P Gerber DP
Administrative Appeals Tribunal
Dr P. Gerber (Deputy President)
This is a case about a film and a couple of documentaries. The film was called La Ronde. It was all about Aborigines in the desert. Unfortunately, it rained during the making of the film, so that the desert turned into rainforest. The film crew could not afford to hang around waiting for Godot, so they adapted the script, yelled ``action'' and went home. This may have contributed to the film's box office failure. It was even taken to Milan and Cannes. Alas, desert Aborigines in a rainforest did not appeal to the Europeans and the film was eventually sold as celluloid to a scrap metal dealer. The same fate befell the documentaries, The Sting, an educational
ATC 671``short'' about a raid on the Treasury over a long weekend and Bogeyman, a video about golf. This must all have come as a bitter disappointment to the financial backers of these films, a disappointment only barely compensated for by the fact that the scheme had, quite fortuitously, the consequence of reducing their assessable income, a reduction which, in the case of this ``taxpayer'' resulted in a nil return in the 1979 tax year.
2. The ``credits'' for these films, produced by Bile Productions Pty. Ltd. for Gallstone Traders (``the partnership'') are:
Director: Slutzkin Todd, of Todd & Fagin, Solicitors Producer: Sweeny Todd (cousin of Slutzkin) Cameraman: Erich von Stroheim Financial Consultants: Tasman Taxation Developments Ltd. Intercontinental Finance Ltd. Wharton Finance Ltd. Media Finance Ltd. Taxpayer: Lucretia Medici Taxpayer's husband: Lorenzo Medici Bit players: Desert Aborigines, Urban accountants, Odds and sods.
3. At the risk of spoiling the plot, it is necessary, in order to gain some comprehension of its complexities, to outline the various somewhat unorthodox roles played by the dramatis personae.
4. Some time in 1978, Slutzkin Todd conceives the idea that there is money to be made from films. The idea is not original, the Fox Brothers had thought of it before. What was original was that the profit was to come, not from the box office, but from selling tax deductions. In due course, a (then) legal academic, specialising in taxation law, is asked for an opinion on the viability of an elaborately constructed scheme which has as its primary purpose the reduction of income tax for its participants. The academic returns his opinion, containing 24 pages of distilled wisdom, commencing, as do all good opinions, with the decision in Ronpibon Tin and concluding with their Lordships' speeches in the two Europa Oil cases. To make assurance doubly sure, two more opinions are obtained from eminent senior counsel, one from Sydney, the other from Melbourne. As these opinions were freely displayed to all potential investors, they were properly made exhibits. Thus, the principal opinion commences with the preamble:
``I am asked to advise as to the efficacy of the following plan designed to minimise the liability to taxation of a taxpayer.''
The central elements of the instructions are then set out, together with the academic's recommendations for refinements to ensure the fiscal success of this venture. The academic then reiterates that, according to his instructions, ``although (commercial) success is most unlikely, in the world of film production such eventualities are not impossible''. He goes on to point out that ``if the partners were simply to pay an annual fee to the production company and sit back and do nothing and wait for the income (sic) to be generated by the production company's endeavours, I think it would be difficult to justify the claim that the partners were carrying on a business... As I suggested in conference, it may also be desirable for the partners to engage in some further business activities in relation to other, albeit much smaller film making activities.'' In case the importance of the message had not sunk in, it is reiterated, some 15 pages later, that ``it is vital that the partners be sufficiently active in carrying out their supervisory and organisational tasks so as to establish that they are carrying on a business.'' It seems that the academic is not convinced that the application of war paint will not make one into a warrior; cf.
Deane & Croker v. F.C. of T. 82 ATC 4112, per Rogers J. at p. 4120.
5. It is, of course, trite to point out that there is nothing whatever wrong with devising a scheme or arrangement which has the effect of reducing the incidence of tax; what's good for the Duke of Westminster is good for the wife of an Italian builder. The question must always be: does the arrangement succeed in its desired purpose?
