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[1993] FCA 74
Federal Court of Australia
1993-03-08
O'Loughlin J, Hill J, Ryan J
Original judgment source is linked above.
Income Tax - Tax Avoidance - whether it would be concluded that scheme entered into by taxpayer was entered into for the dominant purpose of obtaining a tax benefit - significance of Commissioner's delineation of scheme - whether in the circumstances there was a tax benefit - meaning of "reasonable expectation" considered - whether if the scheme as delineated by the Commissioner had not been entered into or carried out shares the subject of the scheme would as a factual matter have been purchased in the name of a corporate trustee - redeemable preference share financing -
Attorney-General v Cockcroft (1986) 64 ALR 97 referred to.
Federal Commissioner of Taxation v Jackson (1990) 27 FCR 1 applied.
Counsel for the Appellant: Mr D.H. Bloom QC Mr A.H. Slater
Solicitor for the Appellant: Sly and Weigall Cannan and Peterson
Counsel for the Respondent: Ms S.M. Kiefel QC Mr C. Newton
Solicitor for the Respondent: Australian Government Solicitor
2. The orders made by O'Loughlin J on 18 September 1992 be set aside and in lieu thereof it be ordered that the objection decision in respect of the appellant's assessment for the year of income ended 30 June 1986 be set aside and that the appellant's objection to the amended assessment of income tax in respect of that year be allowed.
3. The assessment be remitted to the respondent for amendment in accordance with law.
4. The respondent Commissioner pay the appellant's costs of the appeal and of the proceedings before O'Loughlin J.
Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
RYAN J. I have had the advantage of reading Hill J's reasons in draft. I agree with those reasons and the orders which he proposes and have nothing to add. HILL J. The appellant, Mary Genevieve Peabody ("Mrs Peabody"), appeals from the judgment of a judge of this Court confirming the decision of the respondent Commissioner of Taxation to disallow Mrs Peabody's objection to an amended assessment of income tax in respect of the year of income ended 30 June 1986.
2. The assessment complained of was made by the Commissioner following a determination made by him pursuant to s.177F(1)(a) of the Income Tax Assessment Act 1936 as amended ("the Act"). Mrs Peabody duly objected to that assessment and, her notice of assessment having been disallowed, requested the Commissioner to refer the objection decision to this Court. The reference to this Court constituted the instituting by Mrs Peabody of an appeal to this Court against the Commissioner's decision. Jurisdiction to hear that appeal arises in the original jurisdiction of the Court.
3. The primary facts, as found by his Honour, were not in dispute in the appeal. They may be shortly stated.
4. In 1963, Mrs Peabody's husband, Terrence Elmore Peabody, established with his father and another partner a fly ash business. According to Mr Peabody's evidence, fly ash is a light, powdery material known as a pozzolan, which is obtained as a by-product of coal burnt in power stations. When blended with cement, fly ash adds strength and durability to concrete and reduces its cost. It would seem that the Peabody interests developed the process for the use of fly ash in structural concrete and that this use is now the principal use for fly ash.
5. The business flourished and by 1985 was owned as to 62 per cent by the Peabody interests and 38 per cent by a Mr Ray Kleinschmidt, or interests associated with him. The corporate structure involved numerous companies. Suffice it to say that there were four main companies, Pozzolanic Enterprises Pty Ltd, Pozzolanic (Queensland) Pty Ltd, Pozzolanic Bulk Carriers (Queensland) Pty Ltd and Coastal Bulk Haulage Pty Ltd. All other companies were subsidiaries of these companies. With the exception of some minimal holdings in Mr Peabody's name, the shares in the four Pozzolanic companies that were owned by the Peabody interests were held in the name of TEP Holdings Pty Ltd, which company was trustee of a discretionary trust known as the "Peabody Family Trust". Mr Peabody and his wife were the only directors and shareholders of TEP Holdings Pty Ltd.
6. For some time prior to 1985, Mr Peabody had been considering the possibility of a public flotation of the Pozzolanic group. In the judgment below it is recorded that it was Mr Peabody's evidence that his plan was to achieve a public float with his interests retaining 50 per cent control, but that he did not think that he could achieve this objective whilst Mr Kleinschmidt remained such a large shareholder. His Honour found it unnecessary to consider that evidence in detail. At a meeting between Mr Peabody and Mr Kleinschmidt on 14 October 1985, the two men agreed that Mr Kleinschmidt would sell the whole of his interest in the group to the Peabody interests. It seems clear from the evidence given by Mr Peabody and that given by Mr Kleinschmidt, that Mr Kleinschmidt did not want there to be public disclosure of the purchase price of his shares and that Mr Peabody agreed to that.
7. A meeting then took place on 17 October 1985 between Mr Peabody and the stockbrokers who were then called in to advise on the proposed public float. According to his Honour's findings, there was a hope, or at least an expectation, that the public float would be capitalised at a figure well in excess of the amount of $24,000,000 that had been discussed between Mr Peabody and Mr Kleinschmidt as the basis of the bargain between them. Mr Peabody and his advisers saw the possibility of commercial difficulties arising if it became necessary to disclose in the prospectus that, within a short time prior to the float, the shares had been acquired by the Peabody interests at a substantially lesser figure than that at which they were offered to the public. It was further found by his Honour that the wish of Mr Kleinschmidt to keep the price paid to him confidential, was not a determining factor in what thereafter happened.
