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AUSTRALIA AND NEW ZEALAND SAVINGS BANK LIMITED v FC of T

Judges:
Jenkinson J

Court:
Federal Court

Judgment date: Judgment handed down 2 October 1992

Jenkinson J

Appeals against decisions of the respondent on objections against income tax assessments.

The applicant claimed to deduct from its assessable income of the year of income ended 30 September 1986 its share of what it claimed to be a partnership loss incurred by a partnership, between Australia and New Zealand Banking Group Ltd. and itself, formed solely for the purpose of entering into the transactions which have given rise to these appeals. In that year the partners had subscribed for 50,000,000 units, each for a consideration of $1, in a trust fund, and the trustee had purchased what the applicant submits to be three annuities with the funds thus subscribed. Nothing was payable to the trustee under any of those three agreements in that year, but the partners, having borrowed $42,369,456 of the $50,000,000 they had subscribed, incurred in that year interest and other charges in respect of the borrowing, which the applicant claimed to be allowable deductions in the calculation, for the purposes of Division 5 of Part III of the Income Tax Assessment Act 1936, of the partnership loss incurred in that year. The claimed partnership loss derived solely from those expenses. The applicant's share of the loss was $34,163. The claimed deduction having been wholly disallowed by the respondent in assessment, and the applicant having objected, the respondent's decision was that in the calculation, for the purposes of Division 6 of Part III, of the net income of the trust estate, Division 16E of that Part applied to each of the agreements for what the applicant claims to be annuities, as ``qualifying securities'' within the meaning assigned to that expression by s. 159GP, with the result that s. 150GQ required the inclusion of an amount of $1,140,312 in the assessable income of the trust estate, so that the net income of the trust estate was that amount; that in the calculation of the net income of the partnership or the partnership loss for the purposes of Division 5 of Part III that amount of $1,140,312 was assessable income of the partnership; that the expenses which had in assessment been wholly disallowed should be wholly allowed as deductions in the calculation, for the purposes of Division 5, of the partnership loss, and that the applicant's share of that loss, $23,513, should be an allowable deduction from the applicant's assessable income, in lieu of the claimed deduction of $34,163. That decision of the respondent is the subject of the appeal No. 314 of 1989 concerning the year of income ended 30 September 1986.

During the year ended 30 September 1987 payments aggregating $7,279,804 were made to the trustee under one of the three agreements which the applicant claims to be for the payment of annuities, and $1,667,304 of that aggregate sum was paid by the trustee to the partnership as income of the trust fund payable in respect of the investment units of which the partners were the holders. $1,692,304 was the balance of the $7,279,804 after exclusion of the ``deductible amount'' in accordance with the provisions of s. 27H. Of the $1,692,304 an amount of $25,000 was paid to the manager of the trust. The applicant claimed, as it had in respect of the preceding year, that in the calculation of the net income of the partnership or the partnership loss interest and other expenses of the borrowing of $42,369,456 were allowable deductions. Those expenses aggregated $6,920,195. The applicant's share of the partnership loss so calculated was $49,057. Again in his decision on the applicant's

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objection against his assessment (by which he had wholly disallowed the applicant's claim to a deduction in respect of that loss) the respondent treated Division 16E of Part III as applicable to the three agreements for what the applicant claimed to be annuities, and accordingly included, in the calculation of the net income of the trust estate, an amount of $5,164,493 as assessable income of that estate in addition to the $1,692,304 received by the trustee. Thereby $5,164,493 was added as assessable income in the calculation of the partnership loss for the purposes of Division 5 of Part III, according to the respondent's decision. The applicant's share of the partnership loss so calculated (and calculated also after wholly allowing as a deduction the expenses aggregating $6,920,195) was $825. The respondent's decision was that that loss should be allowed as a deduction from the applicant's assessable income. That decision is the subject of the appeal No. 209 of 1990 concerning the year of income ended 30 September 1987.

The applicant contends, and the respondent denies, that in the calculation of ``net income, in relation to a trust estate'', for the purposes of Division 6 of Part III, each of the payments agreed to be made to the trustee under the three agreements, and called therein an ``Annuity Payment'', is ``the amount of any annuity'', within the meaning of that expression in s. 27H(1)(a), and accordingly each of the payments, excluding the ``deductible amount'' in relation thereto, is to be treated as assessable income of the trust estate for the purposes of that calculation. That is the first question which the appeals raise.

The transactions which have raised the question were intended, by those who controlled the participants, to occur only if all the transactions occurred. The trustee, Narvaez Ltd., executed the three agreements on 30 April 1986. In each agreement the trustee's covenant to ``purchase the Annuity on the Acquisition Date by paying to the Annuity Provider the Purchase Price on the Acquisition Date'' was subject to ``conditions precedent'', one of which was ``that all of the Transaction Documents shall have been duly executed by the respective parties thereto''. The ``Acquisition Date'' was defined as 1 May 1986 or such later day on which trading banks are open for business in Sydney, Melbourne and Adelaide as the parties might agree in writing. The ``Annuity Provider'' was New South Wales Treasury Corporation. Clause 1.1 of each of the three agreements defined the expression ``Transaction Documents'' to mean ``collectively'' nine named instruments, most of which I will identify later. One of the nine is the partnership agreement between the applicant and Australia and New Zealand Banking Group Ltd., executed on 30 April 1986. Clause 2.2 of the partnership agreement provides:

``Scope

  • (a) The Partners are partners solely for the purpose of subscribing for the Investment Units and to enter into all the transactions referred to in or contemplated by the Transaction Documents and for any other purposes incidental thereto and hereto.
  • (b) Subject to paragraph (a), the provisions of this Agreement are complete and exhaustive as to the nature and scope of the Partnership and are to be construed as excluding any other act, matter, instrument or thing relating howsoever to the nature and scope of the Partnership.''

