National Mortgage Company Pty Ltd ACN 074 351 796 v Commissioner of Taxation [2008] FCA 9 (15 January 2008)

National Mortgage Company Pty Ltd ACN 074 351 796 v Commissioner of Taxation [2008] FCA 9

TAXATION - objection to taxation assessment - taxpayer had the burden of proving that the assessment was excessive - whether or not payments received by the taxpayer constituted loans or income - whether or not payments received by the taxpayer constituted income not yet earned - application of the principles in Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation [1965] HCA 58; (1965) 114 CLR 314

Taxation (Interest on Overpayments and Early Payments) Act 1983 (Cth)
Taxation Administration Act 1953 (Cth) s 14ZZO(b)(i)

Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation [1965] HCA 58; (1965) 114 CLR 314 considered

NATIONAL MORTGAGE COMPANY PTY LTD ACN 074 351 796 v COMMISSIONER OF TAXATION

QUD 381 OF 2006

DOWSETT J
15 JANUARY 2008
BRISBANE

IN THE FEDERAL COURT OF AUSTRALIA
QUEENSLAND DISTRICT REGISTRY	QUD 381 OF 2006

BETWEEN:	NATIONAL MORTGAGE COMPANY PTY LTD ACN 074 351 796 Applicant
AND:	COMMISSIONER OF TAXATION Respondent

JUDGE:	DOWSETT J
DATE OF ORDER:	15 JANUARY 2008
WHERE MADE:	BRISBANE

Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

IN THE FEDERAL COURT OF AUSTRALIA
QUEENSLAND DISTRICT REGISTRY	QUD 381 OF 2006

BETWEEN:	NATIONAL MORTGAGE COMPANY PTY LTD ACN 074 351 796 Applicant
AND:	COMMISSIONER OF TAXATION Respondent

JUDGE:	DOWSETT J
DATE:	15 JANUARY 2008
PLACE:	BRISBANE

1 From 1996 to 1999 the applicant (the "Taxpayer") carried on business as a mortgage broker. Thereafter it carried on business as a mortgage manager. By arrangement with potential lenders, it would find borrowers, submit loan applications and manage loans subsequently made. One lender with which the Taxpayer dealt was Adelaide Bank Limited (the "Bank"). Initially, it dealt with the Bank as a sub-contractor to other accredited mortgage managers. In about June, 2000 the Bank accredited the Taxpayer as a mortgage manager. Thereafter it dealt directly with the Bank. On 17 October 2000 the Bank and the Taxpayer executed a deed (the "Deed") which regulated their relationship. It is exhibit SD-1 to Mr Dover’s affidavit filed on 16 March 2007. The Taxpayer asserts that despite its not being executed until October 2000, the parties proceeded upon the basis that the Deed regulated their relationship from June 2000. The delay in execution was caused by delay at board level in the Bank. The document which is exhibit SD-2 to Mr Dover’s affidavit is the form of loan agreement typically used in connection with loans from the Bank which were arranged by the Taxpayer.

2 Pursuant to the Deed, the Taxpayer was to find borrowers, submit loan applications and manage loans. It was to receive a monthly "Manager’s Fee" in respect of each loan at a rate fixed by agreement in advance of the loan. The Bank was also to pay to the Taxpayer an "origination subsidy", ‘monthly on the basis of loans settled’ and in an amount to be agreed. The requirement for further agreement raises the spectre of uncertainty, but that has no present relevance.

3 During the year ended 30 June 2001 (the "2001 year"), the Taxpayer received payments from the Bank, described in the Bank’s records as either "incentive fees" or "management fees". The Taxpayer accepts that the latter payments were the Manager’s Fees identified in the Deed. In the course of the proceedings, its attitude to the "incentive fees" has varied somewhat. Mr Dover, the Taxpayer’s managing director originally asserted (at para 22 of his affidavit) that the Taxpayer and the Bank had never agreed on an origination subsidy. However he eventually accepted that the incentive fees were origination subsidies. See ts 60 (second day) at ll 2-3. Such inconsistencies in nomenclature may make these reasons somewhat difficult to follow.

4 In its tax return for the 2001 year the Taxpayer initially returned all incentive and management fees as income. On 4 November 2003 the respondent (the "Commissioner") issued an assessment on that basis. On 11 May 2006 the Taxpayer sought to amend its return. The Commissioner indicated that it was too late to do so but invited the Taxpayer to object to his assessment. The time for such an objection had expired, but the Commissioner had a discretion to treat the objection as though lodged in time. The Taxpayer objected, asking the Commissioner so to treat its objection.

