FEDERAL COURT OF AUSTRALIA

Cohen v Commissioner of Taxation [2000] FCA 833

INCOME TAX – employee of insurance company paid by way of fortnightly advance debited to an account and commissions due to him were to be credited to that account.  No debit balance was repayable – whether fortnightly payments income when received – whether provisions of Fringe Benefits Tax Assessment Act 1986 (Cth)operated to exclude advance payments as income because any negative balance in the account was written off when employment ceased – whether Tribunal erred in remitting penalty where reasons do not disclose under what section the penalty arose.

Administrative Appeals Tribunal Act 1975 (Cth), s 44

Income Tax Assessment Act 1936 (Cth), s 51(1)

Fringe Benefits Tax Assessment Act 1986 (Cth), s 14

Federal Commissioner of Taxation v Steeves Agnew & Co (Vic) Pty Ltd (1951) 82 CLR 408 distinguished

Australian Mutual Provident Society v Allan (1978) 52 ALJR 407 cited

Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation (1965) 114 CLR 314 discussed

Jagelman v Commissioner of Taxation (1995) 95 ATC 4055 cited

PHILLIP LAWRENCE COHEN v

COMMISSIONER OF TAXATION

N 1505 of 1999

HILL J

5 JULY 2000

SYDNEY

ON APPEAL FROM THE ADMINISTRATIVE APPEALS TRIBUNAL

THE COURT ORDERS THAT:

1.         The appeal be allowed in part.

2.         The orders of the Administrative Appeals Tribunal be set aside so far as they concerned the remission of penalty tax to 10% of the tax payable on the amount of $23,185.

3.         The matter be remitted to the Tribunal to consider in accordance with law whether additional tax, if any, should be assessed under ss 226G, 226H or 226K of the Income Tax Assessment Act 1936 (Cth) and, if so, whether the whole or any part thereof should be remitted.

4.         There be no order as to costs.

Note:    Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

ON APPEAL FROM THE ADMINISTRATIVE APPEALS TRIBUNAL

REASONS FOR JUDGMENT

1                     The applicant, Mr Cohen, appeals from a decision of the Administrative Appeals Tribunal (“the Tribunal”) which set aside an objection decision made by the respondent Commissioner of Taxation (“the Commissioner”) and remitted it to him subject to a direction as to the manner in which his taxable income should be computed and reducing the penalty imposed for understating his income to 10 per cent.  The appeal is by virtue of s 44 of the Administrative Appeals Tribunal Act 1975 (Cth) (“the AAT Act”) an appeal on, that is to say limited to, a question of law.

2                     Central to the dispute is the assessability of the sum of $23,185 paid to Mr Cohen during the year of income by             GIO Australia Limited (“GIO”).  A question also arises with respect to a penalty included in the assessment at a rate of 50 per cent which was subsequently reduced by the Tribunal as I have already indicated to 10 per cent of the tax payable with respect to the sum of $23,185.  There were other issues dealt with by the Tribunal relating to outgoings which Mr Cohen claimed to be deductible to him under s 51(1) of the Income Tax Assessment Act 1936 (Cth) (“the Act”).  These issues were decided in Mr Cohen’s favour by the Tribunal and are not in issue in the present application.

The facts

3                     In the year of income Mr Cohen worked as a financial planner with GIO under a contract which was effective as and from 13 February 1995.  Although it is not directly relevant to the appeal, the contract with the GIO was terminated on 28 August 1996 by GIO.

4                     The terms of the contract are critical to the outcome of Mr Cohen’s appeal.

5                     By virtue of clause 2 Mr Cohen was employed, inter alia, to provide financial planning advice to customers and potential customers of GIO and related companies.  That bound him to do what GIO required.  Although clause 2.4 spoke of Mr Cohen being permitted to sell products and services of GIO, it can be inferred from the overall terms of the contract that a very significant part of his employment was the selling of insurance and similar products of the GIO from which it will be seen he was to be paid commissions.

