FEDERAL COURT OF AUSTRALIA
Clements, Dunne & Bell Pty Ltd v Commissioner, Australian Federal Police [2001] FCA 1858
CLIENT LEGAL PRIVILEGE – general principles applicable where claim for production – limitations on scope of the privilege – application of ‘crime/fraud exception’ to the privilege
CLIENT LEGAL PRIVILEGE – ‘crime/fraud exception’ –principles applicable where allegation of illegal or improper purpose made against client or solicitor – degree of proof required to show illegal or improper purpose – where prima facie case established in relation to client
CLIENT LEGAL PRIVILEGE – ‘crime/fraud exception’ – principles applicable where relevant illegal or improper purpose that of a third party – where prima facie case established in relation to third party
Crimes Act 1914 (Cth) ss 29D, 30, 70, 73(2), 86(1)(e), 86A
Income Tax Assessment Act 1936 (Cth) ss 170BB, 177F, 226
Corporations Law s 137
Tax Administration Act 1953 (Cth) s 8P
Baker v Campbell (1983) 153 CLR 52 considered
Carter v The Managing Partner, Northmore Hale Davy & Leake (1995) 183 CLR 121 considered
Greenough v Gaskell (1833) 1 MY&K 97; 39 ER 618 considered
Bullivant v Attorney General for Victoria [1901] AC 196 considered
Grant v Downs (1976) 135 CLR 674 considered
Esso Australia Resources Ltd v Commissioner of Taxation (1999) 201 CLR 49 considered
A M & S Europe Ltd v Commission of the European Communities [1983] QB 878 referred to
Attorney-General for the Northern Territory v Maurice (1986) 161 CLR 475 considered
Commissioner of Australian Federal Police v Propend Finance Pty Limited (1997) 188 CLR 501 referred to
R v Bell; Ex parte Lees (1980) 146 CLR 141 applied
Attorney-General for the Northern Territory of Australia v Kearney (1985) 158 CLR 500 applied
R v Cox and Railton [1884] 14 QB 153 applied
Barclays Bank Plc v Eustice [1995] 1 WLR 1238 applied
Ventouris v Mountain [1991] 1 WLR 607 referred to
Baker v Evans (1987) 77 ALR 565 applied
Beazley v Steinhardt [1999] FCA 447 applied
Beazley v Steinhardt [1999] FCA 1255 referred to
O’Rourke v Darbishire [1920] AC 581 applied
R v Central Criminal Court, Ex parte Francis & Francis [1989] 1 AC 346 applied
Capar v Commissioner of Police (1994) 34 NSWLR 715 considered
CLEMENTS, DUNNE & BELL PTY LTD v COMMISSIONER OF THE AUSTRALIAN FEDERAL POLICE
V 210 OF 2000
NORTH J
20 DECEMBER 2001
MELBOURNE
| IN THE FEDERAL COURT OF AUSTRALIA |
|
| V 210 OF 2000 |
| BETWEEN: | CLEMENTS, DUNNE & BELL PTY LTD APPLICANT
|
| AND: | COMMISSIONER OF THE AUSTRALIAN FEDERAL POLICE RESPONDENT
|
| DATE OF ORDER: | |
| WHERE MADE: |
THE COURT ORDERS THAT:
1. The application be dismissed;
2. The applicant pay the respondent’s costs of and incidental to the proceedings;
3. Leave is granted to the applicant to apply for a variation of the orders in par 2 by filing submissions by 25 January 2002;
4. The respondent is to file and serve any submissions in response by 14 February 2002.
Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
| IN THE FEDERAL COURT OF AUSTRALIA |
|
| V 210 OF 2000 |
| BETWEEN: | CLEMENTS, DUNNE & BELL PTY LTD APPLICANT
|
| AND: | COMMISSIONER OF THE AUSTRALIAN FEDERAL POLICE RESPONDENT
|
| JUDGE: | |
| DATE: | |
| PLACE: |
REASONS FOR JUDGMENT (No. 2)
background
1 The background which gives rise to the present question before the Court is set out in pars 1 to 11 of the reasons for judgment (No. 1) in these proceedings, published on 6 October 2000. Those paragraphs should be read as if incorporated in these reasons.
2 However, for ease of immediate understanding of these reasons, it is useful to record that the proceedings concern documents seized by the Australian Federal Police (AFP) pursuant to search warrants executed against the applicant, Clements, Dunne & Bell Pty Ltd (CDB), a firm of accountants, and against Andrew Gray & Associates, a firm of solicitors. Andrew Gray & Associates was engaged by CDB on behalf of clients of CDB to provide legal advice and services concerned with employee benefit taxation schemes. Legal client privilege was claimed by CDB on behalf of its clients in respect of the documents.
3 It was determined that the proceedings would be dealt with in stages. By agreement of the parties I inspected the documents. In the reasons for judgment (No. 1) I dealt with the first stage of the proceedings. As the documents appeared to relate to legal advice and services concerning the tax affairs of the clients of CDB, I held that, subject to the questions to be raised in the later stages of the proceedings, the documents were subject to client legal privilege.
4 These reasons deal with the next stage of the proceedings. The question to be decided in this stage is whether the documents fall outside the reach of client legal privilege because they were created in furtherance of a criminal, illegal, or improper purpose.
5 The reasons will, first, set out the legal framework applicable, then examine the facts against that framework, and, finally, determine the legal consequences of the conduct of the participants on the claim for legal client privilege.
THE LEGAL FRAMEWORK
The existence of privilege
6 Many cases have examined the circumstances in which client legal privilege arises. In almost all of those cases there has been an attempt to explain the rationale of client legal privilege as a guide to defining the circumstances in which it arises. It is useful to examine the statements of the rationale in order to better understand whether client legal privilege applies in the present case.
7 The early history of client legal privilege was described by Dawson J in Baker v Campbell (1983) 153 CLR 52 at 126-7 as follows:
“The common law doctrine of legal professional privilege emerged in the sixteenth century as a natural exception to the then novel right of testimonial compulsion. See Holdsworth, A History of English Law, vol. 9, pp. 201-202. The history of the doctrine is traced in Wigmore, vol. viii, McNaughton rev. (1961), pars. 2290 et seq. In its origins it was concerned with the duty of the attorney – his oath and his honour – arising out of his professional relationship with his client rather than with the broader consideration of public interest in the effective working of the legal system. The modern theory that the doctrine is necessary to promote freedom of consultation of legal advisers by clients did not clearly emerge until the nineteenth century.”
(See also Toohey J in Carter v The Managing Partner, Northmore Hale Davy & Leake (1995) 183 CLR 121 at 144 and Deane J in Baker v Campbell at 113.)
8 The classical statement of the 19th century rationale is found in the judgment of Brougham LC in Greenough v Gaskell (1833) 1 MY&K 97 at 103; 39 ER 618 at 621:
“But it is out of regard to the interests of justice, which cannot be upholden, and to the administration of justice, which cannot go on, without the aid of men skilled in jurisprudence, in the practice of the Courts, and in those matters affecting rights and obligations which form the subject of all judicial proceedings. If the privilege did not exist at all, every one would be thrown upon his own legal resources; deprived of all professional assistance, a man would not venture to consult any skilful person, or would only dare to tell his counsellor half his case.”
9 Another foundational expression of the reason for client legal privilege was made by the Earl of Halsbury LC in Bullivant v Attorney General for Victoria [1901] AC 196at 201 as follows:
“For the perfect administration of justice, and for the protection of the confidence which exists between a solicitor and his client, it has been established as a principle of public policy that those confidential communications shall not be subject to production.”
10 In Australia, the rationale for client legal privilege appears in the regularly cited passage from the judgment of Stephen, Mason and Murphy JJ in Grant v Downs (1976) 135 CLR 674at 685 as follows:
“The rationale of this head of privilege, according to traditional doctrine, is that it promotes the public interest because it assists and enhances the administration of justice by facilitating the representation of clients by legal advisers, the law being a complex and complicated discipline. This it does by keeping secret their communications, thereby inducing the client to retain the solicitor and seek his advice, and encouraging the client to make a full and frank disclosure of the relevant circumstances to the solicitor. The existence of the privilege reflects, to the extent to which it is accorded, the paramountcy of this public interest over a more general public interest, that which requires that in the interest of a fair trial litigation should be conducted on the footing that all relevant documentary evidence is available. As a head of privilege legal professional privilege is so firmly entrenched in the law that it is not to be exorcised by judicial decision. None the less there are powerful considerations which suggest that the privilege should be confined within strict limits.”
11 This passage identified the fact that, when the law accords protection to particular communications between solicitor and client, the result represents a balance between competing public interests – a public interest in the disclosure of all relevant communications, and a narrower public interest in preserving confidentiality between solicitor and client in aid of the administration of justice.
12 Determining the appropriate balance in particular circumstances has been controversial and unsettled. Thus, for instance, in Grant v Downs four of the five justices determined that a document was privileged if it was brought into existence for the sole purpose of obtaining advice or for use in legal proceedings. In Esso Australia Resources Ltd v Commissioner of Taxation (1999) 201 CLR 49 a majority of three justices (Gleeson CJ, Gaudron and Gummow JJ) held that privilege attached to a document which was brought into existence for the dominant purpose of obtaining legal advice. The decision thereby extended the scope of privilege to communications which would not have been privileged under the test established in Grant v Downs.
13 Esso is the most recent case concerning client legal privilege in the High Court. Although the balance was struck differently than in Grant v Downs, the majority adopted the rationale as expressed in Grant v Downs. They said at par 35:
“The rationale of the privilege has been explained in a number of cases, including Baker v Campbell, and Grant v Downs itself. The privilege exists to serve the public interest in the administration of justice by encouraging full and frank disclosure by clients to their lawyers. In Waterford v the Commonwealth [(1987) 163 CLR 54 at 64-65. See also Carter v Northmore Hale Davy & Leake at 128, per Brennan J; at 134, per Deane J; at 147, per Toohey J; at 163 per McHugh J] Mason and Wilson JJ explained that legal professional privilege is itself the product of a balancing exercise between competing public interests and that, given the application of the privilege, no further balancing exercise is required. As Deane J expressed it in Baker v Campbell [at114], a person should be entitled to seek and obtain legal advice in the conduct of his or her affairs, and legal assistance in and for the purposes of the conduct of actual or anticipated litigation, without the apprehension of being prejudiced by subsequent disclosure of the communication. The obvious tension between this policy and the desirability, in the interest of justice, of obtaining the fullest possible access to the facts relevant to the issues in a case lies at the heart of the problem of the scope of the privilege. Where the privilege applies, it inhibits or prevents access to potentially relevant information. The party denied access might be an opposing litigant, a prosecutor, an accused in a criminal trial, or an investigation authority. For the law, in the interests of the administration of justice, to deny access to relevant information, involves a balancing of competing considerations.”
14 In Baker v Campbell, a majority of the High Court (Murphy, Wilson, Deane and Dawson JJ, Gibbs CJ, Mason and Brennan JJ dissenting) determined that privilege attached to documents seized under search warrants, and was not confined to judicial or quasi-judicial proceedings. The result, again, illustrates the close differences of opinion which have arisen in determining the proper balance between the various interests.
15 It is noteworthy that the two decisions which have the most general impact on the reach of client legal privilege, namely, Baker v Campbell and Esso, have both involved the broadening of the area in which privilege attaches.
16 It may be that the move to widening the scope of client legal privilege can be traced to some alternative formulations of the rationale which have emphasised that privilege is a principle with a human rights element, or one which reflects an aspect of the principle of the rule of law. Each of the majority justices in Baker v Campbell referred to one of these aspects. Murphy J said at 85:
“The privilege is commonly described as legal professional privilege, which is unfortunate, because it suggests that the privilege is that of the members of the legal profession, which it is not. It is the client’s privilege, so that it may be waived by the client, but not by the lawyer (Reg. v Davies (1921) 21 S.R. (N.S.W.) 311, at pp. 313-314; Re Golightly [1974] 2 N.Z.L.R. 297, at p. 303; People v. Doyle (1977) 74 Cal. App. (3d) 691, at p. 692; 141 Cal. Rptr. 639 at p. 640). Its rationale is no longer the oath and honour of the lawyer as a gentleman (see Radin ‘The Privilege of Confidential Communication Between Lawyer and Client’, California Law Review, vol. 16 (1928), p. 487). It is now supported as ‘a necessary corollary of fundamental, constitutional or human rights’ (see A.M. & S. Europe Ltd. v. Commission of the European Communities [1983] Q.B., at 941). In Reg. v. Uljee [[1982] 1 N.Z.L.R. 561, at p. 569], Cooke J. referred to ‘a strong sense that any person charged or in peril of a charge has a fundamental human right to professional advice – which may not be effectively given if facts are withheld.’”
17 Wilson J said at 95:
“It is not only a matter of protection of the client. The freedom to consult one’s legal adviser in the knowledge that confidential communications will be safeguarded will often make its own contribution to the general level of respect for and observance of the law within the community: see an article by Charles A. Miller, ‘The Challenges to the Attorney-Client Privilege’, Virginia Law Review, vol. 49 (1963), p.262.”
18 Deane J, in dealing with the then recent decision of the European Court of Justice in A M & S Europe Ltd v Commission of the European Communities [1983] QB 878, said at 119-120:
“the doctrine of legal professional privilege was plainly accepted by the European Court as a general principle which effectively protects privileged documents from production or seizure by administrative compulsion or in the course of an administrative inquiry. In words reminiscent of what had been said by Knight Bruce V. C. in Pearse v Pearse [(1846) 1 De G. & Sm. 12, at pp. 28-29; 63 E.R. 950, at p. 957], the members of the European Court explained the rationale of the general principle which they held to be part of the law of all member States [1983] Q.B., at 949:
‘That confidentiality serves the requirement, the importance of which is recognized in all of the member states, that any person must be able, without constraint, to consult a lawyer whose profession entails the giving of independent legal advice to all those in need of it.’
That general principle represents some protection of the citizen – particularly the weak, the unintelligent and the ill-informed citizen – against the leviathan of the modern state. Without it, there can be no assurance that those in need of independent legal advice to cope with the demands and intricacies of modern law will be able to obtain it without the risk of prejudice and damage by subsequent compulsory disclosure on the demand of any administrative officer with some general statutory authority to obtain information or seize documents.”
19 Dawson J, in a passage which may not go much further than the traditional formulations, said at 128:
“The restriction of the privilege to the legal profession serves to emphasize that the relationship between a client and his legal adviser has a special significance because it is part of the functioning of the law itself. Communications which establish and arise out of that relationship are of their very nature of legal significance, something which would be coincidental in the case of other confidential relationships. It has been found necessary that professional guidance in the complex processes of the law should be uninhibited by the possibility that what is said to enable advice to be sought or given might later be used against the person seeking the advice.”
20 The same amplification of the rationale can be seen in several other judgments. In Attorney-General for the Northern Territory v Maurice (1986) 161 CLR 475, Deane J said, at 490-1:
“It is a substantive general principle of the common law and not a mere rule of evidence that, subject to defined qualifications and exceptions, a person is entitled to preserve the confidentiality of confidential statements and other materials which have been made or brought into existence for the sole purpose of his or her seeking or being furnished with legal advice by a practising lawyer or for the sole purpose of preparing for existing or contemplated judicial or quasi-judicial proceedings: see generally, Baker v Campbell. The general principle is of greater importance to the protection and preservation of the rights, dignity and freedom of the ordinary citizen under the law and to the administration of justice and law in that it advances and safeguards the availability of full and unreserved communication between the citizen and his or her lawyer and in that it is a precondition of the informed and competent representation of the interest of the ordinary person before the courts and tribunals of the land. Its efficacy as a bulwark against tyranny and oppression depends upon the confidence of the community that it will in fact be enforced. That being so, it is not to be sacrificed even to promote the search for justice or truth in the individual case or matter and extends to protect the citizen from compulsory disclosure of protected communications or materials to any court or to any tribunal or person with authority to require the giving of information or the production of documents or other materials: see Pearse v Pearse [at 28-29]; Baker v Campbell [at 115-116]. The right of confidentiality which the principle enshrines has recently, and correctly, been described in the European Court of Justice as a ‘practical guarantee’ and ‘a necessary corollary’ of ‘fundamental, constitutional or human rights’: see A. M. & S. Europe Ltd v. Commission of the European Communities [at 941, 947]; Baker v Campbell [at 85]. Indeed, the plain basis of the decision of the majority of this Court in Baker v Campbell was the acceptance of the principle as a fundamental principle of our judicial system.: see Murphy J. [(1983) 153 CLR at p. 88]; Wilson J. [(1983) 153 CLR at pp. 95-96]; Deane J. [(1983) 153 CLR at pp. 166-117]; Dawson J. [(1983) 153 CLR, at pp. 131-132]. Like other traditional common law rights, it is not to be abolished or cut down otherwise than by clear statutory provision. Nor should it be narrowly construed or artificially confined.”
21 In Carter,Brennan J said at 127-8:
“In my opinion, the basic justification for allowing the privilege is the public interest in facilitating the application of the rule of law.
Administration of the law is not the function of the courts alone. The law is administered more frequently and more directly by legal advisers than it is by judges. Legal professional privilege ensures that the law’s writ can run effectively whenever a legal problem arises or a person seeks to chart a course of conduct in conformity with the law. The point was made by Advocate General Warner in AM & S Europe Ltd v Commission of the European Communities [at 913]:
‘Whether it is described as the right of the client or the duty of the lawyer, this principle has nothing to do with the protection or privilege of the lawyer. It springs essentially from the basic need of a man in a civilised society to be able to turn to his lawyer for advice and help, and if proceedings begin, for representation; it springs no less from the advantages to a society which evolves complex law reaching into all the business affairs of persons, real and legal, that they should be able to know what they can do under the law, what is forbidden, where they must tread circumspectly, where they run risks.’
In Waterford v The Commonwealth [at 74], I said:
‘the public interest served by legal professional privilege lies in its tendency to broaden the operation of the rule of law as well as to enhance the individual’s capacity to secure its protection.’”
