Allied Mills Industries Pty. Ltd. v. Commissioner of Taxation [1988] FCA 357; (1989) 20 FCR 288

Federal Coke Co. Pty. Ltd. v. Federal Commissioner of Taxation [1977] FCA 3; (1977) 34 FLR 375

Hayes v. Federal Commissioner of Taxation [1956] HCA 21; (1956) 96 CLR 47

Holland (Inspector of Taxes) v. Geoghegan (1972) 3 All ER 333

Inland Revenue Commissioners v. Church Commissioners for England (1977) AC 329

Pritchard (Inspector of Taxes) v. Arundale (1972) Ch. 229

Ridge Securities Ltd. v. Inland Revenue Commissioners (1964) 1 WLR 479

CJ Munro

Solicitors for the Appellant: Sly and Weigall

Counsel for the Respondent: B.J. Shaw, QC

P.R. Macliver

Solicitors for the Respondent: Australian Government

Solicitor

1. The appeal be dismissed.

2. The appellant pay the respondent's costs of the appeal.

Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

JENKINSON, LEE AND O'LOUGHLIN JJ The appellant ("Reuter") appeals from a judgment of a Judge of this Court (Hill J) dismissing Reuter's application for an order that the decision of the respondent ("the Commissioner") disallowing Reuter's objection to the Commissioner's assessment of the amount of income tax payable by Reuter for the year ended 30 June 1988 be reviewed.

2. The issues before his Honour were whether the sum of $8m received by Reuter on 19 November 1987 was assessable income, either within the meaning of sub-s.25(1) of the Income Tax Assessment Act 1936 (Cth) ("the Act") or as a capital gain to which the provisions of Pt.IIIA of the Act applied.

3. The relevant facts as found by his Honour were as follows. In February 1987 Reuter resigned as Chief General Manager of the "Bell Group of Companies". Reuter was employed by The Bell Group Limited. In the sixteen years prior to his resignation Reuter had become experienced in corporate acquisitions and, in particular, had a close involvement in twenty or more bids launched by The Bell Group Limited, or associated companies, to take over public companies.

4. When he resigned, Reuter had no plans to take up other employment. At some time in the financial year 1 July 1987 - 30 June 1988, Reuter commenced business as a financial consultant. It was not put to his Honour that Reuter was carrying on that business on 19 November 1987 and the characterization of the sum of $8m as income was not decided according to principles relevant to the receipts of a business.

5. Between April 1987 and November 1987 Reuter provided his services as a consultant in relation to a bid by Tryart Pty. Ltd. ("Tryart") to take over John Fairfax Limited. How that came about was described by his Honour as follows:

"...in late April 1987, Mr Reuter met with Mr Laurie

Connell, a Western Australian entrepreneur, who

was, at that time, Chairman of Directors of

Rothwells Limited ("Rothwells"), a merchant bank

operating out of Perth. At that meeting Mr Connell

told Mr Reuter that he had been approached by a Mr

Martin Dougherty and a Mr Carnie Fieldhouse

representing Mr Warwick Fairfax, proposing Mr

Connell's involvement on a joint venture basis in a

proposed takeover of Fairfax by Mr Warwick Fairfax.

Mr Dougherty had been a journalist and editor of

various Australian newspapers and worked in the

public relations field. Mr Fieldhouse was a

solicitor practising in Sydney.

Mr Connell secured Mr Reuter's agreement to the

proposal that Mr Reuter should work for one month

on the project for a fee of $50,000. At that time

the proposal was that Mr Fairfax and Mr Connell

would each have a fifty percent equity position,

should the proposed takeover be successful. Mr

Reuter prepared a discussion paper on the proposal

and was later duly paid the $50,000 fee.

Some time in July 1987, Mr Connell informed Mr

Reuter that Mr Fairfax did not wish to proceed with

a joint venture takeover, but wished to pursue the

takeover alone, albeit still with the assistance of

Mr Connell. Mr Connell said that Mr Fairfax was

prepared to pay Mr Connell $100,000,000 if the

takeover was successful. Mr Connell asked Mr

Reuter if he would be prepared to assist. Mr

Connell told Mr Reuter that Mr Dougherty would be

paid a ten percent fee to compensate him for the

work he had done and that the balance of the

$100,000,000 fee, after expenses, would be split

equally between Mr Connell and Mr Reuter.

