Player and Ors and Commissioner of Taxation
[2008] AATA 273
•4 April 2008
Administrative Appeals Tribunal
DECISION AND REASONS FOR DECISION [2008] AATA 273
ADMINISTRATIVE APPEALS TRIBUNAL )
) WT2001/3146
) WT2004/297, 299 – 300
) WT 2004/257
TAXATION APPEALS DIVISION )
Re Eric James Richard Player
Kimberley Bruce Leunig
Lost Gold Pty LtdApplicants
And
Commissioner of Taxation
Respondent
DECISION
Tribunal Mr A Sweidan, Senior Member Date4 April 2008
PlacePerth
Decision The Tribunal affirms the decisions under review ...........[sgd Mr A Sweidan]............
Senior Member
CATCHWORDS
Income Tax – “IPF 97” project – deductions claimed for “franchise expenses” – whether deductions allowable – whether anti-avoidance provisions apply
LEGISLATION
Income Tax Assessment Act 1936 – s51(1) – Part IVA
CASES
Amalgamated Zinc (de Bavay’s) Ltd v FCT (1935) CLR 295 at 309
Australian Trade Commission v Disktravel [1999] FCA 48
Clowes v FCT (1954) 91 CLR 209 at 218Commissioner of Taxation v Sleight (2004) 136 FCR 211 at [47]-[50]
Commissioner of Taxation v Sleight (2004) 136 FCR 211
Commissioner of Taxation v Lau (1984) 6 FCR 202
Commissioner of Taxation v Emmakell (1988) 22 FCR 157
Commissioner of Taxation v Cooke (2004) 55 ATR 183
Enviro Systems Renewable Resources Pty Ltd v ASIC (2001) 80 SASR 1 at [36], [43], [44]Eastern Nitrogen Ltd v FCT (2001) 108 FCR 27
FCT v Consolidated Press Holdings (2001) 207 CLR 235 [95]
FCT v Cooke (2004) 55 ATR 183 at [88].
FCT v Hart (2004) 217 CLR 216FCT v Spotless Services Ltd (1996) 186 CLR 404
FCT vPeabody (1994) 181 CLR 359 at 383.
Ferguson v FCT (1979) 26 ALR 307 at 311Fletcher v Commissioner of Taxation (1991) 173 CLR 1
Hope v The Council of the City of Bathurst (1980) 144 CLR 1
Milne v FCT (1976) 133 CLR 526 at 535
Madison Pacific Property Management & Ors v Australian Securities Commission (1999) 30 Pty Ltd and Ors v Australian Trade Commission [1998] AATA 11Puzey v Commissioner of Taxation (2003) 131 FCR 244 at [46]-[49]
Ronpibon Tin NL v FCT (1949) 78 CLR 47
Travel Vision International Pty Ltd and Ors v Australian Trade Commission [1998] AATA 11
Ure v Commissioner of Taxation (1981) 34 ALR 237
Vincent v FCT (2002) 124 FCR 350 at [64], [65] and [67]REASONS FOR DECISION
4 April 2008 Mr A Sweidan, Senior Member Background and Issues
Issues
1.The claimed deductions relate to expenses incurred by the applicants as franchisees of IPF Finance Corporation Pty Ltd (IPF Finance) and claimed as income tax deductions (the claimed deductions). Those expenses as well as the tax savings and cash benefits obtained by each of the applicants is set out in Annexure A to these reasons.
2.The issues to be determined in each application in respect of the claimed deductions are:
(a)whether the claimed deductions are allowable under section 51(1) of the Income Tax Assessment Act 1936 (ITAA 1936);
(b)if the claimed deductions were allowable under that section, whether the applicants obtained tax benefits in connection with a scheme to which Part IVA of the ITAA 1936 applies.
The IPF 97 Project
3.In these Reasons the “IPF 97 Project” refers to the proposal contained in the IPF 97 Information Memorandum (IM) and the arrangements effected by the Licence Agreements, Franchise Agreement, Management Agreement, Loan Deed and Indemnity Agreement summarised below and matters incidental to those arrangements.
4.It is common cause that the various companies involved in the franchise arrangements for the IPF 97 Project (IPF Finance; Retail Management Australia (RMA); Commercial Credit Finance (CCF), Commercial Insurance Australia (CIA); Insurance Premium Finance (IPF); Easy Rent Pty Ltd (Easy Rent); Mortgages Direct Pty Ltd (Mortgages Direct) and Chambers Capital Group) were associates.
5.IPF Finance (the Franchisor) and RMA (the Manager) were also trustees for the IPF Unit Trust and the Retail Management Services Trust respectively. Denby Vale Pty Ltd (Denby Vale) was the unit holder in those trusts. Denby Vale is associated with Mr Stephen Wharton. A Heads of Agreement was executed by IPF and Denby Vale which, among other things, governed the manner of distributions to Denby Vale by the issue of units and cash distributions: T101 and 102/V1/1-67 and T902/V5/1345-1347.
6.IPF, Easy Rent and Mortgages Direct provided the financial products referred to in the IPF 97 Project documents. Those entities are collectively referred to in this decision as the “Financial Providers”.
The IPF product
7.An annexure to the ATO audit report contained in the “T” documents before the Tribunal summarises the accounts for IPF for the years ending 30 June 1995 to 1998: T820/V5/1297 and T821/V5/1298.
8.The accounts for the year ended 30 June 1996 disclosed that IPF made a net profit of $31,887 on income of $92,306. The income comprised premiums $37,000), other revenue ($7,115) and the interest received ($48,191). Mr Leunig who was one of the principal witnesses for the applicants produced the accounts for IPF for the year ended 30 June 1997 which showed the comparative figures for the previous year (annexure “KBL 1” to his affidavit sworn 22 July 2005 – Ex A3; that affidavit is referred to in these Reasons as Leunig Ex A3).
9.Mr Leunig was cross-examined about the source of IPF’s income for each of the years ended 30 June 1996 and 1997. He was unable to state the source of its income.
10.For the year ended 30 June 1997, IPF made a net loss of $117,765. Its income for that year was $102,680 comprising interest received ($96,800) and other revenue ($5,880). Its expenses in the year ended 30 June 1997 included $124,000 paid in royalties. Mr Leunig was unable to advise as to the reason for those royalty payments.
11.The balance sheet for IPF for the year ended 30 June 1996 showed net assets of $29,461. Its principal asset comprised trade debtors of $321,423. The balance sheet for IPF for the year ended 30 June 1997 showed a deficiency of assets over liabilities of $98,873. The company’s principal assets comprised trade debtors ($286,371) and “loan accounts” ($86,669). Its principal liabilities comprised loans of $274,800 and trade creditors of $171,365. Mr Leunig was unable to identify the trade debtors or trade creditors or the loans made to and by IPF.
12.The accounts for the period 1994 to 1998 summarised in the ATO audit report and the accounts annexed to the affidavit of Mr Leunig indicate that at no time was IPF a profitable company or a company that had, as claimed in the IM, a “successful track record”. In the Tribunal’s view it is clear that any prospective investor who had asked for the past accounts of IPF would have discovered that this statement in the IM was misleading, as was the general impression created in the memorandum that IPF was an established business successfully marketing its product.
13.In Leunig Ex A3 at [15], Mr Leunig referred to relationships being established with insurance brokers and insurance intermediaries in Melbourne and Sydney. He referred to Gow-Gates Financial Services Pty Ltd but could not demonstrate whether any contract had been entered into with that company: see Leunig Ex A3, “KBL 6”/84 and “KBL 8”/100, 109, 114. Nor was there any evidence of executed copies of consultancy agreements.
14.In relation to projected fee income for franchisees from IPF, it should be noted that the agreement to be entered into between IPF and insurance brokers provided that a broker received 35% of the gross interest payments made by borrowers – see the schedule to the consultancy agreement forming part of “KBL18” to Leunig Ex A3 (at p 536).
15.The Franchise Agreement provided that franchisees would receive 60% of the net profit (defined to mean the annual net profit as determined by IPF and Easy Rent in respect of finance provided by them) “derived” by IPF from the insurance premium finance by it (cl 1.1.15 of the Franchise Agreement). That is, the calculation of the franchisees’ income was net of the amount paid to brokers; franchisees received 60% of the net profit earned by IPF from receiving 65% of the gross interest payments made by clients.
The Easy Rent product
16.T909/V5/1385 is a historical company extract for Easy Rent. The extract discloses that Easy Rent was first registered on 30 June 1989 as HID Insurance Services (WA) Pty Ltd; the company changed its name on 16 April 1997 to Easy Rent; Mr Jones was appointed director of Easy Rent on 15 February 1990; Mr Leunig was appointed a director on 1 June 1997; and the ultimate holding company of Easy Rent was Chambers Capital Group Ltd.
17.According to Mr Leunig, it was not until early 1997 that the Easy Rent product was first “publicly” marketed (Leunig Ex A3 at [11] and [12]). Presumably, that coincided with the change in the company’s name.
18.The accounts of Easy Rent for the years ended 30 June 1994 to 1998 are summarised in attachments to the audit report: T822/V5/1299 and T823/V5/1300. For the year ended 30 June 1997, the accounts show that the principal source of income was “contract income”. Mr Leunig was unable to give an explanation as to the source of that income.
19.The profit and loss statement for the year ended 30 June 1997 further shows that the company made a net loss of $38,421. It paid $80,000 in management fees and $40,000 in royalties – again, Mr Leunig was unable to give an explanation as to the reasons for those payments.
20.The balance sheet for Easy Rent for the year ended 30 June 1997 disclosed a net deficiency of assets of $50,073. The company’s principal assets comprised loans made to Jaymark Holdings (a company associated with Mr Jones) and Mortgages Direct. Its principal liability was a loan from CCF.
21.The profit and loss statement for the year ended 30 June 1998 disclosed that Easy Rent received $205,528 in rental income but the company made a net loss of $4,457. The company’s principal expense was rental equipment depreciation. Other major expenses comprised commissions paid ($36,669), franchisee commissions ($29,373) and interest payments ($57,082).
22.Easy Rent’s balance sheet for the year ended 30 June 1998 disclosed a net deficiency of assets of $54,530. The company’s principal assets comprised the rental equipment that it had financed (under the terms of its rent agreements, Easy Rent became the owner of the equipment). The company also had a significant receivable for commissions. The company’s principal liability was a debt of $1,150,558 owing to CCF.
23.The IM at p 9 is clearly intended to convey the impression that the business of Easy Rent was established, at least in Western Australia. Had prospective investors enquired, they would have found that Easy Rent had, at best, barely commenced trading by 30 June 1997. It is clear that at the time of the distribution of the IM there would have been no meaningful trading results on which the projections for franchisee income could be based.
The Mortgages Direct product
24.T910/V5/1393 is an historical company extract for Mortgages Direct. The historical company extract disclosed that:
(a)The company was first registered on 23 March 1998 as Noredale Nominees Pty Ltd. On 7 March 1990 the company changed its name to Noredale Financial Services Pty Ltd. The company changed its name again on 6 May 1991 to Chambers Financial Services Pty Ltd and yet again, on 20 August 1992 to Noredale Financial Services Pty Ltd. On 28 February 1996 the company changed its name to Mortgages Direct.