22 Toohey J, with whom Gaudron J agreed (at 158), said at 145:
“The privilege has been described as an important element in the protection according to the law of the privacy and liberty of the individual which is an essential mark of a free society [Baker v Campbell at 95, per Wilson J], as of fundamental importance to the protection and preservation of the rights, dignity and equality of the ordinary citizen under the law [Baker v Campbell at 118, 120, per Deane J. See also Attorney –General (NT) v Maurice at 490, per Deane J; Waterford v The Commonwealth at 82, per Deane J] and as no less fundamental than the right which supports the privilege against self-incrimination [Baker v Campbell at 127, per Dawson J]. In New Zealand Cooke J has described legal professional privilege in criminal matters as involving ‘a strong sense that any person charged or in peril of a charge has a fundamental human right to professional advice’ [R v Uljee at 569]. Canadian decisions have identified the privilege as a fundamental civil and legal right [Solosky v The Queen (1979) 105 DLR (3d) 745 at 760; R v Littlechild (1979) 108 DLR (3d) 340 at 347; Descoteaux v Mierzwinski [1982] 1 SCR 860 at 880; (1982) 141 DLR (3d) 590 at 609; Geffen v Goodman Estate (1991) 81 DLR (4th) 211 at 232. The existence of the Canadian Bill of Rights at the time Soloksy was decided should be noted.]”
23 His Honour then referred to the passage extracted in the previous paragraph of these reasons from the opinion of Advocate General Warner in the European Commission case.
24 McHugh J said, at 161:
“Now that this Court has held that legal professional privilege is not a rule of evidence but a substantive rule of law, the best explanation of the doctrine is that it is ‘a practical guarantee of fundamental, constitutional or human rights’ [A M & S Europe Ltd v Commissioner of European Communities [1983] QB 878 at 941 and see Solosky v The Queen (1979) 105 DLR (3d) 745 at 760; R v Uljee [1982] 1 NZLR 561 at 569; Descoteaux v Mierzwinski [1982] 1 SCR 860 at 880; (1982) 141 DLR (3d) 590 at 609 citing R v Littlechild (1979) 108 DLR (3d) 340 at 347; Geffen v Goodman Estate (1991) 81 DLR (4th) 211 at 232; Maurice (1986) 161 CLR 475 at 490]. By protecting the confidentiality of communications between lawyer and client, the doctrine protects the rights and privacy of persons including corporations by ensuring unreserved freedom of communication with professional lawyers who can advise them of their rights under the law and, where necessary, take action on their behalf to defend or enforce those rights. The doctrine is a natural, if not necessary, corollary of the rule of law and a potent force for ensuring that the equal protection of the law is a reality.”
His Honour repeated this approach in Commissioner of Australian Federal Police v Propend Finance Pty Limited (1997) 188 CLR 501, at 552.
25 Although one may discern a general tendency in the formulation of the rationale for client legal privilege to expand the circumstances in which privilege applies, one must also have regard to several decisions in which an extension of the circumstances to which privilege applies has been rejected.
26 Thus, in R v Bell; Ex parte Lees (1980) 146 CLR 141,a unanimous High Court held that the communication in confidence by a wife of her address to her solicitor was not privileged. Disclosure could be compelled by the Family Court in order to prevent frustration of an order granting custody of a child to the husband where the wife had disappeared, taking the child with her.
27 In Attorney-General for the Northern Territory of Australia v Kearney (1985) 158 CLR 500,Gibbs CJ, Mason, Wilson and Brennan JJ (Dawson J dissenting) held that legal advice given by legal officers of the Northern Territory government to the that government, in relation to the making of regulations which were in deliberate abuse of the statutory power, was not privileged.
28 Then, in Carter, Brennan, Deane and McHugh JJ (Toohey and Gaudron JJ dissenting) held that a person who had documents subject to client legal privilege could not be compelled to produce them on subpoena, even if the documents might establish the innocence of an accused, or indirectly assist his defence.
Limitation on the scope of privilege
29 Although the overall trend of the cases suggests an expanding area of privilege, it is well accepted that communications falling within what is, inaccurately, known as the crime/fraud exception do not attract privilege.
30 The description is inaccurate, first, because such communications do not fall within a protected category at all and, hence, are not excluded by way of an exception. Second, the communications are not limited to those in pursuit of a crime or fraud, but extend to communications in pursuit of an illegal or improper object.
31 In R v Cox and Railton [1884] 14 QB 153 Stephen J said at 167:
“The reason on which the rule [conferring privilege] is said to rest cannot include the case of communications, criminal in themselves, or intended to further any criminal purpose, for the protection of such communications cannot possibly be otherwise than injurious to the interests of justice, and to those of the administration of justice. Nor do such communications fall within the terms of the rule. A communication in furtherance of a criminal purpose does not ‘come into the ordinary scope of professional employment.’ A single illustration will make this plain. It is part of the business of a solicitor to draw wills. Suppose a person, personating someone else, instructs a solicitor to draw a will in the name of the supposed testator, executes it in the name of the supposed testator, gives the solicitor his fee, and takes away the will. It would be monstrous to say that the solicitor was employed in the ‘ordinary scope of professional employment.’ He in such a case is made an unconscious instrument in the commission of a crime.”
32 And, at 168, his Lordship said:
“In order that the rule may apply there must be both professional confidence and professional employment, but if the client has a criminal object in view in his communications with his solicitor one of these elements must necessarily be absent. The client must either conspire with his solicitor or deceive him. If his criminal object is avowed, the client does not consult his adviser professionally, because it cannot be the solicitor’s business to further any criminal object. If the client does not avow his object he reposes no confidence, for the state of facts, which is the foundation of the supposed confidence, does not exist. The solicitor’s advice is obtained by a fraud.”
33 In Bullivant, the Earl of Halsbury LC said, at 201, after stating the circumstances in which privilege attaches:
“But to that, of course, this limitation has been put, and justly put, that no Court can be called upon to protect communications which are in themselves parts of a criminal or unlawful proceeding.”
34 In R v Bell; Ex parte Lees Stephen J said, at 152:
“The law, although anxious to ensure unrestrained recourse to professional advice on the part of those whose legal rights or duties are in question, has no concern to encourage those who seek advice so that they may the better undertake or continue criminal or fraudulent conduct.”
(See also Wilson J, at 161)
35 In Kearney, Gibbs J provided the following comprehensive review of the scope of the limitation, at 511-4:
“One exception to which the general rule is subject is that communications by a client for the purpose of being guided or helped in the commission of a crime or fraud are not privileged from discovery. This exception is frequently stated as though it were confined to crime and fraud. In Varawa v. Howard Smith & Co. Ltd. [(1910) 10 CLR 382], at p 385, Griffith C.J. said:
‘The point is taken now that the objection of privilege does not apply to a case of fraud, or intended fraud, or of intended crime. I am not sure that the exception has ever been extended beyond these two cases. But I am sure that it has never been held to apply to a case where all that is alleged is that the evidence will show that the plaintiff knew he had not a good cause of action.’
In Crescent Farm (Sidcup) Sports v. Sterling Offices Ltd [(1972) Ch 553], Goff J. held that communications made between solicitor and client for the purpose of committing a breach of contract or furthering a conspiracy to commit a breach of contract did not cease to be privileged. He said, [at p.565]:
‘I agree that fraud in this connection is not limited to the tort of deceit and includes all forms of fraud and dishonesty such as fraudulent breach of trust, fraudulent conspiracy, trickery and sham contrivances, but I cannot feel that the tort of inducing a breach of contract or the narrow form of conspiracy pleaded in this case come within that ambit.’
In Wigmore, op.cit., par.2298, at p.573, it is said that the reasons for the protection given by the privilege ‘cease to operate ... where the desired advice refers not to prior wrongdoing, but to future wrongdoing’, and the question is then asked, amongst others, ‘Must not that unlawfulness [the unlawfulness of the end for which the advice is sought] be either a crime or a civil wrong involving moral turpitude?’ The learned author states, at p.577, that this question should be answered in the negative, but goes on to acknowledge that the decisions show ‘an inclination to mark the line at crime and civil fraud’. He adds:
‘Yet it is difficult to see how any moral line can properly be drawn at that crude boundary, or how the law can protect a deliberate plan to defy the law and oust another person of his rights, whatever the precise nature of those rights may be.’
Mr Bennett, who appeared for the Attorney-General for the Northern Territory, submitted that since a public body which makes regulations for an extraneous purpose does not commit a crime or a fraud, and is not guilty of dishonesty, communications between such a body and its legal advisers for the purpose of obtaining and giving legal advice in furtherance of the unauthorized exercise of the statutory powers remain within the ambit of the privilege. The statement that a public body exercising statutory powers has acted in bad faith does not necessarily import fraud or dishonesty; it may mean no more than that the body has exercised its powers for an ulterior purpose. It was therefore submitted that it would be an unjustified extension of the existing exception which relates to communications in furtherance of crime or fraud to include within it a case in which the communications were made to seek and give assistance in the exercise of statutory powers for an ulterior purpose.
However, not all the authorities state the principle of the exception in a way that would confine it to crime or fraud. In Russell v. Jackson (1851) 9 Ha. 387, at pp 392-393 (68 ER 558, at p 560) Turner V-C. said:
‘Can it then be said that the communication should be protected because it may lead to the disclosure of an illegal purpose? I think that it cannot; and that evidence which would otherwise be admissible cannot be rejected upon such a ground. On the contrary, I am very much disposed to think that the existence of the illegal purpose would prevent any privilege attaching to the communication. Where a solicitor is party to a fraud no privilege attaches to the communications with him upon the subject because the contriving of a fraud is no part of his duty as solicitor; and I think it can as little be said that it is part of the duty of a solicitor to advise his client as to the means of evading the law.
This passage has frequently been cited with apparent approval – e.g, by Isaacs J. in Varawa v. Howard Smith & Co. Ltd., [(1910) 10 CLR 382] at p 389 and by Stephen J. in Reg. v. Bell; Ex parte Lees [(1980) 146 CLR 141, at p 152]. There are other authorities in which the principle is stated with equal width. One of them, Gartside v. Outram [(1856) 26 L.J. Ch 113], is cited in Reg. v. Cox and Railton [(1884) 14 QBD 153, at pp 169-170], together with Russell v. Jackson. In another, Bullivant v. Attorney-General for Victoria [(1901) AC 196 at 201], the Earl of Halsbury L.C. said, ‘that no court can be called upon to protect communications which are in themselves parts of a criminal or unlawful proceeding’. In the same case Lord Shand and Lord Davey spoke of ‘fraud or illegality’ [see at pp.203, 204-205]. It is plain from the judgment of Lord Lindley, [at p.207], that he considered that a communication with a solicitor by a client who says: ‘Tell me how to escape from the consequences of the Act of Parliament, although I am brought within it’ would indicate an intention to seek help to evade the law by illegal conduct and would not be privileged, although if the client asked how he could do something which would not bring him within the scope of the Act, there would be evasion in another sense, but no illegality, and the communication would be privileged.
The explanation given by Turner V-C for the principle on which the exception rests, namely that a communication in furtherance of an illegal purpose is not within the ordinary scope of professional employment, was in substance accepted as correct in Reg. v. Cox and Railton, [at pp 168-169] and is now generally accepted. Cardozo J. put it shortly in Clark v. United States [(1933) 289 US 1, at p 15]: ‘The privilege takes flight if the relation is abused.’
These statements of the principle, and the reason on which it is based, suggest that the exception is not confined to cases of crime and fraud, even in the wide sense in which ‘fraud’ has been used in this context, unless the meaning of that word is extended to include anything that might be described as a fraud on justice.”
36 And Dawson J said at 528-9:
“It is true that different expressions are to be found in the cases to explain what is meant by crime or fraud in the present context: ‘any unlawful or wicked act’ (Annesley v. Anglesea [(1743) 17 St. Tr. 1139, at p 1229)]; ‘a criminal or unlawful proceeding’, ‘fraudulent contrivance, or ... any illegal proceeding’, ‘an improper or an illegal act’, ‘illegality or fraud or trickery’ (Bullivant v. Attorney- General for Victoria [(1901) AC 196, at pp 201, 203, 205 and 206]); ‘crime or civil fraud’, ‘wrong-doing’, ‘illegal object’ (Varawa v. Howard Smith & Co. Ltd., [at pp 386, 387 and 390]); ‘any illegal or improper purpose’, ‘to frustrate the processes of law’, ‘taint of illegality’, (Reg. v. Bell; Ex parte Lees [(1980) 146 CLR 141, at pp 145, 156 and 162]); ‘crime or fraud or civil offence’ (Baker v. Campbell [(1983) 153 CLR 52, at p 86]). Despite their apparent breadth, these expressions have, I think, been used more to explain the nature of the exception rather than to restrict the scope of the privilege.”
37 In Barclays Bank Plc v Eustice [1995] 1 WLR 1238 Schiemann LJ, with whom Aldous and Butler-Sloss LJJ agreed, referred, at 1248-9, to the following passage in the judgment of Bingham LJ in Ventouris v Mountain [1991] 1 WLR 607 at 611:
“The doctrine of legal professional privilege is rooted in the public interest, which requires that hopeless and exaggerated claims and unsound and spurious defences be so far as possible discouraged, and civil disputes so far as possible settled without resort to judicial decision. To this end it is necessary that actual and potential litigants, be they claimants or respondents, should be free to unburden themselves without reserve to their legal advisers, and their legal advisers be free to give honest and candid advice on a sound factual basis, without fear that these communications may be relied on by an opposing party if the dispute comes before the court for decision. It is the protection of confidential communications between client and legal adviser which lies at the heart of legal professional privilege … Without the consent of the client, and in the absence of iniquity or dispute between client and solicitor, no inquiry may be made into or disclosure made of any instructions which the client gave the solicitor or any advice the solicitor gave the client, whether in writing or orally.”
38 Schiemann LJ continued, at 1249:
“It will be noted that in the last sentence cited Bingham L.J. referred to the ‘absence of iniquity.’ In so doing he was recognising the effect of a line of cases which have established that advice sought or given for the purpose of effecting iniquity is not privileged. The present appeal is concerned essentially with the question whether the effecting of transactions at an undervalue for the purpose of prejudicing the interests of a creditor can be regarded as ‘iniquity’ in this context. “Iniquity’ is I believe, without having done any research on the point, Bingham LJ’s word. The case law refers to ‘crime or fraud’ (Reg v Cox and Railton (1884) 14 QBD 153, 165), ‘criminal or unlawful’ (Bullivant v Attorney General for Victoria [1901] AC 196, 201), and ‘all forms of fraud and dishonesty such as fraudulent breach of trust, fraudulent conspiracy, trickery and sham contrivances’ (Crescent Farm (Sidcup) Sports Ltd v Sterling Offices Ltd. [1972] CH. 553, 565). The case law indicates that ‘fraud’ is in this context used in a relatively wide sense.”
39 Then, at 1252, Schiemann LJ said:
“For reasons given earlier in this judgment we start here from a position in which, on a prima facie view, the client was seeking to enter into transactions at an undervalue the purpose of which was to prejudice the bank. I regard this purpose as being sufficiently iniquitous for public policy to require that communications between him and his solicitor in relation to the setting up of these transactions be discoverable.
…
If the strong prima facie case turns out to be correct then the defendants have deliberately indulged in something which I would categorise as sharp practice.”
40 In Propend Brennan J said, at 514:
“In determining whether a claim of legal professional privilege can be upheld, it is open to the party resisting the claim to show reasonable grounds for believing that the communication effected by the document for which legal professional privilege is claimed was made for some illegal or improper purpose, that is, some purpose that is contrary to the public interest.”
41 Gummow J described the scope of this limitation, at 563-4 as follows:
“[T]he privilege does not attach to a communication made as part of a criminal or unlawful proceeding or in furtherance of an illegal object. The privilege would not attach where the plaintiff sought legal assistance as a step in, or preparatory to, the commission of a crime or fraud, even though the solicitor was unaware of the purpose of the communication at the time it was made [R v Bell; Ex parte Lees (1980) 146 CLR 141 at 145]. The communication would still be ‘designed to facilitate future wrongdoing’ [Carter v Northmore Hale Davy & Leake (1995) 183 CLR 121 at 163]. In addition, the privilege does not protect communications made to further a deliberate abuse of statutory power and by that abuse to prevent others from exercising their rights under the law [Attorney-General (NT) v Kearney (1985) 158 CLR 500]. It follows that the operation of the privilege is not decided, as a general proposition, merely by a determination in the instant proceeding of whether facts amounting to a crime have been proved. The nature of the alleged impropriety and thus the issue of existence of the privilege will vary from case to case.”
42 A case in which the limitation was applied, and which bears some similarity to the present case, is Baker v Evans (1987) 77 ALR 565. In that case documents were seized from the offices of solicitors pursuant to a search warrant. The solicitors contended that the documents were privileged. The respondents contended, inter alia, that the documents came into existence in the course of devising and implementing a fraudulent scheme to evade sales tax, and hence, privilege was not available. The scheme involved elaborate documentation which was designed to have the effect of reducing the value of motor vehicles for sales tax purposes. The fraud alleged was not that the scheme, if implemented, would have reduced the tax payable, but rather that the documentation was produced in order to make it appear that certain transactions which reduced the value of the vehicles had been entered into, when, in truth, they had not. The case against the applicants was that the scheme was “a mere pretence”. Pincus J held that there was prima facie evidence that the allegations of illegality had some foundation in fact. His Honour said at 574:
“The sworn information would have conveyed to the first respondent that a scheme had been operated which purported to reduce the value of the property sold at the critical point in the chain of transactions, but which did not in truth reduce it. The failure to achieve a reduction was not a consequence of any esoteric points of property law, but simply of the fact that the transactions which might otherwise have created a security interest were effected when those who participated in them had ceased to have any interest in the goods.”
43 Another example of a case in which the claim to privilege over documents seized from the solicitor was denied is Beazley v Steinhardt [1999] FCA 447. Dowsett J was satisfied that a prima facie case of intention by the applicants to defraud the Commonwealth contrary to section 29D of the Crimes Act 1914 (Cth) had been made out, where the applicants had apparent sources of income from companies resident outside Australia, but had failed to file tax returns for a period of about 20 years. Dowsett J referred to the possibility that the structure utilised by the applicants was a sham, at par 34, as follows:
“It is also possible to infer that the applicants established a structure outside of Australia designed to assist them to conceal the true character of funds available to them, in order to avoid tax. It may be that the structure achieves that purpose in an entirely lawful way, but the concern for secrecy disclosed in some documents arguably suggests a guilty mind, or a least an awareness that the structure may be a mere facade, capable of successful attack by the revenue authorities.”
