Plaintiff's Request for Declaratory Relief on Tax Status Dismissed

The Court dismissed the plaintiff's request for declaratory relief regarding the tax status of a settlement payment, finding that there was a bona fide dispute over the taxability of the payment.

Supreme Court New South Wales

Medium Neutral Citation: [NAME] v [NAME] & Ors [2015] NSWSC 1055 Hearing dates: 29 July 2015 Date of orders: 30 July 2015 Decision date: 30 July 2015 Jurisdiction: Common Law Before: Beech-Jones J Decision: (1) In proceedings number 00213045/2014 the plaintiff's notice of motion filed 23 July 2015 be dismissed.

(2) In the proceedings that were commenced by the summons filed on 29 July 2015, the Court:

(a) Directs the solicitor for the plaintiff to attend upon the registry within a reasonable period to file the summons and pay the appropriate fee; and

(b) otherwise orders that the summons be dismissed.

(3) In proceedings no 00213045 of 2014 the Court orders the plaintiff to pay the costs of the [NAME] and [COMPANY] of the notice of motion dated 23 July 2015;

(4) In the proceedings commenced by the summons filed on 29 July 2015 the Court orders the plaintiff to pay the [NAME]' costs of the summons; and

(5) [ADDRESS] orders that proceedings no 00213045 of 2014 be adjourned for mention before a Registrar at 9:00am on 24 August 2015.

(6) In proceedings no 00213045 of 2014, the Court orders that the costs of the notice of motion filed on 23 July 2015 be payable forthwith;

(7) [ADDRESS] notes [NAME]'s undertaking to the Court not to enforce the costs orders in its favour without the leave of the Court. Catchwords: DECLARATORY RELIEF – discretionary refusal to consider making of declaration – substantive proceedings settled at mediation – heads of agreement involving payment by non-party employee to plaintiff – dispute about whether tax could be withheld from payment – plaintiff seeks declaration that no amount could be withheld from payment for tax – Commissioner of Taxation not a party and not amenable to declarations – found that bona fide dispute as to whether payment was an employment termination payment – refusal to entertain declaratory relief. Legislation Cited: - Civil Procedure Act 2005 – s 73 - Court Suppression and Non-publication Orders Act 2010 – s 10 - Income Tax Assessment Act 1936 – former s 177(1) - Income Tax Assessment Act 1997 (Cth) – s 82.130, s 118.37, s 382.135, schedule 1 (ss 12-85, 16-5, 16-25, 16.30) - Taxation Administration Act 1953 - Cases Cited: - [COMPANY] v Commissioner of Taxation [1981] HCA 27; 147 CLR 360 - Forster v Jododex Australia Pty Ltd [1972] HCA 61; 127 CLR 421 - Ibeneweka v Egbuna [1964] 1 WLR 219 - [NAME] v Federal Commissioner of Taxation [1961] HCA 9; 104 CLR 381 - Masters v Cameron [1954] HCA 72; 91 CLR 353 Texts Cited: [NAME], Declaratory Orders (Butterworths, 2nd Ed, 1984 Category: Procedural and other rulings Parties: [NAME] – Plaintiff [NAME] – First Defendant [NAME] Defendant [NAME] Defendant [NAME] Defendant Representation: Counsel: [redacted] [NAME] – [NAME]

Solicitors: [redacted] [NAME] – [NAME](s): 2014/213045 Publication restriction: See [3] to [5] (and [NAME] v [NAME] & Ors (No 2) [2015] NSWSC 1329)

Judgment (ex temp revised from transcript)

1. This judgment relates to a dispute that has arisen containing the taxation treatment of an amount that had been agreed to be paid to settle proceedings number 2014/213045 (the "substantive proceedings"). As I will explain, the plaintiff seeks declaratory relief to the effect that no tax is payable on the amount that has been agreed to be paid. As declaratory relief is discretionary, a threshold issue has arisen as to whether the Court should entertain the dispute. For the reasons that follow, I consider that it should not.

2. To explain this it is necessary to set out the background to the substantive proceedings and in the course of what occurred around the time the proceedings were supposedly settled and thereafter.