8. In any event, a decision was made by Mr Peabody and those advising him, to seek advice of a Queen's Counsel on whether there was need to make any, and if so what, disclosure in a proposed prospectus of the purchase of Mr Kleinschmidt's shares. Accordingly, a brief was prepared bearing date 21 October 1985. The proposal upon which counsel's advice was sought was merely that there be a purchase of the Kleinschmidt shares followed by a sale by the Peabody interests to a new company to be formed and to be floated as a public company, the sale to be partly for cash and partly for shares in the public company. Following a conference, a written opinion was obtained from counsel bearing date 25 October 1985. That opinion was generally favourable to the view that disclosure was not required. It was, however, not unqualified.
9. On the morning of the day upon which the opinion was dated and presumably received, a meeting was held between Mr Peabody and his advisers in the course of which a telephone call was placed to the brokers. It was in the course of this telephone conversation that the idea originated of acquiring the Kleinschmidt shares and then converting them to a designated class of shares having rights such that they would thereafter be virtually worthless. This would have the consequence of correspondingly increasing the value of the existing shares held by TEP Holdings Pty Ltd. A memorandum of a telephone conversation prepared by Mr Peabody's solicitor at the time pointed out that in this event TEP Holdings Pty Ltd could sell off the shares that it had always owned to the new public company for an appropriate purchase price without having to contend with the provisions of s.26AAA of the Act which, at that time, included in assessable income any profit arising from the sale of property acquired within 12 months of the sale. He explained the proposal in a memorandum as follows:
acquire the shares will buy for $8.5 million and
have them taken up by the public company for $10
or whatever and that entity would be funded by a
loan from Terry and we can have that wound up...
It bumps up the values of Terry's own ordinary
shares by the sum paid out to Kleinschmidt."
10. This memorandum, which was dated 28.10.85, appears to record one of the first discussions at which the idea of financing the transaction through redeemable preference shares taken up by a financier was raised. Over subsequent days, as the solicitor's memoranda disclose, various matters were the subject of discussion between the parties. These matters included the issue of disclosure, the question of s.26AAA, the question of stamp duty and questions of company law.
11. On 7 November 1985, according to a memorandum of the solicitor in evidence, the question of the proposed purchase of the shares from Mr Kleinschmidt was still being discussed. The memorandum suggests that an initial thought that a separate entity would be needed to purchase the shares of the Kleinschmidt interests so as to avoid the provisions of s.26AAA of the Act, was no longer material. The memorandum shows that, as at that date, it was contemplated that TEP Holdings Pty Ltd should be the purchaser.
12. That matter was apparently the subject of further discussions, particularly in the context of financing the acquisition of the shares from Mr Kleinschmidt. At a meeting on 14 November 1985, the advantages of a financier subscribing for redeemable preference shares in the entity that was to purchase the shares from Mr Kleinschmidt, had become apparent. If finance were to be provided in the ordinary way at interest, the interest rate payable would be in the order of 18-20 per cent. On the other hand, if the shares owned by the Kleinschmidt interests were purchased by a corporation and a financier subscribed for shares in that new corporation, in circumstances where after the acquisition of the Kleinschmidt shares a dividend was declared on those shares to the acquirer corporation and thereafter the acquirer corporation declared a dividend to the financier, the effective finance cost would be reduced to 11.7 per cent.
13. This discrepancy arose because, under the income tax law at the time, a public company financier receiving a dividend would receive a 100 per cent rebate of tax pursuant to the then provisions of s.46 of the Act. Effectively, therefore, the financier received the financing charge (equivalent to interest) tax free. The shares issued would be redeemable preference shares and once the financing dividend had been declared, the shares would be redeemed so that the financier would receive what, essentially, represented the principal of a loan. The solicitor, in the memorandum dated 14.11.85, commented:
"if we do it this way we will need a clean
company to buy the shares from Kleinschmidt and
we need to have the company wholly owned by TEP
Holdings in its capacity as trustee."
14. It was at this stage that the name of the proposed company to purchase the Kleinschmidt shares became known, it was to be Loftway Pty Ltd ("Loftway"). The financier to subscribe for 'Z' class redeemable preference shares in Loftway became Westpac Banking Corporation.
15. Thereafter, the proposal having crystallised, it was in due course implemented. Loftway, which originally was a shelf company, acquired the Kleinschmidt shares in the four Pozzolanic companies. The shares in Loftway, in turn, were wholly owned by TEP Holdings Pty Ltd, in its capacity as trustee of the Peabody family trust. The purchase price for these shares was $8,656,177. The finance, to enable Loftway to purchase the shares, was provided by Westpac subscribing for redeemable preference shares in the capital of Loftway. After the shares in the Pozzolanic companies had been acquired by Loftway, dividends were declared by each of the four Pozzolanic companies and paid to Loftway which, in turn, declared a dividend to Westpac. In due course, the Westpac shares were redeemed or otherwise Westpac was paid out. The money to enable this to happen came from the public company float by way of a loan from TEP Holdings Pty Ltd, as trustee of the Peabody Family Trust, to Loftway.
16. Each of the four companies in the Pozzolanic group, with the consent of Loftway, passed appropriate special resolutions converting the shares, which Loftway had purchased, into 'Z' class preference shares. The rights attaching to those 'Z' class preference shares were as follows:
"(i) the right to a fixed non-cumulative
preferential dividend at the rate of
1% per annum on the capital for the
time being paid up thereon or deemed
to be paid up thereon in priority to
all the other shares in the capital
of the company;
(ii) the right to such further
preferential dividend on the capital
for the time being paid up thereon
or deemed to be paid up thereon in
priority to all the other shares in
the capital of the company as may
from time to time be declared by the
company on the recommendation of the
directors;
(iii) the right on a winding-up to be paid the
full amount of the capital for the time
being paid up thereon or deemed to be paid
up thereon before payment of any amount to
the holders of the remaining issued shares
but no right to participate in a winding-
up for any amount in excess of the paid up
capital;
(iv) the Z class preference shares shall
not confer any voting rights
whatever on the holders thereof."