44 His Honour’s decision was upheld on appeal (Beazley v Steinhardt [1999] FCA 1255).
Degree of proof required
45 The major cases which have examined the degree of proof necessary to establish that a communication is not privileged have concerned instances where allegations of fraud or impropriety were made in pleadings or in criminal charges. In such circumstances, the question arose whether the pleading or the charge was alone adequate to establish the existence of wrongdoing such that the court would hold the communication not to be privileged. Whilst the circumstances of the present case are far removed from cases in which the allegation of fraud was barely substantiated, the cases have described the principles applicable to establishing the necessary level of impropriety.
46 In Bullivant, an examination was laid against executors claiming particular duties and alleging that the testator had executed certain voluntary conveyances with intent to evade payment of those duties. The Supreme Court of Victoria ordered the examination on commission of a solicitor in England. In the course of the examination, the witness was asked to produce a diary kept by the solicitors for the testator containing instructions given by the testator in relation to the voluntary conveyances.
47 The House of Lords upheld the claim for privilege. The Earl of Halsbury LC said, at 201:
“If you are to say, ‘I will not say what these communications are because until you have actually proved me guilty of a crime they may be privileged as confidential,’ the result would be that they could never be produced at all, because until the whole thing is over you cannot have the proof of guilt. On the other hand, if it is sufficient for the party demanding the production to say, as a mere surmise or conjecture, that the thing which he is so endeavouring to inquire into may have been illegal or not, the privilege in all cases disappears at once. The line which the Courts have hitherto taken, and I hope will preserve, is this – that in order to displace the prima facie right of silence by a witness who has been put in the relation of professional confidence with his client, before that confidence can be broken you must have some definite charge either by way of allegation or affidavit or what not.”
48 Then, in a passage which has particular relevance to the analysis of the facts of this case, his Lordship said, at 201-2:
“Now, my Lords, when I look at all that is to be found here, I find no such definite charge at all. If, for the purpose of evading the payment of duty to which the man was liable, he entered into some secret and covinous arrangement whereby, although he should still retain the property during his lifetime, nevertheless colourable deeds should be executed which would shew that the property was not liable to duty, that would undoubtedly be a fraud, and I should think there would be no doubt that a person who was engaged in such a transaction could be compelled either to produce the correspondence or to state the conversation shewing how the alleged fraud was intended to be carried out. But there is no such allegation – there is nothing here which any Court can regard as an allegation of fact sufficient to displace the privilege. If the fact were merely that the person did execute voluntary deeds the effect whereof was that the tax never fell upon the property at all, I do not know that there is any offence in that either in Victoria or in this country.”
49 And, at 203, he said:
“[T]he judge would have to satisfy himself whether there was really established to his satisfaction a charge of fraud or something that would displace the privilege – I do not say prove it – but it would be a reasonable and proper thing under the circumstances to establish the proposition that the issue to be tried was whether there was really a fraud or not, and that this was a piece of evidence relevant to establish the fraud.”
(See also Lord Davey at 205).
50 The House of Lords again considered the issue in O’Rourke v Darbishire [1920] AC 581. In this litigation the heir at law and next of kin of Sir Joseph Whitworth made claims to his residuary estate. The residuary estate had originally been left to educational institutions. Sir James altered his will to leave the residue to his executors. The will contained an indication that he had confidence that they would carry out his wishes to the utmost of their power. Part of the claim was that the testator changed his will as a result of the fraud of the executors. They, it was suggested, convinced the testator that the residue would be used for educational purposes, whilst they intended to appropriate the residue largely for themselves. The executors resisted production of certain documents on the grounds that the documents were privileged.
51 Viscount Finlay said, at 604:
“The appellant also relied on the proposition that no privilege comes into existence with regard to communications made in order to get advice for the purpose of carrying out a fraud.
This is clear law, and, if such guilty purpose was in the client’s mind when he sought the solicitor’s advice, professional privilege is out of the question. But it is not enough to allege fraud. If the communications to the solicitor were for the purpose of obtaining professional advice, there must be, in order to get rid of privilege, not merely an allegation that they were made for the purpose of getting advice for the commission of a fraud, but there must be something to give colour to the charge. The statement must be made in clear and definite terms, and there must further be some prima facie evidence that it has some foundation in fact. It is with reference to cases of this kind that it can be correctly said that the Court has a discretion as to ordering inspection of documents. It is obvious that it would be absurd to say that the privilege could be got rid of merely by making a charge of fraud. The Court will exercise its discretion, not merely as to the terms in which the allegation is made, but also as to the surrounding circumstances, for the purpose of seeing whether the charge is made honestly and with sufficient probability of its truth to make it right to disallow the privilege of professional communications. In the present case it seems to me clear that the appellant has not shown such a prima facie case as would make it right to treat the claim of professional privilege as unfounded.”
52 Lord Sumner said, at 614:
“It is therefore the business of the party claiming production to meet a properly framed claim of professional privilege by showing that the privilege does not attach because it is being asserted for documents which were brought into existence in furtherance of a fraud, and he can only do this by establishing a prima facie case of fraud in fact.”
53 Lord Parmoor said, at 623:
“If in the present appeal there is disclosed a real prima facie case of definite fraud, this must be found in the allegations contained in the pleadings and particulars, seeing that there has been no affidavit, and no information from any other source. In the statement of claim fraud is alleged, as an alternative to a secret trust, on the ground that the form in which the testamentary disposition of the testator was settled or arranged by Christie and Darbishire was a mere fraudulent device or scheme for appropriating, to the use of Whitworth’s executors, a very large portion of the testator’s estate. This allegation is not supported by the statement of any facts which might give positiveness or distinctness to the charge, but rests on nothing more than pleading, or mere surmise and conjecture.”
54 Lord Wrenbury said, at 633:
“If I may venture to express this in my own words I should say that to obtain discovery on the ground of fraud the plaintiff must show to the satisfaction of the Court good ground for saying that prima facie a state of things exists which, if not displaced at the trial, will support a charge of fraud. This may be done in various ways – admissions on the pleadings of facts which go to show fraud – affidavits in some interlocutory proceedings which go to show fraud – possibly even without admission or affidavit allegations of facts which, if not disputed or met by other facts, would lead a reasonable person to see, at any rate, a strong probability that there was fraud, may be taken by the Court to be sufficient. Every case must be decided on its merits: Reg v Cox (14 QBD 153, 175). The mere use of the word ‘fraud’ or the prefix of the adverb ‘fraudulently’ from time to time throughout the narrative will not suffice.”
55 Bullivant and O’Rourke have been the foundations for the learning on this question in Australia. The most usual starting point is the judgment of Gibbs CJ in Kearney where, at 516, he said:
“The privilege is of course not displaced by making a mere charge of crime or fraud or, as in the present case, a charge that powers have been exercised for an ulterior purpose. This was made clear in Bullivant v Attorney-General (Vict) [[1901] AC at pp. 201, 203, 205] and in O’Rourke v Darbishire ([1920] AC 581 at pp. 604, 613-614, 622-623, 632-633). As Viscount Finlay said in the latter case, ‘there must be something to give colour to the charge’. His Lordship continued:
‘The statement must be made in clear and definite terms, and there must further be some prima facie evidence that it has some foundation in fact … The Court will exercise its discretion, not merely as to the terms in which the allegation is made, but also as to the surrounding circumstances, for the purpose of seeing whether the charge is made honestly and with sufficient probability of its truth to make it right to disallow the privilege of professional communications.’”
56 In Propend, documents were seized by the AFP from solicitors retained by the respondents to advise on certain tax matters. The respondents and the solicitor were suspected of defrauding the Commonwealth in contravention of ss 86(1)(e) and 86A of the Crimes Act 1914 (Cth) by inter alia, claiming deductions in excess of expenses actually incurred. Also, it was suspected that the respondents had disposed of a partnership in a way which resulted in the payment of all creditors except the Commissioner of Taxation contrary to the provisions of the Crimes (Tax Offences) Act 1980 (Cth).
57 In Propend, the only evidence of the illegal actions was the sworn information on the basis of which the search warrant was issued. One issue considered by the Court was whether this evidence established that the documents seized were brought into existence for an illegal or improper purpose and, hence, not subject to client legal privilege. In separate judgments the Justices held that the evidence was not sufficient to displace client legal privilege. Other than Gummow J, each of the Justices referred to the passage in the speech extracted in par 51 of these reasons of Viscount Finlay in O’Rourke, where he stipulated that in order to establish such purpose there must be “something to give colour to the charge,” and to the adoption of this test by Gibbs CJ in Kearney extracted in par 55 of these reasons: see Brennan CJ at 514; Dawson J at 521; Toohey J at 534; Gaudron J at 546; McHugh J at 556; and Kirby J at 592.
the facts
The Activities of Mr Petroulias and the Promoters
58 The evidence relied upon by the AFP is contained in a large number of affidavits which record the results of the investigation by the AFP into the activities of Mr Nick Petroulias and persons associated with him, including Mr Andrew Gray. Those affidavits are sworn or affirmed by the following deponents on the dates listed:
· Peter Baxter sworn on 22 June 2000;
· Stephen Joseph Brown sworn on 7 July 2000;
· Quincy Tang sworn on 18 July 2000;
· Peter John Donaldson sworn on 19 July 2000;
· Amanda Elizabeth Perks sworn on 19 July 2000;
· Leonie Jayne Bloomfield sworn on 19 July 2000;
· John Steven Burrows sworn on 19 July 2000;
· Peter Baxter sworn on 23 August 2000;
· John Steven Burrows sworn on 18 December 2000;
· Stephen Joseph Brown sworn on 17 January 2001;
· Stephen Joseph Dometto sworn on 19 January 2001;
· Peter Constantinou sworn on 19 January 2001;
· David Kenneth Wildman sworn on 19 January 2001;
· Stephen Wayne Gray sworn on 19 January 2001;
· Raewyn Helen McLean affirmed on 19 January 2001;
· Peter Zdelar sworn on 19 January 2001;
· Peter Baxter sworn on 22 January 2001;
· David Kenneth Wildman sworn on 23 January 2001;
· Quincy Tang sworn on 23 January 2001;
· Kathryn Leigh Tait sworn on 23 January 2001;
· Peter Banach sworn on 23 January 2001; and
· Allen Frederick Willams sworn on 24 January 2001.
59 The respondent relied on four affidavits sworn by Mr Clements on 10 July 2000, 14 July 2000, 27 October 2000 and 12 April 2001. Mr Clements was cross-examined on the contents of his affidavits. The respondent also relied on three further affidavits sworn by directors of clients of CDB. They are:
· Mark Rolls, director of Radioactive Clothing Pty Ltd, sworn on 10 August 2000;
· Alfred Mansour, director of A&G Steel Metal Fabrications Pty Ltd, sworn on 11 August 2000;
· Leo Moio, director of Fraser Jenkinson, filed on 11 August 2000.
60 What follows is an examination of such of that evidence as is relevant to the present question before the Court.
61 In February 1997, Mr Petroulias was engaged through his company Middleduke Pty Ltd as a consultant to the Australian Tax Office (ATO) to undertake work relating to the High Wealth Individuals Task Force. On 11 November 1997, he was appointed as an Assistant Commissioner of Taxation.
62 Toward the end of 1997, a company incorporated in the British Virgin Islands, Productivity Incentive Corporation Limited (PIC), began marketing employee incentive plans in Australia.
63 Mr Petroulias drafted promotional material for PIC which included, for instance, the following:
“Productivity Incentive Corporation Limited is an international specialist in advising businesses on capturing maximum synergies from their human resources. Through our local representatives we can provide our experience to the Australian business community. Our independent representatives can provide an initial consultation on the EROPs [Employee Reward and Ownership Plans] that can be designed to create productivity benefits. You can contact your local representative detailed on the back of the information kit.”
64 In October, November and December 1997 a number of seminars where held by some solicitors and other persons acting in conjunction with PIC. One of the seminars was held by Mr Gray at the Melbourne Hilton on 26 November 1997. Mr Petroulias attended the seminar. The invitation stated that:
“This complimentary seminar will feature commentators who have extensive practical experience in employee reward and incentive schemes, including a senior representative from the Australian Taxation Office. The speakers will discuss:
q Pro-active remuneration planning;
q Individual and team based incentive schemes;
q Strategic performance incentives;
q Innovative management investment;
q Performance plan implementation;
q Variations of popular incentive schemes;
q Efficacy of some schemes in terms of taxation law;
q Payroll Tax, Workcover and superannuation consequences;
q Pitfalls of some schemes – will the bubble soon burst?
q Part IVA and legislation;
q The ATO position relation to various schemes;
q Alternatives to existing schemes; and
q Productivity Incentive Plan alternatives”
65 One of the schemes offered by Mr Gray was called the Productivity Incentive Plan (PIP). The mechanics of the PIP were described in literature produced by Mr Gray as follows:
“ MECHANICS OF THE PRODUCTIVITY INCENTIVE PLAN
The Productivity Incentive Plan (‘PIP’) involves the creation of a special purpose PIP company. The object of the special purpose company is to provide an incentive for the employees of the employer company to become more productive so as to increase the profitability of the business by providing an additional reward to its employees in excess of their normal remuneration. The PIP company will be investing the capital base created by any productivity incentive payments made by the employer company to maximise employee reward in accordance with the objective.
The special purpose company will have the following types of shares:
1. Initial subscriber shares;
2. Incentive providing Shares;
3. Employee shares;
4. Special residuary shares; and,
5. Plan Manager shares.
Incentive providing shares
Each year the employer will subscribe for ‘incentive providing shares’. The shares will be issued at $1.00 each. The shares give the right to put a list of productivity targets and performance criteria to the PIP company which the PIP company is to supervise the achievement of.
There is an obligation on the employer subscriber of those shares to make a ‘a productivity incentive payment’ to the PIP company each period as part of the original consideration for the purchase of the employer shares and is not entitled to receive back any part of the productivity incentive paid to the PIP. The payment of ‘the productivity incentive payment’ which is an integral part of the consideration for the employer shares, will entitle the employer to new incentive providing shares which in turn include the right to put a new list of performance targets and performance criteria to the PIP company to manage.
If in any period, the employees do not achieve their targets in any period, the employer will only need to make a productivity incentive payment of $1.
It is expressly provided that the productivity incentive payment is part of the capital base of the PIP company.
It is also expressly provided that the productivity incentive payment should not be regarded as an integral component of any participant’s current or continuing remuneration package.
Employee Shares
The employee shares will have the necessary restrictions attached to them so as to bring them within the Division 13A of the Act. Those employees who wish to participate in the scheme will apply for $1.00 shares and these will be paid by the employer on behalf of the employee. The acquisition of the employee shares will be [sic] give rise to a discount of $1.00 each for each [sic] which will trigger Division 13A to assess the discount at the time that the shares were acquired by the employee.
Special residuary shares
Special residuary shares have the sole purpose of ensuring that the employer does not receive the PIP investments in the event that all employees become disentitled to the benefits. They are essentially the same as employee shares in that they are subject to the same rights and restrictions. They exist solely to stop the return of the underlying investment to the employer company if all employee shares are forfeited any future time. In the event of a forfeiture by all employees, the employer cannot effectively benefit by being the only shareholder in the PIP company.
An employee who fails to satisfy the conditions attaching to his or her shares and their issue may forfeit his or her underlying rights to those shares. However the PIP company would continue to hold the underlying investments attributable to those forfeited employee shares. Those holding special residuary shares are effectively holding the shares and rights to the underlying investment in a trustee capacity.
Independent Fund Manager Shares
Manager shares are issued to Productivity Incentive Corporation or another independent party of suitable professional standing nominated by the employer with the participating employees to manage the PIP investments ensuring a degree of independence from the employer company and the employees. The holder of the manager shares will be entitled to control the voting of the general meeting and the board of directors. The shares will not entitle any rights to dividends or to a return of capital.
Summary
The employer company will purchase incentive providing shares which give it the right to put list [sic] of targets and performance criteria to the PIP company which independently manages the achievement of those targets and the investment of the capital base for the future benefit of the employees. If the targets are met, the employer will make a productivity incentive payment and that payment will give it the right to purchase further incentive providing shares for setting the next generation of targets. Only if the targets are not met, the productivity incentive payment will be a $1 amount. The $1 payment will nevertheless gives [sic] the employer a right to purchase further incentive providing shares for the setting the next generation of targets.”
66 The tax consequences of the PIP were described in a briefing paper prepared by Mr Gray as follows:
“ TAX IMPLICATIONS OF PRODUCTIVITY INCENTIVE PLANS
For the employer
· Contributions by the employer to the Plan are incurred in the course of carrying on business for the purpose of producing assessable income and are deductible.
· Contributions do not fall within the superannuation guarantee scheme and are not ‘wages’ for payroll tax and workers compensation purposes. This is the result for most States including NSW and Victoria.
· Provided contributions made in respect of a participating employee are reasonable, the provisions of Divisions 26-35 and 26-40 of the 1997 ITAA [Income Tax Assessment Act 1997 (Cth)] (section 65) and section 109 of the Income Tax Assessment Act, 1936 (‘the 1936 Act’) should have no application.
· As the trustee or incentive control company is independent, it is not an ‘associate’ of the employer nor the participating employees for FBT [Fringe Benefit Tax] purposes. No FBT liability will arise in respect of contributions made to the plan and the assets acquired by the plan entity.
· As the shares or units will be issued to the employees for market value, no FBT liability will arise. The loan fringe benefit that arises on the interest free loan is reduced to zero due to the otherwise deductible rule.
· Employees are ultimately taxed under the CGT [Capital Gains Tax] provisions and therefore, can benefit from indexation and averaging.
For the employee
· Participating employees will not be assessable on the amounts contributed by the employer.
· Participating employees are not assessable on the value of the shares or units issued to them.
· Avoids the restrictions in the new sections 108 and 109 of the Tax Act.
· Offers the following advantages over superannuation:
Ø No limit on deductible contributions provided that contributions are reasonable and commercially justifiable;
Ø No 15% contributions (surcharge) tax or SGC liability;
Ø No preservation restrictions; and,
Ø SIS investment restrictions do not apply
· Asset protection from creditors
· Each participating employee will be assessable on his share of the net income of the trust or controlling company for tax purposes.
· Distributions of income and/or capital from the trust or controlling company to participating employees will not be eligible termination payments. Taxation is effectively deferred until units or shares are redeemed by the employee.
Part IVA
Where the dominant purpose of an employer in creating the Productivity Incentive Plan is to retain key employees and increase employee productivity and provided amounts contributed to the plan are reasonable, the general anti-avoidance provisions of Part IVA of the 1936 [sic] will have no application.
Advance Opinion
An advance opinion has been obtained from the Australian Taxation Office which confirms all of the tax implications associated with the Productivity Incentive Plan.”
