FEDERAL COURT OF AUSTRALIA Sent v Commissioner of Taxation [2012] FCAFC 187 Citation: Sent v Commissioner of Taxation [2012] FCAFC 187 Appeal from: Sent v Commissioner of Taxation [2012] FCA 382 Parties: EDUARD CHRISTIAAN SENT v COMMISSIONER OF TAXATION File number: VID 363 of 2012 Judges: EMMETT, EDMONDS AND RARES JJ Date of judgment: 19 December 2012 Catchwords: INCOME TAX – whether a payment made to the appellant's nominee in substitution for past and future bonus entitlements of the appellant under his employment agreement, to enable the nominee to take up shares for the appellant, was assessable income of the appellant pursuant to s 6-5 of the Income Tax Assessment Act 1997 (Cth) – whether the appellant discharged the onus imposed by s 14ZZK of the Taxation Administration Act 1974 (Cth) of establishing that the assessment by the Commissioner of a 50% administrative penalty was excessive. Held: Appeal dismissed. Legislation: Administrative Appeals Tribunal Act 1975 (Cth) s 44 Taxation Administration Act 1953 (Cth) s 14ZZK; Sch 1: ss 284-75, 284-90 Income Tax Assessment Act 1997 (Cth) s 6-5 Cases cited: Constable v Federal Commissioner of Taxation (1952) 86 CLR 402 distinguished Hallstroms Pty Ltd v Commissioner of Taxation (1946) 72 CLR 634 referred to Date of hearing: 29 November 2012 Place: Sydney (heard in Melbourne) Division: GENERAL DIVISION Category: Catchwords Number of paragraphs: 42 Counsel for the Appellant: Mr S Tisher Solicitor for the Appellant: Russell Kennedy Solicitors Counsel for the Respondent: Mr S Sharpley Solicitor for the Respondent: Australian Government Solicitor IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY GENERAL DIVISION VID 363 of 2012 ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA BETWEEN: EDUARD CHRISTIAAN SENT Appellant AND: COMMISSIONER OF TAXATION Respondent JUDGES: EMMETT, EDMONDS AND RARES JJ DATE OF ORDER: 19 DECEMBER 2012 WHERE MADE: SYDNEY (HEARD IN MELBOURNE) THE COURT ORDERS THAT: 1. The appeal be dismissed. 2. The appellant pay the respondent's costs of the appeal, as agreed or taxed. Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011. IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY GENERAL DIVISION VID 363 of 2012 ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA BETWEEN: EDUARD CHRISTIAAN SENT Appellant AND: COMMISSIONER OF TAXATION Respondent JUDGES: EMMETT, EDMONDS AND RARES JJ DATE: 19 DECEMBER 2012 PLACE: SYDNEY (HEARD IN MELBOURNE) REASONS FOR JUDGMENT THE COURT: INTRODUCTION 1 This is an appeal from a judge of this Court – (1) dismissing the appellant's appeal (VID 310/2011) from a decision of the Administrative Appeals Tribunal ("the Tribunal"); and (2) allowing the respondent's ("Commissioner's") appeal (VID 313/2011) from the decision of the Tribunal; and affirming the Commissioner's objection decision. 2 The appellant's notice of appeal raised some 18 grounds of appeal by reference to 11 questions of law, but at the end of the day there were only two primary issues agitated on the appeal. Depending on how those primary issues are resolved, all issues underlying the grounds of appeal would be resolved or there would be a need to address other or consequential issues. 3 It is not clear why the grounds of appeal were framed as they were, that is, by reference to what were said to be questions of law. The appeal to this Court was not an appeal from the Tribunal's decision but an appeal from a judge of this Court. Such an appeal is not circumscribed by the provisions of s 44 of the Administrative Appeals Tribunal Act 1975 (Cth) ("the AAT Act"). ISSUES ON APPEAL 4 The two primary issues before this Court on the appeal were: (1) Whether, as the primary judge held (Reasons ("R") [95]), the amount of $11,600,000 paid by Primelife Corporation Ltd ("Primelife") to Primelife Share Plans Pty Ltd ("Trustee") as trustee of the Primelife Executive Share Trust ("the Trust"), of which the appellant was the sole beneficiary, was assessable income of the appellant in the year of income ended 30 June 2002 ("the year of income"). (2) Whether, as the primary judge held (R [187]), the Tribunal erred in law by not finding that the appellant had failed to discharge the onus he has pursuant to s 14ZZK of the Taxation Administration Act 1953 (Cth) ("TAA") of establishing the excessiveness of the assessment by the Commissioner of a 50% administrative penalty pursuant to s 284-75(1) and s 284-90, Item 2, of Schedule 1 of the TAA on the basis that the shortfall amount had resulted from the recklessness of the appellant's tax agent. 5 The other or consequential issue if the first primary issue is resolved in favour of the appellant, is whether the amount of $11,600,000 was assessable in part as the Tribunal had held or, whether it was not assessable at all as the appellant contended on the appeal. 