Orica Ltd v Commissioner of Taxation
[2010] FCA 197
FEDERAL COURT OF AUSTRALIA
Orica Ltd v Commissioner of Taxation [2010] FCA 197
Citation: Orica Ltd v Commissioner of Taxation [2010] FCA 197 Parties: ORICA LIMITED (ACN 004 145 868) v COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA File number: VID 232 of 2005 Judge: SUNDBERG J Date of judgment: 10 March 2010 Catchwords: INCOME TAX – capital gains – whether assessment excessive – parent company assessed – whether subsidiary should have been assessed instead – asset disposed of – rights under distribution agreement – whether parent or subsidiary owned asset on disposal – identification of disposal giving rise to capital gain – right to payment of amount to be ascertained by valuation process – whether debitum in praesenti solvendum in futuro – release of prospective but not accrued liabilities – whether novation – market value of asset on disposal – valuation evidence – penalties – whether taxpayer’s position reasonably arguable when return lodged. Legislation: Corporations Act 1974 (Cth) Part 2M.3
Income Tax Assessment Act 1936 (Cth) ss 160Z(1)(a), 160ZD, 160ZH, 160ZO, 160M, 226K, 222C(a)
Taxation Administration Act 1953 (Cth) s 14ZZOCases cited: Byrne v Australian Airlines Ltd (1995) 185 CLR 410 considered
Federal Commissioner of Taxation v ANZ Savings Bank Ltd (1994) 181 CLR 467 cited
Federal Commissioner of Taxation v Dalco (1990) 168 CLR 614 cited
Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd [1994] 1 AC 85 cited
O’Keefe v Williams (1910) 11 CLR 171 cited
Olsson v Dyson (1969) 120 CLR 365 cited
Re Ahearn; Ex parte Palmer (1906) 6 SR (NSW) 576 cited
Walker v Corboy (1990) 19 NSWLR 382 applied
Walsh Bay Developments Pty Ltd v Federal Commissioner of Taxation (1995) 130 ALR 415 cited
Walstern Pty Ltd v Commissioner of Taxation (2003) 138 FCR 1 followed
Webb v Stenton (1883) 11 QBD 518 cited
Weldwood‑Westply Ltd v Cundy (1965) 50 DLR (2d) 744 cited
Date of hearing: 5-6 October 2009 Date of last submissions: 6 October 2009 Place: Melbourne Division: GENERAL DIVISION Category: Catchwords Number of paragraphs: 230 Solicitor for the Applicant: Mallesons Stephen Jaques Counsel for the Applicant: AJ Myers QC, SKP Steward SC, L Hespe Solicitor for the Respondent: Australian Government Solicitor Counsel for the Respondent: DH Bloom QC, MF Wheelahan SC, KJ Deards
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
GENERAL DIVISION
VID 232 of 2005
BETWEEN: ORICA LIMITED (ACN 004 145 868)
ApplicantAND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
Respondent
JUDGE:
SUNDBERG J
DATE OF ORDER:
10 MARCH 2010
WHERE MADE:
MELBOURNE
THE COURT DECLARES THAT:
The net capital gain amount of $264,540,764 included in the applicant’s amended notice of assessment issued on 11 October 2004, in respect of the year ending 30 September 1998, is excessive.
THE COURT ORDERS THAT:
1.The appeal be allowed.
2.The amended assessment issued by the respondent on 11 October 2004 be set aside.
3.The matter be remitted to the respondent for determination in accordance with these reasons.
4.The parties make written submissions as to costs, not to exceed 5 pages, in accordance with the following timetable:
(a)the applicant on or before 26 March 2010; and
(b)the respondent on or before 9 April 2010.
Note:Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
The text of entered orders can be located using Federal Law Search on the Court’s website.
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
GENERAL DIVISION
VID 232 of 2005
BETWEEN: ORICA LIMITED (ACN 004 145 868)
ApplicantAND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
Respondent
JUDGE:
SUNDBERG J
DATE:
10 MARCH 2010
PLACE:
MELBOURNE
REASONS FOR JUDGMENT
THE PROCEEDING
The applicant (Orica) appeals against the decision of the respondent (the Commissioner) disallowing its objection to an amended notice of assessment in respect of the year ending 30 September 1998. By that notice, issued on 11 October 2004, a net capital gain of $264,540,764 was included in Orica’s assessable income. The issue for determination is whether the assessment is excessive.
THE FACTS
The facts relevant in this proceeding date back to 1935 and encompass several agreements between different parties. Not surprisingly, over this long period of time, some of the companies have changed their names. These name changes make a complicated story even more so. For ease of reference, I propose to refer to the parties by the names by which they were known in 1998.
Before reviewing the facts in chronological order, it is helpful to provide a succinct background to the events that gave rise to the assessment.
From 1935 to 1998 Orica, either itself or by its subsidiary Orica Australia Pty Ltd (Orica Australia), carried on a pharmaceuticals business (the Business). The Business involved formulating, warehousing, manufacturing and distributing in Australia pharmaceutical products, most of which were acquired from (or at least derived from active ingredients acquired from) Imperial Chemical Industries Limited (ICI), a company incorporated and listed in the United Kingdom.
During this period, the distribution arrangement between ICI and Orica was governed by two agreements: a deed entered into in 1935 and an agreement entered into in 1993. The need for the 1993 agreement arose after ICI sold its pharmaceuticals business to a demerged entity, Zeneca Ltd (Zeneca).
Until 1997 ICI was the majority shareholder in Orica. Then, in September 1998, the Business was sold to Zeneca BV, a subsidiary of ICI. The agreements effecting the sale and various related agreements gave rise to the assessment.
The 1935 Deed
The starting point is the deed entered into between ICI and Orica (Imperial Chemical Industries of Australia and New Zealand Ltd as it was then known) on 17 January 1935 (the 1935 Deed). Clause 4 provided that in consideration of the issue of certain deferred shares in Orica:
[ICI] for itself, and for all its constituent companies, hereby covenants with [Orica] that it will give to [Orica], free of any payments therefor in so far as it has the rights to dispose of the same for Australasia, full information with regard to and the right to use in Australasia all present and future patents and inventions secret ‑ and other manufacturing processes technical and other information calculated to be of interest or service to [Orica] and/or to its Constituent and Controlled Companies…
The expression ‘Constituent Company’ was defined as a company in which ICI or Orica holds or controls 100% of the issued share capital and ‘Controlled Company’ as a company in which either of them holds or controls more than 50% but less than 100% of the issued share capital or voting rights.
Clause 5 provided:
ICI hereby covenants with [Orica] that it will if required by [Orica] so to do appoint or procure the appointment of [Orica] or one or more of its Constituent or Controlled Companies as sole agent or agents for the sale in Australasia of its (ICI) products and the products of its Constituent Companies … upon such terms as may be agreed upon subject to the rights of now and then existing agents for the sale of any such products.
In clause 6 ICI covenanted that it would not, without Orica’s consent, compete with Orica by engaging in the sale or manufacture of any pharmaceutical products to which the 1935 Deed related.
The 1935 Deed did not prescribe a duration for the agency relationship which it established. Thus the arrangement was to be perpetual.
The 1979 reorganisation
In 1979, as a result of a company restructure that saw Orica become the holding company of a series of operating subsidiaries, Orica transferred the Business to Orica Australia (ICI Australia Operations Pty Ltd as it was then known). In support of this reorganisation, Orica relied on a note for a board meeting of Orica on 10 September 1979 which summarised the anticipated state of affairs once the restructuring was completed in October 1979. The note stated that Orica Australia would become a wholly‑owned subsidiary of Orica and that Orica Australia would conduct in its name, all the manufacturing and selling operations of the wholly-owned businesses.
The note is not itself a board minute. It is an annex to the board minute of 10 September. The board minute was not in evidence, but it is to be inferred that the board did in fact make a resolution to the above effect. The transfer of the Business is recorded in the financial statements of both Orica and Orica Australia for the years ended 30 September 1979 and 30 September 1980. In addition, Orica Australia’s Directors Report for the year ended 30 September 1980 stated at par (n)(i) that:
The company purchased the operating assets and assumed certain liabilities and provisions of [Orica] and has taken over the marketing and manufacturing operations previously conducted by [Orica].
Although there was a transfer of the Business, Orica did not expressly assign its rights under the 1935 Deed to Orica Australia. However, this was not a prerequisite to Orica Australia operating the Business, because the 1935 Deed appointed Orica, or one of its subsidiaries, to act as ICI’s agent in Australia.
From 1979 Orica Australia carried on the Business in its own right and purchased pharmaceutical products from ICI under the terms of the 1935 Deed. Until sometime around 1992, the relationship between Orica Australia and ICI was conducted pursuant to ‘operating guidelines’ agreed between the parties from time to time.
There was in evidence a document titled ‘Operating Guidelines in Respect of Pharmaceuticals for Human Use’. The parties to this non-legally binding document were Orica Australia and ICI (or more specifically, ICI’s Pharmaceuticals Division). Clause 1 is headed ‘General Relationship’ and provided:
[Orica Australia’s] primary role is to act as the Australian agency for all [ICI] products for human use (‘the Products’) currently as listed in the attached Appendix. These guidelines cover some of the main principles governing the relationship … [Orica Australia] will seek and follow [ICI] manufacturing, technical, development, medical and marketing advice in respect of the Products.
Under the heading ‘Marketing’, clause 2 stated that “[Orica Australia] is regarded by [ICI] as its vehicle for sale of the Products in Australia”. The guidelines also provided for, amongst other things, notifying Orica Australia of new products and regular meetings between Orica Australia and ICI.
Distribution Agreement
On 30 July 1992 ICI announced that it would demerge its pharmaceuticals business into a separate company which later became known as Zeneca. Following this announcement, ICI, Orica and Zeneca entered into discussions to determine the effect of the proposed demerger on the Business, or more specifically, on Orica’s rights under the 1935 Deed. ICI’s preliminary view was that the rights granted under the 1935 Deed would not legally bind Zeneca.
Orica placed significant value on the exclusive rights in perpetuity that were granted in the 1935 Deed. In internal correspondence Orica noted that a:
substantial part of the value of [the Business] relates to the exclusive rights in perpetuity to ICI products and processes which [Orica] enjoys in Australasia.
Accordingly, Orica did not want to lose its rights under the 1935 Deed. In order to assess the strength of its bargaining position with ICI and Zeneca, Orica obtained advice from Mr J D Merralls QC. Mr Merralls was of the view that:
On balance, the weight of authority and the facts are inclined to favour ICI. On the other hand, [Orica] has a strong moral basis, and a legal basis which is not unsustainable.
A document summarising the discussions between Orica and ICI was provided to the Orica board on 20 October 1992. Relevantly, it stated:
[ICI] believe strongly that their legal advice is ‘rock solid’ and that under the demerger being proposed they are under no legal requirement to translate the provisions of the existing [1935 Deed] into the [new company] … they do acknowledge, however, the ‘equity’ of the situation, and propose a set of agreements be negotiated which reflect much of the provisions of the [covenants in the 1935 Deed].
On 1 June 1993, after several months of negotiating and drafting, Zeneca and Orica entered into a distribution agreement (the Distribution Agreement), which is central to the issues to be determined in this matter.
Article 2 provided that, subject to default provisions, the agreement would continue for a minimum term of 8 years:
[The relevant Articles] shall become effective on the Effective Date and, subject to prior termination of this Agreement under any of its provisions, shall continue until terminated at the expiration of not less than twenty four (24) months written notice given by either party to the other, such notice not to be given before the sixth anniversary of the Effective Date. For the avoidance of doubt it is hereby provided that this Agreement shall continue in full force and effect throughout the period of notice stated above.
