Federal Commissioner of Taxation v Peabody
Encyclopedia
Federal Commissioner of Taxation v Peabody was a 1994 High Court of Australia
tax case concerning certain transactions made by the Peabody family business. The Australian Taxation Office
(ATO) sought to apply the Part IVA
general anti-avoidance provisions of the
Income Tax Assessment Act 1936
.
The case was decided in favour of the taxpayer Mary Peabody, on the slightly technical grounds that there wasn't a reasonable expectation she would have received the income in question (from the family trust) in the year and under the interpretation asserted by the ATO.
The significance of the case today, and the reason it's frequently cited, is principally its place in judicial interpretation of Part IVA. The ATO in particular didn't regard the case as a complete loss, they took remarks in the judgements as confirming their interpretation of that legislation.
, also known as pozzolan
, used in concrete
. It was a set of four companies, called the Pozzolanic Group. Kleinschmidt owned 38%, and the Peabody family owned 62%, through a family trust. The trustee was a company of which husband and wife Terence and Mary Peabody were directors, and the beneficiaries were Mary Peabody and their two sons.
Terence Peabody had planned for some time to buy Kleinschmidt's share then float 50% of the total business on the Australian Stock Exchange
. In late 1985 he and Kleinschmidt reached an agreement where Kleinschmidt would sell his shares for $8.6 million, an amount which was based on a business valuation and which was to remain confidential. Instead of Terence Peabody or the family trust buying out Kleinschmidt directly, the transaction was structured as follows.
The Peabody trust bought a shelf company called Loftway and Kleinschmidt sold his shares to it for the agreed $8.6 million. The Peabodys (now 100% owners) then had the Pozzolanic group companies convert those shares to "Z class" and restrict their rights, rendering them worthless. The shares the Peabody trust owned were then all that remained, a 100% interest in the business (apart from a few owned by Terence Peabody in his own name).
The money to pay Kleinschmidt was provided by Westpac Bank subscribing for $8.6 million worth of Loftway preference shares. The interest
on them was obtained from the Pozzolanic companies paying dividend
s to Loftway, which in turn paid dividends to Westpac. The capital was repaid after the float when the Peabody trust lent $8.6 million from the float proceeds to Loftway in order for it to redeem Westpac's shares. That loan was subsequently forgiven by the trust.
This indirect structure had three apparent purposes,
The last point is a little unclear. Perhaps it was that Loftway's ownership of Pozzolanic shares was not an income producing purpose, so plain interest payments would not be tax deductible. If so then that would be in a sense a consequence of using Loftway, rather than an independent rationale for the structure.
(ATO) took the view that the mechanism was a tax avoidance
scheme, a scheme which came under Part IVA of the Income Tax Assessment Act 1936
. The ATO treated the transaction as Kleinschmidt selling to the Peabody trust, and then on-selling to the public in the float, making a profit of the difference. This was a capital gain, and the 1/3 of that attributable to Mary Peabody as trust beneficiary was $888,005. The ATO added that to her return for the year ending 30 June 1986.
Mary Peabody lodged an objection to the ATO assessment, which the ATO disallowed. She then asked the ATO to refer it to the Federal Court
(as any taxpayer may do). Her argument was that the transaction was structured as it was for the commercial reasons of confidentiality and the cost of financing, as described above.
Justice O'Loughlin in the Federal Court
agreed with the ATO that the devaluation to Z-class shares was a scheme, and considered the argument about non-disclosure to be a "red herring".
Mrs Peabody appealed to the full bench of the court, and they instead considered the transfer, financing and float together, and found for her. The ATO went to the High Court
, which upheld the full bench decision.
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 certain transactions made by the Peabody family business. 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...
(ATO) sought to apply the Part IVA
general 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...
.
The case was decided in favour of the taxpayer Mary Peabody, on the slightly technical grounds that there wasn't a reasonable expectation she would have received the income in question (from the family trust) in the year and under the interpretation asserted by the ATO.
The significance of the case today, and the reason it's frequently cited, is principally its place in judicial interpretation of Part IVA. The ATO in particular didn't regard the case as a complete loss, they took remarks in the judgements as confirming their interpretation of that legislation.
Transaction
The Peabody family and Ray Kleinschmidt owned a business producing fly ashFly ash
Fly ash is one of the residues generated in combustion, and comprises the fine particles that rise with the flue gases. Ash which does not rise is termed bottom ash. In an industrial context, fly ash usually refers to ash produced during combustion of coal...
, also known as pozzolan
Pozzolan
A pozzolan is a material which, when combined with calcium hydroxide, exhibits cementitious properties. Pozzolans are commonly used as an addition to Portland cement concrete mixtures to increase the long-term strength and other material properties of Portland cement concrete, and in some cases...
