Administrative Appeals Tribunal of Australia|2004-10-01

The applicant is an individual taxpayer who is the trustee and a beneficiary of a discretionary family trust ("the trust"). The taxable income reported in the trust return for the year ended 30 June 1998 ('the income year') included a net capital gain of $166,599. The calculation of this amount in the return included a gain of $787,375 from a share transaction and a loss of $800,000 from another share transaction. On 26 June 1998 the applicant, as trustee, resolved that the net capital gain, apart from the first $27,500, be distributed to the applicant as beneficiary and should the respondent increase the net capital gain, the increase was to be deemed to be distributed to the applicant on 30 June 1998. So the balance of the net capital gain (an amount of $139,099) was included as a capital gain in the applicant's personal income tax return for the income year. A notice of assessment of income tax payable was issued to the applicant on 12 January 1999. A notice of amended assessment was issued on 13 October 2000 following an amendment of the applicant's return. On 8 February 2002 the respondent issued a further notice of amended assessment for the applicant for the income year ("the amended assessment"). The amended assessment, which the applicant contends is excessive, arose because the respondent determined, pursuant to s 177F(1)(c) in Part IVA of the Income Tax Assessment Act 1936 ("Part IVA"), that, for income tax purposes, the applicant, as trustee, did not incur the capital loss of $800,000 referred to above. This decision increased the net capital gain in the trust return for the income year by $800,000. The respondent brought this amount to tax in the personal return of the applicant for the income year in accordance with the resolutions concerning the distribution and variance of the taxable income of the trust adopted on 26 June 1998. So the issues to be determined in this matter are whether the applicant, as trustee, incurred the capital loss of $800,000 in the income year under the general provisions of the ("the Act") that governed such losses in that year and, if so, whether the respondent exercised his discretion under correctly when he determined that the applicant did not incur the capital loss for the purposes of the Act. The notice of the amended assessment included tax shortfall penalty and interest amounts which the applicant contended should, in any event, be remitted.

The Tribunal also had the applicant's statement of facts and contentions, amended statement of facts and contentions, a document from the applicant's solicitors headed 'issue of possible disclosure to ASX re share sale' and the applicant's outline of submissions. Both parties lodged a Statement of issues and referred the Tribunal to various authorities.

Directions hearings were held in this matter on 3 December 2003 and 4 May 2004 and submissions on interest were filed by the respondent on 17 May 2004.

