The Federal Court has dismissed a taxpayer’s appeal against an AAT decision that had confirmed the taxpayer, an automotive repair company, was not entitled to deductions for contributions paid to an off-shore “employee welfare fund” in the 1998 and 1999 years, nor resultant carried forward losses in the 1999 income year.
The taxpayer and a number of related companies carried on an automotive repair and spare parts business. The “employee welfare fund” fund had been established in June 1998 as an offshore discretionary trust fund. Its beneficiaries were the 2 employee-operators of the business and a spouse. In 1998, the taxpayer claimed deductions of $400,000 for contributions made to the fund. In 1999, the taxpayer claimed deductions for further contributions of $25,000 and carried forward losses resulting from the original contribution in 1998.
Tax returns were accordingly lodged by the taxpayer and, in 2012, the Commissioner issued amended assessments to deny the original and later contributions and the resultant carried forward losses (including for the 2002 income year), together with issuing Pt IVA determinations.
The AAT found that while the Commissioner could issue assessments called ‘amended assessments’ (but in fact they were original assessments) for the relevant income years in 2012, but an ‘actual’ amended assessment issued for the 2002 income year was out of time to deny a deduction for further carried forward losses – [2014] AATA 414, Re RepairCo and FCT.
The taxpayer argued before the Federal Court that 3 questions of law arose:
- 1.Whether the Commissioner had power to make amended assessments for 1998 and 1999 in the absence of original assessments for those years? The Court said this question did not arise. It considered the notices of assessment were valid. In the Court’s view, the only potential deficiency was that the notices identified themselves as amended assessments, but it said this could not affect the validity of the notices.
- 2.Whether the Tribunal failed to properly apply8-1 of the ITAA in respect of the payments to the Employee Welfare Fund made by the taxpayer? The Court found the Tribunal had properly applied s 8-1 and dealt with the case precisely as it was put by the taxpayer.
- 3.Whether the Tribunal erred in respect of the application for review of penalties? The Court found the Tribunal’s reasons about penalties disclosed no error of principle.
The Court dismissed the taxpayer’s appeal and also his application for relief under s 39B of the Judiciary Act 1903 (Cth).
(Allan J Heasman Pty Ltd v FCT [2014] FCA 1282, Jagot J, 28 November 2014.)
[LTN 232, 1/12/14]
Taxpayer appeals to Full Federal Court
The taxpayer has appealed to the Full Federal Court against the decision in Allan J Heasman Pty Ltd v FCT [2014] FCA 1282. The Federal Court had dismissed the taxpayer’s appeal against an AAT decision that had confirmed the taxpayer, an automotive repair company, was not entitled to deductions for contributions paid to an off-shore “employee welfare fund” in the 1998 and 1999 years, nor resultant carried forward losses in the 1999 income year.
[LTN 237, 8/12/14]
Extract from AAT’s decision on deductibility (Oh dear…)
1. The taxpayer and a number of related companies carry on an automotive repair and spare parts business in suburban Sydney.
2. In 1998 and 1999, now 15 or more years ago, the taxpayer made three payments which it says were deductible outgoings for income tax purposes. It claims the payments were made to the trustee of an “Employee Welfare Fund”. The Fund is said to have been established so that “benefits” could be provided for the “welfare” of the Fund’s beneficiaries – specified individuals who were employees of either the taxpayer itself, or one of the related companies.
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13. Since 1994 the group has been funded by debt finance obtained from Hua Wang Bank Berhad (HWBB), a bank holding a licence to transact offshore banking business in Samoa. HWBB was established in that same year by Mr Vanda Gould, the external accountant to the RepairCo group. The finance provided to the group originated from a loan agreement made between one of the group companies, RepairCo (Sales), and HWBB in June 1994. The “Principal Sum”, referred to in the Schedule to the loan agreement, was AUD750,000. Any amounts drawn down under the loan agreement were guaranteed by Arthur Holbrook and his brother Desmond, who run the business of the RepairCo group.
