Commissioner of Taxation v White; Commissioner of Taxation v White (No 2)
Document type: Decision Impact Statement
Venue: Federal Court of Australia (VID 889 of 2009)
Judgment date: 14 July 2010
Date published: 28 April 2011

Summary of decision:
Outlines the ATO's response to this case which concerned whether amounts paid to an employee incentive trust were assessable to a shareholder/director of the employer company, and whether an administrative penalty of 50% for recklessness was excessive.

Overview of facts:
The taxpayer, an engineer, was the sole director and a shareholder of Troy White Engineering Pty Ltd (TWE), a company carrying on a tooling engineering business during the 1999 and 2000 income years. The taxpayer was also an employee of TWE. | As part of what was purported to be an employee incentive trust plan for TWE, a new company, Kalix Investments Pty Ltd (Kalix), was incorporated on 30 June 1999, and the taxpayer became its employee. It was intended that the taxpayer would become a consultant to TWE, and that Kalix would be paid management fees from TWE for the taxpayer's services. The taxpayer was the sole director of Kalix. | A trust was also established on or about 30 June 1999 for the purported purpose of providing long term incentives to the taxpayer and two important employees of TWE. The taxpayer was a director of the trustee of the trust. | On 30 June 1999, TWE made a payment of $120,120 (for the two employees) to the trustee of the trust. The plan had also been for TWE to make a management fee payment of $22,000 to Kalix, and for Kalix to make a payment of $22,000 to the trustee for the taxpayer. However, TWE made the payment of $22,000 directly to the trustee on 30 June 1999. | In the 2000 income year, one of the other employees of TWE also became an employee of Kalix and a consultant to TWE. A remuneration report recommended that a particular level of incentive payments be made by Kalix to the trustee of the trust for the taxpayer and the other employee. However, the recommendation was not followed, and considerably more was paid by TWE to Kalix as a management fee for the taxpayer ($399,000), and then paid by Kalix to the trustee for the taxpayer. | The Commissioner assessed the amounts of $22,000 and $399,000 to the taxpayer for the 1999 and 2000 years, respectively, as ordinary income from dividends or services rendered, or as deemed dividends under section 109 of the Income Tax Assessment Act 1936 (ITAA 1936). The Commissioner also assessed a penalty of 40% (50% for a tax shortfall caused by recklessness, reduced by 20% for voluntary disclosure made after the start of the tax audit). | The AAT found that the taxpayer used the incentive plan as a means of extracting profits from TWE. In relation to the 1999 year, the AAT found that it would be fanciful to suggest that the taxpayer provided any services to TWE in his capacity as an employee of Kalix. Rather, the payment of $22,000 to the trustee was made by TWE in return for services rendered by the taxpayer as an employee of TWE. The payment was in the nature of ordinary income, which the taxpayer directed be paid to the trustee. | In relation to the 2000 year, the AAT found that the payment of $399,000 from TWE to Kalix was also made for services rendered by the taxpayer to TWE. However, the AAT was satisfied that only $135,000 of the $399,000 was assessable to the taxpayer as either ordinary income, or excessive remuneration under section 109 of the ITAA 1936. | The AAT also found that the penalty imposed for both years should be 20% (25% for a tax shortfall caused by lack of reasonable care, reduced by 20% for voluntary disclosure). | The Commissioner appealed to the Federal Court on the basis that the AAT had erred in not finding that the amount of $264,000 was also assessable to the taxpayer in the 2000 year, and in not finding that the taxpayer was liable to penalty tax at a base amount of 50% (subject to a reduction of 20%) because the tax shortfall was caused by the recklessness of the taxpayer's tax agent. The taxpayer cross-appealed against the AAT's findings that the amounts of $22,000 and $135,000 were assessable to the taxpayer. | Issues decided by the court | In its first decision, the Federal Court (Gordon J) found that, as the AAT had found that the payment of $399,000 from TWE to Kalix was a payment made for services rendered by the taxpayer, the AAT should have found that the amount of $264,000 paid by Kalix to the trustee in the 2000 income year was also derived as ordinary income by the taxpayer (paragraphs 20 to 29). The Court also rejected the taxpayer's cross-appeal that the amount of $22,000 paid to the trustee was not derived as ordinary income in the 1999 year (paragraphs 41 to 44). | In its second decision, on penalty, the Federal Court held that the AAT had failed to address the former section 226H of the ITAA 1936, and that the taxpayer had not discharged the onus of proving that his tax agent was not reckless in filing the taxpayer's tax returns for the 1999 and 2000 income years. Her Honour noted that the conclusion that a 50% penalty applied to the tax shortfall was not inconsistent with any finding by the AAT (paragraphs 17 to 20).

Issues decided:
In its first decision, the Federal Court (Gordon J) found that, as the AAT had found that the payment of $399,000 from TWE to Kalix was a payment made for services rendered by the taxpayer, the AAT should have found that the amount of $264,000 paid by Kalix to the trustee in the 2000 income year was also derived as ordinary income by the taxpayer (paragraphs 20 to 29). The Court also rejected the taxpayer's cross-appeal that the amount of $22,000 paid to the trustee was not derived as ordinary income in the 1999 year (paragraphs 41 to 44). In its second decision, on penalty, the Federal Court held that the AAT had failed to address the former section 226H of the ITAA 1936, and that the taxpayer had not discharged the onus of proving that his tax agent was not reckless in filing the taxpayer's tax returns for the 1999 and 2000 income years. Her Honour noted that the conclusion that a 50% penalty applied to the tax shortfall was not inconsistent with any finding by the AAT (paragraphs 17 to 20).

ATO view of decision:
The Federal Court recognised that, based on the findings of fact made by the AAT, the payments made to the trustee of the incentive trust on behalf of the taxpayer were ordinary income derived by him from the provision of his services. | The Court also recognised that the taxpayer was liable to a penalty under the former section 226H of the ITAA 1936.

Administrative treatment:
Implications on current Public Rulings & Determinations | None

Legislative references: Income Tax Assessment Act 1936 26(e) 44(1) 109 226H 226L Income Tax Assessment Act 1997 6-5(1) 6-5(4) 6-10(3) Taxation Administration Act 1953 14ZZK Administrative Appeals Tribunal Act 1975 44
Case references: FCT v Stone (2005) 222 CLR 289 2005 ATC 4234 59 ATR 50 FCT v McNeil (2007) 229 CLR 656 2007 ATC 4223 64 ATR 431 FCT v Montgomery (1999) 198 CLR 639 99 ATC 4749 42 ATR 475 FCT v Zoffanies Pty Ltd (2003) 132 FCR 523 2003 ATC 4942 54 ATR 280 FCT v Starr (2007) 164 FCR 436 2007 ATC 5447 67 ATR 923 BRK (Bris)Pty Ltd v FCT 2001 ATC 4111 [2001] FCA 164 46 ATR 347
Subject references: Assessable income Employee benefits Deemed dividends Administrative penalty