(b)Mr Jones was appointed a director of the company on 4 August 1988. Mr Leunig was appointed a director on 13 November 1996.
(c)The ultimate holding company of Mortgages Direct was Chambers Capital Group Ltd.
25.The accounts for Mortgages Direct for the years ended 30 June 1994 to 1998 were summarised in an attachment to the audit report – T824/V5/1301 and T825/V5/1302. The profit and loss statements disclosed no income or expenditure for the years ended 30 June 1994 to 1996. The profit and loss statement for the year ended 30 June 1997 disclosed that the company received $103,480 in income, of which $92,000 was described as being “National Mutual”. Mr Leunig was not able to identify the source of that income. Further, the company made a net loss of $43,354. The company’s principal expenditure was $80,000 in management fees and $40,000 in royalties – again, Mr Leunig was unable to provide any explanation for those payments
26.The profit and loss statement for the year ended 30 June 1998 showed that Mortgages Direct received $239,966 in income, nearly all of which was commissions; the company made a net loss of $4,933 and its principal expense was franchisee commissions.
27.The balance sheets for Mortgages Direct disclosed that in every year from 30 June 1994 there was a deficiency of net assets. In the year ended 30 June 1997 the deficiency was $124,256 and in the year ended 30 June 1998, it increased to $129,189. In the year ended 30 June 1997 the company’s principal asset comprised a loan to Jaymark Holdings. Its principal liabilities comprised loans from “Finkelstein” and Easy Rent. In the year ended 30 June 1998 the company’s principal assets comprised commissions receivable - $219,000. That amount, in the form of a liability to pay franchisee commissions, also represented the company’s principal liability.
28.According to Mr Leunig, the Mortgages Direct product began in the early 1990s and was a mortgage broking service. While there was no direct evidence to the contrary, it should be noted from the account summary in the audit report that for the years ended 1994 to 1996 Mortgages Direct received no income and incurred no expenses. There was little evidence of any business activity by Mortgages Direct during 1997 to 2000.
29.There was much uncertainty as to the nature of the business operated by Mortgages Direct (if any). The IM stated that the franchises to be offered were for the operation of a marketing business within the finance industry that provided “confirmed sources of finance” for “securitised home mortgages to the community for new home loans and the refinancing of existing home loans, together with innovative home loan reduction programmes” (p 7). The memorandum further stated that each of the financial “services” had a common denominator – “the lending of money to credit-worthy clients”. Those statements suggest that the business of Mortgages Direct was the provision of home loans. Mr Weir, one of the applicant’s witness, read the IM that way. At [10] of his affidavit (Weir Ex A14), he referred to the statements contained in the IM but noted that he had been instructed that Mortgages Direct in fact took the role “as purely a broker of mortgages”.
30.The IM contained a further description of the business of Mortgages Direct at p 9. It stated that:
“Mortgages Direct does not operate in the market as just another home loan provider or an extension of a finance broking arm, but was formed primarily to develop ‘Finance Consultants’ Australia-wide who wish to provide financial services to their existing client bases.
The concept has the capacity to significantly increase the potential earnings of these finance consultancy firms. Mortgages Direct has targeted in excess of 100 such intermediaries and established contractual relationships with many of these firms.” (emphasis added)
31.The business described by those statements is far from clear. The promotional material prepared by IPF Finance and/or RMA after June 1997 was also equivocal. The promotional material was directed primarily to the “Wealth Pro” product which was not referred to in the IM.
32.“KBL14” annexed to Leunig Ex A3 is a document that Mr Leunig described as being an “early development” of the franchise business (at [22]). The document described the “Franchisor” as operating as a finance company specialising in, among other things, providing residential finance via mortgage originators to home buyers and refinancing existing home loans and providing homesaver insurance through a product known as “Home Saver Insurance”
33.That accorded with references in the Licence Agreement made between IPF Finance and Mortgages Direct: see recital A and cl 5 where it was stated that Mortgages Direct provided residential finance and associated loan protection policies. Significantly, that statement was repeated in the description of the Products in item 6 to the Schedule to the Franchise Agreement.
34.No agreements involving Mortgages Direct were produced in evidence – that is, agreements between Mortgages Direct and lenders pursuant to which Mortgages Direct was appointed as agents for the lenders or between Mortgages Direct and brokers. There was no evidence that Mortgages Direct ever entered into any arrangements with lenders that enabled them to act as a mortgage broker.
35.Having regard to the above analysis of the documentary evidence Mr Leunig’s evidence that the Financial Providers were profitable prior to the commencement of the IPF 97 Project is rejected by the Tribunal. It is inconsistent with the accounts of the companies concerned as disclosed by the audit undertaken by the ATO. It was apparent in cross-examination that Mr Leunig had no understanding and little knowledge of the accounts of the companies. He had not reviewed the accounts prior to making his affidavits and witness statement or giving evidence.
THE AGREEMENTS FOR THE IPF 97 PROJECT
Licence Agreements (T103/V1/68-87)
36.By Licence Agreements dated 1 June 1997, IPF, Easy Rent and Mortgages Direct, as Licensors, each granted IPF Finance, as Licensee, a licence for 10 years from the Commencement Date to market the Products and to franchise the marketing of the Products to third party Franchisees “in accordance with a system developed by the Licensee to enable Franchisees to locate and recruit new Clients for the Licensor for the Products in the Territory and further for the Licensee (as franchisor) to enter into Franchise Agreements with Franchisees for that purpose and to receive royalty fees from Franchisees under the Franchise Agreements” (cl 1) (emphasis added). The Franchisees were not parties to the Licences.
37.Pursuant to the Licences:
(a)the Licensors were to pay direct to the Franchisees the Franchisee’s Entitlement (cl 4);
(b)the Licensors were to deliver annually to the Licensee at the Licensee’s request a report specifying the Clients who had been referred by Franchisees to the Licensor and to whom the Licensor had supplied any Product (IPF and Easy Rent) or with whom the Licensor has entered into a mortgage (Mortgages Direct) (cl 5). There was no evidence that any such reports were requested by the applicants and/or provided.
38.Clause 4.3 of the Licence Agreements with IPF and Easy Rent provided for the Licensee to direct the Licensor to withhold and deduct from the Franchisee Entitlements the amounts set out in cll 4.2, 4.3 and 4.4 of the Franchisee Agreement. Those amounts were interest, management fees, annual royalty and loan principal payable under the various agreements entered into by Franchisees. The Licence Agreement with Mortgages Direct made no such provision.
The IM
39.In about May 1997 IPF Finance issued a “Business Opportunity Information Memorandum” and began marketing the franchises through Chambers Investment Planners. Each applicant produced the IM (Mr Player’s affidavit, Ex A9, “JRP 4”; Mr Fyson’s affidavit, Ex A1. “CHF 6” and Mr Leunig’s affidavit sworn 20 May 2005 Ex A2, “KBL 8”) (Mr Player’s affidavit sworn 14 May 2005 is referred to in this decision as Player Ex A9; Mr Fyson’s affidavit sworn 13 May 2005 is referred to as Fyson Ex A1 and Mr Leunig’s affidavit sworn 20 May 2005 is referred to as Leunig Ex A2).
40.The front sheet of the IM described the content as a “Business Opportunity”, and a “Finance Business Franchise”. “The Franchise Offer” was described at p 8 of the IM as follows:-
“IPF Finance Corporation Ltd (“the Franchisor”) is granting up to nine hundred and fifty (950) franchises, each for a ten year period.
Each Franchise will be granted an exclusive geographic area and will operate in the marketing of financial services within the badged products and services of the Franchisor.
The Franchisor will provide a full service to the Franchisees to assist them to develop and maintain their business.
These include, but are not limited to, computer software, licensing and representative requirements, accounting and financial control, training and marketing. These are provided as a service to benefit and assist the Franchisee.”41.The IM further stated at p 5 that:
“ IPF Finance Corporation Ltd currently provides finance under the badged product names of Insurance Premium Finance, Easy Rent (Rental Finance) and Mortgages Direct.”
42.The “Summary of Franchise Offer” contained in the IM at p 4 stated:
·“IPF Finance Corporation Ltd has identified and operates in three strategic and profitable financial service markets and is now granting exclusive Franchise rights to market these financial services to both businesses and individuals based on specific geographic locations throughout Australia.
·The Franchises have been structured so that the Franchisees have the opportunity to elect to either have their Franchise area managed by a Professional Manager or manage it themselves.
·The first year’s expense is $32,000, followed by annual fees, based on the gross revenue of each Franchise.
·A business loan of up to $20,000 at an interest rate of 7% per annum, secured by the Franchise and repayable from the net profits of the Franchise business is available for Franchisees.
·The Loan Insurance Fee provides the Franchisee with an insurance policy which will repay the business loan and any accrued interest, in full, should the Franchise not make sufficient net profit to repay the loan.
·The loan is repayable from the net profit of the Franchise business and loan insurance is available.
·If the business loan option is used, the Franchisee is required to pay $12,000 of the first year’s Franchise expenses at the time of application. (This includes $375 for legal documentation and stamp duty and $625 Loan Insurance Fee).
·A short term credit facility of $10,000 may also be made to approved applicants.
·Applicants wishing to proceed with this Business Opportunity, should read this Information Memorandum and then complete the Application Form attached and forward it to the Franchisor.”
43.The IM at pp12 and 13 contained “Estimated Returns to Franchisee” on a pre-tax basis from a franchise operated for a 10 year period. No explanation of how the projections were derived, or any assumptions on which they were based was included. The estimated returns were expressly disclaimed.
44.The various experts who gave evidence agreed that the only information in relation to the estimated returns to the franchises was stated at p 11 of the IM as follows:
“The Income and Expenditure estimates for the Franchisee have been based on the business being operated for 10 years.
The estimates are based on the development of a network of intermediaries and mortgage originators to market and distribute the products and services.
The Franchisee receives income from each financial transaction completed in their geographic franchise area.”
(Dawson Ex R8, Report [20]; Acheson Ex R6, Report [2(k)] pp 5-6; 1st and 7th paras p 14; [8] pp 28-29)
45.At p 21 the IM contained information as to how franchises were to be allocated. It detailed the availability of the 950 franchises by State or Territory franchise areas, beginning with New South Wales, as follows: -
“1. FRANCHISE AREA NSW (NEW SOUTH WALES)
IPF Finance Corporation Ltd is granting up to a maximum of 242 Franchises in this area based on postcodes of appropriate size. The first Franchise allocated will be numbered NSW001. The last will be numbered NSW242”……….
and so on for Victoria, Queensland, South Australia, Australian Capital Territory, Tasmania, Northern Territory and Western Australia.
The projections in the IM
46.“KBL 14” to Leunig Ex A3 contained projections for IPF and Mortgages Direct said to have been given to Mr Leunig in the “early development” of the franchising proposal ([22]). The document projected total franchisee income over ten years at $103,250. A loan was to be granted to franchisees which, together with interest, would amount to $23,000 over ten years. Franchisees would earn $81,250 over ten years after deducting the loan and interest.