The trust was settled on 6 March 1992 and the applicant has always been the sole trustee. The applicant is the Managing Director of a company listed in Australia and the UK, a position he has held since May 1995. In 1997 the founder and Chairman of the company, who is the applicant's brother, wished to retire and sold his shares in the company. The applicant, as trustee of the trust, participated in a management buy out and acquired 14,329,100 shares ("the shares") from his brother and a proprietary company associated with his brother, at $0.30 per share over the period July to October 1997 (A5, T12, T13, T14, T15, T18, T19). The applicant used a bank loan of $4.3 million ("the loan") to acquire the shares.
The applicant, in his capacity as trustee of the trust, was advised of the approval of the loan in a letter from the bank of 10 July 1997 which informed the applicant of certain special terms and conditions applicable to the loan (T9).
The loan was a fixed rate, interest only, interest in arrears loan for a fixed term of 3 years from the date of actual drawdown (T10). The loan had to be drawn down in one instalment by 30 September 1997 (T10). The interest payment date was "the last business day of each half year commencing 31 December 1997 and on the day all monies owing under the agreement are finally repaid" (T10). At the time the loan was approved the current indicative interest rate was 8.478% (T9). Interest, at the rate quoted to, and accepted by, the applicant accrued to the bank from the date the loan was drawn down. Interest was calculated daily on the balance outstanding and debited to the trust's business cheque account on each interest payment date (T10). If this caused the balance of the account to be placed in debit, or to exceed any credit facility, it would cause an event of default under the loan agreement (T10). A breach of any covenant or agreement to secure the loan would also give rise to an event of default (T10). The arrangement to secure the loan is set out at item 6 of the schedule to the loan agreement (T10). The loan agreement includes other events of default including the appointment of a new trustee of the trust, or a resettlement or setting aside of any trust funds, without the prior written consent of the bank (T10).
On 1 August 1997 the applicant, as trustee of the trust, agreed to appoint a wholly owned subsidiary of the bank custodian of all securities delivered to it by the applicant (T17). The shares were delivered to the custodian in terms of the loan agreement (T10, T16, and T9). They were registered electronically in the name of the custodian and counsel for the applicant informed the Tribunal that the custodian was given the holder identification number ("HIN"). The applicant appointed the custodian as agent and attorney to do a number of things including to buy, sell and otherwise deal in any investments as properly directed by the bank, and to receive all funds, resulting from the sale of any investments, and other investment receipts. The applicant could only terminate the agreement with the custodian with the consent of the bank (T17). Dividends from the shares were paid to the custodian as the registered owner of the shares (T76). The custodian in turn transferred these amounts to the trust's business cheque account which was nominated as the working account in the loan agreement (T10). It was to this account that the bank debited interest payments on each interest payment date. Surplus dividends, after payment of interest, were to be held on term deposit under a letter of set-off as security for the facility (T9).
The loan was further secured by guarantees and indemnities from the applicant, his brother and associated entities and registered mortgages over certain properties (T10, T11).
On 11 June 1998 the applicant approved certain payment terms and conditions in respect of the sale of a parcel of shares that generated the capital gain of $787,375 reported in the trust return for the income year, referred to at the beginning of these reasons. The purchase price was $800,000 (T20).
On 12 June 1998 a second family discretionary trust ("trust 2") was settled with the applicant as sole trustee. As in the case of the trust, the specified beneficiaries in the trust deed for trust 2 are the applicant and members of his family (T5, T21). The settled sum was $5.00.
On 12 June 1998 the applicant completed a share transfer form transferring 8 million of the shares from the trustee of the trust to the trustee of trust 2 at a consideration of $1,600,000. The applicant signed the form as transferor and transferee (T23). A stamp duty assessment in respect of this transaction was issued on 4 August 1998 (T26). The notice of stamp duty assessment and the share transfer form are stamped for duty paid on 26 October 1998. The only written evidence, before the Tribunal, of the agreement between the applicant as trustee of the trust and the applicant as trustee of trust 2, is an unsigned share sale agreement dated June 1998 (T22). This document is drafted as an agreement for the purchase and sale of 8 million of the shares, free from encumbrances, for a price of $1,600,000, in which the vendor agrees to deliver a share transfer for the shares, which are held on an uncertificated register, against payment of the price. The sale was to be settled on 30 June 1998 and the vendor had the right to deliver the transfer at settlement even if the purchaser did not pay the price at settlement, in which event the purchaser was to pay interest on the price at the rate of 8.32% p.a. payable six monthly in arrears until payment of the price (T22).
On 12 June 1998 the closing price for the shares on the Australian Stock Exchange was $0.20 per share (A6). The applicant did not open a bank account as trustee of trust 2 nor did he pay $1,600,000 for the 8 million shares. No other financial arrangements were made for this acquisition. It was the understanding of the applicant, based on verbal legal advice, that, as trustee of trust 2, he had seamlessly stepped into his shoes as trustee of the trust in relation to $1.6 million of the $4.3 million debt owed the bank. He also understood, on the basis of the same legal advice, that beneficial ownership in the shares passed from the trustee of the trust to the trustee of trust 2. At no stage was the bank informed of the settlement of trust 2 and of the transactions that followed between the trustee of the trust and the trustee of trust 2 in relation to 8 million of the shares.
The applicant testified that he did not open a bank account as trustee of trust 2 but that his accountant, on his instructions, and, where necessary, on those of his lawyer, kept books of account for each trust. In cross examination he confirmed that the single bank account was the trading cheque account in his name as trustee of the trust and that any cheques drawn on that account on behalf of the trustee of trust 2 would be reflected in the books as a loan from the trust to trust 2. He testified further that in relation to the sale and transfer of 8 million of the shares from the trust to trust 2 the accounts for trust 2 showed a liability of $1.6 million to the trust. He stated that there was no loan agreement because it had been explained to him that such an agreement was unnecessary as he was trustee of both trusts. As trustee of trust 2, he assumed the terms of the loan mirrored those of the loan owed the bank.
The financial statements of the trust as at 30 June 1998 reflect a non-current secured bank loan of $4.3 million (T25). The income tax return for the trust for the income year includes franked and unfranked dividends from the shares (T27). The balance sheet for trust 2 as at 30 June 1998 shows borrowings of $1.6 million as a non-current liability and there is no accompanying note to this item. Total assets are shown as $1,600,005 of which $1,600,000 relates to an investment in listed shares (T30). The trial balance as at 30 June 1998 for the trust reflects a current asset of $1.6 million owed by trust 2. Ledger entries for the trust for the year ended 30 June 1998 include an entry for the transfer of the shares to trust 2 (T38). There is also a ledger entry for this transaction for trust 2 for the year ended 30 June 1998.
The financial statements of the trust as at 30 June 1999 reflect a non-current secured bank loan of $4.3 million (T35). The financial statements of trust 2 as at 30 June 1999 reflect current borrowings of $1,608,722 and a trust fund deficiency of $8,717 (T36).
The disputed capital loss of $800,000 in the trust return for the income year ("the capital loss") was claimed on the basis of the sale of 8 million of the shares to the trustee of trust 2.
On 30 June 1999 the applicant signed 2 share sale agreements and 2 share transfer forms. The first sale agreement relates to the sale of 4 million shares, free from encumbrances, from the trust to the applicant personally for a price of $800,000 or $0.20 per share. This document is signed by the applicant as vendor, in his capacity as trustee of the trust, and as purchaser in his personal capacity (T33). A corresponding Australian standard share transfer form was executed by the applicant in the same capacities (T32). The second sale agreement relates to the sale of 8 million shares, free from encumbrances, from trust 2 to the applicant personally for a price of $1,600,000 or $0.20 per share. In this instance the vendor is the applicant in his capacity as trustee of trust 2 and the purchaser is the applicant in his personal capacity (T34) and the corresponding share transfer form was completed accordingly (T31). The share sale agreements are otherwise identical and the bank was unaware of them.
The loan matured in August 2000 and under the arrangements negotiated with the bank in settlement of the applicant's outstanding loan liability, the applicant, as trustee of the trust, transferred the shares to a proprietary company associated with his brother at $0.07 per share. This was achieved using a standard transfer form for non-market transactions that was signed by the applicant, as trustee, and by his brother, as sole director and secretary of the buyer, on 9 October 2000 (T41).
By s.14ZZK of the Taxation Administration Act 1953 ('the TAA") the applicant had the burden of proving on the balance of the probabilities that the amended assessment is excessive. The general provisions setting out the circumstances in which a taxpayer will incur a capital loss in the income year are in Part III A of the Act.
S 160L (1) relevantly provides that Part III A applies in respect of every disposal on or after 20 September 1985 of an asset, whether situated in Australia or elsewhere or not situated anywhere, that, immediately before the disposal took place, was owned by a person in the capacity of a trustee of a resident trust estate and was acquired by that person on or after 20 September 1985. It was not disputed by the parties, and the Tribunal finds, pursuant to s160H (1), that the trust was a resident trust estate in the income year for the purposes of the Act.
The applicant contended that the capital loss was incurred when, as trustee of the trust, he sold the equitable or beneficial estate in 8 million of the shares to himself as trustee of trust 2.
'Asset' is generally defined in s. 160A to mean any form of property and includes: an option; a debt; a chose in action; any other right; whether legal or equitable and whether or not a form of property; goodwill or any other form of incorporeal property; foreign currency and certain partnership interests. Motor vehicles of a particular kind and interests in such motor vehicles, are specifically excluded.
A share in a registered company is a species of transferable personal property, which does not include an interest, legal or equitable, in the assets of the company. See, for example, the Birkenhead, Lancashire and Cheshire Railway Co. v. Pilcher [1850] EngR 78; 5 Ex. 114,125; Poole v. Middleton (1861) 29 Beav.646, 650-651; Re Rose, Rose v. Inland Revenue Commissioners [1952] Ch. 499, 507, 514; Woodlands v Hind [1955] 2 All E.R. 604,605. In relation to the transfer of shares, Millett J in MacmiIlan Inc. v. Bishopsgate Trust (No.3) [1995] 3 All E.R. 747, [1995] 1 W.L.R. 978, 992, describes them as a special sub-species of chose in action with its own rules. On appeal, [1996] 1 All E.R. 585; Lord Justice Aldous, at 620 described shares as property "in the nature of a chose in action which is immovable in the sense that it remains at the place of the company's incorporation"; see also Gambotto v W.C.P. Limited (1994 -1995) [1995] HCA 12; 182 CLR 432 and the cases cited; Salomon v. A. Salomon & Co. Ltd [1897] A.C. 22; Macaura v. Northern Assurance Co. [1925] A.C. 619, 626, 630, 633; Hood-Barrs v. IRC [1946] 2 All E.R. 768 (C.A.) 775; Short v. Treasury Commissioners [1948] A.C. 534, 545. It was not contested by the parties and the Tribunal finds that the shares are assets for the purposes of A of the Act in the income year. The Tribunal makes the further finding that, in light of the definition of an asset in s.160 A, where the equitable estate is divorced from the legal estate in a share, the equitable estate constitutes an asset for the purposes of A of the Act. By s.160 M (1A) a change in the legal ownership of an asset does not constitute a change in the ownership of the asset for the purposes of A of the Act unless there is also a change in the beneficial ownership of the asset.
It was common cause between the parties that the wholly owned subsidiary of the bank had the legal ownership of the shares when they were delivered to it as custodian, and registered electronically in its name. The principal point of contention between the parties in this regard was whether the custodian stood possessed of the shares in trust for the applicant, as trustee of the trust, absolutely or whether, in the words of the respondent's written submission, the applicant's beneficial ownership "was severely attenuated" by the terms of the custody and related agreements.
What constitutes a disposal or acquisition for the purposes of Part III A, is set out in s. 160 M of the Act. Section 160 M(1) provides that where a change has occurred in the ownership of an asset the change shall be deemed to have effected a disposal of the asset by the person who owned it immediately before the change and an acquisition of the asset by the person who owned it immediately after the change.
Section 160 M(2) provides that a reference to a change in the ownership of an asset in s. 160 M (1) is a reference to a change that has occurred in any way, including any of the following ways:

