VINCENT v FC of T
Judges:French J
Court:
Federal Court
MEDIA NEUTRAL CITATION:
[2002] FCA 656
French J
Introduction
1. Julie Vincent is one of several hundred people who, in the mid 1990s invested in a cattle breeding project operated by a group of companies controlled by an accountant/farmer at Tamworth in New South Wales. The agreements under which she invested in the project bear the hallmarks of many such arrangements familiar to those who practice in the area of taxation law and financial advice. Ms Vincent, a person of modest means, claimed tax deductions in 1995 and 1996 in respect of payments which she made in connection with the project. She also claimed deductions in respect of loans which she had agreed, with the Group's finance company, would be made to her in order to meet part of the annual fees payable for management of the cattle breeding project and for leasing of cattle. The loans turned out to be fictious. The finance company did not have any finance and never made any of the payments to the management company which it had promised to make under the Loan Agreement with Ms Vincent.
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2. Although the deductions were initially allowed in her 1995 and 1996 assessments, they were disallowed in 1999 and amended assessments were issued. Penalties and interest were also imposed. Ms Vincent objected to the amended assessments, but her objections were disallowed. She now appeals against those objection decisions.
3. The appeal raises questions about the deductibility of payments actually made in connection with the project and the deductibility of the payments which were never made but which were to have been made on her behalf by the finance company and in respect of which she assumed obligations under the Loan Agreement. It also raises a question about the characterisation of the scheme as one to which the anti-avoidance provisions of the Act apply. As I have found in this case, Ms Vincent entered into the project in good faith after taking advice from her accountant. The gaining of a tax benefit was not her principal purpose. It was her hope that the scheme would eventually yield a modest income stream for her and her family. In the end the scheme has failed, the companies involved have been placed under administration and the deductions disallowed.
4. I have found that the loan payments which were never made on Ms Vincent's behalf by the finance company and which she nevertheless claimed as deductions, could not be so claimed. On the other hand, I have found that the cash outlays which she made, using money borrowed from her father, were deductible under the general provisions of the Income Tax Assessment Act 1936 (Cth). That deductibility, however, is defeated by the application of the provisions of Part IVA of the Income Tax Assessment Act which operates independently of the subjective intention of taxpayers entering into tax avoidance schemes and which applies to all the deductions that she claimed in relation to the project. For that reason her application must be dismissed and the amended assessments must stand.
5. This is not a case of a wealthy or high income person deliberately seeking to avoid her taxation obligations. The conclusions which I have reached do not reflect upon her personally. However, they highlight the need for clear, reliable and independent advice for persons considering participating in mass marketed schemes which promise tax benefits.
Factual History - The Taxpayer's Investment Decision
6. Julie Vincent is a full-time mother and a part-time property developer. In 1993 her marriage broke up leaving her in debt and homeless. She lived with her parents and later in her new partner's home until 1995 when her divorce settlement was finalised. From that settlement she received $170,000 in April 1995 and $50,000 in April 1996. She purchased her own home in April 1995 but subject to a $50,000 mortgage.
7. At about Easter time in 1995 she considered her financial situation and how she might become involved in some form of investment and earn extra income. She was then working as a sales representative selling laboratory and medical equipment and was doing some part-time relief teaching and tutoring.
8. Her accountant Allen Prince suggested that she consider investing in a cattle breeding program operated by Active Cattle Management Pty Limited (ACM). He gave her some material to read. The material comprised a covering letter on the letterhead of ACM and a booklet. The letter described the booklet as designed to show prospective investors ``... how to invest in the breeding of top quality stud cattle without the heavy capital outlays normally required''. The key point of the booklet was the offer of what was called an ``Accelerated Breeding Program''. The letter said:
``The benefits especially when linked to some low rate, fixed interest finance, are set out and are then backed up with illustrative flow charts and cash flow projections.''
The booklet comprised three sections, the first entitled ``A General View of the Industry''. The second, ``What this Booklet is About'' set out details of the Accelerated Breeding Program, a Finance Option, flow charts, cash outlays and cash flows and projections. The third section described ACM, when and where the investor could see his or her cows and finished with a Question and Answer section and references.
9. The first section provided export statistics for Australia's beef and livestock industry which it described as ``the country's leading rural exporter''. This export activity was said to require continual improvement in the genetic
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base of Australia's cattle herd. The small breeder could have as much input as any of the larger breeders provided the herd was well managed and aimed in the right direction. Normal breeding techniques involved a time lag which made it difficult to breed according to market trends. Embryo transfer techniques were said to reduce this time lag greatly and thereby the need for long-range forecasting. The growth of an asset base and the earning of regular income from it were said to have been associated traditionally with the purchase, holding and possible development of real estate. However, the booklet stated:``Real estate is not the only asset which can be negatively geared, with all the income tax advantages that this activity creates.
The development of an elite stud cattle herd, especially when using finance with a limited recourse option (see The Finance Option, p 13), and the earning of regular income from sales of bulls, bull semen and embryos to other breeders, can be of great value in cash flow planning for many investors.''
10. The first section of the booklet did not describe in any detail what was on offer by ACM. There were general statements of a promotional character. They appeared to contemplate that the reader, as a prospective investor in cattle breeding by embryo transfer, might:
- (i) carry on a breeding operation with his or her own herd;
- (ii) carry on a breeding operation assisted by ACM in the development and marketing of the herd;
- (iii) join a partnership of investors. ACM would not form such partnerships as part of its business but was pleased to introduce like-minded investors to each other so they might make their own arrangements;
- (iv) agree with like-minded investors to mutually underwrite each other's income and share sale proceeds from their animals and genetic material ``by putting such up for sale with other similar-minded investors''.
11. The first section of the booklet indicated that an investor in a breeding herd could expect a steady flow of income comprising revenue derived from the sale of bulls and cows not needed for breeding, from the sale of bull semen to other breeders, from the sale of top quality cows and from the renting of bulls and cows to other breeders. In relation to income tax the following statement appeared:
``Minimising taxes on other income.
Australia's income tax legislation allows costs incurred in one business to be offset against profits made in another business conducted by the same taxpayer. (Subject to special limits affecting company taxpayers)
Expenditure on all of the cost of its stud cattle breeding operation, including embryo costs, costs of implantation, holding costs through birth and growing out, and management fees, are all tax deductible.''
12. Following the introductory part of the first section was a discussion of Artificial Insemination and Embryo Transfer. The Embryo Transfer technique was said to be superior to Artificial Insemination and was described thus:
``A single stud cow can be super-ovulated to produce many eggs at one time, all of which can be fertilised by the A.I. technique. After one week, the fertilised eggs or embryos, are flushed from the mother using non-surgical techniques. The embryos may then be implanted, usually in pairs, in a number of ordinary (i.e. non-stud) cows which then carry those embryos to term. The recipient cows become surrogate mothers.
In this way, one stud cow can produce six or more offspring each year.''
There later followed a page dealing with ``The Industry Generally'' and then a discussion headed ``This Operation in Particular''.
13. ACM described itself in the booklet as specialising in the breeding management and promotion of top quality stud cattle for individual clients. Embryo transfers were said to be contracted out to several top Poll Hereford Studs in New South Wales. Facilities were available in other States whenever required by larger clients. The skills and facilities of two embryo transplant centres one at Narromine and another at Tamworth were also used extensively.
14. ACM conducted its operations on a property at Muswellbrook in the Upper Hunter Valley of New South Wales. The property was known as Yamminga and is located about eight kilometres south of Muswellbrook on the New England Highway. It comprises about 500
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acres. The brochure said that a farmer with 41 years of experience in cattle management lived on site and had been engaged to monitor the health of the recipients and to attend to the birth of calves. It was intended to move the company's centre of operations to Tamworth in New South Wales within the next twelve months. ACM was said to have acquired three excellent heifers at auction at the Sydney Royal Easter Show all three of which were pregnant to a top line Bowen bull. The three heifers would be available for the flushing of embryos after they had each dropped their first calf around September or October 1995. In July 1995 the company would be engaging a full-time marketing consultant experienced in both local and overseas buying of breeding stock in genetics. In this way it would ensure a wide range of sales opportunities for its clients. This part of the booklet concluded with the words:``In summary, we provide a total production and sales service for you.''
15. The second section began with the heading ``The Opportunity - an Accelerated Breeding Program''. The service being offered by ACM was described as follows:
- ``• A breeder engaging our services and contracting with us for an agreed number of stud cattle in the first year, will be able to have an equal number of stud cattle bred by embryo transfer techniques in the second year at a reduced rate, reflecting our improved economies of scale. (see p. 17)
- • All recipient cows needed for breeding may be leased. You do not need to buy your own herd of recipient cows. Your capital is conserved.
- • All veterinary checks of the recipients, such as for being empty (i.e. not currently pregnant), fertile, and with acceptable pelvic floor measurement and cross-sectional shape, are carried out free of charge.
- • The suitability of each recipient is guaranteed by the leasing company, with any unsuitable recipients replaced free of charge.
- • The number of animals contracted for in the first year is guaranteed to be delivered by us.
- • For the following seven years, we will assist the breeder to grow their cattle, market them, show them when advisable and generally help to maximise their return. All fees, costs and outlays are agreed in advance.
- • We individually tailor breed plans to suit our clients. Advice as to breeding lines and suitable genetics is free of charge.
- • After the first two years, our management fees come only out of profits earned by our clients. No profits for you? No fees for us!''
A special incentive was offered this being the opportunity for investors to acquire an interest in the property in which the cattle breeding operations would be conducted. This interest was to be offered by way of registered prospectus in 1996.
16. The booklet then dealt with what was called ``The Finance Option''. Clients of ACM were said to have the option of investing their own funds in cattle breeding or using part of their own funds with the remainder being provided by a finance company willing to provide funds. That company was TEI Finance Proprietary Limited (TEI). In addition to a low rate of interest fixed for the term of the loan an investor would be able to borrow up to $4,600 per animal contracted - that is, up to 71.7 per cent of the amount to be invested. TEI also offered ACM's investors the benefits of limited recourse finance which meant that:
- • Repayments need only come from the investor's cattle breeding profits.
- • Repayments were limited to 50 per cent of the profits the investor made each year.
- • The lender could not look to the investor's other assets for repayment.
In order to obtain and keep these benefits of limited recourse finance the borrower had to
- • Pay the first year's interest in advance.
- • Authorise the Manager to pay 50 per cent of the profits to the Lender until the loan was repaid.
- • Not move livestock without first obtaining the Lender's written consent which should not unreasonably be withheld.
ACM recommended the finance option to its clients. As Ms Vincent accepted in cross examination she understood from the brochure that if she prepaid interest on the loan, repayments would only come out of the money made on the breeding program. The loan was therefore to be repaid out of the profits.
17. Under the heading ``Cash Flow and Projections'' diagrams were set out showing
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flow charts for years one and two for an investor. ``Cash Outlays'' for years one and two on a ``per cow'' basis were set out. In each of years one and two the amount for the lease of the recipient cow was to be paid to a company called Viking Investments Proprietary Limited (``Viking'') on behalf of the owner. The lease payment in each year was $300. Embryo costs in the first year were said to be $2,400 and in the second year $1,800. Total costs in the first year were $6,410 and in the second year $5,350. Breeders it was said could pay using their own funds or could use the finance facility provided by TEI. Up to $4,600 of the first year expenses could be borrowed from TEI and up to $3,600 of the second year expenses.18. The following page in the booklet showed ``Cash Flows and Projections - a 7 Year Example''. This page identified, as sources of income, embryo sales, bull and steer sales and cow and calf sales. It assumed no income for year one (30/6/96) and year two (30/6/97). It assumed income of $6,000 in year three (30/6/98), $8,000 in year four (30/6/99), $10,100 in year five (30/6/00), $10,200 in year six (30/6/01) and $12,400 in year seven (30/6/02). Expenses for the corresponding seven years were $6,410, $5,350, $5,089, $5,289, $5,499, $3,077 and $3,368. Year three was the first year for which a profit was estimated of $911 then year four $2,711, year five $4,601, year six $7,123 and year seven $9,032. The loan position would be reduced to nil by year seven. The income estimates were said to be based on a herd of ten bulls and ten cows grown from twenty leased recipient cows. They were divided by twenty to give an average income ``per cow''. Their quantum was derived from recent auction results discounted by 25 per cent. No income from semen sales was shown as this could vary widely. To that extent the income estimates were said to be understated. The expenses for years three to seven were said to be a guide only and would depend upon each investor's aims, preferences, culling rates and the extent (if any) to which use was made of Embryo Transplant techniques in those years ``and... many other factors''. The calculations as to the loan position assumed the uptake of the TEI package.
