FEDERAL COURT OF AUSTRALIA Harris v Commissioner of Taxation of the Commonwealth of Australia [2001] FCA 1689 TAXATION – superannuation contributions paid by a taxpayer, who is a director of a company controlled by him, for his own benefit – whether contributions paid by a taxpayer for the benefit of an eligible employee – whether contributions are deductible Income Tax Assessment Act 1936 (Cth) ss 82AAA(1), 82AAA(2) and 82AAE Cooper Brookes (Wollongong) Pty Ltd v Commissioner of Taxation (Cth) (1981) 147 CLR 297 - cited O'Grady v The Northern Queensland Company Limited (1990) 169 CLR 356 - cited The Workers Compensation Board of Queensland v Technical Products Proprietary Limited (1988) 165 CLR 642 - cited GEOFFREY HARRIS v COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA V 29 of 2001 JUDGE: MERKEL J DATE: 3 DECEMBER 2001 PLACE: MELBOURNE IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY V 29 OF 2001 BETWEEN: GEOFFREY HARRIS APPLICANT AND: THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA RESPONDENT JUDGE: MERKEL J DATE OF ORDER: 3 DECEMBER 2001 WHERE MADE: MELBOURNE THE COURT ORDERS THAT: 1. The appeal of the applicant be dismissed. 2. The applicant pay the respondent's taxed costs of and incidental to the appeal. Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules. IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY V 29 OF 2001 BETWEEN: GEOFFREY HARRIS APPLICANT AND: THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA RESPONDENT JUDGE: MERKEL J DATE: 3 DECEMBER 2001 PLACE: MELBOURNE REASONS FOR JUDGMENT 1 The issue in the present matter concerns whether a director or employee of a company, in which the director or employee has a controlling interest, may contribute unlimited amounts for his or her own superannuation benefits to a non-complying superannuation fund and thereby enjoy full deductibility for the amounts contributed without those amounts being assessable to the trustee of the fund as taxable contributions. 2 The issue arises in an appeal by the applicant ("the taxpayer") to the Court against an appealable objection decision of the respondent ("the Commissioner"). The decision of the Commissioner under challenge was his disallowance of the taxpayer's objection to the Commissioner's amended assessment disallowing the taxpayer's claim that the sum of $315,600, paid as contributions to the POHA Superannuation Fund ("the Fund") during the year of income ended 30 June 1998 ("the year of income"), is deductible from the taxpayer's assessable income pursuant to s 82AAE of the Income Tax Assessment Act 1936 (Cth) ("the Act"). While it does not affect the present matter, s 82AAE was repealed by Act No 89 of 2001. 3 In his income tax return for the year of income the taxpayer claimed that the sum of $315,600 was deductible pursuant to s 82AAE of the Act. Pursuant to the self assessment procedure under s 169A of the Act the taxpayer received an assessment from the Commissioner which allowed the deduction in the sum of $315,600. The Commissioner subsequently issued an amended assessment disallowing the deduction and imposing a penalty, including interest, under s 226L of the Act. The Commissioner also made a written determination under s 177F of the Act that the amount of $315,600, being a tax benefit referrable to the deduction, if otherwise allowable, should not be allowable to the taxpayer in relation to the year of income. 4 The taxpayer's appeal concerns two issues; whether the contributions were deductible under s 82AAE and, if so, whether the Commissioner is entitled to rely on s 177F to disallow the deduction. A third issue, which related to the penalty imposed by the Commissioner, was resolved between the parties. 5 The facts that are relevant to the issue of deductibility under s 82AAE are not contentious. At all material times the taxpayer was a director of G Harris Automotive Pty Ltd ("the company"), in which he had a controlling interest. The company, as trustee of The Harris Wood Unit Trust, carried on a substantial business as a motor vehicle dealer. 6 The taxpayer established the Fund on 16 September 1997 for the purpose of providing superannuation benefits for, amongst others, himself. The Fund is a non-complying superannuation fund, as defined in s 267(1) of the Act. 7 During the year of income the taxpayer contributed a total of $315,600 to the Fund for the purpose of making provision for superannuation benefits for himself. The taxpayer became entitled to the amounts he contributed to the Fund as a result of distributions made to him in his capacity as a beneficiary of the Harris Family Trust, the trustee of which held 70% of the units in the Harris Wood Unit Trust. 8 Section 82AAE allowed as a deduction an amount paid by a taxpayer as a contribution to a non-complying fund for the purpose of making provision for superannuation benefits for an eligible employee. The definition in s 82AAA(1) of an eligible employee "in relation to" a taxpayer includes an employee of a company in which the taxpayer has a controlling interest. The taxpayer was a director of the company and, as such, under s 82AAA(2) was taken to be employed by the company. 9 The taxpayer's case is remarkably simple. He was an eligible employee because he had a controlling interest in the company. Accordingly, as a taxpayer, he was entitled to a deduction under s 82AAE for the contributions he made to the Fund during the year of income for the purpose of providing benefits to himself as an eligible employee. 