Case: Commissioner of Taxation v Sleight [2004] FCAFC 94 ; (2004) 136 FCR 211
Outcome: considered
I reject the respondent's first submission. The payments made by the applicants are allowable deductions if they fall within the terms of s 51(1) of the ITAA 1936 and Part IVA does not apply to them. Part IVA might apply to a scheme but it is well recognised that the relevant deduction may be disallowed only to the extent that it is not reflected in an actual cash outlay: Commissioner of Taxation v Sleight [2004] FCAFC 94 ; (2004) 136 FCR 211 per Hill J at 238-239 [112]-[116]. It seems to me that whether there has been an actual cash outlay cannot turn on whether the taxpayer finds the cash at the time or, through a loan agreement, finds it later. It is the transaction which gives rise to the deduction which is the focus of the inquiry and whether Part IVA applies to it and not the character of the later transaction whereby, for example, a loan is repaid. It might be said that Part IVA only applies to the extent that the scheme has been entered into or carried out for a dominant tax purpose or, alternatively, the discretion in s 177F(b) should be exercised in favour of the taxpayer to the extent that he makes an actual cash outlay either at the time or later. 142 The respondent's second submission is more difficult to deal with. There is force in the respondent's submission, but at the same time there appears to be no dispute that the payments were made and there is no evidence of any obligations of the members of the CECK partnership to Plutora other than in relation to the TVI Project. The total amount in issue is substantial, that is, $300,000 as against the sum of $100,000 accepted by the respondent, and the parties only made written submissions on the point. In the circumstances, I will give them leave to make further submissions if so advised. 143 In the 1996 FY the promoters decided to restructure the existing arrangements. The features of the proposal to restructure the existing arrangements were outlined in a letter from Mr Snow on behalf of Plutora to Mr Prince on behalf of the CECK partnership dated 6 May 1996. 192 The respondent did not formally concede that the deductions fell with s 51(1). However, he did not make any submissions to the contrary and he submitted that it was open to the Court to find that the claimed deductions fell within the terms of s 51(1). Having considered the authorities discussed by Hill J (at 224-228) and Carr J (at 251-252) in Sleight , I think it is proper to hold that the claimed deductions fall within s 51(1) of the ITAA 1936. 193 Section 79D limits a taxpayer's right to claim deductions in relation to assessable foreign income. 194 Section 79D(1) provides as follows: "(1) Where: (a) apart from this section, there are one or more foreign income deductions of a taxpayer in relation to a class of assessable foreign income in relation to a year of income; and (b) either: (i) the taxpayer did not derive any assessable foreign income of that class in the year of income; or (ii) the taxpayer derived assessable foreign income of that class in the year of income and its amount is exceeded by the sum of the foreign income deductions; then, for the purposes of this Act, those deductions are reduced respectively: (c) where subparagraph (b)(i) applies--to nil; or (d) where subparagraph (b)(ii) applies--by amounts proportionate to those deductions and equal in total to the amount of the excess referred to in that subparagraph." 223 The eight matters identified in s 177D(b)(i)-(viii) inclusive are exhaustive of the matters to be considered in determining whether the relevant conclusion should be drawn: Peabody v Commissioner of Taxation (1993) 40 FCR 531 (" Peabody ") at 541 per Hill J (Ryan and Cooper JJ concurring); Calder v Commissioner of Taxation (2005) 226 ALR 643 (" Calder ") at 290 [91]. Whether the relevant conclusion should be drawn is to be determined objectively in the sense that the question is not as to the taxpayer's subjective intention and purpose: Commissioner of Taxation v Spotless Services Ltd [1996] HCA 34 ; (1996) 186 CLR 404 (" Spotless ") at 421-422, 424; Commissioner of Taxation v Hart [2004] HCA 26 ; (2004) 217 CLR 216 (" Hart ") at 223 [37], 243 [65] per Gummow and Hayne JJ; Peabody at 542; Calder at 291-292 [96]. A person may have more than one purpose and that is made clear by s 177A(5). One purpose may be a commercial purpose, but Part IVA will nevertheless apply if the other purpose was to obtain a tax benefit and that purpose was the dominant purpose: Spotless at 415-416; Hart at 227 [16] per Gleeson CJ and McHugh J; Sleight at 229-230 [67] and 238-239 [113] per Hill J (with whom Hely J agreed); Calder at 291 [92]. 224 The authorities also establish that, in any particular case, one of the eight matters may be decisive; in another case, it may only be after a careful weighing of all eight matters that the relevant conclusion can be drawn. Furthermore, even though some matters may be neutral and others may point towards a commercial purpose, the other matters may be such that a conclusion of a dominant purpose of obtaining a tax benefit should be drawn: Sleight at 229-230 [67]; Calder at 290 [91]. 