The matter of a fee being paid by Mr Fairfax was

discussed at two meetings on 12 and 14 August 1987,

between Mr Fieldhouse, Mr Warwick Fairfax, Mr

Connell and Mr Dougherty. At these meetings it was

made clear that the fee to be paid to Mr Connell

was a success fee only and that Mr Fairfax was to

have no financial exposure in the event that the

bid was unsuccessful. Mr Fairfax made it clear

that he wanted Mr Connell and Mr Reuter to work

exclusively on the deal. At a lunch around this

same time, at which Mr Dougherty, Mr Connell and Mr

Reuter were present, Mr Connell told Mr Dougherty

that Mr Connell would be prepared to assist in the

takeover exercise in consideration of the fee of

$100,000,000 and that Mr Reuter and Mr Dougherty

would each have ten percent of the fee.

Notwithstanding that conversation, it was always

agreed between Mr Connell and Mr Reuter that, in

fact, Mr Reuter's share would be approximately

forty-five percent of the $100,000,000 fee. The

matter of the fee payable to Mr Reuter was to be

kept confidential and as will be seen Mr Dougherty

did not become aware of the extent of the fee to be

paid to Mr Reuter until much later.

Up to that time, the discussions with Mr Connell

had been in Mr Connell's capacity as a partner in a

firm trading as L R Connell and partners. However,

on or about 18 August 1987, Mr Connell, at a

meeting with Mr Reuter, advised Mr Reuter that a

decision had been made to "put the deal into Rothwells".

...

Mr Connell's explanation to Mr Reuter for the

involvement of Rothwells was that that company had

the necessary security licences and the Rothwells

name was important to the transaction.

Following this meeting, Mr Reuter took steps to

have prepared a written contract with Mr Connell.

Despite repeated requests of Mr Connell, no such

agreement was ever prepared. There was, however,

executed on 28 August 1987, an agreement between

Rockwood Pastoral Co Pty Ltd, Tryart and Rothwells;

this agreement is hereafter referred to as 'the

Tryart agreement'. Under it, Tryart agreed to

engage Rothwells and Rothwells agreed to accept

appointment to act as consultants and financial

advisers...

For its part, Rothwells undertook to do everything

necessary to ensure the proper performance of the

services it agreed to perform, it being agreed that

those services would be furnished through L R

Connell and Mr Reuter, or such other consultants as

Rothwells should deem necessary."

On 20 October 1987 the values of shares listed on the Australian Stock Exchange plummeted. Notwithstanding the collapse of the stock market, the Tryart bid was not withdrawn and, indeed, on 5 November 1987 was declared to be unconditional. At that point it appeared likely that Rothwells would be able to claim the Tryart fee. The stock market collapse, however, had exposed the financial instability of Rothwells and, despite its prospective entitlement to the Tryart fee, by November 1987 Rothwells was heading for insolvency. For the purpose of the proceedings before his Honour it was agreed between the parties that as at November 1987 Rothwells was insolvent. In early November 1987 Rothwells attempted to discount the Tryart fee and obtained assistance from Reuter in doing so.

6. At that time Connell had informed Reuter that Rothwells was in significant financial trouble. On 9 November 1987 Reuter consulted a solicitor to obtain advice on his position if Rothwells received and applied the proceeds of the discounted fee. Reuter was concerned that he would not receive his share of the fee, then estimated at $40m, if the monies received from the discounted fee were used to satisfy the demands of Rothwells' creditors.

7. On 9 November 1987 Reuter instructed his solicitor to write to Tryart seeking confirmation that Tryart would not consent to the assignment of the fee without prior notice to Reuter and also instructed his solicitor to write to Rothwells seeking an undertaking that Rothwells would account to Reuter for any monies received by discounting the fee. In the latter letter Reuter threatened to commence proceedings against Rothwells to obtain an injunction restraining Rothwells from assigning the benefit of the Tryart fee unless a satisfactory undertaking was offered.

