20 Armed then with the Investor Parent's loan of $1,830,000 and Citibank's loan of $8,520,000, the Investor purchased from the Producer a 15% interest in the copyright in Pitch Black together with one set of the negatives of the film in return for the promise to pay $10,350,000 (that is, the sum of the two loans). This money was apparently advanced on 21 July 2000 pursuant to the Heads of Agreement which had been executed on 30 June 2000. Although where the $8,520,000 actually went is not absolutely clear it seems likely that it was advanced at the direction of the Producer to the film's promoter (of which more below). Having secured this asset, the Investor immediately entered into a distribution agreement also dated 21 July 2000 (the 'Distribution Deed'). The two parties to it were the Investor and Universal, which I shall presently call the 'Distributor'. Under the deed the Distributor modestly promised to 'use its reasonable endeavours to promote and distribute the Film in all media, throughout the entire universe'. The 'Film' was defined as Pitch Black. It also promised to procure an initial release on at least 1,300 screens in the US and to spend $10,000,000 on promoting the film prior to its release in the US. This was a light burden indeed for the film had not only already been launched in the US but in fact had finished its theatrical run altogether by June 2000. Meriton Apartments Pty Ltd had been informed on 2 June 2000 that the initial advertising expenditure together with prints in the US had been US$17,000,000-$20,000,000. Further, as already noted the film had, in fact, opened in 1,832 cinemas during the previous February.
21 In any event, the Investor granted the Distributor an exclusive licence so to distribute the film in all media 'in perpetuity'. In return the Distributor promised to pay the Investor an amount of money calculated in accordance with a specified formula of which it will be necessary to say more later. For present purposes, it is to be observed that one possible outcome might have been that the Distributor might not have become obliged to pay the Investor anything. This would have left the Investor in the precarious position of being obliged to meet the repayments due to Citibank, in accordance with the above table, but with no ready means to satisfy those obligations.
22 The answer to this conundrum lay in a series of complex contractual arrangements which operated as follows:
(a) a company called Shooting Star Pty Ltd, which I will call the 'Promoter', promised the Investor that it would meet all of the Investor's obligations to Citibank under a deed known as the 'Minimum Income Deed'; that is, it promised to make the payments of interest due by the Investor to Citibank;
(b) the Promoter then guaranteed the obligations that the Investor had under the loan agreement with Citibank. Those obligations consisted, inter alia, of:
(i) the obligation to pay the amounts of interest and principal set out in the table above; and
(ii) the obligation to repay the outstanding principal of $6,134,128 which would be due on 30 June 2006 (which appears as the last entry in that table);
(c) the guarantee was supported by the deposit of the guaranteed amount into an account with Citibank. The amount guaranteed was subject to an indemnity given by the Investor secured by a fixed and floating charge on the Investor's assets;
(d) The amount deposited by the Promoter was $8,520,000 which is the same amount borrowed by the Investor from Citibank and which formed part of the $10,350,000 advanced to the Producer. Whether this $8,520,000 is the same money - implying that it was paid by direction to the Promoter by the Investor - is not presently clear although if it was not there is no ready way to understand where the Promoter obtained the $8,520,000 from. In any event, this question does not presently call for resolution;
(e) the Promoter placed the $8,520,000 on deposit at 8% with Citibank, that is, at the same rate which the Investor was paying Citibank on its loan of $8,520,000;
(f) the consequence, as a matter of formality, was that all of the Investor's obligations to Citibank - including the final repayment of principal - could be acquitted from the deposit held by Citibank in the Promoter's name, without any party having to do anything. If the Investor did not make any of the payments required this would allow Citibank to call on the Promoter under the guarantee and, thereupon, to take the amount in question from the deposit. In effect, each payment due by the Investor on its $8,520,000 8% loan would be met by deductions from the Promoter's $8,520,000 8% deposit and this included not only interest but the final payment of principal. If no party took any step Citibank would incrementally transfer the contents of the Promoter's deposit account to repay and discharge in its entirety the Investor's loan account;
(g) the Promoter's payments to Citbank pursuant to its guarantee, however, gave rise to a right in the Promoter to be subrogated to Citibank's rights against the Investor. In relation to the interest payments due during the six year life of the facility the Promoter's subrogation rights against the Investor were fully set-off against its own obligations to the Investor under the Minimum Income Deed;
(h) this was not so, however, in relation to the final repayment of principal of $6,134,128;
(i) in relation to that right the Promoter had an enforceable subrogated right to recover $6,134,128 from the Investor;
(j) subject to one matter, the Promoter was obliged to the Producer to pursue that right and repay any sum so recovered to the Producer. This does not prove, but rather tends to suggest, that the Promoter had originally received the $8,520,000 from the Producer;
(k) the one exception was this: the Investor Parent could exercise a put option which, in its ultimate form, permitted the Investor Parent to require the Promoter to purchase all of the shares in the Investor for $1,000;
(l) if the put option were exercised the Promoter was obliged to cause the Investor to reassign the copyright in Pitch Black to the Producer. Importantly, in that circumstance the Promoter was not placed under a positive obligation to pay the $8,520,000 to the Producer (as it was if the put option were not exercised).
