San Remo Macaroni Co v Commissioner of Taxation

(b) the Commissioner, having regard to any connection between any 2 or more of the parties to the agreement or to any other relevant circumstances, is satisfied that the parties to the agreement, or any 2 or more of those parties, were not dealing at arm's length with each other in relation to the acquisition; (c) the taxpayer gave or agreed to give consideration in respect of the acquisition and the amount of that consideration exceeded the arm's length consideration in respect of the acquisition; and (d) the Commissioner determines that this subsection should apply in relation to the taxpayer in relation to the acquisition, then, for all purposes of the application of this Act in relation to the taxpayer, consideration equal to the arm's length consideration in respect of the acquisition shall be deemed to be the consideration given or agreed to be given by the taxpayer in respect of the acquisition." 9 On 19 December 1995 the Commissioner made nine determinations covering the years of income ended 30 June 1985 to 30 June 1993 inclusive. Except for the year of income referred to, and the consideration of which each notice spoke, each of the determinations was in identical form. That relevant to the 1985 year of income was in the following terms: "1. Under an international agreement, the parties to which include San Remo Macaroni Company Pty Ltd and Bigalle SA, San Remo Macaroni Company Pty Ltd acquired property, being pasta products, from Bigalle SA, during the year ended 30 June 1985 for a consideration of $145,668. 2. I am satisfied that two or more parties to the agreement were not dealing at arm's length with each other in relation to the acquisition of the property. 3. I am satisfied that the consideration given by San Remo Macaroni Company Pty Ltd in respect of the acquisition of the property exceeded an arm's length consideration for that property. 4. I, Glenda Joan Sullivan, in the exercise of the powers and functions conferred upon me as Deputy Commissioner of Taxation, Pulteney Office, by delegation from the Commissioner of Taxation pursuant to section 8 of the Taxation Administration Act 1953, DO HEREBY DETERMINE that subsection 136AD(3) should apply in relation to the acquisition of the property under the agreement."

It is these determinations which the Applicant claims were not validly made.

10 The making of the determinations had the result that it was necessary for the Commissioner to determine what the arm's length consideration in respect of the acquisition of the pasta products referred to in the determinations was. This he purported to do. The consequence was to reduce the deductions which had previously been allowed in the years of income with which the determinations were concerned and cause the Commissioner to issue amended assessments for these years. It is these amended assessments which the Applicant claims were invalidly made.

