Baba v Sheehan

Supreme Court of NSW|2020-04-24|Before: Parker J

Judgment

On 26 September last year I delivered my principal judgment in these proceedings: Baba v Sheehan [2019] NSWSC 1281. This supplementary judgment assumes familiarity with, and uses the terms defined in, the principal judgment. References to paragraphs of the principal judgment are denoted "J".
I described the structure of the proceedings at J [8]-[9]. They involved both the claim by Mrs Baba against Mr Sheehan, Silktote and others, and a cross-claim by Silktote against Mr Baba, Mrs Baba and others.
I concluded that Silktote had been validly appointed as trustee of the SSO Trust, and that Mrs Baba's other claims failed. As a result I dismissed Mrs Baba's claim: J [89]. The present judgment concerns the orders to be made on the cross-claim by Silktote.
Silktote's claim was for repayment of monies paid to Mr Baba and Mrs Baba out of the funds of the SSO Trust. As pleaded, the claim concerned payments made from the 2012 financial year to the 2016 financial year. I describe these payments in more detail below.
In my principal judgment I dealt with Silktote's claim at J [83]-[85]. I referred only to some of the payments which were the subject of the pleaded claim, namely some of the payments made to Mrs Baba by way of purported "salary sacrifice" under the Income Tax Assessment Act 1997 (Cth) ("ITAA"). I thought that those payments appeared to have been an abuse of the ITAA provisions. I concluded that an account was necessary and ordered that Silktote bring in a minute of order, agreed if possible, to provide for such an account to be taken.
It took some time for the parties to agree on the form of orders. On 27 November, I made orders that each of the Babas: file and serve on [Silktote] an account verified by affidavit showing all sums received by [him or her] for each of the financial years 2012 to 2018 from Smart Street Optical Pty Limited [the former trustee, referred to in my principal judgment as SSO] as trustee of the SSO Trust by way of: (a) salary; (b) consultancy fees; and (c) payments by way of salary sacrifice.

