Merchant v Commissioner of Taxation
[2024] FCA 498
•14 May 2024
FEDERAL COURT OF AUSTRALIA
Merchant v Commissioner of Taxation [2024] FCA 498
File number(s): NSD 907 of 2021
NSD 908 of 2021
NSD 1161 of 2021Judgment of: THAWLEY J Date of judgment: 14 May 2024 Catchwords: TAXATION – s 177D in Part IVA of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936) – where tax benefit admitted – where only issue was dominant purpose under s 177D(1) to obtain admitted tax benefit – where vendor sells shares in listed company at market value to related entity such that there was no change in economic ownership – where sale of shares triggered capital loss – where sale occurred in context of predicted capital gains being made by vendor from sale of a company to a third party – held: dominant purpose was one of obtaining the admitted tax benefit
TAXATION – dispute as to market value of future earn-out amounts – market value determined in favour of applicant
TAXATION – s 177E in Part IVA of the ITAA 1936 – dividend stripping – where loans made by related entities to a company the shares in which were going to be sold – whether the loan forgiveness had substantially the effect of a scheme by way of or in the nature of dividend stripping – proper identification of the scheme for the purposes of s 177E – whether consequences of the application of the general anti-avoidance provision taken into account in determining application of s 177E to a related assessment – held: scheme had the effect of a scheme by way of or in the nature of dividend stripping within s 177E(1)(a)(ii)
TAXATION – taxation of financial arrangements (TOFA) – whether certain future payment amounts were financial arrangements under subsection 230-45(1) of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) – if they were, whether future payment rights were excluded by former section 230-460(13) ITAA 1997 – held future earn-out rights were separate financial arrangements, but exception applies
Legislation: Income Tax Assessment Act 1936 (Cth) Division 6, Part IVA, ss 44, 177A, s 177CB, 177D, 177E, 177F
Income Tax Administration Act 1997 (Cth) Division 230, ss 110-25, 116-20, 207-155, 230-45(1), 230-50, 230-460(13), 775-30, 974-85
Superannuation Industry (Supervision) Act 1993 (Cth) ss 34, 62, 65, 126A
Taxation Administration Act 1953 (Cth) Part IVC, ss 14ZZ, 14ZZO, 353-10
Superannuation Industry (Supervision) Regulations 1994 (Cth) r 4.09(2)
Cases cited: B&F Investments Pty Ltd v Federal Commissioner of Taxation [2023] FCAFC 89; 298 FCR 449
BBlood Enterprises Pty Ltd v Commissioner of Taxation [2022] FCA 1112
British American Tobacco Australia Services Limited v Commissioner of Taxation [2010] FCAFC 130; 189 FCR 151
Certain Lloyd’s Underwriters v Cross [2012] HCA 56; 248 CLR 378
CEU22 v Minister for Home Affairs [2024] FCAFC 11
Collis v Commissioner of Taxation (1996) 33 ATR 438
Commissioner of Taxation v Ashwick (Qld) No 127 Pty Ltd [2011] FCA 49; 192 FCR 325
Commissioner of Taxation v Consolidated Press Holdings Ltd (No 1) [1999] FCA 1199; 91 FCR 524
Commissioner of Taxation v Consolidated Press Holdings Ltd [2001] HCA 32; 207 CLR 235
Commissioner of Taxation v Guardian AIT [2023] FCAFC 3; 115 ATR 316
Commissioner of Taxation v Hart [2004] HCA 26; 217 CLR 216
Commissioner of Taxation v Macquarie Bank Limited [2013] FCAFC 13; 210 FCR 164
Commissioner of Taxation v Metal Manufacturers Ltd [2001] FCA 365; 108 FCR 150
Commissioner of Taxation v Sleight [2004] FCAFC 94; 136 FCR 211
Commissioner of Taxation v Spotless Services Ltd [1996] HCA 34; 186 CLR 404
Commissioner of Taxation v Zoffanies Pty Ltd [2003] FCAFC 236; 132 FCR 523
Federal Commissioner of Taxation v Patcorp Investments Limited (1976) 140 CLR 247; 6 ATR 420
Finance Corporation Limited v Federal Commissioner of Taxation [1970] HCA 1; 120 CLR 177
Lacey v Attorney-General (Qld) [2011] HCA 10; 242 CLR 573
Lawrence v Commissioner of Taxation [2008] FCA 1497; 70 ATR 376
Lawrence v Commissioner of Taxation [2009] FCAFC 29; 175 FCR 277
Metal Manufactures Ltd v Commissioner of Taxation [1999] FCA 1712; 43 ATR 375
Mills v Commissioner of Taxation [2012] HCA 51; 250 CLR 171
Minerva Financial Group Pty Ltd v Commissioner of Taxation [2024] FCAFC 28
Division: General Division Registry: New South Wales National Practice Area: Taxation Number of paragraphs: 645 Date of hearing: 15 March 2024; 18 – 20 March 2024; 25 March 2024 Counsel for the Applicants: Mr S Doyle KC and Mr M May Solicitors for the Applicants: Cooper Grace Ward Lawyers Counsel for the Respondent: Ms M Brennan KC, Mr D Ananian-Cooper and Mr N Derrington Solicitor for the Respondent: Gadens ORDERS
NSD 907 of 2021 BETWEEN: GORDON STANLEY MERCHANT
Applicant
AND: COMMISSIONER OF TAXATION
Respondent
ORDER MADE BY:
THAWLEY J
DATE OF ORDER:
14 MAY 2024
THE COURT ORDERS THAT:
1.The parties are to confer and provide a short minute of order giving effect to these reasons and any agreement as to costs within 14 days.
Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.
ORDERS
NSD 908 of 2021 BETWEEN: GSM PTY LTD ACN 074 508 124
Applicant
AND: COMMISSIONER OF TAXATION
Respondent
ORDER MADE BY:
THAWLEY J
DATE OF ORDER:
14 MAY 2024
THE COURT ORDERS THAT:
1. The parties are to confer and provide a short minute of order giving effect to these reasons and any agreement as to costs within 14 days.
Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.
ORDERS
NSD 1161 of 2021 BETWEEN: GORDON STANLEY MERCHANT
Applicant
AND: COMMISSIONER OF TAXATION
Respondent
ORDER MADE BY:
THAWLEY J
DATE OF ORDER:
14 MAY 2024
THE COURT ORDERS THAT:
1. The parties are to confer and provide a short minute of order giving effect to these reasons and any agreement as to costs within 14 days.
Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.
REASONS FOR JUDGMENT
THAWLEY J:
1 OVERVIEW
Factual background
In 1973, Mr Merchant co-founded the business which became Billabong. Billabong Holdings Australia Limited was later formed and changed its name to Billabong Limited (BBG). BBG was listed on the Australian Securities Exchange (ASX) on 11 August 2000.
Through related entities, Mr Merchant remained a shareholder in BBG during the events which are centrally relevant to these reasons for decision. At the time of those events, Mr Merchant wanted to maintain a significant interest in BBG. His interests in BBG were ultimately purchased by the time BBG was delisted from the ASX in August 2018.
Mr Merchant was the director and controlling mind of a number of Australian corporate entities, referred to in these reasons as the Merchant Group. The main entities of relevance for present purposes are described in the following diagram:
As depicted in the diagram, the Merchant Family Trust (MFT) (Gordon Merchant No 2 Pty Ltd (GM2) as trustee for the MFT) held all the shares in what was, when it was acquired in 2010, a start-up company. The company is now called Plantic Technologies Ltd. Plantic relied on the Merchant Group for funding from the time it was acquired by the MFT until the time the MFT sold its shares in Plantic on 2 March 2015. Between 2011 and 2015, three entities in which Mr Merchant held all the shares lent about $55 million to Plantic: GSM Pty Ltd lent about $50 million; Tironui Pty Ltd lent a little over $4 million; and the Angourie Trust (Kahuna Pty Ltd as trustee for the Angourie Trust) lent a little under $1 million (the Plantic Loans).
Mr Merchant became increasingly unhappy about the level of funding Plantic required. By May 2014, if not earlier, he was considering the sale of Plantic. By June 2014, Sealed Air Corporation (a US company) had expressed interest in acquiring Plantic. Ernst & Young (EY), which had acted as Mr Merchant and the Merchant Group’s accountants for a number of years, was consulted about the structure of a sale to Sealed Air and provided advice. It was anticipated that the sale might result in a substantial capital gain in the MFT. EY’s advice included that the preferable structure of a future sale of Plantic from Mr Merchant’s perspective was for:
(a)the MFT to sell its shares in Plantic rather than for Plantic to sell its assets;
(b)the relevant Merchant Group entities to forgive the Plantic Loans of about $55 million; and
(c)the Gordon Merchant Superannuation Fund (GMSF) (GSM Superannuation Pty Ltd (GSMS) as trustee for the GMSF) to acquire from the MFT a substantial number of the MFT’s high cost shares in BBG, with the result that the MFT would crystallise a significant capital loss.
On 4 September 2014, the MFT sold 10,344,828 shares in BBG (the BBG Shares) to the GMSF for $5,844,827.82 (the BBG Share Sale). The result was that the MFT crystallised a capital loss of $56,561,940.
The potential sale to Sealed Air did not eventuate. On 15 October 2014, a representative of Kuraray Co Ltd, a Japanese company which had earlier expressed an interest in Plantic, indicated that he and others were going to recommend to the Kuraray board that they should start due diligence to acquire Plantic. Negotiations with Kuraray were successful and, by a Share Sale Agreement exchanged on 31 March 2015 (SSA), the MFT sold all of its shares in Plantic to Kuraray.
On 2 April 2015, as a condition precedent to the completion of the SSA, the Plantic Loans of $55 million were forgiven by GSM, Tironui and Kahuna as trustee for Angourie under a Deed of Forgiveness. Completion of the SSA occurred on that day.
The MFT’s capital gain on the sale of its shares in Plantic to Kuraray was around $85 million. The capital proceeds included a cash payment of about $60 million, a working capital adjustment and future payments, including what have been referred to as “Milestone Amounts” and “Earn-Out Amounts”, which were valued in the accounts at the time at around $51 million (the Future Payment Rights). The acquisition costs were around $24 million and the cost base in the Plantic shares included amounts paid to lawyers and the payout of employee options, costing a little over $2 million. The capital proceeds were calculated to be about $111 million and the cost base was about $26 million, resulting in a capital gain of about $85 million.
The preceding transactions – particularly the debt forgiveness and the crystallising of the MFT’s capital loss – piqued the interest of the Commissioner of Taxation, resulting in an audit of the affairs of Mr Merchant and the Merchant Group. After the audit, the Commissioner issued two sets of “Reasons for Decision” on 20 July 2020.