It is not necessary to set out the definition of ‘Effective Date’. It is sufficient to say that that date passed, and the agreement came into effect. Article 3 was headed ‘Appointment’:
Zeneca hereby appoints [Orica] to be its exclusive processor and distributor during the term of this Agreement for the sale of the Products in [Australia] and [Orica] agrees to act in that capacity, subject to the terms and conditions of this Agreement. Zeneca and [Orica] agree at all times to perform their obligations and exercise their rights under this Agreement in good faith.
Article 13 dealt with Termination. Article 13.1 provided for termination upon breach and 13.2 provided for termination by agreement. Relevant for present purposes, Article 13.3 provided a right to terminate upon a change of control of the Business:
Either party hereto will have the right at any time by giving sixty (60) days notice in writing to the other party to terminate this Agreement if the other party is taken over, nationalised or closed down in whole or in part by the executive or judicial authorities in England or Australia, as the case may be, or there is a substantial change in ownership or control of its pharmaceuticals business.
[emphasis added]Article 14 was a comprehensive provision headed ‘Consequences of Termination’. The first part of Article 14.1 provided that if the agreement was terminated under Article 13 then:
Zeneca agrees to make a payment to [Orica] equal to the value of the pharmaceuticals business of [Orica] or of its Affiliate to which rights or obligations have been assigned pursuant to Article 21 … as at the termination date.
Article 21, headed ‘Non‑Assignability/Performance through Affiliates’, provided that neither party could assign its benefits or obligations under the Agreement without the prior written consent of the other party, however:
either party may assign this Agreement in its entirety without the prior written consent of the other to a wholly owned affiliated company on the condition that such party remains liable to the other for any breach of the terms of this Agreement by such affiliated company.
There was no such express assignment.
The remainder of Article 14.1 set out a procedure for determining the value of the Business. Each party was to appoint a valuer. If the valuers were unable to agree upon a value and their valuations differed by more than 15% of the lower valuation, they were to appoint a third valuer to make a valuation within the range of the valuations of the first two valuers. If the valuations of the first two valuers differed by 15% or less of the lower valuation, the median point between the two valuations was to be taken as the value of the Business.
Article 14.1 also provided the valuers with certain instructions on how to value the Business. In particular, Article 14.1.1(c)(i) stated that the Business shall be deemed a ‘going concern’ at the date of valuation.
Article 14.1.1(e) provided that:
payment of amounts specified in this Article 14.1 shall be paid by Zeneca on the termination date to a bank account nominated by [Orica].
Article 14.2 provided that “in consideration of the payment made by Zeneca to [Orica] in accordance with Article 14.1”, Orica would transfer to Zeneca all intellectual property, commercial information and any other information which Zeneca may require to carry on the business, along with all permits required by Zeneca and all production assets used in the business. In addition, Orica was to provide certain indemnities relating to any contamination of the site, and use reasonable endeavours to transfer to Zeneca any rights granted to it to process and sell pharmaceutical products of third parties.
Article 14.3 provided, amongst other things, that Zeneca would purchase all stocks of finished products imported by Orica from Zeneca, and at Zeneca’s option Orica would transfer to Zeneca some or all of the employees directly involved in the Business.
Sale of ICI’s majority share in Orica and Letter Agreement
In May 1997 ICI announced it would sell its majority shareholding in Orica. On 19 June 1997 Zeneca and Orica as parties to the Distribution Agreement entered into an agreement (the Letter Agreement) which stated, in effect, that a substantial change in ownership or control of the Business would occur if ICI ceased to hold more than 50% of Orica’s shares. In that event Article 13 of the Distribution Agreement would be triggered and Article 14 enlivened.
The second paragraph of the Letter Agreement provided:
In the event that Zeneca gives notice to terminate the Agreement pursuant to Article 13.3 upon such substantial change of ownership or control, Zeneca and [Orica] shall comply in good faith with all relevant provisions of the Agreement with a view to achieving the timely and efficient transfer of the Business to Zeneca as provided in the Agreement.
In the next paragraph the parties agreed:
that it may be in their mutual interest to negotiate the sale and purchase of the Business from [Orica] to Zeneca without recourse to the time and cost of implementation of the valuation and other provisions as set out in Article 14.1 of the Agreement. Immediately following [the change of control in Orica] [Orica] and Zeneca shall enter into discussions in good faith with regard to the sale and purchase of the Business.
The remainder of this paragraph in the Letter Agreement sets out each party’s obligations with respect to these good faith negotiations, namely, the provision of all relevant information, duties of confidentiality and the acknowledgement that such discussions would occur without prejudice to Zeneca’s rights to give a notice of termination under Article 13.3 of the Distribution Agreement.
Notice of termination of Distribution Agreement
On 8 December 1997, after months of negotiating an alternative to the procedure set out in Article 14 without success, Zeneca gave Orica a notice of termination in accordance with Article 13.3 of the Distribution Agreement that stated:
Accordingly, pursuant to, and in accordance with, Article 13.3 of the Agreement and [the side letter sent on 19 June 1997] Zeneca hereby gives [Orica] notice that the Agreement shall terminate (subject to the provisions of Article 14.1.1(b) of the Agreement) on 6 February 1998.
The notice also stated that:
the Agreement shall remain in full force and effect during the period of notice referred to above and any extension thereof as the case may be.
Following this notice, each party appointed a valuer pursuant to Article 14. Orica appointed Price Waterhouse Corporate Finance Pty Ltd (PwC) and Zeneca appointed Arthur Anderson Corporate Finance (Arthur Anderson). In February 1998 the valuers produced their valuation reports. The difference between the valuations was substantial. The principal reason for this was attributable to the different meanings the valuers gave to the phrase “going concern” in Article 14.1.1(c). Given the significant difference in the valuations (more than 15% variation), Article 14.1 required a third valuer to be appointed. On 6 February 1998 Ernst & Young Corporate Finance Pty Ltd (E&Y) was appointed.
In early 1998 the parties began drafting an agreement for the sale of the Business to Zeneca. The drafts of this agreement were headed ‘Umbrella Agreement’. One such draft, accompanying a letter from Orica Australia to Zeneca dated 13 February 1998, defined the vendors of the Business as Orica Australia and Orica New Zealand Ltd (Orica NZ) which operated a business in New Zealand that was similar to Orica Australia’s in Australia. The recitals stated that the vendors owned the assets of the Business.
Clause 3.1 of the draft provided that Zeneca would pay Orica Australia the amount to be determined by the third valuer in accordance with Article 14 of the Distribution Agreement and that payment would discharge the obligations of Zeneca pursuant to Article 14.1.1(e). Article 14.1.1(e) is set out at [27].
Clause 3.2 required Orica Australia to distribute the payment between itself and Orica NZ.
Another draft of the Umbrella Agreement, dated 13 August 1998, also had Orica Australia and Orica NZ as vendors. However, there were changes from the earlier draft. First, clause 3 now provided that payment be made to Orica, which was to distribute the amount between the vendors. The second change was the deletion of the words in clause 3.1 that payment would discharge Zeneca’s obligations under Article 14.1.1(e) of the Distribution Agreement.
The proceedings in London
On 24 February 1998, on application by Zeneca, Mr Justice Blackburne in the High Court of Justice in London granted an interlocutory injunction restraining the carrying out of the third valuation by E&Y. The ‘Intended Defendant’ named in the notice of motion and order was Orica Australia.
Two days later, on 27 February, his Lordship made further orders in relation to the trial of the action, in which Zeneca also sought declarations concerning the construction of Article 14 of the Distribution Agreement. The orders recited the parties’ agreement that the Distribution Agreement would continue in force:
beyond 8 March 1998 until completion of the third valuer’s valuation and that such valuation (interrupted by the order of [24] February 1998) should be completed within 30 days of the court determining that such an order ought never to have been made or after the trial or compromise of the action, whichever is the earlier.
8 March 1998 was the date by which, under Article 14.1.1(b), the third valuer was required to complete its valuation.
The defendant named in this order was Orica, not Orica Australia.
On 22 July 1998 Mr Justice Park handed down his reasons for decision in respect of the factors to be included in the valuation procedure. The judgment fell largely in favour of Orica as it was held, amongst other things, that the value of future third party opportunities should be included in the valuation.
Whilst it is not necessary to consider Mr Justice Park’s reasons in detail, it is helpful to record some of his Lordship’s findings. With respect to the Distribution Agreement he said on page 5:
its contents fell into two principal categories: the distributorship provisions and the termination provisions … the issues which the case is about all arise from the termination provisions.
On page 11 his Lordship explained how the dispute before him arose:
the big difference between the [two valuations] did not result from the two firms valuing the same items at different figures … the major explanation of the difference is that Price Waterhouse had taken into account and had included in the valuation several items which Arthur Anderson had omitted and which Zeneca contends were, on the correct construction of the agreement, not proper to be taken into account.
On page 14, in dealing with Article 14, his Lordship said:
I pause at this point to make a comment. Article 14 is far more than a conventional provision for the termination of a distributorship. Normally where there are a distributor and a supplier and the agreement between them is terminated, the distributor stays in business and looks for new suppliers; and the supplier might find a new distributor or decide to set up its own distribution arrangements. In this case article 14 goes beyond that; Zeneca is not just terminating [Orica’s] rights to distribute Zeneca drugs; it is acquiring [Orica’s] pharmaceutical business, including Villawood and other assets employed in the business.
In regard to the distribution rights, he said on page 17:
Distributing Zeneca drugs was by far the most important and profitable thing that [Orica] did in its pharmaceutical business in 1993 (when the agreement was negotiated and concluded). It was still the most important and profitable thing in December 1997, when notice of termination was given.
Preservation Agreement
On 1 September 1998 Zeneca sent Orica a fax containing a proposal for the structure of the sale of the Business. In essence, the proposal was for:
·Zeneca and Orica to rescind the termination of the Distribution Agreement which, as appears at [34], had been triggered by Zeneca’s notice of termination on 8 December 1997;
·Orica to sell the Business to nominated Zeneca affiliates. Specifically, the goodwill to be sold to Zeneca BV and the physical assets to other affiliates. Alternatively, Zeneca BV to purchase whole business and then on-sell the physical assets to the other affiliates;
·Orica to novate the Distribution Agreement to Zeneca BV ‘as part of the sale and purchase agreement’;
·proceeds for the business acquisition to be allocated to physical assets at net book value and the balance to goodwill. Such allocations to be explicit in the sale and purchase contract; and
·no proceeds to be allocated to the novation of the Distribution Agreement to Zeneca BV.
Two days later, on 3 September 1998, Zeneca sent Orica a letter outlining what it called its ‘final offer’:
Zeneca has decided to put its position regarding the issue of the pharmaceuticals distributorship to [Zeneca] or Zeneca b.v in writing.
Our proposal was based on a view, backed by independent advice, that a cash sale and purchase by Zeneca b.v would be beneficial to Orica as well as Zeneca. You have intimated that this change is “neutral” to you and that you were willing to contemplate the change on commercial terms, to be agreed.
We have considered our position on this matter. While there are some potential benefits to Zeneca in going the b.v rather than the Ltd. route, neither option is guaranteed to optimise our position and both have downsides.
Given the above and the relatively short time frame available to us prior to completion, Zeneca is willing to make one last attempt to settle this matter before reverting to the original contractual arrangement of a transaction between [Orica] and [Zeneca].
In consideration of the changes we proposed, we are prepared to offer $1.5m in full and final payment towards all legal costs incurred by Orica. We would be willing to pay this money as part of the lump sum payment to you on completion of the sale as we believe that this would add further value for Orica.