8. On the same day a Memorandum of Understanding was executed by Tryart, Rothwells and Bond Media Limited ("BML"). In the Memorandum it was recited that subject to the ANZ Banking Group Limited executing a "Credit Facility Agreement" with Tryart to finance the takeover offer, BML had agreed to purchase (emphasis added) from Rothwells "all of its rights to payment of fees, costs and other moneys under the Tryart agreement". It was also recited that the rights under that agreement had been assigned (emphasis added) to BML pursuant to a Deed of Assignment executed by Rothwells. That Deed was not in evidence before his Honour. The substantive terms of the Memorandum were an acknowledgement by Tryart that Rothwells had assigned to BML its right to payment of fees under the Tryart agreement and an agreement between Tryart and BML that Tryart would pay to BML any fees payable under that agreement.

9. On 10 November 1987 Reuter's solicitor was advised by a solicitor instructed by Rothwells that Rothwells denied that an agreement had been made between Rothwells and Reuter for Reuter to be paid a fee in respect of the Tryart takeover bid. In the course of that day various meetings were held between the parties, the outcome of which was the acceptance by Reuter and Dougherty that Connell, or Rothwells, would pay $8m to Reuter and $2m to Dougherty for the services they had rendered in the Tryart bid.

10. According to the evidence provided by Reuter and his solicitor, at that time neither Reuter nor the solicitor was concerned about the financial position of Rothwells. That evidence was rejected by his Honour. His Honour found that both Reuter and his solicitor were aware that there was a real possibility that Rothwells might be placed in liquidation and that any payment made by Rothwells to Reuter in respect of Reuter's fee would be a sum recoverable by the liquidator.

11. On the same day Reuter's solicitor conferred with a solicitor apparently instructed by both Rothwells and BML. In that conference Reuter's solicitor was informed that Connell, and presumably Rothwells, did not have funds to pay $10m to Reuter and Dougherty and that BML would be making a substantial loan to Rothwells secured by the Tryart agreement. It was suggested to Reuter's solicitor that BML should pay the sum of $10m payable to Reuter and Dougherty as consideration for Reuter and Dougherty agreeing not to obstruct the transaction between BML and Rothwells.

12. On 11 November 1987 Reuter, his solicitor and Dougherty attended a conference with senior counsel convened to discuss the position of Reuter and Dougherty in the proposed transactions. In particular, the advice of counsel was sought on whether the arrangement between Reuter, Dougherty and BML could result in the liquidator seeking to have Reuter and Dougherty return monies received from BML if Rothwells went into liquidation.

13. On 19 November 1987 Reuter and Dougherty, described therein as "the Advisers", executed a Deed of Covenant with BML the recitals to which were as follows:

"A. On or about 28 August, 1987 Tryart Pty Limited

and Rockwood Pastoral Co. Ltd entered into an

Agreement with Rothwells Ltd (hereinafter

called 'the August Agreement') relating to a

proposed takeover of John Fairfax Limited by

Tryart Pty Limited.

B. The August Agreement provides that in the event

of the takeover of John Fairfax Limited being

completed certain payments are to be made to

Rothwells Ltd ('Rothwells').

C. The Advisers have alleged they each have an

interest in the August Agreement to the extent

of certain proportions of the net sums payable

thereunder ostensibly to Rothwells, namely 45%

as to Reuter and 10% as to Dougherty and that

any payments received by Rothwells pursuant to

the August Agreement should be held by it to

the extent of their said proportionate

interests for each of them in their own

beneficial right absolutely.

D. The Advisers believe that Rothwells is

endeavouring to discount or otherwise deal with

the fees payable pursuant to the terms of the

August Agreement or the contractual entitlement

thereof to the exclusion of one or both of them.

E. As a result of this belief Reuter has

threatened to commence legal proceedings to

prevent Rothwells dealing with the August

Agreement and its benefits thereunder in the

manner referred to in Recital D hereof.

