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Tax issues : Professional privilege, the ATO and s263

Every Issue

Cite as: (2003) 77(3) LIJ, p.76

The increased tendency for lawyers to work with other professional advisers has implications for the application of legal professional privilege.

In Commissioner of Taxation v Pratt Holdings Pty Ltd [2003] FCA 6, Kenny J of the Federal Court was asked to rule on some aspects of the boundaries of legal professional privilege. Kenny J’s judgment includes a brief summary of the principles of “litigation privilege” and “advice privilege” and is good practical guidance on a number of issues that can arise where legal professional advice is provided to the client through and in conjunction with advice provided by non-legal professionals.

In Pratt’s case, the Commissioner had issued a s263 notice seeking access, among other things, to documents prepared by the company’s solicitor and documents prepared by the company’s accountants in connection with a major balance sheet reconstruction and refinancing program.

The company claimed legal professional privilege applied and therefore the documents were protected from disclosure. The Commissioner argued that the documents were not protected by legal professional privilege or, if they were, that the company had waived the privilege.

The background to the relevant documents was, briefly, as follows. The company’s taxation and insurance manager had sought legal advice on the proposed reconstruction. The company’s legal advisers recommended that the company obtain a valuation of certain assets from an independent accounting firm.

The company manager instructed the accountants to prepare a background paper, as well as the valuation, to provide the company’s solicitors with a detailed summary about the background and historical perspective relating to the specific transactions giving rise to certain losses and how they had been treated from an accounting perspective. The manager decided that the proposed work should not be done in-house because the matters were complex and time consuming and because the company’s legal advisers had indicated that the valuations should be independent. The accountants were told at or about the time of their engagement that the paper was required for the purposes of obtaining legal advice from the company’s legal advisers and that it might be necessary for the partner from the accounting firm to meet with the external legal advisers.

However, as it turned out, the accountants did not at any time meet with or have direct dealings with the solicitors. In particular, various drafts and the final versions of the valuation and discussion paper were not sent by the accountants directly to the solicitors as the company’s manager wished to control that process.

In the earlier decision of Australian Rugby Union Ltd v Hospitality Group Pty Ltd (1999) 165 ALR 253, Sackville J of the Federal Court had held, based on prior authorities, that communications between a party’s solicitor and a third party are ordinarily privileged only if they are made or prepared when litigation is anticipated or commenced (a situation of “litigation privilege” applying). Sackville J had also held (at page 259) that:

“The limitation on the scope of legal professional privilege does not mean that a communication between a party’s solicitor and a third party (a non-client), made before proceedings are instituted or contemplated, cannot be protected by legal professional privilege. The communication will be privileged if the third party is an agent of the client and if the communication is both confidential and made to the solicitor in his or her professional capacity with a view to providing legal advice to the client.”

Kenny J applied these principles and held that all documents prepared by the accountants for the client were not protected by legal professional privilege. These included the valuations and the discussion paper. It seems that her Honour would have found differently if the accountants had communicated the documents directly to the legal advisers on behalf of the client, holding (at para 54 of the judgment) that “advice privilege does not attach to a confidential communication made by a person who, though an agent of the client for some purposes, is not an agent of the client for the purposes of communicating with the solicitor to obtain or receive the advice”.

Pratt’s case is interesting because the company’s claim of legal professional privilege was based on advice privilege rather than the broader head of litigation privilege. Therefore there is little guidance in Kenny J’s judgment as to the circumstances “when litigation is anticipated [as opposed to commenced]” so that the broader litigation privilege applies.

It does seem on her Honour’s findings that if litigation was anticipated at the time the accountants were engaged to prepare the valuations and the discussion paper, then this would have grounded the documents as privileged.

Kenny J also notes that in the US and Canada the authorities have diminished the gap between litigation privilege and advice privilege. A finding that a party is an agent for advice privilege purposes is resolved by a finding that a communication was made by the agent to the legal adviser for the dominant purpose of obtaining legal advice where the communicator was not acting entirely independently and “under his own steam”.

The gap between litigation privilege and advice privilege is likely to receive considerable judicial attention in the near future, particularly given the increased tendency for legal advisers to work with accountants and other professional advisers in providing advice to clients on complex issues, and the modern tendency for teams of advisers to include in-house and external professionals. In this regard, the observations of Friendly J of the US Court of Appeals in United States v Kovel 296 F 2d 918 (1961) (at 921-2), and referred to by Kenny J with apparent approval, stand in good light:

“Nothing in the policy of privilege suggests that attorneys, simply by placing accountants, scientists or investigators on their payrolls and maintaining them in their offices, should be able to invest all communications by clients to such persons with a privilege the law has not seen fit to extend when the latter are operating under their own steam. On the other hand, in contrast to Tudor times when the privilege was first recognised . . . the complexities of modern existence prevent attorneys from effectively handling clients’ affairs without the help of others; few lawyers could now practice without the assistance of secretaries, file clerks, telephone operators, messengers, clerks not yet admitted to the bar, and aides of other sorts.

“ . . . Accounting concepts are a foreign language to some lawyers in almost all cases, and to almost all lawyers in some cases. Hence the presence of an accountant, whether hired by the lawyer or by the client, while the client is relating a complicated tax story to the lawyer, ought not destroy the privilege . . . the presence of the accountant is necessary, or at least highly useful, for the effective consultation between the client and the lawyer which the privilege is designed to permit . . . What is vital to the privilege is that the communication be made in confidence for the purpose of obtaining legal advice from the lawyer. If what is sought is not legal advice but only accounting service . . . or if the advice sought is the accountant’s rather than the lawyer’s, no privilege exists.”

Taxation of Discretionary Trusts – New Rules
The federal Treasurer has announced that the government will legislate with effect from 12 December 2002 to introduce new provisions in place of s109UB of the Income Tax Assessment Act 1936 dealing with distributions from trusts.
The legislation is based on recommendations of the Board of Taxation in its report Taxation of Discretionary Trusts, which was released on 12 December 2002.
The new legislative measures are intended:
• to improve the effectiveness of the deemed dividend rules so as to more effectively prevent beneficiaries accessing trust income that has borne tax only at the company tax rate; and
• to remove perceived unfairness in the operation of s109UB that is seen to be inducing some small and medium-sized businesses to establish arrangements that enable them to avoid the operation of the section completely.
The Treasurer has also requested the Australian Taxation Office (ATO) to clarify and publish its views on interest deductibility for borrowings used to finance non-assessable distributions to beneficiaries of discretionary trusts and has indicated that it will consider introducing legislation if the ATO is unable to deal with this issue adequately by way of tax rulings.

JAMES JOHNSON is a sole practitioner and the principal of Sutton Johnson Taxation Lawyers.


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