5 In its objection, the Taxpayer asserted that during the 2005-2006 tax year, it had acquired the business of another "mortgage originator" and discovered that it returned income in a different way from that adopted by the Taxpayer for the 2001 year. The Taxpayer asserted that the so-called "incentive fees" ought to have been treated as loans rather than as income, and that the Commissioner’s assessment should be reduced accordingly. It now concedes that if that assertion be correct, there should be further amendments to its return, involving the return of further income and claims to further deductions. Those matters will be better addressed after a more detailed discussion of the evidence. The Commissioner treated the objection as though lodged in time but disallowed it. This is an appeal from such disallowance. The Taxpayer seeks orders that its objection be allowed in full, that the matter be remitted to the Commissioner to be considered in accordance with law and that he make all consequential adjustments, including the payment of interest pursuant to the Taxation (Interest on Overpayments and Early Payments) Act 1983 (Cth).

6 Pursuant to sub-section 14ZZO(b)(i) of the Taxation Administration Act 1953 (Cth) (the "Administration Act"), the Taxpayer bears the burden of proving that the Commissioner’s assessment is excessive.

7 Before considering the evidence of the witnesses it is convenient to consider the relevant terms of the Deed. It is described as a "Mortgage Origination and Management Deed" and is between the Bank, the Taxpayer and Mr Dover as guarantor of the Taxpayer’s obligations thereunder. In recital A it is asserted that the Bank wished to appoint the Taxpayer ‘to originate and manage mortgages’. Subclause 4.1 provided that the Taxpayer was to introduce to the Bank ‘Loans which comply with the Terms in accordance with the provisions of this Deed and the [Bank’s] Credit Criteria’. The Taxpayer was obliged to provide to the Bank all information reasonably relevant to its consideration of each application for loan and to use its best endeavours to ensure that such information was accurate and complete. Pursuant to subcl 4.2 the Bank was obliged to process each application within two business days of its receipt. It was under no obligation to approve any loan. Subclause 6.1 provided that:

8 The other subclauses of cl 6 identified specific aspects of the Taxpayer’s obligations to the Bank. In particular subcl 6.9 required that the Taxpayer use its best endeavours to ensure punctual payment of all moneys due from borrowers. Subclause 6.20 entitled the Bank to deduct from any amount payable to the Taxpayer the arrears on any loan which was in arrears for 60 days or more. If the amount owing to the Taxpayer by the Bank was insufficient for that purpose, the Taxpayer was obliged to pay the shortfall.

10 Subclause 7.3 provided that the Manager’s Fee in respect of variable rate Margin Loans was to be the Manager’s Margin. The case has been conducted upon the basis that virtually all of the relevant loans were of this kind. The expression "Manager’s Margin" was defined in subcl 5.1. It was to be an amount between 0.25% per annum and 0.75% per annum, nominated by the Taxpayer to the Bank at the time of submitting a loan application. Curiously, subcl 5.1 gives no express indication of the figure to which such percentage was to be applied. Other evidence suggests that it was to be applied to the outstanding balance of the relevant loan. Pursuant to subcl 5.4, the borrower’s interest rate was to be fixed by adding the Manager’s Margin to the Cost of Delivered Funds. The latter term was defined in cl 2. Subclause 5.4 supports the proposition that the Manager’s Margin was to be calculated by applying the nominated percentage pursuant to subcl 5.1 to the amount of the loan.

11 Pursuant to subcll 7.2 and 7.3 the Taxpayer was to be paid a Manager’s Fee for each loan equivalent to the Manager’s Margin for that loan. That amount was to be paid monthly throughout the loan period, subject to there being no deductions pursuant to cl 6.20 or any other Event of Default (also defined in cl 2). Again, other evidence suggests that such fee was to be calculated on monthly balances of the relevant loan. In addition subcl 7.1 contemplated the payment in respect of each loan of an "origination subsidy" in a sum to be agreed from time to time. Such subsidies were to be paid monthly on the basis of loans settled. I take that to mean that the origination subsidy was to be a one-off payment for each loan, payable in the month in which the loan was settled, or perhaps shortly thereafter.

12 Pursuant to subcl 7.6 the Taxpayer was entitled to charge each borrower an establishment fee in an amount approved by the Bank. Pursuant to cl 7.7 the Taxpayer was liable for the payment of all application fees, valuation fees and mortgage documentation fees in respect of each loan. It will be necessary to say a little more about the establishment fee after considering Mr Dover’s evidence.