6 On the view we took of the first primary issue, the other or consequential issue referred to in [5] above did not arise. For that reason, it was not necessary to call on counsel for the Commissioner to address the Court on the Commissioner's contention that the provisions of Pt IVA applied to cancel a tax benefit alleged to have been obtained by the appellant in connection with a scheme to which that Part applied. 7 The other or consequential issue if the second primary issue is resolved in favour of the appellant, is whether the Tribunal erred in finding that the appellant was liable to pay an administrative penalty of 25% of the shortfall amount for failure to adopt a reasonably arguable position. FACTUAL CONTEXT 8 To a large extent, the factual context is not in dispute. It is relevantly set out by the primary judge at R [2] to [25]. The one area where there is a dispute concerns the proposal whereby the Trustee was to use moneys settled on it by Primelife to make a loan to the appellant to enable him to take up units in the Trust, of which the Trustee was trustee, to be used by the Trustee to take up five million shares in Primelife. There is no evidence that such transactions actually took place; indeed, they are at odds with the contractual arrangements between the appellant and Primelife that the appellant, or his nominee, would receive five million fully paid ordinary shares in Primelife in return for giving up his bonus entitlements (see [12] below); not for incurring a debt to the Trustee in respect of the acquisition of the shares (see [18(2), (3), (5) and (9)], [22] and [23] below, but see also [25] below). 9 The appellant was the Managing Director and Chief Executive Officer of Primelife. His employment agreement with Primelife provided for a five-year term that commenced on 1 July 1998, and for, in addition to a base salary and a fixed annual bonus, an entitlement to three additional bonus payments ("Additional Bonus Payments") based on Primelife's profits and losses in the five financial years ending 30 June 1999 to 30 June 2003. 10 The Tribunal made a finding of fact that in a series of meetings leading up to June 2001, Primelife and the appellant agreed that the appellant would waive his past and future bonus entitlements in return for the issue to him of five million fully paid ordinary shares in Primelife. 11 As at about October 2001 the appellant's entitlement to the three Additional Bonus Payments fell into three categories: (1) Bonuses that had accrued and were payable. In this category was an entitlement to the bonus titled the First Additional Bonus Payment which was based on Primelife's performance in the three financial years ending 30 June 1999–2001. This bonus was payable as that period was complete. (2) Bonuses that were accruing, relating to periods which had been part performed. Any bonuses earned were not payable until the period was complete. In this category were accruing entitlements to: (a) the Second Additional Bonus Payment based on Primelife's performance in the four financial years ending 30 June 1999–2002; and (b) the Third Additional Bonus Payment based on Primelife's performance in the five financial years ending 30 June 1999–2003. The appellant was not yet eligible for these bonus payments and any bonus entitlement could not be calculated. (3) Bonuses relating to future periods which had not yet accrued in any sense. This category related to those portions of the Second and Third Additional Bonus Payments relating to Primelife's performance in the balance of the 2002 financial year (from October 2001 until 30 June 2002) and the whole of the 2003 financial year. 12 On 2 October 2001 the appellant and Primelife executed a Share Issue Deed, subject to shareholder approval. Recital A of the Deed recorded that Primelife wished to continue employing the appellant as Managing Director and Chief Executive Officer and the appellant wished to continue in that capacity. The Share Issue Deed provided: 2.1 Condition precedent Subject to the approval of shareholders of the Company at the 2001 annual general meeting on or about 30 November 2001 the execution of this Deed will have the following consequences: (a) all existing contracts, agreements and understandings between the Company or any of the Group and the Executive as far as they relate to any remuneration or bonuses (whether by way of money, ordinary shares or options in the company or otherwise) ("Financial Entitlements") payable to the Executive for him carrying out his role as the chief executive officer and managing director of the Company and of the Group shall cease immediately; (b) all accrued Financial Entitlements payable by the Company or any of the Group to the Executive other than holiday leave, sick leave, long service leave or superannuation entitlements is irrevocably waived by the Executive. 