Plaintiff v First Defendant

Plaintiff v First Defendant - [2006] VSC 284 - VSC 2006 case summary — Zoe

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The relevant sequence of events

The scheme

6 The principal participants in the relevant transactions were four individuals, Mr Michael Jarrouge, a director of NPV Finance and NPV WA; Mr Terrence Brain, a director of two related companies named Strategic Project Marketing Pty Ltd and Strategic Distribution Management Pty Ltd ("SDM"); Mr Charbel Nader, an officer of companies in a group of which the publicly listed company Village Roadshow Limited is the parent ("the Village group"); and Mr John Atherton, the second defendant and a director of INS. Mr Jarrouge, Mr Brain and Mr Nader gave evidence. Mr Atherton did not.

7 In referring to the scheme in question here, in the course of his oral evidence, Mr Brain described the Village group as the "manufacturer", his companies as the "distributor", and NPV Finance and NPV WA as the "financier". That seems to me to be an apt description. What occurred, according to Mr Brain, was that the Village group sought to take advantage of its position in the film industry by offering "film investment products" to investors. These "products" were attractive to investors because of what were perceived to be their taxation advantages. The particular advantages sought to be exploited here were deductions available for expenditure on intellectual property pursuant to s.373-15 of the Income Tax Assessment Act 1997 and in accordance with s.373-10 of that Act. In substance, the scheme involved the acquisition of film rights by the investor from a company in the Village group and the licensing of those rights to another company in the Village group. As will be seen, the arrangements were such that the investor could be confident that it would eventually recover from the Village group the capital cost initially paid. If the investor used its own funds, the "cost" of the tax deduction which it was hoped would be obtained would be the time value of the capital expenditure. If the investor used finance available as part of the scheme, the "cost" of the deduction would be the interest payable, which it was expected would itself be deductible. The arrangements were such that the principal of the loan would be met by the eventual recovery of the initial capital outlay to which I have referred.

8 The taxation advantages which were expected were set out in some detail in an advice prepared by a partner of the Melbourne solicitors' firm, Deacons Graham and James, dated 6 June 2000, a copy of which was forwarded to Mr Atherton on behalf of INS by Mr Brain under cover of a letter of 7 June 2000. The advantages were set out in that memoranda of advice as nine "propositions", each of which was separately analysed. The propositions were as follows:

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(1) "That the expenditure incurred by investors on purchasing a percentage of the Film Rights will qualify as expenditure on an item of intellectual property namely an interest in the Film copyright pursuant to section 373-15 of ITAA 97 in accordance with section 373-10 of ITAA 97."

(2) "The capital expenditure on the item of intellectual property will be taken under section 373-2, item 3 of the ITAA 97 to be the purchase price paid by the investor for the acquisition of the Film Rights."

(3) "That the licensing of the distributor by the investors under the Distribution Agreement will constitute "use" of the item of intellectual property for the purpose of producing accessible income within the meaning of section 373-10 of ITAA 97."

(4) "That the investor will be entitled to amortisation deductions pursuant to s.373-20 of ITAA 97 in respect of the purchase cost of the intellectual property (as set out in the relevant schedule to the Offer to Acquire document) over its effective life as defined by section 373-35 of ITAA 97. That is, the investor will be entitled to amortise the cost of the Film Rights on a straight line basis over the income years ending 30 June 2000 and 30 June 2001."

(5) "That the income received by the investor from the licensing of the Film Rights to the distributor will be assessable to the investor pursuant to section 15-20 of the ITAA 97."

(6) "That any interest expenses incurred by an investor upon loan funds used to acquire the Film Rights will be deductible to the investor under section 8-1 of the ITAA 97 in the year in which those expenses are incurred, commencing in the year ended 30 June 2000. However, no prepayments of interest will be able to be deducted in a single income year if part of the prepayment relates to interest incurred in the next income year."

(7) "That, on the basis of documentation and information provided to Deacons Graham and James, the provisions of Part IVA of the Act should not apply to the transactions."

(8) "That on the basis of the documentation and information provided to Deacons Graham and James, the provisions of sections 82KH, 82KJ, 82KK and 82KL of ITAA 36 should not apply to the transactions."

(9) "That GST will be chargeable on the supplies made by the investors to the distributor under the Distribution Agreement for supplies made post 1 July 2000, by the Representative to the investors under the Representation Agreement for supplies made post 1 July 2000 but not on the supplies made by the Vendor to the Purchasers under the Offer to Acquire agreement."