13 Mr Dover claimed that in the Taxpayer’s tax return for the 2001 year, it wrongly included as income, amounts totalling $255,492 received from the Bank by way of loan, which amounts it was obliged to repay with interest over five years. As I have said these amounts were described in documents created by the Bank as "incentive fees". Mr Dover claimed that the Taxpayer had also erroneously omitted from such return assessable income earned in the 2001 year totalling, at most, $32,172. This assertion is based upon another assertion, namely that the monthly Manager’s Fees paid to the Taxpayer during the 2001 year, as agreed pursuant to subcl 5.1 of the Deed, had been reduced by 0.2% of the outstanding monthly loan balances, such reductions being applied in repayment of the "loans" and in payment of interest on the "loans". Mr Dover asserted that the Taxpayer was entitled to claim such interest as a deduction in the amount of, at least, $10,779 but had failed to do so. Thus, Mr Dover claimed, the Commissioner’s assessment, based on the Taxpayer’s return, was excessive in the amount of, at least, $234,099. The Taxpayer must establish the truth of these assertions by reference to the evidence.

14 Mr Dover said that he had, on behalf of the Taxpayer, negotiated the terms of the Deed. The monthly Manager’s Fees were to be calculated on the outstanding balance of the loan in each month, a proposition which is not clear from the Deed. On 18 June 2001 he was advised that the maximum Manager’s Margin had been increased to 0.8% per annum. Mr Dover said that the Bank also "advanced" funds to the Taxpayer, which "advances" were to be repaid, with interest, over 60 months. This was a reference to the "incentive fees". Each advance was calculated as an agreed percentage of each drawn-down loan settled during the month. Where the loan was not drawn down to at least 75% of the approved limit, the amount was calculated by applying the agreed percentage to 75% of that limit.

15 In his affidavit Mr Dover denied that the Bank and the Taxpayer had ever agreed upon an origination subsidy pursuant to subcl 7.1. He asserted that the Bank had rather agreed to advance funds to the Taxpayer upon the terms which I have described. It was said that such an arrangement was ‘industry wide’ and that ‘money lenders simply will not make upfront payments to mortgage managers without requiring them to be repaid with interest.’ He said that the Taxpayer funded its business from such advances, thereby avoiding the need to raise funds from other sources. As I have observed, in his oral evidence Mr Dover accepted that the incentive fees were, in fact, origination subsidies for the purposes of the Deed. He also accepted that such payments were, in effect, advances of Manager’s Fees. See ts 42 (first day) ll 8-21. Mr Dover said that the Bank and the Taxpayer agreed, from time to time, on the percentage to be advanced and the rate at which any advance was to be repaid. The percentage to be advanced was, in July 2000, 0.5%. It gradually increased to 0.7% and then to 0.8%. The Taxpayer repaid it at the rate of 0.2% per annum calculated on the outstanding loan balance in each month. After the end of the 2001 year the parties agreed to increase the advance to 1%, with repayments of 0.25% per annum. There was a further increase in June 2006. These variations are not relevant for present purposes.

16 As can be seen from the above, Mr Dover’s evidence concerning the circumstances and content of his negotiations with the Bank was vague and imprecise. The Taxpayer also sought to rely on an affidavit by an officer of the Bank, Damien Joseph Percy, as establishing such terms. However Mr Percy’s first connection with the Bank’s mortgage business was in early 2002. He does not suggest any earlier contact with the Taxpayer. Mr Dover suggested that at some time in the 2001 year, Mr Percy had confirmed the alleged arrangements between the Taxpayer and the Bank. However, in light of Mr Percy’s evidence concerning the date of commencement of his involvement in the Bank’s mortgage business, I reject that suggestion. Mr Dover identified the officers of the Bank with whom he had negotiated the Deed as Mr Darren McLeod and a woman named Marlene. They were not called to give evidence.

17 The evidence is, to some extent, confused by use of the term "advance". An advance may be a loan in the usual sense, that is an amount to be repaid. Alternatively, it may be payment, in advance, of moneys to become due and payable in the future. The Taxpayer’s case was that the incentive fees were advances by way of loan. However much of the evidence suggests that any such "advances" were of moneys to become owing as Management Fees. The Taxpayer asserts that it repaid part of such advances during the 2001 year by virtue of reductions in Management Fees of 0.2% per annum of the respective balances of the relevant loans. There is no direct evidence that any such reductions were made in the 2001 year, save for Mr Dover’s assertions. Assuming that they were made, the Taxpayer claims that such reductions were applied in repayment of the loans and in payment of interest on the loans. Thus the Taxpayer claims that the amounts of the "advances" should be excluded from its assessable income for the 2001 year, that some component of the 0.2% reduction in Management Fees should be treated as income (applied in repayment of the advances), and the balance of the 0.2% reduction should be treated as interest paid on the advances. The Taxpayer’s case is that such advances were to be repaid over five years.

