HENRY JONES (IXL) LIMITED v FC of T

Judges:
Sweeney J

Court:
Federal Court

Judgment date: Judgment handed down 5 February 1991

Sweeney J

This matter came before the Court by way of a Notice of Referral filed on 12 August 1988 by the respondent Commissioner of Taxation (``the Commissioner'') pursuant to a request by Henry Jones (IXL) Limited (``the taxpayer'') under S. 187 of the Income Tax Assessment Act 1936 (``the Act'') that the Commissioner refer to the Court his decision, which the taxpayer received on 5 June 1987, by which the Commissioner disallowed the taxpayer's Notice of Objection dated 19 April 1984, lodged against an assessment to income tax in respect of the year of income ended 30 September 1982. By the Notice the taxpayer objected to the Commissioner's inclusion in the assessment of the sum of $7,581,691 as assessable income.

On 24 October 1988, pursuant to an order of Jenkinson J, the Commissioner filed his grounds for disallowing the taxpayer's objection to the assessment of income tax in respect of the year of income ended 30 September 1982, which included the following:

``1. The Applicant, HENRY JONES (IXL) LIMITED , is and was at all material times the holder of or beneficially entitled to all of the shares in the issued capital of Kyabram Preserving Co. Ltd. (`Kyabram').

2. At all relevant times the Applicant was engaged in the business of exploiting a series of labels, trade marks, trade names and licenses (`the Henry Jones Group Labels').

3. By an agreement (`the Licence Agreement') made on or about 18th December 1981 between the Applicant, Kyabram, Ardmona Fruit Producers Co-Operative Co. Ltd. (`Ardmona') and SPC Limited (`SPC') -

(a) the Applicant and Kyabram granted to each of Ardmona and SPC, for the period of 10 years commencing on 1st January 1982, the right to use the Henry Jones Group Labels anywhere in the world in relation to the production and marketing of canned fruits;

(b) in consideration thereof Ardmona and SPC agreed to pay to the Applicant and Kyabram in each year during the term of the agreement a royalty equal to 5% of the net value of sales of canned fruits under the Henry Jones Group Labels during the immediately preceding year.

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PARTICULARS

The Licence Agreement was in writing and a copy of the agreement is in the custody of the Respondent's solicitor at whose offices the same may be inspected.

4. By an instrument of assignment made on or about 28th May 1982 between the Applicant, Kyabram and Citicorp Canberra Pty. Ltd. (`Citicorp') -

(a) the Applicant and Kyabram sold and assigned to Citicorp their right to receive the moneys due or to become due under the Licence Agreement;

(b) in consideration thereof, Citicorp paid to the Applicant the sum of $7,581,691.

PARTICULARS

A copy of the assignment is in the custody of the Respondent's solicitors at whose offices the same may be inspected.

5. Contemporaneously with the making of the assignment -

(a) the Applicant entered into a Security Agreement with Citicorp whereby -

(i) the Applicant agreed to pay to Citicorp a funding fee (equal to the difference between the amount received by Citicorp by way of moneys due or to become due under the Licence Agreement and the amount, called the `Expected Royalty Payment', set out in column 1 of the Schedule to the Security Agreement);

(ii) the Applicant agreed to procure that Elders IXL Ltd., the Applicant's ultimate holding company, guarantee to Citicorp the due and punctual performance by the Applicant of its obligations under the Security Agreement;

(b) Elders IXL Ltd. executed in favour of Citicorp a guarantee of the due and punctual payment by the Applicant of all funding fees, interest and other moneys payable by the Applicant under the Security Agreement and the due performance and observance by the Applicant of the terms of the Security Agreement and by the Applicant and Kyabram of the terms of the assignment.

PARTICULARS

A copy of the Security Agreement and of the guarantee are in the custody of the Applicant's solicitors at whose offices the same may be inspected.

6. Accordingly -

(a) the Applicant received the sum of $7,581,691 in exchange for the future moneys which it otherwise would have received under the Licence Agreement; and

(b) the $7,581,691 represented income in the hands of the Applicant in accordance with ordinary concepts under S. 25 of the Act.

7. Further or alternatively to paragraph 6 hereof the $7,581,691 represented the profit arising from the sale by the Applicant of property acquired by it for the purpose of profit-making by sale, or from the carrying on or carrying out of a profit-making undertaking or scheme, in accordance with S. 26(a) of the Act.

8. Further or alternatively to paragraph 7 hereof -

(a) the entry by the Applicant into the Licence Agreement and the acquisition by the Applicant of the right to receive moneys under that agreement constituted part of its income earning activities;

(b) at all relevant times the Applicant intended to turn the Licence Agreement and the right to receive moneys thereunder to its best possible advantage;

(c) in entering into the assignment and the Security Agreement, and by procuring that Elders IXL Ltd. executed the guarantee, the Applicant turned the Licence Agreement and the right to receive moneys thereunder to what the Applicant perceived to be its possible advantage,

and accordingly the $7,581,691 received by the Applicant was income in its hands in accordance with the ordinary concepts under S. 25 of the Act.

9. Further or alternatively to paragraph 8 hereof the $7,581,691 received by the Applicant represented profits from the carrying on of the Applicant's business and

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was accordingly income according to ordinary concepts under S. 25 of the Act.''

The Commissioner originally included grounds relating to Part IVA of the Act but did not rely upon them at the hearing.

The matter came on for hearing on 27 August 1990 with Mr AJ Myers QC leading Mr J de Wijn for the taxpayer. Mr BJ Shaw QC and Mr GA Nettle appeared for the Commissioner. Mr Myers QC in his opening described the amount of $7,581,691 as being received by the taxpayer ``in a lump sum as the consideration for the assignment of rights under a licence agreement''.

The taxpayer's case, as outlined in its written submissions, was that ``for many years before 1981 the taxpayer had been involved in the deciduous canned fruit business both directly and through its wholly owned subsidiary Kyabram Preserving Co. Ltd (`Kyabram')''.

The organisation of the business was described as follows:

``Kyabram carried on manufacturing operations, Henry Jones Limited was the authorised agent of the government selling authority and sold the product. The taxpayer held most of the labels or trade names used in the business and provided management assistance to its two subsidiaries.''

The taxpayer submitted that the deciduous canned fruit business was conducted as a group activity by the three companies, namely the taxpayer, Kyabram and Henry Jones Limited under the management of a division called the Food Group. These companies, it was said, did not carry on separate and distinct businesses, but rather, carried on one business together.

The taxpayer was described as having a long involvement in the deciduous canned fruits industry, dating back to the last century. For a number of years leading up to and including the 1981-82 financial year, it and a number of its subsidiaries, loosely grouped in divisions, had interests in that industry.

In one of those divisions, the General Products Division, Kyabram canned and sold all of its production of deciduous fruits to the Australian Canned Fruits Council under labels, some of which were owned by Kyabram and others owned by the taxpayer and made available to Kyabram without charge.

That Council appointed Henry Jones Limited, another subsidiary of the taxpayer, as the agent of the Council to sell that produce under those labels. At all relevant times the taxpayer provided management services to its many subsidiary companies, including Henry Jones Limited and Kyabram.

In or about 1980, the submission continued, the taxpayer decided that it and its subsidiaries should leave the deciduous canned fruits industry, in which it no longer regarded it as possible to operate profitably in competition with its competitors, each of which was a co-operative. It made a decision to vacate the market ``no matter what'', and if a buyer could not have been found, it would probably have simply closed its doors.

From 1972 onwards the taxpayer had a continuing policy of monitoring the activities of all its ``divisions'', and of selling off or dropping activities which were not sufficiently profitable to meet its test of achieving a 20% return on invested capital.

At a meeting held within the taxpayer's organisation in August 1981 it was decided that, as the canned deciduous fruits business then being carried on was not capable of satisfying the 20% test, it should be sold, or if no buyer could be found, should be shut down.

After that decision was taken, Mr Peter Scanlon, a director of the taxpayer entered into negotiations with Shepparton Preserving Co. (``SPC'') and Ardmona (``Ardmona'') to negotiate a deal with them in respect of the deciduous fruit canning business.

At a very early stage of these negotiations, SPC and Ardmona made it clear that there were two prerequisites of any purchase by them -

(1) that payment of the sum of $12.5 million which had been mentioned must be made by instalments over time;
(2) that the payment must be fully tax deductible by SPC and Ardmona.

Mr P Scanlon had no discussions, either in the Henry Jones group of companies or with outside advisers, concerning liability by it or members of it to taxation upon the payments proposed to be made by SPC and Ardmona.

Mr Brian Scanlon, on behalf of SPC and Ardmona on 8 October 1981 in a telex to Mr P Scanlon said, amongst other things, that their

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ability to agree upon a purchase price was based on an ability to make savings from a rationalised production and sales structure, that there was not sufficient available from the rationalisation to allow for payment to be made on an after tax basis, so that payments ``must be of a deductible nature''.

