BELL v VAHEXI PTY LTD

Members:
Priestley JA
Handley JA
Fitzgerald AJA

Tribunal:
NSW Court of Appeal

Decision date: 27 November 1998

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Priestley JA

This appeal is brought by Mr D.F. Bell, the unsuccessful defendant in an action brought against him in the District Court by Vahexi Pty Limited (Vahexi). The case was heard and decided by his Honour Judge Sinclair QC who adjudged that the appellant should pay $64,354.65 and costs of the action to Vahexi. Vahexi had claimed damages for professional negligence against the appellant, a chartered accountant and tax agent who was the sole principal of an accountancy firm which carried out various services for Vahexi including the preparation and lodgment of its income tax returns.

The appellant's notice of appeal contained only one ground. When the appeal came on for hearing counsel for the appellant said that ground was not to be pursued and sought leave to amend the notice of appeal by substituting for the abandoned ground the following one:

``That the trial judge erred in exercising his discretion to reject the tender into evidence by the defendant of a report dated 3 March 1997 of Anthony Charles Sloane.''

The court deferred deciding whether leave should be granted to the appellant until it had heard full argument both on the application to amend and on the proposed new ground of appeal.

At the end of the argument for the appellant the court did not call on the respondent, being of the view that there was no practical possibility that the appellant's proposed new ground would succeed if leave were granted for its inclusion in the notice of appeal. The court however did not deliver judgment immediately because it was of the view that although the position concerning the practical untenability of the proposed ground was clear, it would take a little time to explain why that was so and the importance of the matter to the appellant justified setting out the reasons for the court's opinion at a little length.

The substance of the respondent's claim against the appellant as pleaded and presented at the trial before Sinclair DCJ was that: the respondent had retained the appellant to prepare the respondent's annual financial accounts and income tax returns, and provide general advice regarding the respondent's liability to pay income tax; the appellant would exercise due care, skill and diligence in carrying out his retainer; would advise the respondent of any changes to the income tax legislation which might increase the respondent's liability for income tax; advise the respondent of structures and methods by which the respondent's liability for income tax would lawfully be minimised; in December 1987 there was an amendment to the income tax legislation applicable to the income tax year ending 30 June 1988 which affected the respondent's right to claim as a deduction from its assessable income interest paid to overseas creditors; the appellant did not advise the respondent of the change; and as a result the respondent suffered damage. The respondent also alleged that the appellant had failed to advise it of a procedure which could have been carried out before 30 June 1988 which would have enabled the respondent to claim as a deduction from its assessable income the amount of interest paid to overseas creditors during that tax year, and that this failure had caused other loss.

The beneficial owner of all the shares in the respondent at relevant times was Mr Bruce H. Tollis. In his defence the appellant pleaded that the plaintiff's annual financial accounts and income tax returns were prepared in accordance with Mr Tollis's instructions. He further pleaded he had not been retained to provide general advice to the plaintiff, that he was not retained to provide the plaintiff with advice of changes to income tax legislation which might increase the plaintiff's liability for income tax, nor did he advise nor was he so retained as to structures and methods by which the income tax of the plaintiff could be lawfully minimised.

At the trial the appellant sought to make good the case he had pleaded. As he put it in his evidence on a number of occasions, he was not a tax expert, and did not believe he was retained as a tax expert, and he did not charge fees on the basis that he was a tax expert. He agreed that as a professional chartered accountant he was required to exercise due care, skill and diligence in carrying out his professional work (transcript 613/97, p 151). His contention was that the care, skill and diligence did not extend to the circumstances that arose when the 1987 amendment which changed the law concerning the deductibility of interest payments made by the respondent to overseas creditors.

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ATC 4057

The trial before Sinclair DCJ began on 4 March 1997. In November 1996 the respondent had served the report of an expert witness, Mr O'Brien, on the appellant. In the report Mr O'Brien explained the 1987 amendment, which came to be called the Thin Capitalisation Rules. He also expressed opinions on some specific questions. Paragraphs 12 and 13 of his report were as follows:

``12. I have been asked to assume the following matters:

• (a) In March 1987, an accountant advised a client who was not a resident of Australia as follows:
  • (i) to acquire a company and to transfer to that company certain real estate,
  • (ii) to have the company issue one share (of two issued shares) to the foreigner and treat as a loan between the company and the foreigner the difference between the value of the real estate which would be transferred to the company and the par value of the shares, and
  • (iii) that interest which the company would pay on the loan would be deductible for taxation purposes.
• (b) The foreign resident acquires a company and:
  • (i) the company issues a share to the foreigner,
  • (ii) the foreigner transferred to the company real estate,
  • (iii) the accountant was appointed a director of the company and was retained to maintain the company's books of account, prepare financial statements of the company and prepare tax returns for the company, and
  • (iv) the accountant recorded in the company's books as a loan between the company and the foreigner an amount equal to the difference between the value of the real estate which was transferred by the foreign resident to the company and the par value of the share which was issued to the foreigner.

