Jones v WHK Sherwin Chan & Walshe HC Auckland CIV-2009-485-001324
[2011] NZHC 791
•25 July 2011
IN THE HIGH COURT OF NEW ZEALAND WELLINGTON REGISTRY
CIV-2009-485-001324
BETWEEN SIR ROBERT EDWARD JONES, YORGEN HOLDINGS LIMITED AND TIROHANGA FAMILY TRUST Plaintiffs
ANDWHK SHERWIN CHAN & WALSHE First Defendant
ANDSHERWIN CHAN & WALSHE LIMITED (IN LIQUIDATION)
Second Defendant
ANDWHK (NZ) LIMITED Third Defendant
Hearing: 21, 22, 23 and 24 March and 18 April 2011
Appearances: M P Reed QC, M G Colson and B S Clarke for Plaintiffs
L J Taylor and P H V Cheng for Defendants
Judgment: 25 July 2011
JUDGMENT OF WHATA J
This judgment was delivered by Justice Whata on
25 July 2011 at 4.00 p.m., pursuant to r 11.5 of the High Court Rules
Registrar/Deputy Registrar
Date:
Solicitors:
Bell Gully, PO Box 291, Wellington
Minter Ellison Rudd Watts, PO Box 2793, Wellington
SIR ROBERT EDWARD JONES, YORGEN HOLDINGS LIMITED AND TIROHANGA FAMILY TRUST V WHK SHERWIN CHAN & WALSHE HC WN CIV-2009-485-001324 25 July 2011
Table of Contents
Para No Introduction [1] Facts [3]
Parties [4]
Scope of services [8] Financial statements [9] Group restructure [14] CFC regime [20] IRD Audit and SCW Admission [21] Dispute [25]
Claims and Defences [40] Statutory context [45] Evidence [63] Preliminary matters [78] Contributory negligence [79] Evidence of contributory negligence [89] Framework of assessment [94]
Scope of duty [102] Nature of the breach [109] Causal Nexus [115] Supervening act: cause in law [121] Wrong advice? [126]
No substitution [131] Anti-avoidance [133] Divisible? [143] Reasonable mitigation [151] Benefits [167] Principles [170]
Tax benefits? [184] Costs on counterfactual [191] Ninth cause of action: Confidentiality [208] Quantum [211] Liability [215] Costs [216] Outcome [217]
Introduction
[1] Sir Robert Jones controls an Australian based company, Pamiers Pty Ltd (―Pamiers‖). He also controls a New Zealand based company, Robert Jones Holdings Ltd (―RJHL‖). They buy and lease buildings. From 2003 to 2007 Pamiers lent money to RJHL, and its predecessor, Sofia Ltd. In March 2007 Pamiers purchased a 20 per cent shareholding in RJHL. The proceeds from the sale of shares partially off-set the accumulated loan balances between Pamiers and RJHL.
[2] The lending and the share sale were subject to the Controlled Foreign Company Rules (―CFC rules‖) under relevant Income Tax legislation. Under those rules the lending and the share sale were deemed repatriation and potentially taxable. Sir Robert‘s then accountants did not advise him about the CFC rules. The accountants admit that this was negligent. This judgment is about how much, if anything, Sir Robert‘s former accountants are liable for the tax that Sir Robert paid on the lending and the share sale. This in turn raises issues about the scope of the CFC rules, the role played by Sir Robert‘s subsequent accountants, and the relevance of the benefits of the negligent advice and any hypothetical costs saved by Sir Robert.
Facts
[3] Given the nature of the claims and the defences it is necessary to record the salient events and figures in some detail.
Parties
[4] The plaintiffs, Sir Robert Jones and Yorgen Holdings Ltd, are trustees (―Trustees‖) of the Tirohanga Family Trust (―Trust‖). Sir Robert Jones (―Sir Robert‖) has been involved in commercial property for almost fifty years. Yorgen Holdings Ltd is a corporate trustee. The Trust is one of a number of entities owned or controlled, directly or indirectly by Sir Robert. Relevant to this proceeding this group comprises the following New Zealand based entities: The Trust, Tirohanga Nominees Ltd, Tirohanga Holdings Ltd, Sofia Ltd, and Featherston Assets Ltd. Sir
Robert also controls, through the Trust, an Australian based entity, Pamiers Pty Ltd
(―Pamiers‖).1
[5] In July and August 2006, Sofia Ltd and Featherston Assets Ltd amalgamated in the name of Featherston Assets Ltd. It was then shortly thereafter renamed as Robert Jones Holdings Ltd (―RJHL‖).
[6] The first defendant, WHK Sherwin Chan and Walshe (―the partnership‖) is a partnership of chartered accountants. The second defendant, Sherwin Chan and Walshe Ltd (―SCWL‖), provided accounting, tax and consultancy services to Sir Robert and the New Zealand group of entities until 31 October 2006. From
1 November 2006 until about February 2009,2 WHK (NZ) Ltd (―WHKNZL‖), the
third defendant, provided those services to Sir Robert and the New Zealand based group.
[7] For the purposes of this narrative the plaintiffs will be referred to as the Trust and the defendants will be collectively referred to as SCW.
Scope of services
[8] In July 2003 the Trust engaged SCW and transferred all of the New Zealand group‘s tax files to SCW from Sir Robert‘s previous accountants, Kendons. The broad scope of the services to be provided by SCW are later recorded in a letter of retainer dated 31 March 2004, including:3
We have identified your requirements to include:
1.Preparing monthly GST returns for your registered group and you personally
2. Preparing annual financial statements and taxation returns
3. Providing accounting, tax and consultancy advice as required
4.Providing information technology products and support services as required
1 First amended statement of claim, 19 March 2010, at [6]-[7].
2 Statement of defence, 17 August 2009, at [2].
3 Common Bundle (CB), at 29.
Financial statements
[9] SCW prepared the New Zealand group‘s financial statements for the years ending March 2004, 2005, 2006 and 2007 (―the financial statements‖). SCW also filed the Trust‘s tax returns for the years ending 2004, 2005, 2006 and 2007.
[10] The financial statements for Sofia and then RJHL recorded advances commencing 26 February 20034 from Pamiers to Sofia with year end balances as
follows:
31 March 2003
$ 518,3905 31 March 2004 $2,952,0646 31 March 2005 $6,495,4087 31 March 2006 $8,755,4928 31 March 2007 ($178,787)9 31 March 2008 $3,171,67610
[11] The financial records for Pamiers record the same advances in the following
terms as at 2006:11
Sofia Ltd 2003 $1,207,423.38 Sofia Ltd 2004 $3,078,542.53 Sofia Ltd 2005 $1,775,912.04 Sofia Ltd 2006 $1,354,560.73
[12] As at June 2007, the above loans are shown as discharged, with a further
entry as follows:12
4 Ibid, at 4.
5 Ibid, at 564.
6 Ibid, at 564.
7 Ibid, at 792.8 Ibid, at 1044.
9 Ibid, at 1280.10 Ibid, at 1387.
11 Ibid, at 1338; I note a discrepancy in relation to the amount owing in respect of Sofia Ltd 2005 where it is recorded as $2,310,912.04. This discrepancy is not explained but I do not consider it to be material.
12 Ibid.
Sofia Ltd 2007 $2,084,674.18
[13] The Pamiers‘ movements and interest loan account on Sofia Ltd shows an accumulating running balance from year to year, but with a summary recording yearly loans as then reflected in the financial accounts. Ultimately they record a loan repayment of $8,106,225.34 as at 13 March 2007, leaving $42,029.49 still owing.13
A further payment for a management fee of $151,250 results in a negative balance
(or credit balance for RJHL/Sofia) of $74,528.39 as at 31 March 2007.14
Group restructure
[14] In a letter from SCW to Sir Robert dated 6 April 2006, SCW proposes the following (among other things):15
Adopt your suggestion of selling an interest in some New Zealand assets to Pamiers with the aim of reducing the Pamiers/Sofia advances, clarifying the BNZ Australia loan position, creating the class B shares (enabling more effective dividends from Australia) and creating a loan from Sofia to Pamiers which Pamiers can repay over time.
[15] This proposal crystallises into a further more concrete recommendation described in a further letter from SCW dated 3 October 2006 as follows:16
Change the constitution of Pamiers to provide for two share classes as previously outlined to you. This will facilitate the payment of dividends to New Zealand.
Sell 20% of Featherston Assets Limited to Pamiers for $16.2m.
Featherston Assets owns Lambton House, Solnet House, Qantas
House and Gen-I House (and other properties). Based on the values you provided it has equity of just under $81m.
The $16m will be used to repay the current loan between Pamiers and Sofia, rearrange the BNZ Australia loan as indicated and create a loan to Pamiers which can be repaid as a means of extracting cash from Pamiers.
We will consider charging Pamiers interest on the outstanding loan.
While this will attract Australian non-resident withholding tax at
10% it will assist to minimise Australian tax.
13 Ibid, at 16.
14 Ibid, at 17 and brief of evidence of Geoffrey Blaikie, at [6].
15 CB, at 57.16 Ibid, at 65.
[16] This proposal was then implemented on 13 March 2007 the following year, with the result that Pamiers acquired 20 per cent of the shares in RJHL at a cost of
$16,200,000.
[17] More specifically the group restructure consisted of the following:17
(a) Share transfer of 20 ordinary shares in RJHL in consideration for
$16,200,000.
(b) An advance in the amount of $10,186,961.26 from the Trustees to
RJHL.
(c) An advance of $1,074,901.12 from the Trust to Pamiers.
(d)Repayment of debt to Sir Robert by the Trust of $4,938,137.62 (Australian $4,550,000).
(e) Partial repayment of debt in the sum of NZ$10,186,961.26 owed by RJHL to Pamiers (leaving interest accruing since 31 March 2006 as outstanding).18
[18] Various deeds and resolutions are executed to record the restructuring. Relevantly, the Deed of Acknowledgement of Partial Repayment of Debt dated
13 March 2007 records:
The Lender acknowledges receipt of NZ$10,186,961.26 from the Borrower in partial repayment of the Debt.
The Borrower acknowledges interest accrued since 31 March 2006 is still outstanding.
[19] The effect of this restructure is captured in the financial records of Sofia, (RJHL) and Pamiers set out at [10]-[13] of this judgment.
17 Ibid, at 66.
18 CB, at 82: Deed of Acknowledgement of Partial Repayment of Debt.
CFC regime
[20] SCW ―did not consider and did not advise on the implications of the attributed repatriation rules in the controlled foreign company (CFC) regime under the [relevant] Income Tax Act‖.19 Under those provisions, increases in lending by Pamiers to Sofia or RJHL and any increase in equity held by Pamiers in RJHL was potentially taxable as a deemed dividend to the Trust.