47.The projections were based on 100 brokers agreeing to exclusively market the insurance premium product with each broker funding $3 million on an interest charge of 7% and with 10% of the interest charged being allocated to two franchisees; a further 100 representatives marketing the insurance premium funding product independently with each representative funding $1 million with interest charges at 7% and 20% of the interest charge being allocated to franchisees; and 100 originators marketing the Mortgages Direct product and each originator writing 60 home loans per annum generating a total of $6,000 home loans with trailing commission.
48.It is to be noted that the projected franchisee income on those assumptions was significantly less than that projected in the IM.
49.There was no evidence as to the circumstances in which the document “KBL 14” was prepared or, indeed, who prepared the document. The significant increase in projected franchisee income in the IM was not explained.
50.The IM contained no information about the derivation of the projections for franchisee income. Further, there was little evidence as to how the projections were made. Consequently, the only means by which the applicants were able to obtain any evidence concerning the reasonableness of the projections was to instruct persons who were supposedly experts in the areas of business conducted by IPF, Easy Rent and Mortgages Direct. Significantly, it was necessary for each of those persons to make their own assumptions so as to assess the projections contained in the IM.
51.In his report (Dawson Ex R8) at paragraph [20], Mr Dawson, a chartered accountant, and independent expert called by the respondent stated that:
“(a) … In these circumstances:-
(i)it would not have been possible for an investor to properly assess whether the returns projected in the IM would adequately compensate for the risk associated with the investment; and
(ii)any calculated measure of return, including an IRR, would have been meaningless.
(b)The figures in the column headed “Total” were arguably misleading because those figures do not include the outgoings in the column headed “Base year”. The figures showing in the “Total” column in the “Net Position” line did not represent the projected net return at the end of the ten year life of the franchise.”
52.In his report (Acheson Ex R6, pp 5-6 and 14) Mr Acheson, a franchise expert and chartered accountant, also called by the respondent refers to mistakes in these estimates and to inconsistencies between the estimates and the Franchise and Management Agreements. Further he states at pp14 and 28-29:
“… there is no apparent attempt to conform to any of the requirements of either the Franchising Code of Practice or the much discussed new Franchising Code of Conduct relating to providing the base/assumptions of the representations and other information. These projections would appear to apply irrespective of the location of the franchise territory with no mention of any variation of projection of estimated net income.” (page 14)
“The projected returns for the franchisees were overstated in the projections as the first year negative figures have not been deducted from the total return. The initial investment of $32,000 should be deducted since the Franchise Agreement unusually has no provision for renewal therefore there is no value left at the end of ten years, capital or income. This contrasts to an investment in say shares where the shares will still exist at the end of ten years with a capital value and a regular income. …”
“… To have the projected earnings of $40,364 over ten years in nominal dollars for an investment of $32,000 is not a great return, for an investment in a new, untested business.” (pages 28-29).
53.The experts called by the applicants, Messrs Harvey, Janeczko, and Weir also agreed that the assumptions they drew to provide their opinions on the projected income figures in the IM were assumptions they would expect to see identified in the IM.It is apparent from their reports that they were not provided with earlier projections contained in “KBL 14” to Leunig Ex A3.
54.The Tribunal notes that the projections bore no resemblance to, and cannot be justified on the basis of, the past financial performance of the Financial Providers. The past financial performance of the Financial Providers would, of course, ordinarily be the starting point for any assessment of the projections. Significantly:
(a)none of the applicants made any inquiries concerning the past financial performance of the Financial Providers prior to entering into the IPF 97 Project;
(b)none of the applicants’ experts sought information about the past financial performance of the Financial Providers prior to expressing their opinions on the reasonableness of the projections.
55.The Tribunal also notes that the projections in the IM indicated that the applicants could not expect to make a net gain over the term of the franchise until year 8 and that the total gain would only be approximately $58,000 (under option B). That represented a very modest projected gain for the amount outlayed given the ten year term of the Franchise Agreement. That is particularly so as most of the gain was projected to be made in the last year – a gain to be made in the tenth year was obviously a highly speculative and uncertain forecast.
The Franchise Agreement (“EJRP 7”, “CHF 9” and “KBL 9”)
56.Recitals A to E of the Franchise Agreement recited that:
A.The Financial Providers have granted the Franchisor the exclusive right under licence to market the following financial services and products:
(1)Insurance Premium Finance;
(2)Easy Rent;
(3)Mortgages Direct.
B.The Franchisor has developed a system for the identification and recruitment of potential clients for the Products.
C.The Franchisor has agreed to grant an exclusive franchise within the Territory to the Franchisee, whereby the Franchisee operates the Franchised Business on the basis of finding new clients for the Products in the Territory in accordance with the System, and upon the terms and conditions contained in this Agreement.
D.The System requires franchisees to strictly comply with the standards, specifications, procedures and policies of the Franchisor for the uniform conduct and operation of the Franchised Business.
E.The success of the System depends upon Franchisees’ compliance with this Agreement.
57.The System was defined in cl 1.1.33 of the Franchise Agreement as follows:
“System means the system developed by the Franchisor involving the identification and recruitment of Clients for the Products through marketing and contact with registered insurance brokers, finance and mortgage originators operating throughout Australia for the purpose of introducing those Clients to the Financial Providers who will:
1.1.33.1provide finance to those Clients for the purpose of allowing those Clients to pay insurance premiums, obtain the use of plant and equipment and purchase residential property;
1.1.33.2pay to the Franchisee the Franchisee’s Entitlement. (emphasis added)
58.By cl 2.1 of the Franchise Agreement the Franchisor granted to the franchisee “an exclusive licence in the Territory for the Term to use the System in relation to the conduct of the Franchised Business and agreed to provide the Franchisor Services” (emphasis added).
59.Relevantly, terms were defined in the Franchise Agreement as follows: -
(a)“Clients” “means those persons introduced to the Financial Providers by the Franchisee for and on behalf of the Franchisor in accordance with the System and upon the terms and conditions contained in this agreement” (cl 1.1.5) (emphasis added);
(b)“Products” means “the financial services and products licensed to the Franchisor by the Financial Providers more particularly known as Insurance Premium Finance, Easy Rent and Mortgage Direct more particularly described in Item 6 of the Schedule”. Item 6 was as follows:
“Item 6 – The Products:
INSURANCE PREMIUM FINANCEThis product provides finance to the clients of General Insurance Brokers throughout Australia to enable them to pay insurance premiums and like payments.
EASY RENT
This product provides rental finance to businesses for the predominant purpose of renting computer equipment and office equipment to allow those businesses to utilise the benefits of continual technology upgrades.
MORTGAGES DIRECT
This product relates to the provision of residential finance and the associated loan protection insurance policy (HOMESAVER) by MORTGAGES DIRECT.”
(c)“Franchised Business” “means the business to be conducted by the Franchisee in accordance with this agreement” (cl 1.1.14);
(d)“Territory” “means the territory outlined in item 10 of the Schedule”, i.e. named suburbs in a State or Territory of Australia (cl 1.1.35);
(e)“Franchise Procedures” “means all of the procedures laid down by the Franchisor from time to time in respect of the operation of the Business including but not limited to manuals, brochures and any other documents detailing the required or desired procedures applicable to the conduct of the Franchise” (cl 3.1.10);
(f)“System” means the system set out in clause 2.1 including such changes and enhancements to the system as shall be implemented by the Franchisor from time to time” (cl 3.1.18);
(g)“Term” means the term specified in item 9 of the Schedule, being 10 years from the Commencement Date specified in item 4 of the Schedule and in the case of each applicant was the date of execution of the Franchise Agreement (cl 1.1.34);
(h)“Financial Providers” means Insurance Premium Finance Pty Ltd, Easy Rent Pty Ltd and Mortgage Direct Pty Ltd (cl 1.1.11);
(i)“Franchisor’s Services” means the services to be provided by the Franchisor to the Franchisee during each year of the Term being those services more particularly described in cl 15;
(j)“Management Agreement” means any agreement that may be entered into by the Franchisee to engage a third party to manage the Franchised Business (cl 1.1.23);
(k)“Management Fee” means any fee required to be paid by the Franchisee to the manager pursuant to the terms of the Management Agreement (cl 1.1.24).
60.The Franchise Agreement made provision for: -
(a)The Franchisee to employ a manager (RMA) subject to the consent of the Franchisor (IPF Finance) but without releasing the Franchisee from any obligations under the Franchise Agreement (cl 43).
(b)Training and assistance by the Franchisor (cl 7). The agreement provided for training at the expense of the Franchisee but according to such arrangements as the Franchisor deemed fit. The Franchisor was also to provide at such times as it deemed appropriate one of its “advisory personnel” for the purpose of assisting the Franchisee with the conduct of the Franchise Business.
61.The Franchisee’s payment obligations were as follows:
(a)Payment by the Franchisee of the Annual Royalty for the first year of the Term of $10,000 in advance within 14 days of the Commencement Date and thereafter an annual royalty of $9,000 or 31.5% of the Franchisee’s Entitlement for the preceding year whichever was the greater (cl 3.1,cl 1.1.3 (definition of Annual Royalty) and item 3 of the Schedule).
(b)A Franchisee could elect to pay the ongoing annual royalty in arrears in an amount equal to $10,000 or 35% of the Franchisee’s Entitlement for the preceding year whichever was the greater. If the Franchisee elected to pay in this way, then to the extent that his entitlement for the preceding year was insufficient to pay the whole or part of the Annual Royalty the unpaid amount was to be carried forward as a debt due to the Franchisor to the next year and deducted from the Franchisee’s Entitlement for the next year in accordance with cl 4.
62.The Franchisee’s Entitlement is set out in cl 4 as:-
“4. FRANCHISEE’S ENTITLEMENT
4.1Subject to Clause 4.2 hereof, the Franchisee’s Entitlement shall be paid annually to the Franchisee by the Financial Providers pursuant to the terms of the Licence Agreement and the Franchisor shall procure the payment by the Financial Providers to the Franchisee of the Franchisee’s Entitlement pursuant to the terms of the Licence Agreement.
4.2Prior to payment to the Franchisee, the Franchisee acknowledges and agrees that the Financial Providers shall be entitled to first withhold and deduct from the Franchisee’s Entitlement the following:
4.2.1Interest – which shall then be remitted by the Financial Providers to the Lender (as defined in the Loan Agreement);
4.2.2the Management Fee (if applicable) – which shall then be remitted by the Financial Providers to the Manager (as defined in the Management Agreement);
4.2.3the Annual Royalty – which shall then be remitted by the Financial Providers to the Franchisor.
4.3The Franchisee acknowledges and agrees that the balance (if any) of the Franchisee’s Entitlement after the deductions referred to in Clause 4.2 hereof shall be divided into two (2) equal parts with the first part to be remitted by the Financial Providers to the Lender in repayment of the First Principal Sum and the second part to be paid to the Franchisee for the Franchisee’s sole use and enjoyment. Upon repayment of the First Principal Sum the Franchisee shall be entitled to the whole of the balance (if any) of the Franchisee’s Entitlement as hereinbefore referred to in this Clause.