3. At the outset I record that since this dispute arose I have made interim orders under s 10 of the Court Suppression and Non-Publication Orders Act 2010 prohibiting disclosure of the course of the proceedings and the material that has been tendered, as well as these reasons, other than to the parties and their legal representatives. This was undertaken because the Court was advised that the settlement reached was confidential and that aspects of the mediation process might need to be revealed to resolve the dispute that had arisen. These matters appear to be prima facie capable of raising issues that could warrant a conclusion that the public interest in the maintenance of the confidentiality of the mediation process outweighed the public interest in open justice (s 8(1)(e)).

4. In making the interim orders it was made clear to the parties that their operation would need to be reconsidered. Thus the parties were put on notice, from the outset, of the potential for the orders to be lifted in relation to some or perhaps all of the course of the proceedings, including the evidence.

5. These observations apply with equal force to these reasons for judgment. I will, at some point, appoint a time, after these reasons have been reduced to written form, for the parties to make submissions as to why any part of the proceedings and these reasons should remain confidential. At this point it suffices to note that, as the issues canvassed included the possible tax treatment of the payment to the plaintiff, the Court will need to be mindful of not taking any step which could possibly be perceived as denying information to the Commissioner for Taxation that she or he would otherwise ordinarily expect to access in proceedings conducted in open Court.

Background 1. In July 2011 the plaintiff was employed in the investment banking division of [COMPANY] ("[NAME]"). Shortly after he commenced, a series of hoax emails were sent from his office computer. The emails were initially circulated within [NAME]. However, according to the plaintiff's statement of claim, they ultimately "spread rapidly throughout professional and social email networks across the world". The plaintiff contends that the distribution of the emails caused him significant psychological harm, emotional distress and reputational damage.

2. In July 2014 the plaintiff commenced the substantive proceedings. In the meantime, he continued to be employed by [NAME]. He only ceased to be employed on 23 July 2015. The plaintiff did not sue [NAME]. Instead he sued four former employees of [NAME] who were said to be responsible for the creation and dissemination of the hoax emails. He sued them for the torts of intentional infliction of psychiatric or psychological harm, injurious falsehood and negligence. He sought damages including exemplary and aggravated damages.

3. Each of the four [NAME] was initially represented separately. However, from February 2015 the solicitors acting for [NAME], commenced acting for the four [NAME].

The Settlement 1. In June 2015 a mediation took place between the plaintiff, the [NAME] and their legal representatives. As part of the mediation process the plaintiff filed a document entitled "Schedule of damages" that set out the parameters of the quantum of his claim.

2. The mediation was, at the time, thought to be successful. A document entitled, "Heads of agreement" was signed on behalf of the plaintiff, [NAME] and the four [NAME] to the substantive proceedings. The substantive part of that document provided "The Parties intend to be bound by this agreement immediately but at the same time propose to have the terms restated in a form which will be fuller or more precise but not different in effect. The Parties agree that: (a) the Parties will enter into one or more formal deeds containing the following terms: (1) the Company will pay to the Plaintiff the sum of xxxxxxxxx in full and final settlement of the Proceedings, inclusive of any applicable duties or taxes and subject to any other withholding required to be made but exclusive of any statutory entitlements owed to the Plaintiff by the Company; (x) xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx (x) xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx (4) the Plaintiff will resign from his employment with the Company effective as of the date of execution of these deeds; (x) xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx (6) the Plaintiff, the Company and the [NAME] will provide mutual releases and indemnities in respect of any matters arising out of or touching on the subject matter of the Proceedings and the Plaintiff's employment (which releases in the case of the Company will be in favour of the Company, its related bodies corporate and all current and former directors, servants, employees and agents of each of them); (x) xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx (x) xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx (x) xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx (x) xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx (x) xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx (x) xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx"

1. It can be seen that the heads of agreement expressly provides that it is legally binding on the parties but contemplates the execution of a deed setting out the terms of their agreement in more detail. Thus it was an agreement that falls within the first class of agreements referred to in Masters v Cameron [1954] HCA 72; 91 CLR 353 at 360.