The taxpayer accepted this as an inescapable requirement. It was proposed that it should receive a payment from Ardmona and SPC of $12 million, by instalments, plus an amount of $667,000 by reason of the costs involved in the retrenchment of employees. Before Mr P Scanlon ceased to be involved in the negotiations, he had agreed that payments be made over a number of years from 1981 to 1992. From that point on he did not take any significant part in the negotiations. He did not have any discussions with other officers or employees of the taxpayer in relation to the question of the payments to be made to the taxpayer being non-taxable in its hands because he was operating, he said, ``under the assumption that they were non-taxable as a capital nature''.

The negotiations were then taken over by other officers of the taxpayer and at a meeting on 12 October 1981 with representatives of SPC and Ardmona, it was noted that they required deductibility and the taxpayer required a tax free receipt. Those officers of the taxpayer, according to Mr Hooke, who was one of them, ``were attempting to get the deal completed without considering the tax ramifications of that and were leaving that up to people in corporate (sic) to handle. And when I use `corporate' I mean people in Elders - in Henry Jones IXL corporate''.

Mr Hooke had commenced employment with Henry Jones Limited on 1 August 1981 as the finance administrator of certain subsidiary and associated companies of Henry Jones Limited, including the taxpayer and Kyabram. His instructions at the time of the negotiations with SPC and Ardmona were ``to close the transaction and effectively take whatever structure of the deal that SPC and Ardmona put to us''.

Minutes of a meeting between representatives of the parties on 5 November 1981 were tendered by the Commissioner as Exhibit L, in which SPC and Ardmona were referred to as ``S and A'', which included the following items:

``TAXATION : S & A advised that the legal agreement must be centred around a 10 year lease/user right agreement of all labels.

S & A advised that care must be taken in any press statements in order that the tax situation is not put in jeopardy.

SECURITY : S & A to meet with the Treasurers and request a government guarantee for total debt. This meeting will be held on Tuesday, 10th November.

If the government guarantee is not forthcoming, further discussions would need to be undertaken to determine an additional price to cover further discounting costs.''

Mr KC Jarrett was in 1981 the Treasurer of the taxpayer and later became its Chief Financial Officer and Chief Executive of Elders Finance Group Limited until 30 June 1990 when he ceased employment with any of the companies.

He gave evidence that he was told by Mr Hooke in November 1981 that a transaction had been completed involving paying some royalty payments over a period of some 10 years. ``I think,'' he (Mr Hooke) ``basically told me that we had agreed to exit the business, that we were to receive some royalty payments over a period of 10 years and I am certain that he told me what the amounts were.'' Under cross-examination, he said that as soon as he was told of the nature of the transaction it was obvious to him that ``we should get cash today, not wait for 10 years to get it''. He thought that ``someone else would be prepared to buy those payments at a price which would be attractive to us because they would not have a 20% return criteria''.

The applicant in its written submissions said:

``The refinement of the deal into one whereby the $12.5 million was to be paid by way of minimum royalty payments was imposed on Henry Jones because -

(a) Henry Jones had decided to vacate the industry `no matter what'; and

(b) Ardmona and SPC insisted that the sale be arranged in such a way as would (so they believed) entitle them to a tax deduction (see, for example, pp. 145.1, 242.8, 279.1 and Exhibits J and L).

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Henry Jones did not choose the royalty arrangement (p. 140.1). Hooke's instructions were to complete the sale regardless of how the payments came (pp. 145.2-4 and 148). Willaton's evidence at p. 290 was that Henry Jones was keen to push the deal along.''

(Willaton was company secretary of SPC.)

Mr Hooke deposed that a licence agreement was made on or about 16 December 1981 between the taxpayer and Kyabram of the one part (the licensors) and SPC and Ardmona of the other part (the licensees), the terms of which, omitting formal parts read as follows:

``WHEREAS

A. The Licensors have been engaged for many years in the production and marketing of canned fruits (within the present meaning of the Canned Fruits Marketing Act 1979) under the labels, trade marks, trade names and licence described in the Schedule hereto (which labels, trade marks, trade names and licence are herein referred to as `the Henry Jones Group labels') and have built up a substantial goodwill in the Henry Jones Group labels.

B. The Licensees are also engaged in the production and marketing of canned fruits and believe that they can utilise excessive productive capacity by taking an exclusive licence (subject only as hereinafter provided) of the Henry Jones Group labels in relation to the production and marketing of canned fruits and as herein provided.

NOW THIS AGREEMENT WITNESSETH as follows:

1. Subject to the payments hereinafter set out the Licensors in their joint and several capacities grant to each of the Licensees for the period of ten years commencing on 1 January, 1982, the right (to be sole and exclusive subject only to the right also conferred hereby on the other Licensee the rights granted to Riverland Fruit Products Co-Operative Ltd. (Receivers and Managers appointed) pursuant to an Agreement dated 21 July, 1978 between that Company and Henry Jones (IXL) Ltd. and the rights granted to Picardi Canners Ltd. of South Africa in relation to the continent of Africa and Mozambique at the date of this Agreement) to use the Henry Jones Group labels anywhere in the world in relation to the production and marketing of canned fruits.

2. To the extent that the Licensors or either of them have registered rights in respect of the Henry Jones Group labels the Licensors will at the written request of the Licensees jointly and severally do all that is reasonable at the cost of the Licensees to ensure that each of the Licensees becomes a registered or permitted user of the Henry Jones Group labels or any of them in relation to the production and marketing of canned fruits.

3. Each of the Licensees covenants with the Licensor that it shall:

(a) Maintain the quality of canned fruits produced and marketed by it under each of the Henry Jones Group labels at least at the same standard as canned fruits produced and marketed by the Licensor immediately prior to the date of this Agreement under the respective labels;

(b) Ensure that the canned fruits produced and marketed under the Henry Jones Group labels are presented to any purchaser at a high standard consistent with the standard of such presentation by the Licensors prior to the date hereof;

(c) Subject to Henry Jones providing at its cost printing plates in a reasonable form ensure that the get up and labelling of products sold under this Agreement corresponds with the get up and labelling by the Licensors or their nominees or third party Licensees of products other than canned fruit under the respective Henry Jones Group label provided however that the Licensees may use all their existing stocks of labels prior to complying with this paragraph; and

(d) Maintain until the registration of the debenture charges referred to in clause 7 the market share and position and do all that is reasonably possible to maintain the shelf space presently afforded by retailers to products bearing Henry Jones Group labels.

4. The Licensors jointly and severally covenant with each of the Licensees that for the period of this Agreement and so long as one or more of the Licensees is not in breach of any of its obligations to the

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Licensors under clause 5, except in relation to sales at no greater than 1981 level within the area referred to in clause 1 of canned fruits produced by Picardi Canners Ltd. the Licensors will not and will ensure that none of its related corporations (within the meaning of Section 6 of the Companies Act 1961 of Victoria) will directly or indirectly sell canned fruits under any of the Henry Jones Group labels or otherwise make use or permit any party other than the Licensees to make use of the Henry Jones Group labels for this purpose.

5. (a) In consideration of the user rights hereby conferred upon it each of the Licensees shall pay to the Licensors on the 31 March in each year during the term of this Agreement commencing 31 March 1983 a royalty equal to 5% of the net value of its sales of canned fruits under the Henry Jones Group labels worldwide during the calendar year ending on the immediately preceding 31 December provided that the following minimum royalties shall be payable by each of the Licensees to the Licensors -
      For the calendar years 1982 to 1986
        (both inclusive)                     $750,000
      For the calendar years 1987 to 1991
        (both inclusive)                     $500,000
          
(b) A Licensee which fails to make a royalty payment on the due date shall be liable to pay to the Licensors in addition to the said royalty interest thereon calculated on a daily basis at the rate equal to the Australian Merchant Bankers' Association Prime Rate for 90 day bills from time to time plus a margin of 1.5% per annum or if the Australian Merchant Bankers' Association Prime Rate is for any reason not available at the rate of 17% per annum for the period from the due date until the date of payment thereof.

(c) The Licensees shall each permit the auditors of the Licensors at all reasonable times during the month of April in each year to examine its books of account to verify the net value of its sales of canned fruits under the Henry Jones Group labels during the relevant calendar year and the amount of the said royalty payable to the Licensors.

6. (a) If a Licensee defaults in the payment of the royalty payable by it hereunder for more than 14 days after the Licensors have given notice in writing to that Licensee of such default the Licensors may without prejudice to their other rights under this Agreement determine that Licensee's rights in respect of the Henry Jones Group labels as herein provided. A Licensee whose rights are so determined may not thereafter be the continuing Licensee for purposes of paragraph (b).

