"[W]e think your suggestion which we received in your last letter is not appropriate. You told us that it was not necessary to interprete the base of your figures, but there is a big difference between your figures and our figures.

Since we do not want to loose our trust between each other, we are enclosing the list prepared by Koyo Shinju. We appreciate if you would review the list and consider it again."

The enclosed list is headed "Koyo Shinju Valuation List" and dated 28 October 1994. It is a projection of Koyo Shinju's half share of the net proceeds of the 1995 and 1996 pearl harvests of the joint enterprise, discounted by 25% to AUD$ 5,661,336.

1. Mr Stephen Arrow responded on behalf of Arrow in a letter of 2 November 1994 (R4). He wrote that while he understood how Koyo Shinju had arrived at its base figure, he was confident that Arrow could never realise a price of between AUD $14-15 million for its entire enterprise (including Koyo Shinju's share) if it were offered on the open market. He continued that it was a difficult time for Arrow as it did not know what technicians it would have in the future and how successful it would be without Koyo Shinju and for these reasons he was not prepared to overburden Arrow with excessive debt. So Arrow, he explained, was not in a position to offer more than AUD$3.5 million.
2. On 4 November 1994 Mr Niall O'Brien signed a letter to Koyo Shinju, for Mr Stephen Arrow, accepting "your figure of AUD $4 million" following a discussion with Mr Koiso on 3 November 1994 (R5). The acceptance is made conditional on Arrow receiving appropriate finance from its banks. The payment terms were as to AUD $2 million, early January 1995, AUD $1 million mid August 1995 (after sale of July 1995 harvest) and AUD $1 million mid August 1996 (after sale of July 1996 harvest). In the concluding paragraphs of the letter Koyo Shinju is asked to note that if the July 1995 harvest is good, Arrow will endeavour to pay the whole AUD $4 million by December 1995, to confirm acceptance of the conditions and to advise any special wording required by Koyo Shinju in the final contract "so that you obtain the best tax advantage in Japan".
3. In a letter dated 21 November 1994 (typed '17th' November 1994 and manually altered to '21st' by Mr Niall O'Brien) to Koyo Shinju and signed by Stephen Arrow, Arrow sets out its "amended terms in acceptance of your AUD $4 million figure". Arrow agrees to pay Koyo Shinju AUD $4,000,000, payable as to AUD $2,000,000 early in January 1995 and AUD $2,000,000 in mid August 1995, after the sale of the July 1995 harvest. Should this harvest be poor Arrow may delay the payment of AUD $1 million until its next harvest. The offer is also made conditional on Arrow receiving appropriate finance from its banks (T11). Mr Niall O'Brien signed an identical letter of the same date (R6), save that it did not include the condition concerning the July 1995 harvest. Mr Arrow's evidence was that the letters were sent to Koyo Shinju.
4. On 24 November 1994 Koyo Shinju wrote to Arrow acknowledging receipt of Arrow's fax dated 21 November 1994 and accepting "your amended terms of AUD $4 million payment figure" (T12). The agreed terms of payment are then set out as follows:

:1. AUD $2 million on early January, 1995. This is for the settlement with Koyo Shinju.

1. AUD $1 million to Koyo Shinju in the middle of August 1995 (after sale of July 1995 harvest).

Another AUD $1 million to Mitsuya Pearl in the middle of August 1995 (also after sale of July 1995 harvest)

These are for the administration and advice fees."

1. The word 'training', in brackets, has been handwritten after 'fees'. Mr Arrow testified that he had made this annotation to the letter but could not say when he had done so. The letter is signed by Koichi Yamamoto in his capacity as President of Koyo Shinju.
2. Mr Niall O'Brien, on behalf of Mr Stephen Arrow, wrote Mr Yamamoto on 28 November 1994 acknowledging receipt of his facsimile of 24 November 1994, thanking him for agreeing "to the pay out figure" and agreeing to the payment terms and conditions listed in his fax (R7).
3. On 16 December 1994 Arrow and Koyo Shinju executed an agreement that Arrow make a payment of AUD$2,000,000 to Koyo Shinju in January 1995 "[A]s the business settlement with Koyo" (T14). During his cross-examination, Mr Stephen Arrow was referred to para 23 of the audit report on Arrow (T41) where it is stated that the "dates when the payments making up the $2 million were paid were 24 January 1995, $213,000 ex cheque account, $787,000 ex money management account and on 3 April 1995 $1,000,000 ex cheque account". It was agreed by the parties, and the Tribunal finds, that Arrow made payments to Koyo Shinju in the amounts, and on the days, referred to in the above extract from para 23 of T41.
4. On 16 December 1994 Arrow and Koyo Shinju executed a memorandum of understanding by which it was agreed that Arrow make payment of AUD$1,000,000 to Koyo Shinju in September 1995 "[A]s managing fee to Koyo" (T13).
5. On 12 December 1994 Arrow and Mitsuya Pearl Pty Ltd ("Mitsuya") concluded a pearl oyster seeding agreement (T15). Under this agreement which was for a period of 3 years commencing 1 January 1995, Mitsuya undertook to seed round nuclei into Arrow's pearl oysters at AUD$13.00 per oyster for 1995 ($10 per oyster for a negative operation) and to harvest the pearls at AUD$8.00 per oyster for 1995. These fees were to be reviewed annually. During cross examination Mr Stephen Arrow confirmed that technicians were provided by Mitsuya under this agreement and that Arrow paid them in accordance with it. He did not know when Mitsuya was incorporated but it was his understanding that three of the original directors of Koyo Shinju broke away from that company to form Mitsuya. According to Mr Stephen Arrow the agreement with Mitsuya came to an end in about October 1996 because Mitsuya reneged on it.
6. On 9 December 1996 Arrow and Fuji Pearls Pty Ltd ("Fuji") concluded an agreement for 5 years, with an option for a further 5 years by either party, to supply a technician seeding service to provide for the seeding of Arrow's wild stock quota, the seeding of Arrow's hatchery quota, the harvesting and re-seeding of Arrow's breeding shells at pearl farms, the re-seeding of vomit shells and "any training of new technicians by mutual agreement between Fuji and Arrow" (T102). By clause 3 the rate for each operation is AUD $5.00 per shell save that it is AUD $7.00 per shell for a re-seeded or second operation harvest shell. There is a bonus agreement for the retention rates stipulated in clause 4.
7. On 6 December 1996 Arrow lodged its income tax return for the year ended 30 June 1996 claiming allowable deductions for training expenses of $1,049,000 (T34). This amount included $1,000,000 Arrow says it paid to Mitsuya or associates of Mitsuya. Arrow also deducted $100 for Commonwealth Bank fees related to this payment. The respondent disallowed a deduction for these amounts increasing Arrow's taxable income for the year ended 30 June 1996 to $2,982,167 in the notice of amended assessment issued to Arrow on 8 August 2000 (T47).
8. On 8 December 1997 Arrow lodged its income tax return for the year ended 30 June 1997 claiming allowable deductions for training expenses of $802,878 (T36). This amount included $800,000 Arrow says it paid to Mitsuya or associates of Mitsuya. The respondent disallowed a deduction for this amount increasing Arrow's taxable income for the year ended 30 June 1997 to $887,062 in the notice of amended assessment issued to Arrow on 14 August 2000 (T49).
9. It was not disputed by the parties that the disallowed expenditure claimed in the 1996 and 1997 years was paid by Arrow as follows:

$125,000 to Mr Takeshi Koiso on 1 September 1995 (T19)

$125,000 to Mr Yoichi Innone on 1 September 1995 (T19)

$250,000 to PT Bima Sakti Mutiara on 16 October 1995 (T20)

$650,000 to PT Bima Sakti Mutiara on 6 August 1996 (T25)

$75,000 to Mr Yoichi Innone on 8 August 1996 (T26 - T30)

$75,000 to Mr Takeshi Koiso on 8 August 1996 (T28 - T30)

Mr Stephen Arrow's evidence of the circumstances in which these payments were made is summarised in paras 61 - 63 of these reasons.

1. Arrow contends that the amended assessments for 1996 and 1997 are excessive because it was entitled to claim the deductions disallowed by the respondent in accordance with the provisions of s 51(1) of the Income Tax Assessment Act 1936 ("the Act").
2. Arrow objected to the respondent's assessment for 1994 (T51) and the amended assessments for 1996 and 1997 (T52, T53). These objections were disallowed in the respondent's notice of decision on objection of 20 February 2003 (T74) on the basis set out in the attached reasons for decision (T75).
3. Mr Stephen Arrow testified at length to the genesis of Arrow, the location and technical nature of its pearling operations including those with Koyo Shinju, the determination of the 1994 deed and the arrangements with Mitsuya, and Arrow's explanation of the disputed sales adjustment for the 1994 year and the disputed expenditure in the 1996 and 1997 years.
4. The substance of Mr Arrow's evidence in chief is reflected in his witness statement (A1) and what follows is a summary of what the Tribunal considers to be the salient points of his evidence.
5. Koyo Shinju and Arrow agreed to develop a pearling enterprise using Arrow's pearling licenses, leases and infrastructure and Koyo Shinju's technical expertise and financial resources. This joint enterprise commenced in about 1987. The early arrangements varied over time but in broad terms Koyo Shinju could purchase half of the pearls produced for half the cost of production which included the cost to purchase or fish for live oysters, transport costs, layout and general shell husbandry costs. Koyo Shinju was to provide technicians and pearl farm management and was to provide the finance needed to cover all the costs of production. Arrow was to facilitate the licensing, provide infrastructure and capital equipment, facilitate all pearl oyster fishing and manage the payment of accounts, pay-roll and other expenses to cover the day to day running costs of the venture. At all times the pearl shell, licences, quotas, infrastructure and large capital items belonged to Arrow.
6. Initially, Koyo Shinju arranged for the sale of the pearls of the enterprise through Japanese pearl trading houses and most of the proceeds from the sale of Arrow's share of the pearls was applied against the loan funds provided by Koyo Shinju to reduce the outstanding loan balances.
7. At paras 5 and 8 of A1 reference is made to the 1987 deed, the 1988 charge, the unsigned heads of agreement and the 1994 deed, referred to above.
8. By 1992/93 the market for the pearls produced by Koyo Shinju and Arrow had softened significantly. Arrow had been advised by other West Australian pearl companies that better prices for pearls could be expected by using Rosario Autore ("Autore") in Sydney. So Mr Arrow told Koyo Shinju that Arrow proposed to use Autore to facilitate the sale of its pearls. Koyo Shinju sold some of its products to Autore in 1993/94 to take advantage of higher prices including some half pearl mabe caps which Mr Arrow believed were of Indonesian origin.
9. Koyo Shinju was a company formed by a group of long-term Japanese pearl technicians. Its directors were very experienced pearl seeding technicians. Koyo Shinju's head technician Takeshi Koiso ("Koiso") ran the farm, and technicians and others working on the farm took their instructions from him. Mr Arrow's evidence is that he was not closely engaged in the fishing of pearl oyster shell in Western Australia and he spent his spare time attempting to obtain further quotas and pearling licences in Western Australia and the Northern Territory at the request of Koyo Shinju who wanted to expand the enterprise. He did meet with Koiso in Broome from time to time although the finance manager, Mr Niall O'Brien, dealt mainly with Koiso, with difficulty because Koiso spoke little English.
10. Koyo Shinju played no part in maintaining the financial statements and accounts of Arrow. It maintained its own records and would occasionally provide Arrow with a copy of its loan account with Arrow for reconciliation purposes.
11. By 1993 Koyo Shinju was still funding Arrow but only for Koyo Shinju's share of the cost of production. The balance of the production costs came from the sale of Arrow's share of the pearls. So the funding from Koyo Shinju was not adequate for expanding the enterprise and Arrow decided to approach the CDB and through it the CTB, for loan funds. For the CTB to provide funds it required the 1988 charge to be varied and it was to this end that the pari passu priority deed, referred to in para 17 of these reasons, was drafted.
12. As at 30 June 1993 Arrow owed Koyo Shinju $2,837,416 based on the figures in the unconsolidated balance sheet for Arrow for the year ended 30 June 1994 (T83). As at 30 June 1994 Arrow owed Koyo Shinju $3,238,104 based on the figures in the consolidated balance sheet as at that date (T82) which include the disputed amount of $1,092,878 referred to in para 53 of these reasons.
