HFGC Nominees (No 2) Pty Ltd v Hancock as Liquidator of 246 Arabella Investments Pty Ltd

AND: GEOFFREY TRENT HANCOCK AS LIQUIDATOR OF 246 ARABELLA INVESTMENTS PTY LTD (IN LIQUIDATION)

1 For some years a company presently called 246 Arabella Investments Pty Ltd (in Liq), which I shall call the taxpayer, was the lessor of premises at 513-515 South Dowling Street, Surry Hills, an inner city suburb of Sydney. Between 1993 and 2003 a business known as the "Design Establishment" was operated from these premises by tenants. In those years the taxpayer claimed as deductions interest payments said to have been paid under a commercial loan agreement by it to another entity which I shall call the Lender. The amount of interest claimed in each year fluctuated but in all totalled $5,983,653. 2 Following an audit of the taxation affairs of the taxpayer the Commissioner disallowed the interest expenses as a deduction and imposed penalties and interest. The total ultimately assessed as due by the Commissioner was $10,395,717.34. The taxpayer lodged an objection to this assessment but, apart from a minor concession which is presently of no moment, the Commissioner disallowed the objection. Ordinarily, a taxpayer would be entitled to appeal against such a decision to the Administrative Appeals Tribunal pursuant to Division 4 of Part IVC of the Taxation Administration Act 1953 (Cth). In this case, however, the taxpayer is in liquidation and the first defendant, who is its liquidator, has declined to pursue the appeal. 3 The second plaintiff, Mr Higgins, is a shareholder of the taxpayer and holds his shares on trust for two other family trusts of which the first plaintiff, HFGC Nominees (No 2) Pty Ltd ("HFGC"), is the trustee. Mr Higgins and HFGC now apply to this Court for an order that would permit Mr Higgins to use the taxpayer's name to pursue an appeal on its behalf in the Tribunal from the Commissioner's objection decision. 4 But for the debt owed by the taxpayer to the Commissioner it appears likely that the taxpayer would be solvent. Its principal assets appear to consist of two book debts owed to it each with a face value of $1.95 million. Each book debt is owed by one of the family trusts on whose behalf Mr Higgins holds his shares in the taxpayer. 5 Mr Higgins has, therefore, two practical interests in seeing the debt to the Commissioner expunged on appeal. One is representative and the other personal. The representative interest springs from his holding of the shares in the taxpayer on trust for the two family trusts. If the taxpayer remains insolvent then it is reasonable to assume that the liquidator will embark upon recovery proceedings against the two family trusts since the two book debts are the taxpayer's principal assets. On the other hand, if the Commissioner's debt ceases to exist following an appeal to the Tribunal it is neither difficult to imagine that the two family trusts might repay their debts to the taxpayer using the proceeds of its winding-up, nor that this might be done by mere book entry. Mr Higgins' representative interest is, therefore, to reduce if possible the economic risk to the two family trusts of having, in substance, to contribute to the taxpayer's obligations to the Commissioner. 6 Mr Higgins' personal interest arises from the fact that he is presently being publicly examined by the liquidator about the affairs of the taxpayer. His examination was commenced on 8 June 2010, but was adjourned pending a decision in this case (which was heard on Wednesday 28 July 2010). The liquidator's conduct of that examination is being funded by the Commissioner who is, as I have said, the only creditor of the taxpayer. It is reasonable to assume that if by reason of a successful appeal the Commissioner ceased to be a creditor of the taxpayer, the liquidator might well take a different attitude to the examination. In particular, the fact that the taxpayer would then be solvent might well be regarded as material to whether the examination should proceed. 7 There was no dispute before me that the Court had power to permit Mr Higgins as a contributory to pursue the appeal before the Tribunal in the taxpayer's name. There is no doubt that Chancery had jurisdiction to permit a creditor or contributory to sue in the name of a company which was being wound-up. The authorities are usefully collected in the judgment of Debelle J (with whom Sulan and Vanstone JJ agreed) in the Full Court of the Supreme Court of South Australia's decision in Ragless v IPA Holdings Pty Ltd (in liq) (2008) 65 ACSR 700 at 712-713 [44]. Debelle J thought the power to be an aspect of inherent jurisdiction. I would accept that it is within the inherent jurisdiction of a court which is conducting the winding-up of a company to make orders of that kind. It is less plain that there is an inherent jurisdiction in cases