CATCHWORDS
INCOME TAX - allowable deductions - payment of premiums for insurance bonds by employer company to provide for lump sum payments to employees - indemnity agreement with associated company - legal expenses - whether premiums and legal expenses deductible.
Income Tax Assessment Act 1936, s.51(1)
Hallstroms v Federal Commissioner of Taxation (1946) 72 CLR 634 at 648.
Ronpibon Tin NL v Federal Commissioner of Taxation (1949) 78 CLR 47 at 55-6
Federal Commissioner of Taxation v Foxwood (Tolga) Pty Ltd (1981) 147 CLR 278 at 285, 293
Fletcher v The Commissioner of Taxation (1991) 173 CLR 1 at 18-19
Magna Alloys and Research Pty Ltd v Federal Commissioner of Taxation (1980) 33 ALR 213 at 233
Federal Commissioner of Taxation v Snowden and Willson (1958) 99 CLR 431 at 444 and 437
Ransburg Australia Pty Ltd v Federal Commissioner of Taxation (1980) 29 ALR 433 at 436
Nilsen Development Laboratories Pty Ltd v Federal Commissioner of Taxation (1981) 144 CLR 616 at 623-5.
W Nevill & Co Ltd v Federal Commissioner of Taxation (1937) 56 CLR 290 at 302
Federal Commissioner of Taxation v James Flood Pty Ltd (1953) 88 CLR 492 at 507
Nilsen Development Laboratories Pty Ltd v Federal Commissioner of Taxation (1981) 144 CLR 616 at 624, 627 and 631
Coles Myer Finance Ltd v Federal Commissioner of Taxation (1993) 176 CLR 640 at 663
GANDY TIMBERS PTY LTD v COMMISSIONER OF TAXATION
NO. WAG 18 OF 1994
R D NICHOLSON J.
PERTH
8 MARCH 1995
IN THE FEDERAL COURT OF AUSTRALIA)
WESTERN AUSTRALIA DISTRICT REGISTRY)
GENERAL DIVISION ) NO. WAG 18 OF 1994
B E T W E E N: GANDY TIMBERS PTY LTD
Applicant
and
COMMISSIONER OF TAXATION
Respondent
MINUTE OF ORDER
JUDGE MAKING ORDER: R D NICHOLSON J.
DATE OF ORDER: 8 MARCH 1995
WHERE MADE: PERTH
THE COURT ORDERS THAT:
(1) The appeal be dismissed
(2) The applicant pay the respondent's costs including the costs reserved.
Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
IN THE FEDERAL COURT OF AUSTRALIA)
WESTERN AUSTRALIA DISTRICT REGISTRY)
GENERAL DIVISION ) NO. WAG 18 OF 1994
B E T W E E N: GANDY TIMBERS PTY. LTD.
Applicant
and
COMMISSIONER OF TAXATION
Respondent
R D NICHOLSON J.
PERTH
8 MARCH 1995
REASONS FOR JUDGMENT
This is an appeal from an objection decision by the respondent in respect of an assessment for the income year ended 30 June 1989 whereby the respondent disallowed the applicant's claim for deductions of $100,000 expended on premiums for insurance bonds and $7,000 expended on legal fees ("the outgoings"). The grounds of the respondent's decision were that neither amounts were incurred in gaining or producing assessable income, nor were they necessarily incurred in carrying on a business for such a purpose, and that the expenditure was capital or of a capital nature and not deductible under sub‑s.51(1) of the Income Tax Assessment Act 1936 ("the Act"). Alternatively, the respondent decided that the arrangements giving rise to the outgoings attracted the provisions of Pt IVA of the Act, thereby rendering the deductions claimed liable to disallowance. It was conceded on behalf of the respondent that the alternative ground of the objection decision was not before the Court on this appeal.
During the relevant year the applicant carried on the business of saw miller and timber merchant and engaged extensively in other activities and operations. Its share‑holders were Gandy Transport Pty Ltd (all the shares of which were beneficially owned by Mr A and Mr B Gandy ("the director employees"), each of whom was a director of the applicant in the relevant year) and Mr A Gandy. The director employees were each employed in predecessor businesses taken over by the applicant and each continued in the relevant year and since to be employed full-time by the applicant.
