Fitzroy Services Pty Limited v Commissioner of Taxation
Document type: Decision Impact Statement
Venue: Federal Court of Australia (NSD 172 of 2012)
Judgment date: 20 May 2013
Date published: 22 November 2013

Summary of decision:
Outline's the ATO's response to a decision concerning the deductibility of 'Interest and bank fees' and 'Management fees'; as well as whether a loan(s) was a sham.

Overview of facts:
The following summary draws heavily and directly on the judgment of Edmonds J. | The dispute concerned assessments for the years ended 30 June 1999 to 2009 (except for 2004), and penalty amounts. The assessments arose as a result of the disallowance of deductions for 'Management fees' and 'Interest and Bank fees'. | In 1994, Allan and Douglas Heasman, who at all relevant times controlled the taxpayer and other entities involved in a business of providing auto-repair services as well as retailing shock absorbers and pneumatic air devices, instructed Mr Vanda Gould to establish a foreign superannuation fund, that they had been advised provided certain benefits over Australian-based funds. A fund was established in Samoa (the Fund) and Allan J Heasman (Sales) Pty Ltd (Heasman Sales) made two initial contributions of $250,000. This was the first of a stream of outbound and inbound remittances which gave rise to claims by companies associated with Allan and Douglas Heasman for deductions for interest and bank fees. | The funds initially contributed were made available to the Hua Wang Bank. In June 1994 Heasman Sales entered into a "loan agreement" with the Hua Wang Bank and Allan and Douglas Heasman entered into a deed with the Hua Wang Bank under which they guaranteed the obligations of Heasman Sales to the Hua Wang Bank. The funds made available to the Hua Wang Bank were then remitted to a bank account in Australia "by way of loan" from the Hua Wang Bank to Heasman Sales. | The affidavit of Allan Heasman provided that from 1994 annual payments of interest were made to the Hua Wang Bank in accordance with the loan agreement (it was said that "I'm no longer sure which of our companies paid the interest in each specific year"). Each interest payment was then borrowed back (and money remitted) from Hua Bank, and later interest payments were calculated on the basis of the enlarged principal debt. In 1999 Heasman Sales applied for an extension of the loan and executed a document that extended the loan facility and renewed the guarantees. | The affidavit went on to explain (judgment at [15]): "32. After some years had passed the making of the annual interest payment to the Hua Wang Bank in order to secure a roll-over of the debt had become quite a notable event for our business. In order to meet the annual payment it was often necessary to pool the money from all our other entities so that sufficient funds were available for the interest instalment. ... 34. Where [Heasman Sales] distributed funds from the rollover of the Hua Wang Bank loan to other Heasman group entities, there was no regular interest charged on these funds. 35. I am aware that the financial statements for [Heasman Sales] for the years up until the end of the 2004 income year show amounts owing to this company from the other Heasman entities. There were never any formal loan agreements under which [Heasman Sales] provided funds to the other Heasman entities. I used to pay funds out of [Heasman Sales] to the other entities purely on the basis of the operational needs of those entities." | Towards the end of the 2004 year of income there was a change in the entity which paid "interest" to the Hua Wang Bank on the moneys "borrowed" by Heasman Sales from that bank since 1994. The change and why it came about are summarily described by Mr Allan Heasman in Ex 3 in the following way: 53. [I]n about May 2004 I asked Gould Ralph to organise for the obligations under the Hua Wang Bank loan to be transferred to Fitzroy Services. The main reason for this was that [Heasman Sales] was insolvent and would ultimately go into liquidation. ... 55. In 2005 Fitzroy Services executed a fixed and floating charge in favour of the Hua Wang Bank. ... 56. For the remainder of the period in dispute, which was up until the end of the 2009 income year, Fitzroy Services continued to pay interest to the Hua Wang Bank and/or a separate entity called Hua Wang Finance, in accordance with our obligations under the loan agreement and claimed deductions. These amounts were borrowed back and capitalised into the loan. 57. In July 2009 Fitzroy Services applied for and was granted an extension of its loan from the Bank. ... | As to management fees, it was contended by the taxpayer that "at any given point", there was a single entity in the Heasman "group" that held the "group's" business premises; a single entity that paid the salaries of the "group" management team; and the "group's" workshop staff were employed by a single entity: at [20]. | Issues decided by the court | 1. Are 'Interest and bank fees' deductible pursuant to section 8-1 or section 25-25 of the Income Tax Assessment Act 1997 (the 1997 Act)? | No (subject to Issue 3). Justice Edmonds said, at [46], that: "... insofar as the interest and bank expenses the applicant incurred to the Hua Wang Bank in the relevant years of income were referable to any assumption of indebtedness by the applicant to the Hua Wang Bank equivalent to Heasman Sales' indebtedness to the Hua Wang Bank as at 30 June 2004, such interest and bank expenses were not allowable deductions under s 8-1, nor under s 25-25." | And, at [50], "insofar as the interest and bank expenses the applicant incurred to the Hua Wang Bank in the relevant years of income were referable to loans made to it by the Hua Wang Bank after 30 June 2004, such interest and bank expenses were not allowable deductions under s 8-1, nor under s 25-25." | We observe that His Honour rejected the Commissioner's contention that the loan was a "sham". His Honour said, at [34], that: 'The loan or loans between the Hua Wang Bank and Heasman Sales, and subsequently the applicant, is not a sham; nor is it a nullity on some "half-way house" principle of not being a "genuine transaction" or being "non-commercial".' | 2. Are 'Management fees' deductible pursuant to section 8-1, section 25-25, or section 40-880 of the 1997 Act? | No (subject to Issue 3). His Honour said, at [24], that: "On the evidence, the Court is not in a position to conclude that the outgoings incurred by the applicant in the relevant years of income and described as "management fees" ... were allowable deductions in those years under s 8-1 of the 1997 Act. While the alternative claims in reliance on s 25-25 or s 40-880 were not pressed orally, on the evidence, the Court is in no better position to adjudicate on those claims." | 3. Did the Commissioner have power to amend the assessment for the year ended 30 June 2005 pursuant to section 170 of the Income Tax Assessment Act 1936 (the 1936 Act)? | No. His Honour, after referring to the Commissioner's submissions and the Commissioner's opinion as to fraud and evasion, said, at [53]: "In the face of my conclusion ... that the loan or loans between the Hua Wang Bank and Heasman Sales, and subsequently the applicant, is not a sham and in the face of the Commissioner's concession that the applicant made the payments to associated companies of the amounts it claimed and described as "management fees", the whole foundation of the Commissioner's opinion ... that there was fraud or evasion falls away." | 4. Did the Commissioner correctly impose penalties in relation to tax shortfalls (years ended 30 June 1999 and 2000) or administrative penalties (years ended 30 June 2001 to 2003 and 2005 to 2009)? And, whether the Commissioner was correct to not remit those penalties? | The shortfall penalties were allowed in part, reduced to 50% from 75%. | The penalty for the year ended 30 June 2005 was set aside in full.