6. Mr Greg Davies of counsel, who appeared for the taxpayer, took me carefully through the entire documentation, and introduced me to various companies operating, in the main, on Norfolk Island for reasons of philately. All operate from the same address. Partnership agreements, numerous loan agreements and deeds with film producers were exhibited, all of which, it was argued, were critical to the successful outcome of this application. In addition, many of the minor bit players were briefly called upon the stage to recite their parts. For present purposes, I am prepared to assume that all the companies were duly incorporated, that every document was executed sequentially, properly and in the pre-ordained order devised by the lawyers, and that all the cheques were shuffled around in the order that God intended. Mr Davies will forgive me if I don't set them all out. It is sufficient for my purposes merely to outline the bare bones of this scheme, which involves the formation of a film production company and some 14 or so partnerships, each containing 20 partners, some of whom may even, for all I know, have had a genuine interest in Australian films, others may not. I know nothing about this taxpayer since she failed to appear. Instead, she sent her husband, also a partner in Gallstone Traders. He did not fare well in cross-examination. The witness was keenly alive to the potential hazards of the word ``tax'' and sought to overcome this problem by the simple device of denying that the word had ever been mentioned in the preliminary discussions between him and the accountant who introduced him and his wife to this scheme. I disbelieve him. The accountant was called as a witness by the applicant and frankly admitted that, in the preliminary discussions with the lawyers, he had sighted at least one legal opinion, although he could not remember the name of its author. He was asked by Mr Shaw Q.C., senior counsel for the respondent, in cross-examination whether, at that preliminary meeting, it was suggested that if an investment was made in one of the proposed partnerships, an income tax deduction would be available which would bear, as to the contribution, a relationship of 100% to 15%, so that the deduction of the partners was 15%? The witness replied: ``I do not recall the percentages you are talking about, but any loss was to be the percentage which the partner had in the partnership. If he held a 20% interest in the partnership, he would be entitled to 20% of the profits or losses.'' I therefore find it inconceivable that this information would not have been conveyed to this couple. On the whole of the evidence, I am satisfied that the purpose of the taxpayer's husband in investing in Gallstone Traders was primarily directed towards a reduction in his tax. The failure to call the applicant does not lead me to make a more benevolent presumption in her favour.
7. As part of the scenario, it was essential that there had to be a company to make Australian films, and, hey presto, Bile Productions is incorporated. To lend verisimilitude to its aims and objects, the company looks around for producers and directors with previous television experience and collects a gaggle of directors and crew, all of whom can pass muster as ``filmy''. Some 14 or so partnerships are formed whose capital consists of the varying contributions of each partner. In the case of this taxpayer, the amount contributed to the Gallstone partnership was $3,750 out of a total capital of $149,000 (or $150,000 depending on which document accurately reflects the total contributions). This constituted 2.5% of the proportion of a substantial loss which the promoters, and, it would seem, everyone else associated with this venture, anticipated would be the end result. In the events that occurred, this taxpayer's assessable income in 1979 was thus reduced to nil, with a carried forward loss into the next year.
8. The scenario begins with the partnership entering into an agreement with the film company, Bile Productions. The agreement is for five years. The company is to produce one Group ``A'' film (a full length one hour feature film), a Group ``B'' film (a short video) and one Group ``C'' film (an educational video). The annual fee is to be one million dollars. Since these partners contributed a mere $149,000 (or $150,000) to the partnership, there was an obvious shortfall of some $851,000. This problem was overcome by borrowing $851,000 from Media Finance on 19 February 1980 by way of a ``non-recourse'' loan agreement. Alas, Media Finance had only $5 in its bank account on that day, so it had to borrow $851,000 from Intercontinental Finance Ltd. Intercontinental Finance was only able to lend this amount because it had received $852,000 a few seconds earlier from Tasman
ATC 673Taxation Developments (pursuant to another loan agreement). That outfit just happened to be flush with ``funds'' because it had, an instant in time earlier, received $940,000 from Bile Productions as consideration for finding more film buffs anxious, in fiscal terms, to use a sprat to catch a mackerel. And Bile Productions, of course, had ``received'' $1 million from Gallstone Traders, which, as will be recalled, had just received $851,000 from Media Finance. This takes us back to square one and Euston Station. I am satisfied (i) that the $851,000 was Monopoly money which had no real existence and was not backed by any demonstrable assets other than (semble) an accommodating bank manager on Norfolk Island; (ii) all of the various loan agreements were intended to give the appearance of creating actual legal rights and obligations different from the legal rights and obligations (if any) which the parties intended to create. It is not a misuse of language to describe these transactions as a ``sham''; cf.