17. The consequence of this conversion was that the Kleinschmidt shares, which previously were worth at least $8.6 million, had a value of something less than $500. Conversely, the shares in the four Pozzolanic companies owned by TEP Holdings Pty Ltd, which had previously represented only 62 per cent of the equity in the group, represented, save for the capital of the 'Z' class preferences, 100 per cent of the equity in the Pozzolanic group.
18. Thereafter, TEP Holdings Pty Ltd sold the whole of its ordinary shares in the Pozzolanic companies to a company established for the purpose, which ultimately became the company floated to the public. This sale was partly for cash and partly for a number of shares which resulted in TEP Holdings Pty Ltd holding 50 per cent of the shares in the public company. The public company, effectively, thereby became the owner of 100 per cent of the equity shares in the four Pozzolanic companies.
19. A prospectus was, in due course, lodged for the proposed public issue by the new public company which became known as Pozzolanic Industries Limited. No mention was made in that prospectus of the price paid for the Kleinschmidt shares. I find it unnecessary to decide whether such a disclosure should have been made. TEP Holdings Pty Ltd, and Mr Peabody in respect of the small number of shares in his own name, agreed to sell the whole of the ordinary shares in the Pozzolanic companies to the public company for $30 million. Of the 'Z' class shares, into which the Kleinschmidt shares had been converted, the prospectus said:
"Thus Pozzolanic Industries Ltd holds directly
or indirectly all the shares in the four
companies shown on the second line of the
diagram on page 7 namely Coastal Bulk Haulage
Pty Ltd, Pozzolanic (Queensland) Pty Ltd,
Pozzolanic Enterprises Pty Ltd and Pozzolanic
Bulk Carriers (Queensland) Pty Ltd except for a
number of 'Z' class preference shares held by
third parties in these four companies. These
'Z' class preference shares are entitled to one
percent non-cumulative preferential dividend and
return of capital only on winding up and have no
voting rights."
20. The public float was successful. In due course, Loftway transferred some, perhaps all, of the 'Z' class shares in the four Pozzolanic companies to TEP Holdings Ltd which, in turn, transferred all, or perhaps some of them, to the public company which thereby became the owner, one would assume, of 100 per cent of the shares in the four Pozzolanic companies including the preference shares.
The assessment and the Part IVA determinations
22. It is obvious that the first step in the making of a determination under the provisions of s.177F of the Act is the identification of the "scheme" to which the provisions of Part IVA of the Act applies. This scheme was identified by the Commissioner as "including" the taking of the following steps:
"(1) The purchase of all of the shares of
Pozzolanic Enterprises Pty Ltd, Pozzolanic
(Queensland) Pty Ltd, Pozzolanic Bulk Carriers
(Queensland) Pty Ltd and Coastal Bulk Haulage
Pty Ltd (collectively referred to as the target
entities) which were owned by R.T. Kleinschmidt
by Loftway Pty Ltd;
(2) The issue of preference shares by
Loftway Pty Ltd to Westpac Banking Corporation;
(3) The conversion of shares in the
target entities to "Z" class preference shares;
(4) The reduction in the considered
value of the target entity shares by Loftway Pty
Ltd;
(5) The special resolution by the target
entities to remove the right of "Z" class
preference shareholders to receive preferential
dividends;
(6) The loan made by T.E.P. Holdings Pty
Ltd which was trustee of the Peabody Family
Trust to Loftway Pty Ltd and the terms and
conditions of that loan;
(7) The public float of Pozzolanic
Industries Ltd which float excluded the "Z"
class shares;
(8) The redemption of its preference
shares in the target entities by Loftway Pty Ltd
from Westpac Banking Corporation;
(9) The sale of the target entities "Z"
class shares by Loftway Pty Ltd to T.E.P.
Holdings Pty Ltd for a consideration of $476.00;
(10) The transfer of the shares by T.E.P.
Holdings Pty Ltd as a gift to Pozzolanic
Industries Ltd."
23. During the course of the hearing below, para.(10) of these particulars was amended by adding the words "or at par value" after the word "gift". Nothing turns upon this amendment.
24. In making his determination under s.177F, the Commissioner determined that the sum of $888,005 should be included in the assessable income of Mrs Peabody, pursuant to the provisions of s.97 of the Act. The calculation made by the Commissioner commenced with what was said to be a computation of the profit on the sale of the Pozzolanic shares. This computation commenced with the sale price of the shares in each of the four Pozzolanic companies, subtracted therefrom the price of those shares in the purchase from Mr Kleinschmidt and subtracted off as well a small sum taken from the Loftway income tax return for purchase expenses, leaving a total profit of $2,664,016. The Commissioner treated this amount as having been added to the net income of the Peabody Family Trust for the year in question, that net income amounting prior to the determination to $30,428. The combined net income of the trust estate was determined by the Commissioner for the purposes of s.95(1) as $2,694,444.
25. The trustees of the Peabody Family Trust had resolved to distribute the whole of the income of the trust estate (including specifically any amounts which the Commissioner should add in as a result of amended assessments) equally among three beneficiaries, one of whom was Mrs Peabody. In the result, therefore, the Commissioner regarded the additional $2,644,016 as having been so divided among the same three beneficiaries in accordance with s.97 of the Act, with the consequence that each of those beneficiaries derived, by force of that section, $888,005. A fractional $1 was disregarded.
