Richards and Commissioner of Taxation
[2007] AATA 1471
•25 June 2007
Administrative Appeals Tribunal
DECISION AND REASONS FOR DECISION [2007] AATA 1471
ADMINISTRATIVE APPEALS TRIBUNAL )
) No WT200500121
TAXATION APPEALS DIVISION ) Re BERNARD A RICHARDS Applicant
And
COMMISSIONER OF TAXATION
Respondent
DECISION
Tribunal Mr A Sweidan, Senior Member Date25 June 2007
PlacePerth
Decision
The Tribunal sets aside the decision under review and remits the matter to the respondent to issue a further amended income tax assessment to the applicant for the year ended 30 June 1997 in accordance with the Tribunal’s decision as follows:
a. The deductions claimed by the applicant relating to his participation in the Oracle International Project are to be disallowed except for actual cash payments made by the applicant.
b. No penalties are to be imposed on the applicant under section 224(2) of the Income Tax Assessment Act 1936.
.........(Sgd. A Sweidan)..................
Senior Member
CATCHWORDS
Income Tax – allowable deductions – “managed investments - Oracle International Project – large “up front” fees with no commercial function – “round robin” – limited recourse loans – application of anti-avoidance provisions
LEGISLATION
Income Tax Assessment Act 1936 – s.51 (1)1
Income Tax Assessment Act 1936 Part IV A
CASES
Sleight v Commissioner of Taxation (2004) 136 FCR 211,
Commissioner of Taxation v Cooke (2004) 55 ATR 183,
Commissioner of Taxation v Lau (1984) 6 FCR 202 at 221 per Beaumont J,
Commissioner of Taxation v Emmakell Pty Ltd (1990) 22 FCR 157,
Puzey v Commissioner of Taxation (2002) 50 ATR 595; (2003) 53 ATR 614,
Fletcher v Federal Commissioner of Taxation (1991) 173 CLR 1
Commissioner of Taxation v Brand (1995) 31 ATR 326,
Commissioner of Taxation v Walker (1984) 84 ATC 4553,
Australian Trade Commission v Disktravel [1999] FCA 1399,
Madison Pacific Property Management and Ors v Australian Securities Commissioner 30 ACSR 218,
Merchant v Commissioner of Taxation 99 ATC 4221).
Clowes v Commissioner of Taxation (1954) 91 CLR 209
Milne v Commissioner of Taxation (1976) 133 CLR 526).
Vincent v Federal Commissioner of Taxation [2002] FCAFC 291
Steele v Deputy Commissioner of Taxation (1999) 197 CLR 459
Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404
Equuscorp Pty Ltd v Glengallan Investments Pty Ltd (2004) HCA 55
Enviro Systems Renewable Resources Pty Ltd v ASIC (2001) 80 SASR 1
Hope v The Council of the City of Bathurst (1980) 144 CLR 1
Ure v Commissioner of Taxation (1981) 34 ALR 237
Calder v Commissioner of Taxation (2005) 59 ATR 655 at [102]
Commissioner of Taxation c Hart (2004) 217 CLR 216
Starr v Commissioner of Taxation of the Commonwealth of Australia [2007] FCA 23
Hopkins v Commissioner of Taxation of the Commonwealth of Australia [2007] FCA 23
Ferguson v FCT (1979) 26 ALR 307 at 311
Travel Vision International Pty Ltd and Ors v Australian Trade Cinnussuib [1998] AATA 11
Amalgamated Zinc (de Bavay’s) Ltd v FCT (1935) CLR 295 at 309
Ronpibon Tin NL v FCT (1949) 78 CLR 47
FCT v Hart (2004) 217 CLR 216 per Gummow and Hayne JJ at [37]
FCT v Peabody (1994) 181 CLR 359 at 393
FCT v Consolidated Press Holdings (2001) 207 CLR 235 [95]
Eastern Nitrogen Ltd v FCT per Carr J at [80]-[84]
REASONS FOR DECISION
25 June 2007 Mr A Sweidan, Senior Member BACKGROUND
1. The applicant seeks a review of the respondent Commissioner’s disallowance of an objection by applicant to an income tax assessment for the year ended 30 June 1997, the respondent’s decision in this regard having been made on 16 September 2003.
2. The applicant was one of a number of investors in the Oracle International Project (the Project).
3. The applicant invested in the Project in the year ended 30 June 1997.
4. The applicant claimed an allowable deduction in the amount of $80,000.00 in the 1997 taxation year for expenditure incurred for two licenses in the Project as follows:
· $15,500.00 for management fees, per license;
· $19,500.00 for marketing fees, per license;
· $960.00 for annual license fees, per license;;
· $2,465.00 for training fees; per license; and
·$1,575.00 for prepaid interest on each of two loans entered into for the purposes of financing the applicant’s payment of the relevant fees.
5. However the respondent contends that the applicant is not entitled to the claimed deductions for his expenditure incurred for his participation in the Project by reason of the expenditure being non-deductible under the following provisions:
(a)Section 51 (1) of the Income Tax Assessment Act 1936 (1936 Act); or alternatively
(b)Part IVA of the Income Tax Assessment Act 1936.
EVIDENCE
6. The application was heard together with two other applications, being applications by Mr Minniello and Mr Burrows.
7. The evidence was given by the three applicants and their witnesses, Michael Burnett, John Liddell and Paul Begley.
8. For the respondent evidence was given by Ken Pendergast and David Acheson.
9. The applicant testified that:
(a)He conducted background research before making a decision to invest in the Project. The applicant sought advice prior to entering the Project.
(b)He enquired about the projected returns contained in the Information Memorandum (“IM”) and was of the view that the projections were reasonable.
(c)He entered into the Project for the long term high financial returns which he could expect. He was able to personally participate and add to the direct income he was to receive from his business.
(d)The applicant had control over the manager as he was able to sack the manager if he was not fulfilling his obligations.
(e)He accepted the financing option set out in the Loan Offer in the IM and did not consider other options as the financing option limited his liability to further payments. The applicant said that he considered it made sound business sense to reduce his downside risk by entering into this finance option.
(f)The applicant said he made a gross profit as an Oracle Licencee and paid tax thereon. He utilised his income to repay the loan and therefore was required to source funds to pay the tax on the income from the Project.
(g)In April 1997 he completed a “sign-up form” and paid $268 by cheque to Oracle International:
(h)In or about early June 1997 he was provided with an Oracle Information Memorandum, the Oracle International Agreements booklet and a copy of a legal opinion from R.K. O’Connor QC and on 9 June 1997 he signed two Oracle Licence Execution Sheets to acquire two Oracle licences:
(i)At around the same time, he entered into a Two Year Income Guarantee:
(j)He also entered into a Short Term Loan for each licence, each for $8,000, to assist in paying the initial cash outlay;
(k)On or about 16 September 1997 (after receipt of his tax refund of approximately $24,217.06) he paid $20,360 to Oracle International being principal and interest repayments together with outstanding deposit of $4,000:
10. In support of the above, the applicant produced the following:-
(a)a cheque butt dated 30 April 1997;
(b)a receipt, with an illegible date;
(c)further receipt dated 16 September 1997;
(d)Licence Execution Sheets recording licence numbers L11-569 and L11-570 respectively and a commencement date 9 June 1997. The Licence Execution Sheet is in the same terms as set out in Miniello (b) above;
(e)Licence Agreements with Oracle Information and Communications Pty Ltd as Licensor for two licences to conduct the Licensed Business, being a business supplying Oracle Products to not less than 5,000 telephone subscribers, allocated to the licensee, during the term of 20 years.
(f)Management and Marketing Agreements with Oracle Infocom Management Pty Ltd as Manager for the Manager to manage the Licensed Businesses;
(g)Loan Agreements with Oracle InfoCom Finance Pty Ltd as trustee of the O.I. Finance Trust each for an advance of $31,500, to be applied in payment of fees to the Licensor and the Manager.
(h)Two Year Income Guarantee by which the Manager guaranteed that in the period 30 June 1997 to 30 June 1999 (the Initial Period) the Gross Profit of the Licensed Business would not be less than $8,589 (the Minimum Gross Profit). The Two Year Income Guarantee bears a stamp recording “Licence Number/s L11-569/570 Number of Licences 2”;
11. Short Term Loan Agreements, each dated 9 June 1997, for an advance of $8,000 for payment to the Manager to be repaid (with interest) by four consecutive monthly instalments of $2,050.
12. Mr Michael Burnett testified that:
(a)He was the Managing Director of Oracle. Since 1982 he had been involved with and had obtained experience in the motivational speaking and business solutions seminar industry in Australia, New Zealand and Asia. His industry experience includes all aspects of management, sales and marketing including, providing personal development programs and business solution seminars and workshops to individuals, small and medium enterprises and major employer groups such as National Mutual, AMP, BankWest, Telstra (who also sponsored an event), Hilton Hotel Group, New Zealand Post, Coca-Cola Amatil, Cadbury Schweppes, LJ Hooker, First National Real Estate and Roy Weston Real Estate. He therefore had the required experience to be the managing director of the Oracle Group.
(b)The projections forecast in the IM for the Project were based on key assumptions which were at the time reasonable. At the time of making the projections, he had been involved in the seminar and motivational speaking industry for about 15 years and was intimate with the various products on offer in the market, the expected price range for the various products on offer in the market, the likely level of response to the various products on offer in the market and the likely cost of sales of the various products. The projections were therefore based on his personal experience and knowledge of the seminar industry.
(c)The Project was managed and marketed for and on behalf of the investors in a professional manner and in accordance with the obligations contained in the agreements.
(d)All the essential requirements to operate a successful personal development and business solutions seminar business were present in the existing infrastructure for the Oracle Group prior to the expansion of the business under the Oracle Project.
(e)At all times the Manager endeavoured to manage and market each licensee’s business as a separate business. This was done by the Manager maintaining individual records and issuing individual reports to licensees, and allocating seminar, workshop and merchandise sales to individual licensees depending upon the identity of the particular attendee from whom the sales revenue was derived. That is, income was not pooled between licensees. Sometimes this resulted in windfall gains to some licensees and losses to other licensees. All licensees’ businesses were treated as individual businesses by the Manager in respect of record keeping and allocation of revenue derivation. As the income was not pooled, licensees would obtain income from a person attending a seminar that was part of their respective territory of people regardless of whether Oracle made money or not.
(f)An agency agreement was signed by Oracle Infocom Management Pty Ltd as manager and Sales Pursuit as agent. As an agent undertaking the business on behalf of the manager, who in turn was performing its duties on behalf of the licensees (such as the applicants), any business introduced by Sales Pursuit was inextricably linked to the licensees of the Project. At all relevant times, this was the relationship between all the relevant parties, conducting the business of promoting and managing seminars on behalf the investors.
13. Mr John Liddell, who was put forward by the applicant as an expert witness testified that:
(a)Based on the experience of the people behind the Project, the Project should, in his opinion, have been able to satisfy all of the requirements of the Project. In particular Michael Burnett was very experienced in running large seminar events which had been successful on a national basis.
(b)The conversion rates predicted by the Project were conservative and reasonable.
