Thinking | 20 March 2018

Talking Tax – Issue 111

Case law

Commissioner of the Australian Federal Police v Hart; Commonwealth of Australia v Yak 3 Investments Pty Ltd; Commonwealth of Australia v Flying Fighters Pty Ltd [2018] HCA 1

Mr Steven Hart, an accountant, was convicted of defrauding the Commonwealth through the operation of tax minimisation schemes. Property held by companies affiliated with Mr Hart was forfeited to the Commonwealth under section 92 of the Proceeds of Crimes Act 2002 (Cth) (POCA). The forfeited property comprised of three aircraft, a motor vehicle and four parcels of real property.

This case is a strong reminder to taxpayers and practitioners of the application and extent of the POCA provisions and how they can be used by the Commonwealth to compel an offender to forfeit the proceeds and benefits derived from activities designed to defeat the operation of the tax law.

Mr Hart was convicted of nine offences of defrauding the Commonwealth in contravention of section 29D of the Crimes Act 1914 (Cth).

Pursuant to section 92 of POCA, property, including that of companies with which Mr Hart was associated (Companies), was automatically forfeited to the Commonwealth.

The Companies filed an application under section 102 of POCA seeking orders for recovery of their interests in certain of the forfeited property, or the payment by the Commonwealth of an amount equal to the value of their interests.

Section 102(1) provides that where property is forfeited to the Commonwealth under section 92, the court that made the order may, on the application of a person who claims an interest in the property, make an order declaring the “nature, extent and value” of the applicant’s interest in the property. An order under section 102(1) can only be made if the court is satisfied that the grounds in subsection 102(2) and (3) are made out. The focus of these appeals was on the conditions in section 102(3), whereby the applicant bears the onus of proving on the balance of probabilities that:

  • the property was not used in, or in connection with, any unlawful activity (Use Condition)
  • the property was not derived or realised, directly or indirectly, from any unlawful activity (Derivation Condition) and
  • the taxpayer acquired the property lawfully (Acquisition Condition).

As one of the properties was purchased with unlawful funds earned from operating the tax minimisation scheme, the Acquisition Condition was not met. Further, as two other properties were used to provide security for a fraudulently induced bank loan, the Use Condition was not met in relation to these properties.

One of the three aircraft was purchased using lawful funds (and passed the Derivation Condition). However, an illegally sourced amount of $50,000 was used to repair the aircraft which was found to be a means to illegally launder that $50,000; so the Use Condition was not met. The funds used to acquire the other aircraft were found to be earned from operating the tax scheme, so the Derivation Condition was not met. The motor vehicle was purchased with a loan secured by one of the aircraft, and as such did not meet the Derivation Condition.

While the judgment does not deal with the income tax implications of funds earned from operating the tax minimisation schemes and of the forfeiture of property under POCA, the proceeds from illegal activities (such as tax minimisation schemes) will generally be assessable (see Tax Ruling 93/25). Conversely, the value of forfeited property would generally not be allowable as a deduction under section 8-1 of the Income Tax Assessment Act 1997 Act (see also s 26-54 of that Act).

Lockyer v Bermingham [No 3] [2018] WASC 61

This Supreme Court of Western Australia case involved a financial adviser who had provided tax advice to a client on a matter which was outside her area of expertise and competence.  Among other things, advice had been provided in relation to the operation and interpretation of the Capital Gains Tax provisions in the Income Tax Assessment Act 1997 and of Division 13A of the Income Tax Assessment Act 1936 (ITAA 1936).

The plaintiff sued the defendant for damages resulting from his reliance on the tax and financial advice that had been provided by the defendant.

The defendant advised her client that he had a substantial liability to pay income tax. It was said to have arisen from an option exercised by the client’s wife to subscribe for shares in the capital of a listed company; of which the client was a director. The options were part of his remuneration and he had directed that they be issued to his wife.

In 2007 and 2008, the defendant advised her client to make a number of negatively geared investments to enable him to set off the resulting tax deductions against his purported taxable income; thereby reducing his tax liability. The client subsequently incurred significant expenditure to make the investments and ultimately suffered losses on a number of them.

The error made by the defendant related to the operation of Division 13A ITAA 1936, and the fact that the premise on which the defendant’s advice was based (namely that her client had a substantial liability to pay tax arising from the exercise of the options) was flawed.

However, the court noted that it was difficult to make findings about precisely how the defendant understood the relevant provisions to apply. As such, it was not in dispute that the defendant’s advice was flawed.

The Court concluded that there had been a breach of duty of care owed by the financial adviser to her client, as the tax advice she provided was complex, and fell outside her area of expertise and competence. The Court was satisfied that the client had suffered the losses as a result of the financial adviser’s negligence, and damages were awarded to the client.