252 The management fees involved very significant sums of money and they were to be paid "up-front" and before any expenses were incurred. There are no details in any of the information memoranda as to how the fees were calculated. I cannot put any weight on the mere assertions of some of the applicants that they considered the management fees to be appropriate and reasonable. No basis for those assertions was provided. Other than referring to some quite general matters, Mr Snow provided no details of the basis on which he calculated the management fees and I do not think I can put any weight on his evidence on this point in the face of such strong objective evidence that suggests that they were calculated at the figures they were in order to provide substantial tax benefits to, among others, the applicants. The terms and conditions of the limited recourse loans are important in this respect. They meant that as to the amounts referred to in the limited recourse loan agreements the respective assets of each applicant were not at risk. The promoters were taking the risk of expenses exceeding actual cash outlays. The terms of the agreements and, in particular, the provision for a percentage of the profits (if any) from the Projects to be paid to the lender (which was one of the promoters) for an indefinite period after the principal had been repaid and to be deemed to be interest were unusual and to my mind they suggest that the dominant purpose of each applicant, objectively assessed, was the obtaining of tax benefits. It seems to me that the management fees were "loaded up" and that that was done so that the applicants obtained tax benefits. The words of Hill J in Sleight at 233 [80] are apposite: "Finally, it should be noted that the financial structure that the management agreement, loan agreement and indemnity agreement created was not necessary to the success of a tea tree project. Presumably the promoters, for example, could have still received the same amount of return by limiting the first year management fee to the actual cash outlay of the investor, and then adjusting the management fee in subsequent years to achieve this result. Arguably, an investor would thus have a legitimate, albeit significantly reduced, tax deduction for his cash outlay because it was actually a necessary cost of the project. This fact points towards a dominant tax incentive purpose because it could be objectively determined or concluded that an investor, who had a dominant commercial purpose, would prefer the project with a normal structure, rather than one which was so structured that it maximised the deductions available by the use of a somewhat artificial structure." 253 An important feature related to the management fees is the method whereby obligations under the limited recourse loan agreements and the management agreements were met. In this respect, I am referring to the endorsing and later cancellation of the bills of exchange in the manner I have described. It was very similar to a "round robin" of cheques which, although effective as a matter of law ( Equuscorp Pty Ltd v Glengallan Investments Pty Ltd [2004] HCA 55 ; (2004) 218 CLR 471 at 486-487 [46] - [47] ) is, as Hill J pointed out in Sleight (at 232 [77]), a feature of many tax avoidance schemes. The method by which the moneys to be paid under the limited recourse loan agreements were paid by the lender and then in turn paid to the manager was known to the members of the CECK partnership because they endorsed the bills of exchange. Even if it was unknown, as might have been the case with the applicants involved in the TVA Project because the bills of exchange were endorsed by Plutora as duly appointed agent and attorney of Civil and Earth, the method of payment is still a matter to be taken into account. Commissioner of Taxation v Consolidated Press Holdings Ltd [2001] HCA 32 ; (2001) 207 CLR 235 at 264 [95] ; Commissioner of Taxation v Cooke (2004) 55 ATR 183 at 216 [88]; Calder v Commissioner of Taxation (2005) 226 ALR 643 at 294-295 [113]-]115]. 258 The substance of the schemes was very different. The applicants played no role in the ongoing activities of the schemes, which were left in the hands of the companies involved in the promotion of the schemes. The applicants were in effect no more than passive investors. As in Sleight (at 233 [81]), once the tax features are removed, it can be seen that the applicants are no more than passive investors in a managed fund. Furthermore, although the applicants undertook substantial financial obligations, the reality was that their cash contributions were much smaller and they were more than outweighed by the tax benefits offered by the "gearing up" of the management fees. As I have said, the management fees were of an amount which could not be explained in pure commercial terms and the limited recourse loan meant that if the manager incurred fees in excess of the actual cash contributions it would be the party taking the risk that the Projects were sufficiently successful to ensure repayment of its fees. The applicants put at risk only their actual cash outlays. 