F. BML wishes to enter certain arrangements with

Rothwells under which it proposes to provide

certain facilities to Rothwells secured by a

charge over Rothwells (sic) rights and

interests in the August Agreement and thereby

to receive certain benefits and the required

security in relation thereto.

G. BML and Rothwells have acknowledged to the

Advisers that the arrangements referred to in

Recital F must be completed with the utmost expedition.

H. BML acknowledges that if the Advisers or either

of them commence legal proceedings in relation

to the proposed transaction between BML and

Rothwells as Reuter has threatened to do, BML

could be prevented from concluding its proposed

transaction with Rothwells and as a consequence

could suffer loss.

I. BML has requested the Advisers jointly and

severally to enter into this Deed of Covenant

on the terms and conditions hereinafter

appearing in order to avoid the threatened

legal proceedings being commenced and in order

to have any threats in relation thereto withdrawn."

14. In the first clause of the Deed of Covenant, Reuter and Dougherty respectively acknowledged that BML had paid to them the sums of $8m and $2m. The clause stated that the sums had been paid in consideration of the covenants provided by Reuter and Dougherty in succeeding clauses. The salient covenants were as follows:

"2. Each of Reuter and Dougherty convenant with BML

that he shall not hereafter and whether against

BML or any other person or corporation without

the prior approval of BML make any claim or

demand whatsoever or take any action including

the institution of legal proceedings or permit

the taking thereof in his name or on his behalf

in relation to the August Agreement any alleged

interest thereunder or entitlement to any

benefit whatsoever thereof.

3. Reuter covenants with BML at all times

hereafter he will indemnify and hold harmless

BML from and against any and all claims,

demands, causes or action, rights, actions,

proceedings, awards, judgments, costs,

expenses, liabilities, losses and damages of

whatever nature arising out of or relating to

any claim or demand made or action taken by or

on behalf of Reuter or in relation to his

alleged interest in the August Agreement or

entitlement to any part thereof but only to the

extent of an amount not exceeding $8,000,000."

15. On the same day BML and Rothwells executed a Facility Agreement and a Deed of Assignment and Charge. In the Deed of Assignment and Charge, in which the Facility Agreement was described as a Credit Agreement, Rothwells gave to BML a charge over various items of property including, inter alia, Rothwells' interest in the Tryart agreement and assigned that interest to BML as security for repayment of the sum to be advanced to Rothwells by BML under the Facility Agreement. The Deed of Assignment referred to in the recitals to the Memorandum of Understanding made between Tryart, Rothwells and BML on 9 November 1987 which had assigned Rothwells' rights under the Tryart agreement to BML, was not referred to in the Deed of Assignment and Charge executed on 19 November 1987.

16. Under the Facility Agreement BML agreed to advance $100m to Rothwells. The Facility Agreement provided as follows in respect of the payment of interest and of "a procurement advisory fee":

"5. INTEREST AND FEES

5.01 (Rothwells) shall on the date the

Drawing is made pursuant to Clause 2.03, pay to (BML):

(i) interest in the amount of $11,000,000, and

(ii) a procurement advisory fee of $17,000,000 provided

that upon (BML's) receipt of such fee, (BML) shall be

obliged to thereupon make payment in accordance with

clause 1 of an agreement dated the 19th November,

1987 between (Reuter, Dougherty and BML)."

17. It appeared from the evidence presented to his Honour that the parties may have sought to amend or rectify the above clause some months later. A letter dated 22 June 1988 from Rothwells to BML under the hand of Connell stated as follows:

"I hereby confirm, for and on behalf of (Rothwells) that:-

i) ...

ii) Clause 5.01 paragraph (ii) of the (Facility Agreement)

should be wholly deleted and replaced by:

'A financing fee of $7,000,000 and a procurement advisory fee

of $10,000,000 provided that upon (BML's) receipt of the

procurement advisory fee, (BML) shall be obliged to

thereupon make paymnet (sic) of such procurement advisory

fee in accordance with Clause 1 of an agreement dated the 19

November, 1987 between (Reuter, Dougherty and

BML)."(emphasis added)

18. The distinction between a "procurement advisory fee" and a "financing fee", was not explained in the evidence presented to his Honour.

