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11 Jun 14 Taxpayer properly assessable on equitable compensation - Howard

The High Court has unanimously dismissed the taxpayer’s appeal from the decision of the Full Court of the Federal Court in the Howard case. The Full Court had decided that the taxpayer was assessable on two amounts received by him in successive income years, namely, his share of an award of equitable compensation received in satisfaction of a judgment, and a distribution from a non-resident trust estate. The Full Court decision is Howard v FCT [2012] FCAFC 149.

The taxpayer appealed by way of special leave to the High Court in relation to the amount of equitable compensation only.

The taxpayer was a director of Disctronics Ltd. In his income tax assessment for the 2005 income year, he did not include, as part of his assessable income, his share of an award of equitable compensation received in satisfaction of a judgment in proceedings in the Supreme Court of Victoria. Those proceedings concerned a joint venture, of which the taxpayer was a member, involving the purchase, lease and on-sale of a golf course. Whilst the joint venture was on foot, the taxpayer and two other directors of Disctronics, who were also members of the joint venture, endeavoured to have Disctronics become the purchaser of the golf course, although two other members of the joint venture did not agree. Subsequently, the two other members of the joint venture diverted to their own use the business opportunity pursued by the joint venture and, in so doing, were found to have breached fiduciary duties they owed to the taxpayer and the other members of the joint venture.

The taxpayer disputed his assessment, claiming that he received the amount of equitable compensation as constructive trustee for Disctronics and that it was, therefore, incorrectly included in his assessable income. He argued that from the time the directors decided to try to involve Disctronics as the purchaser, his fiduciary obligations to Disctronics as a director meant that he could not retain that gain for himself to the exclusion of Disctronics.

The Full Court of the Federal Court held that there could be no conflict of interest in the way contended for by the taxpayer, and no breach of his fiduciary duty to Disctronics. The Full Court also rejected the taxpayer’s additional claim that by a litigation agreement between Disctronics and its directors, entered into at about the time the Supreme Court proceedings were instituted, he had assigned the right to receive the amount of equitable compensation to Disctronics, such that the income was not derived by him beneficially.

The High Court held that the taxpayer did not receive the amount of equitable compensation as constructive trustee for Disctronics because, at the time the taxpayer obtained or became entitled to that amount, there was no actual conflict, and no real possibility of conflict, between his personal interests and his duties as a director of Disctronics. As to the litigation agreement, the court held that as it provided for the assignment of the taxpayer’s future income, rather than his underlying rights to receive those sums, the proceeds of the action were income in his hands. The sum received was correctly included in his assessable income.

Howard v FCT [2014] HCA 21 (French CJ, Hayne, Crennan, Gageler and Keane JJ, 11 June 2014).

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