6                     Clause 3.1 of the contract stated that Mr Cohen’s remuneration was to be “incentive-based” and payable in accordance with schedule 2 of the contract but based on the commission rates in schedule 1.  GIO could, but was not obliged to, provide additional benefits.  Schedules 1 and 2 could be amended by GIO by unilateral notice, inter alia, altering commission rates or changing the basis of Mr Cohen’s remuneration.  In particular the remuneration advance to which reference will shortly be made could be increased or reduced.

7                     Schedule 2 set out the way the incentive-based remuneration was to be computed.  The relevant rates of commission were set in schedule 1.  The rates of commissions shown in the original agreement signed by Mr Cohen were varied by GIO by memorandum dated 30 May 1996 consequent apparently upon Mr Cohen choosing to transfer to a new set of terms which had been announced.  Nothing turns upon the particular rates of commission that were from time to time payable by GIO.

8                     Schedule 2 commenced with a statement that an employee’s incentive-based remuneration had five components.  These were:

“(a)     a Remuneration Advance;

  (b)     a Base Earnings Component;

 (c)       an Investment Activity Component on savings and income products;

 (d)      an Investment Growth Component on savings products and

 (e)       Commission on Insurance and Financial Products; and

(f)        Allowances.”

9                     There was to be kept by GIO an employee’s commission account which was to have two sub-accounts:  a current commission account and a deferred commission account.  The remuneration advance (at all relevant times it was a fortnightly amount of $2,153.85) was in accordance with clause 2.2 of schedule 2 payable fortnightly in arrears.  As it was paid it was to be debited to the current commission account.  Next, any commission payable was to be credited.  Payments actually made to an employee or on behalf of the employee such as compulsory superannuation were also to be debited.  In the employee’s deferred commission account the commission referred to as investment growth commission was to be credited, the investment activity commission credited and there were to be debits made in respect of any payments of the investment growth commission.

10                  The document referred in speaking both of the current commission account and the deferred commission account for there also to be debits to the relevant accounts in respect of commissions.

11                  Clause 1.6 of the schedule provided that the six components to which I have already referred were the employee’s total remuneration.

12                  In accordance with clause 3.1 of schedule 2, a base earning commission calculated at the commencement of each quarter at the rate specified in schedule 1 was to be credited to the current commission account.  If that base earnings commission was more than the remuneration advance payable, the excess was payable to the employee by equal fortnightly instalments during the quarter in conjunction with the fortnightly payments of the remuneration advance.  If the base earnings commission were less than or equal to the remuneration advance amount payable then only the remuneration advance was payable during the quarter (clause 3.3).  There was each quarter to be a quarterly reconciliation carried out.  That quarterly reconciliation was in accordance with clause 7 which provided as follows:

“At the end of each quarter, the Employee’s Commission Account will be reconciled in the following manner:

i)          Current Commission Sub Account

            Balance brought forward at beginning of quarter                 $

            plus:                            Base Earnings Commission                $

            plus:                            Investment Activity Commission        $

                                                (where positive)

            plus or minus:             Insurance and Financial Products

                                                Commission                                        $

            plus:                            Allowances                                          $

            less:                             Remuneration Advance payments      ($)

                                                other payments                                   ($)

            plus or minus:             other adjustments                               $

                                                                                                            ______

            Current Commission Balance:                                                $

                                                                                                            =====

ii)         Deferred Commission Sub Account

            Balance brought forward at the beginning of the quarter     $

            less:     payments made during the quarter                             ($)

            plus:    Investment Growth Commission (where positive)     $

            less:     Investment Growth Commission (where negative)    ($)

            less:     Investment Activity Commission (where negative)    ($)

                                                                                                            ______

            Deferred Commission Balance:                                              $

                                                                                                            =====

            If the closing balance is positive, Deferred Commission

            payable equals Closing Balance x 25%                                  $

iii)        Quarterly Payment

            Commission payable at the end of the quarter is the sum of:

            Current Commission Balance due:                                         $

            Deferred Commission payable:                                              $

                                                                                                            ______

                                                                                                            $

                                                                                                            =====

Where the sum of the Current Commission Balance and any Deferred Commission payable pursuant to paragraph 7(ii) is negative, no quarterly payment is due.