67 Notes of Mr Gray’s contribution at the seminar indicated that he cast doubt on the efficacy of other employee benefit schemes then in the market as follows:
“There can be no doubt that there is a plethora of incentive plans currently being offered by a number of organisations. We are fortunate in that we have been able to consider the efficacy of a number employee incentive plans. Some of the plans examined to date, are in our opinion, technically deficient. We know that some plans have already attracted the attention of the Australian Taxation Office. The technical deficiencies inherent in a number of other plans can, unfortunately, only be certain to attract similar attention in the future.”
68 One selling point relied upon by Mr Gray was that an advance opinion had been obtained from the ATO which confirmed all the tax implications (including Part IVA matters) associated with the PIP. An advance opinion is administratively binding on the Commissioner.
69 Mr Petroulias knew that there was a marketing advantage in having advance opinions and/or private binding rulings from the ATO. He assisted in this aspect of the activities of PIC in the following ways.
70 Geoff Strong and Nick Panos both worked at Coleman & Greig Solicitors. On 2 September 1997, Mr Panos sought an advance opinion on behalf of Productivity Incentive Australia Limited (PIA) in respect of a Productivity Incentive Trust Plan (PITP) (‘the first advance opinion’). Such plans were closely related to the PIPs and achieved similar tax outcomes. PIA was described in the request as “the authorised representative of” PIC. Mr Strong controlled PIA. On 9 September 1997, Mr Petroulias sent a fax to Lowman Chow, the officer at the Hurstville office of the ATO handling the request for an advance opinion. The fax was strongly supportive of providing the advance opinion requested.
71 On 9 September 1997, Mr Panos submitted a request for an advance opinion on behalf of PIA in respect of a PIP (‘the second advance opinion’). This request was directed to Mr Michael Charles at the Dandenong office of the ATO.
72 On 12 September 1997, Mr Petroulias sent a facsimile to Mr Gray attaching a record of a conversation with colleagues about a salary sacrifice arrangement and asked Mr Gray “Can we make it into a product?”. Mr Petroulias sent a further facsimile to Mr Gray relating to the matter on 15 September 1997.
73 On 1 October 1997, Mr Gray wrote to an accountant who was a client of his, Mr Barry Quinn from Phillipson Fletcher Pty Ltd as follows:
“RE: EMPLOYEE INCENTIVE SCHEMES
You will recall that I mentioned the development of a [sic] new employee incentive plans which have tax benefits for both employers and employees.
For some time, we have been working on this project with Productivity Inventive Corporation Limited, a specialist remuneration planner which spends much of its time in the design of employee reward and ownership plans.
On 6 and 7 October 1997 Dr Nick Petroulias will be working with our firm to assist is [sic] us disseminating the many benefits of the new incentive trust and company plans to our more valued clients.
During those days, Nick and I will be holding selective briefings with certain clients of the firm both at our offices, and those of our clients. As we value highly our relationship with Phillipson Fletcher Pty Ltd, we wish to give Phillipson Fletcher Pty Ltd and its professional staff the opportunity of a thorough briefing in relation to the incentive plans which we believe will be of great interest to you all. A brief resume of the trust plan is enclosed.
We could arrange a briefing session either at your offices, or an exclusive briefing session for your professional staff at our offices – whichever you prefer.
There are a number of similar incentive plans being ‘flogged’ in the market place. We know that some of those plans are now under scrutiny by the Australian Taxation Office. We also know that some of those plans are technically deficient and inevitably, will attract such scrutiny. What has been devised with the productivity incentive plans is a technically superior structure, both in creation and implementation, for better benefit of both employer and employee alike. The opportunity has been taken to capitalise on the shortcomings of other plans in the market place and improve upon their technical deficiencies. Interestingly, most other plans lack advance opinions from the Australian Taxation Office. The productivity incentive plans will have advance opinions from the ATO which we understand will be finalised in the next few days. Not only will the advance opinions deal with the efficacy of the plans themselves, but will also deal with testing the plans against the provisions of Part IVA of the Income Tax Assessment Act 1936. Our indications are that the ATO will issue favourable advance opinions (including Part IVA aspects) later this week.
Adoption of the productivity incentive plans by clients of Phillipson Fletcher also allows it as a practice, to value add to the existing, comprehensive range of professional services which it offers. Incentive plan structures of this nature must of necessity, be administered by competent professionals. In this regard, there is more than ample scope for Phillipson Fletcher to value add to its existing client fee base.
Nick and I would welcome the opportunity to speak to yourself, partners and professional staff in relation to the plans and explain to you the many advantages that they offer and their superiority in terms of other plans in the market place. If the opportunity of a briefing session holds attraction please contact me as soon as possible so that we can isolate a suitable time either at your office or ours on Monday or Tuesday of next week.”
74 On 7 October 1997, Mr Gray came to Mr Quinn’s office with Mr Petroulias and they gave a two hour presentation to the staff of Phillipson Fletcher Pty Ltd concerning employee share schemes.
75 There are entries in Mr Panos’ diary for each of 20, 21 and 22 October reminding Mr Panos to “organise payment for Petroulias”.
76 On 8 October 1997, Mr Petroulias again wrote to Lowman Chow, the ATO officer at Hurstville who had the carriage of the first advance opinion. Mr Petroulias wrote in supportive and encouraging terms, and, on the following day, a favourable advance opinion was issued.
77 On 20 November 1997, Mr Petroulias met with Mr Malcolm Cooper, the Managing Director of Australian and International Corporate Services Limited, a company which offered the service of incorporating companies around the world for its clients. Mr Petroulias inquired about establishing a company in Hong Kong with five bank accounts operated through the Hong Kong and Shanghai Bank. He said that the purpose of the arrangement was to share commission among five people. In a file note apparently relating to this possible arrangement, Mr Petroulias noted that the bank account should be in the name of PIC.
78 On 18 November 1997, Mr Petroulias sent a fax to Mr Charles concerning the second advance opinion. He made changes to the draft proposed by Mr Charles. The opinion was essentially favourable to the plan. On 25 November 1997, the second advance opinion was provided by Mr Charles in the terms suggested by Mr Petroulias.
79 On 25 November 1997, Mr Panos made a request for a further advance opinion (‘the third advance opinion’) in respect of a PITP. Mr Panos was acting on behalf of Morgan HR Pty Ltd (MHR) which was controlled by Richard Morgan. Mr Morgan was also involved in selling PIPs. Again, Mr Panos’ request for an advance opinion began by stating that MHR was an authorised representative of PIC. This request was sent to Mr Jim Targett at the Hurstville office of the ATO. On 14 December 1997, Mr Petroulias rang Mr Targett. Mr Targett’s file note of the conversation states:
“ Nick rang.
After examining docs he thought that we should let this one go, in view of earlier rulings issued to the same txpr [taxpayer] (Coleman & Greig).”
80 On 12 January 1998, Mr Targett issued a favourable advance opinion to Mr Panos for MHR.
81 In 1998, staff of the ATO working for Mr Petroulias sent formal notices to promoters of employee benefit schemes seeking details of clients involved in such schemes. A list of taxpayers was compiled. A copy of the list was seized by the AFP at Mr Morgan’s house.
82 Mr Morgan also kept a notebook which outlined a number of schemes which seemed to have the aim of avoiding tax, referred to strategies for marketing those schemes, and made references to Andrew Gray and John McLaren. One note also records “I directed McLaren to act directly with PIC (HK).” There are also further references to PIC and PIA. On 22 September 1998, Mr Morgan transferred $97,355 to a Hong Kong bank account in the name of PIC.
83 Mr Morgan compiled a code which created disguised references to the main participants in the employee benefit schemes including Andrew Gray, who was code named “the Doctor”. There were other code references to “being watched”, “communication bugged”, “profits split”, and “percentage going to the agent”. The existence of this code, and later examples of its use, are strong pointers to the participation of the persons named in it in unlawful activity.
84 Mr Panos continued to act for Mr Morgan throughout 1998. For instance, on 19 May 1998, Mr Panos advised Mr Morgan that while an advance opinion is administratively binding on the ATO, a private ruling is legally binding. He continued:
“We strongly recommend that you advise your clients to seek their own advance opinion or preferably private ruling.”
85 The advantage of a private ruling is that it is legally binding on the Commissioner if it is favourable to the taxpayer: see s 170BB Income Tax Assessment Act 1936 (Cth) (ITAA 1936). The ATO gave private binding rulings in favour of a number of schemes promoted by Mr Morgan throughout 1998. Each of the rulings was made by Emmanual Aivaliotes, a subordinate of Mr Petroulias.
86 In the same letter to Mr Morgan, Mr Panos also said:
“Finally, we must stress that in relation to the Productivity Incentive Trust Plan we are only acting for both Productivity Incentive Australia Pty Limited and Morgan H.R. Pty Limited … In addition, we do not incur any liability whatsoever in relation to any of the agents you have licensed to promote the Productivity Incentive Trust Plan (eg: Andrew Gray & Associates and McLaren Holdings Pty Limited).”
87 On 24 October 1997, Mr Petroulias wrote to Mr John McLaren suggesting that Mr McLaren contact an accountant, Mr Norman Draper. The communication commenced:
“The following gentleman is very interested in the trust plan. It was discussed with him at the BLEC Seminar on International Tax, Sydney 14 October 1997. He has seen the Deacon Graham James scheme and has got a copy of our brochure …”
88 The letter then listed “things to note” including:
“Competitors – comparison
We are the only ones with an advance opinion which includes a Part IVA sign off.”
89 In May 1998, Mr McLaren sold a PIC Productivity Incentive Trust Plan to Judd White Real Estate. A request for a private binding ruling was prepared by Mr Panos. The request was directed to Mr Aivaliotes. The ruling was made on 5 June 1998. It was then used to market further plans. For instance, Mr McLaren sent to another accountant, Matt Keady, of Heal and Brandlie, a facsimile as follows:
“I have attached a copy of a ruling we received today from the ATO in response to the ruling request from the Accountants as shown. This is the form of the ruling that you should receive and I hope it will satisfy your clients. Your request is with the ATO.”
90 Mr McLaren appears to have been the most active salesman of PIC plans. He sold 31 trust schemes for a total commission of $350,000. In October 1998, he telegraphically transferred two amounts of $110,500 to the PIC Hong Kong bank account.
91 The AFP discovered on Mr Petroulias’ laptop computer a letter to Mr Nick Panos dated from early 1999, when the AFP were investigating Mr Petroulias’ affairs. The letter stated:
“Nick,
The DPP has now become involved. They are looking at favouritism towards certain people. There are a number of loose ends that need to be sorted out.
These are:-
Geoff and his mates. As you know, they have been giving us the problems in what they have been saying. It is important that you sort out the position with Geoff.
Further, the meeting in January – the 2 day one where you, me, Geoff and Emmanuel met in the York Street offices to discuss how PIC would operate its plans and that PIC would be sending in a number of plans. It is important that you and Geoff get familiar with those notes. These are notes prepared by either Geoff or you and sent to me. (They are very suspicious of those notes).
The client lists – if Geoff has any, make sure they are destroyed.
McLaren: I believe they now know about Global Growth. What is the relationship with PIC? I don’t know, I am going to say that they are some sort of copycat as Geoff and McLaren swap ideas and letters. But I would not know the full story. That is for you to sort out.
There is a problem with the Ashley Cain application. It is dated 25 March (as are all PIC applications – eg Co Ltd by Guarantee and ETP Plan). Further, answers questions that have not yet arisen until October. Ie the Deed of Contribution is in response to the Commissioner’s ruling in October – they can’t have predicted it back in March.
The only answer I can suggest and please make sure that McLaren has memorised, is that because when they called in October, and I raised the FET concerns, the [sic] amended the application but not the original date. Ie they changed their submission on the FBT point, without changing the date of the original application and faxed it a few times to the ATO to make sure that they got it.
Money – This is particularly important. Everything must be accounted for, even if as loans to Geoff or others. No HK shit. It smells bad. The idea of investing in HK was to set up a major superfund as a spin off from the existing operations.”
In the context the reference to “Geoff” is likely to be a reference to Geoff Strong, and the reference to “Emmanuel” is likely to be a reference to Emmanuel Aivaliotes.
92 On 21 January 1999, Mr Petroulias sent a facsimile to Mr Gray with a request that the facsimile be passed on to Mr Morgan. The facsimile stated:
“To: Andrew Gray
Pls pass on to Richard Morgan …
Richard –
Note:-
· Parabolic microphones that can pick up what you are saying through a window.
\ Keep talking in centre of room
eg. Bathroom
· Phone tapping from the exchange – vcs from interception – won’t know what is going on – ie. Can hear w/out you knowing.
· Keep a routine schedule – you must be doing something – simply staying at home merely creates suspicion.
· Get Panos to come to the office – nothing wrong with that because there is nothing given to him. He can simply come to office & provide material etc.”
93 The following day, on 22 January 1999, Mr Gray sent a facsimile to Mr Morgan which included “I attach an unusual message from Joe”. The reference to Joe appears to be a reference to Mr Petroulias by the use of a code operating among the participants in the sale of the schemes.
94 As a result of these events, Mr Petroulias has been charged with the following offences:
· Under section 29D of the Crimes Act 1914 (Cth):
“OFFENCE
Between about 1 September 1997 and 27 February 1999 Nikytas Nicholas Petroulias (aka Nick Petroulias) did defraud the Commonwealth, namely the Australian Taxation Office, contrary to section 29D of the Crimes Act 1914 in that, while an officer of the Australian Taxation Office, he did, by dishonest means, assist taxpayers to avoid the payment of tax.
Particulars
While an officer of the Australian Taxation Office involved in the regulation of tax avoidance arrangements, in breach of his duty he:
(a) was involved in devising, promoting and implementing tax avoidance arrangements known as employee benefit arrangements; and
(b) facilitated the issue by the Australian Taxation Office of favourable Advance Opinions and Private Binding Rulings to taxpayers entering into such arrangements.”
· Under section 30 of the Crimes Act 1914 (Cth):
“On about 8 April 1999 at Sydney, New South Wales Nikytas Nicholas Petroulias also known as Nick Petroulias did without lawful authority, take property out of the control of the Australian Taxation Office, a Department of the Commonwealth.
Particulars of property:
Originals and copies of Australian Taxation Office documents, including original Advanced Opinion and Private Binding Ruling requests / applications and original copies of issued Advanced Opinions and Private Binding Rulings, which were located in Storage Space number 254, rented in the name of Christopher Marriott at 200 Alexandra Parade, Fitzroy, Victoria.”
· Under section 70 of the Crimes Act 1914 (Cth):
“On about 25 July 1998 at Sydney, New South Wales, Nikytas Nicholas Petroulias also known as Nick Petroulias, then being a Commonwealth officer, with the Australian Taxation Office, did publish to Richard Llewellyn Morgan a person to whom he was not authorised to publish, documents which came into his possession by virtue of him being a Commonwealth officer, and which it was his duty not to disclose.
Particulars of documents published:
Client list from the Australian Taxation Office titled ‘SIA All Investors linked to age’.”
· Under section 73(2) of the Crimes Act 1914 (Cth):
Between about October 1997 and February 1999 at Sydney, New South Wales and elsewhere, Nikytas Nicholas Petroulias also known as Nick Petroulias, then a Commonwealth officer with the Australian Taxation Office, did agree to receive a benefit for himself, namely money, on an understanding that the exercise by him of his duty as a Commonwealth officer would be affected.
Particulars:
1. The defendant was party to an arrangement to market tax avoidance schemes generally known as Employee Benefit Trust Schemes and Non-Complying Superannuation Schemes.
2. It was part of that arrangement that the Defendant receive one third of the profits from the promotion of the Schemes.
3. It was the role of the Defendant in that arrangement to use his position as a Commonwealth Officer to facilitate approval by the Australian Taxation Office of arrangements entered into by individual taxpayers using the Schemes.”
Dealings with Clements Dunne & Bell
95 Clements Dunne & Bell Pty Ltd (CDB) is a company which conducts an accounting practice. Its directors were Paul Clements, Christine Dunne and Raymond Bell. Mr Bell died in an accident on 14 October 1999.
96 In 1997, CDB acted for clients including Radioactive Clothing Pty Ltd (Radioactive), A&G Steel Metal Fabrications Pty Ltd (A&G), Farmer Cortese Pty Ltd (Farmer Cortese), Glow Zone Products Pty Ltd (Glow Zone) and Fraser Jenkinson Pty Ltd (Fraser Jenkinson). At that time, Coadys solicitors were engaged in marketing employee share incentive plans. CDB obtained advice from Coadys concerning the use of such plans for these clients. Each of the clients entered into such a plan.
97 The Coadys’ plan involved establishing a related company. The related companies were as follows: for Radioactive - London Beach Investments Pty Ltd; for A&G - Alfgor Investments Pty Ltd; for Farmer Cortese – Coad-64 Pty Ltd; for Fraser Jenkinson - Henry Court Investments Pty Ltd; and for Glow Zone – Glow Zone Investments Pty Ltd.
98 The stated purpose of the plan was to encourage productivity and loyalty on the part of employees. The plan required the employer to make a payment to the related company. This payment provided a tax deduction for the employer. The amount of the payment was ultimately to be received by the employee when the employee reached specific targets, whether as to turnover, profits or some other measure. The payments were to be treated as capital contributed to the related company. The employee received shares in the related company, which shares entitled the employee to payment upon reaching specified goals.
99 The documentation for the Coadys’ plan was completed prior to 30 June 1997. The contributions from the employers were paid prior to the end of June 1997. The intention at the end of June 1997 was that the employer entities would claim the deduction in their tax returns to be lodged in about March 1998.
100 Evidence of the implementation of the Coadys’ plan included a minute of a meeting of directors held on 30 June 1997 as follows:
“Resolved re Employee Share Plan:
1. The Chairperson confirmed that, in accordance with the previous resolutions of the Company, a new Company COAD-64 PTY LTD ACN 079 005 333 (‘ESP Company’) had been incorporated for the purpose of implementing an employee share plan for the Company’s employees and that employee, manager and residuary share [sic] in the ESP Company had been allotted.
2. That the following contributions to the plan now be made in respect of the shares already issued to the named employees:
PETER FARMER $110,000
JUDITH LORRAINE FARMER NIL
JOHN CORTESE $5,000
BRUCE JOHN FAIRBAIRN $5,000
Applications for Shares:
Applications for 24 employer shares in the ESP Company were tabled by the Chairperson.
