In the first proceeding of Anglo American Investments Pty Ltd (Trustee) v FC of T 2022 ATC ¶20-836; [2022] FCA 971 (Anglo American), Logan J held that the deduction claims had not been made out save for a relatively minor amount of interest and facility fees relating to a documented offshore loan. In the joint proceedings of Melbourne Corporation of Australia Pty Ltd v FC of T; Photo Advertising (International) Pty Ltd v FC of T 2022 ATC ¶20-837; [2022] FCA 972 (Melbourne Corp; Photo Advertising) all deduction claims were rejected. In both sets of proceedings a finding that the conduct of Mr Gould amounted to wilful blindness rather than active dishonesty resulted in the penalties imposed on the tax shortfall being reduced.
This article summarises the two Federal Court decisions in detail, with a focus on the deduction claims and the imposition of penalties. Miscellaneous issues going to the validity of the Commissioner’s assessments are covered in the comprehensive headnotes of the decisions published in CCH’s Australian Tax Cases service and are not repeated below.
Anglo American
The taxpayer in this proceeding was the trustee of the Anglo American Charitable and Cultural Trust (the AA Trust). The AA Trust had been issued with amended assessments of income tax for the years ending 30 June 2001, 2002 and 2004 to 2009. Shortfall penalties had been imposed for the 2001 to 2009 years inclusive at the rate of 75% of the shortfall amount for intentional disregard, increased by 20% for the years after 2001. The AA Trust claimed that the income tax assessments were excessive on the basis that it was entitled to deductions under s 8-1 or 25-35 of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to a management fee, bad debts that had been written off, and interest on loans relating to funds borrowed in the course of carrying on a business.
In respect of the management fee, the AA Trust claimed $123,276 as a deduction for the 2007 year owed to the trustee of the Gould Family Trust (GF Trust). In conjunction with other deduction claims, the management fee was fixed in an amount resulting in a nil taxable income for the AA Trust for that year. In respect of the bad debts, the AA Trust claimed 5 deductions relating to loans of $90,000, $120,000 and $50,000 in the 2005 year, $173,295 in the 2008 year and $185,000 in the 2009 year to various entities that had been written off. There was said to be “plentiful evidence” of the AA Trust making loans and receiving interest income from 1992 to 2009 to constitute a business of money lending.
The interest claims were grouped into onshore debt and offshore debt. The onshore debt stemmed from an amount of $3,063,050 allegedly loaned to the AA Trust by a related Australian entity in June 1992, which was said to have been used to acquire a portfolio of assets. That loan debt was allegedly acquired by another entity in November 1992, then novated several more times until a final novation in 2001 to the GF Trust.
The offshore debt related to 14 loans totalling $4.28 million made to the AA Trust by a Samoan entity, Hua Wang Bank Berhad (HWBB) from July 1994 onwards. In addition to proving that the HWBB loan agreements, advances, interest and facility fees were what they purported to be, the AA Trust had to prove that the funds advanced were deployed for income-producing purposes. An analysis of the AA Trust bank account into which the funds were deposited showed that they were applied to 209 separate expenditures, which were grouped into 21 categories for the purposes of assessing deductibility.
The credibility of Mr Gould was central to resolving the deduction claims and the appropriate quantum of penalties. The AA Trust submitted that it was a “distraction” to make findings in relation to the nature and extent of Mr Gould’s involvement with or control over companies involved in the deduction claims. However, one of the Commissioner’s bases on which the assessments were said to have not been proved excessive was that Mr Gould was a “pervasive, controlling, interested presence” and that the alleged deductions were the product of ex post facto fiscal opportunism rather than contemporaneous legal relationships. Mr Gould was painted by the Commissioner as “a fiscal Svengali” with his controlling presence said to be very much a part of the relevant wider context.
Justice Logan agreed with the Commissioner that a consideration of the deductions claimed in their wider context necessarily entailed detailing the ownership and control of a large number of corporate actors, as well as detailing the roles undertaken by relevant individuals. 114 pages later …
Anglo American decision
After painstakingly unravelling a complex web of arrangements spun over several decades, Logan J found that Mr Gould “had convinced himself that it was possible, in relation to entities which he controlled and by an act of will on his part, to designate, after the end of an income year, that those entities had been in a particular relationship, and incurred particular liabilities in particular amounts, during that year. That act of will then seemed to have been carried over into entries in general ledgers” [26]. Justice Logan said that, although Mr Gould may not have been actively dishonest, again and again he closed his eyes to the obvious to the point of “wilful blindness”. As a result, the accuracy of entries in various accounting records for which Mr Gould had supervisory responsibility was deemed not reliable. With that in mind, Logan J then considered each of the deduction claims.
