Jones and Commissioner of Taxation [2003] AATA 84; (2003) 52 ATR 1063; 2003 ATC 2024 (31 January 2003)

Last Updated: 30 September 2009

Administrative

Appeals

Tribunal

DECISION AND REASONS FOR DECISION [2003] AATA 84

ADMINISTRATIVE APPEALS TRIBUNAL )

) No QT2001/426-428

TAXATION APPEALS DIVISION		)
	Re		PETER ALLAN JONES

Applicant

And

COMMISSIONER OF TAXATION

Respondent

DECISION

Tribunal

Mr B J McCabe, Member

Date 31 January 2003

Place Brisbane

Decision

The Tribunal sets aside the objection decision under review and remits the matter to the Commissioner for reconsideration in accordance with these reasons.

(Sgd) B J McCabe
Member

CATCHWORDS
TAXATION – income tax – partnership – husband and wife - whether partnership established as a tax-avoidance scheme – partnership prohibited under state Professional Engineers Act – whether wife an employee rather than partner – whether Part IVA applies – whether penalty should be imposed on taxpayer

Income Tax Assessment Act 1936 (Cth)
Income Tax Assessment Act 1997 (Cth)
Partnership Act 1891 (Qld)
Professional Engineers Act 1988 (Qld)
Acts Interpretation Act 1901 (Cth)

Federal Commissioner of Taxation v McDonald (1987) 18 ATR 957
Magna Alloys and Research Pty Ltd v Federal Commissioner of Taxation [1980] FCA 150; (1980) 11 ATR 276
John v Federal Commissioner of Taxation [1989] HCA 5; (1989) 20 ATR 1
Fletcher v Federal Commissioner of Taxation [1991] HCA 42; (1991) 173 CLR 1
Tweddle v Federal Commissioner of Taxation [1942] HCA 40; (1942) 7 ATD 186
Toohey’s Ltd v Commissioner of Taxation (1922) (SR)NSW 432
Stewart v Federal Commissioner of Taxation (1973) 3 ATR 603
Broome v Chenoweth [1946] HCA 53; (1946) 73 CLR 583
Reed (Albert E) & Co Ltd v London and Rochester Trading Co Ltd [1954] 2 Lloyds Rep 463
Playfair Development Corp Pty Ltd v Ryan [1969] 2 NSWR 661
Federal Commissioner of Taxation v Spotless Services Ltd [1996] HCA 34; (1996) 141 ALR 92
Eastern Nitrogen Ltd v Federal Commissioner of Taxation [2001] FCA 366; (2001) 188 ALR 415
Federal Commissioner of Taxation v Consolidated Press Holdings Ltd [2001] HCA 32

REASONS FOR DECISION

31 January 2003

Mr B J McCabe, Member

INTRODUCTION

1. The applicant, Mr Peter Jones, is an engineer. Mr Jones and his wife provided consulting engineering services to the Queensland Department of Main Roads and other clients. Mr and Mrs Jones said they were partners in the consulting business. They prepared income tax returns on that basis.
2. The respondent, the Commissioner, has been scrutinising partnerships between family members to ensure they are not tax avoidance schemes. The Commissioner formed the view that the partnership in this case may have breached Part IVA of the Income Tax Assessment Act 1936 (the ITAA36). But in the days immediately before the hearing it was discovered that state legislation prohibits engineers from entering into partnership agreements with persons who are not engineers. This is not an uncommon rule: lawyers are also prohibited from practising in partnership with non-lawyers. The rule is apparently intended to ensure that decision-making power within a professional firm is kept out of the hands of non-professionals who are not subject to the same ethical and other obligations as members of the profession.
3. At the hearing, the applicant said he would withdraw the original assessments and the claim that he was in partnership. He agreed to submit amended returns for the years ended 30 June 1996, 1997 and 1998. The returns would proceed on the basis that (a) Mr Jones’ income included all of the fees paid to the partnership and (b) he employed his wife and paid her a reasonable wage that would give rise to a deduction. It was further agreed between the parties that a reasonable wage was $15 per hour. While I have some reservations about the correctness of this approach (for reasons that will become apparent in the course of these reasons), I will deal with the matter on the basis the parties have agreed.
4. It was therefore necessary for the Tribunal to address two issues:
   • (i) How much work did Mrs Jones actually do for her husband? The applicant says she did around 20 hours per week, but the issue is complicated by the fact that she also ran the household and managed an Amway distributorship. Mr and Mrs Jones’ daughters also did some work in the business. The respondent says Mrs Jones did much less than 20 hours work each week for Mr Jones – perhaps only 5 hours each week.
   • (ii) Should the applicant be liable to pay a penalty in respect of the shortfall?