One concerned the “BBG Share Sale Scheme”. The Commissioner considered that, for the purposes of s 177D(1) in Part IVA of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936), it would be concluded that a person entered into or carried out a scheme, or part of it, for the dominant purpose of enabling GSM to obtain a tax benefit, GSM being the only presently entitled beneficiary of the MFT. In summary, the Commissioner took the view that the predominant reason why the GMSF acquired the BBG Shares from the MFT on 4 September 2014 was to crystallise a capital loss in the MFT which could be applied against the capital gain from the MFT’s anticipated sale of its shares in Plantic, resulting in a reduction in GSM’s assessable income. The Commissioner considered that the BBG Share Sale was analogous to a ‘wash sale’ given that the BBG Shares would remain in the Merchant Group of which Mr Merchant was the ultimate owner.
The Commissioner made a determination under s 177F(1)(c) of the ITAA 1936 that the amount of $56,561,940, referable to a capital loss incurred by the MFT in the year ended 30 June 2015, was not incurred by the MFT in relation to that financial year (the s 177D Determination). As a consequence of this:
(a)the MFT’s net income increased from $5,482,423 to $28,111,179 to reflect the net capital gain (at the 50% discount) of $22,628,756;
(b)an amended assessment dated 24 July 2020 was issued to GSM (the GSM Amended Assessment), increasing GSM’s tax payable by $12,877,000.90 (because GSM was the beneficiary with a 100% present entitlement to the income of the MFT in the 2015 year): CB695; and
(c)although no amount of the net capital gain was assessed to the MFT, a penalty assessment issued to the MFT on 27 July 2020, which assessed it as liable to a penalty of $6,438,500.45 being 50% of the scheme shortfall amount, pursuant to Division 284-C of Sch 1 of the Taxation Administration Act 1953 (Cth) (TAA 1953): CB788.
The second transaction concerned the “GSM and Tironui Debt Forgiveness Scheme”. The Commissioner considered that the forgiveness of debts by two of the three lenders – GSM and Tironui – were schemes having substantially the effect of schemes by way of or in the nature of dividend stripping within the meaning of s 177E(1)(a)(ii) in Part IVA. No consideration was provided for the forgiveness of debt such that the forgiveness had the effect of:
(a)reducing the undistributed profits of GSM and Tironui; and
(b)converting the Plantic Loans to equity, thereby increasing the value of Plantic’s shares and the consideration paid by Kuraray for those shares.
The Commissioner made a determination under s 177F(1)(a) of the ITAA 1936, that the debts forgiven by GSM and Tironui be included in Mr Merchant’s assessable income in the 2015 income year as dividends (the s 177E Determination).
To give effect to the s 177E Determination, on 27 July 2020, the Commissioner issued an amended assessment to Mr Merchant (the Merchant Amended Assessment) in relation to the 2015 year. This increased Mr Merchant’s assessable income by $54,407,000 (being the tax benefit considered by the Commissioner to have been obtained from the release and forgiveness of the Plantic Loans) with the result that Mr Merchant’s tax liability increased to $30,570,438.12, comprising an increase in tax payable and a shortfall interest charge: CB696.
Mr Merchant, the MFT and GSM lodged a joint objection on 22 September 2020 objecting to each of the assessments: CB790. The objections were disallowed on 27 July 2021: CB797; CB798; CB5. In deciding the objections, the Commissioner concluded:
(a)that the MFT had obtained a tax benefit from the BBG Share Sale Scheme, and that the MFT and the GMSF entered into the scheme for the dominant purpose of obtaining a tax benefit such that s 177D(1) applied, with the consequence that the Commissioner was entitled to make a determination under s 177F(1)(c) cancelling the capital loss: CB798; and
(b)in respect of Mr Merchant, that the GSM and Tironui Debt Forgiveness Schemes had the substantial effect of a dividend stripping scheme, attracting the operation of s 177E of the ITAA 1936: CB797 at [59].
It is necessary to say something briefly about two further matters.
First, in each of the 2017 and 2018 years, the MFT’s right to receive certain components of the Milestone Amounts under the SSA expired. When Mr Merchant submitted his returns for each of those years, the expiry of those rights was treated by him as a capital loss of the MFT. The Commissioner accepted this position as correct and issued a notice of assessment:
(a)on 22 May 2018, in respect of the 2017 income year, for $1,019,505.61; and
(b)on 9 April 2019, in respect of the 2018 income year, for $418,558.79.
On 24 September 2019, Mr Merchant lodged an objection to both of those assessments, on the basis that the relevant transaction ought to have been treated as a financial arrangement for the purposes of Division 230 of the Income Tax Administration Act 1997 (Cth) (ITAA 1997) (the TOFA Provisions). In summary, Mr Merchant contended that the Milestone Amounts and Earn-Out Amounts payable under the SSA were each separate “financial arrangements” within the meaning of the TOFA Provisions with the result that gains and losses were to be recognised on revenue account rather than on capital account. The Commissioner took, and maintains, the view that the TOFA Provisions do not apply, both because the relevant arrangements are not “financial arrangements” within the relevant definitions and because a statutory exception applies.
The Commissioner disallowed this objection on 10 September 2021 (the TOFA Objection Decision).
Secondly, on 21 July 2020, the Commissioner – as regulator under the Superannuation Industry (Supervision) Act 1993 (Cth) (SISA) – made a decision under ss 126A(2) and 126A(3) of the SISA to disqualify Mr Merchant from acting as a trustee or responsible officer of corporate trustees of superannuation entities (Disqualification Decision).
Mr Merchant was a director of GSMS, being the trustee of the GSMF at all material times, including at the time of the BBG Share Sale on 4 September 2014. In summary, the Commissioner has taken the view that:
(a)GSMS (as trustee of the GMSF), in using the GMSF’s resources to acquire the BBG Shares from the MFT on 4 September 2014, contravened:
(i)the requirement to comply with operating standards under s 34(1) of the SISA, in particular to give effect to the investment strategy formulated under sub-reg 4.09(2) of the Superannuation Industry (Supervision) Regulations 1994 (Cth) (SISR);
(ii)the sole purpose rule in s 62(1) of the SISA; and
(iii)section 65(1) of the SISA, by using the resources of the fund to give financial assistance to a member of the fund or his relatives.
(b)The contraventions were serious and made at the direction of the guiding mind and responsible officer of GSMS, namely Mr Merchant.
The related proceedings
The events summarised above have ultimately resulted in proceedings in this Court, in the Administrative Appeals Tribunal (AAT) and in the Supreme Court of Queensland. There are three proceedings in this Court, each of which is a proceeding under Part IVC of the TAA 1953 in which the relevant person or entity appeals the decision of the Commissioner to disallow an objection to an assessment and each of which is the subject of these reasons for decision:
(1)GSM Pty Ltd v Commissioner of Taxation (NSD 908/2021): GSM’s appeal from the objection decision which relates to the assessment arising from the cancelling of the capital loss in the MFT in reliance on s 177D(1) applying in respect of a person who entered into or carried out a scheme (the s 177D Proceeding);
(2)Gordon Merchant v Commissioner of Taxation (NSD 907/2021): Mr Merchant’s appeal from the objection decision which relates to the assessment arising from the Commissioner’s conclusion that s 177E(1)(a)(ii) applied (the 177E Proceeding); and
(3)Gordon Merchant v Commissioner of Taxation (NSD 1161/2021): Mr Merchant’s appeal concerning the applicability of the TOFA Provisions (the TOFA Proceeding).
There are three proceedings in the AAT:
(1)Gordon Merchant No 2 Pty Ltd as trustee for Merchant Family Trust v Commissioner of Taxation (AAT Case 2021/6296): The Commissioner issued a notice of assessment of scheme shortfall penalties to GM2 as trustee of the MFT for 50% of a scheme shortfall of $12,877,000.90, being $6,438,500.45. This proceeding is GM2’s application for “review” of the Commissioner’s disallowance of its objection.
(2)Gordon Merchant v Commissioner of Taxation (AAT Case 2021/6294): The Commissioner issued a notice of assessment of scheme shortfall penalties to Mr Merchant in connection with the s 177E assessment. Mr Merchant was assessed as having a scheme shortfall of $26,659,429.97 and was assessed to a 25% penalty, being $6,664,857.24. This proceeding is Mr Merchant’s application for “review” of the Commissioner’s disallowance of his objection.
(3)Gordon Merchant v Commissioner of Taxation (AAT Case 2020/6932): This is Mr Merchant’s application for review of the Disqualification Decision.
The proceedings in the Supreme Court of Queensland concern the advice given by EY. Those proceedings have been stayed until 40 days after judgment is delivered in these proceedings and a decision is made in the AAT proceedings: Merchant v Ernst & Young (a firm) [2023] QSC 259.
Evidence, submissions and definitions
Each of the parties to the Federal Court proceedings and the AAT proceedings wanted the proceedings to be heard together with evidence in the Federal Court proceedings being evidence in the AAT proceedings and (subject to limited exceptions) vice versa.
This approach was followed, it being conducive both to a significant reduction in costs for the parties and to the more expeditious determination of the various proceedings.
The documentary evidence was almost entirely contained in Exhibit 1, being the Court Book. The references in these reasons to “CB” followed by a number are a reference to the relevant tab number of the Court Book.
Subject to two qualifications, the evidence from witnesses was given by affidavit. The first qualification is that the Court Book contained two statutory declarations, one from Mr Merchant and one from Ms Paull: CB442 and CB443. The second qualification is that the Court Book contained transcripts of various interviews conducted by the Commissioner pursuant to s 353-10 of Sch 1 to the TAA 1953. The references in these reasons to the relevant affidavits are provided by stating the name of the deponent and the relevant paragraph number of the affidavit.
Only two lay witnesses were ultimately required for cross-examination: Mr Merchant and Mr McGrath.
In these reasons, the following references are adopted:
·“AOS” is a reference to the applicants’ written opening submissions;
·“ROS” is a reference to the respondent’s written opening submissions;
·“AOCS” is a reference to the applicants’ written outline of oral closing submissions;
·“T” is a reference to the transcript;
·“NA” is a reference to the relevant notice of appeal;
·“AFAAS” is a reference to the applicants’ further amended appeal statement, lodged on 19 March 2024; and
·“RAJAS” is a reference to the respondent’s amended joint appeal statement, lodged on 15 March 2024.
These reasons concern the three Federal Court proceedings.
2 THE PRINCIPAL PEOPLE INVOLVED IN RELEVANT EVENTS
Mr Merchant
As noted earlier, Mr Merchant was the founder of the Billabong business and the owner of the Merchant Group. His involvement in the relevant events is addressed in detail below. Mr Merchant was cross-examined. His recall of the detail of the relevant events during cross-examination was not good. This was in stark contrast to his detailed affidavit and his statutory declaration.
Ms Paull
Mr Merchant was assisted for many years in the day-to-day management of various entities in the Merchant Group, including the GMSF, by Ms Colette Paull. Ms Paull initially did part-time bookkeeping work, but her role expanded and she became a close and trusted colleague and friend of Mr Merchant. At the time of the relevant events, Mr Merchant and Ms Paull spoke regularly, typically on a daily basis.
Ms Paull held a power of attorney for Mr Merchant. Ms Paull implemented decisions on her own behalf and often on behalf of Mr Merchant for the GMSF. She typically signed GSMS and GMSF documents as Mr Merchant’s attorney. Ms Paull died on 6 August 2021.