"(a) by the execution of an instrument;

(b) by the entering into of a transaction;

(c) by the transmission of the asset by operation of law;

(d) by the delivery of the asset;

(e) by the doing of any other act or thing;

(f) by the occurrence of any event."

It is clear from the words of ss 160 M(1) and (2) that a calculation of a capital loss or gain for the purposes of Part III A will only arise on an actual change of ownership of a relevant asset and not on the mere existence of an executed document that purports to effect such a change.
As one of the preconditions for incurring a capital loss is the disposal of an asset by the taxpayer concerned, the question arises as to whether the applicant, as trustee of the trust, could validly sell and transfer a beneficial interest in 8 million of the shares to himself, as trustee of trust 2.
As a general rule "a sale by a person to himself is no sale at all" (see the judgment delivered by Lindley LJ in Farrar v Farrars Limited (1888) 40 Ch D 395 at 409) because a legal entity cannot contract with itself; see De Tasted v Shaw 1 B & ALD. 664, 106 ER 244 to 246; Ellis v Kerr (1910) 1 Ch. 529; Napier v Williams (1911) 1 Ch 361, cited as authorities for the general proposition in the reasons for decision of the Tribunal in case 23/96 ATC 278 at 285 Para. 40.
One of the issues to be determined by the Tribunal in case 23/96 was whether the Occupational Superannuation Standards Act 1987 and regulations had been breached because the trustees ('B1 and B2') of a superannuation fund ('B1 Fund') had borrowed from themselves as trustees of another superannuation fund ('Other Fund'). The Tribunal found, at 288 Para 51 that, "as trustees of the other Fund, B1 and B2 could only enter a contractual arrangement with themselves as trustees of the B1 Fund if the trust deed establishing the Other Fund authorised them to do so." The Tribunal respectfully adopts this finding as the correct exposition of the general rule as it applies to the applicant as trustee of the trust and trust 2.
Clause 8 of the trust deed that established the trust (T5) is headed "Transactions in which the trustee is interested". Subclause 8.1 relevantly provides:

"Notwithstanding anything herein to the contrary or otherwise contained the Trustee shall have power at the Trustee's absolute discretion:

to sell hire lease or dispose of any real or personal property of the Trust Fund or to lend or advance any moneys on any terms with or without security of interest to the Trustee in the Trustee's capacity as Trustee of other trust funds or otherwise howsoever or to any company or partnership whatsoever notwithstanding that the Trustee is a shareholder or director or member or partner of such company or partnership or to any wife husband child or children of the Trustee;"

So the Tribunal finds that the applicant, as trustee of the trust, could enter a contractual arrangement with himself, as trustee of trust 2, in relation to the shares, because he is specifically authorised and empowered to do so by the trust deed of the trust.

S. 160 M (3) of the Act provides for certain deemed disposals in the following terms:

"160M (3) [Deemed disposal] Without limiting the generality of subsection (2), a change shall be taken to have occurred in the ownership of an asset by:

(a) the creation of a trust, by declaration or settlement, over the asset, other than where either:

(i) all of the following sub-paragraphs apply:

(A) the person who owned the asset immediately before the creation of the trust is the sole beneficiary of the trust;

(B) that person is absolutely entitled to the asset as against the trustee or would, but for a legal disability, be so entitled;

(C) the trust is not a unit trust; or

(ii) all of the following sub-paragraphs apply:

(A) the trust is created by the transfer of an asset to a trust from another trust;

(B) the beneficiaries of the trusts are identical;

(C) the terms of the trusts, including the interest of each beneficiary in the income and corpus of the trusts are identical;"

S.160 M (3A) provides that for the purposes of paragraph (3)(a), the transfer of an asset to a trust is taken to be the creation by settlement, of a trust over the asset. The combined effect of s. 160 M (3A) and s. 160 M (3)(a)(ii) is that any transfer of an asset from the trust to trust 2 will not entail a change of ownership of the asset for the purposes of Part III A of the Act in circumstances where the requirements of sub paragraphs (A)(B) and (C) of s 160 M (3)(a)(ii) are satisfied.

