FEDERAL COURT OF AUSTRALIA Spotlight Stores Pty Ltd v Commissioner of Taxation [2004] FCA 650 INCOME TAX – prepayment into a trust fund by an employer of future annual bonuses expected to become payable to its employees – whether the prepayment is an outgoing of capital or of a capital nature – whether the dominant purpose of the employer's scheme in respect of its employees' future bonuses was the obtaining of a tax benefit in connection with the scheme – whether the Commissioner was entitled to cancel the tax benefit FRINGE BENEFITS TAX - whether the prepayment was a fringe benefit when it was not provided in respect of any particular employee EQUITY - whether a trust has been validly established when the members of the class of potential beneficiaries are not beneficiaries of the trust when it is established Income Tax Assessment Act 1936 (Cth) ss 51(1), 266 and 266L and Pt IVA Fringe Benefits Tax Assessment Act 1986 (Cth) s 136(1) Essenbourne Pty Limited v Federal Commissioner of Taxation (2002) 51 ATR 629 – considered Walstern v Commissioner of Taxation (2003) 54 ATR 423 – distinguished In re Hay's Settlement Trusts (Greig v McGregor) [1982] 1 WLR 202 – cited In re Baden's Deed Trusts (McPhail v Doulton) [1971] AC 424 - cited Kinsela v Caldwell (1975) 132 CLR 458 – applied Re Bowles [1902] 2 Ch 650 – cited Re Leeds and Havley Theatres of Variets Ltd [1902] 2 Ch 809 - cited United Energy Ltd v Commissioner of Taxation (1997) 78 FCR 169 - applied W. Nevill and Company Limited v The Federal Commissioner of Taxation (1937) 56 CLR 290 – considered Sun Newspapers Limited v The Federal Commissioner of Taxation (1938) 61 CLR 337 – applied Hancock (Surveyor of Taxes) v General Reversionary and Investment Company Limited [1919] 1 KB 25 – applied British Insulated and Helsby Cables, Limited v Atherton [1926] AC 205 - distinguished B.P. Australia Limited v Commissioner of Taxation of the Commonwealth of Australia (1965) 112 CLR 386 - cited Tucker (Inspector of Taxes) v Granada Motorway Services Ltd [1979] 1 WLR 683 - cited Anglo-Persian Oil Company, Limited v Dale [1932] 1 KB 124 - cited Heather v P-E Consulting Group Ltd. [1973] Ch 189 - cited Jeffs (Inspector of Taxes) v Ringtons Ltd [1986] 1 All ER 144 - cited Ransburg Australia Pty Ltd v Federal Commissioner of Taxation (1980) 29 ALR 433 - distinguished Commissioner of Taxation of the Commonwealth of Australia v Spotless Services Limited (1996) 186 CLR 404 - applied The Commissioner of Taxation v Peabody (1994) 181 CLR 359 - cited Hart v Commissioner of Taxation (2002) 121 FCR 206 - cited Commissioner of Taxation v Sleight [2004] FCAFC 94 – considered Commissioner of Taxation v Mochkin (2003) 127 FCR 185 at 199-200 - considered SPOTLIGHT STORES PTY LTD v COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA V 795 OF 2002 PRIDECRAFT PTY LTD v COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA V 796 OF 2002 MERKEL J 25 MAY 2004 MELBOURNE IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY V 795 OF 2002 BETWEEN: SPOTLIGHT STORES PTY LTD APPLICANT AND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA RESPONDENT V 796 OF 2002 BETWEEN PRIDECRAFT PTY LTD APPLICANT AND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA RESPONDENT JUDGE: MERKEL J DATE OF ORDER: 25 MAY 2004 WHERE MADE: MELBOURNE THE COURT ORDERS THAT within 14 days the parties file and serve draft orders giving effect to the conclusions set out in the reasons for judgment and their submissions in respect of costs. 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 V795 OF 2002 BETWEEN: SPOTLIGHT STORES PTY LTD APPLICANT AND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA RESPONDENT V 796 OF 2002 BETWEEN PRIDECRAFT PTY LTD APPLICANT AND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA RESPONDENT JUDGE: MERKEL J DATE: 25 MAY 2004 PLACE: MELBOURNE REASONS FOR JUDGMENT Introduction 1 The present appeals concern the tax consequences of a $15 million contribution made on 30 June 1997 by an employer to the trustee of a fund out of which future annual bonuses were to be paid to employees. The employer, Spotlight Stores Pty Ltd ("Spotlight"), carries on a retail business of selling fabric and accessories. It opened its first retail store in 1973 and by 1997 had 71 stores and 2,758 employees. Since 1997 Spotlight continued to expand its highly successful business and now has over 100 stores and over 5000 employees. 2 On 30 June 1997 Spotlight, whose directors at that time were Ruben Fried, his brother Morry Fraid, and Vivienne Fried, conducted its retail business as trustee of the Spotlight Stores Trading Trust ("the Trading Trust"). The trustees of the Fried Family Trust and of the M. Fraid Family Trust, which were discretionary trusts for the benefit of the Fried and Fraid families respectively, each held 100 ordinary units in the Trading Trust. Redeemable units in the Trading Trust, which have been issued from time to time for the benefit of employees of Spotlight, are held by Spotlight Profit Share Pty Ltd as trustee of the Spotlight Profit Share Trust ("the Profit Share Trust"). 3 Each of the applicants, Spotlight and Pridecraft Pty Ltd ("Pridecraft"), has appealed to the Court against decisions of the respondent, the Commissioner of Taxation ("the Commissioner"), in relation to the tax consequences of the $15 million contribution. 4 Pridecraft's appeal concerns two decisions of the Commissioner. The first decision is the Commissioner's disallowance of the contribution of $15 million as an allowable deduction for income tax purposes. As a result of the disallowance amended assessments of income tax were issued by the Commissioner increasing Pridecraft's assessable income under s 97 of the Income Tax Assessment Act 1936 (Cth) ("the ITA Act") for the year of income ended 30 June 1997 by $11,916,810. That amount comprised $11,879,365 and an adjustment of $37,445 in respect of depreciation. The disallowance resulted in the Commissioner not allowing the balance of the $15 million contribution, $3,120,635, to be carried forward as a loss for the year of income ended 30 June 1998. The Commissioner also imposed additional tax by way of penalty. 5 The second decision was the Commissioner's determination under Pt IVA of the ITA Act which resulted in the amount of $11,916,810 being included in the Pridecraft's assessable income under s 97 of the ITA Act for the year of income ended 30 June 1997. The Commissioner issued a further amended assessment to give effect to the Pt IVA determination and imposed an additional tax by way of penalty. Under that assessment the amount of Pridecraft's taxable income and the amount of additional tax were not increased. 6 Pridecraft has appealed against the Commissioner's disallowance of its objections to the amended assessments. Pridecraft is a beneficiary of each of the Fried and Fraid family trusts. Under the terms of the respective trust deeds Pridecraft becomes presently entitled to any part of the net annual income of the two family trusts that is not distributed to other beneficiaries. Pridecraft's taxable income, rather than that of Spotlight or the trustees of the Fried and Fraid family trusts, was increased by the amended assessments because the disallowance of Spotlight's claim for a deduction in respect of the $15 million contribution resulted in the increased taxable income of the Fried or Fraid family trusts not being distributed by resolutions of the directors of those trusts. Accordingly, the increased income became income to which Pridecraft was presently entitled as at 30 June 1997. 7 The outcome of Pridecraft's appeal depends upon whether the Commissioner was correct in his treatment of Spotlight's $15 million contribution. The Commissioner claims, and Pridecraft denies, that: · the $15 million contribution by Spotlight is not deductible under s 51(1) of the ITA Act because it did not satisfy the positive limbs of s 51(1) and, in any event, was a loss or outgoing of capital or of a capital nature; · even if the $15 million contribution is deductible under s 51(1), Pt IVA of the ITA Act applies to cancel the tax benefit obtained by Spotlight because the dominant purpose of the scheme, of which the contribution was an integral part, was to obtain that benefit; and · the penalty tax provisions of the ITA Act apply in respect of the contribution. 8 Spotlight's appeal, which was heard together with Pridecraft's appeal, relates to the Commissioner's decision to disallow Spotlight's objection to a fringe benefits tax ("FBT") assessment that treated the contribution of $15 million as a fringe benefit and also imposed additional tax by way of penalty. The Commissioner claims that the contribution was in respect of the employment, and for the benefit, of Spotlight's employees and is therefore liable to FBT. 9 In the course of the hearing Senior counsel appearing for the Commissioner stated that the Commissioner would only pursue the FBT assessment against Spotlight if Pridecraft succeeded in its claims that the $15 million contribution was an allowable deduction under s 51(1) and that Pt IVA did not apply to any tax benefit obtained by Spotlight. The relevant provisions of the FBT Act are complex but a key issue is whether the definition of a "fringe benefit" in s 136(1) of the FBT Act requires that, when the alleged fringe benefit (being the $15 million contribution) is provided, there must be a particular employee who can be identified as a person for whose benefit it is being provided: see Essenbourne Pty Limited v Federal Commissioner of Taxation (2002) 51 ATR 629 ("Essenbourne") at 643 [54] and Walstern v Commissioner of Taxation (2003) 54 ATR 423 ("Walstern") at 440-441 [87]-[88]. Spotlight's Profit Share Bonus Scheme 10 The background to Spotlight's contribution of $15 million is as follows. Spotlight has a long standing policy of paying annual bonuses to reward store managers and employees for the successful conduct of its business. During the 1980's, in pursuance of that policy, Spotlight introduced a Profit Share Bonus Scheme ("the Pre-1997 Scheme"). The profit share arrangements under the Pre-1997 Scheme were implemented by Spotlight on a discretionary basis. Under that scheme Spotlight was under no obligation to pay annual bonuses until the bonuses payable were announced by Spotlight. 11 Under the Pre-1997 Scheme the annual bonuses distributed by Spotlight to its employees totalled about 10 per cent of its pre-tax profit. Two types of bonuses were paid: the Christmas bonus and the mid-year bonus. The Christmas bonus, which was paid in December, constituted 40 per cent of the total bonuses paid, and the mid-year bonus, which was paid in August, constituted the remaining 60 per cent of the total bonuses paid. The Christmas bonus was paid to all staff members but the mid-year bonus was paid only to store managers and staff performing support functions. 12 During the 1997 year of income the directors of Spotlight perceived that there were a number of problems with the Pre-1997 Scheme. Mr Morry Fraid described the problems as follows: "(a) bonuses under the Old Scheme were paid in full immediately after they were determined and announced. This meant that some, especially key, employees resigned very soon after receiving their bonuses, which was usually in the second half of August or the first half of September. Employees who had been recruited by competitors would often stay until they had been paid their bonuses and resign shortly thereafter. I recall, for example, that the store manager at Gosford resigned the day after the annual conference in 1996 or 1997 at which she was paid her bonus. (b) bonuses were paid on the overall profit of Spotlight without sufficient regard to change in profit at a store or department level. Therefore a particularly poor performance which might significantly diminish the profitability of a profit centre would still attract an undeserved bonus. (c) clearly some stores do better because of their location and the size of the store. Under the Old Scheme, the staff at these stores would receive higher bonuses, even if their performance was less than adequate. Some managers in less profitable stores (such as, for example, smaller stores in country areas) could produce tremendous results (for example, by turning around a loss into a profit), but this was not reflected in their bonus. Good managers therefore would not want to transfer to a less profitable store. (d) capital expenditure under the Old Scheme was rapidly depreciated therefore diminishing profits, so employees would not want to go to a new store with the resulting high capital start-up costs, or to incur capital expenditure, because this would result in a lower profit that year and therefore a lower bonus. (e) decision-making by managers tended to be short-term so as to maximise profits in the current year sometimes at the expense of higher long-term profits. Apart from avoiding capital expenditure, managers would not take mark-downs because this would affect short-term results (even though in the long-term it is better to move loss-making stock so as to make room for more profitable stock). (f) a loss made by one store would reduce the bonus pool available to all stores and if the company as a whole didn't make a profit, then no-one received a bonus despite outstanding individual performances. (g) The Old Scheme provided little, if any, security in respect of future bonuses." 13 On 30 June 1997 the Pre-1997 Scheme was replaced by the current Profit Share Bonus Scheme ("the Post-1997 Scheme"). The genesis of the Post-1997 Scheme was Mr Fraid's attendance at a seminar on the Economic Value Added ("EVA") financial system conducted by Joel Stern early in 1997. One aspect of the EVA seminar concerned the calculation of employee bonuses in a manner that took into account individual staff and store contributions to improved profitability. In explaining why he and his brother decided to implement Mr Stern's proposals, which included shares or options being given as part of the incentive package for employees, Mr Fraid stated: "Joel Stern suggested that one third of the individual bonus be paid immediately and that two thirds be kept in what he referred to as the 'bank' or in reserve for future years. He also suggested paying each employee 1/3 of the closing balance of the previous year's 'bank'. Joel Stern said that such a bonus scheme would reward employees like owners and so it would encourage employees to think like owners. This was consistent with the culture that Ruben [Freid] and I aimed to create at Spotlight and we decided that such a bonus scheme would be implemented at Spotlight. The 'banking' of two thirds of the calculated or notional bonus (which we refer to as 'the injection') for future years was an important difference between the Old Scheme and that which we were then considering. The 'banking' of bonuses for the future required a more formal structure than the Old Scheme, as the 'banked' amounts were effectively being earmarked for payment to employees in future years. This 'banked' amount is commonly referred to by Spotlight as the [employees'] 'Reserve'. … Ruben and I decided to implement the EVA financial system including an EVA-based incentive scheme, modified to calculate bonuses on before-tax rather than after-tax profits, which was consistent with the Old Scheme. We did not want the bonus pool under the new scheme to be less than that under the Old Scheme. We decided that one-third of the injection plus one-third of the closing balance of the [employees'] Reserve should be paid each year with the remaining two-thirds of the injection and the balance of the Reserve to be paid in future years." 