13. In my opinion, a reasonably competent accountant in the position of the accountant in the facts which I have assumed above:

• (a) should have been aware by no later than March 1988 of the thin capitalisation rules,
• (b) should before 30 June 1988 have alerted the company of the adverse application of the thin capitalisation rules, and
• (c) should have advised the company of possible remedial courses of action, the most common of which was to allot further shares so as to bring the company's debt to equity ratio within the limits prescribed by the thin capitalisation rules, and thus enable the company to claim the interest as an allowable deduction.''

Two days before the hearing began before Sinclair DCJ, the appellant, late in the day, served an answering expert's report (by Mr Sloane) upon the respondent.

When the trial began, some preliminary evidence was given. Counsel for the appellant then referred to his intention to tender Mr Sloane's report. Objection was taken to its use by counsel for the respondent on the basis that the rules had not been complied with and that its admission would seriously disrupt the timetable of the trial which his client had been anxious for a long time should be heard and which had been adjourned at least once previously.

Mr Sloane's report said at the outset:

``I have been asked to comment on the following matters:

• 1. The general tax skills of accountants in small non specialist accounting firms (ie less than ten employees), including general client expectations of such accountants.
• 2. Whether a competent accountant, in a small non specialist accounting firm (ie less than ten employees), would be expected to know about the workings of the `Thin Capitalisation' provisions shortly after their introduction.
• 3. Whether a competent accountant would have advised a client to issue more shares in an Australian company to avoid losing interest deductions in the year ended 30 June 1988.''

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ATC 4058

Mr Sloane discussed each matter separately, and at the end of each discussion, stated his conclusion on the matter discussed. His conclusions were:

• Matter 1 :
• ``The general tax skills of accountants in small non specialist accounting firms (ie less than ten employees) are compliance based. There is very little technical tax advice work done, except general year end tax planning type work. Clients do not generally expect high level tax advice, and frequently obtain this elsewhere, when the need arises or is perceived to arise.''
• Matter 2 :
• ``Having regard to the plethora of tax measures which have been introduced since the mid 1980s, coupled with the highly complex nature of the Thin Capitalisation provisions, and the fact that they deal with international tax avoidance, I believe that a competent general practice accountant, in a small non specialist accounting firm (ie less than ten employees), would not be expected to know about these provisions shortly after their introduction.
• Moreover, I believe that clients of these firms would not expect their accountants, in the normal course of events, to know about these provisions, particularly in the short term. Such knowledge would generally be outside the terms of the engagement of a typical general practice accountant offering compliance services.''
• Matter 3 :
• ``A competent tax adviser may have advised a client to issue shares in the company in question in order to overcome the Thin Capitalisation provisions. However, this advice would only have been given after properly considering all other relevant tax issues, such as the ones identified above. On the other hand, some advisers would have argued that the provisions did not apply in the first place because there was no `assessment' issued to the company in the 1988 year. On the basis of this argument, no shares would need to have been issued.
• Given the complexity of the thin capitalisation provisions, coupled with the inherent interconnectedness of these provisions with the other tax provisions, I do not believe that a competent accountant, without specialist tax skills, would be expected to advise a client to issue shares in the 1988 year. It would be overly simplistic to conclude that the mere issue of shares was a straightforward solution to such a complex problem. The issue is far more complicated than this.''

In dealing with the objection to the admissibility of the report, Sinclair DCJ approached the matter on the basis, accepted by counsel for the appellant, that the rules required that the report had had to be served on opposing parties at least twenty-eight days before the trial. He said that not only had there been no attempt to comply with the rules, there was substance in the submissions of counsel for the respondent that if it were to be admitted it would cause the respondent to deal with more issues than otherwise and would undoubtedly lengthen the trial. He took into account the fact that Mr Tollis was a resident of France and further, that in his view, the exigencies of the list were such that the admission of the report and the consequent lengthening of the trial would probably have the effect that the trial could not be finished in the available time and would have to be adjourned for three or four months, making it in all probability necessary for Mr Tollis to make another trip from France to Australia. He rejected the tender. Counsel for the appellant did not seek to call Mr Sloane as a witness in the appellant's case, no doubt because he foresaw the likelihood of his oral evidence being objected to and disallowed for the same reasons that had led to those things happening in respect of Mr Sloane's report.