(c)The sales projections in the information memorandum were very reasonable and easily attainable in his opinion.
(d)The Project was more than capable of running the number of seminars they would require in order to achieve the projected income, and this projected income was reasonable based on the Project being able to achieve the projected ticket sales.
(e)In 1997 it was reasonable to have expected a strong demand for the products and services being offered by Oracle, which was shown by the attendances at the 1997 World Masters of Business Events.
(f)The initial training, marketing and management fee charges for a typical licensee holding one Oracle Licence, namely $37,465, were in his opinion reasonable particularly in terms of the knowledge and experience required to operate this type of business and the financial resources required to operate such a business as an individual promoter.
14. Mr Paul Begley, who was also put forward by the applicant as an expert witness testified that:
(a)The information memorandum offered the opportunity to make a sound financial return from an investment in the Project. The Project had an internal rate of return on a before tax before finance basis of 18.14% over the licence period.
(b)The rate of return contained a premium over other asset classes and investments with similar risk.
(c)The use of borrowed funds by an investor to finance their investment in the Project was a sound investment practice when the finance is only recoverable by the lender from the investment. The capacity to borrow on a limited recourse basis was clearly preferable and the most commercially sensible option.
(d)An investor in the Project would not only evaluate the limited risk of the investment by entering into a limited recourse loan, but would also evaluate the potential growth and income of the Project. An additional selling point of the Project would have been the comparative returns to other asset classes and also the potential to diversify the investor’s exposure.
RESPONDENT’S EVIDENCE
15. The evidence of the respondent’s witnesses is referred to below.
Project structure and Documents
16. An Information Memorandum for prospective investors was issued under the auspices of the “Manager of the Issue” Oracle International Pty Ltd. The Key Data Summary at page 3 of the Information Memorandum states:-
“This Information Memorandum outlines to applicants the opportunity to acquire one or more of a limited number of exclusive licenses to carry on a business of developing, promoting and marketing Oracle Products and Services under the Oracle System and the Oracle Image.
…
Benefits include:
§A low initial cash outlay of $10,000.*
§*The initial cash outlay of $10,000 can be financed by making one payment of $2,000 followed by four payments of $2,050 per month.
§An Income Guarantee of $8,589 for the first two years.**
§**Upon the applicant completing the payment of the Initial Cash Outlay of $10,000, a sum equivalent to the licences projected Gross Profit (after deducting the agreed management and licence fees and loan repayments) for the first two years, will be immediately paid into a Solicitors Trust Account, to ensure that sufficient funds are available to meet the Income Guarantee.
§See Income Guarantee document for further details.
§A tax deduction of $40,000.***
§***By making an initial cash outlay of $10,000 and borrowing $31,500 from Oracle InfoCom Finance Pty Ltd, on a limited recourse basis, Licensees are entitled to claim an immediate tax deduction of $40,000 and benefit from a tax saving or refund of up to $19,400, provided that they satisfy the criteria for deductibility as detailed in the Independent Taxation Opinion at pages 12 to 15.
§A tax saving or refund of
§$19,400 (@ 48.7% tax rate).***
§$14,400 (@ 36.0% tax rate).***
§Net projected cash flow, after loan repayments, rising to around $9,000 p.a. in year seven.
§A twenty year exclusive licence.
§Ability to appoint a management and marketing services company to manage and develop the business for you.
§Ability to borrow, on a limited recourse basis, most of the funds to cover the initial costs. That is, a loan of $31,500 repayable only from the proceeds of the business. The loan is secured against your Oracle Licence only and is the full extent of the loan liability.
Oracle’s state-of-the-art Direct Marketing and purpose built, high-technology Telesales Centre, together with the acquisition of additional intellectual property and copy right materials, will be funded from the release of a limited number of exclusive Oracle Licences.”
17. The Information Memorandum at page 16 contained projected cash flows on a pre-tax basis from a licence for a 10 year period 1 July 1997 to 30 June 2007. By clause 2.1 and the definition of “term” in Clause 1.1 of the Licence Agreement the term of a licence was 20 years. No explanation of the projections or the assumptions on which they were based was included in the Information Memorandum.
Licence Agreement
18. By clause 2.1 of the Licence Agreement the Licensor granted to the Licensee an exclusive licence to conduct one Oracle Outlet supplying Oracle Products to the Specified Custoners during the Term.
19. “Oracle Outlet” was defined in clause 1.1 as a business conducted under licence from the Licensor supplying some or all of the Oracle Products.
20. “Licensed Business” was defined in clause 1.1 as the business the operation of which is permitted by virtue of the rights and benefits granted by the Licensor to the Licensee pursuant to the Licence Agreement.
21. Oracle Products, was defined in clause 1.1: “means the goods and/or services authorised by the Licensor from time to time for supply in an Oracle Outlet. As at the commencement date the Oracle Products comprise the following:
a.Personal development and business training seminars and workshops conducted in Australia.
b.Marketing and sale in Australia of books, audio and video programs relating to personal development and business training.”
22. Specified Customers, was defined in clause 1.1: “means the telephone subscribers within the Country [defined as the Commonwealth of Australia] allocated to the Licensee by the Licensor upon the execution of this agreement (and being not less than five thousand (5,000) subscribers) and notified to the Licensee in writing (which notice is deemed to be incorporated into this agreement).”
23. The Term was defined by clause 1.1 to be 20 years commencing on the Commencement Date which was, in turn, defined as the date as set out in the Oracle Licence Execution Sheet.
24. By clause 4, the Licensee agreed to pay: -
(a)a Licence and establishment Fee of $1,500 payable on the Commencement Date;
(b)a Training fee of $220 per month for the first year payable monthly in arrears on the first day of each month (Payment Date) or, if paid in advance on the Commencement Date, $2,465;
(c)an Annual Licence Fee: -
i.for the first year of $85 per month payable monthly in arrears or, if paid in advance on the Commencement Date, $960;
ii.for each subsequent year of 12.5% of the Gross Profit payable monthly in arrears on the Payment Date. Gross Profit was the aggregate gross remuneration received by or on behalf of the Licensee in the conduct of the Licensed Business less the cost, including freight, of Oracle Products sold through the Licensed Business [clause 1.1 and Licence Agreement, clause 1.1, definition of Gross Revenue].
25. By clause 5, the Licensor undertook to:
(a)provide ongoing training during the first year [clause 5.1];
(b)provide management guidance and operations review in respect of the Oracle System and relevant data and information as may be necessary to ensure that the Licensee had the benefits of the exploitation and use in the Licensed Business of the Oracle System [clause 5.2];
(c)make a copy of the Manual relating to the Oracle System available to the Licensee [clause 5.3];
(d)supply to the Licensee upon the Licensor’s prices, terms and conditions of supply prevailing from time to time, such of the Oracle products as may reasonably be required for the Licensed Business but gave no warrant as to the effectiveness or regularity of supplies [clause 5.4];
(e)provide samples of approved promotional material for use in the Licensed Business [clause 5.6].
26. By clause 5.5, the Licensor was empowered from time to time to change, vary or modify the products and services comprising the Oracle Products.
27. By clause 6, the Licensee undertook to:
(a)conduct the Licensed Business efficiently and commercially [clause 6(a)];
(b)charge prices that were competitive and follow the reasonable recommendations of the Licensor with regard to prices [clause 6(c)];
(c)make available to customers in sufficient quantities all product lines forming part of the Oracle Products [clause 6(d)];
(d)conform to the Oracle System as prescribed by the Licensor from time to time [clause 6(e)];
(e)conform to the Oracle Image as prescribed by the Licensor from time to time [clause 6(f)];
(f)conduct the Licensed Business only under its own name or a business name approved by the Licensor;
(g)provide management reports to the Licensor in a form specified in the Manual [clause 11.3].
28. The Licensee further agreed:
(a)that all the goodwill and other rights and interest arising from the use of the Oracle System and the Oracle Image inure for the exclusive benefit of the Licensor [clause 7.5];
(b)not to disclose the Confidential Information relating to the Oracle System or Oracle’s or the Licensor’s methods of business [clause 7.6];
(c)not to engage a person to manage the Licensed Business unless and until the Licensor approved in writing the manager and the manager’s terms of engagement [clause 9];
(d)to conduct such promotion of the Licensed Business during the first year of the term as the Licensor may direct [clause 10].
Management and Marketing Agreement
29. Each Management and Marketing Agreement made between the applicants as Licensees and Oracle InfoCom Management Pty Ltd as Manager included terms as follows:
(a)The Licensee engaged the Manager to be the sole and exclusive Manager to the Licensed Business and the Manager accepted the engagement:
(b)the Manager’s engagement was to commence on the Commencement Date for the 20 year term.
(c)in consideration of the Manager providing management services, the Licensee agreed to pay a Management Fee of:
i.$1,380 per month during the first year of the term or if paid in advance the sum of $15,500 on the Commencement Date;
ii.15% of the Gross Profit in each subsequent year of the term payable monthly in arrears on the first day of each month (Payment Date).
