Case: Federal Commissioner of Taxation v Lenzo (2008) 167 FCR 255
Outcome: cited
177C(1)(b) tells the taxpayer (and others) that a tax benefit in the form of a deduction has been obtained in connection with schematic arrangements if a deduction allowable to the taxpayer under the scheme, would not have been allowable (in whole or in part) if the scheme had not been struck or carried out, or on the second limb, might reasonably be expected not to have been allowable to the taxpayer, in the circumstances of the scheme as struck or carried out. Section 177C(1) thus requires the entire set of schematic arrangements to be set aside so that the postulate contemplated by s 177C(1)(b) might be considered. In Federal Commissioner of Taxation v Lenzo (2008) 167 FCR 255, Sackville J at 278 made these observations concerning the operation of s 177C(1)(b): ... In determining whether Mr Lenzo obtained a tax benefit in connection with the scheme for the purposes of s 177C(1)(b), three things should be noted about the statutory formulation. First, the question posed by s 177C(1)(b) has to be answered on the assumption that the scheme had not been entered into or carried out. Section 177C, unlike for example s 177D, does not refer to "any part of the scheme". Thus the question, in order to be answered as s 177C(1)(b) requires, must be approached by assuming that the entire scheme found by the Court was not entered into or carried out: cf Federal Commissioner of Taxation v Peabody (1994) 181 CLR 359 at 383-384, per curiam . It is not open to the taxpayer to point to what might reasonably be expected to have been done if only part of the scheme had not been entered into or carried out. In this case, for example, it is not open to Mr Lenzo to point to what could reasonably be expected to occur if the Loan Deed is ignored, by the remainder of the scheme is assumed to have continued in tact. Secondly, s 177C(1)(b) applies where the deduction would not have been allowable or might reasonably be expected not to have been allowable had the scheme not been entered into or carried out. As the High Court observed in FCT v Peabody 181 CLR at 385: [a] reasonable expectation requires more than a possibility. It involves a prediction as to events which would have taken place if the relevant scheme had not been entered into or carried out and the prediction must be sufficiently reliable for it to be regarded as reasonable. Thirdly, s 177C(1)(b) presents what might be described, perhaps loosely, as a question of characterisation. For the Court to conclude that a taxpayer has obtained a tax benefit in connection with a scheme, it must find that a deduction is allowable to a taxpayer in relation to a year of income in circumstances where the whole or part of "that deduction" would or might not have been allowable in the absence of the scheme. What does the expression "that deduction" mean? If the expression means the very deduction claimed by the taxpayer, in the sense of a deduction for the precise liability incurred by reason of the taxpayer's participation in the impugned scheme, the Commissioner would have little difficulty in persuading the Court that the taxpayer has obtained a tax benefit in connection with the scheme. By hypothesis, if there were no scheme (assuming the incurring of the liability was a consequence of the scheme) the taxpayer simply could not have claimed the identical deduction. If the expression "that deduction" has a wider meaning, it may be open to a taxpayer to satisfy the onus of showing the Commissioner's assessment is excessive by demonstrating that, had the scheme not been entered into or carried out, he or she would have or might reasonably be expected to have incurred a liability of the kind actually claimed as a deduction. For example, in WD &amp; HO Wills (Australia) Pty Ltd v Federal Commissioner of Taxation (1996) 65 FCR 298, the taxpayer argued that had it not entered into the scheme (involving payment of insurance premiums by it to a "captive" insurer), the taxpayer would have paid an equivalent sum in premiums to another insurer. On that hypothesis, even without the scheme, the whole of the deduction claimed by the taxpayer would have been an allowable deduction. The argument failed on the facts, but was accepted in principle: WD &amp; HO Wills (Aust) Pty Ltd v Federal Commissioner of Taxation 65 FCR at 329. In that sense, the Tribunal did not formulate an incorrect test to be applied in deciding whether the kind of deduction claimed under the scheme would not have been allowable or might reasonably be expected not to have been allowable to the taxpayer, absent the scheme. That test however necessarily involves an examination of the particular activity the taxpayer would have undertaken or might reasonably be expected to have undertaken in lieu of the scheme and whether the activity would or might reasonably be expected to have resulted in an allowable deduction of the same kind as that claimed by the taxpayer in the two tax years, under the scheme: Federal Commissioner of Taxation v Lenzo per Sackville J at [128] and Heerey J at [38] to [41]. There was however no evidence before the Tribunal of that activity. What would or might the taxpayer have reasonably done absent the scheme? Would the taxpayer have paid all the amounts due under the contracts to the two brothers by making the contributions to the superannuation fund? The Tribunal thought not, because the characterisation of the payments involved fully deductible employment contributions by the taxpayer and the taxpayer had implemented the scheme, together with the Trail brothers, so as to enable the contractual payments to be varied and paid to the new Employee Welfare Fund to preserve the fully deductible character of those payments. It followed, in the Tribunal's view, that it was contrary to the interests of the taxpayer and each brother to engage in any activity that "did not allow for complete deductibility of all payments". It necessarily follows, having regard to that finding, that the taxpayer would not have made the pre-scheme contractual payments to the Employee Superannuation Scheme except to the extent of the age-limited deductible contributions. What would the taxpayer have otherwise done or might reasonably be expected to have done in the circumstances absent the scheme? Might it have varied the agreements to negotiate new employment contracts containing particular terms which might have given rise to an allowable deduction of the kind claimed in the full amount claimed, and, if so, on what basis or by reference to what steps? The Commissioner says that it is not part of the s 177C(1)(b) test nor is it therefore relevant to consider the tax implications of the alternate postulate as this simply invites the substitution of a new "scheme" for the one required to be stripped away. The Commissioner also says that since the variation of the agreements is part of the scheme that must be stripped away in its entirety, it is not part of the test under s 177C(1)(b) nor is it relevant, to bring within any formulation of an alternate postulate, any variation of the agreements. The matter is to be remitted to the Tribunal to determine the questions before it by applying the test so as to determine whether there is evidence which supports an hypothesis that the taxpayer would have undertaken or might reasonably be expected to have undertaken a particular activity in lieu of the scheme and whether that activity would or might reasonably be expected to have resulted in an allowable deduction of the same kind as the deduction claimed by the taxpayer under the scheme consistently with the methodology identified in the authorities and in particular, Commissioner of Taxation v Peabody (1994) 181 CLR 359; Commissioner of Taxation v Hart (2004) 217 CLR 216; and Federal Commissioner of Taxation v Lenzo (2008) 167 FCR 255 at 278 [121] to [125] and [128]; Federal Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404.