PROFIT WASHING SCHEME USING A TRUST AND LOSS ENTITY – TAX EVASION OR TAX AVOIDANCE?
The Australian Taxation Office (ATO) has raised concerns about profit washing schemes using a trust and loss entity since 2005. This case is a timely reminder for taxpayers wishing to enter into a profit washing scheme to think twice before entering this scheme.
On 11 June 2014, the Administrative Appeals Tribunal (AAT) in Mack and Commissioner of Taxation  AATA 367 held that the Commissioner was entitled to amend the taxpayers assessments for the 2002 and 2003 income years because the profit washing scheme constituted a scheme to which the general anti avoidance rules in Part IVA of the Income Tax Assessment Act 1936 (Cth) applied.
The AAT described the profit washing scheme (also know as the Danbowl Scheme) promoted by Mr Jeffrey Nirens as follows:
“…, crude. The scheme involved the creation of a new hybrid trust in which an entity associated with the promoter would hold units which entitled it to the income of the trust. The controllers of an underlying business would determine to conduct business through the newly created trust. The trustee would determine to distribute the business income to the promoter entity although it would seem that, in reality, only 15% of the income, representing, I assume, the promoter’s fee, was ever actually paid to the promoter entity. The balance of the distribution would be notionally, at least, “washed” by the promoter through a loss trust and be available to the participants” [at 5].
In this case, the profit washing arrangement had the following features:
- Mr and Mrs Mack are husband and wife. Mr Mack is a principal accountant employed by a southern Queensland accountancy firm named Mack Accountancy Pty Ltd. Mack Accountancy Pty Ltd is also the trustee for the Mack Family Trust, being a family discretionary trust associated with Mr and Mrs Mack.
- The beneficiaries of the Mack Family Trust were Mr and Mrs Mack, various classes of the family members and any company in which a beneficiary held a share, and was or had been a director, and any related trust.
- Mr Jeffrey Nirens promoted a profit washing scheme to Mr and Mrs Mack. Mr Nirens was the director of Danbowl Pty Ltd, which is a trustee for the Eleventh Hour Unit Trust (Promoter Trust).
- A new hybrid trust (Glenferry Downs Trust) was also established to minimise tax liability of the accountancy practice. The trustee for the Glenferry Downs Trust was Drgee Pty Ltd and Mr Mack later replaced Mr Nirens as the sole director. Following several name changes, Drgee Pty Ltd was eventually changed to Mack Grazing Pty Ltd.
- The Glenferry Downs Trust had a number of classes of units with different rights attaching to each class of units. Mr and Mrs Mack, Drgee Pty Ltd and the Promoter Trust were each issued 100 units with different rights attaching to each class of units.
- The units held by the Promoter Trust entitled it only to the income of the Glenferry Downs Trust, specifically the right to receive such proportion of the net income arising from the trust fund pursuant to the trustee’s absolute discretion appoint.
- The Mack Family Trust purportedly distributed net income of the trust of $210,000 and $185,000 respectively in the 2002 and 2003 income years to the Glenferry Downs Trust, as a beneficiary of the Mack Family Trust.
- The Glenferry Downs Trust then purportedly distributed income to the Promoter Trust for the 2002 and 2003 income years. The remaining net income of the Glenferry Downs Trust was reduced to nil in 2002 by reason of accrued director fees in respect of the accounting practice and accrued management fees in respect of farming activities. Similarly, the remaining net income of the Glenferry Downs Trust was also reduced to nil in 2003 by reason of accrued directors fees in respect of the accounting practice and the deferral of livestock profits.
- Mack Grazing Pty Ltd was put into a creditors’ voluntary winding up in 2007 and has since been deregistered.
- Subsequently, the Commissioner made amended assessments for Mr and Mrs Mack’s taxable income for the 2002 and 2003 income years respectively by half of the purported distribution by the Mack Family Trust because the Commissioner determined there had been an avoidance of tax. The Commissioner also imposed a 50% shortfall penalty resulting from recklessness respectively for Mr and Mrs Mack in each income year.
Mr and Mrs Mack lodged appeals in the AAT claiming that the amended assessments for the 2002 and 2003 income years were excessive under section 14ZZK of the Taxation Administration Act 1953 (Cth).
The Commissioner argued, on the basis that Mr and Mrs Mack participated in the Danbowl arrangement, then:
- the scheme was a sham so the amounts purportedly distributed from the Mack Trust to the Glenferry Trust were shared equally between Mr and Mrs Mack in each of the two income years; or
- in the alternative, the general anti-avoidance provisions in Part IVA of the Income Tax Assessment Act 1936 applies to cancel the tax benefit thereby the amounts of the distributions should be deemed income shared equally between Mr and Mrs Mack.
The Tribunal considered that Mr Mack was not a credible witness and was willing to manufacture evidence to support his case.
THE PROFIT WASHING SCHEME AMOUNTS TO TAX AVOIDANCE AND TAX EVASION
The AAT held that Mr and Mrs Mack participated in the profit washing scheme therefore the Commissioner was entitled to amend the taxpayers assessments for the 2002 and 2003 income years because the profit washing scheme constituted a scheme to which the general anti avoidance rules in Part IVA of the Income Tax Assessment Act 1936 (Cth) applied. The AAT also stated that the Commissioner was entitled to amended Mr and Mrs Mack’s assessments for the 2002 and 2003 income years due to tax evasion. Consequently, the AAT held that Mr and Mrs Mack had not discharged the onus of showing that the 2002 and 2003 amended assessments were excessive.
Please contact Vintage Lawyers on + 61 2 9251 1108 should you need specific advice concerning a profit washing scheme using a trust and loss entity.
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