Howard v Commissioner of Taxation (No 2)
[2011] FCA 1421
•14 December 2011
FEDERAL COURT OF AUSTRALIA
Howard v Commissioner of Taxation (No 2) [2011] FCA 1421
Citation: Howard v Commissioner of Taxation (No 2) [2011] FCA 1421 Parties: STEPHEN JAMES HOWARD v COMMISSIONER OF TAXATION File numbers: VID 80 of 2010
VID 28 of 2011Judge: JESSUP J Date of judgment: 14 December 2011 Catchwords: TAXATION – Income Tax – Taxpayer awarded equitable damages as compensation for losses sustained in joint venture where co-venturers acted in breach of fiduciary duties – Taxpayer a director of company proposed by him and some other joint venturers, also directors, to take benefit of business opportunity – Joint venture failed and opportunity lost as result of breach of fiduciary duties – Whether taxpayer held award of damages on trust for company – Given that award had character of income, whether included in assessable income of taxpayer.
TAXATION – Income tax – Distributions by non-resident trust estate – Whether included in assessable income of resident discretionary beneficiary – Net income of trust estate – whether included proceeds of shares sold back to company – Whether difference made by interposition of bare sub‑trust – Taxpayer beneficiary’s share of net income of trust estate – How calculated when all beneficiaries discretionary interest – whether all beneficiaries contingently entitled to whole of corpus of trust estate.
TAXATION – Income tax – Administrative penalty for omission to return as income distribution received from non‑resident trust estate – Counsel’s advice obtained when full facts not known – Supplementary advice not sought – whether taxpayer’s conduct intentional, reckless or involved failure to take reasonable care.
Legislation: Income Tax Assessment Act 1936 (Cth) ss 44, 95, 96B, 96C, 97, 99B, 101, 159GZZZK, 159GZZZP, 170, 475
Income Tax Assessment Act 1997 (Cth) s 6-5
Taxation Administration Act 1953 (Cth) ss 14ZZ, 284, 289
Taxation Laws Amendment (Company Law Review) Act 1998 (Cth) Sch 5
Tax Laws Amendment (Improvements to Self Assessment) Act (No 2) 2005 (Cth) Sch 1
Transfer of Land Act 1958 (Vic) s 118Cases cited: Blair v Curran (1939) 62 CLR 464
Bouch v Sproule (1885) 29 Ch D 635
Canadian Aero Service v O’Malley [1974] SCR 592
Colonial First State Investments Ltd v Commissioner of Taxation [2011] FCA 16
Commissioner of Stamp Duties (NSW) v Sprague (1960) 101 CLR 184
Commissioner of State Revenue v Lend Lease Funds Management Ltd [2011] VSCA 182
Commissioner of Taxation v Patcorp Investments Ltd (1976) 140 CLR 247
Disctronics Ltd v Edmonds [2002] VSC 454 and [2002] VSC 534
Edmonds v Donovan (2005) 12 VR 513
Evans v Bartlam [1937] AC 473
Express Newspapers plc v News (UK) Ltd [1990] 1 WLR 1320
Hill v Permanent Trustee Company of NSW Ltd [1930] AC 720
Hobbs v Federal Commissioner of Taxation (1957) 98 CLR 151
In Re Brooks’ Settlement Trusts [1939] 1 Ch 993
Jalmoon Pty Ltd (in liq) v Bow [1997] 2 Qd R 62
Kingston v Keprose Pty Ltd (1987) 11 NSWLR 404
Kok Hoong v Leong Cheong Kweng Mines Ltd [1964] AC 993
Lygon Nominees Pty Ltd v Commissioner of State Revenue (2007) 23 VR 474
Pearson v Commissioner of Taxation (2006) 232 ALR 55
Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134
Roe v Mutual Loan Fund (1887) 19 QBD 347
Sargent v ASL Developments Ltd (1974) 131 CLR 634
The Commonwealth v Verwayen (1990) 170 CLR 394
Trust Company of Australia Ltd v Commissioner of State Revenue (Qld) (2003) 197 ALR 297
Warman International Ltd & Anor v Dwyer & Ors (1995) 182 CLR 544Dates of hearing: 24 March, 6-8 June, 21-22 June, 15 November and 1 December 2011 Place: Melbourne Division: GENERAL DIVISION Category: Catchwords Number of paragraphs: 199 Counsel for the Applicant: Mr G Beaumont QC with Mr E Power and Mr H Carmichael Solicitor for the Applicant: Oakley Thompson & Co Counsel for the Respondent: Mr P Sest with Dr P Bender Solicitor for the Respondent: Maddocks
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
GENERAL DIVISION
VID 80 of 2010
BETWEEN: STEPHEN JAMES HOWARD
ApplicantAND: COMMISSIONER OF TAXATION
Respondent
JUDGE:
JESSUP J
DATE OF ORDER:
14 DECEMBER 2011
WHERE MADE:
MELBOURNE
THE COURT ORDERS THAT:
1. The amended assessment of the applicant’s income tax for the year ended 30 June 2005, made on 5 August 2009, be set aside.
2. The assessment of the applicant’s income tax for the year ending 30 June 2005, made on 24 October 2005, be reinstated.
3. The assessment of administrative penalty payable by the applicant in respect of the year ending 30 June 2005, made on 5 August 2009, be set aside.
4. The assessment of administrative penalty payable by the applicant in respect of the year ending 30 June 2006, in consequence of his omission to return as income the sum of $5,528,817 paid to him by way of a cash distribution by the Esparto Trust, be varied such that the base penalty amount under s 284-90(1) of the Taxation Administration Act 1953 (Cth) is 25% of the shortfall amount.
5. The application otherwise be dismissed.
6. The parties file written submissions as to costs as follows:
(a)the applicant, on or before 10 February 2012;
(b)the respondent, on or before 24 February 2012;
(c)the applicant in reply, if necessary, on or before 2 March 2012.
Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
GENERAL DIVISION
VID 28 of 2011
BETWEEN: STEPHEN JAMES HOWARD
ApplicantAND: COMMISSIONER OF TAXATION
Respondent
JUDGE:
JESSUP J
DATE OF ORDER:
14 December 2011
WHERE MADE:
MELBOURNE
THE COURT ORDERS THAT:
1. The assessment of administrative penalty payable by the applicant in respect of the year ending 30 June 2006, in consequence of his omission to return as income the sum of $810,916 paid to him by way of a non-cash distribution by the Esparto Trust, be varied such that the base penalty amount under s 284-90(1) of the Taxation Administration Act 1953 (Cth) is 25% of the shortfall amount.
2. The application otherwise be dismissed.
3. The parties file written submissions as to costs as follows:
(a)the applicant, on or before 10 February 2012;
(b)the respondent, on or before 24 February 2012;
(c)the applicant in reply, if necessary, on or before 2 March 2012.
Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
GENERAL DIVISION
VID 80 of 2010
VID 28 of 2011
BETWEEN: STEPHEN JAMES HOWARD
ApplicantAND: COMMISSIONER OF TAXATION
Respondent
JUDGE:
JESSUP J
DATE:
14 DECEMBER 2011
PLACE:
MELBOURNE
REASONS FOR JUDGMENT
The first of two proceedings presently before the court is an appeal by the applicant, Stephen James Howard, pursuant to s 14ZZ of the Taxation Administration Act 1953 (Cth) (“the Administration Act”), against decisions made on 28 January 2010 by the respondent, the Commissioner of Taxation (“the Commissioner”) disallowing objections by the applicant to amended assessments of income tax made by the Commissioner on 5 August 2009 in relation to the 2005 and 2006 taxation years, and imposing a penalty in each case. The second proceeding is a like appeal against a decision made on 17 December 2010 by the Commissioner disallowing an objection by the applicant to a further amended assessment of income tax made by the Commissioner on 21 October 2010 in relation to the 2006 year, and imposing a penalty.
The controversy relating to the 2005 year involves the question whether the sum of $861,853.35, received by the applicant in that year as his share of an award of equitable damages made by the Supreme Court of Victoria (Warren J) in consequence of the determination in Disctronics Ltd v Edmonds [2002] VSC 454 and [2002] VSC 534, and confirmed on appeal in Edmonds v Donovan (2005) 2 VR 513, was assessable income for him. He accepts that the award had the character of income and was made in his favour, but he says that he received the money awarded to him in the capacity of a director, and therefore of a fiduciary, of Disctronics Ltd (“Disctronics”). In point of fact, the money was paid by the solicitors for the successful plaintiffs (including the applicant) in the Supreme Court case to Disctronics, which returned it as income in its own return. The Commissioner issued his amended assessment of 5 August 2009 on the basis that the award of damages was received by the applicant beneficially, and not as a fiduciary.
The controversy relating to the 2006 year has two, closely aligned, aspects. The first aspect concerns the sum of $5,528,817.00 received by the applicant in that year by way of a distribution by a Jersey trust of which the applicant was a discretionary beneficiary. The second aspect concerns the sum of $810,916.00 which the Commissioner, by his further amended assessment of 21 October 2010, included in the assessable income of the applicant because of a non‑cash distribution made in the 2006 year by that trust. The applicant says that both were distributions of capital by a non‑resident trust and were not income for the purposes of the Income Tax Assessment Act 1936 (Cth) (“the 1936 Act”) and the Income Tax Assessment Act 1997 (Cth) (“the 1997 Act”). The Commissioner says that the distributions were properly assessed as income because they represented a share of the income of the trust to which the applicant was presently entitled within the meaning of s 97(1)(a)(i) of the 1936 Act and/or because they represented property of the trust that was paid to the applicant during the year of income for the purposes of s 99B(1) of the 1936 Act, and were not excluded under subs (2) of that section.
2005 YEAR – THE KINGSTON LINKS JOINT VENTURE
The award of equitable damages mentioned above was made to compensate the applicant and his co-plaintiffs for the loss of a valuable business opportunity which, the Supreme Court held, had been misappropriated by the defendants in the case in breach of fiduciary duty. As described by Phillips JA in the Court of Appeal (12 VR at 517 [6]):
[The] idea being pursued by the plaintiffs [was] to purchase a golf course, to arrange for a long term lease over it with a sound tenant and then to sell it all to another at a profit.
The driving force behind the proposed was Kevin Donovan (“Donovan”), who was a director of, and ultimately in control of, Disctronics. He was based in the United Kingdom. In his evidence in this case, he described the features of the proposal in the following terms:
By early 1999 this had evolved into a concept of packaging up an existing golf course operation with a long term tenant for acquisition by a third party investor/equity provider. Revenues would flow from the operations of the course itself, where green fees are payable, as well as from the pro shop, driving range, cafes, bars etc. These income streams would assist in negotiating favourable lease terms with the long term tenant/golf course operator and the rental stream generated from the long term lease, if made with a tenant with a quality balance sheet, would underwrite the financing of the transaction. The total cost of the project, comprising the purchase price plus acquisition costs of the golf course plus a profit for the party packaging the deal, would be funded by a combination of bank debt plus equity funding from an investor. The quantum of the equity funding required to compete [sic] the transaction was the total cost of the project (as referred to above) less the amount of bank finance able to be obtained.