2.2 Share issue (a) In consideration of the Executive waiving his Financial Entitlements the Company will issue to the Executive or his nominee, 5,000,000 fully paid ordinary shares in the Company ("Shares"). (b) The Shares will be issued 10 business days after: i. The Record Date for the final dividend for the holders of ordinary shares in the Company for the financial year ended 30 June 2001; or ii. the 2001 annual general meeting of the Company (assuming the shareholders approve the issue of the Shares), whichever is the later. 13 In summary, the Share Issue Deed provided that in consideration for the appellant waiving his entitlements to any remuneration or bonuses payable to him, Primelife would issue to him or his nominee five million fully paid ordinary shares in its capital. 14 The Tribunal found that the appellant's bonus entitlements under his employment agreement were contingent and subject to what it described as "claw back". The primary judge observed that the expression "claw back" only makes sense as recognition of the fact that the appellant's accruing entitlement to the Second or Third Additional Bonus Payments as at October 2001 might be reduced or even extinguished because of Primelife's performance in the balance of the 2002 financial year and/or in the 2003 financial year. 15 It is uncontroversial that by October 2001 the appellant's entitlement to the Additional Bonus Payments was of significant value. It is common ground that Primelife engaged independent experts PKF Corporate Advisory Services (Vic) Pty Ltd ("PKF"), and that PKF reported in October 2001 that: (a) For the 1999–2001 financial years the appellant's entitlement to Additional Bonus Payments totalled $7,246,572, of which one third, $2,415,524 was presently due and payable; and (b) for the 2002–2003 financial years the appellant could expect to become entitled to further Additional Bonus Payments ranging between $5,122,462 and $5,532,500. This was a total of $12,369,034 to $12,770,072. 16 PKF also opined that: (a) The fair value of five million fully paid Primelife ordinary shares was between $10,300,000 and $12,500,000; and (b) the proposed changes to the appellant's bonus arrangements and the proposed share issue to the appellant for the waiver of his bonus entitlements were fair and reasonable to the shareholders of Primelife. 17 By resolution at the Annual General Meeting on 30 November 2001 the shareholders of Primelife approved the issue of five million shares to the appellant or his nominee ("the Shareholder Resolution"). The resolution provided as follows: That the members approve of and authorise the issue to [the appellant], or his authorised nominee, of 5 million ordinary shares in the Company, in consideration of termination of his current executive service agreements with the Company and in satisfaction of all entitlements under that executive service agreement notwithstanding that this issue will or may result in [the appellant] becoming entitled (within the meaning of the Corporations Act) to more than 20% of the voting shares in the Company. 18 On 4 December 2001 the Trust was created by a trust deed of that date. 19 The Tribunal made findings that the terms of the Trust provided as follows, namely, that: (1) An Employer (an employer accepted by the Trustee as an employer for the purposes of the Trust) would settle money on the Trustee; (2) the monies settled by an Employer would be used to make loans to eligible employees (as defined) for the purpose of applying to the Trustee for units in the Trust; (3) the monies received by the Trustee for units in the Trust were to be used exclusively to acquire shares in the Employer (or the Employer's holding company); (4) the shares acquired through this process were to be allocated to particular share units; (5) the applications by eligible employees for share units were to be accompanied by applications for loans to acquire those units; (6) the issue of units in accordance with the application constituted an acceptance of the loan application; (7) the shares so allocated could not be sold by the Trustee. They could be disposed of by the Trustee by distribution to the unit holders of cancellation entitlements; (8) the cancellation entitlements were equal to an in specie distribution of such of the allocated shares referrable to either the units of a market value equal to the issue price of the units, or to all of the allocated shares; (9) the Trustee was able to set off the amount of any unpaid loan of a unit holder before paying a cancellation entitlement to that unit holder; (10) the units could not be cancelled at the instigation of a unit holder within 12 months of their issue; and (11) upon termination of the Trust any surplus trust property was able to be distributed at the discretion of the Trustee to or for the benefit of any eligible employee or any employee share scheme operated for the benefit of Primelife employees. 