iii.“Gross Profit” is defined in clause 1.1 to have the same meaning as in clause 1.1 of the Licence Agreement and means: “the Gross Revenue less the cost (including freight but without any deductions for the other expenses of distribution and management) of the Oracle Products sold through the Licensed Business.” and the “Gross Revenue” means: “the aggregate gross income and remuneration received by or on behalf of the Licensee in the conduct of the Licensed Business.”;
(d)the management services were to manage, direct and control the Licensed Business on behalf of the Licensee: [clause 4, 6.1];
(e)in consideration of the Manager providing marketing services during the first twelve months of the term, the Licensee agreed to pay a Marketing Fee of $1,740 per month or if paid in advance the sum of $19,500 on the Commencement Date. For subsequent periods the Manager was to provide marketing services to the extent and for fees to be agreed between the parties from time to time: [clause 5];
(f)The marketing services during the first year of the Term were to:
(i) provide training packages for telemarketers;
(ii) provide detailed prospect lists;
(iii)provide, refine and monitor promotional and direct mail materials;
(iv)conduct market research and effectiveness monitoring services:
(g)Clause 6.3 set out certain Management and Marketing Standards including that the Manager was to:
(i)take steps to comply with the Licence Agreement;
(ii)to devote such time and attention to the management of the Licensed Business as may be reasonably necessary in the opinion of the Licensor;
(iii)to be entitled to manage any other business for any other person;
(iv)use its discretion to devote sufficient time and attention to performance of its obligations under the Management and Marketing Agreement;
(v)prepare and make available to the Licensee and the Licensor in accordance with the Licence Agreement for inspection on receipt of written notice the books of account and records of the Licensed Business;
(vi)promptly prepare and convey to the Licensee a report of any matter which the Manager reasonably considers should be brought to the attention of the Licensee concerning the Business from any facts or circumstances which have come to the notice of the Manager;
(h)the Manager was to establish a bank account, the Clearing Account into which the Manager was to pay upon receipt the Gross Revenue i.e. the gross income or remuneration received by or on behalf of the Licensee in the conduct of the Licensed Business
(i)the Manager was to disburse monthly all moneys paid into the Clearing Account, and to that end was irrevocably authorised and directed by the Licensee at the end of each month to calculate the total deposits of Gross Revenue paid into the account during the past month and apply the whole of those funds after paying bank and government charges, fees, imposts and duties as follows:
(i)to pay the cost and freight of Oracle Products and Services purchased for the Licensed Business; and then
(ii)to pay the total licence fees to the Licensor; and then
(iii)to pay the Management Fee and the Marketing Fee to the Manager; and then
(iv)to pay the Loan Repayment to the Lender;
(iv)to pay the balance to the Licensee;
(j)The Licensee authorised and directed the Manager to pay on behalf of the Licensee the moneys to be paid on the Commencement Date by the Licensee under the Licence Agreement, the Management and Marketing Agreement and the Loan Agreement:
(k)The Manager was responsible for all payments, costs, charges and expenses incurred in the conduct and management of the Licensed Business and is to ensure as far as possible that the Licensee is not personally liable for such and indemnifies the Licensee against all such payments
(l)The Licensee could terminate the Management and Marketing Agreement by notice:
(i)if there was four or more breaches of any of the Manager’s obligations under clause 6, the Manager’s Duties provision of the Agreement;
(ii)if the Manager ceased to be approved by the Licensor:
Loan Agreement
30. The Loan Agreement made by the Licensee and Oracle Infocom Finance Pty Ltd as Lender contained the following provisions:-
(a)On the Commencement Date the Lender was to lend $31,500 (the Advance) to the Licensee;
(b)The Licensee irrevocably elected to pay in advance the Initial Licence and Establishment Fee, the Annual Licence Fee and the Training Fee payable under clause 4 of the Licence Agreement, and the Management Fee and the Marketing Fee payable under clauses 4 and 5 of the Management and Marketing Agreement;
(c)The Licensee irrevocably authorised and directed the Lender to pay the proceeds of the Advance:-
(i)to the Licensor in payment of the Initial Licence and Establishment Fee, the Training Fee and the Annual Licence Fee; in advance for the first year; and
(ii)to the Manager in payment of the Management Fee and the Marketing Fee in advance for the first year; and
(iii)if applicable, in payment of the interest in advance for the first year ‑
(d)The Licensee was to repay the Advance and interest thereon by paying:‑
(i)to the Lender on each payment date 97.5% of the Gross Profit in the first year and 70% of the Gross Profit in each subsequent year (the Loan Repayment); and
(ii)if there is a default under the Loan Agreement the whole of the Gross Revenue;
(e)The Licensee was not required to repay the Advance and interest thereon in any way except as provided in clause 3;
(f)The Advance was made on limited recourse terms as the obligations of the Licensee were entered into not as personal obligations with the intent of binding the Licensee personally but were entered into for the purpose only of ensuring repayment to the Lender in accordance with clauses 3 and 4 and binding the Property Charged under clause 6;
(g)The Lender was not entitled to resort for repayment to any asset or property of the Licensee except the Property Charged;
(h)Interest on the Advance was incurred and to be paid as follows:
(i)if paid in advance for the first year, $1,575;
(ii)if not paid in advance for the first year at the rate of 6% per annum calculated monthly;
(iii)after the first year at the rate of 6% per annum or an amount equal to the Loan Repayment, whichever is the lesser;
(i)the Licensee confirmed the irrevocable authority of the Manager to pay the Loan Repayment on each Payment Date to the Lender from the funds held in the Clearing Account;
(j)the Licensee charged the whole of his estate, right, title and interest in the income and profit derived from the Licensed Business (Property Charged) with repayment of the Advance and interest thereon;
(k)the Licensee agreed that the Loan Repayments shall be paid as a first priority from the Gross Revenue and the proceeds received from the assignment or sale of the Licensed Business;
(l)the Licensee pledged the Licence Certificate by way of security with the Lender and irrevocably authorised and directed the Licensor to deliver the Licence Certificate to the Lender;
Short Term Loan Agreement
31. The Short Term Loan Agreement made by the Licensee and the Lender contained the following provisions:-
(a)On the Commencement Date the Lender advanced $8,000 to the Licensee and the Licensee was indebted to the Lender for that amount;
(b)The Licensee irrevocably authorised the Lender to pay the $8,000 to the Manager to be applied in accordance with clause 8 of the Management and Marketing Agreement;
(c)The Licensee was to pay interest on the Advance from the date of execution of the short term loan agreement at the flat rate of 5%;
(d)The Licensee was to repay the $8,000 and the interest thereon by paying to the Lender four consecutive monthly instalments of $2,050. Each instalment to be made on the last day of the month, the first to be made on the last day of the month following the Commencement Date.
Two Year Income Guarantee
32. The Two Year Income Guarantee was given by the Manager in favour of the Licensee and provided in the following terms:-
(a)That in consideration of the Licensee executing the Management and Marketing Agreement, the Manager guarantees that Gross Profit of the Licensed Business during the Initial Period will not be less than $8,589 (Minimum Gross profit);
(b)In clause 1.1, “Initial Period is defined: “means the period commencing on the Commencement Date and ending on 30 June 1999” and “Commencement Date” has the same meaning as in the Licence Agreement.
(c)The Manager will effect immediately the payment of a sum equivalent to the Net Cash Flow during the Initial Period into a Trust Account to be held by the Licensor’s solicitors: [clause 2.2]. “Net Cash Flow” is defined in clause 1.1: “means Gross Profit less Licence Fees, management Fees and Limited Recourse Loan repayments, and in the same amounts set out in the page 7 of the Oracle Information Memorandum.”
(d)In the event that each Licensed Business does not attain the Minimum Gross Profit during the Initial Period the Manager will pay the amount by which the Gross Profit is less than the Minimum Gross Profit (ShortFall) into the Clearing Account and apply it in accordance with the Management and Marketing Agreement;
(e)The agreement was to terminate on expiry of the Initial Period.
Carrying out of the Licence Agreements
33. Under cover of a letter dated 25 August 1997, the Manager provided each applicant with, inter alia, a schedule of telephone listings assigned to each licence. These were selected at random from a database that contained the details of 55 Australian telephone books.
34. An Oracle licensee Training session took place on 18 November 1997. A second round of training sessions was announced for February and March 1998 and 5 October 1998. The applicant did not attend any of these sessions.
Carrying out of the Loan Agreements
35.
The Licensor (incorporated on 5 March 1997), the Manager (incorporated on
10 February 1997) and the Lender (incorporated on 5 March 1997) were associated entities, sharing common directors and office holders and all beneficially owned by Oracle International Pty Ltd, which was incorporated on 30 October 1996 and changed its name to Oracle International Pty Ltd on 5 February 1997.
36. On 28 June 1997 the directors of Oracle Infocom Management Pty Ltd in its capacity as trustee of the OI Management Trust resolved to lend Oracle Information and Communications Pty Ltd as trustee for the OIC Trust :-
§$30,425 for each licence where licensees pay $10,000 as an initial payment i.e. Option 1;
§$37,925 for each licence where licensees pay $2,000 as an initial payment i.e. Option 2;
§$39,925 for each licence where licensees pay $26 as an initial payment i.e. Option 3
with interest at the rate of 6% and repayment as OIC Trust receives repayments from OI Trust.
37. On 28 June 1997 the directors of Oracle Information and Communications Pty Ltd in its capacity as trustee of the OIC Trust resolved to lend Oracle Infocom Finance Pty Ltd as trustee for the OI Finance Trust:-
§ $30,425 per licence where licensees pay $10,000 as an initial payment i.e. Option 1;
§ $37,925 per licence where licensees pay $2,000 as an initial payment i.e. Option 2;
§ $39,925 per licence where licensees pay $26 as an initial payment i.e. Option 3;
with interest at rate of 6% and repayment as OI Finance Trust receives loan repayments from licensees.
38. The above resolutions were effected by run-arounds of cheques. The money lent by the Manager to the Licensor and, in turn, to the Lender was passed back to the Manager in payment of the Licensee’s fees. No cash was required to support the borrowings.
39. Journal entries were then made to record the allocation of the fee components.
40. The $10,000 paid by each Licensee to acquire a licence came into the Manager for disbursement. The Information Memorandum at page 20 required applicants for a licence to make the cheque for $10,000 payable to “Oracle Infocom Management Pty Ltd Clearing Account”. The accounts record the issue of 1430 Oracle licences. Consequently the estimated cash amount received on all the licences was $14,523,080 or rounded to $14.5 million.
41. The analysis in the Pendergast report at Appendix B concludes that the cash paid by the licensees went into the clearing account of the Manager and was journalised to the Manager’s ‘Income in Advance’ account. This account was used as a clearing account and its value reduced to $0 after journal entries were subsequently made to record among the entities the take up of the licences and the allocation of the fee components to the respective entities. Payment by the Manager of $500 to the Lender and $4,925 to the Licensor took place by the run-arounds of cheques. Funds received from licensees on repayment of the short term loans were retained in the Manager’s clearing account.
Business activity undertaken by Sales Pursuit Pty Ltd
42. By a letter dated 14 August 1997 Oracle International made an offer to Sales Pursuit Pty Ltd to acquire an interest in Sales Pursuit Pty Ltd.
43. On 8 October 1997 a Deed was made for the sale of the business carried on by Sales Pursuit Pty Ltd and Roach Enterprises to Wavecrest Holdings Pty Ltd (Wavecrest) for $5.2 million with completion on 8 October 1997 including lease of premises in Surry Hills Sydney, staff, goodwill, trademarks, business names, stock, plant and proceeds from the Tony Robbins seminar organised for 10-13 October 1997 and consultancy agreements with Marlow (agent for Tom Hopkins seminars) and Roach both from 1 January 1998.
44. Annexure J to this deed is an undated agency agreement between Wavecrest and Oracle Infocom Management. The deed does not give a commencement date, but does provide:-
(a)for Wavecrest to sell the goods and services of the Sales Pursuit Pty Ltd business (“the Products”) to Oracle Infocom Management at cost;
(b)for Oracle Infocom Management to sell the Products in accordance with the terms of the Oracle Licences to the telephone subscribers within Australia allocated pursuant to the Oracle Licences;
(c)Wavecrest agreed to act as agent for Oracle Infocom Management to sell the Products.
45. A consultancy agreement was entered into by Wavecrest, Oracle Infocom Management and Mr Burnett for Wavecrest to engage Oracle Infocom Management as consultant to provide services to Wavecrest managing the day to day running of Wavecrest and to organise contracts with speakers for a fee of $80,000 per annum commencing 1 January 1998 and expiring 31 December 2000.
46. Funds of $2 million to complete the acquisition of Sales Pursuit Pty Ltd were transferred from the clearing account of the Manager.
47. About this time Mr Burnett relocated to Sydney informing Licensees in the first report of the Manager that associated interests of Mr Burnett and other shareholders of Oracle International had acquired a controlling interest in Sales Pursuit Pty Ltd and an agency agreement between Oracle Infocom Management and Sales Pursuit Pty Ltd. This would mean making headquarters in Sydney while maintaining an office in Perth “but the focus here will now be directed towards administering Licensees services, reporting and other ancillary operations. The development of our telemarketing operation is also enhanced significantly. Sales Pursuit already operates a relatively sophisticated system and we will direct our efforts to further improve those operations to produce the end results which we desire.”