10 The Commissioner's riposte is equally simple. He contends that S 82AAE is concerned with deductions for superannuation contributions made by one person (the taxpayer) for the benefit of another person (the eligible employee). He supports that contention by referring to the definition of an "eligible employee" in s 82AAA(1) which he contends signifies a relationship between one person (the eligible person) and another (the taxpayer); the eligible person and the taxpayer therefore cannot be the same person. The Commissioner states that that is made clear from the terms of s 82AAE which the Commissioner contends provide, implicitly if not explicitly, for a person (the taxpayer) to be entitled to a deduction for superannuation contributions paid to a fund for the benefit of another person (the eligible employee). The Commissioner's construction of the relevant provisions, so it is said, gives effect to the ordinary and natural meaning of the language used in ss 82AAA and 82AAE and is consistent with the legislative purpose of, in general, limiting the deductibility of superannuation contributions made by self employed persons for their own benefit to complying superannuation funds. 11 In order to deal with the competing contentions it is necessary to refer in more detail to the manner in which the Act provides for deductibility and assessability of superannuation contributions. 12 Subdivisions AA and AB of Div 3 of Pt III of the Act prescribe the requirements to be satisfied for contributions to superannuation funds to be deductible. In Subdiv AA deductibility is provided for contributions to complying superannuation funds (s 82AAC) and to non-complying superannuation funds (s 82AAE) made by a taxpayer for the benefit of "eligible employees" where the specified requirements are satisfied. A deduction is not otherwise allowable to a taxpayer for superannuation contributions for employees or their dependants (s 82AAR(1)). 13 Subdivision AB provides for deductibility of superannuation contributions made by an eligible person for his or her own benefit where the specified requirements are satisfied (s 82AAT), including that the contribution be made to a complying fund. The practical consequence of the definition of an "eligible person" in s 82AAS(2) is that, in general, deductibility is limited to self employed persons. If s 82AAT is not satisfied (for example, if the contributions are not made by an eligible person or a contribution is made by such a person to a non-complying fund) the contributions made by a person for his or her own benefit are not deductible. 14 Part IX of the Act provides for the taxation of the income of superannuation funds, including contributions made to such funds. Trustees of complying superannuation funds (ss 278 and 281) and trustees of non-complying superannuation funds (ss 286 and 288) are liable to pay tax on the taxable income of the funds, which include "taxable contributions" made to the funds in the year of income. 15 The term "taxable contributions" is defined in s 274. Contributions made by a person for the benefit of another (with some limited specified exceptions) are taxable (s 274(1)(a) and 274(1)(aa)). A contribution is also taxable if it is made to a complying fund by a self employed person (that is, an eligible person as defined in s 82AAS(2)) for his or her own benefit and a notice has been given under s 82AAT(1A) stating, inter alia, that the contribution has been made to a complying fund (ss 274(1)(b) and 274(2)). Thus, where the contribution to the fund by the self employed person is deductible it will also be a taxable contribution and will therefore form part of the taxable income of the fund. 16 The taxable income of complying superannuation funds is taxed at the concessional rate of 15% (Income Tax Rates Act 1986, s 26(1)) and the taxable income of non-complying superannuation funds is taxed at the rate of 47% (Income Tax Rates Act 1986, s 26(2)). There are also similar differences in the capital gains tax rates. 17 A complying superannuation fund has the meaning given by s 45 of the Superannuation Industry (Supervision) Act 1993 (s 267(1)). In general, a rigorous and prescriptive supervisory regime applies to complying funds in order to protect and secure the superannuation benefits payable to their members. Non-complying superannuation funds are provident, benefit, superannuation or retirement funds that are not complying superannuation funds (s 267(1)). Non-complying funds do not enjoy the concessional tax rates applicable to complying funds, and are not subject to the supervisory regime applicable to complying funds. 18 In the present case the age-based deduction limits in s 82AAC(2A) left the taxpayer with little or no further deductibility available in the relevant year of income for contributions to the complying fund of which he was a member. The taxpayer's employer, the company, was entitled to make superannuation contributions under s 82AAE to the Fund, as a non-complying fund, for the benefit of the taxpayer as an eligible employee in that year but such payments, while fully deductible, would also be fully assessable at 47% as taxable contributions because they are contributions by a taxpayer for the purpose of making provision for superannuation benefits "for another person" (s 274(1)). 19 The attraction to the taxpayer (and others in his situation) of paying superannuation contributions for his own benefit, purportedly pursuant to s 82AAE, is obvious; such deductions may be unlimited in amount, are fully deductible and, unlike all other deductible superannuation contributions, are not assessable as taxable contributions. Further, the payments may be made to a non-complying fund thereby enabling the Fund and the taxpayer to sidestep the rigorous supervisory and other requirements imposed on complying funds. 