That the AA Trust incurred a management fee in the amount of $123,276 was proved prima facie by the entry in its accounts. However, there were inconsistencies between its accounts for the 2007 year and the financial accounts of the GF Trust and the Gould Share Trust, which also had prima facie evidentiary status. On the balance of probabilities, Logan J found that the transaction recorded in the accounts that grounded the deduction claimed was just a sham. If that finding was incorrect, then it was clear that the dominant purpose of the management fee incurred in the 2007 year was to gain a tax benefit.
Justice Logan agreed that, at a general level of abstraction, it could be accepted that there was “plentiful evidence” that the AA Trust had at least purported to make loans and receive interest over the relevant period. The difficulty for the AA Trust was that the evidence was again contradictory, and that an onus of proof was not discharged at a general level of abstraction. With no reliable evidence that the AA Trust derived any income from the debts, or that supported a conclusion that the debts were bad, or that the debts were written off as bad, the deduction claims were not made out.
In respect of the interest deductions relating to the onshore debt, Logan J said that a conflict of evidence suggested that none of the claimed novations occurred. Assuming, however, that there was a loan and that it was novated and varied in amount owing from time to time, it was not established that the loan ever carried interest. More likely than not, the claimed amounts of interest were just ex post facto constructs by Mr Gould and of no effect in law. They were “just a form of fiscal balancing charge on the revenue account side of the ledger in the same way as the alleged management fees [were] a like balancing charge on the expenditure side of the ledger” [220]. Even if the incurring of interest expenses was other than a sham, the amounts claimed were so disproportionate to the capital sums borrowed that they could not be characterised as incurred to gain or produce assessable income or in carrying on a business for that purpose but merely to gain a tax deduction.
However, according to Logan J, the foundation for the interest and facility fee deductions for the offshore loans, which were made pursuant to written agreements, was very different to that of the onshore debt. Mr Gould and his associates went to a great deal of trouble over many years to carry the relevant loan agreements into effect in terms of invoicing, making related payments (including withholding tax) and accounting for the same. HWBB’s audited financial statements disclosed that most avowed loans made by it to the AA Trust had a matching deposit owed to a Samoan superannuation fund. Similarly, almost every interest liability that the AA Trust had claimed as a deduction was satisfied by a transfer of funds by it. Each had a contractual foundation, as did the facility fees charged and paid.
As to whether the funds advanced by HWBB were deployed for income-producing purposes, the AA Trust discharged the onus of proving that interest was deductible in relation to 5 of the 21 categories of expenditure documented, of which 2 (bank fees and state tax liability) were conceded by the Commissioner in the interest of proportionality. Thus to the very limited extent to which the AA Trust had succeeded in discharging its onus of proof, the relevant assessments were excessive.
In relation to penalties, Logan J said that his view that there was an absence of active dishonesty by Mr Gould precluded a finding of intentional disregard. However, a taxpayer who was wilfully blind to the obvious (ie that the practices he adopted could not possibly give rise to the tax deductions claimed or assessable income or losses returned) would at least be reckless. Fiscally, Mr Gould’s conduct was said to be “outrageous”, much more than just a failure to take reasonable care. In the circumstances, the appropriate characterisation of his conduct was that it was reckless, attracting penalty at a rate of 50% pursuant to s 284-90(1) of sch 1 to the Taxation Administration Act 1953, increased by 20% pursuant to s 284-220 for the years after 2001.
Melbourne Corp; Photo Advertising
The lead appeal in this decision was in relation to Melbourne Corp which, over the 2001 to 2014 income years, claimed deductions in respect of management and consulting fees as well as interest expenses in relation to arrangements with various Australian entities. The Commissioner disallowed the deductions and again imposed penalties at the rate of 75% for intentional disregard, increased by 20% for the years after 2001. The assessments resulted in Melbourne Corp’s taxable income increasing from $168,018 to $2,431,071, with penalties of $589,225 and shortfall interest charge of $175,746 imposed.