14 Mr Fraid and his brother implemented the Post-1997 Scheme by taking the following steps between 27 June 1997 and 30 June 1997. Spotlight Stores Incentive Pty Ltd ("Spotlight Incentive") was incorporated on 27 June 1997 and Messrs Fried and Fraid were appointed directors of the new company. On 30 June 1997 Spotlight, as settlor, and Spotlight Incentive, as trustee, executed a Deed of Settlement that established the Spotlight Staff Incentive Trust ("the Incentive Trust"). 15 The recitals to the Incentive Trust Deed state that Spotlight wishes to set aside a fund to reward its employees and to provide an incentive for those employees to remain in employment. The recitals also state that Spotlight will contribute sums to the fund on one or more occasions in each year, the frequency and amount of which will be "determined by [Spotlight] in its absolute discretion." Beneficiaries of the Incentive Trust are defined as any person who at any time or from time to time is a person falling within the definition in Item 7 of the Schedule. Item 7 defines a beneficiary as: "Any person who immediately prior to the date on which an amount is proposed to be paid by the Trustee to a Beneficiary has been or is an Employee of [Spotlight] and, in the opinion of the Trustee, fulfils the criteria set out in Clause 10." 16 Although Messrs Fried and Fraid and certain family members were employees who were potential beneficiaries it was not expected that they would receive, and they did not receive, bonuses under the Post-1997 Scheme. 17 Clause 3(a) of the Trust Deed provides for the income and capital to be applied for the benefit of the beneficiaries having regard to the criteria referred to in cl 10, which provides: "Subject to any express provision to the contrary herein contained, every discretion vested in the Trustee shall be absolute and uncontrolled and every power vested in it shall be exercisable at its absolute and uncontrolled discretion PROVIDED HOWEVER THAT without limiting the foregoing, in making any determination as to an amount or amounts to be paid to, set aside for or allocated to a Beneficiary whether in relation to the income or capital of the Trust Fund, the Trustee shall first consult with [Spotlight] and it may have regard to all or any of the following criteria and may place whatever weight it chooses on any of the following criteria: (a) the contribution made by the Beneficiary to the revenues or profits of [Spotlight]; (b) the contributions made by the Beneficiary in relation to the business or operation of [Spotlight] in terms of administration, management, staff recruitment, training and management, professional development and client servicing; (c) the extent to which the Beneficiary has attracted new clients to [Spotlight]; (d) the length of service of the Beneficiary with [Spotlight]; (e) the seniority of the Beneficiary in terms of his or her position with [Spotlight]; and (f) any other contributions made by the Beneficiary to the business, operations, profitability and standing of [Spotlight]." 18 The minutes of three meetings of the directors of Spotlight held on 30 June 1997 were as follows: 1. "PRESENT: Mr R.M. Fried (Chairman) Mr M Fraid ESTABLISHMENT OF STAFF INCENTIVE TRUST: The Directors discussed the possibility of establishing [a] fund or bonus pool which is to be used to provide bonuses or otherwise to reward those employees who had made a valuable contribution to the Company, either in a particular year or over an extended period of time. The Directors were of the view that it was advantageous for the Company to establish a fund along such lines for the following reasons: (a) it would provide some incentive for employees to maximise their contributions to the company; (b) it would provide an incentive for the employees to remain with the Company, by the bonuses being used to grant units in a trust upon which further units will be allocated to reflect the performance of the Company; (c) it could be used as a basis for quantifying and evaluating the performance of the employees. (d) it may be used to reward employees in periods where the Company may not generate sufficient cash flow to do so. The Chairman tabled a Trust Deed pursuant to which a fund is established for the purposes described above. There ensued further discussion regarding the structure and merits of the fund, the amount which should be set aside each year, the basis on which employees become eligible to participate and the basis upon which bonuses should be paid. IT WAS AGREED AS FOLLOWS: (a) A fund be established to be known as the Spotlight Staff Incentive Trust. (b) The Trustee of the fund will be Spotlight Stores Incentive Pty Ltd. (c) The fund would be established by an initial contribution by the Company of $20. (d) The Company would contribute further amounts to the Trust annually or bi-annually at its discretion. (e) The amount be paid out to any employee under the scheme should be determined by the Trustee at its discretion, after consulting with the Board. In this respect, regard should be had to the following:- (i) the contribution made by the employee to the revenues or profits of the Company; (ii) the contributions made by the employee in relation to the business or operations of the Company in matters such as administration, management, staff management and training, professional development and client servicing; (iii) the extent to which the employee has attracted new clients to the Company; (iv) the seniority of the employee; and (v) the length of service of the employee. (f) The Trustee would be under no obligation in any year to distribute the whole amount or any amount contributed by the Company in the relevant year. Funds should be retained in the pool to enable bonuses to be paid in years where otherwise no funds might be available. IT WAS RESOLVED that: 1. Subject to making any amendments to the Trust Deed to reflect the matters agreed above, the Company execute the Trust Deed by affixing its Common Seal to the Deed; and 2. The Company contribute an initial sum of $20 in order to establish the Fund. CLOSURE: There being no further business to discuss, the Chairman declared the meeting closed." 2. "PRESENT: Mr R.M. Friend (Chairman) Mr M Fraid PREVIOUS MINUTES: The Minutes of the previous Meeting of Directors were read and confirmed. CONTRIBUTION TO STAFF INCENTIVE TRUST: The Directors discussed the successful year that the Company was enjoying and noted the motivation and contributions of a number of employees. The Directors held that provision should be made to reward these efforts. The Directors therefore discussed the possibility of making a contribution to the Spotlight Staff Incentive Trust. IT WAS AGREED AS FOLLOWS: In light of the successful year that the company had experienced, that $15,000,000 be contributed to the Trust. IT WAS RESOLVED that: 1. The Company contribute $15,000,000 to the Trust. CLOSURE: There being no further business to discuss, the Chairman declared the meeting closed." 3. "PRESENT: Mr R M Fried (Chairman) Mr M Fraid OFFER TO BORROW: IT WAS AGREED to authorise any one director of the company to offer to borrow from Spotlight Stores Incentive Pty Ltd the sum of $14,800,000 on the terms set out in an Offer to Borrow which was tabled at the meeting. The loan is at call and the interest rate in the first 12 months will be 7.55% per annum. CLOSURE: There being no further business to discuss the Chairman declared the meeting closed." 19 The minutes of two meetings of Spotlight Incentive held on 30 June 1997 were as follows: 1. "PRESENT: Mr R M Fried (Chairman) Mr M Fraid CHAIRMAN: With the approval of the meeting Ruben Fried took the Chair. STAFF INCENTIVE TRUST: RESOLVED that the Company accept the position of Trustee of the SPOTLIGHT STAFF INCENTIVE TRUST and affix the Common Seal of the Company to the Trust Deed. BANK ACCOUNT: FURTHER RESOLVED that Ruben Fried and Morry Fraid be authorised to open a bank account with the National Australia Bank for the purposes of the Spotlight Staff Incentive Trust and do all other things convenient or necessary to perfect the appointment. CLOSURE: There be no further business to discuss, the Chairman declared the meeting closed." 2. "PRESENT: Mr R M Fried (Chairman) Mr M Fraid OFFER TO BORROW: A written Offer to Borrow from Spotlight Stores Pty Ltd to the Company was tabled. It was agreed to accept the terms contained in the Offer to Borrow and to make a payment of $14,800,000 to Spotlight Stores Pty Ltd on the terms and conditions contained in the Offer to Borrow. CLOSURE: There being no further business to discuss the Chairman declared the meeting closed." 20 Mr Fraid provided the following explanation in respect of its contribution of $15 million. Shortly before 30 June 1997 Mr Fraid asked Dean Berry, Spotlight's finance manager, to provide an estimate of employee bonuses that would be payable over the first five years of the Post-1997 Scheme. Mr Berry's projections showed that the total estimated bonuses to be paid or deferred in respect of the five year period commencing 1 July 1996 would be $15,575,000. Payment and deferral of bonuses for that five year period were to commence in August 1997 and follow annually thereafter through to August 2001. On receiving this calculation, Mr Fraid and his brother "resolved to contribute $15 million to the Incentive Trust out of which amount (plus the interest earned on that contribution) bonuses would be allocated to employees." Thus, an amount of $15 million was resolved to be paid, and was paid, by Spotlight to the Incentive Trust on 30 June 1997. 21 Mr Fraid stated that by prepaying the $15 million to Spotlight Incentive and securing the loan back to itself, Spotlight was better able to secure the payment of the bonuses. He explained that because the loan from Spotlight Incentive was secured by a debenture, the beneficiaries of the Incentive Trust, Spotlight's employees, were in the position of secured creditors. 22 Mr Fraid was asked why the payment of $15 million was made on 30 June 1997 when payment of the first bonus under the Post-1997 Scheme, which was to be calculated and paid in full in accordance with the Pre-1997 Scheme, was not required to be made until August 1997. His response was as follows: (T63) "Commencing on 1 July, the new bonus scheme was commencing the following day, and the new bonus scheme had the effect of creating the reserve which we felt needed to be secured. When we explained these changes to the staff we wanted to assure them at that time that their future bonuses were safe. [MR DAVIES:] What do you mean by 'secured'?---The loan to Spotlight Trust was secured by the second mortgage debenture. By debenture - and so you're saying - is that the critical matter that was achieved by the trust structure?---Well, it was certainly one benefit - a major benefit. A major benefit?---Mm. What were the other major benefits?---The other major benefit was that it was part of this whole restructure of the scheme for the reserve which would provide for the ongoing loyalty of the staff. We weren't paying out the full amount in that year. We were holding onto some of them with their understanding. It created that long-term focus, rather than the short-term focus. We had the ability to now apply negative bonuses, in fact, to individuals. So rather than a negative performance in one area affecting the bonuses of other good performance, we were able to apply negative against an individual reserve. There are a whole bunch benefits in these changes. The change to EVA accounting which meant that staff had to pay a weighted average cost of capital against the assets they employed. But it's fair to say, isn't it, Mr Fraid, that those other - what I might call other non-security considerations related to the manner in which the bonus was calculated and paid?---Yes, it's true. But it was a package of measures that was implemented at that time. HIS HONOUR: I think what's being suggested is: of the package, which of those measures required the trust rather than just have the company itself undertake liability? I think you've mentioned that there was security. Was there anything else?---I think that would be a major benefit, yes - a major reason. I suppose there was an interest rate component?---True. Did that go to the benefit of the employees under the trust?---It did. It went to the benefit of the trust which was then distributed to employees. So apart from those two aspects can you think of any other benefit that having the money paid to the trust achieved?---That specific element? No." 23 The accounting and tax treatment of the $15 million contribution was described by Mr Berry: "The contribution of $15,000,000 to the Incentive Trust was included in the sum of $50,969,431 shown as 'Wages, Salaries and Employee Benefits' in the accounts of Spotlight as an expense. … A tax deduction was claimed for the $15,000,000 in the tax return of Spotlight for the year ended 30 June 1997. … Spotlight returned a loss of $3,120,635 in its tax return for the year ended 30 June 1997. This loss was carried forward to be offset against future taxable income." 24 Spotlight's balance sheet for the Trading Trust for the year ended 30 June 1997 discloses that, as a result of the payment, there was a net deficiency in trust funds in the sum of $5,331,645. The Trust's Trading, Profit and Loss Statement for that year discloses that, as a result of the payment, there was an accounting loss of $5,331,845. 