What the appellant wanted to argue, if he were allowed to rely on the proposed new ground of appeal, was that the trial judge's discretion had miscarried in rejecting Mr Sloane's report and that a new trial should be ordered so that that evidence could be given. It was submitted that Mr Sloane's evidence went to the heart of the appellant's defence and that his being deprived of it had meant he had not been able to have his defence properly tried.

For the proposed ground of appeal to be of any use to the appellant, he would need to show: 1, that the trial judge in rejecting the evidence was misusing his discretion, and 2, that had the evidence been admitted there was a realistic possibility that it may have given some support to the appellant's defence.

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ATC 4059

If I thought the appellant had any reasonable chance of making good point 2, I would be prepared to examine the claimed miscarriage of discretion very closely. However, if there is no reasonable prospect of point 2 being made good, there is no need to examine point 1.

In coming to consider point 2, I will first mention some further factual matters.

For a number of years before 1987 the appellant had been the accountant for Mr Tollis's mother. He had done taxation work for her (transcript 513197, 124/39). He prepared her income tax returns. He also prepared Mr Tollis's income tax returns for about five or six years (uanscupt 5/3/97, 125/10).

Mrs Tollis died and in the administration of her estate questions arose about distribution of property between Mr Tollis and his broker. Early in 1987 Mr Tollis discussed with the appellant his (Mr Tollis's) ownership of a restaurant in a suburb of Sydney. The appellant knew that Mr Tollis was a resident of France. Mr Tollis asked him for some guidance about the way he should deal with his property. Early in his examination in chief, the appellant described what was then said:

``Q. What did he [ Mr Tollis ] say?

A. Well he said `I'm not too sure which is the best way to handle these assets of mine, as to how I will do it.' Well basically general discussions about what I thought the best way of handling it was, and I made certain recommendations to him.

...

Q. And when he put the proposition to you and you gave him your opinion, what did you say to him?

A. In relation to those companies I have seen this operation work before as it has been given to me by a lawyer who did taxation work and I was looking after some of those companies on his behalf and they were residents of Noumea.

Q. What did you tell him to do?

A. I related to him what they were doing.

Q. What did you tell him?

A. Well I told him that the crust(?) of the assets were all put in the company, that when these assets were in that particular company he would create a loan account for the money which the properties were worth. He would then be entitled to charge interest on his capital by which he would pay income tax at the rate of ten percent.

Q. That's withholding tax?

A. Withholding tax.''

(Transcript 5/3/97, 126)

At a later stage in his evidence in chief the appellant described in more detail just what it was that he had said to Mr Tollis on this occasion:

``Well, Mr Tollis came to me and discussed a company - sorry, discussed how he'd look after his affairs in Australia and which was the best way that I thought would happen and we discussed in great length and I suggested to him that I thought he should incorporate a company and put his assets into that company because the benefits to him would've been to him, as a non-resident he was entitled to withholding tax at a fixed amount of money on his loan account and therefore was a particular advantage to him and I outlined the services I would perform as an accountant. But at no time did I suggest to him that I was doing other than compliance work. I was not an expert.''

(Transcript 6/3/97, 148)

This plan was carried out. Three shares in the respondent were issued, one to Mr Tollis, one to Mr Gerathy, a solicitor friend of Mr Tollis, known to the appellant and one to the appellant himself. Mr Gerathy's share and the appellant's share were held on trust for Mr Tollis. Mr Gerathy and the appellant became directors of the respondent.

According to the chronology filed by the appellant, (i) the discussion between the appellant and Mr Tollis took place in March 1987; (ii) in April 1987 it was announced by the Treasurer that Thin Capitalisation Rules would be introduced into the Income Tax Assessment Act; (iii) in December 1987 Division 16F was introduced into Pt III of the Income Tax Assessment Act to give effect to the Treasurer's announcement; and (iv) in February 1988 the CCH Master Tax Guide and the ``Chartered Accountant in Australia'' both explained the position brought about by the introduction of Division 16F.