19. Details of ACM were given. It was said to have taken over the operations of Five Star Cattle Co Pty Ltd in April 1995 with two clients and contracts to grow 105 head of stud cattle. The first implants were done in May 1994. The first births occurred in February and March 1995. The company had a paid up capital of $200,000. It was described as ``... a Company of substance''. The directors were described thus:
``Peter Jacobsen, qualified Accountant with 24 years experience in Management Accounting, Tax Planning and Insolvency work. Peter has a background in rural accounting in the Upper Hunter Valley of New South Wales. He is experienced in the cost accounting and operation of abattoirs. Peter has had hands-on experience in the operation and management of a prime dairy herd since 1971.
Sally Jacobsen, a graduate of The Calrossy School in Tamworth and now a university under-graduate in Economics at Newcastle University, Sally is the Company Secretary. Since early childhood, Sally has been involved in dairying with particular emphasis on the birthing of calves and their management in the early stages of life.''
ACM's objective was to have 400 head under management by the end of 1995 at which time it was planned to transfer operations to the Tamworth area. Investors would be able to visit and inspect their animals on a Sunday. ACM asked for at least forty eight hours notice which would allow them to roster staff efficiently.
20. A Questions and Answers section came towards the end of the booklet. It was pointed out that the booklet was not a prospectus because it did not offer any ``pooling'' of interests. ACM was said to enter into agreements with individuals, companies, partnerships or trusts on a ``one to one'' basis. One question related to tax deductibility was in the following terms:
``Q. Is it true that my first and second year expenses are fully tax deductible?
A. Active Cattle Management Pty Limited is not qualified to give taxation advice and does not do so. You should consult your own advisers. Having said that, we believe all expenses are fully deductible provided you are engaged in the business of cattle breeding with the intention of making a profit. You are engaging us to assist you to do this. We make no apologies for making profits for our clients.
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Your advisers are welcome to contact us for specific references to various Taxation Rulings dealing with the deductibility of cattle breeding expenses.''
It is not in dispute that ACM, TEI and Viking were under the common ownership and control of Mr Jacobsen, although it does not appear that this was known to Ms Vincent.
21. Ms Vincent knew nothing about cattle when she first looked at the material provided by Mr Allen. She was impressed with the program set out in that material. She had a number of conversations about it with her accountant and read a lot of literature which he passed on to her. She said that by leasing three cows she would be able to breed six and over seven years could expect nearly $38,000 net profit. This was an amount which she described as conservatively projected by averaging auction sales and discounting it by 25 per cent. It also made provision for deaths of cattle. After reading the material she got in touch with the Australian Taxation Office on its general inquiry number and asked a number of questions in relation to the business. One of the questions which she put was the question set out in the booklet namely ``Is it true that my first and second year expenses are fully tax deductible?'' She said it was indicated that such expenses were deductible and that all income earned from the cattle would be taxable. She wanted to be sure about this so she could be confident about repaying the money she intended to borrow from her father. She was also told that travel and accommodation costs associated with visiting the farm could be claimed as deductions. She said that the Australian Taxation Office satisfied her concerns and she felt very comfortable with the cattle breeding business. She believed that the ACM project had great potential. She thought the income projections showed a worthwhile profit. She discussed them with her father whose judgment she trusted. Together they decided that the projections were realistic. She also discussed them with her partner and her partner's father. She considered other investments at the time but the cattle project stood out. She thought it was a winner and had a general awareness that Australia had a good track record in beef cattle production. She thought that she would get the projected return. She did not do any external checking of the ACM figures. She summarised the attractions of the project thus:-
- 1. It was affordable - She could borrow the money short term from her father and be in a position to pay him back from her tax refund;
- 2. It was an Australian primary industry project which she supported to enrich the country;
- 3. With the news in the media about Mad Cow Disease in Europe the idea of further development of our cattle market seemed to make good sense; and
- 4. Over the space of seven years the projected figures showed a good return for the three cows that would produce six offspring. This was the main reason she favoured this investment since it would contribute funds towards her future family's education.
She took three units because that was all she could afford in terms of the amount she would need to borrow and repay to her father if things did not work out.
22. Ms Vincent understood the offer from ACM to be as follows:
- 1. In consideration of the payment of $2,500 per cow of which $1,810 was payable to ACM and $690 payable to TEI, she would engage ACM to breed stud cattle for her, and
- 2. She agreed to have an equal number of stud cattle bred by Embryo Transfer technique in the second year at a reduced rate and upon that she agreed to pay ACM $1,810 per cow before 30 June 1995 and $1,750 per cow before 30 June 1996, and
- 3. She would borrow $24,600 in total from TEI which represented $4,600 per cow in the first year and $3,600 per cow in the second year to fund the breeding program.
She borrowed $10,000 from her father. She agreed in cross-examination that the tax refund to be expected from her investment would essentially cover that cash contribution. The fact that she had a loan to make up the rest of the investment which would only be repaid if the investment yielded a profit, gave her confidence in the program. She denied having regard to the fact that she would not be at risk financially if the program failed. She did not think at the time that it would fail.
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23. Ms Vincent decided to lease three animals, initially for a term of two years. She expected they would yield six offspring. She did not want to pool with other investors and never discussed that option with ACM. She said in cross-examination that she decided to keep her cattle as her property with a view to possible expansion of her herd over time. She was pressed in cross-examination with the projected cashflows which showed income and expenditure over a seven year period and the recipient cows being leased for the first five years. She maintained, however, that the five year lease was just an option. She would have viewed the herd in 1998 to determine which direction she was going to take. By 1998, she thought, she would be in a situation to decide the best breeding program. This did not sit comfortably with her primary position that it was the viability of the business as set out in the cashflow projections that persuaded her to make the investment. I find this aspect of her evidence unconvincing and suggestive of a reconstruction to argue her way out of an inconsistency between the agreements and the projections. It did not reflect her view at the time she entered the program.
24. Ms Vincent made no inquiries about the quality of the genetic material to be used. She accepted that the brochure indicated that the whole purpose of the program was to produce high quality cattle. She saw no need to make her own inquiries in that respect on that issue. Nor did she make any inquiries about the principals of ACM, Mr Jacobsen and his daughter, Sally. She said she accepted the contention in the brochure that the necessary staff would be employed.
25. As was pointed out to Ms Vincent in cross-examination, the Notes relating to the Cash Flows and Projections, as set out in the brochure, indicated that the income figures were ``based on a herd of ten bulls and ten cows grown from twenty leased recipient cows''. She said she had read the Notes before making her investment but did not take the projections to anyone to find out if they held good where only three recipient cows were leased. She made no independent inquiries about the number of leased cows being offered under the program. She could not recall how much land ACM had. Asked whether it was important for her to know whether the program could physically be delivered she said:
``My accountant had looked into it quite sincerely and he himself said he was investing into it. He is a gentleman who I'd known for about 10 years prior to this. I had confidence in his recommendation.''
26. Deficiencies in the brochure were pointed out in a report prepared for these proceedings by Neil Singleton who was appointed administrator of ACM and its associated companies in October 1998. He said, and I accept, that to enable a prudent investor to make an informed investment decision the brochure should have included:
- ``• The specialist expertise of the management team and employees in connection with the breeding operations;
- • The financial position of the management company;
- • The financial position of TEI;
- • An opinion from an independent and properly qualified practitioner in relation to the tax deductibility of management fees paid;
- • Details of the land and facilities acquired by the project to allow breeding operations to be conducted;
- • Evidence that the project had a herd of recipient cows and access to genetic material;
- • The project marketing strategy;
- • Greater detail concerning the projected income and expenditure figures and underlying assumptions.''
27. Ms Vincent is an intelligent person. She is a qualified secondary science teacher and also, as she described herself, ``a part time property developer''. However those attributes do not necessarily translate into an ability to know all the right questions to ask about a proposed investment. There are many examples of people of intelligence and skill in their ordinary spheres of activity who make poor or ill-considered decisions about investments or the acquisition or commencement of new businesses based upon assumptions that may not even be recognised. The omission to make inquiries into detailed aspects of the ACM program is not, of itself, fatal to the conclusion that she intended to derive assessable income from it.
28. On 19 June 1995, Ms Vincent entered into the following agreements:
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- 1. A Livestock Management and Services Agreement with ACM (the Management Agreement).
- 2. A Loan Agreement with TEI (the Loan Agreement).
- 3. A Livestock Lease Agreement with Viking (the Lease Agreement).
On the same day she wrote two cheques one of $5,430 for ACM and the other of $2,070 for TEI. As she understood the terms of the loan she was required to make two repayments of principal, one of $5,430 in the financial year ended 30 June 1995 and another of $5,250 in the financial year ended 30 June 1996. She was also required to pay $2,070 for interest in advance in the financial year ending 30 June 1995. Ms Vincent received a letter from ACM on 30 June acknowledging receipt of $19,230 being payment in full for the services set out in the Management Agreement. She also received letters from TEI acknowledging receipt of $2,070 and advising of the approval of her loan application.
29. Ms Vincent said that in determining the viability of the project she took into account the ability to claim tax deductions for the various expenses such as embryo costs, lease of recipient cows and the payment of management fees. However she said this was not the reason or the purpose for her decision to participate. The obtaining of a substantial profit was her main objective and the profit projections were the most important part of her assessment of the project. Had she not believed that it would be profitable she would not have invested and did not do so with the purpose of obtaining a tax benefit. She said in her affidavit that she recalled being very excited about her new investment and calling herself a cattle breeder. Later in July 1995 she received a letter dated 19 July from Viking acknowledging receipt of payment for the Livestock Lease and informing her that the recipient cows allocated to her were numbered A.016; A.044 and A.067.
30. In his report on the project which has already been mentioned the administrator, Mr Singleton, opined that the investment offered by ACM in 1995 was initially attractive to investors because:
``1. they obtained tax deductions for the value of management fees (and interest on loans in the first year) which produced a tax saving in excess of the cash monies paid assuming a top marginal tax rate. In Year 1, an investor could typically claim a deduction for $7,100 for each cow (management/lease fees $6,410 and prepaid interest $690) in consideration for a cash part payment of management fees ($1,810) and prepaid interest ($690) of $2,500; and
2. amounts borrowed from TEI Finance were in certain circumstances repayable only from profits generated from the sale of that particular investor's cattle.''
That observation was not a matter of expert opinion. It did no more than identify benefits of investing in the project which were obvious to any investor. It may be noted, in relation to the comment about tax deductions, that it assumed the investor was paying a top marginal tax rate. This was not the case for Ms Vincent. On the other hand I accept that at about the time Ms Vincent entered the project its principal, Mr Jacobsen, was marketing it to accountants and financial advisers by reference to its tax advantages. This appears from a number of documents which were produced as part of the agreed bundle comprising Exhibit 3. In particular there is a circular letter evidently sent to accountants in May 1995 under the letterhead of ``Jacobsen Partners, Management Accountants'' signed by Mr Jacobsen and promoting the project. That letter made reference to ``... incidental tax benefits for investors'', and to the deductibility of expenditure and the availability of limited recourse finance. It is apparent that Mr Jacobsen was marketing the project through accountants and others by reference, inter alia, to its tax benefits. That is not to say that, in any subjective sense, the tax benefit was Ms Vincent's primary purpose for entering into the project. In my opinion, despite all the features of the project that are so familiar to those who may have seen such schemes marketed over the years, it cannot be inferred that Ms Vincent would have viewed it with the jaded eye of such experience.