An aspect of the proposal was that those involved – Donovan and the others to be mentioned presently – would chance their arm to an extent, but would need neither capital nor debt on their own account. If everything went according to plan, three separate business entities would be brought into alignment: the present owner of the golf course, the intending purchaser to whom the course would be on-sold and the long-term tenant to whom the course would be let. To save stamp duty, at some point it was contemplated that the property would be transferred directly from the vendor to the ultimate purchaser, but there would be two contracts of sale: one by which the property was sold by the vendor to the Donovan interests, and the other by which the Donovan interests would on-sell the property to the purchaser. The proposal included the facilitation of finance for the purchaser, on the security of the lease of the course to the long-term tenant. As Donovan pointed out in the passage set out above, there would be a need for the purchaser to contribute some of its own equity, and it was thought that, if the numbers came out the right way, this would be an attractive investment for the right organisation. And, if all went according to plan, the Donovan interests would, on the day that the various transactions were settled, come away with the difference between the price paid to them by the intending purchaser and the price paid by them to the existing owner. In the Supreme Court case, and in this proceeding, this was described as the “day‑one profit” yielded by the transactions.
It was also an important aspect of Donovan’s proposal that his group should contain within it people with the appropriate skills and attributes. Ultimately, there came to be six men who formed the group. In addition to Donovan himself, there were the applicant and Michael Quinert (“Quinert”), both of whom were, at the time, practising as solicitors in Melbourne as partners in the firm Oakley Thompson & Co, and were, along with Donovan, Directors of Disctronics (the applicant was the chairman); Richard Bucknall (“Bucknall”) a project manager and consultant to the golf and leisure industries who had, for some time, been seeking golf course investment opportunities on behalf of Donovan and a company with which he (Donovan) was associated, Solette Pty Ltd (“Solette”); Chris Edmonds (“Edmonds”), someone with financial expertise and experience; and a property consultant called Peter Cahill (“Cahill”). The group had, therefore, the legal, financial, property and golfing bases covered; and Donovan himself – also a solicitor by qualification and background – was a kind of team leader (and was referred to as such in some of the communications).
According to the findings of the Supreme Court, these six men formed a joint venture for the undertaking outlined above at a meeting by teleconference on 20 July 1999. It was not long, however, before differences arose between them. I shall refer to the events in question below, but the result of them was that the joint venture disintegrated. Cahill, as the property consultant in the group, had been leading their negotiations with the existing owner of the golf course which they had in mind. He and Edmonds, knowing what the owner was prepared to accept for the course, and knowing the rental to which the prospective long‑term tenant was prepared to agree, made their own offer for the course. That offer was accepted, and the course was thereafter conducted under the ownership of a company associated with Edmonds, Cahill and other investors; and subject to the long‑term lease which was executed with the company whose negotiations had hitherto been with the Donovan group.
In the Supreme court proceeding, Donovan, Quinert, Bucknall and the applicant sued Edmonds and Cahill for breach of fiduciary duty constituted by the events and circumstances referred to above. Disctronics was also a plaintiff, it being alleged that it too was a member of the joint venture. That allegation was rejected by Warren J, in terms to which I shall refer in due course, and was not pursued on appeal. Her Honour did, however, uphold the claims of the individual plaintiffs. She awarded them equitable damages. The appeal by Edmonds and Cahill to the Court of Appeal was dismissed. The award of damages was satisfied, and it is the appropriate share of that award that, according to the Commissioner, formed part of the assessable income of the applicant for the year ending on 30 June 2005.
The applicant resists that conclusion. He accepts that he was, in name at least, one of the persons in whose favour the award was made. He accepts that the award, as received, had the character of income. But he contends that his share of the award was, in his hands, impressed with a trust arising from his position as director of Disctronics and from certain decisions which had been made by him and his fellow directors during the short period when the joint venture with Edmonds and Cahill subsisted. As I have mentioned above, in point of fact the applicant never saw any of this money: subject to the necessary adjustments for costs and disbursements, the proceeds of the award were paid by the solicitors representing the plaintiffs in the Supreme Court case to Disctronics. The Commissioner says that that is neither here nor there: the receipt of the money by Disctronics was the result of an actual or notional direction by the applicant which operated after he had become absolutely entitled under the award of the court, and had no effect on the conclusion otherwise proper to be drawn, namely, that the proceeds of the award were income in his hands.
To resolve the controversy about the character of the applicant’s interest in his share of the award made by the Supreme Court requires an examination of the events which led to the disintegration of the joint venture, and of the place of Disctronics in those events. Disctronics was, according to its annual report for year ended 30 June 1999, the parent entity of a group of corporations – referred to therein as the “economic entity” – whose principal activity was the manufacture and distribution of optical discs. It is apparent from that report that the business was then confronted with a number of challenges, including “global over-capacity in the CD manufacturing industry” and the increasingly common practice of “digital downloading from the Internet”. In that year, the consolidated group recorded a pre-tax operating profit, before abnormal items, of about $3m. Disctronics itself recorded a loss of about $0.5m. The accumulated losses of the group were in the region of $122m, while those of Disctronics itself were $136m.
Initially, the proposal to acquire and to on-sell a golf course had nothing to do with Disctronics. It was an idea of Donovan himself, and/or of his company, Solette. For a time, prior to 1999, Bucknall had been engaged by Solette to find a suitable investment in the golf industry. He had put a number of investment possibilities before Donovan, but was frustrated by the difficulty in obtaining finance. Then, in about January 1999 it seems, Bucknall learnt of a particular financing model as a result of a discussion with a property developer during a round of golf. The idea was that, for a major project which required finance, such as a golf course (or, in the example given by the property developer, a shopping centre), one would first obtain a credible “anchor tenant”, and use the projected returns from the tenancy to show prospective financiers that the project would be viable. Bucknall knew that Spotless Services Australia Limited (“Spotless”) operated a number of public golf courses owned by municipal councils. He made contact with Stuart Rose (“Rose”) of Spotless in February 1999, and asked whether Spotless would be interested in leasing and operating a golf course to be constructed by a group of investors with whom he (Bucknall) was associated. Rose appeared, to Bucknall, to be very enthusiastic about the idea, saying that, every time he had been approached in the past, the developer had asked Spotless to invest in a project, which was not its policy. Donovan too was very keen on the idea.
On 8 April 1999, Rose informed Bucknall that Spotless might be in a position to pay an annual rental of $900,000 for the tenancy of such a golf course as Bucknall had proposed. Up to this point, the proposal would have involved the acquisition of a “green fields” site at Keysborough and the construction of a golf course from scratch. However, on 12 April 1999, Donovan suggested to Bucknall the alternative of purchasing an existing course such as Kingston Links, which had previously been mentioned as an example of a successful public access, pay-as-you-play, course. According to Donovan, the advantages would be that the existing operators would have an established trading pattern, and Spotless would be able to operate the course from day one with the existing cash flows. He considered that it would probably be cheaper to buy an existing course than to build a new one, and that the existing owners of Kingston Links might be keen to sell. Although the original concept (construction of a new course) was retained as an alternative for consideration, from this point the focus of Donovan seems to have been on the Kingston Links proposal.
Spurred on, I infer, by the positive indication received by Spotless, Donovan lost little time in putting together the team of people required for the investment he had in mind. By at least about mid-May 1999, he had invited Quinert and the applicant to participate. In his affidavit in this case, the applicant said that, “[b]y June 1999, the members of the syndicate or consortium … were Mr Donovan, and at his invitation, Mr Quinert and me”. In her reasons of 23 October 2002, Warren J referred to a letter of 19 May 1999 from Cahill to Wood (not in evidence in the present proceeding) in which the involvement of the applicant as well as of Donovan and Bucknall was referred to. The letter said that Solette would be the “investment vehicle”, and that the consortium would include partners of Oakley Thompson & Co. This seems clearly to have been a reference to Quinert and the applicant. In April 1999, Edmonds and Cahill were engaged, at that stage as consultants to be remunerated by fees. Edmonds gave consideration to the financing of the investment. Cahill was in charge of negotiating the acquisition of a suitable property. By about the third week of April, he had spoken to a representative of the owner of Kingston Links, Kevin Wood (“Wood”), who had told him that anything was for sale at a price.
The price that Wood might be prepared to accept was mentioned by him at a meeting with Donovan, Cahill and Bucknall on 22 June 1999. It was $10m. It was resolved that discussions would continue between Cahill and Wood. No doubt prompted by this development, on the same day the applicant wrote to Bucknall (who had the carriage of the negotiations with Rose) stating that, in order to advance discussions with Edmonds’ possible financier, it was necessary to have “an indicative letter from Spotless”. He set out the subjects that ought to be covered by such a letter, including the term of the lease to which Spotless would be prepared to commit, the commencement rent and any increases in rent which Spotless would offer for each successive year of the contemplated lease. On the following day Bucknall passed that request on to Rose. On about 30 June 1999, Spotless forwarded its initial offer for the lease of Kingston Links. The offer proposed a rental of $960,000 per annum. Bucknall, who received that offer, sent a copy of it to Edmonds.
From about the time that Spotless’ interest was confirmed in April 1999, Donovan had it in mind that an alternative to on‑selling the golf course to a willing third‑party investor might be for Disctronics itself to purchase the course. At the time, Donovan was not happy with the performance of some insurance bonds which were the company’s only Australian investment (other than cash). If the amount of equity required of an investor in the golf course, after taking account of the debt funding that could be raised on the security of the Spotless lease, were within the capacity of Disctronics, Donovan’s view was that this might well be a more productive investment than the bonds. He shared that view with Quinert and the applicant, who seemed to see the sense in it.
The receipt of Spotless’ offer of 30 June 1999 appears to have had a significant impact on the thinking of Edmonds and Cahill as to the nature of their involvement in the proposal. According to Warren J, in early July 1999 Edmonds and Cahill “came to the view that they wanted to share in the profit of the proposed transaction” ([2002] VSC 454 at [25]). In the then perception of Edmonds and Cahill, of course, that was the “day‑one profit” which the Donovan group stood to gain from the on-sale of the golf course to a third party investor. They had no inkling of Donovan’s idea that the investor might be Disctronics. Their interest was expressed in a facsimile sent by Edmonds to Donovan on 2 July 1999, in which the participants were named as Donovan, Edmonds, Cahill and the applicant. Quinert and Bucknall were not included. In a conversation with Edmonds on 6 July 1999, Donovan made it clear that he would not accept the exclusion of Quinert and Bucknall. According to Warren J, this facsimile “may have caused Edmonds some embarrassment.”
So Edmonds prepared a revised proposal, and forwarded it to Donovan on 6 July 1999. In it, Quinert and Bucknall were included, making six participants in all. They would share equally the “development profit” that was anticipated to arise from the acquisition and on-sale of the Kingston Links golf course. On the indicative figures by reference to which Edmonds was then working, this would be $427,750, or $71,292 each. The proposal also seemed to retain the payment of fees to Edmonds and Cahill, to which Donovan objected, and told Edmonds so in a telephone conversation of the same day (6 July). Donovan also then informed Edmonds that, if the amount of equity which a prospective purchaser would be required to inject fell within the range of about $1m – $1.5m, Disctronics may provide the equity. As to that indication, Warren J found ([2002] VSC 454 at [28]):
This was the first time that the involvement of Disctronics was disclosed by Donovan or by any of the plaintiffs to Edmonds but even then only in passing.