By s 160 M (3A), any transfer of an asset by the applicant to trust 2 is taken to be the creation by settlement of a trust over the asset. So the Tribunal finds that s 160 M (3)(a)(ii)(A) is satisfied where the applicant transfers an asset from the trust to trust 2.
The requirement in s 160 M (3)(a)(ii)(B) is that the beneficiaries of the trusts be identical. 'Identical' is not defined and it must be given its ordinary dictionary meaning of 'similar in every detail; exactly alike' - Oxford Dictionary of English 2nd edition 2003. Subclause 1.18 of the trust deed of the trust (T5) defines "Specified Beneficiary" and "Specified Beneficiaries" to mean the person or persons named described or defined as such in the Schedule. Item 6 of the Schedule provides that the children of the applicant and his wife are the specified beneficiaries. Sub clause 1.16 of the trust deed of trust 2 (T21) similarly refers to its schedule where the applicant and his wife are the specified beneficiaries and their children are additional members of the class of general beneficiaries. In the case of the trust deed of the trust, by item 7 of the schedule, the applicant and his wife are included as additional members of the class of general beneficiaries.
The definitions of "general beneficiaries" in sub clause 1.9 of the trust deed of the trust and subclause 1.8 of the trust deed of trust 2 are the same save that subclause 1.9.2 of the trust deed of the trust includes uncles aunts and cousins of the specified beneficiaries to reflect the fact that the specified beneficiaries of the trust are children of the applicant and his wife rather than the applicant and his wife as is the case in the trust deed of trust 2. This fact per se does not make the respective beneficiaries of the trusts different.
Sub clause 1.5 of the trust deed of the trust defines "child" or "children" to include an adopted or step child or children, a definition omitted from the trust deed of trust 2. A further distinction is that item 7 to the Schedule of the trust deed of the trust includes additional members of the class of general beneficiaries who have not been similarly included in that class of beneficiaries by the schedule to the trust deed of trust 2. So the Tribunal finds that the beneficiaries of the trust and of trust 2 are not identical for the purposes of s 160 M (3)(a)(ii)(B) and s. 160 M (3)(a)(ii) does not operate to exclude a change in ownership, for the purposes of Part IIIA of the Act, of an asset transferred by the applicant from the trust to trust 2.
Section 160 R provides for the purposes of Part III A that a reference to a disposal of an asset includes, unless the contrary intention appears, a reference to a disposal of part of an asset.
Section 160 Z (1) provides that where an asset has been disposed of during a year of income in circumstances where its reduced costs base to the taxpayer exceeds the consideration in respect of the disposal, the taxpayer incurs a capital loss equal to the excess at the time of the disposal. The consideration in respect of a disposal of an asset is the total amount of money and the market value of any property other than money, that the taxpayer receives or is entitled to receive - s 160 ZD (1).
There are five elements, set out in s. 160 ZH (3), in calculating the reduced cost base of an asset. The principal element, and the only one relevant to these reasons, is the reduced amount of any consideration in respect of the acquisition of the asset. The reduced amount of the consideration for the acquisition of an asset is the amount of the consideration reduced by any part of it that has been allowed or is allowable as a deduction to the taxpayer and that was not included in the taxpayer's assessable income, by virtue of a provision of the Act outside Part III A, as a result of the disposal of the asset, see s 160 ZK (1).
Where part of an asset is disposed of, the reduced cost base is apportioned according to the method prescribed in s 160 ZI.
The capital loss was calculated on a reduced cost base of $0.30 per share and consideration of $0.20 per share, the closing market price of the shares on 12 June 1998 - (A6). This calculation is consistent with the applicant's contention that the custodian of the shares held them wholly for him, as trustee of the trust, and that he, in turn, disposed of the beneficial entitlement as to 8 million of the shares to the trustee of trust 2.
The rights against the company that constitute the shares, such as the right to vote, to receive dividends and to participate in a surplus on a winding up, accrue to the registered holder of the shares, in this instance, the custodian. The extent to which the equitable or beneficial interest in all or some of those rights formed part of the trust estate and so were within the dispositive power of the trustee pursuant to clause 8 of the trust deed (see para. 28 above) must be determined by the terms of the custodian and loan agreements. The respondent conceded in the course of his submission that the applicant did not make an effective transfer of an interest in the shares to trust 2, that the trust had some beneficial interest in the shares.
T22 is an unsigned copy of an agreement by the trustee of the trust to sell 8 million shares, free from encumbrances, to the trustee of trust 2. The applicant testified that he executed this agreement in both capacities. There is nothing in his evidence in chief, or under cross examination, that suggests otherwise and the Tribunal finds that the agreement was signed by the applicant in June 1998 when he completed the share transfer form (T23).
In his written submissions the respondent posed the question as to whether there had been a relevant disposal of an interest in the shares to create the capital loss for the purposes of Part III A? He submitted that there were two aspects to this enquiry. First was the agreement to transfer shares between the trust and trust 2 effective to transfer the beneficial interest in the shares and secondly, was the purported transfer of the shares a sham.
The respondent submitted there was no change in the beneficial ownership of 8 million of the shares on a number of grounds. He submitted that the effect of the custodian agreement was to make the custodian an equitable mortgagee of the shares. He cited, in support of this proposition, the decisions in Harrold v Plenty (1901) 2 Ch 314 and Adelaide Building Co. Pty Ltd (in liq.) v ABC Investment Pty Ltd & Anor. (1990) 8 ACLC 445 that the deposit of share certificates in a company creates an equitable mortgage. It is unnecessary for the Tribunal to consider what effect an equitable mortgage would have had on the applicant's power to dispose of the beneficial ownership of the shares because it was common cause at the hearing that the shares were uncertificated and registered electronically in the name of the custodian, a fact indicative of a legal rather than an equitable mortgage.
The respondent referred to the conditions in the letter from the bank of 10 July 1997 (T9) approving the loan, in particular the condition in clause 2 that dividends from the shares were to be applied in payment of interest for the facility, and surplus funds were to be held on Term Deposit under a Letter of Set-Off as security for the facility. Clause 2 does not render the sale agreement ineffective. It is an undertaking to apply the dividends in a particular way that is consistent with the custodian holding the right to dividends beneficially for the applicant as trustee of the trust.
The respondent referred to the fact that the applicant was bound by the loan document (T10) and the guarantee and indemnity (T11). The loan document lists events and occurrences which shall constitute an event of default until the loan is repaid. This list includes:

