29 Oct 09 Part IVA deduction case remitted to AAT - Trail Bros
The Federal Court (Greenwood J) has upheld the Commissioner's appeal from the decision of the AAT, that set aside a decision of the Commissioner to deny the taxpayer a deduction for payments made to an Employee Welfare Fund (the Fund), that is, a fund established for the benefit of its employees.
The payments were made to the Fund following a change in the law limiting the amount of deductible contributions that could be made to a superannuation fund. The taxpayer company was contractually bound to pay superannuation contributions in excess of the limits to 2 of its employees (Mr Mark Trail and Mr Allan Trail), being 2 of the 3 founders of the business subsequently purchased by the taxpayer company (in which they held a majority interest). The evidence for the taxpayer was that an agreement was reached with the 2 employees to vary the terms of their employment contracts with the company, such that the superannuation contributions required to be made by those agreements would, instead, be made to the Fund.
After finding the payments deductible under s 51(1) ITAA 1936 and s 8-1 ITAA 1997, the AAT rejected the application of Part IVA on the basis that there was no tax benefit. The AAT held that had the scheme not been entered into, and the payments not made to the Fund, the taxpayer would have discharged its obligations to the Trail brothers by making other, deductible payments in some other way ("the alternative postulate" or counterfactual required by s 177C(1)(b) ITAA 1936). However, Greenwood J held that there was "simply no evidence of the counterfactual as found" and, as such, there was an error of law in the AAT's application of the test in s 177C(1)(b).
Greenwood J said, at para 54:
"The difficulty however is that although the Tribunal formulated the correct test, it applied a different test. The Tribunal did not have before it evidence from the taxpayer of the activity it would have undertaken or might reasonably be expected to have undertaken and was thus not in a position to identify as a sufficiently reliable comparative alternate postulate, an hypothesis that the taxpayer would have discharged its obligations to each brother in a way that was fully deductible. That finding or conclusion was not supported by any evidence of activity on the part of the taxpayer that might have brought about that result. Accordingly, it seems to me that the application of the test, properly identified, miscarried by applying a test that did not investigate the strength of the evidence of the alternate postulate to test whether such an hypothesis was just a possibility or unsupported speculation or, alternatively, sufficiently reliable so as to be regarded as reasonable."
Accordingly, the matter was remitted to the AAT to determine whether there is evidence which supported an hypothesis that the taxpayer would have undertaken or might reasonably be expected to have undertaken a particular activity in lieu of the scheme and whether that activity would or might reasonably be expected to have resulted in an allowable deduction of the same kind as the deduction claimed by the taxpayer under the scheme. Greenwood J concluded, at para 61:
"If there is no evidence before the Tribunal that enables a sufficiently reliable prediction to be made of an alternate hypothesis that would or might reasonably be expected to have resulted in an allowable deduction of the kind claimed under the scheme, the hypothesis that represents a sufficiently reliable prediction of future events in the absence of the scheme, is that the taxpayer would have made payments to the Trail Bros Superannuation Fund of amounts equal to the age-based limits under the Act on behalf of each brother, and no sufficiently reliable prediction can be made as to the course of conduct that would or might reasonably be expected to have been adopted as to the balance payments due under the contracts except that no payments beyond the age-based limits would have been paid into the Trail Bros Superannuation Fund."
FCT v Trail Bros Steel & Plastics Pty Ltd  FCA 1210 (Federal Court, Greenwood J, 28 October 2009).
For a copy of the decision, go here