Resolved that the Company make application to COAD-64 PTY LTD ACN 079 005 333 for the issue of 24 employer shares of $1.00 in the capital of that company on which it is proposed to pay a premium of $5,000.00 per share being the company’s contribution towards the employee share plan on behalf of those employees participating in the plan.
Resolved that the company seal be affixed to the application for employer shares in accordance with the Company’s Articles.
Closure:
There being no further business the meeting then closed.”
101 While this minute relates to Farmer Cortese, the evidence indicated that like minutes were passed by the directors of the other employer companies. It is noteworthy that the resolution did not stipulate any targets to be attained by the employees. In the cases of Glow Zone, Fraser Jenkinson and A&G, contributions were made in respect of employees who themselves had control of the employer companies. The transactions were thus not made at arm’s length.
102 In mid November 1997, as part of a review of compliance with tax laws, the ATO wrote to some of CDB’s clients which had entered into employee share plans. The ATO sought details as follows:
“1. The amount of contributions paid by you to the ESP company in the period.
2. The method by which the quantum of contributions paid to the ESP company is decided.
3. The method by which it is decided how the premium paid on the employer shares is allocated to individual employee shares.
4. Details of the financing arrangements in connection with the payment of the contributions.
5. The classes, quantity and recipients of shares allotted in the ESP company.
6. The circumstances in which an employee is able to redeem his or her shares.
7. Profit and Loss Statements of you and the ESP company.
8. Balance Sheets of you and ESP company.
9. Notes to the accounts listed in 7 and 8 above.
10. Details of any private binding rulings obtained in relation to the ESP.”
103 Mr Bell replied to the ATO on behalf of clients including A&G, Glow Zone, Radioactive and Farmer Cortese.
104 On 26 November 1997, Mr Bell attended the seminar conducted by Mr Gray at the Melbourne Hilton. As related earlier in these reasons, Mr Petroulias also attended the seminar representing the ATO. The general message given by the promoters to the meeting was that the Coadys’ plan was not acceptable to the ATO, but that the PIC scheme would come with a private binding ruling demonstrating that it was acceptable to the ATO.
105 A file note prepared by an employee of Mr Gray on the day following the seminar records, by reference to Mr Bell, “may have sold one”. It further records a phone conversation on that day with Mr Petroulias in which it was suggested that Mr Bell put forward a proposal to roll the existing plans into a new plan which the ATO would accept and “pretend the old ones did not exist and roll over into the new as though it was the original .. intention from the start”.
106 Then, on 28 November 1997, Mr Gray spoke to Mr Bell. Mr Gray told Mr Bell that he would speak to Mr Morgan about the costs of transferring five clients from the Coadys’ plans to “something acceptable”. Mr Gray’s file note states “set up for genuine reasons – stress to ATO”.
107 On 18 December 1997, Mr Bell had a meeting with Mr Petroulias. It is noteworthy that the matters in the forefront of interest for Mr Bell were the need to ensure that the contribution already paid on 30 June 1997 continued to be deductible when the tax returns were filed in about March 1998, and that a private binding ruling from the ATO confirmed that outcome. Thus, the day after the meeting, Mr Bell wrote to Mr Petroulias confirming the discussion about clients who enter into the PIC plan as follows:
“Clients who Adopt a Replacement Plan
We will lodge the 1997 income tax returns of the employer, employees and employee share plan company on the basis that the Tax Office will accept the arrangement for 1997 as a genuine employee share plan which satisfies the Tax Office and the Income Tax Assessment Act, Fringe Benefits Tax Assessment Act and any other law which may apply.
The clients who choose this option will also be deleted from the audit list.
We will also arrange for a replacement plan to be adopted which will be effective for the year ended 30 June, 1998 and future years (as soon as possible) which will satisfy the Tax Office and the necessary legal requirements for future years.
Upon receiving the replacement plans we will provide a copy of this documentation together with a Request for Private Ruling for each client. These requests will be forwarded to you and provided the replacement plan meets the necessary Tax Office and legal requirements a Private Ruling will be issued approving the employer to use the plan and accepting the 1997 employee share plan as a genuine arrangement. In the course of discussions you suggested that a Private Ruling may be issued for a period of 3 years (in this instance 30 June, 1997, 1998 and 1999). CCH Federal Tax Reporter suggests at paragraph 971 – 595 (page 871,113) that the Tax Office can only issue a Private Ruling on a particular year of income although a notice of several rulings (ie. in relation to several years of income) may be given in one ruling notice.
This would not create a problem for the years ended 30 June, 1997 and 1998 but if a Public Ruling issued before the 1999 year commenced it seems that the Public Ruling may have the effect of cancelling the validity of the Private Ruling. Section 14ZAW of the Taxation Administration Act effectively enables any inconsistencies in a Private Ruling compared to a Public Ruling to be withdrawn subject to the application of section 14ZAU. Assuming the client (rulee) does not consent to the private ruling, or part thereof, being withdrawn can the Tax Office withdraw the ruling on the basis that the arrangement for the year ended 30 June, 1999 has not begun to be carried out? Although the structure, being the employee share plan company exists the question arises is whether this is a part of the arrangement or is the employer contribution the arrangement?”
108 On the same day, Mr Bell sent a fax to Mr Gray making further enquires about the cost of preparation of an employee share plan which complied with ATO requirements. On 22 December 1997 Mr Gray sent a copy of this fax to Mr Petroulias and asked him “would you suggest an appropriate fee structure?”.
109 On 1 January 1998, Mr Gray sent a fax to Mr Bell in the course of further negotiating the terms of a retainer. This fax again shows the prominence given by Mr Gray to the securing of a private binding ruling. He wrote:
“We are instructed that a number of your firm’s clients are participants in company employee incentive plans (‘plans’), all of which share a common form of Memorandum and Articles of Association, a copy of which you have now supplied to us.
As we have previously advised (and confirm after our review of the copy of the Memorandum and Articles provided), we believe that the structure of your client’s existing plans is deficient in that ultimately, as they are presently structured, the plans will expose employers to Fringe Benefits Tax, and employees (and perhaps also employers) to premature Capital Gains Tax liability. Further, employers may not receive the (anticipated) deduction expected from the share funding exercise. Similarly, employees may not receive the advantages associated with deferred capital gains. As we presently understand the policy of the Australian Taxation Office, the Deputy Commissioner of Taxation holds the same view.
If we are favoured with your instructions to amend documentation for your clients, we propose that in each case, the following methodology be adopted:
1. Amendments to existing Memoranda and Articles of Association be undertaken in relation to each employee incentive company to accord with a variant of the existing plan, in respect of which we have received a favourable advance opinion from the Deputy Commissioner. As we understand your instructions to date, such amendments should ensure that both employers and employees alike will achieve expected outcomes from their respective participation in the plans.
…
4. In each case, an Application for Private Ruling will be made to the Deputy Commissioner of Taxation in accordance with Income Tax Ruling IT 2500.”
110 In reply, Mr Bell sent a fax to Mr Gray on 2 January 1998 concerning further issues relating to the proposed retainer. He stated:
“At this stage you have understandably been guarded about the method in which your plans work but it is necessary that we be fully conversant with the plan prior to finalising your engagement. This is a usual procedure of our practice as we believe that it is incumbent upon a professional adviser to make every effort to satisfy himself as to the operation of any business transaction. We would be prepared to sign a confidentiality agreement to satisfy you of our genuine intentions.”
111 Then, on 12 January 1998, Mr Bell, by fax, further clarified the result of the discussions with Mr Petroulias. His fax elicited a response from Mr Petroulias on the following day in these terms:
“Employee share Plans
Reference is made to your letter dated 12 January 1998. The Commissioner’s approach to the Coadys arrangement is that there is FBT payable on the premium contributed by the employer and that, at the same time, the premium increases the discount received by the employee and forms part of the assessable income of the employee under Division 13A of Part III of the Income Tax Assessment Act 1936. These consequences are independent of whether or not the employer has claimed a deduction.
In the best interests of your clients, you have identified that your options are:
1. to switch into a employee reward plan in respect of which a positive advance opinion / ruling can be obtained; or
2. to dismantle the existing structure.
Where your clients have dismantled the existing structure, there would be no tax shortfall arising and, as such, your clients will avoid the adverse tax consequences that would otherwise arise. Whilst the office would be less inclined to investigate your clients as part of the current project where there is a low risk to the revenue, no undertaking can be given that there will be no investigation of their affairs.
If your clients switch to a plan that receives an advance opinion or private binding ruling, the next issue that has been raised is whether a deduction can be claimed for the 1997 year. On the hypothesis that you have received a positive response from the Commissioner in respect of a proposed alternative plan and in generalised terms which do not take into account individual circumstances, if the new plan does not fundamentally alter the agreed remuneration package of the employees concerned, the employer would be liable to make good on the remuneration package in the 1997 year. As such , there could well be an entitlement to a deduction to the employer in the 1997 year.
It must however be emphasised that the extent to which a remuneration package can be varied without it amounting to a fundamentally new agreement and still be enforceable from the original date is a matter of contract law. The nature of the agreement and its terms will depend greatly on the circumstances. Where the variation has the effect of creating a new agreement, it can only take effect from the date of variation and, as such, will not give rise to a deduction at the time of the original agreement.”
112 In the context in which this letter was written, it can be seen as a piece of strong advocacy in favour of CDB’s clients purchasing the employee share plan offered by Mr Gray.
113 On 20 January 1998, Mr Bell wrote to Mr Gray engaging him to switch Farmer Cortese from a Coadys’ plan to “an employee incentive plan which will be satisfactory to the Tax Office and enable a positive advance opinion / ruling to be obtained”. Enclosed with the letter was an advice from a remuneration consultant. This assessed the market salary payable to a non-arm’s length employee of Farmer Cortese, Mr Peter Farmer, at $180,000. In fact Mr Farmer had been paid a salary package of about $67,000. The result was that the maximum employee share plan contribution could be about $113,000. The amount actually contributed was $110,000. The letter concluded:
“Assuming that the Tax Office respond favourably in regard to this case we will need to contact our other clients to take instructions and engage you to complete the necessary documentation for these. The Application for Private Ruling should address the deductibility of the employer contribution, fringe benefits tax issues, the amount which is assessable income of each employee, Part IVA, capital gains tax issues and any other matters which in your judgement, is appropriate. The Application for Private Ruling should attempt to include as many years as possible in the request and it is imperative that the year ended 30 June, 1997 be one of these years.”
114 The next day, Mr Bell was told by Mr Gray that the application for the ruling should be lodged with Mr Petroulias at Market Street, Sydney.
115 On 23 January 1998, Mr Gray spoke to Mr Petroulias about a pricing structure for providing plans to six clients of CDB. It was proposed that $30,000 “with guarantee” be charged for the six clients.
116 A file note written by Mr Gray, dated 9 February 1998, indicates that he told Mr Bell that “PIC said do all 6 @ 5K with guarantee and repaid guarantee if something goes wrong”. A further file note, dated 11 February 1998, indicates that Mr Gray spoke to Mr Panos and said that he had told Mr Bell that if there were six clients one would be done for free. The file note recorded that six plans would cost $25,000 “with guarantee that put into something that does work”.
117 On 19 February 1998, Mr Gray sent a fax to Mr Bell which, in part, said:
“We confirm that in relation to our fee structure outlined in our letter of 1 January 1998, that fee structure as therein outlined is now vacated. In lieu thereof, and by arrangement with Productivity Incentive Corporation Limited, our fee structure is based on our receiving similar instructions from you in relation to six matters of which we will charge professional fees for five of those matters at $5,000.00 per matter.
We confirm that this variation in our fee structure arises from discussions and representations both with Mr Nick Panos, Solicitor for Productivity Incentive Corporation Limited and our direct discussions with Mr Richard Morgan as Director of Productivity Incentive Corporation Limited.
We confirm your instructions to proceed with the preparation of an Application for Private Ruling in respect of the existing incentive arrangements subsisting between Farmer Cortese Pty Ltd and Coad-64 Pty Ltd.
Whilst this aspect of the matter of course remains the subject of your instructions, it would our [sic] view that it is preferable that the Application for Private Ruling be made in our name and be submitted by us direct to the appropriate officers of the Australian Taxation Office. We would appreciate your specific instructions in relation to this aspect of the matter.”
118 Mr Bell responded by fax on the same day. In part, he stated:
“We refer to your facsimile transmission dated 19 February, 1998 and advise that we would prefer all documentation be forwarded to our office in respect to the Application for Private Ruling.
Our policy is to review all matters in respect to the Application prior to its lodgement. This review obviously requires us to have all documentation to attend to this review. As we have not sighted any information in regard to the Plan we consider this review is essential.”
119 The following day, 20 February 1998, Mr Gray sent a draft of the Application for a Private Ruling for Farmer Cortese to Mr Petroulias “for your perusal and comment”. Copies of further drafts of the application were sent by Mr Gray to Mr Bell on 20 and 23 February 1998.
120 On 24 February 1998, Mr Gray sent the final form of the application to Mr Bell under cover of a fax which stated:
“We refer to discussions with the writer on 23 February and now enclose Application for Private Ruling in final form for lodgement.
We understand that the Application should be lodged with Mr Emmanuel Aiviliotes of the Large Business & International Line, Australian Taxation Office, 100 Market Street Sydney, New South Wales. The appropriate facsimile number is (02) 9374 2811. If forwarded by facsimile in the first instance, we suggest that the original be subsequently forwarded by mail.
One matter in relation to amendments discussed on 23 February requires clarification. It may well be correct that incentive targets were not set in respect of 1996/97 year however, our opinion contained in the Application is relevant not only to that year, but subsequent years. Accordingly, no amendment is necessary in relation to this aspect of our opinion.”
121 Paragraph 4 of the application listed the questions to be answered by the Commissioner. The first question was:
“Having regard to the matters following:
(i) Will the Commissioner accept the retrospective effect of amendments to be made to the Memorandum and Articles of Association of Coad-64 Pty Ltd (ACN 079 005 333) (TFN 94 271 110) (‘EIP Company’) by virtue of the implementation of the proposed arrangements outlined in paragraph 5(c) of this Application?”
122 Paragraph 5 of the application set out the issues to be considered by the Commissioner and a full description of the facts. This included the following assumptions and proposals:
5. Issues to be considered and full description of facts:
…
(b) Assumptions
1. That the Memorandum and Articles of Association of the EIP [Employee Incentive Plan] Company are capable of retrospective amendment.
2. That Fairbairn, Cortese and J. [Judith] Farmer are arm’s length employees of the taxpayer.
3. That a specialist remuneration consultant has determined an arm’s length salary for [Peter] Farmer in respect of the 1996/97 year using a methodology to calculate figures which is available for scrutiny if required.
(c) Proposals
1. That the Memorandum and Articles of the EIP Company be altered with retrospective effect so as to:
(i) redefine the current employee share plan as a ‘Productivity Incentive Plan’; and
(ii) in so doing, the classes of shares on issue in the EIP Company would not change; and
(iii) the Productivity Incentive Plan will not fundamentally alter the agreed remuneration package of the concerned employees of the taxpayer.
Features of the Productivity Incentive Plan:
The existing EIP Company will become a special purpose Productivity Incentive Plan Company (‘PIP Company’), the object of which is to provide an incentive for the taxpayer’s employees to become more productive and thereby increase the profitability of the taxpayer’s business by providing them with an additional reward in excess of their normal remuneration. The PIP Company will be investing the capital base created by any productivity incentive payments made by the taxpayer to maximise employee reward in accordance with this objective.
2. Each year, the taxpayer as employer will subscribe for ‘incentive providing shares’ to be issued at $1.00 each. These shares give the taxpayer the right to put a list of productivity targets and performance criteria to the PIP Company which the latter is to supervise the achievement of. If in any period, the taxpayer’s employees do not achieve their targets, the taxpayer will need only to make a productivity incentive payment of $1.00. It is expressly provided that the productivity incentive payment is part of the capital base of the PIP Company.
…
7. If the productivity incentive targets of the taxpayer’s employees are met, the taxpayer as employer will make a productivity incentive payment and that payment will give it the right to purchase further incentive providing shares for setting out the next generation of targets. Only if the targets are not met, the productivity incentive payment will be a $1.00 amount.”
123 Paragraph 6 of the application set out the opinion of the taxpayer’s agent with reasons. This opinion including the following:
“THE APPLICATION OF PART IVA TO THE ARRANGMENT
Having regard to the eight objective criteria in Section 177 D of the Act, it is submitted that the Commissioner cannot conclude that the dominant purpose of the productivity incentive plan is to obtain a tax benefit in connection with a ‘scheme’. The dominant purpose of the arrangement is to ensure the employer company, through the encouragement of loyalty and productivity of key staff, is able to generate greater taxable income in the long term. That is, the dominant purpose is to encourage the fulfilment of the performance targets of the employer company giving rise to greater amounts of assessable income in the longer term. Likewise the dominant purpose is to encourage staff loyalty and commitment and reduce transaction costs associated with high staff turnover and therefore reduce allowable deductions in the longer term.”
124 It appears that Mr Petroulias spoke to Mr Bell at 3.30pm on the same day (24 February 1998) and indicated certain further requirements in relation to the application. He said that he needed a copy of the Memorandum and Articles with the changes highlighted, and evidence that the remuneration package was entered into earlier. He also indicated that he was not satisfied with page 4 of the application and needed more information. In particular, paragraph 2 on page 4 of the application, which is reproduced in par 122 of these reasons, was circled and the words “key features” were written in the margin next to the paragraph.
125 Again on the same day, Mr Bell reported this conversation between himself and Mr Petroulias, to Mr Gray. He sent Mr Gray a fax as follows:
“We refer to the Application for Private Ruling which we faxed to the Tax Office today and advise that Mr Nick Petroulias telephoned and advised that other matters will need to be provided in the Application.
These are as follows:-
1. He recommended that you consider the original advance opinion provided to you in which the original shares create a link with the new targets each year. He also made reference to a deferred consideration outstanding as part of the purchase of the shares. As I am not fully conversant with your plan I did not fully understand this issue. However, he stated that this is not evident from the Applicant and is critical to the arrangement.
2. A copy of the amendments made to the Memorandum and Articles of Association is to be provided. I did comment that I think you have completely replaced the entire Memorandum and Articles but perhaps you could indicate the amendments or even provide a comment that it is the same as the Memorandum and Articles of Association previously lodged in which the Tax Office have issued a favourable Advance Opinion.