23 All of this came to pass. The Investor borrowed $1,830,000 from the Investor Parent and $8,520,000 from Citibank. It paid the combined total, $10,350,000, to the Producer in return for a 15% interest in the copyright in Pitch Black. The Promoter deposited the same sum with Citibank and, using that deposit as security, guaranteed the Investor's obligations to Citibank. The whole of the Investor's obligations under its $8,520,000 loan was discharged by the Promoter's $8,520,000 leaving nothing but the Promoter's rights of subrogation against the Investor, which, apart from the final principal payment, were set off against the Promoter's obligations under the Minimum Income Deed. On the exercise of the put option the Promoter became the owner of the Investor and those rights were not pursued there being instead a reconveyance to the Producer of the 15% interest in the copyright. Subsequently, in circumstances to which I shall return, the shares in the Investor were returned to the Investor Parent.
24 It is the Deputy Commissioner's position that the $8,520,000 loan is a device and that it merely travelled around a loop contributing no part of the purchase price paid to the Producer. I do not have to resolve that issue for present purposes. Mr Gelski of Blake Dawson Waldron, in a letter of advice of 19 July 2000 thought that the Investor was 'entitled to a minimum return under the Minimum Income Deed, which, if reinvested at a reasonable rate of return, will exceed the interest payable to Citibank'. Further, he recorded that 'it is anticipated, and there are significant prospects, that such variable income will be derived'. Since Mr Gelski had all of the relevant transaction documents the route by which he arrived at that opinion remains opaque to me; still more the place from which TMPL's anticipation of the stream of income derived. These, however, are matters for the Tribunal and I pass them by.
25 These matters do, however, become significant when one comes to ask how large the Investor's investment of capital in Pitch Black actually was. Certainly it involved the amount of $1,830,000 which had been advanced to it by the Investor Parent by way of loan capital. On its face the purchase price also included the $8,520,000 of loan capital advanced by Citibank. If that were correct then the capital invested was $10,350,000. On the other hand, if the structure involving Citibank, the Investor and the Promoter was merely a confection around which the sum of $8,520,000 glided without ever forming part of the purchase price then this would rather suggest that the true capital investment in Pitch Black was only $1,830,000.
26 Why does this matter? Ordinarily, it is not possible to claim a deduction for capital expenditure. In the case, however, of the Australian film industry a different position was formerly brought about by Division 10B of Part III of the Income Tax Assessment Act 1936. It provided that the owner of a 'unit of industrial property' that related to copyright in an Australian film could claim a deduction if it had used the unit for the generation of assessable income: s 124L. The deduction consisted of the residual value of the unit of industrial property divided by the number of years of its effective life: s 124M. The effect of s 124UA was that the effective life was usually 2 years. What was an Australian film? The answer is that it was one certified to be such by the Minister pursuant to s 124K(1). In this case, a delegate of the Minister certified that Pitch Black was Australian on 23 November 1998.