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27 The cheque has never been presented.

28 There is in evidence a covering letter for the cheque signed by Mr Jarrouge and addressed to Mr Nader. The letter refers to the total of the cheque, being $6,260,000, and says that this amount is referrable to a specified list of investors, one of whom is INS for the sum of $2,500,000.

29 The evidence of the parties involved in the settlement, Mr Jarrouge and Mr Nader, was that the handing over of the cheque by Mr Jarrouge to Mr Nader constituted payment of the amount due for film rights, including $2,500,000 referrable to the acquisition of film rights by INS.

30 Mr Jarrouge explained the transaction whereby the cheque was endorsed and handed back as follows. He considered the payment by endorsement and return of the cheque to be a payment in two parts. The first was the net present value of the Distribution Guarantee. His evidence was that the ordinary way in which transactions of this kind were settled involved the Village group paying this sum to him. The second part of the payment was referrable to the specific circumstances of this transaction and the "blind settlement". His understanding was that an amount in addition to the net present value of the Distribution Guarantee was advanced to him by the Village group to be held by him whilst he completed the usual credit checks and refinancing arrangements.

31 Mr Nader's explanation was more complex than that of Mr Jarrouge. According to Mr Nader the endorsement and handing back of the cheque was the provision of security by Nu-Pay View as provided for in the Distribution Agreement, which security was itself in turn subject to the provisions of the first loan agreement. In this particular case he said the agreed amount of the security was $6.26M but that that amount was only the amount "agreed for that day" and was "subject to them working out what we would regard as acceptable security going forward".

32 Mr Nader's explanation, as adopted by counsel for NPV WA, was that this agreed security deposit was nominated security under clause 5.3(b) of the Distribution Agreement, which NPV Finance was entitled to agree upon and deal with under clause 36.1(a) of the first loan agreement, and which resulted in restriction upon NPV Finance's capacity to recover the money owing, pursuant to clause 36.2 of the first loan agreement, other than recovery of interest and other costs as provided for in clause 36.3.

33 A further explanation was proffered by a letter written in July 2004 by the chief tax counsel of Village Roadshow Limited, Mr Tony Pane. That letter relevantly read as follows:

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37 The transaction referred to in the first paragraph of the letter is consistent with the documents which are in evidence. Mr Nader maintained in evidence before me that the transaction referred to in the second paragraph of the letter did happen. It is referred to in correspondence but is not otherwise reflected in the documents in evidence before me.

Problems with interest payments and the "additional" $1m loan

38 According to the evidence of Mr Brain, in July 2000 Mr Atherton sought to increase INS's film rights acquisition to $7m and sought an addition loan of $1m from NPV Finance in order to do so. By a letter which bears no date, but which according to Mr Brain was sent to Mr Atherton on about 12 July 2000, Mr Brain sent Mr Atherton a fresh representation agreement, bearing the date 23 June 2000, which provided for the acquisition of 23.8% of the film rights in "Red Planet" for a purchase price of $7m. The letter requested payments to "First Plus Finance Pty Ltd" (a reference to Mr Jarrouge's companies) of $15,000 (being 1.5% of $1m) and a payment to SDM of $7,500 (being .75% of $1m). INS paid a sum of $15,000 to NPV Finance on 18 August 2000.

39 Meetings were held and correspondence passed between the parties in relation to this request by Mr Atherton to increase his investment and to borrow an additional $1m. No explanation was proffered in the evidence before me as to how this could have been done, given that the transaction had supposedly settled on 30 June 2000. There is in evidence a memoranda from Mr Brain to Mr Jarrouge referring to the fact that Mr Nader perceived a "document management problem". The witnesses before me professed to be unable to remember what this problem was.

40 Mr Jarrouge would not agree to the proposal to increase the loan because he was not happy with the creditworthiness of INS.

41 Throughout the period of the discussions concerning the proposed increase, INS was not paying interest payments which Mr Jarrouge maintained were due. Mr Jarrouge began making demands for payment. He did so not in the name of NPV Finance, but rather in the name of NPV WA, the plaintiff in these proceedings. Mr Jarrouge's evidence was that he treated the obligation as being one owed to NPV WA from 1 July 2000.

42 By a facsimile transmission of 10 October 2000 Mr Jarrouge advised Mr Atherton that he was applying the $15,000 establishment fee paid against outstanding interest due and that the amount of interest then payable was $80,833.33. In due course this amount was paid (together with penalty interest of $66) by INS on 6 November 2000. Thereafter INS made payments of interest, and penalty interest, until 10 July 2003. The total amount paid by INS was $935,783.63. All of the interest payments made were calculated on the basis of an advance of $2.5m.