(b) Where the Licensors pursuant to paragraph (a) of this clause determine the rights of a Licensee (`the defaulting Licensee') under this Agreement the Licensors shall immediately advise the other Licensee (`the continuing Licensee') in writing of such determination and if the continuing Licensee is not then in default in the performance of any of its obligations under this Agreement it will have the right to be exercised within 21 days of being so advised of the service of a notice in accordance with clause 6(a) hereof on the defaulting licensees and on payment to the Licensors of all moneys owing to them by the defaulting Licensee and electing in writing to do so to assume all rights and obligations of the defaulting Licensee under this Agreement. In the event of such payment and election by the continuing Licensee the breach of obligation by the defaulting Licensee under this Agreement shall be deemed remedied and the Licensors will jointly and severally covenant with the continuing Licensee that for the period of this Agreement and so long as the continuing Licensee is not in breach of any of its obligations to the Licensors under clause 5, except as provided in clause 4 the Licensors will not and will ensure that none of its related corporations (within the meaning of Section 6 of the Companies Act 1961 of Victoria) will directly or indirectly sell canned fruits under any of the Henry Jones Group labels or otherwise make use of or permit any party other than the continuing Licensee to make use of the

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Henry Jones Group labels for this purpose.

7. In order to secure to the Licensors the payments due to them pursuant to this Agreement each of the Licensees will on the request in writing of the Licensors grant to the Licensors by 31 January 1982 a charge over its assets and undertaking in a form agreed by the parties. Each of the Licensors agrees that as a pre-condition of the obligation of the Licensees and each of them to grant such charge it will until such time as the said charge becomes fixed enter into such deeds or agreements of priority or postponement as the relevant Licensee requires acknowledging that subject to any agreement to the contrary by the parties such charge ranks for payment behind any other charge securing borrowings by that Licensee. The parties to a charge given pursuant to this clause shall bear their own costs in relation to the preparation of the charge.

8. Upon the expiration of this Agreement by effluxion of time or other earlier determination of a Licensee's rights pursuant to clause 6 or upon default by a Licensee in the performance of its obligations under clause 7 the rights in respect of the Henry Jones Group labels hereby conferred upon the Licensees or that Licensee (as the case may be) shall become the property of Elder Smith Goldsbrough Mort Ltd. or its nominee and such corporation or its nominee shall be required to assume the period until 29 March 1989 or such later date as is from time to time nominated in writing by Henry Jones the obligations of the Licensee's hereunder or the continuing Licensee (as the case may be). The parties hereto acknowledge that the provisions of this clause and the assumption of such obligations by such corporation or its nominee shall not in any manner whatsoever affect the existence or quantum of damage suffered by the Licensors by reason of a default by a Licensee or determination of a Licensee's rights and for all purposes relating to the liability of the Licensees and the quantum of such damage:

(a) the assumption of obligations by the said corporation or its nominee shall be disregarded; and

(b) the Licensors shall be deemed not to have received or be likely to receive or have any contractual or other rights whatsoever to receive royalties from such corporation or its nominee.

9. All moneys payable to the Licensors hereunder may be paid to Kyabram Preserving Co. Ltd. or its assignee.''

On or about 16 December the same parties executed a Quota Share Agreement which Mr Hooke described as follows:

``In consideration of $370,000 to be paid to each of Ardmona and SPC the quota rights of the (taxpayer) and Kyabram to produce and market canned deciduous fruit pursuant to the Canned Fruit Marketing Act 1979 were to be reallocated to Ardmona and SPC.''

On or about the same day the parties also executed an agreement in relation to the sale of stock and other items and another agreement, called ``Restraint of Trade Agreement'', pursuant to which the taxpayer and Kyabram agreed with Ardmona and SPC that for a period of 10 years the taxpayer and Kyabram would not be engaged or interested in the manufacture, processing, canning, exporting or sale or dealing in canned deciduous fruits.

Paragraphs 18-21 and 26-28 of Mr Hooke's affidavit of 16 November 1989 read as follows:

``18. On or about 16 December 1981 the Applicant, Kyabram, Ardmona and SPC executed an agreement in relation to Riverland Fruit Products Co-operative Limited whereby, supplemental to the license agreement, the Applicant and Kyabram undertook to use their best endeavours to ensure that Ardmona and SPC would become responsible for the marketing of Riverland's production of canned deciduous fruits pursuant to an agreement between the Applicant and Henry Jones Limited and Riverland dated 21 July 1978

...

19. On or about 16 December 1981 SPC granted to the Applicant and Kyabram a floating charge as to its undertaking and assets, and a fixed and specific charge in relation to its goodwill, uncalled and called but unpaid capital, its leasehold and freehold land, and other assets, in order to secure the payment to the Applicant and

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Kyabram of the moneys owing to it under the license agreement...

20. I was involved in negotiating the terms of each of the above agreements but the final terms thereof were settled between solicitors acting for the Applicant and Kyabram and the solicitors acting for Ardmona and SPC. The payment of the $12.5 million by way of license fees was proposed by Ardmona and SPC. As far as the Applicant and Kyabram were concerned, their objective was to achieve a satisfactory sale price for their businesses. The Applicant and Kyabram wanted a lump sum payment for the businesses but Ardmona and SPC made it clear that this was not possible. Consequently, a sale price of $12.5 million was negotiated, payable by instalments over 10 years. The calculation of $12.5 million was not based on expected sales but on the Applicant's estimate of the value of the business and goodwill, given the payments were to be by instalment. Although the license granted provides for the payment of a license fee of 5% of the net value of the sales subject to minimum payment guaranteeing the 10 instalments referred to above, it was not contemplated by the Applicant or Kyabram that there would be sufficient sales of products under the relevant labels to result in payments exceeding the minimum annual payments. In fact, no payments in excess of the minimum annual payment have been made. Further, no enquiries have been made by the Applicant or Kyabram as to the level of sales achieved by Ardmona and SPC.

21. I was not at any time, nor to my knowledge was any other person involved in negotiations with Ardmona or SPC, engaged in any negotiations with Citicorp for the assignment of any rights under the agreement with Ardmona or SPC while the substantive negotiations with SPC and Ardmona were taking place...

26. On or about 28 May 1982 the Applicant sent a Notice of Assignment to Ardmona and SPC notifying them that the Applicant and Kyabram had assigned to Citicorp their interest under the licence agreement, and directing them to make all payments due thereunder to Citicorp...

27. On or about 28 May 1982 the Applicant and Kyabram executed the Security Agreement whereby the Applicant agreed to procure Elders IXL Ltd to execute a guarantee to Citicorp, and pay a funding fee to Citicorp if the notional interest rates upon which the assignment lump sum was calculated were less than the actual future interest rates plus Citicorp's fee for making the assignment...

28. On or about 28 May 1982 Elders executed a guarantee to Citicorp guaranteeing the payment by the Applicant of the funding fee due under the security agreement to Citicorp...''

The licence agreement was expressed to operate for a period of 10 years commencing on 1 January 1982. Clause 6(a) conferred upon the licensors the right, if a licensee were to default in payment of royalties, to determine its rights in respect of the labels, subject to the terms of the clause. Clause 8 provided that, upon the expiration of the agreement by effluxion of time or other earlier determination or upon default by the licensees, the labels should become the property of Elders Smith Goldsbrough Mort Ltd, nominated for this purpose by the taxpayer.

Clause 6(e) of the Quota Share Agreement read as follows:

``(e) if Henry Jones and Kyabram become entitled under the terms of a Licence Agreement with Ardmona and SPC in relation to the use of the Henry Jones Group labels to determine the rights of either Ardmona or SPC or both of them in relation to the use of those labels (and the continuing Licensee has not assumed the rights and obligations of the defaulting Licensee under the terms of the Licence Agreement) and so advises the Corporation in writing, the quota for the remainder of the said seasons shall be re-allocated as follows:

(i) Where the rights of Ardmona have been so determined:

(a formula was then set out)

(ii) Where the rights of SPC have been so determined:

(a formula was then set out)

(iii) Where the rights of both Ardmona and SPC have been so determined, the

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quota shall immediately be re-allocated amongst the said canners (including Henry Jones and Kyabram) in the same manner as for the 1981 season.''

The Restraint of Trade Agreement included the following term:

``Notwithstanding the foregoing provisions this Agreement shall cease to have any effect if:

(i) there is a re-allocation of quota to the Covenantors or either of them pursuant to the Quota Share Agreement;

(ii) the Licence conferred on the Purchasers by the Covenantors under a Licence Agreement of even date (`the Licence Agreement') in respect of the Henry Jones Group labels is determined in respect of the Purchasers or either of them pursuant to the Licence Agreement and the obligations of the defaulting Licensee are not assumed by the continuing Licensee;

(iii) under an agreement of even date between Kyabram and the Purchasers in relation to the sale of canned fruits stock tinplate and raw materials used for the manufacture of fruit cocktail there is a default by the Purchasers in the payment of moneys due pursuant to that agreement which continues for more than 30 days after notice in writing from Kyabram requiring them to remedy such default; or

(iv) there is a breach of any monetary obligation under the Quota Share Agreement.''