26. It is from this assessment, and in respect of this determination, that Mrs Peabody objected and it is the Commissioner's disallowance of this objection which has been referred to the Court. The general nature of the appeal, where a Part IVA objection is involved, was considered by the Full Court of this Court in Federal Commissioner of Taxation v Jackson (1990) 27 FCR 1.
27. Part IVA of the Act was introduced by the Income Tax Laws Amendment Act (No.2) No. 110 of 1981, applicable to a "scheme" entered into after 27 May 1981. The Part was intended to provide a general anti-avoidance measure to replace the then anti-avoidance provision, s.260, which in 1981 stood somewhat discredited.
28. As pointed out in the Explanatory Memorandum, circulated by the then Treasurer, the Honourable Mr John Howard, there were, in accordance with the jurisprudence then extant, four major limitations on the scope of the then s.260. These limitations were said, in that memorandum, to be:
"(a) The 'choice principle' is an
interpretative rule according to which
section 260 will not apply to deny to
taxpayers a right of choice of the form of
transaction to achieve a result if the
Principal Act itself lays open to them
that form of transaction. To do so does
not alter the incidence of tax and this is
so notwithstanding that the transaction in
question is explicable only by reference
to a desire to attract the operation of a
particular provision of the Act and so
achieve a reduction in liability to tax
below what it would have been if that
course had not been taken.
(b) The section is expressed in such a way
that the purposes or motives of the
persons entering into an arrangement are
not to be enquired into in deciding
whether the section applies to the
arrangement. Rather, the 'purpose' of an
arrangement is to be tested only by
examining the effect of the arrangement
itself.
(c) It is unclear whether an arrangement to
which the section is found to apply must
be treated as wholly void or whether it
can be treated as only partly void, i.e.,
to the extent necessary to eliminate the
sought-after tax benefit.
(d) The section does not, once it has done its
job of voiding an arrangement, provide a
power to reconstruct what was done, so as
to arrive at a taxable situation."
29. The proposed Part IVA was introduced to overcome these difficulties. The legislative purpose, as the Explanatory Memorandum makes clear, was to restore the law to what it was thought to be after the decision of the Privy Council in Newton v Federal Commissioner of Taxation [1958] UKPCHCA 1; (1958) 98 CLR 1, but subject to ensuring that the four problems, to which reference has been made, were overcome.
30. The power to make a determination under Part IVA arises pursuant to s.177F(1), which, relevant to the present case, 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) in the case of a tax benefit that is
referable to an amount not being
included in the assessable income of
the taxpayer of the year of income -
determine that the whole or a part
of that amount shall be included in
the assessable income of the
taxpayer of that year of income; or
(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,
and, where the Commissioner makes such a
determination, he shall take such action
as he considers necessary to give effect
to that determination."
31. Critical to that power is, first, the existence of a "scheme" to which Part IVA applies and second, the obtaining, by a taxpayer, of a "tax benefit" in connection with that "scheme".
32. The expression "scheme" is defined in s.177A. It encompasses, inter alia, non-enforceable arrangements or understandings as well as courses of action or courses of conduct. In a particular case a unilateral action may constitute a "scheme" for the purposes of the definition. In other cases, as identified by the Commissioner in the present circumstances, the scheme may consist of a series of steps or a course of action. This is not to say that where, as a matter of fact, a scheme consists of a course of action comprising several steps, the Commissioner may isolate out of that course of action one step and classify that as a scheme. Reference in Part IVA to "part of a scheme" (cf s.177A(5)) suggests rather that, in a case where a series of steps constitutes a scheme, that whole series of steps is to be considered, the individual steps being seen as parts of the scheme rather than each step being capable of being seen as a scheme in itself: cf IRC v Brebner (1967) 2 AC 18 at 26, 27.
33. Be that as it may, the Commissioner has identified the scheme as comprising, in the present case, a series of steps, rather than a single step. In particular, it is not the Commissioner's case that the scheme, as such, comprises, for example, merely the resolution to convert the former Kleinschmidt shares into 'Z' class preference shares. As will be seen, this distinction was not always clearly recognised by the learned trial judge.
34. The concept of "tax benefit" is defined in s.177C in terms of assessable income or allowable deductions, as the case may be. As relates to assessable income, s.177C(1) provides:
"(1) Subject to this section, a reference in
this Part to the obtaining by a taxpayer
of a tax benefit in connection with a
scheme shall be read as a reference to -
(a) an amount not being included in the
assessable income of the taxpayer of
a year of income where that amount
would have been included, or might
reasonably be expected to have been
included, in the assessable income
of the taxpayer of that year of
income if the scheme had not been
entered into or carried out;".
35. Thus, for the purposes of Part IVA, the tax benefit obtained in connection with the scheme that has been identified by the Commissioner will be the amount referred to in para.(a), the present case being concerned only with that limb of the definition relating to assessable income. In the present case, nothing turns upon the exclusion of certain benefits as tax benefits, pursuant to the provisions of s.177C(2).
36. It will be seen that s.177C requires the making of an hypothesis as to what might reasonably be expected to have happened had the scheme identified not been entered into or carried out. It is not suggested, in the present case, that if the scheme had not been entered into or carried out there is any amount which would have been included in Mrs Peabody's assessable income. The Commissioner places reliance upon the alternative set out in s.177C(1)(a), namely, that an amount might reasonably be expected to have been included in Mrs Peabody's assessable income if the scheme had not been entered into or carried out.
