question would then arise whether Richard Walter had satisfied the onus upon it of showing that the payments were not income.
66 Finally, and relevantly to the case at hand, it was made clear by the High Court in Raftland at [57] that it is the intention of the parties to the transaction or document that is relevant to a finding of sham and the fact that the legal or other professional advisers intend the transaction or document to take effect in accordance with its terms, will not save the document or transaction from a finding of sham if all the parties did not have that intention. Recently, this Court - see Millar v Commissioner of Taxation [2015] FCA 1104 - held that it was open to the Administrative Appeals Tribunal to reach the conclusion, as a matter of fact, that the subjective conclusion of the parties was not determinative and to find that the relevant intention in the arrangement was that of the professional adviser (at [53]). Whether or not that is correct in the face of what the plurality said in Raftland, need not be explored further; it is not this case. The intention of both, or at least one of the parties to the assailed transactions can be determined by reference to the evidence of Mr Townsing and the findings thereon; even if relevant, it is unnecessary to have recourse to some inference to be drawn as to the intention of a professional adviser who did not give evidence.