Donovan asked Edmonds to provide him with some further financial scenarios.
Still on 6 July 1999, Edmonds did provide those further scenarios to Donovan. One of them had it that equity of $1.44m would need to be injected by the purchaser. In a telephone conversation the following day with Edmonds, Donovan confirmed that Disctronics would be likely to acquire the course under that scenario, since the amount of equity required would be less than $1.5m. Edmonds’ comment was that it was unlikely that the transaction could be effected with that amount of equity.
During the course of that week (ie 5-9 July 1999), Edmonds told Quinert that he (Edmonds) was glad that he (Quinert) was now directly involved in the Kingston Links matter. Edmonds said that he had found it difficult to communicate with Donovan, as the latter was invariably travelling and difficult to contact. He said that the applicant was not overly interested in the project and that it was himself, Edmonds, who was the only person responsible for keeping the project moving. He said that until he himself became involved in the project, it was going nowhere, “like a car whose wheels were spinning in the dirt”. Edmonds told Quinert that he would put together a package of documents regarding the project, which Quinert could read on his flight to London, whither Quinert was travelling on the Sunday (11 July) for purposes which included a Board meeting of Disctronics. Quinert invited Edmonds to leave the documents under his office door, so that he might pick them up on his way to the airport.
On 10 July 1999 Edmonds prepared a memorandum which was expressed as though Donovan had been the author. It read as follows:
This circular aims to provide each team member an overview of the project. Whilst I would prefer such communication to be via a face to face meeting, this is not possible for obvious reasons.
1. STATUS
·Peter, with the assistance of Rick, has commenced dialogue with the owner of the subject property regarding possible acquisition. At this stage, these discussions are of an on-going nature and it is expected to be at least two weeks before we know whether or not they are serious about selling the property.
·Peter and Rick will meet with Spotless, the prospective tenant, next week to progress discussions on possible lease arrangements.
·In due course, Peter will revert to the team with his estimate of current market value and his feel for the vendor’s minimum price. He will also provide his thoughts on the prospective tenant’s position and his estimate of the effect that such lease arrangements will have on the perceived market value of the property.
·Chris and Peter will make approaches to potential equity participants as the numbers begin to firm.
2. FINANCIAL ANALYSIS
It is too early in the process to predict outcomes. Notwithstanding this, the target/desired numbers are as follows:
2.1 Funding Table:
Application of Funds Land Purchase Price $ 8,400,000 Stamp duty and other acquisition costs $ 500,000 Professional / Arrangement fees & disbursements* $ 306,250 Development Profit to Consortium ** $ 893,750 Total Application of Funds $ 10,100,000 Source of Funds Debt $ 7,700,000 Equity $ 2,400,000 Total Source of Funds $ 10,100,000 * Professional / arrangement fees are estimated as follows:
Item Anticipated Fee Cost of Funds – SH /KD $ 15,000 Disbursements incurred to date $ 24,000 Disbursements (legal, valuation) $ 10,000 Property (Acquisitions & Lease) – PJC $ 71,250 Debt arrangement – CTE $ 76,000 Equity arrangement fee # $ 90,000 Introduction Fee – RB $ 20,000 Professional / Arrangement Fees $306,250 (# It is likely that the equity arrangement fee will be payable to a party external our team.)
** Development Profit payable to consortium members is to be divided in six equal parts to SH, KD, MQ, RB, PJC & CTE. Based on a development profit to the team of $893,750, this will equate to $148,958 each.
2.2 Equity:
This opportunity should have appeal to an investor who likes the idea of owning his own golf course and has the financial capacity to invest up to $3m on a long term basis with not necessarily receiving dividend streams. This opportunity offers an investor:
· 100% ownership of the course;
· Arrangement of loan facilities;
· An inherently low risk investment with strong cash flows.
3.0 VALUATION
On the basis that a favourable 15 year lease starting at $1m p.a. can be negotiated, a capitalisation rate of 9% (at best) on the rental stream may be achievable. This would produce a market value of the property in excess of $11.1m.
4.0 ALLOCATION OF RESPONSIBILITIES
As discussed, the necessary tasks are divided along the following lines:
Task Responsible Person Team Leader KD Assistant to Team Assistant CTE Cash for disbursements and holding deposit SH / KD Acquisition of Property PJC Debt Raising CTE Equity Raising CTE / PJC Arrangement of Lease PJC Assistant on Property Issues RB Legals MQ Accounting CTE 5.0 PROGRESS MEETING
Please let me know if you have any comments on the above structure. It is proposed that a telephone conference be arranged for late next week, say 22nd July. By this time it is envisaged that:
· PJC will have progressed the purchase negotiations;
· PJC / RB will have firmed up the lease arrangements;
· MQ will have arranged bank accounts for the incorporated vehicle to be used; and
· CTE / PJC will have commenced discussions with a prospective equity provider.
Of this memorandum, Warren J said ([2002] VSC 454 at [30]):
Donovan was annoyed by this latest scenario for three reasons. First, he realised that Edmonds wanted to be paid both a share of the purchase profit plus a debt arrangement fee of one per cent being $76,000. Secondly, the scenario and the facsimile of 10 July 1999 proposed an equity beyond the capacity of Disctronics. Thirdly, the high equity figure was derived from the allowance of a notional profit to be paid to the consortium by the equity provider.
It is, in my view, not difficult to see why Donovan would have baulked at the scheme of things proposed by Edmonds in his memorandum of 10 July 1999. Edmonds and Cahill had originally been engaged to provide services within their respective areas of expertise, and were to be paid therefor by way of fees. When the potential for the transaction to turn a tidy profit became clear to Edmonds, he and Cahill pressed to become co-venturers, in effect, and to share in that profit. Donovan did not resist that idea as such, but had it in mind that ownership of the golf course, with the benefit of the anticipated income stream from the Spotless rental payments, would be a good investment for Disctronics. It would not be such a good investment, however, if the amount of the equity required was to be set at such a level as would yield a handsome day-one profit for the individual participants in the transaction. By 10 July, therefore, the seed which would later grow into a tree of dissension had been sowed. If the transaction were to be considered as a speculation for six individuals, the higher the purchase price, the better. But, if the transaction were to be considered as an investment for Disctronics, the lower the purchase price, the better. Donovan, Quinert and the applicant, as directors of Disctronics, had reached the point of favouring the latter. But that would be to the detriment of Edmonds and Cahill, assuming – as Donovan appeared to be doing as at 10 July – that they would be likely to participate as co-venturers in their own right.
On Sunday 11 July 1999, Quinert attended his office to collect the documents which Edmonds had undertaken to leave for him, and other files. To his surprise, Edmonds was there when he arrived. Edmonds gave Quinert the documents, and spent 10-15 minutes also giving Quinert his views on what the latter, in his evidence in the Supreme Court, described as “the project”. According to Quinert, Edmonds’ manner was “quite intense”, and he said that he was “the best person to run the project”. He told Quinert that he (Quinert) should know that “Donovan was trying to make the project available as an investment for Disctronics”. Edmonds said that it would be better just to sell the course and get out. Quinert did not enter into this controversy with Edmonds, but said that he would read the documents on the plane and discuss the matter with Donovan in London. The documents given to Quinert by Edmonds on 11 July included his memorandum of 10 July over Donovan’s name.
Quinert arrived in London on 12 July 1999, and met with Donovan and the applicant. Donovan had already received copies of the documents which Edmonds had given to Quinert. Donovan told Quinert and Howard that one of his objectives was to make the project available as an investment opportunity for Disctronics, provided that the equity investment requirement could be handled by the company. He said that, in his view, Disctronics could afford up to $1.5m, most of which could be obtained through the redemption of the insurance bonds. According to Quinert’s evidence in the Supreme Court, “Donovan made out a compelling argument as to why the investment would be beneficial for Disctronics and both Howard and I said that we agreed with his views.” After that discussion, Donovan and the applicant suggested that Quinert should ring Edmonds, and raise certain matters with him.
The Disctronics Board meeting took place on 13, 14 and 15 July 1999, the third day of which was held not in London but at the company’s manufacturing facility at Southwater. On the morning of either 13 or 14 July (it was not entirely clear on the evidence which), before the commencement of the meeting that day, the directors met informally in the hotel room of David Mackie (“Mackie”), the UK-based CEO of the Disctronics group who was the only member of the Board other than Donovan, Quinert and the applicant. What transpired was set out by Quinert in his affidavit in this case as follows:
We informed Mr Mackie that we had been pursuing the Project, and believed that if the equity investment requirement was around or less than $1.5 million, it would represent a suitable investment for Disctronics which could be funded through the redemption of the insurance bonds held in Australia. Mr Mackie did not take great interest in the discussion, as he was primarily focussed on substantial funding and cash flow issues facing the operational businesses of Disctronics. However, since the proposal would not require provision of capital from any of the operational businesses, as it would be funded through encashment of the insurance bonds, Mr Mackie had no objection to us pursuing the Project as a possible investment opportunity for Disctronics.
Both Donovan and the applicant gave evidence to substantially the same effect.
As requested by Donovan and the applicant on 12 July, Quinert did ring Edmonds on the morning of 13 July 1999 (London time). He commenced by expressing a concern about certain fees which, in Edmonds’ proposal, would be received by Edmonds himself. Edmonds thereupon became aggressive and rude, and “shouted a lot of the time”. After what appears to have been a lengthy and difficult discussion on the subject of financing, and of possible third party investors, Edmonds got to the subject of Disctronics. He said that Donovan was pursuing the deal for Disctronics which, according to Quinert’s evidence, “would result in him [Edmonds] being screwed”. Quinert said that Disctronics had the right to take the equity position, given that it had always been “Donovan’s deal”. He said that if Disctronics took up the project, then no equity fee would be payable and that Donovan, the applicant and himself, as directors of Disctronics “would rebate our entitlements to Disctronics so as to enhance Disctronics’ position”. Edmonds said that Donovan wanted Disctronics to “get the deal” so that Donovan could squeeze Edmonds and his friend Cahill on fees and entitlements. He accused Quinert of supporting the Disctronics investment “because Donovan, Howard and I [Quinert] would be able to retain the profits in Disctronics, a company we controlled, and relegate [Edmonds] and Cahill to minor fees”. Quinert told Edmonds that he was paranoid. He told him that Donovan, the applicant and himself “would make more money individually if we did the deal externally”. He said that, if the deal was done by Disctronics, “there were many issues and barriers including dilution factors which would stand between any ultimate profit and a realisation on the part of Donovan, [the applicant] and myself.” He said that the sheer size, volume and volatility of Disctronics’ CD businesses meant that “any profit obtained through the project could literally be wiped out overnight”. He told Edmonds that there were good reasons for Disctronics to be focusing on “tangible investments in Australia”. He said that he (Edmonds) was not privy to all the issues at stake, and that he should not make judgments in matters in which he did not have all the facts. He said that Edmonds was naïve to think that an external equity provider “would not squeeze him and Cahill right down to the minimal position on fees”. Quinert said that he had seen this occur in the past, and that at least with Disctronics’ involvement the uncertainties and difficulties with an external equity provider would be avoided.