Withdrawal of investors and dealings between NPV WA and the Village group

43 The settlement cheque for $6,260,000 was referrable to a number of investors. According to the evidence before me investors for a total sum of $1,600,000 decided after 30 June 2000 to "withdraw". The evidence does not permit me to determine how that was accomplished. Village group's financial records, which are in evidence, address the matter by simply writing back $1.6m as at 30 June 2000, thus leaving $4,660,000 as the amount paid for the film rights on that day.

44 Between November 2000, when INS commenced making interest payments, and June 2001, Mr Jarrouge, Mr Brain and Mr Nader corresponded with each other in relation to "release" of the amount purportedly paid back to NPV Finance at the settlement which was in excess of the usual security deposit being the net present value of the Distribution Guarantee. The amount the subject of these dealings was the portion Mr Jarrouge characterised as the second part of the payment made by the return of the cheque with the endorsement. These dealings were the "working out" of the acceptable security "going forward" as the transactions were described by Mr Nader.

45 By June 2001 the parties were agreed upon the manner in which the accounts between NPV Finance and TAJ Walker would be finally settled, and the payment constituting final settlement was made under cover of a letter dated 21 May 2002. Consequent upon that payment, Mr Jarrouge's companies then held a security deposit in relation to INS at an agreed amount which represented the net present value of the Distribution Guarantee together with an additional amount of $150,000 referrable to the particular circumstances of INS.

46 Considerable attention was given during the trial to explaining, tracking and reconciling the various payments made. In the end, no point was made by the defendants about the detail of the particular payments made by NPV Finance or NPV WA to, or at the direction of, TAJ Walker. Once the security deposit as eventually agreed is deducted, the evidence establishes that the balance of the $2.5m was "released" by payments made to, or at the direction of, TAJ Walker.

The second loan

47 On 19 January 2001 Mr Jarrouge wrote on the letterhead of NPV WA to Mr Atherton. The letter relevantly read as follows:

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61 The issue of whether the transactions are in fact of the character which they purport to be, in the sense of falling within applicable provisions of the Income Tax Assessment Act, is a different issue to the issue of whether the transactions are a "sham". As illustrated by decisions such as Fletcher[7], transactions designed to attract the operation of provisions of the Income Tax Assessment Act may be found not to be properly so characterised, but they are not thereby a "sham".

No loan

62 In this proceeding the defendants take the defence that no loan was in fact advanced by the lender. Their position is similar to that taken by defendants in other proceedings where, in the course of tax minimisation schemes, round robin transactions were undertaken by virtue of which sums purportedly advanced by lenders return at the end of the round robin to those same lenders. Defences based upon the proposition that in those circumstances there was no loan made at all succeeded before the Supreme Court of Queensland at first instance and on appeal in Australian Horticultural Finance Pty Ltd v Jekos Holdings Pty Ltd,[8] and in Equuscorp.[9] The principles set out in those Court of Appeal decisions were accepted, but distinguished, by McKenzie J in the Trial Division of the Supreme Court of Queensland in Borg v Northern Rivers Finance.[10]

63 The Queensland Court of Appeal decision in Equuscorp went to the High Court.

64 Equuscorp concerned a tax minimisation scheme in relation to an aqua-culture project. Investors in that case borrowed money for the purpose of paying management fees, acquiring stock, and paying lease and licence fees, which it was expected, or hoped, would entitle the investors to tax deductions. Several transactions were effected on 30 June 1989 at the offices of the Westpac Bank. The account of the lender, Rural Finance (who later assigned the debt to Equuscorp), was debited with two amounts and the account of the trustee of the scheme, Eagle Star Trustees Limited, was credited with those same amounts. Cheques were then drawn whereby those amounts were paid to companies (referred to as "JFM" and "FJA") to whom the fees and other payments were owing, and those companies in turn placed the funds on deposit with Rural Finance.