IRD Audit and SCW Admission
[21] In September 2008, IRD wrote to SCW and advised commencement of an audit of the New Zealand group of companies for the years 2003 to 2007.20 This was soon followed by further requests for information in relation to the group restructure.21
[22] This prompted SCW to review the position. Mr Burge, the tax specialist for SCW, then discovered the error that had been made, namely that the CFC provisions had been missed. Unsurprisingly, SCW notified its legal advisors.
[23] In February 2009, Mr Burge and Mr Walshe (a senior partner of SCW) and their solicitor Mr Pedersen met with Sir Robert and his legal representatives. The oversight by SCW is acknowledged. They record that there is an initial tax liability of about $2.6 million. This is followed by a letter from SCW, dated 9 February
200922 addressing the tax liability associated with the restructuring. A part of that
correspondence usefully describes the position understood by SCW as at that time:23
10.We estimate that the total tax impact to the Tirohanga Trust as a consequence of this dividend is approximately NZ$2,673,000, being tax on the Tirohanga Trust‘s 50% share of the attributed dividend at the trustee rate of 33%, plus interest at the rate of 14.24%. As no provisional tax has been paid, the amount of interest could be significant (approximately NZ$540,000). We have notified our insurers that this unexpected tax liability has arisen, however, they
19 Brief of evidence of Richard Burge, at [6].
20 Chronology of Key Events; Blaikie at [2.4].
21 Ibid.
22 CB, at 125-6.23 Ibid, at 126.
have reserved their position on coverage while they investigate matters further.
11. In the context of responding to the IRD‘s audit queries, the issue should prudently be managed by fully explaining the wider refinancing transaction and its effect for tax purposes, and indicating that the attributed dividend will be taxable in the hands of the Tirohanga Trust and will be included as income in its return due for filing on 31 March 2009.
…
14.It is important, however, that the tax and any use of money interest be paid as soon as possible in order to avoid penalties. In addition, a response will need to be made to the various IRD audit queries within the next two to three weeks.
[24] Ernst and Young were then retained to assist Sir Robert Jones to deal with the impending tax return requirements and to assess the full tax liability.
Dispute
[25] Inevitably, legal advisors entered the fray. Minter Ellison for SCW in a letter dated 17 February 2009 deny any negligence while at the same time stating:24
More importantly we wish to make it clear our clients will not in any event accept responsibility for any tax penalties or interest which will arise from failure to pay the full tax liability after it had been brought to your client‘s attention. Your client is under a statutory obligation to pay this tax together with accrued interest and must fund this liability from whatever resources are available to it. Our clients are not responsible for any penalties or ongoing interest costs incurred through your client‘s failure to pay that tax.
[26] Sir Robert then also retained tax expert Lindsay McKay to advise on his liability. Mr McKay advised that the Trust was liable in the order of $2,673,000 together with use of money interest.25 He also advised that he considered that the failure to refer to the CFC rules breached the duty owed by SCW to Sir Robert.
[27] In correspondence dated 6 March 2009, Minter Ellison raised two further matters: 26
24 Ibid, at 147.
25 Ibid, at 150.
26 Ibid, at 165.
(a) The taxation result was unavoidable; and
(b)The net effect of the transaction was to give Sir Robert the ability to remove $16.2 million of funds from RJHL corporate group without further charges of tax.
[28] Minter Ellison also repeated the earlier admonition to pay the tax owing and that SCW would not be liable for penalties for failure to pay it.
[29] A tax return was lodged on 31 March 2009 including a taxable deemed dividend of $5,289,588, and tax of $1,736,711.35. The Trust then paid a total of
$2,079,756. This related specifically to the tax payable on the restructuring. It included use of money interest of $343,045 because no provisional tax had been paid.27
[30] At about the same time Sir Robert records his position in the following terms:28
Our policy in Australia is to minimise shareholder drawings from the operation for tax reasons, usually circa A$2m p.a. which goes to Pamiers. Solely because interest rates are higher in New Zealand, as surpluses have evolved in the Pamiers account I have periodically remitted the funds but had I not been misled by WHKSCW, I most certainly would not have done so. There‘s always a use for them in Australia, such as buying another building for example.
[31] Ernst and Young also managed to obtain a three month extension from the IRD to make a post audit notification disclosure to enable Ernst and Young to familiarise themselves with Sir Robert‘s taxation affairs.
[32] Ernst and Young then set about ascertaining what Sir Robert needed to make by way of voluntary disclosure about the lending by Pamiers to Sofia and RJHL between 2003 and 2007. Their advice was that the lending between them gave rise to attributed repatriations and deemed taxable dividends.29 The advice goes on to
say that, if so, these should have been included as taxable income in its tax returns.
27 Blaikie at [6.24].
28 CB, at 200.
29 Ibid, at 219.
They advised that failure to do so gave rise to potential shortfall penalties of some
$260,000. They further advised that this could be reduced by 40 per cent with post notification disclosure and then by a further 50 per cent for previous behaviour, leaving a penalty of $78,748. They refer to the fact that voluntary disclosure was
―standard practice‖.30 I refer to this as the ―Ernst and Young advice‖.
[33] SCW‘s legal advisors did not consider that voluntary disclosure was necessary. In a letter dated 12 May 2009, Minter Ellison responds to the proposal to disclose by emphasising that the lending was not a financial arrangement that attracted liability. The further point was made that the 13 March restructure permanently discharged any debt, with the effect that the lending matured within five years.31 This was rejected by the Trust on the basis that there was still some $42,000 outstanding as at 13 March 2007 and that s CD 39(9) treated a temporary reduction in a loan as tax avoidance. The response concludes that voluntary disclosure should be made.32
[34] Mr McKay also reviewed the Ernst and Young advice.33 In his view the lending was a single financial arrangement that had not matured on 13 March 2007 part repayment. He said:
4.5 With reference to Minter Ellison‘s paragraph 4(c), if as a matter of fact an ongoing principal amount was owing under the loan notwithstanding the 13 March 2007 part-repayment, then section CD 39(8) does not apply to offer potential relief to the Trust;
4.6 Given the absence of a ―maturity‖ of the Pamiers/Sofia financial arrangement within 5 years from the date on which it was entered into, the issues raised in Minter Ellison‘s paragraph 4(d) are substantively irrelevant. I am in any event in agreement with Ernst & Young as to their observations with reference to the concept of ―purpose‖ in the context of section CD
39(13), and ―purpose or effect‖ in the context of section CD 39(9).
[35] Voluntary disclosure34 was then made on 15 May 2009, with an argument in mitigation as follows:35
30 Ibid, at 220.
31 Ibid, at 238.
32 Ibid, at 241-243.
33 Ibid, at 244.
34 Ibid, at 245.35 Ibid, at 248.
In the course of our review of the above matter, representations were made from the previous advisors that the loan in question was repaid on 13 March
2007 as a result of the purchase of 20% of the shares by Pamiers in RJH. WHKSCW represent that while the Pamiers/Sofia current account still had a
small balance of AUD 42,029.49 following repayment of the loan, the share sale transaction was intended to effect a full repayment of the loan.
[36] On 20 October 2009 IRD responds and does not accept the argument in mitigation. In particular the IRD treats the loan arrangement as a variable principal debt instrument (―VPDI‖)36 that has not matured. Accordingly, the IRD proposed that the 2004 – 2007 income tax returns for the Trust be amended to include deemed dividend income.37
[37] Then, after further discussion, the IRD issued an agreed adjustment which included a shortfall in core tax of $1,503,993.41 and shortfall penalties of
$90,239.60. Following further discussion, the IRD then agrees to waive the shortfall penalties with a final adjustment agreed for the 2004 – 2007 years, on 9 December
2010.38
[38] The ultimate outcome is that, after all agreed adjustments are taken into account the Trust paid the following amounts for tax in respect of the lending and restructure.
(a) Lending 2004 – 2007, 2009: $1,667,91139 (b) Restructuring 2008: $1,523,99040 (c) Use of money interest (―UOMI‖) $1,093,40741
[39] To complete the chronology the Trust confirmed that had it ―received full
advice at the relevant time they would have ceased remittances from Australia, [and]
36 Ibid, at 252.
37 Ibid.
38 Ibid, at 275.
39 Blaikie at [6.39].
40 Ibid.41 Closing submissions for the plaintiffs at [1.3].
borrowed externally in New Zealand to repay any outstanding loans from
Pamiers‖.42
Claims and Defences
[40] The proceedings involve nine causes of action. One relates to an allegation of breach of confidentiality. This was barely argued. I propose to deal with it briefly, at the end of this judgment.
[41] The eight primary causes of action involve the core related claim that SCW breached a contractual duty of care and/or was negligent in failing to consider and advise on the tax implications of the CFC regime for the purposes of:
(a) The restructuring advice;
(b) Intragroup lending by Pamiers to Sofia and RJHL; and
(c) Implementation of the restructuring.
[42] Sir Robert claims that had he been properly advised they ―would not have sold 20 per cent of their shareholding in RJHL to Pamiers‖43 and ―would have repaid the lending from Pamiers to Sofia‖.44
[43] SCW admits:
(a) The second and third defendants provided accounting, tax and consultancy services to the Trust.45
(b) The 31 March 2004 letter sets out the scope of services.
42 CB, at 289.
43 Statement of claim, at [27]; first amended statement of claim, at [32].
44 First amended statement of claim, at [32].45 Statement of defence to first amended statement of claim, at [15].
(c) In relation to the restructuring, the second and third defendants owed a duty ―to exercise reasonable professional skill, care and competence (in the terms alleged [by the plaintiffs])‖.46
(d)In the relevant periods the second and third defendants considered the tax consequences of the inter-company lending,47 but they did not advise on the implications of the CFC regime or that the restructure would mean that the plaintiffs would be deemed as receiving taxable income of $8.1 million.48
(e) Tax and use of money interest was payable by the Trust as a result of the restructure.49
[44] SCW denies liability in relation to the intragroup lending. The pleadings lay the foundation for the defence that voluntary disclosure was unnecessary. They refer to facts that support either a finding that the loans were yearly loans or that they matured within five years and therefore were exempt from the CFC rules.50
Statutory context
[45] The issues in this case cannot be sensibly resolved without understanding the
CFC rules and their application.
[46] The lending arrangements and the restructure were subject to the Income Tax
Act 1994 (in the years ended 31 March 1996 to 31 March 2005), the Income Tax Act
2004 (in the years ended 31 March 2006 to 31 March 2008) and the Income Tax Act
2007, for the year ended 31 March 2009 and subsequent years.