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16. At least during the period 1993 to 2005, and therefore throughout the relevant years, Arthur and Desmond were employed not by RepairCo but by RepairCo (Sales). Arthur said the other companies in the group “would pay management fees to [RepairCo (Sales)] which it would return as income, and this money helped fund [his] salary and [Desmond’s] salary during those years”.
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43. In its 1998 income tax return the taxpayer declared total income of id=”mce_marker”,347,574, total expenses of id=”mce_marker”,394,843 (including the amount of $400,145 paid to Asiaciti on 29 June 1998 and referred to in [34] of these reasons) and a resultant loss of $47,269. [FJM Note: It therefore appears that the contribution to the Welfare Fund came from RepairCo (not the employing entity: RepairCo (Sales).]
54. The Respondent’s Written Outline of Submissions (RWS) argues against deductibility. There are two limbs to the argument. The first is that the Employee Welfare Fund and the purported contributions to it were a sham. The second is that, in any event, and even if the arrangement is not a sham, neither paragraph (a) nor (b) of s 8-1(1) supports the deduction claims:
The payments to Asiaciti [trustee of the Welfare Fund] are not deductible under section 8-1(1)(a) of the 1997 Act because the occasion for them is not to be found in what was productive of the taxpayer’s actual or expected income. They are not deductible under section 8-1(1)(b) of the 1997 Act because they are not reasonably capable of being seen to be desirable or appropriate from the point of view of the pursuit of the taxpayer’s business.
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60. Its case is put on the basis that [the Taxpayer: RepairCo] conducts a “business of providing personnel to other entities in the [RepairCo] group”. However, that proposition is not supported by the evidence. Mr Holbrook said in his first witness statement:
In the period 1993-2005 [RepairCo (Sales)] employed [Desmond] and me and paid our salaries. The other companies would pay management fees to [RepairCo (Sales)] which it would return as income, and this money helped fund my salary and [Desmond’s] salary during those years.
61. In other words, RepairCo (Sales) was the employing entity, and the other companies paid fees to the employing entity as a contribution towards the salaries paid by it. That bears no resemblance to an assertion that RepairCo conducts a business of “providing personnel to other entities in the [RepairCo] group”. And in any event, the suggestion that the taxpayer (and the other companies in the RepairCo group) were partly funding the salaries of the Holbrook brothers by paying “management fees” to RepairCo (Sales) is not consistent with the oral evidence that Arthur Holbrook gave in response to questioning from the Commissioner’s counsel, Mr McGovern SC, about the way the fees were reflected in the financial statements of the taxpayer, RepairCo[42]. Those responses indicated that (a) “management fees” was a convenient label applied by Mr Holbrook to any inter-company transfer of funds; (b) funds could be transferred in either direction – both into and out of RepairCo; (c) as a result, and despite Mr Holbrook’s suggestion that the external accountants would “generally come up with [..] the net final figure”[43], in some years the expression “management fees” represented both an income item and an expenditure item in RepairCo’s financial statements.
63. Accordingly I reject the suggestion that “management fees” in the accounts of any of the companies in the group can properly be regarded as representing a contribution by one of the companies towards the salaries paid by another.
64. Here, to prove the assessments excessive, the taxpayer must establish either (i) that the deductions are allowable and are not otherwise negated by Part IVA or (ii) that the assessments are out of time. To consider specifically whether it is either possible or necessary to label the transactions a “sham” can be something of a distraction.
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67. A further significant problem for the taxpayer is the way the Employee Welfare Fund was set up and then operated.
68. First, the suggestion for the creation of the Fund originated not with the business itself, but through Mr Gould. It was an opportunistic arrangement undertaken in the context of mass-marketed offshore schemes that were being promoted at the time. At no stage had the taxpayer identified any need to provide for the retention or rewarding of its employees or the employees of any of the related companies. Instead, Mr Gould put the proposal forward to Mr Holbrook and there is no doubt that he did so because of a perception that the arrangement might provide substantial tax benefits for his client. He had had the earlier dealings with Asiaciti’s Australian tax advisers; he was aware of the favourable opinions and the private rulings from the ATO.