By agreements ("the employment agreements") dated 28 June 1989 the director employees entered into contracts of employment with the applicant. Each was to be employed at a monthly salary of $2,916 or such amount as otherwise agreed from time to time, the employment to continue until determined by mutual agreement or six months notice by either party.
The employment agreements additionally provided that the applicant would pay the director employees "the lesser of the amount of $1,100,000 and the amount standing to the credit of the insurance bond to be effected in accordance with the [employment agreements] plus the value of any property (if any) in which the proceeds or part thereof have been invested by the trustee" of a family unit trust of each of the director employees ("the payment"). The payment was to become due on the 1 July 2002 or on such earlier date as the applicant and director employees mutually agreed or at the expiration of 6 months notice given by the applicant to the director employee.
The employment agreements further provided that the payment was to be made to such person or persons ("the nominee"), not being the applicant or the director employee or an associate of either of them ("as defined by the relevant income tax or other legislation"), as the trustee for the time being of the director employees' family unit trusts should appoint. Section 26AAB(14) of the Act as it read in the relevant year provided that an "associate" means, in the case of a trustee of a trust estate, any person who benefits or is capable of benefiting under the trust estate, either directly or through any interposed companies, partnership or trusts.
With the stated object of better securing the payment to the nominee, the applicant covenanted in each case to arrange for an insurance bond to be effected with a life assurance company in the name of Fanton Holdings Pty Ltd ("Fanton") "as the original beneficial owner and as trustee of" the family unit trust of each of the director employees. The bond was to provide that, subject to payment for additional units at the rate of $50,000 for the year ended 30 June 1989 and subsequently the same amount for so long as the director employee remained in the employment of the applicant, the amount to be paid under each bond on 1 July 2002 would be the sum of $1,100,000. Furthermore, it was agreed between the parties that the amount paid should be for the benefit of and enure for the nominee absolutely.
The directors and shareholders of Fanton in the relevant year were the spouses of the director employees. Fanton was and remains the trustee of the family unit trusts of the director employees. All the units in those trusts were held by family trusts of the director employees. The applicant has no interest in the trusts nor any association with them or control over them.
By deeds of indemnity between the applicant and Fanton ("the indemnity agreements") also dated 28 June 1989, Fanton undertook to make the payment to the nominees under the employment agreements and to hold the applicant free from any liability or claim in respect of the payments. It was also provided that Fanton would have the right to deal with the insurance bonds and any proceeds of them from time to time "as it shall in its absolute discretion see fit" but it was further required to hold such proceeds and any property or investment thereof as trustee for "the aforesaid purposes". In my opinion those latter words refer to the purpose of making payment to the nominee and qualify the former words. This view is supported by reference to the primary obligation of Fanton under the indemnity agreements to pay the nominee and by the further provision in them whereby, in the event of the applicant failing to pay to Fanton within one month of demand in writing, Fanton had the right to surrender the insurance policies and pay the proceeds of the bonds to the nominees. I therefore do not accept the submissions for the respondent that Fanton had an unfettered right under the indemnity agreements to pay whom it chose. I accept, however, that it had an unfettered right to deal with the bonds and proceeds subject to the trust interests and prior to payment to a nominee being required.
The obligation of Fanton under the indemnity agreements being to hold and pay the proceeds of the bonds to the nominee, I accept the submission for the applicant that Fanton was precluded without breach of that obligation from paying the proceeds to a person other than a nominee. Consequently it was precluded from paying the proceeds to a beneficiary under either of the family unit trusts, such beneficiaries being precluded from the class of nominee by being associates. However, that obligation stands in apparent conflict with the obligation of Fanton under the employment agreements to effect the bonds in its name "as the original beneficial owner and as the trustee" of the family unit trusts, by which obligation Fanton was obliged to hold the bonds in accordance with the trusts and therefore for the interest of family members. The obligation arising in this respect under the employment agreements attached to each bond upon it being effected; the obligation under the indemnity agreements arose only upon payment falling due and Fanton as trustee of the family unit trust making a nomination. For the purposes of this appeal it is sufficient to find that, as a result of these provisions, Fanton either held the bonds for the family members or held the proceeds prior to nomination of a nominee for family members with an ultimate obligation upon such nomination to pay the proceeds to the nominee who necessarily was a person other than the applicant, the director employees or an associate of either of them.