[47] A common and useful reference point for the purpose of this proceeding is the Income Tax Act 2004.
46 Ibid, at [12] and [30].
47 Ibid, at [17]-[18].
48 Ibid, at [25 and [53].
49 Ibid, at [27]. [33] and [49].50 Ibid, at [15], [19], [37]-[38], [42]-[43], [59]-[60], [64]-[65].
[48] There is no dispute that Pamiers is a controlled foreign company for the purposes of the 2004 Act. Nor is there any dispute that:
(a) the shares acquired by Pamiers in RJHL on 13 March 2007 represented an increase in Pamiers associated party equity; and
(b) the lending by Pamiers to RJHL was associated party debt.
[49] Associated party equity is the total amount of shares or options over shares, measured at cost, held by the CFC in companies that are at the time both:51
(a) resident in New Zealand; and
(b) associated with the CFC.
[50] Associated party debt is the total amount of balances outstanding, but never totalling less than zero, of all financial arrangements, to which both:52
(a) the CFC is a party; and
(b) a New Zealand resident associated with the CFC at the time is a party. [51] A financial arrangement is defined as:53
… an arrangement under which a person receives money in consideration for that person, or another person, providing money to any person:
(a) at a future time; or
(b) on the occurrence or non-occurrence of a future event, whether or not the event occurs because notice is given or not given.
[52] An increase in associated party equity held by the CFC or an increase in associated party debt to a CFC in any given accounting period is deemed to be
attributed repatriation.
51 Income Tax Act 2004, s CD 36(2)(b).
52 Income Tax Act 2004, s CD 36(2)(c).
53 Ibid, s EW3(2).
[53] CD13 provides that such attributed repatriation is deemed to be a dividend, and taxable.
[54] Relevant to this case is the definition of a variable principal debt instrument
(―VPDI‖). It is defined at s OB1 as:
variable principal debt instrument –
(a) in the financial arrangements rules, means a financial arrangement that contemplates that 1 party may, on demand or call, —
(i) advance further amounts to the other party; or
(ii) require the return of all amounts advanced to the other party, if the other party‘s rights and obligations under the financial arrangement are expressed in a foreign currency.
[55] An arrangement is also defined as:54
an agreement, contract, plan or understanding (whether enforceable or unenforceable), including all steps and transactions by which it is carried into effect.
[56] Under s CD39(6) no account is taken of financial arrangements that are expected to and do mature within 365 days. Notably:55
For the purposes of subsection (6), if 2 or more consecutive or successive financial arrangements may, having regard to the tenor of this section, fairly be regarded as 1 financial arrangement, those financial arrangements are to be regarded as 1 financial arrangement.
[57] Section CD39(10) then allows a financial arrangement to be disregarded for the purposes of the attributed repatriation rules if: ―the financial arrangement matures within five years of the date on which it was entered into‖.
[58] The term maturity is defined in s OB1 of the 2004 Act. The definition reads:
maturity —
(a) in the financial arrangements rules means —
(i) […]
54 Ibid, s OB1.
55 Ibid, s CD 39(7).
(ii) for any other financial arrangement, the date on which the last payment contingent on the arrangement is made:
[59] Sections CD39(11) and (12) provide for reassessment and adjustments to tax liability in respect of lending that matures within five years in accordance with s CD39(10).
[60] The CFC rules however capture arrangements that in combination represent longer term lending. They treat all arrangements with the same associate as a single financial arrangement, with outstanding balances aggregated and netted off.56 A temporary reduction or increase in an outstanding balance is disregarded if it has the purpose or effect of defeating the application of s CD13.57 Interest on accruing amounts are nevertheless treated as new financial arrangements.58
[61] Subsection CD 39(13) provides that a financial arrangement is not treated as maturing within five years of the date on which it was entered into if:
(a) on or after the date of maturity, another financial arrangement (second financial arrangement) is entered into by the CFC or a CFC associated with the first CFC at any time during the term of the second financial arrangement; and
(b) the second financial arrangement is a substitute, in whole or part, for the first financial arrangement; and
(c) the second financial arrangement was entered into with a purpose of ensuring that subsections (11) and (12) apply.
[62] The application of these provisions to the facts is addressed below. For present purposes, it is evident that the regime was introduced primarily to catch distributions made by a CFC to its New Zealand resident shareholders in non- dividend form.59 This scheme operates to capture two primary types of distributions, namely the acquisition of property by a CFC or lending by a CFC to an associated person within New Zealand. There are specified exceptions to the application of
these rules, in particular the rules do not apply to lending that matures within a five
56 Ibid, s CD39(5).
57 Ibid, s CD39(9).
58 Ibid, s CD39(8).59 Brookers Tax Service Historic IRD & TEO Material: Technical Rulings Manual (September 1998), at [38.10.1].
year period and where such lending is not substituted by another financial arrangement or lending which has the purpose of attracting exemption.
Evidence
[63] The narrative of events was provided by Sir Robert and Mr Blaikie for the plaintiffs, and by Mr Burge for the defendants. They broadly agree on the nature of services provided by SCW.60 Helpfully a chronology of key events has also been largely agreed.
[64] The expert evidence falls into three categories. In the first category, Mr Blaikie, a partner with Ernst and Young and Mr Burge of SCW provide a mix of chronology, an account of reasons for the advice given by them and opinion evidence on the implications of that advice and the CFC regime. This evidence is not independent, because of their direct involvement in actions that are the focus of the pleadings.
[65] The second category of expert evidence was provided by Mr Green for the plaintiffs, and Mr Lennard and Dr Harley for the defendants. Mr Green is a tax barrister, specialising in the taxation area for almost 40 years. Mr Lennard is also a tax barrister specialising in tax disputes for 14 years. He was also Inland Revenue‘s Director of Litigation from 1996 to 2004. Dr Harley is also a tax specialist with more than 30 years‘ experience, having completed a doctoral thesis on, among other things, controlled foreign company policies.
[66] Mr Green opines that the SCW advice in relation to the restructure and loan arrangements was negligent by failing to advise on the CFC regime. He maintains that the voluntary disclosure to the IRD of the associated party debt was reasonable and the only prudent course to take.61 He rejects the contention by the defendants that the inter-company loans were exempt from the CFC regime, whether as separate
transactions, yearly transactions or loans that matured within a five year
60 Briefs of evidence of Sir Robert Jones at [2.6]-[2.10]; Burge at [14].
61 Statement of evidence of Richard Green, at [4.2].
exemption.62 He further opines that the inter-company loan arrangements were simply made as part of a variable principal debt instrument (―VPDI‖) that never matured within the requisite five year period.63
[67] He rejects the opinion expressed by Mr Lennard and Dr Harley that the $16.2 million restructure conferred a tax benefit on the plaintiff that otherwise would have been payable if an equivalent distribution had been made by Pamiers to the Trust.64
[68] Mr Green also suggested that such a transaction would be considered susceptible to attack under the anti-avoidance provisions, in particular section GB1(3) of the Income Tax Act 2004 (ss BG1/GA1 and GB1 of the Income Tax Act
2007). Overall Mr Green maintains that voluntary disclosure was necessary.
[69] Mr Lennard considers that the loan arrangements were a series of individual transactions or financial arrangements that did not aggregate to become a VPDI that attracted a tax liability under the CFC regime.65 He maintained that the transactions were dealt with on a yearly basis and similarly did not attract tax liability under the CFC regime.66 Failing that, Mr Lennard expressed the view that all debt was discharged within the five year maturation period as a consequence of the restructure, including through the payment of a management fee.67 Once that debt was replaced by a positive balance (i.e. an amount owing to RJHL), then any VPDI must be deemed to be at an end. The effect of this is that the loan arrangements as a whole were exempt from liability under the CFC regime given that all loans had matured within a five year period. He says, therefore, that the voluntary disclosure undertaken by the plaintiffs was unnecessary. He opined that a voluntary disclosure on the correct basis would have resulted in a reduction of $1,086,764 in tax and use of money interest.68
[70] Mr Lennard further states that the restructure in effect enabled the equivalent of $16.2 million to be shifted between the family of companies without attracting
62 Reply evidence of Richard Green, at [2.3]–[2.4].
63 Ibid, at [2.4].
64 Ibid, at [3.1].
65 Précis of brief of evidence of Michael Lennard, 23 March 2011, at [8.1].
66 Ibid, at [8.1.3].
67 Ibid, at [8.2].68 Brief of evidence of Michael Lennard, at [59].
full tax liability. He calculates the tax benefit as being in the order of NZ$5.616 million.69
[71] Dr Harley agrees with Mr Lennard‘s primary analysis. He supports Mr Lennard‘s basic proposition that the loan arrangements expired within a five year period and accordingly voluntary disclosure should never have been made and was unreasonable.70 He says that there was no evidence of an over arching agreement that could properly constitute a VPDI and that each advance from Pamiers to RJHL represented a separate financial arrangement.71 He agreed with Mr Lennard that all amounts owing by RJHL to Pamiers were repaid as at 31 March 2007 and accordingly that the loans had matured at that point.
[72] He joins with Mr Lennard in suggesting an alternative dispute resolution strategy which he says was both feasible and the more reasonable approach to take.72
He also agrees with Mr Lennard that the extraction of $16.2 million with no further tax to pay is a material and quantifiable benefit of the restructure.73
[73] The third category of expert evidence was given by Professor van Zijl and Mr Bennett for the plaintiffs and Mr Graham for the defendants. These experts address an alleged counterfactual that the defendants say must be taken into account when assessing the true loss to the plaintiffs, if any.
[74] Mr Graham identifies what he considers to be a reasonable investment strategy for Sir Robert in the event that the restructure and inter-company loan arrangements never occurred. His analysis examines a counterfactual where Pamiers invested the loan moneys in bank accepted bills while the New Zealand group borrowed externally. He deducts the interest earned after tax on the bank accepted bills from the interest cost of borrowing money within New Zealand. He also subtracts the tax actually paid by Pamiers on the interest it earned from the lending.
He concludes that the group would have incurred an additional net financing cost of
69 Précis, at [19].
70 Brief of evidence of Geoffrey Harley, at [24].
71 Ibid, at [32]-[33].
72 Ibid, at [45]-[53].73 Ibid, at [56].
NZ$1.29 million in the period 26 February 2003 to 30 June 2010.74 The defendants say this avoided cost must be off-set against the tax liability incurred.
[75] Professor van Zijl critiques Mr Graham‘s analysis as highly implausible, noting in particular that a bank bill investment strategy would have been highly unlikely given the core property investment strategy employed by Sir Robert across his group of companies. This was reinforced by Sir Robert‘s evidence that available money was invested in property (though it was noted under cross-examination that
cash up to $8 million was left ―lying around‖).75
[76] Professor van Zijl also lists other failings of the counterfactual,76 but he does not proffer a counterfactual of his own.