The background facts 11 The account which follows is, in essence, a summary of reports and correspondence assembled by officers of the Australian Taxation Office during the course of an investigation into the affairs of San Remo. It is taken from material in the Commissioner's file tendered (selectively) by the Applicant. The whole file was produced by the Commissioner to San Remo on discovery. However, only parts of that file were tendered by San Remo, which objected to the tender of what were said to be the remaining parts of the file. The San Remo tender was, however, supplemented by some correspondence excluded from San Remo's tender, but tendered by the Commissioner, being correspondence passing between San Remo and the Commissioner. Senior Counsel for San Remo objected to the tender of the remaining material which the Commissioner sought to tender unless it was proved that this was the material which, together with that tendered by San Remo, actually was before the decision maker, or was at least available to him, whether or not considered. The Commissioner declined the invitation that an officer from the South Australian office of the Commissioner which was responsible for the investigation which the Commissioner undertook be flown to Sydney for the purpose of identifying the material on the second day of the hearing. 12 No person gave evidence under oath from San Remo; nor for that matter was any person called from the Australian Taxation Office to verify the result of inquiries which had been made by the Commissioner. The failure of the Commissioner to call evidence with the consequent inability of senior counsel for San Remo to cross examine is relied upon by San Remo as leading to the conclusion that any inference open to me to make can more readily be made, it being able to be said that I could conclude that any evidence which may have been given by the person who made the decision would not assist the Commissioner: Jones v Dunkel (1959) 101 CLR 298; Minister for Aboriginal and Torres Strait Islander Affairs v State of Western Australia (1996) 67 FCR 40 at 61-2. The principle is not in doubt. 13 I am somewhat troubled by the selective tendering of the material before the Commissioner. It is possible that the material not tendered could be relevant but was excluded from tender because it would not assist San Remo. Ultimately the burden of showing that the Commissioner acted in bad faith rests with San Remo, not the Commissioner. However, I propose to proceed upon the basis that the material tendered was the totality of the file, so far as is relevant to the present controversy. 14 It is obvious from what I have said that the account which follows involves no finding of fact on my part. None of what is said in correspondence is on oath. Much of what is in the Commissioner's file would be inadmissible, at least in the form it is, in any Tribunal or curial investigation of the merits. Some of what I am about to say is probably uncontroversial. Other matters would no doubt be in contest in proceedings before the Administrative Appeals Tribunal. 15 San Remo is an Australian company based in Adelaide. Its main business is the manufacture and sale of pasta products. In December 1984 the directors of San Remo formed the view that imports of pasta products from Italy were having an adverse effect upon the company's business. They formed the view that they should import pasta themselves. 16 The directors, or at least some of them, travelled to Europe. They met with a Mr Fernando Seglias, a Swiss accountant affiliated with the international accounting firm of Horwath & Horwath (which firm acted on accountancy matters for San Remo in Australia) and discussed with him the incorporation of a Swiss company. Indeed, it seems, they left with him CHF 50,000 which was deposited in his trust account, for use as capital. It remained in that account (not bearing interest) for some years at least. According to San Remo, it did not proceed with the incorporation of any Swiss company. 17 The directors visited at the same time various Italian pasta manufacturers. The preferred pasta, at least initially, which they proposed to import was manufactured by Pastificio Gazzola, an Italian arm's length manufacturer. That company in the course of investigations told the Italian tax authorities that the pasta which was exported to Australia and sold by San Remo was part of a normal production run. Later the imported pasta was manufactured by two other Italian suppliers: Pastificio Frediani and Pastificio Pallandri. 18 Mr Seglias, it may be assumed, advised against the formation of a Swiss company. However, he did not just do nothing. He incorporated on 14 February 1985, a company Bigalle SA, a Swiss Corporation. It had bearer shares. Apparently 98% of those bearer shares are held by Mr Seglias. Indeed, the only person known to be involved with Bigalle is Mr Seglias and another person in his office who acted as secretary of the company. In interviews the Directors of San Remo suggested that they had been told by Mr Seglias that he had clients in the import/export business who could provide the service which San Remo required. However, Mr Seglias had apparently never volunteered the names of his clients, nor was San Remo apparently interested to know. 19 Bigalle entered into a contract with San Remo said to be evidenced by a letter dated 1 March 1985 on the letterhead of San Remo. There is no acknowledgment of it by Mr Seglias or anyone else on behalf of Bigalle. That letter refers to a meeting held in Mr Seglias' office on 12 February 1985 and records the unanimous agreement of the directors of San Remo to enter into an agreement with Bigalle. 20 The letter, omitting formal parts, reads as follows: "As agreed at our last meeting held in your office, Tuesday 12th February 1985, we set out and confirm our understanding of the proposed business relationship between Bigalle and San Remo. The matter was fully discussed at the last Board meeting and the Directors were unanimous in their decision to enter into this agreement with Bigalle. 1. San Remo will purchase all its Zafarelli pasta for the Australian market exclusively from Bigalle for a period of not less than twelve (12) months provided, (a) Bigalle is able to supply pasta as required by San Remo on time (except industrial disputes, strikes, transport breakdown or delay or any other act not within Bigalle control). (b) The quality and packaging of the product is of no less quality and standard than that agreed. (c) It will be Bigalle responsibility to ensure that the manufacturer of Zafarelli pasta delivers the goods on time. 2. All preparation costs for the production of packaging materials, dies and any other cost incidental to manufacturing and packaging Zafarelli pasta is to be borne by Bigalle. 3. San Remo to be invoiced at CHF 1.45 per Kg of pasta FOB this price to remain firm for a minimum of twelve (12) months and may be renegotiated at the end of that period. If the price should be increased San Remo must be given notice in writing six (6) months before. 4. Payment by direct bank transfer to be at a date not exceeding 60 days from the date the goods were delivered to our store(s) in Australia. 5. Geimex (Mr Stefano Barsotti whom you have met now) will act as coordinator as well as freight forwarder between San Remo, Bigalle and the Manufacturer. All freight costs will be charged by Geimex to San Remo direct. The Board has also agreed, in principle, to Bigalle's request that San Remo will not set up its own entity in Europe in the next five years, provided that Bigalle can perform its part of the agreement as it believes it can, and provided of course that there is an economic advantage that San Remo should not do so. The Board is more than happy to give Bigalle an opportunity to lend funds to San Remo from time to time provided it is willing to lend to no more than 11% or 11.5% interest and accepts, in some instances, less security than would normally be the case in Switzerland. As discussed with you when the matter of lending was first mentioned, there could be an opportunity very shortly on a machine that the company is interested in purchasing. We have every confidence that this business relationship will develop and be successful. We would like to thank you for the time and patience in explaining to us, very comprehensively indeed, the advantages and in particular, the disadvantages, in setting up our own operation and the good advice given to look seriously at other alternatives. We do look forward to a very long and mutually rewarding business relationship. On a more personal basis I would like to thank you for the hospitality extended to me during my stay. (I can't say the same for the weather)." 21 Geimex was the Italian shipping agent for San Remo, the organisers and initiators of the chain of events involving the importation into Australia of pasta products from the time of ordering goods to their despatch to Australia. 22 Despite the revaluation of the Swiss franc against the Australian dollar and the Italian lire no attempt appears to have been made to renegotiate the contract with Bigalle. A consequence of that revaluation was that the gross profit made by Bigalle, that is to say the difference calculated in Australian dollars between the price it paid for pasta to the manufacturer in lire and the price San Remo paid it in Swiss francs, increased. The consequence if all amounts were converted to lire was a mark-up which varied from 40% to 50%. 23 The loans, which the directors of San Remo were "happy" to give Bigalle the opportunity of making, might be thought to be at a rather high rate of interest looked at in $AUD, given the currency fluctuations of the time. The facility was, however, in fact availed of. It gave rise to large claims for interest deductions and of course foreign exchange losses. One loan made at 11.75% interest was made when the normal commercial rate for Swiss franc loans was, according to figures which the Commissioner obtained, 5-6%. There was no formal documentation for the loans. No security was generally required. The inference that this provided a mechanism for the Bigalle profit to be returned to the San Remo interests and an even greater tax deduction (now for interest) would not be difficult to draw. 24 The first shipment of pasta from Italy was in March 1985. So far as the inquiries conducted by the Commissioner could reveal there was little if any communication between the manufacturer of the pasta and Bigalle, apart from invoices which the supplier sent to Bigalle, and which that company paid. Indeed it seems that all negotiations for the supply of pasta products were handled by the staff of San Remo. On more than one occasion it seems that the directors of San Remo visited the factories of suppliers to negotiate prices and to communicate production needs. 25 However, it can be assumed that there was some communication. On 27 October 1989 the financial director of San Remo wrote to Mr Seglias in Switzerland to confirm a discussion which had taken place in Zurich. The letter reads as follows: "We understand and accept your reasons for wanting to have an additional manufacturer of Zafarelli Pasta. Aldo and I visited Pastificio Frediani and we were satisfied with their standards of production and packaging. We therefore have no objection to receiving Zafarelli from two manufacturers. You can advise Geimex to organise our requirements accordingly. We also want to thank you for listening to our proposal regarding working capital needs over the next 12 months…" 26 A month later on 21 November 1990, following a meeting in Zurich on 5 November 1990 Mr Sansovini wrote again to Mr Seglias noting that it "was … pleasing that you have already taken steps to look for another manufacturer." Mr Sansovini had visited another manufacturer Pastificio Pallandri and had reservations about the capacity of that company to fulfil requirements. He had also visited Pastificio Frediani with whom he was dissatisfied. Whether Mr Seglias or any person on behalf of Bigalle did likewise is unknown. 27 The next month Mr Sansovini wrote the following letter to Mr Seglias: "We must again bring to your attention the unsatisfactory quality of Zafarelli pasta that we are receiving from the Frediani factory … we have had countless complaints from customers that the pasta is not up to normal Italian standard… This has caused us considerable financial loss but, more important, it has damaged out goodwill and the reputation of Zafarelli that has taken us so many years to build up. We must insist therefore that unless Frediani improves its quality we will not purchase any more pasta and will look for alternative manufacturers. We trust you can understand our position." 28 Despite the strong tone of the correspondence Mr Seglias appears not to have replied at all. It may be observed that by this time the Commissioner had commenced investigating the transactions. 29 Bigalle did not, so far as the Commissioner was able to determine, communicate with Geimex the Italian shipping agent, although Geimex did forward shipping documents to Bigalle which then sent them to San Remo with invoices. On at least one occasion Geimex sent a separate bill of lading to San Remo "as a precaution." According to San Remo by agreement with Bigalle, orders were placed by San Remo with Geimex which organised the production and export of pasta with the manufacturers and transporters. 30 As outlined in an internal ATO document, the procedure adopted for the importation of pasta by San Remo was as follows:

1. Pasta was ordered by San Remo by instructing Geimex to place the order with Pastificio Gazzola.
2. Geimex then placed an order and arranged for delivery of the pasta from the manufacturer's factory to the sea port of Genoa.
3. Geimex then arranged for the goods to be shipped to Australia FOB with San Remo paying Geimex the freight costs and San Remo insuring the goods.
4. The Italian manufacturer then invoiced Bigalle for the pasta.
5. Payment was made to Bigalle usually 30-60 days from invoice date.
6. Bigalle in turn paid the Italian manufacturer. The difference between what it received and what it paid out was retained by Bigalle in its bank account.
7. Between 1 July 1984 to 30 June 1991 the manufacturer invoiced Bigalle at a price range of 720 lire/kg to a high of 1200 lire/kg whereas Bigalle invoiced the pasta to San Remo at a price of CHF 1.45 (1125 lire/kg) to CHF 2.40 (1860 lire/kg), a mark up of approximately 36% on cost if calculated in lire/kg. The pasta which San Remo imported was imported and sold under the trade mark Zafarelli. That name was first registered in Australia some 6 months after the first importation. The registration is in the name of Continental Distributors Pty Ltd, a subsidiary of San Remo.

The Commissioner's Inquiry 31 It is not completely clear from the material tendered when the Commissioner's inquiry into the Bigalle/San Remo arrangements commenced. It seems however, that the Commissioner was made aware of the possibility of tax avoidance by Customs in around October 1986. The inquiry continued until the making of the determinations in December 1995. During this time attempts were made to obtain information in Italy through the use of Article 26 of the Australia/Italy Double Taxation Agreement. There was also a deal of correspondence between the Commissioner and San Remo in which the Commissioner sought information. Enquiries were made of customs, and of other importers as to prices. I will refer in more detail later to these matters. 32 In a letter dated 19 January 1989 in response to a request for information from the Commissioner Mr Sansovini, an accountant and director of San Remo explained the arrangement with Bigalle. He said that it was necessary for the company to find a reliable manufacture to produce relatively small quantities of pasta. This necessitated a buying entity in Europe. He suggested that it was a sad fact of life that small Australian pasta manufacturers did not have much power in Italy. It may be interpolated that he was presumably suggesting that companies owned by accounting firms do. He wrote that the Directors of San Remo needed some guarantees that pasta would be available when needed in Australia. 33 Mr Sansovini wrote too of the meeting with Horwath & Horwath. He said that that firm had suggested that "a group of their clients were in the import/export business and could be interested in providing the service that we required". That group was presumably suggested to be behind Bigalle. Ultimately he wrote that the proposal was accepted in principle by San Remo subject to successful negotiations in Italy with the Italian agent and freight forwarder and the manufacturer. 34 In another letter dated 25 May 1989, Mr Sansovini spoke of the: "considerable savings just by not having to look after [our]buying entity and having to organise and pay for the art work and plates, dies etc. for Zafarelli Pasta. Furthermore, Bigalle has maintained the same price structure for over three years, a remarkable feat in times of high inflation. This could never have been achieved by San Remo." 35 By January 1991, if not before, Mr Read, who was conducting the investigation on behalf of the Commissioner had concluded that San Remo and Bigalle were not dealing at arm's length with each other. He advised San Remo of this and his intention to discuss with the directors what an appropriate arm's length price was. He did not have invoices from the Italian suppliers in a period ending 30 June 1990. He noted that it had taken by then some three years to get from the Italian authorities such information as had been received. Accordingly a letter was written to San Remo indicating that it was proposed to adjust the taxable income and suggesting that San Remo respond. A schedule of proposed adjustments was forwarded. In the next year - it is unclear what happened in the meantime, a meeting was scheduled. The meeting was held but there was no agreement reached. San Remo indicated that litigation would be necessary to resolve the matter. The tone of correspondence suggests that relationships had become strained. 36 San Remo continued to point out that it had not had to pay for art work, (some information suggested that the art work originated from Geimex) that it had obtained 90 days credit terms, (at one stage consideration was given by an officer of the Australian Taxation Office to allow some fee to Bigalle for credit facilities) that some pasta was made exclusively for San Remo and that it purchased its own brand, not a proprietary brand. San Remo pointed out that the cost of pasta from Bigalle in 1985 had been only marginally higher than San Remo's own costs of production without Durum semolina and thus was advantageous. San Remo rejected the idea that the arm's length cost should be that from the supplier of the pasta since it said, it had not bought pasta from that supplier, but from Bigalle. 37 The calculation of the arm's length price which Mr Read undertook involved him in considering three sources. The first was an anti-dumping report dealing with the alleged dumping of pasta products in Australia by foreign exporters. The second was the actual invoices in a period between Bigalle and the manufacturer Pastificio Gazolla and the third arm's length prices charged by other Italian manufacturers to Australian importers for pasta products. There is little doubt that Mr Read regarded the actual prices charged to Bigalle as representing the true arm's length price. The view was taken that Bigalle added no economic value to the process of importation of pasta, but, to quote an internal document: Bigalle merely performs a reinvoicing function and acts as a conduit for the flow of funds from San Remo to the Italian pasta manufacturer. In reality all commercial and financial risks are borne by San Remo."

The other sources, ie the customs figures and other Italian supplier charges, were regarded more as means to verify this, than as independent source of calculation.

