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[2004] FCAFC 339
Federal Court of Australia (Full Court)
2004-12-23
Sackville J, Ryan J, Sundberg JJ
Original judgment source is linked above.
ryan J: 1 I have had the advantage of reading in draft the reasons for judgment of Sackville J. I agree with those reasons and with the orders which his Honour has proposed. I certify that the preceding paragraph is a true copy of the Reasons for Judgment herein of the Honourable Justice Ryan.
Associate: Dated: 23 December 2004 IN THE FEDERAL COURT OF AUSTRALIA
ON APPEAL FROM A JUDGE OF THE FEDERAL COURT OF AUSTRALIA
AND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
VID 851 of 2004 BETWEEN: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
THE APPEALS 2 These two appeals, to adopt the words of the primary Judge, concern the tax consequences of a $15 million contribution made on 30 June 1997 by an employer ('Spotlight') to the trustee of a fund out of which future annual bonuses were to be paid to Spotlight's employees. 3 The primary Judge held as follows (Spotlight Stores Pty Ltd v Commissioner of Taxation [2004] FCA 650; 55 ATR 745; ATC 4674): (i) The contribution of $15 million to the fund was deductible by Spotlight under s 51(1) of the Income Tax Assessment Act 1936 (Cth) ('ITAA') since it was not a loss or outgoing of capital or of a capital nature. Thus the Commissioner's decision that the contribution was not deductible was to be set aside. (ii) Part IVA of the ITAA had been correctly applied by the Commissioner to cancel the tax benefit obtained by Spotlight, namely the deductibility from its assessable income of its $15 million contribution to the fund. There was a scheme to which Part IVA applied, of which Spotlight's contribution was an integral part. Having regard to the matters identified in s 177D(b) of the ITAA, it would be concluded that Spotlight entered the scheme for the dominant purpose of obtaining a tax benefit. (iii) The contention that Part IVA did not apply to the scheme identified by the Commissioner was 'reasonably arguable' within the meaning of s 226L(e) of the ITAA. Accordingly, the Commissioner should not have imposed the higher level of penalty provided for by Part IVA of the ITAA. (iv) Spotlight was entitled to succeed on its objection to an assessment of fringe benefits tax ('FBT') under the Fringe Benefits Tax Assessment Act 1986 (Cth) ('FBT Act') on the contribution of $15 million. However, this issue was strictly unnecessary to decide because the Commissioner had made it clear that he would not pursue the FBT assessment if he succeeded in upholding his determination under Part IVA of the ITAA. 4 It was not Spotlight which formally challenged the Commissioner's decisions that were the subject of holdings (i), (ii) and (iii). The challenges were made by Pridecraft Pty Ltd. This came about in the following way. Spotlight carried on a successful business of selling fabrics and accessories and did so as trustee of the Spotlight Stores Trading Trust (the 'Trading Trust'). Spotlight's directors included Ruben Fried and his brother, Morry Fraid. The trustees of the Fried Family Trust and of the M Fraid Family Trust, each of which was a discretionary trust, held ordinary units in the Trading Trust. Pridecraft was a beneficiary of each of the Family Trusts and was presently entitled to any part of the net annual income of the Family Trusts that was not distributed to other beneficiaries. Pridecraft's taxable income, rather than that of Spotlight or the trustees of the Family Trusts, was increased by amended assessments issued by the Commissioner following disallowance of Spotlight's claim for a deduction in respect of its $15 million contribution to the fund. 5 Apart from the question of penalties, Pridecraft challenged two decisions of the Commissioner in the proceedings at first instance. The first was the Commissioner's disallowance of the contribution of $15 million as a deduction pursuant to s 51(1) of the ITAA for income tax purposes. As a result of the disallowance, amended assessments of income tax were issued by the Commissioner in November and December 1999 increasing Pridecraft's assessable income under s 97 of the ITAA for the year ending 30 June 1997 by $11,916,810 (that is, the net income of the Trading Trust for the year, after making a small depreciation adjustment). The decision resulted in the Commissioner not allowing the balance of the $15 million contribution, $3,120,635, to be carried forward as a loss for the year of income ending 30 June 1998. The Commissioner also imposed additional tax by way of penalty. 6 The second decision challenged by Pridecraft was the Commissioner's determination under Part IVA of the ITAA, made on 20 May 2002, which also resulted in the amount of $11,916,810 being included in Pridecraft's assessable income under s 97 of the ITAA for the year ending 30 June 1997. The Commissioner issued a further amended assessment to give effect to the Part IVA determination and imposed additional tax by way of penalty. Under that assessment, however, the amount of Pridecraft's taxable income and the amount of additional tax were not increased in order to avoid imposing double taxation. 7 In separate proceedings (heard together with the other proceedings), Spotlight challenged the Commissioner's decision to disallow Spotlight's objection to the FBT assessment and to impose additional tax by way of penalty. The Commissioner claimed that the contribution was in respect of the employment and for the benefit of Spotlight's employees and thus fell within the definition of 'fringe benefit' in s 136(1) of the FBT Act. 8 Pridecraft has appealed against the primary Judge's judgment insofar as it upholds the Commissioner's determination under Part IVA of the ITAA cancelling the deductibility of Spotlight's contribution to the fund. It is important to appreciate that the only issue contested before the primary Judge was whether Spotlight's dominant purpose in entering into the scheme was to obtain a tax benefit. The only grounds identified by the notice of appeal are that his Honour erred in answering that question affirmatively. 9 The Commissioner has cross-appealed against the primary judgment insofar as it sets aside the Commissioner's decision disallowing Spotlight's contribution as a deduction pursuant to s 51(1) of the ITAA. The ground of appeal is that the primary Judge should have held that the contribution was an outgoing of capital or of a capital nature. 10 The Commissioner has also cross-appealed against the judgment insofar as it sets aside the Commissioner's decision to impose additional tax by way of penalty. The Commissioner says that the primary Judge erred in holding that Pridecraft's contention was 'reasonably arguable' within the meaning of s 226L(e) of the ITAA. 11 Finally, the Commissioner has appealed from the judgment insofar as it sets aside the Commissioner's decision confirming Spotlight's liability to FBT. The ground of appeal is that the primary Judge erred in holding that the definition of 'fringe benefit' in s 136(1) of the FBT Act requires that a particular employee (as distinct from a class of employees) must be identifiable in connection with the benefit.