4.4The Franchisee acknowledges and agrees that to the extent that the Franchisee’s Entitlement is in any year insufficient to pay any of the items referred to in Clause 4.2 and 4.3 then the Franchisee’s Entitlement shall be applied in the following order – firstly, to the payment of the Interest, secondly, to the payment of the Management Fee (if any), thirdly, to the payment of the Annual Royalty, fourthly, to the repayment of the First Principal Sum, fifthly, to the payment of the Franchisee. The Franchisee and the Franchisor acknowledge and agree that to the extent that the Franchisee’s Entitlement is insufficient to pay the amounts hereinbefore referred to or any other monies at any time due and owing by the Franchisee under the terms of this Agreement or the Management Agreement or the Loan Agreement then any unpaid amounts in respect thereof shall be carried forward as a debt due to the next year to be first remitted by the Financial Providers to the relevant party from the Franchisee’s Entitlement for that next year in priority to any other amounts with the balance of the Franchisee’s Entitlement in that next year to then be remitted in the same manner for that next year as set out in this Clause 4.”
63.The Franchisee was required to commence operating the Franchise Business on the Commencement Date (cl 6.1). The Commencement Date was defined as the date of execution of the Franchise Agreement. That date for Mr Player was 29 June 1997 and 30 June 1997 in respect of the other applicants. Further and pursuant to cl 14, the Franchisee’s obligations included: -
(a)on execution of the Franchise Agreement, to use the System (cl 14.1);
(b)effect payment of all royalties and other monies payable to the Franchisor in accordance with the Franchise Agreement (cl 14.3.1);
(c)to comply with all the requirements in the Franchise Agreement for the operation and maintenance of the Franchised Business (cl 14.3.10);
(d)to devote the Franchisee’s time and effort to the operation of the Franchised Business (cl 14.3.4);
(e)to conduct the Franchise Business as an independent business and not as a partner, representative, or employee of the Franchisor (cl 14.3.9);
(f)to furnish the Franchisor with completed forms, statements of account, reports, records and other documents required by the Franchisor and make the records of the Franchise Business available for inspection by the Franchisor (cll 14.3.14 and 14.3.15).
64.A Franchisee was also required to cause to be conducted an annual audit of the Franchised Business (cl 17) and take out and maintain insurance stipulated by the Franchisor from time to time and give notice of any claims under any of the insurances (cl 19).
65.Pursuant to cl 15, the Franchisor’s covenants included: -
(a)To provide the System in a proper and professional manner during the Term (cl 15.1).
(b)To provide the Manual (cl 15.7) and the Computer Software (cl 15.8). The “Manual” was defined (cl 1.1.25) as “the manual published by or on behalf of the Franchisor setting out the specifications, advertising and management policy, standards and procedures prescribed at any time by the Franchisor for the incidental operation of the Franchised business and running of the System not expressly dealt with in this Agreement”. The “Computer Software” was defined (cl 1.1.7) as “the computer software to be provided by the Franchisor to the Franchisee pursuant to clause 8 of the Franchise Agreement”.
(c)To promote market and advertise the Products throughout the Term as it determines (cl 15.4).
(d)To make available to the Franchisee improvements and developments to the Intellectual Property belonging to the Franchisor which are relevant to the conduct of the Franchised Business (cl15.5).
(e)To provide advice, training and information to the franchisee in relation to the conduct of the Franchised Business and improvements and enhancements to the System as it deemed appropriate (cll 15.2, 15.3 and 15.6).
The Management Agreement (“EJRP 8”, “CHF 10” and “KBL 9”)
66.The Franchisor was not a party to the Management Agreement but Recital F recorded that the Franchisor had approved the appointment of the Manager to manage the Franchised Business on behalf of the Franchisee.
67.By cl 3.1, the Franchisee commissioned and engaged the Manager as an independent contractor and manager (and not as an agent) to carry out the Services for the Term together with such other duties and obligations during the term as were detailed in the relevant Management Plan. The Manager was to commence to carry out the services on behalf of the Franchisee upon the execution of the Management Agreement (cl 5.3). Mr Player’s agreement was made on 29 June 1997 and the agreements in respect of the other applicants on 30 June 1997.
68.Under cl 4, the Franchisee was to pay to the Manager the annual management fee of $21,000 for the first year of the Term within 14 days of the Commencement Date. The annual management fee was the amount specified in Item 3 of the Schedule to be paid annually for the subsequent years of the Term. A Franchisee could elect in the second or any subsequent year to pay the Management Fee in arrears in an amount equal to 27.75% of the Franchisee’s Entitlement for the preceding year or the amounts specified in Item 3 of the Schedule whichever was the greater. If the Franchisee elected to pay in that way, then to the extent that his Franchisee’s Entitlement for the preceding year was insufficient to pay the whole or part of the Management Fee the unpaid amount was carried forward as a debt due to the Franchisor to the next year and was to be deducted from the Franchisee’s Entitlement for the next year and each subsequent year until all outstanding amounts were repaid in full.
69.Relevantly, terms were defined in the Management Agreement according to the definition of the same terms in the Franchise Agreement.
70.The “Management Plan” referred to in cl 5 was defined to mean “the management plans for the provision of the Services by the Manager referred to in Item 4 of the Schedule hereto”. Item 4 provided as follows:-
“ITEM:4 MANAGEMENT PLAN FOR THE FIRST SIX (6) MONTHS OF THE TERM (Clauses 1.10, 9.2 and 9.3)
Advertising Programme:
The Manager shall conduct constant advertising and promotional activities within the Territory to raise and maintain the general level of awareness of the Products. Specifically the Manager shall during the currency of this Management Plan:
(1) conduct at least 2,000 letter-drops to residents in the Territory;
(2)conduct at least two (2) community based promotions at a local shopping centre in the Territory, giving away novelty items to shoppers; and
(3)place at least one (1) advertisement in a community newspaper in the Territory, promoting the Products.
Marketing Programme:
The Manager shall conduct a marketing programme within the Territory to assist in the location and identification of Clients for the Products. Specifically the Manager shall during the currency of this Management Plan:
(1)contact all insurance brokers, accountancy firms and law firms within the Territory (for the Insurance Premium Finance product), all computer stores and outlets within the Territory (for the Easy Rent Product) and all real estate agencies within the Territory (for Mortgages Direct); and
(2)use its best endeavours to establish within those insurance broking firms, accountancy firms, law firms, computer outlets and real estate agencies individual contacts to assist in the location and identification of the Clients and the general promotion of the Products within the Territory.
Staff:
The Manager shall allocate sufficient staff to conduct the aforementioned advertising and marketing programmes in the Territory and in particular, the Manager shall ensure that the Manager’s staff or consultants during the currency of this Management Plan spend a combined total within the Territory of at least:
(1) fifty (50) hours conducting direct canvassing of Clients;
(2)Two hundred (200) hours participating in and assisting in the promotion of a National marketing and advertising campaign to be conduct by the Manager in respect of the Products.
Additional Matters:
During the currency of this Management Plan, the Manager shall undertake any other marketing, advertising and promotional activities to assist in the generation of Clients in the Territory and shall ensure that an accurate record of established Clients within the Territory are kept for the future marketing and canvassing of those Clients.”
71.By cl 5, the Manager covenanted with the Franchisee “to be responsible throughout the Term for the management of the Franchised Business in accordance with the Management Plan and to carry out or cause to be carried out such services and duties as are usual or necessary for carrying out the Franchised Business in accordance with the terms of the Franchise Agreement”. The Manager was to strictly comply with the terms and conditions of the Franchise Agreement in carrying out the Management Plan (cl 5.2.1).
72.The Manager was also to provide adequate and suitably trained staff and facilities so as to perform its obligations (cl 5.2.2).
73.Under cl 8 the Franchisee had the right to:
(a)object to and disallow any changes to the Management Plan provided that this right was not exercised unreasonably or in such a way as to unfairly prejudice the Manager;
(b)inspect and copy any document or other information relevant to the activities of the Manager in relation to the Services; and
(c)to express opinions and to give recommendations to the Manager relating to any matters the subject of the Agreement;
However, the Manager was only required to give due consideration to any opinions received in writing from the Franchisee relevant to the activities of the Manager under the Agreement and to use its best endeavours to carry out every recommendation from the Franchisee. It was not bound to implement any recommendation made by a Franchisee.
74.The applicants suggested in their opening that Franchisees had an absolute right to terminate the appointment of the Manager. That was not correct, as the applicants subsequently conceded. Further, it is clear that it would be extremely difficult to exercise the power of termination for an alleged breach of cl 8.
75.The Franchisee was entitled to terminate the Management Agreement if the Manager went into liquidation, appointed a receiver, ceased carrying on business or was in default of any obligation under the Management Agreement and the default continued for one month after the Manager received written notice specifying the default (cl 10).
76.At the end of each quarter during the Term, the Manager was to provide the Franchisee with a written record “of all matters howsoever relating to the Franchised Business and the Manager’s management of the Franchised Business including without limitation providing a record of all Clients introduced to the Financial Providers by the Franchisee” (cl 9).
77.Further, no later than six weeks prior to the end of every six month period of the Term the Manager was required to submit a Management Plan for the management of the Franchised Business in the following six months (cl 9.2). Item 4 of the Schedule to the Management Agreement contained the Management Plan for the first six month period of the Term. Subsequent plans were required to contain advertising and promotional activities comparable to those described in Item 4 (cl 9.4).
The Loan Deed (“EJRP 9”, “CHF 11” and “KBL 9”)
78.Franchisees were given the option of financing the first year fees: IM pages 12, 17-18 and 23. CCF, as the Lender, agreed to advance to each Applicant as the Borrower the Principal Sum on the Date of Advance. The “Principal Sum” referred to the “First Principal Sum” and where applicable, the “Second Principal Sum”. The “Date of Advance” was the date described in Item 4 of the Schedule being the date of execution of the Loan Deed (Clauses 2, 1.4 and 1.5 and Items 1 and 4 of the Schedule). Mr Player’s Loan Deed is dated 29 June 1997 and the Loan Deeds in respect of the other applicants are dated 30 June 1997.
79.By cl 8 of the Loan Deed, the Borrower authorised CCF to pay on the Borrower’s behalf from the Principal Sum all monies due and owing or required to be paid by the Borrower to any party pursuant to the Loan Deed, the Franchise Agreement, the Management Agreement including the Annual Royalty and the Management Fee.
80.A Franchisee/Borrower charged its interest in the Franchise Business to secure the repayment of the Principal Sum and all interest and other monies that were due and owing to CCF (cl 7).
81.Clauses 3 and 4 provided for the repayment of the Principal Sum in accordance with Items 4, 5A and 5B of the Schedule. The repayments dates of the First Principal Sum and interest thereon (at the rate of 7% pa calculated daily) was annually at the times and in the manner set out clauses 4.3 and 4.2 respectively of the Franchise Agreement. The balance of the First Principal Sum and the interest thereon was to be repaid on expiry of the term of the Franchise Agreement or on termination of that agreement. The Second Principal Sum and interest thereon (at the rate of 8% pa calculated daily) was to be paid on 30 September 1997.