Summary and analysis of evidence

From the 2012 financial year until the time the dispute arose between the parties in 2016, the Trust's accounts were kept in the following way.
Operation of the bank account, and basic administrative functions, including the maintenance of payroll records, was undertaken by staff of the "Smart Eyes" business employed by SSO. The staff also used accounting software ("MYOB") to record the business' receipts and payments.
These functions were overseen by the two active principals, Mr Carney and Mr Baba, who were both directors of SSO. It seems that Mr Baba was mainly responsible for supervising the accounting and administration tasks, and Mrs Baba undertook most of this work. The third principal, Mr Sheehan, was a director of SSO but was not directly involved in managing the business. From time to time he discussed the conduct of the business with Mr Carney and Mr Baba.
SSO retained an external accountant, a firm named Accounting First ("AF"), to perform higher-level accounting tasks. The principal of that firm was Mr Darren Tappouras. The MYOB ledgers would be provided to AF following the end of the financial year and AF would use them to prepare financial statements and tax returns for the Trust.
As recorded at J [7], Mr Sheehan's appointment of Silktote in place of SSO as Trustee of the Trust did not immediately result in changes to the way in which the business was conducted. The staff of the business continued to report to Mr Carney and Mr Baba, who continued to control the business' bank accounts, which were held in the name of SSO. The accounting procedures which I have described continued and Mr Tappouras continued to accept instructions from Mr Carney and Mr Baba (principally, it seems, Mr Baba) concerning the affairs of the Trust.
In about November 2016, Mr Sheehan brought his own accountant, Gregory Miller, into the picture. Mr Miller's firm is called Talbots. Mr Sheehan provided Mr Miller with bank records and MYOB records for the 2013 to 2016 financial years. In May 2017, Mr Miller prepared a revised set of financial statements for the Trust for the 2016 financial year. These accounts contained a treatment of the payments to the Babas (and the payments to Mr Carney and his company, Sedarni) which was different from the way in which those payments had been treated by AF.
Eventually, once Mr Sheehan, on behalf of Silktote, had obtained complete control of the Trust, Talbots were retained to act as the external accountant in place of AF. In 2018, Talbots prepared financial statements and tax returns for the Trust for the 2017 and 2018 financial years.
Mr Tappouras was not called as a witness in these proceedings. Nor was anyone else from AF. Mr Miller gave evidence in Silktote's case and was cross-examined.
In evidence are financial statements for the Trust prepared by AF for the 2012 to 2016 financial years inclusive. Those financial statements contained a form of trustee's statement to be signed by a director or directors on behalf of SSO, and also contained a form of compilation report from AF to the Trustee. None of those statements or reports in any of the documents in evidence has been signed. Also in evidence are tax returns prepared by AF for the Trust for the 2015 and 2016 financial years, which are also unsigned.
The tax returns for the 2012, 2013 and 2014 financial years (which are not in evidence) would have been completed and lodged long before the dispute between the parties arose. The corresponding financial statements would have been completed at the same time. Even if those financial statements were never signed, they would tacitly have been adopted and approved by the directors of SSO.
The position with respect to the 2015 and 2016 years is not so clear. Both the 2015 and 2016 accounts prepared by AF bear a date in December 2016. Although the tax returns are not dated, I assume that they would have been prepared at the same time. This was after the dispute between the parties had arisen and Mr Sheehan had purported (in October) to exercise his power under the Trust Deed to replace SSO with Silktote as Trustee.
On my findings, the appointment was valid. The Trust's financial statements and tax returns from 2015 onwards should therefore have been prepared and lodged in accordance with Silktote's instructions. But although there is no direct evidence, it seems that the 2015 and 2016 tax returns prepared by AF were later lodged by AF, presumably on the instructions of Mr Baba and Mr Carney. Although this was irregular, the Tax Office would not have known of the irregularity and presumably accepted the returns.
The 2017 and 2018 financial statements prepared by Talbots have not been formally adopted, and the tax returns for those years have not been lodged. According to Mr Miller's evidence, which was given in November 2018, this was because he was waiting for the outcome of these proceedings to do so. I assume that remains the case. Nor have the revised accounts prepared by Mr Miller for 2016 been formally adopted by Silktote.
In his 2018 affidavits Mr Miller set out a summary, taken from the accounts of the Trust, of the payments to the Babas which are the subject of the cross-claim. He took the view, consistently with that taken in the accounts which he had prepared for Silktote, that the payments were wrongful and the Babas were liable to repay them.
Mr Miller's evidence contained an undertaking to abide by the expert evidence code of conduct under the Rules. In response to his 2018 affidavits, the Babas qualified an independent accounting expert, Stephen William Davidson. Mr Davidson wrote a report in March 2019.
In his report, Mr Davidson provided his own summary of the amounts in dispute and expressed the opinion that they were not repayable. In doing so, he gave explanations and justifications for some of the payments. Presumably (although this was not made clear in the report) these were based on instructions from Mr and Mrs Baba.
Whether the payments to Mr and Mrs Baba which are the subject of the cross-claim are repayable is ultimately a legal question which depends upon the facts of the case. It is not really a matter of expert opinion at all. I admitted Mr Davidson's report on a limited basis, as being in effect a submission, and he was not cross-examined.
When the Babas came to file their affidavits of account earlier this year, they were brief. In each case, the Babas simply annexed a one-page description of the payments they had received, summarising the amounts and some associated notations explaining them. This information was taken from Mr Davidson's report. In response, Mr Miller prepared a report in February 2020 reiterating his view that the payments were not legitimate.
Mr Miller was of course a witness of fact insofar as events from November 2016 in which he had been involved were concerned. His summaries of the payments in question, although not based on personal knowledge, were a convenient way of proving what had been paid and how it had been accounted for. Those summaries were not the subject of objection. I have treated Mr Miller's opinions about the legitimacy of the payments in the same way as I have treated Mr Davidson's.
The Trust's payments fell into three categories. The first consisted of salary or wages (together with the compulsory superannuation contribution) paid to those who were recorded as employees. This included Mr Baba and Mrs Baba.
The second category of payment was recorded as "consultancy fees". Such payments were made to Mr Carney's company, Sedarni, and to other employees individually. That included Mr Baba in the 2012, 2013 and 2014 financial years. No consultancy fees were paid to Mrs Baba.
The third category was superannuation payments recorded as "salary sacrifice". Payments of this type were paid to Mr Carney, Mr Baba and Mrs Baba. This category itself included several different types of payment which I discuss in more detail below.
In summary, the payments to Mr Baba for the 2012 to 2018 financial years were: Year of payment Gross Salary Superannuation Guarantee Additional Consultancy Salary Sacrifice Contributions Totals 2012 83,200 7,488 24,199 - 114,887 2013 83,200 7,488 9,873 - 100,561 2014 83,200 7,696 7,571 - 98,467 2015 67,200 6,384 - 23,790 97,374 2016 59,480 5,441 - 26,600 91,521 2017 62,400 6,232 - 28,032 96,664 2018 73,590 6,245 - - 79,835 Totals 512,270 46,974 41,644 78,422 679,310