the legislation 12 Section 51(1) of the ITAA provides as follows: '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.' 13 Part IVA of the ITAA is headed 'SCHEMES TO REDUCE INCOME TAX'. Section 177D provides that Part IVA applies to any scheme where: '(a) a taxpayer (in this section referred to as the "relevant taxpayer") has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and (b) having regard to: (i) the manner in which the scheme was entered into or carried out; (ii) the form and substance of the scheme; (iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out; (iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme; (v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme; (vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme; (vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and (viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi), it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers).' Section 177A(1) defines 'scheme', in the absence of a contrary intention, to mean: '(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and (b) any scheme, plan, proposal, action, course of action or course of conduct.' The definition of 'scheme' is to be read as including 'a reference to a unilateral scheme, plan, proposal, action, course of action or course of conduct, as the case may be': s 177A(3). 14 Section 177A(5) requires the reference to 'purpose' in s 177D to be read: 'as including a reference to the scheme or the part of the scheme being entered into or carried out by [a] person for 2 or more purposes of which that particular purpose is the dominant purpose.' 15 Section 177C(1)(b) of the ITAA provides that a reference in Part IVA to 'the obtaining by a taxpayer of a tax benefit in connection with a scheme' is to be read as a reference to: 'a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out.' Section 177C(1)(d) provides that in a case to which s 177C(1)(b) applies the tax benefit is: 'the amount of the whole of the deduction or of the part of the deduction, as the case may be, referred to in [s 177C(1)(b)]'. 16 Section 177F of the ITAA confers a discretion on the Commissioner to cancel a tax benefit. Section 177F provides as follows: '(1) Where a tax benefit has been obtained, or would but for this section be obtained, by a taxpayer in connection with a scheme to which this Part applies, the Commissioner may: (a) … (b) in the case of a tax benefit that is referable to a deduction or a part of a deduction being allowable to the taxpayer in relation to a year of income - determine that the whole or a part of the deduction or of the part of the deduction, as the case may be, shall not be allowable to the taxpayer in relation to that year of income; or (c) … (d) … and, where the Commissioner makes such a determination, he shall take such action as he considers necessary to give effect to that determination. … (3) Where the Commissioner has made a determination under subsection (1) … in respect of a taxpayer in relation to a scheme to which this Part applies, the Commissioner may, in relation to any taxpayer (in this subsection referred to as the "relevant taxpayer"): (a) … (b) if, in the opinion of the Commissioner: (i) an amount would have been allowed or would be allowable to the relevant taxpayer as a deduction in relation to a year of income if the scheme had not been entered into or carried out, being an amount that was not allowed or would not, but for this subsection, be allowable, as the case may be, as a deduction to the relevant taxpayer in relation to that year of income; and (ii) it is fair and reasonable that that amount or a part of that amount should be allowable as a deduction to the relevant taxpayer in relation to that year of income, determine that that amount or that part, as the case may be, should have been allowed or shall be allowable, as the case may be, as a deduction to the relevant taxpayer in relation to that year of income…'
the facts 17 Although the appellant challenged some of the findings of the primary Judge, most of the facts as found by his Honour were not seriously in dispute on the appeal. The following account is largely taken from his Honour's judgment. 18 Spotlight opened its first retail store in 1973 and by 1997 had 71 stores and nearly 2,800 employees. Spotlight continued to expand after 1997 and at the time of the trial had over 100 stores and 5,000 employees. 19 Spotlight has had a longstanding policy of paying annual bonuses to store managers and employees for the successful conduct of its business. During the 1980s, Spotlight introduced a Profit Share Bonus Scheme ('the pre-1997 Scheme'). This was a discretionary arrangement, whereby Spotlight incurred no obligation to pay bonuses until they were announced. In practice, Spotlight paid about 10 per cent of its pre-tax profits by way of bonuses to employees. Two types of bonus were paid. The Christmas bonus, paid in December, constituted 40 per cent of the total bonus, while the mid-year bonus, paid in August, constituted the remaining 60 per cent. The Christmas bonus was paid to all staff members, but the mid-year bonus was paid only to store managers and staff performing support functions. 20 During the 1997 financial year, the directors of Spotlight identified a number of problems with the pre-1997 Scheme. The difficulties were described by Mr Fraid in terms accepted by the primary Judge, as follows: '(a) [B]onuses under the Old Scheme were paid in full immediately after they were determined and announced. This meant that some, especially key, employees resigned very soon after receiving their bonuses, which was usually in the second half of August or the first half of September. Employees who had been recruited by competitors would often stay until they had been paid their bonuses and resign shortly thereafter…. (b) [B]onuses were paid on the overall profit of Spotlight without sufficient regard to change in profit at a store or department level. Therefore a particularly poor performance which might significantly diminish the profitability of a profit centre would still attract an undeserved bonus. (c) [C]learly some stores do better because of their location and the size of the store. Under the Old Scheme, the staff at these stores would receive higher bonuses, even if their performance was less than adequate. Some managers in less profitable stores (such as, for example, smaller stores in country areas) could produce tremendous results (for example, by turning around a loss into a profit), but this was not reflected in their bonus. Good managers therefore would not want to transfer to a less profitable store. (d) [C]apital expenditure under the Old Scheme was rapidly depreciated therefore diminishing profits, so employees would not want to go to a new store with the resulting high capital start-up costs, or to incur capital expenditure, because this would result in a lower profit that year and therefore a lower bonus. (e) [D]ecision-making by managers tended to be short-term so as to maximise profits in the current year sometimes at the expense of higher long-term profits…. (f) [A] loss made by one store would reduce the bonus pool available to all stores and if the company as a whole didn't make a profit, then no-one received a bonus despite outstanding individual performances. (g) [T]he Old Scheme provided little, if any, security in respect of future bonuses.' 21 In early 1997, Mr Fraid attended a seminar conducted by a Mr Joel Stern. One aspect of the seminar concerned the calculation of employee bonuses in a manner designed to take into account individual staff and store contributions to improved profitability. Mr Fraid explained why he and his brother decided to replace the pre-1997 Scheme with what became a new Profit Share Bonus Scheme ('the post-1997 Scheme'): 'Joel Stern suggested that one third of the individual bonus be paid immediately and that two thirds be kept in what he referred to as the "bank" or in reserve for future years. He also suggested paying each employee 1/3 of the closing balance of the previous year's "bank". Joel Stern said that such a bonus scheme would reward employees like owners and so it would encourage employees to think like owners. This was consistent with the culture that Ruben [Fried] and I aimed to create at Spotlight and we decided that such a bonus scheme would be implemented at Spotlight. The "banking" of two thirds of the calculated or notional bonus (which we refer to as "the injection") for future years was an important difference between the Old Scheme and that which we were then considering. The "banking" of bonuses for the future required a more formal structure than the Old Scheme, as the "banked" amounts were effectively being earmarked for payment to employees in future years. This "banked" amount is commonly referred to by Spotlight as the [employees'] "Reserve". … Ruben and I decided to implement the EVA [Economic Value Added] financial system including an EVA-based incentive scheme, modified to calculate bonuses on before-tax rather than after-tax profits, which was consistent with the Old Scheme. We did not want the bonus pool under the new scheme to be less than that under the Old Scheme. We decided that one-third of the injection plus one-third of the closing balance of the [employees'] Reserve should be paid each year with the remaining two-thirds of the injection and the balance of the Reserve to be paid in future years.' 22 The bonus pool under the post-1997 Scheme was intended to be calculated by reference to cost centres, rather than to the overall profitability of the company. Thus it was theoretically possible for bonuses to be awarded to individuals even though Spotlight itself made a loss in a particular year. In addition, because part of the bonus was to be held in reserve, bonuses might be payable out of the reserve in years when the company made an overall loss. 23 The post-1997 Scheme was implemented in the following manner. Spotlight Stores Incentives Pty Ltd ('Incentives') was incorporated on 27 June 1997 and Mr Fraid and Mr Fried were appointed as directors. On 30 June 1997, the last day of the financial year, the directors of Spotlight held a meeting. They resolved to establish a fund to be known as the Spotlight Staff Incentive Trust ('the Incentive Trust') of which Incentives would be the trustee. The fund was to be established by an initial contribution of $20 to which Spotlight would contribute further sums annually or biannually at its discretion. The amount to be paid out to any employee under the post-1997 Scheme was to be determined by Incentives in its discretion after consulting with the Board of Spotlight, having regard to a number of specified factors. Incentives would be under no obligation to distribute the whole or any part of the amount contributed by Spotlight in the relevant year. Funds were to be retained in the pool to enable bonuses to be paid in years where otherwise no funds might be available. 