The Indemnity Agreement (“EJRP 10”, “CHF 12” and “KBL 9”)
82.The Recitals to the Indemnity Agreement recited that as the Indemnifier (CIA) had agreed to indemnify the Franchisee in respect of the Franchisee’s liability for moneys due and owing under the Franchise Agreement, the Management Agreement and the Loan Deed to the extent that the income and assets of the Franchise Business were insufficient to meet those liabilities.
83.By cll 2 and 4, CIA agreed to indemnify the Franchisee from the Commencement Date on the basis set out in clause 4. The “Commencement Date” meant the same date as the commencement date in the Franchise Agreement, or the date the Indemnity Agreement was executed by the parties, whichever was the later. Mr Player’s agreement is dated 29 June 1997 and the agreements in respect of the other applicants, 30 June 1997.
84.The indemnity was in respect of the difference (if any) between all monies due and owing or required to be paid at any time by the Franchisee to any party pursuant to the Loan Agreement, the Management Agreement and the Franchise Agreement (except the Second Principal Sum and interest on that sum) and the amount payable to the Franchisee by the Financial Providers (referred to in the Indemnity Agreement as the “Indemnified Monies” - see cll 1.1.5 (Indemnified Monies), 1.1.4 (Franchisees Entitlement) and 1.1.9 (Outstanding Amounts)).
85.The Indemnifier agreed to pay the Indemnified Monies owing for which written demand had been made by IPF Finance, RMA and CCF on the date of the expiration or sooner determination of the terms of the respective Franchise Agreement, Management Agreement and Loan Agreement (cl 4.3).
86.The Franchisee’s obligations under the Indemnity Agreement were to:
(a)pay the sum of $625 to the Indemnifier on or before the Commencement Date (cl 3.1);
(b)comply with his obligations under the Franchise Agreement, the Management Agreement and the Loan Agreement (cl 3.2);
(b)pay the Second Principal Sum and the interest on the Second Principal Sum by the Repayment Date being 30 September 1997 (cl 3.3).
ENTRY INTO THE IPF 97 Project
Applications and entry into the franchises
87.The franchises were promoted by the Chambers Capital Group Ltd and Chambers Investment Planners Pty Ltd as “tax effective” (T203-210/V1/224-236 and T218-223/V1/261-267); for example, a promotional letter (T210/V1/234-236) stated:
“The franchise covers a allocated geographical area (with a minimum of 4000 letter boxes per area, or group of postcodes) which will produce substantial returns over the next ten years, with income projected to be at least $72,000 per franchise, when selecting Option B (see page 12 of the information memorandum) and having it run under management, pre-paying all fees in the first year, opting to only pay fees in arrears thereafter, being payable from 50% of the net franchise profits, and opting to take insurance indemnity (the cost of $625 is part of the initial $2,000 outlay) which will indemnify any further cash commitment whatsoever!
The proposed structure on a net taxable income of say $85,000 could allow you to receive sufficient tax refund this year (see attached sheet 1 shows rebate on $85,000 income is $15,217), to totally fund the business, plus provide a bonus cash surplus of about $3,217) which could be used to reduce non-effective debts, or be applied to investments for wealth creation or simply applied to your home loan mortgage reduction.”
88. Mr Player, Mr Fyson and Mr Leunig each stated that they (or in the case of Mr Fyson, Vier Pty Ltd (Vier)) entered the “Project” by signing the application form and executing the Deed of Power of Attorney and Appointment of Agent in the IM. An example of the application form is at p 23 of the IM produced by Mr Player (“EJRP 4” to Player Ex A9); an example of the power of attorney and appointment of agent is at “EJRP 5”. The power of attorney irrevocably appointed IPF Finance as agent and attorney.
89. Mr Player, Mr Fyson and Mr Leunig also produced the various agreements and other documents by which they or Vier applied for and entered into the franchise arrangements. In each instance the documents comprised:
(a) a signed franchise application form;
(b) a signed Power of Attorney and Appointment of Agent;
(c) a letter from Wilson and Atkinson enclosing franchise and related agreements for execution and return and an invoice for legal costs and disbursements;
(d) an executed Franchise Agreement;
(e) an executed Management Agreement;
(f) an executed Loan Deed;
(g) an executed Indemnity Agreement.
Pre-entry inquiries made by the Applicants
90.Mr Player gave the following evidence in Player Ex A9 about the inquiries he made in relation to the entering into the IPF 97 Project:
(a)He had accumulated some knowledge of the insurance and finance lending industry through “reading business magazines and personal business experiences”: [7].
(b)His initial knowledge of the franchise offer came from an advertisement he saw in the newspaper in or about May 1997 advertising the IPF franchise product and emphasising the “franchise business having passive income return over a medium to long term together with tax benefits”: [8].
(c)He had a meeting with the promoters’ Mr Clements at Chambers Investment Planners Pty Ltd in West Perth and they went through the whole business structure. Mr Clements handed him a package at the conclusion of the meeting which contained the IM: [8], [10].
(d)He read the IM several times. He had a tax opinion from Mr Gzell QC that the anti avoidance provision should not apply. He was concerned with the tax issue but accepted the opinion: [11].
(e)He met and spoke with his accountant, Mr Lee, about the project. Mr Lee was comfortable with the financial projections in the IM and the way the business model was structured: [11]. He did not seek any further expert advice: [12].
91.Mr Fyson gave the following evidence concerning his enquiries (Fyson Ex A1):
(a)He was approached by Mr Clements in or about early June 1997. Mr Clements provided him with an IM “which outlined all the details of how to participate in the Project”: [12] and [14].
(b)His previous business experience gave him a good understanding of the financial services industry and the equipment leasing industry: [12].
(c)He “also had a detailed look at the people who were on the board of the Project and also the people who would be managing the Project. Apart from Clements, I did not know any of them prior to the Project, however after considering the IM, it appeared they had a good track record. The IM also indicated that they had extensive backgrounds in the fields to which the Project was directed”: [15].
(d)He considered the IM and the projections and read “all relevant material”. He discussed his taxation position as a whole for that year with his accountant: [17].
(e)He relied on the advice from Mr Clements “that the legal and taxation structure of the Project was all above board. I specifically questioned Clements on the strength of the business and the people behind it”: [19].
(f)He read the expert tax opinions of Mr Gzell QC and Mr de Wijn QC noting “they were of the view that the way the Project was structured was legal from a tax perspective”. He “looked at the taxation side of it and enquired about all legalities and was assured as to it complying and fitting in with the taxation regime at the time”: [20].
(g)The location of the franchises was not discussed “and I assumed that they would be in my area of influence”: [23].
92.Mr Leunig gave the following evidence concerning his enquiries (Leunig Ex A2):
(a)He had been a financial planner for 17 years. He had worked with IPF “within the Chambers Group” and had been “part of the discussions with funding institutions in respect of the original IPF business”: [14]-[15].
(b)He had discussions (unspecified) with “other board members of the IPF businesses and various other groups in relation to how the project was structured and discussed the ability of the project to meet the projections contained in the IM”: [17].
(c)He also had many discussions (unspecified) with legal and accounting based taxation advisers. He read the expert opinions of Mr Gzell QC and Mr de Wjin QC “in relation to the taxation side of the Project”: [18].
93.It is clear that the pre-entry inquiries made by each applicant were almost entirely concerned with the taxation opinion and the income projections. There was little or no focus on the ongoing financial obligations they were incurring; the type of business to be operated and the substance of the Franchisor and the System and the substance of the Manger who was to operate their franchise in accordance with the requirements of the Franchise Agreement for the ten year term.
Payments made in respect of the IPF 97 Project
94.Under the agreements comprising the IPF 97 Project each of the applicants was obliged to “pay” $32,000 on execution of the application form on account of royalties, management fees, legal expenses and stamp duty. Of that amount, $2,000 was immediately payable in cash; $10,000 could be borrowed under a short term loan and repaid by 30 September 1997 and the remaining $20,000 could be borrowed on a long term loan repayable out of the income of the Franchise (with the Indemnity Agreement indemnifying the applicants against the liability to repay that loan at the conclusion of the term of the Franchise Agreement).
95.Consequently, the actual cash outlayed by each applicant for each franchise was $12,000.
96.The royalty fees and management fees to be financed by CCF’s loans to franchisees were completed by cheque exchanges through accounts with St Georges Bank opened on 30 June 1997 by CCF (A/c 551200770), IPF Finance (A/c 551200762) and RMA (A/c 551200754): see respectively T316, 329, 303/V2/338, 475 and 293. Three such cheque exchanges or “round robins” occurred.
97.The applicants did not challenge the fact that the round robins had occurred or the evidence concerning the round robins the details of which are set out in the audit report.
98.Mr Dawson was instructed to report on “how the payment and receipt of franchise fees and the provision by [CCF] of loans to franchisees were dealt with and satisfied through the accounts”: see Ex R8 p 22 at 4.3. From the incomplete financial information available Mr Dawson concluded, among other things, that there was an exchange of cheques which resulted in there being no monies in the St George Bank accounts of CCF, IPF Finance and RMA at 30 June 1997. He also reported that the accounts of RMA and IPF Finance show the cheque receipts from CCF were immediately loaned back to CCF: see Ex R8, p 2 para 5, p 6-7 para 11(c)-(g) and p 8 para 13(b).
99.In his oral evidence Mr Dawson identified the concerns that a round robin triggers for an external auditor including that they can be used to reflect a financial position which in reality an entity does not have, or to misstate a financial position for a particular purpose: Tp 530/3-19.
Application of the funds raised by the IPF 97 Project
100.The ATO audit report disclosed (T806/V5/1221) that:
(a)in the year ending 30 June 1998 IPF Finance and CCF received $8,242,290 in cash from franchises in the IPF 97 Project (being the aggregate of the amounts paid by franchisees in the first year – typically, $2,000 on making the application and subsequent repayment of the short-term loan of $10,000);
(b)of that amount, $5,621,115 (68%) was applied to “non-IPF Franchise Project Activities”.
101.Attachment E to the audit report (T811/V5/1288) summarised the flow of funds raised from franchisees – see also [380] and following of the audit report (p 1222). The attachment disclosed that CCF received $6,155,290, of which $1,804,000 was paid to IPF Finance, $2,052,945 was paid to RMA, $1,749,498 was lent to other entities in the Chambers Group and $548,847 was retained by CCF. Much of the money lent to companies in the Chambers Group went to the “Hadley Hall” project, which was described by Mr Leunig as being a vineyard project associated with Mr Jones and Mr Wovodich.
102.IPF Finance received a total of $3,891,000, being $2,087,000 from franchisees and $1,804,000 as a loan from CCF. At [384] of the audit report (p 1223) there is a breakdown of the application of those funds by IPF Finance. The breakdown disclosed that $891,925 was paid in commissions on the sale of the project to franchisees. A further $538,100 was paid to Denby Vale and Hanlon. Approximately $350,000 was paid in legal costs and stamp duty and $819,625 was paid to RMA.
103.RMA received $2,872,570 comprising $2,052,945 in funds advanced from CCF and $819,625 in funds from IPF Finance. At paragraph 388 of the audit report (p 1224) there is a breakdown of the application of the funds received by RMA. That disclosed that $839,539 was paid to Denby Vale and Hanlon; $228,809 was lent to Advanced Commission Systems (one of the products relevant to the IPF 98 project); $175,949 was paid in wages and directors’ fees to Jones; $120,967 was lent to Mortgages Direct; $513,000 was lent to Easy Rent and $45,000 was lent to IPF.
