Trustees chasing dead directors over dodgy deductions
In this proceeding, the Full Court of the Federal Court considered three main issues:
- whether certain on-lending arrangements gave rise to legitimate tax deductions for interest;
- duties and liabilities of directors who were not directly involved in the impugned transactions; and
- costs payable by a representative where claims were brought against the estate of a deceased director and the representative of that estate, in his own right.
In essence, the loan scheme involved the Binetter family, which held interest bearing offshore deposits in Israeli banks (deposits). Australian companies controlled by the Binetters (finance companies), over time, borrowed funds from the banks and on-loaned the funds to related companies running the family businesses, charging interest to those related companies (loan transactions). The finance companies claimed tax deductions for the full amount of the interest charged by the Israeli bank, despite the true cost to them being less.
The ATO was actively misled by the directors of the finance companies, and others at the directors’ behest, as to the nature of the security for the loans and was specifically unaware of the deposits. Upon becoming aware, the ATO issued amended assessments, disallowing the deductions in full and treating the advances of funds from Israel as income, together with penalty assessments. Consequently, the finance companies went into liquidation.
The liquidators brought claims against the directors of the finance companies (and others) for breach of various duties in causing the finance companies to participate in the loan transactions, and for knowing participation. The claims totalled over $120 million.
The respondents included the personal representatives of deceased directors of the finance companies (Representatives) both in that capacity and in their own right. The Representatives were also directors of some of the finance companies, but not actively or materially involved in management of the finance companies.
The primary judge, Gleeson J, upheld claims against most of the respondents, other than claims against the Representatives in their own right. However, the costs ordered against the Representatives (as representatives) were not limited to assets of the deceased estates, and could be set off against the costs to which they were entitled as a result of the claims failing against them personally.
Four appeals ensued: as to both liability and costs but, by the time of hearing, only the appeals by the liquidators against one of the Representatives (as to liability in his personal capacity) and by that Representative (against the costs orders) remained.
The issues and findings
The loans were not legitimate deductions
Without here setting out in detail the findings as to the transactions, the Full Court upheld the primary judge’s analysis, though in slightly different terms: the loans could not be characterised as commercial loans, despite an obligation to repay their capital and interest. The majority of interest paid by the finance companies to the banks was passed back to the Binetter family, augmenting the deposits securing the loans (essentially the banks credited to the deposit accounts the majority of the interest paid to them by the finance companies). Accordingly, the true expenditure incurred by the finance companies was far less than the interest paid by them – only the fees paid to the banks, the margin between the interest earned on the deposits and the interest payable on the loans that arose on occasion, and the lack of use of the deposit funds during the loans. The Full Court found the deductions were not honestly claimed.
Duties and breach
The appeal proceeded without challenge as to the correctness of the primary judge’s finding of duties that arose. What was challenged was the finding that there had been no breach of them. Those duties were, relevantly, the duties: not to permit a conflict between duty and interest to arise, not to obtain private advantage and not to exercise a power in a manner detrimental to the company (or, as the Full Court preferred the formulation of the last: that the director’s actions be bona fide and in the interests of the company).
The appeal by the liquidator failed as to the claim against the remaining Representative’s personal liability, on the basis, essentially, that:
- no particular act or omission had been demonstrated against him as a director; and
- it was not positively established that he knew of the key elements of the scheme and had agreed to participate in it.
In this regard, the decision is interesting given the extent of the conduct of the Representative from which the liquidators sought to draw inferences of involvement, including that the Representative:
- was one of the owners of the offshore deposits;
- gave false or misleading statements on oath as to his knowledge of the relevant deposits;
- had knowledge of another such “back to back” lending scheme by other family companies, in which he was involved;
- was a director for some time and (the liquidator argued) it should be inferred that he had knowledge of relevant facts from the time he was a director and agreed to continue participation in the dishonest scheme; and
- failed to give evidence.
Costs against the representative
The reasons at  to  set out a useful discussion of costs against representative parties, generally.
The appeal by the Representative succeeded as to costs. The Full Court held that:
- costs ordered against him in his capacity as representative should not extend beyond the assets of the relevant director’s estate; and
- those costs should not be set off against the costs to which the Representative was entitled as successful respondent in his own right.
While accepting that the primary judge had a broad discretion to make the costs orders she did, the Full Court found that the primary judge had erred in failing to have regard to certain relevant matters including that:
- the Representative was defending proceedings, rather than prosecuting them;
- he agreed to act as representative of the estate only to assist in the orderly conduct of the proceeding; and
- there was no suggestion of any unreasonable conduct on the part of the Representative.