2. On 16 June 2015 [NAME] wrote to the plaintiff's solicitors, enclosing a draft deed of release as well as another deed. One of the enclosed deeds proposed the division of the settlement sum such that xxxxxxxx was said to be paid in consequence of the plaintiff's employment being terminated and xxxxxxxx was said to be payable in respect of general and other damages.

3. On 22 June 2015 the plaintiff's solicitors responded. They contended, inter alia, that no tax was payable and that the whole amount of xxxxxxxx should be paid with no deductions. The solicitor enclosed a competing version of the deed.

4. On 1 July 2015 [NAME] replied, setting out the rationale for the sum of xxxxxxxx being treated as an employment termination payment under the Income Tax Assessment Act 1997 (Cth) ("[NAME]"), a matter I will return to.

5. This led to further correspondence which is not necessary to describe other than to note that, at one point, it was asserted by [NAME] that during the mediation Senior Counsel for the [NAME] and [NAME] stated that, inter alia, a portion of the payment should be treated as an employee termination payment. The plaintiff's solicitor disputed that assertion.

The application to this Court 1. On 23 July 2015 the plaintiff filed a notice of motion. Prayer 1 sought an order that [NAME] be joined as a defendant to the substantive proceedings. Prayer 2 sought a declaration concerning the taxation status of the payment referred to in cl (a)(1) of the heads of agreement, which was to the effect that no tax was payable. The source of the Court's power to make the declarations was asserted in the notice of motion to be s 73 of the Civil Procedure Act 2005. Prayer 3 of the notice of motion sought an order directing the parties to execute a deed of settlement that reflected the plaintiff's contention that no tax was payable.

2. I listed the motion for directions before me on 24 July 2015. At that time counsel for [NAME] and the four [NAME], identified what he said were a number of difficulties with the notice of motion, including whether it properly invoked s 73 of the Civil Procedure Act, given that [NAME] was not a party to the substantive proceedings. To allow that issue to be addressed and the parties a further opportunity to resolve their differences, I adjourned the notice of motion until 29 July 2015 and granted the plaintiff leave to file a summons commencing fresh proceedings returnable on the same day. The matter was listed with some urgency because the plaintiff has arranged alternative employment and the resolution of the dispute over the settlement was said to be a necessary step before he could commence that new position.

3. When the matter came before me on 29 July 2015 I granted the plaintiff leave to file a summons of the kind foreshadowed. It named [NAME] and the four [NAME] to the substantive proceedings as the [NAME] to that summons. The summons sought relief in the following form: "1. Declare, pursuant to s 73 of the Civil Procedure Act 2005 (NSW) or the inherent jurisdiction of this Court, that the sum referred to in clause (a)(1) of the Heads of Agreement between the parties and [COMPANY] dated 10 June 2015 ("Heads of Agreement"): a. is in respect of the plaintiff's claim for compensation for a wrong or injury suffered by the plaintiff, for the purposes of s 118.37 of the Income Tax Assessment Act 1997 (Cth); and b. does not have the character of an employment termination payment, for the purposes of s 82-130 of the Income Tax Assessment Act 1997 (Cth).

2. Declare the agreement evidenced in annexure B in the affidavit of [NAME] dated 23 July 2015 represents a binding contract, binding [COMPANY] to pay the plaintiff the sum of xxxxxxxx in full and final settlement of Proceedings no. 2014/00213045.

3. Order that the parties execute Deeds of Settlement and Release in the form attached and marked "A" and "B", or in such other form to give effect to the declaration sought in order 2 above"