48. From October 1997 Sales Pursuit Pty Ltd conducted the seminar business on which the Licensed Businesses were reliant.
49. Mr Pendergast observes at paragraph 79 of his report that the main business of Sales Pursuit Pty Ltd was to organise, promote and manage seminars for their own benefit not just for the Licensees. The documentation did not enable Mr Pendergast to establish how information, revenues and expenses for the Licences was captured and accounted for or which entity carried out the responsibility for maintaining such records.
50. On 14 December 1999 shares in Sales Pursuit Pty Ltd were offered to the public. The prospectus stated the agency agreement would be terminated from 1 July 1999.
51. Notwithstanding the statements in letters to Licensees that the agency agreement with Sales Pursuit Pty Ltd ceased in March 2000, at paragraph 177 of his report Mr Pendergast observes that it appears the business relationship continued. In this regard Mr Pendergast refers to a letter dated 21 March 2001 from the Manager to the Licensees stating that the ‘Unlimited Wealth’ seminar was being presented in Perth by ‘Oracle” in conjunction with Sydney based associate Vision Pursuit, which is a subsidiary of Sales Pursuit Pty Ltd.
52. The total cash receipts of $14.5 million [identified in Appendix C of the Pendergast Report, pages 36-39] were, in turn, applied to the acquisition of Sales Pursuit Pty Ltd ($3.2 million Pendergast Report paragraphs 159 - 165), other business interests of the promoter entities and their associates and payments to Mr Burnett and others and the Crestwin Corporation Ltd. In Appendix D of the Pendergast Report, pages 40-44 payments to related parties of $7,633,494 and $5,656,727 cash expenses including consulting fees and success fees are identified.
53. According to the Information Memorandum (page 9) the pre‑existing seminar business on which the Licensed Businesses were reliant was that conducted by Sales Pursuit. Each Licensee elected to appoint the Manager to manage their Licensed Business on their behalf. Neither the Manager or the Licensor or the Head Licensor conducted a seminar business.
54. The Information Memorandum informed prospective licensees that Oracle planned to significantly grow and enhance the promotion of the business utilizing amongst other initiatives, a modern and sophisticated direct marketing and telesales centre, a “central telemarketing and direct sales and marketing centre incorporating state of the art technology” that would provide “an efficient and effective sales, marketing and management function for the Licensee’s business”. This proposal did not eventuate. The Manager did not establish a telemarketing and direct sales and marketing centre. A review of the accounts of the Manager and the Licensor reveal that neither was involved in a telemarketing and direct sales centre. Nor does a review of the accounts of Sales Pursuit Pty Ltd reveal the operation of a telemarketing and direct sales centre.
55. Business activity was focused on the capital cities, especially, Sydney. See:
(a)Issue No. 1 of the Oracle quarterly report, October 1997. In reporting the acquisition of the business of Sales Pursuit, it stated: “Of immediate consequence, we are now well established in the largest market in Australia – Sydney. This comes just three months after commencement. You may recall that our original forecasts did not envisage any interstate expansion within the first twelve months”
(b)Issue No. 6 of the Oracle quarterly report, February 1999. It contained a summary of the seminar program from July, 1997 to November 1998. Of the 10 seminars conducted over that period, one took place in Adelaide and 9 were conducted in Sydney. Two of those also went to each of Perth, Melbourne and Brisbane;
(c)Letter, 9 March 2000 and Oracle International Quarterly Report – Newsletter, March 2001 which indicate that by March 2000, Oracle was conducting seminars only in Perth.
Business activity - conduct of Licensed Businesses
56. There is no evidence of management reports provided to Licensees to show that the Licensees were in compliance with their undertakings in the Licence Agreement.
57. A review of the Manager’s profit and loss statements reveals that the Manager did little, and incurred minimal expenses in managing and marketing for the Licensed Businesses.
58. No detail of how the Licensee’s sales income entitlements in relation to his licence were determined, was provided
59. Mr Pendergast states in his report that he identified in the expenses of Sales Pursuit Pty Ltd for the nine months to 30 June 1998 an amount of $350,443 described as “Distribution of Funds”. The Manager’s Operating Account identifies payments totalling $291,524.60 received from Sales Pursuit Pty Ltd in the 1998 financial year. Mr Pendergast observes that under the Agency Agreement, Sales Pursuit Pty Ltd agreed to sell the Products to the Manager at cost and the Manager agreed to pay Sales Pursuit Pty Ltd a commission equating to 20% of the Gross Profit (revenue from sale of product less cost price), with the balance of the funds to be disbursed to the Manager. He concludes that the $291,525 compares with the $350,443.
60. The documentation did not enable Mr Pendergast to establish how information, revenues and expenses for Licences were captured and accounted for and which entity carried out the responsibility for maintaining such records. It was not apparent from the documentation from where the amounts included in Licensees’ net income statements had been extracted. The Manager’s ‘Funds held in Trust for Licencees Account’ contained detail of total gross profit and total loan repayments and detail of the individual payments made to Licensees at the end of each quarter. However, there was no evidence of the maintenance of separate records to allow individual reporting of sales and loan repayments or how the individual payments to Licensees each quarter were derived. The actual payments to Licensees were funded out of the Manager’s Clearing Account. Mr Pendergast illustrates the movement of net income funds through the Manager’s ‘Funds held in Trust for Licencees Account’ at paragraphs 96 and 97, Tables 7 and 8 of his report.
61. The Manager provided quarterly and year end statements of income and expenditure reporting sales, cost of sales, profit, licence fees and loan interest and repayments.
62. Nevertheless from March, 1999, quarterly income and expenditure statements provided to the applicants purported to include the number of phone calls and direct mailings made in respect of their licence.
Returns to Licensees
63. The Two Year Income Guarantee in conjunction with the terms of the Loan Agreement had the outcome that in year one 97.5% of the amount of the Income Guarantee would be applied to the loan. As there were no other fees payable by the Licensees in that year the remaining balance would be paid to the Licensee. In Year Two 70% of the Income Guarantee amount would be applied to the loan. The amount that then remained after payment of fees was to be paid to the Licensee.
64. The Guaranteed Income was $2,100 for the first year, ended 30 June 1998 and $6,489 for the second year, ended 30 June 1999 and the funds to be paid to each licensee were:-
1998 1999 Income Guarantee $2,100 $6,489 Loan payment $2,048 $4,542 Balance $52 $1,947 Licence Fees $0 $1,784 Pay to each Licensee $52 $163 Total 1430 Licensees $74,360 $233,090
65. On 30 June 1998 the Manager transferred cash of $283,800 from the Manager’s Clearing Account to the Solicitors Trust Fund Account to support the payment of the Income Guarantee. Of this amount $35,403 was allocated in the Funds Held in Trust For Licensee Account. That account also records in total amounts rather than by Licensee the net income from seminars, the allocation to loan repayments and the small remaining cash distributions to Licensees, including the applicants of $52.51, in the financial year ended 30 June 1998. The cash payments were funded from the Manager’s Clearing Account.
66. The Statements of Income and Expenditure provided to the three applicants recorded the following outcomes in contrast to the gross income projected in the Information Memorandum:-
Gross income per licence – projected (as per Oracle Information Memorandum) vs actual (as per individual statements of income and expenditure)
Year ending 30 June
Information Memorandum
Miniello
Burrows
Richards
1998
$3,428
$2,100
$2,100
1999
$10,593
$6,489
$6,489
$6,488.99 / $6,489
2000
$18,032
$0
2001
$18,574
$0
$0
2002
$19,132
$0
APPLICANT’S CASE
Section 51 (1) of the 1936 Act
67. The applicant contends that:
68. The applicant’s purpose in obtaining a license in the Project was for the purpose of carrying on a business of the promotion, distribution and selling of the Oracle products and services to derive assessable income therefrom. The applicant also elected to appoint the Manager as his manager to undertake his Licensed Business to derive assessable income there from.
69. Assessable income was derived by the applicant in the years ended 30 June 1998 and 30 June 2000 from the promotion, distribution and sale of the Oracle products and services.
70. Pursuant to the License Agreement and the Management Agreement, the applicant has clearly incurred the obligation to make the payment of the relevant fees, such as the management fees in the amount of $15,500.00, marketing fees in the amount of $19,500.00, prepaid interest in the amount of $1,575.00, license fees in the amount of $960.00 and training fees in the amount of $2,465.00 on or before 30 June 1997 for the purposes of carrying on his licensed business, and the evidence supports the view that the applicant had at 30 June 1997 commenced to carry on a business via the Manager.
71. By clause 6 of the Management Agreement, the Manager was to perform its duties on behalf of the licensees including the applicant exercising reasonable care and in a professional manner. The licensees including the applicant had the power, by clause 6.3(h) of the Management Agreement, to instruct the Manager as to how to undertake the various management services and the Manager was obligated to comply, failure to do so on four occasions was a breach of the Management Agreement and the licensees including the applicant could terminate the Agreement.. Moreover, if the licensees including the applicant were not satisfied with the Manager’s performance, the licensees including the applicant were empowered to terminate the Agreement and remove the Manager. The licensees including the applicant also had the power to appoint another manager.
72. There is a plethora of authority that expenditure incurred on management and marketing fees, annual license fees and training fees is revenue in nature rather than capital where the taxpayer is carrying on a business and has employed a manager (over which the investor had control) or has incurred the relevant fees in the course of deriving assessable income (see Sleight v Commissioner of Taxation (2004) 136 FCR 211, Commissioner of Taxation v Cooke (2004) 55 ATR 183, Commissioner of Taxation v Lau (1984) 6 FCR 202 at 221 per Beaumont J, Commissioner of Taxation v Emmakell Pty Ltd (1990) 22 FCR 157, Puzey v Commissioner of Taxation (2002) 50 ATR 595; (2003) 53 ATR 614, Commissioner of Taxation v Brand (1995) 31 ATR 326, Commissioner of Taxation v Walker (1984) 84 ATC 4553, Australian Trade Commission v Disktravel [1999] FCA 1399, Madison Pacific Property Management and Ors v Australian Securities Commissioner 30 ACSR 218, Merchant v Commissioner of Taxation 99 ATC 4221).
73. The applicant asserted that it is highly relevant to note that the above authorities concerned similarly structured managed investment schemes where the taxpayer was not actively involved in the business.
74. The fees paid by the applicant were incurred in the gaining or production of assessable income, or necessarily incurred in carrying on a business for the purpose of gaining income. The income in this case was to be derived from the sale of products and services relating to personal development seminars and workshops.
75. In characterising the applicant’s payment of the relevant fees in the 1997 year it is necessary to identify what the expenditure was for (Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation (1980) 33 ALR 213). Upon a consideration of the evidence, it is clear that the expenditure was incurred to retain a manager to conduct the day to day operations of the applicant to essentially promote, distribute and sell the Oracle products and services.
