Form over substance – the taxpayers' indefatigable battle

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Form over substance – the taxpayers' indefatigable battle Powered By Docstoc
					     tax cases by ambry LeGaL




     Form over substance – the
     taxpayers’ indefatigable battle
     a tax payer v commissioner oF taxation [2006] aata 980


     INTRODUCTION                                       was to be employed in the UK but could         the Australian Company pay this amount 
                                                        be required to work in other locations as      to her in two payments ($145,141.83 and
     T    here are many situations in which 
          taxpayers may not judge or characterise 
     payments received by them in the same way 
                                                        directed by the UK Company. 
                                                         From 1 October 1997 the UK Company 
                                                                                                       $203,198.56), each into a different bank
                                                                                                       account.
     as the Commissioner. The decision by the           seconded the taxpayer to Australian             The taxpayer included the amount of
     Administrative Appeals Tribunal (“Tribunal”)       company “O” (“Australian Company”) for a
                                                                                                       $145,141.83 in her tax return as an ETP, but
     in A Tax Payer v Commissioner of Taxation1         three-year period subject to change by the 
                                                                                                       did not include the amount of $203,198.56
     (“Tax Payer”) is another recent example of         UK Company. The secondment was agreed 
                                                                                                       as she considered this to be an exempt ETP.
     where a taxpayer has objected against the          upon between both the UK and Australian 
     Commissioner’s decision to characterise a          companies so that the taxpayer continued to     The Commissioner issued the taxpayer 
     payment so to include it in the taxpayer’s         be employed by the UK Company pursuant         with an amended assessment for the 2003
     assessable income. Although the decision           to the original employment contract. The       income year to include the $203,198.56
     in the Tax Payer case does not state any           taxpayer applied for and was granted           (“Amount”) in the taxpayer’s assessable
     new principle of law, it is an important case      Australian residency soon after commencing     income. The taxpayer objected to the 
     for its emphasis on, and consideration of,         her secondment with the Australian             Commissioner’s amended assessment,
     the fundamental question of form versus            Company in 1997. 
     substance.                                                                                        which he disallowed on 31 May 2005. 
                                                          On 1 April 2001 the taxpayer became          The taxpayer then sought a review of this
       In this case the Tribunal considered             an employee of the Australian Company          objection by the Tribunal which is the 
     whether payments made to the taxpayer              pursuant to letters dated 1 January 2001 
                                                                                                       subject of this case.
     as eligible termination payments (“ETP”)           and 31 January 2001. These letters 
     in relation to the taxpayer’s employment           included new terms and conditions of her       RELEVANT LEGISLATION
     both in Australia and in the United Kingdom        employment in moving to “local terms”.
     (“UK”) were correctly characterised in             Among these terms and conditions were          Section 27A of the Income Tax Assessment
     relation to her employment in each country,        that the taxpayer:                             Act 1936 (“ITAA 1936”) defines “eligible
     and therefore whether the payment                                                                 termination payment” and “exempt non-
                                                        n	 was entitled to continuity of employment
                                                           	
     arguably relating to her period of foreign                                                        resident foreign termination payment” as:
                                                           from 6 August 1990 (when she
     employment could be characterised as an 
                                                           originally commenced employment with 
     exempt non-resident foreign termination                                                              “Exempt non resident for eign termination
                                                           the UK Company) for the purposes
     payment (“exempt ETP”). The Tribunal held                                                            payment” in relation to a taxpayer, means:
                                                           of termination benefits; and
     that the taxpayer failed to substantiate that
     the payments were calculated in reference          n	 termination of the taxpayer’s                  (a) a payment made in respect of the taxpayer
     to her periods of employment in each                  employment by the Australian Company           to which the following subparagraphs apply:
     country and the entire amount should be               or the taxpayer could occur on six 
     characterised as an ETP, therefore forming            months’ notice or a termination                (i) the payment is made otherwise than
     part of the taxpayer’s assessable income.             payment in lieu of such notice.                from a superannuation fund (as defined
                                                        The taxpayer continued as an employee of          by subsection 6(1)) in consequence of the
     FACTUAL BACKGROUND                                                                                   termination of the taxpayer’s employment;
                                                        the Australian Company until she resigned 
     The taxpayer joined a UK company “W”               on 29 November 2002. Upon termination 
     (“UK Company”) as a UK resident pursuant           the taxpayer was paid $348,340.38 by the          (ii) the payment would, apart from paras (ka)
     to an employment contract dated 6 August           Australian Company (pursuant to a Deed of         and (ma) of the definition of “eligible termination
     1990. Under this contract, the taxpayer            Settlement). The taxpayer requested that          payment”, be an eligible termination payment;