18 It is worth noting that the figure of 0.2% per annum of the outstanding balance of the loan to each borrower bore no apparent relationship to the amount of the relevant "advance" to the Taxpayer or to interest accruing on it. It seems to be suggested that any balance outstanding at the end of five years (notwithstanding the 0.2% per annum reductions) would also be repayable by the Taxpayer. I do not understand the evidence to demonstrate that any such repayment was ever made, either in the 2001 year or thereafter, in connection with loans made during that year. Nor is there any evidence to suggest that such repayment was ever promised. Certain other evidence bears upon this question. I will return to it at a later stage.

19 Exhibits SD-4, SD-5 and SD-6 to Mr Dover’s affidavit are various documents said to evidence relevant dealings between the Bank and the Taxpayer. Exhibit SD-4 contains a number of different categories of document, each issued on a monthly basis. The first category comprises commission statements, apparently issued by the Bank. It shows items described as either "trailing commission" or "incentive fee" credited to the Taxpayer’s account. It is, I think, common ground that the term "trailing commission" describes the monthly Manager’s Fees as paid to the Taxpayer. I have previously discussed the Taxpayer’s varying attitude to the incentive fee. Other adjustments appear, but they are not relevant for present purposes. The commission statements provide no detail as to the methods of calculation used to derive the amounts paid as incentive fees or Manager’s Fees.

20 Documents in the second category are described as "recipient-created tax invoices". They seem to be invoices created by the Bank to evidence amounts payable to the Taxpayer. Each document requests the raising of a credit in favour of the Taxpayer in an identified amount. Documents in the third category are described as "retail financial system incentive fees paid on settlement reports". Such documents show details of loans made during the month, including customer name, interest rate, amount of approved loan, a figure representing 75% of that amount, the actual amount lent, the "calculated amount" of the loan, the date of the advance and the "comm rate", which I take to be the rate of the "commission". The various figures concerning the amount of the loan presumably reflect the different possible bases for calculating the Manager’s Fee, the "calculated amount" being that actually used in calculating the advance to the Taxpayer. It would be either the amount advanced or 75% of the approved limit of the advance, whichever was the greater. Thus, on 28 July 2000, there was an advance of up to $108,000 made to a person whom I shall describe as "GWM", at an interest rate of 7.89%. Seventy-five percent of that amount was $81,000. The amount advanced was actually $90,955.79, which amount became the "calculated amount". The commission rate is shown as 0.5%, yielding a commission of $454.77.

21 Documents in the fourth category are described as "retail financial system originator’s trailing commission reports". The entry for the GWM loan in the trailing commission report dated 1 August shows a debit balance of $90,955.79, commission of $5.88, a commission rate of 0.59% and the debtor’s interest rate of 7.89%. I have not been able to identify how the figure of $5.88 was derived, but there is probably some relationship between the outstanding balance of the loan and the commission rate of 0.59%. The difficulty in identifying the method of calculation may be attributable to the loan having been made during the preceding month so that the commission was calculated for only part of it. There are only three trailing commission reports. They are dated 1 August, 1 September and 1 October 2000.

22 Throughout this documentation the amounts paid or payable to the Taxpayer are described as either incentive fees or management fees. There is, as far as I can see, no reference to an "advance", nor to any repayment thereof. Further, such payments were treated as attracting the Goods and Services Tax ("GST"). I understand it to be accepted that a loan, properly so called, would not generally attract GST.

23 Exhibits SD-5 and SD-6 contain assortments of documents similar to those contained in exhibit SD-4. Mr Dover, in his affidavit, distinguished between the three exhibits on the basis that exhibit SD-4 contained commission statements, exhibit SD-5 contained recipient created tax invoices and exhibit SD-6 contained ‘twelve documents each concerning the amounts advanced’ by the Bank to the Taxpayer. Whoever assembled the exhibits for filing purposes seems not to have adopted this approach. In any event, the documents in exhibits SD-5 and SD-6 do not take the matter any further.