104.Of the total amount of funds raised from franchisees, $1,377,638 was paid to Denby Vale and Hanlon. Of the funds raised, $372,219 was left in IPF Finance Corporation for its business operations and $949,306 was retained by RMA for that purpose. That amounted to a total of 16% of the total funds raised (see paragraphs 385 (p 1223), 389 (p 1224) and 419 (p 1229) of the audit report.
Franchise activity by the applicants
105.Mr Player gave the following evidence concerning the activities he undertook in respect of his franchise (Player Ex A9):
(a)He applied to enter into one franchise on 25 June 1997 by signing the application form and the Deed of Power of Attorney and Appointment of Agent in the IM appointing IPF Finance as his agent and attorney to enter into and execute the Franchise Agreement, the Management Agreement, the Loan Deed and the Indemnity Agreement: [12] and “EJRP5” to “EJRP 10”.
(b)He borrowed $30,000 to meet the first year prepaid royalty fee of $10,000 and $20,000 of the first year prepaid management fee of $21,000.
(c)He made the cash payments of $10,000 required under the Loan Deed and on application, $2,000.
(d)By the Franchise Agreement (Item 10 of the Schedule) he was allocated a franchise territory NSW55 comprising the suburbs of Cremorne Junction, Seaforth and Manly Vale in Sydney to be managed by the Manager: “EJRP7” at p 89.
(e)He understood that by appointing a manager he would have no direct role [15] and he would “share in the benefits and risks of the project” [13].
(f)At times he referred to IPF people who were interested in financing insurance premiums or purchasing a house or renting equipment. He initially stated that after reading the IM and before entering into the project he agreed with Mr Jones that all clients he referred “would be automatically allocated to me regardless of which territory they were located in”. [15]. However, this evidence subsequently changed in cross-examination when he stated that the conversation with Mr Jones occurred after he had signed up: Tp283 and Tp321.
(g)Along with all franchisees, he received requests from IPF Finance to refer business together with a referral form for that purpose: see “EJRP 13” at pp 147, 168, 175, 181-182 and 191.
(h)He attended several franchise meetings where he was informed of progress: [18].
(i)He was sent annual reports by RMA for the financial years ended 30 June 1997 to 30 June 2000: [21] and ”EJRP13”. For the most part, these reported on the operations of the Financial Providers (IPF, Easy Rent and Mortgages Direct); e.g. “EJRP 13” at pp 160-166, 192, 194-195, 214-217.
(j)He was in contact with Mr John Wells regularly. They discussed progress, including how Mr Player’s franchise was going.
(k)To the date of the project’s collapse Mr Player had derived income of $10,047.12 from the project against a forecasted income of $35,295: [17] and “EJRP12”.
106.Mr Fyson stated that he undertook the following activities in respect of the Lost Gold Pty Ltd franchises (Fyson Ex A1):
(a)Vier as trustee for the CH Fyson Family Trust applied to enter into four franchises on 22 June 1997 by signing the application form in the IM and the Deed of Power of Attorney and appointment of Agent in the IM appointing IPF Finance as its agent and attorney to enter into and execute the Franchise Agreement, the Management Agreement, the Loan Deed and the Indemnity Agreement: [22] and “CHF7” to “CHF 12”.
(b)Vier borrowed $80,000 to meet $20,000 of the first year prepaid management fee of $21,000 per franchise: [27] and “CHF11”.
(c)The CH Fyson Family Trust paid $48,000 on application comprising $40,000 for the prepaid royalty fee of $10,000 per franchise and $8,000 in total for the cash payments required on application in respect of each franchise: [27] and “CHF 15”.
(d)By the Franchise Agreement dated 30 June 1997, the CH Fyson Family Trust was allocated franchise territories VIC101, VIC102, VIC103 and VIC104 comprising the suburbs of Burnley, Burnley North, Richmond, Richmond East, Richmond North and Richmond South in Melbourne: [23] and “CHF 9” at p 111.
(e)Some three months after the application had been made he received letters dated 9 October 1997 “confirming” the franchise territories and upon looking to refer some business to IPF (“CHF 13”) Mr Fyson sent a letter dated 10 September 2000 to Mr Wells the General Manager IPF Finance, expressing concern that he had no say on where the franchises were to be located and that the four franchise territories all had the same postcode and shared the income from that limited area. He sought an explanation and advice on how the situation could be rectified. The letter in reply from IPF on 12 September 2000 did not advise as to how the situation could be rectified and it is to be inferred he received no assistance in that regard: [23] and [24], “CHF 14”.
(f)On 30 June 1998, RMA forwarded a package of material (“CHF 20”) that included a “new 12 month Management Plan for 1998/99” and “samples of additional IPF brochures and promotional material”. The accompanying letter sought approval for a twelve month (and not six month) management plan.
(g)He also stated that he “would have no direct role … as I am actively involved in my real estate activities and did not have time”: [26].
(h)He “endeavoured to promote its activities to associates of mine who were looking for finance”: [32] and “CHF19”. Direct requests for referrals were received from IPF: “CHF 20” at pp 231, 233, 234-235.
(i)He followed performance closely and made “enquiries in relation [to] the way the general Project was running on a regular basis”: [32] and [33].
(j)He stated that he was sent annual reports by RMA for the financial years ended 30 June 1997 to 30 June 2000: [34], “CHF 20” and Tp36/43 to Tp37/4, Tp37/11/30. He did not seek any breakdown of the gross income from the three products or how the income was derived. The only inquiries he made were set out in his affidavit. For the most part the reports were about the operations of the Financial Providers: “CHF 20” at pp 223-224.
(k)To the date of the project collapse the CH Fyson Family Trust derived income of $28,490,36 from the Project (that is, for all of the franchises it held) against a forecasted income of approximately $140,000: [30] and “CHF 17”.
107.At all material times Mr Leunig was a director of IPF, RMA, CCF, CIA and the Financial Providers: [T900 /V5/1333-1335]. He was also a director of a number of other “Chambers Group” companies: [3] and [4] of Leunig Ex A2. Mr Leunig stated (Leunig Ex A2) that he undertook the following activity in respect of his three franchises:
(a)He applied to enter into a franchise on 27 June 1997 by signing the application form and the Deed of Power of Attorney and Appointment of Agent in the IM appointing IPF as his agent and attorney to enter into and execute the franchise agreement, the management agreement, the loan deed and the indemnity agreement. [19] and “KBL 9”.
(b)He borrowed $90,000 to meet the first year prepaid annual royalty fee of $10,000 per franchise and part of the $21,000 first year prepaid management fee per franchise: [20]-[21], Application Form and Loan Deed “KBL 9” p 97 and pp 148-153.
(c)He paid $6,000 in cash on application comprising $3,000 balance of the prepaid first year management fee per franchise and $3,000 for the indemnity fee and legal costs: Application Form “KBL 9” p 97.
(d)By the Franchise Agreement dated 30 June 1997 franchise territories VIC292, VIC293 and VIC294 comprising the suburbs of Mooroopna and Shepparton in Victoria were allocated to him, to be managed by RMA: [23], Franchise Agreement: “KBL 9” p 127 and “KBL 11” pp 179-181. His franchise territories were confirmed by letter on 9 October 1997: “KBL 11”.
(e)He knew he “would have no direct role in the day to day management of the franchises as [he] was operating his own financial planning business and did not have the time …”: [25].
(f)He attended all “the public meetings” and most of the IPF board meetings (as a director) where he was informed of progress: [30].
(g)“IPF sent me regular reports in relation to the Project”: [39] and “KBL 11”. These for the most part were reporting on the operations of the Financial Providers: “KBL 11”. As well referrals from franchisees were sought by IPF Finance: “KBL 11” at pp 184-185, 210-202;
(h)On a weekly basis he would make inquiries (as a director) “regarding the status and progress of not only my franchises but also for the other franchisees and of the business as a whole”: [30]. “His involvement with the Project was one of franchisee liaison and otherwise administration”: [25].
(i)Prior to the collapse of the Project he received total income of $17,021.10 from the project against a forecasted income of $35,295 per franchise or $105,885 in total. [29] and “KBL 10” pp 171-177.
THE FRANCHISE BUSINESSES
The System
108.It is apparent from the Licence Agreement, Franchise Agreement and the Management Agreement that the purpose of the Franchised Businesses was to utilise “the System” (note in particular, the grant of right by IPF Finance as Franchisor in cl 2.1.2.1 of the Franchise Agreement). Consequently, the System was central to the rights granted by IPF Finance to Franchisees. The System was the essence of the Franchise as formulated by the Franchise Agreement.
109.As noted above, the System supposedly involved marketing to and contact with insurance brokers and mortgage originators (see cl 1.1.3.3 of the Franchise Agreement). Importantly, there was no reference in the Franchise Agreement to marketing the Easy Rent product although the description of the product in the IM suggested it was to be marketed to wholesale and retail equipment suppliers.
110.Despite its central role, there was no evidence of what constituted the System, how it was devised and by whom or how it was to be used. Mr Leunig produced a document which he described as a “Franchise Business Manual” ( Leunig Ex A3 at [46]). However, the “manual” was a diverse collection of documents for use by insurance brokers in their dealings with IPF, equipment suppliers in promoting the Easy Rent product and promotional material for “Wealthpro”. It was not a manual that related to the conduct of the Franchised Business or the use of the System. It contained no information on how to operate the Franchise Business or how to “identify and recruit” clients. It simply comprised promotional material that was self-evidently prepared for other purposes.
111.Mr Leunig had no reasonable explanation for why he sought to characterise the documents as being a manual for franchisees having regard to their contents: see Tp150 – 151 and Tp161 – 164. Further, Mr Leunig’s evidence on the “manual” reflected a profound lack of understanding of the difference between the businesses supposedly to be conducted by Franchisees and the businesses of the Financial Providers and the Products. His evidence on this matter was one of many instances of him mis-describing documents in a way that he thought would advance his case and that of the other applicants.
112.The Management Plan for the first six months did not refer to the System (which would be expected to govern the contents of any management plan) nor could it be described as a proprietary system.
113.The definition of the System referred to computer software. The software identified by Mr Leunig (Leunig Ex A3 at [27] and [28]) comprised the “Ironbark” system and the “Real Time and Decision Systems” programme. The only documents provided were in respect of the Ironbark system (“KBL 20”). That system was for reporting on all IPF business and was not directed to recruiting or identifying clients or to monitoring the Franchise Businesses.
114.Similarly, the procedure manuals for IPF and Easy Rent produced by Mr Leunig (“KBL 18” and “KBL 19” to Leunig Ex A3) were not manuals for franchisees but for brokers and equipment suppliers dealing with IPF and Easy Rent.
