RESOLUTION OF THE FACTUAL DISPUTE
65 Ceramics' Annual General Ledger included, in addition to numerous debit entries for payments made by Ceramics in discharge of liabilities of Tile, credit entries being amounts that came in from ANZ to Tile, BAS refunds to which Tile was entitled, and rental paid by Ceramics to Tile. It was truly a running account and had all the appearances of a running loan account as its title said it was.
66 Mr Di Lorenzo gave evidence that there was never an intention that Ceramics make a loan to Tile. However, the gravamen of his evidence was that he intended only that his four daughters share equally and that he left all accounting and legal questions to the professionals.
67 Mrs Fresta, a qualified accountant, said that the choice of the language of "loan" had not accurately captured the relationship between Ceramics and Tile. She said of the running account:
The various inflows and outflows went in favour of Tile Investments as intended.
This net amount from Ceramics to Tile Investments was recorded by LCI as loan in the monthly management accounts. From an accounting perspective, I considered that this was a reasonable treatment to reflect that there was some arrangement between Ceramics and Tile Investments, and I myself had marked the ANZ bank statement entries involving these payments as loans to Tile Investments.
I never thought any further about this accounting description of the transactions because I did not consider that the precisely correct characterisation of it was necessary for taxation purposes, until the ATO auditors made their assertions.
There is in evidence a statement of account issued by ANZ in respect of Ceramics' bank account in which Mrs Fresta wrote "Loan DL [or DC] Tile Invest" against an entry for 14 June 2001 of a transfer of $259,467.96 out of the account. The note recognised a loan by Ceramics to Tile.
68 Mrs Fresta also said that the intended arrangement was that she was to receive her one quarter share upfront, and that there was no discussion when the Unit Trust was established in 1999 about her having to subscribe for additional units.
69 Mr Incollingo was the person who had prepared the Annual General Ledger in relation to the "Loan - Di Lorenzo Property Group Unit Trust". He emphasised that there was no separate bank account for the Unit Trust. According to Mr Incollingo, the error had come about because his staff had used a wrong coding - 697 or 698 ("loan") instead of 780 ("investment"). (Mr Incollingo's affidavit refers to code 697, but in cross-examination he referred to code 698.) He agreed that the Annual General Ledger of Ceramics recorded debit entries for payments of legal liabilities of Tile in connection with the construction work, that is to say, payments out to persons and companies who were creditors of Tile for goods and services provided in connection with the construction of the building on its land. Mr Incollingo insisted that the loan was in reality an "investment".
70 In cross-examination, senior counsel for the Commissioner took Mr Incollingo to the running balance of the account as between Ceramics and Tile, showing that the opening balance at 1 July 2001 of $841,704.87 was reduced to $780,648.62 as at 30 June 2002. (I note that the figure of $780,648.62 for the year ended 30 June 2002, taken from an exhibit to Mr Incollingo's affidavit, differs from the figure of $778,982.62 quoted in [44] above for the same period. The $780,648.62 figure appears in an untitled "running balance" sheet. The $778,982.62 figure appears in an exhibit to Mr Farrugia's affidavit being the "Annual General Ledger" of Ceramics from 1 July 2001 to 30 June 2002. The amount of $780,648.62 appears in only the one place and I assume that $778,982.62 is the correct figure.) Senior counsel put it to Mr Incollingo that one does not ordinarily find an investment, but one does ordinarily find a running loan account, in the form of this account with, at times, a reducing balance.
71 Mr Incollingo agreed that the credit entries for rent from Ceramics, BAS refunds and the payments on account of the borrowing from ANZ, were all monies of Tile. He would not agree, however, to the proposition that the making of those credit entries was "consistent with" repayment of a loan to Tile from Ceramics. He did agree, however, that the Ceramics account and the Unit Trust account mirrored each other.
72 Mr Incollingo agreed that he had never protested to Mr Farrugia that the transaction was in fact not a loan but an investment. Mr Incollingo accepted that the response that he and Mr Laureti made to Mr Farrugia was that they could not understand how there could be a deemed dividend because "that outcome was crazy". In fact, in Mr Incollingo's affidavit he stated:
Once it became apparent to me that the correct characterisation of Ceramics' payments was important for taxation purposes, I considered the loan treatment was incorrect.
73 Mr Incollingo was taken to the Unit Trust income tax return for the year ended 30 June 2001 which recorded a current liability of $841,705 as at that date. He agreed that that entry reflected an indebtedness of the Unit Trust to Ceramics, and that if the payments made by Ceramics had been treated as an investment by it in the Unit Trust, that entry in the tax return would not have appeared. Mr Incollingo's explanation was, again, that the payments made by Ceramics out of its bank account had been wrongly shown as a loan to Tile in the various internal financial records.
74 It appears that neither Mr Di Lorenzo nor Mrs Fresta nor any other director or member of Ceramics or Tile gave close attention to the legal character that the payments made by Ceramics on account of Tile's liabilities was to bear. At least there is no evidence of an express agreement that those amounts were to represent either a loan or a subscription for additional units (no one has suggested that they were intended to be a gift). There was no agreement that the amounts were to be repaid by a particular date. There was no agreement that any particular number of additional units was to be issued. The proper characterisation of the payments was, however, left to Mr Incollingo. Mr Di Lorenzo and Mrs Fresta were content to leave it to him to characterise them as he saw fit and to prepare Ceramics' and the Unit Trust's financial statements and tax returns accordingly. One piece of evidence of express instruction is the reference to a loan to Tile written against entries in Ceramics' bank statements that were provided by Mrs Fresta to Mr Incollingo, although that evidence could be regarded as her acquiescence in the course that Mr Incollingo was already taking.