There was also a contemporaneous agreement between the parties described as being in relation to Riverland Fruit Products Co-operative Ltd, whereby, supplemental to the Licence Agreement, the taxpayer and Kyabram undertook to use their best endeavours to ensure that Ardmona and SPC would become responsible for the marketing of Riverland's production of canned deciduous fruits pursuant to an earlier agreement between the taxpayer and Henry Jones Limited and Riverland.

In an assignment in writing dated 28 May 1982 between the taxpayer and Citicorp Canberra Pty Limited (``Citicorp'') it was recited that:

``WHEREAS :

A. The Licensors are the Licensors under a Licence Agreement dated 18 December, 1981 between the Licensors of the one part and Ardmona Fruit Products Co-operative Ltd. of Young Street, Mooroopna, Victoria and SPC Ltd. of Andrew Fairley Avenue, Shepparton, Victoria (hereinafter called `the Licensees') of the other part (hereinafter referred to as `the Licence Agreement').

B. Pursuant to the Licence Agreement the Licensors are entitled to certain payments of royalties (the said royalties being referred to in this Assignment as `the royalty payments') and interest thereon and costs.

C. The Licensors wish to assign to Citicorp all of their right title and interest in and to the royalty payments and interest thereon and costs and Citicorp has agreed to accept the assignment of the royalty payments and interest thereon and costs on the terms and conditions herein contained.''

Clauses 1 and 2 of the assignment read as follows:

``1. Assignment

The Licensors in consideration of the sum of Seven million five hundred and eighty-one thousand six hundred and ninety-one Australian dollars ($7,581,691.00) paid to them by Citicorp on the date hereof in Canberra (the receipt whereof is hereby acknowledged) hereby as beneficial owners transfer convey and assign to Citicorp absolutely the whole of their right title and interest under the Licence Agreement including the moneys due or to become due as the royalty payments and interest thereon and costs pursuant to the Licence Agreement and it is acknowledged that Citicorp shall be entitled beneficially from the date hereof to all the right title and interest of the Licensors in and to the royalty payments and interest thereon and costs including without limiting the foregoing the Licensors' rights pursuant to Clause 5, 6, 7 and 8 of the Licence Agreement.

2. Notice of Assignment

The Licensors shall notify the Licensees of the assignment hereby made and shall

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therein instruct the Licensees henceforth to pay the royalty payments and interest thereon and costs directly to Citicorp in Canberra or otherwise as Citicorp may from time to time direct. The Licensors shall furnish Citicorp with a copy of the notice so given.''

The taxpayer, through the affidavits filed on its behalf, set out to establish that it was only after the licence agreement with SPC and Ardmona had been entered into that it occurred to it that the stream of royalties to be paid under that agreement might be assigned to a bank or other financial institution in return for a lump sum payment.

At the trial counsel for the Commissioner cross-examined the taxpayer's deponents and also called a number of witnesses on subpoena. As has been noted, Mr Jarrett said in cross-examination that in November 1981 when he was told of the nature of the transaction, it was obvious to him that the taxpayer ``should get cash today not wait for 10 years to get it''. The relevant written agreements were entered into on or about 16 December 1981.

It emerged from the taxpayer's own case that it originally wished to obtain a lump sum payment as consideration for its interests in the deciduous fruits canning business, but the only available parties, SPC and Ardmona, were able to offer payment only by instalments over a term of years. They also made it clear that any agreement to be made by them would have to be in a form which would clearly enable them to obtain deductions in respect of the instalment payments. The taxpayer's position was that it had decided that it must ``exit the business'' and to do so it had no choice but to enter into an agreement so drawn as to ensure the taxation objectives of SPC and Ardmona.

The Commissioner contended that the taxpayer did not itself have a fruit canning business but had the rights to a number of marks and labels which it assigned to SPC and Ardmona for a term of years, at the end of which they reverted to it. The 1981 transaction with SPC and Ardmona, it was submitted on behalf of the Commissioner, caused no disruption to the activities of the taxpayer or any change in them. However, it changed the taxpayer's situation in that administration services to Kyabram in relation to the conduct of its canning activities were no longer required from it.

When Mr P Scanlon was cross-examined it emerged that for a number of years up to and including 1981-82 the taxpayer carried on business as the holding company of a number of subsidiaries, to which it provided management services. This was confirmed by the evidence of Mr Hooke and Mr Jarrett. Those witnesses accepted that the taxpayer itself did not have any canned fruit business.

The subsidiaries of the taxpayer were grouped into ``divisions'' but, as counsel for the Commissioner put it, it was the subsidiaries and not the taxpayer which conducted the various businesses.

The Commissioner called the following witnesses on subpoena, Mr Taylor, the General Manager of Ardmona, Mr Turnbull, its Chairman, Mr Willaton, formerly the Company Secretary of SPC, Mr Miller, who had been at one time a taxation partner of Price Waterhouse and at another time an employee of the Elders Group, concerned with its taxation affairs, and Miss Ward, a taxation partner of Price Waterhouse.

In the final submissions in writing of counsel for the Commissioner filed on 14 September 1990 it was submitted as follows:

``20. It emerged from the evidence given in cross-examination and from evidence given in chief by Mr. Hooke, after the cross-examination of Mr. Scanlon, that for a number of years leading up to and including the 1981-1982 financial year HJIXL carried on business as the holding company of a number of subsidiaries providing management services to the subsidiaries (Scanlon at 63; Hooke at 119-123; Jarrett at 195 and 217). HJIXL itself did not have any canned fruit business at all (Scanlon at 60-63; Hooke at 119-123; Jarrett at 195-196, 217). Both HJIXL's accounts and the agreements of December 1981 confirm this, as the accounts for the 1981 and 1982 show that HJIXL had no income at all from any such business (Exhibits `D' at p. 60 and `C' at p. 51) and the agreements of December 1981 do not provide for the disposition of any canned fruit stock, plant or equipment by HJIXL. HJIXL's subsidiaries carried on a wide range of businesses in different industries. Because

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of the disparate nature of the subsidiaries and the businesses which they conducted numbers of the subsidiaries were loosely grouped in what HJIXL described as divisions (Jarrett at 218, 222 and 229). But it was the subsidiaries and not HJIXL itself which conducted the various businesses of these divisions.''

Reference was made to the taxpayer's income returns for the year ended 30 September 1981 and 1982 as showing that in 1981 and 1982 the taxpayer was substantially acting as the holding company of the group. The submission continued as follows:

``It (the taxpayer) provided management services to its subsidiaries and derived income largely from that activity and its position as holding company of the group. But it also had a number of other sources of income which were relatively minor in comparison to the income it derived from its subsidiaries either by way of management services or dividends. One of those minor sources of income was royalties. In both 1981 and 1982 it derived royalty income from General Jones Pty. Ltd. and Provincial Traders Pty. Ltd., by licensing marks and labels (Exhibits `D' at p. 43 and `C' at p. 47). And it had no canned fruit business. That business (like the other businesses in the group's various divisions) was `operated by an underlying subsidiary'. (This was a quotation from the taxpayer's return.)

21. HJIXL had many subsidiaries. A list appears in Exhibit `P' at p. 28. As stated above, for convenience the business the subsidiaries conducted were grouped into divisions. The divisions were Food Processing and Marketing, and Specialist Businesses. The Food Processing and Marketing division was subdivided into an Australian and overseas subdivision and these subdivisions were further subdivided into Australia -

(1) frozen foods;

(2) general products; and

(3) margarine and oils.

Overseas -

(1) South Africa;

(2) International.

The Specialist Businesses division was subdivided into media, contract engineering, hops and malting, timber and stockfeed subdivisions (see Exhibit `D' pp. 7-17; Jarrett at 218, 222, 229).

22....

23. All of Kyabram's production was sold to the Council and the Council in turn appointed Henry Jones Limited as its agent to sell that produce under the Kyabram and Henry Jones IXL labels (Hooke at 119, 120, 121 and 122).

24. For a number of years prior to September 1981 there existed within HJIXL a continuing policy of monitoring the activities of each division and of selling off or withdrawing subsidiaries from division activities as those activities became unprofitable and starting or developing within the division activities which appeared to be more profitable, so as to achieve a 20% return on invested capital (Jarrett at 222).''

The reference in paragraph 24 to those activities becoming ``unprofitable'' was intended to relate to the taxpayer's 20% profit philosophy.

The submission continued:

``25. In or about August 1981 a decision was made within HJIXL that the canned deciduous fruit business conducted by Kyabram and Henry Jones IXL within the general products division was not performing in accordance with the 20% return policy and that steps should be taken for the general products division to cease to operate in that industry and to apply the funds released to activities capable of producing a better return. It was contemplated that withdrawal from the industry would give rise to a lump sum receipt and budgeting was predicated on that assumption (Jarrett at 189, 222 and 289; Scanlon at 112; Hooke at 128 and 147) but otherwise it was not envisaged that the withdrawal of Kyabram from the canned fruits industry would in any way affect the operations of the general division or any other division (Jarrett at 217-219).