38 In one internal document prepared by Mr Read relied upon by senior counsel for San Remo as indicating a lack of good faith, Mr Read discussed the possibility that the loans back to San Remo from Bigalle were shams. He wrote: "Whilst the financial arrangements with Bigalle were not carried out in a normal rigorous commercial manner mere suspicion and inferences based on available data would not in my view sustain a defendable legal argument. (sic) However I am of the view that we should initially attack the loans as "shams" and await the company's response. They may capitulate or offer additional evidence to support their case."

The Customs Information 39 The Australian Customs Service conducted an enquiry from November 1989 to March 1990 into the dumping of pasta onto the Australian market by Italian Manufacturers. The enquiry concluded that significant dumping with margins up to 40% had occurred. Dumped pasta appears to have been exported around 680 to 855 lire per kilogram of pasta. Without dumping margins the assessed normal value of pasta was estimated by customs to be in the range of 1140 to 1425 lire per kilogram. Ultimately no action was taken by customs as a result of the enquiry.

Comparable sales 40 There were two sources from which Mr Read was able to obtain comparable sales information. The first was from Australian importers of Italian pasta products. Mr Read's enquiries revealed that apparent arm's length prices direct from Italian manufacturers were between 670 to 1400 lire per kilogram. 41 The second source was invoices obtained through the Italian tax authorities for the period January 1985 to December 1990. These invoices showed prices ranging from 720 to 1200 lire. 42 In summary Mr Read concluded that the price that had been charged by Gazzola to Bigalle, namely 720 to 1200 lire per kg in the same period was well within the normal export range in the pasta industry.

The Conclusions reached by Mr Read 43 Mr Read concluded that "Bigalle [was] merely a straw/paper company with no substance and therefore no capacity to provide any input into the process of importation of Zafarelli pasta by SRM". He concluded too that the mark-up charged by Bigalle should be ignored because Bigalle was doing no more than re-invoicing. That company was, in his view "a conduit for the flow of funds from SRM to the Italian manufacturer". He recognised that the computation of any arm's length price was difficult having regard to the difficulties of obtaining suitable market information. He formed the view that it was necessary to arrive at "a 'fair result'… consistent as practicable with the arm's length principle" and that it was necessary that any determination he made was supported by "sufficient relevant information to demonstrate that an informed and reasonable decision has been reached in the circumstances of the case". He reached the conclusion that there was sufficient information and evidence to support the argument that the dealings between San Remo and Bigalle were not at arm's length and that the consideration paid by San Remo was not an arm's length consideration so that Division 13 should be applied. 44 Before making a determination the opinion of senior and junior counsel was sought. The file indicates that advice was given to the effect that determinations and subsequently amended assessments should be issued. The matter was the subject of much internal correspondence within the Australian Taxation Office, including responses from an internal tax counsel. In an endeavour to obtain more information a letter was sent to Mr Seglias in Switzerland seeking answers to a long questionnaire designed to throw light on the business dealings between Bigalle and San Remo. So far as the file tendered shows the letter elicited no reply. 45 In October 1995 Mr Read prepared a report recommending that determinations under Division 13 be made. Much of the report is merely a repeat of earlier reports which Mr Read had prepared. The document is a long one. It can not be repeated in full. 46 In the report Mr Read expressed the view that the Commissioner was not in a position to establish any degree of common ownership between San Remo and Bigalle, but nevertheless was entitled to form an opinion that the two companies were not dealing at arm's length. Mr Read set out and dealt with a number of arguments that had been put by San Remo in correspondence and meetings over the years in which the investigation had proceeded. On the question whether the conclusion should be drawn that the companies were not dealing at arm's length with each other Mr Read wrote: "There are a number of aspects of the arrangement which in my view would allow the Commissioner to be satisfied that the companies were not dealing with each other at arm's length. For example, the taxpayer has been unable to produce contemporaneous documentation to show that any real bargaining took place before the (very generous) level of commission receivable by Bigalle was agreed between the parties. There is also a notable absence of documentation setting out the respective rights and obligations of the parties to the agreement. The only documentation providing evidence of the terms of the agreement between the parties of which we are aware was the letter dated 1st March 1985 from SRM to Bigalle S.A. This letter does not define the rights, duties and liabilities of each party. Nor was there any agreement as regards quality standards of the products expected by SRM or any written agreement setting out the performance expected by each party. Another unsatisfactory aspect of the companies transactions was the failure of the SRM directors to satisfy themselves as to the capacity of Bigalle to provide the services sought. SRM management has admitted that it did not know who the directors, managers, or personnel of Bigalle were; the Company's expertise; financial stability; industry contacts; or capacity to carry out the terms of the original agreement. In fact it has been stated that SRM's only point of contact with Bigalle was Mr Seglias, the accounting partner of Horwath & Horwath International of Zurich. Similarly it would be expected that some internal SRM documents would exist which covered pricing policies, product profitability and quality standards, market research information, profits margins of each party, functions to be performed by each party, the assets and skills to be used or available for the use by each party and the nature of risks borne by each party. None of this exists in relation to the dealings between SRM and Bigalle. Based on our functional analysis of the contribution by Bigalle to the process of importation of pasta and tomato products [WP FOLIO, Correspondence File No. 1 letter dated 19 January 1989] it can be concluded that Bigalle merely re-invoiced the goods from the Italian manufacturers to SRM and very little else. One is inescapably drawn to the conclusion that Bigalle is merely a straw or paper company without substance, and with little or no capacity to perform its alleged functions as a supplier of pasta and tomato products to SRM in Australia. I consider that a prudent arm's length party would have made further enquiries as to the capacity of the other party to perform the contract and would have required written information of the manner in which the contract would be performed before entering into an agreement with Bigalle. SRM's failure to do so constitutes 'other relevant circumstances' in terms of paragraph 136AD(3)(b). I thus conclude that the Commissioner is entitled to form an opinion that SRM and Bigalle were not dealing with each other at arm's length in relation to the agreement for the acquisition of pasta and tomato products." 47 On the question of the arm's length price Mr Read wrote: "… I have collected information on the price of pasta as invoiced by Italian manufacturers directly to Australian importers. The following documentation has been collected: · Copies of invoices from various Italian manufacturers to Australian importers, · Copies of invoices from the Italian manufacturer Pastificio Gazzola to the Swiss company Bigalle S.A., · Data from the Australian Customs Service Report on the dumping of pasta on the Australian market. From the above data I have calculated the comparable uncontrolled price which SRM might reasonably have been expected to have paid on the basis of established market prices of imported Italian pasta F.O.B. in Australia. The sample documentation of invoices from the Italian manufacturer, Pastificio Gazzola reveals an invoiced price (dated July 1985) to Bigalle of L800 per kg of pasta, F.O.B. whereas the invoiced price by Bigalle SA to SRM for the identical pasta was invoiced at L1125 per kg of pasta F.O.B. Based on that sample documentation it seems that Bigalle's margin on the purchase and resale was 40.625% on cost. From October 1986 to July 1988 Gazzola reduced its invoiced price of pasta to Bigalle to L720 per kg. F.O.B. This price decrease was not passed on by Bigalle to SRM. This had the effect of increasing Bigalle's profit margin to 56.25% on cost without any additional services being provided by it to SRM. It is noted that the letter of understanding dated 1 March 1985 provided for a fixed price of pasta for a period of 12 months ie to 1st March 1986. It follows that there was nothing to prevent Bigalle acting in a genuine commercial relationship from passing on the price reduction to SRM when subsequent price negotiations were carried out by the parties. Evidence provided by copies of invoices from Italian manufacturers, responses by SRM to ATO questions and invoices from Australian pasta importers were considered in determining an arm's length price. These show that: · The mark-up on pasta products of 40-56% is excessive and commercially unrealistic given that Bigalle added no economic value to the goods. · Bigalle had no recognised industry expertise or business assets, provided no unique service or skills which would warrant a 40-56% mark-up on cost. · The import prices of Italian pasta by Australian firms are comparable with the prices invoiced by Pastificio Gazzola to Bigalle. · The price invoiced by Pastificio Gazzola to Bigalle S.A. therefore represents a true arm's length price. · The price invoiced by Bigalle to SRM does not reflect true market realities. Comparable transactions indicate that Bigalle S.A. invoiced price to SRM exceeds that arm's length price.