[77] Mr Bennett, Wellington Area Manager for BNZ, who was not required for cross-examination, confirmed that the BNZ would have lent funds to the plaintiff in order for it to repay the sums owing to Pamiers as per Sir Robert‘s counterfactual.
Preliminary matters
[78] There are two linked preliminary matters that need to be addressed, namely: (a) Whether the defendants should be allowed to plead and/or argue
contributory negligence;
(b)Whether the evidence from Mr Lennard and Dr Harley supporting a contributory negligence claim is admissible.
Contributory negligence
[79] Contributory negligence is an affirmative defence that should be pleaded.77
74 For calculations of external interest cost, refer brief of evidence at [28], for calculation of interest income refer [31] and for analysis of tax considerations on the interest revenue refer [33], for net position refer [37], and for calculations of benefit derived post March 2007, refer page 17 and summary page 18.
75 Transcript at 21, lines 3-11; and at 23, lines 4-14.
76 Brief of evidence of Antonius Johannes van Zijl, at [3.6]-[3.7].
[80] In closing, the defendants sought leave to amend the pleadings to include a claim for contributory negligence.
[81] The defendants argue that there is no real prejudice to the plaintiffs given that both the pleadings and the evidence seriously question the correctness of the voluntary disclosure. Dr Harley says that the plaintiffs‘ voluntary disclosure was not reasonable.78 An available inference might be that unreasonable advice is negligent and accordingly the plaintiffs should have prepared themselves for that.
[82] The defendants then say they are not seeking to sue Ernst and Young, so that Ernst and Young need not be joined. The defendants wish to submit that the plaintiffs were through their advisors negligent and ought to contribute to the extent of their own negligence.
[83] While the defendants‘ position is not without merit, I am not prepared to
allow that amendment at this very late stage for the following reasons.
[84] First, the late amendment to include contributory negligence would be significantly prejudicial to the plaintiffs. It is one thing to allege that voluntary disclosure was unnecessary. It is quite another thing to claim that voluntary disclosure was so unreasonable as to be negligent. The plaintiffs may have wanted to produce further corroborative evidence specifically tailored to the question of its own alleged negligence, in a similar manner to the multi-layered approach taken by the defendants. The lateness of the application to amend has precluded the plaintiffs
from adopting this type or other strategy for dealing with such a claim.79
[85] Second, it is apparent to me that the evidence has not been framed nor the witnesses for the plaintiffs briefed to meet a negligence claim. While there must be some speculation about this, the critical point is that Mr Blaikie and the other
deponents for the plaintiffs have not been given sufficient advance warning of the
77 McGechan on Procedure HC 5.48.15, Brown v Heathcote County Council (No.2) [1982] 2 NZLR
618 at 621-3; refer also Todd (ed), The Law of Torts in New Zealand (5th ed., Brookers, Wellington,
2009) at 984-985.
78 Brief of evidence, at [45]-[53].
79 Cf. Tewsley Street Properties Ltd v Wright Stephenson Properties Ltd (1993) 7 PRNZ 58.
defendants‘ contributory negligence claim so that I can be satisfied that no injustice would arise by allowing the late amendment.
[86] Third, any contributory negligence claim is complicated by the inevitable need to join Ernst and Young who provided the allegedly negligent advice to voluntarily disclose. This is not a case where it can be said the plaintiffs themselves were negligent. Rather, it is a case where the advice to the plaintiffs was allegedly negligent and in which case the plaintiffs ought to be accountable for some of the loss. A logical consequence of that is that the plaintiffs would then have a claim against Ernst and Young. In my view, it is simply too late to contemplate joinder at this stage, particularly as the primary witness for Ernst and Young has already given evidence and been subject to cross-examination. Ernst and Young could very well want to produce further corroborative evidence to support its defence against any negligence claim.
[87] Fourth, I do not consider that the defendants are unfairly prejudiced by the refusal to allow a contributory negligence claim. The defendants remain free to argue that the advice that the plaintiffs received constituted a supervening act such that the defendants‘ negligence was not causal and operative of the plaintiffs‘ loss. I consider that that issue was squarely before me. Nor does this affect any claim that the defendants might have against Ernst and Young.
[88] Overall, and fundamentally, the plaintiffs have not engaged in the proceedings on the basis of a contributory negligence claim. They have framed their case on the basis that the merits of voluntary disclosure were disputed and unreasonable, not that it was negligent.
Evidence of contributory negligence
[89] The plaintiffs submit that the evidence of Mr Lennard and Dr Harley to the effect that the advice given by Ernst and Young was negligent is inadmissible. The plaintiffs say that the evidence relates to an allegation that was never properly pleaded. The plaintiffs also say that the evidence is not relevant as it does not relate to the pleadings.
[90] I observe that an important distinction needs to be made between evidence supporting the pleadings and the inferences capable of being drawn from the evidence. Evidence that supports the pleadings cannot be said to be irrelevant.
[91] In this case the defendants plainly alleged that voluntary disclosure was not necessary and was unreasonable.80 The evidence of Mr Lennard and Dr Harley is directed primarily to that allegation and therefore cannot be deemed to be inadmissible on the basis that it is irrelevant. Whether it can also be used to ground a claim to contributory negligence is quite a different matter. I have dealt with that in the preceding discussion.
[92] Before I depart from this analysis, in my ruling on admissibility I reserved my position on whether parts of the evidence of Mr Lennard and Dr Harley were admissible. Having had the opportunity to hear all of the evidence and cross- examination, I am satisfied that, save in one respect, the evidence is sufficiently probative of the matters before me for admissibility as expert opinion evidence, particularly as it relates to professional standards and the practical application of the law in this context.
[93] In one respect, however, the evidence must in my view be excluded. At [75] of his evidence, Mr Lennard described his experience with the IRD in relation to a specific matter. It transpires that that experience was not amenable to verification or testing in the normal way. While I have said that the application of the law can be helpful to the Court, if experts are to refer to specific experiences to buttress their position, these must be capable of reasonable testing, as any expert evidence and methodology should be. In this particular respect I consider that the prejudice to the plaintiffs, unable to test such evidence, outweighs its probative value.
Framework of assessment
[94] With the admission by the defendants that the advice was negligent by not considering the CFC regime, the critical issue for assessment is the quantum of
liability.
80 Statement of defence to first amended statement of claim, at [39] and [44].
[95] The parties are however at odds over the proper framework for assessing the quantum of liability. The defendants insist (and the plaintiffs disagree) that:
(a) The true tax liability of the plaintiffs must be assessed;
(b)The value of tax benefits of the negligent advice must be off-set against the loss; or
(c) The costs of a hypothetical counterfactual must be off-set against the loss.
[96] Counsel stressed in submissions that I should follow their respective approaches. Appeals were foreshadowed if I did not follow their suggested routes.
[97] While I have been assisted by the careful argument of counsel, as Tipping J
observed in Attorney-General v Carter:81
The outcome of a duty of care issue should not depend on what analytical method is employed. The ultimate inquiry is whether it is fair, just and reasonable to require the defendant to take reasonable care to avoid causing the plaintiff loss or damage of the kind for which compensation is being sought. Each case will have its own particular combination of circumstances against which the necessary judgment must be made.
[98] The following passage from Henry J‘s judgment in Sew Hoy & Sons Ltd v
Coopers & Lybrand also provides guidance:82
As it was put by Cooke P in Fleming v Securities Commission [1995] 2
NZLR 514 at p 523, whether damage and fault are sufficiently connected is a question of fact and degree: What must be borne in mind is that the law is
concerned with responsibility for the damage or loss in question, or as was
said by Cooke P in McElroy Milne v Commercial Electronics Ltd [1993] 1
NZLR 39 at p 41, "the ultimate question as to compensatory damages is whether the particular damage claimed is sufficiently linked to the breach of the particular duty to merit recovery in all the circumstances".
[99] Furthermore, the admission of negligence should not obscure the need to
properly define the scope of the defendants‘ duty and the nature of any breach.
These elements are directly relevant to what is fair, just and reasonable and whether
81 Attorney-General v Carter [2003] 2 NZLR 160, at 169.
82 Sew Hoy & Sons Ltd v Coopers & Lybrand [1996] 1 NZLR 392, at 402.
there is a sufficient link between the damage or loss and the breach of the particular duty. The following statement by Lord Hoffmann in South Australia Asset Management Corp v York Montague Ltd and Ors is also instructive in this context:83
The principle thus stated distinguishes between a duty to provide information for the purpose of enabling someone else to decide upon a course of action and a duty to advise someone as to what course of action he should take. If the duty is to advise whether or not a course of action should be taken, the adviser must take reasonable care to consider all the potential consequences of that course of action. If he is negligent, he will therefore be responsible for all the foreseeable loss which is a consequence of that course of action having been taken. If his duty is only to supply information, he must take reasonable care to ensure that the information is correct and if he is negligent, will be responsible for all the foreseeable consequences of the information being wrong.
[100] Accordingly, I approach the assessment by addressing the following issues: (a) What was the scope of the duty of care owed by SCW?
(b) What was the nature of the breach of that duty?
(c) Was the resultant damage both causally connected with the breach and not (in law) too remote:
(i) does the loss flow from the breach; (ii) was the loss foreseeable;
(iii)was the Ernst and Young advice wrong and if so was it a divisible supervening act;
(d)In terms of mitigation, was it reasonable for the plaintiffs to rely on the Ernst and Young advice?
(e) What are the relevant benefits gained or real losses and costs saved, if any?
83 South Australia Asset Management Corp v York Montague Ltd and Ors [1996] 3 All ER 365, at
372-3. Cited with apparent approval by Gault J in Bank of New Zealand v New Zealand Guardian
Trust Co Ltd [1999] 1 NZLR 664 at 683.
[101] Where relevant I will deal with the differing contentions as to approach within this framework of assessment.
Scope of duty
[102] The duty of care is broadly defined by the nature and proximity of the relationship between the Trust and SCW.84 This is informed by the level of responsibility assumed by SCW to the Trust, and the reliance placed on SCW by the Trust in managing the Trust‘s tax liability. There are no obvious policy considerations in the present context that might require qualifying that duty once established through proximity.
[103] The scope of duty owed by SCW is framed firstly in the letter of retainer, overlaid by additional services offered and retained by Sir Robert. These are referred to at [8]-[19] above. This included:
(a) Preparation of the financial accounts for Sir Robert‘s New Zealand
based entities in the period 2003 - 2007; (b) To provide tax advice in the same period;
(c) To prepare and file tax returns for the same period;
(d) To provide structural advice, including the proposal to restructure in
March 2007.