13. According to para 18 of A1 "[C]onsiderable dissatisfaction had developed between Koyo and Arrow as to the outcome of sales, and significant changes in views were beginning to emerge with the Koyo technicians". Koyo Shinju was providing technical services to other Australian companies and to emerging Indonesian hatching based pearl farms. Koiso provided Mr Arrow with information showing a considerable difference between the cost of an operation in Australia and a similar operation in Indonesia and this, in Mr Arrow's opinion, was the reason why Koyo Shinju wanted to terminate its Australian presence in preference for Indonesia. Mr Arrow then states that Arrow had to be careful to ensure that Koyo Shinju did not provide technical services to other Australian companies because Arrow had sponsored their immigration visas. By 1994 Arrow's cash flow was very tight because funds from Koyo Shinju were restricted and no funding was forthcoming from the CTB. More cash was required for the fishing program in 1994 and to keep the farm operational until the proceeds of the July 1994 harvest were received.
14. In relation to Arrow's contention that its assessment for the year ended 30 June 1994 is excessive, Mr Arrow's evidence in chief is that Koyo Shinju harvested pearls in April 1994 without consulting him. So it is not disputed and the Tribunal finds, that pearls were harvested at this time. He does not know how many pearls were actually taken from the shell for harvest but, relying on the consignment note to Autore of 26 April 1994 at T61, it appeared to him that 1679 round pearls of an unusually large size were hand selected in an 'x-ray' harvest. He stated that to the best of his knowledge the 350 half pearls referred to in the consignment note did not come from Arrow's farm and were of Indonesian origin. Arrow did not sell its half pearls through Autore but sold them directly to other companies.
15. The Tribunal had before it a copy of an invoice of 19 May 1994 on the Arrow letterhead, signed by its Finance Manager, Niall O'Brien, to Autore for the amount of AUD$1,092,878 in respect of 2029 round pearls (T61). Although the invoice was in Arrow's name and appeared to relate to the consignment note of 26 April 1994, Mr Arrow considered that the pearls belonged to Koyo Shinju because an April harvest was unusual and, when Arrow's pearls were sold through Autore, they were invoiced by Beagle Bay.
16. The invoice amount of $1,092,878 was credited to Arrow's bank account on 16 May 1994 (T79). Mr Arrow says that it was only in October or November 1994 that he became aware of the credit from the end of year accounts and he did not pay much attention to it as he believed it was Koyo Shinju's transaction and had loaned the funds to Arrow as it was required to do in terms of the joint enterprise arrangements between Arrow and Koyo Shinju. So the payment was subsequently excluded from Arrow's sales and the accounts were amended to reflect it as a loan from Koyo Shinju as shown in the year end working papers of 23 November 1994, copies of which were before the Tribunal at T83. In cross-examination Mr Arrow confirmed that he instructed Mr O'Brien to record the transaction as a loan. It is Mr Arrow's understanding that this adjustment was not processed through the general ledger.
17. The balance of the adjustment to the relevant sales figure for Beagle Bay referred to in para 19 of these reasons is an amount of $259,813. Mr Arrow stated that he did not instruct the Finance Manager, Mr Niall O'Brien to make this change. At para 29 of his statement he makes the assumption that the amount is for half the cost of production from the batch of shell harvested in April 1994 and that in the confusion of the business break up between Arrow and Koyo Shinju and in making the adjustment to the accounts in relation to the disputed invoice, Koyo Shinju and Mr Niall O'Brien agreed to reverse this charge.
18. Copies of working papers before the Tribunal (T17) include a calculation of one-half the average cost of production of the April 1994 harvest for Beagle Bay as $259,813.
19. In relation to the termination of the joint enterprise between Koyo Shinju and Arrow, Mr Arrow's evidence is that he was called to a meeting with the members of Koyo Shinju on 8 October 1994 at which he was told that Koyo Shinju wanted Arrow to acquire its 50% interest in the growing pearls of the enterprise at a suggested value of $7-9 million. A new company Mitsuya comprised of some of the members of Koyo Shinju, including Koiso, would agree to provide technical services to Arrow. On 17 October 1994 Mr Arrow wrote to Koyo Shinju offering $3.5 million for its right to purchase half of the pearls growing in the water at any time for half the cost of production subject to finance. A copy of this letter (T9) is before the Tribunal and was referred to at para 19 of these reasons. Mr Arrow later contacted Mr Vic Markovic, Arrow's Relationship Manager at the CDB to advise him of Arrow's position. Mr Markovic's notes of this conversation were before the Tribunal (T10).
20. There followed a period of verbal and written negotiations (sometimes acrimonious) between Mr Arrow and Koiso (see paras 34 - 51 of A1) culminating in the payment agreement (T14) and memorandum of understanding (T13), referred to in paras 22 and 23 of these reasons, and an "agreement for training Technicians at Arrow Pearl Farm" between Arrow and PT Sima Mutiara, JL Pemuda 40, Mataran, Lombok, NTB, Indonesia, dated 10 January 1995 (R16).