26. It also emerged from the evidence given in cross-examination and by the Commissioner's witnesses that the processes

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leading to the entry into the Licence Agreement and the assignment to Citicorp differed markedly from the picture portrayed in HJIXL's affidavits.

27. What emerged from the evidence about the course of negotiations is that throughout the negotiations SPC and Ardmona made it clear that they wanted tax deductibility for the payments they were to make and that HJIXL made clear that the amounts of payments it would accept were dependent upon whether or not the transaction could be structured so as to provide HJIXL with a tax-free receipt. If a tax-free receipt could not be arranged the amounts of the payments would need to be greater (Hooke at 140; Turnbull at 240 and 243; Willaton at 245, 246, 289 and 251 and Exhibits `E' and `F').

28. The first indication of that came early in October 1981 at the commencement of the negotiations when, on or shortly before 8th October 1981, Mr. Peter Scanlon of HJIXL sent to Mr. Brian Scanlon and Mr. R. Turnbull of SPC and Ardmona a telex (Exhibit `E') in which Mr. Scanlon proposed (para. 1) that `in consideration of Z agreeing not to trade in deciduous fruit in Australia and overseas (subject to some exceptions) S and A undertake to pay Z $13,167,000 as follows:

$667,000 on December 1981

$750,000 on June 30 1982

$750,000 on March 31 1983

$1,500,000 on March 31, 1984, 1985, 1986, 1987

$1,000,000 on March 31, 1988, 1989, 1990, 1991, 1992.

Evidence later given by Mr Peter Scanlon established that the letter `Z' meant Henry Jones IXL, the letter `S' meant SPC and the letter `A' meant Ardmona (Scanlon at 72 and 110). Amongst other things the telex contained the following stipulations:

`The purchase price as defined in para. 1. was based on the assumption that the payments were tax deductible to S & A and received as non taxable income by Z. If this cannot be satisfactorily arranged: then an apportionment of the cost (i.e. the extent to which tax is payable by both parties) will need to be determined. For example, if the whole amount is taxable in Z's hands, then S & A to bear two thirds of the tax payable for the purpose of determining the purchase price.

It should be understood that (sic) the importance which Z place (sic) on receiving non taxable income as the Group loses the benefits of substantial tax losses in Z.'

`Z will sell the Z label to S & A for One Dollar.'

`Z will license S & A to use the Z jam label until December 1983 for One Dollar.'

`I agree that in the event of any proposed sale of the existing plant and equipment used to process deciduous fruit, such plant and equipment will first be offered by Z to S & A.'

(para. 2, 7D, 7E, 11)

29. By telex dated 8th October 1981 (Exhibit `F') Mr. Brian Scanlon of SPC responded:

`1. (A) Could agree to $667,000 (reference 7A) being added to the purchase price in circumstances where it is tax deductible for S & A.

(B) If all other matters were resolved satisfactorily, would be prepared to agree to the payment schedule as listed in your telex.

(C) The assignment of the agreement or the writing of a satisfactory alternative agreement by S & A is a condition of the purchase.

2. S & A ability to agree to the purchase price was as you know based on an ability to extract such income from a rationalised production and sales structure. There simply is not sufficient in the rationalisation to allow for S & A payment to be on an after tax basis. S & A payments must be of a deductible nature'.

30. There followed a succession of meetings at the offices of Henry Jones IXL at 20 Garden Street, South Yarra, the corporate headquarters of Henry Jones IXL (Hooke at 142) attended by representatives of SPC,

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Ardmona and Henry Jones IXL, at which the proposal and counter-proposal set out in the telexes were discussed and developed into final agreement. During the course of that process the form of the arrangement originally proposed was changed from that of a payment by SPC and Ardmona to HJIXL `in consideration of Z agreeing not to trade in deciduous fruit' to one whereby SPC and Ardmona agreed to pay what were described as licence fees for the use for a period of 10 years of the trademarks owned by Kyabram and those of the trademarks owned by Henry Jones IXL which to that point had been used by Kyabram in the canned deciduous fruit industry.

31. The course of meetings and how the change in form came about emerged from a series of minutes which were produced to the Court on subpoena directed to SPC and Ardmona and tendered into evidence by the Commissioner. Evidence given by officers of SPC and Ardmona established that the minutes had been prepared at the time of the meetings by officers of HJIXL and circulated to all parties for verification (Turnbull at 237, 238 and 239; Taylor at 157, 159 and 160; and Willaton at 244-246; cf. Hooke at 126 and 314-315).

32. The first set of minutes produced (Exhibit `H') recorded a meeting of 12th October 1981 attended by Messrs. Willaton of SPC, Messrs. Turnbull and Taylor of Ardmona, and Messrs. Herman, Nugent, Hooke and Lawson on behalf of SPC. The minutes recorded that the purpose of the meeting was `discussion of a possible purchase of Z's production entitlement by S & A' and, under the heading `19. Taxation' the following:

`The meeting agreed that it was necessary for the compensation paid by S & A to Z to be tax free in Z's hands, while fully tax deductable (sic) in S & A's hands, S & A were confident that this could be achieved and will advise of method at the next meeting.'

33. Shortly after the meeting Mr. Willaton made some notes for the information of his Managing Director, Mr. Brian Scanlon (Exhibit `Q') in which Mr. Willaton recorded, amongst other things:

`2. Z doubt S & A ability to arrange deductibility. We may need to involve AA & Co. They also require deductibility.'

Mr. Willaton said that the notes were an expansion of rough notes containing a resume of what was covered at the meeting (Willaton at 252) and that the reference to `they also require deductibility' meant that Henry Jones IXL had made clear that they wanted payment in a tax free form (Willaton at 290 and 312).

34. In the course of his cross-examination Mr. Hooke did not deny that HJIXL had said that they wanted a tax free receipt but simply that he could not recall the matter being discussed (Hooke at 127).

35. Then on 16th (or 18th) October 1981 Mr. Willaton sent a telex to Mr. Nugent (Exhibit `S') in which Mr. Willaton recorded that Item 19 of the minutes of 12th October 1981 should read:

`Transaction is dependent on tax deductibility for S & A and is to be structured to achieve this. Price are substitute (sic) for Z revenue but S & A believe there may be a way in which Z may also achieve tax deductibility and will investigate further.'

36. Mr. Hooke later recalled in cross-examination that Mr. Willaton may have put forward such a proposal (Hooke at 143).

37. A second meeting took place at Garden Street on 19th October 1981. It was attended by Mr. Willaton from SPC and by officers of Ardmona and Henry Jones IXL. Mr. Willaton gave evidence that he made rough notes of the proceedings during the course of the meeting and he produced upon subpoena some further handwritten notes, which he said were an expansion of the rough notes made during the meeting (Willaton at 270-273). In that document (Exhibit `R') Mr. Willaton recorded the following:

`19.10.1981 M. Nugent, A. Herman. C. Hooke. B. Plowman.

Tax KY have tax loss to June 82 est. To be $1 million. Will sacrifice if necessary. Requested that efforts should be made to give profit up front for Z if possible. A

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mid point between a present value of transaction before and after tax could be negotiated.'

38. The second set of minutes produced (Exhibit `J') also related to the meeting of 19th October 1981. It recorded that the meeting took place at 20 Garden Street and was attended by Messrs. Hooke, Nugent and Plymin of HJIXL, Messrs. Turnbull, Willaton and Brian Scanlon of SPC and Mr. Turnbull of Ardmona under the heading `Taxation'. Those minutes recorded (in para. 1) the following:

`S & A reiterated the principle that any moneys paid to Z must be tax deductable (sic) for S & A.

Both parties to prepare individual papers detailing the best method of structuring the purchase price in order that S & A can claim a deduction for moneys paid, while Z can treat receivables as capital.'

39. The witnesses called on behalf of Henry Jones IXL, Messrs. Scanlon, Hooke and Jarrett, all said in the course of their evidence that they had no knowledge or recollection of a paper being prepared within HJIXL detailing the best method of structuring the purchase price. Mr. Scanlon said he had no recollection of any consideration being given to tax (Scanlon at 112); Mr. Hooke said that to the best of his recollection no paper was produced (Hooke at 140) but that when the change in structure to a licence was proposed HJIXL did give some consideration to the tax consequences of the change (Hooke at 140); and Mr. Jarrett said that HJIXL never considered any tax consequences (Jarrett at 168).

40. But there was produced from the documents discovered by HJIXL and tendered in evidence by the Commissioner pursuant to S. 7B of the Evidence Act 1905 a document (Exhibit `V') which, in terms, clearly matches the description of a paper prepared within HJIXL detailing the best method of structuring the purchase price in order that S & A can claim a deduction from money paid, while Z can treat receivables as capital. And it is significant that Mr. Jarrett thought that document may be in the handwriting of Mr. Russell, an employee of HJIXL concerned with taxation matters (Jarrett at 192).''

