FEDERAL COURT OF AUSTRALIA

Commissioner of Taxation v H [2010] FCAFC 128

THE COURT ORDERS THAT:

1.                  The appeal be dismissed.

2.                  The applicant pay the respondent’s costs, as taxed or agreed.

Note:Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
The text of entered orders can be located using Federal Law Search on the Court’s website.

REASONS FOR JUDGMENT

THE COURT:

Introduction

1                     This is an appeal from a decision of the Administrative Appeals Tribunal (‘the Tribunal’) reviewing objection decisions of the applicant (‘the Commissioner’) concerning the application of certain provisions of Div 7A of Pt III of the Income Tax Assessment Act 1936 (Cth) (‘the ITAA 36’) to the respondent (‘the taxpayer’) in relation to payments made by a company (‘the company’), during the years of income ended 30 June 1999 to 30 June 2003 (‘the relevant years of income’), for the ultimate benefit of the taxpayer.

2                     Only two of a number of issues ventilated before the Tribunal were pressed on the appeal.  They both relate to the Tribunal’s conclusion that income tax and the general interest charge were ‘present legal obligations’ that had to be deducted in calculating ‘net assets’ and, in turn, ‘distributable income’ in accordance with the formula in s 109Y(2) of the ITAA 36.

3                     Shortly stated, the Tribunal concluded that income tax imposed on the company’s taxable income for a year of income is, as at the end of that year of income, a ‘present legal obligation’ notwithstanding that no notice of assessment of that income tax had issued to the company as at that date.

4                     The Tribunal reached a similar conclusion with respect to the general interest charge liability under s 204(3) of the ITAA 36 that had accrued on unpaid tax since the due date for payment; it too, the Tribunal concluded, was a ‘present legal obligation’ notwithstanding that no assessment incorporating the accrued amount of the charge had issued to the company. 

5                     On the hearing of the appeal, the Commissioner challenged the Tribunal’s conclusion on both of these matters.

The Facts

6                     The relevant facts were found by the Tribunal at [3] – [20] of its reasons.  They are not in dispute and having regard to the confined nature of the issues pressed on appeal, it is unnecessary to fully recite them in these reasons.  Both before the Tribunal and in this Court, it was common ground that s 109C of the ITAA 36 applied to the payments in question, namely, to treat them as dividends equal to the amount paid, subject to s 109Y: see s 109C(2).

7                     In 2007, the Commissioner amended the taxpayer’s assessments for the relevant years of income to include in his assessable income under s  44 of the ITAA 36 amounts treated as dividends by Div 7A (under s 109C, subject to s 109Y) in respect of the payments made for his ultimate benefit.  This led to increases in the taxpayer’s taxable income as follows:

                            Year Ended                                      Increase

                        30 June 1999                                    $119,511

                        30 June 2000                                    $232,200

                        30 June 2001                                      $50,838

                        30 June 2002                                      $28,620

                        30 June 2003                                        $7,953

Legislative Scheme

8                     In the relevant years of income, s 109Y relevantly provided:

‘109Y(1)          Reduction of amounts of dividends.  If, apart from this section, the sum of all the dividends a private company is taken under this Division to pay at the end of the year of income would be more than the company’s distributable surplus for that year, the amount of each of those dividends is the amount worked out under subsection (3).

109Y(2)           Distributable surplus.  A private company’s distributable surplus for its year of income is the amount worked out using the formula:

Net assets   –   Non-commercial   –   Paid-up share   –   Repayments of

                             Loans                       value            non-commercial loans

where:

net assets means the amount (if any), at the end of the company’s year of income, by which the company’s assets (according to the company’s accounting records) exceed the sum of:

(a)        the present legal obligations of the company to persons other than the company; and

(b)        the following provisions (according to the company’s accounting records):

 (i)        provisions for depreciation; 

 (ii)       provisions for annual leave and long service leave;

(iii)      provisions for amortisation of intellectual property and trademarks; 

 (iv)      other provisions prescribed under regulations made for the purposes of this subparagraph. 

If the Commissioner considers that the company’s accounting records significantly undervalue or overvalue its assets or undervalue or overvalue its provisions, the Commissioner may substitute a value that the Commissioner considers is appropriate. 