Snook v. London & West Riding Investments Ltd. (1967) 1 All E.R. 518 at p. 528. The only real money consisted of the contributions from the various partners, which was carved up between the lawyers ($88,000) and the film production company ($60,000). The partnership ``loss'' is said to arise from the fact that it ``paid'' $1 million to Bile Productions, which expended some $40,000 on actual production costs on films (later sold for scrap), the balance - $940,000 - was ``paid'' to Tasman Developments under an agreement which provided for such payment as ``commission on fees received under the participating contracts during the first year of those contracts equal to ninety-four per centum of the gross amount of those fees''. The consideration for this substantial payment being the film company (Bile) agreeing with the contractor (Tasman) to engage it for the purpose of securing persons willing to participate in contracts for the making and marketing of films with the film company. In summary, 94% of each partnership's contribution is expended, not on making films, but on procuring partnerships ready, willing and able to join this scam. It is at this point that the Titanic hits the iceberg and the major ``loss'' to passengers and crew can be shown to occur.
9. The deed entered into between Tasman and Intercontinental Finance Ltd. of Taylor's Rd Norfolk Island, has its own peculiar charm. Clause 6 of what is referred to as the ``Leverage Loan Agreement'' provides that:
``In the event that the borrowers under the Loan Agreement default under Medial [sic] may at its option elect to transfer and assign to Intercontinental the whole of its rights under the Loan Agreement and thereupon Media will be released and discharged from all its obligations to Intercontinental under the provisions of this agreement.''
10. In its first return (1979) Gallstone Traders returned a profit of $150 (the proceeds of the sale of an option), and, with various other expenses of a minor nature, declared a loss of $1,000,020. On that basis, the taxpayer claimed her share of the loss as $24,999. Further losses appear in the next year.
11. The oral evidence can be briefly disposed of. I have already dealt with the testimony of Lorenzo Medici. As pointed out before, I am satisfied that his primary purpose for entering into this scam was to obtain a substantial tax deduction.
12. The accountant was clear in his understanding that (i) the films were most unlikely to make a profit and (ii) the losses could be claimed against other income. He knew that an integral part of the arrangement involved a payment to the film company of $1 million and that the partnership funds contributions would not exceed $149,000. When asked whether he was aware that the production agreement did not oblige the production company to expend any particular sum in production, he replied: ``I have not read it just now and it is ten years ago. I cannot recall.'' He disclaimed any knowledge that part of the arrangement obliged the production company to pay Tasman Developments 94% of the fees received. I disbelieve that evidence. I am satisfied that the witness actively sought out an arrangement which would enable his clients to reduce their tax liability, and that he explained the arrangement to Lorenzo Medici. What his wife knew or understood will never be known unless this case goes on appeal and she is called as a witness. Again, this accountant was keenly alive to the need for the partners to show some ``activity'' if the scheme were to succeed in its intended purpose. He was asked:
``Do I take it that except for the choosing of the films, by that I mean out of the titles which were offered, choosing which ones they were to be, the partnership, so far as you were aware, played no part in the production of the films? - Yes.
Q. All it did, as I take it, was to receive reports from time to time from Bile; that is right is it not? - That is correct.''
13. The next witness was the accountant who drew up the books for the Gallstone Partnership. His evidence consisted, in the main, of explaining the various entries which record the payment to him as accountancy fees ($190); sundry debtors ($141.48); sale of films ($63,404); the same figure ($63,404) again appears as interest payable on the loan received from Media Finance for the ``loan'' (the identity of these two amounts are an interesting exercise in the laws of probability). The final item is $3,337, the fee paid for the sale of the films on behalf of the partnership to the scrap merchant. The witness also kept the books on behalf of the other partnerships involved in the same scam. He was vague in the extreme about the number of partnerships, the amounts ``borrowed'' etc. To some of the questions put in cross-examination, he replied, not unreasonably, that they should be put to Todd & Fagin, the solicitors. Alas, the Tribunal was not afforded that opportunity. I shall return to this omission later.