24 At para 35 of his affidavit Mr Dover asserted that the Taxpayer ‘has prepared a spreadsheet that summarizes the information contained in the 12 documents, and other information as set out in more detail later in this affidavit.’ The spreadsheet is said to be exhibit SD-7. In the course of the trial it became clear that exhibit SD-7 contained errors. As I understand the Taxpayer’s final position, it was that the document which is exhibit 4 (tendered during the hearing), should be read as standing in place of exhibit SD-7 (exhibited to Mr Dover’s affidavit). The ‘12 documents’ referred to in para 35 of Mr Dover’s affidavit are presumably documents relating to the incentive fee. Concerning exhibit 4 it should be noted that whilst the eight columns to the left reflect information contained in exhibits SD-4, SD-5 and SD-6, the information in the last five columns to the right do not reflect information otherwise in evidence, save as alleged by Mr Dover in very general terms.

25 At para 40 of his affidavit Mr Dover asserted that the advances were repayable with interest over five years at the rate of 0.2% per annum, calculated on the loan balance for the month in question. In para 41 he asserted:

26 It is not clear whether Mr Dover meant that the 0.2% "offset" would extinguish the debt after five years, or whether there was to be a further payment of any outstanding balance. The former interpretation seems more likely on the wording of the paragraph. It is also consistent with the fact that it has not been suggested that the Taxpayer actually made any repayments other than the 0.2% reductions. On the other hand, there is no reason to believe that the apparently arbitrary figure of 0.2% would have been appropriate in order precisely to eliminate the alleged "debt" over five years.

28 It is asserted in paras 43-45 that this can be seen from the trailing commission reports in exhibits SD-4, SD-5, and SD-6. They are said to demonstrate that the Manager’s Fee paid by the Bank was the agreed Manager’s Margin for that loan less the 0.2% per annum rate. The trailing commission report dated 1 August 2000, which relates to July 2000, during which month there was only one loan, shows a "commission rate" of 0.59% and the debtor’s interest rate as 7.89%. I understand the Taxpayer to accept that commission rate as being the Manager’s Margin pursuant to the Deed, and therefore also the rate of the Manager’s Fee. The trailing commission report dated 1 September 2000 shows that during August, the Manager’s Fee varied between 0.5% and 0.61%. The only other trailing commission report was dated 1 October 2000. It shows a much wider variation in the Manager’s Fee, between 0.25% and 0.7%. However, of the 26 transactions for which a Manager’s Fee other than zero is shown, 18 involved rates in excess of 0.55%. Those rates are all within the range specified in the Deed. However, if 0.2% were added to any of those rates, the total would exceed 0.75%, the maximum rate specified in para 5.1 of the Deed, which maximum remained in force, according to Mr Dover, until April 2001. I should say that Mr Dover claimed to have, from time to time, successfully negotiated for rates higher than the maximum rate specified in the Deed. However he did not identify the transactions mentioned in the three trailing commission reports as being in that category. In the end those reports offer no objective support for Mr Dover’s claim that there was a 0.2% reduction in the Manager’s Fee, which reduction was, as he alleged, applied in reduction of the "debt" created by the payment of incentive fees.

29 In paras 46 et seq of his affidavit Mr Dover referred to certain documents maintained by the Bank to which the Taxpayer had reference in the course of its business. These documents are exhibits SD-8, SD-9 and SD-10. Exhibit SD-8 is described as "refunded upfront amortization report – National Mortgage Company". This document was apparently printed by Mr Dover on 8 February 2007. It should be read with exhibit SD-9 which relates to two specific loans to borrowers to whom I will refer as "T" and "R". Both loans were made after the end of the 2001 year. Exhibit SD-10 is also relevant to the extent that it includes details of the loans to T and R.

30 The relevance of the refunded upfront amortization report lies in the last five columns on the right-hand side headed "5 year anniversary date", "old upfront factor", "old margin rate", "new upfront factor", "new margin rate". The report demonstrates that the old upfront factor and the old margin rate together total the new margin rate in each case. Mr Dover asserted that this document supports his evidence that the upfront advance was repayable over five years by way of deductions from the Manager’s Fee and that thereafter, the fee was payable at the original (higher) rate. It may be that the document suggests some such arrangement, but none of the transactions identified in the document was made in the 2001 year. (It is common ground that the transaction dates are recorded in the American way, with the number of the month preceding the day of the month.) Further, the document does little to identify the nature of the transactions. If anything, it suggests that the Manager’s Margin was reduced by the amount of the old upfront factor. Such language does not bespeak a loan of money with a promise to repay. It rather suggests an "upfront" payment of moneys, payment of which is to fall due in the future by instalments, with a consequential reduction in the amount of each instalment. Exhibit SD-10 is to similar effect. It may demonstrate that in the case of the loans to each of borrowers T and R, the relevant commission increased by 0.25% on the fifth anniversary of the loan. However the presentation of unproven documents such as these, with no cogent explanation by those who created them, is no real substitute for calling appropriate witnesses who are familiar with the relevant transactions.