19. It was submitted to his Honour by the Commissioner that in the circumstances described the sum of $8m paid to Reuter by BML had the character of income in the hands of Reuter. His Honour agreed that the character of the payment was not found necessarily and solely in the terms describing the payment in the Deed of Covenant. His Honour held, and it was not disputed in this appeal, that the Court was entitled to look at the whole of the circumstances which led to the payment. (See: Federal Coke Co. Pty. Ltd. v. Federal Commissioner of Taxation [1977] FCA 3; (1977) 34 FLR 375; Allied Mills Industries Pty. Ltd. v. Commissioner of Taxation [1988] FCA 357; (1989) 20 FCR 288 at p 309; Ridge Securities Ltd. v. Inland Revenue Commissioners (1964) 1 WLR 479; Pritchard (Inspector of Taxes) v. Arundale (1972) Ch. 229 at p 239; Inland Revenue Commissioners v. Church Commissioners for England (1977) AC 329.) His Honour kept in mind, however, that where consideration has been given for a payment, the form of that consideration, although not conclusive of the issue, could determine whether the payment received had the character of revenue or capital. His Honour also noted that where a nexus existed between a payment and the provision of services by the recipient of the payment and the nexus was sufficiently direct, the payment will carry the character of income in the hands of the recipient. (See: Holland (Inspector of Taxes) v. Geoghegan (1972) 3 All ER 333.)

20. His Honour concluded that the relationship between the provision of Reuter's services and the receipt of the payment from BML by Reuter was more than merely temporal and that the nature of that relationship had given the payment the character of income in Reuter's hands. His Honour stated:

"The payment was so closely associated with the

services which Mr Reuter performed for Mr Connell,

or Rothwells, as the case may be, that it may be

concluded, as a matter of fact, that that payment

was a product of his services."

21. Counsel for Reuter had submitted to his Honour, and contends in this appeal, that whilst it is appropriate to look at all the circumstances which bear upon the character of the payment made, a clear statement in the Deed of Covenant that the payment had been made in return for Reuter's acceptance of a restriction of his right to claim, or commence proceedings in relation to, the Tryart fee demonstrated the character of the payment, namely a receipt in the nature of capital and not one received as income according to ordinary concepts.

22. Counsel suggested that Federal Coke provided support for that submission. In that case, the taxpayer corporation was a producer of coke and the subsidiary of a corporation carrying on business as a producer of coal. The subsidiary, in return for the payment of a fee, produced coke as required by the parent corporation from coal supplied by the latter. The parent corporation agreed with a customer to supply coke to the customer. A dispute arose between the customer and the parent corporation in respect of the customer's failure to perform its part of the agreement. The dispute was settled by an agreement that, inter alia, the customer, pay the parent corporation a sum of money by way of compensation. Subsequent to that accord another agreement was formed in which the customer agreed to pay that sum, or a like amount, to the subsidiary as compensation for a diminution in the value of the subsidiary's land and assets. The subsidiary was not a party to the agreement and received the sum concerned as a volunteer. No submission of sham or of the application of s.260 of the Act was raised. The Court held that the question to be determined was not what would have been the character of the payment if it had been received by the parent corporation but what was the character of the sum received by the subsidiary, and in determining that issue the Court was entitled to look at the whole of the circumstances in which the amount had been paid and was not restricted to the terms of the Deed pursuant to which the amount in question became a voluntary payment to the subsidiary. Those were the principles applied by his Honour. Federal Coke involved an arrangement in which a payment, described as compensation, was paid to a party which may have incurred a detriment in the form of diminution of the worth of its business if the agreement made between the parent corporation and its customer was not performed by the customer. The payment was not related to the provision of any services by the subsidiary. In Reuter's case, Reuter had provided services that had earned the payment of a fee and Reuter had been the recipient of the payment.

