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The recent decision, Cheung v Commissioner of Taxation, reaffirms the principle that familial gifts, when substantiated, cannot be arbitrarily reclassified as income.
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Lessons from the landmark Cheung case
12 December 2024
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On November 29, 2024, the Federal Court of Australia issued a landmark ruling in the Cheung case, a tax dispute steeped in family loyalty, cross-border financial dealings, and the limits of taxation law. Presided over by Justice Logan, the judgment exonerated Rene Cheung, an Australian resident, from accusations of failing to declare taxable income derived from millions gifted by his sister, Mrs. Leong, a prominent businesswoman in Vanuatu. This case underscores the complexities of familial financial arrangements and the importance of fair-mindedness in tax administration.
The Cheung family’s journey from China to Vanuatu in the, probably, pre-World War II era laid the foundation for a rags-to-riches story. Siblings Rene and Mrs. Leong epitomised resilience and enterprise. Mrs. Leong, born in 1942, married George Leong in 1961 and ran a small business. After divorcing in 1978, she expanded her enterprise, eventually creating Vanuatu’s largest supermarket chain by capitalising on market opportunities post-independence in 1980. Eventually, her business employed over 600 people.
Rene, born in 1944, was integral to the family business despite pursuing other jobs. In the 1990s, he moved to Australia for his daughter’s education but continued assisting in Vanuatu. By 2000, health concerns led Rene to retire in Australia, while the family business thrived under his sister’s stewardship.
From 2005 to 2015, Mrs. Leong, perceiving Australia as a safe investment environment, entrusted Rene with $32.8 million in gifts to invest on behalf of the family. She stipulated that Rene could retain any interest generated. Rene declared $1.95 million in interest in his Australian tax returns over the years, but the principal amount raised alarms at the Australian Tax Office (ATO).
The ATO alleged the funds were Rene’s taxable income, offering various theories:
1. Rene was secretly a part-owner of the Vanuatu business.
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2. The funds were remuneration for services rendered.
3. The payments were disguised rent for Australian properties.
4. The funds were an ex-gratia payment for his past contributions.
The ATO pursued Rene for back taxes, penalties, and interest, alleging fraud or evasion to justify reassessments spanning a decade. A departure prohibition order in 2018 further compounded the matter, barring Rene from leaving Australia.
Justice Logan delivered a decisive rebuke to the ATO’s claims, ruling the funds were not taxable income but voluntary gifts of capital. The judgment emphasised the familial bonds and trust underpinning the transactions. Justice Logan noted:
“The amounts given to Rene were gifts of capital voluntarily made by a loving sister…to invest as he saw fit and to draw upon personally if he saw fit.”
The court highlighted the absence of evidence for any of the ATO’s theories. Justice Logan criticised the tax office for failing to consider the “family reality” and accused it of an uncritical application of legal precedents divorced from the facts.
The case reiterates the importance of understanding the distinction between income and capital. Citing precedents like the High Court’s 1999 Montgomery case, Justice Logan underscored the need to assess whether a receipt is considered income in “ordinary parlance.” This approach prioritises common sense over rigid analogies to past cases, which, it seems, the ATO failed to grasp.
The court also stressed the importance of open-mindedness in taxation administration. Justice Logan admonished the ATO for its narrow, assessment-focused perspective.
This ruling highlights a troubling trend of aggressive tax enforcement. The ATO’s actions, including alleging fraud without evidence and pursuing protracted litigation, suggest a shift in power dynamics that may intimidate taxpayers. The Cheung case serves as a reminder of the necessity for balanced decision-making in tax administration, respecting both legal principles and human realities.
For taxpayers, the case reinforces the need for meticulous record-keeping and legal counsel when dealing with significant financial transactions, especially those involving cross-border family arrangements.
The protracted litigation undoubtedly caused immense strain on Rene, Mrs. Leong, and their extended family. Justice Logan’s judgment recounts emotional testimony, including a plea from Mrs. Leong’s son imploring the ATO not to force him to undermine his mother’s credibility. Such moments underscore the profound personal impact of legal disputes on families.
The Cheung case illustrates the power imbalance between taxpayers and the ATO. While the tax office is tasked with safeguarding public revenue, this duty must be exercised responsibly. Overzealous enforcement, as seen here, risks eroding public trust in the tax system.
The Federal Court’s ruling in the Cheung case is a triumph for fairness and justice in taxation law. It reaffirms the principle that familial gifts, when substantiated, cannot be arbitrarily reclassified as income. Moreover, it sends a clear message to the ATO: respect for facts and taxpayer realities must underpin all assessments and objections.
This decision by one of Australia's most respected tax law judges should prompt serious reflection among senior officers at the Australian Taxation Office regarding the necessity of having robust and well-founded grounds before raising assessments and imposing penalties.
The case highlights how the vast resources of the ATO when used aggressively, can impose significant stress on individuals who genuinely believe they are complying with tax laws. Moreover, such actions risk discouraging offshore investors from choosing Australia as a destination for their funds, wary of the potential for conflict with the executive arm of government.
John Jeffreys is a director of John Jeffreys Tax.
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