By Deborah Hill Cone
Friday 7th March 2003
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There are two justices of the peace, just the tops of their greying heads and glasses visible over the bench like a double "Kilroy was here" act. Strangely there is also the top of what looks like a cutglass sherry decanter (I'm sure it's not but they could be forgiven for wanting a snifter).
This is where the Serious Fraud Office is presenting its fraud and moneylaundering case at a depositions hearing against four key figures, John Reid, Peter Connolly, Peter Russel and John Currie, accused of constructing a convoluted tax scheme known as the Digi-Tech arrangement.
The courtroom is strangely top-heavy nine lawyers filling in the front of the court, with three defendants the only people dotted in the public gallery. Mr Reid sits far from Mr Russel, who sits four seats apart from Mr Connolly, none of them talking they're obviously not in this together. As the days go by even their attendance dropped off and they could go to jail for five to seven years if found guilty. I, on the other hand, am still there. (Melbourne-based Mr Currie was excused from the beginning.)
Hard to believe this is one of the SFO's most complex, high profile prosecutions, involving $110 million in tax, approaching the winebox's $137 million.
Despite a squadron of the country's top legal brains taking part, the antiquated process of reading back the evidence means this would never be as racy as something from Ally McBeal. (Depositions are governed by the 1954 Summary Proceedings Act, which states the evidence of witnesses must be read back aloud presumably in the 1950s some witnesses were illiterate.)
So the four defendants are alleged to be the villains of the piece, right? Well, yes and no.
The public proceedings in courtroom 7 are being played out against a background of accusations and counter-accusations involving not just the scheme's promoters but also investors, their advisers, the Serious Fraud Office and Inland Revenue.
Behind the scenes there is much manoeuvring and finger-pointing over who is to blame for the expensive mess after savvy investors thought they could minimise their tax bill.
Like some multi-coloured vector diagram everyone involved has an arrow pointing at someone else and the defendants are not the only target.
Inland Revenue is still embroiled in disputes with some investors to whom it has sent new 372 page Notices of Proposed Adjustment (Nopas) charging 100% shortfall penalties for taking an abusive tax position. The IRD blames the investors for failing to do what it believes was prudent due diligence on the company at the centre of the scheme, Wellington technology firm Digi-Tech and its product Freerider. (Only 33 units of the modem-switching gizmo were ever sold.)
The High Court ruling on which the shortfall penalties are based is still being appealed; at issue whether penalties incurred by the investment vehicle, a loss attributing qualifying company (LAQC), flow through to the investors personally.
Not surprisingly investors are also looking for someone to blame and have threatened to sue accountancy firm Gosling Chapman for its part in promoting the arrangement.
Gosling Chapman is getting it from both sides, with the defendants also critical of the firm. Cross-examination by John Reid's counsel, Murray Gilbert, suggested the firm had been disingenuous in claiming it was also misled about the nature of the Digi-Tech scheme.
And the defendants for their part are derisive of the investors. They find it hard to swallow the Crown casting these sophisticated professionals, including lawyers and technology entrepreneurs, as unwitting victims ripped off by a scam.
The defendants' view: the investors knew this was a high-risk investment and chose to go into it with their eyes open they were even given an opinion from tax specialist Denham Martin spelling out the potential pitfalls.
When it comes to the Digi-Tech blame game, that's just for starters. There are also questions over:
* Gosling Chapman's conflict of interest in clipping the ticket for $1.3 million and failing to tell the investors about it;
* lawyer Geoff Clews' conflict of interest in working for both Gosling Chapman and the investors simultaneously; and
* what happened to John Reid's partner Hugh Milloy, who was a key part of the so-called "merchant bank" Milloy Reid Wong which put the scheme together but who has since kept a very low profile and curiously plays no part in the SFO proceedings.
How the scheme was meant to work: investors signed up for sale and purchase agreements for shares in Wellington firm Digi-Tech with only $95,000 of the $1 million investment payable up front and the bulk of the investment due 10 years in the future. They also took out a loss-of-profits insurance policy guaranteeing the shares' value would increase from $1 to $3 in that time, and received a loan to pay for 96% of the insurance premium.
The advantage to investors: they didn't have to pay much cash up front and by using a loss attributing qualifying company as their investment vehicle they could supposedly deduct the entire insurance premium in year one against their own personal income.
What actually happened: Inland Revenue disallowed the investors' deduction of the premium, investors were charged tax owing as well as shortfall penalties and there were questions over whether the insurance policy existed.