It is apparent from the recitals to the indemnity agreements that they were entered into after the employment agreements and with the intention of perfecting the arrangements put in place by the employment agreements. The director employees were not parties to the indemnity agreements, with the consequence that these agreements did not discharge the applicant from obligations incurred by it under the employment agreements. The indemnity agreement with Fanton does not in truth provide to the applicant any indemnity: the obligation pursuant to the employment agreements remains and the funds in the hands of Fanton might not be used to discharge that obligation.
On the date on which the employment agreements and the indemnity agreements ("the agreements") were entered into, the applicant paid by cheque in the amount of $100,000 the first premiums in respect of each of the insurance bonds. On the same date the applicant agreed to pay the sum of $7,000 to a promoter's company for his services in establishing the arrangements referred to in the agreements. These are the outgoings which were disallowed as deductions by the objection decision.
In respect of each of the insurance bonds a certificate issued dated 30 June 1989 describing the bond as a Capital Guaranteed Accumulation Bond of the non-superannuation type in the name of Fanton. By the terms and conditions of each bond it was provided that a unit account would be established in respect of it and credited with units on receipt of premiums. Provision was made that the policy would terminate on the redemption of all units in the bondholder's unit account. It was provided that each payment received was a single insurance premium to be applied at the bondholder's direction to purchase units which were then credited to the bondholder's unit account. Further provision was made for the bondholder at any time after 14 days from the date of issue of the policy to make application to redeem current units subject to a minimum partial redemption of $500. The value at which units were to be redeemed was in effect a value reflecting an accumulation of the amounts invested plus accumulated income. It was provided that upon redemption the bondholder got out what had been put in together with interest.
Approximately 18 months following the issue of the insurance bonds there was a redemption of the sum of $90,000 against the credit of the bonds. This was drawn and lent to a daughter of Mr A Gandy at an interest rate of 8%. The loan remains outstanding. There is no evidence that Fanton has done more than redeem these bonds and act as trustee.
Certain features of the agreements attract particular attention. The first is that the employment agreements were capable of being terminated by 6 months notice, which notice would also have had the effect of making the payment due. Furthermore, the payment was not to be of the actual amount standing to the credit of the bonds but rather an amount equal to that credit if it be less than the amount of $1,100,000. In addition, while the provision for effecting insurance bonds is expressed to be "in order to better secure" the payment as the primary obligation, it in truth does not do so because that obligation is to make the payment whether or not the proceeds of the bond are used to effect it. Significantly, the right to payment under the bonds is exclusively for the benefit of the nominee and not therefore for the applicant or the director employees, nor any of their associates. It is apparent that this provision has the effect of substantially distancing the arrangements effected by the agreements from the business ends of the applicant. Furthermore, the right of the director employees to terminate the agreement and occasion the payment to be made is exercisable on day two of any period following payment of a premium so that the payment may become due without the director employees having served the business ends of the applicant for the annual period to which the premium relates.
Mr A Gandy's evidence was that in 1989 his confident expectation was that he and his brother would continue to work full-time for the applicant until reaching their respective retirement ages, unless death or illness intervened. Because of the concern as to the latter, he had sought advice on how some funds could be made available through "some form of insurance that would enable the company to continue... for the benefit of our children and our wives in the event of either one of us or both of us...failing to be able to operate the company." He accepted, however, that the effect of the agreements was not to provide any access to capital for the applicant in that event other than by it obtaining a loan from Fanton. It follows that I am unable to accept his evidence that "the principal motivating force [for the agreements] was to provide protection for the company in the event that either myself or my brother could not continue to effectively operate it." As he also testified in cross-examination, the effect of the arrangements was at best to provide funds to the members of the family of each of the director employees and they might then choose to apply the funds in the interests of the applicant. This evidence can only be consistent with the agreements if it is understood to refer to a loan being made by Fanton to the applicant prior to the payment falling due.