20 The Tribunal also found that while the terms of the Trust appeared to accommodate multiple participants, the appellant was the sole beneficiary under the Trust. 21 The Tribunal found that on or about 21 December 2001 Primelife deposited a cheque for $11,600,000 in the bank account of the Trust "in respect of" the appellant. On the same day a cheque for $11,600,000 drawn on the Trust bank account was paid to Primelife as the price for the issue of five million Primelife shares. The weighted average trading price of Primelife shares over the previous week at that time was $2.32 per share which gave the parcel of shares a value of about $11,600,000. 22 On 23 January 2002 the Trust issued five million units in the Trust to the appellant for $11,600,000, representing $2.32 per unit. The units vested one year from commencement of the appellant's participation in the Trust and represented an entitlement to the Primelife shares in the Trust. 23 The Tribunal found the appellant had a debt to the Trust for $11,600,000 as he had not paid the Trust the subscription price for the units. The Tribunal noted that the financial statements of the Trust confirmed that it had two assets, namely, the five million Primelife shares and a debt of $11,600,000 due to it by the appellant. 24 The Tribunal found that in the absence of the appellant taking control of the Trust, the value of any benefit he would get from the Trust was limited by the Trustee's power to set off the appellant's outstanding loan. 25 Ignoring the loan alleged to have been made to the appellant, the Tribunal found that he had an interest in the Trust which had assets worth $11,600,000, enjoyment of which was subject to a contingency. The Tribunal found that this arrangement was in consideration of the appellant waiving his entitlements to all accrued, accruing and future bonus entitlements under the employment agreement. 26 The Tribunal also found that on 1 December 2003, at the request of the appellant, Eskaton Pty Ltd, which was a company controlled by him, replaced the Trustee as trustee of the Trust. What, if anything, happened to the loan said to have been made by the Trust to the appellant was not clear to the Tribunal. 27 The only observation we would make on this fact-finding process concerns the alleged loan or loans made by the Trustee to the appellant to enable him to take up units in the Trust: (1) In our view, there is no evidence to support a finding that any such loan or loans were made and the Tribunal made no such finding; (2) at best for the appellant, the Tribunal found that the appellant was indebted to the Trustee for $11,600,000 on account of the subscription price for the units; but (3) the conclusion is indisputably open that such an indebtedness did not accord or coincide with the contractual arrangements between Primelife and the appellant covering the issue of the units in the Trust. Moreover, the inference is undoubtedly open that, if such an indebtedness existed, it was never intended that the Trustee collect or enforce that indebtedness contrary to those contractual arrangements. CONSIDERATION AND ANALYSIS First Primary Issue 28 Following the execution of the Share Issue Deed on 2 October 2001 and Primelife's shareholders' approval on 30 November 2001, the appellant's accrued and contingent bonus entitlements under his employment agreement had been replaced by an absolute entitlement to be issued with five million fully paid ordinary shares in Primelife. While the execution of the Deed and the shareholders' approval did not give rise to a derivation of assessable income by the appellant, had Primelife subsequently issued the shares to the appellant or, at his direction, to a nominee, such an event would have given rise to a derivation of income by the appellant as a reward for services rendered or to be rendered. 29 It was argued, understandably not with great force, that the appellant's share entitlement was subject to the same contingencies as the bonus entitlements and that until these contingencies were satisfied by the appellant rendering the services under the employment agreement, there could be no derivation. We reject that. The share entitlement was, by the terms of the Share Issue Deed, free and clear of any contingency as to services provided or to be provided and was not defeasible or subject to any condition subsequent which could be described in the way of "claw back", whatever that encompasses. There would be nothing to deny derivation, in the sense of the shares "coming home", at the time they were issued. 30 The derivation point aside, it is, in our view, beyond argument that the character of any such benefit in the form of the shares issued would be income; they would be as much a reward for services rendered or to be rendered as payment of the bonus entitlements. 