468 TAXATION IN AUSTRALIA  Volume 41 No. 9 April 2007
   (iii) the employment was service in a            To satisfy section 27A(1)(a)(iv) ITAA 1936,      The Tribunal considered the Commissioner’s
   foreign country as a holder of an office or      the taxpayer had to satisfy the Tribunal that    written reasons for disallowing the
   in the capacity of an employee; and              part of the termination payment related to       taxpayer’s objection to his amended
                                                    her service with the UK Company in the           assessment. In these reasons the 
   (iv) the payment related solely to a period      UK. Therefore, it was crucial to the taxpayer    Commissioner mentioned that there could 
   of the employment during which the               that the termination payment was split by        not be separate service periods for the
   taxpayer was not a resident of Australia.        the Australian Company, as the taxpayer          purpose of calculating an eligible service
                                                    submitted that each amount constituted           period, as one could only aggregate the
The definition of “eligible termination             approximately one month’s salary for each        periods pursuant to section 27A(1)(a) which
payment” is extensive. Subsections (ka) and
                                                    year of service, based on, seven years’          states that: 
(ma) referred to above state that “eligible
                                                    service in the UK from 1990 to 1997, and,
termination payment” does not include:                                                                  “where the relevant eligible termination
                                                    five years in Australia from 1997 to 2002,
                                                    respectively.                                       payment is an eligible termination payment
   (ka) an exempt resident foreign termination
                                                                                                        by virtue of para (a) or (aa) of the definition
   payment or an exempt non-resident                 The taxpayer’s submission was not
                                                                                                        of eligible termination payment – the
   foreign termination payment;                     supported by her Deed of Settlement
                                                                                                        period, or the aggregate of the periods, of
                                                    as it did not refer to either this particular
   (ma) a payment from a fund that is an eligible                                                       the employment to which the relevant
                                                    calculation of the two payments or these
   resident non-complying superannuation fund,                                                          eligible termination payment relates;”
                                                    two distinct periods of employment.
   or an eligible non-resident non-complying        Moreover, the payments made to the               The Tribunal also considered the explanatory 
   superannuation fund, when the payment is made.   taxpayer did not equate to one month’s           memorandum2 with respect to section 
                                                    salary for each year of service and the          27A to ascertain the purposes of the
ISSUES BEFORE THE TRIBUNAL                          aggregate sum was approximately eleven 
                                                                                                     provisions particularly contained in section 
                                                                                                     27A(1)(a). However, while recognising
The central issue before the Tribunal was           months’ salary for twelve years’ service.
                                                                                                     that an employee may serve in several 
whether the taxpayer was able to satisfy             Neither was the taxpayer’s submission           companies within a group, the explanatory
the requirements contained in section               supported by other documents before              memorandum did not consider the event of
27A(1)(a)(iii) and (iv) ITAA 1936. In the           the Tribunal. An ETP payment summary             a taxpayer serving part of the eligible service
context of the taxpayer’s circumstances,            prepared by the Australian Company stated        period overseas and therefore did not
this involved consideration of the following
                                                    the aggregate sum of $348,340.38 related         provide further assistance to the Tribunal.
questions:
                                                    to an eligible service period beginning 
                                                                                                     If there was one termination payment, could
1. Was the Amount related to the taxpayer’s         1 September 1990. There was also a 
                                                                                                     the Amount be exempt?
   service with the UK Company in the UK?           document before the Tribunal that referred
                                                    to the payment in lieu of notice of eleven       The taxpayer submitted that there were 
2. Could the whole of the termination               months’ salary in accordance with the letter     two separate and distinct payments 
   payment be divided into two to                   of offer dated 1 January 2001. As was the        reflecting her employment in both the UK
   reflect periods of employment in the             case with the Deed of Settlement, there          and Australia. However, the Commissioner
   UK and Australia, respectively?                  was no reference to the UK and Australian        submitted that there was one payment 
                                                    periods of service.                              which was split into two at the taxpayer’s
3. If there was one termination payment,
                                                                                                     request.
   could the Amount be exempt?                        Email correspondence between the
                                                    taxpayer and the Australian Company and            While section 26(d) ITAA 1936, the
4. On either of the taxpayer being
                                                    within the Australian Company was not            predecessor of section 27A(1)(a), required
   seconded to the Australian Company 
                                                    supportive of the taxpayer’s submission. An      payment to be in a specified “lump sum”,
   in 1997, or, on accepting new
                                                    internal email of the Australian Company         there is no such requirement in section
   arrangements with the Australian 
                                                    dated 5 November 2002 noted that “12             27A(1)(a) as explained in the explanatory
   Company in 2001, was there
                                                    months (including the time leading up to 30      memorandum. This is supported by the 
   termination of employment?
                                                    November 2002) [was to be] treated as an         definitions of both ETP and exempt ETP in
5. Did the Taxpayer hold an “office”                ETP”, that the taxpayer was requesting the       the ITAA 1936, as neither definition prohibits
   in the UK concurrently with her                  payment be split in two and the feasibility of   the division of a lump sum for the purposes
   position with the Australian Company             doing this. A further email on 18 November       of section 27A, and also the case of Federal
   so that her employment with the                  2002 brought the date of termination             Commissioner of Taxation v Comber3 where 
   UK Company continued until the                   forward to 29 October 2002 and stated            it was held that where payment is in a 
   termination of her office?                       that the eleven month payment would              lump sum it could be constituted of several
These questions were dealt with separately          be divided in two and paid into separate         components. 
by the Tribunal.                                    bank accounts.                                   On either of the Taxpayer being seconded
Was the Amount related to the Taxpayer’s            Could the termination payment be divided         to the Australian Company in 1997, or,
service with the UK Company in the UK?              into two to reflect periods of employment in     on accepting new arrangements with the
                                                    the UK and Australia, respectively?              Australian Company within the group in
                                                                                                     2001, was there termination of employment?


