Mullens v Federal Commissioner of Taxation
Encyclopedia
Mullens v Federal Commissioner of Taxation was a 1976
High Court of Australia
tax case concerning arrangements where stockbrokers Mullens & Co accessed tax deductions for monies subscribed to a petroleum exploration company. The Australian Taxation Office
held the scheme was tax avoidance
, but the court found for the taxpayer.
In the taxonomy of tax schemes, this was of the kind where a wholly intentional tax benefit is swapped or traded between taxpayers, from someone who can't make full use of it to someone who can.
The principal significance of the case today is its part in judicial interpretation of the section 260 anti-avoidance provisions of the Income Tax Assessment Act 1936
.
in fields in South Australia
and in south-western Queensland
. In August 1968 it formed a new company Vamgas NL
whose sole business would be that exploration. As a petroleum exploration company, monies subscribed for shares in Vamgas would be tax deductible under section 77A of the Income Tax Assessment Act 1936
as it stood at that time.
Vamgas shares had a par value of $0.50 each and Vam itself took up 5 million part paid to $0.10 each. Another 5 million, to be fully paid, were offered by way of a prospectus
; 3 million to Vam shareholders and 2 million reserved for clients of the underwriting stockbroker and certain other brokers (Mullens & Co was not one of them). The offer to the Vam shareholders was by way of non-renounceable rights, which meant they could take them up or let them lapse, but could not sell or transfer them to someone else.
Mr Close was chairman of the board
at Vam. He and his family and friends were substantial shareholders in Vam. They wanted to have an interest in the Vamgas, but couldn't afford to pay for their full allotment of shares (about 433,800, worth $216,900), and/or didn't have enough other income to make use of the tax deductions to be had by subscribing. Mullens & Co stockbrokers knew about the offer (and had had other dealings with Vam) and was in the opposite situation, it had access to funds and had income which it could usefully offset with deductions, but had no particular interest in Vamgas. Close worked with Mullens on the following mutually beneficial arrangement.
The Vam shareholders created trusts under which they took up their Vamgas rights and paid for their new shares with money provided by Mullens. The shares were in the names of those various Vam shareholders, but as trustee
s, with Mullens (or associates) the beneficial owners. Mullens granted those shareholders options
allowing them to buy the Vamgas shares, if they wished, for the issue price (ie. what Mullens had paid), any time until 15 May 1969 (that being a few months after the issue). The benefits of this scheme were,
In effect the Vam shareholders had swapped their potential tax deductions for a combination of short-term finance and protection against the share price falling. It seems Mullens wasn't too concerned about the latter possibility, and indeed Vamgas did rise when it listed on the stock exchange.
The Vam shareholders exercised their options on 14 May 1969, the day before expiry, and paid Mullens the $0.50 per share strike price. They got the money by selling some of their shares (having risen in price) or by selling some new further rights which Vamgas had issued. (Vamgas made a one-for-one rights issue shortly after listing, and under the option conditions such rights belonged to the option holder, ie. those Vam shareholders, not Mullens.)
One of the Vam shareholders, a Mrs Walser, had on 3 April 1969 sold (at a profit) the Vamgas shares she held in trust. This was, strictly speaking, before she exercised her option. Mullens was the selling broker and was obviously unconcerned by formalities of exercise dates, but it did cause Mr Bridges (a partner in Mullens) considerable embarrassment in court (below) because it gave the impression Mrs Walser regarded the shares as hers to trade, and on that basis maybe the trust documents were a sham and she was really the owner. The latter was what the Australian Taxation Office
contended.
s that it didn't need those it would get from section 77A by subscribing money to Vamgas. So instead it negotiated with Mullens on the following further transaction.
Mullens and several associates on 23 May 1969 bought 1,250,000 of Vam's $0.10 part-paid Vamgas shares, for the paid-up value of $125,000. Mullens agreed to give Vam first refusal to buy the shares back, at market price. A few weeks later, on 17 June 1969, they did indeed sell them back to Vam for $0.50 each (with Mullens paying the stamp duty
). This was just under the prevailing market price of $0.51.
The fact that the sale back to Vam was for exactly what Mullens had paid out seems to have been a happy coincidence, i.e. that the market price was exactly that amount at the time; the price later fell to $0.30.
It appears Vam gave up its potential tax benefit for no more than a three-week deferral of its payment on the Vamgas call. Such a small consideration might suggest there wasn't an active kind of market in trading such tax benefits.