1. Counsel for the plaintiff, [NAME], did not press prayer 1 but did not withdraw it. He pressed prayer 2. His submissions made it clear that prayer 2 seeks relief which would deny any entitlement or obligation on the part of [NAME] to withhold any sum on account of taxation. Thus prayer 2 still raises the underlying issue between the parties as to whether any amount should be withheld from a settlement sum on account of any taxation liability. [NAME] pressed prayer 3, but only on the basis that the Court should direct the parties to prepare a deed in a manner that reflects a finding that in effect no tax should be withheld by [NAME]. 2. [NAME]'s response to the summons was consistent with what he told the Court on 24 July 2015, namely that as a matter of either discretion or case management the Court should not entertain the claim for declaratory relief at all or certainly not at this point. This was said to be so because the outcome of any declaration would not be binding on the Commissioner for Taxation as he or she is not a party to these proceedings. [NAME] contended that, in the absence of the Commissioner being joined, [NAME] is placed in a position of particular prejudice in that it might be faced with a declaration from this Court as to its obligations vis-à-vis the plaintiff as to what it must deduct from any payment to be made to the plaintiff, yet it may face action from the Commissioner if he or she takes a different position to this Court in relation to the appropriate withholding. He submitted that, in those circumstances, it would be unfair to [NAME] to have forced upon it a procedure that denies it at least the opportunity to, for example, seek a private ruling from the Commissioner as to the taxation position.

3. In response, [NAME] contended that there was no realistic prospect of it being ultimately found that taxation was payable on the payment and thus that any amount should be deducted. In those circumstances he submitted that his client should not have to incur further cost and delay before receiving his contractual entitlements under the heads of agreement.

Consideration 1. Three propositions should be noted from the outset. First, declaratory relief is discretionary and the discretion to refuse or grant relief is unfettered save that, "judicial pronouncements ought not to be issued unless there are circumstances that call for their making" (Ibeneweka v Egbuna [1964] 1 WLR 219 at 225; Forster v Jododex Australia Pty Ltd (1972) 127 CLR 421 at 435 and 438 per Gibbs J).

2. Second, two matters that guide the discretion to deny declaratory relief include the utility of the declaration and the inconvenience its making may cause the parties or to the public (see [NAME], Declaratory Orders (Butterworths, 2nd Ed, 1984 at [721]).

3. Third, given the statutory powers conferred on the Commissioner of Taxation to make a taxation assessment and the force of law applied to such assessments including, for example, by provisions such as formers 177(1) of the Income Tax Assessment Act 1936 (Cth) then, either as a matter of power or discretion, the Commissioner has said to be not amenable to a grant of declaratory relief by this Court in respect of a taxation liability (see [NAME] op cit at [1107] and [COMPANY] v Commissioner of Taxation (1981) 147 CLR 360).

4. Against that background it is appropriate to return to the respective contentions of the parties. The starting point is cl (a)(1) of the heads of agreement. [NAME] submitted that, on its proper construction, that clause does not permit [NAME] to withhold any amount for taxation even if it was otherwise payable. In effect he sought to construe the payment referred to in cl (a)(1) as a reference to a net amount. That contention has no substance. It is clear that the payment is "inclusive" of inter alia "taxes". Further, it is also clear that it contemplates a "withholding" of applicable "duties", "taxes" or other matters.

5. It follows that, if there is a bona fide dispute about whether an amount of tax should be withheld, then this Court should not entertain the application for declaratory relief. This is so because the party to whom the obligation is owed is not before the Court and is not able to be joined to be bound by the declaration for the reason already stated. 6. [NAME] contended that the proposition that no taxation was properly payable, or at least deductible, in respect of the payment referred to in cl (a)(1), was so strong that there was no justification for delaying the payment of the full amount to his client any further. To address that contention it is necessary to outline in more detail the suggested source of the obligation on [NAME] to withhold an amount of tax from the payment referred to in cl (a)(1) of the heads of agreement. Although reference was made to s 118.37 of the [NAME], the submissions focused on the taxation of employee termination payments.