Mr McGrath
Mr Luke McGrath, through his corporate vehicle, was Mr Merchant’s investment adviser from about 2005. The main entity engaged in investment activities was the MFT. Mr McGrath did not advise Mr Merchant on his investment in BBG, because Mr Merchant was “better placed to decide whether to invest in BBG”: CB442 at [9]. Nor did Mr McGrath provide investment advice in relation to the GMSF’s investments, although – as will be seen below – Mr McGrath made suggestions from time to time in relation to what the GMSF might do.
Ms Lyons
Ms Sue Lyons assisted Ms Paull in daily management of the accounts of the Merchant Group. She was employed by the MFT. Although Ms Lyons signed an affidavit for the purposes of the proceedings, she was not called to give evidence. Her affidavit did not form part of the Court Book, although the various annexures to her affidavit were included. Mr Merchant gave evidence that he had meetings either quarterly or half yearly with Ms Lyons, and that Ms Paull was at these meetings, at times also with EY: T63 - 64.
Mr Burgess
Mr Ian Burgess was a tax partner at EY. He was the Merchant Group’s tax agent and the GMSF’s auditor for a number of years. Mr Merchant did not often speak directly to Mr Burgess about the Merchant Group’s affairs. Ms Paull and Mr McGrath had discussions (and other communications) with Mr Burgess about the Merchant Group’s affairs. Mr Burgess did not give evidence in the proceedings, but his absence is readily explained by the Queensland Supreme Court proceedings.
Mr Morris
Mr Brendan Morris was the Chief Executive Officer of Plantic. Plantic is based in Altona, Victoria. It manufactures and distributes packaging materials that are a plant-based substitute for plastic, involving the extrusion of resin from high-amylose corn starch: Morris at [7]. Plantic was incorporated in July 2001. It acquired the intellectual property in the technology for its manufacturing process from a research group funded by the Australian government: Morris at [8]; Merchant at [70].
As described below, the MFT ultimately came to hold all of the shares in Plantic.
3 THE FACTS
What follows is a chronological outline of all of the facts. A number of these facts are repeated later in these reasons, and in some cases expanded upon, where particularly relevant to an issue. This results in some repetition, but it is convenient before addressing the legal issues to understand the facts in some detail and chronologically.
Billabong: 1973 to 2000
Mr Merchant and his then spouse Rena started a business manufacturing surf-wear in 1973. It began with them making around 20 pairs of boardshorts per week on their kitchen table. It grew to become the globally recognised surf-wear brand, Billabong.
There were significant changes in the ownership of the Billabong business over the years. Initially, Mr Merchant and Rena each owned half of the business. In June 1999, the majority of Rena’s interests were acquired by outside investors (the Perrin family), but a small part was sold to Mr Merchant so that Mr Merchant maintained overall control. BBG was listed on the ASX in August 2000. Immediately after BBG was listed, the Merchant Group (through the MFT and GSM) owned approximately 23% of the issued capital in BBG. Mr Merchant remained on the board as a non-executive director. Ms Paull was also a director until January 2014: T57.
The MFT acquires further shares in BBG: 2004
In September 2004, the MFT and GSM acquired further shares in BBG, resulting in the Merchant Group holding approximately 25% of the issued capital. By the end of the 2005 income year, it held approximately 21%. There were only two other shareholders who held over 10% of the issued capital.
The MFT acquires 14% of Plantic
The MFT acquired 14% of the issued capital in Plantic on 31 March 2005 and Mr Merchant was appointed a director: Merchant at [72]. The Plantic business came to Mr Merchant’s attention by way of his investment advisor, Mr McGrath. Mr Merchant had been looking for his next project after he had ceased day to day involvement in BBG: Merchant at [70]. When Mr Merchant became involved with Plantic, it was in the process of commercialising its technology: Morris at [8].
Over time, Plantic developed a number of different products and also developed different techniques to manufacture those products in a more cost effective way: Morris at [9]. It was researching and developing various types of products that could be manufactured using the technology, building the plant and equipment required to produce the products at scale, and developing relationships with customers and others in the packaging industry, with a view to increasing its sales revenue so as to become profitable.
The MFT sells BBG shares: 2006
On 1 March 2006, the MFT sold 13,403,000 BBG shares for about $200 million, leaving the Merchant Group with approximately 15% of the issued capital in BBG. Mr Merchant remained the largest shareholder. The proceeds were invested by the MFT over time.
Mr Merchant said that he was “reprimanded” in connection with this sale by BBG’s chairman: Merchant at [75]. The chairman was not happy that Mr Merchant had not told the chairman that he intended to sell the shares before he did so. Mr Merchant stated that this made him cautious about BBG management and about board members selling BBG shares.
The GMSF established on 30 June 2006
The GMSF was established on 30 June 2006: CB30.
The GFC and its consequences
The BBG share price was generally on a downward trend from around 2007. The GFC negatively affected BBG, leading to reduced retail sales. In the 2009 year, underlying net profit after tax was down 9.2% compared to the 2008 year. Dividends ceased to be paid from 2012. Mr Merchant’s evidence included:
[105]The years after the GFC were difficult for BBG … [B]roadly, BBG’s retail operations in various countries were not performing. Consumer buying had slowed and at the end of 2011, the company reviewed its capital structure. Based on that review, the company decided to implement a number of strategies. Following the announcement of the capital structure review, BBG received proposals to purchase its issued capital. There were a number of trading halts placed on BBG during 2012. BBG also stopped paying dividends in 2012 …
[106]I continued to buy BBG shares through entities in the Merchant Group after BBG stopped paying dividends because I believed that BBG would be successful again. I have always seen BBG as a personal venture of mine and I have always believed in the Billabong brand. This belief was based on my knowledge of the business as a member of the Board and from my involvement with the business since founding it in 1973.
[107]BBG had been very successful in the past and, even when the business declined, I considered that this was due to the strategic direction that the company had taken - and in particular the focus on acquiring additional retail operations. The business had moved too far away from being a wholesale business and did not have expertise in retail to succeed in the retail industry. I believed that BBG’s poor financial results were due to mismanagement by key staff. I wanted to retain a controlling stake in the company to prevent mismanagement in the future. I believed that if the necessary changes in the management approach were taken it was likely that BBG would become successful again.
The GMSF in 2008 and 2009
The assets of the GMSF were primarily sourced from a significant roll over of funds in the 2008 and 2009 financial years from a super fund in which Mr Merchant was previously a member, in addition to his ongoing concessional and non-concessional contributions: CB33 and CB39.
In the financial year ended 30 June 2009, the GMSF acquired a factory at Yamba which was at all relevant times the GMSF’s only real property asset and which was recorded in the GMSF’s 2009 Financial Statements as having a value of $1,154,202: CB39.
The remaining and predominant assets of the GMSF were: (a) “investment in foreign fund”, with a value of $4,573,926; and (b) “cash at bank” of $12,188,934. As at 30 June 2009, the net assets available to pay benefits was $17,879,735: CB39.
The pension paid to Mr Merchant
On 1 July 2009, the GMSF commenced an account based superannuation income stream for payment of a pension to Mr Merchant, who was then aged 66 and stated to be retired. A letter to Mr Merchant dated 3 November 2009, signed by Ms Paull for herself and as Mr Merchant’s attorney, confirmed that the minimum income stream payment for the year ended 30 June 2010 was $458,750: CB 780 at page 37.
Various resolutions to commute the income stream pension and to start a new income stream pension were made in respect of the 2010, 2011 and 2012 financial years: CB780 at pages 32 and 38. Mr Merchant received a pension of at least $450,000 from the year ended 30 June 2010. In the year ended 30 June 2013, he received a pension of $470,500, leaving a total benefit balance of $10,116,862: CB149 at page 8. One of the consequences of the BBG Share Sale was that the GMSF made a decision to cease the pension from 1 July 2015 and for the fund to go back into the accumulation phase.
Acquisition of 100% of Plantic: November 2010
In November 2010, the MFT acquired all of the remaining shares in Plantic under a scheme of arrangement, paying GB£6.83 million (around A$10.3 million): Merchant at [72], [84] to [85]. Together with the cost of the MFT’s 14% acquisition in 2005, the total cost base of the shares in Plantic owned by the MFT was $24,159,245.35: CB265; CB430.
From this time until the shares in Plantic were sold on 2 April 2015, Mr Merchant, Ms Paull and Mr McGrath were directors of Plantic: CB438. Mr Morris was its CEO and its CFO and company secretary was Mr Daryl Hoy: Morris at [6], [23].
Plantic experienced various technical challenges in establishing the manufacturing process for its products. A frequent topic of discussion at its board meetings was Plantic’s lack of profitability. Early funding from government grants had substantially reduced, and the income it was making from sales was not enough to make it profitable: Morris at [10], [20], [28]; Merchant at [88].
Obtaining funding from banks was difficult as a result of Plantic’s lack of profits and the fact that its assets consisted mainly of intellectual property and bespoke machinery: Morris at [28], [60] to [62]. Between November 2010 and April 2015, the Merchant Group provided the Plantic Loans totalling about $55.2 million: Morris at [19]; Merchant at [88].
In order for the directors to declare that Plantic was solvent, the MFT was required to provide ‘comfort letters’ which confirmed that the MFT would “ensure sufficient additional funds are provided to Plantic … to enable it to meet financial obligations incurred in the ordinary course …”; that it would “not require repayment of any amounts owing by Plantic … during the 12 months following the signing of the financial statements, except in so far as the funds of Plantic … permit repayment”; and that the MFT “or related entities have the financial capability to provide the above noted financial support”: CB56; CB87; CB145.
Plantic was looking to secure new customers to build its revenue and to reduce its costs, but it was not yet profitable: Morris at [28]. From at least early 2011, Plantic was exploring commercial relationships with a number of different overseas entities: Morris at [28] to [31]; Merchant at [98]. Amongst other things, there was discussion of a joint venture in Brazil with Braskem SA (a Brazilian company) from around July 2011, and of a non-exclusive distribution agreement in the United States with Multivac, Inc (a US company) from around May 2011: Merchant at [100] to [103], [123].
Consideration to acquisition of BBG shares by GMSF: 2011
On 23 December 2011, Mr McGrath wrote an email to Mr Merchant which stated (CB69):
With the BBG share price as it is I was thinking that you might like to consider transferring some of GM No 2’s BBG shares to your Super Fund??
This would give you extra money for GM No 2 and is allowable under the share trading window up till next Friday the 30th of December – see attached
The only thing you would need to do is to get Ted’s OK for a transfer as it would be over 1 million shares, but as it is just going from one entity to another that you control there is no possible issue
Say for example the share price was $1.90 next week, depending on the cash in the Super Fund and allowing for keeping some cash there, if you were able to transfer say 6 million BBG shares that could release $11.4 M to GM No 2.
I would need to check with Colette as to how many you could actually do depending on the cash available but that is the idea.
