Snook v London and West Riding Investments Ltd [1996] FCA 454 | Case summary

Federal Court of Australia|1996-06-14|Before: Lehane JJ, Hill J, Tamberlin J, Lockhart J

REASONS FOR JUDGMENT LOCKHART J. This appeal concerns the years of income ended 30 June 1981 to 30 June 1984, and the question is whether certain amounts were properly assessed as assessable income by the Commissioner of Taxation during those years. The case below and on appeal was conducted by the parties on the basis that there were two issues: first, whether loan transactions entered into in 1981 were a 'sham' (to use what Diplock L.J. described as a 'popular and pejorative word' in Snook v London and West Riding Investments Limited [1967] 2 QB 786 at 802); and secondly, whether the transactions are void against the Commissioner pursuant to s. 260 of the Income Tax Assessment Act 1936 ('the Act').

The relevant facts are stated in the reasons for judgment of Hill J. and need not be repeated. The learned primary Judge (Tamberlin J.) found that loans claimed to have been made to Richard Walter Pty Limited, the taxpayer (the appellant), by Morlea Professional Services Pty Limited ('Morlea'), were shams in the sense that it was never intended by the appellant and Morlea that the appellant would repay the monies which it received from Morlea. His Honour listed a number of matters (nine in all) which he said, when considered cumulatively, led to the conclusion that: 'the purported "loans" were simply a false label given in order to mask the real transaction intended by the parties, which was the transfer of the beneficial ownership of the monies to Richard Walter free of any obligation to repay. The nomination of the payments as a loan was calculated to make the true transaction appear as something it was never in truth intended to be.'

There are many cases in the income tax field, particularly cases relating to s. 260, where the word 'sham' has been considered. I discussed some of them in Sharrment Pty Limited v Official Trustee in Bankruptcy (1988) 18 FCR 449, where I said at 454: 'A "sham" is therefore, for the purposes of Australian law, something that is intended to be mistaken for something else or that is not really what it purports to be. It is a spurious imitation, a counterfeit, a disguise or a false front. It is not genuine or true, but something made in imitation of something else or made to appear to be something which it is not. It is something which is false or deceptive.'

This description, which I retain, is similar to the one given by Diplock L.J. in Snook at 802, and I note that it includes a sham which is a disguise or smokescreen for no transaction at all, or a totally false front - surface without substance. 'Sham' is a word which must be used with care in this field of discourse because, as I said in Sharrment at 453: 'It is indeed a pity that it cannot be relegated to its earlier obscurity because of the ambiguity and uncertainty that surrounds its meaning and application.'

Use of the word 'sham' in some cases, and this is indeed one of them, obscures the fundamental issue between the parties. Essentially, it is for the taxpayer to prove that an assessment is excessive: McAndrew v Federal Commissioner of Taxation (1956) 98 CLR 263; Federal Commissioner of Taxation v Dalco (1990) 168 CLR 614; and Federal Commissioner of Taxation v Australia and New Zealand Savings Bank Limited (1994) 94 ATC 4,844. The onus of proving that the assessment is excessive lies upon the taxpayer; although the evidentiary onus in a particular case may shift from time to time. In this case, the appellant has the burden of establishing that the alleged loans to it by Morlea are not income. It is common ground that if this burden is discharged and it is established that the payments here are in fact loans, then the appellant will succeed, provided it survives the possible application of s. 260. I mention this because it is a misconception in my view to assert that the Commissioner has the burden of establishing that a transaction is a sham. The Commissioner may, as he did in this case, submit that the relevant transactions were a sham and of no force or effect. In some cases the evidentiary onus may shift to the Commissioner to establish what the real transaction is for which the sham transaction is a cloak (assuming there is a real transaction); but at most this is an evidentiary onus which may shift back and forth depending upon the facts of the case and inferences which it is proper for the Court to draw. It remains that the burden of proving that an assessment is excessive lies upon the taxpayer. Other members of the Court have discussed in detail the submissions of counsel concerning the factors identified by his Honour which, when taken cumulatively, led him to conclude that the parties never intended there to be an obligation to repay the alleged loans. In my view there are two findings of his Honour which are crucial to that conclusion. The first finding concerns the credibility of Mr Holden. He was closely involved in matters of policy concerning the finances of the appellant and other companies in the group of companies of which the appellant was a member, and he was the only witness called by the appellant. His evidence was crucial to the appellant's case that there were genuine loans involving obligations to repay money, and his Honour did not accept Mr Holden as a reliable witness. On appeal, counsel for the appellant did not ask this Court to reverse the adverse finding of the primary Judge with respect to Mr Holden's credit; nor would any such finding be permissible. The second matter which the primary Judge regarded as significant in reaching his finding of a 'sham' was that no other key people involved in the impugned transactions were called to give evidence. His Honour mentioned specifically Dr Wenkart - at all relevant times a medical practitioner who had been the guiding force of a pathology business established in 1970 in conjunction with Dr Edelsten, and whom his Honour found to be the governing mind of all relevant bodies. His Honour also mentioned the legal and accounting experts who were involved in establishing and implementing the arrangements. In my opinion the rejection by his Honour of Mr Holden, in the absence of any other relevant person in the witness box, assisted his Honour's finding that there was never an intention that the monies paid by Morlea to the appellant were to be repaid. The failure to call Dr Wenkart allowed this inference to be drawn more readily, by reliance upon Jones v Dunkel (1959) 101 CLR 298 at 308. His Honour did not specifically refer to Jones v Dunkel on this point, but it seems to me to underlie his finding: '... that any evidence to be given by other witnesses [other than Mr Holden] which might have been expected to be called by the applicant would not assist the applicant's case.'

Jones v Dunkel is relied on not infrequently in circumstances where it is not available; but in my view this is a case where it is properly applied. As I have said, the appellant bore the burden of proving that the assessments were excessive. It had to establish at the end of the day that the relevant payments made to it by Morlea were not income. The case was that the payments constituted loans. Although accounting records including ledgers, trial balances and audited accounts provided some written evidence in support of the appellant's case that the transactions were loans, this must be set against his Honour's rejection of Mr Holden as a credible witness and the consequent rejection of his sworn evidence that the payments in question were made as loans. His Honour's conclusion that the payments by Morlea to the appellant were not loans is, in my opinion, supported both by his rejection of Mr Holden, the only witness called to support the appellant's case that the payments were loans, and by the appellant's failure to call other persons who could have contributed to the discussion on the true nature of the transactions. His Honour was not satisfied that the payments were loans, and the appellant did not establish a case that the payments could be characterized other than as revenue. Having rejected Mr Holden's evidence that the payments were loans, in my view, there was insufficient remaining evidence in the case from which the primary Judge could have concluded that it was more likely than not that the relevant payments were not income. I agree with what Hill J. said on this question. The appellant did not discharge the burden of proving that the assessments were excessive, and therefore it must fail in the appeal. In these circumstances, it is unnecessary to consider the application of s. 260. I would dismiss the appeal with costs.