"(c) if the Borrower fails in the due and complete performance or observance of any obligations of this Agreement .... And such failure continues unremedied for a period of seven days after written notice thereof has been given to the Borrower of the Bank;

(e) if there is committed a breach of any covenant or agreement contained in the Securities;

(1) if any Borrower is a trustee of a Trust ("the Trust"): -

(i) at any time without the prior written consent of the Bank, a new trustee of the Trust is appointed or any trust funds of the Trust are resettled or set aside, or

(ii) at any time a restriction or limitation shall be placed or deemed or held to be placed upon the right of the trustee of the Trust to be indemnified out of the assets of the Trust."

The guarantee and indemnity (T11) is a security described in item 6 of the Schedule to the loan agreement. The applicant is one of the guarantors in his personal capacity. It is not necessary for the Tribunal to determine whether the sale of shares from the trust to trust 2 is a breach of the loan agreement and the guarantee and indemnity by the applicant, because even if it were, such breach would not render the share sale ineffective. The applicant, as trustee of the trust, did not surrender his beneficial interest in the shares when he entered into the loan agreement and agreed to personally guarantee it.

The respondent adverted to a number of matters that arose on the documents and from the evidence, to support his submission that even if the applicant, as trustee of the trust, retained dispositive power with respect to the beneficial ownership of the shares, he did not exercise that power to transfer 8 million shares to trust 2 and so the documents T22 and T23 have no legal effect because they are a sham or disguise for what is no transaction at all.
The nature of "sham" transactions was comprehensively considered by Justices Lockhart and Beaumont in their decisions in Sharrment Pty Ltd & Ors. v Official Trustee in Bankruptcy [1988] FCA 179; (1988) 18 FCR 449, at 453 to 458 and 467 to 469 respectively. Justice Lockhart, after referring to a number of authorities including the decision of Windeyer J in Scott v. Commissioner of Taxation (Cth) (No 2) (1966) 40 ALJR 265 at 279 and that of Diplock LJ in Snook v London & West Riding Investments Ltd. [1967] 2 Q.B. 786 at 802, defined a "sham", for the purposes of Australian law, as

"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."

Justice Beaumont concluded that in determining whether a particular transaction was a sham, it is necessary to ascertain what were the genuine intentions of the parties to the transaction - see Sharrment Pty Ltd & Ors v Official Trustee in Bankruptcy (1988) 18 FCR at pp 467 - 468 and the cases cited.
The matters that, in the respondent's submission should be taken into account, are summarised in his written submissions as follows:

"21. The following matters also arise on the documents and in the evidence of the applicant, and should be taken into account:

(1) the applicant was Trustee of both vendor and purchaser and had actual knowledge of the security.

(2) The purported share transfer agreement was on its face the transfer of legal title. It was said to transfer the shares free of encumbrances when the shares were held by a custodian/ equitable mortgagee as security. Similarly, T23 transfers shares " standing in my name..." when there were no such shares. While T23 may be the result of using a standard form, neither document is consistent with there being a common understanding that it was the equitable interest in the shares that was being transferred.

(3) On the other hand, and a factor consistent with a genuine transaction, the agreement at T23 was stamped.

(4) The purchase price of $1.6 m was paid by vendor finance. The only evidence of the loan so created are clause 3 of the Share Sale Agreement at T22 (158), and journal entries among related entities.

(5) In particular, the applicant's evidence is that the obligations under the custodial agreement and loan passed to Trust 2. There is no documentation of that at all.

(6) The applicant asserts that the transfer of the shares (or a beneficial interest in them) passed also the obligation to pay interest to NAB and restrictions on the dividends due to T9, and was subject to the security of NAB and the custodian agreement. Yet the shares were transferred at the then market value.

(7) The obligation of the vendor to deliver the standard transfer form was of no substance, as no transfer could be registered.

(8) While the journal entries show interest was paid by the Trust No 2 which was the same rate as and set off the loan from the NAB to Trust 1, this was effected by the dividends being applied (as required by T9) and (in 1999) by a distribution to Trust No 2 from Trust No 1 (see applicant's supplementary documents, Exhibit A1 at 68).

(9) The loan and transfer were made on the day the Trust No 2 was settled. Trust No 2 was settled with $5 capital yet borrowed $1.6 m with its only asset being the corresponding shares which were themselves already mortgaged. Trust No 2 never had its own bank account, and it seems that there was only differentiation of the funds of the two trusts by journal entry.

(10) The applicant never intended to lose his relevant interest in the shares which he had obtained in a management buy-out of the Chairman, and which was the maximum number he was able to own under the corporations law.

(11) The applicant was the trustee, guardian and appointer as well as beneficiary of both trusts: see Trust No 1 Deed at 76, 77; Trust No 2 Deed at 139, 156. It was within his unfettered power and discretion to move money between them as he determined to be appropriate.

(12) The shares were purportedly sold by Trust 2 to the applicant himself, again for the $1.6 m without there being any documented loan agreement, or documents evidencing the transfer of obligations to NAB in relation to the shares.

(13) While the sale from Trust No 1 to Trust No 2 was at then market value, the later sale from Trust No 2 to the applicant was of the same number of shares at the same price, and apparently not at market value. The evidence of the applicant was that correspondence with the earlier price, and not market value, determined the sale price.

(14) The ownership of the shares was never altered on any register or subregister and could not have been; the custodian was not notified, the ASX was not notified."