On the following morning, 14 July 1999, Edmonds telephoned Quinert. He was calm. He said that he had discussed the project further with Cahill. He proposed that he and Cahill should leave the project, and take the Kingston Links property opportunity with them, but that the Donovan group should retain the relationship with Spotless. Quinert said that this was ridiculous, and that there was no logic to “disbanding and thereby separating the two key elements of the Project”. As Quinert was on his way to (the second day of the) Board meeting for Disctronics, he said that he would ring Edmonds later.
After the Board meeting (I infer on 14 July 1999), Donovan, Quinert and the applicant met at a hotel in London to discuss the project, and in particular Edmonds’ latest position. They discussed it for over two hours, although the applicant left after about half an hour once the “key points” had been discussed. They formulated what Quinert described as a “compromise proposal” to put to Edmonds. As set out in Quinert’s evidence in the Supreme Court, the elements of that proposal were as follows:
(a)fees be fixed and agreed at $140,000.00 to Peter Cahill and Edmonds and $140,000.00 to Bucknall, Howard, Donovan and me, provided that $70,000.00 from our side of the fees would go to Rick Bucknall and $70,000.00 was to be retained between Howard, Donovan and me, except if Disctronics completed the transaction in which circumstances that last $70,000.00 would be rebated;
(b)the external disbursements of $140,000.00 would be paid before any profit share was calculated, and the internal disbursements (i.e. $210,000.00 to $280,000.00) would come out of consortium profit;
(c)if external equity was provided, we should try to cap the provider at 22% return on equity, but if internal equity was provided (i.e. by Disctronics) then there would be no profit cap to restrict Disctronics; and
(d)if the equity requirement for the Project was $1.5 million or less then Disctronics had the right to take over the deal, but that if it was more then Edmonds would have the mandate to procure external equity.
Either on that day or the following day, Quinert telephoned Edmonds and went through the compromise proposal that had been formulated. Edmonds said that he liked it, and that he would discuss the matter with Cahill.
On 16 July 1999, by which time Quinert was in Rome, he received a facsimile from Edmonds, sent on that day, but dated 12 July 1999. In the facsimile and the attached tables, Edmonds set out three alternative scenarios, broadly based upon the compromise proposal which Quinert had put to him by telephone on 14 July 1999. Although the numbers and assumptions differed as between these alternatives, the principles by reference to which they had been prepared were stated, in the cover sheet to Edmonds’ facsimile, as follows:
1. ‘Expert disbursements’ are paid as required.
2.‘Internal Disbursements’ of approximately $280k are split between KD, SH, MQ & RB on the one hand and PC & CE on the other.
3. If an external equity provider is used, the ‘profit’ is split six ways.
4.If Disctronics decides to participant [sic] as the owner (scenarios 2a & 2b), ‘profit share’ does not apply.
Quinert sent this facsimile on to Donovan, and later spoke to him. Donovan said that he had not intended that there would be “no profit share” if Disctronics were the purchaser of the golf course. Based on his discussions with Donovan, Quinert telephoned Edmonds on 16 July 1999 and accepted what had been set out in the latter’s facsimile, subject to two matters: first, that Disctronics should not have been referred to specifically in the document, “because the matter at this stage was still confidential”, and secondly, that the “external parties” – Edmonds, Cahill and Bucknall – should get some profit if Disctronics negotiated as purchaser, although the quantum would have to be based on “arms-length negotiations”. According to Quinert, Edmonds said that he was happy with this, and thanked Quinert for reintroducing the prospect of there being some profit share for Cahill and himself, over and above their fees. At this stage, Quinert thought that the issue was resolved.
While these interchanges involving Quinert and Edmonds were taking place, Bucknall was continuing his negotiations with Rose. According to the evidence which he gave in the Supreme Court, by 13 July 1999, Bucknall had asked Rose for an annual rental of $1.2m and was confident that at least this rental would be achieved, so long as the Kingston Links audited revenue figures were substantiated, and the corporate packages lifted the number of rounds to approximately 60,000 annually.
On 19 July 1999, Edmonds sent Quinert a further facsimile which, although not in evidence in the present case, appears to have been by way of variation of that sent on 16 July. In her judgment, Warren J said that it contained “four core proposals” as follows ([2002] VSC 454 at [42]):
(1)External disbursements for the acquisition of the golf course were estimated at $140,000 if an external equity provider was involved.
(2)Moneys for internal disbursements of $200,000 were to be split, that is, $140,000 between Donovan, Howard, Quinert and Bucknall, and $140,000 between Edmonds and Cahill.
(3)Approximately 50 per cent of the notional profit of the transaction, excluding disbursements payable to Donovan, Howard, Quinert, Bucknall, Edmonds and Cahill, accrued to the equity provider.
(4)The remaining notional profit would be applied to pay external disbursements, then internal disbursements and the balance called “a profit share” was to be split six ways between Donovan, Howard, Quinert, Bucknall, Edmonds and Cahill equating to the sum of $30,000 each.
Quinert considered, and Warren J found, that the scenarios set out in this facsimile departed from the telephone conversation which the two men had had on 16 July. The scenarios were, according to Quinert, “largely dependent upon assumptions which were unknown at that time, being the cost of the land and the rental return to be obtained”, and he did not respond to Edmonds’ request to confirm the acceptability of them.
Edmonds’ memorandum was considered at a teleconference on 20 July 1999 attended by Donovan, Quinert, Bucknall, Cahill and Edmonds. The applicant was unable to attend, but he later saw, and agreed with, the minutes of the meeting, and both the case in the Supreme Court and the present case have been conducted by reference to an assumption that he was a notional participant. Those minutes, prepared by Edmonds and subsequently accepted by all concerned, identified the topic of discussion as: “Property Venture to Acquire Kingston Links Golf Course and Arrange Spotless Services Limited to become Long Term as Operator/Tenant”. The substantive parts of the minutes provided as follows:
5. PROPOSED FUNDING TABLE
Whilst it is too premature in the timeline of this transaction to accurately predict final numbers, the broad approach is to be as follows:
‘Acquisition Costs’ are to include cost of the legal work to be undertaken Oakley Thompson & Co which are roughly estimated at $20k.
‘Disbursements – External’ are to be paid as required. Such items are to include cost of funds, disbursements incurred to date (?), equity arrangement fee (if applicable) and valuation fee.
‘Disbursement – Internal’ are to be fixed at $140k for consulting, legal and introduction (KD, SH, MQ & RB) and $140k for property, administration and funding (PC & CE)
‘Profit Share’ / Initial Investor Return’ are to be determined as the transaction unfolds. Profit share to the team is to be split 6 ways. It is anticipated that the day-one return on equity to the investor, net of costs, will be approximately 50% of the notional profit after Government duties and imposts (i.e. excluding disbursements to our team) accruing to the equity provider(s), up to a ROE of 22% for an external equity provider. The factors influencing the final approach will be the saleability of the project to an investor (what is the minimum return acceptable), the marketability of the project to the investor (does it appear as an attractive proposal) and whether or not the equity provider(s) form part of our team.6. PROVISION OF EQUITY
It was agreed that the matter of sourcing equity funding would be further addressed only after the purchase price of the property and details of the lease arrangements are known.
7. ACQUISITION OF SUBJECT PROPERTY
Peter Cahill briefed the meeting on the progress to date of the negotiations with the vendor. Peter tabled a draft letter of offer addressed to Kingstons. After lengthy discussions regarding the requirements to avoid being assessed for double stamp duty and various amendments to the format of the letter, Peter was authorised to proceed to deliver the offer to Kingston. This is scheduled to occur tomorrow.
The potential to immediately sell plant and equipment to the prospective tenant was also discussed.
8. NEGOTIATIONS WITH PROSPECTIVE TENANT
Rick Bucknall discussed progress with Spotless. It was decided that Rick would reapproach Spotless and preposition our expectation that the initial rental would be in the order of $1.1 million per annum.
Warren J held that it was at this teleconference that a joint venture to acquire the Kingston Links golf course came into existence, and that the members of the venture were Donovan, Quinert, Bucknall, Edmonds, Cahill and the applicant.
By letter to Wood dated 21 July 1999, Cahill made a formal offer to purchase the Kingston Links golf course for the price of $7.75m, plus stock at value. The purchaser was identified as Quinert, Edmonds and the applicant, as nominees for a special purpose entity or entities. The offer was subject to three conditions precedent, one of which was that the purchasers should reach formal agreement with a golf club operator as to the terms and conditions of an acceptable management agreement. It seems that the offer was not acceptable to Wood, but he and Cahill continued negotiating. On 3 August 1999, they reached a verbal agreement for the sale of the golf course for the sum of $8.68m. According to a file note of that date made by Quinert, after a conversation with Cahill, that sum included “machinery”.
During the same period, Bucknall’s negotiations with Rose were also proceeding well. By letter dated 29 July 1999 to Donovan, Rose indicated that an annual rental of $1.165m was “achievable”, subject to various matters set out in the letter. The letter also suggested that a minimum ten‑year lease would be required, with a further ten‑year option, and that the parties would need to agree upon a “measure of rental increase” as to which Rose added “usually CPI”.
By early August, therefore, the members of the joint venture which had been formed on 20 July were in possession of the two key parameters by reference to which they could plot their future: the price at which Kingston Links was available for purchase, $8.68m, and the annual rental which was likely to be paid by Spotless, $1.165m. It was in this environment that what Warren J described as “the disintegration of the joint venture” took place.
On 3 August 1999, Quinert (by then back in Australia) had a conversation with Edmonds. Edmonds asked how much money Quinert had; and he also asked whether Donovan and the applicant had access to cash. Quinert responded that he himself, Donovan and the applicant all had access to funds. Edmonds asked a similar question about Bucknall. When asked by Quinert why these inquiries were being made, Edmonds said that, if Quinert, Donovan, Bucknall and the applicant could “come up with a few hundred thousand dollars between [them]” (Quinert’s words in his evidence in the Supreme Court), he (Edmonds) had an idea about a new way that the project could be structured “so as to do it ourselves”. Quinert told Edmonds to set out his proposal in writing.
Edmonds did set out his proposal in writing, on the same day. His memorandum included two scenarios, the first of which was based upon what he described as “external equity”, in which event there would be “50% of initial paper profit to investor(s)”. The second scenario was headed “equity participation by each team member”. This involved an expedient which had not previously been mentioned at any stage, namely, “the six team members retaining ownership of the facility”. In such a case, on Edmonds’ calculations, each team member would be required to inject $126,666, making a total of $760,000.
Quinert discussed Edmonds’ new proposal with the applicant, and the two of them later called Donovan in London. Donovan said that he would not agree to the proposal. He said that Disctronics was to be the equity investor. He told Quinert to tell Edmonds that Disctronics now intended to take up its entitlement in respect of the project, given that an equity injection of less than $800,000 was required.