[104] I also accept Sir Robert‘s evidence that he left the specific task of managing the financial accounting, including in relation to tax, to SCW given that the Trust‘s companies had no in-house capacity.85 I am not suggesting Sir Robert was a nodding automaton, but SCW plainly assumed a central role in assisting Sir Robert in the structuring and financial accounting of the New Zealand based entities. The extent of SCW‘s integration in Sir Robert‘s financial management is evidenced by the
various tasks performed by SCW for the Trust as set out above. The depth of the
84 Attorney-General v Carter supra, at 168-169.
85 Jones, at [2.7].
integration is reflected in correspondence from SCW spanning the affected period, including direct correspondence with Sir Robert‘s management team in New Zealand and Australia, and with his Australian advisers on tax management matters.86
[105] The following extract from a file note written by Mr Burge is illustrative of his mindset:87
If we sold our assets to Pamiers they are happy with that although they noted the process would involve exposing the New Zealand assets to Australian tax including CGT income tax and non resident withholding tax. …
We also talked about selling in more than the current value of the loan so that Pamiers would owe Sofia money. They are happy with that and we would pay interest although they noted there would be a thin cap issue. …
We could look at putting the apartments into Pamiers. (Emphasis added)
[106] Against this background of specific, in depth and comprehensive involvement in the financial affairs of the Trust, I find that SCW‘s duty encompassed a requirement to carefully manage the Trust‘s financial accounting to ensure that the companies were tax efficient and complied with relevant tax regulation. It also required the accounts to be presented in such a way so as to demonstrate compliance with that regulation.
[107] Sir Robert was entitled to rely, and did rely on SCW to handle his financial accounting so that the New Zealand based entities were so managed.88
[108] In this regard I find that Sir Robert Jones acted on the advice of SCW to order his inter-company lending arrangements.89 To the extent that Mr Burge‘s evidence is that SCW‘s role was a passive role,90 I do not accept it. SCW promoted strategies to and did manage the Trust‘s financial accounting, exemplified by but not limited to the recommendations to pursue the restructuring.91 In short, SCW‘s duty was to
advise the Trust on what course of action to take.
86 Burge at [22], refer also Transcript at 36-37; CB, at 31.
87 CB, at 52.
88 Transcript at 18 and 60.
89 Jones, at [2.3]-[2.9].
90 Burge, at [14] and [38].91 CB, at 53-57: letter from SCW to Sir Robert Jones, 6 April 2006; CB, at 31-32 : e-mail correspondence between Burge and Nigel Banks, 8 September 2004.
Nature of the breach
[109] Mr Burge has properly accepted that he failed to advise Sir Robert about the CFC regime.92 While not strictly admitted by Mr Burge, there can be little dispute that this constituted breaches of both contractual and tortious duties to correctly advise Sir Robert about the effect of the same regime.
[110] SCW characterises this breach as negligence by omission, rather than commission.93 Plainly SCW missed the effect of the CFC regime on the Trust‘s affairs. But ―omission‖ is an incomplete description of the nature of the breach of contract and the tortious duty of care. Rather, as I have described above, SCW actively guided Sir Robert toward the outcomes that ultimately attracted potential liability under the CFC regime. The negligence therefore was not limited to an
isolated transaction or the provision of information. Rather it permeated the entire financial accounting of the Trust and its companies.
[111] In this regard, the breach had three related components:94
(a) The failure to advise about the effect of the CFC regime, including exemptions, in relation to both the loan arrangements and the restructuring;
(b) The failure to record the correct financial position; and
(c) The failure to lodge the correct tax returns.
[112] The first component is admitted by SCW. The second and third components are admitted to the extent that the potential tax liability is not addressed in the accounts or the returns. I also find that the error is exacerbated by the failure to present the accounts in a manner that could coherently and legitimately enable the
Trust to claim exemption from the application of the CFC regime.
92 Burge, at [6].
93 Defendants‘ closing submissions, at [8].
94 Statement of evidence of Richard Green, at [6].
[113] Notably Dr Harley described how one of his clients had ―elaborate‖ documentation to support a claim that the relevant financial arrangements fell within the CFC exemptions. When I asked about how those records compare with the records of Sofia and RJHL, he answered:95
Like the night/the day
[114] I therefore find that given the position of responsibility assumed by SCW combined with the complete failure to take into account the CFC regime, the nature of the breach is best described as a systemic failure to advise and to position the Trust so as to legitimately minimise its potential tax liability.
Causal Nexus
[115] There are several layers to the question of causal nexus. It is trite that the plaintiffs must establish on the balance of probabilities that there is a causal connection between the breach and the loss, the quantum of the loss and that the loss was foreseeable.
[116] Firstly, does the loss flow from the breach as a matter of fact? The defendants accept that the tax liability on the restructuring flowed from the breach. There can be little doubt that but for the negligent advice, the restructuring would not have occurred. Moreover, the restructuring followed the defendants‘ recommendation to do so. The tax loss arising from such negligent advice was also foreseeable. I need not concern myself with that aspect of the case further.
[117] I also find that a causal connection between the negligent services provided by SCW and the tax loss on the loan arrangements has been established. This is based on the systemic nature of the failure or breach and the (peculiar) nature of tax liability. It can be said with little controversy that but for the negligent advice, the
tax liability on the loans could have been avoided. The Trust could simply have
95 Transcript at 302.
sourced its money from other sources96 and/or paid the loans well in advance of the five year maturation period.97
[118] More significantly, as the Trust‘s financial management and records utterly failed to account for the CFC regime, the Trust was exposed to the peculiar risk of an adverse statutory assessment by the IRD and thus potential tax liability. The IRD‘s statutory assessment was inextricably linked to the loan arrangements and the flawed financial records describing them. While the assessment is capable of challenge, this comes with the risk that the challenge will fail.
[119] Secondly, was the tax loss on the lending foreseeable? As I have said, the defendants contend that the liability arises by omission.
[120] As I have found, SCW played an integral role in the financial accounting of the Trust. As a direct consequence of the failure to advise about the CFC regime, the plaintiffs borrowed money from Pamiers without any knowledge of the tax consequences. The negligence also produced a systemic flaw in the Trust‘s records. I therefore consider that the adverse IRD assessment and the consequential tax liability is a foreseeable loss arising from SCW‘s flawed advice. Furthermore, even if the breach is characterised as an omission, the defendants remain liable for all of
the foreseeable consequences of the flawed information.98 This must also include
the risk of adverse IRD assessment and consequential tax liability.
Supervening act: cause in law99
[121] The defendants say that if the advice from Ernst and Young was negligent or unreasonable it broke the chain of causation.100 This raises a separate consideration, namely whether the prima facie nexus is displaced by a supervening act, namely the
Ernst and Young advice.
96 Bennett, at [9].
97 Jones, at [10.3].
98 South Australia Asset Management Corp v York Montague Ltd [1996] 3 All ER 365 at 373.
99 A description aptly employed by Todd, The Law of Torts in New Zealand, supra at [20.3].100 Defendants‘ closing submissions, at [8.3].
[122] The plaintiffs characterise this advice differently. They say that the Ernst and Young advice formed part of the process of mitigation, and the sole issue is whether the plaintiffs were reasonable in relying on it. This is relevant to the level of scrutiny employed. I accept that the Court will not scrutinise too closely actions taken by the plaintiffs reasonably and in good faith to mitigate their loss.101
[123] The relevant facts are recorded at [21]-[35] above. An issue as to causation as well as mitigation arises because of the key role played by Ernst and Young and the warnings given by the defendants‘ solicitors. The plaintiffs knew that the defendants did not accept that tax was payable on the loans prior to the voluntary disclosure. The plaintiffs elected to disclose in the face of the defendants‘ warnings. Prima facie, the plaintiffs‘ election is a new act in the chain of events that has a bearing on the connection between the original breach and the ultimate loss. I proceed with the analysis on that basis.
[124] The first question to be resolved is whether the Ernst and Young advice was wrong about the tax liability. The second question is to ask whether, if so, the advice gives rise to a separate cause of loss.
[125] I do not consider it is necessary to show that the advice was unreasonable or negligent at this point in the analysis.102 I am simply concerned with whether the Ernst and Young advice was such that it severed the prima facie causal connection between the defendants‘ breach of duty and the loss. In short, it is enough to find that it did, rather that it did so negligently.
Wrong advice?
[126] On the first question, it remains essentially a question of fact as to whether the financial arrangement or arrangements matured within five years and if so, whether the subsequent financial arrangement was in substitution for the prior
lending for the purpose of s CD39(13).
101 J Powell & R Stewart (eds) Jackson and Powell on Professional Liability (6th ed., Sweet and
Maxwell, London, 2007).
102 See Skandia Property (UK) Ltd v Thames Water Utilities Ltd [1999] BLR 338 (CA) at 344.
[127] That subsection precludes treating a financial arrangement as maturing if another financial arrangement was entered into with a purpose of ensuring subss (11) and (12) apply. These subsections allow reassessment in respect of lending that matures within five years.
[128] The key facts are recorded at [9]-[19]. With the benefit of careful argument and considered expert evidence, I am satisfied that the arrangements did mature within five years. I am also satisfied that the subsequent lending did not trigger s CD39(13).
[129] More specifically:
(a) The lending was a financial arrangement properly characterised as a VPDI, being a financial arrangement that contemplated one party (Pamiers) advancing further amounts on demand to the other party (Sir Robert/Sofia/RJHL);103
(b) The lending pursuant to this arrangement commenced on 26 February
2003 and continued until 13 March 2007, when the loan repayment was made;
(c) Any remaining debt payable under the arrangement was discharged by
31 March 2007 with the payment of the management fee. [130] This is supported by:
(a) The accounting records (either for Pamiers or RJHL) that plainly show the payment of all outstanding debt as at 31 March 2007;
(b)The recorded purpose of the various restructuring deeds of acknowledgement;
(c) The restructuring itself; and
103 Statement of evidence of Richard Green at [9.4]-[9.5]; Blaikie at [4.3]-[4.5].
(d)The ostensible objective of meeting the equivalent Australian seven year maturity rules.
No substitution
[131] The effect of all of this is that the subsequent lending that occurred was a distinct financial arrangement. The restructuring and associated transactions were a watershed in the financial relationship of the companies, unlike the previous lending which flowed seamlessly from one tranche of borrowing to the next. Accordingly, I find that the subsequent financial arrangements did not substitute the earlier debt.
