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02 Feb 2017 AAT upholds Commissioner’s decision to take account of $4.3m worth of additional distributions

Carioti v Federal Commissioner of Taxation [2017] AATA 62 

The AAT upheld the Commissioner’s decision to take account of $4.3 million of additional distributions that flowed to each of the applicants personally.

Background 

The applicants, Mr Carioti and Mr Spagnolo work together on property development projects. Since working together, they have been jointly involved in about 25 property investment and development projects, either on their own account or with other investors. They generally adopt the practice of establishing a new unit trust for each new project and, usually, incorporating a company to act as the trustee for each new project. They refer to their companies collectively as the ‘Brenex Group’. The other applicants were Mrs Carioti and Mrs Spagnolo. 

In relation to Brenex Group’s financial arrangements, Mr Spagnolo started borrowing money from family members and close family friends to help finance some of the projects he and Mr Carioti were involved in. The amounts he borrowed would range between $100,000 and $300,000 at a time. According to Mr Spagnolo, the borrowings were generally at interest but the arrangements were rarely in writing. 

In 2001, Mr Spagnolo agreed to provide short-term financing for a project by a property developer to undertake a mixed residential and commercial development in Balmain. A unit trust (Darling Street Balmain Unit Trust) was established, with one of the applicants’ entities, Flurrie Pty Ltd (Flurrie) as its trustee. Mr Spagnolo decided that the company in the best position to lend money to Flurrie was Sine Two. He identified that Sine Two’s own financial position would be at risk if Flurrie could not repay the loan in full.  

The Balmain project was not as successful as everyone had hoped. The prices achieved were well below expectations, with the proceeds not even covering the full amount that was owed by Flurrie to the builders and the principal lender, Perpetual. 

Following the Commissioner’s audit of the tax affairs of the applicants and their associated entities, an amended assessment was made in relation to one of those entities, a unit trust called Percival Road Unit Trust (PRUT), for the 2007 income year. The amended assessment reflected the disallowance of a $4.3 million capital loss which the Commissioner concluded, and the applicants accept, was not incurred by the PRUT. 

As a consequence, the PRUT had an additional $4.3 million available for distribution to its unit holders. That amount was distributed as to 50% to a discretionary trust controlled by Mr and Mrs Carioti and as to 50% to a discretionary trust controlled by Mr and Mrs Spagnolo. From those discretionary trusts, distributions flowed to each of the applicants personally. 

Each of the applicants objected against their amended assessment and against the assessment of penalty. They claim their respective discretionary trusts are entitled either to a deduction, or to a capital loss, equal to the amount of additional income attributed to it. The applicants claim that each of their trusts guaranteed a loan which the borrower became unable to service, and that the lender called on the guarantors to cover the outstanding loan amount. 

The Commissioner did not accept the applicants’ claims and disallowed each of the objections. 

Issue 

The dispute between the applicants and the Commissioner was centred on the following questions: 

  • Did Sine Two lend money to Flurrie between 2003 and 2007, and if so, how much did it lend?
  • Did Mr & Mrs Spagnolo and Mr & Mrs Carioti guarantee any debt owed by Flurrie to Sine Two?
  • Was Flurrie unable to repay the debt, and if so, did Sine Two write off the debt and call on the guarantee by Mr & Mrs Spagnolo and Mr & Mrs Carioti?
  • If so, did R & A Spagnolo and M & F Carioti satisfy their obligations as guarantors?
  • What, if any, are the tax implications? 

To support their claim that Sine Two lent money to Flurrie, the applicants relied on a Loan Agreement dated 30 June 2003 recording the agreement of Sine Two to advance to Flurrie a sum not exceeding $5 million, for three years, at an interest rate of 10% per annum, an acknowledgment of debt and a Deed of Guarantee.

Decision

The AAT upheld the Commissioner’s decision to take account of the additional distributions based on the absence of a notice of claim. In that absence, the Tribunal found Sine Two did not at any stage formally require the guarantors to perform whatever obligations were thought to have been created by the Deed of Guarantee.

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