115.Further:
(a)there was no explanation of the System in the IM;
(b)there was no evidence that “the System” was ever used by any of the applicants or by RMA;
(c)none of the applicants (including Mr Leunig) could give any description of the System;
(d)none of the applicants (including Mr Leunig) had made any enquiries about the System or its use by RMA;
(e)Mr Fyson and Mr Player made no inquiries about any franchise manual or computer software;
(f)although RMA was to manage the Franchise Business of each Franchisee, the System was only referred to in the recitals to the Management Agreement; there was no obligation expressly imposed on RMA to use the System.
116.The only available inference is that no “System” existed and that the references in the Franchise Agreement and the other agreements to the System were merely a means of giving the appearance of a franchise by adopting the language of franchising (as evidenced by the definition of a franchise contained in the Franchising Code – see the evidence of Mr Hillard at Ex A17).
Allocation of Territories
117.There is no evidence as to the basis upon which the total number of Territories to be offered was determined; in particular, there is no evidence that 950 Territories represented a number that prior investigation had disclosed was viable or which could be properly managed by RMA.
118.Indeed, the evidence concerning RMA and IPF Finance disclosed that as at 30 June 1997 they had no capacity to manage any of the Franchise Businesses and had made no preparations for implementing the Management Plans in each Territory as required by the Management Agreement.
And see at [82] and Calderv FCT at [69] and [117]. Investors in those schemes and the applicants here were, in substance, passive investors in what, once the tax features are removed, is a managed fund where no deduction would be available…” (Hill J in Sleight at [82]).
381.The evidence shows clearly that in these applications, the form of the arrangements similarly took an artificial form not necessary to its commercial outcomes:
(a)they were carried out by related parties and IPF Finance, RMA, CCF and CIA were established in the months leading up to the implementation of the Scheme;
(b)those parties provided the franchises, and indemnified obligations, none of which was necessary to the carrying on of the purported underlying commercial activity of developing and conducting the System;
(c)the franchisee did nothing more than take a franchise and then appoint a manager to conduct all the franchised activities. The underlying commercial activities could as well have been carried out without the creation of the franchise network;
(d)the business that existed was, in substance, conducted by the Finance Providers or IPF Finance/RMA without regard to the franchise network;.
(e)There was no System and the System as described in the IPF 97 Project agreements was in any event unnecessary – the Financial Providers or an entity acting on their behalf could have marketed the Products to insurance and mortgage brokers and equipment vendors (as subsequently occurred);
(f)The manner of allocation of territories and the appointment of a single manager defeated any legitimate commercial role the franchise network might have played.
382.The IPF 97 Project arrangements secured deductions for revenue expenses – franchise fees. Further, loans to meet those revenue expenses were made on an indemnified (effectively, limited recourse) basis and were not the subject of cash transactions in any event. As a result the deductions were in excess of:
(a)the cash amounts participants were required to pay;
(b)any amount participants would ever be liable to pay, owing to the indemnity;
(c)any amount that was ever available to IPF Finance/RMA to conduct the Franchise Businesses.
383.The arrangements lacked any commercial substance:
(a)The fees were purportedly incurred in establishing a business the nature and operation of which was barely defined. The obligations of IPF Finance and RMA were, largely, unspecified. They were not accompanied by business plans, marketing agreements or other detailed proposals for the application of the fees payable.
(b)There seemed little prospect of recouping these fees:
(i)the purported business described by the IM lacked any real substance.
(ii)the assumptions upon which the projected cashflows were based were not disclosed. Neither was there any discussion of risks, business variations, business development, competitors, possible market changes or the like;
(iii)even if the projections were met, the investment of $32,000 would not be recovered for more than 8 years. As the projections might be viewed as no more than unreliable predictions at this point, franchisees were at risk of not recouping the initial investment at all or, at least, not for a considerable period;
(iv)the restriction on franchisee territory would limit the franchisees’ financial return and not make it possible to achieve rapid sales growth and significant net profit.
384.Despite the apparent lack of substance, the applicants made no inquiries about the projected cashflows or the capacity of the Franchisor and the Manager to service their proposed customers or the 950 it was proposing to manage.
385.Ultimately, the large up-front fees payable make no commercial sense and there was no explanation for that aspect of the arrangements. Mr Acheson rightly observed that IPF Finance was supposed to receive very substantial funds from the Project but RMA was only obliged to engage in relatively cheap forms of marketing such as letter drops. The irresistible explanation for the large first year fee was the tax benefit it generated for participants.
Section 177D(b)(iii) – the time at which the scheme was entered into and the length of the period during which the scheme was carried out
386.The document before the Tribunal entitled “Respondent’s Statement of Facts and Evidence” sets out the relevant chronology in relation to the Scheme.
387.Each of the applicants entered into the Scheme with effective franchise Commencement Dates for Mr Player, 25 June 1997; Vier, 22 June 1997; Mr Leunig, 27 June 1997.
388.The IM was prepared in May 1997. The Project was promoted as a tax effective investment. It was structured so as to commence on or before 30 June 1997. The short term loan was repayable in the next financial year. As at the Commencement Date there were no executed agreements by which the Franchise Businesses were to be conducted or recording the arrangements upon which the Franchises were to operate and the rights and obligations of the various participants in the Project.
389.There is no commercial explanation as to why the Franchise Businesses should commence on or close to 30 June 1997 or why the Project was promoted in May/June 1997. A substantial royalty and management fee was payable in Year 1 and immediately on execution of the application form and power of attorney (and not on execution of the actual agreements constituting the franchise arrangements).
390.The inference is overwhelming that the timing reflected a tax benefit not a commercial purpose.
391.The applicants did not receive income and expenditure statements after the financial year ended 30 June 2000.
392.The term of the franchise was for ten years. At the end of that period, the Franchise Agreement automatically came to an end without the Franchisees retaining any capital asset. The termination of the Franchise Agreements would, on the projections contained in the IM, come at a time when the Franchisees were just beginning to receive a return on the funds expended. No explanation was given for such provisions; it was plainly not a term that was consistent with a commercial purpose for the Scheme.
Section 177D(b)(iv) – the result in relation to the operation of this Act that, but for this Part, would be achieved by the Scheme
393.But for Part IVA, the result of the scheme was that the applicants obtained deductions as follows: -
Kimberley Leunig
$93,000
Eric Player
$31,000
Lost Gold Pty Ltd
$128,000
Section 177D(b)(v) – any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the Scheme
394.The deductions claimed by the applicants for the franchise fees they undertook resulted in tax savings which far exceeded amounts actually paid in respect of franchise fees. As a result, the applicants’ cash positions were improved, as summarized below: -
Mr Leunig
Year Deduction
claimed
Tax saving Cash outlays Net cash position 1997 $93,000[1] $8,987.52 $36,000[2] ($27,012.48)
1998 $56,682[3]
Prior year loss -
$7,716.05
NIL $7,716.05
1999
$23,741[4]
Prior year loss
$1,233.20
NIL
$1,233.20
[1] Affidavit of Kimberley Bruce Leunig sworn 20 May 2005 para 7
[2] Affidavit of Kimberley Bruce Leunig sworn 20 May 2005 para 20
[3] Affidavit of Kimberley Bruce Leunig sworn 20 May 2005 para 9
[4] Affidavit of Kimberley Bruce Leunig sworn 20 May 2005 para 11
Mr Player
Year
Deduction
claimed
Tax saving
Cash outlays
Net cash position
1997
$31,000[5]
$12,839.39
$13,000[6]
($160.61)
[5] Affidavit of Eric James Richard Player sworn 14 May 2005 para 5
[6] Affidavit of Eric James Richard Player sworn 14 May 2005 para 20. Note $3,000 was paid on 25 June 97 and $10,000 on 18 September 1997
Lost Gold Pty Ltd
Year
Deduction
claimed
Tax saving
Cash outlays
Net cash position
1997
$128,000[7]
$87,840
$48,000[8]
$39,840
[7] Affidavit of Christopher Hugh Fyson sworn 13 May 2005 para 7
[8] Affidavit of Christopher Hugh Fyson sworn 13 May 2005 para 27
395.It is not material to the question of whether Part IVA applies in respect of the deductions claimed by Mr Player and Mr Leunig that their required cash contributions were not fully met by the tax savings in 1997. The deductions clearly had a considerable value to each of them, more so if the other deductions they claimed were not allowable. See Commissioner of Taxation v Sleight (2004) 136 FCR 211 per Hill J at [88] and Carr J at [225]. Moreover, as Carr J observed, at [224]: “on a proper construction of s 177D(b) the assessment should be made, in respect of this factor … as at the time of entry into the scheme. A reasonable person would be entitled to draw his conclusion about dominant purpose on the basis that the respondent entered into three schemes at one time and that each of those schemes would result (but for Part IVA) in the allowance of the deductions claimed.”
396.Beyond any advantages offered by the tax savings it could not reasonably be expected that there would be any material change in the applicants’ financial positions as a result of their investment.
397.The achievement and extent of any additional benefit from the investment itself was by no means certain however and appears to be highly dubious having regard to the following:
(a)The purported business described by the IM lacked substance.
(b)The assumptions upon which the projected cashflows were based were not disclosed. Neither was there any discussion of risks, business variations, business development, competitors, possible market changes or the like.
(c)Even if the projections were met, the investment of $32,000 would not be recovered for more than 8 years. As the projections might be viewed as no more than unreliable predictions at this point, franchisees were at risk of not recouping the initial investment at all or, at least, not for a considerable period.
(d)The restriction on franchisee territory would limit the franchisees’ financial return and not make it possible to achieve rapid sales growth and significant net profit.
398.Given the deficiencies in the IM, the evidence of Mr Simpson as to the attractiveness of the commercial returns is not accepted by the Tribunal. Mr Simpson said that a comparison of the IRR for the IPF 97 Project obtained from the IM projections and the IRR for the other investments referred to in his report could not be meaningfully made because of the deficiencies in the IM. The primary purpose of his report was to make such a comparison. However, more importantly, his concession is a concession that it was not possible for him to offer any opinion as to the commercial merits of investing in the IPF 97 Project as he did not have the relevant information.
399.Even if it was accepted that there was some commercial substance in the IPF investment, it does not follow that there was no section 177D purpose. That is not in the Tribunal’s opinion the conclusion to be drawn from the decision in Commissioner of Taxation v Cooke (2004) 55 ATR 183.
400.Comparison of different rates of return is not relevant in the Tribunal’s view. There is no scope for comparing the approaches in other cases to select a preferred approach. To do this is to misconceive the task under Part IVA. As Gummow and Hayne JJ put it in Hart (2004) 217 CLR 216 at [52]: “Always the question must be whether the terms of the Act apply to the facts and circumstances of the particular case.” And see Sleight per Hill and Carr JJ at [244] and [111].
401.In Sleight the Court contrasted the availability of tax deductions with the uncertainty of the investment yields, the estimated rate of return and its timing: see (2004) 136 FCR 211 per Hill, J at [88], [93], [94] and per Carr, J. at [216], [226] – [227]. Also see the approach of the trial judge in Calder v FCT (2005) 59 ATR 655 at [106] and [124]. His approach was not the subject of adverse comment by the Full Court in Calder v FCT (2005) 61 ATR 267 at [122]-[124].