I conclude that the consideration paid by SRM exceeded an arm's length consideration and that the condition in paragraph 136AD(3)(c) is therefore satisfied."

48 Mr Read's team leader endorsed the report. The recommendation was accepted and the determinations and amended assessments were issued. San Remo objected, its objections were disallowed and the objection decisions referred to the Administrative Appeals Tribunal. 49 The only other document relied upon by San Remo is the Commissioner's findings of material fact in the Tribunal which was lodged with the Tribunal on 17 October 1997. It is difficult to see the relevance of the document, prepared, as it was, subsequent to the making of the decisions which San Remo seeks to attack. However, much of the document does no more than restate what had been in prior reports prepared by Mr Read. In one part of that document there appears the following comment which is relied upon by San Remo: "The Commissioner concluded from the facts and evidence that: San Remo, contrary to the purported form of the transactions, really imported pasta products from the Italian manufacturer Pastificio Gazzola and not from the Swiss company Bigalle…"

The legal issue between the parties 50 The Act proceeds upon the basis that assessments of income tax made by the Commissioner will be immune from judicial review, other than in accordance with the procedure of objection and appeal now provided for in Part IVC of the Taxation Administration Act 1953. The Act also ensures that the validity of steps leading up to an assessment are not capable of challenge except in the course of the objection and appeal procedure. 51 It does the former in s 177 which relevantly provides that the production of a notice of an assessment or copy: "shall be conclusive evidence of the due making of the assessment and, except in proceedings under Part IVC of the Taxation Administration Act 1953 on a review or appeal relating to the assessment, that the amount and all the particulars of the assessment are correct." 52 It does the latter in s 175 which provides: "The validity of any assessment shall not be affected by reason that any of the provisions of this Act have not been complied with." On a review or appeal to this Court under Part IVC the question will be whether the assessment made and objected to was excessive.

53 It might be thought that a section in the form of s 177 was contrary to the constitutional conferral of jurisdiction upon the High Court with respect to any matter in which a writ of mandamus or prohibition or injunction is sought against an officer of the Commonwealth or would be inconsistent with the statutory conferral of like jurisdiction upon this Court in s 39B of the Judiciary Act 1903 (Cth). However it was early held that while Parliament could not withdraw any matter from the constitutional conferral or abrogate or qualify the grant of jurisdiction to the High Court it could enact laws which would limit the class of cases in which the remedies of mandamus, prohibition or injunction could be awarded. More specifically, Parliament could validly enact privative clauses which treated administrative decisions as conclusive. However, there was nevertheless a limitation upon the High Court accepting the legislative immunity conferred by such privative clauses. That limitation finds expression in the well known decision of R v Hickman; Ex parte Fox and Clinton (1945) 70 CLR 598, particularly in the judgment of Dixon J at 615, where his Honour said:

"Such a clause is interpreted as meaning that no decision which is in fact given by the body concerned shall be invalidated on the ground that it has not conformed to the requirements governing its proceedings or the exercise of its authority or has not confined its acts within the limits laid down by the instrument giving it authority, provided always that its decision is a bona fide attempt to exercise its power, that it relates to the subject matter of the legislation, and that it is reasonably capable of reference to the power given to the body." 54 The jurisdiction conferred upon this Court under s 39B is not constitutionally entrenched, in the way that the jurisdiction of the High Court is. To the extent that s 177 of the Act and s 39B are inconsistent, it would be open to argument that s 39B impliedly amended s 177. (See per Mason CJ in Deputy Commissioner of Taxation v Richard Walter Pty Ltd (1995) 183 CLR 168 at 181, per Brennan J at 203, per Deane and Gaudron JJ at 213, per Toohey J at 234 and per McHugh J at 242-3. Such an argument was, as the references given above show, rejected by a majority of the High Court in Richard Walter. There still remains, however, the question how s 177 and s 39B are to be read together, and more particularly whether it is open to this Court to review an assessment or step in the process of assessment, under s 39B of the Judiciary Act where the Hickman principle is offended to the extent, as is alleged in the present case, that the assessment upon the notification of which s 177 depends, was made in bad faith. 55 No doubt Deane and Gaudron JJ would have been of the view that an assessment made in bad faith is no assessment so that the provisions of s 177 would not preclude this Court from reviewing either the making of the determination or the subsequent assessment. Their Honours were, however, on this point, in the minority. For the remaining members of the Court the issue did not strictly arise. It was not argued in Richard Walter that the assessments were tentative or were vitiated by bad faith. However, Brennan J expressed the view that this Court would have jurisdiction to set aside an assessment if made in bad faith (see at 203). The judgment of Toohey J would suggest to the contrary (see at 234). 56 In Commissioner of Taxation v Stokes (1996) 72 FCR 160 a full court of this Court held three purported assessments of income tax invalid as being tentative. In one sense that is perhaps a different issue than to set aside an assessment on the ground that it was made otherwise than in good faith. However at 173 the Court took the view that the case could be treated as one involving a lack of good faith, while saying that it was strictly unnecessary to determine whether the Hickman doctrine had application. In any case the Full Court in that case was exercising the jurisdiction of the High Court on remitter. The full Court in Darrell Lea Chocolate Shops Pty Ltd v Commissioner of Taxation (1996) 72 FCR 175 likewise set aside assessments of sales tax where a similar privative clause such as s 177 applied (cf s 67(1) of the Sales Tax assessment Act (No 1) 1930 (Cth) ) but in circumstances where it was held that the assessments were made in bad faith. However, the Court in so doing was exercising the objection and appeal jurisdiction rather than jurisdiction under s 39B of the Judiciary Act. The Court said at 188: "When one has regard to the role which s 67 played in protecting an assessment from all judicial scrutiny, it is axiomatic that that protection assumed that the Commissioner would make a bona fide effort to ascertain the liability of a taxpayer to tax by reference to facts which he believed at least could be true. When in Commissioner of Taxation (Cth) v Clarke (1927) 40 CLR 246 at 276 Isaacs ACJ spoke of the Act trusting the Commissioner, his Honour clearly did not intend to convey that this trust extended to a case where the Commissioner acted in such a way as to betray that trust. The extensive powers conferred upon the Commissioner in connection with the assessment and collection of sales tax, or for that matter any other tax, must be so exercised as to deal fairly with each taxpayer… An assessment on facts known by the Commissioner to be untrue is of its nature unfair and oppressive. But equally as important, it involves no process of ascertainment or calculation." 57 Before me it was not argued that a different approach should be taken to that adopted in Darrell Lea. Particularly, it was not argued that the Court lacked jurisdiction to set aside the determinations or assessments having regard to the provisions of s 177 and 175 of the Act where the proceedings were initiated under s 39B of the Judiciary Act rather than by way of objection and appeal. Rather it was accepted that if San Remo succeeded in showing that the determinations or assessments were made in bad faith in the sense those words are used in Hickman, then an order should be made that they be set aside.