I accept the evidence of Mr A Gandy that the amount of salary referred to in the employment agreements was a figure arrived at based very much on the same salary which had been paid to him and his brother in previous years. So far as the figure of $1,100,000 referred to in the indemnity agreements is concerned, his evidence was that he thought the figure had been structured by reference to the allowance of $50,000 a year for both him and his brother for 10 years, and his opinion was that the figure to be provided was $1M. His evidence does not account for the derivation of the figure of $1,100,000.
I also accept Mr A Gandy's evidence in cross-examination that in the relevant year the applicant derived a high taxable income with the consequence that he received advice concerning the arrangements in the agreements on the assumption they would have a direct tax benefit to the applicant. He said Fanton had been introduced to make the bond premium payments deductible to the applicant and the benefits paid under the bonds not assessable to the applicant upon receipt.
In support of its appeal the applicant contended that the outgoings should have been allowed as deductions because, in terms of the second limb of s.51(1) of the Act, they were "necessarily incurred in carrying on a business for the purpose of gaining or producing" income. The case for the applicant on the hearing of the appeal did not place any reliance on the first limb of that sub‑section.
The applicant's statement of the law relevant to the appeal was not contested on behalf of the respondent. The applicant's submission was that the characterisation of the outgoing involves a commonsense or practical weighing of the various aspects of the whole set of circumstances including the direct or indirect object of the taxpayer in making the outgoing and the advantages which the taxpayer sought in doing so: Hallstroms Pty Ltd v FCT (1946) 72 CLR 634 at 648; FCT v Foxwood (Tolga) Pty Ltd (1981) 147 CLR 278 at 285, 293; Fletcher v FCT (1991) 173 CLR 1 at 18-19. "Necessarily" means the outgoing must be appropriate and adapted for the ends of the business carried on for the purpose of earning assessable income: Ronpibon Tin NL v FCT (1949) 78 CLR 47 at 55-6; FCT v Snowden & Willson Pty Ltd (1958) 99 CLR 431 at 444 and 437 cited in Magna Alloys & Research Pty Ltd v FCT (1980) 33 ALR 213 at 233. It means for practical purposes that, within the limits of reasonable human conduct, it is for the person carrying on the business to be the judge of what outgoings are necessary to be incurred: FCT v Snowden and Willson, (supra) at 444; Magna Alloys, (supra) at 233. An outgoing will be necessarily incurred in carrying on the business when, viewed objectively, it is seen in the circumstances to be reasonably capable of being seen as desirable or appropriate in pursuit of the business ends of the business being carried on for the purpose of earning assessable income: Magna Alloys and Research, (supra) 235.
For the applicant it is contended that the object or purpose of the agreements is to be derived from a reading of the agreements alone and that the necessary nexus between the business of the applicant and the premium outgoings appears therefrom. That proposition cannot be accepted. The true object or purpose of the agreements is to be ascertained by reference to the terms of the agreements as explained and elucidated by oral evidence. The obligation in the employment agreements upon the applicant to pay annual amounts of $50,000 for the purchase of units in the insurance bonds and the payment of those amounts is to be assessed for its qualification pursuant to the second limb of section 51 in relation to the entire nature of the arrangement: it is not enough to make it "necessarily" incurred that it has been provided for in the employment agreements. The fact that the payment is made pursuant to a contractual obligation as part of the consideration for the employment agreements does not of itself give to those outgoings the character of being "necessarily" incurred in carrying on the applicant's business.
In making the objective determination in relation to the premium outgoings it is necessary to have regard to the nature of the arrangements established by the agreements. The first is that the effect of the agreements was not to provide that the proceeds of the bonds would be available to assist in the operation of the applicant upon the bonds becoming payable. On the contrary, the bonds were to be held by Fanton until payment became due or redemption was required. There was no legal obligation on Fanton to make payment to the applicant for the purpose of enabling its operations to continue or otherwise. At best Fanton, in the exercise of its discretion, could loan funds to the applicant. Upon payment becoming due, Fanton was obligated to pay the nominee; that nominee not being the applicant or the director employees or any associates of either of them. It follows that there was nothing about the arrangements established by the agreements which advanced the business ends of the applicant.