14. Mr Sweeny Todd, the producer and cousin of Slutzkin, gave evidence how he was approached by his cousin to become a director of Bile, the newly established film production company. He was previously involved in the production of Battleship Potempkin and, since 1964, ``been a performer, writer and composer''. He added that his role was ``on the creative side, looking for projects to be made, producing those programs, that was my basic role''. He gave short biographical details of the other bit players, outlined the plot of La Ronde and gave a harrowing description of the trials and tribulations involved in filming it. He deposed that he told the partners at a meeting that La Ronde ``had a lot of social interest... I could imagine it being shown on BBC, France and Germany, all those sort of places''. I accept that this witness was an innocent cat's paw in the overall scheme of things. His interest in films was genuine as was his effort in marketing the end product. Essentially, his function was to produce and market low budget documentaries for television. He was to add that ``if you are asking did (the partners) get a million dollars worth of picture, not at $40,000. It is obvious''. The witness frankly conceded that it ``was highly unlikely'' that these films would earn $1 million. He was asked some question about a contract of sale of La Ronde to an outfit calling itself Cloondara Pty. Ltd. for $249,000 at or about the same time that this film was sold as scrap for $60,000, the contract of sale to Cloondara being made an exhibit. However, he was unable to shed any light on this somewhat mysterious transaction. It seems that this ``sale'' had the same degree of substance as the various loans. At the conclusion of his evidence, the witness conceded that Bile Productions was not equipped to handle 14 packages for 14 partnerships and that at least 40% of these were sub-contracted out to independent producers.
15. Another partner of Gallstone was called, who was an accountant. He informed the Tribunal as to his own intentions as well as describing the activities of the partners in relation to the film production. He conceded that he was aware that the tax deductions to be derived from this venture would be considerably larger than the amount of contributions, and that he himself had contributed $6000 because ``I felt that I could do with quite a substantial deduction and if it was to be in the form of a loss from such a partnership, so be it.''
16. A director of Bile Productions was called who was familiar with the day to day administrative decisions. This witness took me through the activities of the company at the relevant time. He explained - so far as he was able to recall - how potential investors in these film partnerships were approached, and confirmed that at these Tupperware-like parties (``it was a sort of open invitation, if you like''), which were held in the office of a firm of solicitors, ``the opinion of at least one Queen's Counsel that had made comments about the tax deductibility of the proposal'' was freely made available for the perusal of prospective investors. He later conceded that all three opinions had, in fact, been tabled. He agreed with Mr Shaw that it was explained to everyone ``that under this scheme, deductions would be available in excess of actual capital
ATC 675contributions of the partners, bearing a relationship of something like deduction 100 per cent, and the capital contribution about 15 per cent''.
17. The last two witnesses gave evidence of the attempts made to sell the films, both here and abroad, and documents and critiques were made exhibits which amply support this evidence. I accept that genuine efforts were made to sell them. However, having concluded that these films were made, not for profit, but for tax losses, none of the good intentions of the innocent participants to sell them can alter the nature of the scheme or its tax consequences.
18. The final point that needs to be made in relation to the evidence is that the hearing of this application was re-scheduled at a Directions Hearing at the request of Mr Davies to suit the convenience of his instructing solicitor, Mr Slutzkin Todd. The inference was clear - Mr Davies was briefed that Mr Todd would be giving evidence. When it became clear in the dying stages of the applicant's case that this gentleman would not be called, I was asked to sign two summonses, ordering the appearance both of Mr Todd and the solicitor at whose offices the various Tupperware parties had been held. I was further informed that a process server had been unable to effect service on either gentleman. Whilst the reluctance of the lawyers to give evidence is, perhaps, understandable, it does little to assist their clients.
