 balance sheet, profit and loss account and other financial statements.
The Commissioner saw the need for some relaxation of a strict application of the basic approach. He indicated in his ruling that in some circumstances he would accept another method, namely the estimated profits basis. That would allow a taxpayer engaged in carrying out a long term contract to make an estimate of the expected profit from a contract and to apportion this over the period the contract was expected to run. Estimates could be revised from time to time to allow for changes in the outlook which occurred after the original estimates were made. Subsection 170(9) of the Act permitted this course.
But the estimated profits basis is not the method for which the appellants here contend. Nor, upon analysis, is it the method provided for in the relevant accounting standard, AAS11; see particularly paras 36 and 38 thereof earlier referred to. These paragraphs, notwithstanding their language, advocate, not the estimated profits basis but the emerging profit basis. The accounting evidence is in accordance with this approach. That method involves a wait and see approach. Only when it is fairly clear that the outcome of the contract is likely to be profitable is any element of profit or gain brought to account. That approach is readily understandable in an industry as volatile and uncertain as the building industry is. It is no doubt a sensible basis from the point of view of the company itself, its shareholders and its creditors. Nevertheless, we think it difficult to discern anything in the income tax legislation which allows such a method to be used in returning income for tax purposes, an exercise that has to be done each year. Subsection 170(9) of the Act will not help because the most that it contemplates is the inclusion of an estimated amount of income derived by the taxpayer in the relevant year from an operation, or series of operations, the profit or loss in which was not ascertainable at the end of the year owing to the fact that the operation, or series of operations, extended over more than one year.
It is to be noted that the estimate is not of profit but of income. That is in accordance with the overall approach of the Act which is to ascertain assessable income and allowable deductions and thus the resultant taxable income. If a company engaged in the carrying out of a long term building contract receives an excess of what is apparently assessable income for the year of income in question over the amount of allowable deductions, the result the Act calls for is for the excess to be treated as taxable income. It is true that this statement may represent an oversimplification of the matter. There may be reasons even under the legislation why particular moneys received by a taxpayer ought not to be treated as received as income in a particular year. We do not need to go into this, but payments may be made in advance, they may represent retention sums, or they may be earmarked for further expenditure or application to take place or to be made in subsequent years. And, on the other side of the account, there may be provisions for various contingencies which will properly be allowed as deductions. We mention these matters only to show that we are conscious that the statement which we have expressed in absolute terms may need some qualification. The point we make is that, subject to those matters, the Act requires the account to be made on an annual basis so that taxable income may be brought to tax for each of the tax years in question.
A further and independent matter that needs to be addressed is that the appellants have not in this case really made the case they purport to espouse. There was no submission put to the Court which purported to demonstrate how, in this case, the emerging profit basis was to be applied. Unless one had some means of understanding how the matter was to be approached in detail, as distinct from generally, one could not reach a conclusion on whether it would provide a true reflection of the assessable income earned by Grofam in the periods in question. The submission relied on more general grounds saying that the basic approach was an entirely inappropriate method to apply. This, coupled with the fact that it was far too early in the history of the contract to reach any conclusion on the question whether the contract would ultimately prove profitable, was said to justify the upholding of the objection. That, in our opinion, cannot be correct. That is because the appellants' submissions do not come to grips with the particular circumstances of this case.
That is enough to lead to the conclusion, already foreshadowed, that the appellants' case fails on this aspect of the matter. But there is another and really more compelling factor which applies in relation to the 1983 year of income. It is the transfer by journal entry of the sum of $3.5 million from Grofam to Grollo Australia. This may have been done in order to give effect to the arrangement which was thought to exist or to have been brought about by the notice given to St Martins on 27 October 1983. There is no finding about this matter. Whatever the reason may have been, it is clear in our opinion, that the amount was transferred because it was surplus to needs. Plainly it represented an excess of assessable income over allowable deductions. There is no other view reasonably open. His Honour concluded that the taxable income of Grofam for the 1983 year was $3.5 million. Subject to one further submission which needs to be dealt with, we are unable to detect any error in his Honour's conclusion. Certainly we can detect no error of law.
There is one final matter to be mentioned. It is not surprising that a sum of $3.5 million should find its way from Grofam to Grollo Australia in the circumstances which existed. It will be recalled from the early part of these reasons that it was the practice of the Grollo Group to build at a cost which was usually less than the contract price. In more recent years, the Grollos developed an interest in investing in property and of undertaking building work wholly or partly on their own behalf. In the present case they intended, if they could, to provide the contribution which Grollo Australia was bound to make available under the Joint Venture Deed from excesses of progress payments over expenses, the idea being that their 12.5 per cent share would be paid in this way rather than by an actual contribution made by one or other of the Grollo companies. That again suggests that all along they intended to achieve a situation in which there would be, so far as possible, a substantial surplus of payments or income over expenses. Such a situation called, in our opinion, for the adoption of the basic method of accounting which is advocated by the Commissioner in this case and is indeed the method which the Grollos themselves applied.
For these various reasons, we are satisfied that the submissions made by counsel for the appellants that there was no taxable income earned by Grofam in the 1983 year of income nor during the period 1 July 1983 to 27 October 1983 should be rejected.
Deliberate Understatement of Income
There is a question whether or not the understatement of income which we have found established was made deliberately. There are written submissions about this subject which we have considered. In the circumstances we do not think there can be any doubt about the answer to the question. Plainly the failure to disclose the surplus income in the two periods was done deliberately. That, however, is a conclusion of fact, not of law. No question of law is involved in relation to this aspect of the case. His Honour's findings were clearly open to him on the evidence which was before him.
There are some consequential questions to be dealt with arising from the terms of the relevant legislation. We deal with these later on under the heading "Additional Tax".
Deduction of Amounts Paid by Grofam to Grollo Australia
The appellants submitted that, if it were found that Grofam did derive income or profit from the construction of the Rialto Project in the two periods in question, it should be entitled to claim the amounts of those profits or income as deductions under s.51 of the Act, not in the 1983 year of income but in the 1984 year of income. That, so it was submitted, was because, by reason of the notice of 27 October 1983 and the four building contracts that were executed on that date, Grofam was obliged to account to Grollo Australia for any moneys not spent by it on the construction work. It was submitted that that obligation followed as a matter of law from the fact that the moneys received by Grofam from the work carried out on the construction of the Rialto building up to 27 October 1983 were received by it on behalf of Grollo Australia.
The submission really relies for its validity upon the true meaning and legal effect of the notice of 27 October 1983. Those indeed are the words of the submission. That takes one back to the considerations which were discussed when the legal effect of the notice of 27 October 1983 was being considered. For similar reasons given in relation to that aspect of the case, we would reject the submissions made about the deductibility of the payments made by Grofam to Grollo Australia in the 1984 year of income.
That then completes the treatment of the matters which arise for decision in relation to the period prior to 27 October 1983. Each of the submissions made on behalf of the appellants is rejected.
The Years after 27 October 1983
We turn next to the period after 27 October 1983. A principal question which arises for decision is whether his Honour was correct in upholding the Commissioner's case that he was entitled to invoke the provisions of Part IVA of the Act because there was a scheme to which that Part of the Act applied. But the appeals both by the appellants and the Commissioner raise other questions. The Commissioner took the view that he was entitled to assess the income tax which he contended was due either to Grollo Australia or Grofam or, more correctly