Issues decided:
1. Are 'Interest and bank fees' deductible pursuant to section 8-1 or section 25-25 of the Income Tax Assessment Act 1997 (the 1997 Act)?: No (subject to Issue 3). Justice Edmonds said, at [46], that: "... insofar as the interest and bank expenses the applicant incurred to the Hua Wang Bank in the relevant years of income were referable to any assumption of indebtedness by the applicant to the Hua Wang Bank equivalent to Heasman Sales' indebtedness to the Hua Wang Bank as at 30 June 2004, such interest and bank expenses were not allowable deductions under s 8-1, nor under s 25-25." And, at [50], "insofar as the interest and bank expenses the applicant incurred to the Hua Wang Bank in the relevant years of income were referable to loans made to it by the Hua Wang Bank after 30 June 2004, such interest and bank expenses were not allowable deductions under s 8-1, nor under s 25-25." We observe that His Honour rejected the Commissioner's contention that the loan was a "sham". His Honour said, at [34], that: 'The loan or loans between the Hua Wang Bank and Heasman Sales, and subsequently the applicant, is not a sham; nor is it a nullity on some "half-way house" principle of not being a "genuine transaction" or being "non-commercial".' | 2. Are 'Management fees' deductible pursuant to section 8-1, section 25-25, or section 40-880 of the 1997 Act?: No (subject to Issue 3). His Honour said, at [24], that: "On the evidence, the Court is not in a position to conclude that the outgoings incurred by the applicant in the relevant years of income and described as "management fees" ... were allowable deductions in those years under s 8-1 of the 1997 Act. While the alternative claims in reliance on s 25-25 or s 40-880 were not pressed orally, on the evidence, the Court is in no better position to adjudicate on those claims." | 3. Did the Commissioner have power to amend the assessment for the year ended 30 June 2005 pursuant to section 170 of the Income Tax Assessment Act 1936 (the 1936 Act)?: No. His Honour, after referring to the Commissioner's submissions and the Commissioner's opinion as to fraud and evasion, said, at [53]: "In the face of my conclusion ... that the loan or loans between the Hua Wang Bank and Heasman Sales, and subsequently the applicant, is not a sham and in the face of the Commissioner's concession that the applicant made the payments to associated companies of the amounts it claimed and described as "management fees", the whole foundation of the Commissioner's opinion ... that there was fraud or evasion falls away." | 4. Did the Commissioner correctly impose penalties in relation to tax shortfalls (years ended 30 June 1999 and 2000) or administrative penalties (years ended 30 June 2001 to 2003 and 2005 to 2009)? And, whether the Commissioner was correct to not remit those penalties?: The shortfall penalties were allowed in part, reduced to 50% from 75%. The penalty for the year ended 30 June 2005 was set aside in full.

