FEDERAL COURT OF AUSTRALIA

Pre Paid Professional Administration Ltd v Deputy Commissioner of Taxation [2008] FCA 1580

TAXATION – United States corporation carried on business of selling warrants which entitled bearer to pre-paid professional service – taxpayer acted as agent of US corporation and also provided administration services to “Business Agents” who retailed such warrants – taxpayer collected monies from Business Agents and on-forwarded same to US corporation – taxpayer entitled to fees from Business Agents – whether amounts received from Business Agents constituted ordinary income of taxpayer

Income Tax Assessment Act 1997 (Cth) s 6-5

PRE PAID PROFESSIONAL ADMINISTRATION LTD v DEPUTY COMMISSIONER OF TAXATION

VID 193 of 2008

HEEREY J

23 OCTOBER 2008

MELBOURNE

THE COURT ORDERS THAT:

1.                  The application be dismissed with costs, including reserved costs and the costs thrown away by reason of the adjournment on 1 October 2008.

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

REASONS FOR JUDGMENT

1                     The applicant taxpayer, a New Zealand corporation, is a wholly owned subsidiary of a United States corporation called Pre-Paid Professionals LLC (PPP).  The taxpayer is a resident in Australia for the purposes of s 6-5 of the Income Tax Assessment Act 1997 (Cth).

2                     In the 2005 and 2006 tax years the taxpayer received the respective amounts of $4,728,917 and $634,500.  The monies were paid into a bank account in Australia in the taxpayer’s name.  The respondent Commissioner has assessed these amounts as ordinary income within the meaning of s 6-5(2) on the basis that they were administration fees to which the taxpayer was entitled as “Administrator” under a business scheme relating to “service warrants”.  The taxpayer, however, says that it received these amounts in its capacity as an agent, as first as an agent for the persons paying the monies and then as an agent for PPP.

The service warrant business

3                     PPP operates a business selling warrants which entitle the holder to the provision of pre-paid legal and other professional services.

The Collection Agency Deed

4                     PPP and the taxpayer entered into a deed dated 5 June 2005 called the Collection Agency Deed.  Under cl 3.1(b) PPP, referred to as “the Principal”, appointed the taxpayer, referred to as “the Collection Agent”,

as an independent commission agent of the Principal to collect in a timely fashion on behalf of the Principal all payments due to the Principal from clients seeking to deal with the Principal in the manner set out in this deed …

5                     The taxpayer is to be PPP’s agent (cl 3.2(a)).  PPP agrees to pay the taxpayer “Commission” in accordance with terms previously agreed (cl 2.6).  The taxpayer may appoint any solicitor, barrister, accountant or other professionally qualified person and incur “Collection Expenses” in the course of performing its obligations under the deed (cl 3.7) and may issue legal proceedings (cl 3.8).

6                     The Collection Agency Deed recites in cl 2.1 that the taxpayer has been established to act as the “independent collection and administrative agent” to facilitate clients in Australia dealing with PPP.  It is therefore “acknowledged” in cl 2.2 that the taxpayer will, as a necessary consequence of such a role, also be required to be the agent and attorney of persons in Australia seeking to acquire the services of PPP and have responsibilities to such persons until such time as PPP makes direction for payment.

7                     Clause 4.2 provides for a “Collection Account”.  The taxpayer is to establish in its name a Collection Account at a bank and is authorised by cl 4.2(a) to give a valid receipt for funds

for itself when received as agent of the debtor and on behalf of the Principal at such time that a payment direction has been made by the Principal and completed by the Collection Agent.

8                     Clause 4.2(b) and (c) have the effect that until a “direction” is given by PPP, funds in the account are held on behalf of the client and after such a direction they are held “on trust for” PPP.

9                     Other sub-clauses deal with obligations of the taxpayer, including, under a second sub-clause (c), an obligation not to

mingle any money in the Collection Account with its own money or monies held by the Collection Agent on account of third parties.

The taxpayer is to account to PPP in respect of all monies received each month within five business days of the end of the month and pay on direction of PPP within three days from such direction (cl 4.2(f)).

10                  Clause 4.2(g) is important for the present case.  It provides:

(g)        The Principal hereby directs the Collection Agent that it is implicit in each and every direction to apply the monies payable to the Principal from its Collection Account in this order:

(i)         reimbursement of approved Collection Expenses;

(ii)        payment of relevant fees and commissions to the Collection Agent;

(iii)       payment of any charges whether to satisfy an obligation to pay an instalment, withholding, assessment or other demand or obligation in respect of a payment to the Principal or Collection Agent respectively to the appropriate Public Authority; and

(iv)       payment of the balance to the Principal as directed.

The terms “fees” and “relevant fees” are not defined.  “Commission” is defined in cl 1.1 to mean:

the fee payable by the Principal to the Collection Agent in consideration of the Collection Agent performing its duties under this Deed.