The Tribunal has found, for the reasons stated at paras. 25 to 28 above, that the share transaction is not legally ineffective because the parties are the applicant, as trustee of the trust, and the applicant, as trustee of trust 2. The Tribunal also finds that that fact does not establish that the applicant had no intention that the transaction have legal effect.
The share sale agreement (T22) refers to 8 million shares "free from encumbrances". The corresponding share transfer form (T23) purports to be a transfer of 8 million shares, that stand in the applicant's name in the books of the company, by the applicant as the registered holder of the shares. The applicant was clearly aware of the custodian agreement and the fact that the shares were not registered in his name. He testified that his intention was to transfer his beneficial ownership of the shares and yet he signed documents to transfer unencumbered shares registered in his name. The documents therefore purport to do something more than the parties agreed to do.
Lockhart J. at 454-455 of his decision in Sharrment Pty. Ltd. & Ors. v. Official Trustee in Bankruptcy [1988] FCA 179; (1988) 18 FCR 449, while recognising that a transaction must be characterised in its entirety, identified certain authorities that assist in recognising the significance of particular elements of the transaction under consideration. He cites the decision of Lord Reid in Inland Revenue Commissioners v. Littlewoods Mail Order Stores Ltd. [1963] AC 135 at 155 for the proposition that the artificiality of a transaction does not mean it is a sham or that its documents are a sham in circumstances where the documents have the effect they purport to have and they do not purport to do something different from what the parties agreed to do. The disconnection in this matter between what the parties agreed and what the documents purport to effect, relates to the legal title to the shares and must be distinguished from the situation where say the documents purport to be a lease and the parties have agreed upon a sale. As the respondent conceded, the discrepancy in relation to the transfer form (T23), is attributable to the fact that a standard transfer form was used. This document was stamped for duty paid, a fact that militates against a finding that the share transaction was a sham, even if no transfer could be registered.
Whatever the documents (or lack of them) in relation to the financial arrangements for the acquisition of the shares at $1.6 million by the applicant, as trustee of trust 2, they do not, in the view of the Tribunal, support the conclusion that the applicant did not intend to dispose of the beneficial ownership of the shares and that the share transaction was a disguise for no transaction at all.
The Tribunal, after careful consideration of all the matters raised by the respondent, is unable to characterise the share transaction under consideration, in its entirety, as a sham as defined by Justice Lockhart, for the purposes of Australian law, in his decision in Sharrment Pty. Ltd. & Ors v. Official Trustee in Bankruptcy [1988] FCA 179; (1988) 18 FCR 449 at 454 - see para. 46 of these reasons. So the Tribunal finds that the share transaction was effective to dispose of the beneficial ownership of 8 million of the shares from the applicant, as trustee of the trust, to the applicant, as trustee of trust 2, at consideration of $1.6 million. In light of this finding it is unnecessary for the Tribunal to consider the probative value of the respondent's statement at para. 66 of his reasons for the objection decision (T2) that he has not contended the sale constitutes a sham.
The Tribunal finds that the beneficial ownership in all the valuable rights constituted by 8 million of the shares were disposed of to the applicant, as trustee of trust 2, and so the applicant, as trustee of the trust, incurred a capital loss of $800,000 for the purposes of Part III A of the Act in the income year.
The respondent may determine, pursuant to s. 177F of Part IV A that the whole, or a part, of a capital loss was not incurred by a taxpayer in a year of income if it is a tax benefit obtained in connection with a scheme to which Part IV A applies. Part IV A applies to any scheme entered into or carried out after 27 may 1981 ( s. 177D) and, in the income year, "capital loss" had the same meaning as in Part III A of the Act and "taxpayer" includes a taxpayer in the capacity of a trustee, s. 177A(1).
"Scheme" is defined very broadly in s. 177 A (1) and (3) to mean any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and any scheme, plan, proposal, action, course of action or course of conduct including a unilateral scheme, plan, proposal, action, course of action or course of conduct.
In this matter, the scheme the respondent identified is set out in his statement of facts and contentions, and written submissions, as follows:

(b) the purported sale of 8 million shares by the Trust to the trust No 2 on 12 June 1998;

(c) the purported realisation of a capital loss of $800,000 from the sale of the 8 million shares which was disclosed by the Trust in its income tax return for the income year ended 30 June 1998;

(d) the offsetting of the $800,000 capital loss against the Trust's capital gains for the year ended 30 June 1998; and

(e) the distribution by the Applicant as Trustee for the Trust, of the net capital gains of the Trust for the income year ended 30 June 1998 (after the offsetting of the purported capital loss of $800,000), save for the first $27,500, to the Applicant pursuant to the resolution of the Applicant as Trustee of 26 June 1998;

(f) the purported reduction of the net capital gain distribution to the applicant by the Trust for the year ended 30 June 1998 by $800,000."

In the income year, by virtue of s. 160 ZO(1) of the Act, the assessable income of a taxpayer included an accrued net capital gain in that year. A net capital gain accrued to a taxpayer in the amount (if any) by which total capital gains exceeded total capital losses for the year and net capital losses carried forward from previous years of income, 160 ZC(1).
A capital loss incurred by a taxpayer in a year of income will constitute a tax benefit in connection with a scheme where the whole or a part of the capital loss would not have been, or might reasonably be expected not to have been, incurred by the taxpayer in the year of income if the scheme had not been entered into or carried out, s 177C(1)(ba).
Section 177D prescribes the schemes to which Part IV A applies as follows:

"177D This Part applies to any scheme that has been or is entered into after 27 May 1981 and to any scheme that has been or is carried out or commenced to be carried out after that date (other than a scheme that was entered into on or before that date), whether the scheme has been or is entered into or carried out in Australia or outside Australia or partly in Australia and partly outside Australia, where:

(a) a taxpayer (in this section referred to as the "relevant taxpayer") has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and

(b) having regard to:

(i) the manner in which the scheme was entered into or carried out;

(ii) the form and substance of the scheme;

(iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;

(iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;

(v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;

(vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;

(vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and

(viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi),

it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers)."