76. The respondent’s contention that the applicant was not “actively” involved and therefore not himself carrying on a business is misguided. That is the point of appointing a manager. In Lau, Brand, Sleight, Madison Pacific, Disktravel, Emmakell, Walker, Puzey and Cooke, the taxpayers were passive and did not actively make decisions or hold the business records. The critical point is that the applicant had the power to dismiss the manager and the power to give instructions to the manager.
77. The facts in the case of Madison Pacific are similar to the facts in this case. Similar to this case, Madison Pacific involved a managed investment scheme which offered to investors the opportunity to obtain franchise rights in a residential tenancy property management business relating to a randomly selected territory. Like in this case, the offer to investors for a franchise territory came with it an invitation to have the territory managed and marketed by a manager related to the franchisor and the opportunity to finance their investment in the franchise through a limited recourse loan from a lender related to the franchisor and the manager. The Full Federal Court, whilst considering whether the offer to the investors constituted a prescribed interest for the purposes of the Corporations Law and whether it was exempt from issuing a prospectus, concluded that the structure of a manager being appointed to manage the franchise and the services to be provided by the manager in that case (which are similar to those provided by the Manager in the Project) fell within the scope of the definition of franchise in the Corporations Regulations and therefore exempt from issuing a prospectus. In effect the Full Federal Court found the managed investment scheme to be an effective franchise structure.
78. Importantly, however, his Honour Justice French rejected the Commissioner’s [ASIC] contention in that case that the franchisees were not carrying on a business (either themselves or through a manager/agent) to satisfy the definition of franchise. He concluded.
“The ultimate responsibility for carrying on the business, albeit the business may in effect be created by the manager, is that of the franchisee. The ultimate legal liability, save to the extent that it can be avoided by the manager contracting in its own right, remains with the franchisee. The franchisee has a power to give directions to the manager concerning the general conduct of the business. The manager plainly has legally enforceable obligations to the franchisee and the agreement may be terminated for breach or not renewed upon the expiry of its term.”
79. His Honour Justice Carr, in support of French J’s conclusions, opined (at [122]) that:
“I do not think that there is any doubt that offering to provide and providing the services of property management to lessors of residential properties in return for fees would constitute a business. It may be accepted that the arrangement in this matter is different from the traditional franchise arrangements which surfaced in the three cases which gave rise to the promulgation of the franchise exemption. However, over a decade has passed since those decisions. Business methods, and particularly franchising methods have evolved considerably over that period of time. In my view, there was a relevant business which the franchisee was given the option of conducting either in person or by an agent. The fact that the circumstances may have made it highly unlikely that any agent other than Madison Pacific Management would be appointed by a franchisee, does not, in my opinion, alter the characterisation of the rights conferred upon the franchisee.” [emphasis added]
80. Comparing the facts of the Madison Pacific case with those of the applicant’s, it would be inconsistent for a finding in this case that the licensees including the applicant were not carrying on a business, when compared with the decision of the Full Federal Court in the Madison Pacific case. Whilst taking the view that each of the franchised businesses may have been a small one, his Honour Justice Carr at [125] remained of the opinion that …
“The point [was] … that at any particular time there can be identified a business activity carried on on behalf of a particular franchisee which can be characterised as its [the franchisee’s] business”.
81. Moreover, David Acheson, the expert called by the Respondent, confirms that the Project satisfies the definition of franchise in all respects.
82. The Disktravel case offers further support to a finding that the licensees including the applicant were carrying on a business. At first instance the Administrative Appeals Tribunal held that the licensees in that case were entitled to an Export Market Development Grant for its overseas expenditure on the basis that it had incurred eligible expenditure in the carrying out of its operations and that the range of expenses incurred was “qualifying export development expenditure” within the meaning of the Export Market Development Grants Act 1974. The Tribunal was of the opinion that the licensees in that case were carrying on a business during the claim year through a manager, and the objective purpose of the licensees in that case in incurring the expenditure was for the purpose of export marketing in an attempt to gain sub-licenses. These findings were not disturbed on the appeal to the Federal Court or the Full Federal Court.
83. To the extent that the applicant’s subjective purpose is relevant to the characterisation of these outgoings (Fletcher v Federal Commissioner of Taxation (1991) 173 CLR 1), it does not differ from this purpose. This is not a case where it can be said objectively that at the time of the investment there was no prospect of obtaining a sum of assessable income greater than the outgoings (see forecast projections in the information memorandum and the cross examination of Ken Pendergast – (“… there’s an expectation that the business will generate substantial cash flows”). Nor is this a case where it can be said that at the time of the outlay it was not expected that the Project would run its course. The evidence demonstrates that it was reasonable for the applicant to expect that he would earn assessable income for the duration of the Project.
84. The existence of the required nexus between the outlays and the gaining of income is confirmed by the Information Memorandum, the Project Agreements and by the evidence of Michael Burnett and John Liddell. There was clearly a reasonable basis to expect to derive income from his participation in the Project. In fact the licensees including the applicant did derive assessable income. The Respondent has not provided any evidence to support the contention that it was “unreasonable” for the applicant to expect he would derive income from the Project.
85. This is not a situation where the character of the advantage sought was long lasting or enduring or that the character of the advantage was one in the nature of a passive investment. The licensees including the applicant had control over the Manager of their licensed business and had the power to, and in fact were encouraged to contact their specified customers for the purpose of promoting, distributing and selling the Oracle products and services (cf with Puzey in the second year, cf also with Clowes v Commissioner of Taxation (1954) 91 CLR 209 and Milne v Commissioner of Taxation (1976) 133 CLR 526).
86. Unlike Clowes and Milne the licensees including the applicant appointed a manager to undertake their licensed business to derive assessable income there from over a 20 year period, as opposed to the applicant participating by investing a sum of money on the expectation of a capital increment at the conclusion of the Project. Furthermore, the applicant and all other licensees had the power to participate in the control of the manager’s obligations and had the right to terminate the manager’s services, unlike in Clowes and Milne (see paragraphs 17 and 18 above).
87. In Puzey on appeal, Hill and Carr J at [58] concluded that “there is no doubt that a contractual payment to a manager to manage such a scheme [managed investment scheme] would be deductible” notwithstanding that the taxpayer in Puzey was found not to be carrying on a business due to the restructuring of the scheme imposed by the Australian Securities and Investment Commission and the establishment of a trust to operate the business. Unlike in Puzey the participants of the Project including the applicant were not unit holders in a unit trust entitled to a share of the profits (if any) of the trust. The trust in that case being the entity which was carrying on the activities of the project, engaging the manager and undertaking the sale of the harvested produce. The structure of this Project involves each licensee including the applicant carrying on their own business, engaging a manager to undertake the promotion, distribution and selling of the Oracle products and services with de jure control over the manager.
88. The facts in the case of Vincent v Federal Commissioner of Taxation [2002] FCAFC 291 are dissimilar to the facts of this case. Neither in form nor in substance did the applicant acquire a capital asset in connection with the payment of the relevant fees. In both form and substance the applicant sought and obtained the relevant services, such as management and marketing services, in relation to the promotion, distribution and selling of the Oracle products and services for a period of 13 months. Like the management fee in Lau, Brand, Merchant, Puzey, Sleight, Cooke and Emmakell the fees in this case are revenue in nature for a service period of 12 months. No enduring benefit would have been obtained by the applicant in relation to the payment of the relevant fees.
89. The amount of $1,575.00 being prepaid interest paid by the applicant to Oracle Infocom Finance Pty Ltd is deductible under section 8-1 of the 1997 Act as it was necessarily incurred in the course of earning income, or necessarily incurred in carrying on a business (Steele v Deputy Commissioner of Taxation (1999) 197 CLR 459, Sleight, Cooke).
APPLICATION OF PART IVA
Dominant Purpose – section 177D(b)
90. The applicant contends that:
91. Notwithstanding that each of the eight factors set out in section 177D(b) of the 1936 Act must be considered in determining a taxpayer’s purpose under Part IVA, the Full Federal Court in the cases of Sleight, Puzey, Cooke and Calder have when determining the objective purpose of taxpayers (who have been investors in similarly structured investment schemes) placed considerable emphasis on:
(a)the commercial returns forecast in the Prospectus calculated on a before tax and before finance basis - section 177D(v) of the 1936 Act;
(b)the commercial content and emphasis of the prospectus/information memorandum - section 177D(i) and (ii) of the 1936 Act;
(c)the personal circumstances of the investor - section 177D(i) and (ii) and (v) of the 1936 Act;
(d)the time the taxpayer entered the investment - section 177D(iii) of the 1936 Act; and
(e)the reasonableness/excessiveness of fees charged to the investor - section 177D(i) and (ii) of the 1936 Act.
92. The applicant asserted that to ignore or disregard the evidence concerning those facts which the Full Federal Court has found to be highly relevant in determining the dominant purpose of a taxpayer in a similarly structured investment scheme would be an error in law and indicate that the conclusion of purpose being made is not that of a reasonable person. (Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404 per Brennan CJ, Dawson, Toohey, Gaudron, Gummow and Kirby JJ at 422).
93. Conversely based on the Full Federal Court authorities in Cooke, Sleight, and Calder a reasonable person would regard a round robin financing of the investors participation as at its highest “only mildly pointing to a tax purpose” on the part of the investor. To place considerable emphasis on the financing of the investor’s participation by a loan, implemented by a series of round robin transactions, as heavily pointing to a tax purpose on the part of the investor would, according to the applicant, again be to seriously err in law and indicate that the conclusion was not that of a reasonable person (see Spotless Services).
50.1 Commercial Returns
94. It is highly relevant to the determination of “purpose” under section 177D(b) that the evidence of the expert witness, John Liddell, was that it was reasonable to expect the conversion rate and the revenue forecast to be derived by the licensees including the applicant from the promotion, distribution and selling of the Oracle products and services. The respondent has called no evidence to refute John Liddell’s expert opinion. The applicant asserts that the evidence of Ken Pendergast is pure conjecture and speculation and is solely based on his perceived view that the information memorandum was flawed, and not on any expertise. In fact, Ken Pendergast said in cross-examination that there was an expectation to derive substantial cash flows from the Project.
95. The applicant contends that it is highly relevant to the determination of purpose under section 177D(b) of the 1936 Act that the investment was projected to make a substantial return on a before tax and before finance basis from year 1. Furthermore, the Project was forecast to derive income for 20 years.
96. The Full Court in Sleight upheld the respondent’s application of Part IVA, to disallow the claimed deductions. However, the Full Court did not suggest that it disagreed with the decision in Cooke, but sought to distinguish it on the facts (See Sleight per Hill J at [111] and per Carr J at [244]). The specific point of distinction of Sleight from Cooke was said by Hill J, (at [111]), to be that:
"…the figures in the prospectus [in Cooke], if accepted, showed a very substantial return on cash invested even if the tax consequences were not taken into account".
Carr J (at [245]) sought to distinguish the decision of Cooke by concluding:
“… the generation of loans from an external source and the projected returns in Cooke of profits in excess of 20% per annum from the first year”.