31. In my opinion, from Ms Vincent's perspective, the project in which she invested provided a low risk opportunity to earn income and to fund her initial investment out of the tax refund to be derived. She contemplated an involvement going beyond the two year period for which she leased the recipient cattle. She expected that she would be involved for the period contemplated by the projections. She did
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not address the possibility that the project might fail. I do not accept that she thought, at the time, that she would consider her options at the end of the two year period. It may be that she did not even advert to the fact that the initial leases were for two years only. Having said that, I accept that if she had been asked at the time what she would do at the end of the lease period and had thought about it, that would have been her answer.The Management Agreement
32. This agreement dated 19 June 1995, was made between Ms Vincent as ``the Owner'' and ACM as ``the Manager''. It recited, inter alia, that the owner was the Lessee of cows described in item 3 of the schedule to the agreement by what were said to be their ear tag numbers. These were referred to as ``Recipient Cows'' and identified in the schedule to the agreement by their ear tag numbers A.016; A.044 and A.067. ACM was appointed by Ms Vincent as the Manager ``of the Recipient Cows and their Progeny, for the Management Term'' (cl 1). The Management Term was a period of two years commencing on 19 June 1995 (cl 2). The Manager agreed to implant the recipient cows with full blood Poll Hereford embryos, test them within ninety days of implanting and confirm as them as ``Pregnancy Tested In Calf'' (cl 3). The Manager also agreed to depasture the Recipient Cows and Progeny on such areas of land as it might deem expedient and provide ``... during the Management Term complete and proper management and a high standard of animal husbandry for the Recipient Cows and Progeny'' (cl (b) and (c)). Various other obligations relating to the care of the animals were set out. It was also agreed, under cl 3(j), that the Manager would:
``(j) When requested by the Owner, make all necessary arrangements for the sale of any of the Progeny or Genetic Material therefrom. In consideration thereof, the manager shall be entitled to be remunerated at the rate of Ten Per Centum (10%) of the gross sales proceeds. The balance of the proceeds are to be paid to the Owner as provided herein.''
33. The number of progeny to be delivered pursuant to the agreement was set out in item 6 to the schedule. Three live full blood Poll Hereford calves were to be delivered to the owner within 40 weeks of the end of the first year of the agreement and a further three within 40 weeks of the end of the second year. Clause 7 of the agreement dealt with the fees payable to the Manager which were set out in item 5 of the schedule. The First and Second Years fees were each to be payable yearly in advance. The clause also provided that:
``Fees for subsequent periods each of twelve months commencing on the anniversary of the Commencement Date and the services to be provided therein shall be as determined and agreed upon by the Manager and the Owner or his Representative.''
Clause 8 then provided:
``8. Limitation Upon Fees to be Charged.
Payment of fees for any subsequent periods commencing on and from the second anniversary of the Commencement Date shall be made only out of income from the sale of Progeny and of Genetic Material therefrom. If the income in any twelve- month period is insufficient to reimburse the Manager his agreed fees, then the Manager will be required to accrue such fees until sufficient income has been derived. The Manager shall not be entitled to any interest on the fees so accrued.''
Clause 11 provided for a right of inspection on the part of the owner. Clause 12 dealt with ownership and control and provided that the manager would have no right or title to or interest in the progeny and would not at any time purport to encumber them. Ownership of the progeny would vest in the owner at the time of the birth of each animal. There was provision for management reports to be made to the owner ( cl 13) and a termination clause (cl 14).
The Loan Agreement
34. The Loan Agreement, also dated 19 June 1995, was made between Ms Vincent as the Borrower and TEI as the Lender. The agreement recited the existence of the Management Agreement. The Lender agreed to lend to the Borrower the total amount found by multiplying the amount, described as the First Advance Per Head in item 4 of the schedule, by the number of progeny to be delivered in the first twelve months of the Borrower's contract with the Manager as set out in item 6 of that contract. The amount so calculated was referred to as the First Principal Sum and was to be paid by the Lender upon the execution of the Loan Agreement. The amount of the First Advance
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Per Head was the sum of $4,600 per head of progeny in the first twelve months, a total of $13,800. The Second Advance Per Head was the sum of $3,600 contracted for in the second twelve months of the Management Agreement, a total of $10,800. The Borrower agreed to pay interest on the First Principal Sum at the rate of 18 per cent reduced to 15 per cent per annum if paid yearly in advance. The interest rate on the Second Principal Sum was nil (cl 3). The term of the loan was said to be for a period of seven years commencing on the date of the agreement (cl 4). The loan was secured by a first charge over all of the livestock bred by the Manager for and on behalf of the Borrower under the terms of the contract. The Borrower authorised and directed the Lender to remit the First and Second Principal Sums direct to the Manager (cls 7 and 8). The Borrower also authorised the Lender to accept and direct the Manager to remit to the Lender 50 per cent of all moneys due to the Borrower from time to time under the contract in partial discharge of the Borrower's obligations (cl 9). Under a Limitation of Recourse clause (cl 10) the personal liability of the borrower for the balance of the principal and all interest was removed subject to three conditions:- 1. The payment of interest in advance at the applicable rate as set out in clause 3 of the Loan Agreement.
- 2. The inclusion, in the Loan Agreement, of clause 9, giving Authority to remit part of profits.
- 3. Adherence at all times during its currency to clause 6 of the Loan Agreement which clause was the Borrower's undertaking not to move the livestock from the care of the Manager without first obtaining the written consent of the lender.
Subject to these three conditions the Lender agreed to limit its claims against the Borrower to 50 per cent of all amounts derived from or earned as the result of breeding operations and sales made during the first two years of the Management Agreement and all amounts derived from breeding operations and sales made during the following five years from progeny bred during the first two years of the contract.
The Lease Agreement
35. The Lease Agreement dated 19 June 1995 was made between Ms Vincent as Lessee and Viking as Lessor. The agreement recited that the Lessor was the owner of Recipient Cows identified in item 3 of the schedule. Those cows were described by the same ear tag numbers as applied to the cows the subject of the Management Agreement. Under the operative provisions the Lessor leased to the Lessee the Recipient Cows identified in item 3 of the schedule for the period of two years from 19 June 1995 with an option to extend for up to two additional periods each of a further six months (cls 1 and 3). Nothing in the agreement entitled the Lessor to any of the progeny of the Recipient Cows which progeny remained the sole property of the Lessee (cl 3). The leasing fees for the Recipient Cows were set out in item 6 of the schedule at $300 per head per annum due and payable yearly in advance. The fee for the six month extension of the term was $150. Clause 5 set out the Lessee's obligations which related to the care of the cows and substantially reflected the obligations of ACM as Manager under the Management Agreement.
Factual History - Post Investment Dealings
36. Ms Vincent received a first report letter from ACM on 30 September 1995. The content of the report was stated to be common to all of ACM's clients. Ms Vincent would be advised separately in writing in relation to the events of implantation, pregnancy and birth of calves. An implant schedule was set out in the letter which indicated that recipient cows allocated the tag numbers A.001 to A.125 would be implanted between December 1995 and January 1996. At or shortly after the time at which her embryo transfers were due, Ms Vincent made a number of telephone calls to Mr Jacobsen to find out what had happened. She was told there had been delays for various reasons. Everything was happening as it should but with a bit of a time lag.
37. It was not until 31 May 1996 that Ms Vincent was sent a notification from ACM that two of her recipient cows, A.016 and A.044, had been implanted. A further notice was sent to her on 14 June 1996 advising that A.067 had also been implanted. The notifications were on a standard form. The notes to the standard form in each case stated that the implantations had a success rate of between fifty per cent and sixty five per cent depending upon conditions. Each recipient was to be checked for pregnancy by an Embryo Transplant Veterinarian twelve weeks after implanting.
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38. The next communication which Ms Vincent received from ACM was a letter from 15 June advising that in accordance with the Management Agreement payment for the second year animals was due no later than 30 June 1996. The net amount claimed was $5,250. This was on the basis that the number of animals to be bred for her in 1996/1997 was three, the agreed cost of each animal was $5,350, making a total payable of $16,050. Loan funds already approved by TEI amounted to $10,800, leaving a net amount to be contributed in the sum of $5,250. She was asked to make a cheque out to ACM and ensure it reached that company no later than 30 June 1996. The letter stated that after that payment there were no more funds payable by her unless she specifically requested additional services.
39. On 25 June 1996, Ms Vincent paid $5,250 to ACM by cheque. Having paid her fees for year two, she did not receive any subsequent notification that the implants in her recipient cows were successful. She did not follow up after the implantation notices to find out whether any of her cows was pregnant. Nor did she enquire whether her cows had been implanted a second time as contemplated by the terms of the Management Agreement, which provided that each recipient cow would be implanted once in each of the twelve month contractual periods. She said that she had spoken to her accountant who told her things were progressing but slower than anticipated. She said she was quite unwell ``at this stage'' - which I take to be a reference to 1996 - and regarded implantation times as a management detail.
40. After paying her Second Year Fees in June 1996, Ms Vincent heard nothing specific from ACM save by way of newsletters containing general information. She made no attempt to contact ACM or Viking in 1997 about extending the lease on her recipient cows. She said she was going through a very difficult time. Her twelve month old child had contracted a serious illness and she had to focus on looking after him. She did not contact ACM to find out if her cows had given birth. She said in cross-examination that she assumed that all was happening as it should be happening. She made no contact with ACM in mid 1997 to make arrangements for future management. She said she was ``... fighting for my son's life''. It was put to Ms Vincent that what she did was to pay her initial cash contribution, claim her tax deductions and then walk away from the program. She denied this.
41. On 27 October 1998, Ms Vincent was sent a letter from KJ Group Pty Ltd advising that Peter Jacobsen died on 16 October 1997 and that the sole remaining director for the various companies in the group was his 22 year old daughter Sally. Ms Vincent said that after Mr Jacobsen died she had some communication from his daughter who took over his role as manager. She remembered becoming concerned about the poor drafting of one of the letters she received from Sally Jacobsen and made a couple of calls to her accountant to see if he knew what was going on. He gave her Sally Jacobsen's mobile telephone number. Ms Vincent tried to ring Ms Jacobsen on her mobile and her office number but nobody answered. After that the KJ Group began to press for the business to be placed under administration. On 23 October 1998, Neil Singleton of Sims Lockwood and Partners was appointed voluntary administrator of ACM, TEI and Viking.
42. ACM entered into a Deed of Company Arrangement. Mr Singleton was the deed administrator. On 12 May 2000, he wrote to Ms Vincent advising her that she was owed a total of $37,350. Under the Deed of Arrangement a first and final dividend to the investor class of unsecured creditors was to be declared on 30 June 2000. The dividend was to be made by way of issue of shares by Princess Park Estates. They would be issued pro rata for each $1 of debt for which a claim was admitted by the administrator.
Factual History - How the Project Worked
43. There was little direct evidence of the conduct of the ACM operation on the ground save what was given by Brendan Coonan. He was appointed by Peter Jacobsen as Stud Manager of the herd in August 1996 and employed by Viking in that capacity. He had experience and expertise in the breeding and management of Poll Hereford cattle and had done a course in artificial insemination. He accepted the description put to him in cross- examination that he was ``... the man in the paddock for taking care of the herd''. It is apparent from his evidence that he carried out his duties without any reference to which cattle were allocated to which investors. Mr Jacobsen and his office staff dealt with the investors,
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while he dealt with the herd. Nobody told him of the terms of agreements signed by the investors. He was not asked as stud manager to manage his breeding schedule or program by reference to anything which might be in agreements with them. He said:``... we were just to implant as many cows as we could.''