31 Why, it may be asked, should it be any different if Primelife, instead of issuing five million fully paid shares in its capital to the appellant or his nominee, pays the amount of $11,600,000 to the appellant or his nominee, as it did on or about 21 December 2001 by payment to the Trustee (see [20] above). Clearly, the answer is that it should make no difference. True it is that the payment is made to the Trustee, and not to the appellant, but on any view or level, the payment is made to the Trustee at the request/direction of the appellant such as to trigger the provisions of s 6-5(4) of the Income Tax Assessment Act 1997 (Cth) ("the 1997 Act"). 32 The payment in the present case is not analogous to a payment by Primelife by way of contribution to a superannuation fund for the appellant's ultimate benefit (see Constable v Federal Commissioner of Taxation (1952) 86 CLR 402 at 418.5–418.9 per Dixon CJ, McTiernan, Williams and Fullagar JJ). The payment here was in substitution for the appellant's absolute entitlement to be issued with five million fully paid ordinary shares in Primelife and that itself was in substitution for his bonus entitlements, both accrued and contingent. The payment was undoubtedly a reward for services rendered and to be rendered and, as such, income of the appellant. Moreover, it was derived by the appellant in the year of income it was paid because it was paid, free and clear of the contingencies to which the bonuses were subject at the time they were substituted by the share entitlement. 33 It was argued on behalf of the appellant that the payment of the $11,600,000 was capital in the hands of the appellant on the basis that the right to be issued the shares in Primelife was a capital asset and the payment in lieu partook of the same character. With respect, the argument is misconceived. It is as much an error to characterise a receipt by reference to a "juristic classification of the legal rights, if any, secured, employed or exhausted in the process" as it is to characterise an outgoing as being on revenue or capital account by reference to such matters: Hallstroms Pty Ltd v Commissioner of Taxation (1946) 72 CLR 634 at 648.10 per Dixon J. 34 The payment of $11,600,000 was in substitution for the appellant's entitlement to his right to receive remuneration for his services in the form of the issue to him or his nominee of five million shares in Primelife. The appellant accepted that payment as the performance of Primelife's obligation under the Share Issue Deed to pay him for his services by the issue of those shares. The arrangement under which the appellant gave up his right to the five million shares and accepted the money in its place could be not characterised as converting a receipt of an income character (the right to be issued the shares) into one of a capital character (the payment of the money in substitution for the right to receive the shares). From a "practical and business point of view" (Hallstroms 72 CLR at 648.10), both forms of receipt were intended to reward the appellant for his service to Primelife. 35 If an employer is obliged to furnish an employee remuneration in one form, the fact that the parties treat the employer's obligation as having been discharged because the remuneration is furnished in a different or substitute form, does not alter the character of the receipt in the employee's hands. 36 Here, the appellant was content to have Primelife pay his nominee (the Trustee) the money in substitution for his absolute entitlement to the issue of the shares. But the whole purpose of the arrangements was to remunerate the appellant for his services immediately following upon shareholder approval of the terms of the Share Issue Deed. 37 It follows that the appellant derived the $11,600,000 as ordinary income within the meaning of s 6-5(4) of the 1997 Act as soon as Primelife paid it to the Trustee as his nominee. 38 In our view, the primary judge did not err when he held that the whole of the $11,600,000 payment was assessable income of the appellant in the year of income. 39 It is for these reasons that the other or consequential issue referred to in [5] above, did not arise. Second Primary Issue 40 For the reasons given by the primary judge set out at R [159]–[186], there is no error in the primary judge's conclusion at R [187] that the appellant failed to discharge the onus that he bore pursuant to s 284–290 of Sch 1 to the TAA and s 14ZZK of the TAA of establishing that the assessment by the Commissioner of a 50% administrative penalty for the recklessness of his tax agent was excessive. 41 It follows that the other or consequential issue referred to in [7] above does not arise. CONCLUSION 42 The appeal must be dismissed with costs. I certify that the preceding forty-two (42) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justices Emmett, Edmonds and Rares. Associate: Dated: 19 December 2012