 …

109Y(3)           [Calculation of payment]  The amount of a dividend that a private company is taken under this Division to pay is worked out using the formula: 

                                                Distributable surplus for year of income

Provisional dividend       x          ________________________________

                                                                        Total of provisional dividends

where: 

provisional dividend is the amount of the dividend that the private company would be taken to pay apart from this section. 

total of provisional dividends is the sum of all the dividends the private company is taken under this Division to pay at the end of the year of income apart from this section.’

Income Tax

The Commissioner’s Submissions on Appeal

9                     The Commissioner submitted that the Tribunal erred in the conclusion it drew at [47] of its reasons:

‘[W]e conclude that the obligation to pay tax at the amount subsequently properly ascertained, assessed and determined, is a present legal obligation as at the end of the financial year in respect of which the income is derived and, within in [sic] the meaning of s 109Y(2) of the 1936 Act.’

According to the Commissioner, no present legal obligation within the meaning of s 109Y(2) came into existence until an amended assessment was issued in respect of the relevant amount.

10                  The Commissioner submitted that a present legal obligation, in the context of s 109Y, is an obligation to pay an amount which is legally due.  The amount need not be immediately payable, but it must be due and owing.  The obligor must be bound and the obligee able to enforce by legal action, albeit that it may not have an immediate right to demand payment.

11                  According to the Commissioner, it is only when an assessment of an amount of income tax is issued to a taxpayer for a year of income that the taxpayer has a present legal obligation to pay tax, in the amount assessed. Until an assessment is issued, the Commissioner cannot commence proceedings to recover tax, but when an assessment issues, he may recover the amount specified in the assessment.

12                  With respect to the tax liabilities assessed to the company in 2007 when amended assessments were issued to it, the Commissioner submitted that the tax assessed would not have been recoverable by the Commissioner until those amended assessments were issued, and payment of tax had not been made by the date specified: s 208 and s 209 of ITAA 36 (in respect of the 2000 year and earlier years); s 255-5 of Sch 1 to the Taxation Administration Act 1953 (Cth) (‘the TAA 53’) (in respect of the 2001 year and later years).

13                  Reference was made to Clyne v Deputy Commissioner of Taxation (1981) 150 CLR 1 and what Mason J (with whom Aickin and Wilson JJ agreed, Brennan J also agreeing on this issue at 24) said at 16 – 17:

‘[T]he correct view in my opinion is that income tax is due when it is assessed and notice is served of that assessment and that the tax does not become payable before the date fixed by s 204. Dixon CJ, McTiernan, Williams, Webb and Fullagar JJ in George v Federal Commissioner of Taxation (1952) 86 CLR 183 at 207 said that “tax is only due after it is ‘assessed’ (see, for example s 204).”  I recognize that on other occasions members of this Court have said that “tax is a debt due and owing, although not payable, notwithstanding that no assessment has been made”, in the words of Gibbs J in Re Mendonca; Ex parte Federal Commissioner of Taxation (1969) 15 FLR 256 at 259. This approach can be traced back to the majority decision of this Court in Commissioner of Stamps (WA) v Western Australia Trustee, Executor & Agency Co Ltd (Mortimer Kelly’s Case) (1925) 36 CLR 98, especially at 105, 116 and 118. I think that the decision is to be explained on the footing that it was held that a debt for income tax not assessed until after the deceased’s death was a “debt due by the deceased” for the purposes of Acts imposing death and probate duties.’ (Emphasis added)

14                  The Commissioner acknowledged that bankruptcy jurisprudence is sometimes concerned with whether an amount in respect of income tax is a relevant ‘liability’.  However, he submitted that the definition of ‘liability’ in s 82 of the Bankruptcy Act 1966 (Cth) is significantly broader than ‘present legal obligation’ in s 109Y: it expressly includes, inter alia, future and contingent obligations as well as present obligations, and, further, is to be construed generously: Official Trustee in Bankruptcy v CS & GJ Handby Pty Ltd (1989) 21 FCR 19 at 24 – 25; Commissioner of Taxation v Kavich (1996) 68 FCR 519 at 525.

