The facts of this case were that the taxpayer (and three others in partnership) entered a complex scheme, which involved the partnership, and annuity and loan arrangements. The scheme was financed through a series of “round robin” cheques and promised substantial deductions in the first five years of the 15-year plan. A number of documents were exchanged but no cash payments were made. This was calculated to return neutral cash flows with high tax deductions initially and high assessable income, especially in the last five years. A feature of the scheme was that there was an opportunity to terminate it in the last five years. In the relevant year the partnership derived assessable income of $170,000 and claimed deductions of $360,000.
The issue before the court was whether the taxpayers were entitled to a deduction for interest. A lot of matters were argued before the case reached the High Court but before the Full Court the Commissioner’s contention was that the interest deduction should apportioned and disallowed under s 51(1) to the extent that it exceeded the partnership income.
Their Honours indicated that if a taxpayer’s costs in deriving income were less than the actual income, the deductions would be allowable. However, if the costs exceed the income derived, the taxpayer’s purpose for making the expenditure may be relevant in characterizing and apportioning the expenditure for the purpose of the general deduction provision. This may include the taxpayer’s purpose for incurring the expenditure. Manson CJ, Brennan, Deane, Dawson, Toohey, Gaudron and McHugh JJ said (at ATR 622-3): “…The position may, however, well be different in the case where no relevant assessable income can be identified or where the relevant assessable income is less than the amount of the outgoing…the disproportion between outgoing and income, the whole outgoing is properly to be characterized as genuinely and not colourably incurred in gaining or producing assessable income, the entire outgoing will fall within the first limb of s 51(1) unless it is somehow excluded by the exception of…”.
Their Honours concluded that the issue of whether the taxpayers’ interest deduction would be allowable depended on the determination of whether the 15-year annuity plan would in fact runs its full course. The matter was remitted to the Administrative Appeals Tribunal to determine, as a matter of fact, whether the scheme would run its full 15 years or whether it would be terminated before the last five years. In the former situation, the assessable income would exceed deductions and the interest would be an allowable deduction unde
r s 51(1). In the latter situation, an explanation must be sought for the excess of deductions of some $2.7m over assessable income and to the extent that the explanation lay in substantial tax advantages, the outlays were not incurred in gaining assessable income. On the issue of whose purpose must be considered, the court made the following comments: “In the circumstances of the present case, its determination involves consideration not only of the purposes of the taxpayers but also of the purposes of those who advised them and acted on their behalf and whose ‘acts (and intentions)’ as agents must, as the Second Tribunal expressly pointed out, ‘be imputed to the principals’.”
Reduced to its essential elements, if income exceeds outgoings, the taxpayer’s motives are largely irrelevant. If there is no assessable income or outgoings exceed income, a practical and common sense weighing up of all factors is warranted, including the taxpayer’s motive. As was anticipated in Phillip’s case, a disparity between outlay and income may trigger a more rigorous examination of a contract or arrangement. As was suggested in Ure’s case, the absence of a commercial quid pro quo will raise questions about the purpose of the expenditure. Where there is a dual purpose, or a purpose other than income production, expenditure is to be apportioned and there will be circumstances where purpose may mean subjective purpose or motive.