Taxpayer and Commissioner have mixed success in employment income case - Sent
28 Mar 2011
The AAT has upheld, in part, an assessment by the Commissioner under which $11,600,000 was included in the taxpayer's assessable income, and tax shortfall penalties of 50% based on recklessness were imposed on the taxpayer. However, in so doing, $4,353,428 was excluded from the taxpayer's assessable income, Part IVA was held not to apply to the exclusion, and the reduced penalties (referable to the tax shortfall on the amount of $7,246,572 included in assessable income) were remitted to 25% based on a lack of a reasonably arguable position.
The taxpayer was the Managing Director and Chief Executive Officer of Primelife Corporation Ltd. For the three years to 30 June 2001, the taxpayer had accrued and accruing bonuses of $7,246,572 under his employment contract. Following a series of meetings leading up to June 2001, Primelife and the taxpayer agreed that bonuses accrued to date and all future bonus entitlements would be replaced with an issue of 5 million fully paid ordinary Primelife shares. The consideration for the issue of shares to the taxpayer was the discharge and abandonment of entitlements to bonuses.
Rather than issue shares, Primelife established an employee benefits trust ("the Trust"). On 21 December 2001, Primelife deposited a cheque for $11,600,000 in the Trust's bank account in respect of the taxpayer. On the same day, a cheque for $11,600,000 was drawn on the Trust’s bank account and paid to Primelife as the issue price for 5 million ordinary Primelife shares worth $11,600,000. On 23 January 2002, the Trust issued 5 million Class A units to the taxpayer for a price of $2.32 per unit or $11,600,000 in total. The units were said to vest one year from the commencement of participation in the Trust and to represent an entitlement to Primelife shares under the Trust at the time of vesting. The taxpayer was the only participant in the Trust.
The Commissioner included $11,600,000 in the taxpayer's assessable income in the year ended 30 June 2002 and imposed shortfall penalties of $2,813,000. The Commissioner contended that the amount of $11,600,000 or the market value of the shares was assessable under either ss 6-5(1) or 6-5(4) of ITAA 1997 or s 26(e) of ITAA 1936 or, alternatively, Part IVA of ITAA 1936 applied to include $11,600,000 or the market value of the shares in the taxpayer's assessable income.
The AAT held that to the extent of the bonus entitlements cancelled which were referrable to services already provided by the taxpayer, the decision in FCT v White  FCA 730 governed the outcome. The amount of $7,246,572 was assessable as income derived.
In contrast, the amount of $4,353,428 was not assessable. The AAT said, at para 60:
"Payment of some millions of dollars in advance of the services being provided would raise a presumption that if the services were not provided the amount would be repayable. Accordingly, [the] principles [in Arthur Murray (NSW) Pty Ltd v FCT  HCA 58; (1965) 114 CLR 314] would apply and the amount would not be assessable."
The AAT then turned to Part IVA in relation to the amount of $4,353,428 which had been excluded from assessable income.Although finding a scheme and a tax benefit in the said amount, the AAT held that no party to the scheme had the dominant purpose of enabling the taxpayer to obtain the tax benefit. The AAT commented at para 98:
"If this were not the approach to be adopted when considering if Part IVA could apply to any arrangement under which an employee and an employer change remuneration conditions for prospective services, from taxable salary to another form of benefit which is either not taxed under the income tax system or is taxed under the income tax system in a different way or at a different time under what are colloquially described as salary sacrifice arrangements, then such arrangements would be liable to be defeated by Part IVA."
Finally, in relation to penalties on the tax shortfall arising in respect of the $7,246,572, the AAT held that the taxpayer had not been reckless, having relied on on advice from a firm "who might be expected to have some expertise in the area, who devised the structure, and who could be presumed to be acutely aware of the relevant facts". However, the taxpayer did not have a reasonably arguable position, so tax shortfall penalties of 25% were justified.
Sent and FCT  AATA 198 (AAT, O’Loughlin SM, 25 March 2011).