65 In a single unanimous judgment the Court, constituted by Gleeson CJ, McHugh, Kirby, Hayne and Callinan JJ, rejected the suggestion that the transactions were a sham and held that each of them was legally effective. The Court then went on to deal with the argument there had been no loan made, in these terms:

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The defences raised here - application of legal principles

The "no loan" defence

66 It seems to me that the decision in Equuscorp is on point and must be followed. It is true that the settlement transactions undertaken were cash neutral for NPV Finance. But just as in Equuscorp, NPV Finance applied the money lent as required by INS in payment of the purchase price to the extent of $2,500,000. The fact that TAJ Walker or other companies in the Village group determined to return that sum to NPV Finance the same day, pursuant to arrangements between them and NPV Finance, however they are characterised, does not alter that position. The transactions might result in the conclusion that the tax consequences desired were not achieved, but they do not result in the conclusion that no loan at all was made, unless the transactions were indeed a sham, which is a separate issue.

67 The transactions at settlement, although perhaps accurately described as "artificial", were consistent with the agreements made, as explained by Mr Nader and adopted by counsel for NPV WA, and, whilst the transactions were cash neutral for NPV Finance on the settlement day, NPV Finance or NPV WA did subsequently pay substantial sums to TAJ Walker or at its direction. The sums so paid were agreed and calculated in a manner not inconsistent with the formal written agreements.

The second loan agreement was ineffective

68 I reject the defences based upon the proposition that the second loan agreement was ineffective. What was put in that respect was that the purpose was misdescribed in that it was said to be for the acquisition of film rights when, assuming NPV Finance had made a loan, it was a refinancing.

69 In my view nothing can turn on any such error, even if it is properly described as an error. Mr Atherton was advised in writing that the transaction was a refinancing. On behalf of INS and on his own behalf as guarantor he agreed to it.

70 It was also suggested that NPV Finance had no right to require the refinancing pursuant to clause 48 of the first loan agreement. This is irrelevant. Whether it had the right to require it or not, INS and Mr Atherton agreed to it.

Sham

71 In its amended defence and counterclaim INS and Mr Atherton set out 24 factors which, it is alleged, indicate that the scheme, including the first loan agreement and the second loan agreement, was a sham.

72 The defendants rely on these factors individually, but also rely upon their cumulative effect.

73 Without ignoring the cumulative effect of the various factors relied upon, a number of the factors enumerated are not of individual significance in my view. The factors which fall into this category are the following (references in brackets are references to the particulars under paragraph 2AB of the amended defence and counterclaim):

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• The fact that the transactions settled in a round robin, using a counter cheque, which was never presented, and which could not have been met at the time because of insufficient funds (i - iv): The transactions were intended to offset each other. There was no point in presenting the cheque. The transactions were cash neutral on the day but subsequently NPV Finance or NPV WA did make payments in the manner to which I have referred.

• The fact that Mr Jarrouge in his own mind, and in his own records, treated the loan as one owed to NPV WA (x and xii): Mr Jarrouge did not thereby betray an intention not to create a contract between NPV Finance and INS.

• The Village journal entries (xiii): These journal entries whilst in some respects inaccurate as to the sequence of events are not inconsistent with the explanation of the transactions given by Mr Nader, and they are inconsistent with the suggestion that no relevant obligations were intended to be created or that the obligations intended to be created were different to those documented.

• The existence of the second loan agreement, which (it is said) "served no apparent purpose" (xvi): The second loan agreement served the purpose of addressing the three deficiencies which Mr Jarrouge saw in the first loan agreement and to which I have referred.

• The lack of documentation concerning, and evidence of, the payment of the 101% minimum distribution guarantee (xviii): INS may be entitled to a $25,000 credit on this account but I do not see anything in this factor indicating that the parties did not intend to create the legal obligations provided for.

• Mr Jarrouge's unilateral alteration to the direction annexed to the first loan agreement (xxix): This does not suggest he did not intend that the obligations should be as provided for.

• The lack of "traceable linear" of the film rights (xx): There is no evidence INS did not acquire what it contracted for. TAJ Walker warranted its capacity to transfer the rights the subject of the Offer to Acquire Film Rights.

• The absence of enquiry by the financier as to the security it was to hold (xxi): Mr Jarrouge was most concerned with his security. He was not concerned with the security represented by the mortgage of the film rights themselves, which is not surprising given the $1 option to re-acquire them after 12 months. He was most concerned with the arrangements concerning the security deposit.

• The fact that the only "real" money in the transaction was directed to the various advisers and consultants (xxii) and (xxiv): "Real" money was also directed to TAJ Walker, the company which was the vendor of the film rights. The purported distinction between money which is "real" and money which is not is misconceived.

At a glance

Court

Decision date

Before

Source

Judgment (59 paragraphs)

Parties

Cases Cited (5)