I certify that this and the preceding six (6) pages are a true copy of the reasons for judgment herein of the Honourable Justice Lockhart. Associate Dated: 14 June 1996

IN THE FEDERAL COURT OF AUSTRALIA ) ) NEW SOUTH WALES DISTRICT REGISTRY ) No NG 681 of 1995 ) GENERAL DIVISION ) ON APPEAL FROM A SINGLE JUDGE OF THE FEDERAL COURT OF AUSTRALIA

BETWEEN: RICHARD WALTER PTY LIMITED Appellant AND: THE COMMISSIONER OF TAXATION Respondent CORAM: LOCKHART, HILL & LEHANE JJ PLACE: SYDNEY DATED: 14 JUNE 1996 REASONS FOR JUDGMENT HILL J: The appellant, Richard Walter Pty Limited ("Richard Walter") appeals from the judgment of a judge of this Court substantially upholding objection decisions made by the Commissioner of Taxation. At issue between the parties was whether certain amounts were to be included in the assessable income of Richard Walter for the years ending 30 June 1981 to 30 June 1984 inclusive. The amounts which the Commissioner assessed as assessable income and which Richard Walter disputes are as follows:

YEAR OF INCOME ASSESSABLE INCOME 1981 2,143,148 1982 1,869,195 1983 1,645,165 1984 3,737,581

A further appeal relating to the year of income ended 30 June 1989, in which there was in dispute the allowance of a deduction for a bad debt, was decided in favour of Richard Walter and no appeal has been brought from that decision. Three alternative grounds were advanced on behalf of Commissioner in support of the assessments which he had made. First, it was submitted that certain transactions which had been entered into on or around 25 May 1981 were a sham and of no force or effect. Second, it was submitted that the transactions entered into at that time should be treated as void as against the Commissioner in consequence of the application of s260 of the Income Tax Assessment Act 1936 (Cth) ("the Act"). Finally, the Commissioner had made a determination under Part IVA of the Act and in the result claimed, pursuant to s177F, to be entitled to include in assessable income the amounts. It is now common ground between the parties that the relevant arrangements entered into by Richard Walter upon which the Commissioner relied to support the assessment under Part IVA were entered into prior to 28 May 1981 (in fact on 25 May 1981) with the consequence that Part IVA could not apply to them. Thus, the issues upon which the parties went to trial were restricted to the issue of sham and to the application of s260 of the Act. THE STRUCTURE BEFORE 25 MAY 1981 It is helpful to represent diagrammatically the structure as it existed prior to the arrangements in May 1981 so as to contrast that structure with the result of the rearrangement. It may be represented as follows:

Doctor Wenkart, who appears in that diagram, was, so his Honour found, the governing mind of all relevant identities. He was at all relevant times a medical practitioner who had been the principal in a pathology business established initially in 1970 in conjunction with a Dr Edelsten and operating then through a company, Preventicare Pty Limited. Patients requiring pathology tests were referred to Doctor Wenkart. He, however, had contracted with Morlea Professional Services Pty Ltd ("Morlea"), which employed staff, owned equipment and performed services to carry out the tests. Morlea acted as trustee of a unit trust known as the Morlea Professional Services Unit Trust. All the units in that unit trust were held by Ultera Pty Ltd, which company was trustee of a discretionary trust known as the Morlea Trust. Potential beneficiaries of that trust included members of Doctor Wenkart's family and various other entities including Richard Walter. Payment for pathology services was, in due course, received either from patients or from Medicare and paid to Doctor Wenkart. Ninety-five percent of the fees were then paid to Morlea in return for the services that company provided. Doctor Wenkart retained the balance of five percent. It was not suggested that the amount Doctor Wenkart paid to Morlea was excessive, having regard to the services which Morlea performed. Large amounts of money in this way came to be received by Morlea. Every two or three days Morlea drew cheques for amounts surplus to its requirements in favour of Richard Walter. That company was the group financier. I shall say more concerning what is known of its business activities in more detail later. Suffice it to say here that Richard Walter made loans to companies in the group and outside entities from time to time. Doctor Wenkart appears to have had an aversion to the payment of income tax on what may loosely be referred to as the pathology profits. The steps that were taken to reduce tax in the 1980 year of income were the subject of a decision of this Court in Traknew Holdings Pty Ltd v Federal Commissioner of Taxation (1991) 91 ATC 4272. Put shortly, income of the Morlea discretionary trust was distributed to a company associated with the promoter of trust stripping arrangements in circumstances where there arose to the taxpayer in that case a profit on the sale of shares approximately equal to the income distributed less a commission. A claim was made that the profit was a capital profit to the taxpayer. The taxpayer was unsuccessful in the Administrative Appeals Tribunal and in this Court. THE RESTRUCTURING ON 25 MAY, 1981 On 25 May 1981 a restructuring was undertaken. The end result can be diagrammatically represented as follows:

The restructure was carried out under the guidance of tax accountants and lawyers whose aim was to ensure that the pathology profits would substantially pass through to an entity (Aurelius Commodus Investment BV, "Aurelius Commodus") incorporated in The Netherlands which it was hoped would be entitled to claim an exemption from Australian income tax on moneys distributed to it on the basis that it did not carry on any business in Australia at or through a permanent establishment in this country by reason of Article 7 of the double tax treaty between Australia an The Netherlands. When, in 1985, legislative amendments to the Act were made effectively closing off the effectiveness of this arrangement, other arrangements were put in place. The present appeal has, however, nothing to do with these further arrangements. They were the subject of an appeal to this Court which was subsequently withdrawn. The steps necessary to put in place the 1981 restructure were themselves very complicated. It may be inferred that one reason at least for the complication arose from a need to ensure that Aurelius Commodus was not seen to have been at any time centrally managed and controlled in Australia. Be that as it may, the following steps were taken:

"1. On 18 May 1981 a company known as Ligustrum established the Aurelius Unit Trust off shore, with Ligustrum as both trustee and holder of all the initial units. Ligustrum was a non-resident UK company resident in Hong Kong. The appointer of the trust was represented to be Ultera, a resident company controlled by Wenkart. Ligustrum held all the units in the trust. 2. Subsequently, 99 units in the Aurelius Unit Trust were acquired by Aurelius Commodus and 1 unit was acquired by Ventura Securities Inc (`Ventura'). Ventura was a Californian incorporated limited partnership of which the sole partner was Zeeno of Jersey, and was also controlled by Wenkart. 3. On 19 May 1981 Ultera purported to remove Ligustrum as trustee of the Aurelius Unit Trust and to appoint Sixterra BV as trustee. Sixterra BV was a Netherlands company. 4. On 25 May 1981 at 5.50 pm Ultera removed Sixterra BV as trustee and appointed Iroos, (an Australian resident company), as trustee of the Aurelius Unit Trust. 5. On 25 May 1991 at 5.58 pm Aborda was appointed as trustee of the Aborda Trust which was in turn settled by Holden, the financial controller of the Wenkart companies. 6. On 25 May 1981 at 6.02 pm Iroos and Aborda entered into a partnership agreement for the establishment of the Morlea Partnership in which Iroos held 95% of the capital and Aborda the remaining 5%. 7. On 25 May 1981 Iroos declared that it held its interest in the partnership known as the Morlea Partnership, on trust for the Aurelius Unit Trust. 8. On 25 May 1981 at 6.30 pm Ultera as trustee of the Morlea Trust declared that Aborda and Iroos were the eligible beneficiaries of that trust. Capital was also appointed to Aborda and Iroos. 9. On 25 May 1981 at 6.30 pm Wenkart appointed the Morlea Partnership as an eligible beneficiary of the Morlea Unit Trust. 10. On 25 May 1981 at 6.50 pm MPS Pty Ltd, as trustee of the Morlea Unit Trust, declared an interim distribution to the Morlea Partnership. 11. Morlea Unit Trust was thereafter represented to be determined and all its capital and income after the interim distribution, to have been distributed by book entry to the partners of the Morlea Partnership. 12. On 25 May 1981 at 6.55 pm, Aborda appointed MPS Pty Ltd as its agent with respect to all matters relating to the Morlea Partnership. 13. On 25 May 1981 at 6.58 pm Ultera removed Iroos as the trustee of the Aurelius Unit Trust and appointed MPS Pty Ltd as trustee. 14. On 25 May 1981 at 7.00 pm MPS Pty Ltd accepted appointment to act as agent for Aborda. 15. The partnership agreement between Iroos and Aborda provided that Iroos held 95% of the capital and Aborda 5% of the capital. Thus it appeared that the pathology service business previously conducted by MPS Pty Ltd as trustee of the Morlea Unit Trust was vested in the Morlea Partnership and thereafter conducted by MPS Pty Ltd purportedly in the capacity of agent for the Morlea Partnership." It will come as no surprise that his Honour found that all of the steps listed were prearranged. Documentation to implement them was pre-prepared by tax advisers and the arrangement was implemented in one session of continuous meetings. Nor could there be much dispute as to the subjective purpose motivating the rearrangement. But the fact that Doctor Wenkart, Mr Holden or the various accountants and lawyers involved may have devised and sought to implement a tax avoidance arrangement is scarcely relevant to the issues between the parties. Ultimately the question is whether having regard to the evidence some amount (and if so how much) was to be included in the assessable income of Richard Walter. It will be seen from the diagram, reproduced earlier, that after the restructure, Doctor Wenkart continued to be the source of referral for pathology services. Fees from patients and/or Medicare rebates continued to be directed to him and 95% of those fees continued to be paid to Morlea as in the previous arrangement. Likewise, Morlea continued to make what were said to be loans to Richard Walter. However, Morlea no longer received the service fees as trustee of the Morlea Professional Services Unit Trust. It was said rather that Morlea under the restructured arrangement received the fees acting as agent for a partnership known as the Morlea Partnership, the partners of which were Aborda Pty Ltd and Morlea itself, this time acting as trustee of the Aurelius Unit Trust. Aborda Pty Ltd was acting as trustee of the Aborda Trust and under the partnership had a five percent interest. The Aborda Trust was a discretionary trust, the beneficiaries of which included Richard Walter among others. The Aurelius Unit Trust, which under the partnership agreement was entitled to ninety-five percent of the partnership profits, was a unit trust. One percent of the units of that unit trust was owned by Ventura Securities Inc, and ninety-nine percent of the units was owned by Aurelius Commodus. Ventura Securities Inc was, as already indicated, a Californian limited partnership. Some of the steps taken may not, as a matter of legal analysis have created precisely the relationships which the diagram contemplates. However, as the parties proceeded upon the basis that the steps taken on 25 May 1981 were effective to bring about the restructure I do not find it necessary to consider this issue. Tax returns of relevant entries were prepared on the basis that the ninety-five percent partnership share was derived by Morlea as trustee of the Aurelius Unit Trust and through that trust ninety-nine percent flowed to Aurelius Commodus. Of course that company never saw the physical money. It remained, in the years of income in question, under the control of Richard Walter. Subsequent steps taken by way of restructuring in 1985 and later years led, it was claimed by the Commissioner, to the extinguishment of the amounts claimed by the taxpayer to be loans to Richard Walter. That there was such an extinguishment was not accepted by Richard Walter. No findings were made by his Honour about this. THE CASE AS RUN BELOW By the time the matter came to trial the Commissioner had resiled from his contention that all of the steps taken in May 1981 constituted a sham. In so doing the Commissioner presumably accepted the difficulty he might have in showing that steps implemented under the guidance of senior legal and accounting professionals were not intended to have the effect which on their face they appeared to have. Rather, the Commissioner concentrated upon the payments made by Morlea to Richard Walter. It was the Commissioner's case that the payments, which were recorded as loans in the books of account of both the partnership of which Morlea was said to have been agent and Richard Walter as loans, were not what they purported to be. He submitted that the Court should hold that the loan arrangements were shams. Only one witness was called to give evidence on behalf of the taxpayer. That was Mr Holden. Mr Holden had been employed since 1977 as financial controller and at the time of giving evidence was Finance Director of various companies in the group of companies of which Richard Walter formed a part. At relevant times Mr Holden had been a director of both Morlea and Richard Walter. In his affidavit Mr Holden said that the main function of Richard Walter was to act as the financier of the group. He said: "5. ... For this purpose the cash position of each company in the Group was reviewed daily as were the cash needs of each company in the Group and if any company had a significant credit balance with the Bank, that money was taken over into the account of the Applicant by way of loan and if any company needed additional funds, that money was lent by the Applicant to the company. 6. If the Group as a whole had surplus cash funds, that surplus was invested by the Applicant, either in fixed term deposits with banks or with other financial institutions, to achieve the best available return in the light of the security and terms available. From time to time, if the Group as a whole needed additional funds, then it was the Applicant which made overdraft arrangements or long-term financial arrangements with banks or other financial institutions to secure the necessary working capital for the Group. 7. In some cases, if long term finance was required for a project, then the company concerned would borrow directly from the Bank on security of a first mortgage over its assets and the balance of working capital would be borrowed by the Applicant by overdraft or bill facility from the Bank, and lent to the company requiring funds. ..." Mr Holden then tendered audited financial accounts of Richard Walter for various years including the years of income in question, saying of them that they gave "a true and fair view of the state of affairs of the Applicant at the end of the periods set out in those accounts, and of the results of the Applicant's operation for those years". In other paragraphs of his Affidavit evidence, Mr Holden spoke of borrowings by Richard Walter and loans made by that company. He gave details of what he said to be the total amount of borrowings of Richard Walter in relevant years. Speaking directly of Morlea and the payments it made to Richard Walter, Mr Holden said: "Each working day amounts were transferred from the Macquarie Pathology Services Account to the account of Morlea, as agent for the Morlea Partnership. Business outgoings and expenses were paid from the Morlea account, and surplus amounts remaining in the account were lent to the Applicant, as the Group finance company, on a regular and recurrent basis every two or three days." He indicated that the accounts for the Morlea Partnership had shown as a current asset loans to Richard Walter and that the accounts for Richard Walter had shown as a current liability amounts due to the partnership.