The payments to Mrs Baba for the 2012 to 2018 years were: Year of payment Gross Salary Superannuation Guarantee Additional Consultancy Salary Sacrifice Contributions Totals 2012 32,240 2,901 - - 35,141 2013 34,918 3,142 - - 34,918 2014 36,920 3,415 - - 40,335 2015 30,810 2,926 - 26,950 60,686 2016 35,980 3,266 - 30,170 69,416 2017 27,200 2,736 - 18,396 48,332 2018 - - - 21,900 21,900 Totals 198,068 18,388 - 97,416 313,872

In evidence was an email exchange from April 2013 concerning the consultancy fees. In the context of, apparently, a possible sale of the business, Mr Sheehan had sought a "breakdown" of those fees as shown in the Trust's accounts.
On 3 April at 10.21 am Mr Baba wrote to Mr Sheehan providing an explanation by reference to the 2012 financial year. He referred to their having been two components to the fees. The first component consisted of regular monthly payments. Mr Baba said: If we go back in history, Steve [Mr Carney] & I both opted to take a part of our salaries as consultation fees until Terry Tzannis [the former external accountant] pointed out that proportional to the salaries paid out the consultations fees seemed quite high. So I opted to go for income splitting by employing Anna [Mrs Baba] in lieu of putting in monthly consultations fees. ... Steve has continued to submit the monthly consultation fees. Hence one part of the consultation fees is from Steve's Sedarni P/L: 12 x $2,118.60 = $25,423.20
Mr Baba continued: Secondly, as you will no doubt recall my annual leave would accrue and then I would take long breaks, part of it unpaid leave. Since the commencement of Smart Eyes neither Steve nor I have had the opportunity to use up our annual leave allowances. Hence based on a previous Howard Government initiative Steve & I both got paid out our unused leave in the form of consultation fees. If you contact Terry Tzannis he will confirm this was first done during his time. For the Financial Year 2011/12 this amounted to 4 weeks for Steve and 5 weeks for me. We are both entitled to 4 weeks annual leave: Steve: $8,492.00 Mustafa: $13,308.90 Sub-total $47,224.10
Mr Baba also said that a relatively small payment would also have been made for one of the locum optometrists. He said he could get the precise figure if that was necessary and invited Mr Sheehan to contact him if further information is required. But at 11.13 am, a bit less than an hour later, Mr Sheehan replied: Thanks Mustafa, that is clear and no further explanation is required.
There is no direct evidence about how the consultancy fees paid to Mr Baba in 2013 and 2014 were calculated. But the payments were of a similar order of magnitude to the payment in 2012 and presumably they were likewise payments made by way of purported cash-out of his annual leave entitlements.
The "consultancy fee" payments continued for Sedarni and for some other employees up to 2017, but such payments to Mr Baba ceased in 2015. In 2015, the same year, however, the superannuation "salary sacrifices" began.
On 2 March 2017, apparently in response to a request from Mr Sheehan, Mr Baba sent him an email setting out details of the "salary sacrifice" payments. It appears that such payments had been made every quarter, usually in September, December, March and June. Mr Baba's email contained details from September 2014 to December 2016, thus covering the whole of the 2015 and 2016 financial years, and the first half of the 2017 financial year.
By the time Mr Baba's email was sent, the parties were in dispute and Mr Sheehan had replaced SSO as Trustee with Silktote. About forty minutes after Mr Baba's email was sent, Mr Sheehan sent an acknowledgement. There was no evidence of any further communications between the parties about the payments after that time.
Various categories of "salary sacrifice" payments can be identified in Mr Baba's email. First, there were regularly quarterly payments of what was described as "normal salary sacrifice". Over the two and a half years the subject of the email, these totalled $49,390 for Mr Baba and $12,320 for Mrs Baba.
The payments listed in the email also included payments of "cashed in annual leave" to Mr Carney and Mr Baba in June 2016. Mr Baba's payment was $7,400. There were also payments to Mr Baba and Mrs Baba in October 2016, with the description "cashed in four weeks long service as salary sacrifice". Mr Baba received $6,400 and Mrs Baba $3,200.
Another category of payments was "salary sacrifice / distributions". The email listed payments with this description to Mrs Baba and Mr Carney of $24,000 each in June 2015, and further payments of $24,000 to Mrs Baba and $13,300 to Mr Carney in March and May 2016.
As their description suggests, these payments represented part of the distributions of annual net profit to which Mr Carney and Mrs Baba, as unit holders, were entitled (in Mr Carney's case, the units were actually held by his company Sedarni). The payments were made before the end of the financial year, in anticipation of what the profit would be. The Trust's actual profit for the year was then split between the unit holders in accordance with their respective proportions (Mrs Baba 40 per cent; Sedarni, 35 per cent; and Rijalu, Mr Sheehan's company, 25 per cent). The balance (after deducting the "salary sacrifice" payments) was reported as the unit holders' distribution.
The following table shows the calculations for 2015 and 2016: 2015 Financial Year Distribution Entitlement Reported Distribution "Salary Sacrifice" Mr Sheehan 30,634 30,634 Sedarni 42,887 16,607 26,280 Mrs Baba 49,014 22,734 26,280 Total 122,535 69,975 52,560