97. In Sleight, both Hill J (at [75] and [76]) and Carr J (at [216]) placed great weight on the poor projected financial returns, as Hill J put it (at [75]):
"Without the tax benefits…the commercial returns were far from encouraging".
Carr J at [216] expressed his concerns about the projected returns:
“… [which] can only be described as miniscule projected returns over a long period of time”.
98. Nicholson J in the decision at first instance in Calder (at [123]) also found that the expert evidence of the poor projected returns (when properly calculated before tax and before finance) was a significant factor in reaching his conclusion that Part IVA applied:
“However as to factor (2) Mr Langridge’s evidence was that the Project relied upon the tax deductibility and effect of the initial payments and the gearing up provided by the loan to show any rate of return. In those circumstances it cannot be objectively found that the dominant purpose of the applicant’s entry into the scheme was to enable the applicant to make a commercial investment: the tax benefit was the key to the commerciality of the scheme.” [emphasis added]
99. Nicholson J (at [124]) supported the reasons of both Hill and Carr JJ in Sleight in distinguishing the decision of Cooke (this was not disturbed by the Full Court on appeal):
“In Cooke the projected returns were in excess of 20% per annum from the first year. That is not the case here [Main Camp] when the projected returns are considered in the light of the expert evidence.”
100. Having to rely on the tax benefits or the financing to obtain an acceptable rate of return was the case in Sleight and Calder. It is not the case here, according to the applicant. These objective facts cannot be ignored.
101. The evidence of Paul Begley confirms that it was reasonable for the applicant to expect a potential rate of return forecast for the Project of 18.41% on a before tax and before finance basis, which would have appeared to an investor such as the applicant as an attractive return, after taking into account the associated risks of investing in the Project. The evidence of Paul Begley confirms that the projected rate of return also included a premium over other asset classes and investments with similar risk.
102. The strong returns distinguish the cases in Sleight and Calder. A comparison of the facts in this case with those in Cooke shows that a decision that Part IVA is applicable in this case would be irreconcilable with the result in Cooke, which by implication was approved (but distinguished) by the Full Court in Sleight and Calder.
50.2 Commercial Emphasis in Information Memorandum
103. The applicant contended that it is highly relevant to the determination of purpose under section 177D(b) of the 1936 Act that considered objectively as a whole the information memorandum clearly emphasized the commercial benefits of the investment not the tax benefits.
104. Applicant asserts that on any objective analysis, read as a whole, the information memorandum emphasised the commercial aspects of the Project above any other aspects. If any or minor references to tax benefits were to be treated as a factor pointing to taxation benefits as the dominant purpose, it would mean that all such investment schemes would be caught by Part IVA as taxation considerations are always relevant to prospective investments.
105. Moreover, the information memorandum provided substantial commercial information concerning the proposed promotion, distribution and selling of the Oracle products and services for the income projections. Compared to the commercial and business content the information memorandum had relatively minor references to tax benefits throughout its 21 pages.
106. In Calder the Full Court held that:
“there is no doubt that the emphasis in the prospectus on the commercial aspects of the project would support an inference that viewed objectively, that a person investing in the Project would have done so for a commercial purpose” (at [111]).
In the circumstances of the Full Federal Court authority in Calder for the Tribunal to ignore the overwhelming commercial focus of the information memorandum would indicate that it is not the determination of a reasonable person.
50.3 Personal Circumstances of applicant
107. The personal circumstances of the applicant are objective facts which a reasonable person must have regard to when considering whether the applicant had a dominant tax purpose and in particular when considering, the manner in which the scheme is entered into or carried out (section 177D(b)(i)) and the form and substance of the scheme (section 177D(b)(ii)). See the reasons for decision of Stone J in Cooke at first instance (Cooke v Commissioner of Taxation (2002) 51 ATR 223 at [91] – [94]) (approved by the Full Court at [90]).
50.4 Time of Entry into Scheme
108. The applicant’s participation in the Project commenced prior to 30 June 1999. There was, however, no “flurry of activity”.
109. The duration of the Project points to an ongoing commercial operation over a 20 year period. This is not a case of a scheme which starts and finishes in the year of income once the deduction is availed of (cf Fletcher). Both in form and in substance it contemplated an activity over 20 years. The term of the Project was for 20 years, not dissimilar to the case in Cooke and Calder. In Calder, Nicholson J at first instance (Calder v Commissioner of Taxation (2005) 59 ATR 655 at [102]) concluded that the project in that case contemplated activity over 15 years which, as in this case, supported a commercial purpose in entry to the scheme.
110. The entry into the Project and the length of the period during which the scheme was carried out points to a commercial purpose of the applicant (see Cooke and Calder). To ignore the time of entry into the Project by the applicant would not be the determination of a reasonable person.
50.5 Excessive Fees
111. It is highly relevant to the determination of purpose under section 177D(b) of the 1936 Act whether the fees charged to participants were reasonable. To ignore or disregard the expert evidence of John Liddell that the fees charged were reasonable in determining the dominant purpose of a taxpayer would be an error in law and indicate that the conclusion of purpose being made is not that of a reasonable person.
112. There is no evidence to support a contention that the amount charged for the relevant fees was disproportionate to and did not reflect the value of the services provided by the Manager and the other parties. The respondent has called no evidence to support this contention. Unlike the case of Puzey there is no evidence that any of the fees incurred by the applicant are excessive. Any contention to the contrary simply cannot be maintained on the evidence. To the contrary, the evidence of the expert, John Liddell, is that the fees charged were reasonable.
Structure/Shape or Form or Investment
113. The respondent contends that the scheme was structured for its tax effectiveness. Although not emphasized in the information memorandum there is no doubt tax deductibility was an important feature of the investment. However, as was held by Stone J at [93] at first instance in Cooke
“the fact that the tax deductibility of the project fees was an important part of the structure of the arrangement does not support the conclusion that there was a dominant purpose to produce a tax benefit in the hands of the applicants”.
Borrowing to Invest
114. Simply borrowing to make an investment cannot point to a tax purpose for investing. (Commissioner of Taxation v Hart (2004) 217 CLR 216 per Gummow and Hayne JJ at [53] and Cooke at first instance per Stone J at [95]) Borrowing money to invest is common investment practice and increases the potential return on investment which is why investors often negatively gear their investments.
115. The limited recourse loan was a commercially sensible option for the applicant, according to the expert Paul Begley.
116. Respondent’s expert witness, David Acheson, agrees that the limited recourse loan was a commercially sensible option for investors, including the applicant.
Round Robin
117. The fact that a payment of a substantial part of the applicant’s fees was funded by a round robin of cheques is something on which the respondent places considerable emphasis.
118. Round robin arrangements are legally effective Equuscorp Pty Ltd v Glengallan Investments Pty Ltd (2004) HCA 55 and it is not contended that the payment of the fees in the manner was a sham.
119. The effect was to delay the receipt by the manager of cash funds that would otherwise have been immediately available from the payment of the applicant’s fees. The same effect resulted from the “round robin” financing arrangements in Cooke’s case (see Cooke first instance per Stone J at [7]).
120. As with the prospectus in Cooke’s case (per Stone J at [7, 85 and 86]) it was not evident from the Prospectus that the loans for the fees would be funded via a round robin. Nor was the applicant aware of that.
121. In Sleight’s case, the finding of Hill J (at [77]) in relation to the round robin was that “it cannot be said that the round robin strongly points to what may be called the tax awareness purpose”.
122. In Calder’s case at first instance the finding of Nicholson J (at [91]) in relation to the round robin arrangements was that “[It] supports only a conclusion that it mildly supports a tax benefit purpose” [emphasis added].
123. In any event, there is nothing either sinister or uncommercial about a so-called "round robin transaction", nor does it follow that if there is a "round robin transaction" the funds never become "available for use". It is clear, in this case, from the evidence of Michael Burnett that a great deal of promoting, distributing and selling of the Oracle products and services was conducted, and in fact the licensees including the applicant were distributed income from the activities conducted for the years of income ended 30 June 1998 to 30 June 2000.
124. The respondent argues that the “round robin” enabled the applicant to obtain a tax deduction in excess of his “cash” actually outlaid; but any form of borrowing, whether the funds are advanced by a “round robin” of funds or not, reduces the investor’s cash outlay. This is the whole point of borrowing funds to invest. If the applicant had borrowed from another financier, the applicant would have incurred the same expenditure irrespective of his cash outlays. To borrow to invest is not indicative of a dominant tax purpose. (Hart per Gummow and Hayne JJ at [53] and Cooke at first instance per Stone J at [95]).
THE EIGHT SECTION 177D(B) FACTORS: OBJECTIVE PURPOSE
(i) The Manner in which the Scheme was Entered Into and Carried Out
125. The applicant relies on his earlier submissions in support of his contention that the manner in which the scheme was entered into and carried out, does not point to a dominant purpose of the applicant obtaining a tax benefit.
(ii) The Form and Substance of the Scheme
126. The applicant contends that the form and substance of the scheme, does not point to a dominant purpose of the applicant obtaining a tax benefit.
127. The substance and form of the arrangements were the same. None was a sham (see Carr J in Sleight at [214]). The arrangements entered into were neither complex nor artificial, but similar to other managed investment scheme projects carried on for commercial gain. All of the Project Agreements were entered into at arm’s length. It could not be said that the substance of the arrangements was any different from their form, namely a commercial operation to derive income from promoting, distributing and selling the Oracle products and services.
128. Compared to the taxpayers in Cooke and in relation to the tax deductions claimed, the cash outlay required by the applicant to invest in the Project was substantial. In the initial year the applicant was required to outlay $5,000.00 to claim a deduction of $20,000.00. In Cooke, the taxpayer in the initial year claimed deductions of $429,750.00 (which were funded by borrowings) and made actual cash payments of just $6,750 (Cooke Full Court [95 (ii) and (iii)]). In Cooke the taxpayers were not at risk due to their guaranteed return.
129. The respondent contends that the applicant was not required to undertake any activity beyond completing the application form and making payments, or in other words was a “passive investor”. The applicant’s circumstances are, in this regard, similar to the taxpayers in Cooke where they too were “passive investors” (see Cooke Full Court [73]).
130. The limited participation required of the applicant was seen by him as an attractive feature of the Project, similar to the taxpayers in Cooke. It was contended by the respondent in Cooke (as is in this case) that there had been a construction of liability to prepay management fees (Cooke Full Court [95(iv)]), but the Full Court in Cooke concluded that the taxpayers’ dominant purpose was to obtain a commercial return (Cooke Full Court at [99] – [100]), not to obtain a tax benefit.
131. Similar to the taxpayers in Cooke, the applicant’s decision to prepay his fees using borrowed funds, sought to maximise his commercial returns through the appointment of a manager, and was a “passive investor” who did not physically take part in the Project, does not point to the applicant having a dominant purpose to obtain a tax benefit.
(iii) The time at which the scheme was entered into and the length of the period during which the scheme was carried out
263. The same funds were passed between the Manager, Licensor and the Lender and back to the Manager by a run-around of cheques. No cash was required to support the borrowings. The Manager purported to become, in effect, lender of its own fees – a commercial nonsense.
