The recent Federal Court decision of Rowntree v FCT [2018] FCA 182, (Rowntree) dismissing the taxpayer’s appeal, considered whether amounts received by the taxpayer were income rather than loan receipts.  In Rowntree, the taxpayer unsuccessfully argued his ‘genuine belief’ of the nature of the relevant transactions with his related companies (Companies) was enough considering the lack of other contemporaneous evidence to objectively show there were loan arrangements in place and payments made to him were pursuant to those arrangements.

Tribunal decision

Rowntree was an appeal from a Administrative Appeals Tribunal decision.

In its decision, the Tribunal found that other than in respect of two receipts in the 2013 income year for $1,000,000 and $80,000 respectively (see our further discussion, below) the taxpayer did not discharge the onus of proof that the tax payable under the four income tax assessments for the 2010, 2011, 2012 and 2013 income years was excessive on the basis that the receipts of money were loans to him from the Companies and not income in his hands.  The total amount received and assessed as income over the four income years was $4 million.

The Tribunal disagreed with the taxpayer’s assertion that it was enough that he, as sole director of some and controlling mind of all Companies believed the amounts in question were loans, finding that for him to satisfy the onus of proof he needed to produce contemporaneous, corroborative evidence (documentation) as to the characterisation of the amounts.  The Tribunal said:

“…in assessing whether the taxpayer has discharged the onus placed upon him, the existence of a loan agreement and the character of the advances in particular as to whether they are made pursuant to that loan agreement must inevitably be assessed objectively – that is according to what a reasonable person would conclude having regard to the words and actions of the parties. In this context the subjective intentions of the parties, while broadly speaking relevant, would in no way be determinative...”

In relation to the two receipts in the 2013 income year for $1,000,000 (made on 17 July 2012) and $80,000 (made on 18 December 2012), the Tribunal found they had been paid as part of a loan arrangement under a loan facility agreement made on 19 July 2012.  Even though the receipt of $1,000,000 was made prior to the date of the loan facility agreement, the Tribunal accepted it was reasonable to conclude it was part of the overall loan arrangement.

The Commissioner imposed penalties of 75% based on the taxpayer having intentionally disregarded the law. The Tribunal found the taxpayer genuinely believed that the amounts in question were loans (even if this belief was not supportable by the evidence available and was, in the end, misguided) and his behaviour was better described as reckless.  On this basis, the Tribunal decreased the penalty from 75% to 50%.

Court decision

The Court reviewed three purported loan arrangements considered and analysed by the Tribunal (the two identified receipts in the 2013 income year related to the third of these arrangements).  The taxpayer sought to argue that once the Tribunal had found he genuinely believed the receipt by him of the amounts under each of the arrangements were loans, as sole director of most and controlling mind of all of the Companies involved in the transactions, that was enough to challenge the Tribunal’s finding the amounts were income in his hands.

The Court found there was no reason to accept or reject a party’s evidence about past events just because that evidence could be seen as self-serving but did state in those circumstances the decision-maker should approach assessment of that evidence with caution.  As noted above the Tribunal had found whilst the subjective intentions of the parties are relevant but not determinative.  Determination of the rights and liabilities of the parties to a contract did not involve the parties’ subjective beliefs or understanding of their rights and liabilities but requires an objective assessment of the statement of affairs between the parties.

The Court considered the application of section 198E(1) of the Corporations Act 2001 (Corporations Act) and concluded that although a sole director/shareholder may exercise all powers of a company, the Corporations Act is silent on how exercise of these powers is to be evidenced.   In any case, the Court noted there were ongoing obligations on a company to keep written financial records of its transactions and financial performance to enable preparation of true and fair financial statements (see also section 286(1)).  Where there is no document recording an alleged contract, there must be an examination of the acts and conduct relied on in the context in which they occurred to ascertain whether objectively they evince a contract.

The Court then considered section 109N(1) of the Income Tax Assessment Act 1936  and the taxpayer’s argument that because the section envisaged a loan agreement could be made after the end of the year of income that evidenced transactions during that year of income that evidenced transactions during that year, the Tribunal could have accepted his post-dated agreements which he sought to rely.  The Court noted that this was not the issue: the question for the Tribunal was whether the taxpayer could satisfy it that his challenged receipts were loans and not income.  The Tribunal had found the taxpayer had a ‘highly subjective view of whether a loan existed’ in respect of the relevant receipts which was not supported by an objective view of the facts. 

The Court concluded whilst the taxpayer may have (genuinely) believed the challenged receipts were loans he failed to satisfy that this belief had any sufficient objective support from his conduct at the time of the relevant transactions to prove he had contracted with the Companies to borrow and repay the money he received.  The Court found the loan documentation the taxpayer created subsequent to the challenged receipts (other than in relation to the two identified payments in the 2013 income year) only reflected the possibility of his borrowing in the future and did not acknowledge the happening of the previous transaction/s.  On that basis, the Court found that the taxpayer had not satisfied the onus of proof under section 14ZZK of the Taxation Administration Act 1953.

Conclusion

The Court’s decision is the latest in a long line of cases confirming yet again the weight placed on the taxpayer under section 14ZZK to satisfy the onus of proof in disputed tax matters.  But this decision also includes important discussion and consideration of what is required to prove, objectively, that parties have entered into a formal arrangement (here, a loan arrangement in satisfaction of Division 7A).  In our view the decision has wider implications for any formal arrangement entered into by related and unrelated parties.  Leading evidence that assumes the existence of a formal arrangement is not enough without also being able to prove its existence.

To discuss this article, or for any further information please contact:

Sam Campbell
Associate | Business Law
Sladen Legal
M +61 423 515 454 | T +61 3 9611 0135
Level 5, 707 Collins Street, Melbourne, 3008, Victoria, Australia
scampbell@sladen.com.au

Neil Brydges
Special Counsel | Accredited specialist in Tax Law
Sladen Legal
M +61 407 821 157 | T +61 3 9611 0176
Level 5, 707 Collins Street, Melbourne, 3008, Victoria, Australia  
nbrydges@sladen.com.au