At the initial trial in the Supreme Court of New South Wales
other transactions relating to share sales on capital versus income account were also decided, but they were not taken further and don't have a bearing on the Vam transactions and section 260.
In the Supreme Court the Australian Taxation Office
argued that either the two Vam transactions above were shams, or that if they were real then they came under the section 260 anti-avoidance provisions of the Income Tax Assessment Act 1936
.
A "sham" in this context would mean there was some different underlying arrangement between the parties, and the documents they made were never meant to be enforced (or worse, written or re-written after the fact). The actual arrangement the ATO posited was that Mullens had simply lent money.
Justice Sheppard agreed with the ATO, noting in particular Mrs Walser's dealings, and decided for the ATO as submitted, but without ruling on which alternative was the case (sham or section 260).
The High Court
instead found for the taxpayer in a 2-1 decision, with Chief Justice Barwick
and Justice Stephen
for the taxpayer, and Justice McTiernan
for the ATO.
McTiernan's judgement was that the transactions formally met the requirements of section 77A for deductibility, but that the only practical purpose of them was to relieve Mullens from tax liabilities and hence they came under section 260 as altering the incidence of taxation. (This judgement meant he didn't need to consider the alternative that the transactions might have been a sham.)
Barwick and Stephen on the other hand firstly disagreed with Justice Sheppard's initial conclusion that the transactions could have been shams, finding the documentation and negotiations between the parties ample. They noted in particular that Mullens didn't get the "two-way" option it had wanted (the right to force the Vam shareholders to buy back), so there was a real commercial risk being borne.
Both justices then also disagreed with Sheppard and with McTiernan that section 260 applied. Their view was that section 77A was unequivocal about giving a tax benefit to those who subscribed for petroleum shares, like Mullens had. They noted there were no extra conditions in that section to be fulfilled (though perhaps there ought to have been for instance a minimum holding period).
So with Mullens satisfying the requirements of a section of the act, applying section 260 would take away something the act explicitly gave. Stephen noted Justice Menzies
in Ellers Motor Sales Pty Ltd v Federal Commissioner of Taxation (1969) who said it could not be that an advantage in one part of the act "was given merely to be taken away by the operation of s.260".
The decision here that section 260 did not apply extended the prior "choice principle" from Keighery v Federal Commissioner of Taxation. That case allowed the taxpayer to choose between two alternatives in the act, the Mullens decision allowed a taxpayer to enter a particular set of circumstances described by the act for the purpose of gaining the effects it described, even if those effects were beneficial. This latter principle was subsequently used in cases such as Cridland
.
was repealed before the court cases, that tax concession having apparently served its purpose.
A not dissimilar example of tax benefit shifting came with dividend imputation
in the 1990s. Foreigners were unable to use the imputation credits and so instead "sold" them to Australian institutions by transferring the shares to them just across the dividend record date. General anti-avoidance provisions didn't apply, because both party's taxable incomes increased! A holding period rule of the kind alluded to by Barwick and Stephen above had to be instituted.
High Court of Australia
High Court of Australia
The High Court of Australia is the supreme court in the Australian court hierarchy and the final court of appeal in Australia. It has both original and appellate jurisdiction, has the power of judicial review over laws passed by the Parliament of Australia and the parliaments of the States, and...
tax case concerning arrangements where stockbrokers Mullens & Co accessed tax deductions for monies subscribed to a petroleum exploration company. The Australian Taxation Office
Australian Taxation Office
The Australian Taxation Office is an Australian Government statutory agency and the principal revenue collection body for the Australian Government. The ATO has responsibility for administering the Australian federal taxation system and superannuation legislation...
held the scheme was tax avoidance
Tax avoidance
Tax avoidance is the legal utilization of the tax regime to one's own advantage, to reduce the amount of tax that is payable by means that are within the law. The term tax mitigation is a synonym for tax avoidance. Its original use was by tax advisors as an alternative to the pejorative term tax...
, but the court found for the taxpayer.
In the taxonomy of tax schemes, this was of the kind where a wholly intentional tax benefit is swapped or traded between taxpayers, from someone who can't make full use of it to someone who can.
The principal significance of the case today is its part in judicial interpretation of the section 260 anti-avoidance provisions of the Income Tax Assessment Act 1936
Income Tax Assessment Act 1936
Income Tax Assessment Act 1936 is an act of the Parliament of Australia. It's one of the main statutes under which income tax is calculated. The act is gradually being rewritten into the Income Tax Assessment Act 1997, and new matters are generally now added to the 1997 act.The reason for...