75 In my view there was a loan, because within the scope of his authority Mr Incollingo characterised the payments as loans, that is to say, as an indebtedness of Tile to Ceramics repayable upon demand. It was within the scope of Mr Incollingo's authority to establish a running loan account in the name of Tile, to treat the payments made by Ceramics as debits to it, and to treat the ANZ, rental and BAS receipts as repayments by Tile, as he in fact did.
76 I also do not overlook the convenience of treating as loans payments such as those made by Ceramics to another company under the same ownership and control where, as here, no decision is taken that they are to bear a different complexion. Treating them as loans allows the greatest flexibility for the treatment of them in the future as occasion arises. The company providing the funds might not only require repayment in whole or in part, and at one time or from time to time; it might forego repayment in whole or part, and at one time or from time to time, as consideration for one kind of benefit or another being conferred by the other company. Acting within the scope of his authority, Mr Incollingo took the most convenient course.
77 There was no agreement that the amounts paid by Ceramics were subscriptions for units in the Unit Trust, and the making of such an agreement would have prompted consideration of several practical questions. When were the further units to be issued to Ceramics? How would the gross imbalance between the ever increasing number of units held by Ceramics as against the single unit held by Fresta be avoided? On what basis could one additional unit be issued to Fresta for every three additional units issued to Ceramics? Would there be successive further issues of units? No consideration was given to such questions at the time when the Unit Trust was established.
78 In this respect, Mr Incollingo's affidavit evidence is telling. He stated:
Once it became apparent to me that the correct characterisation of Ceramics' payments was important for taxation purposes, I considered the loan treatment was incorrect. I considered an appropriate way to record properly Ceramics' payments was a further investment by Ceramics and Fresta in the Unit Trust, and that this should be formalised by way of the subscription for additional units in the Unit Trust. Because I knew it was always the intention of Jack and Maria that there be an investment into the Unit Trust and that the respective proportions should always remain 75/25, I considered it appropriate to record formally those decisions that had been informally made and in a way that reflected the formalities of the Unit Trust deed.
I considered that the gift that Jack was in effect making to Maria (by reason that Fresta was attaining 25% of Ceramics' equity contribution) should be formally recorded as the subscription by Fresta of additional units equating to 25% of the issued units. Fresta's subscription was funded by Jack making a gift to Maria, who lent those funds to Fresta.
Now shown to me and marked GI7 is a bundle of directors resolutions of Tile Investments made on 9 February, 2005.
Now shown to me and marked GI8 is the unit register for the Unit Trust, which was altered on 9 February, 2005 to record the additional units.
79 It was as late as 9 February 2005 that Mr Incollingo prepared the minutes and made entries in the Register of Unitholders for the Unit Trust to which he refers in this passage. The minutes of the meeting of directors of Tile on 28 September 1999 provided for the issue of 1,600,000 units at an issue price of $1.00 each - 1,200,000 to Ceramics and 400,000 to Fresta. But Mr Incollingo did not have instructions back on 28 September 1999 (the Unit Trust Deed was dated 27 September 1999) that such additional units were to be issued or that Ceramics was to give Fresta $400,000 with which to subscribe for one quarter of them.
80 Mr Incollingo has attempted to rewrite history in an effort to achieve what he considers to be a more fair and just result for his clients, and one that perhaps he thinks they would have agreed to if he had recommended it.
81 The applicants suggest that a treatment of the payments made by Ceramics on account of Tile's liabilities as an investment in units was somehow supportive of the 75 percent/25 percent arrangement, whereas a treatment of them as a loan was not. I disagree. The 75 percent/25 percent arrangement was fixed by the original issue of three units to Ceramics and one to Fresta. A fluctuating loan account as between Tile and Ceramics does not detract from that arrangement, but dictates the fluctuating value, from time to time, of the four units.
82 The authority given by Mr Di Lorenzo and Mrs Fresta to Mr Incollingo and the fluctuating account, its title, the numerous references to "loan" in the contemporaneous documents and also in things said by Mr Incollingo to Mr Farrugia show that there was a running loan account recording advances by way of loan from time to time by Ceramics to Tile. The loan was repayable on demand. Section 190D of the Act therefore has potential application.
83 In the alternative, the relationship between Tile and Ceramics that arose from the making of the payments by Ceramics at Tile's request in discharge of Tile's legal liabilities was that of creditor/debtor. The relevant common money count was that of "money paid by the plaintiff to the use of the defendant" or simply "money paid" as it came to be called. Section 109C(3)(a) of the Act refers to a payment on behalf of, or for the benefit of, an entity - a concept that captures this alternative legal complexion of the payments that Ceramics made in discharge of Tile's liabilities.
84 I will consider the operation of ss 109C (payments) as well as of s 109D (loans).