There would be no capital gains tax payable by GM No 2 and it is a simple and easy way to get cash out of your Super Fund
And if the BBG share price increases over the next couple of years and you wanted to sell some there would be no capital gains tax payable in the Super Fund
What do you think???
Mr Merchant responded on 28 December 2011 at 6:23am saying (CB69):
Luke just thinking about putting this into Super, how do I access the money in my Super, isn’t there all sorts of restrictions on funds once it goes into my Super?
On 28 December 2011 at 7:18am, Mr McGrath wrote an email to Mr Merchant stating (CB69):
Colette came back when I sent the email and thought the idea of transferring the shares was OK and Ian Burgess your Partner at Ernst and Young thought it was OK as well
You would only be transferring the shares from GM No 2 to your Super Fund so you are not actually disposing or buying any more shares just changing the ownership of part of the shares that you own
Allan McDonald did the same thing back in March this year - see attached
On the Super side the Super Fund is also just buying the shares at market value and therefore is just paying for the shares at that price so the Super Fund ends up with assets that it owns for the cash paid so there are no issues around realising money from the Fund to do that
I will contact Colette after 9 am our time once the market has opened and see if she can contact Ted to see what his reaction is and get back to you
On 28 December 2011 at 9:03am, Mr McGrath wrote an email to Ms Paull, which included (CB70):
Gordon has asked if you can ring Ted to see if he is OK with the idea of transferring the shares from GM No 2 to Gordon’s Super Fund
The number to be transferred depends on the amount of cash in the Super Fund but needs to allow for cash liquidity in the Super Fund so I would suggest keeping a minimum of $4 M cash in the Fund.
So if there was say $16M in the Fund then I would suggest only using $12M for share purchases
So if the share price is say $1.85 then transferring 6.5 Million shares at that price would be $12.025M from the Fund but the number of shares transferred would need to go down or up to ensure that $4M cash is held in the Fund
…
I am sorry to do this to you today but Gordon has only come back to me this morning
Mr Merchant said he was concerned with funding Plantic at this time, that the dividend flow from BBG was reducing, and that his interest in buying BBG shares continued: Merchant at [110] to [115]. In his affidavit at [115], Mr Merchant stated:
I understood, based on Luke’s email to me on 28 December 2011, that transferring BBG shares from MFT to GMSF was permitted under the restrictions that applied to self-managed superannuation funds, provided that the shares were transferred for market value.
Mr Merchant stated in his affidavit that he did not know why he did not proceed, but that it was likely that it was because he could meet Plantic’s funding needs from other sources: Merchant at [116]. This evidence was not supported by evidence of Plantic’s funding needs at the time or by evidence that those needs were met from other sources. To the extent Mr Merchant sought to imply in his affidavit that Mr McGrath’s email was concerned with funding Plantic, something which is not mentioned in the email, I do not accept that this was the predominant reason for Mr McGrath’s inquiry.
On 13 January 2012, Ms Lyons sent an email to Mr Cowley at MinterEllison in relation to a “future transfer of BBG shares” from the MFT to the GMSF: CB74. The email included:
Colette mentioned that she had discussed with you the possibility of having some of the BBG shares owned in the Merchant Family Trust transferred to Gordon’s superannuation fund. This was not done in the last trading window, but Colette mentioned that it is possible that it will happen in the next window. Therefore, we would like to get the paperwork drafted now, so that it is ready to go later - all we have [sic] to insert the correct numbers and dates.
I did a draft in Dec, which I now attach for your review …
The attachments to this email indicate that what was being considered in December was an acquisition of 4,500,000 shares for $7,987,500.
GMSF acquired BBG shares: 29 February 2012
On 17 February 2012, BBG announced a number of dealings following a strategic capital structure review which had been announced on 19 December 2011: Merchant at [125].
An ASX announcement on 17 February 2012, stated that the review had resulted in the following initiatives (CB79):
·the partial sale of Nixon Inc.;
·a review of the Group’s retail network with a view to closing loss-making stores and stores performing below expectations;
·a cost-cutting program; and
·a reduced dividend and fully underwritten dividend reinvestment plan.
On 20 February 2012, BBG announced that it had received a proposal from TPG Capital to acquire all of the shares in BBG for $3.00 per share under a scheme of arrangement: CB80. Mr Merchant stated in his affidavit that he thought that the offer did not reflect BBG’s value, which he believed, based on a valuation the board organised, to be over $5.00 per share: Merchant at [127]. No valuation was in evidence.
An ASX announcement from BBG on 28 February 2012 included (CB82):
The Board and its advisers have now had further discussions with TPG to give TPG the opportunity to increase its non-binding indicative price of $3.00 per share to better reflect the value of the company. In those discussions, TPG was also made aware of the attached letter, received by the company after market close yesterday, from the lawyers of Billabong’s Non-Executive Director and major shareholder, Gordon Merchant, and Non-Executive Director Colette Paull, advising that Mr Merchant and Ms Paull ‘do not support Billabong taking any steps to assist or facilitate a proposal by TPG Capital, including allowing TPG Capital to commence due diligence on Billabong, even if the price TPG Capital offered was $4.00 per share’ which Mr Merchant and Ms Paull ‘consider would still represent a discount on the true value of Billabong shares’.
On 29 February 2012, the GMSF acquired 2,523,600 shares in BBG for $7.89 million (approximately $3.13 per share) in an on-market purchase: Merchant at [119]; CB537. By 30 June 2012 (the opening balance at 1 July 2012), those shares were recorded in the GMSF financial statements at $2,712,870: CB590 at page 3. By 30 June 2013, they were recorded in the GMSF financial statements at $378,540: CB149; CB559; CB590.
Mr Merchant stated in cross-examination that he did not receive any advice from EY in relation to this transaction: T75.21.
This transaction was addressed in statutory declarations prepared by Ms Paull and Mr Merchant in the context of an audit conducted by the Commissioner into the affairs of the GMSF.
In her statutory declaration at [15] to [19], Ms Paull stated that she had discussions with Mr Merchant before the GMSF acquired shares in BBG in February 2012: CB443. She stated:
15. In February 2012, GMSF acquired 2,523,600 BBG shares on market (2012 shares). GMSF [sic] paid approximately $7.89 million for these shares.
16.Before GMSF purchased the 2012 shares, Gordon and I discussed investing GMSF’s cash in assets that generated more wealth for GMSF. Gordon and I agreed that it would be good to try to invest the cash in other growth assets, rather than just having cash in GMSF. I can’t remember how long we had been having these discussions, but it had been for a number of years before GMSF purchased the 2012 shares.
17.During these discussions before February 2012, Gordon suggested that GMSF purchase BBG shares. At that stage, the BBG share price had been decreasing for some time and Gordon and I discussed the share price and BBG’s performance regularly.
18. Gordon said words to me to the effect that:
(a)he believed that BBG’s performance would improve and the share price would increase;
(b)he wanted to buy BBG shares because he saw them as a good investment - the share price was low and he was confident that BBG would improve over time; and
(c) he wanted to hold BBG shares for a long time.
19.At the same time, there were a lot of good offers for BBG shares - for example, they were offering two shares for every one purchased.
In his statutory declaration made on 17 October 2019, Mr Merchant stated (CB442):
Investing in BBG
10. I have always (through various entities in the Merchant Group) been a significant shareholder of BBG.
11. I discussed buying BBG shares with Colette on a number of different occasions. Different entities in the Merchant Group owned BBG shares, including MFT and GMSF.
12. BBG started to decline in around 2010 - I believe that BBG was affected around this time from the global financial crisis.
13. Throughout this time, I continued to purchase BBG shares in the Merchant Group. I always believed that:
(a)BBG would improve and trade out of its difficulties;
(b)as a founder, it was important for me to show the public that I believed that BBG would improve and trade out of its difficulties;
(c)my investment in BBG was a long-term investment; and
(d)BBG would return to paying dividends and I would make a good return on my investment in BBG.
14. Colette and I regularly discussed BBG and me wanting to purchase BBG shares. Whenever I wanted to purchase BBG shares, I spoke to Colette about it.
15.In February 2012, GSMF purchased around 2.5 million BBG shares for approximately $7.89 million. At that stage, the BBG share price had been decreasing. I believed that:
(a)the share price had taken into account BBG’s trading difficulties, so the BBG shares were good value;
(b)the BBG share price would increase;
(c)as a founder, it was important for me to show the public that I believed that BBG would improve;
(d)my investment in BBG was a long-term investment;
(e)I wanted to continue to own (through my various entities) a sufficient number shares that gave me some control - this was around 12% to 15% of the shares in BBG; and
(f)BBG would return to paying dividends and I would make a good return on my investment in BBG.
In cross-examination, Mr Merchant denied that this purchase had anything to do with him wishing to retain his position as a substantial shareholder in BBG: T78.3. I do not accept this evidence as accurate. It is inconsistent with [15(e)] of his statutory declaration. Mr Merchant acted consistently over this period to maintain his position as a substantial shareholder in BBG. The GMSF had cash available to make the purchase and Mr Merchant wanted to maintain the Merchant Group’s relative shareholding position in BBG.
GMSF formulates and adopts an investment strategy: 15 March 2012
On 15 March 2012, Ms Paull (on her own behalf and as Mr Merchant’s attorney) signed a resolution of the directors of the GMSF: CB84. The resolutions were said to have been made at a meeting on 16 February 2012 at which Ms Paull and Mr Merchant were “present (on phone)”. The resolution refers to sub-reg 4.09 of the SISR. The following was set out next to the heading “Investment Objectives & Strategy”:
IT WAS RESOLVED that the primary investment objective of the Fund will be to achieve an after tax rate of return which is at above the rate of inflation.
The strategy is to invest assets as follows:
► 0 - 40% in Shares in Listed Companies;
► 0 - 20% in Shares in Unlisted Companies;
► 0 - 10% in Units in Listed Unit Trusts;
► 0% in Units in Unlisted Unit Trusts;
► 0 - 10% in Managed Funds;
► 0% in Property;
► 0 - 5% in Loans;
► 0 - 50% in Shares in Unlisted Hybrid Funds;
► 0 - 100% in Cash ie Bank Bills/ Term Deposits etc
► 0 - 20% in Fixed interest;
► 0% in other investments
Attached to the resolution was a document dated 15 March 2012, signed by Ms Paull for herself and as Mr Merchant’s attorney, which was headed “Investment Strategy” (the 2012 Investment Strategy Document or 2012 ISD). It stated:
Investment Objectives
Effective from 16 February 2012 the investment objectives of the Fund are as follows:
► to earn an investment rate of return above the inflation rate on the assets under its control;
► to invest so as to have a very low expectation of a negative return in any 12 month period;
► to hold assets in such a form to enable the trustee to discharge the Fund’s liabilities as and when they fall due and to discharge the member’s benefits in a manner that satisfies the member.