.
Transaction 1
In 1968 a company called Vam Limited proposed to explore for natural gasNatural gas
Natural gas is a naturally occurring gas mixture consisting primarily of methane, typically with 0–20% higher hydrocarbons . It is found associated with other hydrocarbon fuel, in coal beds, as methane clathrates, and is an important fuel source and a major feedstock for fertilizers.Most natural...
in fields in South Australia
South Australia
South Australia is a state of Australia in the southern central part of the country. It covers some of the most arid parts of the continent; with a total land area of , it is the fourth largest of Australia's six states and two territories.South Australia shares borders with all of the mainland...
and in south-western Queensland
Queensland
Queensland is a state of Australia, occupying the north-eastern section of the mainland continent. It is bordered by the Northern Territory, South Australia and New South Wales to the west, south-west and south respectively. To the east, Queensland is bordered by the Coral Sea and Pacific Ocean...
. In August 1968 it formed a new company Vamgas NL
No liability
A no-liability company in Australia is a company which, under the Corporations Act 2001 , must have as its stated objects that it is solely a mining company and that it is not entitled to calls on the unpaid issue price of shares...
whose sole business would be that exploration. As a petroleum exploration company, monies subscribed for shares in Vamgas would be tax deductible under section 77A of the Income Tax Assessment Act 1936
Income Tax Assessment Act 1936
Income Tax Assessment Act 1936 is an act of the Parliament of Australia. It's one of the main statutes under which income tax is calculated. The act is gradually being rewritten into the Income Tax Assessment Act 1997, and new matters are generally now added to the 1997 act.The reason for...
as it stood at that time.
Vamgas shares had a par value of $0.50 each and Vam itself took up 5 million part paid to $0.10 each. Another 5 million, to be fully paid, were offered by way of a prospectus
Prospectus (finance)
In finance, a prospectus is a document that describes a financial security for potential buyers. A prospectus commonly provides investors with material information about mutual funds, stocks, bonds and other investments, such as a description of the company's business, financial statements,...
; 3 million to Vam shareholders and 2 million reserved for clients of the underwriting stockbroker and certain other brokers (Mullens & Co was not one of them). The offer to the Vam shareholders was by way of non-renounceable rights, which meant they could take them up or let them lapse, but could not sell or transfer them to someone else.
Mr Close was chairman of the board
Chairman of the Board
The Chairman of the Board is a seat of office in an organization, especially of corporations.Chairman of the Board may also refer to:*Chairman of the Board , a 1998 film*Chairmen of the Board , a 1970s American soul music group...
at Vam. He and his family and friends were substantial shareholders in Vam. They wanted to have an interest in the Vamgas, but couldn't afford to pay for their full allotment of shares (about 433,800, worth $216,900), and/or didn't have enough other income to make use of the tax deductions to be had by subscribing. Mullens & Co stockbrokers knew about the offer (and had had other dealings with Vam) and was in the opposite situation, it had access to funds and had income which it could usefully offset with deductions, but had no particular interest in Vamgas. Close worked with Mullens on the following mutually beneficial arrangement.
The Vam shareholders created trusts under which they took up their Vamgas rights and paid for their new shares with money provided by Mullens. The shares were in the names of those various Vam shareholders, but as trustee
Trustee
Trustee is a legal term which, in its broadest sense, can refer to any person who holds property, authority, or a position of trust or responsibility for the benefit of another...
s, with Mullens (or associates) the beneficial owners. Mullens granted those shareholders options
Option (finance)
In finance, an option is a derivative financial instrument that specifies a contract between two parties for a future transaction on an asset at a reference price. The buyer of the option gains the right, but not the obligation, to engage in that transaction, while the seller incurs the...
allowing them to buy the Vamgas shares, if they wished, for the issue price (ie. what Mullens had paid), any time until 15 May 1969 (that being a few months after the issue). The benefits of this scheme were,
- Mullens got a tax deductionTax deductionIncome tax systems generally allow a tax deduction, i.e., a reduction of the income subject to tax, for various items, especially expenses incurred to produce income. Often these deductions are subject to limitations or conditions...
for the $216,900 subscribed to Vamgas. But assuming the Vam shareholders did exercise their options, then Mullens got all that money back, its only actual expense would be interestInterestInterest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....
on the money for the short period until exercise (they financed with a bank overdraftOverdraftAn overdraft occurs when money is withdrawn from a bank account and the available balance goes below zero. In this situation the account is said to be "overdrawn". If there is a prior agreement with the account provider for an overdraft, and the amount overdrawn is within the authorized overdraft...