3. He requested copies of correspondence and minutes which evidence that the remuneration to be paid is binding and the date of this understanding. For example, he quoted the ideal situation as ‘say date in 1/1/97 – We agree to compensate you in this way …’. That is, there is a binding obligation. I did indicate that we would be unable to provide this and advised on the basis the arm’s length employees amount was determined and the reason why it was paid. As previously indicated the reason was to retain important staff, provide incentives etc.
Attached is a copy of the Directors Minute in which the contributions were determined. I have rung Judy Farmer to see if there are any employment contracts or the like. However it is unlikely that the employment contracts would refer to anything as the amounts contributed were determined as bonus type payments and became obligatory to pay at the time the decision was made by the employer.
You may need to provide us with some guidance on this aspect to be included in the Application for Private Ruling.
I mentioned to Nick that I would organise for you to contact him should you need any clarification on these issues.
We would appreciate if this matter could be finalised tomorrow as we are virtually out of time – we really need a response (formally or informally) from the Tax Office by Friday.”
126 On the following day, 25 February 1998, Mr Gray sent Mr Bell a draft response to the queries raised by Mr Petroulias. The response provided:
“We refer to discussions with your office on 24 February 1998. Arising from those discussions we make the following further comments in support of the Application:
1. The Application for Private Ruling is predicated on the basis that the Memorandum and Articles of Association of Coad-64 Pty Ltd already reflect the proposals outlined in paragraph 5.(c) of the Application. Accordingly, we have no objection if your response to the Application is predicated upon that assumption.
2. Our instructions are that a binding obligation arose between the taxpayer and its employees in respect of the remuneration of employees in discussions which occurred between representatives of the taxpayer and the employees concerned, in or about January 1997. Those instructions were to have been committed to a formal agreement between the taxpayer and its employees however as you would be aware, there was much uncertainty in relation to the effect of amendments to the Workplace Relations Act 1996 which hindered the preparation of formal written agreements. Notwithstanding, the parties to remuneration arrangements have since their agreements, acted and continued to act in accordance with the agreement as if it were a binding obligation. In fact, a formal confirmatory Minute of the agreement in relation to remuneration was made on 30 June 1997. A copy of that confirmatory Minute is enclosed.”
127 On 25 February 1998, Mr Bell sent Mr Petroulias a response in the terms of this draft.
128 On 25 March 1998, a Notice of Private Ruling in relation to the PIP for Farmer Cortese, under the name of Mr Aivaliotes, was sent to Mr Bell. The response in the ruling to the first question posed in the application set out above was as follows:
“(i) The Commissioner accepts the retrospective effect of the amendments to be made to the Memorandum and Articles of Association of Coad-64 Pty Ltd (A.C.N. 079 005 333) (TFN 94 271 110) (‘EIP Company’) by virtue of the implementation of the proposed arrangements outlined in paragraph 5 [c] of the Applicant’s Application For Private Ruling dated 23 February 1998.”
129 The ruling also contained the following:
“(x) On the premise of the retrospective amendment of the Memorandum and Articles of Association of the EIP Company the Commissioner regards the amounts paid by the Taxpayer as premiums to the EIP Company in respect of its employees Farmer, Fairbairn, Cortese and J. Farmer as being deductible to the Taxpayer pursuant to Section 8-1 of the Income Tax Assessment Act 1997 (Section 51(1) of the Income Tax Assessment Act 1936). This is predicated on the fact that the productivity payment will be deductible to the Taxpayer provided the productivity payment is irrevocable and can be shown to provide an incentive to employees.”
130 On 6 April 1998, Mr Clements began his direct involvement with Mr Gray apparently on behalf of A&G and Fraser Jenkinson. On 20 April 1998, Mr Clements sent a fax to Mr Gray authorising him to proceed with an application for a private ruling for Glow Zone. On 22 April 1998, Mr Gray wrote to Mr Clements seeking the same information as had been provided for the Farmer Cortese application. On 26 April 1998, Mr Clements confirmed the instructions on behalf of Glow Zone to:
“engage you to prepare the necessary documentation to switch the existing Coadys type employee share plan to an employee incentive plan which will be satisfactory to the Tax Office and enable a positive advance opinion/ruling to be obtained.”
131 The letter enclosed a report from a remuneration consultant indicating the appropriate arm’s length salary for David Miller and Michael Givoni was $212,530 and $59,114 respectively. The letter indicated that the amount, in fact, paid by the company to each of these employees was approximately $89,000 and $25,000 respectively. The letter also stated:
“In accordance with previous discussions we would also request that you provide supporting documentation including company minutes, etc, which evidence that the remuneration to be paid was binding and the payment was irrevocable and provided an incentive to employees. The Application for Private Ruling should attempt to include as many years as possible in the request and it is imperative that the year ended 30 June, 1997 be one of these years.”
132 Mr Clements indicated that the application and supporting documents would be forwarded by CDB to Mr Petroulias.
133 Mr Clements sent a similar letter of instruction to Mr Gray, on 26 April 1998, in relation to Fraser Jenkinson. The letter explained that this company operated the business of a commercial printer and had a turnover of more than 10 million dollars. The directors, Leo Moio and Frank Moio, were both employed full time in the business. At 30 June 1997, the company employed 78 employees. The letter stated:
“No third party remuneration advice was received however, the basic salaries paid to the employees listed below is considered by the company to be very low given the level of responsibility and duties.”
134 The letter gave the following details of salary and superannuation paid to employees and the employee share plan contributions made:
| EMPLOYEE | POSITION | SALARY | S’ANN CONTR. | ESP CONTR. |
| Leo Moio | Managing Director | 22,400 | 27,170 | 90,000 |
| Bruno Moio | Operations Manager | 22,400 | 9,782 | 30,000 |
| Frank Moio | Warehouse Manager | 22,400 | 9,782 | 20,000 |
| Rocco Moio | Finishing Manager | 22,400 | 9,782 | 20,000 |
| Ray Moio | Print Manager | 22,400 | 9,782 | 20,000 |
| Lucy Moio | Bindery Manager | 22,400 | 9,782 | 20,000 |
| 200,000 |
135 On 27 April 1998, Ms Christina Dunne sent a similar letter of instructions to Mr Gray in relation to Radioactive.
136 By 1 May 1998, Mr Gray had prepared draft applications for private rulings for A&G, Fraser Jenkinson, and Glow Zone, and forwarded the drafts to CDB.
137 On 5 May 1998, Mr Clements raised with Mr Gray several issues concerning the draft ruling in relation to Glow Zone. Part of his file note, indicating Mr Gray’s response, in italics, stated:
“1. No documentation re. Articles, etc. is provided with the ruling. Gray is stating that it is structured in a particular way but the statements could equally apply to the Coadys plan.
- Not providing doc’n to ATO – Gray has 2 concerns with providing all docs to ATO:
1. if provide comprehensive docs – allows ATO to attack other areas; These areas may not be in the area of what we require a ruling on.
2. Gray changes and alters the memo\arts to comply with what the ATO is looking for.
- Gray also advised that it provides the ATO with the complete knowledge of the whole structure – he is only concerned with the technical taxation issues.
- It will also delay processing of the rulings.
- Gray advised that ATO knows him and how he operates – they know that if he says he will do something, he will, i.e. when he sets out what the Employee Incentive Plan (EIP) is to do in the ruling, the ATO know that his documentation will do this.
- I reiterated my concern – clients are not getting a ruling on the documentation – ATO could audit in 2 years time and after reviewing documentation claim that critical particulars were not disclosed in the ruling appln and then potentially knock it on the head. Gray just went through the above again.
We need to advise our clients of this risk
He has an advance opinion on the Articles? Not discussed.
2. No documentation re. the basis of calculation of the bonus or incentive – this was specifically requested in our letter. Therefore ATO not ruling on this. Note that this was stated by the ATO in clause (x) of their ruling re. Farmer Cortese.
Refer 5(b) of Ruling appln – this refers to a formal agreement.
Gray was to provide this agreement, and other relevant documentation, etc. Refer to A. attached which includes a letter from Gray to ATO re. Farmer – but note that Item 5(b) in the Farmer ruling did not include a reference to a ‘formal agreement’.
- Gray not believe that ATO will ask for what they did in Farmer b\c of Cl. 5(b)4. now inserted in these ruling applns.
- ATO will not rule on the issue of remuneration calculations or basis of calculation of the incentive or bonus – if you have an arms length report and incentive\bonus not excessive given that report, difficult for ATO to dispute.
- Gray cannot provide the agreements – he says he does not have them! I asked whether a minute of a meeting would suffice – he said yes – I said that I would try to obtain from clients and fax to him to ensure that it complies with the items of the ruling as stated re. ‘Formal agreement’.
However, note that ruling states that a ‘formal agreement’ exists.”
138 Paragraph 5(b) of the draft application for Fraser Jenkinson, read as follows:
“(b) Assumptions
1. The Memorandum and Articles of Association of the EIP Company are capable of retrospective amendment which accords with and provides the regulatory framework of the proposals outlined in sub-paragraph (c) hereof.
2. That the Memorandum and Articles of Association of the EIP Company already reflects the proposals outlined in paragraph 5(c) of this Application.
3. That the total remuneration package maintained in respect of each of the abovenamed employees to whom this application relates, has been determined so as to achieve an arm’s length result which yields a remuneration package in respect of each employee which is at the lower end of the salary scale for the position, nature of work, work and duties performed by the said employees.
4. There is a binding obligation evidenced by a formal agreement between the taxpayer and the employees concerned in the subject matter of this Application in respect of the remuneration of those employees. The parties to such remuneration arrangements have since their agreement, acted and continued to act in accordance with the agreement as if it were a binding obligation.”
I infer from the content of paragraph 5(b)(4) and references to it in Mr Clements’ file note that the Glow Zone draft application did not differ significantly from the one set out above.
139 Mr Clements revisited this issue in a fax to Mr Gray, on 6 May 1998, as follows:
“1. Item 5.(b)4
This refers to a ‘… formal agreement between the taxpayer and the employees concerned …’
As previously advised, we are not aware of any such formal agreement. Several of our clients obtained independent remuneration evaluations, copies of which were provided to you. The employers, directors, trustees, etc. certainly discussed the incentive plans and determined the amounts that they would contribute.
The amounts contributed were generally paid on the basis of being a reward to the employee for achieving better than target profit results. The amounts were also pitched at levels to not exceed a reasonable market remuneration for the employee.
We understand that the above was also explained to the Tax Office and that Ray discussed same with you re. Farmer Cortese. In this latter instance, you provided a response to the Tax Office in respect to their query requesting a formal agreement. Ray discussed this issue with you and expressed the view that this explanation should not be used as a standard for all cases. You responded that: ‘that’s what you have got me for’. Accordingly we request that you deal with this issue.
Our clients may have minutes of meetings on file, however, to our knowledge, they certainly do not have executed formal agreements. In this regard, the rulings require amendment.”
140 There is no evidence of any further discussion on this issue before 12 May 1998, when Mr Clements lodged the applications for private rulings on behalf of A&G, Radioactive, Glow Zone and Fraser Jenkinson. Copies of these applications have not been located by the AFP. However, a draft application for A&G, later than the draft referred to in par 136 of these reasons, reveals an amendment to par 5(b)(4), removing any reference to a “formal” agreement, and reading as follows:
“4. There is an agreement and understanding between the taxpayers and the employee concerned in the subject matter of this Application in respect of the remuneration of those employees. The parties to such remuneration arrangements have since their agreement, acted and continued to act in accordance with the agreement and understanding as if it were a binding obligation.”
It is likely that this wording appeared in the final form of the application for A&G, Fraser Jenkinson, Radioactive and Glow Zone.
141 In May 1998, there was some activity concerning Farmer Cortese, which is revealing. On receipt of the private ruling, on 25 March 1998, Mr Bell sent a fax to Mr Gray as follows:
“Please find attached a copy of the Notice of Private Ruling in respect of Farmer Cortese Pty Ltd (received by facsimile transmission today).
We draw your attention to clause (x) which states ‘This is predicated on the fact that the productivity payment will be deductible to the Taxpayer provided the productivity payment is irrevocable and can be shown to provide an incentive to employees.’
The payment was made on the basis it was irrevocable and therefore this aspect of the clause is acceptable. The latter part of the clause begs the question as to the surrounding facts on which the payment was made for the year ended 30 June, 1997. Can it be demonstrated that the payment provided an incentive? Please advise of the necessary documentation etc. required which will assist in the employer satisfying this condition.
Please advise as to the manner in which the incentive arrangement for the year ended 30 June, 1998 is to be established. It is imperative that the arrangement provide a genuine incentive to the employees.
Now the Tax Office has issued the Ruling we would appreciate if you could forward the amended Memorandum and Articles of Association in due course.”
142 On 8 May 1998, Mr Bell forwarded some financial records of Farmer Cortese to Mr Gray and made the following request by fax:
“Based upon the attached records we would appreciate if you could provide an incentive based formula to be used for determining incentive payments which could be made by the employer for the year ended 30 June, 1998 and to support the employer contribution for the year ended 30 June, 1997.”
143 Private rulings were issued in favour of A&G, Glow Zone, Fraser Jenkinson, and Radioactive on 5 June 1998. The contact officer in each case was Mr Aivaliotes, the answer to each of the questions asked of the Commissioner was positive, and the rulings each commenced with the explanation:
“WHAT THIS RULING IS ABOUT
This Private Ruling relates to the redefinition of the taxpayer’s Employee Incentive Plan into a Productivity Incentive Plan as outlined in the Application for Private Ruling of the taxpayer dated 1 May 1998 and to the income and fringe benefits tax implications of the taxpayer’s Productivity Incentive Plan which is designed to encourage key employees to remain with the business of the taxpayer and to act as an incentive for employees to become more productive so as to increase the profitability of the business of the taxpayer and which Productivity Incentive Plan of the taxpayer is to operate as outlined in the Application For Private Ruling of the taxpayer dated 1 May 1998.”
144 The issue then arose as to the implementation of the plans. Mr Bell and Mr Clements met with Mr Gray on 16 June 1998 to discuss this matter. On 24 June 1998, Mr Gray wrote to Mr Bell asserting that the professional fees agreed with CDB were $30,000 “to provide Private Rulings and to amend Memorandum and Articles for six Incentive Plans of the company variety”. He said that he had been called upon to go beyond these instructions, and that he was not prepared to do so any further. He undertook to draft the amended memoranda and articles, and to prepare the minutes of the special resolutions necessary to make the amendments, in return for payment of the $30,000. He enclosed a draft minute of a meeting of directors relating to the incentive agreement aspect of the plan, but noted that the range of incentives is “infinitely variable”. The example minute read as follows:
“The Chairman referred to earlier Minutes of today whereby the Company has established a Productivity Incentive Trust Plan which [sic] the objectives of providing an incentive for the employees of the Company who are invited to participate to become more productive in order to ensure the increase in profitability of the Company’s business and in so doing, to provide an additional reward to participating employees in excess of their normal remuneration and to further provide them with an incentive for continuing their employment with the Company.
It was noted that the Company had invited as [sic] its Managing Director (‘employee’) to participate in the Plan.
In his application for ordinary units, the employee has consented to the undernoted performance criteria under qualifying period being prerequisites before the employee is entitled to redeem his units in the Trust.
It was resolved that:
1. The performance criteria that the employee must satisfy during the duration of the qualifying period is as follows:
(a) The generation of at least fifteen (15) referral sources of revenue for the Company which, in the period 1 July 1998 to 31 December 1998 generate gross revenue for the Company in an amount not less than the quantum reflected in sub-paragraph (b) hereof:
(b) From the additional referral providers referred to in sub-paragraph (a) hereof, to generate additional revenue to the Company of not less than $110,000.00 between 1 June 1998 and 31 December 1998.
2. The employee must remain in the employment of the employer for a period of 12 months from the date hereof (‘qualifying period’).”
145 On 23 July 1998, Mr Gray sent CDB a reminder to pay his outstanding fees. He claimed $6,600 for each client, but indicated that he would deduct $600 if payment were made within 7 days. The description of the work covered by the fees was:
“… for professional services rendered herein including: attending you re instructions; drawing and engrossing Application for Private Ruling to the Australian Taxation Office; perusing Australian Taxation Office Private Ruling; drawing and engrossing Memorandum and Articles of Association of Company and Special Resolution as agreed - $6,600.00”
146 On the same day, namely 23 July 1998, Mr Gray sent CDB draft amended articles of association for Coad-64, Glow Zone, London Beach, Alfgor and Henry Court.
147 In a letter dated 24 September 1998, Mr Bell responded with a number of queries. The letter is four pages long and reflects a detailed consideration of the draft articles. A number of drafting alterations were suggested. Also a number of questions of principle were raised. The letter concluded:
“We advise that Glow Zone Investments Pty Ltd is the most urgent as the client has demanded from us that the entire matter be completed no later than 30 September, 1998. However, we are anxious to resolve this long outstanding matter as we need to complete accounts, tax returns, minutes etc.”
148 The letter demonstrates that the draft articles had not been adopted as at 24 September 1998.
149 There was further correspondence and discussion about the outstanding fees until, on 21 October 1998, Mr Gray wrote to Mr Bell saying that as the fees had been outstanding so long he would attend to the finalisation of memoranda and articles only if the fees were paid beforehand. By this time Mr Gray and Mr Bell had agreed that Mr Gray’s fees would be $25,000, being $5,000 for each client.
150 Around the same time, Mr Bell received a call from Lisa – an associate to Mr Petroulias – who said that if the memoranda and articles were not provided to the ATO by the following Friday, 30 October 1998, the plans would be treated as Coadys’ plans and would be subject to audit procedures. In the circumstances, it is open to view the intervention of Mr Petroulias through his staff member, in aid of the collection of fees for providing the plans, as reflecting, in part, a self-interest in the obtaining of the funds.
151 There was an immediate response. Mr Clements spoke to Mr Gray. Mr Clement’s file note records:
“In relation to the amendment of the Memorandum and Articles, etc. he indicated that he is very busy at this stage and was unlikely to be able to finish it by next Friday. He further advised that he does not have any problems with contacting the Tax Office to seek an extension of time.”
152 Under pressure from Mr Gray, CDB agreed that the fees would be paid into Mr Gray’s trust account and released upon completion of the documentation.