Investment Strategy
In order to achieve the investment objectives of the Fund, the investment strategy of the Fund is as follows:
► To maintain asset class holdings in the following ranges:
Investment (%)
Shares in Listed Companies 0 - 40
Shares in Unlisted Companies 0 - 20
Units in Listed Unit Trusts 0 - 10
Units in Unlisted Unit Trusts 0
Managed Funds 0 - 10
Property 0
Loans 0 - 5
Shares in Unlisted Hybrid Funds 0 - 50
Fixed Interest 0 - 20
Cash ie Bank Bills/Term Deposits etc 0 - 100
► To pursue a high growth strategy in order to provide strong returns with diversification of risk. Diversification of risk will be achieved by ensuring the portfolio maintains an exposure to most main investment sectors. At this stage the focus will be mainly through investments in shares in listed companies, and fixed interest and cash. Also, consideration will be given to investments in shares in unlisted companies, units in listed trusts, and managed funds where appropriate.
The Trustee will take into account the following factors when acquiring, selling or replacing assets:
(i) the marketability of the asset, including costs of realisation;
(ii) the risk involved in making, holding and realising, and the likely return from the asset;
(iii) anticipated liquidity requirements;
(iv) the Fund’s ability to discharge its existing and prospective liabilities; and
(v) if the Fund should hold a contract of insurance that provides insurance cover for one or more members of the Fund.
Where appropriate, the Trustee will consult with their financial advisers in relation to the purchase and disposal of investments.
Short term cash flow requirements for the ongoing administration of the Fund and member payment requirements will be met via returns on investments, contributions received and the holding of cash amounts. Investments in equities can also be easily realised to cover cash flow requirements, both in the short term for ongoing administration costs, and in the long term to meet member payment requirements.
In determining the above strategy, the Trustee has taken into consideration all the circumstances surrounding the Fund and the Fund’s investment objectives. The Trustee has also considered the risk and likely return of the investments, the adequacy of the diversification, the Fund’s expected cash flow requirements and the Fund’s ability to meet its existing and prospective liabilities.
The Trustee will continue to monitor the appropriateness of the investment strategy adopted. Depending on the Trustee’s view of the financial markets, the Trustee may vary the investment strategies in order to ensure the Investment Objectives of the Fund will be met.
This Investment Strategy has been adopted.
Mr Merchant gave evidence that he did not recall seeing the 2012 ISD at or before the time it was signed. He stated that he did recall discussing the GMSF’s investments with Ms Paull from time to time and he understood that Ms Paull sought advice from EY about GMSF matters: Merchant at [121], [122].
Although the minutes record Mr Merchant as being present at the meeting, by phone, his evidence in cross-examination was that he could not recall whether he was at the meeting or not: T75.36-41.
As Mr Merchant noted in his evidence, the resolution included a strategy to invest in assets including 0% in property which did not reflect the fact that, by 30 June 2012, a factory in Yamba comprised approximately 9% of the GMSF’s assets: Merchant at [121].
As noted above, the resolution also included a strategy which provided for investment of up to 40% of the GMSF’s assets in listed securities.
The MFT acquires further BBG shares in June 2012
In June 2012, Mr Merchant became aware that BBG was going to announce a non-renounceable entitlement offer.
On 19 June 2012, Ms Paull sent Mr Merchant an email about the paperwork for an increase to the limit of a margin loan the MFT had with NAB (NAB Margin Loan) to $25 million: CB91. I infer that the immediate desire for the increase to the facility limit was for Mr Merchant to acquire more shares in BBG. Mr Merchant replied to Ms Paull’s email stating:
How much is it for? Not sure I’ll need it but it would be nice to have there in reserve. I was figuring to put in 22mil which should leave at around 13+% which I think is just enough to retain control. I’ll have [to] check this.
So with the 15mil and the 11mil that Luke is getting I should have 26 all up. I wanted to leave some for you to use. But I don’t want to give up control
Mr Merchant stated, and I accept, that his reference to “around 13+%” and retaining “control” was a reference to the Merchant Group’s interest in BBG: Merchant at [133]. The reference to the amount of “11mil that Luke is getting” was, I infer, a reference to amounts that would be obtained from the sale of investments in respect of which Mr McGrath was the adviser. The MFT General Ledger for the year end 30 June 2021 indicates that a number of shares (or assets) were sold from 19 June 2012 to 25 June 2012: CB836 at page 11.
On 21 June 2012, BBG announced a non-renounceable entitlement offer: CB100; Merchant at [131]. The MFT General Ledger shows that, on 25 June 2012, an amount of $23 million was received by the MFT drawing down on its overdraft. The balance went from $465,325.72 on 15 June 2012 to $31,086,318.47 on 25 June 2012. On 27 June 2012, $30 million was drawn out of the MFT to acquire 29,411,765 shares in BBG: Merchant at [135], [136], [139]; CB91.
The GMSF did not take up an entitlement in the offer: Merchant at [135]. The GMSF General Ledger for the year end 30 June 2013 records that the GMSF acquired BBG shares by four payments totalling $2,176,000 on 13 and 16 July 2012 and received a refund in relation to those shares on 2 August 2012: CB590. Mr Merchant was taken to these entries but it did not assist his recollection about why the GMSF did not acquire shares: T80-81.
Consideration given to accessing cash from the GMSF: July 2012
On 20 July 2012, Mr McGrath sent an email to Mr Burgess which relevantly stated (CB106):
Gordon just rang about getting some of the cash out of the Super Fund when the redemption of the MSSits money comes through at the end of September / beginning of October
It should be around US$7.4m or so and I was wondering if it was possible for Gordon to retire from a position at that point and turn the Fund into pension phase and withdraw a lump sum?
The idea would be to pay down part of the margin loan with NAB with the proceeds
Could you please advise your thoughts?
Mr Merchant stated that he did not recall the conversation referred to by Mr McGrath in this email: Merchant at [144].
The reference to “MSSits” is a reference to the Macquarie Special Situations Fund (MSSF): Merchant at [144]. Mr Burgess replied the same day stating:
Luke, there are no restrictions on Gordon accessing the funds in the super given he is over age 65. He could take it either as a tax free lump sum or tax free pension – I think we did start him on a pension so that would probably be the form) – another option which might be preferable and which I have discussed with Sue is to have the fund acquire some of the BBG shares from MFT (fund is able to acquire these as listed shares) – in this way the ‘value’ stays protected in the concessionally taxed super environment. I will give you a call to discuss a little later.
Mr Merchant stated that he did not recall any discussion with Mr McGrath about Mr Burgess’ response: Merchant at [144].
Plantic negotiations: July and August 2012
In July 2012, Winpak Ltd and Bemis Company, Inc expressed interest in the possibility of equity participation in Plantic: Merchant at [145]. In August 2012, Kuraray expressed interest in potential cooperation with Plantic: Merchant at [146]. By January 2013, discussions with Bemis turned to potential exclusive technology license agreements: Merchant at [166].
Consideration to GMSF acquiring BBG shares: October 2012
In around October 2012, Mr Merchant became aware that a consortium involving a former BBG director, Mr Paul Naude, was looking to announce an offer to acquire BBG shares: Merchant at [159]. TPG had earlier (on 24 July 2012) announced a proposal to acquire all of BBG’s shares for $1.45 per share. Mr Merchant gave evidence that he did not believe that this correctly reflected BBG’s value: Merchant at [153].
On 14 October 2012 at 4.51pm Mr Merchant emailed Ms Paull asking: “Do you know if I’m able to buy BBG shares using funds in my super fund?”: CB115. Ms Paull replied at 9.36pm stating:
Yes, you can, and you have around $2 mil that you could use, we have to keep some in there.
The $15 mil won’t be in the account until early November.
Our trading window looks like it will be open until December, so that might still be o.k. but you wouldn’t want to use it all for BBG shares as it wouldn’t leave you any if things go pear shaped.
The reference to “the $15 mil” was to an amount that the GMSF and the MFT were due to receive from an investment in the MSSF: Merchant at [157].
On 15 October 2012, Mr Merchant replied to the effect that he was thinking of spending around $4 million, and Ms Paull replied stating: “We should be able to come up with the $4 mil ok”.
Mr Merchant’s statutory declaration of 17 October 2019 included (CB442):
16. On or around 15 October 2012, I sent an email to Colette asking whether she knew if I could buy BBG shares using the funds in GMSF …
17. I know that there are specific rules that apply to self-managed superannuation funds. When I asked Colette about buying shares using funds that GMSF held, I wanted to make sure that I wouldn’t breach any of the superannuation rules if GMSF purchased BBG shares. At the same time, I knew that GMSF had cash that it could use to invest. I thought that BBG was a suitable investment for GMSF.
18. I believe that Colette then spoke to Ian about GMSF buying BBG shares.
On 18 and 19 October 2012, the MFT acquired 900,058 BBG shares for a total of $753,895.21: Merchant at [161]; CB116. Mr Merchant could not recall why more BBG shares were not purchased. The expected return from the MSSF had not then been received. The purchase was funded by a $3 million draw down on the NAB Margin Loan (the balance of which was used to fund Plantic in the sum of $1.55 million and to pay MFT’s other expenses): Merchant at [162].
On 5 November 2012, the GMSF received $6,201,885.26 by way of proceeds of sale from the MSSF: CB590 at page 1. An amount of $6,100,000 was transferred to a different account of the GMSF and the amount remained in the GMSF until it was used in the BBG Share Sale on 4 September 2014.
Plantic negotiations: January to May 2013
By January or February 2013, Kuraray had indicated that it may be interested in acquiring Plantic: CB128; Merchant at [168]. By March 2013, Kuraray had signed a letter of intent expressing its interest in “possible cooperation and alliance between Kuraray and Plantic such as 100% acquisition of or partial capital contribution in Plantic, joint venture, licensing arrangement and so on”: CB136; Merchant at [170] to [176].
By 17 April 2013, Kuraray had indicated it might consider buying the Plantic business at $60-$100 million: CB139. There were also discussions about selling a license to Braskem and about an exclusive North American license to Winpak, both of which might affect Kuraray if it acquired the business: CB139. By 19 April 2013, Kuraray had indicated it did not have approval to make an offer for a 100% acquisition of Plantic. It was, however, interested in Plantic’s business and opportunities to cooperate: Merchant at [176]; CB140.
In May 2013, negotiations with Multivac were put on hold whilst negotiations with Winpak, Bemis, Braskem and Kuraray progressed: Merchant at [177]. In June 2013, Plantic and Braskem had discussed the rough terms of a proposed licensing agreement: Merchant at [178].
The GMSF as at 30 June 2013
The GMSF financial statements for the year ended 30 June 2013 record that:
(a)an income stream based pension of $470,500 was paid to Mr Merchant, leaving a total benefit balance of $10,116,862: CB149 at page 8.
(b)the GMSF investments comprised: BBG shares recorded at a value of $378,540; a “Flaik (SSIWDI Pty LTD) loan” of $547,341; the Yamba factory valued at $1,154,202 and cash of $8,187,967: CB149 at page 4.
The cash balance of $8,147,463 included the proceeds of disposal of the MSSF investment: CB149 at page 4; CB590.
Plantic negotiations: June 2013 to December 2013
Between June 2013 and December 2013, Kuraray discussed a license agreement for Japan and South Korea, and ultimately a distribution agreement for that area. This was entered into in December 2013: Merchant at [179].