23. The consideration for the payment described in the Deed of Covenant is only part of a matrix of relevant events providing the context in which the Deed was executed and in which the character of the payment must be found. The record in the Deed that the payment made to Reuter had connection with the covenants to be provided by Reuter in the Deed, did not exclude connection with other events and was not conclusive of the nature of the payment received by Reuter. The issue to be decided was whether, in fact, the payment was a "product" of the taxpayer's services having regard to all relevant material. (See Hayes v. Federal Commissioner of Taxation [1956] HCA 21; (1956) 96 CLR 47 per Fullager J at pp 57-58.)

24. The following facts found by his Honour were relevant to the character of the payment. Reuter was aware that the threat of administration in insolvency was overhanging Rothwells and that any payment to him by Rothwells may have to be disgorged to a liquidator subsequently appointed. Reuter was also aware that if Rothwells succeeded in assigning or charging its right to be paid a fee by Tryart, Rothwells would not be able to pay any fee to Reuter. On 10 November 1987 Reuter and Dougherty had indicated to Rothwells that they would agree, or had agreed, to accept $10m in payment for the services they had provided to Rothwells. On 19 November 1987, as part of the Facility Agreement made between Reuter and BML, Rothwells required BML to contract with Rothwells that BML would apply $10m of a $17m "procurement advisory fee" payable to BML by Rothwells upon delivery of the loan, to discharge the sum of $10m to be paid by BML to Reuter and Dougherty to obtain their execution of a Deed of Covenant of even date for the purpose of facilitating the loan transaction between Rothwells and BML and the delivery of the loan to Rothwells.

25. It is clear from the foregoing that events outside the Deed bore upon the character of the payment received by Reuter from BML. Such events relevant to characterization of the payment were the willingness of Reuter and Dougherty respectively to accept a fee of $8m and $2m from Rothwells and the agreement between BML and Rothwells that BML would use a fee payable by Rothwells to BML to pay $8m and $2m to Reuter and Dougherty respectively to obtain covenants from them sufficient to encourage BML to perform the Facility Agreement and put Rothwells in funds by the delivery of the loan from BML. If the anticipated covenants in the Deed provided the sole foundation for the payment of $8m to Reuter by BML, Rothwells had no interest in securing from BML a contractual obligation to make that payment from a fee to be paid to BML by Rothwells. The tripartite nature of the arrangements provided a nexus between the services rendered by Reuter to Rothwells which had earned a fee of $8m, the obligation of Rothwells to pay $8m for those services and the sum of $8m received by Reuter from BML. It may be noted that the Deed of Covenant between BML and Reuter did not effect an assignment or relinquishment by Reuter of any rights or of any property. BML paid $8m for Reuter's agreement not to claim any part of the Tryart fee without the prior approval of BML and for Reuter's agreement to indemnify BML to the extent of $8m if Reuter did claim, presumably against BML as assignee of the Tryart fee, any part of that fee. The connection between Reuter's entitlement to a fee for the provision of his services to Rothwells and the sum paid by BML is patent. As long as Reuter continued to acquiesce in the Rothwells proposal that he be paid a fee of $8m for his services, the sum of $8m paid by BML replaced the need for Reuter to make any claim on the Tryart fee. Whether the sum received by Reuter effected a compromise of Reuter's claim against Rothwells for the payment of the agreed percentage of the Tryart fee is unnecessary to decide and is irrelevant to a conclusion that the sum received by Reuter from BML was so connected with the services provided by Reuter to Rothwells as to be a product of those services.

26. It is in that context that the question of the character attached to the sum received by Reuter had to be determined. Part of the relevant evidence was within the Deed but significant evidence outside the Deed made it obvious that the nexus between the sum of $8m received by Reuter from BML and the services provided by Reuter to Rothwells was such that it could be said that the sum received, however described, was a product of those services and properly characterized as income according to ordinary concepts.

27. On the hearing of the appeal counsel for the Commissioner tentatively relied upon an alternative proposition, not put to his Honour, that the sum paid to Reuter was assessable income under sub-s.26(e) of the Act. Having concluded that his Honour correctly held that the sum paid was assessable income within the meaning of sub-s.25(1) of the Act, it is unnecessary to consider that submission.

28. Similarly, the argument foreshadowed in the Commissioner's notice of contention that Pt.IIIA of the Act applied to the payment, does not fall to be determined.