                                                                                                                                                 It’s essential 469
     The Tribunal considered two competing                While the Tribunal accepted that the                based the termination payment 
     views on when termination occurs                   taxpayer did have some claim to an “office”           on eleven months in lieu of notice
     to determine whether the taxpayer’s                upon her initial secondment, this did not             in accordance with the letter of
     employment was terminated either in 1997           further her claim. Particularly as records            offer dated 1 January 2001.
     or 2001. One view was that “employment             of the Australian Company in relation to           (c) The fact that the Australian Company
     may not necessarily be terminated if the           the termination payment were such that                 rather than the UK Company made 
     employee continues to serve, though he             the payment was calculated as payment                  the payment was not fatal to the
     serves under a contract of service whose           in lieu of notice in accordance with her               taxpayer’s case as this was not a
     terms differ from the earlier contract”4.          employment terms set out in the letter of              requirement of section 27A(1).
     As a result, where a person transfers to a         offer dated 1 January 2001.
                                                                                                        2.  The eligible service period was not 
     company within the same group (as was                The Tribunal noted that the taxpayer’s            pertinent to determining whether a 
     the case here) and the person discontinues         biggest problem was that there was not a            payment was an ETP or an exempt ETP
     working under the original employment
                                                        satisfactory nexus between the potential            but was only important in calculating 
     contract, termination of employment does
                                                        concurrent holding of a UK office and               tax payable. In these circumstances,
     not occur. 
                                                        the payment. In relation to this issue, the         the Tribunal had to direct its attention 
      However, Taxation Ruling 93/140 provides a        Tribunal considered that the payments               as to whether the amount could still 
     second view that where a company makes a           must be made as a consequence of the                qualify as an exempt ETP if there
     payment and the company ceases carrying            termination of the taxpayer’s employment.           was a single termination payment. 
     on a business and transfers the business           As a result it was necessary for the Tribunal
     to an associated entity, the payment will be       to consider whether the payment was made        3. It was not fundamental whether there
     an ETP if it is made “in consequence of the        in consequence of the termination of the           was one payment or two. Rather it 
     termination of employment of the former            taxpayer’s employment with the Australian          was important to consider “whether
     employee”5. This argument affirms Taxation         Company or partially in consequence of the         the amount claimed was for service
     Ruling IT 2152 which considers that ”where a       termination of the taxpayer’s employment           in a foreign country and paid solely
     company or other employer ceases carrying          or office with the UK Company. For the             in connection with a period when the 
     on a business which has been transferred to        payment to be made in consequence of any           taxpayer was not a resident of Australia”.
     another associated entity, it will be accepted     or all of these events, a causal connection     4.  The Tribunal held that the only time 
     that the employees of the company have             between the termination and payment                 the taxpayer’s employment was
     been terminated”.                                  needed to be established6.                          terminated was on 29 November 
      After examining these views, the Tribunal                                                             2002. The termination payment 
     concluded that there was no termination            DECISION
                                                                                                            reflected the entire period of service
     of the taxpayer’s employment upon                  The Tribunal held that the taxpayer was             as a goodwill gesture pursuant to 
     secondment in 1997 or on accepting new             unable to satisfy the requirements contained        the letter dated 1 January 2001. 
     arrangements within the group in 2001.             in section 27A(1)(a)(iii) and (iv) ITAA 1936.
     Furthermore, the UK Company did not                Specifically the Tribunal held the following,   5.  The Tribunal held that the taxpayer had 
     cease in business when the taxpayer was            in relation to the questions considered:            not established a causal connection 
     seconded to the Australian Company in                                                                  between the termination of the UK
     1997 or when she commenced employment              1. (a) At no stage did the Australian               office and the payment. There was
     under new conditions with the Australian                  Company understand the reason for            evidence before the Tribunal that showed
     Company in 2001. Termination of the                       dividing the termination payment,            that although the holding of an office
     taxpayer’s employment only occurred upon                  apart from the taxpayer’s request            in the UK was contemplated by the 
     resignation on 29 November 2002.                          to do so, as evidenced by the                taxpayer’s original contract of August
                                                               “reasonable benefit limits” report and       1990, the continuation of that office was
     Did the Taxpayer hold an “office” in the
                                                               other documents generated for tax            not contemplated within the January 
     UK concurrently with her position with the
                                                               purposes for the relevant income year        2001 contract. As the taxpayer was 
     Australian Company?
                                                               which show $348,340.38 as a post             found not to be holding the UK office
     The taxpayer submitted that while she was                 June 1983 component of an ETP.               contemporaneously with her employment 
     on secondment she continued to either be                                                               with the Australian Company the 
                                                           (b) Although the two components of
     employed or hold an office in the UK which                                                             taxpayer could not therefore establish
                                                               the termination payment paid to the 
     continued until the Deed of Settlement                                                                 a connection between the termination 
                                                               taxpayer reflected the taxpayer’s
     was executed, therein terminating both her                                                             payment in November 2002 and 
     employment with the Australian Company                    service in the UK and Australia,
                                                                                                            the termination of her UK office.
     and her UK office. If this was the case, the              respectively, there was no other
     taxpayer argued that her employment with                  evidence or witness statement to 
     the Australian and UK companies ended                     support the taxpayer’s submission
     simultaneously and that the termination                   regarding the method of calculation.
     payment related wholly to her employment                  Meanwhile there was evidence to 
     with the UK Company.                                      suggest that the Australian Company 