Another of the nine is the deed of trust, executed on 29 April 1986, between the trustee and FAI Financial Resources Ltd. (called therein ``the Manager''). The recitals of the trust deed are:

  • ``A. It is intended by these presents to establish a trust.
  • B. The Trustee has agreed to act as trustee for the purposes herein provided.
  • C. The Manager has agreed to act as manager for the purposes herein provided.
  • D. The Manager has paid to the Trustee prior to the execution hereof the sum of twenty dollars ($20.00).
  • E. This Deed is made with the intention that each Registered Holder (as hereinafter defined) shall take and hold Units (as hereinafter defined) in a Fund upon the terms and conditions of this Deed and shall be bound by this Deed.''

Clause 2.1 of the trust deed expresses the trustee's declaration of trust. Clause 2.2 provides:

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``The Trust is hereby divided into two Funds constituted as at the date hereof as follows:-

  • (a) of the sum of twenty dollars ($20.00) paid to the Trustee by the Manager as referred to in Recital D the sum of ten dollars ($10.00) shall be held by the Trustee as property of the A Class Fund and shall constitute the A Class Fund as at the date hereof; and
  • (b) the remaining ten dollars ($10.00) of the sum of twenty dollars ($20.00) paid to the Trustee by the Manager as aforesaid shall be held by the Trustee as property of the B Class Fund and shall constitute the B Class Fund as at the date hereof.''

It is with the B Class Fund that the appeals are concerned. The trust deed provides for additions to a Fund. The beneficial interest in the B Class Fund as originally constituted pursuant to Clause 2.2(b) is divided into 10 B Class Management Units, no more of which are to be created, the trust deed provides. The Manager is the Registered Holder of the 10 B Class Management Units, which are to confer on the Manager such an interest in the income of the Fund as the trustee shall determine, but no interest in the capital. For each $1 added to a Fund an ``Investment Unit'' shall be created. The capital of the B Class Fund is to be held upon trust for the holders (called ``Registered Holders'') of the B Class Investment Units. The partners became the Registered Holders of the 50,000,000 Investment Units in the B Class Fund. The income of that Fund, other than the income entitlement to which the 10 B Class Management Units confer on the Manager, and the capital shall be held on trust absolutely for the Registered Holders of the B Class Investment Units, none of which was held by any person other than the partners. As and when and to the extent that the trustee receives cash representing capital of the Fund the trustee is required by Clause 10 of the trust deed to pay that cash to the Registered Holders of the B Class Investment Units in redemption pro tanto of the Units, at a ``Redemption Price'' of $1 per Unit. Upon the Manager Clause 15 confers extensive management duties ``as the manager of the Trustee for the purposes only of this Deed and as manager of the Trust''. Clause 15.5 provides:

``The Manager shall as and when any cash is received by the Trustee which is or is to be paid or distributed pursuant to Clause 9 or Clause 10, determine the extent to which such cash represents income of a Fund and the extent to which such cash represents capital of a Fund. The Manager shall not be liable for any error in such determination provided that the Manager in making any such determination acts in good faith and has regard to any actuarial advice or certification that may have been obtained by the Manager and made available to the Investors in the relevant Fund.''

The ``Purchase Price'' payable under the ``First B Class Annuity Agreement'' between the trustee and New South Wales Treasury Corporation was $22,350,000, under the ``Second B Class Annuity Agreement'' $13,500,000, under the ``Third B Class Annuity Agreement'' $14,150,000. Each of the three agreements was within the definition of the expression ``Transaction Documents''. Each Annuity Agreement specified the amounts of the Annuity Payments: under the first agreement $3,639,902 on 1 November and 1 May from 1 November 1986 until 1 May 1990, under the second agreement the same amount on the same days from 1 November 1990 until 1 May 1994, under the third agreement on the same days $4,769,042 from 1 November 1992 until 1 May 1994 and $8,408,945 from 1 November until 1 May 1996.

Each Annuity Agreement included an agreement expressed in Clause 5.1 to be that the amount of the stated annuity payments and certain other amounts specified in that agreement ``have been based on assumptions bases and criteria which include the follow- ing: -''. There follows a long catalogue of ``assumptions bases and criteria'', alphabetically listed. The first, (a), is that the annuity payments derived by the trustee under the three agreements in each year of income of the trustee will, for the purposes of computing the net income of the trust in accordance with Division 6 of Part III of the Income Tax Assessment Act 1936, be included in the assessable income of the trustee in respect of that year of income, except to the extent of the aggregate of the amounts, set out in Schedule Two of each of the three Annuity Agreements, in respect of the Annuity Payment Dates occurring in that year of income. Each of those

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amounts, the exclusion of which from assessable income is assumed, is declared in Clause 5.1(a) to be ``the assumed amount of the deductible amount calculated in accordance with Section 27H'' in relation to the right to receive the Annuity Payments in the relevant year of income. And those are the amounts which, for so long as all the ``assumptions bases and criteria'' continue uncontradicted by any event occurring after the making of the Annuity Agreements, the Manager will determine to be capital of the B Class Fund as and when annuity payments are received by the trustee.