2016 Financial Year Distribution Entitlement Reported Distribution "Salary Sacrifice" Mr Sheehan 27,959 27,959 Sedarni 39,143 25,843 13,300 Mrs Baba 44,734 20,734 24,000 Total 111,836 74,536 37,300

The effect of this was to move some of the net profit distributions to Sedarni and Mrs Baba from "below the line" to "above the line"; that is, to treat them as expenses. As a result, the reported distributions did not accord with the unit holders' 40:35:25 entitlements under the Trust Deed.
The 2015 calculations in the above table should have resulted in "salary sacrifice" distribution payments to Mrs Baba and Mr Carney of $26,280 each. Mr Baba's email stated the 2015 payments as having been $24,000 each. This discrepancy is not further addressed in the evidence.
The figures in Mr Baba's email only cover the first half of the 2017 financial year. It is clear from a comparison with the annual totals at [32]-[33] above that there were further payments to Mr Baba and Mrs Baba in the second half of 2017 and in 2018. The evidence before me does not allow these to be broken down any further, except that the payment to Mrs Baba in 2018 must have been a distribution because she was not paid anything by way of salary in that year. As already noted, tax returns for 2017 and 2018 have not yet been lodged with the Tax Office.

Claims for repayment from Mr Baba and Mrs Baba

Silktote makes no claim to recover the wages paid to the Babas or associated superannuation. But Silktote does claim repayment of all consultancy fees and other "salary sacrifice" payments. The total claim against Mr Baba is $120,000. Against Mrs Baba it is $97,000. These amounts include pre-judgment interest.
The Babas' submissions did not dispute that, to the extent that any of the "consultancy fee" and "salary sacrifice" payments were improper, they would have to be repaid. Their case was that the payments reflected their entitlements.
There was surprisingly little direct evidence before me on this question. In particular, the Babas, who might have been expected in their affidavits to explain and justify the payments made to them, did not enter into specifics. They did not set out how the "consultancy fee" and "salary sacrifice" payments were decided upon or calculated. In fact there was no direct evidence from them about what their terms of employment were, so far as remuneration was concerned.