24 At the same meeting, the directors resolved that in the light of the successful year the company had experienced, Spotlight should contribute $15 million to the Incentive Trust. It was further resolved to authorise any one director of Spotlight to offer to borrow from Incentives the sum of $14,800,000 at call, at an interest rate of 7.55 per cent per annum. 25 On 30 June 1997, Spotlight as settlor and Incentives as trustee executed a deed of settlement establishing the Incentive Trust ('Incentive Trust Deed'). The terms of the Incentive Trust Deed were consistent with the resolutions passed at the directors' meeting held on the same day. The Beneficiaries of the Incentive Trust were defined to mean: '[a]ny person who immediately prior to the date on which an amount is proposed to be paid by the Trustee to a Beneficiary has been or is an Employee of [Spotlight] and, in the opinion of the Trustee, fulfils the criteria set out in Clause 10.' 26 Clause 3(a) of the Incentive Trust Deed provided for the income and capital of the Incentive Trust to be applied for the benefit of the Beneficiaries, having regard to the criteria in cl 10. Clause 10 provided as follows: 'Subject to any express provision to the contrary herein contained, every discretion vested in the Trustee shall be absolute and uncontrolled and every power vested in it shall be exercisable at its absolute and uncontrolled discretion PROVIDED HOWEVER THAT without limiting the foregoing, in making any determination as to an amount or amounts to be paid to, set aside for or allocated to a Beneficiary whether in relation to the income or capital of the Trust Fund, the Trustee shall first consult with [Spotlight] and it may have regard to all or any of the following criteria and may place whatever weight it chooses on any of the following criteria: (a) the contribution made by the Beneficiary to the revenues or profits of [Spotlight]; (b) the contributions made by the Beneficiary in relation to the business or operation of [Spotlight] in terms of administration, management, staff recruitment, training and management, professional development and client servicing; (c) the extent to which the Beneficiary has attracted new clients to [Spotlight]; (d) the length of service of the Beneficiary with [Spotlight]; (e) the seniority of the Beneficiary in terms of his or her position with [Spotlight]; and (f) any other contributions made by the Beneficiary to the business, operations, profitability and standing of [Spotlight].' 27 As contemplated in the directors' resolutions, Spotlight contributed $15 million to the Incentive Trust on 30 June 1997. Incentives also accepted Spotlight's offer to borrow $14.8 million. The remaining $200,000 was retained in Incentives' bank account. Clause 3 of the offer provided that the loan was to be secured by a debenture charge over Spotlight's assets. The debenture was not executed until 20 July 1998, more than a year after the advance to Spotlight was made. However, his Honour considered that nothing turned on the delay. 28 Mr Fraid explained the contribution of $15 million on the basis that he had asked Spotlight's finance manager, Mr Berry, to provide an estimate of employee bonuses that would be payable over the first five years of the post-1997 Scheme. Mr Berry's projections showed that the bonuses estimated to be paid or deferred in respect of the five year period commencing 1 July 1996 would be $15.575 million (although the actual payment and deferral of bonuses in respect of the 1996/1997 financial year would not commence until August 1998). In view of this advice, a contribution of $15 million was thought appropriate. 29 Mr Fraid said in evidence that the particular benefits of the trust structure were twofold:
37 Under the post-1997 Scheme, substantial bonuses were paid to employees. The primary Judge adopted Mr Berry's description of the accounts of the Incentive Trust as at 30 June 2002: '… the closing balance of assets held by the Incentive Trust at 30 June 2002 [was] $8,985,626. As at 30 June 2003, this balance was approximately $5,240,000 and following the payment of midyear bonuses in August this year, the balance is $1,680,000. I anticipate that most of this amount will have been paid out as bonuses by June 2004. The original payment of $15,000,000 to the Incentive Trust (together with interest thereof) has satisfied all bonus payments since August 1997, but the employee 'Reserves' currently total $6,864,011. There is no provision in any Spotlight entity to pay such Reserves which are technically (as I understand) at the discretion of the trustee of the Incentive Trust.'
Section 51(1) of the ITAA 38 The primary Judge first considered whether the contribution of $15 million by Spotlight to Incentives was an allowable deduction from Spotlight's assessable income under s 51(1) of the ITAA. His Honour found that the Incentive Trust established a valid discretionary trust and when the $15 million was paid by Spotlight on 30 June 1997 the legal and equitable ownership in that sum passed to Incentives in its capacity as trustee of the Incentive Trust. There is no challenge to this finding. 39 The primary Judge rejected the Commissioner's contention that the contribution was of capital or of a capital nature. His Honour considered that from a practical and business point of view the criteria stated by Dixon J in Sun Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337, at 363, pointed to the $15 million contribution being on revenue, rather than capital, account. His Honour said that the purpose of the payment was transient, in that it was designed to secure the trust and confidence of employees from year to year during the operation of the post-1997 Scheme. This advantage did not have a lasting quality, as the Scheme was intended to operate only over a five year period. 40 In his Honour's view, the pre-payment of future bonuses in a lump sum did not result in the contribution being on capital account. The contribution was designed to enable the payment of bonuses falling due to Spotlight's employees over the ensuing five years and was to be drawn upon and thereby diminished progressively throughout that period. It was in substitution for annual contributions that Spotlight otherwise would have had to make over the period. In contrast to the facts in the well-known case of British Insulated and Helsby Cables Ltd v Atherton [1926] AC 205, the contribution was not the 'nucleus' of a fund that was to endure for the life of the company.
Part IVA of the ITAA 41 The primary Judge noted that the Commissioner had identified the 'scheme' for the purposes of s 177D of the ITAA as follows (at [84]): '(a) the incorporation of [Incentives], the creation of the Incentive Trust, the making of the contribution of $15 million by Spotlight, the loan of $14.8 million back to Spotlight, and the course of conduct undertaken to carry out and implement those transactions; or alternatively (b) the making of the contribution and the loan and the course of conduct undertaken to carry out and implement those transactions.' His Honour referred to the scheme so identified as 'the Part IVA scheme'. 42 His Honour found that as a consequence of his holding that the $15 million contribution was an allowable deduction in respect of the 1996/1997 tax year, Spotlight had obtained a tax benefit within the meaning of s 177C(1)(b) of the ITAA. The benefit was that Spotlight's taxable income for the year ended 30 June 1997 would be reduced to nil and the resulting loss of $3,120,635 could be carried forward. 43 The primary Judge considered that there was no practical difference between the alternative schemes advanced by the Commissioner. It was therefore appropriate to consider the Commissioner's case by reference to the wider definition of the scheme (the 'Part IVA Scheme'). On that basis, Spotlight had clearly obtained a tax benefit 'in connection with the scheme'. 44 The remaining question was whether, having regard to the eight matters specified in s 177D(b) of the ITAA, Spotlight, acting through its directors, entered into or carried out the scheme for the purpose of enabling it to obtain a tax benefit in connection with the Part IVA Scheme. His Honour considered that this question could be resolved by reference to Spotlight's purpose. 45 The primary Judge recognised that Spotlight had both a commercial purpose and the purpose of obtaining a tax benefit in connection with the scheme. The real issue was therefore whether the latter was the dominant purpose (s 177A(5)). His Honour approached this issue by considering each of the eight factors set out in s 177D(b) of the ITAA. 46 Under the heading of 'the form and substance of the scheme' (s 177D(b)(ii)), the primary Judge pointed to aspects of the substance of the scheme that departed from its form. These included the following:
Penalty Tax 49 As Pridecraft succeeded in its s 51(1) objections, it also succeeded in its objections to the penalty tax imposed by the Commissioner in reliance upon the s 51(1) assessments. 50 Additional tax by way of penalty was assessed by the Commissioner in relation to the Part IVA Scheme under ss 226 and 266L of the ITAA. These sections provide for a lower rate of penalty where it is reasonably arguable that Pt IVA does not apply. His Honour was satisfied that Pridecraft's contention that Pt IVA did not apply was 'reasonably arguable' and that the objection to penalty tax should therefore be upheld.