Clause 5.1(b) states the assumption that all the ``Annuity Payments'' under the three agreements will be paid on the agreed dates. Clause 5.1(c) states the assumption that all those payments will be taken, ``for the purposes of Section 27H and for all other purposes of'' the Income Tax Assessment Act 1936, to have been derived by the trustee in the year of income within which the agreed dates respectively fall. Clause 5.1(d) states the assumption that the moneys paid to the partners in redemption of Investment Units, ``to the extent that such moneys are paid out of the cash flow attributable to the Annuity Payments... (other than any part thereof assumed to be included in the assessable income of the Annuity Acquirer pursuant to subclause (a)) shall be treated for all purposes of the Tax Act as capital receipts of the Partnership and shall not be subject to any Tax for which the Investors are liable''. (The expressions ``Tax Act'', ``Partnership'', ``Annuity Acquirer'' and ``Investors'' have defined meanings. The first means the Income Tax Assessment Act 1936, the second the partnership constituted pursuant to the partnership agreement, the third Narvaez Ltd., and the fourth the applicant and Australia and New Zealand Banking Group Ltd. as partners pursuant to that agreement.) Clause 5.1(f) states the assumption that all interest incurred by the Investors under the agreement for the loan of $42,369,456 (called the ``Loan Agreement'' and being one of the ``Transaction Documents'') shall be allowable deductions of the Partnership. There are in clause 5.1 other assumptions concerning the operation and the administration of the Tax Act in relation to the transactions contemplated by the parties. For example, Clause 5.1(m) states the assumption that ``the Commissioner of Taxation in reliance on Part IVA of the Tax Act does not and shall not deny or disallow a deduction in respect of losses or outgoings incurred by the Investors in respect of deductions or allowances referred to in Clause 5.1(f)''. Clause 5.1(g) states assumptions as to the rates of tax applicable to the taxable income of each of the Investors. There are also assumptions stated concerning fees payable by the Investors to the Manager and concerning other costs, fees and expenses.

Clause 5.2(a) provides:

``If the Assumptions set out in Clause 5.1 shall for any reason whatsoever be or become incorrect then and on each such occasion either of the parties hereto may by notice in writing to the other elect:

  • (i) to have the amount of the Annuity Payments set out in Schedule One, and the amounts set out in Schedule Three recalculated and redetermined pursuant to Clause 5.3(a); or
  • (ii) if the obligation of the Annuity Provider to pay the Annuity Payments shall be terminated, to require the parties hereto to make the adjustment referred to in Clause 5.3(b).''