A subsequent affidavit showed trial balances of Richard Walter in which there is shown a credit balance for the Morlea loan account in 1980 and 1981. Mr Holden was then cross-examined. He gave evidence that as one company borrowed money from the bank, cheques would be drawn transferring funds within the group. A great deal of the cross-examination was concerned with matters which went to his credit. One line of questioning was concerned with what Aurelius Commodus was to do with the money which, it was said, it had obtained by way of distribution under the trust arrangements. He was cross-examined as to his knowledge of what happened in the Netherlands and in the Netherlands Antilles. He was cross-examined too as to the effect of the loans on the balance sheet of Richard Walter. Specifically, Mr Holden was asked whether it was his intention that the loans to Richard Walter would ever be repaid. To this question Mr Holden replied that: "If Morlea would have needed the funds to survive, yes, it would have been repaid." Other areas of cross-examination included the subsequent dismantling of the May 1981 arrangements and the treatment of the purported loans in the accounts of Richard Walter as non-current assets, an expression used by accounting convention to convey that loans are not repayable within a year. I shall return to this matter later. THE JUDGMENT BELOW IN RELATION TO SHAM The learned trial judge accepted the Commissioner's submissions that the so-called loan arrangements between Morlea and Richard Walter were shams. After referring to a number of leading cases on the doctrine of sham, including Sharrment Pty Ltd v Official Trustee in Bankruptcy (1988) 18 FCR 449 at 454-455; Snook v London and West Riding Investments Ltd [1967] 2 QB 786 at 802; Allsene Pty Ltd v Federal Commissioner of Taxation (1989) 89 ATC 5333 and Esanda Ltd v Burgess [1984] 2 NSWLR 139 at 144, 146 and 153, his Honour pointed out that the essential feature of a loan was that the parties to it intend that the moneys advanced be repaid. This is but another way of saying that a transaction will not be a loan unless there is an enforceable promise that the one party (the borrower) will repay the money advanced, either at a fixed time or as demanded. It was his Honour's view that there was no real intention that Richard Walter would repay the monies which had been paid to it by Morlea. From which it can be taken that his Honour found that no real obligation to repay the monies had ever been created. In so finding his Honour relied upon a number of factors which he set out. In listing these factors his Honour was careful to point out that some of them individually might not justify a finding that the loans were a sham. Indeed this reservation is clearly correct when regard is had to the factors listed by his Honour. His Honour's conclusion, as expressed in the judgment, was in the following terms: "My conclusion is that the purported loans' were simply a false label given in order to mask the real transaction intended by the parties, which was the transfer of the beneficial ownership of the moneys to Richard Walter free of any obligation to repay. The nomination of the payments as a loan was calculated to make the true transaction appear as something it was never in truth intended to be. Accordingly, I find that the loans were shams and that the reality of the situation was that Richard Walter received the beneficial ownership of the moneys without any obligation to repay." The factors which his Honour took into account as listed in his Honour's judgment were as follows: "1. The moneys were paid without any written evidence of any agreement or obligation to repay apart from book entries made by accounts staff. 2. There was never any written or oral evidence as to the terms and conditions on which the moneys were said to be lent or repaid other than the year end financial statements which were the product of year end journal entries formulated by Holden, the Group Finance Director, to achieve the most desirable tax consequences. 3. It does not appear that any interest was ever charged, payable, or paid by Richard Walter in respect of these loans. There was no group policy that interest should not be charged on intra-group loans according to the evidence of Holden. 4. It is true that, as the applicant points out, there were book entries to indicate some substantial amounts paid by the applicant to MPS Pty Ltd. However, the net movements from MPS Pty Ltd to the applicant were far greater than the converse. For example, to 30 June 1982, the flow of cash from MPS Pty Ltd to the applicant was $1,538,013 and the movement back according to the entries was $500,954. For year ended 30 June 1983, the movement from MPS Pty Ltd to the applicant was $2,301,649 compared with the converse of $866,421.07. In the year ended 30 June 1984, the cash moving from MPS Pty Ltd was $1,926,591 as compared with the converse of $232,459.47. These movements back do not show, in my opinion, that there was an intention to repay all the moneys channelled to Richard Walter. 5. It was within Holden's unfettered power and discretion to move money around the group as he determined to be appropriate. MPS Pty Ltd was completely controlled by Wenkart and Holden. Holden agreed that the real money, the cash money, stayed with Richard Walter and did not go to Aurelius Commodus. He could give no explanation as to the way in which Aurelius Commodus was going to use the 95% of income of MPS Pty Ltd, except that it was going to exploit it by increasing its capital account. He could give no explanation as to what it would do with the amassed capital from time to time. He agreed that part of the arrangement or agreement was that the money be lent to Richard Walter and this was acceptable to Holden because the cash money stayed with Richard Walter. 6. It was impossible for Richard Walter to repay the amounts distributed by MPS Pty Ltd without liquidating the assets of Richard Walter and the evidence was that there was never any intention or even contemplation of doing this. 7. In 1982 the nature of the liability of Richard Walter to MPS Pty Ltd was unilaterally reclassified by Holden from current liability to non-current liability without any board resolution by Richard Walter or MPS Pty Ltd. This was clearly to the detriment of Aurelius Commodus. It appears that no consideration was given by Holden to the trust obligations in this respect. In cross-examination in relation to this matter, Holden was prepared to say as an experienced accountant that he did not know whether a dollar today is worth the same or more in a year's time. That reflects adversely on the credibility of Holden. In my view this unilateral reclassification was done without any thought for, and contrary to the interests of, the beneficiaries allegedly owning the debt due from Richard Walter. 8. The evidence makes it clear that when MPS Pty Ltd needed funds of any size, it borrowed from external financiers instead of calling for repayment of the loan due by Richard Walter which was interest free. There was no evidence of any attempt or proposal to call for repayment of the loan to Richard Walter. 9. The debt alleged to be due from Richard Walter to MPS Pty Ltd was never repaid, but it appears to have been assigned by a series of round robin' artificial paper transactions orchestrated by Richard Walter's legal and accounting tax advisers, none of whom were called in evidence by the applicant. No explanation was proffered for not calling them." THE SUBMISSIONS ON APPEAL Senior counsel for Richard Walter criticised each of the factors to which his Honour had referred in support of an ultimate submission that none of them together or separately provided support for a finding that there was no intention that the loan be repaid. Adopting the numbering which his Honour had used to identify the factors, the criticisms on behalf of Richard Walter may be shortly stated as follows:

It was not unusual for there to be no formal agreement for the repayment of loans between related parties.
There was written evidence of the loans to be found, for example, in the various accounting records including ledgers, trial balances and audited accounts, so that his Honour's second factor misrepresents the evidence.
The fact that no interest is charged between related corporations does not demonstrate that there was no loan.
The fact that moneys passed backwards and forwards between Morlea and Richard Walter indicated, so it was submitted, an intention to repay at least so much of the loans made as was in fact repaid.
...
The suggestion that it would be necessary to liquidate the assets of Richard Walter to repay amounts was fallacious, so it was submitted, because it took into account only the book value of the assets of Richard Walter rather than their market value at any time.
The unilateral reclassification did not take place in the books of the lender but only in the books of the borrower. The fact that there was no reclassification in the books of the lender supported the view that the transaction was in truth a loan. The criticisms made carry more weight when applied singularly to each factor cited by his Honour than they may do when the cumulative force of the matters is considered, particularly the cavalier way in which it would seem Mr Holden was party to reclassifying the so-called loans as being non-current. To a great extent, however, these matters were but peripheral to the conclusion reached by his Honour. At the heart of his Honour's finding, lay two matters of much greater significance. The first is that his Honour made adverse findings as to Mr Holden's credibility. Of him his Honour said: "However, I do not accept Holden as a reliable witness in relation to this matter and would accept his evidence only where it is corroborated by credible testimony or evidence or where objective circumstances make his version more likely. His evidence that he did not think the change of classification from current liability to non-current liability had an effect on the value of the alleged Richard Walter loan cannot be accepted. He took an extreme and absurd position on this. I also do not accept him when he said he had no knowledge of the structure of the Aurelius Unit Trust and of the chain of non-resident entities which had been set up in relation to it. Nor do I accept that he had no knowledge of the liquidation of Aurelius Commodus. He also said that he had no knowledge of the assignment of a loan from Linwood Finance. He misrepresented the position in the tax returns when he allowed statements to be made which represented that Aurelius Commodus was in no way controlled from Australia when that was clearly established on the evidence. There was a misrepresentation in my view made to the Commissioner in claiming the benefit of a deduction for foreign exchange losses incurred under an agreement of 1 April 1986 when the agreement on the evidence did not come into existence until February 1987." It must be accepted that where a trial judge makes a finding which, expressly or by necessary implication depended upon the credit of a witness, the appeal court will not interfere with that finding, for it is the trial judge who has had the advantage of seeing the witnesses: Abalos v Australian Postal Commission (1990) 171 CLR 167. The finding that there was no intention on the part of Morlea and Richard Walter that the loans be repaid necessarily involved not accepting the evidence of Mr Holden. Accordingly, in my view this Court on appeal would not come to a different conclusion. The second significant matter in his Honour's finding was the failure on the part of any other participant in the case to give evidence. The witnesses his Honour mentions are Doctor Wenkart and the legal and accounting advisers concerned with the arrangement. It may be said that the failure to call the legal and accounting advisers would hardly have much relevance to the question whether Morlea, when it made payments to Richard Walter, intended that the moneys so paid would be repaid or whether, for its part, Richard Walter intended to repay them. The tax lawyers and accountants were not parties to these transactions, and it is not suggested that they advised upon them. The same cannot, however, be said of Doctor Wenkart. He was the guiding mind of the relevant companies and, at the least, it can be said his failure to come forward and give evidence leads to the conclusion that his evidence would not assist the case of Richard Walter. To the extent that his Honour's conclusion that the payments by way of loan were not in truth intended to be repaid was based on matters of inference, the failure to call Doctor Wenkart would allow that inference more readily to be drawn: Jones v Dunkel (1959) 101 CLR 298 at 308. WAS THERE A LOAN? Much of the criticism addressed at the judgment in this case concerned what was said to be the necessity that before a transaction could be found to be a sham there had to be demonstrated (sub silentio by the Commissioner) a genuine transaction which might be said to have been obscured by the facade which the sham transaction erected. The correctness of this submission depends, in the end, on an analysis of the ultimate issue for decision in the case and the question of burden of proof. I shall return shortly to those matters. The judgment of Lockhart J in Sharrment traces the history of the use of the word "sham" and the judicial meaning of the word as enunciated in various cases. At 454 his Honour seeks to define the word "sham" as follows: "A sham' which are intended by them to give to third parties or to the Court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create. But one thing, I think, is clear in legal principle, morality and the authorities ... that for acts or documents to be a economic' association. It was the financier of the Wenkart group of companies and these activities generated significant amounts of interest relevant to the total income derived by Richard Walter during the years of income. ... Since 1977 Richard Walter has held and renewed a money lender's licence and subsequently a credit provider's licence." In connection with whether in 1989 (outside the years of income) Richard Walter was entitled to a deduction for a bad debt and related collection expenses, his Honour found that Richard Walter was carrying on a business of money lending. It does not follow from this finding that that business was necessarily being carried on in the years of income in question in the present appeals. However, it can be said that in the year ended 30 June 1985 Richard Walter's accounts recorded forty-seven unsecured loans totalling approximately $10.5 million, two secured loans for approximately $0.3 million and as non-current assets two unsecured loans totalling approximately $2.3 million. It derived interest from subsidiaries an amount of $60,500 and from other related companies of $842,322 and from other persons of $10,806, representing a return of approximately seven percent on loan funds. It would be open for a court to conclude in these circumstances that in the years in question Richard Walter was a finance company in the sense that it was carrying on a business of borrowing and lending money in circumstances where its money was, in effect, its trading stock. In such cases it is clear that profits of such a finance company, at least where made in the ordinary course of or incidental to its business, will be income and likewise its losses will be deductible: Federal Commissioner of Taxation v Unilever Australia Securities Ltd (1995) 95 ATC 4117 and cases there cited. Even where the profit is extraordinary the profit may form part of assessable income, as the decision of the High Court in Federal Commissioner of Taxation v The Myer Emporium Ltd (1987) 163 CLR 199 at 209 demonstrates. If Richard Walter wished to assert that the amounts in question should not be treated as profits of Richard Walter being a finance company, then the onus lay upon it to show that the payments were not properly to be seen as profits made in the course of its business activity or incidental to its business activity. But once the evidence of Mr Holden has been disbelieved and the accounts can no longer be relied upon, there is no evidence one way or another on the question. In short, Richard Walter failed to show, on the balance of probabilities, that the payments to it by Morlea were not assessable income, with the result that it failed to show that the Commissioner's assessment was excessive. THE CASE ON SECTION 260 The Commissioner's case on s260 proceeded on the basis that the payments between Morlea and Richard Walter were to be treated as loans. His Honour concluded, in what at first blush appeared an alternative conclusion, that s260 of the Act applied to permit there to be included in assessable income the amounts, otherwise being loans, paid by Morlea to Richard Walter. However, in a separate judgment his Honour held that the Commissioner was entitled to succeed both because the payments were shams and not loans and because s260 applied. It was submitted on behalf of Richard Walter, both before his Honour and before us, that s260 could only operate to treat as void as against the Commissioner transactions otherwise valid and legally effective. With respect, that proposition is self evident. His Honour, however, concluded that his finding in respect of sham did not mean that s260 could not additionally apply. He did, however, accept that there could be no double tax. However, it was his Honour's view that the Commissioner was entitled to assess on whichever was his preferred basis, namely, sham or s260. It must be said that the Commissioner did not seek before us to support his Honour's conclusion with any conviction. It is unnecessary in this judgment to canvas in any detail the application of s260 to the facts of the present case, assuming that s260 might apply if the payments in the present case to Richard Walter were in truth loans. It may simply be said that for s260 to apply in a given case one of the four prerequisites to the section must be found to apply. Section 260 applies only to a contract, arrangement etc which: "... has or purports to have the purpose or effect of in any way, directly or indirectly: (a) altering the incidence of any income tax; (b) relieving any person from liability to pay any income tax or make any return; (c) defeating, evading, or avoiding any duty or liability imposed on any person by this Act; or (d) preventing the operation of this Act in any respect..."

It is only if these preconditions are satisfied that the arrangement will be treated as being void as against the Commissioner. But if the payments to Richard Walter are to be accepted as income it is impossible to see how the incidence of income tax (at least so far as it affects Richard Walter) is altered in any way favourable to it. The answer is, it is not. Nor is Richard Walter relieved from any liability to pay any tax, nor is any liability which is imposed upon it in any way defeated, evaded or avoided. Finally, it can not be said that the operation of the Act has in any way been prevented. Quite the reverse: the Act operated in the way intended, namely, to bring to tax upon Richard Walter income. Accordingly, I do not find it necessary to consider whether, if the payments to Richard Walter were in fact loans, s260 could have operation. There are real difficulties in the path of the Commissioner in applying s260, as the judgment of Lehane J illustrates. There would be a need for careful consideration of cases such as Federal Commissioner of Taxation v Kareena Hospital Pty Ltd (1979) 79 ATC 4667 and the difficulties the present facts present to the traditional approach to the section, that no (or at least only minimal) reconstruction is permitted. The fact that the Commissioner would have no difficulty in demonstrating that the steps taken in May 1981 bore on their face the stamp of "tax-avoidance", to adopt the language of Kitto J in Peate v Federal Commissioner of Taxation (1964) 111 CLR 443 at 469, does not require the conclusion of itself that s260 applies. THE QUANTUM OF ASSESSMENT AND PENALTY The assessment appears to have been made on the basis that what was taxable to Richard Walter was ninety-five percent of the partnership income of the Morlea Partnership. If the true basis of liability is the fact that the payments to Richard Walter were not loans then a different figure would emerge. Various alternatives were suggested. Of these only two appear to have any logic. The first is to treat as assessable income the gross amount actually paid by Morlea to Richard Walter in the period. According to figures prepared by the Commissioner this would amount to $11,805,258 in the years in question. The alternative is to take annual balances of the loan accounts from year to year, thereby treating the amounts repaid to Morlea as not part of the sham. This approach, which was favoured by the taxpayer, resulted in the total assessable income in the four years being calculated as $6,009,535. The income as assessed to Richard Walter totalled in the period $9,395,089. Although I have some sympathy for the approach adopted by counsel for Richard Walter, it does not ultimately accord with the findings made by his Honour. If the payments made to Richard Walter each few days were in fact not loans, then the fact later that some amount was paid by Richard Walter to Morlea could not operate logically to reduce the assessable income of Richard Walter. The Commissioner does not suggest that we remit the matter to him to increase the assessment. In these circumstances the conclusion that Richard Walter has not satisfied the onus of showing that his assessable income was not greater than that assessed has the result that the assessment of taxable income must be affirmed. At the close of the appeal counsel for Richard Walter sought to amend the grounds of appeal to argue the question of penalty. It was said that it may be inferred that the assessment was made on the basis of s260, or perhaps sham, and that if the Court merely decided the matter by reference to onus of proof the assessment may have been made on a wrong basis so far as concerns the remission of the statutory penalty of 200 percent which the Act imposes. This was not a matter agitated below. The assessor was called by the Commissioner but was not cross-examined as to penalty. It would be difficult for this Court on appeal to examine the basis upon which the penalty was imposed. Although it might be able to be inferred that the assessment proceeded upon a basis of either s260 or Part IVA rather than sham having regard to the figure ultimately included in assessable income. The present appeal is not inconsistent with a finding of sham, although this Court did not need to go so far. In my view, it is now too late for Richard Walter to raise the question of additional tax. Accordingly, I would dismiss the appeal and order Richard Walter to pay the costs of it. I certify that this and the preceding thirty-nine (39) pages are a true copy of the Reasons for Judgment herein of his Honour Justice Hill. Associate: Date:

IN THE FEDERAL COURT OF AUSTRALIA ) NEW SOUTH WALES DISTRICT REGISTRY ) GENERAL DIVISION ) No. NG 681 of 1995 ON APPEAL FROM A SINGLE JUDGE OF THE FEDERAL COURT OF AUSTRALIA BETWEEN: RICHARD WALTER PTY LIMITED Appellant AND: THE COMMISSIONER OF TAXATION Respondent CORAM: Lockhart, Hill and Lehane JJ PLACE: Sydney DATE: 14 June 1996 REASONS FOR JUDGMENT LEHANE J: The circumstances of this "essay in tax avoidance naked and unashamed" (Re Weston's Settlements [1969] 1 Ch 223 at 246) are fully described in the judgment of Hill J and need not be repeated. There are two live issues in this appeal, one relating to the genuineness or otherwise of loans claimed to have been made to the taxpayer by Morlea Professional Services Pty Limited (MPS) as agent for the Morlea Partnership, the other to the application of s 260 of the Income Tax Assessment Act 1936 (the Act). I have come to a conclusion on the first issue which differs from that favoured by the learned trial judge and by the other members of this Court; I express the views to which I have come with considerable diffidence, especially as the difference relates largely to conclusions of fact. My diffidence is increased because, on the view I have taken of the first issue, it is necessary for me to consider the second; and, particularly at this stage of its lingering existence, s 260 can hardly be thought a topic on which much profit is likely to be derived from anything I may have to say. Nevertheless, I think I should explain the conclusions I have reached. I shall consider the two issues in turn. The Loans There is no doubt on the evidence that payments were made every few days by MPS to the taxpayer; equally there is no doubt that from time to time payments (though of a substantially lesser amount in aggregate) were made by the taxpayer to MPS. The books of account of both MPS and the taxpayer consistently treated those payments, respectively, as loans and repayments of loans. Because in each year the sum of the amounts paid by MPS to the taxpayer greatly exceeded the sum of those made by the taxpayer to MPS, the books of account of each party recorded an increasing balance owing on loan account by the taxpayer to MPS. There is evidence of a complex series of transactions which occurred following (or perhaps commenced immediately before) 30 June 1984: the detail of those transactions does not matter, I think, but what seems to be clear about them is that they proceeded on the assumption that the taxpayer was obliged to repay to MPS the balance owing on the loan account and that that obligation was one which might be assigned and which ultimately, by one means or another, was to be discharged. Mr Holden, the chief executive officer of what was described as the Wenkart Group, gave evidence to the unsurprising effect that the purported transactions by way of the making and repayment of loans were indeed transactions of their apparent nature. Although it was only the apparent loan transactions between MPS and the taxpayer which in the end the Commissioner sought to attack as shams, it is nevertheless important to bear in mind the overall 1981 "restructure" as it is described in the judgments of the learned primary judge and of Hill J. Particularly, it is important to note that the money which came to MPS, out of which it made the payments in question to the taxpayer, came to it as a fiduciary: it received the money as agent for a partnership one member of which was MPS itself acting as a trustee and the other member of which was also a trustee. A conclusion that the loans were shams necessarily rests on the proposition that a party which had those fiduciary roles paid money, belonging to its beneficiaries, to a third party gratuitously and on terms which did not require repayment. With that by way of background, I can consider the particular matters which, cumulatively, his Honour regarded as significant indications that the parties never intended there to be an obligation to repay the supposed loans.

The moneys were paid without any written evidence of any agreement or obligation to repay apart from book entries made by accounts staff. Senior counsel for the taxpayer submitted that this is not by any means unusual in the case of loans between related parties: between such parties it might well be more the exception than the rule to find a formal loan agreement. I think counsel's submission is right: certainly I do not think that the absence of a formal agreement is a significant indication of a lack of intention that there be an obligation to repay.
There was never any written or oral evidence as to the terms and conditions on which the moneys were said to be lent or repaid other than the year end financial statements which were the product of year end journal entries formulated by Holden, the Group Finance Director, to achieve the most desirable tax consequences. Senior counsel for the taxpayer argued, again in my view rightly, that this does considerably less than justice to the evidence. Particularly, it appears to ignore the fact that running ledger accounts were kept; additionally, I think, it involves a misapprehension of what, on the evidence, was actually done at the end of the various financial years. For one thing, there seems to be no evidence at all that anything was done which affected the character (or supposed character) of the payments, with which this case is concerned, between MPS and the taxpayer. For another, the journal entries with which his Honour was concerned (a concern arising perhaps from submissions by senior counsel for the Commissioner made before his Honour and repeated before us) had to do not, on the evidence, with any "alteration" of the character of past transactions but rather with distributions resolved to be made to beneficiaries and then made, not in cash, but by debiting and crediting loan accounts.
It does not appear that any interest was ever charged, payable, or paid by Richard Walter in respect of these loans. There was no group policy that interest should not be charged on intra‑group loans according to the evidence of Holden. That certainly is true. On the other hand I think it is equally true, as counsel for the taxpayer submitted, that an interest free loan between related parties, payable on demand, is by no means unusual and the lack of an obligation to pay interest should not be treated as an indication of a lack of obligation to repay principal. It may, perhaps, be said that the making by a fiduciary of an interest‑free loan, particularly in circumstances where it was contemplated that demand for repayment might be less than imminent, may well involve a breach of duty: but, if so, a breach whose magnitude does not approach that involved in simply paying away beneficiaries' money gratuitously to a third (albeit related) party.
It is true that, as the applicant points out, there were book entries to indicate some substantial amounts paid by the applicant to [MPS]. However, the net movements from [MPS] to the applicant were far greater than the converse. For example, to 30 June 1982 the flow of cash from [MPS] to the applicant was $1,538,013 and the movement back according to the entries was $500,954. For the year ended 30 June 1983, the movement from [MPS] to the applicant was $2,301,649 compared with the converse of $866,421.07. In the year ended 30 June 1984, the cash moving from [MPS] was $1,926,591 as compared with the converse of $232,459.47. These movements do not show, in my opinion, that there was an intention to repay all the moneys channelled to Richard Walter. It may fairly be commented, however, that either the payments by MPS to the taxpayer were made on the basis that they were repayable by the taxpayer, or they were not. There could be no suggestion that they were repayable in part, the part being represented by the amounts that were in fact repaid. Either the payments back were made in discharge of an obligation to repay, or they are to be explained on some other basis, none being suggested. If the payments indicate anything relevant, I think they can only be taken as some indication that a repayment obligation was indeed intended. It may be added that an expectation, or intention, that full repayment would not be called for, or made, in the foreseeable future does not demonstrate a lack of intention to create a legally enforceable debt.