20 The only factor that the taxpayer's counsel could point to that made persons in the taxpayer's situation beneficiaries of such fiscal largess was that they were directors or employees of a company which they controlled. The identity of the company they control is irrelevant to the superannuation contribution as it need not be the source, directly or indirectly, of that contribution. Prima facie, control of a company appears to be irrelevant to the purposes for which the legislature has provided deductibility and other tax incentives to persons to make superannuation contributions. The resulting beneficence, allegedly bestowed on directors or employees who happen to be controllers of a company, is not bestowed on any other company controllers, on any non-controlling directors or employees, or on self employed persons. It would not be a misuse of language to describe that outcome as extraordinary or, at the least, anomalous. 21 In a much cited passage Mason and Wilson JJ in Cooper Brookes (Wollongong) Pty Ltd v Commissioner of Taxation (Cth) (1981) 147 CLR 297 at 320-321A stated: "... when the judge labels the operation of the statute as 'absurd', 'extraordinary', 'capricious', 'irrational' or 'obscure' he assigns a ground for concluding that the legislature could not have intended such an operation and that an alternative interpretation must be preferred. But the propriety of departing from the literal interpretation is not confined to situations described by these labels. It extends to any situation in which for good reason the operation of the statute on a literal reading does not conform to the legislative intent as ascertained from the provisions of the statute, including the policy which may be discerned from those provisions. Quite obviously questions of degree arise. If the choice is between two strongly competing interpretations, as we have said, the advantage may lie with that which produces the fairer and more convenient operation so long as it conforms to the legislative intention. If, however, one interpretation has a powerful advantage in ordinary meaning and grammatical sense, it will only be displaced if its operation is perceived to be unintended." 22 It is in that context that I turn to the proper construction of s 82AAE. 23 Section 82AAE, relevantly, provided: "A deduction is allowable under this Subdivision in respect of an amount paid by a taxpayer as a contribution to a non-complying superannuation fund (as defined by subsection 267(1)) for the purpose of making provision for superannuation benefits for an eligible employee…" 24 Section 82AAA(1) contains the definition of an "eligible employee": "'eligible employee', in relation to a taxpayer, means: (a) in the case of a taxpayer whether a company or a person other than a company: (i) an employee of the taxpayer; (ii) an employee of a company in which the taxpayer has a controlling interest; or (iii) an employee of a company in which the taxpayer is the beneficial owner of shares but in which the taxpayer does not have a controlling interest (not being an employee who is associated with the taxpayer or who, or a relative of whom, has set apart or paid, or entered into a contract, agreement or arrangement under which he is, or will or may be, required to set apart or pay, amounts as or to a fund for the purpose of providing superannuation benefits for, or for a relative of, the taxpayer); and (b) in the case of a taxpayer being a company: (i) an employee of a person that has a controlling interest in the taxpayer; or (ii) an employee of a company in which a controlling interest is held by a person who also has a controlling interest in the taxpayer; 'employee' means a person who is employed by a taxpayer and: (a) is engaged in producing assessable income of the taxpayer; or (b) is a resident of Australia and is engaged in the business of the taxpayer. 25 Section 82AAA(2) provides: "For the purposes of this Subdivision, a director of a company shall be taken to be employed by the company." 26 The superannuation contribution that is deductible under s 82AAE is the amount paid by a taxpayer for the benefit of a person who is an "eligible employee". The use of the words "in relation to" in the opening line of the definition of an "eligible employee" in s 82AAA(1) signifies the relationship that must exist between the eligible employee and the taxpayer. It is apparent from s 82AAE and each of the categories of person referred to in the definition of eligible employee in s 82AAA(1) that it is the requisite relationship between the employee and the taxpayer that must be established in order for an employee to be an eligible employee in relation to the taxpayer. Unlike the construction contended for by the Commissioner, the taxpayer's construction would give little or no effect to the relationship signified by the definition of eligible employee. Indeed, the taxpayer's construction would treat the words "in relation to" as having no work to do. That construction would produce the same result without the opening words "in relation to" in the definition of "eligible employee". 27 In my opinion the Commissioner's construction, which gives operative effect to the words "in relation to", has a powerful advantage in an ordinary and grammatical sense and also gives effect to the intended operation of s 82AAE. The words "in relation to" signify some connection or relation between the two persons referred to; the taxpayer and the eligible employee. Although the words "in relation to" are words of wide import, as was said by McHugh J in O'Grady v The Northern Queensland Company Limited (1990) 169 CLR 356 at 376: "The prepositional phrase 'in relation to' is indefinite. But, subject to any contrary indication derived from its context or drafting history, it requires no more than a relationship, whether direct or indirect, between two subject matters." See also Brennan J at 364-365. 