44. In relation to the twelve monthly breeding cycle contemplated by the Management Agreement he said:
``Well, the aim of a breeding program is to do that. To run a property efficiently, you need to get every cow to breed every 12 months.''
At the time that he was appointed the herd was about 700 strong. Implant Details in the computer data base indicated that the first implants had been performed in March 1996.
45. Mr Coonan described the breeding program in some detail in his affidavit. He said preparation would start a month ahead of the proposed implantations. He would select as recipients those cattle which were in the right phase of the breeding cycle. He had to check that they were ``cycling'' or coming into ``heat'' and that, if they already had a calf, the calf was old enough for them to breed again. Generally a cow will not breed until the calf is at least two months old. He would also need to check that the cow was not already pregnant and that it was in suitable condition.
46. Mr Coonan would organise the herd so that all the suitable recipients intended for implantation could be separated out into one ``mob''. The selected recipients would be injected with prostaglandin. This was designed to make them ``cycle'' or come into ``heat''. Ten days later they would receive a second prostaglandin injection designed to have them ``cycling'' together. Two days after this the cattle would be checked by observation of their behaviour to see when they were actually ``cycling''. At this stage he would check the cattle three times a day. When a cow went on to heat that would be recorded and arrangements would be made for the vet to arrive a week later to implant embryos. The implantation process would take about three days. Following implantation the recipients were left alone as a separate mob apart from being fed and watered. The vet would complete a certificate to confirm the transfer and Mr Coonan or one of the office staff would enter the certified details on to the data base at a later date.
47. Nine months after implantation, the mob due for calving would be put into a paddock and checked twice a day. A calf when born would be tagged and weighed. Calving would usually span a period of about three weeks. If a calf were born a decision would be made on whether to keep it for further breeding as an embryo donor or to sell it off. This would involve an assessment of its growth rate, constitution and type. The culling and sale of progeny of the herd was an ongoing process. A small number would be culled and sold when weaned. They were usually fattened and sold at about twelve months of age. Whatever cows did not come into calf around pregnancy testing time would also usually be rounded up and sold off. These would be about eighteen months old. After the other cows had calved, they would also be reassessed for further culling or sale. According to Mr Coonan this process was designed to select out inferior stock in order to ensure that the herd genetics were continually improving which in turn would give rise to improved offspring. Apart from his own observations, the vet would do a physical test to ensure everything was alright when undertaking the embryo implants. Defective cattle would be culled or sold.
48. When Mr Coonan started working for Viking in August 1996 the size of the herd was about 700 cows. There were also six pure bred ``herd'' bulls when he started. He purchased about 1,000 cows in the first three months of his employment. The herd grew reasonably quickly and at its peak it was about 3,000. Prior to the appointment of the administrator in October 1998 all but about 700 or 800 of the cows had been put through a recipient program. Some would have to be put through twice to try and get them in calf.
49. Mr Coonan said that a certain number of cows do not respond to drugs or accept an embryo. It would be unrealistic to assume that a one hundred per cent ``one for one'' cow to calving ratio could be achieved. In his experience a normal herd would probably display a forty per cent infertility or non take-up rate. The majority of embryos which he used were produced from Stud Poll Hereford cows. He also acquired some Red Angus and Charolais cows from different studs across the country. Viking was purchasing stud cows and
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flushing off their own embryos to use in the program. However some embryos were purchased from North America. About 400 were acquired from Canadian Livestock Services, but only 100 of those were implanted before the administration started. According to Mr Coonan, in the time that he was stud manager the operation bred very good cattle. This had generally been confirmed in the prices received for stock sales.50. Mr Coonan gave evidence of computer records relating to Ms Vincent's cows. He consulted the ACM computer data base and verified the allocation to her of cattle numbered A.016, A.044 and A.067. He referred to ``Current Matings Lists'' which were print-outs from the computer system showing their status in September 2000. These records, he said, indicated that A.016 was implanted three times, twice unsuccessfully, on 19 March and 19 July 1996, and again on 29 September 1998. He produced veterinary certificates for the implants. A calf, said to be from the implant of 29 September 1998 was born on 26 June 1999. The cow A.044 was culled without being implanted. According to Mr Coonan, this suggested that it had not responded to the embryo transplant drugs. There was documentation to indicate that work was performed on the cow. A.067 was implanted four times, on 19 July 1996 (unsuccessful), 18 November 1996 (successful), 4 February 1998 (unsuccessful) and 28 September 1998 said to be successful. The calf attributed to the implant made in November 1996 was said to have been born on 6 August 1997. The second calf was said to have been born on 10 July 1999. The computer records, according to Mr Coonan, indicated that Ms Vincent's cattle produced three offspring. They did not establish however that the calves said to have been produced by Ms Vincent's cattle actually resulted from their implantation.
51. The reliability of the records relied upon by Mr Coonan is questionable in light of the evidence of Mr Neil Singleton who was appointed as administrator of ACM and its associated companies in October 1998. Mr Singleton's review of the Group's records found documentary evidence of only 358 embryo progeny born in the period 30 June 1995 to 30 June 1997 as against obligations to investors to provide 5,738 progeny. He also could find a record of only one calf attributed to Ms Vincent's cattle, that being a calf designated S.180 born on 6 August 1997 to the cow A.067.
52. There was evidence of manipulation of the records by ACM staff. A memorandum dated 13 May 1998 from one of the ACM office staff, Sharon Gillmore, to Sally Jacobsen, indicated that calves which had been purchased by Viking with its donor cattle were allocated to long standing investors, the Snabels, as though produced by their own cows. The Snabels had signed up for twenty cattle in June 1994 and a further twenty head as second year cows. The memorandum was objected to on grounds of relevance. In my opinion, however, it may be considered in conjunction with the other evidence from Mr Singleton which raises a question about the reliability of records kept by ACM generally.
53. There was also documentary evidence which indicated in May 1998 that a cow belonging to another investor, Mr Corkhill, had been implanted unsuccessfully three times then put in a paddock with a bull which still did not result in any pregnancy so she was culled. Another unsuccessful recipient was paddocked with a bull and it was expected would produce a commercial calf. Mr Coonan accepted that if Mr Corkhill had signed up for a stud breeding program he should not have been getting a commercial calf. He commented that when the commercial cows were purchased they were usually pregnant or had calves at foot so that calves were commercial before they joined the program.
54. In my opinion I can draw no inference, on the balance of probabilities, that more than one of the progeny attributed to Ms Vincent's cows in the records referred to by Mr Coonan were in fact derived from them and as a result of embryo implantation. In so saying, I do not reflect upon his credibility generally but rather upon the reliability of the records to which he referred. He had not, and did not, claim any direct knowledge of her cattle and their performance. As already noted, he managed the herd as a whole. There is an indication in the memorandum of 13 May 1998 that he was involved in the allocation of purchased calves as offspring of the Snabels' cows. He said in cross-examination that he was not involved in that allocation but rather in providing information about the number of cows on the ground. I would not consider the memorandum
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a proper basis upon which to reject that evidence without the testimony of its author.55. Mr Coonan was referred in cross- examination to a flow chart attached to a report prepared by Ian McMichael, an agricultural consultant, about the viability of the ACM project. The flow chart was entitled ``Events Timetable'' and related to the production of offspring pursuant to agreements made between ACM and Ms Vincent. It showed the production schedule which would have to be met for delivery of six progeny from three cows over two years and forty weeks. Mr Coonan thought it quite ``close'' as a best case scenario. I take it from his response that he accepted the production schedule set out as broadly correctly reflecting what would have to be done to meet ACM's commitment to Ms Vincent.
56. The Events Timetable commenced with signing of contracts in June 1995, and proceeded to implantation in September, birth of the first calves in June 1996 and their weaning in March 1997. Embryos would be collected from heifers in September to December 1997 and stored for sale. Bulls and culled heifers and embryos would be sold in March 1998. These further calves would be born in January 1997 and reared with the recipient mothers until weaning in March 1998 and sale of bulls and embryos in March 1999. It was stated by way of notation to the Events Timetable that it gave an outline of a best case scenario. The low numbers of cattle made it difficult to allow for losses after birth. Any death of a calf after birth would have a major effect on the financial results.
57. In general I accept Mr Coonan's evidence which was not seriously challenged, of the way in which he managed the implantation and culling processes. It is apparent that he managed the herd as a whole and did not have regard to, nor was required to have regard to, agreements between ACM or Viking and the investors.
The Administrator and the Deed of Arrangement
58. Neil Geoffrey Singleton is a chartered accountant and a partner in the firm of Sims Lockwood which specialises in business recovery, reconstruction and insolvency services. On 23 October 1998, he accepted appointments to act as administrator of ACM and associated companies being TEI, Viking, Active Cattle Management (No 2) Pty Ltd, Five Star Cattle Co Pty Ltd, Princess Park Estates Ltd, Roucam Pty Ltd, Tax Efficient Project Sales Pty Ltd and Five Star Brokerage Pty Ltd. This appointment was evidently by resolution of the directors of those companies which I infer had all effectively been under the control of Mr Jacobsen.
59. From his examination of company and accounting records his staff identified and he was satisfied, that about 427 individuals had entered into agreements with and made payments to ACM in association with the Active Cattle Project at Tamworth. The principal assets of ACM were amounts due to it by related companies, TEI and Roucam. There was no evidence that the money had actually been paid to ACM. The amounts due to ACM by TEI and Roucam comprised the aggregate of the amounts which TEI contracted to provide to ACM under the terms of the loan agreements between the investors and TEI, that being in each case the balance of the management fees due by each investor.
60. Late in October 1998, Mr Singleton sent a common form letter to the various investors and other potential creditors. In that letter he advised that he was currently undertaking an assessment of the financial position of the companies and the status of the agreements with the investors. His investigations indicated that ACM had not lodged any income tax returns. The Commissioner of Taxation issued notices of assessment of income tax and lodged proofs of debt totalling $9.227 million in respect of TEI, ACM and Five Star Cattle Co. The income tax assessed was calculated on the basis of the draft financial accounts. ACM's assessable income included the amount it was entitled to receive from the participants for management fees due to be advanced on their behalf by TEI.
61. Creditors of the companies under administration passed resolutions in December 1998 and January 1999 pursuant to s 439C of the Corporations Law that the companies under administration execute a Deed of Company Arrangement. This was substantially in the form of a deed referred to in a resolution proposed by the directors. Mr Singleton was to be the administrator of the arrangement. A Deed of Arrangement was executed between him and the companies on 11 January 1999. The deed referred to two classes of creditors. ``Investor Creditors'' was defined as any
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creditor with an admitted claim arising out of the breach by any of the companies of an agreement relating to the management of a cattle breeding enterprise, the provision of finance in respect thereof or an indemnity relating to finance in respect thereof. ``Viking Creditors'' meant a creditor of Viking. The object of the Arrangement was described in cl 9.1 of the Deed thus:``... to enable the Viking Creditors to be paid the dividend, and for the Investor Creditors to be issued with shares, and for the employees to continue in employmen,t and thereafter allow the Deed to terminate, and allow Princess Park Estates to carry on the business of cattle breeding.''
62. A meeting of creditors on 28 February 2000 approved a variation of the Deed so that payments of entitlements to Non Viking Creditors would be made by way of issue of shares by Princess Park Estates to each Non Viking Creditor, the shares to be issued pro rata for each $1 debt for which a claim was admitted by the administrator. The term ``Non Viking Creditor'' was defined as ``... any Investor Creditor and the Deputy Commissioner of Taxation''. According to Mr Singleton's affidavit evidence the creditors approved further variations in June 2000 whereby, among other things, the Commissioner of Taxation was accepted as a creditor of the companies for the full amount of the tax debt claimed.