37. The determination under s.177C(1)(a) requires a finding based upon "reasonable expectation". In the context, expectation is not used in the sense of prediction as to the future but rather in the sense of supposition or hypothesis. But what is clear is that the expectation must be one which is reasonable and not one which is unreasonable, irrational or absurd.
38. Counsel for the appellant referred us to a number of cases, in differing contexts, in which the words "reasonable expectation", or cognate expressions, have been used. These included: Attorney-General v Cockcroft (1986) 64 ALR 97 at 106 per Bowen C.J. and Beaumont J, 111-2 per Sheppard J; Federal Commissioner of Taxation v Arklay (1989) 85 ALR 368 at 371-2 per Sheppard, Wilcox and Hartigan JJ., in which Cockcroft was followed; Dunn v Shapowloff (1978) 2 NSWLR 235 at 249 per Mahoney J.A.; East v Repatriation Commission [1987] FCA 242; (1987) 16 FCR 517 at 532-3 per Jenkinson, Neaves and Wilcox JJ.; Secretary, Department of Social Security v Copping (1987) 73 ALR 343 at 348 per Jenkinson J; and Davies v Taylor (1974) AC 207 at 212 per Lord Reid and 219 per Viscount Dilhorne.
39. These cases indicate, what would presumably be in any event obvious, that the meaning of words such as "reasonable expectation" depends upon the context in which they appear. Nevertheless, in the present context, as in Cockcroft, the words were intended to receive, and should receive, their ordinary meaning. So too, as in Cockcroft, the word "reasonable" is used in contradistinction to that which is "irrational, absurd or ridiculous". The word "expectation" requires that the hypothesis be one which proceeds beyond the level of a mere possibility to become that which is the expected outcome. If it were necessary to substitute one ordinary English phrase for another, it might be said that it requires consideration of the question whether the hypothesised outcome is a reasonable probability: cf Davies v Taylor.
40. The concept of tax benefit is relevant also to the question whether the scheme is one falling within s.177D. That section provides as follows:
"This Part applies to any scheme that has been
or is entered into after 27 May 1981, and to any
scheme that has been or is carried out or
commenced to be carried out after that date
(other than a scheme that was entered into on or
before that date), whether the scheme has been
or is entered into or carried out in Australia
or outside Australia or partly in Australia and
partly outside Australia, 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
other nature) with the relevant taxpayer, being a change
that has resulted, will result or may reasonably be
(vii) any other consequence for the relevant taxpayer, or for any
person
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 sub-paragraph (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)."
41. The purpose, to which s.177D applies, may be either the sole purpose or, having regard to the provisions of s.177A(5), the dominant purpose. Sections 177A(4) and (5), relevant to the interpretation of s.177D, are in the following terms:
"(4) A reference in this Part to the carrying
out of a scheme by a person shall be read as
including a reference to the carrying out of a
scheme by a person together with another person
or other persons.
(5) A reference in this Part to a scheme or a
part of a scheme being entered into or carried
out by a person for a particular purpose shall
be read as including a reference to the scheme
or the part of the scheme being entered into or
carried out by the person for 2 or more purposes
of which that particular purpose is the dominant
purpose."
42. It will be seen that the determination of what schemes fall within s.177D requires an objective conclusion to be drawn, having regard to the matters referred to in para.(b) of the section, but no other matters. It is notable that the actual subjective purpose of any relevant person is not a matter to which regard may be had in drawing the conclusion. In this way, the provisions of Part IVA stand in contrast to similar provisions subsequently enacted in other legislation, for example, s.67 of the Fringe Benefits Tax Assessment Act 1986 (Cth).
43. The "relevant taxpayer", so far as the present case is concerned, is Mrs Peabody, although the expression could extend as well to the other two beneficiaries of the Peabody Family Trust. The result would be the same in the present case, whichever alternative be accepted. The person about whom the conclusion as to purpose is required to be made, was, in the present case, according to the Commissioner, Mr Peabody. He clearly was a person who participated in each step of the proposal which constituted the scheme as considered by the Commissioner at the time of making his determination and as particularised by him for the purposes of the present appeal.
44. It will be seen, from s.177D, that the conclusion that is required to be drawn is not a conclusion with respect to the scheme itself, but a conclusion as to the purpose of a particular person. In this respect, Part IVA differs from s.260. That person may, in a particular case, have participated in only a part of the scheme. In such a case, the question will be whether the conclusion would be reached that his or her participation in that part of the scheme was for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with that scheme. In other circumstances (including those of the present case), the participation of the relevant person will be in the totality of the scheme. In such a case, the question will be whether the participation of that person was activated by that person's dominant purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme. It may be observed that the tax benefit that is required by the closing words of s.177D to be considered, may, but need not be, the same tax benefit as that actually obtained by the relevant taxpayer. In the ordinary case, however, the tax benefit required by the closing words of s.177D to be considered will be the same as the tax benefit referred to in s.177D(a). It is not suggested in the present case, however, that the tax benefit which has to be considered under those closing words is other than that identified by s.177D(a).
45. It will also be noted that the relevant purpose to be considered is one of enabling the relevant taxpayer or taxpayers to obtain the necessary tax benefit. In this context, the expression "enabling" has its normal meaning of "make able" or "make possible". Its meaning in the present context probably includes "assist in making able or possible" or "contribute to making able or possible": cf Federal Commissioner of Taxation v Students World (Australia) Pty Ltd [1978] HCA 1; (1978) 138 CLR 251 at 265 per Mason J and Federal Commissioner of Taxation v Lutovi Investments Pty Ltd [1978] HCA 55; (1978) 140 CLR 434 at 446. However, it is unnecessary to decide the width of its meaning in the present case.