Were the determinations or assessments made in bad faith? 58 As has already been shortly noted the submission made on behalf of San Remo was that Mr Read approached the task of making the determinations and subsequent assessments with a preconceived view and with a predetermined result in mind. It is said that Mr Read manipulated the material before him as to pasta prices so as to support that view and bring about that result. He did not, so it is submitted, make any real or bona fide attempt to assess what would be the arm's length consideration for the acquisition by San Remo of pasta. The preconceived view was said to be that the transaction between San Remo and Bigalle was a sham; or alternatively that all that was done was that Bigalle reinvoiced at a mark up. The predetermined result was to treat the prices paid by Bigalle, consistent with the preconceived view, as the arm's length price. 59 It is true that there are references throughout the material in Mr Read's file to Bigalle being merely an invoicing vehicle. The word sham is used on a few occasions, albeit rather in the context of the loans which Bigalle made to San Remo than the pasta dealings. It is a word which may have different meanings to different people, albeit that its dictionary meaning is "a pretence". Some might well say that the facts which I have narrated illustrate that the dealings between San Remo and Bigalle are a sham, using the expression, not in a legal sense, but rather in the sense that the insertion of Bigalle between the manufacturers and San Remo was an artifice with no commercial purpose (assuming there was some other relationship between the two companies which remitted the profits to be returned to San Remo.) In Anglo-Australian law the word sham has tended to convey a transaction entered into by two or more parties with the common intention that the transaction is a disguise for some other and real transaction or no transaction at all: cf Sharment Pty Ltd v Official Trustee in Bankruptcy (1988) 18 FCR 449. 60 It would seem to be, to say the least, a difficult case to mount to argue that there was bad faith to be found by the use of the word "sham" in the course of reports leading up to the issue of determinations, which of themselves could only validly issue if in law the transactions involving Bigalle were not shams. Of course if the transactions were shams there would be no occasion for the use of Division 13. The real transaction would be, presumably between the manufacturer and San Remo directly at the price those manufacturers apparently charged to Bigalle. Indeed it is open to be inferred that, assuming there was no real arm's length dealing between San Remo and Bigalle, (and the material to which I have referred permits that conclusion to be reached, but subject ultimately to whatever evidence may be adduced in the objection and appeal proceedings) San Remo would have had the intention that there were real purchases from Bigalle, for ultimately the arrangement would have had no possibility of success, and the tax returns of San Remo would have been inaccurate and expose that company to penalties. 61 Be that as it may, the real substance of the argument was that Mr Read improperly formed the view that the arrangement with Bigalle was merely a reinvoicing arrangement and then "manipulated" the information he obtained as to pasta prices to arrive at a result that was consistent with the approach that an arm's length price was the price at which the manufacturers sold pasta to Bigalle. 62 Whatever the expression "good faith" as used in Hickman may mean there is absolutely nothing in the material before me which would suggest that Mr Read in any way acted other than in good faith in the way he approached the task before him. It was clearly open to Mr Read on the material before him to form the view as he did that San Remo and Bigalle were not dealing with each other at arm's length, even if San Remo had no direct financial interest in Bigalle. The fact that Bigalle appeared to be owned and controlled by an accountant, the circumstances of its incorporation, the fact that no attempt was made to renegotiate prices as the Swiss franc appreciated and that what may have been some of the profit to Bigalle was repatriated to San Remo by way of loan all pointed to this conclusion. These facts pointed also to the conclusion that really all that was happening was a reinvoicing arrangement. 63 If the conclusion was open that San Remo and Bigalle were not dealing with each other at arm's length, as I think it was, then the best evidence of an arm's length price would be the price at which the manufacturer sold pasta to Bigalle. There was nothing before Mr Read to suggest that the manufacturers would have been not prepared to sell pasta to San Remo at that price. 64 The suggestion that Mr Read in some way manipulated the figures available to him to reach the conclusion he did poses the question why he should do so. There is nothing in the file to suggest any reason why he would have done so and none has been proffered by San Remo. It was open to San Remo if they wished to call Mr Read to do so. They did not. No doubt the failure of the Commissioner to call him might permit me, as I have already indicated, more easily to draw any available inference, but it does not permit me to make the inference itself. There is no material from which I could infer any action on Mr Read's part to manipulate figures to arrive at an arm's length price. 65 To say, as San Remo does, that Mr Read had a desire to treat Bigalle as a re-invoicing vehicle notwithstanding what is said to be an admission that the evidence failed to support that suspicion, is simply incorrect. What the file clearly shows is merely that Mr Read was unable to establish any ownership connection between Bigalle and San Remo. The fact that there was no evidence of any ownership connection does not mean that it was not open to Mr Read to conclude that the dealings between Bigalle and San Remo were not at arm's length. What the relevant statutory provisions is concerned with is not whether the two parties to the international transaction were unrelated to each other, but whether their dealing was an arm's length dealing: cf The Trustee for the Estate of the late AW Furse No 5 Will Trust v Federal Commissioner of Taxation (1991) 91 ATC 4007, Barnsdall v Federal Commissioner of Taxation (1988) 88 ATC 4565. 66 It was open, in any case, to Mr Read to infer from the facts already known to him, including the loans back from Bigalle to San Remo, that there was some connection between Bigalle and San Remo beyond the normal vendor, purchaser relationship, whatever that connection may have been. 67 Further, it is simply not true that there was any "manipulation" of the figures which in the course of his enquiries Mr Read had ascertained. 68 In the circumstances of the case, as I have already noted, the best measure of an arm's length price if Bigalle and San Remo were not dealing with each other at arm's length was the price which Bigalle was charged by third party suppliers of pasta to that company. It may be that some adjustment might have been necessary to reflect different terms of trade, but the failure to take that matter into account is not indicative of bad faith. 69 The use which Mr Read made of the other material he acquired was really merely a check on whether the price charged to Bigalle was an arm's length price. He carried out this check by comparing the customs material, invoices of pasta products obtained from Italy and information he had obtained as to the price at which Australian importers had purchased pasta from Italy. Mr Read's use of this material is criticised in a number of ways in the written submissions filed by San Remo as follows: "(a) he used the 1990 Australian Customs Service (ACS) Report, but ignored material relating to average prices of standard pasta imported into Australia dealt with at para. 7.10 of that Report; (b) with respect to the data in the ASC Report he selectively chose to use a range of prices of dumped pasta in a calculation which was further distorted by inappropriately adjusting those prices by reference to the maximum dumping margin reported by the ACS; (c) he ignored the effect of exchange rate variations on the Australian dollar price paid by the Applicant. He determined arm's length price by converting the Italian manufacturer's price in lire to Australian dollars, ignoring the fact that the Applicant was committed to purchasing at a price in Swiss francs; (d) he ignored material indicating that during the period in which an anti-dumping notice was in force (March to August 1990) the arm's length price of imported pasta rose to the assessed normal value for the purposes of the anti-dumping notice (1140 lire per kg.); (e) he also ignored the effect on price of the anti-dumping notice in force in the period from 1984 to 1986; (f) he recognised that Bigalle provided valuable services to San Remo, but chose to ignore that in his purported determination of an arm's length price; (g) he obtained some limited pricing information from other Australian importers of pasta but ignored material which indicated that sales which he relied upon were not comparable to sales from Bigalle to the Applicant." 70 These criticisms misunderstand the issue which the Court has to address; they confuse the question of whether or not Mr Read's calculation was correct with the question whether he bona fide attempted to make an assessment of the arm's length price. The distinction is a crucial one. 71 In Darrell Lea the full Court said at 186: "The fact that an assessment may be wrong could never enliven the Hickman principle. Provided that the Commissioner made a bona fide attempt to assess the relevant tax or … to ascertain the sale value of relevant goods … that notice of assessment will be immune from attack. … There will of course be cases where there will be uncertainty as to the facts. But that uncertainty will not invalidate a bona fide attempt to assess." 