This offer is our final offer. If we are unable to agree to this between us by noon today, Zeneca will instruct its lawyers to revert to our original position on the umbrella agreement.
Orica accepted this offer on the same day.
On 3 September Orica and Zeneca also entered into what Orica called a preservation agreement (the Preservation Agreement). It was in part as follows:
[Orica] and [Zeneca] agree that, despite a notice of termination having been given by [Zeneca] on 8 December 1997 the Distribution Agreement continues in full force and effect but if completion of the sale of the pharmaceuticals business of [Orica Australia] and [Orica NZ] to [Zeneca] or one or more related bodies corporate of [Zeneca] (the Purchaser) including the assignment to the Purchaser of the benefit of the Distribution Agreement has not occurred by 5:00 pm Melbourne time on 8 September 1998 (or such other date as is agreed in writing by [Orica] and [Zeneca] prior to 5:00 pm on 8 September 1998), the Distribution Agreement will terminate effective 5:00 pm on 8 September 1998 and termination of the Distribution Agreement shall not affect any accrued rights or remedies under it including the obligations under Article 14 of the Distribution Agreement.
On 4 September 1998 E&Y provided its valuation report, which valued the Business at $327m. This prompted the parties to execute two separate, but related, agreements: an assignment and a sale of business.
Assignment Deed
Also on 4 September 1998 Orica, Zeneca BV and Zeneca entered into an assignment deed (the Assignment Deed). Recitals A, B and C were as follows:
A.[Zeneca] and Orica are parties to a [Distribution Agreement] dated 1 June 1993, pursuant to which [Orica Australia] and [Orica NZ] continued to conduct a pharmaceuticals business in Australia and New Zealand.
B.Pursuant to a Sale of Business Agreement to be entered into on or about the date of this Agreement … [Orica Australia] and [Orica NZ] have agreed to sell that pharmaceuticals business to [Zeneca BV].
C.As part of the Sale of Business Agreement, Orica has agreed to assign the rights and obligations under the [Distribution Agreement] to [Zeneca BV] and [Zeneca BV] has agreed to assume Orica’s obligations under the [Distribution Agreement].
Clause 2 is headed ‘Assignment’. Clause 2.1, which is headed ‘Assumption of benefits and obligations’, provided:
[Zeneca BV] shall be bound by and comply with the provisions of the [Distribution Agreement] binding on [Orica] and shall enjoy all the rights and benefits of [Orica] under the [Distribution Agreement].
By clause 2.2 Zeneca released Orica from:
all its obligations and liabilities under the [Distribution Agreement] and all actions, claims or proceedings that it may have against Orica under or in respect of the [Distribution Agreement].
Sale of Business Agreement
On or around 4 September 1998 a Sale of Business Agreement (the Sale Agreement) was executed by the following parties: Orica Australia, Orica, Zeneca BV, Zeneca, Zeneca Pharmaceuticals Australia Pty Ltd, Orica NZ and Zeneca Pharmaceuticals New Zealand Ltd. The Sale Agreement was in a similar form to the draft Umbrella Agreements discussed at [36]‑[39] and gave effect to Zeneca’s letter of 3 September set out at [45].
The consideration for the sale was $328.5m, made up of E&Y’s valuation of the Business and the additional $1.5m for legal fees.
The recitals to the Sale Agreement were as follows:
A.For over 19 years [Orica Australia and Orica NZ] have conducted the Business in their respective countries.
B.[Orica Australia and Orica NZ] have agreed to sell the Business as a going concern to Zeneca bv on the terms and conditions of this Agreement.
C.Zeneca bv wishes certain of the assets and liabilities of the Business to be transferred by [Orica Australia and Orica NZ] directly to [Zeneca’s nominee companies in Australia and New Zealand].
Clause 2 stated that Orica Australia and Orica NZ, for their respective rights and interests, sell as legal and beneficial owners and Zeneca BV purchases the assets of the business, including goodwill. Goodwill was defined to include ‘the benefit of the Distribution Agreement’.
Clause 3 required the purchase price to be paid to Orica “for and on behalf of” Orica Australia and Orica NZ, and Orica was obliged to distribute the payment between Orica Australia and Orica NZ according to their entitlements. Clause 5.2 required Orica Australia and Orica NZ at completion to deliver to Zeneca BV a counterpart of an assignment of the Distribution Agreement duly executed by Orica.
LEGISLATION
The capital gain provisions of the former Part IIIA of the Income Tax Assessment Act 1936 (Cth) involve the identification of an asset, its disposal, the consideration in respect of the disposal and the cost base of the asset. If the consideration in respect of the disposal exceeds the indexed cost base in respect of the asset, a capital gain equal to the excess is deemed to have accrued to the taxpayer at the time of the disposal: s 160Z(1)(a).
It is common ground that Orica’s rights under the Distribution Agreement were assets for the purposes of Part IIIA: s 160A, and that, if not otherwise disposed of, there was a disposal of Orica’s rights under the Distribution Agreement by clause 2.1 of the Assignment Deed: s 160M. Section 160M(1) provided:
Subject to this Part, where a change has occurred in the ownership of an asset, the change shall be deemed, for the purposes of this Part, to have effected a disposal of the asset by the person who owned it immediately before the change and an acquisition of the asset by the person who owned it immediately after the change.
Subsection (2) listed a number of ways in which a change in the ownership of an asset may occur. Subsection (3) provided that without limiting the generality of subs (2), a change shall be taken to have occurred in the ownership of an asset by:
(b)in the case of an asset being a debt, a chose in action or any other right, or an interest or right in or over property – the cancellation, release, discharge, satisfaction, surrender, forfeiture, expiry or abandonment, at law or in equity, of the asset.
Section 160ZD(1) provided that the consideration in respect of the disposal of an asset is:
.1if the taxpayer has received or is entitled to receive an amount or amounts of money as a result of or in respect of the disposal – that amount or the sum of those amounts;
.2if the taxpayer has received or is entitled to receive property other than money as a result or in respect of the disposal – the market value of that property at the time of the disposal; or
.3if the taxpayer has received or is entitled to receive both an amount or amounts of money and property other than money as a result of or in respect of the disposal – the sum of that amount or those amounts and the market value of that property at the time of the disposal.
Subsection (2) provided that:
if a taxpayer has disposed of an asset and:
(a)there is no consideration in respect of the disposal;
(b)the whole or a part of the consideration received by the taxpayer in respect of the disposal cannot be valued; or
(c)the amount that would, but for this paragraph, be taken to be the consideration received by the taxpayer in respect of the disposal is greater or less than the market value of the asset at the time of the disposal and, in the case where the asset was disposed of to another person, the taxpayer and that other person were not dealing with each other at arm’s length in connection with the disposal;
the taxpayer shall be deemed to have received as consideration in respect of the disposal an amount equal to the market value of the asset at the time of the disposal.
Subsection (2A) provided:
For the purposes of the application of subsection (2) to the disposal of an asset otherwise than to another person, the market value of the asset at the time of the disposal is the amount that would have been the market value at that time if that disposal did not occur and was never proposed to occur.
ORICA’S CASE ‑ OVERVIEW
Orica’s case was in two parts. The first was that in 1979 it sold the Business, including the benefit of the Distribution Agreement, to Orica Australia. The ‘disposals’ relied on by the Commissioner (all by Orica) are of an asset (the Distribution Asset or the Article 14 right) that belonged to Orica Australia. Thus the Commissioner has assessed the wrong taxpayer. The second way Orica puts its case assumes that it fails to establish the first. It then contends that three of the various alternative disposals of either the Distribution Asset or the Article 14 right asserted by the Commissioner did not take place, and that the fourth disposal asserted by the Commissioner, with which Orica agrees, was for a nil consideration. I will deal first with the ‘wrong taxpayer’ contention. If that is successful, it will answer the Commissioner’s ‘disposal’ case however it is put.
The wrong taxpayer?
Orica’s contention that the Commissioner has assessed the wrong taxpayer was developed on the basis of the matters recorded in this and the ensuing nine paragraphs. In 1979 Orica transferred its pharmaceuticals business to Orica Australia. Though no formal documents evidencing this are available, the annex to the board minute recorded at [12]‑[13] describes the group restructuring as the sale of the operating assets and transfer of operating liabilities from Orica to Orica Australia. The position after the restructure was that Orica would be the holding company, “not manufacturing or trading in its name”. It would act as financier, borrowing and lending as appropriate. It would own existing land and buildings, most of which it would lease to Orica Australia. Orica Australia would be wholly owned by Orica. It would conduct in its name all the manufacturing and selling operations of the wholly owned businesses.
Orica’s Annual Report for 1979 records that from 1 October 1979 its marketing and most of its manufacturing operations had been transferred to its wholly owned subsidiary Orica Australia. Orica Australia’s financial statements for 1979 record the same event. The 1980 statements record that the company had purchased the operating assets and assumed certain liabilities and provisions of Orica and had taken over the marketing and manufacturing operations previously conducted by Orica.
From 1 October 1979 Orica Australia carried on the pharmaceuticals business, but there was no express assignment to it of any rights under the 1935 Deed.
The Operating Guidelines of 12 April 1984 referred to at [16] describe Orica Australia’s primary role as acting as the Australian agency for all ICI Pharmaceuticals Division products for human use listed in an appendix, which is not in evidence. Under the heading ‘Marketing’ it is said that Orica Australia is regarded by ICI Pharmaceuticals Division as its vehicle for sale of the listed products in Australia. Orica says these Guidelines recognise that the benefit of the Business belongs to Orica Australia, and that the benefit of the distribution rights under the 1935 Deed belong to Orica Australia and not Orica.
Orica says that in 1993 it entered into the Distribution Agreement with Zeneca in substitution for the 1935 Deed. It describes the termination provisions as requiring Zeneca to purchase what it rendered as “the business of Orica Australia” for a price determined by a valuation process.
After Zeneca’s notice of termination was served in December 1997, Zeneca and Orica implemented the valuation process. The completion of the process was halted as a result of the proceedings in the Chancery Division. At this time Zeneca and Orica negotiated as to whether Zeneca would buy the Business or proceed to termination of the Distribution Agreement. In the first of the two draft Umbrella Agreements in evidence (between Orica Australia, Orica NZ, Orica and Zeneca), Orica Australia and Orica NZ are described as the vendors. Recital A states that the vendors have conducted the Business in their respective countries since 1 October 1979. Recital B states that “In connection with the Business, the Vendors own the Assets”. Clause 2 defines “Assets”. Zeneca was to pay the purchase consideration to the vendors according to their respective entitlements.
Save for the addition of some Schedules, the second draft Umbrella Agreement is to the same effect as the first except that the purchase price was to be paid to Orica for and on behalf of the vendors.
Both draft Umbrella Agreements refer in various places to the Distribution Agreement as the Agreement dated 1 June 1993 between Orica and Zeneca.
The Preservation Agreement of 3 September 1998 identifies Orica Australia and Orica NZ as the vendors in the potential sale of business agreement.
By the Sale Agreement of 4 September 1998 Orica Australia and Orica NZ sell the Business to Zeneca BV. Orica is a party, but does not sell anything. The vendors sell “as legal and beneficial owners” various assets, including the “Goodwill”, which is defined so as to include the Distribution Agreement “between [Orica] and [Zeneca]”.
On the basis of the foregoing Orica submits that the Commissioner’s case, which it says is essentially that part of the consideration of $328,500,000 was for the benefit of the Distribution Agreement (some $268 million), is at odds with the agreement between the parties and with the underlying business facts which had existed for 20 years. Orica contends that the 1935 Deed, essentially a distribution agreement, and later the Distribution Agreement that replaced it, belonged to Orica Australia, which built up the Business and in 1979 paid to acquire it.