46. In arriving at his conclusion, the Commissioner must have regard to each and every one of the matters referred to in s.177D(b). This does not mean that each of those matters must point to the necessary purpose referred to in s.177D. Some of the matters may point in one direction and others may point in another direction. 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.
47. One of the difficulties of the judgment, heavily relied upon by counsel for the appellants before us, was the failure by his Honour to bear steadily in mind what the scheme was which the Commissioner had taken into account in making the determination under s.177F.
48. At various parts of the judgment, his Honour appears to have regarded the scheme as being merely the conversion of the Kleinschmidt shares into 'Z' class shares. In other parts of the judgment, a wider scheme appears to be contemplated by his Honour. Be that as it may, his Honour was of the view that the decision to convert the Kleinschmidt shares into 'Z' class preference shares was a decision motivated by the desire to avoid possible tax under s.26AAA of the Act, rather than by any desire to avoid disclosure in the prospectus. Thus, his Honour said, after considering the evidence:
"I consider the issue of not disclosing the
purchase price of the Kleinschmidt shares in the
prospectus as a 'red herring'. I have come to
that conclusion for the following reasons: if it
be accepted that there was genuine concern to
keep secret the amount paid to Mr Kleinschmidt
for his shares, neither the evidence nor
counsel's submissions have explained how the
conversion of the shares to Z class shares
allowed or permitted or authorised or justified
the non-disclosure. Expressed another way, if
there was any obligation to make such a
disclosure in the prospectus, the devaluation of
the shares subsequent to their purchase by
Loftway would not have removed the requirement
to disclose. I am not rejecting the evidence
that Mr Kleinschmidt wished to keep secret the
price that was paid for his shares - I am merely
expressing my finding that his wish played no
part whatsoever in the decision to engage in the
exercise of devaluing his shares. However,
there is a further obstacle in the path of the
taxpayer. There was no need to use a limited
liability company to implement the conversion
scheme; the act of converting the Kleinschmidt
shares was the separate act of each of the four
Pozzolanic companies. The act of conversion
required the consent of the owner of the shares,
but the owner could have been the Trust; it did
not have to be a company such as Loftway. Even
without recourse to Mr Dutney's notes, it is
abundantly clear that the conversion exercise
and the devaluation of the Kleinschmidt shares
was implemented to avoid the provisions of
s.26AAA of the Act; Mr Dutney's notes merely
corroborate that which was already obvious."
49. His Honour then considered the use of Loftway as purchaser. While recognising the importance of a corporation in the transaction involving Westpac, his Honour said:
"But such importance as might attach to that
observation must be weighed against the fact
that the decision to convert the Kleinschmidt
shares to Z class shares preceded, and was
independent of, the decision to finance the
purchase by issuing redeemable preference shares
to the banker; the former decision was made, at
the latest, by 28 October (see Mr Dutney's
notes of his telephone conversation with Messrs
Wruck and Thurecht on that day) whilst the
latter decision was made at the earliest on 13
November when Mr Wruck discussed proposals for
financing the share purchase with a potential
lender. For the purpose of considering the
taxpayer's challenge to the amended assessment,
I have come to the conclusion that the method of
financing the purchase of the shares, despite
its commercial importance, can be put to one
side."
50. Having done so, his Honour looked again at the transaction involving the conversion of the Kleinschmidt shares to 'Z' class shares and concluded that it came about to avoid the operation of s.26AAA. Hence, his Honour said:
"The Peabody interests had negotiated the
purchase of a large parcel of shares in the
group based on the group having a net worth of
about $24M. Within a period of 12 months of
that purchase there was to be a public float
based on the group having a net worth of $30M.
Somebody, (the particular taxpayer or taxpayers
within the Peabody family who would purchased
the Kleinschmidt shares) stood to make a capital
gain that was equivalent to about 38% of $6M.
However that taxpayer or those taxpayers would
be liable to tax on that capital gain unless
some lawful avoidance measure could be
implemented."
51. His Honour then turned to consider the various aspects of Part IVA. Under the heading "Is there a scheme?", his Honour held that there was a scheme, that it was unilateral and constituted a course of action being:
"the decision to convert the Kleinschmidt shares
to worthless Z class shares and certain
consequential transactions that were implemented
to give effect to that decision."
"Whether the scheme should be classified as
stopping with the conversion of the shares to Z
class shares or whether it should be extended to
include Loftway's issue of redeemable shares to
fund their purchase is an interesting question,
but it is one which it is not necessary to
decide. Let it be assumed that the scheme did
extend to the legitimate purpose of obtaining
cheap finance through the issue of redeemable
preference shares; that will not save the
relevant taxpayer if some other proscribed
purpose existed that can properly be classified
as the dominant purpose of the plan:
(sub-s.177A(5))."
53. His Honour, under the heading "The identity of the relevant taxpayer" identified the three beneficiaries of the Peabody Family Trust. This was not the subject of any criticism before us. His Honour then turned to consider the question of "the tax benefit". He indicated that it was his view that the language of "reasonable expectation" was "not very demanding". He concluded that all that was needed to support the Commissioner's view of the matter was:
"a reasonable expectation that an amount might
have been included in the assessable income of
the taxpayer."
54. He formed the view that an expectation that Mrs Peabody might have, but for the scheme, received as assessable income one third of the capital gain was reasonably based. Accordingly, his Honour held that Mrs Peabody had obtained a tax benefit in respect of the scheme.