It was impossible for Richard Walter to repay the amounts distributed by [MPS] without liquidating the assets of Richard Walter and the evidence was that there was never any intention or even contemplation of doing this. Again, given the obvious and unsurprising confidence that there would be no sudden demand for repayment, this is not very remarkable. Senior counsel for the taxpayer submitted also that it was inappropriate, in considering whether the taxpayer could have repaid the debt, to take into account only the book value of its assets. Be that as it may, again it is not unusual to find a member of a corporate group borrowing short from another member and investing long (to use terminology appearing in Mr Holden's evidence) in the confident expectation that the borrowing would not be called unless the circumstances of the group as a whole made that course necessary or desirable.
In 1982 the nature of the liability of Richard Walter to [MPS] was unilaterally reclassified by Holden from current liability to non‑current liability without any board resolution by Richard Walter or [MPS]. This was clearly to the detriment of Aurelius Commodus. It appears that no consideration was given by Holden to the trust obligations in this respect. In cross‑examination in relation to this matter, Holden was prepared to say as an experienced accountant that he did not know whether a dollar today is worth the same or more in a year's time. That reflects adversely on the credibility of Holden. In my view this unilateral reclassification was done without any thought for, and contrary to the interests of, beneficiaries allegedly owning the debt due from Richard Walter. The first thing to be said about that is that despite senior counsel's ingenious efforts to justify Mr Holden's answers in cross‑examination on this topic, I have no doubt that his Honour's comment on them was well justified. That is a matter to which I shall have to return. That apart, however, I am not convinced that the "reclassification" has any particular significance for present purposes. It is curious that whereas the audited accounts of the taxpayer reflected the reclassification, the audited accounts of MPS did not, but rather continued to treat the debt said to be owing by the taxpayer as a current asset. It is curious also that the reclassification was permitted to be reflected in the audited accounts of the taxpayer. After all, the treatment of an asset or liability as current or non‑current depends upon, rather than dictates, the terms of the obligation giving rise to the asset or liability. In other words, one treats an asset as non‑current because it is not to be discharged within the next year; one does not alter the terms of a liability payable on demand by unilaterally classifying it as "non‑current". The obvious and, I think, most likely correct conclusion is that the reclassification was simply improper and certainly ineffective to change the terms of any obligation as between MPS and the taxpayer. If that is right, then what was done did not itself amount to a breach of trust; it is worth pointing out again, however, that for a trustee to lend interest‑free where repayment is not expected in the near future is hardly a less significant breach of trust than submission, in circumstances where that has already been done, to a reclassification of the kind which occurred here. I have already referred to the considerably more significant breach of trust which happened if the payments by MPS were not loans at all.
The evidence makes it clear that when [MPS] needed funds of any size, it borrowed from external financiers instead of calling for repayment of the loan due by Richard Walter which was interest free. There was no evidence of any attempt or proposal to call for repayment of the loan to Richard Walter. Again, it is perhaps not surprising to find, rather than a tender regard for the interests of beneficiaries, what can readily be explained as decisions made in the interests of the group as a whole and reflecting, particularly, a preference for external borrowing rather than a course which might require the taxpayer to dispose of assets.
The debt alleged to be due from Richard Walter to [MPS] was never repaid, but it appears to have been assigned by a series of "round robin" artificial paper transactions orchestrated by Richard Water's legal and accounting tax advisers, none of whom were called in evidence by the applicant. No explanation was proffered for not calling them. It must be recalled that there were at least some, by no means insignificant, payments in the reverse direction. Additionally, what happened might at least be taken to indicate, as I have said, that everyone recognised that there was an obligation which had to be dealt with in some way. I agree with Hill J in thinking that no particular significance is to be attached to the failure to call the various tax advisers. The failure to call Dr Wenkart may be another matter, and, once again, I shall return to that. I acknowledge the force of Hill J's comment that a number of indications, none of which has by itself much significance, may nevertheless in some circumstances cumulatively have some weight. In these circumstances, however, given my comments about each individual indication, the sum of them in my view suggests no more convincingly an intention that there be no obligation to repay than does any of them individually. Moreover, it must be borne in mind that it is of the essence of a structure intended to be effective to minimise tax that it be created by means of real transactions, giving rise to real rights and obligations, however "artificial" they may be, in the sense of being incapable of rational explanation except on the basis of their tax consequences. It cannot be said, I think, that there is anything more artificial in the transactions with which we are concerned than there was in those which, in a somewhat different context, confronted the Court in Sharrment Pty Ltd v Official Trustee in Bankruptcy (1988) 18 FCR 449. One expects, in a case such as this, that transactions are intended to have their apparent legal effect because it is only if they do that they are efficacious to achieve the desired consequences. In this particular case it is no longer suggested that any of the transactions involved in the 1981 "re‑structure" had any legal effect other than their apparent effect; it is suggested only that the "loans" to the taxpayer were not really loans at all but payments which were gratuitous and which were not intended to be recoverable. That, for reasons which I have given, seems to me a conclusion so surprising that one would be reluctant to accept it in the absence of cogent evidence. However, there is nothing in the documentary evidence which supports that conclusion: indeed, the documentary evidence is to the contrary effect. Nor, of course, is there anything in the affidavit or oral evidence of Mr Holden that does so. Subject to two matters, therefore, I could not, with respect, support a positive conclusion that the purported loans were intended to have any but their apparent legal effect. The two matters to which I refer are, first, his Honour's adverse findings as to the credibility of Mr Holden and, secondly, the failure to call Dr Wenkart. As to the former of those two matters, I accept that it would be wrong for this Court to disturb the primary judge's findings as to the credibility of the witness. Moreover, a reading of the evidence makes it plain, if I may say so, that the conclusions of the primary judge as to the general credibility of Mr Holden's evidence were amply justified. It is, however, one thing to reach a conclusion about the degree of credence to be given to the evidence of a particular witness; it is quite another to say that such a view of a witness's evidence generally ought to lead one to a conclusion, in the absence of other evidence, contrary not just to what the witness asserts but also to the documentary material (such as it is) and to what would ordinarily be regarded as the probabilities (see Jack v Smail (1905) 2 CLR 684 at 697, 698). I have indicated why I do not regard the matters relied on by his Honour - particularly Mr Holden's evidence about the effect of the "reclassification" - as sufficient for this purpose. Similar comments may be made about the failure to call Dr Wenkart. It may be said at once that the complex facts and issues in this case are a world away from those in Jones v Dunkel (1959) 101 CLR 298. The weight to be attributed to a Jones v Dunkel inference in relation to a particular issue in a particular case must, I think, be assessed having regard to the number and complexity of the facts and issues in the case in relation to which the potential witness might have been able to give evidence. In any event, the principle for which that case stands is, as expressed in the judgment of Kitto J at 308, "that any inference favourable to [a party] for which there was ground in the evidence might be more confidently drawn when a person presumably able to put the true complexion on the facts relied on as the ground for the inference has not been called as a witness by [the other party] and the evidence provides no sufficient explanation of his absence". If, as I think, there is in this case no clear inference otherwise to be drawn in the Commissioner's favour on the issue of the genuineness or otherwise of the loans, it seems to me that the failure to call Dr Wenkart adds little if anything to the balance. The Commissioner's success does not, however, depend on a positive finding that the parties intended that there be no obligation to repay, and that therefore there was no loan. The burden is on the taxpayer to establish that the assessment is excessive: Commissioner of Taxation v Dalco (1990) 168 CLR 614; Commissioner of Taxation v Australia & New Zealand Savings Bank Ltd (1994) 94 ATC 4,844. I accept that in order to discharge that burden the taxpayer must show on the balance of probabilities that the payments (i.e. the purported loans) are not income. The taxpayer may do this if it shows, on the balance of probabilities, that the payments were indeed loans. This is not, I think, a case of payments whose character, on the evidence, is simply unexplained by the taxpayer. If, as I think, his Honour's positive finding that the loans were not genuine should not stand, the considerations which lead me to that conclusion lead me equally to conclude that it should be held that the payments which the Commissioner has assessed as income were in fact loans and that (subject to the possible application of s 260) the assessments are to that extent excessive.