31 Returning to exhibit 4 (replacing exhibit SD-7) the Taxpayer asserts that the total of the amounts in the column headed "maximum repayment amount for the whole year", being the total of the 2% reductions in the Manager’s Fees for all loans made during the 2001 year, was $32,172.94. It is said that this amount is undeclared income for that year, in the sense that it was earned and disposed of, effectively at the Taxpayer’s direction. Part of such amount was used to repay the upfront advances, and the balance was applied against interest on those advances. As the advances were used in connection with the Taxpayer’s business, such payments of interest are said to be deductible.

33 This proposition assumes that the 0.2% reduction was, in some way, calculated so that it would, in the usual course, lead to repayment of the advance over five years. As I have observed, it is hard to see why that should be so, given that the amount of the advance was calculated as a variable percentage of the loan, whilst the 0.2% reduction was calculated on the outstanding balance in each month. Mr Dover caused his accountant to enquire of the Bank as to what would happen in the event of a shortfall. In response the Taxpayer (or its agent) received a letter dated 13 December 2005 from Mr Percy. It is exhibit SD-11 to Mr Dover affidavit. It reads as follows:

According to Mr Dover, the reduction in the Manager’s Fee rate was increased to 0.25% in November 2001.

34 As I have said, Mr Percy had no knowledge of the actual arrangements entered into between the Bank and the Taxpayer for the 2001 year, his association with the Bank’s mortgage business having commenced in early 2002. His understanding of the position in March 2007 is of little, if any, evidentiary value. However the letter is informative for other reasons. It refers to a deferred establishment fee. Pursuant to subcl 7.6 of the Deed the Taxpayer was entitled to charge an establishment fee payable by the borrower. In exhibit 2 (the specimen home loan contract) the establishment fee payable to the Taxpayer is shown as $385. It records that a subsidy and a monthly fee were also payable to the Taxpayer. The contract also provides that a deferred establishment fee would be payable to the Bank in the event of termination of the contract within 48 months of the settlement date. The amount payable was a percentage of the total amount owing at the "disclosure date", a date specified in Section A of the contract. If discharge occurred in the first year the percentage was 1.3%, if in the second year, 0.98%, if in the third year, 0.65%, and if in the fourth year, 0.33%. The letter (exhibit SD-11) demonstrates that this amount was to be used to offset any loss to the Bank in connection with the upfront commission as a result of early repayment of the loan. In other words, the Bank would look to the borrower and not to the Taxpayer. However the deferred establishment fee was only payable if the loan contract was terminated, presumably by repayment of all outstanding amounts. Thus, if the loan were partly repaid at an early stage, the amount recouped by the Bank as a result of the 0.2% reduction in the Manager’s Fee would be reduced, but the deferred establishment fee would not be payable.

35 The letter (exhibit SD-11) states that as at 13 March 2007, more than five years after the end of the 2001 tax year, the Taxpayer owed no amount to the Bank in connection with "upfront payments". It strongly suggests that the Bank did not generally expect any such "repayments" beyond the 0.2% or 0.25% deductions. However the penultimate paragraph of the letter appears to assert that in some circumstances, the Bank might seek to recover any "shortfall". That paragraph is a little difficult to understand. The first sentence suggests that the Bank did not keep records of the extent to which upfront payments had been "repaid" ‘on an individual loan basis or at a partner level’. It is not clear to me what is meant by the expression "at a partner level". Perhaps the Bank used the word "partner" to describe mortgage managers such as the Taxpayer. If the upfront payments were properly characterized as advances, in the sense of being loans, one would have expected that balances would have been kept. Such balances would be necessary in order to calculate interest and for the preparation of accounts, especially statements of assets and liabilities. Both the Bank and the Taxpayer would need such figures, but neither seems to have bothered about them. To my mind this suggests that their relationship was not that of debtor and creditor.

36 The second, rather lengthy, sentence in the paragraph is more difficult. The words "As a consequence" seem to suggest that what follows was the result of the fact that the Bank did not keep the records mentioned in the first sentence. The ultimate statement of fact in the sentence is that the Bank may seek recovery of any shortfall from a mortgage manager, but the words commencing with "though" and ending with "over time" seem to imply that there is something counter-intuitive about seeking such recovery. In any event, notwithstanding the claim to be entitled to do so, the letter generally suggests that such an event would be unusual. Further, there is no evidence of any legal basis for such recovery.