In regard to the purported management fees, each of the 6 claims was sought to be proved by a combination of evidence from Mr Gould attesting to the rendering of the service and a journal entry. There were no other contemporary written agreements or documents supporting the existence of any arrangement for the provision of management services by any of the entities concerned. In regard to the interest deduction claims, Melbourne Corp claimed amounts said to be incurred in respect of advances under 4 loan agreements totalling $2,265,297.
Melbourne Corp decision
After careful analysis of the evidence tendered in the Anglo American proceeding as well as the further evidence tendered in the present proceedings, Logan J held that neither the management fee deduction claims or the interest deduction claims had been proved on the balance of probabilities.
Justice Logan found that the various entities did not render any management services to Melbourne Corp in the relevant years, nor did Melbourne Corp incur any expense in respect of such. Mr Gould’s explanations for the fees were inconsistent and simply not credible. According to Logan J, the “amounts claimed and entities purportedly rendering the service are so random and arbitrary and so devoid of any plausible explanation … as to make it inherently unlikely that the services were rendered as claimed” [138]. The journal entries that purported to record management fee liabilities incurred by a particular entity prior to the end of a given income year were but a façade in respect of a liability that was never incurred prior to the end of the income year concerned.
Similarly, the reallocation of loan amounts from one entity to another between 30 June 2001 and 30 June 2014 more likely than not occurred after the end of the relevant income year as part of Mr Gould’s overall “closing adjustments”. The evidence revealed a complex reallocation of what were, nominally, loan accounts between Mr Gould’s private entities whereby, in respect of each income year, Mr Gould gave a semblance of advances and repayments of loans that were, in turn, used as the basis of charging what purported to be interest between the entities as he thought fit in order to minimise taxation.
In most of the income years in question Melbourne Corp’s income tax position, as returned, was that it had no tax liability. This was not a coincidence but rather the result of a succession of ex post facto constructs by Mr Gould, with the corresponding entries in accounts and tax returns a mere charade. However, were his conclusions as to sham transactions wrong, Logan J went on to find that the amounts of management fees and interest were wholly referrable to creating a tax deduction in a particular amount rather than the worth of any service. The overwhelming dominant purpose of all dealings between the entities concerned was to obtain a tax benefit.
In line with his findings in Anglo American, Logan J said that Mr Gould appeared to genuinely believe that his practice of making “closing adjustments” in order “to achieve the best overall tax outcome for the group” [53] was lawfully permissible. He was thus not actively dishonest in relation to the claiming of management fees or interest deductions but rather mistaken to the point of wilful blindness in fixing and claiming these amounts. The conclusion that Mr Gould was wilfully blind over a sustained period to the obvious meant that his conduct, and that of Melbourne Corp, was better characterised for penalty purposes as reckless rather than as intentional disregard.
Note that, in respect of the second proceeding, it necessarily followed from the conclusions reached in Anglo American that Photo Advertising failed in relation to its challenge to its income tax liability but succeeded in relation to its penalty liability to the same extent as the other taxpayers.
Key takeaways for future fiscal Svengalis
First, an act of will, no matter how genuine, does not overcome lack of documentation, contradictory evidence, unreliable ledger entries or transactions devoid of any plausible explanation. Second, making ex post facto constructs or “closing adjustments” after the end of an income in order to achieve a fiscally convenient outcome does not serve to minimise tax but rather leads to a finding of sham. Third, even if the incurring of expenses as recorded in financial accounts and ledgers is other than a sham, where the outgoing is disproportionate to the benefit of the income it will be struck down as having been incurred merely to gain a tax deduction.
Last but not least there is the imposition of penalties to consider. Given the Commissioner’s overwhelming dominance in the deduction field, none of the proceedings seemed like a match-up that would “come down to pens”. But penalties loomed large throughout due to the quantum of tax shortfalls involved. In each proceeding the penalties were initially imposed at the rate of 75% for intentional disregard for the first year, which was then increased by 20% for subsequent years. This effectively resulted in a penalty rate of 90% of the tax shortfalls for all but the base year.
The view that Mr Gould could not be said to be actively dishonest meant that his conduct (and that of the corporate taxpayers) could not be labelled intentional disregard. Instead, Logan J thought Mr Gould’s wilful blindness was more appropriately categorised as recklessness, which meant that the 75% rate of penalty (90% with uplift) became 50% (60% with uplift). Given the amounts of shortfall involved (even after adjustment for the claims allowed) this seems a generous outcome for a highly qualified accountant who believed he could “equate deduction pretence with reality” (Anglo American at [23]).