Section 260 Section 260 of the Act provided, when the restructure was effected, as follows: Every contract, agreement, or arrangement made or entered into, orally or in writing, whether before or after the commencement of this Act, shall so far as it has or purports to have the purpose or effect of in any way, directly or indirectly - (a) altering the incidence of any income tax; (b) relieving any person from liability to pay any income tax or make any return; (c) defeating, evading or avoiding any duty or liability imposed on any person by this Act; or (d) preventing the operation of this Act in any respect, be absolutely void, as against the Commissioner, or in regard to any proceeding under this Act, but without prejudice to such validity as it may have in any other respect or for any other purpose. Before the events of late May 1981, what happened was substantially as follows. Dr Wenkart conducted a pathology practice and received fees both from Medicare and directly from patients. In turn Dr Wenkart paid a substantial proportion of those fees to MPS as consideration for services provided by MPS to the pathology practice. MPS provided the services in exercise of its powers as trustee of a trust known as the Morlea Professional Services Unit Trust and received the fees as trustee of that trust. The holder of all the units in the trust - that is, the sole beneficiary of it - was Ultera Pty Limited. Ultera Pty Limited in turn held the units as trustee of a discretionary trust called the Morlea Trust, the discretionary beneficiaries of which included members of Dr Wenkart's family and companies in which he or they were interested, among them the taxpayer. However, the practice was already well established by which MPS lent to the taxpayer, every few days, a substantial portion of the service fees which it received. The primary judge made detailed findings, the substantial accuracy of which was not challenged, as to the events of May 1981. They are as follows:

On 18 May 1981 a company known as Ligustrum established the Aurelius Unit Trust off shore, with Ligustrum as both trustee and holder of all the initial units. Ligustrum was a non‑resident UK company resident in Hong Kong. The appointer of the trust was represented to be Ultera, a resident company controlled by Wenkart. Ligustrum held all the units in the trust.
Subsequently, 99 units in the Aurelius Unit Trust were acquired by Aurelius Commodus and 1 unit was acquired by Ventura Securities Inc ("Ventura"). Ventura was a Californian incorporated limited partnership of which the sole partner was Zeeno of Jersey, and was also controlled by Wenkart.
On 19 May 1981 Ultera purported to remove Ligustrum as trustee of the Aurelius Unit Trust and to appoint Sixterra BV as trustee. Sixterra BV was a Netherlands company.
On 25 May 1981 at 5.50 pm Ultera removed Sixterra BV as trustee and appointed Iroos, (an Australian resident company), as trustee of the Aurelius Unit Trust.
On 25 May 1991 at 5.58 pm Aborda was appointed as trustee of the Aborda Trust which was in turn settled by Holden, the financial controller of the Wenkart companies.
On 25 May 1981 at 6.02 pm Iroos and Aborda entered into a partnership agreement for the establishment of the Morlea Partnership in which Iroos held 95% of the capital and Aborda the remaining 5%.

On 25 May 1981 Iroos declared that it held its interest in the partnership known as the Morlea Partnership, on trust for the Aurelius Unit Trust.
On 25 May 1981 at 6.30 pm Ultera as trustee of the Morlea Trust declared that Aborda and Iroos were the eligible beneficiaries of that trust. Capital was also appointed to Aborda and Iroos.
On 25 May 1981 at 6.30 pm Wenkart appointed the Morlea Partnership as an eligible beneficiary of the Morlea Unit Trust.
On 25 May 1981 at 6.50 pm MPS Pty Ltd, as trustee of the Morlea Unit Trust, declared an interim distribution to the Morlea Partnership.
Morlea Unit Trust was thereafter represented to be determined and all its capital and income after the interim distribution, to have been distributed by book entry to the partners of the Morlea Partnership.
On 25 May 1981 at 6.55 pm, Aborda appointed MPS Pty Ltd as its agent with respect to all matters relating to the Morlea Partnership.
On 25 May 1981 at 6.58 pm Ultera removed Iroos as the trustee of the Aurelius Unit Trust and appointed MPS Pty Ltd as trustee.
On 25 May 1981 at 7.00 pm MPS Pty Ltd accepted appointment to act as agent for Aborda.
The partnership agreement between Iroos and Aborda provided that Iroos held 95% of the capital and Aborda 5% of the capital. Thus it appeared that the pathology service business previously conducted by MPS Pty Ltd as trustee of the Morlea Unit Trust was vested in the Morlea Partnership and thereafter conducted by MPS Pty Ltd purportedly in the capacity of agent for the Morlea Partnership.
All of these steps were pre‑arranged and documentation was drafted by the group's tax advisers and implemented at one meeting by means of minutes, drafted in advance and about which the only explanation given was that they "worked" for tax purposes. The date of the meeting was said to be two days before Part IVA of the Act came into operation. So far as the flow of cash was concerned, nothing of any significance had changed. Dr Wenkart continued to receive fees from Medicare and directly from patients; he continued to pay service fees to MPS; MPS continued to lend to the taxpayer a substantial portion of the fees it received. The capacity in which MPS provided the services, received the fees and made the loans had, however, undergone a radical change. The capacity in which it did so was now that of agent of the partnership between itself as trustee of the Aurelius Unit Trust and Aborda Pty Ltd as trustee of the Aborda Trust. Within that structure, the taxpayer appeared only as one member of the class of discretionary beneficiaries of the Aborda Trust, a class (for what it may be worth) already of considerable size and capable of almost indefinite expansion. As I have said, and as was conceded, it is obvious that the restructure, in a general sense, had at least one of the avoiding purposes or effects described in s 260. The section, however, avoids contracts, agreements or arrangements only so far as they have one of those purposes or effects; and, in order to ascertain how, and with what result, the section operates in relation to the restructure it is necessary to identify with precision the elements of the transactions described by his Honour which had at least one of those purposes or effects. The Commissioner contended that the contract, arrangement or understanding avoided by the section was made up of the following steps: (1) the inclusion in the Morlea Partnership of Iroos Pty Ltd; (2) the appointment of Iroos Pty Ltd as an eligible beneficiary of the Morlea Trust;

(3) the distribution by Ultera Pty Ltd to Iroos Pty Ltd of 95% of the units in the Morlea Professional Services Unit Trust; (4) the distribution by Morlea Professional Services Pty Ltd to Iroos Pty Ltd of 95% of the interim income of the Morlea Professional Services Unit Trust; (5) the distribution by Morlea Professional Services Pty Ltd to Iroos Pty Ltd of 95% of the capital of the Morlea Professional Services Unit Trust. (6) the entry in the Morlea Professional Services' books of account of journal entries purporting to record as loans payments made to Richard Walter Pty Ltd by Morlea Professional Services Pty Ltd. It is convenient to begin, as his Honour did, with the loans. The taxpayer contended that the loans should not, on any view, be regarded as part of any arrangements made towards the end of May 1981 and avoided by the section. The taxpayer pointed out that the practice of lending to the taxpayer the bulk of the cash coming to MPS by way of service fees was established well before May 1981 and continued unchanged afterwards. The loans were simply not to be regarded as a part of any contract, agreement or arrangement made or entered into having any of the relevant purposes or effects. The primary judge held, however, that the continued making of loans could not be regarded as independent of the tax‑avoiding arrangement but comprised, rather, a central part of it. As his Honour said, this was the way the cash was retained in Australia rather than following the paper chain to the Netherlands. His Honour then held (judgment, p 42): In my view, the loans were part of the scheme. They had the required purpose of avoiding or altering the incidence of tax. The loans are avoided by the application of s 260 as are the other parts of the scheme set out earlier in steps 1‑5 above, as identified by the Commissioner.

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.

Conclusion I would therefore allow the appeal with costs and set aside the Commissioner's objection decision disallowing the taxpayer's objections to assessments to income tax in respect of the years of income ended 30 June 1981 to 30 June 1984 inclusive. I certify that this and the preceding 22 pages are a true copy of the Reasons for Judgment of the Honourable Justice Lehane. Associate: Dated: 14 June 1996 Heard: 26 February 1996 Place: Sydney Decision: 14 June 1996 Appearances:Messrs D H Bloom QC and M Cashion of counsel instructed by Mallesons Stephen Jacques appeared for the appellant. Mr G A A Nettle QC and Ms M Gordon of counsel instructed by the Australian Government Solicitor appeared for the respondent.

Snook v London and West Riding Investments Ltd

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