Distributions by way of "salary sacrifice"

As already noted, the evidence confirms the preliminary view expressed at J [83] that the payments to Mrs Baba and to Mr Carney from 2015 onwards by way of "salary sacrifice / distribution" were in reality payments on account of the distributions of net income of the Trust to which they (or Sedarni, in the case of Mr Carney) were entitled as unit holders. The Babas' written submissions accepted that that was so.
The Babas' submissions argued that payment of the distributions in this way made no difference to the Trust from a financial point of view. But that does not justify the practice. The result has been that, on the Trust's accounts and tax returns for 2015 and 2016 as they were prepared by AF, the amount shown as the net distribution has been understated and has not been proportionally divided among the unit holders as was required by the Trust Deed. At J [55] I rejected the suggestion that Mr Sheehan gave his approval to what was done. Even if he had, that would not justify the failure to comply with the terms of the Trust.
The purpose of the arrangements was clearly to take advantage of the tax concessions applicable to superannuation payments, which were presumably perceived as more attractive than the unit holders receiving distributions of ordinary taxable income. In principle, there is nothing wrong with the trustee of a trading trust remunerating his or her employees in a tax effective way. But in the present case it is clear, as foreshadowed at J [84], that the payments were an abuse of the relevant ITAA provisions. They did not represent a true sacrifice of salary to which Mrs Baba and Mr Carney were otherwise entitled. They were simply payments on top of Mrs Baba's and Mr Carney's ordinary remuneration. It was not in the interests of the Trust for SSO, as Trustee, to make itself party to this type of tax evasion. Indeed the Trust might be exposed to penalties as a result.
Silktote's submissions argued that the payments to Mrs Baba in question should be repaid. The submissions acknowledged that this would result in an adjustment in Mrs Baba's favour as unit holder, but contended that such adjustments should be brought to account in the year of repayment.
I do not accept this argument, at least as it applies to the 2015 and 2016 financial years. The payments in question reflected actual entitlements to the Trust's net income for the years in question. The problem was not that unjustified payments were being made. It was that those payments were inaccurately characterised in the Trust's records and returns. Furthermore it would be wrong to require repayment from Mrs Baba and not from Mr Carney.
In these circumstances I think the proper approach is to modify the Trust's accounts so as to reflect the true character of the payments. This should be done for both Mrs Baba and Mr Carney/Sedarni. The payments should be recorded, not as employee superannuation contributions, but as payments on account of the relevant unit holders' distribution entitlements (that is so even though the payments were actually made to Mrs Baba's and Mr Carney's superannuation funds: from the Trust's point of view they should be treated as payments by direction of the unit holders). The financial statements and tax returns of the Trust prepared by AF should be amended accordingly.
Although the Trust was required to lodge tax returns, all of its income for the years was distributed to unit holders. Amendment to the Trust's tax returns should therefore not result in the Trust having to pay any tax. It will be a matter for Mrs Baba (and Mr Carney/Sedarni) to deal with the tax consequences of recognising the proper characterisation of the monies in their hands.
The "salary sacrifice / distribution" payments made to Mrs Baba and Mr Carney in 2017 and 2018 should likewise be treated as payments on account of the share of net income to which Mrs Baba and Sedarni were entitled. The accounts and tax returns should be completed on this basis.