where the winding-up is not the result of a curial order or where the winding-up is being conducted under the auspices of another court. However, it is not necessary to resolve those difficulties in this case because the Corporations Act 2001 (Cth) affords a ready solution in s 511 which provides: Application to Court to have questions determined or powers exercised (1) The liquidator, or any contributory or creditor, may apply to the Court: (a) to determine any question arising in the winding up of a company; or (b) to exercise all or any of the powers that the Court might exercise if the company were being wound up by the Court. (1A) APRA may apply to the Court under subsection (1) in relation to a company that is a friendly society within the meaning of the Life Insurance Act 1995 and which may be wound up voluntarily under subsection 180(2) of that Act. (2) The Court, if satisfied that the determination of the question or the exercise of power will be just and beneficial, may accede wholly or partially to any such application on such terms and conditions as it thinks fit or may make such other order on the application as it thinks just. 8 In Ragless, Debelle J described the inherent power as "entirely consistent" with s 511 (65 ACSR at 713 [45]) and it is apparent that his conclusion that the contributory could sue in that case rested both on the inherent power and upon s 511. Rares J in this Court reached a similar conclusion that s 511 could be utilized to authorise a contributory to sue in the name of a company subject to a members' voluntary winding-up in Commissioner for Revenue (ACT) v Slaven (2009) 178 FCR 334 at 348 [44] ("Slaven"), a conclusion with which I respectfully agree. 9 In those circumstances, Mr Higgins' status as a contributory permits him to apply under s 511. Although his interest as contributory is held on trust for the two family trusts to which I have referred (more strictly, on trust for HFGC which holds its interests subject to the terms of the family trusts) this does not give HFGC the right to pursue a claim under s 511. If there were evidence that Mr Higgins was refusing to use his status as a contributory to apply to sue in the taxpayer's name then, in all likelihood, HFGC as beneficiary of that trust could sue in its own name under the principle expounded by Powell J in Ramage v Waclaw (1988) 12 NSWLR 84 at 91; see also Lidden v Composite Buyers Ltd (1996) 67 FCR 560 at 563-564 per Finn J. However, since Mr Higgins, as trustee, is in fact applying for such relief HFGC, as beneficiary, cannot apply. It follows that its claim must be dismissed. 10 The question then arises whether leave should be granted to Mr Higgins. In Slaven Rares J approached that question on the basis that the party seeking leave had to show that the proposed case was "sufficiently arguable" (178 FCR at 348 [46]). I take from that that the Court would not permit a proposed appeal of the present kind to be pursued if it were, putting the matter shortly, a waste of time. This in turn requires an assessment of the prospects of the taxpayer's appeal. The liquidator, very properly, has indicated that his position is that he sees little merit in the appeal. Bearing that in mind, it is nevertheless necessary to consider the proposed appeal. 11 To do that one needs to understand the Commissioner's reasons for his objection decision. The broad position put by the taxpayer to the Commissioner was that: (a) the interest had been paid by it to the Lender pursuant to a commercial loan arrangement; and (b) the interest had been paid in the course of earning assessable income. 12 In a sense, the existence of the commercial loan proved, if established, that what was paid was indeed interest rather than some other kind of payment. The fact of it having been paid in the course of earning assessable income, if established, would bring it within the general deduction provisions of s 51(1) of the Income Tax Assessment Act 1936 (Cth) ("the 1936 Act") and s 8-1 of the Income Tax Assessment Act 1997 (Cth) ("the 1997 Act"). The taxpayer failed to persuade the Commissioner of either of these matters. The taxpayer's more particular case to the Commissioner was, as I understand it, that: (a) the taxpayer had leased the premises successively to two related entities and that those entities conducted a furniture business under the name "Design Establishment". I will refer to these two entities as the tenants. (b) The taxpayer had borrowed from the Lender (another related entity) a significant (but unspecified) sum of money and used it in conduct of its furniture business. 