55. Finally, his Honour turned to s.177D and considered the matters there set out by reference to the conversion of the Kleinschmidt shares to worthless 'Z' class shares. His Honour found the necessary purpose to be present. He said:
"In this case I am satisfied and so find that Mr
Peabody entered into the scheme in order to
avoid the provisions of s.26AAA of the Act and
it was a direct and intended consequence of that
avoidance that Mrs Peabody and his children
would obtain a tax benefit. It is therefore
proper to say that Mr Peabody's purpose of
enabling his wife to obtain a tax benefit was
his dominant purpose in entering into the
scheme."
56. One final argument made before his Honour should be noted. It was submitted for Mrs Peabody that in computing the amount which should ultimately be included in Mrs Peabody's income if Part IVA applied, it would be necessary to take into account the fact that if the scheme had not been entered into or carried out, the financing would most likely have been by bank bill borrowings. There was evidence that such borrowings would have involved the incurring of an additional cost of at least $1,160,952. His Honour took the view that such a notional interest cost should not be taken into account in determining the tax benefit obtained in connection with the scheme. In so holding, his Honour said:
"As I have already pointed out, the method of
financing the purchase of the Kleinschmidt
shares by the use of redeemable preference
shares was a commercially acceptable
proposition. It was a transaction that was
capable of being implemented independently of
the transaction whereby the shares were
converted to Z class shares; expressed another
way, it did not owe its existence to the
conversion scheme.
The conclusion that I have reached is that the
conversion of the shares to Z class shares was
the essential element of the scheme that gave
rise to the tax benefit. That scheme was, of
course, based upon and owed its existence to the
purchase of the Kleinschmidt shares. But the
scheme did not dictate the manner in which the
purchase of the Kleinschmidt shares would be
financed. The purchase could have been financed
by a bank bill facility, by other conventional
borrowing or, as the Peabody interests chose to
do, by using a company and issuing redeemable
preference shares to their financier. That
choice of financing had nothing to do with the
decision to convert the shares to Z class
shares. It therefore had nothing to do with the
obtaining of a tax benefit."
57. Counsel for the appellant submitted that as the Commissioner's exercise of discretion under s.177F of the Act was made by reference to a "particular scheme", the Court was restricted to considering that scheme in an appeal arising following an assessment made to give effect to the s.177F determination. It was submitted that, even if the Commissioner might have made a valid determination in respect of some other scheme, that was irrelevant to the appeal in this Court for before us the assessment could not be supported by reliance on a determination other than that actually made which was before the Court for review. In support of this proposition, the decision of the Full Court of this Court in Federal Commissioner of Taxation v Jackson (1990) 27 FCR 1 was relied upon.
58. It was further submitted that his Honour had erred in finding that there was a tax benefit to Mrs Peabody and also in finding, by reference to the scheme as a whole, that the necessary purpose existed. Particularly, it was submitted that the conclusion as to purpose had to be arrived at by reference to the scheme as a whole, rather than by reference to a part of that scheme (ie the conversion of the Kleinschmidt shares). The decision of the House of Lords in IRC v Brebner (1967) 2 AC 18 was relied upon in support of that submission. Alternatively, it was submitted that even if it were possible to consider the issue of purpose by reference to something less than the scheme as a whole, on the facts a conclusion as to the dominant purpose of Mr Peabody was not well founded.
59. Counsel for the Commissioner submitted on the other hand, that because s.177D refers to a person entering into, or carrying out, inter alia, a part of a scheme, that section permitted a conclusion as to purpose to be drawn where it could be shown that a person who carried out a part of the scheme had the relevant purpose to obtain a tax benefit in connection with the scheme as a whole. By this was meant, it was said, that it would suffice as a prerequisite for the making of a determination if a part of the scheme could be seen as having the purpose of tax-avoidance, notwithstanding that the relevant person's purpose in respect of the overall scheme had been purely commercial. Subject to this point, the Commissioner submitted that the findings of his Honour were amply supported by the evidence.
60. It is abundantly clear that the determination, which the Commissioner is authorised to make under s.177F must depend upon the scheme which he has identified. It is that scheme which has to be considered by the Court when an objection decision is referred by a taxpayer to this Court. As was explained in Jackson (at 13), this Court cannot stand in the shoes of the Commissioner and exercise discretions which the legislature has committed to the Commissioner. This Court is confined to deciding whether the Commissioner's decision has been affected by some error of law, whether the Commissioner has addressed himself to the right issue or whether he has taken some extraneous factor into consideration or failed to take into account some relevant factor.
61. It may well be that if the Commissioner in the present case were now to form the view that some quite different scheme had been entered into or carried out, he could make a fresh determination and, subject to the limits contained in s.170 of the Act, make an amended assessment. But that is not a matter of concern in the present appeal.
62. Once it is realised that the scheme to be considered is that propounded by the Commissioner, in the present case commencing with the acquisition by Loftway of the Kleinschmidt shares and ending with the transfer of the 'Z' class shares to either TEP Holdings Pty Ltd or Pozzolanic Industries Ltd (and including the steps involving the finance transaction with Westpac), it is obvious that the appeal must be allowed. This is so because there cannot be found to be, in my opinion, a tax benefit to Mrs Peabody, nor can the requisite conclusion as to purpose be made under s.177D. I shall deal with each of these matters separately.