63. On 12 May 2000, Mr Singleton wrote to Ms Vincent, (under her maiden name Clitheroe) advising that the records of ACM indicated that she was owed an amount of $37,350 calculated as follows:
Year 1 fees paid $ 5,430
Advance interest paid $ 2,070
Loan Indemnity Fees --
September interest paid --
Year 2 fees paid $ 5,250
Amount financed $24,600
-------
Total $37,350
Ms Vincent was invited to complete a proof of debt in that amount and return it to the administrator's office if she agreed with the calculation. She was informed that her claim would be admitted for that amount. Mr Singleton's records indicate that Ms Vincent subsequently lodged a proof of debt in the amount of $37,350 and was thereafter issued a share certificate for $37,350 ordinary shares in Princess Park Estate as evidenced by a share certificate dated 31 October 2000 which was annexed to his affidavit.
64. Following reconstruction of the group, according to Mr Singleton, the remaining assets including cattle were sold.
The Viability of the Project
65. A report on the viability of the cattle breeding project during the period 1995-1998 was commissioned from Mr Singleton by the Australian Taxation Office. He considered the issue of commercial viability in terms of the following question:
``Would the project, as it was proposed to be established and operated, likely achieve the outcomes incorporated in the promotional material provided to prospective investors?''
In his opinion the commercial success of the project as outlined in the material provided to investors was predicated upon:
``i) the ability of the project to provide the requisite expertise and initial infrastructure assets to support the breeding operations such as land and recipient cows;
ii) the availability of sufficient capital to meet the project expenses which were detailed in the promotional material, particularly in the initial years when there was no income from cattle or embryo sales; and
iii) a high level of breeding success and profitable trading in cattle and genetic material in Years 3-7 which would provide funding of management costs during those years.''
66. Tangible assets of the group companies as at 30 June 1995 were nominal. Group records disclosed that management fees payable by investors which were, according to the promotional brochures, to be applied to breeding and herd management, were utilised in part to procure the project's underlying capital assets by way of land, recipient cattle, plant and equipment. The project's business model was based upon the receipt of management fees from investors for the first two years and thereafter from trading in livestock and embryos. The initial management fees were to be funded from two sources, namely the investors and TEI which was controlled by the project's principals. A review of the available accounting records and bank accounts operated
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by TEI during the period 1996 to 1998 disclosed no evidence that it advanced any funds pursuant to the loan agreements with investors for the benefit of the project. Nor was there any evidence that TEI had made any attempt to access any external facilities for that purpose or that it had the ability to source them.67. During the years ended 30 June 1995, 30 June 1996 and 30 June 1997 the Group entered into agreements with investors to produce 5,738 progeny. The project fell a long way short of meeting its primary obligations to investors during that time. There was documentary evidence that only 358 embryo transfer progeny were born during that period. Despite the limitations of the information in support of the business model Mr Singleton was of the opinion that the project did not meet its obligations and would have continued to fall short in the absence of adequate capital to fund the breeding operations. He was of the opinion that the project could not be considered to be commercially viable.
68. The preceding outline of his conclusions is taken from his Executive Summary. I accept those conclusions. Nothing in his evidence in cross-examination detracted from them. Nor were they otherwise contradicted. Moreover they were consistent with the views of another expert witness, Mr McMichael, which are referred to below. In reaching his conclusion that the project was not commercially viable, Mr Singleton did not consider the validity or value of tax deductions which may have been available to individual investors as he did not believe them to be relevant to project viability.
69. At the time he assumed control of the business operations of the ACM Group Mr Singleton found that there were some 3,200 head of cattle leased by the Group. There were about eight employees at the time of his appointment who were involved in office and farm management. The reasons for the failure of the Group included the lack of capital to carry out operations at a level commensurate with the commitments entered into by the investors particularly as a result of the inability of TEI to provide funds pursuant to the Loan Agreement. The death of Mr Jacobsen and adverse publicity associated with the investigation of the company by the Australian Taxation Office were also accepted as reasons. In my opinion, however, Mr Singleton's report clearly establishes that want of operating capital was the primary cause of the project's failure.
70. A further report on the viability of the project was commissioned by the Australian Taxation Office from Ian McMichael, an agricultural consultant. He described the breeding outlines and program set out in the ACM brochure as ``... long on rhetoric and short on fact''. In his opinion no serious livestock or stud cattle breeder would avail themselves of the program. The physical breeding program was feasible but:
- (a) There was no outline of the genetics to be used. The supply, purchase and sale of the genetic material are the main driver of the success of such a program. Animals that have an unidentified breeding background have a lower value.
- (b) There was no physical breeding projection outline on which the cash flow figures were based.
- (c) The background experience and qualifications of personnel carrying out the programs were not mentioned.
- (d) The outline of ``Sales and Marketing - The Key to Success'' offered no names of the personnel or their experience and qualifications, nor the success factors and methodology necessary to achieve a quality outcome.
- (e) The financial projections were poor in detail relating to sales outcome and expensive in the costing.
- (f) Drawing together a reasonable production outcome for Ms Vincent and a financial outcome after the period of the Management Agreement plus the Lease Agreement ceasing - it would appear there was a deficit of $22,000 offset by the ownership of two heifer calves worth approximately $4,400 at the end of the period. This was not a viable outcome.
Mr McMichael reviewed the viability of the project from Ms Vincent's perspective on the assumption that her involvement was limited to two years plus the forty extra weeks to cover completion of the second breeding and selling cycle. The projections provided by ACM however showed no returns for Year Three. Nothing in cross-examination detracted from these opinions, including the conclusion that the project was not viable. I accept his conclusions.
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Factual History - Returns, Assessments, Part IVA Determinations and Amended Assessments
71. In her income tax return for the year ended 30 June 1995, Ms Vincent described her main business activity as Stud Cattle Breeding. She disclosed a nil business income and total expenses of $21,300 comprising $2,070 by way of prepaid interest and $19,230 as ``all other expenses''. The latter sum was made up of First Year Fees for the three recipient cows calculated at $6,410 per cow. As appears from Item 5 in the schedule to the Management Agreement that sum comprised the following:
Lease of Recipient Cow $ 300
Embryo Costs $2,400
Implantation Charges $ 600
Veterinary Costs of implantations $ 380
Labour $ 550
Transport $ 120
Insurance $ 145
Agistment $ 520
Special Feeding Costs $ 377
Selection expenses $ 135
Share of farm overheads $ 378
Management fees $ 375
Veterinary services $ 130
------
Total $6,410
Of that sum $4,600 was to be provided by TEI as the First Advance per head referred to in the Loan Agreement. Her business loss was therefore declared at $21,300. $13,8000 of that reflected the amount which was supposed to have been advanced by TEI to ACM.
72 For the year ended 30 June 1996, Ms Vincent again disclosed a business income of nil and total expenses of $16,050. The sum of $16,050 was made up of Second Year Fees of $5,350 for each recipient cow. $10,800 of that reflected the amount which was supposed to have been advanced by TEI to ACM. As appears from Item 5 in the schedule to the Management Agreement the sum of $5,350, being the Second Year Fees, comprised:
Lease of Recipient Cow $ 300
Embryo Costs $1,800
Implantation Charges $ 300
Veterinary costs of implantations $ 260
Labour $ 400
Transport $ 100
Insurance $ 110
Agistment $ 500
Special feeding costs $ 300
Selection expenses $ 107
Share of farm overheads $ 378
Management fees $ 290
Registration fees and royalties $ 375
Veterinary services $ 130
------
Total $5,350
Of that sum $3,600 was to be provided by TEI as the Second Advance per head under the Loan Agreement. Her business loss was therefore declared at $16,050.
73. In her annual return for 1995, Ms Vincent declared income from other sources of $38,893. Her income from other sources in the year ended 30 June 1996 was $42,057. The deductions she claimed in relation to the ACM project reduced her taxable income in each of those years to $17,593 and $26,007 respectively. The tax payable was reduced in 1995 from $9,870.49 to $2,534.90 and in 1996 from $10,254.29 to $4,708.90. Notices of assessment for the years ended 30 June 1995 and 30 June 1996 issued on 25 August 1995 and 30 July 1996 respectively. Ms Vincent was sent refund cheques of $7,988.35 and $7,081.20 respectively.
74. On 8 December 1999, an officer of the Australian Taxation Office, Colin Shawcross, signed determinations under s 177F of the Income Tax Assessment Act 1936 relating to the years of income ended 30 June 1995 and 1996 respectively. The determination for 1995 was in the following terms:
``DETERMINATION MADE BY THE COMMISSIONER PURSUANT TO SECTION 177F OF PART IVA OF THE INCOME TAX ASSESSMENT ACT, 1936 (THE ACT) THAT:
I, Colin Shawcross Director of Small Business Executive Level 2, hereby determine pursuant to s 177F of the Income Tax Assessment Act 1936 (The Act) that:
the amount of $21,300 (being the whole of the tax benefit that is referable to a deduction or part of a deduction that has been allowed in Stud Cattle Breeding Project to Julie K Vincent Tax File No [ omitted] (the `taxpayer')) for the year of income ended 30 June 1995 shall not be allowable to the Taxpayer in the year of income ended 30 June 1995.
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Dated the 8 day of December 1999.
................................................
Colin Shawcross
DIRECTOR OF SMALL BUSINESS CANNINGTON
POSITION NO 460017''
A like notice signed on the same day for the year ended 30 June 1996 disallowed the sum of $16,050. Amended assessments issued on 10 December 1999 for the year ended 30 June 1995 and 1996 specifying as the sums due for payment, $11,140 and $18,962.50 respectively.
75. Objections against the amended assessments were lodged in February 2000. Both objections were disallowed on 23 November 2000. Notices of appeal against the disallowance were filed in this Court on 27 November 2000 pursuant to s 14ZZ(a) of the Taxation Administration Act 1953.
76. Ms Vincent received a letter from the Commissioner of Taxation, through her tax agent, dated 14 September 2001 advising her that a new determination under Part IVA of the Income Tax Assessment Act had been made and that she would soon be issued with a new amended assessment for the year ended 30 June 1995. The new amended assessment was to be issued as a precaution. The letter informed her that the Australian Tax Office had been advised that an administrative error may have occurred in the processing of the Part IVA determination connected with the earlier amended assessment. The letter stated that the new assessment had no affect on her tax debt. She was asked to sign a form of objection attached to the letter which asserted a wish to object to the new amended assessment on the same grounds as her first amended assessment for the year ended 30 June 1995. She received the new Notice of Amended Assessment on or about 30 September 1997. It was dated 17 September 1997 and asserted an amount payable of $8,670.85 including $733.55 by way of penalty and $3,071.57 by way of interest. The new Part IVA determination dated 14 September 2001 which was attached to the letter was in the following terms:
``Determination made pursuant to section 177F of Part IVA
Of the Income Tax Assessment Act 1936
I, Neil Mann, Deputy Commissioner, in the exercise of the powers and functions delegated to me by the Commissioner of Taxation by instrument of delegation signed and dated on 1 February 2001 determine under paragraph 177F(1)(b) of the Income Tax Assessment Act 1936 (the Act) that the amount of $21,300 being a tax benefit that is referable to a deduction being allowable to Mrs Julie Vincent, TFN [omitted] (the taxpayer) for the year of income ended 30 June 1995 shall not be allowable to the taxpayer in relation to that year of income.
Dated the 14th day of September 2001
Neil Mann pp Marina Dolevski
Deputy Commissioner''
The present proceedings relate to the first amended assessments.