37 Nowhere in the material is there any reference to a loan or to interest. Nowhere is there any mention of repayment. Nowhere is there any record of a debt owed by the Taxpayer to the Bank. The Taxpayer clearly did not, in 2001 or at the time of filing its tax return for the 2001 year, consider the amounts received as incentive fees to have been loans. Had it done so it would not have included such amounts as income. Further, if the Bank or the Taxpayer considered such amounts to have been loans, it is unlikely that either would have considered that GST was payable in respect of them. Finally, the fact that the Taxpayer made the enquiry which led to the letter of 13 March 2007 demonstrates that, at best, the Taxpayer had no clear understanding or view as to the nature of the amounts received as incentive fees. The availability to the Bank of the deferred establishment fee also causes one to doubt whether there was any promise by the Taxpayer to make repayments of any part of the incentive fees.

38 In the course of his cross-examination at ts 11 (second day) Mr Dover conceded that the figures referred to in paras 93 and 94 of his affidavit were obtained from the Taxpayer’s accountant, and that he did not know how they had been calculated. In his cross-examination, at ts 10, 11, 12 and 13 (second day), it became clear that Mr Dover also knew little about the way in which exhibit SD -7 to his affidavit had been prepared. I infer that he also knew little about exhibit 4. He agreed in cross-examination that the amounts claimed as interest payments had also been calculated by the accountant, and that he could not vouch for them. The accountants were not called. It is difficult to see how the Taxpayer hoped to demonstrate that the Commissioner’s assessment is excessive. Mr Dover agreed that the Taxpayer had made no repayments to the Bank other than by reductions in the Manager’s Fee.

39 Damien Joseph Percy said that in January 2002 he was appointed head of mortgage origination within the Bank and subsequently became familiar with its arrangements, including those with the Taxpayer. He said that all of the Bank’s mortgage managers operated pursuant to deeds similar to the Deed exhibited to Mr Dover’s affidavit. There were two versions, one pre-GST and one post-GST. He was not aware that any mortgage manager had negotiated different arrangements with the Bank. In particular he was not aware of any arrangement by which the Bank paid "upfront" amounts to a mortgage manager, which amounts were not refundable. Much of Mr Percy’s affidavit was excluded as inadmissible. He was not cross-examined.

40 Although Mr Dover asserted that the Taxpayer entered into an oral agreement for the advance of funds, to be repaid primarily by way of reductions in the amounts payable as Management Fees, he failed to identify any conversation in which such agreement was reached. He rather asserted that conclusion without any direct evidence to support it. The Taxpayer’s contemporaneous treatment of such amounts as income strongly suggests an understanding that they were not loans. The view that the amounts attracted GST might reinforce this view. However I do not know when the Taxpayer became aware of such treatment. The relevant documents were generated by the Bank. It is better that I disregard the GST question. The Bank also treated the payments as payments of commission. No record was kept of the outstanding balance of any loan or of repayments thereof. The letter, exhibit SD-11 and Mr Perry’s evidence must be seen in this light. Even Mr Percy’s claim in exhibit SD-11, that the Bank might seek recovery from the Taxpayer in some circumstances, gave no indication of any legal basis for that claim. I do not accept that the incentive fees were paid by way of loan. By that I mean that there was no express promise to repay or any implied promise to do so.

41 The incentive fees may be better characterized as partial advances against instalments of the Manager’s Fees to become payable in the future. The agreement between the parties may well have been that in consideration of such "upfront" payments the Taxpayer would accept a 0.2% reduction in the Manager’s Fees for the first five years of each loan. Whilst I consider that possibility to be more likely than that the arrangement was for loans, there is no real evidence of it, apart from Mr Dover’s assertions, exhibit SD-11 and Mr Percy’s vague assertions. Exhibits SD-4, SD-5 and SD-6 and exhibits SD-8, SD-9 and SD-10 may be consistent with the existence of such an arrangement but, on the balance of probabilities, they do not persuade me as to such existence. I am unable to reach any conclusion, on the balance of probabilities, as to the precise relationship between the parties. That finding is a sufficient basis for dismissing the Taxpayer’s appeal, but I will also deal with one other argument. For that purpose, I proceed upon the basis that the incentive fee was by way of part-payment of the Manager’s Fee.