THE MATERIAL BEFORE THE TRIBUNAL

5. The Tribunal was provided with the documents required under s 37 of the Administrative Appeals Tribunal Act 1975. It was provided with a statement prepared by Mr Jones. Mr and Mrs Jones gave evidence in person. The Tribunal was also provided with photographs of the work space in the downstairs area of the Jones family home.
6. Mr Hack, SC represented the applicant. The respondent was represented by Mr Robertson.

THE FACTS

7. Mr Jones is a consulting engineer. His consultancy trades under the business name Pajengco. Pajengco provides advice to a number of clients on matters within Mr Jones’ expertise, which extends to quality assurance. The biggest client during the relevant period was the Queensland Department of Main Roads (the DMR).
8. At all material times the applicant proceeded on the assumption he was in partnership with his wife, Helen Jones. Mrs Jones is not an engineer. The applicant says he established a partnership in March 1994 after consulting a lawyer. (There were earlier plans to enter into a partnership with another couple, but they did not proceed. That arrangement is irrelevant to these proceedings). He conceded the advice may have been given verbally, although he says he also spoke with his accountant about the business structure. He says he was unaware there was any legal obstacle to being in a partnership with his wife, and he made no secret of her involvement. Mr Hack, for the applicant, pointed out that the DMR was obviously untroubled by the business structure.
9. Mr Jones appeared to me to be an honest man. His evidence was given in a careful and deliberate way, and he appeared to be forthright. His motivation for setting up a partnership emerged during the course of his cross-examination. The prospect of obtaining a tax advantage did not appear to be a high priority for him. Adopting a partnership in the business was more of a statement about his relationship with his wife, whom he clearly regarded as a life partner. As he explained in answer to a question from Mr Robertson:

“When Helen and I met we wanted to do things together and we felt this was the way to do it. To be where I am now is just something that is so difficult to work with and funny because we thought we’d done everything right. We wanted to do everything jointly and we had done so with regard to buying a property and houses and all that stuff for all those years, and then we just wanted to do business together. That’s the basis for what we did. I don’t think there was any other basis that you could even identify.”

10. I formed the strong impression that the applicant believed each member of the family had an important and useful role to play in the business, and he expected them to take those responsibilities as seriously as he did. I think this attitude was most obvious in the case of his wife. I formed the impression the applicant would be genuinely surprised and offended on his wife’s behalf by the suggestion that his wife’s contribution was purely domestic or informal. I think he meant it when he said they “wanted to do business together”. Mr and Mrs Jones also expected their daughters to make a contribution to their family business, which included an Amway distributorship trading as Alimeg Innovations. The applicant said his daughters worked after school in the businesses. Mr Jones took the concept of a family business seriously. He apparently viewed it as an extension of family life.
11. The applicant said he provided a bundle of services to his clients. As an independent contractor, he had to provide his own administrative support. He accepted that he was able to access some of his client’s facilities (such as photocopying, fax machines and telephones) when he was on site, but most of the administrative support for his business came from Mrs Jones who was located in the office under the house.
12. Mrs Jones was not an engineer. She was therefore unable to make a direct contribution to the work of the business. But the applicant said she provided extensive administrative support. The applicant says he was often out in the field providing advice and assistance to clients. Someone had to answer the phone, collect and open the mail, attend to the accounts and perform a range of other tasks that were essential to the operation of the business, and that would leave the applicant free to attend to the high-value tasks for which he was trained. His wife typed and proof-read reports and other correspondence the applicant wrote. She would also transcribe the applicant’s notes made in the field. She provided a sounding board for her husband and she ran errands. Performing these tasks amounted to a real and important contribution to the successful operation of the family business.
13. Mrs Jones also ran an Amway distributorship from the office. It was suggested this was a full-time business, but Mr Jones confirmed in his evidence that was not the case. Mr Jones did the presentations to potential customers, while his wife attended to the rest of the business, which included ordering and delivering products (although Mr Jones occasionally delivered products after hours as well). The applicant and his wife confirmed Mrs Jones was also a home-maker. The couple did not like to engage baby-sitters, and they wanted one of them to be available to their teenage daughters at all times.
14. Of course, one cannot simply have regard to the list of Mrs Jones’ duties in isolation. Even if she was not actively involved in typing or doing other tasks, she was required to be available in case a client or potential client called, or in case Mr Jones rang. Mr Jones relied on his wife. While he probably could have done much of the work himself, his work practices were developed on the assumption that his wife would be available to assist him whenever he needed it.
15. Mr Hack acknowledged it was difficult to provide a precise estimate of the amount of time devoted to Pajengco’s activities each week. After hearing the applicant and his wife describe Mr Jones’ duties, and taking into account the amount of time that would have been devoted to Alimeg Innovations (the Amway business), and the fact that Mrs Jones was also a full-time home-maker, I am not convinced Mrs Jones worked an average of 20 hours each week on Pajengco business. But the real figure is not far short of that. She did have a number of regular tasks to perform, such as collecting the mail and processing the paperwork, and she was required to be available to take phone calls and run errands. In all the circumstances, I think it is likely that around 15 hours each week was devoted to Pajengco.