Fringe Benefits Tax 51 Since the FBT assessment had been the subject of full argument, the primary Judge dealt with the objection on the merits even though it was unnecessary to do so. His Honour considered that for a benefit to be provided to an employee 'in respect of the employment of the employee', within the definition of 'fringe benefit' in s 136(1) of the FBT Act, a particular employee had to be identified in connection with the benefit. At the time the $15 million contribution was made, it was not provided in respect of the employment of any particular employee, since the employees of Spotlight were not beneficiaries of the Incentive Trust at that time. Thus Spotlight was entitled to succeed in relation to its FBT objection.
pridecraft's appeal - part iva OF THE ITAA 52 As Pridecraft's appeal was argued first, it is convenient to commence with the issues relating to the application of Part IVA of the ITAA. I do so on the assumption that the primary Judge correctly held that but for the operation of Part IVA, Spotlight would have been entitled to deduct the contribution of $15 million from its assessable income in the 1996/1997 taxation year pursuant to s 51(1) of the ITAA.
submissions 53 Pridecraft submitted that the primary Judge had made several factual findings that were inconsistent with the evidence and that vitiated his Honour's conclusion that the dominant purpose of those entering the Part IVA Scheme was to obtain a tax benefit. Pridecraft also submitted that his Honour should have found that the commercial benefits of the Incentive Trust could not have been obtained by Spotlight under any alternative arrangements available to it. 54 Independently of these alleged factual errors, Pridecraft challenged his Honour's conclusion that the dominant purpose of Spotlight in entering into and carrying out the Part IVA Scheme between 27 and 30 June 1997 was the obtaining of a tax benefit in connection with the Scheme. Mr de Wijn QC, who appeared with Ms Jacques for Pridecraft, argued that the primary Judge had wrongly limited himself to a consideration of the events occurring between 27 and 30 June 1997. In taking this approach, so Mr de Wijn contended, his Honour had failed to give proper consideration to the ongoing operation of the Incentive Trust. In particular, his Honour had given insufficient weight to:
principles 58 The operation of Part IVA of the ITAA was summarised in the joint judgment of the High Court in Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404, at 413, as follows: 'Pt IVA operates where (i) there is a "scheme" as defined in s 177A; (ii) there is a "tax benefit" which, in relation to income amounts, is identified in par (a) of s 177C(1) as an amount not included in the assessable income of the taxpayer where that amount would have been included or might reasonably be expected to have been included in that assessable income for the relevant year of income if the scheme had not been entered into or carried out; (iii) having regard to the eight matters identified in par (b) of s 177D, it would be concluded that there was the necessary dominant purpose of enabling the taxpayer to obtain the tax benefit; and (iv) the Commissioner makes a determination that the whole or part of the amount of the tax benefit is to be included in the assessable income of the taxpayer (s 177F(1)(a)). The Commissioner then "shall take such action as he considers necessary to give effect to that determination" (s 177F(1)).' 59 In Commissioner of Taxation v Mochkin (2003) 127 FCR 185, Sackville J said this (Merkel and Kenny JJ agreeing) (at 194 [26]): 'The making of a determination under s 177F(1)(a) that the amount of a tax benefit is to be included in a Taxpayer's assessable income is the "pivot upon which the operation of Pt IVA turns": Spotless at 413. It is in this sense that Pt IVA of the ITAA is not self-executing. The Commissioner is empowered to make a determination only where there is a tax benefit obtained in connection with a scheme to which Pt IVA applies. That is, as a matter of "objective fact", a Taxpayer must have obtained a tax benefit in connection with such a scheme: Commissioner of Taxation (Cth) v Peabody (1994) 181 CLR 359 at 382, per curiam. The question in every case, therefore, is whether a tax benefit that the Commissioner has purported to cancel is in fact a tax benefit obtained in connection with a Part IVA scheme and so susceptible of cancellation at the direction of the Commissioner: Peabody at 382. If the Taxpayer has obtained a tax benefit in connection with a scheme to which Part IVA applies, the determination will be valid. If the Taxpayer has not obtained such a tax benefit, the determination will be invalid and will not support an assessment.' 60 The primary Judge in the present case cited the following propositions stated by Hill J (with whom Hely J agreed) in Commissioner of Taxation v Sleight (2004) 206 ALR 511, at 528 [67]: '(1) Part IVA does not authorise consideration of evidence of the subjective purpose or motivation of a particular person. The subjective state of mind of a person is not a matter listed in s 177D(b) to which regard may be had. Rather the section requires consideration of the eight matters listed in s 177D(b) and no other matters … (2) The reference to dominant purpose in a case where more than one purpose is present is a reference to the "most influential and prevailing or ruling" purpose … (3) The conclusion as to dominant purpose may be reached not only with respect to the dominant purpose of the taxpayer, it may be reached by reference to the dominant purpose of any other person or persons so long as they are persons who entered into or carried out the scheme or any part of it … Likewise, the purpose of an adviser may be attributed to the taxpayer in an appropriate case … (4) It is possible to arrive at the conclusion as to purpose by making a global assessment of the facts, so long as it is clear that the relevant eight factors are taken into account … (5) Some of the eight factors (there is clearly some overlap among them) may point one way, others may point in the opposite direction, and some may be neutral: it is the evaluation of these matters, alone or in combination, some for, some against, that s 177D requires in order to reach the conclusion to which s 177D refers … (6) There is no inconsistency between a finding that the purpose of a person lay in the pursuit of commercial gain in the course of carrying on a business and a finding that the dominant purpose was to enable the relevant taxpayer to obtain a tax benefit …' (Citations omitted.) 61 The primary Judge also cited this observation from FCT v Mochkin, at 199 [45]: '… the question of dominant purpose is usually to be determined by reference to the time when the scheme is entered into, although there may be cases where the purpose can be tested while the scheme is still being carried out …' 62 After the primary Judge delivered judgment in the present case, the High Court handed down its decision in FCT v Hart. Neither party suggested that anything said in FCT v Hart is inconsistent with the principles applied by the primary Judge. Nonetheless it is useful to note some of the observations made in that case. 63 Gleeson and McHugh JJ emphasised (at 210 [5]) that the definition of the scheme is important because any tax benefit identified must be related to the scheme, as must any conclusion of dominant purpose. In FCT v Hart itself, the tax benefit was not the whole of the deduction for interest claimed by a borrower under a 'split loan facility'. It was that part of the deduction which represented the difference between the interest in fact claimed as a deduction (that is, the whole) and the interest payable on the principal sum calculated as if there had been rateable principal and interest payable on that sum (at 210 [5]). This followed from the finding that but for the 'wealth optimiser structure' of the split facility loan (which was designed to allow all interest payments to be deductible), the taxpayers would have borrowed funds in terms requiring monthly payment of principal and interest (at 211 [8]). 64 Gleeson and McHugh JJ reaffirmed that a transaction may take a form such that the dominant purpose of those entering the scheme is to obtain a tax benefit even though the scheme advances a wider commercial objective: at 213 [16]. Gummow and Hayne JJ agreed (at 226 [64]) that the 'presence of a discernible commercial end does not determine the answer to the question posed by s 177D'. Three members of the Court explicitly accepted that the question posed by s 177D(l) is objective and thus the answer does not depend on why the taxpayer or its agents acted as it did: at 226 [65], per Gummow and Hayne JJ; at 238 [86], per Callinan J (there is nothing in the reasoning of Gleeson CJ and McHugh J to the contrary). Gummow and Hayne JJ also pointed out (at 225 [63]) that the question posed by s 177D is directed to ascertaining the dominant purpose of the relevant person or persons, not the dominant purpose of the scheme itself. 65 Gummow and Hayne JJ noted that under s 177C(1)(b), the taxpayers would obtain a tax benefit in connection with a scheme where, had the scheme not been entered into or carried out, the deduction might reasonably be expected not to have been allowable to the taxpayer in relation to the relevant year of income: at 226 [66]. Consequently, the inquiry directed by Part IVA requires comparison between the scheme in question and 'an alternative postulate'. In FCT v Hart itself, the taxpayer had alternative ways of borrowing available to them that would have produced less advantageous tax consequences.