Any commission payable at the end of a quarter is payable as a lump sum by the third fortnightly payday after the end of the quarter.”

13                  Clause 12 of the schedule provided that in the event of termination of employment the current commission account and deferred commission account were to be combined after debiting any amounts payable to the employee in relation to termination other than statutory leave.  If there was a debit balance, that debit balance was to be written off by GIO (clause 12.2).  If there was a credit balance, that credit balance was to be paid to the employee as soon as possible (clause 12.3). 

14                  It seems that in each quarter in the year of income there was a negative balance in the current commission sub-account (it increased each quarter) and amounts payable to Mr Cohen other than for remuneration advance payments were shown as a negative figure, that is to say that the only cash payments actually paid to Mr Cohen in the year of income were the amounts of the fortnightly remuneration advance payments.

15                  In accordance with the provisions in schedule 2, when ultimately in the next year of income Mr Cohen’s employment with GIO was terminated, the amount as a negative balance in the commission accounts was written off by GIO.

16                  Although not relevant at least to the substantive issue, it may be noted that the GIO deducted PAYE tax from the remuneration advance payments it made to Mr Cohen.  The group certificate which accompanied his return of income for the year of income in dispute shows him thus to have received salary and wages in the amount of $56,000.10.

17                  Mr Cohen’s income tax return was apparently not in the key papers forwarded to the Tribunal by the Commissioner.  However I was told from the bar table that Mr Cohen in his return included the amount of the remuneration advance as income but actually claimed a deduction of $23,185.  Precisely how this deduction was expressed I do not know.  It seems, at least from the statement of findings on material questions of fact forwarded to the Tribunal under s 37 of the AAT Act, that it was shown as a work related expense.  Mr Cohen from the bar table said he treated the amount as unearned income.  The amount of $23,185 in essence represented the difference between commissions in fact earned by Mr Cohen in the year of income on insurance he had effected for clients and the amount of the advance or, in other words, the figure in question was the amount that had been debited in the year of income by GIO against his commission account and which, in accordance with the contractual arrangement, would be taken into account in the calculation of amounts owing to him by debiting that amount against commission earnings to be credited to him.

The Tribunal’s decision

18                  The Tribunal delivered oral reasons immediately after the luncheon recess, argument having concluded shortly before the adjournment.  Mr Cohen requested the Tribunal to furnish written reasons and the Tribunal furnished these to Mr Cohen by furnishing to him a copy of the oral reasons delivered as they had been transcribed by Auscript, the Commonwealth’s reporting service.

19                  The Tribunal was of the view that the remuneration advance was income in ordinary concepts derived by Mr Cohen as and when it was paid to him.  It was not, in the Tribunal’s view, despite the name which the parties attributed to it in the employment agreement, an advance against commission.  It differed, thus, from the advance made to the taxpayer in Federal Commissioner of Taxation v Steeves Agnew & Co (Vic) Pty Ltd (1951) 82 CLR 408 which was found not to be salary and wages falling within the definition of s 221A of the Act.

20                  The Tribunal also rejected Mr Cohen’s argument based upon s 14 of the Fringe Benefits Tax Assessment Act 1986 (Cth) (“the Fringe Benefits Tax Act”) saying only of that argument that that section had no application.  The learned Tribunal member then turned to the question of penalty.  The Commissioner submitted that Mr Cohen had been reckless in preparing his return so that the provisions of s 226H of the Act should operate to require a penalty of 50 per cent.  Mr Cohen argued for his part that he had an arguable case stating that the decision of the High Court in Steeves Agnew had been referred to him by an officer of the Australian Taxation Office.