THE LAW WITH RESPECT TO THE DEDUCTION FOR PAYMENTS MADE TO MRS JONES

16. Mr Robertson pointed out in his submissions that at least two steps had to be taken before the deduction could be said to be allowable. Firstly, it was necessary to determine whether or not the payments are of a private or domestic nature. If they are, they would be excluded under s 51(1) of ITAA36 and ss 8-1 and 8-2 of the Income Tax Assessment Act 1997 (the ITAA97). Secondly, even if the payments were deductible, the payments must not exceed a reasonable amount within the meaning of s 65 of ITAA36 and s 26-35 of ITAA97.
17. I turn firstly to the treatment of the outgoings for the purposes of s 51(1) ITAA36 and ss 8-1 and 8-2. If it were simply a matter of examining the applicant’s subjective purpose, I would have little difficulty: he believed the outgoings were incurred in carrying on a business. I am satisfied from his evidence that he believed his wife’s contribution was made in a business-like way. It was not a domestic arrangement, and he did not treat it or think of it as such. I am satisfied from his evidence that he was not merely seeking to “advance his wife’s finances”: cf Beaumont J in Federal Commissioner of Taxation v McDonald (1987) 18 ATR 957 at 970. He genuinely regarded his wife’s administrative contribution as essential to the commercial success of the business. The payments made to Mrs Jones were made to earn assessable income. It is less clear whether he viewed his daughters’ contribution in the same light.
18. Several cases explore the circumstances in which the taxpayer’s subjective purpose or motive (these expressions might not be synonyms: see Magna Alloys and Research Pty Ltd v Federal Commissioner of Taxation [1980] FCA 150; (1980) 11 ATR 276 at 278-279 per Brennan J) can be taken into consideration. The discussion is confusing. It seems obvious that many matters, including the taxpayer’s parol evidence, go to establish whether or not, on an objective view, the expense was incurred “in gaining or producing...assessable income”. (For a detailed discussion of purpose in this context, see Corkery, “Section 51(1) – The Rock of ‘Purpose’ Amid Storms of ‘Form’ and Waves of Inconsistency” (1984) Taxation Convention Papers, Tax Institute of Australia, pp 16-24). Even so, the effect of the decisions of the High Court in John v Federal Commissioner of Taxation [1989] HCA 5; (1989) 20 ATR 1 and Fletcher v Federal Commissioner of Taxation [1991] HCA 42; (1991) 173 CLR 1 and of the Federal Court in Magna Alloys appears to be that subjective purpose would ordinarily only be relevant if the transaction or outgoing in question cannot on its face be readily characterised as being undertaken for a business purpose.
19. Mrs Jones was acting as her husband’s administrative assistant on a part-time basis. Given his work habits, the applicant would have employed an assistant if Mrs Jones had not been available. Alternatively, the applicant might have changed his work practices, but it is not for the Commissioner or the Tribunal to tell him how to do his job. As Williams J explained in Tweddle v Federal Commissioner of Taxation [1942] HCA 40; (1942) 7 ATD 186 at 190:

“It is not suggested that it is the function of the income tax Acts or of those who administer them to dictate to taxpayers in what business they shall engage or how to run their business profitably or economically.”

