In a majority decision, the Full Federal Court has allowed the Commissioner's appeal and found that it was not open to the judge at first instance to find that payments of around $4 million made from a foreign company to its Australian subsidiary and other related companies were genuine loans (and not "shams"). In particular, the Court majority found it was not appropriate to find that the taxpayers had discharged the onus of proving that assessments were excessive in circumstances where the taxpayers had made inconsistent (or "alternative") arguments about the nature of the payments.

Background

The case involved assessments and amended assessments issued to several taxpayer companies covering the 1994 to 2009 income years. In these assessments, the Commissioner claimed that payments from several overseas companies (Normandy Finance and Investments Asia Ltd, Normandy Finance and Investments Limited and Hua Wang Bank Berhad) to the taxpayers were not loans, but sham transactions. Mr Henry George Townsing was the directing mind and will of each of these taxpayer companies, and the "lender" companies were owned by a company controlled by Mr Vanda Gould.

The Commissioner assessed the taxpayers on the basis that the payments were shams and that the amounts were ordinary income of the taxpayers and assessable under s 6-5 of the ITAA 1997. Normandy Finance claimed that some $3.8 million it received from Normandy Asia was by way of loans or financing.

At first instance, in Normandy Finance Pty Ltd v FCT [2015] FCA 1420, the Federal Court held that the payments were genuine loans, and not shams. It did so on the basis of finding that while the written agreements were shams or largely shams, they were only implemented for the limited purpose of making third parties believe that the borrowers were at arm's length from the lenders. However, otherwise, the Court at first instance found that the advance and repayment obligations (whether in the loan agreements or from some oral agreement) were "genuine".

On appeal, the Commissioner argued that it was not open to the primary judge to make this finding, as it was contrary to the case the taxpayers had put for the purpose of discharging their onus of proving that the assessments were excessive. In particular, the Commissioner claimed that the Court at first instance could not find that the payments were "loans" when the taxpayers had inconsistently argued that, on one hand, the loans were "wholly genuine" while, on the other (in their "alternative" argument), the loans involved at least some pretence for the limited purpose of making third parties believe that the borrowers were at arm's length from the lenders.

Note that following the decision of the Court at first instance, Edmonds J, sitting as a Presidential Member of the AAT, also ordered that a number of the assessments of income tax and penalty tax issued to the relevant parties should be accordingly reduced.

Decision

The Full Federal Court majority agreed with the Commissioner that it was not open to the Court at first instance to make the finding that the loans were genuine, as it was "impermissible for the primary judge to determine the case on a basis inconsistent" with the manner in which the taxpayers had argued the matter – namely, that on one hand the loans were genuine but, on the other hand, they were shams for a different purpose (ie for the purposes of their "alternative" case).

In short, the majority found that arguing the case in this manner "necessarily meant that only one outcome was open – the taxpayers had not discharged their onus of proof that the assessments were excessive because they had not proved the moneys advanced were loans".

Specifically, the majority considered the conclusion of the Court at first instance was "not only inconsistent with the evidence of the directing mind and will of the borrowers, but was incapable of any form of rational reconciliation with that evidence". Furthermore, the majority said it was a conclusion "made in circumstances where all of the lenders had been cross-examined on the basis of a different case before the alternative case was first raised by the primary judge (which may not be fatal of itself, given that their evidence was of marginal significance), but also where the evidence of the key witness, Mr Townsing, precluded any possibility of the credibility of the alternative case being explored in cross-examination (which is fatal in and of itself, given that Mr Townsing was the directing mind and will of the taxpayers)".

Logan J, in dissent, was of the view there was no basis for disturbing the conclusions reached by the Court at first instance, and at the same time rejected the Commissioner's contention that the primary judge delivered inadequate reasons.

However, in relation to dealings between Normandy Asia and Normandy Australia involving loans, the majority accepted that it would have been open to the primary judge, on the case which the taxpayers ran, to conclude that the taxpayers had discharged their burden of proof with respect to the dealings between Normandy Asia and Normandy Australia involving loans. The majority considered that this aspect of the appeal "must be remitted for further hearing and cannot be dealt with as part of the appeal".

FCT v Normandy Finance and Investments Asia Pty Ltd [2016] FCAFC 180, Full Federal Court, Logan, Jagot and Davies JJ, 16 December 2016, http://www.austlii.edu.au/au/cases/cth/FCAFC/2016/180.html.