25 As recorded in the resolutions, on 30 June 1997 Spotlight made, and Spotlight Incentive accepted, a written "Offer to Borrow" $14.8 million with interest payable at the rate of 7.55 per cent per annum. Mr Fraid stated that the interest was a "higher rate of interest than available on deposit with the bank". The remaining $200,000 was not loaned back to Spotlight but was retained in the bank account of Spotlight Incentive. 26 Clause 3 of the Offer to Borrow provided that the loan "shall be secured by a Mortgage Debenture Charge over the assets of [Spotlight]." Pursuant to cl 7 the loan was repayable on seven days demand, which could be made at any time for the whole or any part of the loan then outstanding. Under cl 5 interest, if not paid may be capitalised. Generally, repayments of the loan and payments of interest have been made in amounts that matched, and thereby enabled, the payment of bonuses by Spotlight Incentive to Spotlight's employees under the Post-1997 Scheme. The payments were usually made by Spotlight and appropriate debit and credit entries were made in the loan accounts of Spotlight and Spotlight Incentive. 27 The mortgage debenture that was to secure the loan was not executed until 20 July 1998, more than one year after the loan was made to Spotlight. The minutes of a meeting of directors of Spotlight Incentive held on 20 July 1998 state: "PRESENT: Mr R M Fried (Chairman) Mr M Fraid MORTGAGE DEBENTURE: IT IS NOTED that in June 1997 the Company had lent Spotlight Stores Pty Ltd the sum of $14,800,000, which has been partly repaid. It was now agreed to accept as security from Spotlight Stores Pty Ltd a Second Ranking Mortgage Debenture and to execute all necessary documentation." 28 Mr Fraid was also questioned as to why the debenture to secure the loan was not issued until 20 July 1998: "Can you explain why it is that if the security was seen as a major aspect for adopting the trust structure, the security was not taken until July 1998?---Yes, the first year that the – sorry, the August and December 97 bonuses were paid in full under the old scheme and therefore there was no reserve to secure. The first creation of an actual reserve for the employees was in August of 98 and it's at that time that the security – we say that as – at that time it became important obviously because that's when actually [we are] holding funds for our employees." 29 Mr Berry explained the Post-1997 Scheme as follows: "Key elements of the Profit Share Bonus Scheme are as follows: (a) Spotlight made a contribution of $15 million to the Incentive Trust on 30 June 1997, calculated in the manner I have described [below]; (b) the Incentive Trust makes a distribution of only a portion of what is called the staff member's Mid Year bonus when this bonus is announced (being in the August following the year on which the bonus is based). In August 1998, the portion of Mid Year bonus that was paid was 67%. In August 1999, the portion of Mid year bonus that was paid was 50%. Since August 2000, the portion of Mid Year bonus paid has been 1/3. A higher portion was paid in early years to ensure that there was no decrease in the bonus paid under the Profit Share Bonus Scheme from that paid under the Old Scheme. Although the bonuses paid in August 1997 were paid by the trustee of the Incentive Trust, the calculation of this bonus was still made under the Old Scheme as the bonus related to the last year of the Old Scheme. (c) the trustee of the Incentive Trust makes a distribution of what is called a staff member's Festive Bonus when this bonus is announced (being in December following the year on which the bonus is based); (d) the unpaid or deferred portion of the employee's Mid Year bonus is added to the employee's 'Reserve', or 'Bank'. Each year in August the trustee of the Incentive Trust pays to each employee by way of distribution, 1/3 of the balance in their Reserve at the start of the year in addition to the relevant proportion, which since 2000 has been 1/3 of the Mid Year bonus. (e) although payment of an employee's 'Reserve' is at the discretion of the trustee of the Incentive Trust, there is (and as I understand the scheme, the trustee of the Incentive Trust wishes to create in the employees of Spotlight) an expectation that, subject to appropriate performance, the deferred bonus or 'Reserve' will be paid to them. Normally: (i) if an employee leaves Spotlight having given 3 months' notice and assisting with the transition to a replacement employee, the trustee of the Incentive Trust will distribute to the employee the balance in their Reserve at the same time the balance would have been paid had they remained in employment with Spotlight; (ii) if an employee leaves Spotlight giving the minimum notice of 2 weeks, the Incentive Trust will not usually distribute the balance in the employee's Reserve; and (iii) if an employee takes maternity leave, long service leave or sabbatical leave, the Incentive Trust will distribute to them the balance in their Reserve at the same time the balance would have been paid had they not been on leave. By the Incentive Trust deferring payment of some of the 'bonus' and treating it as a staff member's Reserve, staff are encouraged to make longer term decisions, rather than trying to maximise profits in the current year in order to maximise bonus payments and then leave Spotlight. The Reserve arrangements thus help to address one of the principal problems with the Old Scheme which encouraged short term rather than long term decision-making. Although employees do not have any strict entitlement to their 'Reserve', the contribution to the Incentive Trust ensured that there were sufficient funds set aside to meet bonuses and Reserve payments which it was expected would be paid to and 'accrue' to employees in the first 5 years of the Profit Share Bonus Scheme." 30 Under the Post 1997-Scheme the percentage of the annual bonus payment payable and paid by Spotlight Incentive was gradually reduced to one-third of the bonus, with the remaining two-thirds of the bonus being provided for in the Reserve. The remaining two-thirds in the Reserve was to be paid over the ensuing two years, although during that period the Reserve was further increased by two-thirds of the amount of the further annual bonuses, which were not paid but were provided for in the Reserve. The first provisions in the Reserve in favour of individual employees were to be made, and were made, in respect of the bonuses paid in August 1998. 31 Although an important aspect of the Post-1997 Scheme was the employees' Reserve the documents executed by the parties made no provision for the creation of the Reserve. Mr Berry explained that outcome as follows: "As employees do not have a strict entitlement to their Reserve the formal accounts for the Incentive Trust do not make any provision for the Reserve. However, as the trustee of the Incentive Trust expects to pay and employees expect to be paid their Reserve the Incentive Trust keeps detailed computer records of each employee's 'Reserve'. These records are maintained by Sharon Fitzgerald who is the group's payroll manager. The total of all employees' Reserves as at the following dates was as follows: 30 August 1998 $377,058 30 August 1999 $815,931 30 August 2000 $3,118,095 30 August 2001 $3,335,357 30 August 2002 $5,322,951 30 August 2003 $6,864,011" 32 Mr Fraid stated that "[e]ven though employees had no strict entitlement to their Reserve they had an expectation that the Reserve would be paid in accordance with the principles under which the Profit Share Bonus Scheme operated". In the course of cross-examination the following questions were asked of Mr Fraid: "MR DAVIES: There was a discretion in the Incentive Trust as to whether or not a bonus would be paid?---I know technically there was, but I certainly morally and ethically felt, and still do feel that we would always abide by what we've - and probably contractually have to abide by those commitments that we gave our staff. HIS HONOUR: Is there some reason why what you described as ethically and morally a commitment was not translated into a legal commitment? I don't want to get into what your lawyers may have told you. If it does, let me know, but as far as you're concerned, why the gap?---There was no conscious decision to not have it legally – it's just never been an issue. We've always paid it, we always intend to pay it. People are clear on the rules. They are clear on how and when they get it and it's just clear to everybody that's involved it. There's no reason – it's never come up. Nobody has ever asked for it. No-one has ever asked for what?---For a legal document guaranteeing their future bonus payments. I mean, it's just not the way we operate as a company. The unions have never asked for it and they understand the entitlement." 33 Spotlight's Managers were informed about the Post-1997 Scheme at the Spotlight Managers' Conference in August 1997. At the conference Mr Fraid and Spotlight's Chief Financial Officer explained to the managers how the new scheme would work. Mr Fraid stated: "It is essential to the EVA incentive system that managers and employees be trained in business literacy, and in accounting and financial management, in order to respond appropriately to the incentive scheme." 34 At the conference Mr Fraid used presentation notes and overhead slides to outline the reasons for changing the bonus scheme and explain the benefits that Spotlight expected to achieve from the changes. Mr Fraid stated that the presentation notes were also given to employees at the August 1997 conference. The notes and slides provided complex and detailed information about how the Post-1997 Scheme was to work but did not mention the Incentive Trust or the payment of $15 million to secure employees' bonuses over the ensuing five years. They did, however, contain the following section: "HOW DO WE PAY BONUSES? · In 1998 half the injection is paid as a bonus. · 1999 and thereafter one third is paid as a bonus. · The balance of the injection is retained by the company in a 'Bank' for future [years'] bonus payments. · One third of the Bank balance is paid each year · The Bank is being started with approximately $1,000,000. For example:- 1997 1998 1999 2000 2001 TOTAL INJECTION THIS YEAR 1,700 3,000 3,600 600 4,500 ____________________________________________________________ 1/3rd of this year paid [1/2] 1,500 1,200 200 1,500 1/3 of injection fund 333 722 1,282 988 balance______________________________________________________ TOTAL PAID 1,833 1,922 1,482 2,488 Bank balance carried forward 1,000 667 1,445 2,563 3,000 2/3rds of this year [1/2] 1,500 2,400 400 1,975 BANK BALANCE 2,167 3,845 2,963 4,975 WHAT HAPPENS TO THE BANK AT THE END? · Planned termination of employment by agreement [eg. retirement, redundancy] will result in a 1/3rd 'golden handshake' followed by 1/3 the following two years. The employee will make themselves available for advice, information and Bonus Nights. · Unplanned termination [eg. sudden resignation, dismissal through misconduct or incompetence] will result in zero payout. · Stepping down from management is considered termination. · Death or permanent disability means the total bank is paid. · One third of the Bank is still paid during maternity leave, long service leave or Sabbatical leave [not the 1/3rd injection]" 35 Mr Fraid stated in his affidavit that as part of his presentation he informed managers "that funds had been set aside in a separate trust fund to pay for bonuses for the first few years of the scheme." Mr Berry stated in his affidavit that he attended the conference and recalled Mr Fraid "saying words to the effect that Spotlight had set aside into a separate fund sufficient moneys to enable payment of bonuses (including Reserves …) for the next few years". 36 In the course of being cross-examined about his presentation Mr Fraid gave the following answers to questions asked of him: "[MR DAVIES:] You don't indicate anywhere, do you, in your description of the Stern seminar that as part of what was being recommended that a trust be set up along the lines of the incentive trust?--- No, the purpose of that was to secure the future bonuses, the reserves, et cetera, which was recommended by the Stern proposal. I see, so that the Stern proposal recommended securing a fund?---They recommended deferring payments. Did it recommend a fund?---I don't recall a specific recommendation on that. Well, there is a difference, isn't there, between deferring payments and securing a fund?---There is a difference. We wanted to satisfy the staff that those deferred payments would be secured. Because you could defer payments without adopting a trust structure, couldn't you?---In theory, but we could also risk losing the trust of our staff. And would you just explain how one is connected with the other - that answer is connected with your previous answer?---Well, if we say to our staff, 'You've got a thousand dollar bonus. We're going to give you $333 today. Trust us, you'll get the rest eventually' - that's not the way we like to operate. We would like staff to know that we have put those funds aside for those future payments. HIS HONOUR: But the way the deed works by giving a complete discretion to the directors is exactly that – 'We're giving you this now and trust us to give the rest later'?---But what we told the staff was that in fact we were putting away funds for that purpose. Did you tell them how much or you just said, 'We're putting away funds for the future'?---We said 'funds for the future'. It was couched in general terms. MR DAVIES: And you could have created a reserve within Spotlight Stores' accounts itself to set aside the funds, could you not?---I don't know. Did you discuss that aspect with anybody around 30 June?---I don't recall discussing that alternative, no. Document MF1 is a document that you gave your employees at the August 1997 conference. Is that so?---Yes. Where in that document is it that they are informed that a trust fund is set up for the payment of bonuses?---These are actually overhead slides as you can see in abbreviated dot point form. Each of these points were discussed and there was a lot of information that was given to the staff that wasn't in these overheads. This forms the substance of what was told to them at the conference. Is that not so?---These are the overhead slides. Who prepared the overhead slides?---I did. When you prepared the overhead slides it didn't occur to you that a critical aspect of what the employees might want to know is the fact that a trust had been set up?