21. Mr Arrow testified that the termination agreement to pay Koyo Shinju $2 million was to settle all outstanding issues with Koyo Shinju in relation to the joint enterprise and included the payment of any funds due to Koyo Shinju. As at 31 December 1994 the balance of the loans owed Koyo Shinju was $2,664,246. After the payment of $2 million was applied to these loans the balance of the debt was forgiven by Koyo Shinju. Payment of the $2 million was made in 3 tranches being $213,000 on 24 January 1995, $787,000 on 24 January 1995 and $1,000,000 on 31 March 1995, A1 para 56.
22. He then stated that it was clearly understood by Koyo Shinju, Mitsuya and Arrow that the second balance of $2 million was for "on the job" training and advice that was to be provided over a 3 year period to Arrow staff. Although the training was to be provided by Mitsuya, the directors of Koyo Shinju and Mitsuya wanted the payment split as $1 million to Koyo Shinju and $1 million to Mitsuya. The Tribunal notes at this point that the memorandum of understanding with Koyo Shinju (T13) refers to the payment of $1 million "[A]s managing fee to Koyo", see para 23 of these reasons. The training agreement with PT "Sima Mutiara" (R16) for $1 million is for the period 1 January 1995 to 31 December 1995. Mr Arrow refers to this agreement as being between Arrow and PT Sima Mutiara (Mitsuya), A1 para 52.
23. Payment for the training was later negotiated to be paid over a 3 year period, an arrangement, according to Mr Arrow, that favoured Arrow because if Koyo Shinju or Mitsuya failed to provide training then Arrow would be able to withhold payment. Mr Arrow stated that he planned to time the making of payments so that they would occur after the season's operations and related training had concluded.
24. According to Mr Arrow, $500,000 was paid for training in relation to the July/August 1995 harvest in three instalments - $125,000 on 1 September 1995, $125,000 on 1 September 1995, and $250,000 on 16 October 1995. The trainers were Mr Koiso, Mr Innoue, Mr Maeda and Mr Minoke. The Arrow staff trained in the areas of nuclei selection, nuclei insertion, harvest and reseeding were Mr Arrow, John Ewing, Phil Thomas, Kim Harvey, Ian Fanning and Serena Sanders. Mr Arrow, Penny Arrow, Judi Arrow, Phil Thomas, Ian Fanning and Serena Sanders were trained in cleaning and grading the harvested pearls. The smaller pearls that were left in August 1995 were harvested in April 1996 when the technicians provided further training especially in relation to pearl grading and marketing. They also provided Arrow with the names and addresses of various suppliers and pearl buyers. Following this a further $500,000 was paid in two instalments, $250,000 on 13 June 1996 and $250,000 on 13 June 1996 - see para. 38 of these reasons.
25. After the seeding or harvest in June or July 1996 a total of $800,000 was paid in three instalments for training, $75,000 on 8 August 1996, $75,000 on 8 August 1996 and $650,000 on 6 August 1996 - see para. 38 of these reasons.
26. Mr Arrow stated that he received a fax from Mitsuya in September 1996 informing him that they would not be attending Arrow's harvest in 1997 owing to commitments in Indonesia. So Arrow withheld the final amount of $200,000 owing under the training agreement.
27. Arrow paid a total of $1,073,308 to Mitsuya over the 1995 and 1996 seasons pursuant to the pearl oyster seeding agreement (T15) referred to in para 24 of these reasons.
28. After the agreement with Mitsuya came to an end Arrow engaged Fuji Pearl Pty Ltd to provide seeding services and training support (T102) - see para 35 of these reasons.
29. In its notices of application for review of the respondent's objection decisions relating to its amended assessments for the years ended 30 June 1996 and 30 June 1997, one of the grounds relied upon by Arrow is that the preconditions under s 170 of the Act for authorising the issue of an amended assessment have not been satisfied (T52, T53). This issue was not raised in Arrow's statement of issues and it was not pursued by Arrow at the hearing, so the Tribunal finds that Arrow has not proved that its amended assessments to income tax for the years ended 30 June 1996 and 1997 were excessive because the conditions mentioned in s 170, governing the respondent's power to impose a liability to income tax by amendment of an assessment, were not fulfilled. The amended assessments in dispute being valid, Arrow had the burden of proving that they are excessive.
30. Section 190(b) of the Act, the forerunner of s 14ZZK(b)(i) of the Taxation Administration Act 1953, cast the same onus of proof on taxpayers disputing a decision of the respondent on an objection to an assessment. The term 'excessive' relates to the amount of taxable income assessed, McAndrew v Federal Commissioner of Taxation [1956] HCA 62; (1956) 98 CLR 263 at 271, and Arrow had the burden of establishing affirmatively that the disputed amounts of taxable income, for which it has been assessed, exceed the actual amounts of taxable income it derived in those years, George v Federal Commissioner of Taxation [1952] HCA 21; (1952) 86 CLR 183 at 201. As Latham CJ put it in Trautwein v Federal Commission of Taxation [1936] HCA 77; (1936) 56 CLR 63 at 88, the taxpayer must show "not only negatively that the assessment is wrong, but also positively what correction should be made in order to make it right or more nearly right". So the disputed assessments must stand unless Arrow has shown by evidence that they are incorrect, Gauci v Federal Commissioner of Taxation [1975] HCA 54; (1975) 135 CLR 81 at 89; Macmine Pty Ltd v Commissioner of Taxation (1979) 53 ALJR 362 and McCormack v Federal Commissioner of Taxation [1979] HCA 18; (1979) 143 CLR 284, at the pages cited by the High Court in (1989 - 1990) 168 CLR at 624 and 625.