21                  After setting out the terms of s 222C of the Act the Tribunal continued:

“It would seem to me that, although the applicant’s case certainly doesn’t meet that standard, there is on the other hand, a matter of self-assessment.  The fact that the Commissioner must accept that persons will make claims with which he will disagree.  That is the risk in such a system, and the question is, is the difference between the parties plain fraud on the one extreme, or a legitimate disagreement as to principles of tax law on the other.

The applicant, to my point of view, certainly had a case which was arguable.  He has also had some success in this Tribunal, in relation to some albeit minor items.  It seems to me therefore, that as there is a discretion under section 227 of the act [sic] to produce, that the penalty should be reduced to 10 per cent...”

Was the remuneration advance income derived by Mr Cohen when received?

22                  A convenient starting point for the discussion of this central issue is the decision of Dixon J, as his Honour then was, in Steeves Agnew which Mr Cohen relied upon as conclusive of his case and indistinguishable.

23                  Steeves Agnew concerned a taxpayer company which carried on an insurance brokerage business.  It had employed Mr Welch, its managing director, under agreements (there were different agreements entered into from time to time) which provided that his remuneration consisted wholly of a share of profits varying in accordance with the provisions of the agreement.  One of the agreements entered into provided that Mr Welch should draw an amount monthly in anticipation of his remuneration, such drawings to be computed on the assumption that his remuneration was £1,000 per annum.  Each half year an account was to be taken and all necessary adjustments made in respect of his remuneration.  Mr Welch drew amounts on account of his salary in fact as he thought fit.  In one year his drawings amounted to £5,856 13s 5d.  In the year ended 30 June 1944 the drawings were £5,612 5s 9d but actual earnings for the same year were £3,993.  In other words he had overdrawn by some £1,280.

24                  The taxpayer company did not withhold tax under the PAYE system.  The question at issue was whether it should have done so, treating the advances made to Mr Welch as salary and wages.

25                  The resolution of the issue in the High Court depended upon the character of the payments made to Mr Welch.  The same is true in the present case.  In the circumstances of that case, Dixon J was of the view that the amount overdrawn by Mr Welch was to be characterised as a loan to him.  These amounts were not salary or wages.  I should say that if the amounts paid to Mr Cohen by way of advance remuneration, to the extent that they exceeded the commissions he earned in the year, were also properly to be characterised as loans, Mr Cohen must succeed.  One thing is clear enough.  A loan made to a person is not income.

26                  There are however two material differences between the facts of Steeves Agnew and the facts of the present case.  The first is that Mr Welch was not entitled to draw, as Mr Cohen was, a specified amount per week or per fortnight.  The second, and more important, difference is that Mr Welch was obliged, in the event that the drawings were greater than the earnings, to repay any excess.  Mr Cohen says that that is his case too.  With respect, however, an analysis of the agreement with GIO does not lead me to that conclusion.  The prima facie interpretation of the agreement is rather that the remuneration advance represented the minimum amount Mr Cohen was to receive.  There was no obligation upon him to repay any part of it.  Dixon J at 416 analysed the situation that prevailed in Steeves Agnew as follows:

“... I think that the sums drawn must be treated as advances on account of salary and not as definite payments in respect of salary.  They are drawings on account of an expected obligation which did not become a complete obligation under the first agreement until the accounts were made up at the end of the year and the amount of remuneration ascertained.  Although the second agreement refers to making up accounts at the end of six-monthly periods, it would appear from the evidence that the company in fact made up its accounts annually.  So far as concerns the first and second of the three ways in which I have said the plaintiff commissioner’s case was presented on this point enough has been said to dispose of it ...”

27                  It may be noted that in Steeves Agnew when the drawings were made the liability for remuneration had not arisen.  Even in the case of agreements which permitted in effect a drawing of £20 per week, the amount drawn could not be seen to be remuneration for service or work done over a period of time.  Indeed on at least one occasion Mr Welch in fact repaid an amount: see at 420.