[132] I do not form a final view regarding the evidence of Mr Lennard and Dr Harley that the subsequent lending was pursuant to a different arrangement as it was separated by the credit balance as at 31 March. But it seems more cogent to suggest that a credit balance and/or base price adjustment is relevant but not determinative of whether an arrangement has matured. This would better align with the CFC rules specifically designed to catch successive and substituted arrangements.
Anti-avoidance
[133] The plaintiffs maintain that all of this is still problematic in terms of the anti- avoidance rule in s CD39(13).104
[134] I accept SCW‘s basic contention that the purpose of the payments could not sensibly be said to have been intended to ensure that subsection (11) and (12) apply. The Trust did not know about the CFC rules. But approaching the matters through a still wider lens, the intention underlying the payment was to deal with the equivalent Australian seven year rule. That could lead to a inference that the Trust intended to substitute the previous lending and to trigger s CD39(13).
[135] I am not in a satisfactory position to resolve this aspect one way or another with certainty. It exemplifies the difficulty confronted by Ernst and Young in dealing
with the failure to take into account the CFC rules. But on the evidence before me I
104 A similar argument in relation to s CD39(9) was not pursued in closing.
am not satisfied that the subsequent lending arrangement was entered into with a purpose of ensuring that subsections (11) and (12) apply. The discharge of the debt attracted their application. Unsurprisingly, there is scant documentary evidence that the purpose of the arrangement was to achieve that outcome. Conversely, the associated transactions comprising the restructure provide a concrete point of severance between the two financial arrangements.
[136] For completeness, it is not sufficient in my view to rely on the effect of a subsequent or second financial arrangement to establish ―purpose‖ in this specific context. Some care has been taken by the drafters of the Income Tax Act 2004 to capture both ―purpose‖ and ―effect‖ where that is intended. For example:105
tax avoidance arrangement means an arrangement, whether entered into by the person affected by the arrangement or by another person, that directly or indirectly —
(a) has tax avoidance as its purpose or effect; or
(b) has tax avoidance as 1 of its purposes or effects, whether or not any other purpose or effect is referable to ordinary business or family dealings, if the purpose or effect is not merely incidental
…
[137] There is no reference to ―effect‖ in s CD39(13).
[138] Given also that the underlying objective of the rule is to avoid purposeful substitution, there must be an intent (objectively assessed) to substitute the lending to achieve an exemption. In this regard, approaching the available information objectively, Mr Green‘s explanation best sums up the situation - it was a fortuitous flick.106
[139] On the basis of the foregoing, the advice that the five year maturity exemption did not apply was incorrect. I consider the implications of this below.
105 Income Tax Act 2004, s OB1.
106 Transcript at 113, line 12.
[140] For completeness, I agree with Mr Green that it is neither valid nor realistic to describe each entry in the ledger as a separate financial arrangement or that the arrangements were yearly arrangements.
[141] The Pamiers‘ lending was a facility made available to Sir Robert on demand. This was reflected in the loan accounts of Sofia and RJHL. From a New Zealand perspective the lending was seamless from year to year for the full period of the lending. It had the appearance of an overdraft facility. While the Pamiers‘ accounts recorded yearly values, the sums continued to aggregate as if it was a continuing arrangement. Notably s CD39(7) provides that successive financial arrangements can be regarded as one financial arrangement and s CD39(9) provides that temporary reductions or increases are to be ignored.
[142] Mr Lennard and Dr Harley also make much of the absence of a formal loan agreement to support their contentions. But the definitions of arrangement, financial arrangement or VPDI do not require an agreement in writing. It need be only an understanding. There can be little doubt that Sir Robert understood that he could
draw at will on funds provided by Pamiers107 and that any debt arising would be paid
by Sofia or RJHL. In those circumstances the IRD did correctly treat the arrangements up to 31 March 2007 as a single VPDI.108
Divisible?
[143] While the Ernst and Young advice was wrong insofar as it suggested that the loans had not matured within the five year period for exemption, it did not break the chain of causation.109
[144] First, the IRD independently assessed the plaintiffs to be liable for tax in association with the lending. That assessment was based on the exercise of a
statutory function. The plaintiffs‘ voluntary disclosure cannot be sensibly described
107 Transcript at 17 and 22-23.
108 In this regard I accept the evidence of Mr Green at [9.4], also see Transcript at 113.
109 Todd, supra at [20.3.01] and cases cited therein, see also Board of Governors of the Hospitals for
Sick Children v McLaughlin & Harvey plc (1987) 19 Con LR 25, at 96.
as causing the outcome of the statutory assessment. The IRD‘s correspondence
suggests that it formed its own view of the position.110
[145] Second, the plaintiffs‘ loss remains within the scope of risk created by the defendants‘ breach. The defendants‘ failure not only created the opportunity for the tax loss to be incurred, it exacerbated the risk of tax liability.111 The defendants‘ negligence amplified the prospect that the IRD would assess that tax was owing on the loan arrangements by failing to provide any clear documentary basis demonstrating that the loans were exempt from the CFC rules. The Trust therefore was not only vulnerable to potential tax liability, it was made vulnerable to an adverse IRD assessment through inadequate financial accounting. This opened up
the prospect of litigation in the event that the IRD did not agree with the plaintiffs‘
assessment of the true tax position.
[146] Third, the advice of Ernst and Young should be seen within the wider context of risk management, rather than simply as a new act giving rise to additional liability.
[147] The defendants criticise the plaintiffs for making voluntary disclosure on the basis that it was unnecessary. But Ernst and Young and the plaintiffs were confronted with multiple risks, including penalties, the potential for an adverse reaction from the IRD, adverse publicity and tax litigation.
[148] It is easy to say with the benefit of hindsight that the plaintiffs could have refused voluntary disclosure, made more of the arguments suggested by the defendants and objected to the assessment. But all scenarios available to the plaintiffs involved some further risk of exposure, some of it unquantifiable, arising directly from the breach by the defendants. This fortifies my view that the plaintiffs advice, though incorrect, was simply part of a foreseeable risk management option linked to the original flawed advice.
[149] Finally, this case is markedly different from the cases ordinarily associated with supervening acts, for example the surgeon that incorrectly diagnoses an injury
110 CB, at 251-253.
111 Cf. Sew Hoy & Sons Ltd v Coopers & Lybrand [1996] 1 NZLR 392.
leading to even greater injury.112 In that context the defendants cannot reasonably be expected to have foreseen that a skilled surgeon will be negligent. In the present case the risk profile is far more complex, with each option potentially leading to foreseeable loss to the plaintiffs. For example had the plaintiffs pursued what I have described as the correct interpretation of the tax position, and the IRD disagreed, the ultimate result could still have been adverse to the plaintiffs. These are the vagaries of litigation.
[150] I therefore find that instead of being a supervening act, the plaintiffs advice, though wrong, formed part of a foreseeable chain of events linked to the initial breach and culminating in the loss suffered by the plaintiffs. I also reject the suggestion that the plaintiffs should not have disclosed and should have contested the IRD‘s assessment. As I will explain below, both courses were reasonably open to the plaintiffs.
Reasonable mitigation
[151] The defendants maintain that the plaintiffs and Ernst and Young have failed through unreasonable action or inaction to take steps to avoid loss to the plaintiffs.113
[152] The defendants submit, and I agree, that the issue of reasonableness does not require proof of conduct amounting to negligence.114 The real issue is whether, as the defendants contend, the plaintiffs have acted reasonably toward the defendants in view of the plaintiffs‘ duty to mitigate damages.115
[153] As I have foreshadowed however, the Court will not scrutinise too carefully the actions of the plaintiffs, provided those actions have been taken reasonably and in good faith. In addition, the focus in this context is the action of the plaintiffs
rather than Ernst and Young.
112 Refer cases cited in Board of Governors of the Hospitals for Sick Children v McLaughlin & Harvey plc (1987) 19 Con LR 25 at 96-7.
113 Defendants‘ closing submissions, at [23].
114 Skandia Property (UK) Ltd v Thames Water Utilities Ltd [1999] BLR 338 (CA).
115 British Westinghouse Electric and Manufacturing Co. Ltd v Underground Electric Railways Co. of
London Ltd [1912] AC 673 at 689; Defendants‘ closing submissions, at [23].
[154] The defendants also acknowledge that they bear the onus of showing either:116
(a) That there was loss that the plaintiffs could have avoided, but failed through unreasonable action or inaction, to avoid;
(b)That steps taken by the plaintiffs in an attempt to mitigate their loss were not reasonable;
(c) That the plaintiffs therefore failed to mitigate their loss and/or contributed to their loss to the extent of the additional tax liability.
[155] The defendants‘ primary complaint is that the plaintiffs had the opportunity to avoid the full tax liability and did not take it. Instead, they say that the plaintiffs rejected the defendants‘ suggestions in favour of an option that maximised the core liability and saved only $60,000 in penalties.117
[156] The relevant chronology of events is detailed at [26]-[39] above. These events do not indicate unreasonable conduct by the plaintiffs.
[157] On the contrary, the plaintiffs acted quickly to minimise their potential exposure based on a significant amount of information. This included:118
(a) The advice from SCW dated 9 February 2009 that the plaintiffs were liable for tax of approximately $2,673,000 being tax on the Trust‘s 50 per cent share of the attributed dividend at the trustee rate of 33 per cent, plus interest at the rate of 14.24 per cent.119
(b) Advice from Ernst and Young.120
(c) Advice from Lindsay McKay.121
116 Defendants‘ closing submissions, at [24.1].
117 Defendants‘ closing submissions, at [23.11].
118 Plaintiffs‘ closing submissions, at [2.66].
119 CB, at 126.120 Ibid, at 153 and 167.
(d) Advice from Ernst and Young on voluntary disclosure.122
(e) Advice from Lindsay McKay reviewing the Ernst and Young advice.123
(f) Comments from Minter Ellison Rudd Watts (―MERW‖).124
(g) A review of the MERW advice by Ernst and Young and Lindsay
McKay.125
(h) The response by the IRD to the voluntary disclosure.
[158] The pool of information also included the advice from MERW that voluntary disclosure was not necessary. To a certain extent however the message was a mixed one. In correspondence dated 17 February 2009 and 6 March 2009, MERW warned the plaintiffs to avoid penalties.126 They refused to accept liability.127 In a further letter dated 3 April 2009 the defendants record their view (through their solicitors) that ―we do not think that there is any benefit to be gained from engaging in a technical debate around the Ernst and Young advice‖.128
[159] There is nothing inherently wrong with all of this. But, from the plaintiffs‘ perspective they remained exposed to all of the consequences of the flawed tax advice without any obvious remedy.