69. Second, the implementation was, to put it bluntly, sloppy. The directors of the taxpayer purportedly resolved to “arrange for the establishment of the Fund” on the day after it had actually been established.
70. Third, the basis on which the Fund was to be used remains opaque. The Trust Deed is incomplete. Critical concepts such as “benefits” and “welfare purposes” are not explained. The basis on which Beneficiaries may benefit pursuant to clause 7.1 is not explained. No light is shed on the “trusts, powers and provisions as are hereinafter declared” that guide Asiaciti’s investment of the assets of the Fund. There is no definition of “Member”. There is no definition of “Dissolution Date”.
71. Fourth, the Trust Deed provides that:
Employees of an Employer shall become Beneficiaries of the Fund upon admission by the Trustee as Members of the Fund following an invitation from the Employer, making an application to the Trustee and fulfilment of any other conditions prescribed pursuant to this Deed.
72. The taxpayer has produced a number of “Invitations to become a member”, and a number of “Applications to become a member”, but no documents to show that the Trustee ever admitted anyone as a member of the Fund. Furthermore, those pages of the Trust Deed that have been produced to the Tribunal do not include amongst them any reference to “any other conditions prescribed pursuant to this Deed” which may need to be fulfilled before acceptance of a prospective Member.
73. Fifth, the quantum of the contributions bears no apparent relationship to the needs, whether perceived or real, of those who are apparently to benefit from the contributions. As Mr Holbrook said, at least in relation to the first contribution, “it was based upon what we could afford”. And I infer from the fact that, if deductible, the contributions would have had the effect of entirely extinguishing what would otherwise have been a positive amount of taxable income, that they were also based upon the amount of tax deductions needed to secure that very outcome.
74. Sixth, I find that the largest single contribution to the Fund, $400,145, found its way (as part of the larger amount of $544,977.86), via HWBB, back to the taxpayer two months after it was made. There is no evidence that the sum was used for any employee welfare purposes. That makes it difficult to accept that the true purpose of the contribution was as asserted.
75. Seventh, over 90% ($22,780) of the second largest contribution to the Fund, $25,000, was transferred by Asiaciti to the local bank account of the RepairCo (Sales) Employee Welfare Fund and was then used to pay the private health insurance premiums of the Holbrooks and, later, Mr Vincent. That arrangement, to that extent, is nothing more than an attempt to recharacterise non-deductible private expenditure of the individuals as allowable deductions for the company: see Re JKY Projects and Commissioner of Taxation [2004] AATA 874. The third payment, of id=”mce_marker”0,000, has the same look about it; it took an even more direct route, not troubling to call in on the Asiaciti account on the way through.
76. Eighth, the payment of $22,780 is so far the only payment ever made out of the Fund. In other words, after 15 years, only a little over 5% of the Fund has been paid out. And the circumstances of that payment are not entirely clear. The Information Circular explains that:
“[i]n order to apply for benefits from the Fund, it is necessary to complete and send a claim form to the Trustee. Claim forms are available from the Company and the Trustee”; and
“[b]oth Members and their dependants can apply for benefits from the Fund”.
77. But no claim forms relating to the payment of $22,780 are before the Tribunal, and no evidence has been given to explain which “Members” of the Fund, or which of their dependants, applied for benefits.
78. Ninth, there is some doubt about the true identity of the Trustee of the Welfare Fund. According to a printout that Mr Holbrook obtained from the New Zealand Companies Office, the New Zealand company registration number 671265 (shown in the incomplete Trust Deed as the apparent registration number of the Trustee of the Welfare Fund, Asiaciti Trust (New Zealand) Limited) actually belongs to a company named Asiaciti Trustees N.Z. Limited. That company was deregistered in 2002. If that is the company that was the Trustee of the Welfare Fund, then its deregistration would have left the Welfare Fund without a trustee and, on the face of it, the money inaccessible.