Alleged Inconsistencies 66 Pridecraft submitted that there was an inconsistency between the primary Judge's findings made in relation to the deductibility of the contribution under s 51(1) of the ITAA and his Honour's conclusion that the dominant purpose of those entering into or carrying out the Part IVA Scheme was to obtain a tax benefit. In particular, Mr de Wijn submitted that the finding that the post-1997 Scheme was intended to achieve, and did achieve, significant commercial benefits, such as improved staff morale, efficiency and loyalty, was inconsistent with the finding on dominant purpose. Mr de Wijn also pointed to the findings that from a business point of view the advantage sought by the $15 million contribution was to secure the prepayment of bonuses, so as to obtain the trust and confidence of Spotlight's employees. Mr de Wijn argued that in view of these findings the purpose of the Part IVA Scheme as a whole was a commercial purpose. 67 There are two answers to this submission. The first is that the inquiry that must be made under s 51(1) of the ITAA is different from the inquiry that must be made under Part IVA. The s 51(1) inquiry requires the expenditure to be characterised by reference to the nature of the payment and advantage sought by the making of the outgoing: Mount Isa Mines Ltd v Commissioner of Taxation (1992) 176 CLR 141, at 149, per curiam. The second requires an objective assessment of the dominant purpose of the persons who have entered a particular scheme, having regard to the statutory criteria. A finding as to the appropriate characterisation of an outgoing for the purposes of s 51(1) does not foreclose the inquiry required by Part IVA. Indeed, the necessity to invoke Part IVA in relation to an outgoing only arises where it is an allowable deduction pursuant to s 51(1) or some other provision of the ITAA. 68 The second answer is that there is a 'false dichotomy' between a 'rational commercial decision' and 'the obtaining of a tax benefit' in determining the dominant purpose of taxpayers in making an investment: FCT v Spotless Services, at 415 (joint judgment). The fact that a scheme has a commercial objective does not determine the answer to the question posed by s 177D: FCT v Hart, at 213 [16], per Gleeson CJ and McHugh J; at 225-226 [64], per Gummow and Hayne JJ. A finding that the post-1997 Scheme, of which the $15 million contribution was an element, was intended to secure commercial advantages for Spotlight does not necessarily mean that those who entered or carried out the Part IVA Scheme identified by the Commissioner, or any part of that scheme, did not have the dominant purpose of obtaining a tax benefit having regard to the matters in s 177D(b) of the ITAA. As the High Court observed in Commissioner of Taxation v Consolidated Press Holdings Ltd (2001) 207 CLR 235, at 264 [96]: 'a person may enter into or carry out a scheme, within the meaning of Pt IVA, for the dominant purpose of enabling the relevant taxpayer to obtain a tax benefit where that dominant purpose is consistent with the pursuit of commercial gain in the course of carrying on a business.'
Alleged Factual Errors 69 Mr de Wijn identified three significant factual findings that he contended were inconsistent with the evidence, as follows: (i) the evidence did not establish that Spotlight's employees were informed in any meaningful sense that a trustee and a separate trust fund had been established, or that any contribution exceeding $1 million had been made to secure the employees' entitlements (at [102]); (ii) under the post-1997 Scheme annual bonuses were not due and payable until they were declared and paid as a consequence of the profits earned in the preceding year (at [104]); and (iii) there was a discrepancy between the amounts required to secure payment of the 'Reserves' and the $15 million contribution, thus suggesting a non-commercial purpose for the payment. 70 Mr de Wijn criticised the first finding, on the ground that the primary Judge had misconstrued a statement in the overheads used by Mr Fraid in his presentation to employees, to the effect that 'the Bank is being started with approximately $1,000,000'. Mr de Wijn pointed out that there was unchallenged evidence that Mr Fraid had told employees that Spotlight had set aside sufficient moneys in a separate fund to enable payment of bonuses, including reserves, for the succeeding few years. 71 There is no inconsistency between the unchallenged evidence and the finding made by his Honour. Mr Fraid did not claim in his evidence that he told employees that any more than $1 million would be contributed to the 'fund' nor that he told them about the trust structure that was to be established for the post-1997 Scheme. The primary Judge quoted (at [36]) a passage from Mr Fraid's evidence which indicates the limits of the information communicated to Spotlight's employees: '[MR DAVIES:] You don't indicate anywhere, do you, in your description of the Stern seminar that as part of what was being recommended [was] that a trust be set up along the lines of the incentive trust?--- No, the purpose of that was to secure the future bonuses, the reserves, et cetera, which was recommended by the Stern proposal. I see, so that the Stern proposal recommended securing a fund?--- They recommended deferring payments. Did it recommend a fund?--- I don't recall a specific recommendation on that. Well, there is a difference, isn't there, between deferring payments and securing a fund?--- There is a difference. We wanted to satisfy the staff that those deferred payments would be secured. Because you could defer payments without adopting a trust structure, couldn't you?--- In theory, but we could also risk losing the trust of our staff. And would you just explain how one is connected with the other - that answer is connected with your previous answer?--- Well, if we say to our staff, "You've got a thousand dollar bonus. We're going to give you $333 today. Trust us, you'll get the rest eventually" - that's not the way we like to operate. We would like staff to know that we have put those funds aside for those future payments. HIS HONOUR: But the way the deed works by giving a complete discretion to the directors is exactly that - "We're giving you this now and trust us to give the rest later"?--- But what we told the staff was that in fact we were putting away funds for that purpose. Did you tell them how much or you just said, "We're putting away funds for the future"?--- We said "funds for the future". It was couched in general terms. MR DAVIES: And you could have created a reserve within Spotlight Stores' accounts itself to set aside the funds, could you not?--- I don't know. Did you discuss that aspect with anybody around 30 June?--- I don't recall discussing that alternative, no. Document MFI1 is a document that you gave your employees at the August 1997 conference. Is that so?--- Yes. Where in that document is it that they are informed that a trust fund is set up for the payment of bonuses?--- These are actually overhead slides as you can see in abbreviated dot point form. Each of these points were discussed and there was a lot of information that was given to the staff that wasn't in these overheads. … When you prepared the overhead slides it didn't occur to you that a critical aspect of what the employees might want to know is the fact that a trust had been set up?