72 Paraphrasing what the court said, but by reference to the facts of the present case, the fact that Mr Read got it wrong in calculating an arm's length price because, for example, he ignored the effect of exchange rate variations on Australian dollar prices paid, does not permit the Court to set aside the assessments. So long as he made a bona fide attempt to determine the arm's length prices the notices of assessments which issued and were based on that price are immune from attack in proceedings for judicial review. They may, however, be the subject of a full review on the merits when the matter comes to be heard in the Administrative Appeals Tribunal. That Tribunal may, standing as it does in the shoes of the Commissioner, substitute its own opinion for that upon which the assessment was based. 73 The difference is well made by a consideration of two examples. First, let it be assumed that the Commissioner is faced with the question of determining for the purposes of a default assessment under s 167 of the Act what the amount should be upon which tax is levied. If the Commissioner merely plucks a figure out of the air without any attempt to make a real calculation and on no intelligible basis, the assessment upon which that is based may not be protected by s 177: cf Trautwein v Federal Commissioner of Taxation (1936) 56 CLR 63 at 88; R v Commissioner of Taxation (WA); Ex parte Briggs (1986) 12 FCR 301 at 308. Second, let it be assumed that the Commissioner faced with the same question attempts a calculation, it may be an approximation only, but does so on a wrong basis. The assessment thereafter made will be protected from judicial review, albeit that it is wrong. It may, however, be corrected by the Tribunal on a review of the objection decision of the taxpayer, or by the Court on an appeal from that objection decision. 74 So, it may be that there is material in the Report of the Australian Customs Service which might be relevant to the computation of an arm's length price; it may be that adjustment of prices in that report by reference to the maximum dumping margin would lead to a wrong result; it may be that consideration of the fact that San Remo was committed (at least for the initial term of the contract) to pay for pasta imported in Swiss francs was left out of account; it may be that Bigalle provided "valuable services" over and above the services which would have been provided by Italian manufacturers; it may be that there was other material which could suggest that some Australian importers were paying higher prices; but none of these factors demonstrate that there was no attempt to assess in good faith. At best, they go to a question not relevant here, namely that the arm's length price determined by Mr Read was wrong. 75 Senior counsel for San Remo additionally criticised the calculation of arm's length prices in the period from January 1991 to November 1992. In this period manufacturers other than Gazzola were selling pasta to Bigalle which in turn resold the pasta to San Remo. Yet Mr Read continued to used the prices charged by Gazzola in the period to December 1990 as the arm's length prices. 76 It may be that before the Tribunal San Remo may be able to show that in the period from January 1991 to November 1992 the prices charged to Bigalle from companies which in fact sold pasta to Bigalle were less than the figures which Mr Read used, emanating as they did from the prices charged by Gazzola. It this can be shown, then it will be open to the Tribunal to conclude that some other figure should be substituted for the arm's length prices upon which the assessments were based. The assessments will then have been shown to have been excessive. But the fact that Mr Read used the Gazzola figures does not lead to the conclusion that he acted in bad faith or so as not to make any real assessment at all. 77 Mr Read had conducted his investigation over a long period. He had had difficulty in obtaining information through the Italian authorities. He fell back on the Gazzola prices. It is not as if he merely made some guess or pulled some figures out of the air. The figure arrived at was made in the course of a process of assessment. If it turns out to be wrong then there is a proceeding already on foot to correct it. 78 Then, it is submitted that the Commissioner had collected no information as to comparable uncontrolled prices in the period from 1 July 1985 to 30 June 1987. As I have sought to show, that is not strictly so. He had made the enquiries which I have summarised. He used the results of that enquiry to form the best view he could as to an arm's length price. He made an assessment. It has not been shown that he did so in bad faith. The assessment he made, once a notice of it has been tendered in these proceedings, is conclusive. The tender of that assessment leads to the result that the Application must be dismissed. 79 The final submission made on behalf of San Remo is that the Commissioner improperly took into account a number of matters in concluding that San Remo had not dealt at arm's length with Bigalle in the sales of pasta products between them. The matters said improperly to have been taken into account are listed in the written submissions of San Remo as follows: "(a) his own allegation that the Applicant failed adequately to document aspects of its dealings with Bigalle; (b) his own allegation that actions of the Applicant were inconsistent with prudent commercial dealings; (c) his own incorrect assertion that the directors of the Applicant visited factories of Italian pasta manufacturers with a view to negotiating prices of pasta; and (d) his own allegation that Bigalle was a company without substance and without the capacity to perform its functions as a supplier of pasta and tomato products to the Applicant, when the evidence before him was to the contrary." 80 The submission lacks any substance. The matters which are said to be "assertions" or "allegations" are all matters either of judgment or inference. As matters of judgment they do not demonstrate bad faith; as matters of inference, the inferences were open. 81 It is said that the fact that Mr Read took no account of the possibility that Bigalle may well have been a vehicle set up by Italian pasta manufacturers for the purpose of avoiding Italian taxes indicated that the determinations and related assessments should be set aside. There is, I suppose, a possibility that this was the case. It was not, however, a hypothesis which Mr Read accepted. The objective facts make it clear why. Ultimately the Commissioner had to form a view whether San Remo and Bigalle were dealing with each other at arm's length and what an arm's length price was. Mr Read, upon whose recommendations the determinations and assessments were made formed a view on the first matter, a view open to him and on the second, made a calculation. Both views may, when evidence is adduced before the Tribunal, be shown to have been wrong. It will be open to San Remo to call Mr Seglias to explain the circumstances in which Bigalle was incorporated, who was behind it and what dealings Bigalle had with external suppliers and what Bigalle did. It will be open for the directors of San Remo on oath to explain the circumstances by reason of which they came to deal with Bigalle, their lack of connection with Bigalle, the relationship between Bigalle's profits and the loans made by Bigalle to San Remo and their dealings, or lack of dealings with the arm's length suppliers. It will be open to San Remo to adduce such evidence as may be available to it to demonstrate that the price paid by San Remo was actually an arm's length price, or that the arm's length price which Mr Read calculated was too high. It may be able to satisfy the onus upon it of showing that the amended assessments are excessive. But that matter lies in the future. 82 I would not conclude these reasons without comment on the procedure adopted in the present case. The events in question occurred between 1984 and 1993. The investigation in the Australian taxation office appears to have commenced in 1986. The determinations and assessments were issued in 1995. The proceedings under Part IVC of the Taxation Administration Act came before the Administrative Appeals Tribunal in or about October 1997. The proceedings in this Court were instituted in January 1998. It is now October 1999. So far as appears from the material before me the assessments remain unpaid. There is some suggestion in the material, it may not be true, that San Remo would be unable to meet the assessments. It is possible, I would not make any finding to this effect, that the present proceedings were commenced to earn yet more time for San Remo. This is easier to infer where there is no substance in the claim which has been advanced, and no material from which any suggestion of bad faith could be inferred. 83 I offered the parties the opportunity of having both the Tribunal reviews and the judicial review in this Court heard at the same time. That offer was not received by the applicant with any enthusiasm. The Tribunal proceeding has been stood over awaiting the decision in the present application. This is a very unsatisfactory situation. The Tribunal, no doubt, was concerned not to proceed with its hearing, in deference to this Court perhaps deciding that the assessments were invalid. In cases such as the present it would be preferable if the Tribunal proceeded with its hearing, notwithstanding that an application for judicial review has been filed in the Court. It would be a very rare case where a taxpayer will be able to show that an assessment has, in the relevant sense, been made in bad faith, so that it should be set aside. To defer the Tribunal proceedings until an application of this kind has been determined will usually result in injustice to the Commissioner, unless the assessment has been paid. The policy of the Act is still that income tax is payable and is recoverable, whether or not a taxpayer objects to the assessment. It will be open to the taxpayer, if there is a prima facie case of bad faith, to have this Court intervene to halt the proceedings in the Tribunal pending the determination of the application for judicial review. 84 The application will be dismissed with costs. I certify that the preceding eighty-four (84) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Hill.

Counsel for the Applicant: D H Bloom QC, B Sullivan

Solicitor for the Applicant: Minter Ellison (Adelaide)

Counsel for the Respondent: G Nettle QC, A Richards QC, M Gordon

Solicitor for the Respondent: Australian Government Solicitor