13 The Commissioner was unpersuaded by this. In particular, he was concerned that the loan was undocumented and that the loan funds had never appeared in accounts of the taxpayer. The Commissioner was also concerned about the non-periodic nature of the interest payments and the absence of any security for the loan. The taxpayer had argued that since the loans were all, in a sense, in-house between various manifestations of the family trusts the absence of documentation was less surprising then it might otherwise have been. 14 The Commissioner was also not satisfied that even if the loan agreement had existed that the interest paid by the taxpayer was incurred in the course of earning assessable income. Before the Commissioner the taxpayer's solicitor explained the taxpayer's use of funds in these terms: Based on the facts of this case [the taxpayer] used the funds as intended and established a successful furniture business that produced significant assessable income. Therefore, there is a clear and obvious commercial explanation for the incurring of interest, to derive assessable income from a successful furniture business. The ATO records will confirm that [the taxpayer] included this income in its tax returns. 15 The Commissioner did not accept this contention. It suffered from the particular difficulty that the taxpayer did not conduct the furniture business. Indeed it is now tolerably clear that the furniture business had been conducted by the two tenants (one after another) to whom reference has already been made. 16 Before this Court a somewhat different tack was taken. It was accepted that it was the tenants and not the taxpayer who conducted the furniture business. It was now said, however, that the taxpayer had on-lent the money it had borrowed from the Lender to the tenants who had then paid interest upon it. The argument, as I apprehend it, is that the interest paid to the Lender was incurred in the course of earning assessable income, namely, the interest paid by the tenants. Paragraph [20] of an affidavit sworn in these proceedings by Mr Higgins put the matter this way (note, Kristim Design was the first of the tenants): Monies that were lent to the [taxpayer] by the [Lender] were on lent at various times in various amounts to others in the Higgins Group and Kristim Design, and used by the latter in the running of [Design Establishment]. Those monies were treated as loans by… the [Lender], the [taxpayer] and in turn by Kristim Design. The [taxpayer] received interest from time to time on moneys advanced. It also received the higher premium rent from Kristim Design. The outstanding loans as at 30 June each year were recorded in the annual financial accounts of each of the [Lender], the [taxpayer] and Kristim Design. Further, the amount of interest paid by the [taxpayer] to the [Lender] was recorded in the profit and loss statement in the financial accounts of the [Lender] (as a receipt) and by the [taxpayer] (as an expense). This is reflected in the income tax returns of the [taxpayer] and the [Lender]. 17 If that evidence were to be accepted, it would suggest that one way the taxpayer earned income was by lending money to one of the tenants and that the interest that it incurred on the borrowing of the funds was a cost incurred in the course of earning of that income.

Consideration 18 On any appeal the taxpayer will need to establish that: (a) there was a commercial loan from the Lender to it and that it actually paid interest under that loan; and (b) that those payments of interest were made in the course of earning assessable income. 19 As to (a) I think it may be possible to take a more lenient view of some aspects of the matter than the Commissioner did. For example, the fact that the corpus of the loan funds do not appear in any accounts of the taxpayer may be susceptible to the explanation that they were paid by direction to the tenants. Further, although the Commissioner was unpersuaded by the argument that a degree of casualness about loan documentation is to be expected with intra-group loans I do not think that the contrary view is necessarily untenable. Further, it may be the case that the absence of documentation can also be explained by the effluxion of time. I do not mean to give these propositions any particular credence. Rather, the point to be made is that it is possible that the Tribunal could be persuaded by them even though the Commissioner was not. No doubt, the cross-examination of Mr Higgins is likely to aid in that process. For myself I can well understand some of the Commissioner's misgivings. However, at this stage, I do not think that it can be said that a contention by the taxpayer that there was a commercial loan agreement between it and the Lender is not arguable. It will be up to the Tribunal to decide whether it accepts Mr Higgins' evidence. 