259 Furthermore, there were a number of somewhat artificial features of the agreements comprising the Projects. First, there was the fact that one company granted a licence to an investor who nominated a company related to the licensor to carry out the activities envisaged by the licensee. In relation to the overseas territories, there was the additional feature of a sub-licence and the puzzling clause as to the circumstances in which the licensee was not required to carry out certain obligations in the licence. Secondly, there was the unusual feature of the limited recourse loans under which no interest in the usual sense was payable but an amount of advertising revenue was payable for an indefinite period, which amount was deemed to be interest. Thirdly, there was the unusual feature that the licences were only for a year, with options to extend, in circumstances in which the amounts borrowed by the licensees were very substantial. Fourthly, there was disparity between the initial fee for overseas licences and the projected initial fee for sub-licences. As I have said, the reason for that difference was unexplained. 260 In my opinion, all of the considerations relating to the form and substance of the schemes suggest a conclusion of a dominant tax purpose should be drawn. 263 The result that would be achieved by the schemes but for Part IVA is that each of the applicants would be entitled to substantial deductions in excess of funds actually contributed by them. That points to a dominant tax purpose: Sleight at 234 [84] per Hill J. However, it must be borne in mind that simply because a taxpayer pays less tax if one form of transaction rather than another is made does not demonstrate that Part IVA applies: Hart at 240 [53] per Gummow and Hayne JJ. 268 The applicants pointed to the evidence of Mr Simpson that the internal rate of return of the Travel Vision Projects calculated by reference to the financial projections in the information memoranda were attractive and were commensurate with the risks involved in the particular Projects. As I have said, that does distinguish this case from cases in which the commercial returns, if achieved, were likely to be very modest, or were only likely to be received many years into the future. At the same time, the fact is that the Travel Vision Projects in the 1994 FY, 1995 FY and 1996 FY did not generate any commercial returns. Furthermore, the tax benefits from the scheme were relatively certain, whereas the commercial benefits were quite uncertain and, after the first year or so, very uncertain. That is a fact pointing to a dominant tax purpose: Sleight at 234 [88] per Hill J. 269 Overall, the considerations under this paragraph point to a dominant tax purpose. 270 The respondent referred to the financial effects of the schemes on Plutora and TVI. He submitted that the management company, Plutora, received only a fraction of the management fees in cash. The cash that was received related to licence fees and marketing fees in relation to overseas territories. The respondent submitted that the funds received by Plutora and TVI were sourced from the tax benefits received by investors by reason of their participation in the Travel Vision Projects and that the funds received by those companies were directed towards the marketing of the Travel Vision system in overseas territories and that was done with a view to obtaining development grants. The respondent also pointed to the fact that the financial position of the promoters did not change beyond the cash payments made to them. Plutora in effect was a lender in relation to its own fees. It is difficult to see why Plutora would apparently lend such large amounts when in effect the fees, or at least the bulk of them, could only be recovered from the revenue generated by the Projects. If the amounts were genuine then the promoters were taking the entire risk associated with their recovery in circumstances where the applicants could "walk away" from the loans by not renewing their licences after one year and their only recourse was to the revenue, if any, generated by the Projects. 271 It seems to me that there was not a relevant connection within s 177D(b)(vi) between the applicants (other than Mr Sleight) on the one hand, and TVI and Plutora on the other. The position in this case is the same as it was in Sleight where Hill J said (at 234-235 [89]): "This is not a case where a taxpayer received a tax benefit and a person associated with him or her received some collateral capital payment. No doubt the promoter companies made money out of the scheme, but they would hardly seem to be entities having any real connection of a business nature with Mr Sleight as that expression is used in s 177D(b)(vi)." 272 In the case of Mr Sleight it might be said that there was a relevant connection because he received commissions from the promoters in the 1994 FY and in the 1996 FY for introducing investors to the Projects (see Sleight at 256 [229]-[232] per Carr J) but even if this is so, I do not think anything under this paragraph advances the case much beyond the considerations under the other paragraphs. 273 Neither party suggested that there were any considerations under these paragraphs of s 177D(b). 274 In my opinion, having regard to the matters in s 177D(b), the conclusion should be drawn that each of the applicants entered into the respective schemes and carried them out for the dominant purpose of enabling the relevant applicant to obtain a tax benefit in connection with the scheme.