1. Arrow's explanation for the adjustment to the sale figure for Beagle Bay for the year ended 30 June 1994 is that the amount of $1,092,878 paid to Arrow by Autore on 18 May 1994 was not Beagle Bay's sales revenue because it was the sale proceeds of 1,679 round pearls and 350 half pearls belonging to Koyo Shinju. The balance of the adjustment, $259,813, was a reversal of a debit of that amount to Koyo Shinju's loan account for half the cost of the April 1994 harvest when it was decided to treat the amount of $1,092.878 as a loan to Arrow from Koyo Shinju. The original sales figure in the draft accounts for Beagle Bay was decreased by $1,352,691 from $2,978,541 to $3,625,850. So the question to be determined by the Tribunal is whether Beagle Bay's true sales revenue for the year ended 30 June 1994 was $3,625,850 and not, as the respondent contends, $4,978,541. This question must be answered in Arrow's favour if it has proved affirmatively, on the evidence before the Tribunal, that Koyo Shinju, unbeknown to Arrow, harvested 1679 round pearls in April 1994 for its own account and consigned them for sale with 350 half pearls from another source, to Autore, in the name of Arrow, in fulfilment of its financing obligations to Arrow. Arrow will discharge the onus of proof it bears if this proposition is established on the balance of probabilities. In its closing submissions in relation to the alleged omitted assessable income for the 1994 year, Arrow relied upon specific aspects of the evidence before the Tribunal.
2. Arrow's Finance Manager, Mr Niall O'Brien, kept a manual spreadsheet for Beagle Bay of shell numbers for the year ending 30 June 1994 (T17) ('the spreadsheet'). According to his evidence on behalf of Arrow when each harvest was performed a calculation was made to work out the cost attributed to 50% of the pearls harvested. Koyo Shinju then acquired 50% of the harvested pearls from Arrow at that cost which amount was recorded as sales income in the accounts of Arrow and debited against "advances on pearl sales", the amounts advanced by Koyo Shinju to Arrow for its share of the running costs and to assist Arrow in meeting its share of those costs (A13). The spreadsheet indicates that 7,077 shells were harvested in April 1994.
3. Arrow does not dispute that a harvest occurred in April 1994 but claims that it was much smaller than the spreadsheet indicates (approximately 2418 shells) and that it was performed by Koyo Shinju prematurely and without the knowledge of Arrow. The claim that fewer shells were harvested than the number indicated on the spreadsheet accords with the number of round pearls (1679) consigned to Autore. Implicit in this submission is the claim that Koyo Shinju acquired 100% of the pearls harvested rather than 50% which they were entitled to under the joint enterprise arrangements with Arrow.
4. In cross-examination, Mr Stephen Arrow stated that he was not aware that the April 1994 harvest was taking place. When asked to explain why it was that he did not know about such an important event he said that he wasn't there at the time. He continued that he did not know about it and "it was never advised to me that it was going to be taking place and.....although the stock numbers indicate a higher level of harvest, the actual number of pearls is much less." He was asked about Arrow's stock records of pearls produced and sold and when it was suggested to him that Arrow must have comprehensive records, he replied "Yeah, there would be - yeah, there would be something kept in the paperwork for that" and at a later stage he testified that he relied on his team of accountants to keep those records "because I myself am not very good at keeping records."
5. Mr Stephen Arrow confirmed in cross-examination that over 90% of the 7077 shells reported to have been harvested in April 1994 in the spreadsheet had pearls in them. He had previously been referred to the invoice of 19 May 1994 to Autore in respect of 2029 round pearls (T61) and was asked what had happened to the balance of the pearls from the April 1994 harvest, when were they sold and where are the records for them. He replied that what he believed had happened was that 7077 odd shells had been X-rayed and that after X-ray only about 2000 pearls were harvested and that the balance of the 7077 shells were carried forward to harvest later in 1994. He then testified that the invoice of 19 May 1994 was incorrect and that the reference to 2029 round pearls was actually for 1679 round pearls and 350 half pearls.
6. Mr Arrow was asked whether, when he became aware of it, he had discussed the entry of 7077 shells in the spreadsheet with Mr O'Brien and responded that he hadn't and that he assumed that the pearls belonged to Koyo Shinju.
7. Mr Phil Thomas, who was Arrow's Operations Manager in 1994 testified that he could not recall a harvest in April 1994 at all but that if a single technician had harvested 7077 shells, the harvest would have taken about 8 days to complete whereas it would take about 2 days to harvest 1679 pearls.
8. In para. 25 of these reasons the Tribunal refers to 'Koyo Shinju's Valuation List' (R3). Arrow submits that the reference to 2418 shells in R3 at D1-94-4 under the heading 'Harvest 1996' supports its claim that only that number of shells was harvested in April 1994. This entry, in Arrow's submission, indicates that approximately 2418 shells were harvested and then operated for a second time.
9. According to the spreadsheet, 8700 half pearls were harvested in the period from November 1993 to January 1994. In cross-examination Mr Arrow was unable to say, or produce a record to show, how many of the half pearls were still in stock in April 1994. When it was suggested to him that the 350 half pearls consigned to Autore could have come from one harvest 5 months earlier, he stated that would have been unusual because inferior half pearls were kept for the shop in Broome and they were not drilled off the shell and most of the rest would have been drilled off and sold as caps. He also stated in his evidence in chief that Arrow did not sell its half pearls through Autore but sold them directly to other companies - see para. 52 above. In cross-examination he said that he thought he had been shown some of the half pearls by the Koyo Shinju technicians that had been harvested from their Lombok farm, in Indonesia. Arrow relied on the Autore letter of 24 May 2001 (T60) to support this contention because in it, Autore expresses the view that the half pearl caps (mabes) invoiced by Koyo Shinju in the 1993/1994 financial year "are likely to have been of Indonesian origin".