153 On 26 October 1998, Mr Gray issued amended memoranda of fees seeking $5,000 from each of the five CDB clients. On 27 October 1998, Mr Bell sent a facsimile to Mr Gray requesting him to complete the memorandum and articles for A&G, Farmer Cortese and Fraser Jenkinson and attaching copy cheques for each. On 28 October 1998, Mr Gray advised Mr Clements and Mr Bell that the documentation had been completed and would be available on receipt of the agreed $25,000. On the same day, five cheques for $5,000 each were sent to Mr Gray. The next day, the memoranda and articles were sent by Mr Gray to CDB by courier.
154 On 29 October 1998, each of the related companies adopted the amended memoranda and articles by special resolution at an extraordinary general meeting, and the memoranda and articles were submitted to the ATO.
155 The rules of the PIP referred to in Annexure A of the articles of each of the related companies provided, in part, as follows:
“(i) In every income period, the employer may subscribe for the issue of further employer shares of a particular class referable to each employee who holds shares in the company, to be issued at their par value. Each annual further subscription shall entitle the employer to set incentive targets pursuant to Rule (iii).
(ii) Upon the employer making each subscription to share capital referred to in Rule (i), the employer shall be issued with one (1) further employer share in respect of each employee who holds employee shares in the company.
(iii) In every income period, the employer shall (in addition to the subscription for employer shares described in Rule (i), make a further, irrevocable subscription to the company which subscription shall form part of the par value of each employer share, of such sum as recommended to the employer by an independent professional consultant which sum shall be deemed to form part of the purchase price paid by the employer to the company in respect of the issue by the company to the employee of the employer share referred to in Rule (i) (‘further employer share subscriptions’). The further employer share subscription forms part of the company’s capital for the purpose of encouraging increased productivity and long term loyalty in staff and does not form part of any entitlement which the company may from time to time provide to any employee by way of remuneration.
(iv) Upon the issue of the further employer shares referred to in Rule (ii), the employer shall contemporaneously instruct the company in writing by setting incentive targets (‘targets’) in respect of any employee or group of employees who each hold employee shares in the company. The incentive or productivity targets set by the employer will be lawful, capable of performance, and set for the sole purpose of enabling the employer to become more productive and increase its profitability. The incentive or productivity targets so set by the employer may include a requirement that a relevant employee or employees serve a minimum period of employment with the employer (‘retention period’). The company shall record instructions received from the employer in the form of director’s minutes acknowledging receipt and recording steps taken by the company to meet the targets set by the employer.
(v) Subject to any other condition or contingency which may attach to the holder of an employee share, the said holder may redeem the employee shares held in consideration of payment by the company of the employee redemption amount, if the manager pursuant to Rule (viii) hereof certifies that the employee has achieved the targets and if applicable, the retention period. Any certification from the manager and subsequent redemption shall be recorded in minutes of the directors of the company.”
156 The following terms, used in the rules, were defined in article 1.1.1 as follows:
“‘incentive target’ :- a target, threshold or achievement set by the employer (proof of which shall be evidenced by written memorandum signed by both the employer and manager), which the manager is reasonably expected by way of supervision to be capable of ensuring is met by the company’s employees;
‘income period’ :- means the financial year commencing on the 1st day of July and concluding on the 30th day of June in every year or, in the event that the employer has adopted a substituted reporting period in accordance with the Tax Act, shall mean that substituted period of not less than 12 calendar months in duration;
‘manager’ :- excluding an employer or employee, means the holder of manager shares;”
157 Rule (vii) defines the role of the holder of manager shares as follows:
“The holder of manager shares in the company shall be responsible for:
- the supervision of employees of the company in ensuring that they meet the targets and if appropriate, the retention period;
- investment of any amount representing the employee investment comprising the employee redemption amount;
- certifying its assessment of the achievement of the targets and/or compliance with any retention period;
- certifying the employee’s entitlement to the employee redemption amount and in the absence of the targets being achieved, any residuary redemption amount that arises as a consequence of Article 4.7;
- ensuring that employee and residuary shares are not redeemed until such time as the targets have been achieved, including any retention period that may be applicable;
- ensuring that all income by way of employee dividend entitlements and residuary dividend entitlements is distributed to the holders of employee or residuary shares, as the case may be; and
- in the case of the targets not being met, certifying to the company that rights and entitlement arise in respect of the holders of residuary shares and defining those rights in accordance with the company’s Articles.”
158 On 30 October 1998, Mr Gray sent CDB a copy of an explanatory memorandum dealing with the mechanics of the PIP. His accompanying letter stated:
“In light of draft Taxation Ruling TR98/D12, the copy of Explanatory Memorandum enclosed is provided subject to the express disclaimer that we are no longer in a position to make any recommendations as to the use of Productivity Incentive Plans or Employee Incentive or Benefit Trusts having regard to the content of the draft Ruling.”
159 The draft ruling TR98/D12 was published on 29 October 1998. It indicated that the ATO considered that employee benefit arrangements essentially similar to the PIP were subject to FBT. On 19 May 1999, a final ruling to the same effect was issued by the ATO.
160 In March 1999, each of Radioactive, A&G, and Fraser Jenkinson lodged tax returns claiming deductions for contributions under the PIP.
161 On 24 May 1999, the ATO wrote to Fraser Jenkinson (and presumably to A&G and Radioactive) and indicated that the Commissioner took the view that the employee benefit scheme operated by Fraser Jenkinson was not effective. The ATO gave the company the option to amend its tax return and to pay a fixed penalty. If this option were not accepted, the ATO indicated that it would raise additional assessments, including for FBT.
Conclusion concerning Mr Petroulias and the Promoters
162 On the basis of the evidence discussed, and on the basis of inferences open to be drawn from this evidence, I summarise my major conclusions as follows.
163 Mr Petroulias had effective control of ATO policy concerning the tax effectiveness of employee share benefit schemes. Using his position in the ATO he cast doubt on the effectiveness of existing schemes. He, together with others, formulated alternative schemes to achieve the same result. In this activity he enlisted the help of, at least, Mr Gray.
164 In order to promote and sell the alternative schemes he needed access to clients. For this purpose he agreed with Mr Strong (through PIA) and Mr Panos (both of Coleman & Greig, solicitors), Mr Morgan (through Morgan HR), Mr Gray, and Mr McLaren to market the alternative schemes. Mr Petroulias actively participated in and encouraged the efforts of these promoters by addressing seminars arranged by them and attending meetings with their clients. Mr Petroulias and the promoters represented Mr Petroulias as the official spokesman for the ATO. This was itself a strong marketing tool in the sale of the alternative schemes. However, the critical attraction to CDB was the promise of a private binding ruling from the ATO in favour of the alternative scheme.
165 As explained in the next section of these reasons under the heading ‘Conclusion concerning the position of CDB’, when the private rulings were sought and obtained, Mr Petroulias and Mr Gray knew that the clients had not established genuine employee benefit plans, and knew that the employee benefit schemes were purportedly entered into for the dominant purpose of avoiding tax. The purpose of Mr Petroulias providing, and Mr Gray obtaining, the private rulings was to protect the taxpayers from any future challenges to the arrangements. The rulings were to deflect any interest of the ATO away from the particular taxpayers. The private rulings were to provide an official cloak of authenticity.
166 Mr Petroulias procured the necessary rulings from subordinates working for him at the ATO by the use of his position.
167 Mr Petroulias also arranged for Mr Morgan to obtain a list held by the ATO of all taxpayers using the pre-existing schemes. The purpose of making this list available to Mr Morgan was to identify for him those persons likely to be interested in purchasing the alternative schemes.
168 Mr Petroulias was to be paid by the promoters for his role in formulating and promoting the alternative scheme, and ensuring that the promised rulings would be provided. Such payment was to be made surreptitiously through PIC, a company incorporated in the British Virgin Islands, using a bank account opened in Hong Kong.
169 Mr Petroulias and the promoters knew that they were engaged in unlawful activity, and attempted to protect themselves from detection by the use of a code for communication among themselves.
170 There is a prima facie case that Mr Petroulias engaged in the unlawful conduct alleged in the charges under ss 29D, 30, 70, and 73(2) of the Crimes Act. There is also prima facie evidence that Mr Gray knew that Mr Petroulias was engaged in that conduct, and participated with him in some of that conduct.
171 Although the evidence satisfies me that there is a prima facie case of criminal conduct by Mr Petroulias and Mr Gray, the cases, and Propend in particular, probably do not require proof to that degree. Unlike some of the cases discussed earlier in these reasons, this is not a case in which there is a bare allegation of fraud. The evidence is extensive. There is at least prima facie evidence that the allegations of unlawful conduct have a foundation in fact. The evidence gives “colour to the charge”: see O’Rourke per Viscount Finlay at 604.
Conclusion concerning the position of CDB
172 CDB was concerned at the end of 1997 that its clients who had entered Coadys’ schemes might not achieve the benefits they intended. CDB was attracted to the PIP because it was endorsed by Mr Petroulias on behalf of the ATO, and particularly because its tax effectiveness was “guaranteed” by a private binding ruling in respect of each taxpayer.
173 I am not persuaded that there is prima facie evidence that CDB knew, or should have known, that Mr Petroulias was acting unlawfully in promoting and receiving payment for his role in marketing these schemes and procuring private binding rulings. Although it should have seemed unusual to CDB for Mr Petroulias to attend the seminar and, as a senior officer of the ATO, to take such an active role in organising the making of the rulings, these factors were not sufficient to alert CDB to the particular unlawful activity of Mr Petroulias and the promoters.
174 On the other hand, there is prima facie evidence that CDB knew that its clients’ entry into the PIP was a sham, and that the dominant reason for their purporting to adopt the scheme was to achieve a tax benefit, as opposed to providing productivity incentives to employees. There is at least prima facie evidence that these allegations have a foundation in fact. The evidence gives “colour to the charge”: see O’Rourke per Viscount Finlay at 604.
175 Further, for the reasons about to be explained, Mr Petroulias and Mr Gray were parties to this conduct. They knew that the purported implementation of the PIP by the clients of CDB was a sham, and was attempted for the dominant purpose of avoiding tax. There was a direct link between the illegal and improper conduct of CDB, its clients, and Mr Gray and Mr Petroulias.
176 It is accepted by the parties, correctly, that the knowledge of CDB is to be taken to be the knowledge of the clients. Not only does this conclusion flow as a matter of law from the fact that CDB was the agent of the clients, but the directors of CDB were directors of each of the related companies formed to participate in the PIP.
177 The position taken by CDB in this proceeding was that Mr Bell, Ms Dunne and Mr Clements were not experts in employee benefit schemes. They engaged Mr Gray because he was an expert. Consequently, CDB argued, it relied on him to establish and implement the scheme, and it relied on his assurance that it was legitimate and effective. Thus, CDB contended that it and its clients were innocent of any alleged illegal or improper conduct.
178 The evidence does not support this conclusion. There is prima facie evidence that CDB knew that the participation by A&G, Fraser Jenkinson, and Radioactive in the PIP was a sham, and had the dominant purpose of obtaining a tax benefit.
179 The evidence shows that Mr Bell and Mr Clements were both careful and thorough accountants. Mr Bell dealt with Mr Gray initially. Mr Bell quizzed Mr Gray on a number of occasions about how the scheme would work. He also spoke to Mr Petroulias about the effectiveness of the scheme. He was alert to, and raised, some of the potential problems with the scheme. For instance, he noticed that the private rulings were to be issued for three years and questioned whether the law allowed private rulings to operate in respect of more than one year. He was concerned to learn of the detail of the operation of the scheme despite Mr Gray’s reluctance to provide such detail. He retained a close interest and function in submitting the application for a private ruling.
180 After the private ruling concerning Farmer Cortese was issued, Mr Clements began his involvement with Mr Gray, in connection with his clients A&G and Fraser Jenkinson. Although he drew on Mr Bell’s experience arising from the Farmer Cortese ruling, he adopted an independent and questioning position concerning the legitimacy of the scheme and the method of implementation. This is particularly evident in his file note dated 5 May 1998 and in his fax dated 6 May 1998 referred to in pars 137 and 139 respectively of these reasons. Importantly, the main issue reflected in those documents was how to demonstrate that there was an agreement for the provision of an incentive to the employees in the absence of any documentary evidence of such an agreement, and, as I find, in the absence of any actual incentive agreement with the relevant employees.
181 Thus, CDB exercised an active and independent role involving careful scrutiny of the workings of the scheme and its implementation. In the exercise of this function, Mr Clements was uncomfortable with the failure of Mr Gray to disclose to the ATO all documents he considered relevant to the application for a private ruling. This appears from several passages in his evidence as follows:
“MR CRENNAN: Is he [Mr Gray] not saying that there is – it’s not just not necessary to provide full details, it is dangerous to provide full details? --- Again, I was relying on his advice
HIS HONOUR: But you raised a problem with him, did you? --- Yes.
…
HIS HONOUR: Yes. Did that satisfy you, or did you come away with some feeling of lack of ease? --- I wasn’t as comfortable as what I would have been, had everything been provided.
…
MR CRENNAN: All right. There wasn’t full disclosure, in your opinion, was there? --- No.
…
MR CRENNAN: Did the secretiveness of Mr Gray, going back to your notes of 5 May, did that cause you any concern – that is, his wish to conceal things from the Australian Taxation Office? --- Yes, it did cause me some concern at the time.”
182 There is prima facie evidence that CDB did not believe Mr Gray’s assertion that the PIP was lawful, but went along with it uncertain of its legitimacy. CDB was induced to arrange for its clients to enter into the schemes because CDB was persuaded by Mr Gray that the clients could “get away with it” – in other words, the ATO would accept the scheme. But this was against CDB’s own doubts concerning the legality of the arrangement.
183 Again, in relation to the working of the scheme, I find that, prima facie, CDB did not rely upon Mr Gray to advise that the scheme was legitimate. Rather, CDB did not understand how the scheme differed from the Coadys’ scheme, but was prepared to proceed because CDB believed that the ATO would accept it. The lack of understanding of the difference between the two schemes appears from the following cross-examination of Mr Clements:
“MR CRENNAN: The question really is why you understood the new scheme would operate when the old one was brought into question by the ATO. That’s the question? --- We didn’t understand it at the time, and I think Ray makes mention of that.
MR CRENNAN: Do you understand it now? --- Well, not completely, no.”
184 But, in my view, the most significant indication that CDB knew that the participation by A&G, Fraser Jenkinson, and Radioactive was a sham related to the implementation of the scheme.
185 The central concept of the scheme was that the employer would provide a benefit to an employee as an incentive to the employee to attain a specified goal or target. The financial incentive to the employee was dependant upon reaching the goal. As the goal was so pivotal to the scheme, the rules of the scheme required that the goal be specified in writing by the employer in the financial year concerned. The relevant rules are set out in par 155 of these reasons. The incentive payment was funded by the employer through the purchase of employer shares in the related company and the subscription of capital approximating the amount of the incentive payment to be made.
186 How then was the scheme implemented in relation to A&G, Fraser Jenkinson, and Radioactive?
187 Two matters warrant particular attention – the payment of contributions under the schemes, and the setting of incentive targets under the schemes.
188 Payments which were said to be “contributions” to the scheme were made by the employer companies to the related scheme companies on 30 June 1997 in respect of the 1996/97 financial year, and in May or June 1998 in respect of the 1997/98 financial year.
189 When the purported contributions were made in both 1997 and 1998, the scheme had not been adopted by the companies. This only occurred in October 1998, when the special resolutions were passed amending the articles of the related companies.
190 Consequently, as a matter of fact, it cannot be said that the contributions, when made, were contributions to the PIP. The scheme did not exist at that time. Thus, it is not surprising that the payments did not take the form of a purchase of employer shares. Had the contributions been made under the rules of the scheme they would have reflected a purchase of employer shares.
191 When the scheme was adopted in October 1998 it was too late for the employer companies to stipulate the targets to be reached by the employees in the 1996/97 and 1997/98 financial years. The scheme rules required that the targets be set in writing by the end of the particular financial year.
192 Whether targets were ever set was taken up in the cross-examination of Mr Clements. Although the issue is not relevant to whether the scheme was implemented in accordance with the rules of the scheme, Mr Clements’ evidence is revealing on the question whether the schemes were genuinely adopted by his clients at all.
193 No documents were produced which showed that the targets were set. Mr Clements said he believed there may have been resolutions on the question. His evidence on this matter was evasive. At the highest his evidence was merely speculative. Tax returns for the employer companies for 1997/98 were filed in about March 1999. I am satisfied that, prima facie, at the time when the returns were filed, the employer companies had not established the targets required to be set by the rules of the scheme.
194 Counsel for CDB contended that no adverse conclusion can be drawn from the fact that the articles were only adopted in October 1998, that is, after the date stipulated for the setting of targets for 1996/97 and 1997/98, because CDB acted on the view expressed in the private rulings made on 5 June 1998 in which the ATO accepted the retrospective effect of the amendments. There are a number of difficulties with this attempted explanation.
195 First, the private rulings did not say that the articles could be effectively amended retrospectively. Rather, the rulings recorded that the views expressed in them were based on the assumption that the articles were amended retrospectively. This was an assumption which CDB’s clients asked the ATO to accept for the purpose of making the rulings.
196 Second, the resolutions effecting the amendments did not purport to operate retrospectively. Absent some specific provision, an amendment operates from the date of the making of the special resolution (s 137 Corporations Law). The draft minutes of the extraordinary general meeting of Glow Zone, which I take by way of example, record the text of the special resolution as follows:
“1. The Company’s existing Articles of Association be deleted in their entirety; and
2. The amending Articles of Association be substituted as from the date of this meeting to thenceforth be the Company’s Articles of Association.” (emphasis added)
I infer that the special resolution was passed in the form of this draft. It is noteworthy that the chairperson of the meeting is recorded as being Mr Clements.
197 Third, even if the amendment had operated retrospectively, implementation of the scheme required the facts upon which the articles would operate. Thus, the amendment, arguably, could have provided that a target set prior to the making of the amendment be taken as the target for employees under the scheme then adopted by the articles. But no targets had been set, and hence, no basis existed for any retrospective operation of the amendments.
198 The way in which Mr Petroulias, Mr Gray and Mr Bell dealt with the question of retrospective amendment of the articles throws light on the nature of the transaction. From the outset, CDB was insistent that the new scheme operate for the 1996/97 financial year. Mr Bell only made contact with Mr Gray in November 1997; that is, after the end of the 1996/97 financial year. The retrospective amendment of the articles was meant to allow CDB to say that the scheme operated in 1996/97. The intention was revealingly expressed by Mr Petroulias in a discussion with Mr Bell, in the circumstances set out in par 105 of these reasons. Mr Petroulias suggested that Mr Bell should put forward a proposal to the ATO to “pretend the old ones [Coadys’ schemes] did not exist and roll over into the new as though it was the original … intention from the start”. Consistent with this discussion, the retrospective operation of the scheme was a pretence, and was recognised by Mr Petroulias and Mr Gray to be such. In all the circumstances, there is no reason to believe that Mr Bell did not also recognise this fact.
