Once the loans are disregarded the situation is that Richard Walter has received the moneys from MPS Pty Ltd without any obligation. For reasons given earlier I consider that the moneys were assessable income in the hands of Richard Walter.
By that his Honour meant, I think, that once s 260 had annihilated the loans, what was left exposed was a circumstance where the taxpayer had received a series of substantial payments beneficially and without any obligation to repay them, so that the payments thus received were to be regarded as assessable income in the same way, and for the same reasons, as they would have been had the loans been correctly characterised as shams.
The difficulty with that, it seems to me, is that one cannot in this context consider the loans in isolation. His Honour accepted, and so much at least seems to be clear, that other elements of the restructure were avoided as against the Commissioner by s 260, whether or not the loans were avoided. On the appeal, the Commissioner did not suggest that the loans could be regarded in isolation. Instead, counsel for the Commissioner sought to support his Honour's conclusion on the footing that, the loans being avoided as against the Commissioner, what was exposed was the receipt by the taxpayer of regular payments; and those payments were to be given the character of assessable income of the taxpayer because, the taxpayer being a discretionary beneficiary of the Aborda Trust, and as the payments could not be explained as loans, the only proper inference was that MPS, as trustee, had acted lawfully and had properly distributed the payments to the taxpayer as a beneficiary of that trust. Counsel for the Commissioner sought to apply Traknew Holdings Pty Ltd v Commissioner of Taxation (Cth) (1991) 91 ATC 4,272, especially observations of Hill J at 4282, 4283. But that approach necessarily depends on a
conclusion as to the effect of s 260 on other aspects of the arrangements, to which I must now turn.
In essence, the Commissioner's argument was that the only aspects of the May 1981 arrangements which had a purpose or effect referred to in s 260 were those to which I have already referred. Those aspects only of the arrangements were, therefore, avoided as against the Commissioner who was entitled, and perhaps bound, to treat the arrangements as otherwise effective: see e.g., Hancock v Commissioner of Taxation (Cth) (1961) 108 CLR 258 at 278, 279; Commissioner of Taxation (Cth) v Gulland (1985) 160 CLR 55 at 73, 74; Traknew at 4282, 4283. The avoidance of the steps identified by the Commissioner left standing, so he contended, the receipt by MPS of money from Dr Wenkart not as agent of a partnership but as agent for Aborda Pty Ltd as trustee of the Aborda Trust; the taxpayer was a beneficiary of the Aborda Trust; the loans being avoided, the taxpayer was revealed as the recipient of payments out of income of a trust of which it was a beneficiary; the proper inference, accordingly, was that the payments represented distributions of income to which the taxpayer was presently entitled. But that in turn is correct only if it is a true statement of what, in this case, stands revealed after s 260 does its work and does not involve any impermissible reconstruction.
There is no doubt that we are bound by the proposition that s 260 only effects a "fictitious annihilation of contracts, agreements and arrangements" and does not "proceed to substitute an alternative basis on which tax should be calculated" or authorise a "hypothetical reconstruction" of transactions: those phrases are taken from the joint
judgment of Mason CJ, Wilson, Dawson, Toohey and Guadron JJ in John v Commissioner of Taxation (Cth) (1989) 166 CLR 417 at 432, 433; another well known formulation of the same proposition is to be found in the joint judgment of Dixon CJ, Williams, Webb, Fullagar and Kitto JJ in Bell v Federal Commissioner of Taxation (1953) 87 CLR 548 at 572, 573:
The section is, of course, an annihilating provision only. It has no further or other operation than to eliminate from consideration for tax purposes such contracts, agreements and arrangements as fall within the descriptions it contains. It assists the Commissioner, in a case like the present, only if, when all contracts, agreements and arrangements having such a purpose or effect as the section mentions are obliterated, the facts which remain justify the Commissioner's assessment.