470 TAXATION IN AUSTRALIA  Volume 41 No. 9 April 2007
COMMENT AND CONCLUSION                            However, the Tribunal held that the entire       AMBRY LEGAL
                                                 termination payment was an ETP. There
This case, while not remarkable for any
                                                 was a raft of evidence against the taxpayer
new legal proposition, serves as a timely                                                          Reference notes
                                                 and she was unable to discharge the 
reminder that despite taxpayers structuring                                                        1   [2006] AATA 980.
                                                 required burden of proof. This included
transactions in a myriad of ways to reflect                                                        2   No 3 of 1984.
their perception of why a particular payment     substantial written evidence that the             3   (1986) 10 FCR. 88
was made, substance will rule over form.         Australian Company had consistently based         4   Professor Parsons in Income Taxation in Australia
                                                 calculations of the termination payment               (1986), referring to Henly v Murray [1950] 1 ALL ER.
 Although the Tribunal expressed its             upon payment in lieu of notice in accordance      5   Taxation Determination 93/140.
sympathy for the plight of the taxpayer in       with the letter of offer dated 1 January          6   In consideration of the finding in Le Grand v
her expectation that the Australian Company      2001. There had never been any reference              Commissioner of Taxation [2002] FCA 1258.
should recognise her period of employment        to the taxpayer’s UK service, which was
overseas, this expectation could not alter       buttressed by the fact that her employment
the correct characterisation of the payments     conditions had moved to local Australian 
made to her.                                     terms. Moreover the Australian Company 
 The Tax Payer case considered whether           had reported the termination payment to the 
components of a termination payment              tax office as an ETP. The taxpayer’s case was
could be referenced to two periods of the        not assisted by her being unable to produce 
taxpayer’s employment — one in Australia         written evidence or witnesses capable of
and one in the UK. The taxpayer argued           supporting her fundamental contention and
that one component was an exempt                 challenging the evidence against her. 
ETP because it related to her period of            To reiterate, substance will continue to rule
employment with the UK Company while in          over form. A spade will continue to be a
the UK and directed her employer to split the    spade unless alternative characterisations 
termination payment into two reflecting her      are supported by the circumstances and 
approximate length of service in the UK and      evidence. Taxpayers’ expectations will not be
Australia, respectively.                         indulged. 




                                                                                                                                                 It’s essential 471

				
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Description: Form over substance – the taxpayers' indefatigable battle