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In 1959, the distinguished accountant J A L (John) Gunn, author of the standard Australian commentary on income tax law,[1] demonstrated that a lifetime of studying tax need not destroy one’s sense of humour. He published a little book entitled Tax Sputniks, or Ideas Which Should Have Been Shot into Space before Conception.[2] In it he dealt in humorous vein with a number of absurdities in our tax laws, one or two of which are still with us.
Gunn was a master of all he surveyed since the tax law of the time was understandable by a single person, though he or she would needed to have been a person of strong intellect and long experience. Such an understanding of course is no longer possible,[3] but in the huge jungle of the present law one occasionally comes across provisions that invite the inquiry “whatever were they thinking of” or, worse “were they thinking at all?” What follows is a selection of three present day ‘tax sputniks’.
Sometimes anomalies in tax law are caused by the reform process itself; new legislation covering some new perceived problem is inserted without adequate consideration of the effect on existing provisions. Sensible provisions can be rendered ambiguous or meaningless by subsequent changes. The high degree of caution displayed by the drafters of our tax legislation means that if there is the slightest doubt that a new measure might contain some loophole, the existing provision will be retained. Caution is commendable in this area; mistakes can be very costly. On the other hand, retrospective amendment to correct drafting mistakes is now routine and few grieve for opportunists who attempt to profit from obvious errors.
Hard cases make bad law. In 1925 a syndicate of London businessmen made a killing on a deal involving Malayan rubber plantations that it resold to a company floated for the purpose.[4] The Revenue’s attempt to tax the transaction failed on the ground that it was not “an adventure in the nature of trade” even though there was a clear intention when the interest in the plantations was acquired to resell it at a profit. After the House of Lords decision confirming this result,[5] the Commonwealth Parliament, despite the different structure of the Australian legislation, enacted what became s 26(a) of the Income Tax Assessment Act 1936 (Cth) (“ITAA 1936”). This provision sought to include in assessable income two categories of profit – the so-called first and second limbs:
1. Profit on property purchased with the purpose of resale at a profit; and
2. The proceeds of “a profit-making undertaking or scheme”.
Section 26(a) (s 25A(1) in the last few years of its existence) had a remarkable forensic history with over 1000 reported cases between 1931 and 1986.[6] However the overwhelming majority of these cases concerned the application of the first limb, the issue usually being the intentions of the taxpayer at the time of acquisition of the property in question. The first limb became a narrow, capricious and unpredictable capital gains tax, sometimes extending to profits made on property held for many years, without any reduction for inflation. The second limb, however, gave rise to few reported cases.[7] This was not surprising since it was merely a paraphrase of words used in an earlier High Court decision[8] to describe the type of ’once off’ transaction that might give rise to ordinary income.
In the 1980s three events changed the landscape for the taxation of isolated property sales. The first two were cases, the decisions in Whitford’s Beach Pty Ltd v FCT [9]and FCT v Myer Emporium Ltd.[10] These cases together brought about a considerable widening of the tax law concept of ordinary income. The third was the introduction of a capital gains tax in which, for the most part, liability was not dependent on intention in relation to an asset, but only on whether there was disposal of an asset.
When the capital gains tax was introduced on assets acquired after 19 September 1985, s 25A(1) was limited in its application to property acquired on or before that date. The legislative intention clearly was that future property gains, if they fell outside the ordinary income concept, were to be taxed under the capital gains tax provisions.
On 1 July 1997, the ITAA 1997, product of the Tax Law Improvement Program (“TLIP”), came into force. The first limb of s 25A(1) was not re-enacted. The second limb, however, did re-appear as s 15-15 of the ITAA 1997.[11] It includes in assessable income “profit arising from the carrying on or carrying out of a profit-making undertaking or plan” if the profit is not assessable as ordinary income and does not arise in respect of property acquired on or after 20 September 1985.
It is somewhat of a puzzle as to what s 15-15 is directed towards. Clearly, it can only apply to transactions involving property acquired before 1985, or to profit-making undertakings or schemes that do not involve the sale of property yet do not produce ordinary income. To sustain an assessment the Commissioner needs to argue the existence of some undertaking or plan to produce a non-income profit. In the light of Whitford’s Beach and Myer the circumstances where this will occur must be very limited, if they exist at all. It would generally be much easier to argue that the existence of a profit-making undertaking or scheme, albeit of a ‘once off’ nature, would be a strong indication that the profit was ordinary income.