---I don't think our employees would know the difference between a trust and any other entity. I don't think that - it is a fairly technical, I think, distinction from an employee's point of view, and they just wanted to know if part of their bonus was being held over, that should anything happen to Spotlight, they would get the money. …" 37 The Chief Financial Officer of Spotlight also prepared a detailed report on the Profit Share Trust. Employees at the August 1997 conference were informed that they would hold redeemable units in the Profit Share Trust, the trustee of which would hold units in the Trading Trust. The bonuses actually paid were to be automatically applied by Spotlight Incentive to the subscription of units in the Profit Share Trust, which in turn held units in the Trading Trust. Employees were entitled to redeem units in the Profit Share Trust twice a year if they so desired, but their units had to be redeemed upon their departure from employment. The staff unit holding arrangements provided employees with an additional basis for sharing in the profits earned by Spotlight. 38 Mr Fraid stated that the Post-1997 Scheme is explained to managers every August, and a full four day training course for new team leaders is carried out, usually between April and June, every year and at that stage "the workings of the profit share scheme" are explained. 39 After the initial transition period, in which the bonuses continued to be calculated and paid in accordance with the Pre-1997 Scheme, the first distribution of bonuses calculated and payable in accordance with the Post-1997 Scheme was made during August 1998. A pro forma letter sent out to employees stated: "Thank you for your valued contribution to Spotlight during the year. Your efforts have resulted in a profit for the company and enabled a growth from 72 stores to 74 stores. In recognition of your achievements your profit share is $≪GROSS≫ representing your part of the [company's] profit share scheme. The after tax bonus of $≪NET≫ has been applied to purchase units in the Spotlight Profit Share Trust. Attached you will find your unit certificate." Each August a schedule of proposed bonuses was prepared and, after being approved by Messrs Fraid and Fried, the relevant employees were informed of their bonuses. By August 2003 the form of letter sent out to employees had become more detailed. As the letter reflects how the Post-1997 Scheme worked in practice it is appropriate to set out its terms. An example is as follows: "Thank you for your valued contribution to Spotlight during the year. Your efforts have resulted in a profit for the company and enabled a growth from 94 stores to 98 stores. The after tax bonus of $22,745 has been applied to purchase units in the Spotlight Profit Share Trust. [Attached] you will find your statement and redemption certificate. Those that left their bonus units in the Trust for the 2001/2002 year earnt a return of 27.02%. However, if you wish to redeem all or part of your units, you must complete the redemption certificate enclosed. … … In recognition of your achievements your profit share is $44,164 as calculated below: 2000 2001 2002 2003 Injection (Based on proportion of year) 46,266 31,749 45,797 68,309 Percentage of injection paid. 33% 33% 33% 33% This year paid 15,268 10,583 15,163 22,708 Plus 1/3 of last year's 'Reserve' balance if 2002 6,580 14,719 16,868 21,456 Reserve is positive. Plus 1/6 of last year's 'Reserve' Balance if 2002 Reserve is negative. TOTAL BONUS PAID (Difference due to rounding)21,847 25,302 32,032 44,164 Reserve Reserve Balance carried forward 13,159 29,438 33,736 42,913 Add to 'Reserve' this year 30,998 21,166 30,633 45,601 RESERVE BALANCE 44,157 50,604 64,369 88,514" 40 Although employees were shown to have balances in their respective Reserve accounts, payments of amounts out of the "Reserve" were discretionary. However, in the normal course, amounts were paid by Spotlight Incentive to employees pursuant to the Post-1997 Scheme. But, if an employee left Spotlight without giving appropriate notice, or was dismissed for disciplinary reasons, no bonus payment was paid to the employee. 41 Under the Post-1997 Scheme the bonuses paid to employees were substantial. The accounts of the Incentive Trust as at 30 June 2002 were described by Mr Berry: "… the closing balance of assets held by the Incentive Trust at 30 June 2002 [was] $8,985,626. As at 30 June 2003, this balance was approximately $5,240,000 and following the payment of midyear bonuses in August this year, the balance is $1,680,000. I anticipate that most of this amount will have been paid out as bonuses by June 2004. The original payment of $15,000,000 to the Incentive Trust (together with interest thereof) has satisfied all bonus payments since August 1997, but the employee 'Reserves' currently total $6,864,011. There is no provision in any Spotlight entity to pay such Reserves which are technically (as I understand) at the discretion of the trustee of the Incentive Trust." 42 Pridecraft claims that employees knew about the existence and operation of the Incentive Trust as each new employee signed a Tax File Number Declaration Form for Spotlight, which pays the employee's regular wages, and for the "Spotlight Staff Incentive Trust", which pays the bonuses. In addition, Pridecraft claims that Spotlight Incentive issued employees with group certificates for the bonus payments made. Thus, employees of Spotlight received two Group Certificates, one from Spotlight and the other from Spotlight Incentive as the trustee of the Incentive Trust. 43 The evidence establishes that the benefits expected to be achieved, and which were in fact achieved, by the implementation of the Post-1997 Scheme included improved staff retention rates, lower staff turnover and improved staff morale, efficiency, productivity and loyalty which, in turn, enhanced Spotlight's profits. Section 51(1) 44 Section 51(1) of the ITA Act provides: "All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income." 45 At the outset it is appropriate to deal with the Commissioner's submission in reliance upon Walstern at 437 [69] and 440 [85] that, because there were no employees who were beneficiaries of the Incentive Trust when the $15 million contribution was made, there was a resulting trust in favour of Spotlight which remained the owner in equity of the contribution until beneficiaries of the Trust came into existence by satisfying the requisite criteria set out in the Incentive Trust Deed. 46 When the contribution of $15 million was made by Spotlight to Spotlight Incentive on 30 June 1997 the amount paid became part of the Incentive Trust Fund and was required to be administered by Spotlight Incentive in accordance with the terms of the Incentive Trust Deed. Plainly, it was the intention of the parties to the Trust Deed, Spotlight and Spotlight Incentive, that upon payment of the contribution Spotlight ceased to have any right, title or interest in the sum paid. Indeed, on the same day Spotlight and Spotlight Incentive entered into a loan agreement pursuant to which $14.8 million of the amount paid was lent by Spotlight Incentive to Spotlight on the terms set out in the agreement. In such circumstances the Court should be slow to hold that the trust failed with the consequence that there was a resulting trust back to the Spotlight in respect of the $15 million. 47 The Commissioner, however, contends that must be so as, when the contribution was made, there was no beneficiary in existence for whose benefit the trust was required to be administered. The problem with that submission is that so long as the object of the trust is sufficiently certain, or is not too vague, and is not shown to offend against some rule of law or equity it should be held to be valid: see In re Hay's Settlement Trusts (Greig v McGregor) [1982] 1 WLR 202 at 212. Ensuring certainty of beneficiaries does not require that it be possible to list all members of the class of beneficiaries. Rather, it must be possible to say with certainty in a particular case whether a person is or is not a member of the class: see In re Baden's Deed Trusts (McPhail v Doulton) [1971] AC 424 at 456. As was observed by McTiernan, Stephen and Mason JJ in Kinsela v Caldwell (1975) 132 CLR 458 at 461. "A trust is not uncertain merely because the actual persons to whom the distribution will be made cannot be known in advance of the date of the distribution; it is sufficient that the provisions of the trust ensure that upon that date the beneficiaries can be ascertained with certainty." 48 It is clear that the beneficiaries of the Incentive Trust can be ascertained with certainty on the date of any distribution. In any event the class of beneficiaries is clearly defined and is sufficiently certain. The fact that at the date of the establishment of the trust the defined class of beneficiaries can only become beneficiaries upon the occurrence of a future event does not result in invalidity of the trust. For example, a trust for the unborn children of a particular marriage has not been regarded as failing merely because the beneficiaries are not in existence when the trust is established: see Re Bowles [1902] 2 Ch 650 at 653, Re Leeds and Havley Theatres of Variets Ltd [1902] 2 Ch 809 at 819; Ford and Lee: Principles of the Law of Trusts, 3rd Edition at [5030] and Jacobs' Law of Trusts in Australia 6th Edition (at [107]). 49 Walstern does not require or justify a different conclusion. In Walstern Hill J, at 437 [69], and 440 [85] concluded that, in the particular circumstances of that case, which included provisions relating to a superannuation fund that are clearly distinguishable from the provisions of the Incentive Trust Deed, the ownership in equity of the contribution paid by the employer to the superannuation fund remained with the contributor until an employee was nominated as a beneficiary of the fund and the nomination was accepted after payment of a qualifying contribution. His Honour stated at 437-438 [69]: "The fact is that unless and until any person became a member (and this did not happen until the later year of income) it simply was not correct to say that Walstern had made a contribution to a fund for the benefit of a person who was an eligible employee. It remained within the power of Walstern to have the contribution repaid to itself as owner in equity of the money, unless it took the further step of nominating a person as a member." 50 The Incentive Trust Deed and the $15 million contribution to the trust fund stand in a quite different position. It did not remain in the power of Spotlight to have the contribution repaid to itself as owner in equity of the contribution. Rather, its right was to a loan back to it of $14.8 million and to have the Incentive Trust Deed administered by Spotlight Incentive in accordance with the terms and conditions set out in the Deed. Further, if it be relevant, there is no question of a beneficiary having to nominate or pay a qualifying contribution to become a member of the fund. Rather, the fund is for the benefit of each of Spotlight's employees, subject only to the discretion under cl 10 being exercised in favour of the employee by a payment being made to an employee who, in the opinion of Spotlight Incentive, fulfilled the criteria in cl 10 of the Deed. In the circumstances no question of uncertainty, vagueness, contravention of a rule of law or equity or of a resulting trust arises. 51 Accordingly, the Incentive Trust Deed established a valid discretionary trust and when the contribution of $15 million was paid by Spotlight to Spotlight Incentive on 30 June the legal and equitable ownership of the sum paid passed from Spotlight to Spotlight Incentive in its capacity as trustee of the Incentive Trust. 52 I turn next to consider the Commissioner's contention that the contribution is of capital or of a capital nature. The principles to be applied in determining whether an item is of a capital nature are well settled. They were summarised in the joint judgment of Sundberg and Merkel JJ in United Energy Ltd v Commissioner of Taxation (1997) 78 FCR 169 ("United Energy") at 191-192: "The classic formulation of the matters to be taken into account in determining whether an outgoing is of a capital nature is that of Dixon J in Sun Newspapers Ltd and Associated Newspapers Ltd v Commissioner of Taxation (Cth) (at 363): 'There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.' More recently the High Court in GP International Pipecoaters Pty Ltd v Commissioner of Taxation (Cth) (1990) 170 CLR 124 at 137 said: 'The character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by the making of the expenditure, for the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of … what is paid. …' In Mount Isa Mines Ltd v Commissioner of Taxation (Cth) (1992) 176 CLR 141 at 149 the High Court, after citing this passage from GP International Pipecoaters, emphasised the importance of characterising the expenditure by reference to the advantage sought by the making of the outgoing rather than the purpose served by the outcome achieved as a result of the outgoing having been made. In Hallstroms Pty Ltd v Commissioner of Taxation (Cth) (1946) 72 CLR 634 at 648 Dixon J said: '… What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.' Lord Pearce, delivering the judgment of the Privy Council in BP Australia Ltd v Commissioner of Taxation (Cth) (1965) 112 CLR 386 at 394-395, accepted as a 'valuable guide to the traveller in these regions' the judgment of Dixon J in Sun Newspapers Ltd, but recognised that the line of demarcation between revenue and capital is '…sometimes difficult indeed to draw and leads to distinctions of some subtlety between profit that is made 'out of' assets and profit that is made 'upon' assets or 'with' assets.' His Lordship said that the observation of Viscount Radcliffe in Commissioner of Taxes v Nchanga Consolidated Copper Mines Ltd [1964] AC 948 at 960 that the demarcation between 'the cost of creating, acquiring or enlarging the permanent (which does not mean perpetual) structure of which the income is to be the produce or fruit and the cost of earning that income itself or performing the income-earning operations' was 'as illuminating a line of distinction as the law by itself is likely to achieve'. His Lordship observed (at 397): '… Although the categories of capital and income expenditure are distinct and easily ascertainable in obvious cases that lie far from the boundary, the line of distinction is often hard to draw in border line cases; and conflicting considerations may produce a situation where the answer turns on questions of emphasis and degree. That answer 'depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process' (per Dixon J in Hallstrom's case). As each new case comes to be argued felicitous phrases from earlier judgments are used in argument by one side and the other. But those phrases are not the deciding factor, nor are they of unlimited application. They merely crystallise particular factors which may incline the scale in a particular case after a balance of all the considerations has been taken.'" 