28                  It is clear enough that a definition of income as being that which comes in will be a slender reed upon which to determine whether a taxpayer has derived an amount of income.  In the case of a taxpayer assessed for tax on a cash basis (and Mr Cohen is such a taxpayer), commission income is ordinarily assessed for tax when it is earned.  Prima facie that will be no sooner than the point of time at which the relevant commission is credited to the taxpayer.  Indeed it will ordinarily not be merely a crediting of the commission which will constitute derivation of the income but actual payment of it.  In a relevant case payment need not arise by virtue of cash being handed over but may come about by virtue of a set-off.  There is a discussion of the concept of set-off by Dixon J in Steeves Agnew at 420-1.

29                  If Mr Cohen received a true advance from GIO, that is to say an advance that was repayable by him, then as commissions due to him were applied to reduce the amount of the advance, it would be clear that Mr Cohen would at the time of the notional set-off payment have derived income relating to his employment.  But that is only where what Mr Cohen received initially was a real advance.

30                  It is necessary therefore to consider by reference to the terms of the agreement whether, as Mr Cohen says, the remuneration advance represented a true advance or in other words a loan, or whether, as the Commissioner submits, it represents an unconditional reward for the services which Mr Cohen agreed to perform for GIO.

31                  The agreement is far from easy to construe in this context.  The fact that the parties have referred to the payment as “remuneration advance” supports Mr Cohen’s view.  The label which the parties use will not necessarily be determinative of the true nature of the payment:  Australian Mutual Provident Society v Allan (1978) 52 ALJR 407 at 409 (PC).

32                  The fact that, although the remuneration advance has been paid commissions earned are offset against it in the commission accounts, provides a prima facie picture of an advance which is to be repaid out of commissions earned as they become payable to an employee.  On the other hand the fact that any ultimate debit balance is not repayable on termination tells against the “advance” being a real loan.  One can test whether payment of the “advance” is repayable by asking whether any circumstances could arise under which any debit balance owing at a particular time might be recovered from the employee.  Truly if that were the case it would be correct to say that the amount of the advance was not earned or derived when paid. 

33                  However, when one looks at the agreement as a whole, I think it is clear that it does not contemplate that the employee could ever be required to repay any amount which stands as a debit balance in the commission accounts.  I think there are two reasons for this.  First, the agreement does not in fact provide that any debit balance is repayable or for that matter determine when it could be repayable.  Secondly, it is clear from the agreement that any debit balance in the commission account carries forward from quarter to quarter.  This is not the case where there is a credit balance in the account and clause 3.2 provides the manner of payment to the employee of the amount of the credit balance.  Had the parties intended that the advance was in fact a true advance and repayable it could be expected that a provision along the lines of 3.2 would operate in reverse.

34                  My view of the matter is confirmed by the provisions of clause 1 of schedule 2 which makes it clear that the remuneration advance is part of an employee’s remuneration.  It is not in fact repayable but in my view earned when paid.  The commission from the sale of GIO products which is then payable to an employee is calculated taking into account the fact that the advance has already been paid.  I do not think it is correct to say that the advance in part is repaid each quarter from and to the extent of any commission that is credited.

35                  The case is not like Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation (1965) 114 CLR 314 where remuneration was received in advance of the performance of the services to which it related.  Mr Cohen was entitled to receive, under the contract with GIO, a minimum remuneration of the amount which from time to time was nominated as the advance.  That was part of the remuneration that he was to receive for the services he performed under the contract from day to day.  He may have become entitled to other remuneration having regard to commissions from GIO products or services which he sold.  His remuneration was thus the combination of the advance and any amount which became payable to him under clause 3.2 of schedule 2 or in accordance with the amount to which he became entitled by virtue of the calculation under clause 7.

36                  It follows in my view that, on the proper construction of the agreement with the GIO, the remuneration advance was income derived by Mr Cohen as and when it was paid.  It was not an advance in the sense of a loan to him.

Did s 14 of the Fringe Benefits Tax Act apply?