--- I don't think our employees would know the difference between a trust and any other entity. I don't think that - it is a fairly technical, I think, distinction from an employee's point of view, and they just wanted to know if part of their bonus was being held over, that should anything happen to Spotlight, they would get the money …' 72 In my view, the evidence justified his Honour's unwillingness to find either that Spotlight's employees had been informed of a separate trust fund or that they had been told of a contribution greater than $1 million. The statement that $1 million had been used to start the 'Bank' could only have been understood by employees as a reference to an unspecified fund, the nature of which was not made clear to them. 73 As to the second finding criticised by Pridecraft, it was not strictly accurate for his Honour to imply that bonuses would be paid as a consequence of profits earned. In theory, bonuses could be declared to some employees even if the company made a loss and 'Reserves' were still payable (subject to the trustee's overriding discretion) even in loss-making years. However, it is clear that his Honour was aware of these facts, since he had previously referred expressly to the disadvantages of the pre-1997 Scheme as including the absence of any entitlement to a bonus in any year in which the company made a loss. 74 His Honour's comment (at [104]) was made in the context of a finding that Spotlight's substantial business did not create a real risk of default and that '[i]n any event, the evidence did not suggest that there were any expected future liquidity problems that made the prepayment of five years' annual bonuses an appropriate measure.' The comment amounted at most to no more than a slip which had no significant bearing on his Honour's reasoning. 75 The attack on the primary Judge's third finding rested on a misunderstanding of the point his Honour was making. Mr de Wijn correctly observed that the actual payments over the first five years of the post-1997 Scheme totalled about $9.7 million and that, as his Honour found, the total of employees' Reserves at 30 August 2002, was $5.3 million. The two sums more or less equalled Mr Berry's projection as to the amounts required to pay or provide for bonuses over the five year period. According to Mr de Wijn, this meant that, contrary to his Honour's finding, there was no 'discrepancy'. 76 The point his Honour was making was that the contribution of $15 million vastly exceeded any amount required to be set aside in order to 'secure' employees' future bonuses. Mr Berry's 1997 calculations yielded total estimated bonuses over the five years of the proposed scheme of $15.75 million. But his calculations proceeded on the basis of annual increases in turnover of between 8 and 11 per cent. More importantly, they assumed an increase in net margins from $14.7 million in 1996/1997 to $37.2 million in 2000/2001. In other words, Mr Berry assumed a period of large and increasing profits, which would be matched by substantial increases in bonuses from $3.42 million in 1997/1998 (the first year of operation of the post-1997 Scheme) to $3.98 million in 2000/2001. 77 The primary Judge in substance rejected Mr Berry's assumption that Spotlight had a commercial need to secure a sum equivalent to the total amount of bonuses expected to be paid over the five year period of the post-1997 Scheme. If Spotlight were to enjoy years of growth and increasing profits (as it did), bonuses would increase but there would never be any difficulty in the company meeting its 'obligations' to pay accrued bonuses to employees. It is true that in the event of the company suffering a succession of lean years, bonuses could still be declared in favour of some employees. However, the bonuses presumably would not have been payable at anything like the levels assumed by Mr Berry who, in any event, made no attempt to estimate the bonuses payable in those unlikely circumstances. 78 The primary Judge referred to the amounts in the 'Reserves' from time to time in order to make the point that these were effectively the only sums theoretically at risk in the event of a financial catastrophe striking the company. Yet there had been no attempt to tailor the initial contribution to an estimate of these amounts and no 'top-up' of the fund was made during the five years the post-1997 Scheme was in operation. In my view, the evidence strongly supported his Honour's conclusions about the discrepancy between the Reserves and the contributions. Indeed, the absence of any clear connection between the quantum of Spotlight's one-off contribution to the Incentive Trust and the need to secure the employees' entitlements is a powerful objective factor in favour of his Honour's finding that those entering the Part IVA Scheme, or that element of it comprising the contribution of $15 million to the Incentive Trust, had as their dominant purpose the obtaining of a tax benefit. 79 A fourth criticism of the judgment made by Pridecraft was that his Honour should have found that the commercial benefits of the Incentive Trust were not available under alternative arrangements. Mr de Wijn submitted that a separate reserve in the accounts of Spotlight (as put to Mr Fraid by senior counsel for the Commissioner) would not have provided security for employees, bearing in mind the unitholder's beneficial entitlement to the income and assets of the Trading Trust. 80 One difficulty with this submission is that it was not put to the primary Judge. Perhaps this is not surprising since the onus was on Pridecraft to show that there was no feasible alternative to the post-1997 scheme. Mr Fraid merely said that he did not know whether a reserve could have been created in Spotlight's accounts to set aside the required funds and that he could not recall discussing the possibility with anyone. 81 Mr de Wijn asserted that it would not have been possible for Spotlight to have set aside reserves in its own accounts equivalent to the reserves 'declared' as bonuses in favour of employees. He based this assertion on cl 21(a) of the Deed of Trust establishing the Trading Trust. This provision required the trustees to pay or set aside the whole of the net income of the trust fund of the relevant accounting period for the benefit of unit holders in proportion to their unit holding. There was, however, no attempt in the evidence at trial or in submissions to the primary Judge or to this Court to explore whether it would have been consistent with cl 21(a) of the Deed of Trust for Spotlight to set aside reserves sufficient to ensure that bonuses declared in favour of employees would be paid in accordance with a scheme designed to secure staff loyalty and commitment. It is by no means clear that establishing such reserves would be inconsistent with cl 21(a). 82 On the evidence before the primary Judge, his Honour was not in error in failing to find that the structure adopted by Spotlight was the only means available to achieve its commercial objectives. In any event, as is discussed below, even if there was no alternative to establishing a trust fund, that does not mean that Spotlight had to make a contribution of $15 million, or anything like that sum, to the fund in order to achieve its commercial objectives. Nor does it mean that Spotlight needed to make a contribution to the fund, whether of $15 million or any other amount, prior to 30 June 1997 in order to achieve its commercial objectives.