ATO view of decision:
The Commissioner considers the Court's application of the law to the facts to be uncontroversial and respectfully correct.

Administrative treatment:
Implications for ATO precedential documents (Public Rulings & Determinations etc) | N/A

Legislative references: Income Tax Assessment Act 1997 s 8-1 s 25-25 s 40-880 Income Tax Assessment Act 1936 s 170 s 222A-226ZB s 227 s 204 Taxation Administration Act 1953 s 8AAG s 14ZZK Sch 1 Div 284 s 298-20 s 280-100 s 280-160
Case references: Deputy Commissioner of Taxation v Hua Wang Bank Berhad [2010] FCA 1014 80 ATR 449 Richard Walter Pty Ltd v Commissioner of Taxation (1996) 67 FCR 243 33 ATR 97 96 ATC 4550 Sharment Pty Ltd & Ors v Official Trustee in Bankruptcy [1988] FCA 179 (1988) 18 FCR 449 Raftland Pty Ltd v Commissioner of Taxation [2008] HCA 21 (2008) 238 CLR 516 68 ATR 170 2008 ATC 20-029 Re Securitibank Ltd (No 2) [1978] 2 NZLR 136 Price v Parsons [1936] HCA 5 (1936) 54 CLR 332 Boydell v James [1936] NSWStRp 53 (1936) 36 SR (NSW) 620 Olsson v Dyson [1969] HCA 3 (1969) 120 CLR 365 Federal Commissioner of Taxation v Total Holdings (Aust) Pty Ltd [1979] FCA 30 (1979) 43 FLR 217 9 ATR 885 79 ATC 4279 Federal Commissioner of Taxation v E A Marr and Sons (Sales) Limited [1984] FCA 213 (1984) 2 FCR 326 15 ATR 879 84 ATC 4580 Associated Minerals Consolidated Ltd v Federal Commissioner of Taxation (1994) 53 FCR 115 29 ATR 147 94 ATC 4499 R v Meares (1997) 37 ATR 321 Gashi v Commissioner of Taxation [2012] FCA 638 2012 ATC 20-325 House v R [1936] HCA 40 (1936) 55 CLR 499
Subject references: Deductions Interest Management fees Sham Penalties Fraud and evasion