This is the admirable Toohey principle, discussed by Ferguson J in Toohey’s Ltd v Commissioner of Taxation (1922) 22 (SR)NSW 432 at 440-441. Mrs Jones made a real contribution that assisted the applicant to earn assessable income. She made that contribution in a business-like way on a daily basis from a dedicated office in the downstairs area of the family home. While I am not ultimately satisfied the daughters’ contribution can be seen in the same light, I accept the payments made to Mrs Jones would give rise to an allowable deduction under s 51(1) ITAA36 and s 8-1 ITAA97.

20. The second issue is whether the amounts paid were unreasonable under s 65 of ITAA36 and its equivalent at s 26-35 of ITAA97. Mr Robertson conceded during the course of the hearing that an amount of $15 per hour was reasonable. In his written submissions, he said that payment of $300 each week (the amount the applicant has claimed) to Mrs Jones to answer the phone in her home was unreasonable. He relied on the decision of Menzies J in Stewart v Federal Commissioner of Taxation (1973) 3 ATR 603. In that case, his Honour said it was unreasonable to claim a deduction in respect of money paid to the wife for answering the phone when she was at home and might be expected to answer the phone in any case. It was clear Mrs Jones was expected to do more in the administration of the business than answer the phone. She performed a range of activities. I am satisfied from her evidence that when she undertook those activities, she was “at work”, albeit within the physical environment of the home. While she was also a home-maker, I do not accept her work for her husband could be treated as if it were a mere distraction from the vacuuming and other domestic tasks. It follows I accept that the payment of $15 per hour for 15 hours of work each week is reasonable in the circumstances. This is a total of $225 per week, less by $75 than the taxpayer’s claim of $300.

SHOULD PENALTIES BE IMPOSED IN LIGHT OF THE SHORTFALL?

21. The respondent says that a penalty is properly imposed under any one of ss 226G, 226H, 226K and 226L.
22. I turn firstly to the arguments in relation to of ss 226G, 226H and 226K. All of these provisions deal with the taxpayer’s failure to comply with the taxation laws – whether because of a want of reasonable care (s 226G) or recklessness (s 226H), or because of an unarguable interpretation (s 226K).
23. The problem in this case has arisen because the applicant’s assessment proceeded on the basis he was in partnership with his wife. The provisions of the Partnership Act 1891 (Qld) appear to be satisfied, and (subject to the respondent’s point about the partnership being entered into for the dominant purpose of splitting income) there was nothing irregular about the way the applicant approached the assessment. But it is illegal for the applicant to practice in partnership with his wife because of the operation of the Professional Engineers Act 1988 (Qld). It could therefore be argued the tax shortfall arose because of a failure to comply with state legislation rather than the taxation legislation. That argument must be considered in light of the fact the provisions are penalty provisions, and are therefore interpreted strictly: see Broome v Chenoweth [1946] HCA 53; (1946) 73 CLR 583 at 597-598 per Dixon CJ.
24. How does that argument fare in relation to s 226G? The section provides:

“Subject to this Part, if:
(a) a taxpayer has a tax shortfall for a year; and
(b) the shortfall or part of it was caused by the failure of the taxpayer or of a registered tax agent to take reasonable care to comply with this Act or the regulations;
the taxpayer is liable to pay, by way of penalty, additional tax equal to 25% of the amount of the shortfall or part.”

25. I accept the applicant’s decision to enter into a partnership in contravention of the Professional Engineers Act 1988 was the product of a want of reasonable care. Mr Jones or his legal advisers probably should have known of the prohibition. But their negligence lies in the failure to observe the provisions of the Professional Engineers Act, not the taxation legislation. The fact the negligence resulted in a taxation shortfall because everyone proceeded on the mistaken basis there was a valid partnership does not amount to a contravention of s 226G.
26. I do not accept that s 226K applies in this case in any event. Section 226K refers to conduct that is reckless. Recklessness means more than mere carelessness. It incorporates an element of rashness or heedlessness. The Court concluded in Reed (Albert E) and Co Ltd v London and Rochester Trading Co Ltd [1954] 2 Lloyds Rep 463 at 475 per Devlin J that recklessness “means deliberately running an unjustifiable risk”. Mr Jones’ conduct in submitting his tax return for assessment on the basis that he was in partnership was not rash or heedless. The prohibition on entering into partnerships was apparently not widely known: Mr Jones was not aware of it, and – as Mr Hack pointed out – the DMR neither knew nor cared. He added that the applicant and the respondent only became aware of the problem a matter of days before the hearing, notwithstanding extensive research. In order to qualify as reckless conduct, I think it would be necessary to conclude Mr Jones knew of the prohibition and disregarded it, or was wilfully ignorant of the existence of the prohibition. The evidence does not justify that conclusion.
27. The wording of s 226K is subtly different to the other provisions. The section says:

“Subject to this Part, if:
(a) a taxpayer has a tax shortfall for a year; and
(b) the shortfall or part of it was caused by the taxpayer, in a taxation statement, treating an income tax law as applying in relation to a matter or identical matters in a particular way; and
(c) the shortfall or part, as the case may be, so caused exceeded whichever is the higher of:
(i) $10,000; or
(ii) 1% of the taxpayer's return tax for that year; and
(d) when the statement was made, it was not reasonably arguable that the way in which the application of the law was treated was correct;
the taxpayer is liable to pay, by way of penalty, additional tax equal to 25% of the amount of the shortfall or part.”

28. The section addresses taxpayers who rely on bad (as opposed to legitimate, but ultimately incorrect) legal arguments. The explanatory memorandum accompanying the Taxation Laws (Self-Assessment) Bill 1992 recognises the possibility the section might not apply if the legal conclusions are based on incorrect assumptions about the primary facts. (The Tribunal may legitimately have regard to the explanatory memorandum by reason of s 15AB(2)(e) of the Acts Interpretation Act 1901 (Cth)). Penalties may apply in some cases: the Explanatory Memorandum says (at p 83) penalties may apply under the section in relation to “a question of interpretation (including a conclusion of fact, for example, whether the taxpayer is carrying on a business)...”.. The challenge, then, is to determine which errors of fact will attract the operation of the section. What of the applicant’s claim that he should be treated as if he were practising in partnership?
29. One determines whether or not a partnership exists as a matter of fact by interpreting and applying the provisions of the Partnership Act 1891 and the general law to a set of primary facts. In this case, the terms of the Professional Engineers Act 1988 were also relevant. The process is similar to the process one adopts if one is attempting to determine as a matter of fact whether the taxpayer is conducting a business. The only distinction is that the question of whether or not the taxpayer is conducting a business is determined directly under the taxation laws, as opposed to the law of partnership that has its own sphere of operation. I do not accept that is a relevant difference.
30. If it is accepted there is no partnership, the applicant’s argument that he ought to be assessed on the basis he was a member of a partnership collapses. In those circumstances, a penalty may be imposed under s 226K.
31. That leaves the question of a penalty under s 226L. The section provides:

“Subject to this Part, if:
(a) a taxpayer has a tax shortfall for a year; and
(b) the shortfall or part of it was caused by the taxpayer in a taxation statement treating an income tax law as applying in relation to a scheme in a particular way; and
(c) the scheme was a tax avoidance scheme within the meaning of subsection 224(1); and
(d) none of the scheme sections applies in relation to the scheme;
the taxpayer is liable to pay, by way of penalty, additional tax equal to:
(e) if, when the statement was made, it was reasonably arguable that the way in which the application of the law was treated was correct - 25% of the amount of the shortfall or part; or
(f) in any other case - 50% of the amount of the shortfall or part.”

32. The section strikes at tax avoidance schemes that have not been caught under the anti-avoidance provisions in ss 224, 225 or 226. Section 224 defines a tax avoidance scheme as follows:

“tax avoidance scheme means a scheme within the meaning of Part IVA that was entered into or carried out for the sole or dominant purpose of enabling a person to pay no tax or less tax.”

33. I have some trouble with the suggestion a partnership is a scheme within the meaning of s 177A. The label “partnership” is used to describe a state of affairs– specifically, a partnership is “a relation which subsists between persons carrying on a business in common with a view of profit”: s 5, Partnership Act 1891 (Qld). If the parties satisfy the test, it is a partnership regardless of how they describe it or see it: see, for example, Playfair Development Corp Pty Ltd v Ryan [1969] 2 NSWR 661 at 666 per Street CJ. If the partnership exists as a matter of legal fact, then all the rights and obligations created by the Partnership Act and the general law also apply. That will include the obligation imposed by the tax laws to submit a partnership tax return.
34. Yet a partnership (or, more accurately, the state of cooperation recognised by the Partnership Act as constituting a partnership) is ultimately the product of an agreement. Given the definition of scheme in s 177A(1) extends (at s 177A(1)(b)) to a “course of action or course of conduct”, I accept that a partnership can constitute a scheme within the meaning of the legislation. I do so with some reluctance, given the explanatory memorandum accompanying the introduction of Part IVA suggests that arrangements of this nature are not caught by the legislation: see Explanatory Memorandum to the Income Tax Laws Amendment Bill (No 2) 1981 at p 3.
35. One consequence of this extended view of scheme is some potentially odd results if one undertakes the analysis required under s 177C. I am troubled by the argument that the applicant and his wife received a tax benefit. If you accept (as I do) that Mr and Mrs Jones carried on a business in common with a view of profit, then s 177C really requires me to ask:

“Would an additional amount have been included in the applicant’s tax if he had not been carrying on a business in common with his wife with a view of profit?”

36. The short answer to the question is undoubtedly “yes”, but is a curious question given my finding the applicant and his wife in fact carried on a business in common with a view of profit. They did not attempt to dress up their conduct so that it appeared to be what it was not, or adopt formal arrangements that were designed to lend the facts a certain colour. There was nothing artificial in the way they reported their conduct to the Commissioner. If they had not carried on a business in common, or did not do so with a view of profit, they would not be entitled to have the income assessed on the basis it is a partnership.
37. Having said that, I acknowledge that the wording of the legislation is cast in broad terms. In light of the High Court’s approach to commercial transactions in cases like Federal Commissioner of Taxation v Spotless Services Ltd [1996] HCA 34; (1996) 141 ALR 92, I must accept there is a tax benefit in this case.
38. In order to determine whether it is a tax avoidance scheme (or would have been, had the attempt to create a partnership been effective), it is necessary to decide whether the scheme was entered into for the dominant purpose of obtaining a tax benefit.
39. The High Court discussed the concept of dominant purpose in its decision in Spotless.. In a joint judgment, Brennan CJ, Dawson, Toohey, Gaudron, Gummow and Kirby JJ explained (at 98):

“Much turns upon the identification, among various purposes, of that which is ‘dominant’.. In its ordinary meaning, dominant indicates that purpose which was the ruling, prevailing, or most influential purpose.”

40. I have already observed I am satisfied that Mr Jones’ subjective purpose in going into partnership with his wife (that is, carry on a business in common with a view of profit) was to make a statement about his relationship with Mrs Jones. I am satisfied from his evidence (and from the absence of evidence suggesting he obtained extensive advice about how to minimise his tax) that obtaining a tax advantage was not a high priority for him, although the prospect of a tax advantage was probably considered a welcome incidental benefit as it is or can be in almost any business entity or business relationship. But s 177D says the taxpayer’s purpose must be determined having regard to the factors set out in s 177D(b). Moreover, the court is required to adopt an objective view of the facts and determine how a reasonable person would view the taxpayer’s purpose in light of the matters referred to in s 177D(b). As the High Court explained in Spotless (at 102):

“In the present case, the question is whether, having regard, as objective facts, to the matters answering the description in [s177D(b)], a reasonable person would conclude that the taxpayers entered into or carried out the scheme for the dominant purpose of enabling the taxpayers to obtain a tax benefit in connection with the scheme.”

41. Does that mean the taxpayer’s subjective purpose is irrelevant? I have already observed I am satisfied the taxpayer’s real reason for choosing this form of arrangement was a personal or idiosyncratic one that had little to do with obtaining a tax benefit. Regrettably, the scheme of Part IVA does not permit the Tribunal to consider the subjective or actual purpose of the taxpayer when making its assessment of the taxpayer’s “dominant purpose” within the meaning of s 177D: Eastern Nitrogen Ltd v Federal Commissioner of Taxation [2001] FCA 366; (2001) 188 ALR 415 at 431 per Carr J.
42. The emphasis on objective evidence is probably inevitable. In more complicated transactions, for example, the taxpayer might otherwise be able to rely on his or her ignorance of tax matters to justify a transaction that was devised and implemented by professional advisers. That sort of ignorance cannot be used to avoid the reach of Part IVA. Thus in Federal Commissioner of Taxation v Consolidated Press Holdings Ltd [2001] HCA 32, the High Court said (at par 95) that the dominant purpose of a professional adviser might be attributed to the taxpayer.
43. In this case, the purpose of any of the taxpayer’s professional advisers is unclear. The taxpayer did not consult outside advisers in detail about what sort of arrangement he should enter into. If he had done so, he probably would not have made the unfortunate decision to adopt a form of business association that was not permitted in the circumstances.
44. The thrust of the Commissioner’s case is that - having regard to the eight factors set out in s 177D(b) – the applicant entered into a scheme (a partnership) for the purpose of obtaining a tax advantage. I think that submission is misconceived because it proceeds on a misunderstanding of the law of partnership. To illustrate the point, I will deal with the eight factors in s 177D in turn.