The Administration Agreement

11                  The taxpayer, referred to as “the Administrator”, entered into agreements with entities referred to as “Business Agents”.  They were to be in effect retailers of the warrants, although it was apparently contemplated that they might also pay for and use warrants themselves.  Such an agreement, dated 2 June 2005, was in evidence.  The purpose of this “Administration Agreement” was described in recitals as follows:

A.        The Business Agent is in the business of providing professional services for cash and interests in causes of action and seeks to use the Pre-Paid Professionals Business Plan and business model to access service providers and service packages as a means of providing those services and seeks to develop and expand the business concepts by entering into its own specialised markets for professional services and litigation funding.

B.        For the purpose of administering the Business, the Business Agent wishes to engage the Administration Services of the Administrator and to appoint the Administrator as its Agent and attorney to undertake all the administrative issues necessary and convenient to conducting its business in accordance with the Business Agent’s instructions SUBJECT ALWAYS that nothing said in this agreement removes or mitigates the overriding day to day control exercised by the Business Agent over the Administrator by the provision of instructions sought by the Business Agent.

C.        The Administrator is prepared to provide its Administration Services on the terms and conditions set out in this Agreement.

12                  By cl 2.1.1 the Business Agent appointed the taxpayer as “Administrator of the Business”.  “Business” was defined in cl 1.1(4) to mean

the business of selling services using service warrants to provide those services which can be more precisely sub-categorised as researching, sourcing and designing service warrant packages, facilitating, negotiating and marketing the supply of discounted, wholesale, reliable, high quality wealth creation, financial, legal and taxation services to the public and including the prospecting of clients with attractive causes of actions who will assign (in whole or in part) or otherwise mortgage that cause of action in return for tailored service warrant packages designed to such client’s circumstances.

13                  Clause 5 provided for “Minimum Deposit Accounts”.  By cl 5.1 the Business Agent, on the execution of the agreement is to pay to the taxpayer

as the Agent and as Administrator of the Business, an amount of at least 15% of the value of all service warrants/rights committed to (PPP) for the following year (the minimum deposit commitment amount) by the end of the financial year, which will be allocated in accordance with clause 5.2.

14                  By cl 5.2 the taxpayer “as Administrator of the Business shall pay, direct or disburse the full 15% amount as a part payment for the entire amount of pre-paid services irrevocably committed to by the Business Agent to (PPP)”.

15                  Clause 6 sets out the entitlement of the taxpayer to fees.  It provides for alternative methods: a percentage of the value of warrants committed, or a percentage of “gross business income”.  Its terms are as follows:

6.         Administrators Fees and Election

6.1       Subject to the overlap election in sub-clause 6.3, the Administrator will be entitled by the end of the financial year to an administration fee to the amount of 15% of the value of all service warrants/rights committed to Pre-Paid Professionals for the following year.  In addition, the Administrator will be entitled to the following percentages of the value of all service warrants/rights committed to Pre-Paid Professionals for the following year:

(1)        10% representing both incurred and prepaid Production Fees;

(2)        2.5% representing both incurred and prepaid Distribution and Selling Fees;

(3)        1% representing both incurred and prepaid Business Management Fees; and

(4)        1.5% both incurred and prepaid Technology Licence Fees.

6.2       Subject to the exercise of the overlap election in clause 6.3, the fees incurred by the Business Agent remain outstanding to the Administrator by the Business Agent and can, at the election of the Administrator, be set off as against cash proceeds received by the Administrator for the Business Agent.

6.3       The Administrator may exercise an overlap election by electing to instead of receiving the fees it is entitled to in clause 6.1, to receive in substitution the administration fees in clause 6.4 and hence the fees in clause 6.1 have not arisen.

6.4       Upon the exercise of an election pursuant to clause 6.3 by the Administrator, the Administrator may instead be entitled as administration fees, to 30% of the gross business income from the proceeds of the endorsement of the service warrants.

16                  One of the issues in this case is whether the taxpayer has exercised the elections referred to in cl 6.2 and 6.3 of the Administration Agreement.  While its primary contention is that this question is irrelevant, the taxpayer contends in the alternative that there has been such an election.  It relies in part on a document provided to Business Agents entitled “Pre-paid Professionals (PPP) Frequently Asked Questions”, question 15 of which states (PPPA being the taxpayer):

What is the extent of liability for owners of the business (Is it limited to the contribution of the individuals or the entities)?

As with any new business, the owners face a real commercial risk.  However, because of the strategic alliances that are set in place there already exists such a demand for services that will exceed the expectations of the business.  Therefore, the owners can anticipate that they will sell all of their pre-paid contracts before the commencement of the next financial year.

The business is professionally managed by PPPA who sells these services on behalf of the dealership or partnerships.  PPPA will charge commissions but has undertaken in order to get your business going (and in anticipation of greater fees once it is growing) only to charge reasonable administration charges from profits.  That is, to help you get started, PPPA will waive its administration fees if you do not make a profit.