7. It was not disputed that, as an employer, [NAME] is obliged to withhold and ultimately remit to the Commissioner an amount of tax in respect of employee termination payments, and that a failure to do so is an offence and can otherwise expose [NAME] to a penalty (see Taxation Administration Act 1953 sch 1, ss 12-85(b), 16-5, 16-25, 16-30). In particular, s 82.130(1)(a) of the [NAME] defines an employee termination payment as, inter alia, a payment received by the employee "in consequence of the termination" of their employment. Section 82.135 provides various exceptions to this including: "(i) A capital payment for, or in respect of, personal injury, to you so far as the payment is reasonable having regard to the nature of the personal injury and its likely effect on your capacity to derive income from personal exertion." 1. [NAME] submitted that it was clear from cl (a)(1) of the heads of the agreement that the payment was made in "full and final settlement of the proceedings". He contended that, as no part of the substantive proceedings involved any claim against the employer, that is [NAME], but did involve claims in respect of the suffering of psychiatric and personal injury then it followed that the payment could not possibly be considered a payment "in consequence" of the termination of the plaintiff's employment.

2. Further, [NAME] pointed to the schedule of damages provided to the mediator which he submitted demonstrated that the amount agreed to be paid was clearly referable to the injuries suffered by his client. He submitted that, even if the motivation of [NAME] to make the payment was somehow connected to the termination of his client's employment, that was irrelevant, because when it came to categorising the payment the "uncommunicated reasoning" of one party, in this case [NAME], was irrelevant (see [NAME] v Federal Commissioner of Taxation (1961) 104 CLR 381 at 391; "[NAME]"). 3. [NAME] submitted there was no basis for apportioning the payment in the manner that had been suggested on behalf of [NAME] by [NAME] because "it cannot be appropriate where the payment or receipt is in respect of a claim or claims for unliquidated damages only and is made or accepted under a compromise which treats it as a single, undissected amount of damages" to apportion the payment ([NAME] at 391).

4. There is considerable force in [NAME]'s contentions, but there are also significant countervailing considerations. The first is to note that the party making the payment under the heads of the agreement is the employer, [NAME], not the [NAME] to the substantive proceedings. The second is to note that the heads of agreement includes provisions unrelated to the claims for relief in the proceedings, namely, the plaintiff's resignation of his employment and releases in favour of an entity who is not a party to the proceedings, namely the employer, [NAME]. These are matters that are potentially capable of leading to a different categorisation of the payment.

5. Further, the letter from [NAME] referred to above noted, inter alia, that the plaintiff had previously offered to settle the proceedings without resigning from [NAME] for xxxxxxxx xxxxxxxx and that, at the mediation, [NAME] had offered to make a payment of xxxxxxxx without any condition that requested the plaintiff's resignation. Collectively all these matters are capable of supporting a characterisation that at least part of the payment is a payment "in consequence" of the plaintiff's resignation. As [NAME] submitted, it would follow that the application of the principle in [NAME] might then lead to all of the payment being so characterised, although that will still leave room for the application of the exception in s 82-135(i) of [NAME] noted above.

6. Further, all the matters to which I have referred appear to have been matters that were communicated between the parties either during the mediation or at least as recorded in the heads of agreement (cf [NAME]).

7. The end result is that I am satisfied that there is a bona fide issue as to whether [NAME] is obliged to withhold at least some amount of the payment referred to in cl (a)(1) of the heads of the agreement on the basis that some or all of the payment may constitute an employee termination payment. It further follows that the appropriate forum for determining the existence of any such tax liability is via the statutory scheme providing for tax rulings and assessments. It would be inappropriate for this Court to attempt to truncate that process by granting declaratory relief, especially as such relief will not bind the Commissioner.

8. Otherwise I note the following matters. First, in his submissions [NAME] made reference to the fact that the first time any issue concerning the withholding of tax on account that the payment might be characterised as an employee termination payment was raised was after the mediation. This is apparently contested but it is in any event irrelevant. By its terms, cl (a)(1) of the heads of agreement clearly confirms that the parties deferred any issue of tax payable on the amount referred to in that subclause.

9. Second, during the course of argument mention was made of the possibility that the Court might order the parties to enter into one of the various competing forms of deeds that have been tendered. [ADDRESS]'s power to order specific performance of the obligations in the heads of agreement does not enable it to rewrite the parties' agreement, including by adding such matters as recitals or particular clauses that might assist one party or another in obtaining a beneficial tax treatment.

