Case: Federal Commissioner of Taxation v Peabody (1994) 181 CLR 359
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. At [26], the Tribunal noted that in the absence of any variation to the contracts, the amounts that would have been deductible under s 82AAC of the Act as superannuation contributions were in 1997 $27,170.00 (Mr Mark Trail) and $9,782.00 (Mr Allan Trail) and in 1998, $28,620.00 (Mr Mark Trail) and $10,232.00 (Mr Allan Trail). At [27], the Tribunal noted that s 177C(1)(b) requires the making of an hypothesis as to what might reasonably be expected to have happened had the scheme not been entered into or carried out. The Tribunal noted the observations of Gummow and Hayne JJ in Commissioner of Taxation v Hart (2004) 217 CLR 216 at 243 [66] that the enquiry directed by Part IVA requires comparison between the scheme in question and an alternative postulate. The Tribunal also noted that the High Court in Commissioner of Taxation v Peabody [1994] HCA 43 ; (1994) 181 CLR 359 determined that a reasonable expectation requires more than a possibility with the result that the prediction must be sufficiently reliable for it to be regarded as reasonable. 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.