Taxpayer’s business operations

17                  Evidence was given by Mr William Watkins, a New Zealand resident, who was a director of the taxpayer for two months from May to June 2005.  Mr Watkins came to Brisbane in May 2005 and worked there for about eight weeks setting up the taxpayer’s business.

18                  According to Mr Watkins’ affidavit, the taxpayer would obtain powers of attorney from “clients” (presumably the “Business Agents”) appointing the taxpayer their attorney for dealing with PPP.  The taxpayer would collect funds and issue tax invoices for the receipt of funds by PPP.   The taxpayer, in Mr Watkins’ words,

then processed the standard documents, conducted the first formal meeting establishing the client’s “dealership” or “partnership dealership”, and sent out the document set to the participants.

19                  Mr Watkins said in evidence that the number of Business Agents during the period he was working in Brisbane was “well into the hundreds”.

20                  The taxpayer maintained as the Collection Account an account with the Brisbane branch of HSBC.  Statements of that account in evidence show on 2 August 2005 a debit of $3,628,118.

21                  On the same day the sum of $3,584,000.09 was credited to PPP’s Australian dollar account with the Auckland branch of HSBC.  The taxpayer was identified as the source of that credit.  The following day $3,580,022.46 was transferred from PPP’s New Zealand account to the account of Atlas Trustee Limited, to be held on behalf of PPP.

The taxpayer’s case

22                  Counsel for the taxpayer submitted that cll 5.1 and 6.1 of the Administration Agreement create separate obligations to pay separate sums of money for different purposes.  (That is on the assumption the Business Agent made a commitment to acquiring warrants; if it decided not to acquire any warrants there would be no obligation to pay anything).  Once a commitment is made, the Business Agent is also obliged to pay the remaining 85 per cent; only 15 per cent however is required to be paid before the end of the financial year.

23                  Turning to the Collection Agency Deed, counsel submitted that the effect of cl 4 was that when funds were received by the taxpayer from a Business Agent they were held by the taxpayer on the Business Agent’s behalf.

24                  The term “relevant fees” in cl 4.2(g) of the Collection Agency Deed, it was argued, does not denote the fees referred to in the Administration Agreement, which is an agreement between the taxpayer and the Business Agent.  There was “just no linkage”, counsel said.  “Relevant fees” referred to the relevant collection expenses that the taxpayer was entitled to deduct.

Conclusion

25                  The amounts of the assessments do not reconcile with the figures in the bank statements that were in evidence, but this is because those statements do not cover the complete period of the taxpayer’s business.  In any event, the taxpayer does not raise any issue as to the receipt of the funds which the Commissioner has assessed as ordinary income. 

26                  Given therefore that the taxpayer received the funds in question, has the taxpayer made out its case that it held the funds purely as agent on behalf of the Business Agent and then PPP?

27                  If the taxpayer held funds to which, or to any part of which, it was beneficially entitled by way of fees or commission, it would pro tanto have derived ordinary income.  It is not necessary for the taxpayer to have made some appropriation or earmarking of the funds to which it was entitled.  Nor does it matter if for some reason such as mistake, or surprising generosity, the taxpayer in fact passed on all funds it received to PPP.

28                  The taxpayer not having raised any issue as to whether the end of the financial year had arrived, the conclusion to be drawn is that the taxpayer became entitled to the administration fee specified in cl 6.1 of the Administration Agreement.  By that clause the taxpayer was entitled to such fee as against the Business Agent.  As against PPP the taxpayer was entitled to deduct the fee by virtue of cl 4.2(g)(ii) of the Collection Agency Deed.

29                  The taxpayer has not raised any issue of apportionment of the monies received so as to distinguish between fee entitlements and the remainder.

30                  The term “relevant fees” in cl 4.2(g)(ii) the Collection Agency Deed plainly includes the fees to which the taxpayer was entitled under the Administration Agreement.  The two documents must be read together.  They relate to the same business operation.  They form part of the same legal and commercial landscape.  Indeed cl 2.2 of the Collection Agency Deed explicitly refers to and acknowledges the relationship that the parties (PPP and the taxpayer) contemplate that the taxpayer will have with Business Agents. 

31                  As to election under cl 6.2 or 6.3 of the Administration agreement, there is simply no evidence of any such election being exercised on behalf of the taxpayer.  None of the witnesses called by the taxpayer said there had been any election.  Such an election would have to be communicated to the Business Agent.  Clause 20.1 of the Administration Agreement requires any “notice or other communication” connected with this agreement to be in writing.  Methods of service – pre-paid post, fax or delivery – are provided for: cl 20.2.

Orders

32                  The application will be dismissed with costs, including reserved costs and the costs thrown away by reason of the adjournment on 1 October 2008.

Associate:

Dated:         23 October 2008