For convenience the case is referred to as Digi-Tech but another mirror-image scheme involved NZIL, a separate company consisting of bundled up stakes in several companies, including Escalator Advertising and trailer firm Fruehauf Pacific.
The depositions hearing last week adjourned until March 17, when the second tranche of the three parts of the seven-week hearing will take place. The depositions are a one-sided affair, with the Crown compelled to reveal all in an attempt to prove it has a prima facie case but with little incentive for the defence to show its hand.
But there is no doubt the high-powered fleet of lawyers acting for the defendants will use the SFO's depositions to help craft their own cases when it, undoubtedly, goes to a full hearing.
Mr Reid's lawyers, Murray Gilbert and Adam Ross; Hugh Fulton for Mr Connolly; John Billington QC and Claudia Farry for Peter Russel; and John Haigh QC and Paul Wicks for Mr Currie have kept their powder dry when it comes to cross-examining the SFO's 36 witnesses.
The JPs take a passive role. Observing the interactions between the Crown's Jim Farmer QC and Mike Ruffin, and defence counsel during adjournments, one can't escape the conclusion the lawyers are running the case not their worships who are hearing it.
Matters that might usually be debated in chambers before a judge are sorted out with consensus reached during an informal chat during coffee breaks.
The lawyers then politely inform the JPs of what decisions they have jointly made such as the choice to short-circuit the lengthy proceedings by handing up briefs of evidence for all but the most contentious witnesses.
The most interesting of the contentious witnesses is David Tanner, a forensic accountant with the SFO. His evidence is essential to the prosecution's case that the loan and insurance premium structure was fictitious, with a circular movement of funds. Mr Tanner will describe what he discovered about the loans and the insurance premiums and tracing the money flows of the insurance premium deposits, which relate to the moneylaundering charges.
Much of the depositions case has focused on the structure of the scheme and whether the insurance policy and bank loan were bona fide the SFO claims they were fictional but another strand to the case has been the role of Gosling Chapman and the fall-out as the scheme collapsed.
Sources highlight what they claim was the firm's insistence the insurance policy should be transferred to a purpose trust, a vehicle apparently recognised only in two jurisdictions (Bermuda and Lichtenstein) and which cannot be sued.
Why was this necessary? Where would it leave investors in the event the insurance vehicle could not cover the insurance payout in year 10?
Meanwhile, defendant John Reid claims the IRD will be embarrassed by inconsistencies in its own approach to Digi-Tech and NZIL.
A letter sent from Mr Reid to investors in NZIL late last year may give a flavour of his possible defence.
In the letter Mr Reid claimed after he had met IRD staff they conceded they were wrong in assuming the insurer could not meet its obligations in year 10.
Mr Reid quoted a file note from an IRD solicitor saying: "If the documents reflected this, as asserted by John Reid, then all parties would be embarrassed."
The IRD also confirmed the insurance policy did not have to be provided by a registered insurance company to qualify for tax deductions, Mr Reid's letter says.
There are questions over whether the SFO and the IRD have different and contradictory criticisms of the transactions.
On one hand, in the Digi-Tech transaction the SFO says the deduction of the insurance premium was disallowed because the insurance company was fictional and the transaction was circular and a sham.
On the other, the taxman takes the view the expenditure for the premium in the NZIL transaction did occur, meaning the insurance company was not a sham.
But in that case the deduction was disallowed because the LAQCs did not qualify as share traders (meaning the expenditure was on capital not revenue account) and the transaction was void because it was deemed to be a tax avoidance arrangement.
"The commissioner considers that the deductions claimed by the taxpayer were tax benefits obtained under that arrangement. The commissioner was therefore entitled to reconstruct the arrangement to counteract that tax benefit by denying those deductions," the IRD writes in the Nopa document to one investor.
On one view those two positions are conflicting either the transaction was a sham or it wasn't.
This position is important against the background of claims outlined in the SFO's case that the insurance company, Epicharmus Vastgoed BV, trading as Hong Kong-based Asia Pacific Underwriters Trust, was not an arm's-length entity.
Meanwhile, the third phase of the case, set down for April, will take place in Hong Kong. Witnesses there include staff in the office of accountancy firm Grant Thornton Byrne, where defendant John Currie was employed, as well as Hong Kong detective inspector Kin Man Leung who carried out five search warrants at Insinger de Beaufort Holdings (Asia), solicitors Horvath & Giles and the Bank of New York-Intermaritime bank, which took part in the loan transaction.
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