So why was s 15-15 enacted? It has been suggested[12] that members of the private tax profession wanted it retained to create “certainty”, but that seems inherently implausible. The best explanation is an abundance of caution, or to be less charitable, anal retentiveness on the part of the draftspersons. Generally, the 1997 re-write was not intended to bring about substantive changes to our tax laws.[13] By 1997 s 25A was a dead letter and should have been repealed in full, but the draftspersons could not bring themselves to let it go.
Does it matter? Probably not very much, since it is unlikely, in view of the evidence required to sustain an assessment, that s 15-15 will be relied upon in preference to s 6-5, which brings into charge ordinary income. However, as long as taxpayers have pre-1985 property to dispose of, there is the danger that they may cross the line between the “enterprising disposal of a capital asset”[14] into the carrying out of a profit-making undertaking or plan, even though ordinary income is not thereby produced.
What is perhaps of more significant is the evidence this issue provides of the practical sovereignty the tax administration has over the content of our tax laws. The TLIP was staffed largely from the Australian Taxation Office (“ATO”) and despite the use of outside consultants and the review of the TLIP’s work by parliamentary committees, the final form represents the ATO’s views on what the law is, and (to an extent) should be.
There has been a general anti-avoidance provision in our income tax legislation since the start of Commonwealth income tax in 1915. The provision adopted for income tax purposes in 1915 was adapted from one in earlier land tax legislation and can be traced back to the New Zealand Land Tax of 1878. The original reason for such a provision was specific to land tax, especially one with a graduated rate, such as the early New Zealand tax. It was to prevent the owners of land from avoiding the tax by transferring title to another while retaining the real ownership and control. Perhaps because it was already in the Commonwealth land tax legislation in 1915 it was thought convenient to apply it to income tax as well, as had occurred in New Zealand where the land and income taxes were imposed by the same statute. Thus was enacted s 53 of the Income Tax Assessment Act 1915 (Cth). It soon became evident that it was far too broad to apply according to its terms and the courts began to place restrictions on its operation.
By 1956 Justice Kitto was able to say of s 53’s successor, s 260 of the ITAA 1936:
Section 260 is a difficult provision, inherited from earlier legislation, and long overdue for reform by someone who will take the trouble to analyse his ideas and define his intentions with precision before putting pen to paper. [15]
It took a long time,[16] but Part IVA of the ITAA 1936, after a considerable amount of consultation, replaced s 260 in May 1981. The first case on the new provision was not decided until 1989[17] and it was not until 1994 that the High Court got to interpret it.[18] There has been only one other High Court decision since then, though two significant cases on Part IVA have been heard by the Full Federal Court.[19] More litigation can be expected.
Section 260 purported to be self-executing and to render void, for income tax purposes, any contract agreement or arrangement having the purpose of avoiding tax. In practice, however, the Commissioner had to decide whether a tax avoidance scheme existed, and to define its extent. Part IVA, on the other hand explicitly gives the Commissioner discretion to cancel any “tax benefit” arising from a tax avoidance scheme. Conceivably the Commissioner could decide not to bother.
The test in s 177D as to whether a tax avoidance scheme exists is whether, having regard to a list of eight factors,[20] it can be concluded that the scheme was entered into with the purpose of obtaining a tax benefit. In theory it is broader in scope than s 260, which, as interpreted by the Privy Council in Newton v FCT,[21] required you to be able to say that the transaction was entered into in that particular way to avoid tax, and not be explicable by reference to some other business or family reasons.[22] In practice however Part IVA has much the same limitation. Much then depends on the identification of a “scheme” especially in the context of some larger admittedly commercial transaction and being able to ascribe to the identified scheme the dominant purpose of tax avoidance. In short, much of the uncertainty in the application of the provision remains.