Orica submits that nothing turns on the fact that one company is the wholly owned subsidiary of the other. The matter should be determined as though the parties were at arms length.
Orica relies on the principle recognised by Griffith CJ in O’Keefe v Williams (1910) 11 CLR 171 at 191 that:
Every contract between subject and subject involves an obligation, implied if not expressed, that neither party shall do anything to destroy the efficiency of the bargain which he has made. The implied covenant or agreement for quiet enjoyment in the case of a demise of land is merely an instance of the application of this rule.
In reliance on this principle, Orica submits that Orica Australia having purchased the Business which depended for its existence on the distribution provisions of the 1935 Deed, the benefit of that Deed, either by reason of an implied contractual obligation “or some doctrine of promissory estoppel”, was thereafter held for Orica Australia’s benefit as the conductor of the Business. Thereafter, for almost 20 years, the vendor of the Business stood by and let the purchaser build up its value. This, Orica says, created an estoppel which would give rise to a trust. Then in 1993 when Orica negotiated with Zeneca about a replacement for the 1935 distribution arrangements, it was plainly doing so for the benefit of Orica Australia, to which it had sold the business and for which it held the existing distribution rights.
Although the 1979 documentation is meagre, I am satisfied that Orica sold the operating assets of its pharmaceuticals business to Orica Australia, which assumed some of Orica’s liabilities in relation to the business. I infer from the words “sale” and “purchase” that Orica Australia gave consideration for the acquisition. I am satisfied that from 1 October 1979 Orica Australia carried on the business, and at least after 1984 on the basis described in the Guidelines. The Guidelines also suggest that it did this in reliance on the distribution rights conferred by the 1935 Deed. Having regard to the Orica Group structure as it then existed, there was no need for the 1935 Deed to be assigned to Orica Australia, because Orica was entitled to undertake the distribution business by itself or by its constituent affiliates, of which Orica Australia was one. It was not in dispute that the business was dependent for its profitability, indeed its existence, on the availability of the distribution rights granted by ICI under the 1935 Deed.
Although I accept that Orica sold the operating assets of the business to Orica Australia and that the latter assumed some of the former’s operating liabilities, I am not prepared to infer that thereafter the benefit of the distribution rights belonged to Orica Australia. Orica accepts that there was no express assignment of those rights. If, as Orica asserts, the 1935 distribution rights were held by it on trust for Orica Australia, the trust must have come into existence at or about the time of the sale in 1979. In Walker v Corboy (1990) 19 NSWLR 382 at 386 Priestley JA, dealing with cases where the parties have not expressly stated their intention to create a trust, said:
It seems to me to be prudent not to approach the question whether equitable doctrines are applicable in a commercial situation with the thought in mind that one should be disinclined to give a positive answer to that question. The question simply is, do the particular circumstances attract equitable rules.
…
In situations where there is no express agreement [requiring the application of equitable rules for their working out], then ultimately whether a court will apply equitable rules will depend upon the court’s understanding of the expectation of the parties implicit in their dealings with one another in the commercial milieu in which the particular dispute has arisen. It is to these areas that the court’s factual and evaluative attention should be directed and upon which decision should be based.At 390 Clarke JA spoke of:
the caution which should be exercised when deciding whether an intention to impose trust obligations should be inferred from the complex set of circumstances which often attend the commercial relationship of parties who have traded together for a long period of time. If, however, the court, applying due caution, concludes that it is proper to infer, or impute, the requisite intention then it is the duty of the court to give expression to that conclusion.
At 395 Meagher JA said:
except in the case of constructive trusts where a trust is thrust on the parties irrespective of their intentions and as a matter of policy, an intention to create a trust is an essential element of a trust …
When, as here, the parties have no expressed intention, it then becomes necessary to see, in all the circumstances of the case, what intention the law should impute to them: see Trident General Insurance Co Ltd v McNiece Bros Pty Ltd (1988) 165 CLR 107 at 120-121 per Mason CJ and Wilson J (at 146‑147) per Deane J.
…
It is necessary to look at the nature of the transaction, the particular provisions of the agreement of the parties, and the whole of the circumstances attending the relationships between the parties. If one examines the whole of the relevant circumstances in the present case I am of the view that the law would not impute to the parties any intention to create a trust.In Walsh Bay Developments Pty Ltd v Federal Commissioner of Taxation (1995) 130 ALR 415 at 423 Beaumont and Sackville JJ, with whom Jenkinson J agreed, approved the passages from Walker v Corboy 19 NSWLR 382 quoted at [75] above.
Adopting the above approach and looking at all the circumstances of the present case, no intention on Orica’s part to create a trust is to be found. Nor is any such intention to be attributed to it. The fact that Orica Australia had access to the distribution rights under the 1935 Deed made it unnecessary for the parties to turn their minds to some other basis for access.
The position is the same if the matter is viewed as at mid‑1993 when the Distribution Agreement was being negotiated. Article 21, which is set out at [24], enabled Orica to assign the Agreement to a wholly owned affiliate without Zeneca’s consent. Thus the benefit of the distribution arrangements could be passed to Orica Australia. In those circumstances, Orica evinced no intention to create a trust in Orica Australia’s favour and no such intention should be attributed to it. The parties showed in clause 21 the way in which Orica Australia might derive the benefit of the distribution rights. It was not by way of a trust. Article 14 also points against any intention on Orica’s part that it hold the benefit of the Agreement on trust for Orica Australia. Article 14.1 required Zeneca to make a payment to Orica equal to the value of Orica’s business or the business of its affiliate assignee under Article 21.
The events that later happened show, to my mind, that the distribution rights remained with Orica. In 1993, after the negotiations about replacing the distribution rights under the 1935 Deed, Zeneca appointed Orica its distributor. If in 1979 Orica had been paid for the benefit of the 1935 Deed, it would not have made sense for Orica to have been appointed distributor in 1993. This confirms my view that the 1935 Deed was not part of the 1979 sale, and that Orica kept the distribution rights to itself until they were replaced by the 1993 Distribution Agreement.
In my view the Sale Agreement proceeds on a false basis. By clause 2 the vendors (Orica Australia and Orica NZ) sold the listed assets to Zeneca BV “as legal and beneficial owners”. One asset was “the Goodwill”, which included “the benefit of the Distribution Agreement, which was defined as the 1 June 1993 agreement between Orica and Zeneca. As I have indicated, Orica retained ownership of the Distribution Agreement. There was no trust in Orica Australia’s favour.
The Commissioner sought to derive assistance from a 1995 agreement between Zeneca and Orica Australia, by which Zeneca appointed Orica Australia its subdistributor of various Ohmeda pharmaceutical products (the 1995 agreement). The Commissioner said this showed that when Zeneca intended to confer a benefit on Orica Australia, it did so expressly. I doubt that much assistance can be derived from the contrast between the Distribution Agreement and the 1995 agreement. Clause 3.1 of the 1995 agreement provided:
Pursuant to [Orica Australia’s] rights under Article 4.3 of the distribution agreement dated 1 June 1993 between Zeneca and [Orica Australia], Zeneca hereby appoints [Orica Australia] as its exclusive sub‑distributor of the Products in the Territory …
Clause 4.3 of the Distribution Agreement provided that if during the term of the agreement Zeneca acquires the rights to sell the products of a third party in the Territory, such rights will be offered to Orica. The drafter of the 1995 agreement has confused Orica (called ICI Australia in the Distribution Agreement) with Orica Australia (called ICI Australia) in the 1995 Agreement.
The Disposals
Without suggesting that the Commissioner bears any onus (cf s 14ZZO of the Taxation Administration Act 1953 (Cth)), it is convenient to deal with the second way in which Orica puts its case by reference to the various disposals for which the Commissioner contends.
The Commissioner identifies two relevant assets: first, the Distribution Asset constituted by the rights Orica acquired in 1993 under the Distribution Agreement, and second, the Article 14 right, consisting of the bundle of termination rights pursuant to Article 14 of the Distribution Agreement. One of those rights was to receive a payment on termination pursuant to Article 13.3.
The Commissioner contends that Orica disposed of the Article 14 right in two alternative ways. The first was in consequence of Zeneca giving notice of termination of the Distribution Agreement pursuant to Article 13.3. The second was upon Orica agreeing on or about 3 September 1998 to enter into a new set of agreements, including the Sale Agreement, the Assignment Deed and the Preservation Agreement.
In further alternatives the Commissioner contends that Orica disposed of the Distribution Asset upon execution of the Sale Agreement or upon execution of the Assignment Deed.
First Article 14 disposal
The contention is that on 8 December 1997 when Zeneca exercised its right under Article 13.3 to terminate the Distribution Agreement, Orica’s bundle of rights under Article 14 was discharged, and in its place arose a right to payment of the amount to be ascertained by the valuation process. The Commissioner asserts that Orica’s replacement right was debitum in praesenti solvendum in futuro: the amount to which Orica was entitled was capable of ascertainment and was payable in the future. The Commissioner contends that the Article 14 right was discharged because it consisted of rights that could no longer be enjoyed. There was therefore a deemed disposal of the Article 14 right within s 160M(3)(b).
The facts do not support the disposal for which the Commissioner contends. The notice of termination stated that the Distribution Agreement would terminate on 6 February 1998, but would remain in force during the period of the notice and any extension of the period. The parties then commenced the process contemplated by Article 14.
As at 6 February 1998 the parties were still working through the valuation process. Before that date each party’s valuer had produced a report. On 6 February the third valuer, E&Y, was appointed. Before it had reported, Mr Justice Blackburne enjoined the carrying out of the third valuation. His Lordship’s subsequent order of 27 February 1998 recited the parties’ agreement that the Distribution Agreement “continues in force beyond 8th March 1998 until completion of the third valuer’s valuation”. The significance of 8 March 1998 is that that was the date by which the third valuer was to complete its valuation. Article 14.1.1(b) provided that if a third valuer was appointed, the date of termination of the Agreement as specified in Articles 13.1 and 13.3 was to be extended from 60 days to 90 days. That extension would have made the date of termination 8 March 1998.
By the Preservation Agreement of 3 September 1998 the parties agreed that the Distribution Agreement “continues in full force and effect”. They also agreed that if completion of the sale of the Business, including the assignment to the purchaser of the benefit of the Distribution Agreement, had not occurred by 8 September 1998, the Distribution Agreement would terminate on that day. Such a termination was not to affect any accrued rights or remedies under the Agreement including the obligations under Article 14. The Preservation Agreement was preceded by the negotiations recorded at [45] by which the Business was to be sold to nominated Zeneca affiliates.
As appears from the foregoing, the parties did not terminate the Distribution Agreement. There was no “discharge” of the Article 14 rights. Rather the parties reverted to their original plan of sale by Orica Australia and Orica NZ to Zeneca.
In my view Orica did not on 8 December 1997 obtain the “replacement right” for its Article 14 rights being debitum in praesenti solvendum in futuro. Orica relied on Re Ahearn; Ex parte Palmer (1906) 6 SR (NSW) 576 (Re Ahearn) for the proposition that for there to be a debt there must be a liquidated amount or at least it must be possible by “mere calculation or arithmetic” to produce such an amount. Orica’s submission was that the valuation process involved much more than mere calculation or arithmetic. The case does not establish Orica’s proposition. There an unliquidated amount was reduced to a liquidated amount by the parties’ agreement. Mr Justice Cohen said:
For his failure to meet his contracts he was liable in damages, and, so long as it rested in damages, the liability was not a liquidated sum; before it could become so, it would have to be assessed either under the Stock Exchange rules, or by the ordinary tribunals, or by agreement between the parties, for the parties may meet and agree upon an amount which one shall be deemed to owe the other. There is no special virtue in having the amount assessed by a Court or a domestic tribunal, for an assessment between the parties is equally efficacious for the purpose of constituting the amount of a liquidated amount.