So the issue to be decided by the Tribunal is whether the respondent correctly determined, pursuant to s. 177 F (1)(c), that the applicant, as trustee of the trust, did not incur the capital loss for income tax purposes because it was a tax benefit connected with the scheme identified by the respondent and the scheme is one to which Part IV A applies.
The question whether the capital loss is a tax benefit connected with the scheme identified by the respondent, turns on whether, on the evidence, there is a reasonable expectation that the applicant, as trustee of the trust, would have incurred the capital loss had he not entered into or carried out the scheme. "A reasonable expectation" according to the decision of the High Court in Peabody v. FCT [1994] HCA 43; (1994) 181 CLR 359; 94 ATC 4663 at 4671, "requires more than a possibility. It involves a prediction as to events which would have taken place if the relevant scheme had not been entered into or carried out and the prediction must be sufficiently reliable for it to be regarded as reasonable."
In his evidence, the applicant was asked whether he had discussed the share transaction involving the trust and trust 2 with the bank and he answered "No". He then confirmed that there had been some discussion with his lawyer and accountant as to how the transaction would be done. He explained that his initial position had been to get the permission of the bank to sell the shares and repurchase them on market but he spoke to his accountant and lawyer "because obviously there was a problem with them being mortgaged." They discussed the alternatives that were available and although he was of the opinion that the bank would have agreed to the on market sale and purchase, provided he paid the charges, fees and stamp duty, he chose the share transaction from the trust to trust 2 because it was explained to him "that the trust was entitled to do that in terms of the beneficial ownership and that seemed to be a more straight forward way of achieving the same result." He then denied that he wouldn't have acted at all, reiterating his belief that the bank would cooperate and concluded by saying: "The $800,000 gain was a significant sum and I believed I had several options."
The applicant, at para. 25 of his outline of submissions, contended that the capital loss was not a tax benefit connected with the scheme identified by the respondent because there was at all material times a reasonable expectation that a sale of the beneficial ownership in the shares would have occurred in an alternative form or forms. The transaction involved in the scheme identified by the respondent had additional commercial advantages (the applicant testified that it served the purpose of distancing the shares from the trust's creditors) and it lacked commercial disadvantages associated with the alternatives - publicity, risk of driving share price down, paying brokerage and making the bank nervous.
On the evidence before it, the Tribunal is unable to reliably predict that the bank would have consented to the alternative transactions for incurring the capital loss suggested by the applicant. The shares were mortgaged to the bank's subsidiary to secure a substantial loan to the applicant as trustee of the trust. It is unlikely that the bank would have consented to a sale of 8 million of the shares to realise a loss, without repayment of the loan, for the same reasons the applicant decided not to seek its consent to such a sale. So the Tribunal finds for the purposes of s. 177D (a) of the Act that the applicant, as trustee of the trust, obtained a tax benefit connected with the scheme identified by the respondent because, in the circumstances of this matter, it is unreasonable to expect that the applicant would have incurred the capital loss had the scheme not been carried out. The scheme identified by the respondent includes the sale of 8 million of the shares at the capital loss.
S. 177 D (b) prescribes eight matters to which the tribunal must have regard in determining whether it would be concluded that the applicant, as trustee of the trust, carried out the scheme, or any part of it, for the purpose of obtaining the tax benefit that is the capital loss. The inquiry required by Part IVA is objective, Commissioner of Taxation v. Hart [2004] HCA 26 (27 May 2004) at 9 para 37, and the Tribunal has proceeded in this matter mindful of the fact that "[Always the question must be whether the terms of the Act apply to the facts and circumstances of the particular case." - see the judgment of Gummow and Hayne JJ in Commissioner of Taxation v Hart at 14 para 52.
The Tribunal finds, after consideration of all the matters referred to in s.177D(b)(i) to (viii) in relation to the facts and circumstances of the scheme identified by the respondent in this matter, that a reasonable person would conclude that the applicant, as trustee of the trust, carried out the scheme with the sole purpose of obtaining the tax benefit that is the capital loss and so Part IV A applies to the scheme pursuant to s 177D.
The applicant submitted, in relation to the manner in which the scheme was carried out, that it was simple and straightforward and that the elements of the scheme are duplicated in numerous share trading transactions. The following statement at para. 53 in the decision of Gummow and Hayne JJ in Commissioner of Taxation v Hart is relevant to this submission:

"The bare fact that a taxpayer pays less tax, if one form of transaction rather than another is made, does not demonstrate that Part IVA applies. Simply to show that a taxpayer has obtained a tax benefit does not show that Part IV A applies. With these considerations in mind, it is sometimes said that it is necessary to read Part IV A in a way that will not bring "ordinary" transactions to tax. It is obvious that the content of such a proposition turns entirely upon what is meant by "ordinary"."

The provisions of Part III A operate in relation to transactions that are disposals of relevant assets and the proposition referred to by their Honours may apply where a taxpayer ordinarily disposes of an asset at a capital loss to achieve a particular net position in relation to capital gains and losses in a year of income. That was not the case in the present matter. The share sale, of necessity, was not carried out in an ordinary manner because the shares were mortgaged to the bank's subsidiary entity in circumstances where the applicant was contractually obliged to obtain the bank's consent to any sale of shares. There were also other commercial reasons for not adopting that course.
As to the form and substance of the scheme, the share sale agreement refers to 8 million units free from encumbrances and the vendor's obligation to deliver a share transfer against payment of the price whereas the applicant, as trustee of the trust, only had a beneficial interest in the shares. So there was a disconnection between the form and the substance of the share sale agreement.
On 11 June 1998 the applicant settled the sale of a parcel of shares for $800,000 that generated the capital gain of $787,375 reported in the trust return for the income year. On 12 June 1998 trust 2 was settled and 8 million of the shares were sold to the applicant, as trustee of trust 2, at a capital loss of $800,000. The time at which the scheme was entered into is a matter referred to in s. 177D(b)(iii).
The Tribunal is obliged by s.177D (b)(iv) to have regard to the fact that, by entering into the scheme, the applicant, as trustee of the trust, incurred a capital loss that was offset against capital gains derived in the year of income to work out the applicant's net gain or loss for that year as trustee of the trust. A substantial change in the personal financial position of the applicant resulted from the scheme because the balance of the net capital gain of the trust for the income year, that was distributed to the applicant and included in his assessable income for the purposes of the Act, was reduced from $939,099 to $139,099, s 177 D(b)(v).
In relation to the matters set out in s 177 D (b)(v)(vi)(vii) and (viii) the applicant submitted that a commercial benefit accrued to the applicant, and to members of his family, from the scheme because the shares that were sold to him, as trustee of trust 2, were no longer available to the unsecured creditors and future creditors of the trust. In the event that the loan were redeemed and that the shares rose in value, trust 2, which had no creditors, would have valuable unencumbered assets. When all the matters listed in s 177 D (b) are considered in relation to the facts and circumstances of the scheme in this matter, the Tribunal finds that it would not be concluded that the applicant's purpose, or one of the applicant's purposes, in carrying out the scheme, was to shelter 8 million of the shares from any claims that the creditors, or future creditors, of the trust may otherwise have on them.
In light of the Tribunal's finding at paragraph 67 of these reasons, the Tribunal affirms the respondent's determination, pursuant to s 177 F (1)(c) in Part IV A, that the applicant, as trustee of the trust, did not incur the capital loss in the year of income.
By section 226(1) of the Act, the amended assessment included a liability for an amount of additional tax by way of penalty because the respondent's determination under s 177 F(1) was taken into account in calculating the tax assessable to the taxpayer. The respondent calculated the amount of additional tax at a penalty percentage of 50% as defined in s 226(2)(a). Section 226 (2)(b) defines 'penalty percentage' to mean 25% if it is reasonably arguable that Part IV A does not apply. The applicant contends that it was reasonably arguable that Part IV A did not apply to the scheme identified by the respondent in this matter and so the correct penalty percentage was 25% and the amount of additional tax should be reduced accordingly.
The applicant relied on three lines of argument set out at para.29 of his outline of submissions:

(a) Part IIIA of the Act permitted taxpayers to take steps to realise genuine capital losses and Parliament did not intend that Part IVA apply to such transactions;

(b) the scheme in this matter was a normal sale of the beneficial interest in shares - it conferred no relevant benefit on the applicant because it could have been done in alternative ways which were less attractive by reason of commercial, and not tax, considerations; and

(c) a reasonable person could not reach the conclusion that the applicant's dominant purpose in carrying out the scheme was such as to fall within Part IVA.

The facts of the scheme in this matter, as found by the Tribunal, and the relevant provisions of Part IVA, do not, in any material sense, support the position taken by the applicant in relation to Part IVA and so it would not be concluded, for the purpose of s.222C, that what the applicant argued for is about as likely as not correct. The Tribunal finds that it is not reasonably arguable that Part IVA does not apply to the scheme and so the correct penalty percentage for calculating the amount of additional tax is 50% as defined in s.226(2)(a).
The respondent charged the applicant an amount of tax shortfall interest in respect of the tax shortfall that arose from the determination under Part IV A in respect of the capital loss (T55, T57). The applicant contended that the amount of the interest should, in the circumstances of this matter, be remitted and the respondent submitted that his decision not to remit all or some of the interest charged is not reviewable by the Tribunal.
The interest was charged pursuant to s 170 AA(1) of the Act. The amount of interest up to 30 June 1999 was calculated in accordance with the provisions of s. 214A of the Act. The amount of interest from 1 July 1999 is a general interest charge calculated in terms of the relevant provisions of Division 1 of Part II A of the TAA.
By s. 14ZZA of the TAA, the Tribunal is empowered to review a reviewable objection decision which is an objection decision of the respondent in response to an objection that a taxpayer is permitted to make by a provision of an Act or of regulations, see ss 14ZQ 'objection decision'; 'taxation objection'; 14ZY; 14ZL - TAA.
S. 175 A of the Act provides that a taxpayer who is dissatisfied with an assessment made in relation to the taxpayer may object against it in the manner set out in Part IV C of the TAA. The exclusive definition of 'assessment' in s 6(1) of the Act does not include interest charged pursuant to s. 170 AA(1). Until 30 June 1999 the respondent was required by s.170 AA (9) to notify the taxpayer of the details of the interest payable under s.170 AA and, by s.170 AA(10), such notice could be incorporated in a notice of assessment. Since 1 July 1999 s. 170 AA(9) of the Act provides:

"Unless the contrary intention appears, in sections 172, 205, 206, 215, 216, 254, 255, 258, 259, and 265, but not in any other section, income tax or tax includes the general interest charge payable under this section."

None of the sections mentioned is relevant to the decision under review. So the Tribunal finds that the additional tax shortfall interest notified in the amended assessment is not part of that assessment and the decision under review is not a reviewable objection decision, for the purposes of s. 14ZZA of the TAA, to the extent that it is the decision of the respondent not to remit all or some of the additional tax shortfall interest.

For the reasons set out above, the Tribunal finds that the applicant has not proved on the balance of probabilities that the amended assessment is excessive for the purposes of s. 14ZZK (b)(i), and so the Tribunal affirms the respondent's decision of 4 July 2002 in this matter to the extent that it is a reviewable objection decision.

I certify that the 84 preceding paragraphs are a true copy of the reasons for the decision herein of Associate Professor G A Barton, Member

Signed: ..............(sgd V Wong)...................................

Solicitor for the Respondent Australian Government Solicitor

Appeals Tribunal Act 1975

Superannuation Standards Act 1987

Tax Assessment Act 1936

Administration Act 1953

The Taxpayer and Commissioner of Taxation [2004] AATA 1041; (2004) 57 ATR 1149; 2004 ATC 220 (1 October 2004)

Gambotto v W.C.P. Limited (1994 -1995) [1995] HCA 12; 182 CLR 432

Sharrment Pty Ltd & Ors. v Official Trustee in Bankruptcy [1988] FCA 179; (1988) 18 FCR 449

Inland Revenue Commissioners v. Littlewoods Mail Order Stores Ltd. [1963] AC 135

Peabody v. FCT [1994] HCA 43; (1994) 181 CLR 359; 94 ATC 4663

Commissioner of Taxation v. Hart [2004] HCA 26 (27 May 2004)

The Taxpayer and Commissioner of Taxation [2004] AATA 1041; (2004) 57 ATR 1149; 2004 ATC 220 (1 October 2004)

At a glance

Court

Decision date

Source

Judgment (46 paragraphs)

Legislation Cited (4)

Cases Cited (9)

The Taxpayer and Commissioner of Taxation [2004] AATA 1041; (2004) 57 ATR 1149; 2004 ATC 220 (1 October 2004)