15                  Reference was made to Taylor v Commissioner of Taxation (1987) 16 FCR 212 where, after outlining the authorities including Clyne and Re Mendonca, Woodward and Northrop JJ observed at 218:

‘In the absence of an assessment, the tax is not due, in the sense of owing, and is certainly not payable.  It is a liability contingent on an assessment being issued and served.’ (Emphasis added)

16                  Reference was also made to Kavich where Lockhart J (with whom Lee J agreed) referred to the proposition that liability to income tax is imposed by the relevant statute, and to the view of Gibbs J that income tax is due once income is derived, but stated at 527 in conclusion on this issue:

‘In my view, as indicated earlier, the reasoning of Mason J (Aickin and Wilson JJ agreeing) [in Clyne at 16-17], that income tax is not due until it is assessed and notice is served of that assessment, shows that before an assessment has been made the obligation imposed on a taxpayer by the Assessment Act is to pay income tax at a future date when the tax has been assessed and a notice of that assessment has been served.’ (Emphasis added)

17                  The Commissioner also referred to what a Full Court of this Court said in Commissioner of Taxation v Jones (1999) 86 FCR 282 at 290:

‘While it is true that income tax is an annual tax which is usually assessed annually by reference to taxable income, it is also a tax which, in the event of bankruptcy can be assessed by reference to the period from the commencement of the income tax year until the moment of bankruptcy. Hence, for present purposes it can be said that as at the moment of bankruptcy there exists an obligation to pay income tax on the taxable income derived from the commencement of the year of income until the commencement of the bankruptcy, which only matures as a debt due and payable after assessment under s 168.’ (Emphasis added)

18                  Finally, reference was made to Bluebottle UK Ltd v Deputy Commissioner of Taxation (2007) 232 CLR 598, where Gleeson CJ, Gummow, Kirby, Hayne and Crennan JJ held at 627 that the phrase ‘tax which is or will become due’ in s 255 of the ITAA 36 means tax that has been assessed; and to their Honours’ observation at 627:

‘Until the tax payable by the non-resident has been assessed it is not possible to say more than that there may be tax due by the non-resident. It is not possible to say that tax is due or that tax will become due.’ (Italics emphasis in original; bold emphasis added.)

19                  In summary, the Commissioner submitted that:

(1)               According to the legislative regime and the substantial weight of authority, a taxpayer does not have a present legal obligation, within the meaning of s 109Y(2), to pay an amount of income tax until the issue of the assessment under which that amount becomes due.

(2)               The amounts which the Tribunal found at [47] and [48] of its reasons to be present legal obligations of the company at the end of the respective 1999 to 2003 years of income, are those amounts that were included in the company’s assessable income in August 2007 by the amended assessments.  They do not arise under the original assessments issued to the company (through s 166A) in respect of each of the income years in question (1999 to 2003).

(3)               Until the issue of these amended assessments in August 2007, the company did not have a present legal obligation to pay the amounts specified in the amended assessments and there was no right in the Commissioner to take legal action with respect to the amounts.

The Taxpayer’s Submissions on Appeal

20                  The taxpayer submitted that the Tribunal correctly held that as at 30 June in each year of income, the liability to pay income tax on the taxable income for that year is a ‘present legal obligation’ even though the amount is not yet ‘due and payable’.

21                  The taxpayer observed that the Tribunal’s analysis correctly commenced with the language of the statute.  The Tribunal found that a ‘present legal obligation’, as a matter of language, was a wide-ranging expression and covered more than the expressions ‘due’, ‘payable’, ‘due and payable’ and ‘debt’.

22                  According to the taxpayer, there is no issue between the parties that income tax is not ‘due and payable’ until there is an assessment or amended assessment.  That, however, as the Tribunal correctly found, is not the question posed by the statute.  The references by the Commissioner to the authorities which establish that income tax is not due and payable until an assessment is issued were well understood by the Tribunal.

23                  The taxpayer submitted that the Tribunal correctly determined that the language used in relation to the obligation to pay income tax was to be distinguished from the ascertainment of an amount being due and payable (i.e. enforceable as a debt).  According to the taxpayer, the Commissioner’s submissions impermissibly elide these concepts.

24                  The taxpayer submitted that the Tribunal concluded that the obligation to pay tax arises under statute and not by the issue of a notice of assessment.  Nothing that a taxpayer does after 30 June can alter the amount of tax that is to be paid.  In those circumstances, the Tribunal concluded that the obligation to pay tax as at 30 June was a present legal obligation and not a future obligation or a contingency.  The Tribunal did not fall into any legal error in so concluding.