19. The above are the bare bones of this scheme and the evidence. I now turn to the law.
20. The main thrust of Mr Davies' submissions was - in the language of Rogers J. - that the application of war paint to a person makes him into a warrior and/or, having earned some $150 by way of an option on one of its films in one year and some salvage in the following year, the expenditure by the partnership of some $1 million constitutes an outgoing incurred in producing the assessable income. Mr Shaw, on the other hand, asserted that what was involved here was not war paint, but some kind of synthetic make-up that would come dripping down like Turkish Delight in the first shower of rain. It was only in his reply, that Mr Shaw, goaded by Mr Davies, suggested in a throw-away line that, in any event, the better view was that the cost of the paint was an affair of capital. It is tempting to speculate that this argument deserved to be developed at greater length, given the ``once and for all'' nature of the payment and its magnitude, as well as the insignificant and contrived involvement of the partners in the whole venture. In the circumstances, I do not propose to deal with it further. Again, sec. 260 was not relied upon on the assumption that the provision could not apply to ``defeat or reduce any deduction otherwise truly allowable under s. 51.''; cf. per Dixon C.J.,
Cecil Bros Pty. Ltd. v. F.C. of T. (1964) 111 C.L.R. 430 at p. 438. So be it. It may well be that one day, a superior court may conclude that an ersatz outgoing, created for no other purpose than to reduce the incidence of tax, does not qualify as a deduction ``otherwise truly allowable under s. 51''. As far as this Tribunal is concerned, it must apply the law, not seek to change it.
21. In developing his argument, Mr Davies submitted that there was no evidence that the partnership - or, rather, the partners - had anything other than an intention that the $1 million would be expended on the production of films, and had no knowledge that the bulk of the $1 million would be paid to Tasman Taxation Development. With great respect, this submission flies in the face of the evidence. We know that the opinions of the various counsel were tabled for all to read. We know that the so-called loan agreements were not concealed from the partners. We know of the discussions between the lawyers and the various accountants. Why should I infer that these partners were simple businessmen making a commercial investment in the film industry? We also know that this taxpayer's accountant was keenly alive to the fact that the primary purpose of this scam was to ``buy'' a tax deduction. What the Medicis knew or didn't know is therefore quite irrelevant. The knowledge of their accountant must be imputed to them. Qui facit per alium facit per se. Having concluded that these so-called loan agreements were shams in the classic sense of that word, that is really the end of the case. However, it is urged upon me that this cheque shuffling, evidencing ``loans'', has been legitimated by the Federal Court in
F.C. of T. v. Lau 84 ATC 4929. Whilst the material facts in Lau bear some pale resemblance to those presently before me, the critical distinction between the two cases on this point is that in the former, the
ATC 676Commissioner expressly disclaimed ``sham''; in the instant case he relies upon it, and, in my view, properly so.
22. In summary, I find that the various loan agreements were not intended to take effect according to their tenor and were mere ``war paint'', designed to lend some verisimilitude to a blatant tax avoidance scheme.
23. If, as I find, the purpose of the various active participants in this scam was to avoid tax, that purpose colours the outgoing and removes it from the protective umbrella of sec. 51(1). In
F.C. of T. v. Ilbery 81 ATC 4661, Toohey J. (in whose judgment the other two members of the Court concurred) stated (at p. 4667):
``As Brennan J. pointed out (in
the Magna Alloys case 80 ATC 4542 at p. 4547):
- Though purpose is not the test of deductibility nor even a conception relevant to a loss involuntarily incurred, in cases where a connection between an outgoing and the taxpayer's undertaking or business is affected by the voluntary act of the taxpayer, the purpose of incurring that expenditure may constitute an element of its essential character, stamping it as expenditure of a business or income-earning kind.'
Conversely, I would add, purpose may stamp the outgoing as one having no relevant connection with the gaining or producing of assessable income.''
To the extent that this loss requires characterisation, I find that it is a loss or outgoing directed toward one purpose only: to obtain a tax deduction. As such, it requires some courage to claim it as an allowable deduction as a loss or outgoing incurred in the derivation of assessable income.
24. In the alternative, the respondent relied, albeit faintly, on some provisions enshrined in Subdiv. D of Div. 3 of the Tax Act (sec. 82KH to 82KL).