10. It was not disputed that the pearls in contention were consigned to Autore as if they were Arrow's pearls. Arrow submitted that the following facts show that it was not in truth a sale by Arrow. The consignment note (T61, A9); the letter of confirmation of consignment (A10) and the letter from Arrow to Autore (A11), all of the 26 April 1994, and on Arrow letterhead, are not signed on behalf of Arrow. Mr Stephen Arrow, Mr Phil Thomas and Mr Niall O'Brien testified that such documents were usually on the Beagle Bay letterhead. The invoice from Arrow to Autore of 19 May 1994 (T61) was signed by Mr Niall O'Brien routinely in response to a request for same by Autore (A6).
11. The sale proceeds of the disputed pearls were initially recorded as sales income in the company's financial records. Mr Niall O'Brien prepared draft financial statements for the year ended 30 June 1994 in November 1994 which he showed to Mr Stephen Arrow, who noticed that sales revenue was higher than he expected. In cross-examination Mr Arrow was asked to recount what he recalled of his conversation with Mr O'Brien and he replied: "I am pretty sure I said: there is no way these are our pearls. These would be Koyo Shinju's pearls. Just book them out to Koyo Shinju." When asked what Mr O'Brien had said to that, Mr Arrow replied: "He just would have nodded and gone off and done what I told him to do." It is not disputed that Mr O'Brien carried out Mr Arrow's instructions (T82/640).
12. Mr Arrow's explanations to the respondent for treating the disputed sales revenue as a loan from Koyo Shinju were not consistent. Arrow's submission in this regard is that at first Mr Arrow had no knowledge about the matter and his knowledge changed as he became aware of various facts and the views he expressed at various times reflected his then state of knowledge. Mr Arrow, it was submitted, has been consistent on the one essential point that the sale of pearls from the April 1994 harvest was a sale of Koyo Shinju's pearls and not Arrow's pearls and so the sale proceeds are not properly part of Arrow's assessable income.
13. The respondent made the amended assessments in dispute after a lengthy investigation into Arrow's operations which were described in great detail by witnesses for Arrow at the hearing. The principal witness, Mr Stephen Arrow, has a substantial interest in Arrow and Arrow had the control of the disputed moneys from the sale of pearls which the respondent included in Arrow's assessable income for the year ended 30 June 1994. Although the joint enterprise arrangements between Arrow and Koyo Shinju were formalised in legal documents, Mr Arrow testified that they were not strictly adhered to and, when it came to the financial documents for Arrow, he said that he had only a layman's understanding of the terminology and that he relied on employees such as the Finance Manager, Mr Niall O'Brien, to keep Arrow's accounts and records. It was open to Mr Arrow to challenge the accuracy of the records but, in the circumstances, the Tribunal has treated his evidence cautiously, especially in the absence of any direct evidence from Koyo Shinju that the disputed sale of pearls was on their account and for the financial accommodation of Arrow. So, on all the evidence, the Tribunal finds that Mr Arrow's uncorroborated assertion, albeit it consistently made, that the pearls in question were sold on Koyo Shinju's account, does not, on the balance of the probabilities, prove that the adjustment to the disputed assessment was incorrect.
14. The fact that the harvest in April 1994 was premature, in the sense that Arrow usually harvested pearls later in the calendar year and that Mr Arrow only became aware of it after it had occurred, does not support Arrow's position in any material way. His evidence was that early harvests occurred, using X-ray technology to harvest 'streakers', that is pearls that matured before the end of the usual 24 month cycle. He testified extensively as to his role in Arrow's pearling operations, negotiating leases and quotas, and to the fact that he was not always present when Koyo Shinju was performing its seeding, harvesting and grading functions and, he testified that he was away on such business in April 1994.
15. The Tribunal finds that neither the evidence of Mr Phil Thomas nor the relevant entry on Koyo Shinju's valuation list ("the valuation list") proves that approximately 2418 shells were harvested in April 1994 and not 7077, as recorded in the spreadsheet. Mr Thomas was Arrow's operations manager in Broome in 1994. He testified that the pearls came from Gerrard Bay some 150 nautical miles away because "Beagle Bay was empty of fully harvestable pearls". He had no recollection of an April 1994 harvest but went on to say that the farm manager at Gerrard Bay "could have done virtually anything without my knowledge". The author of the valuation list did not testify and the valuation list which was drawn to demonstrate the value, in October 1994, of Koyo Shinju's right to half the joint enterprise pearls, was disputed by Mr Arrow.
16. The balance of the adjustment to Beagle Bay's sales revenue for 1994 was the amount of $259,813 which, in Arrow's submission, was half the cost of production of the April 1994 harvest recorded in the spreadsheet. According to Arrow, Mr O'Brien reduced the sales figure by that amount when directed by Mr Arrow to treat the proceeds from the sale of the pearls as a loan from Koyo Shinju. Such a reversal would only have been warranted on the basis that none of the pearls was from the joint Arrow/Koyo Shinju operation, a position not taken by Arrow at the hearing.
17. The Tribunal finds that Arrow has not established that it is more likely than not that Koyo Shinju harvested 1679 round pearls in April 1994 for its own account and sold them, together with 350 half pearls from another source, through Autore, in Arrow's name, in order to loan the proceeds to Arrow. So the Tribunal finds that Arrow has not proved that its amended assessment to income tax for the year ended 30 June 1994 is excessive.