25                  According to the taxpayer, the Tribunal correctly held that the reasoning of the Full Court in Kavich and Jones supported the conclusion that the obligation to pay the tax arises when the taxable income has been derived and not only after the tax is quantified as a tax due and payable on or after assessment.  The Tribunal did not fall into legal error in so concluding.

26                  The taxpayer observed that the language of s 109Y that falls to be construed is the composite phrase ‘present legal obligation’.  The Commissioner’s submission seeks to equate the concept of tax being ‘due and payable’ with the statutory phrase and in doing so has substituted for the words of a provision language which does not appear: see Hill J in Kidston Goldmines Ltd v Commissioner of Taxation (1991) 30 FCR 77 at 85.

27                  According to the taxpayer, at the time Div 7A was introduced, it was well settled that income tax was not due and payable until service of a notice of assessment.  Parliament is deemed to know the law, including statute law and the cases that interpret those statutes: Williams v The Official Assignee of the Estate of William Dunn (1908) 6 CLR 425 at 441, Dennehy v Reasonable Endeavours Pty Ltd (2003) 130 FCR 494 at 500; Commissioner of Taxation v Energy Resources of Australia Ltd (2003) 135 FCR 346 at 351.

28                  The taxpayer submitted that had it been intended that only assessed liabilities to income tax which were due and payable were to be included in the calculation of a company’s ‘distributable surplus’ it would have been appropriate to have used the expression ‘debts due and payable’.  The phrase used, however, ‘present legal obligation’, is an altogether broader concept than a ‘debt due and payable’, as the Tribunal correctly concluded.

29                  The taxpayer further submitted that the Tribunal also correctly concluded that income tax was a ‘present legal obligation’.  Because the obligation to pay income tax comes into existence as at 30 June it is a ‘present’ legal obligation for the purposes of s 109Y.  There is at the last moment of the last day of the financial year a statutory duty which must be met at a later date when the amount is correctly determined or quantified by the assessment process.

30                  The taxpayer observed that the notion that a present, or existing, obligation is wider than an enforceable obligation and includes an obligation whose legal foundation has been established, finds support in the High Court decision of Crimmins v Stevedoring Industry Finance Committee (1999) 200 CLR 1.  Crimmins concerned the meaning and effect of s 14(b) of the Stevedoring Industry Acts (Termination) Act 1977 (Cth) which provided:

‘[T]he Committee is, by force of this section, liable to perform all the duties and to discharge all the liabilities and obligations of the Authority that existed immediately before the expiration of [the transitional] period.  (Emphasis added)

31                  Gaudron J held (at 15) that a liability or obligation that ‘existed’ is not synonymous with one that is ‘enforceable’ and that the words in the provision should be construed as including not only a liability or obligation that was enforceable at the expiration of the transitional period, but also one whose foundation should then have been in existence.

32                  Finally, according to the taxpayer, the Commissioner’s submission that as the liability here to pay income tax arose under an amended assessment some different result follows should be rejected.  The Tribunal correctly concluded that as at 30 June in each of the years of income, there was a present obligation to pay income tax, notwithstanding that payment is due at some future time.  The obligation was to pay the true amount of tax payable.

33                  The taxpayer submitted that the Tribunal did not fall into any legal error in concluding that the (unassessed) income tax liability of the company was a ‘present legal obligation’ as at 30 June in each year and should accordingly be deducted from the assets of the company in determining the distributable surplus under s 109Y(2).

Analysis

34                  The starting point for undertaking a search for the proper construction of the term ‘present legal obligations’ in the definition of the term ‘net assets’ in s 109Y(2), in particular, whether it includes income tax imposed on a company’s taxable income for a year of income, as at the end of that year of income, but which has not been assessed at that date, is the legislative context in which these terms are to be found, namely, Div 7A of Pt III of the ITAA 36, informed by the legislative policy or purpose underlying that context.  The explanatory memorandum, circulated by the Treasurer of the day, accompanying the Bill which introduced Div 7A into Pt III of the ITAA 36, provides some guidance as to the policy or purpose in this regard.