This case highlights the risks that arise for advisers who do not remain within their area of expertise and competence, as well as the inherent complexities of what can be initially perceived as simple tax matters.

MWYS and FCT [2017] AATA 3037

The AAT in MWYS and FCT [2017] AATA 3037 held that the Commissioner’s amended assessments were excessive and amounts described as ‘tainted sales income’ should not have been included as assessable income of the taxpayer (Taxpayer). This case turned on the definition of ‘associate’, and the circumstances in which an entity will be found to be ‘sufficiently influenced’ by another.

The key issue in dispute was whether a UK listed public company's (UK Co) indirectly wholly owned Australian subsidiaries were ‘associates’ of a Swiss company (Swiss Co) for the purpose of the definition in section 318 of the Income Tax Assessment Act 1936 (ITAA 1936). Specifically, pursuant to section 318(2) ITAA 1936, UK Co would be an associate of Swiss Co if Swiss Co was ‘sufficiently influenced’ by UK Co.

Relevantly, the broad definition of ‘associates’ required the AAT to determine whether the Taxpayer and UK Co were associates of Swiss Co and whether the Taxpayer and UK Co were associates of each other.

The AAT made the following key findings about the term ‘sufficiently influenced’:

  • the absence of formal directions or instructions is relevant but not conclusive of an absence of sufficient influence and
  • an analogy can be made to the term ‘accustomed to act’ which is discussed in Corporations Law cases on shadow directors; which relevantly says there should be ‘habitual compliance’ shown by a ‘pattern of behaviour’ over a time.

Facts

The Taxpayer was an Australian public listed company. The Taxpayer entered into a dual-listed Company (DLC Arrangement) with a UK Co for the purpose of allowing economic arrangements between the two companies. As part of the DLC Arrangement, the Taxpayer indirectly (through a chain of wholly owned subsidiaries) acquired a 58% interest in a Netherlands company (Netherlands Co), while the remaining 42% was held indirectly by UK Co.  Netherlands Co held 100% of Swiss Co.

Swiss Co carried on a business of marketing and trading in products including raw materials, metal and energy. Swiss Co purchased some of its commodities from the Taxpayer’s wholly owned subsidiaries, and from UK Co’s wholly owned subsidiaries, and sold these commodities at a profit (referred to as Taxpayer Purchase Profits and UK Co Purchase Profits respectively).

Swiss Co is a controlled foreign company (CFC) of the Taxpayer pursuant to section 340 ITAA 1936 (as the Taxpayer indirectly controls more than 50% of Swiss Co). This means the Taxpayer must calculate the attributable income of Swiss Co and include its share in its assessable income.

Its assessable income will include amounts of ‘tainted sales income’. ‘Tainted sales income’ is defined in s 447 ITAA 1997 and includes income from the sale of goods by the CFC that it acquired from an associate who is either an Australian resident or a non-resident carrying on business through a permanent establishment.

It was undisputed that the Taxpayer Purchase Profits were tainted sales income and the Taxpayer correctly included them in its assessable income.  However, the Commissioner issued an amended assessment to the Taxpayer which included the UK Co Purchase Profits as tainted sales income assessable to the Taxpayer.  The Taxpayer’s objection was rejected and the Taxpayer appealed to the AAT.  The AAT determined that the income was not tainted sales income of the Taxpayer.

AAT decision

Regarding the relationship between the Taxpayer and UK Co, the AAT found:

  • neither party abrogated ‘effective control’ under the DLC Arrangement
  • the Taxpayer, UK Co and Swiss Co’s Boards all exercised independent judgement in making their decisions
  • even though the DLC Arrangement required the parties to consider each other’s interests and even though the parties often acted in concert, this was not inconsistent with each company’s constitution and did not mean they were influencing each other and
  • it was not fatal that it the same individuals were on the Taxpayer’s Board and UK Co’s Board, as they acted in separate capacities.

For these reasons, the Taxpayer and UK Co were not associates.

In respect of Swiss Co, the AAT found:

  • Swiss Co was not controlled by a third party, it was controlled by its own Board
  • Swiss Co had a formal governance structure which it adhered to and
  • it is likely that Swiss Co’s interests regularly coincided with the Taxpayer and UK Co, but that does not mean it did not exercise its own judgement.

For these reasons, Swiss Co and the Taxpayer/UK Co were not associates.

As UK Co and Swiss Co were not associates, the UK Co Purchase Profits were not tainted sales income and were not assessable to the Taxpayer.

Rowntree v FCT [2018] FCA 182

In Rowntree v FCT [2018] FCA 182, the Federal Court of Appeal held that receipts by the taxpayer, a solicitor, from companies he controlled were income despite noting that the taxpayer “genuinely believed that there were arguments to support his view that a loan was in existence”.

The background facts to the case and the AAT decision are discussed in detail in Talking Tax Issue 44.