53 From a practical and business point of view the criteria stated by Dixon J in Sun Newspapers Limited v The Federal Commissioner of Taxation (1938) 61 CLR 337 at 363 ("Sun Newspapers") point to the $15 million contribution being on revenue, rather than capital, account. The contribution was made as part of the restructuring of Spotlight's annual employee bonus scheme by implementing the Post-1997 Scheme as from 1 July 1997. The advantage sought by the contribution was securing the prepayment of bonuses so as to obtain the trust and confidence of Spotlight's employees from year to year in the Post-1997 Scheme, which was expected to yield improved staff retention rates, lower staff turnover and improved staff morale, efficiency, productivity and loyalty. The incentive given to staff by the Post-1997 Scheme was expected to result in the enhancement of Spotlight's profit for each year in which the scheme operated. That advantage did not have a lasting quality as it could only be expected to be enjoyed during each annual period in which the Post-1997 Scheme operated. That is consistent with the fact that the trust fund established by the contribution was to be diminished as each year's bonuses were paid in return for the advantage secured in respect of the year for which the bonuses were paid. 54 The manner in which the advantage was to be used and enjoyed was the maintenance, from year to year, of Spotlight's employees' trust and confidence in the Post-1997 Scheme thereby improving Spotlight's annual profitability. Thus, the advantage, being from year to year, was recurrent. 55 In so far as the contribution was concerned, the means adopted to obtain the advantage was the prepayment of the bonuses expected to become payable (by payment or being part of the employees' Reserves) over the succeeding five years, which was commensurate with the periods in which the advantage was expected to be enjoyed. The advantage was secured from year to year by part of the contribution being applied towards annual bonuses, with further contributions being required when the bonuses paid exceeded the initial contribution (and the interest earned thereon). 56 It follows from the foregoing that the purpose of the payment was transient and connected with "the ever recurring question of personnel." In that regard Dixon J, in W. Nevill and Company Limited v The Federal Commissioner of Taxation (1937) 56 CLR 290 at 306, explained why a payment to cancel the agreement to employ an additional managing director as a measure to increase business efficiency was on revenue account: "In the present case the payment of a lump sum to secure the retirement of a high executive officer may have been unusual. But it was made for the purpose of organizing the staff and as part of the necessary expenses of conducting the business. It was not made for the purpose of acquiring any new plant or for any permanent improvement in the material or immaterial assets of the concern. The purpose was transient and, although not in itself recurrent, it was connected with the ever recurring question of personnel." 57 The prepayment of future bonuses in a lump sum does not result in the contribution being on capital account. In Hancock (Surveyor of Taxes) v General Reversionary and Investment Company Limited [1919] 1 KB 25 ("Hancock") at 37-38 Lush J, in explaining why a lump sum paid to purchase an annuity as a retiring allowance was an ordinary deductible business expense, observed: "It seems to me as impossible to hold that the fact that a lump sum was paid instead of a recurring series of annual payments alters the character of the expenditure as it would be to hold that, if an employer made a voluntary arrangement with his servant to pay the servant a year's salary in advance instead of paying each year's salary as it fell due, he would be making a capital outlay." 58 The Commissioner, however, relied upon the decision of the House of Lords in British Insulated and Helsby Cables, Limited v Atherton [1926] AC 205 ("Atherton") to contend for the contrary view. In Atherton the taxpayer established a pension fund for its salaried employees who, with the taxpayer, were expected to contribute to the fund. The dispute in Atherton related to the deductibility of the substantial lump sum payment made by the taxpayer, which formed the nucleus of the fund and provided the amount necessary to enable past years of service of senior staff to rank for pension. The payment was made out of current years profits and was calculated on the basis that the sum would ultimately be exhausted when the object for which it was paid was attained. 59 The House of Lords was divided on the deductibility of the payment for income tax purposes. Viscount Cave LC (at 213-214) regarded the payment as one which was made, "not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade" and therefore considered that "in the absence of special circumstances leading to an opposite conclusion" there was very good reason for treating the expenditure as properly attributable to capital. His Lordship, in a frequently cited passage, stated (at 214): "The payment of 31,784l., which is the subject of dispute, was made, not merely as a gift or bonus to the older servants of the appellant company, but (as the deed shows) to 'form a nucleus' of the pension fund which it was desired to create; and it is a fair inference from the terms of the deed and from the Commissioners' findings that without this contribution the fund might not have come into existence at all. The object and effect of the payment of this large sum was to enable the company to establish the pension fund and to offer to all its existing and future employees a sure provision for their old age, and so to obtain for the company the substantial and lasting advantage for being in a position throughout its business life to secure and retain the services of a contented and efficient staff. I am satisfied on full consideration that the payment was in the nature of capital expenditure…" 60 Lord Atkinson and Lord Buckmaster also concluded that the expenditure was on capital account. However, Lord Carson and Lord Blanesburgh dissented, stating that the lump sum payment, being an actuarially calculated pension payment for the older employees, was indistinguishable from the payment in Hancock. Lord Carson stated (at 226): "I can find no reason for holding that a payment made to make up the contribution to a sufficient sum to enable the older servants of the company to enjoy the benefits of the pension fund brings into existence an asset or an advantage for the enduring benefit of trade and might therefore be attributed not to revenue but to capital." 61 Lord Blanesburgh observed (at 230-231): "In truth, we have here a much plainer case than that of Hancock. There the payment was made in respect of an officer who had retired. The main justification suggested for it was the protection of the company against recurrent demands. Here the payments are made on account of officials still in the service, and are made that that service may be more contented, more efficient and more prolonged. Can any higher warrant than this for the payment of any staff salary be suggested?" 62 In Sun Newspapers at 361-362 Dixon J cited the observations of Viscount Cave in Atherton: "'An asset or an advantage for the enduring benefit of a trade' is the phrase of Viscount Cave, a phrase which by constant use has become almost a formula. The elastic application which the expression should receive is illustrated from the facts in reference to which it was first used. For it was held to include the 'lasting advantage of being in a position throughout its business life to secure and retain the services of a contented and efficient staff,' which advantage a taxpayer company obtained by contributing the nucleus of a fund to pension its employees (British Insulated and Helsby Cables Ltd. v. Atherton). But the idea of recurrence and the idea of endurance or continuance over a duration of time both depend on degree and comparison. As to the first it has been said it is not a question of recurring every year or every accounting period; but 'the real test is between expenditure which is made to meet a continuous demand, as opposed to an expenditure which is made once for all' (per Rowlatt J., Ounsworth v. Vickers Ltd.). By this I understand that the expenditure is to be considered of a revenue nature if its purpose brings it within the very wide class of things which in the aggregate form the constant demand which must be answered out of the returns of a trade or its circulating capital and that actual recurrence of the specific thing need not take place or be expected as likely. Thus, in Anglo-Persian Oil Co. Ltd. v. Dale the establishment and reorganization of agencies formed part of the class of things making the continuous or constant demand for expenditure, but the given transaction was of a magnitude and precise description unlikely again to be encountered. Recurrence is not a test, it is no more than a consideration the weight of which depends upon the nature of the expenditure." 63 Similarly, in B.P. Australia Limited v Commissioner of Taxation of the Commonwealth of Australia (1965) 112 CLR 386 ("B.P. Australia") at 396-397 Lord Pearce, delivering the judgment of the Privy Council, cited the observations of Viscount Cave in Atherton and stated: "Those words are useful as an expression of general principle on prima facie indications, but the benefit in the particular case was the foundation of a fund that would endure for the whole of life of the company and provides no analogy to the present case. The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer." 64 Similar observations have been made in other cases in the United Kingdom. For example, in Tucker (Inspector of Taxes) v Granada Motorway Services Ltd [1979] 1 WLR 683 ("Tucker") at 686 Lord Wilberforce observed: "It is in this connection that so many discussions start from the well-known phrase of Viscount Cave LC in British Insulated and Helsby Cables Ltd v Atherton [1926] A.C. 205, 213: '…when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage from the enduring benefit of a trade…' These words were regarded as having quasi-statutory force until, in a later case, it was revealed that they might cover an advance more of a revenue character. So Rowlatt J. in Anglo-Persian Oil Co. Ltd. v. Dale (1931) 16 T.C. 253, 262, explained the phrase as meaning: '…a benefit which endures, in the way that fixed capital endures; not a benefit that endures in the sense that for a good number of years it relieves you of a revenue payment. It means a thing which endures in the way that fixed capital endures. It is not always an actual asset, but it endures in the way that getting rid of a lease or getting rid of onerous capital assets…endures.'" 65 See also the appeal from Rowlatt J in Anglo-Persian Oil Company, Limited v Dale (Inspector of Taxes) [1932] 1 KB 124, 138-139, 142-143 and 146. 66 In the United Kingdom payments by an employer to establish a fund for the benefit of employees have generally been held to be payments on revenue account. In explaining his approach to that issue Lord Denning MR, in Heather v P-E Consulting Group Ltd. [1973] Ch 189 ("Heather") at 217, referred to Viscount Cave in Atherton and stated: "It seems to me that the purpose of these payments was to provide an incentive for the staff, to make them more contented and ready to remain in the service of the taxpayer company, and also to help in the recruitment of new staff. They were annual payments too; all of which made them more like the annual payments in Atherton's case than the nucleus fund. They were like the taxpayer company's contribution to a cash profit-sharing scheme and to the pension fund. They were all regarded by the taxpayer company as rewards to staff for the profits they had helped to make." 67 Buckley LJ discussed Atherton at 219: "The decision in Atherton's case [1926] A.C. 205 must have turned on the character of the payments there in question as being the nucleus of a new pension fund. The annual contributions which the company was thereafter to make under the pension fund scheme were conceded to be deductible. I confess to sympathise with the view expressed by Lord Blanesburgh, who dissented in that case. He could see no difference in principle between the initial payment and the annual payments. The majority of the House of Lords, however, thought that there was such a difference, though I do not find it very easy to put a finger on any passage in any of the speeches which clearly states what the difference was. The fact that the payment was a single payment and not one of a series of recurrent payments is no doubt a circumstances to be taken into account, but cannot have been conclusive, any more than the circumstances that a payment is made by instalments or is a periodic payment of some other kind as the price of a capital asset could establish that those payments were not properly to be regarded as capital expenditure." 68 In holding that the payments to the fund established to buy shares for the benefit of employees were deductible, Buckley LJ described one of the objectives of the incentive scheme at 220 as: "…intimately connected with the day-to-day operation of the taxpayer company's business; for the goodwill of the staff was something which might change or fluctuate from day to day. The advantage to be obtained by giving the staff an incentive to greater effort is one which would depend upon the state of the taxpayer company's business from time to time and the state of the employer/employee relation between the taxpayer company and its employees from time to time. It was also an objective directly related to the profitability of the taxpayer company's business from time to time." 69 And at 222: "…in the present case the objects of this scheme were to enable this taxpayer company's business to be carried on more efficiently. They were directed to improving and maintaining the trading potential of the taxpayer company and facilitating its trading to advantage." 