In oral submissions Mr Shaw QC pointed out that the taxpayer could, if it wished, have called Mr Russell as a witness to offer some explanation as to whether it was in his handwriting or not, but did not choose to do so.

Indeed, there was an eloquent silence on the taxpayer's behalf in relation to the facts extracted rather painfully by the Commissioner's cross-examination and by evidence on subpoena.

The submission continued:

``41. For present purposes the most significant parts of the document are:

`Tax and Accounting Implications on sale from KY to S & A

Tax

There appears to be only 1 method in obtaining our sale price of $12.5 million keeping in mind the objective that S & A require a tax deduction over the ten years in which the payments are made.

The method open is by means of a royalty which should be structured as a percentage of sales or so much per annum whichever is the higher. Such a structure should enable S & A to claim the deduction, however if the DC of T found out that the KY labels etc. had been phased out he would deny the deduction. I guess if S & A are happy with such a basis then it is in their court to substantiate such a deduction. It is essential that this agreement is correctly structured as the DC of T could interpret the royalty as inherently capital and disallow the deduction to S & A and treat the income as capital to KY or even further by disallowing the deduction to S & A and treating as taxable income to KY.

Assuming that S & A receive the deduction on the basis of yearly royalties paid KY then has three means of taking the royalty up for tax purposes.

(i) Taking the yearly payment up both for tax and accounting as received. (However in year 1 a substantial loss would result due to the other costs.)

(ii) Front-end the royalty payment for accounts purposes (if allowed by

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auditors) and show in the tax return an adjustment schedule taking up the yearly payment on a receipt basis. I consider that the basis would have a high risk element in that it highlights:

(a) change in business

(b) difference in accounting for the profit for tax could give the DC of T the answer that there is a capital element regarding the whole transaction.

(c) strengthen the risk of non recovery of KY losses.

(iii) Income stream the income by making a valid assignment to the rights. That is transfer the existing chose in action to the Bank/Finance house the right to income for a period in excess of 7 years. (Division 6A S. 102A-C.) In this case the income would be front-end, S & A should receive an annual deduction for tax and it should be classified as a capital receipt in KY.

It should be noted that the Bank/Finance house would not be able to claim a deduction for the income stream payment but would be taxed on the annual receipt.

The above appear to be the only valid options available for S & A to receive the annual deduction however the nature of the whole transaction has additional ramifications on KY for tax purposes:

(i) Greatly increases the risk of the recovery of KY's existing losses

...

In summary for tax I believe the income streaming to be the most practicable solution bearing in mind what we want to achieve for accounting purposes.

The only other tax worry we may have is the new Section 240 (sic) `Division IVA' but no one knows how the DC of T will interpret this new anti avoidance legislation.'

42. This document was never explained by HJIXL. As stated above it does match the document proposed on 19th October 1981 to be prepared by HJIXL in Exhibit `V'. It may well be that document. But whether it is that document or not is perhaps not critical. What matters is that the document must inevitably be inferred, from its custody, form and terms, to be part of HJIXL's business records and prepared internally by HJIXL by one of its officers involved in consideration of tax and accounting aspects of the transaction on behalf of HJIXL. It is submitted that its terms make clear that it must have been prepared before HJIXL agreed to structure the transaction as one whereby the $12.5 million was paid as fees for the right to the labels i.e. at latest in early November 1981 or probably in late October 1981. It is submitted that it confirms what the telexes, the minutes, and further evidence about to be referred to demonstrate, namely that from October 1981 and before HJIXL agreed to structure the transaction in the way ultimately adopted, it was concerned to be sure that if such a structure was adopted, it could itself ensure that what it received, was received by it in a capital non-taxable form. It was advised that it could ensure this in only one practical way - by assigning its right to the stream of payments to a bank or financial institution in return for a (capital) lump sum.

43. It emerged from further documents produced on subpoena that, contrary to the appearance created by the Applicant's affidavits, on and before 19th October 1981, officers of Henry Jones IXL concerned with the accounting and taxation affairs of the company were consulting with Miss Ward, then an employee of Price Waterhouse concerned with the provision of taxation advice to HJIXL, on the accounting and taxation consequences of the transaction to HJIXL (Ward at 368, 369 and 377; Miller at 390).

44. In a document dated 19th October 1981 (Exhibit `T') which was produced on subpoena by Price Waterhouse and identified by Miss Ward as a file note made by her, Miss Ward recorded the following:

`IXL

Barry Russell 19 October 1981

Assignment of Royalty income for S and A where royalty for 10 years

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CCH - s 19

- Assignment effective: where existing chose in action.

Not effective - if only mere expectancy or possibility of becoming entitled to future income.

Cases.

Norman v. Federal Commissioner of Taxation (1963) Full HC - Re Interest or Divs.

Shepherd v. Federal Commissioner of Taxation (1965) Full HC - Re assignment of 90% title and income from patent.

Everett v. Federal Commissioner of Taxation (1980) HC.

Assign't of share in p'ship: held to be assign't of present property carrying right to future income - rather than solely right to future income.

- Distinguish: payment from S and A on capital and on lease of royalties from assignment of right to title and agreed royalty flow from S and A for capital sum from (say) bank.

- Tax

If valid tfr - no income to be derived by IXL company. Capital receipt.

- no deduct'n to company (bank) - paying for right and future income.

- income to bank.

NB - Valid documentation - Must be assign't present chose in action (eg agreed royalty flow, etc.

- Agreement first re use of right royalty.

- Risks(?)

Section 19 Deemed income. If assignment not valid for tax purposes.

(See above Re the req't for tax assign't see CCH.)

Section 102A-C (Div 6A)

- Tfrs of right to receive income without tfr of asset for period of 7 yrs or less.

- Division (prob) not apply where interest in the property as well as the interest in the income is tfrd.

Part IVA - last resort

Passed on those comments to B K Russell and K Biggins - over loudspeaker call.

J. Ward (signed)

19/10/81'

45. In a further document dated 19th October 1981 (Exhibit `U') which was also produced on subpoena by Price Waterhouse and identified by Miss Ward as a file note made by her, Miss Ward recorded:

`Re KY

Meetings - in addition to those noted in minutes

(1) Mon 29 Spt. 81 - a.m. Pre meeting with Scanlon Discussion with RCAB & BKR.

(2) Mon 5 Oct. 81 - Urgent meeting with RCAB, K. Biggins, BKR.

Numerous calls from BKR from 29 Spt. to present - per diary.

J. Ward 19/10/81.'

46. In the course of her evidence Miss Ward explained that Mr. Russell and Mr. Biggins were both accountants employed by Elders (Ward at 379 and 388) and that the initials `RCAB' represented Mr. Brown who was the financial controller of HJIXL. Mr. Biggins was the chief financial controller responsible for taxation (Scanlon at 113, Jarrett at 174). Mr Russell apparently was his subordinate working in the financial area (Scanlon at 113).

47. A third meeting between representatives of SPC and Ardmona and Henry Jones IXL followed on 23rd October 1981. A third set of minutes (Exhibit `K') produced on subpoena by SPC and identified by officers of both SPC and Ardmona as in all probability prepared by officers of HJIXL (Willaton at 244, Taylor at 157 and 160, Turnbull at 237, 238 and 241) showed that the meeting was attended by Messrs. Nugent, Herman and Plymin of HJIXL, Mr. Brian Scanlon of SPC and Messrs. Turnbull and Taylor of Ardmona. That the minutes were prepared by HJIXL is made more

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likely by the fact that Taylor and Turnbull swore that they did not prepare the minutes and that Mr. Brian Scanlon was the Chairman of SPC and therefore less than likely to be concerned with the mechanical task of recording the discussion at the meeting. The fact that Exhibit `S' (telex from Willaton of SPC to Nugent of HJIXL correcting the minutes) was from SPC to HJIXL also tends to confirm this.

48. Under the heading `Taxation', the minutes recorded:

`The legal firm representing S & A have been instructed to prepare the necessary legal documents. These documents will be prepared on the basic premise that the consideration paid must be tax deductable (sic) in the hands of S & A.'

49. The fourth and apparently final meeting followed on 5th November 1981. Minutes of the meeting (Exhibit `L') again produced on subpoena directed by the Commissioner to SPC and apparently prepared by HJIXL show that the meeting was held at 20 Garden Street on 5th November 1981 and was attended by Mr. Brian Scanlon of SPC, Messrs. Turnbull and Taylor of Ardmona, Messrs. Hooke, Nugent, Plymin and Herman of HJIXL and by one B. Bradbury whose identity was not revealed by the evidence. Under the heading `Taxation' those minutes recorded:

`S & A advise that the legal agreement must be centred around a 10 year lease/user right agreement of all labels. S & A advise that care must be taken in any press statements in order that the tax situation is not put in jeopardy.'

