The High Court on Wed 11.6.2014, dismissed a taxpayer’s appeal from the Full Federal Court decision in Howard v FCT [2012] FCAFC 149. The Full Federal Court had upheld the Commissioner’s appeal against a decision that damages were received by the taxpayer in a fiduciary capacity (meaning the damages were thus assessable to the taxpayer).
The taxpayer was involved in a failed golf course joint venture project. The taxpayer and the other 2 joint venturers, who were directors of a company (DL) involved in the project, successfully sued the other joint venturers for breach of fiduciary duty and in 2002 and were awarded damages by the Supreme Court of Victoria for the loss of a business opportunity (a decision that was upheld on appeal in 2005). The taxpayer received $861,853. The Commissioner assessed the taxpayer on this amount, but the taxpayer objected on the basis that he had received the money as trustee for DL and it was therefore assessable to the company. At first instance, in Howard v FCT (No 2) [2011] FCA 1421, the Federal Court agreed with the taxpayer, but that was reversed by the Full Federal Court.
The High Court held that the taxpayer was liable to income tax on the equitable compensation received in satisfaction of the Supreme Court judgment. The Court said the taxpayer did not receive the amount as constructive trustee for DL because, at the time he obtained or became entitled to that amount, there was no actual conflict, and no real possibility of conflict, between his personal interests and his duties as a director of DL.
As to the litigation agreement, the Court held that as it provided for the assignment of the taxpayer’s future income, rather than his underlying rights to receive those sums, the proceeds of the action were income in his hands. The sum received was correctly included in his assessable income, the High Court said.
(Howard v FCT [2014] HCA 21, High Court, French CJ, Hayne, Crennan, Gageler and Keane JJ, 11 June 2014)
[LTN 110, 11/6/14]
High Court’s summary of the Judgment
Today the High Court unanimously dismissed an appeal from a decision of the Full Court of the Federal Court of Australia, holding that the appellant, Stephen Howard, was liable to income tax on equitable compensation received in satisfaction of a judgment.
- Mr Howard was a director of Disctronics Ltd (“Disctronics”).
- In his income tax assessment for the 2005 income year, he did not include, as part of his assessable income, his share of an award of equitable compensation received in satisfaction of a judgment in proceedings in the Supreme Court of Victoria.
- Those proceedings concerned a joint venture, of which Mr Howard was a member, involving the purchase, lease and on-sale of a golf course.
- Whilst the joint venture was on foot, Mr Howard and two other directors of Disctronics, who were also members of the joint venture, endeavoured to have Disctronics become the purchaser of the golf course, although two other members of the joint venture did not agree.
- Subsequently, the two other members of the joint venture diverted to their own use the business opportunity pursued by the joint venture and, in so doing, were found to have breached fiduciary duties they owed to Mr Howard and the other members of the joint venture.
The Commissioner of Taxation (“the Commissioner”) assessed Mr Howard to income tax on the basis that his share of the equitable compensation was part of his assessable income for the relevant year.
Mr Howard disputed the assessment, claiming that he received the amount of equitable compensation as constructive trustee for Disctronics and that it was, therefore, incorrectly included in his assessable income. He argued that from the time the directors decided to try to involve Disctronics as the purchaser, his fiduciary obligations to Disctronics as a director meant that he could not retain that gain for himself to the exclusion of Disctronics.
Mr Howard appealed to the Federal Court in the exercise of its original jurisdiction against the Commissioner’s decision. The primary judge held that Mr Howard had received the compensation as constructive trustee for Disctronics and that it was, therefore, incorrectly included as part of his assessable income.
That holding was reversed on appeal to the Full Court, which held that there could be no conflict of interest in the way contended for by Mr Howard, and no breach of his fiduciary duty to Disctronics.
The Full Court also rejected Mr Howard’s additional claim that by a litigation agreement between Disctronics and its directors, entered into at about the time the Supreme Court proceedings were instituted, he had assigned the right to receive the amount of equitable compensation to Disctronics, such that the income was not derived by him beneficially. By grant of special leave, Mr Howard appealed to the High Court.
Dismissing the appeal, the High Court held that Mr Howard did not receive the amount of equitable compensation as constructive trustee for Disctronics because, at the time Mr Howard obtained or became entitled to that amount, there was no actual conflict, and no real possibility of conflict, between his personal interests and his duties as a director of Disctronics.
As to the litigation agreement, the Court held that as it provided for the assignment of Mr Howard’s future income, rather than his underlying rights to receive those sums, the proceeds of the action were income in his hands.
The sum received was correctly included in his assessable income.