25. ``Tax avoidance agreement'' is defined in sec. 82KH as follows:
```tax avoidance agreement' means an agreement that was entered into or carried out for the purpose, or for purposes that included the purpose, of securing that a person who, if the agreement had not been entered into or carried out, would have been liable to pay... less income tax in respect of that year of income than that person would have been liable to pay if the agreement had not been entered into or carried out;''
Section 82KJ provides:
- (a) a loss or outgoing in respect of which a deduction would, but for this Subdivision, be allowable, was incurred by a taxpayer after 19 April 1978 by reason of, as a result of or as part of a tax avoidance agreement;
- (b) having regard to the benefit in respect of which the loss or outgoing was incurred (but without regard to any benefit relating to the acquisition or possible acquisition of the property referred to in paragraph (c)), the amount of the loss or outgoing was greater than the amount (if any) that might reasonably be expected to have been incurred, at the time when the loss or outgoing was incurred, in respect of that benefit if the loss or outgoing had not been incurred by reason of, as a result of or as part of a tax avoidance agreement;
- (c) property has been, will be, or may reasonably be expected to be, acquired by the taxpayer or by an associate of the taxpayer as a result of, by reason of, or as part of the tax avoidance agreement; and
- (d) the consideration (if any) that was payable in respect of the acquisition of that property was less, or the consideration that may reasonably be expected to be payable in respect of the acquisition of that property is less, than the consideration that might reasonably be expected to have been payable, or to be payable, as the case may be, in respect of the acquisition of that property if the loss or outgoing had not been incurred,
notwithstanding any other provision of this Act, a deduction is not allowable to the taxpayer in respect of the loss or outgoing.''
Section 82KL(4) provides:
- (a) an amount of eligible relevant expenditure is incurred by a partnership;
- (b) apart from this sub-section, this section would not operate to deem a tax benefit not to be allowable and never to have been allowable in respect of any part of that amount of eligible relevant expenditure; and
- (c) the Commissioner is satisfied that any partner in the partnership became a partner in the partnership by reason of or as a result of an agreement (whether or not that agreement was the agreement by virtue of which the partner became a partner in the partnership) that was entered into by any of the parties to the agreement for the purpose, or primarily for the purpose, of ensuring that this section would not operate to deem a tax benefit not to be allowable and never to have been allowable in respect of any part of the amount of the eligible relevant expenditure,
then, notwithstanding any other provision of this Act, a tax benefit is not allowable and shall be deemed never to have been allowable in respect of any part of that amount of eligible relevant expenditure.''
26. Although neither party was able to cite any relevant decisions dealing with these sections, I am satisfied that, in the alternative, the agreement between the partners and the production company constitutes a ``tax avoidance agreement'' as defined, and that sec. 82KL covers the situation where - as in this case - a partnership ``borrows'' an amount equivalent to 85% of its investment, and thereupon becomes ``liable'' to pay interest on the borrowed funds. Here, the only real money - $150,000 - is gobbled up between the lawyers and the production company, the balance - $851,000 - has the same degree of reality as Hamlet's ghost. Yet it is solemnly submitted that, having ``repaid'' the loan of $851,000, the partnership thereupon becomes entitled to receive, tax free, an amount equivalent to 85% of its share in the expenditure as ``eligible relevant expenditure''. I cannot accept that view. As I read these sections, they have the effect of rendering ineffective, as against the Commissioner, any arrangement entered into by a taxpayer pursuant to which he/she becomes a partner in a partnership which is conducted for the purpose (whether, ``primary'', ``sole'', ``main'', or ``dominant'') of incurring paper losses from its business activities. In the instant case, this taxpayer entered into the impugned arrangement for the primary purpose of reducing her taxable income. In the circumstances, she cannot rely on any provisions contained in Subdiv. D of Div. 3. Mr Davies attempted to extricate himself from the dilemma posed by these sections by submitting that sec. 82KL had no application to this case, being limited to partnerships: (``Where - (a) an amount of eligible relevant expenditure is incurred by a partnership...'') and, in any event, is limited to cases where it can be shown that the parties entered into an agreement for the primary purpose of avoiding the provisions of sec. 82KL. Even assuming that this somewhat narrow interpretation of this section is correct, it can offer little comfort to this taxpayer, who, as I have found, had no discernible reason for joining this partnership other than to obtain a precalculated tax deduction. She is thus caught even within the limited meaning afforded the section by Mr Davies. In any event, the definitional provisions of sec. 82KH appear to me to identify, for tax purposes, a partner with the partnership; cf. sec. 82KH(1)(d).
27. In the circumstances, Mr Davies' interesting and instructive argument on the meaning of ``benefit'' in sec. 82KH(1J), and whether or not the release of the debt by Media Finance constitutes such a ``benefit'' to the partners for tax purposes need not be pursued.
28. For the above reasons, I would affirm the Commissioner's decisions on the objections in the two years now under review.