The issue on appeal was whether in forming its conclusion, the Tribunal erred in the exercise of its fact-finding jurisdiction.

Having found that he believed that what he had done involved him receiving a loan, the taxpayer submitted that the AAT’s search for indicia of loan documents had distracted it from appreciating the decisiveness of his belief. That is, while the AAT accepted that the taxpayer believed that he had received a loan, it incorrectly found that this was not sufficient to discharge his onus of proof under section 14ZZK of the Tax Administration Act 1953. With reference to Taxation Ruling TR 2010/3, the taxpayer further noted that no writing is required in law to evidence an ordinary loan.

The Federal Court of Appeal held that the AAT had not erred in the exercise of its fact-finding jurisdiction and that the taxpayer had simply failed to prove that he had made contracts for loans with his companies when he caused them to pay him the relevant receipts. As such, the appeal was dismissed with costs.

It is worth highlighting that the taxpayer failed because he could not provide substantial documentary evidence that the loans existed at the time the payments were made. This scenario could have easily been avoided if loan agreements were created and properly documented contemporaneously before any payments were made to the taxpayer.

State taxes

Banting (as Executor of the Estate of the Late K C Banting) v Chief Commissioner of State Revenue [2018] NSWCATAD 38

In the case of Banting (as Executor of the Estate of the Late K C Banting) v Chief Commissioner of State Revenue [2018] NSWCATAD 38 Senior Member Higgins held that the taxpayer failed to satisfy the primary production exemption under section 10AA(3)(b) of the Land Tax Management Act 1956 (NSW) (LTMA) due to a lack of evidence. That is, the Civil and Administrative Tribunal New South Wales (Tribunal) found that the taxpayer failed to demonstrate that the dominant use of the land was primary production for the maintenance of animals.

The taxpayer held a number of lots of land as part of a deceased estate for which the vast majority of the land was used for grazing cattle.

The main issue for determination was whether the land the subject of cattle grazing was exempt from land tax under section 10AA(3)(b) LTMA. Relevantly, the taxpayer needed to show that the dominant use of the land was for the maintenance of animals for the purpose of selling them, or their natural increase or bodily produce.

This case highlights the continued scrutiny that the State and Territory Revenue Offices are placing on those claiming primary production exemptions.

The Commissioner contended that the fact that two of the ten paddocks were used at any one time for grazing was not sufficient itself to establish necessary dominant use under s 10AA(3)(b) LTMA.

The applicant relied on statutory declaration evidence, which ultimately did not satisfy the Tribunal that the land had been used for primary production. Relevantly, the applicant submitted that there were 70 head of cattle on the land on a quick drive around the property whereas another record of the applicant’s father (deceased) declared previously there were 45 head of cattle on the land.  In addition, it was noted that the applicant did not adduce any evidence as to the number of the cattle that could be grazed on the land or whether the cattle were rotated through the remaining paddocks and how often.

Senior Member Higgins commented that the witness was reliable, but that he was left with the impression that a large portion of the land was not used for cattle grazing and in particular that the use was not a dominant use for the purpose of section 10AA(3)(b) LTMA.

Senior Member Higgins noted that the section requires that the maintenance of cattle must be for the purpose of selling them, or their calves, or their bodily produce; such as milk. It was held that the applicant took no steps to sell any cattle or their calves, or to demonstrate that there was a breeding program in place.

Even if the applicant had adduced evidence to demonstrate full use of the land for grazing, this would not be enough to claim the exemption as the maintenance of cattle must be for the purpose of selling the cattle, maintaining a natural increase or bodily produce, all of which would have required additional evidence.

 

ATO Updates

Update to ATO web guidance and consultation on substantiating cryptocurrency taxation events

The ATO has recently updated their web guidance on the Tax treatment of cryptocurrencies and has commenced its consultation around substantiating cryptocurrency taxation events.

The purpose of the ATO’s consultation is to seek feedback on practical compliance issues arising from complying with taxation obligations in relation to cryptocurrency transactions.

We will be providing feedback to the ATO in the next month. If you have any issues or concerns that you would like to discuss and to be reflected in our feedback, please contact us.

Contact

Adam Dimac

Adam is an experienced tax lawyer, advising on a range of matters, including Division 7A, CGT and corporate restructuring.

Related practices

You might be also interested in...

Tax | 15 Mar 2018

NSW Foreign Person Surcharge Duty and Surcharge Land Tax

On 5 March 2018, legislative provisions came into effect which give concessions from NSW foreign person surcharge duty and surcharge land tax.

Tax | 13 Mar 2018

Talking Tax – Issue 110

The State Administrative Tribunal of Western Australia (Tribunal) has determined that two individuals (Applicants) were not entitled to a two-year land tax exemption for construction of a private residence under section 24A of the Land Tax Assessment Act 2002 (WA)(LTAA).