27 Assuming, therefore, that everything ran to plan and that the interest in the copyright was a 'unit of industrial property' used for income generating purposes (an issue which it will be for the Tribunal to resolve) then s 124M would permit its residual value to be deducted over two years. On the evident basis that this was so, the Investor claimed two deductions of $5,175,000 in the income years 2000 and 2001 (that is, half of $10,350,000 in each year). Since the Investor did not earn any other assessable income in those years this generated losses in both years of $5,175,000. Although the consolidation provisions in Pt 3.90 of the Income Tax Assessment Act 1997 (Cth) had not yet come into force nevertheless it was possible at that time for a parent which owned 100% of the share capital of a subsidiary to take advantage of those loses which the Investor Parent, TMPL, in due course did. Accordingly, TMPL utilised the Investor's losses of $5,175,000 in the 2000 and 2001 year to reduce its assessable income and the amount of tax it had to pay across the years 2000-2002.
28 Of course, if the true consideration paid for this transaction was only $1,830,000 the appropriate claim by the Investor would have been $915,000 in each of 2000 and 2001. The Deputy Commissioner, however, does not accept that to be so either. He contends that the grant to the Distributor of the exclusive right to distribute and exploit the film meant that the Investor was not the owner of a unit of industrial property for Division 10B purposes. He has a number of other complaints about it, too, which I need not set out but one of which is that this was not an income generating venture at all but in contradistinction a scheme entered into only to generate Division 10B deductions. I will return to these matters below when I come to consider the merits, from the creditors' perspective, of TMPL's current attempts to persuade the Tribunal that it is entitled to claim the benefit of the Investor's two deductions of $5,175,000 in two separate income years in circumstances where it apparently only outlaid $1,830,000.
29 Little mention has yet been made of the Distribution Deed but, in a sense, it lies at the heart of any argument about the commercial realities of these arrangements for it tells one the profit mechanisms at work. Under that deed, the Investor was entitled to 1.5% of 'Net Proceeds' but only after 'First Breakeven'. 'First Breakeven' was defined in the Exhibit to the Second Schedule of the deed, as was 'Net Proceeds'. The two were interrelated. The First Breakeven was the initial point at which Net Proceeds would become payable. 'Net Proceeds' was defined in cl A9(b) as, in substance, a residue after the deduction by the Distributor of various fees and charges. That immediately raises the question of what the deduction was taken from and here the answer was given by cl A2 which erected the concept of 'Accountable Gross'. This was defined, in effect, to be the worldwide receipts of certain kinds derived by the Distributor from the distribution of Pitch Black less a 30% distribution fee. From that figure the deed then contemplated various further deductions. These were:
(1) distribution expenses relating to the cost of distributing the film (such as advertising, printing, royalty payments etc);
(2) an administrative fee of 22.5% of the distribution expenses;
(3) participation payments, being any payment which the Distributor was contractually obliged to pay to persons which were based on a percentage of net proceeds (i.e. persons who were being paid a share of the film);
(4) 37.5% of the cost of producing the film.
30 Prior to acquiring the Investor's 15% interest in Pitch Black TMPL was given financial forecasts by the National Australia Bank ('NAB'). These were included in a bundle of documents described by Mr de Vries as 'due diligence material provided to [the Investor] by Universal's promoter, the National Australia Bank relating to [the Investor's] investment in the film Pitch Black'. The bundle was located at pp 466-544 of Exhibit ADV-1 to Mr de Vries' affidavit. At pp 517 of that bundle there is a worked example of what the First Breakeven might be. It assumed distribution expenses of $45,110,000, participation payments of $12,840,000 and production costs of $33,600,000. Based on those assumptions it calculated the First Breakeven in the following way:
Distribution Fee (30% of accountable gross) $58,500,000
Distribution Expenses $45,110,000
Administration expenses (22.5% of distribution expenses) $10,149,750
Participations $12,840,000
37.5% of Production costs $12,600,000
Total Deductions $139,199,750