In its return for the relevant year when the applicant sought a ruling in relation to the outgoings, it did so on the basis that it "sought to secure key persons within the company and in order to do so, they negotiated employment contracts with the employees, whereby the employees would continue to serve the company for a defined period (10 years) and in return the company would pay the employees a lump payment at the expiration of the contract." In addition it was said that "in order to meet its future obligation, the company has taken out indemnity insurance by way of bond certificates to meet such future commitments." It is apparent from the facts as found that no such purpose existed. The evidence of Mr A Gandy was that he and his brother had worked with the applicant since they left school and had absolutely no intention of leaving it unless their death or disability intervened. There was therefore no purpose of securing or retaining a valued or key employee by the agreements. The employment agreements did not commit either director employee to service for that or any other period, there being express provision for termination by 6 months notice in writing by either the applicant or the employee.
Furthermore, I consider it is the inevitable inference from the evidence of Mr A Gandy and from the conduct of Fanton in redeeming funds for a loan in favour of his daughter, and I so find, that the principal purpose of the agreements was to pass to Fanton and hence the spouses of the director employees in a way which was thought to be tax effective to the applicant, control over funds earned by the applicant. It follows again that there was nothing about the arrangements flowing from the agreements which had as its purpose the advancement of the business ends of the applicant.
In Ransburg Australia Pty Ltd v FCT (1980) 29 ALR 433 the taxpayer company claimed deductions for payments made to a related company pursuant to what was referred to as a "contract of indemnity", designed substantially to indemnify the company against future liability for employees' holiday pay and long service leave. Appeals against the disallowance as deductions of those payments under s.51 were dismissed. In the present case the circumstances pertaining in Ransburg have been varied by the introduction of Fanton between the taxpayer company and the company providing the bond. In addition, there is as a consequence no provision for assignment of bonds. In my opinion this fact cannot affect the conclusion which I have reached in relation to the character of the premiums. Indeed, the introduction of Fanton distances the fund from the business purposes of the applicant because Fanton has a discretion both to redeem units and to pay persons not associated with the employer or the director employees. Additionally, it is a company managed and owned by family interests of the director employees. In my view, these considerations require that the appeal be determined against the applicant.
There is a further reason why the applicant cannot succeed. The analysis of the nature of each of the bonds shows that, upon payment of the premiums, a unit account is credited with units. Current units may be redeemed at any time. The value at which units are redeemed reflects an accumulation of the amounts invested plus accumulated income. Upon redemption, the bond holder gets out what has been put in together with interest. Furthermore the payment of premiums was not truly consideration for an indemnity because, as has been seen, that was not the effect of the indemnity agreements. The consequence is the premium outgoings are in the nature of a deposit akin to a savings bank deposit and consequently are an affair of capital, so that deductibility under s.51(1) is precluded. Cf Ransburg (supra) at 436 per Deane J. and 440-2 per Fisher J. As in Ransburg, the premium outgoings were not on revenue account by way of consideration for an indemnity but rather as investment on capital account.
For the respondent further alternative arguments were put having as their premise the question whether the payment when made would be deductible under s 51. In my view it is not necessary to characterise the future product (the payment) in order to determine that the premium outgoings in the relevant year were properly disallowed.
So far as the legal expense outgoings are concerned, the finding that the arrangements established by the agreements were unrelated to the business ends of the applicant has the consequence that these expenses were also properly disallowed.
In my opinion this appeal falls to be determined in the same way as Ransburg (supra) and Case Z38, 92 ATC 350.
For these reasons I would dismiss the appeal.
I certify that this and the preceding 12 pages are a true copy of the Reasons for Judgment of his Honour Justice R D Nicholson.
Associate:
Date:
APPEARANCES
Counsel for the Applicant: M Komesaroff
Solicitor: Morris Komesaroff
Counsel for the Respondent: G Nettle QC
Solicitor for the Respondent: Australian Government Solicitor
Date of Hearing: 8 February 1995
Date of Judgment: 8 March 1995