The exercise of an election under Clause 5.2(a) of any of the three agreements is deemed to constitute exercise of the election under Clause 5.2(a) of each of the other two agreements. Clause 5.3(a) deals with a case to which Clause 5.2(a)(i) applies. Clause 5.3(a) requires that the remaining Annuity Payments shall, with effect from the date of exercise of the election, ``and taking into account any recalculation and redetermination or adjustments and payments made or to be made pursuant to Clause 5.3 of'' either or both of the other two agreements, ``be recalculated and redetermined by the Manager... so as to cause the Investors' respective Actual Rates of Return throughout the period referred to in the Investors' Letter to be equal to their respective Required Rates of Return''. Clause 1.1 of each Annuity Agreement contains the following definitions:

```Actual Rate of Return' means, in relation to an Investor, the actual after Tax rate of return of that Investor earned from time to time under the Transaction Documents and the transactions described therein or contemplated thereby as calculated by the Manager using the methods of analysis reflected in the Investors' Letter and on the

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basis of the Assumptions but having regard to any of the Assumptions set out in Clause 5.1 which shall have been or become incorrect.

...

`Assumptions' means the assumptions, bases and criteria utilised by the Manager in originally analysing the transactions described in or contemplated by the Transaction Documents including, without limitation, the assumptions bases and criteria set out in Clause 5.1.

...

`Investors' Letter' means the letter dated the same date as this Deed from the Manager to the Investors and includes the computer printouts and other information and documents annexed to that letter a copy of all of which, initialled by the Investors and the Manager for the purposes of identification, has been lodged with Messrs. Freehill, Hollingdale & Page, Sydney on the date hereof.

...

`Required Rate of Return' means in relation to an Investor, the after Tax rate of return required by that Investor to be earned by it under the Transaction Documents and the transactions described therein or contemplated thereby, being that rate ascertained in accordance with the Investors' Letter.''

The Investors' Letter is not one of the Transaction Documents. Clause 8.11 of each Annuity Agreement provides that the trustee shall provide New South Wales Treasury Corporation with a copy of that document upon request ``in the event of any recalculation and redetermination or adjustment by the Manager hereunder'' and in certain other specified circumstances. The Investor's Letter contains the following statement:

``The Investors' Required Rate of Return in terms of the Transaction Documents is to be calculated by the multiple investment sinking fund method of analysis applied from the date of payment for the 50 million $1.00 B Class Investment Units acquired under the Trust Deed by the Investors jointly until the earlier of either the payment of the final Annuity Payment by the New South Wales Treasury Corporation under the B Class Annuity Agreements or the payment of the aggregate lump sum amounts by the New South Wales Treasury Corporation upon a commutation of the remaining Annuity Payments Under Clause 7 of each of the B Class Annuity Agreements, being:

an after-tax yield of 12.661% (increased to such extent as may be necessary to give effect to the proviso) per annum effective on the Investors' outstanding equity balance from month to month using an after-tax nominal monthly sinking fund rate of 3.5% per annum (the Investors' initial equity balance for purposes of those calculations will not be reduced by ANZ's Fee payable by the Manager as prescribed in this Investors' Letter) provided that by using an after-tax nominal monthly sinking fund rate of 0.0% per annum, the after-tax effective yield is to be not less than 10.92% per annum.''

There is a number of schedules attached to the Investors' Letter, directed to demonstrating that the moneys to be received by the partnership, either as income or in redemption of the B Class Investment Units, will suffice to repay the $42,369,456 loan with interest in accordance with the terms of the written agreement for the loan, to pay certain relatively minor fees and expenses due by the partnership in connection with the transactions, to afford the stated ``after-tax yield'' on the balance of the partners' $7,630,544 contribution to the $50,000,000 investment which is treated in calculation as from time to time unrecouped, and to recoup that contribution. Although Clause 5.3(a) refers to ``the Investors' respective'' rates of return, there was only one rate of return, applicable to each of the partners. Clause 5.5 provides:

``If a recalculation and redetermination under clause 5.3(a) occurs then, and on each such occasion:-

  • (a) the amounts so recalculated and redetermined shall with effect from the date of exercise of the election pursuant to Clause 5.2 apply in lieu of those previously applicable; and
  • (b) the Annuity Acquirer or the Manager shall, as soon as practicable following the date of exercise of the said election notify the Annuity Provider of such recalculated and redetermined amounts.''

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Clause 5.3(a) ordains, in a case to which it applies, recalculation not only of the periodical payments described as ``the remaining Annuity Payments set out in Schedule One'', but also of ``the amounts set out in Schedule Three''. Clause 7.1 of each of the three Annuity Agreements provides:

``The Annuity Provider and the Annuity Acquirer shall each have the option to commute the Annuity Payments to a lump sum payment in accordance with this Clause 7.''

Exercise of the option under each of the other two agreements is deemed to have occurred whenever the option is exercised under one of them, unless the last date for an ``Annuity Payment'' has passed: Clauses 7.6 and 7.7. If notice of exercise of the option has effect on ``an Annuity Payment Date'' the amount set out in Schedule Three with respect to that date, together with the Annuity Payment due on that date, is the ``Lump Sum'' payable by the Annuity Provider to the Annuity Acquirer. There is provision for the inclusion of other amounts, such as any arrears and certain costs, but they may be ignored for present purposes. Each of the Lump Sum amounts set out in Schedule Three is the amount which, when aggregated with Annuity Payments previously received and the amounts specified in Schedule Three of the other two Annuity Agreements with respect to the same date, will suffice to enable the partners to repay to Fazen Pty. Ltd., by which the $42,369,456 were lent to them, the outstanding balance of that loan and interest, and to give them recoupment of their own contribution of $7,630,544 and interest thereon providing their ``Required Rate of Return'' to the date of payment of the Lump Sum. The agreement for the loan provides for repayment of the loan in the event that an exercise of the option to commute the Annuity Payments to a Lump Sum payment in accordance with Clause 7 occurs. If the notice of the exercise of the option has effect on a date which is not an Annuity Payment Date the appropriate lump sum is to be calculated by the Manager in respect of that date.

The Annuity Provider's option to commute the Annuity Payment arises, Clause 7.3 provides, upon the occurrence of the following events, namely if:-

  • ``(a)(i) the Assumptions or any of them shall be or become incorrect; or
    • (ii) there shall be any change, amendment, addition to or replacement of the Tax Act in force as at the date hereof or to the policy of the Commissioner of Taxation or any proposed change amendment, addition to or replacement of the Tax Act or the policy of the Commissioner of Taxation is officially announced or there shall be a change in the interpretation of the Tax Act or any determination by the courts or tribunals of Australia or any change in or amendment of a change in the administration of the Tax Act by the Commissioner of Taxation the result or effect of which in the reasonable opinion of the Annuity Provider will be that the Assumptions or any of them will be or become incorrect,
