Tax Telegraph, February 2013
Deduction disallowed for contribution made to company facing financial difficulties
The AAT has upheld the Commissioner's objection decision that a taxpayer was not entitled to a deduction for the contributions he made to a company which subsequently went into liquidation.
Over the period February 2005 to January 2009, the taxpayer contributed $350,000 to a company which was facing financial difficulties. In return for money contributed over the period February 2005 to June 2006, the taxpayer received shares in the company and from November 2006 to January 2009, the taxpayer contributed sums for which the taxpayer did not receive shares, but which the taxpayer said were loans to the company. During the 2010 income year, the company went into liquidation and the taxpayer lost the total amount of his contributions to the company. In his income tax return for the 2010 year, the taxpayer claimed the $350,000 loss as a deduction under section 8-1 of the ITAA 1997, on the basis that the contributions were incurred in gaining or producing assessable income.
The taxpayer contended that he undertook a profit-making scheme which involved the purchase of shares with a view of selling them at a profit. The Commissioner disallowed the claim, and the taxpayer's objection against the Commissioner's assessment was disallowed.
The AAT held that the taxpayer failed to satisfy the threshold issue that his intention or purpose in making the contributions to the company was to make a profit or gain. The distinct lack of commerciality in the arrangement indicated that there was no basis on which it could be objectively inferred that he entered into the transactions with an intention or purpose to make a profit or gain.
Dividends found to fall within section 23AJ
On appeal against an objection decision made by the Commissioner, the Full Federal Court has unanimously held that section 23AJ of the Income Tax Assessment Act 1936 (ITAA 1936) applied to treat dividends of approximately $183 million, received by a trust as the head company of a consolidated group, as non-assessable non-exempt income.
The taxpayer, Intoll Management Pty Ltd, was the trustee of a public trading trust (known at various times as Infrastructure Trust of Australia (II), Macquarie Infrastructure Trust (II) and Intoll Trust (II)). The trust held shares in two Luxembourg incorporated companies and received dividends from those companies. The trust made a choice to form a tax consolidated group with the trust as the head company. The issues before the court were:
- Who is the taxpayer properly subject to the provisions of sections 44 and 23AJ of the ITAA 1936 – the entity that is the trust, or the entity that is the trustee?
- Is the Commissioner bound by Tax Determination TD 2008/25 which considers whether section 23AJ of the ITAA 1936 can apply to a dividend paid by a non-resident company to the trustee of a trust, even where the trustee then pays an amount attributable to the dividend to an Australian resident company beneficiary? The ruling part of the determination states that section 23AJ of the ITAA 1936 will apply to a dividend paid to a trust which is part of a consolidated group, but the explanation part of the determination suggests this is only the case where the trust is a subsidiary member, not the head company.
The court held as follows:
- The trust does not receive the dividend as trustee, but for its own benefit as an assumed company, so as to be assessable upon it under section 44 of the ITAA 1936, subject to the operation of section 23AJ of the ITAA 1936. Under section 713-140(4) of the ITAA 1997, the word 'trustee' in section 23AJ(a) of the ITAA 1936 is taken not to refer to the trustee of the trust. The Commissioner assessed the trust (as head company) on the basis that the trust (as head company) derived, for its own benefit, and so was assessable upon, the dividend income. But in relation to the application of section 23AJ of the ITAA 1936, the Commissioner contended that the trust (as head company) did not receive the dividends from the Luxembourg companies for its own benefit, but rather as trustee. In the Full Court's view, the first proposition was correct and it followed that section 23AJ of the ITAA 1936 applied to the taxpayer's receipts of the dividends from the Luxembourg companies
- Although the Full Court did not have to consider the second issue, it concluded that the Commissioner was bound by the ruling part of TD 2008/25 (refer paragraph 1), which states that "section 23AJ will apply to a dividend that is paid to a trust which is part of a consolidated group or a multiple entity consolidated (MEC) group". The explanation part of the tax determination (paragraph 18) referred to a trust that was a subsidiary member of a consolidated group but that was not part of the ruling.
Payment into executive share trust in substitution of bonus entitlements held to be ordinary income
The Full Federal Court has dismissed the taxpayer's appeal and upheld the decision of the Federal Court in Sent v Commissioner of Taxation  FCA 382 that the taxpayer was assessable under section 6-5 of the ITAA 1997 on the whole of a payment of $11.6m made by the taxpayer's employer to an executive share trust (of which the taxpayer was a beneficiary) as part of changes to the taxpayer's employment arrangements. The taxpayer was the managing director and chief executive officer of a company and, following renegotiations of his employment contact, his accrued, emerging and future bonus entitlements were extinguished and the employer company paid $11.6m to an executive share trust. The payment of $11.6m was in substitution for the taxpayer's entitlement to receive remuneration for his services in the form of five million shares in the company issued to him or his nominee. The funds were ultimately used to purchase shares in the company for the benefit of the taxpayer.