Factual History - Mr Shawcross' Authority to Make a Part IVA Determination
77. There was a question, reflected in the decision to make fresh Part IVA determinations, about the authority of Mr Shawcross to make the original determinations. Factual aspects were addressed in the affidavit of Stephen Chapman who, prior to 1 March 1999, held the office of Deputy Commissioner of Taxation - Withholding and Indirect Taxes. His evidence was not challenged and I accept it.
78. Mr Chapman said that from 1 March 1999 to 31 December 1999 he was directed by the Commissioner to perform the duties of Deputy Commissioner of Taxation - Small Business. On 1 March 1999 the Commissioner signed a general delegation under the Tax Administration Act 1953 delegating to the person holding the office of Deputy Commissioner of Taxation - Small Business Program, powers and functions of the Commissioner under the Income Tax Assessment Act. These included the power to make a determination under Part IVA.
79. Mr Chapman in turn made an Instrument of Authorisation authorising several officers in the ATO's Small Business Program to exercise the powers and functions delegated to him These included the power to make determinations under Part IVA of the Income Tax Assessment Act. Mr Colin Shawcross was a member of the staff covered by that authorisation.
The Pleadings
80. In her statement of claim filed in these proceedings, Ms Vincent says that she entered
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into the ACM program in June 1995 with the intention, and for the purpose of gaining or producing assessable income or carrying on a business. The three agreements with ACM, TEI and Viking are particularised. The payments required under the agreements and made pursuant to them are set out. Ms Vincent says that at all relevant times she held a belief and expectation that the income she would derive from the arrangement entered into pursuant to the agreements would exceed the outgoings paid and/or incurred by her in connection with the project. Her purpose in entering the agreements and incurring liabilities and making the payments was to gain, produce or derive assessable income. The management fees, rent and interest paid in the 1995 and 1996 years were said to be losses or outgoings incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for that purpose. The 1995 and 1996 payments are therefore said to have been allowable deductions under s 51(1) for the years in which they were made. The embryos are said not to have been trading stock so that s 51(2A) has no application. Ms Vincent denies that she obtained a tax benefit as defined in s 177C of the Income Tax Assessment Act in either the 1995 year or the 1996 year in respect of the project or any part of the project. She pleads in the alternative that if she did obtain a tax benefit in connection with a scheme as contemplated by s 177D(a) it could not be concluded that, having regard to the matters referred to in s 177D(b) she entered into or carried out any relevant scheme for the dominant purpose of obtaining a tax benefit. In the alternative, if it could properly be concluded that she did enter into or carry out a scheme for that dominant purpose, the Commissioner did not or did not properly exercise his discretion under s 177F of the Act and accordingly any purported determination under that section was invalid. Further, or in the alternative, it was said the Commissioner did not make any lawful determination under s 177F.81. The amended assessments are then pleaded. The amended assessment issued in respect of the 1995 year is said to have been issued outside the four year time limit imposed by s 170(2)(b)(ii) of the Act and is said to be invalid to the extent that it purports to rely upon provisions of the Act other than Part IVA. The objections to the amended assessments and the disallowance of the objections is also pleaded.
82. The Commissioner's response denies much of the applicant's pleading. It asserts that the applicant did obtain a tax benefit in connection with a scheme as contemplated by s 177D(a) of the Act. The Commissioner denies the claimed entitlement to a deduction pursuant to s 51(1) in the 1995 and 1996 years. He asserts that the agreements referred to in the statement of claim were shams. He denies the deductibility of the payments of $21,300 and $16,050 under s 51(1) of the Act. He seeks to characterise the payments as outgoings of a capital or of a capital, private or domestic nature and, in the alternative, says that s 51(2A) of the Act operated to disallow the whole or part of the amount in each of the two years in question.
83. In the alternative Part IVA is relied upon to support the contention that the sums of $21,300 and $16,050 were not allowable deductions for the 1995 and 1996 years. He asserts that if Ms Vincent made the agreements referred to in par 1 of the statement of claim their making and the steps and transactions carried out pursuant to them constituted a scheme within the meaning of s 177A. The claimed deductions were ``tax benefits'' which Ms Vincent obtained in connection with the scheme within the meaning of s 177C(1) and s 177D(a). Moreover, having regard to the matters referred to in s 177D(b) of the Act it would be concluded that the person or one of the persons including Ms Vincent who entered into or carried out the scheme or a part of the scheme did so for the sole or dominant purpose of enabling her to obtain the deductions in the two relevant years.
84. The Commissioner also asserts that it made and was authorised to make the Part IVA determinations. In addition, and in the alternative, it is asserted that Ms Vincent is liable to pay by way of interest and penalty the amounts of interest and additional tax included in the amended assessments.
Statutory Framework
85. Section 51 of the Income Tax Assessment Act 1936 (Cth) provides in subss (1) and (2):
``51(1) All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a
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business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income....
51(2) Expenditure incurred or deemed to have been incurred in the purchase of stock used by the taxpayer as trading stock shall be deemed not to be an outgoing of capital or of a capital nature.''
86. The Commissioner in this case relies upon s 51 and also upon Part IVA of the Income Tax Assessment Act. That Part is concerned with ``schemes'' broadly defined in s 177A(1) as:
``(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and
(b) any scheme, plan, proposal, action, course of action or course of conduct;''
The class of scheme to which Part IVA applies is defined in s 177D:
``177D This Part applies to any scheme that has been or is entered into after 27 May 1981, and to any scheme that has been or is carried out or commenced to be carried out after that date (other than a scheme that was entered into on or before that date), whether the scheme has been or is entered into or carried out in Australia or outside Australia or partly in Australia and partly outside Australia, where-
- (a) a taxpayer (in this section referred to as the `relevant taxpayer' ) has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and
- (b) having regard to-
- (i) the manner in which the scheme was entered into or carried out;
- (ii) the form and substance of the scheme;
- (iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;
- (iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;
- (v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;
- (vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;
- (vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and
- (viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi),
it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers).''
The reference to ``purpose'' must be read with the provisions of s 177A(5) which provides:
``177A(5) A reference in this Part to a scheme or a part of a scheme being entered into or carried out by a person for a particular purpose shall be read as including a reference to the scheme or the part of the scheme being entered into or carried out by the person for 2 or more purposes of which that particular purpose is the dominant purpose.''
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87. The definition of ``obtaining by a taxpayer of a tax benefit in connection with a scheme'' is to be found in s 177C. Relevantly that provides:
``177C(1) Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to-
- ...
- (b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out; or''
88. Section 177F, relating to cancellation of tax benefits by the Commissioner, as it stood at the time of the determinations relied upon in these proceedings was, in the relevant parts, in the following terms:
``177F(1) Where a tax benefit has been obtained, or would but for this section be obtained, by a taxpayer in connection with a scheme to which this Part applies, the Commissioner may-
- ...
- (b) in the case of a tax benefit that is referable to a deduction or a part of a deduction being allowable to the taxpayer in relation to a year of income - determine that the whole or a part of the deduction or of the part of the deduction, as the case may be, shall not be allowable to the taxpayer in relation to that year of income; or
- ...
and, where the Commissioner makes such a determination, he shall take such action as he considers necessary to give effect to that determination.''
89. Amendment of assessments pursuant to determinations is covered by s 177G:
``177G(1) Nothing in section 170 prevents the amendment of an assessment at any time before the expiration of 6 years after the date on which tax became due and payable under the assessment if the amendment is for the purposes of giving effect to subsection 177F(1).
177G(2) Nothing in section 170 prevents the amendment of an assessment at any time if the amendment is for the purpose of giving effect to subsection 177F(3).''
The Issues
90. The principal issues for determination in this case are:
- 1. For the 1995 year - whether Part IVA of the Act operates to disallow the claimed deduction of $21,300. No question arises as to whether the amounts claimed were allowable as deductions for the 1995 year. It is conceded by the Commissioner that the period during which he was permitted to amend the applicant's assessment for the 1995 year, other than under Part IVA, expired before the amended assessment was issued.
- 2. Whether for the 1996 year the business loss of $16,050 claimed was an allowable deduction pursuant to s 51(1).
- 3. If the amount of $16,050 claimed as a business loss for the 1996 year was deductible pursuant to s 51(1) did Part IVA operate to disallow that deduction.
Whether the 1996 Business Losses were Allowable Deductions under section 51(1)
91. The question of deductibility under s 51(1) is logically anterior to the question of disallowance under Part IVA. If there is no deduction there is no tax benefit and therefore nothing upon which Part IVA can operate. It is therefore convenient to deal with the question of deductibility first even thought it arises only in respect of the 1996 year. The question whether Part IVA applies to disallow Ms Vincent's claimed losses applies to both 1995 and 1996.
92. The question whether the Second Year Fees were allowable deductions under s 51(1) requires consideration of the first limb of that subsection. To establish deductibility under the first limb it must be shown that the losses or outgoings claimed ``... incurred in gaining or producing... assessable income''. To satisfy that condition it is sufficient that the expenditure be made in the given year or accounting period and that it be incidental and relevant to the operations or activities regularly carried on for the production of income -
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Ronpibon Tin NL & Tongkah Compound NL v FC of T (1949) 8 ATD 431 at 435-436; (1949) 78 CLR 47 at 56-57;
FC of T v Snowden &
Lunney v FC of T (1958) 11 ATD 404 at 411; (1957-1958) 100 CLR 478 at 496-497. The motive and purpose of the expenditure may have evidentiary significance and, in some cases, may decide its characterisation. They are not determinants of deductibility -
Magna Alloys & Research Pty Ltd v FC of T 80 ATC 4542 at 4549 and 4558-4559; (1980) 33 ALR 213 at 222 and 234-235;
Fletcher & Ors v FC of T 91 ATC 4950 at 4957; (1991) 173 CLR 1 at 17. In
John v FC of T 89 ATC 4101 at 4105; (1989) 166 CLR 417 at 426-427 it was said that:
``It is readily understandable that, if no income has been gained or produced and a question arises as to whether the occasion would be expected to produce assessable income, consideration of the purpose for which the expenditure was outlaid might not be wholly irrelevant.''
The broad approach taken by the authorities to the connection between losses and outgoings in the gaining of income allow that expenditure may be deductible although related only to income generated in years other than that in which it was incurred -
FC of T v Finn (1961) 12 ATD 348 at 351; (1961) 106 CLR 60 at 68; Ronpibon Tin (supra) at ATD 435; CLR 56; Snowden & Willson Pty Ltd (supra) at ATD 464; CLR 436;
John Fairfax and Sons Pty Ltd v FC of T (1959) 11 ATD 510 at 511 and 518; (1959) 101 CLR 30 at 35 and 46 and Fletcher (supra) at ATC 4957; CLR 16. More recently in
Steele v DFC of T 99 ATC 4242 at 4251; (1999) 197 CLR 459 at 475 it was said:
``... The temporal relationship between the incurring of an outgoing and the actual or projected receipt of income may be one of a number of facts relevant to a judgment as to whether the necessary connection might, in a given case, exist, but contemporaneity is not legally essential and whether it is factually important may depend upon the circumstances of the case.''
The existence of a disproportion between the outgoing and the income to be derived may raise a question of characterisation which requires consideration of the objectives and advantages which the taxpayer sought in making the outgoing. In that case what is needed is a commonsense or practical weighing of all the factors - Fletcher (supra) at ATC 4957; CLR 18-19. That is to say, beyond the simple case in which assessable income exceeds the outgoing, there is an evaluative, and possibly multi-factorial, judgment to be made in determining the character of the outgoing for the purposes of s 51(1).