On 4 August 1999, Quinert replied to Edmonds’ memorandum of 3 August, and he did so effectively also on behalf of Donovan and the applicant. At the outset, Quinert confirmed that Disctronics “intends to exercise its entitlement to take on the acquisition”. In the circumstances, the second scenario proposed by Edmonds was, according to Quinert, “not possible”. The remainder of Quinert’s memorandum was concerned with matters of detail, and of contention as between Edmonds and the Donovan group, and it is not necessary to set them out at length. The memorandum did, however, contain the following paragraphs:
In an effort to perhaps allay your fears I assure you that I believe the transaction can procure a real and substantial profit. As such there will be an entitlement to non associated consortium members for a return significantly greater than the agreed professional fees. Given that as I understand it, yours and PC’s engagement was originally to be as consultants only this outcome when viewed in that context probably represents the best deal you have ever done. It would be extremely disappointing if you were not happy in those circumstances.
To be candid your approach always seems directed towards pushing the other consortium members to a position rather than simply discussing and resolving the matter in an open and co-operative serve. This is not my style and, frankly, I am personally not going to participate in such a process with people I consider associates. That is how I feel.
Also on 3 August 1999, Quinert activated a shelf company called Corwen Grange Pty Ltd (“Corwen Grange”) and caused Disctronics to acquire one ordinary share in it. The purpose of this was so that Corwen Grange could be the nominee company to whom the golf course would be transferred on behalf of Disctronics. Quinert informed Cahill of that intention, and instructed him to name Corwen Grange as the offeror in the formal offer which he, Cahill, was then, as Quinert assumed, preparing to send to Wood.
The dispatch of Quinert’s memorandum of 4 August 1999 led to some acrimonious discussions between the two contending sides, largely involving the applicant and Edmonds. According to Warren J ([2002] VSC 454 at [52]), “Edmonds, and also Cahill, asserted that the imposition by Donovan and the others of Disctronics into the role of equity provider in the transaction had an impact on the agreed profit share.” Her Honour also said (at [56]):
On 5 and 6 August 1999 various discussions ensued between Howard, Quinert and Edmonds as to the position of Edmonds and Cahill. By this time relations between Edmonds on the one side and Howard and Quinert on the other had become strained. Edmonds was concerned that Donovan was allowing Disctronics to take over the acquisition whilst he saw an opportunity for the six team members to provide the equity themselves. Donovan, Howard and Quinert on the other hand saw Edmonds as seeking to gain more than he was entitled to and at the expense of Disctronics.
According to the evidence of the applicant in the Supreme Court, after he had read Edmonds’ proposal of 3 August and Quinert’s response of 4 August, he went to see Edmonds in his office (which was located conveniently to the offices of Oakley Thompson & Co where the applicant and Quinert were partners) on 4 August 1999. The applicant’s evidence continued:
I told Edmonds that I thought the Disctronics scenario was contrived by him to enable the individuals to usurp Disctronics’ entitlement, that the fees for which he and Cahill were asking were excessive, and that his suggestion that they were based on a paper profit was absurd and illogical. I asked him to reconsider the sum being sought. My final words were to the effect that I would not allow him to torpedo Disctronics’ corporate opportunity.
By this stage, it seems, the discussions had become what was, in effect, a negotiation as to the size of the fees that would be paid to Edmonds and Cahill in total, given that they were clearly unhappy about their prospects of securing any significant profit on the transaction, now that Disctronics was to be the purchaser.
The applicant telephoned Donovan in London, who authorised him to negotiate a settlement of the dispute with Edmonds. The applicant and Quinert then went again to see Edmonds in the latter’s office. After some bargaining, the position being taken by Edmonds was that he and Cahill would accept nothing less than $340,000 jointly, and the position being taken by the applicant on behalf of the Donovan group was that no more than $200,000 would be offered. That remained the position until late in the afternoon of 5 August 1999, when the applicant again went to see Edmonds. He told him that “Disctronics’ final position was $300,000 (expressed on a joint all in basis)”. Edmonds consulted Cahill, and returned to the applicant (now in his own office) with the advice that they would accept $300,000 jointly.
If Edmonds and Cahill were to be the beneficiaries of cash payments, it was necessary to define the conditions which would attach to that entitlement. The applicant’s evidence in the Supreme Court continued:
I had already started to write out possible terms of settlement in the interval between leaving his room and him responding to me. I asked him whether the equity figure of $760,000 he had set out in the scenario entitled “Equity participation by each Team member” was able to be achieved. He told me that it was a bankable deal given the Spotless lease. He told me that he couldn’t wait for me to complete the document as he had a commitment at Preston. I therefore told him that the fee payable was based upon first, the offer of $8.68m being accepted; second, a gross rent return of $1.165 million being received from Spotless Group; third, the sum of equity to be made available by Disctronics being ballpark what the individuals would on his scenario be required to inject; and finally that the finance facility would be sought on a non‑recourse basis. He emphatically responded “yes” to each part and then hurriedly left.
The applicant completed his handwritten draft of the terms of settlement and, because he was to be away from his office the following day, 6 August 1999, left it for his secretary to type and to hand to Quinert for review. The typed document, as provided by Quinert to Edmonds, was as follows:
Our fee agreement is as follows:
Subject to:l.a wholly-owned subsidiary of Disctronics Limited “D.L.” or its/their nominee satisfactorily completing the acquisition of the Kingston Links Golf Course (“the Property”) for an aggregate price not exceeding $8.688 m. (“the net purchase price”) which said net purchase price includes all land, buildings, tradenames, goodwill, plant and equipment, machinery etc at on, upon or appurtenant to the enjoyment and use of the Property; and
2.C.E. and P.C. procuring bank finance (“the finance facility”) for D.L. at not more than prevailing commercial rates of interest, fees and charges to a level which requires D.L. to contribute equity of not more than $750,000 to acquire the Property; and
3.the finance facility being provided on a non-recourse basis to the directors of D.L.; and
4.the finance facility being premised upon a net rental available to D.L, of $1.065m., being the gross rental payable by the intending Lessee (being a member of the Spotless Group of Companies who must unconditionally consent to entering into an Agreement for Lease of the Property for a term of not less than 5 x 5 x 5 x 5 years at a gross commencement rental of not less than $1.165 m. per annum plus rates, taxes, and outgoings within one month of D.L. entering into a conditional contract to purchase the Property) less the reasonable cost of engaging R.B. for a term of 1 x 1 x 1 years at a commencement salary package not to exceed $80,000 per annum to supervise the intending lessees use of the Property so as to preserve and enhance its value.
Then, but not otherwise:
5.D.L. shall pay C.E. and/or nominee on completion of the purchase of the Property $150,000; and
6.D.L. shall pay P.C. and/or nominee on completion of the purchase of the Property $150,000; and
7.D.L. shall pay R.B. and/or nominee on completion of the purchase of the Property $100,000.
These terms are confidential.
On 10 August 1999, Edmonds responded to Quinert in the following terms:
I acknowledge receipt of your proposal on Friday evening 6 August 1999, which purports to be an agreement. I must emphasise that no such agreement is in place. Confirmation of your revised offer was sought so that I could discuss the matter with Peter Cahill. However, the offer is a dramatic variation from the profit sharing arrangements that were agreed and documented and it is therefore unacceptable. Whilst Peter acknowledges being invited into the consortium initially as a consultant, the deal very clearly and demonstrably evolved into a joint venture between yourself, Kevin Donovan, Stephen Howard, Rick Bucknall, Peter Cahill and myself. From my end, I always considered that my interests, through Home Link Mortgage Corporation Limited, were part of a partnership/joint venture. The basis of the agreement and the formula for equity/profit sharing was documented (and countersigned by Kevin Donovan without objection from any of the participants). Clearly, you believe the joint venture (for which Oakley Thompson & Co is the appointed legal firm) is now at an end because you have excluded Peter, Rick and myself from any involvement as principals and are seeking to appoint us merely as consultants to the transaction so as to maximise your own commercial returns. I am immensely disappointed that you have repudiated the joint venture arrangements, which were very clear cut. The present proposed terms for our on-going involvement is unacceptable. Peter and I are somewhat relieved that we are no longer involved because we believe your integrity and ethics are profoundly lacking.
It may not have been entirely irrelevant to the content of this communication that Edmonds and Cahill were, by then, receiving their own legal advice.
On 11 August 1999, Quinert wrote to Cahill, noting that he had received Edmonds’ memorandum of 10 August that day, and asking for Cahill to clarify his own position as soon as possible. Quinert’s letter continued:
As I confirmed to you in our telephone conversation of 4th August last the Disctronics group had then elected to proceed with this acquisition through a wholly owned subsidiary Corwen Grange Pty Ltd. This election was made pursuant to the prior agreement of all concerned, which fact has been acknowledged by Chris Edmonds in the presence of myself and Stephen Howard. As such, you as agent have had a fiduciary obligation to the Disctronics group to act on its behalf and in its best interests in your discussions with the vendor. Please advise me of what action you have taken as the responsible agent towards securing the acquisition on behalf of Corwen Grange Pty Ltd.
Quinert added that, if the acquisition of the golf course had been successfully concluded, then Cahill’s company would be entitled to the “success fee/estate agent’s commission” provided for in its original letter of engagement to Donovan. If the acquisition had not been concluded, Quinert invited Cahill to submit his claim for hourly fees. He also asked Cahill for a report on the status of negotiations, so that the Donovan interests could “pick up the threads and proceed to the completion of the transaction”.
On 12 August 1999, Quinert replied to Edmonds’ memorandum dated 10 August 1999. In doing so, he said:
I made my position clear to you in my memorandum dated 4 August last. The document of 6 August was prepared by [the applicant] to confirm terms of a resolution which had been reached by you and he. I approved of and endorsed that resolution as did Kevin, Rick and on your representation so did you and Peter Cahill.
The Disctronics Group will be pursuing its right to acquire Kingston Links. This right has been acknowledged by all concerned including yourself. Any attempt on your part to undermine or frustrate that process will constitute a breach of your fiduciary obligations as a former consultant to the project. I will take legal action to prevent or remedy such a breach if required.
I consider the contents of your letter to be nothing more than a concoction of self serving misrepresentation and falsehood. I do not wish to speculate on your motives for this or the unnecessary and personal attack on my character. Suffice to say you have deemed it appropriate to dispense with nine years of friendship and loyalty to satisfy your purpose. No one is the better off for such a decision.
On 12 August 1999, the applicant wrote a lengthy letter to Edmonds, in what Warren J described as “self‑serving terms”. It was, to say the least, a forceful rejection of Edmonds’ letter of 10 August 1999, which the applicant described as covering “the gamut from the distasteful to the artfully distorted”. The applicant said:
1.Indisputably, the chronology of this transaction commenced with you and Peter Cahill acting as consultants to Solette Pty Ltd and subsequently that relationship moved to a joint venture. The venturers were Messrs Bucknall, Cahill, Donovan, Edmonds, Howard and Quinert. At all material times it was agreed between the venturers that if equity of less than $1.5m was required to acquire the Kingston Links Golf Course (“the Course”) then the Disctronics Group of Companies could elect to proceed to solely acquire the Course and the joint venture would cease to exist subject always to satisfactory arrangements being made with the non‑Disctronics Directors which would reward them for their endeavour and participation;
2.On the 3 August 1999 Michael Quinert, for the Disctronics Group, exercised Disctronics’ entitlement by appropriately advising you.