‘Overview

9.1               Part 1 of Schedule 9  of the Bill will insert new Division 7A, of the Income Tax Assessment Act 1936 (the Act) to ensure that all advances, loans, and other credits (unless they come within specified exclusions) by private companies to shareholders (and their associates), are treated as assessable dividends to the extent that there are realised or unrealised profits in the company.  In addition, debts owned by shareholders (or associates) which are forgiven by private companies are treated as dividends.

Summary of the amendments

Purpose of the amendments

9.2               The purpose of the amendments is to ensure that private companies will no longer be able to make tax-free distributions of profits to shareholders (and their associates) in the form of payments or loans.’

35                  This extract from the explanatory memorandum manifests both the legislative policy of Div 7A as a whole, and s 109Y in particular.  Section 109Y is to provide a ‘cap’ or limit on such loans, advances or other credits being treated as assessable dividends, namely, up to but not exceeding the realised and unrealised profits in the company.

36                  The term ‘distributable surplus’ is to be understood in that context, namely, the realised and unrealised profits in the company available for distribution.  The profits of a company available for distribution are its ‘after-tax’ profits.  As Fullagar J observed in Commonwealth v O’Reilly (1984) VR 931 at 938:

‘In my opinion the profits out of which dividends may be paid are the profits remaining after deduction from gross profits of, inter alia, federal income tax, or at least a bona fide estimate thereof.  A bona fide assessment of profits involves a bona fide estimate of income tax.’

37                  It is within this legislative context, informed by the legislative policy and purpose referred to in the explanatory memorandum, that the ingredients of what goes to make up ‘distributable surplus’, including the term ‘present legal obligations’, fall to be considered.  A construction of those ingredients which gives the term ‘distributable surplus’ a measure which approximates the profits (realised and unrealised) available for distribution is to be preferred to a construction which results in a divergence between the measure of the distributable surplus so construed and the measure of the profits (realised and unrealised) available for distribution.

38                  The requirement that there be an ‘obligation’ does not require the existence of a debt due, in the sense of owing, any more than it requires the existence of a debt due, in the sense of being payable.  The term ‘obligation’ embraces situations outside the confines of a creditor/debtor relationship.  On the other hand, in O’Reilly, Fullagar J, after referring to what was said by Gibbs J in Re Mendonca at 259, expressed the view that the Commissioner was a creditor of each company (in that case) even prior to assessment.  His Honour said at 940:

‘In my opinion the Tax Commissioner was, in respect of the financial year, a creditor of each company from the expiry of 30 June at the end of the relevant financial year, even though the amount of the company’s liability to him had not been assessed and the amount was not immediately payable.’

39                  It is common ground in this proceeding that unless and until an assessment is made and notice is served of that assessment, income tax is not due, and nor is it payable before the date fixed by s 204 of the ITAA 36: Clyne, per Mason J at 16 (with whom Aickin and Wilson JJ agreed), Brennan J also agreeing on this issue at 24.  Nor does it appear to be in dispute that unless and until an assessment is made and notice is served of that assessment, the Commissioner has no legal right to recover an amount of income tax.  On the other hand, the correctness of these statements is no impediment to a conclusion that prior to the making of the assessment and service of notice of that assessment, the taxpayer had an obligation to pay income tax in the future, and that obligation came into existence on 30 June of the year of income in respect of which the income was derived.

40                  The obligation is no less an obligation because the Commissioner cannot, until he makes an assessment and serves notice of that assessment, enforce it as a debt due and payable.  So understood, the obligation to pay income tax ‘matures as a debt due and payable after assessment’, to use the words of the Full Court in Jones at 290, but that maturation does not deny the existence of the obligation prior to the making of the assessment and service of notice of that assessment: see Kavich at 527 per Lockhart J.

41                  The Commissioner’s submission that the obligation is not a present obligation but a future one misconceives the true position.  The obligation is a present one in the sense that it exists; the fact that the obligation is to do something at a future date does not deny its standing as an existing obligation.  At worst it may be a contingent obligation, contingent on an assessment being made and notice of that assessment served, but that does not disqualify it as a present legal obligation.

42                  The Commissioner’s suggestion that this construction leads to the strange situation of the company having parallel present legal obligations; an obligation to pay the amount specified in the assessment plus an obligation to pay the ‘true amount’ of tax for that year of income, again misconceives the position.  The present legal obligation arising under the Income Tax Act matures into a debt due and payable after assessment so that at no relevant time is there more than one present legal obligation.