[160] On 12 May 2009 the defendants do then engage in the technical debate in response to the Ernst and Young proposal to voluntarily disclose. While it was not accepted by the plaintiffs, it was not rejected out of hand. It was in fact referred to a leading tax expert, Mr McKay, who rejected the ―maturity‖ argument advanced by
the defendants.
121 Ibid, at 150.
122 Ibid, at 219.
123 Ibid, at, 236.124 Ibid, at 238.
125 Ibid, at 241 and 244.
126 Ibid, at 147 and 165.
127 Ibid.128 Ibid, at 197.
[161] It may be that Mr McKay was misinformed about the effect of the payment of the management fee. If so, this was a material omission. But it appears this was not an obvious error at the time to anyone. Notably the MERW letter of 12 May 2009 does not refer to this payment.
[162] It is also relevant that Dr Harley, quite properly in my view, accepted that it was reasonable for Sir Robert to take advice from Ernst and Young and from Mr McKay.129
[163] This important factor takes this case outside the auspices of Skandia Property (UK) Ltd v Thames Water Utilities Ltd130 relied upon by the defendants. In Skandia, water had escaped from the defendants‘ pipe causing damage to the plaintiff‘s building. The plaintiff and its experts had assumed that the water must have damaged a comprehensive waterproofing system. The plaintiffs therefore replaced that system and claimed the cost of doing so from the defendants.
[164] It transpired that there was no such effective waterproofing system prior to the flood. The Court of Appeal found that the plaintiffs could not recover the cost of installing a new system: 131
[T]he assumption that Vala and its experts made that damage had been caused to a comprehensive waterproofing system was not reasonable, and it was thus not reasonable to replace what was there with such a system.
[165] The Court of Appeal then observed: 132
What should be emphasised is that it must be rare if ever that a plaintiff will be able to establish the reasonableness of any assumption of damage to something which is accessible and inspectable. Certainly, simple reliance by a plaintiff on an expert cannot be the test as to whether a plaintiff has acted reasonably in making an assumption, albeit, provided the plaintiff has provided the expert with all material facts and the expert has made all reasonable investigations, the advice will be a highly significant factor.
[166] Returning to the present facts, while the Ernst and Young advice was wrong,
the plaintiffs‘ actions were not unreasonable. The key issues were thoroughly
129 Transcript at 284.
130 Skandia Property (UK) Ltd v Thames Water Utilities Ltd [1999] BLR 338 (CA).
131 At 344.132 Ibid.
investigated and the Ernst and Young advice was independently tested. This is unlike a situation where the true extent of the damage is a matter of existing fact, examinable by experts. Rather, a judgment had to be made, based on all available advice and information. It cannot be said that the judgment made by the plaintiffs was unreasonable.
Benefits
[167] The defendants claim that they are entitled to set off the value of any benefits that have accrued to the plaintiffs as a result of the restructure transaction. The alleged benefits include:
(a) The distribution of $16.2 million from Pamiers to the Trust pursuant to the restructure saved in the order of NZ$5.6 million in tax.
(b)In particular, the above transaction resulted in $4.9 million being made available to Sir Robert for payment of a personal debt to the Bank of New Zealand without attracting tax liability. This part of the transaction resulted in actual tax savings in the order of NZ$1.9 million.
[168] They add that the benefits cannot be said to have arisen through an independent or disconnected transaction. Therefore they should be taken into account in the overall assessment of the plaintiffs‘ position and the loss caused by the negligent advice.133
[169] It is evident that the benefits described were contemplated at a high level of generality in the letter of recommendation by SCW dated 6 April 2006:134
Selling New Zealand assets to Pamiers also provides opportunities to create a more effective manner of repatriating Pamiers profits to New Zealand and a method of clarifying the interest position on the BNZ Australia loan.
133 Defendants‘ closing submissions at [33.1]-[33.4] .
134 CB, at 55.
Principles
[170] This part of the defendants‘ case is novel. It seeks to offset the benefits of the competent part of the advice against the losses arising from the negligent aspect of the same advice. I therefore commence this analysis by returning to first principles. As stated in Jackson and Powell on Professional Liability:135
The principal object of an award of damages is to put the claimant in the position he would have occupied if the breach of duty had not occurred, so far as money can do this and subject to the rules as to remoteness and mitigation of damage. [Footnotes not included.]
[171] In the context of tax cases the same authors helpfully observe:
Negligent tax advice by an accountant may result in a client paying more in tax than would have been paid given competent advice. In that event the normal measure of damages is the excess tax paid together with the interest thereon. [Footnotes not included.]
[172] I would add that in contract:136
… where a party sustains a loss by reason of a breach of contract, he is, so far as money can do it, to be placed in the same situation, with respect to damages, as if the contract had been performed.
[173] Plainly, any remedy should not over-compensate a plaintiff.137 This point was aptly described by Professor McLauchlan in the following terms:138
Given that the court seeks to ensure that the plaintiff is not put in a better position that if the contract had been performed, the touchstone should always be whether it can fairly be said that all or part of the loss in respect of which damages are claimed has either not been suffered or has been avoided or is offset by a gain made.
[174] Also as discussed by Burrows in Remedies for Torts and Breach of
Contract,139 before a benefit can be taken into account:
135 At [3-001].
136 Robinson v Harman (1848) 1 Ex 850, 855 per Parke B, see also D McLauchlan ―Some Issues in the Assessment of Expectation Damages‖ [2007] NZ Law Review 563.
137 British Westinghouse Electric and Manufacturing Co Ltd v Underground Electric Railways Co of
London Ltd [1912] AC 673.
138 Supra at 628.
139 A Burrows Remedies for Torts and Breach of Contract (3rd ed, Oxford University Press, Oxford,
2004) at 156.
... the benefit in question must arise from the breach of contract or tort; that is, the breach of contract or tort must be a cause of the benefit according to the ‗but for‘ test of factual causation.
[175] Finally, a duty to take reasonable care should not be conflated with a warranty as to outcome.140 But in my view the law should not compel an innocent party who has relied on negligent professional advice, and irrevocably changed its position in doing so, to subtract related benefits from the loss suffered, unless it can be put in the position it would have been had the advice been correct.141
[176] Returning to the facts, I see no basis for benefits based offset in this case. The alleged benefits are not remedial of the loss caused by breach of the duty of care. Nor are they a subsequent gain made through the remedial process. Rather, the alleged benefits were inherent to the service provided. They are part of the performance of the contract of services.
[177] I therefore do not consider that the benefits arise from the negligence. In any event, if the benefits were caused by the negligence (i.e. in the sense that but for the negligence the restructuring would not have occurred), they are not a net gain to the plaintiffs. The plaintiffs have established that they would not have pursued the restructuring in the counterfactual, presumably because the benefits of doing nothing outweigh the benefits of the flawed restructuring. In reality, the plaintiffs are worse off because of the tax liability.
[178] The facts of this case are also removed from the facts in the leading authority cited by the defendants, British Westinghouse Electric and Manufacturing Co Ltd v Underground Electric Railways Co of London Ltd.142 In that case, the respondents, in mitigation of a breach of contract to supply engines, substituted superior engines that they could not have obtained under the contract. This gain was relevant to the assessment of damages. That is hardly applicable to the present facts. There is no
such substituted gain in this case.
140 Lion Nathan Ltd v CC Bottlers Ltd [1996] 2 NZLR 385 at 388.
141 Consider, by analogy, Lipkin Gorman (a firm) v Karpnale Ltd [1992] 4 All ER 512 at 534; National Bank of New Zealand Ltd v Waitaki International Processing (NI) Ltd [1999] 2 NZLR 211 (CA) at 219. See also Sempra Metals Ltd v Inland Revenue Commissioners [2008] 1 AC 561, Lord Hope at 583-586.
142 British Westinghouse Electric and Manufacturing Co. Ltd v Underground Electric Railways Co. of
London Ltd [1912] AC 673.
[179] The defendants also refer to Grimm v Newman.143 That case concerned a claim for compensation in respect of alleged negligent tax advice on the acquisition of property using funds sourced from an overseas investment. The Court of Appeal (by majority) found that there was no negligent advice. The Court (without dissent) also found that any negligence would not have caused the plaintiff loss, because the tax could not have been avoided by an alternative scheme. The defendants say the implication of this case is that as the tax benefits of the restructure could not occur without the tax liability, they should be offset against that liability.
[180] In my view, the comparative analysis employed in Grimm has no application to this case. It presupposes that the underlying commercial transaction is pursued in the counterfactual. This critical assumption cannot be replicated here. The plaintiffs have established, and the defendants accept, that the lending and restructuring would not have been pursued if the correct advice had been given. Accordingly the Grimm comparative reasoning is inapposite.
[181] Furthermore, had the correct advice been given, the financial arrangements could have been structured in a way to clearly and ostensibly meet the maturity exception. As such, any associated debt tax liability need not have arisen.
[182] More fundamentally, the plaintiffs sought tax efficient management of their inter-company arrangements. They did not receive this. They received a flawed inter-company restructure in response to flawed and avoidable financial arrangements, all precipitated by SCW‘s negligent advice. In order to remedy the various flaws the plaintiffs paid the assessed tax. In this context it is a misnomer to describe any residual tax efficiency as a remedial benefit to be offset against the price paid to fix the flawed restructuring.
[183] In summary, the benefits highlighted by the defendants were inherent to SCW‘s advice. They were part of the performance of the contract of services. It would be perverse to apply them to remedy a breach of the same contract. Nor do they represent a net gain to the plaintiffs over the position they would have been in
had the correct advice been given.
143 Grimm v Newman [2003] 1 All ER 67.
Tax benefits?
[184] It is not strictly necessary for me to address the question of whether the restructuring did confer real tax benefits on the Trust and Sir Robert. However given the attention placed on it, I make the following brief observations.
[185] The restructuring plainly enabled the movement of $16.2 million dollars from Pamiers into the New Zealand group. Of this $8.1 million was taxable under the CFC rules. The balance was not taxed. This transfer enabled the Trust to create a loan facility in favour of RJHL and then to fund repayment of Sir Robert‘s personal debt to the Bank of New Zealand. In this way Pamiers‘ profits are being utilised by the Trust and Sir Robert with only a partial deemed dividend arising. Dr Harley
described this benefit in the following terms:144
A. I can explain what I mean. When the Trust sold its shareholding interest in RJHL to Pamiers it realised a 16.2 million capital amount.
Q. Yes.
A. And that‘s the purest form of benefit a trust can derive.
[186] I agree in part. It is no surprise that this type of transfer was deemed repatriation under the CFC rules. But for the fact that the Trust only holds a 50 per cent share of Pamiers, the tax liability could have been much greater.