  • and as a result thereof the amounts payable by the Annuity Provider hereunder will be increased to an extent unacceptable to the Annuity Provider (in its absolute discretion).
    • (b) any amounts shall become payable (ignoring the provisions of Clause 8.1 of the Loan agreement) by the Investors to the Lender pursuant to Part 9 of the Loan Agreement and agreement as to any alternative funding arrangements (acceptable to the Annuity Provider), as referred to in Clause 9.2 of the Loan Agreement, is not reached between the parties to the Loan Agreement within sixty (60) days of notice from the Lender pursuant to Clause 9.1 of the Loan Agreement.''

Part 9 of the Loan Agreement provides that, if any one of a set of events occurs by reason whereof the lender Fazen Pty. Ltd. is financially disadvantaged in relation to the loan, it may require the borrowers to pay it an amount it considers will compensate it for the disadvantage. If such a requirement is made the parties to the Loan Agreement are required to negotiate for a maximum of 60 days ``with a view to finding alternate funding arrangements acceptable to the parties hereto and the Annuity Provider so as to avoid'' those disadvantages. If agreement is not reached the borrowers, ``without prejudice to Clause 7.3 of any of the

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Annuity Agreements may elect to prepay'' the whole balance of the loan. The notice in writing of such an election takes effect, Clause 9.2(b) of the Loan Agreement provides, on a date for payment of interest on the loan, which is also an Annuity Payment Date. On that date, Clause 9.2(b) ordains, the borrowers shall repay the whole balance of the loan. Under another of the nine Transaction Documents, a deed of mortgage to which the Annuity Provider is a party, such an obligation of the borrowers to the lender is to be discharged pro tanto by payment to the lender of any moneys which come to the trustee as Annuity Payments. Once that payment was made a number of the Assumptions, in the defined sense, would ``become incorrect''. For example, the Assumption specified in Clause 5.1(f)(i) of each Annuity Agreement - that the allowable deductions of the partnership would include interest incurred under the Loan Agreement ``which shall be treated as deductible on the basis... that such interest will be incurred in the amounts and in respect of the periods set out in the Investors' Letter'' - would become incorrect. Clause 7.3(b) of the Annuity Agreements would enable the Annuity Provider to exercise the commutation option in anticipation of that occurrence.

The events on the occurrence of which the Annuity Acquirer may exercise the option are default by the Annuity Provider in making any payment due under the Annuity Agreement or in performance of any other obligation under the Annuity Agreement, events betokening the likelihood of such a default (such as the appointment of a receiver of the Annuity Provider's assets or the issue of distress against the Annuity Provider), and similar events in relation to either of the other two Annuity Agreements. If a guarantee, given by the Government of New South Wales, of the Annuity Provider's performance of its obligations, and being one of the Transaction Documents, ``shall not be or shall cease to be legal valid and binding obligations of the Government enforceable against the Government in accordance with its terms'', the Annuity Acquirer's option is exercisable.

No exercise of the commutation option has occurred. There has been a recalculation, pursuant to Clause 5.3, of the Annuity Payments and of the amounts set out in Schedule Three, in consequence of an alteration of the rate of tax applicable to the taxable income of each of the partners which contradicted assumptions concerning those rates set out in Clause 5.1(g).

At the time when the three Annuity Agreements were executed, s. 27H provided in part:

``(1) The assessable income of a taxpayer of a year of income shall include-

  • (a) the amount of any annuity derived by the taxpayer during the year of income excluding, in the case of an annuity that has been purchased, any amount that, in accordance with the succeeding provisions of this section, is the deductible amount in relation to the annuity in relation to the year of income; and
  • (b) the amount of any payment made to the taxpayer during the year of income as a supplement to an annuity, whether the payment is made voluntarily, by agreement or by compulsion of law and whether or not the payment is one of a series of recurrent payments.

(2) Subject to sub-sections (3) and (3A), the deductible amount in relation to an annuity derived by a taxpayer during a year of income is the amount (if any) ascertained in 

                              A (B-C),
accordance with the formula   -------
                                 D
where--

A is the relevant share in relation to the annuity in relation to the taxpayer in relation to the year of income;

B is the amount of the undeducted purchase price of the annuity;

C is -

  • (a) if there is a residual capital value in relation to the annuity and that residual capital value is specified in the agreement by virtue of which annuity is payable or is capable of being ascertained from the terms of that agreement at the time when the annuity is first derived - that residual capital value; or
  • (b) in any other case - nil; and

D is the relevant number in relation to the annuity.

...

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(4) In this section-

...

`annuity' includes a superannuation pension;

`approved actuary' means a person referred to in sub-section 4A (2) of the Life Insurance Act 1945;

`life expectation factor', in relation to a person in relation to an annuity, means the number of years in the complete expectation of life of the person as ascertained by reference to the prescribed Life Tables at the time when the annuity first commenced to be payable;

`relevant number', in relation to an annuity in relation to a year of income, means -

  • (a) where the annuity is payable for a term of years certain - the number of years in the term;
  • (b) where the annuity is payable during the lifetime of a person and not thereafter - the life expectation factor of the person; and
  • (c) in any other case - the number that the Commissioner considers appropriate having regard to the number of years in the total period during which the annuity will be, or may reasonably be expected to be, payable;

`relevant share', in relation to an annuity derived by a taxpayer during a year of income, means -

  • (a) in a case where the annuity derived by the taxpayer is a share of an annuity (which annuity is in this paragraph referred to as the `total annuity') payable to the taxpayer and another person or other persons - the fraction ascertained by dividing the number of whole dollars in the amount of the annuity derived by the taxpayer during the year of income by the number of whole dollars in the amount of the total annuity derived during the year of income by the taxpayer and the other person or persons; or
  • (b) in any other case - the number 1.''

Section 13 of the Taxation Laws Amendment Act (No. 4) 1987 amended s. 27H by adding at the end of the definition of ``annuity'' in sub- section (4) ``, but does not include an annuity that is a qualifying security for the purposes of Division 16E''. The amendment applies in relation to annuities issued at or before 8 o'clock in the evening by standard time in the Australian Capital Territory on 19 September 1986 as if it had come into operation on 29 October 1987: see ss. 48 and 49 of the Taxation Laws Amendment Act (No. 4) 1987.

Counsel for both parties accepted, as applicable to the resolution of the question whether the Annuity Payments were each ``the amount of any annuity'' within the meaning of that expression in s. 27H, two propositions which Viscount Simon stated in