The negotiations with Bemis and Winpak proved difficult due to Plantic pressing for the companies to pay an upfront license fee: Merchant at [181]. Nonetheless, by September 2013, Plantic was close to finalising a license agreement with Winpak that would include an upfront license fee, expected to be $1.5 million: Merchant at [182].
By November 2013, the Plantic board had resolved not to pursue a relationship with Winpak or Bemis, and to re-engage with Multivac: Merchant at [185].
By November 2013, Sealed Air had expressed interest in potentially acquiring Plantic: Merchant at [186]. Mr Merchant was told that Sealed Air’s representative had indicated that “if Plantic went down the path of signing individual distribution and manufacturing agreements especially in North America that Sealed Air would not be interested in talking to Plantic”: CB163.
In an email on 5 November 2013, Mr Merchant stated: “I do not want us to get sidetracked again by another we might want to buy the company scenario. If someone wants to buy us especially an opposing brand they need to make us an unconditional offer and until then it’s business as usual”: CB163.
By December 2013, the Plantic team were growing frustrated with Braskem’s delays, but Braskem was asking for more time: Merchant at [187]; CB497 at page 1116. Plantic and Sealed Air had signed a confidentiality agreement to facilitate discussions, but Mr Merchant told the Plantic board that he “agreed to proceed with caution and that [the] objective should be to hear what Sealed Air had to say and not give up Plantic information at this stage”: CB497 at page 1117.
BBG renounceable rights issue: September 2013 to March 2014
On 19 September 2013, BBG entered into agreements with Centerbridge Partners, LP and Oaktree Capital Management, LP entities (Centerbridge/Oaktree) for them to provide long term finance to BBG: Merchant at [189], [190]. In summary, under the agreement:
·BBG would borrow $386 million from Centerbridge/Oaktree;
·a $135 million equity placement would be issued to Centerbridge/Oaktree;
·a $50 million renounceable rights issue would be available to BBG shareholders other than Centerbridge/Oaktree;
·BBG would use the proceeds from the equity placement and renounceable rights issue to repay part of the loan from Centerbridge/Oaktree; and
·29.6 million options would be issued to Centerbridge/Oaktree.
The equity placement and rights issue would dilute Mr Merchant’s shareholding in BBG so he decided to acquire BBG shares under the renounceable rights issue to reduce the extent of dilution of his shareholding: Merchant at [191]. As can be seen from the following communications, consideration was given to the GMSF acquiring shares in BBG through the entitlements of other Merchant Group entities, but this ultimately did not proceed because Mr Burgess considered that such a course raised tax issues.
On 25 November 2013, Ms Lyons emailed Ms Paull attaching some calculations: CB165. The email included:
1. Approx. cash in the bank now is $8,059,826.79 – this excludes super and Foundation and Rocky group.
2. Perhaps you could buy some of the BBG shares in the super fund? This would mean that there was more $ to access for the purchase. Might not work – depends on the terms of the purchase available.
3. Cash balance stays in the black until Nov next year – balance then approx. $1.2M only.
4. Plantic commitments up to Dec 2013 only. Assumed no cash required by them after that date.
5. The interest on the NAB loan is listed right at the bottom of the sheet – this is not included in the cashflow as the interest is just capitalised to the loan at the moment. The NAB loan is currently at around $10.911M and this continues to increase with interest charged.
6. I have assumed approx. $500K per month for drawings for Gordon. While this amount might differ from month to month, the annual total is based on the last 2 years drawings.
7. I have included estimated costs for the following based on 2013 figures but have just projected them at an equal amount per month:
a. Helicopter costs
b. Angourie property costs
c. Neil’s fee
d. Administration costs of all entities
e. Motor vehicle costs
8.The income in the form of dividends has been included based on 2013 amounts and I have included them with the timing the same as for 2013.
9. I have not included any interest income on the foreign bank accounts.
10. I have not included any income or capital calls on the property trust investments (like MREEF and SREEF etc), as these are unknown to me. Not sure if Luke would know any other info.
On 26 November 2013, Ms Paull forwarded that email to Mr Merchant, stating relevantly (CB165):
Here is the cash flow that Sue has sent to me, i thought i would send it onto you so we were all on The [sic] same page. …
If we need around $10 mil for BBG shares we could use some of the super fund money if we are allowed To [sic] do it that way, we have $8 mil in cash available which we can give to you as you are retired and buy Them that way. Or we can draw down again on the NAB and because its BBG shares again we wont have to Pay [sic] interest if you would prefer to do it that way.
This is just a couple of suggestions we can do other things as well.
On 26 November 2013, Mr Merchant replied, stating relevantly:
It would be fantastic if we could use the Super fund to purchase the shares? Can you please find out if this is possible? I know it’s a possible tax deduction if we draw the 10 million from the National Bank overdraft but I’m worried about our ability to service that much debt. I’d try and use the Super Fund money as much as we possibly can. Given there is a real chance I’ll have a huge tax bill when I sell Plantic or hopefully my shares in Billabong in few years time what does Sue think is the best way to raise the funds is given our current situation. I think Sue’s answer would be dependent on how much Plantic and deliver over the next twelve months. Best have Daryl give us a cash flow for the next twelve months regardless. I still think you [sic] Super Fund is the best way to go if we can do it.
The Centerbridge/Oaktree equity placement occurred on 6 February 2014. On 13 February 2014, Mr Merchant forwarded to Ms Paull an email he had received discussing whether he was to be an institutional or retail investor in the forthcoming rights issue: CB175. Ms Paull forwarded the email to Mr McGrath on 14 February 2014. Mr McGrath responded the same day and, after setting out the likely timing of the institutional and retail offers, stated (CB175):
The questions that we need answered for Gordon at this stage are 1) can his entitlements under the Institutional / Retail offer for the various entities – GM No2, GSM etc. – be transferred or assigned or preferably issued originally to the Super Fund? – do you want me to double check with Burge that there is no adverse tax consequence of this happening once we find out if it is possible?? 2) will he be provided with exactly the same number of entitlements under the Institutional offer as he would be under the Retail offer?
Mr McGrath gave evidence that he raised the possibility of the entitlements under the capital raising offer being transferred to the GMSF on the basis that he thought it was desirable because the GMSF had cash that could be used to buy the shares, and he understood that Mr Merchant wanted to minimise debt: McGrath at [57(c)]. Mr McGrath also gave evidence that his reference to finding out “if it is possible” was intended as a reference to whether the rules of the capital raising allowed the rights issue to be assigned or issued to the GMSF.
Earlier on 14 February 2014, Mr McGrath sent an email to Mr Burgess referring to the offer and stating relevantly (CB176):
It would be preferable if the full entitlement across all of Gordon’s entities could be taken up by the Super Fund as it has cash available
Colette is checking with BBG on whether the various entities entitlements – GM No 2, GSM etc. – can be transferred or issued in the Super Fund’s name and therefore all the entitlements can be taken up there
I just wanted to check that there would be no adverse tax outcomes for the other entities if that happens? The offer this time is renounceable and I am therefore presuming transferable but the offer is being done at 28 cents and the present trading price for BBG shares is about 70 cents
Mr Burgess replied the same day stating (CB176):
thanks Luke - has any documentation come out about this yet? if renounceable and given the disparity between the offer price and trading price will investors get any form of payment where they renounce? i guess what i am saying is that there could be some issues for the fund if it is able to get more of the low cost shares because of a ‘non-arm’s length arrangement’ with the other entities of Gordon’s. understand the preference to do it all via super fund because that is where the cash is …
Mr McGrath sent Ms Paull an email on 14 February stating relevantly (CB176):
FYI – Ian asked the same thing as me below re the documentation
So I rang him and we had a talk about different options and one option that is also available is that if there are problems with issuing the share entitlements to the Super Fund or transferring them, or any potential tax situations – which there could also potentially be – that an option would be for the Super Fund to buy some of the bank shares from GM No 2 thus transferring cash to No 2 allowing it to be able to take up its rights.
Burge said that there are enough losses in No 2 so that there should not be any tax payable on a gain by selling the shares down the track
So in summary there are a number of options available that there should be enough flexibility to allow it to happen in the most, or a combination of the most, advantageous ways for Gordon
Mr McGrath did not have a specific recollection of his discussion with Mr Burgess as mentioned in that email: McGrath at [58(d)].
On 18 February 2014, Mr McGrath sent Ms Paull an email estimating that the effect of the rights being issued was that the Merchant Group’s 15.6% stake would go down to 9.75% if all of the Group’s rights were taken up: CB180.
Consideration continued to be given to whether the GMSF could acquire BBG shares through the entitlement of other Merchant Group entities: CB182; CB186; CB567. Ultimately, however, this did not occur because of various potential taxation issues raised by EY. On 21 February 2014, Mr Burgess sent an email to Ms Simone Mouritz and Ms Megan Kachel of EY referring to various tax issues which might arise if the GMSF purchased BBG shares using the entitlement of other entities and stating that he had discussed the issues with Mr McGrath and that the “end result is that each entity will take up its own entitlement”: CB186. It is clear from this email and the subsequent acquisitions, that the GMSF did not acquire any shares in BBG through the entitlements of other Merchant Group entities.
The entitlement offer was made by a prospectus dated 26 February 2014.
On 31 March 2014 (Merchant at [199]):
·the MFT acquired 24,679,850 BBG shares for approximately $6,910,357;
·GSM acquired 850,873 BBG shares for approximately $238,244; and
·the GMSF acquired 946,350 BBG shares for approximately $264,977 (0.28 cents per share).
After the rights issue, the Merchant Group held approximately 10% of the voting power in BBG, and was no longer the largest shareholder: Merchant at [202].
Mr Merchant’s evidence as to why he (through the Merchant Group entities) acquired the shares included (Merchant at [203]):
At the time, Rider had acquired approximately 10% of BBG’s share capital and was pushing to have a seat on the board. Rider had plans to increase the distribution channels that Billabong products were sold through - for example, selling Billabong products through lower-end retailers like Kmart. I disagreed with this plan because I thought this would cheapen the brand. I considered that selling Billabong products at a ‘discount’ retailer would diminish the value of the brand forever. I disagreed with Rider’s plans for BBG and wanted to make sure they did not get a seat on the board. These kinds of considerations are why I felt that I needed to keep acquiring BBG shares.
Multivac distribution agreement and Braskem negotiations: March – May 2014
On 18 March 2014, Plantic and Multivac entered into an exclusive distribution agreement: CB197. Under that agreement, Plantic appointed Multivac as exclusive distributor of certain Plantic products in the United States. It provided an “Introductory Period”, ending on 30 September 2014, during which either party could terminate at will.
On 16 April 2014, there was a Plantic board meeting (CB495):
(1)Mr Morris stated that Braskem had indicated it would be ready to sign an agreement in the week commencing 5 May 2014.