Amended assessment for the years ended 30 June 1996 and 30 June 1997

1. The issue before the Tribunal is whether Arrow has proved on the balance of the probabilities that the amended assessments for 1996 and 1997 are excessive because the respondent disallowed expenditure of $1,000,100 in 1996 and $800,000 in 1997 that was deductible from assessable income for the years in which it was incurred - see paras. 36 and 37 of these reasons. It was not disputed, and the Tribunal finds, that the amounts in contention were paid by Arrow as set out in para. 38 of these reasons. So it was encumbent upon Arrow, in the first instance, to prove precisely what they were paid for.
2. Arrow's closing submission in this regard was that part of the final agreement between Arrow and Koyo Shinju to terminate their association in December 1994, was that a total of $2 million was to be paid by Arrow for training to be provided by Koyo Shinju or its nominated entities or individuals. According to Arrow this arrangement was made orally between Mr Arrow on its behalf and Mr Kioso on behalf of Koyo Shinju in late November 1994. Mr Kioso did not testify at the hearing. As previously stated in these reasons, Mr Arrow has a substantial interest in Arrow and so his evidence must be carefully scrutinised especially where there are no adequate records or documents and his evidence is not otherwise independently corroborated.
3. Arrow submitted that the oral training agreement between Mr Arrow and Mr Koiso is further evidenced by Koyo Shinju's letter of 24 November 1994 accepting Arrow's offer of $4 million (T12); the memorandum of understanding between Koyo Shinju and Arrow of 16 December 1994 (T13) and an agreement between Arrow and PT Sima Mutiara of 10 January 1995 (R16).
4. The content of Koyo Shinju's letter of 24 November 1994 is set out in para. 29 of these reasons. Arrow relies on the fact that Koyo Shinju stipulates in this letter that one of the terms of payment of the amount of $4 million is that $1 million will be paid to each of Koyo Shinju and Mitsuya in August 1995 (after the sale of the July 1995 harvest) for "the administration and advice fees". The Tribunal finds that this is not an oblique reference, for Japanese cultural reasons, to an oral agreement to provide future training to Arrow's employees. Koyo Shinju is accommodating Arrow financially by requiring payment after the sale of the July harvest and stipulating that the payments be called "administration and advice fees" for Koyo Shinju's own purposes. This accords with Mr Niall O'Brien's response to Mr Yamamoto on 28 November 1994 thanking him for agreeing to the payment terms (R7).
5. The memorandum of understanding of 16 December 1994 (T13) between Arrow and Koyo Shinju is that Arrow will pay Koyo Shinju $1 million as a "managing fee" in September 1995. The Tribunal finds that this document varies the undertaking to Koyo Shinju stipulated in its letter of 24 November 1994 (T12) which relates to the payout amount of $4 million and, as such, cannot be construed as a reference to an oral agreement that Koyo Shinju provide future training to Arrow staff for $1 million. The fact that the payment is described as a managing fee or an administration and advice fee, in the letter of 24 November 1994 (T12), is consistent with Arrow's invitation to Koyo Shinju to advise any special wording required in the final contract to obtain the best tax advantage in Japan (R5), see para. 27 of these reasons.
6. On 14 November 2003 Arrow served on the respondent, and lodged with the Tribunal, a copy of a document headed 'Agreement for training technicians at Arrow Pearl Farm' (R16). The agreement, between Arrow and PT Sima Mutiara, is dated '10 Januari 1995' and is on a PT Sima Mutiara letterhead. The stated object of the agreement is "to train the technicians for pearl farming", the term of the agreement is from 1 January 1995 to 31 December 1995 and the agreed fee is AUD $1 million - payable by 31 December 1995. AUD $500,000 was to be paid to each of Mr Takeshi Koiso and Mr Yoichi Inoue at the branch of the Indonesian Kharisma Bank nominated in the agreement. It is stated, after the term of the agreement, that details should be discussed and agreed. The agreement is signed by Noor Rachmat on behalf of PT Sima Mutiara and by Stephen Arrow on behalf of Arrow.
7. Mr Stephen Arrow was the only party to this agreement to testify. He stated in cross-examination that the document had probably come to his attention in the six months preceding his testimony. When asked why he had not raised it with the respondent earlier he said that he was confident that what he had said about the oral agreement for training was sufficient. Mr Arrow had no personal knowledge of PT Sima Mutiara or Noor Rachmat and despite this he signed the document because "[A]s far as I was concerned, I was paying Koiso and Yoichi and I didn't really care what this document said because if I didn't get the training I wasn't going to pay them". He said that the agreement had been procured for him by Mr Phil Thomas who had a better working relationship with the Japanese. Mr Thomas presented it to him and he signed it. This is inconsistent with Mr Thomas' evidence in cross-examination that Koiso never mentioned a training agreement to him and that as operations manager, Mr Arrow did not inform him of the agreements concluded with Koyo Shinju. Mr Arrow's evidence establishes that he attached little or no significance to the content of the agreement with PT Sima Mutiara and his evidence, especially when contrasted with that of Mr Thomas, casts little, if any, material light on the genesis of the agreement. No payments in the amounts stipulated in the agreement were made to Mr Koiso and Mr Inoue.
8. There were no invoices before the Tribunal, to Arrow from the recipients of the disputed payments detailing the reasons for the payments. None of the documents associated with the payments mentions training or any other service. Mr Arrow couldn't explain this other than to say that it really didn't matter in his view because he was receiving the training and they all knew what it was about and what it was for.
9. Arrow submitted further that the evidence made it abundantly clear that Mr Stephen Arrow was gravely concerned as to how Arrow's business could continue to operate successfully and profitably unless the personnel who would carry on the business after the termination of the arrangements with Koyo Shinju could be trained to undertake and perform all the skilled and technical work undertaken until then by the Japanese technicians. The testimony given at the hearing, it was submitted, clearly establishes that the training was carried out ie. the services for which payment was made were performed by the Japanese technicians.
10. The Tribunal has considered all the relevant evidence and it finds that when the joint enterprise with Koyo Shinju was terminated, Mr Arrow's concerns were addressed by the pearl oyster seeding agreement with Mitsuya (T15) and that some training of Arrow's staff, by Mitsuya technicians, occurred when those technicians were fulfilling Mitsuya's obligations under the pearl oyster seeding agreement. The evidence does not, in the Tribunal's view, show affirmatively that the disputed payments, some of which were not paid to Mitsuya technicians, were made specifically for that training. As the Tribunal has said previously in these reasons, Mr Arrow testified at great length to the manner in which he conducted Arrow's business and, in particular, to the cultural and other reasons for the fluid contractual arrangements that existed between Arrow and Koyo Shinju. These considerations, however, do not detract from the onus Arrow bears of showing unequivocally how the amended assessments for 1996 and 1997 should be corrected, Trautwein v FC of T [1936] HCA 77; (1936) 56 CLR 63 at 87-88. Arrow has not met that onus because it has not, on the balance of the probabilities, established the relevant facts. So the Tribunal finds that Arrow has not shown that its amended assessments to income tax for the years ending 30 June 1996 and 30 June 1997 are excessive.