IRC v. Wesleyan and General Assurance Society [1948] 30 T.C. II at 25, thus:

``First, the name given to a transaction by the parties concerned does not necessarily decide the nature of the transaction. To call a payment a loan if it is really an annuity does not assist the taxpayer, any more than to call an item a capital payment would prevent it from being regarded as an income payment if that is its true nature. The question always is what is the real character of the payment, not what the parties call it. Secondly, a transaction which, on its true construction, is of a kind that would escape tax is not taxable on the ground that the same result could be brought about by a transaction in another form which would attract tax. As Lord Greene, M.R., said in the present case [Page 16 ante]: `In dealing with income tax questions it frequently happens that there are two methods at least of achieving a particular financial result. If one of those methods is adopted, tax will be payable. If the other method is adopted, tax will not be payable... The net result, from the financial point of view, is precisely the same in each case, but one method of achieving it attracts tax and the other method does not.'''

Nor were they in disagreement that, in application to an annuity that has been purchased, the essential characteristic of an ``annuity'' within s. 27H is accurately expressed thus:

``An annuity means where an income is purchased with a sum of money, and the capital has gone and ceased to exist, the principal having been converted into an annuity.''

(per Watson B. in
Lady Foley v. Fletcher (1858) 3 H. & N. 769 at 784; 157 E.R. 684 at 685.)

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Mr. Bloom Q.C., who appeared with Mr. O'Sullivan and Mr. O'Callaghan for the applicant, submitted that in determining the question recourse must be had to the Annuity Agreements, because they were the sources of the obligations to make the Annuity Payments, the character of which was to be ascertained, upon the proper construction of those three agreements, as they were derived by the trustee. The circumstance that by virtue of other obligations deriving from the trust deed and the partners' acquisition of Investment Units in the B Class Fund the trustee would thereafter deal with each Annuity Payment derived by it in a particular way could not, it was submitted, affect that characterisation.

It is true, as Mr. Bloom pointed out, that there is no express incorporation of any of the other Transaction Documents with an Annuity Agreement. But the relationship between the latter agreements and the others is intimate. Not only do events and circumstances affecting the performance of agreements embodied in other Transaction Documents have a determinative influence on the amount of each Annuity Payment. Variation without the Annuity Provider's consent of any of the Transaction Documents, and action by the Annuity Acquirer not authorised or contemplated by any of the Transaction Documents, are expressly excluded from the class of events in consequence of which a right to recalculation of Annuity Payments may arise. Clause 5.4 of each Annuity Agreement provides, in part:-

``In calculating the Actual Rate of Return of an Investor the Manager shall disregard any reduction in the Actual Rate of Return of that Investor, and neither the Annuity Acquirer nor the Investors shall have any right to any adjustment pursuant to this Deed as a result of any reduction in the Actual Rate of Return of that Investor, arising directly as a consequence of:-

  • ...
  • (h) any amendment, variation or replacement to any of the Transaction Documents or the Investors' Letter effected without the prior written consent of the Annuity Provider;
  • ...
  • (m) Units failing to be redeemed pursuant to Clause 10 of the Trust Deed as and when they are required to be redeemed (other than where such failure arises as a result of default by the Annuity Provider in making any payments under and in accordance with this Deed, the Second Annuity Agreement or the Third Annuity Agreement);
  • (n) any investment of the B Class Fund other than as contemplated by the Transaction Documents (other than the Trust Deed) being made;
  • (o) the Annuity Acquirer pursuant to the directions or with the consent of the Investors or any of them under the Trust Deed taking any action other than under or in connection with the terms of the Other Transaction Documents or (to the extent that, such action relates to the Other Transaction Documents or the transactions respectively described therein or contemplated thereby) under or in connection with the Trust Deed;''

The expression ``Other Transaction Documents'' is defined to mean the Transaction Documents other than the trust deed. Those provisions of Clause 5.3 form part of the contractual determination of the amount of an ``Annuity Payment'' and in my opinion afford material relevant to the characterisation of such a payment as ``an amount of any annuity'' or not. And those provisions require reference to the Transaction Documents, other than the Annuity Agreements, the terms of which are in my opinion impliedly incorporated with the Annuity Agreements.

Questions arose during the hearing concerning the admissibility of evidence designed to show that the amounts which the partners from time to time received (or might be considered to have received by virtue of payments to their lender, Fazen Pty. Ltd.) pursuant to the trust deed were the same amounts, and were treated as capital and income in the partners' hands in the same amounts respectively, which they would have received, and which would have been so treated, at those same times if the partners had paid the $50,000,000 to New South Wales Treasury Corporation in performance of a contract of loan the terms of which were those commonly adopted in financial transactions commonly undertaken by large financial institutions in borrowing and lending to one another large sums of money for periods of

ATC 4640

years. The evidence was received subject to objection. I have not taken that evidence into consideration in reaching my conclusion on the question under present consideration. But I have taken into consideration other evidence which it was not always easy during the course of the hearing to keep distinct. The latter evidence was of ``the methods of analysis reflected in the Investors' Letter'', and of ``the Assumptions'', to both of which reference is made in the definition of the expression ``Actual Rate of Return'' in the Annuity Agreements. That latter evidence disclosed that those methods of analysis involved a demonstration that the receipts and the allocation between capital and income ordained by the trust deed while the ``Assumptions'' were not falsified by any event mirrored what might have been the receipts and the allocation under the terms of a contract of loan on certain identified terms. The significance I accorded that demonstration is stated hereafter.

I have not made any use of any of the evidence of Paul Edward Melling and need not therefore rule on the objections to some of that evidence which Mr. Bloom raised.

I should state further that I interpret the definition of the word ``Assumptions'' in Clause 1.1 of the Annuity Agreements as comprehending those ``assumptions, bases and criteria'' utilised by the Manager in composing the ``Investors' Letter'' and its attachments, even those which find no expression in Clause 5.1. Mr. Bloom did not concede that that was the proper construction of the word for all purposes.

Counsel for both parties accepted as correct and applicable to the question of characterisation what Megarry J. said in
IRC v. Church Commrs for England [1975] 1 W.L.R. 251 at 266:

``Again, I think that the mere existence of a capital sum of money in the minds of either or both of the parties must be contrasted with the actual existence of a capital obligation. As a matter of valuation, all capital can be expressed in terms of income, and all income can be expressed in terms of capital. An annuity or rentcharge, whether in perpetuity, for an uncertain period such as life, or for a fixed term of years, may readily have its capital equivalent ascertained by valuers and others: yet such capital equivalents, though useful on either side as a means of appraising the effect of a proposed transaction, and perhaps as an aid to bargaining, remain mere units of calculation so long as they form no part of the bargain that is struck, and never represent any true obligation, existing or past. The comments of Sir Wilfrid Greene M.R. in