That this is so should not be surprising. In fact it has been argued that uncertainty is a positive virtue of such a provision since that keeps the more adventurous tax planners back from the edge, or perhaps the more timid in line. But uncertainty as to legal outcomes is no way to run a legal system, nor, it is suggested a tax system. Several comparable tax systems have no counterpart to Part IVA (eg, USA and UK). New Zealand gave us the idea of general anti-avoidance provisions but the history of its own such provision does not inspire confidence in their utility, though the pattern of court interpretation had been different.[23] Canada introduced a general anti-avoidance rule (“GAAR”)[24] in 1988 after public concern arose over the approach of the courts to tax avoidance schemes.[25] Although retrospective legislation is not to be encouraged the Commonwealth has on occasion resorted to it to deal with flagrant tax fraud (as in the case of recovery of revenue lost from “bottom of the harbour” schemes[26]). Retrospectivity, it is suggested, is the real nuclear weapon in the government’s armoury, not Part IVA.
In short, the world would not end if Part IVA were repealed. It will of course never happen while the ATO controls the tax legislative process. Repeal will shorten the Act by only a small amount, but it will make the application of our tax laws a good deal easier.
All the hard work has been done for us here by the Review of Business Taxation (“Ralph Review”), which recommended last year that FBT be imposed on employees rather than as presently on employers.[27] Such a process has been facilitated by the inclusion of the value of fringe benefits provided to employees on group certificates from 1999-2000. Imposing the tax on employers may have been good politics but it is bad tax policy. A tax should be paid by those who bear its economic cost, at the rate applicable to them, not to somebody else at an arbitrary rate. Under the present arrangements the tax is imposed on employers at 48.5 per cent, the top individual rate, even though the employee concerned may be on a lower marginal rate. Yet the real problem with the FBT, as the Ralph Review pointed out is not its apparent harshness but its concessionary nature. FBT was intended to discourage remuneration in the form of fringe benefits; instead the valuation methods adopted created a raft of opportunities for tax planning. If the tax were borne directly by the employee, many of these opportunities could be eliminated.
It took the Government no time at all to reject the Ralph Review recommendation on FBT,[28] and that is a pity, if understandable in the context of the amount of other current change in the tax system. But FBT on the employer makes the system less equitable and more complex than it need be. If equity and simplicity in our tax system are more than mere empty aspirations, FBT, which equity requires, should be paid by employees.
[*] Associate Professor of Law, University of New South Wales.
[1] Gunn’s “Commonwealth Income Tax Law” was first published in 1936 and went through many editions. It became the loose-leaf Butterworth’s Tax Service and survives today as Australian Tax Practice.
[2] Jacaranda Press (1959). The “Sputnik” was the first satellite put into orbit around the earth, and was launched by the Soviet Union in October 1957. On board was a small dog whose name was Lemka, Russian for Little Lemon. A Russian joke perhaps?
[3] The income tax legislation of 1959 ran to about 500 pages and could be fitted into one volume; the Acts we have to deal with are in 4 volumes amounting to perhaps 8000 pages and expanding at the rate of hundreds of pages each year.
[4] The taxpayers did not purchase the plantations; they obtained (without payment) options to buy the properties which they then sold to the company.
[5] Jones v Leeming [1930] AC 415.
[6] The only other provision which has given rise to more litigation are the general deduction sections, s 51 of the ITAA 1936 and s 8 of the Income Tax Assessment Act 1997 (Cth) (“ITAA 1997”).
[7] The most important were Official Assignee of Fox v FCT [1954] HCA 16; (1954) 90 CLR 598 and the notorious decision of the Privy Council in McClelland v FCT [1970] HCA 39; (1970) 120 CLR 487.
[8] “The principle of law is that profits derived directly or indirectly …in carrying out any scheme of profitmaking are assessable to income tax, whilst proceeds of a mere realization or change in investment are not income nor assessable to income tax.” Ruhamah Property Co v FCT [1928] HCA 22; (1928) 41 CLR 148 per Knox CJ, Duffy, Powers and Starke JJ at 151.
[9] [1982] HCA 8; (1982) 150 CLR 355.
[10] [1987] HCA 18; (1987) 163 CLR 199.