93. The Management Agreement under which Ms Vincent paid the Second Year Fees was for a term of two years - the ``Management Term''. It involved the assumption by ACM of obligations with respect to implantation of embryos, delivery of progeny and sale which extended out to a period of forty weeks after the end of the second year. The Lease Agreement with Viking was also for a term of two years. The content of management services and the fees payable for them after the expiry of the two year Management Term was ``... to be determined and agreed upon by the Manager and the Owner or his representative''. The lease of recipient cows was subject to options to extend for up to two additional terms of six months each. It was clear however, from the cash flow projections in the ACM brochure, that Ms Vincent was not to expect any profit from the project before Year 3. The Commissioner submitted, on the basis of the formal commitment of two years made by Ms Vincent, that the expenditure she incurred could not be expected to produce any assessable income.
94. In my opinion the disconformity between the terms of the Management Agreement and the Lease Agreement on the one hand and the seven year timeframes of the cash flow projections and the Loan Agreement on the other, is not, of itself, fatal to the deductibility of the Second Year Fees. The duration of Ms Vincent's prospective and intended involvement was not limited by the terms of the agreements. As I have found, she contemplated continuing beyond the two year period for which she leased the recipient cows. She initially expected that she would be involved for the period contemplated by the projections. She did not consider the possibility that the project might fail. The fact that she had effectively an option to terminate her involvement after two years does not affect that position.
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95. It was further argued by the Commissioner that the three recipient cows which Ms Vincent proposed to lease could not produce sufficient progeny or volume of genetic material to earn income. Reliance was placed in this respect on Mr McMichael's evidence and, in particular, the Events Timetable which has been mentioned earlier in these reasons and which appears as Table 2 to his report. As is evident from the report however, Table 2 was directed to the viability of Ms Vincent's investment on the assumption that it was to be assessed over the period of two years. What he said in this respect in his report was:
``Drawing together a reasonable outcome for Ms Vincent (refer Table 2, Page 6) and a financial outcome after the period of the management services agreement plus the lease agreement ceasing; it would appear there is a deficit of $22,000 (approximate) plus the ownership of two heifer calves approximate value $4,400 (refer Table 3, Page 10) at the end of this period. This is not a viable outcome.''
As I have already indicated, in my opinion the judgment as to deductibility in this case is not to be limited by the assumption, derived from the terms of the agreements, that Ms Vincent's involvement was subject to an a priori limitation of two years.
96. The characterisation of the outgoings in Year Two is not determined by the ex-post facto assessments of the commercial viability of the project offered by Messrs Singleton and McMichael. Had Ms Vincent, been in the words of Mr McMichael a serious livestock or cattle breeder, armed with the relevant expertise and had she raised the questions about the breeding program identified by Mr McMichael and had she inquired about the working capital position she might have come to the conclusion that the project was not going to yield assessable income. In my opinion, however, it is not a condition of the deductibility of outgoings under the first limb of s 51(1) that the taxpayer has conducted what an expert in the relevant field would regard as all necessary inquiries to assess the return to be derived. In so saying it must be accepted that a failure to conduct any inquiries at all or wilfully disregarding easily ascertainable risks that the project will yield little or no return could support the conclusion that the outgoing was not genuinely incurred in gaining or producing assessable income. But mere imprudence on the part of the taxpayer or failure to make adequate or full inquiry does not of itself take the outgoing out of the scope of the section.
97. In this case the investment had been suggested by Ms Vincent's accountant of ten years whom she trusted. The projections promised an income stream over a seven year period. She had a number of conversations about it with her accountant and read literature which he passed to her. She discussed the investment with her father whose judgment she trusted and with her partner and her partner's father. She considered other investments at the time. The fact that she hoped to repay her father's loan out of the tax refund does not negative the overall purpose of the outgoings as the derivation of assessable income. There would, after all, be little point in investing in the project if the best she could hope to achieve were the repayment of the money she borrowed to invest in it.
98. These considerations lead into the Commissioner's further argument that there was a disproportion between Ms Vincent's outgoings and the assessable income which was to be explained by her pursuit of a taxation advantage. The disproportion argument was based upon a comparison of her outlay with the projected and actual assessable income. I accept that a factual basis for the disproportion argument existed. As earlier observed, where there is disproportion, characterisation of the outgoing requires a common sense or practical weighing of all the facts including the objectives and advantages which the taxpayer seeks from the expenditure. One of the factors which may be taken into account is that, from Ms Vincent's point of view, the Loan Agreement did involve the assumption of an obligation, however light it may have been, by virtue of the limited recourse condition. The repayment arrangements under that agreement would have affected the income stream projected over the seven year period covered by the ACM brochure. It is also appropriate to have regard to the limited financial advantage she obtained when the actual reduction in her taxation liability is set off against her cash outlay. Counsel for Ms Vincent submitted that in 1996 the extra tax properly payable, if the deduction of $16,050 had not been claimed was $5,545.93. Set off against her actual cash outlay (not including TEI borrowings) of $5,250, the
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net benefit was $295.39. Counsel argued, albeit in the context of Part IVA, that what this demonstrated was that Ms Vincent's dominant purpose in entering the project was not to obtain tax deductions.99. Having regard to these considerations and the findings I have already made against the contention that Ms Vincent did not intend to be involved in the project for more than two years, I do not accept that the disproportion between her outgoings and the assessable income defeat the characterisation of those outlays as incurred in gaining or producing assessable income within the meaning of the first limb of s 51(1).
100. The Commissioner submitted that the outgoings were of a capital nature which secured for Ms Vincent an interest in a business operated by ACM. She was a passive investor in someone else's business. The focus of this argument seemed to be on the two year term of the Management Agreement and the Lease Agreement and Ms Vincent's inactivity in relation to the actual operation of the project. Her failure to extend these agreements was said to indicate that what she did in investing in the project was no more than make a one off arrangement for the delivery of progeny. Reference was made to evidence of her passivity as an investor. She did not ensure that the terms upon which ACM had contracted to deliver her progeny were complied with. She did not monitor ACM's management of the recipient cows or when or how the First Year and Second Year Fees were spent. She kept no records of expenditure made on her behalf and lost some of the information she was provided with. She did not monitor progress and breeding. The factual aspects of these contentions were substantially accurate. It does seem that in 1996, after paying her Second Year Fees, Ms Vincent lost interest in the project. She was going through a difficult time. Her evidence was not contradicted that her twelve month old child had contracted a serious illness in that year and she had to focus on looking after him. In my opinion her failure to follow up the performance of the project in that year does not indicate that her outgoings were of a capital nature.
101. The Commissioner referred to
Clowes & Anor v FC of T (1954) 10 ATD 316; (1954) 91 CLR 209 and
Milne v FC of T 76 ATC 4001; (1976) 133 CLR 526. These cases concerned the characterisation of proceeds from investments in timber plantations as capital in the hands of the investors rather than as assessable income. In each case the taxpayer had paid a lump sum for a lot upon which timber was grown and sold with costs being deducted from the proceeds remitted to the taxpayer. Dixon CJ said in Clowes at ATD 319; CLR 218:
``From the taxpayer's point of view it was nothing but a casual investment of capital in hope of enlargement at the end of many years. It was done in the course of the taxpayer's business. There is no suggestion that it formed part of any system or practice. It is likely enough that it was nothing but the result of yielding to a canvasser.''
In Milne it was held that the facts of the case could not be distinguished in any relevant way from the facts in Clowes' case. The Commissioner also relied upon
Enviro Systems Renewable Resources Pty Ltd v Australian Securities and Investments Commission (2001) 80 SASR 1. That case involved the question whether a scheme offering members of the public an opportunity to participate in the growing and selling of timber was a franchise for the purposes of the Corporations Law. Martin J, in the Supreme Court of South Australia, held that the scheme was not a franchise because the participants were predominantly passive investors not running their own businesses. None of these authorities, in my opinion, supports the characterisation of the Second Year outgoings as capital. I reject the Commissioner's contentions that they were. In
FC of T v Lau 84 ATC 4929; (1984) 6 FCR 202, Beaumont J (Jenkinson J agreeing) rejected a submission by the Commissioner, in reliance upon Clowes and Milne, that payments made by a taxpayer leasing land with a number of others in a forest management scheme for the purpose of establishing and maintaining a pine plantation were on capital account. The relationship of the parties was characterised by his Honour as differing from that in Clowes' case and Milne's case, the taxpayer having an identifiable interest in specific trees in the area under lease. He said, at ATC 4944; FCR 221:
``... In this context, it is appropriate to refer to the contractual quid pro quo to determine the nature of the outgoing... and, prima facie, moneys outlaid in return for such recurrent services are paid on revenue account. In my view, the circumstance that
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the fee is to be paid as a lump sum in advance is not sufficient to displace this presumption. The important considerations are the nature of the services to be rendered and the periodic manner in which they are to be rendered. In my opinion, the outgoings fell within s 51, being directed not to the profit-yielding subject of the taxpayer's business but to the process of operating it.''
102. The Commissioner also submitted that apart from the cash payments she was required to make in the second year, Ms Vincent incurred no obligation pursuant to the Management Agreement. This argument was based upon the proposition that the Loan Agreement was a sham. It was submitted that the Loan Agreement created the facade that Ms Vincent's payment obligations as set out in the Management Agreement were real. This was, however, only one of three agreements which together constituted an arrangement for Ms Vincent's participation in the project. The fiction was said to become apparent when the Loan Agreement was considered in the context of the interdependent set of agreements of which it formed part.
103. It was submitted that on the face of the agreements, if Ms Vincent were to walk away from the project at the end of the two year term no moneys would ever be paid in reduction of her supposed liability under the Loan Agreement. The Loan Agreement was for a seven year term whereas the Management and Lease Agreements were for two year terms. Nothing in the Loan Agreement required Ms Vincent to extend the project beyond the two year term given it by the other agreements and she knew that. She was bound only to carry on the farming and cattle breeding business described in the Management Agreement. Over the two year term of that agreement it was not contemplated by anybody that the project would yield funds from which the loan might be repaid. It was said to follow, that Ms Vincent must have known that the loan was a pretence. She could not genuinely have thought, it was said, that the money would be paid to ACM on her behalf in circumstances where it was plainly never to be repaid.
104. The sham argument reflects the Commissioner's pleading in par 22 of the Response to the Statement of Claim. In this context it is desirable to go back to what Diplock LJ said in
Snook v London and West Riding Investments (1967) 1 All ER 518 at 528:
``One thing I think, however, is clear in legal principle, morality and the authorities... that for acts or documents to be a `sham', with whatever legal consequences follow from this, all the parties thereto must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating. No unexpressed rights of a `shammer' affect the rights of a party whom he deceived.''
See also
Sharrment Pty Ltd v Official Trustee in Bankruptcy (1988) 18 FCR 449 at 454 (Lockhart J).
105. I am not prepared to infer that Ms Vincent entered into the Loan Agreement other than in the belief and with the intention that she would be bound by its terms and that the obligations it purported to create were obligations which she assumed. The fact that, upon reflection, it might have been open to her to conclude that the loan was ultimately unenforceable because she could walk away from the project after two years does not alter the position. What may be discerned by a lawyer's analysis, undertaken retrospectively, of the operation of the agreement under certain circumstances, does not require a finding that, in the words used by the Commissioner, ``the applicant must have known the loan was a pretence''.
106. A further submission was made by the Commissioner that if the loan contemplated by the Loan Agreement was not made then Ms Vincent's obligations under the Management Agreement did not arise. This was based upon the interrelationship of the agreements. In this context reference was made to
Osric Investments Pty Limited v Woburn Downs Pastoral Pty Ltd (2002) 20 ACLC 1; [2001] FCA 1402 and
Jekos Holdings Pty Ltd v Australian Horticultural Finance Pty Ltd (1996) 34 ATR 41. Even if that submission be correct it does not, in my opinion, negative the characterisation of Ms Vincent's 1996 cash outlay as an allowable deduction under s 51(1). A payment does not have to be made pursuant to a legal obligation in order to qualify as an allowable deduction under the first limb.