70 Orr LJ (at 223-224) agreed generally with the views expressed by Lord Denning MR and Buckley LJ. Similar views were also expressed concerning Atherton by Scott J in Jeffs (Inspector of Taxes) v Ringtons Ltd [1986] 1 All ER 144 at 157-159. 71 The lasting advantage found to have been secured by the "once and for all" outgoing in Atherton was the provision of the nucleus of a fund that would secure and retain the services of a contented and loyal staff throughout the taxpayer's business life. That advantage, which was to "endure for the whole of the life of the company" (see B.P. Australia at 397), may be contrasted with the advantage secured by Spotlight's contribution in the present case. The contribution was to be used to enable the payment of bonuses falling due to Spotlight's employees over the ensuing five years and was to be drawn upon and thereby diminished progressively throughout that period. Rather than the contribution being a "once and for all payment" which provided "a nucleus" for a fund supplemented by annual contributions as was the case in Atherton, Spotlight's contribution was in substitution for the annual contributions it would otherwise have had to make over the ensuing years. The Incentive Trust Fund, not having a nucleus, had to be replenished by further contributions from time to time as the need for such contributions arose. Spotlight's contribution can be fairly described as made to meet a continuous demand which must be answered out of the returns of trade (see Sun Newspapers at 362) and was enduring only to the extent that for a good number of years it was expected to relieve Spotlight of a revenue payment (see Tucker at 686). Further, as explained above, the advantage to be obtained was giving staff an incentive to greater effort from year to year and was thereby related to the profitability of the taxpayer from year to year (see Heather at 220). In summary, the $15 million contribution was to pay future, not past, annual bonus entitlements and cannot be characterised as the "nucleus" of a fund that was to endure for the whole life of the company. 72 For the above reasons, Atherton does not assist the Commissioner in the present case. Of course, as has so often been emphasised, the capital/revenue dichotomy involves questions of fact and degree. Thus, a lump sum prepayment may still fall within the Atherton principle if, in truth, it forms the nucleus of the employees' fund and, as such, provides a lasting advantage for the employer. In the present case I am satisfied that the $15 million contribution is not such a prepayment. 73 The Commissioner also sought to rely upon the decision of the Full Court in Ransburg Australia Pty Ltd v Federal Commissioner of Taxation (1980) 29 ALR 433 ("Ransburg") which concerned the deductibility under s 51(1) of the ITA Act of payments between related companies to secure "indemnity" against future liability for employees' holiday and long service leave pay. The indemnity granted to the taxpayer was in respect of the lesser of the amount specified in the indemnity agreement and the amount actually paid to the particular employee. Deane and Fisher JJ denied deductibility on the basis that the payments were on capital account. Lockhart J dissented on the basis that the payments were incurred in relation to the management of the income producing enterprise. Deane J observed at 436: "In the present case, the relevant payments neither were calculated to produce, nor did they in fact produce, any discharge or lessening of the obligation to make future payments in respect of annual and long service leave. That obligation remained, for both theoretical and practical purposes, unaffected and unimpaired by the payments. … The object for which the outgoings in the present matters were incurred was to procure for the taxpayer at some future date funds which it could apply for the purposes of its business or which could replace funds so applied. Putting to one side the question of any excess of the amounts received over the amounts outlaid, those outgoings represented matters of capital and not of revenue. They represented capital set aside to provide for revenue contingencies of the business rather than outgoings of revenue incurred in meeting such contingencies. They were not deductible pursuant to s 51 (1) of the Act." 74 The dissenting view was summarised by Lockhart J at 447-448: "What the taxpayer received as consideration for paying to Manipa the sums of $21,040 and $16,371 under the two agreements were the promises of Manipa to pay the taxpayer sums directly referable to and measured by the liabilities of the taxpayer that must accrue in the future. On any view of the matter those very liabilities must themselves be incurred in gaining or producing the taxpayer's assessable income or be necessarily incurred in carrying on its business for the purpose of gaining or producing such income." 75 As with Atherton, Ransburg is another example of the difficulty in defining a clear line in the capital/revenue dichotomy. In my view the indemnity arrangement in Ransburg has no analogy with the present case. Spotlight Incentive provided no indemnity to Spotlight in return for the $15 million contribution. Rather, it held the contribution under the terms of the Incentive Trust Deed and, unlike the position in Ransburg, the contribution effectively relieved Spotlight of the obligation to pay annual bonuses to employees until the contribution (and interest thereon) had been paid as bonuses to employees. 76 Accordingly, subject to the operation of Pt IVA, the contribution is deductible under s 51(1) of the ITA Act. Pt IVA 77 Section 177D provides that Part IVA applies to any scheme where: "(a) a taxpayer (in this section referred to as the 'relevant taxpayer') has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and (b) having regard to - (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), it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers)." 78 Section 177A(1) defines "scheme", in the absence of a contrary intention, to mean "(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and (b) any scheme, plan, proposal, action, course of action or course of conduct". 79 A "scheme" is to be read "as including a reference to a unilateral scheme, plan, proposal, action, course of action or course of conduct, as the case may be": see s 177A(3). and the reference in s 177D to "purpose" is to be read "as including a reference to the scheme or the part of the scheme being entered into or carried out by [a] person for 2 or more purposes of which that particular purpose is the dominant purpose": see 177A(5). Relevantly, for present purposes, s 177C(1)(b) provides that a reference in Pt IVA to "the obtaining by a taxpayer of a tax benefit in connection with a scheme" is to be read as a reference to: "a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out". 80 Section 177C(1)(d) provides that in a case to which s 177C(1)(b) applies the tax benefit is "the amount of the whole of the deduction or part of the deduction, as the case may be, referred to in [s 177C(1)(b)]". 81 Section 177F(1)(b) confers power on the Commissioner to determine to cancel a tax benefit that is referable to an allowable deduction or part of an allowable deduction in relation to a year of income, that has been obtained, or would but for s 177F be obtained, by a taxpayer in connection with a scheme to which Pt IVA applies. The determination to cancel the tax benefit may relate to the whole or part of the deduction (ss 177F(1)(b) and 177F(3)(b)). 82 The making of a determination under s 177F(1) is "the pivot upon which the operation of Pt IVA turns": see Commissioner of Taxation of the Commonwealth of Australia v Spotless Services Limited (1996) 186 CLR 404 ("Spotless") at 413. However, the determination may only be made where, as a matter of "objective fact", a taxpayer has obtained a tax benefit in connection with a scheme to which Pt IVA applies: see The Commissioner of Taxation v Peabody (1994) 181 CLR 359 ("Peabody") at 382. If the taxpayer has not obtained such a tax benefit, the determination will not be valid and will not support an assessment of the Commissioner in reliance on Pt IVA. 83 The Commissioner is entitled to define the scheme upon which he relies and, in doing so, may define the scheme broadly but, in the alternative, the Commissioner may define a narrower scheme that is part of the wider scheme: see Peabody at 382. However, the Commissioner must identify the alternative scheme at a time and in a manner that does not cause unfair prejudice to the taxpayer (Peabody at 382-383) and any narrower scheme must be capable of being regarded as a scheme in its own right. The Commissioner is not permitted to take a set of circumstances and characterise them as a separate scheme if they "are incapable of standing on their own without being 'robbed of all practical meaning'" (Peabody at 383-384). As was observed by Hely J in Hart v Commissioner of Taxation (2002) 121 FCR 206 at 231 [85] ("Hart") the advantage from the Commissioner's perspective of a more narrowly defined scheme is that: "The more the scheme can be confined to the essential elements by which the tax benefit is obtained, the more likely it will be that the conclusion will be drawn that the dominant purpose for a person entering into a scheme so defined was to obtain the tax benefit." 84 In the present case the scheme relied upon by the Commissioner was: (a) the incorporation of Spotlight Incentive, the creation of the Incentive Trust, the making of the contribution of $15 million by Spotlight, the loan of $14.8 million back to Spotlight, and the course of conduct undertaken to carry out and implement those transactions; or alternatively (b) the making of the contribution and the loan and the course of conduct undertaken to carry out and implement those transactions. 85 The Commissioner submitted: "The sum of $15 million was a deduction which would not have been allowable or might reasonably be expected not to have been allowable to Spotlight Stores in relation to the 97 year had the scheme not been entered into or carried out. Accordingly Spotlight Stores obtained a tax benefit in connection with the scheme in the sum of $15 million. It is submitted that having regard to the matters listed in s 177D(b), it would be concluded that all or any of Spotlight Stores, Spotlight Stores Incentive and their respective directors and advisors entered into or carried out the scheme or a part of it for the sole or dominant purpose of enabling Spotlight Stores to obtain the deduction in the amount of $15 million in the 97 year… … Here the steps that were taken would have made 'no sense' but for Spotlight Stores obtaining the deduction in the amount of $15 million in the 97 year: (a) there was in place already a bonus scheme that the company had operated under for about 10 years without, as the result, incurring a trading loss. But in the 97 year, the effecting of the arrangements under the new scheme caused the company to have both an accounting and tax loss for the 97 year. There was no compelling reason why the company should suffer an accounting loss because the timing and amount of the payment of the bonuses would have been at its sole discretion. Yet it suffered an accounting loss as the result of the making of a lump sum payment on the last day of the income year and in the circumstances where no employee was intended to benefit under the new scheme until the following income year. Additionally, there was no objective need for the incentive trust to be placed in funds of that magnitude as evidenced by the immediate loan back to the trading trust of $14,800,000, the incentive trust retaining a mere $200,000 for its purposes; (b) there is no explanation for the interposition of the incentive trust between the trading trust and its employees other than as a receptacle for the upfront payment, thereby enabling the trading trust to claim a deduction for an outgoing which would not have been deductible if the trading trust had put the money into some special fund or investment to be used as and when required. It may be true that there was an obvious commercial objective sought to be achieved by the establishment and operation of the 'Profit Share Bonus Scheme' but that circumstance does not preclude the conclusion that the dominant purpose for doing it in the way in which it was done was to enable Spotlight Stores to obtain the deduction in the amount of $15 million in the 97 year nor is it inconsistent with it." 86 Pridecraft's responding submissions were: "However one identifies the scheme it cannot be isolated from the terms and purpose of the Incentive Trust and its place in the Profit Share Bonus Scheme. Having regard to all of the circumstances relating to the Profit Share Bonus Scheme one could not reasonably conclude that the contribution was made for the dominant purpose of enabling Spotlight to obtain a tax deduction for $15 million. In any event, it is not correct to say that the steps taken in the 'schemes' identified by the Respondent make 'no sense' but for Spotlight obtaining a deduction in the amount of $15 million in the 97 year. By making the contribution to the Incentive Trust, Spotlight irrevocably passed $15 million over to a trustee for the benefit of its employees. There is no suggestion, nor could there be, that the trust was a sham or was not established to benefit Spotlight employees. The dominant purpose of establishing the Incentive Trust and making the payment was to benefit employees with the ultimate object of increasing the profits of the business. It is not correct to say that there is no explanation for the interposition of the Incentive Trust between the trading trust and its employees other than as a receptacle for the upfront payment: the Incentive Trust had the benefit of providing security for the bonuses (including Reserves) under the Profit Share Bonus Scheme. Moreover, the Incentive Trust was one in which the objects now had rights to compel proper administration by application to the Supreme Court. To put the money into some 'special fund or investment to be used as and when required' would not have provided such security." 