20 That is an empty conclusion, however, unless Mr Higgins also establishes that the interest payments, if made, fell within the general deduction provisions and were paid in the course of earning assessable income. If the Tribunal were to accept paragraph [20] of Mr Higgins' most recent affidavit there would be some prospects of making that point good. If that view were taken it may well be that the interest could fall within either of the limbs of s 51(1) of the 1936 Act (or s 8-1(1) of the 1997 Act); that is, it may be seen as having been incurred in the course of gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of earning assessable income. Those questions are not necessarily straightforward in the case of financing conduits as is shown in cases such as Federal Commissioner of Taxation v Total Holdings (Aust) Pty Ltd (1979) 9 ATR 885 at 889-890 per Lockhart J (with whom Northrop and Fisher JJ concurred) and Federal Commissioner of Taxation v BHP Billiton Finance Ltd (2010) 182 FCR 526 at 560-561 [18]-[22] per Edmonds J (with whom Sundberg and Stone JJ agreed). However, one cannot say at this stage that the taxpayer's position is without substance. There may ultimately be reasons for rejecting Mr Higgins' account in paragraph [20] of his affidavit but I do not think that this is the forum for that kind of debate. That being so I am willing to accept that this contention is sufficiently arguable to be allowed to proceed in the Tribunal. 21 It follows that the proposed appeal by the taxpayer is in principle the proper subject of a grant of leave under s 511. There is, however, a complicating factor. As events transpire Mr Higgins commenced a review application in the Tribunal entitled Christopher Higgins on behalf of 246 Arabella Investments Pty Ltd (in liquidation) v Commissioner of Taxation (6058 of 2009). At the time he indicated to the Tribunal that he would seek orders from this Court clarifying his entitlement to bring that application. The short question which arises is whether an order may be made under s 511 which retrospectively authorises Mr Higgins' earlier commencement of the application in the Tribunal. I think that the answer to that question is yes and that an order nunc pro tunc may be made. The power in s 511 is evidently intended to ensure that a jurisdiction of the kind formerly possessed by Chancery in the case of companies being wound-up by the Court extends to windings-up which are not court superintended. Given the inherent nature of the power in Chancery, it would be surprising if the power in s 511 would not be able to be exercised retrospectively. Certainly the view has been taken in this Court that its inherent power - or more accurately, the power under s 23 of the Federal Court of Australia Act 1976 (Cth)- can be exercised nunc pro tunc: Barnes v Fortytwo International Pty Ltd [2010] FCAFC 87 at [12] per Stone, Jacobson and Nicholas JJ. That conclusion is supported by an analogy which may be drawn with the case of proceedings commenced against companies in liquidation. It is accepted that an order granting leave to proceed against such a company may be made nunc pro tunc: Bell Group Ltd v Westpac Banking Corporation (2000) 104 FCR 305 at 319-320 [58] per Carr J. There is conceptually little to distinguish the situation of proceeding against a company in liquidation and proceeding in the name of the company in liquidation from the perspective of whether leave can be granted retrospectively. No doubt the question of whether an order under s 511 may be made nunc pro tuncrequires attendance to the statutory language (see Emanuele v Australian Securities Commission (1997) 188 CLR 114 at 124 per Brennan CJ) but here, so it seems to me, the statute is silent. In those circumstances it is appropriate to conclude that the power may be exercised nunc pro tunc. 22 The Commissioner did not oppose the granting to Mr Higgins of leave but did draw my attention to the fact that proceedings in the Tribunal would be likely to delay the ordinary course of the winding-up. No doubt that is true but in circumstances where the Commissioner is the only creditor I do not regard that as a sufficient reason to deny Mr Higgins his chance to undermine the Commissioner's status as a creditor. The prejudice in terms of delay is much less then the prejudice to Mr Higgins if the tax assessments are truly liable to be set aside but go unchallenged. 23 Mr Higgins accepted that if leave were granted orders should be made which rendered the liquidator harmless; that is, that the full cost of pursuing the Tribunal appeal should be borne by Mr Higgins and should not impact upon the taxpayer or the liquidator in any way. This is so and such orders should be made. Mr Higgins is entitled to an order granting him leave to pursue the Tribunal proceedings in the name of taxpayer and that order should be made nunc pro tunc. HFGC's claim should be dismissed as should the balance of Mr Higgins' claims. There should be no order as to costs. I certify that the preceding twenty-three (23) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Perram.