Key News Summary – In Queensland Maintenance Services Pty Ltd (In Liquidation) v FCT, the AAT found that the Commissioner was right to disallow general deductions, under s8-1 of the ITAA97, for ‘renovation compensation invoices’ because of curious facts affecting purpose and ‘management fee expenses’ because they were to buy the right to manage the ABC leaning centres.
The taxpayer, was the head company of a consolidated group, and it performed or engaged subcontractors to provide a range of services to childcare centres (ABC Learning Centres). These services included general maintenance, fleet management, plumbing and electrical work.
Amended assessments were issued to the taxpayer for
- the 2007 income year, disallowing a deduction of just over $35.36m in payment of “renovation compensation invoices”, and
- the 2008 income year, disallowing a deduction of just over $13.35m for “management fee expenses” paid by a subsidiary member of the consolidated group.
These extra facts give some context to this.
- The structure of ABC’s business was that the Centres were run by licensees.
- The taxpayer established it’s business in 2003, at the suggestion of the ABC founder, who was then a the brother-in-law of the Taxpayer’s director: Mr Zullo.
- During the 2007 year, the taxpayer recieved 845 ‘renovation compensation invoices’ from 376 Licencees, for compensation from renovation works etc, totalling $35m, which presumably it paid to those licensees.
- It seems that these invoices didn’t start until the 2007 year (or certainly, the Tribunal referred to them as a ‘deluge’ in that year) and didn’t continue into the 2018 year. Mr Zullo couldn’t account for this.
- The Taxpayer’s income, for the 2007 year was large: $139m and the taxable income was quite large: $7m.
- The Taxpayer subsequently into administration and then liquidation over the 2012 calendar year.
The AAT disallowed the $35m ‘compensation’ deduction because it found that there was an absence of documentary evidence of any concluded agreement pursuant to which the taxpayer was obliged to pay the renovation compensation invoices, ie for delays and disruptions caused by renovation work. Further, the AAT was not satisfied that if the taxpayer refused to make the renovation compensation payments ABC would engage other competitors and the taxpayer’s renovation services business would be at risk.
This sound’s curious, on the face of it. It seems that the amounts were actually paid (viz: there’s a loss or outgoing). On the face of it, they were incurred in respect of work previously undertaken, on the centres, for which it was paid a fee. This ought to establish that these amounts were paid in the derivation of the Taxpayers (prior) assessable income (like in the Placer Pacific case). Neither was it obvious that there was any subterfuge, if the payments were made to 376 persons, the Taxpayer had no obvious connection to.
However, the reason is that the AAT ‘smelt a rat’, even if it couldn’t join the dots. In para 75, the AAT noted that the work was done at a 10% to 15% markup on cost, whereas the compensation was a 30% uplift in cost (viz: those jobs seem to be ultimately at a loss). So, in para 77, the Tribunal said that there must have been some other purpose of the expenditure (other than legitimate compensation paid to earn its assessable income). The Tribunal put it this way.
- I am drawn to the conclusion, nonetheless, advanced by the Commissioner, that subjecting QMS to a liability in excess of $35 million in the last seven months of the 2007 income year is not explicable by reference to commercial expediency. There is some undisclosed purpose for the invoices and payments, especially where it does not appear that any renovation compensation charges were sought or paid in the 2008 income year.
The AAT also also disallowed deductions for the ‘management fees’ as they were not for actual management of childcare centres, but were fees for the acquisition of the management rights and therefore expenditure of a capital nature.
Finally, the 2007 penalty of 75% of the shortfall amount, based on intentional disregard of a taxation law, was reduced to 50% on the basis that the taxpayer’s conduct had been reckless.
The 2008 penalty of 50% of the shortfall amount was upheld.
(Queensland Maintenance Services Pty Ltd (In Liquidation) and FCT  AATA 4525, AAT, File Nos 2015/3326 and 2015/3327, Molloy DP, 5 December 2018.)
[LTN 239, 11/12/18; Tax Month – December 2018]
CPD (comprehension) questions
- Did the Taxpayer do contract work for ABC, from its formation to the end of the 2007 year (and beyond)?
- Were the 845 compensation invoices received from 376 licensees of ABC leaning centres?
- On what basis might you expect the aggregate $35m of payments to be deductible?
- Were the compensation payments more than the profit on those jobs (typically)?
- What else made the AAT suspect some other purpose, for making the payments (other than deriving past contract income)?
- What was the reason for disallowing the $13m outgoing for ‘management fees’?