The taxpayers accepted the findings of the Full Federal Court and abandoned any claim that their expenses were deductible, but they objected to the imposition of penalties under the former ss 224 and 226L. Those sections empowered the Commissioner to impose penalties where deductions were claimed in respect of a "tax avoidance scheme" and none of the specific tax avoidance provisions of the Act applied. The term "tax avoidance scheme" was defined in s 224(2) to mean "a scheme within the meaning of Part IVA that was entered into or carried out for the sole or dominant purpose of enabling a person to pay no tax or less tax".
Before the AAT, the taxpayers gave uncontested evidence that their purpose (and that of their advisors) in entering into the scheme was to obtain a commercial return. While tax benefits were relevant, they were not the sole or dominant purpose. The AAT rejected this evidence, holding that s 224(2) did not involve an inquiry into the subjective purposes of the taxpayers concerned. On appeal to the Federal Court, the taxpayers submitted that the AAT had erred in law in rejecting their subjective purposes. French J agreed.
French J said, at para 52:
"It is to be recalled that s 226L was a penalty provision. The fact of entry into a tax avoidance scheme was a necessary condition of the imposition of the penalty for which it provided. If the purpose of penalties is to secure compliance with the tax laws, they may ordinarily be expected to be concerned with the conduct and purposes of defaulting taxpayers. That is to say their actual conduct and actual purposes. It is difficult to see why if two constructions of s 224(2) be available that construction should be adopted which would permit the imposition of a penalty by reference to a purpose which the taxpayer never had. Of course, purpose could be assessed even under s 224(2) by reference to objective factors. It may also be that the statements of individual taxpayers about their purposes relevant to the imposition of penalty would be given little weight. But the relative weight and extent of subjective and objective evidence relevant to that determination will be an accident of the particular proceedings in which the question arises. In this case the evidence of the taxpayers and the advisors was unchallenged."
French J held that there was no point in remitting the matters to the Tribunal as the evidence about the taxpayers’ actual purposes in entering the schemes was not contested by the Commissioner. Accordingly, he set aside the decisions of the Tribunal and allowed the taxpayers' objections: Starr v FCT  FCA 23 (Federal Court, French J, 23 January 2007).
For a copy of the decision, go here
TAXVINE NOTE: The penalty provisions relevant to this appeal were to be found in Pt VII of the ITAA. By operation of s 222AA it does not apply to "statements made, or schemes entered into, in relation to the 2000-01 year of income or a later year of income". It has been replaced by Div 284 of Schedule 1 of the Taxation Administration Act 1953 (Cth). The latter provisions are materially different from those considered in the appeal, and impose an objective test in determining the purpose for which a "scheme benefit" was obtained.