37                  Section 14 of the Fringe Benefits Tax Act defines a debt waiver benefit.  Where a person in the capacity of employer waives the obligation of another person to repay the amount of a loan, there will be a debt waiver benefit in respect of which fringe benefits tax will become payable under s 15, by reference to the taxable value of the debt waiver fringe benefit calculated in accordance with s 15.  A debt waiver occurred, according to Mr Cohen, in the year of income following the year in respect of which the assessment was made.  Mr Cohen’s submission is that the provisions of s 23L of the Act operate to exclude fringe benefits upon which fringe benefits tax is payable from being included in assessable income under s 26(e) of the Act.  It may, for present purposes, be accepted that where fringe benefits tax is payable no amount representing the same fringe benefit is to be included in assessable income.  The problem is that there is no real relationship between, on the one hand, the so-called waiver of the benefit if there be one and the amounts received fortnightly by Mr Cohen on the other hand.  Indeed in my view there is not really a waiver of an amount owing at all.  The effect of an agreement to waive repayment of an advance before the advance is made will be to negate the existence of an advance with the consequence that no fringe benefit tax is payable.

Remission of penalty

38                  In my view that part of the Tribunal’s reasons which deals with the question of penalty is far from satisfactory.  In saying that I am aware of the difficulties under which the Tribunal labours and the danger of being over critical of reasons given extemporarily in an unduly technical search for legal error: cf Jagelman v  Commissioner of Taxation (1995) 95 ATC 4055 at 4062.

39                  Nevertheless, the reasons disclose the following difficulties.

1.         The Tribunal does not avert at all to what section, if any, it believes a penalty should accrue under.  As counsel for the Commissioner concedes, sections which might be appropriate are ss 226G, 226H or 226K.

2.         Penalties which the Act imposes in breach of any of the three sections in question differ.  Sections 226G and 226K refer to a penalty of 25 per cent.  Section 226H refers to a penalty of 50 per cent.  The exercise of remission of penalties could not properly be carried out unless the starting point of the remission is known.

3.         The Tribunal made no direct finding in respect of the Commissioner’s submission that s 226H applied.  That section operates where a tax shortfall as defined arises by virtue of recklessness.  I think it may be inferred that the Tribunal did not accept the submission.  However it is certainly not at all clear.

4.         The Tribunal considered the question whether, as Mr Cohen submitted, the matter he argued was reasonably arguable.  It seems that the Tribunal rejected that submission although it found that Mr Cohen had “a case that was arguable”.  No doubt there are degrees of arguability ranging from barely arguable to reasonably arguable.  I have to say that I admire the ability of the Tribunal member to conclude, if he did with such certainty, that the matter was not reasonably arguable.  In my view it was.

Counsel for the Commissioner conceded that a decision on whether a point of law such as the present was or was not reasonably arguable itself involved an issue of law.  If that were so, I would be inclined to set aside the penalty decision for that reason alone.  However it is unnecessary for me to reach a conclusion on whether a question of law would in such a case arise.

40                  The significant problem in the Tribunal’s reasons lies in the failure to commence with identifying the relevant section imposing the penalty, in the process of exercising the discretion under s 227.

41                  There is another matter which causes me some concern.  It is implicit in the Tribunal’s reasons on penalty that the Tribunal treated Mr Cohen as having omitted assessable income.  That is not, it seems, what he did in the return.  It is true that in the objection he argued for the excision from his assessable income of the $23,000 saying it was merely an advance against commission.  That in itself should hardly be seen to constitute an action meriting a penalty of omitting income.  In any event, the penalty objected against was dealt with at a time antecedent to the objection, namely in the assessment process.

42                  In my view the decision, so far as it concerns penalty, should be set aside and remitted to the Tribunal for rehearing.  I need do no more than call the attention of the Tribunal to the relevance of the return when it comes to consider the question of penalty afresh.

43                  As both parties have been partially successful it seems to me that the appropriate order in the circumstances would that there be no order as to costs.

Associate:

Dated:              5 July 2000