42 The Taxpayer submitted that if the incentive fees were, in fact, partial advances of Manager’s Fees to become payable in the future, then, in determining whether they comprised income received in the 2001 year, the decision of the High Court in Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation [1965] HCA 58; (1965) 114 CLR 314 should be applied. The effect of that decision was said to be that amounts received in one year, to be earned in a subsequent year, should not be treated for tax purposes as income received in the year of receipt. They should rather be treated as being received in the year in which they are eventually earned.

43 Arthur Murray was a company which conducted ballroom dancing lessons. It sold courses of tuition, usually consisting of 5, 15 or 30 hours to be taken by appointment within a year, payment often being made in advance, either in a lump sum or by instalments, with a variable discount for immediate payment. There was no contractual right to a refund in the event that a course was not completed. In practice, refunds were sometimes given. In the company’s books fees were credited, upon receipt, to an account-styled "Unearned Deposits – Untaught Lessons Account". As lessons were taught, amounts were transferred from that account to an account-styled "Earned Tuition Account". The company prepared its income tax on the footing that fees received in advance of tuition formed no part of its assessable income at the moment of receipt, but became income as and when earned by the giving of the tuition.

46 To my mind the facts in Arthur Murray differ from the present facts in substantial respects. Firstly, in that case, as far as can be seen from the report, all services to be provided in consideration of receipt of the relevant fees were to be provided subsequent to payment. In other words, there was no suggestion that any part of the remuneration had been earned in advance of such payment. In the present case it is clear that a significant part of the Taxpayer’s function (for which it was to be remunerated) was performed in locating a potential lender and facilitating the loan transaction although, of course, some duties remained to be performed by way of management of the loan after it was made. Thus some part of the consideration for the Manager’s Fee had been earned prior to payment of each incentive fee. There is no evidence which demonstrates any basis for apportioning the Manager’s Fee as between such preliminary work and the subsequent management of each loan. Whilst in Arthur Murray, the upfront payment must have been for the tuition, it cannot be said that in the present case, the Manager’s Fees were only payable in consideration of the Taxpayer’s managing the loan after it was made. It is quite possible that the reduced amount of the Manager’s Fee fairly represented the proportion of the total fee attributable to such management.

47 Secondly, in Arthur Murray, there was evidence of an accounting nature, suggesting that it was consistent with good business practice that amounts paid in advance of services to be provided not be credited to any revenue account until the services had been rendered. There is no such evidence in the present case, although there is evidence which suggests that both the Taxpayer and the Bank treated the relevant amounts as having been paid by way of commission, with no suggestion that they were by way of loan. In the business which the Taxpayer acquired in the 2005-2006 tax years, the incentive fees were treated in a different way, but no attempt has been made to demonstrate that such treatment was more appropriate, from a business point of view, than was that adopted by the Taxpayer in its return and accepted by the Commissioner.

48 The Taxpayer bears the ultimate onus of proof. It asserts that the incentive fees should be treated as unearned in the year in which they were received simply because some management duties remained to be performed over the first five years of each loan. However there is no evidence as to how the Manager’s Fees should be apportioned amongst the duties which were to be performed by the Taxpayer. It might be argued that as subcl 7.1 of the Deed contemplated monthly payments of the Manager’s Fee, this suggests that each monthly fee related to the work to be performed in that month. However that would be an unrealistic approach. Firstly, it would fail to recognize the fact that a substantial part of the overall work performed by the Taxpayer was in identifying the borrower and facilitating the loan. Part only was attributable to subsequent management. Secondly, such an approach would overlook the fact that however the Manager’s Fee was characterized in the Deed, the parties conducted themselves upon the basis that there should be an advance payment of part of it.

49 The Taxpayer has not demonstrated that it had not, prior to payment of each incentive fee, earned that part of the Manager’s Fee which it represented. The evidence is simply silent on that point. In those circumstances, accepting that the incentive fee was an advance of part of the Manager’s Fees, the Taxpayer’s appeal must fail.

I certify that the preceding fifty (50) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Dowsett.

Counsel for the Applicant:	Mr M Robertson

Solicitor for the Applicant:	MacGillivrays Solicitors

Counsel for the Respondent:	Mr S Lumb

Solicitor for the Respondent:	Australian Government Solicitor

Dates of Hearing:	16 and 24 July 2007

Date of Judgment:	15 January 2008

Federal Court of Australia

National Mortgage Company Pty Ltd ACN 074 351 796 v Commissioner of Taxation [2008] FCA 9 (15 January 2008)