(2)Mr Morris confirmed, in response to a question from Mr Jones, that Braskem would be required, within 14 days of signing, to pay USD $4 million and the first instalment of a USD $1.5 million engineering fee. Ms Paull and Mr Merchant “indicated that [Mr Morris] should not be surprised that there might be a further delay when they went to Brazil”.
(3)There was discussion about a “Plan B” in the event that the deal with Braskem did not eventuate, recorded in the board minutes as follows:
•[Mr Morris] indicated that he had spoken to Ingredion about an alternative plan B to Braskem (back up plan), a potential company with extrusion capacity has been identified and a call will be scheduled after Easter to explore the opportunity. Plan was that Plan B would be in place by the end of June 2014;
•[Mr Merchant] asked if Plantic went with Plan B was there any opportunity for Plantic to distribute in Sth America, [Mr Morris] responded by stating that Plantic currently have three projects in the region – BRF, JBS – biggest meat processor in the world and Marfrig all large in size. Multivac have a subsidiary in Sth America and therefore could be asked to distribute material;
(4)There was also discussion at the meeting about Kuraray, recorded in the board minutes as follows:
•[Mr Morris] also noted that Kuraray had indicated that they wished to proceed with the Japan and South Korea distribution agreement and would pay first licence fee instalment of $600K by 30 April 2014;
•In response to [Mr Merchant], [Mr Morris] indicated that Kuraray had not given any indication of volume forecasts and expected the roll out would be relatively slow albeit that the trialling to date has been positive;
•[Mr Morris] confirmed that Kuraray were visiting Plantic Altona on the 20th-22nd May at which discussion would take place on how both Kuraray and Plantic could work together to produce a barrier bottle that could be used in the recycling stream;
By May 2014, Mr Merchant was frustrated with the fact that Plantic continued to require funding from him. Mr Merchant considered that Plantic should have been self-funding by this time: Merchant at [207]; CB207.
Mr McGrath approached EY to provide taxation advice in relation to an appropriate structure for the sale of Plantic in about May 2014: T156.14. On 5 May 2014, Mr Burgess sent an email to Mr Hoy and Mr Morris, copied to Mr McGrath and two employees of EY, in which he referred to discussions the Friday before: CB573. An attachment to the email included a note which indicated that consideration had been given to an asset sale and a share sale.
On 14 May 2014, Mr Merchant emailed Mr Morris to ask if he and Mr McGrath had been able to “pin” Braskem “to a definite time frame for moving forward”: CB205. Mr Morris replied stating that he had spoken with a representative of Braskem who had “advised that the final sign off meeting was booked with the CEO and executive team” on Friday, 16 May 2014. Mr Morris stated that the Braskem representative considered that the CEO and executive team “would need a week to get the signatures”.
Forecasts of the cash funding requirements were sent to Mr Merchant and other Plantic directors on 28 May 2014 for the period June 2014 to December 2014: Merchant at [208]; CB211. These indicated that in the “base/worse case” the funding required for June 2014 to December 2014 was $4.4 million. An email dated 29 May 2014 from Mr Hoy addressed cash funding requirements for the first half of 2015: Merchant at [209]; CB213. The attachment to Mr Hoy’s email revealed a “base case” funding requirement of $900,000 and a “target case” funding requirement of $300,000.
In June 2014, Mr Merchant sold some industrial land in Hawaii “to free up cash to fund Plantic”: Merchant at [213]; T92. The proceeds were an amount of about $2.3 million: T92.33.
On 16 June 2014, Mr Hoy emailed Ms Paull noting that Plantic had applied for a $4 million working capital facility with NAB secured only against Plantic’s assets, but that a response was not expected before 23 June 2014: CB221. He also noted that the Braskem licence fee was still subject to approval and would not be received until late July or August 2014. He stated that Plantic’s cash requirements were $500,000 on 23 June 2014 and $600,000 on 14 July 2014. Ms Paull sent instructions to Ms Dawn Cooper, a Merchant Group employee, to make the payments and stated in the email (CB587):
They are trying to get funding, but, don’t count on it.
Gordon has sold another block of land in Hawaii, his, industrial block, and is fully aware that his money is going into Plantic.
He hates it but, is now willing to sell it, but, he won’t make much on it, that is if he’s lucky enough to get what he wants.
By June 2014, Mr Merchant wanted to find a buyer for Plantic. At [218] of his affidavit, Mr Merchant stated:
By this time, I was getting cold feet. I didn’t believe that I had the assets to continue to fund Plantic until it was profitable by itself. I had no faith in the budgets we were receiving from Plantic. I did not know when Plantic would be profitable on its own, but I knew that it would not be for some time. I wanted to find a buyer for Plantic.
The GMSF as at 30 June 2014
The GMSF Financial Statements for 30 June 2014 record that:
·Mr Merchant’s total benefit balance was $10,464,744 – see: Member’s Statement at CB592 at page 9.
·the GMSF investments comprised: a parcel of BBG shares recorded at a value of $1,734,975; the “Flaik loan” at $347,342 (reduced from $547,341); the Yamba factory at $690,000 (reduced from $1,154,202); and
·cash at bank was $7,855,587.
Negotiations with Sealed Air: June and July 2014
On 28 June 2014, Mr Morris sent an email to Mr McGrath (and others) which provided an overview of a meeting he had with Sealed Air representatives in June 2014: CB226. He noted that Sealed Air was aiming to obtain approval to send a non-binding offer by 24 July 2014. Mr Morris stated that Sealed Air had a “target date of the end of September to close”. Mr Morris said he felt that Sealed Air were committed, and he had given them the idea that they should move quickly “before someone else gets in”.
On 10 November 2021, the applicant filed a notice of appeal against an appealable objection decision under s 14ZZ of the TAA 1953 contending that the 2017 and 2018 assessments are both excessive. All issues related to forex gains and losses have been abandoned.
The legislation
Division 230 of the ITAA 1997 taxes certain financial arrangements that certain entities start to have on or after the start of their first applicable income year.
There is no issue that the MFT met the relevant threshold tests in the 2010 income year so as potentially to enliven the TOFA provisions.
Section 230-1 explains that the Division is about the tax treatment of gains and losses from “financial arrangements”, allowing a taxpayer to recognise the gains and losses, as appropriate, over the life of a financial arrangement and to ignore distinctions between income and capital, unless specific rules apply. Subsections 230-45(1), 230-50(1) and 230-50(2) provide tests which specify when a financial arrangement has arisen.
Section 230-15(2) permits the deduction of a loss made from a “financial arrangement” to the extent that it is made in gaining or producing assessable income or is necessarily made in carrying on a business for the purpose of gaining or producing assessable income.
Section 230-45(1) provides:
230-45 Financial arrangement
(1) You have a financial arrangement if you have, under an *arrangement:
(a) a *cash settlable legal or equitable right to receive a *financial benefit; or
(b) a cash settlable legal or equitable obligation to provide a financial benefit; or
(c) a combination of one or more such rights and/or one or more such obligations;
unless:
(d) you also have under the arrangement one or more legal or equitable rights to receive something and/or one or more legal or equitable obligations to provide something; and
(e) for one or more of the rights and/or obligations covered by paragraph (d):
(i) the thing that you have the right to receive, or the obligation to provide, is not a financial benefit; or
(ii) the right or obligation is not cash settlable; and
(f) the one or more rights and/or obligations covered by paragraph (e) are not insignificant in comparison with the right, obligation or combination covered by paragraph (a), (b) or (c).
The right, obligation or combination covered by paragraph (a), (b) or (c) constitutes the financial arrangement.
Note 1:Whether your rights and/or obligations under an arrangement constitute a financial arrangement can change over time depending on changes either to the terms of the arrangement or external circumstances (such as particular rights or obligations under the arrangement being satisfied by the parties). For example, a contract may provide for the transfer of a boat in 6 months time and payment of the contract price at the end of 2 years. Until the boat is delivered, there is no financial arrangement because of the operation of paragraphs (d), (e) and (f) above. Once the boat is delivered, there is a financial arrangement because those paragraphs are no longer applicable.
…
The term “arrangement” is defined in s 995-1 as follows:
arrangement means any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.
Section 974-160 states:
974-160 Financial benefit
(1) In this Act:
financial benefit:
(a) means anything of economic value; and
(b) includes property and services; and
(c) includes anything that regulations made for the purposes of subsection (3) provide is a financial benefit;
even if the transaction that confers the benefit on an entity also imposes an obligation on the entity.
(2) In applying subsection (1), benefits and obligations are to be looked at separately and not set off against each other.
(3) The regulations may provide that a thing specified in the regulations is a financial benefit for the purposes of this Act.
Section 230-50 provides two further tests for financial arrangement. Subsection 230-50(1) provides that an equity interest constitutes a financial arrangement. Under s 230-50(2), you have a financial arrangement if you have, under an arrangement, one or more legal or equitable rights to receive or provide something that is an equity interest.
However, for the purposes of Div 230, specific grouping and disaggregation rules apply.
Section 230-55 provides:
230-55Rights, obligations and arrangements (grouping and disaggregation rules)
Single right or obligation or multiple rights or obligations?
(1)If you have a right to receive 2 or more *financial benefits, you are taken, for the purposes of this Division, to have a separate right to receive each of those financial benefits.
(2)If you have an obligation to provide 2 or more *financial benefits, you are taken, for the purposes of this Division, to have a separate obligation to provide each of those financial benefits.
(3) Subsections (1) and (2) apply for the avoidance of doubt.
Matters relevant to determining what rights and/or obligations constitute particular arrangements
(4)For the purposes of this Division, whether a number of rights and/or obligations are themselves an *arrangement or are 2 or more separate arrangements is a question of fact and degree that you determine having regard to the following:
(a)the nature of the rights and/or obligations;
(b)their terms and conditions (including those relating to any payment or other consideration for them);
(c)the circumstances surrounding their creation and their proposed exercise or performance (including what can reasonably be seen as the purposes of one or more of the entities involved);
(d)whether they can be dealt with separately or must be dealt with together;
(e)normal commercial understandings and practices in relation to them (including whether they are regarded commercially as separate things or as a group or series that forms a whole);
(f)the objects of this Division.
In applying this subsection, have regard to the matters referred to in paragraphs (a) to (f) both in relation to the rights and/or obligations separately and in relation to the rights and/or obligations in combination with each other.
The Explanatory Memorandum to the Taxation Laws Amendment (Taxation of Financial Arrangements) Bill 2008 (Cth) stated:
2.47The various rights and obligation subsisting under a contract will typically constitute the relevant arrangement for the purposes of Division 230. That is, the contract is typically viewed on a ‘stand alone’ basis. In this context, the contract is neither aggregated with another contract (or contracts), nor disaggregated into component parts, when determining the relevant arrangement to be considered under Division 230.
Division 230 is subject to various exceptions, which are set out in Subdiv 230-H. If an exception applies to the relevant right or obligation that gives rise to the gain or loss, then that right or obligation is not subject to the operation of the Division. The exception presently in issue is contained in s 230-460, which provided, as at 31 March 2015 (which is the relevant time for the purposes of this part of the proceeding):
(1) This Division does not apply to your gains and losses from a *financial arrangement for any income year to the extent that your rights and/or obligations under the arrangement are the subject of an exception under any of the following subsections.