The remainder of the applicant’s letter was largely concerned to dispute the complexion placed upon things, particularly the discussions in which the applicant himself had been involved in the period leading to 6 August 1999, by Edmonds’ memorandum of 10 August 1999. On 13 August 1999, Edmonds responded to the applicant, rejecting the latter’s proposition that there had been an agreement that Disctronics could become the purchaser of the golf course if less than $1.5m by way of equity was required. According to Warren J, that rejection “contradicted the discussions between [Edmonds] and Donovan in July 1999 and between Edmonds and Quinert in July also”.
Unbeknown to Donovan, Quinert or the applicant at the time, on 10 August 1999, Cahill wrote to Wood, advising him that the consortium was “dissolved”. On the following day, 11 August, Wood replied to Cahill stating, according to Warren J ([2002] VSC 454 at [64]) “that he would be delighted if Cahill considered the acquisition in his own right or with another party”. On 10 August 1999, Cahill contacted one Michael Buxton (“Buxton”), a business acquaintance of his. He proposed that Buxton should participate in a joint venture to acquire the Kingston Links golf course. As I shall mention presently, that proposal was put into effect, but not immediately.
On 19 August 1999, Quinert wrote to Wood enclosing a formal offer to purchase the Kingston Links golf course for the sum of $8.688m. The offer was made in the name of Corwen Grange. Giving Wood some background as to the nature of the joint venture which had then recently disintegrated, Quinert said:
As you are aware Mr Peter Cahill of Domain Hill Property Services Pty Ltd was until recently engaged in negotiations with you regarding the proposed acquisition of Kingston Links Golf Course (“the facility”). In conducting those negotiations Mr Cahill was acting as an agent for, and was a member of, a consortium which, was formed to pursue the acquisition on behalf of an equity investor. Pursuant to certain financial parameters agreed to by the consortium members, the equity investor which took up the option to pursue the acquisition was an unlisted public company group which operates pre-dominantly in the United Kingdom and the United States of America. Certain members of the consortium including myself, Mr Stephen Howard and Mr Kevin Donovan are also Directors of the equity investor group. On the 3 August last, Peter advised me that following further discussions, you had informed him that you would be prepared to recommend an offer of $8,688,000.00 for the acquisition of the facility subject only to that offer being put in writing. On the basis of that advice arrangements were made to incorporate a local subsidiary of the equity investor group on behalf of which the formal acquisition offer could then be made. The company so incorporated was Corwen Grange Pty Ltd ACN 088 393 337. Mr Howard and I were appointed as Directors of Corwen Grange Pty Ltd. At that point in proceedings a negotiation was initiated by a member of the consortium regarding advisory fees and other entitlements arising out of the consortium. This individual had originally invited Peter to participate first as an advisor and ultimately as a member of the consortium. Although Peter neither initiated nor participated directly in this kerfuffle, we were not surprised that as a friend and invitee of the chief protagonist, he felt bound to hold the line. We presume this is why when that person withdrew from the consortium so did Peter; despite the fact that he had substantially succeeded in his specific task of securing an agreement to purchase the property. Certainly, we have sought to assure Peter that upon settlement it is our intention to remit his fees and entitlements in recognition of Domain Hill's work. Unfortunately the abovementioned events have delayed the communication of the formal offer you requested from Peter. We regret any inconvenience caused by that delay and hope this explanation at least enables you to appreciate our position. As indicated, the investor group has always and still intends to proceed with the formal offer which was the subject of your discussions with Peter. As such, we enclose herewith the written offer put by Corwen Grange Pty Ltd.
Most likely because of the recent contact which he had received from Cahill, it seems that Wood did nothing in response to this offer from Quinert.
On 27 August 1999, Emanbee Pty Ltd (“Emanbee”), a Buxton company, made a written offer to Wood to purchase the Kingston Links Golf course for the sum of $8.7m. As noted by Warren J this was a mere $12,000 more than the offer which had been made by Corwen Grange. Although not informed by Cahill or Edmonds of the making of this offer, Quinert suspected that they may have put a competing offer to Wood. Accordingly, on 1 September 1999, he sent a letter, on the letterhead of Disctronics, to Cahill repeating a warning which he had earlier given about the latter’s breach of fiduciary duty, requesting that Cahill withdraw as a competitor, threatening litigation and seeking a response. On the same day, 1 September 1999, in conversation with Bucknall, Wood said that his company had resolved to accept the offer from Emanbee. That is what subsequently happened. Kingston Links Country Club Pty Ltd (“KLCC”) was registered on 12 October 1999 with Buxton, Edmonds and Cahill as directors. On 29 October 1999, KLCC executed a contract of sale with the registered proprietor of the land upon which the Kingston Links golf course stood. The transfer was registered on 14 December 1999. On 8 December 1999, KLCC entered into a lease with Spotless.
On 22 December 2000, Disctronics lodged a caveat over the title to the land on which the golf course stood, asserting the existence of a constructive trust in its favour. In her Honour’s reasons of 23 October 2002, Warren J observed that no explanation had been given as to why Disctronics waited so long before taking that step. On 8 June 2001, KLCC commenced a proceeding for the removal of the caveat (“the caveat proceeding”). On 26 June 2001, the proceeding in the Supreme Court first referred to in para 2 above (and to which I shall hereafter refer as “the main proceeding”) was commenced. Donovan, Quinert, Bucknall and the applicant were plaintiffs, as were Solette and Disctronics. In the then case of the plaintiffs, Disctronics was said to be a member of the joint venture which had been formed on 20 July 1999.
On 15 June 2001, Donovan, Quinert and the applicant, of the one part, and Disctronics, of the other part, executed an agreement (in which the parties of the first part were referred to as “the directors” and Disctronics was referred to as “DL”) in the following terms:
Whereas
A.The directors were formerly members of a joint venture to acquire the Kingston Links Golf Course (KLGC) with others namely Christopher Edmonds (CT) [sic], Peter Cahill (PC) and Richard Bucknall (RB) to package an approved tenant and KLGC to an investor (the joint venture). The joint venturers agreed that the investor would be either a third party or DL;
B.On or about 14.07.’99 in London meetings of DL, the directors agreed that if the equity requirement to require KLGC was less than AUD$1.5m then the directors would seek to have DL become the equity participant and purchaser of KLGC (the “option”). The directors further agreed that if DL exercised its Option then the directors would rebate to DL any entitlement (whether on revenue or capital account) they may have as a consequence of their participation in the joint venture;
C.On 16.07.99 Mr Edmonds was informed of the directors’ intention for DL to become the investor or equity participant. CE (for himself and PC) agreed with the directors’ Option proposal. RB separately agreed with the Option proposal;
D.On 04.08.99 MJQ (for the directors of DL) wrote to CE exercising DL’s Option and the right to acquire KLGC as the equity required to acquire KLGC was less than AUD$1.5m;
E.CE and PC (with others), in wilful breach of the terms of the joint venture and their obligations and duties to the venturers (including DL) have acquired KLGC, via a corporate vehicle, for themselves utilising confidential information obtained whilst either a consultant to DL (or the directors) or as a member of the joint venture. As a consequence of the wrongful action of CE and PC, DL has been precluded by deceit of CE & PC from acquiring KLCC notwithstanding the valid exercise of the Option;
F.In December 2000 DL lodged a caveat (“the caveat”) claiming, inter alia, a constructive trust over and upon the freehold land component of KLGC;
G.Legal proceedings are foreshadowed to be imminently issued out of Supreme Court of Victoria by DL, the directors and RB in relation to both the Option and the caveat (“the proceedings”);
H.The directors have concerns about their ability to fund from their own resources the anticipated costs of the proceedings. The directors are advised that the case to be put is compelling and the prospects of a favourable outcome are strong. The directors desire to prosecute the proceedings, as contemplated, which requires the directors to accept the litigation risk of being individual [sic] named plaintiffs with DL, in order to ensure that DL is afforded the opportunity of exercising its right to seek damages and compensation for the loss of its corporate opportunity and the wrongful appropriation of KLGC by CE, PC and others.
Now, for good and valuable consideration, this agreement witnesses:
1.DL shall pay all legal fees and disbursements associated with the prosecution of the proceedings, or either of them, to Mallesons, counsel, Oakley Thompson & Co including reasonable travel and accommodation costs;
2.The directors have agreed with RB that he will not be liable for either any legal fees or disbursements associated with the prosecution of the proceeding or in relation to any damages or costs orders of any description in favour of CE, PC (or others);
3.DL shall indemnify the directors (and for their obligation to RB) against payment of any order/s for costs, howsoever arising, in favour of CE, PC (or others) arising out of the prosecution of the proceedings or any damages they are found liable to pay to CE, PC (or others);
4.In consideration of DL’s promises set out in paras 1 and 3 hereof the directors, and each of them, assign absolutely into and to the sole use of DL, any award of damages (whether our revenue or capital account), costs or interest made in their favour as a consequence of their participation in the joint venture or arising out of the proceedings and the ultimate outcome thereof;
5.The directors will do all such things required by DL, or its solicitors, to diligently prosecute the proceedings and to provide all reasonable assistance to DL.
On 16 November 2001, KLCC entered into a contract for the sale of the golf course to a third party, Gauntlet Services Pty Ltd (“Gauntlet”) for the sum of $14m. Because of the existence of the Disctronics caveat, settlement of the contract was postponed. On 20 March 2002, the Supreme Court ordered that the caveat be removed, and that the proceeds of the sale of any settlement as between KLCC and Gauntlet be deposited into a trust account controlled by the parties’ solicitors. On 9 April 2002, the trial of the main proceeding and the caveat proceeding commenced before Warren J, and ran until 1 May 2002. On 8 May 2002, notwithstanding the orders made on 20 March 2002, Gauntlett apparently served a notice of repudiation upon KLCC. The sale to Gauntlet did not, therefore, proceed. However, the property was in fact sold to another purchaser by contract of sale dated 17 June 2002.
On 23 October 2002, Warren J gave judgment in the main proceeding and the caveat proceeding. As to the former, her Honour explained the nature of the plaintiffs’ case ([2002] VSC 454 at [95]):
They alleged that it was a term of the joint venture agreement that investigations would be conducted as to the financial viability of a joint venture golf course project. The plaintiffs alleged that the project was to be investigated on two bases, first, that the equity participant to acquire and own the golf course would be a third party to be identified at a later time. Secondly, that Disctronics or one of its related entities would be the equity participant in the project if it chose to do so.
The defendants accepted that a joint venture came into existence on 20 July 1999, but they denied that Disctronics was part of it, and they denied that Disctronics was entitled to be the equity participant if it chose to do so. Warren J described their position as follows ([2002] VSC 454 at [105]-[106]):
105.The K.L.C.C. defendants alleged that on about 20 July 1999 an agreement was entered into between Donovan, Quinert, Howard, Bucknall, Edmonds and Cahill to acquire the Kingston Links Golf Club, to split any profit share derived from such acquisition six equal ways between them and that the manner of funding the acquisition would be determined at a later time.
….
106.The defendants described this agreement as “the Golf Club Purchase Agreement”. The defendants alleged that arising from that agreement each of the participants were in a fiduciary relationship and owed duties to one another. They alleged, also, that there were terms of the golf club purchase agreement that they would act in the interests of the group, act in good faith, not use confidential information imparted to them to the prejudice of the interests of the group and not seek to prefer their interests to the interests of the group and other related terms.