199 The retrospective operation of the articles had nothing to say about the setting of the required targets. That was a separate issue. It was an issue apparently overlooked in the design of the pretence. Although there was a pretend scheme, there was no pretend incentive. That omission points strongly to the purported transaction being a sham.
200 Some further insight into the position of CDB can be gained from the way it dealt with Mr Gray on the issue of seeking to set targets for the employees. If the incentive arrangement was genuine, one would have expected that the employer company, rather than its solicitor, would have set the targets to be reached by its employees. The knowledge and information about the business relevant to setting the incentive targets was available to the clients far more readily than to Mr Gray. The nature and level of the targets depended on the practical circumstances of the business operations, and on judgments to be made by those operating the business. Yet CDB, on behalf of its employer clients, relied on Mr Gray to formulate the nature of the incentives to be paid to the employees.
201 For instance, it appears that Mr Petroulias raised the problem of the particulars of the incentive arrangements in the context of the Farmer Cortese application for a private ruling. Mr Bell sent Mr Gray a fax, the content of which is set out in par 125 of these reasons, which described the contributions already made as “bonus type payments” and then went on to say:
“You may need to provide us with some guidance on this aspect to be included in the Application for Private Ruling.”
202 In response, Mr Gray formulated an answer which was sent by Mr Bell to Mr Petroulias on 25 February 1998. That response is set out in par 126 of these reasons. Paragraph 2 of the response refers to a binding obligation between the employer and employees which was made in or about January 1997. In Mr Bell’s report of his conversation with Mr Petroulias, set out in full in par 125 of these reasons, Mr Petroulias is recorded as suggesting this very date as being acceptable to the ATO, as follows:
“He [Petroulias] requested copies of correspondence and minutes which evidence that the remuneration to be paid is binding and the date of this understanding. For example, he quoted the ideal situation as ‘say date is 1/1/97 – We agree to compensate you in this way …’. That is, there is a binding obligation.”
203 Furthermore, on 5 May 1998, Mr Clements made a file note concerning a discussion with Mr Gray over the draft ruling in relation to Glow Zone. Paragraph 2 of the file note, which is set out in par 137 of these reasons, again shows that Mr Clements relied upon Mr Gray to formulate the evidence of an incentive agreement as follows:
“Refer 5(b) of Ruling appln – this refers to a formal agreement.
Gray was to provide this agreement, and other relevant documentation, etc.”
204 Mr Gray’s role is further confirmed in a fax, which is set out in par 139 of these reasons, from Mr Clements to Mr Gray on 6 May 1998. In that fax, Mr Clements recorded that, in relation to providing an explanation of the incentive agreement to the ATO, Mr Gray had said “that’s what you have got me for”. After receipt of the private ruling in relation to Farmer Cortese, Mr Bell sent Mr Gray a fax which is set out in par 141 of these reasons, which included the request to Mr Gray to:
“advise as to the manner in which the incentive arrangement for the year ended 30 June, 1998 is to be established.”
205 Finally, as part of the resolution of the dispute over payment to Mr Gray, Mr Gray provided a sample incentive arrangement, which is set out in par 144 of these reasons, which might be used by the clients.
206 Further, the differential between the contributions paid and the salary paid to the employees of the clients is consistent with an entirely unreal transaction. For instance, the Managing Director of Fraser Jenkinson, Mr Leo Moio, received a salary of $22,400 and an employee share plan contribution of $90,000. Then, again to justify the employee share plan contribution for Mr David Miller, who was employed by Glow Zone, a remuneration consultant advised that the appropriate salary was $212,530, whereas Mr Miller was in fact paid $89,000. I do not accept that the level of the base salary and the differential between it and the total remuneration in all the circumstances, prima facie, represents a real transaction. Mr Clements was asked to explain the practical business circumstances relating to each of his clients which were relevant to the setting of the incentive payments. His evidence was not persuasive on this issue. The totality of his evidence leads me to conclude that there was no attempt at analysis by Mr Clements and his clients of strategies to provide incentives to employees for the purpose of the PIP, either before or after CDB received the draft articles.
207 Finally, the nature of the three employer companies made them unlikely participants in a genuine incentive scheme. In each case, the employer made contributions on behalf of employees who were also the owners or controllers of the companies either as directors, or shareholders, or the family of directors or shareholders. At least in the case of Mr Clements’ clients - A&G and Fraser Jenkinson - the employer companies did have arm’s length employees who could have participated in such a scheme, but, in each case, those employees were not included. Rather, it was the non-arm’s length employees who were included in the scheme. In all the circumstances, I do not accept Mr Clements’ evidence that it was intended to extend the schemes to arm’s length employees in later years. There is no persuasive reason why that could not have been done immediately if the reason for establishing the schemes was to provide incentives to employees. Further, by the 1998 financial year, the PIP was, as far as the ATO was concerned, in its second year of operation, and no arm’s length employees had been added to the PIP.
the legal consequences
208 Against the legal framework outlined earlier in these reasons, and the factual conclusions set out in the previous section, what consequences follow in respect of the claim for client legal privilege? It is convenient to examine this issue by reference separately to the effect of the improper and illegal conduct of the clients through CDB, their solicitor Mr Gray, and Mr Petroulias and the other promoters.
The effect of the clients’ conduct
209 The documents passing between Mr Gray and CDB which have been seized under the warrants were brought into existence in furtherance of a prima facie wrongful claim for tax deductions on behalf of the clients. The claims involved a number of illegal or improper actions.
210 The evidence establishes that the clients lodged tax returns claiming deductions on the basis that they had implemented the employer benefit schemes. I infer that the clients made declarations when lodging the tax returns to the effect that the statements in the returns were truthful. In respect of the claims for deductions for contributions to the employee benefit schemes, the declarations were not truthful. Prima facie, the declarations were known to be false. At the relevant time, knowingly making a false declaration was an offence under s 8P of the Tax Administration Act 1953 (Cth) (TAA). The maximum penalty for a first offence is a fine of $3,000 and for a second or subsequent offence is a fine of $5,000 or imprisonment for 12 months or both.
211 Further, prima facie, in purporting to enter into the schemes the clients had the dominant purpose of obtaining a tax benefit rather than the purpose, as asserted, of providing incentives to employees. Part IVA of the ITAA 1936 contains general anti-avoidance measures in relation to tax. In essence, it allows the Commissioner of Taxation to ignore the target transactions and to impose tax as if the transactions had not occurred. For the purpose of this proceeding, I am satisfied, on a prima facie basis, that the clients’ conduct in purporting to enter into employee benefit schemes falls within Part IVA.
212 The applicant argued that Part IVA established an administrative mechanism designed to protect revenue, but that it did not render illegal schemes which fell within it. Section 177F gave the Commissioner a discretion to cancel a tax benefit gained as the result of entering a scheme. Counsel for CDB emphasised the fact that the cancellation of the tax benefit was not automatic, but depended on the exercise of discretion by the Commissioner. Whilst this is so, the complete picture must take account of s 226 of the ITAA 1936 which provided that, where the Commissioner cancelled a tax benefit, there was an automatic statutory penalty of up to 50% of the amount of tax payable as a result of the cancellation of the benefit. There is, therefore, a clear punitive aspect to the regime. In my view, the fact that the provisions of Part IVA are applicable to the scheme renders the clients’ actions improper in the sense required for the application of the doctrine which limits the reach of client legal privilege.
213 Finally, there is prima facie evidence that the actions of the clients, through CDB, were illegal in the ordinary sense namely, that they constituted a criminal offence. Their actions, prima facie, constituted a breach of s 29D Crimes Act 1914 (Cth), which made it an offence to defraud the Commonwealth. It was a fraud on the Commonwealth to pretend that they had entered into transactions when they had not, and in particular, when those purported transactions permitted them to avoid tax which would otherwise have been payable.
The effect of the solicitor’s conduct
214 Where a client is engaged in fraudulent conduct, communications with their solicitor in furtherance of the fraud are not privileged, and that is so, whether the solicitor is party to the fraud or not.
215 But, in this case, CDB claimed that it and its clients were innocent of any fraud, even if Mr Gray was party to the fraud of Mr Petroulias and the other promoters.
216 If, contrary to my findings, CDB and the clients were not party to the underlying fraudulent avoidance of tax, but the sale of the schemes to them by Mr Gray was the implementation by him of the illegal plan organised by Mr Petroulias and the other promoters, are the documents privileged? I have found no case which considers the situation where there was no fraudulent conduct directly affecting the solicitor client relationship. However, the issue is no different in principle to the issue raised in the two cases considered in the next section, which dealt with the effect of fraud of third parties on the existence of client legal privilege. I now turn to consider that question.
The effect of the conduct of Mr Petroulias and the other promoters
217 In R v Central Criminal Court, Ex parte Francis & Francis [1989] 1 AC 346 the House of Lords considered whether documents held by a solicitor were subject to legal professional privilege. Mrs G purchased a property and engaged solicitors to act for her in that transaction. The Drug Squad of the Metropolitan Police believed that the property was purchased with funds given to Mrs G by a relative who had acquired the funds from drug trafficking. The police applied for an order to obtain access to the solicitor’s file. It was accepted that Mrs G was innocent of any complicity in illegal conduct, and that the solicitors acted with complete propriety in the transaction. The statute under which the police acted did not permit access to items subject to legal privilege. But, s 10(2) of the Police and Criminal Evidence Act 1984 (UK) provided that:
“Items held with the intention of furthering a criminal purpose are not items subject to legal privilege.”
218 The majority of their Lordships determined that, on the proper construction of s 10(2), the intention referred to was not restricted to the intention of the holder of the document, but extended, if the holder was a solicitor, to the client or even a third person. Lord Goff (with whom Lord Griffiths agreed at 385), addressed the question of the fraud of a third person at 395-7 as follows:
“There remains however a further question. Does the exception in subsection (2) apply (in the case of items in the possession of a solicitor) where the intention of furthering a criminal purpose is not the intention of the client, but is the intention of a person who is using the client as an innocent tool for the purpose of effecting his intention?
That the words of the subsection are wide enough to embrace such an intention, I have no doubt. But once again a literal reading cannot provide, of itself, a satisfactory answer. It is necessary to consider the words in their context, including in that context not only the remainder of the section but also the evident legislative purpose.
As I have already indicated, it appears to me, having regard to the contents of subsection (1), and the construction which I have considered must be placed upon subsection (2), that the intention of the legislature was to encapsulate in section 10 the common law principle relating to what used to be called legal professional privilege. It is appropriate therefore to turn to the common law for guidance. Unfortunately, however, there is no authority directly in point; for, so far as the researches of counsel have revealed, the point has never before arisen for legal decision. It follows that it is necessary to consider the point as a matter of first impression.
The crucial question is whether the third party’s criminal intention should have the effect of excluding the privilege of the client whom the third party is using as an innocent tool. The Divisional Court answered this question in the affirmative. Lloyd L.J. said ante, p. 355E-G:
‘I feel great hesitation about this. But I am fortified by Mr. Newman’s concession that “a criminal purpose” in section 10(2) must mean “any criminal purpose”. If so, then the logic of the argument which I have accepted so far, leads to the conclusion that the criminal purpose may be the purpose of a third party as well as the client, at any rate if the client is the innocent instrument or beneficiary of the third party’s criminal purpose. That is indeed the position in the present case on the facts alleged by the police.’
In considering this question, it is necessary to inquire what is the rationale of this exception to legal professional privilege at common law. This is to be discovered from Reg. v. Cox and Railton, 14 Q.B.D. 153 itself. In that case, the judgment of the Court for Crown Cases Reserved (Grove J., Pollock and Huddleston BB., Lopes, Hawkins, Stephen, Watkin Williams, Mathew, Day, and Smith JJ.) was delivered by Stephen J. He referred, at p. 167, to the judgment of Lord Brougham in Greenough v. Gaskell (1833) 1 My. & K. 98, 103, in which he stated the foundation of the rule of legal professional privilege to be as follows:
‘It is out of regard to the interests of justice, which cannot be upholden, and the administration of justice, which cannot go on without the aid of men skilled in jurisprudence, in the practice of the courts, and in those matters affecting rights and obligations which form the subject of all judicial proceedings.’
Stephen J. then continued:
‘This rule has been accepted and acted upon ever since, and we fully recognise its authority, but we think that the present case does not fall either under the reason on which it rests, or within the terms in which it is expressed. The reason on which the rule is said to rest cannot include the case of communications, criminal in themselves, or intended to further any criminal purpose, for the protection of such communications cannot possibly be otherwise than injurious to the interests of justice, and to those of the administration of justice. Nor do such communications fall within the terms of the rule. A communication in furtherance of a criminal purpose does not “come into the ordinary scope of professional employment.”’
Now, when I have regard both to the purpose which has long been understood to underline the principle of legal professional privilege, and to the reason why communications passing between a client with a criminal purpose and a solicitor who is innocent of any such purpose are held not to be protected by such privilege, it appears to me to be immaterial to that exception whether it is the client himself, or a third party who is using the client as his innocent tool, who has the criminal intention. In either case, to adopt the words of Stephen J., the communications are intended to further a criminal purpose; in either case, the protection of such communications cannot be otherwise than injurious to the interests of justice; and in either case, the communications are in furtherance of a criminal purpose, and so cannot come within the ordinary scope of professional employment. Accordingly, unless there is some authority, or compelling reason, leading to an opposite conclusion, I would hold that the criminal intention of the third party will, in the circumstances under consideration, exclude the application of the principle of legal professional privilege at common law, even though the privilege, if it attached, would be the privilege of the client and not the third party.
I have already stated that, so far as I am aware, there is no authority which points to the opposite conclusion. Is there any compelling reason which does so? The only reason suggested in the course of argument was that the client (as opposed to the third party) might be making the relevant communications to his solicitor in circumstances in which he was entitled to assume that the matter was protected by privilege, and in which he therefore felt able to communicate with his solicitor freely and without fear that his communications might thereafter be disclosed without his consent. To that objection there are, I consider, a number of answers. The first is that his privilege will only be excluded in so far as it relates to communications (or items enclosed with such communications, or to which reference is made in them) made with the third party’s intention of furthering a criminal purpose. No other communication will be excluded from the application of the privilege; and the client’s confidence will to that extent be protected. Second, the client is ex hypothesi innocent of the criminal purpose; disclosure of the circumstances will not in that respect be to his disadvantage. Third, the type of case under consideration must surely be most exceptional. Fourth, and most important of all, it seems to me that the disclosure of the third party’s iniquity must, in the interest of justice, prevail over the privilege of the client, innocent though he may be.
Such being the principle at common law, I can see no reason why section 10(2) of the Act of 1984 should not be construed to the same effect.”
219 In Capar v Commissioner of Police (1994) 34 NSWLR 715, the applicant sought a declaration that documents in the possession of the Legal Aid Commission were subject to legal professional privilege. The applicant was charged with murder. Two of his children provided statements to the police which implicated the accused. Shortly afterwards, another of the applicant’s children, named Canan, procured the two children who had made initial statements to make further statements exculpating the applicant. These later statements were left in a mail box of the Legal Aid Commission. The police applied for the issue of a search warrant to obtain the later statements from the Legal Aid Commission to assist their investigation of an attempt by Canan to pervert the course of justice. Donovan A-J concluded that the statements did not fall within the Grant v Downs test current at the time, and hence, the documents were not privileged. He then considered whether, if the documents were otherwise privileged, such privilege did not apply because the statements were part of an illegal enterprise. He found that there was prima facie evidence of illegality. He then said at 722:
“Mr Molomby, for the plaintiff, has argued in response that all the cases of illegality which have been put forward are cases which taint the client, in that in some way or another the client is involved in the fraud or illegality. He argues that the present case is no such situation, the plaintiff is not tainted by the illegal acts of Canan. It seems to me that it may be, and I put it no higher, that Canan, in attempting to assist his father by obtaining the allegedly false statements, does, for the purposes of the present situation, sufficiently taint the client. I do not need to decide that issue. Rather, it seems to me that although there are no authorities where illegality has been held to arise where the illegality was that of a third party rather than that of the client or the solicitor, nevertheless the principle of illegality still applies.
The above reason why illegality may not apply in the present case was solely because the third party, Canan, in obtaining the statement, had done so unilaterally without creating any relationship between himself and the solicitor or the client at the time when he procured the statements. It would follow, in my view, that if he acted independently and unilaterally, thereby not tainting the plaintiff with the illegality, then the communication would not be one which falls within the true third party legal professional privilege. If, on the other hand, he had acted within the category of legal professional privilege, then the illegality would sufficiently taint the whole relationship for the illegality to be a basis for the removal of the privilege.”
Although decided some five years after Francis, this case is not mentioned in the judgment of Donovan A-J. Even so, his Honour does not seem to express any doubt about the existence of the third party illegality exception to legal professional privilege.
220 I agree with the analysis made by Lord Goff in Francis that the rationale for legal client privilege rests on the public interest, and that the public interest is best served in extending the limitation on the reach of client legal privilege to cover cases of fraud by third parties. This would, if necessary, provide a further reason why the documents in the present case do not attract client legal privilege. Those documents form part of the implementation of the fraudulent conduct of Mr Petroulias and Mr Gray.
Conclusion
221 For the reasons given, the application must be dismissed. In these circumstances, it is not necessary to consider whether the privilege was lost as a result of waiver, which would have been determined, if necessary, in the final stage of the consideration of the application.
222 In the ordinary way, the costs of the proceeding should follow the event. Arrangements should be made with my Associate for the return of the documents which are the subject of the proceedings.
| I certify that the preceding two hundred and twenty-two (222) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice North. |
Associate:
Dated: 20 December 2001
| Counsel for the Applicant: | Mr Dreyfus QC with Mr Herskope |
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| Solicitor for the Applicant: | Rigby Cooke |
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| Counsel for the Respondent: | Mr Crennan SC with Mr Ginnane |
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| Solicitor for the Respondent: | Australian Government Solicitor |
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| Date of Hearing: | 4, 5, and 6 June 2001 |
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| Date of Judgment: | 20 December 2001 |