43                  As the Tribunal observed at [42] of its reasons, income tax is imposed by the Income Tax Act 1986 (Cth) (s 5(1)) at the rates declared by the Income Tax Rates Act 1986 (Cth).  The income tax so imposed is levied by s 7 of the Income Tax Act, which also requires it to be paid for the relevant financial year.  The obligation to pay income tax so imposed arises by operation of the Income Tax Act itself and not by the issue of a notice of assessment.

44                  In our view, the Tribunal did not err in concluding that the obligation to pay tax at the amount subsequently properly ascertained, assessed and determined, is a ‘present legal obligation’ as at the end of the financial year in respect of which the income is derived and within the meaning of s 109Y(2) of the ITAA 36.

General Interest Charge (‘GIC’)

The Commissioner’s Submissions on Appeal

45                  The Commissioner submitted that:

(1)               The GIC in question arose as a result of the 2007 amendments of the company’s assessments for the years ended 1999 to 2003 (s 170AA until the 2000 year, s 204(3) thereafter).  For the same reason that the income tax assessed under those amended assessments is not a present legal obligation until and if the amended assessments are issued, the GIC thereon is not due any earlier either.

(2)               Although s 170AA(l) and s 204(3) provide that GIC is payable, this liability is only triggered by the issue of an amended assessment.  Until and unless there is an amended assessment, there is no liability for the relevant GIC.

(3)               Furthermore, there are additional contingencies that would prevent GIC being a present legal obligation as at 30 June of the income years in question, in any event, by reasoning analogous to that of the Tribunal in respect of penalty.  GIC may be remitted by the Commissioner under s 8AAG of the TAA 53, in which case there is no present legal obligation to pay GIC at all.

(4)               The GIC in question was not a present legal obligation of the company in any of the years of income ended 30 June 1999 to 30 June 2003.

The Taxpayer’s Submissions on Appeal

46                  The taxpayer submitted that:

(1)               The liability for the GIC is imposed by force of the ITAA 36 itself (s 204(3) and s 170AA) and not by any act of the Commissioner or as the result of an assessment: Commissioner of Taxation v Trautwein (1936) 56 CLR 211 at 216.

(2)               GIC becomes a liability from the time the income tax remains unpaid after the time by which it is due and payable.  In the case of amended assessments the liability for GIC accrues from the due date of the original assessment: s 170AA(4).

(3)               In the present case, because in each relevant year the company did not pay the proper amount of tax by the due date it came under an obligation for GIC.  GIC accrued every day the tax remained unpaid.

(4)               The due date in each case fell during the following year of income.  Accordingly, in calculating the ‘distributable surplus’ for the year ended 30 June 2000, the liability for GIC on the unpaid tax for the 1999 year was a ‘present legal obligation’ because the liability for interest arose during the following year (i.e. in December 1999).  Further, because the tax was unpaid for each of the following years in issue, the GIC remained a ‘present legal obligation’ for those years as well (see s 8AAE of the TAA 53).

(5)               Contrary to the submission of the Commissioner, the ability of the Commissioner to remit GIC (s 8AAG of the TAA 53), does not ‘prevent’ the GIC from being a ‘present legal obligation’.  Unless and until remitted, the GIC remains a ‘present legal obligation’ on each day on which the tax that should have been paid remains unpaid.

Analysis

47                  The Tribunal observed at [63] of its reasons that a person’s liability to the GIC accrues on a daily basis as a direct consequence of the fact that tax remains unpaid after the due date.  In consequence, the Tribunal was of the view that GIC becomes a ‘present legal obligation’, for the purposes of the calculation in s 109Y(2), on each day on which tax that should have been paid remains unpaid.

48                  The Tribunal’s view of the matter is undoubtedly correct.  On the hearing of the appeal the Commissioner pointed to his power of remission of GIC under s 8AAG of the TAA 53 as being a further impediment to the Tribunal’s view of the matter, but unless and until remitted, the GIC remains a ‘present legal obligation’ on each day on which the tax that should have been paid remains unpaid.

Conclusion

49                  The appeal must be dismissed with costs, as taxed or agreed.

Associate:

Dated:         20 October 2010