, used in concrete
Concrete
Concrete is a composite construction material, composed of cement and other cementitious materials such as fly ash and slag cement, aggregate , water and chemical admixtures.The word concrete comes from the Latin word...
. It was a set of four companies, called the Pozzolanic Group. Kleinschmidt owned 38%, and the Peabody family owned 62%, through a family trust. The trustee was a company of which husband and wife Terence and Mary Peabody were directors, and the beneficiaries were Mary Peabody and their two sons.
Terence Peabody had planned for some time to buy Kleinschmidt's share then float 50% of the total business on the Australian Stock Exchange
Australian Stock Exchange
The Australian Securities Exchange was created by the merger of the Australian Stock Exchange and the Sydney Futures Exchange in July 2006. It is the primary stock exchange group in Australia....
. In late 1985 he and Kleinschmidt reached an agreement where Kleinschmidt would sell his shares for $8.6 million, an amount which was based on a business valuation and which was to remain confidential. Instead of Terence Peabody or the family trust buying out Kleinschmidt directly, the transaction was structured as follows.
The Peabody trust bought a shelf company called Loftway and Kleinschmidt sold his shares to it for the agreed $8.6 million. The Peabodys (now 100% owners) then had the Pozzolanic group companies convert those shares to "Z class" and restrict their rights, rendering them worthless. The shares the Peabody trust owned were then all that remained, a 100% interest in the business (apart from a few owned by Terence Peabody in his own name).
The money to pay Kleinschmidt was provided by Westpac Bank subscribing for $8.6 million worth of Loftway preference shares. The interest
Interest
Interest 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 them was obtained from the Pozzolanic companies paying dividend
Dividend
Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be distributed to...
s to Loftway, which in turn paid dividends to Westpac. The capital was repaid after the float when the Peabody trust lent $8.6 million from the float proceeds to Loftway in order for it to redeem Westpac's shares. That loan was subsequently forgiven by the trust.
This indirect structure had three apparent purposes,
- Kleinschmidt's shares "disappeared", so when Pozzolanic floated it was not necessary to disclose how much Kleinschmidt was paid. This had two motivations,
- It respected Kleinschmidt's wish for confidentiality.
- It wouldn't make the new investors wonder why they were being asked to pay a higher price after just a short period of time. Kleinschmidt's sale valued the total business at $24 million, the float price valued it at $30 million.
- If the Peabody trust bought shares from Kleinschmidt then sold them to the public, it would have incurred capital gains taxCapital gains tax in AustraliaCapital gains tax in the context of the Australian taxation system applies to the capital gain made on disposal of any asset, except for specific exemptions. The most significant exemption is the family home...
on the price difference.
- The money borrowed (from Westpac) to pay Kleinschmidt could be obtained at lesser cost by paying interest with dividends, because dividends were eligible for intercorporate rebates in Westpac's hands.
The last point is a little unclear. Perhaps it was that Loftway's ownership of Pozzolanic shares was not an income producing purpose, so plain interest payments would not be tax deductible. If so then that would be in a sense a consequence of using Loftway, rather than an independent rationale for the structure.
Assessment and court
The Australian Taxation OfficeAustralian 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...
(ATO) took the view that the mechanism was a 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...
scheme, a scheme which came under Part IVA 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...
. The ATO treated the transaction as Kleinschmidt selling to the Peabody trust, and then on-selling to the public in the float, making a profit of the difference. This was a capital gain, and the 1/3 of that attributable to Mary Peabody as trust beneficiary was $888,005. The ATO added that to her return for the year ending 30 June 1986.
Mary Peabody lodged an objection to the ATO assessment, which the ATO disallowed. She then asked the ATO to refer it to the Federal Court
Federal Court of Australia
The Federal Court of Australia is an Australian superior court of record which has jurisdiction to deal with most civil disputes governed by federal law , along with some summary criminal matters. Cases are heard at first instance by single Judges...
(as any taxpayer may do). Her argument was that the transaction was structured as it was for the commercial reasons of confidentiality and the cost of financing, as described above.
Justice O'Loughlin in the Federal Court
Federal Court of Australia
The Federal Court of Australia is an Australian superior court of record which has jurisdiction to deal with most civil disputes governed by federal law , along with some summary criminal matters. Cases are heard at first instance by single Judges...
agreed with the ATO that the devaluation to Z-class shares was a scheme, and considered the argument about non-disclosure to be a "red herring".
Mrs Peabody appealed to the full bench of the court, and they instead considered the transfer, financing and float together, and found for her. The ATO went to 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...
, which upheld the full bench decision.