March 11, 2015

Tax Litigation and Waiver of Privilege – Disclosure of the “Gist” of advice

In Krok v Federal Commissioner of Taxation [2015] FCA 151, the Federal Court decided an interlocutory dispute regarding implied waiver of legal professional privilege (LPP).
On 6 February 2015, the Court handed down a decision finding that legal advice mentioned in affidavit material filed by Mr Krok amounted to an implied waiver of LPP and was required discover the documents.

BACKGROUND
The proceedings are a result of a dispute between the Commissioner and Mr Krok concerning income and capital gains resulting from transactions and agreements between Mr Krok and an associated entity, Polperro Enterprises SA (Polperro), during the tax periods when Mr Krok was a resident of Australia.

The Transactions & Agreements
Mr Krok was a resident of South Africa and immigrated to Australia in 2002. Between the time Mr Krok left South Africa, and the time he entered Australia, Mr Krok executed a number of agreements which had the effect of selling certain assets, and Mr Krok’s interest in income derived from those assets, to Polperro.

Polperro was a company incorporated in the British Virgin Islands. The shares in Polperro were wholly owned by the Polperro Foundation (a “siftung” established in Liechtenstein). Mr Krok was appointed the first beneficiary of the Polperro Foundation.

The consideration payable by Polperro under the sale agreements was about 69 million South African Rand (around $7.7M AUD). Polperro did not pay this money to Mr Krok, rather the amount payable was treated as an unsecured interest-free loan owed by Polperro to Mr Krok. Mr Krok then assigned the benefit of the amounts owed to him to a trust (Judcour Trust) for no consideration. Mr Krok and his children were the beneficiaries of the Judcour Trust. Mr Krok was also the director, secretary and shareholder of the trustee of the Judcour Trust, Judcour Pty Ltd.

In 2008, Mr Krok emigrated from Australia to the United Kingdom. In the days immediately before and after Mr Krok’s departure from Australia, a number of transactions occurred which had the effect of terminating or unwinding the arrangements previously put in place concerning Polperro and the Judcour Trust. The capital of the Judcour Trust, being the loan owed by Polperro, was distributed to Mr Krok, and the Judcour Trust was terminated. At the same time, Mr Krok, as sole director and shareholder of Judcour Pty Ltd, resolved to wind up Judcour Pty Ltd. The two shares in Polperro, previously held by the Polperro Foundation were then appointed to Mr Krok. Then Mr Krok, as sole shareholder of Polperro, resolved to wind up Polperro. The liquidator of Polperro subsequently resolved to distribute all of the assets of the company to Mr Krok.

The Dispute
The Commissioner assessed Mr Krok on the basis that this income was derived by Mr Krok during his time as an Australian resident. The Commissioner contends that the agreements between Mr Krok and Polperro were shams or facades, which disguised the fact that Mr Krok at all times retained a beneficial interest in the assets purportedly transferred to Polperro. Alternatively, the Commissioner says that the arrangements and agreements involving Mr Krok, Polperro and the Judcour Trust constituted a scheme to which Part IVA of the Income Tax Assessment Act 1936 (Cth) applied (schemes to reduce income tax).

Mr Krok, however, says that he derived no income or capital gains from the assets whilst he was a tax resident of Australia because the assets were beneficially owned at the time by Polperro. He maintains that the transactions and agreements that transferred the assets to Polperro were legally effective and that he did not derive, or intend to derive, any tax benefit from the transactions.

Implied Waiver of LPP
LPP exists to protect the right of individuals to obtain confidential legal advice. This privilege protects legal advice given by a lawyer to their client, and communications pertaining to actual or contemplated litigation.

Events can trigger the loss of LPP, such as inadvertent disclosure of the privileged material, or waiver of LPP, as discussed in our article, When Privileged Documents Are Inadvertently Disclosed.

Mr Krok obtained legal advice in relation to the structure of the transactions and agreements between himself and the associated entities. In support of his contentions that the transactions were legally effective, Mr Krok filed affidavit material making partial disclosure of the legal advice provided by his South African lawyers.

The Commissioner sought disclosure of the advices referred to in the affidavits, and Mr Krok refused, claiming LPP applied to the advices.

In its reasoning decision, the Court referred to the decision of the Full Court in Commissioner of Taxation v Rio Tinto Ltd [2006] FCAFC 86, described the principle of implied waiver in the following terms:

… the privilege holder has expressly or impliedly made an assertion about the contents of an otherwise privileged communication for the purpose of mounting a case or substantiating a defence. Where the privilege holder has put the contents of the otherwise privileged communication in issue, such an act can be regarded as inconsistent with the confidentiality that would otherwise pertain to the communication.

THE DECISION
The Court found that:

  • the partial disclosure of the advice provided to Mr Krok, or the disclosure of the gist, substance or effect of it, is inconsistent with the confidentiality that would otherwise attach to the communications recording the advice;
  • the privilege that would otherwise attach to these communications has been waived; and
  • Mr Krok should be required to discover the documents.

This case highlights the conflict that can arise with respect to disclosure of otherwise privileged legal advice in taxation litigation, which focuses on the intention of the taxpayer or the rationale behind their actions.

In light of this decision, any reference to legal advice needs to be carefully considered given the likelihood that it will be regarded as an act inconsistent with the confidentiality that attaches to LPP.