).
- The Vam shareholders got any market price rise above the issue price of the new Vamgas shares, with no cash outlay or risk.
In effect the Vam shareholders had swapped their potential tax deductions for a combination of short-term finance and protection against the share price falling. It seems Mullens wasn't too concerned about the latter possibility, and indeed Vamgas did rise when it listed on the stock exchange.
The Vam shareholders exercised their options on 14 May 1969, the day before expiry, and paid Mullens the $0.50 per share strike price. They got the money by selling some of their shares (having risen in price) or by selling some new further rights which Vamgas had issued. (Vamgas made a one-for-one rights issue shortly after listing, and under the option conditions such rights belonged to the option holder, ie. those Vam shareholders, not Mullens.)
One of the Vam shareholders, a Mrs Walser, had on 3 April 1969 sold (at a profit) the Vamgas shares she held in trust. This was, strictly speaking, before she exercised her option. Mullens was the selling broker and was obviously unconcerned by formalities of exercise dates, but it did cause Mr Bridges (a partner in Mullens) considerable embarrassment in court (below) because it gave the impression Mrs Walser regarded the shares as hers to trade, and on that basis maybe the trust documents were a sham and she was really the owner. The latter was what the Australian Taxation Office
Australian Taxation Office
The Australian Taxation Office is an Australian Government statutory agency and the principal revenue collection body for the Australian Government. The ATO has responsibility for administering the Australian federal taxation system and superannuation legislation...
contended.
Transaction 2
A second similar transaction took place in May 1969, this time between the Vam company itself and the Mullens group. Vam had to pay the $0.40 balance of its part-paid Vamgas shares, but it had enough of its own tax deductionTax deduction
Income tax systems generally allow a tax deduction, i.e., a reduction of the income subject to tax, for various items, especially expenses incurred to produce income. Often these deductions are subject to limitations or conditions...
s that it didn't need those it would get from section 77A by subscribing money to Vamgas. So instead it negotiated with Mullens on the following further transaction.
Mullens and several associates on 23 May 1969 bought 1,250,000 of Vam's $0.10 part-paid Vamgas shares, for the paid-up value of $125,000. Mullens agreed to give Vam first refusal to buy the shares back, at market price. A few weeks later, on 17 June 1969, they did indeed sell them back to Vam for $0.50 each (with Mullens paying the stamp duty
Stamp duty
Stamp duty is a tax that is levied on documents. Historically, this included the majority of legal documents such as cheques, receipts, military commissions, marriage licences and land transactions. A physical stamp had to be attached to or impressed upon the document to denote that stamp duty...
). This was just under the prevailing market price of $0.51.
The fact that the sale back to Vam was for exactly what Mullens had paid out seems to have been a happy coincidence, i.e. that the market price was exactly that amount at the time; the price later fell to $0.30.
It appears Vam gave up its potential tax benefit for no more than a three-week deferral of its payment on the Vamgas call. Such a small consideration might suggest there wasn't an active kind of market in trading such tax benefits.
Court
A total of eleven cases that went before the courts, involving different companies associated with the Mullens stockbroking group, but they all had the same facts and so just Mullens was considered, with the rest agreed by the parties to follow the judgement of that one.At the initial trial in the Supreme Court of New South Wales
Supreme Court of New South Wales
The Supreme Court of New South Wales is the highest state court of the Australian State of New South Wales...
other transactions relating to share sales on capital versus income account were also decided, but they were not taken further and don't have a bearing on the Vam transactions and section 260.
In the Supreme Court the Australian Taxation Office
Australian Taxation Office
The Australian Taxation Office is an Australian Government statutory agency and the principal revenue collection body for the Australian Government. The ATO has responsibility for administering the Australian federal taxation system and superannuation legislation...
argued that either the two Vam transactions above were shams, or that if they were real then they came under the section 260 anti-avoidance provisions of the Income Tax Assessment Act 1936
Income Tax Assessment Act 1936
Income Tax Assessment Act 1936 is an act of the Parliament of Australia. It's one of the main statutes under which income tax is calculated. The act is gradually being rewritten into the Income Tax Assessment Act 1997, and new matters are generally now added to the 1997 act.The reason for...
.
A "sham" in this context would mean there was some different underlying arrangement between the parties, and the documents they made were never meant to be enforced (or worse, written or re-written after the fact). The actual arrangement the ATO posited was that Mullens had simply lent money.