His Honour did not use the expression “mere calculation or arithmetic”.
Although Re Ahearn does not establish Orica’s proposition, I do not disagree with its contention that there can be a liquidated amount even though its quantification may require a process of calculation or arithmetic. I do not accept the Commissioner’s contention that on the giving of the termination notice there arose a debt, though payable in the future, because the amount payable was capable of ascertainment by the valuation process. Debitum in presenti requires the existence of a present debt. That involves a liquidated amount or something that is then capable of quantification. In the present case, there would have been a debt if the two valuers had agreed on a valuation, or had their valuations differed by 15% or less of the lower valuation so that the average of their valuations could be calculated, or had the third valuer made its valuation while the Article 14 process was still in being. The Commissioner’s submission involves ascertainment (quantification) in the future.
Some assistance in this connection is provided by the Court of Appeal’s decision in Webb v Stenton (1883) 11 QBD 518. A judgment debtor was entitled for his life to the income arising from a fund vested in trustees, payable half‑yearly in February and August. Upon application by the judgment creditor in November for a garnishee order attaching the debtor’s share of the income in the hands of the trustees, it appeared that the last half‑yearly payment had been made, and that there was no money in the hands of the trustees. It was held that there was no debt “owing or accruing” at the time when the order was applied for which could be attached under Order 45 rule 2 of the Rules of Court. Sir Baliol Brett MR, with whom Lindley and Fry LJJ agreed, said at 524:
The law has always recognised as a debt two kinds of debt, a debt payable at the time, and a debt payable in the future, and unless the legislature intended to invent a new kind of debt not known to the law, “accruing debt” can only be what the judges have so stated … Therefore it seems to me that the meaning of “accruing debt” … is debitum in presenti, solvendum in futuro, that it goes no further, and that it does not comprise anything which may be a debt however probable and however soon it may be a debt.
So in the present case, however likely it may have been on 8 December 1997 that a final value would be ascribed to the Business, that did not come about until the third valuer completed his valuation in September 1998, by which time the parties were no longer proceeding with the Article 14 process.
It was common ground that the valuation of the Business involved subjective judgments on the part of the valuers. They were not engaged in a mere process of calculation. In fact the first two valuers’ opinions were far apart because their approaches to what they were valuing were different. This was what led to the proceedings in London. Mr Justice Park in effect gave the valuers guidance as to the basis on which the valuation was to be made.
Orica did not on 8 December 1997 own a present debt payable in the future. The Commissioner’s first Article 14 disposal is not made out.
Second article 14 disposal
Commissioner’s submissions
The Commissioner’s alternative case is that if there was no disposal of the Article 14 right as a result of the giving of the notice of termination on 8 December 1997, that right was disposed of as a result of Orica entering into the Preservation Agreement (above at [46]), the Deed of Assignment (above at [48]) and the Sale Agreement (above at [49]‑[53]) (together the September agreements).
The Commissioner asserts that by the beginning of September 1998 Zeneca remained indebted to Orica in the amount to be ascertained by the agreed valuation process. He says that on 4 September the third valuer furnished its written valuation of $327 million. However, immediately before publication of the valuation, the arrangements between the parties were varied. The Commissioner’s rendering of the events described at [45]‑[53] is as follows:
(a)On 3 September Zeneca and Orica purported to agree that, notwithstanding the notice of termination, the Distribution Agreement was to remain in full force and effect until 5:00 pm on 8 September.
(b)On 4 September Zeneca, Orica and related companies of each of them entered into the Sale Agreement. The purchaser was Zeneca BV. The purchase price was $328.5 million, made up of E&Y’s $327 million and the further sum of $1.5 million Zeneca had agreed to pay towards Orica’s legal costs.
(c)As part of the Sale Agreement the parties agreed that there would be a novation of Orica’s rights under the Distribution Agreement. Clause 5.2(d) required the vendors to deliver to Zeneca BV a counterpart of an assignment of the Distribution Agreement executed by Orica.
(d)The novation of the Distribution Agreement constituted performance by Orica of “an implied obligation” under the Sale Agreement. At common law it was bound to do all things reasonably necessary to secure performance of the Sale Agreement.
(e)The Assignment Deed of 4 September effected a novation of the Distribution Agreement, so that from the completion of the Sale Agreement on 4 September Zeneca BV became bound by the provisions of the Distribution Agreement that were binding on Orica, and Orica was released from its obligations.
The Commissioner asserts that the interrelated September agreements were entered into in exchange for Orica’s right to receive payment following the termination of the Distribution Agreement under Article 13.3 thereof. He says that the September agreements substituted for Zeneca’s existing obligation to pay $327 million to Orica (as owner of the Distribution Asset) a new arrangement whereby the businesses of Orica Australia and Orica NZ were sold to Zeneca BV and the Distribution Agreement was to be assigned to Zeneca BV. The Commissioner describes one of the issues in the case as whether the 3 September Preservation Agreement, which he calls a “contrivance”, undid the capital gains tax consequences which had already arisen.
The Commissioner invites the Court to infer that on or about 3 September 1998 the parties entered into an agreement whereby the original contractual arrangement would be “cancelled or surrendered” and there would be substituted therefor a sale of the business assets to Zeneca BV for the same amount as would have been payable under the original arrangement plus an amount for legal costs. He contends that it was a term of the “Substitution Agreement” that on entry into the three September agreements, the parties would “surrender or cancel” their rights and release each other’s obligations under the Distribution Agreement, “including the debt owed by Zeneca to Orica under Article 14”.
The Commissioner submits that the above events constituted “a disposal of the debt owed by Zeneca to Orica, which had arisen on 8 December 1997 upon Zeneca giving notice of termination of the Distribution Agreement”.
Orica’s submissions
Orica takes issue with the submission recorded at [99(d)] that novation of the Distribution Agreement constituted performance by it of one of its obligations under the Sale Agreement. It contends that the Sale Agreement imposed no such express obligation on Orica. It was the vendors, Orica Australia and Orica NZ who were subject to the obligation imposed by clause 5.2(d).
Orica also contests the claim that it was under the implied obligation recorded at [99(d)]. It submits that no such term should be implied having regard to the execution of the Assignment Deed on the same day as the Sale Agreement, and its acceptance of Zeneca’s proposal that there were to be two agreements, one for the sale of the business and the other for the assignment of the Distribution Agreement.
Orica disputes the Commissioner’s “contrivance” contention recorded at [100], first on the ground that the proposal to revert to a sale of business was made by Zeneca, and secondly on the ground that at the time of Zeneca’s proposal there was no existing obligation on Zeneca’s part to make a termination payment of $327 million to Orica. Cf [99] above.
Conclusion on second disposal
The Commissioner’s second disposal is put as an alternative to the first disposal. However an essential element of the second disposal is the existence of a debt owed by Zeneca to Orica which had arisen on 8 December 1997. Thus he contends that:
(a)By the beginning of September 1998 Zeneca remained indebted to Orica in the amount to be ascertained by the agreed valuation process.
(b)The September 1998 agreements substituted a new arrangement for an existing obligation that a termination payment of $327 million be made to Orica.
(c)The letter agreement of 3 September 1998 purported to rescind the notice of termination that had already given rise to Orica’s right to receive payment following termination.
(d)The original contractual obligation that was replaced by the substituted arrangement was that Zeneca was bound to pay Orica $327 million.
(e)It was a term of the substituted agreement that the debt owed by Zeneca to Orica under Article 14 would be released.
(f)As a result of the September 1998 agreements there was a “disposal of the debt owed by Zeneca to Orica, which had arisen on 8 December 1997”.
As appears from [92]‑[97] I have rejected the Commissioner’s contentions that the notice of termination gave rise to a debt owed by Zeneca to Orica, and that Zeneca was then contractually bound to pay Orica $327 million. Upon receipt of the notice of termination Orica may well have acquired a chose in action, namely a right in the future to receive a sum of money ascertained in accordance with Article 14. But that chose was not a present debt. Nor was it a right to be paid $327 million.
Accordingly, the second disposal propounded by the Commissioner founders for the same reason that his first disposal is not made out.
The Commissioner contended that in order to achieve the “substitution” recorded at [101], Orica and Zeneca considered it necessary to enter into the 3 September 1998 Preservation Agreement, “which purported to rescind or undo the notice of termination that had already given rise to [Orica’s] right to receive payment following termination”. He describes this agreement as a “contrivance”, a description with which Orica took issue. It is not clear to me that anything in fact turns on the propriety of the Commissioner’s description. In case it does, I should record first, that no case of “sham” on Orica’s part (or Zeneca’s) is raised by the pleadings. Further, apart from the use of the word “contrivance” and a comparable statement that by the preservation agreement the parties “purported to agree” that the Distribution Agreement remained in effect notwithstanding the notice of termination, the Commissioner did not seek to run such a case. In those circumstances I treat the various September 1998 documents as having whatever effect their language gives them.
Secondly, although the Commissioner’s animadversions appear to be directed at Zeneca as well as Orica, in my view Orica correctly points out that the proposal to revert to a sale of business came from Zeneca. By facsimile of 1 September 1998 from Mr Brimacombe of Zeneca to Mr Reynolds of Orica, the former set out the steps that would be involved in the sale of the Business to Zeneca BV. Ms Gibson’s evidence was that those steps “were matters that Zeneca had proposed; they were not requirements of Orica”. On 3 September 1998 Zeneca wrote to Orica about what it described as “our proposal”. The context shows that that is Zeneca’s proposal and not anything in the nature of a joint proposal or position. Thus the opening words of the letter state that Zeneca has decided to put “its position” on the matter in writing, and concludes by saying that if the parties are unable to agree on Zeneca’s “final offer” by noon that day, it would revert to its original position on the umbrella agreement. Ms Gibson’s evidence was that Dr Patterson of Zeneca told her the proposed changes were “for Zeneca’s tax reasons”.
Thirdly, when Zeneca made its proposal, there was no existing obligation on Zeneca’s part to pay Orica $327 million. Thus the basis for the Commissioner’s contrivance and “purported” agreement contention does not exist.
I am satisfied that the Commissioner’s second propounded disposal did not take place.
Third disposal
Commissioner’s submissions
The Commissioner contends that the Distribution Agreement was disposed of upon entry into the Sale Agreement. He says that the Assignment Deed effected a novation of the Distribution Agreement, and that the novation was in performance of an obligation that arose under the Sale Agreement. On the Commissioner’s submission there was a novation because, despite clause 2 of the Assignment Deed being headed “Assignment”, Zeneca BV agreed therein to assume Orica’s obligations (as well as its rights) under the Distribution Agreement. He submits that the novation cancelled or released the rights and obligations of Orica and Zeneca under the Distribution Agreement, and created a new set of rights and obligations between Zeneca BV and Zeneca.
It was a term of the Sale Agreement that at completion the vendors would deliver to Zeneca BV a counterpart of the Assignment Deed duly executed by Orica: clause 5.2(d). The Commissioner repeats his earlier submission that Orica was subject to an implied obligation under the Sale Agreement to execute the Assignment Deed so as to facilitate performance and completion of the Sale Agreement. He draws attention to the statement in recital C that “As part of the Sale of Business Agreement”, Orica has agreed to assign its rights and obligations under the Distribution Agreement. The Commissioner also relies on recital B of the Sale Agreement whereby the vendors sell the business “as a going concern”, and contends that Zeneca BV could not have carried on the Business without the benefit of the Distribution Agreement.