87 In Commissioner of Taxation v Sleight [2004] FCAFC 94 ("Sleight") a Full Court considered the operation of Pt IVA in relation to a scheme which involved a claim for an allowable deduction in respect of prepaid management fees and interest. As was pointed out by Hill J (with whom Hely J agreed) at [64]: "The first requirement of a scheme to which the provisions of Part IVA will apply is that there be obtained by the taxpayer a tax benefit in connection with the scheme. There will be relevantly a tax benefit obtained in connection with a scheme where there is a deduction allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out." 88 I have already concluded that, subject to Pt IVA, the $15 million contribution is an allowable deduction in respect of the year of income ended 30 June 1997. As a consequence of that conclusion Spotlight's taxable income for that year would be reduced to nil and the resulting loss of $3,120,635 would be able to be carried forward to be offset against future taxable income. Thus, it is clear that a tax benefit has been obtained by Spotlight. 89 Although the Commissioner has purported to define the "scheme" both broadly and more narrowly there is no practical difference between his two definitions. The reason for that is that the scheme that has been more narrowly defined as the course of the conduct that implemented the $15 million contribution and the loan back of $14.8 million would be "robbed of all practical meaning" if those transactions were considered without regard to each of the steps described in the broader definition. In any event, the course of conduct that implemented the two transactions includes each of the steps described in the broader definition. Neither party contended that the Profit Share Scheme, pursuant to which employees' bonuses were to be applied to the subscription of redeemable units in the Spotlight Trading Trust, should be considered to be part of the relevant "scheme" for the purposes of PtIVA. 90 Accordingly, it is appropriate to consider the Commissioner's Pt IVA case by reference to his broader definition, which is clearly capable of constituting a "scheme" for the purposes of Pt IVA. However, I agree with Pridecraft's submission that, however the "scheme" is identified, it cannot be isolated from the terms and purpose of the Staff Incentive Trust and its place in the Post-1997 Scheme. 91 It must follow that Spotlight has obtained a tax benefit in connection with the broader scheme defined by the Commissioner, which I will refer to as "the Pt IVA Scheme". The remaining question is whether, having regard to the eight matters set out in s 177D(b), Spotlight, acting through its directors Messrs Fraid and Fried, entered into or carried out the Pt IVA Scheme for the purpose of enabling it to obtain a tax benefit in connection with that scheme. Although s 177D enables the Court to look beyond Spotlight and its directors I am satisfied that there is no need to do so because, for the purposes of Pt IVA, the matter can be resolved by reference to Spotlight's purpose. 92 The evidence clearly establishes that Spotlight had both a commercial purpose and a purpose of obtaining a tax benefit in connection with the Pt IVA Scheme. Accordingly, the real contest between the parties is whether obtaining the tax benefit was the dominant purpose (see s 177A(5)). In Sleight Hill J at [67], citing authority, stated a number of propositions that can be taken as decided regarding the manner in which the Court is to determine a person's purpose in a Pt IVA case: "1 Part IVA does not authorise consideration of evidence of the subjective purpose or motivation of a particular person. The subjective state of mind of a person is not a matter listed in s 177D(b) to which regard may be had. Rather the section requires consideration of the eight matters listed in s 177D(b) and no other matters. The subjective state of mind of a person is not such a matter. Hence the section seeks to establish the conclusion which would be reached by reference to what may be referred to as objective factors, that conclusion being however, a conclusion as to the purpose of a person who entered into or carried out the scheme … 2 The reference to dominant purpose in a case where more than one purpose is present is a reference to the 'ruling, prevailing or most influential' purpose … 3 The conclusion as to dominant purpose may be reached not only with respect to the dominant purpose of the taxpayer, it may be reached by reference to the dominant purpose of any other person or persons so long as they are persons who entered into or carried out the scheme or any part of it … Likewise, the purpose of an adviser may be attributed to the taxpayer in an appropriate case … 4 It is possible to arrive at the conclusion as to purpose by making a global assessment of the facts, so long as it is clear that the relevant eight factors are taken into account … 5 Some of the eight factors (there is clearly some overlap among them) may point one way, others may point in the opposite direction, and some may be neutral: it is the evaluation of these matters, alone or in combination, some for, some against, that s 177D requires in order to reach the conclusion to which s 177D refers … 6 There is no inconsistency between a finding that the purpose of a person lay in the pursuit of commercial gain in the course of carrying on a business and a finding that the dominant purpose was to enable the relevant taxpayer to obtain a tax benefit …" 93 In Commissioner of Taxation v Mochkin (2003) 127 FCR 185 at 199 [45] and [49] Sackville J (with whom I and Kenny J agreed) observed that: "…the question of dominant purpose is usually to be determined by reference to the time when the scheme is entered into, although there may be cases where the purpose can be tested while the scheme is still being carried out: Vincent v Commissioner of Taxation (Cth) (2002) 124 FCR 350 at 372-373; 193 ALR 686 at 707 [93] per curiam." And: "…this Court has recognised that Pt IVA must be applied having regard to the reality that the tax laws affect the shape of nearly every transaction. Accordingly, the form of the transaction may be tax driven, yet the scheme giving rise to the transaction may be one to which Pt IVA does not apply. As Hill J observed in Hart, at 221 [43]-[44]; 4,619 [43]-[44], it is permissible to take into account the commercial outcome of a transaction, at least where the outcome has nothing to do with tax, even though the form of the transaction is tax-driven and generates a tax benefit for the relevant Taxpayer. It follows, as Hely J noted in the same case (at 230-231 [83]; 4,626 [83]), that drawing the line between commercial transactions that are and are not caught by Pt IVA is a matter of degree having regard to the eight factors specified in s 177D(b). See too Eastern Nitrogen, at 49-50, per Carr J." 94 I turn to consider each of the eight factors set out in s 177D(b). 1. The manner in which the Scheme was entered into or carried out 95 The Pt IVA Scheme was entered into and carried out between 27 and 30 June 1997 by the incorporation of Spotlight Incentive, the establishment of the Incentive Trust, the payment of the $15 million contribution and the loan back of $14.8 million in accordance with the terms of the loan agreement. Each of the above steps was carried out in accordance with the resolutions passed by the directors of Spotlight and Spotlight Incentive and the documentation executed by the parties. 96 In August 1998 a debenture was granted by Spotlight to Spotlight Incentive to secure repayment of the $14.8 million loan. I do not regard anything as turning on the delay in executing the debenture because one of its main purposes was to secure payments of amounts in the "Reserve" accounts of the employees, which only came into existence in August 1998. 2. The form and substance of the scheme 97 When considering the substance, as opposed to the form, of the Pt IVA Scheme it is appropriate to consider the role of the Pt IVA Scheme in implementing the Post-1997 Scheme. As explained above, the Pt IVA Scheme established, and cannot be isolated from the implementation of, the Post-1997 Scheme. Thus, to the extent that aspects of the Post-1997 Scheme's implementation (including events occurring after 30 June 1997) can throw light on Spotlight's purpose, viewed objectively, in establishing or carrying out the Pt IVA Scheme between 27 and 30 June 1997 it is appropriate to consider those matters. Of course, if later occurring events were unexpected they would be unlikely to throw any light on Spotlight's purpose as at 30 June 1997. That does not appear to be an issue in the present case as the later occurring events relied upon by the parties were the expected or intended results flowing from the carrying out of the Pt IVA Scheme. 98 Considering implementation of the Pt IVA Scheme in that broad manner in the present case is consistent with the view contended for by Pridecraft that a consideration of the Pt IVA Scheme solely by reference to its implementation prior to 1 July 1997 would deprive the scheme of all practical meaning. The reason for that is that the implementation prior to 1 July 1997 involved an entirely discretionary scheme with no entitlements accruing to any employees unless and until bonuses were declared to be payable to them. Plainly, in those circumstances, there would be some difficulty in justifying the prepayment of $15 million of bonuses in support of the scheme unless the substance, as opposed to the form, suggested that those entitlements would accrue as such in due course in a practical, if not a legal, sense. 99 The Pt IVA Scheme was, in substance, part of the remodelled Post-1997 Scheme which was to provide a more focused incentive to Spotlight's employees by offering to pay them annual bonuses out of Spotlight's profits as a reward for their efficiency, productivity and loyalty. However, the trust and confidence of Spotlight's employees in their employer and its administration of the Pt IVA Scheme was critical to securing Spotlight's objectives. The measures taken by Spotlight to secure that trust and confidence reveal certain aspects of the substance of the Pt IVA Scheme that departed from its form. 100 First, the substance of the Pt IVA Scheme was that employees were entitled to annual bonuses calculated in accordance with the Post-1997 Scheme. However, under the terms of the Incentive Trust Deed all bonus payments were in the discretion of the trustee, Spotlight Incentive. Also, although employees were to have "Reserve" accounts established in respect of their deferred annual bonuses, apart from recording the amounts in each employee's Reserve account, no such accounts were separately established. I do not, however, regard those factors as pointing away from a commercial purpose. Rather, they suggest that the directors of Spotlight and Spotlight Incentive wished to retain an overriding discretion as to how the Pt IVA Scheme might work, particularly if unforeseen or unexpected circumstances occurred. Further, notwithstanding the departure between form and substance, the scheme was administered on the basis that the employees were entitled to the bonuses they ultimately received, including bonuses that were payable out of their Reserve accounts. 101 Second, if the Pt IVA Scheme was to achieve its objectives it had to be perceived by the employees as an incentive to them to be efficient, productive and loyal. Thus, the manner and extent to which they were informed of the scheme can throw light on its purpose. Although employees were informed of the complex calculations that would determine their annual entitlements they were not informed of the establishment of the Incentive Trust or of the $15 million contribution. Rather, when managers and other Spotlight staff attended the August 1997 conference, at which they were informed of the details of the Pt IVA Scheme, they were merely informed that Spotlight had started a "Bank with approximately a $1,000,000". They were also informed that their Reserve accounts would accrue from year to year as the "Bank Balance". That information was provided to them in an overhead slide and in a document they were given. In their affidavits Messrs Fraid and Berry state that the employees were also told that a "few years" bonuses had been paid into a separate fund. But, in his evidence before the Court Mr Fraid, when asked what employees were actually told, stated: "We said 'funds for the future'. It was couched in general terms." 102 In the light of that answer I am not prepared to find that Spotlight's employees were informed in any meaningful sense that a trustee and a separate trust fund had been established or that any contribution exceeding $1 million had been made to secure the employees' entitlements under the Pt IVA Scheme. I would add that I do not accept that the mere fact that employees signed Tax File forms or received group certificates in respect of Spotlight Incentive meant that they knew about, or were informed of, the existence and operation of the Incentive Trust. The discrepancy between the information provided to employees about Spotlight's contribution to Spotlight Incentive and the contribution actually made is significant as it suggests that, viewed objectively, Spotlight's commercial purpose of providing an incentive to its employees and of obtaining their trust and confidence in the scheme did not require and was not aided by its employees being informed of the separate trust fund or of the $15 million contribution to that fund. Rather, the evidence suggests that that purpose was able to be served by an explanation to the employees of their entitlements and, putting it at its highest for the taxpayer, the statement that Spotlight had started a "Bank" with "approximately $1,000,000 injection". The clear implication is that, to extent that more than $1 million was paid when the Pt IVA Scheme was carried out, the payment was not made in pursuance of the commercial purpose described above but, rather, was made in pursuance of some other purpose. 103 However, contrary to the submissions of the Commissioner I do not regard the establishment of the Incentive Trust, without more, as pointing to a tax, rather than a commercial, purpose. Employees were informed that $1 million had been set aside by Spotlight for the purpose of securing bonuses. It was integral to the commercial success of the Pt IVA Scheme that entitlements, including those in the "Reserve" accounts of employees, would be paid. The establishment of a separate vehicle, such as a trust, as a means by which to ensure and secure payment, at least of the "Reserve" entitlements, is one way in which the Pt IVA Scheme's commercial objectives were able to be achieved. 