In his evidence, the appellant said that he had heard something said about the Thin Capitalisation Rules in December 1987, but as

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ATC 4060

what he heard related to international financial institutions (transcript 5/3/97, 129), he did not associate it with the respondent. In his evidence he also said that he kept the current Master Tax Guide and current issues of the ``Chartered Accountant in Australia'' in his office. Relevant pages from these had been made part of the evidence by the respondent. For the appellant, who had advised Mr Tollis to rearrange his affairs in the way that was carried out by use of the respondent, the explanation and discussion of Division 16F in the two publications could not have been difficult to understand.

However, the appellant did not become aware of the significance of Division 16F for the affairs of the respondent until some time between March and June of 1989. In the meantime his employees, for whom he acknowledged he was responsible, had prepared and filed an income tax return for the respondent for the year ended 30 June 1988 in ignorance of the effect of Division 16F. Consequently, the respondent in its return had wrongly shown itself as having made a loss for the tax year on the basis that interest payments it had made to Mr Tollis were allowable as deductions when they were not, because the issued share capital of the respondent was insufficient to meet the requirements of Division 16F.

After the appellant became aware of the requirements of Division 16F he saw to it that by 30 June 1989 further shares in the capital of the respondent were issued to Mr Tollis sufficient to comply with the requirements of Division 16F. Interest payments by the respondent to Mr Tollis for the years ending 30 June 1989 and later years were allowed as deductions by the respondent from its assessable income.

In 1992 the Australian Taxation Office (the ATO) did an audit of the respondent's income tax returns for the years ended 30 June 1988, 1989, 1990 and 1991. The ATO then became aware of the wrong basis on which the return for the year ended 30 June 1988 had been made. After the resulting investigation, the ATO communicated its decisions concerning the respondent by letter dated 14 January 1993. This said that no action was proposed in regard to the respondent's 1989 income tax return but that for the previous tax year the company had not satisfied the Thin Capitalisation requirements and an adjustment to the company's tax return for that year was therefore necessary. An adjustment sheet was enclosed adding back to the respondent's taxable income the interest paid to Mr Tollis in the year ended 30 June 1988. This had the effect of changing the loss as returned for that year to a taxable income of $52,186. The tax on this was $25,571, the interest imposed by the Australian Taxation Office $11,752 and the penalty of 25% on the tax was $6,393, making a total of $43,716.

Mr Tollis asked the appellant to pay this amount. The appellant refused and the respondent brought the action in which Sinclair DCJ found in its favour.

What has already been set out shows that the assumptions made by Mr O'Brien in par 12 of his report were substantially proved. In addition, the trial judge formed an unfavourable view of the reliability of evidence given by the appellant on contested factual matters. He also had before him a number of statements by the appellant in which he sought to justify his defence that he was not responsible for any adverse consequences to the respondent of the 1987 amendment. Typical of what the appellant said on a number of occasions was the following:

``Q. You knew in January 1993 that you'd made a mistake?

A. We discussed that before the assessment arrived, Mr Tollis was made aware in evidence which I've said before today, that I informed him as soon as the tax inspector arrived, probably the same day and that's what we started to talk about, in fact thin capitalisation was mentioned to him back in June '89 when I said to him, We have to issue more shares', and that's also in evidence.

Q. Are you aware by January 1993 that that situation had arose because of an error within your firm?

A. No it wasn't an error in my firm at all, we didn't know - we weren't engaged as tax consultants, it wasn't part of our duty, we came across it and as accountants fortuitously we thought we should tell him then we have found this out and the suppliers, and we did just that. If I may again say, I personally am not a tax expert, I would claim to be one and that's on record as I say at CPA's. We did compliance work

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ATC 4061

in accordance with our engagement and I had no instructions besides that, so I wasn't bound to go and advise him of changes in taxation laws, but you would do as a matter of course if you came across them.''

(Transcript 6/3/97, 181-182)

The trial judge took as an appropriate guide to the question of the appellant's liability a number of propositions stated by Dunford J in
Pech & Anor v Tilgals & Anor 94 ATC 4206 . Those presently relevant appear from the following passage in Dunford J's reasons:

``As a person holding himself out as possessing professional skill as an accountant and tax agent the defendant was bound to exercise the skill and diligence of a reasonably competent and careful practitioner in that profession. Charlesworth on Negligence 6th ed para 935. The contract between the parties and the relationship between them required the defendant to take reasonable care to submit accurate returns disclosing the correct taxable income for each of the parties; what was required was reasonable care, that is the care to be expected of a reasonably prudent and careful accountant:
Walker & Ors v Hungerfords & Ors 88 ATC 4920 at 4929 .''