In the main proceeding, each side accused the other of repudiation. The defendants (including Edmonds and Cahill) alleged that Quinert’s memorandum of 4 August 1999, and the actions of the Donovan interests thereafter down to about 9 August, repudiated the joint venture agreement which they (the defendants) asserted came into existence on 20 July. The plaintiffs alleged that Edmonds’ memorandum of 10 August 1999 repudiated their own alleged version of the joint venture agreement of 20 July. Quite plainly, the intention of Donovan, Quinert and the applicant to put Disctronics forward as the purchaser of the golf course was central to this controversy. According to the plaintiffs, they were entitled to nominate Disctronics as the purchaser, such that Edmonds and Cahill were then contractually bound, without more, to proceed with the transaction at the price that had been negotiated with Wood. According to the defendants, assuming a purchase of the course at or about the negotiated price, all members of the joint venture were obliged to use their best endeavours to on-sell the property on the most advantageous terms, and the Donovan parties were not entitled to prefer their own interests, as directors of Disctronics, to those of the members of the joint venture.
According to the Commissioner, the unlikelihood of the applicant being the only one of the seven beneficiaries ultimately to derive the benefit of the corpus of the Esparto Trust was not to the point. The mere possibility justified the conclusion that he was, on 30 June 2006, “contingently entitled” (to use the wording of s 475) to 100% of the corpus. Rejoining to the obvious response that this would produce the result that all of the persons who, on 30 June 2006, were discretionary beneficiaries of the trust would likewise be contingently entitled to 100% of the corpus – yielding a total contingent entitlement of 700% – the Commissioner referred to s 96C(6), which not only contemplated, but provided a means of resolving, situations in which the sum of the attribution percentages of different Australian taxpayers exceeded 100%.
At the general level, I would accept the Commissioner’s proposition that a beneficiary under a discretionary trust who is within the class of persons to whom the corpus of the trust was required to be distributed in default of any other disposition of the corpus either while the trust is an ongoing entity or upon termination of the trust is to be regarded, at every time while he or she remains in that position, as “contingently entitled to acquire” the corpus: see In Re Brooks’ Settlement Trusts [1939] 1 Ch 993, 997-998; Hobbs v Federal Commissioner of Taxation (1957) 98 CLR 151, 161. Notwithstanding that, it must be said that the Commissioner’s construction of para (b) of the definition of “attribution percentage” would yield some rather odd results in practice. Take, for example, a case in which there was one resident beneficiary in a non-resident discretionary trust of which there were, in total, 10 beneficiaries. The attribution percentage would be 100%. Subsection (6) would have no operation. The taxpayer’s share of the net income of the trust estate under s 96C(2) would be 100%. That is to say, notwithstanding that the taxpayer was one of only ten persons who were equally contingently entitled, the whole of the net income of the trust estate would be treated, under s 97, as though it were the assessable income of the single resident taxpayer. It would not be difficult to reach the instinctive conclusion that a result like this is unlikely to have been intended.
Neither, however, is it difficult to envisage situations in which the construction for which the Commissioner contends would be the only one that would give sensible operation to the definition of “attribution percentage” in s 96C(5). Take the case of a testamentary trust, under which the testator left a fund on trust, to be taken by his son absolutely if the son married before the age of 25, otherwise to be taken by his daughter absolutely. Because the interests of the son and daughter would be in the alternative, at some point before the son turned 25 it could not be said that they each contingently held a 50% share of the corpus of the trust. Indeed, it could never be the case that either would become entitled to 50% of the corpus. One only of them would become entitled to 100% of the corpus. The conclusion that each was contingently entitled to acquire 100% of the corpus would, in my view, be inescapable.
Although the construction for which the Commissioner contends is not always an attractive one, I am bound to say that I do not see any satisfactory alternative. Given the universe of miscellaneous contingent entitlements with which the definition must potentially cope in practice, a legislative intent that all contingent beneficiaries should be assumed to have equal entitlements, or even that their respective interests could be horizontally calculated to yield total of 100%, cannot be regarded as likely. Indeed, as the Commissioner pointed out, subs (6) implies a legislative assumption that the attribution percentages of individual beneficiaries may well exceed 100%. In the circumstances, I would accept the Commissioner’s case on the construction of the definition of “attribution percentage” in s 96C(5) of the 1936 Act.
It follows that it is not necessary to take account of what was the corpus of the Esparto Trust on 30 June 2006. One needs only to know, first, that there were seven discretionary beneficiaries of the trust on 30 June 2006, secondly, that the interests of these beneficiaries were identical and included the right to share equally in the corpus on default, and thirdly that three of then were residents of Australia on that date. That latter circumstance was the subject of evidence from the applicant received very late in the piece, after the Commissioner had indicated his reliance on subs (6) of s 96C in the way I have explained above. For the applicant the attribution percentage was, therefore, (100/300) x 100 = 33.33%.
In the year to 30 June 2006, the applicant held an interest in the Esparto Trust for 227 days. The calculation required by s 96C(4) is, therefore, as follows:
The figure yielded by this calculation is £1,681,223.73. In recent submissions, the Commissioner referred to his “published exchange rate” as at the date of the share buyback, namely, $A1 = £0.4262. The applicant accepted that rate as applicable for present purposes. It would yield a figure of $3,944,682.61. That was the applicant’s share of the net income of the Esparto Trust under s 96C(2) of the 1936 Act and it was, therefore, included in his assessable income under s 97(1) of that Act.
Alternatively, and supplementally, to s 97 of the 1936 Act, the Commissioner relied on s 99B as a basis for bringing into the assessable income of the applicant the benefit which he received as a beneficiary of the Esparto Trust in the year ended 30 June 2006. To the extent presently relevant, s 99B provided as follows:
(1)Where, at any time during a year of income, an amount, being property of a trust estate, is paid to, or applied for the benefit of, a beneficiary of the trust estate who was a resident at any time during the year of income, the assessable income of the beneficiary of the year of income shall, subject to subsection (2), include that amount.
(2)The amount that, but for this subsection, would be included in the assessable income of a beneficiary of a trust estate under subsection (1) by reason that an amount, being property of the trust estate, was paid to, or applied for the benefit of, the beneficiary shall be reduced by so much (if any) of the amount, as represents:
(a)corpus of the trust estate (except to the extent to which it is attributable to amounts derived by the trust estate that, if they had been derived by a taxpayer being a resident, would have been included in the assessable income of that taxpayer of a year of income);
(b)an amount that, if it had been derived by a taxpayer being a resident, would not have been included in the assessable income of that taxpayer of a year of income;
(c) an amount:
(i)that is or has been included in the assessable income of the beneficiary in pursuance of section 97….
On any view, the distributions received by the applicant from the Esparto Trust in March 2006 fell within subs (1) of s 99B. The more contentious issue was whether it was reduced, and if so to what extent, under subs (2). The Commissioner submitted that the figure calculated under s 97 (see para 178 above) should be taken into account under subpara (i) of para (c), but otherwise that there should be no reduction.
Dealing first with para (a) of subs (2), the Commissioner accepted that the whole of the distribution represented the corpus of the trust. The question which then arose was whether so much of the corpus as was represented by the distribution would, had it been derived by a resident taxpayer, have been included in his or her assessable income. This looks to the character of the corpus by reference to the circumstances of its derivation. In the present case, the relevant accretion to the corpus of the Esparto Trust was derived by way of the proceeds of the sale-back to Esparto of the shares held in the name of Juris. In my consideration of the issues arising under s 96C above, I have held that, had Mourant been a resident taxpayer, its assessable income would, pursuant to s 97, have included those proceeds. It follows that, although the whole of the amount paid to the applicant represented corpus, that whole amount was excepted under the parenthetical passage in s 99B(2)(a). There was, therefore, no reduction under that paragraph. It also, and correspondingly, follows that para (b) of the subsection is of no benefit to the applicant in the present case.
On the other hand, the reduction referred to in para (c) of s 99B(2) is clearly applicable on the conclusions I have reached in this part of the case. The sum of $3,944,682.61 included in the assessable income of the applicant under s 97, should be applied by way of reduction of the sum otherwise yielded under s 99B(1).
The result is that, of the total sum of $6,339,733 which was distributed to the applicant from the Esparto Trust –
(a) $3,944,682.61 was included in his assessable income under s 97; and
(b) the balance, $2,395,050.39, was so included under s 99B.
The total sum was that in relation to which the Commissioner assessed the applicant for income tax. It follows that, save with respect to penalties (with which I deal separately below), the applicant’s appeals in relation to the year ending on 30 June 2006 must be dismissed.
2006 YEAR – PENALTY
The Commissioner took the view that, because the applicant did not return the distributions of March 2006 as income, he had made a statement that was false or misleading in a material particular within the meaning of s 284-75(1) of Sch 1 to the Administration Act. Because the statement would have produced a lower tax-related liability for the applicant than a return which disclosed the distributions, the applicant had a shortfall amount within the meaning of s 284-80(1). The Commissioner considered that the shortfall amount resulted from an intentional disregard of a taxation law on the part of the applicant, and assessed him for a 75% penalty under item 1 in the table in s 284-90(1). This was done both in respect of the cash distribution and in respect of the non‑cash distribution. In the present case, the applicant challenges the correctness of this assessment.
In order to consider the strength of that challenge, it is necessary to return to the events which led to the distribution of March 2006, and to the lodgement of the applicant’s tax return for the 2006 year.
In September 2005, Donovan, Mackie, Quinert and the applicant met in Hong Kong as members of the Board of Koda. They discussed the future direction of the Koda group. Donovan proposed a business opportunity which would, it seems, have involved the applicant in spending considerable periods of time outside Australia. For that reason, he did not favour the proposal. Neither did Quinert or Mackie. In his affidavit of 1 December 2010, the applicant continued (with reference to the Board meeting of September 2005):
I recall that Kevin Donovan acknowledged to the meeting the contributions of Messrs Mackie, Quinert and me in helping the owners of the company realise a significant increase in the real value of the company over a long period of time. I recall Kevin Donovan then advised that he, as the Settlor of the Esparto Trust, would approach the Trustee of the Esparto Trust and request that it exercise its discretion to add Messrs Mackie, Quinert and me as beneficiaries of that trust for the purpose of making a distribution to each of us out of the corpus of the Esparto Trust. I recall he said words to the effect that he recognised and appreciated the respective contributions, over and above our past contributions as directors, of each of Messrs Mackie, Quinert and me, which culminated in the Esparto Trust obtaining a demonstrable value for the holdings its nominees had held in Esparto Limited since the establishment of the trust.
The applicant was not challenged on this evidence.
Anticipating the receipt of a distribution from the Esparto Trust, the applicant promptly sought the advice of counsel as to the taxation consequences of any such distribution. Counsel was briefed with a copy of the trust instrument, but no record of any other written instructions provided to counsel is in evidence. Notwithstanding that deficiency, the drift of those instructions may be gathered from the opening paragraphs of counsel’s memorandum of advice dated 12 October 2005:
1.I am briefed to advise as a matter of some urgency on the Australian tax consequences of a distribution from the corpus of the Esparto Trust to an individual Australian resident taxpayer.