For those reasons the Commissioner urges that the novation of the Distribution Agreement was partial performance by Orica of its obligations under the Sale Agreement. That agreement was the source of the obligation to novate the Distribution Agreement which Orica discharged by entering into the Assignment Deed. Accordingly, he says, the Sale Agreement effected a disposal of the Distribution Asset as well as the other assets of the Business, the consideration for all of which was the agreement to pay Orica $328.5 million. He relies on s 160M(3)(b), in particular the words “cancellation [or] release … of the asset”.
Orica’s submissions
Orica disputes the Commissioner’s contention that there was a novation of the Distribution Agreement on three grounds. First, that under clause 2.2 Orica did not receive a full release of its obligations under the Distribution Agreement. Second, that the parties did not intend to effect a novation. They bargained for an assignment of rights and a partial release of potential liabilities. Third, the Distribution Agreement did not come to an end. It had to survive to enable Zeneca to enforce any rights “accrued or arising before the Effective Date”: cl 2.2.
Orica contends that the Sale Agreement was not the source of the obligation to “assign” the Distribution Agreement. It says that Zeneca BV could have carried on the Business without the benefit of the Distribution Agreement because, as a wholly owned subsidiary of Zeneca, it could have obtained a fresh grant of distribution rights at any time. All it needed from Orica were the essential elements of its pharmaceutical business, including its plant, product registrations, staff, confidential information and customer lists and its trading stock Orica contends that the source of the obligation to “assign” the Distribution Agreement was the express terms of the Assignment Deed. Because of those express terms, there is no need to imply an obligation under the Sale Agreement.
Conclusion on third disposal
Novation
The burden of a contract cannot be assigned without the consent of the other party to the contract, in which event the consent will give rise to a novation. Similarly, it is impossible to assign “the contract” as a whole, because it consists of both burdens and benefits. As Lord Browne‑Wilkinson said in Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd [1994] 1 AC 85 at 103, although lawyers often purport to assign a contract, thereby intending to assign the benefit of the contract, “since every lawyer knows that the burden of a contract cannot be assigned”, the assignment will be construed as intending to pass the benefit only. To the same effect is Century 21 (South Pacific) Pty Ltd v Century 21 Real Estate Corporations (1996) 136 ALR 687 at 698.
Rights and obligations can be effectively transferred by a novation: a transaction by which all parties to a contract agree that a new contract is substituted for an existing contract. It involves the extinguishment of one obligation and the creation of a substituted obligation in its place: Olsson v Dyson (1969) 120 CLR 365 at 388. A novation can be express or implied from the circumstances. Whether there is an implied novation ultimately depends on the intention of the parties: Vickery v Woods (1952) 85 CLR 336 at 345.
The terms of the Assignment Deed are set out at [48]. It is important to repeat that the parties were Orica, Zeneca and Zeneca BV. Recital C records Orica’s agreement to “assign the rights and obligations” under the Distribution Agreement to Zeneca BV, and the latter’s agreement to assume Orica’s obligations thereunder. Although clause 2 is headed “Assignment”, its verbiage goes further. In addition to becoming entitled to enjoy all the rights and benefits of Orica under the Distribution Agreement, Zeneca BV agrees to be bound by and comply with the provisions of the Distribution Agreement binding on Orica. In view of this lack of symmetry, clause 1.1 of the Deed is to be noted. It provides that headings are for convenience only and do not affect interpretation. In any event, the significance of the “Assignment” heading is reduced by the immediately following subheading – “Assumption of benefits and obligations”. What is important is that recital C and clause 2.1 (including its subheading) reflect an intention that the benefits and burdens of the Distribution Agreement should pass to Zeneca BV.
The circumstances leading to the making of the September 1998 agreements disclose that the parties intended there to be a novation of the Distribution Agreement. The overture for a change from the umbrella agreement to a sale of the Business to Zeneca BV came from Zeneca. Mr Brimacombe’s facsimile of 1 September proposed the rescission of the termination notice subject to Orica selling and Zeneca purchasing the Business, “including novation of the 1993 Distribution Agreement”. Dr Patterson’s facsimile of 3 September repeated the proposal, and added the sweetener of the $1.5 million towards Orica’s legal costs. Ms Gibson wrote “Accepted 3.9.98” on the document.
I do not accept Orica’s submissions, recorded at [116], that the Assignment Deed did not effect a novation of the Distribution Agreement to Zeneca BV. The first is that Orica did not receive a complete release from all its obligations. Clause 2.2 covered prospective liabilities only, because it was made without prejudice to any rights of Zeneca accrued or arising before the Effective Date. That, says Orica, means that there was not a complete discharge of the Distribution Agreement between Orica and Zeneca. It relied on the following passage from the judgment of Windeyer J in Olsson v Dyson 120 CLR at 388‑389:
Novation is the making of a new contract between a creditor and his debtor in consideration of the extinguishment of the obligations of the old contract: if the new contract is to be fully effective to give enforceable rights or obligations to a third person he, the third person, must be a party to the novated contract.
…
In Scarf v. Jardine (1882) 7 App Cas 345 at 351 Lord Selborne said novation “means this ‑ the term being derived from the civil law ‑ that there being a contract in existence, some new contract is substituted for it, either between the same parties (for that might be) or between different parties; the consideration mutually being the discharge of the old contract”. In that sense “novation” means simply a new contract standing in the place of the old.The question is what is meant by “the extinguishment of the obligations of the old contract” and “the discharge of the old contract”. The two core elements of novation are the rescission by agreement of an existing contract or part thereof and the entering into of a new contract by way of substitution. In a helpful article Bayley J, “Novation” (1999) 14 Journal of Contract Law 189 at 191‑194 the author considers a contract between A and B which is rescinded by agreement and replaced by a new contract between A and C. After noting that A must now look to C for performance of contractual obligations under the new contract and cannot look to B for fulfilment of the contractual obligations which were extinguished by the novation, the author considers whether the fact that A can no longer look to B for performance of B’s primary obligations under the original contract, means that A cannot hold B liable for past breaches of contract, because the contract no longer exists. He concludes that whether the novation lets B off the hook depends on what the parties intended to do in rescinding the original contract. If they intended only to rescind the original contract without affecting existing causes of action, A will be able to pursue B for past breaches. But if it was intended that the original contract and all accrued causes of action arising out of the contract were to be discharged by the novation, that will be the effect of the novation. Mr Bayley concludes:
The reason this occurs is that the incidents and consequences of a consensual rescission are essentially plastic to the intention of the parties. This flexibility has been summarised by one jurist as follows:
In the sphere of rescission by the acts of the parties themselves and express consensus, the only limits that can be placed to the possible incidents of rescission of a contract are the limits to the power of making one.
The jurist referred to is Morison, The Principles of Rescission of Contracts (Stevens & Haynes 1916) p 4.
In the present case the parties agreed that future events were to be governed by a contract between Zeneca and Zeneca BV in the same terms, mutatis mutandis, as those in the former contract between Orica and Zeneca. Orica falls out of the picture so far as they are concerned. But as to the past, the parties agreed that Orica would remain liable to Zeneca in respect of events that occurred before the rescission. What the parties have done is to adopt the scheme of rescission for breach. The contract is not rescinded as from the beginning. The original parties are discharged from further performance of the contract, but rights are not divested or discharged which have already been unconditionally acquired. Rights and obligations which arise from the partial execution of the contract and causes of action which have accrued from its breach alike continue unaffected. Cf McDonald v Dennys Lascelles Ltd (1933) 48 CLR 457 at 476‑477.
I adopt the analysis outlined at [120]‑[124] because it accords with contractual principle. It is also supported by authority. In Weldwood‑Westply Ltd v Cundy (1965) 50 DLR (2d) 744 a company was indebted to the appellant for an amount exceeding $20,000. The appellant and the respondent, with the acquiescence of the company, agreed that the respondent would assume liability to pay $20,000 of the debt owing by the company to the appellant, and that the company would be discharged from having to pay the $20,000. The Supreme Court of Canada held that there was a novation. Spence J dealt specifically with whether a novation could take place if the original contract was rescinded only in part. Dealing with a defence relied on by the respondent that there was no novation because the old debt was not extinguished, his Lordship said at 749:
Certainly, the old debt was extinguished as to $20,000 thereof and therefore the defence must be that there could not be a novation of only part of the old debt. I have been unable to find any authority for that proposition … I have found that Williston in vol 6 of the revised edition of his authoritative work on Contracts, at p 5241 states:
Novation necessarily involves the immediate discharge of an old debt or duty, or part of it, and the creation of a new one.
Thereby implying that the novation may be of part only of the original debt. In my view, Hodgson v Anderson (1825) 3 B&C 842, 107 ER 945 and Fairlie v Denton and Barker (1828) 8 B&C 395, 108 ER 1089, are authorities for that proposition.
See also Jenkins S, Corbin on Contracts (Revised ed, 2003) vol 13 §§71.3(1).
Orica referred me to no authority that a provision such as clause 2.2 of the Assignment Deed is inconsistent with a novation. Such a contention does not accord with Orica’s own documentation. The Sale Agreement contained a pro forma Assignment Deed (Sch 8) and a pro forma Novation Deed (Sch 9). These Deeds were to be used in relation to contracts between Orica and third parties. The parties to the Novation Deed are Orica Australia, Zeneca Pharmaceuticals Australia Pty Ltd, which is called “Zeneca”, and the third party. Recital C provides that the parties:
have agreed that the Main Agreement will be novated on the terms of this Deed, so that:
(a)Zeneca becomes a party to the Main Agreement in place of Orica; and
(b)Orica is released from its obligations under the Main Agreement.
Clause 3 is headed “Novation”:
With effect from the Effective Date:
(a)Zeneca shall be substituted for Orica as a party to the Main Agreement; and
(b)the Main Agreement shall take effect as an agreement on the same terms as previously except that references to Orica shall be read and construed as if they were references to Zeneca.
Clause 3.2 is in the same terms as clause 2.1 of the Assignment Deed. Clause 3.3 is in the same terms as clause 2.2 of the Assignment Deed. That is to say, the release of Orica is without prejudice to the accrued rights of the other party to the original contract.
The Commissioner contests Mr Selak’s opinion that the Distribution Agreement is an asset that cannot be valued (s 160ZD(2)(b)) because it is not possible to identify it as a separately identifiable intangible asset. He relies on Mr Samuel’s report (pars [30]‑[50]) for these propositions:
·The Distribution Asset meets the criteria in AASB 138 for the recognition of an intangible asset. It is a “separate” asset (Samuel par 45).
·It is irrelevant that the parties to the Sale Agreement did not allocate any of the consideration to the Distribution Asset (if that be the case) (Samuel par 48).
·The revenue associated with the Distribution Asset can be isolated. It is the revenue derived from the sale of the Zeneca products. The value of the asset can be estimated by applying techniques provided for in AASB 138 (Samuel par 49).
·The Distribution Asset was by far the most valuable right the Orica group had in relation to the Business. Without it the Business did not exist.
The Commissioner accepts that there should be some amount as the cost base, but says he is not in a position to address this issue because Orica has not adduced any evidence to support a positive cost base.
Orica’s written submissions in reply
Orica rejects the Commissioner’s submission that it “deliberately” failed to adduce evidence of the market value of the release. It says the Commissioner’s case has always been that the market value of Orica’s rights under the Distribution Agreement constitute the capital proceeds for the disposition of those rights. Orica’s case has always been that the capital proceeds are not to be determined by reference to the value of those rights. By showing that it in fact received valuable consideration for those rights, namely a release, it has demonstrated the error in the Commissioner’s case and thus the excessiveness of the assessment. The value of the release should be remitted to the Commissioner for determination.