1. Arrow's amended assessments for the years ending 30 June 1994, 30 June 1996 and 30 June 1997 included assessments to additional tax, by way of penalty, equal to 75% of Arrow's tax shortfall for the year in question. The respondent made these assessments to additional tax pursuant to s 226J of the Act which provides:

(a) a taxpayer has a tax shortfall for a year, and

(b) the shortfall or part of it was caused by the intentional disregard by the taxpayer or by a registered tax agent of this Act or the regulations;

the taxpayer is liable to pay, by way of penalty, additional tax equal to 75% of the amount of the shortfall or part."

1. Section 226J(b) is satisfied in this matter if, on the evidence, the relevant tax shortfalls arose because Arrow, through Mr Stephen Arrow, deliberately turned a blind eye to the provisions of the Act when giving instructions relevant to the preparation of Arrow's income tax returns for the years in contention. Mr Arrow did not admit that fact and so the issue becomes whether it is to be inferred from the evidence before the Tribunal that he did so. In this regard, the respondent submitted that the Tribunal find that Arrow, through Mr Stephen Arrow, intentionally sought to claim deductions for payments which were falsely described as payments for training services, but which it well knew were capital payments to Koyo Shinju, and intentionally altered its 1994 income year accounts (which formed the basis of its 1994 tax return) to reduce its income by $1,352,692 by falsely showing sales income as a loan from Koyo Shinju and further reducing its income by reversing an amount otherwise attributable to the half cost of production.
2. By s 226H of the Act a taxpayer, who has a tax shortfall for a year, is liable to pay additional tax equal to 50% of the amount of the shortfall if the shortfall was caused by the recklessness of the taxpayer with regard to the correct operation of the Act or the regulations. In Jones v FCT 2003 ATC 2024 the Tribunal found that recklessness means more than mere carelessness, citing the decision in Reed (Albert E) and Co Ltd v London and Rochester Trading Co Ltd [1954] 2 Lloyd's Rep 463 at 475 that recklessness "means deliberately running an unjustifiable risk".
3. The Tribunal finds that the circumstances of Arrow's conduct in including the statements in contention in its income tax returns for 1994, 1996 and 1997 based on facts that it has not been able to establish for the purposes of the correct operation of the Act, amounted to a reckless disregard of the correct operation of the Act that caused Arrow's tax shortfalls in the years in question, for the purpose of s 226H(b) of the Act. So the Tribunal finds that Arrow is liable to pay additional tax pursuant to s 226H of the Act in respect of the 1994, 1996 and 1997 years.
4. The Tribunal finds that the evidence does not establish that Arrow's conduct, referred to above, amounted to a deliberate evasion of income tax as submitted by the respondent. The evidence of Mr Arrow's unilateral decision to adjust Arrow's sales revenue for the 1994 year and of his indifference to the payees and the form of the documentation of the disputed payments in 1996 and 1997, when considered in the context of the evidence as a whole, does not lead to the conclusion, on balance, in the Tribunal's view, that he intended to disregard the Act for the purpose of sub para. 226J (b). So the Tribunal finds that Arrow did not intend to disregard the Act in relation to its tax shortfalls in 1994, 1996 and 1997 for the purpose of s 226J, and that it is not liable to pay additional tax pursuant to s 226J of the Act in respect of those years.
5. The Tribunal affirms the decisions under review as they relate to the applicant's liability to income tax for the years ended 30 June 1994, 30 June 1996 and 30 June 1997. The Tribunal sets aside the decisions under review as they relate to the applicant's liability for additional tax for those years and remits this matter to the respondent for reconsideration in accordance with the following direction that further amended assessments be issued on the basis that the applicant is liable to additional tax pursuant to s 226H of the Act.

I certify that the 101 preceding paragraphs are a true copy of the reasons for the decision herein of Associate Professor GA Barton, Member