264. Ultimately, by the cheque transactions, the Manager was not put in funds in the significant amounts contemplated by the Management and Marketing Agreements for the pursuit of the Licensed Businesses. The allocation of the different fee components of the Licence including that funded by the loan from the Lender were recorded in the Manager’s general ledger by journal entry.
265. In the result, the applicants were relieved of all obligations except the making of agreements and limited cash payments: -
(a)they signed the Oracle Licence Execution Sheet to agree to be bound by the various agreements;
(b)the terms of the various agreements required nothing of participants:-
i.all activities were to be undertaken by the Manager;
ii.save for initial fees, some of which were required to be in cash, all payments in respect of fees, repayment of loans, and of interest on loans, were to be met from the income of the Licensed Businesses;
iii.the Manager was authorised to deal with any income under the licences and to deduct payments due.
266. In the result, little effort was required of the applicants to secure tax deductions which were by reason of the limited recourse terms of the Loan Agreements, provided an enduring financial benefit. They were free to undertake significant obligations without regard to how the fees charged were to be applied or recouped. As a result of the tax savings, the applicants covered their initial payment obligations and retained cash benefits without further risk and regardless of the performance of their investment.
267. The applicants’ entry into the scheme followed, at best, a desultory approach to the information with which they were presented.
268. Inquiry would have revealed that: -
(a)the projections were based on expansion from 9,000 to 7.2 million contacts in a few weeks which made it the most ambitious franchising operation ever undertaken in Australia;
(b)Oracle did not have the staff, the infrastructure or the experience to cope with such a rapid expansion.
(c)The viability of the licence as a business proposition had not been tested by commercial lending criteria. Because of the in-house finance, it was likely not a viable proposition.
269. Fees were incurred without making any/adequate attempts to understand or consider the effect of the arrangements. Mr Burrows and Mr Richards do not say what their purported businesses were. They speak in terms of an investment, of “the Project” and of its viability and the investment potential. Mr Miniello says that he understood from the Information Memorandum that he would be “carrying on a business as a licensee to develop, promote and market Oracle Products and Services” ([39]) which is inconsistent with (wider than) the terms of the Licence Agreement. Otherwise he speaks in terms of the Project, its commercial viability and his investment in the Project.
270. This lack of understanding or consideration is apparent in the way the applicants express their understanding of the arrangements, as follows:-
(a)Mr Richards says that he understood that “by agreeing to participate in the Project, I would be part of a business”, share in the profits and be exposed to its risks and losses.
(b)Similarly, Mr Burrows says, “I would be part of the Oracle business”.
(c)Mr Miniello says, in turn: “I would … share in the benefits as well as the risks of the Project”.
(d)The applicants did not perceive the telephone listing as relevant to the activities of the Manager. Rather, Mr Richards says, “I would still be entitled to receive a list of 5,000 telephone numbers for each licence which would allow me to increase my income from the Project by selling Oracle products myself”. Similarly, Mr Burrows equates his licence with a general ability to promote Oracle products and services ([28]), as does Mr Miniello: “a single licence was all that was required to enable me to promote the Project to clients”.
271. The applicants incurred obligations for fees without question. An appropriately directed inquiry would have revealed that the first year fees were very high and the ongoing Licence and Management fees were extremely high compared to the Australian average particularly for a new untested business: see Acheson Report at page 3.
272. They gave no consideration to the practicalities of running the business contemplated by the Licence Agreement which would have revealed the following practical difficulties:-
(a)services they ostensibly paid for were largely undefined;
(b)the Information Memorandum and agreements were, effectively silent on how the Licensed Business was to be conducted. They were so vaguely and broadly expressed as to be meaningless;
(c)the Licensor’s obligations were unusually light and the standards placed on the Manager low;
(d)marketing was only to be provided in one year whilst the standards for marketing were very low. The huge inflow of funds in the first year should have pointed to more powerful marketing than referred to in the Information Memorandum.
273. There was no track record provided for the business. No business or marketing plans were provided to the applicants and none were sought. There was no complaint or inquiry about the conduct of the business despite:-
(a)poor financial performance;
(b)eligible activity undertaken vis a vis Specified Customers; (????)
(c)reports indicating business was being conducted by Sales Pursuit;
(d)the proposed listing of Sales Pursuit.
(e)Oracle’s consideration of branching out into other (unspecified) income producing activities.
274. Despite the projections in the Information Memorandum, Oracle did not have the infrastructure to cope with a system of 1430 licensees and expand contacts to 7.2 million (1430 x 5,000 subscriber listings) as apparently envisaged. As it turned out the Licensed Businesses and the Manager’s activities were not in accordance with the terms of the Management and Marketing Agreement and the Licence Agreement. Sales Pursuit Pty Ltd conducted the business activity of developing, promoting and marketing seminar products and services. Through an agency agreement the Licensees shared in the proceeds from that business activity. The Manager was a clearing house for the receipt and allocation of any funds flowing to Oracle licensees from that process.
Section 177D(b)(ii) – the form and substance of the scheme
275. The fundamental form of the scheme was the conduct of a business supplying Oracle products to 5,000 allocated telephone subscribers and the appointment of the Manager to do so.
276. In respect of the scheme under consideration in Commissioner of Taxation v Sleight (2004) 136 FCR 211, Hill, J. stated as follows: -
“Finally, it should be noted that the financial structure that the management agreement, loan agreement and indemnity agreement created was not necessary to the success of a tea tree project. Presumably, the promoters, for example, could still have received the same amount of return by limiting the first year management fee to the actual cash outlay of the investor, and then adjusting the management fee in subsequent years to achieve this result. Arguably, an investor would thus have a legitimate, albeit significantly reduced, tax deduction for his cash outlay because it was actually a necessary cost of the project. This fact points towards a dominant tax incentive purpose because it could be objectively determined or concluded that an investor, who had a dominant commercial purpose, would prefer the project with a normal structure, rather than one which was so structured that it maximized the deductions available by the use of a somewhat artificial structure.”
277. And see 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…” (per Hill J in Sleight at [82]).
278. Here, the form of the arrangements, similarly took an artificial form not necessary to its commercial outcomes:
(a)they were carried out by related parties established in the months leading up to the implementation of the scheme;
(b)those parties provided licences, limited recourse loans and undertook management and marketing obligations, none of which was necessary to the carrying on of the underlying commercial activity of developing, marketing and conducting personal development seminars and products;
(c)the Licensee did nothing more than take a licence and then appoint a manager to conduct all the licensed activities. The underlying commercial activities could as well have been carried out without the creation of the licensor and the manager, who were under the same control;
(d)the Manager and the Licensor did not conduct any seminar business. The Manager was no more than the conduit or clearing house recording and allocating any sales income from Sales Pursuit Pty Ltd’s activities for the Licensed Businesses as well as the fees and loan repayments from that income.
279. This form of the arrangements secured deductions for revenue expenses – licence, training, management and marketing fees. Further, loans were made on a limited recourse basis and were not the subject of cash transactions in any event. As a result the deductions were well 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 limited recourse loans;
(c)any amount that was ever available to the Manager to conduct the management and marketing activities.
280.The arrangements lacked commercial substance in any event: -
(a)the fees were purportedly incurred in establishing a business the nature and operation of which was barely defined. The obligations of the Manager pursuant to the Management and Marketing Agreement 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 Information Memorandum asserted “a proven successful history of performance” without providing any evidence of the previous financial performance of the Oracle Group or of earlier businesses conducted by Mr Burnett;
ii.the Oracle business lacked substance. Price Waterhouse’s report on the income projections described the “businesses associated with holding the Oracle licences offered for sale” as being at a “formative stage”. According to the Information Memorandum, it was proposed to establish a “state-of-the-art Direct Marketing and Telesales Centre” and to undertake “the acquisition of additional technology, intellectual property and copyright materials.”
iii.despite this apparent lack of substance, rapid expansion was proposed with the establishment of a network of licensees marketing to potential customers situated throughout Australia, described by Mr Acheson as a “sudden and rapid expansion of a possibly new group, structure and scheme with new management but little history of financial performance or substance” (Acheson Report, page 25.5). As Mr Acheson also reports, such expansion was unprecedented in franchising (Acheson Report, pages 4, 24-25). Nevertheless, the applicants made no inquiries about the capacity of the Manager to service their 5,000 customers or of the number of Licensed Businesses it was proposing to manage;
iv.the applicants sought no explanation of the projected cashflows in the Information Memorandum although the assumptions upon which they were based were not disclosed. Neither was there any discussion of risks, business variations, business development, competitors, possible market changes or the like. Moreover, the applicants accepted the projections despite the reservations expressed about them by the Price Waterhouse report which also appeared in the Information Memorandum. As Mr Acheson comments, Price Waterhouse, essentially concluded that the projections could not be taken as “Projections for a Typical Oracle Licence” despite being headed that way. Further, as Mr Acheson points out the projections were mechanistic and unrealistic: -
a.they assumed the same prices, products and product mix for 10 years;
b.they predicted sales to triple from 1998 to 1999 and almost quintuple from 1998 to 2000 and then stay the same for eight years, all without provision for marketing or training which ceased after the first year of the term.
v.Even if the projections were met, the investment of $41,500 (the projections in the Information Memorandum at page 16 do not provide for the $10,000 initial cash outlay) would not be recovered for more than 8 years. As the projections might be viewed as no more than unreliable predictions at this point, licensees were at risk of not recouping the initial investment at all or, at least, not for a considerable period.
(c)The large up-front fees payable to the Manager make no commercial sense. 1430 licences were sold for $40,000 prepaid deductible fees per licence, with the Manager making management and marketing fees of $50,050,000 in the first year. The projected cash flows per licence on page 16 of the Information Memorandum showed deductible licence and management fees in subsequent years as set out below. The marketing promised in the Information Memorandum and Management and Marketing Agreement did not support the size of the prepaid management and marketing fees charged in the first year: see Acheson report at page 10.
1999$1,784 x 1430 = $2,551,120
2000$3,047 x 1430 = $4,357,210
2001$3,138 x 1430 = $4,487,340
2002$3,232 x 1430 = $4,621,760
2003$3,329 x 1430 = $4,760,470
2004$3,429 x 1430 = $4,903,470
2005$3,531 x 1430 = $5,049,330
2006$3,637 x 1430 = $5,200,910
2007$3,747 x 1430 = $5,358,210
There is no apparent commercial reason for setting such a disproportional first year fee. The irresistible explanation for the large first year one 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
281. The document entitled “Respondent’s Statement of Facts and Evidence” sets out the relevant chronology in relation to the scheme.