Consultancy fees and other "salary sacrifice" payments

On the evidence, the "consultancy fees" paid to Mr Baba in 2012 represented a purported cash-out of annual leave, as did the "salary sacrifice" payment in June 2016. As already foreshadowed, I infer that the "consultancy fees" paid to Mr Baba in 2013 and 2014 were of the same type.
Although there are apparently industrial relations rules about how and when a cash-out is permitted, there is no doubt that Mr Baba was happy to cash out his leave entitlements. I think the substantial question for present purposes is whether the payments represented actual leave entitlements which Mr Baba had. Although there is no direct evidence on the question, I do not think there is any real reason to doubt that this was so. The payments were made before any dispute had arisen between the parties. Mr Sheehan appears to have accepted Mr Baba's explanation for the 2012 payment without question.
What this means is that payments were not in truth "consultancy fees" or "salary sacrifice" at all. But, as with the distribution payments, that does not of itself mean that they must be repaid.
Again I think the proper course for Silktote is to draw up, and where necessary amend, the Trust's accounts and tax returns to show the payments to Mr Baba in their correct light. The same should be done for the payments to Mr Carney. If, as I suspect, that means treating them as wages, the Trustee will also have to make any consequential adjustments to payments made on account of wages such as superannuation and worker's compensation premiums. It will be a matter for Mr Baba (and Mr Carney) to meet any additional tax which may be imposed upon them as a result of the correct classification being adopted.
But I think the "salary sacrifice" payments to Mr Baba and Mrs Baba in October 2016 by way of purported cash-out of long service leave fall into a different category. The payments were made outside the ordinary pattern of quarterly payments. No equivalent payment was made to Mr Carney. It is difficult to escape the suspicion that, although recorded in Mr Baba's email as having occurred on 25 October, the payments were in fact a response to Mr Sheehan's action in replacing SSO as trustee with Silktote, which happened the following day. At all events there was no evidence that as at that date there was any such entitlement accrued. In my view these payments were not justified and must be repaid.
This leaves the "normal salary sacrifice" payments from 2015 onwards. A summary of the relevant tax provisions published by the Tax Office was in evidence. This stated that an employee has no right to insist upon a salary sacrifice arrangement. The employer must agree, and cannot be compelled to do so.
I have been troubled by the lack of specific evidence about these payments. If they were no more than bona fide reallocations of salary to which the Babas were entitled, it should have been easy to demonstrate directly that that was so.
Nevertheless the table set out at [32] above shows that in Mr Baba's case there was a large reduction of salary which roughly coincided with the salary sacrifice payments. In fact Mr Baba's overall remuneration declined from the 2014 financial year to the 2015 financial year, and again from 2015 to 2016. This was at a time when the income and expenditures of the business were generally increasing.
There is no evidence of Mr Sheehan expressly consenting to the payments. But the payments made up to September 2016 were made before it was clear that Mr Sheehan had any concerns about the way in which the business was being operated. In those circumstances, I think that taking advantage of available salary sacrifice opportunities was within the implied authority of Mr Carney and Mr Baba as the active principals of SSO. On balance I am not satisfied that the payments were other than what they purported to be.
For these reasons, I reject Silktote's claim to repayment of the "normal salary sacrifice" payments up to September 2016. But matters changed once Silktote was appointed as the Trustee in October. From that point onwards, any implied authority from Mr Sheehan to Mr Carney and Mr Baba as directors and employees of SSO to manage the Trust's financial affairs ceased.
In these circumstances, it was not open to the Babas and Mr Carney just to carry on as before. Even if Mr Baba did voluntarily reduce the payments which he received under his existing employment arrangements, those arrangements had been made with SSO and did not bind Silktote as the new Trustee. In my view any "normal salary sacrifice" payments made to the Babas after September 2016 must be repaid.

Interest

There was no dispute that interest should be awarded on any amounts repayable by the Babas. For Mr Baba this presents no difficulty. But for Mrs Baba it is more complicated.
There appears to have been a unit holder's loan account between Mrs Baba and the Trust. Presumably payments on account of distributions were debited to that account and the actual distribution entitlements credited when they were known. I was not referred to any evidence showing the running balance on that account from the 2015 financial year onwards (and presumably the account is a continuing one, because Mrs Baba remains a unit holder in the Trust, and thus entitled to an ongoing share of its profits). On the face of it, payments which I have found to be repayable by Mrs Baba should be debited to this account, and interest will only apply to the overall debit balance (if any).

Orders

It will be necessary for the components of the "salary sacrifice" payments to Mr and Mrs Baba which I have found to be repayable to be quantified and pre-judgment interest recalculated on those amounts (if appropriate, in Mrs Baba's case). I will stand the proceedings over for a short time to allow this to occur. Any contest about costs can be resolved at the same time.
The orders of the Court are:
I adjourn the proceedings for 7 days or such other period as may be agreed with my Associate.
I direct that the cross-claimant bring in a minute of order giving effect to this judgment, and dealing with costs.

Amendments 04 June 2020 - make minor typographical amendments DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated. Decision last updated: 04 June 2020

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Judgment (12 paragraphs)

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