(at 4211)

On the facts before him Sinclair DCJ said he was quite satisfied that by the standards stated by Dunford J the appellant was negligent and in breach of his obligation under his retainer. He accordingly found him liable for $43,716 which the respondent had had to pay to the ATO, together with interest which brought the judgment sum to $64,354.65.

The critical question raised by the appellant's proposed new ground of appeal is whether Mr Sloane's report, had it been allowed into evidence, might by any reasonable possibility have affected the result reached by the judge.

In coming to deal with this question I make some preliminary observations. For present purposes Dunford J's statement of what is required of accountants seems to me to be correct. I do not think that the circumstances of this case require any more detailed discussion of the appropriate tests.

Next, it seems to me there is a real question whether a number of the opinions expressed by Mr Sloane in his report were of the kind that the rules about expert evidence permit to be given. However, my opinion on other matters in the case makes it unnecessary to explore my reservations on this point.

Third, the comments made by Mr Sloane and his conclusions on the three matters he was asked to deal with were all directed to general categories. He was not asked to comment on a specific set of assumptions as had happened in Mr O'Brien's report.

The result of this was that his first conclusion was dealing with a category of accounting firm into which the appellant's business did not fall, so far as the respondent was concerned. The appellant did give Mr Tollis technical tax advice in 1987. Mr Sloane's first conclusion may be right as a matter of generality (if it was properly the subject of opinion evidence), but it had no application to the appellant.

Similar considerations apply to Mr Sloane's second conclusion. The appellant had advised on a matter falling in the category of international tax avoidance, he had been aware of the 1987 amending Act (although he had not realised its relevance for the respondent), he had materials explaining it fully in his office no later than February 1988, and he had said in evidence that he tried to keep up with matters affecting his clients. Further, the second conclusion went no further than saying that the category of general practice accountant Mr Sloane was speaking of would not be expected to know about the Thin Capitalisation provisions shortly after their introduction (my italics). They were introduced in December 1987 and were effective for the year ending 30 June 1988. I do not read Mr Sloane's second conclusion as extending the period of not being ``expected to know'' as far as 30 June 1988. Particularly is this so in the circumstances already mentioned relevant to the appellant, these being his advice to Mr Tollis in March 1987, his implementation of the arrangements which he advised Mr Tollis to make (which on any understanding of compliance practice together went distinctly beyond compliance work) and the wide publicity within professional accountancy circles about the amending legislation. I do not see how Mr Sloane's second conclusion could have been of any assistance to the appellant in the circumstances of his case.

Mr Sloane's third conclusion was speculative. He spoke of the complexity of the thin capitalisation provisions and the possibility either of problems in dealing with them or the

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ATC 4062

possibility even of their non applicability in the 1988 year. The evidence before the trial judge of what actually happened must have had the result of completely pre-empting any possibility of any such conclusion. The appellant made arrangements and carried them through for the year ended 30 June 1989 which produced compliance with the Thin Capitalisation requirements, and what was done was accepted by the ATO, not only for that year but for later years. The evidence overwhelmingly shows that had he caused the arrangements to be made and carried through for the year ended 30 June 1988 which he did for the following years, a proper tax return would have been made for the year ended 30 June 1988 and there would have been no adjustment sheet penalties etc directed by the ATO to the respondent.

My opinion therefore is that had Mr Sloane's report been admitted into evidence and had the statements in it been completely unchallenged, it could have made no difference to the fact finding and legal conclusions of the trial judge.

Not all of the matters I have mentioned concerning the essential irrelevance of Mr Sloane's report could have been within the knowledge of the trial judge at the early stage of the trial when he rejected the tender of the report. This court however has the advantage of looking back over what happened at the trial and of knowing the basic facts of the case which are either beyond argument or came from the appellant's own evidence, and would not have been affected by Mr Sloane's opinions. On those facts it is possible now to see that the admission of Mr Sloane's report could have made no practical difference to the result of the trial.

The trial was concerned primarily with the question whether the appellant was in breach of his duty, either in contract or tort. The concentration on this question is reflected by the fact that no ground of appeal was ever filed questioning, for example, the amount for which judgment was entered against the appellant, or the basis on which it was arrived at. Only two grounds of appeal have ever been put forward, the first being the original and only one in the notice of appeal, abandoned at the commencement of the appeal hearing, the second the one with which I have been dealing.

Because I do not think that, in the circumstances of the case, the proposed ground of appeal raises in any tenable way the evidentiary or fairness questions the appellant wanted to argue, it is my opinion that the application to add that ground to the notice of appeal should be refused. It follows in my opinion that the appeal should be dismissed with costs.