Orica disputes the Commissioner’s reliance on s 160ZD(2) (market substitution rule).
(a)Assuming the Assignment Deed was a novation, the market value of the Distribution Rights on 4 September 1998 was nil. Orica relies on Mr Selak’s first report: at par 102. The Commissioner provided no valuation of those rights as they were assigned on 4 September 1998. Mr Samuel’s report is based on assumptions of fact that never occurred. The assumptions are included in the letter of instructions from the Australian Government Solicitor dated 15 May 2009.
(b)Again assuming a novation, and that s 160ZD(2A) is engaged, that provision does not affect Mr Selak’s conclusion. In his second report he was asked to value the Distribution Rights on the assumption required by subs (2A), namely that the rights were not disposed of and were never proposed to be disposed of. He concluded that the market value of the distribution rights as at 4 September 1998 on these assumptions was nil. The Commissioner has produced no valuation evidence to contradict this.
(c)As to the Commissioner’s attack on Mr Selak’s valuation, Mr Selak agreed that the Distribution Agreement was a separately identifiable asset, but said that its value cannot be separately measured reliably: second report at par 80. His opinion was that at best those rights were a source of Orica Australia’s goodwill.
As to the cost base of the Distribution Agreement, Orica submits that by entering into the Distribution Agreement in 1993 it abandoned any rights it had under the 1935 Deed. The loss of these valuable rights in exchange for the rights under the Distribution Agreement formed part of its cost for determining the ongoing cost base under s 160ZH of its rights under the Distribution Agreement. It relies on a report by Mr Churchill filed by the Commissioner valuing Orica’s business as at 1 June 1993 at $115.4 million. It says that, inferentially, this evidence was filed for the purpose of ascertaining Orica’s cost base.
Commissioner’s closing submissions
The Commissioner submits that in order to demonstrate that the assessment is excessive Orica must prove that the value of the release is less than the gain assessed. It has not done so. He rejects Orica’s claim that he does not contend that the release had a value equal to the amount of the capital gain assessed. The Commissioner’s position is that he makes no submission about the value of the release “because he does not know what it is”. Nor does the Court, because there is no evidence to establish that value. There is only an unsupported assertion in par 7(c) of Orica’s Statement of Facts Issues and Contentions that its value is $700,000, and the reply submission that the value of the release is a “nominal sum”: par 8 of Reply.
Mr Selak’s first report valued the distribution rights on the assumption that Orica was capable of employing them for only four days. He did not attribute any value to Orica’s right to receive a termination payment.
As to Mr Selak’s second report:
(a)Valuation one is based on assumptions which again led him to exclude any value attributable to the right to receive the termination payment.
(b)In Valuation two Mr Selak declined to attribute a value to the distribution rights because he was unable to isolate revenue associated with the rights from the revenues associated with other assets and liabilities. He regarded himself as obliged by AASB 138 to come to this conclusion. However AASB 138 is a reporting standard, and does not prevent a valuer forming a judgment as to what an asset might be worth for purposes other than reporting.
(c)Mr Samuel’s report shows that a valuer can form an opinion as to what might be the value of the Distribution Asset.
There is no evidence as to the amount of the cost base asserted by Orica. Mr Churchill’s report, upon which Orica relies, was not in evidence and cannot be relied on.
Even if there were evidence showing that the market value of the release was $700,000, s 160ZD(2)(c) would apply. Mr Samuel’s evidence was that the market value of the asset disposed of was $250 million.
Orica’s closing submissions
Counsel was critical of Mr Samuel’s evidence: he had no particular expertise in valuation; he didn’t have a particularly good grasp of the accounting standards dealing with goodwill; his choice of comparable companies was not bona fide, and he rejected the 11.7% profit margin for Advanced Sciences “and instead chose a figure which was almost twice that and so it necessarily, as a matter of mathematics, doubled the amount that would be attributable to the distribution agreement”.
Conclusion on consideration
Expert evidence
I do not accept the evidence of Mr Selak that as at 4 September 1998 the market value of the Distribution Asset was nil. In both his reports he identified only two rights conferred on Orica by the Distribution Agreement – the right to produce and distribute Zeneca products in the territory and the opportunity to facilitate the transfer or sale of the pharmaceutical business. I agree with Mr Samuel that Mr Selak has failed to attribute any value to Orica’s right to receive a termination payment under the Distribution Agreement. Under Article 14.1 Orica had the right to receive a payment equal to the market value of the Business on a going concern basis in the event that a termination notice was given. Mr Samuel was correct in describing this as an important right, because it precluded Zeneca from withdrawing Orica’s other two rights under the Distribution Agreement without compensation.
Nor do I agree with Mr Selak’s conclusion in his second report that “it is not possible to separately identify the Distribution Asset as a separately identifiable intangible asset”, with the result that he is unable to attribute value to the asset under the assumptions in Valuation two. This conclusion is attributed in part to his understanding of AASB 138. In par 43 he sets out the Standard’s criteria for an asset to be classified as an intangible asset and be allocated a fair value. In par 44 he paraphrases par 12 of AASB 138 by saying an asset meets the identifiability criterion if it (a) is capable of being separated or divided from the entity and sold, transferred etc, or (b) arises from contractual or other legal rights. In par 45 he says that “where there is uncertainty as to whether an asset constitutes an identifiable intangible asset, no separate value should be attributed to that asset”.
Mr Samuel’s report contains a more thorough review of the relevant provisions of AASB 138. He first points out that the Standard is not strictly applicable to the valuation of the Distribution Agreement because it is not carried out for the purpose of recognising an asset in financial reports in accordance with Part 2M.3 of the Corporations Act 1974 (Cth). See par Aus 1.1(a)‑(c) of AASB 138. However, Mr Samuel agrees that the Standard provides authoritative guidance as to issues relevant to the identification and valuation of intangibles, and would typically be referred to by accountants performing valuations. Mr Samuel draws attention to AASB 138 par 38, quoted at [151], that uncertainty in the valuation of intangibles acquired in business combinations enters into the measurement of the asset’s fair value, rather than demonstrates an inability to measure fair value reliably.
Mr Samuel’s valuation methodology is unexceptionable. In his second report Mr Selak described a range of valuation methodologies that can be used to assess the market value of intangible assets. He said that broadly speaking the value of an intangible is determined by the expected future earnings or cash flow (that is future economic benefits) that can be obtained from the use or sale of the asset. On the Economic Value or Income Approach, the value of the intangible is the present value of the expected economic income to be earned from it. This approach has two components:
·identification, separation and quantification of the earnings or cash flows attributable to the asset, and
·capitalisation of those earnings or discounting the cash flows.
Mr Selak said that many different methodologies based on the income approach may be used to provide an indication of value for an intangible. They include “methods that estimate the value of the intangible asset as a residual from the value of the overall business enterprise value”.
Thus, in Mr Selak’s opinion, the approach adopted by Mr Samuel was a common valuation methodology – estimating the value of the intangible asset as a residual from the value of the overall value of the relevant business: par 77(c)(ii) of Mr Samuel’s report and par 40 (page 11) of Mr Selak’s first report.
In cross‑examination, it was put to Mr Selak that Mr Samuel’s report contained a “reasoned judgment” as to his opinion of the value of the Distribution Asset. His response was that “Mr Samuel’s judgment is significantly flawed and I don’t accept that it’s reasoned”. Mr Selak had the opportunity to explain why Mr Samuel’s judgment based on a common valuation methodology recognised by Mr Selak was significantly flawed, but did not explain why or otherwise particularise his opinion.
I have found the first part of Mr Samuel’s report persuasive. It is a methodical, well‑reasoned refutation of Mr Selak’s contention that Orica’s rights under the Distribution Agreement had no real value as at 4 September 1998. In particular I accept his treatment of Mr Selak’s three reasons for not applying valuation methodologies to the Distribution Asset. I refer to the discussion at [154] to [159] above.
Mr Samuel’s discussion of and disagreement with Mr Selak’s attribution of a nil value to Orica’s rights under the Distribution Agreement was directed to the latter’s “Valuation two”, which involved the assumption that those rights were transferred by the Sale Agreement. On the view I have taken, the rights were transferred under the Assignment Deed. I do not think this makes any difference to Mr Samuel’s opinion as to whether the rights were able to be valued and were valuable. That is shown by his general disagreement with both of Mr Selak’s reports: the first assuming Orica’s rights were disposed of under the Assignment Deed and the second assuming they were disposed of under the Sale Agreement. In both cases Mr Selak’s reasons were the same, and Mr Samuel’s reasons for disagreeing with the nil valuations were the same.
Counsel for Orica claimed that Mr Samuel “didn’t have any particular expertise in valuation”. However, there was no formal objection to the admissibility of his report on the ground that he lacked specialised knowledge based on his training, study or experience (s 79 of the Evidence Act 1995 (Cth)). Nor was there an application that the report should be excluded under s 135. In any event I am satisfied that he has the required degree of expertise. His report discloses his experience as including:
(a)over 20 years as a Chartered Accountant including the analysis of financial statements and accounting records for the purposes of audit, due diligence, valuation or disputes;
(b)the valuation of numerous businesses and intellectual property assets conducted since 1991;
(c)joint responsibility for launching PwC’s Intellectual Asset Management Group in 1998. This group provided services and thought leadership in the identification, management and extraction of value from intellectual assets, including intangible assets. He was a member of the group between 1998 and 2004;
(d)assessment of damages arising from lost profits or loss of value in numerous engagements since 1991, including intellectual property disputes.
Mr Samuel made no attempt to inflate his valuation expertise. In cross‑examination he said that although he had carried out valuations every year for the last 16 or 17 years, “I don’t go to market as a valuer, per se”.
My confidence in Mr Samuel’s valuation expertise was confirmed by his report, which as I have said was methodical and well‑reasoned. It was further confirmed by his response to cross‑examination which was at times robust. Despite being called a cheat, he retained his composure and, as appears from [166]‑[173] above, repelled the attacks upon his work.
Once Mr Selak’s opinion that Orica’s rights are not capable of valuation or are of no value is put aside, I am left with Mr Samuel’s opinion, which I accept, that the rights are capable of valuation and are not worthless. In the second part of his report he attributes to them a value of $250.5 million as at 4 September 1998.
I accept the propriety of Mr Samuel’s choice of “comparable” companies. There was no suggestion that Amrad was not comparable. Its principal activities were the development and commercialisation of pharmaceutical programs and projects, the supply of pharmaceutical products, and the manufacture and supply of diagnostic products and biotechnology reagents. It was not suggested that it had a retail division.
Faulding’s principal activities were the manufacture and distribution of health and personal care products. Until 1997 it was a wholesaler. In that year it launched a retail business. That business did not contribute to profit in the 1997/1998 financial year. It was in my view comparable to Orica.
Despite its retail division, Sigma’s 1998/1999 Annual Report describes its principal activities as the manufacture and wholesale distribution of pharmaceutical and allied products and the provision of financial and other services to retail pharmacists.
Despite API’s retail activities, its 1998 Annual Report describes its principal activities as the wholesale distribution of pharmaceutical and allied products and the provision of finance and other services to retail pharmacists.
I accept Mr Samuel’s evidence that he chose the companies in question because they were the most comparable to Orica that he could find, and that those with retail divisions and that were customers of Orica Australia did not cease to be comparable for those reasons. As he said, there will always be differences between the company being valued and the “comparables”. With the exception of CSL, which he initially considered and discarded, it was not put to Mr Samuel that there were companies he could have chosen that were more comparable to Orica than the ones he selected.
I accept Mr Samuel’s reason for putting CSL aside, namely that it had a significantly larger investment in plant and machinery ($188 million) than Orica ($3 million).