Sothern-Smith v. Clancy [1941] 1 K.B. 276 to which I have already referred seem to me to be in point.

For somewhat similar reasons, I cannot attach any great weight to the question whether, without there being any obligation to pay a capital sum, such a sum appears in some way on the face of the transaction or can by due diligence be detected in it. I cannot see why the bare inoperative mention of a capital sum should affect the nature of what is being paid under the contractual obligation.''

Mr. Bloom relied upon the reasoning of Greene M.R. in
Sothern-Smith v. Clancy (Inspector of Taxes) [1941] 1 K.B. 276 and upon the High Court's acceptance of that reasoning in
Atkinson v. FC of T (1951) 9 ATD 329 at 333; (1951) 84 C.L.R. 298 at 307. The headnote states the relevant facts of the former case thus:

``S. entered into a contract with an insurance society whereby in consideration of a single payment the society undertook that they would pay him an annual sum during his life; that in the event of his death before the sum of the annual payments equalled the capital invested, they would make annual payments of the same amount to a named recipient until the sum of the annual payments equalled the capital invested. S. having died before the annual payments equalled the capital invested the society continued to make the annual payments to the recipient.''

Greene M.R. observed ([1941] 1 K.B. at 283, 285-286):

``Let me take the simple case of a contract under which in consideration of a single payment by B., A. agrees to pay to him an annuity for a period of years. The legal nature of such a contract is beyond question. The property in the sum paid by B. passes absolutely to A.; no relationship of debtor and creditor with regard to that sum is ever constituted. The sum as a sum ceases to exist, when once it is paid. Its place is taken by A.'s promise to pay the annuity and B.'s

ATC 4641

only right is to demand payment of the annuity as it accrues due. If A. repudiates the contract, B. may sue for damages, the measure of damages being the sum of the payments still remaining to be paid, subject to discount. Is it then permissible to look behind the legal nature of the transaction and inquire into its financial nature? If this is done, it is at once apparent that the annual payments are calculated on the basis that at the expiration of the period of the annuity, B. will have received an amount equal to the sum which he paid together with a sum in respect of interest, for it is on that basis that in such a transaction the amount of the annual payments is calculated.

...

I feel bound to regard the purchase of an annuity of the kind to which I have referred as the purchase of an income and the whole of the income so purchased as a profit or gain notwithstanding the way in which the payments are calculated. The sum paid for the annuity has ceased to have any existence and the fact that at the end of the annuity period the recipient will have received an amount equal at least to what he paid I feel bound to treat as irrelevant. Nor do I think it can make any difference if this result is stated on the face of the transaction. Perrin's case [1930] 1 K.B. 107 decides at any rate that the absence of such a statement cannot prevent the annual sums paid from being capital since extrinsic evidence was admitted; it appears to me to follow that the presence of such a statement cannot prevent them from being income.

I need not set out in detail the terms of the present contract. It bears upon its face statements to the effect that the result of its operation will be that the annual payments made under it will in the aggregate amount at the least to the sum paid by Mr. Sothern, while if Mr. Sothern were to live long enough they would exceed it. But the contract is in reality a contract to pay an annual sum to Mr. Sothern during his life with the added provision that in a certain event the payments will continue annually until an ascertainable date is reached, that date being fixed by reference to the amounts paid to Mr. Sothern in his lifetime. In other words, the contract is to pay an annual sum for an ascertainable period of years or for the period of Mr. Sothern's life whichever might prove to be the longer. There is no debt nor is there anything which can properly be described as analogous to a debt. The sum paid by Mr. Sothern has gone once for all; the reference to it in the contract is inserted not for the purpose of altering the nature of the company's liability, but for the purpose of putting a term to a liability which is throughout the same, namely, a liability to pay an annual sum. During Mr. Sothern's life the sums paid to him were payments of a life annuity: in the events which have happened, further annual payments fell to be made for a definite period and the fact that this period was ascertained by reference to the capital sum paid by Mr. Sothern and the amounts received by him during his life cannot, in my opinion, make these further payments anything different from the ordinary payments of an annuity for a fixed term. Mr. Sothern purchased an income and the capital amount which he paid only came into the matter for the purpose of defining the shortest period during which that income was to be paid.''

In Mr. Bloom's submission that reasoning is applicable here: the explicit contractual mechanisms employed to ensure, so far as possible, that the Annuity Payments will afford a particular return on what the partners contributed of their own money together with amounts equal to the amount of their contribution and amounts sufficient to discharge their obligations to Fazen Pty. Ltd. do not differ in kind, merely in degree of sophistication, from provisions of the kind which were under consideration in the two cases last cited and in other authorities. Nor in Mr. Bloom's submission do the ``commutation'' provisions of the Annuity Agreements take this case outside the class which that reasoning comprehends. An annuity may be prematurely terminable, either with or without provision for payment of some amount at the time of termination. That the amount of that kind of payment was in this case such a sum as would afford the partners the same rate of return, to the date of premature termination, as the receipt of all the Annuity Payments until 1 May 1996 did not take this case out of that class. It is a circumstance, according to the submission, of no different significance in

ATC 4642

characterising the Annuity Payments in this case from the significance of the circumstance that the aggregate of the annual payments in the Sothern-Smith Case was equal to the single payment the annuitant made in consideration for them. In particular, Mr. Bloom submitted, the relatively close arithmetical and economic equivalence of the payments ordained by the Annuity Agreements and the payments which would be ordained by a contract for loan by the partners to New South Wales Treasury Corporation of $50,000,000 on similar terms as to rate of return was of no legal significance in characterising the Annuity Payments.

It might be said that the provisions concerning commutation are to be disregarded when characterising any of the Annuity Payments, by reference to an observation by Greene, M.R. on
Perrin v. Dickson (Inspector of Taxes) [1929] 2 K.B. 85;
Perrin v. Dickson (Inspector of Taxes) [1930] 1 K.B. 107. The headnote of the report of that case in the Court of Appeal states the facts thus:

``By a policy of assurance effected by a parent with an Assurance Society to provide for his son's education, the Society, in consideration of six premiums of 90l. each, paid annually between 1912 and 1917, agreed to pay to the son's guardian an annuity of 100l. each year for seven years as from September 29, 1920. If the son should die before the expiry of the seven years the premiums were to be repaid to the parent or his representatives less any annual payments already made, but without interest. The parent also effected a similar policy to provide for his daughter's education by which the Society agreed to pay him 50l. a year during a period of five years. There was evidence that the sums payable were calculated so as to return, in the event of the son and daughter living the full period, the amounts paid to the Society with compound interest.''

The Court of Appeal held that none of the annual payments by the Society was an annuity: they were held to effect repayment of the capital sum paid as premiums. The decision was criticised by Greene M.R. in Sothern-Smith's Case and in Atkinson's Case the High Court said (9 ATD at 333; 84 C.L.R. at 307) that ``it may safely be disregarded''. Greene M.R. said of the provision for repayment of premiums in the case of premature death ([1941] 1 K.B. at 284):

``The other important element in the case was the undertaking of the insurance company to repay in an event which did not happen the whole or part (as the case might be) of what had been paid by way of premium. This seems to have led the Court to regard the whole transaction as similar to that of a loan repayable by instalments or (in one event) in a lump sum. My difficulty here is that the transaction certainly was not a loan transaction although I could better have understood an argument to the effect that it was a transaction which in the event which did happen was the purchase of an annuity and in the event which did not happen was in substance the repayment of the whole or part of what had been paid.''

Mr. Bloom submitted that the commutation provisions of the Annuity Agreements, being conditioned on contingencies, cannot influence characterisation of payments made before it can be known whether any of those contingencies will occur.

In my opinion the terms of the Annuity Agreements, of their own force, operate to ensure that amounts aggregating $50,000,000, together with other amounts calculated arithmetically as percentages of sums which have defined relationships to the balances from time to time unpaid of $7,630,544 and $42,369,456 respectively in respect of the periods during which the balance remains unpaid, will be received by the Annuity Acquirer; second, that whenever events occur which increase those other amounts (by reason of the operation of the contractual provisions defining those relationships) the Annuity Provider is entitled to complete forthwith the payment of all the amounts; third, that whenever there is actual default, or certain indications of likely default, in performance by the Annuity Provider of its obligations under an Annuity Agreement the Annuity Acquirer is entitled forthwith to make all the amounts immediately payable. The consideration for the three Annuity Agreements being $50,000,000, I am impelled by those considerations to the conclusion that none of the Annuity Agreements is a contract for the purchase of an annuity, but that they are together a contract of loan. It is, I think, difficult to conceive of the $50,000,000 as having ``gone and ceased to

ATC 4643

exist, the principal having been converted into an annuity'', when the person postulated as the purchaser of the annuity is given the option of making immediately payable an amount equal to the unpaid balance of that amount and interest whenever default in payment of what is described as the annuity occurs. Such a provision results in quite a different contract from that which Greene M.R. analyses in the passage I have quoted. The mechanisms for assuring a constant rate of return are directed, not to compensating for changes of purchasing power, as annuity contracts may, but to maintaining a constant nominal relationship between interest and the unpaid balance of $50,000,000 (one relationship to the $7,630,544, another to the $42,369,456). Those mechanisms are indicative of a loan at interest, not an annuity. So, too, is the right of the ``Annuity Provider'' to terminate its obligation to make the payments suggested to be annuity payments whenever the operation of those mechanisms increases the amount of those payments, by making a payment equal to the unpaid balance of the $50,000,000 and interest to the date of payment. That contractual right enables New South Wales Treasury Corporation to ensure that its monetary obligations under the Annuity Agreements will not exceed, except to a relatively trivial extent, what they would be if those agreements were for a loan for a term of the $50,000,000 at interest with the right of premature repayment.

The foregoing considerations arise from the terms of the Annuity Agreements. They are descriptive of legal right and obligation, not merely of what Greene M.R. called ``financial result'' and Megarry J. called ``mere units of calculation''. Notwithstanding the mode of expression adopted in defining the legal obligations created, the relationship created is in my opinion that of debtor and creditor. The sum paid by the trustee, $50,000,000, has not in my opinion ceased to exist, but remains the subject matter of that relationship.

It is not in my opinion correct to deny significance to the commutation provisions in characterising the Annuity Payments, by regarding those provisions as extraneous to the legal relationship between the parties until events have occurred which enable the provisions to operate. They are provisions defining the relationship as much as any other provision, in my opinion. The argument to which Greene M.R. refers on this subject is one which in my opinion becomes available only after the periodic payments have been characterised as annuities.

In reaching the conclusion stated no significance has been attributed to the circumstance that after it has been derived the Annuity Payment is treated as part capital and part income of the B Class Fund, except the significance which that circumstance has in the ascertainment of the ``Actual Rate of Return'' and the ``Required Rate of Return'', each of which is of course a conception essential to the operation of provisions of the Annuity Agreements. The provisions, no less than the two conceptions, require that a distinction between capital and income in relation to what the partners receive be given effect in calculation. The rates of return are not to be denied characterisation as rates of return to the Annuity Acquirer because they are calculated by reference to what is, and what is required to be, a rate of return to the partners in certain defined circumstances. But I have not, I hope, at any point failed to keep in mind that it is the characterisation of what the trustee derived, not of what the partners derived, that is in question.

In
Australia and New Zealand Savings Bank Ltd. v. FC of T 91 ATC 4107 I held that documents disclosing negotiations between the parties to the Annuity Agreements which preceded and led to the making of those agreements were discoverable. A number of such documents was received in evidence on the hearing of these appeals. I should make it clear that my conclusion owes nothing to any evidence except the Transaction Documents and the Investors' Letter and its attachments and the oral evidence which enabled me, as I hope, to understand the arithmetical calculations in those attachments and the meanings of words and phrases - to those in the Australian community who have occasion to give expression to the arithmetical and financial conceptions which such words and phrases express - which are found in those documents. The expression ``an after-tax nominal monthly sinking fund rate of 3.5% per annum'' in the Investor's Letter is an example of such a phrase.

My understanding is that upon the conclusion I have stated the parties accept that the appropriate order disposing of each appeal is that it be dismissed.

ATC 4644

THE COURT ORDERS THAT:

1. The appeal be dismissed.

2. The respondent's costs of the appeals (including costs reserved) be paid by the applicant.


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