…
Proceeds from certain business sales
(13)A right to receive, or an obligation to provide, *financial benefits arising from the sale of:
(a) a business; or
(b) shares in a company that operates a business; or
(c) interest in a trust that operates a business;
is the subject of an exception if the amounts, or the values, of those benefits are contingent only on the economic performance of the business after the sale.
Neither the term “economic performance”, nor the phrase “contingent only on the economic performance of the business”, is defined in the Act.
However, the applicants relied upon s 974-85(1), which is found in Div 974 of the ITAA 1997. Division 974 is entitled “Debt and equity interests” and sets out whether an interest is a debt interest or an equity interest for tax purposes. Subdivision 974-C is entitled “Equity interests in companies”. Within Subdiv 974-C, s 974-85(1) provided, as at 31 March 2015:
(1) A right, or the amount of a return, is not contingent on the economic performance of an entity, or a part of the entity’s activities, merely because the right or return is contingent on:
(a) the ability or willingness of an entity to meet the obligation to satisfy the right to the return; or
(b)the receipts or turnover of the entity or the turnover generated by those activities.
The section currently defines the phrase “contingent on aspects of the economic performance”.
Section 974-85 was introduced by the New Business Tax System (Debt and Equity) Act 2001 (Cth). The Explanatory Memorandum for that Act contained the following:
Disregarded kinds of economic performance – de minimis contingencies and turnover based payments
2.32There can be circumstances where a right to a return or an amount of return is based on the turnover of the entity obliged to make the relevant payments. An example is a lease contract where part of the rentals are based on the lessee’s turnover. Generally speaking, turnover based returns will be excluded from being regarded as contingent on economic performance in the relevant sense. [Schedule 1, item 34, paragraph 974 85(1)(b)]
2.33However, there may be types of contracts where turnover is a close proxy for an economic performance indicator other than turnover (e.g. profitability) of the payer. Regulations may be made to treat such contracts as equity interests. Regulations may also be made to clarify when a particular return is or is not contingent on economic performance. [Schedule 1, item 34, subsection 974 85(2)]
2.34Where a right to a return or an amount of return on an interest is contingent on profitability or some other economic performance indicator (other than turnover) to a minor extent, regulations may be made to exclude such types of interests from being equity interests. [Schedule 1, item 34, subsection 974 85(2)]
Consideration
Are each of the Expired Future Payment Rights a “financial arrangement”?
The applicants submitted that each of the Expired Future Payment Rights was a “financial arrangement” within the meaning of s 230-45 of the ITAA 1997 because:
(a)each was a cash settlable legal right to receive a “financial benefit”; and
(b)the MFT did not have, under the arrangement, a right to receive or an obligation to provide, anything that was not a “financial benefit”.
The Commissioner contended that the SSA was a single arrangement, including after the shares were transferred, with the result that there was no “financial arrangement” under s 230-45 because the arrangement included non-cash settlable rights which were “not insignificant”: ROS[529]. In this regard, the Commissioner relied upon (ROS[531]):
(a)the rights to information contained in cl 8 and 9;
(b)the duties imposed on Kuraray by cl 8 and 9 in regard to the management of the Plantic Business in the period between Completion and the point at which the Milestones were due to be completed and the Earn-Out Period; and
(c)the obligation imposed upon the MFT not to engage in a competitive business or solicit clients contained in cl 5.
The Commissioner submitted that these obligations were plainly significant because they “formed part of the value being exchanged between the parties, and were intrinsic to the value of the cash settlable rights that comprised the Milestone Amounts and Earn-Out Amounts” and that “[w]ithout them, the value of those rights would have changed significantly for both parties”: ROS[532].
For the reasons set out below, the exception in s 230-460(13) applies such that it unnecessary to reach a conclusion about whether the Expired Future Payment Rights constitute one or more financial arrangements. Nevertheless, I will address the issue briefly.
Had it been necessary to decide, I would have been inclined to conclude that the rights relied upon by the Commissioner set out at [625] above were “insignificant in comparison with the right[s]” otherwise attracting the operation of the provision, namely the rights to receive the future payments. The contractual provisions were important because of the protections they afforded, and in that sense significant, but they were in the nature of typical contractual protections associated with post-completion financial benefits. The statutory question raised by s 230-145(1)(f) is not whether a right is “insignificant” when looked at on its own. The question is whether it is “insignificant in comparison with the right” otherwise attracting the operation of the provision.
The Commissioner submitted that the expired rights could, in any event, not individually constitute a financial arrangement: ROS[493].
It is to be accepted that the Milestone Amounts and the Earn-Out Amounts were interlinked. Earn-Out Amounts were payable at differing rates depending on what amount had been received in respect of the Milestone Amounts. Specifically:
(a)up until the time when the MFT had received the maximum US$25 million Milestone Amounts, an Earn-Out Amount would be payable at 2.5% of gross sales exceeding US$20 million in a given year. The percentage would increase to 4.5% to the extent that the Gross Sales exceeded specified targets (being a number varying from $55 million in the 2018 calendar year up to $290 million in the 2024 calendar year); and
(b)once the MFT had received amounts equal to the maximum US$25 million Milestone Amounts (either by way of Milestone Amounts or by way of Earn-Out Amounts), then the MFT would only be entitled to an earn out payment if the Gross Sales in a given year exceeded specified targets, in which case, the Earn-Out Amount would be 6.5% of the amount by which the Gross Sales for the year exceeded that year’s specified target.
Further, the Milestone Amounts were affected by the Extrusion Coating Milestone or whether “Formal Corporate Approval” was obtained.
However, whether aggregation is appropriate is “question of fact and degree”: s 230-155(4). Had it been necessary to decide, I would have been inclined to the view that the Expired Future Payment Rights were appropriately treated as individual financial benefits when assessing the matter in a commercial, practical way in light of the apparent object of the TOFA Provisions.
Does the exception in former s 230-460(13) apply?
The applicants accepted that each of the Expired Future Payment Rights was a right to receive financial benefits “arising from the sale of … shares in a company that operates a business”, within the meaning of s 230-460(13): AOS[337]. However, the applicants submitted that it should not be concluded that the “the amounts, or the values” of those benefits “are contingent only on the economic performance of the business after the sale”. The applicants submitted that the contingencies that affected the expired future payment rights were (AOS[338]):
(a)whether “Formal Corporate Approval” was obtained for the Extrusion Coating Line – failing which, the Extrusion Coating Milestone would be unavailable and cl 8.17(a) would operate to make the higher sales milestone amount applicable; and
(b)whether “Sales Volume” in each category and period met the targets specified in sch 9 of the SSA. Sales Volume referred to the aggregate volume in metric tonnes of products sold by Plantic (less the aggregate volume of any products returned).
According to the applicants (AOS[339]):
(a)these contingencies do not make the Future Payment Rights “contingent only on the economic performance of the business after sale”;
(b)s 974-85(1) makes clear that a right does not meet that description “merely because the right ... is contingent on … the receipts or turnover of the entity or the turnover generated by those activities”; and
(c)“economic performance” must be understood as directed at profitability, which is independent of turnover.
The applicants submitted that this understanding of the expression “economic performance” is confirmed by the explanatory memorandum, referred to earlier, which gives the example of turnover rents not being contingent on economic performance in the relevant sense. Similarly, according to the applicants, contingencies fixed by whether corporate approval is given for a project or by reference to volume of sales (regardless of profitability) do not fall within the section: AOS[339].
At the relevant time, s 974-85(1) in Div 974 defined the phrase “contingent on the economic performance”. The definition in s 974-85(1) is not a definition provided for the purposes of the whole Act (compare s 975-60, set out at [614] above). The phrase “contingent only on the economic performance” in s 230-460(13) is not defined by s 974-85(1) and that section provides no real assistance in construing the different phrase in s 230-460(13). The Divisions address quite different issues. Division 974 addresses debt and equity interests. Subsections 974-85(2) to (4) contemplated that regulations might specify the circumstances in which a right or return is to be taken to be contingent, or that s 974-85(1)(b) might not apply in circumstances specified in the regulation. Section 230-460(13) addresses financial benefits arising from the sale of a business under an earn out arrangement.
The Explanatory Memorandum to the Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008, which, when enacted, inserted (former) s 230-460(13), relevantly provides:
2.184 A right to receive, or an obligation to provide, financial benefits arising from the direct or indirect sale of business, including those rights or obligations arising from the sale of shares in a company (or interests in a trust) that operates the business, may be the subject of an exception. These rights and obligations will only be the subject of this exception where the amounts or the values of the financial benefits to be received or provided are contingent on the economic performance of the business after the sale. [Schedule 1, item 1, subsection 230-460(13)]
2.185 This exception applies to exclude arrangements commonly known as ‘earn-outs’.
The words “contingent only on the economic performance of the business after the sale” mean what they say. The phrase “economic performance” is not the same as, or equivalent to, the word “profitability”. Profitability is one way to measure the success or otherwise of a business’s “economic performance”, but “economic performance” refers to a business’s performance, not its profitability.
If the legislature had wanted to limit the exception to profitability, it could have done so by using the phrase “contingent only on the profit of the business after sale”.
It is clear enough that the exception was intended to address, amongst other things, earn-out arrangements. These are commonly structured by reference to performance of the business other than by way of profit. Earn-out arrangements might be structured, for example, by reference to numbers of clients retained or gained or volume of sales. These are both appropriately described as matters of “economic performance”. They are indicators of performance or profitability and are commonly used because they do not turn on choices that the incoming purchaser might make about business operations or the cost of sales being matters which affect profitability.
The Milestone Amounts were contingent only on sales volumes. They were contingent only on the economic performance of the business after the sale. Each of the rights said to have expired was a right contingent only on the economic performance of the Plantic business after the sale, and so is within the exception set out in s 230-460(13). It does not matter that the contingency (volume of sales) does not also factor in the cost of sales such that the contingency is not one which calculates profit.
It is true that the amount to be paid in respect of the Australasian sales milestones and the milestones for J&G Foods and Valley Fine Foods was affected by whether or not the Extrusion Coating Milestone was met (which it was not), but that does not mean that the rights which expired were relevantly contingent on anything other than the economic performance of the Plantic business after the sale. The Extrusion Coating Milestone was not a contingency which affected whether or not the sales milestones were payable. And, in any event, it was appropriately classified as a contingency about economic performance.
Conclusions in relation to the TOFA Provisions
On the assumption that the Future Payments Rights were “financial arrangements” to which the TOFA Provisions would otherwise have applied, the rights were subject to the exception in (former) s 230-460(13) of the ITAA 1997.
It follows that the TOFA Proceeding should be dismissed.
7 CONCLUSION
The parties should confer with a view to agreeing orders to give effect to these reasons within 14 days.
I certify that the preceding six hundred and forty five (645) numbered paragraphs are a true copy of the Reasons for Judgment of the Honourable Justice Thawley. Associate:
Dated: 14 May 2024
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