(i) the manner in which the scheme was entered into or carried out;

45. This inquiry is classically directed towards elaborate and wholly artificial arrangements, but it might also catch other arrangements. In this case, the applicant has chosen to adopt a common form of business association. Arguably, given the way he ran his affairs in company with his wife, the form of association chose him: if Mr and Mrs Jones carried on a business in common with a view of profit and therefore satisfied the statutory definition of a partnership in the Partnership Act 1891 (Qld), they are partners at law regardless of how they might describe themselves. I have already concluded that Mrs Jones made a real contribution to the business (albeit one that has now been characterised as a contribution by an employee in order to avoid the prohibition contained in the Professional Engineers Act 1988 (Qld)).

(ii) the form and substance of the scheme;

46. The scheme was a partnership in form. Mr Robertson for the Commissioner suggested Mrs Jones did not really make a contribution to the business – certainly not a contribution that was comparable to that made by the applicant. On that analysis, the scheme might not be considered to be a partnership in substance. I disagree. Partners do not have to make the same contribution to the firm. They routinely make different contributions to the business – one partner might contribute money, another brings client contacts, another invests her human capital (ie, labour). Those contributions might be grossly unequal, although one would ordinarily expect the inequality of contribution to be reflected in the distribution of profits from the firm amongst its members. It is true Mrs Jones’ contribution was of much less value than that of her husband, but that does not allow us to single out this partnership arrangement from many others. If the decision-maker accepts the parties are carrying on a business in common with a view of profit, then the arrangement is a partnership in form and in substance.

(iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;

47. This was not a one-off scheme entered into for a quick benefit. It was a way of conducting business over the longer term.

(iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;

48. The result would not be any different if Part IVA did not exist. If one accepts, as I do, that the applicant and his wife were in business in common with a view of profit, the Partnership Act 1891 deems them to be in partnership with each other. Unless they fall outside the definition of partnership in the income tax legislation, they would be taxed on the basis they were a partnership whether they liked it that way or not because the existence of a partnership is a legal fact. A problem has arisen in this case because other state legislation prohibits professionals practicing in partnership with non-professionals. But that has nothing to do with Part IVA.

(v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;

49. The taxpayer and his wife both improve their financial position by being partners because one consequence of being in partnership is the distribution of profits amongst the partners. Income splitting is almost certainly an advantage in circumstances like these where both of the partners are also married and living together in the one household..

(vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;

50. See discussion in relation to (v) above.

(vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and

51. Mrs Jones made a substantive contribution to the Pajengco partnership’s business. Bringing her into the business meant the taxpayer would have someone available to meet his business needs whenever they arose. The applicant could reasonably assume that his wife would be more flexible and accommodating and committed to the success of the business than a regular employee. Going into partnership with her also meant he was relieved of the obligation pay wages (as a partner, his wife would take the risk that the partnership would make money) and gave her an interest in the business, securing her future and that of their children. The reasonable person could undoubtedly identify other advantages that might accrue to spouses in their business and domestic arrangements from adopting this form of business association.

(viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi)...

52. See discussion in relation to (vii).
53. Having considered all the facts of the case in light of the matters referred to in s 177D(b), and without having regard to the taxpayer’s subjective purpose, I am satisfied neither he nor his wife entered into the partnership for the dominant purpose of obtaining a tax benefit. There is no evidence that professional advisers or anyone else had that purpose in mind when the Jones’ first went into the partnership together. There is no basis for imposing a penalty under s 226L.

CONCLUSION

54. The objection decision under review is set aside and the matter is remitted to the Commissioner for reconsideration in accordance with these reasons.
    

I certify that the 54 preceding paragraphs are a true copy of the reasons for the decision herein of Mr B J McCabe, Member

Signed: Sarah Oliver

Associate

Date of Hearing 4 July 2002

Date of Decision 31 January 2003

Counsel for the Applicant Mr P E Hack, SC

Solicitor for the Applicant McKays Solicitors

Counsel for the Respondent Mr M L Robertson

Solicitor for the Respondent ATO Legal Practice