402.It is therefore inappropriate to compare rates of return indicated by the projections here with returns predicted in other cases without an understanding of the risks of the project there. For example, In Cooke the Court’s consideration of the commercial viability of the project was restricted to the prospectus without more: see (2004) 55 ATR 183 at [19], [72], [98] and [100]. As the evidence here shows, the predicted returns are not to be taken at face value. As already noted Mr Simpson’s opinions expressed in his report were substantially undermined by the concessions he made in cross-examination.
403.Here, because of the Indemnity Agreement the applicants could keep the tax benefits regardless of the outcome of their investment. They could take a chance on the commercial performance of the project. Any return achieved on the franchise was an additional benefit.
Section 177D(b)(vi) – any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the Scheme
404.Owing to the extent of the deduction for fees in the first year (geared up by the indemnified loan) and the resulting tax savings to participants, the cash receipts of IPF Finance and RMA were, essentially, funded by the Revenue. The cash receipts were, in turn, paid into bank accounts of the IPF Unit Trust and largely disbursed to beneficiaries.
405.Beyond the cash payments sourced from participants’ tax savings, the financial position of IPF Finance, RMA and CCF did not change as a result of the scheme. The loans to franchisees were effected without actual cash funds being made available and by reciprocal book entries, and were not intended to be funded by actual cash.
406.On the other hand the analysis of the evidence as set out above shows that, had income by way of Franchisee Entitlements been earned, most of it was to be withheld and retained by the promoter entities, as follows:
(a)to the Lender for loan interest ;
(b)the Manager for the management fee;
(c)the Franchisor for the annual royalty;
(d)the balance was to be divided into two equal parts and the first part to be remitted to the Lender in repayment of the First Principal Sum. The Franchisee was entitled to retain the balance if any.
Section 177D(b)(vii) – any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out
407.It is significant that once the Franchise Applications were signed and the cash payments made there were no other consequences, financial or otherwise, for the applicants in entering into and carrying out the scheme.
Section 177D(b)(viii) – the nature of any connection (whether of a business, family or personal nature) between the relevant taxpayer and any person referred to in paragraph (vi)
408.There was a business connection between the applicants Mr Player and Lost Gold Pty Ltd and the IPF entities. Mr Leunig on the other hand was a director of the promoter entities and promoted the scheme to clients of his financial planning business and the Chambers Group.
Conclusion with respect to section 177D(b)
409.It is the Tribunal’s finding that, having regard to the eight factors set out in section 177D(b), it would be concluded that each of the applicants entered into or carried out the Scheme for the dominant purpose of obtaining tax benefits, in the form of the deductions they claimed in the 1997 year.
410.Similarly, it would be concluded that the promoter entities entered into or carried out the Scheme for the dominant purpose of obtaining tax benefits for the applicants. Their purpose in entering into or carrying out the Scheme, was to obtain a tax benefit for participants in IPF franchises, including the applicants. It is not to the point that the overall commercial objective of the promoter entities was to make money. They achieved their commercial purpose by creating a structure to which the attractiveness of the tax advantages it secured was central. Obiter comments made in the Full Court decisions in Vincent at [100] and Sleight at [95]-[96] must now be read in light of the High Court decision in Hart, where it was pointed out that the pursuit of a commercial objective is not inconsistent with the existence of a dominant purpose of enabling the taxpayer to obtain a tax benefit particularly where the shape or form of the scheme entered into by the promoter entities points to the purpose of obtaining tax benefits.
411.The agreements by which the scheme was implemented “took such a form that there is a particular scheme in respect of which a conclusion of the kind described in s177D is required, even though the particular scheme also advances a wider commercial objective”: FCT v Hart (2004) 217 CLR 216 per Gleeson CJ and McHugh J at [16]. That form enabled the applicants to obtain large deductions in respect of obligations largely funded by loans covered by an indemnity. The consequent tax savings were to the applicants’ advantage, with or without the commercial success of their investment. But for the tax savings, the scheme might have taken the more usual form of an investment scheme, as Hill, J. suggested at [80] of his judgment in Sleight, quoted above. In doing so, he articulated the relevant “alternative postulate” contemplated by Gummow and Hayne JJ in Commissioner of Taxation v Hart (2004) 217 CLR 216 at [66].
412.In the result, the potential commercial performance of the applicants’ investments, and even their nature, were irrelevant. Additionally, however, as the foregoing examination of the scheme by reference to each of the eight factors set out in section 177D(b) demonstrates, the scheme lacked commercial substance and, in many respects, defies rational commercial explanation.
413.The Tribunal finds that that if, contrary to its finding the claimed deductions were allowable to the applicants under section 51(1), then it was appropriate for the respondent to make the determinations under section 177(1) of the ITAA 1936 in respect of the claimed deductions.
ADDITIONAL TAX
414.As the Tribunal finds that the claimed deductions were not allowable to the applicants under section 51(1), the Tribunal also finds that the elements of section 226L of the ITAA 1936 are satisfied, and accordingly, that section applies to impose the penalties by way of additional tax assessed to each applicant.
415.Alternatively, if Part IVA applies to disallow the claimed deductions then the Tribunal also finds that sub-sections 226(1) and (2) of the ITAA 1936 apply to impose the penalties by way of additional tax that were assessed to each applicant.
ANNEXURE A
Calculation of tax savings and cash benefits
The claimed deductions and tax savings
416.The expenses alleged incurred by the applicants as franchisees of IPF Finance Corporation Pty Ltd (IPF Finance) and claimed as income tax deductions (the claimed deductions) were: -
(a)Eric Player, $31,000 - claimed in the income year ended 30 June 1997 in respect of his acquisition of one franchise and comprising a first year annual royalty fee of $10,000 and a first year management fee of $21,000 [Player T docs/19 and 14-17; Ex A9, “EJRP 1”];
(b)Lost Gold Pty Ltd, $128,000 - Vier Pty Ltd as trustee for the CH Fyson Family Trust claimed in the income year ended 30 June 1997 in respect of the acquisition of 4 franchises and comprising per franchise a first year annual royalty fee of $10,000, a first year management fee of $21,000, indemnity fee of $625 and legal costs of $375 [Lost Gold T docs /26 and 14-22; Ex A1” CHF “1 p 19];
(c)Kimberley Leunig, $93,000 - claimed in the income year ended 30 June 1997 in respect of his acquisition of 3 franchises comprising per franchise a first year annual royalty fee of $10,000 and a first year management fee of $21,000 [Leunig T docs/179 and 43-48; Ex A2” KBL 1” p 19].
417.The claimed deductions resulted in tax savings and cash benefits of:-
Tax Savings Cash Benefits
Mr Player 1997 $12,839.39 ($160.61)
Lost Gold Pty Ltd 1997 $87,840.00 $39,840
Mr Leunig 1997 $8,987.52 ($27,012.48)
1998 $7,716.05 $7,716.05
1999 $1,233.20 $1,233.20
418.Those tax savings and cash benefits are calculated as follows:
Eric Player: 1 Licence 1997 year Cash payments $13,000 Claimed Deduction $31,000.00 Taxable income returned $24,271.00 Tax on taxable income returned $4,274.14 Medicare Levy $412.60 Rebates and other credits 64.16
$4,622.58
Taxable income without claimed deductions $55,271 Tax on taxable income without claimed deductions $16,579.37 Medicare levy 939.60 Rebates and other credits 57.00
$17,461.97
Tax saved: Tax without claimed deductions $17,461.97 Tax after claimed deductions 4,622.58
$12,839.39
Tax position: Tax saved $12,839.39 Cash payments 13,000.00
Net deficit ($160.61) Refund Notice for 97 year (Player T4/18)
Notice of amended Assessment for 97 year (Player T7/22)
Ex A9 Player Affidavit [5] and [22]Lost Gold Pty Ltd: 4 Licences 1997 year Cash payments $48,000.00 Claimed deduction $128,000.00 Taxable income returned $209,216.00 Tax on taxable income returned $75,317.76 Other credits 1,914.12
$73,403.64
Taxable income without claimed deductions $453,216.00 Tax on taxable income without claimed deductions $163,157.76 Other credits 1,914.12
$161,243.64
Tax saved: Tax without claimed deductions $161,243.64 Tax after claimed deductions 73,403.64
$87,840.00
Tax position: Tax saved
Cash payments$87,840.00 48,000.00
Net surplus $39,840.00 Company Assessment for 97 year (Lost God T6/24)
Notice of Assessment for 97 year (Lost God T8/27)
Ex Al Fyson Affidavit [7] and [27]Leunig: 3 licenses 1997 year Cash payments $36,000.00 Claimed deduction $93,000.00 Taxable income without claimed deductions $36,318[9] Tax on taxable income without claimed deductions $8,370.12 Medicare levy 617.40 Rebates and other credits Nil
$8,987.52
Tax saved: Tax without claimed deductions $8,987.52 Tax after claimed deductions Nil
$8,987.52
Tax position: Tax saved $8,987.52 Cash payments 36,000.00
Net deficit (27,012.48) Nil tax advice for 97 year (Leunig T6/49)
Notice of Amended Assessment for 97 year (Leunig T17/184)
Leunig Affidavit sworn 20 May 2005 [20]1998 year Cash payments Nil Prior year loss $56,682.00 Taxable income returned NIL Tax on taxable income returned Nil Medicare Levy Nil Rebates and other credits Nil
$Nil
Taxable income without loss $32,941.00 Tax on taxable income without prior year loss $7,221.94 Medicare levy 494.11 Rebates and other credits Nil
$7,716.05
Tax saved: Tax without prior year loss $7,716.05 Tax after claimed deductions Nil
$7,716.05
Tax position: Tax saved $7,716.05 Cash payments Nil
Net surplus $7,716.05 Refund Notice for 98 year (Leunig T10/165)
Notice of Amended Assessment for 98 year (Leunig T18/185)
1999 year Cash payments Nil Prior year loss $23,741.00 Taxable income returned NIL Tax on taxable income returned Nil Medicare Levy Nil Rebates and other credits Nil
Nil
Taxable income without loss $13,415.00 Tax on taxable income without prior year loss $1,503.00 Medicare levy 5.20 Rebates and other credits 375.00
$1,233.20
Tax saved: Tax without prior year loss $1,233.20 Tax after claimed deductions Nil
$1,233.20
Tax position: Tax saved $1,233.20 Cash payments Nil
Net surplus $1,233.20 Refund Notice for 99 year (Leunig T13/177)
Notice of Amended Assessment for 99 year (Leunig (T19/186)
[9]Notice of amended assessment for 97 year (T17/184). Calculated as $25,652) net loss for $1997 + $93,000 deduction added back – ($31,030) prior year loss: see Return for 97 year (T5/45).
DECISION
419.The Tribunal affirms the decisions under review.
I certify that the 419 preceding paragraphs are a true copy of the reasons for the decision herein of Mr A Sweidan, Senior Member
Signed: ..........[sgd Mr J Lim].....................
AssociateDate/s of Hearing 16-26 April 2007 & 18 October 2007
Date of Decision 4 April 2008Counsel for the Applicant Mr M.McCusker
Mr D Romano
Solicitor for the Applicant Wilson & Atkinson
Counsel for the Respondent Mr M Corboy SC
Ms L Price
Solicitor for the Respondent Australian Government Solicitor
0
22
0