282. Each of the applicants entered into the scheme with effective licence commencement dates in June 1997:-
Miniello 27 June 1997
Burrows 13 June 1997
Richards 9 June 1997
283. By October 1997, the business underlying the Oracle licences was that conducted by Sales Pursuit Pty Ltd. On 14 December 1999 when shares in Sales Pursuit Pty Ltd were offered to the public, the prospectus stated the agency agreement between Wavecrest and Oracle Infocom Management Pty Ltd would be terminated from 1 July 1999. By March 2001 any income producing activity relating to the Licences was apparently not pursued on a national basis but confined to seminars in Perth. The applicants did not receive income and expenditure statements after the financial year ended 30 June 2001. The detail in this regard is at paragraphs [45] – [68] of the facts and evidence section of the respondent’s submissions
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
284. But for Part IVA, the result of the scheme was that the applicants obtained deductions in respect of the 1997 year as follows: -
John Miniello
$20,000
Douglas Burrows
$40,000
Bernard Richards
$80,000
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
285. The deductions claimed by the applicants for the whole of the licence, management and marketing fees they undertook resulted in tax savings which far exceeded amounts recorded as actually paid in respect of licence, management and marketing fees. As a result, the applicants’ cash positions were improved, as summarized below: -
John Miniello
Year
Deduction claimed
Tax saving
Cash outlays
Net cash position
1997
$20,000
$9,433.96
$5,042.87
$4,391.09
Douglas Burrows
Year
Deduction claimed
Tax saving
Cash outlays
Net cash position
1997
$40,000
$25,239.14
$10,085.75
$2,135.61
Bernard Richards
Year
Deduction claimed
Tax saving
Cash outlays
Net cash position
1997
$80,000
$24,223.81
$268.00
$23,955.81
1998
$20,487
prior year loss from 1997 claim$9,677.71
$20,360.00
($10,682.29)
$33,901.52
$20,628.00
$13,273.52
286. Beyond the cash 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. A Two Year income Guarantee was largely absorbed by fees and loan repayments leaving only a small cash distribution to the Licensees.
287. Accordingly, the taking up of the licences in June 1997 resulted in no material change in the applicants’ financial positions beyond the benefits they took from the deductions claimed in the 1997 income year.
288. The achievement and extent of any such additional benefit from the investment itself was by no means certain, however:-
(c)the Information Memorandum asserted “a proven successful history of performance” without providing any evidence of the previous financial performance of the Oracle Group or of earlier businesses conducted by Mr Burnett;
(d)the Oracle business lacked substance. Price Waterhouse’s report on the income projections described the “businesses associated with holding the Oracle licences offered for sale” as being at a “formative stage”. According to the Information Memorandum, it was proposed to establish a “state-of-the-art Direct Marketing and Telesales Centre” and to undertake “the acquisition of additional technology, intellectual property and copyright materials”.
(e)despite this apparent lack of substance, rapid expansion was proposed with the establishment of a network of licensees marketing to potential customers situated throughout Australia, described by Mr Acheson as a “sudden and rapid expansion of a possibly new group, structure and scheme with new management but little history of financial performance or substance”. As Mr Acheson also reports, such expansion was unprecendented in franchising. Nevertheless, the applicants made no inquiries about the capacity of the Manager to service their 5,000 customers or of the number of Licensed Businesses it was proposing to manage;
(f)the applicants sought no explanation of the projected cashflows in the Information Memorandum although the assumptions upon which they were based were not disclosed. Neither was there any discussion of risks, business variations, business development, competitors, possible market changes or the like. Moreover, the applicants accepted the projections despite the reservations expressed about them by the Price Waterhouse report which also appeared in the Information Memorandum. As Mr Acheson comments, Price Waterhouse, essentially concluded that the projections could not be taken as “Projections for a Typical Oracle Licence” despite being headed that way. Further, as Mr Acheson points out, the projections were mechanistic and unrealistic: -
§they assumed the same prices, products and product mix for 10 years;
§they predicted sales to triple from 1998 to 1999 and almost quintuple from 1998 to 2000 and then stay the same for eight years, all without provision for marketing or training which ceased after the first year of the term
289. Neither did the applicants seek the assistance of advisors involved in franchising who might have advised them that Oracle’s proposed arrangements, in particular the size and distribution of the proposed fees was highly unusual.
290. Given the deficiencies in the Information Memorandum and those outlined above, the evidence of Messrs Petchell and Begley as to the attractiveness of the investment’s potential commercial returns should not be accepted.
291. The applicant attaches some significance on the projected investment return in Commissioner of Taxation v Cooke (2004) 55 ATR 183 and references to it in Sleight as significant. However, even if it was accepted that there was commercial substance in the Oracle investment, it does not follow that there was no section 177D purpose. Comparison of different rates of return is immaterial.
292. 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.” The reasoning of the members of the Court in Sleight in distinguishing Cooke was the same: per Hill, J. at [111] and Carr JJ at [244].
293. Similarly, the conclusion of the trial judge in Calder v FCT (2005) 59 ATR 655 was not limited to his examination of that project’s projected rate of return but, correctly, based broadly on a consideration of the whole of the facts and circumstances there. His approach was not the subject of adverse comment by the Full Court in Calder v FCT (2005) 61 ATR 267 at [122]-[124].
294. Moreover, 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.
295. Had gross profit been earned in respect of the exploitation of the licences, a licensee’s share would, in any event, be reduced by: -
§97.5% in Year 1 and 70% in subsequent years was to be paid to the Lender in respect of the limited recourse loans; and then
§licence fees of 12.5%;
§management fees of 15%.
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
296. Owing to the extent of the deduction for fees in the first year (geared up by the limited recourse loans) and the resulting tax savings to participants, the cash receipts of the Manager and the Licensor were, essentially, funded by the Revenue. The total cash receipts of $14.5 million were, in turn, applied to the acquisition of Sales Pursuit Pty Ltd, other business interests of the promoter entities and their associates and payments to Mr Burnett and others and the Crestwin Corporation Ltd. In Appendix D of the Pendergast Report, pages 40-44 payments to related parties of $7,633,494 and $5,656,727 cash expenses including consulting fees and success fees are identified.
297. Beyond the cash payments sourced from participants’ tax savings, the financial position of the Manager and the Licensor did not change as a result of the scheme. The investor’s Loan Agreements were affected without actual cash funds being made available and, by the operation of directors’ resolutions and the run-arounds of cheques, were not intended to fund by actual cash. On 28 June 1997 the common directors of the Manager and the Licensor made resolutions each purporting to put the other in funds to meet the loans. The same funds were passed between the Manager, Licensor and the Lender and back to the Manager by run-arounds of cheques. The consolidated net movement between the bank accounts of these parties showed a net movement of $0. Paragraph 115 of the Pendergast Report states that the allocation of the different fee components of the Licence including that funded by the loan from the Lender were recorded in the Manager’s general ledger by journal entry.
298. Because of the limited recourse loans the applicants could keep the tax benefits regardless of the outcome of the investment in Oracle. They could take a chance on the commercial performance of the project. Any return achieved on the Licence was an additional benefit.
299. On the other hand, had gross profit been earned, most of it was to be retained by the Manager, the Licensor and the Lender, as follows: -
(a)the Lender was entitled to 97.5% in Year 1 and then 70% subsequently until the loan was projected to have been paid in 2003; and then
(b)the Manager was entitled to 15%;
(c)the Licensor was entitled to 12.5 %;
300. Moreover, the limited recourse loans were to the commercial disadvantage of the lender. There were no fixed loan payments but entitlement to a percentage of the revenue generated by the Licensed Businesses. Income generated by the licensees was unlikely to be sufficient to repay the loans, as discussed at [75] above.
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
301. It is significant that once the Licence Execution Sheets were signed and the cash payments made on application and pursuant to the terms of the short term loan agreements 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)
302. There was a business connection between the applicants and the Oracle entities.
Conclusion with respect to section 177D(b)
303. 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.
304. 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 Oracle, 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.
305. 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 limited recourse loans. The consequent tax savings were to the applicants’ considerable cash 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].
306. 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.
TRIBUNAL’S FINDINGS
Section 51 (1) Income Tax Assessment Act 1936
307. For the reasons contended by the respondent the applicant was not carrying on a business as contemplated by Section 51 (1) (b). The applicant’s assertions to the contrary are rejected by the Tribunal.
308. However, the Tribunal is of the view that, as contended by the applicant, Section 51 (1) (a) of the Income Tax Assessment Act 1936 applies to allow a deduction for the amounts claimed by the applicant on the basis that they were losses or outgoings incurred in gaining or producing assessable income which were not of a capital nature and the Tribunal rejects the respondent’s assertions to the contrary in this regard.
Part IVA
309. The Tribunal notes that, consistently with the findings in the cases of Spotless Services, Consolidated Press Holdings, Sleight, Calder, Cooke and Hart (Supra) 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.
310. The Tribunal notes further in this regard that as contended by the respondent it is clear in the Tribunal’s view that the promoter entities entered into or carried out the scheme for the dominant purpose of obtaining tax benefits for the applicants. The purpose of entering into or carrying out the scheme was to obtain a tax benefit for participants in the Oracle project, including the applicants and the Tribunal agrees with the respondent’s contention that it is not to the point that the overall commercial objective of the promoter entities was to make money or that, similarly to the position in Vincent (supra) at first instance whatever the subjective purpose of the applicant and his state of knowledge about the true nature of the scheme into which he entered, a reasonable person would conclude having regard to the eight listed factors in section 177D(D) that the applicant and those other tax payers who entered into the project did so with the dominant purpose of obtaining a tax benefit in connection with it.
311. The Tribunal notes that the applicant concedes that the arrangements constituted a scheme for purposes of the definition contained in Part IVA and also concedes that the applicant obtained a tax benefit for purposes of section 177C(1) and section 177D(a).
312. The Tribunal further accepts the respondent’s contentions in light of the above that all, substantially all of section 177DB factors are met and that the respondent was accordingly entitled to apply the provisions of Part IVA to disallow the deductions claimed by the applicant, except for the actual cash payment made by the applicant.
PENALTIES
313. The Tribunal accepts that the applicant’s actual or subjective purpose in entering into the scheme was, as set out above, to obtain assessable income. Accordingly, in light of the decisions in Starr and Hopkins (supra), the Tribunal concludes that the respondent should not have imposed penalties under section 224 (2) of the Income Tax Assessment Act 1936. The Tribunal notes that the decisions in the Starr and Hopkins matters are on appeal to the Full Federal Court and in the event that the decisions at first instance are overturned then, if this takes place before amended assessments are issued by the respondent in the accordance with the Tribunal’s decision as set out below, the respondent should have regard to the decision of the Full Federal Court in those matters.
DECISION
314. The Tribunal finds that the decision under review should be set aside and the Tribunal remits the matter to the respondent to issue a further amended assessment to the applicant in accordance with the Tribunal’s decision as follows:
(a)The deductions claimed by the applicant are to be disallowed except for actual cash payments made by the applicant.
(b)No penalties are to be imposed on the applicant under s 224(2) of the Income Tax Assessment Act 1936.
I certify that the 314 preceding paragraphs are a true copy of the reasons for the decision herein of Mr A Sweidan, Senior Member
Signed: ....................(Sgd. R Riberi)....................
AssociateDate/s of Hearing 1, 2 and 5 February 2007
Date of Decision 25 June 2007
Counsel for the applicant Mr D Romano
Solicitor for the applicant Wilson & Atkinson
Counsel for the Respondent Ms H Symons/Ms L Price
Solicitor for the Respondent Australian Government Solicitor
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