DOMINANT PURPOSE 83 It is important to appreciate the issue that arises on the appeal. Pridecraft did not challenge the primary Judge's finding that Spotlight had obtained a tax benefit in connection with the scheme identified by the Commissioner. The Part IVA Scheme identified by the Commissioner and relied on by the primary Judge comprised the incorporation of Incentives, the establishment of the Incentive Trust, the making of the $15 million contribution by Spotlight, the loan back of $14.8 million and the course of conduct undertaken to implement these transactions. The tax benefit was the deductibility in the 1996/1997 taxation year of the contribution of $15 million. 84 Section 177C(1)(b) of the ITAA defines 'the obtaining of a tax benefit in connection with a scheme' to include a deduction being allowable to a taxpayer in relation to a year of income where that deduction (or part of it) might reasonably be expected not to have been allowable to the taxpayer in relation to that year of income had the scheme not been carried out. As Gummow and Hayne JJ pointed out in FCT v Hart (at 226 [66]), s 177C(1)(b), when read with s 177D(b), requires a comparison to be made between the scheme and an 'alternative postulate'. That is, Part IVA requires consideration of what would have or might have occurred had the scheme not been entered into. 85 Part IVA provides for the Commissioner to make compensating adjustments where a determination is made pursuant to s 177F(1). In the case of a determination referable to a tax benefit in the form of a deduction being allowable to a taxpayer in a particular year of income, s 177F(3)(b) permits the Commissioner to make a compensatory adjustment. The adjustment can be made if, in the opinion of the Commissioner:
Section 51(1) of the ITAA 95 In view of the conclusion that Pridecraft's appeal on the Part IVA question should be dismissed, it is not strictly necessary to consider whether, independently of Part IVA, the contribution of $15 million to the Incentive Trust was an allowable deduction pursuant to s 51(1) of the ITAA. However, it is appropriate to record my agreement with the primary Judge's reasoning on this issue. 96 His Honour dealt with the Commissioner's contention that the contribution was of capital or of a capital nature at considerable length. He identified the relevant principles in terms that have not been challenged: see Sun Newspapers v FCT, at 363, per Dixon J; United Energy Ltd v Commissioner of Taxation (1997) 78 FCR 169, at 191-192, per Sundberg and Merkel JJ (and the authorities cited there). The effect of those principles is that the distinction between expenditure on revenue and on capital account is not to be found in any 'rigid test or description', but in considering the 'whole set of circumstances, some of which may point in one direction, some in the other': BP Australia Ltd v Commissioner of Taxation (1965) 112 CLR 386 (PC), at 396-397, per Lord Pearce. 97 The Commissioner submitted that having regard to the nature of the advantage sought by Spotlight, the making of the contribution was of a capital nature. The principal contention advanced by Mr Davies was that the principles stated in British Insulated v Atherton were applicable to the present case. He argued that the basis of the decision of the House of Lords in British Insulated v Atherton was that the taxpayer had made a contribution to a pension fund for staff members 'once and for all [and] with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade' (at 213, per Viscount Cave LC). 98 It is important to remember two things about British Insulated v Atherton. The first is that the House of Lords was divided on the question of whether the contribution by the employer was on capital account (Viscount Cave, Lord Atkinson and Lord Buckmaster held that it was, while Lords Carson and Blanesburgh dissented). Secondly, the test stated by Viscount Cave 'seems to leave open doubts as to what is meant by "enduring"': Anglo-Persian Oil Co v Dale (Inspector of Taxes) [1932] 1 KB 124, at 138, per Lord Hanworth MR. As Dixon J observed in Sun Newspapers v FCT, at 361-362, the 'formula' articulated by Viscount Cave requires 'elastic application' and the idea of endurance or continuation over time depends 'on degree and comparison'. 99 The primary Judge distinguished British Insulated v Atherton on the ground that in that case the lasting advantage found to have been secured by the nucleus of a fund that would secure and retain the services of a contented and loyal staff through the taxpayer's business life. By contrast, the advantage secured by Spotlight's contribution was the securing of bonuses falling due over a period of five years, the intention being that the lump sum would be progressively diminished over that period. Whether or not it was appropriate in British Insulated v Atherton to characterise the advantage obtained from the contribution to the pension fund as enduring for the benefit of trade is perhaps debatable. Be that as it may, the primary Judge in the present case was justified in distinguishing British Insulated v Atherton on the facts. 100 There was no error in the reasoning or conclusion of the primary Judge that the contribution of $15 million to the Incentive Fund was an allowable deduction pursuant to s 51(1) of the ITAA.
legislation 101 Section 226(1) of the ITAA provided at the relevant time for the imposition of additional tax by way of penalty where a determination was made under Part IVA and, but for the determination, no tax would have been assessable to the taxpayer in the year of income. In those circumstances, the additional tax is determined by reference to the 'penalty percentage'. That term is defined to mean 50 per cent unless it is 'reasonably arguable' that Part IVA does not apply, in which case it is 25 per cent: s 226(2). 102 Section 226L applied the penalty percentage where a taxpayer had a tax shortfall for a year caused by the taxpayer in a 'taxation statement' (including an income tax return) treating an income tax law as applying to a 'scheme' in a particular way. A 'scheme' was defined to mean a scheme within the meaning of Part IVA which was entered into or carried out for the sole or dominant purpose of enabling a person to pay no tax or less tax: ss 226L(c), 224(1). Section 226L applied only if s 226 did not: s 226L(d). There is no dispute in the present case that, assuming the Commissioner's determination stands, either s 226 or s 226L applies. 103 Section 222C of the ITAA reads as follows: '(1) For the purposes of this Part: (a) the correctness of the treatment of the application of a law; or (c) another matter; is reasonably arguable if, having regard to the relevant authorities and the matter in relation to which the law is applied or the other matter, it would be concluded that what is argued for is about as likely as not correct. (2) For the purposes of this Part, if the treatment of the application of a law assumed that the Commissioner would exercise a discretion in a particular way, the correctness of the treatment is reasonably arguable, in so far as it consisted of the assumption, if the exercise by the Commissioner of the discretion in that way would be reasonably arguably in accordance with law. (3) For the purposes of this Part, the exercise, or assumed exercise, by the Commissioner of a discretion is reasonably arguably in accordance with law if, having regard to the relevant authorities and the matter in relation to which the discretion is or would be exercised, it would be concluded that a court would be about as likely as not to hold that the exercise is or would be in accordance with law. (4) In this section: "authority" includes: (a) an income tax law; or (b) material for the purposes of subsection 15AB(1) of the Acts Interpretation Act 1901; or (d) a decision of a court (whether or not an Australian court), the Tribunal or a Board of Review; or (e) a public ruling within the meaning of Part IVAAA of the Taxation Administration Act 1953. (5) For the purposes of this section, the Commissioner exercises a discretion if the Commissioner: (a) forms an opinion; or (b) refuses or fails to form an opinion; or (c) attains a state of mind; or (d) refuses or fails to attain a state of mind; or (e) makes a determination; or (f) refuses or fails to make a determination; or (g) exercises a power; or (h) refuses or fails to exercise a power.'
submissions 104 The Commissioner submitted that the primary Judge erred in holding that Pridecraft's argument that Part IVA did not apply to the Part IVA Scheme was 'reasonably arguable' for the purposes of s 226L of the ITAA. Mr Davies identified the relevant test as that stated by s 222C(1). He contended that the statutory test requires the taxpayer to show, by reference to the relevant authorities, that its position is objectively one that can be argued on rational grounds to be right. He asserted, without elaboration, that Pridecraft could not satisfy this standard. 105 Pridecraft submitted that the primary Judge had been correct in finding that it was reasonably arguable that Part IVA did not apply. Mr de Wijn pointed to s 222C(2) and (3) as the relevant provisions rather than s 222C(1), although he did not suggest that the test was any different from that applied by his Honour. Mr de Wijn asserted that the arguments relied on by Pridecraft, even if ultimately unsuccessful, could be said on rational grounds to be right.