[11] The corresponding loss provision, s 52 of the ITAA 1936 was re-enacted as s 25-40 of the ITAA 1997.
[12] To the author by a member of the TLIP. It was also argued in the Explanatory Memorandum to the Bill that became the ITAA 1997 that the case law supported the proposition that the second limb of s 26(a) had application to profits which fell outside the concept of ordinary income. It is true that in Whitford’s Beach Murphy J supported this view at 150 CLR 386 but Gibbs CJ at 363-5 and Mason J at 376-81 were more cautious. Wilson J at 401 did not regard the construction of the second limb as settled by existing authority.
[13] See ITAA 1997, s 1-3.
[14] Or as the majority of the Privy Council put it in McClelland v FCT “… a landowner may develop and realise his land without making a profit which partakes of the character of income, even though he goes about the realisation in an enterprising way so as to secure the best price.” [1970] HCA 39; (1970) 120 CLR 487 at 494.
[15] FCT v Newton [1957] HCA 99; (1956) 96 CLR 577 at 596.
[16] See Mason J’s remark in Cridland v FCT [1977] HCA 61; (1977) 140 CLR 330 at 337: “This remark, despite its clarity, does not seem to have reached its intended destination.”
[17] (1989) AAT case 5219 – a case which despite its straightforward facts evidently gave the presiding member some difficulty, as 14 months elapsed between the hearing and the handing down of the decision.
[18] Peabody v FCT (1994) 181 CLR 359, where the taxpayer succeeded in circumstances which suggested a number of weaknesses in the provision. The Commissioner later had a win in Spotless Services Ltd v FCT [1996] HCA 34; (1996) 186 CLR 404
[19] Grollo Nominees Ltd v FCT (1997) 36 ATR 392, where the taxpayer lost; FCT v Consolidated Press Properties Ltd (1999) 42 ATR 150; where both parties have sought special leave to appeal to the High Court.
[20] The factors are:
(i) the manner in which the scheme was entered into or carried out;
(ii) the form and substance of the scheme;
(iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;
(iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;
(v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;
(vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;
(vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and
(viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi).
[21] [1958] UKPCHCA 1; (1958) 98 CLR 1.
[22] Lord Denning, delivering the advice of the Privy Council said; “…you must be able to predicate – by looking at the overt acts by which it was implemented – that it was implemented in that particular way so as to avoid tax. If you cannot so predicate, but have to acknowledge that the transactions are capable of explanation by reference to ordinary business or family dealing, without necessarily being labeled as a means to avoid tax, then the arrangement does not come within the section”: Ibid at 8.
[23] Compare the approach taken by the High Court in FCT v Everett [1980] HCA 6; (1980) 143 CLR 440 with the New Zealand Court of Appeal’s approach in IRC v Hadlee [1991] 3 NZLR 517; affirmed by the Privy Council at [1993] UKPC 8; [1993] 2 NZLR 385. Both cases involved income splitting by means of assignment of interests in professional partnerships. The New Zealand Court explicitly invoked policy considerations and applied s 99 of the Income Tax Act 1976 (NZ), the general anti-avoidance provision, in finding for the revenue. The High Court decided the case in the taxpayer’s favour on the technical effectiveness of the assignment, the Commissioner not having thought it worthwhile to apply s 260.
[24] Income Tax Act (Canada), s 245.
[25] For a fine treatment of the background and an evaluation of several countries’ general anti-avoidance provisions see BJ Arnold and JB Wilson “The General Anti Avoidance Rule-Part 1” (1988) 36 Can Tax J 829. See also BJ Arnold ”The Canadian General Anti –Avoidance Rule” [1995] BTR 541. Arnold and Wilson make the point that there might be a stronger need for a GAAR in a country where the judicial anti-avoidance doctrines have proved inadequate, which is not the case, for example, in the United States.
[26] By the Taxation (Unpaid Companies Tax) Act, enacted in 1982 but affecting transactions entered into since 1973.
[27] Australia, Review of Business Taxation, A Tax System Redesigned: More Certain, Equitable and Durable, July 1999 at 42-6 and 217-227 (“Ralph Review”).
[28] The government seems in fact to have disowned the proposal before it was made.
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