Justice Sheppard agreed with the ATO, noting in particular Mrs Walser's dealings, and decided for the ATO as submitted, but without ruling on which alternative was the case (sham or section 260).
The High Court
High Court of Australia
The High Court of Australia is the supreme court in the Australian court hierarchy and the final court of appeal in Australia. It has both original and appellate jurisdiction, has the power of judicial review over laws passed by the Parliament of Australia and the parliaments of the States, and...
instead found for the taxpayer in a 2-1 decision, with Chief Justice Barwick
Garfield Barwick
Sir Garfield Edward John Barwick, was the Attorney-General of Australia , Minister for External Affairs and the seventh and longest serving Chief Justice of Australia...
and Justice Stephen
Ninian Stephen
Sir Ninian Martin Stephen, is a retired politician and judge, who served as the 20th Governor-General of Australia and as a Justice in the High Court of Australia.-Early life:...
for the taxpayer, and Justice McTiernan
Edward McTiernan
Sir Edward Aloysius McTiernan, KBE , was an Australian jurist, lawyer and politician. He served as an Australian Labor Party member of both the New South Wales Legislative Assembly and federal House of Representatives before being appointed to the High Court of Australia in 1930...
for the ATO.
McTiernan's judgement was that the transactions formally met the requirements of section 77A for deductibility, but that the only practical purpose of them was to relieve Mullens from tax liabilities and hence they came under section 260 as altering the incidence of taxation. (This judgement meant he didn't need to consider the alternative that the transactions might have been a sham.)
Barwick and Stephen on the other hand firstly disagreed with Justice Sheppard's initial conclusion that the transactions could have been shams, finding the documentation and negotiations between the parties ample. They noted in particular that Mullens didn't get the "two-way" option it had wanted (the right to force the Vam shareholders to buy back), so there was a real commercial risk being borne.
Both justices then also disagreed with Sheppard and with McTiernan that section 260 applied. Their view was that section 77A was unequivocal about giving a tax benefit to those who subscribed for petroleum shares, like Mullens had. They noted there were no extra conditions in that section to be fulfilled (though perhaps there ought to have been for instance a minimum holding period).
So with Mullens satisfying the requirements of a section of the act, applying section 260 would take away something the act explicitly gave. Stephen noted Justice Menzies
Douglas Menzies
Sir Douglas Ian Menzies KBE , Australian judge, was a Justice of the High Court of Australia.-Biography:Menzies was born in Ballarat, Victoria, in 1907. He was educated at Hobart High School and Devonport High School in Tasmania, before returning to Victoria to study at the University of Melbourne...
in Ellers Motor Sales Pty Ltd v Federal Commissioner of Taxation (1969) who said it could not be that an advantage in one part of the act "was given merely to be taken away by the operation of s.260".
The decision here that section 260 did not apply extended the prior "choice principle" from Keighery v Federal Commissioner of Taxation. That case allowed the taxpayer to choose between two alternatives in the act, the Mullens decision allowed a taxpayer to enter a particular set of circumstances described by the act for the purpose of gaining the effects it described, even if those effects were beneficial. This latter principle was subsequently used in cases such as Cridland
Cridland v Federal Commissioner of Taxation
Cridland v Federal Commissioner of Taxation was a 1977 High Court of Australia case concerning a novel tax scheme whereby some 5,000 university students became primary producers for tax purposes, allowing them certain income averaging benefits...
.
Subsequently
Section 77A of the ITAA 1936Income Tax Assessment Act 1936
Income Tax Assessment Act 1936 is an act of the Parliament of Australia. It's one of the main statutes under which income tax is calculated. The act is gradually being rewritten into the Income Tax Assessment Act 1997, and new matters are generally now added to the 1997 act.The reason for...
was repealed before the court cases, that tax concession having apparently served its purpose.
A not dissimilar example of tax benefit shifting came with dividend imputation
Dividend imputation
Dividend imputation is a corporate tax system in which some or all of the tax paid by a company may be attributed, or imputed, to the shareholders by way of a tax credit to reduce the income tax payable on a distribution...
in the 1990s. Foreigners were unable to use the imputation credits and so instead "sold" them to Australian institutions by transferring the shares to them just across the dividend record date. General anti-avoidance provisions didn't apply, because both party's taxable incomes increased! A holding period rule of the kind alluded to by Barwick and Stephen above had to be instituted.