2.I have been favoured with a copy of the Esparto Trust Deed which upon examination gives a power to the trustee on the exercise of its discretion to make either capital or income distributions to its specified beneficiaries.
3.On my instructions:
(a)Esparto Ltd, as trustee for the Esparto Trust is a non-resident trust for Australian tax purposes;
(b)Esparto Ltd as trustee for the Esparto Trust owns 100% of the issued capital of Koda Holdings Ltd. (“Koda Holdings”)(non-resident corporation);
(c)Koda Holdings is in a position that requires it to consider its options in relation to its future direction;
(d)As a result of decisions made by Koda Holdings, the Esparto Trust is capital enriched;
(e)By Deed of Variation, the Esparto Trust was varied to include further specified beneficiaries which included Australian residents;
(f)A decision has been made by the trustee, Esparto Ltd. in the exercise of its discretion to make capital distributions from corpus to various specified beneficiaries, including an Australian resident beneficiary during the 2005/2006 year.
I would make the following observations about the apparent tenor of counsel’s instructions. First, it is not clear why counsel’s advice was required “as a matter of urgency”. Secondly, it seems that counsel had been misinformed as to the identity of the trustee of the Esparto Trust. Thirdly, it also seems that counsel was not informed as to the existence of Juris and Lively. Fourthly, counsel appears to have been informed that, as at October 2005, the trust itself was “capital enriched”, whereas the enrichment of capital which ultimately funded the distributions of March 2006 then lay in the future.
In his memorandum of advice, counsel considered the provisions of the 1936 Act that might have had the potential to include distributions from the Esparto Trust in the applicant’s assessable income, and expressed the view, substantially because those expected distributions would be sourced from capital, that they would not be so included. With respect to s 99B of the 1936 Act, counsel said:
A further relevant provision in Division 6 is Section 99B of ITAA36 which is headed: RECEIPTS OF TRUST INCOME NOT PREVIOUSLY SUBJECT TO TAX, and states, “where, at any time during a year of income, an amount, being property of a trust estate, is paid to, or applied for the benefit of, a beneficiary of the trust estate who was a resident at any time during the year of income, the assessable income of the beneficiary of the year of income shall, subject to subsection (2) include that amount.” So, where an amount is paid to an Australian resident beneficiary out of foreign source income that has been accumulated in a non-resident trust, such an amount is assessable to the beneficiary in the year of receipt. But, of course the operative word is income and sub-section 99(2) excludes from that section amounts paid out of the corpus of the trust and so, the provisions of Section 99B are not applicable to our fact situation.
Counsel did not advert to the parenthetical passage in subs (2)(a) of s 99B.
As a member of the Board of Koda in March 2006, the applicant was involved in the resolution to buy shares back from Esparto. I would readily infer that the applicant well knew that the ultimate purpose of that buy‑back was to put the Esparto Trust in funds sufficient to make the distributions foreshadowed by Donovan in September 2005. There is no evidence that the applicant sought supplementary advice from counsel as to the taxation consequences, if any, of these developments.
On 3 July 2006, the Commissioner served a notice under s 264 of the 1936 Act upon Oakley Thompson & Co with respect to certain international funds transfers made in March 2006. As it happened, those transfers included the cash distribution from the Esparto Trust in favour of the applicant. Amongst other things, the notice required the firm to identify the person on whose behalf it was acting in relation to the transfers, and to state the “nature and purpose of the transfers”. Writing on behalf of the firm, on 7 August 2006 the applicant provided written responses to the s 264 notice. He said that the nature and purpose of the particular transfer which related to him was “capital distribution”. He also provided the following information:
On behalf of Mr Howard we are instructed to advise that these funds are the remittance of a capital distribution from the Trustee of the Esparto Trust. This Trust is a non-resident discretionary trust for Australian taxation purposes. We enclose a copy of correspondence dated 19 July 2006 received from Mourant & Co Trustees Limited of Jersey, Channel Islands. It is noted that Mr Howard became a discretionary beneficiary (contingent or otherwise) to, any part of the corpus of the Esparto Trust prior to being so added as a beneficiary.
Along with his correspondence to the Commissioner of 7 August 2006, the applicant enclosed a letter from Mourant to Oakley Thompson & Co, the relevant terms of which were as follows:
Stephen Howard was added as a discretionary beneficiary of the Esparto Trust, a Jersey Discretionary Trust, on the 15 November 2005. Mr Howard along with Mr Michael Quinert are the only 2 Australian resident beneficiaries of the Trust. Prior to this date Mr Howard had no interest in this Trust and therefore had never received any benefit from it.
The statement that the applicant and Quinert were the only Australian resident beneficiaries of the trust was, of course, incorrect, but nothing presently turns on that. The applicant also wrote a letter to the Commissioner on his own behalf dated 4 August 2006. In that letter, the applicant said:
I advise that I became a beneficiary of the Esparto Trust on 15 November 2005. On or about 13 March 2006 Oakley Thompson & Co Pty Ltd received the sum of $5,528,817 to the credit of its trust account from Mourant & Co Trustees Limited of Jersey, Channel Islands.
I am the ultimate beneficiary of those moneys.
I wish to fully cooperate with the Australian Taxation Office in relation to enquiries it may have about my receipt of a capital distribution from the Trustee of the Esparto Trust.
Assuming that the Commissioner’s interest in the international funds transfers of March 2006 had been satisfied by his correspondence of 7 August 2006, on 24 May 2007 the applicant lodged his income tax return for the 2006 year. He did not return as income either of the March 2006 distributions.
Dealing first with the cash distribution of $5,528,817, the Commissioner justified his conclusion that the applicant had intentionally disregarded the law by reference to the fact that he had, in instructing counsel in September or October 2005, stated that the distribution was of capital, rather than laying out all “the unadorned facts” so that counsel himself might have formed a view as to the capital or income nature of the distribution. The Commissioner then submitted that the applicant’s omission to return the distribution as income was “a deliberate act based on legal advice”. I cannot accept this attack on the applicant’s conduct in relation to his tax return. In the present case as ultimately conducted in court, the Commissioner did not contest that the distribution had been made from the corpus of the trust and was, therefore, of a capital nature. That is to say, the characterisation of the distribution given to counsel by the applicant was, in point of substance, ultimately uncontroversial. It follows that, with respect to the question whether the applicant intentionally disregarded the law, nothing turns on that characterisation.
The Commissioner also submitted that counsel’s advice of 12 October 2005 “inter alia did not address the operation of s 159GZZZP(1)” of the 1936 Act. To the extent that this submission implied a criticism of counsel, or of the applicant for not having referred to this provision in his instructions to counsel, I would reject it. There was no suggestion that, in September or October 2005, the Esparto Trust was going to be put in funds to make the then contemplated distributions by a sequence of off‑market share buy‑backs. When the applicant was under cross‑examination, it was not put to him that he then ought to have anticipated that such a mechanism would be used. At that time, neither the applicant nor his counsel had any reason to think that s 159GZZZP might play a crucial role in determining the assessability as income of the then contemplated distribution. The result, unsurprisingly, was that counsel’s advice of 12 October 2005 did not give consideration to the potential relevance of s 159GZZZP – with respect either to s 96B(3) or to the parenthetical exception in s 99B(2)(a) – to the question then at hand.
However, by March 2006, things were different. The applicant then knew the means by which the trust was to be, and had been, put in funds to make the cash distribution. Because this was done by way of off‑market share buy‑backs, s 159GZZZP potentially came into play. Not directly, of course, as I have held above. But, to the extent that his instructions to counsel in September/October 2005 reflected the applicant’s thinking in March 2006 (and there is no reason to think that they did not), he appears not to have been giving any consideration to the position of Juris and Lively. What is presently important is that he appears to have given no consideration to the potential role of s 159GZZZP in the calculation of assessable income. What was the quality of the applicant’s shortcoming in that regard? It was not put to him that, in March 2006, then knowing how the distribution was to be funded, he also knew, or recklessly turned a blind eye to the prospect, that the 1936 Act operated, or might well be held to operate, so as to bring the amount of the distribution into his assessable income. It was not put to him that, conscious of such a prospect, he deliberately refrained from returning to counsel to obtain further advice on the question of his tax liability. In these circumstances, I could not uphold the Commissioner’s position that the applicant’s shortfall amount resulted from his intentional disregard of the law. Neither did it result from his recklessness as to the operation of the law.
But I am of the view that the shortfall amount resulted from a failure by the applicant to take reasonable care to comply with the 1936 Act. The instructions by reference to which counsel had given his advice in October 2005 were very high‑level ones. That may have been entirely appropriate in the circumstances which were then known to the applicant. However, particularly given the size of the distribution, the complexity of the transactions by which the Esparto Trust was put in funds to make it, and the applicant’s position as director of Koda, the applicant’s omission to take further advice in March 2006 once he knew the details of those transactions was not, in my view, the conduct of a taxpayer who was concerned to take reasonable care to ensure that his obligations under the 1936 Act were met. A taxpayer in the position of the applicant who was concerned to take reasonable care would, in my view, have realised that much more potentially relevant information was to hand in March 2006 than had been available when counsel gave his advice in the previous October, and that it was not prudent to rely, or to rely only, on that advice.
I also consider that the relative state of inactivity on the part of the Commissioner after the sending of the applicant’s letter of 7 August 2006 was not a sufficient basis for an assumption by the applicant that the Commissioner most probably would accept that the cash distribution of March 2006 was not income in the applicant’s hands. That state of inactivity would certainly not provide a justification for the applicant omitting to take the additional steps of a reasonable taxpayer as referred to in the previous paragraph. The letter of 7 August 2006 said nothing about how the trust came to be sufficiently funded to make the distribution and gave the Commissioner, therefore, no immediate reason to consider the significance of Div 16K of Pt III of the 1936 Act. To the extent that the applicant relies, for the purposes of penalty, upon the Commissioner’s response to his letter of 7 August 2006, then, the letter itself was associated with the same failure to take care as I have found above in relation to the applicant’s own position generally.
Turning next to the non‑cash distribution of March 2006, the only respect in which the Commissioner submitted that that involved considerations different from those applicable to the cash distribution was that the applicant did not disclose it in his correspondence of 7 August 2006 in response to the Commissioner’s s 264 notice. That is, in my view, a distinction rather than a difference, or at least a relevant one. The s 264 notice enquired only about the international funds transfer. The applicant was not asked about, and had no reason to provide information about, the forgiveness of his debt to the trust which constituted the non‑cash distribution.
In other respects the questions which arise under s 284-90(1) of the schedule to the Administration Act with respect to the non‑cash distribution are precisely the same as those which arise with respect to the cash distribution. I would provide the same answers. The applicant’s omission to return the non‑cash distribution was, in my view, the result neither of an intentional disregard of the law, nor of recklessness, on the part of the applicant. It was, however, the result of the failure by him to take reasonable care to comply with the 1936 Act.
For the above reasons, I consider that item 3 in the table to s 284-90(1) of the schedule to the Administration Act is applicable in the case of the cash and non‑cash distributions of March 2006. The penalty payable by the applicant was, therefore, 25% of the shortfall amount. I shall uphold his appeals to that extent.
I certify that the preceding one hundred and ninety-nine (199) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Jessup. Associate:
Dated: 14 December 2011
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