107. The question remains whether the failure by TEI to make the promised advance to ACM in 1996 affects Ms Vincent's ability to
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claim the amount of that promised advance as an allowable deduction. In my opinion the advance never having been made, Ms Vincent was under no obligation arising out of her Loan Agreement in relation to its repayment. That is to say she was not even under the qualified obligation imposed under the limited recourse provisions. The sum of $10,800 which comprised part of the sum of $16,050 claimed by her for the year ended 30 June 1996 was therefore not an allowable deduction.108. Ms Vincent's position can be no better under the second limb of s 51(1) than under the first and it is therefore unnecessary for me to express a concluded view about it. Nevertheless, having regard to her non- involvement in the operation of the project and the way in which ACM managed the herd as undifferentiated group of cattle without regard to the rights of particular investors, I could not accept that her outgoings were necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. I would therefore not have allowed the deduction under the second limb of s 51.
The Validity of the Part IVA Determinations
109. At the threshold of the argument about the operation of Part IVA in this case was the contention advanced by counsel for Ms Vincent that Mr Shawcross, who signed the necessary determinations under s 177F, did not have authority to do so and, alternatively, failed to do so in an appropriate form indicating that he was acting on behalf of the Commissioner or a delegate of the Commissioner. In my opinion there is no substance in either of these contentions. The affidavit of Mr Chapman, which was not contested, makes it clear that Mr Shawcross was given the relevant authority by a delegate of the Commissioner who had power to make such determinations. A delegate may authorise another to exercise delegated powers on his behalf -
O'Reilly & Ors v Commrs of the State Bank of Victoria & Ors 84 ATC 4156; (1983) 153 CLR 1;
Carltona Ltd v Commissioner of Works (1943) 2 All ER 560 at 563.
110. Provided the person purporting to make the determination has power to do so, it is not a condition of that power, to be found in the Act or otherwise that he could not effectively exercise the power unless he did so expressly in the name of the delegate. In any event in the present case the determinations made by Mr Shawcross were headed, inter alia, ``DETERMINATION MADE BY THE COMMISSIONER...''. Nor is there anything in the other point taken on behalf of Ms Vincent that her individual circumstances were not considered in the exercise of the discretion to make the determination. Provided the requisite factors were considered the power to make the determination was enlivened. It is the Court's task to decide whether Part IVA applied and thus whether or not the amended assessments were excessive.
The Application of Part IVA
111. The Commissioner contended that the scheme to which Part IVA applies comprises the making of the Management Agreement, the Lease Agreement and the Loan Agreement and the steps and transactions carried out pursuant to those agreements. I accept that this defines a scheme to which Part IVA may apply. It is then necessary to consider, pursuant to s 177D, whether Part IVA does apply to the scheme so defined.
112. The first condition of the application of Part IVA is that a taxpayer has obtained, or would, but for s 177F, obtain a tax benefit in connection with the scheme. In this case Ms Vincent has obtained deductions for the years 1995 and 1996 which she would not have obtained in relation to those years of income if the scheme had not been entered into or carried on. For the 1995 year, the relevant benefit is the deduction claimed and allowed in the sum of $21,300. For the 1996 year, the benefit is the sum of $5,250. It is to be remembered that the inclusion in the original 1995 assessment of the full amount of the deduction claimed for that year, including the loan payment that was never made, cannot be the subject now of any amended assessment by reference to s 51(1) having regard to the lapse of time since the original assessment was made. That does not, however, prevent the application of Part IVA to the deduction allowed in relation to that year.
113. The second condition for the application of Part IVA requires a finding that a person or one of the persons who entered into or carried out the scheme or any part of it did so for the sole or dominant purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme. This follows from ss 177A(5) read with s 177D(b). Each of the eight factors set out in s 177D(b) must be considered in making a finding on that issue.
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But while the section requires the Commissioner to have regard to each of those matters, the relevant dominant purpose may be so apparent on the evidence taken as a whole that consideration of the statutory factors can be collapsed into a global assessment of purpose -FC of T v Consolidated Press Holdings Limited (No 1) 99 ATC 4945 at 4971; (1999) 91 FCR 524 at 552. Nevertheless, even where the dominant purpose of those entering the scheme is apparent, it is still prudent for the decision- maker or the Court, as the case may be, to expressly have regard to each of the eight factors set out in s 177D(b). As Hill J observed in
Peabody v FC of T 93 ATC 4104 at 4114; (1993) 40 FCR 531 at 543, the condition that each of the factors be considered does not require that they must all point to the necessary purpose referred to in the section. Some may point in one direction and others in another. As His Honour said:
``... It is the evaluation of these matters, alone or in combination, some for, some against, that s 177D requires in order to reach the conclusion to which s 177D refers.''
In what follows I refer to each of the eight factors:
114. 1. The manner in which the scheme was entered into or carried out.
As submitted by the Commissioner, evidence from the agreed documents indicated that the scheme was promoted by Mr Jacobsen to a number of financial advisers on the basis of its taxation advantages and was otherwise widely marketed through use of the brochure. The information booklet made express reference to the taxation advantages to investors. As evidenced by Ms Vincent's experience investors were required to do no more than sign the relevant agreements and make the initial payments. The assumption of the obligations under the agreements including the making of the initial payments, generated the tax deductions. As to the carrying out of the scheme, ACM conducted its cattle breeding operation without close regard to the obligations which it owed to Ms Vincent or other investors in respect of their particular cattle under the Management Agreements.
115. 2. The form and substance of the scheme.
I accept the submission made by the Commissioner that the form of the scheme as embodied in the transaction documents comprising it bore no relationship to its substance as operated by the ACM Group. The most salient features of the discrepancy between form and substance were the inability and failure of TEI to provide any loan money and the management of the herd with little or no reference to the requirements of the Management Agreement and the rights of individual investors, including Ms Vincent, thereunder. The disconformity between the terms of the Management and Lease Agreements on the one hand and the period of time necessary to establish an income stream on ACM's own projections threw up a matter of substantial discrepancy between its form and substance. Related to this was the disconformity between the limited terms of the Management and Lease Agreements on the one hand and the obligations for repayment of the loans under the limited recourse conditions on the other. Plainly the loans could not begin to be repaid out of income earned by individual investors until the third year when the ACM projections forecast sales.
116. 3. The time at which the scheme was entered into and the length of the period for which the scheme was carried out.
Ms Vincent entered into the scheme in June 1995. The Management Agreement and the Lease Agreement expired in June 1997. ACM had a further forty weeks to deliver progeny. She did not take any steps to extend the agreements beyond the initial two years. The Commissioner makes the point that the time for which she was involved in the project was all that was necessary to generate the tax deductions she claimed.
117. 4. The result in relation to the operation of this Act that, but for this Part would be achieved by the scheme.
As was submitted by the Commissioner the result of the scheme was that but for Part IVA, Ms Vincent became entitled in the 1995 year to deductions for the First Year Fees of $19,230 and prepaid interest of $2,070. In the 1996 year she became entitled to a deduction for the Second Year Fees of the amount she actually outlaid, $5,250, the loan amount of $10,800 not being allowable as a deduction under s 51(1) as it was never paid.
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118. 5. Any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme.
The relevant change is measured by the cash outlays that Ms Vincent made in 1995 and 1996, the entitlement to deductions that she thereby generated and the consequent reductions in her taxable income. In 1995 she was able to recoup all but $164.41 of her cash outlay from her tax refund. Having regard to the view I have formed about the deductibility of the loan payment in 1996, she would not be able to recoup all of her cash outlay from her tax refund properly assessed under s 51(1).
119. 6. Any change in the financial position of any person who has or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme.
As a result of the scheme the ACM Group raised money from investors. With that money it acquired cattle, plant and equipment and land.
120. 7. Any other consequence for the relevant taxpayer or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out.
There is no dispute that there were no other consequences for Ms Vincent.
121. 8. The nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi).
Again, it is not in dispute that there was no connection other than the contractual relationships created by the transaction documents.
122. In this case I have already found, in connection with the issue of deductibility under s 51(1), that the obtaining of a tax deduction was not Ms Vincent's dominant purpose in entering into the project. That finding however does not obstruct the application of Part IVA to Ms Vincent's claimed deduction. The purpose which must be found in order to attract the application of Part IVA under s 177D(b) is that which a reasonable person would conclude was the dominant purpose of one or more of the persons entering into the scheme. That is to say, it is an objective purpose attributed to them. As Carr J said in
Eastern Nitrogen Ltd v FC of T 2001 ATC 4164 at 4177; (2001) 108 FCR 27 at 44:
``The whole tenor of the language in which s 177D(b) is expressed is that of ascertaining an objective purpose by having regard to objective facts.''
See also
CC (New South Wales) Pty Limited (In Liq) v FC of T 97 ATC 4123 at 4146-4147 (Sackville J),
FC of T v Spotless Services Limited & Anor 96 ATC 5201 at 5211; (1996) 186 CLR 404 at 424 and Peabody v FC of T (supra) at ATC 4113; FCR 542 - a view the correctness of which was not questioned by the High Court on appeal. More recently in
FC of T v Consolidated Press Holdings Ltd & Anor 2001 ATC 4343 at 4360; (2001) 179 ALR 625 at 643, the Court said:
``... One of the reasons for making s 177D turn upon the objective matters listed in the section, it may be inferred, was to avoid the consequence that the operation of Pt IVA depends upon the fiscal awareness of a taxpayer.''
In that case the Court was considering the attribution of the purpose of a professional adviser to one or more of the taxpayers entering into a scheme. It acknowledged that in some cases the actual parties to a scheme subjectively might not have any purpose, independent of that of a professional adviser, in relation to the scheme or part of the scheme, but that would not defeat the operation of s 177D.
123. In my opinion, whatever the subjective purpose of Ms Vincent and her state of knowledge about the true nature of the scheme into which she entered, a reasonable person would conclude, having regard to the eight listed factors, that those taxpayers who entered into the project did so with the dominant purpose of obtaining a tax benefit in connection with it. From an objective point of view there was little other benefit to be derived.
124. Senior counsel for the Commissioner was unable to refer me to any authority on the question whether s 177D may operate to attract the application of Part IVA to a scheme by reference to the purposes of the scheme's promoters. In my opinion, the reference in s 177D to a person or persons who entered into or carried out the scheme or any part of it, extends to participants in the scheme such as the promoter or the entities which the promoter controls. In this case the relevant participants
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are ACM, TEI and Viking, all of which were controlled by the scheme's principal promoter, Mr Jacobsen. The companies and Mr Jacobsen were each ``persons who entered into or carried out the scheme''. They did so for their own purposes of financial gain but upon an objective view based upon factors some of which were not known to Ms Vincent, their dominant purpose was to enable her and other taxpayers to obtain tax benefits in connection with the scheme.125. In the circumstances, I am satisfied that Part IVA of the Act did apply to the scheme and that the determinations made under that Part were properly made.
Penalty and Interest
126. The rate of penalty imposed on Ms Vincent by the amended assessments pursuant to s 226 of the Act was fixed at 10%. This represents a figure of $733.55 in relation to the 1995 year and $554.53 in relation to the 1996 year. The interest component of the amended assessments was $3,071.57 for the 1995 year and $1,721.90 for the 1996 year.
127. The notice of objection in each case asserted that the Commissioner should exercise his discretion to remit the whole or at least a part of the penalties payable by the taxpayer. In my opinion, however, the penalty rate has been struck at a low level that has proper regard to the circumstances of this taxpayer and I do not consider that I should interfere with it.
128. No separate submission was put in relation to remission of the interest level pursuant to s 170AA and I do not propose therefore to interfere with that aspect of the amended assessments.
Conclusion
129. In each case therefore the application will be dismissed and the objection decision confirmed. I will hear from the parties as to costs.
THE COURT ORDERS THAT:
1. The application be dismissed.
2. The objection decision be confirmed.
3. The applicant is to pay the respondent's costs of the application.
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