FCT v Phillips 73 ATC 4,361

[1] [edited] … The firm is a large one and carries on business throughout Australia, with
branches in each state other than Tasmania. It is a member of an international partnership,
Whinney, Murray, Ernst & Ernst in conjunction with a British and a United States firm. As
chartered accountants its business comprises accounting and secretarial work, auditing,
taxation and management advice, maintenance of share registers, and conduct of liquidations
and receiverships. In the course of this business the partners employed substantial numbers of
staff, both professional and non-professional.

[2] The entry of a substantial judgment in the Supreme Court of New South Wales early in
1970 against another large firm of chartered accountants based on professional negligence
(Pacific Acceptance Corp Ltd v Forsyth (No 2)) caused the partners of the firm to consider
the impact which such a judgment would have upon their own business. In particular, they
were concerned to protect their assets and the assets used in the firm's business against the
possibility of an award being made against them in excess of their professional negligence
cover. Moreover there was disquiet at the time concerning the considerable increase in
premiums payable to obtain cover and whether it might be impossible in the future to obtain
the necessary cover at a reasonable cost.

[3] In or about the month of July 1970 discussions took place with solicitors in Melbourne
regarding the possible establishment of a unit trust scheme to take over certain of the
activities of the firm and to acquire certain of its assets. A draft trust deed was prepared by
the solicitors which was considered by a meeting of all partners held in the month of October
1970. … [edited] … On 22 December 1970 two companies were incorporated. The first,
Fellstar Holdings Pty Ltd (‘the trustee company’) was set up for the purpose of acting as
trustee of the trust deed. However, its function was rather in the nature of a ‘custodian’
trustee in that the second company, Fellstar Secretariat Pty Ltd, (‘the management company’)
was incorporated to act as manager of the proposed unit trust.

[4] In mid-June 1971 the national committee of the firm decided to proceed with the scheme.
… On 30 June 1971, the trust deed was executed by the trustee company as trustee and by the
management company as manager and it provided for execution [i.e. signing] then or
thereafter by persons who applied for units, being beneficial interests in the fund therein
defined. The trust and the fund were established by the management company lodging the
sum of $100 with the trustee company and the trust thereby constituted was called the ‘First
Meritable Trust.’ It was contemplated, as was in fact ultimately the case, that units in the trust
would be applied for and held by wives, family trusts and companies of the partners.

[5] The essence of the scheme was that certain of the business activities of the firm being
those currently performed by the non-professional staff of the firm would be performed by
such staff employed by the trustee company. These activities in general comprised: typing;
secretarial and general clerical work; maintenance of share registers; photocopying and
printing work; organisation of seminars and training courses and insurance agency work. In
addition it was contemplated that the furniture and equipment would be purchased by the
trustee company and leased back to the firm.

[6] In a circular attached to a memorandum sent out to all partners in the middle of July 1971
an explanation of the scheme was made, its advantages and disadvantages were summarized

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and the consent of each partner to the scheme was sought. … The reasons for establishment
of the scheme were stated as follows:
‘1. To move assets away from partners to minimize consequences of successful
litigation.
2. To reduce taxes; income tax during your lifetime and death duties upon your
death.’
The circular also indicated that each partner or his nominee might apply for a specified
number of units, the particular number depending upon whether the partner was a full or
fractional partner.

[7] Under the trust deed dated 30 June 1971 the trustee company was constituted as trustee
of the First Meritable Trust. The directors and shareholders of the trustee company were at all
relevant times two Melbourne solicitors [i.e. lawyers] holding the two issued shares. The
deed also constituted the management company as manager of the investments of the trust
and of any business carried on by the trustee company. There were again only two issued
shares held by persons neither of whom was at the time a partner in the firm. These persons
were also the sole directors. The powers and duties of the trustee and the manager were set
out in the trust deed in some detail and provision was made for creation and issue to other
persons of units additional to those subscribed for by the management company. The funds
provided by the subscribers were payable to the management company for lodgment by that
company with the trustee company and provision was made for investment of the funds in
authorized investments selected by the management company. Authorized investments were
defined as including, inter alia, the purchase of chattels including typewriters and other
business machines and office equipment and any other equipment used in the conduct of a
commercial undertaking or business. A business undertaking acquired by the trustee company
at the request of the management company was also an authorized investment. Finally,
provision was made for the distribution of the income of the trust fund to the unit holders in
proportion to the number of units each held and for the transfer and repurchase of units.

[8] The circular and memorandum distributed to the partners contemplated the scheme being
implemented as from 1 August 1971. Just prior to that date funds were subscribed by the
nominees of the partners in their respective proportions or in one instance by a partner
personally. … In consequence of the overall subscriptions, units to the value of $220,000
were in early August issued to the subscribers.