reasoning 106 Although nothing turns on it, the better view would seem to be that the test to be applied in the present case, as his Honour held, is that stated by s 222C(1). It is true, as Mr de Wijn pointed out, that s 177F(1) of the ITAA confers a discretion on the Commissioner to cancel a tax benefit which, but for the determination, would have been obtained by a taxpayer in connection with a scheme to which Part IVA applies: Commissioner of Taxation v Peabody (1994) 181 CLR 359, at 382, per curiam. But the discretion is enlivened only if there is a scheme to which Part IVA applies. There can be no such scheme unless the requirements in s 177D(b) are satisfied. Those requirements involve the ascertainment of objective facts: FCT v Peabody, at 382. 107 The issue in the present case concerns the application of s 177D(b) of the ITAA. No question has arisen as to the exercise of the Commissioner's discretion in a particular way. Accordingly, the correctness of the imposition of penalty tax at the rate of 50 per cent depends on whether it was reasonably arguable (as Pridecraft contended) that the terms of s 177D(b) were not satisfied in relation to the Part IVA Scheme identified by the Commissioner. 108 In Walstern v Commissioner of Taxation [2003] FCA 1428; 54 ATR 423; ATC 5076, Hill J (at [108]) outlined the correct approach to the imposition of additional tax by way of penalty under s 226C(1) of the ITAA: '1. The test to be applied is objective, not subjective. This is clear from the use of the words "it would be concluded" in par (1)(b) of the section. 2. The decision maker considering the penalty must first determine what the argument is which supports the taxpayer's claim. 3. That person will already have formed the view that the claim is wrong, otherwise the issue of penalty could not have arisen. Hence the decision maker at this point will need to compare the taxpayer's argument with the argument which is considered to be the correct argument. 4. The decision maker must then determine whether the taxpayer's argument, although considered wrong, is about as likely as not correct, when regard is had to "the authorities". 5. It is not necessary that the decision maker form the view that the taxpayer's argument in an objective sense is more likely to be right than wrong. That this is so follows from the fact that tax has already been short paid, that is to say the premise against which the question is raised for decision is that the taxpayer's argument has already been found to be wrong. Nor can it be necessary that the decision maker form the view that it is just as likely that the taxpayer's argument is correct as the argument which the decision maker considers to be the correct argument for the decision maker has already formed the view that the taxpayer's argument is wrong. The standard is not as high as that. The word "about" indicates the need for balancing the two arguments, with the consequence that there must be room for it to be argued which of the two positions is correct so that on balance the taxpayer's argument can objectively be said to be one that while wrong could be argued on rational grounds to be right. 6. An argument could not be as likely as not correct if there is a failure on the part of the taxpayer to take reasonable care. Hence the argument must clearly be one where, in making it, the taxpayer has exercised reasonable care. However, mere reasonable [care] will not be enough for the argument of the taxpayer must be such as, objectively, to be "about as likely as not correct" when regard is to be had to the material constituting "the authorities". 7. Subject to what has been said the view advanced by the taxpayer must be one where objectively it would be concluded that having regard to the material included within the definition of "authority" a reasoned argument can be made which argument when contrasted with the argument which is accepted as correct is about as likely as not correct. That is to say the two arguments, namely, that which is advanced by the taxpayer and that which reflects the correct view will be finely balanced. The case must thus be one where reasonable minds could differ as to which view, that of the taxpayer or that ultimately adopted by the Commissioner was correct. There must, in other words, be room for a real and rational difference of opinion between the two views such that while the taxpayer's view is ultimately seen to be wrong it is nevertheless "about" as likely to be correct as the correct view. A question of judgment is involved.' (Emphasis added.) Both parties accepted that this is the correct approach. 109 The primary Judge in the present case made a judgment that the competing arguments on the application of Part IVA of the ITAA were sufficiently finely balanced to warrant Pridecraft's position being characterised as 'reasonably arguable' for the purposes of ss 226 and 226L of the ITAA. There was no suggestion that his Honour misunderstood or misapplied the propositions stated by Hill J in Walstern v FCT, which both parties accepted as correct. I do not think that his Honour's reasoning or conclusion reveals any errors justifying appellate intervention. 110 Pridecraft's contentions, made to the Commissioner, the primary Judge and this Court, rested on the proposition that the Part IVA Scheme had a clear commercial purpose. The fundamental reason this argument has not been accepted is that an element of the Part IVA Scheme - the contribution of $15 million to the Incentive Trust at the very end of the 1996/1997 tax year - warranted the conclusion that Spotlight entered or carried out that part of the scheme for the purpose of enabling it to obtain a tax benefit. It must be remembered that the inquiry required by s 177D(b) of the ITAA is an objective one. Given the undisputed evidence that the post-1997 Scheme as a whole was prompted by a desire to restructure Spotlight's Profit Share Bonus Scheme and had a genuine commercial objective, I think it fair to say that there was room for a rational argument that, viewed objectively, Spotlight's dominant purpose in entering the Part IVA Scheme was not to obtain a tax benefit. Accordingly, the Commissioner's cross-appeal on this issue should be dismissed.
fringe benefits tax 111 The Commissioner's submissions indicated that it was only necessary to decide its appeal from the primary Judge's holding that Spotlight was not liable to pay fringe benefits tax on the contribution of $15 million to the Incentive Trust if the contribution was held to be an allowable deduction. It is therefore not necessary to deal with this appeal. 112 A further reason for not dealing with the fringe benefits tax question is that the Commissioner challenged the correctness of the decision of Kiefel J in Essenbourne Pty Ltd v Commissioner of Taxation [2002] FCA 1577; 51 ATR 679; ATC 5201 and the reasoning of Hill J in Walstern v FCT. It is undesirable to consider whether those cases were correctly decided when it is not necessary to do so.
conclusion 113 The appeals must be dismissed. In each appeal, the appellant must pay the respondent's costs. I certify that the preceding one hundred and twelve (112) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Sackville.
ON APPEAL FROM A JUDGE OF THE FEDERAL COURT OF AUSTRALIA
AND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
VID 851 of 2004 BETWEEN: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
SUNDBERG J: 114 I agree with the orders proposed by Sackville J and with his Honour's reasons for making them. I certify that the preceding paragraph is a true copy of the Reasons for Judgment herein of the Honourable Justice Sundberg.
Associate: Dated: 23 December 2004 Counsel for Pridecraft Pty Ltd and Spotlight Stores Pty Ltd: JW de Wijn QC with J Jacques
Solicitor for Pridecraft Pty Ltd and Spotlight Stores Pty Ltd: Cornwall Stodart
Counsel for the Commissioner: GJ Davies QC with J Davies SC
Solicitor for the Commissioner: Australian Government Solicitor
Date of Hearing: 8 November 2004
Date of Judgment: 23 December 2004
Pridecraft Pty Ltd
Commissioner of Taxation
(1938) 61 CLR 337
(2004) 206 ALR 207
(1996) 186 CLR 404
(2003) 127 FCR 185
(2004) 206 ALR 511
(1992) 176 CLR 141
(2001) 207 CLR 235
(2001) 108 FCR 311
(2001) 117 FCR 424
(1997) 78 FCR 169
(1965) 112 CLR 386
(1994) 181 CLR 359