63. As I have indicated, it is necessary to determine what the expected outcome would be if the scheme adopted had not been entered into or carried out. This does not mean, as counsel for the appellant seemed to submit, that the Kleinschmidt shares could never be treated as having been acquired. Clearly, there is a reasonable expectation that they would have been. The real difficulty lies in the submission of the Commissioner that it would be reasonable to expect that the Kleinschmidt shares would, as a matter of fact, have been purchased by TEP Holdings Ltd.
64. It may be accepted, as counsel for the Commissioner submitted, that the initial contemplation was that the Kleinschmidt shares would be purchased by TEP Holdings Ltd. There followed thereafter, in subsequent meetings, consideration of various matters including company law, tax and stamp duty, which led to the possibility of a shelf company being used as the purchaser. However, the matter remained quite fluid until the question of financing the purchase arose. There was, as the solicitor's memorandum recording the conversations of 13 and 14 November 1985 showed, a difference in the financing costs of redeemable preference share financing as against loan at interest financing of between 6.3 per cent and 8.3 per cent. Converted into monetary terms, this difference was, we were told, in the order of $1,160,952. A redeemable preference share financing required there to be a corporation in which the financier would subscribe for shares. But it required more than that. It required that the borrowing corporation pay a dividend to the financier (Westpac) which could be received by Westpac as a rebatable dividend. As a matter of elementary company law, that dividend could only be declared and paid out of profits. The proposal was that those profits would come from the shares in the four Pozzolanic companies acquired from Mr Kleinschmidt. This meant that Loftway (or some similar company) had to be the purchaser to obtain the benefit of that form of financing. It should be said that it was not suggested that such a method of financing was other than commercial or that it infringed Part IVA. It provided a tax rebate rather than a tax benefit under s.177C.
65. It was submitted by the Commissioner that Loftway need not have been the purchaser if it had been interposed as an intermediary financier between itself and TEP Holdings Ltd. In this case, for Loftway to pay the dividend, it would have been necessary for it to have derived income by way of interest. That interest would have been assessable income to it and taxed at the then rate of 46 cents in the dollar. This would have completely negated the financing differential as well as reducing by 46 cents in the dollar the dividend payable on the shares held by Westpac.
66. The hypothesis that if the scheme had not been entered into or carried out, the purchaser would have been TEP Holdings Ltd is, in my view, one that can properly be described as unreasonable or irrational. The only expectation, on reasonable grounds, that can be formed is that a corporation would have been the purchaser and that TEP Holdings Ltd, a trustee, would not have been. Accordingly, if the scheme had not been entered into or carried out, it could not reasonably be expected that any amount would, in the year of income, have been included in the assessable income of Mrs Peabody or any of the other two beneficiaries in the Peabody Family Trust, arising to them under the provisions of s.97 of the Act.
67. This conclusion, namely, that there was no tax benefit in the circumstances of the present case, is sufficient to require the appeal to be allowed. However, it is also the case that it was not open to draw the conclusion as to dominant purpose.
68. The question which was required by s.177D to be answered on the facts of the present case was whether, having regard to the matters in s.177D(b), it would be concluded that Mr Peabody carried out the whole of the scheme, from acquiring the Kleinschmidt shares through the financing arrangements and concluding with transferring the shares either to the public company or to TEP Holdings Ltd, for the purpose of excluding from the assessable income of each of the three beneficiaries of the Peabody Family Trust the sum of $888,005. One has only to pose that question to see how absurd such a conclusion would be. Clearly enough, the whole scheme, as formulated, was entered into or carried out by Mr Peabody with a dominant commercial purpose, namely, the acquisition of shares from Mr Kleinschmidt and the flotation of a public company. The fact that an element of that scheme had a tax advantage does not detract from the dominant purpose of Mr Peabody in relation to the scheme as a whole. The matters to which regard may be had under s.177D clearly direct attention on the one hand to the commercial elements of the scheme and on the other hand to the tax elements. They require a balancing of the two. But the factors which predominate in the present scheme considered as a whole are purely commercial. Once the scheme is analysed as encompassing the acquisition of shares, the financing of those shares and the ultimate flotation of a public company, it is hard to see, in a case such as the present, how the relevant conclusion as to purpose could have been drawn. Part IVA would seldom, if ever, operate to permit the Commissioner to make a determination, carrying with it as it does an automatic penalty upon a taxpayer assessed, where the overall transaction is in every way commercial, although containing some element which has been selected to reduce the tax payable. Part IVA is no more applicable to such a case than was its predecessor, s.260.
69. I would, accordingly, propose the following orders:
1. The appeal be allowed. 2. The orders made by O'Loughlin J on 18 September 1992
be set aside and in lieu thereof it be ordered that
the objection decision in respect of the appellant's
assessment for the year of income ended 30 June 1986
be set aside and that the appellant's objection to the
amended assessment of income tax in respect of that
year be allowed.
3. The assessment be remitted to the respondent for
amendment in accordance with law.
4. The respondent Commissioner pay the appellant's
costs of the appeal and of the proceedings
before O'Loughlin J.
COOPER J. I have had the opportunity to read the draft reasons for judgment of my brother Hill. I agree with the orders proposed by him for the reasons he has given.
# Re Mary Genevieve Peabody
Commissioner of Taxation \[1993\] FCA 74;
(1993) 112 ALR 247
(1993) 40 FCR 531
(1986) 64 ALR 97
(1990) 27 FCR 1
(1958) 98 CLR 1
(1989) 85 ALR 368
(1978) 2 NSWLR 235
(1987) 16 FCR 517
(1987) 73 ALR 343
(1978) 138 CLR 251
(1978) 140 CLR 434