[187] Nevertheless, the plaintiffs make the cogent point that the transfer did not result in any net realisable gain to the Trust or to Sir Robert at this time. The transfer came at the price of the RJHL shares. The payment to Sir Robert was offset by a reduction in the Trust‘s debt to Sir Robert. The net position of the Trust and Sir Robert therefore has not changed in real terms. In addition, there may be contingent tax liability on any as yet unrealised gains.
[188] It may be that a related tax benefit may be distributed via tax free capital gains on the sale of RJHL‘s buildings or on its liquidation. But I also agree with the plaintiffs that any potential distribution from RJHL via the sale of buildings is too
remote for valid consideration. The evidence is clear. Sir Robert does not sell
144 Transcript at 305.
buildings. Liquidating RJHL may be another mechanism for capturing the alleged profits. But this is a rather fanciful proposition for present assessment purposes and a weak basis for attributing benefit.
[189] I therefore find that the restructuring did result in a potential gain to the Trust via the extraction of $16.2 million to the New Zealand group and tax has only been paid on $8.1 million of that. But that is not yet a real or net gain to the Trust or Sir Robert. There may also be contingent tax liability. In those circumstances I find that the benefit, if any, is too inchoate to set off against the actual tax paid.
[190] I offer no view on whether the transfer constitutes tax avoidance. That might be a matter for future assessment (without suggesting it should be) and I do not consider that I should pre-empt any such assessment unless it was strictly necessary to do so. It is not.
Costs on Counterfactual
[191] The question remains as to whether or not all the losses suffered are claimable by the plaintiffs. This also requires an analysis of the loss that may have been suffered by the plaintiffs had the correct advice been given.145
[192] There is no dispute between the parties that had the proper advice been given, the Trust would not have undertaken the restructuring and would have paid the loans. Certainly there is nothing in the evidence to contradict this observation. The defendants have used it as a basis for establishing costs on the counterfactual.
[193] The defendants contend that the plaintiffs would have incurred considerable cost in the counterfactual, including significant costs of external borrowing less interest earned (after tax) on the Pamiers‘ money. In total, this sums up to $1.29 million.
[194] I acknowledge that there is support for the principle advocated by the
defendants in Lord Hoffmann‘s discussion on calculating a lender‘s loss on an
145 Benton v Miller and Poulgrain (a firm) [2005] 1 NZLR 66.
inaccurate valuation in South Australia Asset Management Corp v York Montague
Ltd.146 He observed:147
But in principle there is no reason why the valuer should not be entitled to prove that the lender has suffered no loss, because he would have used his money in some altogether different, but equally disastrous venture. Likewise the lender is entitled to prove that, even though he would not have lent to that borrower on that security, he would have done something more advantageous than keep his money on deposit: a possibility contemplated by Lord Lowry in Swingcastle Ltd v Alastair Gibson (a firm) [1991] 2 All ER
353 at 365, [1991] 2 AC 233 at 239.
[195] Before dealing with the cogency of the costs on the counterfactual, there are problems with applying Lord Hoffmann‘s reasoning to the present facts. The Trust has fundamentally changed its position in reliance on the negligent advice. It cannot sensibly now undo the lending or the restructuring without incurring the tax loss. To then measure the Trust‘s ―true‖ loss by reference to hypothetical counterfactual losses appears divorced from commercial reality and unfair.
[196] In any event, I turn to the hypothetical facts presented by the defendants. The plaintiffs have established that the tax losses will not arise in the counterfactual. The remaining issue therefore concerns only any other costs or losses that the Trust may have incurred without the lending.
[197] I was invited by SCW to approach this assessment on a loss of chance basis, citing Benton v Miller & Poulgrain (a firm). 148 However, I believe that this is an inappropriate method to assess hypothetical costs that may have been incurred by the plaintiffs in this case. Loss of chance methodology developed out of the need for the Court to fairly deal with hypothetical losses claimed by a plaintiff who has been wronged. In Benton the plaintiff had to show how his estranged wife would have reacted to a properly constructed property matrimonial agreement in order to quantify his lost opportunity. In the present case however the defendants are seeking
to show the losses the Trust would have incurred with proper advice. If I am
146 South Australia Asset Management Corp v York Montague Ltd [1996] 3 All ER 365.
147 At 376.
148 Benton v Miller & Poulgrain (a firm) [2005] 1 NZLR 66.
satisfied that the plaintiffs would have not responded in that way on the balance of probabilities, then no further refinement is needed.149
[198] I also approach this inquiry on the basis that it is for the defendants to provide a sound evidential basis that the counterfactual costs are realistic and reasonable, as it is the defendants who allege that these costs would have been incurred (as opposed to the Trust alleging a lost hypothetical gain to establish the true extent of its losses). If the defendants provide that evidential basis, then the plaintiffs carry the burden of establishing, on the balance of probabilities, that it would not have incurred those costs.
[199] There is a major difficulty with the defendants‘ assessment of the costs on the counterfactual. It is based on an assumption that the Pamiers‘ money would be placed in bank accepted bills, with the interest earned used to off-set the interest cost on the external borrowings by RJHL. The balance, less the tax that Pamiers paid in any event, represents the total cost on the counterfactual. It will be seen that the earnings on the Pamiers‘ money from the deposits are a critical component in the evaluation.
[200] Problematically for the defendants, the core business of the Trust is property investment.150 The assumption is therefore inconsistent with the core business of the Trust and Pamiers. In this regard Mr Graham conceded under cross-examination that he did not consider the actual investments in property made by Pamiers during the relevant period.
[201] Sir Robert accepted under cross-examination that from time to time large sums of money could be left ―lying around‖.151 A sum of $8 million was mentioned by him. But that is quite different from adopting an investment strategy spanning several years of placing the Pamiers‘ money in bank accepted bills. Nor do I accept that Sir Robert conceded that he would not have invested the funds in property or to
pay down debt, as put to me in closing submissions.152 The overriding impression I
149 Ibid, at [47].
150 Transcript at 309 and 313.
151 Transcript at 21, lines 9-18.152 Defendants‘ closing submissions, at [29.2].
developed from the evidence and cross-examination is that the funds would have been put to personal use, or, where opportunities arose, towards the purchase of buildings.153
[202] I note for completeness that Sir Robert‘s rather adamant response to a series of leading questions that he would never put money on deposit has not influenced my reasoning.154
[203] Overall, therefore, the counterfactual is not grounded in the commercial reality of the Trust, Pamiers or Sir Robert. It provides an unsound basis for assessing ultimate costs on the counterfactual. It certainly does not satisfy what I perceive Lord Hoffmann to have contemplated, namely proof that the plaintiffs have suffered no loss because Sir Robert would have applied the monies in some equally loss- causing fashion.
[204] The plaintiffs also challenge the overall evaluation undertaken by Mr Graham. Certainly Mr Graham uses average annual borrowing rates, calculated from the financial statements for the various entities. The provenance of these figures is unclear to me. The statistical basis for using an average (as opposed to a median, mode or other measure) is not explained. I also observe that the various criticisms made by Professor van Zijl cast serious doubt on Mr Graham‘s analysis for
the purposes of assessing counterfactual losses.155
[205] In particular, I accept as highly plausible Professor van Zijl‘s explanation for the differences in the costs of borrowing over the relevant periods: 156
… it would simply reflect the fact that the borrowing and lending takes place in different countries, that is, any difference largely reflects expected movement in the exchange rate between New Zealand and Australia. Thus,
it must be expected that at the conclusion of a borrowing/lending period, the cost and return would be equal. If that was not so, then borrowing in the
lower rate country and lending in the higher rate country would provide a
simple but very productive money making machine.
153 Transcript at 22-23.
154 Transcript at 40.
155 Antonius Johannes van Zijl, at [3.6]-[3.7].156 Ibid, at [3.6(e)].
[206] In addition, when the evidence of the financial performance of the Trust is viewed in the round, I find it highly probable that with proper advice, the Trust would have ordered its affairs to avoid the counterfactual losses alleged by Mr Graham. As Sir Robert stated, the asset holdings have continued to expand through a period of several years including the recent recession. Their current net worth is in the order of several hundred million dollars with rental up to $100 million
a year.157 While the tax losses in this case are significant they need to be viewed in
the wider context of a very large successful business with holdings of that order of magnitude. Accordingly, I am satisfied that, without negligent advice, the alleged costs on the counterfactual would either not have arisen or would have been off-set with commensurate real gains.
[207] I note for completeness that I was initially troubled by the lack of evidence from the plaintiffs on the counterfactual. I have had to resort to the general evidence to be satisfied that such costs would have been avoided. But I am satisfied overall that the defendants‘ counterfactual lacked a proper evidential foundation.
Ninth cause of action: Confidentiality
[208] The plaintiffs seek compensation from the defendants for the unauthorised disclosure of the plaintiffs‘ financial arrangements to a third party. The plaintiffs did not pursue this in closing, so I do not dwell on it.
[209] In any event I accept the defendants‘ basic position. The undertaking as to confidentiality must be reasonably qualified by an assumption that the defendants could disclose that information for the purposes of taking legal advice on a confidential basis. Further, a confidential disclosure to the defendants‘ insurers, if not permissible, must give rise only to minimal damages, if any.
[210] Accordingly, I dismiss this claim.
157 Transcript at 20-23.
Quantum
[211] As to quantum, this is fixed by reference to the IRD assessment together with use of money interest paid, namely:
(a) Lending 2004 - 2007, 2009: $1,667,911 (b) Restructuring 2008: $1,523,990 (c) Use of money interest (―UOMI‖) $1,093,407
[212] The plaintiffs also claim interest at 8.4 per cent to 21 March 2011.
[213] I agree with the defendants‘ submissions that the interest rate should better reflect the prevailing interest rates in the key period. But some care is needed here, as the true cost to the plaintiffs may not be reflected in recent interest rates.158
[214] Rather than take a completely arbitrary approach to this, I invite the parties to identify the modal interest rate for the relevant period. Memoranda should be filed within 14 days, hopefully with the quantum agreed.
Liability
[215] The defendants contend that any liability attaches solely to the second and third defendants. The plaintiffs do not object to allocation of liability in this way. I will approach judgment on that basis.
Costs
[216] I am minded to award costs to the plaintiffs on a category 2B basis together with reasonable disbursements. Nevertheless, memoranda seeking costs are to be
filed within 14 days of the date of this judgment, with replies 14 days thereafter.
158 Sempra Metals Ltd v Inland Revenue Commissioners [2008] 1 AC 561.
Outcome
[217] There is judgment in the sums set out at [211] above against the second and third defendants, together with interest and costs to be determined in accordance
with [214]-[216].
Whata J
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