I accept Mr Samuel’s evidence as to the need to exclude from his calculation of Orica’s net profit margin the Advanced Sciences net profit margin of 11.7% on the ground that to include it would be comparing Orica partly with itself. I also accept his reason for not using the 11.7% in calculating the value of the Distribution Agreement, namely that that percentage comprised more than just the pharmaceuticals business he was seeking to value.
I also accept Mr Samuel’s evidence that he used the most recent actual results that were available to him. I entirely acquit him of “cheating” by not using Orica’s 1996/97 net profit margin (23.6%). He disclosed the 23.6% in his report (see [171] above) and in his evidence explained why he did not use it.
The result of the foregoing is that I accept Mr Samuel’s valuation of Orica’s rights under the Distribution Agreement.
Conclusion
I have found that the Assignment Deed itself effected the disposal of the Distribution Asset, that the Assignment Deed constituted a novation, and that there was accordingly a deemed disposal under s 160M(3)(b) – a cancellation or discharge. Orica contends that s 160ZD(1)(b) is applicable to the disposal, and that it received valuable consideration for the disposal, namely the release it obtained from Zeneca. The Commissioner agrees that if the Assignment Deed alone effected the disposal, and the consideration for the disposal was the release, s 160ZD(1)(b) applies, and the consideration for the disposal is the market value of the release. In my view the consideration for the disposal was the release given by Zeneca. Although the Commissioner did not concede that this was the case, he did not point to any other matter that could constitute consideration moving from Zeneca.
Orica adduced no evidence of the market value of the release at the time of the disposal of the Distribution Asset. On that basis the Commissioner contended that Orica had failed to discharge the onus of showing the assessment is excessive.
By clause 2.2 of the Assignment Deed Zeneca released Orica from all its obligations and liabilities under the Distribution Agreement and all actions, claims or proceedings that it may have against Orica under or in respect of that agreement. The release did not include any rights of Zeneca accrued or arising before the date of completion under the Sale Agreement. Having regard to the amount of the assessment, I accept Orica’s submissions that even though there is no direct evidence of the market value of the release, I should infer that it is considerably less than $264,700,000.
The Commissioner submits that even if it is to be inferred that the market value of the release was less than the amount of the assessment, s 160ZD(2)(c) applied to deem the market value of the Distribution Asset to be the consideration. It was not I think in dispute that a consideration derived under s 160ZD(1)(b) could be displaced by operation of subs (2)(c). Subsection (1) is expressed to be “Subject to this Part”, and the terms of subs (2)(c) – “but for this paragraph”, appear to refer back to a consideration ascertained under subs (1). Because the Assignment Deed effected a novation, the arm’s length component of par (c) is not applicable, and the provision can be rendered in simplified form as applying to a taxpayer who has disposed of an asset and:
the amount that would, but for this paragraph, be taken to be the consideration received by the taxpayer in respect of the disposal is greater or less than the market value of the asset at the time of the disposal …
In those circumstances:
the taxpayer shall be deemed to have received as consideration in respect of the disposal an amount equal to the market value of the asset at the time of the disposal.
Paragraph (c) will apply if the consideration received by Orica (the market value of the release) was less than the market value of the Distribution Asset. The market value of the Distribution Asset is $250.5 million. I have inferred that the market value of the release is much less than $264.7 million. I also infer that it is less than $250.5 million. Accordingly, the consideration in respect of the disposal is deemed to be $250.5 million.
Orica’s only answer to par (c) (on the assumption that the Assignment Deed effected a novation), was that as at 4 September 1998 the market value of the Distribution Asset was nil. I have rejected that contention.
CONCLUSION ON FOURTH DISPOSAL
Section 14ZZO of the Taxation Administration Act imposed on Orica the burden of proving that the assessment is excessive. The task for the taxpayer on an appeal is to show that the amount of money for which tax is levied by a notice of assessment exceeds the actual substantive liability of the taxpayer: Federal Commissioner of Taxation v Dalco (1990) 168 CLR 614 and Federal Commissioner of Taxation v ANZ Savings Bank Ltd (1994) 181 CLR 467 at 479. The parties are agreed that the issue is whether the net capital gain amount of $264,540,764, or some lesser amount, was properly included in Orica’s assessable income pursuant to s 160ZO of the Act. A lesser capital gain amount of $250.5 million should have been included in the assessable income, namely a net capital gain of $250,340,764, being $250.5 million minus the cost base used by the Commissioner of $159,236. Orica has shown, by reference to Mr Samuel’s report, that the amended assessment of 11 October 2004 is excessive. As I have said at [192], Orica adduced no evidence of the cost base of the Distribution Asset.
PENALTY
The Commissioner has imposed additional tax pursuant to s 226K of the 1936 Act on the basis that it was not reasonably arguable that Orica was not required to include in the calculation of its assessable income a capital gain of $264,540,764. Section 226K provided:
Subject to this Part, if:
(a)a taxpayer has a tax shortfall for a year; and
(b)the shortfall or part of it was caused by the taxpayer, in a taxation statement, treating an income tax law as applying in relation to a matter or identical matters in a particular way; and
(c)the shortfall or part, as the case may be, so caused exceeded whichever is the higher of:
(i) $10,000; or
(ii) 1% of the taxpayer’s return tax for that year; and
(d)when the statement was made, it was not reasonably arguable that the way in which the application of the law was treated was correct;
the taxpayer is liable to pay, by way of penalty, additional tax equal to 25% of the amount of the shortfall or part.
Section 222C(a) provided:
the correctness of the treatment of the application of a law …
is reasonably arguable if, having regard to the relevant authorities and the matter in relation to which the law is applied … it would be concluded that what is argued for is about as likely as not correct.
The word “authority” is defined to include the relevant tax Act, court, tribunal or board of review decisions or public rulings.
In Walstern Pty Ltd v Commissioner of Taxation (2003) 138 FCR 1 at [108] (Walstern) Hill J, in a series of propositions approved by later Full Courts (Pridecraft Pty Ltd v Federal Commissioner of Taxation (2004) 213 ALR 450 at [108] and Cameron Brae Pty Ltd v Federal Commissioner of Taxation (2007) 161 FCR 468 at [67]), explained the operation of s 226K. It is sufficient to set out proposition 7:
… the view advanced by the taxpayer must be one where objectively it would be concluded that having regard to the material included within the definition of “authority” a reasoned argument can be made which argument when contrasted with the argument which is accepted as correct is about as likely as not correct. That is to say the two arguments, namely, that which is advanced by the taxpayer and that which reflects the correct view will be finely balanced. The case must thus be one where reasonable minds could differ as to which view, that of the taxpayer or that ultimately adopted by the Commissioner was correct. There must, in other words, be room for a real and rational difference of opinion between the two views such that while the taxpayer's view is ultimately seen to be wrong it is nevertheless “about” as likely to be correct as the correct view. A question of judgment is involved.
Section 226K(d) requires the “not reasonably arguable” question to be answered “when the statement was made”. In this case that was when the income tax return was lodged on 30 July 1999. There is no direct evidence of “the way in which the application of the law was treated” at that time. The earliest expression of Orica’s understanding of its position that is in evidence is its letter to Mr Selak of 19 August 2004 asking him for his opinion of the market value of Orica’s rights under the Distribution Agreement on 4 September 1998. The first six pages recite the background facts and exhibit the basic documents, including the Distribution Agreement, notice of termination, side letter of 3 September 1998, Sale Agreement and Deed of Assignment. The letter then noted some matters “that may be relevant” to the opinion sought:
(a)Orica could not assign its rights without the consent of Zeneca except to a wholly‑owned affiliate.
(b)Although the Distribution Agreement had been extended so that it was operative on 4 September 1998, the effect of the side letter of 3 September 1998 was that if the sale of the Business to Zeneca including the assignment of the Distribution Agreement had not been completed by 5:00 pm on 8 September 1998, the Distribution Agreement would terminate then, without prejudice to any accrued rights under it, including those under clause 14.
(c)The fact that the Distribution Agreement was not assignable without Zeneca’s consent, save to a wholly owned affiliate had a number of effects:
(i)as a matter of practical reality, the Distribution Agreement was not assignable to any third party, but only to a third party to which Zeneca had consented;
(ii)even if it is assumed that Zeneca would have consented, any acquiring party, including Zeneca BV, would still hold an asset with restrictions on its assignability;
(iii)even if Orica had assigned the Distribution Agreement to an affiliate, the affiliate would hold an asset with restrictions on its assignability.
(d)If there had been no agreed extension of the Distribution Agreement, Orica through its affiliate, Orica Australia, in accordance with Article 14, would have transferred the Business to Zeneca for an amount, the calculation of which had been contractually pre‑determined (but yet to be confirmed by the English High Court). In that instance, no amount could have been attributable to the Distribution Agreement because that agreement would not have been in existence and therefore could not have been assigned.
(e)Because the sale proceeded, the Distribution Agreement was not terminated before it was assigned. No rights to payment for the business ever accrued to Orica under Article 14 and so such right was or could be assigned by Orica to Zeneca.
(f)Zeneca BV did not pay any amount for the assignment of the Distribution Agreement. The rights under the Distribution Agreement which were sold by Orica were rights which Orica would not have been able to exploit in the future. As at 4 September 1998, absent a sale of the Business to a Zeneca associate, the Distribution Agreement had 4 days to run. Orica could not derive any benefit from the rights of distribution for 4 days because Orica had not carry on the Business.
Mr Selak provided a draft valuation on 5 October 2004. In some respects it differed from his first report (2006). However, the essential reasoning is the same as that described at [137] to [140] above, and its conclusions are the same.
In its initial Statement of Facts Issues and Contentions (31 October 2005) Orica contended:
(a)by reason of the Assignment Deed its rights under the Distribution Agreement (the Distribution Asset) were disposed of;
(b)it received no consideration for the disposal of the Distribution Asset;
(c)by reason of s 160ZD(2) it is deemed to have received as consideration in respect of the disposal an amount equal to the market value of that asset at the time of the disposal;
(d)by reason of the service of the notice of termination, the agreement reached between Orica and Zeneca on 3 September 1998, the entry into the Sale Agreement and the terms of the Distribution Agreement, the market value of the Distribution Asset on 4 September 1998 was nil, or a nominal amount, or alternatively some amount less than $264,540,764.
It can be seen from the above that Orica’s case as outlined in its letter to Mr Selak of 19 August 2004, as reflected in his draft report and as cast in terms of Part IIIA in the Statement of Facts Issues and Contentions, was essentially that presented at trial in reliance on Mr Selak’s reports. That is that Orica’s rights under the Distribution Agreement as at 4 September 1998 were valueless.
Attributing to Orica as at 30 July 1999 the understanding of its case described above as “the way in which the application of the law was treated” for the purposes of s 226K(d), the question in Walstern terms is whether Orica’s contention that the Distribution Asset was valueless on 4 September 1998 based on Mr Selak’s reasoning, though ultimately held to be wrong, is nevertheless “about” as likely to be correct as the view that ultimately prevailed in the sense that reasonable minds could differ as which view was correct. A question of judgment is involved, and in my view the view that has ultimately prevailed is so clearly superior to Orica’s that it cannot be said that its view is “about” as likely to be correct as the one that prevailed.
The imposition of the penalty was based on a tax shortfall of $95,234,675. On the view I have taken it was somewhat less than that. The parties are agreed that the penalty issue is whether additional tax by way of penalty of $23,808,668.78, or some lesser amount, was properly payable by Orica pursuant to s 226K. The lesser amount of $22,545,000 is properly payable on that account.
I certify that the preceding two hundred and thirty (230) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Sundberg. Associate:
Dated: 10 March 2010
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