It is trite that it is not always obvious where annihilation ends and reconstruction begins. Thus, in the course of his discussion of the authorities in Davis v Commissioner of Taxation (Cth) (1989) 86 ALR 195 at 228, 229, Hill J said:
In the application, however, of the section in Peate v FCT (1964) 111 CLR 443; (1966) 116 CLR 38; [1967] 1 AC 308 and perhaps in Gulland it may be argued that the Courts applied some elements of reconstruction while paying lip service to the principle that no such reconstruction was possible. Be that as it may, the taxpayer's liability to income tax must, as a matter of principle, clearly be found in what Brennan J in Gulland (CLR at 81) referred to as the hypothetical situation left after s 260 has done its work, "the situation that would have existed had the arrangement not produced the specified effect".
See also Bunting v Commissioner of Taxation (Cth) (1989) 24 FCR 283 at 295 (Gummow J) and at 300, 301, 306 - 310 (Hill J). Hill J points out in Bunting that the cases which are most difficult to reconcile with a strict principle against reconstruction
are Peate and Gulland; that each commenced with a status quo ante in which medical practitioners derived income from personal exertions, the effect of the arrangements with which the cases were concerned being to divert that income elsewhere; and that the High Court in John reconciles the cases with the principle, immediately following the passage I have already quoted, as follows:
There [sc in Peate and Gulland] the annihilation of the arrangements in question revealed the source of income as the personal exertions of the taxpayer respondents in the same form as had existed prior to the arrangements which were held to offend s 260.
If that is the explanation of Peate and Gulland, Commissioner of Taxation (Cth) v Kareena Private Hospital Pty Ltd (1979) 41 FLR 307, though decided at a time when perhaps the course of decision in the High Court encouraged a more restrictive approach to s 260 than more recent cases display, must operate as a substantial obstacle in the path of the Commissioner's argument in this case which, like Kareena, concerns income which is not, so far as the taxpayer is concerned, income from personal exertion.
Here, it seems to me that the principal difficulties for the Commissioner are to be found in steps (1) and (2) of those which he has identified as making up the arrangement avoided by s 260. Senior counsel for the taxpayer argued that it was incorrect to describe as a step in the arrangement the "inclusion" of Iroos Pty Ltd in the Morlea Partnership: what actually happened was that a partnership was formed, on certain conditions, between Iroos Pty Ltd and Aborda Pty Ltd. Equally, Counsel suggested, it was incorrect to say that Iroos Pty Ltd was appointed as an eligible beneficiary of the Morlea Trust: the actual
appointment was of "a partnership known as the Morlea Partnership between Iroos Pty Ltd (as to 95%) and Aborda Pty Ltd (as to 5%), that is to say Iroos Pty Ltd and Aborda Pty Ltd in their capacity as partners in the Morlea Partnership". Given the facts found by his Honour, the suggestion is correct. A partnership was formed and the partners acquired rights - rights as beneficiaries of a trust - as partnership property. If one treats as annihilated the formation of the partnership and the appointment which actually was made, it is impossible to see revealed a situation where Aborda Pty Ltd was appointed alone as a beneficiary of the Morlea Trust. Likewise with steps (3), (4) and (5): even if one regarded those steps as correctly described in the submission for the Commissioner (again, it was submitted, and I think correctly, that they were not because as a matter of fact the distributions were received as partnership property) to strip them away does not reveal Aborda as the recipient of the whole of each distribution. To assert that Aborda is to be treated as having received the whole is, I think, to substitute fiction for fact just as much as the Commissioner's argument in Kareena was held to do (Brennan J at 316).
That being so, it seems to me that the basis suggested by the Commissioner for treating the taxpayer as entitled to what, but for s 260, would be the entire net income of the Morlea Partnership (or asserting that the taxpayer must be taken to have received the money, in fact lent to it, as distributions of income of the Aborda Trust to which it was presently entitled) must necessarily fail. I can see no other way in which the assessments can be supported by an application of s 260, and none was suggested. It follows that the assessments cannot be supported on the basis of the operation of that section.