[9] On 31 July 1971 the firm terminated by notice the services of all of its non professional
staff who were then all offered employment from 1 August 1971. This offer of employment
was made by the management company ‘on behalf of the trust’ i.e. on behalf of the trustee
company as trustee of the trust fund. All accepted the offer of new employment. On the same
day the management company purchased on behalf of the trustee company the whole of the
furniture, office machines, partitions and office equipment owned by the firm for $198,973.

[10] Again on that day the management company by decision of its directors resolved to
carry out certain specified business undertakings on behalf of the trustee company as trustee
of the First Meritable Trust. These business undertakings included such activities as
previously contemplated, namely, the leasing of office furniture, machines, partitions and
equipment, provision of clerical and secretarial staff, provision of share registry facilities and
printing and photocopying services, making of deposits at call and acting as insurance agents.
The resolutions did not spell out that these business undertakings were to be performed only
in conjunction with the firm, though with certain minimal exceptions that is what in fact

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occurred. By the same resolutions the directors also provided for the salaries to be paid to the
Sydney and Melbourne managers of the management company.

[11] On the following day the directors determined upon a charge to be made for the services
offered, namely a percentage on purchase price for the lease of office furniture and
equipment; a fee for provision of clerical and secretarial staff based on the formula of annual
salary/number of productive hours x 1.5; and a fee for share registry services at the rate of 95
cents per shareholder as a maintenance fee and 95 cents for each transfer.

[12] By letter of the same date the management company by its manager in Melbourne
offered the above-mentioned services to the firm. The services were offered generally and not
for any particular period of time. The firm accepted these services and leasing propositions at
the specified rates but again there was on neither side no reference to a term, whether as a
minimum period or otherwise. It is common ground that since 1 August 1971 the
management company as manager of the business operations which the trustee company
owns as an investment of the trust has provided the secretarial and other services required by
the firm and has hired the office plant and equipment used by the firm. These services and
hirings are hereinafter compendiously described as ‘the services.’

[13] It is relevant at this stage to consider the charges made by the management company to
the firm for the services in each of the years of income under consideration, and the particular
matters in respect of which the charges were made. These charges were made on a monthly
basis and were either paid by the firm or alternatively accrued pursuant to a further
arrangement (hereinafter called ‘the amended arrangement’) which is later described.

[14] In the year of income ending 30 June 1972 a total sum of $375,217 was charged by the
management company to the firm. This sum was made up as follows:

Provision of typing and filing staff, telephonists, receptionists, messengers etc. 275,961
Leasing of furniture, fittings, office machines etc. 35,533
Provision of share registry services. 53,976
Interest on advances made pursuant to the amended arrangement. 9,747
375,217

[15] In the year of income ending 30 June 1973 a total sum of $470,819 was charged for the
services by the management company to the firm.
[edited]

[16] The amended arrangement was to the effect that the firm was not required to pay
immediately the whole of the charges for services. These charges were rendered on a monthly
basis. So much of those charges as remained unpaid was accepted as being loan moneys
repayable at call and bearing interest at 10% per annum. Subsequently the repayment of these
sums (which totalled $174,353 at 30 June 1972 and $254,444 at 30 June 1973) was secured
by way of a first charge over the book debts of the firm and the interest rate was reduced to
8.5% per annum.

[17] The trial judge found that the charges made against the firm by the management
company for the services were realistic and not in excess of commercial rates. … As to the
rate fixed for staff, i.e. in effect a loading of 50% on wages paid, this was the rate charged in
the market place by a client engaged in hiring of office personnel. In return for paying or

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incurring this charge the firm not only acquired the services of the staff but was relieved from
most problems of staff and office management and all financial obligations in respect of
wages, sick leave, annual leave, workmen's compensation, statutory holidays and long service
leave. In respect of the leasing charges the trial judge found that the rate fixed represented a
return of 6% to 8% on funds employed and that such a return could not be said to be
excessive. Similarly, he found that the charge for share registry services could not be said to
be excessive. …

[18] The sale of the plant and equipment of the firm to the trustee company had a benefit to
the firm in that it released working capital which might otherwise have had to be provided by
bank overdraft or by the partners … Beneficial results also accrued to the firm in
consequence of the arrangement whereby charges remained on loan at reasonable rates of
interest secured by the first charge over book debts. Again it increased the amount of working
capital available to the firm and had the effect of reducing the assets of the firm and
protecting these assets against the consequences of an unfavourable judgment against the
firm.

[19] This was the re-arrangement of the firm's affairs to which the taxpayer was a party. The
benefits were not only those specifically set out above but additionally included the obvious
advantage of decreasing [the profit of the firm and in consequence] what otherwise would
have been the taxable income of the taxpayer [i.e. his share of firm profit] and providing an
income for his wife [the wife had become a beneficiary of the trust] upon which she was
taxable at her relevant [lower] rate.

[The remainder of the judgment is concerned with taxation issues.]