The Full Court held that the taxpayer derived the amount of $11.6m as ordinary income within the meaning of the constructive receipt rule in section 6-5(4) of the ITAA 1997 as soon as the employer company paid the amount to the trustee as the taxpayer's nominee. The Full Court concluded that there was no difference between the taxpayer (or his nominee) receiving consideration for the taxpayer waiving his entitlement to bonuses by way of the issue of five million fully paid shares or a payment of $11.6m. This was because in either case, the shares issued or the payment made would be in substitution for his bonus entitlements, both accrued and contingent, and therefore income, as they would be a reward for services rendered and to be rendered.
The Full Court held that the amount was derived by the taxpayer in the year the amount was paid because it was paid free and clear of the contingencies to which the bonuses were subject at the time they were substituted by the share entitlement. Further, the Full Court was of the view that the arrangement under which the taxpayer gave up his right to the five million shares and accepted the money in its place could not be characterised as converting a receipt of an income character (the right to be issued the shares) into one of a capital character (the payment of the money in substitution for the right to receive the shares), as the whole purpose of the arrangement was to remunerate the taxpayer for his services to the company.
Commissioner's refusal to allow utilisation of non-commercial losses affirmed
The Administrative Appeals Tribunal (AAT) has affirmed the Commissioner's decision not to exercise his discretion under Division 35 of the ITAA 1997 to allow the taxpayer to offset non-commercial losses from a vineyard business against her other assessable income. The taxpayer had decided to establish a vineyard – an industry that has seen producers struggle recently. It was proposed that the planting of the vineyard be staggered over several years rather than planting it entirely at once, which meant that the vineyard operation would not reach full production for approximately ten years.
The taxpayer applied to the Commissioner under section 35-55 of the ITAA 1997 for a private ruling permitting her to offset losses from the vineyard business during the 2010 to 2018 income years against her other income. The Commissioner declined to make the private ruling sought by the taxpayer.
In affirming the Commissioner decision, the AAT found that while it agreed that the taxpayer's approach to developing the vineyard may have been a commercially prudent one, expert evidence tendered to the AAT suggested that it was possible to have the vineyard completely planted and reach peak production within five years and not eight or nine years. On that basis, it could not (as required under section 35-55(1)(c) of the ITAA 1997) be said that the business, because of its nature, would be unable to produce income in excess of deductions during the nine year period contended by the taxpayer.
Taxpayer fails to prove that acquisition of shares was not at arm's length – net capital gain affirmed
The Full Federal Court has dismissed the taxpayer's appeal and upheld the decision of the Federal Court in Healey v Commissioner of Taxation  FCA 269 that the taxpayer was assessable on a net capital gain to which she was presently entitled as a result of the sale of shares by a trust. The trust (of which the taxpayer was a beneficiary) had previously acquired the shares under a 'transfer' executed on 1 May 2004 for a consideration of approximately $4.5 million. The shares were subsequently sold in November 2005 (with the transaction completed in January 2006) for approximately $18.5 million. However, the May 2004 share transfers were not registered until December 2005.
At first instance, the Federal Court held that the net capital gain of approximately $14 million made by the trust on the sale of shares was not eligible for the 50% capital gains tax (CGT) discount on the basis that, broadly, CGT event E2 applied to the initial acquisition of the shares by the trust such that the shares were deemed to have been acquired by the trust when the shares were 'transferred' in December 2005 (not when the contract was entered into) and this had occurred within 12 months of the date of the sale of the shares. The Court also dismissed the taxpayer's argument that cost base of the shares should be deemed to be the market value of the shares at the time of transfer on the ground that the taxpayer had failed to adduce sufficient evidence to establish that the acquisition was not at arm's length.
On appeal, the taxpayer argued before the Full Federal Court that:
- She had in fact discharged her onus of proving that the acquisition of the shares by the trust was not at arm's length and that under section 112-20(1)(c) of the ITAA 1997, the market value of the shares at the time of transfer should be substituted as the cost base of the shares
- The market value of the shares was approximately $18.5 million.
The taxpayer's first contention was dismissed by the Full Court as the Court found there was uncertainty concerning several features of the transaction and in particular, the taxpayer had failed to call a crucial witness who could have assisted the Full Court with its inquiry into the nature of the transaction. In light of the 'unsatisfactory nature of the evidence', the Full Court held an inference could not be drawn that the parties were not dealing at arm's length.
Also, although not necessary to decide, the Full Court considered and dismissed the taxpayer's second contention on the basis that the lack of evidence of the surrounding facts and circumstances of the dealing made it difficult for the Court to infer that the market value of the shares was that which was put forth by the taxpayer.
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