50. The task of obtaining government approval was apparently left to Mr. Brian Scanlon of SPC. In a telex dated 11th November 1981 (Exhibit `G') he reported the following to Mr. Peter Scanlon of HJIXL:

`1. Meeting last evening considered productive with positive expressions of support for concept from government. Ball in government court at this moment. Have no alternative other than to be patient for a short time. As security factor not required to be settled urgently believe both parties can live with current position for the present.

2. Summation of agreed points to date:

(1) Price $13,167,000 payable as follows:

$667,000 December 31, 1981

$750,000 June 30, 1982

$750,000 March 31, 1983

$1,500,000 March 31, 1984,

1985, 1986, 1987

$1,000,000 March 31, 1988, 1989, 1990, 1991, 1992

(2) Payment in the form of an annual fee for the use rights of all Z canned fruit labels for the period 1.1.1982-31.12.1992 (the period of payment)

...'

51. The process of drafting the documents was not made wholly clear by the evidence but it seems probable that the first draft was not produced until 3rd December 1981 (one suspects after government approval was obtained); that a second draft was produced on 12th December 1981; and that the final execution form of the documents was produced shortly before 16th December 1981.

52. Two sets of the draft agreements were produced, again on subpoena directed by the Commissioner to Price Waterhouse, and both were received into evidence (Exhibits `Y' and `Z'), the first dated 3rd December 1981 and the second dated 12th December 1981. The final execution form of documents was undated but said to have been dated either on the 16th or 18th December 1981. No other drafts were produced and it was not suggested that there were any.

53. It is probable that both sets of draft documents were sent by HJIXL to Price Waterhouse at the times at which they were produced. Evidence given by Miss Ward (Ward at 436) showed that the two sets of draft documents were the only copies of the documents found upon search of the Price Waterhouse taxation file. It is possible but improbable that the drafts were sent by Henry Jones IXL to Price Waterhouse much later than the dates on which they were prepared. Documents in final form were

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executed on or about 16th or 18th December 1981 and it is illogical to assume that the purpose of sending the drafts to Price Waterhouse was other than to afford Price Waterhouse the opportunity of considering the drafts before the documents were executed.

54. It is also probable that the two sets of draft documents were considered by Price Waterhouse at or about the time they were prepared and before the documents in final form were executed. This is confirmed by the handwritten annotations on the drafts of 3rd December 1981, and the terms of Exhibit AA: `Reviewed original draft agreements plus new draft agreement'. It appears that it was between the draft of 3rd December 1981 and that of 10th December 1981 that the words `commencing 31 March 1983' were inserted into clause 5(a) of the Licence Agreement. The introduction of those words had the effect that the first royalty payment fell due under the agreement on 31st March 1983 instead of 31st March 1982. It will be recalled that from before 8 October 1981 (Exhibits `E' and `G') it had been settled that the first `royalty' payment was to be made on 30th June 1982. The reason for this change at this time has not been satisfactorily explained. Mr. Hooke said that SPC and Ardmona requested it (Hooke at 149). But his memory is suspect (Hooke at 146) and in any case, why should HJIXL agree to such a change at such a time, except with a view to ensuring that assignment should take place before any payment was due?

55. Keith Henry Miller, who was called as a witness for the Commissioner, gave evidence that he was until March 1982 a partner of Price Waterhouse specialising in taxation and concerned with the giving of advice on taxation matters to HJIXL (Miller at 317 and 318). He identified (Miller at 319) as a file note which he made while still a member of Price Waterhouse a document (Exhibit `AA') also produced on subpoena directed by the Commissioner to Price Waterhouse. That document is as follows:

JAW

GJJ

HENRY JONES IXL LTD

KYABRAM PRESERVING CO. LTD

then

File Tax

Attached are agreements in relation to sale of Kyabram's Canned Fruit Business to SPC.

Notes prepared by K H Miller

1. Reviewed original draft agreements plus new draft agreements.

2. Basically:

SALE OF STOCK AGREEMENT

(a) sale of stock on hand plus tin plate at standard cost less $125,000.00 less 1% allowance less usage of tin plate for apricot season

(commenced December 1981)

QUOTA SHARE AGREEMENT

(b) pass Ky's market allocation to SPC and Ardmona (voidable if not achieved under Canned Fruits Marketing Act)

LICENCE AGREEMENT

(c) (i) receive Royalty for use of Henry Jones Ltd. labels worldwide for 10 years. 5% of sale - minimum royalty.

$750,000.00

pa 1982-86

500,000.00

pa 1987-91

(ii) pay

$740,000.00

on 31/12/81.

(iii) Debenture issued to secure above.

RESTRAINT OF TRADE AGREEMENT

(d) H Jones agreed not to compete for 10 years includes group and not use Ky factory for canned fruit in this period.

RELATIONS WITH RIVERLAND

(e) Replace HJ as marketing agent for Riverland by SPC and Ardmona.

Licence fee minimum 1982/86 could drop by $100,000 pa.

3. Discussed risk of Ky failing same business test. Agreed risk there but need

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to take. Strengthen by Ky canning apricots thus during 1981/82 year canned as season short argue this is sufficient.

4. Discussed sale at standard cost. On basis receive money must be some chance.

5. Not covered in agreement but intention is for Henry Jones IXL Ltd to `income stream' royalties so as sell `paper' for a lump sum to finance house so as receive capital sum. SPC/Ardmona continue getting deduction for amounts paid as minimum royalties (Never any possible that 5% of proceeds re Jones labels will ever be received as intention not to use labels.)

K H Miller (signed).'

56. The document suggests that Mr. Miller discussed with officers of HJIXL the results of his perusal of the draft documents and learned as a consequence of his discussion that it was the intention of HJIXL to assign its rights under the documents, once executed, to a finance house, so as to convert the income stream into a tax-free lump sum.

57. In his evidence Mr. Miller said first that he thought that he made the note in December 1981 (Miller at 319) but he later said that he thought he made the note in February 1982 shortly before leaving Price Waterhouse to take up the position with HJIXL (Miller at 396-397) and evidence given about the position in the file from which the document was taken suggested that that may be so.

58. However regardless of when the note was made, the fact remains that the document refers to draft documents only, and no copies of executed documents were found on the tax file (Ward at 436). Although Mr. Miller said he believed that he made the note considerably later than the discussion referred to in the note (Miller at 391), he seems to have thought that his information came all at one time after the agreements were executed (Miller at 453-454) in final form. Since the terms of Exhibit `AA' itself make clear (by saying `Received original draft agreements plus new draft agreements') that he was consulted before the agreements were executed, it is likely that he was informed at that time of HJIXL's intention to assign.''

Having set out the effect of the various agreements of December 1981, the submissions continued:

``60. It is doubtful whether the transactions effected by these agreements can properly be characterised as a sale by Kyabram of its canned fruit business. Rather Kyabram agreed to stay out of the business of canning fruit for a period of 10 years and to facilitate the filling by SPC and Ardmona of the position of Kyabram in the canned fruits industry prior to the commencement of the 10 year period. But whatever is the proper characterisation of what Kyabram did, it is submitted that it is clear that HJIXL did not sell any business of its. What it did was to facilitate the replacement of Kyabram in the industry by SPC and Ardmona and, as part of that process, to license SPC and Ardmona to use the HJIXL marks previously used by Kyabram.

61. Although the agreement for the assignment to Citicorp Canberra Pty. Ltd. of the HJIXL and Kyabram's licence rights under the agreement and the associated agreements (Exhibits `CAH12', `CAH14' and `CAH15') were not executed until 25th May 1982, it is clear that negotiations with Citicorp began at latest in December 1981, may be 20th December 1981 (Jarrett Affidavit para. 8 and Jarrett 179), if not before.

62. On 25th May 1982 the assignment and the agreements associated with it were executed (Exhibits `CAH12-15'). These agreements were -

(a) an instrument of assignment made 28th May 1982 between HJIXL and Kyabram and Citicorp Canberra Pty. Ltd. whereby, in consideration of the sum of $7,581,691 expressed to be paid to HJIXL and Kyabram (but in fact paid to HJIXL alone), HJIXL and Kyabram transferred conveyed and assigned to Citicorp absolutely the whole of their right title and interest under the Licence Agreement including the moneys due or to become due as the royalty payments and interest;

ATC 4139

(b) a notice of assignment dated 28th May 1982 from HJIXL and Kyabram to Ardmona and SPC;

(c) a security agreement made 28th May 1982 between HJIXL and Citicorp Canberra whereby -

(i) in consideration of Citicorp entering into the assignment HJIXL agreed to procure the execution by Elders IXL Ltd. in favour of Citicorp of a guarantee of the due and punctual performance by HJIXL of its obligations under the agreement and the obligations of both HJIXL and Kyabram under the Assignment;

(ii) HJIXL agreed to pay to Citicorp any difference between the amounts as determined in accordance under the formula expressed in the agreement and the actual amounts of the royalty payments made under the Licence Agreement;

(iii) Citicorp undertook that upon payment in full of all moneys which are or may become payable under the agreement it would at the cost of HJIXL assign to HJIXL or as it may direct the right title and interest of Citicorp under the assignment;

(d) a guarantee made 28th May 1982 whereby Elders IXL Ltd. guaranteed to Citicorp Canberra the due and punctual payment by HJIXL of all funding fees, interest and other moneys payable by HJIXL under the Security Agreement and the due performance and observance by HJIXL of the terms of the Security Agreement.''