28 Similarly, Deane, Dawson and Toohey JJ in The Workers Compensation Board of Queensland v Technical Products Proprietary Limited (1988) 165 CLR 642 at 653-654 stated in relation to analogous words "in respect of": "Undoubtedly the words 'in respect of' have a wide meaning, although it is going somewhat too far to say, as did Mann C.J. in Trustees Executors & Agency Co. Ltd. v. Reilly,…that 'they have the widest possible meaning of any expression intended to convey some connection or relation between the two subject matters to which the words refer'. The phrase gathers meaning from the context in which it appears and it is that context which will determine the matters to which it extends." 29 Although the ambit of the matters to which such words (ie "in relation to" or "in respect of") of relationship or connection extend may be a matter of contention, depending upon the context in which such words are used, there can be no doubt that they pertain to a relationship or connection between distinct subjects or subject matters. It is inherent in the use of those words that each of the subjects or subject matters in question is distinct. In the present context the use of the words "in relation to" is not apt to refer to a relationship or connection between the same person, albeit in his or her respective capacities as a taxpayer and as an employee. 30 The specific context in which the definition in s 82AAA(1) is to be applied supports the Commissioner's construction. Section 82AAE refers to an amount paid by a taxpayer to provide superannuation benefits for an eligible employee. It is implicit that the section is referring to amount paid by one person (the taxpayer) for the benefit of another person (the employee) who is an "eligible person" only if that other person's, direct, or indirect, employment relationship with the taxpayer falls within one of the classes described in s 82AAA(1). 31 The general context, to which I have briefly referred, also supports the Commissioner's construction. That context shows that, in general, deductibility for contributions by a taxpayer for the benefit of another person is provided for in subdiv AA, and deductibility for contributions by a taxpayer for his or her own benefit is provided for in subdiv AB. 32 The legislative history of s 82AAE supports the Commissioner's construction. The predecessor to the section, substantially in its present form, first appeared in cl 18 of the Income Tax and Social Services Contribution Assessment Bill (No 3) 1964 which, as enacted, contained ss 82AAA(1) and 82AAE (then s 82AAD), relevantly in substantially the same form as they later appeared in the Act. The Explanatory Memorandum to the Bill stated that superannuation contributions will be deductible if paid by a defined class of persons (employer, controller of the employer etc) for the benefit of an employee. The limitation on the classes of person who may make contributions for the benefit of an eligible employee was explained as follows: "This limitation on the classes of person who may contribute to a superannuation fund for the benefit of an employee is designed to remove the opportunity that exists under the present law for a person to obtain deductions in respect of such contributions for the benefit of an employee with whom he has no business relationship." 33 The predecessor to the present sub-para (ii) of the definition in s 82AAA(1) was explained as follows: "By sub-paragraph (ii) an employee of a company in which the taxpayer making a contribution for the benefit of the employee has a controlling interest will qualify for the purposes of the definition. Deductions will, accordingly, be available to a parent company which contributes to a fund for employees of a subsidiary company and to an individual contributor who has a controlling interest in the company which employs the employees for whom he contributes." 34 There is nothing in Explanatory Memorandum or the legislative history of the relevant sections that indicates a legislative intention that the taxpayer making the contribution, and the employee for whose benefit the contribution is made, can be the same person. The passages to which I have referred suggest the contrary. 35 Finally, as explained above, there is no basis for concluding that the legislature intended to confer any special or preferential benefits in respect of superannuation on directors or employees who happen to control a company. 36 Accordingly, in my opinion the Commissioner's construction of s 82AAE should be accepted. It is therefore not necessary to consider the issues arising in relation to the Commissioner's determination under s 177F. 37 It follows that the taxpayer's appeal against the Commissioner's disallowance of the deduction claimed for superannuation contributions paid by the taxpayer for his own benefit in the year of income is to be dismissed. As the taxpayer has failed in his appeal it is appropriate to order that he pay the Commissioner's taxed costs of the appeal. I certify that the preceding thirty-seven (37) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Merkel. Associate: Dated: 30 November 2001 Counsel for the Applicant: Mr TP Murphy and Ms D Harding Solicitor for the Applicant: Aitken Walker & Strachan Counsel for the Respondent: Mr DH Bloom QC and Mr GJ Davies QC with Ms J Davies Solicitor for the Respondent: Australian Government Solicitor Date of Hearing: 22 and 23 October 2001 Date of Judgment: 3 December 2001