10. At this point the only form of deed that the Court could consider ordering the parties to enter into is one that recorded a payment obligation in the exact form of cl (a)(1). If that were to occur then, at the time payment is to be made, [NAME] would have to withhold the amount it reasonably considered it was required to in order to meet its taxation obligations and hand over the balance to the plaintiff. The parties would then have to consider their respective positions as a consequence.

11. It may be that the plaintiff might then have to await the outcome of a private ruling or assessment process. There is the potential for any such delay in that process to be remedied by interest, but it is clear that the undertaking of that process has the real potential to produce significant inconvenience and cost for the plaintiff. However that inconvenience and cost is simply the consequence of an entry into a settlement which expressly made the payment subject to withholding for tax.

12. It follows from the above conclusions that both the summons and the notice of motion should be dismissed.

13. All of the substantive relief is declaratory, and for the reasons stated, the Court cannot and should not entertain those declarations. It will now be for the parties to determine the steps that they wish to take to effect their settlement. I will also hear them shortly as to what orders they wish to make in the substantive proceedings.

14. Accordingly:

1. In proceedings number 00213045/2014 the Court orders that the plaintiff's notice of motion filed 23 July 2015 be dismissed.

2. In the proceedings that were commenced by the summons filed on 29 July 2015, the Court: 1. directs the solicitor for the plaintiff to attend upon the registry within a reasonable period to file the summons and pay the appropriate fee; and 2. otherwise orders that the summons be dismissed. [The parties addressed on costs.]

1. Counsel for the [NAME], seeks his clients' (including [NAME]'s) costs of the plaintiff's notice of motion and the summons on the basis that the position he articulated on their behalf has been vindicated by the Court's judgment.

2. The solicitor for the plaintiff seeks to resist that order. First, he points to the course of the mediation and the correspondence that followed it. In particular he contends that the question of whether any part of the payment might be treated as an employee termination payment was not agitated at the mediation. As my judgment makes clear, that is a contestable issue that I consider to be ultimately irrelevant. The recorded agreement made it clear that the parties deferred any question of taxation.

3. Second the plaintiff contends that in effect his client had no choice but to approach this Court once the dispute broke out. I disagree. Ultimately what underlay all of this appears to be a contention that the position of the [NAME] that tax appears to be payable, or is at least arguably payable, was not pursued bona fide. The effect of my judgment is that there is a bona fide basis for believing that tax was payable. Further, the proposition that it was inappropriate to approach this Court to seek declaratory relief to resolve that was made clear to the plaintiff and was certainly reiterated by the [NAME] in the directions hearing last Friday.

4. The course of that directions hearing involved both the [NAME], and to an extent the Court, inviting the plaintiff to consider interim arrangements so that he could pursue new employment, obtain the undisputed amount of the payment, and allow an orderly process for the resolution of the issue as to whether any tax was truly payable on the payment to unfold. It is clear that he declined to take that course. Instead, having pursued the matter, and having had his position rejected, there is simply no other course to take than to require him to pay the defendant's costs. Given that the notice of motion sought the joinder of [NAME], it is clear that it is entitled to the costs of its notice of motion as well.

5. Accordingly:

1. In proceedings no 00213045 of 2014 the Court orders the plaintiff to pay the costs of the [NAME] and [COMPANY] of the notice of motion dated 23 July 2015;

2. In the proceedings commenced by the summons filed on 29 July 2015 the Court orders the plaintiff to pay the [NAME]' costs of the summons; and 3. [ADDRESS] orders that proceedings no 00213045 of 2014 be adjourned for mention before a Registrar at 9:00am on 24 August 2015. [The parties addressed on whether the costs of the notice of motion should be payable forthwith.]

1. Given the discrete nature of the notice of motion it is appropriate that the costs of the notice of motion be payable forthwith. Accordingly: (6) In proceedings no 00213045 of 2014, the Court orders that the costs of the notice of motion filed on 23 July 2015 be payable forthwith; (7) [ADDRESS] notes [NAME]'s undertaking to the Court not to enforce the costs orders in its favour without the leave of the Court.

******* DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated. Decision last updated: 11 September 2015