The taxpayer's final submissions in writing were filed on 21 September 1990. In them it was contended that it should be found that Mr P Scanlon ``negotiated the effective deal with SPC and Ardmona'', albeit that ``fine tuning'' and the precise form of the deal was later finalised with other executives of the taxpayers.

In my opinion, such a finding would fly in the face of the mass of evidence adduced by the Commissioner in the cross-examination of the taxpayer's witnesses and in the testimony of the witnesses he called, together with the documentary evidence referred to in the written submissions of the Commissioner. I am satisfied that the ``effective deal with SPC and Ardmona'' was arrived at after Mr P Scanlon's departure from the scene.

In the taxpayer's written submissions it was put that ``the refinement of the deal into one whereby the $12.5 million was to be paid by way of minimum royalty payments was imposed'' on the taxpayer because it had decided to vacate the industry ``no matter what'' and Ardmona and SPC insisted on tax deductibility.

It was submitted that the structuring of the transaction to provide for royalty payments was not at the initiative of the taxpayer but was a commercial requirement of Ardmona and SPC which was accepted by the taxpayer because it was, in effect, the only way out of a ``take it or leave it'' situation.

In my opinion, these were the reasons which led the taxpayer to agree to the terms of the December 1981 agreements but they do not modify, or detract from, the terms of those agreements, under which the taxpayer granted a licence to Ardmona and SPC to use the labels in return for royalties spread over the term, at the expiration of which they were to become the property of Elder Smith Goldsbrough Mort Ltd or its nominee. By December 1981 a reconstruction of the taxpayer had taken place which effectively made that company its successor.

It is true, as the taxpayer contended, that the assignment by the taxpayer to Citicorp was an assignment of the whole of the rights under ``the royalty agreement'', as the taxpayer's written submission correctly described it.

Contrary to the submissions of the taxpayer, I have no hesitation in drawing the inference that before ``the effective deal'' was negotiated, officers of the taxpayer other than those called by it as witnesses had taken a lively and natural interest in the best way in which the deal could be expressed so as to assist its claim that it should not be taxed on the proceeds, given the commercial realities in which it found itself. It is not necessary to attempt to make a series of findings as to precisely how that interest was expressed, or exactly when the question was discussed with Price Waterhouse or within the taxpayer's own organisation but they all preceded the making of ``the effective deal''.

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I am satisfied that the taxpayer originally wanted payment in a lump sum and found that it could not receive it from Ardmona and SPC. Its corporate philosophy as expressed in the 20% rule made it plain that it would not be content to leave an arrangement whereby payment extended over ten years to run its course. This is most clearly seen from Mr Jarrett's immediate reaction to the transaction when he first became aware of it. Any senior financial officer of the taxpayer must have been aware of this philosophy and its consequences. It is not necessary to be satisfied that the taxpayer had decided to assign the agreement to a particular company before it entered into the deal with Ardmona and SPC, but I have no hesitation in drawing the inference that before it entered into that deal it had decided that it would assign its rights under it to a bank or financial house in return for a lump sum payment. This inference is supported by the evidence summarised in the Commissioner's submissions and is reinforced by the failure of the taxpayer to call any of its senior officers or outside advisers in reply to that evidence.

As the Commissioner submitted, that burden of proving that the assessment is excessive lies on the taxpayer (S. 190 of the Act). In my opinion, the taxpayer has failed to discharge this onus.

As things stood after the execution of the agreements between it and SPC and Ardmona, it was entitled to royalties in respect of the licence to use the labels which it granted, but it did not convey the property in the labels to SPC and Ardmona. It became entitled to a stream of future income and, had no more been done, the receipts of royalties would have been assessable in the hands of the taxpayer. The principal effect of the agreement with Citicorp was to assign the right to receive future income, which was a conversion of future income into present income. The payment received by the taxpayer from Citicorp was, in my opinion, income within the meaning of S. 25(1) of the Act.

In
Commissioner of Internal Revenue v. P.G. Lake Inc. (1958) 356 U.S. 260 (which was cited with approval in the
Myer case 87 ATC 4363 at p. 4371; (1987) 163 CLR 199 at p. 218) the Court said at p. 266:

``Cash was received which was equal to the amount of the income to accrue during the term of the assignment, the assignee being compensated by interest on his advance. The substance of what was assigned was the right to receive future income. The substance of what was received was the present value of income which the recipient would otherwise obtain in the future. In short, consideration was paid for the right to receive future income, not for an increase in the value of the income producing property.

These arrangements seem to us transparent devices. Their forms do not control. Their essence is determined not by subtleties of draftsmanship but by their total effect.''

In the Myer case (at ATC p. 4371; CLR p. 218) the High Court said:

``If the lender sells his mere right to interest for a lump sum, the lump sum is received in exchange for, and ordinarily as the present value of, the future interest which he would have received. This is a revenue not a capital item - the taxpayer simply converts future income into present income...''

In my opinion, the same conclusion should follow where a sale is made of the right to receive future royalties.

In Myer, the Court said (at ATC pp. 4366-4367; CLR pp. 209-210):

``Although it is well settled that a profit or gain made in the ordinary course of carrying on a business constitutes income, it does not follow that a profit or gain made in a transaction entered into otherwise than in the ordinary course of carrying on the taxpayer's business is not income. Because a business is carried on with a view to profit, a gain made in the ordinary course of carrying on the business is invested with the profit-making purpose, thereby stamping the profit with the character of income. But a gain made otherwise than in the ordinary course of carrying on the business which nevertheless arises from a transaction entered into by the taxpayer with the intention or purpose of making a profit or gain may well constitute income. Whether it does depends very much on the circumstances of the case. Generally speaking, however, it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain

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will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business. Nor does the fact that a profit or gain is made as the result of an isolated venture or a `one-off' transaction preclude it from being properly characterized as income
(F.C. of T. v. Whitfords Beach Pty. Ltd. 82 ATC 4031 at pp. 4036-4037, 4042; (1982) 150 C.L.R. 355 at pp. 366-367, 376). The authorities establish that a profit or gain so made will constitute income if the property generating the profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit.''

I am satisfied that when the taxpayer entered into its commercial transaction with Ardmona and SPC whereby it acquired the rights to receive future royalty payments from them, it had already formed the intention of selling those rights to a bank or finance house for a lump sum.

In Myer, the High Court, having cited the
Californian Copper Syndicate case ((1904) 5 T.C. 159) said (at ATC p. 4367; CLR p. 211) that the important proposition to be derived from it is that

``a receipt may constitute income, if it arises from an isolated business operation or commercial transaction entered into otherwise than in the ordinary course of the carrying on of the taxpayer's business, so long as the taxpayer entered into the transaction with the intention or purpose of making a relevant profit or gain from the transaction.''

Later (at ATC p. 4369; CLR p. 213) the Court said:

``It is one thing if the decision to sell an asset is taken after its acquisition, there having been no intention or purpose at the time of acquisition of acquiring for the purpose of profit-making by sale. Then, if the asset be not a revenue asset on other grounds, the profit made is capital because it proceeds from a mere realization. But it is quite another thing if the decision to sell is taken by way of implementation of an intention or purpose, existing at the time of acquisition, of profit-making by sale, at least in the context of carrying on a business or carrying out a business operation or commercial transaction.''

In the present case I am satisfied that the decision to sell the rights which the taxpayer expected to acquire from the transaction with SPC and Ardmona had been taken by it before they were acquired. The decision of the taxpayer to sell those rights to Citicorp was taken by way of implementation of an intention or purpose, existing at the time of acquisition, of profit-making by sale, in the context of carrying out a business operation or commercial transaction.

Not only did the amount here in question, in my opinion, form part of the income of the taxpayer under S. 25(1) of the Act, but in any event, it would have constituted assessable income under the second leg of S. 26(a).

I find it unnecessary to deal with the remaining submission of the Commissioner based upon his citation of the
Allied Mills Industries case 88 ATC 4852; (1988) 20 FCR 288.

The order of the Court is that the objection of the taxpayer to the relevant assessment be dismissed with costs and that the Commissioner's disallowance of the taxpayer's objection dated 19 April 1984 be confirmed.

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