104 Third, the Incentive Trust and the $15 million contribution were expected to ensure that sufficient funds were available to pay amounts due as annual bonuses (whether payable or deferred) to employees up to at least August 2001. However, annual bonuses were not due until they were declared and paid as a consequence of the profits earned in the preceding year. Spotlight's substantial business together with the fact that the bonuses were payable as a percentage of those profits suggest there was no real risk of default. In any event, the evidence did not suggest that there were any expected future liquidity problems that made the prepayment of five years' annual bonuses an appropriate measure. The main commercial purpose of any prepayment to the Incentive Trust, and of the Debenture, was that they would secure the amounts accruing from time to time in the employees' "Reserve" accounts. Mr Fraid's oral evidence was to that effect. Although those amounts were expected to become substantial over time they fell well short of the $15 million contribution. For example, the "Reserves" totalled $377,058 in August 1998, $815,931 in August 1999 and $3,118,095 in August 2000. The projected payments into the "Reserves", based on the five year profit projection made as at 30 June 1997, would not have resulted in the amounts in the "Reserves" from time to time approximating a sum that substantially exceeded the actual figures referred to above. The discrepancy between the amounts required to secure payment of the "Reserves" and the contribution made also points to a purpose other than a commercial purpose. 3. The time at which the scheme was entered into and the length of the period during which the scheme was carried out 105 The Pt IVA Scheme was entered into and carried out between 27 and 30 June 1997. The Post-1997 Scheme commenced as from 27 June to 30 June 1997 and has continued since that date. However, the time at which the Pt IVA Scheme was entered into points strongly to a purpose of obtaining a tax benefit. While it was consistent with Spotlight's commercial purpose for the Post-1997 Scheme to operate as from 1 July 1997 there was no commercial or legal reason why it needed to be in existence on 30 June 1997 or at any other time prior to its announcement to employees in August 1997. In that regard it is relevant to note that the Pt IVA Scheme was discretionary, was not announced to employees until the August 1997 conference and, in so far as it related to bonuses due in respect of the year to 30 June 1997, those bonuses were to be calculated under the Pre-1997 Scheme and paid without any deduction on account of the employees' Reserve. The timing of the Pt IVA Scheme therefore points towards a purpose of obtaining a tax benefit. 4. The result in relation to the operation of the ITA Act that, but for Pt IVA, would be achieved by the scheme 106 The result is a $15 million allowable deduction to Spotlight in respect of the year of income ended 30 June 1997. That deduction reduced Spotlight's taxable income for that year to nil and enabled it to carry forward, as a loss against future taxable income, the sum of $3,120,635. Plainly, the result provided Spotlight with a substantial tax benefit. 5. Any change in Spotlight's financial position that has resulted, will result or may reasonably be expected to result, from the scheme 107 The financial outcome reasonably expected to result from the Pt IVA Scheme was the improved profitability of Spotlight. That outcome points to the commercial purpose claimed by Spotlight. Spotlight's prepayment also effectively relieved it from any obligation to pay annual bonuses to its employees for at least 5 years. 108 However, the cost to Spotlight of the prepayment was offset by $14.8 million being lent back to Spotlight leaving it out of pocket only in the sum of $200,000. While Spotlight was to pay interest at a commercial rate on the loan that factor was neutral as the interest was to be capitalised until paid together with Spotlight's repayments of the loan in order to enable Spotlight Incentive to pay annual bonuses due to Spotlight's employees. To the extent to which the payment of interest was applied to the payment of bonuses Spotlight was relieved from paying the bonuses. Thus, as a result of the loan back agreement the actual cost to Spotlight of the scheme was minimal. 109 Further, the loan back agreement suggests that there was no objective need for the Incentive Trust to be placed in significant funds. That is confirmed by the fact that payments of most of the bonuses were ultimately made by Spotlight in the form of repayments of the loan and, to a lesser extent, interest. Pridecraft contended that Spotlight would not part with $15 million of its funds to obtain a tax benefit. The contention, however, fails to recognise that the funds were immediately lent back and the loan repayments were to be applied to discharge Spotlight's obligation to pay the bonuses to its employees. 110 Although the resolution of Spotlight's directors that was passed on 30 June 1997 records that the contribution is being made in the context of the successful year Spotlight was "enjoying" and "had experienced" the contribution resulted in Spotlight making an accounting loss for the year in the sum of $5,331,845 and in it having a net deficiency in trust funds of $5,331,645. The loss and deficit came about because of the magnitude of the contribution. Spotlight's commercial purposes did not require a contribution that resulted in both a loss and a net deficiency in trust funds. It is also relevant to observe that the contribution was voluntary in that it did not discharge any existing obligation or liability of Spotlight. However, those matters lose much of their significance when balanced against the fact that, notwithstanding the loss and deficiency, Spotlight was trustee of a family trading trust that had earned substantial profits, held substantial assets and conducted a highly successful and profitable business. 6. Any change in the financial position of any person who has a connection with Spotlight, being a change that has resulted, will result or may reasonably be expected to result, from the scheme 111 This factor does not appear to be relevant to Spotlight's purpose as the only relevant changes in financial position were those that related to Spotlight. In arriving at that conclusion I have not regarded the fact that Spotlight's directors fell within the class of potential or contingent beneficiaries of the Incentive Trust as significant. As explained above, it was not a purpose of the Pt IVA Scheme that it benefit Spotlight's directors and no bonuses have been paid to them under the scheme. 7. Any other consequence for Spotlight, or any person connected with it, of the scheme having been entered into or carried out. 112 This factor does not appear to be of significance to Spotlight's purpose unless Spotlight's employees are included in the relevant class of persons. In so far as they are included, one consequence was the incentive the scheme provided to them. However, I have already dealt with that matter. Another related consequence is that their future bonus payments, at least to about August 2001, were secured by the debenture. However, putting to one side the issue of securing the Reserve accounts with which I have already dealt, as explained above the lack of any doubt about Spotlight's capacity to make such payments significantly reduces the commercial purpose one might otherwise have been discerned from that situation. 8. The nature of any connection between Spotlight and persons connected with it. 113 This factor is not of significance to Spotlight's purpose for the same reason as the preceding factor is not of significance. 114 As is apparent from the above discussion some of the factors set out in s 177D(b) point to a commercial purpose, some to a tax purpose and others are more neutral. There can be no doubt that a purpose of the Pt IVA Scheme was to secure the commercial advantages that led me to conclude that the $15 million contribution was a payment on revenue account. That purpose has again been adverted to by me in considering the factors required to be taken into account by s 177D(b). 115 However, the present case is one in which "a flurry of activity around the end of the tax year" in establishing and carrying out the Pt IVA Scheme was clearly aimed at obtaining a substantial deduction in that year: cf Hart at 227 [67] per Hill J. Further, as explained above, as a consequence of the deduction Spotlight's taxable income for the year was reduced to nil and a substantial loss was able to be carried forward for the following year of income. In addition, the following factors point to a dominant tax purpose as at 27 to 30 June 1997: · save for the tax benefit, no other commercial purpose appears to have been served by the Pt IVA Scheme being entered into or carried out by 30 June 1997; · while there was a commercial purpose for Spotlight establishing the Incentive Trust and funding the Trust in a manner that secured the employees' future entitlements to be paid out of their Reserve accounts, that purpose was not served by, nor did it require, the contribution of $15 million, or any other significant contribution, being made by 30 June 1997; · there is a large disconformity between the $15 million contribution and the quantum of any contribution that could be said to be required, or desirable, to fully achieve Spotlight's commercial purposes; · the loan back agreement covering most of the $15 million suggests that there was no objective need for the Incentive Trust to be placed in funds of the magnitude of the contribution; and · the Pt IVA Scheme was implemented by Spotlight at minimal cost to it as a result of the "round robin" loan back arrangement. 116 The factors referred to above have led me to conclude that the ruling, prevailing or most influential purpose of Spotlight in entering into and carrying out the Pt IVA Scheme between 27 and 30 June 1997 was the obtaining of a tax benefit in connection with that scheme. Accordingly, the Commissioner's Pt IVA determination is valid and supports his Pt IVA amended assessment. Penalty tax 117 As Pridecraft has succeeded in its s 51(1) objections it must also succeed in its objections to the penalty tax imposed by the Commissioner in reliance upon his s 51(1) assessments. 118 That leaves for determination the penalty tax assessed by the Commissioner in relation to Pt IVA. That penalty was assessed under s 266 and 266L. Both sections provide for a lower rate of penalty in a case where it is reasonably arguable that Pt IVA does not apply. It is common ground that in the present case penalty tax was assessed on the basis that it was not reasonably arguable that Pt IVA did not apply to the Pt IVA Scheme. It is also common ground that the test for whether "it is reasonably arguable that Pt IVA does not apply" is whether, on balance, the taxpayer's argument can objectively be said to be one that, while wrong, could be argued on rational grounds to be right: see Walstern at 443-445 [102]-[108]. Having regard to the authorities on Pt IVA I am satisfied that the present case is one in which minds might differ on the application of Pt IVA (cf Sleight at [94]). In all the circumstances I am satisfied that Pridecraft's argument that Pt IVA did not apply was "reasonably arguable". Accordingly, it is entitled to succeed in its objection to the basis on which the higher level of penalty tax in relation to the Pt IVA Scheme was imposed. The parties were agreed that if I were to arrive at that conclusion it would be appropriate for them to prepare minutes of draft orders that give effect to my conclusion. Fringe Benefits Tax 119 The Commissioner indicated that he would not pursue his FBT assessment if he succeeded in upholding his Pt IVA determination. However, as the matter was fully argued and as I have concluded that Spotlight is entitled to succeed in its FBT objection, it is appropriate that I deal with that objection on its merits. 120 The reasons for my conclusion may be briefly stated. "Fringe benefit" is, relevantly, defined in s 136(1) of the FBT Act as follows: "'[F]ringe benefit', in relation to an employee, in relation to the employer of the employee, in relation to a year of tax, means a benefit…provided to the employee or to an associate of the employee by…the employer…in respect of the employment of the employee…" 121 In Essenbourne at 643 [54] Kiefel J concluded that the definition requires that for the benefit to be provided in respect of the employment of "the employee," a "particular employee" must be able to be identified in connection with the benefit. In Walstern at 440-441 [87]-[88] Hill J agreed with Kiefel J's view. In the present case, it is clear that when the benefit (that is, the $15 million contribution) was provided it was not provided, whether to "the employee" or to Spotlight Incentive as an "associate" of "the employee", in respect of the employment of any particular employee because the employees of Spotlight were not beneficiaries of the Incentive Trust at that time. The Commissioner contended that I should not follow Essenbourne or Walstern but I am not satisfied those decisions are clearly wrong and, accordingly, propose to follow them. It must follow that Spotlight is entitled to succeed in its appeal in relation to its FBT objection. Conclusion 122 Pridecraft has succeeded in its appeal against the Commissioner's disallowance of its s 51 objections and in relation to its Pt IVA objections to penalty tax but has otherwise failed in its appeal against the Commissioner's disallowance of its objections to the Pt IVA assessment. Spotlight has succeeded in its appeal against the Commissioner's disallowance of its FBT objections to FBT and to penalty tax. In the circumstances I propose to allow the parties an opportunity to file submissions as to the costs orders that are appropriate. 123 The parties should file short minutes of draft orders setting out the orders they contend the Court should make to give effect to the conclusions at which I have arrived. I certify that the preceding one hundred and twenty-three (123) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Merkel. Associate: Dated: 24 May 2004 Counsel for the Applicants: Mr J de Wijn QC with Ms J Jacques Solicitor for the Applicants: Cornwall Stodart Counsel for the Respondent: Mr GJ Davies QC with Ms J Davies Solicitor for the Respondent: Australian Government Solicitor Date of Hearing: 30 and 31 March 2004 Date of Judgment: 25 May 2004